Economic Growth Amid Premature Deindustrialization

The strategy that must be taken is not only to focus on the domestic market, but also to make Indonesia a production base.

Illustration

The room was quiet. The door to the workspace on the third floor corner of Rubenstein building at Harvard Kennedy School is wide open. Across from it, several research assistants are engrossed in their cubicles, fixed on computer screens.

I knocked lightly on the open door. A silver-haired man, wearing a blue sweater, greeted warmly. He flashed a big smile. "Welcome back to Cambridge," he said kindly. Dani Rodrik is the man's name, a leading economics professor at Harvard Kennedy School.

I took a seat in front of the desk, facing the window. From a distance, I saw mist creeping over the Charles River. The morning was so cold.

Dani Rodrik is perhaps one of the most influential economists in the world on issues of industrialization, globalization and political economy. His books, Has Globalization Gone Too Far? and Globalization Paradox are references and discussion materials. Both admired and criticized. His thinking does have magnetism.

His argument about the role of industrial policy (industrial policy) has now become almost a permanent menu item in discussions of economic development strategies in almost all places in the world.

Indonesia's domestic market is large, but its purchasing power is still limited.

Premature deindustrialization

We discussed economic development strategies in emerging markets and developing economies (EMDE).

Rodrik expressed his gloomy views about industrialization in developing countries, which he said were experiencing premature deindustrialization (premature decline in the contribution of the industrial sector to the economy).

Their latest study with Joseph Stiglitz shows that the world is changing. The previously optimistic view on economic development in developing countries - which was focused on global integration and export-oriented industries - has been shaken by several factors.

Technological advances are making the manufacturing sector less labor intensive, reducing its effectiveness as a growth strategy.

On the other hand, EMDE's economic growth which was starting to slow down was further exacerbated by the Covid-19 pandemic. Rising debt, geopolitical tensions and a shift to services from manufacturing further complicate growth prospects.

In addition, the climate crisis and the importance of green transitions have had a negative impact on the agricultural sector and reduced global demand for natural resources. This further complicates matters for developing countries (Rodrik and Stiglitz, to be published).

Less labor-intensive manufacturing industries are no longer capable of creating good job opportunities. Therefore, Rodrik sees the importance of the role of the service sector in providing good employment opportunities.

I responded to that argument carefully, reminding them that jobs in the service sector also require high skills and are not labor-intensive, such as in the finance and information technology industries.

In the future, technological disruption will also affect the service sector. Artificial intelligence (AI) will make the service sector less labor intensive. Call center and back office, for example. What remains may be tourism, which is relatively labor intensive and has high productivity.

The trade sector, although labor intensive, tends to be informal and low in productivity.

Also read: The Middle Class and the ”Chilean Paradox”

The issue does not depend on the service or manufacturing sectors, but on the improvement of human resources quality. Rodrik nodded in agreement, acknowledging the opinion. Therefore, according to him, developing countries will face difficulties in achieving faster growth in the future.

With slowing economic growth, he suggests that EMDE focus on improving institutions, social protection, and increasing human resource quality. This argument is similar to the 2023 White Paper from LPEM FEB UI.

It is highly relevant, especially considering the vulnerability of the middle class in several countries, including Indonesia. Unfortunately, Indonesia does not have many options other than to grow faster. Without that, there is a risk of getting old before becoming wealthy.

So what to do?

Perhaps there are several things that need to be noted. First, it is true that the services sector will have an important role in the future. Look at India. Why is it that India, which has similar problems to us, was able to grow 8.4 percent in the fourth quarter of 2023 (although this figure is widely questioned)?

The answer: because India—in addition to carrying out a series of reforms in the fields of banking, taxes, infrastructure development—is starting to enter the "new economy” (new economy), such as digital infrastructure and the application of digital technology (Panagariya, forthcoming).

Currently, India is the country with the largest proportion of digital financial transactions in the world. The export of ICT services from India is far superior to Indonesia. Digitalization in India has been able to significantly reduce transaction costs.

The Digital India Campaign has succeeded in growing digital platforms and new business models. The widespread spread of technology to society (technological diffusion) increases productivity. In the end, it encourages economic growth. That is why efforts to enter the new economy, such as AI and digitalization, are very important.

In the future, technological disruption will also affect the service sector.

Second, it is interesting to learn from China, India and Vietnam which grew rapidly after adopting export-oriented policies. Why?

To remain competitive, export products require investment and innovation. They need to absorb technology, improve skills, and continuously enhance quality. There is indeed a risk of early deindustrialization, but to improve productivity, export-oriented industrialization still plays a very important role.

The Indonesian domestic market is indeed large, but its purchasing power is still limited. Take the automotive industry for example. Car production in Thailand surpasses that of Indonesia, even though our domestic market is larger.

Therefore, the strategy to be taken should not only focus on the domestic market, but also make Indonesia a production base for the global market. This strategy has been chosen by Vietnam, which in 2023 recorded an export value of 355 billion US dollars, surpassing Indonesia which reached 258.8 billion US dollars.

For the past few decades, Vietnam has been implementing reforms to boost exports. The country has become a global production base for various products, such as mobile phones, computers, shoes, and textiles.

World Bank data (2022) shows that Vietnam's ratio of foreign investment (net inflows) to gross domestic product (GDP) far exceeds that of Indonesia. Apart from that, Vietnam has also succeeded in enjoying investment reallocation from China. Indonesia can benefit from this phenomenon by continuing to improve its investment climate so that the ratio of FDI (net) to GDP increases.

Thirdly, the export-oriented strategy is risky and makes the Indonesian economy vulnerable to global turbulence. Therefore, it is important to maintain a balance between domestic and global markets. The export-oriented strategy must be accompanied by diversification of products and destination countries.

Unfortunately, our export diversification is still very limited. My study with Rahardja (2011) showed that the driving force behind Indonesia’s exports in the past few decades has been the same products sold to the same markets. New discoveries? Less than 5 percent.

My and Rahardja's studies show that countries that have a high proportion of medium and high tech manufacturing tend to have low export volatility. On the other hand, countries that rely on natural resources have high export volatility.

Industrialization became important. Entrepreneurs must continually experiment with new products. He adopted technology from outside for local needs.

The main performance index is not producing rules, but simplifying and accelerating economic activity.

A process that Rodrik calls self-discovery. However, there is a problem: if the entrepreneur fails in this experiment, he will be at risk. If it is successful, other manufacturers will copy it. As a result, not many people are interested in self-discovery. Experiments with new products can only be done if there is a profit. High logistics costs reduce profits. Therefore, efficient infrastructure development is non-negotiable.

Fourthly, the industrial revolution has indeed increased productivity. However, concerns that machines would completely replace workers did not entirely materialize. Barry Eichengreen from the University of California Berkeley wrote: what actually happened was not the loss of jobs, but the redefinition of jobs.

In the future, professions such as nurses, doctors, accountants, or workers will still exist but will require new skills: mastery of technology. In other words, what is needed is the adjustment of the capabilities and qualities of human resources.

New economy, export diversification requires good human resources. Here's the thing: transformation to new skills requires education or training. Unfortunately, government facilities, information and training capacity are limited.

BPS data shows that the increase in young unemployment actually occurred in the group of vocational high school graduates. This may be because what is studied in vocational high schools does not match the needs of companies.

We may remember that in Indonesia, there was a time when most bankers came from certain banks. Why? Because they had good training. We can emulate this pattern.

To encourage this, provide incentives and double tax cuts for companies to conduct training. This step can begin with pilot projects, followed by an evaluation of the results.

Spur economic growth

For me, the industrial policy to encourage human resources and research and development - to adopt technology according to local needs - has justification. It is similar to investing in health and education. This idea has been actually implemented, but its implementation is still complex.

Implementation requires field trials. I remember my experience when I was at the Investment Coordinating Board (BKPM) around 2012.

BKPM created a form that investors must fill out to apply for an investment permit. Everything looks good on paper. However, I asked for a trial. We conducted a focus groupdiscussion (FGD) and asked investors to fill out the form.

Apparently, that simple form still poses a challenge for investors. The case is trivial: within the form, there is a question about the volume of product production. Some investors asked that their product production consists of solid and liquid materials, which have different units. Unfortunately, the column provided in the computer is only one. What is the solution?

The bureaucracy's inconsistent response to the issue is due to their failure to anticipate it. Investors are struggling to obtain investment permits. This is a very small example, but a real one. Certainly, there are many other examples.

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In essence, all regulations must be field-tested first: whether they can work or instead cause problems. The key performance indicator is not in producing rules, but in simplifying and accelerating economic activities. Reform can start from small and easy things.

For example, creating quick results (quick wins) whose impact can be felt immediately by society. With this, the policy maker's credibility increases, political capital increases, so that he has support to carry out more complex reforms (Basri, 2017). That's what I call: the political economy of the possible

The world is indeed changing. Rodrik may be correct that it is not easy for EMDE to grow more quickly. However, we do not have many options other than to encourage higher economic growth.

The time is showing 12 noon. We will end this interesting conversation. I bid farewell. Looking out the window, the fog over Charles River seems to be dissipating. The air is starting to improve. However, the cold remains biting.

KOMPAS/RADITYA HELABUMI

Muhammad Chatib Basri

Muhamad Chatib Basri, Teacher at the Faculty of Economics and Business, University of Indonesia