Services Trade in Indonesia

4. Reform scenarios

Abstract

This chapter uses the OECD STRI to present potential reform packages that target services trade in Indonesia and examines their possible impact on the Indonesian economy.

Key points

• The OECD STRI offers extensive information to identify policy measures that would reduce services trade restrictions in Indonesia and facilitate the design of reform packages. Reform packages targeting horizontal policy measures can reduce the STRI score for most services sectors covered by the STRI in Indonesia. Other examples of reform scenarios using sector-specific policy measures can have a stronger impact on the targeted sectoral STRI scores.

• Many important reforms have been implemented in recent years, and enhancing these would substantially benefit firms and consumers in Indonesia. Reform packages could reduce trade costs by significant amounts. Indeed, the most ambitious reform package targeting legal services could cut services trade costs by 71%.

• Removing barriers to services trade can have positive effects along supply chains, boosting the productivity performance of manufacturing firms and sectors that use services intensively as intermediate inputs.

From a policy perspective, identifying reforms can be a daunting task, especially when it is not sufficiently clear where reforms are most needed and what benefits these may bring to domestic firms and consumers. The STRI regulatory database and indices enable policy makers to identify services sectors where reform could be undertaken and simulate the potential impacts of such reforms on the index values. In turn, the simulated indices can be used in empirical analysis to understand a reform’s likely impact on key variables such as trade cost reductions or productivity increase in manufacturing industries downstream in the supply chain. This chapter explores two types of potential reform scenarios for Indonesia: on a horizontal level to assess the scope for economy-wide reforms that affect all sectors, and secondly in selected services sectors of key importance such as transport, logistics, and communication services. The selection of measures included in the scenarios are based on whether there is currently a restriction in place for those measures and whether a prospective reform measure could progressively take place through policy action.

4.1. Description of the reform packages

Horizontal reform packages can be impactful as they apply across all sectors in the economy with potential spill-over effects going beyond services industries. Table 4.1 illustrates horizontal measures that currently reflect some degree of restrictiveness in Indonesia (Chapter 3). The action on the measures listed would hypothetically lower the measure specific STRI score to zero for all sectors. This represents the horizontal reform scenario.

Table 4.1. Reform scenario: List of horizontal measures where reforms could be made in Indonesia

Remove requirement that managers must be national

Ease restrictions on acquisition and use of land and real estate by foreigners

Lift performance requirements

Lift commercial presence requirements

Remove labour market tests or similar economic considerations for intra-corporate transferees, contractual and independent services suppliers

Ease preferences for local suppliers in public procurement

Source: OECD STRI Regulatory database 2023.

Developing reform scenarios beyond the horizontal one is contingent on selecting those sectors that are relevant for Indonesia’s services trade, have the greatest potential for innovation, and create scope for participation in global value chains for Indonesian firms. As such, services such as transport and logistics are important sectors to consider. Moreover, some services are key for a large number of business activities and support competitiveness in other sectors. For example, telecommunications and legal services are among the most widely used services inputs across all business activities. Consideration should also be given to Indonesia’s domestic and regional trade strategies and priorities in order to maximise the benefits of implementing these reforms in the future. Table 4.2 presents the measures proposed for the reform scenarios for air and maritime transport, logistics cargo-handling services, telecommunications services, and legal services.

The left-hand side charts in Figure 4.1 and Figure 4.2 below display the changes in the sectoral STRI scores implied by the horizontal and sector-specific reform scenarios, respectively.

Table 4.2. Reform scenario: List of sector-specific measures where reforms could be made in Indonesia

Maritime transport
Remove foreign equity restrictions
Remove limits to the proportion of shares that can be acquired by foreign investors in publicly-controlled firms
Ease measure that requires operation through joint ventures only
Remove restrictions to own and/or register vessels under national flags
Improve access to cabotage for foreign vessels
Lift statutory monopoly on port services
Lift local presence requirements
Remove exclusive rights for port concessions to operate the port infrastructure
Air transport
Remove foreign equity restrictions
Remove limits to the proportion of shares that can be acquired by foreign investors in publicly-controlled firms
Remove restrictions on legal form
Lift exemption for publicly-controlled firms from the application of the general competition law
Improve competitive allocation and exchange of airport slots
Remove price regulation on domestic routes
Logistics cargo-handling
Remove limits to the proportion of shares that can be acquired by foreign investors in publicly-controlled firms (air, ports, road and rail)
Ease measure that requires operation through joint ventures only
Lift exemption for publicly-controlled firms from the application of the general competition law (cargo-handling at airports, ports, road and rail
Remove price regulation
Improve accounting separation and limit cross-subsidisation
Telecommunications
Remove limits to the proportion of shares that can be acquired by foreign investors in publicly-controlled firms
Ease conditions on subsequent transfer of capital and investments
Monitor and adjust ex ante competition rules in mobile segment
Legal services
Remove foreign equity restrictions to practice international law
Remove equity restrictions applying to not licensed individuals or firms in international law
Remove prohibitions on hiring locally-licensed lawyers
Remove nationality or citizenship requirements to practice international law

Source: OECD STRI Regulatory database 2023.

4.2. Description of impacts

The cumulative effect of implementing both horizontal and sector-specific reform scenario as described above could lead to a 50% decrease in the average STRI for 22 services sectors covered by the STRI index. Section 4.2 illustrates what this could mean for Indonesia’s trade costs and productivity.

Services trade reforms can have large and positive economic impacts. An initial direct effect of removing policy restrictions to services trade can materialise through lower services trade costs. This is important given that services trade remains subject to higher trade costs compared to agriculture and manufacturing, especially in emerging economies (WTO, 2019[1]). Regulatory restrictions to services trade as captured by the sectoral STRI scores for Indonesia imply very high trade costs for the corresponding sectoral services trade flows.

One approach to quantify the potential benefits of reforms is to estimate the trade cost reduction associated with a lower STRI score. Based on the methodology applied in Benz and Jaax (2020[2]), the estimated trade cost reductions for the Indonesian sectors analysed ranged from 9% for accounting services to 29% for insurance services (Figure 4.1).

Figure 4.1. Horizontal measures reform scenario

 

 

Note: Percentage reductions in trade costs are based on changes in ad valorem equivalents (AVE) of STRI scores. The AVE of an STRI score for Indonesia is the uniform ad valorem tariff rate (expressed as a percentage of the price) that, if applied by Indonesia to the relevant trade flow, would result in the same estimated reduction of services imports by Indonesia due to the regulatory barriers reflected in its STRI score. The following sectors were not covered in the estimations due to lack of data: broadcasting services, construction services, distribution services, motion pictures and sound recording services. In legal services, changes in the horizontal measures have no implication due to a combination of sector specific barriers that effectively close the market for international trade.

Source: OECD STRI database 2023. Trade costs calculations based on methodology in Benz and Jaax (2020).

The scenario developed from the horizontal reform package described in Section 4.1 is associated with economically significant trade cost reductions for the majority of the covered sectors. As illustrated by Figure 4.1, the highest gains are estimated for the two financial services sectors, where the horizontal reform package could lead to a decrease in trade costs of almost 30%.Computer and courier services follow with trade cost reductions of just around 20%. A small impact is estimated for accounting services and legal services. For the latter, there is no trade cost reduction estimated as the hypothesised horizontal reform package would not lead to any reduction in the STRI score given that foreign companies cannot establish law firms in Indonesia and Indonesian nationality is required to obtain a license to practice. These two sector specific barriers effectively close the market to international trade, with the result that the horizontal reform package has no impact on the regulatory regime.

The case of legal services in Indonesia provides a good reason to assess the potential impact of reform packages that go beyond horizontal measures. The most critical barrier to foreign entry in legal services is the exclusion of foreign equity from legal firms operating in the country. Relaxing this restriction on foreign equity would have a significant effect in and of itself, although policy measures that would allow foreign firms to provide legal services would enable greater benefits. In terms of estimated reduction in trade costs, the hypothesised reform package specific to legal services is associated with trade cost reductions of 71%. While smaller, the estimated trade cost reductions associated with the other sector specific reform packages imply significantly lower trade costs for telecommunication, maritime and air transport services, and logistics cargo-handling services (Figure 4.2).

Lower services trade costs can have implications that go beyond the targeted services sector. Given the prominent role of services as intermediate inputs across manufacturing sectors, reducing services trade costs also means facilitating access of manufacturing firms’ to international markets of key intermediate inputs, such as financial services, telecommunication or transport services. Under the assumption that international markets can offer a greater variety of services at a lower quality-adjusted cost, reforms that remove policy restrictions to services trade can positively impact the economic performance of Indonesia’s manufacturing firms. The variety, quality, and cost of services available to manufacturing firms can help determine their productivity.

A growing body of empirical evidence shows that when restrictions on (upstream) services trade are lifted, the performance of (downstream) firms and sectors using services intensively in their production processes improves.1 Joint work by the Economic Research Institute for ASEAN and East Asia (ERIA) and the OECD provides an in-depth analysis of this spillover effect with a review of selected studies from the relevant body of empirical research (Zen et al., 2023[3]). This joint work provides new estimates for empirical linkages between removing restrictions to trade in financial services and firm-level productivity in Indonesia. The analysis by Zen et al. (2023[3]) uses firm-level data sourced from Indonesia’s census of medium and large manufacturing firms and shows that lower barriers to financial services trade in Indonesia are associated to economically and statistically significant increases in the productivity of firms that rely on financial services as intermediate inputs. Zen et al. also find that restrictions to financial services trade can exert a more pronounced impact among the smaller firms in their sample. Due to the fixed cost nature of many services trade barriers, eliminating these restrictions will disproportionately favour smaller firms that, due to their limited scale, generally have fewer incentives and resources to cover these fixed costs.

Figure 4.2. Sector-specific measures reform scenario

 

 

Note: Percentage reduction in trade costs are based on changes in ad valorem equivalents of import values.

Source: OECD STRI database 2023.Trade costs calculations based on methodology in Benz and Jaax (2020[2]).

Looking beyond policies that target financial services, other OECD analysis extends the investigation of the spillover effects of regulatory reforms to several services sectors (Benz et al., 2023[4]). Using the OECD STRI as a measure of services trade policy reforms, and data on labour productivity for 17 manufacturing sectors in 44 economies2 during the five-year period 2014-2018, Benz et al. (2023[4]) find positive, economically and statistically significant linkages between removing services trade restrictions in financial services, air transport and telecommunication services, and with labour productivity of manufacturing sectors that use these services as intermediate inputs. Their estimates can be used to quantify the productivity increases associated with some of the reform packages described in Section 4.1. Figure 4.3 and Figure 4.4 display the estimated changes in labour productivity corresponding to the horizontal and the sector specific reform packages in air transport and telecommunication services, respectively. More precisely, they show how these estimated changes would increase productivity in Indonesian manufacturing sectors from its average level computed over the period 2014-2018.3

Figure 4.3. Downstream effect on productivity in Indonesia’s merchandise sectors: Air transport services scenarios

 

 

Note: The maximum and minimum productivity estimates post-scenario are based on 90% confidence intervals. Labour productivity is measures as value added (in thousands current US dollar) per employee. The sector of coke and refined petroleum products features outlier values of labour productivity and is removed from this quantification exercise.

Sources: OECD STRI database 2023. Trade costs calculations based on the methodology presented in Benz et al. (2023[4]). Data on labour productivity in Indonesia are sourced from the OECD Trade in Employment (TiM.) database.

Figure 4.4. Downstream effect on productivity in Indonesia’s merchandise sectors: Telecommunications services scenarios

 

 

Note: The maximum and minimum productivity estimates post-scenario are based on 90% confidence intervals. Labour productivity is measures as value added (in thousands current US dollar) per employee. The sector of coke and refined petroleum products features outlier values of labour productivity and is removed from this quantification exercise.

Sources: OECD STRI database 2023. Trade costs calculations based on the methodology presented in Benz et al. (2023[16]). Data on labour productivity in Indonesia are sourced from the OECD Trade in Employment (TiM.) database.

Estimated productivity increases are economically significant. Lower barriers to trade in telecommunication services following the hypothesised horizontal reform package, are associated with an estimated average increase in labour productivity across manufacturing sector of 8%. This figure raises to 30% when considering the sector-specific reform package for telecommunication. The reduction in the STRI score for air transport implied by the horizontal reform scenario is associated with an 18% average downstream productivity increase, while the estimated average productivity increase corresponding to the sector specific reform package for air-transport is equal to 19%.

Estimated downstream productivity increases are very large for several manufacturing industries. For example, the reduction in barriers to air transport trade embedded in the sector specific reform package are expected to increase productivity by 42% for the set of economic activities in the sector labelled “Furniture, other manufacturing”, which includes activities such as “manufacture of medical and dental instruments” as well as “installation of industrial machinery and equipment”. The average labour productivity of this sector in Indonesia over the period 2014-2018 is roughly USD 4 000 of value added per employee, the third lowest values across the 17 manufacturing sectors covered in the analysis. The estimated productivity change associated with the hypothesised reform package could bring labour productivity in the sector from the baseline level of USD 3 700 to a post-reform value between USD 4 700 and USD 6 200 (Figure 4.3, Panel 2). Increased openness to trade in air transport services is expected to be advantageous for the transportation of high-value-to-weight ratio goods and for business travel by engineers and managers in these manufacturing industries.

Moving to the reform packages for trade in telecommunications services (Figure 4.4), the simulation foresees steep increases in labour productivity within the "Computers, electronic and optical products" manufacturing sector. In the case of the sector-specific reform package (Figure 4.4, Panel 2), the hypothesised policy change would increase labour productivity of that manufacturing sector from a baseline level of USD 13 000 of value added per employee to a post-reform level of between USD 16 400 and USD 27 400 value added per employee, making this sector the fifth best performer in Indonesia in terms of labour-productivity. This outcome underscores the significant contribution of telecommunications services in furnishing the foundational infrastructure for contemporary information and communication technology.

The estimated trade cost reductions and productivity increases associated with services trade reforms presented in this section are indicative and subject to the methodological caveats that are extensively discussed in the technical literature. However, they provide a strong signal in support of a positive role of an open regulatory framework in services sectors for economic development in Indonesia.4 While this signal can inform policy design, the literature points to the existence of significant heterogeneity in the impact of services reforms, something which is still largely unexplored.

Indeed, regulatory changes that target services sectors do not happen within silos and their outcomes can be influenced by interactions with other aspects of the policy and economic landscape in the reforming country.5 For example, broad aspects of governance institutions (e.g. the control of corruption, regulatory quality, and the rule of law) in a country implementing services trade policy reforms can be crucial in triggering positive spillover effects of increased openness to services trade (Beverelli, Fiorini and Hoekman, 2017[5]). Building on this finding, Beverelli, Fiorini and Hoekman (2019[6]) show how weak governance institutions can limit the downstream effects of ambitious policy reforms targeting Mode 3 services trade for ten economies in the East Asian region, including Indonesia.6 One implication in the context of services reform design is that the objective of removing restrictions to services trade should not be pursued in isolation, but accompanied by efforts to identify other relevant barriers that could prevent economic actors taking full advantage from greater openness. Detailed priorities and solutions cannot be pre-determined, however; they require analysis and deliberation by government officials, regulators, and stakeholders, including the private sector. Recent developments to tackle corruption, reduce bureaucracy and improve the regulatory framework for investors documented by the OECD 2020 Investment Policy Review of Indonesia are important efforts in the right direction (OECD, 2020[7]).

4.3. Concluding remarks

Based on the detailed policy measures in the OECD STRI database, this chapter has presented a portfolio of possible reform packages that would remove some of the main restrictions to services trade in Indonesia. An illustrative reform package focusing on policy measures targeting all services leads to a decrease in the STRI score across nearly all services sectors in Indonesia. Tailored reform scenarios that have sector-specific policy measures have a greater impact on the STRI scores of targeted sectors.

Reform packages have been assessed in terms of their potential impact on the Indonesian economy. By mapping STRI score reductions with estimated percentage changes in trade costs, this chapter has documented how services trade reforms can significantly reduce the high trade costs embedded in the regulatory restrictions across Indonesian services sectors. Lower services trade costs increase access to services for consumers and businesses. Building on methods and results from a growing body of empirical evidence, the present analysis has also shown the strong potential for services trade reforms to boost labour productivity of manufacturing sectors.

The hypothesised reform packages proposed here and the analysis of their possible impact on the Indonesian economy can help inform policy action to ensure an open and competitive services sector in line with the APEC Services Competitiveness Roadmap, and ultimately to leverage the potential of services trade as a driver of economic growth and development in Indonesia.

References

[8] Ahsan, R. (2013), “Input tariffs, speed of contract enforcement, and the productivity of firms in India”, Journal of International Economics, Vol. 90/1, pp. 181-192, https://doi.org/10.1016/j.jinteco.2012.11.006.

[11] Arnold, J. et al. (2015), “Services Reform and Manufacturing Performance: Evidence from India”, The Economic Journal, Vol. 126/590, pp. 1-39, https://doi.org/10.1111/ecoj.12206.

[10] Arnold, J., B. Javorcik and A. Mattoo (2011), “Does services liberalization benefit manufacturing firms?”, Journal of International Economics, Vol. 85/1, pp. 136-146, https://doi.org/10.1016/j.jinteco.2011.05.002.

[12] Arnold, J., A. Mattoo and G. Narciso (2008), “Services Inputs and Firm Productivity in Sub-Saharan Africa: Evidence from Firm-Level Data”, Journal of African Economies, Vol. 17/4, pp. 578-599, https://doi.org/10.1093/jae/ejm042.

[13] Barone, G. and F. Cingano (2011), “Service Regulation and Growth: Evidence from OECD Countries”, The Economic Journal, Vol. 121/555, pp. 931-957, https://doi.org/10.1111/j.1468-0297.2011.02433.x.

[14] Bas, M. (2014), “Does services liberalization affect manufacturing firms’ export performance? Evidence from India”, Journal of Comparative Economics, Vol. 42/3, pp. 569-589, https://doi.org/10.1016/j.jce.2013.06.005.

[2] Benz, S. and A. Jaax (2020), “The costs of regulatory barriers to trade in services: New estimates of ad valorem tariff equivalents”, OECD Trade Policy Papers, No. 238, OECD Publishing, Paris, https://doi.org/10.1787/bae97f98-en.

[4] Benz, S. et al. (2023), “Right here, right now? New evidence on the economic effects of services trade reform”, OECD Trade Policy Papers, No. 271, OECD Publishing, Paris, https://doi.org/10.1787/1159657f-en.

[5] Beverelli, C., M. Fiorini and B. Hoekman (2017), “Services trade policy and manufacturing productivity: The role of institutions”, Journal of International Economics, Vol. 104, pp. 166-182, https://doi.org/10.1016/j.jinteco.2016.11.001.

[15] Bourlès, R. et al. (2013), “Do Product Market Regulations in Upstream Sectors Curb Productivity Growth? Panel Data Evidence For OECD Countries”, The Review of Economics and Statistics, Vol. 95/5, pp. 1750-1768, https://doi.org/10.1162/rest_a_00338.

[9] Fiorini, M. and B. Hoekman (2018), “Services trade policy and sustainable development”, World Development, Vol. 112, pp. 1-12, https://doi.org/10.1016/j.worlddev.2018.07.015.

[16] Hoekman, B. and B. Shepherd (2015), “Services Productivity, Trade Policy and Manufacturing Exports”, The World Economy, Vol. 40/3, pp. 499-516, https://doi.org/10.1111/twec.12333.

[6] Ing, L., M. Richardson and S. Urata (eds.) (2019), The impacts of services trade restrictiveness on the productivity of manufacturing sectors in East Asia, Routledge, London, https://doi.org/10.4324/9780429433603.

[7] OECD (2020), OECD Investment Policy Reviews: Indonesia 2020, OECD Investment Policy Reviews, OECD Publishing, Paris, https://doi.org/10.1787/b56512da-en.

[1] WTO (2019), World Trade Report 2019: The Future of Services Trade, https://www.wto.org/english/res_e/publications_e/wtr19_e.htm.

[3] Zen, F. et al. (2023), “Financial Services Trade Liberalisation in Indonesia: Policy Patterns and Economic Linkages”, ERIA Research Project Report 2023 No 21, https://www.eria.org/publications/financial-services-trade-liberalisation-in-indonesia---policy-patterns-and-economic-linkages.

Notes

← 1.  See, for example, Arnold, Mattoo and Narciso (2008[12]); Arnold, Javorcik and Mattoo (2011[10]); Arnold et al. (2015[11]); Barone and Cingano (2011[13]); Bas (2014[14]); Bourlès et al. (2013[15]); Hoekman and Shepherd (2015[16]); Beverelli, Fiorini and Hoekman (2019[6]); and Benz et al. (2023[4]).

← 2.  The sample covers all OECD countries, as well as Brazil, The People’s Republic of China, India, Indonesia, Russian Federation, and South Africa.

← 3.  Labour productivity is measured as value added per employee (in thousands of current USD), based on data from the OECD TiVA database and the OECD Trade in Employment (TiM) database (Benz et al., 2023[4]).

← 4.  Sustainability dimensions of the Indonesian economy will also likely be affected by services trade reforms. Reduced policy barriers to services trade can positively impact Indonesia’s sustainability performance by increasing the availability and quality of services that are relevant to the process of achieving sustainable development goals. Indicative findings in the literature show a negative correlation between services trade restrictiveness and poverty reduction, life expectancy, gender equality, access to water, and reduction of CO2 emissions (Fiorini and Hoekman, 2018[9]). Further research is required for a more robust empirical assessment of these relationships.

← 5.  Discussions on the methodological caveats in the empirical assessments of the impact of services trade reforms is found in Benz and Jaax (2020[2]) and Benz et al. (2023[4]). The latter underscore and partially investigate the heterogeneity in the effects of services trade reforms.

← 6.  In a similar vein, Ahsan (2013[8]) studied the effect of removing trade barriers to the importation of intermediate (goods) inputs on the productivity of Indian firms. Greater productivity gains are observed in those Indian states where the judicial system is more efficient, suggesting that complementary reforms that increase the speed of contract enforcement can bolster the positive effect of a trade policy reform designed to provide domestic firms with greater access to foreign inputs.