Low productivity in the textile sector

Dan Kingsley, Jakarta

We have read quite a bit recently about how Indonesia's non- oil manufacturing exports have been decreasing. In fact, there has actually been negative investment in this sector if the number of international trading companies (export manufacturing, retail buyers, international investors) that have left the country is taken into account.

Given that non-oil manufacturing exports are mostly comprised of labor-intensive industries such as garments and furniture, many Indonesians lost their jobs in recent years, while an average of 2-2.5 million new job seekers are estimated to be entering the labor market annually. The textile and garment industry is a major labor-intensive source of employment opportunities. It has, however, seen a decline in international competitiveness due to rising labor costs and other factors, including recent increases in infrastructure costs, national autonomy measures and tight lending policies.

It has been anticipated by many foreign buyers, branded label companies, and manufacturing firms that the situation will only worsen in the textile/garment sector beginning in 2005, when the implementation of the quota free era begins. At this time the 10 year phase out period established at the Uruguay Round will end, and quotas from 146 World Trade Organization (WTO) member countries will expire.

Two key factors challenging the industry today -- increased competition from lower-cost overseas producers and the imminent end of the quota system -- are to a large extent beyond the industry's control. Of course the second factor cannot be controlled, as foreign buyers try to establish new sources in countries such as China and Vietnam. In these countries higher productivity in factory production translates into cheaper prices.

This is not to say that the Indonesian worker is less productive. Indonesian garment and textile worker, supervisors and managers are very experienced in fact, and are as productive as those in other countries given the same machinery and factory conditions. However, due to a lack of new investment in the industry, many workers are working in old, outdated factories and with technologically uncompetitive machinery.

As in any manufacturing industry it is necessary to continually update technology in order to remain competitive.

The lack of capital reinvestment in new machinery and facilities has not been consistent with either the global competition, or with what would be considered best business practices.

A comprehensive survey by PT Sucofindo surveyor company of over 4,000 companies between 2001 and 2004 revealed the fact that to be globally competitive the industry must invest over USS500 million. The ministry of trade and industry has acknowledged this.

Why, if labor costs are relatively cheap in Indonesia, are producers successful under the era of quota restrictions choosing not to re-invest in the industry as the non-quota era approaches? These are smart businessmen, who have obviously researched the competitive situation through their buyers, if not directly. They know the relative costs of production in other countries, so they obviously feel that Indonesian costs are not competitive, and choose not to compete on a level playing field.

It comes down to productivity; costs in Indonesia are higher because the total process of buying components, hiring labor, producing the product and getting it to the shop or port is higher than in other countries. This process is known as the supply chain, and to become globally competitive the sector must reduce these supply chain costs to levels at or below competing nations.

It is vital that we look at all of the factors contributing to the high cost/productivity ratio along the production chain:

Labor costs: Recent labor regulations on severance pay, and especially Law No. 13 passed in December 2003 on manpower, have drastically increased the costs of doing business. Foreign competitor countries do not require the exorbitant costs incurred through similar labor laws in their respective countries.

The supply chain: These costs will include local transportation, local government charges and "lobbying" charges. Each of these three components in the supply chain was estimated to be up to 3 percent of total production cost.

There will be serious problems when honest hard working people lose their jobs due to inefficient production. This will be compounded by the fact that many factories will plead that they do not have the funds for severance pay, and make the necessary donation to the relevant authority to back them up. Then things will really hit the fan, so to speak.

Astute measures to counter this disadvantage in the short term have been proposed, such as signing free trade agreements with large buying countries such as the U.S. in order to reduce tariffs. However, the government should take a serious business diagnose of why the costs of domestic production have been so high.

The write is Managing Director of Trade Management and Development Services (dkingsley@tmiconsulting.com).