The Role of Foreign Final Demand on
Indonesia’s Economy: A Global Value Chain
Perspective
Master Thesis
University of Groningen, Faculty of Economics and Business July 2013
Author:
Aditya Paramita Alhayat s2157802
i Abstract
This paper aims to study the role of foreign final demand, especially in advanced and developing economies, in generating Indonesia’s value added and employment. The methodology used in the analysis follows the global value chain framework of Timmer et al. (2012a), which has been previously introduced by Johnson and Noguera (2012). Through this method we are able to calculate value added, which gives more precise picture on international trade flows than traditional measure of gross export. Additionally, we examine Indonesia’s income and jobs induced by foreign final demands in a relatively longer period of 1995-2009 using the World Input-Output Table provided by the WIOD project.
ii Contents
I. Introduction ... 1
II. Context of the Study ... 3
II.1. Global Production Fragmentation, Trade Statistics, and Value Added... 3
II.2. Overview of Indonesia’s Exports Performance and Structure ... 5
III. Research Methodology... 8
III.1. Introducing Input-Output Table and World Input-Output Table ... 8
III.2. Accounting Framework for Value Added ... 11
III.3. Calculating Value Added Exports: A Simple Example ... 14
IV. Empirical Results and Discussions... 16
IV.1. Impact of Foreign Demand on Indonesian Income and Employment ... 16
IV.2. The Dominant Export Markets and Sectors for Indonesia’s Economy ... 20
IV.3. Factor Contents on Indonesia’s Value Added Export... 22
V. Concluding Remarks ... 24
References ... 25
Appendix ... 28
1. Share of Indonesia’s Value Added Exports by Particular Markets for Final Goods ... 28
2. Sectoral Contribution for Indonesia’s Incomes by Markets for Final Goods (% of GDP) ... 28
3. Share of Indonesia’s Value Added Exports by Sectors and Markets for Final Goods ... 28
4. Compensation for Factor Inputs in Indonesia by Markets for Final Goods (% of GDP) ... 29
1 I. Introduction
Indonesia’s export performance has suffered from the global economic recession 2008. International trade data from the Indonesian Statistics (BPS) shows that the level of Indonesia’s merchandise exports to the world in 2009 declined by 14.9% compared to those in 2008. Indeed, the latest decline is more severe than the previous Asian crisis in 1998, in which export declined by only 8.6%. In addition, the configuration on the Indonesia’s export destination apparently tends to shift from developed economies to developing ones since the global recession. Share of Indonesia’s exports to developed countries toward its total exports to the world in 1996 reached 81.0%, and it slightly declined to 70.1% in 2005. This share significantly dropped after the global economic recession in 2008 and accounted for 57.8% in 2012. On the contrary, the share of Indonesia’s exports to developing economies has increased, particularly to the emerging markets such as China, India, and Brazil.
Based on the international trade statistics above, we would easily conclude that the developed economies are losing much of their relative importance to Indonesia’s economy during the last decades, particularly after the global economic turmoil. Nevertheless, recent studies1 have criticized
the flawed measure of international trade statistics under the so-called global value chain2. In this
perspective, the relation between an exporting country and an importing country is represented not only by the direct trade flows but also by the indirect trade flows. This is caused by the fact that the process of goods production is no longer entirely completed by one company in a single country, but it is now conducted by many companies in various countries. However, the international trade statistics only capture the direct effect between two trading partners without distinguishing the trade flows into intermediate goods or final goods. This would undermine the importance of the third country in which the underlying export product will be finally consumed. Therefore, this standpoint would argue that the decline of Indonesia’s exports to developed economies in terms of conventional trade statistics might not necessarily represent the real decline of those economies contributing to Indonesia’s economy. In addition, the developed countries might still be the main end-buyers (final demand) for Indonesia’s export products.
As an illustration, suppose that Indonesia produces natural rubber and exports it to China. The material is then to be transformed into soles of rubber and used for producing footwear. Afterwards, the footwear is not only sold domestically but also exported to the United States (US). In this example, Indonesia has a direct trade relationship with China and has an indirect trade
1 Many researchers have criticized the measurement of international (gross) trade statistics and put it as the background of their studies, among others are Daudin, Rifflart, and Schweisguth (2009), Pula and Peltonen (2009), Maurer and Degain (2010), Koopman, Wang, and Wei (2012), Johnson and Noguera (2012), and Armstrong and Burt (2012).
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relationship with the US. However, international trade statistics only portray the trade relationship between Indonesia and China or between China and the US. If the amount of footwear exported to the US is higher than those sold in China’s market, the ultimate demand of Indonesian rubber is much driven by the consumer in the US. As the purchasing power of the US consumers is reduced (due to, for example, the economic recession), the imported footwear with soles of rubber from China also declines. Subsequently, it reduces the demand on Indonesian natural rubber.
Another drawback of the international trade statistics is the double counting problem. Taking the previous footwear case as an example, the total trade value of footwear with soles of rubber consumed in the US is the summation of the value of rubber shipped from Indonesia to China and rubber soled footwear shipped from China to the US. The double counting appears as the flow of footwear from China to the US also contains the imported rubber from Indonesia. On the contrary, the measurement of trade flows based on value chain approach avoids the double counting problem, because it only accounts for the value that has been added by each country involved in the global chain of production (value added of trade). The total value added constitutes the value for producing rubber in Indonesia and value for fabricating rubber soled footwear in China in order to fulfill the footwear demand in the US. Consequently, it generates incomes for capital and labor on each production activity in both countries.
This paper aims to analyze the role of foreign final demand toward Indonesia’s economy within the global value chain perspective. By modeling trade in the global input-output linkages, we expect to have more precise figures of the effect of ultimate demand in advanced and developing countries on Indonesia’s incomes and employment. Diversifying market destination becomes a growing issue for policy makers in response to the recent global economic crisis, especially promoting export to developing countries, which are perceived to have strong economic growth.
Therefore, the proposed research question is “To what extent do the final demands in advanced and
developing economies generate value added and employment for Indonesia’s economy during 1995-2009?”
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The rest of this paper is organized as follows. Section II provides critical discussion on Indonesia’s exports in the context of global production fragmentation. Section III introduces the research methodology, particularly on the accounting framework of value added. To provide clear illustration, we introduce the basic outline of the International Input Output Table and provide technical procedures for calculating value added through a hypothetical example. The empirical results are analyzed in Section IV, and Section V concludes our paper.
II. Context of the Study
This section essentially links the development of Indonesia’s exports to the new nature of international global trade. The presence of global production fragmentation may lead to a misleading analysis on a country’s exports if it relies solely on the traditional trade measure. Therefore, the first sub-section discusses the issue of global production fragmentation as well as its consequences to the trade measure. For instance, the drawbacks of international trade statistics will be highlighted as well as the proposed measure of value added and its basic concept. The second sub-section reviews the performance and structure of Indonesia’s exports in previous decades and provides the notion of trade flows when the global production fragmentation took place.
II.1. Global Production Fragmentation, Trade Statistics, and Value Added
The evolving structure of current global trade is characterized by the diffusion of key players in global trade, increasing trade interconnection, growing role of global supply chains, and diffusion of high-technology exporters (Riad et al., 2012). Slicing up global production stages, which allows for specializing in specific tasks along the global production chains, is one of the important new natures of international trade (Hummels, Ishii, and Yi, 2001). The specialization of activities in which countries have the highest competitive level is needed to reap the benefit of globalization since the international competition is likely to occur between workers performing the same tasks in different nations (trade in tasks) rather than competition among factories/sectors in different nations (trade in goods) (Baldwin, 2006). Therefore, one can argue that country’s competitiveness should be based on activities in global production in generating incomes and jobs, rather than relying solely on a country’s share in world exports (Timmer et al., 2012b).
The emerging global production fragmentation3 brings an important consequence as international
trade statistics may provide misleading pictures on the importance of trade to economic growth. Conventional trade statistics calculate the value of gross trade when the physical goods pass through a country’s border (Maurer and Degain, 2010). If the transformations of inputs require a production process which involves many countries, then the trade flows are calculated multiple times (double counting), and it is likely to be inflated. This is due to the fact that the increasing global value chain leads countries to export significant intermediate goods. In addition, the existence of the global supply chain blurs the concept “country of origin” because products are no longer made in a certain country, but rather they are made in the world (WTO and IDE-JETRO, 2011). Custom authorities consider “country of origin” as the last processing country irrespective of
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its relative position within the global value chain (WTO and Commission des Finances du Sénat, 2011). Hence, conventional trade statistics distort the picture of the real trade partner where the product is produced. Moreover, the grouping of transactions on the traded goods causes the conventional measure to misrepresent the relative importance of some sectors in international trade (Armstrong and Burt, 2012). This is because the processing of goods also involves service sectors (non-tradable goods) which can be the most dominant production factor in the underlying countries.
The limitations on gross statistics become a point of departure for many parties (particularly researchers) to construct a new measure that represents the latest international trade developments. The trade measurement based on value added solves the double counting problem embedded on the gross trade statistics. This approach only estimates the value that is added by each country (and industry) within stages of an international production process. The imported inputs (completed in the previous stages of production by other countries) used in producing goods for export by the underlying country are not counted. In this circumstance, the value added could be seen as a compensation for the production factors (labor and capital). It implies that the consumption of goods in importing country does not only induce income but also generates employment in exporting country where the production takes place. These linkages are illustrated below.
Figure 1. Global Value Chain: Relations between Expenditure, Production, and Income
Source: Adapted from Timmer et al. (2012a)
In the fragmented global production, the flows of products and services can be presented as arrows in Figure 1. The demand of consumption goods in the United States stimulates either domestic production (US) or foreign production (Indonesia and China). In this case, the US could directly import final goods from Indonesia and China, or it can import intermediate products to be processed domestically. Hence, the flows of international trade do not only occur in the final products but also in the intermediate products. The highly fragmented production would lead more countries to participate in the value chain as well as increase trade in intermediate inputs. Because the production activities (tasks) are now fragmented across countries, the utilization of capital and labor will create value added at each stage of production in the respective countries. One can also
Consumption Production Capital and Labor
Consumption Production Capital and Labor
Consumption Production Capital and Labor
EXPENDITURE PRODUCTION INCOME
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read the opposite direction of arrows in Figure 1 as flows of payments. For instance, consumer’s expenditure on the final goods in Indonesia will generate compensations for the capital owners and labors, which involve in domestic production and/or production abroad. It also allows for indirect trade (no arrows of final and intermediate products) between Indonesia and China through the third country (the US) as a hub.
II.2. Overview of Indonesia’s Exports Performance and Structure
In the last two decades, Indonesia has experienced two economic crises, i.e. Asian Financial Crisis (AFC) 1997/98 and Global Economic Recession (GER) 2008. Each crisis has a different impact upon the performance of Indonesia’s economy and trade. The former caused severe damage for Indonesia’s economic structure because it attacked the macroeconomic fundamentals (collapsing banking sector, massive currency depreciation, and capital flight), and it was followed by the domestic political instability during the end of Suharto's presidency (Hill, 2012). The decelerating export performance during this period was caused by the supply-side, especially on trade financing, rather than the demand-side (Aswicahyono and Pangestu, 2000). The macroeconomic management in the last crisis was fairly good (Hill, 2012), but the impact was obviously visible in the trade along with the weakening of global demand (Basri and Rahardja, 2010). During AFC, exports were influential to sustain the structure of Indonesia’s economy indicated by moderate ratio of exports of goods and services to GDP of 53% in 1998, whereas the ratio of merchandise exports to GDP reached 51.2% (World Development Indicators). Using the same data source, the export-to-GDP ratio on goods and services during GER was only 24.2% in 2009 while the export-to-GDP ratio on merchandise amounted to 21.6%. Those ratios reaffirm the relative importance of the export sector during the Asian Financial Crisis rather than during the recent Global Economic Recession.
According to traditional export indicator, Indonesia's total exports to the world during 1990-2004 expanded steadily at 6.4% per year (Figure 2). Afterwards, the Indonesia’s export performance increased sharply by 12.5% per year during 2005-2012. During the last two decades, there are several export dynamics that should be considered, particularly related to the external environments. An upward export in 2000 was driven by the sluggish demand response to the enormous exchange rate depreciation4 in 1998 (Athukorala, 2006). However, in the subsequent
years of 2001 and 2002, Indonesia’s export performance were depressed because of the impact of September 11 attacks, which caused weak global demands (Soesastro and Basri, 2005). The significant exports’ surge, occurred from 2005 until shortly before GER, was supported by the high commodity prices in the international market. More specifically, Indonesia—as one of the world largest producers of crude palm oil—was really helped by the rising price of palm oil in 2007 due to high demand for the biodiesel industry in Europe and demand of household cooking oil in China and India (Basri and Patunru, 2012). In addition, decelerating production in Malaysia, as Indonesia’s major competitor, also inclined palm oil prices at the global level. After a drop of 14.9% in 2009 as a consequence of global crisis, Indonesia’s exports in 2010 regained a high momentum of growth.
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Figure 2. Indonesia’s Merchandise Exports, 1990-2012 (US$ Billion)
Source: Indonesian Statistics (BPS) supplied by Center for Trade Data and Information, Ministry of Trade
Looking at the composition of exports, the role of non-oil sector is considerably important for Indonesia. After the end of oil boom in 1982, Indonesia attempted to diversify exports of non-oil and gas products by implementing an outward-oriented strategy (Wie, 2000). As a result, the dependency on oil and gas revenues declined from 43.1% in 1990 to 23.1% in 2000 and shrank further to 17.8% in 2010 (Indonesian Statistics). In fact, Indonesia has become a net oil importer since 2004 and officially deferred from the membership of Organization of the Petroleum Exporting Countries (OPEC) in September 2008 (Pallone, 2009). On the other hand, the manufacturing sector has become the backbone for generating revenues in non-oil and gas sector. In 2010, the share of manufacturing products to non-oil and gas exports reached 75.5%, whereas share of this sector to total exports in the same year amounted to 62.1%. As can be seen in Figure 2, the exports decline in 2009 mainly occurred in manufacturing sector.
The role of developing countries as Indonesia’s export destinations is apparent after the global economic recession 2008. Share of exports to developing countries in Indonesia’s total exports to the world in 2009 reached 39.2% and continued to increase to 42.2% in 2012. Brenton and Ikezuki (2003) also found the importance of developing countries as Indonesia's export destinations (Soesastro and Basri, 2005). They noted that the share of manufacturing Indonesia exports to non-OECD experienced a significant increase from 41% in 1990 to 80% in 2001 and accompanied by competitiveness improvement in these markets.
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growth of 4.5% per year during 2009-20125 (World Development Indicators). Share of Indonesia’s
exports to BRICMT has increased from 6.1% in 1996 to 20.3% in 2012 (Figure 3). Of the six major emerging economies, the contribution of the Chinese market is the most dominant. China’s entry to the WTO membership in 2001 has a substantial impact of Indonesia's exports in 2003. The share of Indonesia’s exports to China almost doubled from 3.9% (2001) to 6.2% (2003). The trade relationship between Indonesia and China has grown substantially after the full implementation of the ASEAN-China Free Trade Agreement (ACFTA) in 1 January 2010; started with the implementation of Early Harvest Program6 in 2004 (Nugraha, 2010).
Figure 3. Share of Indonesia’s Exports by Country Group Destination, 1996-2012
Source: Author’s calculation based on Indonesian Statistics (BPS) supplied by Center for Trade Data and Information, Ministry of Trade.
Notes: We define advanced economies according to IMF classification7 and put the rest as developing economies.
BRICMT stands for Brazil, Russia, India, China, Mexico, and Turkey while G7 comprises the US, Canada, Germany, France, Italy, United Kingdom and Japan.
However, it needs to be underlined that the developments of Indonesia’s export performance above are based on gross statistics. Boosted import of developing countries is a signal of increased demand for Indonesia’s export products. However, it does not automatically represent a shift of final demands from developed economies to developing economies. China’s integration to the regional production chain reinforces the expectation that developing Asian countries, including Indonesia, only serve as suppliers of raw materials and intermediate goods for further processing (assembly) in China and to be marketed in developed countries (He, Cheung, and Chang, 2007 and Basri and Rahardja, 2010). Indonesia’s increasing exports to developing countries are probably due to growing exports of the intermediate goods rather than the final goods causing to overestimate of Indonesia’s export value to these markets. Based on Maurer and Degain (2010), Indonesia’s share
5 Only China and India which experienced positive growth in 2009, amounted to 9.2% and 8.2% respectively.
6 Early Harvest Program (EHP) is tariff cuts on agricultural products.
7 There are 36 countries categorized as advanced economies. For the detail see
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of intermediate goods8 in non-fuel merchandise trade in 2008 was around 41% for exports and
slightly above 60% for imports. Calculation of Indonesia’s value added, induced by the final demand in the absorbing countries, will show the importance of other countries to Indonesia's economy. Rather than analyzing the role of regional demands in Indonesia’s exports, we are interested in investigating the role of final demands in different levels of economic development, i.e. advanced and developing economies. We are motivated by previous empirical studies9, which found the
significantly positive relations between trading partner’s incomes and country’s trade performance; inferring that destination market’s higher incomes would lead to higher export demands. Moreover, the consumption patterns of rich countries are different with poor countries’: countries with high income per capita are likely to spend more of their incomes on high-quality goods10 (Hallak, 2010).
We then refine the broad category into sub-categories of mature markets (G7 countries11 of US,
Canada, Germany, France, Italy, United Kingdom and Japan) and emerging markets (Brazil, Russia, India, China, Mexico, and Turkey-BRICMT) to find out the extent of impact to which the diffusion of key players in global trade has to Indonesia’s export dynamics.
III. Research Methodology
In this section, we will firstly discuss the underlying concepts of Input-Output Table with a brief explanation of the structure of World Input-Output Table, as well as the way how to read this table. It also deals with the data source that will be used for the study. Finally, the most important part is the framework used to calculate value added exports and a simple example on how to perform this calculation.
III.1. Introducing Input-Output Table and World Input-Output Table
According to Dietzenbacher (2012), Input-Output Table (IOT) is a systematic part of the National Accounts which emphasizes production. IOT represents economic transaction activities in a given area at a point of time (snapshot). Rows on the IOT represent the selling sectors that produce or deliver outputs, whereas the columns show the purchasing sectors that use or buy those outputs. Purchasing sector can be an industry or a final consumer (households, companies, and government) representing the demand of goods. The goods produced by a manufacturer can be purchased by other manufacturers as an input in their production (intermediate demand). The goods can also be used by consumers in the final form (final demand). The flow of goods is usually measured by the monetary unit using double entry bookkeeping system so that the total output produced by selling sectors is equals to the total inputs used by purchasing sectors12.
Since the IOT portrays economic transactions in a specific area, we can assign National Input-Output Table (NIOT) for a country and World Input-Input-Output Table (WIOT) for the world/international. In principle, the building blocks in a WIOT are same as those in a NIOT
8 Intermediate goods are based on the UN classification of Broad Economic Categories (BEC), particularly on Code 22, 42, and 53 which having the words “part” or “components.”
9 These studies are commonly utilizing gravity approach, for example, Nitsch (2000), Egger (2001), Márquez-Ramos (2007), and Insel and Tecke (2010).
10 This refers to Linder’s (1961) hypothesis for trade. 11 IMF defines G7 countries as major advanced economies. 12
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(Timmer, ed., 2012). There are intra- and inter-industry linkages describing the use of output for each sector in production process (intermediate input) and also the flow of product to the consumers as a final use. The origin of intermediate input as well as the flow of final consumption is detached between domestic and foreign. However, WIOT explicitly specifies the “country of origin” of imported products and destination country of exported products. Therefore, we prefer to use WIOT in this study.
Table 1 provides general structure of WIOT which can be simplified into three countries (Country 1, 2, and 3) and two industries (Industry 1 and 2). The variables of , , , and represent intermediate goods, final goods, value added, and input/output respectively. Same as a standard input-output table, rows in WIOT represent the flow (use) of outputs from given industry whereas the columns indicate the origin (input) from a particular industry. The superscript in the intermediate use indicates the flow of transaction between countries while the subscript denotes the transaction between sectors. For example, represents the value of intermediate goods produced by Industry 2 in Country 1 that is exported to the Country 3 and used as input in Industry 1. The output of Industry 2 can also serve as final use which is consumed domestically in Country 1 which indicated by .
10 Table 1. Basic Outline of the WIOT
Intermediate Use ( ) Final Use ( ) Total Output
( )
Country 1 Country 2 Country 3 Country
1
Country 2
Country 3
Ind 1 Ind 2 Ind 1 Ind 2 Ind 1 Ind 2
C o u n tr y 1 In d 1 In d 2 C o u n tr y 2 In d 1 In d 2 C o u n tr y 3 In d 1 In d 2 Value Added Total Input
Note: the shaded area is inter-industry linkages (use of intermediate inputs in production stages)
In the presence of global production fragmentation, the fruitful analysis and policy making should be based on a globally constructed database, pose historical development (time-series data), cover various aspects on socio-economic and environmental, and have a coherent framework (Dietzenbacher et al., 2013). As the construction of WIOT in the World Input Output Database (WIOD) project meets those important aspects, we will use it on this study. In addition, the WIOD is built from publicly available national statistics that is consistent with the national account, allowing national input-output tables to be linked across nations through bilateral trade data13.
To be more specific, this study use World Input-Output Table at current prices (WIOT Analytical) retrieved from the WIOD website (http://www.wiod.org/database/iot.htm) released in April 2012. The WIOT Analytical provides information on inter-industry linkages, final use, total output, and value added. The final use (consumption) of industrial output can be separated into five categories: household expenditure, non-profit organizations serving households (NPISH) expenditure, government expenditure, gross fixed capital formation, and changes in inventories. The WIOT defines economic transactions among 40 countries accounted to more than 85% of word GDP, and it represents the whole economy by adding up rest of the world (RoW). It also covers 35 industries ranging from natural resource, manufacture, and services. Hence, the Intermediate Use matrix in the WIOT has the dimension of 1435 x 1435.
The data on employment are taken from the Socio-Economic Accounts (http://www.wiod.org/database/sea.htm) or commonly called as satellite account which has same
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data structure (country and industrial classification) to the WIOT Analytical. We prefer using the number of persons engaged (EMP) rather than the number of employees (EMPE) because it represents the whole employment, including self-employed and family workers14. The satellite
account also provides the amount of capital and labor compensation as well as the share of labor compensation based on the different type of skill, i.e. high, medium, and low-skilled workers. It should be noted that the monetary values in the Socio-Economic Accounts are in the national currency whereas the monetary values in the Socio-Economic Accounts are in the US Dollar (US$). Therefore, we need to convert the national currency into US$ using the exchange rate which is also provided in the WIOD database.
The WIOD delivers yearly time-series data from 1995 until 2009. Therefore, we would like to employ all available data to analyze the role of final demand toward Indonesia’s economy. We try to include the up-to-date data as far as possible to examine the changing patterns of Indonesia’s export destinations, especially due to the world economic recession in 2008. Unfortunately, the latest data of the WIOD is only available until 2009. By using the relatively longer time span, we hope for getting information on the effect of China’s inclusion in the WTO before and after their membership in 2001 toward Indonesia’s economy. China is one of the developing countries which has an important role in the world economy today. As noted by Rumbaugh and Blancher (2004), China’s accession to the WTO has remarkable impacts on its penetration to developed markets as well as their importance as an export destination for other Asian countries. Moreover, China’s position in global trade has improved from being the sixth largest merchandise exporter and importer in 2001 to be the biggest exporter and the second greatest importer in 2010 (Singh, 2011).
III.2.Accounting Framework for Value Added
Basically, we are interested to measure how much value added of a country is embedded in the final demand of certain destination market. Therefore, it requires an accounting framework taking account inter-industry (intermediate) linkages across countries as well as the goods flows (goods originate) and the use of goods. By following the Global Value Chain concept as introduced by Johnson and Noguera (2012) and Timmer et al. (2012a), one can track the value added generated by a country along the stages of production in different nations15. In the initial step, the market
clearing conditions for the whole countries need to be set, and the production outputs need to be distinguished into intermediate and final use. The final demand is then allocated based on the group of country destinations. Afterward, we will be able to calculate the amount of output that should be produced to meet the specific final demand. Because the respective output contains direct factor input, we can derive the value added.
The analysis using Input-Output model can be expressed in matrix notation. Therefore, it is important to firstly provide information on some general notations. Based on the common convention, matrices are shown by bold capital latters ( ); vectors by bold lower case letters ( ); and scalars in italic lower case letters ( ). Vectors are defined as column vectors so a row vector is
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The number of self-employed workers in Indonesia is estimated using the ILO data. EMPE is obtained by subtracting EMP by the estimated self-employed workers (Erumban et al., 2012).
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constructed by transposition indicated by a prime ( ’). The diagonal matrices are indicated by a hat above the letter ( ) which consists of vector on the main diagonal and zeros on the off-diagonal. Now assume that goods flow from source sector as input for sector destination and move from country origin to country destination . The goods circulations can represent intra-industry trade ( = ) or inter-industry trade ( ≠ ) as well as domestic trade ( = ) or foreign trade ( ≠ ). Quantity of goods produced by country equals to the amount of goods used for both domestic and overseas consumption. Assuming that there is only single price for each product (irrespective of the use) then the value of output of country at market clearing condition is
= ∑ + ∑ ∑ , (1)
Equation (1) essentially states that the value of output received by producers is the same as the total amount of the consumer spending whether for final consumption ( ) and/or for further production process or intermediate inputs ( ). For instance, is production value of sector of country ; is expenditure on final goods from sector in country ; and , is expenditure on intermediate goods used on sector in country .
In the input-output approach, matrix notation can be used to describe the market clearance condition for S sectors and N countries creating SN dimension. The output value for each country-sector is expressed by the column vector with SNx1 dimension, while final demand for output is defined in column vector (SNx1). Finally, we denote intermediate input linkages in the global matrix # (SNxSN). Each element of the matrix # consists of the proportion of the output sector from country which is used for an input sector in country toward total output sector of country , so it can be expressed as $ , = , / . In the input-output notation, the global market clearance condition is as follows.
& ⋮ ( ) = & # # … # ( # # … # ( ⋮ ⋮ ⋱ ⋮ #( #( … #(( ) & ⋮ ( ) + , -.∑∑ ⋮ ∑ ( /0 0 1 (2)
It should be noted that reflects production level in country consisting S-vector and represents final demand country of output from country for each sector S. Equation (2) can be summarized into
= # + (3)
The equation above represents input-output system in which total output is distinguished into intermediate and final use. Solving for gross output , we get:
= 2 − # 4 (4)
Leontief input-output inverse 2 − # 4 shows the input requirements, both direct and indirect, on all other producers, are generated by one unit of final output. Identity matrix 2 is SNxSN consisting of ones on the diagonal element and zero on the off-diagonal elements.
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final demand in advanced economies 657and due to the final demand in developing economies 587. Substituting this decomposition of final demand in linear system, we can derive
= 2 − # 4 5+ 2 − # 4 657+ 2 − # 4 587 (5)
Value added incomes are generated by pre-multiplying equation (3) with vector 9 of 1xSN designating value added per unit output (value added coefficient). Focusing only to the external orientation, the value added created in country absorbed in final demand abroad (export of value added) is
:8= 9′ 2 − # 4 f657+ 9′ 2 − # 4 587
= :657+ :587 (6)
Since our concern is value added creation in Indonesia, so we set all elements in the vector of value added 9 to zero except for value added created by Indonesia. Following the same logic in Equation (6), by replacing elements of vector 9 with the relevant vector of factor inputs coefficients, we can derive the generated employments to satisfy the respective final demand.
The WIOD database only defines 40 countries and the rest of the world (RoW) and most of the advanced countries are included in that database. Therefore, we firstly set the final demand of advanced economies referred to the IMF classification and put the others, including RoW as developing economies. The advanced countries—based upon the IMF classification which are not explicitly defined in the WIOD—consist of Iceland, Israel, New Zealand, Norway, San Marino, Singapore, and Switzerland16. Among these countries, Singapore is the most important trade
partner for Indonesia17. Nevertheless, we argue that our classification will not lead to the biased
results because the calculation of trade flows in this study is based on the final demand absorbed into the destination market. It should be noted that Singapore is one of the main re-export countries18 which relies much on the imported intermediate inputs (Choy, 2009). Re-export activity
is part of the double-counting problem embedded in the gross trade statistics which will cause distorted picture on the how much of the exporting country depends on the foreign market.
We can further define the new sub-category for advanced economies into mature markets (G7) and other advanced economies as well as the sub-category for developing economies into emerging markets (BRICMT) and other developing economies. This decomposition aims to know the extent of impacts the underlying markets have on Indonesia’s economy in terms of incomes and job creation, especially after the global economic recession in 2008. It is also possible to obtain information about the products/sectors (agriculture, manufacture, and services) of related trading partners that Indonesia has benefited the most from.
16
Hong Kong is also included as an advanced country on the IMF classification. However, in the WIOD, Hong Kong data have been combined into the Chinese trade data (Timmer, ed., 2012)
17
Based on the UN Comtrade database, Singapore is Indonesia’s fourth largest export destination in 2009 which accounted to US$ 10 billion or 8.8% of Indonesia’s total export to the world.
18
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III.3.Calculating Value Added Exports: A Simple Example
To make the accounting framework on the previous sub-section clearer, we provide technical procedures for calculating value added exports involving the operation on matrices. Let suppose that the World Input Output Table (WIOT) in year X is given in Table 2, consisting of three countries of Indonesia (IDN), China (CHN), and Rest of the World (RoW) and two sectors of Agriculture (Agr) and Manufacture (Man). We try to replicate the appearance of the WIOT in Table 2 as close as possible to the structure of WIOT provided in the WIOD Database but in the simple form19. For
instance, it depicts several building blocks consisting of industrial (intermediate use), final demand, output, value added, and even for taxes. In addition, all of values in Table 2 are in the monetary unit of billion US$.
Table 2. Simple Example of World Input Output Table (US$ Billion)
Industries
Final Demand Total Output Agr Man Agr Man Agr Man
IDN IDN CHN CHN RoW RoW IND CHN RoW
In d u st ri es Agr IDN 14 25 4 9 1.5 5 9 7 3 77.5 Man IDN 21 30 5 6 5 9 13 9 5 103 Agr CHN 8 5 20 35 9 8 4 8 6.4 103.4 Man CHN 4 6 25 29 10 15 7 16 17 129 Agr RoW 3 2.8 6 17 14 17 8 15 8.7 91.5 Man RoW 1 3 9 10 19 15 10 10 18.5 95.5 Taxes 1.5 1.2 1.4 2 1 0.5 Value Added 25 30 33 21 32 26 Output at basic prices 77.5 103 103.4 129 91.5 95.5
In this example, we want to calculate how much value added of Indonesia’s exports finally consumed in China and the RoW20. Referring to the accounting framework in Section III.2 we need
matrix # of technical input coefficients, vector of final demand, vector of total output, and vector : of value added. Based on the WIOT we can assign each building block in the notational matrix as follows = , -.14 25 421 30 5 9 1.5 56 5 9 8 5 20 35 9 8 4 6 25 29 10 15 3 2.8 6 17 14 17 1 3 9 10 19 15/0 0 0 0 1 , = , -. 77-.5103 103.4 129 91.5 95.5 /0 0 0 0 1 , GH( = , -.79 8 16 15 10/0 0 0 0 1 , IJK= , -. 35 6.4 17 8.7 18.5/0 0 0 0 1 , : = , -.2530 33 21 32 26/0 0 0 0 1 , :L5(= , -.2530 0 0 0 0 /0 0 0 0 1
19 The monetary values in this WIOT do not represent the economic structure of the respective countries or inter-linkages among economic units.
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We are only interested in the Indonesia’s value added, so we replace all value in : except for Indonesia and get :L5(. To get value added per unit output 9L5(, :L5( is divided by diagonal vector . Recalling that $ = / , matrix # then can be calculated by dividing each element in matrix to the respective element in column vector . In matrix notation, it can be express as # = 4 . Afterward, we calculate Leontief matrix M = 2 − # 4 . The results of vector 9L5(, matrix # and M are
9L5( = , -.0.320.29 0 0 0 0 /0 0 0 0 1 , # = , -.0.18 0.24 0.04 0.07 0.02 0.050.27 0.29 0.05 0.05 0.05 0.09 0.10 0.05 0.19 0.27 0.10 0.08 0.05 0.06 0.24 0.22 0.11 0.16 0.04 0.03 0.06 0.13 0.15 0.18 0.01 0.03 0.09 0.08 0.21 0.16/0 0 0 0 1 , M = , -.1.45 0.57 0.24 0.31 0.20 0.280.65 1.71 0.30 0.36 0.30 0.39 0.38 0.33 1.57 0.72 0.41 0.44 0.33 0.33 0.63 1.69 0.45 0.53 0.20 0.19 0.29 0.41 1.39 0.43 0.16 0.18 0.31 0.35 0.44 1.40/0 0 0 0 1
Now, the calculation of the value added exports is straightforward. Indonesia’s value added exports in the Chinese market is :L5(GH( = 9L5(′M GH( whereas the value added exports in the RoW’s market is :L5(IJK= 9L5(′M IJK. Thus, the amount of Indonesia’s value added attributed to the Chinese final demand and attributed to the RoW’s final demand are respectively US$ 19.7 billion and US$ 15.1 billion.
For the purpose of analysis, we would often compare the value added exports with gross export statistics to examine how big the distortion of goods flows if we merely rely on the traditional measure. In addition, we would also calculate the ratio of value added exports to GDP in order to measure the exporting country's dependence on the particular export market. The higher value of the ratio indicates the higher role of the respective markets for the source country in generating export revenues. The gross exports and GDP are calculated using the information available in the WIOT.
Based on Table 2, the gross exports of Indonesia to China is the summation of the entire Indonesia’s output flows (agriculture and manufacturing) to China that are used as intermediate inputs (US$ 24 billion) and final consumption (US$ 16 billion). Hence, we get Indonesia’s gross exports to China amounted to US$ 40 billion. In the same way, we calculate the Indonesia’s gross exports to the RoW of US$ 17.7 billion. By comparing the value added exports and gross exports, it can be seen that the Indonesia’s gross exports to China is 50.7% higher than the calculation using value added approach. Meanwhile, Indonesia’s gross exports to RoW is 47.1% higher than the value added exports to the respective flow. The results calculated using the value added method exhibit lower values compared to the gross exports which indicate a correction on the biased figure of gross export statistics.
16 IV. Empirical Results and Discussions
This section will explore the empirical findings based on the accounting framework described in Section III. First, it will discuss the discrepancy between value added exports and the gross export statistics. Afterwards, it analyzes the general trends of Indonesia’s income and employment generated by foreign final demands. To answer the research question, the role of advanced and developing countries will be analyzed in more details by decomposing the value added into countries, sectors, and factor inputs.
IV.1. Impact of Foreign Demand on Indonesian Income and Employment
Before discussing the magnitude of dependency of Indonesia’s economy toward export markets, it is better to first compare our results with related existing literatures. By doing this benchmarking, we will be more confident on the reliability of the results as well as to avoid fallacy on the interpretation. In this respect, the study by Johnson and Noguera (2012) is one of the literatures that should be considered.
Johnson and Noguera (2012) define value added exports as value added produced in the source country and absorbed in the destination country. In addition, they calculate the ratio of value added exports to gross exports (called as “VAX ratio”) to measure the intensity of production sharing. Following their works, we have also calculated the ratio of Indonesia’s value added exports absorbed in the foreign final demands to Indonesia’s gross exports. Surprisingly, our value added to gross exports ratio for Indonesia in 2004 was 0.79, same as what Johnson and Noguera (2012) found. Recalling that result, we used WIOD database while Johnson and Noguera (2012) used GTAP database to calculate value added exports.
In this study, we can interpret the ratio of value added exports to gross exports as a measure of distortion embedded in the gross export statistics. The ratio can be lower or higher. For the aggregate level, the ratio is always smaller than one as found in Johnson and Nogurea (2012). However, in the sector-level, the ratio may pose value greater than one, particularly on the Agriculture & Natural Resources and Services. It is because Manufactures, which are directly exported, contain value added from other sectors. The higher gap between gross exports and value added exports means that the gross export statistics will lead to more bias in capturing the real trade flows. Based on our calculation, the average ratio of Indonesian value added exports for fulfilling foreign final demand toward its gross exports during 1995-2009 was 0.82. In other words, Indonesia’s value added exports was 18% lower than gross export statistics, confirming to the notion given by Johnson and Nogurea (2012) that value added exports are smaller than gross exports at the aggregate level.
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billion respectively. Before that, the developing economies had been much less important for Indonesia than advanced economies, even in 2005.
By comparing the value added exports and gross exports as shown in Table 3 panel c, it can be implied that the double counting problem on Indonesia’s exports to developing economies is more problematic than the export to advanced economies. On average, the ratio of Indonesia's value added exports to the gross exports attributed to developing economies was 0.78, lower than the ratio attributed to advanced economies which amounted to 0.84. The smaller the ratio, the more the double counting problem encompasses the export flows. This is probably due to the fact that a lot of materials and intermediate goods were imported into Indonesia before being processed and then exported to developing economies.
Panel d on Table 3 indicates the relative contribution of Indonesia’s value added exports toward Indonesia’s economy. For example in 2000, Indonesia’s value added exports generated from serving the world’s final demands contributed to almost 30% of Indonesia’s GDP. It was mainly due to the value added exports to the advanced economies (23.4% of Indonesia’s GDP). However, in 2009, the advanced economies became less important, as indicated by the lower ratio of Indonesia’s value added exports to GDP of 10.5%. On the contrary, the role of developing countries for generating Indonesia’s incomes became more important, even though it was not so strong. Despite the dynamic role of foreign final demands toward Indonesia’s economy, Indonesia still relied heavily on domestic final demands, which induced to 75% of total value added (on average) during 1995-2009.
To understand whether Indonesia has gained or suffered from global demands, we compared the annual growth of Indonesian value added export-to-GDP ratio with the annual growth of destination market’s GDP-to-World’s GDP ratio within the same period. The former ratio refers to Indonesia’s income from exports to fulfill particular foreign demands, and the latter ratio represents economic condition of the respective export market. This is based on the fact that developing economies are now becoming more important for the global economy. For instance, the share of developing countries’ GDP to the world’s GDP was increasing at 3.0% per year (Table 3 panel e). Therefore, it can be considered as an advantage for Indonesia if their incomes from export expand faster than the economic performance of a particular market in the global economy. This shows that Indonesia is able to capture market opportunities abroad.
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Table 3. Selective Indicators of Indonesian Export Performance and Foreign Market Condition, 1995-2009
Description 1995 2000 2005 2009
1995-2009
Average Trend
(%/year)
a. Indonesia's Value Added Exports (US$ billion), to:
World 45.1 52.0 74.9 115.1 67.8 7.7
Advanced Economies 35.6 40.7 48.0 59.2 44.6 4.3
Developing Economies* 9.6 11.3 26.9 55.9 23.2 15.3
b. Indonesia's Gross Exports (US$ billion), to:
World 54.1 65.3 93.9 134.9 82.9 7.6
Advanced Economies 42.6 50.5 55.6 66.8 52.6 3.6
Developing Economies* 11.6 14.9 38.3 68.1 30.3 16.4
c. Ratio of Indonesia's Value Added Exports to the Gross Exports, to:
World 0.834 0.795 0.798 0.853 0.815 0.1
Advanced Economies 0.835 0.806 0.864 0.886 0.844 0.7 Developing Economies* 0.829 0.758 0.703 0.821 0.778 -0.9
d. Ratio of Indonesia's Value Added Exports to the GDP, to:
World 0.187 0.298 0.270 0.205 0.249 0.6
Advanced Economies 0.147 0.234 0.173 0.105 0.174 -2.6 Developing Economies* 0.040 0.065 0.097 0.100 0.076 7.7
e. Ratio of Foreign GDP to the World's GDP, in:
Advanced Economies 0.784 0.769 0.734 0.658 0.742 -1.1 Developing Economies* 0.207 0.225 0.259 0.332 0.251 3.0
Note: * Indonesia is excluded
Source: Author's calculation based on the WIOD Database
Turning to the annual results as depicted in the Figure 4, Indonesia’s value added exports to the world-to-GDP ratio climbed during 1995-2001 and continued to fall afterwards; resulting in average ratio of 24.9% during 1995-2009. The most visually striking change in Figure 4 is the sharp increase of value added export-to-GDP ratio in 1998. A year after Indonesia had undergone crisis in 1997, the total value added decreased considerably by 60.4%, especially on the value added generated from domestic final demands. At the same time, the value added exports attributed to the final demands abroad experienced smaller drop, thus creating the highest value added export-to-GDP ratio of 35% within the period of 1995-2009. On the contrary, there was only 65% value added generated to satisfy Indonesia’s final demand in 1998. Before that year, the value added reached more than 80% (rest over the bar in Figure 4).
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faster than those in the advanced economies, particularly after the Global Economic Recession 2008.
Figure 4. Value Added Exports by Market for Final Goods (% of GDP)
Figure 5. Employments Induced by Foreign Final Demand (% total workers)
Note: The bars in Figure 4 (Figure 5) depict the share of Indonesia’s value added exports (employments) induced by foreign final demands in advanced economies and developing economies. The remaining shares of the respective combined bars indicate Indonesia’s value added exports (employments) induced by domestic final demand. Thus, the summation of the whole shares in each respective year will be 100%.
Source: Author's calculation based on the WIOD Database
With regard to employment, Indonesia’s export activities contributed to 16.4% of total jobs in average during 1995-2009. For the benchmark years that are available on the Indonesia’s Input-Output Table, our results are mostly similar to the work of Aswicahyono and Manning (2011). They found that the shares of employments induced by export activities to the total employment were 11.8% in 1995, 19.0% in 2000, and 16.6% in 2005. In this case, most of our results on the respective year are higher than those estimated by Aswicahyono and Manning (2011). Of course, we would not have similar results because of the different databases used. They used Indonesian Input-Output Table of 66-sector classification. Meanwhile, we used World Input-Output Table of 35- sector classification and we also covered 41 countries (including RoW). In addition, different exchange rate also causes different values of transaction flows on both Input-Output Tables. Therefore, we argue that our results are better because we considered different export demands from different trade partners. In the International Input-Output setting, we are able to consider not only the direct effects of exporting final goods but also indirect effects induced by exports in intermediate goods caused by feedback effect and spillover effect21 (Meng, Fang, and Yamano,
2012). Nevertheless, both results have the same magnitude, in the sense that employment induced by exports in 2000 was the highest and followed by those in 2005 and 1995.
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The pattern of employment generated by serving foreign final demands in Figure 5 is almost the same as the pattern of the value added exports in Figure 4. It would not cause much difference whether we focus on the value added export or employment at the aggregate level. When the exports play important contribution to Indonesia’s income in certain years, the increasing employment is also visible in the respective year. In 1998, for example, exports contributed mostly for generating income as well as for inducing employment. In contrast, the weak global demands in 2009 led to decreasing contribution of export value added toward Indonesia’s GDP as well as the share of export-related employment toward Indonesia’s total employments.
Looking at more details of 1998, the number of employment induced by export activities increased by 67.6% or an additional 7.9 million workers from the previous year. This was because many workers had to switch from formal sectors to the informal sectors due to massive layoff during recession (Feridhanusetyawan, 2002). It should be noted that the employment data used in this analysis refers to the number of people involved in the production activities and is not limited only to employees but also the self-employed workers. The number of persons engaged (EMP) for total industry in the WIOD database showed an increase of 0.7% in 1998 compared with 1997, while the number of employees (EMPE) dropped by 4.3%. To this respect, Agriculture, Hunting, Forestry and Fishing sectors had the largest contribution for inducing employment in 1998. It reaffirms that the informal sectors play an important role in creating Indonesia’s employment during the Asian Financial Crisis.
Before turning into the next sub-section, it is worth mentioning our overestimation on the results. Indonesia’s value added exports and employments induced by fulfilling final demands in developing economies are slightly overestimated because Rest of the World (RoW) is included in the developing economies category. Most RoW consists of developing countries, but some of them are considered to be advanced countries, i.e. Iceland, Israel, New Zealand, Norway, San Marino, Singapore, and Switzerland. Recalling from Section III.2, the advanced economies of which data are not available are also put into RoW in the WIOD database.
IV.2. The Dominant Export Markets and Sectors for Indonesia’s Economy
The further decomposition of final demand indicates that Indonesia’s major markets in advanced countries during the period 1995-2009 were concentrated in only G7 countries, particularly on the US and Japan. The average contribution of Indonesian value added exports to the G7’s markets was relatively stable at 73.7% of total value added exports to the advanced countries (Appendix 1.A). Therefore, the declining Indonesian value added exports to developed countries markets during 1995-2009 were due to rapid annual drop of the value added export generated in G7 countries (-3.2%) relative to the other advanced countries (-0.9%).
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countries. This led to a conclusion that Indonesia’s exports to developing countries are much more dependent on Asian markets, especially in ASEAN countries. However, we cannot investigate it further since the WIOT does not provide the breakdown of those countries. In addition, there was a sharp increase on Indonesia’s export of value added in satisfying final demands for China, from 1.8% of GDP (2004) to 2% of GDP (2005). This may indicate that the commencement of ASEAN-China Free Trade Agreement (ACFTA) in 2004 has substantially impacted Indonesia’s income. The tariff reduction under the ACFTA scheme does help Indonesia in boosting export flows directly to Chinese market or indirectly through other ASEAN countries.
Turning to sector decomposition, manufacturing exports to advanced and developing countries contributed the most to Indonesia’s GDP, followed by agriculture & mining and services (Appendix 2). However, the contribution of manufacturing during 1995-2009 tended to decrease rapidly relative to other sectors (Appendix 3). The production characteristics of manufactured goods, which are easily to be fragmented across borders and the growing competition among global players, were the possible reasons for the declining export of value added on Indonesia’s manufacturing. Along with the decline in the manufacturing and agriculture & mining sectors, the contribution of service sector to the Indonesia’s GVC income in advanced economies also experienced a decrease.
To better understand the impact of final demands in advanced economies and developing economies on Indonesia’s economy at detail sector-level, we plotted some important export-related activities for Indonesia as presented in Figure 6. The sizes of the bubbles are proportional to the average amount of value added during 1995-2005 in the corresponding sector; the vertical axis shows the annual growth of the sectoral value added exports; and the horizontal axis indicates the annual growth of employment of the respective sector. Irrespective to the market for the final goods, the higher contributors for Indonesian income mainly come from the same sectors (8 of 10 largest sectors). Moreover, they are dominated by natural resource-based products, such as mining, agriculture, and coke & refined petroleum.
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Figure 6. The Development of 10 Largest Sectoral Indonesia’s Value Added Exports and Employment Induced by Final Demand in Advanced and Developing Economies
Notes: - Descriptions of the bubbles: (c1) Agriculture, Hunting, Forestry and Fishing; (c2) Mining and Quarrying; (c3) Food, Beverages and Tobacco; (c4) Textiles and Textile Products; (c6) Wood and Products of Wood and Cork; (c7) Pulp, Paper, Paper, Printing and Publishing; (c8) Coke, Refined Petroleum and Nuclear Fuel; (c9) Chemicals and Chemical Products; (c14) Electrical and Optical Equipment; (c15) Transport Equipment; (c20) Wholesale Trade and Commission Trade, Except of Motor Vehicles and Motorcycles; and (c28) Financial Intermediation.
- The 10 largest export-related activities to developing economies covered 74.9% of total value added exports to developing countries on average during 1995-2009, while the average share of 10 largest sectoral value added exports related to advanced economies was 72.4%.
Source: Author's calculation based on the WIOD Database
IV.3. Factor Contents on Indonesia’s Value Added Export
Under the Heckscher-Ohlin framework, the compensation for abundant factor of production should be relatively lower (Stehrer, 2012). Therefore, we expect to see that the labor abundant countries like Indonesia have smaller compensation for labor rather than compensation for capital. The competition among labors may drive down their bargaining power to attain higher rewards. In addition, Indonesia’s labor supply remains dominated by low-skilled workers because of the lower attainment on their education. Based on the National Labor Force Survey (Sakernas) in August 2009, the number of workers who completed primary school or lower education level reached 55.2 million people or 52.6% of total working population.
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Table 4. Share of Capital and Labor Compensation in Indonesia to Fulfill Final Demand in Advanced and Developing Economies, 1995-2009
Description 1995 2000 2005 2009
2009 minus
1995 a. Value Added Export to Advanced
Economies (US$ billion)
35.56 40.69 48.03 59.16 23.60
Capital (%) 58.2 62.6 64.8 65.1 6.9
High-skilled Labor (%) 5.0 3.9 5.8 6.2 1.3
Medium-skilled Labor (%) 11.1 9.9 10.2 11.6 0.5 Low-skilled Labor (%) 25.8 23.6 19.2 17.1 -8.7 b. Value Added Export to Developing
Economies (US$ billion)
9.58 11.26 26.92 55.90 46.32
Capital (%) 59.6 60.6 64.6 64.5 4.9
High-skilled Labor (%) 4.3 3.8 4.9 5.3 1.0
Medium-skilled Labor (%) 10.5 10.1 10.0 11.5 1.0 Low-skilled Labor (%) 25.6 25.5 20.5 18.7 -6.9 Source: Author's calculation based on the WIOD Database
Further decomposition on the labor compensation demonstrates that exporting to advanced and developing economies was important for generating income on Indonesia’s low and medium-skilled labors. However, the share of low-skilled labor tended to decrease over time whereas the shares of medium and high-skill labor tended to increase. The contribution of low-skilled labor attributed in serving final demands in advanced countries toward Indonesia’s total value added in 2009 decreased by 8.7% points compared to 1995, while the share for serving developing countries dropped by 6.7% points. This changing composition of labors indicates that Indonesia’s low-skilled labor was losing out when serving foreign final demands. It is not in line with the trade theory, which hints that developing countries, commonly possessing comparative advantage in labor-intensive industries, should specialize more on their relatively abundant of unskilled labor.
It is worth noting that the shares of labor by type of skills in Table 4 are in value terms. Therefore, the declined share on low-skilled labor might not represent the declined use of low-skilled labor in physical units. To support our interpretation on the labor specialization, we need to compute how many workers induced by fulfilling the foreign final demands by different types of skills (high-skilled, medium-(high-skilled, and low-skilled). Nevertheless, the WIOD database does not provide numbers of workers for the three types of skills. The best proxy for the physical units of labor was to use the hours worked of persons engaged by types of skills available in the WIOD database. The results show that the share of working hours for low-skilled persons engaged decreased, both for fulfilling the advanced economies’ final demand and for fulfilling the developing economies’ final demand (Appendix 5).
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in Indonesia, which internationally integrated through foreign ownership, exports, or imported inputs, tend to have higher share of skilled workers in their total employment. It is inferred that openness to international trade induces the producers to reallocate their labors and capital to factories with higher efficiency and quality. Hence, upgrading manufacturing plants leads to higher demand of skilled labor. Additionally, using the Indonesia employer survey of skill/labor demands and job vacancies in 2008, they show that most jobs in the Indonesian formal sector require an adequate minimum education level. For example, most employers now prefer to hire technicians, clerks, service and sales workers, and craft workers who have at least upper-secondary level education.
V. Concluding Remarks
We have analyzed the role of final foreign demands on Indonesia’s value added and employments during 1995-2009. By using global value chain framework developed by Johnson and Noguera (2012), which was extended by Timmer et al (2012a), we have been able to calculate the values that have been added in Indonesia to fulfill the final demands abroad (value added export). This measure is better than gross trade statistics, which embedded a double-counting problem. We have demonstrated that using gross trade statistics to analyze the role of final demands of export markets on Indonesian income will lead to overestimation by almost 20%.
The empirical findings also show that the value added generated in Indonesia to meet the foreign final demands has had a declining trend since 2002. The decline has been caused by the deteriorating income from serving the advanced economies’ demands. Fortunately, Indonesia’s income induced from catering market in developing economies is growing. It indicates that Indonesia has benefited from stronger demands, which currently occurred in most developing countries. Serving market demands in developing countries is followed by increasing Indonesia’s exports of value added, employment, as well as compensation for the capital and labor. Moreover, share of compensation for medium and high-skilled labors has tended to rise, which indicates that export to developing countries also requires better human resources. Therefore, the diversification of export markets to developing countries currently encouraged by Indonesian government will continue to have positive impacts on Indonesia’s economy, particularly for generating income and jobs.
