After seeing industrialization stall for a decade after the 1997 financial crisis, Indonesia appears to be getting a second chance, with foreign direct investment picking up once again. But let’s not celebrate yet: The success of this new round of industrial revitalization depends on whether or not it is accompanied by sufficient transfer of knowledge and innovation.
Recently, the government released investment approvals data for the second quarter of 2012. The numbers were a reason to be optimistic. Despite recent controversies surrounding a number of trade and investment policies, FDI approvals still managed to grow 30 percent compared to the same period last year. Indonesia’s large domestic consumption base, young demographics, low debt levels and macroeconomic stability obviously remain a strong magnetic field for cross-border investors.
From a historical perspective, it appears that the country is getting its second chance at it. In the 1980s and early 1990s, Indonesia had also been en route toward following the footsteps of industrialized Asian economies, seeing double-digit growth in manufacturing output.
However those hopes were quickly dashed when the 1998 Asian financial crisis came ashore — the currency devalued and FDI quickly dried up. In the ensuing decade, up until 2010 when the current round of revitalization started, manufacturing output growth hovered at a meager 5 percent per annum.
The latest round of industrial revitalization has been driven to a large extent by the changing global landscape, as growth in developed markets stalls amid a spiraling debt crisis. Of course, the Indonesian government could be given credit too, for the various facilities that accommodate capital goods purchases, as well as tax holidays and allowances for new investment in certain sectors. New policies have also been geared to encourage more investment in the downstream sectors in order to capture more value-added.
It will be interesting to see how far the progress goes this time. Indeed every country has different paths to industrialization. But if there’s anything to learn from the experience of China, the success story of the decade, it is that technological transfer and innovation are crucial factors for moving up the value chain more sustainably.
Back at home, the government appears to have been very focused over the years on attracting FDI back into the country. However it is not very clear how much has been done to prepare the infrastructure and human capital needed to accommodate technological transfer and innovation once FDI does come in.
There has been progress in terms of school enrollment, along with the increase in share of education spending since 2009. Indonesia saw some decline in the portion of the population lacking formal education, from 22.3 percent in 2010 to 20.3 percent in 2012.
Yet, almost half of the population has advanced no further than primary or junior high school. Of course, one can argue that improving education levels cannot be done overnight. However, the statistics on personnel engaged in research and development is not so inspiring either.
For comparison, Unesco data shows the number of full-time employed R&D personnel in China grew from 548 to 863 people per million inhabitants over the decade to 2009. In Indonesia, not only was the number much smaller, but the trend was in the opposite direction: from 211 declining to just 90 people per million inhabitants over the same period.
The data on R&D expenditure don’t give much hope either. While gross domestic expenditure on R&D in China reached 1.7 percent of the size of gross domestic product in 2009, Indonesia’s R&D expenditure was only 0.08 percent of GDP, although it did grow from 0.07 percent in 2000. Meanwhile, government expenditure on energy subsidies this year is expected to reach 3.5 percent of GDP.
Another obvious structural flaw caused by the lack of domestic innovation is the economy’s very high reliance on capital goods imports. Around 90 percent of new machinery investment in Indonesia is sourced from abroad.
Clearly much more emphasis must be placed on human resource capacity building and R&D. Perhaps the government can first start by further increasing the R&D incentive for the private sector and universities. Currently the majority (85 percent) of R&D personnel in Indonesia are government employed, whereas in the higher GDP per capita countries such as China, South Korea and even Malaysia, the private sector and universities play a strong if not the leading role.
The key objective now is to ensure that if FDI dries up again for any reason, the knowledge base doesn’t, and domestic companies can lead the way in moving up the value chain. Without sufficient transfer of knowledge and innovation, this would be hard to achieve. Indonesia’s industrial revitalization should not be left to stand on shaky ground.
Helmi Arman is an economist at Citibank Indonesia.