Indonesia | Economics

Friday, December 30, 2005

When being just good enough is not enough

Productivity, not trade policies, to boost exports.

(, 31 December 2005). The economy did rather well in 2005. Estimates by the Asian Development Bank put its growth above that of the regional (Southeast Asian) average and its ASEAN-5 neighbors.

Exports became one of the main sources of growth, contributing to around 80 percent of total growth in the first two quarters of 2005. Non-oil-and-gas exports in the first three quarters of 2005 grew by more than 23 percent from that in the same period in 2004 -- more than double the growth in the first three quarters of 2004.

Yet, this rosy picture from the top was contradicted by a different picture on the ground. Exporters and businesses complain daily about rising costs, both from policy action (e.g., domestic fuel price increases) and inaction. All of these failings, they say, are eroding their international competitiveness, particularly in the face of rising China, Vietnam -- and, to a lesser extent, India.

How can we explain these conflicting pictures? In essence, I think they describe both the potentials and risks inherent in our economy. Undeniably, our economy, despite all the policy problems, has been performing well enough -- pointing to the resilience of the economy. However, intensifying global competition will soon make well-enough not enough. The leap beyond well-enough requires swift solutions to the problems on the ground.

The evolution of Indonesia's export structure is illustrated in the figure below. The vertical axis indicates the growth of exports from Indonesia for the particular commodity, while the horizontal axis indicates world export growth for the commodity. The size of the bubble represents the share (in terms of value) of a particular commodity's export to Indonesia's total export, indicating its importance to Indonesia's export.

Two things emerge from this figure.

First, the growth of Indonesia's leading manufacturing sectors -- notably electronics, textiles, wood and wood products, as well as footwear and pulp-and-paper (not shown above) -- are either stagnant or declining, despite the relatively strong growth of these sectors in the world market.

Second, there is a marked shift from manufacturing products toward primary commodities. The three sectors whose share of total exports increased the most between 2000 and 2005 are palm oils, base metals and natural rubbers, while the three whose share declined the most are textiles, electronics and wood products.
The changing structure of Indonesian exports reflects the significance of China's entry into the global economy. Chinese firms become strong competitors in the low-cost manufacturing sector, but provide a market for our primary commodities. The latter translates into some static gains for the Indonesian economy. However, the shift away from manufacturing toward primary commodities will sap the dynamism of the Indonesian economy.

Direct competition with Chinese -- and, to some extent, Vietnamese -- manufacturing firms highlights an important fact: Indonesia is losing its comparative advantage in low-cost manufacturing. The latest fuel-subsidy reduction policy, it was argued, rubbed salt into the wounds of many manufacturers and exporters of low-cost goods as it weighed down on their competitiveness even further.

In response to such an argument, one minister reportedly replied: "In other ... countries with similarly high fuel-prices, (firms can manufacture) competitive products. Why can't we?" This question was made more than 20 years ago by former minister of industry A.R. Soehoed. Even so, it is as relevant now as it was then -- especially since fuel prices in China -- and indeed, in most of Asia -- are significantly higher than those in Indonesia.

Why is Indonesia losing competitiveness in low-cost manufacturing? One possible explanation is the natural progression of the economy: As the economy matures, high demand for low-skilled workers drives wages upward, making labor costly. While this might have been true prior in 1996, it is no longer true.

Another possible explanation, which seems to fit Indonesia, is related to Indonesia's "business climate". A good business climate can be defined as an environment that gives ample incentives for all actors to engage in productive activities. This notion can be interpreted in many ways, but it essentially refers to an environment with a relatively high-level of competition and low cost of doing business -- of which, Indonesia is not.

A good illustration of this is the problem of trade infrastructure in Indonesia's ports. Indonesia had the most expensive terminal handling charges (THC) amongst its Southeast Asian neighbors. Under pressure to "reduce the high-cost economy", the Ministry of Transportation issued a regulation that slashed the THC to US$ 95 in order to make the business climate more competitive.

Yet, the THC is but one of many problems infesting Indonesia's ports. JICA (2005) points to the quality of service and infrastructure as one of the reasons why many ships avoid Tanjung Priok Port. The reason for this poor infrastructure and service, it argued, was the lack of competing ports in the area -- hence it recommends improvement through the introduction of a second port.

Arguably, no major improvement in economic policy-making outside that of macroeconomic policy has happened in the past year. Yet, despite this, the economy grew well enough. The resilience of the Indonesian economy, not to mention its endowment of natural resources, somewhat compensates for the relative incompetence of policymakers.

As such, we are living in what Paul Krugman called "an 'age of diminished expectations'...in which our economy has not delivered very much but in which there is little political demand that it do better." This kind of "policy of no policy" was good enough in the absence of intense competition from abroad. But now, good enough is simply not enough.

To move beyond good enough, productivity needs to improve. Indeed, the most important policy to boost exports is not located in trade policies, but in productivity-improving policies. For an economy such as Indonesia, it is not too difficult to find such policies. Reducing corruption, illegal fees, and other transaction costs is one. Investment in infrastructure -- including in the "knowledge infrastructure" through basic research -- is another. Creating a predictable business regime -- particularly with regards to taxes, for instance -- is another one.

All of these policies require good coordination. But more importantly, a sense of urgency is required across the administration, chiefly in the technical departments -- not only in ministries traditionally associated with exports and the economy -- and the legislature. Politicians need to be reminded that the era when good enough is enough is (almost) over.

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