Notes from watching "Ngobrol Tempo" on "Import Substitution of Electronics Products"

This morning I watched “Ngobrol Tempo” on YouTube. The show featured officials from the Ministry of Industry, the Ministry of Trade, and Gabel, the electronics manufacturers’ association. The topic was how to pursue import substitution for electronics products, amid the Ministry of Industry’s policy to cut imports by 35%. I found the program quite interesting and was very pleased with how Bu Ratna from Tempo moderated the discussion. Several points struck me as particularly noteworthy.

The Government’s Typical Mercantilist View

The first, naturally, is the government’s characteristically mercantilist outlook. By mercantilist I mean the state sees itself as an individual firm: a competitive nation is one whose exports exceed imports. Imports mean losing, exports mean winning. Exports mean profit, imports mean loss. This mercantilist view is quite popular not just in the Indonesian government but also among the general public, and even in other countries’ governments.

In this show, the mercantilist view was quite segmented, focusing on electronics products. They even brought up sectoral trade deficits, noting that in certain HS codes, Indonesia is a net importer. Interesting, because I usually hear the government talking about bilateral trade deficits. Here they went as far as sectoral trade deficits. Very specific. I wonder, if there were a show about CPO, would we discuss the CPO surplus? Probably not.

It is indeed difficult to use exports and imports as indicators of industrial competitiveness. It is hard to pin micro-level conclusions on trade deficits, which are fundamentally a macro phenomenon. In today’s world of rapid financial transactions, you cannot discuss trade deficits without discussing financial flows. As a country that targets capital inflow, it is natural for the current account to be negative. Moreover, Indonesia imports a lot of capital goods and components, which arguably represents good use of FDI.

Trade deficits must also be viewed alongside overall trade. Indonesia’s exports in other products are enormous. You cannot expect surpluses in everything. Do not forget dutch disease, where exports in one sector reduce competitiveness in another. So trying to discuss a deficit in a single sector seems problematic. Besides examining how to curb imports, the government should also scrutinize the financial management of companies in high-export sectors. Are they saving a lot? Holding cash? Paying dividends? Reinvesting? Are their savings overseas or domestic? How much does the state earn from export industries?

Comparing with Vietnam

The second hallmark is comparing with Vietnam. This has been trendy not just in government but also among consultants and academics. Comparing with Vietnam has intensified because of Global Value Chains (GVC). They say that in the early 2000s, Indonesia’s share of world trade was 0.9% while Vietnam’s was 0.25%, but by 2019, Indonesia’s share was 1% while Vietnam’s was 2%.

Some problems with comparing Indonesia to Vietnam:

• Vietnam is a small country. Its GDP and $\frac{\text{GDP}}{\text{capita}}$ are still below Indonesia’s. They don’t have a large market, so they are compelled to exploit the global market. Indonesia? Its domestic market alone is enormous. That is why it is “easy” to pursue protectionist policies.
• Vietnam’s exports are large but so are its imports. That is, the value added is small. What is called “Vietnam’s huge electronics exports” is actually the work of many countries. Vietnam just happens to be the final assembly location. If you look only at trade statistics, you overestimate Vietnam’s electronics manufacturing.
• Vietnam is called a GVC success story not because it is protectionist, but precisely because it embraced globalization. That is why its imports are so large. Because it embraced globalization, it also managed to sign trade agreements with other countries faster than Indonesia. The fact that Indonesia’s textiles face 15% tariffs to the EU while Vietnam pays 0% is partly due to this.
• As shown below, while Vietnam’s $\frac{\text{trade}}{\text{GDP}}$ ratio is enormous, its trade balance is not that different from Indonesia’s. Don’t forget that Vietnam ran trade deficits continuously from 1986 to 2011. If I recall correctly, the late 90s was when they started attracting FDI.

So given the differences in size and approach (import substitution vs. export expansion), there is little point in overly comparing ourselves with Vietnam. Vietnam also lacks natural resources to export and its domestic market is too small. It is natural for them to depend on the global market. That said, comparing institutions (ease of doing business, logistics management, trade agreements) remains perfectly reasonable.

Oh, and this should also be linked to the mercantilist school. Just because a country exports a lot does not mean it is doing well. Vietnam’s per capita income is still below Indonesia’s. They make fancy phones, but how many Vietnamese can buy them? This is because the value added that actually stays in Vietnam is tiny (labor-intensive). Indonesia wants to go 4.0, right?

Furthermore, we are in the same boat, aren’t we? Indonesia exports massive amounts of coal and CPO, yet many regions still struggle with electricity and cooking oil is now expensive. Is that good? What is the point of exports if ordinary people’s income and consumption barely change?

Public Policy

The show also touched on several interesting policy points. The panelists were asked what policies are being or will be implemented to boost the competitiveness of electronics products and curb imports. The speakers explicitly mentioned WTO constraints on their policymaking. In other words, their policies must be in line with international rules such as trade agreements and the WTO.

Trade Barriers

Several trade-related policies were mentioned:

1. Non-tariff barriers (NTBs) such as SNI and TKDN (local content requirements).
2. Trade remedy and anti-dumping measures.
3. Reviewing trade agreements, including the Information Technology Agreement.
4. Technical considerations for import approval (effectively another NTB).
5. Use of the Commodity Balance Sheet (Neraca Komoditas – also effectively an NTB).

These NTBs will be focused on 25 electronics products, mostly consumer electronics. They claimed that the AC import approval regulation (Permendag 64/2020) successfully attracted foreign investment. According to Gabel, thanks to this new NTB, domestic AC supply rose from 20% of total AC sales in Indonesia (i.e., 80% imported) to 30% (imports down to 70%). As usual, the ones complaining are AC retailers whose stock comes from imports.

I have heard the first two points many times. But the last two are fairly new. Apparently, the Ministry of Industry wants to introduce import quota licensing for downstream electronics products through technical considerations. If implemented, products like TVs, refrigerators, and ACs would need to apply for an import permit from the Ministry of Industry, specifying the quantity they wish to import. The Ministry would then issue a technical approval specifying the allowed import quota.

The problem is that this kind of technical-approval-based import licensing is precisely what the Commodity Balance Sheet is meant to eliminate. Eventually, products covered by the Commodity Balance Sheet should be importable according to the balance sheet without technical approval, just through the Ministry of Trade. The Commodity Balance Sheet is supposed to be fully implemented by 2023, so why push for technical approvals?

One more thing: using technical approvals or Commodity Balance Sheets will also face WTO problems because they are basically quota restrictions. This is what happened with Brazilian chicken. The question now is whether major exporting countries to Indonesia – such as China, Japan, and South Korea – will file a dispute like Brazil did.

Investment Policy: Expertise or Financing?

On investment, it seems new investments will receive tax holidays or corporate income tax reductions. This incentive is premised on the logic that foreign investment will help increase domestic production capacity. Once again, Vietnam is frequently cited as a model for attracting foreign investment and boosting exports. Why? Because foreign investment brings not just physical capital but also know-how (both managerial and technical) and international production networks (foreign suppliers and buyers). Foreign investment also absorbs a lot of labor and outsources various things from domestic producers (spillover). All these advantages make the potential tax revenue loss from tax holidays worthwhile.

Gabel raised an interesting point about Indonesia’s electronics industry. They said Indonesia is already quite competitive in ASEAN. However, Indonesian consumers are still low-end. Household electricity is still dominated by 900 watts. The best-selling AC in Indonesia is the 1/2 HP model, to avoid circuit breakers tripping. Refrigerators are also small because many Indonesian workers are paid daily, so they shop daily – no need for a large fridge. As a result, the electronics market in Indonesia can be considered a commodity: easy to copy with no differentiation advantages.

If that is the case, the role of foreign investment in terms of technical know-how is almost nil. Since the products are still low-end, complex high-end features and large-capacity manufacturing are not really needed. If know-how is not really needed, shouldn’t domestic investment suffice?

But investing in Indonesia is difficult. Interest rates are high, banks do not accept production equipment as collateral, and the government keeps issuing bonds with attractive yields (crowding out). Domestic investors lack liquidity, while foreign investors are happy to enter Indonesia because interest rates abroad are low and Bank Indonesia zealously maintains a stable exchange rate (by raising interest rates, LOL). Crowding out intensifies when the export sector fails to boost domestic liquidity.

Fragmented Policy

Back to the first discussion: trade is a macro issue. There is so much to consider. Competition, domino effects, etc. Expensive electricity, extortion, and protection of upstream industries (like steel) all play crucial roles. Exports from other sectors (CPO and coal, for instance), the money supply, exchange rates, and interest rates all have massive effects. It is certainly difficult to use a macro lens (total imports) to make policy for micro phenomena (the competitiveness of the electronics industry using trade barriers).

On upstream protection, it was also amusing to hear India mentioned as having cheaper automotive products than Indonesia, even though Indonesia has been pampering its automotive sector since the 80s (lots of incentives and protection). Don’t forget that steel in India is cheaper and more competitive than in Indonesia. If steel is cheap, literally almost every other industry will also be cheaper (including construction and capital goods).

From this show, I still feel that the policies being adopted are somewhat fragmented and poorly coordinated. Both ministries need to talk with other institutions handling capital flows, interest rates, energy, export commodities like mining, CPO and coal, and so much more. Fair enough – the speakers were from the Ministry of Industry and the Ministry of Trade, so the policies discussed naturally focused on trade barriers.

But Gabel’s secretary general made an interesting point: if import substitution is to be taken seriously, it must be discussed nationally. Too many factors are at play. I have heard the 35% import substitution program trumpeted by the Ministry of Industry too many times while others (Ministry of Finance, Ministry of Agriculture, Ministry of Energy, Bank Indonesia, etc.) seem to never mention it.

One more thing. No country can export everything. Not every sector needs to be a champion with a trade surplus. Not every country that exports a lot in one area (Vietnam in electronics) also exports a lot in another (Vietnam does not export coal or CPO). Inefficient policies will only reduce people’s purchasing power, and we will be back to selling low-end products.

BTW, the show I watched is below. Let me know what you think! Mention me at @imedkrisna