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The Role Of The State In The Development Of The Indonesian Textile And Garment Industries

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The Role Of The State In The Development Of The Indonesian Textile And Garment Industries

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UMI
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THE ROLE OF THE STATE IN THE DEVELOPMENT OF THE
INDONESIAN TEXTILE AND GARMENT INDUSTRIES
by
Chandra Emirullah
A Dissertation Presented to the
FACULTY OF THE GRADUATE SCHOOL
UNIVERSITY OF SOUTHERN CALIFORNIA
In Partial Fulfillment of the
Requirements for the Degree
DOCTOR OF PHILOSOPHY
(Political Economy and Public Policy)
August 1995
UMI Number: 9616956
UMI Microform 9616956
Copyright 1996, by UMI Company. Ail rights reserved.
This microform edition is protected against unauthorized
copying under Title 17, United States Code.
UMI
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UNIVERSITY OF SOUTHERN CALIFORNIA
THE GRADUATE SCHOOL
UNIVERSITY PARK
LOS ANGELES, CALIFORNIA 90007
This dissertation, written by
under the direction of h./..$.. D issertation
Committee, and approved by all its members,
has been presented to and accepted b y The
Graduate School, in partial fulfillm ent of re
quirem ents for the degree of
D O C TO R OF PH ILOSOPH Y
C. . ✓
Dean of Graduate Studies
Date SlS
DISSERTATION COMMITTEE
Chairperson
DEDICATED TO MY BELOVED MOTHER, NURLINA TIWON,
MY LOVELY WIFE, DESY, AND MY WONDERFUL CHILDREN
ROMY, WINDY, RICO AND MELISA.
ACKNOWLEDGEMENT
I would like to thank Drs. John E. Elliott, Laurie Brand
and Yan Tang who have provided me with valuable insights
during the writing of this dissertation and Farideh Motamedi
for her support during my study at USC.
TABLE OF CONTENTS
DEDICATION
ACKNOWLEDGEMENT
LIST OF TABLES
LIST OF FIGURES
CHAPTER
CHAPTER
I.
II
CHAPTER III.
CHAPTER IV.
CHAPTER
CHAPTER
CHAPTER
V.
VI.
VII .
CHAPTER VIII,
BIBLIOGRAPHY
INTRODUCTION
THE DEBATE ON THE RELATIVE ROLES OF
MARKET AND STATE IN ECONOMIC DEVELOPMENT
THE DEVELOPMENT OF THE INDONESIAN TEXTILE
AND GARMENT INDUSTRIES (1950-1984)
GOVERNMENT POLICIES AND THE DEVELOPMENT
OF THE INDONESIAN TEXTILES AND GARMENT
INDUSTRIES DURING EXPORT-ORIENTED
INDUSTRIALIZATION (1985-PRESENT)
THE MULTIFIBER ARRANGEMENT AND THE
INDONESIAN TEXTILE EXPORT QUOTA
ALLOCATION SYSTEM
LABOR - GOVERNMENT RELATIONS
THE EXPERIENCES OF THE EAST ASIAN NICs
IN THE DEVELOPMENT OF THE TEXTILE AND
GARMENT INDUSTRIES
CONCLUSIONS
XI
iii
iv
vii
1
10
50
93
138
173
205
248
257
iv
LIST OF TABLES
3.1.
3.2 .
3.3.
3.4.
3.5.
3.6.
3.7.
3.8.
3.9.
3 .10
4.1.
4.2 .
4.3 .
4.4.
4.5.
4.6.
4.7.
Change in Real Gross Domestic Product (GDP),
1960-1992 54
Average Annual Growth of Manufacturing
Industries, 1960-1992 56
Manufactured Exports, 1980-1992 58
Rates of Inflation, 1960-1990 68
Oil and LNG Exports, 1969-1986 69
Effective Rates of Protection for Textiles
and Garments, 1971, 1975, and 1984 82
Production of Textile Products and Garments,
1975-1984 83
Textile Machineries, 1971, 1981, and 1984 84
Exports of Textile Products and Garments,
1974-1984 88
Distribution of Manufacturing Value-Added in
the Textile Sector in 1975 and 1985 89
Economic Conditions of Indonesia (1979-1986) ,
Selected Years 94
Investments in the Textile Sector (1985-1992) 109
Exports Values and Shares of Textile Products
Using BAPEKSTA Facilities (1987-1992) 112
Total Credit Allocated to Textiles and Garment
Industries (1986-1993) 118
Export Insurance Coverage for Textiles and
Garments through ASEI (1986-1992) 121
Effective Rates of Protection for Textiles and
Garments, 1984, 1987, and 1989 127
Effective Rates of Protection for Textile and
Apparel Producers by Sales Destination, 1989 128
4.8 .
4.9.
4 .10
4.11
5.1
5.2
5.3
5.4
5.5
5.6
5.7
5.8
5.9
6.1
6.2
6.3
7.1
Estimates of the Effective Rates of Assistance
for the Weaving and Garment Industries, 1988
Textile Machineries, 1985, 1989, and 1993
Production of Textile Products and Garments
(1985-1992)
Exports of Textile Products and Garments,
1985-1992
The Number of Quota-Restricted Categories of
Indonesian Textiles and Garment Products by
Importing Countries (1982-1992)
Trade Coverage Ratio of Indonesian Exports
to the United States, 1988-1989
Trade Coverage Ratios of Indonesian Textile
Exports to the European Community, 1987-1989
Quota Utilization Rates for Garment Exports
to the United States, 1985/86-1991/1992,
Selected Years
Quota Utilization Rates for Garment Export
to the European Community (1985-1992)
Unit Values of Indonesian Garment Exports to
the Major MFA-Restricted Countries (1988-1992)
Values and Shares of Indonesian Textile and
Garment Export According to the Type of
Importing Countries (1987-1992)
Values and Shares of Indonesian Textiles and
Garment Exports According to the Type of
Importing Country (1987-1992)
Unit Values of Product Categories with High Quota
Utilization for the United States (1988-1989)
Strikes/Work Stoppages in Selected Asian
Countries, 1961-1990
Hourly Textile Labor Cost in Selected Countries,
1985/6, 1990, and 1991
Labor Market Conditions in Indonesia
Main Textile Exporting Countries, 1990
129
131
132
134
154
155
156
165
166
167
168
169
171
186
196
198
206
vi
7.2 Main Garment Exporting Countries, 1990 207
7.3 Approximate Effective Exchange rates of
Cotton Yarn Applicable to Domestic Sales
and Exporting, 1953 and 1966
7.4 Values of Production and Export of Textiles
Products of Taiwan, Selected Years, 1964-1986
7.5 Effective Exchange Rates for Exports and
Imports, Selected Years, 1964-1975
7.6 Production and Export Values of Textiles and
Garment of South Korea, Selected Years,
1970-1988
7.7 Effective Rates of Assistance of Thai Textiles
and Garment, 1985
7.8 Production of Textiles and Garment of Thailand,
Selected Years, 1970-1986
7.9 Export Values of Textiles and Garment from
Thailand, 1982-1988
216
217
229
229
242
242
243
vii
LIST OF FIGURES
4.1 Real Effective and Nominal Exchange Rate
Index (1979-1990) 104
viii
CHANDRA EMIRULLAH JOHN E. ELLIOTT
ABSTRACT OF
THE ROLE OF THE STATE IN THE DEVELOPMENT OF THE INDONESIAN
TEXTILE AND GARMENT INDUSTRIES
The purpose of this dissertation is to examine the -role
of the Indonesian government in developing its textile and
garment industries which have experienced remarkable expansion
during the New Order period. The study was motivated by the
ongoing debate between the neoclassical economists and the
interventionists about the economic role of government. In the
last several years the debate became more heated and focused
as adherents of both schools use the success of the East Asian
NICs to vindicate their views.
I examined four major aspects that affected the
development of the Indonesian textile and garment industries:
import-substitution industrialization (ISI) policies, export-
oriented industrialization (EOI) policies, the textile export
quota allocation system, and government-labor relations.
During the ISI period, the nationalists played an
influential role in shaping industrial development policies,
strengthened by the oil bonanza. By adopting protective
policies the government created a great incentive to produce
for the domestic market relative to exports resulting in rapid
development of the textile and garment industries. By the mid
1970s, domestic demand for basic clothing had been met and a
large export capacity created.
l
The dramatic drop in oil prices in the mid 1980s forced
the government to reorient its industrial development strategy
to EOI giving the liberal technocrats the helm of
policymaking. The switch to the EOI, however, did not lead to
a smaller government role in industrial development. The
government took a range of measures to promote exports,
creating a great incentive to export relative to sell in the
domestic market. As a result, the exports of textiles and
garments expanded very rapidly contributing to industrial
growth and foreign exchange earnings. The textile export
success was also supported by the government's effectiveness
in managing export quota allocation and controlling labor
unions to create industrial peace.
A comparative study of Taiwan, South Korea and Thailand
shows that the governments of these countries also played
significant roles in developing their textile and garment
industries with a similar pattern of government intervention.
Based on these results, I conclude that a government can play
a positive role in industrial development by creating a sound
macroeconomic and productive environment and providing
incentives and disincentives based on performance to enhance
entrepreneurs' competitiveness.
CHAPTER I
INTRODUCTION
1.1. INTRODUCTION TO THE PROBLEM
The role of the state in economic development has long
been a topic of heated debate among economists and political
scientists as well as policymakers. Those who believe in the
efficacy of the free-market system {i.e. the Neoclasscists)
espouse a minimal role for the government, to allow the market
mechanism to allocate available resources to achieve maximum
efficiency and thus promote economic growth. On the other
hand, those who are dissatisfied with the working of the
market mechanism (i.e. the Interventionists) advocate an
active state role in the economy to influence resource
allocation in order to attain development objectives. The
controversy regarding the relative roles of market and state
that can best promote economic development can be traced back
at least to Adam Smith's and Alexander Hamilton's era in the
eighteenth century and continues into the present twentieth
century.
In the 1950s and 1960s, the prevalent view was that the
state should play a major role in the economy to correct the
market failures inherent in the operation of the market
system. In less developed countries (LDCs), this view was
1
accepted with great enthusiasm by political leaders and
policymakers. The state was assigned the role of leading
industrialization efforts to speed up economic development.
Except for a few states, the results were not very
encouraging, however. Many of the LDCs are still caught in
serious economic problems resulting from the distortions and
inefficiencies caused by government intervention in the
economy.
Some developing countries have suceeded in achieving high
rates of economic growth and industrialization, namely, the
newly industrializing countries (NICs). The more well-known
among this group are four East Asian countries: South Korea,
Taiwan, Hongkong and Singapore. There are some indications
that four other countries from this region (Malaysia,
Thailand, China and Indonesia) are in varying degrees
following the path of those newly industrializing countries.
Although it is generally agreed that the governments of
these East Asian countries have a role in the
industrialization of their economies, there is debate as to
the extent and nature of their intervention. While some
authors contend that government interference in these
economies was minimal and directed to correct market
imperfections, others claim that it was more complex and
affected many sectors of the economy.
In this dissertation, I would like to illuminate this
issue by examining the role and effectiveness of the
2
Indonesian government in promoting its textile and garment
industries. During the last ten years, Indonesia has achieved
an impressive growth of textile and garment production and
exports. In 1982 the export value of these products was only
$160 million; but in 1992 it reached $6 billion, making
Indonesia one of the major textile and garment exporters in
4
the East Asia region. The development of these industries has
contributed to overall growth of industry and employment
creation and thus economic growth. The rapid growth of exports
of textiles and garments seems to repeat the pattern
experienced earlier by the Newly Industrializing Countries,
such as Hong Kong, Taiwan and South Korea.
Another reason I have chosen the textile and garment
industries as the object of the study is that these industries
are labor-intensive and have relatively unsophisticated
technologies, suitable for the less developed countries at an
early stage of industrialization. Some authors say that these
industries could pave the way for more advanced industries by
accumulating technology and foreign exchange earned from
exports. Due to their high labor costs, it is often claimed
that developed countries are losing competitiveness in these
products, providing the opportunity for the LDCs to earn the
much needed foreign exchange to finance their development. The
experience of the East Asian NICs (as well as the classic case
of Great Britain in the Industrial Revolution) show that the
3
textile and garment industries were among the first to develop
before other more advanced industries.
1.2. HYPOTHESIS AND PURPOSE OF THE STUDY
The Indonesian government has a long history of
involvement and protection in its textile industry, but during
the last ten years there has been a rapid growth of textile
and garment exports. This phenomenon seems to be in conflict
with the neoclassical economic view that government
intervention (such as protection and regulation et cetera) in
a specific industry is undesirable because it does not enhance
efficiency, so it would be difficult for the products to be
competitive in the world market. However, the experiences of
Indonesia and other East Asian countries show that the
development of their industries and thereby exports has been
stimulated by government policies and intervention. This
phenomenon led me to the following hypothesis:
The remarkable growth of the textile and garment exports in
Indonesia was the result of government intervention.
The purpose of this study is to assesss this hypothesis
by examining specifically:
1. The form and extent of Indonesian government intervention
in the textile and garment industries.
2. The effects of government intervention on the development
of textile and garment industries and exports.
4
3. The effect of the Multi-Fiber Arrangement(MFA) on the
textile and garment exports and the corresponding
government role.
4. The effect of government's labor relations policy on wages.
5. Comparisons between the Indonesian and the NlCs' government
policies toward their textile and garment industries.
1.3. SIGNIFICANCE OF THE STUDY
As noted, there is a vigorous debate about the role of
the state in the economy. Neoclassical economists advocate a
minimal role of government in the market to avoid distortions
and inefficiencies retarding economic growth, while the
interventionists emphasize an active role of state in the
economy so that economic agents and resources can be promoted,
directed and allocated into desired activities. The economic
success of the East Asian newly industrializing countries has
renewed and refocused the debate. Neoclassicists admit there
was some government intervention in these economies, but claim
that this intervention was directed simply to minimize market
imperfections. Interventionists, on the other hand, argue that
the NICs1 success was caused by active government involvement
as well as government's ability to guide the economy.
It is clear that more studies are needed to clarify the
proper roles of state in economic development. This study,
which will examine the role of the Indonesian government in
the development of its textile and garment industries, should
5
illuminate this issue. An examination of government
intervention in Indonesia, and comparisons with the experience
of the Newly Industrializing Countries, should reveal and
enhance the understanding of strategies and measures taken by
these countries to promote their textile and garment
industries. The lessons that may be derived from this study,
especially regarding the kinds of government intervention that
have worked successfully, hopefully should be beneficial for
other less developed countries aspiring to achieve
industrialization and economic development.
1.4. SCOPE AND DEFINITIONS
As noted in the study’s statement of purpose, this
dissertation attempts to investigate the role of the state in
promoting the growth of the textile and garment exports. Some
definitions are in order. Textile products are defined to
consist of fiber, yarn, fabrics and other products. Garments
are ready-to-wear clothing such as shirts, blouses, pants,
jeans, skirts and so on, which use fabrics as their main
inputs. The role of the state is defined here as the form,
extent and effect of measures taken by a government or state
apparatus in order to affect the growth of those industries.
The countries which are objects of this study are Indonesia,
Taiwan, South Korea and Thailand. The time dimension of the
study will depend on the period during which the textile and
garment industries achieved rapid growth of production and
exports in each country. In Indonesia this is the period of
1972-1992. This study is limited to the analysis of the role
of the state and does not attempt to analyse the welfare
effects of government intervention.
1.5. METHODOLOGY
The hypothesis will be assesed by examining the five
specific objectives stated in the purpose of this study. The
forms of government intervention will be described and those
which can be quantified will be assessed using the concepts of
the effective rate of assistance/protection (ERA/ERP) and
effective exchange rates (EER). The effects of government
measures on sales incentives, namely sales for home and export
markets, will be examined by relating them to ERA/ERP and EER.
Government efforts in attracting foreign direct investments
will also be examined. The effects of government policies on
development of the textile and garment industries during
import-substitution industrialization (ISI) and export-
oriented industrialization (EOI) will ba evaluated.
The demand side of the textile and garment exports will
be addressed by examining the impact of the Multi-Fiber
Arrangement (1985-1992) and relevant government measures such
as in allocation of textile export quotas. The political
economy aspect will be discussed by looking into the
government-labor relationship which affected labor market
7
policy and determination of wages as one of the main
determinants of product competitiveness. Finally, based on the
framework used to analyse the Indonesian case, a similar but
more general analysis will be conducted on the experiences of
South Korea, Taiwan and Thailand to discern whether there is
a pattern of government intervention in these four countries.
1.6. ORGANIZATION OF THE STUDY
This dissertation is organized as follows. Chapter 1
states the hypothesis, purpose, significance, scope,
methodology and organization of the study. Chapter 2 reviews
the literature on the role of the state in economic
development and industrialization. It considers the economic
role of the state, the role of government in the East Asian
Newly Industrializing Countries, export-led industrialization
strategy in the NICs, and previous studies on textile and
garment industries. Chapter 3 reviews the development of the
Indonesian textile and garment industries in the 1950-1984
period. Chapter 4 examines government policies and their
effects on the export and production growth of textile and
garment during the export-oriented industrialization period
(1985-1992) . Chapter 5 focuses on the effect of the Multi-
Fiber Arrangement on the exports of Indonesian textiles and
garments as well as the role of government in textile export
quota allocation. Chapter 6 analyses labor-government
relations affecting these industries. Chapter 7 contains
8
comparisons of government policies toward textile and garment
industries in three East Asian countries, namely South Korea,
Taiwan and Thailand. Chapter 8 ends the study with
conclusions.
9
CHAPTER 2
THE DEBATE ON THE RELATIVE ROLES OF MARKET AND STATE
IN ECONOMIC DEVELOPMENT
The purpose of this chapter is to review the literature
on the role of the state in economic development and
industrialization. First, the main theoretical approaches, the
neoclassicist and the interventionist, which form the
foundation of the ongoing debate on the economic role of
state, are discussed. Next, these two different
interpretations of the role of government in two large East
Asian NICs, Taiwan and South Korea (which are more comparable
to Indonesia and Thailand than the two city-state NICs, Hong
Kong and Singapore), are reviewed. This will be followed by a
discussion of the export-led industrialization strategy which
forms the theoretical framework of this, study. A review of
previous studies on textiles and garments then follows.
Finally, a summary will be presented.
2.1. THE ROLE OF MARKET AND STATE IN ECONOMIC DEVELOPMENT
2.1.1. The Neoclassicist View
In principle, the neoclassicist view of the relative
roles of market and state in the economy is based on Adam
10
Smith's notion of the "invisible hand" contained in his
famous treatise The Wealth of Nations (1937/1776). He argued
that economic progress will be best achieved if the allocation
of resources in an economy is left to market forces instead of
to state intervention as was commonly held by the
mercantilists in his era. He envisioned markets to comprise
many individual economic agents, consumers and producers, who
are assumed to be utility maximizers. Markets allow
specialization and facilitate exchange between economic
agents, resulting in an equilibrium where demand equals supply
at a certain quantity and price.
The competition of many small producers to get profit
will bring to the market goods and services demanded by
consumers at the lowest possible price. Thus the market system
via the price mechanism functions as "an invisible hand,"
which allocates scarce resources according to their best uses,
generating output in the most productive manner for the
welfare of the overall society. As Blaug phrases it, "each man
if let alone, will seek to maximise his own wealth; therefore
all men, if unimpended, will maximise aggregate wealth."
(Blaug 1978: 57).
Based on this optimistic view of the market, the
neoclassicists contend that there is no need for the state to
interfere in the operation of the market mechanism. Whatever
allocation of resources and investment is generated is already
(in the sense of Pareto-optimality). Any interference in the
11
market mechanism will send the wrong signals to market
participants and therefore will result in inefficient economic
outcomes.
Nevertheless, the neoclassicists admit that in some cases
markets fail to supply goods and services demanded by the
public, allowing the state to step in to correct them. In this
regard Smith mentioned "three duties of great importance" for
the state: provision of security, administration of justice
and public infrastructure, where the costs of providing these
goods are too high for private producers. Besides supplying
these public goods, state intervention may be justified by a
neoclassicist in the cases of regulatory framework, imperfect
competition (e,g.monopoly), externalities and incomplete
markets. Other than these, the state is assigned the duty of
"nightwatchman," responding passively to the imperfections in
market operations.
The neoclassical principle of free-market also applies in
the realm of international trade based on comparative
advantage theory, inspired by Adam Smith and developed by
David Ricardo (1871/1817) . It says that to achieve maximum
national and international welfare, countries should
specialize in goods that they can produce at the lowest
comparative costs. This means producing goods that require the
kinds of inputs with which they are relatively well-endowed.
Thus, a country that possesses abundant natural resources
would benefit most by specializing in and trading natural
12
resource-based commodities, while a country that is well-
endowed with abundant labor should specialize in labor-
intensive products. The pattern of production regulated by the
principle of comparative advantage is believed by
neoclassicists to result in efficient allocation of resources
and ultimately in maximum economic welfare. This requires a
regime that does not interfere with the price mechanism: a
free trade regime. Consequently, protectionist measures, which
create a wedge between the home and world prices, induce
distortions in production and consumption patterns, resulting
in economic inefficiencies and welfare losses.
The Neoclassical Political Economy
The neoclassicists are concerned not only with
inefficiencies caused by distortions in the market place but
also with those resulting from distortions in political life.
The literature that deals with the latter topic is known as
neoclassical political economy. It emphasizes the welfare
costs associated with rent-seeking activities (Srinivasan
1985: 41). Anne Krueger argues that government measures to
protect domestic producers from imports create rents by
raising the prices of domestically produced tradable goods
above their world prices. In order to reap maximum rents,
domestic producers may invest in production capacity to a
level that is uneconomical in terms of efficiency {Krueger
1974). Besides, much of the effort expended to acquire rents
13
is not productive activity that contributes to the generation
of goods and services beneficial for the whole society
(Bhagwati 1982) .
The underlying cause of government measures to protect
domestic producers in specific sectors may lie in interest
groups or bureaucrats themselves. Mancur Olson contends that
in a politically stable society, interest groups have ample
opportunities to affect government policies for the sake of
their own fortunes by organizing their activities and lobbying
government officials. Selective intervention which creates
rents for certain firms activates interest groups in order to
capture the rents (Olson 1982). The initiative of
intervention may originate from bureaucrats themselves, who
find it compatible with their objective of maximizing their
official budget (Niskanen 1971). In this view, government
interference in the working of the market mechanism is
motivated by self-serving interest that would result in less
than optimal economic performance (Islam 1992: 72).
Consequently, neoclassicists are not very enthusiastic
about market failure arguments which often are used by
structuralist economists to call for the government to
intervene in certain sectors of the economy. According to
them, market failures that can be corrected by selective state
intervention are rare. Even in the strong cases of market
failure such as imperfect capital markets, the protection
should be non-discriminatory among sectors so that resources
14
are not allocated in an inefficient manner. The neoclassicists
do not have much faith in the capability of the state to
protect or promote certain firms without being captured by
interest group politics which subvert public policies. In this
view, an imperfect market solution is much better than an
imperfect state. The implication is that government should
restrain itself from interfering in the economy, the market
should be given free-rein in determining resource allocation,
and, most important, a free-trade regime should prevail in
order to facilitate the economy's achieving its maximum
potential.
The failure of many LDCs to achieve sustainable
development by implementing import - substitution
industrialization (ISI) and the success of a small group of
NlCs that adopted export-oriented industrialization (EOI) has
been associated by the neoclassical economists with excessive
government intervention in the former and minimal government
intervention in the latter. There is no surprise in the
prescription given by these economists, especially those from
the World Bank and the IMF, for the LDCs which are suffering
from economic stagnation or slow growth; the advice is the
reduction of the state role in the economy by liberalization
and privatization. The importance of "getting prices right"
has been the universal message of the neoclassical economists
for LDCs all over the world.
15
2.1.2. The Interventionist View
The interventionist view of economic development is
inspired by Alexander Hamilton, who provided a classic
intellectually coherent argument for state intervention in the
economy. In his Report on Manufactures (1964/1790), he
disagreed with Adam Smith's view of the limited role of
government in the economy. On the contrary, he proposed a much
greater role for the United States government in order to
promote its manufacturing industries over agriculture and thus
economic development. He suggested that the fostering of
domestic industries could be accomplished by restricting
imports of competing goods from the countries that had more
established industries and by providing infrastructure such as
public roads to facilitate transportation and a central bank
to facilitate investment.
In Germany, Hamilton's ideas were introduced by Friedrich
List who wrote an influential book, The Natural System of
Political Economy (1983/1837), contending that free trade
theory was the brainchild of the English economists to
validate the imposition of the international division of labor
for the benefit of English manufacturers. Their own
manufacturing firms were protected by state power when they
were in their infancies. He argued that comparative advantage
can be nurtured, provided the domestic fledgling industries
16
are given protection in reasonable time before jumping into
competition with the more experienced producers of other
countries.
In the twentieth century the argument for greater state
intervention in the economy, especially in the advanced
capitalist countries, got a new rationale with the birth of
Keynesian economics. Criticizing neoclassical economic theory,
Keynes maintained that market economies, if left alone, cannot
produce optimal results because of imperfections in market
behavior. Contrary to the neoclassical belief in the
flexibility of key economic variables, Keynes showed that
relative downward rigidity in interest rates (that is,
relative to expected profit rates) tends to cause the economy
to generate inadequate aggregate demand. If not offset by
state action, this can result in massive unemployment and
depression, as happened in the early 1930's. To overcome these
problems, he recommended that governments take fiscal and
monetary measures to counterbalance these imperfections in the
market's operation and help the economy to regain equilibrium
and maintain full employment (Keynes 1965/1936). The appeal
and strength of Keynes' argument have had a significant impact
on the economic policies of many countries resulting in
greater state intervention in the economy.
In the meantime, a group of economists concerned with the
economic development of the developing countries have observed
an increasing gap in the standard of living between the
17
advanced industrial countries and the underdeveloped
countries. These economists, Raul Prebisch (1959), Hans Singer
(1975), Ragnar Nurkse (1952) and Rosenstein-Rodan (1943),
among others, who are often called structuralist economists,
emphasize the structural problems inherent in the
international economic system and in the economies of the LDCs
themselves that cause this inequality of wealth and obstacles
to development.
In the sphere of the international economic system, as
argued by Prebisch, market imperfections in the capitalist
world economy have divided the world into a center and
periphery dichotomy. In the center lie the advanced industrial
countries, which specialize in the manufacture of goods that
tend to have relatively high income and price elasticities. In
the periphery lie the LDCs, which produce mainly primary
commodities which have low income and price elasticities. The
difference in the characterictics of the goods exchanged
results in a secular deteroriation of the LDCs 1 terms of trade
and export instability, benefiting the center countries
disproportionately. This unequal exchange requires the LDCs to
produce and export ever larger quantities of commodities to
pay for their imports, such as capital and intermediate goods
from the industrial countries. The continuation of this
transfer of purchasing power from the LDCs to the industrial
countries, the structuralists argue, retards the development
of the former and makes them become more dependent on the
18
latter, especially in terms of export earnings, investment
capital and technology. To overcome the LDCs1 problem of
declining terms of trade, the structuralist economists have
advocated import-substitution industrialization, backed by
state protectionist policies (Gilpin 1987: 275-276).
The case for government intervention became stronger when
these economists looked into the nature of the economies of
the LDCs, which they found to be significantly different from
those of the developed ones. Unlike the neoclassical model
where, in response to trade opportunities, factors of
production can be moved along the production possibility
frontier (PPF) smoothly, in LDC economies structural
rigidities exist that are perceived to hamper smooth factor
reallocation. Ian D. Little descibes it as follows:
The structuralist sees the world as
inflexible. Change is inhibited by
obstacles, bottlenecks, and constraints.
People find it hard to move or adapt,
and resources tend to be stuck. In
economic terms, the supply of most things
is inelastic. Such general inflexibility
was thought to apply particularly to LDCs.
Peasants were hardly economic men and were
stuck in the mud; people were ruled by
custom and authority; entrepreneurs were
lacking; and communications were poor.
There was little choice as to what to
produce from the land. As a result of
poverty, demands, too, were inflexible,
especially for food. If there was to be
any development, the demand for imports
would be highly inelastic, since capital
goods must come from abroad. Demands also
were inelastic, especially for food, for
imports into developing countries, and for
their exports. (Little 1982: 20)
19
These structural rigidities do not result only from
supply and demand inelasticities, shortage of entrepreneurs,
lack of infrastructure and shortsightedness. They may also be
caused by other problems, such as shortage of foreign exchange
and intermediate goods, fragmented financial markets and
distribution problems which restrict a country's
responsiveness to international price changes. The problem
will be greater for a country that produces only a few primary
commodities because in many instances most of the
infrastructure is devoted to their smooth production and
distribution, making it difficult to use other productive
alternatives (Todaro 1985: 388).
The reason why markets fail to respond immediately to
price changes as expected by neoclassical theory is that
markets work incrementally. Shifts in demand and supply take
time because economic agents need to adjust to changed market
signals. The magnitudes of the shifts depend on the degree of
the elasticities. However, in general, elasticities of supply
and demand are greater in the long-run than in the short-run
because of the gradual and lagged nature of market responses
(Ardnt 1988: 227) . Because market forces are perceived to be
unable to generate a rapid change in the economy (such as
rapid industrialization), state measures are required to help
bring it about.
The appeal of state intervention also relates to the
failure of markets in playing their role. Kaldor classifies
20
the role of markets into allocative and creative functions. He
argues that the latter functions are more important than the
former ones because of their dynamic role in raising
productivity. This can be induced by increasing investment
which, through increasing returns to scale, will promote
invention and innovation, thereby stimulating economic growth
(Kaldor 1972). However, in the underdeveloped countries the
number of entrepreneurs who are willing to invest and innovate
is perceived to be relatively small. Moreover, they are
isolated from each other. This situation provides a prima
facie case for the state to take direct actions to increase
investment by providing infrastructure and public goods,
investment planning, establishing state enterprises and other
measures (Ardnt 1988: 228) .
Thus, a rapid and big change in the economic structure of
an underdeveloped country, for example, from an agrarian to
industrialized economy, needs rather extensive and intensive
state intervention in the economy to supplement and enhance
private (market) initiatives. Support for this view was
provided by Alexander Gerschenkron in his historical studies
of nineteenth century European industrialization. He argued
that there was a difference in the approach to
industrialization between the early and late industrializing
countries. The early industrializing countries, such as Great
Britain, promoted industrialization by providing a suitable
environment for private investments. In the late
21
industrializing countries, such as Germany and Russia, the
state had greater involvement in the extraction and allocation
of resources, such as in creating investment banks,
establishing and managing state enterprises, and providing
industrial facilities. Gerschenkron concluded that the more
backward a country the more state development efforts are
required to overcome market rigidities and thus to help
accelerate industrialization and growth (Gerschenkron 1962).
Another major study on the development of European
countries conducted by Dieter Senghaas also found that state
intervention was a significant factor in their
industrialization. He observed that only England enjoyed rapid
economic growth by pursuing free trade policies while most
other countries grew rapidly only by adopting protectionist
policies which sheltered their industries from competing
imports. Some countries even disengaged themselves from
international trade during which time they developed
processing industries to increase the value-added of primary
commodities otherwise exported (e.g. raw cotton), devised mass
production of simple consumer products (e.g. textiles) and
started a capital goods industry (e.g. textile machinery).
Only after internal markets were conquered and domestic
industries were mature enough to compete in the international
markets, did they reestablish links with the world economy
(Griffin 1989: 101-102).
22
The significance of state intervention in development is
also discussed at some length by Robert Solo (1967, 1982) . He
distinguishes between a nationalist and a liberal state. In a
nationalist state, the national interest is the most
important, over and above individual and private interests.
The state has a dominant role mobilizing and controlling all
resources within its border to strengthen the country, even at
the expense of individual liberty. The leading example of this
kind of state is the Prussian state, which succeeded in
advancing the German nation in a relatively short time.
At the other extreme, in a liberal state such as the
United States, liberty is regarded as the supreme value.
Although there have been nationalist elements in some state
agencies such as the Department of State and Department of
Navy, their influence in the course of American affairs is
only within certain limits. Individuals are relatively free to
pursue their own interests to maximise their happiness. The
role of the liberal state is limited to facilitating the
pursuit of these interests by enforcing contracts and
protecting individual security and property (Solo 1982: 56-
59) .
However, Solo observes that the United States has been
undergoing a transformation to a less and less liberal state
since the emergence of Keynesian economics, which accords the
state a greater role to maintain a full-employment economy.
The ongoing changes are also reinforced by a multitude of
23
economic problems faced by the country using greater state
intervention because no other agency has a stronger capability
to deal with those problems.
First, the great depression in the 1930s transformed the
liberal American state into a welfare state with its newly
assigned task of providing a safety net for people to offset
the insecurities of the free enterprise economy. Then the
decline in key American technologies and other problems
forced the state to take a more active role to sustain the
rate of economic growth, transforming the state further into
a "positive state" (a state which plays an active role in the
economy). The tasks of the state became greater, more
centralized and more complex, involving planning, organizing,
managing and monitoring activities (Solo 1982: 60-63).
Thus, according to Solo, the increasing complexity of
economic problems necessitates greater state intervention than
that allowed in a pure liberal state. In developing nations,
the imperative to accelerate economic growth calls for even
more extensive government involvement, perhaps leaning towards
a nationalist state, for a number of reasons.
First, to enable economic development to occur freely and
smoothly, basic social reconstruction is required. For
example, prior to and during the Industrial Revolution in
Western Europe, this took the form of increasing prevalence of
rational individualism eroding the feudalism culture. In
poverty-stricken underdeveloped countries, social
24
reconstruction means freeing the societies from traditional
values and apathy which inhibit growth and replacing them with
new values in culture, cognition and functional organization
supportive of new developments. Bringing about these changes
needs guidance and leadership from state elites. They should
be dedicated, responsible and competent leaders and have a
common view of what to be achieved and done {Solo 1967: 389-
390) .
Second, most developing countries lack scientists, middle
technicians and mechanics, who are indispensable to industrial
development through invention, innovation and transformation
capability. They also lack the base of people trained in
technology and science. The generation of these human
qualities in a reasonable period of time needs a planned
system of training and education which can only be done by the
state (Solo 1967: 482-483). Third, familiarity with science
also facilitates technology transfer and the establishment of
science-based technologies. These are achieved through the
ability to evaluate the costs and benefits of technology
transfer, to adapt those technologies to the particular needs
and characteristics of the developing society, to organize the
processes which will utilize the transfered technologies and
to maintain the competitiveness by continued improvement in
the application of the new technology through research and
development (R & D) efforts. The process of scientific
learning and progress together with the establishment of a
25
science infrastructure which organizes and provides scientific
services requires government involvement in providing the
necessary education system and financial resources (Solo 1967:
421-424).
The_Arguments for Industrialization
From the earlier discussion it is clear that virtually
all proponents of state intervention such as Hamilton, List,
and Prebisch regard industrialization as the main vehicle to
achieve rapid economic development.
Besides the declining terms of trade argument expounded
earlier, there are several other reasons often stated by
structural economists to justify the promotion of industries
instead of agriculture as a development strategy. First,
externalities, that is benefits received free of charge by
individual firms or industries, whether in the form of lower
input prices or technological diffusion, would spread among
firms (Marshallian externalities) or industries which enhance
higher efficiency and further industrial development
(Rosenstein-Rodan 1943: 250, Nurkse 1952: 260). Second,
linkage, that is, the type of investment which is
complementary to other types of investment, would encourage
industrial investments in related activities. For example,
investments in upstream activities which produce inputs for
downstream industries would promote investment in processing
industries or forward linkages. On the other hand, growth in
26
downstream investments would encourage development in related
upstream industries or backward linkages (Hirschman 1958: 100-
101). And third, higher productivity is expected to come from
the more dynamic nature of manufacturing industries (Singer
1975: 47). As stated by Joan Robinson, "Investment in
expanding manufacturing leads to technical advance, learning
by doing, specialization of industries and accelerating
accumulation, while investment in wine runs up a blind alley
into stagnation" (Robinson 1974: 6).
Probably those arguments are the most compelling reasons
why the structuralists recommend industrialization for the
LDCs to speed up their economic development. The social net
benefits of establishing a new industry are regarded as much
higher than the private benefits implying the need for the
state’s active role, to promote industrialization (Myrdal
1978: 277). In Prebisch1s view, the establishment of
industries in the peripheral countries is justified even if
the costs of domestic production are higher than the import
prices. The relevant criterion in creating domestic industries
is not the comparison between local production costs and
import prices but the incomes generated by the employment of
factors of production in the new industries compared to those
acquired in the export sector alternative (Prebisch 1959:
257). Once the new industries have been established to serve
the internal market, the government should take protectionist
27
measures that shelter these industries from cheaper imports,
giving them a chance to learn by doing and improve their
efficiency.
This argument for temporary protection of domestic
industries is known in the literature as infant industry
protection. The argument runs as follows. A newly established
manufacturing firm in an undeveloped country is generally not
yet efficient because of lack of experience. Therefore its
products are not able to compete with those of the foreign
suppliers who are already established and competitive in world
markets. To encourage the development of domestic industries,
new firms should be temporarily protected to give them an
opportunity to learn by doing. After a certain period of time,
when management and labor have gained maturity and sufficient
productivity, protection should be abolished to compel these
firms to compete with foreign ones. In this way, new domestic
firms are able to grow without having to suffer unacceptable
losses which lead to their bankruptcies and thus discourage
new investments. This argument for infant industry protection
strongly influenced the development strategy of many LDCs
leading to wide-spread adoption of ISI from 1950 to 1970.
2.2. THE ROLES OF MARKET AND STATE IN TWO EAST ASIAN NICs;
TAIWAN AND SOUTH KOREA
2.2.1. The Neoclassical Interpretation
Consistent with their theoretical premises, the
neoclassical economists who observe the economic development
28
of two prominent members of East Asian NICs, Taiwan and Korea,
argue that their remarkable economic growth was caused mainly
by adherence to the market mechanism and an open economic
system that allowed them to exploit their comparative
advantage. Although they acknowledge that the two countries
did intervene in their economies, they claim that most of this
intervention was meant to compensate for the weaknesses of the
market mechanism {Papanek 1988: 39). Some neoclassical
economists even contend that the intervention was unneccessary
and might have caused lower economic growth than otherwise
(Kim and Roeraer 1981: 154, Scott 1979: 380) . Rejecting the
interventionists' claim that state intervention was the main
factor behind Korea's impressive development, Depak Lai
contends: "Nor does the fact of government intervention
imply, ... that intervention is on balance responsible for
Korea's success. Indeed, it could be argued that success has
been achieved despite intervention." (Lai 1985: 46).
In explaining the rapid development of the NICs,
neoclassical economists tend to emalyse broader aspects of
economic growth. In general they identify the following as
indispensable to the NICs development: agriculture
development, capital accumulation, export-oriented strategy,
and government measures to support development. In each of
29
these aspects they emphasize the critical importance of the
market-mechanism as the means to attain an efficient economic
outcome.
Agricultural development. For a developing country which has
a large population in the rural sector, agricultural
modernization is required to support development efforts to
provide food for the population and workers in sufficient
quantity and at reasonable prices. Increased farm
productivity as the result of agricultural modernization could
generate higher rural savings which benefit domestic
industrial markets and provide a source of capital for
investments. While the NICs have recognized, from the
beginning, the importance of agriculture in economic growth,
many developing countries, especially in Africa, ignored
agricultural development. To subsidize industrial workers and
urban dwellers, the governments set farm prices unreasonably
low, harming the agricultural sector {Bates 1981).
In Taiwan and Korea, agricultural development was
preceded by land reform, which distributed land to small
individual farmers. Contrary to the market pessimists' belief
that peasants are irrational and unresponsive to price
incentives, the neoclassical economists argue that the
experience of Taiwan and Korea show that farmers are rational
economic agents. They are sensitive to price signals, taking
measures to increase profits such as in productivity
30
improvement and product diversification. As reported by K.T.
Li: "The policy experience of Taiwan land reform followed by
external orientation has shown that when "the prices are
right," farmers can take care of themselves, show flexibility
and market sensitivity, and produce wave after wave of new
products...." {Li 1988: 114).
The result of the farm rationalization has been
remarkable. In Taiwan and Korea, the growth rate of
agricultural production reached 5% in the 1950's and continued
until 1965. Since then the rate has slowed down to around 3%,
offset by much higher growth in the industrial sector
(Scitovsky 1986: 155). The two countries were regarded as
especially successful in developing their agriculture
considering the heavy damage they suffered from World War II
{and the Korean war in the case of South Korea). Only after
increased farm productivity succeeded in producing high
agricultural growth did the governments of both countries aid
industrial growth. This was done by lowering the prices of
staple food grains and maintaining price stability allowing
more financial surplus for industrial investment. However,
this sectoral resource transfer was greater in Taiwan than
South Korea due to its less successful land reform (Chowdury
and Islam 1993: 60, 63).
31
Capital Accumulation. In order to maintain high economic
growth, a country needs to have a high level of capital
investment. In the early years of Taiwan and South Korea,
their existence received aid flows from the United States to
finance deficits in their balance of payments and control
inflation. The judicious use of aid enabled these countries to
rebuild infrastructure and concentrate on development efforts
sooner than otherwise would have been the case (Scott 1979:
371-378).
Capital accumulation is closely related to the level of
financial development which determines the efficiency of the
working of the financial system. Neoclassical economists argue
that the lack of investment capital in LDCs is caused by
financial underdevelopment, which in turn is caused by
financial repression (Shaw 1973, McKinnon 1973). In order to
promote ISI, these governments suppress the interest rate
below its equilibrium level, encouraging capital-intensive
industries but discouraging potential savers.
In this regard, the governments of Taiwan and Korea were
credited with liberalizing their financial system and
developing efficient financial institutions. Improved
incentives in the form of high interest rates resulting in
positive real returns on financial savings and the widespread
development of saving institutions were claimed to be the
major factors that greatly increased domestic saving rates in
Taiwan and Korea (James et al 1989: 64) . The high level of
32
domestic savings available for investment has contributed to
their high economic growth since the 1960s.
Export-oriented industrialization (EOT). Virtually all of the
neoclassical economists attribute the phenomenal growth of the
NICs to their export-oriented development strategy. This is
natural because this strategy, which emphasizes production of
goods and services based on comparative advantage is
consistent with the liberal economists' faith in the free-
market system. This strategy contrasts with the one followed
by many other LDCs: an inward-looking strategy which promotes
import substitution industrialization (ISI) through
protectionist measures. In the 1970s and 1980s, this strategy
came under increasing attack by the neoclassical economists
who argued that the prevalent price distortions it created
were responsible for the slow economic growth in the
countries that adopted it (Little et al. 1970, Bhagwati 1978,
Krueger 1978, World Bank 1983). These studies confirm their
belief in the efficacy of the export-oriented
industrialization strategy. As stated by Balassa:
"The evidence is quite conclusive: countries applying
outward-oriented development strategies had a superior
performance in terms of exports, economic growth, and
employment whereas countries with continued inward
orientation encountered increasing economic difficulties."
(Balassa 1981: 16-17).
33
The neoclassical economists claim that the governments of
Taiwan and Korea realized the limitations of ISI much earlier
than most other LDCs and switched to EOI through exchange rate
reform resulting in the (near) equilibrium rate,
liberalization of their foreign trade regimes, and elimination
of anti-export bias. In this way the balanced incentive system
that was created facilitated the achievement of a more
efficient allocation of resources by encouraging the movement
of resources to labor-intensive export production in which the
NICs had a comparative advantage.
The export-led industrialization strategy proved to be an
amazing success for the NICs. The shares of the four East
Asian NICs in world exports increased from merely 1.6 % in
1965 to 7.6 % in 1989 (Chowdhury and Islam 1993: 72). In the
period 1970-1985 the compounded growth rate of manufactured
exports of Taiwan and Korea reached 28.2% and 26.4%
respectively, much higher than the world rate of 13.9% (James
et al. 1989: 32) . The high rate of manufactured export
expansion in turn contributed to the high growth rate of these
two countries, which averaged between 7% and 10% during the
past three decades (Chowdhury and Islam 1993: 174).
Supporting Government Policies. Besides the three factors
mentioned above, the neoclassical economists also argue that
rapid growth of the NICs was made possible by government
measures that strengthened the working of the free-market
34
system or compensated for their weaknesses. The most important
government measures include the management of the
macroeconomy, labor markets, and human resources.
In macroeconomic management, they claim that the
governments effectively used the instruments of fiscal and
monetary policy to maintain price stability as the
prerequisite of economic development because such policies
affect the key economic variables: the interest rate and
exchange rate (Hughes 1992: 23) . In the case of fiscal policy,
they adopted conservative budgets, developed well-organized
tax systems and maintained relatively small government,
keeping expenditures relatively low. Monetary policy was also
supportive in regulating the money supply in order to keep
inflation under control and thus enhance price stability (Li
1988: 119; Ro 1991: 171-186).
In the case of labor markets, the neoclassical economists
argue that the governments of NICs succeeded in maintaining a
competitive labor market in which the wage rate was close to
the equilibrium level, in contrast to those in other countries
that imposed minimum wage rates often much higher and above
the equilibrium rate, resulting in uncompetitive wages (Fields
1985: 369). The relatively low wage rates (for given skills)
in the two countries have contributed to export
competitiveness and thus rapid growth of their labor-intensive
manufactured exports.
35
Human Resource Development. The neoclassical economists give
credit to the East Asian NICs for their success in checking
population growth, resulting in population growth rates among
the lowest among the LDCs (James et al. 1989: 178) . The
decrease in population growth rates, together with the
increasing demand for labor in the manufacturing sector,
resulted in relatively low unemployment rates and high living
standards. The governments also actively sought to improve the
quality of human resources by promoting formal education and
vocational training for their populations. These development
policies have contributed to high-quality work forces,
facilitating the attainment of high productivity and rapid
economic growth.
2.2.2. The Interventionist Interpretation
In contrast with the neoclassical interpretation which
emphasizes the importance of market mechanisms and downplays
the state's role, the interventionists argue that the
development success of Taiwan and Korea was very significantly
affected by state intervention, which deliberately distorted
prices to encourage resources to flow into desired activities.
They contend that liberalization measures such as exchange
reform, trade deregulation and other market-oriented policies
did not automatically lead to industrial expansion. Instead,
this rapid growth was made possible by state involvement in
36
the economy by mobilizing capital resources and channeling
them into the targeted industries. The state also manipulated
the incentive structure and controlled trade to promote
domestic industries. This objective was supported by a wide
array of policy instruments such as fiscal and monetary
policies, establishment of state-owned enterprises and banks,
and industrial estates as well as foreign exchange controls.
In short, the state is deeply involved in industrialization
efforts.
The interventionists question the validity of the
neoclassical economists' claim that the key to success in
Taiwan's and South Korea's remarkable industrial growth is the
liberalization of foreign trade in these countries. While
acknowledging that the devaluation of the exchange rate was an
important liberalization step, they argue it was not
accompanied by any significant reduction in the tariff
structure or import controls (Luedde-Neurath 1986). Instead,
export promotion was implemented by providing a set of export
incentives without significant changes in the trade barriers
protecting the domestic industries (Alam 1989: 130;
Kirkpatrick and Nixson 1983: 41). One important element of
export incentives is the exemption from tariff duties of
imported inputs going into export production, which
neoclassical economists claim resulted in a free-trade
regime. However, this neoclassical contention is not warranted
37
because a host of other policies accorded exporting greater
profitability than selling in the domestic market (Alam 1989:
4) .
The interventionists also argue that financial
liberalization did not take place to the extent claimed by the
neoclassical economists. The interest rate increased much and
was above the pre-reform level, contributing to impressive
domestic savings mobilization. But the rate cannot be said to
be near the equilibrium level because, in most of the 1960s
and 1970s, it was still below the informal curb market by a
factor of two or more {Alam 1989: 5). Based on these facts,
the interventionists argue that the liberalization measures
did not create the free trade regimes claimed by the liberal
economists and cannot be regarded as the key factor
accounting for the rapid industrial development in these
countries. Even a neutral trade regime {that does not create
a bias against producing for sales in either the domestic or
the world market) cannot be regarded as a necessary condition
for high growth. The critical factor in determining the
sufficient condition, the interventionists claim, is the
state's vigorous intervention in the economy (Wade 1988:
130)).
In explaining the superior performance of the NICs, the
interventionists turn the neoclassical economists' proposition
of "getting prices right" on its head by claiming that high
performance was the result of "getting prices wrong" policies
38
of the state. They argue that in newly industrializing
countries such as Korea and Taiwan, the state deliberately set
a number of prices "wrong" (such as multiple exchange and
interest rates) to change the price signals by manipulating
prices in order to affect private enterprises' behavior in the
allocation of resources compatible with the development
objective. As argued by Alice Amsden:
Under such disequilibrating conditions, the
state's role in late industrialization is
to mediate market forces. The state in late
industrialization has intervened to address
the needs of both savers and investors, and
of exporters and importers, by creating
multiple prices. Some interest rates are
higher than others. Importers and exporters
face different prices for foreign currency.
Insofar as the state in late industrialization
has intervened to establish multiple prices in
the same market, the state cannot be said to
have gotten relative prices 'right' as dictated
by supply and demand. (Amsden 1989: 13)
In Korea and Taiwan, the main form of price intervention
was the provision of subsidies. The subsidies were needed not
only in the case of capital or technology-intensive
industries,.but also in promoting labor-intensive industries,
where a developing country with abundant labor has clear
comparative advantage compared with more advanced countries,
especially at the beginning of export penetration. However, to
be effective, the subsidies were not provided without
conditions. Performance standards were imposed on the firms
receiving subsidies; for example, the meeting of export
targets as in Korea.
The argument that the states in the NICs manipulated
prices and intervened actively to promote industrial
development is also supported by Robert Wade, who advances the
so-called Governed Market (GM) theory. According to Wade, the
superior economic performance of East Asian NICs has been
caused by the state which governs the market to achieve
development goals. Specifically, the market is guided in
"augmenting the supply of investible resources, spreading or
'socializing1 the risks attached to long-term investment, and
steering the allocation of investment by methods which combine
government and entrepreneurial preferences." (Wade 1990: 27).
These policies, he claims, have succeeded in raising and
allocating investment to levels and compositions that would
not have occured had the governments left investment to market
forces. The high level of investment enabled faster
incorporation of new machinery, which in turn encouraged
faster adoption of more modern technology in production
processes, resulting in high productivity and output growth
(Wade 1990 : 29) .
Thus in the interventionists' interpretation, the
governments of Taiwan and Korea had more important roles than
the market mechanism in allocating resources and guiding
private investment. The state was very active, playing its
dirigiste role, deciding which industries had high growth
potentials, and channelling the resources to develop them (Das
1992: 146) . Once established, these industries were protected
40
from foreign competition to give them a chance to close the
efficiency gap by learning by doing. The government continued
to support the targeted industries even when they had
established themselves in the international market. This is in
contrast to the neoclassical economists' contention that
liberalization measures have significantly reduced the
protection accorded to the domestic industries increasing
their efficiency and competitiveness. The fact is that most of
these industries continued to be protected even when the
policy shifted from import-substitution to an export-oriented
strategy.
The dirigiste strategy has successfully developed the
NICs' industrial edge, leading to rapid export expansion and
high economic growth. This observation has led a statist-
oriented analyst to conclude that "the government of Taiwan
has never been guided by free-market priciples as such; so to
attribute Taiwan's success to a commitment to such principles
whether in theory or in practice, is misleading" (Amsden 1989:
90). Many interventionists would agree that the same can be
said of South Korea.
The interventionists do not limit their analysis to the
economic issues of state intervention, however. They also
consider the state capable of determining how it is to
mobilize and allocate resources into desired activities. Wade
argues that the type of regime most able to govern the market
is an authoritarian state which maintains corporatist
41
relations with the private sector. This type of regime has a
greater possibility of conferring autonomy on its economic
bureaucracy and insulating it from vested interests (Wade
1990: 29). Indeed, it is argued that the reason why the states
in the NICs were able to escape the trap of rent-seeking
activities as supposed by the neoclassical economists is this
kind of institutional arrangement (Haggard 1990: 45). Even in
taking liberalization measures to get the prices right, a hard
state will be in a better position to counter the actions of
vested interest groups hurt by the change in policy. Thus some
countries have better chances of successful economic
intervention than others. The ignorance of this difference in
state capability, the interventionists argue, is the main
weakness of the neoclassical economists' analysis of the NICs1
developement success (Wade 1988: 130, 159).
2.3. THE ROLE OF THE STATE IN EXPORT-ORIENTED
INDUSTRIALIZATION STRATEGY
Virtually all LDCs regard industrialization as the
principal means to achieve high economic growth. Because
market forces alone are perceived to be unable to generate
rapid industrialization, many governments assume the
responsibility of promoting industrial development. To carry
out this duty the state basically faces a choice between
import-substitution industrialization (ISI) and export-
42
oriented industrialization (EOI) strategy, although they are
not necessarily mutually exclusive. ISI can be divided further
into IS-1 which produces consumer goods and IS -2 which
produces consumer durables and capital goods. EOI can also be
classified into EO-1, producing labor-intensive manufactured
goods, and EO-2, developing capital-intensive and high-
technology products (Chen 1989: 57). The role of the state in
a country that followed ISI is to create a situation in which
domestic producers face greater incentives to sell in the
domestic than in the export market. However, in a country that
followed EOI, the state's role is to provide producers at
least neutral incentives between exporting and selling their
products in the domestic market (Griffin 1989: 73).
Most LDCs adopted IS-1 in the initial phase of their
industrialization. To encourage the development of import-
substituting industries producing light manufactures such as
textiles, simple electronics and processed foods, the state
protects these infant industries by providing a favorable
(i.e. overvalued) exchange rate and instituting tariff and
non-tariff barriers as well as other policies. After the
scope of import-substitution of these simple manufactured
goods has been exhausted, these countries continued to the IS-
2 phase, producing capital-intensive goods. Taiwan and South
Korea also followed this strategy, first adopting IS-1 and
then IS-2. However, they did not stay long in IS-2, because
the policy-makers quickly realized its weakness due to their
43
country's lack of comparative advantage and comparable
efficiency in producing capital-intensive goods (which
requires more advanced technology know-how in addition to
heavy investment) compared with the advanced countries.
Therefore, they switched to EO-1.
Neoclassical economists argue that industrial growth of
a country will be most easily achieved if the government
adopts an outward-oriented strategy because it allows the
exploitation of its comparative advantage. The neutral
incentives created by a free trade policy will reduce
distortions and encourage efficient allocation of resources
(Balassa 1982: 59). EOI is also regarded as having additional
benefits. First, selling in the world market enables domestic
producers to gain greater profit from economies of scale,
inducing them to expand output production. Second, exposure to
foreign competition forces domestic producers to increase or
maintain competitiveness in order to survive, resulting in
efficient industrial establishments. Third, an outward-
oriented strategy forces the state to maintain sensible
economic policies and reduces rent-seeking activities (James
et al. 1989: 19, 28; Chowdhury and Islam 1993: 44).
The experiences of South Korea and Taiwan show that the
shift in policy from ISI to EOI accords the state an important
role. The state is responsible for taking measures that
encourage export activities, for example, by building
infrastructure (i.e. port facilities, export-processing zones,
44
industrial parks et cetera), easing foreign direct investment
and providing export incentives, either in the form of price
or non-price incentives. It has to reduce the bias against
exporting caused by former ISI policies to create a balanced
incentive structure between producing for the home and export
market by devising a "simulated free trade regime". This
regime requires the state to maintain two conditions. First,
inputs which are used in the production of exports can be
imported freely without restrictions both in terms of tariff
and non-tariff barriers. Free-trade input prices will give the
export-oriented industries equal ground in competing with
foreign exporters. Second, the exchange rate must be kept at
a realistic level to reflect its equilibrium value. The
realization of these conditions will enhance the
competitiveness of domestic producers and encourage them to
engage in profitable exporting activities.
Another important aspect related to competitiveness is
labor market policy, because it affects the wage rate, one of
the major elements in production cost. The state's role is to
adopt a labor market policy which contributes to the existence
of the equilibrium wage rate. This policy will enable the
country to exploit more fully its comparative advantage.
From the discussion above it can be argued that the state
has a significant role even in implementing the neoclassical
economists' prescription for economic growth: export-oriented
industrialization. It is required to be active, taking
45
measures necessary to promote rapid development of export-
oriented industries, the measures that sometimes go beyond the
extent prescribed by market-oriented economists (who believe
that once the trade regime is liberalized, export-led
industrialization will take place automatically). To examine
the validity of this argument, I will analyze the experience
of Indonesia and three other East Asian countries in
developing one of their export-oriented industries; the
textile and garment industry, using the above framework of
export-oriented development strategy.
2.4. PREVIOUS STUDIES ON THE INDONESIAN TEXTILE AMD GARMENT
INDUSTRIES
There are relatively few studies on the role of the
Indonesian government in the development of textile and
garment industries and exports in the New Order era (1966-
present) , and possibly no comparative study has ever been done
comparing the textile development policies of Indonesia with
those of the East Asian countries.
A study of the impact of government policy on the textile
industry development in Indonesia during the Old Order period
(1950-1965) was done by Ingrid Palmer. She found that although
the industry experienced some growth, government intervention
in the industry was not coherent and effective, resulting in
various problems for the industry (Palmer 1972).
46
A brief study of the development of Indonesian textile
and garment industries in the New Order period was done by Hal
Hill. He argues that the rapid development of the Indonesian
textile and garment exports was caused by the liberalization
of the trade regime which, among other things, regulated the
export and import of these products. He dismisses the theory
that attributes the export success of the Indonesian textile
and garment commodities to the import substitution policies
adopted by the government in the 1970s preparing the two
industries to enter the export-oriented phase (Hill 1992: 66) .
However, the evidences that he provides are insufficiently
convincing requiring a further study in order to draw a proper
conclusion of government's industrial development policy.
A study of the political economy of the textile industry
by Makarim Wibisono focused on the decision-making aspect of
the New Order government's bureaucracy in dealing with private
interests . His thesis is that government authority in textile
development policy is not as absolute as is commonly thought.
Besides bureaucratic politics, the role of private interests
and presidential mediation also affect policymaking and
implementation of the textile development policy (Wibisono
1987). In a similar vein, Andrew MacIntyre, in his case study
of the politics of the Indonesian textile industry, also
argues that since the mid-1980s the government apparatus'
policymaking is not immune to external influence (contrary to
what is hypothesized by the state-centered theory) in
47
explaining the relation between business and politics in
Indonesia. On the contrary, it has been significantly affected
by independent business groups that have been able to organize
themselves effectively. For example, the well-organized
Sekbertal, an association of spinners, was able to persuade
the government to remove restrictions on the import of raw
cotton by using the press to articulate their interests
(MacIntyre 1991).
As stated before, the purpose of this dissertation is to
analyze the role of the Indonesian government in developing
the textile and garment industry during the New Order period
by examining the extent and effectiveness of government
intervention in this particular industry. The analysis that
will be conducted includes economic aspects such as the policy
intruments used in implementation as well as a political
aspect specifically in the role of government in managing
labor relations, an important issue in regard to rapid
expansion in textile and garment exports. The study also
attempts to draw a comparison with the role of three East
Asian governments in developing their textile industries and
exports.
2.5. SUMMARY
This chapter has discussed two competing theoretical
approaches to the relative roles of market and state in
economic development: the neoclassicist perspective, which
48
espouses a free-market system, and the interventionist
position, which advocates state intervention. This difference
is carried on in the interpretation of the economic success of
the East Asian NICs. The neoclassicists attribute the superior
performance of the NICs to the market-mechanism, whereas the
interventionists credit it to government intervention. Thus,
there is still no consensus as to the extent and role the
state should play in the economy to facilitate growth, whether
it should be limited to strengthening the market or go beyond
it, directing the market.
In view of the relative paucity of studies on the role
of the state in developing the textile industry in Indonesia,
this study is expected to give greater understanding of the
state's role in the promotion of export-oriented industries in
these countries (particularly in the context of a comparative
study with the NICs).
49
CHAPTER 3
THE DEVELOPMENT OF THE INDONESIAN TEXTILE AND GARMENT
INDUSTRIES (1950-1984)
The main purpose of this chapter is to review the
development of the Indonesian textile and garment industries
(ITGI) from 1950 to 1984, the period prior to the
implementation of Export Oriented Industrialization (EOI) in
1985. First, however, I discuss the main factors that play an
important role in determining industrial development strategy
and thus the extent of government intervention as an
introduction to Indonesian economic policymaking. The
development of the ITGI here is divided into two periods: 1)
1950-1965, which is the Old Order era under President
Soekarno; and 2) 1966-1984, within which period the ISI took
place under the New Order government, led by President
Soeharto.
In both periods, the influence of the nationalist (i.e.
interventionist) ideology was dominant. However, the results
were different. The Old Order government failed to develop the
ITGI adequately due to the lack of resources (including
foreign exchange) and ineffective economic policy. On the
other hand, the New Order administration, which is more
committed to development, succeeded in advancing the ITGI
50
during the ISI era, supported by ample oil revenues and
appropriate policy.
3.1. THE MAIN FACTORS DETERMINING THE ROLE OF GOVERNMENT IN
INDUSTRIALIZATION IN INDONESIA
The extent and nature of the role of a government in
promoting domestic industrialization is determined by the
orientation of its development policy: an inward-looking or
outward-looking strategy. As has been noted in chapter 2, an
inward-looking industrialization strategy necessitates a high
degree of state intervention in the economy, while an outward-
looking industrialization strategy implies a low degree of
state intervention.
In Indonesia, since the military-backed New Order
government took office in 1966, the policy orientation has
alternated from outward-looking (1966-1971), to inward-looking
(1972-1984) and back to outward-looking (1985-present). The
frequent changes in development strategy and thus, the extent
of the government's economic role, were caused by two main
factors. The first is ideology, which comprises two contending
elements: economic nationalism and economic liberalism. This
ideological factor intermingles with the second factor, the
resources available to the government, determined by the ups
and downs of the world price of oil, which is Indonesia's
primary export commodity. The combination of the two factors
51
affects Indonesian policymakers in determining the main
strategy of industrial development.
The nationalist ideology originated from the bitter
experience of Dutch colonization. In the late stage of their
colonial rule, the Dutch imposed a plantation economy on
Indonesia to produce profitable export commodities and raw
materials for their manufacturing industries (Glassburner
1971: 2). The development of industries in Indonesia itself
was neglected except for a number of extractive activities
such as coal and petroleum exploitation. This situation left
a deep impression on many Indonesian nationalist leaders,
leading to a suspicion of Western liberal capitalism. They
believe that the exploitation of the natural resources of the
country and the neglect of manufacturing development by the
Dutch kept Indonesia poor.
This impression was continued after Indonesia achieved
independence in 1945. Consequently, the generation of 1945,
who struggled for independence, including Soeharto, tends to
regard industrialization as the main key to prosperity. The
development of industry is perceived to be more effective than
that of the agricultural sector (Woo and Nasution 1989: 22).
Because the private sector was still small and weak, the state
needed to intervene in the economy in order to achieve rapid
industrialization and development. The notion of the
importance of the state role in the economy is enshrined in
Article 33 of the 1945 Indonesian Constitution, which
52
stipulates that economic activities which affect the daily-
life of the people should be controlled by the government.
The nationalist dogma was dominant during the Soekarno
era, especially during the "Guided Economy" period (1959-
1965), characterized by high trade barriers, extensive state
involvement in industrial programs and intolerance of foreign
investment. The economic mismanagement and the political
struggle among the powerful constituencies during this period
led to the fall of the Soekarno regime in 1965.
In the New Order administration, the influence of
nationalism in economic policy making was countered by
economic liberalism when Soeharto sought help from a group of
economics professors from the University of Indonesia1 (all
of whom were subsequently appointed to economic cabinet posts
for a relatively long time) on how to salvage the economy from
the crisis in 1966. These technocrats, as they are often
called, were basically neoclassical economists whose
underlying philosophy was market liberalism. Gillis desribes
them as follows: "Policies associated with this group tend to
be premissed on the assumption that producers and consumers,
as well as savers and investors, are sensitive to changes in
relative prices: only in the very short-run are elasticities
of demand and supply assumed to be near zero." (Gillis 1984:
248-249). Thus, they tend to believe in the efficacy of the
market mechanism, the comparative advantage principle, outward
53
economic orientation, and an incrementalist approach to
industrialization.
Accordingly, the measures they took to rescue the economy
were in line with their underlying inclination: dismantling
excessive government interventions to give markets and the
private sector dominant roles in the economy. The
liberalization measures resulted in an outward-looking economy
that had relatively low tariff and non-tariff-barriers. They
succeeded in putting the economy back on the right track,
growing at 6.0 percent from 1966 to 1971, compared with 2.0
percent from 1960 to 1965 (Table 3.1).
Table 3.1
Change in Real Gross Domestic Product (GDP), 1960-1992
Year Percent Year Percent Year Percent Year Percent
1960 2.0 1970 6.5 1980 7.9 1990 7.1
1961 5.7 1971 7.0 1981 7.4 1991 6.6
1962 1.8 1972 9.4 1982 -0.3 1992 5.8
1963 -2.2 1973 11.3 1983 3.3
1964 3.5 1974 7.6 1984 6.0
1965 1.1 1975 5.0 1985 2.4
1966 2.3 1976 6.9 1986 4.0
1967 2.3 1977 8.9 1987 3.9
1968 11.1 1978 7.7 1988 5.7
1969 7.1 1979 6.3 1989 7.4
Source : Woo et al (1994), Table A.l, p . 167 and Tomich (1992)
Table 1, p. 7.
The liberal economic regime did not last very long,
however. In the early 1970s, the flow of cheap imports induced
by the low tariffs began to threaten the existence of domestic
manufacturers, especially those in consumer products. In
54
another development, the dramatic increase in oil export
revenues as the result of the rise in oil prices in late 1973
greatly relaxed the government's financial constraints in
promoting industrial development.
The threat of foreign competition reinforced by the oil
boom led to the resurgence of influential nationalist figures
for the first time in the New Order period. This time they
consisted of an amorphous group of intellectuals: engineers-
turned bureaucrats, military advisors and structuralist
economists.2 Most of the officials inclined to the
nationalist view worked at the Ministry of Industry and the
Ministry of Trade. Being pessimistic about the quick response
of market agents to price signals, they tended in general to
be impatient with the incrementalist approach taken by the
liberal technocrats in pursuing industrial advancement. This
group is united in a common belief in the validity of the
infant industry argument and Big Push industrialization
(Gillis 1984: 248).
Basing their views on the market failure argument, one of
the main proponents of big push industrialization contended
that the government should directly invest in big upstream
projects to ensure a strong base for industrial development.
Private enterprise could not be expected to enter the upstream
sector because of the relatively small profit margins, high
risk, and huge capital requirements involved in those projects
(Soehoed 1988: 46). The case for "accelerated
55
industrialization" received support from the army, the most
powerful group in the country. It also succeeded in convincing
the president, the ultimate decision-maker, who wanted to see
the nation achieve rapid economic progress.
The impact of strong nationalist influence in Indonesian
economic policymaking resulted in import-substituting
industrialization (ISI) strategy. The role of the government
in the economy once again became extensive. Buttresed by the
tremendous oil revenues and foreign aid, the government was
able to promote domestic industrial development by adopting an
overvalued exchange rate, protective trade barriers, heavily
regulated investment procedures, and generous fiscal and
credit incentives. The ISI strategy brought about remarkable
industrial growth at an average annual rate of 14 percent from
1973 to 1981 (Table 3.2).
Table 3.2
Average Annual Growth of Manufacturing Industries,
1960-1992
Period Percent
1960-1966 1.8
1967-1972 10 .2
1973-1981 14 .2
1983-1989 12 .3
1990-1992 10 .2
Source: Woo et al (1994), Table A.29, p. 200 and Tomich (1992)
Table 1, p. 7.
Rapid industrialization began to falter when oil prices
dropped drastically, first in early 1983, then in January
56
1986. The considerable and sudden contraction in the
government's revenues and export earnings from the oil sector
created a balance of payments crisis and reduced significantly
the government's ability to support the implementation of the
ISI strategy. The oil slump together with the decline in the
prices of Indonesian primary export commodities such as rubber
and coffee due to the sluggish demand from the industrial
countries, led to a decline in Indonesia's terms of trade
(TOT) . Meanwhile there was a growing excess supply of many
locally produced goods due to the saturation of the domestic
market, but these goods lacked competitiveness for sale in
international markets.
These adverse developments returned the helm of economic
policy to the liberal technocrats. They emphasized that the
country needed to reduce its dependence on oil exports by
promoting non-oil exports such as manufactured goods. To do
this, the policy orientation needed to be shifted from ISI to
EOI, which meant liberalizing the economy from excessive state
intervention.
A series of reform packages were introduced by the
government after 1983 to deregulate various aspects of the
economy. The record shows that the reform has brought
satisfactory results. Manufacturing industries grew at an
average annual rate of about 12 percent per year from 1986 to
1992. Most of this growth was led by manufactured exports,
57
which grew at an average rate of more than 20 percent annually
in the same period (Table 3.3).
Table 3.3
Manufactured
(million
Exports, 1980-1992
of U.S. dollars)
Year Value Year Value
1980 501 1989 7, 018
1983 1, 373 1990 9, 014
1986 2, 639 1991 11,816
1987 3, 895 1992 15,494
1988 5,476
Source: Hill (1992), Table 8, p. 31.
3.2. THE DEVELOPMENT OF THE ITGI DURING THE OLD ERA PERIOD
(1950-1965)
After the struggle to defend the independence declared in
1945 was over in 1949, the government began to establish
programs to rehabilitate industries. Most of them, including
the textile industry were destroyed during the Japanese
military occupation (1942-1945) of Indonesia. Since 1950 the
government has put a high priority on the textile industry
because it was regarded as an important vehicle to achieve
industrialization due to its high employment-absorbing
capacity, simple technology and relatively low capital
58
requirement, especially in the weaving industry (Palmer 1972:
80). However, the various measures taken by the government in
this era to promote the textile industry did not produce
satisfactory results due to a number of problems among others,
a high inflation rate, ineffective protection policy, the
shortage of funds and foreign exchange and the lack of skill
and experience in the bureaucracy.
In 1951 the government issued an 'Urgency Program' which
aimed at stimulating the industries that could meet the
people's basic consumption needs (Palmer 1972: 85). To
facilitate the development of the textile industry, the
government set up a Textile Industry Center (TIC) in Majalaya,
West Java. The functions of this Center were to procure raw
materials and to sell the final products. Besides these, it
was also expected to: l) purchase the fabrics produced by the
small weavers to meet the needs of the army for uniforms; and
2) finance the mechanization of the small weavers' mills,
which primarily employed hand looms. To help the large weavers
and spinners modernize their equipment, the National Bank for
Industry (Bank Industri Negara) was instructed to provide the
necessary credit. However, the program did not meet
expectations due to the government's lack of funds, and thus
was discontinued (Matsuo 1970: 49-50).
One important objective of the government in this era was
to develop a class of indigenous entrepreneurs to reduce the
domination of the Chinese in commercial and manufacturing
59
sectors. This was implemented by providing privileges to a
group of native businessmen in the form of cheap credit and
import licensing in the commercial sectors, including
textiles. Owing to the lack of business experience and skills
in management, marketing and production, few indigenous
entrepreneurs were successful (Palmer 1972: 113-114).
The high inflation rate during this period rendered the
government's effort to protect the domestic industries
ineffective. The resulting overvalued exchange rate made
imports cheaper and induced the inflow of competing textile
products. To restore the realistic value of the rupiah, the
government had to make frequent exchange rate adjustments.
However, the protective tariff was not adjusted accordingly
(Palmer and Castles 1971: 331-332). These effects not only
threatened the existence of the domestic manufacturers (who
were still relatively uncompetitive due to their
simple/traditional technology) but may also have undermined
their confidence to make new investment or expand their
business (Palmer 1972: 112).
In order to promote the weaving industry, the government
often allowed imports of yarn in large quantities while the
domestic spinning industry was suffering from low capacity
utilization as in 1954, 1956 and 1958-59. In 1951 and 1957 the
weaving industry faced a similar situation (Palmer and Castles
1971: 331) . This fact shows the government's difficulty in
trying to protect two related industries where the output of
60
one industry (spinning) becomes the input of the other
(weaving).
Policy inconsistency also existed in the tariff
structure. For example, in August 1952, there was no tariff
duty on yarn or low-quality cloth, which were direct
competitors of the domestic products. However, in September
1955, a month after a new cabinet (Burhanuddin Harahap's
cabinet) came to office, the tariff rate on imported fabric
was raised to more than 50 percent, while the imported yarn
still faced no tariff duty. Although the frequent changes of
cabinet during this period could account for this erratic
import policy, "the existence of separate groups of lobbyists
for the spinning and weaving industries" might also have been
responsible. As a result, there were fluctuations in competing
imports, inducing instability in domestic production (Palmer
and Castles 1971: 331-332).
The inconsistent government policies led to a decline in
textile production. Whereas in 1955 cloth output was 213.6
million meters, in 1959 this figure dropped to 140 million
meters. The supply of yarn also decreased from 34,599 tons in
1955 to 33,000 tons in 1959. This setback occured despite an
increase in weaving capacity during the period (Indonesia
1982: 8-9) .
The political fragmentation caused by incessant conflicts
among the leading political parties during the parliamentary
democracy period (1950-1958)--the communist party (PKI), the
61
nationalist party (PNI) and the Moslem parties (Masyumi and
NU),--led to government instability.3 This, in turn,
generated ineffectiveness in the formulation and
implementation of economic policies, leading to increasing
economic problems. Inflation became more acute and foreign
exchange reserves were dropping rapidly. These problems
created serious difficulties for manufacturing industries and
the export sector, causing their respective shares in the
national income to decline, from 12 percent to 11 percent and
from 12.4 percent and 6.8 percent in the 1953-1958 period
(Robison 1986: 64).
These economic problems were aggravated by serious
political complications arising from the weaknesses of the
party government and the political system. In the meantime
there was growing polarization among the three main forces,
the army, the communist party and the president, each with its
own power base. Many regional military commanders in Sumatera
and Sulawesi expressed their dissatisfaction with the central
government and the political party system which excluded the
military from political representation by carrying out large-
scale smuggling. This smuggling was then followed by the
outbreak of rebellions in 1957 and 1958 led by several anti
communist army colonels in these two important outer islands.
The military operations to suppress these rebellions depleted
the government's already limited resources, forcing it to
62
undertake inflationary financing and intensifying the economic
problems (Mas'oed 1989: 33, 47).
These adverse developments weakened Soekarno's regime and
led him to claim that liberal democracy was not suitable for
Indonesia. He proposed to replace it with what he called
"guided democracy" where the state would play a paramount role
in guiding political life. The path for this new kind of
democracy was paved when another parliamentary cabinet fell on
14 March 1957 (Mas'oed 1989: 33). His objective of
strengthening his presidential power was realized when he
dismantled cabinet government and appointed a working cabinet
in 1958 (Robinson, 1986: 63) . The "guided democracy" came into
effect in 1959 when Soekarno, through a presidential decree,
dissolved the parliament and formed a new one, the members of
which were appointed by the president.
In the economic sphere, President Soekarno also gave the
state a leading role based on the concept of a "guided
economy" supposedly the counterpart of "guided democracy".
This was a nationalist economic doctrine, influenced by a
socialist development strategy which attempted to make the
country "stand on its own feet" (become self-reliant).
The new policy was initiated by the nationalization of
the Dutch importing houses and their transformation into state
trading enterprises. In order to overcome the chronic shortage
of raw material supplies to the textile industry because of
scarce foreign exchange, the government brought the
63
importation of cotton, yarn and textiles under state control
(Palmer 1972: 143). For this purpose, in 1958, the government
established two state trading enterprises whose duty was to
import and allocate cotton yarns. The first company, called
the Bureau of Industrial Materials (JBP), catered to the
import needs of the small and medium-size weavers. The second
one, named USINDO, specialized in serving the needs of the
larger weavers (Matsuo 1970: 53). The establishment of these
enterprises was intended to provide a direct and sure supply
of raw materials to the weaving industry.
In line with the socialist production system, the
government set output targets for yarn and fabric. The supply
of yam was allocated to weavers who were registered with the
state according to their licensed capacity. All weaving mills
which bought yam from the state trading companies were
obliged to sell back to these companies certain amounts of
their products based on the ration they had received. These
products would then be sold to the public (Matsuo 1970: 54;
Wibisono 1987: 46-47). Besides this scheme, to promote the
development of the textile industry the government was also
directly involved in the construction of ten spinning and two
weaving factories located throughout the country.
The continuing foreign exchange crisis and the
inefficient operation of the state agencies led to the
deepening of the raw material supply problem and rampant
speculative activity. In 1962, the weaving industry in West
64
Java, where most of the weavers are located, received rationed
cotton yarn, but only enough to utilize 11 percent of its
capacity. In late 1964, this situation had worsened as almost
all hand looms and 95 percent of power looms were idle because
of input scarcity (Palmer and Castles 1971: 325; Matsuo 1970:
58) .
This situation forced the government to relieve the
Ministry of People's Industry from its exchange-allocation and
material distribution functions and transfer them to a newly
established state agency, called the Supreme Command of
Economy Operation (KOTOE) in July 1964 (Palmer 1972: 167) . Its
subsidiary, named the KOTOE Clothing Team (Team Sandang KOTOE)
was given the function, among others, of setting the prices
of textile commodities sold and bought from private
enterprises and improving the yarn distribution system. To
strengthen further efforts to promote the textile industry,
in May 1965, a Ministry of Textile Industry was created
(Palmer and Castles 1971: 329-330). At the same time the
government also formed KOPROSAN, the Operation Command for
Textile Projects, whose function was to complete as soon as
possible the government-sponsored textile projects comprising
ten spinning and two weaving productive facilities mentioned
earlier (Indonesia 1989: 25).
In an effort to strengthen state control of the textile
field to facilitate state-initiated industrial promotion, in
May 1965, the government sponsored a national textile
65
conference (MUBESAN). The conference produced a number of
further institutional initiatives. An Organization of
Homogeneous Enterprises (OPS) for the textile industry was set
up, together with a National Clothing Council (Palmer and
Castles 1971: 330). The system of raw material allocation was
reorganized by placing it under the authority of the
Coordinating Minister for Development. The conference also
established a goal to achieve self-sufficiency in clothing by
1968. To attain this goal the government would provide
"guided integrated planning, 1 1 to be followed by the relevant
state agencies in implementing textile policy. This plan
included an allocation of yarn according to a production
target, instruction to manufacturers regarding what items to
produce and distribution control. Besides these, the Eight
Year Overall Development Plan (1960-1968) contained measures
to promote cotton production to achieve self-sufficiency in
raw cotton through large-scale expansion of cotton acreage in
Indonesia (Palmer and Castles 1971: 330, 323).
The implementation of this plan unfortunately was not
supported by a healthy political and economic environment.4
The government's preoccupation with the political matters,
complicated by the sharpening political conflicts between the
communists and the army, led to the neglect of economic
affairs. As the result, Indonesia's existing capital stock
declined, export earnings dropped from $750 million in 1961 to
$450 million in 1965, and foreign debt reached $2 billion with
66
estimated arrears in debt servicing amounting to $530 million
(Robison 1986: 74, 76) . The major turning point came when
General Soeharto crushed the communist-initiated coup d'etat
on 1 October, 1965 and later became the second president,
replacing Soekarno.
3.3. THE DEVELOPMENT OF THE ITGI DURING THE ISI PERIOD
. 0 30 2- t JL9.B.4).
3.3.1. The Adoption of an Import-Substitution
Industrialization Strategy
When General Soeharto assumed effective power in March
1966, he faced an economy that was on the brink of bankruptcy.
Hyperinflation was at an annual rate of around 600 percent in
1965 and 1966, foreign reserves were negative, the external
debt was in arrears and the economy was paralyzed by excessive
state intervention. The strategy taken by the liberal
technocrats who were given the task of bringing the economy
out of the crisis followed neoclassical prescriptions; namely,
economic liberalization and conservative fiscal and monetary
policies.
To bring inflation under control, the government banned
the monetization of the budget deficit. Deficits could be
financed only by foreign concessionary loans secured by the
government from Western donor countries, known as IGGI (Inter-
Governmental Group on Indonesia). The central bank was
instructed to restrict credit allocation to the state and
private enterprises. These measures succeeded in bringing the
67
inflation rate down to 17 percent in 1969 and to only 4
percent in 1971 (Table 3.4).
Table 3.4
Rates of Inflation, 1960-1990
Year Percent Year Percent Year Percent
1960 20.0 1970 12 .3 1980 18 .5
1961 76.7 1971 4.4 1981 12 .2
1962 155.9 1972 6.4 1982 9.5
1963 128 .8 1973 31.0 1983 11.8
1964 135 .3 1974 40.6 1984 10.5
1965 593 .0 1975 19 .1 1985 4.7
1966 635.4 1976 19 .8 1986 5.9
1967 112 .2 1977 11.0 1987 9.1
1968 84 .8 1978 8.1 1988 5.8
1969 17 .4 1979 20.6 1989
1990
6.0
10.0
Source: Woo et al. (1994), Table A.2, p. 167.
The dismantling of state control over the foreign trade
regime (including the abolition of yarn allocation) induced
large flows of imports, notably consumer and intermediate
goods that were previously in short supply. Consequently, in
the early 1970s the competing imports of consumer products
began to threaten the existence of domestic manufacturers who
were used to being protected under the former regime. Many
domestic weavers who still operated non-mechanized looms went
out of business because their products could not compete with
the cheaper but better quality imported textiles.
In the meantime, there was growing concern in some
nationalist quarters about the large inflows of foreign
investment especially from Japan. These developments led to
68
the resurgence of nationalist sentiment and influence within
and outside the bureaucracy. The need to protect domestic
industries was also in line with the government's objectives
to provide employment and save foreign exchange through import
substitution. Accordingly, the government began to increase
tariff barriers for a number of goods, including textiles.
The slide to an ISI strategy was strengthened by the
dramatic increase in world oil prices in 1973 as the result of
oil boycott which accompanied the war between Israel and the
Arab countries. The fourfold rise in Indonesian oil export
prices led to the expansion of both government revenues and
foreign exchange earnings. The net revenues from oil and LNG
(liquid natural gas) exports soared from $0.9 billion in 1972
to a peak of $14.8 billion in 1982 (Table 3.5). The oil sector
became the main pillar of the Indonesian economy.
Table 3.5
Oil and LNG Exports, 1969-1986
(millions of U.S. dollars)
Year Exports Year Exports
1969 383 1978 7,439
1970 446 1979 8, 871
1971 565 1980 12,850
1972 913 1981 14,390
1973 1,609 1982 14,861
1974 5, 211 1983 13,478
1975 5, 311 1984 12,097
1976 6,004 1985 7, 670
1977 7,298 1986 5,167
Source: Woo et al. (1994), Table A.8, p. 171.
69
The large inflow of export revenues eased the
government's resource constraints, increasing its capacity to
finance industrial projects. This favourable situation, in
turn, gave the nationalists, who favor a dominant role for the
state in industrial development, a greater role in the
formulation of economic policy vis-a-vis the liberal
technocrats. The most influential of them, Ibnu Sutowo, the
president director of Pertamina (the state oil company), using
a part of oil export earnings, undertook a wide range of
large-scale industrial projects (Robison 1986: 152). Other
nationalist figures heading the Ministry of Industry, the
Ministry of Trade and the State Investment Board were also
able to exert greater influence and autonomy in policymaking
helping to shape an inward-looking industrialization strategy.
3.3.2. Government Policies Affecting the ITGI
In the ISI era, the government adopted economic policies
intended to support and promote the development of domestic
industries based on the replacement of imports with
domestically produced goods. Like the previous regime, the New
Order government gave the development of the textile industry
a top priority together with the program of self-sufficiency
in rice.
The efforts of the government to promote the ITGI are
reflected in the development of the policies that it took
either at the macro level, such as exchange rate policy, which
70
has economy-wide effects, or at the micro level, which
specifically affects the ITGI such as textile import policy.
The next sections review the measures taken in exchange rate,
investment, import, fiscal, and credit policies.
Exchange Rate Policy
The exchange rate is one of the most important factors
that affects trade. Ideally, to facilitate trade at an optimum
level, the exchange rate should be maintained at a realistic
level. An overvalued currency tends to cause excessive
imports, resulting in balance of payment problems, while an
undervalued one will result in over-exporting at the expense
of domestic welfare. However, to encourage industrialization
many developing countries adopted an overvalued exchange rate.
The costs of imported capital and intermediate goods in
domestic currency are then cheaper, inducing the development
of capital-intensive industries (Todaro 1985: 410).
In August 1971, the rupiah, the Indonesian domestic
currency, was devalued from Rp.3 78 per U.S. dollar to Rp.415
per U.S. dollar. This exchange rate remained constant until
November 1978, although the inflation rate in Indonesia was
higher than that in the USA during that period, thus leading
to the overvaluation of the rupiah. The higher inflation rate
was caused by rapid growth in foreign reserves and increased
government spending as the result of the oil price hikes in
1973 and 1974.
71
This surge in international reserves enabled the
government to maintain the overvalued exchange rate to
encourage industrialization. As the result of the overvalued
currency, capital and consumer imports increased and
agricultural and manufactured exports declined. However, the
balance of payments remained strong throughout the period.
Thus, there was no compelling reason to alter the exchange
rate.
Nonetheless, in November 1978, the government devalued
the rupiah from Rp.415 to Rp.625 per U.S. dollar. This came as
a great surprise to many people, some of whom had even
predicted that the rupiah would be revalued due to the strong
performance of the balance of payments. There were several
arguments advanced to explain why the government took the move
despite the absence of an imminent balance of payments crisis.
The first interpretation argued that the devaluation was
taken to restore the competitiveness of Indonesian non-oil
exports, which were suffering from the high inflation rate
induced by the spending of the government's large oil revenues
while the export prices were fixed in dollars.5 The second
argued that the rapid extraction and domestic consumption of
oil would soon lead to resource depletion and, therefore, it
was necessary to devalue earlier to encourage the exporting of
non-oil commodities. This would avoid speculative activity and
an even larger devaluation. The third interpretation saw the
1978 devaluation in more political economy terms, arguing that
72
it was taken to appease the rural population, whose incomes
largely depend on agricultural exports and labor intensive
export-activities (Woo and Nasution 1989: 100; Gillis and
Dapice 1988: 320).
Whatever the real reason, the devaluation succeeded in
increasing the exports of primary and labor-intensive
manufactured commodities, including textiles. The export value
of garments, for example, increased from $42.9 million in 1978
to $154.4 million in 1979.
Investment Policy
Shortly after coming into office, the New Order
government liberalized investment regulations by issuing a
foreign investment law in 1967 (PMA/1967) and a domestic
investment law in 1968 (PMDN/1968). A state agency, called the
Investment Coordinating Board (BKPM), was created to process
investment applications and implement investment regulations.
The new investment laws offered generous incentives to foreign
and domestic investors, namely: a) customs duty exemptions on
imported capital and intermediate goods; b) tax holidays for
a minimum of two years; c) exemption from corporate income tax
for the first five years after production had begun; and d)
for the investment projects already underway, additional
incentives were offered, including carry-over losses during
the first six years of operation, accelerated depreciation to
a maximum of 25 percent, exemption from dividend taxes,
73
investment allowances of 20 percent for four years, and
exemption from property taxes and some other charges (Poot
1981: 92) .
Some of these incentives had capital-cheapening effects.
As a result, together with tariff protection and the
increasingly overvalued currency these incentives succeeded in
inducing the opening of foreign and domestic modern textile
establishments, which were much more efficient and productive
than the old mills left over from the previous era. During the
1967-1978 period, foreign investment in textiles made up 25
percent of the total foreign investment. While domestic
investment in textiles constituted 28 percent of the total
domestic investment in the same period (Poot 1981: 93).
The effect of the new investments in the textile sector
was impressive. Production increased significantly, doubling
in the period of the first five-year development plan (1969-
1973). However, the applications for new investment in textile
continued to come in, exceeding the capacity target for the
second five-year plan (Rosendale 1974: 19).
In the meantime, the rapid growth of foreign investment,
especially Japanese, sparked nationalist sentiment against
foreign domination. Concern over the increasing role of
foreign businesses in the economy culminated in a violent
student protest during the visit of Japanese Prime Minister
Tanaka in January 1974. This event had a deep impact on the
investment climate in Indonesia. Investment regulations became
74
more restrictive. Foreign investment now had to be in the form
of joint-ventures with an Indonesian partner. Textile
investment was also restricted. It could only be undertaken
outside Java, in order to promote industrial development in
the outer islands (Hill 1988: 31; Wibisono 1987: 90).
To direct new investments according to the government's
industrial objectives, especially to ensure an orderly
development of industrial capacities, in 1977, the BKPM
introduced a priority list (PL) which divided investment areas
into four categories with different degrees of incentives.
This list was revised annually. Some sectors were reserved for
the economically weak indigenous entrepreneurs. The government
also tightened the time schedule for the Indonesianization of
employees in the foreign investment enterprises (Hill 1988:
31). These regulations made the Indonesian investment law the
most restrictive in the ASEAN countries. However, the impact
on textile investment was favorable. Over the period 1967-
1983 the textile sector received the biggest share of total
foreign investment, mostly coming from Japan (Poot et al.
1990: 239, 247).
Import Policy
In the early 1970s, the rapid growth of textile
production as the result of large-scale foreign and domestic
investment and the inflow of both legal and illegal (smuggled)
textile products began to tighten the textile market and
75
squeeze the profitability of domestic manufacturers. This
unfavorable situation led them to complain loudly about their
problem and demand protection from the government. The
government responded positively to these demands. To lessen
the pressure from competing imports and to protect the textile
industry more effectively, it took several steps.
To discourage the inflow of contraband products, the
president himself declared that smuggling was a crime of
economic subversion which carried harsh punishment. The
government judged that the tariffs were not an adequate
protection instrument and thus resorted to more direct import
controls. In August and September 1970, the government
prohibited the import of certain kinds of textile products.
The use of quantitative restrictions accelerated in 1974. To
encourage the development of the domestic cotton industry, the
private sector was prohibited from importing cotton. The right
to import some important types of cotton was transfered to a
state-owned enterprise.
As the result of large-scale investment in the textile
sector after the introduction of the new investment laws in
1967 and 1968, the easy phase of import-substi tut ion in the
textile industry was already over by the mid 1970s. Domestic
demand had been met and there was a growing excess supply in
the market (Donges et al. 1980: 391). Accordingly, the
protection accorded the domestic textile industry increased
rapidly thereafter.
76
In October 1975, following the demand for more protection
by the textile manufacturers, the government banned the import
of 23 kinds of textile articles . Some of them, such as sarongs
and unbleached cotton, were already produced in sufficient
quantity to meet domestic needs (Wibisono 1987: 87).6
Competing imports were also limited by the government's
decision to restrict domestic credit for importing textiles.
In December 1974, the government announced that 30 types of
textile products could be imported only if the full price of
imports was paid when opening a Letter of Credit (L/C) and if
the import duty was paid in advance. The banks were also
prohibited from providing credits to finance textile imports.
In February 1975, the government abolished the prefential
exchange rate for textile imports and replaced it with the
regular rate. And in May 1977 the use of the merchant L/C for
importing textiles was prohibited. Different from the Banker's
L/C, which requires importers to pay 40 percent of the import
value in advance, a merchant L/C required only 25 percent
advance payment, thus reducing the transaction cost of
importing (Rice and Hill 1977: 13-14).
To reduce the corruption from the understatement of the
value of imports, the government applied import checkprices
(the minimal import prices that can be declared at customs),
based on which tariff duties and import sales taxes were
calculated. An inter-departmental team was established to set
these checkprices. In time they became an increasingly
77
protective instrument for a number of domesticaly produced
goods, including textiles, without changing the tariffs
themselves. For example, after increasing the checkprices for
textiles of lower quality by 20 percent and those for higher
quality textiles and weaving yarns by 50 percent in April
1975, the government raised both checkprices again by 25
percent on May 1, 1975 (Pitt 1991: 157) . This means the
importers had to pay increasingly higher import duties and
sales taxes, thus discouraging imports.
In the first half of the 1980s, the use of quantitative
restrictions became more extensive to protect the producers
of intermediate goods which had developed to supply the
domestic producers of finished products. Formerly, any
importer and manufacturer who had a license from the Ministry
of Trade could import raw materials and intermediate goods for
further distribution or for their own production.
Growing complaints from the domestic producers of import
substitutes led the government in November 1982 to introduce
a system of approved traders and a list of raw materials,
intermediate goods and products that could be imported.
Importing could be carried out only by licensed traders who
were eligible to apply for permission to import a certain type
and quantity of product. This application could be granted or
denied depending on whether the import would hurt the domestic
manufacturers. The types and amount of the goods allowed to be
imported as well as their fixed selling prices were often
78
decided after a discussion between the interdepartmental team,
and industry and business representatives (Pangestu and
Boediono 1986: 14).
In December 1983, the government issued seven ministerial
decrees appointing approved traders eligible to import a
specified list of industrial goods, including textile
products. These were followed by a decree in November 1984 and
another one in June 1985 limiting the list of products that
could be imported (Muir 1986: 26).
By the mid-1980s, a pattern developed whereby a group of
domestic manufacturers in the priority sector who could show
they could produce goods in sufficient quantity and of
sufficient quality to meet the domestic demand but who faced
serious difficulties with competing imports, could petition
the government to place their products on the list of
protected goods. The interdepartmental team would restrict the
competing imports if the tariff duties did not exceed 20
percent and if there was an agreement between the producers
and consumers. However, this measure would be taken only with
the understanding that the restriction was temporary and the
possibility of allowing imports if there was price instability
due to supply shortages (Pangestu and Boediono 1986: 14).
The growing list of the prohibited or restricted textile
imports shows that the government sectoral ministries such as
the Ministry of Trade and the Ministry of Industry, led by
79
bureaucrats of nationalist orientation were very supportive of
the domestic industries during the ISI era.
Fiscal Incentives
Due to the excess supply of textile products resulting
from the rapid growth of production, in 1976, the government
offered fiscal incentives (besides those offered in the
investment policy) in the form of a duty drawback scheme to
induce domestic textile producers to export their excess
products. Exporters of manufacturers were given rebates on
tariff duties, import sales taxes and other indirect taxes
paid on the imports of raw materials, intermediate goods and
spare parts used in export production (Pitt 1991: 158) .
In November 1978, this scheme was replaced by an export
certificate (EC) scheme by which manufacturing exporters of
certain goods including textiles were eligible to receive a
rebate. It was calculated as the product of the exported
product's checkprice and the export certificate percentage.
This percentage was supposed to reflect the rate of tariffs
paid on imported inputs. However, due to the liberal
calculation of the rebate percentage, this scheme developed
into an effective export incentive (Pangestu and Boediono
1986: 16; Barichello and Flatters 1991: 281).
Although this scheme did not reverse the slide toward the
inward-looking industrialization strategy, it succeeded in
stimulating manufactured exports. Most of the manufactured
80
commodities, including textile products and garments, that
experienced a jump in exports in 1979 and afterward received
the export certificate incentive (Pitt 1991: 159).
Credit Policy
To facilitate the development of manufacturing
activities, the government provided subsidized credit through
its state-owned banks. The real interest rate charged on
credit allocated to the textile industry was negative during
most of the ISI period (Hill 1980: 91).
In 1978, the manufacturing sector received 32 percent of
the total short-term credit: 37 percent of rupiah credits and
19 percent of foreign exchange credits. The government also
introduced longer-term investment credits to finance both
fixed assets and working capital. By early 1979, the share of
credit extended to manufacturing industries reached 40 percent
of the total; only 8 percent of this in the form of rupiah
credits (Poot 1981: 95). The high share of foreign exchange
credits might be the result of the tendency to import capital-
intensive and modern machineries induced by the overvalued
currency, especially prior to the November 1978 devaluation.
The government also took export encouragement measures by
reducing the interest rate charged on credit provided to
exporters and exportable producers from 25 percent to 12
percent. And in January 1982 the government reduced the
interest rate further from 12 percent to the range of 6 to 9
81
percent per year depending on the commodity exported, to
stimulate exports due to the sluggish world demand for
Indonesian commodities (Scherer 1982: 17).
3.3.3. The Effect of Government Policies on ITGI Development
The ISI policies described above led to highly effective
protection for the domestic textile industry from the
competition of foreign products. This is shown in Table 3.6,
where the rates of effective protection during the 1971-1984
period were commonly above 50 percent and often over 100
percent, especially in weaving, knitting, and spinning
activities. The most heavily protected industries, such as
weaving and knitting, enjoyed effective rates of protection as
high as 569 percent in 1984 and 331 percent in 1975
respectively.
Table 3.6
Effective Rates of Protection for Textiles and Garments
1971-1984
( % )
Sector 1971 1975 1984
Spinning 134 .3 56.0 62 .0
Weaving
Other textile goods
- IVA 191.7 569 .1
(excluding garments) - IVA 297 .6 12 .4
Knitting -IVA 331.5 91.6
Garments 198 .6 110.0 -19.1
Carpet, rope, etc. -IVA 101.4 324.1
Other textiles n.a. n.a. -9.5
SOURCE: Hal Hill. Indonesia1 1s Textile and Garment Industries.
Occasional Paper No. 87, Institute of Southeast Asian
Studies: Singapore, 1992, p. 66.
82
The highly effective protection combined with consumer
backlog and high economic growth during the ISI period (1972-
1984) facilitated the development of the TGI (Hill 1992: 88) .
The expansion in the textile sector was also aided by the
relatively liberal investment policy adopted by the
government, especially before 1974.
The growth of the production of textile products can be
seen in Table 3.7.
Table 3.7
Production of Textiles and Garments
(1975-1984)
volume: tons
p
i i 1
f
1 TJ
1 0
1 5 - J
i i i
u c t
Fiber Yarn Fabric Garment
1975 3, 846 80,796 136,707 -
1976 21,914 112,994 167,608
_
1977 41,605 123,054 179,099
-
1978 45,374 151,886 184,946 50,400
1979 50,269 181,037 256,720 56,000
1980 53,790 214,778 272,487 61,000
1981 55,077 239,992 281,452 67,900
1982 73,474 284,356 229,677 70,050
1983 89,584 301,495 315,484 78,050
1984 105,157 321,595 322,796 89,950
SOURCE: Ministry of Industry, unpublished data.
It can be seen that output of each commodity grew very
rapidly during the ISI period. For the first time, fibers and
garments were produced in significant quantities as their
output began to be recorded in 1975 and 1978 respectively.
83
The textile and garment industries also experienced rapid
machinery development during the 1971-1984 period as can be
seen from the following table.
Table 3.8
Textile Machineries, 1971, 1981, and 1984
Subsector Unit 1971 1981 1984
Spinning spindle 481,780 2,160,841 2,574,516
Weaving loom 35,635 88,648 103,267
Knitting machine 5, 853 10,592 15,415
Garment machine - 42,350 63,656
SOURCE: Ministry of Industry, unpublished data
The expansion of machinery in each activity was
accompanied by increasing sophistication in technology
enabling generation of products at higher speed and of better
quality. In spinning, many of the spindles used were open end
and jet spinning systems which are much more productive than
the older ring spinning model. In weaving, the highly
productive shuttleless looms were increasingly used, while in
knitting, more multifeed machines and electronically
controlled equipment came into operation. In the case of
garments, there was also improvement in technology,
with the use of highly productive modern cutting machines
(Indonesia 1989: 21).
84
The growth in income per capita during this period led to
a change in demand for textile products from traditional
clothing such as aaKQngfi and __s.elendancrs to modern western-
style apparel. There was also increasing demand for clothing
made from synthetic materials (Hill 1992: 7) . Consequently,
the textile industry began to require man-made inputs for
production in addition to the traditional cotton inputs. This
development led to the establishment of domestic synthetic
fiber and yarn industries for the first time in Indonesia.
The fiber industry started in 1973 with the construction
of a polyester plant with the capacity of 27,500 tons of fiber
and 21,000 tons of filament per year to meet the demand of
domestic spinners for man-made fibers (Indonesia 1994: 108).
This plant began production in 1974. The number of fiber
plants then multiplied rapidly in the 1970s and early 1980s.
Another major input for synthetic yarn, rayon staple fiber,
began to be produced in 1982. Although starting from a low
base, the fiber output grew at a very rapid rate from 3,846
tons in 1975 to 89,584 tons in 1983.
The yarn industry also developed remarkably, partly
facilitated by the availability of locally-produced synthetic
fibers, while nearly all cotton input was still imported. Many
textile producers, especially Japanese investors, built
integrated spinning and weaving factories to ensure a smooth
supply of spun yarn in sufficient quantity and of satisfactory
quality. Domestic investment in spinning increased rapidly
85
during the 1970s because compared with the demand from the
weaving and knitting industry, the domestic production of yarn
was still short of meeting their needs. In the early 1980s,
domestic yarn demand was met and the excess output began to be
exported. As can be seen from Table 3.2, yarn output grew from
only 80,796 tons in 1975 to 321,595 tons in 1984.
The weaving and knitting industry has undergone a
significant restructuring in technology since the early 1970s.
The generous fiscal incentives offered by BKPM, high trade
protection and the overvalued exchange rate made investment in
capital-intensive production process attractive (Bautista
1983: 8). Consequently, most of the small weavers who still
employed traditional hand and outdated mechanized looms were
driven out of the market because they could not compete with
the large-scale weavers using highly efficient modern
automatic power looms.
As the result of the large increase of investment in the
weaving industry, fabric production increased very rapidly. In
1975, the output of weaving and knitting was 136,707 tons; in
1984 it had reached 322,796 tons. Even in the mid 1970s,
textile production had already reached the target of meeting
domestic demand, forcing the government to find ways to
channel excess production to the export markets. Among other
ways, this was achieved by offering the export certificate
scheme and subsidized export credit to exporters.
86
The growth of textile products was accompanied by-
significant improvements in product quality as the result of
both the use of modern machinery embodying the latest
technology and the increase in labor productivity. There was
also product diversification in each stage of production, such
as in synthetic fiber and yarn (polyester, rayon), coloring
materials, and garments (Indonesia 1989: 22).
Initially, domestic demand for garments was fulfilled by
small-scale producers including individual tailors and
imports. The high import tariff imposed during ISI began to
encourage local producers to establish garment factories to
meet growing demand due to higher income and population
growth. Improved export incentives in the second half of the
1970s, including the November 1978 rupiah devaluation,
stimulated garment industry development. The export value of
garments increased from a mere $4,9 million in 1974 to $256,6
million in 1984 (Table 3.9).
However, during the 1970s, except for a small volume of
garments, the inward-looking strategy did not encourage
production of other textile products for export.
87
Table 3.9
EXPORTS OF TEXTILE PRODUCTS AND GARMENTS (1974-1984)
(U.S.$ thousand)
Year Fiber Yarn Cloth Garment Other Finished
Textile Products
1974
_ —
4,994
—
1975
- - - 12,700
-
1976
- - -
26,300
-
1977 - - - 25,500
-
1978 - - - 42,900
-
1979
- - -
154,400 -
1980 77 3, 149 30,554 100,910
-
1981 360 1, 753 27,786 80,045 -
1982 360 1, 300 33,131 112,970
-
1983 549 13,712 106,800 171,938
-
1984 189 17,003 146,439 256,610 59,042
SOURCE: Ministry of Industry, unpublished data.
The export of other textile products began in 1980 as the
result of saturation in the domestic market. However, the real
exchange rate was eroded by an increase in the inflation rate
as the result of the 1979 oil boom, thus reducing the
incentive to export to some extent. Exports were stimulated
again with the March 1983 devaluation. Thus the base for
export growth was established in the early 1980s.
The development of the ITGI can also be assessed from its
contribution to the generation of value-added in manufacturing
production.
88
Table 3.10
Distribution of Manufacturing Value-Added in the Textile
sector in 1975 and 1985 (billion rphs)
1975 1985
O v v U w Ju
Value % Value %
Textiles 71.7 15.1 762.5 11. 7
Garment 0.9 0.2 117.4 1.8
Total manufacturing 476.4 100.0 6,520.6 100 .0
SOURCE: H. POOT, Industrialization Strategy and Policies in
Indonesia during Repelita V. Working Paper No. 6,
Industry Planning Project, Centre for Data and
Analysis, Ministry of Industry: Jakarta, 1988, p. 12.
From Table 3.10, it can be seen that both textiles and
garments experienced high growth in value-added. Textile
value-added increased from Rp.71.7 billion in 1975 to Rp.762.5
billion in 1985, although its share in total manufacturing
value-added declined from 15.1 percent to 11.7 percent. The
value-added contributed by the garment industry increased from
merely Rp.0.9 billion to Rp.117.4 billion during the period.
Similarly its contribution to total manufacturing value-added
rose from 0.2 percent to 1.8 percent.
3.4. SUMMARY
There were two main factors that affected the role of the
Indonesian government in promoting industrial development:
economic ideology and government's financial resources. In the
Old Order era, the influence of the nationalist (i.e.
89
interventionist) was dominant resulting in excessive
government intervention in industrialization including the
textile industry. However, the outcome was dissapointing
because the effort to promote industrial development was not
supported by favorable economic and political conditions.
In the New Order period, the nationalist ideology was
challenged by the economic liberalism. The interventionists
had a great influence when the government enjoyed windfall
gains from the dramatic increase in oil revenues in the 1973-
1984 period, enabling it to undertake import substitution
industrialization. As a result, the textile industry
experienced a tremendous expansion during that period, meeting
the domestic demand and having a large capacity for export.
However, the oil slumps, first in 1983 and then in 1986,
forced the government to change the industrialization strategy
from import substitution to export promotion in 1985 giving
the textile industry great opportunity for further expansion.
ENDNOTES OF CHAPTER 3:
1. They are Dr. Wijoyo Nitisastro (former head of the National
Development Planning Board (BAPPENAS) and Coordinating
Minister of Economic Affairs), Dr. Ali Wardhana (former
Minister of Finance and Coordinating Minister of Economic
Affairs) , Dr. Mohammad Sadli (former head of the Investment
Coordinating Board (BKPM) and Minister of Mining and
Energy), Dr. Emir Salim (former Minister of Communication
and Minister of Environment) and Dr. Subroto (former
Minister of Mining and Energy). Because most of them are
90
graduates from the University of California at Berkeley,
this group is often dubbed as the 'Berkeley Mafia1.
2. The most influential figures of this nationalist group are
Dr. Ibnu Sutowo (former head of Pertamina (the state oil
company), Dr. B.J. Habibie (the present Minister of
Research and Technology), Ir. (engineer) A.R. Soehoed
(former Minister of Industry), Ir. Hartarto (former
Minister of Industry, now the the Coordinating Minister of
Trade and Industry), and Ir. Ginanjar Kartasasmita (former
Junior Minister for the Utilization of Domestic Components,
Minister of Mining and Energy and now the head of
BAPPENAS).
3. In this liberal democracy period, a large number of
political parties existed. For example, there were forty
political parties contesting for parliament seats in the
general elections first held in Indonesia in 1955. However,
none of them won enough votes to control a majority in
parliament which to form a strong cabinet. As a result, in
the 1950-1958 period, as many as eight cabinets were
formed. The Djuanda cabinet was in office the longest, from
March 1957 to August 1959 (see Glassbumer, 1971: 70-98).
4. During the guided democracy period (1959-1965), the
government was preoccupied with various military conflicts,
among others, the campaign to to take over Irian Jaya (West
New Guinea) from the Dutch, the confrontation against an
expanded Malaysia and the suppresion of rebellions in
several regions. In international politics, Soekarno,
aspiring to be one of the leaders of the "new emerging
forces" (the third world and socialist countries) was
active to promote Indonesia and himself by hosting GANEFO
in the early 1960s (Games of the New Emerging Countries)
and initiating other expensive pet projects. These
political activities drained the government's
resources badly (Wibisono, 1987: 41-42).
5. This phenomenon is known in economic literature as the
"Dutch disease", where an export boom in an oil/natural gas
sector led to the deteroriation in the competitiveness of
the non-oil/gas sector owing to the appreciation of the
domestic currency (see Gillis et al, 1987: 535-541).
91
6. Although "indirect" lobbying by some of textile
manufacturers through channels close to the policymakers
also played a role in the granting of high protection to
the textile industry, a more feasible explanation was that
provision of clothing was one of the two main targets
(besides provision of food), especially in the First
Development Plan (1969/70- 1973/74) . See Pangestu and
Boediono, 1986: 31-32.
92
CHAPTER 4
GOVERNMENT POLICIES AND THE DEVELOPMENT OF THE INDONESIAN
TEXTILES AND GARMENT INDUSTRIES DURING EXPORT-ORIENTED
INDUSTRIALIZATION (1985-PRESENT)
The main purpose of this chapter is to examine the
government's role in facilitating the development of the
Indonesian Textile and Garment Industries (ITGI) during the
export-oriented industrialization period from 1985 to the
present. First, I review the background of the shift in
industrialization approach from ISI to EOI strategy. Then,
after discussing the government policies, their effect on the
ITGI will be analyzed. It will be apparent that the Indonesian
government has played a significant role in promoting the TGI
development during this EOI period through the range of
measures that it has taken.
4.1. THE ADOPTION OF AN EXPORT-ORIENTED INDUSTRIALIZATION
STRATEGY
The shift in industrialization strategy from ISI to EOI
was triggered by an external shock; namely, the collapse in
world oil prices. First, in March 1983 world oil prices fell
from $34.50 to $29.50 per barrel; then they fell drastically
further in early January 1986 to $13 per barrel. The oil price
93
slump was caused by the world economic recession in the first
half of the 1980's and the failure of OPECs members to reach
an agreement that could limit petroleum production to boost
its price.
This drastic decline in oil prices dealt a heavy blow to
the Indonesian economy because of its dependence on the
commodity (see Table 4.1).
Table 4.
Economic Conditions of Indonesia
1
(1979-1986)f Selected Years
1979 1980 1982 1984 1986
a) General economic
conditions
Income growth in
industrial nations 3.4 1.3 -0.4 2.7 2.4
Real price of oil in
foreign purchasing
power (1980=100) 67 .7 100 .0 124 .1 109.1 59.1
Indonesian inflation
rate (%) 20.6 18 .5 9.5 10 .5 5.9
Indonesian growth
rate (%) 6.3 9.9 2.2 6.6 2.4
b) Balance of payments
situation
Merchandise exports
to GDP (%) 27.5 27 .9 20.8 24.3 21.4
Current account balance
to GDP (%) 1.9 4.0 -5.9 -2.5 -4.3
c) Non-oil export sector
(1974=100)
Import price deflated
by housing cost 62 .5 62 . 8 56 .9 59.8 57 .7
Export price deflated
by housing cost 99.0 101.0 80.5 102 .9 98 . 9
In foreign purchasing
power 162 .4 155.9 107 .3 169.3 168 .2
Source: Woo and Nasution (1989), Table 6.7, p. 108.
94
At the peak of the oil boom in 1981/82, the oil and
LNG (liquid natural gas) sector contributed three-fourths of
export earnings and two-thirds of government revenues. After
the oil shock, those earnings declined significantly. The drop
in oil prices was coupled with a decline in the prices of
Indonesian non-oil commodities due to the sluggish
international demand from the industrial countries, especially
the United States. Consequently, during 1986 Indonesian terms
of trade (TOT) dropped sharply by 26.2 percent, equal to the
loss of Rp.5.9 trillion in purchasing power (Hill 1987: 4).
The deteroriation in TOT had adverse effects on the
balance of payments and on economic growth. The current
account experienced a sharp deteroriation in 1982, 1984 and
1986, forcing the government to seek more foreign borrowing
thus increasing significantly the external debt. Lower
government expenditures and the decline in the terms of trade
caused a severe contraction in aggregate demand, reducing the
annual growth rate to 3.0 percent in the period 1981-86 from
7.5 percent during 1973-81.
The economy's vulnerability to oil shocks made Indonesian
policymakers realize that economic growth could no longer
depend on oil if it was to continue in a sustainable manner.
A prolonged domestic economic recession would undermine the
stability of the New Order regime, which derived its political
support from its ability to deliver satisfactory development
6performance to almost all sectors of the country. Besides,
95
the protectionist policies accorded to the domestic industries
discourage non-oil export activities. Consequently,
development policy must be reoriented toward an EOI strategy
in the hope of boosting the non-oil manufactured exports to
reduce dependence on the oil sector and restore the pace of
industrialization and economic growth.
The economic slump also triggered criticism of the
government's economic policies from the liberal economists.
They forcefully but persuasively argued that the economy
needed to be liberalized from protectionist policies to
increase its efficiency and competitiveness (Dick 1985: 19).
Quantitative restrictions should be replaced with uniform
tariffs, which in turn should be gradually reduced in a
certain period of time to finally force local producers to
compete with foreign suppliers both in domestic and world
markets (Liddle 1987: 210).
The president, although basically a nationalist, was also
a pragmatist. He realized the serious nature of the economic
problems and supported the liberal economists' position on the
need to adjust the development strategy in the post oil-boom
era. Initially, the reforms were confined to macroeconomic and
financial policies over which the liberal technocrats who
control the Ministry of Finance and the National Development
Planning Board (BAPPENAS) have authority. First, they
implemented several fiscal austerity measures by cancelling a
number of large state industrial projects and freezing civil
96
servants' and military salaries. In March 1983, they devalued
the rupiah, which had become increasingly overvalued since the
1978 devaluation. Also in 1983 they deregulated the banking
system by lifting the ceiling on the interest rate.
Thereafter, the reform expanded to other sectors gradually but
in a clear direction: toward a more market-oriented economy.
4.2. GOVERNMENT POLICIES AFFECTING THE ITGI
The new economic initiatives taken by the government in
reorienting the industrialization strategy from ISI to EOI
also affected the ITGI sector. Textiles, and especially
garments, are two labor-intensive industries that have the
potential to develop rapidly through the expansion of export
opportunities. However, the protectionist policies accorded
the two industries during ISI made their products relatively
uncompetitive in the world market. Therefore the government
took a number of steps to increase their efficiency and
promote exports. This required deregulation of the restrictive
trade regime and adoption of other export-promotion measures.
To better understand the role of government in the
development of the TGI during the EOI, I shall discuss the
measures that have been taken and have affected the two
industries. Because the thrust of the EOI strategy is
basically the reversal of the former ISI policies discussed in
97
chapter 3, I discuss them in roughly the same order in the
next sections.
Exchange Rate Policy
EOI requires an exchange rate regime that maintains an
equilibrium or at least a realistic exchange rate, a rate
which is not grossly overvalued or undervalued, to realize
optimal benefits from exporting. This means the change of
industrialization strategy from ISI to EOI requires an
adjustment of the overvalued exchange rate to a realistic
level.
In managing its exchange rate system during this period,
the Indonesian government has shown a strong commitment to
maintaining a competitive exchange rate policy and rupiah
stability. Whenever necessary it has been willing to take
tough measures which are politically unappealing, such as
devaluation, subsidy elimination and tight monetary policy.
Government intervention in the foreign exchange and monetary
market is particularly important due to the vulnerability of
the Indonesian economy to external shocks.
A drastic decline in export revenues and a large increase
in the current account deficit in 1982 and the beginning of
1983 prompted the government to devalue the rupiah on 30
March 1983, from Rp.703 to Rp.970 per U.S. dollar. To maintain
a realistic exchange rate, since 1981 the government has
implemented a managed floating exchange rate system, where the
98
exchange rate is always adjusted to compensate for the
difference between the Indonesian inflation rate and that of
its major trading partners. The 1983 devaluation resulted in
an increase of Indonesian manufactured exports. Textiles and
garment exports rose from $293 million in 1983 to $479 million
in 1984.
However, this situation did not last long because the
slowing down of the industrial countries' growth in 1985 led
to low demand for oil and other commodities (Woo and Nasution
1989: 110). As a result, another oil price slump occured in
January 1986. People's confidence in the rupiah was shaken and
the bitter experience of the March 1983 sudden devaluation
made them suspicious that the government would soon devalue
the rupiah again. To protect the value of their money, many
holders of savings and time deposits denominated in rupiah
began to withdraw their money, to convert it into foreign
deposits, and even to send it abroad. Although the top
government officials, including the president himself, made
repeated statements that the government had no intention of
devaluing this time due to a sufficient level of foreign
exchange reserves, a massive attempt to get rid of rupiahs
continued (Liddle 1987: 209).
Some observers were of the opinion that the government' s
statement that it would not devalue was economically
convincing. The relatively high level of foreign reserves at
Bank of Indonesia (BI) , the Indonesian Central Bank, and ample
99
commercial and stand-by loans made no strong case to devalue.
Furthermore, the real effective exchange rate was higher than
it was in 1983, when the last devaluation had taken place.
Thus the rupiah was not overvalued (Muir 1986: 17).
Other observers speculated that to avoid political risk,
the goverment would not devalue until after the general
elections, which were to be held in May 1987, However, only
after Dr. Soemitro Djojohadikusumo, the most senior and highly
respected economist, confirmed the government's plan not to
devalue after a meeting with the president in late March 1986,
did the run the on rupiah abate (Liddle 1987: 209).
In the month of August and the first week of September
1986, the devaluation rumour quieted down and the foreign
exchange market was relatively calm. However, on 12 September
1986, the government announced a major devaluation of the
rupiah from Rp. 1,134 to Rp. 1,644 per U.S. dollar, a 31 percent
change. The move caught many people by surprise, including
most members of the cabinet itself. The goverment apparently
succeeded in keeping its intentions secret in its attempt to
protect the foreign exchange reserves from speculation
pressure, although it had to break its promise and sacrifice
its credibility. The reason given was that the balance of
payments was in danger and the need to encourage non-oil
exports obliged the government to devalue the rupiah, thereby
adjusting to the reality of much lower oil revenues (Liddle
1987: 209) .
100
The effect of the devaluation was a decline in business
confidence. The government lost its credibility for breaking
its promise. Many businessmen, foreign and domestic, put off
or canceled their investment plans due to the uncertainty in
the foreign exchange market (Pangestu 1987: 2) . Some critics
claimed that the real purpose of the devaluation was to
increase government revenues in terms of the domestic
currency, by converting its oil export revenues received in US
dollar into rupiahs (Simanjuntak 1986: 442). This claim,
however, was denied by some observers close to the
government's inner circle (Booth 1986: 18-20).
The devaluation shock continued to hang on several months
after it happened. The fear of another devaluation and further
government measures to protect limited foreign reserves, such
as foreign exchange control and forced conversion of savings
deposits into government bonds, led to another destabilizing
speculative run in the foreign exchange market, resulting in
substantial capital flight in late 1986. Capital outflows
reached $1.8 billion in December 1986 while in the previous
months the amount ranged only between $200 and $300 million
(Pangestu 1987: 3).
In order to restore public confidence in the rupiah and
reverse the capital flight, the government first increased the
interest rate to a small extent hoping that the speculative
rush in the foreign exchange market would abate. This did not
happen. Then the interest rate was raised again. Nevertheless,
101
the purchase of strong foreign currencies continued to
increase, resulting in a deep drop in the foreign exchange
reserves of the Bank of Indonesia in spite of government
insistence that it would not carry out another devaluation or
impose exchange controls.
To counter the increasing attack on the rupiah, the
government finally decided to take a drastic and unprecedented
measure. In June 1987 the acting Minister of Finance,
Dr.Sumarlin, ordered four large state-owned enterprises to
withdraw most of their funds deposited in the state banks and
use them to buy Central Bank deposit certificates (SBIs). The
total withdrawal amounted to Rp. 900 billion, which severely
reduced the liquidity of the money market. This unexpected and
strong move by the government caused the banks to scramble for
liquidity causing the interbank interest rate to jump from
13.6 percent in April 1987 to a peak rate of 39 percent in
early July 1987 {Binhadi and Meek 1992: 115). The higher
interest rate succeeded in inducing a return of rupiahs and
eased the pressure on the foreign exchange market.
After the speculative run on reserves had ended, the
government showed its readiness to "get tough" and intervene
in the money market at the first sign of capital flight, such
as what happened when a new speculative run on the rupiah
occured in February 1991, which closely resembled the June
1987 events (Parker 1991: 10-11). It made every effort to keep
the exchange rate at a realistic level. This is achieved by
102
keeping the inflation rate down and adjusting the exchange
rate to movements in the cross rates of Indonesia's principal
trading partners.
The exchange rate policy was supported by stringent
fiscal and monetary measures brought about by the oil-induced
financial squeeze. For the first time in the New Order regime,
in 1986 the government reduced the state budget in real terms.
To restrain inflation, the government was also willing to
adopt a tight monetary policy even if it raised the interest
rate and slowed down business activity as it did in 1990 when
there was excess demand caused by the overheated economy.
These conservative policies, together with the active
management of the rupiah's external value, have succeeded in
helping to keep the real exchange rate at a competitive level
since the 1986 devaluation. As can be seen from Figure 4.1,
the increasing tendency of the indices of the REER shows that
there has been an improvement in the competitiveness of
Indonesian export commodities in international markets. It is
clear that for the Indonesian government maintaining a
realistic exchange rate is of paramount importance in
implementing EOI.
103
Figure 4.1
REAL EFFECTIVE AND NOMINAL EXCHANGE RATE INDEX (1979-1990)
(1980 = 100)
♦♦
♦♦♦♦♦
loo.oo - ['
50 00
000
6 6 87 88 69 85 83 84 90 62 79 80
■ REER SDR □ REER Trade ♦ Nom ER
•SDR and trade weights.
SOURCE: Anwar Nasution. 1991. "Survey of Recent
Developments.", Bulletin of Indonesian Economic
Studies 27 (2) p. 36.
In Figure 4.1 the REER indices are measured in terms of
nominal exchange and trade-weights of Indonesia's trading
partners.
Investment Policy
As was noted in chapter 3, during the ISI phase the
government pursued an investment policy that encouraged
orderly development of domestic industries and channeled
104
investments into the desired activities by heavily licensing
and regulating investment. Investment and industrial licensing
were also used as instruments to protect existing producers,
especially small-scale producers, from excessive competition
in domestic markets (Barichello and Flatters 1991: 276). To
prevent overcapacity, the government closed certain sectors
perceived already to have achieved capacity sufficient to
fulfill domestic needs.
The steep decline in private investment levels due to
this restrictive regime and the decline of the state's
capacity to finance new public projects led the government to
improve the investment climate after 1985 by gradually
liberalizing the regulations and conditions for investment.
To promote investment, in 1985 the government reduced the
extent of licensing and regulations. The government introduced
incentives to foreign investors by offering a rescheduling of
obligations and expanding investment opportunities. The new
incentives offered were as follows:
1) the time period for foreign investors to sell 51 percent of
their equity to Indonesian interests was extended from 7 to 10
years; 2) foreign investments located in export-processing
zones were required to have only 5 percent local equity
instead of 20 percent as stipulated previously; and 3)
foreigners who wanted to establish service companies such as
export consultancies were exempted from the requirement of
paying $1 million minimum capital (Muir 1986: 22).
105
To promote investments, in May 1986 the government
introduced a reform package which among others opened all
sectors to foreign and domestic investors if they would export
at least 85 percent of their production, relaxing the prior
requirement of 100 percent. Foreign firms which sold 75
percent of their equity to Indonesian partners or 51 percent
majority equity in the Jakarta stock exchange to local
investors would be treated as domestic investment with equal
access to state-subsidized bank credits and control over
distribution and marketing.1
In June 1987, the government issued a more liberal
Investment Priority List. Among other improvements, a license
is declared valid as long as the plant is in operation.
Previously, the license had to be renewed every five years.
Also, the scope of investment opportunities was broadened
considerably. The expansion of capacity up to 30 percent over
the licensed capacity no longer required an additional permit.
The processing of investment applications was also simplified
(Poot 1988: 34).
In December 1987, the government further deregulated
foreign investment. To encourage investment in export
production, foreign companies were allowed to export their
output without having to go through a local trading company.
They were also permitted to export other companies' products.
In order to facilitate the export of domestic producers, they
were permitted to establish trading companies. With this
106
arrangement, the government hoped that large foreign companies
with established export markets would export products not only
from their own factories in Indonesia but also the products of
domestic companies, especially small and medium-scale ones,
which usually lacked marketing skills (Booth 1988: 27).
The December 1987 package also further relaxed the time
frame of the foreign investors' obligation to sell 51 percent
of their stocks to Indonesian shareholders from 10 to 15
years. Now, foreign investors engaged mainly in export
production (at least 65 percent for export, down from 85
percent) could be established with only 5 percent domestic
equity, but were required to increase it to 20 percent within
10 years (Booth 1988: 28).
Foreign investors located in export processing zones
(EPZs) were given a much greater incentive; they could
establish a venture with 5 percent domestic shareholding and
with no obligation to increase local participation provided
all production was directed for the export market. The strict
regulation concerning expatriate employment was also relaxed
considerably. Foreign investors were allowed to bring in
foreign managers and consultants to help in export production
and marketing (Booth 1988: 28).
In 1989 the Investment Priority List was considerably
simplified from a positive to a negative list. Under the
positive list system, areas open for investments were
specified in detail and thus formed a long and complex list.
107
Now on the negative list, only fields closed to new investment
are listed, while those not mentioned are automatically open
to investment.
Since 1987 there has been a rise in investment from the
Asian NICs, Korea, Taiwan, Hong Kong and Singapore, in
Indonesia. Most of this investment is in the manufacturing
sector, including the textile industry. These countries are
losing their comparative advantage in labor-intensive
manufacturing activities due to rising costs of labor and the
appreciation of their currencies. These factors have led to
the relocation of their industries to the ASEAN countries
which have lower wages and land costs (Wie 1991: 60-61).
To attract investment from the NICs, the Indonesian
government has taken several specific measures. It negotiated
with the governments of these countries investment guarantees
agreement and bilateral tax treaties to avoid double taxation
(to prevent a foreign enterprise e.g. a multinational
corporation investing in Indonesia from being taxed twice; by
the government of Indonesia as the host country and by that of
the home country, from where the enterprise comes from). To
attract small-scale overseas investors, in 1989 the government
reduced the required minimum amount of investment from $1
million to $250,000. For the first time since the 1965
attempted communist coup, the government allowed the
108
establishment of a Chinese languange school for the education
of Taiwanese investors' and their employees1 children (Wie
1991: 60).
These efforts, together with deregulation measures have
succeeded in attracting large amounts of investments from the
Asian NICs. In 1989 the shares of South Korea, Taiwan, and
Hong Kong reached more than 70 percent of the total
investment approvals in textiles and garments (Hill 1992: 23) .
The development of investments in the textile sector
during the period 1987-1992 is shown in Table 4.2.
Table 4.2.
Investments in the Textile Sector
(1985-1992)
YEAR
Foreign
Investment
(million US$)
Domestic
Investment
(billion Rp)
Non-Facility/
Non-BKPM
(billion Rp)
1985 120, 6 85,4 20,2
1986 23, 2 447, 5 104, 4
1987 181, 4 1.274,7 173,4
1988 61, 9 2.346,9 273, 8
1989 391, 9 3.669,7 136, 9
1990 3.041,7 10.163,8 985, 8
1991 405, 6 2,669,9 396, 7
1992 105, 6 715, 5 122, 4
SOURCE: Indonesia. 1994. Buku Petuniuk Industri Tekstil
Nasional 1993 (Guidebook on National Textile Industry
1993). Ministry of Industry, Jakarta, Table IV.2. p.
106.
109
It can be seen that although there are some fluctuations
in the investment figures, since 1985 investment in the
textile sector has tended to increase. The peak was reached in
1990, when there was a dramatic jump in each of the three
categories of investment. However, the tight monetary policy
adopted by the government to restrain inflation in 1991
resulted in a decline of investment in 1991 and 1992
(Indonesia 1994: 106).
Import Policy
As noted, tariff and non-tariff barriers were the main
policy instruments used effectively by the government to
protect and facilitate the development of the Indonesian
textile industry during the ISI phase. The restriction imposed
on competing imports, however, had negative effects. Many of
the restricted items were crucial inputs to export-oriented
manufacturing activities. The resulting high prices of both
imported and domestically produced intermediate goods
increased the production costs for domestic downstream
producers and thus adversely affected their competitiveness in
the world market.
To make manufacturing industry more efficient and
competitive in the context of the export-oriented development
strategy, since the mid-1980s, the government has introduced
a series of reforms to liberalize the trade regime. In April
1985 the government reduced tariff rates across the board and
110
as well as the tariff dispersion. The highest nominal rate for
most items was lowered from 225 percent to 100 percent and
the number of tariff categories was reduced from 25 to 11
(Poot 1988: 23).
In May 1986 the government introduced a major trade
reform package which significantly increased the
competitiveness of the domestic manufacturing exporters by
providing them access to inputs at international prices. The
new scheme, which has been very instrumental in boosting
Indonesian manufacturing exports, consists of two parts. In
the first, export-oriented manufacturing companies which
export at least 85 percent of their production are allowed to
import raw, intermediate and capital goods free of import
duties and restrictions. In the second part of the scheme, the
firms which export less than 85 percent of their output are
entitled to import inputs otherwise subject to import
restrictions if the prices of the domestic supplier's products
are higher than those of imported inputs (of comparable
quality). For this group of exporters, a duty drawback
facility was created. In both cases exporters can import
intermediate goods directly without having to go through the
licensed importers or monopolists (Poot 1988: 23; Sjahrir and
Brown 1992: 127-128).
To administer export facilities under the May 1986
package, an agency which is now called the Agency for Export
Facility Services and Financial Data Processing (BAPEKSTA) was
111
set up within the Ministry of Finance. This office works
efficiently and is able to process exemption and drawback
applications within a relatively short period of time, usually
seven days.
Table 4.3.
EXPORT VALUES AND SHARES OF TEXTILE PRODUCTS
USING BAPEKSTA FACILITIES
(1987-1992)
YEAR
Number
of
LPSE
Exports through
BAPEKSTA
(000 US$)
Total
Exports
(000 US$)
Percentage of
Total Exports
(%)
1987 1,336 47,024 1,025,402 4.6
1988 1, 741 68,240 1,410,931 4.8
1989 17,580 770,751 2,020,496 38.1
1990 29,174 1,044,055 2,880,670 36.3
1991 47,114 1,730,548 4,002,512 43 .2
1992 49,144 2,056,087 5,955,534 34.5
SOURCES: BAPEKSTA, Ministry of Finance and Ministry of
Industry, unpublished data.
Table 4.3 shows that the share of textile product
exports through BAPEKSTA has been increasing very rapidly. In
1987 merely 4.6 percent of exports utilized the duty
exemption/drawback facilities; whereas in 1992, the share had
already reached 34.5 percent. The increasing number of
verification reports by export surveyors (LPSE) also indicates
112
that more and more textile and garment exporters are attracted
by the scheme.
With this particular arrangement, the government enables
the companies which produce mainly for export to circumvent
both import monopolies and local producers by importing their
inputs directly at much more competitive international prices
without having to dismantle the whole import restrictions and
regulations protecting domestic producers.
These deregulation measures led domestic producers in the
affected upstream industries including the producers of
polyester fiber, to complain publicly and loudly about the
difficult prospects they faced, demanding the reimposition of
high tariffs on all imports (Muir 1986: 11). However, the
government was not persuaded and continued to issue new
reforms .2
In October 1986, the government liberalized further the
trade regime by reducing the number of items restricted by
import license, replacing for the first time licensing
arrangements for some products with import tariffs and
reducing the tariff duties imposed on goods which were not
produced locally. In the textile sector, the import of cotton,
the major input of the industry, was deregulated by
transfering the import license from its sole importer, P.T.
Cerat Bina Tekst.il Indonesia (CBTI) , to six state-owned
trading enterprises. The import of polyester and rayon
fibers, two other main inputs, was also relaxed by placing
113
them under the general importer category which did not need a
license to import them (Pangestu 1987: 29, 32).
On January 15, 1987, another reform package was
introduced which also affected the textile sector. The import
procedures for the textile products were relaxed further by
placing 88 items under the general importer category, and 114
items under the importer producers category whereby the
textile manufacturers were given permission to import inputs
used in producing their products. However, the import of 253
items in the batik category and 15 items in the non-batik
category were still prohibited with their placement under the
approved importer category and with a zero quota for their
import. The reason given by the government for continued
protection of these two groups of products was that they were
produced by economically weak and mostly indigenous producers
who employed a relatively large number of laborers (Pangestu
1987: 33).
This reform package also removed further the restriction
on the import of cotton, by placing it under the general
importer or importer producer category which enabled domestic
producers to import cotton directly. Moreover, the obligation
of the textile producer to buy domestic cotton in the ratio of
1 to 10 relative to imported cotton (as an effort to promote
the domestic cotton industry) was abolished. Although domestic
producers still have to purchase domestic cotton, the
114
obligation is not as binding as the previous one (Pangestu
1987: 33) .
The last reform measure affecting the textile sector was
the July 1992 package which liberalized a number of import
categories including batik textiles. With this reform,
virtually all of the quantitative restrictions had been
removed in the textile sector. The main protection instrument
that remained was in the form of tariffs.
Fiscal. . . Jncent ives
The most important fiscal incentive provided to promote
exports, was the export certificate drawback scheme.
Introduced in January 1979, this scheme revised the
compensation system to exporters in effect since April 1976
for import taxes, import duties, import sales taxes, and MPO
(withholding) taxes on imported inputs. The export certificate
scheme provided eligible exporters of manufactures rebates on
import duties paid on imported raw materials and intermediate
goods used in the production of exports. This scheme also
allowed exporters of manufactures to defer the payment of
import duties for six months. After the commodities had been
shipped for export, the formal exemption from the taxes would
be granted (Poot et al. 1990: 503).
The export certificate scheme evolved to become a direct
subsidy program of substantial assistance to exporters, since
the rebate calculation was based, not only on import duties
115
paid on imported materials, but also on other inputs purchased
from domestic producers (Barichello and Flatters 1991: 281).
In 1984/85 the total value of rebates paid amounted to Rp.200
billion, which was about 19 percent of total exports (Dick
1985: 8) .
The apparent success of the export certificate scheme in
boosting Indonesian textile exports, especially to the U.S.
market, elicited a protest from the U.S. government in late
1984. The United States stated that the hidden subsidy
provision behind the scheme was an unfair trading practice and
it threatened to impose countervailing duties on Indonesian
textile exports. To avoid those duties, the United States
demanded that Indonesia sign the GATT Code on Subsidies and
Countervailing Duties and eliminate the export certificate
program by 1 April 1986. Indonesia had no choice but to comply
with those demands to guarantee smooth access to the U.S.
market for its growing textile exports. Indonesia became a
consignatory to the GATT Export Subsidy Accord and in April
1986 replaced the export certificate program with a duty
drawback scheme (Barichello and Flatters 1991: 281-282).
Under the new duty drawback program, exporters are no
longer compensated for domestically purchased inputs which
generally are more expensive than imported goods. The higher
domestic prices arise either because the local producers are
still inefficient or because the right to import those inputs
is in the hands of monopolistic trading companies.
116
To assist small-scale exporters, the government extended
to them fiscal incentives previously granted only to foreign
and domestic investors applying through the BKPM. Now they,
too, are exempted from paying import taxes and VAT (value-
added taxes) when importing machinery and equipment intended
for export production. A group of exporters who have
demonstrated good performance are given VAT exemption on the
purchase of domestically produced goods by the Ministry of
Finance. However, the VAT involved has to be paid if the
products are sold in the domestic market (Booth 1988: 24).
To enable more exporters to enjoy these incentives, the
Ministry of Finance also relaxed the definition of "exporter".
Formerly, an exporter could receive the privilege if at least
85 percent of its total production was exported. This was
reduced to 65 percent. Thus, a manufacturer can get taxes
exemption even if only two-thirds of his output is exported
(Booth 1988: 24).
C re d i t Po l i c y
As noted, as a part of its ISI policies, the government
provided investment and working capital credit to facilitate
the growth of domestic industries, including the textile
industry. However, the glut that developed in the textile
market in 1982 due to recession-induced weak demand depressed
the prices of textile products and led to severe financial
problems for their manufacturers. Many of them were not able
117
to pay back their debts to the state-owned banks which had
provided the bulk of the credits. Therefore, the government
instructed the banks not to allocate further credit to the
textile industry.3 However, as the textile market condition
improved, especially after exporting became more attractive
due the policy shift to the export-oriented strategy, the
banks informally began to grant credit to the textile
producers again. Table 4.4 shows that credit provided to the
textile and garment industries from 1986 to 1993 grew in line
with the expansion of the two industries.
Total
Table 4.4
credit allocated to Textiles
(1986-1993)
and Garment industries4
(millions of rupiahs)
YEAR Textiles Garment
1986 671.8 214.6
1987 954 .8 305 .0
1988 1.399.7 447.1
1989 2.170 .0 693 .3
1990 2.571.8 821.6
1991 5.921,6 1.925,9
1992 6.883,9 1.942,3
1993 8.945,0 2.678,0
SOURCE: Bank of Indonesia, unpublished report.
118
In an effort to assist exporters who were hurt by the
removal of the export certificate program, the government
offered a special export financing program through the
Commodity Exchange (Bursa Komoditi) with an interest rate of
9 percent for primary commodities and 11.5 percent for non
primary commodities. Compared with the market interest rate,
which was around 22 percent, the subsidy provided to exporters
was very generous. This incentive applied to both domestic and
foreign firms with the difference that domestic exporters
could receive 85 percent of export financing (based on FOB
value) while the foreign ones were eligible for only 70
percent (Dick 1985: 8-9). The export credit scheme did not
last long, however, because it was a form of subsidy
prohibited under the GATT Accord. In compliance with this
regulation, the government abolished the program in April
1990.
To offset this drawback, in November 1991, the government
through Bank of Indonesia issued a decree requiring banks to
extend a minimum of 80 percent of their total foreign exchange
credits to finance export activities either for investment or
for working capital funds. Previously, foreign banks had been
required to allocate at least 50 percent of their loans to
finance export activity. As a result, extended export credits
rose by 33.1 percent in the financial year of 1991/1992
conpared to 5.1 percent in FY 1990/1991.5
119
To facilitate export and import payments, the government
allowed the use of types of L/C other than the Irrevocable
L/C, which was commonly used as the means of payments for
imports and exports. In line with this policy, in November
1985, the government established a credit insurance
corporation, called ASEI (Asuransi Ekspor Indonesia), under
the supervision of the Ministry of Finance, to minimize the
risks involved in the use of other terms of payments, in
particular for exports in the non-oil sector. More
specifically, its mission was to support the program of export
expansion in the non-oil sector by providing 1) export credit
guarantees to banks in Indonesia that extend loans to
exporters for export purposes; and 2) export credit insurance
to exporters in Indonesia who sell goods to overseas buyers
(Muchtar 1993: 35).
This export insurance scheme appeared to encourage the
expansion of textiles and garments, as exporters are protected
from the risk of payment failure when they ship their products
to importers or countries with which they are not very-
familiar. Table 4.5 shows that the export insurance coverage
for both textiles and garments increased remarkably during the
1986-1992 period, suggesting the importance of this insurance
facility in promoting exports.
120
Export
Table 4.5.
Insurance Coverage for Textiles and
through ASEI (1986-1992)
(thousand rupiah)
Garments
Year Textiles Garments
1986 - 250.796
1987 - -
1988 1.028.815 -
1989 1.193.818 109 .000
1990 711.546 16.206.698
1991 2 .467.151 10.286.428
1992 2.290.726 36.871.884
SOURCE: Indonesia Export Credit Insurance Corporation (ASEI),
unpublished data.
Export Promotion Policy
In the export promotion program, the government has taken
the following measures.
-The improvement of Customs and Port services.
To facilitate the smooth flow of imports and exports at
the Indonesian ports, in April 1985 the government, in an
unprecedented move, relieved the Directorate General of
Customs and Excise from its duties and assigned them to a
Swiss international surveying company, SGS. The dismantling of
the Customs department, notorious for its inefficiency and
corrupt officials, was a bold decision taken by the government
121
as many of the senior customs officials came from a military
background and were close to the military leadership. The duty
of SGS was to execute customs inspections for import
consignments and exports in a speedy and efficient manner. The
measure also included efforts to improve port operations and
inter-island shipping. These actions succeeded in greatly
simplifying and speeding up import and export processing at
ports and thus reduced costs significantly (Barichello and
Flatters 1991: 280; Muir 1986: 21).
-The Establishment of the Export Supporting Board (ESB).
In 1986 the Ministry of Trade established an Export
Supporting Board which began to operate in 1988. Its duty was
to increase the competitiveness of Indonesian exports by
assisting exporters in hiring experts to improve production
management, including efficiency, product quality, and
international marketing. The forms of assistance include
providing technical assistance, printing leaflets and catalogs
and organizing trade fairs and seminars. From the 19 kinds of
commodities which received promotion assistance until 1993,
the garment industry received Rp.1.3 million and US $688,214
(15 percent of the total aid) reflecting the priority given by
the government to this industry.6
122
-The Establishment of Export Processing Zones (EPZs).
To promote non-oil exports, the government established
several bonded zones as export-processing sites. These zones
are exclusive areas because they are treated as outside the
Indonesian Customs authority. Export-oriented manufacturers
located in these areas can import directly and free of tariff
duties the raw materials and intermediate goods required for
the production of their products without having to go through
cumbersome customs procedures. Other facilities offered
include one-stop service, competitive rent, and transportation
and cargo handling facilities.
The existence of the EPZs attracted many textile and
garment investors, both foreign and domestic, to establish
their factories there. For example, in May 1992, 75 percent of
the industries (80 companies) located in the Tanjung Priok EPZ
(KBN), Jakarta, were textile and garment industries.
An EPZ is very suitable for these two export-oriented
industries because of the easy access it provides to imported
intermediate materials. This facility enables them to meet
orders in time, a very important factor especially for the
garment manufacturers who often have to respond to foreign
customers' requests on a relatively short notice.
The companies here are also allowed to sell 15 to 25
percent of their output in the more lucrative domestic market,
thus increasing the incentive to locate there. The success of
this EPZ in attracting export-oriented industries led the
123
government to build more bonded zones in four cities
throughout the country.7
-The Establishment of the National Agency for Export
Development (NAFED).
The government established NAFED in 1971, but its
activity became significant only after development policy
shifted to the outward-looking strategy. The agency is
assigned the task of promoting and facilitating the export of
Indonesian products throughout the world, and finding markets
for those products, including textiles and garments. Supported
by the government, it provides a comprehensive range of
services to both exporters and foreign importers of Indonesian
goods. In textile promotion, NAFED offers periodic workshops
to update manufacturers on current styles, fashions and trends
for garments as well as other textile products. This
information about the latest trend in fashion and styles
helped the garment and textile manufacturers to respond
effectively to changing market demands.
Industrial Deepening Measures
To achieve a balance between downstream and upstream
industries development, during the EOI period the government
emphasized the deepening and diversification of industrial
structure by strengthening backward linkages between
124
industries. The government encouraged the development of
industries that process intermediate goods, such as those
produced by the petro-based and wood-based industries as well
as those that process domestic raw materials (Poot 1988: 8).
In this connection, the government puts a high priority on
balanced development in the textile sector from the most
upstream industry, such as purified therephtalic acid (PTA),
a major input for synthetic fibers, to such downstream
industry as garments. This is intended to strengthen the
structure of the domestic textile and garment industries and
enhance their competitiveness in international markets. The
diversification of textile products into many branches of an
industrial tree (pohon industri) such as tire cord, hosiery,
upholstery, velvet, interlining, safety fabric and so on was
also encouraged to reduce dependence on garment and fabric
commodities (Wibisono 1987: 80).
Since Indonesia imports 95 percent of its cotton
requirements, the government has tried to develop the domestic
cotton industry and has initiated the building of plants that
produce raw materials for synthetic fibers using available
domestic natural resources such as petroleum and wood as main
inputs. In this regard the government has succeeded in
sponsoring the construction of several large scale upstream
plants, among others, two PTA aromatic plants in Plaju and
Cilacap, a rayon fiber plant in Porsea, North Sumatera and a
pulp plant in South Sumatera.® As a result, the fiber
125
industry, synthetic or cellulosic, is developing very fast in
Indonesia (Indonesia 1994: 111-112). The increasing
availability of intermediate goods reduces significantly
Indonesia's imports of raw materials for textiles and makes
domestic products more competitive due to lower procurement*
costs.
4.3. THE EFFECTS OF GOVERNMENT POLICIES ON THE EFFECTIVE RATES
OF PROTECTION AND ASSISTANCE (ERP/ERA)
According to the neoclassical argument, the shift from
ISI to EOI requires liberalization of the trade regime by
first replacing the quantitative barriers with import tariffs.
Tariff protection is expected to give a better competitive
environment because tariffs are more transparent than
quantitative restrictions. To encourage competition further,
tariffs should be lowered gradually so that domestic producers
tend to base their calculations on international prices in
both outputs and inputs. Balassa recommends effective
protection be reduced to approximately 10 percent to promote
manufacturing industries (Balassa 1971: 97).
How does this argument relate to the Indonesian
experience in the reform of its trade policy? From the data in
Table 4.6, from 1987 to 1989 there has been in general a
slight decline in effective protection in the textile and
garment sector as the result of the liberalization measures
126
introduced beginning in the mid 1980s. However, in 1984 and
1987, the level of protection was still very high, generally
over 50 percent. It also varies widely across activities. In
1989, weaving enjoyed an ERP of 217 percent while knitting
received an ERP of only 3.5 percent.
Table 4.6
Effective Rates of Protection for Textiles and Garment,
1984, 1987, and 1989
(Percentage)
Sector 1984 1987 1989
Spinning 62 .0 120.0 57 . 8
Weaving 569.1 195 .1 217 .3
Other textile goods
(excluding garments) 12 .4 94 .4 84.9
Knitting 91.6 24.9 3.5
Garments -19 .1 39.1 16.5
Carpet, rope, etc. -324.1 44 .0 50.6
Other textiles -9.5 -8.6 6.8
SOURCES : Hal Hill .1992. Indonesia's Textile and Garment
Industries. Occasional Paper No. 87, Singapore:
Institute of Southeast Asian Studies, p. 66.
The high level of effective protection means that
domestic producers still enjoy high profitability selling in
the domestic market because foreign textile products are not
competitive due to the high tariff rate imposed on them. At
the same time, this also means exporters of textiles and
127
garments are at a relative disadvantage and thus are
discouraged from exporting. The structure of protection for
both segments of the textile market has been estimated by
Wymenga (1991), as shown in the following table.
Table 4.7
Effective Rates of Protection for Textile and Apparel
Producers by Sales Destination in 1989
(Percentage)
Sectors Total Sales Domestic Sales Export sales
Textile goods 84.9 109 .4 -2.0
(excl. apparel)
Wearing apparel 16.5 101.4 -1.3
SOURCE: P. Wymenga. 1991. "The Structure of Protection in
1989 in Indonesia". Bulletin of Indonesian Economic
S-Lufljgs 27 (1), p. 140.
It can be seen that domestic producers who sold their
products in the local market enjoyed protection of more than
100 percent on their value-added at the international price.
On the other hand, those who exported experienced negative
protection due to the non-tradable intermediate inputs they
still had to purchase at high domestic prices. This
differential protection structure reveals that despite the
measures that it has taken to liberalize the trade regime,
especially in the textile sector, the government is still
strongly committed to protect domestic producers from cheaper
imported products to enable them to gain enough experience and
capital before they are forced to compete with foreign
producers. But how can this anti-export bias in the incentive
128
system be reconciled with the remarkable export performance of
the Indonesian textile sector (discussed below)? The answer to
this puzzle lies in the export incentives given by the
government in the form of tariff-duty exemption and drawback
facilities offered through Bapeksta and the subsidized export
credits through the Bank of Indonesia's discount facility, as
has been noted before. These incentives enabled exporters to
more than offset their relative disadvantage vis-a-vis
domestic producers by purchasing tradable inputs at cheaper
world prices and by acquiring credit at a lower interest rate,
thus reducing production costs.
This contention is supported by the estimates of
effective rates of assistance (ERA). This is a more complete
indicator of effective protection than ERP. It includes in its
calculation various other forms of government intervention
besides tariff and non-tariff protection such as fiscal and
credit subsidies (Findlay and Garnaut 1986: xvi). The ERAs for
the weaving and garment industries are presented in Table 4.8.
Table 4.8.
Estimates of the Effective Rates of Assistance for
the Weaving and Garment industries, 1988
(%)
ERA Total Sales Domestic Sales Export Sales
Weaving 5.2 2.2 12.7
Garments 10 .6 -18 .1 13.6
SOURCE: Ilyas Saad. 1992. The Impact of Trade Reforms and the
Multi-Fibre Arrangement on Indonesian Clothing and
Textile Exports in the 1980's. Unpublished Ph.D.
Dissertation, Australian National University:
Canberra, pp. 135-136.
129
By including the value of the tariff-duty exemption/
drawback and export credit assistance granted by the
government in the calculation of the ERA estimates, Saad found
that the incentive structure is reversed in favour of
exporting. Now export- oriented weavers received 12.7 percent
effective assistance, while the domestic-oriented ones got
only 2.2 percent. In the case of garments, their exporters
enjoyed much greater government support vis-a-vis the
producers who sold in the local market, receiving an ERA of
13.6 percent compared with -18.1 percent for domestic sales.
It is clear that government policies have resulted in an
incentive structure biased toward export. This pro-export
incentive system is not achieved by a comprehensive
liberalization of the import regime, as the rate of effective
protection to the domestic textile producers is still very
high, but by the granting of import-duty exemption/drawback
and export credit facilities to exporters. Together with the
maintenance of a realistic exchange rate as well as other
government measures to promote exports, this export incentive
may explain why Indonesian exports of textile products grew
very rapidly in the period 1985 to 1992. The provision of
those facilities also enabled the government to continue
pursuing its goal of protecting domestic producers while
fostering development of the export sector.
130
4.4. THE DEVELOPMENT OF TEXTILE AND GARMENT INDUSTRIES
The change in policy incentives in favor of export
activity as the result of the measures taken by the government
during the last ten years has led to rapid export-led
industrial growth in the textile sector. This achievement was
also made possible by the strong industrial base established
in the ISI period. The build-up of production capacity, the
modernization of machinery, the development of upstream
industries and a more productive labor force in the textile
sector created a basis for an expansion of the industry
motored by export growth.
From Table 4.9, it can be seen that textile machineries
grew rapidly during the 1985-1993 period, especially spinning
and garment machinery. Spinning looms have increased in number
from 2,525,326 in 1985 to 6,178,286 in 1993. Garment sewing
machines also increased rapidly from 63,656 in 1985 to 221,177
in 1993 in line with the improved incentive to export
(Indonesia 1994: 109-110).
Table 4.9
Textile Machineries (1985-1993)
SUBSECTOR UNIT 1985 1989 1993
Spinning spindle 2,525,326 3,821,582 6,178,286
Weaving loom 107,313 128,348 191,508
Knitting machine 16,382 22,928 36,515
Garment machine 63,656 119,341 221,177
SOURCE: Ministry of Industry, unpublished data.
131
The large increase in textile machinery and thus
installed production capacity in each subsector made possible
a rapid expansion of textile output, as shown in Table 4.10.
Table 4.10
Production of Textile products and Garment (1985-1992)
(tons)
YEAR --
Fiber
P R
Yarn
0 D U C T
Fabric Garment Total
1985 109,150 340,540 335,846 94,680 880,216
1986 120,164 389,635 371,169 101,120 982,088
1987 139,685 434,691 429,319 116,820 1,120,515
1988 160,176 486,534 468,994 130,740 1,246,444
1989 170,693 617,864 683,957 171,250 1,643,764
1990 177,065 643,759 683,090 204,920 1,708,834
1991 216,156 729,238 717,983 210,670 1,874,047
1992 333,229 988,667 901,477 270,020 2,493,393
TOTAL 1,426,318 4,630,928 4,591,835 1,300,220 11,949,301
SOURCE: Ministry of Industry, unpublished data.
In only seven years, textile production increased almost
threefold. Between 1985 and 1992 output grew at an average
annual rate of 16 percent at an increasingly large base. This
growth rate is higher than that of the non-oil manufacturing
industries, which averaged 12 percent during the same period.
The roughly same rate of increase shows that there is a
balance in the development of downstream and upstream
industries in this sector. Growth was also facilitated by the
increasing availability of textile raw materials
in the domestic market due to the expansion of capacity in the
fiber and yarn industries.
132
Although the rise in domestic demand is also significant,
the main factor that led to the rapid expansion of the textile
sector is the export growth that accelerated during the
period.9 From Table 4.11, it can be seen that each textile
commodity experienced rapid export growth both in value and
volume. The export value of textile and garment products
increased at an average annual rate of 37.5 percent from 1985
to 1992. Among the five products, garments show the most
remarkable export performance, increasing at an average rate
of 40 percent per year in value and contributing 50 percent of
the textile export revenues. There was also a rise in the
value per unit of each product, implying an improvement in the
quality of the products exported. The sharp increase in
exports during the period made the textile sector in 1991 the
largest foreign exchange earner among the non-oil manufactured
exports and the second after petroleum.
The significance of exports in the expansion of the
textile industry can be seen by comparing its rates of real
growth in output and exports. Whereas the average rate of
total output growth is 16 percent, the rate of export growth
is 30 percent, implying its role as the leading factor in the
expansion of production.
133
Table 4.11.
Exports of Textile Products and Garment (1985-1992)
upper row : value (U.S.$ thousand)
lower row : volume (tons)
YEAR
Fiber Yarn
P R O
Fabric
D U
Garments
C T
Other Tex. Total
1985 98 12,633 162,314 294,491 73,896 543,432
99 5, 338 39,247 33,840 18,883 97,407
1986 1,503 19,946 232,337 497,316 43,119 794,221
1, 520 7, 270 50,863 54,653 12,177 126,483
1987 2,144 84,386 295,995 588,067 54,810 1,025,402
1, 034 26,508 65,211 75,435 13,717 181,905
1988 14,448 109,428 448,241 796,454 42,360 1,410,931
10,308 37,036 75,246 62,582 13,303 198,475
1989 20,343 112,260 683,314 1,122,205 82,374 2,020,496
9, 798 33,898 103,999 85,073 14,621 247,389
1990
C O
C O
C O
H
104,084 1,054,232 1,572,257 131,213 2,880,670
9,487 32,390 138,535 110,356 17,760 308,528
1991 30,535 203,565 1,444,710 2,089,618 234,084 4,002,512
18,865 61,888 164,981 135,895 25,373 407,002
1992 36,394 343,944 2,332,077 2,984,950 258,169 5,955,534
27,038 114,169 218,159 176,916 41,143 577,425
SOURCE: Ministry of Industry, unpublished data.
The textile sector also made progress in term of its
share of non-oil manufactured exports. In 1984 its share was
still 14 percent, but in the period 1987-1990, it increased to
134
30 percent. Similarly, in terms of value-added, its growth has
increased, from an average 14 percent per year in the 1975 to
1985 period to an average 24.2 percent per year in the 1985 to
1990 period. This production expansion was accompanied by
significant growth in employment from 5.35 percent per year to
15.7 percent per year during the respective periods (Khatkhate
1992: 183).
4.5. SUMMARY
The above discussion has shown that the Indonesian
government has played an important role in promoting the
development of the textile and garment industries during the
EOI period through the deregulation measures it has taken. The
textile and garment industries are developing very rapidly,
propelled by export growth. The replacement of quantitative
and licensing restrictions with tariffs in the textile import
regime may have enhanced the competitiveness of the ITGI to
some extent due to more transparent price signals.
The remarkable export-led development in the ITGI,
however, is not the result of a comprehensive liberalization
of the trade regime, as is commonly claimed by the
neoclassical economists in explaining the success of export-
led industrialization in the East Asian countries. It is
caused by a multitude of government measures, the most
important of which is the import duty exemption/drawback
135
facilities, which make producing for export sales more
attractive than selling in the internal market. The
effectiveness is also facilitated by the government's
readiness to implement tough measures and "bite the bullet" in
order to make the export drive successful.
ENDNOTES OF CHAPTER 4:
1. Far Eastern Economic Review. 22 May 1986, "Small
Scale Concessions", p. 62.
2. It appeared that the deregulation measures produced a
new "interest group" comprising export-oriented
entrepreneurs who benefited from the new trade policy. As
the deregulation measures began to generate positive
results in the form of expanded exports, they gradually
became an influential factor in government policymaking
which more than offset the pressure of the domestic
manufacturers who demanded continued protection. An example
of this is the campaign waged by the association of the
spinning industry during 1986-1987 to press for further
deregulation of the controls on the purchase of imported
and local cotton. The lobbying activities of this
industry's association together with the informal alliance
with the liberal technocrats helped to bring about
extensive reforms in the textile industry (MacIntyre,
1991) .
3. Kompas daily, "Belum Dicabut, Larangan Kredit Industri
Tekstil" (Not Yet Revoked, the Ban on Credit Provision to
the Textile Industry), 23 January 1987.
4. In the BI's report, from 1986-1990, the total credit
granted to textiles, garment and leather industries is
subsumed under the textile, garment and leather industry
category. To get the estimates of credit given to the
textile and garment industries separately, I calculated
them based on their shares of credit in the 1991-1993
period.
136
5. Bank of Indonesia's Report for the Financial Year
1991/1992, p. 55.
6. Tekstil & Garment. No. 20/THN 1/1992, "DPE dan Perannya
Menyiasati Ekspor" (ESB and its Role in Promoting Export),
p. 8.
7. Tekstil & Garment. No. 7/THN 1/1992, "Kawasan Berikat
Nusantara: Manfaat dan Kendalanya" (Nusantara Bonded Zone:
Its Benefits and Problems), p. 3-4.
8. Merdeka daily, 31 October 1988, "Pengembangan Industri
Tekstil Diarahkan Untuk Capai Keseimbangan" (The
Development of the Textile Industry is Directed to Achieve
a Balance).
9. According to the Ministry of Industry's data, in 1985, the
consumption of fiber and finished products was 1.77 and
1.40 kg per capita respectively. In 1992, the consumption
reached 3.61 and 2.86 kg respectively.
137
CHAPTER 5
THE MULTIFIBER ARRANGEMENT AND THE INDONESIAN
TEXTILE EXPORT QUOTA ALLOCATION SYSTEM
This chapter discusses the role of the Multifiber
Arrangement (MFA) which regulates international trade in
textiles and garment. As a signatory to the MFA, Indonesian
exports of textile products were constrained by the rules of
this international textile regime. The MFA presented
governments of exporting countries with an important task:
administering export quotas. The success of textile exports is
affected by the government's effectiveness in implementing
this task, besides the efforts expended by exporter-
entrepreneurs in improving their competitiveness.
In this chapter I shall argue that although the MFA has
become more restrictive, Indonesian textile exports were able
to grow remarkably. Export expansion was enhanced by the
government's ability to use the quota allocation system to
encourage export development.
5.1. THE MULTIFIBER ARRANGEMENT: ITS BACKGROUND AND
DEVELOPMENT
5.1.1. The__Background to the MFA
Since the Second World War, international trade has been
conducted under the auspices of the General Agreement on
-Tariffs and Trade (GATT). Two of GATT's basic principles in
138
international trade are: 1) that a participating country is
not allowed to discriminate against other countries in its
trade regime; and 2) that to protect its domestic producers,
a participating country is allowed to impose tariffs, but not
quantitative restrictions. (Choi et al. 1985: 13). The purpose
of these rules is to facilitate the expansion of international
trade based on the comparative advantage of each nation.
The GATT's rules include the international textile trade.
But in the mid-1950s, some western industrial countries,
especially the United States and the United Kingdom, began to
feel pressure from the rapid increase in cotton textile
imports from Japan and Hong Kong. The low prices and
relatively good quality of textile products from these two
countries posed a serious threat to their domestic textile
producers. Therefore, the American textile manufacturers
demanded that their government impose quantitative
restrictions on the import of Japanese cotton products. The
United States government, feeling obliged to stand by the
rules of GATT that it itself helped to create, began to seek
other ways and means that could reduce Japanese textile
imports. It proposed the adoption of a Voluntary Export
Restraints (VERs) scheme, which had also been used to restrict
textile imports from Japan in the 1930s (Yoffie 1983: 49-50) .
After long and intense bargaining, the United States
finally succeeded in pressing Japan to enter into a new VERs
agreement. It basically required Japan to "voluntarily"
139
restrain its cotton textile exports, especially in sensitive
articles such as gingham, velveteen and women's blouses, so
that they did not upset the American producers' market share
(Yoffie 1983: 54-58; Aggarwal 1985: 50-52).
The U.S. government tried to reach a similar agreement
with Hong Kong but failed. Under pressure, Hong Kong had
already signed a VERs agreement with Britain, its colonial
master. But it did not face the same constraint in dealing
with the United States. Moreover, Hong Kong's laissez-faire
economic system which entailed little government interference
in the trade regime made its producers and government
reluctant to implement VERs. The absence of a restraint
agreement meant Hong Kong exports continued to expand.
Consequently, Hong Kong's market share in the American textile
market increased dramatically at the expense of Japan's
(Yoffie 1983 : 64-78) .
The invasion of textile products from Hong Kong and other
emerging exporters such as Taiwan and South Korea in the early
1960s forced President Kennedy to find a multilateral solution
to the textile problem. Kennedy was obliged to help domestic
textile producers in exchange for their support in his bid for
the presidency. Together with the European importing
countries, the United States sponsored a multilateral
discussion with the exporting countries (mostly less developed
countries) to find a framework for regulating international
trade in textiles outside the GATT regime (Cline 1990: 147).
140
The agreement, which was called the "Short-Term Arrangement"
{STA), contained a number of clauses aimed at restricting
cotton textile imports to avoid "market disruption" in
importing countries, thus giving them the right to impose
quantitative restrictions to protect their textile industries
(Yoffie 1983: 84) . The STA remained in effect from mid-1961 to
mid-1962. This arrangement proved to be such a success that,
after its expiration, the STA was replaced by the "Long Term
Arrangement" (LTA). This new arrangement enabled the United
States to conclude bilateral agreements with new major
exporters such as Hong Kong, Taiwan and South Korea (Yoffie
1983: 108). The LTA was extended several times until the end
of 1973.
Meanwhile, during the 1960s and early 1970s there was a
shift in textile consumption patterns from cotton to man-made
fiber products. Japan, South Korea, and Taiwan were able to
develop their synthetic textile industries and export these
products aggressively to the western industrial countries.
Renewed calls for protectionist measures in this line of
products from domestic interests led the importing countries
to seek an appropriate way further to restrict textile
imports. This was achieved by reforming the LTA, expanding the
coverage of restrictions to include man-made textile products.
This new international arrangement in textile trade was called
the "Multifiber Arrangement" (MFA).
141
5.1.2. The Growing Restrictiveness of the MFA
The first Multi-Fiber Arrangement, which was negotiated
in 1973 and governed the international trade of textile and
garment from January 1, 1974 to December 31, 1977, contained
a general framework for determining the conditions under which
textile and garment trade could be controlled. Article 1 of
the Arrangement stated: "The basic objectives shall be to
achieve the expansion of trade, the reduction of barriers to
such trade and the progressive liberalization of world trade
in textile products, while at the same time ensuring the
orderly and equitable development of this trade and avoiding
disruptive effects in individual markets and on individual
lines of production in both importing and exporting
countries." {Aggarwal 1985: 133).
Another objective was "to further the economic and social
development of developing countries and secure a substantial
increase in their export earnings from textile products, and
to provide scope for a greater share for them in world trade
in these products". For the importing developed countries, the
most inportant provisions of the MFA were contained in
Articles 3 and 4. Article 3 provided that an importing
country, on the grounds of market disruption, was allowed to
consult with the exporting country to limit the exports of a
particular product. If an agreement could not be achieved in
a certain period, the importing country had the right to
impose a unilateral restriction. Article 4 provided that an
142
importing country may seek bilateral agreements with an
exporting country to eliminate "real risks of market
disruption" (Dao 1985: 84-85).
To facilitate cooperation from the less developed
countries, MFA I provided that bilateral restraint agreements
should allow 6 percent annual growth of import volumes, and it
provided three types of "flexibility provisions":
transferability of quotas (to the extent of 5 to 7 percent)
across product categories during a particular year, known as
"swing"; the ability to borrow against a future year's quota,
known as "carry forward", and the ability to add unused quotas
to subsequent years imports, known as "carry over" (Hufbauer
et al. 1986: 128).
The less developed countries, who were in weak positions,
tried to maintain a strong regime to minimize departures from
the Arrangement by the protectionist importing countries. They
hoped this objective could be achieved with the establishment
of the Textiles Surveillance Body (TSB), whose duty it was to
assess all measures taken in the implementation of the MFA and
mediate any dispute between the member countries (Aggarwal
1985: 174; Yoffie 1983: 162).
With the conclusion of this Arrangement, the United
States government immediately held talks with the exporting
countries to renew its cotton bilateral agreements to include
other fibers and renegotiated its multifiber agreements
previously made with a number of exporting countries,
143
including Hong Kong, South Korea and Taiwan. By 1975 the
United States had successfully achieved its goal to control
the import flow of textiles from these countries. And by
October 1977, the United States completed
eighteen bilateral agreements, including cotton textile
constraints. It also secured agreements with ten countries to
hold consultations in the case of sudden import surges
(Aggarwal 1985: 137).
In the renewal of MFA in 1977, the United States did not
try to make more restrictive changes for international and
domestic reasons. The domestic textile manufacturers were
content with the reduced flow of textile imports under MFA,
while a larger share of the products were diverted to
the European Community (EC) countries and other importing
countries than before the existence of MFA (Aggarwal 1985:
144) .
In contrast with the United States, the EC actively
pressed for a more restrictive arrangement because it was
experiencing considerable trade deficits in textiles (Cline
1990: 151). Within the EC member states, the textile industry
and labor groups put heavy pressure on member governments for
greater protection. The United Kingdom, which previously was
more liberal, joined the French in calling for tighter
restrictions. These factors, together with the threat of
individual member-countries to impose unilateral restriction
forced the EC officials to press for a more restrictive MFA if
144
it was to be renewed. The Europeans maintained that the MFA
was not able to protect their domestic textile industries. The
EC threatened to abandon the MFA and return to the imposition
of unilateral restrictions if its demands were not met {Yoffie
1983: 163).
The EC demanded the flexibility of departures from the
norm of 6 percent import growth. Formerly, to depart from this
norm required a rather complex procedure to prove that an
import surge really disrupts the domestic market or damages
production. After strong opposition from the LDCs, the EC
managed to incorporate an important change in the MFA II text
allowing "jointly agreed reasonable departures" from the 6
percent norm of quota growth (Cline 1990: 152) .
After some struggle, the LDCs managed to incorporate two
provisions in the text of the Arrangement. The first provision
was a paragraph stating the continuation of the function of
the Textile Surveillance Body and of the Textile Committee.
They hoped, in the situation of growing protectionism, that a
strong regime would restrain the behavior of the importing
countries and reduce bilateralism in the implementation of the
MFA. Second, the LDCs were able to make a change in the
protocol stating that "reasonable departures" would be applied
only temporarily (Aggarwal 1985: 159-160).
The renewal of MFA was signed by the participating
countries in December 1977. With it, the permission of
"reasonable departures" proved to be another tool of the
145
developed countries to take more restrictive measures and to
violate the MFA objectives. This new provision enabled the
importing countries to cut back the 6 percent target of quota
growth and also to depart from the flexibility norm {swing and
carry-over provisions) contained in the original MFA. These
restrictive measures were implemented in the bilateral
agreements with the exporting countries, causing the bilateral
agreements to be more protective than the MFA itself (Cline
1990: 152).
Under the MFA II the EC adopted a crucial change in the
treatment of textile products from the so-called "low cost
countries". It determined global maximum limits for imports
from these countries in sensitive groups of products under the
terms of "cumulative market disruption". This means if there
were disruptive effects from an import surge, the importing
country could not only curtail the quota growth of the
individual exporting country but also tighten restrictions on
the other countries exporting the product, including small
suppliers due to the global definition of disruption (Cline
1990: 153) .
Under the MFA II, the United States also put protective
measures into the conclusion of bilateral agreements with
exporting countries. The Carter Administration froze import
growth for Hong Kong, South Korea and Taiwan during 1977 under
the safety provision. Then, in 1979-1980 the United States
made bilateral agreements tightening further the swing and
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carry-over flexibility for these three countries (Yoffie 1983:
163) . In the categories of products where the quotas were
considerably unfulfilled, the United States removed the quotas
in some of its agreements with the big three suppliers;
however, a "call" mechanism for consultations to set new
quotas was provided in case there was a sudden import jump
above a certain level.
However, the United States tended to give favorable
treatment to the new entrants and small supplying countries.
The argument of the need to freeze the import growth of the
big three exporters to allow more growth opportunities for
new, small suppliers continued to appear in the subsequent
renewals of MFA (Cline 1990: 153).
Negotiations in 1981 for the second renewal of the MFA
(MFA III) continued the trend toward protectionism. The EC
strove for reductions in the import growth of the major
suppliers. It maintained that this could be achieved using the
provision of reasonable departure of the MFA. In its proposal
to renew the MFA for five years, the EC aimed to cut the
import growth rates, to differentiate among the LDCs regarding
their exports, to step up control on cheating, to tighten the
swing, carry-forward and carry-over flexibility, and to
increase the number of categories of sensitive products
subject to very restrictive quotas. It also suggested a number
of other proposals such as greater reciprocity by the LDCs,
more imports by the U.S. and Japan to achieve better "burden
147
sharing", and some agreements on outward processing to
encourage the LDCs to buy from European textile producers
{Aggarwal 1985: 171). In arguing for more burden sharing, the
EC maintained that its imports per capita from the LDCs were
much greater than those of the United States and Japan (Cline
1990: 154).
In the negotiations of the MFA renewal, initially the
United States' position was to maintain a weak regime of MFA
II without attempting to make major changes. As long as the
MFA allowed a sharp limit on import growth from Hong Kong,
South Korea and Taiwan, the US negotiators said they would not
be concerned with the exact language of the new agreement. By
July 1981, the US goal was to negotiate a protocol that would
ensure it would achieve "minimal growth....in large quotas on
import-sensitive categories" in bilateral agreements with the
"big three" countries {Aggarwal 1985: 167).
The United States finally succeeded in achieving its
objectives:
- allowing the import growth rate of 6 percent {in volume
terms) to be lifted for "dominant suppliers" (e.g. Hong
Kong, Taiwan, South Korea) for certain fibers and when
there was "market disruption" (e.g. when importing
countries were confronted with large import increases
causing disruptive effects on their "minimum viable
production").
148
- allowing the exercise of "anti-surge" provisions to
prevent full utilization of unused quotas of the previous
period, giving compensation to other products.
- redefining "market disruption" to include the overall
growth for the product in the importing country, thus
taking into account any reduction in growth as the result
of changes in demand pattern (Hufbauer et al. 1986: 139).
The LDCs, on the other hand, tried to achieve greater
discipline in the MFA III and to abolish the "reasonable
departures" provision, especially on export restrictions. The
agreement finally did eliminate the clause allowing for
reasonable departures. However, this was in exchange for the
inclusion of a new provision permitting special restriction if
there was an import surge of sensitive products with
previously underutilized quotas. In addition, the protocol
incorporated the term of supplier "goodwill" which required
the dominant suppliers to be ready to cooperate with the
importing countries in restraining their exports (Cline 1990:
154) .
In the implementation of the bilateral agreements, the
United States administration also increased its control. It
divided the U.S. textile products under the MFA into three
main levels: textiles, apparel, and woolen textiles and
apparel. Under the MFA III, the United States had a tendency
to provide maximum limits at three classes: aggregate, group
149
and specific products. During MFA III the United States tended
to abandon the aggregate and group ceilings. It required that
consultations between the United States government and the
exporter's authorities be held before an individual product
not under special restrictions could be exported. In December
1983, the United States determined the products that were
subject to the trigger system for consultations. By 1986,
however, in addition to that, the U.S. government also
reestablished specific ceilings for the three classes of
products, and moved away from consultation categories to
outright quotas for the main suppliers. By mid-1986 all these
administrative procedures and bilateral agreements had
tightened restrictions resulting in increased overall
protectionism for the United States textile products. However,
although the restrictions had increased, the representatives
of the U.S. textile and garment industry still critized the
government measures as inadequate. They argued that the
permissible import growth rates for the three major suppliers
(Taiwan, South Korea and Hong Kong) should be frozen instead
of being reduced because the inflow of their products since
1982 had caused disruptive effects in the U.S. market. They
were also worried that the U.S. administration would conclude
more liberal agreements with other suppliers (Cline 1990: 214-
215) .
In the third MFA renewal (MFA IV) , the text of the
arrangement remained the same. However, the protective
150
provisions in the new MFA were broadened to cover import-surge
arrangements, anti-fraud procedures, more flexibility for
departures from the MFA's stipulations for import growth, and
special treatment of imports in certain product lines. The
agreement enabled the importing countries to extend
restrictions to textiles made of vegetable fibers and blends
containing silk. Ramie, silk blends and linen were now
included in the list of controlled fibers (Cline 1990: 219).
The MFA IV strengthened the right of the importing
countries to impose unilateral restrictions. They were allowed
to extend the previous 12-month quota without having to reach
an agreement first with the exporting country (Dao 1989: 88).
In addition, the removal of quotas could be considered in
cases where quotas were underutilized to reduce the problems
arising because of the substantial increases in import volumes
as the result of full utilization of the quotas. These
provisions accomplished the U.S. objective of tightening the
MFA against import increases.
The agreement also provided that in the case of
substantial import surges caused by the fulfillment of large
quota levels by a country enjoying a very large share of the
market of the importing country, the importing country could
make arrangements so that the import volumes were frozen or
even reduced. With this provision and claiming that the import
growth of textiles from the three big suppliers needed to be
frozen to allow more import growth from other LDCs, the U.S.
151
got legitimization to impose almost zero import growth on
Taiwan, Korea and Hong Kong in their 1986 bilateral agreements
(Cline 1990: 214). Therefore, the new MFA gave much room to
the importing countries to restrict imports, especialy from
the major supplying countries. The MFA provision of 6 percent
import growth allowance seemed no longer observed.
Although the MFA IV practically sucessfully incorporated
all the U.S. objectives of tightening textile and garment
imports, the American domestic producers were still not
satisfied. Through certain representatives in Congress, they
strongly critisized the agreement, saying that it would not
protect against import surges and that it contained too many
loopholes. On the other side, the representatives from LDCs
also critized MFA IV, maintaining that it was the most
restrictive textile arrangement that had ever been made (Cline
1990: 220).
When the MFA IV expired at the end of July 1991, the GATT
textile committee decided to extend the MFA for 17 months from
1 August 1991 until 31 December 1992 without making any
changes. The LDCs' effort to eliminate the MFA was finally
successful when the Uruguay Round multilateral agreement was
reached in April 1994, which decided to bring the textile
trade back under the GATT auspices within ten years.
152
5.2 . THE MFA AND INDONESIA
Indonesia became a member of the MFA in 1979 when its
growing export of textile products began to penetrate several
industrialized countries. Prior to that year, its export
levels were still low, and did not cause "market disruption"
in those importing countries. Thereby, Indonesia did not feel
obliged to join the MFA. However, in 1979, the United Kingdom
government threatened to impose import quotas on Indonesian
textile products unilaterally. The threat was real because
Indonesia was not an MFA participant. To avoid heavy quota
imposition through unilateral action, Indonesia decided to
sign the MFA. The bilateral agreement reached with Britain
was soon followed by other western industrialized countries
who also felt their industries were upset by textile imports
from Indonesia.
At present, Indonesia has bilateral textile agreements
with several countries, namely the United States, the European
Community (comprising Belgium, the Netherlands, Luxembourg,
Denmark, Ireland, England, Italy, Germany, France, Spain,
Portugal and Greece), Canada and Norway, which impose import
quotas on Indonesian textile products based on Article 4 of
the MFA. Some importing countries, although they are MFA
members (such as Japan, Austria, Finland, and Switzerland) do
not apply quantitative restrictions on Indonesian textile
exports, while Australia adopts global quotas.
153
The impact of the growing restrictiveness of the MFA on
Indonesia is reflected in the number of quotas imposed in
bilateral agreements.
Table 5.1.
The Number of Quota-restricted Categories of Indonesian
Textiles and Garment Products by Importing Countries
(1982-1992)
YEAR USA EC Canada Norway Sweden
(Group)
1982 2
- - - -
1983 3 3
- - -
1984 5 3 2 - 4
1985 11 3 2
-
4
1986 35 5 2 - 4
1987 43 5 10 8 4
1988 46 6 10 8 4
1992 141 10 9 4 -
1993 141 10 12 4 -
SOURCE: Ministry of Trade, Unpublished Data.
From Table 5.1, it is clear that the U.S. market has
become the most restrictive for Indonesian products. When
Indonesia first signed a bilateral agreement with the United
States in 1982, there were only 2 categories that were
restricted. In 1993, this number jumped dramatically to 141,
which means practically all categories were subject to quotas
either specifically or globally. The EC and Canada also show
a tendency to increase protectionism, although much less
severely. Interestingly, the two Scandinavian countries,
Sweden and Norway, show a liberalizing tendency. Sweden
abolished all quotas in mid-1991. The awareness of the high
154
welfare costs suffered by consumers to protect the sinking
industries may have led this country to give up its
protectionist policy.
Another measure of MFA restrictiveness is trade coverage
ratio, which is textile and garment exports subject to
bilateral quotas stated as percentage of total exports
(REST/TOT). A high trade coverage ratio means that a high
proportion of textile and garment exports are affected by
quotas.
As shown in Table 5.2, trade coverage ratio of Indonesian
textile exports (represented by clothing) to the United States
market rose from 90.9 percent in 1988 to 92.6 percent in 1989.
This is consistent with the data in Table 5.1 showing the
growing restrictiveness of the U.S. market for Indonesian
textile exports.
Table 5.2.
Trade Coverage Ratio of Indonesian Exports to
the United States, 1988-1989
(percentage)
1988 1989
Clothing: 100.0 100.0
Quota 90.9 92 .6
Non-quota 9.1 7.4
Share in total exports:
Clothing 58.2 61.1
Total exports in million SME 257.3 326.8
Note: SME = Square Meter Equivalent
Source: Ilyas Saad (1992), Table 6.9.
155
For the EC market, the trade coverage ratio, although
rising from 24 percent in 1987 to 25 percent in 1988, declined
to 22 percent in 1989. Thus, there is an inconsistency between
trade coverage ratio and the number of restricted categories
as indicators of MFA restrictiveness. This may be caused by
the bias tendency of trade coverage ratio, since the value of
the numerator might be restrained by the restrictions
themselves (Hamilton and Kim 1990: 164).
Table 5.3
Trade Coverage Ratios of Indonesian Textile Exports to
the European Community, 1987-1989
(percentage)
Country 1987 1988 1989
EC (12) : 24 25 22
Benelux 10 15 17
Denmark 32 22 13
France 43 39 35
Greece 16 - -
Italy 9 41 36
Ireland 2 4 4
Portugal
- - 4
Spain 27 20 12
United Kingdom 48 18 17
Germany, Federal Rep. 25 28 24
Source: Ilyas Saad (1992), Table 6.10.
5.3 . ADAPTING TO QUOTAS
In light of the increasing restrictiveness of the MFA,
why were some countries still able to expand their textiles
and garment exports ? Vincent Cable (1990) suggests that
besides the industries' effort, this ability might be affected
156
by the way a government allocates textile export quotas. A
quota allocation system would be more effective in increasing
export revenues if it encourages exporters to do the
following:
a. Maximize utilization of quotas.
Export earnings can be greatly enlarged if quotas are
fulfilled effectively. This is measured by the quota
utilization ratio, which indicates the rate at which a quota
is utilized relative to the total amount available in a
specific category or group. Quota fulfilment will be
facilitated if there is a flexibility mechanism (Trela and
Whalley 1990: 20). The form of flexibility includes a swing
provision which allows an exporter to transfer some portion of
an unutilized or underutilized quota in a product category to
a category whose quota is already reached. A carry-over
provision allows a supplier to transfer some portion of the
previous year’s unused/underutilized quotas for the present
year's use, while carry-forward makes it possible to borrow
some portion of the next year's quotas to be used in the
present year.
b. Increase unit values.
Because the MFA quota is not based on value, but on
quantity or weight, upgrading the quality of exported products
under quotas can produce higher prices per unit which will
157
result in greater export values. Besides quality improvement,
higher unit values can be achieved by increasing local value
added through backward linkages development (such as producing
quality fabric and developing local design).
c. Diversify products.
Quota restrictiveness can be offset by diversifying
product mix, to categories not yet restricted. This may
involve opening new lines of production, producing and
exporting new products such as synthetic or blended fabrics
and fibers instead of the heavily restricted cotton-based
products.
d. Diversify markets.
Many exporters only concentrate on selling in MFA-
restricted countries because their quotas guarantee them
access to these markets. But exports can be augmented if the
exporters can be induced to spend more effort to penetrate
nonquota markets. Besides reducing the risk of export earning
instabilities caused by importing countries' restrictive
policies, diversification to nonquota markets will also
increase exporters' efficiency due to the highly competitive
nature of the non-quota markets. Even in the MFA-markets,
exporters may still be able to increase their market share by
focusing on those which have lower protectionist tendencies
and thus lower quota resistance.
158
e. Maximize scarcity rent.
Lastly, higher export values can be obtained by
maximizing the retention of rent earnings in product lines
restricted by a quota, thus generating scarcity value (the
difference between the price paid by consumers for a product
and the price which prevails if it is not restricted). This
rent may be appropriated either by the government (if quotas
are auctioned to the highest bidders) or by private exporters
(if quotas are allocated on a first-come first-served basis
subject to minimum prices or sold in a secondary
market/commodity exchange). High retention of the scarcity
rent should be reflected in higher unit values. However, in
practice it is difficult to differentiate between the share of
a unit value rise as a result of product upgrading and the
share as a result of increased retention of rent earnings.
The next section evaluates the effectiveness of the
Indonesian government in allocating textiles and garment
quotas based on the criteria discussed above.
5.4. THE INDONESIAN QUOTA ALLOCATION REGIME
Since becoming a member of the MFA in 1979, Indonesia,
through the Ministry of Trade, put textile trade under a
special regulation, which governs the export of textiles and
garments to the countries which impose quotas on Indonesian
products. The regulation affects both exporters and the
159
quantities of textiles and garment permitted to be exported by
each supplier for each category for a certain MFA-country in
a certain quota period. A quota period is the duration of the
quota determined in a bilateral agreement between the
government of Indonesia and that of the importing country.
In order to maximize revenues from textiles and garment
exports, the government uses the quota allocation system to
achieve maximum quota utilization and to encourage exports to
nonquota countries and exports of nonquota products. Another
objective is to induce exporters to get higher unit prices
through improvement of product quality. To achieve these
objectives the government gives an incentive to exporters who
perform well and imposes a penalty on those who perform badly.
The implementation of this "carrot and stick" system can
be seen from the way the Ministry of Trade allocates the
textile and garment quotas which can be distinguished into
five types as follows.
a. Basic (permanent) quota.
The national basic quota is the main source of quota
distribution. Its aggregate level is determined in bilateral
agreement with MFA-importing countries. Previously the basic
quota was distributed as follows :i) 80 percent for established
exporters (who have past performance) ; ii) 10 percent for
small exporters (those who have capital less than Rp. 100
million; and iii) 10 percent for new exporters. Beginning 1
160
March 1991, the distribution was changed: i) 85 percent for
established exporters ii) 6 percent for small exporters and
cooperatives which became a permanent quota; and iii) 9
percent was distributed as incentives to good exporters which
also became a permanent quota.
The allocation of the basic quota based on the export
volume realized by exporters in the past period is intended to
give business confidence and enable good production planning
for this group of exporters. Individual firms are entitled to
a quota as a prorated share of exports undertaken in the
previous twelve months, while quotas for small and new
exporters are distributed equally.
Exporters who have received a PP (past performance) quota
but fail to utilize it will lose that quota entitlement in the
next period. Quotas that are underutilized or returned in the
first half of a quota year will be reallocated as a bonus to
better exporters in the beginning of the second half. An
exporter who cannot fully realize his allocated quota in a
category will be penalized in the form of a cut in his basic
quota by 100 (previously 200) percent of the unrealized quota
in the next quota period.
b. Flexibility (temporary) quota.
This temporary quota arises from the ability to borrow/
transfer between categories (swing provision) or between years
(carry-forward and carry-over provisions). The level of
161
flexibility quota is also set in bilateral agreements with
importing countries. In the allocation of the flexibility
quota, priority is given to exporters who have products ready
for shipment and supported by a foreign buyer's purchase
order, but have exhausted their quotas for these product
categories. Carry-forward quotas can be borrowed only by
exporters who have past performance, because they have to pay
them back with a part of their basic quota in the next quota
period.
Flexilibity quotas are also used as an incentive for
successful exporters. To increase textile exports of product
categories which are not in strong demand, an exporter who is
capable of fully utilizing his borrowed quota, including basic
quota (in the same category) , will be given a bonus as
follows:
i). If the national quota utilization rate for this category
is 50 to 80 percent, then he does not need to return the
borrowed quota. And in the next period, the exporter will
still get his full basic quota.
ii). If the national quota utilization rate for this category
is below 50 percent, then export realization for the borrowed
quota is treated as performance and therefore in the next
quota period he will get an increased basic quota for the same
amount of the borrowed and realized quota.
162
c. Growth quota.
This is the annual increase in the basic quota given by
an importing country and set in a bilateral agreement. The
annual quota growth rate is around 3 to 10 percent.
Previously, the growth quota was allocated equally to small
exporters (50 percent) and new exporters (50 percent). Since
1 March 1991, it has been distributed only to small exporters
and cooperatives.
d. Basket (residual) quota.
This consists of the remaining unallocated basic quota,
returned PP quota, returned borrowed (carry-over and swing)
quota and penalty quota. Basket quotas are allocated as
bonuses to exporters who in the past period have a better
individual export share (compared to the national performance
in exporting to non-quota countries) and a better unit price
than the average price for a quota category. Those who have
below average export performance will receive a penalty in the
form of reduction in their basic quota in the next period. A
fully-realized basket quota coming from an unallocated basic
quota is treated as a performance quota which will be retained
in the next period. On the other hand, export realization of
a basket quota coming from returned carry over or swing quota
is not treated as performance and thus the exporter is not
eligible for a bonus quota.
163
e. Transfered quota.
Quotas that cannot be realized by exporters are allowed
to be sold on the Indonesian Commodity Exchange. However, an
exporter who transfers his quota will receive a penalty in the
form of a reduction in his basic quota as much as 100
(previously 20) percent of the transfered quota and the
exporter who receives and fully utilizes it will get an
additional basic quota as much as 100 (previously 20) percent
of the transfered quota in the next quota period. But if he
fails to realize the tranfered quota, his basic quota will be
reduced by 100 percent of the unutilized quota.
Besides the policies mentioned above, the government also
encourages diversification and new investment in nonquota
products. Before an exporter is allowed to export restricted
products to an MFA market, he is required to have exported at
least $400,000 worth of nonquota items. An exporter applying
for flexibility or basket quota needs to have exported at
least $200,000 worth of nonquota products in a quota period.
In the case of a product that has a quota restriction imposed
for the first time, the exporter of that product in the last
twelve months will be given a permanent quota as an incentive.
5.5. THE EXPORT PERFORMANCE
Using the criteria mentioned above, I now assess the
performance of Indonesian textiles and garment exports.
164
a. Quota utilization
In terms of the utilization of export quotas, Indonesia
consistently achieved relatively high rates in the period
1985/86 - 1991/92. This can be seen from the following tables.
Table 5.4.
Quota Utilization Rates for Garment Exports to
the United States (1985/6-1991/2)
(percentage)
YEAR GROUP I GROUP II
1985/86 93 95
1986/87 96 106
1987/88 99 122
1988/89 101 109
1991/92 95 90
Average 97 104
SOURCE: Ministry of Trade, Unpublished data.
In the case of the United States (Table 5.4), all groups
are practically above 90 percent, which means the quotas
imposed by the United States were binding for Indonesian
products. The flexibility provisions even allowed quota
utilization rates in some years to exceed 100 percent. During
the period the Indonesian exporters were able to utilize the
quotas in group II better than group I, as shown by their
average rates: 104 and 97 percent respectively.
165
Indonesia was also able to achieve a relatively high
quota utilization in the EC market as shown by Table 5.5.
Although starting from a low rate, Indonesia showed a tendency
to achieve increasing quota utilization rates in 1985-1992
period.
Table 5.5.
Quota Utilization Rates for Garment Export to
The European Community (1985-1992)
(% of quota volumes)
YEAR AVERAGE OF ALL ITEM CATEGORIES
1985 68
1986 74
1987 85
1990 98
1991 96
1992 90
Average 85
SOURCE: Ministry of Trade, Unpublished Data.
The average rate of 85 percent implies that the EC market
was less restrictive than the U.S. market for Indonesian
textile products, although both tended to show the same
protectionist policies.• The ability of Indonesia to achieve
high quota utilization rates is also supported by Trela and
Whalley (1990: 19) and Erzan et al. (1990: 72).
b. Unit Values
As can be seen in Table 5.6, although in some years there
are fluctuations in certain countries, in general all of the
166
unit prices of the garment exports from Indonesia to the
restrictive MFA-countries increased in the period 1988-1992.
Table 5.6
Unit Values of Indonesian Garment Exports to the
Major MFA-Restricted Countries (1988-1992)
(U.S. dollar)
IMPORTING COUNTRY 1988 1989 1990 1991 1992
The United States 13 .58 13 .58 13 .96 15.37 15 .23
Canada 11.19 11.11 12 .41 12 .76 13 .63
Germany 12 .11 13 .76 15 .12 16.67 17 .12
The United Kingdom 11.05 11.82 13 .69 14 .43 14 .37
France 12 .98 13 .43 14 .92 15.90 20 .43
Netherlands 11.59 12 .95 13 .91 15 .03 12 .98
Sweden (fn) 12 .59 14 .44 15 .31 14 .30
—
SOURCE: Calculated from unpublished data, Ministry of Trade.
It can be seen that during the 1988-1992 period a
relatively high increase in unit values was attained in the
French and German markets, increasing by 57 and 41 percent
respectively. In other countries, the price per unit increased
at slower rates.
c. Product Diversification
As demonstrated by Table 5.7, Indonesia also has
succeeded in its product diversification effort. In the 1987-
1992 period, nonquota products rose both in terms of values
and share. In 1987 their values were only $517 million with
the export share of 50 percent; in 1992 the figures already
reached $4,459 million, comprising 73 percent of the total
export of textile products. In contrast, the quota items,
167
although still rising in values, declined in importance, from
50 percent in 1987 to 27 percent in 1992.
Table 5.7
Values and Shares of Indonesian Textiles and Garment Exports
According to Item Restrictiveness (1987-1992)
(million U.S.$)
IMP.COUNTRY 1987 1988 1989 1990 1991 1992
QUOTA ITEMS 511.3 608.5 803 .2 1,047.7 1,149 .8 1,683 .0
U.S.A. 423 .8 472 .2 640 .9 708 .2 672 .0 997.9
EC 66.6 106.1 121.4 297 .6 434 .8 637 .6
Canada 20.9 26.6 35 .8 37 .4 36 .2 45 .2
Sweden - .5 1.6 4.1 3.9 -
Norway
- 3.0 3.7 .3 2.9 2.4
NONQUOTA
ITEMS 517.0 819 .5 1,229 .1 1,869.8 2,925.6 4,458.9
EC 192 .4 273 .9 420 .0 617 .7 859.8 987 .2
Canada 9.3 6.9 14.7 19 .8 22 .3 30.6
Sweden 16 .4 17.3 16 .6 17 .0 21.3 3.0
Norway 5.3 1.0 .5 5.9 3.0 23 .7
ASEAN 105 .5 176 .7 288 .5 497 .8 819 .9 1,435 .4
Other Asia 51.3 133 .3 172 .8 235 .3 368 .6 541.5
Australia 26.0 31.5 48 .9 60.2 70 .5 88 .7
Middle East 42 .3 94.9 169.4 279 .9 480 .2 717 .7
Others 68.4 83.9 97 .7 136 .9 280.0 631.2
TOTAL 1,028.3 1,428.0 2,032 .8 2,917.5 4,075 .4 6.141.9
% of Quota
Items 50 43 40 36 28 27
% of Non-
Quota Items 50 57 60 64 72 73
SOURCE: Ministry of Trade, Unpublished Data.
d. Market Diversification
The increasing values and shares of the Indonesian
textiles and garment exports to quota and nonquota countries
presented in Table 5.8, show that the government's efforts to
168
encourage export diversification to the non-MFA countries were
successful.
Table 5.8
Values and Shares of Indonesian Textile and Garment Export
According to the Type of Importing Country (1987-1992)
(U.S.$ million)
IMPORTING COUNTRY 1987 1988 1989 1990 1991 1992
QUOTA COUNTRIES 740 908 1, 255 1, 708 2, 056 2, 704
The United States 424 472 641 708 672 998
European Community 259 380 541 915 1, 295 1. 625
Canada 36 34 50 57 58 78
Sweden 16 18 18 21 25
-
Norway 5 4 4 6 6 5
NONQUOTA COUNTRIES 288 520 777 1, 210 2, 019 3,438
ASEAN 106 177 289 498 820 1,435
Other Asia 51 133 173 235 367 541
Australia 26 32 49 60 71 89
Middle East 42 95 169 280 480 718
Sweden
- - - - - 24
Other countries 63 84 98 136 280 631
TOTAL 1,028 1,428 2, 032 2, 917 4, 075 6,142
% of Quota
Countries 71.9 63 .6 61.8 58 .6 50 .5 44 . 0
% of Nonquota
Countries 28.1 36.4 38 .2 41.4 49 .5 56 .0
SOURCE: Ministry of Trade, Unpublished Data.
Although the export values to the quota countries had
increased, the Indonesian export share to this group of
countries decreased rapidly from 71.9 percent in 1987 to 44
percent in 1992. On the other hand, both export values and
share to the nonquota countries rose, where the latter
169
increased from 28.1 percent in 1987 to 56 percent in 1992.
Japan, Singapore and Saudi Arabia became increasingly
important markets for Indonesian textile products. Because
more than half of its textiles and garment export goes to
nonquota countries, Indonesia is now less affected by export
instabilities arising from protectionist measures of the MFA
importing countries.
e. Rent Maximization
Although rent maximazition is not an explicit objective
in the Indonesian quota allocation system, the provision of
incentives to encourage higher unit values based on the
average unit price might have induced Indonesian exporters to
increase rent earnings generated by quota-induced scarcity.
Rent maximization is most likely to occur in the country where
quota restriction is very binding, as with the United States
in the case of Indonesian garment.
Table 5.9 shows that most of the unit prices for product
categories with high quota utilization ratios in the US market
increased in 1989 from their levels in 1988. A number of
categories enjoyed a particularly large increase, such as
category 433 (men/boys suit-type coats) from $120.17 per dozen
in 1988 to $861.00 per dozen in 1989, a more than 600 percent
rise.
170
Table 5.9
THE UNIT VALUES OF PRODUCT CATEGORIES WITH HIGH QUOTA
UTILIZATION FOR THE UNITED STATES (1988-1989)
CATEGORY DESCRIPTION PRICE PER DOZEN
1988
(U.S.$)
1989
333 M/B suit-type coats 76 .15 183.60
340 M/B shirts, not knit 52 .71 62 .29
341 W/G knit shirts & blouses 48 .47 44.49
347 M/B trousers, slacks & shorts 70 .02 79 .62
348 W/G trousers, slacks & shorts 74 .63 77 .14
351 Nightwear & pajamas 51.84 53 .74
433 M/B suit-type coats 120.17 861.00
634 Other M/B coats 62 .04 71.37
635 W/G coats 68.91 89 .55
638 M/B knit shirts 44 .89 44.99
639 W/G knit shirts & blouses 31.89 35 .94
640 M/B shirts, not knit 35 .29 38.24
647 M/B trousers, slacks & shorts 34 .59 48 .13
840 Not knit shirts & blouses 71.82 119.32
847 Trousers, slacks & shorts 54.61 55 .19
SOURCE: Ministry of Trade (from Trade Monitoring Service)
A large increase was also recorded in category 333
(men/boys suit-type coats) and 840 (non-knit shirts and
blouses) from $76.15 and $71.82 per dozen respectively in 1988
to $183.60 (an increase of 140 percent) and $119.32 (an
increase of 67 percent) per dozen in 1989.
The increase in the unit value of these products could be
attributed to rent appropriation efforts, but could also be
caused by successful product upgrading by exporters. Because
of the difficulty in differentiating between the two effects
based on the available data, it can be stated safely here that
171
rent maximization might have played a role in increasing the
price of some Indonesian garment exports to the United States.
5.6. SUMMARY
This chapter has shown that international trade in
textiles, which has been governed by the Multifiber
Arrangement (MFA), a special trade framework outside the
GATT's regime, has become increasingly restrictive since its
inception in 1974. The MFA has been used as an instrument by
the advanced industrial countries to control textile imports
from the developing countries in order to protect their
domestic textile industries.
In spite of the MFA's increasing restrictiveness, a
number of countries, especially the East Asian NICs and South
East Asian countries, including Indonesia, have succeeded in
expanding their textile exports. One factor that contributed
to this success is the way the government manages textile
quota allocation. In the case of Indonesia, the government
uses a "carrot and stick" approach in its quota allocation
system rewarding exporters with good performance- and
penalizing those with bad performance. As a result, the
government objective of expanding textile and garment exports
through improvements in quota utilization, unit values,
product and market diversification has been achieved.
172
CHAPTER 6
LABOR-GOVERNMENT RELATIONS
As has been noted in chapter 4, in the mid-1980s
Indonesia adopted export-led industrialization, following the
development strategy of the East Asian NICs. The dramatic fall
in the price of oil in the early 1980s forced policymakers to
abandon the import-substitution industrialization that had
been followed previously. In the new strategy, labor-
intensive, light manufacturing activities such as textile,
garment and footwear industries have been promoted to generate
non-oil export revenues.
Many observers of the East Asian NICs attribute their
successful export-led industrialization to the maintenance of
a cheap and docile labor force through strict labor control by
the state (Deyo et al. 1987, Deyo 1987: 199). It is argued
that the political exclusion of labor in these countries has
effectively restrained the labor activity and militancy. The
suppression of labor unions and action led to deprivation of
wage workers of their rights and the weakening of their
bargaining position vis-a-vis employers.
In the case of Indonesia, I would argue that the
government's labor relations system, which emphasizes the
maintenance of industrial peace and order has contributed to
the prevailing low wages and compliant labor force. But the
173
underlying cause of the low wages is the high labor surplus
which exists in the country's labor-abundant economy.
6.1. THE OLD ORDER PERIOD: LABOR UNIONS AND THE ROLE OF THE
GOVERNMENT
In Soekarno's era, especially during the experiment with
parliamentary democracy (1950-1957), labor in Indonesia
enjoyed relative freedom. Compared with the New Order era,
they had greater freedom to organize and to strike to achieve
their demands. The successive governments in power during this
period tended to be pro-labor. In this period the rights of
Indonesian workers were among the most extensive in the world
(Manning 1993: 62). The government also tended to side with
labor, especially in disputes with foreign employers.
The state’s sympathy for labor derived from the active
participation of labor organizations in the struggle to defend
the national independence against the Dutch, who tried to
return to Indonesia after the Japanese military's departure at
the end of World War II. After independence, many labor unions
were formed, commonly belonging to thirteen large labor
federations. These federations, in turn, were labor divisions
of political parties intended to serve as instruments to
gather votes in a general election (Hawkins 1971: 201; Sukarno
1979: 4). Labor's alignment with the political parties
enhanced both the power of the unions and the power of the
parties.
174
There were three main ideological leanings underlying the
political parties in this era: nationalism, communism and
Islam. The labor unions were divided along these ideological
lines and could not achieve a consensus to form a national
trade union that would have had a stronger influence. In many
instances, Moslem labor unions refused to participate in a
strike called for by a communist union because the former
stressed "sharing the wealth with the poor" while the latter
emphasized the "class struggle" (Hawkins 1971: 204;
Tedjasukmana 1958: 46). Consequently, the Moslem and, to a
lesser extent, the nationalist trade unions, were considered
moderate compared to their communist counterpart.
Most of the labor unions took the form of federations
organized along industrial lines. For example, the largest
federation, the All Indonesian Central Labor Organization
(SOBSI), comprised forty national craft unions, including
railroads workers, oil workers and textile workers. SOBSI was
affliated with the Indonesian Communist Party (PKI), and had
around one million members, half of the total number of
workers belonging to trade unions (Hawkins 1971: 215). SOBSI
was also a well-managed and well-funded federation. Although
many of its members were not communists, its programs were in
keeping with the communist objective of maximizing the working
class' welfare at the expense of the capital-owning class.
In general, however, all of the labor unions, especially
SOBSI, were active to improve their members' welfare by
175
pushing for higher wages and better working conditions. Many
employers felt that (in negotiating a collective bargain)
labor unions' demands were excessive and unrealistic. They
tended to reject the union's demand and bring the dispute to
state arbitration officials, who would generally suggest a
more acceptable solution based on the last position of each
party (Hawkins 1971: 202). The activities of trade unions in
the field of labor-employer relations had some influence in
social and economic spheres. Several prominent labor leaders
were elected to Parliament and some were appointed to head the
Ministry of Labor (Hawkins 1971: 208) .
Besides issuing labor legislation, the government played
a significant role in labor relations. It was itself a large
employer of both civil servants and workers in a large number
of state enterprises. It also played the role of mediator.
For example, to settle disputes that arose between labor
and employers, based on the 1951 Emergency Act No. 16 revised
by the Basic Law No. 22 of 1957, the government set up
tripartite labor disputes committees at the regional (P4D) and
the national level (P4P) comprising labor, employers and
government representatives.1 The dispute mediation might
involve three stages. First, when there was a dispute, the
employees and employer were expected to attempt to find a
solution, before referring it to the local Labor Relations
Office for mediation. If an agreement could not be reached,
the case could be brought to the P4D (Regional Committee for
176
Labor Disputes Settlement). This committee would examine the
case carefully and, based on the result of the investigation,
would propose a solution. If this suggestion was also not
agreed on by either party, then the case could be turned over
to the P4P (the Central Committee for Labor Disputes
Settlement) in Jakarta. The central committe would then study
the dispute and make a recomendation which was binding. The
P4P could also enforce its decision by court order. If a case
had a precedent, the P4P could use the previous ruling to
resolve it. However, the 1957 law gave the Labor Minister the
authority to suspend or reverse a P4P decision within fourteen
days (Hawkins 1971: 237-238, 242).
In this way, many of the labor disputes could be settled.
Although the use of collective bargaining tended to increase,
this compulsory arbitration largely substituted for free
negotiations commonly used in the Western industrial countries
to reach agreement on the terms of work contracts between
labor and employers.
The take-over of the Dutch enterprises in 1957 brought an
important change. The government assigned regional military
officers to run those enterprises. As a consequence, the
military managers had to face the labor movement, often led by
the more militant unions represented in the leftist SOBSI. To
secure cooperation from the workers in running the plants and
at the same time, to counterbalance the influence of SOBSI
over labor, the military took the initiative to form an
177
organization called BKS-BUMIL (Labor-Military Cooperative
Body) . This development was significant because it marked the
beginning of military involvement in the state-labor relations
in Indonesia. Although the role of BKS-BUMIL declined in later
years, the army continued to be involved in labor affairs,
especially in controlling the activities of leftist unions
(Hawkins 1971: 243; Hadiz 1994: 194) . And as a part of the
emergency security measures in the effort to liberate Irian
Jaya (West New Guinea) from the Dutch occupation, in 1957 the
government banned strikes in essential industries such as
state-owned enterprises (i.e. the newly nationalized
enterprises, public utilities and banks) and government
departments. Thus, compared to the pre-1957 period, government
intervention in the field of labor relations increased.
Internal political conflicts among the three main forces
(the communist party, the army and President Soekarno)
deteroriated in the first part of the 1960's. Due to the
increasing influence of PKI, SOBSI became more militant and
radical. It was increasingly involved in political activities
such as in Irian Jaya liberation and "crush Malaysia"
campaigns, demands for participation in enterprise management,
and the take over attempts of foreign (especially Dutch,
American and British) enterprises (Suroto 1985: 31)2.
In 1962 the army sponsored the establishment of an
association of employees of state industries, SOKSI (Union of
Indonesian Socialist Employees Organizations) to offset the
178
powerful SOBSI (Hadiz 1994: 194). President Soekarno through
his Minister of Labor in the early 1960s tried to unite the
labor unions which were fragmented along political ideological
lines by proposing the establishment of an all-embracing Labor
Front, the Organization of Indonesian Worker Associations
(OPPI), but failed because of SOBSI's objection (Hawkins 1971:
244-245) .
6.2. THE NEW ORDER PERIOD: A SINGLE CORPORATIST LABOR UNION
AND THE INCREASING GOVERNMENT .CONTROL
The abortive coup d'etat by the Communist Party at the
end of September 1965 brought a disaster to SOBSI. It was
outlawed and many of its prominent leaders were jailed and
some were killed in the aftermath of the event. The
government and average Indonesians became suspicious of labor
union activity. This resulted in a vacuum in the leadership of
the big trade unions, leading to the weakening of their
movement.3
The unfavorable economic situation partially due to
various internal and external political conflicts during the
Soekarno era led the New Order government to place a premium
on stability in its rehabilitation program. The maintainance
of social and political stability was regarded as critical to
ensure successful economic development (Murtopo 1972: 82-87;
Hadiz 1994: 191). While economic stability was achieved
mainly by controlling fiscal deficits, political stability was
179
attained by managing the political activity of mass
organizations including political parties and labor unions.
The Formation of FBSI
The main objective of the New Order's labor relations
policy has been to provide conditions conducive to capital
accumulation through the maintenance of industrial peace and
order (Murtopo, 1975: 10). Since the beginning, policymakers
have been very cautious regarding the possible reemergence of
leftist labor movements. They were perceived to be responsible
for creating continous conflicts both between labor and
employers and labor and the government in the Old Order era.
This perception in turn led to distrust of independently
organized labor organizations because their unrestrained
activities could pose a threat to economic stability.
However, the immediate cause that led the New Order
government to control the labor movement was the precarious
economic condition of Indonesia at the end of the Old Order.
The government's military and economic advisors agreed that
restoration of economic growth would be facilitated if there
was a sound investment climate to encourage capital
accumulation. It was hoped that the existence of industrial
peace together with cheap Indonesian labor would attract large
foreign investments, and thus help increase economic growth.
Because the Old Order experience showed that an unrestrained
and fragmented labor movement had negative effects on
180
industrial relations, avoiding the possibility of renewed
labor unrest through labor control was perceived to be
necessary. The negative effect on labor of the curtailment of
their freedom was expected to be more than offset by the
improvement in their standard of living from increased
investments and economic progress (Lubis 1982: 60). It was
agreed that a single and unified labor organization would
facilitate the achievement of these objectives (Manning 1993:
68). Thus, an alliance between the ruling military officials
and the liberal technocrats in the New Order era paved the way
for the political exclusion of labor.
The government objective of creating a single labor union
became possible after it initiated the consolidation of the
political parties. Although there had been a reduction in the
number of political parties since 1965, there was a thinking
both in society and in government circles that the ten
political parties then in existence were regarded as too many
and not efficient. There were even some ideas about
establishing a two-party system. However, the consolidation
could not be realized until after the 1971 general election.
After intensive discussion and consultation between political
leaders and government officials, a "national consensus" was
reached. In the beginning of 1973 the ten political parties
were consolidated into three major groups, namely the
Development Unity Party (PPP) , the Indonesian Democratic Party
(PDI) and Golkar (Sukarno 1979: 7-9).
181
The elimination of the original political parties
automatically severed the relations with their affliated labor
unions. In February 1973, the government sponsored the
formation of a new federation of labor organizations, called
the All-Indonesia Labor Federation (FBSI). Nineteen labor
unions and many of their leaders joined the new labor
federation. The organizational structure of FBSI comprised
sector-based individual unions (SBLP) including a textile and
clothing trade union (SBTS/FBSI).
Immediately after its formation, the government announced
that FBSI was the only labor organization recognized by the
state and the only one allowed to represent workers in
Indonesia. To reduce the possibility of the establishment of
other labor organizations, the government revised the
regulation regarding the registration of labor organizations.
The former regulation was very liberal: 10 workers who stated
their intention to form a labor union had already satisfied
the requirement for registering with the Ministry of Labor.
According to the new regulation, however, only a federation of
labor unions which has branches at least in 20 provinces and
15 sector-based individual unions can register (Rudiono 1992:
63) .
The creation of this all-embracing labor union enabled
the state to keep trade union activity in line with government
objectives. This was achieved by controlling FBSI's leadership
and financial affairs. Its chairman, Agus Sudono, a labor
182
unionist with broad international connections and a leader of
a former Moslem political party's trade union, GASBINDO, was
induced to join Golkar, the ruling government party. Many of
its leaders, especially at the central and regional levels,
were closely "vetted" by the military {Manning 1993: 73). In
order to create a sense of responsibility among the labor
leaders of the importance of order and security, the head of
the national security command (KOPKAMTIB), Admiral Sudomo
instructed that FBSI chairpersons at the central and regional
level be appointed members of OPSTIB (the State Security
Apparatus).
The government also instructed that labor union dues were
to be collected through employers and that their use had to be
reported to Minister of Manpower. In spite of this "Check Off"
system, many union members did not pay their dues. The lack of
financial resources made FBSI dependent on government aid
{around Rp. 3 million a month in 1981), resulting in even
greater state influence in its operation {Indoc 1981: 67).
With its leadership supplied from the top and screened by
the state, FBSI lacked the capacity and the will to struggle
for the interest of its members. This passivity and the
tendency to operate superficially led an Indonesian human
rights activist to label FBSI as an "armchair labor movement"
(Lubis 1982: 67). The fact that FBSI was controlled by the
state was made clear when FBSI itself announced a ban on
183
strikes. As stated by its chairman, "Industrial action is a
luxury developing countries can't afford.{Indoc 1981: 70) .
Besides the strike ban, workers also had difficulty in
forming a labor union at the workplace (enterprise) level
because of management interference and refusal to cooperate in
the process. According to the law, any private company
employing more than 25 people is allowed to have a union unit,
provided that unit is a member of the FBSI. However, workers
who pioneered establishing a labor union in an enterprise had
to face the risk of being sacked by management usually by
alleging that they caused unrest in the workplace. FBSI even
issued a policy that workers who wanted to form a labor union
in an enterprise should consult with the management (Rudiono
1992: 62-63). As a result, enterprise units of FBSI usually
resulted from a compromise with the management, which also
explains why the labor unit tended to side with the company
rather than the workers.
Pancasila Labor Relations
In order to secure cooperation from the unified labor
movement, the government introduced a new ideological
framework called Pan c a s i l a habQF .R elat.ig .n s (PliR) , following
the establishment of FBSI.4 The main objective of the PLR was
to erase the notion of the conflictual nature of the
relationship between labor and employers prevailing in the Old
Order era and in the Western industrialized countries.
184
According to the new concept, the labor-employer relationship
was to be based on the principles of a "harmonious family"
under the guidance of the state. Accordingly, the principle to
be followed is that labor and management are equal partners in
the production process, mutually dependent, and working
harmoniously to produce profits to be enjoyed together
{Murtopo 1975: 13-15) . Any dispute should be resolved through
discussion, conciliation and mutual concessions between
workers, employers, and if necessary, the government. In this
notion, although the right to strike is guaranteed by law,
strikes are not tolerated because they are not compatible with
the tenets of Pancasila philosophy (Sharma 1985: 47). To
encourage investment and economic growth, labor is
expected to prevent potential losses from disturbances to
production activity due to unsettled conflicts (Indoc 1981:
65) .
Admiral Sudomo as Minister of Manpower
The New Order labor relations system appeared to work
well in reducing labor unrest. The number of strikes fell
sharply from 40 in 1961-65 period to only 7 in 1966-1975
period (Table 6.1). Compared with other East Asian countries,
the figure was remarkably low.
185
Table 6.1
Strikes/Work Stoppages in Selected Asian countries, 1961-90
(average per year)
Period Indonesia Thailand Philippines Malaysia S. Korea
1961-65 40 8 89 71 42
1966-70 2 15 108 55 11
1971-75 5 232 45 65 24
1976-80 66 49 54 40 104
1981-85 112 25 245 24 150
1986-90 46 9 333 13 1, 541
Source: Chris Manning. 1993. "Structural Change and Industrial
Relations During the Soeharto Period: An Approaching
Crisis?" Bulletin_of Indonesian Economic Studies
29 (2), p. 70.
However, in the late 1970s and the early 1980s the number
of strikes rose dramatically. A number of economic factors
were responsible for the increasing industrial unrest. First,
many firms faced demand saturation in the domestic market,
exarcebated by the world recession in this period. Second, the
1978 devaluation taken to restore the competitiveness of
Indonesian exports was followed by the second oil boom in 1979
increasing the inflation rate and thus costs. And third, the
oil slump in the early 1980s worsened the economic situation
in the country. These negative effects forced many distressed
industries to rationalize or close their businesses. Most of
the labor unrest was related to the unilateral dismissal of
workers by employers. The impact of the recession in the early
186
1980s hit the textile industry particularly hard. Many textile
firms had to lay off their workers, creating concerns among
workers and the government officials5. FBSI did little to
defend its member workers.6
The high level of labor unrest raised concerns for the
government because it did not bode well for the government's
efforts to encourage investment. The early 1980s also saw
declining oil-export revenues which made the promotion of
export manufacturing activities a top government priority. In
the face of such conditions, the maintenance of industrial
peace and order could be achieved only by imposing more
controls on labor.
This was made possible with the 1983 appointment of
Admiral Sudomo, the head of the internal security body
(KOPKAMTIB), to a new post, Minister of Manpower fi983-1988) .
As a top official responsible for order and security, he had
played a role in labor union control and labor unrest
management. With that experience, when the economy was in
crisis and industrial unrest was on the increase, he was
regarded as capable of keeping labor in line. Reflecting his
background, Sudomo adopted a hardline security approach toward
labor relations. He issued a number of policies which
increased the state's (i.e. the Ministry of Manpower and
military) involvement in labor affairs.
As the security chief, Sudomo had already paid great
attention to FBSI. He had been critical of its federal nature
187
comprising independent sectoral unions which he regarded as
"liberal". It was perceived as similar to major trade unions
in the western industrial countries, and hence unsuitable for
Indonesia. In the second congress of FBSI in November 1985, he
repeated this criticism. He called for simplifying the
structure of FBSI. Sudomo also critisized the word "labor"
used in the name of that labor organization. For him it
carried a notion of "a repressed group of society that always
rebels", and suggested that it be changed to "worker", which
was regarded as politically neutral (Rudiono 1992: 67).
Following Sudomo's suggestion, the congress decided to
change the federal structure of FBSI and change its name to
the All Indonesia Union of Workers (SPSI). With this
reorganization, twenty-one occupational trade unions which
belonged to FBSI were declared dissolved and were replaced by
nine departments under the direct control of the top SPSI
leadership. The centralized and hierarchic structure of this
single labor union eliminated even the very small degree of
independence reflected in the federal structure of FBSI. SPSI
comprised labor unions established at the work unit
(enterprise) level. This arrangement enabled a strike to be
confined to a particular factory due to the reduced
possibility of coordinated planning or actions, still possible
when the structure was based on sectoral trade unions. Thus,
it can be seen that the main motive behind Sudomo* s effort to
push for FBSI reorganization was to consolidate state control
188
over the labor movement. This was made even easier when the
congress elected Imam Soedarwo as the SPSI chairman, a
candidate backed by the government.7
Continued government control of SPSI under Soedarwo's
leadership made it difficult for it to develop into an
effective labor movement able to defend workers' rights even
at the firm level. As with its predecessor, FBSI, the election
of leadership and decision making were restricted to the
regional level. The control of labor unions was also applied
at the work-unit level by involving the officials of the
Ministry of Manpower, SPSI, and businessmen. Their involvement
was not only in the formation of the SPSI branch at the
enterprise level, but also in operating the union. Many trade
union executives at the work-unit level were not elected by
fellow workers but were appointed by management, often came
from the ranks of management, and thus tended to represent the
interest of employers {Katjasungkana and Masduki 1993: 67).
Many members of the regional boards of SPSI were military
officials or members of Golkar. With this kind of leadership,
SPSI clearly lacked interest in representing workers'
grievances.
Although PLR has been used to permit restrictions on
labor's right to strike since it was introduced in 1974, for
more than one decade it was not based on legislation, only on
"consensus". In the Sudomo period, PLR was renamed Pancasila
Industrial Relations (PIR) and given a legal foundation by the
189
Minister of Manpower's decree No.645/MEN/1985 regarding the
Guidance on the Implementation of Pancasila Industrial
Relations. This formal legitimization of PIR gave Sudomo a
stronger hand in discouraging labor actions.
Sudomo's aversion to strikes had been clear when he was
the security chief. In a speech he gave to a conference of
unions of the textile and garment workers (SBTS/FBSI) in 1981
in Bogor, he denounced strike actions in Indonesia's Pancasila
democracy as "anarchic" (Rudiono 1992: 63). And in a seminar
on the regulation of labor conflicts in 1987 he restated his
view: "strikes, which employees see as a way of improving
their position, must not only be avoided but must also be
considered irreconciliable with the system of PIR. Strikes are
opposed to national development and in view of Pancasila,
unnecessary."8
Workers were further discouraged from striking when the
government issued a decree in 1986 allowing employers to
assume that a worker had retired from a company if he did not
work for six days consecutively without contacting the
employer (Katjasungkana and Masduki 1993: 68).
Under Sudomo, military involvement in labor reached new
levels as a result of his ministerial decree No. 342/1986
which allowed the security apparatus to interfere in the
settlement of labor disputes. In the case of a strike that
might cause physical damage, Manpower Ministry officials were
instructed to coordinate actions with local government and the
190
military. In practice, security personnel were used to quell
every strike, even if no physical damage was done by workers
(Rudiono 1992: 80). As a result of this policy, companies
tended to ask for military intervention when there was a
dispute and, hence, strikes were always of short duration.
The deepening involvement of the military in labor
affairs is also marked by the growing use of local military
headquarters as sites to adjudicate labor disputes as well as
by the number of army and police officers in state
institutions that deal with labor (Hadiz 1994: 195).
Labor Dispute Settlement System
The system of conflict resolution in the New Order regime
was still based on the law about the settlement of labor
disputes enacted in 1957, but became much more restrictive.
When a labor dispute cannot be resolved by means of
consultation with the employer, workers, as far as they are
affiliated with the SPSI (thus excluding any other labor union
and workers who are not yet organized within the SPSI) ,
officially have the possibility of recourse to the Regional or
National Committee for the Settlement of Labor Disputes
(P4D/P4P). These committees comprise representatives of the
government (Ministry of Manpower) , the employers and the SPSI.
Under Sudomo, this channel of appeal for workers'
grievances became more restrictive and cumbersome. In settling
a labor dispute at the firm level, the management is expected
191
to play a more active role. Any dispute should be resolved
first by a worker's direct supervisor. If unsuccessful, a
higher level manager should be involved. If still unresolved,
then bipartite discussion between the trade union and
management can be held. At the tripartite level, there are two
phases: first, the local and then, regional Ministry of
Manpower office. If there is no settlement at these two
levels, the case can be brought to the Regional and Central
Committees for the Settlement of Labor Disputes (Rudiono 1992:
78). As a result, the settlement procedure takes a long time
and both Committees find more frequently in favor of employers
than workers. The P4D and P4P decisions had no legal force in
the civil law code. In the cases of the P4D/P4P decisions
favorable to them, workers often had to ask the courts to
declare the decisions executable although many could not
afford to pay for the legal expenses (Indoc 1981: 68-69;
Manning 1993: 92). Since March 1980, however, the courts were
no longer allowed to back up a P4D/P4P decision, and this
right now lies in the hands of the Minister of Manpower. In
Sudomo's time, the Manpower Minister had the authority to
cancel or postpone P4P decisions (Rudiono 1992: 78) .
International Criticism of Indonesia's Labor Relations System
and Government Response
Sudomo's hardline security approach toward labor
relations proved effective in containing industrial unrest.
The number of recorded labor disputes declined sharply from
192
more than 200 in 1982 to under 40 in 1987-88 and merely 19 in
1989 (Manning 1993: 75). However in 1987-88, heavy state
control on labor and the unsatisfactory labor standards began
to elicit strong criticism from various international labor
organizations and national as well as foreign human rights
groups. The International Confederation of Free Trade Unions
(ICFTU) made a formal protest to ILO headquarters in Geneva
about the lack of freedom of the labor movement in Indonesia.
ICFTU also refused to recognize SPSI on the ground that it is
merely an extension of government. A more serious complaint
came from the AFL-CIO (The American Federation of Labor and
Congress of Industrial Organizations), which filed a petition
for three consecutive years (1987, 1988 and 1989) with the
U.S. Trade Representative to remove Indonesia's GSP privilege
due to its poor labor record (Manning 1993: 76, Katjasungkana
and Masduki 1993: 70) .
Although the AFL-CIO expresses its solidarity with
Indonesian workers, its concerns with poor labor relations and
low wages have not been solely motivated by altruistic reasons
but also by protectionist ones. This was made clear by the
AFL-CIO's complaint regarding Indonesia's exports of textile
products to the United States. Because of Indonesia's low
production cost, its garment imports were perceived to pose a
potential threat to the garment industry in the USA, which has
high labor costs. If wages in Indonesia could be forced to
193
increase, its production costs would increase, reducing the
competitiveness of its garment products in the U.S. market9.
In response to these complaints, in the last few years the
U.S. government has sent representatives on fact finding
missions to determine Indonesia's eligibility for GSP
(Katjasungkana and Masduki 1993: 70).
Because of the government's efforts, however, none of the
appeals from these major labor organizations has resulted in
the imposition of sanctions on Indonesia. To counter the
international criticism, a range of actions have been taken by
the government. The Minister of Manpower, Admiral Sudomo, was
replaced in 1988 by a civilian minister, Cosmas Batubara. The
new minister has played an active role in defending
Indonesia's labor relations policy at the ILO and other
international forums. The effort to improve Indonesia' s
reputation in the field of labor relations was facilitated,
when Batubara, as a result of government lobbying, was
nominated and elected to the prestigous position of president
of the International Labor Conference for 1991. Responding to
United States' criticism on the lack of Indonesian workers'
right to organize due to the strict conditions for
establishing a labor organization, the government argued that
a new draft regulation would relax the requirements. Now a
labor organization can be established if it has regional
branches in at least 5 provinces, with at least 25 district-
level branches, 100 enterprise-level unions and 10,000
194
members. In June 1990, the Manpower Minister revoked the 1963
legislation that prohibited strikes in vital industries.10
To defuse international criticism of the dependent and
centralized nature of SPSI, Batubara called for its reform. As
a result, SPSI was again restructured along industrial lines
during its second congress in 1990. Thirteen industrial
sectors within SPSI were created and given greater autonomy in
order to "improve workers' welfare and protection, at the same
time increase their professionalism."11
In an effort to contain both domestic and foreign
criticism of the inadequacies of labor organization and wages,
Batubara made a promise to improve real wages and followed it
up by issuing minimum wage legislation. It threatens to impose
a harsh penalty on employers who fail to pay the minimum wage.
The government also decided not to ban the new "independent"
trade unions, the Solidarity Free Trade Union (Setiakawan)
established in September 1990 and the Indonesian Prosperity
Trade Union (SBSI) established in May 1992. However, the
Minister and other government officials have openly expressed
their disapproval of the establishment of the two new labor
organizations and promised not to extend their formal support
or recognition.12
Low Indonesian Wages and their Principal Cause
In view of government policies to control the labor
movement to encourage investment and capital accumulation as
195
discussed above, what is the wage level of textile labor in
Indonesia relative to other countries? As shown in Table 6.2,
Indonesian textile labor cost is one of the lowest in the
world, even among countries at a similar level of development.
In 1991, at only $0.28 per hour, the Indonesian textile wages
were the lowest among the low cost textile exporters. From
1985/86 to 1991, the hourly textile labor wage in Indonesia
increased only 3 cents, compared with increases of 34 cents
and 14 cents in Thailand and China, respectively, Indonesia's
main competitors in garment export in the same period. The low
wage rate clearly helps the competitiveness of the Indonesian
textile exports.
Hourly Textile
TABLE 6.2
Labor Cost in
(U.S. dollar)
Selected Countries
Country 1985/6 1990 1991
Thailand 0 .53 0 .92 0.87
Philippines na 0 .67 0 .67
India 0 .61 0 .72 0.55
Egypt 0 .79 0 .45 0.43
SriLanka 0 .29 0.24 0 .39
Pakistan 0.31 0 .39 0.38
PR China 0 .20 0.37 0.34
Tanzania 0.44 0 .32 0.32
Nigeria 1.56 0 .30 0.30
Indonesia 0 .23 0 .25 0 .28
SOURCE: Werner International, Inc.
/THN 1/1992, p. 9.
in Tekstil & Garment No. 21
However, as a consequence, the government1s labor
relations system in general, and wage policy13 in particular,
is seen by many observers, both domestic and foreign, as an
196
instrument of maintaining low wages in order to induce foreign
investment and keep exports cheap. This view is clearly stated
by a Dutch-based human rights group:
"...the (Indonesian) government's major approach to an
official wages policy has been the suppression of free
collective bargaining through the use of force, enabling it to
hold down wages sufficiently to offer the lowest rate in the
whole of the South East Asian region." (Indoc 1981: 71).
In another part, it says:
". .the need to attract increasing levels of foreign investment
continues to be stressed, and this alone will make a cheap and
compliant labor force as essential in the 1980s as it was in
the 1970s." (Indoc 1981: 73).
In an almost similar vein, a domestic commentator argues:
"After the end of the oil boom, the government began to face
structural pressure to change its industrialization strategy,
from import substitution to export orientation. The
implication is the necessity to prepare a disciplined
industrial workforce, and to press wages in order to be
competitive in the international market." (Rudiono 1992: 61).
Although government control of labor tended to increase
in the 1980s and early 1990s, there is little evidence that it
was caused by a deliberate government effort to maintain a
cheap and docile labor force neccessitated by the shift to the
new manufacturing export drive strategy or the desire to
attract foreign investment. Labor control had been on the rise
197
since 1974 with the establishment of the FBSI, long before the
adoption of export-led industrialization in the mid-1980s. As
argued by Manning: "The strict government control on labor
arises from apprehension about the direct effects of labor
unrest on production and the general investment climate rather
than from "any concern that wage rates may be too high"
(Manning 1993: 88). The strict labor controls on labor have
helped to weaken labor's bargaining position in soliciting
wage increases from the employers. But the argument that
associates the low wage rates in Indonesia solely with the
government's policy of labor control is not based on the
country's underlying labor market conditions (see Table 6.3) .
Table 6.3
Labor Market Conditions in Indonesia
1971 1980 1990 Rates of growth
1971-80 1980-90
1. Population
(millions) 119 147 179 2.33 1.96
2. Employment
(millions) 39 .2 51.6 72 .0 2.95 3.45
% distribution
-rural 85 .2
-
73 .3
-urban 14 .8
- 26 .7
3. Unemployment
(percentage)
-rural 8.2 2.1
-urban 12 .5
-
6.3
-urban aged 15-24 16 .0 16 .7
SOURCE: Hull and Jones (1994) , Table 3.1 p. 125 and Table 3.8
p. 146.
198
Although the rate of population growth tended to decline
and the rate of employment increased due to rapid economic
growth in the 1971-1990 period, the supply of labor was still
high relative to the demand, resulting in high unemployment
rates, especially in the urban areas. The economy remained
predominantly agrarian in spite of the declining share of
agriculture. The low supply price of labor from the
rural/agricultural14 and urban/informal sectors as well as
the tendency of investors to keep labor costs down to the
market level are the main factors leading to the existence of
low wages in the modern sector of the economy, including the
new export manufacturing activities such as textile and
garment industries. Although there have been increases in
domestic and foreign investments in Indonesia since 1967, the
employment opportunities that are created have not been able
to keep pace with the large work force, which was expanding at
an annual rate of 2.8 percent (around 2.5 million job seekers
each year) during the 1980s (Jones and Manning 1992: 364) .15
Hence, the real wage levels in Indonesia tend to be
determined by market forces, the supply of and demand for
labor. In this situation, any attempt to increase average
wages substantially above the market rates tends to fail.
Government efforts to enforce the minimum wage laws would not
have a significant impact due to the prohibitive
implementation costs (Manning 1993: 88-89).
199
These labor conditions may explain the government's
dilemma in implementing the minimum wage policy, although
violations are widespread. With a large annual increase in the
work force and the limited capacity of labor absorption of the
manufacturing sector,16 wage rates tend to be depressed,
which in turn result in the labor's weak bargaining power.1 7
Thus, even if labor controls were less restrictive, the
attempts of organized labor to improve wages and working
conditions would be unlikely to bring desired results.
1B Even if the enforcement of the minimum wage stipulation
were possible, it could be achieved only at the cost of lower
employment growth and decreased overall labor welfare (Manning
1993: 91). In a situation of high unemployment19 which could
threaten social stability, the government clearly wants to
avoid these potentially adverse effects.20
6.3. SUMMARY
One important factor that is often associated with the
success of the East Asian NICs in their export-led
industrialization is the existence of cheap and docile labor
in these countries. It is argued that this industrialization
strategy led the government to make deliberate attempts to
control labor in order to hold down wages and make
manufactured exports competitive in the world markets.
200
In the Indonesian case, the government also exercises
tight control on labor. However, the objective of the control
is not primarily to maintain low wages, but to create a sound
investment climate through industrial peace and order to
achieve high economic growth. The urge to control the labor
movement also comes from the bitter experience of the Old
Order era where the actions of politicized labor unions
contributed to social instability.
It appears that the New Order government's efforts to
contain labor unrest and create industrial peace through the
adoption of Pancasila Industrial Relations System and the
establishment and control of the single corporatist labor
organization, SPSI, have achieved the desired effect. This is
reflected in the relatively small number of strikes during
most of the New Order period. Although the wage levels in
Indonesia are among the lowest in the world, they are not the
direct result of the government's labor control (although
these controls have weakened labor's economic bargaining power
and helped depress the wages). The principal cause of the low
wages is the high levels of labor surplus prevailing in the
economy.
ENDNOTES OF CHAPTER 6:
1. Before June 1958, when the Labor Disputes Acts of 1951 was
still in force, the members of the P4D and P4P were
201
representatives from seven government ministries, headed
by a Ministry of Labor official. The 1957 Labor Disputes
Law changed the structure of the membership by including
representatives from workers and management, appointed by
the president based on the recommendations from labor and
employer organizations. In the new structure of the
committees, each party i.e. the government, employees and
employers were representated by five members.
2. These actions appeared to be preliminary manuevers before
the staging of the September 1965 coup. The same pattern
of increasing militant activity also occured before the
1948 PKI-sponsored rebellion in Madiun, where in Mei 1948
SOBSI launched strikes in Klaten area centering in
Delanggu (Suroto, 1985: 30-31).
3. Several union leaders associated with the army as well as
nationalist and Moslem labor organizations contending to
lead the labor movement stepped in to fill the vacuumm.
However, in general they were less effective than the
SOBSI leaders. Besides, their activity was constrained by
the government's preoccupation with political and economic
stabilization which lasted until the early 1970s (Manning,
1993: 68) .
4. This concept is based on the state philosophy, Pancasila..
which comprises five principles: belief in God,
humanitarianism, national unity, democracy, and social
justice. Pancasila is intended to be used as broad
guidance in social and political life in Indonesia.
5. Sinar Harapan. 1 December 1982 and Pelita 21 December
1982.
6. Tempo. 21 September 1985.
7. During the congress Sudomo was able to assert his
influence in the nomination of Imam Soedarwo, as the
chairman of SPSI (Tempo, 7 December 1985). Soedarwo, who
was considered to lack background in union work, is a
member of the central board of Golkar, the government's
political party. He is an owner of four companies, one of
which is a textile and garment company. At the time of his
election to SPSI chairmanship, he was General Manager of
PT. Korwell, a garment firm, in addition to being
202
President of the Employers association of textile industry
{Tempo, 7 December 1985, Inside Indonesia 1987, 19) .
8. Tempo. 15 August 1987.
9. Inside Indonesia. December 1992, p. 19.
10. Inside Indonesia. December 1992, p. 19.
11. Tempo. 8 December 1990.
12. Inside Indonesia. December 1992, p. 18.
13. The wage system in Indonesia has three levels, namely the
minimum wage stipulation (KUM), basic physical needs
(kfm), and basic living needs (KHM). The basic physical
needs (KFM) is a standard used to determine the minimum
wage. Although the government has adopted minimum wage
policy as a "safety net", there is still no national
minimum wage. The minimum wage is determined regionally
and sectorally, thus it tends to reflect the ability to
pay of each region and industrial sector (Rudiono,
1992:70-71). Until 1989 the minimum wage policy was not
backed by legislation to make it enforceable. Therefore,
although minimum wages had been set periodically, they
remained recommendations only and few sanctions have been
imposed on employers who failed to comply. The minimum
wage itself does not cover the basic cost of living of
workers in the industrial and manufacturing sector. The
Minister of Manpower himself admits that it covers only 60
percent of a person's basic physical needs (Inside
Indonesia. December 1992: 18). Even at this substandard
level, only 50 percent of firms located in Jakarta's
industrial zones were paying the minimum wage (Inside
Indonesia, June i99i: 3).
14. Labor mobility in Indonesia is relatively high especially
between unskilled/informal labor markets. As stated by
Rucker: "Indonesia's labor markets can be viewed as a
multiplicity of interconnecting markets with varying ease
of entry depending on the specific markets between which
labor flows occur. Labor mobility appears greatest within
the urban informal, the rural off-farm, and the unskilled
labor markets as a whole and the agricultural labor and
rural off-farm markets. Labor mobility appears least
between the skilled labor markets, the urban formal and
rural markets and the inter-island labor markets.
Nevertheless, although labor mobility is not perfect, with
203
the possible exception of the relative immobility between
interisland markets, the functioning of Indonesian labor
markets does not appear to be a major factor contributing
to the existence of an employment problem" (quoted in Woo
et al. 1994: 19).
15. As has been noted in chapter 4, the low wage levels in
Indonesia have attracted large scale relocation of light
manufacturing industries from South Korea, Hong Kong and
Taiwan in the late 1980s and early 1990s making Indonesia
one of the top foreign investment recipients in the East
Asian region. However, the desire to take advantage of the
low labor costs has also led the investors from these
countries to pay wages at the low market rates (Manning,
1993 : 86) .
16. In 1985, the manufacturing sector in Indonesia provided
less than 16 percent of the total employment, much less
than other East Asian countries such as the Philippines
(20.4 percent in 1980), Peninsular Malaysia (29.4 percent
in 1985), South Korea (34.4 percent in 1980) and Taiwan
(37.1 percent in 1980). See Hull and Jones, 1994: 175.
17. See Tempo. 8 June 1991, "Pecat Satu Mendaftar Seribu" (One
Worker Sacked, One Thousand Job Seekers Come to Apply).
18. Even in the Old Order era when organized labor exercised
more power, wage levels were low. As stated by Hawkins:
"As long as population tends to increase rapidly in Java
without a corresponding increase in capital investment,
severe pressure will remain on wages, and the bargaining
position of unskilled labor will not be strong. The really
low subsistence level of most wage earners in Indonesia
keeps labor in its subordinate position" ( Hawkins, 1971:
218)
19. There were high unemployment rates among educated young
people in the 1980s which could have caused "politically
destablizing effects" (see Jones and Manning, 1992: 397-
398) .
20. See Tempo. 8 June 1991, "Seperti Memegang Burung" (Like
Holding a Bird), an interview with the Manpower Minister,
Cosmas Batubara.
204
CHAPTER 7
THE EXPERIENCES OF THE EAST ASIAN NICs IN THE DEVELOPMENT
OF THE TEXTILE AND GARMENT INDUSTRIES
In the last four chapters (chapter 3 through 6) I have
discussed the role of the Indonesian government in developing
its textile and garment industries. In this chapter, I will
examine the experiences of three East Asian countries: Taiwan,
South Korea and Thailand to see whether the government in
these countries also have had a significant role in the
development of their textile industries. Based on the
framework that I used in analyzing the role of government in
the Indonesian case, a similar but more general approach will
be employed in examining the three countries. It would be
apparent that as in the case of Indonesia, the governments of
Taiwan, South Korea and Thailand have also played important
roles to promote the development of their textile and garment
industries.
7.1. POSITION OF SOUTH KOREA. TAIWAN AND THAILAND IN THE WORLD
TEXTILE MARKETS.
South Korea, Taiwan and Thailand have succeeded in
developing their textiles and garment industries and have
become major textile exporting countries in the world. This
can be seen from the following tables.
205
Table 7.1.
The Main Textiles Exporting Countries, 1990
1990 SHARE ANNUAL GROWTH SHARE IN MANUF.
COUNTRY
(%) (%)
EXPORTS
(%)
Mil .$ 1980 1990 1989 1990 1980 1990
Germany 13.3 11.5 12 .0 5.0 20.0 3.5 3.5
Italy 9.5 7.5 8.5 6.0 20.0 5.5 5.5
Hong Kong* 8.2 3.0 7.5 19.0 8.0 9.0 10.0
China 7.2 4.5 6.5 3.0 0.0 14.0 12.0
Belgium-Luxemb. 6.4 6.5 5.5 6.0 20.0 5.5 5.5
Taiwan 6.3 3.0 5.5 20.0 15.0 9.0 9.5
S. Korea 6.2 4.0 5.5 11.0 15.0 12 .5 9.5
France 6.1 6.0 5.5 7.0 22 .0 3.0 3.0
Japan 5.9 9.0 5.5 0.0 6.0 4.0 2.0
USA 5.0 6.5 4.5 12.0 15 . 0 1.5 1.5
♦Re-export from Hong Kong's imports was 10.8 %
Source: Indonesia (1994) , Buku Petuniuk Industri Tekstil
Nasional 1993 (Guidebook on National Textile Industry 1993),
Ministry of Industry, Jakarta, Table 3.IV p. 71.
In the case of textiles, as Table 7.1 shows, Taiwan and
South Korea were the sixth and seventh largest exporters in
1990. In that year, Taiwanese textile exports reached $6.3
billion while South Korean exports were $6.2 billion. Taiwan's
export share in the world market rose from 3 percent in 1980
to 5.5 percent in 1990. Its textiles' share in manufactured
exports increased from 9 percent in 1980 to 9.5 percent in
1990 although there was a slowing down in its annual growth
rate from 20 percent in 1989 to 15 percent in 1990.
South Korea also has succeded in increasing its share in
the world textile exports from 4 percent in 1980 to 5.5
percent in 1990. There was also an increase in the annual
growth of textile exports from 11 percent in 1989 to 15
206
percent in 1990. However, due to the expansion of other
manufactured export commodities, the share of textiles in
manufactured exports declined from 12.5 percent in 1980 to 9.5
percent in 1990.
In the case of garments, South Korea, Taiwan and Thailand
were among the ten biggest exporters in 1990 as shown Table
7.2.
Table 7.2.
The Main Garment Exporting Countries, 1990
1990 SHARE ANNUAL GROWTH SHARE IN MANUF
(%) (%) EXPORTS (%)
COUNTRY---------------------------------------------------
Mil .$ 1980 1990 1989 1990 1980 1990
Hong Kong* 15.4 12 .0 13 .5 19.0 10.0 25 .0 19.0
Italy 11.8 11.0 10 .5 4.0 25.0 6.0 7.0
China 9.7 4.0 8.5 17 .0 18 .0 9.0 15.5
S. Korea 7.9 7.0 7.0 5.0 (13.0) 17 .0 12 .0
Germany 7.0 7.0 6.0 5.0 25 .0 1.5 2.0
France 4 . 7 5.5 4.0 10.0 29.0 2.0 2.0
Taiwan 4.2 6.0 3.5 1.0 (12.0) 12 .5 6.0
Portugal 3.5 1.5 3.0 13 .0 35.0 13 .5 21.5
Turkey 3.3 0.5 3.0 17.0 22 .0 4.5 25.5
Thailand 3.3 0.5 3.0 45 .0 15.0 4.0 14.5
* Re-exports from Hong Kong's imports was 28.3 %
Source: Ministry of Industry, Buku Petunjuk Industri Tekstil
Nasional 1993 (Guidebook on National Textile Industry
1993), Jakarta, Table III.2 p. 70.
In 1990, South Korea exported garments at the value of
$7.9 billion, which made it the fourth largest exporter. In
the 1980s, it experienced slow export growth in this commodity
as China, Thailand and other less developed countries began to
207
enter the world garment market. However, although there was a
decline in garments share of manufactured exports world wide
from 17 percent in 1980 to 12 percent in 1990, South Korea
maintained its share of world garment exports at 7 percent
during the period.
In 1990 Taiwan was the seventh largest garment exporter
with an export value of $4.2 billion. However, Taiwan like
South Korea, was losing its export competitiveness in
garments, as reflected by the low and even negative annual
growth rates of exports in 1989 and 1990 and the decrease in
garments share of manufactured exports from 12.5 percent in
1980 to 6 percent in 1990.
Thailand also has succeeded in developing its garment
industry to become one of the major garment exporting
countries in the world. In 1990 its garment exports totaled
$3.3 billion, which made it the tenth largest exporter. The
share of garments in manufactured exports increased remarkably
from 4 percent in 1980 to 14.5 percent in 1990. This was made
possible by the very high rates of garment export growth,
which reached 45 percent in 1989 and 15 percent in 1990.
In the wake of the notable performance of the three
countries in textile exports, in the next sections I will
examine the role of government in contributing to these
successes.
208
7.2. TAIWAN
7.2.1. The..Backgr_ound_of Taiwanls Textil el ndu st ry Development
The development of the textile industry in Taiwan was
originally motivated by balance of payments considerations.
Textile imports occupied an important place in the import
bills in the late 1940s and early 1950s. The objective of
reducing the large trade deficits and saving foreign exchange
led the Taiwanese government to support the effort to build a
domestic textile industry through import substitution. In the
early 1950s, the price of imported cotton fabrics was lower
than that of domestically produced goods. Therefore, academic
economists argued in favor of continuing textile imports based
on comparative advantage and consumer welfare arguments.
However, this argument was rejected by K.Y. Yin, the vice-
chairman of the Taiwan Production Board, who believed that
Taiwan possessed a long-term comparative advantage in textile
production and led the effort to develop the national textile
industry (Lin 1973: 63).
7.2.2. Import Substitution Policies
The Taiwanese government took various measures to help
expand domestic production of cotton yarn and fabrics.
F o re i g n e x c h a n g e Po l i c y
One of the most important policies that stimulated the
expansion of the textile industry in Taiwan was foreign
209
exchange policy. Due to the relatively high inflation rate in
the early 1950s, the exchange rate was overvalued. As a
result, there was excess demand for foreign exchange. In order
to reduce the imbalance, the government imposed foreign
exchange controls in 1951. Foreign exchange was allocated with
the highest priority given to the importation of raw cotton
and spinning and weaving machinery. The government also
adopted a multiple exchange rate system whereby private
spinning companies were offered favourable lower rates
(Yamagata 1993: 98). The adoption of foreign exchange
allocation and the multiple exchange rate system which
prioritized certain sectors contributed to the increase in
the profitability of targeted import-substituting activity
such as the textile industry {Lin 1973: 45; Kuo 1983: 298).
Regulation of Imports
From 1949 through 1955 many foreign textile imports of
either finished or intermediate goods that competed with
domestic products were put under strict import controls. In
September 1949, imports of cotton piece goods were restricted.
In 1954, imports of cotton yarn and fabric were added to the
controlled list. Under the import regulation, a manufacturer
of a certain product or its association could petition the
government to restrict the imports of the competing good if
the domestic substitute had the same level of quality and if
the cost of imported raw materials did not exceed 70 percent
210
of total production costs (Lin 1972: 92). Import controls
became more restrictive when tariffs were replaced by non
tariff barriers such as import quotas due to balance of
payments and protective considerations.
Fiscal Incentives
The government provided fiscal incentives to encourage
the importation of modern machinery used in textile
production. The companies were allowed to defer or pay in
installments customs duties levied on imported textile
machinery. Banks were also permitted to provide collateral
guaranting payments in installments by companies which
imported textile machinery for export production (Yamagata
1993: 98-99).
Result of Import Substitution Policies
These government policies to develop the textile industry
through import substitution achieved the desired effect. The
adoption of import and foreign exchange controls as well as
other measures resulted in a substantial increase in the
profitability of import substituting activity. The difference
between the price of a domestically produced good and the CIF
(cost, insurance and freight) costs of a competing import was
greater than would have been caused by the imposition of
tariffs alone. For a number of manufactures, the excess was in
the range of 50 to 100 percent. But for some other products
211
such as rayon and rayon yarn, prices exceeded those of the
foreign equivalent by more than 100 percent (Lin 1973: 95).
From 1950 to 1958, the production of manufactures
doubled. Significant progress was achieved, particularly in
the production of textiles. However, further growth in IS
manufactures was soon limited by saturated consumer demand due
to the small size of the domestic market. As a result, firms
were involved in severe competition to maintain their share in
the internal market, leading to a sharp decline in prices.
7.2.3. Export Promotion Policies
The government quickly recognized that import-
substitution had limited scope for industrial growth in a
small island country like Taiwan. Therefore, the focus began
to shift from import-substitution to export-oriented
industrialization. The new strategy was implemented by the
adoption of a series of policy reforms from 1958 to 1961.
The reform of foreign exchange policy was carried out in
several steps. First, the overvalued currency was devalued.
Then the exchange rate was simplified and finally unified
into a single rate in 1961 (Liang and Liang 1986: 105). Prior
to this, exporters were allowed to retain foreign exchange
they earned and exchange rates applicable to them were raised
several times. To maintain a realistic exchange rate, the
government took necessary measures to control inflation.
Tighter monetary policy was imposed to limit the expansion of
212
credit by the commercial banks. Tax rates for several goods
were raised and efforts were made to encourage the movement of
private funds into bank deposits.
In February 1960, the government introduced a crucial
policy called the Nineteen-Point Reform Program covering
economic, fiscal, monetary and trade policies. Its purposes
were to reduce bureucratic controls on industry and trade,
improve the investment climate, and increase export promotion
incentives.
L i b e r a l i s a t i o n . , o f. .Im p o rt -C on t r o l s
To increase export competitiveness, the government
liberalized the import regime. Quantitative restrictions on
raw materials used in export production were greatly reduced.
The resulting lower prices of these goods reduced the
production cost of exports. Manufacturers who produced for
export could apply to import the necessary raw materials if
they were not produced domestically and if the price of the
domestic substitute exceeded by more than 10 percent the CIF
import price. As a result, export manufacturers were in a
favorable position compared with producers selling in the
home market because the latter could apply to import material
inputs only if the excess price of the domestic over the
foreign equivalent was more than 25 percent before 1964,
although the permissible rate was lowered to 15 percent in
1964 and 10 percent in 1968 (Lin 1973: 100).
213
Exporters of manufactures were given an incentive in the
form of an export - import link. Those who performed well in
exporting were given preferential treatment in their import
applications. Exporters were also allowed to retain the
foreign exchange they earned to use in importing materials and
machinery. In this way, they were freed from having to go
through foreign exchange application procedures. In addition,
they were permitted to sell their import privileges to other
firms (Liang and Liang 1986: 106).
Rebates of Import Duties
A system of tax rebates on customs duties paid on raw
materials used in export production was introduced much
earlier, in 1954, when some light manufacturing products such
as cotton fabrics, woolen yarn and fabrics showed signs of
demand saturation in the home market (Lin 1973: 101). Besides
this, other fiscal incentives were also given to
manufacturers of exports. They were exempted from paying
business and related stamp taxes, and were allowed to deduct
from their taxable income 2 percent of yearly total export
earnings. Manufacturing firms that exported more than 50
percent of their products received a 10 percent tax reduction
(Liang and Liang 1986: 106) .
214
Preferential Export Credit
Beginning in July 1957, favorable financial facilities
had been made available to export manufacturers in the form of
low cost export loans. The interest rate for short-term loans
was set at only 6 percent per year if repaid in foreign
currency and 11.88 percent if repaid in local currency. These
interest rates were considerably lower than the 19.8 percent
(secured) and 22.32 percent (unsecured) charged on regular
loans provided to the private business sector (Lin 1973: 105) .
The preferential credit policy for export financing and for
well-managed and financially sound companies was continued in
the 1960s.
Export Processing Zones
One of the important factors that helped to stimulate
export activity was the creation of export processing zones in
1965. The tax and duty-free facility accorded to firms that
manufactured or processed products for export in these bonded
zones encouraged the establishment of many export-oriented
textile and garment enterprises. The exemption from paying
import tariffs was regarded as more advantageous than the tax
rebate system (whereby firms had to pay tariffs first and got
the refund only after the products had been exported) because
it reduced interest costs. To help facilitate export
transactions, various relevant government agencies were set up
in the zones. They appeared to work well in simplifying the
215
administrative procedures for registration, import and export,
and foreign exchange transactions (Liang and Liang 1986: 106) .
The Effect of Government Policies on the Incentive Structure,
Production and Export
The Taiwanese government's export promotion measures
described above resulted in a strong bias toward exporting.
This is indicated by the structure of effective exchange rates
for cotton yarn in the following table.
Table 7.3.
Approximate Effective Exchange Rates of Cotton Yarn Applicable
to Domestic Sales and Exporting, 1953 and 1966
(NT dollars per U.S. dollar)
Period Domestic Sales Export Sales
Second half, 1953 22 .13 15 .55
First half, 1966 46 .41 60 .35
Source: Ching-yuan Lin (1973), Industrialization in Taiwan:
Trade and Import Substitution Policies for JDevel.QPi.ng
Countries. London: Praeger Publishers, Table 5.8 p. 114.
In 1953, when the import substitution industrialization
was underway, the effective exchange rate for cotton yarn
applicable to manufactures selling in the domestic market was
NT$22.13 per US dollar, which was higher than the rate for
export sales at NT$15.55 per U.S. dollar. Therefore producing
cotton yarn for domestic sales was more profitable than
exporting. In 1966, however, the bias was reversed. Exporters
of cotton yarn enjoyed a much more favorable rate (NT$60.35
per U.S. dollar) compared with the rate faced by manufacturers
216
selling in the domestic market (NT$46.4l per U.S. dollar). As
a result, producing for export was a more profitable
business, leading to rapid expansion in textile production and
exports.
Table 7.4
Values of Production and Export of Textiles Products of
Taiwan Selected Years, 1965-1986
1965 1970 1975 1980 1985 1986
Production
(mil. NT$) 3, 772 10,492 27,281 79,211 138,470 161,680
Export
(mil. US$) 71 470 1,477 4,480 6, 053 7, 305
Sources: 1. Tatsufumi Yamagata (1993), Table 4.2 p. 91
2. Taiwan Statistical Data Book 1987.
As table 7.4 shows, the production value of textile
products increased very rapidly, from NT$3,772 million in 1965
to NT$161,680 in 1986. Production was induced by the
remarkable expansion in exports which jumped from only $71
million in 1965 to $7.3 billion in 1986.
7.2.4. Export Quota Management
Taiwan's textile export expansion was also made possible
by the high quota utilization ratios in the restricted markets
such as the U.S. and the EC markets (Erzan et al. 1990: 72-
74) . One important factor that contributed to this success was
the effectiveness of Taiwan's export quota allocation system.
The textile quota allocation was managed by the Taiwan
Textile Federation, to which textile and garment firms wishing
217
to get export quotas had to submit their applications. The
quotas were categorized into two types: basic quotas (planned
quotas) and free quotas (temporary quotas). Basic quotas were
distributed on the basis of the export performance of the
preceding year. If the total exports of the firms applying for
quotas were greater than 95 percent of the quotas available
for that year, then the quotas would be allocated according to
each firm's past export performance.
Free quotas were the remaining quotas after basic quotas
had been distributed. If the total exports of the previous
year were lower than 95 percent of the present year's quota,
then the remaining quotas would be allocated as free quotas.
However, if the total exports exceeded 95 percent of the
quota, a minimum of 5 percent would be set aside to be
allocated in the form of free quotas.
Free quotas were used as an incentive to increase quota
utilitization and to develop export capability for newcomers.
The allocation of free quotas was also based on applications.
If the volume of applications did not exceed the free quota
availability, then applications would be granted as requested.
However, if the applications for free quotas exceeded the
quota limit, the allocation would be based on the contracted
unit price, where firms that secured high unit prices would
receive a priority.
Although firms were allowed to transfer quotas, there
were some restrictions. Firms which had received quotas, but
218
were unable to utilize them were required to return them by a
certain date. Those which failed to comply with this rule were
not permitted to apply in the next quota period resulting in
lost quota entitlement and confiscation of the guarantee
deposit. (Yamagata 1993: 110).
7.2.5. Labor Regime
When the Kuomintang (KMT) began to occupy Taiwan after
World War II, it imposed strict labor controls under a martial
law regime. Labor legislation was very restrictive. Unions
were obliged to mediate disputes. Union activity was
controlled by government officials. Strikes were not allowed
before mediation and arbitration procedures were followed.
Unions were prohibited from making demands for wage increases
above the standard wage set by the government. Disputes over
wages and other compensation were to be resolved by mediation
boards for conciliatiation and tripartite arbitration boards.
Conflict resolution through the mediation of the unions
at the enterprise level and ad hoc mediating committees at the
local level proved to be very effective and hence direct state
intervention in labor disputes was relatively limited.
However, the state had a significant role in indirect labor
controls by instituting broad regulation on personnel
practices and unions at the enterprise level. Big enterprises
were instructed to form plant committees consisting of
management and labor representatives to resolve non-wage
219
conflicts. The legislation also required them to contribute to
an employee welfare fund which provided a range of financial
assistance to workers.
Trade unions were another state instrument of indirect
labor control. Union activities were backed by the government,
and often complemented by financial support. New unions could
be established and their officials could assume their
positions only after being approved by local government
officials. Many KMT cadres occupied important leadership
positions in the unions. These factors helped the
effectiveness of labor unions in managing labor disputes at
the enterprise level, resulting in low levels of industrial
disputes in Taiwan in the 1960s (Deyo 1989: 115-118).
In the 1970s and 1980s, labor unions' role in pacifying
workers was expanded by providing greater welfare assistance.
The government supported the unions1 activity through a
"mandatory check-off system for collecting member dues" and
increased financial support. These factors, together with the
high effectiveness of arbitration and settlement mechanism at
the enterprise level, helped to maintain industrial peace
during these periods (Deyo 1989: 133-135).
7.3. SOUTH KOREA
7.3.1. The Background of South Korean-Textile Industry
The development of the modern textile industry in South
Korea began after the end of the Korean war (1950-53), which
220
destroyed many textile productive facilities and caused a
decline in production. As in the Taiwanese case, foreign aid
(largely from the United States) helped to finance the
development of many industries in South Korea. This is
particularly so for cotton weaving and spinning industries,
which received relatively large amounts of foreign aid, around
10 percent of the total aid to all industry in South Korea
(Amsden 1989: 65). The aid was used to import raw cotton and
weaving and spinning machinery. Textile production expansion
was also significantly helped by government measures to
promote the domestic industry in the framewok of import-
substitution industrialization, which in the case of the
textile industry, took place until 1957.
7.3.2. import Substitution Policies
Foreign Exchange Policy
In the 1950s, the government adopted overvalued exchange
rates, which allowed private manufacturers to import the
necessary raw materials, machinery and equipment at lower
costs. This was particularly true for the textile industry,
which at the time mainly served the domestic market. The
disadvantage of receiving lower export earnings in won (the
currency) was more than offset by
the advantage of cheaper import of inputs and equipment
(Amsden 1989: 67).
221
The maintenance of the overvalued exchange rates was made
possible by the availability of foreign reserves provided by
various sources of foreign aid. The government also adopted a
multiple exchange rate and preferential exchange rate system
which encouraged the importation of essential industrial
products and discouraged luxury goods imports and imports
competing with domestic products (Suh 1975: 198).
Since there was high demand for foreign exchange while
its supply was limited due to low level of exports, the
government had to ration the foreign exchange that was
available. From December 1952 to July 1954, two forms of
special loans in foreign exchange were offered to
entrepreneurs. The first loan was provided to exporters and
manufacturers based on export performance and raw materials
requirements. The second loan was distributed to large
domestic industries which needed foreign fund to import
capital goods.
After this system was discontinued, the government
adopted various ways to allocate foreign exchange: by auction
and bidding, lottery and exchange tax systems (Suh 1975: 199) .
A considerable part of foreign exchange allocated was used by
domestic manufacturers to import raw materials, intermediate
products and capital goods.
222
Import Regime
The government used tariffs to provide protection for
domestic industries as well as to generate government revenue.
The tariffs imposed varied according to the types of goods:
low tariffs on unfinished goods, but high tariffs on finished
and luxury goods. Products that were not produced domestically
received tariff reductions. No duties were levied on import
of noncompetitive capital goods and intermediate inputs for
domestic import substituting industries (Frank et al. 1975:
36) . The government offered certain major domestic industries,
including textiles, tariff exemptions on the import of
machinery and equipment. Besides tariffs, imports were also
controlled by the adoption of a quota
system that was revised every six months. The quota
adjustment was also made according to the balance of payments
conditions.
Financial Assistance
The development of the textile industry was greatly
stimulated by financial assistance extended by the Korean
development Bank under the direction of the Central Bank of
Korea. Under the Central Bank's policy, the textile industry
was targeted as a key industry which should receive the
highest priority in loan distribution. The loans were given at
subsidized interest rates which were much lower than the
official discount rates. As a result, in the 1954-1958 period,
223
37.7 percent of domestic investment in basic industries was
carried out in the textile sector (Yoshino 1993: 75).
Export incentives
In this period, the government also took measures to
increase exports, by introducing several export incentives.
One major inducement was in the form of an export-import link
system, in which foreign exchange earnings from export were
converted into foreign exchange certificates which could be
used to import various favorite products otherwise not allowed
to be imported. The attached import privilege made foreign
exchange certificates a commodity that was freely exchanged at
a high premium in the foreign exchange market (Suh 1975: 199) .
As a result, exporters were able to receive more won through
the higher effective exchange rate in this market than what
they would get if they sold their foreign exchange at the
official rate.
Direct subsidies were another important incentive whereby
an allowance in cash was granted to exporters according to the
types of commodities exported. Exporters were also offered
export loans at preferential interest rates. These loans were
allocated on the basis of past export performance (Suh 1975:
199, Frank et al. 1975: 39).
224
Result of Import Substitution Policies
Many import substituting industries were able to fully
take advantage of promotional and protective measures taken by
the government. By 1957 the textile industry had attained
"complete import substitution." Many textile firms had built
large productive capacity ahead of demand, financed by the
cheap subsidized loans." (Amsden 1989: 64) . The industry began
to face oversupply due to the saturation of domestic demand,
leading the government to further prohibit textile imports. To
help the domestic industry escape from the obstacle of the
limited home market, the government began take serious steps
to promote exports.
7.3.3. Export Promotion Policies
The transition from import substitution to an export-
oriented industrialization strategy took place in the early
1960s through a series of government measures to encourage
export expansion and activity.
Exchange Rate Policy
The first step taken was the adoption of a unified
exchange rate in 1961. This was achieved successfully by the
military government, a task that the preceeding civilian
government had failed to accomplish (Suh 1975: 200). Then, two
major devaluations were carried out to restore the overvalued
exchange rate to a realistic level, first in 1961, then in
225
1964. The latter devaluation was followed by a sliding peg
system, whereby the Bank of Korea continuously intervened to
adjust the exchange rate for inflation differentials. As a
result, by the mid 1960 the government had established a
relatively stable and competitive exchange rate regime that
was very supportive of the export-promotion efforts (World
Bank 1987: 32-33).
Fiscal Incentives
Exporters received various fiscal incentives: a 50
percent reduction of income taxes on export earnings and
allowance for accelerated depreciation. However, one of the
most important export incentives was the provision of
unrestricted and duty-free access to raw materials and
intermediate inputs required in the production of exports.
This scheme gave exporters equal footing in competing with
foreign competitors because they could obtain inputs at the
world price (Rhee et al. 1984: 11).
Credit Facilities
As during the import substitution phase, the development
of the manufacturing industries, including the textile
industry in the export-led industrialization period, was
significantly facilitated by the provision of credit
facilities at preferential interest rates through the state-
controlled banking system (World Bank 1987: 155). The Korean
226
government set up special funds, administered by the banks,
for promoting exports and financing the purchase of inputs by
export-oriented industries. While the regular lending rate
charged by the commercial banks was raised from 16 to 26
percent, the low interest rate for exporters was maintained
(Suh 1975: 202) . In the export-promotion phase, the conditions
for getting investment and working capital loans for the
textile industry were made more favorable relative to other
industries (World Bank 1987: 155).
In the period of 1971-75, the average interest rate on
loans provided to the textile industry was lower than the rate
for the manufacturing sector in general. This interest rate
differential has continued to exist since 1976, with the
exception of the year 1984 (Kishi 1988: 321).
To stimulate exports, the banks were instructed by the
government to use past export performance as a criterion to
determine an exporter's creditworthiness (World Bank 1987:
36) . Domestic manufacturers were also given the opportunity to
take advantage of the cheap loans prevailing in the
international money market (Suh 1975: 202).
Other Export Incentives
Besides the major export promotion policies described
above, the government provided several other incentives. One
was called wastage allowance, whereby exporters were permitted
to add a certain wastage allowance to the standard amount of
227
raw materials required in export production in their import
application for those inputs. The portion of wastage allowance
which was not used in production was allowed to be sold in the
domestic market. Because of the limited availability of
imported materials in the local market, the export
manufacturers often made handsome profits from the sale of
this wastage allowance (Frank et al. 1975: 50).
After being temporarily discontinued, the export-import
link was reintroduced in 1966. Its objectives were to expand
export of commodities which had low profit margins and to
develop new export markets. These goals were to be achieved by
giving exporters the right to import certain popular import
items or import raw materials for export processing relative
to export performance. For example, manufacturers who exported
woolen yarn and fabrics, sweaters, and garments were entitled
to import raw wool and mohair at a rate of 25.5 to 85 percent
of their export earnings, depending on the type of the
exported product (Frank et al. 1975: 51).
The Effect of Government Policies on the Incentive Structure.
Production and Exports
The export promotion policies adopted by the South Korean
government resulted in an incentive structure which was
favourable to exporters. As Table 7.5. shows, the effective
exchange rates for exports were always higher and tended to
increase continously relative to the rates for imports during
1964-1975 period.
228
Table 7.5.
Effective Exchange Rates for Exports and Imports,
Selected Years, 1964-1975 {won per dollar)
1964 1967 1970 1973 1975
Export Rates 281 333 399 493 566
Import Rates 247 296 336 418 510
Source: Wontack Hong (1981), Table 8.6 p. 352.
The incentive bias toward exports induced increased
export activity and production in the textile industry as
reflected in the following table.
Production and Export
South Korea,
Table 7.6
Values of '
Selected
Textiles and
Years, 1970
Garment of
-1988
1970 1975 1985 1988
Production
(Value Added;
billion won) 291 1, 424 2,297 3, 867
Export
(million US$) 389 1, 870 7,004 14,111
Sources: 1. Fumio Yoshino (1993), Table 3.2 p. 68.
2. Hamilton and Kim (1990), Table 7.1 p. 160.
In terms of value-added, the production value increased
impressively from 291 billion won in 1970 to 3,867 billion won
in 1988. However, the export performance of South Korea's
textile industry was even more phenomenal, increasing from
$389 million in 1970 to $14.1 billion in 1988.
229
7.3.4. Export Quota Management
South Korea has had a record of a high quota utilization
ratio and high unit values of exports in the 1980s (Erzan et
al. 1990: 72-74, Hamilton and Kim 1990: 166-168). The quota
allocation system was managed by both the Korea Export
Association and the Korean Garments & Knitwear Export
Association, based on the allocation regulations drawn up by
the Ministry of Trade and Industry. The quota was also divided
into two types: basic quota and open quota. The basic quota
was allocated on the basis of past export performance. In
1982, the basic quota for popular items was given
at only 90 percent of the previous year's export performance,
while for less popular (marketable) items, it was given at
full 100 percent.
The distribution of the open quota was based on non-quota
export performance (50 percent) and average price (50 percent)
criteria. The first criterion means that a manufacturer who
succeeded in exporting a quota item to a non-restraining
country or a non-quota item to a restraining country would be
given a priority in the allocation of an open quota. The
second one means that an exporter who obtained a higher than
average unit price would also be entitled to receive an open
quota. A company which succeeded in fulfilling the open quota
it had received would get a basic quota of the same amount in
the following year.
230
Until 1982, basic quotas could be transferred, but only
until August of the year. However, the transfer of open quotas
was not allowed. In the case of temporary transfer, a company
still had the right to receive its basic quotas. While in the
case of permanent transfer, it could lose that right.
A company that failed to utilize its quotas received a
penalty in the form of the withdrawal of the unrealized quota.
There was also a penalty for low utilization of a quota. For
instance, in 1982, a company which failed to achieve 60
percent of quota utilization by June of that year, was
penalized for a low rate of quota utilization (Lee 1988: 36-
37) .
7.3.5. L abour -Regime
After the Korean war, the Syngman Rhee government imposed
tight controls on labor by monitoring union activities and
finances, and establishing a new trade organization, FKTU (the
Federation of Korea Trade Unions), as the state's medium to
help create labor peace. Unions affiliated with the Federation
were supported and protected by the government with
legislation prohibiting newly formed unions to challenge the
position of an existing union. Unions were banned from
engaging in political activity. However, in practice they were
asked to act as the labor extension of the ruling government
party to maintain industrial peace and raise productivity. The
government also formed a network of mediation and arbitration
231
committees that had an important role in dispute settlement
and thus helped to reduce strike activity.
Following the ban on strikes and union deregistration
under martial law after the 1961 coup, the Park Chung Hee
government began to restore labor relations by establishing a
new government-backed FKTU in 1963. The government played a
significant role in influencing the selection and activity of
its leaders. As a result, the FKTU became the government's
instrument of labor control. Organized labor was further
constrained when new legislation was enacted to increase
government representation on the Labor Committee (tripartite
dispute settlement board), to declare union demands made at
the beginning of mediation "illegal", to deregister unions
unilaterally, and to impose terms of dispute settlement. These
measures succeeded in creating industrial peace during the
1960s as reflected in the remarkably low numbers of strikes in
the period (Deyo 1989: 118-121)
Government intervention in labor affairs continued to
increase in the 1970s and early 1980s. In 1969-1970, new
legislation was introduced giving special protection to
foreign enterprises. Emergency rule imposed by Park Chung Hee
following the 1971 presidential elections, gave the president
the power to ban strikes and impose "mandatory mediation" on
disputes. In 1973 an act was issued forbidding any collective
bargaining before obtaining certification of legality from the
Labor Committee. In the 1975-1980 period, the labor unions
232
launched organizational drives by offering a range of welfare
benefits supported by the government in the form of
legislation regulating the use of membership fees and
stronger enforcement of compulsory union membership. Using the
1974 Emergency Decree, the government imposed harsher
penalties on labor standard violations by employers which
helped to strengthen the labor unions. As a result, the union
membership doubled from 531,000 in 1974 to more than one
million by 1980. In spite of these corporatist efforts,
however, repression on labor millitancy and protest continued
into the 1980s {Deyo 1989: 135-139; Choi 1989: 142-143).
7.4. THAILAND
7.4.1. The Background of Thailand's Textile Industry
The modern textile industry in Thailand developed
relatively late compared with Taiwan and South Korea. Several
private textile mills began operating only after the Second
World War. For several years the industry expanded rapidly,
especially in mechanized spinning, with a capacity rising from
3,600 spindles in 1946 to 43,000 spindles in 1952. However, in
the second half of the 1950s, the textile industry faced stiff
import competition from Pakistan, which also produced low-cost
cotton textiles triggering a steep decline in production and
bankruptcies of several spinning mills. This adverse
development led the government to intervene for the first time
233
in the industry. To protect domestic textile producers, the
government imposed import restrictions on cotton yarn in 1955,
and on cotton fabrics in 1957 (Suphachalasai 1990: 55).
In the 1960s, the Thai textile industry experienced rapid
growth as a result of government policies to promote import
substitution industries. The remarkable development continued
when the government adopted an export-oriented strategy in the
early 1970s.
7.4.2. Import Substitution Policies
Compared with Taiwan and South Korea, the Thai government
tended to intervene less in the economy. It adopted relatively
few policies to promote the development of import-substitution
industries. There were two major import-substitution policies
that significantly affected textile industry development: an
investment promotion program and tariff protection.
Investment Promotion Program
In 1960, the government introduced a program for
industrial promotion in which textiles was one of the major
industries which received promotional status. The Investment
Promotion Act issued that year and improved in 1962 offered
various fiscal incentives. Promoted firms were given a
corporate income tax holiday for a five-year period. They were
also granted an exemption from paying business tax and tariff
duties on machinery, equipment and materials required in the
234
establishment and operation of productive facilities. In
addition, promoted firms were eligible to receive full or
partial reduction in tariffs on imported inputs for a five-
year period (Santikarn 1981: 42).
The tax exemptions reduced the cost of fixed capital
while the income tax holiday helped firms take care of initial
lags in investment and profits. These factors induced many
large firms to invest in the textile industry. Due to their
promotional status, textile and garment firms received
considerable fiscal concessions from these investment
incentives (Tambunlertchai and Yamazawa 1983: 61-62; Akrasanee
1981: 425).
Tariff Protection
Initially, the government's main objective in imposing
tariffs in the early 1960s was to increase state revenues.
Thus, the average tariff rates were relatively low except for
a small number of luxury goods. In spite of the low rates, the
tariffs were able to accord some protection to domestic
industries. As the import substitution industrialization was
progressing, the government began to use tariffs as a
protective policy. Tariff rates on consumer and intermediate
goods competing with domestic products were increased several
times, first in 1964, then in 1969. In fact, the government
assured promoted industries that it was willing to impose
tariffs on request to shield them from foreign competition.
235
Although the tariff protection was to be provided temporarily,
in practice its imposition lasted longer than expected
(Santikarn 1981: 46-47).
Besides tariffs, the government also imposed an import
ban on some products, regarded as sufficiently produced by
domestic industries. Although the import of most products was
subject to "approval," in general, most import applications
were refused.
During the 1960s and the first part of the 1970s,
controls on competing imports proliferated. In 1962, imports
of silk textiles were put under control. In the 1966-69
period, cotton yarn imports were restricted. And in 1970 and
1971, many more products were put under import controls,
including polyester fibers (Akrasanee 1981: 410) . In 1972, the
government announced another form of protection in the form of
a special surcharge of no more than 50 percent of the CIF
import cost of competing products. This policy was aimed at
domestic industries which required immediate protection and
was to be in effect not more than one year. Finally, in 1974
the government increased some tariff rates in response to
demand for greater protection following the reduction in
fiscal incentives provided under the investment promotion
program (Akrasanee 1981: 407).
236
Exchange Rate Policy
During the 1960s, the Thai baht was overvalued because it
was tied to the U.S. dollar, which in turn was overvalued in
relation to other major currencies such as the yen and the
mark. As a result, imports from Japan and West Germany, two of
Thailand's major trading partners became cheaper in baht
(Akrasanee and Ajanant 1986: 87). This was an advantage to
the users of imported industrial inputs such as the textile
industry. However, in contrast with the trade policy, exchange
rate policy was not the main policy to promote
industrialization in Thailand in this period (Tambunlertchai
and Loohawenchit 1981: 193).
The Result of Import Substitution Policies
The textile industry experienced a tremendous capacity
expansion during the import substitution period. The number of
spindles increased from 92,516 in 1961 to 637,720 in 1972,
while the number of looms jumped from 6,936 to 34,589 in the
same period, resulting in rapid growth of textile production
(Tambunlertchai and Yamazawa 1983: 63) . The synthetic fiber
industry also began to develop, taking advantage of high
tariff rates erected by the government to protect the promoted
firms. However, the growth of the textile industry began to
decline in the late 1960s due to the inability of the domestic
market to absorb the expanding output. Consequently, the drive
to promote exports was initiated.
237
7.4.3. Export Promotion Policies
In 1972 the government began to shift the
industrialization strategy from import substitution to export
promotion. A number of policies to encourage export activity
were introduced. What follows is a discussion of these export
promotion measures.
Exchange Rate Policy
The government continued to peg the baht to the US
dollar. Beginning in late 1971 the baht depreciated following
the depreciation of the U.S. dollar against other major
currencies. The baht depreciation improved the competitiveness
of Thai manufactured exports in the early 1970s, when the
export drive was launched. In November 1978, the government
adopted a new system whereby the exchange rate was adjusted on
a daily basis to allow more flexibility in the determination
of the exchange rates. The baht was tied to a "basket" of
foreign currencies, instead of to the U.S. dollar alone,
resulting in a stable baht exchange rate. (Tambunlertchai and
Loohawenchit 1981: 195, 197).
It must be noted, however, that the effectiveness of
exchange rate policy in Thailand was supported by a prudent
macroeconomic strategy with the adoption of conservative
fiscal and monetary policies. As a result, the inflation rate
was relatively low, contributing to the maintenance of a
238
realistic exchange rate which, in turn, helped increase export
competitiveness and export expansion (Suphachalasai 1990: 69) .
Investment Incentives for Promoted_F_irms
The change to an export promotion strategy began with the
revision of the investment Promotion Act and the issuance of
the Export Promotion Act in 1972* Promoted firms were given
exemptions from, or at least were made eligible to receive a
50 percent reduction in custom duties and business taxes on
machinery and equipment required for their productive
facilities. These firms were offered up to a 90 percent
reduction in import tariffs and business taxes on material
inputs. They were also eligible to receive a corporate income
tax holiday for a three to eight year period. In the case of
promoted textile firms, the period was five years
(Tambunlertchai and Yamazawa 1983: 23, 67).
The government also provided a number of incentives to
stimulate exports. Export-oriented firms were exempted from
import tariffs and business taxes on imports of raw materials
and intermediate goods as well as from business taxes on local
inputs used in export production. They were also allowed to
deduct from their corporate taxable income as much as 5
percent of an increase in export earnings over the previous
year.
To receive promotional status, export-oriented firms were
obliged to export all or at least a certain portion of their
239
production depending on the commodity produced. For textile
manufacturers, at least 65 percent of their output had to be
exported, while, for garment firms, all of their products had
to be exported.
Tax Rebates
Beginning in December 1972, manufacturers of exported
products who were not under the BOI promotional scheme were
also given fiscal concessions through a tax rebate system.
Once export had taken place, export manufacturers were
eligible to get a refund on import tariffs, and business and
local taxes they incurred when acquiring material inputs used
in export production. The tax rebates were provided to
producers of manufactured exports who had export performance
in excess of 50,000 baht and had to be claimed within one year
after export payments in the form of foreign currency had been
received (Tambunlertchai and Yamazawa 1983: 32-33).
Credit Assistance
The government, through the Bank of Thailand, provided
short term export credits, known as packing loans, to
exporters at the preferential interest rate of 7 percent. This
was a major form of financial assistance to exporters,
considering the prevailing market interest rate in Thailand
was around 14-15 percent in the 1970s and rose to 18-19
percent in 1980-82 period. In addition to this, the government
240
financial institution, called the Small Industry Finance
Office (SIFO), provided special credit assistance to
enterprises with assets below 5 million baht in the form of
low-interest medium and long-term loans (Tambunlertchai and
Yamazawa 1983: 41).
Other Incentives
Besides the major incentives discussed above, there were
other measures taken by the government to encourage export
activity. These included the construction of export processing
zones, reductions in the cost of electricity to exporters, and
the establishment of the Export Service Center.
The Effect of Government Policies on the Incentive ■Structure.
Production and Export
As represented by the structure of incentives measured in
terms of effective rates of assistance in 1985, the effect of
Thai government measures to promote export resulted in a
favorable incentive for textile and garment exporters,
although the difference in the incentive was only slight for
manufacturers of fabrics.
241
Table 7.7.
Effective Rates of Assistance of Thai Textiles and Garment
in 1985 (percent)
Industry Domestic Sales Export sales
Textiles (weaving) 6.5
Garment -6.1
6.3
-9.8
8.2
5.0
Source: Suphat Suphachalasai (1990), Table 10, p. 67.
As displayed in table 7
assistance for exports at 5.0
.7, with the effective rate of
percent, garment manufacturers
received more of a stimulus from the government to export
their products than the producers who sold in the domestic
market who suffered negative protection.
As a result of higher incentives to export, production
and export of Thai textiles and garment increased rapidly
during the export-oriented industrialization period as
exhibited in Table 7.8. and 7.9.
Table 7.8.
Production of Textiles and Garment of Thailand,
Selected Years, 1970-1986
1970 1975 1980 1985 1986
Production
Fabrics (million
square yards) 497 1,128 1, 821 2, 494 2, 633
Yarns (thousand
tons) 56 135 227 292 310
Man-made Fibre
(thousand tons) 1.2 39 113 127 131
Garment (million
pieces) 249 488 722 946 1, 035
Source: Suphat Suphachalasai (1990), Table 5, p. 58.
242
Table 7.9.
Export Values of Textiles and Garment from Thailand, 1982-88
(million U.S. dollar)
1982 1983 1984 1985 1986 1987 1988
Textiles 232 221 252 342 422 490 531
Garment 345 383 514 584 807 1, 454 1, 880
Total 577 604 766 926 1, 229 1, 944 2,411
Source: Suphat Suphachalasai (1990), Table 6, p. 59.
7.4.4. Export Quota Management
In Thailand, export quota allocation was managed by the
Department of Foreign Trade. The allocation of quotas had been
implemented efficiently resulting in a high quota utilization
ratio (Suphachalasai 1990: 62; Erzan et al. 1990: 72).
Export quotas were divided into two categories: principal
(basic) quotas (usually 70 to 80 percent of the total quota
available) and residual quotas. The basic quota was allocated
at the beginning of the year on the basis of past performance
of exporters (excluding international trade firms). A company
was penalized if it exported less than 90 percent of its
quotas. And any unutilized quotas had to be returned to the
Department of Foreign Trade for reallocation, at least three
months before the end of the year, otherwise the company's
principal quota would be cut in the next allocation period. A
manufacturer who failed to export at least 90 percent of the
243
previous year's principal quota was not permitted to apply for
free residual quotas, for a period ranging from one to four
months.
Residual quotas were the remaining quotas after the
principal quotas had been distributed. They were allocated on
a monthly basis and intended for newcomers. However,
manufacturers with or without basic quotas and international
trade firms (which mainly exported for large companies) were
also allowed to apply. The latter group was entitled to
receive 20 percent of the residual quota. The remaining 80
percent was distributed on the basis of four criteria: 1) raw
materials utilization; 2) unit price; 3) value added; and 4)
length of time between order and export shipment dates. A new
exporting firm that had received a residual quota and was able
to fully utilize it would be entitled to receive a principal
quota in the following year.
In principle, quotas, which were allocated free of
charge, were not permitted to be transfered to other
companies. However, international trading companies were
allowed to sell their quotas to firms who planned to export
through the trading company. (Hamilton 1986, 239-240;
Suphachalasai 1990: 61).
7.4.5. Labor Regime
A watershed in goverment-labor relations in Thailand
occured in October 1958 when, after staging a coup in the
244
previous month, General Sarit Thanarat revoked the Labor Act
of 1956 leading to a ban on labor actions and the
imprisonment of many union leaders. The reason given for his
actions was that labor unions were the "main obstacles to
economic development" because they caused disunity and
conflicts between employers and labor.
To resolve the continuing labor conflicts, in 1965 the
government enacted the Settlement of Labor Disputes Act which
provided machinery of dispute settlement. However, they were
rarely used by workers, due to the complexity of the
settlement procedure. The inadequacy of the dispute settlement
mechanism and particularly, the lack of freedom of labor
unions elicited criticism from various international
organizations including the International Labor Organization
(ILO) . This led the government to promulgate a law which
regulated working hours, holidays, overtime payment, female
and child labor, severence pay and others. The legislation
also allowed the establishment of non-political trade unions.
The government consciously promoted the formation of weak and
small unions at the enterprise and provincial levels.
Following a series of strikes in the period 1973-74 due
to adverse economic conditions and the lack of effectiveness
of labor protection law, the government promulgated the Labor
Relations Act in 1975 which improved the previous labor
legislation. This new law gave labor greater freedom of
245
association and collective bargaining as well as mediation and
arbitration mechanisms to resolve labor disputes.
In spite of this, the large number of work stoppages that
had occured since 1973 led the government to impose a ban on
strikes from October 1976 until January 1981. The result was
a drastic decline in stoppages to as few as 7 in 1977 and
never exceeded 70 during the period, from the peak of 501 in
1973. Since then, the Thai government has been promoting
"industrial peace" equating it with the moral of a "social
contract". And the means to achieve this goal was state-
sponsored tripartism (Sharma 1985: 68-75).
7.5. SUMMftBX
From the examination of the experiences of Taiwan, South
Korea and Thailand above, it can be concluded that the
governments of these countries played an important role in
promoting the development of their textile industries. As with
Indonesia, their industrial development, particularly the
textile industry, followed the same pattern: beginning with
import- substitution industrialization phase and, after the
domestic market had become saturated and the industry's
capacity had been built, the industry continued to grow
through export expansion in the export-led industrialization
phase. At each stage, the government played an active role in
affecting the incentive system to encourage textile industry
246
development, it provided adequate protection and assistance
through import-substitution and export-promotion policies.
These policies were also accompanied by the effectiveness
of the governments in managing export quota allocation and
industrial relations. As in the case of Indonesia, the
governments of the three countries devised a system of textile
quota allocation that encouraged exports by providing
incentives to successful exporters and imposing penalties on
less successful ones. Lastly, industrial development was
supported by the government1s systems of labor control to
achieve industrial peace. This factor, together with the
existence of a disciplined and relatively cheap labor force,
helped to make these countries' labor-intensive manufactured
goods such as garments and other textile products highly
competitive in the world market.
247
CHAPTER 8
CONCLUS IONS
The writing of this dissertation was motivated by the
ongoing debate about the role of government in the economy
between the neoclassical economists and the interventionists.
In the last several years the debate has become more heated
and focused, as adherents of both schools used the development
success of the East Asian NICs to vindicate their views. While
the neoclassical economists maintain that the success of these
countries was caused by market forces as the result of
liberalization measures, the interventionists argue that it
was brought about by government intervention in the economy.
This dissertation attempts to shed light on this issue by
examining the experiences of Indonesia, the main focus of the
study, and three other East Asian countries (Taiwan, South
Korea and Thailand) which have succeeded in developing their
textile and garment industries. Its purpose has been to
determine whether the governments in these countries have
played a significant role in the development of these two
industries. To answer this question, I analyzed the
government's role in promoting the textile industry by
focusing on four major aspects: import- substitution
industrialization policies, export-oriented industrialization
248
policies, textile export quota allocation system, and
government-labor relations.
In examining the Indonesian case, the study started by
identifying the key variables that affected the role of
government in industrialization. These variables, economic
ideology and government1 s financial resources, strongly affect
the extent of government intervention. In the Old Order
period, the nationalist ideology which prefered an active
state role in industrial development prevailed, especially
during the "guided economy" period (1959-1965). However, the
results were disappointing because of unsupportive economic
and political conditions. The output of the textile industry
declined, although there was an increase in production
capacity. As a result, the government's objective to meet
domestic demand in basic clothing was not achieved.
In the New Order period, the textile industry was able to
expand rapidly, encouraged and supported by government
promotion efforts. After a short period of liberal economic
regime at the beginning of the New Order era, during which
time the economy was stabilized, the government embarked upon
an import-substitution industrialization strategy (1972-1984) .
During this period, the interventionists played a significant
role in shaping industrial development policies, bolstered by
the large inflows of oil revenues.
249
To promote the development of the textile industry, the
government maintained an overvalued exchange rate, gave
liberal investment incentives and regulated investments,
restricted competing imports, and provided fiscal incentives
and subsidized credits. These promotion policies created a
great incentive to engage in import substitution activity in
the textile sector. As a result, the textile industry
developed remarkably both in output and capacity. The domestic
demand for textiles was met by the mid 1970s. By late 1970s,
the textile and garment industries had begun to export its
surplus production to industrialized countries in significant
quantities.
The deteroriation in Indonesian terms of trade due to the
sluggish oil and nonoil exports in the mid 1980s forced the
government to reorient its development policy from import-
substitution industrialization to export-oriented
industrialization.
However, the change in the policy did not mean less
government's involvement in industrial development. To
encourage export activity, the government took a range of
promotion measures. It made every effort to keep the exchange
rate at a realistic level. It liberalized investment
regulations and provided additional investment incentives,
such as investment guarantee and double taxation arrangements.
Import controls, especially on raw material inputs such as
cotton and fabrics for export-oriented activities, were
250
liberalized. Textile and garment exporters were exempted from
customs duties on inputs used in export production. The
government provided subsidies in the form of an export
certificate scheme and export loans. It also took several
institutional measures to promote export activity such as
establishing a credit insurance corporation, an export
supporting board, export processing zones, and an export
development agency, as well as improving the customs and port
services. And, to provide a smooth and cheaper supplies of
essential inputs for the textile industry, the government
sponsored the development of several large-scale upstream
industries which produce PTA, rayon fiber, and pulp using
natural resources available in Indonesia as the main inputs.
These government promotion policies resulted in a
favorable climate for export-oriented activity in the textile
sector. The data on effective rates of assistance (ERA) show
that in 1988 the incentive to export was greater than the
incentive to sell in the domestic market. As a result, textile
and garment exports increased remarkably, leading to tremendous
expansion in output and capacity as well as improvement in
product quality. In 1991 textile and garment became the second
most important export commodities afer oil. The two industries
also contributed significantly to industrial and employment
growth during the export-oriented period.
The success of export-led development in the textile
industry was also made possible by government effectiveness in
251
managing textile export quota allocation. To encourage export
expansion, the government adopted a "carrot and stick" system
whereby good exporters were rewarded increased basic quota
while bad exporters were penalized in the form of reduction in
their basic quotas. In this way, there were increases in quota
utilization rates, unit values, and market and product
diversification, resulting in rapid export growth although the
MFA bilateral agreements became increasingly restrictive on
Indonesian textile and garment exports.
Another important factor contributing to the rapid
development of the textile industry is the industrial peace
and order created by the government's strict labor relations
policy. The experience of politicized and adversarial labor
relations in the Old Order era led the New Order government to
conclude that in order to establish a sound climate for
capital accumulation and industrial development, labor
movemements must be restrained. Labor control was achieved by
establishing a single labor organization, introducing a new
concept of industrial relations based on the state ideology,
and inviting greater military involvement in labor affairs.
Some commentators, however, argue that the main purpose
of the labor control was to keep the wages down, leading
Indonesian labor wages to be among the cheapest of the LDCs1
textile exporters. Although the government's strict labor
policy did contribute to the weakening of labor's position
vis-a-vis employers in wage determination, a more convincing
252
explanation of the low wages is the excessive labor surplus in
the economy. The high rate of population growth, the abundant
availability of unemployed/underemployed labor in the rural
and informal sectors, as well as the limited capacity of
manufacturing industries to absorb the labor force all tend to
depress the wages. As a consequence, the wage levels are more
determined by supply of and demand for labor than by
government1s labor control policies.
From the examination of the four aspects of government
measures discussed above, it is clear that the Indonesian
government played a significant role in the development of
textile and garment industries. But what about other East
Asian countries, did their governments also have a role in
developing their textile and garment industries?
Using the same approaches used in analyzing the
Indonesian case, this study found out that the governments of
South Korea, Taiwan and Thailand, to varying degrees,
intervened significantly to promote both industries by
manipulating the incentive system. Like Indonesia, their
textile and garment industries developed in two stages:
import-substitution and export-promotion industrialization.
During the ISI period, the governments implemented both
protectionist and promotive measures to the domestic textile
industries allowing them to grow rapidly. After domestic
demand had been met and saturated, the government changed this
industrialization strategy to EOI. In this phase, the
253
governments actively encouraged exports by maintaining
competitive exchange rates and providing a range of other
export promotion incentives. As a result, there were great
incentives to export relative to production for the domestic
markets, enabling textile exports to expand impressively and
making these countries major textile and garment exporters in
the world.
The examination of their quota allocation systems and
labor relations policies revealed similarities with Indonesia.
The governments of South Korea, Taiwan and Thailand devised
quota allocation systems that rewarded successful exporters
and penalized less successful ones, increasing the incentive
to expand exports and contributing to rapid export growth. The
governments of these countries played an active role in
controlling labor movements to create industrial peace. As
labor- abundant countries, their textile and garment exports
also benefited from the availability of a cheap and docile
labor force, especially during the early phase of their
export-oriented industrialization period.
From the experiences of these four countries, it can be
concluded that their governments have played an important role
in developing their textile and garment industries. This
conclusion has an important implication because, in contrast
with the neoclassical economists' argument that economic
growth will be best served if resource allocation is left to
the market, this study found out that it is possible for a
254
government to foster industrial development by affecting
incentive systems faced by economic agents.
The intervention has a greater possibility of success if
the country has a comparative advantage in the industry being
promoted. As this study demontrates, all of the four countries
intervened in the market to induce entrepreneurs to invest in
textiles and garment, labor-intensive commodities in which
they have a comparative advantage vis-a-vis the industrialized
countries due to their cheaper labor costs. In this case,
government intervention was in line with market conditions
because it enhanced the comparative advantage already possesed
by these countries' exporter-entrepreneurs.
Besides indirect measures to affect the incentive
structure, a government can also directly affect the behavior
of entrepreneurs by rewarding incentives for good performance
and imposing penalties for bad performance, as illustrated by
the export quota allocation systems. In this way, exporters
will be encouraged to find ways of expanding exports because
of the inducements they will receive for success. In South
Korea, the government also implemented an export targeting
system according to which successful exporters were given
prefential treatment in taxes and other government services.
Industrial development will be more likely to occur if
there is industrial peace which can assure a smooth working
environment that facilitates productive activity. The
experiences of Indonesia and the three other East Asian
255
countries show that a government's labor relations policy can
contribute to the maintenance of industrial peace and the
existence of market-determined wages. These two factors proved
to be essential in the development of export-oriented
manufacturing industries such as textiles and garments in
these countries.
The attainment of the policy objectives discussed above,
especially in the early phase of export-oriented
industrialization during which time trade and industrial
policies are being liberalized, requires government's deep
commitment, because of possible resistance of vested interest
groups who are favored by former ISI policies. The Indonesian
case shows that a strong government backed by political
constituents who benefited from the fruits of economic reforms
was able to press ahead with its agenda. The "snowball" effect
of reform measures resulted in further generation of interest
groups supporting the implementation of the new economic
policies leading to their success.
256
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Creator Emirullah, Chandra (author)

Core Title The Role Of The State In The Development Of The Indonesian Textile And Garment Industries

Degree Doctor of Philosophy

Degree Program Political Economy and Public Policy

Publisher University of Southern California (original), University of Southern California. Libraries (digital)

Tag Economics, Commerce-Business,economics, general,OAI-PMH Harvest,political science, public administration

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Contributor Digitized by ProQuest (provenance)

Advisor Elliott, John E. (committee chair), Brand, Laurie A. (committee member), Tang, Yan (committee member)

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