Indonesia Table of Contents

New Order Developments

After coming to power, the New Order government supervised the rapid industrialization of the Indonesian economy. Industrial production, as a share of total GDP, grew from 13 percent in 1965 to 37 percent in 1989. The protective trade policies of the 1970s contributed to the changing composition of industry, away from light manufacturing such as food processing and toward heavy industries such as petroleum refining, steel, and cement. These industries were often dominated by government enterprises. Although these large-scale, capital-intensive firms offered few employment opportunities to the rapidly growing labor force, the surge in manufacturing exports begun in the mid-1980s promised to increase employment and the role of private investment in the 1990s.

Despite its increasing significance, the industrial sector employed only about 10 percent of the work force. The BPS conducted a comprehensive economic census roughly every ten years beginning in 1964. The 1986 economic census provided detailed information on approximately 13,000 firms with more than twenty employees in all industrial sectors except oil and natural gas processing. Economist Hal Hill analyzed in detail Indonesian industrial growth based on census data, combined with national income account data on the oil and gas sector. The most important industrial sector, according to these studies, was oil and natural gas processing, which accounted for more than 25 percent of total value-added in industrial output. The second major industrial activity was the production of kretek cigarettes, the popular traditional Indonesian cigarette made from tobacco blended with cloves. Cigarette production accounted for 12 percent of total industrial valueadded . A diverse range of almost thirty major industrial sectors, from food processing to basic metals, accounted for the remaining production.

Hill identified seven ownership categories of industrial firms, including privately owned, government owned, foreign owned, and a variety of joint-venture combinations among government, the private sector, and foreign investors. Almost 12,000 firms from the total number of 12,909 firms surveyed were privately owned. Some 350 private-foreign joint ventures and 400 private-foreign-government joint ventures accounted for most of the remainder. The private firms were much smaller than the joint ventures; compared with government joint ventures, private firms were less than one-tenth the size and employed on average one-sixth the number of workers. Although far less numerous, government joint-venture firms still accounted for 25 percent of the total value of industrial production.

Government enterprises controlled all oil and natural gas processing and were important in other heavy industries, such as basic metals, cement, paper products, fertilizer, and transportation equipment. The improved economic climate for private investors following the trade deregulations is indicated in the importance of private ownership among the exporting manufacturing industries. Based on data from 1983, Hill estimated that the major manufacturing export industries, including plywood, clothing, and textiles, had over 60 percent of private Indonesian ownership.

The growing export manufacturing industries also offered many more employment opportunities than the heavy industries dominated by government and foreign joint ventures. Taken together, wood products, textiles, and garment industries accounted for 32 percent of the 1986 industrial labor force employed in large and medium size firms. Oil and natural gas processing, whose total production was equal in value to these three labor-intensive industries, employed only about 1 percent of the labor force. Basic metals industries also employed only 1 percent of the labor force, although they accounted for 6 percent of industrial production.

Foreign Inputs

The predominance of joint ventures with foreign firms over entirely foreign-owned firms, which numbered around fifty, reflected increasing limitations on foreign investment during the 1970s, following a liberal policy from 1967 to 1974. One of the first legislative acts of the New Order was to pass the Foreign Investment Law of 1967, which encouraged foreign investment with tax incentives and few limitations on equity ownership and employment of foreign personnel. Popular discontent with foreign economic domination, voiced in widespread protests during the 1974 visit of the Japanese prime minister Tanaka Kakuei, contributed to greater restrictions on foreign investment. New provisions required that all foreign investment be in joint ventures with Indonesian nationals, whose equity share should reach 51 percent within ten years. Enforcement of these provisions was somewhat arbitrary, however, and the greatest deterrent to foreign investment may have been the complex and sluggish bureaucracy implementing the everchanging regulations.

In the mid-1980s, foreign investment policy was again liberalized as part of the general reform movement. Administration of foreign investment was simplified, and the Investment Coordinating Board (BKPM) was required to approve projects within six weeks of initial application. In special cases, domestic equity could be as low as 5 percent for the initial investment, and licenses were subject to renewal for up to thirty years, altering an earlier policy under which all foreign investment licenses expired in 1997. The minimum investment amount of US$1 million was also lifted for special cases.

Overall, government and private ventures with foreign partners accounted for more than 40 percent of industrial production, according to the 1986 economic census. Japan was the major foreign investor in industry from 1967 to 1988, followed by Hong Kong and South Korea. The United States was the source of less than 1 percent of foreign investment in industry. This figure excluded the major United States investments in crude oil and gas exploration and production, considered part of the mining sector.

Foreign investment was often crucial for the development of capital-intensive heavy industries. A prime example was the Asahan Aluminum Project, a government joint venture with a consortium of Japanese companies that formed Nippon Asahan Aluminum Company. The aluminum smelter plant and two hydroelectric power stations, located in Sumatera Utara Province, were completed in 1984 with a capacity to produce 225,000 tons of aluminum ingots per year. The US$2.2 billion project became the focus of controversy when unforeseen difficulties in power generation and a decline in aluminum prices forced a major financial restructuring. The government equity share was increased from 25 percent to 41 percent, and in 1989 a provisional agreement was reached to allocate 51 percent of the plant's production to Indonesia, with the remainder exported to Japan.

Singapore joined Indonesia's manufactured export drive by assisting in the development of an industrial park on the island of Batam, located in Riau Province only nineteen kilometers offshore from Singapore. The 485-hectare facility, built by a state-owned company from Singapore and two private Indonesian firms, began operations in 1991. The Indonesian government hoped to attract foreign investment to the park by permitting full foreign ownership of export-oriented industries for five years. Singapore viewed the project as part of a "growth triangle" linking Singapore, Malaysia, and Indonesia, that would permit Singaporean investors to take advantage of more ample land and cheaper labor available in the neighboring countries.

In many industries, foreign firms supplied technical assistance and arranged for domestic production under licensing agreements, without direct equity participation in the domestic firm. For example, automobile assembly plants in Indonesia produced about twenty international brand name automobiles, from Fiat to Toyota, primarily under license agreements. The automotive assembly industry grew amidst heavily protected markets. The capacity of domestic firms in 1991 to produce about 250,000 units per year of as many as eighty different types and makes of vehicles meant that it would be difficult for the industry to achieve low-cost, largescale production for export. By international standards, a firm must produce at least 100,000 units of a particular vehicle to be competitive.

Under the leadership of the minister of state for research and technology, Bacharuddin J. Habibie, the government attempted to move into aeronautics with foreign technological assistance. The Archipelago Aircraft Industry (IPTN) was established in 1976 to assemble aircraft under license from Construcción Aeronauticas of Spain, and helicopters under license from Aerospatiale of France and Messerchmitt of Germany. By 1986 IPTN had delivered 194 aircraft, almost entirely to domestic buyers. A critical review of IPTN by two foreign economists argued that the endeavor was a premature leap into advanced technology and could only hope to be profitable by mandating continued domestic purchases of its aircraft. The government justified the US$3 billion investment on broader criteria than financial profitability, including the potential stimulus to domestic suppliers of aircraft parts and the training of highly skilled workers. Among the 12,000 employees, 2,000 were university graduates, many of whom were trained abroad. However, most aircraft parts were still imported in 1986.

Small-scale Industry

The modern sector of medium and large firms was the focus of government policy, but small-scale factories that employed from five to nineteen workers and cottage industries that employed up to four workers--usually family members--were far more numerous and supplied the majority of jobs. Small-scale establishments engaged in a wide range of activities, from traditional bamboo weaving to metal and leather working. Many of these industries offered parttime employment to rural workers during offpeak seasons. Statistics on these activities were tenuous because of the seasonal patterns and interviewing difficulties. A review of the available BPS data by economist Tulus Tambunan showed that small-scale industries employed 3.9 million workers in 1986, compared with 1.7 million employees of medium- and large-scale firms. Still, this figure reflected a significant decline from small industries' share of employment in 1974, which was about 86 percent of total industrial employment, or 4.2 million employees compared with only about 700,000 in medium and large industries.

Regional Industrial Development

The pattern of regional development in Indonesia mirrored the diversity of natural resources among the Outer Islands and the historical dominance of Java as the densely populated agrarian center. Java remained the economic center of the nation, producing about 50 percent of total GDP in the 1980s. Sumatra, the heart of the nation's oil and rubber production, ranked second with 32 percent of GDP. Half of total foreign investment, excluding the oil sector, from 1967 to 1985 was in Java, with the remainder dispersed widely throughout the nation.

In spite of this regional imbalance, there were important and more-or-less uniform features of economic development. By 1983 agricultural production, including nonfood crops such as rubber and forestry and fishing, had declined to less than half of total production in almost all twenty-seven provincial-level administrative units. The majority of the labor force still found employment in these activities, however. Almost all provinces shared in the rapid growth rates of the 1970s, and most attained annual growth rates between 4 and 8 percent per year. Specific industries usually reflected local resource endowments; for example, sawmills and plywood factories dominated manufacturing in Kalimantan, whereas Sumatran manufacturing was more diverse, including rubber processing, cement, and plywood. Major industries on Java included motor vehicle assembly in Jakarta, weaving in Jawa Barat Province and Yogyakarta, kretek cigarette production in Jawa Timur Province, and sugar refining in Jawa Tengah Province.

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Source: U.S. Library of Congress