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e-Magazine (For the Japanese version of this article)

Indonesia’s Re-“Industrialization” and Japan Yuri Sato Executive Vice President Institute of Development Economies (IDE-JETRO) [Date of Issue: 30/November/2018 No.0285-1094]

Date of Issue: 30/November/2018

Indonesia's Re-“Industrialization” and Japan

Yuri Sato
Executive Vice President
Institute of Development Economies (IDE-JETRO)

Indonesian President Joko Widodo is now in the fifth and final year of his current term. While currently focused on completing a whole range of infrastructure development projects as a tangible measure of his first term, according to the President, all this infrastructure development is actually a means to an end: “industrialization”. Here I examine why Indonesia is so interested in “industrialization” at this point in time.

“Industrialization” and “downstreaming”

Leading local paper Kompas ran an interview with Joko Widodo, also known as Jokowi, on 20 October 2018, the fourth anniversary of his taking power. Responding to questions about the economy, the President repeatedly referred to “industrialization” and “downstreaming.” A term often used in Indonesia, downstreaming, means processing raw materials into products at home, rather than exporting them overseas for other countries to add value.

Infrastructure development is probably the current administration's major achievement, but when asked if he was satisfied with the progress he has made, the President observed that infrastructure development needs to be continued over the medium to long term as a necessary condition for the downstreaming and industrialization critical to sustaining economic growth through not just consumption but also production. Moreover, the focus should be on infrastructure development beyond Java, across Indonesia as a whole, particularly outside Java, as a means of promoting downstreaming and industrialization in resource-rich non-Java regions.

Asked how the government would deal with the recent weakening of the Indonesian rupiah, the President noted that the key issue was to gain the market's confidence, which would require reducing the current account deficit. The market would need to see the government working to boost exports of processed products and pushing forward with added-value industrialization.

President Jokowi is known as a strong proponent of infrastructure development and digital industry, but what comes through in this interview is his emphasis on the need for industrialization as the starting point for socio-economic development.

Need for industrialization in the post-commodity-boom period

Jokowi's recalibration of his goals is a timely one, in that this is indeed the moment when Indonesia needs to be stepping up a gear with its industrialization.

Indonesia locked on to a six-percent economic growth trajectory in the 2000s, riding out the global financial crisis that followed the Lehman Brothers collapse with barely a twitch. However, behind this apparently robust development, manufactured exports actually shrank from 59 to 41 percent of gross exports between 2000 and 2010. Amidst the commodity boom fueled by China's double-figure growth, Indonesia was exporting more and more low-processed commodities. Feeding coal and crude palm oil (CPO) to China as well as strongly-growing India, Indonesia in fact became the world's biggest exporter of these two commodities.

In resource-rich countries like Indonesia, the economy's structural dependence on resources tends to grow every time international commodity prices spike. If there is no domestic driver, industrialization stalls or even goes backwards, a phenomenon known as the “resource curse,” or the “Dutch disease.” During the oil boom of the 1970s, crude oil accounted for 80 percent of Indonesia's exports. In terms of industrial structure, however, due to the Suharto regime driving the development of heavy industry and domestic auto parts production, manufacturing's share of gross domestic product (GDP) continued to grow.

After the oil boom ended, economic recession led the government to introduce measures to boost manufactured exports, and in the 1990s, Indonesia became an exporter of industrial products such as plywood, rubber products, apparel, and electrical products. However, another resource boom in the 2000s not only brought resources back into the export prominence noted above, but also caused a marked drop in manufacturing's share of GDP. With successive post-Suharto democratized administrations trying to avoid the authoritarian policy intervention, processing industries of raw materials such as crude palm oil, natural rubber, and forestry resources went backward.

Jokowi's administration came into power as commodity prices were dropping from their lofty 2011 peak, with the country's growth rate continuing to languish at around five percent. Just as infrastructure investment was finally beginning to drive up domestic demand, the US administration's decision to raise interest rates, the currency crisis in Turkey, and other external factors caused the rupiah to plunge, leaving the government with no choice but to raise interest rates and restrict imports.

Today, with the commodity boom well and truly over, policy incentives encouraging investment in industrialization and downstreaming have taken on great significance. President Jokowi too positions infrastructure development as a precondition for industrialization. He has also suggested that import restrictions are a stopgap measure and not as important as growing manufactured exports, with his priority accordingly on industrialization as a means of achieving this.

Relevance to Japan

With its ongoing demographic dividend boosting investment and consequently imports, Indonesia needs to take this opportunity to bolster its export capacity to counterbalance import growth. There is certainly room for Indonesia to expand its export capacity, through adding value by downstreaming domestically-produced resources, or through making Indonesia an industrial production hub that addresses both domestic demand as well as exports. Japanese investment could help Indonesia in that direction, while also enabling us to co-opt an Asian growth market.

Japan has always viewed Indonesia as a source of mineral resources such as oil, natural gas, coal, and mineral ore, even during the 1990s when Indonesia became a manufactured product exporter. In the 2010s too, mineral resources have accounted for a substantial 45 to 47 percent of Japan's imports from Indonesia. Things have been changing in the last few years, however, with mineral resources dropping to 36 percent of total imports in 2017, and both the value and share of chemical products, apparel, steel products, electrical machinery and auto parts, etc., gradually increasing in their stead. It bears noting that while gross import value remains flat, a structural change is beginning to occur.

At the same time, there are a number of issues that need to be addressed. For example, while Japan might be importing more products from Indonesia, there has also been a marked rise in imports of non-mineral raw materials such as gemstones and natural rubber. Indonesia's export capacity also remains weak in regard to agricultural, forestry and fisheries products, processed goods, and food products, areas where the country should be taking advantage of its tropical climate to build competitiveness. In addition, Indonesia still exports very little manufactured products to Japan compared to its total world exports. It would therefore be a useful exercise to examine from a more broad-ranging perspective the possibilities for rebuilding the bilateral trade and investment relationship in such a way as to contribute to industrialization and downstreaming in Indonesia—in other words, to the upgrading of Indonesian industrial structure. This will be one of the key pillars in the policy proposals to be announced by both countries at the end of this year to mark the 60th anniversary of the establishment of diplomatic relations between Japan and Indonesia.

About the Author
Yuri Sato
Executive Vice President, Institute of Development Economies (IDE), Japan External Trade Organization (JETRO)

After graduating from Sophia University, Yuri Sato entered the Institute of Development Economies, and was stationed in Indonesia as a researcher over 1985-87 and 1996-99, and as a special advisor for the Indonesian Chamber of Commerce and Industry (KADIN Indonesia) in 2008-10. She obtained a doctorate in economics from University of Indonesia. Her research focuses on the Indonesian economy, industry and business. She took up her current position in October 2015. As Executive Vice President of JETRO, she is in charge of Southeast Asia and Oceania. Her publications include Economic Giant Indonesia: Conditions for Growth in the 21th Century, for which she won a Grand Prix Asia Pacific Award and the Okita Memorial Prize for International Development Research, Asia's Motorcycle Industry, and Democratizing Indonesia.

(For the Japanese version of this article)

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