The Impact of US Foreign Direct Investment in Indonesia: Status and Future Challenges - Coursework Example

The impact of US Foreign Direct Investment in Indonesia: Status and Future Challenges Contents Contents 2 The of economy of Indonesia 3 US FDI Investments in Indonesia; current status 4 Effects of USA FDI in Indonesia 8 Positive effects of USA FDI Indonesia 8 Trade effects 8 Human capital input 9 Spillover effects 9 Increase in Competition level 10 New Management and Governance Methods 10 References 13 Introduction Foreign Direct investments are investments that a company or a country makes in another country, by either setting up a subsidiary in the foreign company or by acquiring shares of an overseas firm (Dannin & Narula, 2003). It can also be done through mergers and joint ventures. US companies have expanded their operations in Indonesia as a way of increasing their customer base, and taking the advantages that emerging markets have like Indonesia. FDI results to rapid economic growth, and helps the host country to alleviate problems like; poverty, unemployment, as well as income inequalities. The paper presents the status, the effects and the future challenges of US FDI in Indonesia, as well as how to mitigate the challenges. It has been divided in several sections that address the current state of affairs with regards to US FDI to Indonesia, the reasons why US companies invest in the country, the socio-economic and political effects of the FDIs, as well as the challenges that foreign companies experience in the country. Section one gives a brief overview of the Indonesia economy, and forms the basis of this discussion. The state of economy of Indonesia Indonesian economy is the largest in Southeast Asia, and is among the emerging economies across the region. The nation is a member of the G-20 economies, and is classified as a newly industrialized economy. The government plays a very important role in the economy, meaning that it is not purely capitalistic. The government does this by controlling ownership of the major enterprises in the country. More than 141 enterprises are said to be owned by the government, and it is the role of the government to determine process of basic goods such as electricity, rice, as well as fuel (Froot, 2008). After the economy crisis of 1997, the government acquired several private enterprises through debt restituting and acquisition of nonperforming bank loans. Since 1999, the economy has recovered from recession, and grows an average rate of more than 5% per annum (Froot, 2008). The country regained its investment grade rating in late 2011, after it had lost it in 1997 when Asia was hit by financial crisis. The crisis forced Indonesia to spend more than $50 million to bail out bank lenders (Lipsey et al 2008). By 2012, the economy had fully recovered attracting investments from all parts of the world. US companies have ventured in Indonesia for various reasons, and brought various benefits, as it will be discussed in the following sections. US FDI Investments in Indonesia; current status The history of USA foreign direct investment in Indonesia started in 1924 when geologists from Chevron were exploring the jungle of Sumatra. The explorers came across the Duri field, one of the largest oil fields in the country, which ushered in a positive relationship with the United States. Today, American brands are familiar in Indonesia. In consumer goods industry, Procter and Gamble, and Johnson & Johnson have been well positioned. 3M, a manufacturer of diversified products, and Energizer, an energy manufacturing company, own owns a large market share in their respective industries. US firms operating in Indonesia have helped the country record enormous growth in oil and gas industries because of their large investments in the country (Salidijanova, 2011). Though the United States retains its traditional focus on FDI in developed countries, mainly in Western Europe, there has been a notable rise in USA FDI investments in Indonesia in the recent past. While USA investments in the advanced nations of Western Europe is generally found in the monetary sector and done through holding corporations, in developing Asian economies, the USA focuses on the manufacturing sectors due to lower production costs. It has been identified that in Asia, labor costs are cheaper compared to that of developed economies. This explains why some of the manufacturing companies have shifted their operations in Indonesia. However, such corporations retain branches in their home country. In the past two years, the US appeared as the second-biggest investor in Indonesia after Japan (Javorcik et al, 2011). Furthermore, there is a remarkable growth visible in the distributional patterns of USA operations in Indonesia. Hitherto, it had been greatly concentrated on Indonesias mining sector (such as Exxon, Freeport, and Newmont,). Lately, however, the direct investments have been more and more focused on other sectors of the economy such as the automobiles or food industry, and the financial sector. It is worth to note that through these foreign investments, the USA does not just think of Indonesia as a low-priced production hub, but then also as a consumer market for her goods and services. This further explains why corporations from the USA have expanded their base into the country. Indonesia is growing middle class and has a rising per capita GDP, and this has made the nation a stimulating and growing marketplace for US companies (Ito, 2013). According to the Indonesia Investment Coordinating Board (BKPM), total FDI in the country grew 16.4 % in the second quarter of 2014 to USD $10.0 billion, which is the highest quarterly investment in the country, and thus shown that Indonesia’s elections in 2014 were no motive to postpone foreign direct investments (Salebu et al 2014). Foreign direct investment (FDI) totaled USD $6.7 billion, whereas domestic direct investment (DDI) was USD $3.3 billion (Salebu et al, 2014). This indicates that there is more foreign investment in the nation than the domestic investment, where most of the FDI is coming from US based companies. This is healthy for the economy as it has several benefits, discussed in the following sections. According to Mahindra Siregar, Chairman of the BKPM, this growth of investment in 2014, was upheld during the election period to a point of reaching at its maximum. This condition indicates the level of confidence to Indonesia’s economic and political solidity. Indonesia is said to have stable political economy as compared to most Asian countries (Davies, 2014). This could further explain why USA firms invest in the country. Political stability is one of the factors that influence economic growth, and FDI in a country. Most developing economies are not politically stable, and due to this, investors are not free to invest in such nations. The fact that Indonesia held peaceful elections states why USA firms will continue investing in the country. USA-Indonesia Trade/investment Initiatives The USA is dedicated to increasing trade and FDI relations with Indonesia through the U.S.-Indonesia Inclusive Trust and has seen measurable growth in the past year. Mutual goods trade raised to $23.4 billion in 2010, and within the first six months of 2011 U.S. merchandises exports to Indonesia grew by 17 percent per year while importations from Indonesia expanded by 22 percent (Min & Djamli, 2012). Indonesia remains to be a topmost recipient of U.S. trade inclinations prolonged under the Comprehensive Scheme of Inclinations, with $1.9 billion value of goods inflowing the U.S. economy duty free under the scheme in 2010. The relationship is also gaining momentum: in 2009, U.S. FDI stock in Indonesia extended to $16 billion and Indonesian Foreign Direct Investment in the US grew to 175 percent from 2008, with a total of $256 million (Min & Djamli, 2012). The following are some of the initiatives developed by the two nations to facilitate trade and investments: U.S. Exports and Savings in Indonesia: The United States is the main provider of airplane and rail transportation apparatus and much equipment to advance Indonesia’s energy segment. United States agronomic exports to Indonesia exceeded $3 billion in 2011, which was 53 percent more than that of 2010. U.S.A firms have specified their intent to open or reopen manufacturing plants in Indonesia with a joint investment of more than $450 million (Chaudhuri & Mukhopadhyay, 2014). U.S.-Indonesia Trade and Asset Negotiation: The United States of America and Indonesia occasionally address trade and investment matters over the Indonesia- U.S Trade and Investment Framework Agreement (TIFA), and discuss issues like market access limits in vital sectors like agricultural products, energy and pharmaceuticals, Private enterprise Support: The United States confirmed its obligation to indorsing free enterprise in Indonesia through a Global Private enterprise competition comprising of 32 Indonesian small enterprises and 11 prominent U.S. industrialists and stockholders, as well as funding for the ASEAN Provincial Private enterprise Conference, in July 2011, at which Secretary Clinton conveyed annotations (Chaudhuri & Mukhopadhyay, 2014). U.S. Funding for Energy Investment in Indonesia: The U.S.-Indonesia Discourse reinforced several measures in 2011 to encourage growth and asset financing in Indonesia’s energy sector, such as the USTDA geothermal power expansion exercise in six sites in Indonesia emphasizing on clear and fair tendering processes. In May 2011, the U.S. Division of Energy held the U.S.-Indonesia Energy Venture Forum that provided a location for high-ranking officials from both nations and the private sector to discourse zones of opportunity and development in energy venture. OPIC Trade and Venture Meeting: In May 2011, Over 300 contributors in lieu of 22 republics and more than 100 U.S.A corporations went to the Overseas Private Investment Corporation (OPIC) global investment meeting in Jakarta. OPIC decided to deliver long-term funding for a $21 million development plan to build and run a state-of-the-art rice grinding plant in East Java province that will sustain more than 50,000 agribusiness families in the province (Arnold & Hussinger 2013). U.S. Funding to PT Kereta Api: The U.S Trade and Growth Agency extended a technical assistance endowment valued at $593,000 to PT Kereta Api (PT KAI), the state held railway firm, to advance a deliberate plan to improve the PT KAI signaling and broadcastings network the end of 2011 (Singh & Mora, 2012). Effects of USA FDI in Indonesia Having identified that the US and Indonesia has very close business ties, this section discusses the socio-economic, and political impacts of USA FDI in the host country. Indonesia has benefited a lot from the USA, and so does the US. This means that both countries benefit from one another as a result of foreign direct investment in Indonesia. When a country welcomes foreign investors, there are various indicative factors that can help measure the impact of the foreign investors in the host nation. Such indicators include, the quality of life, increase in GDP per capita, infrastructural development, political landscape, people’s welfare, balance of trade, the exchange rate as well as inflation, just to mention a few. It is worth noting that the effects may be positive or negative. Negative effects of FDI include, suppressing infant local firms, political dominance, as well as increased prices of goods. Positive effects of USA FDI Indonesia Trade effects US FDI in Indonesia continues to influence economic growth by raising total factor production and the effectiveness of resource use in oil and gas industries. It raises the capital stock of the host country and thus increases the output levels. The central trade-related advantage of FDI in Indonesia is that it contributes to the incorporation of Indonesia into the global economy by creating and increasing foreign trade flows as well as the formation of transcontinental distribution networks. This, in turn, suggests that Indonesia will follow a strategy of openness to international trade to benefit from FDI. The government of Indonesia has already started to appreciate the fact that liberal economies are better than economies that are strictly controlled by the government (Chandran & Tang, 2013). Human capital input US FDI’s influence on human capital in Indonesia is significant. US companies have increased workplaces in Indonesia, thereby reducing the unemployment in the host nation. They typically provide greater wages and better working situations due to their higher efficiency, which is expounded by greater technical know-how and modern administration of skills that permits them to compete efficiently in overseas markets. The transferal of technical and administrative know-how through partners also gives rise to direct paybacks and raises attractiveness in Indonesia. For example, local employees can move from overseas to domestic organizations. Domestic organizations might surge their efficiency through learning from overseas firms by partnership. The presence of foreign firms have forced the Indonesian government to invest more in education, as the demand for accomplished labor by these corporations is very high (Chandran & Tang, 2013). Spillover effects US Companies operating in Indonesia like Procter and Gamble usually own a sophisticated level of technology, which is the key aspect of their higher efficiency. One of the encouraging effects of USA FDI is that it creates significant hi-tech spillovers in Indonesia. Foreign corporations usually offer technical assistance, training to intensify the superiority of the suppliers’ products. A good example is the summits that are organized by the two countries where people go to the USA and acquire scientific know-hows. However, domestic firms might surge their efficiency as a result of acquiring access to current, upgraded, or low-priced intermediate inputs from multinationals. Sales of these inputs by foreign firms might be accompanied by provision of promotional services which might not be accessible through imports. Domestic sub-contractors can also profit from foreign firm’s international links, thus achieving more access to overseas markets. USA FDI can also raise exploration and expansion initiatives of local firms (Vu & Im 2013). Increase in Competition level USA FDI in Indonesia exerts a noteworthy effect on the competition level in the country. The presence of multinationals assists the economic growth by motivating the internal competition and thus leading to advanced productivity, invention, lower prices and more effective resource allocation. The oil and gas industry has seen enormous growth as a result of US companies’ operations in the country. New Management and Governance Methods USA FDI through acquisition of local firms such as PT Kereta Api has resulted in the changes in management and commercial governance. The US firms generally impose their own corporation policies, internal reporting schemes and values of information release. This effect expands the business situation and progresses the commercial efficiency. Furthermore, different cases show that USA FDI also creates a fair and justice environment in the country and corruption is said to have reduced by a very great percentage. US multinationals encourage fair government policies, raise corporate transparency as well as assisting in fighting corruption which had taken root in the nation (Soltanpanah & Karimi, 2013). Negative effects of US FDI in Indonesia Despite the above benefits, it can be noted that US FDI in Indonesia has several negative effects such as; crowding effects. Some of the multinationals investing in the energy sector are said to slowly gain monopoly power in the state. Domestic firms have disappeared as a result of higher efficiency and better product quality offered by multinationals. Other negative effects include, negative wage spillovers, profit repatriation, where the US companies send back large sums of money to their economies, as well as dual economy effect, which has made Indonesia to have two economies, a developed economy in the energy sector dominated by US multinationals and the underdeveloped informal sector owned by local firms (Soltanpanah & Karimi, 2013). Future challenges of US FDI in Indonesia Though US FDI in Indonesia is booming, there are several challenges that the US firms might encounter in the future. Such challenges stems from the fact that Indonesia has a new administration, which might come with new policies and regulations. Current economic data highpoint the challenges awaiting the new administration: slowing economic growth, broadening current account deficit, and burdens on the state budget. The nation’s current account deficit extended to 4.3 percent of GDP in the second quarter of this current year (Bayer, 2014). Recurring factors regularly surge the current account shortfall in the second quarter of every year. But the significant rise in the deficit came regardless of general cooling of the Indonesian economy. GDP grew by 5.1 percent in this year to the second quarter, which is the lowest rate since 2009 (Bayer, 2014). The administration’s ban on the shipment of unprocessed minerals, which was applied in January, has not helped to address the current account deficit. This may be a result of the determinedly large trade deficit in the energy sector, which is aggravated by fuel price subventions. Oil imports have unrelentingly risen regardless of some alteration of fuel price aids in July 2013. The swelling fuel funding bill, combined with declining tax rate means the new management will also inherit a more thought-provoking fiscal atmosphere. The new President should ensure the budget deficit does not surpass the legitimate limit of 3 percent of GDP. That makes fuel funding reduction an emergency, as is improving government income - without which the new administration will not be able to fund his assured growth and growth programs. Conclusion The research paper highlights the current situation of USA FDI in Indonesia, where it has cited that US firms continues to invest in Indonesia due to several incentives that are being offered by the two partners. Indonesia has been cited as an emerging market, which is also low-cost production hub. Due to increase in FDI in Indonesia, the country has benefited a lot, and among the highlighted benefits are, spillover effects, improved ways of production, improved quality of life, as well as better management. However, the paper cites economic challenges that foreign companies will have to undergo, as they struggle to come to terms with the new administration. Several economic reforms are intended to take place as from 2015, and this may affect foreign companies in one way or another. References Arnold, J. M., & Hussinger, K. (2013). Exports versus FDI in German manufacturing: firm performance and participation in international markets. Review of International Economics, 18(4), 595-606. Beyer, H. M. (2014). Compulsory licensing in the TRIPS agreement: a study of long-run effects on innovation and foreign direct investments. Chaudhuri, S., & Mukhopadhyay, U. (2014). Role of FDI in Developing Countries: Basic Concepts and Facts. In Foreign Direct Investment in Developing Countries (pp. 1-17). Springer India. Chandran, V. G. R., & Tang, C. F. (2013). The impacts of transport energy consumption, foreign direct investment and income on CO< sub> 2 emissions in ASEAN-5 economies. Renewable and Sustainable Energy Reviews, 24, 445-453. Davies, K. (2014). Inward FDI in China and its policy context, 2012. Dunning, J., & Narula, R. (2003). Foreign direct investment and governments: catalysts for economic restructuring. Routledge. Froot, K. A. (Ed.). (2008). Foreign direct investment. University of Chicago Press. Javorcik, B. S., Özden, Ç., Spatareanu, M., & Neagu, C. (2011). Migrant networks and foreign direct investment. Journal of Development Economics, 94(2), 231-241. Ito, T. (2013). Export‐Platform Foreign Direct Economic Studies, 47(1), 35-63. Salidjanova, N. (2011). Going out: An overview Investment: Theory and Evidence. The World Economy, 36(5), 563-581. Lipsey, R. E., & Sjöholm, F. (2011). Foreign direct investment and growth in East Asia: Lessons for Indonesia. Bulletin of Indonesian of Chinas outward foreign direct investment. US-China Economic and Security Review Commission. Min, N. H., & Djamli, A. (2012). Analysis Of Factors That Influence On South Korean FDI Fluctuation And Realization in Indonesia (Doctoral dissertation, Universitas Gadjah Mada). Salebu, J. B., & Otsuji, Y. (2014). Foreign Direct Investment and Economic Growth: An Analysis With Granger Causality Panel Data Approach in Indonesia Period 1994–2010 (Doctoral dissertation, Universitas Gadjah Mada). Singh, N., & Mora, J. (2012). Trade productivity upgrading, trade fragmentation, and FDI in manufacturing: The Asian development experience. Soltanpanah, H., & Karimi, M. S. (2013). Accumulation of human capital and foreign direct investment (FDI) inflows in ASEAN-3 countries (Malaysia, Thailand, Indonesia). African Journal of Business Management, 7(17), 1599-1605. Vu, T. B., & Im, E. I. (2013). Impacts of FDI Relations between the US and East Asia on Economic Growth. Asia Pacific Journal of Social Sciences, 5(1), 18-30. Read More