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Mainstream
economists view industrial policy with disdain and it is indeed true that the
record of such policies has been mixed. Still, it is possible to learn lessons
from past mistakes and to implement an industrial policy tailored to Indonesia’s
special circumstances, which can boost Indonesia’s economic development.
What went wrong and what worked well with previous attempts at industrial policy?
Indonesia’s experience with industrial policy was not a great success. But this need not have been the case if previous policies had been structured wisely.
First, in its previous incarnation, industrial policy gave government bureaucrats full authority to select industrial products; this encouraged corruption and cronyism. Established and wealthy business groups had the resources to win the favor of bureaucrats giving out licenses and issuing regulations. Consequently, industrial policy tended to entrench existing vested interests that were able to distort the economy to their benefit. Since the profits from such licenses and regulations were substantial, there was a great incentive for protected companies to reward the bureaucrats with substantial bribes as well.
Second, past industrial policies failed to produce globally competitive and sustainable Indonesian companies which could be weaned off protectionism and subsidies. It is important to understand the reasons for this.
Apart from the uncoordinated and often incoherent implementation of these policies, industrial policy relied on substantial protectionism. This meant that the Indonesian companies selected to become national champions did not have the spur of intense competition to push them to greater heights of proficiency in their respective markets.
This was markedly different from Korea, for example, where high tariff and other protectionist barriers did protect the local champions from external competition but the government planners also ensured vigorous domestic competition by selecting not one but several local companies in each industrial sector. The result of this intense competition was companies that kept improving their production processes, technology, brand power and marketing skills.
The government also pushed these companies to enter the international market to prove their worth. Eventually, as these Korean companies improved the quality and appeal of their products, they were able to survive the competition when the Korean government removed protectionist barriers. Today, they have become world-beating, globally competitive companies.
Third, the selection of which industries to target was flawed. Instead of basing the decision on a clear-headed understanding of the areas in which Indonesia had clear competitive advantage, such decisions were often based on the whims of political leaders such as a fondness for high-technology areas where it would have been difficult for Indonesia to establish itself credibly.
Finally, the enabling environment for industrial policy to succeed was not established. One of the most critical aspects of the enabling environment was the development of human capital: the nation sorely lacked a critical mass of universities, polytechnics and vocational training institutes which churned out highly-skilled engineers, technicians, production supervisors, technical foremen and the like — all critical to successful manufacturing ventures.
How should Indonesia move with industrial policy?
Fifteen years after the end of Indonesia’s financial crisis, the economy has stabilized and is enjoying reasonable but not exciting growth. As China’s rising costs and strengthening currency weaken its competitive edge in labor-intensive manufacturing, manufacturing that is relocating out of China. Indonesia has a once-in-a-lifetime opportunity to capture this outflow as it can leverage off a large pool of relatively cheap labor, a growing consumer market as well as existing large clusters of industrial activity which are competitive.
It is timely, therefore, to consider a new push on industrial policy to take Indonesia to a higher level of industrial competence so that its manufacturing sector can become a more powerful driver of economic growth and a creator of good jobs for Indonesians. What should Indonesia do?
First, it needs to work harder at building human capital. A group of tertiary educational institutions and vocational schools should be selected to be developed into world class institutions matching the best available in successful countries such as Japan and Germany. The apprenticeship scheme which Germany has benefited from so spectacularly should be brought into Indonesia so that a cadre of skilled and dedicated craftsmen can be developed over time. Indonesia can learn much from Japan’s approach of learning by doing.
Second, it needs to remove impediments which undermine local companies’ competitiveness. These include excessively generous provisions in labor regulations as well as tariffs and other government interventions which inflate costs for selected industries.
Third, technology transfer should be accelerated. Government funds should be set up to fund the acquisition of existing patents and technology by local companies. National research agencies modeled on Taiwan’s successful ones should be set up to undertake discoveries, create new products and develop new processes which can be transferred to Indonesian companies.
Fourth, follow the market in deciding areas in which Indonesia should excel. Instead of picking winners and pouring resources into areas such as aircraft manufacturing which are inherently difficult for Indonesia, the policy makers should take the cue from what the private sector is doing. It is clear from the pattern of investment flows that private companies find Indonesia competitive in a range of areas such as motor cycles and fast-moving consumer goods.
Thailand’s extraordinarily successful approach to developing its auto sector provides a good lesson. Thailand did not pick local companies as potential winners but focused on enticing global auto producers and their top notch sub-contractors to cluster in the eastern seaboard region to the southeast of Bangkok — using tax incentives, the lure of well-developed industrial estates and newly developed transport linkages. As a result, a huge auto cluster has developed which has allowed Thai companies to develop by supplying components and services. In fact, several Thai companies have become globally competitive suppliers of all kinds of components to the thriving auto sector.
In short, Indonesia is in a good position now. All it has to do is to put in place a few key policies and it can ignite a new phase of industrial growth in the country. ●
What went wrong and what worked well with previous attempts at industrial policy?
Indonesia’s experience with industrial policy was not a great success. But this need not have been the case if previous policies had been structured wisely.
First, in its previous incarnation, industrial policy gave government bureaucrats full authority to select industrial products; this encouraged corruption and cronyism. Established and wealthy business groups had the resources to win the favor of bureaucrats giving out licenses and issuing regulations. Consequently, industrial policy tended to entrench existing vested interests that were able to distort the economy to their benefit. Since the profits from such licenses and regulations were substantial, there was a great incentive for protected companies to reward the bureaucrats with substantial bribes as well.
Second, past industrial policies failed to produce globally competitive and sustainable Indonesian companies which could be weaned off protectionism and subsidies. It is important to understand the reasons for this.
Apart from the uncoordinated and often incoherent implementation of these policies, industrial policy relied on substantial protectionism. This meant that the Indonesian companies selected to become national champions did not have the spur of intense competition to push them to greater heights of proficiency in their respective markets.
This was markedly different from Korea, for example, where high tariff and other protectionist barriers did protect the local champions from external competition but the government planners also ensured vigorous domestic competition by selecting not one but several local companies in each industrial sector. The result of this intense competition was companies that kept improving their production processes, technology, brand power and marketing skills.
The government also pushed these companies to enter the international market to prove their worth. Eventually, as these Korean companies improved the quality and appeal of their products, they were able to survive the competition when the Korean government removed protectionist barriers. Today, they have become world-beating, globally competitive companies.
Third, the selection of which industries to target was flawed. Instead of basing the decision on a clear-headed understanding of the areas in which Indonesia had clear competitive advantage, such decisions were often based on the whims of political leaders such as a fondness for high-technology areas where it would have been difficult for Indonesia to establish itself credibly.
Finally, the enabling environment for industrial policy to succeed was not established. One of the most critical aspects of the enabling environment was the development of human capital: the nation sorely lacked a critical mass of universities, polytechnics and vocational training institutes which churned out highly-skilled engineers, technicians, production supervisors, technical foremen and the like — all critical to successful manufacturing ventures.
How should Indonesia move with industrial policy?
Fifteen years after the end of Indonesia’s financial crisis, the economy has stabilized and is enjoying reasonable but not exciting growth. As China’s rising costs and strengthening currency weaken its competitive edge in labor-intensive manufacturing, manufacturing that is relocating out of China. Indonesia has a once-in-a-lifetime opportunity to capture this outflow as it can leverage off a large pool of relatively cheap labor, a growing consumer market as well as existing large clusters of industrial activity which are competitive.
It is timely, therefore, to consider a new push on industrial policy to take Indonesia to a higher level of industrial competence so that its manufacturing sector can become a more powerful driver of economic growth and a creator of good jobs for Indonesians. What should Indonesia do?
First, it needs to work harder at building human capital. A group of tertiary educational institutions and vocational schools should be selected to be developed into world class institutions matching the best available in successful countries such as Japan and Germany. The apprenticeship scheme which Germany has benefited from so spectacularly should be brought into Indonesia so that a cadre of skilled and dedicated craftsmen can be developed over time. Indonesia can learn much from Japan’s approach of learning by doing.
Second, it needs to remove impediments which undermine local companies’ competitiveness. These include excessively generous provisions in labor regulations as well as tariffs and other government interventions which inflate costs for selected industries.
Third, technology transfer should be accelerated. Government funds should be set up to fund the acquisition of existing patents and technology by local companies. National research agencies modeled on Taiwan’s successful ones should be set up to undertake discoveries, create new products and develop new processes which can be transferred to Indonesian companies.
Fourth, follow the market in deciding areas in which Indonesia should excel. Instead of picking winners and pouring resources into areas such as aircraft manufacturing which are inherently difficult for Indonesia, the policy makers should take the cue from what the private sector is doing. It is clear from the pattern of investment flows that private companies find Indonesia competitive in a range of areas such as motor cycles and fast-moving consumer goods.
Thailand’s extraordinarily successful approach to developing its auto sector provides a good lesson. Thailand did not pick local companies as potential winners but focused on enticing global auto producers and their top notch sub-contractors to cluster in the eastern seaboard region to the southeast of Bangkok — using tax incentives, the lure of well-developed industrial estates and newly developed transport linkages. As a result, a huge auto cluster has developed which has allowed Thai companies to develop by supplying components and services. In fact, several Thai companies have become globally competitive suppliers of all kinds of components to the thriving auto sector.
In short, Indonesia is in a good position now. All it has to do is to put in place a few key policies and it can ignite a new phase of industrial growth in the country. ●
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