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Indonesia’s Manufacturing Sector Picks up Pace

October 10, 2012

Jakarta, October 10, 2012 – Indonesia’s manufacturing sector may be getting its second win, says the World Bank in a new set of policy notes entitled Picking up the Pace: Reviving Growth in Indonesia’s Manufacturing Sector, released today. The policy notes say demand has grown strongly in recent years and the latest investment data suggest that growth is picking up pace. At the same time, Indonesia’s rapidly growing middle-class and competitive workforce are luring more foreign investors into the sector. Growing opportunities in the region are also making Indonesia look even more attractive.

The recent boost in manufacturing output growth can be attributed to domestic demand, which has increased particularly for basic metals, food, chemicals, and automotive parts. Domestic demand has been remarkably resilient since the start of the global financial crisis, growing by 6.4 percent in the first quarters of 2012 on the backs of investment and private consumption. .

At the same time, foreign direct investment in Indonesia’s manufacturing sector is also on the rise. Recent BKPM data suggest that in the second quarter of 2012, foreign direct investments in manufacturing activities reached $1.2 billion, up by more than 62 percent year-on-year. Rising wages in China are likely to prompt companies in labor-intensive industries like TCF to diversify their operations to Indonesia. Indonesia’s auto industry is also likely to benefit as more Japanese automakers set up new supplier networks.

Indonesia could potentially boost its global market share in manufacturing, create millions of new jobs and facilitate structural transformation. But riding on the back of domestic and international demand is not enough. To improve overall competitiveness and sustain growth, the government and private sector need to overcome the main challenges in the manufacturing sector,” says Stefan Koeberle, World Bank Country Director for Indonesia.

Since the Asian financial crisis, a number of macroeconomic challenges have led to a growth decline in Indonesia’s manufacturing sector. The real appreciation of the rupiah, rising unit labor costs, a shift to commodities and resource-intensive sectors, strong international competition (especially from China) and a tightening of profit margins have all made Indonesia’s manufacturing sector less competitive than its regional neighbors. Productivity growth in Indonesia is also lagging relative to its competitors. Major micro level challenges for Indonesian firms are high transportation and logistics costs, difficulties to get a bank loan, and the lack of transparency and certainty in regulations. They discourage new entrants to set up shop and prevent existing manufacturers from expanding and enjoying economies of scale.

The myriad challenges have led to a “missing middle” – a large proportion of small and unproductive manufacturing firms – which due to problems in the business environment has prevented the manufacturing sector from making a greater contribution to Indonesian economic growth and job creation.

To address the macro- and microeconomic challenges, policies are needed to improve cost competitiveness and reduce opportunity costs for investing in the manufacturing sector. Policies to improve value-based competitiveness in manufacturing are also needed to advance and sustain growth,” says Sjamsu Rahardja, World Bank Senior Economist for Indonesia and lead author of the Manufacturing policy note series. “Reviving the manufacturing sector also requires greater coordination across government agencies and local governments. The private sector also needs to be brought into policy discussions and their feedback needs to be recorded through a credible mechanism.”

Specific policy recommendations include:

  • Making it easier for smaller firms to grow and fill in the “missing middle”, especially by opening up access to resources and finance and simplifying labor market conditions;
  • Making it easier for non-exporting firms to become exporters and for exporters to expand their market share abroad, especially by resolving transportation and logistics issues and reducing non-tariff barriers to market access abroad (e.g., by promoting international standards and improving the standards regime)
  • Helping firms move up the value chain, for example, through greater investment in education, worker skills and technology and greater cooperation between firms and educational institutions;
  • Increasing overall market efficiency by encouraging competition and maintaining economic openness.
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