Many commentaries from Indonesian pundits and members of the press corps suggest that the ASEAN-China Free Trade Agreement (ACFTA) will do more harm than good to Indonesia’s economy – or industry, or national integrity, or political influence, or fate (...insert whatever you want, here...).
Alas, most of them are based on misunderstood data and incomplete interpretations. Like most economic narrative, free trade has, at least, two sides of the same story.
Let me show you the other side of story many of our ACFTA critics fail to notice.
First, critics love to cite the Indonesian trade deficit against the Chinese as the reason to reject ACFTA.
True, we have bought more goods from the Chinese more than we sold to them. Data from UN-Comtrade shows that we have had US$820 million trade surplus with China in 2005, but $2.5 billion deficit in 2009. Bad news? Not necessarily.
Let’s take a modified illustration from Steven Landsburg of University of Rochester ( 2007 ) and consider this indisputable fact: My household has run a trade deficit against Warung Padang (Padang restaurant) near my home in Depok since, uhm, forever.
All these years, I have spent my money buying my rendang (meat simmered with spices and coconut milk) from them; and I have never received a penny by selling something to them. If somehow they reduce their price, my trade deficit would grow, considering that we really like their rendang.
Do I have to lose my sleep? No. Why? Because my household have trade surplus against other parties – School of Economics at the University of Indonesia, where I work for, and School of Anthropology, Padjadjaran University, where my wife used to work. Or, if we were a goods producer, anyone to whom we sell our products.
This is exactly what has been going on in Indonesia. In 2005 and 2009, Indonesia registered $27.96 billion and $19.68 billion trade surpluses against the rest of the world – much higher than the deficit against the Chinese.
Now back to my household example: suppose the money we earn from teaching is less than we pay to Warung Padang and all of other places we purchase our needs and wants from.
We ran trade deficit against everyone. What to do? We can still use our credit card or dig out our money reserve — technically speaking, we make a financial transaction or change in our reserve.
Our record tells us that money in always equals money out plus the change of our money reserve – a balance coming from our trade transactions, financial and capital flow, as well as the change of our reserve. For an economy, this record is called the Balance of Payment (BOP).
The point is that you cannot just look at the bilateral trade deficit – say, between Indonesia and China – or even the BOP, to assess the welfare impact of free trade agreement on the economy.
Second, many pundits also tell us that ACFTA is bad because it harms the domestic industry. What they (almost) always forget to mention is that consumers benefit from cheaper and/or better products.
There must be a reason for Chinese goods to flood in Indonesian market – many of us, Indonesians, find those goods desirable and we buy them.
Now, let us assume that Chinese products are cheap because they are low quality (for the record, I do not share this view). Then the Indonesians who bought Chinese products must be the ones who cannot afford more expensive high quality products.
It shall be a good news that they now too have opportunity to buy one or two more pairs of decent shirts, ride a motorcycle, or enjoy sinetron (soap opera) from their made-in-China TV set. Who are they, by the way? The lower-middle and low income groups.
These people may be not as sophisticated as you, The Jakarta Post readers, who like to sneer at Chinese products and prefer Prada, Lexus or a high-end home theater systems to enjoy, alas, the same crappy sinetron.
But you can’t just simply overlook such increasing consumer’s welfare story.
Third, critics also argue that we need to protect domestic industries from Chinese competitors. Our industries are not ready for it because they still have lower productivity than their foreign competitors – even in our own domestic market.
Well, protectionism to nurture domestic industry productivity does not work in Indonesia. Look at all those so-called strategic industries protection schemes during Soeharto era, they failed miserably.
Moreover, little that those critics probably realize, trade liberalization can induce productivity through import competition as well as learning effect.
Mary Amiti and Josef Koenig ( 2007 ) show that for the period of 1991 to 2001, 10 percentage point reductions to tariffs on inports increases a firm’s productivity by 12 percent. The same reduction for final goods raises firm’s productivity by around 6 percent.
Better yet, we can attain even higher productivity if we could manage to fix our own supply side problems that has nothing to do with the Chinese – that is, corruption, lack of infrastructure, and an inflexible labor market.
My point: free trade can enhance domestic firms’ productivity.
Fourth, critics like to mention that China is cheating by artificially keeping the yuan undervalued to keep their products cheap.
Indeed, recently, there has been a debate between economists such as Paul Krugman on one side, who accused China of manipulating their currency and harming the world’s economic recovery; and, on the other side, scores of respectable economists who point out that either it was neither the case or nor very relevant to the current crisis and recovery.
But suppose that is what the Chinese did. The same logic goes that while producers might be harmed by competitor’s artificially low price, the consumers gain.
To put it in another way, the Chinese keep their currency undervalued for Indonesian consumers to afford their goods.
In fact, keeping yuan low has its own price – while their export quantity goes up, Chinese producers do not enjoy the price effect of exchange rate appreciation. This policy also might not be sustainable for the Chinese for the following reason.
According to Gregory Mankiw of Harvard University (The New York Times op-ed, Feb 7, 2009), to keep the exchange rate low, the Chinese needs to supply yuan and absorb the excess of dollar in their economy. These dollars is in turn invested abroad, mainly in the US.
But along with the crisis, return on investing those excess dollar in the US market is now very low. In other words, it becomes more costly for the Chinese to maintain this policy.
To conclude, I just hope that our critics in their noble effort to inform the general public are more willing to spend some time and look at the other side of ACFTA story because in every downside of ACFTA they claim, usually there is an overlooked upside.
There must be a reason for Chinese goods to flood the Indonesian market – many of us find the goods desirable and we buy them.
The writer is PhD student in Economics, George Mason University, Fairfax, Virginia.