Wayan Reda Susila

Lecturer at Prasetiya Mulya University

Background

Inspired by the Absolute Advantage Theory promoted by Adam Smith in 1776 and Comparative Advantage Theory byDavid Richardo in 1817, export policies have been more dictated by export specialization regime, especially until the end of 1990^th.  According to the theories, every country should focus on products on which the country has comparative advantages. In other words, countries tend to be more specialized on a limited number of exported products or commodities. The specialization is perceived to offer more efficient use of domestic resources by taking advantage of economies of scope and economies of scale. Some economists argue that better international competitiveness would require more specialization in exports rather than better diversification (Samen, 2007).

The importance of export diversification as the opposite of the export specialization has gained its importance in export policy regime especially in the last two decades.  Despite the well-known efficiency benefits expected from specialization, the risks of too narrow specialization have been long identified. It is widely recognized that specialization in narrow group of export products expose a country to increased instability in export earnings.  These countries have been very vulnerable to any various global risks, such as technical risk, price risk, and policy risk (Samen, 2007). Thus, export diversification is more concerned on stability because economists perceived that the costs of export instability can be greater that the benefits gained from efficiency due to export specialization (Ali, Alwang, and Siegel, 1991). UNESCAP (2004) pointed out that export diversification is not only to minimize volatility in export earnings, but it also to foster economic growth. Various internasional shocks such as global economic crisis in 2009-2010, pandemic Covid-19, and the Russia-Ukraine have thought policy makers of the risks export earning instability, especially for the countries whose export are less diversified. 

As mentioned in the Ministry Trade Strategic Plan 2019-2024, Indonesia has consistently promoted export diversification as one of the main strategies in increasing and stabilizing the export performance.  As other exporting countries, Indonesia has been trying to diverse the exported products as well as country destination. For an example, in responding various global shocks, Indonesia has prepared various policies such as promotion, fiscal incentives, trade and economic cooperation, and also trade facilitation support to consistently promote export diversification (Ministry of Trade, 2019).

In optimizing the export diversification, opportunities and challenges of export diversification has to be clearly identified.  Identification of the potential non primary products for export should be identified for accelerating the export diversification coupled by their effective market entry strategy. Moreover, considering the importance of the private sector as the main actor in the field, partnership between government and private sector is a critical issue.  Therefore, the objectives of this papers are to briefly describe:

1. Opportunities and markets potential for Indonesia export diversification mainly on non-commodity.
2. Challenges in diversifying Indonesia’s export portfolio beyond its primary commodities.
3. Market entry strategies and policies including the government and private sector collaboration to support the export diversification non-traditional exports including creative industries or technology-related products. 

In Indonesia context, export diversification is limited to only non-oil and gas products contributing to around 75.7% of the total export in 2022.  The oil and gas export has special treatment and have been highly intervened by the government since these products are included as strategic products.  I addition, Indonesia has exported crude oil, imported refined oil and has become an oil net importing country.  Therefore, export diversification in this report is confined on non-oil and gas products only.   

Opportunities and Market Potential of Export Diversification

 To better understanding of export diversification, we should recognize that there are three types of export diversification as follows:

• Horizontal export diversification:  expanding the number of exported primary products (raw materials/commodities) such oil palm, unprocessed fishery products, and coal;
• Vertical export diversification: expanding the number of more processed products with higher added value including high-tech products. For an example, vertical diversification in palm means increasing the number of the exported products of processed palm oil- based products such as cooking oil, oleo chemical, and bio-diesel;
• Country destination diversification: by exploring new export markets (countries) outside the traditional export markets such as the China, US, Singapore and Japan.

For Indonesia, improving horizontal export diversification seems to be not a priority, but more on vertical and country destination diversification. First, the Indonesia government has strongly promoted production and export of processed products, known as down-streaming industrial policies. The objective of the policy is to gain more value added, tax, employment, and export value. The government stipulated various policies to accelerate the development of the down-stream industries such as tax incentives (tax allowance and tax holiday), infrastructure and energy support, special economic zone, higher export tax for exporting raw material (e.g., CPO and cocoa bean) and even the ban of the export of raw material (e.g., nickel). Second reason which is less important is that the current horizontal export diversification is quite good.  Indonesia has exported almost all raw materials produced in the countries.  Using the export of the HS 2-digit classification (a mix between processed and processed products), Indonesia has exported 97 products out of 99 products (Trade Map, 2023).  However, the share of the processed product was only 55 % in 2021, far below Vietnam attaining to 78.5 % even in 2016 (Ministry of Trade, 2020 and CIPS, 2022).    

Therefore, the government has focused to improve the vertical diversification meaning promoting downstream industries in order to consistently increase the processed product share in the Indonesia export structure. Based on the data from UNCTAD (2023) that compile export diversification of most of the country members, Indonesia has a big potential in export diversification (Table 1).  In 2022, Indonesia produced around 14,113 products and has a potential to add 1,267 new products and 1,069 more complex/sophisticated or high-tech products. In line with the government policy to increase the share of the processed products, about 46% the export potential is for new and more complex products.  So, in general, Indonesia has a potential to increase its vertical integration accounting for almost 50% of the total export potential.

Table 1. Current and Potential Products for Export Diversification, 2022

Description	Number of Products
Current diversification	14,113
Potential new products	1,267
Potential new products more complex than the country’s average	1,097
Export opportunity in more complex products (percentage)	46

Source: UNCTAD (2023) -https://unctad.org/system/files/official-document/tcsdtlinf2022d6_id.pd 

The export diversification potentials are also disaggregated based on sectoral opportunities, which is dominated by processed products, specially manufacture products such as vehicles, chemical, machinery, pharmaceutical products (Table 2).  These four products contribute almost 50% of the total export opportunities.   

Table 3. Potential New Sectors for Export Diversification

(percentage of export opportunities)

Source: UNCTAD (2023) -https://unctad.org/system/files/official-document/tcsdtlinf2022d6_id.pd 

As one of the main agricultural product exporting countries, Indonesia has a big potential in diversifying its agricultural product export.  As seen in Table 3, Indonesia has 15 main agricultural products that have a significant contribution (share) in the export diversification. This indicates that Indonesia has a big number of agricultural products that can increase the export diversification. The big four, namely meat, fish, seed oil, and cereal have a big potential, accounting for almost 70% of the total export diversification potential. This export diversification potential is definitely vertical diversification meaning that Indonesia has to promote and support the downstream industry development of the products. 

Table 3. Potential New Sectors for Diversification for Agri-Business Products s (percentage of export opportunities)

Source: UNCTAD (2023) -https://unctad.org/system/files/official-document/tcsdtlinf2022d6_id.pd  

Service sectors have also a potential to improve the export diversification, although it is not as big as good sectors. As seen in the Figure1, Indonesia has six service sectors that have a potential for export, namely, travel, transportation-passenger, transportation-freight, transportation-others, telecommunication and IT, and other business services (Bank Indonesia, 2022).  Considering that the growth rate of demand of the services has been faster that that of good, the government has stipulated various policies to promote the development of the services sectors, such more intensive promotion for of tourist destination and improving supporting infrastructure.

Figure 1. Indonesia Export of Service Sectors (US$ Billion)

Source: Bank Indonesia (2022)

Creative industry has also a potential to improve export diversification. The Minister of Tourism and Creative Economy expected that the export value of Indonesia’s creative economy in 2022 can reach US$ 25.14 billion US dollars after reaching US$ 23.9 in 2021.  Fashion is the main export contributing to around 61.6 percent of the export value of the economic creative sector, followed by craft (31%) and culinary commodities (7%). Other prospective commodities include as game applications, television, radio, photography, advertising, publishing, performing arts and fine arts (Kompas.com, 22 Agustus 2022).

Indonesia is lucky to have natural resource heterogeneity based on the region so that so that export diversification can be done from various locations in Indonesia, depending on the type of product to export.  As seen in Table 4, each region has its own potential products to support export diversification. Regions in Java for example have been rich in agricultural, fishery, manufacture products, creative industry products and services as the basis for export diversification. While Kalimantan, Sumatra, Sulawesi, and Papua could be the center of perennial crops-based product such palm oil, rubber, and very importantly is mining products such as coal, and other rare ore products. Bali on the hand is the center for services products such as tourism and creative industries such as craft sectors.

Table 4. Regional Potential of Export Diversification Products

No	Region	Main Products for Export Diversification
1	Java	Manufacture (chemical, rubber, plastic, textile and clothing, leather, paper and electronic), creative industry, services, agricultural, forestry and fishery-based products
2	Sumatra	Perennial crops (palm oil, rubber, cocoa, coffee) and mining products
3	Kalimantan	Mining, Perennial crops, and fishery products
4	Sulawesi	Perennial crops, mining including rare ores, fishery
5	Papua	Mining including rare ores, fishery and perennial crop products
6	Bali	Services such as tourism and creative industry products
7	West and East Nusa Tenggara	Agricultural and fishery products
8	Maluku	Fishery, agriculture, and mining products

   Source: Homecare24 (2023) and Central Bureau of Statistics (2023).

Indonesia has been also trying to improve the country destination diversification by exploring new markets, called non-traditional markets.  Indonesia has strongly depended on its main export markets, called top 10 traditional markets. For example, in 2022 the top 10 are: China, The US, Japan, India, Malaysia, Singapore, The Philippine, Korea, Chinese Taipei, and Vietnam. The export value of Indonesia to these countries accounted for 73.6% of the Indonesia export total value (US$ 292 billion). The top 5 of these countries accounted to 54.1% of the total export value indicating low export diversification of country destination.

Realizing this low export diversification, the Indonesia government has tried to explore non-traditional markets mainly Africa, South and Northen America, the EU especially East and North Europe, and also Asia region, especially the Middle East Countries.  As seen in Table 5, although the traditional markets such as China and the US have high potential for export diversification, the government of Indonesia has emphasized its strategy to explore opportunities in non-traditional markets.  This option has been supported by the government real actions by negotiating an economic and trade cooperation with these countries such as Indonesia-The EU Comprehensive Economic Partnership Agreement (CEPA), Indonesia-Mercosur (Brazil, Argentina, Uruguay, and Paraguay) CEPA, Indonesia-Tunisia Preferential Trade Agreement (PTA) and Indonesia-Marocco PTA.      

Table 5. Top Markets for Potential New Products (percentage of export opportunities)

Source: UNCTAD (2023) -https://unctad.org/system/files/official-document/tcsdtlinf2022d6_id.pd 

Challenges of Export Diversification

As discussed before, Indonesia has not yet successful in improving export diversification both in term of vertical and country destination export diversification. The share of the processed products in the export value is relatively low, only 55% in 2022, while the export country destinations has been traditionally focused on 10 importing countries, contributing to 73.6% of the total value. Many studies found there are so many factors preventing Indonesia to accelerate its export diversification program, including problems of raw materials, production technology, investment climate, cost of capital, market barriers, domestic and international trade policies.  The following factors are the most important factors that are directly and significantly inhibit the export diversification program.

Lack of specific and updated market information. Available market information provided by the government, especially the Ministry of Trade, tend to be general and many occasion is less updated. On the other hand, marketing new and processed products or consumer goods require much more specific and updated information such as related to market potential, product design, trade facilitation, tariff and NTMs and specific regulations in importing countries. These problems have caused difficulties for exporters in penetrating the markets, especially for the processed product to support vertical export diversification.

Market barriers to entry.  Indonesia exporters have faced various barriers to entry the global markets especially for new or processed products for various reasons as follows: 

• Tariff escalation.  Almost all countries have applied what so called tariff escalation policy meaning that the higher the level of processing, the higher the import tariff.  In order words, processed products face higher import tariff than that of primary products.  In many occasions, the different between the two is too high so that Indonesia processed products cannot penetrate the market. This difficulty has prevented Indonesia from accelerating its vertical export diversification.
• Dominance of Multi-national companies (MNCs) on processed product markets. Many MNCs is so dominant in the global markets of processed goods such as in the food and beverages market, footwear or more sophisticated products.  They have created a barrier to entry in the form of technological (patent), capital, and market barrier. For the sake of efficiency for an example, these MNCs have applied global value chains (GVCs) approach by dividing the works among most efficient suppliers around the world. Unfortunately, the participation of Indonesian companies on GVCs has been relatively low, compared to Thailand, Malaysia, and Vietnam (Degain, Maurer, dan MacFeely, 2016; AIPEG, ADB, 2019).  In addition, using their sophisticated marketing and advertising strategies, they have really imposed a thick wall to prevent new comers entering the market. Confronted by these barriers, new comers almost impossible to enter the global market.
• Increasing use of non-tariff measures (NTMs).  After significant decreases in import tariff due to trade cooperation/liberalization, many countries have increased the uses of NTMs for various reasons such as food safety, consumer protection, and even sustainability (environment) arguments.  The EU known as the most restrictive ones, has applied 7116 NTMs, followed by the US (2786 NTMs) and China (2554 NTMs).  The increasing use of NTMs has caused new “barriers” not only faced by primary products, but even much more difficult for the new and processed products.  Food products as an example of processed products have faced various NTMs, from the source of the main raw materials, storage, transportation, labelling, and various limitations of hazardous ingredients.  This has caused a significant increase in costs and time leading to difficulty in penetrating the export market.

Key Market Strategy and Policies  

In order to overcome the challenges mentioned before, all stakeholders especially government and private sectors have to synergy in formulating and implementing effective and efficient marketing strategies and policies. The government and private sector may have a long list of strategies and policies, but they are recommended to focus on the followings:

Stipulation of good and services priority for export diversification.  The government and private sectors have to work closely in defining products and services that will be stipulated as priority (product priority).  In stipulating the product priority, the government perspective considering more complicated aspects (e.g., GDP, employment, foreign earning, government revenue, income distribution) has to be synergized with the private sector perspective which is focused on firm performance (e.g., cost, revenue, profit, market share). Thus, products and services priority have to compromise based on  these two perspectives, but competitiveness of the products has to be a mandatory condition.  Once the priority is stipulated, both parties have to consistently use the list of priority as the guidance in export diversification strategy and policies.  

Strengthening market information for products priority. The government supported by private sector has to build a kind of database containing specific and updated data regarding the market of the product priority. In formulating this market data base, the Ministry of Trade should be the focal point supported my technical ministries (e.g., Industry, Agriculture, Fishery, Forestry, Energy and Mineral Resources), the Ministry of Investment, the Ministry of Foreign Affair and private sectors represented by their commodity or product associations.

Strengthening market access through trade and economic cooperation. As market access is one of the main barriers for product diversification, Indonesia has to fully utilize ongoing and forthcoming trade and economic cooperation to open widely their market access, especially on NTMs and tariff escalation.  In addition, Indonesia has to urge its partner countries to include mutual recognition agreement (MRA) regarding to various aspect of NTMs such as certification, laboratory testing, verification, and inspection. With MRA, exporters will be able to reduce costs regarding to these activities. For example, in the Indonesia-Australia CEPA, Indonesia exporter can enjoy zero tariff for 6900 products, indicating a significant market access improvement.  In addition, trade and economic cooperation with countries in Africa, South America, East Europe, South Asia and Middle East have significantly increase Indonesia to these regions.  In 2021, Indonesia export to South Africa and East Africa increased by 138% and 57%, respectively (Ministry of Trade, 2022).

Fiscal incentive for accelerating export diversification. The government needs to provide sufficient fiscal incentives to accelerate the export growth of the priority products.  The fiscal policies could be in the form of lower import tariff for supporting inputs and  lower export tax/retribution for processed products.

Increase in the GVC participation. The companies producing the priority products have to supported to increase their GVC participation level, especially those require a big investment, high-tech and face difficulty in penetrating global market.Four important government policies to increase the GVC participation are (i) relaxation of foreign company ownership limit; (ii) relaxation in minimum local content requirement; (iii) simplification the procedure/mechanism of cooperation between foreign company and local company; and (iv) improvement on trade infrastructure capacity and quality.

Concluding Remark

As a global trend, Indonesia has implemented various strategy and policies to improve its export diversification, especially vertical and country destination ones, not much on horizontal export diversification. Various global economic shocks have taught to the policy makers that countries need to implement export diversification in order to stabilize their export performance both in term of stability and also growth.  However, the diversification policies have to be focused on competitive products implying that export diversification strategy as a complement of the export specialization strategy. 

Indonesia has a big potential in improving its export diversification because of its relative rich natural resources (agriculture, forestry, fishery, mining), many manufacture and high-tech products, services, and also creative industry products.  However, in pursuing its export diversification, Indonesia have faced various inhibiting factors, mainly market access related problems. Therefore, the government working together with private sectors are recommended to strengthen its market strategies and policies, mainly by on stipulation of product priority for export diversification, strengthening market information system, strengthening market access through effective trade and economic cooperation, fiscal incentive, and improving its GVCs participation level.

 WRS/1 Nov 2023