Indonesia’s trade pattern has been shifting in the last 10 years. During the period of 2010-2014, natural resources and commodity exports were an important source of revenue as global demand for and prices of these commodities significantly increased.

Since 2015, when commodity prices dropped sharply, commodity exports have become more vulnerable to price fluctuation. Currently, Indonesia should focus more on how to boost growth of the manufacturing industry to alleviate the dependency on commodity exports.

The pattern of world trade has changed rapidly toward industrial component (intermediates) trading, which accounts for an increasing share of global trade. Regional and global supply chains are thus becoming much more important to manufacturers. According to the Organization for Economic Cooperation and Development (OECD) database, nearly 60 percent of the volume of world merchandise trade is trade in components and/or intermediate goods.

In Asia the figure is closer to two-thirds. The import content of exported goods now stands at an average 40 percent, up from 20 percent only two decades ago. The level of import intensity in export production has created an unprecedented level of inter-dependency among countries engaged in supply chains.

Indonesia should join the global value chains (GVC) as much as other Asian countries to speed up industrialization. High-performing export countries such as China and South Korea have seen the import content of their exports increase significantly.

An 2016 OECD report shows that the import content of Korea’s exports is 30 percent; even the import content of the Philippine exports reached 23.4 percent. In contrast, Indonesia’s exports have not followed this trend to the extent that its regional competitors have. Unfortunately, the average import content of Indonesia’s exports in 2016 is only 11 percent. Clearly, if Indonesia is to promote products that rely on GVCs, such as automobiles, it needs to be more open to trade in intermediate goods and services.

Furthermore, many of Indonesia’s export products depend on imports. There is a strong positive correlation between Indonesia’s exports and imports. The more a sector is permitted to import inputs, the more it is able to grow and develop exports. However, Indonesia’s current restrictive trade policies have prevented Indonesia from taking full advantage of this fact and partly explain the limited participation in GVCs.

To improve Indonesia’s export performance, the government will therefore need to shift its international trade negotiation strategy. The traditional strategy has tended to focus on negotiating for access to export markets through the removal of tariff barriers. Going forward, the important thing will be promoting exports of goods from key sectors to boost manufacturing growth.

This will involve the removal of tariff and nontariff measures (NTMs) in key export markets. Crucially, it will also involve efforts to reform Indonesia’s own tariffs and NTMs in intermediate goods and services. NTMs are especially common in processed food, chemicals and textile products.

The Indonesian manufacturing sector needs access to modern and competitive services. Manufacturers use services in two ways: first, during production to create value in their products and second, as part of their sales strategy to gain and maintain market share. The services input needs of manufacturers are, of course, diverse. They range from professional, legal and accounting services to banking and nonbanking financial services; research, development and design services; energy and telecommunication services, marketing services and transportation, storage and distribution services.

Indonesia needs to reduce trade barriers in the services sector, including in legal services, retail and wholesale trade, logistics and transportation services. Based on findings from a Trade Ministry study of 2015, the combined impact of restrictions to foreign direct investment (FDI) and labor supply in the service sector means Indonesia’s GDP is an estimated 10.41 percent lower than it otherwise would be.

The estimated cost to the economy is based on the discriminatory measures in the service sector and do not include other losses from nondiscriminatory but costly regulations and regulatory procedures, which add to the cost of doing business in Indonesia. The second finding is that FDI restrictions in the service sector cost the country 2.28 percent of its GDP. The estimates do not take into account the dynamic effects of FDI from increased productivity through technological spillover and skill-upgrading.

The downstream industry sectors that would benefit most from lower prices with the opening up of more FDI are textiles and footwear, food and beverages, electronics, automotive and chemicals. These industry sectors are among the key export products and/or priority sectors included in the vision of Making Indonesia 4.0.

To sum up, manufacturing in Indonesia’s priority sectors should be supported by policies that increase Indonesian exposure to trade, both imports and exports of goods and services and by policies that increase the integration with regional and GVCs.

Indonesian manufacturers wish to be regionally or globally competitive and need access to the best possible inputs (goods and services) at the lowest possible prices. Maintaining a restrictive import regime harms Indonesia’s competitiveness by increasing the cost of components and other raw materials.

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The writer is an industry analyst at Bank Mandiri.

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