Indonesia: Toiling over transition

Swinging a machete, Achmad Pailkol hacks a path through his three-hectare plantation in Indonesia’s Maluku province. The 67-year-old complains that his ageing clove trees are drying up and his children have no desire to take over the business, though the plot has been in the family for generations.

In the 17th century Mr Pailkol’s trade was a lucrative one that put Indonesia’s eastern islands at the centre of global trade. Mariners from England, Portugal and the Netherlands braved uncharted waters and tropical disease in search of the ‘spiceries’ — the only place in the world where cloves were found, alongside nutmeg and other medicinal spices. Today, the pungent black buds are abundant and farmers like Mr Pailkol sell their produce to the local “kretek”, or clove cigarette industry, at meagre prices.

“Back then you could compare the price of cloves to the price of gold — it’s like Heaven and Earth,” says Zeth Sahuburua, deputy governor of Maluku province, a post that was once prestigious and hazardous in equal measure, as foreign vessels rolled in proffering both trade and the threat of invasion.

Indonesia’s spice trade began to fade some 300 years ago, but the country has more recently looked to other resources, from raw minerals to coal and palm oil, to drive growth. With global prices falling, Southeast Asia’s largest economy is hearing echoes of the past in its overreliance on commodities.

“It’s not a challenge of just hanging on until commodity prices come back,” says Steven Tabor, country head for the Asian Development Bank, explaining that diversifying the economy is essential. “There you get some growth but you don’t necessarily get much in terms of jobs and government revenues and what we might call ‘shared prosperity’.”

The journey of Indonesia’s cloves — from poor agricultural workers to vast kretek factories and the millions of consumers addicted to the cheap cigarettes — highlights three areas central to the attempts to revive the economy: agriculture, manufacturing and consumption. Between 2001 and 2012 the economy almost doubled in size to $580bn as China’s rapid expansion fuelled commodity price rises. But with that boom over, global prices for key exports such as liquefied natural gas, rubber and palm oil have dropped to around 50 per cent of their 2011 highs, according to World Bank data, leaving the Indonesian economy reeling as its exports lose value.

In the last quarter, growth in gross domestic product came in at 5 per cent year on year, dragged down by a paltry 3 per cent expansion on the island of Sumatra and a near stagnant economy in Kalimantan, where mining activities and plantations are concentrated. While impressive by global standards it is well short of the 7 per cent-plus growth Indonesia was experiencing when investors saw it as one of the brightest stars among emerging markets.

Following decades of inertia when Jakarta invested little in infrastructure and education, the country remains dependent on commodity exports in what economists say is a classic case of the “resource curse”.

“Maybe the greatest damage done by the resource curse is simply the complacency that it generates among the policymaking community,” says Adam Schwarz, author of A Nation in Waiting: Indonesia’s Search for Stability. “It is freed, at least for a time, from the discipline to make the difficult reforms needed to keep the non-resource sector competitive.”

Commodity downturn

Joko Widodo, Indonesia’s president, took power in 2014 as the effects of the commodities crash were becoming difficult to ignore. He pledged to boost growth to 7 per cent by cutting wasteful fuel subsidies and redirecting spending to much neglected infrastructure.

Eighteen months into his five-year term, Mr Widodo reiterated in an interview with the Financial Times last week his commitment to make the economy “competitive and open”. But in a country with a fast-growing population of 250m, Jakarta is searching not for a single new engine of growth but a group of varied generators. The aim is to diversify the economy: doubling tourism, improving the use of its fertile agricultural land and boosting manufacturing.

If manufacturing is to drive growth in Indonesia, the vast factories of East Java represent the country’s future.

Outside an industrial compound in Surabaya the air is sweet with the savoury smell of cloves. Here, every day 3,000 workers roll, cut and package some 3.6m packs of kretek, which now use almost all Indonesia’s clove harvest. Though only 20 per cent of the 314bn cigarettes sold in Indonesia every year are handmade kretek, Sampoerna, Philip Morris’ local affiliate, still employs more than 60,000 people in this labour-intensive process.

“It’s very different, a machine-made [compared with] a hand-rolled kretek,” says Nur Hayati, 38, among the rows of female workers crouched over fiddly, basic tools in the sweltering workshop. “Here we make it with love so it’s going to be tastier.”

Hand-rolling is, however, a dying segment according to Paul Janelle, Sampoerna’s president director. It survives only because the government charges a higher excise duty on cigarettes produced in mechanised plants to keep these unskilled women in work.

Yet with half the population under 30 and 1.5m people potentially joining the workforce every year, the business is one example of the labour-intensive manufacturing Jakarta needs to cater for those entering the workforce.

“The fundamental challenge is to put the private sector, particularly the young private sector, in a position where with this labour force they can exploit whatever opportunities lie out there,” says Ben Bingham, country head for the International Monetary Fund.

Manufacturing change

When oil prices last dropped this dramatically in the 1980s, Indonesia was counted alongside Malaysia and Thailand as one of Asia’s so-called Tiger economies where rapid industrialisation was driving growth. From 1990 to 1996, Indonesia’s manufacturing sector excluding oil and gas expanded 12 per cent a year, contributing one-third of total growth. That figure had slowed to just over 5.6 per cent by 2014, as the focus shifted away from industry back to natural resources.

As countries across the region compete for the unskilled jobs China is shedding, Indonesia’s low wages could make it an attractive destination for investment. But economists mourn the low quality of education and low levels of productivity in the country. Gross production per worker employed in manufacturing in Malaysia, for example, is more than 2.6 times higher than in Indonesia, according to the World Bank.

To boost industrial development, the Widodo government must address the many complaints of local businessmen, among them employment laws requiring generous severance pay, which some say deters investors.

“People who have been working for a company for more than five years, their intention is not to work — it is to get fired,” says Peter Tjioe, a Surabaya-based businessman leading the local industry lobby. “That is the number-one enemy of industry.”

The government is well aware of the impact these regulations can have on investment. But with strong unions warning that those laid off from jobs in Indonesia’s crowded cities would plunge into poverty, few expect Mr Widodo to radically overhaul what are seen as politically sensitive labour laws.

An arguably greater hurdle for manufacturers is logistics. Following decades of under-investment, the ADB estimates Indonesia is facing a $700bn infrastructure deficit.

Jakarta’s Tanjung Priok, Indonesia’s largest port, for example, handles more than two-thirds of the country’s merchandise trade but has the capacity to handle only around 6m 20-foot containers a year, far short of the 10.5m at the rival Laem Chabang Port in Thailand and 30m in Singapore.

In his first year Mr Widodo, who began his career as a furniture exporter, was overwhelmed by political wrangling. It led to a string of confused and protectionist policies including import duty increases. But he has since launched a series of reform packages, including a new mechanism to calculate minimum wages and a pledge to cut port delays.

More importantly, perhaps, the president has kick-started infrastructure investment. Last year, he laid out plans to expand six oil refineries, install 35,000 megawatts of electricity capacity and build 24 seaports and 15 airports.

As Jakarta rolls out reforms, there are questions around the impact technology will have on the sort of old-fashioned manufacturing that drove China’s initial industrialisation and which employs millions.

In a small, air-conditioned room set apart from Sampoerna’s sweltering kretek factory a small group of women experiment with new, efficient devices that roll and pack more cigarettes per hour, requiring less manual labour.

“As we are experiencing a demographic bonus we still have a large labour force and they need jobs,” says Bambang Brodjonegoro, finance minister. “But we cannot just replicate what we have done in the 1990s because at that time labour intensive just meant labour intensive — we need to be smarter.”

Getting rich before ageing

By a filthy creek in central Jakarta a band of men gather around wooden benches at the street food stall, puffing unfiltered kretek, watching the cloves crackle quietly as they burn. Rather than being traded in distant European markets, it is in this noxious habit that most of Indonesia’s clove harvest now ends its journey.

“The economy is doing all right at the moment,” Muhmad, the stall’s owner, says through tobacco-stained teeth. “People are still buying the same number of cigarettes as before: nobody complains, though prices are rising.”

Alongside commodities exports, consumer spending — on everything from cigarettes to cars and washing machines — is the linchpin of the Indonesian economy, with an expanding middle-class of 150m people. Despite heavy lay-offs in the natural resources sector over the past year, this consumption still contributes more than 50 per cent of GDP.

To create longer-term growth, economists warn that Indonesia needs to restructure its economy but with major roadblocks to manufacturing, policymakers need to foster other industries, like tourism and agriculture.

The need is urgent. If Indonesia is to promote new industries it must act fast. The country’s working age population is expected to peak between 2025 and 2030, and economists say the country must take advantage of its demographic dividend before then.

In Singapore, Hong Kong and Japan, for example, income per capita topped $12,000 before the population began to age. Indonesia can only cross that bar by 2030 if it grows 9 per cent every year.

“No country becomes rich after it gets old,” warns Rodrigo Chaves, country director for the World Bank. “The rate at which you grow [with] a whole bunch of old people on your back is much lower than the rate of growth at which you can grow when people are active, are educated, are healthy.”

Some three-and-a-half centuries ago the Dutch shook hands on what is possibly the most misguided trade deal in history. Pursuing a monopoly in the spice trade, Amsterdam agreed to take one small island in eastern Maluku province from the British in return for another small island in the US — Manhattan.

Centuries after the spice trade evaporated Indonesia is still struggling to regain its position at the centre of the global economy. It may have just one more decade to act.

Letter in response to this article:

Indonesia’s ecosystems are owed a duty of care / From Edward Davey