Impact of ASEAN Economic Community and ASEAN Free Trade Area on Indonesia

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Impact of ASEAN Economic Community and ASEAN Free Trade Area on Indonesia
26 June 2014

By Shafira Nindya Putri

The ASEAN Free Trade Area (AFTA) agreement was signed in 1992 by the regional grouping's six member countries at the time: Brunei, Indonesia, Malaysia, Philippines, Singapore and Thailand. Cambodia, Laos, Myanmar and Vietnam joined the Association of Southeast Asian Nations after 1992 and all four signed the AFTA agreement.

ASEAN member countries are working toward the total elimination of import duties on all products to achieve the ultimate objective of a free trade area. The AFTA Council agreed that the target dates to achieve this objective would be 2010 for the six original ASEAN member countries and 2015 for the newer members.

Elimination of import duties is expected to create an integrated market where there is a free flow of goods within the region. The main implementing mechanism for AFTA is the Common Effective Preferential Tariff (CEPT) agreement. CEPT requires that tariff rates levied on a wide range of products traded within the region be reduced to 0% to 5%. Quantitative restrictions and other non-tariff barriers are to be eliminated. The purpose of AFTA is to help products produced within ASEAN compete in the global market, attract more Foreign Direct Investment to the region, and increase intra-ASEAN trade.

According to Indonesia's Center of State Revenue Policy's Fiscal Policy Agency (Pusat Kebijakan Pendapatan Negara – Badan Kebijakan Fiskal), there are several benefits of AFTA for Indonesia, i.e., greater and wider market opportunity for Indonesian products, lower production costs for Indonesian businesses that require capital goods and raw/auxiliary materials from other ASEAN member countries, more diverse product options in the domestic market for consumers, and greater opportunity to enter into alliances with business actors from other ASEAN member countries.[2] The next step is the establishment of the ASEAN Economic Community (AEC), including AFTA, with the main objectives of creating a single market and production base, a highly competitive economic region of equitable economic development, and a region fully integrated into the global economy by 2015. AEC would transform ASEAN into a region with free movement of goods, services, investment, skilled labor, and capital. A key characteristic of AEC is a single market and production base. Below we describe the more specific impacts of AEC and AFTA on various industries in Indonesia. Trade

  • Export

It is argued that economic integration will largely benefit Indonesia considering the number of multinational companies like Unilever relocating their factories to Indonesia for the reason of cheaper labor costs. Multinational companies like Unilever can export goods to ASEAN countries, which in turn will increase the value of Indonesia's exports.

  • Import

Indonesia, through its Ministry of Finance (MOF), has implemented its AFTA commitment by imposing certain tariff rates on imported goods based on the ASEAN Trade in Goods Agreement (ATIGA). This can be seen in MOF Regulation No. 20B/PMK.011/2012 regarding Determination of Import Duty Tariff in the Context of ATIGA (PMK ATIGA). PMK ATIGA regulates the gradual tariff adjustment from January 1, 2013, until December 31, 2015. Most of the tariffs on the goods are 0%, except for cane or beet sugar and chemically pure sucrose, in solid form. Financial Sector (Banking, Insurance, and Investment) Indonesia's banking sector needs to gear up to compete with banks in other ASEAN countries. AFTA's schedule, which has been accelerated, requires the Indonesian banking sector to step up efforts to compete with other banks in the region. One issue concerns interest rates on loans employed by Singaporean, Malaysian, and Thai banks, which are lower than those of Indonesian banks. With the implementation of AFTA, the Indonesian banking sector will have more responsibility in helping small and medium enterprises. Bank Indonesia, the central bank, has drawn up four main policies to prepare for AFTA, i.e., improving banking system durability, increasing banking intermediation, increasing the role of Shariah banking, and increasing the role of rural banks in providing micro- financing.[3] For the insurance sector, according to Edi Subekti, President Director of PT Asuransi Jasa Indonesia (PT Jasindo) from 2001 to 2008, there are consequences to the implementation of AFTA, i.e.:[4]

  1. An influx of foreign capital and technical skills
  2. Globalization may accelerate product innovation and marketing diversification
  3. The presence of new capital will increase competition in the domestic market and
  4. Globalization will open opportunities for insurance companies to go international.

Antonius Anton Lie, Chairman of the Education Commission of the Indonesian Insurance Council, said one of the consequences of the implementation of AFTA was that more foreign insurance companies, especially from ASEAN countries, would enter Indonesia. If local insurance companies are not ready to compete with these foreign companies, in terms of capitalization, products, marketing, and human resources, they will find themselves pushed to the edges of the industry. The current Insurance Law and its implementing regulations have placed limits on the entrance of foreign insurance companies into the local insurance market by limiting foreign share ownership in Indonesian insurance companies. The participation of Indonesia in AFTA does not require Indonesia to abolish such restrictions on foreign ownership in the local insurance sector. While the entrance of more foreign insurance companies to the local market could have positive impacts in terms of capitalization and technical skills, there is no indication that limits on foreign investment under the Insurance Law and its implementing regulations will be liberalized due to AFTA. In the investment sector, AFTA, as a free-trade system in Southeast Asia, will result in an interdependency and integration of investment and will impact investment and economic management, including in Indonesia, by making trade free of tariff and non-tariff barriers meaning that goods produced by ASEAN countries will be free to enter each ASEAN member country.[5] Foreign investment in Indonesia is regulated and limited under Indonesia's Negative Investment List, or Daftar Negatif Investasi (DNI). A new DNI was issued this year and, according to Mr. Hatta Rajasa, who was Indonesia's Coordinating Minister for Economic Affairs at the time, one of the reasons for revising the DNI was to accommodate ASEAN economic integration to allow the free flow of investment.[6] Agriculture The implementation of AFTA will affect the export and import of Indonesian agricultural commodities. The net export of Indonesian agricultural products has increased since the implementation of AFTA in 2003.[7] It might be advisable for Indonesia to focus on the production and export of rice, corn and soybeans, commodities for which it has the advantage of plentiful land and low production costs. Indonesia was the top rice-producing country in ASEAN from 1990 to 2008.[8] Countries with low production costs may want to specialize in a few products and increase their exports of these products. Countries can import those goods for which high production costs mean it does not make economic sense to produce the goods domestically. Construction and Infrastructure In a report prepared by the ASEAN Constructors Federation (ACF), ASEAN countries in general are seen experiencing robust growth in the construction industry. Indonesia had the largest construction industry among ACF member countries in 2002, valued at US$9.92 billion. The adoption of AFTA benefits the region in terms of better procurement of construction materials, allowing the materials to move through the region more freely than before.[9] The abundance of land outside Java that remains undeveloped makes Indonesia an attractive destination for foreign investment.[10] Further, the need for infrastructure development and cheaper land present a tempting opportunity for foreigners entering the Indonesian construction industry. Expansion of infrastructure, particularly the construction of highways, also provides opportunities to contractors from ACF member countries. In addition, the Indonesian government has worked to open up its market to foreign firms to form joint ventures with local construction firms for such projects. These foreign firms are issued a three-year construction license.[11] With AFTA, the reduction in import duties could facilitate the expansion of the regional steel market,[12] lowering the price of steel products and enhancing the pace of construction projects. Manufacturing While AFTA promotes the liberalization of trade, for Indonesia, which has adhered to its commitments, some manufacturing sectors are expected to face difficulties as a result of AFTA implementation. One of the biggest and most prominent regards the impact on workers. Most manufacturing sectors in Indonesia still use less advanced technology and are labor intensive.[13] This is to say that many manufacturing sectors in Indonesia, particularly textiles and wood products, depend on low-cost labor. The implementation of AFTA will require manufacturers to ensure the sustainability of their businesses by moving away from low-cost labor and improving the quality of their goods or finding some other advantage. This will allow Indonesian products to stand alongside products from other ASEAN countries. Labor In an ILO/ASEAN Joint Study on the Social Implications of AFTA on Labor and Employment, free trade is seen leading to greater efficiency and cheaper products. The idea is that removing trade barriers would bring huge benefits to the people of ASEAN, lead to greater specialization and division of labor as each country concentrates on producing goods and services in which it has a competitive advantage. On the downside, however, the greater levels of competition unleashed by AFTA will lead to the collapse of inefficient companies that have been operating behind protectionist barriers. Therefore, for countries, the key to taking advantage of trade liberalization is very much determined by the competitiveness, or quality, of its labor force.[14] Unfortunately, a low-quality labor force is still a problem for Indonesia. This is reflected by the relative lack of education of Indonesian workers compared to other Asian countries. This will hinder the process of industrial transformation that would otherwise take place at a faster pace due to trade liberalization, because workers are not flexible enough to change jobs and move into more advanced sectors. Indonesia also has a relatively high unemployment rate, which will prevent it from reaping the full benefits of trade liberalization. As the economy opens up, Indonesian workers could find it difficult to compete with workers from neighboring countries.[15] The implementation of AFTA will result in the free flow of skilled labor in the ASEAN region. To facilitate such free flow of skilled labor, ASEAN is working to improve the issuance of visas and employment passes for ASEAN professionals and skilled workers who are engaged in cross-border trade and investment-related activities. Conclusion There are positive and negative impacts from the implementation of AEC and AFTA in Indonesia. While businesses may benefit from the highly competitive market as a venue to expand their production and networks, small enterprises and poorly educated laborers may find it difficult to compete with the free flow of goods, services, and skilled workers. The Indonesian government will play a pivotal role in reconciling this gap. Comprehensive and clear regulations regarding the implementation of AFTA and AEC could help all of Indonesia benefit from an integrated market of high-quality goods, services, and human resources.

[1] From AFTA towards an ASEAN economic community … and beyond ( [2]‎ [3] [4] [5] Dr. Bismar Nasution, SH, MH, Implikasi AFTA Terhadap Kegiatan Investasi Dan Hukum Investasi Indonesia, page 1 [6] [7] Yermia Pehulisa, The Implication of Free Trade on Indonesian Agriculture Products, page 20. [8] Ibid, page 21 [9] Ibid [10] Ibid., page 44 [11] Article 13 paragraph (1), Regulation of Minister of Public Works No. 5 of 2011 regarding Guidance on the Requirements to Grant Foreign Construction Company Representative License [12] Supra note 7, page 53 [13] Sarah Anabarja, Kendala dan Tantangan Indonesia dalam Mengimplementasikan ASEAN Free Trade Area Menuju Terbentuknya ASEAN Economic Community, page 64 [14] Tirta Hidayat and Diah Widarti, ILO/ASEAN Joint Study on: Social Implications of ASEAN Free Trade Agreement (AFTA) on Labour and Employment: The Case of Indonesia, page 59 [15] Ibid

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