Indonesia's next economic recession just around the corner

Indonesia's next economic recession just around the corner

Hans W. Vriens, Managing Director, PT APCO Indonesia,
Jakarta

A sad picture appeared on the front page of The Jakarta Post
on July 6. Some 500 workers of a factory producing Reebok shoes
protested in front of the U.S. Embassy. They demanded that the
embassy take "moral responsibility" following an unexpected
termination of orders for Reebok shoes placed with the Bandung
factory. The protestors said that all 5,400 employees faced the
threat of being fired.

This factory producing Reebok shoes is not the first or the
last to close. About 100 out of a total of 300 Indonesian shoe
manufacturers have closed shop in the last three years, according
to the Indonesian Footwear Association (Aprisindo). Exports fell
by a staggering 40 percent in the first five months of this year
compared to the same period in 2001. This is on top of a 30
percent drop last year, explained Djimanto, Secretary General of
Aprisindo in an interview in Sinar Harapan last week.

"All footwear factories will be shut down in the next five
years," predicts Anton J. Supit, of Aprisindo.

He is probably too optimistic.

A combination of disastrous government policies will likely
lead to a more rapid death of the shoe industry.

In particular, a new labor law will lead to an exodus of labor
intensive industries, like shoe manufacturing. Textiles and
garments will follow after the elimination of quotas at the end
of 2004. The toy industry has already moved to China. The
furniture industry is also moving to the Middle Kingdom.

According to the labor bill, night-shift workers will not be
allowed to work for more than 35 hours per week; and companies
have to pay severance pay to employees who voluntarily resign. It
obliges companies to pay workers salaries during a strike. On top
of this, it threatens jail terms for employers who are in
violation of these regulations.

I suspect few employers look forward to the risk of being
thrown in jail by judges, 90 per cent of whom (according to some
statistics) sell their verdicts to the highest bidder. Many
foreign investors are excluded from these auctions as a result of
anti-corruption laws in their home countries.

The over generous labor law comes on top of steep increases in
minimum wages (39 percent) and the prices of electricity,
telephone, regional taxes and fuel. Indonesia is pricing itself
out of the market just at the moment when many outside Indonesia
wonder how to deal with increasing competition from China. A
highly productive army of Chinese will be producing even more
goods, more cheaply than ever before. World Bank studies show
that Chinese apparel production is expected to nearly quadruple
in the coming decade.

This export drive has been made possible because the Chinese
government keeps on investing billions of dollars in improving
its infrastructure (often with the help of foreign investors) and
the quality of Chinese universities.

The only improvement in the infrastructure in Jakarta I have
noticed in the last two years is the renovation of the fountain
at the Hotel Indonesia roundabout. A visiting American furniture
buyer asked a rhetorical question after a tour of furniture
factories: "Many prices have doubled since my last visit six
months ago. How can I place orders in Indonesia when I can buy
the same furniture for less than half the price in China."

Another industry that will collapse in Indonesia is mining.
Indonesia is the second largest tin producer in the world; no. 4
in copper, no.5 in nickel, no.7 in gold and no. 8 in coal. All
very respectable figures. Mining should be thriving. Indonesia is
home to 50 percent of all natural resources in Asia. Instead, the
industry is dying. Less than 1 percent of exploration money is
allocated to Indonesia.

Again, a combination of poorly thought-through laws have made
Indonesia the most uncompetitive mining country in the world. No
exploration means no new mines. The decline of an industry that
contributed US$1.6 billion (or 2.5 percent of gross domestic
product) to the economy in 2000 will be painful.

One wonders what Indonesia's strategic plan is to deal with
the coming collapse of so many pillars of its economy. Finance
Minister Boediono summed up the government policies recently:
"The economy is almost out of the woods and economic indicators
are picking up with the rupiah and the stock market climbing in
recent months." Boediono seems quite pleased with the current
growth rate of 3 percent a year. He is fooling himself. The
arithmetic is simple. Indonesia's economy needs to grow by at
least 6 percent to create enough jobs to absorb about 1.8 million
new entrants into the work force each year.

At the current rate of 3 percent of GDP a year almost 1
million will not be able to find a job. They will join the army
of under- and unemployed of around 45 million, one third of the
work force. The only way to deactivate this time bomb is to
achieve GDP growth rates of 7 percent or more. This can only be
achieved through a steep increase in foreign and domestic
investment. Massive inflows are needed to improve Indonesia's
highly dilapidated infrastructure and generate jobs in the
private sector.

Indonesia is not terribly successful in attracting foreign
capital. From an inflow of US$11.5 billion in 1996, private
capital has been flowing out of the country at a rate of about
US$10 billion a year in the last four years, according to the
International Finance Corporation.

The main reason is a lack of confidence in the country's
business environment. More specifically, it is apprehension
regarding what has become one of the worst legal systems in the
world. Several high-profile lawsuits have made Indonesia the
laughing stock of the world. Kaltim Prima Coal is being sued by
the provincial government, the recent bankruptcy ruling against
the local subsidiary of Manulife and the way Pertamina keeps on
defying a string of U.S. court orders in the Karaha Bodas case.

"Pertamina's continuous disregard for the U.S. and
international law succeed only in perpetuating the worst fears
that many foreign companies have about doing business in
Indonesia. Pertamina is not acting in the best interest of
Indonesia. Its contemptuous conduct is a cautionary tale for
other companies considering investments in Indonesia," says
Christopher Dugan, chief litigator for Karaha Bodas, the company
that had planned to build two geothermal power stations in West
Java before the crisis.

His words seem prophetic.

Hardly any power stations are being build at the moment. "As a
result the lights will go out all over Java next year", predicts
the president director of a large foreign power producer in
Indonesia. "Java has no spare capacity. We can expect major
brownouts starting soon." In fact, it is already happening. Many
parts are already being hit by power outages several times a
week. The economic consequences of this power crisis will be
severe. Factories without electricity will find it difficult to
keep operating. A similar crisis in the Philippines in the early
1990s stripped 1.5 percent from GDP.

One doesn't have to be a rocket scientist to understand that
the accumulation of all these developments will result in an
economic recession. An economy cannot be forever powered by
consumption alone. Investment is a conditio sine qua non for
long-term economic growth. So, why do so many government policies
result in chasing investment away?

PT APCO Indonesia is a wholly owned subsidiary of APCO
Worldwide, a Washington-based global firm, specializing in public
affairs and strategic communications.