Experiences of Japan, Taiwan, Korea, Singapore and now China and India, show that closer integration of the domestic economy to global markets allows them to expand exports and to tap global financial resources and grow rapidly. The export-oriented strategy has also been successfully used to tap into skilled laborers and other global factors of production, to upgrade infrastructure and technology for development.

Experiences of these countries also show that growth strategy on developing industrial bases, rather than specializing according to comparative advantages is the fastest way to develop. Through strategic state-owned enterprises and industrial policies, China has successfully forced foreign companies to transfer technology.

Those countries started their economic development by processing our natural resources and have now become producers of high-tech products. In thirty years, China has transformed from a low income and backward communist country to become a respectable member of emerging BRIC with external reserves in the range of US$2 billion.

The export-oriented strategy consists of two broad policies. First, to correct the Dutch disease of the exchange rate and make the real effective exchange rate (REER) positive. REER is the nominal exchange rate adjusted against a basket of foreign currencies with which the country trades.

On the domestic front, positive REER makes domestic-made products have financial competitiveness in international markets. On the external front, it affects international competitiveness exports and, hence trade balance. The second policy to promote international competitiveness is to raise economic productivity through training and education as well as building institutions.

The Dutch disease happens because of the large export revenues from exports of some booming products and capital inflows have appreciated external value of the rupiah. The appreciation of the rupiah hurts other sectors of the economy as it makes prices on import cheaper and raises prices of exports in foreign currencies. The strong rupiah also provides incentives for production of low-productivity activities such as the non-traded sector of the economy.

Non-traded goods, such as the rapidly expanding shopping mall, construction, hail cuts and the public sector, are not internationally traded and their markets are where they are being produced. The competitive exchange rate management is therefore to correct this and encourage the transfer of economic resources from the low-productive non-traded sector of the economy to the high-productive traded sector.

The present deregulation policies with unclear objectives have allowed us exploit comparative advantages of our economy as a producer of raw materials such as nickel, coal and other minerals and agriculture products such as palm oil and cocoa. The boom in these commodity markets was partly due to the rapid economic growth in China and India.

On the other hand, we are now more depending on imported food, fruits and manufactured consumer goods that are mainly produced by farmers and manufacturers on the populous island of Java that cannot compete with imports. All the way from our high-end shopping malls in Jakarta down to outlet shops in Bandung and traditional markets in remote villages are selling Chinese-made manufactured products and imported fruits from all over.

Liberalization in the capital account of the balance of payments and the financial sector since the crisis in 1997 have increased participation from foreigners in large plantations., the mining sector, as well as in our service industry such as banks and telecommunications. The role of foreign capital is also on the rise in our narrow and shallow bond and capital markets.

The appreciation of the rupiah has also contributed to regional imbalances between the most populous island of Java and outer islands. This is because most of the booming primary products are produced off Java.  

On the other hand, most of the economic sector hurt by the appreciation of the rupiah, such as food, agriculture and horticulture, and labor intensive manufacturing products, are being produced on Java.

Promoting structural transformation from low productivity of the non-traded sector of the economy to high-productivity of tradables also requires building social institutions. This includes protection of property rights, enforcement of contract, correction of market failures and externalities, the elimination of red tape and corruption, and improvements in the investment climate and the cost of doing business.

For the foreseeable future, Indonesia still needs short-term and long-term foreign capital to finance budget deficits and to satisfy other financing needs. Because of this reliance on foreign capital, policy makers should be aware of the impact of short-term capital flow on the exchange-rate movements and external reserves.

To mobilize domestic savings and enable the domestic market to absorb more government and private sector bonds, Indonesia should reestablish the Postal Saving Bank that had been destroyed by the past high inflation and regional conflicts. In addition, other long-term financial institutions such as pension funds and insurance should also be promoted.

The writer is a professor of economics at the University of Indonesia, former senior deputy governor of Bank Indonesia (Central Bank) and former chairman of  the Supreme Audit Agency (BPK).

Popular

To my horror, it’s just a movie!

RI, Australia strengthen partnership on taxing crypto assets

Pentagon chief congratulates Prabowo on being elected President