Foreign direct investment is not coming to Indonesia. Really? - Edimon Ginting

The economic topic receiving most attention in the last few days is certainly that of foreign direct investment, or FDI, thanks to the World Bank, which brought this issue to Indonesia’s President Joko Widodo’s attention. One of the key messages was that, FDI is simply not coming to Indonesia. The evidence cited was that 33 investors have exited People’s Republic of China (PRC) since June due to the escalating trade war.  Most shifted their investment to Viet Nam and, crucially, none came to Indonesia. Since attracting FDI is one of President Jokowi’s priorities, his reaction to this was swift. All ministries involved in facilitating FDI had to address the problem fast. Intrigued by the news coverage, I did some online research on the issue. To my surprise, it barely hit the headlines in PRC and Viet Nam but there was a huge amount of coverage on President Jokowi’s reaction. This prompted me to dig deeper to get to the heart of the matter.

Total FDI to Indonesia is still rising

Firstly, this is a key fact: total FDI in Indonesia is still rising. After an absence from the FDI destination list for a few years after the 1997–1998 Asian Financial Crisis, Indonesia was back in the top 10 destinations following the 2007–2008 Global Financial Crisis (Table 1), thanks to reforms during the government of former President Yudhoyono as well as improved domestic economic growth prospects.

Table 1: Top Recipients of FDI in Asia (US$ million)

Source: United Nations Conference on Trade and Development. World Investment Report 2019 Statistical Annex Tables. Accessed September 2019.

President Jokowi continued the FDI-friendly policy when he took office in 2014 and FDI flows to Indonesia continued to increase. In nominal terms, FDI flows to Indonesia in 2018 increased by $7.8 billion compared to the annual average flows in 2008–2016, higher than the increase in India and Viet Nam over the same period at $6.5 billion and $6.2 billion, respectively. So why the perception that FDI is not coming to Indonesia?

FDI to manufacturing is declining

Most FDIs to Indonesia in the last few years have been channeled to non-manufacturing sectors. The top five destination of FDIs in Indonesia have been renewable energy, mining, chemical, real estate, and metals. After that, sectors of choice were services such as hotels, information technology, and finance. Only at number 10 does a manufacturing sector—the automotive industry—figure. Broadly speaking, FDI to manufacturing in Indonesia has been shrinking in the last few years, whereas foreign investment in Viet Nam’s manufacturing sector has been surging.  Somehow, foreign investors see Indonesia’s strength lying outside manufacturing. When they come here, they gravitate to natural resources, tourism, and other booming service sectors. And those investors who do look at manufacturing, such as automotives, do so to tap the domestic market.

Source: Haver and Indonesia’s Coordinating Investment Bureau (BKPM)

Reflection

It is these key facts that underlie the reasons why those 33 investors opted to overlook Indonesia. Trade tensions, by their very nature, affect export-oriented manufacturing sectors the most. So, when investors need to find a new home, naturally they go to places that are also export-oriented.  Viet Nam is ahead of most other Asian countries in this respect since it has always espoused an export-oriented growth strategy. A progressive FDI policy supports that. The country also has a good education system considering its level of development capable of producing an ample quantity of skilled labor that can participate in a wide range of manufacturing. Geography helps too. Viet Nam exports more to PRC than any of its competitors in part because it is located right next door.

The World Bank advised the Indonesian government to address FDI policy credibility, certainty, and compliance with President Jokowi’s policy.  This is something the government has been working on, which is why FDI has been increasing in the past few years. But to match Viet Nam in attracting FDI to manufacturing, the government will need much more than that. The long-term challenges in the inflexible labor market needs to be addressed. Schools and colleges need to produce graduates with better skills, which can nicely match with industry’s needs. Additionally, Indonesia’s export-oriented sectors not only need an FDI-friendly policy, but it also needs progressive policies to attract manufacturing investors. PRC and now Viet Nam are examples of countries that have benefited from progressive FDI policies. Yes, there are costs associated with progressive FDI policy. One of them is the need to accommodate a small number of foreign workers. But the benefits are much larger, including increasing productive employment, inclusion into the global value chain, and, more importantly, opening wider opportunities for learning and chances to be part of the global technological innovation. Finally, to ensure investors come to Indonesia and stay here, the government should make sure all parts of the FDI engine are working smoothly and in sync under a strong and effective coordination framework.