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.