Manufacturing the Key to Acceleration

In early February, Indonesia\'s gross domestic product (GDP) growth rate in 2018 was released. The results are quite encouraging since in 2018 the domestic economy was caught in the midst of considerable global economic upheaval caused by the trade war issue. Growth in 2018 was recorded at 5.17 percent, a slight improvement from 5.01 percent in 2014.

This figure is still an achievement in itself given the magnitude of the pressure on the rupiah exchange rate in 2018, when the authorities had to raise interest rates to maintain economic stability. Maintaining a balance between stability and growth is important especially because economic growth still has a large dependence on imports and investment from abroad.

In 2018, the main engine of economic growth still came from consumption and investment. The two sources of growth are still growing positively thanks to good coordination between fiscal and monetary authorities so that they can maintain positive perceptions from the side of consumers, companies or investors.

However, growth of around 5 percent is still considered not optimal for the Indonesian economy to be able to absorb more workers. Various policies have been implemented, but there are no signs of faster acceleration.

If we look deeper into GDP data, the sectors that recorded positive performance were mainly service sectors, such as the trade and repair sector, which grew 5 percent year on year (yoy), as well as the accommodation sector, the food and beverages sector, and the professional services sector (consulting, education, public administration) which grew more than 5 percent, faster than the national growth average.

KOMPAS/NIKSON SINAGA

Rubber plants belonging to local residents in Lakhene village, Mandrehe district, West Nias regency, North Sumatra, Sunday (13/1/2019). People in the Nias Islands, 80 percent of whom are rubber farmers, are facing financial difficulty due to the sharp decline in rubber prices in recent years.

Meanwhile, the performance of the manufacturing sector still looks stagnant, only growing 4.3 percent over the past four years. The dominance of the service sector was also confirmed by direct investment data released by the Investment Coordinating Board (BKPM).

In the last two years, the inflow of investment in the service sector was greater than the investment flow that entered the manufacturing sector. This is an indication that the prospect of the service sector looks increasingly attractive to investors. One of the examples is the rapid development of digital platforms (e-commerce).

However, of course, it needs to be remembered that e-commerce services also require manufacturing production as its basis. If the manufacturing sector develops late, e-commerce will be dominated by imported products, which will certainly burden the trade balance.

Boosting exports

The increasing role of the service sector amid the slowdown in the manufacturing sector indicates that the economy is still oriented toward domestic activities. This poses a problem in the current account because the export-oriented sector, which is mostly commodities or manufactured goods, grows more slowly. This leads to imports arising from economic activities and infrastructure development that cannot be covered by export revenues. Therefore, this state of affairs causes a significant deficit in the current account (3 percent of GDP) in 2018.

This year, the challenge to improve the trade balance is getting bigger. The impact of the escalation of trade conflicts especially between the US and its trading partners begins to be felt. The global economy is predicted to slow down and have the opportunity to further suppress exports due to the decline in commodity demands and prices so that the trade balance will be increasingly difficult to return in surplus.

KOMPAS/ERWIN EDHI PRASETYA

Employees work in the garment division of PT Sri Rejeki Isman Tbk (Sritex) in Sukoharjo, Central Java, Wednesday (13/2/2019). The textile industry and textile products still have many opportunities in the domestic and export markets but face the challenges of efficiency and global competition.

Finally, it is important for us to immediately take steps to boost exports. The key is in the manufacturing sector. The acceleration of manufacturing can have many positive impacts on the economy.

First, the development of manufacturing, especially export-oriented manufacturing such as textiles, electronics and chemistry, can take over the role of the commodity sector as a support for the trade balance. Acceleration in the manufacturing sector will also in turn increase consumption and investment because this sector has the potential to absorb a large number of workers. Based on data from Statistics Indonesia (BPS), the manufacturing sector is able to absorb around 15 percent of the workforce, the third-largest after the agriculture and trade sectors. With a substantial contribution to GDP, which is around 21 percent, the multiplier effect that will occur will be greater for the national economy.

Speaking about manufacturing, various studies have been conducted, but indeed there seems to be no easy or instant solution. We have frequently heard that inadequate infrastructure is one of the main roots of the problems. However, in the last few years the construction of physical infrastructure has begun on a large scale and accelerated to overcome the fact of having fallen behind. However, in reality, the problems being faced are not only related to infrastructure.

The second problem is consistency and clarity regarding investment regulations. The system of regional autonomy sometimes causes the central government and the regional administrations to frequently have regulations that contradict each other. Reform has also been carried out by deregulating licenses, but central and regional coordination still seems to be a problem. Efforts to harmonize the regulations have actually been attempted by the government through routine meetings with regional leaders, but still its implementation will not be easy.

The third is related to regulation and labor competitiveness. The government must be able to balance labor welfare efforts and efforts to attract investment. The size of our wages is on average higher than, for example, Vietnam and the Philippines, so it is less attractive in the eyes of long-term foreign investors. There should be other forms of incentives (such as tax breaks) so that production costs can compete with countries in the region that have cheaper labor/production costs.

The limited availability of experts, research and technology transfer also means that our manufacturing sector is superior to low-end manufacturing commodities, such as textiles, rubber products, plastics, machine components, electrical equipment with minimal levels of product differentiation.

Based on a joint study by the Asian Development Bank and the National Development Planning Agency (Bappenas), the level of complexity of Indonesian manufacturing is still relatively small and remains under the regional countries. This certainly means that the added value to be obtained will not be large. The government needs to provide a quite attractive incentive that can make the companies allocate more funds for the development of domestic labor and research, including the transfer of knowledge and technology from foreign experts. We need to remember that the allocation of research funds must not only come from the government, but also the private sector.

Continuing the structural reform

Fourth, manufacturing development needs investment and financing. Sources of domestic financing are still relatively limited so foreign funds must enter to fill the gap. However, the phenomenon that has been seen lately, foreign investment is targeting many tertiary sectors, especially in the utilities sector and the service sector which in fact indeed shows strong growth.

In recent years there have been many reforms and deregulations carried out through a series of government policy packages. Progress begins to be seen mainly in road infrastructure, connectivity and electricity availability. Deregulation and the provision of tax incentives have also been made to increase convenience and increase investment attractiveness. The results can be seen in the ease of doing business in Indonesia, which has improved significantly. Indonesia managed to rise to 72nd rank in 2018, a significant jump from 91st in 2017.

In the future, reforms need to be aimed at more focused and directed policy coordination. For example, the government can prioritize manufacturing products that have high comparative advantages and can then harmonize the provision of incentives, financing and ease of access to infrastructure in these priority industries.

In the short term, improvement of regulations and competitiveness is expected to attract US and Chinese companies that may want to relocate to avoid high tariffs due to trade wars in their countries of origin. Developing countries, especially in the ASEAN region, will be a potential destination. It will be a pity not to use this opportunity.

Mapping the direction of development of the manufacturing sector certainly needs to be accompanied by intensive communication among institutions, investors and related business actors.

With regard to the election to be held this year, it would be very good for whoever is elected to maintain and develop the focus and consistency of investment and industry policies so that the rise of dominance in the manufacturing sector, which is expected to provide greater added value, could be realized soon.

Dian Ayu Yustina

Economist of PT Bank Danamon Indonesia, Tbk