If industrialisation only targets the domestic market instead, we will continue missing out on lucrative opportunities in vast production networks like East Asia. — The Jakarta Post
THE manufacturing sector, combined with labour-intensive exports, played a major role in Indonesia’s economic development, especially in the two decades prior to the 1997 to 1998 Asian financial crisis.
A growth rate of around 10% pulled up overall economic growth, but it has since been on a decreasing trend.
Today, the share of manufacturing value added (MVA) in gross domestic product (GDP) has dropped to 18%, from almost 30% in early 2000s, and at less than 4%, its growth is below overall economic growth.
As a comparison, Vietnam has been growing close to 7% on average for the past two decades, as its MVA constitutes around one-third of its GDP.
A decline in the manufacturing sector is not necessarily a bad thing, and industrial slowdown in Indonesia is a result of a complex process: a commodity boom that rendered manufacturing less competitive, stiffer global competition due to China’s rise in the world market, and Indonesia’s high logistics costs.
However, misallocation of resources is also a problem.
That is, while the service sector is picking up the slack, a closer look reveals that it is mostly low-end services and informal jobs, such as food service activities and retail trade.
Furthermore, within the manufacturing sector itself, production in capital-intensive sub-sectors like basic metal has increased significantly, but it has decreased markedly in labour-intensive sub-sectors such as textile and footwear.
Industrial policies like downstreaming have contributed to this shift.
As a result, the ability of the manufacturing sector to create jobs has gone down significantly.
In the 2014 to 2019 period, every 1% growth in the sector was associated with more than 150,000 jobs. In contrast, in 2019 to 2023, every 1% additional growth only added less than 15,000 jobs.
Indonesia needs faster economic growth to create jobs and reduce poverty. With its still-abundant labour force, it needs to move from low-productivity agriculture and informal services to higher-productivity manufacturing.
By some measures, Indonesia’s demographic dividend (larger working age population and lower dependency ratio) will last five to 10 years.
Without productive employment for youth, we will not be able to take advantage of the remaining opportunity, nor can we reduce poverty more effectively. Today, 10 out of 100 Indonesians are poor.
That is 25 million people, more than the entire population of Sri Lanka or Taiwan. Improvement in the manufacturing sector can help achieve faster growth. As in the past, however, this must be combined with export orientation.
At present, Indonesia’s exports are dominated by commodities and raw materials.
Pursuing a higher economic growth rate through trade necessitates further integration into global production networks.
This means that allowing domestic manufacturing to link further with the global manufacturing value chain is key.
Therefore, the new government should avoid an industrial policy that distorts the allocation of resources.
Outgoing president Joko “Jokowi” Widodo’s key industrial policy includes downstreaming and local content requirements or TKDN.
While this policy is not new – president Soeharto implemented some variants of it – Jokowi made it his development mantra. Nor is it uniquely Indonesian.
Malaysia has been promoting “advanced economic complexity”, while Japan and South Korea are tailoring their industrial strategy to compete with China and the United States, especially in semiconductors.
Industrial policy made a comeback following the global financial crisis and the Covid-19 pandemic.
The fragmentation of the global trading system and the weakening of the World Trade Organisation also played a role. But today’s industrial policy is, and should be, different from that in the 1960s and ‘70s.
Global trade is no longer driven by the “one country one product” marketplace; it is a market where a product is made by several countries in a production network.
Almost two-thirds of the world trade flow runs through global value chains (GVCs).
Unfortunately, both down streaming and the TKDN as implemented in Indonesia are an artefact of old-style industrial policy. They are basically an import substitution strategy.
They run counter to the objective of participating in the production networks: GVCs involve the slicing up of production processes across borders. As such, it thins out the domestic value added in each process.
If industrialisation only targets the domestic market instead, we will continue missing out on lucrative opportunities in vast production networks like East Asia.
Such a policy also denies domestic industries high-quality (and often cheaper) imported inputs, making their products less competitive in export markets. Ironically, it often incentivises innovation to the benefit of competitors.
In 2001, we banned the export of logs to support the domestic plywood industry.
Not long afterward, we imported a particle board that outcompeted plywood. In 2012, we banned the export of natural rattan to protect the domestic furniture industry, and then synthetic rattan came. — The Jakarta Post/ANN
Arianto A Patunru is a researcher at the Australian National University. The views expressed here are the writer’s own.
