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ASEAN ANALYSIS

Asean Affairs    30 April 2012

INDONESIA'S ECONOMIC INFLECTION POINT

By Ernest Bower, Senior Adviser & Director Southeast Asia Program, CSIS

Indonesia is at an economic inflection point, which was dramatically underlined this week as two stories broke on the same day. First, Indonesia reported that it set a historic record of $5.7 billion in foreign direct investment in the first quarter of 2012, an increase of 30 percent over the same period in 2011.

The second story: Standard & Poor’s announced it was sustaining its rating of “junk” status for Indonesian debt based on the country’s trade and subsidies policies. At the same time that the world has found Indonesia and wants to buy in, Indonesian policymakers have become ambiguous about whether they want to let the world in and under what conditions. To counter this, U.S. companies and policymakers need to go to a new level of engagement to find alignment with their Indonesian counterparts. The fact is, both sides are interested in the same things, and a paradigm shift could offer relief, prevent counterproductive policies from being implemented, and spur sustained historic new investment and growth levels.

The World Finds Indonesia
Indonesia’s economic situation is draped in a certain irony. The country worked hard for many years to get the attention of companies looking for an Asian base outside of China. The proud archipelago of more than 17,000 islands had a certain allure as the largest country and largest economy in the 10-country Association of Southeast Asian Nations (ASEAN), hulking over its regional siblings with a GDP more than twice the size of Thailand’s. As Soeharto fell, the country was focused on political reforms, not business and economics, becoming the world’s third-largest democracy. In addition, seemingly endemic problems ranging from lack of infrastructure to corruption to political risk assessments kept many potential investors at arm’s length. Even the world’s largest companies, those deploying proactive regional strategies in Southeast Asia, found that their market penetration and sales in Indonesia underperformed globally and relative to other ASEAN countries.

The macroeconomic situation has changed. Indonesia is now bounding forward as a large economy with a GDP of approximately $1 trillion that grew by 6.5 percent last year. The World Bank projects GDP growth will continue at 6.1 percent this year. Politics are relatively stable. Indonesians are looking to move ahead, make money, and invest in the future. They are innovators and social media mavens, creative and open to new ideas.

Governments and companies from around the world have taken notice. Indonesia is now a member of the G20 and for all practical purposes a BRIC (Brazil, Russia, India, China) economy—bigger and faster-growing than the B and the R in that grouping. It will host one of the most important annual meetings of leaders in Asia in 2013, the APEC Economic Leaders’ Meeting. What’s more, investors are flying in from everywhere to figure out how to be part of the Indonesia growth story.

Is Policy Aligned with Objectives?
Here is where the story takes a turn. As investors press their noses against the proverbial shop-front window of Indonesia, peering in at the multitudinous opportunities on display, they are becoming more and more frustrated with a set of policies that smack of economic nationalism. These policies appear to want to force investors to do what investors would prefer to do without a regulatory gun to their head—namely, invest in the country. In that sense, such policies are counterproductive.

Indonesia’s proposed new Trade Law offers many relevant examples. Armed with the country’s strong macroeconomic performance, consumer-fueled growth, and over-confidence borne of an economy that has arrived, Indonesian policymakers have tabled a dizzying array of new regulations. These seek to protect local companies, implement old-fashioned import-substitution requirements, and require foreign companies to give up control, equity, and the power to distribute their goods while demanding that they invest.

These policies do not appear to be coordinated, but instead are the response of a bureaucracy under enormous pressures from a few well-resourced local interests focusing on aspects of the economy they hope to protect. There is also an ideological dimension, namely a long standing skepticism of capitalism and the market which is particularly imbedded in some parts of the bureaucracy. These factors are combined with an entirely rational desire to ensure Indonesia is involved in making value-added products, not just supplying raw materials for more developed economies to turn into higher value products.

However, the bureaucracy does not have the level of experience and coordination needed to marry these objectives with incentives that will result in attracting the desired value-added investment. To do so requires a careful linkage between line ministries, investment promotion, and finance. Lastly, Indonesia’s constitution promotes a defensive ideology by emphasizing that natural resources belong to the state. In the end, these factors combine and the result is that many of the proposed new regulations affect other ministries and are inconsistent with Indonesia’s laws and its international commitments.

There is no clear direction from President Yudhoyono on what Indonesia wants from its engagement in trade and economic development. The last trade minister was removed from her position based on what most agree was a backlash to Indonesia’s negative experience with the results of the ASEAN-China free trade agreement. Chinese goods flooded into the country, hurting local manufacturers. As a result, Indonesia has been reluctant to engage in new trade agreements and has remained aloof in the face of encouragement to join the nine-country Trans-Pacific Partnership (TPP) negotiations.

A New Paradigm
The current policy dynamic needs to shift. It has set Indonesian policy and investors on opposite sides of the table, and this does not need to be the case. In fact, U.S. companies and trade policy officials should proactively work to change the paradigm.

The fact is that U.S. companies want the same things that Indonesians want: they want Indonesians to have more equity in their companies and growth in their economy; they want to create jobs and invest in training, education, and communities; they want to bring money and technology to Indonesia and implement nationwide business plans. U.S. companies are well poised – and eager – to support the Indonesian government’s ambitious new Master Plan for the Acceleration and Expansion of Economic Development (MP3Ei). In short, U.S. companies and their Indonesian counterparts should be on the same side of the table. The same is true for trade and economic officials. For instance, the U.S. trade representative just announced a new innovative model for bilateral investment treaties, commonly known as BITs, with adjustments to seek progress in large developing economies like China and India. That new model should be tabled with Indonesia as soon as possible.

The barriers to alignment of goals on trade and investment are surmountable with leadership and a policy reset. In practice, these barriers include protectionist interests that are pressing a thinly staffed bureaucracy in Jakarta to implement shortsighted and parochial policies. Such policies will rob the majority of Indonesians of new jobs, sustained growth, training and educational opportunities, and investment in their communities. Well-intentioned policymakers end up promulgating regulations that have the opposite effect. An example is the obsession about achieving food self-sufficiency through import substitution schemes. Instead of self-sufficiency, the result has been soaring food prices, increased inflation, and a decrease in much needed higher protein products that would be available with a more open agricultural trade policy.

Americans need to be humble in pointing out these concerns and should offer the United States’ own experiences as a lesson. In the 1990s, there was vocal opposition to Japanese investment in the U.S. automotive sector. Two decades later, workers and communities in states like South Carolina and Tennessee consider companies like Toyota and Honda to be local companies, providing high-paying jobs and buoying their communities with economic dynamism. Innovative companies working in Indonesia are starting to get this ‘global but local’ space right, and they are seeing tremendous expansion, profitability, and stability as a result.

History shows that protectionist policies can push countries into a middle-income trap, unable to invest in infrastructure and missing the ingredients of long-term growth and innovation. Indonesian policymakers are right to be deeply concerned about Indonesia becoming “stuck.” However, allowing laws that force divestment or localization kills investment and exploration, and creates the equivalent of regulatory extortion. The proposed Indonesian mining law, for example, contains policies that will force divestment, limit future exploration, and undercut stated goals of enhancing investment in valued-added development of metals and energy in Indonesia.

A Bright Future
Good leaders can and should change the dynamic that currently discourages investors from providing what Indonesians want and need to partner with them in developing the economy.

One such leader is Indonesian trade minister Gita Wirjawan. He has world-class capabilities and experience, and can be credited for marketing Indonesia’s impressive growth and bringing in a record amount of foreign investment. However, he has been deployed to play the equivalent of a defensive role. This is like asking football superstar Lionel Messi, the planet’s premier goal producer, to play goalie, and it begs the question of what Indonesia’s economic growth numbers could be if leaders were empowered to make new deals and coordinate policies that brought investment and international standards to Indonesia. Growth rates of 6.5 percent could be closer to 8 or 9 percent.

Indonesia faces a key decision point. Should it use this time, when the world wants to participate and invest in Indonesia’s growth, to put in place forward-looking policies that encourage investors and empower local companies? Or should it play defense and protect a near-term opportunity for large domestic companies to dominate their respective sectors and soak up the benefits of the current growth cycle? Building a world-class economy takes leadership and requires defining the country’s long-term goals so as to build a strong, long-term foundation. Indonesia has the vision to make that determination, and good partners should support and encourage that strategy.

“This post originally appeared on the Center for Strategic and International Studies cogitASIA blog.”


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