Indonesian trade policy and the search for added value
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The fear about Indonesia’s import escalation and export decline is quite obvious.
Some trade policies have been implemented to tighten imports, such as introducing non-automatic licenses for imported products.
These restrictive import policies add to many other regulations and policies that have been introduced to control Indonesia’s export of raw materials and intermediate inputs.
These policies are in line with common perception that Indonesian industries should produce goods with higher added value. Restrictions on the exports of raw rattan and mining products, the export tax on crude palm oil and incentive schemes to increase domestic production all point to the same intention.
Such obsession with increasing domestic added value is not limited to raw material production, but also involves manufacturing products.
The fact that almost 70 percent of industrial goods imported are parts and components has raised concern about the country’s dependence on imports.
Many commentators urged the government to push manufacturers to produce parts and components domestically and increase local content in the manufacturing sector.
Import-phobia and the value-added obsession are not new to Indonesia. In fact, import substitution strategies such as local content requirements were implemented in the past without much success.
The current arrangement of international production makes such strategies today even more unlikely to succeed.
In the new production arrangement, goods are no longer produced in one specific country, but rather made in many countries.
While everybody knows that Apple’s iPod is a product of a US firm, it is actually manufactured in more than 10 countries, involving a large number of suppliers contributing very specific tasks to the value chain.
A high level of production efficiency is reached because different tasks are placed in different countries with suitable situations. Assembling tasks, which are relatively labor intensive, are best located in countries with abundant supplies of labor, while research and design should be done in a country where highly skilled experts are widely available.
The rise of international production networks (IPN) makes it almost impossible for a product to be processed fully in one country. While that country, with excessive government support, may be able to produce the whole value chain domestically, it is extremely difficult to produce an internationally competitive product in this manner.
This would only create inefficient industries that require intensive government support and protection. The Malaysian car program is an example of how the ambition to produce a national product with high value added led to an inefficient industry and uncompetitive products (Baldwin 2011).
In this new production arrangement, a country exporting electronic products depends a lot on its imports of parts and components. Higher dependence on imported parts and components indicates higher involvement in IPN. More than 30 percent of China’s manufacturing exports come from imports, while the import content of Indonesian exports is less than 18 percent. Other indicators show that Indonesia’s involvement in IPN is quite low compared to other countries in the region.
Added value explains the difference between revenue and costs related to production. It can be seen as per-unit value added or the total value added of production activity. Current discussions and trade policies in Indonesia focus on the former.
It is noted that goods that are processed domestically may acquire higher per-unit value added, but not necessarily higher total value added.
New arrangements in international production have forced companies and countries to become more highly specialized than ever before.
Production of hard disk drives, for instance, which are only a small part of a computer, takes place in many different countries, each specializing in producing small components that create a few dollars per-unit of added value.
IPN enables those companies to produce components for global demand, which is much greater than they would have produced if they had manufactured their own computer.
At the same time, specialization creates higher levels of efficiency and lower costs of production.
The combination of specialization, which reduces costs of production, and greater volume, which increases revenues, leads to higher total value added. This is what is most important.
It does not matter whether a country can produce its own national car, which generates per-unit added value of thousands of dollars, or whether it produces several parts of a car, which are worth a few hundred dollars, as long as production can be performed efficiently and generate the same or higher amounts of total value added.
Therefore, Indonesia’s industrial and trade policy should focus less on developing the whole value chain of production, and instead concentrate in increasing productivity and efficiency for certain tasks suitable to the country’s abundant unskilled labors.
This focus should also be accompanied by an improvement of the general business climate and
It might not be glamorous to build industries specializing in low per-unit value-added activities to supply IPN. But this strategy is necessary in order to build efficient and competitive industries.
By increasing Indonesia’s involvement in IPN, Indonesia also has a good opportunity to acquire technical know-how needed for industrial advances and producing higher per-unit value-added products in the future without sacrificing efficiency and competitiveness, as many countries in East Asia have done.
The writer is a researcher at the Centre for Strategic and International Studies (CSIS), Jakarta.