Export Diversification in Indonesia Evaluating Its Effectiveness in Maintaining Economic Growth Stability through Trade

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EXPORT DIVERSIFICATION IN INDONESIA

EVALUATING ITS EFFECTIVENESS IN MAINTAINING

ECONOMIC GROWTH STABILITY THROUGH TRADE

NADYA NURUL HASANAH

POSTGRADUATE SCHOOL

BOGOR AGRICULTURAL UNIVERSITY BOGOR

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STATUTORY DECLARATION

I, Nadya Nurul Hasanah, hereby declare that the master thesis entitled “Export Diversification In Indonesia Evaluating Its Effectiveness In Maintaining Economic Growth Stability through Trade” is my original work under the supervision of Advisory Committe and has not been submitted in any form and to another higher education institution. This thesis is submitted independently without having used any other source or means stated therein. Any source of information originated from published and unpublished work already stated in the part of references of this thesis. Herewith I passed the thesis copyright to Bogor Agricultural University.

Bogor, February 2015

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RINGKASAN

NADYA NURUL HASANAH. Diversifikasi ekspor di Indonesia. Evaluasi Kefektifannya dalam Menjaga Stabilitas Pertumbuhan Ekonomi melalui Perdagangan. Dibimbing oleh NOER AZAM ACHSANI dan FLORIAN PLOECKL

Indonesia berkeinginan untuk menjadi salah satu negara maju. Untuk dapat mencapai tujuan tersebut, Indonesia membutuhkan kestabilan ekonomi. Akan tetapi, ketergantungan ekspor Indonesia terhadap produk-produk dan pasar-pasar tertentu membuat pertumbuhan ekonomi Indonesia rentan terhadap adanya guncangan eksternal, yang berpotensi untuk mempengaruhi kestabilan pertumbuhan ekonomi. Sehingga, hal ini menjadi penting bagi Indonesia untuk dapat menjaga ketabilan pertumbuhan ekspornya dengan cara mendiversifikasi ekspor. Tulisan ini mengkaji peran dari diversifikasi ekspor dalam menstabilkan pertumbuhan ekspor dan peran dari pertumbuhan eksport yang bervolatilitas rendah dalam menstabilkan pertumbuhan ekonomi. Hasil penelitian ini menunjukkan bahwa upaya diversifikasi ekspor yang dilakukan Indonesia belum sukses dalam menstabilkan pertumbuhan ekspor, sebagaimana diversifikasi ekspor ini belum mengurangi ketergantungan Indonesia terhadap produk dan pasar tertentu. Selanjutnya, pencapaian kestabilan pertumbuhan ekonomi di Indonesia setelah krisis tidak bergantung pada upaya diversifikasi ekspor, tetapi dipengaruhi oleh berbagai factor lain. Oleh karena pengaruh dari diversifikasi ekspor tidak cukup kuat untuk menstabilkan pertumbuhan ekonomi Indonesia, kebijakan-kebijakan lain seperti perjanjian dagang dan fasilitasi perdagangan dibutuhkan untuk membantu mendiversifikasi ekspor Indonesia.

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SUMMARY

NADYA NURUL HASANAH. Export Diversification in Indonesia Evaluating Its Effectiveness In Maintaining Economic Growth Stability through Trade. Under Supervision of NOER AZAM ACHSANI and FLORIAN PLOECKL

Indonesia wants to become one of the high-income group countries. To do this, it needs stable economic performance. However, the dependency of Indonesian exports on certain products and markets makes export growth vulnerable to external shocks, potentially affecting the stability of economic growth. It is thus vital for Indonesia to maintain its export growth stability by diversifying its exports. This study examines the role of export diversification in stabilising export growth, and the role of less volatile export growth in stabilising economic growth. The findings show that export diversification in Indonesia has not successfully stabilised export growth,

as it has not reduced Indonesia’s dependency on particular markets and products.

Further, Indonesia’s achievement of economic growth stability following crises has

not depended on export diversification; it is likely driven by other factors. Since the effects of export diversification are not strong enough to stabilise Indonesia’s economic growth, other policies, such as on trade agreements and trade facilitation,

are needed to help in diversifying Indonesia’s exports.

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© Copyright belongs to IPB, 2015

Prohibited quoting part or all of this paper without including or mentioning the source. The quotation is only for educational purposes, research, scientific writing, preparation of reports, writing criticism, or review an issue; and citations are not detrimental to the interests of IPB.

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EXPORT DIVERSIFICATION IN INDONESIA

EVALUATING ITS EFFECTIVENESS IN MAINTAINING

ECONOMIC GROWTH STABILITY THROUGH TRADE

NADYA NURUL HASANAH

Master Thesis

as a requirement to obtain a degree Master of Science in Economics Program

POSTGRADUATE SCHOOL

BOGOR AGRICULTURAL UNIVERSITY BOGOR

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Thesis Title : Export Diversification in Indonesia

Evaluating Its Effectiveness in Maintaining Economic Growth Stability through Trade

Name : Nadya Nurul Hasanah NIM : H151120401

Approved Advisory Committee,

Prof Dr Ir Noer Azam Achsani, MS Dr Florian Ploeckl

Agreed,

Coordinator of Major Economics

Dr Ir Nunung Nuryartono, MSi

Dean of Postgraduate School

Dr Ir Dahrul Syah, MScAgr

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ACKNOWLEDGMENT

I am very grateful to Allah SWT God Almighty, who has provided me an opportunity to obtain a scholarship and study abroad. I would like to acknowledge the support and contributions of the following persons towards the completion of my thesis.

My gratitude goes to Dr Florian Ploeckl and Prof. Noer Azam Achsani, my supervisors, for their constant support, encouragement, valuable comments and critical contributions throughout the research process until the end.

I would also like to thank the lecturers and staff of the University of Adelaide, especially Nicole Rizzo-Gray, Athena Kerley, Niranjala Seimon and Augustine Bhaskarraj for their excellent support and assistance during my study.

I acknowledge with thanks the Ministry of Trade (Kemendag) and Australian Awards Scholarship for financing my study in Indonesia and Australia. I thank my institution, the Directorate of Market Development and Export Information, Ministry of Trade, Republic of Indonesia for providing permission and the opportunity to continue my studies.

I would like to acknowledge Elite Editing for giving me editorial assistance to improve the quality of my thesis. The editorial intervention was restricted to Standards D and E of the Australian Standards for Editing Practice.

I am grateful to my colleagues and fellows in the Applied Economics major, and especially to the Indonesian group (lima sekawan plus one [Tesa, Shanty, Indra, Meindro and Ari]). I really appreciate the support, togetherness and friendship we have given one another throughout our study in Indonesia and Australia. Thank you also to my friends in Indonesia for their support and discussion during my time in Adelaide.

To my beloved parents and family members, I thank you for your continuous support during my study. This study would not have been possible without your prayers and sacrifice.

Last but not least, I thank B.A.W. for his encouragement throughout the entire study process and for his love, support, patience and prayer. This thesis is dedicated to You.

Bogor, February 2015

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LIST OF TABLES

Table 4.1 Concentration ratio, 2004–2013 10

Table 4.2 Share of main, potential and other products, 2004–2013 12 Table 4.3 Share of main and potential products in Indonesian exports, 2009–2013 13

LIST OF FIGURES

Figure 2.1 Indonesia’s GDP per capita growth (annual %) 2

Figure 2.2 Composition of Indonesian exports, 1970–1987 (percentage) 3

Figure 3.1 Categories of export diversification 5

Figure 4.1 Indicators of market diversification 10

Figure 4.2 The concentration ratio of Indonesia’s export, 2009–2013 11 Figure 4.3 Change in export share based on destination regions, 2009 and 2013 12

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1 INTRODUCTION

In the 1980s, as the world suffered due to the decrease in oil prices, the Indonesian economy also felt the impact. In 1982, after more than a decade of high economic growth, the Indonesian economy experienced negative growth. Sixteen years later, due to the Asian Financial Crisis in 1998, for two consecutive years, Indonesia experienced another breakdown of its economy. These external shocks

significantly affected Indonesia’s economy, particularly its economic growth.

Stable economic growth is important for any developing country seeking to join the ranks of the high-income group countries. After showing incredible growth for many years, Indonesia is now still in the middle-income group1_{. Indonesia therefore} needs to be careful in order to avoid falling to the middle-income trap. Tho (2013)

describes this trap as a ‘phenomenon’ experienced by a country that cannot escape

from the middle-income level. Indonesia needs stable economic growth to keep off this trap and to join a high income–group country.

To maintain the stability of Indonesian economic growth, reducing the volatility of export growth is important, as export growth is one of the factors contributing to economic growth. Previously, Indonesian exports relied too heavily on certain products, such as oil in the 1960s (Pangestu 1992). Due to this high dependency, the export performance of Indonesia is vulnerable to external shocks.

More recently, export diversification has been seen as a strategy to overcome volatile export growth. By diversifying its export base, a country will have greater strength in facing external shocks. While external shocks may affect a particular export product, other products not affected by those shocks might take over the share of the affected product in its export value. In this way, export growth, and by extension the economic growth of the country, can be kept stable.

The objectives of this study are to examine the role of export diversification in Indonesia to support export growth and to stabilise economic growth when external shocks occur. An examination of the role of export diversification will provide a clear picture for policy makers and export experts in Indonesia of the importance of diversifying Indonesian exports.

The next section presents a brief outline of the history and reasons behind Indonesian export diversification. In Section 3, the literature on export diversification and its relationship with economic growth and external shocks is reviewed. Section 4 discusses the progress of export diversification in terms of the market and products in Indonesia, export diversification’seffectiveness in maintaining Indonesia’s economic growth, and the policies supporting export diversification in Indonesia.

1According to The World Bank (2013), the group income is classified based on the country’s GNI.

These groups are “low income (GNI ≤ $1,035), lower-middle income ($1,036 ≤ GNI ≤ $4,085), upper

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2 BACKGROUND

Indonesia has been classified as a middle-income country since 1993. Even though Indonesia classified as a low-income country due to the Asian Financial Crisis, it was able to re-join the middle income group in 2003 (The World Bank n.d.). Despite being resource-rich, Indonesia has not been able to join the group of high-income countries. For almost two decades, from the mid-1960s to the 1980s, Indonesia experienced positive growth in its GDP per capita. However, this positive growth was not stable: it varied between 3.5% and 9% per year (see Figure 1). The high growth experienced by Indonesia was supported by its export of oil during the oil boom of the 1970s. Pangestu (1992) argued that the increase in oil prices in the early 1970s increased the share of oil exports from Indonesia and contributed to the increase in Indonesian GDP per capita.

Figure 2.1 Indonesia’s GDP per capita growth (annual %) Source: (The World Bank 2014b)

However, as Pangestu (1992) argued in her article, the fall in oil prices in 1982 led to a decline in the share of oil exports in Indonesian exports. Since during that time oil was the main commodity exported by Indonesia, Indonesian exports experienced negative growth. For five consecutive years (1982–1986), Indonesian exports dropped, with their value decreasing significantly from US$26.85 billion in

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3 1981 to US$15.60 billion in 1986 (The World Bank 2014c). This decline in exports eventually affected the economic performance of Indonesia, as shown in Figure 1. In 1982, the GDP per capita of Indonesia dropped by around 1.16%.After the oil shock, the Indonesian economy started to recover. Even though its exports continued to experience negative growth, Indonesia achieved positive economic growth in per capita terms in the range of approximately 2–7% every year (see Figure 1). However, this positive growth did not last long. In 1998, Indonesia’s economy was hit for the second time, by the Asian Financial Crisis. This crisis had a profound impact on the Indonesian economy and placed Indonesia into a deep recession (Tambunan 2010). Indonesian GDP per capita dropping by about 14% (see Figure 1). In addition to the depreciation of its currency and the fall in economic growth, Indonesian export performance was also affected by this crisis. Theoretically, the depreciation of the

country’s currency should have led exports to increase. However, while the share of exports in GDP per capita growth during this period did increase significantly (27.85% in 1997 to 52.97% in 1998), the value of exports fell dramatically from US$60 billion in 1997 to US$51 billion in 1998. This trend of decreasing export value continued for two years (The World Bank 2014c).

Figure 2.2 Composition of Indonesian exports, 1970–1987 (percentage)2 Source: (The World Bank 2014b)

By 2000, supported by a favourable political environment, Indonesia’s economy had recovered from the crisis and its GDP was growing at approximately 3– 5% per annum (see Figure 1). Further, Indonesia was only minimally affected by the

2_{This export composition only consists of three sectors. There are three other sectors that are not}

included in this graph: Food, Ores and Metal and the Service sector.

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Global Financial Crisis of 2007–08: GDP per capita growth dropped off to about 3.2% after four consecutive years of more than 4% growth (see Figure 1), and Indonesian exports declined by approximately 14.47% from the previous year (The World Bank 2014c). agricultural sector. However, this marked the starting point for the increased contributions from the manufacturing sector. As shown in Figure 2, the share of exports from the Indonesian manufacturing sector increased gradually after 1982, and in 1991, the manufacturing sector took its place as the main segment of merchandise exports in Indonesia, contributing about 40% of total exports.

Based on its journey from the early 1960s, it is clear that Indonesia is vulnerable to external shocks. The external shocks experienced by Indonesia affected its economic performance, causing a slowdown in Indonesia’s progress towards joining the high-income group of countries. This has led to recognition of the importance of keeping export performance stable. While stable export performance can help to stabilise a country’s economic growth, the method in achieving this is important. The next section focuses on export diversification as the method for stabilising economic growth.

3 LITERATURE REVIEW

In this section, the relationship between export diversification and economic growth and external shock is discussed from a theoretical perspective, with support from previous empirical studies.

Export Diversification

Traditional trade theory suggests that a country should focus on specialisation rather than diversification. The Heckscher-Ohlin model states that a country should specialise in and export the commodity which uses its abundant factor intensively (Markusen et al. 1995). However, the urgency of diversifying a country’s export base starts to increase since volatility in commodity prices may affect economic growth in the long run.

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5 (market) diversification. The extensive margin in terms of product diversification refers to an increase in the number of export good categories (that is, an increase in the number of products exported). Those products can be exported to old or new destinations. The extensive margin in terms of market is defined as an increase in the number of market destinations (Amurgo-Pacheco & Pierola 2008). A clear graphical instrument (see Figure 3) can be used to summarise this definition.

Figure 3.1 Categories of export diversification Source : (Amurgo-Pacheco & Pierola 2008)

Several measurements can be used to quantify the level of a country’s export diversification. The World Bank (2014a) gives these measurements as:

1. Herfindahl-Hirschman Product Concentration Index (HHPCI)

HHPCI=∑

xik

Xi 2

- 1ni ni

k=1

1- 1ni where:

Xi : The total export value from country i

xik : The export value of product k from country i

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This index measures the distribution of the trade value from the export product. Ranging from 0 to 1, a lower index shows that a country has diversified its export base, while a higher index indicates that a country’s exports remain concentrated in limited sectors. This index has limitations, as the lower index may not show a higher diversification if the number of products is very low.

2. Herfindahl-Hirschman Market Concentration Index (HHMCI)

HHMCI=∑

Xi : The total export value from country i

xij : The export value from country i to country j

ni : The total export partner of country i

This index measures the level of export diversification in terms of trading partners (market destinations). Ranging between 0 and 1, a higher index indicates that a country has a high concentration of exports to a few trading partners. As the index moves closer to 0, this shows that a country has diversified its trading partners. However, as with the HHPCI, the HHMCI has its limitations. If the country only trades with a few partners, then the lower index may not show the higher degree of diversification.

Even though the World Bank has assigned several criteria to assess the level of diversification in terms of products and markets, Indonesia, through its Ministry of Trade, has established its own calculation to measure the level of export diversification. As outlined in the Strategic Plan of the Ministry of Trade (Ministry of Trade Republic of Indonesia 2010), the indicator used to measure the level of export diversification in terms of markets is the concentration ratio of market share from the five largest trading partner countries for non-oil and gas exports. For diversification in terms of product, the Ministry classifies 10 main export products and 10 potential export products and calculates their share of Indonesia’s total exports.

While Indonesia’s measurements of export diversification are quite simple, they are in fact part of the HHMCI and HHPCI. By using its own criteria, it is easier to see in which country or product Indonesian exports are concentrated and to see the dynamic changes in export product and destination. This will make it easier for policy makers to identify which strategies should be implemented to diversify Indonesia’s market destinations and export products. These measurements are explained below:

1. Concentration Ratio 5 (CR5)

CR5= s1+s2+s3+s4+s5;

in whichsi=total export of Indonesian products to country i_{total export of Indonesia}

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7 2. Export share of main or potential products

Export share of main or potential products= s1+s2+⋯+s10

in which si=total export of main or potential product i_{total export of Indonesian products}

Ranging from 0 to 1, export diversification in terms of product is classified as high if the export share of main products is less than or equal to the export share of other products (potential and remaining products). This classification is explained in more detail later in Section 4.

Export Diversification and Growth

Exports are one channel driving the economic performance of a country. One of the characteristics of developing countries is that they have high dependency on primary products or particular markets. This makes a country more vulnerable to trade shock. More than 60 years ago, ‘Raul Prebisch and Hans Singer argued that specialisation in primary products would lead to secular falls in the purchasing power of primary exports’ (Brenton et al. 2009, p. 1). Specialisation also places a country at risk of instability in its terms of trade, causing effects such as a decrease in investment (Helleiner 1986 cited in Amin Gutiérrez de Piñeres & Ferrantino 1997b).

Several empirical studies found that export diversification has a positive relationship with growth in per capita terms. Al-Marhubi (2000) found that export diversification plays an important role in promoting the economic growth of a country. He discovered that countries with a higher degree of diversification and a lower concentration in exports tend to grow faster. Amin Gutiérrez de Piñeres and Ferrantino (1997b) showed that export specialisation, which is a source of economic risk, had declined in Latin American countries, with export diversification having had a positive effect on growth in those countries. In their study of the Chilean economy, Amin Gutiérrez de Piñeres and Ferrantino (1997a) argued that export diversification enhances economic performance. Even though export diversification occurred during a time of structural change for Chile’s exports, it was expected that export diversification would have a long-run effect on growth. This was evidenced by Herzer and Nowak-Lehnmann (2006), which revealed a long-run relationship between export diversification and growth in Chile. They further found that to achieve higher growth, it is more important to encourage industry to export more, rather than to increase the share of exports from high value-added products.

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export diversification, this can reduce export instability, reducing the importance of the increase in savings level.

From this empirical evidence, it is apparent that certain countries’ economic growth and export stability have been positively affected by their having undertaken export diversification. The question arises whether export stability has an impact on growth. This is answered by Bleaney and Greenaway (2001) which revealed that

trade instability has a negative effect on countries’ economic growth through

reducing the incentive to invest in the export sector, thereby reducing overall investment.

Export Diversification and External Shock

As mentioned earlier, external shock can affect a country’s economic performance. The vulnerability of a country’s economic performance increases as the country opens for international trade. Therefore, while openness to trade makes countries specialise in certain products, dynamic changes in commodity prices have a huge impact on their economic growth.

While such external shocks cannot be anticipated, free trade agreements (FTAs) are one kind of trade shock that can be anticipated. In addition to being used to increase trade volume, FTAs can also be used to reduce trade barriers (tariff or non-tariff) and therefore increase the volume and value of trade. More than 250 FTAs have been proposed and almost 50% of these have been signed and implemented (Asia Regional Integraton Center 2014). According to Cusolito and Hollweg (2013), FTAs can potentially result not only in trade creation through tariff reductions and trade diversion from third parties through increased preference margins, but also in export market diversification within and outside the region. FTAs can help to remove trade policy barriers, which are a major obstacle to export diversification. Therefore, FTAs may play a very important role in export diversification. However, the effects of FTAs on export diversification are not sufficiently clear. Dingemans and Ross (2012) argued that FTAs open new markets; however, in Latin American countries, only a few countries under FTAs started exporting to the new countries.

Based on this review of the literature, not many studies have investigated the effectiveness of export diversification in stabilising economic growth, in relation to Indonesia and when external shocks occur. The next section discusses the progress of export diversification in Indonesia and its role in stabilising economic growth in that country.

4 DISCUSSION

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9 product extensive margin and market extensive margin, as defined by Amurgo-Pacheco and Pierola (2008).

Progress of Export Diversification in Indonesia

Under the regime of President Susilo Bambang Yudhoyono (2004–2014), Indonesia has attempted to direct its focus to export diversification in terms of markets and products. The concern to diversify products and markets arose after the oil price shock affected Indonesia in the 1980s. After the crisis, ‘non-oil exports … lagged far behind’ because of the Dutch Disease3 and other factors that made the manufacturing sectors uncompetitive (Pangestu 1992). In response, Indonesia began to focus on export diversification to diversify away from the oil and gas sector. Nowadays, as Indonesia is an importer of oil and gas products; it now emphasises its export diversification within the non-oil and gas sectors. As such, the export diversification discussed in this paper concerns only non-oil and gas products and the markets for non-oil and gas products.

Export Market Diversification

Export market diversification in Indonesia aims to decrease the country’s dependency on certain markets and increase its number of trading partners. Figure 4 shows that export diversification in Indonesia is trending in the right direction, with a gradual decrease in the HHMCI. In line with that, Indonesia has increased the number of countries to which its products are exported. This significant increase in the number of importing countries of Indonesian products began in 1997 following

Indonesia’s commitment to the World Trade Organization (WTO) on multilateralism and the removal of export restrictions. Despite the substantial increase in number of markets for Indonesian exports at this time, the HHMCI index did not change significantly since it only showed a little decrease.

3_{the discovery of natural resource that has made the manufacture sectors of the country less}

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Figure 4.1 Indicators of market diversification Source: (The World Bank 2014c)

Even though the HHMCI shows Indonesia has been experiencing a higher degree of diversification, the measure used by the Indonesian government for accessing the importance of trade partners (Concentration Ratio 5/CR5) shows that export market diversification in Indonesia has not reached the established target of 43–47% for the period 2010–2014. Regarding diversifying markets for non-oil and gas products, since 2009, the share of exports to the five biggest trading partners (CR5) shows a slight upward trend (see Table 1). This means that Indonesia continues to be heavily dependent on these five trading partner countries for its export markets.

Table 4.1 Concentration ratio, 2004–2013

Year 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

CR5 (%) 50.7 50.3 50.2 48.8 47.5 47.9 48.8 49.4 49.5 50.6

Source: (Author’s Calculation from Statistics Indonesia 2014)

As can be seen from Figure 5, the increase in CR5 is mainly due to the changes

in composition of China’s imports from Indonesia. From 2009 to 2013, Indonesia’s exports of coal and lignite to China escalated by more than 156% and 61%, respectively (Statistics Indonesia 2014). China is the top coal importing country, and Indonesia is the second biggest exporter of coal to China after Australia. However, this number may decrease, as there have been attempts in China to propose a ban on

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11 low quality coal which is Indonesia’s main coal export product (Hoyle, R & Li, Y 2013).

Figure 4.2 The concentration ratio of Indonesia’s export, 2009–2013

In 2009, the Indonesian government formulated the target to diversify its exports into markets located in the Middle East, Africa, Eastern Europe and Latin America (Ministry of Trade Republic of Indonesia 2010). However, since it is clear that the target of export diversification was not achieved, it should be evaluated. Success in diversifying export markets depends on several factors. Tarman et al. (2011) discussed the competitiveness of the export product and the growth in the target market as the main factors contributing to reaching the higher level of diversification. They identified the African countries as the main potential market to increase the level of export market diversification. The Middle Eastern countries are another potential target of Indonesian export diversification, as the share of Indonesian exports is low in this region. Therefore, export diversification efforts should focus more on these two regions rather than on other regions.

However, these regions appears to not get the full attention of the Indonesian government as potential main export markets. As shown by Figure 6, the share of exports by region did not change much from 2009 to 2014. There was only a slight increase in the share of exports to Asia, Africa and Oceania, and the share of Indonesian exports to the Middle East saw a small decline, mainly because this region was experiencing political and security issues that indirectly affected the regional economy and therefore the demand for Indonesian products. As a result, the target of export market diversification identified by Indonesia has clearly not been progressing as expected.

0 10 20 30 40 50

2009 2010 2011 2012 2013

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Figure 4.3 Change in export share based on destination regions, 2009 and 2013

Export Product Diversification

The Indonesian government measures export diversification using two major categories: main products and potential products, with each category consisting of 10 products. Previously, the main products accounted for more than 50% of Indonesian exports. High dependency on certain products can put Indonesia at enormous risk with regard to falling export growth. As Amurgo-Pacheco and Pierola (2008) revealed, developing countries have a tendency to concentrate their exports on commodities with volatile demand. This volatile demand translates to instability of income, or in other words, economic growth volatility. Diversification in terms of export products becomes more demanding because Indonesia cannot rely only on the main products. This makes the step taken by the government of Indonesia to promote potential products such as leather, handicrafts and jewellery very important.

Table 2 shows a downward trend in the share of main product exports during the period 2004–2013. Conversely, the share of potential products was varied over this period, and was considerably smaller than for the ‘other products’ category; that is, those products that are not a focus of export diversification in Indonesia.

Table 4.2 Share of main, potential and other products, 2004–2013

Year 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

ASIA EUROPE AMERICA AFRICA MIDDLE EAST AUS OCEANIA

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Overall, to 2013, diversification in terms of export products showed a positive result in line with the government target to increase the share of non-main products to 53–60% of Indonesian exports over the 2010–2014 period. As Table 3 shows, in 2013, the share of main products of Indonesian exports was only 45.73%, while potential products and other products, respectively, comprised 7.28% and 46.99% of Indonesian exports. This shows that the potential product share has already given the expected result. However, upon reviewing the significant upward trend in the share of other products of Indonesian exports from 2004 to 2013, where the increase was greater than the result for potential products, it is necessary to re-evaluate which products are classified as potential products. There are products that have not been identified as potential products, but they could have the potential to contribute to boosting Indonesian export performance.

Table 4.3 Share of main and potential products in Indonesian exports, 2009–2013

Product Type Share of Export (%)

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From Table 3 it can be seen that several potential products already have a higher share of exports than the main products. However, based on the assessment of the Indonesian government, these products—jewellery, processed food and fish products—are still considered as potential product due to their expected potency to gain a greater export share.

Export Market and Product Diversification

Overall, the progress of export diversification over the years has shown that the efforts to diversify in Indonesia are particularly focused on export product diversification. This is supported by the composition of the extensive margin released by the World Bank (2014a). Its definition of extensive margin is slightly different to that by Amurgo-Pacheco and Pierola (2008). For extensive margin, the World Bank (2014a) classified products as ‘old products’ if they had been exported to at least one country, and it classified markets as ‘old markets’ if at least one product had been exported to these markets.

Figure 4.4 The extensive margin, 1989–2013 Source: (The World Bank 2014c)

As shown in Figure 7, using the World Bank’s (2014a) definition of extensive

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15 Meanwhile, the product extensive margin during this period only supported 11.38% of the export growth, while the market extensive margin only contributed 2.86% of the export growth (see Figure 7).

The lower contribution of the market extensive margin is because, since 1997, Indonesia has already exported to almost all countries, leaving only a few countries that could serve as new target markets for Indonesian exports. However, since the CR5 for Indonesian exports is still large, the target of diversifying exports should be achieved not by adding new markets, but by strengthening Indonesia’s position in those markets to which it is not yet a main exporter.

Meanwhile, even though the product extensive margin made a higher contribution to export growth than the market extensive margin, it still focused on exporting new products to existing markets rather than to new markets, because of the dependency of Indonesia on its existing markets. The contribution of product extensive margin to export growth is influenced by the demands of Indonesia’s traditional trading partners:4 the United States, Thailand, Japan and Hong Kong. In 2013, Japan and the United States together account for almost 21% of Indonesia’s exports while Thailand and Hong Kong also have a considerable share of Indonesian exports, at more than 5% together (Statistics Indonesia 2014).

Indonesian Export Diversification and Economic Growth Stability

Regarding the efforts of Indonesia in diversifying its export base, the role of export diversification in maintaining the country’s economic growth stability is now assessed. This section analyses the contribution of export diversification to

Indonesia’s capacity to counter external shocks.

When the oil price shock affected Indonesia, the manufacturing sector replaced the oil sector as the main commodity-exporting sector. This shift was extended further by Indonesia’s greater focus on diversifying its exports. Pangestu (1992) suggested Indonesia focus more on the manufacturing sector than on the oil sector. During this period, the recovery of Indonesia’s economy depended on several factors. Indonesia responded to the oil shock by significantly reducing its fiscal imbalance and controlling ‘inflationary pressure’ (Ahmed & Chhibber 1992). Indonesia also responded through an exchange rate adjustment that eventually affected the tradable

sector. Indonesia’s real exchange rate depreciated by 55% from December 1981 to December 1988 (Ahmed & Chhibber 1992). Further, Ahmed and Chhibber (1992) revealed that the trade balance from non-oil commodities increased by more than 1% for every 1% depreciation in the real exchange rate. In addition, the Indonesian economy became more open to international trade as the government implemented trade liberalisation policies and focused more on industrialisation so that its economy could recover from the oil shock (Elias & Noone 2001). The low export diversification did not help during the crisis and the recovery process involving

4_{There is no certain definition of the term}‘_traditional’_{, but the partner countries that have a long trade}

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export growth was driven by an exchange rate adjustment that made Indonesian products cheaper. Therefore, since export diversification was not the driver of export growth during this crisis, it seems that export diversification had no effect on

stabilising Indonesia’s economic growth.

In 1997, the Asian financial crisis hit the Indonesian economy, affecting trade. During this crisis, there was high pressure to depreciate the Indonesian rupiah after the period of stability and move from a fixed to a floating exchange rate. In 1998, the Indonesian rupiah was floated and depreciated strongly, worsening the private sectors. Compounded by a period of political chaos in Indonesia, this crisis had a huge impact on the Indonesian economy. Recovery from this crisis began after a change in the political structure of Indonesia, and with the help of the International Monetary Fund (Indonesia-Investments n.d.). Economic growth started to steady, but the role of export diversification in this period is not clear. The value of exports showed negative growth, and in the period 1998–1999, the fall in the intensive margin of trade (old products to old markets) contributed more than 140% of negative export growth (The World Bank 2014c). The extensive margin slowed decline in export growth during this period, but it only offset certain parts of the decline in the intensive margin. This offset was mostly shown by the market extensive margin rather than the product extensive margin. The economic recovery and increased stability in Indonesia after the Asian financial crisis appears to be influenced by the extensive margin. However, since the effects of the extensive margin were not strong enough to offset the intensive margin, export diversification appears only had a small and weak impact on stabilising the Indonesian economy during this period.

During the Global Financial Crisis, since export diversification in Indonesia has not been fully successful, it did not contribute to stabilising export growth as much as was expected. From the period 2009 to 2013, Indonesian exports fluctuated. In 2010 and 2011, Indonesian export value increased to US$129 billion and US$162 billion, respectively. However, in 2012 and 2013, Indonesian export performance deteriorated, and the export value decreased to US$153 billion and US$149 billion, respectively (Ministry of Trade Republic of Indonesia 2014). Meanwhile, Indonesian economic growth in per capita terms from 2009 to 2012 remained stable, in the range of 4–5%. This positive economic performance can be attributed to the quick response of the Indonesian government using lessons learned from the previous crises, the stable spending of Indonesia’s citizens and the country’s healthy banking and

financial sectors (Tambunan 2010). Indonesia’s economic growth did not show a

decrease like that seen during the other two crises, but export growth did decline. Therefore, export diversification was not effective in stabilising economic growth and was not sufficiently strong to offset the shocks in the international market.

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17 Supporting Policies

From the discussion so far, it can be concluded that export diversification in Indonesia has not met its targets and does not yet fully support stable export growth. This section will review the trade policy implemented by Indonesia and identify future policy applicable for supporting export diversification.

Trade Agreement

Refer to Figure 3 above, up to now, the trade agreements signed by Indonesia support the intensive margin rather than the extensive margin. So far, all of the agreements have been made between Indonesia and its old market destinations for old export products. However, these agreements can be maximised to increase the product extensive margin by adjusting the agreements to add the possibility to export new products to these destinations. These agreements can be used to relax the product standards from the importing countries, to provide exporters the opportunity to increase their product quality to meet these standards.

To increase the market extensive margin, Indonesia should sign agreements with new countries to export existing products. As these markets will already have market leaders for these products, it will be difficult for Indonesia to compete. Using FTAs, Indonesia can come to arrangements that target niche markets in these new countries. The FTA between ASEAN, Australia and New Zealand can be an example for Indonesia when forming this kind of FTA. Under this agreement, Australia as a meat exporter is able to export not only beef but also game meat such as kangaroo and offal to ASEAN countries. Unlike beef, game meats are a niche product in this market (Department of Agriculture and Food 2010).

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important to promote higher export diversification, since trade facilitation eliminates the barrier for trade.

Due to the high cost of exporting to countries outside Asia, Indonesia’s trading partners are mostly located in Asia; only two of its 10 main partner countries are located in America and Europe. To reduce the cost of trade, Indonesia should focus on improving the efficiency of its port and customs services. According to the Organization for Economic Cooperation and Development (OECD; 2014), compared to other lower middle–income countries, in 2013, Indonesia performed well in terms of electronic procedures and the availability of information. This increases export costs for the exporter. Concerning electronic procedures, the export mechanism conducted in Indonesia’s ports is mostly manual, using written documents, unless the Electronic Data Interchange (EDI) is applied (Directorate General of Customs and Excise n.d.). In relation to information availability, Indonesia provides both exporters and importers with market information, including market data and market research. Indonesia also has local, global and virtual exhibitions for importers and exporters. This indicates that the facilities offered by the government are not being maximally utilised by exporters and importers.

When export procedures can be done electronically and there is easy access to information, the trade cost of exporting will be reduced. A lower cost will benefit small enterprises in Indonesia, enabling them to export new products and access new markets, in turn increasing the degree of diversification in Indonesia. This is supported by Dennis and Shepherd (2011), which found that every 10% decrease in export cost, international transport cost and market entry cost will increase export diversification by 3%, 4% and 1%, respectively.

Indonesia has further facilitated product and market diversification by establishing trade-promotion centres in several countries. This kind of trade facilitation benefits the export diversification strategy by identifying the potencies, challenges and obstacles for increasing exports to certain markets for all products. However, Indonesia’s trade-promotion centres seem inadequate for assisting the export diversification strategy, as they are concentrated in America and Europe. This contradicts the target to diversify exports to Africa and the Middle East. Trade-promotion centres have also not successfully boosted the share of exports to America and Europe. This indicates that the effectiveness of these centres should be evaluated. One possible step to consider is to maximise the utilisation of trade-promotion centres to do market research, since they can interact directly with importers and local government. This gives them greater access for promoting Indonesian products and more opportunities to select exhibitions in line with the prospective product in the countries in which they are placed.

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19 established by Indonesia, as the low cost they provide is needed in Indonesian ports and trading partners’ ports. Lower trade costs in importer countries will create more opportunities for Indonesian products to penetrate these markets.

5 CONCLUSION

As a lower middle–income country, Indonesia needs to stabilise its economic growth. However, external shocks can make export growth volatile and contribute to volatility in economic growth. Export diversification is believed to reduce this potential instability and thus maintain stable export growth.

Indonesia has experienced three external shocks since the 1980s: (a) the oil price shock, (b) the Asian Financial Crisis and (c) the Global Financial Crisis. During the first two of these crises, the Indonesian economy experienced a breakdown, as did export growth. However, even though previous studies have shown export diversification to have a positive effect on economic growth, Indonesia’s recovery from these first two crises seems not to have been affected by export diversification. During these periods, the effects of export diversification were not strong enough to stabilise economic growth in Indonesia. Further, the role of export diversification in stabilising economic growth after the Global Financial Crisis was weak; during this period, a deterioration in export growth was experienced, whereas economic growth remained relatively stable. It is also clear that export diversification targets have not been met in Indonesia. Up to 2013, Indonesia still had a high dependency on its main trading partners: China, Japan and the United States. In terms of products, Indonesian exports continue to concentrate on established rather than new products.

Since export diversification is not progressing as expected, support is needed from other policies. Indonesia has been becoming more liberal in trade and is now involved in several FTAs, both bilateral and multilateral. As these agreements are seen to have little impact on export diversification, in the future, Indonesia should consider the interests of export diversification when making agreements. Regarding Indonesia’s implementation of trade facilitation to reduce the trade cost, several aspects of this require improvement to give greater support for export diversification.

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BIOGRAPHY

Author was born in Jakarta on 9th February 1987 as a third child of Mrs. Hamdani Hamzah and Mr. Ambiar Lani. The author pursued her undergraduate study in Statistics, Bogor Agricultural University and graduated on 2009. In 2012, the author was accepted in a double degree program between Master of Science in Economics, Bogor Agricultural University, and Master of Applied Economics, The University of Adelaide, Australia, funded by the Ministry of Trade RI and the Australia Award Scholarships.