Fri, 19 Nov 2010

From: The Jakarta Post

By Silmy Karim, Jakarta
It is a stretch of the imagination to think that domestic capital offers more benefit to a nation compared to FDI (Foreign Direct Investment) or vice versa.

This is a false dichotomy, dressed in rhetoric for political expedience. In and of itself, origin is less meaningful than impact. What matters are outcomes; they are what ought to be measured.

Indonesia targets growth of more than 6 percent per year, for which it would need Rp 10,000 trillion (US$1.1 trillion) in investment over the next five years. About 55 percent of this is expected to come from private capital. This cannot be met by domestic sources alone.

Indonesia’s fiscal capacity has been only 15 to 20 percent of GDP. Its banking system is constrained by an asset base of $250 to $300 billion. Total pension funds, at around $40 billion, have been typically parked in short duration instruments.

If domestic capital is limited and much of it is not deployed for long-term productive purposes, then it is by process of elimination that FDI picks up the slack, both in terms of investment size and social benefit. Money must come from somewhere if the wheels of social progress are to continue to turn.

Indonesia’s neighbors recognize FDI’s role in development. China, Malaysia, Thailand and Vietnam have sophisticated promotion strategies designed to grab FDI - employing fiscal incentives, nation-branding, enabling regulation, among others. Indonesia therefore needs to catch up to their performance.

Undue suspicion about FDI will not help that cause. The economies with which Indonesia ought to keep pace seldom makes a peep about the FDI. From a nationalist perspective, there perhaps is no better example than China from which Indonesia should take its cue.

Today China leads non-OECD countries as the largest recipient of global FDI inflow, accounting for over one-third of their FDI. Its strategy focuses not only on obtaining greater quantity but also better quality of FDI.

Chinese authorities have remarked that their challenge is to attract “high-quality foreign direct investment”, that is FDI that supports the continued rise in social welfare.

“The only businesses that will lose out from rising FDI levels are those who seek to be coddled by the government against the coming of change and competition.”

Appreciate the inference from this statement. A nation historically inward-looking and fiercely proud of that fact thinks that foreign capital can help its people gain a higher standard of living than it can attain through its own means.

Multinational companies with a foothold in China’s market have enhanced capital formation and export competitiveness. In its manufacturing sector, they have had a positive impact on job creation, mainly by opening access to export markets and transferring knowledge to domestic firms.

Indonesia must also leverage FDI’s extra-financial benefits. Studies have found that FDI can create jobs, one of Indonesia’s development goals. Karlsson, Lundin, Sjoholm and He (2007) offer empirical evidence bearing out this relationship in China, the typecast for an economy biased towards domestic actors.

FDI creates not only more but also better jobs. Foreign firms are self-interested in sharing competitive gains. They rely on pay incentives to ensure quality and productivity because of the cost of monitoring from overseas.

They offer above-market wages in an effort to reduce labor turnover and the risk of their competitive advantage from spilling over to rival firms.

There is a debate in academia about FDI’s effects but data supporting the linkage between FDI and job creation is convincing and accessible if one is curious enough to take a look.

Such research on Indonesia is limited but growing. Dhanani and Hasnain (2002) find that FDI in Indonesia positively affects job growth in the manufacturing sector, total capital formation, transfer of knowledge and technology, tax and net export revenues. Anderson (2000), Takii and Ramstetter (2003), Todo and Miyamoto (2002), and Blalock and Gertler (2002) all find that FDI in Indonesia’s manufacturing sector raises productivity levels.

Arnold and Javorick (2009) show that, by the third year of foreign participation, Indonesia’s plant productivity becomes 13.5 percent higher.

More importantly, the economic gains to Indonesians who help make the manufacturing plants become more productive are substantial. Lipsey and Sjoholm (2002) find that manufacturing plants with foreign ownership in Indonesia pay higher wages than those exclusively held by local owners.

OECD shows that foreign participation results in a rise in average wages. The study concludes that, by the third year of foreign participation, the average wages increase in Indonesia was by a factor of between 10 percent and 20 percent.

Implicit in these studies is the notion that productivity and wages tend to rise not because of some work ethic that foreign participation brings but rather because of gaps in access, ideas and technology that foreign owners must fill to compete in production centers and markets overseas. FDI’s effects thus do not turn on geography per se, either origin or destination.

This is a subtle yet significant point to make for recipient economies of FDI with a post-colonial heritage. In Indonesia, this must be underlined, lest some try to score political points by exploiting legacies that collectively linger.

It should also be stressed that wholly owned domestic firms also can benefit from FDI. This happens through natural economic forces of cooperation and competition, through backward and forward linkages in the supply chain and labor mobility within industries.

The only businesses that will lose out from rising FDI levels are those who seek to be coddled indefinitely by the government against the coming of change and competition.

Preferential government treatment for strategic sectors and infant industries undoubtedly has a place in policy formulation and implementation.

But the boundary and duration for this shelter must be defined, communicated and enforced, otherwise protectionism will be entrenched and the point of government assistance will become moot.

One of the government’s tasks is to map our nation’s economic vision and coordinate the means to achieve that end. In our democratic system of governance, differences in views are the strength of our nation, but debates need to contribute to growth and to maintain focus on keeping public servants accountable for outcomes.

The writer is a lecturer at Paramadina University.