The political economy of manufacturing protection in Indonesia 1975-1995

Abstract

This study attempts to elucidate the determinants of trade protection over time together with the inter-industry variations of protection in the Indonesian manufacturing sector. This study draws on the political economy of protection literature which has so far only focused on the developed countries, and has included some modifications to portray a model specification more suitable for the Indonesian institutional context. For the determinants of trade protection over time a political economy model for Indonesia is established and its inferences tested with empirical analysis using a Vector Autoregression. This model elaborates the relationship between average tariff and some economic variables, such as the real oil price and real exchange rate. As for inter-industry variations of protection in the Indonesian manufacturing sector, three principal models are employed i.e. the interest group variant model, the national policy model and the Grossman and Helpman model. Furthermore, to supplement and enrich the understanding of the determinants of trade protection in the manufacturing sector, this thesis has delved into two case studies i.e... the Indonesian automotive and textiles industries. This study results in several key findings. First, there is positive relationship between trade protection and the real oil price, suggesting that pressure for import protection tended to increase during the oil boom. As for the real exchange rate, the econometric results show that depreciation of the real exchange rate indirectly protects domestic goods from imports, leading to less pressure for import protection. Second, there were at least six major groups influencing economic policy in Indonesia, i.e. technocrats, economic nationalists, interest groups (business associations), foreign firms, external institutions and the liberal epistemic community. Economic nationalists played a dominant role in the oil boom period of 1973-1981. However, following the collapse of the oil price, the role of the technocrats became increasingly important, particularly during 1985-1990. They tended to place more emphasis on the market approach. At the same time, the role of crony capitalists around Soeharto also became increasingly important, and interest groups began to emerge. Third, the econometric results show that the inter-industry variations in protection in the Indonesian manufacturing sector, were not simply random in nature. The trade protection was influenced by national policy preferences for social concerns and for developing the Indonesi1n manufacturing sector in 1975. Whereas, for 1986,1987 and 1995, trade protection was influenced by Soeharto's crony capitalists and interest groups. Fourth, as for the Indonesian automotive industry, there is evidence that the causality between rent-seekers and trade protection worked both ways, meaning that rent-seekers caused trade protection and vice versa. These results imply that both the interest group variant model and the national policy model are quite relevant in explaining the pattern of protection in the automotive industry in 1975-95. In contrast to the popular political economy studies on rent-seeking in Indonesia, which argue that economic policy (including trade policy) was very much State-centred, the case studies indicate that the role of major local business players, business associations, foreign principals and multilateral institutions was relatively strong in determining the policy of trade protection in the automotive industry. Fifth, the case study in the textiles industry shows that the relatively low level of trade protection after the mid 1980s was a result of bargaining and conflict between interest groups in up-stream and downstream industry. As a result, when the government liberalised the trade regime, there was no strong and coherent pressure for trade protection. In addition, there is evidence that the allocation of exports quotas attracted rent-seeking activities. This chapter also argues that the role of interest groups was relatively strong in influencing the policy of trade protection after the mid 1980s.