WHAT has happened to Indonesia’s manufacturing sector? Manufacturing was the engine of growth in the 1980s and for much of the 1990s, thanks largely to a series of trade reforms following the end of the oil boom. Indeed, so fast was the growth that by 1991, the sector’s contribution to gross domestic product (GDP) exceeded that of agriculture.

Much of the expansion was concentrated in low-skill, labour-intensive, export-oriented industries, and it contributed greatly to a decline in poverty by providing expanded job opportunities.

The average annual growth of manufacturing in the years preceding the Asian Financial Crisis was 11.6 per cent.
Since then, however, the manufacturing sector has been almost stagnant, and the “newly industrialising economy” appellation once conferred upon Indonesia by the World Bank has been quietly set aside. More seriously, the declining growth in labour-intensive manufacturing has been hampering government efforts to reduce poverty further.

One of the most commonly cited reasons for the turnaround is the country’s substandard infrastructure, which forces up transportation costs. Port facilities and other logistics systems in particular are widely regarded as needing urgent attention. Two government-sponsored infrastructure summits, one in January 2005 and another in November 2006 had only limited success in encouraging foreigners to invest in infrastructure projects.

One oft-cited reason investors have been reluctant to become involved in infrastructure projects is the lack of legal certainty regarding land ownership and use. Corruption, together with the nation’s myriad and often conflicting regulations, have also contributed to the problem. Indeed, the regional autonomy laws that followed the transition to democracy created a constantly changing regulatory patchwork that even specialists have difficulty keeping up with.
Since the late 1990s, Indonesian manufacturing has also faced increased competition from other low-wage producers such as India and China.

Then, of course, there are the country’s labour laws. Under president Suharto, only one trade union was allowed to exist, and its activities were strictly controlled. The collapse of the New Order, however, ushered in a period of frenetic trade union activity as repressive regulations were lifted. Instead of dealing with just one union, employers found themselves having to deal with multiple labour organisations, many of which were in competition with one another for members.

In the late 1990s, state-mandated minimum wages also rose faster than productivity, providing potential employers with yet another reason not to invest in the country.

“The labour law of 2000 compounded the problem by giving employees exorbitant rights,” notes economist Thee Kian Wee of the Indonesian Institute of Sciences. “Such was the anti-business spirit of the time that even employees who committed crimes were entitled to hefty severance payments.” President Susilo Bambang Yudhoyono attempted to get the legislation revised in 2005, but backed off in the face of determined opposition from the country’s noisy trade unions.
Despite more recent attempts at liberalisation, Dr Thee notes Indonesian bureaucrats still exhibit “an ambiguous attitude” towards foreign investment. In 2007, when the government announced that it would no longer distinguish between foreign and local investors when issuing licences, it also announced a negative investment list (of economic sectors off-limits to foreigners) that was much longer than that previously in use.

Manufacturing still survives in Indonesia, of course. But many of the reasons it does so are hardly the sort of things officials would want to publicise. Dr Thee, who has completed several academic studies on Indonesian manufacturing, points out that the textile industry is buttressed in part by a desire on the part of Taiwanese companies to avoid placing all their investments in mainland China.

The pharmaceutical industry is also doing well in an environment where domestic demand for a wide range of prescription drugs is high as a result of the loose official regulation of local pharmacists. Meanwhile, the automotive industry is benefiting from the continued failure of the authorities to develop a reliable public transport network. Sales of motorcycles in particular have soared in recent years.

In the latter years of Mr Suharto’s New Order government, manufacturing accounted for nearly 30 per cent of the nation’s GDP and manufactured goods made up almost 50 per cent of merchandise exports. Today, manufacturing accounts for just 26 per cent of GDP while the country’s exports are dominated by primary products such as palm oil and coal – a situation that is not that much different from the colonial period.

Recent developments in other countries, notably sharp wage increases in China and ongoing political instability in Thailand, have made Indonesia look more attractive to investors. But more sustained growth in the manufacturing sector awaits reforms that may not see the light of day for years.

Copyright © 2011 Singapore Press Holdings Ltd