Indonesia for Indonesians: Can the United States Relate?

Indonesians want to own all aspects of their economy—equity, capital, technology—and they want it run by Indonesians. Indonesia for the Indonesians. The question for the United States is whether it can relate to this new Indonesia or, more appropriately, can it afford not to.

The populist impulse dominating Indonesia is not a new instinct for a newly empowered country. Indonesians wrested a democracy from the authoritarian rule of President Suharto in 1998 and spent a decade focused almost exclusively on politics. Meanwhile, the economy bounced along with wild gyrations in currency valuation, debt levels, and inflation. Today, Indonesia’s political stability is among the best in Asia. What’s interesting now is its economy. Indonesia sits in the geometric center of the world’s newest sources of economic growth. Like Panama and its canal in the twentieth century, Indonesia connects this century’s two most commercially vital oceans—the Indian Ocean and the Pacific. It is also the world’s fourth-largest country and home to one of the fastest-growing major economies on the planet. Gross domestic product has grown between 5 and 6 percent annually for nearly a decade despite the global slowdown.

As the world’s 16th largest economy with a total GDP of nearly $1 trillion, Indonesia now is indisputably an emerging economic power. However, the share of U.S. companies in Indonesia is less than it might have been. Despite its size, Indonesia ranks only 34th among the United States’ trading partners, with two-way trade roughly equal to much smaller countries like, you guessed it, Panama.

Indonesia has never been an easy place to do business—the Global Trade Alert ranks Indonesia alongside such nations as Zimbabwe, Uzbekistan, and Paraguay in ease of doing business—but even so, American firms still rank fourth among foreign investors in the country. Much of U.S. companies’ stock investment in the country, valued at $11.6 billion, is in the mining and oil and gas sectors.

U.S. investment in manufacturing, a sector in which U.S. companies are heavily invested in nearby Singapore, Malaysia, and Thailand, remains shockingly small. The historical reason for this anomaly is that Indonesia’s infrastructure, governance issues, legal system, and dependence on natural resources pushed investors to locate plants in smaller countries with better answers to investors’ questions.

But now that Indonesians can choose their own government and want better economic opportunities, education, equity, and higher wages, the government is responding with less sophisticated policies. These measures bear the tag of populism and import-substitution rather than trying to compete with more policies to draw in capital, technology, and high-end investment. 

Over the past few years, a raft of protectionist measures has made a tricky environment even more difficult. In the U.S.-Indonesia Comprehensive Partnership launched in 2010, economic relations lag far behind political, security, and people-to-people ties. The strong bilateral military, diplomatic, counterterrorism, and educational collaboration stands in stark contrast to a tense, in some ways worsening, trade and economic relationship.

Some of the government’s measures have not only disrupted the trading activities of U.S. companies, but caused considerable domestic heartburn as well. For instance, the Trade Ministry’s suspension of garlic from China caused prices to surge more than 30 percent in February. Restrictions on beef imports have resulted in Indonesian consumers paying among the highest beef prices in the world. However, in both cases Indonesian pragmatism prevailed, with the government recently taking steps to ease imports, increase supply, and lower consumer prices.

U.S. companies ranging from consumer goods providers to oil and gas firms to pharmaceutical companies face a complex and constantly changing series of regulations. New regulations are often imposed without consulting the appropriate ministries, affected firms, or other key stakeholders, resulting in confusion, shortages, and rising prices.

The country’s 2009 mining law stipulates that beginning in 2014, mining firms are required to process ore before exporting it. Last year, however, the government suddenly decided to implement the measure two years early, creating considerable anxiety for mining companies. Regulation 79, signed in 2010, allows the government to change the terms of existing oil and gas production-sharing contracts, eliminate tax deductions for some expenses, and change the terms and criteria for cost recovery, creating uncertainty for U.S. energy companies. This, in combination with a series of nationalist policies that discourage exploration, has led in part to a fall in the country’s oil production of nearly 50 percent over the past 15 years.

Despite complaints about protectionism, U.S. firms operating in Indonesia regularly tell the American Chamber of Commerce in Jakarta that they are doing well in the country and intend to ratchet up investments. Most U.S. companies are rapidly learning to adjust to the new rules of the game and to Indonesia’s newly assertive and muscular trade policies. However, the complexity and vagaries of the investment climate keep new U.S. companies from entering the market and blunt capital expenditure on new investment that established companies are keen to make.

Indonesia has long had a tendency toward economic nationalism. The country’s giant size, wealth of natural resources, and 240-million-person economy give it the luxury of considerable self-sufficiency. Domestic consumption accounts for almost 60 percent of GDP, and international trade is a much smaller driver of growth than in many developing countries. These attributes, along with deft macroeconomic management and thriving democracy, have given Indonesians a healthy dose of self-confidence.  

A widespread perception has taken hold in the country that free trade is a one-way street. Indonesians often cite the “damage” done to domestic firms by the ASEAN-China free trade agreement (FTA) or by Australia’s unilateral ban on the export of live cattle in 2011. Indonesians are surprised that ASEAN economic integration and the ASEAN FTA with Australia and New Zealand make it easier for companies to export into Indonesia rather than adding value in the country. In this context, the introduction of non-tariff measures is described as an effort to protect the market share of domestic companies.

Most senior Indonesian policymakers genuinely want Indonesia to avoid getting caught in the lower-middle-income trap. They desperately want to add value domestically in everything from manufacturing to commodities to ownership of banks. But the capacity of the bureaucracy and policymakers to create sophisticated incentives to add value in Indonesia is limited. In effect, the Indonesian government attempts to achieve these goals through regulation – often through a punitive approach – resulting in frustrated investors who would otherwise like to adhere to the rules so that they can access the size and potential of the Indonesian market.

So how should U.S. companies and the government operate in Indonesia? For starters, U.S. companies must have boots on the ground. They should engage Indonesia like a rising power, much like they do India and Brazil, two other tough markets for U.S. firms.

John Riady, who heads up the U.S.-Indonesia Committee of Indonesia’s Chamber of Commerce and Industry, suggests that U.S. companies not take the vagaries of new regulations personally or assume ill intent. Companies need to recognize that Indonesia is a high-risk regulatory market before jumping in.

The U.S. government and companies could launch an “America Matters for Indonesia” campaign, which would highlight jobs created and income generated by U.S. investment. Without greater understanding of the positive role of foreign investment and trade there is little chance of Indonesia joining the United States, Japan, and 10 other countries in the Trans-Pacific Partnership trade negotiations. In advance of the APEC summit in October, the American Chamber of Commerce in Indonesia, in collaboration with two Indonesian universities, will release a study showing the long-term economic and social contributions of American investment in Indonesia.

Indonesia today looks much like other large, competitive democracies, complete with the risks associated with electoral cycles and populist campaigning. No Indonesian politician will run on a platform of “free trade.” In this sense, Indonesia resembles the democracy of the United States—or that of comparable economies like India or Brazil. Indonesia is neither the toughest trade relationship for the United States nor a uniquely difficult investment climate. It is just that we are not used to the newIndonesia. But this is likelythe new normal, so companies—and governments—must learn how to adapt.

(This Commentary originally appeared in the May 30, 2013, issue of Southeast Asia from the Corner of 18th & K Streets.)

Murray Hiebert is senior fellow and deputy director of the Sumitro Chair for Southeast Asia Studies at the Center for Strategic and International Studies in Washington, D.C. Douglas Ramage is chairman of the Trade & Investment Committee of the American Chamber of Commerce of Indonesia and managing director for Indonesia, BowerGroupAsia.

Commentary isproduced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

© 2013 by the Center for Strategic and International Studies. All rights reserved.

Murray Hiebert
Senior Associate (Non-resident), Southeast Asia Program

Douglas Ramage