Commentary | 07 September 2018

Australia should be encouraging Indonesian growth

Originally published in Australian Financial Review 

Originally published in Australian Financial Review 

Scott Morrison's recent trip to Indonesia has brought much needed attention to Australia's increasingly important northern neighbour. While the long awaited Indonesia Australia Closer Economic Partnership Agreement (IA-CEPA) will not transform the economic relationship overnight, it pulls in the right direction for both countries and contains some important measures.

For Australia, this is part of a broader strategy aimed at better capitalising on Asia's economic rise. It is also about building stronger partnerships in the region at a time when we are being increasingly squeezed between a more powerful China and a seemingly unreliable America.

By some projections, Indonesia could be the fifth largest economy in the world by 2030. That not only makes it an important growth market, but also an increasingly powerful regional and global player.

The relevance of IA-CEPA for Indonesia itself is more nuanced but potentially more important, including in ways Australia should care deeply about.

Like other emerging economies, Indonesia has been caught up in generalised capital outflows as investors react to trouble in Turkey and Argentina and as US interest rates rise. The Indonesian rupiah is now plumbing near 20-year lows against the US dollar while its equity and bond markets are also down.

Indonesia's economic fundamentals remain in good shape, so it will likely overcome these challenges with some but not excessive difficulty (barring a far more serious dislocation in global capital markets). The cost however – in particular the need to tighten monetary policy – will be to crimp economic growth, which has already been lacklustre for some time.

Like Australia, Indonesia has been adjusting to the end of the China-fuelled commodity boom. But while Australia's economic adjustment has been somewhat drawn out, Indonesia's has arguably stalled.

Indonesia's economy is now looking at its fifth consecutive year of growth stuck at about 5 per cent a year, down from over 6 per cent previously. Though this remains solid by international comparison, it is inadequate once rapid population growth is taken into consideration.

Most economists think Indonesia needs to grow at about 7 per cent a year to create enough good quality jobs for its growing working age population, which currently increases by more than 2 million people every year. On current trends, even by 2030 about half of Indonesian workers would still toil in informal jobs, with weak productivity, low pay, and little economic security.

That is hardly a recipe for social stability, nor for becoming a confident major player on the world stage. For Australia, that means our interests in Indonesia's future prosperity should extend well beyond tapping into its growing market or partnering with it in the international sphere – we need to help with Indonesia's own development.

Indeed, that is what China is doing through its substantial infrastructure investments, while also gaining greater influence in the process – with Indonesia continuing to seek more Chinese investment despite having experienced some difficulties (including domestic sensitivities) with this along the way.

One key reason Indonesia has struggled to grow faster is that its economy remains relatively closed in a number of critical ways. Import tariffs are reasonably low but it imposes extensive non-tariff barriers in the form of permit requirements, local content rules, and other administrative restrictions. Indonesia also has some of the most prohibitive rules among major economies when it comes to foreign investment and services – despite both being key to improving Indonesia's competitiveness.

IA-CEPA will include measures across these areas, so it is a step in the right direction. Opening up tertiary education could be particularly important and is a key way Australia can contribute to Indonesia's development, given our capabilities in this area.

Tertiary training institutions in Indonesia are generally weak. Not one Indonesian university, for instance, is even among the top 800 in the world – according to the Times Higher Education rankings. Bringing in high quality external service providers is an important way Indonesia can fast track plugging this gap – especially critical as rapidly advancing technology and rising automation make education the key to longer term prosperity.

Also welcome is the IA-CEPA's inclusion of capacity building to Indonesia to assist with implementing trade and investment related reforms. This kind of co-operation – usually funded as part of overseas aid (which has otherwise seen large budget cuts) – is an important element of building a stronger partnership with Indonesia and supporting its development in a mutually beneficial manner.

Finally, there is some hope that the IA-CEPA might prove to be a stepping stone towards Indonesia joining the Comprehensive and Progressive Agreement for Trans Pacific Partnership (CPTPP).

This would be politically difficult for the Indonesian leadership, but it would also reap important dividends. Signing up to the extensive requirements of CPTPP would deliver significant economic benefits, create a strong framework to anchor ongoing reform, and allow Indonesia to join Australia and others in providing international leadership at a time of rising protectionism.

For Australia, attracting Indonesia into the CPTPP is the critical next goal. As a signatory, Australia would benefit from enhanced market access. More importantly, bringing Indonesia into the CPTPP would significantly improve the deal's ability to attract other new members – an agenda that remains crucial to expanding its economic and strategic benefits to Australia.