Can Indonesia Get Benefit from Global Economic Reshoring?

By: Kiki Verico, Associate Professor of International Economics - Universitas Indonesia and Senior Advisor on Industry and International Trade to the finance minister

Can Indonesia benefit from global economic reshoring? The short answer is yes, but how? Let us start with the big picture before going into more detail. Indonesia, officially in its long-term development plan, aims to achieve a high-income level by 2045. 

In the next 20 years, Indonesia must increase its current income per capita around four times, requiring at least 7.5% average economic growth annually. Given its economic structure as both a developing and emerging country, Indonesia needs its manufacturing sector to be back as the puller of economic growth. Indonesia needs to embrace the recent global challenges in manufacturing. 

The first challenge is shifting production methods from labor-intensive to smart machinery automation. After the global pandemic of COVID, the world has been witnessing a decreasing trend in labor-intensive manufacturing due to the rapid rise of automation, the Internet of Things (IoT), and artificial intelligence (AI) that accelerates, for instance, the 3D Printing that reduces the role of labor.  

Economists named it "labor-saving technological progress". This phenomenon hurts labor-intensive manufacturing, especially those with dominant unskilled labor in clothing and footwear manufacturing. All of this manufacturing across developing countries around the globe are under pressure. To be agile, Indonesia's manufacturers need to catch up with the rapid progress in production technology. This adjustment immediately requires yet consistently improves the skill of labor. Economists named it the "Total Factor Productivity (TFP)" improvement.

The second challenge is the changing pattern in global economic tension, called "economic wars," from financial to actual sector activities. The world has witnessed the global economic heating increase, from financial issues called the currency war in the 2000s to the trade war in the 2010s and now the chip war since the early 2020s. The first tension, the currency war, was a short-run issue and indirectly affected the actual sector activities. Yet, the second and third, trade and chip wars were more fundamental, long-run and directly affected the real sector activities. Unfortunately, these last two global economic wars significantly affect developing countries' economic growth sources.

Referring to Keynes and Solow-Swan's Model, economic growth mirrors an international reserve that is seen in its flow pattern of the Balance of Payment (BoP) in both the Current Account (CA) and Financial Account (FA). The CA (CAS) surplus indicates the country's accelerated economic growth and massive real sector transformation. The FA surplus reflects the positive trust of global investors due to that country's economic reputation. To be attractive for FDI inflows, Indonesia must show a positive trend in CA, particularly in the manufacturing goods trade. Nevertheless, they must not necessarily own CAS.

According to the BoP structure, the economic growth of a developing country like Indonesia fundamentally requires good performance in manufacturing trade and increasing long-run investment of Foreign Direct Investment (FDI) inflows. The chip war has not only changed global goods and service flows, as it did amid the trade war but also shifted the FDI flows. This phenomenon is called reshoring, and now this term has enlarged to "friend-shoring and nearshoring". All developing countries, including Indonesia, need to transform their manufacturing sector from dominant unskilled labor to skilled labor, particularly in electronic and electric (E&E) products. The latter is because of the chip war that happens in E&E products.

Now, let us move to more detailed issues. Amidst the chip wars, the reshoring of E&E products is possible. On March 11th, the Financial Times published an article entitled "Malaysia: The Surprise Winner from the US-China Chip Wars". With 50 years of experience in the semiconductor supply chain, it is reasonable for Malaysia to receive reshoring in semiconductor products. Data shows that in 2023, for HS-8541 (Semiconductor Devices), Malaysia was in the top four global exporting countries after China, Hong Kong, and Singapore. For HS-8542 (Electronic Integrated Circuits), Malaysia was in the top six after Hong Kong, Taipei, China, Singapore, and the Republic of Korea (ROK). 

For semiconductor devices with an export value of US$173.5 billion in 2022, Indonesia's network was tighter with China, Hong Kong, Singapore, Germany, and Malaysia. For electronic ICs, with an export value of US$517.7 million in 2022, Indonesia's network was tighter with Singapore, Germany, Mexico, China, and the USA and very low with Malaysia. Despite being lower in export value and ranking in the global market, the positive spillover of friendshoring and nearshoring with the USA and Malaysia's networks, for Indonesia, is higher in ICs than in semiconductors. A good opportunity is available for Indonesia if it can have a strong semiconductor network with Germany and ICs with Malaysia. 

GTAP Simulation of mine on the country's productivity with the increasing value-added technology in Southeast Asia showed that the USA, Mexico, and Canada have an equal positive spillover magnitude, followed by Latin America and South Asia. It proves that nearshoring is practical and that trade creation has potential. Nevertheless, it takes time to see the trade diversion or positive outcome from increasing FDI of ICs in Malaysia. It must wait for Malaysia's share progress in the USA market for some years to come. The share of the USA's imports from China still increased from 2019 to 2023 from US$1.57 billion to US$1.84 billion, or 4.8 percent to 5.1 percent, respectively.

The combination of descriptive data analysis and GTAP simulation confirmed that Indonesia could benefit from reshoring if it can improve its E&E's trade and FDI inflow network. Economic transformation to higher value-added products, such as E&E, requires developing countries to improve the TFP and increase the number of skilled laborers; therefore, they can increase R&D and innovation capacity (Pugel, 1981; Walz, 1997; Hejazi & Safarian, 1999). They require necessary and sufficient conditions.

As for the sufficient condition, Indonesia must adopt the appropriate international economic strategies for its trade and investment competitiveness. Success in managing these two factors will enormously accelerate Indonesia's economic growth. General analysis based on Indonesia's partner-country relations can be found in V-CIM (Verico, 2024), while the detailed analysis at the product level can be assessed from the combination of RCA and CMSA3 quadrant (Verico, 2023).

As for the necessary conditions, Indonesia must improve its essential factors. They are of domestic institution quality. Appropriate and continuous reforms are needed to create a friendly investment ecosystem. A study by Park and Park in 2008 proposes the application of the domestic reform index to ensure their domestic reforms work on track. These reform efforts must be adaptive and sensible to fast global progress and comply with the frameworks of green and digital inclusive economies.

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