Fri, 21 May 2010

From: The Jakarta Post

By Carunia Mulya Firdausy, Jakarta
The CAFTA (China-ASEAN Free Trade Agreement) is widely opposed in Indonesia because there are strong fears here that Chinese products will severely damage the country’s economy.

But as the implementation of the ASEAN Economic Community (AEC) is only five years away,
we need to start paying it the attention it deserves, as its impact could be even more severe on our economy.

Unlike the negative impacts brought by CAFTA, AEC will not only hit the commodity sector harder, but also the capital and employment sectors.

This is simply because under the AEC it has been agreed that capital and skilled labor will be able to move freely within ASEAN member countries. So, what benefits will the AEC bring?

Certainly, there are many reasons why the AEC is needed to be pursued by Indonesia. Of these reasons, the need to increase of the inflow of foreign direct investment (FDI) to Indonesia has been argued as the most important.

Apart from new capital inflows brought by FDI, it will also bring in new technology, modern management methods, foreign exchange and provide the country with better access to export markets.

ASEAN as a region has somehow been able to maintain its competitiveness, even against the economic juggernaut that is China.

This fact, of course, denies the popular belief that the rise of China will absorb most FDI flows, leaving little for a smaller region like ASEAN.

The share of world FDI flowing into the ASEAN region has been recorded at around 3.6 percent from 2003 to 2009. Meanwhile, during the same period, China’s share of world FDI inflows declined drastically from almost 10 percent to 4.6 percent.

UN Conference on Trade And Development (UNCTAD) in its 2008 report argued that under the AEC structure, ASEAN will be able to provide a favorable investment environment, which will subsequently lead to more resilient economic growth and further progress in regional integration.

In addition, intra-ASEAN investment will increase significantly as a result of the present strong cross-border merger and acquisi-tion sales and strong reinvested earnings.

Indonesia, Malaysia, Singapore and Thailand, for example, received over 40 percent of FDI inflows from reinvested earnings.

This phenomenon was supported by the Balance of Payment data from Bank of Indonesia, in which most FDI flowing into Indonesia came in the form of equity capital and re-invested earnings.

Another contributing factor to support AEC is due to the present trade linkages and the development of regional trading arrangements in ASEAN.

Previously, it was true that Japan, Taiwan, Hong Kong and Korea are important sources of FDI to the ASEAN economies as they continue to relocate their labor-intensive manufacturing production to these lower cost economies.

This has now change in that Japanese firms are now shifting their low cost production bases away from ASEAN, especially Malaysia and Indonesia, and into China.

Indonesia will no doubt benefit from the AEC. However, a long list of improvement should be made. While three conducive economic environments - macroeconomic policies, the trade regime and domestic competition policies - remain necessary, the government must recognize the needs and the problems faced by FDI.

These problems are not only related to infrastructure and legal certainty, but also with regional bylaws, labor regulations and other administrative paper work and management.

In this context, the government has to speed up the assessment of local regulations and nullify contradicting local regulations as the part of the objectives of the 2007 Capital Investment Law.

Finally, to move forward after the global financial crisis, Indonesia needs to diversify its export structure in order to reduce its vulnerability to exogenous shocks of commodity prices and promote employment growth.

Diversification can be achieved by promoting high-tech manufacturing or more efficient resource-based and natural resource processing sectors, as these have substantially lower degree of concentration than primary sectors.

Also, learning from the financial crises of the late 1990s and 2008, it is observed that short term capital flows such as portfolio capital or banking loans are vulnerable to internal or external shocks. In view of this, promoting more FDI is arguably better strategy for long term investment financing.

The AEC will be upon us soon, so serious preparations must be made to maximize the benefits that it has the potential to bring. Otherwise, like with CAFTA, it will be too late.

Indonesia needs to diversify its export structure in order to reduce its vulnerability to exogenous shocks of commodity prices

The writer is Professor in economics and deputy for the state minister for research and technology.