Indonesia's recent economic policy pronouncements indicate that the country will become increasingly protectionist as President Joko "Jokowi" Widodo's government heads for its second year. Foreign investors are wary that Jokowi might bow to strong political pressure to restrict imports in favour of local production.
Their concerns became a reality last month, as Indonesia raised import tariffs between 10 and 90 percentage points for many consumer goods ranging from food to cars. The Indonesian government argues that such measures are needed to protect local industries and jobs amid global economic uncertainty.
Rising protectionism is worrying, as the region gears up for the Asean Economic Community at the end of this year with the goal of having a single market with free movement of goods, services, capital, investment and skilled labour. Alas, Indonesia - as the most populous member of Asean - is moving in the opposite direction.
Nine months into President Joko's five-year term, the challenges facing the Indonesian economy are mounting. In the first quarter of this year, gross domestic product (GDP) growth slowed to 4.7 per cent, far below the level needed for the two million new entrants to the labour market annually.
At the same time, most - if not all - of the country's engines of growth are currently weakening. Household consumption that used to drive the economy is now significantly weaker due to declining consumer purchasing power. The rupiah has lost nearly 12 per cent of its value since Jokowi took office.
In addition, the commodity sector that used to be the main exports earner has been hit hard by weak global demand. Private investment is lacklustre, while most of the President's big infrastructure projects have been slow to kick in.
Government fiscal spending provides little respite as the roll-out of new programmes is hampered by paralysing bureaucracy and a lack of coordination across ministries.
PRESSURE TO SAFEGUARD JOBS
To be fair to the Jokowi administration, it is hard to resist the temptation to safeguard local businesses in the wake of the deteriorating global economic outlook. This happens not only in Indonesia, but also in other parts of the world. Specifically in the case of Indonesia, local businesses and labour unions, who wield significant political influence, put strong pressure on Mr Joko.
However, as protectionist measures are increasing, foreign investors' expectations that Mr Joko will implement much- needed structural reforms to improve the business environment are diminishing. The government appears to prioritise local and small businesses ahead of tackling pressing structural problems.
Protectionist measures have been implemented, not only in the consumer goods sector, but also in other sectors. For instance, various local content requirements have been mandated in mining, oil and gas, automotive and, recently, the telecommunication sectors. These sectors are targeted because they are the biggest contributors to Indonesia's trade deficit.
The government argues that the local content policies would further encourage companies to invest in Indonesia to spur expansion in domestic manufacturing. This would, in turn, provide the impetus to move up the value chain in the manufacturing sector.
In addition, such policies are also meant to spur employment growth in higher value-added and high-skilled sectors. However, countries that were successful in creating employment in high-skilled sectors are the ones that have a higher proportion of workers with higher skills and higher education. In Indonesia, less than 9 per cent of the workforce have a university or college degree. Nearly half have only elementary education. Therefore, the local-content policies will not bear fruit without first addressing the fundamental problem of a low-skilled labour force and improving educational levels.
There are also other potential drawbacks from the local-content policies. For foreign investors, they severely limit their ability to make decisions on sourcing parts, components and personnel that would allow them to function efficiently. As a result, firms will see lower productivity and profits.
Also, the policies might encourage more smuggling, given Indonesia's notoriously weak law enforcement and the lack of excise and Customs supervision to regulate the importation of machinery, parts and components. Without proper and effective import controls, the market will be distorted with contraband and counterfeit products.
STRUCTURAL PROBLEMS NEED ADDRESSING
Instead of protecting the local industry, the key issue that the Jokowi administration has to tackle is the structural problems that hamper industrial competitiveness.
The manufacturing sector has been under-performing compared with its regional peers because of low efficiency and productivity. Higher dependency on commodities such as coal and palm oil has, to some extent, contributed to the manufacturing sector's decline in performance.
A poor business climate has made the manufacturing sector unable to link up effectively with the global value chain.
Previous protectionist measures failed to address the lack of industrial competitiveness, as they were not designed to tackle the core problems.
Mr Joko needs to restore investor confidence. For a start, the government should rethink its protectionist policies. These will not solve the local industry's lack of competitiveness.
It is more important that efforts are made to address fundamental issues such as the lack of infrastructure, lack of skilled workforce, inefficient bureaucracy and unclear regulations. After all, foreign investment is needed to help tackle such core structural problems, which also include energy deficits and over-reliance on commodity exports.
If Mr Joko fails on this score, he must realistically lower the government's 7 per cent annual growth target.
The writer is a visiting fellow at the Institute of Southeast Asian Studies.
S.E.A. View is a weekly column on South-east Asian affairs.
This article was first published on Aug 6, 2015.
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