RI's foreign investment and technological development

RI's foreign investment and technological development

By David Ray

MELBOURNE (JP): In my articles last year in this paper I argued that producing and using "ideas" (technology) was crucial to Indonesia's continued development. "Producing ideas" essentially means product and process innovation as well as research and development, while "using ideas" means exploiting technology that is already available in advanced countries. The focus of this article is on the latter.

For many developing countries like Indonesia, the most common method of learning and using foreign technology is through some form of contact with transnational corporations. Technology transfer from such corporations to local firms can be generated through a licensing agreement or through direct foreign investment.

The type of foreign investment attracted to a country is indicative of the host country's technological capacity. Higher human capital levels and a better-developed science and technology infrastructure would not only attract more technology- intensive foreign investment but also facilitate greater technology transfer.

In Indonesia's case however there is widespread skepticism about the technological benefits from inflows of foreign investment, or resulting spin-offs. Much of the recent inflows of foreign investment have been in low-tech labor-intensive manufacturing, such as textiles, garments, shoes, consumer electronics consisting primarily of assembly operations using imported parts and components.

Critics such as Technology Minister Habibie see such investment as "footloose", suspecting that it will simply relocate elsewhere whenever domestic wage rates get too high, and can therefore not be relied upon to help generate a stronger industrial structure.

Much of the dramatic increase in foreign investment approvals over the past 7-8 years reflect the trend for relocation of foreign industrial firms to Indonesia.

The recent liberalization of foreign investment laws, plus the relatively low wages and less stringent environmental regulations have made Indonesia a popular destination for relocation investment from firms in Japan, the United Kingdom, the United States, Taiwan and Singapore.

The key issue for Indonesia is whether these investments represent the relocation of a number of "sunset" industries that contribute very little to the host country's technological development, or whether such investment is becoming more knowledge-intensive commensurate with Indonesia's need to "move up the technology ladder.

To explore this issue I shall use methods developed here at the Center for Strategic Economic Studies as a means to construct an index of technology composition for Indonesia's incoming foreign investment.

Using this approach we can divide Indonesia's foreign investment into 22 main industry groups according to their degree of knowledge-intensity. This is measured by the average level of Research and Development expenditure per unit of production in those industry groups for the OECD countries taken as a whole.

The highest R&D-production ratios are found in industries such as aerospace (20.2%), computers (12.4%) and electronics (10.8%) whilst the lowest are in the wood and furniture (0.1%), paper and printing (0.2%) and textiles and clothing (0.2%) industries.

The investment data are then weighted using these R&D ratios, summed and rebased to produce an index of technology composition whereby an index value greater than one indicates that inflows of foreign investment are concentrated in industries with a high R&D intensity, while a value less than one indicates a concentration in industries with low R&D intensities.

Empirical results suggest that there is a general upward trend in the technology composition index of foreign investment. However, the series is very uneven due to the "lumpiness" of the data, as there are large jumps in investment approvals for certain industries. The upward trend of the technology index is made significantly clearer using five year averages (see graphic).

There are however a number of important caveats that need to be mentioned before interpreting these results.

Firstly, it must be remembered that the index has been constructed using R&D-production ratios from the OECD countries from the late 1980s.

However for any specific country, be it developed or developing, the R&D intensity of production might be quite different to that of the OECD average, reflecting the unique conditions of that country at that time.

One of the key problems with this approach is that it assumes that the knowledge-intensity of activities in, say, the electronics and pharmaceutical industries in the OECD countries would be the same as that in Indonesia.

In the OECD such industries focus their activities more toward research and design in stark contrast to Indonesia where the electronic and pharmaceutical industries are involved in mainly assembling and packaging with little or no R&D activities.

Another important caveat relates to what exactly the data represents. Due to data constraints, the above empirical analysis focuses on investment approvals rather than realized investment.

This has become standard practice for those researching both domestic and foreign investment in Indonesia. Only about 40-50% of approved investment is realized. This reflects, amongst other things, the complicated bureaucratic procedures involved in investing in Indonesia, and the fact that investors file multiple applications and later seek capital backing for successful projects.

Some Indonesian economists argue that there is little point in relying on the BKPM (Investment Coordinating Board) data to accurately measure the inflow of foreign investment. For the purposes of this study, however, the BKPM data is able to show what type of foreign investment is attracted to the Indonesian manufacturing sector. As the above graph indicates, foreign investment over the past few decades has gradually become more knowledge-intensive commensurate with Indonesia's need to climb the "technological ladder."

The writer is a researcher/doctoral candidate/consultant at the Center for Strategic Economic Studies, Melbourne Australia.