Towards a free trade nation (2)<\/p>\n
This the second of two articles based on an excerpt from a
\npaper by Ali Wardhana presented at the seminar of Indonesia and
\nthe World at the Beginning of the 21st Century jointly organized
\nby The Jakarta Post and the Center for Strategic and
\nInternational Studies on Oct. 17 in Jakarta in connection with
\nthe 50th anniversary of Indonesia's independence.<\/p>\n
JAKARTA (JP): The government must do more than join and shape
\ninternational agreements if we are to take full advantage of the
\nglobal economy. I stated earlier that comparative advantage is
\nnot a static concept. As our abundant labor and natural resources
\nare absorbed into industry and modern services, we will find that
\nthe cost of these resources climbs as our incomes rise. We will
\nhave to move on to more skill-intensive and more technology-
\nintensive industries. The role of government in preparing for
\nthis transition is one of the burning policy questions that we
\nface.<\/p>\n
There are those who would have us \"pick winners\". This is the
\nstrategy attributed to Korea and Japan. In fact, the importance
\nof picking winners in Korea and Japan is hotly debated by
\ndevelopment specialists. There is no consensus on the extent to
\nwhich these policies contributed to the rapid growth of those
\ncountries. But in a number of ways the debate is a moot one. The
\nglobalization of the world's economy and the emergence of widely
\nagreed-to-rules on acceptable practices toward trade and
\ninvestment mean that the policies attributed to Korea and Japan
\ncan no longer be followed.<\/p>\n
The industrial policies of those countries revolved around a
\nset of controls that enabled a government to allocate credit and
\nforeign exchange to firms in the chosen sectors which conformed
\nto the government's will. Further, those firms were protected at
\nhome from competition from imports and from local production by
\nforeign investors. Unlike most inward-looking Latin American
\ncountries, however, the governments of Korea and Japan demanded
\nefficiency of the favored firms. They had to face the rigors of
\nexport competition, or they did not receive credit or foreign
\nexchange, or, in some cases, even further protection from foreign
\ncompetition. The tools required to implement such a policy are
\ncomplex. More important, they are no longer tolerated in today's
\nintegrated world.<\/p>\n
Our commitment today must be to the private sector, with a
\nrole for government only where the private sector cannot be
\nexpected to undertake tasks. There are two tasks that the
\ngovernment must perform to ease the transition to the industries
\nof the future: the provision of broader and better education and
\neasing the way for private firms to develop technology and to
\nacquire it from abroad.<\/p>\n
The most significant obstacle to technology transfer is the
\ncapacity of developing economies to absorb and adapt technology.
\nThis capacity depends primarily on the human resource capacity of
\neach economy. In recognition of the importance of science and
\ntechnology to our development, Indonesia has made human resource
\ndevelopment a top priority during our second 25 year development
\nprogram. This priority manifests itself both in our commitment to
\nnationwide junior secondary education and in our commitment to
\nincrease the quantity and quality of tertiary graduates. This
\nincludes greatly increasing the number of natural science and
\nengineering students in higher education.<\/p>\n
One of the key lessons to be learned from other countries'
\nexperiences is that technology development must be market-
\noriented and serve the needs of the private sector. Research
\nconducted within government institutions and state enterprises
\ncan be divorced from the needs of modern business and industry.<\/p>\n
This is a particular problem for Indonesia, where roughly 80
\npercent of research and development is both funded and performed
\nby the government or in state-owned industries, and over 75
\npercent of natural scientists and engineers are employed by the
\ngovernment. The most urgent step currently needed is to increase
\nthe efficiency of technology diffusion by getting research and
\ndevelopment out of government labs and state enterprises and into
\nthe private sector, where it would be directly relevant to
\nindustry. To support this process, the government is encouraging
\nprivate firms to devote greater resources to research and
\ndevelopment.<\/p>\n
As we strive to raise the level of technology in Indonesian
\nindustry, we must be careful not to adopt policies that weaken
\nour existing industries. In this regard I agree with Professor
\nSumitro's observation on the need to find the correct balance
\nbetween \"comparative\" advantage and \"competitive\" advantage,
\nwhile at the same time preparing ourselves for the future when we
\nmust move up the technology ladder.<\/p>\n
We cannot prematurely reject natural resource-intensive and
\nlabor-intensive industries as we lay the groundwork for the skill
\nand capital-intensive industries of the future. We must continue
\nto support these industries for two reasons. First, they are a
\nvital source of foreign exchange, accounting for almost one-half
\nof non-oil exports, but on the other hand contributing very
\nlittle to our net foreign exchange earnings and unlikely to do so
\nfor some time to come.<\/p>\n
In light of the recent increase in our current account
\ndeficit, it would be unwise to abandon the industries that have
\nbecome a mainstay of our economy over the past decade. Second,
\nhigh-technology industries employ primarily skilled workers, such
\nas technicians, engineers and natural scientists. However, two-
\nthirds of Indonesia's labor force has no more than a primary
\nschool education. If we push aside labor-intensive industries to
\ndevote resources to high-tech industries, where will these 60
\nmillion-odd workers find jobs? Let us continue to support
\nindustries in which we are currently competitive, while investing
\nin human resource development that holds the promise for
\nIndonesia's future.<\/p>\n
The dilemmas of managing the domestic economy in a world where
\nborders are open to the easy flow of goods and money have long
\nbeen clear from economic theory. The theory said that with highly
\nmobile international capital, if we chose to maintain stability
\nin the exchange rate, then our ability to use macro economic
\npolicies to stabilize the economy would be limited. On the other
\nhand, if we insist on ease in managing the domestic economy, then
\nwe would have to accept greater instability in the exchange rate.
\nManaging stability in both simultaneously would be extremely
\ndifficult.<\/p>\n
In practice, until recently the constraints were more a
\ntheoretical matter than a real dilemma. When the economy became
\noverheated in 1991, for example, we were able to apply monetary
\nbrakes without a serious challenge to the exchange rate policy.
\nAs many of you will remember, rather straightforward and simple
\npolicies that raised interest rates were effective in slowing the
\neconomy.<\/p>\n
The world has, however, changed very rapidly. Global capital
\nmovements are now somewhere in the order of 70 times the value of
\nworld trade in goods. This integration of world capital markets
\nhas caused the theoretical problem to become a real problem.
\nToday, if we raise interest rates significantly above
\ninternational rates plus some risk premium, we are likely to face
\nmassive inflows of capital. These incoming funds would push the
\nexchange rate up, requiring the central bank to purchase foreign
\nexchange with rupiah and thereby increase money supply. But these
\nincreases in money supply would run counter to the original goal
\nof slowing down the economy.<\/p>\n
Some academics would say that there is a simple solution to
\nthe problem. Ignore the exchange rate: just let it seek its own
\nlevel and concentrate on the domestic economy. In the short run
\nexports would be hurt by the higher valued rupiah, but eventually
\nthe exchange rate would return to a rate that allows exports. Or
\ndomestic prices would be held in check until exports were once
\nagain competitive. This is, of course, a purely academic
\nsolution.<\/p>\n
There are those who would say that a country could resolve
\nthis dilemma by imposing controls on the flows of capital, that
\nin this way a country could have stability in its exchange rates
\nas well as control over the domestic economy by limiting the
\ncross-border flows of capital. This sounds deceptively simple.<\/p>\n
Before I address those who would support capital controls, let
\nme say that Indonesia has followed a policy of open capital
\naccount for some 25 years, and we have no intention of abandoning
\npolicies that allow investors to repatriate their profits and
\ncapital without restriction. This policy has served us well, and
\nwill continue to do so.<\/p>\n
Are we then on the horns of a dilemma, with no effective
\npolicy tools? I am convinced that the answer is no. But I do
\nbelieve that we need to draw on a more complex set of management
\ntools and may even need to somewhat revise the incentives under
\nwhich some of our institutions operate.<\/p>\n
First, the inflows of foreign capital that accompany higher
\ninterest rates need not increase the money supply and thus
\ngenerate impacts opposite to those intended. Thus far, there is
\nno evidence that the inflows accompanying tightened monetary
\npolicy are greater than those that can be sterilized by the
\nconventional tools of selling Bank Indonesia's deposit
\ncertificates and issuing less money market securities. Bank
\nIndonesia has generally been very effective in these policies,
\neven create difficulties for sterilization efforts.<\/p>\n
Second, we have not exhausted other tools for managing the
\neconomy. We have more options than simply driving up interest
\nrates through the sale of Bank Indonesia's deposit certificates
\nor the manipulation of money market securities. We have, for
\nexample, not varied the reserve requirements of our bank, as
\nother countries do. Radical changes could certainly threaten the
\nsolvency of some banks, but small changes may act as an effective
\ntool for managing the domestic economy.<\/p>\n
Third, fiscal policy remains an effective tool for managing
\nthe economy. Slowdowns in government spending, for example, or
\nacceleration of tax collection serve to slow the economy. If
\ninflation and current account imbalances become a serious
\nconcern, Indonesia could strive for an overall fiscal surplus
\nalong the lines achieved by other fast-growing, low inflation
\neconomies as Thailand and Malaysia. Some neighboring countries
\nhave also relied quite heavily on a variant of fiscal policy as
\nthey have timed releases from their \"provident\" funds to counter
\nbusiness cycles.<\/p>\n
Fourth, Indonesia can support the efforts of international
\nagencies such as the World Bank and the International Monetary
\nFund to seek new institutional means for responding to crises
\nthat disrupt world financial markets. The Mexican crisis of less
\nthan a year ago drew the world's attention to the serious
\ndisturbances that can result from the integration of capital
\nmarkets and the ease with which money now flows across
\ninternational borders. Large capital inflows can mask imbalances
\ncaused by poor macroeconomic management, and capital -- including
\ndomestic capital -- can bail out in a hurry when the imbalances
\nbecome unsustainable.<\/p>\n
Moreover, if investor confidence in one market is shaken, the
\nensuing ripple can threaten perfectly sound economies.<\/p>\n
Dr. Ali Wardhana is a former economics minister and is one of
\nthe leading architects of the New Order economy.<\/p>\n
Window A: As we strive to raise the level of technology in
\nIndonesian industry, we must be careful not to adopt policies
\nthat weaken our existing industries.<\/p>\n
Window B: We need to draw on a more complex set of management
\ntools and may even need to somewhat revise the incentives under
\nwhich some of our institutions operate.<\/p>",
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