Indonesian officials are obsessed with a 1950s economic policy that did South America little good.
President-elect Joko Widodo has proposed policies to promote import substitution, a strategy aimed at reducing the need for imports by switching to home-grown commodities, industries and technologies. The model, often credited to Argentine economist Raúl Prebisch in the 1950s, lost favor after its widespread adoption in Latin America ended with the debt crisis of the 1980s.
An excessive focus on meeting domestic needs could cut off Southeast Asia’s biggest economy from the global supply chain and product development, increase protectionism and leave its industries uncompetitive, analysts say. It also risks elevating demand for foreign currency to fund machinery imports for local production, without creating a flow of exports to balance that financing need.
“Import substitution is an archaic policy,” said Arianto Patunru, an economist at Australian National University’s Indonesia Project in Canberra. “In these days when global production is fragmented and everything is made in everywhere, a call for import substitution is a major setback. Indonesia is currently behind its peers in the region in terms of reaping the benefits of regional and global production networks.”
Indonesia has tried to use such policies to develop value-added processing and boost self-sufficiency, from this year’s mining-ore export ban aimed at spurring more smelters, to beef import quotas designed to encourage domestic cattle production. The current administration has made it more difficult to import smartphones, and Widodo plans to limit the expansion of some plantations to free up land for food crops.
The challenge for Widodo, known as Jokowi, is balancing nationalist fervor for import substitution without sacrificing the development of industries that will help achieve a growth target of 7 percent. Jokowi takes office in October and will inherit an economy expanding at its slowest pace since 2009 and a current-account deficit that widened to near a record last quarter.
“Indonesia risks sliding backwards with an import substitution strategy,” said Hak Bin Chua, a Singapore-based economist at Bank of America Merrill Lynch. “Increasing investments in infrastructure, cutting energy subsidies and attracting higher value-added FDI will be a more progressive strategy,” he said, referring to foreign direct investment.
The rupiah has gained almost 4 percent this year against the dollar, on optimism the new leader will replicate nationally the success he had in Jakarta in cutting red tape and kick-starting infrastructure development. The currency slid 21 percent in 2013 as falling exports and elevated import levels spurred the current-account deficit.
Yet Jokowi’s plan to impose a moratorium on the expansion of some plantations could affect commodities producers in the world’s largest producer of palm oil, second-biggest rubber grower and third-biggest robusta coffee and cocoa producer. The president-elect wants to achieve rice and corn self-sufficiency by 2018, and aims to reduce imports of soybeans, a staple protein source, according to a campaign policy document.
“The unity of the people and helping each other will be the new power to rebuild an Indonesia that is politically sovereign, economically independent,” Jokowi said on his Facebook page last week.
Likewise, the administration of current President Susilo Bambang Yudhoyono recently considered a tax on imported smartphones and has limited shipments to certain ports, while trying to encourage iPhone manufacturer Foxconn Technology Co. and Samsung Electronics Co. to build production plants.
“We have to build industry from upstream to downstream,” Trade Minister Muhammad Lutfi said when asked about import substitution. More than three-quarters of the country’s imports are raw materials and components, he said.
Consumption of everything from sugar to wheat to palm oil is climbing in Indonesia as the population and incomes increase. The world’s fourth-most populous nation will replace China as the top sugar importer in the year to April, U.S. Department of Agriculture data show.
Elements of import substitution have persisted in countries including Malaysia, which built a domestic carmaking industry with protectionist import tariffs while wooing foreign electronics manufacturers with tax breaks. Russia, facing U.S. and European sanctions, is now aiming to boost its local manufacturing in industries such as aviation. In India, Prime Minister Narendra Modi pledged in a speech this month to revive manufacturing and reduce reliance on imports.
Yet across Asia, countries from Singapore to Thailand have made exports a key contributor to their economies, producing automobiles, computers and smartphone parts for a global market as Indonesia remained largely a commodity producer where growth is supported by domestic demand.
While its smaller export dependence helped Indonesia avoid sliding into recession during the global financial crisis, the risk is that its focus on meeting domestic needs will distract policy makers from creating a competitive economy, said analysts including Wellian Wiranto at Oversea-Chinese Banking Corp.
“Tinkering with the minutiae of industrial policy runs the risk of the urge to create national champions which would just engender preferential treatment for specific firms,” Wiranto said. “By indulging in another big-government policy of import substitution, that will only create more problems down the road.”
Officials from the outgoing government and Jokowi’s transitional planning team are meeting this month to work on proposals for potential reforms, with the structure of the cabinet, economic policy and next year’s budget up for review.
Yudhoyono’s government has backtracked on rules setting food import quotas, as an effort to encourage domestic production of cattle and soybeans led to price spikes that fueled inflation and caused protests.
“Import substitution will not be sufficient, it has to be overall reform,” said Bambang Prijambodo, assistant to the current minister of planning. “From the external side, export competitiveness in the short to mid-term has to be increased, scrapping bottlenecks.”
Jokowi, who started a furniture export business before going into politics, wants to support small and medium-sized manufacturers. His political party is led by Megawati Soekarnoputri, the daughter of Indonesia’s first post-colonial leader Sukarno, who ruled at a time when import substitution industrialization gained currency in emerging economies.
The incoming government should seek a newer version of the theory, by improving export competitiveness through building infrastructure while still seeking to reduce imports, said Eric Alexander Sugandi, an economist at Standard Chartered Plc in Jakarta.
“Unlike the old ISI, the new ISI policies should not use limited monopoly rights as in the past, but instead it should give incentives to investors, both local and foreign,” Sugandi said. “That will help to address the current-account problem and create a more independent industrial structure.”