Indonesia's protectionist policy aimed at attracting investment is wrong, economists say

On December 3, the Indonesian Deputy Minister of Industry told reporters that the country is considering increasing the local content requirement for smartphone investments.

Plans come after government refused a 100 million dollars Apple's proposal to pave the way for iPhone 16 sales. Instead, the government is now asking Apple to invest 1 billion dollars in the production of mobile phone components in the country.

The content requirements, which apply to various industries ranging from solar panels to electric vehicles, aim to protect local industries and create a value-added supply chain in Indonesia.

Their potential acceleration comes at a time when Indonesia is competing with other developing Southeast Asian countries, such as Vietnam, to attract investment and supply chains diverted from China.

But even though the content policy has attracted commitments from some manufacturers in the past, economists say it remains flawed and ignores many of the deeper reasons why Indonesia has failed to attract technology supply chains.

“I call it pseudo-protectionism. It is less about protecting the domestic market from imported products and more about trying to scare away foreign direct investment into the country,” said Bhima Yudhistira Adhinegara, executive director of the Center for economic and legal studies (CELIOS). , an Indonesian think tank.

“They think that if they scare off big companies like Apple, they will invest more in Indonesia,” he added.

An Apple analyst previously told CNBC that Indonesia would be a promising growth opportunity for the Cupertino-based company if it was able to gain a foothold in the market.

Until recently, Apple had gained market favor by establishing “Apple Developer Academies” in the country, where students are trained in skills such as software development.

During a visit to Indonesia in April, Apple CEO Tim Cook announced that the company open a fourth academy in Bali.

However, the government is now more interested in Apple's supply chain and wants local facilities to be involved in the actual manufacturing of the products.

Those responsible also said that the value of investments previously offered by Apple is lower than that of its Indonesian sales, arguing that smartphone companies like China's Xiaomi and South Korea's Samsung have invested more.

On Indonesia's side of the negotiating table, it has the largest consumer base in Southeast Asia and the fourth largest population in the world.

Indonesia, however, remains a small overseas sales market for Apple, with few consumers wealthy enough to buy a cutting-edge iPhone, economists say. The company's market capitalization alone is greater than Indonesia's gross domestic product.

On this, Apple may be more interested in using Indonesia as a gateway to the regional market, said Arianto Patunru, board member of the Center for Indonesian Policy Studies and economist at the Australian National University .

He added that global technology supply chains such as Apple's involve a reduction in value added, so each country can only make a small contribution.

Indonesia's content policy requires 40% of smartphones and tablets to be manufactured locally.

Most economists who spoke to CNBC said they didn't think content policies would help attract companies like Apple and would instead have the opposite effect.

“Local content requirements have failed to attract FDI to Indonesia. Quite the contrary,” Patunru said, suggesting they have contributed to companies like Foxconn'sand TeslaThe withdrawal of projects in the country in recent years.

Instead, Indonesia's attempts to use “scare tactics” toward companies like Apple “could backfire,” according to CELIOS's Adhinegara.

“I think it's very bad for the investment climate in Indonesia and it creates uncertainty about regulation,” Adhinegara said, noting that regulations often seem to be applied on a case-by-case basis.

Yessi Vadila, trade specialist at the Economic Research Institute for ASEAN and East Asia, said local content requirements in Indonesia have always been linked to an increase in costs, a decrease in export competitiveness and productivity losses, while having little impact on growth or employment.

Other economists have noted that local content policies have had some superficial successes in the past, while arguing that they alone would not be enough to attract more investment from companies like Apple.

“I would say they have managed to build factories and facilities,” said Indonesian economist Krisna Gupta, noting that other smartphone makers, like Samsung, have it was necessary to invest in the market due to regulations.

In addition to its local content requirements, Indonesia has also implemented other protectionist policies, including tariffs, to attract more investment into the country. Last year, a new law banned TikTok's commercial application until the company invested through a local partner.

However, while Gupta said the strategy may see some success in the short to medium term, it will face long-term problems unless the government is also able to increase productivity and the business climate. in general.

“Indonesia will need to step up its game at all levels,” Gupta said, noting that businesses consider a range of factors, including law enforcement, trade policy stability and the labor market.

“They can't just say: we have a great market; you have to want to be here, so please invest more,” he added.

To attract more FDI, the country must prioritize building competitive infrastructure, developing human capital and providing investment incentives, according to Adhinegara of CELIOS.

Economists who spoke to CNBC highlighted Vietnam as a country that has managed to attract more technology investment even though it does not have as large a local consumer market as Indonesia.

Instead of strict local content requirements, Vietnam has managed to leverage investment incentives, consistent policies and strong infrastructure compared to its regional peers, they said.

The country has also managed to put in place a free trade agreement with Europe, while Indonesia is still trying to reach agreements on a case. Vietnam has also been a major beneficiary of China's shifting supply chains amid growing trade tensions between the United States and China.

According to Adhinegara, Indonesia may soon be presented with a great opportunity to attract a backdoor manufacturing industry, with the return of Donald Trump to the White House.

The president-elect has proposed a massive escalation of tariffs on China, which could spark a new trade war and upend Asian supply chains.

However, unless the Indonesian government understands why companies like Apple have chosen Vietnam over Vietnam in the past, they could miss out once again, Adhinegara said.

While Indonesia's foreign direct investment has increased over the years, its share of FDI in GDP has only declined over the past two decades, according to data of the World Bank.