Selecting strategic industries with high added value, such as electric car batteries, is a necessary first step. This is followed by selecting production stages for developing the industry in Indonesia.
In mid-October, Indonesia was found to have violated World Trade Organization (WTO) regulations regarding its nickel export ban. Indonesia has appealed this ruling. Following the nickel ban, President Joko Widodo also banned bauxite exports, with other mining commodities, tin and copper, soon to follow.
The President's policy is understandable given its multiplied economic value through the downstreaming of domestic industries. For nickel, export revenues have increased nearly 22-fold compared to before the export ban. For bauxite, revenues are expected to more than triple. The same applies to copper, tin, and other raw materials.
Lifting Indonesia out of the middle-income trap, with at least a solid foundation, was the President's promise during his second inauguration. While belated, the aforementioned downstreaming policies deserve praise. Moreover, Indonesia's per capita gross domestic product (GDP) was still one-third of the minimum threshold for developed countries in 2021.
Also read: Processing Industry Boosted, Raw Bauxite Exports Banned Starting June 2023
Keun Lee (2019) emphasized the need for innovation capabilities to become a developed nation. When an industry possesses innovation capabilities, the resulting products will have high added value, thus increasing economic growth. What is Indonesia's industrial strategy?
Innovation capabilities
Most policymakers are obsessed with turning their regions into a second Silicon Valley. According to Dan Breznitz (2021), this obsession is misguided because such policies suboptimally impact a region's economic growth and only benefit residents with specific competencies.
High added value is enjoyed by only a handful of people, but most of the “ship passengers” are less affected.
As an illustration, the bicycle industry, which began in the early 19th century, has yet to see radical innovation. However, it boasts two major global players. Shimano, a transmission system manufacturer, is the dominant global player.
It's hard to find a bicycle with a transmission or other components without Shimano. This is also true for Giant, the Taiwanese bicycle manufacturer with US$2 billion in annual revenue.
A joint project with the government-owned Industrial Technology Research Institute (ITRI) has made Giant a global leader in bicycle frames made from carbon fiber and other advanced materials.
This innovation capability has resulted in American and European bicycle manufacturers becoming less innovative and losing market share, while Chinese and Indian manufacturers have chosen to focus on lower quality (and of course cheaper) bicycles.
The same thing is happening in the smartphone, computer, automotive, and even aircraft industries. It's increasingly rare to find manufacturers working from design to consumer. Globalization is driving fragmented production, with each company focusing on innovating components and/or systems in which they excel.
Fragmentation of production
Increasingly integrated digitalization and transportation facilitate globalization. Specialization is occurring in various parts of the world, with the winners developing superior innovation capabilities at the production stage of a product.
Chris Miller (2022) describes Taiwan's strategic importance in the chip war, which plays a central role in a wide range of high-tech products, from smartphones to electric cars. Taiwan Semiconductor Manufacturing Company (TSMC) supplies nearly 54 percent of the world's chips, focusing on manufacturing chips based on customer designs.
Meanwhile, companies in Silicon Valley, California, or Israel, will focus on developing and designing new chips. This allows them to focus on attracting the right talent to develop the new chips they develop.
TSMC itself is focusing on equipment investment, with an investment value reaching US$36 billion by 2022 alone, and its fabrication process.
This specialization is what makes the company increasingly superior with its innovation capabilities.
Furthermore, economies of scale and scope at the production stage also play a significant role. The existence of contract manufacturing organizations (CMOs), such as Foxconn, which produces all Apple products, is becoming increasingly important.
The ability to mass produce products, but flexibly, depending on the brands that use its services and the support of existing telecommunications industry suppliers in China, makes its role crucial for the world.
William and Victor Fung do the same thing in the global textile and apparel industry. Their clients include Nike, Timberland, Tory Burch, Balenciaga, and even Prada.
Considering that each stage of production requires different innovation capabilities, the ecosystems that need to be built are also different.
Breznitz divides four stages of production that organizations and countries can choose from to develop their innovation capabilities. The choice will depend on each region's strengths and resources and the advantages it will build upon.
First, novelty becomes the obsession of entrepreneurs, company leaders, and policymakers around the world. This stage transforms new inventions into useful innovations.
This stage made Silicon Valley legendary, with venture capital support for the development of new technologies and industries. Naturally, a talent supply was essential, and this was met by the world's top universities in California and the surrounding areas.
If not found locally, digitalization facilitates the integration of talent from diverse global backgrounds. This is why the economic impact of this phase on a region is less significant than initially hoped.
Second, companies that have a good idea, but are hesitant to go straight into production, can utilize the services of design, prototype development, and production engineering companies.
In the telecommunications industry, the dominance of Taiwanese companies at this stage has made Silicon Valley, Tel Aviv, and others heavily dependent on them. This stage enables Taiwan to provide high-paying jobs with a wide range of skills in demand.
Breznitz divides four stages of production that can be chosen by both organizations and countries in developing their innovation capabilities.
Third, second-generation product and component innovation. This stage produces incremental innovation by combining and expanding the functionality of existing products. All major global automakers are currently at this stage, including Shimano and Giant, as mentioned above.
Fourth, production and assembly are stages of combining hundreds or even thousands of components into a product that will be consumed.
Naturally, the components come from various parts of the world due to the fragmented production mentioned above. This stage is also linked to a system capable of dynamically changing product specifications according to market needs.
China's Guangdong Province is renowned for its diverse range of unbranded product manufacturers. Their years of expertise in producing millions, even billions, of products, modifying them, and even discontinuing them at short notice, have made them a global leader.
This is what Foxconn, or William and Victor Fung, does. Hundreds of products from diverse brands around the world utilize their best expertise.
Although rarely covered by the media, innovation at this stage creates jobs for millions of people and more equitable economic growth than startups like Silicon Valley or highly competent talent in Taiwan.
Recommendation
Competing with other countries in industrial sectors that rely on low costs (especially human resources/HR) or the exploitation of raw materials is not the right choice to escape the middle-income country trap.
Selecting a strategic industry with high added value, such as electric car batteries, is a necessary first step. This is followed by selecting the production stages mentioned above to build the industry in Indonesia. Breznitz's study shows that most regions focus on one of the above stages, but rarely does a combination of two or more succeed.
The most important thing is how the chosen industry and production stage have a unique position and value so that it has high added value.
This selection will also serve as a basis for determining the capabilities and innovation ecosystem to be developed in Indonesia. The President emphasized the importance of managing the ecosystem for the electric car battery industry and other strategic industries that Indonesia plans to develop.
Also read: The Electric Vehicle Ecosystem Needs to be Built Holistically
It's important to follow up on this directive by identifying each player in the industrial ecosystem to be developed. In the context of the electric car battery industry, the involvement of the central and regional governments as regulators is certainly necessary, particularly regarding the incentives that will be provided.
Also investors who will carry out downstreaming, financing institutions (banking), BUMNs that will be involved, universities that educate ready-to-use human resources (both vocational and academic), the community where the industry operates, and other parties who contribute to this industry.
By identifying resources, roles, added value, and what each party will gain (ecosystem pie model, Talmar et al., 2020), the electric car battery industry ecosystem, or other strategic industries, will operate. As a result, the total linkage effect generated by the industrial ecosystem will be able to become a new driving force for Indonesia's economic growth.
Badri Munir Sukoco, Professor of Strategic Management, Faculty of Economics and Business, Director of the Graduate School Universitas Airlangga
https://www.kompas.id/baca/opini/2023/01/18/strategi-industri-indonesia