75415 EXPORT COMPETITIVENESS IN INDONESIA’S MANUFACTURING SECTOR An assessment of export performance and determinations of competitiveness in Indonesia’s manufacturing sector based on an analysis of the apparel, wood furniture and automotive components sectors EXPORT COMPETITIVENESS IN INDONESIA’S MANUFACTURING SECTOR An assessment of export performance and determinants of competitiveness in Indonesia’s manufacturing sector based on an analysis of the apparel, wood furniture, and automotive components sectors Thomas Farole and Deborah Winkler December 2012 This report is a part of background report for the World Bank study on the competitiveness manufacturing sector and is funded by Multi-Partner Facility for Trade and Investment Climate Table of Contents EXECUTIVE SUMMARY .................................................................................................................................. 1 I. INTRODUCTION ..................................................................................................................................... 3 1.1. Background to the study ............................................................................................................... 3 1.2. Objectives...................................................................................................................................... 4 1.3. Framework and methodology....................................................................................................... 4 1.4. Structure of this note .................................................................................................................... 6 II. TRADE OUTCOMES ANALYSIS ............................................................................................................... 7 2.1. Summary of broad manufacturing sector trends ......................................................................... 7 2.2. Apparel ........................................................................................................................................ 12 2.3. Wood furniture ........................................................................................................................... 22 2.4. Automotive components ............................................................................................................ 28 2.5. Summary of main findings .......................................................................................................... 32 III. COMPETITIVENESS DIAGNOSTICS ................................................................................................... 34 3.1. Market Access ............................................................................................................................. 34 3.2. Supply side: Incentive framework for trade ............................................................................... 35 3.3. Factor inputs, productivity, and trade costs ............................................................................... 43 3.4. Proactive measures to promote trade ........................................................................................ 56 3.5. Summary of conclusions from Competitiveness Diagnostics ..................................................... 62 IV. CONCLUSIONS AND POLICY IMPLICATIONS .................................................................................... 63 4.1. Summary of main conclusions .................................................................................................... 63 4.2. Policy priorities............................................................................................................................ 64 Executive Summary 1 EXECUTIVE SUMMARY Despite buoyant economic growth in recent years, there are fears that Indonesia’s manufacturing sector, which has stagnated since the Asian crisis, is in terminal decline, perhaps having reached a “middle income trap�. If this is true, it could have significant long-term growth implications, given the critical importance of the sector for job creation, along with the risk that would come from leaving the Indonesian economy increasingly dependent on potentially volatile commodity sectors. In this context, this note analyzes three manufacturing subsectors – apparel, wood furniture, and automotive components – in order to assess the state of competitiveness in the Indonesian manufacturing sector and to identify policy options to improve competitiveness and quality upgrading of Indonesia’s manufacturing product. The note uses Indonesia’s export performance in these sectors as a lens through which to assess competitiveness more generally. The three subsectors analyzed face quite different global dynamics and have performed very differently in the face of them. Overall, however, this note finds the conventional wisdom that Indonesia’s manufacturing sector is in the midst of an inevitable process of stagnation and decline may actually be an incorrect starting point, at least looking at it from the context of early 2011. Despite declining performance in the sector particularly in the wake of the Asian crisis, and the clear leadership of natural resources based sectors in driving the economy over the past decade, there is recently an upswing in the prospects of the traditional manufacturing sector. Two major sources of advantage are driving the potential revival of the traditional manufacturing sector: 1) the very large, low wage labor force (wages are now one-third that of coastal China and among the lowest in the region); and 2) the potential for market access of production scale economies based on Indonesia’s large and growing domestic market and the increasingly integrated regional market. Few countries are fortunate to have such an opportunity to revive a critical labor-absorbing and technology-producing sector like manufacturing. Of course, this opening will not last forever (indeed, wage pressures are growing). It is therefore critical that the Indonesian government and private secvtor act now to take advantage of this opportunity:  In the short term: ensuring it is able to exploit the existing wage gap with China, and extend this advantage for as long as possible – this will require attention to: o Raising productivity by addressing labor market rigidities and improving access to skills development and training, as well as improving the quality of management of firms. o Improving non-price competitiveness factors, in particular by addressing issues related to transport and trade facilitation. o Ensuring an environment that promotes investment and firm growth by lowering the barriers to accessing finance addressing regulatory barriers that prevent expansion. o Improving the transparency and predictability of the policy, regulatory, and governance environment in order to lower risk and facilitate private sector investment.  In the short and the medium term: better leveraging the domestic market and the potential for integrating into regional value chains – this will require attention to: o Improving the business regulatory environment to promote a more sophisticated domestic market Export Competitiveness in Indonesia’s Manufacturing Sector 2 Executive Summary o Improving links between domestic firms and FDI (as well as other regional producers) o Facilitating inward investment but also promoting outward FDI o Facilitating greater collective action and coordination among firms  In the medium term: preparing for the eventual erosion of price-based competitive advantage – this will require attention to: o Improving product quality to meet recognized global and market standards o Promoting greater focus on innovation, including through development of engineering and design skills and greater cooperation in research and development o Improving the firm-level sophistication, including addressing management quality Several policy priorities derive from this analysis. Some of them have long been part of the discourse in analysis of the Indonesian economy, while others have perhaps had less attention: 1. Improving both hard and soft infrastructure to facilitate transport and trade 2. Facilitating access to finance to support investment in the manufacturing sector 3. Freeing up labor markets and incentivizing training 4. Promoting innovation and firm-level sophistication 5. Improving the standards regime 6. Promoting greater collective action and coordination by industry 7. Improving transparency and predictability in the governance and policy environment to encourage greater private sector investment 8. Using the SEZs as “bridgeheads to reform� rather than as spatial industrial projects Export Competitiveness in Indonesia’s Manufacturing Sector Introduction 3 I. INTRODUCTION 1.1. Background to the study Through a foundation of sound macroeconomic management and political stability, the Indonesian economy grew by an average of almost 6 percent annually between 2004 and 2008; and despite the global economic crisis, it maintained a 4.5 percent growth rate in 2009. While personal consumption has played a significant role in driving growth over the past decade, the investment-to-GDP ratio also rose to 25 percent in 2008, almost reaching its pre-Asian crisis level. Foreign investment (both FDI and portfolio investment) has increased rapidly in recent years. Key to growth has been the role of the export sector. Fuelled by agricultural and natural resource commodities, Indonesia’s non-oil and gas exports grew 22.6 percent annually between 2004 and 2008, more than double their rate in the 2000-2004 period. This period of growth has contributed to significant job creation for the first time since the Asian crisis, with formal sector employment growing 2.2 percent annually in the 2004-2008 period. In this story of growth, however, there are fears that the manufacturing sector – which fuelled Indonesia’s export-led growth in the decade leading up to the Asian crisis and still contributes 28 percent of Indonesia’s GDP – has been left behind. Real manufacturing GDP grew by an annual average 4.6 percent in 2004-07 compared with 10.5 percent in 1990-95. Many possible symptoms have been identified for Indonesia’s relatively weak manufacturing sector performance over the past decade. One source of concern is the fact that, despite its rich natural resources, Indonesia has not made significant progress in transforming its exports of raw materials into processed products.1 For example, Indonesia’s exports of wood furniture have declined in recent years while export of plywood continues. Moreover, there is a concern that Indonesian manufacturers are experiencing some sort of “middle income trap�: no longer able to compete on price with other low-cost Asian suppliers (e.g. China, Vietnam, Bangladesh) but not making sufficient progress in increasing the level of sophistication in its industrial products to compete on quality with suppliers from Malaysia, Thailand, and (increasingly) China. This weak competitive positioning is not only impacting Indonesian manufacturers in export markets but, as Indonesia has significantly opened its market and integrated its trade with East Asia region in the past decade, it is making it increasingly difficult for manufacturers to defend share against imports in the domestic market. Stagnating growth in the manufacturing sector has significant implications on job creation in the Indonesian economy; indeed, the manufacturing sector is the second-largest source of employment after agriculture sector. Thus, in the absence of robust growth from the manufacturing sector, there is a concern that the country will be unable to generate enough jobs, even in this period of rapid growth, to absorb the huge number of Indonesians entering the labor force each year, forcing job seekers to look for informal jobs with lower value. Moreover, in the absence of a competitive, growing manufacturing sector, long-term economic growth is likely to become increasingly dependent upon global commodity markets over which Indonesia has little control. Finally, as trade in the manufacturing sector has traditionally played a critical role in facilitating access to technology and “learning by doing� for 1 See “Boom and Bust and Up Again? Evolution, Drivers and Impact of Commodity Prices: Implications for Indonesia.� The World Bank (2011) Export Competitiveness in Indonesia’s Manufacturing Sector 4 Introduction Indonesian firms, stagnation in the growth and quality of manufacturing exports could have wider implications for the upgrading of Indonesia’s economy. 1.2. Objectives In this context, the World Bank office in Indonesia is conducting an Economic Sector Work (ESW) on “Initiating Evidence Based Policy Dialogue on Investment in Indonesia’s Manufacturing Sector�. The project aims to engage the government and private sector in policy dialogue to overhaul growth in manufacturing sector, by: 1) understanding microeconomic and structural dimensions of the business environment in Indonesia’s manufacturing sector in the context of international comparisons; 2) identifying changes in constraints to, and supporting factors for private investment in manufacturing sector; and 3) strengthening private sector and local think-thank organizations in the ongoing process of policy dialogue to support institutional changes in policy-making, particularly for Indonesia’s manufacturing sector. As part of the wider project, this note is a background study to assess policy options to improve competitiveness and quality upgrading of Indonesia’s manufacturing product. This background note studies three specific manufacturing sectors – apparel, wood furniture, and automotive components – and uses them as a basis to generalize about wider competitiveness issues in the Indonesian manufacturing sector. The specific objectives of this background paper are the following:  To give better understanding on overall level of export competitiveness and sophistication of Indonesia’s manufacturing products in the context of regional comparisons.  To identify key challenges for Indonesian manufacturers to invest in increasing their value of manufacturing output and competitiveness on global markets  To strengthen the capacity of stakeholders i.e., Indonesia’s government and private sector, to have an informed discussion on the feasible policy options 1.3. Framework and methodology This note follows the Trade Competitiveness Diagnostics analytical framework developed by the International Trade Department of the World Bank2, as illustrated in Figure 1.1 below. This involved an analysis of the Indonesia manufacturing sector, with a focus on three specific sectors (see below), with the following approach: 1. Conducting a desk-based, largely quantitative analysis (including comparisons against “peer� countries) of Indonesia’s manufacturing sector trade performance against four determinants of trade competitiveness – the intensive margin (export levels, growth and market share); the extensive margin (diversification); the quality margin (sophistication and quality); and the sustainability margin (firm participation and export survival) 2. Conducting a desk-based analysis of Indonesia’s performance across a range of factors that contribute to the observed trade competitiveness – specifically across three main categories: 2 see World Bank (forthcoming) Trade Competitiveness Diagnostic Toolkit, Draft, March 2011; and Farole, Reis, and Waglé (2010) Analyzing Trade Competitiveness: A Diagnostics Approach, Policy Research Working Paper 5329, World Bank. Export Competitiveness in Indonesia’s Manufacturing Sector Introduction 5 a. Market access: focusing on the external trade policy environment that may facilitate or constrain exporters from entering and maintaining competitiveness in markets, including tariffs and quantitative restrictions, preferential agreements, and standards and other technical barriers. Note that these same issues are covered in the macro- incentives section on trade policy – however, in that section the focus is on how it affects imports; here the focus is on exports. b. Supply-side factors: covering a broad range of determinants in two sub-categories: i. The macro-incentive framework includes factors which establish the broad environment that influences private sector investment and participation in exports, including the macro-fiscal environment, exchange rates, trade and investment policy, competition, and the governance and regulatory environment. ii. Factor conditions impacting the cost and quality of production; these include: access to finance, scale economies, labor regulations and skills, firm-level technical efficiency, land and infrastructure, intermediate inputs, services inputs, and trade facilitation & logistics. c. Trade promotion infrastructure covers the range of interventions by government to address market failures (coordination challenges, asymmetric information) and government failures that restrict export participation and performance, including traditional export promotion and SEZs, industry coordination bodies, standards & certification, and innovation. 3. In-depth field interviews, including individual interviews and focus groups, with more than 30 public and private sector organizations during missions in February-March 2011 and October 2011. Interviews and focus group sessions were held in Jakarta, Bandung, Surabaya, Semarang, and Jepara. As noted previously, the analysis in this note focuses on three specific manufacturing subsectors: apparel, wood furniture, and automotive components. The selection of these sectors was motivated by the desire to study:  Two traditional labor intensive sectors which appear to have been stagnating or declining in the post-Asian crisis era – one of which is highly impacted by competition in global production networks (apparel) and another of which is natural resources intensive, and so faces issues of value addition (wood furniture)  One sector which is medium technology intensive (but also fairly labor intensive) in which Indonesia’s exports have been growing rapidly, albeit from a relatively small base (automotive components). The selection of an “export success story� subsector in comparison with traditional sectors may highlight important structural and policy-induced factors which contribute to Indonesia’s broader manufacturing competitiveness. Export Competitiveness in Indonesia’s Manufacturing Sector 6 Introduction Figure I-1: Trade Competitiveness Diagnostics Framework TRADE OUTCOMES ANALYSIS Growth and share Diversification Quality &sophistication Entry & Survival (Intensive margin) (Extensive margin) (Quality margin) (Sustainability margin) Channels Entry cost Factor & transactional costs Technology and efficiency Market access Supply sidefactors Trade promotion Infrastructure Macro-incentive Factor condition framework 1.4. Structure of this note This note summarizes the main findings of the analysis. It is structured as follows: Section II of the report presents an analysis of Indonesia’s overall manufacturing export performance across the four determinants of export competitiveness discussed above, followed by a specific analysis of each of the focus sectors; Section III then analyzes the factors that contribute to this observed performance, organized according to the Trade Competitiveness Diagnostics framework; Finally Section IV discusses policies that may be considered to address the opportunities and competitiveness gaps identified. Export Competitiveness in Indonesia’s Manufacturing Sector Trade Outcomes Analysis 7 II. TRADE OUTCOMES ANALYSIS 2.1. Summary of broad manufacturing sector trends Indonesia’s manufacturing sector was an important engine of growth for the economy from the 1970s well into the 1990s. However, in the decade following the Asia financial crisis3, manufacturing growth has slowed dramatically while non-manufacturing exports (particularly commodities) have boomed. This “decline� in manufacturing is relative not absolute – in fact, manufacturing exports still grew 12% annually during the 1998-2008 period despite the growth rate of exports halving over this period. But as can be seen in Figures 2-1 and 2-2, it is relative in two regards. First, in comparison to non- manufacturing (non-oil) exports, growth has been relatively slow – manufacturing’s share of Indonesian exports declined from 50% to 40% since the crisis. Second, it has fallen behind many of its regional peers, with manufacturing export levels now only half those of Malaysia and Thailand. Moreover, Vietnam, which only in 2007 had manufacturing exports only half the level of Indonesia’s, has now caught up. Figure 2-1: Growth and share of Indonesian Figure 2.2: Manufacturing exports 1990-2010 (US$b) manufacturing exports (1970-2009) Source: calculated from BPS data Source: Comtrade Within Indonesia’s manufacturing sector, the dynamics of growth across subsectors varies significantly since the crisis. The top four export sectors4 in 1996 – Cork and wood manufactures (-7.1%); Articles of apparel (4.3%); Textile yarns and fabrics (-0.6%); and Footwear (3.8%) – either grew modestly or declined. Meanwhile, more resource and capital intensive sectors like nonferrous metals (16.3%), rubber manufactures (15.4%), and Road vehicles (18.8%) posted much higher growth rates. As can be seen in Table 2-1, the implications are a significant shift in the composition of manufacturing exports over the decade. Indeed the top four sectors, which combined for over 53% of manufacturing exports in 1996, accounted for only 31% by 2008. It is hard to point at systematic differences in Indonesia’s sectoral pattern of export growth compared with that of Thailand and Malaysia over the past 15 years. Other than nonferrous metals, the two sectors in which Indonesia has clearly outperformed both Malaysia and Thailand are apparel and footwear. In road vehicles, both Indonesia and Thailand have outperformed Malaysia. 3 Throughout this note when we use the term “the crisis�, we are referring to the Asian financial crisis of 1998 -1999; reference to the global economic crisis of 2009-10 will be specifically referred to as such. 4 SITC 2-digit level Export Competitiveness in Indonesia’s Manufacturing Sector 8 Trade Outcomes Analysis 5 Table 2-1: Indonesia’s primary export manufacturing sectors by SITC 2-digit code, 1996-2010 SITC Product % of % of CAGR 2000-2010 Code Mfg. Mfg. Exports Exports 1996 2010 IDN MYS THA 84 Articles of apparel and clothing accessories 15.8% 15.7% 4.3% 0.9% 0.3% 77 Electrical machinery, apparatus and appliances 4.4% 11.0% 6.0% 5.1% 7.0% 76 Telecommunications and sound-recording equipment 7.8% 8.7% 3.9% 2.3% 9.6% 68 Non-ferrous metals 2.8% 8.4% 16.3% 5.8% 10.0% 65 Textile yarn, fabrics, made-up articles and related products 11.1% 6.1% -0.6% -2.9% 2.4% 85 Footwear 11.3% 6.0% 3.8% -1.6% -2.4% 89 Miscellaneous manufactured articles 4.9% 5.7% 6.8% 7.2% 5.7% 64 Paper, paperboard and articles of paper pulp 3.3% 5.7% 1.1% 3.8% 1.9% 75 Office machines and automatic data-processing machines 3.2% 5.1% 0.1% -2.8% 7.0% 78 Road vehicles 0.9% 4.3% 18.8% 6.0% 20.6% 82 Furniture, and parts thereof 5.0% 3.9% 0.4% 2.6% -0.6% 63 Cork and wood manufactures 18.8% 3.5% -7.1% -0.7% -0.7% 62 Rubber manufactures nes 1.1% 3.4% 15.4% 16.1% 21.7% Source: Calculated based on data from Comtrade Looking further at the issue of relative growth of the manufacturing sector, we find that the SITC 2-digit sectors in which Indonesia gained significant world market share in the period 2005-20106 is apparel, footwear, road vehicle, non-ferrous metals, and rubber. This is perhaps telling of the changing structure of competitiveness problem in Indonesia’s manufacturing sector over the decade. All the machinery and equipment sectors (in blue in Table 2-2) grew at significantly higher rates than world trade in the previous five years, but then (with the exception of automotive) declined sharply in the second half of the decade. The opposite situation appears in the light manufacturing sectors (textiles, apparel, and footwear), while natural resources linked sectors show mixed results. Table 2-2: CAGR by main manufacturing sector: 2000-2005 and 2005-2010 SITC Product CAGR, 2000-2005 CAGR, 2005-2010 Code Indonesia World Indonesia World 75 Office machines and automatic data-processing machines 16.3% 4.8% -13.9% -1.4% 76 Telecommunications and sound-recording equipment 11.1% 9.9% -2.8% 2.7% 77 Electrical machinery, apparatus and appliances 16.0% 6.4% -3.2% 2.7% 78 Road vehicles 25.8% 9.4% 12.1% -0.1% 65 Textile yarn, fabrics, made-up articles and related products 0.2% 4.5% -1.2% -1.7% 84 Articles of apparel and clothing accessories 3.2% 6.4% 5.5% 1.4% 85 Footwear -1.4% 6.9% 9.4% 3.6% 63 Cork and wood manufactures -3.0% 9.1% -11.0% -3.1% 64 Paper, paperboard and articles of paper pulp 0.3% 6.0% 2.0% -0.6% 82 Furniture, and parts thereof 4.6% 10.3% -3.7% 1.6% 62 Rubber manufactures nes 15.4% 10.7% 15.4% 5.2% 68 Non-ferrous metals 25.1% 8.1% 9.4% 6.1% 89 Miscellaneous manufactured articles 10.3% 8.6% 3.3% 3.1% Source: Calculated based on data from Comtrade 5 These 13 sectors accounted for over 90% of manufacturing exports in 1996. 6 Although they gained marginally in ‘footwear’ and ‘miscellaneous articles’ Export Competitiveness in Indonesia’s Manufacturing Sector Trade Outcomes Analysis 9 Figure 2-3, which maps manufacturing sector growth based on Lall’s technological classification of exports7, reinforces this picture, showing a relative decline in low technology manufacturing since the crisis, but evidence of a return since 2008; and, while medium and high tech manufactures continued to grow through the crisis, they too turned downward after 2003, with medium-tech exports returning again since 2008. By contrast, while the share of natural resources based exports fell to around 60% just before the Asian crisis, it expanded again after 2003, to reach almost 70% by 2008, before falling back again. A similar pattern can be observed in Malaysia, but the overall levels of natural resources based exports from Indonesia is dramatically larger, and the overall share of non-resources based exports from Indonesia is dramatically smaller than that of regional peers. Figure 2-3: Share of exports by technological classification: 1990-2010 Indonesia Malaysia 100% 100% 90% 90% Resource Based 80% 80% 70% 70% Primary Products 60% 60% 50% 50% Medium Tech 40% 40% 30% 30% Low Tech 20% 20% 10% 10% High Tech 0% 0% 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Thailand Vietnam 100% 100% Resource Based 90% 90% 80% 80% Primary Products 70% 70% 60% 60% Medium Tech 50% 50% 40% 40% Low Tech 30% 30% 20% 20% High Tech 10% 10% 0% 0% 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Source: Calculated based on data from Comtrade, using Lall (2000) A comparison of relative export sophistication (EXPY)8 provides evidence of this pattern of export evolution in Indonesia, showing growth and the prospect of convergence with regional peers up until the crisis, stagnation from the crisis until 2003, and then decline since. Indeed, relative to the five peer 7 Lall, S. (2000) The Technological Structure and Performance of Developing Country Manufactured Exports, 1985-1998, Working Paper, Q. E. House, University of Oxford. 8 EXPY measures the income content of a country’s export basket; Source: Hausmann, R., Rodrik, D. and J. Hwang (2006) What You Export Matters, NBER Working Paper 11905, Cambridge, MA. Note that EXPY does not explain competitiveness but is simply an indicator of the sophistication of a country’s export basket. In Indonesia’s case, it highlights that the country specializes in products that are produced (on average) by relatively poorer countries. Export Competitiveness in Indonesia’s Manufacturing Sector 10 Trade Outcomes Analysis countries shown in Figure 2-4, by 2009 Figure 2-4: Manufacturing sector export sophistication Indonesia had the lowest level of (EXPY): 1990-2009 manufacturing export sophistication, CHN MYS THA IND VNM IDN virtually unchanged in a decade, below 16,000 Vietnam, and far below Malaysia, Thailand, 15,000 and China. Indeed, as Figure 2-4 shows EXPY 14,000 13,000 for the manufacturing sector only, 12,000 Indonesia’s declining export sophistication is 11,000 not explained simply by a growing share of 10,000 9,000 natural resources exports, but also by 8,000 declining quality of the export basket within 7,000 the manufacturing sector. Specifically, the 6,000 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 decline in EXPY appears to be driven by a decline in exports of some of the more Source: Calculated based on Hausmann, Rodrik, and Hwang (2006) sophisticated machinery exports, as can be seen in Table 2.2. Figure 2-5 summarizes the past two decades’ export performance by decomposing export growth of Indonesia relative to Malaysia, Thailand, and Vietnam. It suggests that, like Malaysia and Thailand, Indonesia is facing some competitive challenges in its traditional products and markets, with significant losses in the intensive margin, including extinction of product-market relationships. On the other hand, while Malaysia and Thailand’s pattern of growth reflects that of “mature� exporters, Indonesia shows relatively high growth in the extensive margin – in selling existing products to new markets. This accounted for more than half of Indonesia’s manufacturing export growth over the past decade . While Indonesia was already exporting to most markets at the beginning of this period, this extensive margin growth suggests a robust pattern of “cross-selling� products from one market to the next, perhaps taking advantage of the existing infrastructure and information networks established by other sectors and products that were already selling in these markets. Figure 2-5: Decomposition of manufacturing export growth: 1990-2010 175.2% 118.4% 116.8% 72.8% 43.5% 30.0% 16.3% 9.7% 3.3% 0.5% 0.3% 0.2% 0.1% 0.0% 0.0% 0.0% -2.8% -3.3% -14.5% -18.8% -36.5% -26.0% -40.1% -45.1% Increase of Fall of existing Extinction of Increase of new Increase of new Increase of existing product inproduct in existingexisting product in products in new products in existing products existing markets markets existing markets markets existing markets in new markets IDN MYS THA VNM Source: Calculated based on data from Comtrade Export Competitiveness in Indonesia’s Manufacturing Sector Trade Outcomes Analysis 11 Figure 2-6: Export participation in the manufacturing Figure 2-7: Export intensity of firms in the sector – 1990-2008 manufacturing sector – 1990-2008 18% 16.8% 16.6% 4,500 55,000 80 15.6% 15.4% 52,500 16% 4,000 75 13.9% 50,000 14% 3,500 47,500 70 12% 3,000 45,000 65 42,500 10% 2,500 40,000 60 8% 2,000 37,500 55 6% 1,500 35,000 32,500 50 4% 1,000 30,000 2% 500 45 27,500 0% 0 25,000 40 1990-1993 1994-1997 1999-2002 2003-2006 2007-2008 1990-1993 1994-1997 1999-2002 2003-2006 2007-2008 No. of exporters (right axis) Share of firms exporting (left axis) Average exports per firm (m IDR at 2000 prices) Average export share (% output) Source: Calculated based on data from Manufacturing Census Source: Calculated based on data from Manufacturing Census Finally, before turning to analysis of specific sectors it is worth exploring briefly some firm-level dynamics for exporters to see if the patterns of export participation and survival shed any light on the trends we observe in manufacturing sector competitiveness. Figures 2-6 and 2-7 show a clear pattern of rapidly growing export participation and intensity leading up to the crisis – the number of exporting firms grew by more than one-third between the period 1990-93 and 1994-97, while the share of firms exporting grew from 15.6% to 16.8%. Both the number and share of exporting firms declined significantly with the crisis, however. And while export participation recovered quickly after the crisis, it never again reached pre-crisis levels. However, growing export share per firm after 2004 suggests that post-crisis period may have involved a process of significant consolidation of exporting firms. Interestingly, this growth in average real exports corresponds with a decline in the export share of firm output. This provides further evidence for consolidation in the manufacturing sector and may also indicate the growing importance of the domestic market for manufacturers. At a broad level over the past decade, export survival does not appear to be a major problem in Indonesia (Figure 2-8). While export survival rates are far below those of China, they compare relatively well with regional peers, coming just below Malaysia and Thailand, and ahead of Philippines and especially Vietnam (which still has high levels of export death)9. The one year survival rate for Indonesia’s manufacturing exports is 54%; the two year rate is 40%; and the five year rate is 24%. But while Figure 2-8 analyzes export survival based on total export flows from the country, Figure 2-9 looks at export participation and survival from the perspective of individual firms. Here we see a more interesting pattern. Export entry rates10 dropped dramatically during the crisis years; while they have improved since, they have remained below pre-crisis levels. Meanwhile, export death rates11 increased significantly (from 35% to 43%) during the crisis and have actually increased further in the post-crisis 9 Note that Figure 2-6 tracks survival rates of export flows at the product-market level for each country’s exporters overall and not for individual exporters. This is important as one should expect countries with more firms to have higher survival rates, as only one individual firm would need to maintain exports for the country’s product-market export pattern to register survival from one year to the next. 10 An export entry is defined as a firm that was not exporting at the beginning of the period and starting exporting during the period (maintaining it through the period). 11 An export death is defined as a firm that was exporting at the beginning of the period and stopped exporting during the period. Export Competitiveness in Indonesia’s Manufacturing Sector 12 Trade Outcomes Analysis years. Overall, just over 16% of manufacturing firms (with greater than 20 employees) export – this is down somewhat from pre-crisis periods, but broadly in line with lower and middle income countries like South Africa, Brazil, and Russia. Patterns of export participation and survival vary significantly across sub-sectors, as will be discussed in the sections to follow. Figure 2-8: Ten year export survival function Figure 2-9: Patterns of export firm entry and death in the manufacturing sector 50% 45% 43% 45% 40% 35% 35% 30% 25% 20% 15% 10% 10% 6% 4% 5% 0% 90-96 96-00 00-08 export death export entry Source: Calculated based on data from Comtrade Source: Calculated based on data from Manufacturing Census Thus the analysis of export participation and survival seems to support the broad story of a manufacturing sector hit hard by the crisis, experiencing some restructuring and only very slowly re- emerging in recent years, but in a much more precarious competitive position. In the sections that follow, we explore recent trade performance in three important manufacturing subsectors – apparel; wood furniture, and automotive components – in order to explore and test more specifically some of the broad trends that are suggested in the analysis of the overall manufacturing sector, and in order to get some perspective on how successes and struggles in specific sectors may guide decisions on policy for the manufacturing sector in the coming years. 2.2. Apparel This section will focus on the apparel manufacturing subsector. While there will be some discussion of upstream parts of the textiles sector (including production of fabrics and yarns as well as spinning), the primary analysis covers only the production of apparel. 2.2.1. Intensive margin: levels, growth, and share The export apparel manufacturing sector first developed significantly in Indonesia during the 1970s, around the same time that it began to develop elsewhere in the region, most notably China. Apparel manufacturing was, along with footwear, one of the most important “traditional� manufacturing sectors that drove Indonesia’s export-led development in the 1980s and 1990s. It was, and remains, a critical employment-creating sector for the country – based on data from the Manufacturing Census, which excludes firms below 20 employees and the informal sector, around 400,000 workers are employed in the sector across more than 1,500 firms; more than 150,000 (39%) of these workers are in the exporting Export Competitiveness in Indonesia’s Manufacturing Sector Trade Outcomes Analysis 13 firms (11% of all firms). Only 141 of these firms have foreign ownership, but they account for 35% of all exporting firms and two-third of exports by value. By the early 1990s, Indonesia was beginning to lose out to China in competition for global markets. In fact, the growth of Indonesia’s apparel exports had actually begun to slow significantly already as early as 1993. Exports were hit hard during the Asian crisis, and the rapid rise in wages in the post-crisis years may have significantly constrained reinvestment in the sector during the early 2000s. After the end of the Multi-Fibre Arrangement in 2005, not only did the challenge of Chinese competition become more acute, but Indonesian manufacturers had to deal with competition in key markets from rapidly emerging apparel manufacturing countries like Vietnam and Bangladesh. Moreover, as Indonesia’s own trade regime has liberalized, apparel producers are facing increasing competition for the domestic market (see Box 2-1). But while there has been much talk Figure 2-10: Indonesia apparel exports (US$B) and annual growth (%) of the sector as a “sunset industry�, 8 300% apparel exports are continuing to 7 250% grow; indeed, during the period 6 200% 2003-08 they grew at almost 10% 5 150% annually compared to a global Billions USD 4 100% growth of 8% (i.e. Indonesian gained 3 50% world market share). This is well 2 0% below the levels of growth enjoyed 1 -50% in the early 1990s (exports grew at a 0 -100% 15% annual rate in the period 1990- 1991 1992 1994 1995 1997 1998 2000 2001 2003 2004 2005 2006 2007 2008 2009 2010 1990 1993 1996 1999 2002 1996), but is still relatively robust. While exports declined with the Exports (B. USD), left axis YTY Growth (%), right axis global economic crisis in 2009, they Source: Calculated based on data from Comtrade did so at less than the global average in the sector. Box 2-1: Import penetration and competitiveness in the Indonesian domestic market Even in the context of a highly export-oriented sector, most individual apparel firms remain focused on the domestic market. Evidence from Indonesia’s manufacturing sector shows that more than 85% of apparel firms sell 12 wholly to the domestic market . For them, trade competitiveness is not a question of competing with China or Vietnam in export markets, but rather in the Indonesian market. Anecdotal evidence from the industry suggests that rising imports, mainly from China but also from second-hand (retail liquidations) clothing from EU and US markets, have been a major problem for Indonesian apparel producers, particularly those operating in the price- conscious segment of the market (which accounts for the large majority of the domestic market). Moreover, 13 according to API , consumers in Indonesia tend to have a “foreign branded orientation�, with little regard for the quality of products manufactured in Indonesia. One way of assessing relative trade competitiveness is by looking at import penetration in the domestic market. 12 As the Manufacturing Census covers only firms with 20 or more employees, in fact the share of total firms that are non- exporters is probably significantly higher (as smaller firms are less likely to export). 13 Asosiasi Pertekstilen Indonesia (Indonesia Textiles Association) Export Competitiveness in Indonesia’s Manufacturing Sector 14 Trade Outcomes Analysis Import penetration measures the share of the domestic market that is supplied by imports rather than by domestic producers. This is normally difficult to do as data on domestic market transactions is not normally readily available. In the figure below, we analyze input-output data from Indonesia and China, as well as more limited data from 14 Thailand and Vietnam . Unfortunately the data is available only aggregated at the level of the broad textiles sector, so we may be capturing dynamics that are happening outside of apparel. Indeed, significant growth of imports to Indonesia has taken place in the middle levels of the textiles value chain, particularly in terms of fabrics, where imports from China now dominate. The data suggests that there has indeed been an increase in import penetration in Indonesia’s textiles sector since the pre-crisis level, and that the level of import penetration is higher than in some peer markets. Import penetration of consumer market- textile and clothing On the other hand, it suggests that import penetration may have 25% 23% 23% actually declined since 2000. 20% Evidence from Comtrade seems to 16% support this, reporting exports of 15% apparel from all countries to 10% 9% 10% Indonesia at 6,409m in 2002, 5% 4% 5% declining steadily year by year to 5% only US$ 4,100m by 2008. China too 0% reports declining exports of apparel Indonesia China Thailand Vietnam to Indonesia, from US$1,460m in 2002 to US$ 1,237m in 2008. 1995 2000 2005 On the other hand, evidence from Source: Calculated based on data from OECD input-output tables Indonesia’s Manufacturing Census of declining real output in the apparel sector over the past decade (around 20%), with rising real exports (also around 20%) suggests that growth in import penetration has been substantial over the past decade, unless: 1) consumption is falling in the domestic market; or 2) smuggling is growing substantially. Whatever the case, it is clear that the challenge for the Indonesian apparel sector is not simply one of export markets. For the majority of the sector, the trade competitiveness challenge is most acute in the domestic market. And while some exporters are thriving by finding niches where they can differentiate on delivery and quality, the domestic sector is more in survival mode, with competition based primarily on price, highlighting the critical importance of cost competitiveness. But while Indonesia is gaining global market share, an important question is how sustainable is this trend. Indonesia has been part of the shift of the apparel sector to “factory Asia�, which has decimated traditional sourcing markets for the US and EU, particularly since the end of the MFA. For example, in the US market (which accounts for 25% of the global apparel imports), Mexico saw its market share decline from 14% to 5% in just a decade (1999-2009); in Europe, Italy’s share declined from 9% to below 4%. Similarly suppliers from Central America and Sub-Saharan Africa (US), and from East Europe and North Africa (EU) have lost out to Asian producers in recent years. But growth from displacement of these suppliers will reach its limits soon, so continued growth for Indonesia depends on its competitiveness relative to other Asian suppliers, including Vietnam, Bangladesh, and China. From this perspective, Indonesia apparel growth performance has been less impressive. For example in the US market – Indonesia’s most important – its share grew from 3.1% to 14 Source: OECD input-output tables; data on Thailand and Vietnam only available for one year (2005 and 2000 respectively) Export Competitiveness in Indonesia’s Manufacturing Sector Trade Outcomes Analysis 15 4.6% in the last decade, while Bangladesh grew from 3.0% to 5.3%; Vietnam from 0.1% to 7.8%; and China from 11% to 38%. In the EU, Indonesia actually lost share (from 2.2% to 1.6%), while shares of India and Bangladesh grew to from only 2.5% to reach nearly 6% and over 7% respectively; and China grew from 9% to 35%. The same trend holds in Japan, where Indonesia’s share halved to 0.6%, while Vietnam’s grew to over 4% and China consolidated its dominance with an 84% share. Thus, on a global basis, Indonesia’s apparel exporters appear to be struggling to meet the challenge of competition from low cost Asian producers and, as a result, failing to take advantage of the huge geographical shifts in production in the sector. On the other hand, the overall positive performance in the US market gives some ground for hope that a competitive position can be carved out. Figure 2-11: Analysis of market share growth by Figure 2-12: Summary of product-level market share 15 16 apparel product in US market – Indonesia v China across three markets – Indonesia v China (2000-’10) 100% 90% 80% 90 106 70% 166 60% 10 50% 30 40% 30% 123 35 59 20% 66 10% 24 0% 9 9 US EU Japan + IDN>CN + IDNCN -IDNCN indicates products in which Indonesia gained market share over the decade at a faster rate than China (or where Indonesia gained and China lost share); +IDNCN indicates market share losses for Indonesia but at a slower decline than experienced by China; and –IDNCN� refers to market share gains or no changes in market share; “ -“refers to losses in market share. Where Indonesia recorded no exports in a product for both 2010 and 2000, the product is not included in the analysis. Export Competitiveness in Indonesia’s Manufacturing Sector 16 Trade Outcomes Analysis the overall situation is less positive, with Indonesia having lost share in 201 of 276 apparel product lines, while China lost share in only 44. In the 75 lines in which Indonesia gained share, they only outperformed China in 9 of them. The same trend broadly holds in Japan, where Indonesian apparel exporters lost share in 60% of their product lines over the decade, outperforming China in only 24 of the 83 product lines in which they gained share. A previous study on the Indonesian apparel industry in the immediate post-MFA environment19 attributed the positive performance of exports to the US to a shift in focus to products in which Indonesia was not producing head-to-head with China, and to an increase in quality performance relative to China. Extending that analysis to 2008, however, we find little support for those initial findings. Indonesia’s main apparel export products to the US have not changed much between 2002 and 2008 – only two of the top ten export products in 2008 were not in the top ten in 2002 (see Box 2-2). Moreover, four of Indonesia’s top five exports products are also among China’s top five export products. Indeed, Indonesia’s exporters are competing head-to-head to with China’s. And for the most part they are losing. For four of these five products, China has, on average, almost four times greater market share in the US than does Indonesia. Moreover, Chinese exporters are realizing a higher unit value for these products than Indonesia’s. Box 2-2: Cotton trousers: an Indonesian apparel success story? HS 610462 – “women’s’ and girls’ trousers, overalls, breeches and shorts, cotton, knit� – better known as cotton th trousers was Indonesia’s 50 most important clothing export to the US in 2002, accounting for only US$7m in total th exports. Only six years later exports had risen almost 20-fold to US$137m, making it Indonesia’s 8 most important apparel export product to the US. Perhaps more telling, of Indonesia’s top 10 exports to the US it is the only one in which Indonesia had a higher market share than China in 2008. The downside of this story is the nature of the product. Of Indonesia’s top 10 apparel export products, cotton trousers have the lowest unit value and have experienced the lowest growth in unit value over this period. Thus, Indonesia’s exporters are becoming competitive in a product where the margins are likely to be low and coming increasingly under pressure. On the other hand, it argues against the conventional wisdom that Indonesia can no longer compete with “low cost� producers at the low end of the market. In summary, the Indonesian apparel sector has benefitted from the global shift toward Asian suppliers. But its competitive performance among these Asian producers does not appear to be particularly strong, raising doubts over how much further global trends can pull the sector. 2.2.2. Extensive margin: diversification While Indonesian apparel producers are facing competitive challenges in their core product range, there appears to be no significant problem with lack of diversification. The downside of this, of course, is that Indonesian producers have relatively little scope to seek growth outside of their existing product-market relationships. Indonesia already provides one of the most diversified ranges of apparel exports among its regional peers. Despite the competitiveness challenges versus low-cost producers (note Vietnam’s massive rise over this period), Indonesia does not appear to have been forced out of many products in 19 World Bank (2007) Indonesian Textile and Apparel: A New Dawn for a “Sunset Industry�? , Financial & Private Sector Development Technical Note, Issue 4, September 2007 Export Competitiveness in Indonesia’s Manufacturing Sector Trade Outcomes Analysis 17 the apparel export basket, as has been the case in Malaysia. Indonesia’s exports are somewhat more concentrated than China’s – for example its top 5 products (of 215) account for 36% of exports to the US and its top 20 for 75% (compared to 25% and 55% respectively for China). But overall these do not reflect significant concentrations. In terms of markets, Indonesian apparel exports reach a fairly wide range of countries, but there is still scope for further market diversification. Its Index of Export Market Penetration (IEMP)20 in knit products has grown relatively slowly over the past decade, but has reached a relatively strong 60% (non-knits shows the same trend and relative position). Export growth can take place at the intensive margin (selling existing products to existing markets) or at the extensive margin (selling existing products to new markets, new products to new markets, and new products to existing markets). In the context of diversification, drawing on Hummels and Klenow (2005) 21 , it is possible to infer, (i) how big a player a country is in what it exports (intensive margin- IM), and (ii) how important is what it exports to the world (extensive margin – EM)? This approach improves on the method of simply counting how many new export items or countries have been introduced by weighing the new products or markets by their share in world trade. So, adding carrots to the export portfolio is not the same as adding cars; adding Comoros is not the same as adding China22. In Figures 2-13 and 2- 14, the IM and EM are plotted jointly (y and x axis, respectively) for Indonesia relative to peer countries in apparel exports for the years 1998 and 2008. Where the arrow connecting the points to the right it indicates a growth in the breadth of the export portfolio (of products or markets), while a left-ward pointing arrow reflects a decline in product or market breadth. Where the arrow points upward it indicates a relative growth in the importance of the country as a global exporter (i.e. it has a larger relative share in the products or markets in which it sells). Figure 2-13, shows that in terms of products Indonesia sits in the middle between Vietnam and China, on the one hand, who are extending their range and consolidating share in this range, and Malaysia and Thailand, who are both consolidating their range and losing share. While Indonesia is experiencing the same general trend as Malaysia and Thailand, its global share loss is significantly less. In terms of market diversification, all countries appear to be consolidating, but while Vietnam, Bangladesh, and China are becoming significantly more important players in the markets they serve, Indonesia, Malaysia, Thailand, and Philippines are becoming slightly smaller players (again, Indonesia less so than the others). 20 IEMP calculates a country’s total number of exports, and the number of markets that each of those products reach. Then, the number of countries in the rest of the world that import each of those products is counted. Pairing products and countries this way, we obtain the maximum potential number of export relationships that a country can establish given its export portfolio. 21 See Hummels, D. and P. Klenow (2005) “The Variety and Quality of a Nation’s Exports.� American Economic Review, Vol. 95:3 22 i Specifically: If K is the set of products exported by country i, X ki the dollar value of i’s exports of product k to the world, and X kw the dollar value of world exports of product k, the intensive margin (IM) below calculates a country’s share in its representative products. The extensive margin (EM) calculates the breadth of one’s export portfolio relative to all exports that exist in the world. X i k X w k IM i  ki EM i  ki X w k X w k ki kw Export Competitiveness in Indonesia’s Manufacturing Sector 18 Trade Outcomes Analysis Figure 2-13: Hummels-Klenow intensive and extensive Figure 2-14: Hummels-Klenow intensive and extensive margin – apparel products margin – apparel markets Intensive and Extensive Margin in Products -Clothing Intensive and Extensive Margin in Markets - Clothing VNM BGD 4 1.2 IDN IDN 1 3 VNM Intensive Margin Intensive Margin THA .8 IDN IDN BGD 2 PHL THA .6 MYS THA PHL THA MYS 1 .4 VNM VNM PHL MYS PHL MYS .2 0 99.92 99.94 99.96 99.98 100 44 45 46 47 48 49 Extensive Margin Extensive Margin 1998 2008 1998 2008 Source: Calculated based on Comtrade data Source: Calculated based on Comtrade data Note: China excluded as its intensive margin is too large to allow for Note: China excluded as its intensive margin is too large to allow for perspective of the other countries perspective of the other countries Over the past decade, Indonesia has achieved relatively significant growth in exports from entering new markets (See Figure 2-19). Looking forward, one might consider the possibility of further extensive margin growth through penetrating the ASEAN market. However, it is unclear how much scope there is for this. The big market, of course, is China. Evidence to date shows that Indonesian apparel exporters have made little headway in that market, despite strong gains in the upstream textiles sector. In both 2008 and 2009, for example, Indonesian apparel exports to China were on the order of only US$25m, less than a tenth of Indonesia’s apparel imports from China. However, given rising wages in China (as will be discussed later in this report) and the implementation of the ASEAN-China FTA, there may be further potential to exploit this opportunity in the coming years. 2.2.3. Quality margin: sophistication and quality One of the big questions for Indonesian apparel exports is whether they are getting caught in the middle, between low cost and high quality (i.e. higher value per unit), unable to compete effectively in either domain. Evidence from growth in unit value of apparel exports to the EU23 suggests this may be the case. Average unit prices for Indonesian exporters are below that of Thailand (and on par with China), but above Bangladesh and (just slightly) Vietnam. Moreover, Indonesia (along with Thailand and Vietnam) experienced overall growth of average unit values over the period 1988-2009, while China, Bangladesh and (surprisingly) Malaysia experienced declines. It is difficult, however, to draw conclusions from this. For one, these dynamics could reflect Indonesia increasing quality competitiveness or decreasing cost competitiveness – or indeed both, depending on the product in question. Therefore, in Figures 2-15 and 2-16 we move down to the product level to assess Indonesia’s quality performance in like-for-like products. Figure 2-15 shows that unit prices in Indonesia top five export products do, in fact, 23 Note that a robust unit value database is available for the EU market only based on a database recently developed by the World Bank’s International Trade Department; while a similar database exists for imports to the US market, the data runs only up to 1990 and is thus insufficient for this analysis. Export Competitiveness in Indonesia’s Manufacturing Sector Trade Outcomes Analysis 19 sit in the middle relative to regional peers, well below Malaysia and Thailand (and rising at a slower rate) significantly above China, Vietnam, and Bangladesh, to whom they are losing share in these products. Figure 2-16 assess changes in relative quality (see Box 2-3) along with changes in market share performance in apparel exports to the EU. Each bubble represents a product, defined by an 8-digit Combined Nomenclature code. The x-axis shows the growth rate of market share (log difference of market shares) between 1996-08 and 2006-08. The y-axis represents the growth rate of the average quality measure between the same periods of time. The size of each bubble is the importance of each product within Indonesia’s apparel exports. It shows that in most products (and in all the largest export products), Indonesia experienced declining relative quality over the decade. For the majority of them, declining quality also came with declining market share, although in a number of important products market share increased over this period. In fact, Indonesia has lost market share in the EU in all five of the products shown in Figure 2-15 between 2000 and 2008, with China gaining share in all of them. In the US, by contrast, Indonesia as grown share moderately in four of these five (while China has grown share significantly in all five) – unfortunately in the absence of data on unit prices for the US market over this period, we are unable to assess how quality relates to this market share performance. Figure 2-15: Average unit prices (US$) of Indonesia’s Figure 2-16: Changes in market share and relative 24 top 5 export apparel products to the EU (1988-2009) quality of apparel exports to the EU 28 61-62 Clothing 26 Changes in Market Shares and relative Quality (Ave.06-08/Av.96-98) 2 24 22 1 Log diff in relative quality 20 18 0 16 -1 14 12 -2 10 1990 1995 2000 2005 2009 -3 -4 -2 0 2 4 6 Log diff market shares BGD CHN IDN MYS THA VNM Source: PRMTR unit price database Source: Calculated based on data from PRMTR unit price database 24 Unit price data is based on imports of apparel products into the European Union (specifically here we look at Indonesia’s fiv e largest volume apparel export products to the EU) during the period 1998-2008. Average annual unit price are computed based on data from a dataset developed by the International Trade Department of the World Bank. Export Competitiveness in Indonesia’s Manufacturing Sector 20 Trade Outcomes Analysis Box 2-3: Measuring the relative quality of exports using disaggregated trade data We rely on the COMEXT database from EUROSTAT to characterize the relative unit values of imports in each EU member country. As in Schott (2004), unit values were calculated simply as the quotient of general imports values and quantities. Within any product (8-digit Combined Nomenclature code) for any given year, we then have a distribution of unit values of imports from the different source countries. For each good and exporting country , in time year , we generate a measure of relative quality as: th Where denotes de unit value of the good and denotes the value at the 90 percentile of the unit value distribution across countries for that product. denotes the relative quality of the country’s export of that good, i.e., quality relative to other countries exporting the same good. It is important to note that this analysis measures relative and not absolute quality. So declining relative quality does not necessarily mean declining unit prices. Unit prices may be rising but at a slower rate than average for the importing country; similarly rising relative quality may reflect unit values actually declining, but at a slower rate than the average. 2.2.4. Sustainability margin: export participation and survival Indonesia’s apparel export sector has undergone a significant transformation over the past decade. Prior to the Asian crisis, there was a rapid rise in the number of firms entering export markets. But the number of exporters collapsed in the Asian crisis and has not recovered. Evidence from Indonesia Manufacturing Census indicates that since the crisis, both export participation and survival has declined. In the period 1990-1996, 13% of non-export firms began exporting; however, this collapsed to 5% in the crisis years and fell even further in the 2000-2008 period. Meanwhile export deaths (firms that exported at the beginning of the period and stopped exporting during the period) rose substantially throughout, suggesting an increasingly risky export market. Overall, less than 15% of all apparel firms (with more than 20 employees) were exporting in 2008; this is down 40% since the pre-crisis period and even down 30% since 2000. Figure 2-17: Export participation and survival Figure 2-18: Firm size dynamics 60% Apparel CAGR in firm size 1990-2008 50% 50% 39% 19.0% 40% 12.5% 30% 22% 20% 3.6% 4.7% 5.6% 13% 3.4% 0.1% 0.2% 1.0% 10% 5% 4% -0.5% 0% 90-96 96-00 00-08 Overall Exporter Non-exporter Foreign Domestic export death export entry Mean Median Source: Manufacturing Census Source: Manufacturing Census Export Competitiveness in Indonesia’s Manufacturing Sector Trade Outcomes Analysis 21 Output remains above pre-crisis levels, however, which suggests substantial consolidation in the export sector – i.e. there are now fewer, larger exporters, reflecting actual mergers and/or the growth of productive firms and the exit of unproductive ones. The driver of this consolidation appears to be a major expansion in foreign-owned firms, which increasingly dominate the export sector (see Figure 2- 18). The median apparel exporter in 2008 has 518 employees while non-exporters had only 34; but foreign exporters were particularly large, with 920 employees. This indicates on the one hand that the export sector is consolidating around large, foreign-owned players, which should be relatively competitive. On the other hand, it also means that barriers to entering export markets are growing. Thus smaller domestic players are likely to increasingly depend on the highly price competitive domestic market for survival. In either case – export or domestic focus – the market dynamics highlight the critical importance of Indonesian exporters improving their productivity. 2.2.5. Conclusion: apparel sector The analysis of Indonesia’s performance in the apparel sector over the past decade does not depict a sector in serious decline. On the other hand, the data suggests cause for concern over its future prospects, as it appears to have very much been buoyed by the rising tide of Asian production in the sector. Yet it has failed to take significant advantage of these trends and faces a threat of decline if it is not able to raise its competitiveness relative to the other Asian producers. Figure 2-19 summarizes the situation, with a decomposition of export growth in the apparel sector over the past decade. What stands out most is that, relative to the emerging competitors in the region, Indonesia appears to be experiencing much greater churn in the intensive margin, with the highest levels of growth from existing products in existing markets, but also the highest levels of decline. This suggests some sort of structural change within the sector. Indonesia has also had relatively good performance in finding new markets – but as noted, there are limits to how much further market diversification can take the sector. There is also some evidence that Indonesia’s prospects in the apparel sector may be more sanguine than is suggested by its recent performance. Anecdotal evidence from interviews point to a “tipping point� in China’s rising manufacturing wages, supported by the post-global financial crisis shift in economic strategy toward greater domestic consumption, which may be pushing investment back into Indonesia’s apparel sector. While this specific investment trend does not show up in the FDI data from BKPM, where China’s FDI in Indonesia’s manufacturing sector overall is virtually non-existent, it is possible that the trend is too recent (this data reflects realized investments) or that it may not be picked up in the FDI data for some reason. Finally, the significant growth in FDI from countries like Singapore, Korea, the US, and Japan may well reflect shifts of existing or marginal investment away from China. Other measures of FDI in the wider textiles sector do give some indication of a possible resurgence in the sector. For example, imports of textile machinery grew by 120% since 2005 – more than all regional peers, with the exception of Vietnam25. Moreover, realized FDI in the textile sector grew substantially from 2007 through 2009 from around US$150m to US$250m annually. Domestic realized investment showed an even stronger upward trend. 25 China grew only 20%; Malaysia 4%; Philippines and Thailand declined by 60% and 20% respectively; Bangladesh grew more than 25%; Vietnam doubled Export Competitiveness in Indonesia’s Manufacturing Sector 22 Trade Outcomes Analysis Should this initial evidence of Figure 2-19: Decomposition of apparel sector export growth (1999-2009) FDI returning to the sector be 176.7% borne out, it may have 107.3% 104.9% significant implications on the 94.9% assessment of Indonesia’s prospects in apparel exports 13.2% 11.6% 3.2% 2.4% 0.0% 0.0% going forward. With such a large wage arbitrage opportunity vis- -2.5% -2.9% -3.1% -3.4% -5.6% -6.8% à-vis China and wage rates -17.1% -72.8% beginning to converge with Vietnam and Bangladesh (who Increase of Fall of existing Extinction of Increase of new Increase of new Increase of are experiencing significant existing product product in existing product products in new products in existing products in existing existing markets in existing markets existing markets in new markets upward pressure on wages), markets markets Indonesia may have once again emerged as a low cost location IDN BGD CHN VNM for garment production, and Source: Calculated from Comtrade significant growth may ensue. Of course, the opportunity would likely be for only a limited time as Indonesia is also experiencing wage pressures that are likely to grow in the coming years. So while the short term opportunity exists to use the labor cost advantage to establish a new foundation for the sector, maintaining competitiveness in the medium term will require a focus on productivity and quality. Finally, in considering Indonesia’s prospects for growth in the apparel sector, it is important to take into consideration the nature of the global value chains in which the industry operates. These “buyer driven� chains are controlled by brands, retailers, and increasingly by full-service designer-manufacturer intermediaries. This makes it increasingly difficult for exporters to gain control within the value chain, raising challenges for upgrading. Moreover, particularly since the global economic crisis, global buyers are consolidating their production networks both in terms of suppliers and sourcing markets. Increasing competitiveness will, therefore, be critical to ensuring the long-term future of the sector. 2.3. Wood furniture 2.3.1. Intensive margin: levels, growth, and share For a country with extensive forestry resources, furniture and wood products have always represented an important craft and manufacturing sector, responsible for large scale employment in many parts of the country. While only 125,000 workers are employed in formal sector firms with greater than 20 staff (half of which are exporters), it is estimated by ASMINDO26 that 80% of firms in the sector are micro and small firms, including many individual contractors in the many furniture clusters around Jepara and elsewhere in Central and Eastern Java. Jepara alone is said to be home to some 4,000 firms organized through an extensive network of subcontracting. 26 Indonesia Furniture Industry and Handicraft Association Export Competitiveness in Indonesia’s Manufacturing Sector Trade Outcomes Analysis 23 In 1998, furniture was Indonesia’s Figure 2-20: Indonesia furniture exports (US$b) and annual growth (%) sixth most important 3.0 200% manufacturing export sector, 2.5 150% accounting for some 4.6% of manufacturing exports. Despite 2.0 100% Billions USD growing at just below 6% annually 1.5 50% over that period (in US$ terms), it 1.0 0% has declined significantly in its 0.5 -50% importance within the manufacturing export basket, now 0.0 -100% 1990 1992 1993 1994 1995 1997 1998 2000 2001 2003 2004 2005 2006 2007 2008 2009 1991 1996 1999 2002 2010 placing only 11th. As shown in Figure 2-20, exports grew rapidly Exports (B. USD), left axis YTY Growth (%), right axis from a small base through the Source: Calculated based on data from Comtrade 1990s, were erratic through the crisis years, and returned to a steady but much slower rate of growth from 2001. Exports dropped off substantially in the global economic crisis, dropping over 22% in 2009. Losses have stabilized in 2010, but exports still declined slightly further in the year. And while the domestic market is significant and import penetration has traditionally been much less an issue than in the apparel sector (although it is increasingly becoming one27), growth in the formal furniture sector depends much more strongly on export markets than in sectors like automotive and apparel. Indeed, stagnating export performance is reflected in total output in the sector, which has declined by one-third in real terms since the end of the crisis, after doubling in the five years running up to the crisis. Like in the apparel sector, the major shifts in global market share have been away from regional suppliers like Canada, Denmark, and Italy, and dramatically toward Asia28. And, even more so than in apparel, Indonesia has failed to benefit. Indonesia’s slow growth in furniture exports is reflected in steadily declining global market share, from 4.9% in 1999 to 4.4% in 2009. Furniture is one of the few manufacturing sectors in which Indonesia’s growth trailed the global average both in the immediate post-crisis years and the period 2005-2010. At the same time, China’s share in world markets grew from 12% to 29% in one decade, while Vietnam grew from less than 1% in 1999 to 7% by 2009. Figure 2-21 shows that Indonesia lost modest share in all major markets over this period. The product-level analysis in Figure 2-22 shows that in the US and EU Indonesian exports have gained share in just under half the product lines. Although relative to China, Indonesia has actually only gained share in two product lines in the US (rattan and wooden bedroom furniture) and Japan (rattan and wooden kitchen furniture), and it has lost share to China in all product lines in the EU. According to ASMINDO much of the Indonesian furniture sector does not compete head-on with China in export markets, as much of Indonesia’s export sector is in the labor-intensive handmade furniture sector, while China specializes in the large volume, mechanized sector. On the other hand, ASMINDO does consider both Vietnam and Malaysia to be important competitors. Vietnam has dramatically 27 Data from input-output tables indicates import penetration in the wood products sector accounts for only 3.3% of the market as of 2005; however, this share has tripled since 1995. 28 The one exception being Poland, which grew its global market share from 3.5% to 5.4% Export Competitiveness in Indonesia’s Manufacturing Sector 24 Trade Outcomes Analysis outperformed Indonesia in export markets. Against Malaysia it has had a mixed performance (gaining share in the US and losing it Japan) in terms of market share but competes poorly on quality. Figure 2-21: Analysis of market share growth Figure 2-22: Summary of product-level market share (absolute) by wood furniture market – 2000-2010 across three markets – Indonesia v China (2000-’10) 100% 90% 80% 70% 9 11 12 60% 50% 0 40% 0 30% 6 0 20% 7 3 10% 2 2 0% 0 US EU Japan + IDN>CN + IDNCN -IDNCN + IDNCN -IDN