Editions : October-December 2013

JOURNAL | INDONESIA 360 By: the American Chamber of Commerce in Indonesia , the US Chamber of Commerce in Washington

The long story of American foreign direct investment in Indonesia began back in 1924, when geologists from Standard Oil of California (now Chevron), were trekking through the jungles of Sumatra Island. Those early explorers, trudging through the hills and forests of modern day Riau province, found the Duri field, one of the biggest oil finds in Indonesia, and began a lasting and positive relationship between US companies and Indonesia.

Today, nearly 100 years later, leading American brands are a familiar sight in the archipelago, big-ticket extractive industry players helped to build the oil and gas and mining industries over several decades, and US manufacturing firms see even greater promise in Indonesia. These are lasting relationships that are poised for significant growth and mutual benefit, but they are sometimes misunderstood and the full extent of US foreign direct investment (FDI) is not well known.

In an effort to grasp the full depth and benefits of US FDI to Indonesia, the American Chamber of Commerce in Indonesia and the US Chamber of Commerce commissioned a comprehensive analysis of the full impact of American FDI on the Indonesian economy — the first study of its kind. The research was carried out by Gadjah Mada University, Paramadina University and Ernst & Young. The study, released on October 3, went beyond existing data to include in-depth interviews with the companies themselves.

We spoke with senior executives from 35 firms with direct investments in Indonesia, including in manufacturing, mining, oil and gas, retail and many other sectors. We asked both for qualitative inputs and quantitative data. We sought insights on the current investment climate, corporate social responsibility activities, challenges that American companies face in Indonesia and issues going forward. We also received hard numbers on both existing and planned investments.

On the basis of those interviews alone, we concluded — conservatively — that from 2004 to 2012, American direct investment in Indonesia totaled $65 billion, including capital expenditures and M&A transactions, making the US potentially the largest investor in the country during that period. This contrasts sharply with most published data that suggests the US is only the fourthlargest investor in the country. We note that more narrowly defined official figures from Bank Indonesia show US FDI for the period at only $7 billion.

The study found that in 2012, more than 95 percent of total US foreign investment in Indonesia was focused on extractive industries (oil and gas and mining) and manufacturing. While the study shows that extractive industries are the largest FDI sector for US companies, the manufacturing sector is increasing in prominence. The compound annual growth rate for the extractive sector between 2004 and 2012 was 11 percent, while for manufacturing it was 21 percent. With extractive investment limited by finite quantities of natural resources, there is greater potential growth for manufacturing, assuming that income and consumption continues to grow. The study also shows that US investment is concentrated in the populous islands of Java and Bali and resource-rich Eastern Indonesia.

Our interviews found that in the next three to five years, US companies plan $61 billion worth of investments in Indonesia, an amount that will be critical in helping the government achieve its growth and investment targets. In terms of contributions to government revenues, the US companies in our study paid on average $74.2 million in corporate income tax in 2012, for a total of approximately $2.6 billion. Taking into account capital expenditures and M&A activities in a variety of sectors, the study also found that US FDI has a tremendous multiplier effect on the Indonesian economy with positive impacts on government revenue, domestic consumption, direct and indirect employment, the creation of new domestic companies throughout supply chains and infrastructure development. In rural areas, for example, American companies have built roads, schools and basic infrastructure that have enhanced community development, leading to local business growth and a more educated workforce.

Broadly put, the multiplier impacts of US FDI in Indonesia are:

• National GDP: $1.44 for every dollar invested

• Employment: 242 jobs (person years) per million dollars invested.

When these impacts are multiplied across the economy over the period of the study, US FDI has contributed:

• $94.1 billion in GDP.

• 1.74 million people employed each year in various sectors.

In the upstream oil and gas sector alone, major US companies contributed an estimated $17 billion to Indonesian national revenues in 2012, 47 percent of the total non-tax state revenue. In the mining sector, US companies employ approximately 35,000 people in their operations in Eastern Indonesia. According to an outside study, one of the largest American companies in Eastern Indonesia contributed up to 96.9 percent to regional GDP in its operations area and 2.2 percent to national GDP between 2006 and 2011. That company also increased national household income by up to 1.3 percent during the period and regional household income by up to 95.3 percent.

In compiling these figures, we combined publicly available data of US FDI inflow with the actual investment done by the companies we interviewed, which represent only about 10 percent of US companies active in the country. It is fair to conclude, therefore, that the investments we can document represent only a fraction of the total. In other words, our findings show that US companies are investing more and doing more than is widely known, with plans already made to invest a further $61 billion in the next five years, an amount nearly equal to investments made in the past nine years, assuming there is a conducive regulatory environment.

Well-positioned Indonesia

Having weathered the 2008 Global Economic Crisis relatively unscathed, Indonesia has relied on its large domestic market, young workforce and strong natural resource base to keep growth rates well above 5 percent while much of the West has been stagnant or in recession. With a per capita GDP that has grown beyond $3,000, the accepted mark for middle-income status, and a population of about 240 million people, the study found that US companies are largely motivated to invest in Indonesia because of its growth potential and natural resource base.

As the largest economy among the 10-member Association of Southeast Asian Nations (ASEAN), Indonesia has become a leading investment destination at a time when the region itself has caught the eyes of investors because of its 600 million people, growing prosperity, and relative political and social stability. In the study’s first chapter, “Indonesia: Riding on Global and Regional FDI Trends,” we note that Southeast Asia received more foreign direct investment in 2012 than either India or China. In 2012, ASEAN received around 26 percent of total foreign direct investment in Asia, making it the largest recipient. Indonesia received 18 percent of the investment directed to ASEAN last year, a total of $19.8 billion.

Chapter 2,”Impact of US FDI on Indonesian Economy,” discusses where the investment is going, what it contributes and why US investors are keen to put more FDI into Indonesia. The research concluded that US companies are attracted to the growth potential of the Indonesian market, accord-ing to 30 percent of respondents, while 14 percent of respondents cite the relatively low cost of labor as a main driver of investment decisions. Finally, Chapter 3, “Challenges in the Indonesian Business and Investment Climate,” looks at the policy considerations, infrastructure issues and human capital challenges that play a role in US companies’ investment decisions.

Broad impact

The impact of US foreign direct investment goes far beyond simple dollar figures. It creates jobs and builds a skilled workforce, grows markets, enhances social responsibility, instills best corporate practices, transfers technology, and forges partnerships between international companies and the Indonesian people. The study found that American companies in Indonesia directly employ approximately 183,000 people, at salaries that are very competitive; the average monthly wage paid per employee by companies in the study is Rp 4.4 million ($396), which is higher than the legal minimum wage anywhere in Indonesia.

While the popular perception often seems to be that US companies prefer to hire expatriates at a steep premium over locals, this is a misconception. Comparative employment data for the 2007-2012 period from the 35 participating US companies shows a trend strongly in favor of domestic employment, with the number of local employees nearly doubling during that period. At the same time, the number of expatriates employed by these companies in 2012 was only one-fourth what it was in 2007 despite the growth in investment in Indonesia.

Moreover, US companies invest in their workers: the companies in the study had an average employee training budget in 2012 of $2.1 million, an increase of 150 percent between 2007 and 2012. Interviews show that the companies encourage an average of 40 learning hours annually for every employee.

Socially involved

American engagement with Indonesian communities is no less significant. Companies in the study spent an average of $5.8 million in 2012 on corporate social responsibility programs, an increase of 95 percent between 2007 and 2011. There are numerous approaches to corporate social responsibility, of course, ranging from community development projects to competitions such as those hosted by Hewlett-Packard to promote improvements in education, creativity and entrepreneurship. Colliers has a program in which disabled people work in the company for six months, and then the company assists them in finding suitable jobs. Others emphasize the environment. Agricultural company Cargill, for example, has a partnership with Fauna & Flora International and the World Wildlife Fund to support the protection of endangered species and conserve high-value forest.

Many US companies provide assistance through nongovernmental organizations that are active in nutrition, education and environmental awareness. Mondelez International (formerly Kraft Foods) works with Helen Keller International to combat blindness among children. Freeport and General Electric are major supporters of Prestasi Junior Indonesia, or Junior Achievement, which encourages entrepreneurship among young people. HM Sampoerna, a unit of Philip Morris International, is deeply involved in education and support for small business. The list of social programs is long and aimed at improving the quality of life of Indonesians.

In other community aspects, the American companies in our study spent an average of $1 million in 2012 on waste treatment, an increase of more than 200 percent since 2007. For its environmental efforts, Chevron received a Gold PROPER rank from the Indonesian Ministry of the Environment, which is given to less than 1 percent of all registered companies. Other US companies received Green and Blue PROPER ranks. The ethical business practices that US companies emphasize have intangible but very real effects on corporate governance in Indonesia, which supports and reinforces the Indonesian government’s efforts to combat corruption. American companies promote responsible business conduct by complying with the Foreign Corrupt Practices Act, a 1977 law passed by the US Congress that makes it unlawful for any American company to participate in acts of corruption including bribing foreign officials. US companies also seek to remain in compliance with the even tougher United Kingdom Bribery Act, which is considered one of the strictest regulations worldwide with respect to bribery.

Training and knowledge transfer

American companies invest in their workforces. Many US companies provide mentorship, training and other learning experiences. Our respondents noted that some companies allow tuition assistance for university education as well as management and language development courses. Most major US companies integrate senior employees into their global workforces, giving them the opportunity to work overseas.

Examples of this commitment can be found in on-the-job training, job rotation policies and internship programs. An American company in the financial services sector described a longstanding partnership with a local university to provide internships and mentoring as a way of identifying potential skilled employees to be hired upon graduation. For several years the program has helped produce knowledgeable, professional and productive graduates. Another very successful program is Citibank’s Management Associate Program, many of whose graduates now hold significant positions in business and government including many familiar names in the corporate sector.

Beyond training and human resource development, US firms facilitate transfer of knowledge and technology, which has had a positive impact on productivity. US companies positively affect the productivity level of Indonesian companies within the same industry by extending best global industry practices into the domestic sphere, spreading technology within the value chain and transferring knowledge via labor mobility from American to domestic companies.

Plans and policy considerations

With an additional $61 billion of planned investments on the horizon during the next three to five years, US companies are eager to significantly boost their involvement in Indonesia. But the study found serious issues that need to be addressed. Our respondents discussed the challenges and specific policy considerations in three main categories: regulatory uncertainty, infrastructure and human capital, which are summarized below:

Regulatory environment.

There is a lack of regulatory coherence with abrupt changes in regulations, a lack of regulatory clarity and frequent gaps in implementation and enforcement of regulations. In addition, respondents cited continuing concerns about decentralization leading to inconsistent regulations. Policy considerations:

• Simplify investment procedures. The average number of procedures involved in setting up a business in Indonesia is 15.3, higher than Singapore at 8.3, Malaysia at 10.5 and Thailand at 11.5. Reducing the number of procedures will improve Indonesia’s investment competitiveness.

• Involve civil society and the business community in the policy-making process. Involving key stakeholders who are impacted by policy will facilitate support and ensure practical and timely compliance.

• Implement evidence-based policy. This will provide improved confidence, based on empirical evidence, that a given policy will achieve its intended objective.

• Use investment-related parameters as performance indicators for government institutions. Establishing key investment-related performance indicators across government ministries will ensure improved cooperation, coordination and implementation of policy decisions.

• Strengthen the roles of the Indonesian Ministry of Home Affairs and provincial governments. By strengthening the role of these stakeholders, which play a critical role in the adoption and implementation of policy, conflicts in policy implementation will be reduced.

• Establish a “dashboard” at the central government level. Conflicting regulations and uneven implementation of policy create investor uncertainty. A centralized dashboard coordinated by the vice president or coordinating minister for the economy, would serve to monitor coherence of investment regulation and its implementation.

Infrastructure. Indonesia is seen as less competitive than its Southeast Asian neighbors in terms of logistics and infrastructure. Hard infrastructure such as ports, roads and railways are still underdeveloped, and there are concerns about insufficient government spending on infrastructure. Policy considerations:

• Increase government spending. During the Soeharto era, the government allocated more than 30 percent of its budget to national infrastructure development. Recently, however, this figure dropped to approximately 10 percent and nearly 10 percent of what was allocated was not spent. Increased spending will promote economic competitiveness.

• Improve implementation of the Land Acquisition Law (Law 22/2012) and Presidential Regulation 71/2012. They provide a clear framework for land acquisition for public projects. However, the lack of decisive implementation makes the law ineffective.

• Promote public-private partnerships (PPPs). The government has established several institutions to provide guarantees and funding support for PPPs. However, limited capital, authority and regulatory flexibility have undermined their effectiveness.

Human capital. There continues to be a shortage of skilled educated workers, leading to a mismatch between supply and demand for workers with specific skills. Significant effort is required to improve the quality and productivity of the Indonesian workforce, and the limited number of academic institutions and qualified teachers are seen as holding back the national education system. Policy considerations:

• Improve access. Indonesia has done very well in terms of primary education, but high schools, vocational schools and universities lag behind. Two strategies should be considered: (1) providing more scholarships for students who cannot afford education, and (2) using online technology to reach remote areas.

• Improve quality. Facilities, teachers/lecturers, teacher salaries, teaching materials and delivery of services all need improvement.

• Provide resources for engineering and science. Provide incentives in the form of scholarships, research grants and facilities to fill human resource needs in engineering and the sciences.

• Link education to business needs. Harmonize workforce supply and industry demand by developing a system that incorporates basic on-the-job training into educational materials such as internships.

The way forward

There is a consensus among our respondents and many others that Indonesia’s economy holds enormous potential. The study found that the greatest factor driving foreign investment in Southeast Asia’s largest economy is the continued growth of GDP, largely as a result of the country’s huge domestic consumption, which in turn is spurred to further growth by continuous investment.

American FDI has long been a very important, if somewhat under-recognized, contributor to the Indonesian economy on many levels, from driving growth to building vital infrastructure, transferring technology and instilling corporate best practices in a range of industries. Given plans to significantly increase investment in Indonesia, the companies participating in this study seek to deepen their partnerships with Indonesia.

However, growth in US investment cannot be taken for granted. Our respondents were clear in wanting to see consistent policies, a long-term commitment to infrastructure development and steady improvement in education.  

 

This essay was adapted from a comprehensive study commissioned by the American Chamber of Commerce in Indonesia and the US Chamber of Commerce in Washington.

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