Lessons learned from foreign investment in Indonesia from the colonial-era until the reformation era.
Indonesia is known as one of the countries with a strong economy in Southeast Asia. As the fourth most populous country in the world, Indonesia has the largest market in Southeast Asia that supports the growth of business opportunities in Indonesia. Through 2018, Indonesia attracted more than USD 20 billion in foreign direct investment. There are even a lot of foreign investors trying to expand their businesses to this country.
Foreign investment is not a new thing in Indonesia. It has contributed a lot to the development of business investment and the economy of Indonesia. The history of investment development is inseparable from the discussion about the wave or periodization of investment, namely the period of colonialism and post-independence. The colonialism period began in the 17th and 18th centuries. Through the policy of the Dutch East Indies, the government allowed the entry of foreign capital from Europe to invest in the mining sector.
In 1870, the Dutch colonial government enacted the Agrarian Law whereby the government opened opportunities for the entry of foreign capital in the plantation sector. Meanwhile, other business fields such as mining, trade, and so on were still controlled and run by the Dutch government. Private investment increased rapidly in the 1910s and 1920s, far ahead of government investment. The ratio between total capital stock and gross domestic product (GDP) climbed from one-third in 1913 to four-fifths in 1930.
Relative changes in foreign investment, GDP and export revenue, 1910-1940
Firms owned and managed by residents of Chinese descent also often sought the legal status offered by incorporation under Dutch law; many of them are therefore also included. Foreign investment of apparent non-Dutch origin was strongly dominated by British-owned firms and other non-Dutch investors, including Belgian, American, and Japanese companies. However, Dutch investors did possess a comparative advantage above rivals from other countries because of their familiarity with language, regulations, and institutions. Foreign investment has contributed to several developments in Indonesia, including an increase in agriculture production, and the authority to act for workers to earn income.
Investment in post-independence
After independence, in 1953 the government drafted a Foreign Investment Law that was designed for various minimum requirements while encouraging foreign investment in particular business fields. Foreign investment remained important in newly independent Indonesia under Soekarno, although little fresh investment entered the country with the oil industry forming the sole exception to the rule. After the nationalization was carried out, the average growth rate of Indonesia’s GDP in the 1957-1966 era only stopped at 1.8%. In fact, in the era of 1949-1957, GDP growth reached 5.5%. This shows that the nationalization policy of foreign companies in 1957 during the New Order era precluded economic growth in Indonesia.
Gross Domestic Product by Industrial at Constant 2000, Structure, 1986-2005
Foreign Investment gave a positive effect on the “New Regime” of Soeharto, which showed from the growth of GDP on average per year of between 7% and 8% made Indonesia one of the countries in ASEAN with high growth. With this high growth rate, the average national income per capita in Indonesia has increased rapidly every year, which in 1993 had already passed the 800 marks in US dollars. Foreign investment also plays a very important role in the development of non-oil and gas exports, particularly manufactured goods. In the early 1980s, the manufacturing industry contributed 20% of total non-oil and gas exports, but before the 1997 crisis, its share had risen to 70%.
Foreign Investment Patterns in Indonesia
The era of industrialization in Indonesia began in 1970, several years after the economic liberalization was implemented. Soeharto, in his regime, launched the Five Year Development Plan (Repelita) project which was welcomed by the increase in economic growth in Indonesia. This high dependence on foreign investment has made Indonesia only focus on the market seeking orientation. When compared with other motives such as the supply of production factors, efficiency, or control of strategic assets seeking oriented, the market seeking motive is quite weak. This motive makes investors interested in investing their capital only because of the market potential, which is trending at a certain time and does not consider other potentials in Indonesia.
Foreign investment is expected to be export-oriented and in line with the potential trend of developing global value chains. However, the orientation towards GDP and exports is still considered insufficient to develop foreign investment patterns in Indonesia. This motive is felt to be similar to the main motive of the Netherlands to invest its company in Indonesia, namely to meet the needs of the Netherlands only and not to widen its focus to the global arena. As a result, the protection of industrial infantry is less because many factors are ignored to achieve optimal GDP from a nominal point of view.
The Economic Impact
The scope of impact was determined by both business strategies in the individual enterprise and colonial economic policy vis-à-vis foreign capital. The most decisive determinant was the profitability of foreign investment and the extent to which profits were transmitted overseas. The high profitability of producing for the world market attracted foreign capital, whereas more investment enhanced the capacity of export production. In the Dutch Colonial era, although FDI has played an essential role in the Indonesian economic development, FDI did not guarantee to make Indonesia prosperous. FDI was treated as a medium to exploit Indonesian natural resources.
Thus, there was a vacuum of new foreign direct investment inflows. Under the “Old Order” regime, the government paid little attention to economic development. The government was grappling with the transition from colonialism to independence. Since the “New Order” regime, the government saw a sharp change in economic policy, with introducing a multi-year economic plan (Repelita) to maintain economic development. The economic policy became much more market-oriented. FDI was seen to bring capital, technological innovations, and skills needed for Indonesian development. Now in the “Reformation” era, the government has continued to attract foreign investment.
Investing in Indonesia: Lesson Learned
What is history trying to tell us? How can foreign companies prepare themselves to get the challenge and learn from the past to invest in Indonesia? In our view, there are five points to be paid attention to:
The government induced unpredictability. The biggest issue though are the sudden regulatory changes. There are 6,300 active government regulations, which half contradict each other. With the regional autonomy regulations, this can all make for a daunting interpretation of the rules. For instance, the rules from the 1950s to 1968 changed drastically when it comes to the regulations for foreign companies.
It is important to stay abreast of the trends by joining the industry association and being friendly with the regulators so that your business can anticipate the changes. Or simply build up reserves to cushion for unpredictability.
Seeing Indonesia as a moving picture. This was implemented in the colonial period where Dutch investors did possess a comparative advantage above rivals from other countries because of their familiarity with language, regulations, and institutions. This can be beneficial for long term investment to see Indonesia not only from one point of view. Understanding the business culture in Indonesia seems to be very important.
For example, the majority of Indonesian are Muslim, and the culture has been affected by Islam for a long time. Making an equity investment isn’t easy. In many ways, Islamic finance or shariah finance is very similar to equity finance. It is a profit-sharing, or dividends model.
Human resource scarcity. To optimize the flow of FDI into the country, the human resource aspect is very crucial to be addressed. Labor costs depend on productivity as well as on wage rates. Productivity is highly dependent on the educational level of the workforce and several papers find education and skills of the workforce to be important in multinational firms‘ location decisions. Scarcity of talent is especially irksome in the Tech industries of e-commerce, banking, and telecommunications.
These three sectors absorb so many tech graduates and professionals that small companies struggle to recruit and retain. On the other hand, countries with low-quality human resources can only fill the bottom line of existing jobs. Various other strategic positions are filled by more competent foreign nationals. Companies often recruit from expensive Singapore or Malaysia instead.
Infrastructure. Indonesia is an archipelago with 17,000 or so islands that span more than 5,000 km (around 3,200 miles), 6,000 of them inhabited. Startups in the field of logistics have been mushrooming. At shorter distances, the ride-hailing companies are capitalizing on their logistic services. All of this is badly needed since logistics costs time and money. The proper infrastructure will help to improve the productivity and quality of the products. In this way, there will be more infrastructure to contribute to providing a huge income for the country. So analyzing the costs and time well before investing is important.
Investing in a local business. The growth in the Indonesian startup ecosystem as well as the increase in wealthy millennial and entrepreneurial Indonesians that have been educated abroad, now makes it easier to find like-minded co-investors in young high growth businesses. Additionally, more foreign investors are more open to investing in Indonesia, if there is a local lead investor that can lead them through the myriad of regulations and cultural particularities. It is highly recommended to become acquainted with cultural values beforehand in order to know how to socialize with Indonesian business partners and Indonesian employees as well as to grasp Indonesia’s business culture. This will make the business more efficient and effective, especially in the long term.
Indonesia is a wonderful country with a long journey in the past in terms of the economic sector. From the colonial period until now, foreign investment contributed positively to Indonesia’s GDP, export revenues, and employment. We can also see that Indonesia has been experiencing a great deal of rising inflation along with its economic growth yet the economy shows growth and monetary stability. Indonesia’s market capitalization is significantly smaller than the Southeast Asia region economies, which has room to grow.
However, entering Indonesia is not as easy as in many of the more developed markets. The entry barriers will keep the competition relatively low. Just as with the economic impacts, it appears that a great deal more could have been done with the available resources than what occurred. Finally, Indonesia has strong economic growth and favorable demographics make it a great country for investors.
Investing with BRIGHT Indonesia
Indonesia’s interesting background in foreign investment has occurred since the colonial era. Understanding the pattern of Indonesia’s history can be beneficial to enter Indonesia’s market.
BRIGHT Indonesia provides several services such as Market Insight Research, Management and Strategy Consulting, Business Registration and Establishment, and Foreign Direct Investment Promotion (FDI). To help the growth of your company we can provide services such as providing a list of potentially suitable partners, developing corporate or business strategies, and linking your company both from the private sectors in global FDI.
With exceptional local market expertise and networks in Southeast Asia, BRIGHT Indonesia will offer excellent services designed specifically to achieve your company’s goal. For more information, email email@example.com.