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The context: Globalization of the Indonesian economy

Given the open economic policy and the favourable socio-political climate of Indonesia, which is continuously being improved through a series of reforms, globalization of the country is accelerating.

Although sociocultural and political interactions among countries are important aspects of the internationalization or integration of a country into the world, it cannot be denied that economic interaction or linkage is the most dominant factor affecting the growth and development of a national economy.

In Indonesia, recent policies to improve the finance sector and policies on foreign direct investment and international trade have enhanced the country's international linkages and orientation. Not ignoring the importance of other socio-political considerations, it can be accepted that these economic policies, supported by transportation and communications technology, strengthened Indonesia's integration within the Asia-Pacific region.

Three factors that have been among the major factors affecting Indonesia's economic globalization are policies on direct foreign investment, international trade, and the finance sector.

Direct foreign investment

Over time, the perception of the role of foreign investment in the economic development process of Indonesia has changed considerably. During the post-colonial era until late 1965, foreign investment was not allowed and many foreign companies were expropriated. The new government stabilized the economic climate and had a more objective view with regard to foreign investment. Later, foreign investment was more actively promoted and there was no longer any major differentiation between foreign and domestic investors in terms of areas open to them or of access to fiscal incentives.

Investment procedures in Indonesia are regulated by a number of laws. The foreign direct investment law of 1967 provides a legal framework for foreign investments in the country. All foreign direct investors in Indonesia have to apply for the approval of the Investments Coordinating Board (BKPM). With the exception of investment in the energy sector (oil, gas, and coal) and banking, to which different procedures apply, all investments with sizeable foreign participation have to be approved by this Board. In the earlier development period, the priority for investment, including foreign investment, was in the import-substituting industries, in order to fulfil domestic market needs by concentrating on the provision of consumption goods. This is in line with the government's import-substitution policy. In later stages, there was a strong government commitment to reorient the industrialization strategy from import substitution to a more outward-oriented policy. Much new investment is now in export-oriented manufacturing.

This change has, in turn, led Indonesia to increase its accessibility and interaction with the outside world and to be more aware of and rely on market signals for the country's production orientation.

Table 11.1 shows the shift of investment priority from import substitution to export orientation for both foreign and domestic investment.

With regard to the distribution of foreign direct investment in Indonesia, Java (including Jakarta) absorbed 73.2 per cent of the total number of projects but only 54.1 per cent of their value. The majority of the investments over the period 1967-1990 were dominated by Asian countries, namely, Japan (39.8 per cent), Hong Kong (12.8 per cent), South Korea (5.8 per cent), and Singapore (2.7 per cent) (table 11.2). Indonesia is one of the major recipients of Japanese investments in South-East Asia because of advantages offered such as inexpensive labour and abundant natural resources. The advantages happen to match Japanese motives for investing in ASEAN - to obtain lower labour costs and to expand their markets (MITI, 1987).

Table 11.1 The development of new export-oriented foreign and domestic investment projects, 1986-1990

Source: BKPM, January 1991.

The increase in foreign investment from other newly industrializing countries such as Hong Kong, South Korea, and Singapore reflects the strategy of those countries to relocate some of their labour-intensive industries under the impact of rising labour costs, as well as with the objective of circumscribing the tighter quota limits in several of their major markets (foot, 1990).

Several reforms and incentives were introduced in Indonesia to attract more investment by the private sector, including foreign investment. Tax holidays granted by the government at the beginning strongly encouraged investment, but this was no longer effective in later years. However, this type of investment incentive has recently been reintroduced to promote development in the eastern part of Indonesia.

It was feared that the tax reform introduced in 1983 would bring substantial decline in investment. Indeed in 1984, both foreign and domestic investment declined, but by 1985 both had increased substantially. This was brought about by the investment climate abroad and the deregulation policy of the Indonesian government in relaxing restrictions on foreign investment, trading, and access to finance. An investment boom occurred in 1989 and 1990. The establishment of Export Processing Zones (EPZs) is another important export promotion instrument. Of the three EPZs in Indonesia, two are located in Jakarta.

Table 11.2 Foreign investment in Jakarta by country of origin, 1967-1990

Source: Pusat Data Bisnis Indonesia.

Another reform that has had a positive impact on foreign investment was the major investment licensing reform, i.e. the replacement of a positive investment list by a negative one, which specifies only areas closed to investment. This has opened up new opportunities for investment. Since 1986, regulations regarding foreign investment have also been substantially relaxed, allowing foreign firms 100 per cent equity in export production and extending the period in which majority ownership has to be transferred to the domestic partner.

Investment licensing has also been facilitated by raising capacity expansion limits and permitting broad-banding of product categories, which enables a firm to diversify its production within a broader product category. Other incentives for investment introduced by the government included, among others, import duty exemptions on imported machinery and equipment for investment projects, as well as on raw materials for a period of two years, and deferral of payment of value-added tax. These new regulations and incentives contributed to the rapid rise in foreign investment in the second half of the 1980s. The improved regulations have also increased the capital inflows of foreign direct investment. Therefore it can be concluded that government measures have a positive impact in attracting foreign investment (Bank Indonesia, 1989).

International trade

The second parameter for measuring the internationalization of Indonesia's economy is related to foreign trade. Indonesia probably accomplished greater trade liberalization in the 1980s because its initial level of protection was higher than the other economies'. Since the mid-1980s, Indonesia has embarked on a series of trade deregulation measures to reduce the high cost of doing business domestically and to increase the competitiveness of domestic production. A central component of economic strategy had been trade reforms. In the period 1985-1989, four major policy packages were introduced addressing three principal areas: non-tariff barriers (NTBs), tariffs, and duty-free inputs for exporters. Through the May 1990 package, a new deregulation, which encompassed measures to reform the trade regime further (reduced NTB coverage) and streamline investment licensing procedure, was issued. Generally speaking, trade policy reform has been designed mainly to move away from import licences towards tariffs.

In 1985 the government announced across-the-board reductions in nominal tariffs and introduced a package of measures to provide inputs to exporters at international prices. A year later the government announced its intention to remove quantitative restrictions altogether. According to World Bank estimates (World Bank, 1991), under this policy the overall value of imports subject to control fell from 43 per cent in mid-1986 to 15 per cent in May 1990. Import tariffs had also been subject to change. The average import tariff weighted by import value had been reduced from 22 per cent during the early 1980s to about 10 per cent in 1990.

The reorientation of the industrialization strategy towards export promotion has been strongly underpinned by more active exchange rate management by the government. Two major devaluations took place during the 1980s, in 1983 and 1986. Since the devaluation in 1986, the rupiah has been subject to a managed float against Special Drawing Rights (SDR), which resulted in the fall of the rupiah exchange rate against the US dollar, and this is substantially increasing the profitability of exports and import substitution.

Exports have been strongly supported by the introduction in 1986 of an effective scheme through which exporters are provided with duty-free access to imported inputs. The scheme has two components: a direct import exemption facility and a duty drawback facility. Under the direct import facility, producers that export at least 65 per cent of their output are permitted to import their inputs directly free from import duties, value-added tax, and surcharges. Other exporters that also function as producers are allowed to bypass importers through the duty drawback facility if their inputs are imported directly and subject to licensed importers.

As in other developing countries, the role of primary products in Indonesia was initially large, but subsequently they were replaced by oil and gas, especially after the energy crisis in 1973. Since then, oil and gas became more important, but their role decreased in 1982. The primary consumers of Indonesian oil and gas products are Japan and the United States, which had shares of 61 per cent and 24 per cent in 1988, respectively. In regard to Indonesian exports, it is clear that the Asia-Pacific region is continuously increasing its share of Indonesian exports, with Japan holding the biggest share.

As is the case with exports, the main countries of origin for most of Indonesian imported goods are Japan, ASEAN, European countries, and the United States, which account for 65 per cent of total imports. Within ASEAN countries, Singapore seems to be the most important trade partner. The share of Asia-Pacific trade partners in the total imports of Indonesia is slightly higher than their share of its exports. However, the same pattern is found in which Japan and Singapore are still the main partners.

The finance sector

Indonesia started the 1980s with a highly regulated financial structure dominated by state banks. However, reforms implemented in 1983, 1988, and 1990 have led to a substantial deregulation of the finance sector. Measures implemented included liberalizing interest rates on deposits and on credit extended, the abolition of credit ceilings, facilitating the entry of both domestic and foreign private banks, lowering reserve requirements, the abolition of most concessional credit schemes, and liberalizing the capital market. The reforms have resulted in a substantial increase in the number of banks, the mobilization of domestic savings, and rapid growth in the amount of capital mobilized through the capital market.

To promote the role of banks in the development process, on 27 October 1988 deregulation measures for the banking sector were issued. Through this policy package, banks were, among other things, expected to expand their operational network, to enhance their services, and to promote efficiency. This has resulted in the opening of bank offices and the establishment of new banks. The improvements included allowing foreign banks to open sub-branch offices and permitting the establishment of joint-venture banks.

Starting in October 1988, foreign banks are allowed to open one sub-branch office in several major cities: Jakarta, Surabaya, Semarang, Bandung, Medan, Ujung Pandang, and Denpasar. This improvement is meant to support the promotion of exports other than oil and gas.

Licensing the establishment of joint-venture banks encouraged foreign banks to locate representative offices in Indonesia. These foreign banks must be categorized as major banks in the country of origin, which must adopt a reciprocal relationship with the Indonesian government. Joint-venture banks are allowed to domicile in Jakarta, Surabaya, Semarang, Bandung, Medan, Denpasar, and Ujung Pandang and open one branch office in each of those cities. Since the launch of the policy package on 27 October 1988, six joint-venture banks have been established, mostly in Jakarta.

To promote investment activities and the involvement of the general public in productive investment, Indonesia encouraged the development of the capital market in 1987, after it had been dormant for 10 years. In this regard, the government also introduced a policy package on 20 December 1988 that covered the opening of stock exchange markets outside Jakarta, the establishment of a private stock exchange market, the promotion of stock trading at the Jakarta Stock Market, and the development of financing institutions. Following those incentives, the number of firms going public significantly increased, as did the number of security houses from outside the country. To date, around 20 foreign security houses are active in the Jakarta Stock Market, while the stock market itself is increasingly integrating with other stock markets in the world.

The above account indicates the move of the Indonesian economy towards more integration with the world economy, more specifically in the ASEAN and Asia-Pacific regions. If conditions remain the same as they have been in the past decade, the globalization of the Indonesian economy will become more firmly established in coming years. Clearly this will have an impact on the Indonesian urban system, especially the larger urban areas.

Integration with the global economy stimulates growth in industrialization and services and technological change. The link with technology is twofold. On the demand side, firms respond to increasing external competition by minimizing costs, and, on the supply side, technology is embodied in imported inputs and capital goods, licensing agreements, foreign direct investment, contracts with overseas buyers, and labour movement.

Open trade regimes will to some extent enable the country to attract more foreign direct investment and to be more efficient in resource allocation, encourage consolidation and specialization, and result in better-quality inputs for the export sector. These stimuli seem to have had a positive impact on the development of Jakarta since most of the reforms tend to favour Jakarta.

This impact has also spread to the surrounding areas of Jakarta. It appears that these areas have increasing opportunities to benefit from this positive impact by accommodating the growth and development of activities that have spilled over from Jakarta. The issue is how to maximize the benefits to these surrounding areas. A compatible joint development mechanism or working relationship needs to be established.

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