Attracting foreign investment requires substance in policy reform
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.