Domestic and international trade complement each other

Domestic and international trade complement each other

The following article is excerpted from an address at a
conference on globalization, domestic trade and decentralization
in Jakarta on April 3. The writer, William E. James, chairs the
research division of the International Centre for the Study of
East Asian Development. The event was organized by the
Partnership for Economic Growth, the United States Agency for
International Development and the Indonesian Ministry of Industry
and Trade.

JAKARTA: One of the clearest stylized facts of modern economic
growth is that it has been accompanied by the growth in
international economic transactions, particularly the volume of
international trade.

Historical data indicate that world trade volume, measured by
exports, has risen relative to world production from under two
percent in the early 19th century to about 15 percent today.

During periods of prosperity the ratio of trade to production
has risen and in periods of depression and war it has fallen.

The lowering of protective barriers to international
transactions under the General Agreement of Tarrifs and Trade/
World Trade Organization, at the regional level and through
unilateral reform has eased the flow of international trade and
investment.

The consequent rise in trade volume brought about by this
process has delivered unprecedented gains to both developed and
developing countries. And while this expansion of international
economic activity, often associated with "globalization" has been
asserted to be a dominant trend, in reality it is more modest
when measured against domestic trade and economic activity.

Domestic trade and production remains the most important share
of economic activity despite globalization.

This so-called home bias is reflected in studies of trade
between states and provinces across one of the most open borders
in the world, that which separates the whole of continental
Canada and the lower 48 states of the United States.

Trade flows across the U.S.-Canadian border are amongst the
freest in the world. Empirical analysis of inter-provincial trade
flows within Canada reveals that such flows remain many times as
dense as the trade that flows across the border to the United
States despite the free trade agreement between the two
countries.

Foreign direct investment (FDI) is also often cited as a major
facet of globalization, but FDI rarely exceeds a small fraction
of national fixed capital formation.

Indonesia's experience with more open trade and FDI is worth
considering. Most studies have found that greater openness has
been positively associated with growth and productivity.

Indonesia has deregulated imports and foreign investment and
benefited from the surge in FDI inflows between 1986 and 1997.

Recent data from the 1996 annual census of manufacturing
reveal that plants with foreign ownership account for 16.5
percent of manufacturing employment and about 30 percent of
value-added.

Not only is average labor productivity higher in
establishments with foreign ownership, but wages are also
significantly higher even when factors such as education, plant
size and input use, as well as industry characteristics, are
taken into account.

Moreover, the presence of foreign owned establishments has
exerted an overall positive impact on manufacturing wages of
Indonesians in domestic establishments.

Beyond the beneficial effects, foreign owned establishments
have significantly higher export-sales ratios than domestic
establishments.

The prospects for national economic growth and development in
today's Indonesia seem to hinge critically on the decisions that
are taken with respect to economic activity at the level of local
government.

Advocates of fiscal decentralization argue that devolution of
fiscal powers to local governments tends to enhance efficiency:
local government is more accountable to their constituency than
is central government and local government is better informed
about local demand for public goods and services.

Fiscal decentralization therefore should lead to a more
efficient allocation of resources and is expected to be
positively associated with growth in real gross domestic product
per capita of the country as a whole.

Critics of fiscal decentralization have warned of the dangers
of corruption among local officials, a problem that cannot be
taken lightly in the Indonesian context.

In particular, with decentralization in Indonesia, concerns
have been expressed over the propensity of local authorities to
impose arbitrary taxes and restrictions on domestic trade, to
restrict citizenship rights, and to adopt discriminatory policies
towards businesses located outside the local jurisdiction.

Excessive taxation of commerce between the regions and
localities would be harmful to the national interest by
increasing costs to firms and individuals, introducing further
uncertainty in an already difficult investment environment, and
by rendering Indonesian goods and services less competitive in
foreign markets.

Decentralization and the local autonomy movements in the
regions today are in an important sense a backlash against
previous government's overly centralized control.

With decentralization, it is predictable that regions and
localities with valuable natural resources will demand a greater
share of the resource rents. A fair system for revenue-sharing is
essential.

However, it is critical that local governments adopt
appropriate policies and fiscal instruments.

What is clear from experience is that taxes on domestic trade,
particularly those that discriminate against producers in other
localities, are harmful to national economic welfare.

In principle both domestic and international trade are equally
important. The history of economic advance provides strong
evidence in support of this presumption. And this is highly
relevant to today's deliberations on globalization and
decentralization in Indonesia.

Countries that have impeded the relatively free flow of
commerce within their borders have lagged in growth and
development.

India is an example of the negative impacts such domestic
trade restrictions have on a large, geographically contiguous
country. The adverse effects of internal trade barriers are
likely to be even more severe in an archipelago like Indonesia.

Domestic trade taxes, particularly those applied on movement
of agricultural products from remote rural areas are extremely
harmful in that they make it more difficult for low-income
farmers to benefit from distant urban markets in the country.
Multiple taxation of such produce is clearly against the
development of remote locations and may widen income disparities
between regions.

The concept of "voting with one's feet" is key to
understanding the problems of a decentralized fiscal system in a
democracy. Local governments must compete with each other in
order to attract business activity, private investment and
citizens with skills that confer benefits upon the community.

Competition among districts will ultimately constrain the
behavior of local authorities. If decentralization is to bring
benefits to local jurisdictions in Indonesia, use of appropriate
fiscal instruments will be critical.