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Lessening Pressure on by Diversifying

Muhammad Chatib Basri Director, Institute for Economic and Social Research, University of Indonesia

INDONESIA

istory has shown us that protectionism and financial crisis. This phenomenon has led to lively beggar-thy-neighbor policies were key factors discussions among commentators, politicians and Hin bringing down the global economy into some policymakers in Indonesia about the impor- the Great Depression in the 1930s. We do not want tance of relying less on exports and focusing more to repeat a similar mistake again. So at the onset of on the domestic market. Often the advice given to the global financial crisis, G-20 leaders called on Indonesian policymakers from these discussions each other to refrain from raising new barriers to is to pay less attention to the “openness” to trade investment and trade. This commitment has been and investment and instead concentrate more on reaffirmed in almost every G-20 meeting follow- protecting the domestic economy against exter- ing the Washington meeting in November 2008. nal volatility. This experience is influencing these Fortunately, so far there has been no significant groups to embrace somewhat more nationalistic increase in trade barriers like what had happened or protectionist views for a new reason. As often during the Great Depression of the 1930s. captured by print media, there seems to be a think- ing that Indonesia should limit openness and inte- The global financial crisis was associated with a gration with the global economy to prevent itself trade collapse, which affected many countries in from being dragged down by the global economic the world. It is natural that a collapse in the trad- slump. This view adds to the existing view that ing system combined with acute macroeconomic openness exposes Indonesian firms to unfair com- instability led policymakers to question the rele- petition. Political pressures against more openness vance of an -led growth strategy. Given the sometimes influences policymakers to implement magnitude and impact of the trade collapse, pro- more inward looking policies and to rely less on tectionism has become an obvious concern, espe- exports. So what is the relevance of a strategy of cially when the global recovery is still underway. facilitating exports and openness to economic growth? As for Indonesia, many believe that its relatively insulated economy is the reason why it has per- Amidst that debate, a study by Basri and Rahardja formed relatively better than other economies (2010) indicates that exports are in fact an impor- during the global financial crisis (Basri and Ra- tant source of Indonesia’s economic growth. Ex- hardja, 2010). This then brings to the surface the ports have a large effect in supporting economic question of whether an export-led growth strategy growth, albeit less stable compared to domestic de- is still relevant, bearing in mind that what saved mand. Therefore, a strategy safeguarding a balance Indonesia from the dreadful effects of the global between the domestic economy and global orien- financial crisis was its domestic economy. This is tation, such as becoming a part of a production not only specific to Indonesia because data shows network and promoting export-oriented growth, that many countries that are supported more by must become a part of the development strategy their domestic economies are proven to have a of the national economy. Strengthening domestic better performance compared to countries that are demand can be done without resorting to protec- extremely dependant on exports during the global tionist policies. The study by Basri and Rahardja

Think Tank 20: Global Perspectives on the Seoul G-20 Summit 27 (2010) also shows the strong link between exports Basri and Rahardja (forthcoming) show that Indo- and strength in the domestic economy. They ar- nesia can still do more to diversify its exports. It is gue that it is likely that commodity exports play true that the reform package on trade liberaliza- an important role in driving consumption in In- tion in the 1980s dramatically increased Indone- donesia. The economic activities in resources-rich sia’s export product diversification. A set of poli- provinces increased as a result of the commodity cies that reduced barriers to entry, improved trade boom that had occurred in the previous years. This facilitation and reduced bureaucratic inefficiencies development was reflected by relatively high credit unlocked business opportunities in Indonesia’s growth in resource-rich provinces several years non-oil sectors. As a result, Indonesia became one ago. The growth of third party funds in commod- of the platforms for a footloose ity-producing regions also experienced a slow in- industry. The process was also accompanied by a crease. This fact strengthens the argument that the global quota arrangement on textiles and clothing, economy in resource-rich provinces improved as measures discouraging exports of raw agriculture a result of the commodity boom; and during the commodities and relatively low global commodity crisis period, residents in those areas were capable prices that made exporting manufactured products of making use of their accumulated savings to sup- more attractive than exporting commodities. Our port their consumption during the global financial findings also suggest that Indonesia has increased crisis. In addition, services exports played an im- exports of existing products to some new markets, portant role because surprisingly strong exports which is part of the extensive margin. However, we in , creative designs and workers’ remit- also find that extensive margins driven by the dis- tances are likely to have direct links with private covery of new products and exports to new mar- consumption. kets are still quite low.

With that evidence, an inward looking strategy is Basri and Rahardja (forthcoming) show that about not the right choice. This is also true for the coun- 71 percent of the increase in Indonesia’s exports tries that do not have a large domestic market like from 1990-2008 was due to growth of the same set Singapore. Thus, a strategy to facilitate exports will of products sold to the same markets. Exports of provide relevant results for the Indonesian econo- existing products to new markets only comprised my or countries with small domestic markets. If a 2.9 percent of the increase in total exports between strategy facilitating exports is still relevant for In- 1990 and 2008. Finally, there seems to be very donesia, will that strategy be able to reduce volatil- little discovery in Indonesia’s exports. Exports of ity in Indonesia’s economic growth? new products, either to existing or to new mar- kets, contributed only 2 percent of the increase in A study by Haddad, Lim and Saborowski (2010) total exports in that period. The limited capacity shows striking results of a positive connection be- and effective public institutions to facilitate R&D tween export concentration and the total effect of and new exporters could limit incentives of manu- openness on volatility. The more concentrated ex- facturers to engage in new product discovery. As ports are, the higher the total effect of openness a consequence, Indonesia has depended more on on volatility is. The implication is that the effect exports of old products to existing markets as the of growth volatility as a result of the choice of an main driver of export growth. export-led growth strategy in the economy would diminish through export diversification. This Recent efforts to diversify exports in markets and study provides an exit road for Indonesia to still products have been increasingly more challeng- an export-led growth strategy as long ing. Competitiveness issues are constraining In- as an export diversification policy is carried out. donesian manufacturers and limiting their returns Therefore, it is very important to examine the ex- as they face an increasingly competitive global perience of export diversification in Indonesia. market. Booming commodity prices and the

Think Tank 20: Global Perspectives on the Seoul G-20 Summit 28 appreciation of the rupiah’s real exchange rate have efforts on export diversification and may trigger increased the opportunity costs from investing protectionist pressures. outside of the commodity-related businesses and lowered the margins for manufacturers to com- Indonesia’s past experience and dependence on oil pete globally. Interestingly, declining performance commodities reminds us that there are risks in its of Indonesia’s manufactured exports also coincides economy. Therefore, in the future Indonesia has to with the appreciation in the real exchange rate and issue policies to diversify exports. There are several rising exports of resource-based commodities. The policies to be carried out, such as development im- increased price of commodities raises export rev- provements in the financial sector, improvements enues and increases pressure for real appreciation in the logistics system or connectivity, reduction of the rupiah. Meanwhile, the increase in the price in dependency toward primary exports, safeguard- of commodities could also have increased fac- ing competitiveness from exchange rates (prevent- tors of production intensively used in commod- ing Dutch disease), improvements in R&D and ity sectors, such as labor and capital, squeezing the quality of products, increasing the role of the profitability in traditional manufacturing sectors services sector as well as improvements in promo- that are facing competitive world prices and the tion and marketing. If these policies are smoothly strengthening rupiah. In addition, the threat of a implemented, Indonesia will maintain an export- “ war” may complicate the situation. The led growth strategy while also supporting domes- loose monetary policies and measures of advanced tic consumption. Ultimately, export-dependant economies prop up the carry trade and conse- countries can still safeguard an export-led growth quently lead investors to buy assets in emerging strategy as long as an export diversification policy economies, thereby creating pressure on exchange is carried out. This export diversification strategy rate appreciation which may hamper Indonesia’s will also help to ease the pressure on protectionism.

Think Tank 20: Global Perspectives on the Seoul G-20 Summit 29