Tuesday, November 18, 2014

The Structure of Protection in Indonesian Manufacturing Sector

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This paper aims to analyse structure of protections in Indonesian manufacturing sector. Firstly, it describes the evolution of Indonesian industrial and trade policies. To some extent, Indonesian industrial and trade policies follow a statement of the supporters of liberalization: "good times mean bad policies and bad times mean good policies". Secondly, effective rate of protection analysis shows that Indonesian manufacturing sector has been liberalized more, especially after the 1997 economic crisis. The liberalization in manufacturing sector has also been encouraged by international/regional commitments such as the WTO, IMF, ASEAN Free Trade Agreement and other preferential trade agreements. Thirdly, Indonesian trade liberalization in the manufacturing sector was faster than that of Thailand and could catch up with Malaysian trade liberalization. [PUBLICATION ABSTRACT]

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This paper aims to analyse structure of protections in Indonesian manufacturing sector. Firstly, it describes the evolution of Indonesian industrial and trade policies. To some extent, Indonesian industrial and trade policies follow a statement of the supporters of liberalization: "good times mean bad policies and bad times mean good policies". Secondly, effective rate of protection analysis shows that Indonesian manufacturing sector has been liberalized more, especially after the 1997 economic crisis. The liberalization in manufacturing sector has also been encouraged by international/regional commitments such as the WTO, IMF, ASEAN Free Trade Agreement and other preferential trade agreements. Thirdly, Indonesian trade liberalization in the manufacturing sector was faster than that of Thailand and could catch up with Malaysian trade liberalization.

Keywords: Effective rate of protection, inward-looking, liberalization, manufacturing sector, Indonesia.

(ProQuest: ... denotes formulae omitted.)

I. Introduction

Trade and industrialization have been the engines of economic growth for East Asian expansion. Following the "flying geese" (FG) formation1 (Akamatsu 1961, 1962), Japan had high economic growth based on exports in the 1960s and it was followed by the newly industrialized East Asian economies - Hong Kong, Taiwan, Singapore and the Republic of Korea - in the 1970s and 1980s, the ASEAN (Malaysia, Indonesia and Thailand) in the 1980s; and China in the 1990s. To promote exports, the governments of the East Asian countries provided various incentives such as subsidized credit for exports, duty rebates, credit facilities with preferential lending rates, duty-free imports for manufacturing exported products, one-stop services for investment, etc. Later, the governments have implemented more general incentives and instruments including appropriate exchange rates, reforms of trade and investment regimes and macroeconomic policies (World Bank 1998; Aswicahyono and Pangestu 2000).

Indonesia has been implementing various trade and industrial policies since 1970s. Due to the oil boom, trade protection levels were relatively higher from the 1970s up to the mid-1980s (Basri 2002). Since Indonesia had pursued a strategy of import substitution for industrialization, it adopted inward-looking policies. Consequently, many "infant industries" required special treatment from the government such as subsidy and protective barriers for the foreign competition. From the time when the import substitution strategy was in place, the manufacturing sector was highly protected with tariff and non-tariff barriers. This strategy was set aside in the mid-1980s and since then the government has reduced both tariff and import licensing requirement.

Under various industrial and trade policy reforms, trade protection has been reduced significantly since the mid-1980s. Decrease in oil price and the 1997 economic crisis have encouraged the government to implement industrial and trade policies, which are much more "pro-liberalization". As a member of the World Trade Organization (WTO) since 1 January 1995, the government of Indonesia is required to reduce all bound tariffs to 40 per cent or less over a ten-year period, subject to an exclusion list of products for which this commitment did not apply. The largest tariff reductions in Indonesia began in 1995 although the government had reduced tariffs long before that. Tariffs on final goods had fallen from an average of 21 per cent in 1995 to an average of 8 per cent in 2001, with large variations across and within industries (Amiti and Konings 2005).

The shifts in trade regime from a liberal trade regime to a protective one during the period of increase in oil price ("oil boom") and then going back to a liberal trade regime during the decrease in oil price and the economic crisis have been part of the Indonesian trade and industrial development. Hence, Indonesia provides an interesting case study of trade protection, especially in the manufacturing sector. It shows a conventional cycle of trade protection, which states that protectionism is likely to become stronger during the weaker economic position of the country (Frey 1985; Basri 2002). To what level have the effective rate of protection (ERP) been reduced? Which industries are most protected? Compared with other countries, how fast is the Indonesian liberalization in the manufacturing sector? This paper deals with these questions and focuses only on the structure of protections in Indonesian manufacturing sector. The rest of this paper is organized as follows. Section II describes the evolution of industrial and trade policies in Indonesia, and pays more attention to the underlying political economy. Section III represents trends in the comparative advantage of Indonesian exports. Section IV shows structure of protections in Indonesia and in some other countries. Finally, concluding remarks are presented in section V.

II. The Evolution of Industrial and Trade Policies

Trade liberalization is sometimes illustrated as a two-edged sword, since it can create opportunities as well as threats for the domestic economic development. For example, governments provide some specific industries with protective trade barriers during the implementation of import substitution strategy. The opening up of markets not only offers welcome opportunities for the development of exports but also provides a competitive environment for international and domestic markets. The benefits or losses from the opening up of the markets depend very much upon the readiness of all domestic economic agents (producers and consumers) as well as the government. Trade liberalization and industrialization in East Asia follow the "flying geese" (FG) formation (Masuyama 1997; Kojima 2000; Rao 2001). Japan abandoned its import substitution policies by the early 1960s while Korea and Taiwan shifted to export-promotion strategies since the early 1970s. However, the Southeast Asian countries, including Indonesia, still pursued import substitution policies until the mid-1980s.

Like the other East Asian countries, Indonesia has undertaken both import substitution and export-oriented industrialization policies that have been closely related to international trade performance. There have been at least five phases of the development of industrial and international trade policies in Indonesia.2 First, the phase of very rapid growth in the period 1967-73 was pushed by liberalization and the return of normal economic conditions. Getting transfer of power from the first president of Indonesia Soekarno (through the "Supersemar" presidential letter of command signed by Soekarno on 11 March 1966), the second president Soeharto had to deal with the chaos of hyperinflation (around 630 per cent), low economic growth (only about 0.5 per cent), high unemployment, deficit of government budget (almost 200 per cent), multiple exchange rates and direct control system (Dumairy 1996; Tambunan 2003). After the economic stagnation in the transition period (1966-67) from the Old Order (Orde Lama) to the New Order (Orde Baru), output of manufacturing sector increased significantly by almost 9 per cent in 1968, moreover it exceeded 14 per cent in 1969 (Hill 1997). The New Order regime promptly introduced a macroeconomic stabilization programme and began liberalizing trade and investment based on the trilogy of development "Trilogi Pembangunan" - i.e. stability, growth, and equity. Two most significant policies implemented in this first phase were the openness of its capital account and the establishment of a law that guaranteed foreign investors the right to repatriate both capital and profits.

Second, the phase of "inward-looking" strategy (1973-82) was dominated by the fact that the increase in prices of oil and non-oil commodity had raised the government revenue. Economic policies became inward-looking in the periods of non-oil commodity boom (1975-79) and the oil price shocks (1973-74 and 1979-81), which tripled Indonesia's terms of trade. From the Government Budget (Anggaran Pendapatan dan Belanja Negara, APBN) data, it is clear that government revenue depended heavily on oil revenue. Indonesia is sometimes called a "missed opportunities" economy (Booth 1998) referring to the fact that although Indonesia has abundant natural resources and fabulous variety of cultural tradition, the economy has been underperforming for long periods of history. Indonesia missed an opportunity to have high economic performance financed by the oil boom of 1973-81. Bad governance (institutional or political spheres) in managing the opportunity of oil boom has created other problems such as protectionism in international trade, infant industry, cronyism, conglomeration, corruption and nepotism.

Table 1 describes how the directions of Indonesian economic policies were significantly steered by the external shocks, especially oil price. The oil boom led to fundamental revisions of trade and industrial policies. It is argued that Indonesian industrial and trade liberalization has followed a statement of the supporters of deregulation and liberalization: "good times mean bad policies and bad times mean good policies" (Fane 1996). During the oil boom, the Indonesian government followed an inward-looking strategy i.e. statedirected industrialization or import substitution characterized by high but inefficient growth (Hill 1997; Karseno 1997).

In addition, the government used some of the oil revenue to speed up the industrialization process through extensive public investment and state-owned enterprises (SOEs) in capitalintensive import substituting industries, which were extensively protected. From the political economic point of view, there were two politically competing groups of advisers to President Soeharto, i.e. the "economic nationalist" and the "technocrats" (Fane 1996). The first group consisted of several sub-groups but the most dominant of which were the "engineers" led by the Minister for Research and Technology, Dr B. J. Habibie. The group was eager to support selfsufficiency in food in general and rice in particular (swasembada pangan) and to promote advanced technology, capital intensive and large industries such as steel, cement, fertilizer, aeronautics, and petrochemical. Such industries must be state-owned, subsidized, and protected from imports (Karseno 1997). Beside Habibie's department, this group also dominated the national oil company (Pertamina), the government agency for food procurement and marketing (Badan Urusan Logistik, BULOG) and the Ministry of Industry. Meanwhile, the "technocrats", many of them who were academic staffs and professional economists, relied on market forces. This second group dominated the National Development Planning Agency (Badan Perencanaan dan Pembangunan Nasional, BAPPENAS) and the Ministry of Finance. This group also had a significant influence in the Central Bank (Bank Indonesia, BI) (Fane 1996). During the oil boom, the "economic nationalist" got the president's support. The government intervened in the market through direct state-owned banks that provided various subsidized credits for the favoured clients and implemented somehow complex regulations aimed to promote industrial policy objectives (Vansetti, McGuire, and Prabowo 2005). Departing from its liberal trade introduced in the late 1960s and introducing more tariffs and nontariff barriers as well as recycling some of the oil revenue into the SOEs had ensured big increases in domestic income over this period, which created the demand for output of manufacturing sector (Hill 1997).

Third, Indonesian first major trade reforms adopted in the mid-1980s due to the decline of oil prices in 1982-85 led to a slowdown in GDP to about 4 per cent and a huge deficit in the balance of payment (Dumairy 1996). Decrease in oil price also affected government revenue significantly (adverse fiscal shocks), and this in turn affected the ability of the government to subsidize the "economic nationalists" projects (Fane 1996). The influence of Pertamina decreased due to its lower contribution to the government revenue. In contrast, this had raised the relative influence of the "technocrats", since the bargaining position of the Ministry of Finance whose tax reforms helped to make up for lost oil revenue, was rising. The decline of the oil price triggered the third phase, which was characterized by the main response on prudent macroeconomic management, financial (banking) reform and a large devaluation in 1983. The monumental tax reforms began in 1984 and trade reforms started in 1985.3

Fourth, external factors - the sharp decline in oil price in 1986-88 and other external shocks such as the decline in primary commodity prices, the debt problem due to yen appreciation and the increase competition from other developing countries - made the government realize that there must be a shift in the basis of exports from oil export-basis to manufacturing export-basis. This also led to the fourth phase of industrial and trade policies. Therefore, Indonesia has embarked upon a strategy of export-oriented industrialization or growth-oriented trade4 from 1986 to the present. Tariff ceilings were lowered to 60 per cent, the number of tariff levels were reduced from 25 to 11 and several import licences (which at their peak covered 43 per cent of tariff lines) were converted into tariff equivalents (DFAT 2000). Exports and private sector involvement have become the primary engines of industrial growth. Industrial policy has taken the form of deregulation, reform and improvement of the performance of non-oil and manufacturing sector. The purpose of those policies are to maintain the past rapid economic growth by shifting the engine of exports from natural resource export-basis (especially oil), which were mostly monopolized by the government, to manufacturing export-basis in which the private sector has a bigger role (Karseno 1997). However, Indonesian trade liberalization slowed down in the early 1990s and the simple average tariff rate remained steady. Tariff increased on some chemical products and the national car scheme was established exempt from domestic luxury tax and protected by tariff and non-tariff measures (Vanzetti, McGuire, and Prabowo 2005).

Several observers - Karseno (1997) and Fane (1996), among others - argue that starting from the early 1990s, the Soeharto regime established some new regulations favouring mainly individual firms rather than whole industries. Such policies have been both cause and consequence of the importance of "cronyism" in Indonesia. Some famous examples were the national car "Timor" plan (the private firm owned by one of the President's sons), the heavily protected soybean crushing plant (controlled by the largest of Indonesian conglomerates close to the President, the Salim group), special tariff protection to the giant Chandra Asri petrochemical projects (a joint venture between Japanese and Indonesian investors - the largest shareholding are one of the President's sons and a timber tycoon, Prajogo Pangestu); private monopoly over the trade in cloves (Badan Penyangga dan Pemasaran Cengkeh, BPPC - the private firm owned by members of the President's family) (Fane 1996).

Fifth, hit by total (financial, economic, social, and political) crisis in 1997 made the Indonesian government adopt good macroeconomic and international policies. The government decided to have deeper integration with the world market and to accelerate trade liberalization. Trade reforms were intensified at the start of the International Monetary Fund (IMF) programme, with the highlight being the gradual elimination of nontariff measures for agricultural products and measures to protect the national car scheme. The gradual reduction of import tariffs included those on chemical products, iron and steel to 5-10 per cent. Various commodities including wheat and wheat flour, soybean and garlic were freely imported under a General Importer licence (Soesastro and Basri 2005). During the crisis, the government committed itself to removing all import licences including licences that fell outside previous WTO, removing import-licencing requirements on commodities controlled by the national logistic agency (BULOG), opening rice to import competition. In addition, the liberalization has been also encouraged by the international commitments under the ASEAN Free Trade Agreement (AFTA), Asia-Pacific Economic Cooperation (APEC) and Preferential Trade Agreements (PTAs). To sum up, while the general trend since the 1997 crisis has been further liberalization, protection has recently increased in some areas. However, this increase in protection is not taking the form of highly visible tariff but non-tariff measures (Vanzetti, McGuire, and Prabowo 2005).

In the past, increase in oil price led to a rise in oil revenue for the government. However, the government has misallocated it to the inefficient industries or SOEs, which supported the inwardlooking regime. Currently, the increase in oil price is not a "windfall" anymore but a "burden" for the government since more oil subsidies are required in the APBN. Following the statement of supporters of deregulation and liberalization: "now, the increase in oil price (bad time) means more liberalization (good policies)". Therefore, we argue that Indonesia should continue the liberalization process in the manufacturing sector. This will improve trade and economic development. By using the computable general equilibrium (CGE) INDORANI,5 Widodo (2007) indicates that Indonesian trade liberalization in the manufacturing sectors will have positive impacts on stabilizing inflation, creating employment, increasing competitiveness and reducing pollution emission. Similarly, by applying a global general equilibrium, Vanzetti, McGuire, and Prabowo (2005) analyse some scenarios where Indonesia's interests lie. The scenarios are: (1) "Going back" - increasing protection, particularly in sensitive sectors such as agricultural products, chemicals, motor vehicles, steel and textiles; (2) "Standstill" - remaining at the current level of protection while others liberalize; (3) "Going forward faster" with unilateral trade liberalization - Indonesia liberalizing while trading partners maintain their policies; (4) "Going forward faster" with liberalization via a bilateral agreement - a free trade agreement with the United States; (5) "Going forward faster" with trade liberalization via a regional - an expansion of ASEAN to include China, the Republic of Korea and Japan; (6) "Going forward faster" with trade liberalization via multilateralism - a WTO proposal as it may eventuate. Their analysis shows that "Going back" the increasing protection results in economic losses while "Standstill" and "Going forward faster" creates economic gains.

III. Trends in Comparative Advantage

Figure 1 shows the values of exports and imports for 1960-2005 corresponding to the phases previously described. The values of exports and imports were very low during the Old Order. The values increased during the early stage of importsubstitution (1973-82), decreased during 1983-85 and increased significantly after 1986 when export-orientation policies took place. With some fluctuations, the positive trends in exports and imports have continued in the period after the 1997 economic crisis.

To show the impact of trade and industrial regimes on export performance, we plot the phases of trade and industrial regimes discussed previously and the comparative advantage index in Figure 2. The index of comparative advantage used in this paper is the "revealed" symmetric comparative advantage (RSCA) by Laursen (1998). The RSCA is a simple transformation of the "revealed" comparative advantage (RCA) index, which is formulated as RCA^sup ij^ = (Z^sub ij^ / x^sub in^) / (X^sub rj^/x^sub rn^), by Balassa (1965). x^sub ij^ represents total exports of country i in group of products j. Subscript r denotes all countries (the rest of world) without country i, and subscript n stands for all groups of products excepting group of product j. The RSCA index is formulated as RSCA^sub ij^ = (RCA^sub ij^ -1) / (RCA^sub ij^ +1). The values of RSCA lie between -1 and +1. RSCA^sub ij^, greater than zero implies that country j has comparative advantage in group of products j, and RSCA^sub ij^, less than zero implies that country i has comparative disadvantage in group of products j.

We calculate the RSCA based on data on exports by 3-digit the Standard International Trade Classification (SITC) Revision 2 consisting of 237 groups of products obtained from the United Nations - Commodity Trade Statistics (UNCOMTRADE). This paper employs the classifications of products (industries) by the Empirical Trade Analysis (ETA).6 On the basis of the United Nations Conference on Trade and Development (UNCTAD) and the WTO classification using the SITC Rev. 3, the ETA distinguishes the following five main groups of products at the 3-digit level based on their factor intensities: (1) primary products (83 SITC), (2) natural resowce-intensive products (21 SITC), (3) unskilled labour-intensive products (26 SITC), (4) technology-intensive products (62 SITC), (5) human capital-intensive products (43 SITC) (See Appendix 1 for the detailed classification). We calculate the median7 of RSCA for each product category and present it in Figure 2.

Figure 2 shows that during the inward-looking regime (1973-82), Indonesia had no comparative advantage. The oil boom might cause reallocation of sources from exportable goods industries such as manufacturing to oil sector, through the "Dutch disease" effect. However, Hill (1997) argues that the "Dutch disease" did not happen for at least two reasons - the Indonesian government began to depart from its liberal trade policies and to recycle some of the oil revenue into the SOEs, which in fact were inefficient. Consequently, although the industrial output grew around 3 per cent, this was only for the domestic market. Meanwhile, during the first major trade reform (1983-85), the comparative advantage of two industries i.e. unskilled labour-intensive products (especially garments, textile, footwear and electronics) and primary products (dominantly oil and gas) increased significantly. A large devaluation of domestic currency rupiah in 1983 had raised the comparative advantage of unskilled labourintensive products and primary products. Enormous investments in oil and gas allocated in the oil boom era resulted in the huge increase of 22 per cent in manufacturing output in 1984 (Hill 1997).

The increase in comparative advantage of unskilled labour-intensive products and primary products continued even faster during the period of growth-oriented trade regime (1986-88). The comparative advantage of natural resowrce-intensive products and human capital-intensive products also increased significantly, while technology-intensive products increased moderately during this period. From 1985, the levels of protection had decreased and Indonesia shifted from import substitution to export orientation strategies, particularly in the manufacturing sector. Exports and the private sector had become the engines of economic growth. The annual rate of GDP growth was about 6.3 per cent during 1985-90 (Soesastro and Basri 2005), while that of non-oil manufacturing output was more than 11 per cent during 1985-92 (Hill 1997).

The trends of comparative advantage relatively slowed down for the early 1990s until just before the economic crisis 1997. In natural resourceintensive product, exports of plywood (accounted almost 50 per cent of the total exports of all manufacture in the mid-1980s) grew quite slowly following the introduction of the log export ban. In unskilled labour-intensive products, garment and textile exports had faced quota limit under the Multifibre Arrangement (MFA). For the period after the economic crisis 1997, there have been upward trends in the comparative advantage excepting that of unskilled labour-intensive products, which seems to be difficult to increase since many competitors such as China and Vietnam have come into the market.

IV. Structure of Protection

IVl Nominal Tariff

The classifications of outputs regarding tariffs and industries are different. The tariff lines are at the Harmonized Commodity Description and Coding System, for example nine -digit level consisting of thousands of product codes. The outputs of the manufacturing sector are recorded under the International Standard Industrial Classification (ISIC). Hence, the coding systems of HS and ISIC are different. Fortunately, with the help of an unpublished concordance between this HS ninedigit classification and the five-digit ISIC from the Indonesian Central Bureau of Statistics (Badan Pusat Statistik, BPS), Amiti and Konings (2005) have calculated a final goods tariff for each fivedigit industry in 1991, 1995, and 2001. The final good tariffs by ISIC are given in Table 2.

Table 2 describes the variations and changes in average tariffs by ISIC two-digit industries for 1991, 1995, 2001, and 2005. The last three columns show the rates of tariff reduction for the periods 1991-95, 1995-2001 and 2001-2005. During the period 1991-95, the largest decrease of tariff was in Metals (ISIC 36) -53.91 per cent followed by Paper (-52.43 per cent) and "Other" group (-31.93 per cent). The "Others" manufacture had a decrease in tariff not more than 30 per cent. During the period 1995-2001, the largest decrease in tariff was in Wood (ISIC 33) -61 per cent followed by Paper (-60 per cent). The "others" manufacture had a decrease more than 40 per cent except Food (-22 per cent) and Machinery (-28.59 per cent). For 2001-2005, the largest decrease in tariff was Food (-57.5 per cent) industry followed by Paper (-38 per cent), Chemical (-27.7 per cent) and Wood (-27.6 per cent).

IV.2 Effective Rates of Protection

In the context of the Indonesian economy where export promotion is pursued alongside importsubstitution policies (double-track industrialization), it is important to estimate effective rate of protection (ERP) for import competing and export-oriented industries separately. However, because of the unavailability of data on export subsidies, import duty rebate and other duty concessions, we focus only on ERP for the manufacturing sector as a whole. We have to keep in mind that such non-tariff barriers are important. Kim (2004) finds that the coverage of import prohibitions was increased from 7 to 27 tariff lines, while the coverage of import licensing was increased from 27 to 1,027 lines for the period 2001-2003.

We estimate the ERP based on data from the input-output (IO) tables in 1990, 1995, 2000 and 2005(8) and data on the tariffs calculated by Amiti and Konings (2005) and the tariffs scheduled as at late 2004 obtained from APEC website (See Appendix 2 for the ERP formula). By using the corresponding IO, it is hoped that the estimates have taken into account the technological changes in the process of production. It is important to note that the estimates might probably understate the true values since they do not capture various nontariff measures.

In the past, protection in the manufacturing sector was implemented intensively for some reasons related to the way political systems and the process of policy-making operated. Hill (1997) states that there are at least three models explaining pattern of protection, i.e., "adding machine model", "interest group model" and "national interest model". In the first model, government acts to maximize the likelihood of their re-election. Then, the more labour-intensive in the process of production, the higher will be the protection put in that industry. The second model relies on cost-benefit analysis. The tariff structure depends on the cost and benefit of the pressure groups to secure protection. The third model postulates that government might take the view that there are particular market failures that need to be overcome. There may be objectives with a higher priority than the short-run efficiency maximization. In the case of Indonesia, Hill (1997) argues that the second and third models are appropriate in explaining the structure of protection in Indonesian manufacturing sector especially during the New Order era.

The Indonesian government has undertaken substantial reforms on structure of protection, especially following the 1997 financial crisis, becoming member of WTO and fulfilling some commitments of regional economic cooperation such as the APEC, the AFTA, ASEAN-China Free Trade Agreement (ACFTA), ASEAN-Korea Free Trade Agreement (AKFTA), ASEAN-Japan Comprehensive Economic Partnership and other preferential trade agreements (PTAs). Currently, in term of tariffs, there have been relatively low levels of protections and such protections are widely varied across industries. Table 3 exhibits ERP in the manufacturing sector ISIC 2-digit in 1991-2005. The rates were relatively high during the period 1991-95 but the rates decreased during the period 2001-2005.

The average ERP for all industries in the manufacturing sector was 57 per cent, 42.4 per cent, 16.5 per cent, and 10.2 per cent in 1991, 1995, 2001, and 2005, respectively. The average ERP of 57 per cent in 1991 implies that the combined domestic value added in the manufacturing sector production under the structure of import tariff in 1991 was 57 per cent higher than what was achievable under free trade. In contrast, the average ERP 10.2 per cent in 2005 means that the combined domestic value added in the manufacturing sector production under the structure of import tariff in 2005 was only 10.2 per cent higher than what was achievable under free trade. In 1991, it ranged from the lowest 30.8 per cent (Machinery, ISIC 37) to the highest 78.9 per cent (Textile clothing, ISIC 32). In 2005, it ranged from the lowest 4 per cent (Paper, ISIC 34) to the highest 15.4 per cent (Food, ISIC 31).

IV.3 Some Comparisons across Countries

It is interesting to compare the structure of protections between Indonesia and other ASEAN countries. Table 4 shows the ERP of the manufacturing sector (in the Input-Output table classification, ??-code) in Indonesia, Malaysia and Vietnam. In general, the ERP of the manufacturing sector in Indonesia were still higher than in Malaysia but much lower than in Vietnam. The simple average of Indonesian ERP in the manufacturing sector was 11.6 per cent in 2005. Meanwhile, the simple averages of Malaysian ERP and Vietnamese ERP in 2003 were 10.4 per cent and 32.2 per cent, respectively.

The estimates also show that Indonesia in 2001 had the same degree of variation in ERP across industries as that of Malaysia in 2003. It is shown by the same value of coefficient of variation, i.e., 0.8. However, this coefficient was only 0.4 in the case of Indonesia in 2005. Decrease in the coefficients of variation indicates that the discrimination levels of protections in the manufacturing sector have declined in Indonesia. This was contributed significantly by the elimination of protections in Food; Oil and fat; Rice milling; Hour; Sugar; Other food; Beverage; and Tobacco industries.

The simple average of ERP decreased from 55.6 per cent in 1991 to only 11.6 per cent in 2005. The (simple) averages of ERP in Table 4 and Table 3 are slightly different due to the different classification in industries between the IO and ISIC codes. In general, we can say that the ERP associated with domestic market-oriented industry was relatively smaller than export-oriented industry. The most protected industry is Food manufacturing industry with ERP 29.4 per cent in 2005. Oil and fat; Rice milling; Flour; Sugar; Other food; Beverage; Tobacco; Knitting; Textile, wood and leather; Bamboo, wood and rattan; Fertilizer and pesticide; Cement industries still had double digit ERP, greater than 10 per cent. In the case of Malaysia, Athukorala (2005a) finds that ERP associated export-oriented industries (for example, household machinery; industrial machinery; radio; TV and computer equipment; and other electronics) was much smaller compared with domestic market-oriented industries (for example, motor vehicles; cycles and motorcycles; metal products; rubber goods; plastic products; and furniture) in 2003.

Table 5 represents some comparisons between the ERP estimates for Indonesian manufacturing sector and available estimates for seven major East Asian economies. A strict comparison of estimates across the countries is not possible because of significant differences in estimates in terms of the coverage given the various elements of the trade regime in each country. Nevertheless, based on the order of magnitude alone, one can safely infer that the current level of effective protection to domestic manufacturing in Indonesia is clearly in line with the protection levels in other countries in the region.

By the late 1980s or the beginning 1990s, the ERP in the manufacturing sector in Indonesia, Malaysia, the Philippines and Thailand ranged around 20-60 per cent. Panagariya (1994) finds that the ERPs in Malaysian, the Philippines and Thai manufacturing sector were 23 per cent in 1988, 32 per cent in 1992, and 51 per cent in 1988, respectively. World Bank (1993) finds that the ERP in Indonesian manufacturing sector was 59 per cent in 1990. Therefore, Indonesia had relatively higher ERP in the manufacturing sector than the other three ASEAN countries in the 1970s. It is estimated that the ERP in Indonesian manufacturing sector was only 10.2 per cent in 2005. Such figure is lower than that in Malaysia, which was estimated around 16 per cent in 2003. The ERP in Thai manufacturing sector was estimated to be about 22.7 per cent in 2004. The Philippines had faster liberalization in the manufacturing sector as the ERP in its manufacturing sector decreased from 32 per cent in 1992 to only 10 per cent in 1999.

V. Concluding Remarks

Over the past thirty-five years, Indonesian manufacturing sector has been liberalized but this has not been without periods of increasing protection in the short or medium periods. This paper has described the evolution of the industrial and trade policies in Indonesia. To some extent, the Indonesian industrial and trade policies follow a statement of the supporters of deregulation and liberalizations: "good times mean bad policies and bad times mean good policies". The increase in the government revenue during the oil boom in 1973-82 (good times) had changed the policy orientation from liberal to inward-looking policies (bad policies); in contrast, decrease in the government revenue due to decrease in oil price during 1982-85 and due to the financial crisis (1997) (bad time), made the government implement more liberalization policies (good policies). However, the current increase in oil price is not a "windfall" anymore but a "burden" for the government since more oil subsidies are required in the APBN. Indonesia should continue the liberalization process in the manufacturing sector to encourage efficiency, rather than give several protections to the manufacturing sector. SOEs in the manufacturing sector should also be managed professionally and efficiently. It is commonly believed that their operations have been intervened by the political interest of the ruling political party.

The ERP analysis shows that Indonesian manufacturing sector has been liberalized more, i.e., starting from very high in ERP during inward-looking regime to low ERP after the Asian financial crisis. The liberalization in the manufacturing sector has also been encouraged by international/regional commitments such as the WTO, IMF, AFTA and PTAs. During the crisis, the government committed itself to removing all import licences. While the general trend since the Asian crisis has been further liberalization, protections have recently increased in some areas in the form of non-tariff measures. Therefore, further analysis of the current structure of protections in Indonesia should consider non-tariff measures, which is beyond the scope of this paper.


The author would like to thank Professors Masumi Hakogi, Toshiyuki Mizoguchi, Haruko Nokita, and two anonymous referees for valuable comments and suggestions.

1. The "flying geese" paradigm was introduced by Kaname Akamatsu in the 1930s to explain the catching-up process of industrialization of latecomer economies from intra-industry, inter-industry and international aspects.

2. Hill (1997) notes four of them.

3. Deregulation in the taxation included income tax (in 1984), value added tax (in 1985) and property tax (in 1986). Deregulation in trade covered reduction of trade tariff from 0-225 per cent to 0-60 per cent (March 1985), duty drawback and imported inputs (Presidential Decree No. 4/1985 about Custom Duties). Financial deregulation covered the devaluation of Indonesian currency rupiah by 28 per cent (March 1983), abolishment of control on interest rate and credit ceiling (June 1983).

4. Some examples of the policies are the change from import licence to general import, elimination of non-tariff barriers and continued tariff reduction (October 1986-January 1987); simplification of quota on textile (July 1987); continued deregulation on export-import system and foreign investment (December 1987); elimination of monopoly on plastic and steel import (November 1988); introduction of harmonized system (HS) of trade classification (January 1989). Financial deregulation covered abolishment of swap ceiling (October 1986), devaluation of rupiah by 31 per cent (12 September 1986), new bank establishment, reserve requirement from 15 per cent to 2 per cent and abolishment lending limit (October, 1986), share and derivative market (December 1987), financial service (December 1988).

5. The CGE INDORANI model is an economy-wide and sector level static -comparative model of an applied general equilibrium model for the Indonesian economy. The model is derived from the ORANI model first developed by the IMPACT Project at Monash University, Australia (see Dixon et al. 1977; Powell 1991). It has been adjusted in terms of equations, closures, parameters, and data according to the current Indonesian economic conditions and behaviour, which are unique in nature, for example, in the labour market, household breakdown, energy sectors, and regional breakdown.

6. See Empirical Trade Analysis at for further information.

7. Since the distribution of RSCA is skewed one, the median is a better measurement than the mean.

8. The Indonesian Central Bureau of Statistics (Badan Pusat Statistik, or BPS) regularly publishes IO table every five years. This paper requires IO Table for 1990, 1995, 2000 and 2005. Since IO Table for 2005 has not been published yet, this paper estimates IO Table 2005 by using the non-survey method known as the "RAS" method. See Miller and Blair (1985) and CEPPS (2004), among others, for the detailed explanation. The 'RAS' method is used to find the matrix of technology by using the available matrix of technology. Let A^sup 2^ and A(O) denote the initial (existing) and the final (updated) technical coefficient matrices in the IO table, respectively. Let R^sup 1^ and S^sup 1^ denote diagonal matrices related to total industry sales by sector i and total inter-industry input purchase by sector j in year 1, respectively. Miller and Blair (1985, p. 281) formulate A^sup 2^ = R^sup 1^A(O)S^sup 1^. Ignoring superscripts and the (0), representing base-year information, we have 'RAS' on the right-hand side. This is the origin of the name of the non-survey technique.


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Tri Widodo is a lecturer at the Faculty of Economics and Business, Gadjah Mada University, Indonesia; and currently a student at Doctoral Program, Graduate School of Economics, Hiroshima University of Economics (HUE), Japan.



Effective Rates of Protection

If α^sub ij^ and α^sub ik^ represent the amount of material inputs (J) and primary inputs (k) used per unit of output (i), respectively; P^sub j^ and P^sub k^ are their world market prices; the world market price of output (F1) is set to be unity; and r denotes the percentage excess of domestic world market prices, world market and domestic prices can be represented by equations (1) and (2), respectively:

ll is assumed that the product (i) and its material inputs (J) are traded and primary input (k) are not traded. Differences (r) between domestic and the world market prices of trade goods can be due to tariffs and other protective measures. Hence, equation (2) can be represented by:

Domestic prices of inputs and inputs might be different from international ones. The percentage excess of domestic prices over world market prices for the output and for material inputs is called the nominal rate of protection (T). Taking the contribution of primary inputs to output (value added) as a unit, the effective rate of protection (D) is defined as the percentage excess of the domestic price of the value added unit over its world market price. The relevant world market prices are those a country faces in foreign trade, i.e., cost-insurance-freight (CIF) prices for actual and potential imports and free-on-board (FOB) prices for export. In this paper, it is assumed that domestic prices equal the sum of the CIF price and the tariff in the first case and the sum of FOB price and export subsidies in the second. Since input coefficient are assumed to be constant, this general formulation of effective protection can reinterpreted as the percentage of domestic value added (DVA) over world market value added (WVA).

In this paper, the ERP of Indonesian manufacturing sector is calculated by the use of input-output coefficients, which refer to the value of inputs per unit of output. Under free trade conditions, input-output coefficients (ai) will be equal to the corresponding input coefficient defined in natural units time the ratio of the world market price of the

input to that of output ... (taking again the world market price of output to be one). Equation (3)

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