IN THE JOURNAL | COVER STORY
Indonesia - connecting to the region and beyond
October-December 2013
By: Gita Wirjawan

In the coming days and weeks, Indonesia will host two pivotal international events with significant implications for world trade: the 21st Asia-Pacific Economic Cooperation (APEC) forum Leaders Meeting beginning October 7, and the Ninth World Trade Organization (WTO) Ministerial Conference beginning December 3. As world leaders and trade ministers converge on Bali, the site of both events, many are asking what these gatherings mean for Indonesia. How can Indonesia use its influence as host of both the APEC summit and the WTO conference to benefit itself and the region? How should Indonesia navigate the increasingly complex labyrinth of regional and global forums — APEC, the East Asia Summit (EAS), the G20, the WTO — not to mention negotiations for regional free trade agreements such as the Regional Comprehensive Economic Partnership (RCEP) and Trans-Pacific Partnership (TPP)?

Answering these questions requires an appreciation of Indonesia’s growing economic influence, as well as an understanding of the changing nature of international commerce. Indonesia’s selection as host of these two meetings reflects not only its size and economic strength, but also its growing importance as a regional leader. Indonesia is now the world’s 15th-largest economy, growing rapidly at more than 6 percent per year. It is the fourth-most populous country, behind only China, India and the United States. Indonesia’s vast wealth of resources and human capital confers natural advantages in the global economy. Yet Indonesia also faces significant challenges. One of them is to engage with international and regional fora to propel economic development that is both socially inclusive and environmentally sustainable.   

Some reflections: Asia

During the past 30 years, trade has become increasingly important within the world economy, outstripping growth in global output. Developing countries are responsible for most of this growth. In 1980, developing countries accounted for only 34 percent of global exports. Today, that figure is 47 percent. Moreover, developing countries are increasingly trading with each other. The so-called South-South trade rose from just 8 percent of the global total in 1990 to 24 percent in 2011, and continues to climb.

Asia is at the forefront of these trends. In 2011, Asia was responsible for more than 30 percent of world trade, up from 13 percent in 1960. Around 80 percent of trade among developing nations involves Asian countries. And not only is Asia a producer, it is an increasingly hungry consumer. During the next decade, Asia will become the world’s fastest-growing consumer market, driven by a growing middle class that will push up demand for more sophisticated goods and services.

The expansion of global trade relative to global GDP is due to two main factors. First, trade barriers have fallen. Second, these falling trade barriers, coupled with improvements in transportation and communications technology, have ushered in a new model of global manufacturing: global value chains. These refer to the fragmentation of production beyond traditional geographic boundaries. Instead of confining to a single country the various activities necessary to take a product from conception to end-use, businesses have become increasingly global in their operations. The processing of raw materials into final products may involve multiple steps in multiple countries. In these global or regional value chains, parts and components as well as the research and design of many products — from clothes to cars to mobile phones — are traded across numerous borders during conversion into final goods.

The allocation of different stages of production across different countries, based on cost advantages, maximizes economic efficiency. Countries can specialize in particular tasks in which they have a competitive advantage. These tasks range from sophisticated product design services and the development of new technologies, to relatively simple assembly of components into final products. Global value chains are transforming the way we think about trade. The simplistic, mercantilist view that “exports are good and imports are bad” no longer makes sense because exports depend more than ever on imports.

Nowadays, around 60 percent of world trade is in intermediate goods (goods that have not yet been converted into final form, such as parts or components) or embedded services (services essential to the manufacturing chain, such as research and design, distribution and after-sales). Around onethird of the total value of global exports is foreign value-added, more than twice the proportion in 1990. In small economies, it is 50 percent. Services, too, are much more important in manufacturing than previously thought. The share of the services value-add in gross exports of goods ranges from around 30 percent in China to 50 percent in the United States.

APEC 2013

Global value chains would not have become such a dominant model in global manufacturing without the reductions in trade barriers and advances in transportation and communications that have taken place during the past 20 years. The conclusion and implementation of the last round of multilateral trade negotiations — the Uruguay Round, which resulted in the creation of the WTO in 1994 — helped open up international trade flows. But other factors have also contributed. APEC, the pre-eminent economic forum in the Asia-Pacific, has been instrumental in changing the collective mindset about the importance of open trade and investment to economic development. In 1994, in the small city of Bogor, West Java province, APEC leaders agreed to the common goals of free and open trade and investment in the APEC region by 2010 for developed economies and 2020 for developing economies. These targets, known as the Bogor Goals, would promote the free flow of goods, services and capital among APEC economies, as well as with economies outside the region. This approach of “open regionalism” reflected a shared belief that reducing barriers to trade and investment, through a combination of collective and individual actions, was a key to realizing the region’s growth potential. APEC’s raison d’etre remains just as valid today as it did 20 years ago.

Unlike the WTO, APEC operates on the basis of voluntary participation. Decisions and commitments made in APEC are not legally binding. Rather, they are based on mutual trust and shared approach. Average applied tariffs (outside of free trade agreements) in the APEC region fell from around 17 percent in 1989 to 5.7 percent in 2011. While some of this is due to commitments made during the Uruguay Round, much can also be attributed to the “APEC effect.” APEC helped create an environment conducive for member economies to unilaterally liberalize trade and investment, confident in the knowledge that other economies in the region were undertaking similar actions. Instead of stressing mercantilist “gains versus costs” — considerations that predominate in free trade agreement negotiations — APEC emphasized the mutual gains of trade and investment liberalization and their positive impacts on economic development. It’s about benefits: to producers through importation of cheaper intermediate goods, consumers through lower prices and improved product choices, as well as the obvious benefits to exporters.

This year, APEC comes back to the country where the Bogor Goals were born nearly 20 years ago. APEC’s agenda of liberalization and facilitation has catapulted total trade in APEC from $3.1 trillion in 1989 to $16.8 trillion in 2010. Wages have increased significantly and so has employment and the standards of living of people in the region. However, some studies confirm that liberalization and facilitation alone are not sufficient to address income inequality and the development gap. There should be policy intervention to ensure that liberalization and narrowing the development gap go hand in hand toward sustainable growth.

It is under Indonesia’s chairmanship this year that APEC tries to address this issue by adopting the overarching theme of “Resilient Asia-Pacific, Engine of Global Growth.” It has three priorities: attaining the Bogor Goals, promoting sustainable growth with equity and enhancing connectivity. APEC should continue pursuing its Bogor Goals of free and open trade and investment, but due consideration should also be given to the realization of an APEC community that is equitable — something that is very much an integral element of the 1994 Bogor Declaration.

Indonesia and the WTO

The WTO is another area of particular focus for Indonesia, and the same view applies as with APEC: the need to address developmental issues. In view of the ongoing stalemate of the Doha Development Agenda negotiations since its commencement in 2001, Indonesia offered last year to host the Ninth WTO Ministerial Conference. Without doubt, the greatest challenge will be to deliver a modest but credible package of outcomes.

It is estimated that the successful conclusion of the Doha Round could boost world trade by around $360 billion. So why has Doha stalled? When the potential gains are so great, why have WTO members been unable to agree on reforms to further liberalize global trade? Part of the explanation is that the easy work has already been done. Tariffs on industrial goods have come down significantly as a result of the Uruguay Round, leaving much more sensitive sectors, most notably agriculture, behind thick protectionist walls. The outcomes of the Uruguay Round were unbalanced. With the benefit of hindsight, it has become clear that developing countries did not emerge from the Uruguay Round with gains commensurate with concessions. New domestic regulations adopted in areas such as services and intellectual property were not adequately offset by market access improvements in areas of interest to developing countries, such as textiles and agriculture. The Doha Round, in name at least, was intended to redress this lack of balance by improving opportunities for developing countries to participate in global trade.

Despite the rhetoric of a “development round,” developed countries have so far been unwilling to open their agricultural markets to exports from developing countries. In the United States, Europe and Japan, agricultural producers are powerful lobbyists accustomed to receiving massive state support and protection. The Organization for Economic Cooperation and Development (OECD) estimates that, on average, consumers in advanced industrialized countries spend 10 percent of their annual consumption on agricultural products in support of local farmers. In 2009, more than 40 percent of consumer expenditure on domestic commodities in countries such as Switzerland, Norway, Japan and South Korea went to support local farmers.

The problem is that this kind of support entrenches inefficiencies in agricultural production and distorts global markets for food products, affecting agricultural exporters in developing countries, such as Indonesia. Distortion of food markets also impacts global food security. One of the best responses to global food security pressures is to have open, well-functioning world markets for food products.

In response to the lack of action on agriculture, developing countries have been unwilling to make new commitments to open up services to developed country exporters under the Doha negotiations. Having learned from the experience of the Uruguay Round, developing countries have formed strong coalitions in Geneva to pursue their interests. Indonesia, for example, is a member of the G33 group of developing countries and the G20 group of developing country agricultural exporters, as well as the Cairns Group of agricultural trading countries (which also includes the developed nations of Australia, New Zealand and Canada). The emergence of groups such as the G33 and G20 has had a galvanizing effect. It is now much more difficult for large developed countries to browbeat smaller developing countries into making unwanted concessions.

Agriculture will be an important theme in the WTO conference in Bali; without a satisfactory outcome on agriculture, there will be no deal. While it is not feasible for the entire issue of multilateral agricultural liberalization to be resolved, a modest package of outcomes that addresses the interests of developing countries could act as a fillip for waning confidence in the Doha Round itself. Indonesia, as host and also chair of the G33, plays a lead role in efforts to bring more balance to the WTO Agreement on Agriculture, which is the multilateral agreement that sets the framework for agricultural trade.

At present, WTO rules for agricultural support are stacked in favor of developed countries. As a first step, the G33 has tabled a proposal to allow developing countries more policy space to implement programs to enhance food security and rural development. These are critical global issues the WTO cannot afford to ignore. An agreement to increase flexibility for developing countries to implement food security programs could generate the confidence necessary to resume the Doha Round talks in earnest.

It is important that Doha is concluded. The potential gains for the global economy offered by a successful resolution far outweigh those stemming from the current proliferation of bilateral free trade agreements. This is partially because WTO rules automatically apply to all members. In contrast, for businesses to obtain the benefits of free trade agreements they must meet specific rules and requirements that vary from one agreement to another. This regulatory burden explains why the utilization of the preferential access offered by trade pacts is often disappointingly low — especially for small and medium enterprises that lack the time and resources to navigate through the complex regulatory requirements of free trade agreements. Therefore, multilateral liberalization is the most effective way to avoid the problems posed by the increasingly complex, confusing and competing tangle of bilateral agreements — the so-called noodle bowl of Asian free trade agreements.

As well as potentially kick-starting agriculture negotiations under the Doha Round, the WTO conference offers another significant opportunity in the area of trade facilitation, which refers to the elimination or reduction of administrative obstacles to the movement of goods across borders. Examples include the simplification of customs procedures, implementation of “single window” systems for online processing of documents and cooperation on the application of technical standards. All these actions reduce the time, cost and uncertainty of moving goods across borders.

Targeting trade facilitation at the WTO conference makes sense. The realization of an agreement on trade facilitation would not only raise flagging business confidence in the WTO, but also reassure member countries that meaningful trade liberalizing agreements are still possible, despite the torpor that has characterized the Doha negotiations. Trade facilitation is an excellent area in which to pursue an agreement because, by and large, it does not involve reciprocal tradeoffs. Trade facilitation will benefit all member countries, developing and developed.

With the rise of global value chains and the corresponding increase in trade of intermediate goods used in manufacturing, the relative importance of trade facilitation, transportation and infrastructure as impediments to trade has increased. The speed, cost and reliability of transportation and customs clearance are critical factors for business. On average, every extra day required to ship goods reduces trade by 1 percent. For an average sea voyage of 20 days, each extra day at sea reduces trade between any two trading partners by nearly 5 percent. The OECD estimates that even a 1 percent reduction in the global cost of trading could boost the world economy by $40 billion, and twothirds of this benefit would flow to developing countries.

More than three-quarters of Indonesia’s exports comprise raw materials and intermediate inputs into global value chains. For Indonesia, as for all countries participating in global value chains, lowering trade transaction costs is crucial to attracting investment and making the country a production base for both the domestic market and exports. 

Enhancing connectivity

The increasingly widespread acceptance of the importance of trade facilitation mirrors a broader agenda: the need to boost regional connectivity. While a multilateral trade facilitation agreement in the WTO would deliver tremendous benefits in terms of increasing trade flows, other regional fo- SR10_2_rums and organizations can also play an important role in increasing connectivity.

APEC is doing very useful work in the area of trade facilitation and connectivity. APEC’s regional economic integration agenda is aimed at increasing the degree of connectivity among APEC members in trade in goods and services, investment capital, people and ideas. As mentioned earlier, under “Resilient Asia-Pacific, Engine of Global Growth,” Indonesia has established “connectivity” as a major priority for APEC 2013. In Bali, Indonesia will launch a multiyear work program on infrastructure development to improve the enabling environment for investment in trade-related infrastructure.

The aim is to advance public sector expertise in project prioritization and the management of public-private partnerships. Indonesia will also launch a new APEC Framework on Connectivity, which will provide a platform to enhance three aspects of connectivity: physical (supporting infrastructure investment), institutional (promoting structural reform, services liberalization and good regulatory practices) and people-to-people connectivity (boosting cross-border education and exchange of visits). Enhancing peopleto- people connectivity will help Indonesia harness its demographic advantages.

With more than half of its population less than 30 years old, Indonesia has vast potential resources in human capital. Education will be critical to transform this potential into a skilled workforce. Across the APEC region, trade and investment in education will help developing economies move up the value chain into higher value-added manufacturing and knowledge-intensive services sectors.

In addition to APEC, the East Asia Summit has an important role to play in boosting regional connectivity. First and foremost, the EAS can help avoid conflicts that would threaten regional trade through the disruption of critical sea lanes. Expansion of the EAS to include the United States and Russia in 2011 created a forum suited to cooperation on regional security. If tensions in the South China Sea or East China Sea were to escalate, momentum towards increasing connectivity in the region would decelerate; cooperation on regional economic integration would slow. Asia’s economic success has only been possible because of ongoing peace and political stability. Therefore, the EAS should serve as a forum for regional players to resolve disagreements through discussion, not conflict.

While the EAS does not have APEC’s track record in regard to economic cooperation, it nevertheless has significant potential for advancing regional integration. With membership stretching across Asia, from India to China, the US and Russia, the EAS’s support of the ASEAN connectivity agenda offers massive potential rewards. Cooperation on infrastructure finance, in both the EAS and APEC, can create an enabling environment for investment in infrastructure to link South and North Asia via ASEAN.

This is where Indonesia and ASEAN countries need to think strategically. The ASEAN region is ideally situated between two of the world’s largest developing country markets: China and India. Individually, many ASEAN countries, by nature of their size, may struggle to compete with these economic behemoths. But deeper regional economic integration will allow ASEAN members to tap into growth through participation in value chains stretching across Asia. Indonesia, as ASEAN’s largest member, can play a leadership role in ASEAN, APEC and the EAS to advance such integration. And this is only one of many reasons for Indonesia to look more into RCEP than TPP. 

TPP or RCEP?

Enhancing connectivity through “megaregional” free trade agreements is another area where Indonesia and ASEAN can profit. Dissatisfaction with the rate of progress in the Doha negotiations has prompted many countries to seek bilateral free trade agreements as a (less effective) mechanism for liberalizing trade. With 76 concluded agreements as of April 2013, Asian countries are at the forefront of free trade negotiations. But the bureaucratically complex trading environment that has resulted from bilateral FTA activity does not readily address the rise of value-chain manufacturing, which depends on multiple transactions across multiple borders.

In response, countries are turning towards “mega-regional” FTAs as a way to simplifying the trading environment, to tease apart the increasingly tangled noodle bowl of Asian bilateral agreements. Two mega-regional negotiations dominate the Asia-Pacific landscape: the Trans- Pacific Partnership and the Regional Comprehensive Economic Partnership. While it is convenient to categorize the TPP and RCEP as competing processes, in the longer term this is not strictly the case. Rather, the TPP and RCEP may be seen as complementary.

Both negotiations represent possible paths up the same mountain at the summit of which sits the Free Trade Area of the Asia-Pacific. This is APEC’s long-term vision: a free trade panacea promising seamless connectivity of goods, services, people and capital across the region. What, then, is in Indonesia’s best interests? Should Indonesia join the TPP in addition to RCEP, as some other ASEAN members have chosen (Malaysia, Vietnam, Singapore and Brunei)? Or should it limit its involvement to RCEP, at least in the foreseeable future?

To answer these questions, Indonesia’s participation in RCEP and the TPP needs to be considered from both a pragmatic and geostrategic perspective. From a pragmatic viewpoint, Indonesia believes it is in its best interest to continue observing rather than joining the TPP negotiations at this stage. In the TPP, the most emphasis in the negotiations is on next-generation trade issues — agreement on legally binding disciplines that go beyond the traditional framework of conventional free trade agreements. Such disciplines include areas of economic policy previously considered the responsibility of national policymakers and regulators, such as competition policy, environment, labor standards, regulatory disciplines and other “behind the border” regulations.

In addition, the TPP negotiations place a strong emphasis on issues of most interest to developed countries, such as intellectual property and government procurement. On the other hand, at least from the Indonesian perspective, there has been little or no progress on issues of particular interest to developing countries, such as market access for textiles and agriculture. And despite or perhaps because of the presence of some of the world’s biggest subsidizers of agriculture — the US, Canada and Japan — the TPP will not tackle the vexing problem of market-distorting agricultural subsidies.

While next-generation trade issues will become increasingly important as Indonesia develops, they are not an immediate focus. As a developing country, Indonesia needs to retain the flexibility to implement structural reforms behind the border at a pace appropriate to its needs, rather than at a pace dictated by an external legal agreement. At present, the TPP’s level of ambition is too high and too heavily weighted towards the most advanced economies’ trade issues. In contrast, the RCEP, while tackling many of the same issues as the TPP (trade in goods and services, investment, economic and technical cooperation, intellectual property, competition and dispute settlement), is more balanced towards the needs of developing country members.

Moreover, the RCEP’s built-in flexibility, enabling special and differential treatment  ASEAN members, will allow each partner to consider its own needs. But while this flexibility is important, it will be critically important that members do not appeal to it as a means to avoid engaging on more sensitive issues. The more genuinely integrating that RCEP is, and the more it can disentangle the effects of bilateral free trade agreements, the more effective it will be in enhancing regional connectivity. In fact, efforts by RCEP’s participating countries to work toward a single schedule of commitments that applies to all should be seen as a distinct feature not to be found in the TPP, but that will significantly address the issue of noodle bowl effects.

Rules of Origins (ROO) will be a critical area of the RCEP negotiations. In the five existing ASEAN+1 free trade agreements and the 23 bilateral FTAs involving ASEAN members, the Rules of Origin (which determine a product’s country of origin and its eligibility for preferential treatment) vary massively. For example, only about 30 percent of tariff lines across the ASEAN+1 FTAs share common ROOs. The sheer number and variability in regional ROOs makes the task of harmonizing them more difficult. But it is only through consolidating ROOs that the bureaucratic burden to business posed by the noodle bowl of regional FTAs can be overcome.

Geostrategically, the TPP and the RCEP differ, not only in the composition of the negotiating group but also in their geographic architecture. The TPP does not as yet include China and India, and is dominated by wealthy countries, such as the United States, Canada, Japan, Australia and New Zealand. It is centered around the US at the “hub,” with Latin American and Asian members at the “spokes,” a configuration maintained by America’s insistence to negotiate market access for goods bilaterally. While a hub-and-spoke configuration may simplify the regional trade landscape for US exporters, it will do comparatively little for trade among members at the spokes.

In contrast, the RCEP is centered around ASEAN+1 trade agreements with members comprising Australia, China, India, Japan, South Korea and New Zealand, as well as the ASEAN countries. For Indonesia and ASEAN, the RCEP is much more attractive than the TPP from a purely architectural perspective. While the TPP is essentially a vehicle for the US hub-and-spoke model of regional engagement, the RCEP places ASEAN at the region’s core.

Moreover, while RCEP does not include the US, it contains Japan, South Korea and three of the largest developing countries in the world: China, India and Indonesia. Conservative estimates suggest that implementation of the RCEP would be worth between $260 billion and $644 billion to the world economy. The RCEP also offers more potential in terms of economic growth and growth in trade. Book-ended by China and India, ASEAN can utilize its geographic position at the center of the region to profit from growth in the North and in the South. For years now, ASEAN itself has been the thirdlargest source of foreign direct investment for ASEAN after the European Union and Japan, and the largest source of origin of visitors to ASEAN countries.

Nevertheless, it will be important that RCEP emerges as a high-quality agreement. Liberalization of trade in goods, including agriculture, will be important; but the RCEP could also have an impact in the area of trade in services. The development of vibrant, open and competitive services markets is critically important for Indonesia, enabling it to move up the value chain into higher-skilled, higher-margin industries. Modern economies depend on services as drivers of economic activity, growth and job creation.

Services such as transportation and logistics, telecommunications and financial services create the basic economic infrastructure while education, health and social services increase the availability and quality of labor. Professional services, meanwhile, provide the specialized expertise required to increase productivity and competitiveness. In high-income countries, services account for around three-quarters of economic output. In Indonesia, the figure is only 40 percent. Nevertheless, services and services-related sectors are the fastest growing segment of the Indonesian economy.

In the WTO, services liberalization has stalled along with other aspects of the Doha Round. Developing countries have been unwilling to open up sensitive services sectors because rich countries, most notably the US and Europe, have been unwilling to free up trade and subsidies in agriculture. In response, a group of 28 primarily rich countries have taken the decision to negotiate a plurilateral agreement on services, known as the Trade in Services Agreement (TiSA). Their hope is that by negotiating their own agreement, developing countries will feel the pressure to “come on board” or miss out.

But the RCEP, if it emerges with highquality commitments on services, could provide a counterpoint to TiSA. By and large, the membership of the TiSA does not include developing Asia. It does not include any of the developing countries in the connectivity corridor from India to China. And yet this is where the growth potential for services lies. Outside of Pakistan and a few Latin American participants, membership in the TiSA is dominated by wealthy countries with comparatively mature services markets that are already open to one another. Services liberalization in the RCEP region, however, offers far greater returns provided that RCEP partners can successfully reconcile ambition with flexibility. 

Conclusion

The international trading system is at a critical juncture. In the wake of the global financial collapse and European sovereign debt crisis, global trade has sunk to historic lows and there are worrisome signs of rising protectionism in many parts of the world. Widespread disaffection with multilateral trade negotiations has prompted many countries to pursue alternative avenues to trade liberalization, including through bilateral and mega-regional free trade agreements. Indonesia, too, has adopted this pragmatic approach.

Commensurate with its emerging economic posture, Indonesia is aspiring to play a bigger role on both the regional and global scenes, and take part in redefining the future maps of global trade. APEC this year provides an avenue for Indonesia to get the message across: liberalization works but is not sufficient to address development gaps. Similarly, at the multilateral level, the message projected by hosting the WTO conference is clear: the multilateral trading system should work for all, especially developing countries.

In addition to APEC and the WTO, Indonesia will look to continue its leadership role in ASEAN, the EAS and the RCEP negotiations, to advance regional economic integration and promote inclusive, sustainable and resilient growth. These three fora perfectly fit Indonesia’s approach toward regional economic integration, which should center on ASEAN and build upon existing agreements. It should be underlined, however, that the success of all the above steps is contingent upon the recovery of the global economy sooner rather than later.

Efforts to re-energize APEC, work toward the ASEAN Economic Community by 2015, and better utilize the existing ASEAN+1 FTAs while negotiating an RCEP agreement, may provide some easing valves for Indonesia and countries in the region to minimize the impacts of the global economic slowdown. Nonetheless, as no economy operates in a vacuum, faster recovery in the euro zone and stronger economic growth in the US are imperatives for success. After all, everyone is dependent upon each other an increasingly connected world.

 

Gita Wirjawan is the trade minister of Indonesia.

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