00074918.2011.556055
Bulletin of Indonesian Economic Studies
ISSN: 0007-4918 (Print) 1472-7234 (Online) Journal homepage: http://www.tandfonline.com/loi/cbie20
Foreign direct investment and growth in East Asia:
lessons for Indonesia
Robert E. Lipsey & Fredrik Sjöholm
To cite this article: Robert E. Lipsey & Fredrik Sjöholm (2011) Foreign direct investment and
growth in East Asia: lessons for Indonesia, Bulletin of Indonesian Economic Studies, 47:1, 35-63
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Bulletin of Indonesian Economic Studies, Vol. 47, No. 1, 2011: 35–63
‘Indonesia in Comparative Perspective’ Series
FOREIGN DIRECT INVESTMENT AND GROWTH
IN EAST ASIA: LESSONS FOR INDONESIA
Robert E. Lipsey*
National Bureau of Economic Research
and City University of New York
Fredrik Sjöholm*
Research Institute of Industrial Economics,
Stockholm, and Örebro University
Foreign direct investment (FDI) has been important in the growth and global integration of developing economies. Both Northeast and Southeast Asia, especially
the latter, have been part of this development, with increasing inlows of FDI and
greater foreign participation in local economies. However, Indonesia has been an
outlier within the region. Inlows of FDI have been lower to Indonesia than to other
countries, especially in manufacturing, and they have been lower than could be
expected from Indonesia’s size, population and other country characteristics. We
show that the inlows that have occurred have beneited Indonesia, and use the East
Asian experience to identify measures that are likely to increase these lows. A relatively poor business environment, ineficient government institutions, low levels of
education and poor infrastructure all seem to be important explanations for the low
inlows of FDI to Indonesia.
INTRODUCTION
Foreign direct investment (FDI) has been a key aspect of increased globalisation
in recent decades. Growth in FDI has been higher than growth in international
trade. Multinational irms have come to account for about 10% of world output
and 30% of world exports, and these irms develop and control a large share of
new technologies (Jungnickel 2002).
FDI has played, and continues to play, a large role in Asian development. China
is one of the world’s largest recipients of FDI and Japan is a major source. Some
countries in the region, such as Singapore, have based much of their development strategy on reliance on foreign multinational enterprises (MNEs). Finally,
East Asia is a prime home to the vertically integrated cross-country production
networks of MNEs, in which different afiliates of a irm produce different parts
and components, and others import and assemble them.
FDI often requires the coordination of complicated operations over long distances. Input goods and services need to be shipped internationally between
* We are grateful for comments and suggestions by Chris Manning and two anonymous
referees. Jing Sun and Takuya Hasebe have provided excellent research assistance. Fredrik
Sjöholm gratefully acknowledges inancial support from the Torsten and Ragnar Söderberg Foundation.
ISSN 0007-4918 print/ISSN 1472-7234 online/11/010035-29
DOI: 10.1080/00074918.2011.556055
© 2011 Indonesia Project ANU
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36
Robert E. Lipsey and Fredrik Sjöholm
branches of the MNE, and coordination and supervision require visits by staff and
a steady low of information. It is clear that the complexity of operations across
national borders places large demands on the host country economic environment. Countries differ in their ability to attract and handle FDI, which depends
on characteristics such as infrastructure, trade regimes, labour force skills and
institutional quality.
It should therefore come as no surprise that inlows of FDI differ substantially
among countries in East Asia. FDI lows to Indonesia have been relatively modest, and lower than would be expected from the country’s size. This paper seeks
to explain the low inlows of FDI by relating Indonesia’s experience to that of
other countries in the region. East Asia’s heterogeneity provides an opportunity
to identify and evaluate the determinants of FDI. What factors are typically most
important in explaining FDI inlows into East Asia?
The paper offers an overview of FDI in East Asia (Northeast and Southeast
Asia) and discusses its main determinants.1 We analyse FDI inlows to Indonesia
by comparing actual inlows with those that could be predicted from Indonesia’s
country characteristics. A literature survey identiies the main effects of FDI on
the Indonesian economy. The evidence from the studies surveyed leads us to conclude that Indonesia would beneit from higher FDI inlows. We use our analysis
of the determinants of FDI in East Asia to suggest policy strategies that are likely
to increase inlows of FDI to Indonesia. The paper ends with some conclusions
about the main obstacles to more rapid economic growth in Indonesia, and especially to growth fuelled by inward FDI.
While the aggregate FDI data analysed in the irst part of the paper cover all
industries, our analyses of the effects of FDI focus on manufacturing, for several
reasons. First, manufacturing FDI in Indonesia and elsewhere has been studied
more intensively than FDI in other industries. Second, data on manufacturing are
much stronger than data on the service industries. Third, while studies of FDI in
mining, including petroleum, are relatively numerous, Indonesia is an outlier in
East Asia in terms of the importance of mining, and few comparisons can be made
with other countries in the region for this industry.
FDI IN THE GROWTH OF DEVELOPING EAST ASIA
The three main regions of the developing world, Asia (other than Japan), Latin
America and Africa, have fared very differently since the middle of the 20th
century. As late as four decades ago, Latin America had the highest per capita
income, there was a good deal of optimism about Africa, and Asia was far behind
Latin America. By the early 2000s, Northeast Asian countries had largely caught
up with Latin America, and Southeast Asian countries were not far behind –
indeed, some of the latter had even outstripped Latin America. Incomes in both
1 Much of the analysis in the paper compares Indonesia with selected countries in Northeast Asia (China, Hong Kong, South Korea and Taiwan) and Southeast Asia (Malaysia,
the Philippines, Singapore, Thailand and Vietnam), but regional aggregates, such as those
in igure 1 and tables 1 through 4, are deined as in the data sources shown, to include all
countries in the region for which data are available.
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Foreign direct investment and growth in East Asia: lessons for Indonesia
37
FIGURE 1 Inlows of FDI to Developing East Asia
($ billion, logarithmic scale)
1,000
100
Developing East Asia
10
Developing East Asia excluding China
1
0.1
1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009
Source: 1970–2008: United Nations Conference on Trade and Development (UNCTAD) interactive database, Division on Investment and Enterprise, ; 2009: UNCTAD (2010).
Northeast and Southeast Asian countries far surpassed those in Africa by this
time.2
Most studies ind FDI to have been a source of the rapid growth in East Asia.3
That has been the case for most of the countries in the region, although less so and
later for the Republic of Korea (hereafter ‘South Korea’) and Taiwan; they initially
followed the Japanese model of placing restrictions on foreign-controlled irms, and
only after 1990 began catching up with the rest of the region in receptiveness to FDI.
Inlows of FDI to East Asia have been rising since the 1970s, with interruptions. They accelerated after the opening of China around 1990 (igure 1). The rise
in inlows was set back briely in the mid-1970s, again in the mid-1980s and by
the 1997–98 Asian inancial crisis, and then once more in the early 2000s by the
troubles of the information technology industry, a major beneiciary of FDI capital
inlow. The inancial crisis that began in 2008 has left its mark: inlows declined in
2009, but remained close to their highest levels to that point.
A crude measure of the role of inward FDI is the ratio of the inward stock of
FDI to GDP, shown for selected East Asian countries in table 1. East Asia became
a major destination for lows of FDI well before other developing regions did. The
gross inward stock of FDI in 1980, for example, was about 42% of GDP in Northeast Asia and 9% in Southeast Asia; it was 10% in Africa but only 5% in Latin
America. By 1995, Southeast Asia had surpassed Northeast Asia, and the ratios of
2 For data on per capita incomes, see Heston, Summers and Aten (2009) and the other
Penn World Tables at .
3 See, for example, among many, the country studies in Ito and Krueger (2000); Urata, Chia
and Kimura (2006); and Zhang (2001).
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38
Robert E. Lipsey and Fredrik Sjöholm
TABLE 1 Stock of Inward FDI as a Percentage of GDPa
1980
1985
1990
1995
2000
2005
2009
616.8
616.3
45.7
39.1
59.1
20.3
3.0
2.8
5.7
1.7
5.7
0.4
515.6
509.1
60.0
54.0
30.3
22.8
5.1
6.0
6.0
1.8
4.6
2.0
262.3
246.8
82.6
61.4
25.5
22.6
9.7
10.2
7.0
1.9
5.9
5.1
157.8
103.1
78.2
36.5
34.5
31.2
10.5
13.7
9.3
1.8
5.8
13.4
269.3
39.7
119.3
58.0
66.1
56.2
24.4
23.9
15.2
7.1
6.1
16.2
294.3
29.2
160.9
60.5
58.8
32.2
34.3
15.2
14.4
12.4
12.1
11.8
432.0
37.0
200.7
76.2
57.1
39.0
36.2
14.5
13.5
13.3
13.1
10.1
Northeast Asiae
Gross
Netc
41.6
41.6
38.6
38.1
25.6
24.3
20.7
16.1
31.8
14.4
25.6
12.9
25.5
11.9
Southeast Asiae
Gross
Netc
9.4
9.0
12.5
12.1
18.1
15.9
22.5
17.3
44.5
35.0
44.7
31.3
46.3
32.0
Africa
Latin Americaf
9.6
5.0
10.2
8.7
12.1
9.1
16.9
10.1
25.9
20.9
27.7
26.6
35.8
30.1
Hong Kongb (gross)
Hong Kongb (net)c
Singapore (gross)
Singapore (net)c
Vietnamd
Malaysia
Thailand
Philippines
Indonesia
South Korea
Taiwan
China
a GDP is as used in UNCTAD calculations (see source).
b 1980–95 data are estimated by UNCTAD from 1998 stock and earlier low data.
c ‘Net’ ratios are based on the difference between inward FDI stock and outward FDI stock.
d 1980–2000 stock is estimated by UNCTAD by cumulating inlows from 1970.
e See footnote 1.
f Latin America: Central America and South America.
Source: UNCTAD, UNCTADstat online database, .
inward FDI stock to GDP were 23% in Southeast Asia, 21% in Northeast Asia, 17%
in Africa and 10% in Latin America.
China is a major contributor to the growth of FDI in the East Asian region.
It has been the developing world’s largest recipient of FDI in the last decade
(UNCTAD 2009: appendix table B-2). However, the growth in FDI to China
started from a negligible base. Despite the large lows, China’s stock of inward
FDI relative to its size (as measured by GDP) is still not very high by East Asian
standards.
The highest ratios were those for the two entrepôts, Hong Kong and Singapore. In both cases, much of the FDI that entered these economies ended up in
other countries, presumably inancing productive assets located elsewhere in the
Asian region. We therefore show for these two locations not only total inward FDI
stocks, as for the other countries, but also net inward FDI stocks – total or gross
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Foreign direct investment and growth in East Asia: lessons for Indonesia
39
TABLE 2 FDI Inlow as a Share of Gross Capital Formation
(period averages)a
Singapore
Vietnamb
Thailand
Malaysia
Philippines
Taiwan
Indonesia
China
Hong Konge
South Korea
Northeast Asiaf
Southeast Asiaf
1980–84
1985–89
1990–94
1995–99
2000–04
2005–09
18.9
–
2.7
12.6
2.0
1.2
0.9
0.8
13.7
0.4
29.2
0.2
4.6
9.9
7.2
3.5
1.7
2.3
22.8
1.2
27.9
34.4
4.3
20.0
7.9
2.2
3.9
9.4
15.4
0.6
39.0
26.0
8.9
16.2
8.6
2.5
5.7
11.8
2.7
2.6
62.7
11.2
13.9
11.6
7.3
3.8
–2.4
8.6
1.9
3.4
63.7c
16.5
14.5c
13.6d
11.1
6.1
6.1
5.5
5.3c
2.0c
1.8
5.3
3.5
7.2
5.9
10.3
7.7
15.3
6.9
15.5
5.2
16.2
a The period-sum of FDI inlow as a percentage of the period-sum of gross capital formation.
b For Vietnam, 1980–84 data are not available, and data in the 1985–89 column are for 1986–89.
c 2005–08.
d 2005–07 and 2009. Data for 2008 are not reported.
e Up to 1996, Hong Kong’s inlows are as reported by UNCTAD. For 1997 on, when most were matched
by outlows, presumably to China, Hong Kong’s inlows are measured as inlow minus outlow.
f See footnote 1. Countries other than those listed above were dropped from the aggregation if the
data on their FDI inlows or gross capital formation were not available. The effect on the aggregate
ratios was small.
Sources: UNCTAD, UNCTADstat online database: ; World Bank, World dataBank online, ; National Statistics, Republic of China (Taiwan), .
inward stocks minus outward stocks – which might come closer to representing
the FDI remaining in the country.4
Hong Kong (when measured on a gross basis) and Singapore were followed
by Vietnam,5 Malaysia and (after 2000) Thailand. Indonesia has a substantially
lower ratio of FDI to GDP than these three neighbouring countries. At about
14% in 2009, it was similar to the igure for the Philippines and to those for the
latecomers to FDI inlows, Taiwan and South Korea.
An alternative measure of the importance of FDI to a country is the ratio of
inward FDI lows to capital formation. This is shown, by ive-year periods, in
table 2. The ratio of FDI to total capital formation in Southeast Asia has been
4 For a description of the entrepôt roles of Hong Kong and Singapore, see Low, Ramstetter,
and Yeung (1998).
5 The inward FDI estimates for Hong Kong and Vietnam, at least through 1990, were
roughly estimated by UNCTAD (see source for table 1) and should not be taken as based
on substantial data.
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40
Robert E. Lipsey and Fredrik Sjöholm
higher than the ratio in Northeast Asia since 1980, and in 2005–09 it was more
than three times as high. FDI lows were very high relative to capital formation
in Hong Kong, if measured on a gross basis (as they are through 1990–94 and the
irst two years of the next period in the table), and in Singapore, again because
much of the capital formation inanced by the FDI took place in other locations.
The ratios are relatively high also in Vietnam, Malaysia and Thailand. The ratio
of FDI to capital formation has increased over time in Indonesia – from about 1%
in 1980–84 to 6% in 2005–09. This increase notwithstanding, the ratio is lower for
Indonesia than for any other Southeast Asian country shown in the table.
Another indicator of the extent of inward FDI, calculated by the United Nations
Conference on Trade and Development for 2005 and earlier years (UNCTAD
2008), is what is referred to as ‘transnationality’. This is a combination of several
ratios of inward FDI activity to country characteristics, including FDI inlows as a
percentage of gross ixed capital formation, 2003–05; inward FDI stocks as a percentage of GDP in 2005; value added in foreign afiliates as a percentage of GDP in
2005; and employment in foreign afiliates as a percentage of total employment in
2005. A high igure on the transnationality index means a large presence of inward
FDI. The average igure for developing countries in East Asia is approximately
25.5; the values range from 104 and 65 in Hong Kong and Singapore to about 8.5
in Indonesia, making it, by this measure, the least transnational of the Northeast
and Southeast Asian countries.
WHY HAS SO MUCH FDI GONE TO EAST ASIA?
Openness to FDI
A fundamental criterion for attracting FDI is that the host country welcomes such
investments. This has not always been the case in East Asia. Developing countries
for a long time used import substitution to encourage formation and growth of
domestic irms. A natural part of this strategy was to restrict the access of foreign
MNEs to the domestic market and to use other methods to acquire foreign technology. Japan used this strategy successfully, and that success had a strong impact
on development strategies in other countries across East Asia in the 1960s and
1970s.
Some Asian countries eventually experimented with a different development
strategy, including a stronger reliance on foreign MNEs. Singapore pioneered this
approach. When it was expelled from Malaysia in 1965, Singapore lost most of its
former domestic market on the Malay peninsula.
[Its] original economic strategy, which was relected in its irst … development
plan, became inoperative … Clearly, import replacement made no sense for a citystate … the most rapid economic progress seemed to lie in industrialization … The
question was how to bring it about. The decision was made to encourage FDI …
(Krause, Koh and Yuan 1987: 3).
The economic success of Singapore inspired other countries in East Asia to liberalise their trade regimes and encourage the entrance of foreign MNEs. The FDI
regimes still differ among East Asian countries, with some being more open than
others, but all countries have become more open to FDI over time (Brooks and Hill
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Foreign direct investment and growth in East Asia: lessons for Indonesia
41
TABLE 3 Regional and Country Rankings on the Ease of Doing Businessa
2006
2008
2010
Singapore
Hong Kong
Thailand
South Korea
Malaysia
Taiwan
China
Vietnam
Indonesia
Philippines
2
6
19
23
25
43
108
98
131
121
1
4
19
22
25
58
90
87
127
136
1
3
12
19
23
46
89
93
122
144
Northeast Asiab
Southeast Asiab
Latin America
Africa
45
66
91
130
44
66
99
136
40
65
105
137
a In 2007, 2009 and 2010, the Doing Business reports adjusted the previous years’ ‘ease of doing busi-
ness’ rankings for changes in methodology, data corrections and the addition of new economies. The
igures shown are the adjusted rankings. Regional rankings are unweighted averages of country rankings calculated by the authors from the same sources.
b See footnote 1.
Sources: World Bank (2006, 2008, 2009) and .
2004). The exact reason for adopting a more liberal FDI regime varied. In some
countries it was an attempt to augment domestic savings, in others to encourage
technology transfer or to gain access to international markets for exports (Dobson
1997).
The business environment
While openness to FDI is a necessary condition for attracting foreign MNEs, it is
not a suficient one. The host country needs to provide an economic environment
that is attractive to multinational irms. A ranking of countries by ease of doing
business, published annually by the World Bank, provides a set of indicators of
the business environment. The major regions of the developing world have differed substantially over the years with respect to the ease of doing business, a
characteristic that summarises many of the obstacles and advantages of a country’s institutions. Rankings of the four main developing regions and of individual
East Asian countries are shown in table 3. A low rank represents a favourable
business environment and a high rank indicates dificult conditions. Northeast
Asia was the easiest of the four regions for doing business and its average rank
has been improving. Southeast Asia has the second best ranking among the developing regions, followed by Latin America and inally by Africa, the most dificult
environment for business. The margin by which East Asia leads the other developing areas has increased over the period.
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42
Robert E. Lipsey and Fredrik Sjöholm
Global production networks
A feature of the recent development of East Asian economies has been their participation in the global production networks of MNEs from developed countries,
particularly the US and Japan (Athukorala 2005; Zhou and Lall 2005). MNEs
locate different parts of the production process in different Asian countries to
increase eficiency and reduce costs. One consequence of this ‘fragmentation’ of
multinational irms’ production is to reduce the importance of country size in the
location of production, since a small country can participate by specialising in a
single stage of production for eventual use in many markets.
A series of papers by Ando and Kimura, summarised in Ando, Arndt and
Kimura (2006), emphasises the importance of the growth of trade in machinery
parts and components, and contrasts that trend in Asian trade with its absence
in Latin American trade. When countries are arrayed in order of the importance
of machinery and machinery parts and components in their exports, seven East
Asian countries are above the median, and only one, Indonesia, is below it.
Among the Latin American countries, only one, Mexico, showed a high share and
nine a low share. Athukorala (2005: 9) shows that East Asia’s share of global trade
in parts and components increased from 35% in 1990 to 40% in 2000. The bulk of
trade in parts and components is conducted by MNEs.
Electronics has been the most important sector for international production networks. International electronics irms were already looking in the 1960s and 1970s
at opportunities to locate labour-intensive parts of their production in foreign countries. East Asian countries were the prime location for these irms. For instance,
Texas Instruments and National Semiconductor had located production in Singapore as early as the 1960s (Sjöholm 2003a). They were attracted there by subsidies,
but also by an eficient bureaucracy, which, for instance, enabled Texas Instruments
to start production 50 days after its investment decision (Huff 1994: 325).
Malaysia too became an important destination of foreign electronics companies
at a relatively early date. One important location was the southern Malaysian
state of Johor. This development was partly the result of strong historical links
with Singapore, but it was facilitated by liberalisation of trade and border procedures in Malaysia and by investments in infrastructure on both sides of the border (Sjöholm 2003a: 109). MNEs were able to ship goods back and forth between
plants on both sides of the border. Similar networks have over time been spreading to countries such as China, Thailand, the Philippines and Vietnam.
Other determinants of FDI
The cost of production is particularly important for the location of vertically integrated production networks, and it depends on a host of factors including wages,
productivity, infrastructure, tariffs and taxes. The authors whose work is summarised in Ando, Arndt and Kimura (2006) associate success in participating in
these international production-sharing arrangements with the FDI environments
in the host countries, and especially with the presence of supporting infrastructure, including ‘costly communications and coordination infrastructure’ (p. 7).
Labour
Labour costs depend on productivity as well as on wage rates. Productivity is
highly dependent on the educational level of the workforce, and several studies
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Foreign direct investment and growth in East Asia: lessons for Indonesia
43
ind the education and skills of the workforce to be important in MNEs’ location
decisions.6 The level of education required varies, of course, with the type of
production, but even relatively simple manufacturing typically calls at least
for basic literacy and numeracy. For more sophisticated production, the skill
requirements of the workforce are higher.7
Many East Asian countries were early leaders in the education of their populations. Since the 1960s they have had higher rates of completion of secondary education than Latin America, Africa and South Asia, and higher rates of completion
of tertiary education than all other developing areas except Latin America (Barro
and Lee 2010: table 3). This lead in education may in part explain the early attractiveness of some of these countries to investors. However, educational attainment
differs within East Asia, with higher levels in Northeast than in Southeast Asia
(Booth 1999a, 1999b).
Corruption
A number of studies try to identify additional determinants of FDI. For instance,
Gastanaga, Nugent and Pashamova (1998) ind a general negative effect of corruption on FDI in developing countries. Woo and Heo (2009) examine corruption
in eight Asian countries and ind that it has a negative effect on FDI inlows. Hines
(1995), in a study of US FDI, and Wei (1997), in a study of FDI in OECD countries,
arrive at similar conclusions. The negative effect of corruption on FDI may seem a
paradox, given that large inlows of FDI and high levels of corruption co-exist in
many East Asian countries. One explanation is that other country characteristics
such as cheap labour and large markets make up for the negative effect of corruption. Another explanation might be the nature of corruption in East Asia. Rodriguez, Uhlenbruck and Eden (2005) examine corruption from two perspectives:
pervasiveness and arbitrariness. Highly pervasive corruption tends to be institutionalised and predictable, whereas arbitrary corruption increases uncertainty.
Corruption in East Asia tends to be of the predictable sort: irms know whom
to bribe, and once the payment is done they will be free from the need to make
similar payments to other actors. Lee and Oh (2007) argue that this predictability
is especially important for foreign MNEs whose knowledge of local conditions is
relatively poor: arbitrariness and uncertainty about whether bribery will have a
favourable outcome are more harmful to foreign irms with limited knowledge of
local conditions. That reform was important for business was implied by the unfavourable stock market reaction to a reformist Indonesian minister’s resignation in
May 2010 (‘Reformer resigns, rattling Indonesia’, Wall Street Journal, 6/5/2010).
The ‘corruption perceptions index’ published each year by Transparency International suggests that there have been persistent differences among developing
regions in the prevalence of corruption (table 4). The index is constructed from
surveys and ratings by risk agencies and country analysts. The data are combined
to form an index scaled from 0 to 10, with 0 representing the highest level of
6 See World Bank (2007: 180–1) for a discussion of skills and FDI in East Asia.
7 Several studies ind that a more educated workforce increases the positive impact of FDI
on the host economy. For instance, Zhang (2001) and Blomström and Kokko (2003a) stress
that the growth effect of FDI is higher in East Asia than in Latin America because education
is superior in the former.
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Robert E. Lipsey and Fredrik Sjöholm
TABLE 4 Corruption Perceptions Index in Selected Developing Regionsa
2001
2009
Singapore
Hong Kong
Taiwan
South Korea
Malaysia
China
Thailand
Indonesia
Vietnam
Philippines
9.2
7.9
5.9
4.2
5.0
3.5
3.2
1.9
2.6
2.9
9.2
8.2
5.6
5.5
4.5
3.6
3.4
2.8
2.7
2.4
Northeast Asiab
Southeast Asiab
Latin America
Africa
5.4
4.1
3.8
3.2
5.7
4.2
3.6
2.9
a The index ranges from 10 (very low perceived corruption) to 1 (very high perceived corruption).
Regional indices are unweighted averages of country indices calculated by the authors from the same
source.
b See footnote 1.
Source: Transparency International, .
corruption and 10 the lowest. Among the developing regions, Northeast Asia was
perceived as the least corrupt in 2001 and 2009, followed by Southeast Asia. Africa
was perceived as the most corrupt.
With respect to the prevalence of corruption, the igures on individual countries in table 4 suggest that there are three groups of countries: Singapore and
Hong Kong, with low perceived corruption; Taiwan, South Korea and Malaysia,
with intermediate levels of perceived corruption; and China, Thailand, Indonesia,
Vietnam and the Philippines with relatively high levels of perceived corruption.
Indonesia was perceived to have the highest level of corruption in 2001 but has
made some progress: its corruption perceptions index in 2009 is similar to Vietnam’s and better than that of the Philippines.
Institutional factors, infrastructure and the role of export-processing zones
Other studies also highlight the importance of institutions. Chantasasawat et al.
(2004) examine FDI to eight East Asian countries between 1985 and 2001. Their
results suggest that various institutional factors are among the most important
determinants of FDI. For instance, low corporate taxes, low levels of corruption and
a high degree of openness to the international economy are associated with higher
levels of FDI. One explanation of the relationship lies in the role of production networks. Such networks rely on low tariffs and low transactions costs to be able to
ship parts and components economically among afiliates in different countries.
It is a major task for a developing country to implement all the policies
that will increase FDI inlows. A number of East Asian countries have used
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Foreign direct investment and growth in East Asia: lessons for Indonesia
45
export-processing zones (EPZs) to address this dificulty. Improvements in
infrastructure can be concentrated in certain geographic locations, where the
irms often receive special treatment in terms of taxes and regulations. Typical
advantages of locating in EPZs include lower import and export restrictions,
less restrictive labour requirements, lower taxes, liberal ownership regulations,
liberal foreign exchange regulations and access to superior infrastructure and
communications technologies (Madani 1999).
Countries such as Malaysia and Thailand have for decades relied heavily on
EPZs. Other countries, such as Vietnam, started later but have also been relatively
successful in using EPZs to attract FDI. China is perhaps the case for which such
zones have been most instrumental in generating rapid growth. Foreign irms
came in large numbers to the four zones established in 1980, and later to new
zones that opened up at a rapid pace in the coastal provinces. As a result, foreign
irms’ share of exports rose from 1% in 1985 to more than 50% in 2005 (Hofman,
Zhao and Ishihara 2007).
It seems that EPZs are particularly important in countries with poor institutions. In those instances, EPZs allow foreign MNEs to avoid some of the domestic
regulations and constraints. As countries develop, conditions in the surrounding
economy tend to converge with those in the EPZs, and the role of the latter tends
to decline.
Summary
East Asian countries as a group have for several decades been superior to other
developing regions in respect of all the characteristics identiied here as attractive
to investment by multinational irms. This has been the case for the education of
the labour force, the control of corruption, the atmosphere for conducting business, the reliability of the infrastructure needed for coordinating chains of supply
and production, and the willingness to make changes in institutions to attract
foreign irms. The result has been a higher presence of foreign multinationals in
East Asia than in other areas of the developing world.
INDONESIA AS A RECIPIENT OF FDI
We have shown that FDI inlows have been large to most countries in East Asia,
but relatively modest to Indonesia. A useful way of describing Indonesia’s record
in attracting inward FDI is to compare inward stocks over time with what might
be predicted from equations that relate the expected inward stock to possible
determinants of FDI inlow. In other words, how did Indonesia perform in terms
of FDI inlows given its economic characteristics and performance on standard
macroeconomic indicators?
In one of these calculations, the variables used for the prediction are the real
GDP of the country ive years earlier, growth in real per capita GDP in the previous ive years, and a measure of the openness of the economy’s trade policy that
we call ‘residual openness’. This is the residual from an equation relating a standard measure of openness – the ratio of exports plus imports to GDP – to a country’s population and land area. It takes account of the fact that larger countries,
in terms of both population and land area, trade less, relative to GDP, than small
countries with the same degree of deliberate trade restriction. It is an attempt to
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46
Robert E. Lipsey and Fredrik Sjöholm
TABLE 5 Ratio of Actual to Predicteda Inward FDI Stock, 2005
Host Country
2005
Singapore
South Korea
Thailand
Taiwan
Chinab
Malaysia
Indonesia
Philippines
2.16
1.78
1.52
1.28
0.94
0.77
0.59
0.52
a Predicted from equation:
FDI Inward Stock t = α + β1 GDPt − 5 + β 2 per capita GDP growth + β 3 RES .Op .t − 5
GDP is real GDP at the economy level, which is the product of real GDP per capita and population, both
from the Penn World Table (Heston, Summers and Aten 2009). Per capita growth is calculated using the
real GDP per capita chained index based on 2005 (see ). Residual openness (‘RES.Op’) is calculated as the residual of the regression of trade share
on population, land and a constant term. The samples in that regression are all the countries for which
data were available, excluding OECD countries other than South Korea and Mexico. The same countries were used to calculate predicted inward stock except where necessary variables were unavailable.
Negative openness estimates were replaced by zero.
Most data were obtained from the World Bank’s World Development Indicators at . Data on the trade share for Singapore are from the Penn World Tables at . For Taiwan, the data are from
National Statistics, Republic of China (Taiwan), at . Data on
FDI inward stock are from the online database of UNCTAD (see source for table 1).
b
Hong Kong is combined with China in this table. The inward FDI stock in China is China’s inward
stock plus Hong Kong’s inward stock minus its outward stock.
Sources: See note a for sample sources.
provide a more precise measure of the openness of trade policy than a simple ratio
of trade to output.
Table 5 compares the inward FDI stocks predicted from such a regression with
actual stocks in 2005. The actual inward stock of FDI in Indonesia in 2005 (as
reported by UNCTAD at ) was 59% of the
stock predicted by the equation shown below table 5. Actual levels for four East
Asian countries were higher than predicted levels, and only the Philippines had a
lower ratio than Indonesia of actual to predicted FDI stock.
The data on aggregate stocks and lows of FDI to individual countries are subject to many problems of measurement and interpretation. For some countries,
such as Hong Kong and Singapore, part of the FDI inlow does not add to the
productive assets of the nominal destination country, but moves through to other
countries, where it inances the creation of physical capital and the employment
of labour.
For FDI from the US, more information is available about the composition and
characteristics of lows and stocks. The main advantage of this is that we can study
the real activities of multinational afiliates rather than looking at inancial lows.
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Foreign direct investment and growth in East Asia: lessons for Indonesia
47
Employment in all US afiliates, and in manufacturing afiliates, can be predicted
from the same independent variables that were used to predict the stock of inward
FDI for table 5. These predicted levels can then be compared with data from actual
surveys of US multinationals that give revised estimates of afiliate employment
by country of location in 1985, 1990, 1995, 2000, and 2005 (available at ).
Employment in all US afiliates in Indonesia between 1985 and 2005 ranged
from about half of the predicted level to a peak of 90%. For no other Northeast
or Southeast Asian country was the over-prediction of US afiliate employment
consistently greater than for Indonesia. Employment in US afiliates in manufacturing in Indonesia was only 11% of the expected level in 1985, but it increased
steadily to over 80% of expected employment in 2005, close to the median. In
absolute terms, it was only a fraction of afiliate manufacturing employment in
such small economies as Hong Kong and Singapore, until a more than doubling
from 2000 to 2005 brought it above the levels in both of these countries.
In contrast, the level of physical capital in US afiliates in Indonesia, as represented by net property, plant and equipment, was far above the predicted values in
all the years from 1985 through 2005. That contrast is explained, as discussed below,
by the large role of investment in capital-intensive mining in US FDI in Indonesia.
The igures above suggest, again, that the inlow of FDI to Indonesia, and
especially the inlow to labour-intensive manufacturing, is lower than would be
expected from standard macroeconomic indicators. Below we try to determine
why FDI lows to Indonesia are low. One possibility is that FDI to Indonesia is
concentrated in sectors where alternative locations are few, and that multinational
irms choose other countries for their investments in sectors where there are alternatives.
Some support for this hypothesis is given by igures on employment in afiliates of US irms in Indonesia and other East Asian countries (table 6). The composition of US irms’ employment in Indonesia was very different from that in
the other East Asian countries shown. The share in mining was much higher in
Indonesia, at over 27%. In none of the other countries was that share over 2.1%.
The share in machinery is particularly low in Indonesia, at less than half of 1%,
while in the other countries (except the Philippines) it ranged from 1.3% to 5.8%.
Computers and electronic products accounted for less than 1% of employment in
US irms’ afiliates in Indonesia, whereas the shares in the other countries ranged
from 3.6% in Hong Kong to over 50% in Malaysia. In general, investment in Indonesia from the US avoided the manufacturing industries in which technology was
important. An exception is chemicals, in which investment was probably drawn
to Indonesia by the petroleum industry. The low share of US FDI in electronics
suggests that Indonesia plays a quite minor role in the production networks of
US-based MNEs. The ’other manufacturing‘ industries, which account for over
one-third of US afiliate employment in Indonesia, include beverages and tobacco
products; textiles, apparel and leather products; wood and paper products and
printing; petroleum and coal products; and furniture and related products. These
are mainly relatively low-tech industries.
The view that Indonesia is largely excluded from US multinationals’ production networks is supported by the low share of the sales of manufacturing afiliates
in Indonesia that are made outside the host country (table 7). US manufacturing
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48
Robert E. Lipsey and Fredrik Sjöholm
TABLE 6 Shares of Industries in Employment by All Non-bank Afiliates
of US Parent Companies, 2007a
(% of employment in all industries)
Indo- China Hong South Malay- Philip- Singa- Taiwan Thainesia
Kong Korea
sia
pines pore
land
All industries
Mining
Utilities
Manufacturing
Food
Chemicals
Primary & fabricated metals
Machinery
Computers & electronic
products
Electrical equipment, appliances & components
Transport equipment
Other
Wholesale trade
Information
Finance (except depository
institutions) & insurance
Professional, scientiic &
technical services
Other industries
100
27~33
0.6
100
0~1
0.0
100
0.0
0~1
100
0.0
0.0
100
2.1
0.0
100
0.0
0~1
100
1.1
0.0
100
0.0
0.0
100
1.5
0.0
55.6
5.2
9.4
60.7
3.1
6~13
40~47
0.2
1.8
60.5
1~2
3.8
71.7
0.8
4.2
55.8
11.3
4.7
49.7
0.3
4.8
35.9
0.6
4.1
73.0
11.2
5.8
0.6
2.3
0.6
1.2
0.1
0.1
0.2
1.0
0.6
0.4
5.8
1.6
4.9
1.3
0.3
4.6
2.3
0.9
17.9
3.6
13.8
51.9
22.2
1~2
5.4
4~8
1~2
2~5
4~9
1.0
5~10
0.6
1.0
36~37
1.7
1~2
6~13
1~14
5~6
1.2
1.3
8~10
6.6
0.7
4~9
0~9
2.8
0.5
4.2
0~15
12.8
4.4
2.5
0~11
11.8
2.0
5.2
22~24
4.9
0.3
2.7
0.7
8.3
4~8
2.4
2~3
4.9
10~24
3.9
0.9
1.7
7.3
4.6
2.9
16.1
8.3
5~10
1.3
5~9
30.0
13.6
21.5
18.7
24~36
15.2
0.0
21~33
29~31 0~15
13.7
7.7
3.3
1.9
20~27 17~21
20~35 10~16
2~3
24.4
a ‘0’ indicates fewer than 500 employees. Some shares, such as for mining in Indonesia, can only be
shown as ranges (indicated by ‘~’), because the numbers are suppressed in the source to preserve the
conidentiality of individual irm responses.
Source: USBEA (2010).
afiliates in Indonesia made only about 21% of their sales outside the country,
while those in Taiwan and Thailand made over 40% of their sales abroad, and
those in the other East Asian countries (except China and South Korea) made over
50% of their sales outside their home markets.
We also examined inlows of FDI from other countries where similar data on
the activities of foreign afiliates are available. This partly conirmed our inding
that inlows of FDI to Indonesia were lower than could be expected.8 Germany’s
FDI in Indonesia was lower than would be expected from a prediction based
on its FDI in all developing countries, whereas employment in Japanese-owned
manufacturing plants in Indonesia was close to predicted levels.
The variables included in the predictions described above relate to Indonesia as
a market for the investing irms and therefore capture mainly market-seeking FDI.
8 The results are available upon request.
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Foreign direct investment and growth in East Asia: lessons for Indonesia
49
TABLE 7 Share of Sales Outside the Host Country by Majority-owned
Foreign Manufacturing Afiliates of US Parent Companies, 2004a
(%)
Host Country
Malaysia
Philippines
Singapore
Hong Kong
Thailand
Taiwan
China
Indonesia
South Korea
%
72.2
69.2
59.9
50.9
44.1
41.4
31.1
20.9
15.0
a Sales outside the host country are total sales by afiliates minus local sales by afiliates.
Sources: ; USBEA (2008).
However, our results are corroborated in other studies using broader sets of variables that relect Indonesia’s attractiveness as a location for export-oriented production. For instance, UNCTAD (2010) conirms Indonesia’s under-performance
in terms of FDI inlows relative to predictions based on a set of country
characteristics. This source ranks Indonesia 119th of 141 countries in terms of FDI
inlows, but 85th in terms of an estimate of potential inlows based on 12 economic
and policy variables.
The history of FDI in Indonesia has thus been one of fairly low participation
of foreign irms compared with other countries in the region. Indonesia is not
the country most closed to foreign irms, but it ranks low as a location for FDI in
general and for participation in chains of production organised by foreign irms.
In its modest inlows of FDI, Indonesia stands in sharp contrast to neighbouring
countries, which are all characterised by a heavy concentration of MNEs.
THE EFFECT OF FDI ON THE INDONESIAN ECONOMY
It would be in Indonesia’s interest to increase inlows of FDI only if such inlows
beneit the country. We therefore briely survey the literature on the effects of FDI
in Indonesia. Table A1 in the appendix lists studies that look at a range of effects
of FDI. They show surprisingly consistent beneits to Indonesia from FDI.
Productivity
Foreign irms bring in new production processes or begin to produce new products. These beneits to the country are likely to manifest themselves in relatively
high productivity in foreign irms. A number of studies show that this is indeed
the case for Indonesia: foreign irms have higher labour productivity and higher
total factor productivity than local irms. Moreover, not only the level but also
the growth of productivity is higher in foreign irms. Finally, all of the studies
listed in appendix table A1 ind productivity to be higher in foreign than in
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50
Robert E. Lipsey and Fredrik Sjöholm
local irms even after controlling for irm characteristics such as size and capital
intensity.
Exports
The literature also reveals a clear difference in export intensities between foreign and domestic irms: foreign irms are substantially more integrated into the
international economy through exports. This is not surprising: it is a result found
in most countries. One interesting inding on Indonesia is that even foreign irms
that start producing only for the Indonesian market are better able than local irms
to switch to producing for export.
Wages
Foreign-owned establishments in Indonesia are found to pay higher wages than
domestically owned irms, even when the studies control for the educational level
of their employees. Accordingly, foreign acquisition of an Indonesian manufacturing plant results in higher wages for the plant’s employees. Foreign irms also
pay a higher premium for higher levels of education than do domestic irms. Foreign irms’ entry thus increases not only wages but also the returns to education,
thus encouraging investment in further education.
Employment
A similar story applies to growth in employment. Foreign irms exhibit higher
growth in employment than domestic irms. Moreover, foreign acquisitions of
domestic irms increase growth in employment, despite the fact that foreignowned irms are relatively large and large irms tend to have relatively low
growth rates of employment.
Spillovers to local irms
The studies listed in table A1 suggest that foreign irms have higher productivity
and higher exports, pay higher wages and demonstrate higher growth in employment than domestic irms. If local irms beneit from FDI, it is clear that there are
gains to the country from hosting foreign MNEs, but the beneits are less clear if
local irms are instead hurt by the presence of foreign irms. The effects of FDI
on local irms are often termed ‘spillovers’. Positive spillovers could arise, for
example, from the transfer of technologies from foreign to domestic irms or from
the expansion of markets for domestic suppliers of intermediate goods. Negative
spillovers could result from increased competition if this forces domestic irms
out of business or compels them to operate at a lower scale of production.
Appendix table A2 summarises existing studies of spillovers in Indonesia.9
Most studies focus on spillover effects on productivity, but there are also two
studies of wage spillovers. All of the studies ind evidence of positive spillovers
– of local irms beneiting from the presence of foreign irms within the industry
or region. For productivity, the positive effect is likely to come from technology
spillovers – new technologies and knowledge that are made available to domestic
irms – and from increased competition, a pressure to improve to secure market
share and survival. For wages, the positive effect of FDI is likely to be the result
9 See also the review article on spillovers in Indonesia by Lipsey and Sjöholm (2005).
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Foreign direct investment and growth in East Asia:
lessons for Indonesia
Robert E. Lipsey & Fredrik Sjöholm
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Bulletin of Indonesian Economic Studies, Vol. 47, No. 1, 2011: 35–63
‘Indonesia in Comparative Perspective’ Series
FOREIGN DIRECT INVESTMENT AND GROWTH
IN EAST ASIA: LESSONS FOR INDONESIA
Robert E. Lipsey*
National Bureau of Economic Research
and City University of New York
Fredrik Sjöholm*
Research Institute of Industrial Economics,
Stockholm, and Örebro University
Foreign direct investment (FDI) has been important in the growth and global integration of developing economies. Both Northeast and Southeast Asia, especially
the latter, have been part of this development, with increasing inlows of FDI and
greater foreign participation in local economies. However, Indonesia has been an
outlier within the region. Inlows of FDI have been lower to Indonesia than to other
countries, especially in manufacturing, and they have been lower than could be
expected from Indonesia’s size, population and other country characteristics. We
show that the inlows that have occurred have beneited Indonesia, and use the East
Asian experience to identify measures that are likely to increase these lows. A relatively poor business environment, ineficient government institutions, low levels of
education and poor infrastructure all seem to be important explanations for the low
inlows of FDI to Indonesia.
INTRODUCTION
Foreign direct investment (FDI) has been a key aspect of increased globalisation
in recent decades. Growth in FDI has been higher than growth in international
trade. Multinational irms have come to account for about 10% of world output
and 30% of world exports, and these irms develop and control a large share of
new technologies (Jungnickel 2002).
FDI has played, and continues to play, a large role in Asian development. China
is one of the world’s largest recipients of FDI and Japan is a major source. Some
countries in the region, such as Singapore, have based much of their development strategy on reliance on foreign multinational enterprises (MNEs). Finally,
East Asia is a prime home to the vertically integrated cross-country production
networks of MNEs, in which different afiliates of a irm produce different parts
and components, and others import and assemble them.
FDI often requires the coordination of complicated operations over long distances. Input goods and services need to be shipped internationally between
* We are grateful for comments and suggestions by Chris Manning and two anonymous
referees. Jing Sun and Takuya Hasebe have provided excellent research assistance. Fredrik
Sjöholm gratefully acknowledges inancial support from the Torsten and Ragnar Söderberg Foundation.
ISSN 0007-4918 print/ISSN 1472-7234 online/11/010035-29
DOI: 10.1080/00074918.2011.556055
© 2011 Indonesia Project ANU
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36
Robert E. Lipsey and Fredrik Sjöholm
branches of the MNE, and coordination and supervision require visits by staff and
a steady low of information. It is clear that the complexity of operations across
national borders places large demands on the host country economic environment. Countries differ in their ability to attract and handle FDI, which depends
on characteristics such as infrastructure, trade regimes, labour force skills and
institutional quality.
It should therefore come as no surprise that inlows of FDI differ substantially
among countries in East Asia. FDI lows to Indonesia have been relatively modest, and lower than would be expected from the country’s size. This paper seeks
to explain the low inlows of FDI by relating Indonesia’s experience to that of
other countries in the region. East Asia’s heterogeneity provides an opportunity
to identify and evaluate the determinants of FDI. What factors are typically most
important in explaining FDI inlows into East Asia?
The paper offers an overview of FDI in East Asia (Northeast and Southeast
Asia) and discusses its main determinants.1 We analyse FDI inlows to Indonesia
by comparing actual inlows with those that could be predicted from Indonesia’s
country characteristics. A literature survey identiies the main effects of FDI on
the Indonesian economy. The evidence from the studies surveyed leads us to conclude that Indonesia would beneit from higher FDI inlows. We use our analysis
of the determinants of FDI in East Asia to suggest policy strategies that are likely
to increase inlows of FDI to Indonesia. The paper ends with some conclusions
about the main obstacles to more rapid economic growth in Indonesia, and especially to growth fuelled by inward FDI.
While the aggregate FDI data analysed in the irst part of the paper cover all
industries, our analyses of the effects of FDI focus on manufacturing, for several
reasons. First, manufacturing FDI in Indonesia and elsewhere has been studied
more intensively than FDI in other industries. Second, data on manufacturing are
much stronger than data on the service industries. Third, while studies of FDI in
mining, including petroleum, are relatively numerous, Indonesia is an outlier in
East Asia in terms of the importance of mining, and few comparisons can be made
with other countries in the region for this industry.
FDI IN THE GROWTH OF DEVELOPING EAST ASIA
The three main regions of the developing world, Asia (other than Japan), Latin
America and Africa, have fared very differently since the middle of the 20th
century. As late as four decades ago, Latin America had the highest per capita
income, there was a good deal of optimism about Africa, and Asia was far behind
Latin America. By the early 2000s, Northeast Asian countries had largely caught
up with Latin America, and Southeast Asian countries were not far behind –
indeed, some of the latter had even outstripped Latin America. Incomes in both
1 Much of the analysis in the paper compares Indonesia with selected countries in Northeast Asia (China, Hong Kong, South Korea and Taiwan) and Southeast Asia (Malaysia,
the Philippines, Singapore, Thailand and Vietnam), but regional aggregates, such as those
in igure 1 and tables 1 through 4, are deined as in the data sources shown, to include all
countries in the region for which data are available.
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Foreign direct investment and growth in East Asia: lessons for Indonesia
37
FIGURE 1 Inlows of FDI to Developing East Asia
($ billion, logarithmic scale)
1,000
100
Developing East Asia
10
Developing East Asia excluding China
1
0.1
1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009
Source: 1970–2008: United Nations Conference on Trade and Development (UNCTAD) interactive database, Division on Investment and Enterprise, ; 2009: UNCTAD (2010).
Northeast and Southeast Asian countries far surpassed those in Africa by this
time.2
Most studies ind FDI to have been a source of the rapid growth in East Asia.3
That has been the case for most of the countries in the region, although less so and
later for the Republic of Korea (hereafter ‘South Korea’) and Taiwan; they initially
followed the Japanese model of placing restrictions on foreign-controlled irms, and
only after 1990 began catching up with the rest of the region in receptiveness to FDI.
Inlows of FDI to East Asia have been rising since the 1970s, with interruptions. They accelerated after the opening of China around 1990 (igure 1). The rise
in inlows was set back briely in the mid-1970s, again in the mid-1980s and by
the 1997–98 Asian inancial crisis, and then once more in the early 2000s by the
troubles of the information technology industry, a major beneiciary of FDI capital
inlow. The inancial crisis that began in 2008 has left its mark: inlows declined in
2009, but remained close to their highest levels to that point.
A crude measure of the role of inward FDI is the ratio of the inward stock of
FDI to GDP, shown for selected East Asian countries in table 1. East Asia became
a major destination for lows of FDI well before other developing regions did. The
gross inward stock of FDI in 1980, for example, was about 42% of GDP in Northeast Asia and 9% in Southeast Asia; it was 10% in Africa but only 5% in Latin
America. By 1995, Southeast Asia had surpassed Northeast Asia, and the ratios of
2 For data on per capita incomes, see Heston, Summers and Aten (2009) and the other
Penn World Tables at .
3 See, for example, among many, the country studies in Ito and Krueger (2000); Urata, Chia
and Kimura (2006); and Zhang (2001).
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Robert E. Lipsey and Fredrik Sjöholm
TABLE 1 Stock of Inward FDI as a Percentage of GDPa
1980
1985
1990
1995
2000
2005
2009
616.8
616.3
45.7
39.1
59.1
20.3
3.0
2.8
5.7
1.7
5.7
0.4
515.6
509.1
60.0
54.0
30.3
22.8
5.1
6.0
6.0
1.8
4.6
2.0
262.3
246.8
82.6
61.4
25.5
22.6
9.7
10.2
7.0
1.9
5.9
5.1
157.8
103.1
78.2
36.5
34.5
31.2
10.5
13.7
9.3
1.8
5.8
13.4
269.3
39.7
119.3
58.0
66.1
56.2
24.4
23.9
15.2
7.1
6.1
16.2
294.3
29.2
160.9
60.5
58.8
32.2
34.3
15.2
14.4
12.4
12.1
11.8
432.0
37.0
200.7
76.2
57.1
39.0
36.2
14.5
13.5
13.3
13.1
10.1
Northeast Asiae
Gross
Netc
41.6
41.6
38.6
38.1
25.6
24.3
20.7
16.1
31.8
14.4
25.6
12.9
25.5
11.9
Southeast Asiae
Gross
Netc
9.4
9.0
12.5
12.1
18.1
15.9
22.5
17.3
44.5
35.0
44.7
31.3
46.3
32.0
Africa
Latin Americaf
9.6
5.0
10.2
8.7
12.1
9.1
16.9
10.1
25.9
20.9
27.7
26.6
35.8
30.1
Hong Kongb (gross)
Hong Kongb (net)c
Singapore (gross)
Singapore (net)c
Vietnamd
Malaysia
Thailand
Philippines
Indonesia
South Korea
Taiwan
China
a GDP is as used in UNCTAD calculations (see source).
b 1980–95 data are estimated by UNCTAD from 1998 stock and earlier low data.
c ‘Net’ ratios are based on the difference between inward FDI stock and outward FDI stock.
d 1980–2000 stock is estimated by UNCTAD by cumulating inlows from 1970.
e See footnote 1.
f Latin America: Central America and South America.
Source: UNCTAD, UNCTADstat online database, .
inward FDI stock to GDP were 23% in Southeast Asia, 21% in Northeast Asia, 17%
in Africa and 10% in Latin America.
China is a major contributor to the growth of FDI in the East Asian region.
It has been the developing world’s largest recipient of FDI in the last decade
(UNCTAD 2009: appendix table B-2). However, the growth in FDI to China
started from a negligible base. Despite the large lows, China’s stock of inward
FDI relative to its size (as measured by GDP) is still not very high by East Asian
standards.
The highest ratios were those for the two entrepôts, Hong Kong and Singapore. In both cases, much of the FDI that entered these economies ended up in
other countries, presumably inancing productive assets located elsewhere in the
Asian region. We therefore show for these two locations not only total inward FDI
stocks, as for the other countries, but also net inward FDI stocks – total or gross
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Foreign direct investment and growth in East Asia: lessons for Indonesia
39
TABLE 2 FDI Inlow as a Share of Gross Capital Formation
(period averages)a
Singapore
Vietnamb
Thailand
Malaysia
Philippines
Taiwan
Indonesia
China
Hong Konge
South Korea
Northeast Asiaf
Southeast Asiaf
1980–84
1985–89
1990–94
1995–99
2000–04
2005–09
18.9
–
2.7
12.6
2.0
1.2
0.9
0.8
13.7
0.4
29.2
0.2
4.6
9.9
7.2
3.5
1.7
2.3
22.8
1.2
27.9
34.4
4.3
20.0
7.9
2.2
3.9
9.4
15.4
0.6
39.0
26.0
8.9
16.2
8.6
2.5
5.7
11.8
2.7
2.6
62.7
11.2
13.9
11.6
7.3
3.8
–2.4
8.6
1.9
3.4
63.7c
16.5
14.5c
13.6d
11.1
6.1
6.1
5.5
5.3c
2.0c
1.8
5.3
3.5
7.2
5.9
10.3
7.7
15.3
6.9
15.5
5.2
16.2
a The period-sum of FDI inlow as a percentage of the period-sum of gross capital formation.
b For Vietnam, 1980–84 data are not available, and data in the 1985–89 column are for 1986–89.
c 2005–08.
d 2005–07 and 2009. Data for 2008 are not reported.
e Up to 1996, Hong Kong’s inlows are as reported by UNCTAD. For 1997 on, when most were matched
by outlows, presumably to China, Hong Kong’s inlows are measured as inlow minus outlow.
f See footnote 1. Countries other than those listed above were dropped from the aggregation if the
data on their FDI inlows or gross capital formation were not available. The effect on the aggregate
ratios was small.
Sources: UNCTAD, UNCTADstat online database: ; World Bank, World dataBank online, ; National Statistics, Republic of China (Taiwan), .
inward stocks minus outward stocks – which might come closer to representing
the FDI remaining in the country.4
Hong Kong (when measured on a gross basis) and Singapore were followed
by Vietnam,5 Malaysia and (after 2000) Thailand. Indonesia has a substantially
lower ratio of FDI to GDP than these three neighbouring countries. At about
14% in 2009, it was similar to the igure for the Philippines and to those for the
latecomers to FDI inlows, Taiwan and South Korea.
An alternative measure of the importance of FDI to a country is the ratio of
inward FDI lows to capital formation. This is shown, by ive-year periods, in
table 2. The ratio of FDI to total capital formation in Southeast Asia has been
4 For a description of the entrepôt roles of Hong Kong and Singapore, see Low, Ramstetter,
and Yeung (1998).
5 The inward FDI estimates for Hong Kong and Vietnam, at least through 1990, were
roughly estimated by UNCTAD (see source for table 1) and should not be taken as based
on substantial data.
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Robert E. Lipsey and Fredrik Sjöholm
higher than the ratio in Northeast Asia since 1980, and in 2005–09 it was more
than three times as high. FDI lows were very high relative to capital formation
in Hong Kong, if measured on a gross basis (as they are through 1990–94 and the
irst two years of the next period in the table), and in Singapore, again because
much of the capital formation inanced by the FDI took place in other locations.
The ratios are relatively high also in Vietnam, Malaysia and Thailand. The ratio
of FDI to capital formation has increased over time in Indonesia – from about 1%
in 1980–84 to 6% in 2005–09. This increase notwithstanding, the ratio is lower for
Indonesia than for any other Southeast Asian country shown in the table.
Another indicator of the extent of inward FDI, calculated by the United Nations
Conference on Trade and Development for 2005 and earlier years (UNCTAD
2008), is what is referred to as ‘transnationality’. This is a combination of several
ratios of inward FDI activity to country characteristics, including FDI inlows as a
percentage of gross ixed capital formation, 2003–05; inward FDI stocks as a percentage of GDP in 2005; value added in foreign afiliates as a percentage of GDP in
2005; and employment in foreign afiliates as a percentage of total employment in
2005. A high igure on the transnationality index means a large presence of inward
FDI. The average igure for developing countries in East Asia is approximately
25.5; the values range from 104 and 65 in Hong Kong and Singapore to about 8.5
in Indonesia, making it, by this measure, the least transnational of the Northeast
and Southeast Asian countries.
WHY HAS SO MUCH FDI GONE TO EAST ASIA?
Openness to FDI
A fundamental criterion for attracting FDI is that the host country welcomes such
investments. This has not always been the case in East Asia. Developing countries
for a long time used import substitution to encourage formation and growth of
domestic irms. A natural part of this strategy was to restrict the access of foreign
MNEs to the domestic market and to use other methods to acquire foreign technology. Japan used this strategy successfully, and that success had a strong impact
on development strategies in other countries across East Asia in the 1960s and
1970s.
Some Asian countries eventually experimented with a different development
strategy, including a stronger reliance on foreign MNEs. Singapore pioneered this
approach. When it was expelled from Malaysia in 1965, Singapore lost most of its
former domestic market on the Malay peninsula.
[Its] original economic strategy, which was relected in its irst … development
plan, became inoperative … Clearly, import replacement made no sense for a citystate … the most rapid economic progress seemed to lie in industrialization … The
question was how to bring it about. The decision was made to encourage FDI …
(Krause, Koh and Yuan 1987: 3).
The economic success of Singapore inspired other countries in East Asia to liberalise their trade regimes and encourage the entrance of foreign MNEs. The FDI
regimes still differ among East Asian countries, with some being more open than
others, but all countries have become more open to FDI over time (Brooks and Hill
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Foreign direct investment and growth in East Asia: lessons for Indonesia
41
TABLE 3 Regional and Country Rankings on the Ease of Doing Businessa
2006
2008
2010
Singapore
Hong Kong
Thailand
South Korea
Malaysia
Taiwan
China
Vietnam
Indonesia
Philippines
2
6
19
23
25
43
108
98
131
121
1
4
19
22
25
58
90
87
127
136
1
3
12
19
23
46
89
93
122
144
Northeast Asiab
Southeast Asiab
Latin America
Africa
45
66
91
130
44
66
99
136
40
65
105
137
a In 2007, 2009 and 2010, the Doing Business reports adjusted the previous years’ ‘ease of doing busi-
ness’ rankings for changes in methodology, data corrections and the addition of new economies. The
igures shown are the adjusted rankings. Regional rankings are unweighted averages of country rankings calculated by the authors from the same sources.
b See footnote 1.
Sources: World Bank (2006, 2008, 2009) and .
2004). The exact reason for adopting a more liberal FDI regime varied. In some
countries it was an attempt to augment domestic savings, in others to encourage
technology transfer or to gain access to international markets for exports (Dobson
1997).
The business environment
While openness to FDI is a necessary condition for attracting foreign MNEs, it is
not a suficient one. The host country needs to provide an economic environment
that is attractive to multinational irms. A ranking of countries by ease of doing
business, published annually by the World Bank, provides a set of indicators of
the business environment. The major regions of the developing world have differed substantially over the years with respect to the ease of doing business, a
characteristic that summarises many of the obstacles and advantages of a country’s institutions. Rankings of the four main developing regions and of individual
East Asian countries are shown in table 3. A low rank represents a favourable
business environment and a high rank indicates dificult conditions. Northeast
Asia was the easiest of the four regions for doing business and its average rank
has been improving. Southeast Asia has the second best ranking among the developing regions, followed by Latin America and inally by Africa, the most dificult
environment for business. The margin by which East Asia leads the other developing areas has increased over the period.
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Robert E. Lipsey and Fredrik Sjöholm
Global production networks
A feature of the recent development of East Asian economies has been their participation in the global production networks of MNEs from developed countries,
particularly the US and Japan (Athukorala 2005; Zhou and Lall 2005). MNEs
locate different parts of the production process in different Asian countries to
increase eficiency and reduce costs. One consequence of this ‘fragmentation’ of
multinational irms’ production is to reduce the importance of country size in the
location of production, since a small country can participate by specialising in a
single stage of production for eventual use in many markets.
A series of papers by Ando and Kimura, summarised in Ando, Arndt and
Kimura (2006), emphasises the importance of the growth of trade in machinery
parts and components, and contrasts that trend in Asian trade with its absence
in Latin American trade. When countries are arrayed in order of the importance
of machinery and machinery parts and components in their exports, seven East
Asian countries are above the median, and only one, Indonesia, is below it.
Among the Latin American countries, only one, Mexico, showed a high share and
nine a low share. Athukorala (2005: 9) shows that East Asia’s share of global trade
in parts and components increased from 35% in 1990 to 40% in 2000. The bulk of
trade in parts and components is conducted by MNEs.
Electronics has been the most important sector for international production networks. International electronics irms were already looking in the 1960s and 1970s
at opportunities to locate labour-intensive parts of their production in foreign countries. East Asian countries were the prime location for these irms. For instance,
Texas Instruments and National Semiconductor had located production in Singapore as early as the 1960s (Sjöholm 2003a). They were attracted there by subsidies,
but also by an eficient bureaucracy, which, for instance, enabled Texas Instruments
to start production 50 days after its investment decision (Huff 1994: 325).
Malaysia too became an important destination of foreign electronics companies
at a relatively early date. One important location was the southern Malaysian
state of Johor. This development was partly the result of strong historical links
with Singapore, but it was facilitated by liberalisation of trade and border procedures in Malaysia and by investments in infrastructure on both sides of the border (Sjöholm 2003a: 109). MNEs were able to ship goods back and forth between
plants on both sides of the border. Similar networks have over time been spreading to countries such as China, Thailand, the Philippines and Vietnam.
Other determinants of FDI
The cost of production is particularly important for the location of vertically integrated production networks, and it depends on a host of factors including wages,
productivity, infrastructure, tariffs and taxes. The authors whose work is summarised in Ando, Arndt and Kimura (2006) associate success in participating in
these international production-sharing arrangements with the FDI environments
in the host countries, and especially with the presence of supporting infrastructure, including ‘costly communications and coordination infrastructure’ (p. 7).
Labour
Labour costs depend on productivity as well as on wage rates. Productivity is
highly dependent on the educational level of the workforce, and several studies
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Foreign direct investment and growth in East Asia: lessons for Indonesia
43
ind the education and skills of the workforce to be important in MNEs’ location
decisions.6 The level of education required varies, of course, with the type of
production, but even relatively simple manufacturing typically calls at least
for basic literacy and numeracy. For more sophisticated production, the skill
requirements of the workforce are higher.7
Many East Asian countries were early leaders in the education of their populations. Since the 1960s they have had higher rates of completion of secondary education than Latin America, Africa and South Asia, and higher rates of completion
of tertiary education than all other developing areas except Latin America (Barro
and Lee 2010: table 3). This lead in education may in part explain the early attractiveness of some of these countries to investors. However, educational attainment
differs within East Asia, with higher levels in Northeast than in Southeast Asia
(Booth 1999a, 1999b).
Corruption
A number of studies try to identify additional determinants of FDI. For instance,
Gastanaga, Nugent and Pashamova (1998) ind a general negative effect of corruption on FDI in developing countries. Woo and Heo (2009) examine corruption
in eight Asian countries and ind that it has a negative effect on FDI inlows. Hines
(1995), in a study of US FDI, and Wei (1997), in a study of FDI in OECD countries,
arrive at similar conclusions. The negative effect of corruption on FDI may seem a
paradox, given that large inlows of FDI and high levels of corruption co-exist in
many East Asian countries. One explanation is that other country characteristics
such as cheap labour and large markets make up for the negative effect of corruption. Another explanation might be the nature of corruption in East Asia. Rodriguez, Uhlenbruck and Eden (2005) examine corruption from two perspectives:
pervasiveness and arbitrariness. Highly pervasive corruption tends to be institutionalised and predictable, whereas arbitrary corruption increases uncertainty.
Corruption in East Asia tends to be of the predictable sort: irms know whom
to bribe, and once the payment is done they will be free from the need to make
similar payments to other actors. Lee and Oh (2007) argue that this predictability
is especially important for foreign MNEs whose knowledge of local conditions is
relatively poor: arbitrariness and uncertainty about whether bribery will have a
favourable outcome are more harmful to foreign irms with limited knowledge of
local conditions. That reform was important for business was implied by the unfavourable stock market reaction to a reformist Indonesian minister’s resignation in
May 2010 (‘Reformer resigns, rattling Indonesia’, Wall Street Journal, 6/5/2010).
The ‘corruption perceptions index’ published each year by Transparency International suggests that there have been persistent differences among developing
regions in the prevalence of corruption (table 4). The index is constructed from
surveys and ratings by risk agencies and country analysts. The data are combined
to form an index scaled from 0 to 10, with 0 representing the highest level of
6 See World Bank (2007: 180–1) for a discussion of skills and FDI in East Asia.
7 Several studies ind that a more educated workforce increases the positive impact of FDI
on the host economy. For instance, Zhang (2001) and Blomström and Kokko (2003a) stress
that the growth effect of FDI is higher in East Asia than in Latin America because education
is superior in the former.
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Robert E. Lipsey and Fredrik Sjöholm
TABLE 4 Corruption Perceptions Index in Selected Developing Regionsa
2001
2009
Singapore
Hong Kong
Taiwan
South Korea
Malaysia
China
Thailand
Indonesia
Vietnam
Philippines
9.2
7.9
5.9
4.2
5.0
3.5
3.2
1.9
2.6
2.9
9.2
8.2
5.6
5.5
4.5
3.6
3.4
2.8
2.7
2.4
Northeast Asiab
Southeast Asiab
Latin America
Africa
5.4
4.1
3.8
3.2
5.7
4.2
3.6
2.9
a The index ranges from 10 (very low perceived corruption) to 1 (very high perceived corruption).
Regional indices are unweighted averages of country indices calculated by the authors from the same
source.
b See footnote 1.
Source: Transparency International, .
corruption and 10 the lowest. Among the developing regions, Northeast Asia was
perceived as the least corrupt in 2001 and 2009, followed by Southeast Asia. Africa
was perceived as the most corrupt.
With respect to the prevalence of corruption, the igures on individual countries in table 4 suggest that there are three groups of countries: Singapore and
Hong Kong, with low perceived corruption; Taiwan, South Korea and Malaysia,
with intermediate levels of perceived corruption; and China, Thailand, Indonesia,
Vietnam and the Philippines with relatively high levels of perceived corruption.
Indonesia was perceived to have the highest level of corruption in 2001 but has
made some progress: its corruption perceptions index in 2009 is similar to Vietnam’s and better than that of the Philippines.
Institutional factors, infrastructure and the role of export-processing zones
Other studies also highlight the importance of institutions. Chantasasawat et al.
(2004) examine FDI to eight East Asian countries between 1985 and 2001. Their
results suggest that various institutional factors are among the most important
determinants of FDI. For instance, low corporate taxes, low levels of corruption and
a high degree of openness to the international economy are associated with higher
levels of FDI. One explanation of the relationship lies in the role of production networks. Such networks rely on low tariffs and low transactions costs to be able to
ship parts and components economically among afiliates in different countries.
It is a major task for a developing country to implement all the policies
that will increase FDI inlows. A number of East Asian countries have used
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Foreign direct investment and growth in East Asia: lessons for Indonesia
45
export-processing zones (EPZs) to address this dificulty. Improvements in
infrastructure can be concentrated in certain geographic locations, where the
irms often receive special treatment in terms of taxes and regulations. Typical
advantages of locating in EPZs include lower import and export restrictions,
less restrictive labour requirements, lower taxes, liberal ownership regulations,
liberal foreign exchange regulations and access to superior infrastructure and
communications technologies (Madani 1999).
Countries such as Malaysia and Thailand have for decades relied heavily on
EPZs. Other countries, such as Vietnam, started later but have also been relatively
successful in using EPZs to attract FDI. China is perhaps the case for which such
zones have been most instrumental in generating rapid growth. Foreign irms
came in large numbers to the four zones established in 1980, and later to new
zones that opened up at a rapid pace in the coastal provinces. As a result, foreign
irms’ share of exports rose from 1% in 1985 to more than 50% in 2005 (Hofman,
Zhao and Ishihara 2007).
It seems that EPZs are particularly important in countries with poor institutions. In those instances, EPZs allow foreign MNEs to avoid some of the domestic
regulations and constraints. As countries develop, conditions in the surrounding
economy tend to converge with those in the EPZs, and the role of the latter tends
to decline.
Summary
East Asian countries as a group have for several decades been superior to other
developing regions in respect of all the characteristics identiied here as attractive
to investment by multinational irms. This has been the case for the education of
the labour force, the control of corruption, the atmosphere for conducting business, the reliability of the infrastructure needed for coordinating chains of supply
and production, and the willingness to make changes in institutions to attract
foreign irms. The result has been a higher presence of foreign multinationals in
East Asia than in other areas of the developing world.
INDONESIA AS A RECIPIENT OF FDI
We have shown that FDI inlows have been large to most countries in East Asia,
but relatively modest to Indonesia. A useful way of describing Indonesia’s record
in attracting inward FDI is to compare inward stocks over time with what might
be predicted from equations that relate the expected inward stock to possible
determinants of FDI inlow. In other words, how did Indonesia perform in terms
of FDI inlows given its economic characteristics and performance on standard
macroeconomic indicators?
In one of these calculations, the variables used for the prediction are the real
GDP of the country ive years earlier, growth in real per capita GDP in the previous ive years, and a measure of the openness of the economy’s trade policy that
we call ‘residual openness’. This is the residual from an equation relating a standard measure of openness – the ratio of exports plus imports to GDP – to a country’s population and land area. It takes account of the fact that larger countries,
in terms of both population and land area, trade less, relative to GDP, than small
countries with the same degree of deliberate trade restriction. It is an attempt to
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Robert E. Lipsey and Fredrik Sjöholm
TABLE 5 Ratio of Actual to Predicteda Inward FDI Stock, 2005
Host Country
2005
Singapore
South Korea
Thailand
Taiwan
Chinab
Malaysia
Indonesia
Philippines
2.16
1.78
1.52
1.28
0.94
0.77
0.59
0.52
a Predicted from equation:
FDI Inward Stock t = α + β1 GDPt − 5 + β 2 per capita GDP growth + β 3 RES .Op .t − 5
GDP is real GDP at the economy level, which is the product of real GDP per capita and population, both
from the Penn World Table (Heston, Summers and Aten 2009). Per capita growth is calculated using the
real GDP per capita chained index based on 2005 (see ). Residual openness (‘RES.Op’) is calculated as the residual of the regression of trade share
on population, land and a constant term. The samples in that regression are all the countries for which
data were available, excluding OECD countries other than South Korea and Mexico. The same countries were used to calculate predicted inward stock except where necessary variables were unavailable.
Negative openness estimates were replaced by zero.
Most data were obtained from the World Bank’s World Development Indicators at . Data on the trade share for Singapore are from the Penn World Tables at . For Taiwan, the data are from
National Statistics, Republic of China (Taiwan), at . Data on
FDI inward stock are from the online database of UNCTAD (see source for table 1).
b
Hong Kong is combined with China in this table. The inward FDI stock in China is China’s inward
stock plus Hong Kong’s inward stock minus its outward stock.
Sources: See note a for sample sources.
provide a more precise measure of the openness of trade policy than a simple ratio
of trade to output.
Table 5 compares the inward FDI stocks predicted from such a regression with
actual stocks in 2005. The actual inward stock of FDI in Indonesia in 2005 (as
reported by UNCTAD at ) was 59% of the
stock predicted by the equation shown below table 5. Actual levels for four East
Asian countries were higher than predicted levels, and only the Philippines had a
lower ratio than Indonesia of actual to predicted FDI stock.
The data on aggregate stocks and lows of FDI to individual countries are subject to many problems of measurement and interpretation. For some countries,
such as Hong Kong and Singapore, part of the FDI inlow does not add to the
productive assets of the nominal destination country, but moves through to other
countries, where it inances the creation of physical capital and the employment
of labour.
For FDI from the US, more information is available about the composition and
characteristics of lows and stocks. The main advantage of this is that we can study
the real activities of multinational afiliates rather than looking at inancial lows.
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Foreign direct investment and growth in East Asia: lessons for Indonesia
47
Employment in all US afiliates, and in manufacturing afiliates, can be predicted
from the same independent variables that were used to predict the stock of inward
FDI for table 5. These predicted levels can then be compared with data from actual
surveys of US multinationals that give revised estimates of afiliate employment
by country of location in 1985, 1990, 1995, 2000, and 2005 (available at ).
Employment in all US afiliates in Indonesia between 1985 and 2005 ranged
from about half of the predicted level to a peak of 90%. For no other Northeast
or Southeast Asian country was the over-prediction of US afiliate employment
consistently greater than for Indonesia. Employment in US afiliates in manufacturing in Indonesia was only 11% of the expected level in 1985, but it increased
steadily to over 80% of expected employment in 2005, close to the median. In
absolute terms, it was only a fraction of afiliate manufacturing employment in
such small economies as Hong Kong and Singapore, until a more than doubling
from 2000 to 2005 brought it above the levels in both of these countries.
In contrast, the level of physical capital in US afiliates in Indonesia, as represented by net property, plant and equipment, was far above the predicted values in
all the years from 1985 through 2005. That contrast is explained, as discussed below,
by the large role of investment in capital-intensive mining in US FDI in Indonesia.
The igures above suggest, again, that the inlow of FDI to Indonesia, and
especially the inlow to labour-intensive manufacturing, is lower than would be
expected from standard macroeconomic indicators. Below we try to determine
why FDI lows to Indonesia are low. One possibility is that FDI to Indonesia is
concentrated in sectors where alternative locations are few, and that multinational
irms choose other countries for their investments in sectors where there are alternatives.
Some support for this hypothesis is given by igures on employment in afiliates of US irms in Indonesia and other East Asian countries (table 6). The composition of US irms’ employment in Indonesia was very different from that in
the other East Asian countries shown. The share in mining was much higher in
Indonesia, at over 27%. In none of the other countries was that share over 2.1%.
The share in machinery is particularly low in Indonesia, at less than half of 1%,
while in the other countries (except the Philippines) it ranged from 1.3% to 5.8%.
Computers and electronic products accounted for less than 1% of employment in
US irms’ afiliates in Indonesia, whereas the shares in the other countries ranged
from 3.6% in Hong Kong to over 50% in Malaysia. In general, investment in Indonesia from the US avoided the manufacturing industries in which technology was
important. An exception is chemicals, in which investment was probably drawn
to Indonesia by the petroleum industry. The low share of US FDI in electronics
suggests that Indonesia plays a quite minor role in the production networks of
US-based MNEs. The ’other manufacturing‘ industries, which account for over
one-third of US afiliate employment in Indonesia, include beverages and tobacco
products; textiles, apparel and leather products; wood and paper products and
printing; petroleum and coal products; and furniture and related products. These
are mainly relatively low-tech industries.
The view that Indonesia is largely excluded from US multinationals’ production networks is supported by the low share of the sales of manufacturing afiliates
in Indonesia that are made outside the host country (table 7). US manufacturing
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Robert E. Lipsey and Fredrik Sjöholm
TABLE 6 Shares of Industries in Employment by All Non-bank Afiliates
of US Parent Companies, 2007a
(% of employment in all industries)
Indo- China Hong South Malay- Philip- Singa- Taiwan Thainesia
Kong Korea
sia
pines pore
land
All industries
Mining
Utilities
Manufacturing
Food
Chemicals
Primary & fabricated metals
Machinery
Computers & electronic
products
Electrical equipment, appliances & components
Transport equipment
Other
Wholesale trade
Information
Finance (except depository
institutions) & insurance
Professional, scientiic &
technical services
Other industries
100
27~33
0.6
100
0~1
0.0
100
0.0
0~1
100
0.0
0.0
100
2.1
0.0
100
0.0
0~1
100
1.1
0.0
100
0.0
0.0
100
1.5
0.0
55.6
5.2
9.4
60.7
3.1
6~13
40~47
0.2
1.8
60.5
1~2
3.8
71.7
0.8
4.2
55.8
11.3
4.7
49.7
0.3
4.8
35.9
0.6
4.1
73.0
11.2
5.8
0.6
2.3
0.6
1.2
0.1
0.1
0.2
1.0
0.6
0.4
5.8
1.6
4.9
1.3
0.3
4.6
2.3
0.9
17.9
3.6
13.8
51.9
22.2
1~2
5.4
4~8
1~2
2~5
4~9
1.0
5~10
0.6
1.0
36~37
1.7
1~2
6~13
1~14
5~6
1.2
1.3
8~10
6.6
0.7
4~9
0~9
2.8
0.5
4.2
0~15
12.8
4.4
2.5
0~11
11.8
2.0
5.2
22~24
4.9
0.3
2.7
0.7
8.3
4~8
2.4
2~3
4.9
10~24
3.9
0.9
1.7
7.3
4.6
2.9
16.1
8.3
5~10
1.3
5~9
30.0
13.6
21.5
18.7
24~36
15.2
0.0
21~33
29~31 0~15
13.7
7.7
3.3
1.9
20~27 17~21
20~35 10~16
2~3
24.4
a ‘0’ indicates fewer than 500 employees. Some shares, such as for mining in Indonesia, can only be
shown as ranges (indicated by ‘~’), because the numbers are suppressed in the source to preserve the
conidentiality of individual irm responses.
Source: USBEA (2010).
afiliates in Indonesia made only about 21% of their sales outside the country,
while those in Taiwan and Thailand made over 40% of their sales abroad, and
those in the other East Asian countries (except China and South Korea) made over
50% of their sales outside their home markets.
We also examined inlows of FDI from other countries where similar data on
the activities of foreign afiliates are available. This partly conirmed our inding
that inlows of FDI to Indonesia were lower than could be expected.8 Germany’s
FDI in Indonesia was lower than would be expected from a prediction based
on its FDI in all developing countries, whereas employment in Japanese-owned
manufacturing plants in Indonesia was close to predicted levels.
The variables included in the predictions described above relate to Indonesia as
a market for the investing irms and therefore capture mainly market-seeking FDI.
8 The results are available upon request.
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Foreign direct investment and growth in East Asia: lessons for Indonesia
49
TABLE 7 Share of Sales Outside the Host Country by Majority-owned
Foreign Manufacturing Afiliates of US Parent Companies, 2004a
(%)
Host Country
Malaysia
Philippines
Singapore
Hong Kong
Thailand
Taiwan
China
Indonesia
South Korea
%
72.2
69.2
59.9
50.9
44.1
41.4
31.1
20.9
15.0
a Sales outside the host country are total sales by afiliates minus local sales by afiliates.
Sources: ; USBEA (2008).
However, our results are corroborated in other studies using broader sets of variables that relect Indonesia’s attractiveness as a location for export-oriented production. For instance, UNCTAD (2010) conirms Indonesia’s under-performance
in terms of FDI inlows relative to predictions based on a set of country
characteristics. This source ranks Indonesia 119th of 141 countries in terms of FDI
inlows, but 85th in terms of an estimate of potential inlows based on 12 economic
and policy variables.
The history of FDI in Indonesia has thus been one of fairly low participation
of foreign irms compared with other countries in the region. Indonesia is not
the country most closed to foreign irms, but it ranks low as a location for FDI in
general and for participation in chains of production organised by foreign irms.
In its modest inlows of FDI, Indonesia stands in sharp contrast to neighbouring
countries, which are all characterised by a heavy concentration of MNEs.
THE EFFECT OF FDI ON THE INDONESIAN ECONOMY
It would be in Indonesia’s interest to increase inlows of FDI only if such inlows
beneit the country. We therefore briely survey the literature on the effects of FDI
in Indonesia. Table A1 in the appendix lists studies that look at a range of effects
of FDI. They show surprisingly consistent beneits to Indonesia from FDI.
Productivity
Foreign irms bring in new production processes or begin to produce new products. These beneits to the country are likely to manifest themselves in relatively
high productivity in foreign irms. A number of studies show that this is indeed
the case for Indonesia: foreign irms have higher labour productivity and higher
total factor productivity than local irms. Moreover, not only the level but also
the growth of productivity is higher in foreign irms. Finally, all of the studies
listed in appendix table A1 ind productivity to be higher in foreign than in
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Robert E. Lipsey and Fredrik Sjöholm
local irms even after controlling for irm characteristics such as size and capital
intensity.
Exports
The literature also reveals a clear difference in export intensities between foreign and domestic irms: foreign irms are substantially more integrated into the
international economy through exports. This is not surprising: it is a result found
in most countries. One interesting inding on Indonesia is that even foreign irms
that start producing only for the Indonesian market are better able than local irms
to switch to producing for export.
Wages
Foreign-owned establishments in Indonesia are found to pay higher wages than
domestically owned irms, even when the studies control for the educational level
of their employees. Accordingly, foreign acquisition of an Indonesian manufacturing plant results in higher wages for the plant’s employees. Foreign irms also
pay a higher premium for higher levels of education than do domestic irms. Foreign irms’ entry thus increases not only wages but also the returns to education,
thus encouraging investment in further education.
Employment
A similar story applies to growth in employment. Foreign irms exhibit higher
growth in employment than domestic irms. Moreover, foreign acquisitions of
domestic irms increase growth in employment, despite the fact that foreignowned irms are relatively large and large irms tend to have relatively low
growth rates of employment.
Spillovers to local irms
The studies listed in table A1 suggest that foreign irms have higher productivity
and higher exports, pay higher wages and demonstrate higher growth in employment than domestic irms. If local irms beneit from FDI, it is clear that there are
gains to the country from hosting foreign MNEs, but the beneits are less clear if
local irms are instead hurt by the presence of foreign irms. The effects of FDI
on local irms are often termed ‘spillovers’. Positive spillovers could arise, for
example, from the transfer of technologies from foreign to domestic irms or from
the expansion of markets for domestic suppliers of intermediate goods. Negative
spillovers could result from increased competition if this forces domestic irms
out of business or compels them to operate at a lower scale of production.
Appendix table A2 summarises existing studies of spillovers in Indonesia.9
Most studies focus on spillover effects on productivity, but there are also two
studies of wage spillovers. All of the studies ind evidence of positive spillovers
– of local irms beneiting from the presence of foreign irms within the industry
or region. For productivity, the positive effect is likely to come from technology
spillovers – new technologies and knowledge that are made available to domestic
irms – and from increased competition, a pressure to improve to secure market
share and survival. For wages, the positive effect of FDI is likely to be the result
9 See also the review article on spillovers in Indonesia by Lipsey and Sjöholm (2005).
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