Indonesia: An economy that lacks of dynamism<\/p>\n
Haryo Aswicahyono<\/p>\n
Over the last nine months, inflation and interest rates have
\ncontinued to fall. Fiscal consolidation, bank and corporate
\nsector restructuring is continuing, while capital outflow has
\nturned into an inflow. Favorable macroeconomic conditions have
\nbeen translated into positive consumer confidence and business
\nsentiment.<\/p>\n
However, there is little evidence that increasing macroeconomic
\nstability and reduced vulnerability is translating into higher
\ngrowth. Growth has been mainly driven by consumption and investment,
\nwhile exports weakened and the slow down in manufacturing growth
\ncontinues to drag down overall growth. It is likely that Indonesia
\nmay be settling into a medium-low growth equilibrium unless
\nmeasures are taken to invigorate exports and the manufacturing sector.<\/p>\n
One of the important factors behind the modest growth
\nperformance is the weakening of the manufacturing sector. The
\nfollowing figures and tables clearly indicate the decelerating
\ntrend in manufacturing growth (year-on-year) since the first
\nquarter of 2000.<\/p>\n
Prior to the crisis, manufacturing industries were growing at
\na rate of 10% per annum, much higher than the overall rate of GDP
\ngrowth. The growth rate declined considerably to a meager 3.8%
\nduring 2000-2003. The weakening of the manufacturing sector took
\nplace across the board, notably in the large resource intensive
\nsector such as petroleum and gas; food, beverages and tobacco;
\nwood and wood products; and paper and printing. However, amidst
\nthe gloomy picture, we witnessed an outstanding performance by
\nchemical industries, transport equipment and other manufacturing
\nproducts.<\/p>\n
Missed opportunity<\/p>\n
Elsewhere in this edition, economist M. Chatib Basri shows
\nthat one factor that distinguishes Indonesia's growth performance
\nfrom the rest of the crisis-affected countries is Indonesia's
\npoor export performance. The following figures confirm Chatib
\nBasri's observation and the previous discussion on economic
\ngrowth.<\/p>\n
The vertical axis in the figure indicate the dynamics of the
\nsector in the world market, the horizontal axis measures change
\nin Indonesia's shares of the world trade due to the
\ncompetitiveness factor, while the size of the bubbles reflects
\nthe important of the sector to Indonesia. The figure reveals an
\ninteresting story behind the lag of dynamism in Indonesian
\nexports. First, due to increases in the oil price on the world
\nmarket, the share of mineral exports in the world market has
\nincreased considerably during the period (1995-2001).<\/p>\n
Unfortunately, Indonesia missed the opportunity to ride the wave
\nof growing demand. Second, even though Indonesia is still
\ncompetitive in many products, notably wood products, these
\nproducts have been lagging behind and their share in the world
\nmarket has been shrinking. Third, Indonesia has been losing
\ncompetitiveness in two labor intensive industries, miscellaneous
\nmanufacturing and leather products. Fourth, Indonesia have gained
\ncompetitiveness in fast-growing sectors such as electronics,
\nelectronic components and transport equipment.<\/p>\n
A more detailed analysis not shown here reveals that the poor
\nperformance of Indonesia's exports has been caused by Indonesia's
\ninability to adjust her export structure to bring it into line
\nwith the dynamics of world demand. It is therefore imperative for
\neconomic recovery that Indonesia reinvigorate exports through
\nincreased competitiveness and the creation of a more flexible
\neconomy in which firms can relocate their resources in line with
\nworld market dynamics. The question now arises, what factors
\nhinder such dynamism?<\/p>\n
Unnecessary costs<\/p>\n
Even though an Indonesian firm is very efficient and exchange
\nrate, labor and capital costs are competitive in the world
\nmarket, if it faces considerable transaction costs, such as
\ntransport costs and bureaucratic costs, the costs faced by
\ndomestic consumers will be high and our exports will become
\nuncompetitive. There are numerous study showing that transaction
\ncosts in Indonesia are high. Two examples illustrate the point:
\nport costs and bureaucratic costs.<\/p>\n
It goes without saying that efficient ports are of critical
\nimportance factor to the national economy. The following figure
\nshows that Tanjung Priok port is one of the least efficient ports
\nin the region. Moreover, unit costs are the highest in the region.<\/p>\n
The second factor that determines transaction costs is the
\nquality of governance. The following figure shows disappointingly
\npoor governance quality in Indonesia. The percentage rank of
\nIndonesia is the lowest in all governance aspects: government
\neffectiveness, regulatory quality, rule of law and control of
\ncorruption. The quality of government in Indonesia is even lower
\nthan that in Vietnam<\/p>\n
Status quo<\/p>\n
As far back as the 1940s, Schumpeter warned that adjustment in
\nresponse to economic shock requires a painful creative
\ndestruction process, during which resources must be reallocated
\naway from the "sick" parts of the economy to the "healthy" ones.
\nSuch creative destruction requires sophisticated institutions
\nthat can handle innumerable transactions to create and destroy
\nproduction units efficiently.<\/p>\n
The prolonged restructuring process in Indonesia and the
\nprevious table clearly show that Indonesia does not have such
\ninstitutions. Moreover, the restructuring process is much more
\ndifficult during a recession because of the financial constraints
\nfaced by the "healthy" part of the economy. The labor that is
\nreleased from the "sick" economy will feed into unemployment and
\nthe informal sector rather than into the "healthy" sector. Will
\nshall now identify a number of factors that may hamper the
\nprocess.<\/p>\n
Growing protectionism<\/p>\n
One of the most damaging effects of protection is that it
\nprevents the growth of dynamic sectors and promotes the status
\nquo. Unfortunately, we have recently witnessed a trend toward a
\nmore protectionist trade regime. These include such things as the
\nreimposition of a number of non-tariff barriers, new valuation
\nprocedures as goods pass through customs, import licensing and
\nantidumping measures (BIES Vol. 39, No. 3, 2003)<\/p>\n
Financial intermediary<\/p>\n
As mentioned earlier, another factor that is essential to the
\nadjustment process is the resumption of lending, which in turn
\ndepends on lending rates. Lending rates have been stubbornly high
\ndespite the decline in SBI rates noted above. This could be the
\nresult of a number of factor: (i) due to past trauma, banks
\nprefer to increase their interest spread in order to strengthen
\ntheir balance sheets, (ii) banks may now insert higher risk
\npremiums in their loan pricing, (iii) banks may also be cautious
\nof sudden reversals in sentiment with concomitant large capital
\noutflows, and (iv) lack of confidence in the legal system in
\nprotecting property rights (BIES Vol. 39, No. 3, 2003)<\/p>\n
Labor<\/p>\n
Finally, creative destruction also requires a flexible labor
\nmarket, whereby the growing sectors may absorb labor released by
\nthe shrinking sectors. These include a rational minimum wage
\nwhich reflects labor productivity, reasonable severance pay, and
\na fair dismissal process not only for labor but also for firms.
\nIn this regard, Indonesia's draconian labor law is inimical to
\nthe recovery process.<\/p>\n
Conclusion<\/p>\n
The resumption to high economic growth path seems to hinge not
\non new initiatives in industrial policy in which the government
\npicks the winners and caters to specialized interest group. Given
\nthe poor quality of our institutions, it is quite likely that the
\ngovernment will only pick losers and encourage corruption. What
\nIndonesia needs is a return to orthodox competition based upon
\nrational economic policies, guarded by efficient, accountable and
\ntransparent institutions.<\/p>",
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