The Political Economy of Trade Policy in Indonesia

CSIS WORKING PAPER SERIES
WPE 092






The Political Economy of Trade Policy
in Indonesia




Hadi Soesastro
M. Chatib Basri

March 2005

Economics Working Paper Series
http://www.csis.or.id/papers/wpe092




The CSIS Working Paper Series is a means by which members of the Centre for Strategic and
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1
© 2005 Centre for Strategic and International Studies, Jakarta

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The Political Economy of Trade Policy in Indonesia
Hadi Soesastro
M. Chatib Basri
CSIS Working Paper Series
WPE 092
March 2005


ABSTRACT

This paper focuses on Indonesia’s trade policies after the economic crisis. It examines the trend
towards protection and addresses the issues of competitiveness. The concluding part briefly
discusses Indonesia’s policies on and involvement in free trade agreements (FTAs), which have
recently proliferated in the Asia Pacific region.



Keywords: Indonesia, political economy, trade policy, economic crisis, free trade agreement



Hadi Soesastro
M. Chatib Basri
hadi_s@pacific.net.id
Institute for Economic and Social Research
Department of Economics
Faculty of Economics
CSIS Jakarta, INDONESIA
University of Indonesia
Jakarta, INDONESIA



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The Political Economy of Trade Policy in Indonesia
Hadi Soesastro
M. Chatib Basri

Introduction

The performance of the Indonesian economy before the economic crisis was rather
remarkable. Structural transformation had been taken place in agriculture, manufacturing
and also the utilities and services sectors. The period from the mid 1960s to 1980s was a
notable one in Indonesian economic history.

In the 1980s, the economy was faced with various problems. The weakened of oil prices
in the early 1980s significantly reduced export earnings and budget revenues. The large
decline in oil prices severely affected Indonesia’s balance of payments. During the 1980-
85 the economy grew by 3.7% p.a., which was much slower than the 7.5% during the
period 1975-80. In response to this situation the Indonesian government undertook some
adjustment programs to increase economic efficiency, altering its trade regime to become
more outward looking, and accorded high priority to develop non-oil and gas (NOG)
exports. No less than 24 packages of economic reforms were introduced from 1983 to
1995, aimed at increasing economic efficiency and encouraging investment as well as
non-oil exports. Along with this change of orientation, the government changed its
investment policy from one of control to one of promotion. In addition, various trade
reforms were introduced to improve the trade and industrial policy regime. The
Indonesian trade regime prior to the mid 1980s was relatively protected. However, from
1985 when trade reform was embarked upon, the levels of protection had declined and
Indonesia entered an era of export orientation. These highlights accentuate the historical
shift from import substitution to export orientation, particularly in the manufacturing
sector. These various measures revived the economy, and during 1985-90 the annual rate
growth of GDP was 6.3%.


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In 1997 Indonesia was hit by the economic crisis. It forced the government to turn to the
IMF and to adopt an economic recovery and reform program, including in trade. This
paper focuses on Indonesia’s trade policies after the economic crisis. It examines the
trend towards protection and addresses the issues of competitiveness. The concluding part
briefly discusses Indonesia’s policies on and involvement in free trade agreements
(FTAs), which have recently proliferated in the Asia Pacific region.


Indonesia’s Pattern of Trade and Competitiveness

Pattern of trade
In 2001 the key markets for Indonesia’s non oil exports were developing East Asia
(accounting for 26%), Japan (15%) and NAFTA (16%), mainly the United States. It is
worth noting that exports to East Asia increased significantly from 15% in 1990 to 26%
in 2001. This was in large part due to an increase in exports to other ASEAN countries,
whose share doubled to 16% of the total non oil exports. Brenton and Ikezuki (2003)
shows that Indonesia’s manufacturing exports to non-OECD countries in 1990 were 41%
of those to OECD countries. This ratio has risen significantly to around 80% in 2001.
This finding suggests that developing countries are becoming important markets for
Indonesia. It is interesting to note that Indonesia has been quite successful in competing
in developing countries. Its market share has been increasing throughout the last decade,
thus making developing countries as important as OECD countries as destination of
Indonesia’s exports. This trend can be seen in Figure 1.1

This trend is in contrast to China’s trade pattern, where developed countries are becoming
more important as export destination. This could suggest that in the future Indonesia
should consider targeting its exports to the developing economies. In this regard, it
should be noted that in general developing countries have higher levels of tariff than

1 Developing economies are defined as East Asia (excluding Japan), Latin America, Middle East and N.
Africa, Other Europe and C. Asia, South Asia and Sub-Saharan Africa.

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developed countries. Indonesia already has a much lower tariff than developing countries
in general. This further suggests that it is in Indonesia’s interest to see that tariffs in
developing countries are being reduced.



Figure 1
The geographic destination of Indonesia and China exports
100%
90%
80%
70%
60%
China's export to developed countries
Indonesia's export to developed countries
50%
China's export to developing countries
Indonesia's export to developing countries
40%
30%
20%
10%
0%
Calculated from UN COMTRADE Statistics
1985
1990
1995
1999
2000
2001
Export Performance and Competitiveness
Export growth remained sluggish since 2001. It is true that in 2001 and 2002 the
slowdown of Indonesian exports could be attributed to weak global economic demand
after September 11. However, the industrial production index has started to pick up in the
1st half of 2003: textile, leather and footwear products grew by 7.5%, whereas wood
products grew by 6.9%. One of the possible explanations for this improvement was the
shift of demand from some East Asian countries to Indonesia due to SARS. This was

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definitely the case for garments.2 From January-July 2003 exports of textiles grew by
more than 5%.

Nevertheless, serious problems persist and appear to be systemic. The slowdown of
Indonesian exports can be attributed to supply problems, including the cost of doing
business (high cost economy), weak industrial relations policy, minimum wage hikes and
poor infrastructure conditions. These factors have become a major constraint to rapid
growth of exports.

Table 2 shows that from 1985 to 2001 the growth of exports was driven by the increase
of market share (competitiveness factor), but from 1995 to 2001 the source of growth was
dominated by demand factors. In-depth observation shows that the majority of Indonesian
exports experienced a decline in market share, except for palm oil, printing and writing
paper and electronics. Table 3 shows the trends in Indonesian major manufacturing
products’ specialisation based on the Revealed Comparative Advantage (RCA).3 From
1985 to 1995, all of these products experienced an increase in RCA (arrow from left to
right). However, from 1995-2001 the RCA of some of these products, including plywood,
textiles, footwear and garments, showed a declining trend (arrow from right to left).
These figures reinforce the earlier suggestion that export growth was mainly driven by
the supply side (competitiveness) rather than the demand side from 1985 to 1995, but this
was no longer the case from 1995 to 2001. This suggests that the main obstacles to
Indonesian export growth mainly stem from the supply side.



2 Based on an interview with Benny Soetrisno, the Chairman of the Indonesian Textile Association.
3 RCA is calculated as: (Xij/Xj)/ (Xiw/Xw). Where Xij is export commodity i from country j, Xj is total export
of country j, Xiw is export of commodity i in the world market and Xw is total world export.

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Table 2: Decomposition of Indonesia’s export changes

Export Changes, 1995-2001 ($ mill)
Export Changes, 1985-2001 ($ mill)

Demand Competitive Diversi-
Demand Competitive
Diversi-
Partner
Factor Factor
fication
Factor Factor
fication
China 43059
131306
271
53155
318560
200
Hong Kong, China
12601
-14747
-244
72668
-39096
-4700
Indonesia 7164
5460
461
19129
20828
333
Korea 21546
14179
1
74832
49337
363
Malaysia 18280
3601
342
43462
43146
796
Philippines 4649
17574
24
22844
12843
-71
Singapore 27809
-29677
-734
48574
15041
770
Taiwan, China
27963
-4814
117
112240
1096
-251
Thailand 8907
5811
414
14857
44655
232
Vietnam 520
7640
-18
403
13310
-74







Al Above Countries
172498
136334
635
462164
479722
-2402







Japan 103104
-132464
-791
506926
-232044
-15647
European Union
(15) 160661
-33740
-37
754854
-112113
-12225
NAFTA 116775
-97126
-5259
516344
-152427
-9313
Source: Calculated from UNCOMTRADE statistics












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Table 3: Indonesia’s Manufacturing Products’ Revealed Comparative
Advantage 1985-2001
SITC-
4
Product (Revision 2)
1985
1995
2001
Plywood consisting of sheets of
6342 woo
6349 Wood,simply shaped,n.e.s.

6597 Plaits and similar products of plaits

Improved wood and reconstituted
6343 woo
6353 Builders' carpentry and joinery

8421 Overcoats and other coats, men,s

7511 Typewritters;cheque-writting machin

6516 Yarn of discont.synth.fibres,contai

8432 Suits & costumes,women's,of textile

8510 Footwear

Manufactures of wood for
6354 domestic/d
8443 Under garments,women,s,of textile f

Registers,exercise books,note
6423 books
6531 Fabrics,woven of continuous synth.t

8442 Under garments,excl.shirts,of texti

8433 Dresses,women's,of textile fabrics

7628 Other radio-broadcast receivers

Cotton
6521 fabrics,woven,unbleached,not

5621 Mineral or chemical fertilizers,nit

6581 Sacks and bags,of textile materials

Calculated from UN COMTRADE statistics


To make things worse, this declining competitiveness was accompanied by creeping
protectionism. Protectionism should not be the answer to the difficulties in making
progress at the multilateral level (WTO), and does not provide a sustainable basis for

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growth. While there is no conclusive relationship between trade openness and growth in
many countries, there is also no evidence that trade protection is systematically
associated with high economic growth (Rodrik, 2002). This is particularly true for
Indonesia. Protectionist policies will undermine the current open trade regime that has
served Indonesia so well in the past (Aswicahyono, 1998; Basri 2001; Hill, 1996). The
continuing signs of increasing protectionism imply that the Indonesian government has
resorted to trade policy to overcome inefficiencies in the supply side. The government
has not addressed the problem of lagging productivity through measures to increase
efficiency. Instead, it tends to preserve the inefficient industries by increasing
protectionism. The government has issued various ad hoc trade policies, including
protectionist measures in a number of sectors. From 2001, protectionism has been on the
rise, as evident in the increase in tariffs on wheat flour and trade regulations and licensing
(tata niaga) on textiles, steel, sugar and clove. It is worth noting that the most common
instrument of protection is non-tariff barriers, which fall directly under the authority of
the Ministry of Trade and Industry (Ray, 2003). In contrast, the Ministry of Finance,
which is responsible for tariffs, is less inclined to protectionism. Despite continuing signs
of increased protectionism, the level of protection in Indonesia is still low compared to
other Asian countries. including Thailand (Basri and Hill, 2004).

As for textiles and garments, the uncertainty of future prospects, particularly the post-
Multi-Fiber Agreement (MFA), looms largely. While the integration of MFA into WTO
and quota elimination provide new opportunities to the textile industry, the ability to
capture these opportunities will depend heavily on the Indonesian textile industry’s
competitiveness. Entering the post-MFA era in 2005, competition will become more
intense, and the development of high skilled expertise and know-how will be the key
success factor for the industry. Unfortunately, some of Indonesia’s manufacturing
products, including textiles, are faced with various problems, particularly coming from
the internal or supply side, including erosion of competitiveness in upstream industry and
low labour productivity compared to other emerging Asian countries. In addition, the
industry also suffers from the lack of new investments. In 1988-1992, for example,
investment growth reached 14.41%, while in 1995-2001 it declined to 2.3% per annum.

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With such low growth, the machinery and other equipment have rapidly become obsolete
and thus contribute to the high production costs. On the external front, the emergence of
strong textile and garment competitors in China and Vietnam and other low cost ASEAN
countries have placed Indonesia in a difficult situation. As pointed out by Tanudjaja
(2002), textiles and textile product exports from Indonesia to the US have continuously
decreased since 1999. Compared to China, Korea and Taiwan, Indonesia’s share in the
US market is very small. A similar trend occurred in the European Union: in 1994
Indonesia ranked first with a 22.6 % share, but in 2001 Indonesia ranked number three
after China and Thailand, with a share of 10.5 %.

Trade Reform during the Economic Crisis
In November 1997, the International Monetary Fund (IMF) entered the picture following
various unsuccessful attempts by the Indonesian government to stabilize the rupiah.
Unlike in Thailand and other pervious IMF packages, the Indonesian agreement includes
trade reform which normally was beyond the mandate of the IMF (Soesastro and Basri,
1998). As pointed out by Soesastro and Basri (1998), in the structural adjustment
program was to include a gradual reduction of import tariffs, including those on chemical
products, iron and steel and fisheries products, to 5-10%. In addition, various
commodities including wheat and wheat flour, soybean and garlic could be imported
freely under a General Importer license. As for wheat flour the government imposed a
10% import tariff and would be reduced 5% in the year 2003. In fact, before 2003 the
government has already reduced the tariff to 0% but reversed it back to 5% in 2002. In
the structural reform program of 15 January 1998, domestic trade in agricultural products
was fully deregulated. The clove marketing board was also being eliminated. In February
1998 all other marketing arrangements were abolished specifically for cement and paper,
and the plywood cartels were dissolved. In the investment sector, formal and informal
barriers to investment in palm oil plantation were removed in February 1998, and this
was followed by removing all restrictions on investment in wholesale and retail trade. As
for cement, internal and external trade restrictions were eliminated, allowing traders to
buy and distribute all cement brands in all provinces and to export under the General

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