Trade Policy at the Crossroads - The Indonesian Story

 

David Vanzetti, Greg McGuire and Prabowo[1]

 

7th Annual Conference on Global Economic Analysis

The World Bank, Washington, D.C., United States

June 17-19, 2004

 

Abstract

Following the crises of the late 1990s and the subsequent slowdown of the world economy, many countries in the developed and developing world are at the crossroads in their trade strategy, uncertain whether to advance with trade reforms, to stand still or even to backtrack into protectionism. While the case for liberalisation has been widely accepted as a long- term goal, the gains from trade have not always been forthcoming and macroeconomic crises have exacerbated the situation. The delayed and uncertain benefits of reform, plus the costs of adjustment, the need to offset tariff revenue losses, and the possible benefits of some degree of intervention to foster industrialisation have all contributed to this indecision. Support for the WTO multilateral negotiations now appears half-hearted, and there are even calls for increased protection. Following the failure of multilateral negotiations at Cancún, attention has inevitably turned to regional and bilateral agreements.

 Indonesia provides an interesting case study of the potential benefits and costs of alternative trade strategies that are under active consideration in many developing countries. The ASEAN region has recently announced a deepening of its commitments and is considering widening the agreement to include countries such as China, Japan and Korea. A bilateral agreement with the United States is also a possibility. Against this background, Indonesia’s options on trade policy range from reversing previous trade liberalisation to actively pursuing bilateral, regional and multilateral initiatives.

The results of a global general equilibrium analysis point to several interesting implications for policymakers. Reverting to protectionism results in economic losses. After undergoing further adjustments, estimated annual gains to Indonesia from a conservative Uruguay Round style outcome within the WTO system adds up to an estimated $380 million (0.22 per cent of GDP). However, annual gains from a completely liberalised ASEAN plus China and Japan, Korea regional trade agreement are estimated at $2.3 billion, again after adjustment. Indonesia could capture half of these benefits by liberalising unilaterally. The major source of the gains from unilateral, regional and multilateral liberalisation is improved efficiency following removal of tariffs on the politically sensitive sectors such as motor vehicles. This improves productivity in many downstream sectors. There are significant trade diversion effects from regional integration, with non-members worse off as a result. The results have implications for other countries having second thoughts about their strategy.

 

Key words: Trade policy, WTO negotiations, regional trade agreements, Indonesia, ASEAN.

 

Trade Policy at the Crossroads - The Indonesian Story

 

1. Which Way Forward?

 

Multilateral trade liberalisation is a two-edged sword for many countries. The opening up of markets provides a welcome opportunity for the development of exports. On the other hand, it also brings increased competition, not only in export markets but also in domestic markets. To take advantage of market opportunities, resources need to flow from inefficient sectors to those where productivity is greater. The reallocation of land, labour and capital inevitably involves some costs of adjustment, and meanwhile tariff revenues may fall before alternative sources can be implemented. Where capital and labour markets are functioning poorly, and where government administration is poorly developed, the negative effects of trade liberalisation may appear to outweigh the potential but distant benefits, especially in an ailing macro-economy such as has been experienced in Indonesia since the crisis of 1997-98. For these reasons, many countries are having second thoughts about further trade liberalisation.

 

In the long run, developing countries have little choice but to continue down the liberalisation road as the world becomes increasingly integrated. Liberalisation is recognised as a desirable objective for all economies and WTO Members have committed themselves to moving towards this objective. While openness is the end goal, the real question is how to get there, with the loudest voices – and many vested interests – calling for a standstill of current liberalisation or an increase in protection. The various trade strategy options include increasing protection in selected industries, or doing nothing, through to unilateral, bilateral, regional and/or multilateral liberalisation.

 

The appeal of winding back liberalisation (that is, increasing protection) is that sensitive industries can be sheltered from foreign competition, per haps on a temporary basis, with the hope that in time protected industries will become competitive. There are examples of industries that have become competitive after government funding (for example, Japanese motor vehicles) but governments often find it difficult to remove the protection. The US steel sector is a painful example. A more compelling argument may be that the externalities of locating industries in clusters, so that subsidising or providing infrastructure or other support for one industry may benefit others. High technology industries may be such an example. However, protecting an industry through border measures often means that users of intermediate inputs have higher costs.

 

Doing nothing may seem a more attractive option during periods of macro-economic weakness. This avoids the costs of adjustment. Structural adjustment necessitated by technological change or trade liberalisation is one of the biggest problems facing policy makers, and it becomes more difficult as the pace of change quickens. Structural adjustment essentially relates to moving primary factors such as land, labour and capital out of declining industries. There is limited scope for moving land out of agriculture, apart from converting it into forestry. The scope for moving labour out of agriculture is also somewhat limited, as this is likely to involve retraining and relocating resources. Retraining of labour can be a major cost, and many people find it stressful to have to face a period of unemployment and retraining after working in one job for many years. This is a real economic and social cost, albeit difficult to quantify. Sectors with a substantial proportion of aged workers, such as the rice growing sectors of Malaysia or Japan, face serious social and political costs in restructuring, particularly in the absence of social safety nets.

 

A further justification for doing nothing is concern over a potential fall in tariff revenues, especially where there is a lack of administrative capacity to put in place alternative income, capital, value added or consumption-based taxes.

 

Nonetheless, liberalisation has benefits that cannot be ignored. Unilateral liberalisation has its own rewards though improved efficiency in the allocation of resources, and many countries have been encouraged to go at least partly down this path, albeit somewhat hesitantly. Removing domestic distortions is important because taxes on imports raise costs to users of intermediate inputs. For example, taxes on motor vehicles raise the cost of transport and make it difficult for export sectors to compete. One approach is a uniform tariff, which removes much of the domestic distortions but leaves in place a distortion between traded and non-traded goods, for example many services industries that, while not directly involved in trade, provide inputs for export industries.

 

But trade liberalisation by itself is insufficient for sustainable growth, and authors such as Rodrik and Stiglitz have underlined the importance of institution-building. Capital and labour markets need to function so that resources can be moved to more productive sectors. Infrastructure may need to be provided so that countries can physically ship products to new markets. High transport costs are an impediment to an expansion in trade in many countries. Macroeconomic stability is important so that exports are not implicitly taxed by an overvalued exchange rate. The tax system may need to be reformed to move away from a dependence on tariff revenues as tariff rates are reduced. Safety nets need to be in place to protect workers and encourage entrepreneurs to undertake risky investments. These reforms need to be sequenced in such a way as to avoid undesirable consequences or outright failure.

 

There is also a lack of consensus about the best path to achieve long-term growth. Development economics is prone to fads, primarily because what works for some economies does not work for others. While a competitive exchange rate, fiscal discipline, trade liberalisation, sound investment climate and secure property rights is considered necessary, it is no longer considered sufficient. Other variables include good governance, low levels of corruption, flexible labour markets, inflation targeting and social safety nets. There is an increasing emphasis on the appropriate institutions, such as well-developed legal and financial systems, as necessary conditions for sustained growth. Furthermore, the empirical evidence is mixed, as some countries (for example, in Latin America) have largely followed these conditions with little apparent benefit, while others (for instance, in Asia) have managed to sustain high growth rates without fulfilling all the conditions.

 

If there is much to be gained, at least in the longer term, from autonomous liberalisation, then even more may be gained when a number of countries choose to follow the same path simultaneously, creating a synergistic effect. It also makes it easier to “sell” reforms politically at home if other countries are opening their markets at the same time. This is an advantage of the multilateral system, whose rules-based approach provides some protection for small players. The disadvantage is the difficulty in getting agreement. Multilateral agreements tend to be wide but shallow, with the need to incorporate substantial flexibility if a negotiated outcome is to be reached.

 

The uncertainty of the benefits of more liberalisation is likely to have contributed to the Cancún Ministerial Meeting of September 2003 ending in failure, a lost opportunity.[2] However, apart from critical areas such as agriculture, the so-called Singapore issues (investment, competition policy, government procurement and trade facilitation), and non-agricultural market access, there was also considerable concern about the lack of progress in fulfilling the promises on development issues. However, if the failure at Cancún leads to a better outcome in the future, then it may be seen as a watershed in international economic relations if the development impact of the WTO agenda is given priority over extending the mandate or rule-making for its own sake. It may also be seen as far-sighted if it gives an opportunity for consolidation and building genuine consensus on the future shape of the WTO system. Nonetheless, the lack of momentum in the multilateral negotiations provides an opportunity to assess the benefits and costs of an alternative trade strategy in developing countries.

 

However, the blockage at Cancún will inevitably also lead to a reinforcement of the trend since the early 1990s towards the formation of regional trade and integration agreements. Bilateral and regional agreements seem to afford opportunities for faster, deeper liberalisation with selected trading partners. It is much easier to get agreement with a few rather than many countries. The most obvious example of a successful agreement is the European Union. Developing countries are queuing up to obtain access to developed country markets, both in Europe and the Americas. The difficulties with these agreements are the unequal bargaining power between the members, particularly for hub and spoke arrangements where one large economy essentially has bilateral arrangements with several smaller countries.[3] The danger is that the larger power excludes products of particular interest to its partners or exacts other policy changes that may be premature or costly for the smaller, developing partner. The recently negotiated Australia-US Free Trade Agreement is an example where sugar was excluded. The EU has mostly excluded agriculture from its network of agreements with the Euro-Mediterranean and Central and Eastern European countries as well as largely requiring conformity with the acquis communautaire.

 

Indonesia provides a useful case study of a country at the crossroads. It has undertaken substantial reforms, especially following the 1997 Asian financial crisis, but is yet to see the expected benefits. As a result there is indecision about the way forward in its trade policy. In the remainder of the paper we examine the options for Indonesia and attempt to draw implications for developing countries more generally. In the next section, an overview is provided of the evolution of Indonesia’s trade regime since the 1960s. The structure of the Indonesian economy in relation to existing trade flows and protection levels is examined next. The sectors enjoying or facing the largest protection rates and hence are likely to be most affected by pending changes are agriculture, textiles and motor vehicles. In the following sections, alternative scenarios are described and results from simulations using the GTAP computable general equilibrium model are discussed. The penultimate section discusses timing and sequencing issues for Indonesia in progressing further liberalisation before the concluding section draws implications for policies that may also be of value to other countries facing a similar trade policy dilemma.

 

2. Indonesia at the crossroads

 

Indonesia has been engaged in a process of wide-ranging economic reforms, including in the area of trade for more than 10 years, under structural adjustment packages agreed with international funding institutions, but there have been important periods of reform and reversals of those reforms for more than 30 years. Average tariffs on merchandise trade have fallen from above 27 per cent in the mid-1980s to around 7 per cent (simple average) today, although there are significant tariff barriers in certain sectors, such as motor vehicles. However, in the wake of the recent crises, applied tariffs on certain agricultural products, including sugar and rice have been raised, and there is a call for further increases in these and other sectors.

 

The evolution of Indonesia’s trade policy regime

 

In the past 35 years, Indonesia’s trade and investment policy has undergone substantial transformation from a closed and protected regime to a more open one. Indonesia has moved from an inward looking import substitution strategy during the oil boom in the 1970s and early 1980s to a more export-oriented economy after the oil bust in the mid-1980s. The 1997 Asian financial crisis led to substantive trade liberalisation reforms as part of meeting IMF conditions. In addition, Indonesia has implemented its commitments under the ASEAN Free Trade Area (AFTA), the Asia Pacific Economic Cooperation (APEC) and the WTO.

 

While Indonesia is now one of East Asia’s most liberal trade regimes, the road to this status has been long and winding, with episodes of trade liberalisation followed by increased protection and vice versa. Trade reform has not tended to be an ongoing reform process but reacts to the external developments of the day with these reactions closely tied to the price of oil (Basri and Hill, 2004). During the period of high oil prices, protection increased as the economy relied on oil revenues to stimulate economic growth. During low oil prices major trade liberalisation reforms were implemented as the government realised the need to diversify away from the reliance on oil revenue to stimulate economic growth.

 

Indonesia’s road to liberalisation: The 1960s to the 21st century

 

Before the period of rapid economic growth from 1967 to 1997, the performance of the Indonesian economy under the Soekarno administration had been very poor and Indonesia was considered by many as a ‘basket case’. Decades of poor social indicators and economic growth were a stimulus for drastic action from the then new 1967 Soeharto regime. Trade, along with investment, policies were liberalised when Soeharto came to power. Import licensing was dismantled and a new ‘export bonus’ scheme introduced. In 1970, the government introduced a major trade policy package, which included simplification of exports and import procedures. The elimination of international capital controls marked an important moment in Indonesia’s capital account policy (Aswicahyono and Feridhanusetyawan, 2003).

 

However, this period of trade liberalisation was shortlived. Indonesia suddenly received large windfall gains from increasing oil prices during the 1970s from which it could rely to stimulate economic growth. The government was unwilling to institute further trade liberalisation reforms as increased foreign exchange reserves could be used to finance development. Protection increased and Indonesia adopted an import substitution strategy. In addition, the government intervened in the market to direct state owned banks to provide subsidised credit for favoured clients, directed production in heavy industries through State owned enterprises and implemented complex regulations aimed at promoting industrial policy objectives. In the early 1980s, protection was further increased (Feridhanusetyawan 2001). A new import system was introduced which controlled imports through quantitative restrictions. This substantially limited the capacity to import freely and provided many opportunities for vested interests to capture rents.

 

Indonesia’s first major trade reforms occurred in the mid-1980s when the 1985 recession and 1986 collapse of oil prices halted the protectionist tendencies and prompted trade reforms. The Government lowered tariff ceilings to 60 per cent, reduced the number of tariff levels from 25 to 11 and converted several import licences (which at their peak covered 43 per cent of tariff lines) into tariff equivalents (DFAT, 2000). The simple average tariff rate was reduced from 27 per cent in 1986 to 20 per cent to 1991. Other reforms abolished import monopolies, simplified customs and outsourced substantial customs responsibilities. These reforms, combined with industrial and investment reforms, underpinned Indonesia’s strong economic growth in the late 1980s and 1990s.

 

Trade liberalisation slowed in the early 1990s and the simple average tariff rate remained steady. Tariffs increased on some chemical products and the national car scheme was made exempt from domestic luxury tax and protected by an extensive range of tariff and non-tariff measures. These developments fuelled doubts about the resolve of the Soeharto Government to continue trade reform. By the crisis of 1997, the simple average tariff rate on agriculture and industrial goods was stagnating at around 13 per cent (refer to Figure 1).

Figure 1 Declining Indonesian tariffsa

a The World Bank WITS database does not provide a complete time series and data for some years have been estimated.

Source: WITS (2003).

 

When the 1997 Asian financial crisis set in, the government chose not to close itself off to the rest of the world but sought deeper integration by accelerating trade liberalisation. Trade liberalisation reforms were intensified at the start of the IMF program with the highlights being the elimination of non-tariff measures for agricultural products and measures to protect the national car scheme. During the crisis, the government committed to removing all import licenses, including import licenses that fell outside previous WTO commitments. The government introduced competition in agricultural products by removing import-licensing requirements on commodities controlled by BULOG, the national logistics agency. The government also opened rice to import competition. While the general trend since the crisis has been further liberalisation, protection has recently increased in some areas. However, this increase in protection is not taking the form of highly visible tariffs but highly distortionary and opaque non-tariff measures. The coverage of import prohibitions was increased from 7 to 27 tariff lines and while the coverage of import licensing was increased from 27 to 1027 lines between 2001 and 2003 (Kim, 2004).

 

The renewed liberalisation efforts in the 1990s were supplemented by international commitments under AFTA, APEC and the WTO. Strong political will to deregulate paved the way for Indonesia’s active participation in the formation of the AFTA by 2008, a target later bought forward to 2003 and then to 2002 (Feridhanusetyawan and Pangestu, 2003). In 1994, the year it hosted the APEC meeting in Bogor, Indonesia emerged as a champion of concerted unilateral liberalisation, giving APEC the legacy of the Bogor goals of free and open trade and investment by 2010 for developed countries and 2020 for developing countries. In 1995, the Government committed for the first time to a schedule of tariff reductions that anticipated a maximum tariff rate of 10 per cent by 2003. Non-tariff measures were reduced and tariffs covered 65 per cent of tariff lines in 1995. Despite these 1995 commitments many of the actual tariff reductions were behind their targets in 1999 (DFAT 2000). However, sensitive products whose production was closely connected to the government – chemicals, motor vehicles and steel – continued to be largely untouched by the trade reforms.

 

Many of the areas excluded in the past from major trade liberalisation continue to be excluded (refer to Table 1). Tariff peaks in these occur in agriculture and manufacturing areas for different reasons. Agriculture protection reflects concerns over food security and the belief that this concern can best be met by achieving self-sufficiency in staple commodities, especially rice (WTO, 2003).[4] Agriculture is relatively important to the Indonesian economy, employing 45 per cent of the labour force but producing only 17 per cent of national output (Banerjee and Siregar, 2002). Agricultural bound tariffs are very high, around 65 per cent in trade weighted terms, and significantly exceed applied tariffs that averaged 7 per cent before the recent increases in sugar and rice. There are high applied tariffs on rice (now around 30 per cent), meat (around 20 per cent), bananas (20 per cent), skim milk powder (25 per cent), tomatoes (25 per cent) and roasted coffee (25 per cent) (UNCTAD, 2003a).[5] Because bound tariffs are often more than twice applied levels, negotiated reductions of 50 per cent or less are likely to have little economic impact in the agricultural sector.

 

Much of the high protection in the manufacturing sector reflects the past and present ability of powerful interest groups – conglomerates and state trading enterprises – to influence government policy. Chemicals, motor vehicles and steel have been largely untouched by the major trade liberalisation reforms of the mid-1980s and 1997. Protection in the automobile industry, mainly a legacy of Soeharto family connections, and steel and chemicals reflects the entrenched interests of large state controlled enterprises. In addition to tariffs, these sectors are also protected by a wide range of non-tariff measures in the form of import prohibitions and licensing.

Table 1 Little change in tariff protection in sensitive sectors since the crisis (per cent)

ISIC

Sector

1996

 

1998

 

2002

 

 

 

Tariff

Range

Tariff

Range

Tariff

Range

 

 

%

%

%

%

%

%

 

 

 

 

 

 

 

 

3121

Food products

15

5-170

13

5-170

6

5-170

3131

Distilling, rectifying, blending spirits

170

170-170

170

170-170

170

170-170

3132

Wine industries

135

5-170

137

5-170

137

5-170

3133

Malt liquors and malt

17

5-40

17

5-40

17

5-40

3511

Industrial chemicals

6

0-30

5

0-30

4

0-30

3513

Resins, plastics and man-made fibres

13

0-40

12

0-35

8

0-30

371

Iron and steel

8

0-30

8

0-30

7

0-25

3819

Manufacture of fabricated metal products

14

0-30

13

0-25

10

0-20

3843

Manufacture of motor vehicles

48

0-200

52

0-200

21

0-80

3844

Manufacture of motorcycles and bicycles

42

0-150

42

0-150

19

0-60

3849

Manufacture of transport equipment

30

0-30

25

25-25

20

20-20

Source: WITS/TRAINS (2003).

 

In summary, over the past thirty-five years, Indonesia has moved to a more liberal trade regime but it has not being without periods of increasing protection and the direction of trade liberalisation in the short to medium-term has again come into question. While trade liberalisation is a desirable long-term objective and has been strongly espoused by Indonesia at international forums such as AFTA, APEC and the WTO, the real question is how should Indonesia get there. Indonesia is already going forward by meeting international commitments. Some are frustrated with the little or no return on the post-crisis reforms and argue that Indonesia should go back and increase protection. Others argue that going forward faster with further liberalisation will shift resources to areas of comparative advantage and stimulate economic growth. Some argue for a standstill or to stop liberalisation to give the economy time to adjust to the historic post-crisis reforms before undertaking further reforms. Further questions arise about which approaches to progress further liberalisation – unilateral versus bilateral versus regional versus multilateral.

 

3. Indonesia’s Trade and Barriers in Export Markets

 

Indonesian trade is predominantly North-South with a low proportion of South-South trade. Since special and differentiated treatment applies to developing countries at the WTO negotiations, this has implications for Indonesia negotiating strategy. In 2002, around 39 per cent of Indonesia’s goods and services imports are from developed countries (WITS/TRAINS, 2003). The major sources of imports are from Japan ($4.4 billion), European Union ($3.9 billion), and the United States ($2.6 billion). Indonesia’s South East Asian neighbours (Malaysia, Philippines, Singapore, Thailand and Vietnam) collectively import $4.6 billion from Indonesia. Japan provides 62.8 per cent of the motor vehicles, whereas the European Union has a stranglehold on services, particularly business services.

 

In terms of destination of Indonesian exports, two thirds of Indonesia’s exports are to developed countries. The major regions are the European Union ($8.1 billion), Japan ($11.8 billion) and the United States ($7.5 billion). Exports to the South East Asian region are less than ten per cent of the total at around $9.4 billion. A distinguishing feature of Indonesian trade as compared to other developing countries is its reliance on the export of oil and gas. As the only South-East Asian member of OPEC, Indonesia exports $12.3 billion in coal, oil and gas and another $1.9 in petroleum and coal products. Agriculture exports, mainly vegetable oils, are $6.6 billion and manufacturing exports, which are dominated by office machinery and telecommunications equipment and textiles and clothing, are $34.2 billion.

 

In services, Indonesia exported around $6.6 billion and imported $17.1 billion giving a deficit of around $10.5 billion in 2002 (UNCTAD, 2003c). Indonesia has a structural deficit in services from importing these higher value products for which it is unable to produce itself.

 

Of greater interest are the barriers facing Indonesia in its export markets. Total goods and services exports from Indonesia amount to $55.8 billion (in 2000) and the major contributors to this are timber and paper products ($7.6 billion), coal, oil, gas and derivatives ($14.6 billion) and textiles and apparel ($6.8 billion). The implicit tariff revenues charged against these exports are textiles and apparel ($1490 million), vegetable oils ($265 million), other foods ($630 million), and timber and paper products ($577 million). These are shown in Figure 1 and in more detail in Annex Table A1 (excluding barriers within the ASEAN region which are to be removed). A combination of significant tariffs with substantial trade flows generates these large numbers and indicates where the gains from liberalisation might lie.

 

 

 Figure 2 Tariff barriers facing Indonesian exports

Source: GTAP database.

 

4. The Road Ahead for Trade Liberalisation – Six Scenarios

 

Six scenarios are analysed here to assess where Indonesia’s interest lie: (i) reversal - that is, increasing protection; (ii) standstill - doing nothing while others liberalise; (iii) unilateral - liberalising while trading partners maintain their policies; (iv) bilateral - free trade agreement with the United States; (v) regional, - an expansion of ASEAN to China, Korea and Japan; and (vi) multilateral - a WTO proposal as it may eventuate. Some of these scenarios are politically unobtainable at the moment, but are useful to illustrate the value of the various options being faced by Indonesia and indeed other developing countries in a similar situation. Indonesia still has room to move in its trade policy but important questions arise on how to proceed – go back, standstill, go forward faster, wider or deeper.

 

However, as for other countries, there are some limitations on the options facing Indonesia: the scope for further trade reforms must be considered in the context of existing trade commitments, some of which are legally binding. In Indonesia’s case, the room it has to move, without negative implications, depends on its commitments under ASEAN, APEC and the WTO. It can obviously accelerate liberalisation at a faster pace with no implications, but is likely to be more limited if it chose to standstill or go back. The scope under ASEAN, which covers about 20 per cent of Indonesia’s trade, is limited. Indonesia has already locked into legally binding tariff reductions, with few exceptions, as part of AFTA. ASEAN has expressed its intention to achieve zero tariffs on all trade between founding members by 2015. There is more flexibility under APEC and the WTO. Indonesia has a number of non-binding commitments under APEC, which is seeking to achieve free and open trade and investment by 2020 for developing economies. Under the WTO, Indonesia is progressively liberalising but for some products where the bound rates are significantly higher than the applied rates there is significant scope to increase the applied rates.

 

The six scenarios are somewhat speculative because in each case the terms are subject to negotiation. These scenarios involve liberalisation of sectors, such as sugar, motor vehicles and cement that in the past have been considered politically sensitive. It remains to be seen whether these would be quarantined from future liberalisation. If so, the estimated impacts would need to be reconsidered. Table 2 provides an overview the specifications for each scenario.

 

Reversal

 

There has been much discussion in Indonesia that liberalisation has gone too far and in fact ought to be wound back. That is, protection should be increased, particularly in the sensitive sectors such as chemicals, motor vehicles, steel and textiles. In recent years, further liberalisation of certain agricultural commodities has aroused calls for protection to be increased. For example, rice farmers concerned about the market penetration of lower cost, foreign rice called for rice tariffs to jump from 30 per cent to between 90 and 120 per cent (DFAT, 2000). Sugar industry representatives have also argued that the 20 to 25 per cent tariff on sugar was too low compared with some developed country tariffs of 14 to 240 per cent (Bisnis Indonesia, 2000). These pressures for increased protection are simply modelled as a 50 per cent increase in specific sectors.

 

Standstill

 

As Indonesia has already undertaken more liberalisation than many other countries, it could consolidate its position by keeping its applied tariffs unchanged while other countries pursued liberalisation. In recent years, the voices have also been loud to maintain the existing level of liberalisation. Steel industry representatives, led by the state owned Krakatau Steel, argue strongly to maintain indefinitely steel tariffs at 25 per cent, claiming Japanese, Chinese and Korean imports are often dumped (CSIS, 2000). The petrochemical industry, the country’s largest ethylene producer, opposes liberalisation and has sought to maintain its tariff (Jakarta Post, 2000). In a modelling context, these pressures are simulated by a WTO Uruguay Round scenario (see below under Multilateral) without participation from Indonesia.

 

Unilateral

 

Some countries have followed the path of liberalising completely. Indeed, Indonesia has gone much of the way down this path. Indonesia has pursued many of the major trade reforms in the past three decades on a unilateral basis. The major trade and investment reforms of the mid-1980s, the implementation of the seven-year tariff reduction schedule committed in 1995 and the post crisis reforms under the guidance of the IMF were all pursued unilaterally. While also being in line with regional and multilateral obligations, they have often gone beyond international commitments. As part of the IMF programme, Indonesia adopted unilateral reforms for financial and other services that substantially exceeded its WTO commitments. Indonesia has also committed to further voluntary unilateral trade liberalization within APEC. Thus, this scenario involves Indonesia completely removing its remaining protection while other countries retain their current levels. This effectively shows the opportunity cost of maintaining protection.

 

 Bilateral - Indonesia- US Free Trade Agreement

 

At present, the United States is focusing on regional rather than multilateral trade agreements, and recently concluded bilateral agreements with Singapore and Australia, and is currently in discussion with Thailand. Under this scenario, tariffs on agricultural and industrial products between the United States and Indonesia are completely removed. However, it must be kept in mind that the United States appears reluctant to fully open its agricultural market to any significant degree. Once again, the simulation represents the scope of the potential gains.

 

 Regional - ASEAN+3

 

The regional scenario involves elimination of tariffs between the current ASEAN plus Japan, China and Korea or ASEAN+3. Within the region, Indonesia has substantial trade ($13 billion) with Japan so there are significant gains from liberalisation from a preferential trade agreement that includes this country. Indonesian exports mainly forest and energy products to Japan. However, processed food exports attract duties of more than 30 per cent. In the other direction, Indonesian tariffs on imports of Japanese motor vehicles amount to $435 million. Removal of these tariffs would lower transport cost in many sectors and have benefits throughout the economy. A similar situation applies to vehicle imports from Korea, where average duties are higher still.

 

The opening of the Chinese economy affects Indonesia in conflicting ways. The significant size and growth in China's economy provides a potentially major market for exports from Indonesia and other Asian neighbours with the advantage of proximity. In addition, Indonesia will be able to source many cheaper intermediate and consumer goods from China. However, Indonesia will also experience competition from China in its export markets, for example in labour-intensive exports, including textiles and clothing.

 

Indonesia already has a foothold in these this export market. ASEAN members are increasingly seeking co-operation with non-members. The ASEAN+3 members agreed in November 2002 to study and formulate options to establish an East Asia Free Trade Area gradually (WTO, 2003). This obviously provides opportunities for Indonesia to increase the level of cooperation and expand its trade in an expanded ASEAN.

 

This scenario assumes that trade between the additional three countries is freed up. The trade between these three countries is much more significant than trade with and within ASEAN. Furthermore, it is difficult to imagine Japan and Korea opening their agricultural markets as postulated. In that sense, this scenario represents the potential rather than probable gains.

 

Multilateral

 

Indonesia has stated its commitment to the WTO and actively participates in the multilateral system. It is a member of the Cairns Group but is currently less enthusiastic than other members in pressing for reform. As a mid-ranking developing country it has limited ability to influence the outcome, but it has plenty of flexibility to raise applied tariffs on sensitive agricultural products and maintain tariffs on some industrial products. The WTO proposal as simulated here is a continuation of the Uruguay Round, essentially a fallback position and the least that could reasonably be expected at some point despite the failure of Cancún. However, this specification does not include any attempt at harmonisation of tariffs as agreed at Doha. The simulated cuts are based on the specified minimums, that is, 15 per cent in developed countries and 10 per cent in developing countries.[6] The cuts are implemented against applied rates. Where these are different from bound rates, an overestimation of the cuts occurs.

 

In each scenario the tariffs between the current ASEAN members are removed prior to the simulation. These cuts have been agreed, if not implemented, and it is useful to remove their influence to assess the impacts of further liberalisation.

 

Table 2 Alternative trade liberalisation scenarios

Reversal

50 per cent increase in tariffs on vegetable oils, other crops (mainly sugar), leather, textiles, apparel, chemicals, rubber & plastics, and motor vehicles.

 

Standstill

No change in Indonesia. As for Multilateral scenario for other countries.

 

Unilateral

Elimination of Indonesian agricultural and industrial tariffs. No change elsewhere.

 

Bilateral

Elimination of tariffs in agriculture and industrial trade between Indonesia and the United States. No reductions in services, domestic support or export subsidies.

 

Regional

Elimination of tariffs in agriculture and industrial trade between ASEAN countries and Japan, China and Korea. No reductions in services, domestic support or export subsidies.

 

Multilateral

15 per cent reduction in applied tariffs in agricultural and industrial sectors in developed countries. Two third reductions in developing countries. No reductions in services, domestic support or export subsidies.

 

 

 

The big black box

 

Simulations are undertaken using the GTAP model with the version 5.4 database. The database has 78 countries and regions and 57 sectors that are aggregated to 20 regions and 21 commodities as shown in Table 3 to reflect the trade interests of Indonesia. GTAP is a general equilibrium model that includes linkages between economies and between sectors within economies. Industries are assumed to be perfectly competitive and are characterised by constant returns to scale. Imports are distinct from domestically produced goods as are imports from alternative sources. Primary factors are substitutable but as a composite are used in fixed proportions to intermediate inputs. The database includes tariffs, export subsidies and taxes, subsidies on output and on inputs such as capital, labour and land. Border measures are specified bilaterally, so the impact of preference erosion can be ascertained. This makes the model suitable for analysing preferential trade agreements.