Beyond well enough

Beyond well enough

Arya B. Gaduh
Jakarta

The economy did rather well in 2005. Estimates by the Asian
Development Bank put its growth above that of the regional
(Southeast Asian) average and its ASEAN-5 neighbors.

Exports became one of the main sources of growth, contributing
to around 80 percent of total growth in the first two quarters of
2005. Non-oil-and-gas exports in the first three quarters of 2005
grew by more than 23 percent from that in the same period in 2004
-- more than double the growth in the first three quarters of
2004.

2004 2005 2006

ADO*Update**ADO*Update**
Southeast Asia6.35.455.65.4
ASEAN-5
Indonesia5.15.55.76.05.9
Malaysia7.15.75.15.35.3
Philippines6.05.04.75.04.8
Singapore8.44.14.04.54.7
Thailand6.15.64.05.85.0

Source: Asian Development Outlook 2005 Update. *Projection as
of April 2005; ** As of September 2005

Yet, this rosy picture from the top was contradicted by a
different picture on the ground. Exporters and businesses
complain daily about rising costs, both from policy action (e.g.,
domestic fuel price increases) and inaction. All of these
failings, they say, are eroding their international
competitiveness, particularly in the face of rising China,
Vietnam -- and, to a lesser extent, India.

How can we explain these conflicting pictures? In essence, I
think they describe both the potentials and risks inherent in our
economy. Undeniably, our economy, despite all the policy
problems, has been performing well enough -- pointing to the
resilience of the economy. However, intensifying global
competition will soon make well-enough not enough. The leap
beyond well-enough requires swift solutions to the problems on
the ground.

The evolution of Indonesia's export structure is illustrated
in the figure below. The vertical axis indicates the growth of
exports from Indonesia for the particular commodity, while the
horizontal axis indicates world export growth for the commodity.
The size of the bubble represents the share (in terms of value)
of a particular commodity's export to Indonesia's total export,
indicating its importance to Indonesia's export.

Two things emerge from this figure.

First, the growth of Indonesia's leading manufacturing sectors
-- notably electronics, textiles, wood and wood products, as well
as footwear and pulp-and-paper (not shown above) -- are either
stagnant or declining, despite the relatively strong growth of
these sectors in the world market.

Second, there is a marked shift from manufacturing products
toward primary commodities. The three sectors whose share of
total exports increased the most between 2000 and 2005 are palm
oils, base metals and natural rubbers, while the three whose
share declined the most are textiles, electronics and wood
products.

The changing structure of Indonesian exports reflects the
significance of China's entry into the global economy. Chinese
firms become strong competitors in the low-cost manufacturing
sector, but provide a market for our primary commodities. The
latter translates into some static gains for the Indonesian
economy. However, the shift away from manufacturing toward
primary commodities will sap the dynamism of the Indonesian
economy.

Direct competition with Chinese -- and, to some extent,
Vietnamese -- manufacturing firms highlights an important fact:
Indonesia is losing its comparative advantage in low-cost
manufacturing. The latest fuel-subsidy reduction policy, it was
argued, rubbed salt into the wounds of many manufacturers and
exporters of low-cost goods as it weighed down on their
competitiveness even further.

In response to such an argument, one minister reportedly
replied: "In other ... countries with similarly high fuel-prices,
(firms can manufacture) competitive products. Why can't we?" This
question was made more than 20 years ago by former minister of
industry A.R. Soehoed. Even so, it is as relevant now as it was
then -- especially since fuel prices in China -- and indeed, in
most of Asia -- are significantly higher than those in Indonesia.

Table 2. Prices of Diesel in Selected Asian Countries, November
2004
CountriesPrice per liter (US$)
China, People's Rep. of43
Southeast Asia

Cambodia61

Indonesia18

Lao People's Dem. Rep.63

Malaysia22

Myanmar10

Philippines34

Singapore55

Thailand37

Vietnam32

*Prices as of November 04. By November 2005, the Chinese
government has adjusted fuel prices upward three times.

Why is Indonesia losing competitiveness in low-cost
manufacturing? One possible explanation is the natural
progression of the economy: As the economy matures, high demand
for low-skilled workers drives wages upward, making labor costly.
While this might have been true prior in 1996, it is no longer
true. (Unemployment rate)

Another possible explanation, which seems to fit Indonesia, is
related to Indonesia's "business climate". A good business
climate can be defined as an environment that gives ample
incentives for all actors to engage in productive activities.
This notion can be interpreted in many ways, but it essentially
refers to an environment with a relatively high-level of
competition and low cost of doing business -- of which, Indonesia
is not.

A good illustration of this is the problem of trade
infrastructure in Indonesia's ports. Indonesia had the most
expensive terminal handling charges (THC) amongst its Southeast
Asian neighbors. Under pressure to "reduce the high-cost
economy", the Ministry of Transportation issued a regulation that
slashed the THC to US$ 95 in order to make the business climate
more competitive.

THC per container size(US$)

20 feet40 feet
Indonesia150230
Thailand6598
Malaysia90135
Singapore107158
Source: JICA (2005)

Yet, the THC is but one of many problems infesting Indonesia's
ports. JICA (2005) points to the quality of service and
infrastructure as one of the reasons why many ships avoid Tanjung
Priok Port. The reason for this poor infrastructure and service,
it argued, was the lack of competing ports in the area -- hence
it recommends improvement through the introduction of a second
port.

Arguably, no major improvement in economic policy-making
outside that of macroeconomic policy has happened in the past
year. Yet, despite this, the economy grew well enough. The
resilience of the Indonesian economy, not to mention its
endowment of natural resources, somewhat compensates for the
relative incompetence of policymakers.

As such, we are living in what MIT (Massachusetts Institute of
Technology) economists called "an 'age of diminished
expectations'...in which our economy has not delivered very much
but in which there is little political demand that it do better."
This kind of "policy of no policy" was good enough in the absence
of intense competition from abroad. But now, good enough is
simply not enough.

To move beyond good enough, productivity needs to improve.
Indeed, the most important policy to boost exports is not located
in trade policies, but in productivity-improving policies. For an
economy such as Indonesia, it is not too difficult to find such
policies. Reducing corruption, illegal fees, and other
transaction costs is one. Investment in infrastructure --
including in the "knowledge infrastructure" through basic
research -- is another. Creating a predictable business regime
-- particularly with regards to taxes, for instance -- is another
one.

All of these policies require good coordination. But more
importantly, a sense of urgency is required across the
administration, chiefly in the technical departments -- not only
in ministries traditionally associated with exports and the
economy -- and the legislature. Politicians need to be reminded
that the era when good enough is enough is (almost) over.

The writer is a researcher at the Centre for Strategic and
International Studies (CSIS), Jakarta. He can be reached at
abgaduh@cbn.net.id.