Indonesia's integration into the regional and global economies

Abstract

This study analyses Indonesia's engagement with the regional and global economies in terms of trade and investment. It aims to answer three research questions: 1) What are the impediments to Indonesia's trade flows? 2) Does trade protection applied to Indonesia's manufacturing products have an impact on the export performance in manufacturing sectors? and 3) What factors determine foreign direct investment (FDI) bilateral flows in Indonesia? The gravity model is used to answer these questions. The results show that Indonesia's trade flows are sensitive to trade impediments such as tariffs and non-tariff measures as well as to a lack of trade facilitation measures. Behind-the-border non-tariff measures are found to be particularly harmful to trade flows, while providing better trade facilitations at-the-border such as seaport and time to trade has greater impact on trade flows than that of behind-the-border provisions such as container transportation and shipping. The results also suggest that Indonesia's export measures such as export taxes, export quotas and export licencing requirements are negatively associated with manufacturing exports. This study shows that trade protection remains high in Indonesia due to the increasing use of non-tariff measures (NTMs). Furthermore, the lack of trade facilitation contributes to increasing costs of trade, especially those related to trade logistics and administration (red tape). The proliferation of NTMs and the lack of trade facilitation can inhibit Indonesia's further integration its economy into the regional and global economies. The results of the FDI study show that both horizontal (market access motivation) and vertical FDI (low cost inputs motivation) co-exist in the bilateral aggregate data of Indonesia's FDI flows, but the horizontal FDI appears to be more dominant. The dominance of the horizontal type of FDIs in Indonesia's bilateral FDI flows may deny the country's benefits from vertical FDI gains, which can otherwise help Indonesia to participate more in global production networks and thus create more jobs for the Indonesian workforce. Policy focuses on a reduction in Indonesia's NTMs, improving trade facilitation and encouraging vertical FDI is thus suggested in order to increase Indonesia's trade and FDI flows. If these policies can be consistently conducted, they should become powerful drivers of Indonesia's participation in the regional and global economies. Show more