Complaints about cheap Chinese goods flooding
the Indonesian market as a result of the Asean-China Free Trade Area frequently
appear in the Indonesian media.
Given
that Indonesia’s manufacturing products are often more expensive than their
Chinese counterparts, these criticisms are perhaps justified.
But a
closer look reveals that such complaints are not entirely rational, as
Indonesia has many comparative advantages over China. In particular, Indonesia
has significant natural resource endowments and a substantial supply of
low-cost labor.
Indonesia
has a much younger population than China: the percentage of Indonesia’s
population aged 0–14 is almost 10 percent higher than that in the former, while
the median age of the Indonesian population is nine years younger than in
China. Indonesia’s unemployment rate is also 3.6 percent higher than China’s,
and average labor costs in the Indonesian manufacturing industry are less than
half of China’s.
These
comparative advantages will not disappear after policy intervention and will
lead to serious trade gains if they are fully realized. Indonesia thus has the
potential to develop a strong manufacturing industry and gain from trade
liberalization, particularly vis-a-vis China.
But
Indonesia’s competitive advantages have not been well developed in the past,
meaning that many industries are not confident about facing competition from
China.
Indonesia’s
steel industry is a case in point. It is well placed to compete considering the
above comparative advantages and Indonesia’s proximity to Australia, which is
the major source of coal and iron ore for China’s steel products. Thus
Indonesia has the potential to produce cheap steel products. But the steel
industry too has joined the chorus, complaining about cheaper Chinese products.
These
kinds of complaints mask the true potential of Indonesia’s international
competitiveness, and if followed blindly will hurt the country’s industrial
sector and its national economy in the long run.
Developing
the manufacturing industry would be a comprehensive way for Indonesia to exert
its comparative advantages. A competitive manufacturing industry would help
create enough jobs for its growing labor force and would help Indonesia gain
from trade liberalization.
The
success of such an approach was demonstrated by China’s experience acceding to
the World Trade Organization in 2001. Before then, and for a couple of years
after, the WTO was viewed as a “wolf at the door” because the reforms needed to
bring in foreign investment and promote a market economy created huge pressure
for domestic industries.
Similar
to the current situation in Indonesia, many Chinese industries also complained
that China’s less competitive industries would suffer if tariffs were reduced
and restrictions on foreign rivals lifted.
Ten
years later, many Western brands have indeed entered the Chinese market, but
Chinese products have also flooded the world market. China’s gross domestic
product quadrupled and exports almost quintupled in the 10 years following its
accession to the WTO. Even industries that were not considered competitive,
such as the automotive sector, have finally gained from trade liberalization.
But so
far Indonesia’s manufacturing industry has not been robust enough to meet the
challenges created by the Asean-China Free Trade Area .
This is
a direct result of insufficient investment in the manufacturing and related
sectors, rather than an effect of trade liberalization. For example, the high
cost of steel products is a result of high transportation costs, long delivery
times, high container rents and high electricity tariffs.
So,
investment in the manufacturing sector and the establishment of a competitive
manufacturing industry would be a key indicator of successful structural reform
in Indonesia. There are many hurdles for such investment, including poor
infrastructure, high electricity rates, restrictive labor regulations and
onerous licensing controls.
According
to the World Bank’s Doing Business Index, Indonesia is ranked 129 among 183
countries, making its manufacturing sector a risky destination for investors.
This also means the banking sector is less inclined to provide loans to the
manufacturing sector.
But
these hurdles are surmountable through well-executed policy intervention. One
necessary policy intervention, as evidenced from China’s experience in entry to
the WTO, is structural reform. Structural reform must aim to improve
institutional frameworks, regulations and policies to minimize
behind-the-border barriers and thus improve economic performance and regional
economic integration.
The
opportunities to be had from openness to trade and foreign direct investment
may not be realized if behind-the-border policies do not support competition
and efficiency.
Structural
reform in Indonesia would help support trade liberalization by increasing the
level and competitiveness of the country’s manufacturing industry. Structural
reform in Indonesia must focus on improving regulations, governance, and legal
and economic infrastructure. Promoting competition is not an immediate
priority, as the country liberalized significantly following the Asian financial
crisis of 1997-98.
But
Indonesia must be prepared for the hard work required to implement structural
reform.
East
Asia Forum
Xunpeng
Shi
The
Jakarta Globe
Business & Investment Opportunities
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