The Necessity of Industrial Transformation

KOMPAS/PRAYOGI DWI SULISTYO

Bambang Brodjonegoro

As the National Development Planning Minister/Head of National Development Planning Agency (Bappenas), I frequently receive questions as to why the Indonesian economy has only grown by about 5 percent?

The macroeconomic textbook explains that the magnitude of a country\'s economic growth is largely determined by its potential economic growth. It means that potential economic growth is the highest economic growth that can be achieved by an economy without causing high inflation. In other words, potential economic growth shows the ability of the production side of an economy.

Bappenas’ calculation shows that Indonesia\'s potential economic growth in the past few years was only around 5.3 percent. Therefore, it is not surprising that Indonesia\'s economic growth was only in the range of 5.0-5.2 percent.

Meanwhile, at present we are also busy with the widening current account deficit. The non-oil and gas trade balance, which was once strong enough to be a cushion for the oil and gas balance deficit, has become increasingly depleted, thereby making it increasingly difficult for it to serve as a bumper to the widening oil and gas deficit. Various arguments to answer this phenomenon include the global economic condition, which has weakened due to the uncertain trade war, declining international commodity prices causing Indonesian exports, which are dominated by coal and palm oil, to also decline, as well as rising oil imports because Indonesia\'s oil production has also declined.

This condition is often called balance of payment constraint growth (BOPCG), meaning that the balance of payment condition -- especially the trade balance -- can limit growth of the long-term economy of a country so that it cannot grow even higher. In the case of Indonesia, the high dependence on commodity exports and the low diversification of manufactured products export has led to low income elasticity of exports. Global market growth or the weakening of the exchange rate cannot necessarily cause Indonesian exports to increase because exports, which are dominated by commodity goods and low value-added goods, are more influenced by commodity price movement, not by movement in world income growth.

Examples from other countries, such as Japan, show that the policy of devaluing the yen will immediately increase Japanese exports, which are dominated by manufactured products. Likewise, in Korea and China, exports from these two countries will increase along with the increase in global demand, meaning that the income elasticity of exports for these three countries is quite high compared to Indonesia.

Why can\'t Indonesia increase its export of manufactured products? One important key to increasing manufacturing product exports is certainly a strong domestic industry structure. The Indonesian processing industry actually began to rise in the early 1990s and grew rapidly in line with deregulation policy and the change in orientation of industrial growth toward exports. However, the 1998/1999 economic crisis suddenly disrupted industrialization and then formed a new pattern in industry development in post-crisis Indonesia, where the processing industry changes its character to be more oriented towards efforts to meet domestic needs.

Compared to the development of processing industry in other equal countries, the development of processing industry in Indonesia is currently experiencing obstacles in structural transformation. Over the past eight years, the performance of the processing industry has declined while its productivity has tended to stagnate. The participation of the national processing industry in the export market and global production networks is also lower than in other countries.

The condition of the bureaucracy that is still high cost and the lack of quality infrastructure and human resources also contribute to the problems of the national industry sector.

The low level of innovation, quality of investment, and domestic barriers are the root of structural transformation problems. The processing industry has not been able to produce products that are more diversified in the structure of Indonesian product exports and a part of its products are still dominated by low to moderate technology content. Most capital investment in the processing industry still targets the domestic market and has not been export oriented. The condition of the bureaucracy that is still high cost and the lack of quality infrastructure and human resources also contribute to the problems of the national industry sector.

Obstacles to the transformation of the industrial sector have caused the Indonesian economy to be driven by a higher-growth service sector, which offers more employment for the community compared to the manufacturing sector. Changes in spending pattern also occur toward tertiary needs, such as tourism and high-end product services. However, our big challenge now is that the creation of quality jobs on a massive scale cannot be provided only by the service sector. Industrialization is a necessity for Indonesia to be able to provide quality employment, increase economic productivity, which in turn can boost potential medium and long-term economic growth. Moreover, the industrialization process will be accompanied by an increasing proportion of young and middle-class population. It means that it is still very relevant for Indonesia to give special and massive attention to the development of industry in Indonesia.

Besides that, adaptation to the dynamics of the global market is also a key factor to make industrialization in Indonesia remain relevant to become a driving force for the medium and long-term economy. Rapid transformation of digital technology also needs to be considered in determining the direction of industrialization in the future because digitalization will have a dual impact. On the one hand, digitalization helps increase productivity and efficiency in the modern production process and brings convenience and comfort to consumers; on the other hand, it brings the challenge for job creation. The role of the correct policy will be an important key to the success of Indonesian industrialization in the digital era.

Industry transformation strategy

There is no need to debate the importance of the processing industry in the economic development of a country. For Indonesia, which is growing towards a developed country, besides contributing to the added value of domestically produced goods and absorbing labor, the processing industry will also encourage improvement of economic productivity and encourage technological development in the country.

The following are policy strategies that can be implemented to encourage the growth of the processing industry. First, optimizing the fulfillment of large domestic demand through domestic production with quality products. This strategy can be an alternative source of growth in the processing industrial sector when global demand is declining.

Creating a conducive innovation ecosystem should be one of the government\'s main priorities.

Second, boosting the export-oriented manufacturing industry to ensure the sustainability of the national processing industry and increase the economies of scale. The development of the export-oriented industry will be a trigger for Indonesia\'s manufacturing industry sector to be highly competitive, by producing good quality products that meet international standards with increasingly diverse types. Competitive products are an absolute prerequisite for meeting the increasingly complex and diverse tastes of the world\'s consumers, and that competitiveness can only be realized through continuous innovation. Creating a conducive innovation ecosystem should be one of the government\'s main priorities.

Third, encouraging the production of more high value-added manufactured goods that are part of the value chain of global manufacturing production, unique products, and branded products that are recognized in the global market. Actually, Indonesia already has unique and high value-added export goods, such as golf balls, musical instruments (piano and guitar), wigs, artificial eyelashes, and contact lenses.

Indonesia\'s main export destination for artificial hair and artificial eyelashes is the US and Indonesia are the second largest supplier after China on the US market. Unexpectedly, Indonesia is the second largest exporter of upright piano products after Japan. The share of the Japanese piano market in the world is 44.1 percent and Indonesia has been able to fill this product market share of 21.6 percent of global demand. Indonesia is also the seventh largest exporter of golf ball products with an export value of US$25 million, with major export destinations to the US, UK and Australia.

On the other hand, Indonesia is a well-known producer of instant noodles in the international market with a global brand because the taste of Indonesian instant noodles is very popular with local and international communities. Indonesian food products have the potential to become a global brand. Indonesia is also one of the world\'s largest suppliers of margarine. It means that it is not difficult for Indonesia to change the export structure to be based on high value-added products with unique products and global branded products because Indonesia has been able to produce and export such items.

Fourth, increasing investment for industrial innovation. Based on the experience that commonly occurs in a number of countries in the world, the creation of innovation goes hand in hand with an increase in foreign investment (PMA) and an international trade regime that facilitates imports for high-quality intermediate inputs that cannot be produced domestically. PMA introduces more advanced technology to the national industry, such as sophisticated production machines brought from other countries. Similarly, the import of quality input-intermediate goods, in which there are advanced technological content from other countries. Therefore, PMA and the import of quality production input goods also provide opportunities for national industry players to adopt advanced technology. In the end, this technology adoption will facilitate innovation not only at the product level, but also at managerial level and good corporate governance.

However, the effectiveness of PMA in facilitating technology transfer depends on whether the domestic industry has the capacity to absorb the advanced technology brought by the PMA or which is then often referred to as the "absorptive capacity". Basically, this capacity depends on the quality of existing human resources. As an illustration, the use of a new production machine cannot be maximized if there are no human resources capable of operating or unavailability of maintenance services for the machine.

Structural problems like this often make technology transfer ineffective and hinders improvement in competitiveness.

Moreover, production efficiency is also influenced by the availability of infrastructure and the availability of energy at competitive prices.

Fifth, improving production efficiency, which can be encouraged through improving the performance of the service sector supporting the processing industry, such as logistics services, maintenance services, construction services, and several other service sectors. Moreover, production efficiency is also influenced by the availability of infrastructure and the availability of energy at competitive prices.

Institutional reform and deregulation

The success of the five above-mentioned strategies requires continued support of credible and consistent institutional reform and deregulation. Given the wide scope of the implementation of the various strategies above and the complexity of relations among government institutions and agencies, improvement in policy governance is very important. Institutional reform and conducive macroeconomic policies will be able to trigger the transformation process and the continued development of the processing industry.

We realize that discussion about industrialization has been long discussed, but its implementation has not been carried out properly. The next five years are a critical time for Indonesia because the golden opportunity of industrialization is when Indonesia experiences a demographic bonus. This industry transformation effort needs to really be a priority in the next five years of development so that Indonesia\'s target to get out of the middle income trap, as stated in the Indonesia Vision 2045, can be realized.

Without industrialization, it will be difficult for Indonesia to become a developed country. Without hard will, industrialization will be difficult to achieve. Therefore, the key to the success of industrial transformation is "political will" that does not only come from the government, but also from other related parties.

Bambang PS Brodjonegoro, National Development Planning Minister/Head of National Development Planning Agency (Bappenas)