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Indonesia: faltering growth and a hint of protectionism?

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In Brief

Indonesia, ASEAN's largest economy, faces a growth dilemma. Faltering growth has prompted the introduction of new restrictive trade and investment measures.

Yet  such policies have historically had little success in connecting enterprises with global value chains.


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Indonesia should instead renew its commitment to an outward-orientation and enact complementary policies to sustain her growth.

Indonesia’s growth slowed in 2012 as a result of the global financial crisis and economic slowdown. The economy grew at 6.2 per cent in 2012, down slightly from 6.5 per cent in 2011. This is still a respectable figure. Indonesia’s growth in the previous decade was below 6 per cent. Furthermore, developing Asia as a region only grew at 6.1 per cent in 2012. This slight dip notwithstanding, a turnaround seems to be ongoing in commodity-rich Indonesia. Evidently, the nation’s fundamentals are better this time around than they were during the 1997 Asian financial crisis, when Indonesia was hampered by the pervasive crony capitalism it sheltered.

Indonesia’s respectable growth performance over the past decade can be attributed to three main factors. First, a strong demand for commodities — the mainstay of Indonesia’s economic activity — including coal, oil and palm oil from rapidly growing China and India. Second, buoyant domestic consumption: around 60 per cent of Indonesia’s GDP comes from domestic consumption. Indonesia has a thriving middle class of about 120 million people hungry for consumer goods including food, cosmetics, white goods, and cars. Third, a pick-up in manufacturing activity, particularly by large foreign companies. Led by expansion in production capacity by Japanese car makers Toyota and Nissan as well as French cosmetics company L’Oreal, inward investment surged to a record $23 billion in 2012.

The modest fall in growth in 2012 reflects a slowing of growth in the fourth quarter. This is partly linked to a tapering demand from China and India for coal imports and uncertainties among consumers reflecting the lingering global economic slowdown and national elections in 2014.

Amdist the dip in growth, there are concerns that Indonesia is adopting more restrictive policies and risks backsliding on past outward-oriented policy reforms. In 2011–2012, a raft of new measures were introduced. One was an export tax of 20 per cent for 65 mining commodities such as nickel, tin, copper, bauxite and iron ore. This was coupled with new laws regulating foreign ownership of mines, which may have shut off the sector to new Inward investment. Another policy was an export ban on unprocessed raw commodities like rattan — a  kind of palm tree used to make traditional furniture. Additionally, horticultural imports can now only enter Indonesia at selected ports. This list excludes the business port of Tanjung Priok in Jakarta. Horticulture importers must now also register with and seek approval from the Ministry of Agriculture. Finally, new regulations have been adopted for imports of finished goods and imports of fruits and vegetables.

Indonesia’s move towards more restrictive policies has multiple motivations. First, continuing uncertainties in the global economy and a dip in growth in Indonesia inevitably means more unemployment. With 12 per cent of the population below the poverty line and elections approaching in 2014, politicians may wish to limit the impact of external shocks and job losses via the trade channel. Second, with a budget deficit approaching 4 per cent of GDP, there is a macroeconomic imperative to boost government revenue. Trade taxes are seen as having revenue raising potential. Third, the government seems to be deploying import restrictions to engineer a structural shift in economic activity from low value added to high value added production. The country’s nascent manufacturing sector, particularly large domestic business groups and small and medium enterprises are considered the engines of future economic growth.

It makes economic sense to pursue diversification and structural change in commodity dependent economies like Indonesia. This reduces economic vulnerability to fluctuations in international commodity prices. The industrial success of Japan, the four East Asian tigers (Korea, Taiwan, Singapore and Hong Kong) and China illustrates that markets and governments working together can indeed create new comparative advantages over time.

Yet a key lesson from the experiences of these East Asian countries was that arbitrary protectionist measures do not work in fostering internationally competitive industrialisation.

Instead, the recipe for success is to create the conditions for enterprises to enter and upgrade a country’s position in global value chains. This is best achieved by a combination of outward-oriented policies with complementary measures like infrastructure development, educational investment to ensure a supply of the skilled workers required by industry, improvements to industrial technological capabilities, deepening sources of industrial finance, and advances in government capacity.

No one size fits all economic strategy exists for growth and industrialisation. But Indonesia should abandon its protectionist tendencies and refocus on connecting its enterprises with global value chains and developing a closer public-private sector partnership for sustaining growth.

Ganeshan Wignaraja is Director of Research at the Asian Development Bank Institute, Tokyo.

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