Triggering a sustaining acceleration of Indonesia's economic growth in a new East Asian economic geography

Date December 3, 2009
Speaker Djisman SIMANDJUNTAK(Chair, Board of Directors, Centre for Strategic and International Studies (CSIS) Foundation)
Moderator URATA Shujio(Faculty Fellow, RIETI / Professor of Graduate School of Asia-Pacific Studies, Waseda University)
Materials

Summary

Djisman SIMANDJUNTAKDjisman SIMANDJUNTAK
Indonesia is an interesting country in the sense that it has rarely experienced prolonged high growth or very bad performance. However, the growth corridor of the country is very thin. If Indonesia is to play a major role in East Asia, it must accelerate its economic growth. The question is how to go about doing this.

We are faced with a new economic geography in East Asia with the rise of China, a fully developed South Korea, the participation of India in East Asia, and growth in Vietnam. In the midst of this, Indonesia has been doing quite well, at least relative to Thailand, Malaysia, and Singapore. Indonesia is growing at a little over 4% right now, and this growth is basically consumption-triggered, fueled by favorable growth in agriculture. This year, again, we are likely to enjoy a growth of over 4%.

Agriculture and telecommunications services have seen double-digit growth for the last few years. In particular, telecommunications has been growing at 13-14%, providing a large contribution to the economy.

Since 1993, Indonesia has been plagued by an erosion in manufacturing competitiveness. The devaluation of the Chinese yuan in 1994 exacerbated this situation. Our manufacturing will have to be reinvented if Indonesia is to accelerate growth on a sustainable basis.

Indonesia is basically a moderate inflation country. Even when neighbors are showing signs of deflation, Indonesia generally sees inflationary trends. However, this year, we are likely to have an inflation rate around 3%, which is very low by Indonesian standards, since the target set by the central bank is 5%. Contributing factors to this include gains made by the rupiah on the U.S. dollar, declines in international commodity prices, and relatively weak demand. A downside to this is that if labor unions ask for a high nominal increase in wages, it amounts to a relatively high real increase in wages the following year.

Indonesia's current and capital accounts are showing surpluses. Indonesia's stock market has been one of the best performers in the region. Capital is coming in through the stock market due to the fact that government bonds have a relatively high interest rate. The promissory note rate (the BI rate) is still 6.5%. Looking at the full macroeconomic picture, Indonesia looks quite safe right now.

This safe situation is not the case, however, for unemployment. The Bureau of Statistics says that unemployment has declined to around 8%. We are used to a high unemployment rate, and we do not have a social security system to pay into when unemployment rises, but this is a big issue that Indonesia will have to deal with in the future. Open unemployment is estimated to be around 8% now, but many doubt this figure. More importantly, the issue of vulnerable employment is huge. Only 30% of Indonesians work in the formal sector and are usually self-employed or family workers. Clearly unemployment is a big problem, but we do not have a political party that will clearly spell out what to do about unemployment.

Moving on to the global economy, Japan and China are recovering very strongly. This situation poses the risk of currency misalignment for Indonesia. The pegging of the yuan to the U.S. dollar is likely to create problems for some of us in the ASEAN region. If the U.S. dollar continues to weaken, that would mean that the yuan would also weaken vis-a-vis our currency, eroding further our manufacturing competitiveness.

All of a sudden East Asia has become a very active player in regional integration and cooperative initiatives. How much this very wide network can strengthen the region has yet to be seen, but in Indonesia, the global environment in 2010 is expected to be a little more encouraging than it was in 2009 thanks to regional ties.

The International Monetary Fund projects 5.5% growth for Indonesia in 2010. It may actually be close to 6% according to some analysts. However, there is a new problem in Indonesia now involving the rescue of a small bank, Century Bank. There is an ongoing investigation into this and some big names have been implicated. This issue has the potential to affect the economy quite a bit as it will erode the credibility of policymaking.

In the very short term Indonesia does not have very much to worry about as we have ample room for fiscal and monetary policy maneuvering. The stimulus package this year is only 1.3% of GDP, compared to the global average of 4.3%, making it one of the smallest stimulus packages in the world when measured against GDP. The Ministry of Finance is probably doing this because the economy's absorption capacity is limited. There are a number of structural obstacles which cannot proceed very fast due to land rights issues, like toll road construction. However, Indonesia's debt to GDP ratio is very favorable right now, allowing ample room for macroeconomic policy maneuvering.

Moving on to the medium-term outlook, the core challenge for us is how to catch up with East Asia. If China continues to grow at 8-9%, India at 7-8%, and Vietnam at 6-7% but Indonesia only manages to grow at 6%, we are going to be left behind. The manufacturing sector has the potential to be a driver of the economy, rather than natural resources or services. This is particularly true when it comes to job creation. As long as the unemployment rate remains at 7-8% a year, it is hard to imagine that wages will rise in Indonesia. Since the rise of China, our manufacturing has been losing competitiveness overall to China.

In the years to come we may witness a more cautious attitude toward privatization, liberalization, and deregulation on the international scene. But to countries like Indonesia this is still a problem. Many in Indonesia are now worried about losing ground to our neighbors when we implement the various agreements we have signed. Many businesspeople have expressed concern that the country is not in a position to compete with others in the coming years. Hopefully this will not result in anti-integration sentiments.

Indonesia is very close to China, India and Vietnam, and this gives the country an advantage. In particular, the energy crisis provides an opportunity for Indonesia. The country is very well endowed with geothermal potential. Additionally, Indonesia has overtaken Malaysia as a producer of palm oil. A number of palm oil companies in Indonesia have established a company to turn palm oil into biofuel. Indonesia is also an ideal place for solar energy. The same also applies to the food crisis to a certain extent. Indonesia is better known as an importer rather than an exporter of food, but it has great potential in exporting certain products.

Indonesia also has an opportunity in terms of demographics. The labor forces in South Korea and Japan are declining, and China is entering a stage where wages are going to rise very quickly, at least in the coastal cities. This should create opportunities for Indonesia to reenter competition in the manufacturing sector. Malaysia is also growing, but not as fast. There is strong competition from India, but that country has been drawn more to the ICT sector rather than to products like textiles, apparel, footwear and the like. In terms of automotives, Indonesia has become part of the global component production system. This involvement could be further strengthened in the years to come.

Many in the world now look at Indonesia in a favorable light because the country is considered to be a good example of democratization, and this goodwill could be capitalized on. There are downsides in terms of Indonesian politics. These include slow decision making, challenges to major decisions, and limited political power among district governments. Regarding district governments, all issues outside of the judiciary, religious affairs, foreign affairs, defense and monetary affairs are now under the purview of the district governments, compounding the problem of inadequate competency at the district level.

Despite Indonesia being an interesting and attractive location, it is a logistical nightmare. With around 5,000 inhabited islands out of the 17,000 islands in the archipelago, connecting people physically is very difficult.

Still, I would like to talk about some of the advantages of Indonesia. Indonesia is now the world's number one exporter of coal. The country also exports other minerals like nickel, copper and gold. Other exports include palm oil, rubber, and products of industry plantations. The labor force is much better educated now than it was 20 years ago and urbanization is proceeding rapidly.

Indonesia is now half way through democratization. The country has learned how to form consensus through democracy, but has not yet learned how to harvest the fruits of democracy. The constitution is somewhat suspicious of business. Indonesia has hundreds of state-owned enterprises, and has not been a major player in terms of privatization in the last thirty years, though this may be changing as "entrepreneur" has become a respectable status.

Despite these advantages, Indonesia faces some difficulties. Our capacity for stored electricity has increased only 8% in the last eight years, while production has increased by almost three times. Electricity will remain an obvious obstacle to reinventing our manufacturing sector. There is good potential for water in Indonesia; however, it is centralized in labor-scarce areas outside of Java, where the labor force is centered. Transportation is also a problem as the construction of paved roads is not increasing quickly enough despite the fact that the number of motor vehicles has almost doubled in the last six years.

The labor issue of severance payments is considered to be a major obstacle to investment. I was told by the employers association that they were close to a deal with labor unions on this, but as long as the required amount of severance payment continues to be large, it will be hard to attract labor-intensive manufacturers.

Moving on to labor issues in general, there is uncertainty about the enforcement of laws. We have learned about how to pass laws, but when it comes to enforcement, there is much to be desired. A number of high profile cases now cast a shadow on Indonesia as corruption is a real problem.

We have been catching up in terms of human capital, but we are still far behind our neighbors. We invested too little into education in the past, so the government recently decided to push investment in education, allocating 20% of government expenditure to education.

Changing Indonesia all at once is impossible since the country is geographically divided. Lombok is the island just to the east of Bali. From there to the west is part of Southeast Asia, but from there to the east is part of Oceania. The flora and fauna between the two are different, though the people are not. There are many islands which are basically isolated. We call the islands to the west of Sumatra the Mentawai islands. The Mentawai people are basically hunters and gathers. There are also isolated villages like this in the province of Papua. On the other hand, Jakarta is truly metropolitan. There must be a catalyst to ignite change in the archipelago, and special economic zones may act as such a catalyst.

Special economic zones do not have to be invented anew. There are a few industrial estates that could easily be converted into special economic zones with a view to acquiring best practices in bureaucratic services, service to investors, infrastructure management, labor-industrial relations, and corporate governance and management. There are places where this could be done around Jakarta, Surabaya, Sumatra, and near Singapore.

Other catalysts could be major increases in public spending on health, education, and entrepreneurship. Even if a great deal is spent on education, without health, people are unlikely to benefit. According to recent surveys, Indonesians have become more entrepreneurial. Employers with permanent workers have increased dramatically since 1996.

Furthermore, policy measures to support crisis-ridden sectors would help. These sectors include food, energy, electricity, transportation, and telecommunications infrastructure. The form of policy needs to be discussed, but there is probably a good case for policy in these areas.

Considering all of this, and considering that the nature of Indonesians is to change policy incrementally, it is probable that for the next five years Indonesia will remain in a narrow corridor of economic growth. Growth will probably oscillate between 6-7% a year as the country overcomes the crisis. Indonesia will probably have to wait to achieve a very high growth rate, which is one of the features of a successful transformation.

Questions and Answers

Q: Regarding Indonesia's FTA with Japan, I would like to know the view of researchers and the general public about this. There are many potential medical caregivers who have come to Japan through the FTA, and I think that this has been reported in the newspapers in Indonesia.

Japan is hosting APEC next year, and as everyone knows, 2010 is a very important year for the Bogor Goals. I would like to know your assessment of APEC so far, and if you have any expectations for APEC next year in Japan.

Djisman SIMANDJUNTAK
The overall attitude of Indonesians toward FTAs is indifferent. This is a problem. The government has not done its work well. We have done too little in terms of raising consciousness about FTAs in our part of the world.

In recent months we have witnessed businesspeople expressing a kind of defensive attitude saying the government has gone too far, that they were not consulted. Business people were consulted and the chamber of commerce was invited on all occasions, but overall, the attitude is one of indifference.

The overall perception is that there is little for us to gain. It is hard for the people to believe that Indonesia is gaining much from the FTA. I think that the government could really change people's attitudes through the enactment of a well-planned program involving businesspeople in capacity building and facilitation.

As for the nurses, we would love to send more Indonesians overseas, but we already have a very large workforce outside the country. Four million Indonesians are now working overseas. Unfortunately the majority are unskilled laborers, mostly domestic workers. We are somehow emulating the cycle in the Philippines. In the long run it is not sustainable. In contrast, South Koreans have said that they plan to replace domestic workers with robots by 2020. The question is not about whether to send people or not, it is about how to restructure the composition of the people we send overseas.

Sending out nurses should be one area we participate in, but in order to be able to compete, we need to have good nursing schools in Indonesia. We do not have such schools now at adequate capacity, although one or two are being established. Likewise, we might perhaps compete in the field of shipping. In the past, Philippine sailors were very much appreciated. However, the training for sailors remains the same as it was 20 years ago because we have not invested in facilities. I think this could be one area in which Indonesia could profit through the use of FTAs with countries in East Asia.

One interesting tendency of Indonesians is that they are not very outgoing. We tend to be very inward looking. For example, many of my friends who fled during the riots in 1998 are now back. Our inward-looking nature is reflected in our trade. Our trade is the most slowly developed in East Asia. In 1980 we were far ahead of China in terms of exports, but now, we have been overtaken by even Thailand. Part of the reason for this is the attitude, if you can survive domestically, why go overseas?

In relation to APEC, I am becoming more realistic. It is simply too big. I am now more persuaded that before APEC can succeed, something will have to happen in East Asia. As an Indonesian, I should be one of the major defenders of the Bogor Goals, but my feeling is not one of pride.

Q: I have noticed some protectionist sentiments in Indonesia and I have some concerns about this. In the past, Japan welcomed Indonesia as a member in the G20 community and I strongly hope that Indonesia can be a good member of that kind of community. Recently, Indonesia's Ministry of Industry has proposed a postponement or suspension of the full implementation of the Indonesia-China FTA, which forms part of the wider Asian-China FTA, signed in late 2004. I wonder what is causing this. I understand that the Indonesia-China FTA is a legally binding commitment, so it is not appropriate for a government Minister to postpone it. I would like to know what the situation is behind this kind of situation.

Djisman SIMANDJUNTAK
I think the Minister's attitude is not specific to this particular FTA. His feelings are about FTAs in general, not just the Indonesia-China FTA and hopefully these feelings stem from ignorance. Hopefully he verifies the numbers so he can see that Indonesia can gain in a number of areas from FTAs. Even without reinvention, Indonesia can gain in the number of product groups competing with China, India, and Vietnam through this FTA. The situation has not yet deteriorated to a point of no return, so I think there is still time for us to remedy it.

Q: Why are you unhappy with a growth rate of 6 or 7%? China wants to keep 8% because of employment requirements, but you are not satisfied with 6 or 7%. What need do you have for higher growth?

In the early 1990s, China depreciated its currency, and you said that this hurt the Indonesian economy. Could you talk about how the yuan affects the Indonesian economy?

Djisman SIMANDJUNTAK
Actually, there is a rule that if you grow at 6% you double your income in 12 years, but if you grow at 9% you double your income in 8 years. If our neighbors grow at 8% and we continue to grow at 6%, we will fall behind. Sooner or later we would look strangely underdeveloped. Secondly, we are still struggling with widespread poverty due to low incomes in Indonesia. Many people live on one or two U.S. dollars a day. Furthermore growth should be adjusted to circumstances. If our neighbors' grow rapidly but we continue to grow slowly, it can be a problem down the road.

As for the yuan, in 1993 Indonesia was experiencing high export growth. Indonesia almost made it through in developing through trade. This growth was aborted. One of the reasons for this was the devaluation of the yuan in 1994 while the Indonesian rupiah increased in value. I think this cost us competitiveness in the European and U.S. markets. A similar problem could arise with the pegging of the yuan to the dollar if the rupiah continues to appreciate. By this measure, we have gained almost 12% on an annual basis this year.

Q: What are the characteristics, roles and power of the economic technocracy in the policy making process during the Post-Suharto era?

Secondly, from an Indonesian perspective, what is the most important agenda item of economic diplomacy vis-a-vis the rest of the world including international organizations?

Djisman SIMANDJUNTAK
It is very clear that economic technocracy is losing importance. Parliamentarians, local as well as central, are now very outspoken and can essentially block anything the government proposes. However, this really depends on personalities. The strength of the so-called Berkeley Mafia was actually the strength of individuals. Without Widjojo Nitisastro, the Mafia would not have been as reputable as it was. Currently, technocrats do not have as much influence on policy-making.

I myself wonder what Indonesia really wants internationally. It has never been spelt out clearly. Security-wise, our number one interest is a peaceful East Asia because we will never be able to grow without peace in East Asia. That is why we are participating in the ASEAN regional forum and in the Council for Security Cooperation in the Asia Pacific. Economically, our main interest is still market access. I think we are more comfortable with regional approaches now. I also think we would like to see ASEAN more appreciative of human rights. This is a point of contention between Indonesia and some members, particularly Myanmar. Overall, Indonesia's priorities are not very clear when it comes to foreign policy agenda.

*This summary was compiled by RIETI Editorial staff.