Fluent Essays

In this assignment, you will be able to apply what you have learned in this unit and Unit V to real-world concepts. Read the following two articles and apply the course concepts in a comparison of import substitution and export orientation.Narjoko, D., Anas, T., & Herdiyanto, R. (2018, Winter/Spring). The elusive pursuit of import substitution in 21st century Indonesia. Asian Economic Papers, 17(1), 73–93. https://libraryresources.columbiasouthern.edu/login?url=http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=128141238&site=ehost-live&scope=siteRasiah, R., & HingAi, Y. (2009, May). Industrializing Southeast Asia. Journal of the Asia Pacific Economy, 14(2), 107–115. https://libraryresources.columbiasouthern.edu/login?url=http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=37276648&site=ehost-live&scope=siteIn your article review, in addition to your comparison of import substitution and export orientation as related to the articles, be sure to include the components listed below. Briefly summarize the premise and main points of the articles. Create (do not copy and paste) a graph illustrating the effect of tariffs on trade. Explain arguments for protectionism in the context of import substitution policies. Describe how export orientation leads to more economic growth in factors or production and improved technical progress. Your article review must be at least three pages in length. Adhere to APA Style when constructing this assignment, including in-text citations and references. Please note that no abstract is needed. The Elusive Pursuit of Import Substitution in 21st Century Indonesia* Dionisius Narjoko Economic Research Institute for ASEAN and East Asia ERIA Annex Office Sentral Senayan II, 6th floor, Jalan Asia Afrika No. 8 Gelora Bung Karno, Senayan, Jakarta Pusat 10270, Indonesia [email protected] Titik Anas Presisi Indonesia and Padjajaran University Menara BCA, 50th floor Jl. M.H Thamrin No 1, Jakarta 10310, Indonesia [email protected] Robertus Herdiyanto Presisi Indonesia Menara BCA, 50th floor Jl. M.H Thamrin No 1, Jakarta 10310, Indonesia [email protected] Abstract This study evaluates the possible impact of an import substitution strategy recently implemented by the Government of Indonesia on the development of the intermediate inputs industry. Based on de- scriptive analysis, the study suggests that the implementation of the strategy was a misguided decision. Experiences from several countries confirm the negative impact of an import substitution strategy. The econometric analysis shows that trade protection impedes firms’ performance. Thus, it would be prefer- able for the government to have an open trade regime and to intensify foreign presence in the industry. 1. Introduction Indonesia, like many other emerging countries, views the development of a thriving in- termediate inputs industry, including processed raw materials and capital goods, as a cornerstone of its industrialization process. As laid out in the Master Plan 2011–25, the government aims to promote policies that encourage processing of raw materials and semi- processed materials into parts-and-components, to increase domestic value added and to * This paper draws from the project “Is Import Substitution a Viable Strategy to Develop the In- donesian Intermediate Industry?,” financially supported by the World Bank. The authors thank Miryana Vinka for excellent research assistance. The authors also thank the comments from two discussants of the paper and the conference participants during the Asian Economic Panel Meeting at Keio University, Tokyo, on 22–23 August 2016. Asian Economic Papers 17:1 © 2018 by the Asian Economic Panel and the Massachusetts Institute of Technology doi:10.1162/ASEP_a_00588 The Elusive Pursuit of Import Substitution in 21st Century Indonesia reduce imports (Rahardja and Varela 2014). This policy objective has not been achieved, as most of the intermediate inputs for domestic production are still imported. Therefore, the government is interested in evaluating the possible impact of an import substitution strategy (ISS) on the development of the intermediate goods industry. Generally, an ISS aims to replace previously imported commodities with domestic pro- duction and supply.1 Often, the country using an ISS will impose trade barriers to restrict the import of certain products and encourage the domestic production of these products to displace imports. In line with escalating trade barriers, the government commonly of- fers tax or investment incentives to attract foreign investors to inject capital in these sec- tors by establishing plants domestically, either in the form of greenfield investment or joint ventures. The proponents of ISS admit that the initial costs of domestically produced products that used to be imported will be higher than world prices. Nonetheless, they argue that the strategy will eventually bring down production costs through economies of scale because domestic producers will have the necessary time to learn and improve the production process. Despite its optimistic objective, ISS raises few concerns as recorded in the literature. First, overly protected industries will make firms operate inefficiently and will prevent national output from reaching its optimum level through misallocation of resources. Further, too much protection can lead to the creation of excessively long-term rents for domestic pro- ducers. Second, as stated, ISS implementation often coincides with tax and investment incentives. Foreign investors will also make use of those incentives, serve the domestic market, and reap the benefits of the high protection wall. Nonetheless, their profits then will be remitted back to their home country. So, the projection that ISS will generate profits and encourage public savings may not be accomplished. Third, ISS implementation may be supported by government subsidies to import capital goods and intermediate products to develop national industrialization. Hence, the large remittance of profits and import of capital goods may lead to balance of payment difficulties. This paper aims to ascertain the possible costs and benefits of ISS for the development of intermediate input industries in Indonesia. This is necessary considering that the pub- lic costs for implementing the strategy is significantly high but there is no guarantee of a successful result from this strategy. It is worth noting that Indonesia once applied ISS in the 1970s but dismantled it in 1980s because of the lack of public funds to support the 1 See Todaro and Smith (2015) for further explanation about ISS or the other usually adopted indus- trialization strategy, export promotion. 74 Asian Economic Papers The Elusive Pursuit of Import Substitution in 21st Century Indonesia strategy.2 The switch toward an export promotion strategy starting in the early 1990s in fact seems to have provided more benefit, as the country manufacturing sector started to grow rapidly only after a number of reforms/deregulations implemented to support the export promotion strategy.3 This paper continues with an explanation of the methodology used by this study in Section 2. Section 3 presents a descriptive analysis, using several statistical measures. Section 4 provides the econometric framework and estimation results. Section 5 concludes the paper. 2. Methodology 2.1 Data and definitions The study utilizes information from the following data sets: 1. The survey of Indonesian medium-sized and large establishments (with at least 20 em- ployees). This survey contains two groups of data sets: a. The “standard” data set is commonly known as Statistik Industri (hereafter SI). Badan Pusat Statistik (BPS, or Statistics Indonesia) publishes an annual summary report of Indonesian manufacturing industry based on the SI. This study, however, will use the raw data version of the unpublished data sets of the SI. The SI covers a wide range of information including industry codes, a unique plant code, number of em- ployees, value-added, imports, and export values. Industry codes are defined up to the five-digit International Standard Industrial Classification (ISIC) level. The data set covers the years 1990–2013. b. The raw material or input data set, which provides detailed information on the in- puts used by each plant in producing each product. The types of input are differen- tiated based on locally produced or imported inputs. The information is available in value, quantity, and units. The period covered by this data set is 2000–13. 2. The United Nations Conference on Trade and Development (UNCTAD) Trade Analy- sis Information System (TRAINS) database. This database provides the tariff rates for products at the six-digit level HS code. This study used data for 1990–2013. 3. The wholesale price index. It is utilized to deflate the nominal value-added. The study will use the three-digit level wholesale price index published by BPS. 2 At that time, the profit from oil suddenly disappeared because of the oil crisis in the 1980s. For more on the implementation of ISS in the 1970s, see Aswicahyono (1997) for a discussion of the government support programs in the automotive sector, namely, a local content requirement and a deletion program to substitute foreign-produced parts with locally produced ones. Also, as an impact of various non-tariff measures applied for the ISS, a number of estimates suggested that the effective rate of protection during this period was high (Hill 1996). 3 See Pangestu (1996) for the elaboration of these deregulation packages. 75 Asian Economic Papers The Elusive Pursuit of Import Substitution in 21st Century Indonesia The analysis using all these data will utilize the intermediate input definition from the broad economic categories (BEC), which are in Appendix A. Thus, we will make use of the concordance of the HS and ISIC codes to the BEC.4 2.2 Variables The following describes all key variables and the methods to compute them, organized by the issues covered by the study: • Value-added: Calculated in real terms using the wholesale price index as the price deflator. • Employment: Calculated as headcount employment. • Labor productivity: Defined as the proportion of real value-added and total labor. • Export and import: To examine export and import trend over time, we use a data set from World Integrated Trade Solutions focusing on the trade value of Indonesia in five- year intervals from 1990 to 2013, based on six-digit level HS 1988–92. 2.3 Composition of intermediate inputs by source of the inputs (local or imported, across plants in manufacturing industries and over the time) The composition utilizes the information from the detailed raw material and input used by plants in SI data, and therefore it is only available for 1996 and 2001–10. 2.4 Ownership pattern (i.e., private local, state-owned, or foreign) of plants producing intermediate inputs This study examines the pattern of ownership across intermediate inputs during 1990–2013 over five-year intervals. The descriptive analysis draws from ownership share information available in the SI data set. This study classifies the ownership into three categories (pri- vate local, state-owned, and foreign) and, to precisely define the controlling role in joint ventures, it defines three joint venture groups (foreign-government, foreign-domestic, and foreign-government-domestic). All joint ventures are considered foreign plants in this study.5 4 Instead of using the widely known concordance from the United Nations Statistics Division, the concordance utilized in this study is taken from the Ministry of Trade of Indonesia that concords the six-digit HS 2007 to the five-digit Indonesia-specific product code (or known as the Klasifikasi Baku Lapangan Usaha Indonesia, KBLI). KBLI is the more disaggregated version of ISIC rev. 4 and the BEC code. 5 Previous studies suggest that the share of foreign ownership does not necessarily reflect the extent of control. Aswicahyono and Hill (1995), for example, showed that local partners often play a relatively minor role even when they hold most of the equity; this is particularly true for matters related to finance and technology. 76 Asian Economic Papers The Elusive Pursuit of Import Substitution in 21st Century Indonesia 2.5 Difference in quality between locally produced and imported intermediate inputs This study compares the information from SI data of the locally produced and imported input used by plants, and therefore it is available only for 1996 and 2001–10. Conceptually, price is assumed to reflect the quality of the product, and the average price approach is adopted to control for annual price fluctuation. To maintain coherence with regard to the input unit, we use only those data with unit of kilogram for the reason that it is the most used unit in the data set. Thus, the price of locally produced intermediate input i for every year t (Pl,i,t) is defined as the following, using information of plant p in industry i in SI data: Pl,i,t = ∑n p−1 (output)l,p,i ∑n p−1 (quantity)l,p,i . (1) Meanwhile, price of imported intermediate input (Pm,i,t) is defined similarly, with m denoting import: Pm,i,t = ∑n p−1 (output)m,p,i ∑n p−1 (quantity)m,p,i . (2) 2.6 Trade protection over time and across industries in manufacturing The patterns cover both final goods and intermediate inputs. This study uses nominal rate of protection (NRP) for intermediate input industries (NRPi) or for final goods indus- tries (NRPj), with i and j denoting intermediate input and final goods sector, respectively. The NRP measures the degree of protection (ideally, from tariffs and non-tariff measures [NTMs]) in a certain product or sector without considering the impact of protections in other sectors that support its production process. In calculating the NRP, import tariff rates of products from the UNCTAD TRAINS database were averaged per sector of the input– output table. NTMs are too complex to be numerically calculated into the NRP; thus, only tariff rates were accounted for in this procedure. 3. Descriptive analysis The following subsections present the results and their analysis based on the methodology defined in Section 2.6 As stated earlier, the scope of the study covers trends over time related to real value-added, employment, productivity, allocative efficiency, and exports and imports. In addition, we highlight the trends in terms of value, growth, and share. Figure 1 presents the trend in value-added and employment. Looking at the pattern across the group of intermediate 6 Unless otherwise stated, the source of the tables and figures in this section are based on the au- thors’ computation from all data used for this study. 77 Asian Economic Papers The Elusive Pursuit of Import Substitution in 21st Century Indonesia Figure 1. Trend in intermediate inputs Indonesian manufacturing, 1990–2013 Source: Authors’ computation. Note: See those of Table 2. inputs (Figure 1a), output is dominated by BEC 220 (industrial supplies) consistently over time from the 1990s to the 2000s. There is no clear pattern over time for BEC 121 (food and beverages, mainly for industry), BEC 210 (industrial supplies, primary), and BEC 420 (parts and accessories of capital goods [except transport equipment]), and their local production is similar. There is, however, an increasing pattern for BEC 220 and BEC 530 (parts and accessories of transport equipment), 78 Asian Economic Papers The Elusive Pursuit of Import Substitution in 21st Century Indonesia Table 1. Real value-added for broad economic category 220 (thousands of IDR), 1990–2013 ISIC Rev. 2 1990–94 1995–99 2000–04 2005–09 2010–13 321 37,298 29,036 16,616 17,550 16,530 331 31,058 18,955 12,906 6,336 4,664 341 10,767 8,088 9,532 9,150 10,220 Source: Authors’ computation. Note: IDR = Indonesian Rupiah; ISIC = International Standard Industrial Classifica- tion; ISIC 321 = manufacture of textiles; ISIC 331 = manufacture of wood and wood products; ISIC 341 = manufacture of paper and paper products. especially over the last 10 years or so. The escalating pattern may be driven by higher pro- duction by a few industries under BEC 220. Examining the data in more detail in Table 1, we find the top three outputs under BEC 220 are in ISIC 321 (manufacture of textiles), ISIC 331 (manufacture of wood and wood products), and ISIC 341 (manufacture of paper and paper products). In terms of employment, cross-section pattern is the same as that of output (Figure 1b). Most employment is dominated by industries in BEC 220. The pattern over time for each group reveals two interesting observations. First, there is an increasing pattern for BEC 420 and BEC 530, suggesting expansion of these sectors. Second, in contrast, there is a declining pattern for BEC 220, suggesting improvement in labor productivity, given the increasing output pattern observed in Figure 1a. Table 2 presents the annual growth rate of output, employment, and productivity of all intermediate input groups from the 1990s to the 2000s. Several observations are worth not- ing. First, output growth has been steady at about 8 percent per year since the mid 1990s for all intermediate inputs (Table 2a). This is much lower (i.e., halved) than the growth in the early 1990s, most likely due to adjustments to the 1997–98 economic crisis. Second, employment growth fell significantly, from 7 percent per annum in the first half of the 1990s to just below 1 percent per annum in 2000s (Table 2b). This is a mas- sive contraction, again, most likely the result of the more rigid labor regulation after the 1997–98 crisis. Third, the sharp employment contraction seems to have improved industry performance, albeit unfavorably from a social point of view. Indeed, productivity has increased substan- tially since the crisis, even reaching about 16 percent per annum during 2010–13 (Table 2c). Fourth, the figures indicate an unexceptional recent performance of BEC 420, and espe- cially for BEC 530. Output and productivity growth for these two sectors were about 20 percent and 30 percent per annum during 2010–13, respectively. 79 Asian Economic Papers The Elusive Pursuit of Import Substitution in 21st Century Indonesia Table 2. Growth of intermediate inputs Indonesian manufacturing, 1990–2013 (%) a) Real value-added BEC 1990–94 1995–99 2000–04 2005–09 2010–13 121 9.3 0.2 10.7 21.1 0.7 210 29.4 42.6 −11.1 30.6 9.5 220 19.7 9.1 6.2 7.2 3.4 420 26.1 21.7 10.7 6.2 21.6 530 19.1 4.2 34.2 3.0 33.8 All intermediate inputs 18.5 7.9 8.1 7.1 8.4 b) Employment BEC 1990–94 1995–99 2000–04 2005–09 2010–13 121 3.4 0.3 −1.8 2.4 −3.6 210 1.0 7.6 −3.5 17.2 −0.3 220 6.9 1.0 0.6 −1.4 0.9 420 18.0 2.6 0.1 8.6 1.1 530 8.3 −3.3 6.9 2.8 4.1 All intermediate inputs 7.0 0.8 0.7 −0.2 0.8 c) Labor productivity BEC 1990–94 1995–99 2000–04 2005–09 2010–13 121 6.0 2.8 13.4 18.8 6.6 210 20.0 29.3 −8.2 13.7 10.5 220 11.9 7.9 5.6 9.4 2.8 420 8.2 15.1 10.9 −0.7 20.3 530 12.1 6.4 25.1 0.6 28.1 All intermediate inputs 8.3 8.9 10.3 4.8 15.9 Source: Authors’ computation. Note: BEC = Broad Economic Category; 121 = Food and beverages, processed, mainly for industry; 210 = Industrial supplies, nec (not elsewhere classified), primary; 220 = Industrial supplies, nec, processed; 420 = Parts and accessories of capital goods (except transport equipment); 530 = Parts and accessories of transport equipment. Table 3 illustrates the relative importance over the time and across intermediate input groups. As suggested, BEC 220 dominates national production, but the production of BEC 530 is quite important and has become relatively more important since the mid 1990s (Table 3a). The output share of BEC 530 in total national production increased from 6.8 per- cent in 1995–99 to 22.7 percent in 2010–13. It is worth noting other important observations concerning BEC 530. First, the figures suggest that there is a sector under BEC 530 that is quite capital-intensive. This is in- ferred from the share of the sector’s employment that has been consistently about 10 percent of the total employment for all intermediate input sectors (Table 3b). Second, in terms of productivity, BEC 530 contributes almost half of the total productivity of all intermediate input sectors (Table 3c). In addition, BEC 420 is the second-largest con- tributor to overall productivity of all intermediate input sectors. Its importance has declined over time, however, due possibly to a rapid increase in the importance of BEC 530. 80 Asian Economic Papers The Elusive Pursuit of Import Substitution in 21st Century Indonesia Table 3. Share of intermediate inputs Indonesian manufacturing, 1990–2013 (%) a) Real value-added BEC 1990–94 1995–99 2000–04 2005–09 2010–13 121 8.1 5.1 4.3 4.5 4.4 210 0.6 1.1 0.7 0.9 1.3 220 77.2 79.6 76.9 75.8 64.3 420 5.7 7.4 6.8 5.7 7.4 530 8.4 6.8 11.3 13.1 22.7 All intermediate inputs 100 100 100 100 100 b) Employment BEC 1990–94 1995–99 2000–04 2005–09 2010–13 121 7.9 7.3 6.7 6.8 6.3 210 1.1 1.3 1.1 1.6 2.0 220 82.0 81.6 81.9 79.0 77.3 420 4.0 5.0 5.2 6.4 7.0 530 5.0 4.8 5.2 6.2 7.4 All intermediate inputs 100 100 100 100 100 c) Labor productivity BEC 1990–94 1995–99 2000–04 2005–09 2010–13 121 18.1 13.2 11.2 12.8 11.0 210 10.0 16.1 11.1 11.1 10.6 220 16.7 18.5 16.5 18.4 13.2 420 25.1 26.5 22.7 17.1 16.7 530 30.1 25.7 38.4 40.5 48.5 All intermediate inputs 100 100 100 100 100 Source: Authors’ computation. Note: See those of Table 2. Figure 2 shows the contribution of locally produced versus imported inputs. The contribu- tion from imports tends to be persistent over time at about 25–30 percent, albeit there is a declining trend over the past decade. Figure 3 illustrates the composition of intermediate input sectors. There are some variations, but the basic trend holds—that is, a declining importance and share of imported inputs. The declining pattern cannot tell us precisely whether firms oper- ating in Indonesia rely on locally produced inputs, however. It may have been dis- torted by, for example, origin of the imports, or other factors that constrain the flow of imported inputs. A more formal analysis to confirm the story will be done later using econometric method- ology. At this point, however, one may speculate on two potential explanations. First, the declining share may be the result of the increase in the tariff rate of intermediate in- puts. Second, local firms may not be interested in sourcing from imports because they are not aiming to produce intermediate inputs of the highest quality. Theory suggests that high-quality inputs are necessary for export, and many Indonesian manufacturers are not exporters. 81 Asian Economic Papers The Elusive Pursuit of Import Substitution in 21st Century Indonesia Figure 2. Composition of intermediate inputs by source, Indonesian manufacturing, 1996–2010 (%) Source: Authors’ computation. Table 4 presents the ownership share of the intermediate sectors. The population of inter- mediate input producers in Indonesian manufacturing is dominated by private local (as defined by percent ownership share) companies (Table 4a). This pattern persists from 1990 to 2013. The private local share declined significantly during 2000–04 but soon returned to the higher levels seen in the previous period. The decline matches the increase in the share of government ownership in the same period, suggesting some acquisition by the government. Evidently, this was temporary, as the share of government ownership subsequently returned to the previous period’s level. The temporary reallocation between private and government ownership may have reflected a bailout policy by the government, which benefitted some local private companies that were severely affected by the 1997–98 crisis. The foreign ownership shares, although concentrated in a few BECs, are small. Foreign ownership is considered important for industries in BEC 420 and 530, particularly in the post-crisis period, and this was characterized by above-average ownership shares. This indication is in line with the fact that production networks are growing along with the pro- liferation of trade agreements regionally since the early 2000s. Table 4b displays the ownership share in terms of real value-added. State-owned enter- prises are important for BEC 121, although the trend has been declining in the past five years or so. Lastly, foreign ownership is essential in BEC 220, 420, and 530, starting in the mid-1990s. 82 Asian Economic Papers The Elusive Pursuit of Import Substitution in 21st Century Indonesia Figure 3. Composition of intermediate inputs, Indonesian manufacturing by source and broad economic category, 1996–2010 (%) Source: Authors’ computation. Note: See those of Table 2. This section attempts to contrast the quality of locally produced and imported intermedi- ate inputs. Figures 4 and 5 display the patterns for all intermediate inputs and by BEC. In general, imported inputs are of much higher quality and this is consistent over 1996–2010. The figures for each BEC are in line with that of the general pattern, except for BEC 420, where local inputs are of better quality than imported ones. An interesting observation in 83 Asian Economic Papers The Elusive Pursuit of Import Substitution in 21st Century Indonesia Table 4. Ownership share by broad economic category in Indonesian manufacturing, 1990–2013 (%) a) In terms of plant population Private local BEC 1990–94 1995–99 2000–04 2005–09 2010–13 121 81.7 84.6 68.5 88.6 88.3 210 84.8 88.8 74.2 87.4 87.0 220 89.2 89.3 70.3 85.9 84.8 420 79.2 79.6 65.8 80.2 79.6 530 89.0 83.5 62.5 75.0 74.0 Total 87.9 88.1 69.6 85.3 84.3 State-owned enterprise BEC 1990–94 1995–99 2000–04 2005–09 2010–13 121 17.3 14.3 30.1 9.5 9.6 210 14.3 9.1 23.1 8.2 8.6 220 5.5 3.6 22.0 4.2 3.3 420 6.1 2.1 17.7 2.6 1.6 530 2.9 2.6 20.3 2.2 1.5 Total 6.7 4.5 22.3 4.6 3.8 Foreign BEC 1990–94 1995–99 2000–04 2005–09 2010–13 121 1.0 1.1 1.4 1.9 2.1 210 0.9 2.1 2.8 4.4 4.4 220 5.3 7.0 7.7 9.9 11.9 420 14.7 18.2 16.6 17.2 18.8 530 8.1 14.0 17.2 22.8 24.6 Total 5.4 7.4 8.1 10.1 11.9 b) In terms of real value-added Private local BEC 1990–94 1995–99 2000–04 2005–09 2010–13 121 43.1 63.5 50.1 51.9 50.2 210 64.5 49.7 60.0 76.1 83.7 220 72.7 72.8 60.0 59.4 62.6 420 69.9 63.4 53.7 52.1 38.5 530 65.2 58.4 29.8 44.3 39.2 Total 72.2 72.6 59.7 59.2 61.7 State-owned enterprise BEC 1990–94 1995–99 2000–04 2005–09 2010–13 121 55.3 34.6 46.4 41.1 27.7 210 35.1 43.7 27.5 7.4 8.8 220 9.7 6.4 19.9 7.7 7.6 420 5.7 1.2 7.2 1.4 2.8 530 14.2 10.3 17.1 1.9 1.2 Total 10.3 6.6 20.0 7.9 7.6 Foreign BEC 1990–94 1995–99 2000–04 2005–09 2010–13 121 1.6 1.9 3.4 7.0 22.0 210 0.5 6.6 12.5 16.4 7.5 220 17.6 20.8 20.0 32.8 29.8 420 24.4 35.4 39.1 46.5 58.7 530 20.5 31.3 53.1 53.8 59.6 Total 17.5 20.8 20.3 32.9 30.6 Source: Authors’ computation. Note: See those of Table 2. BEC 121, 210, and 530 is that the quality of imported inputs is significantly superior to that of local inputs, particularly in the case of BEC 530. 84 Asian Economic Papers The Elusive Pursuit of Import Substitution in 21st Century Indonesia Figure 4. Quality of intermediate inputs, Indonesian manufacturing by source, 1996–2010 (thousands of IDR) Source: Authors’ computation. Note: IDR = Indonesian Rupiah. Figure 5. Quality of intermediate inputs, Indonesian manufacturing by source and broad economic category, average 1996–2010 (thousands of IDR) Source: Authors’ computation. Note: See those of Table 2. IDR = Indonesian Rupiah. The most pragmatic approach to evaluate trade protection policy is to look at the nominal tariff rates, depicted in Figure 6 for Indonesia during the period 1996–2014. At the onset of the 1997–98 crisis, nominal tariff rates were high, with an average of 17 percent in 1996. 85 Asian Economic Papers The Elusive Pursuit of Import Substitution in 21st Century Indonesia Figure 6. Effectively applied tariff (simple and weighted average) (%) Source: UNCOMTRADE Database, retrieved from WITS (World Integrated Trade Solutions). Note: See those of Table 2. Crisis-support assistance from the IMF forced the government to undertake unilateral lib- eralization across the board. Tariff rates then dropped to only 6 percent and continued to decline until 2008–09, when they increased slowly but steadily up to 2014. This pattern is also observed at a more disaggregated level. Among the five identified BECs, BEC 220 and 121 have the highest applied tariff rates, and BEC 210 and 530 had the lowest rates. It is encouraging to see that, in general, the tariff rate is relatively low, which means the inter- mediate inputs sectors are relatively open and supportive to production networks. 86 Asian Economic Papers The Elusive Pursuit of Import Substitution in 21st Century Indonesia 4. Econometric analysis An econometric approach is adopted to generate new evidence on the impact of ISS mea- sures (i.e., tariffs and NTMs) on the performance of industries, focusing on intermediate input industries based on the objectives of the paper. Because the impact will eventually affect final goods, however, the study will also assess the impact on final goods industries. The study estimates the following equation for the impact of tariffs (nominal tariff, NRP) on the performance of an intermediate industry, (Performance)i,t = αi + β1NRPi,t + Zi,t + εi,t , (4) where is the performance variable considered by this study. The subscript i denotes the in- termediate input industry and subscript t denotes the year. Industry i is defined at the five- digit ISIC level; this is because many of the performance variables are computed using SI data (ISIC-based) whereas NRP is drawn from the UNCTAD TRAINS database (HS-code based). αi refers to intermediate-input and time-invariant effect to capture the unobserved characteristics of the industry. Zi,t is the set of control variables at the industry level that are introduced to control for: (i) the degree of product market competition, or (ii) other industry characteristics that change over time. Proxies considered for product market competition are: • Concentration ratio (CR4), or • Measures of firm dynamics (e.g., entry and exit rate). Meanwhile, the time-variant control variables included in the model are: • Foreign … Journal of the Asia Pacific Economy Vol. 14, No. 2, May 2009, 107–115 Industrializing Southeast Asia Rajah Rasiaha∗ and Hing Ai Yunb a Faculty of Economics and Administration, University of Malaya, 50603 Kuala Lumpur, Malaysia; bFaculty of Social Sciences, National University of Singapore, Singapore This paper introduces the state of industrialization in Southeast Asia, rationale used to promote industrialization, the timing of policy emphasis on export orientation and the different outcomes enjoyed by the market and transition economies. Although a number of economies have experimented with import substitution policies, industrialization in the Southeast Asian economies is largely driven by export markets. The paper ends by providing the setting for a deeper scrutiny of manufacturing issues selectively by industry in Southeast Asia. Keywords: industrialization; Southeast Asia; import substitution; export orientation JEL classifications: O14, O25, O53 1. Introduction Following the controversial publication of the East Asian Miracle by the World Bank (1993), there has been intense debate on the drivers of industrialization in East and Southeast Asia. Among the key findings of World Bank (1993) was that government intervention was indeed pervasive in the Northeast Asian economies while market forces were the dominant driver of industrialization in the Southeast Asian economies, and because ‘government failure is more serious than market failure as well as because the global economy no longer tolerates interventionist policies’, the latter route is the more desirable one for developing economies to adopt. Accepting eventually that interventions accompanied rapid economic growth, neo-liberal works argued that it was achieved through perspiration rather than inspiration (see Krugman 1994). Young’s (1994, 1995) influential articles using the total factor productivity (TFP) methodology, originally developed by Solow (1956) and Swann (1956), had shown that these countries had grown because of expansion in factor inputs rather than technical change. There were subsequently a number of works with neo-liberal economists using adapted TFP methodologies or using different periods to show that growth could be sustained owing to higher TFP levels, but the dirigistes shattered the planks of Young’s works by simply attacking the methodology used (Lall 1994, 1996, Rasiah 1995, 2003, Felipe 2003). Kaldor (1960), Nelson (1994), Singh (1998) and Rasiah (2000, 2008) had argued that the TFP framework failed to capture technical progress embodied in capital and replacement capital. Whatever the ideological and theoretical problems of the leading economic arguments, the Asian financial crisis applied serious pressure on the Southeast Asian economies to ∗Corresponding author. Email: [email protected] ISSN: 1354-7860 print / 1469-9648 online C© 2009 Taylor & Francis DOI: 10.1080/13547860902785948 http://www.informaworld.com 108 R. Rasiah and Hing A.Y. pursue belt-tightening industrial strategies. Unlike the Northeast Asian economies where local capital drove industrial catch-up, foreign ownership led export-oriented industrial- ization in most of Southeast Asia. Export-processing zones a la Singapore, Malaysia and Thailand became the prime industrial approach adopted across Philippines, Indonesia, Viet- nam, Cambodia, Laos, Myanmar and East Timor. Foreign direct investment became a key source of capital inputs in these strategies. Myanmar and East Timor have experienced little industrialization owing to serious political instability. Industrialization never figured as an important policy objective only in Brunei. This special issue is targeted at bringing together industrial transformation that has occurred across Southeast Asia. Because past policies are important in explaining these developments, the papers in the issue take account of the history of industrialization of each of the countries for the respective industries chosen. The focus of this issue is neither on establishing the efficacy of neo-liberal arguments nor on proving the state’s efforts to get relative prices wrong. It focuses on explaining government mediation of domestic efforts as well as international forces and their industrial consequences in Southeast Asia. This introductory paper is organized as follows. The next section provides the rationale for the pursuit of industrial policy and the form it took in Southeast Asia. The subsequent section discusses the importance of manufacturing in the Southeast Asian economies. The last section provides the setting for the issue. 2. Why industrialize? The arguments on industrialization as the vehicle to promote growth arose largely from the advocates of industrial policy. Smith (1776) and Young (1928) had articulated the arguments incisively to show why industrialization is essential to drive increasing returns activities in particular economies. Gerschenkron (1962), Chang (2003), Lall (2001) and Reinert (2007) provided historical evidence systemically to argue that all successful developers have used industrial policy either consciously or unconsciously to industrialize. Kaldor (1967) used the Verdoorn relationship to argue that manufacturing possessed increasing returns properties and hence enjoyed the greatest potential for supporting rapid economic growth. Using two econometric equations, Kaldor (1967) demonstrated that manufacturing enjoyed a positive and the strongest elasticity of change with gross domestic product (GDP). Several other studies also provided quantitative evidence to show the cumulative causation effects of manufacturing (see Cripps and Tarling 1973, Brailovsky 1981, Weiss 1984, Rasiah 1995). Industrialization – both the growth in share of GDP and the diversification into higher- value-added activities – has been associated with the successful development of the OECD (Organization for Economic Cooperation and Development) countries in the initial years of rapid growth (see Reinert 2007). East and Southeast Asia’s successful developers – Japan, Korea, Singapore and Taiwan – enjoyed rapid industrialization throughout their high growth years (see Hamilton 1983, Amsden 1989, Rodan 1990, Wade 1990). Attempts to discuss the importance of industrialization will not be complete without a discussion on the trade and the structural orientation of industries that should be promoted. The 1950s advocates of industrial development recommended a focus on inward-oriented heavy and capital goods as an integral part of final consumption goods manufacturing. This approach arose from Marx (1867), Kalecki (1976) and McFarlane (1984) who argued that the department capital goods were critical complementary inputs for the development of other industries. Britain, the US, Germany, Japan, Korea and Taiwan very much en- joyed the development of both light manufacturing and complementary heavy industries, thereby making them versatile in entering a wide range of final goods industries. Yet, light manufacturing goods such as textiles and garments also grew rapidly in these countries. Journal of the Asia Pacific Economy 109 Apart from Britain – which had de-industrialized rapidly by the 1970s – the other countries are also at the frontier in the manufacture of electronics devices (WTO 2007). The focus on heavy industries behind import substitution – in both large and small domestic markets – failed in many countries because of a combination of a lack of scale and crony approaches that removed competitive pressures to drive firm-level technological catch-up. Poorly coordinated and cronyist import substitution policies failed in Latin Amer- ica (Jenkins 1987, Evans 1995, Cardoso 2001), Philippines (Ofreneo 2008) and Malaysia (Jesudasan 1987, Jomo 1990, Rasiah 2003). However, Korea and Taiwan managed to achieve competitiveness in the heavy industries of steel, shipbuilding and cars and machinery and steel by using import substitution for export promotion, and a deliberate learning and innovation strategies and performance standards (Fransman 1986, Amsden 1989, Rasiah and Lin 2005). Governments in these countries enjoyed autonomy from clientelist groups to enforce stringent conditions on the manufacturers. Hence, it can be argued that strategic industrial policy a la the Northeast Asian models has been successful. Unlike the Northeast Asian experiences where local capital became the pivot upon which technological catch-up was achieved, foreign capital has been the prime driver of industrialization in Southeast Asia. The small-size status prevented any possible replication of the Northeast Asian approach in Singapore, and hence manufacturing by and large evolved as multinationals incorporated the Island into their value chains by relocating particular stages of production and distribution. Nevertheless, government intervention was crucial to strengthen the quality of supporting high-technology environment in the country to stimulate upgrading in multinationals. Hence, Singapore managed to sustain improvements in value-added manufacturing while at the same time attracting knowledge- intensive services activities. Malaysia, Thailand, Philippines and Indonesia took on a more complex but eclectic approach trying to marry both the Northeast Asian experiences when supporting heavy industries and the Singaporean approach when attracting foreign investment in export- oriented light industries. Whereas the Northeast Asian economies started industrialization as resource-poor economies, most Southeast Asian economies have enjoyed strong en- dowments in petroleum and other minerals, metal ores, timber and agricultural crops. Malaysia continues to have such a dualistic policy framework. Thailand does not have an explicit policy to protect manufacturing since the 1990s but incentives remain im- portant in some industries (Rock 2000). Political instability and severe balance of pay- ment problems by the 1980s forced Philippines to abandon its protectionist policies and adopt liberal export-oriented policies to promote industrialization. The 1997–1998 finan- cial crisis and subsequent political fallout drove Indonesia to pursue similar policies from 2000. There is also recognition in the transitional economies about the significance of indus- trialization for development. Apart from isolated Myanmar, the transitional economies of Vietnam, Cambodia and Laos have been integrating rapidly into export-oriented industrial value chains. 3. Southeast Asian industrialization Although each country is different, the industrialization experience of the Southeast Asian economies can be examined under the categories of market and transition economies. Whereas the market economies enjoyed integration in the capitalist system much earlier, the transition economies were cut off from formal economic relations until Doi Moi started in Vietnam in 1989. 110 R. Rasiah and Hing A.Y. 3.1. Market economies Although proactive industrialization in Southeast Asia began first in Philippines, Indone- sia and Thailand behind import substitution policies, Singapore and Malaysia enjoyed the highest manufacturing widening and deepening following their exposure to export-oriented industrialization since the 1960s and 1970s respectively. Malaysia had faced import sub- stitution since the Pioneer Industry Ordinance of 1958, and Singapore until it left the Federation of Malaysia in 1965, but the small domestic market discouraged further expan- sion. The Malaysian government also entered heavy industrialization from 1981 but there is little evidence to suggest that this policy has succeeded. In fact, its steel plant, Perwaja, went bankrupt by the late 1990s despite a massive bailout in the late 1980s (Khor 1987, Jomo 1998). The import substitution experiences of Indonesia, Malaysia, Philippines and Thailand have generally been unsuccessful. Malaysia enjoyed considerable success in stimulating the transition from crude palm oil exports to processed palm oil exports and oleo-chemicals when the government imposed an export tax briefly in the early 1980s (see Gopal 1999). The import substitution automobile policies of Thailand, Philippines and Indonesia were gradu- ally eliminated following inefficient operations, trade pressures from abroad, governments’ inability to provide subsidies and the success of export-oriented industries. Malaysia has persisted with protecting the automobile industry but its export capacity has remained low compared to Thailand, Philippines and Indonesia. Automotive exports from Malaysia only rose from US$307 million in 2000 to US$920 million in 2006, whereas exports from Thai- land, Philippines and Indonesia rose from US$2417 million, US$583 million and US$369 million respectively in 2000 to US$9901 million, US$1506 million and US$1724 million respectively in 2006 (WTO 2007, Table 11.54). Singapore showed the largest amount of manufactured exports with the figure rising from US$37.5 billion in 1990 to US$117.7 billion in 2000 and US$214.1 billion in 2006 (see Figure 1). Malaysia followed next with manufactured exports rising from US$15.8 billion in 1990 to US$78.9 billion in 2000 and US$117.9 billion in 2006. Thailand was a close third followed by Indonesia. 9.0 15.8 5.6 37.5 14.6 36.9 78.9 34.8 117.7 51.7 44.4 117.9 40.6 214.1 98.5 0.0 50.0 100.0 150.0 200.0 250.0 Indonesia * Malaysia * Philippines * Singapore Thailand 1990 2000 2006Note: * or nearest year. U S $ B il li o n Figure 1. Manufactured exports, market economies, 1990–2006. Source: WTO (2007), World Bank (2007). Journal of the Asia Pacific Economy 111 Figure 2. Manufacturing share in exports, market economies, 2000–2006. Source: WTO (2007), World Bank (2007). The share of manufactured exports in GDP of Philippines was the highest in the years 2000 and 2006 (see Figure 2). The shares of manufactured exports in the GDP of Philippines, Singapore, Malaysia, Thailand and Indonesia in 2000 were 87.4, 85.4, 80.4, 74.8 and 56.5% respectively. Except for Thailand the shares for the rest fell in 2006. The share of manufactured exports in the GDP of Thailand alone rose to 75.3% in 2006. 3.2. Transition economies Industrialization in the transitional economies of Vietnam, Cambodia, Laos and Myanmar took off on a rapid scale only from the 1990s. Indeed, Vietnam’s industrial transformation 1.3 0.2 6.2 3.7 0.7 24.1 0.0 5.0 10.0 15.0 20.0 25.0 30.0 Cambodia Laos Vietnam U S $ B il li o n s 2000 2006 Figure 3. Manufactured exports, transition economies, 2000–2006. Source: WTO (2007), World Bank (2007). 112 R. Rasiah and Hing A.Y. 47.8 11.1 23.5 67.3 19.9 39.5 0.0 10.0 20.0 30.0 40.0 50.0 60.0 70.0 80.0 Cambodia Laos Vietnam P e rc e n t (% ) 2000 2006 Figure 4. Share of manufactured exports in GDP, transition economies, 2000–2006. Source: WTO (2007), World Bank (2007). has been dramatic given the focus of socialism before the 1989 (see Beresford 1988, 1997) account of socialism in Vietnam. The fall of the Soviet Union was instrumental in the shift towards market-augmenting industrial focus in Vietnam and Laos. Whereas stable governments had already emerged behind socialism in Laos and Vietnam by the end of the 1970s, civil war prevented Cambodia from pursuing unification and development until the 1990s, while Myanmar continues to languish in chaos. Myanmar is not discussed in this paper because of problems with data reliability. Manufactured exports grew strongly over the period 2000–2006 in Cambodia, Laos and Vietnam. Driven largely by garment exports, Cambodia’s manufactured exports grew from US$1.3 billion in 2000 to US$3.7 billion in 2006 (see Figure 3). Driven by a combination of agro-processed products, wood products and garments, manufactured exports from Laos grew from US$0.2 billion in 2000 to US$0.7 billion in 2006. Manufactured exports from Vietnam grew from US$6.2 billion in 2000 to US$24.1 billion in 2006. Although these figures are small when compared to the Southeast Asian market economies, the expansion rates suggest that it will be a matter of time that their significance becomes as important. Whereas the share of manufactured exports in the GDP of Indonesia, Malaysia, Philip- pines and Singapore had declined over the period 2000–2006, the shares rose in the late- comers of Cambodia, Laos and Vietnam (see Figure 4). By far manufacturing was the most significant in the Cambodian economy accounting for 47.8% and 67.3% of GDP in 2000 and 2006 respectively. Nevertheless, the growth was also important in Laos and Vietnam where the share of manufactured exports in GDP rose from 11.1% and 23.5% respectively, in 2000 to 19.9% and 39.5% respectively in 2006. Overall, it can be seen that manufacturing’s significance in the economies of Southeast Asia is either rising rapidly as is the case with the transition economies or is still very important as in Indonesia, Malaysia, Philippines, Singapore and Thailand. 4. The setting For a number of reasons this issue makes no attempt to provide an exhaustive account of industrialization in Southeast Asia. In addition to paucity of data, the area specialization Journal of the Asia Pacific Economy 113 of experts,1 as well as the relative importance of particular industries in certain coun- tries, makes some omissions unavoidable. Nevertheless, the issue attempts to provide a substantive albeit selective account of industrialization in Southeast Asia. The papers were selected on the basis of the significance of particular industries to the Southeast Asian economies and their importance to particular countries. Electronics has dominated manufactured exports from Singapore, Malaysia, Philippines, Thailand and Indonesia for a number of decades and hence is discussed in greater detail. Indonesia excels in wood-based products accounting for the largest exports of plywood in the world in 2000. Garment exports have become very important for Vietnam, Cambodia and Laos since the turn of the millennium. Its significance initially also rose in Myanmar but has since the imposition of trade sanctions in 2003 by the US gradually declined in importance. Because of the peculiarity of trade-involving countries enjoying LDC (least developed country) status as they have been accorded preferential access through the ‘everything but arms’ clause by the European Union since 2001 and bilateral trading agreements with others such as the US, Vietnam is examined separately from Cambodia and Laos. Whereas metal smelting dominated Malaysian exports for over a century, its signifi- cance has fallen since the crash of the tin mining industry in 1980 (Jomo 1990). It is for these reasons Philippines was chosen for this assessment, which offers a good example of an economy that has done well in metal-based products since the 1990s. Typical with in- dustrialization in the country the industry’s evolution has been dominated by liberalization and trade union pressures. Singapore exemplifies how a strong state role can push a tiny economy up to higher levels of technological proficiency (Wong 2004). 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