Attracting foreign investment requires substance in policy reform
Dan Kingsley Jakarta
The Indonesian economy, following the adoption of a tightening monetary stance by Bank Indonesia in mid-August and strengthening inflation due to the recent fuel price increase, has shown declining economic growth in the last half of 2005. It accepted that this is due to weakening domestic consumption, and that growth in 2006 must be catalyzed and maintained through foreign investment, as export growth has also weakened relative to other ASEAN countries. This marks the onset of a new cycle for the economy into 2006 .
However, the economy's fundamentals have strengthened following macro-economic consolidation and the implementation of structural reform during the past few years so the adjustment of fuel subsidies, will have a positive impact on the fiscal position and the balance of payments in the long run. These developments highlight the critical impact that foreign investment -- or domestic investment through repatriation of the billions of dollars in off-shore funds held by the elite -- will have on future growth potential.
The Indonesian economy must reduce non-labor and production component costs to improve its global competitiveness, the key to attracting foreign direct investment (FDI) and expanding its manufacturing and agricultural export markets. Given that the global economy is consolidating, it is vital that the Indonesian economy become competitive globally in order to keep it's old markets and develop new markets, and attract new (Greenfield) investment to create jobs and generate new revenue streams. Law and policy reform to facilitate a more transparent and transaction-cost free market economy with reduced bureaucratic constraints will be attractive to foreign investors.
Over the past five years, the country has lost FDI relative to other developing countries with similar human resource potential and natural resources. Research shows that over regulation and selective regulatory enforcement of taxation and labor laws are just a few of the contributing factors to this deteriorating situation. A high cost economy encourages investment from those countries that will have little impact on sustainable growth, usually from countries with similar ( high transaction cost, rent seeking officials) public sector implementation policies and procedures.
These practices encourage investment in "black" markets, such as illegal logging, unsustainable natural resource exploitation, and imports, at the expense of domestic production and government revenue. The legitimate foreign investor, local entrepreneur and employees are the victims, while businesses in those foreign countries prosper.
There have been high profile conferences, like the infrastructure summit, and "theme" economic initiatives sponsored by Aburizal Bakrie when he was coordinating minister for the economy, but the need is for substance in government initiatives to facilitate and catalyze FDI flows. Foreign investors are interested, but only in secure investments. They require reform in political mechanisms, legal enforcement, and policy for government staff/officials. These issues need to be addressed if Indonesia plans to attract FDI.
Infrastructure, agricultural and export oriented sectors can attract FDI if there are transparent government offices, and processes and procedures. The investors that want to follow procedure and policy require effective enforcement for financial security, transparent laws and regulations for efficiency. The priorities that the government should set to attract these investors can be based on simple principles:
o Create a secure legal framework for policy implementation and accountability
o Enforce regulatory transparency
o Eliminate selective legal enforcement processes
o Implement institutional efficiency and equity
Institutional development that promotes efficient resource allocation, open markets, transparency and, ultimately, competitive advantage in the new international economy, will invite investment opportunities. It requires democratic principals in policy management, mechanisms for accountability and transparency, and a restructuring of the existing management (status quo) in those institutions.
Clear policy directives will help to establish a positive perception encourage FDI flows to Indonesia rather than other countries, as would policy consistent with free market principles. Numerous studies have shown that there are unresolved and outstanding policy issues contributing to the poor competitiveness of the Indonesian economy. The following reforms may be necessary to improve FDI flows:
o Build capacity of public sector institutions to work on behalf of the people
o Simplifying administrative procedures
o Improving administrative services
o Improve access to, and dissemination of, information between the private sector and government institutions
o Build structural changes in the governments institutional communications process
o Develop criterion to eliminate ambiguous and inconsistent legalities
o Improve accountability to eliminate selective enforcement
o Empower more than one (currently only police) government institutions to enforce legal compliance
The private sector elite and public sector status quo will continue to create barriers to these changes , and the effect is a constraint on the FDI flows that are so urgently needed to drive growth and job creation.
The infrastructure, agriculture and natural resource sectors are critical growth and employment sectors that can attract Greenfield investment, and new jobs and markets. Tourism, manufacturing (auto parts garments/textiles, metal products, electronics, machinery), chemicals food and beverages industries are all attractive sectors for this type of investment.
Foreign competition for FDI is very strong, however, and cost becomes a comparative factor for an investors when choosing a country. The comparative high cost of Indonesian products and exports have, and will continue to, reduce the amount of FDI in the export oriented sectors.
Forecasts for FDI in Asia show that future FDI flows to top developing countries will be in human capital-intensive industries, which is perfect for Indonesia. Investment in construction and ICT-related activities, from outsourcing by western countries would benefit Indonesia. Although China, India and Thailand are expected to be the top FDI destinations in the Asian region, Indonesia is expected to attract investment ahead of Singapore and Vietnam.
It should be noted that investing corporations planning investment in Asia were surveyed in this extensive UNCTAD report, and that this was consensus of those corporations for the economic prospects in Asian region from 2004 to 2009. This is the reality of the situation Indonesia faces, and is not something that can be ignored through positive press releases or high profile conferences.
Large amounts of investment in India and China will not necessarily result in a loss of investment for Indonesia and may promote investment in Indonesia from those countries. Countries are interested in investing in Indonesia, such as Singapore, China, India and the Middle Eastern countries, due to high natural resource and labor prices in their countries. This is not the sustainable investment that Indonesia so desperately needs, and is this the type of investment that Indonesia needs in the long term?
There are three relevant issues that must be addressed sincerely by the Indonesian government at the national, including the Parliament, and at the provincial level as Indonesia competes for badly needed FDI:
* An attractive and secure enabling environment, which offer the highest risk-adjusted returns. Indonesia will need to develop the appropriate enabling conditions to make return on investment worthwhile to the investor.
* The long term outflows from non-western countries and the inflows to China will necessitate an understanding of the global FDI environment. This will be less favorable to Indonesia than in the 1980s and 1990s, as Indonesia will be held accountable to investors through its internal legal system.
* Although FDI will be a critical element, the key to successful economic growth will be structural and implementation policies within the government economic ministries. The government must develop a higher revenue stream through taxation and new business growth that enables investment in human capital through education. This operational policy must be supported by effective, equitable and concrete enforcement and compliance policies.
Indonesia's rich natural and human resource base is attractive to any legitimate investor, but since the period of the Dutch East India Company the elite have traditionally controlled the policy process rather than all stakeholders. Many foreign investors were naive in the 1990s, but now they will be wary of investing in Indonesia until the processes of law and policy making, enforcement and implementation are consistent with free enterprise and international best practices.
Collaboration between policy makers, regulatory implementers, legal enforcers and the private sector in the processes to facilitate greater transparency are other reform measures that will attract the larger, more sustainable investment from the more transparent countries , including the U.S., Britain, France, Germany and Australia.
Dan Kingsley is Chief of Party, USAID Global Infrastructure Development Partnership in Washington DC. He can be reached at dkingsley@tmiconsulting.com.