Signed during the 10th ASEAN Summit in November 2004 in Vientiane, Laos, the CAFTA is not a well-thought through free trade agreement (FTA).
On our side, there has been practically no program on how to make our economy competitive in order to reap its benefits. Strengthened by high exports of primary products, mainly to China (PRC) and India, the rupiah exchange rate fails to encourage exports of agriculture products and manufacturing.
Also missing is a systematic program to improve productivity that includes rules of law, improvements in modern economic infrastructure, high-quality education, commercial innovation and a world-class technology base.
Ever since the CAFTA became effective on Jan. 1, 2010, our farmers and industrialists and small-scale handicraft producers have been complaining about the surge of cheap Chinese industrial and agricultural products in our domestic market. What has gone wrong?
The theory of comparative advantage tells us that a country, such as Indonesia, should selectively sign FTA agreements with countries to maximize the benefits of its competitive industries and minimize damages to its vulnerable and less competitive industries.
The main objective for signing a bilateral or multilateral FTA is to further exploit comparatively advantaged industries by eliminating trade barriers.
In general, competitive industries flourish from FTAs while vulnerable industries suffer. For example, Indonesia and the PRC have their industries X, Y and Z. Indonesia is competitive in industry X and not competitive in industry Z.
After the two countries sign the CAFTA, Indonesia’s industry X benefits from increased potential to exploit Indonesia and PRC markets, but industry Z will suffer due to an influx of cheap Chinese products. In Indonesia, industries X and Y will survive and industry Z will disappear.
If Thailand has a competitive advantage in industry Y, only industry X will survive in Indonesia
To conclude, FTAs will encourage Indonesia to specialize in industry X, with industries Y and Z destined to disappear and shifted to our free trade partners, namely, Thailand and China.
The scenario would cause little problem if Indonesia was a company and could concentrate on its competitive business sectors and give up non-competitive fields. For a country as a whole, the situation is more complicated because the workforce is employed in industries Y and Z and will be forced to find work elsewhere. Moreover, if industry X gets into trouble, the entire Indonesian economy will be hit hard.
The ideal FTA partner is a country whose competitive industries are non-existent in Indonesia. In the agriculture sector, free trade with a country that has a comparative advantage in the production of wheat that can be grown in temperate zone is a good example. Being a tropical country, however, Indonesia does not grow wheat.
The next best FTA partner is a country that specializes in a few specific agricultural products. If Thailand, Malaysia and Vietnam have comparative advantages in producing durian, starfruit and rice respectively, Indonesia should concentrate on the production of other tropical agriculture products. The worst FTA partner is a country that produces commodities similar to Indonesia’s major production.
The IMF and many countries, including the US, complain that PRC has for some time adopted a policy of keeping its currency, the renminbi or Chinese yuan, undervalued to make its export artificially competitive in international markets.
The US Peterson Institute for International Economics estimates the renminbi is undervalued by between 20 and 40 percent. According to Paul Krugman (International Herald Tribune, March 16, 2010, p.7) the Chinese policy seriously damages large economies that are now in deep recession as they cannot generate recovery by cutting interest rates as they are now already close to zero. The unwarranted Chinese trade surplus offsets the fiscal stimulus introduced in those countries.
On March 15, 2010, 130 US congressmen send a letter to the Obama administration describing the PRC as a currency manipulator and calling for countervailing duties to be placed on Chinese imports.
Faced with similar problems of undervalued foreign currencies, the US imposed a temporary 10 percent surcharge on imports in 1971 until Germany, Japan and other countries raised the dollar value of their national currencies.
If the US imposes a countervailing duty on Chinese imports, the PRC will divert some of its exports to other parts of the world including Indonesia. As a result, Indonesian producers will suffer twice: first because of the undervaluation of the renminbi and second because of the dump of excess supply.
Undervaluation not only acts as an export subsidy. Like an import tariff, the undervaluation of currency is a protectionist trade policy that makes imports more expensive. The real victims of the renminbi overvaluation and trade war between the PRC and the US are the low-income emerging economies, including Indonesia, as they are the main competitors of the PRC. Like other emerging economies, the PRC only assembles products made in the rich countries, including the US.
The writer is professor of economics at the University of Indonesia, Jakarta.
