Dr. Hidayat Yorianta, Director of International Affairs Office
Mr. Nazaruddin Nasution, moderator
Thanks to Al-Azhar for this valuable opportunity to speak on a subject of great importance, namely how trade can help Indonesia meet its economic goals. President Jokowi has set out an ambitious agenda to increase Indonesia’s economic growth and to reduce poverty. To reach his targets, he has rightly pointed out that Indonesia can no longer rely simply on exporting commodities and consumer spending to drive growth. Boosting investment and building up manufacturing capacity, including for export, are two other important engines of economic growth for Indonesia. Today, I would like to discuss how trade can be a major pillar of Indonesia’s strategy to achieve the President’s goals of economic growth and poverty reduction. Indonesia can play to its strengths and prosper without closing its borders.
Why is Trade Important?
First of all, why is trade important? At the basic level, trade is essential because it allows countries to specialize in the goods and services they produce most efficiently, while benefitting from the production that other countries can do most efficiently and cheaply. Most of you have heard of the theory of comparative advantage. In short, it’s a theory that says people, companies, or countries have different strengths and should focus on those strengths, producing goods or services that play to what they are good at. They can then export those products while importing other products others have a comparative advantage in. That way, consumers in an open trading system can buy the best products and services at the lowest prices.
Let’s take the example of coffee. Indonesia grows lots of delicious coffee, arguably the world’s best. Indonesia’s rich soil and tropical climate make for great coffee growing. As a result, Indonesia exports it all over the world, including to the United States. On the other hand, most of the United States has a climate that just isn’t right for growing coffee. But Americans love to drink coffee, so we import a lot of it. Since growing coffee isn’t our strength, it makes sense to import it rather than trying to grow it at home. By using our resources to focus on other things, American consumers get great quality coffee at a lower cost than if we only drank coffee grown in the United States.
Put another way, trade creates opportunities. For consumers, trade means lower prices and a wider choice of goods and services at a range of quality levels that suit every need. For an economy like Indonesia’s, in which consumer spending is an important component of economic growth, ensuring that consumers have access to a wide range of products and services at the lowest prices is a good way to ensure that growth continues and the benefits of growth can be enjoyed by more people.
For industries, trade creates opportunities for innovation or expansion into new territories. Manufacturers can expand their sources for new technology, tools and inputs and can also take advantage of new markets for their products. They can improve their efficiency and leapfrog technologies to better serve their customers, whether at home or abroad.
For governments, expanding trade creates opportunities to both broaden and deepen a country’s economic resiliency. Strong trading relationships give nations the ability to smooth out economic dislocations from unexpected events – whether natural or man-made – and can also create a virtuous circle that encourages both economic growth and closer relations between nations. When countries are less dependent on one export commodity, or group of commodities, or less dependent on the ebbs and flows of the domestic market, that’s good for economic stability.
Trade Reduces Poverty
Finally, reducing barriers to trade is quite possibly the most important thing a country can do to reduce poverty. Study after study has shown how reducing barriers to trade helps the poor by lowering prices of imports and keeping prices of basic goods affordable.
Perhaps some of you are familiar with the Millennium Development Goals. The MDGs were agreed upon in 2000 as a way to focus attention on specific development priorities. As an example, one of the goals was to try to halve the 1990 global extreme poverty rate and who are malnourished by 2015, among many others. The world made real progress in lifting hundreds of millions people out of poverty during that period and reducing the percentage of people who are malnourished by half, despite the world’s populations growing by almost 2 billion more people.
A group of Nobel prize winning economists and other economic experts recently reviewed 169 proposed follow-up goals to determine which new goals could most effectively reduce poverty rates world-wide. They found that the most cost effective, by a large margin, was reducing barriers to trade. According to these experts, reducing trade barriers in Asia alone would increase per capita incomes in developing countries in this region by as much as US$1900.
If countries around the world could conclude the latest round of negotiations to reduce trade barriers, known as the Doha Round, economists estimate per capita incomes would increase to over US$3000 per person globally. Contrast that with returns to investments in family planning or nutrition which increase incomes by US$120 or US$45, respectively. Those are still a great return, but clearly lowering barriers to trade has a very significant effect on raising incomes and promoting economic growth.
No region of the world has illustrated better the benefits of adopting more outward looking trade policies than Asia. Japan in the 1960s and 70s; the Asian Tigers (Hong Kong, Singapore, South Korea and Taiwan) in the 1970s and 80s; China in the 1990s and 2000s; and Malaysia, Thailand and Vietnam more recently all leveraged trade to increase growth.
I did a quick review of World Bank data for all these countries, specifically looking at trade volumes as a percentage of GDP. Since the 1980s, all the economies that have seen trade as a percentage of GDP increase have also seen their national incomes rise the most. That includes the biggest and the smallest of these economies. Put another way, those countries that opened up most to trade, as a rule, have seen their incomes rise and poverty fall the most. Those that have not have seen incomes grow more slowly.
So what does all this mean for Indonesia?
Trade offers significant opportunities for Indonesia. First, let’s talk about the ASEAN Economic Community or AEC. ASEAN is the second-fastest growing economy in Asia after China. Today, ASEAN has a combined GDP of $2.4 trillion and a consumer base of 626 million. And both of those are likely to increase substantially because of the young populations and growing middle class of ASEAN countries. As the AEC promotes greater economic integration and allows goods and services to flow more easily between ASEAN countries, the AEC offers a significant opportunity for Indonesia to export to a much larger market than the one within its own borders.
So the AEC is an opportunity, not a threat. And as the largest market in ASEAN, Indonesia can capitalize more than any other ASEAN country because it can attract investment not only to produce goods and services for the Indonesian market, but also to export to the rest of the ASEAN market. But it also must be sure that it matches or exceeds the incentives other ASEAN countries provide to investors or those investors will move elsewhere. More on that later.
The Trans-Pacific Partnership
From the U.S. perspective, another major trade opportunity will be to conclude the Trans-Pacific Partnership or TPP. TPP will be the most ambitious, comprehensive trade agreement in history. We are in the endgame of negotiations, with 12 nations participating: the United States, Australia, Brunei Darussalam, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, and Vietnam. TPP is a next-generation, Asia-Pacific trade agreement that will include some of the world’s most robust economies and representing nearly 40 percent of global GDP.
This group shares a commitment to concluding a high-standard, ambitious agreement and to expanding the initial group to include additional countries throughout the Asia-Pacific region. From the U.S. perspective, we see TPP as a way to boost U.S. economic growth and support the creation and retention of high-quality American jobs by increasing exports in a region. TPP is not about closing doors to other countries, but about multiplying the positive benefits of trade.
Trade of Growing Importance to U.S. Economy
In the United States, we’ve seen a shift in the way people think about trade. In the 1990s, the U.S. entered into our largest-ever free trade agreement, NAFTA. There were lots of people who warned against it. One presidential candidate famously warned that we’d all hear a “giant sucking sound” as jobs left the United States for Mexico. The truth is that in the years after NAFTA came into force trade between Canada, Mexico and the United States more than tripled, from $290 billion in 1993 to over $1.1 trillion in 2012.
And contrary to what the doomsayers predicted, the U.S. actually saw a net increase in jobs during that period. What’s more, the jobs in trade tend to be higher income than the jobs they replaced. The years after NAFTA were a boom time in the United States. Unemployment dropped to below 4 percent and GDP growth jumped to over 4 percent – a combination almost unheard of in the United States. The supply chains that sprang up crossed boarders and took advantage of the strengths of each of the three members to increase prosperity for all of them. Those global supply chains now extend far beyond the borders of NAFTA, but they have been a driver for growth in all those economies they touch.
That’s not to say that everyone benefits equally. As our economy changed, some people lost their jobs. Our manufacturing base shifted and that adjustment wasn’t always easy. But as President Obama recently told a huge crowd at Nike, “we can’t stand on the beaches and stop the global economy at our shores. We’ve got to harness it… “ Now that’s not just true for the United States, but applies to everyone.
Now let me talk about another part benefit of trade, which is how it benefits small and medium sized enterprises or SMEs. Interestingly, it is SMEs, not large corporations that are poised to gain the most from an open trading system. Now why does that matter? Because SMEs make up the majority of businesses in Indonesia and the United States, and they are a key source of innovation and job creation. In the U.S., 98% of exporters are SMEs. Trade is a source of growth for them and for the economy in general. The same is true for Indonesia.
Another interesting fact is that the companies most active in exporting are among America’s most dynamic and productive companies. Exporters tend to be more technologically sophisticated, pay higher wages to their employees, and usually create better jobs and at a faster rate, than firms that are domestic only. Apple—with its booming sales of iPhones, iPods, and iPads all over the world— is one example of this. In addition, firms with a global reach tend to be better diversified and are in a better position to respond to new market opportunities wherever they may arise, because these companies already have very flexible infrastructures in place.
The bottom line is this: trade leads to more and better jobs for domestic workers. In the last half of 2013, U.S. exports alone accounted for nearly half of American economic growth. Over 60 percent of American exports go to the Asia-Pacific region. And throughout this decade, most of the United States’ increase in trade is predicted to be with Asian countries.
I was surprised to see that Indonesia’s trade as a percentage of GDP hasn’t changed much from 1980 to today, at a bit more than 50 percent. And Indonesia’s economic growth and development, while quite impressive, especially over the past ten years, still lags behind some of its neighbors. There are lots of people who believe that the best way for Indonesia to make the jump from an economy that depends on natural resources and its domestic market for its growth, to one that is more reliant on manufacturing is to put up barriers to imported goods and services, look for domestic substitutes, demand locally sold goods contain specific amounts of local content, and protect Indonesian companies from competition so they can grow.
These are not new ideas. Countries have been following this model since the 1950s. The problem with this strategy is that it is an inward looking policy that leads to higher prices and less consumer choice, often lower quality goods and protected industries that don’t have incentives to respond to market demand or invest in R&D. As we saw in Latin American countries that pursued this policy through the 1980s, the modest gains are far outweighed by the costs in lost productivity and the increases in inequality. In fact, many refer to this period as Latin America’s lost decade.
Indonesia has been very vocal in its drive to attract more investment yet at the same time, Indonesia has introduced barriers to trade, like local content regulations. But experience around the world has shown that local content and other import restrictions tend to scare off investors. Investors need access to imports so they can specialize in what Indonesia does best. Global supply chains mean that production of goods is different today than in the past. While investors may want to manufacture in Indonesia, it might not make business sense for them to make each and every component and each and every product here.
Take the iPhone, for example. Market share for smart phones and devices are some of the most hotly contested markets in the world, and device companies rely on an incredibly efficient global supply chain to remain competitive. The iPhone is assembled in China, but its parts and components come from countries around the world, with Apple finding the most efficient and cost-effective ways to source components. To best attract investment, Indonesia is continuing its efforts to improve the business climate, like the One Stop Service at the Investment Coordinating Board. But investors also want to be able to import and export freely.
Reducing restrictions on trade helps domestic companies to grow through access to new markets—and often bigger markets—overseas. I’ve heard some companies say that the Indonesian market is big enough for them. And Indonesia is fortunate to have a large and growing market. But ASEAN is a much bigger market with even bigger opportunities to grow. AEC is bigger, RCEP is even bigger, and the TPP will be an even bigger market – as I said, 40% of global GDP, with opportunities to match. And contrary to what some might fear, there is no reason Indonesian companies cannot compete and win in ASEAN, Asia and beyond. Competition isn’t always easy, but it encourages firms to specialize and improve their products, and also increases the potential for more innovation.
U.S. companies already operating in Indonesia are manufacturing for export out of Indonesia. Honeywell produces advanced avionics technology such as the famous black boxes from a plant in Bintan for its global customers. Caterpillar makes heavy mining trucks and equipment for the Indonesian and regional market. Fluidic Energy is an innovative green battery technology developed with a DOE grant which manufactures here for Indonesian and global clients. Cargill refines cacao for international markets. The list goes on and on.
President Jokowi’s plan to improve infrastructure, ensure reliable energy supplies, streamline permitting processes, and reduce logistics costs all could make Indonesia a more attractive country in which to do business and produce for export.
The world’s demand for manufactured goods will only increase over time, and with Indonesia’s young and large labor force, Indonesia is in the right place to develop this sector. Jobs in this field tend to provide higher wages and better work conditions, in turn helping Indonesia move to the next stage of the country’s economic development.
But here is the hard fact. Investors are like any other consumers. They shop around for the best deal. They look at which countries offer the best tax and other incentives. They look at which places are the easiest places to start a business, get land and other permits, and ensure contracts are enforced with strong rule of law. In the latest World Bank index of Ease of Doing Business, Indonesia ranks behind Singapore, Malaysia, Thailand, Vietnam, the Philippines and Brunei.
The success of countries like Singapore shows that an incentive based approach that makes it easy to do business is the most effective way to attract foreign capital. Indonesia would do well to study what incentives its ASEAN competitors are offering and match those so that Indonesia can attract the investments of companies seeking to produce for the ASEAN market.
Ladies and gentlemen, Indonesia today is faced with a strategic choice. It can turn inward and pursue policies designed to protect its companies and industries, accepting the inefficiencies, higher prices and less choice for consumers, inequality and lack of innovation that entails. But I hope you agree that Indonesia doesn’t need a lost decade like the countries of Latin America.
This country is well placed to benefit from a greater openness to trade. The AEC, RCEP and someday the TPP can make Indonesia’s economy more dynamic, more creative and ultimately competitive with anyone. An outward looking Indonesia is a strong Indonesia, one who attracts investment through incentives, and looks to new engines of growth for its economy to grow in an inclusive manner that will reduce poverty, create better and more sustainable jobs for Indonesian workers, and increase opportunity.