RI needs incentive environment

RI needs incentive environment

By David Ray

BANDUNG (JP): Investigating determinant of Indonesia's long term economic growth is a difficult task. Short term issues cloud the long-run horizon. Since Indonesia gained independence in the late 1940s the country has undergone so many dramatic changes in its economic and political circumstances that it is difficult to isolate what has been the key determinant of long-run growth.

Throughout much of the 1950s and early 1960s, political instability and poor economic management prevented the economic from achieving a higher rate of development. From the mid-1960s to the mid-1970s economic rehabilitation and the introduction of a more liberalized policy environment generated a number of short-run growth benefits. Beginning in the early 1970s and extending until the crash of international oil prices in the mid- 1980s, the Indonesian economy was driven by the huge inflows of oil money and the subsequent highly interventionist and regulatory policy stand of the government. Since the mid-1980s Indonesia has enjoyed the previously unexploited short run growth benefits associated with the move by industry into low technology labor intensive manufacturing -- the area where Indonesia is most competitive according to proponents of the comparative advantage trade theory.

But is this final stage representative of Indonesia's long- run growth path? To answer this we need to consider what has been the key determinants of long-run growth internationally.

Economists have struggled to come up with a realistic and consistent theory on why some countries grow faster than others. The one point where there is consensus is that technology is an essential feature of modern long-run growth. It is no coincidence, for example, that the dramatic improvement in global economic conditions that has occurred over the past two centuries has also been accompanied by equally dramatic technological developments.

Thus it is ideas of knowledge about the way we make or do things that generates economic value and therefore growth. Consider the example of two computers, one built this year and the other ten years ago. The raw materials required to produce both computers are essentially the same. The big difference, however, is the more sophisticated knowledge required for the production of the newer computer.

So where does this analysis leave us in terms of Indonesia's long-run growth path? The answer is simple. To generate higher long-run growth, Indonesia need to move into more knowledge based or value-added production. Low-technology, labor-intensive manufacturing has given Indonesia a decade of impressive growth but this will not continue. The recent downturn in many of Indonesia's export prima donnas suggests that the next decade will not be as simple as making use of an abundance of low- skilled cheap labor.

The emergence of China and India -- who themselves have been able to move into more knowledge based production -- as regional competitors in low-technology and labor-intensive manufacturing, as well as the development of a number of labor saving technologies in the West, compels Indonesia to move up the technology ladder. This means better and more innovative designs and processes. More importantly, it means cheaper products so that Indonesian goods such as shoes. garments, textiles, wood and electronic products remain internationally competitive.

But Indonesia should not continue to produce just these types of goods. Patriotic sentiment and indeed good economic sense require that Indonesian industry diversify to new knowledge based goods. The computer and electronics industries (beyond the assembly stage) is the most apparent choice right now.

So the key question is how to improve the technology or innovation capacity of Indonesian industry. Rather than selectively developing just a few high-tech industries which end up operating in a high income enclave with little or no linkages to the local economy, a more effective policy approach is to provide functional assistance to all industries.

Such functional assistance could include policies to improve human resource levels since skillful, educated people are better equipped to deal with modern technology. Similarly, government research and development needs to be better linked and driven by the private sector. Foreign investment needs to feel more welcome here -- particularly technology intensive long term investment. The right sort of arrangements must be established to facilitate technological transfer like in Malaysia.

But most importantly, Indonesia needs to have the right incentive environment that will foster private sector innovation. This means ensuring a competitive domestic environment where industries are not controlled by a few large firms or cartels, but where firms compete with each other to produce better quality and lower-price goods.

The writer is a researcher and doctoral candidate at the Centre for Strategic Economic Studies in Melbourne, Australia.