EAST JAVA ECONOMY

EAST JAVA’S SAGA OF MISSED CHANCES
© Duncan Graham 2006

East Java was once the province with most promise.

It was the nation’s second most important industrial powerhouse, a forest of smokestacks, a roar of turbines. Raw materials from across the archipelago poured ceaselessly into the maws of the manufacturing giants; they emerged as glittering goodies and enticing edibles for the world.

The province had a skilled workforce and an abundance of natural resources. It enjoyed high productivity and consistently outpaced national growth figures.

This was despite a lower level of international investment compared to West Java and Jakarta.

Like all South-East Asian economies East Java was slugged hard by Krismon (the economic crisis of eight years ago). A temporary setback. The province might be on the ropes but it had the corporate muscle, tenacity, experience and enough capital to bounce back as king of the ring.

Or so said the corporate screen jockeys juggling data and finessing forecasts.

They were wrong according to a new report that claims East Java has fumbled the chances for a comeback and lost many opportunities to get ahead in the big league.

Equivocating bureaucrats, shortsighted planners, nail-biting investors and fearful businesspeople have all allegedly contributed to East Java falling behind other provinces.

The report was written by Bambang-Heru Santosa from the Central Bureau of Statistics in Jakarta, and Heath McMichael from the Australia-Indonesia Partnership for Reconstruction and Development.

“Surabaya’s failure to establish strong linkages with international capital and markets stymied industry diversification in East Java,” said the authors. “This retarded flows of foreign and domestic direct investment to East Java’s manufacturing sector.”

By comparison, Penang in Malaysia and Cebu in the Philippines – strategically located cities similar to Surabaya - have prospered since Krismon. That’s because they’ve attracted international capital and been smart enough to create new export industries, particularly in electronics.

East Java failed to diversify its manufacturing base that relies mainly on food, drinks and tobacco products – primarily for domestic consumption. About 70 per cent of the industrial labor force works in these areas.

These products are the most vulnerable to competition from other Asian countries where production costs are lower.

East Java has a population of 35 million, which is a huge local market by any standards outside China. It is also a major primary producer; 35 per cent of the food on the nation’s table comes from this one province.

While Surabaya slumbered other industrial cities used Krismon to update equipment, introduce modern technology, build new infrastructure and seek fresh markets.

In East Java infrastructure suffered through inattention to upgrading and modernisation. Improvements focussed on the SUGRESID (Surabaya, Gresik and Sidoarjo) region. This has left other parts of the province suffering from clogged highways and rutted roads.

LOSERS AND WINNERS

Industries that have lost heavily include leather processing (Sidoarjo) and footwear (Mojokerto), both undercut by China and Vietnam where labor costs are lower.

PT Panen Raya, a leather shoemaker closed six of its seven factories in the Surabaya region in 2002, including its largest manufacturing unit in Sidoarjo, and by early 2003 operated only one factory.

Managers also blamed new labour laws that require substantial payouts for dismissed workers for the closures.

“Furniture manufacturing has suffered a similar decline,” said the authors. “Bojonegoro and Pasuruan are the main centres for teak furniture production.

“In recent years the industry in Pasuruan has suffered because of rising raw material prices – sixty per cent more than the Perhutani forestry company basic price.

“Rising timber prices have both reduced the number of craftsmen fashioning furniture in Pasuruan, in comparison with the number of furniture traders, and led to a decline in the quality of finished furniture.”

However it’s not all gloom. The winners include food processors like PT Pangan Lestari, part of Sekar Group. Up to 40 per cent of the company’s principal lines are exported, mainly to Korea, Japan, Europe and New Zealand.

PT Eratex Djaja manufactures clothing including high quality jeans that are finding a ready market despite intense competition. In the past two years the workforce has increased from 3,500 to 5,000 to meet demand.

There have also been success stories in electronics manufacturing, particularly for the multi-faceted Maspion Group which employs 30,000.

But this is a fickle industry forever ready to up-roots and flee to any country offering better tax breaks, fewer bureaucratic hassles and cheaper workers.

PROBLEM POINTS

Focus group discussions held by the World Bank with the private sector in East Java highlighted infrastructure as “a significant business constraint.”

As every Surabaya commuter knows, this was just stating the bone-jarring, temper-testing, bleeding obvious.

The frequently crowded toll road south was originally planned to reach Malang 85 kilometres from Surabaya. But it peters out after 25 km. into a congested, badly-formed highway shared with local markets, schools and factories.

The toll road extension to Juanda international airport comes to a sudden halt because land purchase difficulties remain unresolved. The Suramadu bridge linking the capital to Madura island (see The Jakarta Post 3 February 2006) is years behind schedule.

The Tanjung Perak seaport suffers from heavy siltration – though this doesn’t affect the container terminal.

The rail system is considered so inefficient that very few containers take to the tracks. Around 2,000 a day are hauled by slow moving trucks. The fleet is old and poorly maintained – congesting the roads and polluting the already filthy air.

Regular power black-outs have forced many factories to install their own generators, adding to start-up costs.

Banks in East Java haven’t helped. Most of their business has been in retail banking rather than providing credit for small to medium businesses.

Up to 80 per cent of the regional government’s budget is used to maintain routine activities – including paying public servants - leaving only 20 per cent for new projects.

The right ratios, says the business lobby, are 40 and 60 per cent.

LEVIES LEGAL AND OTHERWISE

The report says that the “perceived hidden cost of investing” may be a factor that’s stymied growth.

One survey found that illegal levies were a serious problem. Reported the authors: “In Sidoarjo up to 36 per cent of manufacturing enterprises were aware of some form of levy imposed by local police while 27 per cent of businesses claimed to have been targeted by ‘social organisations’ soliciting donations.”

Decentralisation has given the regions more power. This has also become a synonym for fresh opportunities to relieve investors of their cash through regulations and local levies known as Pendapatan Asli Daerah. (PAD).

“Many regulations duplicate those issued by Kabupaten and Kotamadya (sub region and district) governments,” said the authors.

“As a result, many economic activities are doubly burdened with identical or similar levies.

“Food manufacturer Nestle paid up to Rp 80 million (US $9,000) to fulfil a local government requirement to renew a ‘disturbance permit’.

“There’s a danger that PAD levies will become an impost on the most profitable industries, such as cigarette manufacturers. PT Gudang Garam (Indonesia’s highest corporate taxpayer) contributes Rp 5 billion (US $500 million) to Kabupaten Kediri’s coffers each year in local taxes.”

The East Java economy is heavily dependant on kretek cigarette manufacturing mainly for domestic consumption. Elsewhere this is a dying industry – literally and metaphorically - as public health advocates push governments to crack down on tobacco sales.

However Indonesia is one of the few nations not to sign the World Health Organisation’s Convention on Tobacco Control. The government seems set to leave the industry in peace and profit, so the urge to diversify and build export markets is absent.

“The story of manufacturing industry in East Java is basically one of failure to take advantage of considerable resource endowments and diversify into international markets,” say Santosa and McMichael.

“Since the Asian financial crisis, East Java’s manufacturing sector has not performed as well as other similarly well-endowed regions in Southeast Asia and has fallen behind some other provinces of Indonesia in comparative terms.

“The province’s considerable physical infrastructure endowments; the educational level of attainment of its population; and its public sector tradition of sound economic and financial management stand out as factors that should have propelled East Java manufacturing to a position of regional if not international significance.”

GIVE YOUTH A CHANCE

US-educated businessman Gatot Irianto is a serious enthusiast for change.

“There’s maybe two million unemployed in East Java and the number is growing,” he said. (The workforce is about 24 million)

“We have to develop the entrepreneurial capacity of our people. This is our major concern.”

East Java Inc. is a scheme to change the mindset of people who wait for someone to provide them with a job, and are then content to hold that position till pension day.

The scheme, organised by the East Java Chamber of Commerce and Industry (KADIN), has already put 1,500 young people though its courses and workshops.

“Believing we’re not good enough is part of the heritage from the Dutch era,” said Gatot, a furniture exporter and vice chair of KADIN’s business network development unit. “The colonialists suppressed our creativity and our education system is feudal

“This is social engineering on a big scale. We’re doing this because we’re concerned about the future that is going to get tougher and tougher.

“The national government is trying to lure overseas investors, but what about encouraging local investors?

“The government keeps saying we must employ more and more people, but the future is towards technology.

“The government is still inside its coconut shell. It must decide where it’s going – and if it wants to develop opportunities it should let the private sector take over.”


SURVIVAL OF THE FITTEST

Despite the busy cranes nodding across Surabaya erecting more and more malls for hard-pressed consumers to go window-shopping, there’s no hiding the victims of Krismon.

Their rain-stained, rusting skeletons stand tall on the skyline, corroding monuments to what might have been.

Contractor Erlangga Satriagung has a terse one-line response to the question: How did you survive when so many fell?

“I’m a businessman,” the KADIN chairman replied gruffly.

Certainly Krismon showed that Darwin’s theory of evolution applies equally in the concrete jungle as it does in the forests and oceans.

“We don’t accept all the criticisms of the (Santosa McMichael) report and we are addressing many of the issues, like the bureaucratic difficulties with regional administrations,” he said.

“There is a problem with gas supply for industry and this has to be fixed. There are big plans for a petro-chemical plant and fertiliser industries – but there’s clearly not enough investment.

We have good relations with the government but it must become pro-business. That attitude also has to go down to the district administrations.

“This is the downside of decentralisation. Local governments think they can do anything, but most just don’t understand business.”

(First published in The Jakarta Post 27 February 2006)