Varied motives color investment in RI

By Ilyas Saad and Asep Suryahadi

JAKARTA (JP): Indonesia is currently facing stiff competition in attracting foreign direct investment from other Asian countries, particularly China.

The large drop in approved foreign direct investment in Indonesia reported by the Investment Coordinating Board (BKPM) in February reflects the fierce competition. The government plans to issue new deregulation measures soon in order to improve Indonesia's competitive edge.

Actually, foreign direct investment is not only affected by pull factors, which determine capital allocation amid recipient or host countries, but also by push factors, which determine the size of capital flow out of source countries.

Therefore, in order to formulate correct strategies and policies to attract investment to Indonesia, the government needs to assess both the motives of investors from main source countries and the problems they are facing here.

Recent research shows that enterprises from the United States continue to be greatly concerned with domestic markets in host counties when choosing investment locations.

In general, U.S. investors consider developing countries unattractive for export platforms because of their tendency to reduce protection and set artificially high wages.

The U.S. entrepreneurs prefer to locate their plants for export oriented industries in more advanced countries because of better infrastructure, research and development facilities and highly skilled labor. They want to maintain their monopolistic capabilities in producing high quality goods through technology and capital intensive modes of production.

Japanese firms take a different approach. In the 1960s and 1970s, Japanese investors came to Indonesia with the motive of exploiting natural resources in order to maintain the continuity of raw materials supplies for their industries and the enlargement of their domestic market share through development of import substitution industries.

Since the middle of the 1980s, the motive has shifted to developing export platforms along with more widespread production and marketing networks. Manufacturing of export-oriented industrial products in Japan is not competitive anymore due to higher labor costs and the appreciation of the yen.

In the next few years, Japanese enterprises can be expected to push their investments abroad, but in non-traditional forms such as technology contracts, management contracts, franchise arrangements, turnkey projects and production sharing.

This development is supported by higher capabilities in technology and innovation as a result of intensive research and development activities. Inter-country transfer of technology through informational methods and the product cycle process will be faster.

This will make the monopolistic power and firm-specific advantages of Japanese enterprises of shorter duration so that direct investment becomes less attractive for them.

Newly Industrialized Countries (NICs: South Korea, Hong Kong, Taiwan and Singapore) have become one of the main sources of foreign direct investment in developing countries, including Indonesia. Export platforming also seems to be the main motive behind the flow of capital from the new industrial powers.

They seek the comparative advantages of the abundance of labor and low wages in developing counties, which have become rare in their own countries. For export purposes, they also try to maintain their market share of simple and labor intensive industrial products in host countries.

In the past, the NICs themselves were recipients of similar investments from Japan. Now they have lost their competitive edges in these industries so they have to step into more technology intensive sectors, although to some extent they remain in relatively skilled labor intensive sectors, such as electronics.

The development of technological intensive industries is conducted through systematic collaboration with Japanese firms. Japanese companies seem determined to maintain their dominant power in the production and marketing of electronic goods in Asian as well as global markets.

In this effort, some well-known Japanese companies have moved their supervision and research and development centers to NICs, particularly Singapore.

The movement of foreign direct investment from Japan to NICs and further to developing countries follows a pattern called the "flying geese style." It means that Japan as the main source of technology and capital "is flying" in the forward position, followed by NICs and then developing countries.

At the micro level, enterprise formation in certain industries follows a billiard ball pattern. An enterprise which undertakes a deficiency process will be automatically pushed out to look for a more efficient location. This means that a company's network will have a division of labor on a more widespread base area.

Although still relatively insignificant, there is a visible tendency for the intra-developing-countries capital flow to increase. Most of those movements are initiated by private investors who see business opportunities abroad, mainly through developing market shares.

Another motivation is that they want to start a process of internationalization for their companies.

Assessment of the motives of investors indicates that Indonesia is still considered an attractive alternative location for foreign direct investment. Therefore, it has become very important now to assess the problems faced by foreign investors in implementing their investments in Indonesia.

Basically, these problems can be separated into absolute and supportive conditions.

The first absolute condition involves the low level of capability and productivity of human resources. There is much evidence that Indonesian workers are slow in improving their productivity and have poor capability to absorb new technologies.

The second absolute condition is related to the low level of quantity and quality of infrastructure, particularly limited supplies of electricity, a dearth of communication devices and the lack of clean water.

This is a dilemma because most investment activities take place on Java where although infrastructure is more extensive than on outer islands, demand leads to shortages.

Infrastructure development on the outer islands has been left out of the investment picture almost entirely. This makes it very difficult for investors to find alternative locations.

There are six problems in relation to supportive conditions which can be identified. First, distortions in raw or intermediate materials importation procedures. Many investors feel obstructed by how slowly the SGS inspector works. In addition, many customs officials still manage to create as much red tape as possible.

Second, the use of expatriate staff by investors has to pass through rigid and difficult procedures. Actually, highly skilled foreign workers are part of investment activities. Since it is difficult to find workers with comparable capabilities in Indonesia, investors find the policy discouraging.

Third, the requirements of 100 percent foreign ownership is too rigid. The period for transfer of equity to the local partner is too short. Many investment activities are based on long-term perspectives.

The requirements disregard the conditions of investing companies and their local partners' capabilities. This creates an impression that foreign entrepreneurs are just being used to develop enterprises which, after they succeed, should be handed over to Indonesians.

A forced transfer of equity will push the local partner to look for sufficient domestic capital, while the foreign partner has to go out along with their capital.

Fourth, the time limit on the land-use license is too short. The regulation does not differentiate between footloose industries and resource based industries. In fact, the land-use needs of the two kinds of industries are very different.

Fifth, distribution and forwarding activities are closed to foreign direct investment. Investors feel that this has restricted their room for movement because the current distribution and forwarding activities by local companies are considered inefficient.

Sixth, deregulation has not been balanced by reforms in the bureaucracy.

The list of problems discussed above is by no means complete. Further research on the subject needs to be done. However, in the light of the problems identified here, some recommendations can be set forth.

First, it is advisable for Indonesia as a host country to help investors assess the risk and uncertainties of their investment here.

Investors need to be secure in the knowledge that they can invest safely and profitably in Indonesia. Therefore, the government should eliminate all ambivalent regulations which could discourage foreign direct investment.

Second, considering the intense criticism of the quality of bureaucratic services in Indonesia, the government should put higher priority on the implementation aspects of every deregulation measure issued.

Third, the experience of other countries has proved that foreign direct investment is beneficial to economic development of host countries. Therefore, it would be better for the government to direct its efforts toward maximizing the benefit of foreign direct investment rather than on restricting the room for movement of investing companies.

The writers are economists. Ilyas Saad is a graduate of Australian National University.Asep Suryahadi is a graduate of Pennsylvania State University.