Indonesia has successfully outperformed many of its ASEAN peers in attracting foreign direct investment (FDI) over the past five years. Yet these positive trends have yet to contribute to increasing the capacity of its human capital, one of Indonesia’s most important development goals. Indonesia’s investment in research and development (R&D) and tertiary education is notably the lowest among G20 nations, resulting in its lagging innovative capabilities compared to global developments.
Indonesia’s historical underinvestment in R&D and tertiary education, driven by political instability and governance challenges, has skewed its economy towards natural resource exports and low-value manufacturing. Cultural perceptions and a lack of integrated policy linking education, as well as R&D and industrial policy, have also contributed to this trend. This approach has limited the workforce’s advanced skills and innovative capacity, impairing its ability to fully utilise the technology and knowledge brought by FDI.
Indonesia risks becoming merely a destination for low-value industries, unlike countries like South Korea and Singapore, which have achieved sustainable growth by investing heavily in high-tech sectors through education and R&D. Recognising this, Indonesia should shift its focus towards human capital development to compete globally in high-tech industries.
Indonesia has been betting heavily on the electric vehicle (EV) and battery industry to leverage its nickel resources. But there are other industries where Indonesia could push for more investment to better serve its development goals, such as renewable energy and semiconductors. Investing in renewable energy and semiconductors offers Indonesia key development advantages. Indonesia is looking to ratify the New and Renewable Energy Bill in 2024, emphasising the country’s desire to transition away from fossil fuels. The historical significance of oil in shaping global geopolitics is also likely to wane with the rise of alternative energy sources.
Developing a semiconductor industry will advance technological capabilities, shift the economy from low to high-value manufacturing, and attract high-value FDI. These sectors not only diversify the economy but also build resilience against global economic shifts, marking a strategic move from a resource-dependent to a technologically advanced economy. Indonesia’s large nickel reserves are pivotal for the semiconductor industry. As a leading nickel producer, Indonesia can significantly impact the battery supply chain, directly linking its resources to the growing semiconductor sector.
Recent semiconductor shortages have spurred a global move towards self-sufficiency and acquiring a competitive edge in this critical industry. As global geopolitical dynamics shift, there is an increasing drive to broaden semiconductor sourcing options. This presents an opportunity for Indonesia to integrate nickel mining with battery and semiconductor manufacturing, potentially boosting its role in the global technology industry and enhancing its manufacturing capabilities.
Indonesia does not need to move away from its natural resources but rather to rethink its growth strategy to meet its development goals. Indonesia’s economic model, heavily reliant on natural resource exports, subjects it to the volatility of global markets and environmental concerns and has historically constrained the scope of industrial diversification and the advancement of human capital.
Though Indonesia has begun leveraging assets like nickel for burgeoning industries such as battery production, there remains a significant gap in investment in human capital. This shortfall in developing a skilled workforce and fostering innovation is a crucial area that needs attention for Indonesia to fully realise the potential of its reformed economic strategy. By focusing on education, training and R&D, Indonesia can enhance its workforce’s ability to support and propel these emerging sectors, thereby ensuring a more balanced and sustainable economic growth path.
Indonesia can also achieve more investment in R&D and human capital by introducing conditionalities in their FDI policies. Conditionalities are potent tools that governments can use to shape investment and co-create markets with the private sector.
Indonesia can use conditionalities in its FDI policies to boost R&D and human capital, with possible measures like technology transfer mandates, local employment quotas and R&D investment requirements. But enforcing these conditionalities poses challenges, including balancing investment attractiveness with strict requirements, ensuring compliance with international commitments, and avoiding trade retaliation risks.
For example, in 2020, the government issued a regulation that allows taxpayers conducting specific R&D activities to receive a 100 per cent deduction on gross income for incurred costs, with additional deductions for collaborations resulting in patents or commercialisation. The Global Minimum Tax initiative aims to standardise corporate tax rates, but could make Indonesia’s tax breaks for R&D less attractive to multinational companies, affecting foreign investment in R&D.
Further, overly stringent conditions can deter investors from committing resources. Adopting a tough stance on commodities like Indonesia’s nickel export ban could hasten the development and adoption of technologies that do not rely on nickel, such as lithium. Lithium is gaining traction as the EV battery material of choice as it is less expensive than nickel and it can be obtained with lower transportation costs and a more secure supply chain.
For conditionalities to be effective, Indonesia must balance its autonomy and embeddedness in dealing with corporations and other private entities. Indonesia has substantial regulatory power over private enterprises but faces challenges in exercising it effectively. Its diverse population and geography pose logistical challenges. Bureaucratic inefficiencies, policy inconsistency due to political changes and a lack of capacity and expertise in regulatory bodies are significant hurdles. Corruption and transparency issues further complicate effective regulation. Conflict of interest might arise when Indonesian state-owned enterprises and officials are heavily involved in industries as both profit-making entities and regulators.
For example, in Indonesia’s nickel industry, the state-owned enterprise PT Aneka Tambang (Antam) exemplifies potential conflicts of interest due to its dual role in commercial operations and regulatory influence. Antam, a key player in nickel mining and processing, impacts heavily on the environment, while it is also linked to the regulatory body responsible for environmental standards in mining. Addressing this conflict of interest requires robust, independent environmental oversight, transparent environmental audits and community involvement in monitoring.
Ronald Tundang is PhD candidate at the Chinese University of Hong Kong.