Global Business Guide Indonesia

Sign up for the GBG Indonesia Quarterly Business Intelligence Report for the latest news on your sector.
Sign Up
Business Updates | Indonesia and the ASEAN Economic Community – Ready for Regional Integration?

Having first declared its support for the establishment of the ASEAN Economic Community (AEC) in 2007, Indonesia now faces the significant hurdle of realising the extensive regional integration that it mandates before 1st January 2016. In progressing beyond requirements for the elimination of tariffs detailed in the ASEAN Free Trade Area (AFTA), the AEC aims to establish a single market and production base among ASEAN member states by necessitating the free flow of goods, services, investment, capital and skilled labour.

The scale and scope of reform that will be needed to actualise these ambitious plans calls into question Indonesia’s readiness to open itself up to neighbouring markets. Though the country cannot be accused of ignoring its regional integration obligations – evidenced in the fact that 279 measures (or 79%) of the AEC blueprint have already been fulfilled – several major challenges are as of yet unaddressed. As explained by Mr Iwan Azis as head of the Office of Regional Economic Integration at the Asian Development Bank in a Bloomberg report, following through on the remaining elements will prove more difficult, given that the next phase of ASEAN integration will need to involve its most contentious sticking points, such as product standardisation and industry specialisation by country.

Given that the single market created by the AEC stands to rival the world’s largest economies with a GDP in excess of $2.4 trillion USD, Indonesia’s strategy in approaching these final hurdles should be of immediate interest to companies and investors operating in the archipelago nation. Success in turning the AEC into a reality opens the door to an unprecedented level of intra-ASEAN business activity and trade, which, to date, has been largely untapped.

Trade to trend upwards

Trade data from the ASEAN suggests cause for optimism in projecting the potential impact of the AEC on business opportunities. By and large, intra-ASEAN trade has yet to reach heights commensurate with rhetoric extolling the importance of economic interdependence among member nations. In 2014, trade between ASEAN countries accounted for only 24.1% of total trade, a figure dwarfed by intra-EU trade as a proportion of total trade at more than 60% as well as by intra-NAFTA at 48%.

Per a Bloomberg Brief on the topic of ASEAN integration, Indonesia, specifically, stands as one of the biggest culprits in this regard in that its exports within ASEAN accounted for only 12% of the region’s total.

Source: ASEAN Statistics

Though damning in the sense that it reveals the extent of Indonesia’s failure to diversify its export markets, the state of Indonesian exports to ASEAN members holds promise in that it shows that there is room to grow. Local businesses have yet to take full advantage of opportunities to expand their presence in neighbouring markets, and should find that the AEC will further facilitate their entry. Despite its current low level, intra-ASEAN trade has been rising at a rate faster than extra-ASEAN trade since the initial implementation of AFTA in 1993, and it is expected that this trend will continue when the AEC is formally launched and brings with it the ASEAN Single Window to expedite customs procedures.

Integration at an impasse?

The magnitude of a boost to trade among ASEAN members depends upon the extent to which a number of lingering concerns are properly addressed. First and foremost, there remains a lack of certainty pertaining to the harmonisation of product standards that has businesses in the region unsure as to whether their goods can be marketed across ASEAN without being subject to costly quality tests in each country. While initiatives to lower this technical barrier have been initiated by the ASEAN Consultative Committee on Standards and Quality (ACCSQ) through the drafting of Mutual Recognition Agreements, anecdotal evidence on the ground hints at a still less than transparent system. As an example detailed in an Ernst & Young report, Malaysian exporters have found that air conditioners and refrigerators produced in Malaysia are still subject to Singapore’s prescribed minimum energy standards and thereby have to be sent to approved testing laboratories, which comes at a cost to both expenses and efficiency. To be sure, all member countries will need to accelerate their efforts to introduce harmonised standards for goods and services beyond priority products such as electronics (See Electronics and Home Appliances Manufacturing in Indonesia; Finding its Edge) and pharmaceuticals (See Overview of Indonesia’s Pharmaceutical Sector). Whether the governments involved have the political will and motivation to take such steps is another question entirely.

Hesitation on the part of ASEAN governments to approve a uniform set of standards across a full range of goods and services can likely be attributed to a desire to protect their respective industries of speciality. Herein lays another impediment to the maximisation of the AEC’s potential, namely, competing interests.

In becoming an effective single market, the ASEAN through the AEC requires each member state to hone in on existing areas of economic strength as a means of ensuring greater efficiency. In practice, however, this emphasis on specialisation is liable to falling flat in circumstances where multiple countries have the same priority industries and are therefore less willing to cede to one another. The automotive industry, as an example, has been zeroed in on by both Indonesia and Thailand, and may therefore see slower progress in lowering technical barriers between ASEAN states as well as in developing a streamlined ASEAN production chain (See Indonesia’s Automotive Industry).

Patterns gleaned from trade data amongst ASEAN members certainly belies the notion that specialisation is alive and well in the region as it moves towards integration. In 2014, the composition of intra-ASEAN exports closely mirrored that of extra-ASEAN exports (in which mineral fuels, machinery and vehicles stood among the most traded goods), suggesting that there is not yet a unique strategy specifically tailored to meet regional needs or geared towards setting up the ASEAN as a single production base.

A regional talent gap

Further complications related to the AEC exist in the fact that ASEAN member nations have entered unchartered territory with the provision of improved mobility for skilled labour and underpinning this obstacle is unequal education levels and skills proficiency amongst the 10 member countries. Despite rampant efforts to improve the quality of national education, Indonesia ranked 69th in maths and science out of 76 countries surveyed by the OECD in 2015, further illustrating the education divide between member-states; Singapore ranked 1st, while Thailand and Malaysia finished in 47th and 52nd, respectively.

Allowing for the movement of skilled labour, while positive in its short-term impact on the productivity of local businesses, has the potential to worsen Indonesia’s already lackadaisical pace in creating a better-educated labour market (See Higher Education: Indonesian Academia Must Open Up). The country is not alone in this regard, and steps would need to be taken to ensure that ASEAN members with lesser-developed labour forces do not fall into a cycle of relying upon skilled employees from Singapore, for example, while lacking the urgency to build upon local capabilities. 

Early initiatives to produce an adept ASEAN-wide workforce include the creation of Mutual Recognition Arrangements that establish mutual licensing and certifications in eight high-skilled professions: engineering, nursing, architecture, medicine, dentistry, accounting, tourism, and for surveyors. The MRA is also set to include a Qualification Framework – harmonising regulatory arrangements between countries – to better attend to the skills divide between each nation-state. This therefore does not constitute a free movement of labour; rather it provides greater leniency in manpower mobility. With the deadline fast approaching, the ASEAN has yet to make headway with regards to the feasibility of an ASEAN-wide work visa and existing MRAs still require workers to abide by domestic laws related to employment.

Other disparities to despair over

In taking stock of Indonesia’s readiness to face the AEC, it is necessary to accept that the quality of its human capital relative to other ASEAN nations is not the only potential impediment to the regional competitiveness of its businesses. Foremost among the country’s potential areas of vulnerability are its well-documented infrastructural inefficiencies impinging upon its internal connectivity as well as its links to neighbouring markets. Set against its territory as a massive archipelago, Indonesia provides easy air travel but stands far below par in terms of maritime and land transportation.

Taking a look at its vibrant aviation sector, Indonesia leads ASEAN’s skies by a substantial margin with more than 703,000 flight departures within its territory in 2014 compared to Malaysia as the second busiest with 438,000 takeoffs (See Indonesia’s Aviation & Airports Sector). The number of air travelers further reflects this as 94.5 million passengers were transported by plane in the same year compared to Malaysia with 47.5 million or Singapore with 32.8 million. Within the context of the proposed ASEAN Open Sky initiative, competition between carriers from different ASEAN states itself is not expected to impact the sector greatly in the short and medium-term as the fifth freedom rights is yet to be fully implemented; this right allows an airline to fly between two foreign countries on a flight originating or ending in one's own country. Restrictions will include a cap on slots given to airlines, and a caveat limiting flights to between capital cities only.

Moreover, Garuda Indonesia as Indonesia’s national carrier has performed well in establishing itself among the world’s best airlines. Garuda has indeed gone from strength to strength in recent years by ranking first in the Best Cabin Staff category at the World Airlines Awards while attaining a top ten place in no less than 13 other categories. This state-owned company has also just joined the SkyTeam Alliance, a network of 20 global airlines which combined covers 1,057 destinations throughout the globe. Meanwhile, Indonesia’s Soekarno-Hatta International Airport has been identified by OAG, an air travel intelligence provider, as Asia’s largest mega-hub for air traffic with Djuanda Airport in the city of Surabaya also ranked 9th to confirm Indonesia’s strategic position in the global aviation network. Indeed, Indonesia is in a highly advantageous position to serve transit flights/stops between Asia, Oceania, Europe and the US while simultaneously providing a wealth of tourism and business destinations itself.

The questionable state of Indonesia’s maritime and land transportation infrastructure, on the other hand, is best evidenced by a rail line which as of September 2015 covered only 4,069 kilometers of active track (PT KAI data). Thailand – a country one fourth the size of Indonesia by land area – by comparison has already successfully developed 5,327 kilometers of rail track. Years of neglect and the failure to foresee the strategic advantage of such infrastructure have also led to the rail tracks being built mostly in western Indonesia, particularly on the islands of Sumatra and Java, thus exacerbating the infrastructure woes of the swathes of underserved cities and high potential regions in the central and eastern part of the country (See The Missing Link: Investment Opportunities in Indonesian Railways). A similar case impedes Indonesia’s regional competitiveness when looking at its maritime sector with the development of its infrastructure only being stepped up recently (See Indonesia's Maritime Ambitions Require Massive Upgrade of Seaports). To provide further perspective, container traffic in Indonesia in 2013 only amounted to 10.7 million TEUs compared to Malaysia at 21.4 million TEUs or Singapore at 33.5 million TEUs.

The struggle with severe infrastructure underdevelopment between regions is further hampered by poor roads even in the country’s industrial hubs and occasional bottlenecks at inter-island ports caused by overcapacity. As a result, the World Bank’s 2014 Logistics Performance Index saw Indonesia come in fifth among ASEAN nations as it trailed behind Singapore, Malaysia, Vietnam and Thailand. Overall, Indonesia placed 53rd among 160 countries. An accelerated approach is therefore needed to address issues regarding the quality of infrastructure and logistics services, ease of arranging competitively priced shipments, better facilities for tracking and tracing consignments, and the guarantee of on-time delivery of shipments. At 24% of its GDP (World Bank), Indonesia’s logistics costs are significantly higher compared to most other Southeast Asian countries (See Indonesia’s Logistics Sector; Making Connections).

With the implementation of the ASEAN Economic Community only months away, Indonesia must develop an integrated national logistics network for the long-term. As a means of comparison, mainland Southeast Asia currently already offers several logistics corridors that support the establishment of manufacturing bases. For example, the Greater Mekong Subregion serves as a key logistics hub for Thailand with about 98% of its road network having been paved and 13 highways connecting the country with its neighbours. There is also the corridor that connects Vietnam’s port city of Danang in the east coast of mainland Southeast Asia to Myanmar's Mawlamyine Port in the west coast which facilitates multi-modal transportation of goods and faster access though the land mass; in Thailand, 800 kilometers of this road is a four-lane highway. Moreover, Singapore and Malaysia have gone to new heights in pursuing connectivity improvements between the two countries. Talks between the nations have entered advanced stages on both the construction of a new bridge aimed at replacing the old Johor-Singapore Causeway, and a high-speed rail project between Kuala Lumpur and Singapore.

A long way to go towards a worthwhile objective

As has been detailed at length in the preceding sections, several roadblocks remain in Indonesia’s path towards regional integration. For the country to make the most of the opportunities afforded by the AEC, it will need to make significant strides in addressing longstanding issues related to infrastructure development and education as well as take upon an active role in providing solutions to potential points of conflict between ASEAN member states such as product standardisation – a responsibility that it should embrace as the region’s economic powerhouse. The fact that this process will be difficult should not detract, however, from the immense potential of the AEC to Indonesian businesses, particularly with regards to improving upon low trade volumes to other ASEAN nations.

All told, in taking full advantage of this potential, it is vital that Indonesia views the implementation of the AEC on 1st January 2016 as the beginning and not the end of its journey towards regional integration. As has been repeated at length by the ASEAN through its press materials, the building of the AEC should be thought of as a process, not an event, and will therefore only pick up in intensity going forward. The signing of a new roadmap by the ten heads of state during the 27th ASEAN Summit held in Kuala Lumpur from 18th-22nd November 2015 provides the formal platform from which to double down on the elimination of non-tariff barriers to trade, among other impediments to a single market and production base. It would behove Indonesia to actively follow through on plans laid out in this document (which provides an overview of the ASEAN’s integration strategy for 2016-2025), if it hopes to reap the benefits of greater regional openness and access to neighbouring markets unimpaired by the last vestiges of protectionist policy at the country level.

Global Business Guide Indonesia - 23rd November 2015

icone share

Indonesia Snapshot

Capital: Jakarta
Population: 259 million (2016)
Currency: Indonesian Rupiah
Nominal GDP: $936 billion USD (IMF, 2016)
GDP Per Capita: $3,620 USD at Current Prices (IMF, 2016)
GDP Growth: 5.0% (2016)
External Debt: 36.80% of GDP (BI, Q2 2016)
Ease of Doing Business: 91/190 (WB, 2017)
Corruption Index: 90/176 (TI, 2016)