Indonesia’s new ‘Omnibus Law on Job Creation’ was marred by the public controversy that surrounded its passage late last year. The government nonetheless hailed the law as a major regulatory overhaul that would attract foreign investment and create jobs. In reality, it lacks important detail, meaning its success will ultimately depend on the vagaries of implementation.
Members of Indonesian labor organizations protest against the country’s controversial job creation bill that aims to boost investment in Jakarta, Indonesia, 12 April 2021 (Photo: Reuters/Ajeng Dinar Ulfiana).
The first batch of implementing regulations released this year however show some promise — introducing important steps to liberalise the labour market while notionally cutting away a plethora of restrictions on inward foreign direct investment (FDI). Notwithstanding important limitations, this represents the first set of serious liberalising reforms to be introduced under President Joko Widodo after almost seven years in power.
While sixteen so-called ‘reform packages’ were released during Widodo’s first term, these were not ambitious enough to yield much in accelerating economic growth and generating more formal sector jobs. Nor did they succeed in attracting greater foreign direct investment (FDI) or capturing international supply chains relocating from China, which mostly went elsewhere in Southeast Asia.
The latest measures significantly moderate two longstanding problems in the labour code for Indonesia’s international competitiveness, while otherwise leaving strong worker protections mostly intact.
First, severance payments that firms must provide when laying off workers have been substantially scaled back, effectively reducing these costs by roughly half. This should bring Indonesia broadly in line with its Asian peers, after having previously had one of the highest severance requirements in the world.
Second, the rules governing minimum wage increases have been significantly tightened. This will help to contain the rapid increases that have been eroding Indonesia’s external competitiveness while nonetheless failing to serve as an effective safety net for workers. Over the past decade, Indonesia’s manufacturing labour productivity has risen by less than 20 per cent while nominal minimum wages have doubled.
Future minimum wage increases will be based on either local inflation or real economic growth (whichever is higher), rather than the sum of the two — as had been the case since 2015 when Widodo last sought to tighten the rules. This is another decent step forward. However, because minimum wage increases can still outpace growth in labour productivity, it remains a partial solution.
The recent FDI reforms are potentially more transformative, at least on paper. Indonesia previously had one of the most restrictive FDI policies among the 84 economies assessed by the OECD. The reforms cut the number of business lines subject to FDI restrictions dramatically from 528 to 215, including in areas important to industrial upgrading such as telecoms, e-commerce, transport, vocational training and health.
Indonesia’s investment environment is however notoriously complex, not only because of rent-seeking and corruption, but also due to inconsistencies between the central FDI policy regime and protectionism embedded at the sectoral level.
The final outcome will therefore probably vary considerably across areas. For instance, mining is now fully open to foreign ownership, but existing mining sector policies still mandate gradual divestment to majority local ownership. Given the government’s proclivities towards resource nationalism, the inconsistency is probably intentional. But in other areas such as telecoms and construction, follow-up sectoral reforms may be more likely. A lot will also depend on specific regulatory decisions and practices in individual industries, for example medical services.
The latest reforms could ultimately be stymied by protectionist forces. Yet, World Bank analysis suggests that past liberalisation of the central FDI policy regime did indeed result in higher FDI inflows — providing some hope that the latest reforms will also see some follow through.
A host of other barriers remain to attracting substantially greater investment — from infrastructure deficiencies to the proliferating mass of non-tariff barriers that limit access to the best inputs and make it difficult to participate in complex supply chains criss-crossing international borders. In the immediate term, overcoming the pandemic and reviving the domestic economy are an absolute necessity — especially as Indonesia’s large domestic market is a key point of attraction for foreign investors.
Indonesian policymakers are nonetheless right to look more seriously to FDI as a key part of the recovery strategy. Not only does FDI usually confer important productivity benefits but, in the wake of the pandemic, other avenues for financing Indonesia’s growth and development will be heavily constrained. Banks, state-owned enterprises and private firms will all be left financially damaged, inhibiting investment. And while fiscal policy should be used to support the recovery, the capacity to do so will be checked by rising debt service payments and the imperative to bring the budget deficit back within the normal 3 per cent of GDP legal limit in due course.
As domestic demand recovers, the current account deficit could also return as a key macroeconomic vulnerability. The US Federal Reserve will eventually look to unwind its crisis policy settings. That could threaten a re-run of the 2013 ‘taper tantrum’ but at a potentially more damaging moment. With such risks on the horizon, relying more on FDI instead of unstable portfolio flows would be a real advantage.
Until May last year, health centres in Japan were using fax machines to send handwritten reports of COVID-19 cases to the health ministry. While the reporting moved online soon after, the issue exemplifies Japan’s struggle to move away from requiring signatures or hanko stamps on physical paper for authorisation. Despite its high-tech image, Japan is still very much a paper-based analog society, including in the widespread use of hard cash and a reluctance to adopt digital payment.
The application forms for the Japanese government’s 100,000 yen cash handout program in Tokyo, Japan on 23 June 2020 (Photo: Naoki Morita/AFLO via Reuters).
In the digital age, the degree to which a nation can adopt and employ new digital technologies has become a crucial determinant of its capacity for economic transformation. The ability to innovate through digital technologies reached a new level of urgency with the onset of the COVID-19 pandemic and will, to a great extent, predict the propensity of an economy to absorb and emerge from the pandemic shock.
While most governments aspire to attain digital competitiveness and devote considerable resources to this end, their efforts do not always translate into success. A nation’s capacity to navigate the digital landscape does not necessarily correlate with its economic weight or technological competency.
Japan is a case in point. Despite its status as the world’s third largest economy and a long history of being a leader in technological development, it ranked only 27th in the latest IMD World Digital Competitiveness Ranking — a survey of how nations employ digital technologies.
This stands in contrast to the small state of Estonia, which eclipsed Japan, coming in at 21st place. Driven by its limited human resources, Estonia adapted rapidly in the digital world and has achieved a competitive edge across a number of digital sectors, including being a world leader in cyber security. This in turn has enabled Estonia to adjust swiftly in the pandemic world.
In our lead article this week, Richard Katz explores the reasons behind Japan’s failure to adapt to the digital world. A central problem he identifies is the lack of business agility among Japanese companies in their use of Information and Communications Technology (ICT).
He says that ‘most Japanese companies use ICT primarily to cut costs by automating tasks they are already doing, like inventory control’. They have failed, however, to capitalise on the potential of ICT to revolutionise the ways in which their companies operate. Such technology should ideally be enabling businesses to ‘reach more customers and suppliers via e-commerce’ and ‘use big data and the internet to develop new products and improve old ones’.
Katz also highlights the failure of analogue-era champions like Sony to adapt their business practices to the changing times. These ‘champions were so successful that they have an ingrained mindset which companies find hard to change — even when they try hard. These firms do not hire or promote recruits who are eager to revamp business models. Around 82 per cent of senior managers in Japan’s leading corporations have never worked in another firm. In Germany, that share is 28 per cent and in the United States, just 19 per cent’.
The consequences of Japan’s lagging performance in the digital world are manifold. With a stagnant economy and a rapidly shrinking population, the need to reinvigorate commerce to enhance business performance is becoming ever more urgent. ‘Different technological regimes give rise to and require different business institutions. When circumstances change, so must the institutions. Otherwise yesterday’s strengths become today’s weaknesses, and economic growth slows’, Katz argues.
While a shift to work-at-home practices has been a common strategy to mitigate the spread of COVID-19 in most countries, many Japanese workers found themselves forced back into the office, unable to work from home due to the lack of progress with digitisation in their companies and workplaces. This is at least one of the reasons that COVID-19 has maintained a stronghold in Japan, threatening public health and undermining preparation for the impending Tokyo Olympic Games.
Japan’s faltering approach to digital innovation is a far cry from the resourcefulness and technological innovation that fuelled its skyrocketing economic growth in the 1970s and 1980s.
If Japan’s government and business leaders of today could effect a digital revolution, it would help alleviate many of the nation’s economic woes, including by lifting faster the productivity of its contracting labour force.
As Katz surmises: ‘If Japan wants to revive, it has to recognise that, to paraphrase the famous American car commercial, “This is not your father’s economy”’.
Once populations are vaccinated and societies can return to the new normal of living with COVID-19, many workplaces in Japan and around the world are likely to undo much of the progress made during the pandemic, require workers to return to the office irrespective of the benefit and revive past practices. The long and crowded commutes will return and managers will once again monitor employees by input based on time in the office instead of output and productivity. Part of the reason will be the lack of digitalisation and failure to address the task of adapting to new, more efficient and flexible systems. That would be a missed opportunity and would serve to undo one of the silver linings of the pandemic. Now is the time for Japan to reinvent its work practices, take the lead in innovation once again, and transform its society for the better.
Different technological regimes give rise to and require different business institutions. When circumstances change, so must the institutions. Otherwise yesterday’s strengths become today’s weaknesses, and economic growth slows. This is unfortunately Japan’s plight, with its analogue era champions failing to adapt to today’s digital world. No longer does Sony churn out one must-have product after another.
TV screens at an electronics store in Fukuoka, southwestern Japan, show Prime Minister Yoshihide Suga speaking at a press conference on 7 January 2021 (Photo: Kyodo via Reuters).
Japan ranked a dismal 25th in overall digital competitiveness in 2020 according to the IMD World Competitiveness Center. Companies in Japan spend plenty on information and communications technology (ICT), but get less bang for the yen. Japan ranks 56th in ‘business agility’, which measures how well a country uses ICT.
Most Japanese companies use ICT primarily to cut costs by automating tasks they are already doing, like inventory control. But what makes ICT revolutionary is that companies can do things that were previously impossible. They can not only reach more customers and suppliers via e-commerce, but also use big data and the internet to develop new products and improve old ones. UPS parcel delivery trucks have internal sensors to monitor conditions that typically precede a part breaking down, avoiding expensive failures of trucks filled with parcels.
Using ICT should enable the rest of the economy — distribution, services and non-ICT manufacturing — to increase productivity and get, for instance, a 2 per cent increase in output from a 1 per cent hike in inputs. Unfortunately, Japan’s non-ICT sectors have not enjoyed this productivity boost. During Japan’s ‘economic miracle’ following the Second World War, in the analogue era, technological innovation was led by giant, capital-intensive and vertically integrated companies. They relied solely upon themselves and long-time allies in corporate conglomerates — known as keiretsu — to create distinct products. Companies moulded themselves to conform to this technological regime.
But we now live in a digital world, where the vanguards of innovation are often newer, entrepreneurial and knowledge-intensive companies. It is a world where giants regularly partner with others, including newcomers, in a process called ‘open innovation’. Pfizer’s COVID-19 vaccine was developed by a small German biotechnology firm founded in 2008 called BioNTech. Amazon’s Alexa and Google’s Android and Chrome are all products developed through open innovation.
In Japan, 70 per cent of corporate giants still believe that they must do everything in-house. However, with 10 per cent of a car’s manufacturing cost involving software — and with that amount steadily increasing with time — automakers can no longer go it alone. Having repeatedly failed to develop a collision-avoidance system on its own, Honda finally bought technology from Bosch, only to face outrage from the company’s research and development veterans who insist that using homegrown parts was central to ‘Honda’s soul’.
Analogue era champions were so successful that they have an ingrained a mindset which companies find hard to change — even when they try hard. These firms do not hire or promote recruits who are eager to revamp business models. Around 82 per cent of senior managers in Japan’s leading corporations have never worked in another firm. In Germany, that share is 28 per cent and in the United States, just 19 per cent.
The difficulty of teaching an old dog new tricks is hardly unique to Japan, but what differentiates it is the difficulty new firms face in supplanting past corporate leaders. Not a single new manufacturer has entered the top ranks of electronics since 1946, when Sony and Casio were born. By contrast, 8 of the top 21 electronics hardware manufacturers in the United States did not exist in 1970. Among rich countries, Japan has the second-lowest rate of new firms entering and old firms exiting.
In the digital era, bigger is not necessarily better. Back in 1981, 71 per cent of all business research and development in the United States was carried out by firms with at least 25,000 employees and just 4 per cent by those with fewer than 1000. By 2014, the share of giant firms halved to just 36 per cent, while the share of those with less than 1000 increased to 20 per cent.
Japan resists this trend. In 2015, only 7 per cent of its research and development was conducted by firms with fewer than 500 employees, compared to 17 per cent in the United States and 33 per cent in France and the United Kingdom. One reason is that Tokyo directs almost 90 per cent of the government’s financial aid for research and development to large incumbents — the highest ratio in the OECD.
Prime Minister Yoshihide Suga has announced a program to increase digitisation, including the creation of a new digitisation agency. It is a good first step, but one unfortunately limited to intra-governmental functions and citizens’ dealings with the government. If it is to be helpful to Japan’s economy, it needs to be extended to business.
If Japan wants to revive, it has to recognise that, to paraphrase the famous American car commercial, ‘This is not your father’s economy’. Its analogue era champions are holding Japan’s economy back.
Agriculture remains an important sector in the developing world. In Cambodia, it is one of the top three economic sectors. But for a long time the sector has faced several critical barriers. One such barrier is the gap between farmers and financial support, and the failure of the Agricultural and Rural Development Bank (ARDB) grant-credit program to bridge it.
A man collects rice in a rice paddy field in Kandal province, 11 February 2015 (Photo: Reuters/Samrang Pring).
The ARDB is a public bank that aims to contribute to the development of agriculture and the rural economy. But the bank seems to be moving away from this goal.
The bank’s subsidies have focussed mainly on rice (76 per cent of total credit in 2019), especially funding for rice storage, drying facilities and collecting purchase paddy from farmers. Yet most of the firms that receive ARDB funding are medium-sized enterprises that are operated by knowledgeable people who are able to independently find funding sources from private banks and who are members of the Cambodia Rice Federation. These firms collect fragrant paddy and are exporting rice to markets around the world.
The government wants to reduce rice production costs for exporters and help farmers benefit from the sale of paddy at reasonable prices. But most agricultural producers and traders have not benefited from this subsidy program, including farmers that produce different products as well as traders exporting white paddy to neighbouring markets.
White rice producers in Takeo province claim that, because of a lack of collateral, they are forced to borrow from informal institutions with high interest rates of 7–10 per cent per month. They use these loans during the short planting season. Meanwhile they often also owe local traders for production materials. Their ability to repay debt is dependent on the success of the harvest season.
ARDB loans for working capital and investment projects have an interest rate of only 5 per cent and 5.5 per cent per year, respectively, while private banks have interest rates of about 18 per cent.
For the ARDB to contribute to the farming sector more effectively, it should provide loans to a broader cross-section of primary producers and create a new system in the form of an agriculture hub. This hub would allow stakeholders to facilitate and hold up agricultural investment. This could involve providing loans with technical assistance and other forms of support, rather than just loans themselves. This mechanism has proven useful in the United States, Canada and other developed agricultural countries.
Developing countries face many great challenges in agricultural development. Recent studies show that Cambodia’s agriculture still suffers from a lack of physical and virtual agricultural infrastructure, low labour productivity, a lack of technical equipment, high rental costs, high production costs, uncertainty, challenges in accessing financing, and a lack of effective leadership.
Cambodian farmers are in general need of support to reduce production costs, build irrigation infrastructure, prevent pest damage, build farms resilient to climate change, and ensure high yields. Their actual needs also vary depending on the type of crop they produce, the animals they raise and the particular circumstances they face.
The ARDB should compile and categorise customer information into regional groups and business types to make it easier to assist farmers through defined strategies. Cambodia could prepare a team of technical experts from the Ministry of Agriculture, Forestry and Fisheries to collaborate with the ARDB. This team may provide agricultural assistance, practical training and business consultation.
When new customers come to borrow, bank credit officers could provide more detailed information about loan terms and customer support through this agricultural hub framework. Farmers and investors generally understand their financial challenges and the type of support they would need, but until now the support has been mostly absent. The public bank could act as an effective mediator to facilitate the coming together of borrowers and financial supporters. Clients may gain the power to communicate and seek assistance from bank stakeholders — agricultural and finance businesses that are members of the bank and that may be able to provide expertise and assistance to the farmers that need it.
While credit processes and administrative services must be timely, reasonable, reliable and secure, government-owned banks should improve their processes by adopting new technology, including mobile applications, to allow borrowers to fill out loan and savings forms, conduct financial transactions and find information about their loans online.
Failure or success in the agricultural sector depends primarily on markets. A new hub would allow farmers to gain better access to information, as well as find new markets and trading and finance partners.