The Indonesian Growth Slow-down and Recovery: Causes and Consequences.

In 2011 Anne Booth, SOAS, University of London, contextualised these concerns in a paper: China’s Economic Relations with Indonesia: Threats and Opportunities.

This is the backstory!

When world oil prices began to fall in Indonesia in the early 1980s, the Suharto government embarked on a series of reform measures which were designed to make the non-oil export sector more competitive, including two large devaluations, a duty drawback scheme for exporters, and measures to make ports more efficient.

By the early 1990s these reforms seemed to have been very successful; the manufacturing sector grew rapidly, and exports of textiles, garments, footwear and wood products all increased. But the growth collapse which followed the Asian crisis in 1997/98 was extremely severe in Indonesia, and recovery was slow. Per capita GDP only regained its 1997 level in 2004. The cost of  recapitalizing a devastated banking sector was enormous, and most of the burden fell on the government budget. This meant much needed  government investment in education and infrastructure had to be drastically cut back. Government infrastructure investment had already slowed in the final years of the Suharto regime, when powerful private firms, often controlled by the presidential extended family and their cronies were  given lucrative contracts to build infrastructure.  Projects were often finished late and at high cost; in some cases they were never completed. 

After the crisis, manufacturing growth slowed, and through to 2006 it was about the same as total GDP growth, although there was considerable variation across industrial sectors in growth of both output and exports (Aswicahyono, Narjoko and Hill  2008:  31).  It became clear after 1998 that at least part of  the growth in manufactured exports which occurred  in the decade from 1987 to 1997 was based on  fragile foundations, including the unsustainable exploitation of timber to produce plywood, and  draconian treatment of labour. In addition, by the early 2000s, there was abundant evidence that congested roads and ports, unreliable and expensive power supplies, and shortages of skilled workers were adding to the costs of export producers in both agriculture and manufacturing, and deterring investors, both domestic and foreign. A further set  of problems related to the political changes which took  place after the resignation of Suharto. Three presidents took office between May 1998 and July  2001, when the MPR removed  Abdurrahman Wahid and installed Megawati Sukarnoputeri. The lack of  continuity in policy making aggravated an already bad investment climate. New policy initiatives such  as the sweeping decentralization laws which were implemented in 2001 added to the perception that the central government had little control over much of the country. 

This perception was reinforced by the rise in violent conflicts in several parts of Sumatra, Kalimantan and  Eastern  Indonesia, and the emergence of Islamic terrorist groups with international links whose bombing campaigns caused  tragic loss of life in Bali and Jakarta. President Megawati was thought to be relying more heavily on the military to maintain order, often by repressive means. She also sought support from organized labour by introducing laws which increased minimum wages and made it more difficult and expensive for firms to dismiss workers. These policies further deterred foreign investors, who pointed out that labour costs were higher in Indonesia than in China, Vietnam, and Cambodia. The higher costs were not compensated by higher productivity; the educational and skill level of much of the labour force remained low.

While most analysts agreed that Chinese exports of textiles, garments and footwear were displacing those from both Indonesia and the Philippines in OECD markets, the solution seemed clear; these countries would either have to implement reforms to make their labour-intensive manufactures more competitive in world markets, or they would have to develop new export industries, taking advantage of growing demand in both China and other parts of the world for resource-based products.

In fact the years from 2004 to 2010 have seen considerable improvement in Indonesia‟s export performance. Between 2003 and 2010, Indonesian exports more than doubled in terms of nominal dollars. Part of this increase was due to price increases for important exports such as oil and gas and vegetable oils, but part was also the result of quantity increases. Only 20 per cent of the increase in export value between 2003 and 2010 came from oil and gas, and another 23 per cent from other mining products, including coal. Much of the rest of the growth came from manufactures including processed vegetable oils. Over these seven years, Indonesian exports to China grew more rapidly than total exports, and accounted for around twelve per cent of the total growth in dollar terms. By 2009, coal was the most important single export, followed by palm oil, gas, crude petroleum, and crumb rubber. Together these five products accounted for around 58 per cent of total exports to China in value terms in 2009.

By 2009, China had become Indonesia's second largest export market after Japan, and had overtaken Singapore. On the import side, growth between 2003 and 2010 was also very rapid, with only a slight decline in value terms in 2009. By 2010, Chinese imports to Indonesia in dollar terms had overtaken those from both Singapore and Japan. They far outstripped imports from both the EU and the NAFTA countries. The balance of trade between Indonesia and China, which had been running in Indonesia's favour in the earlier part of the decade had turned in China's favour after 2008.

What was Indonesia importing  from China? In 2009, around half of Chinese imports were in the machinery and transport equipment category; the second largest category was other manufactures, followed by chemicals. In these three categories, China was running a large trade surplus with Indonesia. Imports of machinery were dominated by power generating and telecommunications equipment. It is probable that Chinese imports in these types of machinery were associated with the investments made by Chinese firms in the power and gas sectors. Some machinery imports might also have displaced imports from more advanced countries such as Japan or Germany. In this sense, they can be seen as a net gain to Indonesia,  rather  than displacing local production. But the pattern of trade with China which had emerged by 2009 was clearly one of exchanging unprocessed or semi-processed primary products for imports of manufactures. The implications of this are discussed further below.

The rapid growth in Indonesia's export and import trade with China over the 2000s has been mirrored in China's trade with other ASEAN countries.  Between 2004 and 2008, bilateral trade between China and the ASEAN countries as a group more than doubled, and was estimated by the ASEAN Secretariat to have reached US$ 231.12 billion by 2008, although there was some contraction in 2009, given the overall decline in world trade in that year. By 2009, China had become the largest trading partner of the ASEAN-10, overtaking the EU, Japan and the USA. In that year the ASEAN-10 accounted for 8.8 per cent of China's exports and 10.6 per cent of imports, although the percentage for Indonesia were much lower at 1.2 per cent and 1.4 per cent respectively. In ASEAN as a whole, the value of exports and imports was balanced, and Malaysia, Brunei, the  Philippines and Thailand ran trade surpluses. The other countries in the region were running deficits which were substantial in Myanmar, Cambodia, Vietnam and Singapore (National Bureau of Statistics of China 2010: 238).

Since the early 2000s, there has also been an increase in Chinese investment in the ASEAN countries. The estimates of Scissors (2011) show that cumulative non-bond investment outflows from China to Indonesia in the years from 2005 to 2010 amounted to 9.8 billion dollars, which made Indonesia the eight largest recipient of Chinese non-bond investment over these years, after Australia, the USA, Nigeria, Iran, Brazil, Kazakhstan and Canada. It received more investment than any other ASEAN country,  including  Singapore.  Much  of  this outward  investment in all the recipient countries was in the mineral, oil, gas and power sectors. This was certainly the case in Indonesia where the largest investors from China were power, gas, energy and steel companies. By 2009, the flow of Chinese investment into Indonesia  appeared  to  have  slowed;  in  that  year Indonesia was not in the top twenty recipients of Chinese investment, although both Singapore and Myanmar were (Salidjanova 2011). ASEAN investment into China also continued to grow especially from Singapore.

Aswicahyono, Haryo, Dionisius Narjoko and Hal Hill (2008), “Industrialization after a Deep Economic  Crisis: Indonesia”, Working  Paper  No  2008/18, Canberra: Australian National University, Arndt-Corden Division of Economics, College of Asia and the Pacific.

National Bureau of Statistics of China (2010), China  Statistical  Yearbook  2010,  No  29,  Beijing:  China Statistics Press

Salidjanova, Nargiza (2011), “Going Out: An Overview of China's Outward Foreign Direct Investment”, USCC Staff Research Report, Washington: U.S.-China Economic and Security Review Commission

Scissors, Derek (2011), China Global Investment Tracker, Washington: Heritage Foundation, (www.heritage.org/research/reports/2011/01/china-global-investment-tracker-2011), accessed 20/5/2011