DECEMBER 1996 INDONESIA: INDUSTRIAL TECHNOLOGY DEVELOPMENT FOR A COMPETITIVE EDGE By Darius Mans, Senior Industrial Economist, EA3IP INDONESIA DISCUSSION PAPER SERIES NUMBER 4 EAST ASIA AND PACIFIC REGION COUNTRY DEPARTMENT III SUMMARY INDONESIA: INDUSTRIAL TECHNOLOGY DEVELOPMENT FOR A COMPETITIVE EDGE Darius Mans Senior Industrial Economist, EA3IP There is growing consensus in Indonesia that technology development is central to the nation's efforts to improve productivity, efficiency and competitiveness and to sustain the rapid growth of its industrial sector. However, there has been inadequate promotion and diffusion of best practice technologies to help Indonesian industry compete better internationally. Now that the Government of Indonesia (GOI) has announced a major trade liberalization program to the year 2003, there is only limited time to begin to address the issue seriously. DISCUSSION PAPERS PRESENT RESULTS OF COUNTRY ANALYSIS UNDERTAKEN BY THE DEPARTMENT AS PART OF ITS NORMAL WORK PROGRAM. To PRESENT THESE RESULTS WITH THE LEAST POSSIBLE DELAY, THE TYPESCRIPT OF THIS PAPER HAS NOT BEEN PREPARED IN ACCORDANCE WITH THE PROCEDURES APPROPRIATE FOR FORMAL PRINTED TEXTS, AND THE WORLD BANK ACCEPTS NO RESPONSIBILITY FOR ERRORS. SOME SOURCES CITED IN THIS PAPER MAY BE INFORMAL DOCUMENTS THAT ARE NOT READILY AVAILABLE. THE WORLD BANK DOES NOT GUARANTEE THE ACCURACY OF THE DATA INCLUDED IN THIS PUBLICATION AND ACCEPTS NO RESPONSIBILITY FOR ANY CONSEQUENCE OF THEIR USE. INDONESIA: INDUSTRIAL TECHNOLOGY DEVELOPMENT TABLE OF CONTENTS Page No. Executive Summary ..................................................... i 1. Introduction and Analytical Framework ......................................... 1 2. Using Deregulation to Drive Industrial Technology Development...................... 7 A . O verview . ................................................................................................. 7 B. Indonesia's Deregulation Program .................................................................................. 7 C. The Im pact of Deregulation............................................................................................... 8 D. The Role of Overall Economic Policies in Technology Development ......................... 8 3. Improving Human Resources for Technology Development ................15 A . O veryiew ................................................................................................................................. 15 B. The East Asian Experience of Investing in Human Resources for Technology ........15 C. Improving the Quality of Indonesia's Human Resources for Technology ................ 17 4. Maximizing the Use of Foreign Technology...........................................................21 A . O verview ................................................................................................................................. 21 B. Indonesia's Approach to the Acquisition of Foreign Technology ............................... 21 C. The Experiences of Other East Asian Countries........................................................... 22 D. Lessons of Cross-Country Experience ............................................................................ 26 5. Financing Technological Activity ..... ................................................................ 29 6. Focusing Indonesia's Technological Support Institutions....................................33 on Effective Technology Diffusion A . O verview ................................................................................................................................. 33 B. The Experiences of the East Asian Industrializing Economies .................................. 33 C. The Limited Contribution of Indonesia's Public Technology Support ...................... 38 Institutions D. Other Technology Support Services .............................................................................. 43 E. The Strategic Industries .......................................... 47 7. Summary and Conclusions ...................................................... 49 A nnexes .........................................................................................................................................53 This report was prepared by Darius Mans (Task Manager), with contributions from Ramesh Mashelkar, Sanjaya Lall and Thee Kian Wie (Consultants). Francine Coscolluela was responsible for document pro- cessing. Deborah Davis was responsible for editing and Melissa Fossberg for the layout of the report. I N DON E S I A D I S CU S S i. o N P A P E R S E R I E S LIST OF TEXT TABLES, FIGURES AND BOXES Text Tables: Table 1.1 Links Between Stages of Export Marketing and Industrial Technology Development Table 2.1 Technological Capability Rating, Engineering Industries Table 6.1 R&D Expenditures and Sources of R&D by Country, 1990 Table 6.2 Degree of Self Financing of Selected Public R&D Systems Figures: Figure 1.1 TFP Growth in East Asia and Other Regions Figure 1.2 Technology Development: The Strategic Elements Figure 5.1 Real Average Annual Interest Rates in East Asia Figure 6.1 Improved Production and Management Practices (Shoes) Figure 6.2 Improved Production and Management Practices (Printed Circuit Boards) Boxes: Box 4.1 Singapore's FDI Strategy Box 4.2 Local Content Provisions and Singer in Taiwan Box 6.1 Technology Marketing in an MOIT R&D Laboratory Box 6.2 Recommendations for Reform of MOIT Labs Box 6.3 Cost Sharing Grant Schemes to Facilitate Public and Private Technology Extension Services Annex Tables: Annex Table 1 Analysis of the Activities in the Institutions Visited Annex Table 2 Assessment of the Institutions Visited at a Glance N D 0 N E S I A D i s c u s s i o N P A P E R S E R IE S ABBREVIATIONS AND ACRONYMS APEC Asia Pacific Economic Cooperation BPPI Agency for Industrial Research and Development, MOIT BPPT Agency for the Assessment and Application of Technology FDI Foreign Direct Investment GATT General Agreement on Tariffs and Trade GOI Government of Indonesia GDP Gross Domestic Product HKPC Hong Kong Productivity Center HPEACs High Performing East Asian Countries ITD Industrial Technology Development ITDP Industrial Technology Development Project ITRI Industrial Technology Research Institute (Taiwan, China) KIM National Institute of Metrology, LIPI KTDC Korea Technology Development Corporation LIPI Indonesian Institute of Sciences MENRISTEK State Ministry of Research and Technology MOI Ministry of Industry MOIT Ministry of Industry and Trade MNCs Multinational Corporations MSTQ Metrology, Standards, Testing and Quality OEM Original Equipment Manufacture NIEs Newly Industrialized Economies PTSIs Public Technology Support Institutions PUSTAN Center for Industrial Standards, MOIT R&D Research and Development RD&E Research, Design and Engineering S&T Science and Technology SDF Skills Development Fund SMEs Small and Medium Enterprises TDC Technology Development Center (Singapore) TSGs Technical Service Groups VITB Vocational and Industrial Training Board (Singapore) N0 0 N E S I A D i s c u s s i o N P A P R SE R I E S Executive Summary 1. There is growing consensus in Indonesia that 2003, there is only limited time to begin to technology development is central to the nation's address the issue seriously. efforts to improve productivity, efficiency and 2. International experience shows that competitiveness and to sustain the rapid growth macroeconomic stability, procompetition of its industrial sector. However, there has been economic policies and the development of inadequate promotion and diffusion of best prac- human resources are the basic conditions tice technologies to help Indonesian industry required to promote industrial technology compete better internationally. Now that the development. Although these are necessary Government of Indonesia (GOI) has announced conditions for industrial technology devel- a major trade liberalization program to the year opment, they are not sufficient to sustain it. It also is important to have policies that ensure access to foreign technology, foreign direct in- vestment, financing for technology development, and technology support services. 3. This report identifies three priorities for technology development strategy: * Maintain macro policies which encourage firms to make long-term investments in technol- ogy development; c Continue economic deregulation so that firms will have to upgrade their technology to re- main competitive; I Upgrade the quality of human resources for technology development. To improve the enabling conditions for industrial technology development, the major priorities are to: 3 Improve Indonesia's access to foreign technology by expanding the role of foreign trade companies and buyers and improving technology licensing procedures and intellectual prop- erty protection; * Make greater use of foreign direct investment as a tool for technology development; * Strengthen the policy and institutional framework for financing technology development, Tand carefully target fiscal incentives for technology development; * Reorient public technology support services toward effective diffusion of best practice tech- nologies to industry and promote the private provision of those services. Within this framework Indonesia should let the market play a greater role in developing tech nology intensive industries. BAsic CONDITIONS good track record. Nevertheless, its real in- 4. Macro Policies. Chapter 1 notes that stable fis- terest rates are high compared to those of cal, monetary and foreign exchange policies are other countries in the region. Prudent essential to reduce the risks of investing in tech- macroeconomic policies and financial sector nology development, which often has a long ges- improvements to reduce risk are essential to tation period. In this regard, Indonesia has a very bringing down Indonesia's high domestic real I N DO N E S I A D i sC U S S i 0 N PA P E R S K R I E S EXECUTIVE SUMMARY interest rates and increasing the availability universities, and good management training and of term finance. development programs are key building blocks 5. Deregulation. Technological capabilities at for sustained industrial technology development the firm level are driven by the overall incen- and for enabling a country to respond flexibly tive framework. A competitive environment to rapid economic and technological change. is a prerequisite for rapid adoption and dif- Indonesia has made major strides in this regard fusion of new technology, effective choice, by developing basic skills among its labor force, and efficient use of technology. As noted in including a rapid rise in the stock of technicians, Chapter 2, the overall policy environment is engineers and scientists. But despite substantial far more important than any specific technol- improvement in the quantity of education and ogy policies or other interventions to encour- training, the quality of that training, including age firms to increase productivity and qual- management training, needs improvement. ity or to innovate. A key lesson from the ex- 8. Chapter 3 identifies the priority measures In- periences of the high-performing East Asian donesia needs to take to improve the quality of countries is that an outward-oriented and education and training for technology develop- procompetition policy environment is criti- ment, and to increase the utilization of its exist- cal for industrial technology development. In ing stock of scientific, technical, engineering and Indonesia, continued liberalization of exter- managerial talent. These priorities are to: nal trade, as planned in the context of its raise the quality of primary and secondary APEC and GATT commitments, as well as education to provide the basis for subsequent policies to promote greater domestic compe- training, and place greater emphasis on train- tition, will drive firms to strengthen their ing technicians and craftsmen rather than technological capabilities. scientists and engineers; 6. Continued deregulation also could put facilitate the private provision of high qual- more pressure on Indonesia's conglomerates ity pre-employment and in-service training, to increase their contribution to technology by establishing transparent licensing and ac- development. This is surprisingly low, given creditation of private training institutions, their substantial human and financial re- and developing systems for national skills sources. The dominant firms among them are standards and certification and for accredi- insulated from competition and are almost tation of all technical and vocational train completely concentrated on protected domes- ing schools; tic markets. Trade liberalization and deregu- lation of domestic markets and distribution undertake more effective measures to foster channels should encourage them to acquire employer-provided training, as noted in the the technological capabilities needed to move World Bank's recent report on Training and up the value added ladder and be more com- the Labor Market in Indonesia (Report No. petitive internationally. Government should 14413IND) also encourage rivalry for any type of assis- improve industry's links with public tech- tance it gives to firms and insist on demon- nology support institutions and research uni- strated results. versities, since that is where most of 7. Human Resources. A broadly skilled labor Indonesia's scarce scientific, technical and force, an effective technical training system, engineering talent is located; strong science and engineering faculties at N 0 0 N K S I A D i S C U S S 1 0 N P A P E R S E R I E S torpdeoomcadtcnloia hne EXECUTIVE SUMMARY * increase the utilization of returnees from dertake minor process improvements, en- overseas training fellowships through better hancing productivity and product quality. human resource planning and staff deploy- This is the stage where many Indonesian ment, and by making the bonding system firms are now. However, elsewhere in East more transparent; Asia many leading firms were able to move * improve the quality of domestic university on from that stage to become original equip- and graduate education, particularly in en- ment producers for multinationals based on gineering and the natural sciences; their cost competitiveness and ability to con- gineringsistently deliver products to precise specifi- * strengthen formal management training pro- cation. Gradually, firms in Japan (and, more grams and use foreign direct investment recently, Korea) developed product design more effectively as a vehicle for training fu- skills and significant capabilities to carry out ture generations of Indonesian managers. research and development for products and ENABLING CONDITIONS processes in competition with Western mul- tinationals. 9. Access to Foreign Technology. Chapter 4 notes 11. While Indonesia's policies governing ac- that the central issue of technology development cess to foreign technology have been rela- in Indonesia is acquiring the capability to use tivel liberal foreign tradin companies technology developed abroad and adapting it to y g g r Indonesian conditions in order to produce more soule eouraed o pl a egrear competitively. The purpose of technology devel- a ale sorces o ea deign opment is not to acquire the capability to invent mareting omo toperoreign technology but to acquire and effectively utilize buyers, especial ofime mpeprcts existing technology. This was the development lare orinal e etmanufcture by strategy followed by Japan and other high-per- aecom anies lrcs colo forming East Asian countries. In contrast, until em siict sources of ogy the late 1980s, India pursued an inward-oriented tranfr. le thesen are fore at approach to technology developmenttively promote them by allowing foreign in- rigid controls on technology acquisition and high vestment in wholesale trade. Reduction of the import barriers. This isolated many Indian en- high rates of effective rotection on engeer- terprises from technological developments in the . rest of the world, and as a result, they tended to g products would also improve firms' ac- lag behind international standards in terms of cess to technology Improvements in technol- technologyogy licensing procedures and the administra- t0Ehnoogyen de efficien tclg d v lp tion of intellectual property rights are also 10. Experience shows that technology develop-needed. ment in the high-performing East Asian coun- 12. Use of Foreign Direct Investment. Indo- tries was stimulated by the discipline of having nesia attracts substantial amounts of foreign to meet export requirements. Based on low wage direct investment. However, international rates, firms initially built up basic production capabilities through simple assembly of mature comparisons indicate that it is not using that products for export, often using technical assis- investment effectively for lechnological gain. tance provided through foreign buyers. Success- Among the reasons are high required facili- ful firms took advantage of this learning period tation payments, costs of infrastructure ser- detak inorqut processiprosveent,ren to develop some independent capability to un- v in ut and p aty TN D 0 N E S I A D I S C U S S 0 N P A P E R S E R I S firm arenow Howver elswhee inEas EXECUTIVE SUMMARY space, the lack of transparency and lengthi- the confidence to finance technology develop- ness of approval processes, and the past prac- ment projects of ITDP beneficiary firms. tice of forced marriages between foreign and 14. Experience elsewhere is that traditional tax local investors. These impediments need to incentives to promote technology development, be overcome if Indonesia is to extract more e.g., accelerated depreciation allowances and re- transfer of technology from foreign direct in- search and development tax credits, tend to ben- vestment. Indonesia also will need to build efit larger firms disproportionately. They rarely up a skilled labor pool (para. 7) and take a generate much additional research and develop- more proactive approach to attracting the ment beyond that which those firms would un- kind of foreign direct investment needed for dertake without such incentives. To improve the effective technology transfer, as Singapore, payoff from the fiscal resources available for in- Malaysia, Thailand and the Philippines have dustrial technology development, it would be done. Development of supplier industries better to use them to finance carefully targeted will be essential. In this regard, Indonesia programs. For example, the technology match- should encourage development of backward ing grant program of ITDP, a program supported linkages as have Singapore and Taiwan, by the World Bank, helps small and medium- China. Instead of relying on import barriers sized enterprises (SMEs) to adopt new technolo- and local content requirements, they have gies and improve productivity using existing emphasized provision of low-cost, user- technology. driven technology, training and marketing 15. Technology Support Services. Chapter 6 support programs. These programs have been carried out in conjunction with directpoints out that effective technology support ser- toe laridoal suier romn mtintion al drc vices are also needed to help firms improve their support totechnological capabilities. These services include investors with significant purchasing needs who were willing to help reduce costs, MeTo s tndars tes an q ty shorten lead times, improve flexibility and tQsu Tis involves,oaong ter reducetional standards and assistance to firms seeking 13. The Availability of Finance for Technol- ISO 9000 certification; industrial extension ser- ogy. As noted in Chapter 5, another critical vices to help firms improve productivity, qual- element for industrial technology develop- ity, delivery times and product designs; and in- ment is the availability of financing. For tech- formation services that keep firms up to date on nology-intensive industries, it is important best practice, globally competitive technologies. that entrepreneurs do not lack financing as The major issues are how to make the existing they attempt to move into competitive inter- technology support institutions more proactive, national markets. In this regard, Indonesia's market driven and commercially oriented. In this efforts to improve the tax treatment of ven- respect, Indonesia's public technology support ture capital funds are noteworthy. The avail- institutions are substantially behind those in ability of term financing .for investments in competitor countries in the region. The private technology upgrading would be improved, provision of technology support services in In- however, by strengthening the appraisal ca- donesia is rare. In other Asian countries the use pacity of the banking system. Approval from of publicly backed private firms is increasingly the technology service providers supported common. under the recent Industrial Technology De- velopment Project (oTDP) should give banks 1N D 0 N E S I A D i s c u S S e 0 N P A P E R S E R I E S iv EXECUTIVE SUMMARY 16. GOI has recently adopted an Action Plan to across industries, rather than trying to de- improve the provision of technology support ser- velop a full range of capabilities in par- vices. The Plan, to be supported by the World ticular subsectors; Bank, calls for four main actions: getting the private sector to play a cen- * create incentives for technology support in- tral role in formulating the strategies and stitutions to become more demand driven, policies of the public technology support commercially oriented, and self financing; institutions through membership on their * reduce government controls to encourage boards of directors and advisory councils these institutions to become more responsive and by bringing people with substantial to the technology needs of industrial firms, industrial experience into their top man- while also increasing their accountability for agement. results; 18. Developing Technology Intensive Indus- * implement management reforms in the in- tries. Chapter 6 also notes that the centerpiece stitutions to make them more efficient; of Indonesia's efforts to promote industrial technology development has been the acqui- * encourage private provision of technology sition of technological and manufacturing support services and competition among capabilities in state-owned strategic indus- public and private technology service pro- tries which have provided valuable interna- viders. tional training opportunities and exposure for 17. Greater accountability of the public technol- Indonesian scientists and engineers. The chal- ogy institutions could be achieved by linking lenge now is to deploy those valuable indus- government funding to each institution's earn- trial resources for maximum economic gain ings from sale of technology, technology licens- by clearly separating technology develop- ing, contract and joint research with industry, ment objectives from manufacturing activi- management consultancy, training and testing ties, and by putting the latter on a fully com- services. In other countries, the matching funds mercial basis. The provision of infant indus- approach has resulted in more professional, mar- try protection and monopoly status for those ket-responsive and outward-looking systems of industries through trade and investment bar- R&D management within public laboratories. In- riers and preferential treatment in govern- centives to commercialize research could also be ment procurement should be phased out ac- enhanced by clarifying the rules under which cording to preannounced schedules to ensure laboratories can set up subsidiaries and take eq- their maturation. Labor mobility into and out uity positions in companies that utilize the tech- of the strategic industries also needs to be en- nologies they create. There may also be scope for couraged to increase technological spillovers further restructuring of the public technology and the spinning off of new companies. support institutions by: 19. Large government investments in new * merger and consolidation of institutions that R&D projects in the strategic industries serve similar client bases but report to dif- should be strictly limited in the interest of ferent ministries; maintaining fiscal balance. Experience else- closing institutions that cannot function com- where (e.g., Korea, India and Brazil) shows mercially;that concentrating government investment in mercilly;heavy industries and advanced technologies * reorganization of labs along functional rather leads to much less efficient growth, with high than sectoral lines to meet generic needs *N D 0 N E S I A D i s c u s s i N P A P E R S E R I S V EXECUTIVE SUMMARY capital output ratios and slow increases in continuing government support and protection. consumption. Indonesia's scarce public re- As long as the governent has laid the proper sources could be used instead to help sup- foundation by creating an environment condu- port low risk but potentially high payoff in- cive to innovation, ensuring that high-technol- vestments in restructuring and modernizing ogy entrepreneurs do not lack financing, by im- the rest of the country's technological infra- proving the quality of human resources for in- structure. This infrastructure has been rela- dustrial technology development, and by seeing tively neglected and is in danger of not being to it that there is an effective infrastructure of able to meet the needs of private industry. technology support services, competitive mar- Private investment, and foreign direct invest- kets should be allowed to decide which firms ment, in particular, should be used to develop and industries will flourish or perish. technology-intensive industries, rather than using state-owned enterprises which require IN D 0 N E S I A D j S C U S S 1 0 N P A P E R S E R I E S Ae CHAPTER I INDONESIA DISCUSSION PAPER SERIES Industrial Technology Development for Competitive Gain: Introduction and Analytical Framework By Darius Mans, Senior Industrial Economist, EA3IP D eveloping the capability to effectively use technology and upgrade it over time is the basis of industrial technology development (ITD). This capability includes gaining the skills necessary for enterprises to set up a plant, run it efficiently, improve and expand it over time, and develop new products and processes. ITD is an integral part of the process of efficient industrial development. Is ITD IMPORTANT? THE IMPORTANCE OF ITD TO 1.02 The effective use of technology is essential to PRODUCTIVITY: THE MAcRo EvIDENCE maintaining and diversifying a country's industrial 1.05 The East Asian Miracle Study noted that base in an increasingly competitive world market total factor productivity (TFP) growth has been where technological change is constantly altering the an important source of growth for many of the basis of competition. The accelerating pace of techni- high-performing countries of East Asia and that cal change in industry is leading to shorter product technological capabilities have played an impor- life cycles. In addition, new technologies, such as elec- tant role in TFP growth.' However, Indonesia's tronics and communications, are changing the way growth, like that of Malaysia and Singapore, has the world does business in traditional as well as new been driven mainly by investment, i.e., by the ac- industries. cumulation of physical and human capital, rather 1.03 Factor cost advantages are being replaced by than by productivity, as it has been in South Ko- technology-related factors such as zero-defect prod- rea, Hong Kong, and Taiwan, China. The growth uct quality and international certification of firms' of total factor productivity in Indonesia has been quality assurance systems (e.g., ISO 9000) in deter- very low compared to other countries in East Asia mining international competitiveness. Central (Figure 1.1). to maintaining competitiveness is the ability Figure 1.1: TFP Growth in East Asia and Other Regions of producers to respond quickly and effectively 1960-1 989 to changing demamainds in the international mar- the ket, giving those with the best links to mar- kets and the greatest flexibility the competi- Hong Kongg tive advantage. Korea fd inI a 1.04 Technology upgrading has been a core Thiland m t o c element of the competitiveness strategy for all Singuore industrializing countries. In Indonesia, as well, abiltysig improving firms' technological capabilities is1960-1989 an important element in the overall strategy Malay to improve productivity and efficiency. Latin America East Ulu Sb-Sohrran Africa 3 Other Regions -1 -(.5 01 0.5 1 1.5 2 2.5 3 3.5 4 Source: World Bank, The East Asian Miracle, Oxford University Press, 1993. IN D 0 N E S I A D i s C U S S i 0 N P A P E R S E R I E S I INTRODUCTORY AND ANALYTICAL FRAMEWORK 1.06 There was no statistically significant in- diversify sources of competitive advantage. This ne- crease in Indonesia's TFP from 1979 to 1985. cessitates TTP growth. Nearly all growth during this period was due to the accumulation of physical and human capital. However, the series of deregulation packages in- AT THEFIRM LEVEL troduced by the government beginning in 1985 1.10 There is substantial evidence that technology have had a substantial impact on productivity. plays an important role in determining efficiency and TFP growth increased by 1.95 percent per annum competitiveness at the firm level. For example, a re- from 1986 to 1992 and accounted for over 30 per- cent World Bank survey of SMEs in Indonesia, Ma- cent of per capita economic growth during that laysia, Mexico, Colombia and Taiwan, China, shows period.2 strong statistical links between technology related fac- 1.07 Indonesia's ability to generate sustained tors and firm-level efficiency. TFP growth is important for three reasons. First, 1.11 While there are Indonesian firms with tech- Indonesia's TFP growth rate is significantly be- nological capabilities at or very near world standards, low that of nearly all of its regional competitors. these are the exceptions. As discussed in Chapter 2, Second, the average annual rate of productivity the technological capabilities of most Indonesian growth in Indonesia is 1.2 percent below that of manufacturing firms are extremely limited. This ad- the high-income countries. This may be an indi- versely affects the ability of the industrial sector to cation that the already substantial gap between respond to the challenges, not only of increasing in- international best practice technologies and aver- ternational competition from other low-wage coun- age practice in Indonesia may be rising, something tries, but also from trade liberalization within the con- which could affect its long-term industrial com- text of GATT and APEC. Indonesia needs to address petitiveness. constraints on ITD as an important part of its overall 1.08 Third, Indonesia's slow productivity strategy for sustaining rapid growth of manufactured growth is a matter of great concern because the exports and improving industrial competitiveness. natural resource sectors-oil, natural gas and for- estry-cannot sustain rapid growth over the long WHT DIVES ITD? term. Indonesia is likely to become a net oil im- 1.12 Macroeconomic stability, procompetition porter in ten years. Soon after the year 2000, natu- economic policies, and the development of human ral gas exports could drop sharply unless new dis- resources are necessary but not sufficient conditions coveries are made. In the forestry sector current for ITI. The enabling conditions for technology de- cutting rates exceed sustainable levels. Therefore, velopment must be created through policies that af- the manufacturing sector will need to continue its fect access to foreign technology, foreign direct invest- rapid expansion to keep Indonesia on a high ment, financing for technology development, and growth path. technology support services. Figure 1.2 illustrates the 1.09 Continued rapid industrial growth will main strategic elements that influence industrial tech- have to come from productivity gains. This is par- nology development. An integrated approach that ticularly important in light of increasing compe- addresses each of those elements is required to pro- tition from other low-wage countries, since inter- mote ITI successfully.' national capital will increasingly flow to countries THE BAsic CONDITIONS FORITD with the best prospects and conditions for pro- ductivity gains. Industrialization based on low 1.13 The Overall Incentive Framework. TFP growth proved possible at the early stages of Macroeconomic and procompetition policies provide Indonesia's industrial development. However, for the overall framework of incentives for firms to un- Indonesia to sustain rapid industrial growth, it dertake the long-term planning and investment re- will need to bring traditional manufacturing ac- quired to develop technological capabilities. Stable tivities up to modem levels of efficiency and to fiscal and monetary policies are essential to mitigate N D 0 N E S I A D j S C U S S 0 N P A P E R S E R I E 2 CHAPTER I the risks of investing in technology development, and risks. Search, experimentation, and learning which often has a long gestation period. In addition, can be prolonged and expensive. Many East Asian as demonstrated by the experiences of the high-per- governments have used technology policies to forming East Asian countries, a competitive environ- help firms move along the learning curve for ment is one of the prerequisites for technology up- adopting new technologies. They have also inter- grading. Competition is the fundamental force com- vened to encourage positive technological exter- pelling firms to invest in technological development.' nalities through spillovers to other firms. In addi- 1.14 Human Resources for ITD. Technological ca- tion, they have undertaken demonstration projects pability requires people, not just machinery. In the for firms which, for lack of information, may un- process of acquiring, using, improving and develop- derestimate the value of and need for technology ing technology, a key input is the human resource improvements. On the supply side, there is im- base. This requires an education system that, at the perfect information about available technologies. primary and secondary levels, provides a good basic 1.16 In addition to pursuing policies aimed at education, including solid training in technical and macroeconomic stability, the promotion of com- engineering-related areas, enabling workers to make petition and development of human resources, local adaptations and improvements on the shop floor. government technology At the university level, it is necessary to produce policies, programs and in- graduates who can monitor and assess technological stitutions have played other trends and help develop a strategy for taking advan- important roles in the ITD COMPETITION tage of those trends. In addition, technically trained process in East Asia. These HAS TO BE THE and qualified workers are needed at all levels to as- roles include establishing similate, adapt, and improve technology obtained policies to: promote access from abroad, and to develop and manage new tech- to foreign technology, at- DRIVING FORCE nology. Because of the rapidly changing nature of tract foreign direct invest- COMPELLING FIRMS technology, ITD also requires on-the-job training to ment as a tool for technol- continuously upgrade Worker skills. ogy development, make fi- TO INVEST IN THEIR nancing available for ID, TECHNOLOGICAL THE ENABLING CONDITIONS FOR ITD and provide effective tech- 1.15 In addition to these basic conditions for ITD, nology support services. DEVELOPMENT. there are important supply and demand issues that 1.17 Access to foreign need to be explicitly addressed. On the demand side, technology. Foreign tech- technology upgrading often involves substantial costs nology can be acquired in many ways. These in- dlude formal arms-length transactions such as for- Figure 1.2: Technology Development: The Strategic Elements eign direct investment (FDI), technology licens- _tg agreements, import of capital goods, and for- OVERALL eign education and training. While these modes INCENTIVE HUMAN of technology transfer are important, much tech- RESOURCESnology transfer takes place through less formal FRAMEWORK means, such as copying or reverse engineering and participating in world trade. In fact, positive technological externalities from a heavy orienta- FIRMS tion toward exports is one of the most important explanations for the high TFP increases of many FOREIGN of the high-performing East Asian economies SUPPORTAL TECHNOLOGY (HPEACs) such as Korea and Taiwan, China. government1.18 Much technology development in the SERVICES FINANCE HPEACs has been export led. Based on low wage rates, firms built up basic production capabilities IN D 0 N E S I A D I S C U S S 1 0 N P A _P E R S E R I 1E S 3 INTRODUCTORY AND ANALYTICAL FRAMEWORK through simple assembly of mature products Te 1.1 Lnks Between Stages of Export Marketing for export, often with the technical assistance and Industrial Technology Development of foreign buyers. Successful firms used this assembly-based, learning period to develop their capacity to undertake minor process im- Marketing states Technology stages provements, enhancing productivity and product quality. From there, many leading 1. Passive importer - pull Assembly skills, basic production firms in East Asia were able to become origi- Cheaplabour assemblycapabilities nal equipment manufacture (OEM) producers Dependent on buyers for Mature products for multinationals based on their cost competi- distribution tiveness and ability to consistently deliver products to precise specification. Gradually, 2. Active sales of capacity Incremental process changes for they developed product design skills and later Quality and cost-based quality and speed gained significant capabilities to carry out Foreign buyer dependent Reverse engineering of products R&D for products and processes in competi- tion with Western and Japanese multination- 3. Advanced production sales Full production skills als. Table 1.1 shows the links between export Marketing dept. established Process innovation marketing and ITD.1 In effect, this process of Starts overseas marketing Product design capabiity export-led technology development, which Markets own designs has been essential in the HPEACs, turns on its head the traditional Western model of inno- 4. Product marketing push Begins R&D for products and processes vation, where the entry point is R&D leading Sells direct to retailers to export success and the development of and distributors overseas Product innovation capabilities products which eventually become mature. Builds up product range 1.19 Foreign Direct Investment. For many Starts own-brand sales countries foreign direct investment (FDI) plays an important role in transferring management 5. Own-brand push (ompettive R&D capabilities expertise and access to export markets, pro- Markets directly to customers R&D linked to market needs viding access to global information and tech- Independent distribution Advanced product/process nology networks. One of the most important channels, direct advertising innovation determinants of successful technology upgrad- In-house market research ing and expansion of local technological ca- pabilities in East Asia has been the ability to Source: Hobday, Innovation in East Asia (1995) attract FDI and make effective use of it in pro- moting supplier industries and building up a pool and only large firms that can cross-subsidize techno- of skilled labor and local managers, as well as en- logical activity are able to undertake serious R&D. trepreneurs who later establish their own firms. Capital market failures of this sort are recognized in Qualboth developed and developing countries, especially 1.2 s inanecnlg Tevelopmen s abt o fi c re inve the financing of smaller technology startups. Many ciallement thogy TDelopmlentlso ilsa - of the newly industrialized economies (NIEs) have ization, when firms use easy technologies with lauctivity,iun staihemet o funcnds frcvnturey low capital requirements and limited possibilities apita ie Pc, in n ovation, SMEa upgrain g and inur for improvements, the absence of specialized tech-a ting i l nology finance may not be a major handicap. As restructuring. In addition, many countries have used 4.an array of tax incentives to promote technology de- industrial evelopmentproceeds,towever,rseo easicudn aclrodcnation depabiition D takes the form of long-term and risky investments obandot rel ated sales ceis in new technologies. The local financial system is mre ne not usually geared to financing such investments, N t 0 N S I A D i s c u s s i 0 N P A P R S R I E 4 CHAPTER I 1.21 Technology Support Services. To enable the ENDNOTES effective use and diffusion of technological informa- 'World Bank, The East Asian Miracle, Oxford Uni- tion, appropriate networks of support services must versity Press, 1993. be developed to keep up with technology trends, both worldwide and locally, and help local firms use this 2World Bank, Indonesia: Stability, Growth and Eq- information to improve competitiveness. One impor- uity in Repelita VI, Report No. 12857-R-D, p. 25. tant part of that infrastructure is the system of me- 3A recent review of World Bank lending for In- trology, standards, testing and quality control (MSTQ) dustrial Technology Development (Report No. which is essential to meeting increasing demands for 12138), carried out by the World Banks Opera- quality products at the lowest cost in international tions and Evaluation Department, highlighted the markets. Technology extension services also can play importance of such an integrated approach. an important role in helping SMEs reduce costs and This contrasts with early economic models in delivery times and improve productivity, product which economic monopolies were considered es- quality, and product design and development. In the sential to technology development because mo- early stages of industrialization, such services are pro- nopoly profits could provide deep pockets to fi- vided mainly by public technology support institu- nance large R&D budgets. tions. Later, private providers play an increasing role. 1.22 R&D institutions also important for ITD. However, their role changes over time. In most de- eg 199,provd ell-dcument cs sud- veloping countries, these institutions can make an im- iesof eorlet ng dvlm n by suc- portant contribution by supporting the acquisition, Singapore, Korea and Taiwan, China. assimilation, adaptation and improvement of technol- ogy obtained primarily from abroad. Additionally, some R&D can be focused on special problems, such as the use of local raw materials or specific produc- tion problems and product characteristics of the local environment. It is only as the economy matures that more basic research is needed. For example, as its in- dustrial sector developed, Korea required more ad- vanced technology, but had difficulty acquiring it from abroad. The private sector then started to invest heavily in its own R&D, and, as a result, the publicly funded R&D institutes are now redefining their role and are moving into more basic, precommercial re- search. 1.23 The subsequent chapters review each of these elements of Indonesia's basic and enabling conditions for ITD. They draw on the experiences of other Asian countries to make recommendations for Indonesia's strategy for promoting industrial technology devel- opment. IN D 0 N _E S I _A D i s c u s s i 0 N P A P E Rt S E R I E S. ENDNOTE  CHAPTER 2 Using Deregulation to Drive Industrial Technology Development A. OVERVIEW reform of the customs administration by 2.01 Aimed at achieving macroeconomic stability, transferring customs surveillance for nearly trade growth, and deregulation of the economy, all imports to a reputable private company; Indonesia's economic policies have led to rapid in- 9 the provision of free trade status for export- dustrialization and, in particular, to the rapid growth ers through the introduction of duty draw- of industrial exports. These policies have also played back schemes. a central role in promoting ITD by encouraging firms 2.04 The second pillar of the reform program to improve productivity, product quality and prod- has been the progressive deregulation of the in- uct design. However, many firms' technological ca- vestment regime, including: pabilities remain extremely limited, adversely affect- ing Indonesia's ability to remain competitive. Con- replacing a highly complex investment licens- tinued deregulation of external trade and domestic ing list, involving over 7,000 subsectors, with competition is essential to compel firms to upgrade a short negative list and gradually reducing their capabilities in order to improve productivity and the number of activities on the negative list; competitiveness. simplifying investment approval procedures B. INDONESIA'S DEREGULATION PROGRAM by reducing the number of requirements; 2.02 Since 1985/86, Indonesia's rapid economic providing incentives in the form of duty-free growth has been led by annual increases of 10 per- imports of machinery, equipment and inputs cent in the manufacturing sector. Economic reform needed for initial production; policies have played a major role in stimulating in- encouraging FDI by providing foreign inves- dustrial growth. Maintaining macroeconomic stabil- tors the same incentives as those accorded to ity through the judicious use of fiscal, monetary and domestic investors. exchange rate policies has been at the core of the re- form program. Since 1986 the government has also The deregulation packages of 1994/95 removed introduced several deregulation packages to get rid virtually all barriers to foreign investment and of the restrictions put in place during the previous have made Indonesia, at least on paper, one of the era of inward-oriented economic policies. most competitive FDI regimes in East Asia (Chap- 2.03 The deregulation process has focused on three broad areas: trade reform, investment deregu- 2.05 Third, substantial reform measures have lation and financial sector reform. In the trade regime been undertaken in the financial sector, includ- there has been: ing: * a substantial reduction in the coverage of nontariff 0 abolishing credit ceilings, barriers in manufacturing production; 0 eliminating interest rate controls, * a gradual lowering of tariff ceilings and the num- 0 reducing subsidized directed credits, ber of tariff rates, including a schedule announced in mid-1995 to reduce tariffs to an average level of 7 percent with a standard deviation of only 4 banks, percent by 2003; including joint ventures with foreign banks, introducing measures to develop capital mar- kets. I N D 0 N h S I A b i s c u s s i 0 N P A P E Rt S R I E S 7 USING DEREGULATION TO DRIVE INDUSTRIAL TECHNOLOGY DEVELOPMENT C. THE IMPACT OF DEREGULATION D. THE ROLE OF OVERALL ECONOMIC 2.06. These measures have generated a strong POLICIES IN TECHNOLOGY DEVELOPMENT response from the private sector, including a boom 2.08 Indonesia's general economic policies have in private investment and rapid growth in out- also heavily influenced the pace of industrial tech- put, nonoil exports, employment, and labor pro- nology development. Indonesia's pro-export policies, ductivity. The manufacturing sector has led the i particular, have strengthened linkages of local firms recovery of overall GDP and helped wean the with the world economy and have led to substantial economy from its extreme dependence on oil. technology upgrading. Indonesian manufacturers Growth in manufacturing averaged 12 percent a have found ways to improve their technological ca- year from 1986 to 1994, increasing its share in GDP pabilities by meeting world market requirements for from less than 12 percent to over 20 percent, and product quality, learing to manufacture to buyers' almost tripling its absolute size from about $10 specifications and acting as subcontractors to foreign billion to $28 billion. In contrast to the period 1980- finms. In addition, import liberalization has also im- 85, when a large proportion of growth originated proved firms' access to foreign technology. In Indo- from large capital-intensive activities, labor-inten- nesia, as in all of the high-perfoming economies of sive sectors contributed most of the growth after East Asia, expanding trade has resulted in improved 1986. Growth in manufacturing employment and technological performance. labor productivity averaged 7 percent a year, a rate 2.09 Economic deregulation since 1986 has also almost double that of the rest of the economy. The led to rapid expansion of investment, including FDI. manufacturing sector contributed about 30 per- Indonesia's macroeconomic and political stability has cent of the growth in both nonoil GDP and total provided a favorable environment for private sector employment. investment in modernization of plants and equip- 2.07 There has also been significant structural ment. In the late 1980s, private investment in new change in manufacturing which has become in- plants and equipment boomed; investment in real creasingly outward oriented since the mid 1980s. terms in 1990 was three times the level of ten years From 1985/86 to 1992/93, manufactured export earlier. This private sector-led, dynamic process of growth averaged about 30 percent, doubling the acquiring technological capabilities by exploiting sector export-to-output ratio to almost 20 percent. trade and investment linkages has been the principal Exports contributed over 40 percent of manufac- driving force for technology upgrading. Today, there turing sector growth during the period, compared is hardly a firm that does not have a technology link to only 13 percent during 1980-1985. The sector abroad through FDI, technology licensing agree- contributed about three-fourths of overall nonoil ments, contacts with suppliers of equipment, or for- export growth, as the share of manufactured ex- eign buyers. ports in total nonoil exports (and total exports) 2.10 On the other hand, some of Indonesia's eco- increased from 38 percent (12 percent) to 63 per- nomic policies have adversely affected the pace of cent (about 50 percent) between 1985/86 and industrial technology development. Previous restric- 1994/95. Continued strong manufactured export growth is also considered the key to Indonesia's economic performance during the current Sixth policies stymied the development of industrial tech- FiveYea Deelomen Pla, RPELTAV, wichnology. For example, experimentation with local con- Five Year Development Plan, REPELITA VI, which tn ue nteatmtv nutyecuae covers the period 1994/95-1998/99. The Plan has ot of the dom ti indus t ecostaof programmed nonoil exports to increase by 17.8 g percent a year in dollar terms, compared to 17.9 percent yearly growth realized during REPELITA prices and lack of competitiveness in the auto parts industry. The complex investment licensing process limited incentives for firms to innovate and increase N D 0 N E S I A D is c u s s i 0 N P A P E R S ke R I E S wihtewrdeooyad8aeldt usata CHAPTER 2 productivity. Now, greater domestic competition is of their output. This dualism was encouraged by being encouraged through progressive deregulation a trade system which provided access to tradable of the investment regime (para. 2.04). inputs at internationally competitive prices, while 2.11 On the trade side, the inward-looking pro- domestic market-oriented textile and garment tectionist policies in force from 1974 to 1984 encour- producers enjoyed substantial effective protection. aged firms to adopt excessively capital-intensive tech- As a result, technological capabilities in the tex- nologies and reduced the incentive for cost saving in- tile industry vary considerably. Many firms use novation. Until the trade reform packages of the mid older production methods and machinery much 1990s, high average tariff and nontariff barriers of it imported secondhand in the 1970s and early shielded domestic industry from competition against 1980s, and are unable to meet the quality stan- imports, e.g., engineering products. High tariffs also dards sought by foreign buyers and middle-in- limited competitive pressure on protected firms to use come Indonesian consumers. They supply only their equipment and facilities more efficiently and the less quality-conscious upgrade to international standards. However, the tar- portion of the domestic iff cuts in 1995 (para. 2.03) will substantially increase market. These firms, which THE EXPORT import competition and will create strong incentives have not invested substan- ORIENTED FIRMS IN for firms to enhance their competitiveness and up- tially in modernizing their grade technology. facilities, are under increas- 2.12 On balance, the current economic policy ing competitive pressure TYPICALLY INVESTED framework provides firms with relatively open access from the export-oriented HEAViLY IN to foreign technology and encourages them to invest tirmsic ae bease IMPROVING THEIR in technology upgrading. Consequently, some firms ofiresi inoes oe - A FT I have developed substantial technological capabilities, onesin comes and including, for example, United Tractors and Asahimas CAPABILITIES IN Flat Glass.' But such firms are rare exceptions. The p otm et Th ex- technological capabilities of most remain extremely limited. oriented firms have typi- INTERTIONALLY... cally invested heavily in ___________ 2.13 This is apparent from the following review improving their manufac- of firm-level technological capabilities in three key turing capabilities, often with the help of their subsectors: textiles, a major industry in Indonesia but overseas buyers and joint venture partners, in or- one under significant competitive pressure from other der to compete internationally. In many instances, low-wage countries; electronics, one of the fastest they also have made substantial efforts to develop growing industries in the country, but one that is start- domestic suppliers of materials. ing from a low base and facing very sharp regional 2.16 There are threemajor technologicalweak- competition; and the engineering industry, which is nesses in the Indonesian textile industry that have still in its infancy. to be addressed if it is to maintain its position TEXTILES AND GARMENTS against its fierce Asian competitors, China, India 2.14 The Indonesian textile and garment industryabundant labor at has grown tremendously over the last few years due to inc es exo substan t ist weak- to policies encouraging exports. By 1994, the indus- ns iscthat exports relshaily on forsignebu- try accounted for exports of $5.8 billion, about 34 per- es andjoit enture partners for ign ass- cent of total manufactured exports. It is now the larg- esadjitvnueprnr o ult ses est exporting industry in the country. ment, since there are no internationally recognized est xpotin inustr inthecoutryquality certification systems in place in Indone- 2.15 However, historically the industry has had a sia. This limits the capacity of exporters to quickly dual structure, with firms that supply only the do- develop new foreign markets since buyers have mestic market coexisting with others that export most to come out for site visits. Many customers prefer I N D 0 N E S I A D I S C U S S 1 0 N P A P E R S E R I K S 9 USING DEREGULATION TO DRIVE INDUSTRIAL TECHNOLOGY DEVELOPMENT to rely on the internationally recognized quality 2.20 The component base is extremely weak for control certification which competitive countries both passive as well as active components. Some offer. simple passive components are manufactured locally 2.17 Second, many export firms lack capabil- but not in sufficient quality or quantity to meet do- ity in product design and production systems that mestic demand. A few joint ventures assemble some can respond quickly to meet changing market de- higher value added components, such as tuners, mands. While this was not a constraint only a few video heads and flyback transformers, and there is years ago, it is becoming increasingly important also some limited local capacity for the production as Indonesian firms attempt to move upmarket. of printed circuit boards, but not of the quality re- The lack of design capability limits their flexibil- quired for export. There is one integrated circuit ity in coping with fashion trends, their capacity manufacturer operating a plant that was established, to work on a more equal basis with their custom- but later sold, by National Semiconductor. However, ers, and their ability to move up the value added its product and manufacturing technology is outdated chain. By comparison, in the developed countries, and uncompetitive. and increasingly in some of the more competitive 2.21 The development of technological capabili- Asian countries, garment and textile firms have ties in the electronics industry has been heavily in- invested in computer-integrated manufacturing fluenced by government policy. For example, the de- and quick response systems to ensure their abil- letion program of the 1970s, which required that a ity to compete at the large volume and high end certain percentage of components be produced lo- of the industry and to react quickly to changing cally, discouraged final equipment makers from pro- fashion. ducing in Indonesia, thus limiting the demand for 2.18 Third, the rapid growth of the industry has local components. Moreover, the component led to shortages of skilled technicians and man- industry's output does not match the users' needs: agers. While there is a textiles R&D institute in Indonesia's component industry exports about 90 Bandung that provides training, many firms find percent of its production, while the import share of that before its graduates can work efficiently they purchased components is typically 80 percent inmany require substantial additional training. There are produd areas. Until the deregulation of the mid 1980s, also skill shortages in some key technical areas, substantial import protection in the form of tariff pro- including weaving and dyeing. tection, as well as a range of quantitative restrictions to encourage localization, encouraged growth. In ELECTRONICS addition, substantial incentives were offered to attract 2.19 In the last five years electronics has been foreign direct investment under that umbrella of pro- Indonesia's fastest growing export. Exports were tection. While the industry grew rapidly under these only $286 million in 1990, but reportedly reached policies, foreign direct in electronics has been $2 billion in 1995, equivalent to about 5 percent of miniscule, in comparison to other Southeast Asian total manufactured exports.2 Although many elec- countries, and was primarily in assembly operations tronics firms are joint ventures, these are prima- that supplied consumer electronics to the domestic rily simple assembly operations. The industry market. In 1990, substantial reductions of tariff and lacks technological depth, and its major activity nontariff protection were made. As a result, a dualis- is relatively low value added assembly of con- tic structure emerged in which there appeared a num- sumer products, primarily for export. This reflects ber of export-oriented manufacturers that sell very the limited range of components domestically little to the domestic market, and other producers that manufactured in Indonesia, long lead times re- sell mainly to that market. However, both are prima- quired to import parts and components, lack of rily assembly operations. support for product quality in the form of stan- 2.22 Supplier linkages are also very weak. For ex- dards and technical support services, and limited ample, the local procurement rate of multinationals design and development capability operating in Indonesia's consumer electronics N D 0 N m e A D I S C U S S d 0 N P A P E R S E R I E s 10 CHAPTER 2 subsector is reportedly only 30 percent. This is very of the May 1995 deregulation package will reduce low compared to other countries, especially consid- the ERP only to 61 percent by 2003, compared to ering the fact that materials and parts account for over a projected average of 7 percent for all manufac- 80 percent of the total manufacturing cost of consumer turing, excluding oil refining. However, invest- electronics. To the extent that subcontracting takes ments that have received BPKM approval are al- place, it is in relatively low-technology areas such as ready able to obtain imports of capital goods and injection molding, printed circuit board manufacture, associated inputs duty free, which has led to sub- and some passive components where the prices of- stantial defacto import competition. The industry's fered by local suppliers are competitive. Despite com- ability to respond to that competition has been petitive prices, however, a recent survey of buyer limited because of protection granted to the gov- firms found many complaints about quality and the ement-owned steel industry which supplies its ability of local suppliers to deliver on time.3 major inputs. 2.23 With a few notable exceptions, product qual- 2.26 The automotive components subsector is an ity is one of the biggest problems in Indonesia's elec- example of an industry tronics industry. A few firms, particularly joint ven- where local content require- tures and subcontractors to major international coi- ments have been used. Under ANY ACTION PLAN TO panies, have invested in total quality control systems. the mandatory deletion pro- However, quality management, even for these firms, gram, which lasted from 1989 S is not supported by an effective system of national to 1993, automobile assem- ELECTRONICS standards and product certification. This has stifled blers had to pay a 50 percent INDUSTRY HAS TO development in an industry where product reliabil- duty on the import of man- ity and quality are essential elements of competitive- datory parts. Consequently, INCLUDE A REDUCTION ness. While some firms have a degree of in-house ca- local producers set their price OF REMAINING pability in production engineering, development and at a point just below the im- design capabilities in the industry are generally very ported item's price to maxi- INDUSTRY weak. In addition, supplier companies require estab- mize profits and had little in- PROTECTION. lished industrial standards and the necessary calibra- centive to export, upgrade tion, inspection and certification facilities to qualify technology or look for ways them to those standards. They also need support for to improve efficiency. materials testing, product development and techni- 2.27 Due to these policies, engineering is one of cal training. the least internationally competitive of Indonesian THE ENGINEERING INDUSTRIES industries, as evidenced by the low level of ex- ports in the industry's total output (6 percent) and 2.24 The engineering industries are a diversified of engineering products in total industrial exports subsector, comprising the manufacture of fabricated (5.8 percent). Engineering has also been a mar- metal products, machinery and equipment. It is one ginal supplier to the domestic capital goods, of the oldest industries in Indonesia, dating back to equipment and machinery markets, where de- the colonial period when Dutch entrepreneurs mand continues to increase rapidly to support founded metalworking firms in Surabaya for ship re- rapid overall industrial growth. However, these pairs. Successive governments have undertaken mea- shares are not out of line with the high-perform- sures to promote the industry, including trade pro- ing East Asian countries when they were at com- tection and local content requirements, which have parable stages of industrial development. strongly influenced its technological development. 2.28 In terms of technological capability, 2.25 The engineering industry has enjoyed the Indonesia's engineering industry has mastered a highest rate of trade protection of any sector except range of relatively simple and mature technolo- food and beverages. In 1995, the effective rate of pro- gies; it can design simple products and equipment. tection (ERP) for the engineering industry was 82 its enterprises show some strength in manufac- percent. The tariff reductions that were the centerpiece IN D 0 N E S I A D i s c u S S 1 0 N P A P _E R S E R I E the RP oly t 61percnt b 203, cmpard 1t USING DEREGULATION TO DRIVE INDUSTRIAL TECHNOLOGY DEVELOPMENT turing technology, and, in addition, there are a the modest technological ambitions of larger en- number of areas of success where: terprises, which could play a more important role * imported technologies have been successfully as prime contractors, but do not because of highly assimilated, effective protection. * reverse engineering capabilities have been de- SUMMARY OF FiRm-LEVEL veloped, TECHNOLOGICAL CAPABILITIES * product designs have been adapted to meet 2.31 These subsector reviews reveal several broad the needs of the domestic market, patterns of ITI in the private sector. SMEs focused " adquae tainng rogrms avebee imle-on the domestic market have limited capacity to up- * adequate training programs have been imple-grade their manufacturing capabilities, and poor mented. quality and maintenance management. They also Examples include technologically advanced have poor design and development capabilities. weaving looms, plastic processing machinery, tea However, a few have good process technologies im- processing machinery, diesel generators, boilers, ported from abroad, and some manufacturers have irrigation pumps and water treatment plants, steel been able to adapt imported technology to local con- pipes, tools and dies, and industrial fasteners. ditions. However, many of these firms have limited 2.29 However, Indonesia's overall economic capability to select foreign technology Export-on- policies have adversely affected development of ented SMEs typically have much better quality con- the industry's technological capabilities. A recent trol, but their product technologies are unsophisti- study of the engineering industries4 rated the cated. They also have limited capability to upgrade subsector's technological capabilities in seven their manufacturing methods and generally depend product categories, with each category broken heavily on foreign designs. down into discrete subcategories of output. These 2.32 Among the large private firms, capabilities subcategories were rated strong, weak or absent, for production engineering and product development depending on the number of sources for each are generally weak, since many of them have relied product, the range of models/variations available heavily on foreign suppliers of technology Produc- on the market, and overall strength of firms oper- tivity growth among both large firms and SMEs has ating within that subcategory. The ratings sum- been lower that of their competitors in the newly in- marized below (Table 2.1), show that only 11.4 percent of subcategories were strong, while 41.6 percent were weak and 47 percent were absent. Table 2.1: Technological Capability Rating, 2.30 There are major gaps in the structure of Engineering Industries products as well as the depth and integration of technologies and managerial capabilities. These Product Total No. of Rating of Subcategories lead to variable quality, low productivity, low lo- Category Sub-Categories Strong Weak Absent cal sourcing of parts and components and poor export performance. Technology upgrading in the Basc Processes 21 2 20 5 industry is constrained by: Basic Machine Elements 25 4 10 11 * a shortage of strong engineering and mana- Industrial Components 34 2 12 20 gerial skills; Tooling 17 3 9 5 * lack of information and technical support for Machine Tools and small enterprises; Material Handling 10 1 3 6 a underdeveloped subcontracting networks; Process Equipment 14 5 4 5 Electronic Components 22 0 4 18 N D 0 N E S I A D i s c u S S p 0 N P A P E R S E I ES 12 CHAPTER 2 dustrializing countries. Many large firms have diffi- ENDNOTES culty conforming to international technology stan- IThere also are a number of impressive examples dards. Consequently, the technological basis for sus- of technological capability in the state sector; e.g., taining industrial growth is weak even though pro- e ductivity improvement, which is heavily influenced gneringncapabilitat P.t. Le ofate by ITD, is becoming increasingly important to govenmentownd sre in ri ae Indonesia's ability to sustain industrial growth (para 6)rnde orld-caprocess enginerin and 1.09).fertilizer manufacturer. However, their techno- 2.33 Continued economic deregulation is needed logical achievements have been driven more by to compel firms to improve productivity by invest- government investment decisions and technol- ing in technology and adopting international best ogy-oriented managers than by the incentive practice manufacturing methods. This will be essen- framework. tial if Indonesian industry is to improve its interna- 2ThiS is still quite small compared to electronics tional competitiveness, diversify manufacturing ex- exports of $13 and $8 billion from Malaysia and ports, increase value added, and meet the targets of Thailand, respectively. REPELITA VI and the Second Twenty-Five Year Long- o Term Development Plan. 2.34 Deregulation also could help to maximize the sia, Backward Linkages: Impediments, and Op- role of conglomerates in ITD, which, given their sub- portunities," May 1995. stantial human and financial resources, should be SRI International, "Technology Development leading role the development of Indonesia's techno- Plan for Indonesia's Engineering Industries," logical capabilities. Although the private business 1992. sector in Indonesia is dominated by family- owned conglomerates, their contribution to Indonesia's tech- nological development and to exports has been very limited compared to the role played by their counter- parts in Korea. Excluding wood exports, the contri- bution of the top 50 groups to total manufacturing exports was only about 16 percent in 1992. The domi- nant groups are insulated from the forces of competi- tion and are predominantly concentrated on protected domestic markets. Trade liberalization and deregula- tion of domestic markets and distribution channels should encourage greater export orientation of the conglomerates as well as acquisition of the techno- logical capabilities needed to move up the value added ladder and be more competitive internation- ally. IN 0 0 N E S I A D i s c u S S 1 0 N P A P E R SE R I r S 13 u e CHAPTER 3 Improving Human Resources for Technology Development A. OVERVIEW deric training. Only 40 percent of Taiwan, China's 3.01 An educated and trained workforce is essen- high school students were in the vocational track tial to a country's ability to respond flexibly to rapid in 1963, but by 1980 that figure had risen to al- economic and technological change, produce higher most 70 percent. quality products, adopt and improve new production 3.04. Taiwan, China's mix of public spending processes and technologies, and develop the skills to also shifted in favor of higher education, and meet new demands. Over the last decade, Indonesia within higher education, toward engineering and has made great strides in training and educating its the natural sciences and away from the humani- labor force, including substantially increasing the ties and agriculture. The government intervened number of scientists, engineers and technical work- at the university level by providing financial sup- ers. The quality of education and technical training port for new departments for industrial engineer- will become even more important as Indonesian ing, industrial design, and automatic controls. As manufacturers switch to more complex products. a result, enrollment in graduate engineering and material science programs doubled to 40 percent B. THE EAST ASIAN EXPERIENCE of the total graduate enrollment from the mid OF INVESTING IN HUMAN 1960s and late 1980s. Govenment also made a RESOURCES FOR TECHNOLOGY major effort to encourage the return of college 3.02 All countries in the region have been acutely graduates who had gone abroad for postgradu- conscious of the need for high-level technical, engi- ate study. neering, and scientific skills to boost ITD. Korea, SINGAPORE Singapore and Taiwan, China have invested most in the education of technicians, scientists, and engineers 3.05 Singapore has developed an extensive as part of their strategy to acquire technological ca- system for creating industrial skills. The higher pability. Their governments have been able to involve education system is tightly regulated and directed industry in setting university curricula and in the by government to ensure high standards and rel- provision of technical training. In addition to under- evance to emerging technological needs. It re- standing the importance of human capital to ITD and ceives considerable financial support from the international competitiveness, those countries have state. The elitist colonial educational system has also been flexible in adapting the educational struc- been transformed into one that is merit based, ture to meet the demands of economic change. Some vocationally oriented, and demand driven. Higher examples of human resource development strategies education has three levels: the public universities for ITD in those countries are given below. at the top, four polytechnics in the middle, and job-oriented training institutes at the bottom. TAIWAN, CHINA These include centers set up by the government 3.03 Taiwan, China's early industrialization effort in collaboration with multinational corporations was helped by the initial high literacy rate of its labor (MNCs), as well as a number of centers set up by force; employers could count on cheap and unskilled, statutory boards, professional bodies, and private yet literate and efficient, labor during the early phase institutions. As a result, Singapore is a regional of export-led growth. With the growing scarcity of leader in employee training programs held out- unskilled workers and rising real wages in the late side the workplace. 1960s, compulsory primary education was extended 3.06 The Vocational and Industrial Training from six to nine years. The government also placed Board (VITB) has established an integrated train- an increased emphasis on vocational rather than aca- ing infrastructure. Since 1979, it has trained and IN D 0 N E S I A D I S C U S S 1 0 N P A P E Rt S E R I E 8 is IMPROVING HUMAN AND FINANCIAL RESOURCES FOR TECHNOLOGY DEVELOPMENT certified more than 112,000 individuals, about 9 ment and encourages significant in-firm training of percent of the existing workforce. Its Full-Time employees. It has the highest relative university en- Institutional Training Program provides pre-em- rollments in science and technology of the Asian coun- ployment skills training for school leavers. Its tries. For instance, it has more engineering students Continuing Skills Training Program offers work- enrolled at the tertiary level than India, 347,600 com- ers part time skills courses and customized pared to 201,300. courses based on requests from companies and 3.09. The government has promoted education of tailored specifically to their needs. Its Continuing high level technical manpower by setting up institu- Education Program provides part time classes for tions like the KoreaAdvanced Institute of Science and working adults, while the Training and Industry Technology (KAIST) at the postgraduate level, and Program offers apprenticeships to school leavers the Korea Institute of Technology for undergraduates. and former national servicemen. The government These were aimed at exceptionally gifted students. has collaborated with MNCs to set up join spe- KAIST had 6,652 graduates between 1975 and 1990. cialized training centers and funds a large part of 832 were Ph.D.s, and the rest M.Sc.s. A foreign train- the salaries of employees while they are being ing program was administered by the Korea Science trained.' and Engineering Foundation. 3.07 Under the Industry Based Training Pro- 3.10 Korea also has strongly encouraged in-firm gram, employers, with VITB input, conduct train- training. The government levies a 5 percent payroll ing courses for their specific needs. VITB also pro- tax on large firms, refundable if they undertake em- vides testing and certification of its trainees and ployee training in approved programs. While such apprentices, as well as trade tests for public can- payroll taxes are found in many countries, they usu- didates. Using various grant schemes, the Na ally are around 1 percent. The exceptionally high tional Productivity Board's Skills Development Korean rate may have been a response to the country's Fund (SDF) created 405,621 training places in 1990. urgent need for new skills as it moved into heavy and The SDF is responsible for various schemes to help high technology industry It may also have reflected SMEs finance their training needs and upgrade the initial reluctance of firms to invest in employee their operations. It has also introduced a Devel- training. Absent a tradition of lifetime employment, opment Consultancy Scheme to provide grants to which allows Japanese finns to invest heavily in skill SMEs for short-term consultancy assignments for upgrading, employers feared being unable to get ad- management, technical know how, business de- equate return on their investments if their trained velopment and manpower training.2 The Train- workers left for new jobs. ing Voucher Scheme supports employers in aug- menting training resources. This enabled the SDF C. IMPROVING THE Q.ALITY OF to reach more than 3,000 new companies in 1990, INDONESIXS HUMAN RESOURCES many of which had 50 or fewer employees. There 3.11 Like all rapidly growing countries in East is also a Training Leave Scheme which encour- Asia, Indonesia has invested heavily in expanding ages companies to send employees for training education and training. As a result, it has made ma- during office hours. jor advances in developing basic skills among its la- KOREA bor force. Whereas almost 70 percent of the labor force 3.08 Korea has one of the highest levels of in- had no education at all, or an incomplete primary dustry-relevant education of any developing school education, in 1970, this proportion had fallen country. Its secondary and tertiary level enroll- to 44 percent by 1990. The stock of technicians, scien- ment, 90 and 40 percent, respectively, is at devel- tists, and engineers has also grown rapidly because oped 90 of increased enrollment in senior secondary, techni- and the system, based on international compari- sons, is very good at imparting numeracy. It has and engineering university graduates is relatively impressive levels of vocational training enroll- large and expanding. These constituted nearly one N D 0 N e S I A D i s c u S S l 0 N P A P E R S E R I S 16 CHAPTER 3 third of all diploma and degree graduates in 1992. ers, particularly in math and science, as well as There were 14,000 engineering graduates alone, cor- improved school materials. There is also a need pared to 6,000 annually in Korea, Malaysia and Thai- for better student and school assessment systems. land. In some areas, however, enrollment rates still This is especially important since secondary edu- lag far behind those of other countries in the region. cation is increasingly being provided by private The net enrollment rate in junior secondary school in schools. Currently, private schools account for Indonesia is 47 percent, compared to 88, 75, 70 and 80 about 40 percent of junior secondary and over half percent in South Korea,, Hong Kong, Singapore and of senior secondary education. Because of this, Taiwan, China respectively. Nevertheless, the educa- government needs an improved system for ac- tional and skill levels of Indonesia's work force can creditation and licensing of educational institu- be expected to rise rapidly as older employees retire tions. and younger people who have benefited from the re- 3.15 Indonesia's voca- cent school and training programs take their place. tional training system also 3.12 Despite the substantial quantitative improve- needs strengthening. As DESPITE THE ments in education and vocational and technical train- noted in the World Bank's SUBSTANnAL ing, there is concern in Indonesia about its quality. recent report (see 3.13, Tests show Indonesian primary and secondary stu- above), one priority is to PROGRESS MADE IN dents have less reading and math competency than equalize public and private IMPROVING ThE their regional counterparts. The inferior quality of training through the use of education is also indicated by low wage differentials clear accreditation criteria, between Indonesian workers with and without pri- effective licensing and train- EDUCATION AND mary and junior secondary education. Poor school ing certification systems. TRAINING, THERE ARE quality has also affected dropout and graduation While improving the qual- rates. Secondary school enrollment has declined over ity of vocational training, SUBSTANTIAL the last five years, and each year 1.2 million children these measures also would CONCERNSIN drop out of primary school. Employers complain that provide useful information INDONESIA ABOUT ThE primary and secondary school graduates lack solid both to employers and literacy and numeracy skills. trainees. In addition, em- QUALITY OF BASIC 3.13 As noted in the World Bansployers need to be more ac- and Labor Market Study (Report No. 14413-IND), tive in helping training in- much Indonesian technical training is also of poor stitutions establish their VOCATIONAL AND quality because of deficiencies in equipment and programs. TECHNICAL TRAINING. teaching materials, uneven teacher training, weak 3.16 The experience of links with industry, and unresponsive administration. other countries, especially There are also substantial gaps in the training cur- Singapore (para 3.05), shows that employer- based riculum. For example, there are no courses available training could play a much more important role. in skills, such as advanced welding, which are in great Firms should be directly involved in worker train- demand. Managers of SMEs complain that large firms ing programs make them more responsive to their snap up graduates of the better, often private, train- needs. This would require changing the current ing schools, and those they are able to recruit are of levy grant scheme to have the private sector un- highly variable quality. Executives in foreign firms say dertake program management and to have the the weak skills base prevents them from transferring funds collected from payroll taxes kept in a dedi- technology to local partners and subcontractors.4 cated account.5 3.14 Improving the quality of basic education is a 3.17 Utilization of scientific and engineering major goal of Indonesia's Sixth Five Year Develop- talent also needs improvement. Currently, almost ment Plan. Achieving this goal will, however, require 66 percent of Indonesia's limited number of ad- better selection, training, and remuneration of teach- vanced degree holders work primarily in govern- iN D 0 N E S I A D i s c u s s i 0 N P A E R S E R I S 17 IMPROVING HUMAN AND FINANCIAL RESOURCES FOR TECHNOLOGY DEVELOPMENT ment. R&D laboratories, where they often are to spend time developing technological solutions for underutilized due to poor management, lack of industry without risk to their academic careers. Ex- research facilities, and scarcity of programs rel- perience in the high-performing East Asian countries evant to industry (see Chapter 6). shows that researchers in public institutions are an 3.18 Another 30 percent of Indonesia's scien- important reservoir of technological development tists and engineers with advanced degrees are talent for the private sector. employed in public higher education. University 3.21 Policies regarding overseas fellowships need R&D activity is typically of low quality, and very to be reexamined. The universities, the national R&D little of it is of any technological use to industry. labs, and the civil service, especially BPPT, the Agency Low pay and limited career prospects cause uni- for Industrial Research and Development in the Min- versity researchers to take second jobs, such as istry of Industry and Trade (MOIT), tend to monopo- teaching in private universities, which do not help lize overseas fellowships for upgrading of their re- them keep abreast of devel- searchers. A broader spectrum of Indonesia's scien- opments in their fields. In- tific community should be represented in overseas PRIVATE EMPLOYERS donesian university re- fellowship programs. Moreover, returnees should be searchers also publish very given assignments that take maximum advantage of little. The number of their the training they have received. Finally, and perhaps ACTIVE ROLE AT THE articles in internationally most importantly, more of them should be placed in INSTITUTIONAL LEVEL recognized scientific jour- the private sector. The current system of bonding re- nals each year is only a third tumees to government service should be made more IN TRAINING POLICY that of Thailand's, less than transparent. MAKING AND IN 10 percent of Korea's, and 3.22 In addition to making better economic use HELPING TRAINING only 2 percent of Taiwan, of overseas fellowship training, the government China's. needs to substantially upgrade the quality of domes- INSTITUTIONS 3.19 Only about 6 tic graduate education, particularly in engineering ESTABLISH THEIR percent of the country's and science. This will require giving greater au- PROGRAMS. R&D personnel with ad- tonomy to universities, allocating public spending for vanced degrees work in the them on the basis of their performance, encouraging industrial sector. With so greater private sector involvement, and, as Malaysia few scientists and engineers working directly on is now doing, allowing the private sector to offer industrial technological development, Indonesian graduate education.6 industry's capacity for innovation is obviously CONCLUSION small. However, with continuing economic de- regulation and as firms strive to improve competi- 3.23 Indonesia needs to improve the quality of tiveness and diversify exports, private sector de- education and training, and to make better use of its mand for such employees should increase. existing stock of scientific, technical, and engineer- 3.20 To stimulate that demand, GOI should ing talent. The priorities for developing human re- subsidize scientists and engineers in R&D insti- sources for ITD in Indonesia should be to: tutions and universities to provide technological improve the quality of primary and secondary services to industry. The experience should make education in order to provide an appropriate ba- the lab workers and academics more aware of and sis for subsequent training, and to place greater responsive to the needs of the private sector, keep emphasis on training of technicians and crafts- their own research skills from atrophying, and men (para. 3.14); make firms aware of their existence and capabili- facilitate private provision of high quality pre- ties. Government sponsorship of industrial re- search fellowships and sabbaticals in partnership employment ansre tining inc with private creditation of private training institutions, devel- INO0O0N E S IA D s S U sSSIO0N P A P Z R S E R I E S 18 CHAFER 3 opment of systems for national skills standards ENDNOTES and certification, and rigorous accreditation of all I Soon, Teck-Wong and C. Suan Tan, Singapore: technical and vocational training schools (para Public Policy and Economic Development, World 3.15); Bank, 1993, background paper for The East Asian * undertake measures to foster employer provided Miracle. training, as noted in the World Bank's Training 2 Soon, Teck-Wong, "Singapore," in S. D. and the Labor Market Report (paras. 3.13 and Meyanathan, Industrial Structures and the Develop- 3.16); ment of Small and Medium Enterprise Linkages: Ex- * improve industry's links with public technology amplesfrom East Asia, World Bank, Economic De- support institutions and research universities velopment Institute, 1994. where most of Indonesia's scientists, technicians, 3Agrawal, N., Indonesia: Labor Market Policies and and engineers talent are located (para 3.20); International Competitiveness, Policy Research * improve the use of returnees from overseas train- Working Paper No. 1515,1995. ing fellowships through better human resource See The, K. W. and M. planning, staff deployment and mobility, and by Pangestu, Technological Capa- SCIENTISTS AND making the bonding system more transparent bilities and Indonesia's Manu- (para 3.21); factured Exports, Report for ENGINEERS WORKING * strengthen university and graduate education in SeeTAIng and th THE COUNTRY'S science and engineering, including allowing the Labor R&D INSTITUTIONS private sector to enter the field (para 3.22); Market in Indonesia: Policies for Productivity Gains and AND UNIVERSITIES * strengthen formal management training pro- Employment Growth, World SHOULD BE grams and use foreign direct investment more ef- Bank Report No. 14413-T. fectively as a vehicle for training future genera- 6 Malaysia's largest compa- tions of Indonesian managers. nies, including Telekom PROVIDE TECHNOLOGY Malaysia Bhd. and Tenaga SERVICES TO Nasional BHD, the largest INDUSTRY TO MAKE power utility, have applied to have their training centers THEM MORE upgraded into accredited RESPONSIVE TO THE universities offering engi- neering and other technical NEEDS OF INDUSTRY. or science-based courses. N D 0 N E S I A D I S C U S S 1 0 N P A P E R -S E R I E S 19  CHAPTER 4 Maximizing the Use of Foreign Technology A. OVERVIEW portunity. Now that those policies havebeen aban- 4.01 For developing countries, a key strategy is to doned, it is expected that EDI will play a more take maximum advantage of available foreign tech- important role in ITD. nology. The East Asian countries have used various 4.04 Indonesia's recent FDI package will be approaches to get foreign technology and foreign di- judged by its success in reducing bureaucratic red rect investment (FDI) in order to develop their tech- tape and delays involved in getting investment nological capabilities. Each approach has its own im- approvals, particularly approvals at the local level. portant lessons for Indonesia. Other priorities are development of the infrastruc- ture (e.g., power, ports), required to attract FDl, B. INDONESIAS APPROACH TO THE facilitating trade by addressing the problem of Aco_uIsITION slow turnaround at the ports and customs, reduc- OF FOREIGN TECHNOLOGY ing the cost of factory space, and also reducing 4.02 Compared to many countries in the region, In- donesia has provided relatively open access to tech- 4.05 The East Asian experience demonstrates that nology imports, including among its policies a rela- participation in foreign trade is the most signifi- tively liberal regime for FDI. However, in many re- cant source of information for technology upgrad- spects GOI's technology import policies are restric- ing (para 1.18). However, despite the shift from tive. As noted in Chapter 2, high rates of protection import-substitution policies to export promotion and nontariff barriers have been used to safeguard since the nd-1980s, Indonesia's trade policies still the domestic capital goods industry. Moreover, licens- show a substantial anti-trade bias. For example, ing of foreign technology has been hampered by weak the rate of effective protection for import-compet- enforcement of intellectual property laws. ing products exceeds that for export-competing products.' Furthermore, Indonesia's export pro- 4.03 Although Indonesia attracts substantial FDI, its motion/trade facilitation agencies (NAFED and impact on indigenous technological capabilities has ESB) are weak compared to the trade promotion been limited for several reasons. First, joint venture offices of other countries in the region which work firms in industries which have been opened to FDI actively to strengthen links between producers are shielded from competition. Second, until the re- and buyers. cent liberalization, the negative list prohibited FDI in many important areas of the economy, including the C. THEEXPERIENCES Strategic Industries (para 6.61), which were, in effect, OF OTHEREAST ASLAN COUNTRIES reserved for influential local private firms. Third, the past practice of matching foreign investors with pre- t h ees o fore in con- selected local partners minimized technological trest an d usin egn chny spillovers. The local partners were often more inter- varesubstanti v eless eac cony ested in quick returns with minimal effort than in p long-term development of technological capabilities. sia. Fourth, the imposition of equity restrictions on joint 4.07 Hong Kong: Hong Kong's industrial and ventures in the form of requirements of equity dilu- manufactured export growth began in earnest af- tion over time also discouraged foreign investors from ter establishment of the People's Republic of transferring technology to local partners. These re- China (PRC) in 1949, when many Chinese techni- strictions encouraged these partnerships to use out- cians and entrepreneurs emigrated to the Crown dated machinery and allow their technologies to be- Colony. They established dynamic SMEs special- come obsolete. Mandated equity transfers also re- izing in labor- intensive manufacturing for world sulted in one-time transfers of technology and skills, markets. The colony's strong base of entrepot trade low value-added production, and limited export op- and the presence of well-established, British-run N D 0 N I S I A Discu ssioN P A P p k S e w I S 21 MAXIMIZING THE USE OF FOREIGN TECHNOLOGY trading, finance, property, and other enterprises NIEs (around 2 percent in the 1990s), and its manu- (the Hongs) provided the new SMEs with impor- factured exports (excluding re-exports) have declined tant financial and trading skills, market informa- by 10 percent a year during the same period. The tion and connections, and financial support. These economy has continued growing by moving into ser- enterprises obtained the relatively simple and vices and relocating manufacturing facilities to lower- quickly mastered technologies they needed in cost areas, especially mainland China. However, as mainly externalized forms. Technological infor- far as technological deepening and diversification are mation needs were filled by international equip- concerned, Hong Kong's experience has not been im- ment suppliers and through growing contacts pressive. with export markets. Foreign buyers were also 4.09 Singapore: Singapore has deepened its industrial sources of technological information and assis- structure far more than Hong Kong and has main- tance. The government helped technology imports tained high manufacturing growth rates. Like Hong indirectly through export promotion and produc- Kong, it also started with good entrepot facilities, but tivity improvement measures. For example, the unlike Hong Kong, it had a relatively weak entrepre- Hong Kong Trade Develop- neurial base and did not benefit from an influx of ex- ment Council provided in perienced businessmen and technologists. After an MALAYSIA'S INITIAL formation on markets and early experiment with import substitution, it switched ~ WS BSED assisted foreign buyers mi to free trade and aggressively sought FDI. The strat- SUCCESSestablishing contacts with egy of attracting FI, at a time when most other de- ON TARGETING FIRMS local suppliers, while the veloping economies were shunning it, was so suc- THAT WERE Hong Kong Productivity cessful that rapidly rising wages reduced Singapore's Council assisted SMEs in attractiveness to the multinationals. In response, the RELOCATING LABOR- importing and adopting government revised its strategy for attracting foreign INTENSIVE new techniques. However, companies by investing heavily in its ports, air fa- ELECTRONICS the colony's access to labor cilities and telecommunications, the physical infra- at relatively low wages and structure required to facilitate exports, and in raising ASSEMBLY ACTIVITIES disinterest in heavy indus- labor force productivity. It also has used a variety of AWAY FROM try resulted in continuing interventions to guide investors into preferred activi- specialization in unsophis- ties (Box 4.1). At one time, it experimented with de- SINGAPORE. ticated labor-intensive liberately raising wages to force MNCs to upgrade products. Along with rising their technology. This policy was dropped when in- wage and land costs, this lack of technological dustrial growth slowed. More recently, the govern- depth has led to some significant ment has invested in R&D centers, hoping to stimu- deindustrialization. late foreign interest and participation. 4.08 The Hong Kong experience suggests that, 4.10 Other NICs, especially neighboring Malaysia, where the skills, institutions and infrastructure a which has been very successful in attracting high- present, free market policies alone produce invest- technology MNCs into manufacturing, have copied andcopettiensecilo-tehnog inuspi- ment adcmeiieesilo-eho,yn-Singapore's strategy. Like Singapore's, Malaysia's dustry. However, this does not necessarily lead to economic growth has depended on MNC-supplied industrial or technological deepening. Where technology. Malaysia's initial success was based on learning costs are high, and specialized skills and targeting firms that were relocating labor-intensive information are required, more direct government electronics assembly activities away from Singapore. support may be needed after the first stage of in By offering low wages, good infrastructure, literate dustrial development has been achieved. Hong and trainable labor, a stable macroeconomy, efficient Kong now lags behind other Asian NIEs in high- pro-private sector policies, as well as generous incen- technology areas such as electronics. Partly as a tives for export-oriented activity, it was able to pre- result of its hands-off industrial strategy, it has the empt other developing countries in the electronics' lowest rate of manufacturing growth among the N D 0 N S I A D id f u S S 1 0 N P A P E S R I E S 22 CHAPTER 4 Box 4.1: Singapore's FDI Strategy to offset the lack of large private firms or groups by setting up public enterprises in heavy indus- Basically, MNCs made the decisions about what new technologies to try, combining interventions in technology trans- respndin (or fer with infant industry protection. In the 1950s, bring into Singapore, with the Singapore government respondingit pursued liberal FD policies, with no discrimi- anticipating through proactive planning and consultation) by providing nation by origin, activity (except for services), or the necessary skilled manpower in consultation with the MN(s. In many de instances, it is the speed and flexibility of government response that gave Singapore the competitive edge compared with other competing gime became more discriminatory, using case-by- host countries. In particular, the boom in investment in offshore case approvals to ensure that technology imports production by MNCs in the electronics industry in the 1970s and the were in line with national priorities. Where do- early 1 980s created a major opportunity by ensuring that all the mestic firms were strong, FD1 was actively dis- enabling supporting industries, transport and communication couraged; where they were weak, foreign firms infrastructure, as well as the relevant skill development programs, tehnology th t loa rers. tn the their were available to attract these industries to Singapore. This concentra- the government encouraged labor-intensive in- tion of resources helped Singapore to achieve significant agglomeration dustries such as textiles, garments and electron- economies and hence first-mover advantages got many electronics ics assembly. It established facilities for export- related industries. An example is the disk-drive industry, where all the oriented activities in special enterprise promotion major US disk-drive makers have located their assembly plants in zones. In the 1970s, it sought out high- technol- Singapore. These industries demanded not only electronics components ogy investors, discouraging labor-intensive FDI and PB assembly support, but also various precision engineering- and favoring automation, informatics, and preci- related supporting industries such as tool and die, plastic injection sion instruments. This policy was strengthened molding, electroplating and others. These supporting industries were i actively promoted by the government as part of a "clustering" n t Hsih th etab t ofaience approach to ensure the competitiveness of the downstream industries. a tes c As labor and land costs rose, the Singapore government used the 4.12 The government maximized technological opportunity to encourage MNCs to reconfigure their operations on a regional basis, making Singapore their regional administrative llor fro sucto c fir s y p ong headquarters and/or regional marketing/distribution/service/R&D by setting local content rules, insisting that for- centers to support manufacturing and sales operation in the ASEAN and eign firms transfer skills and technology to sub- Asia-Pacific region. To promote such reconfiguration, new incentives contractors, and raising the technological capabili- such as the regional headquarters (RHQ) scheme, international ties of local firns. The Singer case is a good ex- procurement office (IPO) scheme, international logistics center (IL ample of how the subcontracting policy was ap- scheme and the approved trader (AIT) scheme were introduced plied (Box 4.2). The local content policy produced significant technology upgrading among local assembly boom of the early 1970s. Once establishedJapan asseblyboo ofthe arl 190s.Onceestblihed (where long-term, stable relations with a few large in Malaysia, MNCs responded to rising wages by in- buyers were the norm), competed aggressively for creasing automation and process upgrading rather orders, switching customers, seeking out foreign than by relocating. Having achieved almost full em- joint-venture partners and soliciting government ployment, Malaysia is now adopting Singapore-style assistance to modernize their technologies. policies to induce MNCs to upgrade further by un- 4.13 Government played a direct role in attract- dertaking local design and development and by deep- ening local supply linkages. ing advanced technologies by entering into joint ventures with technological leaders. For instance, 4.11 Taiwan, China.2 In the 1960s, Taiwan, China had a Taiwan, China lagged behind Korea i semicon- strong base of human capital and a large number of ductor production, and local private firms were dynamic SMEs. This gave it a unique opportunity for too small to set up the necessary capital-intensive nTD in skill-based activities. The government sought I N D 0 N E S I A D I S C U S S 1 0 N P A P E R S E Rt I E S 23 MAXIMIZING THE USE OF FOREIGN TECHNOLOGY facilities. In the late 1970s, the government set up the Electronic Research and Service Organization Box 4.2: Local Content Provisions (ERSO) to import and develop process technolo- and Singer in biwan gies for very large integrated circuits. A decade later, it set up a joint venture for wafer fabrica- When the Singer Sewing Machine Company started operations in tion, the Taiwan Semiconductor Manufacturing Taiwan in 1964, there were several small sewing machine Company (TSMC), with Philips of the Nether- manufacturers in the country, with poor technology and no lands and local private participants. The govern- standardization, unable to compete in world markets. The ment also orchestrated the design and manufac- government stipulated that Singer procure 83 percent of parts and turing activities of numerous small electronics components locally within I year, provide local suppliers with firms. Once TSMC was established, local private standardized blueprints, provide technical experts to improve companies started producing semiconductors, mi- productivity, prepare materials spedifications and inspect final croprocessors and related products. products. Singer was to provide local sewing machine producers 4.14 Foreign firms accounted for only a small part with its own locally made parts at no more than 15 percent above of Taiwan, China's industrial and export success. the price of parts imported from Singers foreign parts. The Local enterprises, predominantly SMEs, led the company was also required to raise exports rapidly. export drive, first by using the Chinese connec- The company fulfilled all these requirements, sending several tion in Asia and then, as their horizons widened, technical and management experts to Taiwan to train and upgrade by tapping Japanese trading companies and local suppliers and organize the entire production system. It American mass market buyers. In the 1960s, about provided a wide range of technical assistance to competing local 60 percent of textile exports were sold through sewing machine manufacturers free of charge. Suppliers were Japanese sogo shosha, and even today these com- given standardized blueprints, enabling them to work to common panies handle a third to half of Taiwanese exports. specifications; they were also given measuring instruments and With the government facilitating their contacts access to Singer's tool room and technical advice. Classes were with small suppliers, US buyers later grew more conducted for parts suppliers in technical and management important. In addition, large numbers of relatively problems. small local trading houses emerged. They proved The result of the forced local content policy was a significant to be valuable sources of technical, design, and transfer of technology, increase in backward linkages and marketing information to Taiwanese exporters. upgrading of competitive capabilities for the industry as a whole. Large foreign buyers, especially of more complex Within three years Singer was using only local parts (except for products such as electronics, sold as original some needles) and by 1986 was eporting 86 percent of its total equipment manufacture (OEM) by large manu- output. Other local firms also became maor exporters, as local facturers, were even more significant sources of parts became standardized and improved in quality. One reason technology transfer. for this striking success was that relatively little capital investment 4.15 In addition, the goverrnment set up support was entailed. The existing base of technological capabilities in the systems to promote exports and ITD. The China local suppliers made the transfer and upgrading of technology External Trade Development Council, which pro- relatively rapid and low-cost. This pattern was repeated in several vided technical assistance to exporters after 1970, industries over the years. was funded by an 0.625 percent levy on exports. Souce:DahIranandSananikone,1990. By 1989, the organization had 700 staff and 28 1 1 branch offices overseas. Its computerized data of North America, which provided investment capi- banks on foreign markets, buyers and suppliers provided the country with a one-stop export in- tand advane ha l skills Iecntyear,Ti formation center, and its Industrial Design and wnese nies ecre through Promotion Department helped exporters develop iestreni dvlopc es w he hye- designs and packaging for foreign markets. tab s T e aances withuleain hgh-te l- 4.16 Another important source of technology for Taiwan, China was the ethnic Chinese population N T 0 N a S I A D i sr w s e s N P A P E R S E R I S 24 CHAPTER 4 facilitated this sort of overseas investment. However, the SME sector still gets government help in buy- some Taiwanese firms have failed in their attempts ing technologies overseas. Korea compiled a da- to start own-brand production overseas, forcing a re- tabase on technology sources and prices that was treat to OEM manufacture. Linked to similar databases overseas and provided 4.17 Korea: When Korea switched from import sub- online in major industrial centers. There was also stitution to export orientation in the early 1960s, it a government program to increase SMEs'techno- started by encouraging exports of labor-intensive logical linkages with the chaebol. products, where it had an existing competitive ad- 4.20 As elsewhere, foreign buyers were a valu- vantage. Moreover, it maintained a strong import- able source of technology.5 The Korean Overseas substituting sector, especially in such heavy indus- Trade Agency provided contacts and market in- tries as chemicals and petrochemicals, and later, en- telligence and brought foreign buyers and Korean gineering, metals, electronics and transport equip- suppliers together. ment. The government provided these industries with The chaebol themselves KOREA ENCOURAGED import protection and subsidized credit, as well as were instrumental in other forms of support. Especially favored were a promoting exports by REVERSE ENGINEERING few firms that showed particular aptitude as export- other firms, via their (I.E., COPYING), ers. These became the conglomerate chaebol that led trading companies ADAPTATION AND R&D By Korea's entry into world markets for complex, high- modeled on the Japa- technology products and later became major multi- nese sogo shosha. They IMPORTING FIRMS TO nationals in their own right. Firms qualified for offi- had the financial and BUILD UPON cial favors by their competitive performance in gov- marketing strength to ernment contests. Korea was thus able to contain the allow Korea to estab- TECHNOLOGY IMPORTS TO distortions generally created by such selective poli- lish its own brand DEVELOP INDIGENOUS cies? names in international 4.18 Korea tended to eschew FDI as a means of ob- markets. taining technology, relying instead on imports of capi- 4.21 The People's Re- CAPABILITIES. tal goods, licensing, and technology transfer agree- public of China: The ments. It encouraged reverse engineering (i.e., copy- PRC has turned to the West for advanced tech- ing), adaptation, and R&D by importing firms to de- nology and know-how. The government sees tech- velop indigenous technological capabilities. Conse- nology transfer as the best way to achieve eco- quently, many of its larger firms were later able to nomic modernization and has embarked on a enter into collaborative ventures on an equal basis massive program for acquiring technology from with world technology leaders. Korea used FDI when abroad through a variety of channels, including it was the only way to obtain a particular technology direct foreign investment, technology imports, li- or to gain access to world markets; even then, the gov- censing and study abroad. While China has at- ernment encouraged majority Korean-owned or equal tracted substantial FD1, which has made a signifi- joint ventures.4 In recent years, Korea has liberalized cant contribution to the country's economic de- its foreign investment laws, but it still remains a rela- velopment, it has not yet led to the transfer of high tively small recipient of FDI. technology envisaged by the Chinese leadership. 4.19 In the field of plant and process engineering, the The bulk of FD1 has come from Hong Kong and gover-nment stipulated that foreign contractors trans- Taiwan, China and remains concentrated in fer their design knowledge to local firms, which simple, labor-intensive assembly or packaging quickly absorbed the technologies. The government operations for export markets, often using second- also intervened successfully in technology licensing hand equipment. FDI in more technology-inten- negotiations to lower prices and to strengthen the sive industries has been relatively limited, owing position of local buyers. The chaebol soon developed to: sufficient international presence and the expertise to investors' concerns about China's long-term manage their technology imports independently, but political future and macroeconomic situation; IN D 0 N E S I A D i S C U S S 1 0 N P A P E R S E R I E S 25 MAXIMIZING THE USE OF FOREIGN TECHNOLOGY * uncertainty concerning the supply of local ward linkages, as was done in several other coun- raw materials and inputs; tries in the region (e.g., Singapore and Taiwan, China). * weak enforcement of intellectual property Instead of relying on import barriers and local con- righttent requirements, their governments have empha- rightlaws;sized the provision of low-cost, user-driven technol- * shortage of skilled technical workers; ogy, worker training and marketing support pro- * inefficient infrastructure. grams. These programs have been carried out in con- junction with direct firm-to-firm support given to lo- 4.22 Another feature of China's policy has been cal suppliers by multinational investors who were encouragement of technology imports through tax willing to help reduce costs, shorten lead times, im- exemptions applied to technology license fees, prove flexibility, and reduce the need for capital in- technology services, consulting contracts, soft- vestment. ware, or import of technology equipment. More 4.25 As noted in Chapter 1, for many countries in the recently, China has ceased relying on technology region, export market development, particularly imports as its primary form of technology acqui- through relationships with international trading sition. Today, FDI is complemented by a compre- houses, licensing, subcontracting or original equip- hensive program of technology diffusion and as- ment manufacture arrangements, has been central to similation and upgrading of the national science development of their technological capabilities. Con- and technology system (Chapter 6). sequently, Indonesia's participation in export markets D. LESSONS FROM CROSS-COUNTRY through all these channels will continue to be impor- EXPERIENCE tant for its technological growth. In this regard, re- cently announced reforms to permit the establishment 4.23 These countries' experiences with gaining of 100 percent foreign-owned trading houses are access to foreign technology provide valuable les- welcome. In addition, restructuring of Indonesia's sons for Indonesia. The successful countries of trade promotion agencies is in order. The experience East Asia have all, through a variety of strategies, of the successful East Asian exporters shows that such been able to import foreign technology and adapt agencies must be well managed, autonomous, am- it to local circumstances to improve their indus- ply funded, and have excellent information systems trial productivity and competitiveness in interna- and communications networks. In Indonesia, that tional markets. means that NAFED and ESB should be replaced with 4.24 FDI can be an important conduit for skill and an autonomous trade promotion institution capable technology acquisition. Although the extent to of Providing timely trade and market information and which it has been permitted varies from one coun- carrying out effective trade promotion activities. In try to another, some, most notably Taiwan, China, addition, that institution should selectively offer firm- have used explicit policies aimed at maximizing level upgrading services and have an independent technological spillovers from FDI. Nevertheless, source of funding. even though policies such as local content rules 4.26 Restrictions on capital goods imports, a form of played an important role in developing local ca- disembodied technology, have been used by a num- pabilities early on, in all these countries there was ber of countries to encourage import substitution. a critical mass of SME entrepreneurship and tech- However, such restrictions were imposed within an nical skills that allowed them to take advantage overall policy of export-led growth. This has not been of opportunities. In Indonesia, which lacks that the case in Indonesia, where substantial tariff and critical mass, protectionist policies have retarded nontariff protection against capital goods imports the development of competitive industries. Un- served only to make domestic industry insular and der the circumstances, Indonesia would benefit uncompetitive. Reduction of trade protection on capi- more from using a market-based approach, rather tal goods is essential to modernization of industry. than by encouraging the development of back- IN D 0 N 9 S I A D I S C U 5 S 1 0 N P A P E R S E R I E S 26 CHAPTER 4 4.27 There should be more use of FDI for technology 5 Westphal, L. E., "Industrial Policy in an Export- transfer and for training Indonesian workers and Propelled Economy: Lessons from South Korea's managers. In this regard, impediments to higher-qual- Experience," Journal of Economic Perspectives, 1990; ity FDI need to be overcome by introducing greater and Kim, L., "National System of Industrial In- transparency, reducing the time it takes for investment novation: Dynamics of Capability Building in Ko- approvals, reducing facilitation payments, and mak- rea," in R. Nelson (ed.), National Innovation Sys- ing the cost of infrastructure services and industrial tems: A Comparative Analysis, Oxford: Oxford Un- real estate more competitive. Benchmark studies show versity Press, 1993. that facilitation payments, space costs and permit 6 Apart from general measures such as devalua- processing times are significantly higher in Indone- tion and general tax incentives, there were dis- sia than in competitor countries. The government has cretionary measures such as access to restricted to shift from a passive stance to a pro-active strategy imports and direct cash subsidies, subsidized of soliciting investments for building technological credit, and information support. The state-con- capability. It also has to work harder at providing an trolled banking system channeled funds into ex- attractive business environment. port support, and export performance increas- ENDNOTES ingly became the criterion for creditworthiness. These incentives were backed by powerful direct In 1994 the antitrade bias coefficient, defined as ((1 pressures, such as regular meetings between busi- + ERP Import-competing)/(1 + ERP export-compet- ness leaders and government, and export target- ing) - 1), was 20, i.e.; import competing industries ingattheindustryandfirmlevels(backedbylink- could be 20 percent less efficient than export indus- ing tax auditing and imported inputs and tech- tries (compared to international prices). Even after the nologies to export performance). The export drive announced trade reforms it will fall only to about 17 also received considerable support from trading by 2003. and producing conglomerates, assistance to test- 2 Wong, P. K., "Singapore's Technology Strategy," in ing and quality assurance services, export mar- D. F. Simon (ed.), The Emerging Technological Trajec- ket information, design assistance, and so on. tory of the Pacific Rim, New York: East Gate, 1995. Overt subsidies declined over the 1980s, but in- 3 Dah1man, Carl J. and Ousa Sananikone, "Technol- stitutional support and the indirect influence of ogy Strategy in the Economy of Taiwan: Exploiting the government has continued strongly. Foreign Linkages and Investing in Local Capability," The most recent study on the electronics indus- World Bank, 1990 (draft). try is McKenzie and Company, "Study for Improv- 4 World Bank, East Asia Miracle Study, Oxford, Ox- ing Competitiveness and Export Potential of the ford University Press, 1993. Indonesian Electronics Industry," World Bank, 1996. IN D 0 N E S I A D I S C U S S 1 0 N P A P E R S E R I E S 27 s e CHAFTER 5 Financing Technological Activity 5.01 Many of Indonesia's competitors have used fis- ments in R&D facilities; and tax deductions for cal incentives and established specialized financing part of the SMEs' investments in laboratory and instruments and institutions to encourage technology inspection equipment and for all of their techni- upgrading, development and R&D among industrial cal consulting expenses. The government also firms. Indonesia has also done this and plans to do granted a tax exemption for 10 percent of the cost much more. There may be some merit in providing of relevant equipment, reduced import duties for SMEs with incentives to invest in technology devel- imported research equipment, and lowered the opment. However, at this stage, when Indonesia's pri- excise tax on technology-intensive products. The vate sector invests very little in industrial technology Korea Technology Advancement Corporation development, such efforts should be very selective helped firms commercialize research results. A 6 and carefully limited in scope and cost. percent tax credit, or special accelerated depr- ciation, provided further incentives. Technology THE EAST ASIAN EXPERIENCE imports were promoted by making the cost of 5.02 All of the high-performing East Asian countries patent purchases and other technology import have used fiscal and financial mechanisms to promote fees tax deductible. Income from technology con- technology development. These mechanisms include sulting was tax free, and foreign engineers were technical assistance to firms for technology upgrad- exempted from income tax. The government also ing, lines of credit for equipment modernization, di- gave long-term, low-interest loans, grants, and tax rect financing and indirect support through the tax privileges to participants in national R&D projects system for firm-level research and development, and (para. 6.21). Technology finance was available the commercialization of the results of R&D. from the Korea Technology Development Corpo- 5.03 Levels of private sector investment in ITD, and ration (KTDC). the interventions used to promote them, vary greatly 5.05 KTDC was started jointly by government in East Asia. Korea has been the most successful of and the private sector in the early 1980s with the Asian NIEs in stimulating R&D, and, as a propor- World Bank support. Industrial firms at that time tion of GDP, the level of its R&D financed by indus- had great difficulty raising funds for technology try (1.7 percent of GDP) is now higher than all other development from existing financial institutions developing countries. Indeed, it is higher than that of and needed financing instruments of a risk-shar- most OECD countries. Taiwan, China comes next (0.8 ing nature, particularly for precommercial stages percent), but because of its SME-dominated structure of research. KTDC provided these instruments, over half of total R&D is performed by the govern- and thereby accelerated imports of advanced for- ment. Singapore's comparable figure is 0.6 percent, eign technology and stimulated in-house work. with government spending accounting for 40 percent While KTDC's activity was especially designed of total R&D. The new NIEs have much lower R&D to benefit SMEs, it covered the entire range of propensities, with industry financed R&D reaching premarket technological activity, reaching farther only 0.17 percent in Malaysia, 0.04 percent in Indone- than venture capital institutions in other countries. sia, and 0.03 percent in Thailand. 5.06 KTDC's primary objective was to remedy KoREA capital market failures in technology develop- ment, but it was also supposed to provide infor- 5.04 In Korea, the government encouraged private mation on technological trends, and to nurture R&D by making available various incentives and and reinforce a positive attitude towards R&D other forms of assistance. Incentive schemes included activities by industry. KTDC helped identify in- tax-exempt Technology Development Reserve funds; ternational trends and areas in which industry tax credits for R&D, both for upgrading human capi- should focus its technological efforts. In addition, tal related to research and for setting up industry re- it served as a consultant to the government on search institutes; accelerated depreciation for invest- technology policies. Over time, it introduced new IN D 0 N E S I A D I S C U S S 1 0 N P A P E R S E R I E S 29 FINANCING TECHNOLOGICAL Acrivmy financing instruments (such as leasing), and set 5.10 Financial incentives for R&D offered by the Tai- up a subsidiary, Korea Technology Investment wanese government have included: Corporation (KTIC), to invest in technology Facilitation of funding for venture capital com- startups. panies, including venture capital finance from the 5.07 An official assessment of KTDC activities in Bank of Communications (BOC). In high-risk, 1986 found that its financing had had a signifi- high-technology projects, BOC provided up to 25 cant impact on productivity, employment, and percent of the equity; sales of improved and new production. The as- sessment also declared that the incremental ben- efits of its operations appeared to be very high, gic industrial products. One hundred and fifty- and rated its portfolio quality "excellent." After one firms benefitted in 1982, increasing to 214 in six years of operation, only 13 projects out of 850 1987. The government provided NT$20 billion in had failed. About half of its loans (almost 69 per- preferential interest rate loans for buying equip- cent of the number of projects) went to SMEs. It ment. This was 65 percent of the investment re- also supported SMEs with promotional activities quired in these areas; and technical/managerial advice. KTDC's success Encouragement of product development, with led to the establishment of several private ven- matching grants for approved projects; ture capital funds in Korea, which today has the highest number of venture capital companies in the developing world and the largest outstand- and accelerated depreciation for equipment; ing loan portfolio to technology-based startups. 0 Special incentives for enterprises based in the 5.08 Despite all the financing instruments and Hsinchu Science Park, with government finan- institutions used to promote ITD in Korea, it is cial institutions able to invest up to 49 percent of clear that the greatest stimulus to R&D came from the capital, and the investor able to count pat- the intensely competitive environment in which ents and know-how, up to a maximum of 25 per- the technological leaders, the chaebol, operated, cent, as part of equity both internationally and within the country. Com- 5.11 Taiwan, China has also provided financial sup- petition forced these firms to invest in upgrading port for restructuring some key industries. Textiles is their technological capabilities and was clearly an important example. Textile exports, the nation's much more important for ITD than any of the di- second largest foreign exchange earner ($12 billion rect and indirect fiscal and financial incentives in 1993), today consist mainly of synthetic fibers, since provided by government. labor-intensive garment production has been largely TAIwAN, CHINA relocated to lower-wage countries. Faced with rising labor costs and intensifying competition, the govern- 5.09 Taiwan, China has also employed a variety ment embarked in the late 1980s on a major program of mechanisms to promote ITD. Its basic strategy of restructuring and upgrading the industry. has been to promote R&D through publicly 5.12 The Industrial Development Bureau of the Mi- funded, but largely privately executed, national R&Dprogram, of which 95 percent was allocated to pri- ing biotechnology, production automation, vate firms as grants to speed up technological reno- electro-optics, and food. In the late 1980s, 43 per- vation, encourage R&D, improve design capabilities, cent of total R&D expenditures went into eight and train technical and managerial personnel. Over national strategic programs, of which 62 percent 250 textile plants are scheduled to receive financial was carried out by private enterprises. Develop- and technical assistance under this program. In ad- ment of engineering capabilities accounted for dition, substantial technical aid for technology up- over 70 percent. N D 0 N E S I A D i s c U S S 1 0 N P A P E R S E R I E S 30 CHAPTER 5 grading is being provided. The Taiwan Textile Fed- 5.16 With World Bank support, a line of credit eration and the CETRA Industrial Design Center have was also provided to facilitate restructuring for given information to firms, provided design training, enhanced competitiveness in three subsectors of and sponsored design shows. The China Productiv- Indonesian industry: textiles, pulp and paper, and ity Center sends out technical teams to visit plants the engineering industries.' The evidence idi- and advise on automation. Banks provide low-inter- cates that many companies successfully used the est loans to SMEs to move their facilities overseas and line of credit to upgrade production technologies, have created a special credit line for them (up to improve product quality, and increase sales in $60,000 each) to import new equipment. These efforts domestic and export markets.2 However, it has are starting to bear fruit as textile firms use the latest been suggested that firms would have achieved open end rotor spinning, and water jet and air jet even greater competitiveness gains had adequate weaving technologies. Indigenous designers are be- technical services been pro- ginning to establish a reputation in export markets, vided as part of a compre- and there is relocation of simpler facilities to China hensive package Of support THE EXPERIENCE OF and Southeast Asia. for restructuring, as has been done in Taiwan, China OTECUNRS HONG KONG (para. 5.11). While this was SHOWS THAT TAX 5.13 Even the traditionally laissez faire Government part of the original design, CREDITS FOR R&D of Hong Kong has become much more intervention- the technical assistance ist, including getting involved in the provision of fi- component of the project TEND TO GO nancing for ITD. The government has recently estab- was delayed, and restruc- DISPROPORTIONATELY lished a $25 million fund, which will match the in- turing assistance was not vestment of technology-intensive startup companies made available until after in exchange for an equity stake. the beneficiaries had used SINCE SMALL AND INDOESIAthe line of credit. MEDIUM-SCALE INDONESIA 5.14 Like its neighbors, Indonesia has also employed 5.17 Innes h o r- a variety of fiscal and financing mechanisms to pro- age the use of venture capi- TYPICAL TARGET GROUP mote technology upgrading. In 1990, the Indonesian tal. Technology- intensive FOR SUCH INCENTIVES government introduced tax code provisions allowing startup projects typically do limited deductibility of training costs, R&D expendi- not have the collateral to OFTEN HAVE LOW tures and royalty payments. By and large, industry secure financing from com- TAX LIABILITIES. has not responded to this inducement because of the mercial banks, which, i any limitations on allowable deductions, and also because case, often do not know of inadequate tax administration procedures. how to assess the risks in- 5.15 The experience of other countries shows that volved. Consequently, private sector venture capi- tax credits for R&D tend to go disproportionately to tal funds are beginning to emerge to finance them. larger firms, since SMEs, the usual target group for Recently, the government has supported the such incentives, often have low tax liabilities. Tax in- growth of venture capital by improving the tax centives also rarely generate additional R&D efforts framework for the funds. However, their expan- by large firms beyond those they would undertake sion will be constrained by: anyway. Indonesia's limited fiscal resources available 0 a shortage of experts to staff the venture funds to support ITD might better be used to directly finance and help startup companies develop; carefully targeted programs, such as cost-sharing grants to support technology upgrading of SMEs 0 slow growth in the flow of potential deals to (para. 6.51). the venture funds due to the limited number cN D 0 N a S I A D i s c u S S 0 N P A P E R S E R I S 31 FINANCING TECHNOLOGICAL AcTvTIY of technology-intensive companies coming Figure 5.1 into the market; the difficulties of being able to publicly sell Real Average Annual Interest Rates in shares in those companies in order to divest East Asia the shareholdings of the venture funds. 18.0 Efforts to promote venture capital as a tool to pro- 16.0 mote ITD will need to address these problems. 14.0 5.18. Perhaps a more important financing issue 10.0 Singapore concerns the cost of credit. For firms contemplat- Malaysia ing long-term investments in new technologies, 6.0 bank credit in Indonesia is substantially more ex- 4.0 pensive than in competitor countries (Figure 5.1). 2.0 0.0 I High domestic real interest rates in Indonesia dis- 1986 1987 1988 1989 1990 1991 proportionately affect SMEs, which, unlike the Year large business groups, typically are unable to bor- row at lower rates offshore. Prudent banks more comfortable when deciding whether to macroeconomic policies and financial sector im- finance the technology development projects of ben- provements to reduce risk are essential to reduc- eficiary firns. ing Indonesia's high domestic real interest rates and improving the availability of term finance for investments in technology upgrading. Term fi- ENDNOTES nance for ITD would also be improved by 1 The line of credit was a major component of the strengthening the appraisal capacity of the bank- ing system. The seal of approval from the tech- nology service providers supported under the 2 See Final Report on Monitoring and Evaluation of the Industrial Technology Development Project, IR, PT MultiSentra, March 1995. partly funded by the World Bank, should make N D 0 N E S A D i S C U S S I 0 N P A P R S R I 32 CHAPTER 6 Focusing Indonesia's Technology Support Institutions on Effective Technology Diffusion A. OVERVIEW HONG KONG 6.01 Indonesia spends about 0.2 percent of its GDP 6.03 Despite Hong Kong' traditional laissezfaire on technology infrastructure. This consists of the pub- approach to economic policy, its government has lic R&D institutions under the State Ministry of Re- provided substantial technical support to SMEs search and Technology and the Ministry of Industry through the Hong Kong Productivity Council (MOI). Government also provides technology support (HKPC). HKPC was started in 1967 to help SMEs services in the areas of metrology, testing, calibration, upgrade from declining labor-intensive produc- quality upgrading (MSTQ), technology extension and tion to more advanced, high-value-added activi- information services. However, the contributions of ties. It provides information on international stan- these institutions to industry's technological devel- dards and quality, training, consulting, and dem- opment and enhanced competitiveness have been lim- onstration services on productivity and quality to ited. This chapter draws from the experiences of other more than 4,000 small firms a year at subsidized East Asian countries to identify reform measures and rates. Its on-line information retrieval system now restructuring programs that can enhance the contri- has access to more than 600 international data- bution of Indonesia's public technology support in- bases in a comprehensive range of disciplines. Its stitutions (PTSIs) and promote private provision of technical reference library subscribes to more than technology support services. It also recommends 700 journals, and has over 16,000 reference books. ways to maximize the role of the strategic industries 6.04 HKPC also acts as a technology transfer and in Indonesia's industrial technological development. technology development agent, with specialized B.technical services for the different industrial sec- B. EPERINCESOF TE EAT ~tors. It first identifies new technologies in the in- INDUSTRIALIZING ECONOMIES ternational market, builds up its own mastery of 6.02 The infrastructure for ITD includes MSTQ sup- them and then introduces them to industry. It also port institutions, public research institutions, and provides management and technology courses for technical support and extension services to SMEs. some 15,000 participants each year. For firms that Many of these functions are public goods. Every coun- are unable to release staff to attend courses, it or- try has these institutions, but many of those in devel- ganizes in-house training programs. To help dis- oping countries suffer from similar problems: a lack semmate information technology, it has formed of close linkages with industry; the pursuit of theo- strategic alliances with major computer vendors. retical science rather than technology and its diffu- It provides specially designed software for local sion; poor staffing and funding of industrial technol- industry, as well as consulting and project man- ogy extension services; and unreliability of the MSTQ agement in computerization. HKPC also provides system. MSTQ backwardness increasingly causes dif- consulting services in ISO 9000 systems, and has ficulties because the international market now re- helped several firms obtain certification. In 1993/ quires quality management systems such as ISO 9000 94, it undertook 1,354 consulting and technology and ISO 14000. There are important lessons to be assistance projects, trained more than 15,000 learned from the experiences of those East Asian NIEs people and provided manufacturing support ser- which have invested heavily, in setting up technol- vices in 2,400 cases. To promote private provision ogy support institutions and making them more rel- of technology support services, HKPC's policy is evant to industry. not to participate when private consultants are available. As a result of growth in the institution's N 0 N ( S I A D i s c u s s I s N P A P E R S I E S 33 FOCUSING INDONESIA'S TECHNOLOGY SUPPORT INSTITUTIONS ON EFFECTIVE TECHNOLOGY DIFFUSION revenue-earning work, the government now con- for eight SME programs, including product develop- tributes only about 40 percent of HKPC's budget. ment assistance, technical assistance to import con- 6.05 Recently, Hong Kong has become much sultants, venture capital to help technology startups, more active in supporting technology diffusion robot leasing, training, and technology tie-ins with to industry because of the business community's foreign companies. increasing concern over the lack of industrial and 6.07 The Singapore Institute of Standards and In- technological depth in the colony.' The Hong dustrial Research disseminates technology to SMEs Kong Industrial Technology Center (HKITC) is and provides them with information on how to meet one of the colony's most recent commitments to foreign standards and technical requirements. The supporting technology-oriented companies. The National Productivity Board provides firms with Center promotes technology development by management advice and consulting services, while nurturing small companies and providing rela- the Technology Development Center (TDC) helps tively inexpensive state-of-the-art facilities for them to identify their technology requirements and more established ones. The government package purchase technologies. It even helps them design supporting the Center includes a one-time grant technology upgrading strategies. Since it was of HK$250 million, the ability to tap a HK$188 founded in 1989, TDC has provided more than 130 million credit line (at 7 percent a year), and 5,700 firms with various forms of technical assistance. It square meters of land next to one of the colony's also administers the Small Industry Technical Assis- busiest train stations. The government has pro- tance Scheme (SITAS) and the Product Development vided a HK$250 million grant for a new Industry Assistance Scheme to help firms develop their design and Technology Center, has completed a new and development capabilities. It has given grants to- University of Science and Technology, and has taling more than $1 million to 29 SITAS in the past 5 initiated plans for a HK$2.8 billion science park. years, mainly to local enterprises, and its earnings In addition, the government supports local design have risen to a level where its cost recoverable activi- capabilities through its school of design and the ties are self financing. The EDB encourages subcon- Hong Kong Design Innovation Company. tracting to local firms through its Local Industries SINGAPORE Upgrading Program, under which MNCs are per- suaded to source components locally by adopting 6.06 Provision of technology support services to particular SMEs as subcontractors. In return for a industry has also been a major priority in commitment by the MNCs to make on-the-job train- Singapore. Two aspects of Singapore's technology ing and other assistance available to subcontractors, infrastructure programs are worth noting. The the government provides a package of assistance to first is its policy on SMEs. In 1962, the EDB the latter, including cost-sharing grants and loans for launched a program to help SMEs modernize equipment, consulting and training. equipment with funds provided by the UNDP. In 6.08 The second interesting aspect of Singapore's ap- the mid-1970s, EDB started several other pro- proach is its public R&D program. In 1991, the gov- grams for financial assistance. Of these, the most ement set an R&D spending target of 2 percent of significant was the Small Industries Finance GDP by 1995, compared to less than 1 percent in the Scheme to encourage technological upgrading in early 1990s. It selected a number of sectors for tech- SMEs.2 The 1985 recession induced the govern- nology development,3 and established a S$2 billion ment to take even stronger measures. It estab- fund for R&D. Biotechnology is a good example of lished a Venture Capital Fund to help SMEs ac- Singapore's systematic approach to developing a do- quire capital through low-interest loans and eq- mestic innovative base by using public R&D funds uity. A Small Enterprises Bureau was established and institutions to build up basic research capability in 1986 to act as a one-stop consulting agency, and so attract R&D participation by MNCs. helping SMEs with management, training, finance and grants, and coordinating assistance from other 6.09 mapnoreai ttepg to oe Intte agencies. In 1987, US$519 million was provided ent aista th te o n IN 0 0 N E S I A D i s c u S S 1 0 N P A P E R S E R I E S 34 CHAPTER 6 of Molecular and Cell Biology (IMCB). Placed within opened in 1990, seeks to improve purification, syn- the National Biotechnology Program, started in 1988 thesis and fermentation methods for commercial to strengthen the national R&D base and fund bio- production. The Unit recently achieved large technology development, IMCB is an ambitious yields of TNF-[betal, which other companies, in- project in the government's overall strategy of using cluding Genzyme in the United States and high technology to strengthen its economy. An im- Boehringer Mannheim in Germany, are eager to portant incentive for firms to participate in this pro- put into clinical cancer trials. The National Uni- gram is the granting of pioneer industry status, which versity Medical Institute, now being built near gives tax exemption for 5 to 10 years, with the largest IMCB and the National University Hospital, is benefits given to technology-intensive and export-ori- modeled on the U.S. National Institutes of Health. ented projects. In addition, government funding is 6.13 One obstacle to Singapore's quest for sci- provided if firms actively collaborate with public sec- entific success, however, is its shortage of well- tor research. The foundation of this effort is the strong qualified scientists and engineers. To overcome program in basic research at the National University this, IMCB recruited western scientists, offering of Singapore (NUS), which houses the IMCB. NUS them research freedom, ample funding, and sala- conducts one third of Singapore's R&D, and its sci- ries of up to $50,000 with renewable three-year entists have achieved international recognition in sev- contracts. Singapore's own students, however, eral areas, including materials technology, microelec- represent the largest source of scientific talent at tronics and information technology. IMCB. Its two polytechnics are training techni- 6.10 The decision to spend S$13.8 million to build cians to fill the growing demand frombiotech labs IMCB and to provide annual funding of S$17.5 mil- and industries. In addition to tuition, graduate lion reflects the government's belief that Singapore students at 1MCB receive a $10,000 a year stipend. can become a world leader in biotechnology. The biotech industry requires few natural resources, is AiwAN, CHINA high value added and can make use of Singapore's 6.14 Taiwan, China's technology support poli- extensive global business networks. To make this be- cies have focused on the needs of the country's lief a reality, the government created Singapore Bio- 700,000 SMEs, which account for 70 percent of em- Innovation Pte Ltd. (SBI). By 1991, SBI had invested ployment, 55 percent of GNP, and 62 percent of S$41 million in 12 local biotech startup firms with manufactured exportS.4 In 1981, the government 1,428 employees making health care, food and agri- set up the Medium and Small Business Adminis- cultural products. SBI also invests in overseas com- tration to coordinate the several agencies provid- panies that might be strategic allies. ing assistance to SMEs. Among these agencies are 6.11 The investment in IMCB appears to be paying the Taiwan Medium Business Bank, the Bank of off scientifically. One IMCB group is at the forefront Taiwan, the Small and Medium Business Credit of research on tyrosine phosphates, a hot topic in can- Guarantee Fund and the Small Business Inte- cer research. Another group is sequencing the ge- grated Assistance Center. Management and tech- nomes of several fish species, which could serve as a nology assistance are provided by the China Pro- reference vertebrate genome for the human genome ductivity Center, the Industrial Technology Re- project. IMCB laboratories' innovative assay systems search Institute (ITRI) and a number of industrial convinced Glaxo, the pharmaceutical MNC, to estab- technology centers for the metals industry, textiles, lish a S$31 million trust fund for a drug screening cen- biotechnology, food and information. The joint ter within IMCB. Glaxo also invested S$30 million for Services Center of the Ministry of Economic Af- an IMCB neurobiology lab. fairs acts as a source of information on SME assis- 6.12 Encouraged by these successes, the government SMe fee for coers thee an expanded IMCB's research base by establishing the SMa Bsinsldinistraion h a ani Bioscience Center at NUS, and the Food Biotechnol- lion fun fr mnro tion he CeNT$r-Satl- ogy Center. The Bioprocessing Technology Unit, lite factfory Promordtion. The of che lntre ling GenzoyPrmetionPormo the nitd iSt tesan IN D 0 N E S I A D i s c u s s i o N P A P E R S E R I E-S 35 FOCUSING INDONESIA'S TECHNOLOGY SUPPORT INSTITUTIONS ON EFFECTIVE TECHNOLOGY DIFFUSION of Economic Affairs integrates smaller factories Taiwan Handicraft Promotion Center supports handi- around a principal one in a program involving craft producers, particularly small ones with export vendor assistance, productivity-raising efforts, potential. The Program for the Promotion of Tech- and a rational sharing of manufacturing tasks nology Transfer maintains close contact with foreign among participating enterprises. By 1989, there corporations that have developed leading edge tech- were 60 networks with 1,186 satellite factories in nologies in order to facilitate their acquisition. The operation, mainly in electronics. China Productivity Center (CPC is well known for 6.15 ITRI, established in 1973 to do R&D con- its efforts to promote automation. CPC sends engi- sidered too risky for the private sector, became neers to visit plants throughout the country to dem- increasingly isolated from industry in its early onstrate the best means of automation and solve tech- years. The government initiated major reforms nical problems. Over the past two years, CPC teams starting in 1982, when it insisted that the institute visited more than 1,000 plants and made more than start to finance itself through the sale of services 4,000 suggestions for improvement. CPC also does to industry. To obtain funding, ITRI's researchers independent research on improving production effi- have to submit proposals with fixed budgets, ciency and links enterprises with more complex tech- timetables and deliverables specified for review nical problems with the appropriate research centers and monitoring by a technical group from indus- that can solve them. try, academia and government. Today, ITRI is con- 6.18 There are three other major manufacturing sidered one of the most successful ITD support R&D institutes in Taiwan, China. The China Textile institutions in the world.- Research Center was set up in 1959 to inspect exports, 6.16 One of ITRI's most important responsibili- but its duties have expanded to indude training, qual- ties is technology development for SMEs. While ity systems, technology development, and direct ac- it covers a range of industrial technologies (met- quisition of foreign technology. The Metal Industries als, chemicals, energy and aerospace), electronics Development Center was established in 1963 to work has been its principal focus. Its Electronics Re- on practical development, testing and quality con- search and Service (ERSO) division accounts for trol work in metalworking industries. It later orga- two-thirds of its $450 million budget. ERSO de- nized a CAD/CAM center to provide training and velops new electronics technologies and diffuses software. The Precision Instrument Development them to industry through licensing and setting up Center has now moved into advanced areas such as joint venture companies in which government vacuum and electro-optics technology. provides technical support and some funding 6.19 In addition, the government encourages private while the private partners put up the majority industry to contract research to universities. The Na- stake. ERSO's laboratories also set up and spin tional Science Council funds about $100 million worth off private manufacturing enterprises; six major of such contracts a year, with enterprises providing integrated circuit manufacturers in Taiwan, China, matching funds. In the 1980s, the government spent including the most successful, are such spinoffs. US$500 million to set up a science town in Hsinchu, ITRI and other government R&D institutions have which now has 13,000 researchers in two universi- also gone into joint ventures directly with the pri- ties, six national laboratories (including ITRI), and a vate sector. One example is the Philips wafer fab- huge technology institute, as well as some 150 com- rication operation. ITRI has also trained technol- panies specializing in electronics. Hsinchu makes ogy-oriented venture capitalists and encourages special efforts to attract startups, providing them with members of its own staff to become private sector factory space, five-year tax holidays and generous entrepreneurs. grants. 6.17 Other SME support agencies include the In- KOREA stitute for the Information Industry, which complements ITRI's work on hardware by devel- 6.20 In 1966 the Korean government set up KIST oping and introducing software technology The (Korea Institute of Science and Technology) to per- form applied research for industry. In its early years, N D 0 N E S I A D p m S o 0 N P A P E R S R I E 36 CHAPTER 6 KIST focused on solving simple problems of technol- 6.23 Other technology policy measures in Korea ogy transfer and absorption. In the 1970s, the gov- included setting up university Science Research emiment set up other specialized research institutes Centers and Engineering Research Centers, the (on machinery, metals, electronics, nuclear energy, re- common utilization of advanced R&D facilities sources, chemicals, telecommunications, standards, and the establishment of science towns. Daeduk shipbuilding, marine sciences and so on), largely spun Science Town has been under construction since off from KIST. By the end of the decade, Korea had 16 1974, and a large number of research and educa- R&D institutions. In 1981, the government decided tional institutions are already well established to reduce their number and rationalize their opera- there. Other such towns are under construction. tions. The existing institutes were combined into 9 The Korea Institute for Economics and Technol- under the supervision of the Ministry of Science and ogy diffuses technology by collecting, processing Technology. KIST was merged with KAIS (Korea Ad- and disseminating technical information to indus- vanced Institute of Science) to become KAIST, but try. became a separate organization again in 1989. 6.21 The government launched a series of national R&D projects in 1982. These were large scale activi- 6.24 All countries in East Asia have invested ties regarded as too risky for industry to tackle alone heavily in R&D infrastructure. However, the role but considered in the country's strategic industrial of their technology support institutions, as in interest. They were conducted jointly by industry, many other developing countries, and in some de- public research institutes, and the government, and veloped ones as well, is undergoing major change. dealt with areas such as semiconductors, computers, Economic polcymakers are disillusioned with the fine chemicals, machinery, material science and plant traditional big science, mission-oriented, supply- system engineering. These projects were part of driven approach, which has left their laboratories Korea's strategy of identifying and developing the isolated from industry. The public technology in- country's comparative advantages, orchestrating the stitutions are under increasing pressure to become activities of participants, underwriting part of the more market responsive and to have their research risks, providing large financial grants, and acting di- enhance the competitiveness of industry. Budget rectly in problem areas where the market alone could constraints on technology support institutions are not provide a solution. Total expenditure on these partly a result of the global trend of fiscal auster- projects between 1982 and 1989 was $680 million. The ity as well as disappointment with the value sums involved increased steadily from $25 million in added generated by the institutes. Increasingly 1982 to $151 million in 1989. Strategic technological governments have been requiring the institutions activities are still targeted and promoted today. to compete for what government research money 6.22 A recent evaluation of the Korean government r example, only 2 percent of ITRI's research institutes (GRIs) suggests that their greatest throug ir govenmen gs n deo impact has been on human resource development.6 tro government nsj ts p th KoT The institutes trained a generation of R&D special- bet. Technlogysu t ispeae bIng ists who helped to establish and operate the private eugeto oerateor comme and e labs that emerged as large firms increased their R&D engugen theatomy and a t efforts. They also played an important role in the de- velopment of national industrial strategies. However, 6.25 Recent studies have identified some com- they provided only limited technical assistance to mon external and internal characteristics of suc- private firms, largely due to the fact that large-scale cessful institutional transformation.7 Among the government funding for the national research projects external factors, the extent to which the export destroyed any incentive for the GRIs to sell technol- market creates industry demand for technology ogy and technical services directly to industry. services is paramount. Strong linkages with in- dustry to help determine the strategic direction of the institutes are also very important. For ex- IN D 0 N E S I A D i S C U S S 1 0 N P A P E R S E R I ES 37 FOCUSING INDONESIA'S TECHNOLOGY SUPPORT INSTITUTIONS ON EFFECTIVE TECHNOLOGY DIFFUsION ample, many of the most successful institutes have facturers. They lack systems to market their research substantial industry representation on their to firms or to assess the R&D requirements of indus- boards of directors. Institutes also have had to try. Many entrepreneurs are not even aware of the become more self-financing to cope with stagnant R&D capacity that exists within the institutes. Even or declining public sector financing. when they are, they are skeptical about its relevance 6.26 Among the internal factors, the most impor- to the technology development and competitiveness tant are to have: issues with which they are grappling. Whle firms ac- * strong institutional leadership that empha- knowledge that some of them, e.g., the MIDC (for the sizesmetalworking industries) and the IRDTI (for textiles), and technicalportanceo played an important role in diffusing technologies to and echica excllece;industry 10 to 15 years ago, they say the labs have * a clear, well-defined strategy and measurable not kept abreast of developments in their industries goals; and are now years behind. Unlike those in several * a technically competent staff with strong in- other countries in the region, none of Indonesia's centives to carry out the institutional strategy; government-funded R&D labs have industry partici- * the capacity to continually renew staff skills pation on their boards of directors to help in setting through training and the institutional capac- agendas. Moreover, communication among the insti- ity to learn from work with clients; tutes and universities about the development and " god pojet mnagment moitoingand application of technology for industry is negligible. *egoo poet em et 6.29 Not surprisingly, Indonesia's PTSIs get rela- evaluation systems.ively little income from the sale of technology and C. THE LIMITED CONTRIBUTION OF technology services to industry. For example, on av- INDONESIAS PUBLIC TECHNOLOGY erage, M01's R&D institutes generate only about 20 SUPPORT INSTITUTIONS percent of their budgets from such sales, and very little of that comes from contract research, prototype 6.27 Indonesia invests substantial resources, development or licensing of technology generated by about 1 percent of the national budget annually, the labs. Most earnings come from training and test- in its publicly funded R&D laboratories, account- ing services. The degree of self-financing among all ing for about 80 percent of national R&D expen- of Indonesia's public technology support institutions diture (see Table 6.1). is low compared to that of There are several indus- other developing countries trial labs under the State Table 6.1: R&D Expenditures and Sources of R&D in Asia (Table 6.2). Ministry for Research and by Country 1990 6.30 i Indonesia, incen- Te ch tehnology ogycde tiveslforothe PTS stoiearn issues with which thy aincome are limited. They are tion, the Ministry of In- R&D Expenditure Source unable, for example, to played, anrimportan rly generate income, and un- for Industrial Research Japan 2.9 16 78 6 used earnings must be re- and Development (BPPI), South Korea 1.9 16 84 turned to government at the 12darnationrsalind Uliketeseinsevra laboratories, specialize Singapore 1.0 46 54 end of the fiscal year. Lab obthetrrias nstecraie5 i directors also generally gvn nfd R&D1absial ub ahave little decision-making well as several regional India 0.9 61 30 3 power. Even in the few cases R&D institutes.t China 0.7 62 38 where the institutes have 6.28 Only a few PTSIs Indonesia 0.2 80 19 1 developed commercially vi- work closely with manu- able technologies in de- N D 0 N E S I A D i sR& n s s N P A P E R S E R I E2 38 CHAPTER 6 mand by industry, their capacity Table 6.2: Degree of Self Financing of Seleced Public R&D Systems and motivation to strengthen in- dustry linkages are also severely limited since they lack systems for pricing, marketing, or licensing Singapore Singapore Institute of Standards and Industrial Research 60 the technologies they have devel- Hong Kong Hong Kong Productivity Center 60 oped (see Box 6.1). Germany Fraunhofer Institute 50 6.31 Indonesia's PTSIs are much Tiwan Industrial Technology Research Institute 35 more dependent on public financ- ing of R&D than their regional India Council of Scientific & Industrial Research 33 counterparts. While R&D bud- South Korea Korean Institute of Science & Technology 28 gets grew at about 15 percent a Australia Commonwealth Scientific & Industrial Research Organization 25 year in the 1980s, in the past few years funding has kept only Indonesia Indonesian Institute of Sciences 10 slightly ahead of inflation, and Agency for the Assessment & Application of Technology 5 there is little prospect of a return 30 to the healthy increases of the Mnsr fIdsr & nttts 1980s. Moreover, as is the trend Sources: Various World Bank reports and Institute Annual Reports 1980. M reoer,as s te tend These institutes now belong to the Ministry of Industry and Trade (MOMT. elsewhere in the region (para. 6.24), the government has re- cently begun allocating a small but growing share of Box 6.1: Technology Marketing in an MOlT R&D Laboratory its public funding for R&D on the basis of competi- tive research grants and mandatory industrial par- The Industrial Institute, Semarang has developed technical services ticipation. Consequently, many lab directors are com- in industrial design and engineering that have been well used by ing to see that they can survive only by carrying out industry. The lab has developed good capability in pollution control cient-driven technology support activities, particu- technology. During the last three years the institute has served about larly R&D and technical services to private industry 110 firms in providing industrial waste treatment technologies, dis- MINISTRY OF INDUSTRY LABORATORIES posal monitoring services, industrial process equipment design, waste 6.32 A recent World Bank report on Indonesia's R&D treatment equipment and training services. It has also developed institutes under the former Ministry of Industry (now and sold waste water and disposal gas treatment facilities. Even the Ministry of Industry and Trade after its recent after transferring the technology it has developed, the institute has ,continued to work dosely with its clients for further improvements. enrly with the form er rist ofT ade) s w t However, the institute does not have expertise in the commercial- naits al te in s are pr imarily egagedw) ization of technology. In cases where there is scope for selling its tain tst ing a rc t ertifiction ( elw technologies to many clients, the institute lacks expertise in tech- tn iati te rese ent takng lacec th re - nology marketing, licensing, pricing or estimating and monitoring toi uali, theng ass sn tud tat an re- the costs of technology development. Many of the R&D institutes souret-drivnagenolog in strup re, otiits adtink- hv hs ekessiomn ages with firms and other institutes are all weak ar-indu eas for the MOIT labs. 6.33 The labs' institutional framework is an impor- and obsolete equipment and facilities. Box 6.2 pro- tant cause of their weaknesses. They work under dif- vides specific recommendations for reform of the ficult bureaucratic restrictions on travel, materials and MO T R&D lab system. Many of these recommen- equipment procurement, which constrain their abil- dations are being implemented as part of the ity to go to industry understand its requirements a d government's Action Plan for restructuring its offer services. Researchers' salaries and incentives are technology support institutions (para. 6.45 below). low.h0 They also have outmoded, poorly maintained tN D 0 N S I A D in sn tcn s N P A P R S E R I S 39 FOCUSING INDONESIA'S TECHNOLOGY SUPPORT INSTITUTIONS ON EFFECTIVE TECHNOLOGY DIFFUSION THE NONDEPARTMENTAL R&D plication of technology for industrial and national LABORATORIES development. BPPT's 21 technical directorates cover 6.34 In addition to those under line ministries the basic and applied sciences, technology develop- such as MOIT, there are nondepartmental labora- ment, industrial analysis, natural resource develop- tories. The Indonesian Institute of Sciences (LIPI) ment and systems analysis and also run technical was established in 1967 to assist the president in laboratories in such fields as aerodynamics and gas organizing national R&D; give guidance, services dynamics, energy resources and construction testing. and advice to government on national science and They employ about 3,000 people, of which about ten technology policy; improve Indonesia's scientific percent have advanced degrees. In 1993/94 BPPT's capability; and cooperate with national and inter- budget was about US$42 million, 95 percent funded national scientific bodies. It does basic research by government. and carries out technology development activi- ties in the natural sciences, engi- neering sciences, social sciences, and humanities and also plays a Box 62 Recommendations for Reform of MOrT Labs major role in the development of the country's science and technol- 0 Grant substantial autonomy to the institutes to ensure emergence of professional sys- ogy infrastructure, by providing tems of R&D management and generation of strong market-responsive, outward-look- MSQT and information services. ing systems. Autonomy to be coupled with accountability. LIPI employs about 4,000 people, o wic a bou te n including more than 300 with Giewonasautotelbsotathycnrtithiidsralanng,eod Ph.Ds and Masters degrees, and staff who generate that income, and reduce dependence on government funding. has a budget of about US$42 nil- * Also decentralize recruitment (presently done at the center) to the institute level. lion, abut 90bprcentegvernmen nd a out ecno Create incentive systems for the institutions. Link the development budgetary support Tgiven to the institutes annually to their industrial earnings in the previous year. Allocate 6.35ingesciency forial ssnes, ment and Application of Technol- 50 percent of t he earnings from industry as extra budgetary support from the govern- ogy (BPPT) was established in ment, which would serve as an additional driving force for the institutes to seek more 1978 to be in charge of the selec- funds from industry. tion, assessment anid application * Audit earnings from industry separately. Effectively set up a "dual system" for auditing, of science and technology for the with a faster track for funds earned from private industry. development of national industry. Review salary structure of scientists in MOlT institutes. In the meantime, implement a Like LIPI, BPPT is a nondepart- scheme to share industrial earnings to augment the income of MOI institute staff in- mental government agency re- valved in generating hose earnings. porting directly to the president. Its principal tasks are to: (a) for- * In each institute, set up research advisory committees with membership from private mulate technology policies and sector industry and other professionals to give an unbiased external look at the insti- programs to promote industrial tuts and to suggest ways and means of improving their performance. and national development; (b) Develop a scheme to promote mobility of scientists among the institutes under MOlT, ensure coordination in the imple- MENRISTEK and academia. mentation of programs for the as- sessment and application of tech- Organize annual meetings of the publicly funded R&D institutions, in-house R&D de nology; (c) provide services to partments in industry and academia to discuss and debate the issues linked to commer- government and the private sec- cialization of R&D. tor in the application of technol- Create annual awards for industries which commercialize R&D from publicly funded ogy; and (d) support the R&D institutions; such public recognition will stimulate the usage of the expertise in government's policies on the ap- R&D institutions by industrial firms. I N 0 0 N E S I A D f S C U S S 1 0 N P. A P E R S E R I E S 40 CHAPTER 6 6.36 The nondepartmental labs, like those under ket driven and to improve their working environ- MOIT, also have very limited contacts with private ment. This would entail both granting them industry. A recent analysis of BPPT and LIPP found greater autonomy and establishing mechanisms their management highly bureaucratic, operating the to ensure greater accountability labs under an inefficient, rule-bound, supply-driven 6.41 Greater accountability could be achieved by system inadequately responsive to the needs of the linking government funding to each institution's private sector. Selection of projects is largely a formal earnings from industry through sales of technol- process, often merely extending existing projects with ogy, technology licensing, contract research for little attempt to analyze their relevance or feasibility. and joint research with industry, management Project costing, control and evaluation mechanisms consulting, and provision of training and testing are extremely weak. services. This approach of providing matching 6.37 Human resource planning is inadequate. Job funds has been adopted in other countries and has descriptions, classification systems and utilization of encouraged the emergence of more professional, staff are all poor. Attitude surveys reveal low job sat- market-responsive and outward-looking systems isfaction ratings among researchers because of: of management within R&D laboratories. * lack of a clear mission statement, strategic direc- 6.42 In addition, advisory boards with substan- tion, or goals set by management; tial private sector representation should be estab- * absence of clear research priorities, clear tasks, or esue that &D aedaee rflec ind targets; needs. In addition, quantitative performance in- * inadequate performance rating systems for mak- dicators, such as earnings from industry, the num- ing career development and staff remuneration ber of publications in international research jour- decisions. nals, and the number of patents received, should 6.38 Recognizing many of these problems, BPPT and p p g g LIPI have begun pilot projects to improve office and monitor staff performance. Such indicators could logistics management, human resource utilization, help to determine institutional funding, promo- and R&D project management systems. These pilot tions, salaries and bonus payments. projects will now be expanded with support from the 6.43 The labs should have more freedom to re- Industrial Technology Development Project, which tain and use their earnings from industry. In this has received World Bank financing. way, they could provide better incentives to their 6.39 In addition, the government has implemented staff and help pay for the costs of marketing and a new "One Gate" policy for centralized screening of providing their services to industry. Government all government-financed R&D project proposals, in stfftpocureentmat and euint, an effort to ensure greater relevance of publicly ad tr oeed o bersubstan euced, funded research. As the program moves forward, ata e tse are finand rernngs improvements will need to be made, particularly in this wlge the r& ins nce nives the capacity of the screening panels to monitor and evaluate proposals during and after their implemen- to market and price their services more aggres- tation. It also will be important for the panels to have sively. Today, they can only charge for direct la- a mix of theoretical and practical perspectives by in- er of simil seve tesug) chare their cluding representatives of academia and industry as es on the sis of.fulleovery ofacosti well as some foreign participants. 6.40 Requiring peer and panel reviews may help cluding overhead), plus a profit. improve the quality of public sector R&D projects. 6.44 All MOIT and nondepartmental laborato- However, to maximize the benefits from R&D, direct ries should strive to become client-funded, respon- Hoevurer,shouldbetakn to ma te f m oe sive, demand-driven organizations. Clearly, this will require granting them greater autonomy for IN D 0 N E S I A D i S C U S S 1 0 N P A P E R S E R IE S 41 FocUSING INDONESIA'S TECHNOLOGY SUPPORT INSTITuTIONS ON EFFECTIVE TECHNOLOGY DIFFusION decisionmaking while at the same time holding panies that utilize their technologies. There may also them accountable for improved performance. This be scope for further restructuring, including: could be achieved by changing internal manage- 0 merger and consolidation of institutions that ment systems, improving incentives, developing their capability to respond to demands from in- sres dustry and reforming the public R&D financing system to reduce reliance on government fund- 0 Closing institutions that cannot produce viable ing. strategies and business plans for commercializa- 6.45 The government's Action Plan to commer- tion; cialize PTSIs will be supported by an Industrial 0 reorganizing labs along functional rather than Technology Development Project (ITDP), which sectoral lines in order to meet more generic needs has recently received World Bank funding. The across industries, rather than focusing on devel- Plan calls for the following: oping a full range of capabilities in selected in- * giving PTSIs the necessary incentives to be- dustrial subsectors; come more demand driven and commercially encouraging the private sector to play a central oriented, and establishing self-financing tar- role in the formulation of PTSIs' strategies and gets; policies through membership on boards of direc- * reducing government controls to encourage tors and advisory councils. the institutions to become more agile in re- D.OTHER TECHNOLOGY SUPPORT SERVICES sponding to the technological needs of indus- trial firms, while also increasing their account- TECHNOLOGYEXTENSION SERVICES ability for results; 6.47 Indonesian SMEs facing productivity efficiency * implementing internal management reforms and quality problems often are simply unaware of to ensure that the institutions become more the technology assistance available to them. In many professionally managed and results oriented; countries, including the United States, Japan, South * encouraging private technology support ser- Korea and Taiwan, China, technology extension ser- vices and competition among public and pri- vices play an important role in improving productiv- vate technology services providers. ity, product quality, delivery and manufacturing methods for SMEs. Implementation of the Action Plan should signifi- 648 International experience shows that for these cantly improve operations of the PTSIs, as should f the solution to becoming competitive is not to the greater emphasis given to performance mea- develop new products. Instead, it is to employ cur- surement, including assessment of the impact of rent best manufacturing practices by extending the technology services on firms, and monitoring and evaluation of publicly funded R&D projectsleghoteprdcinyl,im ovgivnoy larlyn efied budead exDpectot controls, tightening up management of facilities and against staff, and increasing internal process efficiency (e.g., puts. by reducing scrap rates, improving machine reliabil- 6.46 In the next stage of PTSI reform, greater ac- ity and eliminating bottlenecks). Figures 6.1 and 6.2 countability could be achieved by linking govern- show, in the specific areas of shoes and printed cir- ment funding to each institution's earnings from cuit boards, how technology extension services can sale of its R&D products and services to industry be invaluable for improving the ability of firms in Incentives to commercialize R&D could also be developing countries, such as Indonesia, to compete enhanced by allowing PTSIs to set up commer- globally with manufacturers in the NICS.12 cial subsidiaries and take equity positions in com- N s0 N S I A D i s c u S S 0 N P A P E R S E R I E 42 CHAPTER 6 6.49 This has also been demonstrated in practice in world are often reluctant to use external exper- Indonesia. In 1992, with World Bank support, the tise because of concerns about confidentiality, Ministry of Industry established semiautonomous affordability and value. Therefore, as experience Technical Service Groups (TSGs) to provide nation- elsewhere with such schemes demonstrates, it wide technical support and environmental services may be necessary initially to provide subsidized to firms in three subsectors (textiles, engineering prod- services to firms to show them how technological ucts, and pulp and paper manufacture). The govern- knowledge can be applied to their production ment provided a 90 percent subsidy to firms that used problems. Once firms see the benefits, they may the TSGs' services. be more willing to pay full cost. Cost-sharing helps 6.50 The TSGs, now being phased out, had a mixed develop a market for support services while pro- record. They delivered valuable services to industry viding firms with needed technical assistance. and demonstrated clearly that there is demand from Such a scheme will be implemented in Indonesia SMEs for a variety of technical support services, and on a pilot basis as part of a recently approved In- that most firms are willing to pay, albeit at highly sub- dustrial Technology Development Project (ITDP), sidized rates, for such support. On the other hand, partly funded by the World Bank. their geographical coverage was limited. They pro- METROLOGY, STANDARDS, TESTING, AND vided extension services to only a few subsectors, and UALITY SUPPORT SERVICES to only a limited number of firms in those subsectors. Costs were high, and complex government adminis- 6.53 To meet the demand for quality products trative procedures were burdensome. Moreover, their in international markets, and to ensure fairness services were delivered primarily by expatriates, with in domestic trade and public safety, all countries national experts (i.e., retired engineers) and counter- need an effective MSTQ system. To control qual- part staff from the sectoral R&D institutes making a ity it is necessary to be able to measure physical much smaller contribution. Nevertheless, the TSGs and chemical properties against properly speci- provided a useful demonstration to the institutes and fled standards. Consequently, MSTQ plays a very some training of institute staff on how to promote and important role in helping firms improve competi- deliver technical services to industry, and helped fo- tiveness. They also are an important instrument cus the government's attention on the need to give for the diffusion of technological information to, greater autonomy and incentives to the institutes. and lowering transaction costs for, firms by expe- 6.51 The provision of technology consulting ser- diting product specifications and quotations, and vices, with respect to both the number of firms and by eliminating the need for calibration and test- subsectors served and the suppliers of technical sup- ing at foreign laboratories or onsite third party port, needs to be expanded. Singapore, the Philip- inspectors. pines, Mauritius and the United Kingdom have all 6.54 However, Indonesian MSTQ is very weak, successfully used cost-sharing grants to stimulate an6 dissemination of national and international SME demand and to encourage the participation of standards to industry, quality awareness among private sector consultants as well as public technol- firms, and industry training in quality manage- ogy support institutions in the provision of technol- ment practices, especially by SMEs, are also ex- ogy extension services (see Box 6.3). tremely limited. Likewise, testing and calibration 6.52 Cost-sharing schemes in Indonesia would have services.are poor. None of the Indonesian testing several benefits. They could substantially extend the and calibration laboratories is internationally rec- sectoral and geographical coverage of extension ser- ognized. As a result, firms have to use foreign vices, and, by introducing competition among service laboratories at considerable expense. At the same providers, improve quality. SMEs throughout the time, demand for support services for upgrading product quality is growing rapidly as firms seek N d 0 N E S I A D o r S 0 N P A P E sRc S E R S 43 FocusING INDONESIA'S TECHNOLOGY SUPPORT INSTITUTIONS ON EFFECTIVE TECHNOLOGY DIFFusION to attain the international standards, including Figure 6.1 ISO 9000 certification, which are increasingly be- coming a requirement to sell in major export mar- kets. Using German and Japanese technical assis- MANAGEMENT PRACTICES tance, Indonesia's National Standards Council (SHOE) (DSN) has developed a Master Plan to strengthen MSTQ. 23.00 6.55 Under this plan, the ITDP would provide 21.00 technical assistance and training to the National Metrology Center (KIM-LIPI) and the Ministry of . ------. Industry's Center for Industrial Standards (PUSTAN). This will improve the ability of those agencies to disseminate standards to industry, es- 15.00 pecially SMEs, and to implement programs for im- a) ' 0 . proved testing and calibration services, leading to national certification of product quality and Scenario quality management practices, including ISO 9000 certification. 6.56 The National Metrology Center (KIM) is Indonesia's primary metrology center. It also op- Figure 6.2 erates a national calibration network consisting of a number of private and public sector calibra- tion service providers. One of its major tasks is to IMPROVED PRODUCTION & calibrate the equipment in the nation's public and MANAGEMENT PRACTICES private sector testing laboratories. However, KIM (PRINTED CIRCUIT BOARDS) is not yet recognized internationally. Firms can 105.00 send their equipment abroad for calibration, but this is an expensive alternative. As part of the plan, P . ITDP will support a twinning relationship for KIM with a leading international metrology and cali- bration laboratory. The latter will give KIM tech- 75.00 nical assistance for building its management and institutional capacity, with the objective of its gain- ing international recognition and accreditation, something vital for Indonesia's ISO 9000 certifi- cation program. Scenario 6.57 MOI's Center for Industrial Standards LDC Scenario NIE Benchmark (PUSTAN) also has an important role to play in (Manual) (Manual) establishing a national industrial standards sys- tem and gaining ISO 9000 certification for Indo- nesian industries. PUSTAN would receive tech- with the Indonesian Chamber of Commerce and In- nical assistance under the project from an inter- dustry to promote quality awareness and implemen- nationally accredited laboratory to gain recogni- tation in industry; and (b) to gain ISO 9000 certifica- tion and accreditation for five of MOI's testing tion for 40 SMEs as a demonstration to the rest of in- laboratories. Furthermore, staff in eight MOI R&D dustry and as a leaning-by-doing training program institutes would be trained as MSTQ extension for its staff. In cooperation with several Indonesian agents. PUSTAN also will receive technical assis- technical universities, PUSTAN will conduct a com- tance to: (a) develop programs, in cooperation prehensive training program for SME managers, su- N D 0 N E S I A D i S c u S S i 0 N P A P E R S R I S 44 CHAPTER 6 pervisors and quality-control personnel in all as- pects of quality management. In addition, PUSTAN Box 6. Cost Sharing Grant Schemes to Facilitate will translate into Indonesian and distribute widely Public and Private Technology Extension Services eight major MSTQ textbooks. 6.58 There also are private sector testing labora- e ale f usfu in gac s m n tories in Indonesia. Since they are often more mod- em and better maintained and provide better ser- A productivity improvement program for SMEs in the vice than the public labs, they charge higher fees. Philippines, supported by the World Bank and the Philippine However, the private labs tend to be concentrated Government as part of a proposed industrial technology in West Java, are few in number, usually provide development project; a review of the pilot program, only very specialized services and are not licensed undertaken in 1992-93, identified significant benefits for both to grant ISO 9000 certification. Greater private sec- firms and consultants. tor participation in the provision of MSTQ services * A cost-sharing grant scheme for SME in Singapore to subsidize should be encouraged by privatizing some of the technical and business development consutancy: The scheme public testing labs, removing restrictions on spe- has had a maior impact on the growth of local consultancy cialized testing and product certification services firms as well as benefiting the recipients of assistance. and ensuring that private firms could, like public 0 A similar program in the UK, the Consultancy Initiatives, under labs, become registrars of ISO 9000 standards. which 50,000 consultancy projects were provided to SME over PRODUCTIVITY CENTERS a five year period 1988-93: A thorough evaluation of the 6.59 Many countries also provide technological program demonstrated substantial benefits for participating support and training in technologies that are rel- firms and an increase in both the quantity and quality of suppt olr esbe ffrs eg,cmue-ie business and technical consultants. Participating firms also evant to a large subset of firms, e.g., computer-aideddeosrtdaigfcnlyhhrpoestyoue design, engineering and manufacturing; total qual- ity control systems; just-in-time management; and consulants at full market rates for subsequent assistance. flexible manufacturing. There is a need for this in facturin roblems and information on atented Indonesia as well. The Institute for Machine Tools, and g p p Automation and Production Technology (MEPPO) in services could have large economies of scale, and Bandung was designed for this purpose. However, it the services themselves are important public has concentrated on advancing the manufacturing goods, experience shows that technology infor- technologies of large firms, particularly the strategic mation centers have to be very well managed and industries (para. 6.62). The challenge for MEPPO is to find ways to transfer technology to SMEs. In addi- roacie ilrsp d to mr nees They tion to establishing prototyping facilities, MEPPO reqire speal to ec for arce tfer could do this by encouraging participation of SMEs information requirements. or their industrial associations on its board of direc- tors and establishing demonstration projects for 6.61 In Indonesia there are two public sector in- groups of firms. It could also use its facilities to train formation services: IPTEKNET, which is admin- SME staff members and trainers, including teachers istered by BPPT, and PUSDATA under MOI. The from the polytechnics and trade schools. IPTEKNET system provides Internet access to six public R&D institutions. There are plans to expand TECHNOLOGY INFORMATION SERVICES both services substantially. However, they will 6.60 Technology information centers also help pri- need major restructuring if they are to survive, vate firms by accessing and processing the vast stores let alone expand, in what is a very competitive of data available worldwide, including best-practices information services market with a growing num- technologies, approaches to solving particular manu- ber private providers. To be able to compete with the private sector for customers and employees, both PUSDATA and IPTEKNET need to be com- *N D 0 N c S I A D i S C U S S f 0 N P A P E R S E R I E S 45 FocusING INDONESIA'S TECHNOLOGY SUPPORT INSTITUTIONS ON EFFECTIVE TECHNOLOGY DIFFUSION mercialized, and eventually privatized, using treatment in government procurement should be sound business strategies to operate in viable phased out according to announced schedules. La- niche markets. bor mobility into and out of the strategic industries also needs to be encouraged to increase technologi- E. THE STRATEGIC INDUSTRIES cal spillovers, spinoffs, and the creation of startup 6.62 Indonesia has also made substantial invest- companies. ments in the acquisition of advanced technologi- 6.64 Large government investments in new R&D cal capabilities in its state-owned strategic indus- projects in the strategic industries should be strictly tries. These include ship building and repair, limited for fiscal reasons. Experience elsewhere (e.g., heavy machinery, diesel, telecommunications Korea, India and Brazil) shows that substantial gov- equipment, defense rolling stock, steel and elec- ement investment in heavy industries and ad- tronics. Indonesia has invested heavily in these vanced technologies is inefficient, leading to high subsidized industries, adopting an infant indus- capital-output ratios and slow consumption growth. try approach to their development. In compari- Scarce public resources could be used instead to help son to other Indonesian enterprises, local or for- support low-risk but potentially high-payoff invest- eign, these firms have the most ambitious and the ments in restructuring and modernizing the rest of most systematic technological objectives. They the country's technological infrastructure, which has also employ many of the country's best-trained been relatively neglected and is in danger of not be- R&D and technical personnel. ing able to meet the needs of private industry. 6.63 The strategic industries have made an im- 6.65 Private investment, and FD in particular, portant contribution by providing valuable inter- should be used to develop technology-intensive pri- national training opportunities and exposure to a vate industries rather than state-owned enterprises, cadre of young Indonesian scientists and engi- which require continuing government support and neers. The challenge now is to deploy those valu- protection. As long as the government has laid the able resources for maximum economic gain. This proper foundations by creating an environment con- should be done by clearly separating the strate- ducive to innovation, ensuring that high-technology gic industries' technology development objectives entrepreneurs do not lack financing, improving the from their manufacturing objectives, and by put- quality of human resources for ITD and by seeing to ting the latter on a fully commercial basis. To en- it that there is an effective infrastructure of technol- sure maturation of those industries, their infant ogy support services, competitive markets should be industry protection and monopoly status, as well as trade and investment barriers and preferential IN D 0 N E S I A D I S C U SS1 0 N P A P E R S E R I E S 46 CHAPTER 6 allowed to decide which firms and industries will 6 See Review of Science and Technology Policyfor flourish or perish. Industrial Competitiveness in Korea, Science and ENDNOTESTechnology Policy Institute, 1995. ENDNOTES 'Thenumer f eployes nvovedin mnufctu- ~See Goldman, op. cit., and Bessant, E., J. Arnold, The number of employees involved in manufactur-"Background/Bench- ing in Hong Kong has dropped to about half a Mil- mark Study for the Venezuelan Institute of Engi- lion, down 36 percent since 1980, and now accounts neering," University of Brighton, 1993. for one fourth of the colony's workforce. The sector contributed only 13 percent of GDP in 1992, compared the Ministry of Indstry er wIth to 24 percent in 1980. tMstry o Trade Tf 2 Soon, Teck-Wong, 1994, op. cit. dsr n rd Ml) I3on ekWn,19,o.ct See Mashelkar, R., Restructuring and Reforms in These are: information technology, microelectron- Public R&D Management Systems in Indonesia, ics, electronic systems, advanced manufacturing tech- World Bank, mineo, 1994. nology, materials technology, energy and water re- 0 In many cases, salaries of scientists, engineers sources, environment, biotechnology, food and and technicians in MOI's labs are only one third agrotechnology, and medical sciences. those of their counterparts in MENRISTEK labo- 4 For a fuller analysis of that program, see Dah1man ratories. and Sananikone (op. cit.); Brautigam, D. (1995), "The 1 Under a World Bank-funded Professional and State as Agent: Industrial Development in Taiwan, 1952-1972," in H. Stein (ed.), Asian Industrialization and Human eSource deeloe Poec (ns3134- Affica, London: Macmillan, 1995; and Hou, Chi-Ming D the ScienceIandiTechnologyePolicy Institute and San Gee, "National Systems Supporting Techni- ofvteKe ISTut iene angen cal Advance in Industry: The Case of Taiwan," in R. e m Er Nelson (ed.), National Innovation Systems, Oxford: Oxford University Press, 1993. 1 Indonesia was one of two industrializing coun- 5 See Goldman, M., Institutions and Policies for Indus- tries in the studies of the footwear and printed trial Technology Development, World Bank, mimeo, circuit boards (Mexico was the other). See Mody 1995. et al., Industry and Energy Department Working Paper No. 51, International Competition in the Foot- wear Industry: Keeping Pace with Technological Change; and No. 53, International Competition in the Printed Circuit Board Industry: Keeping Pace with Technological Change), 1991. 1N 0 0 N E S I A D i S C U S S 1 0 N P A P E R S E R I E S 47  CHAPTER 7 Summary and Conclusions 7.01 Indonesia faces major challenges in its efforts though the nature of intervention differed signifi- to accelerate the pace of industrial technology devel- cantly in the two countries. While the Singapore opment. Even though it has some of the lowest labor government's direct role in supporting ITD has costs in the world, labor productivity and the growth been far more limited than in those countries, it of total factor productivity are low. Product quality is has invested heavily in technical and scientific often inconsistent, and wage rates are rising. Other education and training and in technology support Asian countries (e.g., China and, increasingly, Viet- services for SMEs. Its main strategy has been to nam and India) are becoming more competitive in create conditions that would encourage R&D by many of Indonesia's export markets and are compet- high-technology multinationals, although recently ing aggressively to attract FDI in labor-intensive ex- the government has played a more active role in port industries such as garments and footwear, where promoting development of local capabilities in Indonesia has been strong. The competitive advan- such industries as biotechnology and microelec- tage based on low factor costs, Indonesia's traditional tronics. In Hong Kong, the government has tradi- strength, is giving way to a new paradigm for com- tionally adopted a laissezfaire approach to tech- petitiveness. Other factors, including the ability to nology policy. However, recently it has become manufacture to buyers' specification, with total qual- much more interventionist because of concern ity management, reliability and fast delivery times, about its lagging industrial performance and the which add value and work effectively within buyers' recognition that ITD policies and programs in global supply networks, are becoming more impor- other East Asia countries have been instrumental tant. in laying the foundation for sustained industrial 7.02 To sustain export growth and increase value and technological development. added in its traditional industries while diversifying 7.04 Indonesia's competitors in the region into new industries with more demanding technologi- have already learned these lessons and have be- cal requirements, Indonesia must continue gun to revise their technology policies accordingly. deregulating its economy. Indonesia must also shift For example, India, in addition to adopting more its technology strategy away from mission- oriented, open trade and industrial policies to encourage public sector-driven R&D toward: exports and increase competitive pressure on * making more effective use of linkages to sources firms, has relaxed restrictions on importation of oftechnology and FDL It has also embarked on ma- of freig tehnolgy;jor restructuring of its public R&D labs to make * improving the quality of basic and technical edu- them more autonomous, demand-driven and cation; commercially oriented, tying their budgets to * exercising greater selectivity in the use of public earnings from industry and other similar mea- resources for financing ITD in private industry;Indonesia (Chapter 6). resorce forfinncin lT in rivte idusry; addition, the industrial standards infrastructure * providing effective, demand-driven technology has been substantially strengthened. There has support services to the private sector, including also been rapid development of the capital mar- encouraging the private provision of those ser- kets, including encouragement of the growth of vices. venture capital as a source of financing for the 7.03 As noted throughout this report, these have increasing number of innovative SMEs. been core elements of the technology strategies of the 7.05 In China, recent reforms in technology East Asian NICs, even though emphasis has varied policy include: considerably from one country to the next. For ex- liberalizing access to foreign technology; ample, government policy interventions in South Ko- rea and Taiwan, China have been important factors 0 encouraging technology-oriented FDI; shaping industrial and technological capabilities, even N s 0 N e S I A D if S I a s i n P A P E R S E R I E S 49 SUMMARY AND CONCLUSIONS * granting public R&D institutions greater au- FDI and R&D; and encouraging venture capital for tonomy and promoting their restructuring research-oriented firms. Thailand has emphasized the through budgetary reforms to make them need for greater autonomy, flexibility and account- more market oriented; ability of its publicly provided technology support * establishing technology diffusion agencies infrastructure and for closer focus on ways to stimu- and productivity centers to respond more ef- the demand for TD including the use of match- and rodctivty entes t resondmoreef-ing grant funds for private industry aimed at encour- fectively to firms' need for technology sup- aging technology upgrading. port services; * passing laws to protect intellectual property rights and implementing improved legal pro- 7.07 In Indonesia, there is an emerging consen- cedures to protect those rights. sus that technology development is central to improv- 7.06 Malaysia's recent master plan for ITD i- ing international competitiveness and sustaining cludes a broad strategy for: strengthening the edu- rapid growth of its industrial sector, and that inad- cational base, including the linkages between edu- equate attention has been paid to promoting best- cation and industry; encouraging firm-level train- practice technologies that will help Indonesian indus- ing; developing a more effective network of in- try compete better internationally. dustrial technology extension services and qual- 7.08 To address these issues, the major elements ity improvement and productivity centers; becom- of Indonesia's ITD strategy should be to: ing more selective in approving tax incentives for USE ECONOMIC DEREGULATION TO DRIVE FIRMS TO INVEST MORE IN TECHNOLOGY UPGRADING. Several of Indonesia's regional competitors have been much more successful in putting pressure on firms to adapt and improve on technology available from abroad through FDi foreign buyers of their export products, imports of capital goods, and technology licenses. In Indonesia, procompetition policies of the kind described in detail in the World Bank's recent industrial sector and economic reports would have the dual benefit of helping sustain the momentum of industrial growth and of encouraging companies to view continuous upgrading of their technological capabilities as central to their competitiveness strate- gies. IMPROVE THE QUALITY OF HUMAN RESOURCES FOR TECHNOLOGY DEVELOPMENT. Indonesia needs to improve the quality of primary and secondary education in order to provide an ap- propriate basis for subsequent training. It must also place greater emphasis on training technicians and craftsmen rather than scientists and engineers. The private provision of high quality pre-employment and in-service training should be facilitated through transparent licensing and accreditation of private training institutions, development of systems for national skills standards and certification and rigorous accreditation of technical and vocational training schools. Mechanisms also need to be developed to ensure better utilization of technicians and scientists who benefit from overseas graduate fellowships through: (a) wider participation of research staff of all re- search organizations in overseas training fellowships; (b) assigning these individuals to positions that take maximum advantage of the training they receive, should they remain in government service; and (c) encouraging greater mobility of those returnees, including movement into the private sector. Upgrading the quality of domestic university and graduate education also is essential and will require giving greater autonomy to universities, allocating funding for those institutions on the basis of performance. gses IMPROVNE THE QALITY OF UAN RSUS FOR PTECHNOLOGY DEELOPMENT. Inoei5ed0oipoeteqaiyo rmr adscnayeuaini re opoiea p CHAPTER 7 MAXIMIZE THE BENEFITS FROM FOREIGN TECHNOLOGY. Indonesia also needs to derive more technological benefits from the substantial foreign direct investment it receives. FDI should be used as a means for technology transfer and for training Indonesian workers and managers. Impediments to higher quality FDI need to be overcome by introducing greater transpar- ency, reducing the time it takes for investment approvals, reducing facilitation payments and making infrastructure services and industrial real estate more competitive. The government has to shift from a passive to a proactive strategy of soliciting strategic investments for building technological capability, as well as providing an attractive business environment. FDI should also become a source of new industries rather than being used to support state enterprises, which may require continuing government subsidies and protection from imports. Reduction of trade protection on capital goods imports is also needed. In addition, procedures for licensing technology need to be improved, making sure fees reflect the duration of licenses and patents and the complexity of the technologies involved. Adequate legal protection for copyrights and trademarks must be provided. IMPROVE THE FRAMEWORK FOR FINANCING ITD. Prudent macroeconomic policies and financial sector improvements to reduce risk are essential to bring down Indonesia's high domestic real interest rates. These disproportionately affect SMEs, which find it difficult to borrow offshore at lower interest rates. Lower rates would increase the availability of term finance for investments in technology development, which often have long gestation periods. The avail- ability of term financing would also be improved by strengthening the capacity of the banking system to appraise technology investments. Fiscal incentives for ITD should limited and carefully targeted to en- courage SMEs to adopt new technologies and improve productivity using existing technology. REORIENT THE TECHNOLOGY INFRASTRUCTURE TOWARD THE DIFFUSION OF BEST-PRACTICE TECHNOLOGIES TO INDUSTRY. The infrastructure of government technology services has to be substantially restructured and strength- ened to support firms striving to improve their technological capabilities and competitiveness. The deliv- ery of MSTQ has to be improved, starting with effective dissemination of information on standards and effective outreach services to industry, especially small and medium-sized engineering firms. Public R&D laboratories need to become more dema.id driven and service oriented. They should acquire interna- tional accreditation for granting product certification in Indonesia and for providing, in competition with private consulting firms, effective technology extension services in order to help firms improve manufac- turing and design capabilities. In addition, through membership on laboratory advisory councils and boards of directors, businessmen should help ensure that PSTI programs directly benefit the private sec- tor. Government budgetary support should reflect the laboratories' ability to generate income by sale of their knowledge, services, and products to industry. In addition to making PSTI resource allocation more performance based, Indonesia also needs to improve coordination among PSTI programs through merger and consolidation of institutions that work in simi- lar areas but fall under different ministries, and by restructuring institutions along functional lines to achieve generic capabilities in industrial technologies, rather than along subsector lines, as is the case today. While greater accountability should be required of these public agencies, they should, at the same time, be allowed greater autonomy with respect to the use of income generated through the sale of services to industry, and with respect to staffing, salaries, procurement and training. For the restructuring of the institutes to succeed, government will have to make substantial investment in modernization of facilities and professional staff development. However, such investment should be undertaken only if the other recommended measures are adopted and implemented. Greater use of peer and technical panel reviews of public R&D proposals and programs to promote joint public/private sector RD&E activities should be IN D 0 N E S I A D I S C U S SI 0 N P A P E R B E R I E S 51 SUMMARY AND CONCLUSIONS accompanied by better monitoring and evaluation systems. This would allow Indonesia to experiment with publicly funded but privately executed R&D projects, an approach which has worked successfully elsewhere in the region. Finally, private sector provision of infrastructure services should be encouraged by establishing clear institutional arrangements and procedures for accreditation of private testing ser- vices. IMPROVE THE CONTRIBUTION OF STRATEGIC INDUSTRIES. In shifting the emphasis of Indonesia's ITD strategy toward these priority areas, some attention also needs to be paid to the strategic industries, which employ some of Indonesia's best scientists and engi- neers. To ensure that these valuable human resources are deployed for maximum economic gain, the strategic industries' R&D work should be separated from their manufacturing and commercial activities, with the latter put on a fully commercial basis. The provision of infant industry protection and monopoly status to those industries through trade and investment barriers and preferential treatment in govern- ment procurement should be phased out. Labor mobility into and out of the strategic industries also needs to be encouraged to increase technological spillovers in the form of spinoffs and the creation of startup companies. New government investments in R&D projects in the strategic industries should be strictly limited so there will be adequate resources to support low-risk but potentially high-payoff investments in restruc- turing and modernizing the rest of the country's technological infrastructure. The market should be al- lowed to play a greater role in the development of technology-intensive industries by creating, through deregulation, a competitive environment that is conducive to innovation, ensuring that high- technology entrepreneurs do not lack financing, improving the quality of human resources for ITD and maintaining an effective infrastructure of technology support services. Within this framework, competitive markets would decide which firms and industries will flourish or perish. IN D 0 N E S I A D I S C U S S I 0 N P A P E R S E R I ES 52 BIBLIOGRAPHY Agrawal, N., Indonesia: Labor Market Policies and International Competitiveness, Policy Research Working Paper No. 1515, 1995. Bessant, E., J. Arnold, M. Hobday, and H. Rush, "Background/Benchmark Study for the Venezuelan Institute of Engineering," University of Brighton, 1993. 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World Bank, Training and the Labor Market in Indonesia: Policies for Productivity Gains and Employment Growth, Report No. 14413-IND. IN D 0 N E S I A D i s c u s s I 0 N P A P E R S E R I E S The World Bank East Asia and Pacific Region, Country Department III 1818 H Street, NW Washington, DC 20433-0001 Marianne Haug, Director INDONESIA DISCUSSION PAPER SERIES REDESIGNING GOVERNMENT'S ROLE IN HEALTH: LESSONS FOR INDONESIA FROM NEIGHBORING COUNTRIES (No. 1) SAMUEL S. LIEBERMAN, 1996 INVESTING IN JUNIOR SECONDARY EDUCATION IN INDONESIA: RATIONALE AND PUBLIC COSTS (No. 2) HANEEN SAYED, 1996 PROJECT QUALITY AT ENTRY: TEN KEY ELEMENTS (No. 3) RICHARD CALKINS, 1996 INDUSTRIAL TECHNOLOGY DEVELOPMENT FOR A COMPETITIVE EDGE (No. 4) DARIUS MANS, 1996 INDONESIA IN PERSPECTIVE: A COUNTRY BRIEFING (No. 5) VARIOUS CONTRIBUTORS, 1996 POVERTY AND INEQUALITY IN ASIA: A SURVEY OF RECENT LITERATURE AND RESEARCH AGENDA (FORTHCOMING) MUTTUKRISHNA SARVANANTHAN, 1996 EFFECTIVE PRIVATE PARTICIPATION IN TOLL ROADS (FORTHCOMING) JORIS VAN DER VEN, 1996 FINANCIAL DEREGULATION AND THE COST STRUCTURE OF STATE AND PRIVATE BANKS IN INDONESIA: SOME EVIDENCE FROM MICROECONOMIC DATA (FORTHCOMING) LLOYD KENWARD, 1996 The World Bank Eas Asia and Pacific Region, Country Department III 1818 H Street, NW Washington, DC 20433-0001 Marianne Haug, Director