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«adb economics no. 411 working paper series october 2014 ASIAN DEVELOPMENT BANK   ADB Economics Working Paper Series Industrial Policy in Indonesia: ...»

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InDustrIAl PolIcy In

InDonesIA: A GloBAl

VAlue chAIn PersPectIVe

Julia Tijaja and Mohammad Faisal

adb economics

no. 411

working paper series

october 2014

ASIAN DEVELOPMENT BANK

 

ADB Economics Working Paper Series

Industrial Policy in Indonesia:

A Global Value Chain Perspective

Julia Tijaja (julia.tijaja@asean.org) is an Assistant

Julia Tijaja and Mohammad Faisal

Director and Senior Economist at the ASEAN

No. 411 | 2014 Integration Monitoring Office (AIMO) of the ASEAN Secretariat. She was formerly a Research Analyst at the Fung Global Institute. Mohammad Faisal (faisal@coreindonesia.org) is a Research Director of the Center of Reform on Economics (CORE) Indonesia.

The views expressed in this paper are those of the authors and should not in any way be attributed to the institutions with which they are associated.

ASIAN DEVELOPMENT BANK

Asian Development Bank 6 ADB Avenue, Mandaluyong City 1550 Metro Manila, Philippines www.adb.org © 2014 by Asian Development Bank October 2014 ISSN 2313-6537 (Print), 2313-6545 (e-ISSN) Publication Stock No. WPS146901-3 The views expressed in this paper are those of the author and do not necessarily reflect the views and policies of the Asian Development Bank (ADB) or its Board of Governors or the governments they represent.

ADB does not guarantee the accuracy of the data included in this publication and accepts no responsibility for any consequence of their use.

By making any designation of or reference to a particular territory or geographic area, or by using the term “country” in this document, ADB does not intend to make any judgments as to the legal or other status of any territory or area.

Note: In this publication, “$” refers to US dollars.

The ADB Economics Working Paper Series is a forum for stimulating discussion and eliciting feedback on ongoing and recently completed research and policy studies undertaken by the Asian Development Bank (ADB) staff, consultants, or resource persons. The series deals with key economic and development problems, particularly those facing the Asia and Pacific region; as well as conceptual, analytical, or methodological issues relating to project/program economic analysis, and statistical data and measurement. The series aims to enhance the knowledge on Asia’s development and policy challenges; strengthen analytical rigor and quality of ADB’s country partnership strategies, and its subregional and country operations; and improve the quality and availability of statistical data and development indicators for monitoring development effectiveness.

The ADB Economics Working Paper Series is a quick-disseminating, informal publication whose titles could subsequently be revised for publication as articles in professional journals or chapters in books.

The series is maintained by the Economics and Research Department.

 

–  –  –

The gains of a country from participating in global value chains (GVCs) will depend on the productive activities taking place in its jurisdiction and their linkages to the domestic economy. Lead firms’ decision on where to locate and how to coordinate production activities is influenced, among others, by industrial policies. On the one side, policy space provides governments with some leverage in guiding economic activities and influencing development outcomes. On the other hand, policy risks have the potential to adversely affect the outcomes. This study focuses on industrial policies in Indonesia, using the mineral sector as a mini case study. The case study assesses the Indonesian Government’s recent effort to boost domestic value addition in the sector. This paper argues that the effectiveness of government policies in maximizing the gains from GVC participation depends not only on policy design, but also on policy consistency and coherence, effective implementation, and coordination.

Keywords: Industrial policy, Indonesia, global value chain, upgrading.

JEL Classification: F63, F68, L52, L76, O25,  

–  –  –

International production sharing means greater opportunity for country and firm participation in global value chains (GVCs). At the level of individual economic actors, the benefits and costs of such participation will depend on where and how they are involved in the GVC; rarely is this a free choice.

The decisions by the lead firms on where to locate and how to coordinate various production activities are often key influencing factors, with implications for the development and diversification outcomes in the host countries.

Returns to different production activities are not homogeneous, and are reduced over time by new entrants and intensified competition. The speed with which this occurs is affected by a number of factors, both external and internal to value chains. Informed decisions by lead firms would take account of these factors. Among the external factors is policy, including industrial policy. Industrial policy is introduced by governments to guide resource allocation to specific industries or sectors, or activities.

The gains from GVC participation for each economy will depend on the productive activities taking place in its jurisdiction and their linkages to the domestic economy. Governments’ concerns go beyond GVC participation and its immediate returns, but also include broader and longer term public policy objectives, such as the number and quality of jobs created, the non-economic impact of industrial activities, the dynamic scope for upgrading, skills and knowledge development, and more generally, contributions to economic diversification and resilience. Policy space provides governments with some leverage in influencing the outcomes, although policy risks have the potential to adversely affect them.





Industrial policy, or more precisely specific industrial policy, refers to non-neutral government intervention that seeks to alter market signals. The objective is to steer investment and production activities to industries or sectors that are deemed more beneficial to an economy in the longer term.

Risks are present along the policy process and as early as the sector identification process. The costs of mistakes can be disproportionately high in resource-scarce developing economies. The risk of government failures has been commonly cited by the opponents to industrial policy, while its proponents argue that it is not necessarily higher than that of market failures. A second type of industrial policy refers to horizontal, broad-based policy that is relevant to industrial development, such as infrastructure, energy, business regulations, and connectivity. While this type of policy is more universally accepted, it may not be sufficient on its own to overcome market failures and spur industrial development.

From a GVC perspective, industrial policy can be targeted at specific activities in a particular sector or industry that are deemed to deliver greater benefits to the economy. Recognition of the organization and the working of GVCs mean that the aim should be to move toward international competitiveness rather than reckless domestic expansion behind a high wall of protection. This requires balancing the objective of maximizing domestic linkages with the pursuit of achieving international competitiveness, including through the use of competitive imported intermediates.

Government capabilities are therefore imperative along the policy process, from design and administration to monitoring and evaluation.

The study focuses on industrial policies in Indonesia. It starts by providing a descriptive overview of the economic structure in Indonesia. It continues with a historical overview and the state of play of the country’s industrial policy. The paper then focuses on policy relating to a priority sector.

2 | ADB Economics Working Paper Series No. 411 Specifically, the paper looks at the mineral sector as a mini case study. The choice of sector is made in light of the explicit aspiration of the Government of Indonesia (GOI) to boost domestic value added by encouraging downstreaming in the sector. It is also inspired by the shared aspiration of many other resource-rich economies to do the same. The study hopes to shed some light on the lessons and complexities that arise from the pursuit of this objective.

–  –  –

Indonesia is one of the larger emerging market economies in the world and a member of the G-20 major economies. With gross domestic product (GDP) amounting to $873 billion in 2013,1 it becomes the largest economy in Southeast Asia, contributing nearly 40.0% to the region’s GDP, and ranks 16th in the world. Indonesia has also become one of the fastest growing economies in the last decade and has demonstrated resilience through the global economic crisis in 2008. In 2013, Indonesia’s GDP was growing at 5.8% after experiencing a higher growth (above 6.0%) in the previous years.

More than half of Indonesia’s GDP was contributed by the services sector (Figure 1), while contributions of the manufacturing industry, agriculture and mining are 24.0%, 14.0% and 11.0%, respectively. Services have also become the fastest growing sector in the last few years, while manufacturing, agriculture, and particularly mining have been growing slower than GDP (Table 1). In 2013, for example, the growth of the manufacturing sector was merely 5.6%, lower than the total GDP growth of 5.8%. Given the slower growth of the sector compared to GDP, Indonesia has experienced de-industrialization in recent years.

–  –  –

                                                            

Central Board of Statistics, 2014 Industrial Policy in Indonesia: A Global Value Chain Perspective | 3

–  –  –

Private consumption was the biggest contributor to GDP, accounting for 55.0% in 2013 (Figure 2). The role of trade has also been growing in significance, with export and import accounting for around 24.0% and 26.0% of GDP, respectively. Japan has traditionally been Indonesia’s major trading partner for decades, but the role of the People’s Republic of China (PRC) has become increasingly important in recent years. In 2013, Japan was still Indonesia’s export market accounting for 14.4% of the total, followed by the PRC, 12.3% and the European Union (EU), 9.1%. As for imports, Indonesia’s largest partner was the PRC with 16.8% share, followed by Singapore, 15.3% and Japan, 10.8% (Table 2).

–  –  –

Source: Central Bank of Indonesia.

Indonesia’s exports have long been dominated by primary commodities, such as mineral fuels, lubricants, animal and vegetable oils, fats, and waxes (Figure 3). It has become the world’s largest exporter of coal and crude palm oil in recent years. Among the Association of Southeast Asian Nations (ASEAN) countries, Indonesia is the most competitive trader in primary commodities (Figure 4a). In contrast, however, it has become one of ASEAN’s least competitive traders due to its declining trade competitiveness in manufactured goods in the last decade (Figure 4b). Most of Indonesia’s imports are intermediate goods to support its domestic industry, such as chemical products, machinery, and transport equipment. The dominance of low value-added commodities in Indonesia’s exports and the country’s high dependence on higher value-added manufactured imports have resulted in Indonesia’s declining trade performance in recent years. It should be noted, however, that importing intermediate goods is not bad in itself, and in a world of GVC is even a key strategy for adding value to exports. The challenge is therefore to ensure the attainment of international competitiveness in parallel to climbing the value chain.

–  –  –

1995–1999 2000–2004 2005–2009 2010–2012

–  –  –

To give a better understanding of how Indonesia arrived at its current economic structure the next section looks into the evolution of the country’s industrial policies and subsequent developments.

6 | ADB Economics Working Paper Series No. 411

–  –  –

The Indonesian economy had more or less stagnated since its independence in 1945. Until the mids, the process of modern industrialization had barely commenced in Indonesia (Aswicahyono et al. 2010, Rock 2003). By 1965, the economy was described to be in shambles. Modern industrial policies only started with the New Order2 in 1966. In the second half of the 1960s, Soeharto’s government was focused on putting the political house in order, and only afterwards was it able to push through with its economic development strategy.

For 3 decades up to the Asian Financial Crisis (AFC) in 1997, Indonesia enjoyed a rapid growth in manufacturing. From 1970 to 1996, the industry sector was growing at least 9.0% annually barring for 2 years. This was not, however, a linear period of growth as shown later. Following the AFC, Indonesia has yet to get back on its feet in terms of industrial development for various reasons. Recently, however, the GOI has started to demonstrate a more proactive approach to industrial policies. At the beginning some skeptics have argued that this was merely another pre-election3 populism, but others believed that these efforts might be more than just short-lived; so far the latter seemed to be closer to it. Seeing the structural implications that these may have and the current growth in the economy buoyed by relative political and macroeconomic stability, the stake is too high for any mistakes in policymaking.

Having weathered the 2008–2009 Global Financial Crisis (GFC) relatively well, the GOI’s attention has shifted from improving economic resilience against external shocks to improving the balance of payments. At least for some sectors, the GOI sees greater domestic linkages and building international competitiveness to be a preferred strategy. The challenge is how to find the right balance to achieve the two.

A. Pre-crisis (1966–1996)



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