Industrial Policy in Indonesia: A Global Value Chain Perspective

Tijaja, Julia; Faisal, Mohammad Working Paper Industrial Policy in Indonesia: A Global Value Chain Perspective ADB Economics Working Paper Series, No. 411 Provided in Cooperation with: Asian Development Bank (ADB), Manila Suggested Citation: Tijaja, Julia; Faisal, Mohammad (2014) : Industrial Policy in Indonesia: A Global Value Chain Perspective, ADB Economics Working Paper Series, No. 411, Asian Development Bank (ADB), Manila, https://hdl.handle.net/11540/1279 This Version is available at: https://hdl.handle.net/10419/109506 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. http://creativecommons.org/licenses/by/3.0/igo ASIAN DEVELOPMENT BANK AsiAn Development BAnk 6 ADB Avenue, Mandaluyong City 1550 Metro Manila, Philippines www.adb.org Industrial Policy in Indonesia A Global Value Chain Perspective This paper traces the evolution of industrial policies in Indonesia from a global value chain (GVC) perspective. As the gains of a country participation in GVC are influenced, among others, by industrial policies, an understanding of both policy leverage and risks is imperative. Using the mineral sector as a mini case study, the paper assesses the Indonesian Government’s recent effort to boost domestic value addition in the sector. It argues that the effectiveness of government policies in maximizing the gains from GVC participation depends not only on policy design, but also on policy consistency and coherence, effective implementation, and coordination. About the Asian Development Bank ADB’s vision is an Asia and Pacific region free of poverty. Its mission is to help its developing member countries reduce poverty and improve the quality of life of their people. Despite the region’s many successes, it remains home to approximately two-thirds of the world’s poor: 1.6 billion people who live on less than $2 a day, with 733 million struggling on less than $1.25 a day. ADB is committed to reducing poverty through inclusive economic growth, environmentally sustainable growth, and regional integration. Based in Manila, ADB is owned by 67 members, including 48 from the region. Its main instruments for helping its developing member countries are policy dialogue, loans, equity investments, guarantees, grants, and technical assistance. InDustrIAl PolIcy In InDonesIA: A GloBAl VAlue chAIn PersPectIVe Julia Tijaja and Mohammad Faisal adb economics working paper series no. 411 october 2014  ADB Economics Working Paper Series Industrial Policy in Indonesia: A Global Value Chain Perspective Julia Tijaja and Mohammad Faisal No. 411 | 2014 Julia Tijaja ( [email protected]) is an Assistant Director and Senior Economist at the ASEAN Integration Monitoring Office (AIMO) of the ASEAN Secretariat. She was formerly a Research Analyst at the Fung Global Institute. Mohammad Faisal ([email protected]) is a Research Director of the Center of Reform on Economics (CORE) Indonesia. The views expressed in this paper are those of the authors and should not in any way be attributed to the institutions with which they are associated. ASIAN DEVELOPMENT BANK Asian Development Bank 6 ADB Avenue, Mandaluyong City 1550 Metro Manila, Philippines www.adb.org © 2014 by Asian Development Bank October 2014 ISSN 2313-6537 (Print), 2313-6545 (e-ISSN) Publication Stock No. WPS146901-3 The views expressed in this paper are those of the author and do not necessarily reflect the views and policies of the Asian Development Bank (ADB) or its Board of Governors or the governments they represent. ADB does not guarantee the accuracy of the data included in this publication and accepts no responsibility for any consequence of their use. By making any designation of or reference to a particular territory or geographic area, or by using the term “country” in this document, ADB does not intend to make any judgments as to the legal or other status of any territory or area. Note: In this publication, “$” refers to US dollars. The ADB Economics Working Paper Series is a forum for stimulating discussion and eliciting feedback on ongoing and recently completed research and policy studies undertaken by the Asian Development Bank (ADB) staff, consultants, or resource persons. The series deals with key economic and development problems, particularly those facing the Asia and Pacific region; as well as conceptual, analytical, or methodological issues relating to project/program economic analysis, and statistical data and measurement. The series aims to enhance the knowledge on Asia’s development and policy challenges; strengthen analytical rigor and quality of ADB’s country partnership strategies, and its subregional and country operations; and improve the quality and availability of statistical data and development indicators for monitoring development effectiveness. The ADB Economics Working Paper Series is a quick-disseminating, informal publication whose titles could subsequently be revised for publication as articles in professional journals or chapters in books. The series is maintained by the Economics and Research Department.  CONTENTS TABLES AND FIGURES v ABSTRACT vi  I. INTRODUCTION 1  II. INDONESIA AND GLOBAL VALUE CHAINS 2 A. Economic Profile 2 B. Trade Profile 3 III. INDUSTRIAL POLICIES IN INDONESIA: A HISTORICAL OVERVIEW 6 A. Pre-crisis (1966–1996) 6 B. Economic Crisis (1997–1998) 9 C. Post-crisis (1999–2007) 9 D. Global Financial Crisis (2008–2009) 12 IV. CURRENT INDUSTRIAL POLICY (2008–PRESENT) 13 A. National Industrial Policy (Presidential Regulation No. 28 of 2008 and Regulation of the Minister of Industry 41/M-IND/PER/3/2010 ) 13 B. Master Plan for Acceleration and Expansion of Indonesia Economic Development (MP3EI) 15 C. The New Industrial Bill (2014) 18 D. Main Industrial Policy Trajectory 19 E. Assessment of Other Policy Objectives 20 V. OTHER RELEVANT BROAD-BASED POLICIES IN PLACE 21 A. Improving the Effectiveness of Policy Implementation 21 B. Infrastructure Catch-up 22 C. Economic Corridors 23 D. Power and Energy 24 E. Global Connection 24 VI. FROM POLICY TO IMPLEMENTATION 25 A. Trade Taxes 25 B. Non-tariff Measures 26 C. Tax Facilities 27 D. Upgrading Support 29 E. Investment Regime 29 F. Local Content 30 G. The Weakest Link 30 Contents VII. CASE STUDY: THE MINERAL SECTOR 32 A. Overview 32 B. Sectoral Policy Objectives 33 C. From Policy to Implementation 34 D. Lessons for Policy Recommendations 38 VIII. CONCLUSIONS 38 REFERENCES 41  TABLES AND FIGURES TABLES 1 Sectoral Growth, 2011–2013 3 2 Top Export and Import Partners, 2013 4 3 MP3EI Six Economic Corridors 23 FIGURES 1 Sectoral Composition of Indonesia’s GDP, 2013 2 2 Share of Indonesia’s GDP Components, 2013 3 3 Indonesia’s Merchandise Specialization Trade Index by Commodity, 1995–2012 4 4 Indonesia’s Trade Specialization Index Compared with other ASEAN Countries 5  ABSTRACT The gains of a country from participating in global value chains (GVCs) will depend on the productive activities taking place in its jurisdiction and their linkages to the domestic economy. Lead firms’ decision on where to locate and how to coordinate production activities is influenced, among others, by industrial policies. On the one side, policy space provides governments with some leverage in guiding economic activities and influencing development outcomes. On the other hand, policy risks have the potential to adversely affect the outcomes. This study focuses on industrial policies in Indonesia, using the mineral sector as a mini case study. The case study assesses the Indonesian Government’s recent effort to boost domestic value addition in the sector. This paper argues that the effectiveness of government policies in maximizing the gains from GVC participation depends not only on policy design, but also on policy consistency and coherence, effective implementation, and coordination. Keywords: Industrial policy, Indonesia, global value chain, upgrading. JEL Classification: F63, F68, L52, L76, O25,  I. INTRODUCTION International production sharing means greater opportunity for country and firm participation in global value chains (GVCs). At the level of individual economic actors, the benefits and costs of such participation will depend on where and how they are involved in the GVC; rarely is this a free choice. The decisions by the lead firms on where to locate and how to coordinate various production activities are often key influencing factors, with implications for the development and diversification outcomes in the host countries. Returns to different production activities are not homogeneous, and are reduced over time by new entrants and intensified competition. The speed with which this occurs is affected by a number of factors, both external and internal to value chains. Informed decisions by lead firms would take account of these factors. Among the external factors is policy, including industrial policy. Industrial policy is introduced by governments to guide resource allocation to specific industries or sectors, or activities. The gains from GVC participation for each economy will depend on the productive activities taking place in its jurisdiction and their linkages to the domestic economy. Governments’ concerns go beyond GVC participation and its immediate returns, but also include broader and longer term public policy objectives, such as the number and quality of jobs created, the non-economic impact of industrial activities, the dynamic scope for upgrading, skills and knowledge development, and more generally, contributions to economic diversification and resilience. Policy space provides governments with some leverage in influencing the outcomes, although policy risks have the potential to adversely affect them. Industrial policy, or more precisely specific industrial policy, refers to non-neutral government intervention that seeks to alter market signals. The objective is to steer investment and production activities to industries or sectors that are deemed more beneficial to an economy in the longer term. Risks are present along the policy process and as early as the sector identification process. The costs of mistakes can be disproportionately high in resource-scarce developing economies. The risk of government failures has been commonly cited by the opponents to industrial policy, while its proponents argue that it is not necessarily higher than that of market failures. A second type of industrial policy refers to horizontal, broad-based policy that is relevant to industrial development, such as infrastructure, energy, business regulations, and connectivity. While this type of policy is more universally accepted, it may not be sufficient on its own to overcome market failures and spur industrial development. From a GVC perspective, industrial policy can be targeted at specific activities in a particular sector or industry that are deemed to deliver greater benefits to the economy. Recognition of the organization and the working of GVCs mean that the aim should be to move toward international competitiveness rather than reckless domestic expansion behind a high wall of protection. This requires balancing the objective of maximizing domestic linkages with the pursuit of achieving international competitiveness, including through the use of competitive imported intermediates. Government capabilities are therefore imperative along the policy process, from design and administration to monitoring and evaluation. The study focuses on industrial policies in Indonesia. It starts by providing a descriptive overview of the economic structure in Indonesia. It continues with a historical overview and the state of play of the country’s industrial policy. The paper then focuses on policy relating to a priority sector. 8 | ADB Economics Working Paper Series No. 411 Another hallmark of the New Order was favoritism in preferential allocation of lucrative import and distribution licenses, and the rise of patrimonial network between the state (or high-ranking government officials) and the Indo-Chinese business community known as cukongism (Rock 1999). The relationship between stable macroeconomic situation and interventionist micro policies, however, was not as distant as some scholars claimed. The former facilitated the growth of the few conglomerates that in turn provided resources to the political elites. The business elites’ dependence on the political elites helped guarantee their acceptance of the GOI’s localization and rationalization policies. This interventionist and arguably inward-looking period nevertheless highlighted the general consensus that Indonesia should not limit the development of its industries to its short-term static comparative advantage (Rock 1999). Mid-1980s to 1996: Rationalization and Export Orientation At the height of the boom, the oil sector contributed up to 70.0% of total revenue, but the boom did not last forever. Oil price began falling in the early 1980s and accelerated in 1986 during which the price dropped by two-thirds in just 6 months. Indonesia was able to escape the worst by half, anticipating this in recognition of its excessive dependence on oil and implementing preemptive structural adjustments. A series of structural adjustments was undertaken during 1983 and 1984, including the rationalization of a public investment program and the cancellation or rescheduling of projects. A comprehensive tax reform was also introduced, although it did not initially include tariff reform (Lewis 1994). The most fundamental change was the realization that industrial development cannot be achieved by leaving protection from import competition to work its magic, and there is a need to ensure the emergence of competitive firms. The mid-1980s saw a period of reforms. Among the key reforms was the customs reform in 1985, which significantly reduced clearing time and import costs. This was soon followed by the adoption of the first deregulation package in May 1986, which included the Agency for Import Duty Exemption and Restitution (Pusat Pengelolaan Pembebasan dan Pengembalian Bea Masuk or P4BM). The P4BM put in place duty drawback facilities and tariff exemption to replace the export subsidy scheme which was General Agreement on Tariffs and Trade (GATT) incompliant. The scheme allowed firms to gain access to internationally competitive inputs. Unconditional ex-ante tax exemption or ex-post rebate, which replaced complex licensing, also significantly reduced business costs and uncertainties. Management of the scheme was placed under the Ministry of Finance, instead of the Ministry of Trade and Industry. The former was deemed more insulated from vested interests than the latter. Strict processing time reduced the room for rent-seeking behavior. These reforms contributed to boosting export competitiveness (Lewis 1994). The rupiah was further devalued by 45.0% in August 1986, after which the GOI pursued the policy of pegging the rupiah to the dollar with frequent nominal adjustment. The May 1986 reform package was followed by more packages, each targeting a different sector or policy. These reform efforts substantially reduced non-tariff restrictions both in terms of coverage and degree. Between 1985 and 1992, the percentage of imports covered by quantitative restrictions dropped from 43.0% to 3.0%, as the average nominal tariff declined from 22.0% to 9.0%. The fact that the GOI chose to undertake reform in stages, without setting an initial target at the outset, reflected the only possible way to navigate through domestic politics. This strategy was successful in creating an expectation of continued reform. Industrial Policy in Indonesia: A Global Value Chain Perspective | 9 The GOI also reformed its investment regime by replacing the investment priority list with the investment negative list (Daftar Negatif Investasi or DNI), and undertaking further deregulation. The reform efforts led to a prolonged investment boom, with the value of investment projects approved by The Indonesia Investment Coordination Board (Badan Koordinasi Penanaman Modal or BKPM) rising from $1.7 billion in 1986 and peaking at $12.5 billion in 1991 (Lewis 1994). This success could not be credited to a single factor, but rather an interplay of various reform packages with varying impacts across sectors and industries. By mid-1980s, labor intensive exports had replaced inefficient SOE-led industries as the country’s engine of economic growth. Indonesia also underwent a period of rapid structural change, as exports diversified from simple consumer goods and basic resource processing to a wider range of manufactures with increasing technological sophistication (Aswicahyono et al. 2010). The country soon emerged as a significant industrial exporter. In 1996, Indonesia joined the middle-income group. This achievement, however, was shortlived as the country almost immediately fell back following the AFC during 1997 and 1998. It took another 6 years before Indonesia regained its middle-income status. B. Economic Crisis (1997–1998) In 1997, Asia faced a deep economic crisis, which started with the collapse of the Thai baht. Indonesia was among the worst hit in the region. It experienced a large scale capital flight in the second half of 1997, rapid depreciation and financial distress (Aswicahyono et al. 2010). There was a loss of macroeconomic control, as the rupiah depreciated from Rp2,500 per US dollar to Rp17,500 at its worst point, and inflation was running at over 100.0% on an annualized basis. By 1998, the economy had contracted by almost 14.0%. The economic crisis culminated with the end of Soeharto’s 32 years of authoritarian regime in May 1998. The collapse of domestic and foreign investment continued for years after the crisis. Because the global economy remained buoyant despite the AFC, firms were impacted differently by the crisis depending on, among others, their market orientation. C. Post-crisis (1999–2007) 2000 to 2004: The Recovery Period Indonesia has struggled to regain its growth momentum in the period following the AFC. From 2000 to 2005, average growth was just at 4.5%, considerably lower than the pre-crisis average of 7.3% from 1990 to 1996. Performance varied across sectors, but the slowdown was even more pronounced in manufacturing, where output since 2000 had been growing at little more than half the pre-crisis rate (Aswicahyono et al. 2010). Indonesia was hit relatively harder that other Asian economies for a number of reasons. Some assumed that with sound macroeconomic management and relatively wellperforming international economy, exporting firms in Indonesia would have enjoyed a boost of competitiveness from depreciation. However, many businesses also held foreign-denominated debts, which rendered them in trouble. The first priority of the GOI post-AFC was to regain control over macroeconomic stability. The GOI sought assistance from multilateral institutions, including the International Monetary Fund (IMF). While Indonesia had kept a broadly open economy at the time of the AFC (after the 1980s reform), there was further liberalization during 1997–1998 as part of the conditions imposed by the IMF in 10 | ADB Economics Working Paper Series No. 411 exchange for loans. The country exited the programme in 2003, and until very recently had continued with its policy. Both political and macroeconomic stability was restored by 2004. Indonesia was unable to recoup the outflow of investment following the crisis. It was the only economy that registered net FDI outflow for several years. Indonesia enjoyed annual FDI inflows averaging $2.7 billion before the crisis, but was experiencing average net annual outflows of $1.4 billion for 5 years after the crisis (Aswicahyono et al. 2010). Recovery performance varied across sectors. In general, sectors in which demand was less elastic and are more export oriented were able to recover faster, while sectors with elastic demand or protected sectors feeding into the domestic market took the worst hit. The food processing sector, for example, did not record negative growth, and growth declined less sharply during the crisis. The resource-based sector recovered slowly post-crisis despite the boost in competitiveness from real effective exchange rate depreciation, partly because of the difficulty in securing input supply. Chemical-related industries experienced only a mild decline due to a strong inelastic demand from the domestic-oriented fertilizer industry. Non-metallic mineral products took a bad hit, reflecting the collapse of the construction industry; similarly with basic metals, and machinery and equipment sectors, where the former fed into the latter with a high level of protection and dependence on the domestic market. The electronics sector managed to sail through the crisis due to its export orientation and the boost in competitiveness it received from exchange rate depreciation; its output has recovered by 2000. The automotive sector, which was also highly protected, was able to adjust better thanks to the agility of the private sector in deepening its technological learning and export orientation. Some studies were fast to point at changes in labor market policies as the main cause for Indonesia’s inability to recoup competitiveness. Prior to the crisis, real wages rose at a lag relative to Indonesia’s rapid economic growth. Under Soeharto’s authoritarian regime, trade unions were heavily managed. After the crisis, pro-labor pressures emerged, resulting in a sharp hike in regulated minimal wage and the introduction of rigidities in hiring processes. This led to an increase in wages but not in productivity. In reality, the labor market in Indonesia is less than perfect and there is definitely room for improvement. However, it is unlikely to be the main cause for the slow recovery. The inability to maintain, let alone invest in, infrastructure at the pre-crisis level was a strong factor in hampering the recovery process. One thing unanimously agreed on was the cost of institutional uncertainty in Indonesia. Political and institutional infrastructure was imperfect even before the crisis, and profiteering was rampant. However, the highly patrimonial political system, and well-established connections between the political and business elites, had resulted in some certainties for those politically well-connected. After the crisis, this centralized structure has broken down, exacerbated by the decentralization process that started in 2001, which created a highly decentralized environment of 500 sub-national governments. As authoritarianism collapsed, the central government had less control in formulating and implementing a consistent development strategy across the vast economy, and in allocating the scarce resources (Kimura 2005). This had resulted in relative economic inertia, since the New Order until very recently, creating a very uncertain investment environment, particularly for foreign investors. This situation hit the resource-based industry, such as minerals especially hard, partly due to the lower level of mobility of such value chains, hence adding to the picture the complexity of bargaining with local stakeholders and political interests. Despite Indonesia’s strong comparative advantage in resource-based industry, their long term viability requires predictable and sustainable access to raw materials (Aswicahyono et al. 2010). There are also other key factors, such as the lack of Industrial Policy in Indonesia: A Global Value Chain Perspective | 11 competitive supporting services sector as well as sufficient and well-maintained infrastructure. Foreign investors, but also small and medium enterprises (SMEs), local or foreign, are likely to require facilitation to navigate these institutional complexities. Facilitation is often just as, if not more, important than liberalization in attracting investment (Kimura 2005). 2004 to 2007: Recovery of Demand and the Start of Proactive Industrial Policy Since 2003, the Indonesian economy has been showing some signs of recovery. Domestic demand for automobiles and motorcycles increased rapidly, the exchange rate stabilized around Rp9,000 to Rp10,000 per US dollar, and the inflation rate at around 6.0% (Kimura 2005). Supply capacity, however, did not recover as well as demand. While Indonesia has made a steady progress in its political reform, no clear plan was in place in terms of its mediumto long-term economic development. When the first Indonesian Unity Cabinet5 came to power, the GOI was determined to address this. In 2007, the GOI introduced Law No. 27 on Long-Term National Development Plan (Rencana Pembangunan Jangka Panjang Nasional or RPJPN) for the period 2005–2025. RPJPN placed the industrial sector as the engine of growth for strengthening the economic structure. This is to be supported by agriculture activities in its broad term, the mining sector, and effective services provision. The law also included a commitment to apply industry and management best practices for robust economic security. Improving efficiency, modernization, and value addition in the primary sector, including mining, was highlighted as the main target to promote local and international competitiveness, and strengthen the national industrial base. Reference was also made to the integration of SMEs into the value chains, stronger forward and backward value chain linkages, more balanced economic development outside the most populated island of Java, and a commitment to eliminate monopolistic behavior and other market distortions. Value chain development through product processing and diversification (downstream development), structural deepening (upstream development), and vertical integration (upstream and downstream development) was expressly mentioned in the RPJPN. The plan also underscored the need to strengthen horizontal inter-industry relations, including with supporting and complementary industries, goods and services, and networks of relevant multinational firms. In an encouraging development, RPJPN recognizes the institutional and infrastructural issues requiring urgent attention, including transportation, communication, energy, and technology. It also highlighted the need for calibration, testing, standardization, and quality control institution and infrastructure. This is particularly pertinent as standard compliance capacity is increasingly becoming a non-negotiable criterion for participating in GVCs. The desire not to be trapped in low value-added GVC participation was also reflected in the mention of the need for industrial education and training facilities. The development of the manufacturing industry would be focused on subsectors that meet one or more of the following criteria: create employment, meet domestic needs (such as food or pharmaceuticals), process domestic natural resources, including agricultural resources in its broadest sense, and have export development potential. While minerals can be argued to meet at least two of  5 The first Indonesian Unity Cabinet referred to the first term of the current coalition government from 2004–2009 as led by President Susilo Bambang Yudhoyono. 12 | ADB Economics Working Paper Series No. 411 the four criteria, it was not among the 106 clusters listed as priority for the next 5 years under the first Medium-Term National Development Plan (Rencana Pembangunan Jangka Menengah Nasional or RPJMN). Implementation of the RPJPN is operationalized through the 5-yearly RPJMN. The latter serves as a basis for ministries and government agencies in formulating their strategic and budget allocation plans. To ensure better central–regional coordination, regional governments are also required to take RPJMN into account when formulating and adjusting their Regional Development Plans (Rencana Pembangunan Jangka Menengah Daerah or RPJMD). To ensure the timely and effective implementation of the RPJPN, the RPJMN is further elaborated in the Annual Government Work Plan (Rencana Kerja Pemerintah or RKP) that will then become the basis for formulating the Draft Government Budget (Rencana Anggaran Pendapatan dan Belanja Negara or RAPBN).7 The second RPJMN covers the period 2010–2014. The effectiveness of RPJPN and RPJMN would depend on their implementation. Inconsistencies and lack of coordination across ministries, between central and local governments, between theory and practice, still remain an issue. It is nevertheless encouraging to see recognition of some of the underlying obstacles to industrial development. D. Global Financial Crisis (2008–2009) The 2008 GFC did not have the same catastrophic impact on the Indonesian economy as the 1997 AFC due to its different nature. In 2008, the Indonesian domestic economy held up better than the international economy. The country’s financial sector remained broadly intact, while the exchange rate depreciated only moderately. Export-oriented firms, particularly those focused on traditional markets which were hit worst by the recession, might have been affected more, while the effect on the domestic market was much less felt (Aswicahyono et al. 2010). This historical overview of industrial policy in Indonesia showed that the country has not been following one linear policy trajectory. In general, however, there is a move toward greater exportorientation, a greater desire for maximizing domestic value added and realizing the benefits from the country’s natural resources, a greater focus on employment generation, and SME participation. Macroeconomic policy tends to be more technically formulated, while the reverse might be observed for microeconomic policy. The country’s recent move toward decentralization has, to an extent, contributed to increased policy uncertainty due to the increase in decision making points. Policy inconsistency and uncertainty remain a key outstanding problem. The next section would focus on the current state of the industrial policy in Indonesia, starting with its National Industrial Policy as set out in the Presidential Regulation No. 28 in 2008.  6 The ten clusters are: (1) food and beverage industry, (2) marine resource processing, (3) textiles and garments industry, (4) footwear industry, (5) oil palm industry, (6) wood-products industry (including rattan and bamboo), (7) rubber and rubber products industry, (8) pulp and paper industry, (9) electric machinery and electronics industry, and (10) petrochemicals industry. 7 See http://www.indonesia-investments.com/id/proyek/rencana-pembangunan-pemerintah/rencana-pembangunan-jangka -menengah-nasional-rpjmn-2010-2014/item307 Industrial Policy in Indonesia: A Global Value Chain Perspective | 13 IV. CURRENT INDUSTRIAL POLICY (2008–PRESENT) In addition to the RPJPN and the RPJMN, two other key documents have formed the basis of Indonesia’s current industrial policy. The first is the 2008 National Industrial Policy and the second is the Indonesian Master Plan for Acceleration and Expansion of Indonesia Economic Development (MP3EI) launched in 2011. Both documents would be deliberated below. Indonesia has also just endorsed its new Industrial Bill in late 2013 and its new Trade Law in early 2014; many of their implementing regulations are still forthcoming. A. National Industrial Policy (Presidential Regulation No. 28 of 2008 and Regulation of the Minister of Industry 41/M-IND/PER/3/2010) The 2008 Presidential Regulation on National Industrial Policy has set a long-term industrial development vision for Indonesia to be a strong industrialized nation by 2025. This vision was elaborated further in the Regulation of the Ministry of Industry issued in 2010,8 which states that the vision of Indonesia to be a strong industrialized nation by 2025 would be achieved through becoming a new industrial developed country by 2020 (Vision 2020). The two different timeframes (i.e., 2025, for becoming a strong industrialized nation and 2020, for becoming a new industrial developed country) created some confusion as the difference between the two targets was not clearly articulated. The document only stated that to be a new industrial developed country, Indonesia should meet the following broad criteria: 1. It has a huge role and contribution to the national economy, 2. SMEs have balanced abilities with large industries, 3. It has a strong industrial structure (Industrial Tree is complete and in-depth), 4. It has an advanced technology that has been at the forefront of development and market creation, 5. It has a tough industry services to support the international competitiveness of the industry, and 6. It has a competitive advantage to face full liberalization within APEC countries. The policy has a target to increase the contribution to GDP of non-oil and gas industry from the current 24.0% to 30.0% by 2020.9 It also aims to raise the contribution of small and medium industries to be comparable to large industries. To achieve this, the sector will need to grow by 9.4% on annual average during 2010–2020, a very ambitious, if not impossible, target. The policy highlighted seven “strategic outcomes” required to achieve this target, which include increasing industrial value added, market share at home and abroad, innovation and technological capabilities, and broadening industrial development. Nevertheless, it was unclear how these outcomes are to be achieved and how the GOI plans to monitor when and whether the outcomes have been achieved. The 2008 National Industrial Policy was launched a year after the RPJPN and the first RPJMN. The development of this policy has referred to and is in line with the RPJPN 2005–2025  8 Regulation of the Minister of Industry No. 41/M-IND/PER/3/2010 on Strategy Mapping and Key Performance Indicators for the Ministry of Industry. 9 See http://www.kemenperin.go.id/artikel/19/National-Industrial-Policy. Average contribution of non-oil and gas industry to GDP during 2010–2013 (Central Board of Statistics, Indonesia).  14 | ADB Economics Working Paper Series No. 411 (Law 17/2006) and the RPJMN 2004–2009 (Presidential Regulation 7/2005). The 2010 Ministerial Regulation also refers to the more recent RPJMN 2010–2014 (Presidential Regulation 5/2010).10 It does not, however, clearly mention any reference to the 2008 Presidential Regulation in which the notion of industrial cluster development was initially suggested. To operationalize the Plan, the Ministry of Industry has adopted a two-pronged approach. First is a top-down approach through the development of 35 priority industrial clusters planned by the central government, to be followed by local and regional participation. Second is a bottom-up approach through determining local industries that become core competencies in each region, followed by the development of provincial, or regency or municipal excellence industry. The second approach is pursued based on the spirit of decentralization and regional autonomy. Based on the website of the Ministry of Industry, 18 provinces and five regencies have developed their roadmaps of provincial excellence industry and regency roadmaps of industrial core competencies, respectively. The 35 priority industrial clusters planned by the Central Government are further categorized into agro-industry (12 clusters), transportation equipment industry (4 clusters), electronics and ICT industry (3 clusters), base materials industry (4 clusters, one of which is iron and steel industry), machinery industry (2 clusters), labor-intensive manufacturing industry (2 clusters), supporting and specific creative industry (3 clusters), and specific small and medium industry (5 clusters). The rationale behind the adoption of this cluster approach is to achieve collective competitiveness through the establishment of networks. In addition to the 35 clusters, future industries are also identified as industries with high competitiveness, based on the country’s endowment (vast area, large number of population, and availability of natural resources) as well as less tangible assets, such as capability, creativity, skills, and human resource professionalism. These future industries are (i) agro-based industry, (ii) transportation industry, (iii) information technology and telecommunication equipment industry, and would be the first ones to be developed. This industrial group is considered more sustainable because it relies on knowledge and skilled-labor, renewable natural resources, and technological mastery. Using different terms in the same document, such as “priority industrial clusters” and “future industries,” results in confusion as such terms are ambiguous in conveying the GOI’s level of priorities. It might have been better to use the same term and indicate the level of priorities in terms of implementation timeframe. Maintaining consistency over the criteria for and the result of prioritization, and having in place a clear and transparent review mechanism is imperative to minimize the costs of policy uncertainty. The development of these clusters has also been poorly coordinated across authorities as this initiative is regarded by other ministries as merely the domain of the Ministry of Industry, whereas the Coordinating Ministry for Economic Affairs seems to have a limited capacity in coordinating various ministries and sectors related to industrial development. The Ministry of Industry argues that it will take a few more years to see the results of the development of these clusters, considering several issues that have hampered industrial development in the country, such as limited infrastructure, increasing labor costs, increasing electricity tariff, limited supply of energy, e.g., oil and gas, the influx of illegal imported products as well as bureaucratic issues and red tape. However, they mention some  10 Based on interviews with the Ministry of Industry, Coordinating Ministry of Economic Affairs, National Development Planning Agency (BAPPENAS), and the Association of Indonesian Employers (APINDO) in April 2014 Industrial Policy in Indonesia: A Global Value Chain Perspective | 15 clusters of petrochemical industry in Banten Province and Bontang (East Kalimantan Province), which have shown good progress.11 As for the development of provincial excellence industry, or regency or municipal roadmap of industrial core competencies, the Ministry of Industry has provided technical guidelines on the development of these industries. However, as this is a bottom-up approach, the initiative or proposal for the development of regency or municipal core competencies comes from the regencies or cities. This approach is aimed at accommodating Indonesia’s decentralized system of governance implemented since 2000, where district and provincial governments have been given broad authorities in planning and managing various sectors of development in the regions. B. Master Plan for Acceleration and Expansion of Indonesia Economic Development (MP3EI) In 2011, Indonesia launched its Master Plan for Acceleration and Expansion of Indonesia Economic Development (MP3EI). The MP3EI aims to encourage rapid, balanced, equitable and sustainable economic growth. The goal of the MP3EI is for Indonesia to become a high-income country by 2025, and the world’s 10th and 6th largest economy by 2025 and 2050, respectively. The MP3EI is a working document and as such, will be updated and refined periodically. While it is a source of possible confusion, the GOI has claimed that the MP3EI is an integral part of the national development planning scheme and is not meant to substitute the existing Long-Term Development Plan 2005–2025 (Law No. 17 year 2007, RPJPN) and the Medium-Term Development Plans (Presidential Decree No. 7 year 2009, RPJMN). Like the RPJPN, the RPJMN, and the National Industrial Policy, the MP3EI also combines sector and regional approach, in its case, into the economic corridors strategy. The MP3EI also includes regulatory reforms as an integral step in accelerating economic development. The MP3EI seeks to pursue its objective based on a three-pillar strategy: 1. Spreading economic development across the country through the development of six economic corridors, 2. Improving domestic and international connectivity, and 3. Enhancing technology and human resources. To meet the goal of the MP3EI, Indonesia needs to achieve a quantitative target of GDP per capita of $15,000 by 2025, a marked increase from its current $3,500. This requires GDP to grow between 6.4% and 7.5% during 2011–2014, and between 8.0% and 9.0% during 2015–2025. To do so, Indonesia could no longer afford to rely on business as usual, and would require accelerated industrialization. The Ministry of Industry is targeting for the industrial sector to grow at 8.5% in 2014 and to continue until it reaches 9.8% in the years 2020–2025. The share of industrial products in total non-oil and gas exports is targeted to achieve 61.9% by 2014 and 95.0% by 2025, and the sector is expected to contribute 25.0% of total employment by 2025 (Ministry of Industry 2012). In addition to six economic corridors, the MP3EI would focus on eight main programs of agriculture, mining, energy, industry, marine, tourism, telecommunication, and the development of  11 Interview with the representative of the Ministry of Industry on 14 April 2014. 16 | ADB Economics Working Paper Series No. 411 strategic areas. The eight main programs further consist of 22 main economic activities, which include nickel, copper, bauxite, and steel.12 Although different ministries and business associations have been involved in the design process of the MP3EI, there are no clear links at the technical level. Coordination across relevant stakeholders is also limited in its implementation stage. The major constraint in coordination is the lack of enforcement and leadership in synergizing efforts among line ministries or sectors. The Ministry of Industry suggested that a series of consultations has been conducted with the Coordinating Ministry for Economic Affairs during the development of the MP3EI, and the plan has taken into account the development of industrial clusters under the Ministry of Industry. However, it is not clear how the 8 main programs and 22 activities in the MP3EI are linked to the 35 priority clusters and the 3 future industries implemented by the Ministry of Industry. Accelerated Industrialization in the MP3EI: From Theory to Practice The MP3EI points to the critical importance of international competitiveness and the need to focus the industrial development strategy on developing sustainable competitiveness in the international market. This could be interpreted as the current GOI’s commitment not to revert to an inward-looking approach to industrial policy. In doing so, the GOI seeks to optimize “all efforts to exploit the country’s resource potentials and the capability to exploit every opportunity on hand, from inside and outside.” This could also be understood as an aspiration to maximize the benefits from current endowments, such as natural resource endowments, and from accessing international opportunities, including access to external markets and competitive imported inputs. The MP3EI seeks to identify potential strengths and constraints to determine the basic strategy of accelerating industrial development. The Plan aims to pursue accelerated industrialization through five main strategies: 1. Promoting participation of the business sector in infrastructure development, 2. Debottlenecking of bureaucratic barriers, 3. Re-orienting export policies of raw materials and energy resources, 4. Enhancing productivity and competitiveness, and 5. Improving domestic market integration. The above strategies will be implemented through the application of six policy areas: 1. Domestic industry security, by enhancing industrial competitiveness in facing global competition and industrial restructuring, 2. Infrastructure development, 3. Improvement in the quality of service bureaucracy, 4. Improvement and harmonization of regulations, 5. Fiscal policy, and 6. Development of human resource-based industry (labor-intensive industry).  12 The other 18 activities are: palm oil, rubber, oil and gas, coal, cocoa, animal husbandry, timber, fishery, tourism, food and agriculture, Greater Jakarta (Jabodetabeka) area, Sunda Straits strategic area, transportation equipment, ICT, shipping, textiles, food and beverages, defense equipment. Industrial Policy in Indonesia: A Global Value Chain Perspective | 17 Based on these considerations, during 2012–2014 the MP3EI’s accelerated industrialization effort focuses on 15 subsectors under three major groups: mining industry group,13 agriculture-based industrial group,14 and human resource-based industry and domestic markets.15 How these selected subclusters are linked to the main programs and activities under the MP3EI, however, remains unclear. MP3EI Implementation Framework Apart from a departure from business as usual, the MP3EI also differs from previous initiatives in terms of the level of political support and an expressed desire for more inclusive coordination. On the apex of the MP3EI implementation framework is the Committee on Economic Development Acceleration and Expansion of Indonesia 2011–2025 (abbreviated KP3EI in Indonesian). The KP3EI was established under Article 4 of the Presidential Decree No. 32 of 2011. The tasks of the KP3EI are: 1. to coordinate the planning and implementation of the MP3EI, 2. to monitor and evaluate the implementation of the MP3EI, and 3. to outline the steps and policies in the context of solving problems and barriers to the implementation of the MP3EI. The full structure of the MP3EI implementation committee comprises the following: 1. The Implementation Team is composed of Ministers, the Chair of Non-Ministerial Institutions, and representative agencies that shall contribute to the implementation of the MP3EI. The team is responsible for providing general guidance, approving strategic decisions, and solving strategic issues which may arise during the implementation of the MP3EI. 2. The Working Team is composed of high-ranking officials (echelon 1) and key officials from relevant agencies involved in the implementation of the MP3EI action plans. The team is responsible for coordinating the implementation of investment projects and infrastructure projects. This team will act in collaboration with relevant agencies and is also responsible for solving inter-ministerial problems, and ensuring government support for the implementation of the MP3EI. 3. The Secretariat is composed of a dedicated and full-time support team that is responsible for developing a monitoring and coordinating system for the MP3EI implementation. The Secretariat will actively support the Implementation Team and the Working Team by providing them with a clear analysis of, and technical proposal to overcome, the problems arising from daily monitoring. The KP3EI is chaired by the President, while the Secretariat is chaired by the Coordinating Minister for Economic Affairs. This signifies the central government’s leadership and ownership of, and commitment to, the MP3EI (Strategic Asia 2012). It is yet to be seen if this structure would be carried on by the new government under the Jokowi’s administration. Ideally, any long term plan would be placed under the custody of able bureaucrats to insulate it from politically induced changes. One weakness highlighted in the implementation framework of the MP3EI is the limited involvement of  13 Four subsectors that come under this group: coal conversion industry, refining and oil refinery industry, basic chemical industry (including petrochemicals), and basic metal industries. 14 Five subsectors that come under this group: edible oils and fats industry, sugar cane-based industry, cocoa processing industry and chocolate manufacture, pulp and paper industry, and rubber goods-based industry. 15 Six subsectors that come under this group: textiles, apparel and footwear, industrial machinery and household appliances, electronic components and telecommunications industries, components and accessories of automotive and motor vehicle engine parts, shipbuilding industry, and furniture industry. 24 | ADB Economics Working Paper Series No. 411 D. Power and Energy Indonesia’s total energy demand has been growing annually by around 7.0%, and is expected to increase to 9.0% by 2019 as transportation and industrial sectors grow and households become more affluent. A large proportion of demand is currently met by fossil fuels, mainly oil. Electricity demand represents a significant share of total energy demand. Indonesia’s electricity demand is estimated to grow at 9.5% annually for the next 5 years, and demand growth easily outpaces growth in power generation capacity. The country’s electrification rate has been on the rise, standing at 80.1% in September 2013, a 13.0% increase from 2011, bringing Indonesia closer to its electrification target of 90.0% by 2020. Nevertheless, this rate remains relatively low compared to other ASEAN members, and there are still 50 million people without access to electricity. The GOI has launched two 10,000 megawatt (MW) Fast Track Programs (FTPs) for completion in 2013 and 2015. Under the GOI’s power generation development planning, 57,000 MW of power generation would be developed by 2021, 53.0% by the state-owned electricity company, Perusahaan Listrik Negara (PLN), and the rest by Independent Power Providers (IPPs).20 The total investment required is $77 billion. Anecdotes gathered from the field, however, suggest that only 30.0% to 35.0% of projects under FTP 1 were successful due to poorly written project proposals. FTP 2 also has not been progressing well, due to its high reliance on geothermal projects,21 few of which have materialized due to problems with the issuance of licenses. In the MP3EI, additional electricity demand is projected to reach about 90,000 MW by 2025, a near doubling of the September 2013 total installed capacity of 46,420 MW. The GOI aims to increase electricity generation capacity by 5,000 MW per year to meet growing demand and support economic growth. The country’s electrification drive had added 4,000 MW to 4,500 MW of capacity per year since 2011. From 2014 to 2020, the average annual capacity increase should be gradually increased to 5,000 MW per year if power generation capacity is to catch up with demand. Apart from issues relating to infrastructural development, another (distorting) contributory factor to Indonesia’s power problem is the strictly regulated and under-priced electricity market. The domestic political realities mean that the GOI faces great difficulty in bringing the current subsidized selling price of electricity closer to the market rate as any changes to the price require parliamentary approval and hence are prone to political decisions. Efforts to reduce fossil fuel subsidy have also been hampered by the difficulty in diversifying to more sustainable supply sources. E. Global Connection Understanding the value of global linkages, Indonesia has been actively participating in trade and economic partnership talks with partners around the world, either individually or jointly as a region with the rest of ASEAN member states.  20 Jarman (2013) Indonesia’s Electricity Policy and Cooperation between Japan and Indonesia, Presentation by the Director General of Electricity on the Occasion of Visit by FEC Delegation, 18 March 2013, Jakarta: Directorate General of Electricity, Ministry of Energy and Mineral Resources (MEMR). 21 Big players are involved in geothermal projects, such as Chevron and Medco. Industrial Policy in Indonesia: A Global Value Chain Perspective | 25 Indonesia already has a number of agreements in place with bilateral and plurilateral partners and is also a signatory to the ASEAN Free Trade Agreement (AFTA). It also has its first economic partnership agreement (EPA) with Japan, implemented since 2008. Indonesia is currently negotiating bilateral agreements with Iran, India, Pakistan, Australia, and the European Free Trade Association (EFTA) countries, and undertaking joint studies on potential FTAs with Chile, Turkey, Tunisia, and Egypt. In July 2012, Indonesia held the first round of negotiations for a free trade and investment cooperation agreement with the Republic of Korea known as the Indonesia Korea–Comprehensive Economic Partnership Agreement (IK–CEPA). Indonesia is one of the founding members of ASEAN. The ASEAN FTA is one of the pillars that would support effective implementation of the ASEAN Economic Community (AEC) in 2015. As a member of ASEAN, Indonesia is a party to preferential trade agreements with Australia and New Zealand (AANZFTA), the PRC (ACFTA), Japan, the Republic of Korea, and India. In November 2012, Indonesia, with ASEAN, started negotiations, with the six regional free-trade partners of Australia, the PRC, India, the Republic of Korea, Japan, and New Zealand under the Regional Comprehensive Economic Partnership (RCEP). ASEAN has also started FTA negotiations with Hong Kong, China as well as negotiations to upgrade the ACFTA with the PRC. A plan to commence negotiations for a comprehensive economic partnership agreement with the EU is also in the pipeline. In multilateral negotiations, the Ministry of Industry is the lead negotiator of Non-Agricultural Market Access (NAMA), as its portfolio covers almost 80.0% of tariff lines. The new Industrial Bill states that the Ministry of Finance would be in charge of setting the level of tariffs. More information is needed on the consultation and decision making process, particularly among the relevant authorities, including Ministry of Finance, Ministry of Trade, Ministry of Industry, other line ministries as well as relevant non-state stakeholders. VI. FROM POLICY TO IMPLEMENTATION This section briefly discusses some of the policy instruments used by Indonesia to pursue its industrial policy objectives. The list is non exhaustive and is intended to give a broad outline of how the GOI translates these objectives into action and what are the likely implications. It serves as a precursor to the next section that focuses discussions on a specific sector. A. Trade Taxes The level of trade taxes, including import duties and export taxes, are influenced by a number of factors including fiscal consideration, trade facilitation, industrial policy objectives and international commitments. While there are currently no international rules governing export taxes, there are growing pressures for greater future export disciplines at various fora. Under its WTO obligations, Indonesia has bound 96.6% of its tariff lines, with 94.6% at a rate of 40.0%. Its simple average bound tariff is 37.5%, with an average bound tariff for agricultural products of 47.7%. Despite the high bound rates, Indonesia’s simple average Most Favoured Nation (MFN) applied tariff is only 6.8%, much lower than most of the ASEAN economies. Its simple average applied tariff for agricultural products is 8.4%, while its average applied tariff for non-agricultural products is 6.6% (Hidayat 2012). 26 | ADB Economics Working Paper Series No. 411 As tariffs have minimal contribution to its tax revenue (only 4.0% in 2007), Indonesia has a greater scope to make tariffs as a main trade policy instrument for Indonesia. Other than domestic fiscal and real sector consideration, the ability of a country to use tariff-related measures is also restricted by its multilateral, bilateral and plurilateral commitments. As earlier shown, Indonesia has a wide binding overhang (the difference between its bound and applied tariff rates), which gives it considerable policy space. However, excessive, ad hoc, and inconsistent use of tariff policy would be costly to business and self-defeating to Indonesia’s efforts to enhance GVC participation. Tariff policy, however, is one of the few industrial policy tools left for developing country governments to use. On the defensive side, tariffs are used to shield potentially competitive domestic industry from premature import competition. On the offensive side, lower or annulment of tariffs on intermediate goods can boost productivity of domestic plants. Indonesia has become increasingly active in using its tariff overhang in recent years by periodically changing its applied rates. In 2009 and 2010, the GOI increased tariffs on a range of goods that directly compete with locally manufactured products, including chemicals, electronic products, milling machines, cosmetics, medicines, and a range of agricultural products. In December 2011, the GOI increased applied import duties for wheat and soybeans from 0.0% to 5.0% (Tijaja 2013a). While this might reflect efforts to promote domestic value addition, it would have short-term implications for domestic industries currently relying on imported inputs, and more critical long-term implications if not clearly articulated in the context of consistent and transparent policy objectives. More recently, ad hoc setting of tariffs has been more common, particularly for food products, with the main purpose of ensuring domestic price stability. There has also been an increasing use of export taxes with the objective of ensuring sufficient domestic input supply to support domestic downstream industry. In a number of cases this objective has been made explicit, as in the case of export taxes on cocoa, rattan, crude palm oil, and mineral ores. In some cases, the use of export taxes has led to some success in promoting greater domestic processing, as in the case of cocoa. However, in others, it might supress income for raw material producers and workers in the short term, and in the long term it might even reduce supply capacity due to a disincentive to produce and improve productivity. The exact implications vary from case to case and depend on manifold factors. B. Non-tariff Measures Indonesia has also introduced a number of non-tariff measures (NTMs) of late. The recent proliferation of regulations related to licensing is a cause of concern. Regulations on non-automatic import licensing were recently applied to a broad range of final consumer goods, and there is also a requirement for pre-shipment verification for some. In these cases, import licences will now be issued subject to the discretion of relevant sector ministries, and have become a source of business costs and uncertainty. Importation of certain horticulture products is now also restricted to specific designated ports and airports (Tijaja 2013a). The GOI has also recently introduced separate import licences for goods imported for use in the production process (value-added manufacturing) and further distribution (not for further processing) applicable for some products. Various import restrictions are also in place for key commodities, such as rice, sugar, and salt as well as alcoholic beverages. The increasing use of NTMs has generated concerns among businesses and investors. NTMs are generally less transparent, harder to monitor, and less coordinated due to their cross-agency nature, as such, they are a potential source of business uncertainty. The GOI needs to communicate clearly and consistently the policy objectives Industrial Policy in Indonesia: A Global Value Chain Perspective | 27 of any new measures that are being introduced, including NTMs. It needs to do so with an awareness of the implications they may have on current and potential business and investment, the longer term costs to value chain competitiveness, and their international obligations. One type of NTMs is standards. Standards have become increasingly prevalent in GVCs. The capacity to meet the ever demanding standard requirements of international and other high-value markets, has become a criteria for participating in GVCs. Standards are also used by governments for the public policy objective of protecting the health and safety of their population and environment. Standards allow the codification of complex technical and quality information that would address information asymmetry and enable hands-off coordination among firms in GVCs, and as such, facilitate the fragmentation of production processes. Standards allow inter-operability in network economies and are also used by firms to signal the quality of their products. However, standards can also be used as a trade-distorting measure when they are introduced with the intent to deter access of competing imported goods and services, resulting in deadweight loss (Tijaja 2013b). There are three key roles that governments can play in regard to standards. First is to strengthen the country’s standards and conformance infrastructure. Second is to enhance the compliance capacity of domestic industry actors (particularly the smallholders). Third is to strategically participate in standards-setting bodies. Accessibility of conformity assessment services is critical, and while most can be competitively provided by the private sector, others might need to be provided by public institutions on a reasonable or concessional user-pay basis. The costs of standards compliance can also be prohibitive for smallholders, particularly for training and certification (Tijaja 2013b). The new Industrial Bill regulates measures relating to standards compliance. One of the provisions stipulates that the implementation of Indonesian National Standard (Standard Nasional Indonesia or SNI) is voluntary. However, the other provision provides for mandatory adoption of SNI, with technical specifications and guideline procedures, as determined by the Minister of Industry, and the penalties for noncompliance. The bill does not just regulate standards in relation to goods but also to services. Article 25.7 stipulates that administrative sanctions will be imposed on companies in industrial zone that are not complying with the National Standard for Work Competencies (Standar Kompetensi Kerja Nasional Indonesia or SKKNI). The SKKNI uses the same reference as the Profession Certification Institution (Lembaga Sertifikasi Profesi or LSP), where the GOI has been encouraging Indonesian workers to get certification from to prepare them for competition when the AEC is launched in 2015 (Jakarta Post 2014b). The transparency of requirements and the process of SKKNI are crucial in determining whether it will be trade facilitating or will act as a non-tariff barrier. C. Tax Facilities In 2011, the Ministry of Industry issued Regulation No. 93/M-ID/PER/11/2011 on guidelines and processes of applying for corporate income tax exemption or reduction facility for the industrial sector. The six pioneer industries eligible for tax facilities are base metal industry, oil refinery industry and/or basic petrochemical industry, machinery industry, renewable resources industry, and telecommunication equipment industry. The Minister of Finance may decide on other pioneer industries provided that they meet these criteria: industries that have wide networks, high value added and externalities, can introduce new technology, and have strategic value for the national economy. 28 | ADB Economics Working Paper Series No. 411 The granting of tax facilities is subject to analysis and verification by a working team composed of the Director General of Industrial Development, Industrial Climate and Quality Policy Analysis Body (Badan Pengkajian Kebijakan Iklim dan Mutu Industri or BPKIMI), the Secretariat General, the Investment Coordinating Board (BKPM), and led by the Director General of Industrial Development for the relevant sector. Firms are required to submit an application for such facility to the Minister of Industry, copied to the head of the working team. The application will need to contain details on infrastructure availability in the location of investment, domestic employment absorption, assessment on how the criteria of a pioneer industry have been met, and proposed steps for technology transfer. The regulation sets out a strict timeline and steps for the processing of applications. In addition to income tax facility, the GOI also offers fiscal incentives in the form of import duty exemptions to industries in certain sectors on an annual basis. The GOI reviews the list of eligible industries every year, taking into consideration the input from industry players. Exemptions are provided for industries using imported goods and materials to produce goods and/or services with the following criteria: 1. providing goods and/or services for public interests, being consumed by the general public, and/or protecting consumers’ interests; 2. improving competitiveness; 3. creating more job opportunities; and 4. contributing to state revenues. Goods and materials for which an application for exemption is made must fulfill the following conditions: 1. not yet produced locally; 2. already produced locally, but not yet fulfilling the specifications required; or 3. already produced locally but the volume is not sufficient to cover the industry’s demands. Import duty exemption is also available for the import of capital goods for certain business sectors, e.g. , by an independent power producer, or for a purpose. An example is the Minister of Finance Regulations No. 177/PMK.011/2007 that controls import duty exemption on goods imported for the purpose of upstream oil and gas, and geothermal business activities. Import duty reduction facilities may also be granted to manufacturing or service companies that are developing or expanding their business in Indonesia. These incentives include a reduction of the duty rate to 5.0% on imported machinery (excluding spare parts and components) and raw materials for a specified period, e.g., 2 years22. Import Facilities for Export Purpose (KITE) is also offered, and is defined as the granting of exemption and/or restitution of duties for imported goods and/or materials to process, assemble, or be installed on other goods, the products of which are mainly intended for export. KITE, however, is not applicable to raw materials and supporting materials that are not integrated with finished products (Deloitte 2012).  22 See http://www.kpmg.com/cn/en/aspac-trade-and-customs/pages/trade-customs-indonesia.aspx Industrial Policy in Indonesia: A Global Value Chain Perspective | 29 D. Upgrading Support Indonesia’s industrial policy objectives point to the desire to achieve global competitiveness through, among other things, the application of appropriate technology and knowledge. The GOI is keen to support higher value added participation in GVCs, including through the building of technological capabilities and industrial upgrading. One policy instrument that has been used by the GOI to facilitate upgrading is the provision of support for machinery upgrading of select industries. The objective of this measure is to improve the competitiveness of the sector by replacing old machinery with newer machinery that would be more productive and energy efficient. So far resources have been allocated for the textile, apparel, and footwear industry, and the sugar industry. In the case of textile, enterprises have the choice of receiving a rebate23 for direct purchase of new machinery or soft credit. Some questions were raised regarding the effectiveness of the measure. First is the issue of redundancy rate; that is, how much of those investments would have been made anyways without the measures (Thébault-Weiser 2008). Second, whether the measures evenly reach all firms in the sector, including small and medium enterprises or only relatively large firms would benefit from them. Last, but not least, it appears that the measures are currently targeted at existing rather than new (pioneer) industries, which raise the question of whether the right industries have been targeted. E. Investment Regime The Investment Law of 2007 sets the parameters of the investment regime in Indonesia. The law guarantees national treatment, protection against expropriation, and recourse to international arbitration in the event of a dispute with the government. The law also sets out the guidelines for investment incentives and institutional arrangements to administer investment projects. In a general sense, the law positively reflects the GOI’s commitment to an open and transparent investment regime (Tijaja 2013a). There are two priority areas that require addressing in Indonesia’s investment regime. First is policy certainty. The review process for the investment negative list (Daftar Negatif Investasi or DNI) can be improved through better consultation, transparency, and link to current industrial policy framework. Under the current system, a sectoral ministry might introduce new restrictions to investment that are not timely incorporated into the prevailing investment negative list, creating uncertainties and confusion. Having a transparent review process for the negative list that would serve as the main mechanism for any changes to the investment regime in any sector will improve policy certainty. The second area that needs addressing is the existence of inconsistencies between national and sectoral policy, and between national and subnational policy. Indonesia’s decentralization effort may be aimed at reducing bureaucratic red tape and making investment more responsive to regional needs and priorities However, the unintended consequence is increased uncertainties and inconsistencies for investors when there is discrepancy between subnational and national policies. This is partly due to the varying capacity of local authorities to formulate, interpret, implement and enforce the regulations, and the lack of a framework (or weak implementation of such a framework) to  23 The rate of rebate is differentiated between domestic and imported machinery. This might be in violation of Indonesia’s WTO commitments. 30 | ADB Economics Working Paper Series No. 411 coordinate investment policies at all levels of government. Under the current Medium-Term Development Plan (RPJMN 2010–2014), the GOI, led by BAPPENAS, plans to conduct a comprehensive regulatory review of inventory, and review and simplify laws and regulations at all levels of government. This effort, if successful, will build on the current momentum of high investment flows. F. Local Content The new industrial bill includes a provision that would allow the government (through the Minister of Industry) to set local content requirements for selected industries.24 The bill also contains a provision that would encourage government institutions and SOEs to use domestic products.25 Details of the definition and criteria of domestic products and strategic industries are needed to allow for policy assessment. Depending on the definition, flexibility might also be required in light of the fact that some goods might not be domestically produced to the required level of quantity and quality. The GOI also currently has a procurement program to promote the use of domestic products by obliging government authorities to maximize local content in procurement using public budget. To operationalize this policy, the GOI is providing free certification services for firms that would like to verify the level of local content in their products. This service is outsourced to two designated surveyors. Certified goods and services would be granted prioritization in the procurement process. In practice, implementation of this measure might have uneven implications, as it might be harder for smallholders or firms located in outer regions to benefit from such initiative. G. The Weakest Link The measures above highlight how the GOI has sought to pursue its industrial development objectives. Some measures are likely to be more effective than others, nevertheless, they all point to the government’s effort to adopt a holistic and proactive approach to industrial policy. There are two areas that appear to be the weakest link in this strategy. First is labor and human capital, and second is innovation; the two are related. It is commonly acknowledged that labor market instability is a key source of business uncertainty in Indonesia. The implementation of regulations relating to outsourcing and the setting of regional minimum wages has regularly led to workers’ strikes. So far, discussion focuses mainly on reducing hiring (and firing) costs, particularly from the business perspective. Due to a large number of unemployed persons (7.4 million in August 2013), the bargaining power of workers in Indonesia, particularly those in labor-intensive industries, is very low. They are not only forced to accept low real wages, but also a non-permanent, contract-based employment, which makes them even more vulnerable. They can be easily replaced by new job applicants, who are not inexperienced as the latter have been previously hired by another firm but, for some reason, had to leave and look for a new employer. A minimum wage policy that is created by region is problematic for several reasons. First, the process of determining regional minimum wage, which is based on predetermined living cost indicators, has been more political than technical. Even though a survey has been conducted to assess regional living costs, which involve representatives from workers, employers and the local governments  24 Article 87, verse 4. 25 Article 86, verse 1. Industrial Policy in Indonesia: A Global Value Chain Perspective | 31 (tripartite), the decision made by the local government on the minimum wage often does not refer to the survey. Instead, the government decision tends to be influenced mostly by an imbalanced negotiation between employers and workers. Second, once the minimum wage is decided by the local government, law enforcement for the policy is often weak. Many companies often request postponement to comply with the new minimum wage due to financial constraints. There are also some companies that still pay their laborers under the minimum wage without getting penalties. In addition to the problem of low real wages, there have been very limited government incentives provided to workers relating to health, education for children, pension as well as accommodation and transportation costs. Except for those who live in Jakarta, there are no health or education subsidies provided by the local governments. There are also very limited subsidies provided by local governments and/or employers to cover accommodation and transport costs to and from the workplace while these costs may account for 35.0% of wages. Furthermore, because many firms impose a contract-based employment, there is no superannuation or pension provision, or incentives based on productivity and experience. Vocational training for workers has rarely been found particularly in labor-intensive sectors. Training services provided by government-funded training centers are also very limited and often irrelevant to the needs of the industry. This is different from the situation in the 1980s and 1990s when there were many firms, especially Japanese firms, which conducted vocational training during the weekends for their laborers. 26 Policymakers and businesses should start to consider workers as assets and a source of productivity and innovation rather than costs to production. While having a stable labor market is important, the main objective should also include developing a competitive labor market. The latter should focus policy toward developing workers’ productivity, including through education curricula and training centers, and also providing incentives to employers and workers to participate in on-thejob training and invest in productivity improvement. Labor policy should be an integral part of industrial policy as labor is an indispensable input to the industrialization effort. For instance, if the government has to raise minimum wage, they should prepare a set of policies to minimize the increase in other production costs, such as energy costs, loan interests, and deregulate to minimize logistics costs, etc. This burden sharing between the government and firms will be able to sustain or even increase industrial competitiveness. On innovation, there has been an increasing awareness on the part of the GOI on the contribution of science and technology (S&T) on economic development. However, it was not until recently that there are focused efforts to integrate S&T into the national development strategy. The MP3EI expressly acknowledges increasing technology contribution as one of its three main strategies. Innovation-driven development underlies the third phase of the MP3EI implementation. Innovation is an underlying contributor to upgrading GVC participation at the firm and at the wider economy level. R&D in Indonesia had lagged behind other economies in the region. The two main reasons for this are the lack of synergy and awareness between research efforts and industry needs, and the low technological capabilities of domestic industries, as evidenced in the low adoption rate of developed technologies.  26 Interviews with the Confederation of Indonesian Trade Unions (KSPI) on 5 March 2014 and the Confederation of National Trade Unions (KSPN) on 12 March 2014, in Jakarta. 32 | ADB Economics Working Paper Series No. 411 R&D is still mostly undertaken as in-house efforts by individual firms, with few collaborations and sharing among industries, and between industries and research institutions. Better alignment of regulations, policies and incentives to promote innovation is also required, and would include regulations on S&T, finance and tax systems, manufacturing and service industries as well as trade, education, and intellectual property policy. The GOI should demonstrate commitment to supporting R&D, among other things, by meeting the current expectation to allocate a greater share of the GDP for supporting R&D. Current efforts to boost innovation are centered on the development of a national innovation system as stated in the Ministry of Research and Technology’s Strategic Plan 2010–2014. The establishment of National Innovation Committee was mandated by Presidential Regulation no. 32/2010, and the review process of S&T law and regulations is underway. There are also plans to revitalize the National Research Council, develop or revive S&T Park and research centers, and facilitate the formation of R&D consortiums (Pahlevi 2013). A regional and/or cluster approach to innovation will also be undertaken by putting innovation in the center of the development of the six economic corridors. Strong human resources, good information network, and established quality institutions were highlighted as imperative to innovation efforts (Pahlevi 2013). VII. CASE STUDY: THE MINERAL SECTOR A. Overview The mining sector provides a concrete example of the GOI’s effort to accelerate industrial development. It is a sector that Indonesia is blessed with natural comparative advantage in and one that is well-connected to GVCs. The GOI, however, does not want development of the sector to be constrained by static comparative advantage alone. This aspiration is not a new one, but one that has only recently gained momentum in its realization. The myriad of stakeholders and interests involved, and manifold factors for consideration point to the challenge of designing and implementing an effective industrial policy. This high risk, however, is no reason to fully abandon efforts. Under the right conditions, the potential benefits of intervention may more than offset the potential loss for leaving matters in the invisible hands of the, often imperfect, markets. The mining and quarrying sector comprised 11.2% of Indonesia’s GDP in 2013 (Bank Indonesia Real Sector Statistics 2014).27 Indonesia is the world’s largest exporter of refined tin and nickel ore and a significant exporter of iron ore and bauxite (Tijaja 2013a). Mineral ores have long been a key contributor to Indonesia’s exports, which are still concentrated on energy and natural resource-based products (minerals), with little change over the last decade. In 2010, mining and quarrying (including coal) accounted for 27.0% of total exports, followed distantly by food, beverages and tobacco at 8.0%. The share of mining in total exports has been on the rise lately at the expense of the shares of agriculture and industry exports. Overall mining exports amounted to $31.32 billion throughout 2013, out of $182.57 billion in total exports (Yulisman 2014c). This means mining accounted for 17.0% of total exports in 2013, a near tripling of the share in 2003 of 6.5%. The shares of agriculture and industry fell in the same period from 4.2% to 3.1%, and from 66.9% to 61.9% respectively (Kementerian Perdagangan 2014). As shown later, this is at least partly a short-term reaction to the GOI’s policy of banning mineral ore exports by 2014.  27 See http://www.bi.go.id/sdds/series/NA/index_NA.asp Industrial Policy in Indonesia: A Global Value Chain Perspective | 33 B. Sectoral Policy Objectives Earlier in the paper, we have highlighted Indonesia’s industrial policy direction focusing on increasing the contribution of non-oil and gas manufacturing, maximizing the value adding potential of its domestic resources, including through ensuring domestic supply of raw materials and achieving international competitiveness. These are echoed in the sectoral policy objectives of the Ministry of Energy and Mineral Resources (Kementerian Energi dan Sumber Daya Mineral or KESDM). The vision of KESDM is to realize energy security, and improve energy and mineral value added to generate greater benefits for the Indonesian people.28 Its missions include improving domestic supply security for mineral commodities, developing domestic capacity in processing minerals, and increasing value added from mineral resources. The mining sector and its various subsectors have been highlighted as priority sectors in a number of policy documents. In the MP3EI mining is identified as one of the sectors that will be the focus of accelerated industrialization efforts. Of the 22 main economic activities under the MP3EI, four are directly related to the mining sector— nickel, copper, bauxite, and steel. The base metal industry is also identified as one of the six pioneer industries eligible for income tax facilities. The GOI’s decision to promote domestic refining of mineral ores is not without considerations. Indonesia is the world’s main supplier of nickel (18.0% for ores and 5.0% for processed nickel), lead (20.0%), and bauxite (15.0%). Up to October 2013, Indonesia exported 46.5 million tons of nickel ores, 16.1 million tons of iron ores, 47.0 million tons of bauxite, and 1.0 million tons of copper. Global demand for various commodities, most distinctly from the PRC, has been on the rise, but this increase is not always reflected in the price. Despite this significant level of, and increase in, exports, there is also little increase in government revenue from the sector, either from royalty or tax income. Promoting greater domestic value adding will increase the sector’s income earning potential, and consequently, revenue potential. Taking the example of nickel, Indonesia exported 55 million tons of nickel ore at around $35 per ton. This amount of nickel ore can be converted to half a million ton of nickel at $18,000 per ton. The potential difference in the value of exports would be $7.1 billion (Soelarno 2014). How this would be translated into economic returns, however, would depend on the costs of developing and operating the downstream nickel industry in Indonesia. The short-term impact of the ban will be the upward impact on the world price of commodities, particularly for minerals, for which Indonesia is a major global supplier. Buyers that rely heavily on Indonesian ores would be among the worst affected. The PRC, for example, imported 70.0% of its bauxite from Indonesia (Sulistio 2014). At the same time, opponents to the ore export ban also point to the likely worsening of the country’s trade balance due to the decline in ore exports. In one estimate, trade deficit will increase by $5.0 billion to $17.7 billion or from 1.1% to 1.7% of GDP (Sulistio 2014). This view is incomplete, however, as it does not take into account of the longer-term impact of the ban, which, assuming competitive downstream industries could be developed, would lead to an increase in processed mineral exports that would more than offset the initial loss. Experts have also argued that due to the high capital requirement in setting up smelters, Indonesia cannot afford to further postpone the implementation of the ban, as the economic  28 See http://www.esdm.go.id/ministry-of-energy-and-mineral-resources/vision-and-mission.html  REFERENCES Alford, P. 2014. 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The Jakarta Post. 13 February. http://www.thejakartapost.com/news/2014/02/13/trade-law-not-against-wto-s-rules-says -govt.html ———. 2014c. Government Flexes Muscles to Reduce Trade Gap. The Jakarta Post. 10 March. <http://www.thejakartapost.com/news/2014/03/10/government-flexes-muscles-reduce-trade -gap.html> ———. 2014d. Govt to Develop Industrial Estates Outside Java. The Jakarta Post. 22 July. ASIAN DEVELOPMENT BANK AsiAn Development BAnk 6 ADB Avenue, Mandaluyong City 1550 Metro Manila, Philippines www.adb.org Industrial Policy in Indonesia A Global Value Chain Perspective This paper traces the evolution of industrial policies in Indonesia from a global value chain (GVC) perspective. As the gains of a country participation in GVC are influenced, among others, by industrial policies, an understanding of both policy leverage and risks is imperative. Using the mineral sector as a mini case study, the paper assesses the Indonesian Government’s recent effort to boost domestic value addition in the sector. It argues that the effectiveness of government policies in maximizing the gains from GVC participation depends not only on policy design, but also on policy consistency and coherence, effective implementation, and coordination. About the Asian Development Bank ADB’s vision is an Asia and Pacific region free of poverty. Its mission is to help its developing member countries reduce poverty and improve the quality of life of their people. Despite the region’s many successes, it remains home to approximately two-thirds of the world’s poor: 1.6 billion people who live on less than $2 a day, with 733 million struggling on less than $1.25 a day. ADB is committed to reducing poverty through inclusive economic growth, environmentally sustainable growth, and regional integration. Based in Manila, ADB is owned by 67 members, including 48 from the region. Its main instruments for helping its developing member countries are policy dialogue, loans, equity investments, guarantees, grants, and technical assistance. InDustrIAl PolIcy In InDonesIA: A GloBAl VAlue chAIn PersPectIVe Julia Tijaja and Mohammad Faisal adb economics working paper series no. 411 october 2014