A Retrospection of Industrial Competitiveness

KOMPAS/DIDIE SW

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As the rupiah continuously declined in the past few months, with its exchange rate taking a dip below Rp 15,000 per US dollar, many questions and concern have come up.

This is understandable, especially if we consider the national nightmare of the 1997-1998 financial crisis with its lasting multidimensional effects.

However, unlike the 1997-1998 crisis, the rupiah’s depreciation this time is mostly due to external factors, including the US-China trade war, the Federal Reserve interest rate hike and concerns about spillover from the weakening of the Turkish lira, the Argentinian peso and currencies of several other emerging economies. Domestic fundamental factors are believed to be strong, as reflected in economic growth of 5.27 percent in the second quarter of this year, up from 5.06 percent in the previous quarter and 5.01 percent in the same quarter last year.

Numerous other macro indicators are also in good condition, including the year-on-year inflation of 3.18 percent in July this year and the debt-to-GDP ratio of less than 3 percent.

Nevertheless, our current account deficit (CAD) increased to US$8 billion in the second quarter this year from $5.7 billion in the previous quarter. The CAD up to the first semester this year was 2.6 percent of GDP. Despite the debt-to-GDP ratio being at a relatively safe level of below 3 percent, it is highly important to watch CAD fluctuation, as it reflects the country’s competitiveness, especially in the context of global trade and investment (capital flows). The CAD deficit may potentially be a source of vulnerability in the currency’s exchange rate. It is also prone to becoming an object of speculation.

Trade balance and industrial competitiveness

Specifically, if we focus our analysis on the trade balance as the main component of the current account balance (apart from the capital balance) in the past three years (2015-2017), we will see its relatively good performance in the form of surpluses (total exports higher than total imports) compared to deficits in the five preceding years. Specifically from 2016 to 2017, the surplus increased from $15.3 billion to $18.8 billion – despite a little decline in the surplus in the first semester this year.

Nevertheless, we should neither be too joyful nor too proud of this trade surplus, especially when taking into account the export competitiveness of Indonesia’s manufacturing (non-oil and gas) industries compared to those of other ASEAN countries (especially Malaysia, Thailand, the Philippines and Vietnam), China and India (Ridhwan et al., 2015, 2016). Several relevant studies by the World Bank and other agencies came to similar conclusions.

First, in terms of structure/composition of goods, our exports have been dominated by raw and intermediate materials requiring a low level of technology to produce (commonly agriculture, fishing and mining products) in the past 10-20 years. Consequently, their added value is lower than that of imported products dominated by manufactured products with high added values and elastic to income, especially gadgets/smartphones, automotive products and other modern electronic goods.

Related to the import of consumer goods, export-oriented national industries are still too dependent on imports of raw materials and capital goods. The domestic manufacturing industry’s links to global value chains are limited to supporting work, such as automotive assembly and packaging, instead of core work, such as the manufacture of engines and designs/prototypes.

Second, in the past 10 years, the number of Indonesia’s exported products only increased by 83 items (compared to Vietnam’s increase of 1,024 products). Furthermore, exports to high-income countries such as the US, Japan and EU members only account for 53 percent of Indonesia’s total exports, lower than those of ASEAN competitors.

Third, Indonesia’s product mortality rate of 311 is higher than that of Thailand (132), India (137) Malaysia (241) and China (99) from 2010 to 2015. Meanwhile, based on their export value, Indonesia’s surviving products are mainly those based on natural resources, especially palm oil, coal and liquefied natural gas. Based on their market distribution, surviving products include paper and paperboard, furniture and art products/sculptures (statues and other products).

A product space analysis (Hidalgo et al., 2017) indicated that Indonesia’s product space is moving further away from the core. This means Indonesia is witnessing a decline in the number of products with comparative advantage (machines, electronics, garments, textiles and furniture) and, therefore, their number of suppliers (supply chains) in the domestic market is also declining. As it turns out, much of this advantage has been “absorbed” or “taken over” by China. Consequently, with low competitiveness in industry clusters with high proximity (dense forest), it will be difficult for Indonesia to transition to a higher income group (which means we may be heading into the “middle income trap”).

This has been confirmed by the relatively similar findings of Ricardo Hausmann (Harvard, 2017) as follows. First, there has been a slowdown in exports per capita in manufactured/non-oil and gas priducts (2012-2015). Rodrick (Harvard) highlights the phenomenon of premature deindustrialization in Indonesia, as seen in the continuous decline of the processing industries’ share of GDP, while the service industries’ share of GDP is increasing.

In China, the service sector blossomed after its industries were well-developed. In Malaysia and Thailand, the manufacturing industry also started out in textiles before moving up to electronics and machinery (1980-2017). Meanwhile, Indonesia has remained stuck in the textile industry in the past 30 years. We have yet to see much development of products requiring higher technology.

Second, from 2000 to 2015, the total export value of Indonesia’s four “new” products was only $2.6 billion, much lower than Vietnam’s (51 items worth $51.7 billion) and Thailand’s (51 items worth $17.4 billion).

To identify the key challenges/problems that impede the domestic export performance/competitiveness, my studies (in 2016 and 2017) to diagnose our trade competitiveness found that these factors were related to (precondition) enablers, especially human resources related to wage rigidity, logistics related to inter-regional connectivity, limited alternatives to export funding sources other than banks and limited cheap credit facilities for exporters. License issuance and coordination between government institutions were also problematic.

Third, in terms of market access, despite the majority of import duties to export destinations being low (below 2 percent, except to the US), many advanced countries are imposing more nontariff barriers on Indonesian products compared to those from Vietnam, the Philippines and Thailand.  The spatial (regional) marketing strategy, namely by utilizing industrial parks and special economic zones, is not yet optimal, especially as these areas lack integration with supporting infrastructures (energy, connectivity and others) and lack clarity of management between regional governments and special bodies created by the central government.

Short-term strategy

Based on these findings, people may realize the (structural) complexities of the challenges/problems in improving the export competitiveness/performance of the national manufacturing industry, especially amid the current global economic uncertainties (with the trade war between the US and China). However, we must stay optimistic and spirited in coming up with applicative and innovative strategies in order to avoid the global economic turbulences as much as possible.

Therefore, considering our urgent need for foreign exchange (to over our CAD), the following few quick-win policies should be considered, especially to boost foreign exchange receipts. First is a nonconventional marketing strategy through expanding/diversifying to new export destinations, such as Asian developing countries (Cambodia, Laos, Myanmar) and Africa and through bilateral free-trade agreements (FTAs), such as with Australia and others. Furthermore, the domestic market can still be strengthened, as Indonesia’s population of 260 million is a huge potential market (internalization), especially through the improvement of interregional economic interconnectivity (integration).

Second is the strengthening of policies to boost the development of small- and medium-scale home industries with much added value and oriented on exports. Support can include marketing, human resource improvement, technological skill improvement and access to funding. Third is skilled human resource development through training involving users (industries) and utilizing international training opportunities provided by industry principals with local investments.

Fourth, in the short term, agro and fishery commodities must be polished for export, especially those with high added values, including tropical fruit (mangosteen, mango, pineapple and others) and exotic forest products, such as essential oils and dammar resin.

In this globalized digital era dominated by millennials, the rapid growth of the leisure economy, including tourism, can be used to quickly grow our foreign exchange reserves. Considering our famed natural and cultural wealth that lacks promotion, coordination and communication both in central and regional governments are important.

Policymakers should consider these strategies, especially for the short term, in response to global economic uncertainties that may disrupt national macroeconomic stability. Such efforts to achieve stabilization – including controlling the current account deficit and stabilizing the currency exchange value – should be the collective responsibility of all stakeholders instead of merely being the responsibility of the national monetary authority. Continuous and consistent structural reforms are key to solving these problems.

MHA Ridhwan, Economic observer; Bank Indonesia employee