CRANFIELD UNIVERSITY CURIE MAHARANI SAVITRI CONTRIBUTION OF OFFSET TO DEFENCE INDUSTRIALISATION IN INDONESIA CRANFIELD DEFENCE AND SECURITY PhD THESIS Academic Year 2016 Supervisor: Professor Ron Matthews May 2016 “This thesis is submitted in partial fulfilment of the requirements for the Degree of PhD” @Cranfield University, 2014. All rights reserved. No part of this publication may be reproduced without the written permission of the copyright holder the page is intentionally left blank ABSTRACT Offset is compensation given to a buyer country for an arms sale. Initially perceived as ‘necessary evil’ in an imperfect defence market, it now serves dual purposes: a marketing strategy for defence industry and a procurement policy for buyer country to generate add on benefits from arms import. Offsets proliferate, and so are stricter mandatory government policies. Still evaluation of offset has been difficult, mostly done in a country-based setting using anecdotal evidence that result in mixed findings. Following the issuance of mandatory offset policy in Indonesia through Law on Defence Industry in 2012, evaluation of past and current offset practice have become not only relevant but also critical to provide policy feedback. This dissertation provides an empirical examination on how offset has been understood and practised in Indonesia, and its contribution to defence industrialisation. The timeframe chosen is 1988-2014, when countertrade has been used to support the lifecycle of strategic industries: development (1988-1998), survival (1999-2009), and revitalisation (2010-2014). This study derives its validity and reliability from triangulation, comprising secondary data, survey, and case study. Three variables are analysed: technology development through ‘strategic industries’, defence offset, and defence industrialisation. Technology development focuses on how technology policy centred on a strategic industries paradigm and ladder of production to initiate industrialisation push. Defence offset discusses the conceptual and practical aspects of offset in Indonesia, including strategic objectives, regulation and institution frameworksin the defence procurement context, and offset life cycle and financing. Defence industrialisation discusses the impact of offset through employment, skill enhancement, transfer of technology, export promotion, domestic supply chain creation, and R&D. Field works were conducted in three firms representing different industrial sectors: PT DI (aerospace), PT Pal (shipbuilding), and PT Pindad (landsystem). Research findings indicate that, first, offset practice has mostly taken place on an ad hoc basis, with no clear reference to strategic objectives, as well as long-term management and financing- that mirror deficiencies in defence procurement. Second, i as result of the deficiencies, offset results have been varied from one firm to another, across the different industrial sectors of aerospace, maritime, as well as ammunition and land system. While offset has a positive impact on skill enhancement and technology transfer, it seldom translates into new employment, supply chain creation, export, or R&D. This study generates the following recommendations. First, Indonesia needs to strengthen the management of offset through pre-offset planning and preparing practical guidelines for offset stakeholders in parallel with human resources to support the programme. This means identification of offset potential in procurement (convergence of long term technology policy and long term defence procurement plan), estimation of offset premium cost, allowing participation of industry in the early stage of the offset cycle, as well as devising methods of evaluating offset. Second, Indonesia needs to formulate strategic objectives for offset that relate closely to the dual purposes of defence modernisation and industry revitalisation. Third, Indonesia must strengthen the technology absorptive capability in industry in order to sustain the benefit of offset. ii ACKNOWLEDGEMENTS Alhamdulillah (Praise to Allah). One learned a great deal about her character and the value of family and friendship when she had to juggle between family, work, and dissertation. And one learned why teacher is called a ‘second parent’, when she has a PhD supervisor. This dissertation would never have been completed without the unwavering support of my PhD Supervisor, Prof Ron Matthews. I would like to thank Cranfield University for giving me the scholarship. I took tons of strength and comfort from my family: My own petite family-ayah and Philo; Keluarga Pasar Minggu alias Sunday Market (Mbak Wi, Mas Aang, Alit, Wafi, mbak Rum); Keluarga Tangerang (Mbah Titi, Puguk, kel Mbak Wulan, kel Yudi), and Keluarga Ciracas (Mas Ajie, Mamah Siti). Family provides free foods and wi-fi, childcare, sleepover times, and the most of all, reassurance that with problem comes ease. I owed to colleagues in KEMHAN (especially Ibu Nur and Pak Maman), BAPPENAS (Pak Yudo), BINUS University, as well as ‘Singapore Connection’ (especially Collin Koh) for their discussions, share of knowledge, experience, and much more. Lastly, I would like to thank Tim Kecil Offset (Sezsy, Mas Jup, Mas Ditya) for mixing friendship and passion when serving our beloved country. Special thanks for Mas Adi dan Mbak Cha-cha, I owe you guys a lot. I dedicate this thesis to my parents, Ibu dan Bapak. Everything that I am now is because of you. iii the page is intentionally left blank LIST OF CONTENTS 1 1. THE PHENOMENON OF DEFENCE OFFSET ..........................................17 1.1 Making the Case for Study ................................................................................. 17 1.2 Growing Phenomenon of Offset ........................................................................ 17 1.3 Offset: The ‘Third Way’ for Developing Countries? ....................................... 20 1.4 Indonesia’s Offset: the Tale of Habibie, Soeharto, and Strategic Industry Champions ............................................................................................ 22 1.5 The Rise and Demise of Offset in Indonesia .................................................... 24 1.6 Research Aim and Enabling Objectives ............................................................ 26 1.7 Study Value: The Contribution to Knowledge ................................................ 28 1.8 Conceptual Framework ....................................................................................... 30 1.9 Research Methodology ........................................................................................ 33 1.9.2 Research Philosophy ............................................................................... 35 1.9.3 Research Approaches .............................................................................. 36 1.9.4 Research Strategies .................................................................................. 36 1.9.5 Time Horizons ......................................................................................... 38 1.9.6 Data Collection Methods ........................................................................ 39 1.9.7 Research Design ...................................................................................... 41 1.9.8 Triangulation ........................................................................................... 41 1.9.9 Data Analysis ........................................................................................... 46 1.9.10 Ethical Considerations ............................................................................ 47 1.10 Study Structure ..................................................................................................... 48 2 2. FROM DEVELOPMENT… TO DEFENCE ‘AND’ DEVELOPMENT .....................................................................................................55 2.1 Introduction .......................................................................................................... 55 2.2 The Purpose of Offset: Industrial and Technological Development ............. 57 2.2.1 Adam Smith - The Liberalisation Guru ................................................ 59 2.2.2 Rostow’s “Take-off” Strategy ................................................................ 60 2.2.3 Balanced v Unbalanced Growth Models ............................................. 61 2.2.4 Development Through Trade ................................................................ 62 v 2.2.5 ‘Catch Up’ Industrialisation Strategy: The Critical Role of Government Planning ............................................................................ 64 2.3 Technological Development and Transfer Framework .................................. 69 2.3.1 Autarky and State’s Quest for Technology Change and Transfer ... 70 2.3.2 Conduits of Technology Transfer ......................................................... 73 2.3.3 Challenges of Technological Catch-up ................................................. 78 2.3.4 Determinants of Adaptation: Technological Absorptive Capability ................................................................................................. 80 2.4 Technological Development Models and the Globalisation of Technology ............................................................................................................ 83 2.4.1 Technology Development Model .......................................................... 83 2.4.2 International Product Life-cycle Theory .............................................