Building U.S.-Indonesia Mutual Understanding Since 1994

Regional Challenges to Indonesia’s Economic and Political Future; A Wake-Up Call

Erland Heginbotham
Adjunct Professor at SAIS, Johns Hopkins University

Erland Heginbotham dissents from those who see the rising role of China in the international economy as a win-win situation for all countries in Asia.  In a talk at USINDO on May 18 he agreed that in the immediate future China’s burgeoning economy means greater export income for countries like Indonesia, but in the medium term, 3-5 years, China will no longer need many of the things it now imports from Indonesia, and that in an increasingly competitive global market Indonesia will trail behind and be reduced to exporting only its resources, an insufficient base for its prospects of significant economic development.

At present, the impact of China on the region is good, he said.  China is importing energy, construction material, iron, steel, aluminum, chemicals and components for its manufactures.  But in 3-5 years China’s imports will grow at a slower rate.  China is developing import-substitution industries and is exporting on a massive scale, despite difficulties in implementing some aspects of the WTO Accession Agreement.  Southeast Asia will face a more serious challenge from Chinese exports in the future.  Many Southeast Asian countries will continue to be a hedge location for foreign direct investment (FDI) as alternatives to investing in China exclusively.  But Indonesia will not be among them, Heginbotham said, because it has failed to seize opportunities to make FDI attractive.  He noted that Indonesia had an opportunity for Chinese investment in liquefied natural gas facilities, and was prepared to import LNG from Indonesia.  That prospect is now in the doldrums because the Indonesian parliament failed to pass the laws to underpin an FDI agreement.  Meanwhile, this month Indonesia became a net energy importer.

The competitive environment in East Asia has changed radically since 1998, he said.  Since 2001-2 the level of competition has doubled.  China’s accession to the World Trade Organization in 2001 has had a major impact on globalization in the region, further elevating China’s dominance of FDI flows in Asia and setting the stage for China’s dominance of competition and trade in the region seen at the end of 2003.

In addition, the general slowing of economies around the world, the sudden emergence of India as a potential mid to high-technology competitor, and the emergence of export-led economies of Latin America, all mean bad news for less competitive countries such as Indonesia.  Additionally, productivity growth, as measured in terms of improvements in corporate and state governance, will be essential for countries in the region to maintain and enlarge on their positions.

For 30 years, he said, leading Southeast Asian nations achieved development through export-led economies.  But the trends noted above, experienced on top of the economic crisis in Asia of 1997-98, have signaled the “beginning of the end of export-led growth as the dominant industrial development strategy.”  China has now intensified trade competition in low and middle value-added exports as the so-called “manufacturing workshop of the world.”  The end of the Multi-Fiber Agreement, slated to expire at the end of this year, will mean that Indonesia will face an “impending flood” of competition in textiles exported from China and India.  (The MFA places quotas on the amount of textiles that the United States will import from various countries.  In the past Indonesia has pressed for increased quotas for its textile exports.  But when all quotas are eliminated Indonesia may lose out altogether against cheaper goods from China and India.)

“Asia didn’t perform ‘miracles’ but simply took people off farms and put them into manufacturing for export,” he said.  Now, this manufacturing capacity has moved elsewhere.  Even China, now a giant for low-end manufactures, is moving into high technology.  It will soon no longer need the components for manufacture that it now imports, and even Japan is investing in technology, research and development industries in China.  “Japan is moving offshore anything needing more than five percent in cost of labor,” he said.

All this means that Indonesia may end up as a resource-exporting country just as it was at the start of its economic development in the 1960s, although expansion of the domestic market may create some growth.  That’s not good enough for significant economic development, Heginbotham said, because of several factors.  Commodity markets are notoriously volatile, and the capacity for increased production, requiring much capital and time to develop, is slow to respond, resulting in even more volatility.  Moreover, resources are concentrated in specific areas, and local governments will, especially in this era of decentralization, keep most of the profits at home.  This means greater inequality of incomes and job distributions.

Most other Southeast Asian countries are responding more successfully to competition with China.  “Other countries with strong English language capabilities – Malaysia, Taiwan, the Philippines and Vietnam – are better poised for general competition and especially in intelligence technology fields,” he said.

What are Indonesia’s best hopes?  Southeast Asian economies are 60-70 percent controlled by the overseas Chinese community, Heginbotham said.  This group is “wired in” to the global economy, and in Indonesia it may find niche opportunities that will provide prosperity to a segment of the economy, at least.

But real results will only come from strong political leadership that insists on reforms that will help Indonesia move up to the next stage in a developing economy after it passes the export-driven stage.  That is, an increase in productivity through skilled labor, sound management and good corporate governance, backed by government-provided infrastructure and policies that permit a predictable economic environment.  So far, Heginbotham said, Indonesia does not show any indication of appreciating these facts.

Q:  Would it be an option for Indonesia to do as Japan did: to foster domestic consumption and competition before entering the global market?

A:  Investment at home is an option up to a point, but it does not tend to result in goods for export and thereby foreign exchange earnings.  It is a limited tool for substantial and widespread economic development.  The growth of a middle class in Indonesia is very constrained.  Industrialization is not spreading.

Q:  What about China’s own shortcomings?  For example, China’s bank loans are 67 percent unresolved.  How will China work out its own vulnerabilities?

A:  China’s banking system will not collapse.  It does not have foreign debts; these debts are owed internally.  However, China is on a knife’s edge on many economic issues, though banking is not one of the top ones.  More severe is the necessity to grow 20 million jobs per year, double the regular increment, to sustain development; also the problems of local corruption, agriculture.

Q:  The atmosphere of activity and optimism in Indonesia is much different than the data you are offering.  Why aren’t things looking more gloomy?

A:  Things may look optimistic.  Because export-led growth is no longer an option, there is a move to encourage domestic consumption.  Credit is moving into the market.  But consumer credit is risky.  Korea is closing credit card companies.  Indonesia can do 4-5 percent growth based on consumption.  In the broader context, not all Asean countries are moving up after the four Asian tigers.  Malaysia and Thailand are moving up, while the Philippines and Indonesia are moving down.