This article was originally published in The Jakarta Post Special Issue on October 18, 2024
The manufacturing sector, combined with labor-intensive exports, played a major role in Indonesia’s economic development, especially in the two decades prior to the 1997-1998 Asian financial crisis. A growth rate of around 10 percent pulled up overall economic growth, but it has since been on a decreasing trend.
Today, the share of manufacturing value-added (MVA) in gross domestic product has dropped to 18 percent, from almost 30 percent in early 2000s, and at less than 4 percent, its growth is below overall economic growth.
As a comparison, Vietnam has been growing close to 7 percent on average for the past two decades, and its MVA constitutes around one-third of its gross domestic product (GDP).
A decline in the manufacturing sector is not necessarily a bad thing, and industrial slowdown in Indonesia is a result of a complex process: a commodity boom in the early 2000s, manufacturing competitiveness, stiffer global competition due to China’s rise in the world market, and Indonesia’s high logistics costs.
However, Indonesia has not been successful in maintaining a strong manufacturing sector and has been overly dependent on its labor-low-end service sector, where informal work prevails and productivity is low.
Furthermore, external challenges, such as the trade war and the global pandemic, have increased uncertainty for the sector.
In response to this, Jokowi’s administration has been promoting industrial policy. The goal of hilirisasi (downstreaming) has contributed to this shift.
As a result, the ability of the manufacturing sector to create jobs has gone down significantly. In the 2014-2019 period, 5 percent growth in the sector was associated with more than 150,000 jobs. In contrast, in 2019-2023, over 1 percent additional growth only added less than 15,000 jobs (Wihardja, 2022).
Indonesia needs faster economic growth to create jobs and reduce poverty. With its still-abundant labor force, it needs to move from low-productivity agriculture and informal services to higher-productivity manufacturing.
By some measures, Indonesia’s demographic dividend (larger working age population and lower dependency ratio) will last 5-10 years. Without productive employment for youth, we will not be able to reap the full benefit of this remaining opportunity, nor can we manage poverty more effectively. Today, 10 out of 100 Indonesians are poor. That is 25 million people, larger than the population of Malaysia.
Important work needs to be done in improving employment creation. At the same time, policymakers have to prevent a decline in our human capital. More importantly, Indonesia needs stronger economic growth rather than relying on raw materials, which face grim future prospects as the world pivots to the green economy.
Manufacturing output is essential to keeping Indonesia’s economy growing and labor absorption increasing. This is where Jokowi Widodo’s key industrial policy includes downstreaming and local content requirements (TKDN). While this policy is not new—President Soeharto implemented downstream/affront—Jokowi has made it a national development mantra.
Nickel is uniquely Indonesian. Malaysia has been promoting downstreaming for its palm oil industry. Japan and South Korea are doing it for their tech industries. Meanwhile, China and the United States are pushing similar efforts, especially in semiconductors and electric vehicle (EV) manufacturing.
However, Indonesia’s industrial policy is different from the downstream efforts of the 1970s. Global trade integration has made cross-border production chains indispensable for economic growth. High-tech industries, such as EV batteries, rely on global partnerships. The Jokowi administration has been focusing on this strategy, and the TKDN is implemented in Indonesia as an anti-import policy. In fact, there is barely any industrial policy today that has no import substitution strategy. They run counter to the objective of maximizing the production networks GVCs allow the slicing up of production processes across countries, which in turn optimizes value, but this can be at odds with pursuing import substitution.
If Prabowo implements the policy to make Indonesia a hub for EV, as Jokowi did for nickel, this is not consistent with import substitution and domestic production. What it does do is align well with global demand for strategic goods, making Indonesia a critical player in the production of materials used for export.
Finally, the industrial policy needs to be implemented with a focus on labor absorption. Manufacturing can spur economic growth and labor absorption more effectively than the synthetic rattan example.
Time will tell if the similar policy for nickel ore exports to support nickel manganese cobalt (NMC) batteries inadvertently helps boost the production of its competition, lithium ferrophosphate (LFP) batteries.
The government’s concern about the lack of foreign direct investment (FDI) in the sector is well founded. Despite some reductions in the Jobs Creation Act, which had the potential to attract foreign investment, it is at odds with pursuing import substitution.
Effective implementation of the law is likely to induce an increase in imports of the materials, equipment and services needed to support domestic production and job creation. Yet it is also crucial to keep reducing costs and building supporting infrastructure.
What is the better policy for the Prabowo administration to revive the economy? Again, it would rely heavily on domestic economic fundamentals. One method that could help restore economic dynamism is to push for a more flexible labor market. Allowing easier hiring and firing would also help make the employment sector more resilient.
It is also crucial to instill political discipline and maintain strong anti-corruption policies. A flexible monetary system should be employed with strict fiscal discipline. The government must also make companies take responsibility for sustainability for any support provided, with clear targets. The free-trade system must be maintained, but at the same time the government should not discourage any protection policies that ensure sustainable economic growth. The answer to Prabowo’s economic challenges is not import or export tax, as much as a smarter approach to industrial support, such as an import ban or export ban.
About the Author:
Arianto Patunru is a Researcher at the Australian National University and Chairman of the Center for Indonesian Policy Studies.
Image source: Kementerian Sekretariat Negara Republik Indonesia
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