Indonesia hasn't been able to capitalise on the trade war as much as its neighbours

Investment by foreign firms into Indonesia is lower than in regional peers, with labour laws seen as part of the problem

An employee works on an engine at the Sunter 1 Plant, an engine manufacturing facility operated by PT Toyota Motor Manufacturing Indonesia (TMMIN), a subsidiary of Toyota Motor Corp., in Jakarta, IndoShow more

In the Central Java province of Indonesia, amid a patchwork of rice fields and farms where sugar and indigo crops once dominated, garment factories are now bustling.

In one cavernous building of the PT Sri Rejeki Isman factory on the outskirts of the city of Solo, thousands of sewing machines hum and clatter as workers stitch clothes for H & M, Guess?, Walmart and others. At a PT Pan Brothers plant just down the road, an assembly line is pumping out thousands of red and white hoodies for Adidas.

Indonesia’s textile industry, which was slowly being overtaken by lower-cost regional neighbours like Vietnam and Bangladesh, is on the cusp of a new boom thanks to the seismic shift in global supply chains caused by the US-China trade war. American buyers are looking for alternatives to Chinese suppliers to bypass higher tariffs, and many of them are turning to locations in Southeast Asia.

Textiles and garments are only one bright spot in a manufacturing sector that’s otherwise been fairly lacklustre. In 2001, Indonesia’s manufacturing sector contributed 29 per cent to GDP — now it’s below 20 per cent. Its share of Asia merchandise exports is 2.3 per cent, compared with about 3.1 per cent for regional peers like Malaysia and Thailand, according to data from the United Nations Conference on Trade and Development.

There are concrete signs that Indonesia isn’t benefitting the way it probably should from the trade war tensions. In a closed-door presentation to President Joko Widodo in September, the World Bank cited research showing that of 33 Chinese companies that announced plans to set up or expand production abroad between June and August, none chose Indonesia. Vietnam was the clear winner, while others like Cambodia, India and Malaysia were also favoured over Indonesia.

As a destination for foreign direct investment, Indonesia struggles against its regional peers. FDI to Indonesia stood at 1.9 per cent of GDP in 2018, well below Vietnam at 6.3 per cent and Thailand at 2.6 per cent, according to the World Bank.

The reasons for the poor performance are well documented: inadequate infrastructure, particularly in transport; rigid labour rules; limits on how much foreigners can invest in several industries; bureaucratic red tape and a habit of backtracking on regulations that makes it tricky to do business in the country.

But while competitors like Vietnam, Thailand and Cambodia face similar problems, they’ve done better than Indonesia over the past few years to attract businesses that were already relocating out of China because of rising wages there.

“Indonesia has done nothing to prepare itself for that shift and the trade war has further exposed Indonesia’s industrial policy as a risk if there is no reform,” said Edward Gustely, managing director of Penida Capital Advisors in Jakarta and an adviser to four presidents and finance ministers.

There’s now a greater sense of urgency from Widodo to fix those problems. He was sworn into office in October for a second five-year term, promising to overhaul labour and investment rules that have hindered job creation and growth in the $1 trillion (Dh3.67tn) economy.

The stakes are high for Jokowi, as the president is known. With the world’s fourth-biggest population and a median age of 30, Indonesia is sitting on a demographic gift or a ticking time bomb.

Indonesia’s massive labour pool — 73 per cent of the nation’s 270 million people are of working age — will be a key source of economic growth for years to come as long as young people entering the labour market have the right skills and can find jobs. Data released last Tuesday showed growth slowed to 5 per cent in the third quarter, while the unemployment rate rose to 5.3 per cent.

“Right now, we are at the peak of the demographic bonus,” Jokowi said in his inauguration speech in October. “This is a big challenge and also a great opportunity. This could be a big problem if we cannot provide jobs, but it will be a big opportunity if we are able to develop superior human resources, supported by an advantageous political and economic ecosystem.”

If Indonesia’s economy continues to grow at its current pace of about 5 per cent, then it will create about 22 million to 25 million jobs over the next 10 years, according to Bambang Brodjonegoro, former planning minister and now minister for research & technology in Jokowi’s new cabinet. But even with that kind of expansion, “with our level of productivity I don’t think we can be, let’s say the next China,” he said. “We cannot be even the next Japan.”

At the top of the list of the president’s reform priorities is the need to tackle a complex and overlapping system of labour rules and conditions that vary from province to province. Businesses also complain about severance pay conditions that are among the most generous in the world, presenting a major hurdle to investment.

Touring the Pan Brothers factory near Solo in early October, Jokowi said textile and garment industries often complain about the labour laws. He’s vowed to now ease some of the rules by as early as the end of the year. And to win over labour unions, he’s compromised by proposing the rule changes apply to new jobs only, thereby protecting rights of existing workers.

Iwan Setiawan Lukminto, president and director of garment maker Sri Rejeki Isman, says the government must work harder to improve Indonesia’s attractiveness as an investment destination, and boosting training and skills in the workforce will be key to that objective. “If they don’t listen then we would be worried. But now they are listening,” Lukminto said. “We have to wait to see what Mr Jokowi does in his second term. This is the priority.”