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Globalization and the Automotive Industry:
Is Indonesia missing out?
Abstract
International trade in automotive and auto parts has grown rapidly during the last two decades but
Southeast Asia largest economy, Indonesia, is lagging behind in its export performance. This paper uses
comparative perspective in examining Indonesia's role in automotive production networks in the context of
the contemporary debate on opportunities for reaping gains from economic globalization through
engagement in global production sharing. Panel data regression on all countries for period 1988-2007 isapplied to analyse factors affecting a country’s participation in global production networks. The regression
result suggests that a country's ability to gain from global production sharing depends more on the service
link factors than production cost factors. Indonesia is indeed left behind in export side but not on the
import side of the global production network. The major factors which affect Indonesian condition are the
costly business practice and low quality of institutions and legal certainty which discourage foreign
investor
Keywords: automotive, auto parts, globalization, product fragmentation, global production networks,
Indonesia, Thailand.
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I. Introduction
International trade in automotive and auto parts is growing rapidly in the last two decades where
the growth of automotive production reached the highest annual growth during the period 1989-
2000 with almost 5% growth per annum. There is a shift in a global production pattern from the
North America and European countries dominance in 1960 to Japanese dominance in 1970s and
1980s. And for the last twenty years some developing countries increased their production shares in
global market.
The participation of developing countries in automotive industry was made possible by the
technology development and innovations in telecommunication and transportation, which enable
automotive industry to fragment the production process into smaller segments in which
components of productions or assemblies can be relocated to different places based on cost
advantages. The relocation of segmented production process creates global production networks.
However Indonesia as the largest economy in Southeast Asian seems to miss out the opportunity to
reap gains from the globalization in the automotive industry.
This paper examines from a comparative perspective Indonesia's role in automotive production
networks in the context of the contemporary debate on opportunities for reaping gains from
economic globalization through engagement in global production network. Automotive industry is
considered as vital ingredients in national economic development strategies therefore government
involvement in automotive industry is quite intense. Therefore it is necessary to evaluate the role of
government policies in Indonesia on the development of the industry. Analysis on the dynamics of
Indonesian automotive industry is important to ascertain the impacts of government regulation on
the industry and determine Indonesian position in the global automotive industry.
A pooled panel data regression is undertaken to determine the factor affecting countries'
participation in production network in the automotive industry which has become increasingly
globalized over the past two decades. The regression result suggests that a country's ability to gain
from global production sharing depends crucially on labour cost as well as the quality of institutions
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explaining the global production networks. Section 4 describes Indonesian automotive industry and
its position on global automotive production and trade. Section 5 presents the analytical framework
which includes model specification, variable constructions and data, and estimation method. Section
6 reports the result and discussion. Section 7 concludes.
II. Globalization in Automotive Industry
The automotive industry is one of the biggest in the world and employs more than eight million
people making the vehicles directly, and more than forty million people indirectly through related
manufacture and services sectors (OICA, 2007). In principle, the automotive industry is an assembly
industry, where more than a thousand parts and components are produced by independent
industries. Dicken (2003) categorized the major processes in the automotive industry prior to the
final assembly process into the manufacture of bodies, of components and of engines (as shown in
Figure 1).
Figure 1:
MAJOR
SUPPLYING
INDUSTRIES
Bodies
Components
1. Manufacture of mechanical and electrical
components (e.g. Instruments, carburettors,
braking systems, steering components, etc)
2. Manufacture of wheels, tyres, seats,
windscreens, exhaust systems, etc.
Engines and transmissions
Consumer
Market
Final
Assembly
Manufacture
and stamping of
body panels
Body
assembly
and painting
Steel and other
metals
Rubber
Electronics
Plastic
Glass
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assembly line developed by Henry Ford in 1913. During the 1920s the US car production contributed
84% of world car production and in 1929 it started to export 10% of its production, which
accounted for 35% of the world market. The expansion of the US production urged the European
governments to protect their domestic car producers and promote their national automotive
industries.
The second transformation occurred at the end of 1950s with the implementation of the General
Agreement of Tariff and Trade (GATT). The significant reduction in tariffs integrated the markets
and enabled the European automotive producers to expand their markets with their specialization
on small cars which were energy-efficient. At the beginning of the 1980s the US’s domination of the
world’s automotive producers started to decline, while European production increased.
The third transformation occurred in the 1970s when Japan started to penetrate the world market
with their new lean production system. This new system enabled Japan to produce automotive more
efficiently compared to the US and Europe, with far fewer employees and a “just-in-time” system
compared to the “just-in-case” system operating in the US. The expansion of the Japanese automotive
industry threatened domestic production in the US and Europe and urged the US and European
governments to apply interventionist policies such as import quotas, tariffs and Voluntary Export
Restriction (VER). The differences between craft production, Fordist mass production and Japanese
lean production is summarized in Table 1.
Since 2000 China became one of the major car producers in the world and since 2008 it replaced
Japan’s position as the second largest car producer. India also shown significant growth in their car
production and its share in the global car production increased significantly from 1.5% in early 2000
to almost 5% in 2010.
Along with the continuous transformation, global automotive production experienced a change of
pattern as shown in Table 2. Global production of automobiles was dominated by North America and
European countries in 1960. North America contributed more than 50% of automotive production
while European countries shared almost 40% of global production or around 13 thousand units. The
US d G h i d f bil d i h i d D i h 1970
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5
Table 1: Comparison among Craft Production, Fordist Mass Production and Japanese Lean Production
Characteristics Craft Production Fordist Mass Production Japanese Lean ProductionTechnology Simple, but flexible tools and
equipment using un-standardized
components
Complex, but rigid single-purpose
machinery using standardized component.
Heavy time and cost penalties involved in
switching to new products
Highly flexible methods of production
using modular component systems.
Relatively easy to switch to new
products
Labour Force Highly skilled workers in most
aspects of professional production
Very narrowly skilled workers design
products but production itself performed by
unskilled/ semi skilled “interchangeable”
workers. Each performs a very simple task
repetitively and in a predefined time and
sequence
Multi-skilled, polyvalent workers
operate in teams. Responsibilities
include several manufacturing
operations plus responsibility for
simple maintenance and repair
Supplier relationships Very close contract between
customer and supplier. Most
suppliers located within a single city.
Distant relationship with suppliers, both
functionally and geographically. Large
inventories held at assembly plant ‘just in
case’ of disruption of supply
Very close relationship with a
functionally tiered system of
suppliers. Use a ‘just in time’ delivery
systems encourages geographical
proximity between customers and
suppliers
Production volume Relatively slow Extremely high Extremely high
Product variety Extremely wide – each product
customized to specific requirements
A narrow range of standardized designs
with only minor product modifications
Increasingly wide range of
differentiated products
Source: Dicken (2003), table 4.2
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An important characteristic of the auto parts is that there are few fully generic parts and
components which can be used in a wide variety of final products without extensive customization
such as in the electronics industry. This characteristic limits auto parts firms in reaching economies
of scale in production and economies of scope in design. The relationship between auto parts
suppliers and car assemblers are typically captive and relational. Many components are relatively
heavy compares to electronics industry therefore relocation to close proximity is preferable to a
more distant location. This condition leads to agglomeration in the automotive industry.
Sturgeon et al (2008) argue that the dispersion of the automotive industry has a nested geographical
and organizational structure. Global integration occurred through buyer-supplier relationships,
especially between car makers and their largest suppliers. Production tends to organize regionally
or nationally, where parts and components which are bulky and heavy tend to locate in close
proximity with the assembler to ensure on-time delivery and to save transportation costs.
Meanwhile smaller, lighter and standardized parts and components can be located at a distance totake advantage of lower labour cost and economies of scale. Vehicle development is concentrated in
a few design centres. As a result, local, national and regional production networks in automotive
industry are nested within the global organization and structures of the largest car maker firms.
There are three large regional clusters in the automotive industry: Europe, North America and Asia.
Within a region there is a tendency to shift investment locations to lower operating cost countries,
such as Mexico in North America, Spain and Eastern Europe in the European region and to Thailand
and China is Asia. Auto parts are more heavily traded within a region compared to the finished
goods. Within a country, production and employment are concentrated in a location which provides
better infrastructure and which in turn lowers the service link costs.
World’s auto parts trade increased significantly from $170 billion in 1990 to almost $700 billion in
2007, with an annual growth of 8.7% which reflects the higher intensity of global production
networks in the automotive industry (see Table 3). The world auto parts trade is dominated by the
EU(15) and North American countries. There is no significant change in the trend of auto parts trade
in the world during 1990-2007.
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share are South Korea, Thailand and Indonesia. South Korea’s share increased from 1.5% in 1990-
1994 to more than 2.3% in 2007, while the increase on Thailand and Indonesia’s export shares are
relatively modest.
On the import side, the East Asian countries’ contribution is much lower than on export side. It only
contributes around 11% of world import, while the share of North American countries’ import is
around 32% which is higher than their export’s share. Most of ASEAN countries experienced a
decline in import value in 2000 due to the depreciation of their local currency caused by the Asian
financial crisis in 1997-1998, as this resulted in more expensive imported goods. In 2007, some
ASEAN countries such as Thailand and Indonesia recovered from the Asian financial crisis and their
imports of auto parts were even higher than the 1995 level. Although in 2007 the import value
increased more than double from the 1995 level, East Asian countries’ import share is relatively
constant at 11% of world auto parts imports.
Table 4 depicts the mapping of the East Asian auto parts trade. Most East Asian auto parts are
exported intra-regionally (36% of total East Asian exports), while exports to North American and EU
(15) countries are relatively lower (26% and 14% respectively). This pattern is consistent with the
characteristics of auto parts which are relatively heavier and larger than the electronics parts and
components. The larger the intra-regional export in East Asia over time reflects the stronger regional
production network in East Asia, as explained by Sturgeon (2008). Prior to 1995 Thailand was a
major export destination for East Asia with a share of 6%, but now, China is the top export
destination for the auto parts export (20% in 2007), followed by Japan (7%) and Thailand (4%). East
Asian exports to China are larger than exports to NIEs (8%) and slightly lower than exports to
ASEAN countries (11%).
Intra-region trade is more apparent on the import side, where 63% of East Asian imports of auto
parts come from East Asian countries. An increase in intra-regional imports in East Asia together
with an increase in East Asian imports from the EU (15) resulted in a sharp decline in imports from
North American countries. This pattern reflects an upgrade of the East Asian auto parts industry,
where some parts which originally came from North America can now be produced in East Asia.
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Table 4: East Asian auto parts trade: geographic composition, 1990 - 2007
Percentage 1990 1995 2000 2007Export to
World 100.00 100.00 100.00 100.00
East Asia 20.97 32.20 28.36 35.59
Japan 0.94 2.15 4.32 6.58
China 0.96 6.12 5.97 9.88
NIEs3 7.35 9.19 7.83 7.84
Hong Kong 1.83 3.63 2.98 3.18 South Korea 3.03 2.59 2.83 3.23
Singapore 2.48 2.97 2.01 1.42
ASEAN5 11.73 14.74 10.24 11.29
Indonesia 3.49 3.94 2.79 2.89
Malaysia 2.06 3.20 2.51 2.55
Philippines 0.98 1.57 1.44 1.12
Thailand 5.16 5.81 3.01 3.79 Viet Nam 0.04 0.22 0.48 0.95
North America 43.37 35.00 35.88 25.88
EU (15) 16.92 15.69 16.95 14.41
Others 18.73 17.11 18.81 24.12
Import from
World 100.00 100.00 100.00 100.00 East Asia 56.03 59.36 59.29 62.82
Japan 48.29 43.89 32.18 23.24
China 0.72 5.08 10.95 18.88
NIEs3 3.96 5.50 6.38 7.93
Hong Kong 0.38 1.08 1.09 0.38
South Korea 2.23 2.23 3.09 6.39
Singapore 1.35 2.19 2.20 1.16 ASEAN5 3.07 4.89 9.78 12.77
Indonesia 0.21 0.51 1.66 2.83
Malaysia 1.30 1.99 2.53 1.64
Philippines 0.64 1.26 2.07 1.86
Th il d 0 92 1 10 3 12 5 37
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III. Product Fragme
In the initial formulation, all pro
place as a single integrated
development together with in
development of a fragmented p
as shown in Figure 2(B). These
service links such as transporta
others services. Several patter
can be envisaged. Figure 2(C) s
another production block, whi
blocks exists where there is a si
these is assembled in the last p
the number of stages or produ
importance of service links.
Figure 2: Production Network
tation Theory
duction processes in the automotive industry w
roduction block as shown in Figure 2(A).
ovations in telecommunication and transport
oduction process which consists of more than
production blocks are not independent, but ar
ion, design, quality control, insurance, R&D, tel
s of interdependence between production blo
ows that an output of one production block can
e in Figure 2(D) a more complex relationshi
ultaneous operation of production blocks and
roduction block. The degree of fragmentation
ction blocks. As the degree of fragmentation in
re conducted in one
owever technology
ation promoted the
ne production block
connected through
communication and
ks and service links
become an input for
among production
the output of each of
can be measured by
creases, so does the
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Production network started in t
other industries such as spor
machines, office equipments,
publishing. One example of th
example, has an assembly cen
several countries in East Asia, a
other East Asian markets. To
follows the same pattern whe
countries and then assemblies t
other East Asian markets.
Fragmentation theory was dev
th b ki d f th i t
e electronics and clothing industries and then
t footwear, automobiles, televisions and radi
ower and machine tools, camera and watch
global production network is Japanese car pr
re for cars in Thailand. This assembly centre
sembles those parts and then exports the finis
ota also has another assembly centre for SU
re Toyota Indonesia imports parts and comp
hese parts and components before exporting t
loped by Jones and Kierzkowski (1990). Prod
t d i t t t f d ti
radually spread into
o receivers, sewing
s and printing and
oducers. Toyota, for
imports parts from
ed cars to Japan and
s in Indonesia that
nents from several
e SUVs to Japan and
ct fragmentation is
( d ti bl k )
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When a firm’s output increases
integrated production process
Cost (MC), or it can switch to a
flatter than TC1 because of tra
from an increased specializatio
caused by setting up new pro
emerge to connect the produc
process increases to TC2’. Notecost is independent of output le
is steeper than TC2.
Figure 3: Total Cost and Output
The process described in Figure
blocks and connecting service
combination of fixed cost and
above Y1 as shown in Figure 3, a firm can choos
otal Cost (TC1) which consists of some Fixed Co
fragmented production process with Total Cos
e-off between a lower MC and a higher FC. A l
of productive tasks and division of labour, whil
uction blocks. With a fragmented production
ion blocks, therefore the total cost of the fra
that TC2 and TC2’ are parallel because we assuvel. If service links cost is driven up by the leve
3 can be repeated to higher orders, creating a n
links as shown in Figure 4. For any degree
arginal cost within the production blocks ensu
e either to stay at an
st (0A) and Marginal
t of TC2. Here, TC2 is
wer MC is obtained
e an increase in FC is
block, service links
gmented production
e that service linksof output, then TC2’
mber of production
f fragmentation the
es that average cost
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Figure 4: Cost and Output unde
Following the significant reduct
barriers, fragmentation is likel
international market. Firms ar
prices among countries in de
comparison between local prod
total cost (fixed and variable co
line H’ represents additional co
locate a production block in an
technologies available in that
Fragmentation
ion to international coordination costs such as
to occur first on a local or national basis an
able to take advantage of differences in tec
signing a more global production network.
uction networks and global production networ
t) when all production blocks are located in one
st associated with local service links. Suppose
ther country in order to take advantage of fac
ountry The home country has a lower marg
rade and regulatory
then spread to the
nologies and factor
igure 5 shows the
s. Line H represents
country (Home) and
now that a firm can
or endowments and
nal cost in the first
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Figure 5: Total Cost and Output
The traditional theories of trad
of specialization according to c
production blocks. Both the
Heckscher-Ohlin model on fact
production blocks. The results
and fragmentation as level of
complicates the analysis since i
in the traditional theory into si
and components. The answer athe standard considerations of
relative cost and efficiency of s
2003).
: Effect of Foreign Service Links
are still relevant in the product fragmentation
mparative advantage is still a basis for a decisi
icardian model on the variety of factor pr
r prices and factor intensities provide explanat
rom comparative advantages add the gains fro
utput increases. The introduction of cross-b
increases the number of products being trade
tradable items if each of the final products ha
to which country will specialize on which itemcomparative advantage in the production blo
ervice links between any pair of countries (Kie
heory. The principle
n on the location of
ductivities and the
ons for trade within
increasing returns
order fragmentation
from two products
s two tradable parts
depends not only oncks, but also on the
rzkowski and Arndt,
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rise whenever firms in one country supply not only their own industry, but foreign one as well. It is
no longer necessary for producers to master the entire production chains, therefore large and small
firms can save the learning cost and focus on component production
Based on production technology, the intensity of fragmentation depends on four factors (Lall, et.al,
2004): fist is the technical “divisibility” of the production process: not all production processes can be
divided into separate stages. Some industries have discrete stages of production and components
with different scale, skill and technology requirements which enable the stages then to be separated
and located at different locations and different ownership. Electronics and automotive
manufacturing are examples of these industries. On the other hand, the chemical industry, for
example, has continuous production process is not economically separable. Second, the factor
intensity of the process: the relocation of a production process to a low-wage site is economical only
if it is labour intensive and the reduced cost from labour is greater than the transportation and
coordination costs. Third, the technological complexity of each process: it is not always economical to
relocate a labour intensive process to a low-wage site unless the technology accompanying this
process is simple and stable enough to be conducted by low-wage countries. Finally, the value-to-
weight ratio of the product: the distance of relocation depends on the value-to-weight ratio of the
product. If the parts and components are light and of high value then the relocation of the process to
a further location in order to exploit cost differences is still economical. If the parts and components
are heavy and have low value then it is economic to relocate to proximate areas and encourage
agglomeration.
Service links are essential for production networks in order to connect production blocks into one
integrated production process. Following Kimura and Takahashi (2004) elements of service link
costs can be categorized into four groups: trade costs, investment costs, communication costs and
coordination costs.
Trade costs are those costs related to the trade of parts and components among production blocks
whether it happened in the same firm or with other firms (arm’s length firm), both domestic and
international. Most of production blocks located in foreign countries conducted through Foreign
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Table 5: Elements of Service Link Costs
IV. Indonesian Automotive Industry
Automotive industry in Indonesia has been established since 1927, but it was mainly for trading
activities since the assembly activities was still very limited and the import of cars was not regulated.
After 1940s the assembly activities in Indonesia increased with the importation of completely
knocked-down (CKD) packs to increase labour utilization and technical skills as well as a saving of
foreign exchange. However with further declining of foreign exchange, even the importation of CKD
was ceased except for assembly for government’s need which was financed by government-to-
government grants from other countries (Witoelar 1983). The New Order government under
Soeharto in 1966 realized the need to increase the supply of all goods and commodities including
automobiles. The government allowed any kind of automobiles importation, from completely build
up (CBU), CKD, semi-knocked down (SKD) and even used cars. This surge of imported goods
hampered the development of assembly auto parts industry in Indonesia. The open door policy to
Category Subcategory Details
Trade Costs
transportation costs shipment charge, freight chargepolicy barriers tariff barriers: ad valorem tariff, specific tariff, non-tariff barriers
(quotas, others)
information costs search cost for sellers or buyers, research costs for preference of
foreign people
costs associated with the use of
different currencies
cost of exchange rate volatility, risk edge and uncertainty
legal and regulatory costs direct and indirect costs to deal with legal regulatory issues and
procedures
local distribution costs cost to utilize local infrastructure, and to efficiently deliver goods to
local consumers
Investment Costs
policy barriers indirect cost due to prohibition to entry, absence of national
treatment, and other fdi discriminated measures
information costs search cost for suppliers
contract enforcement costs direct and indirect costs to make sure
legal and regulatory cost direct and indirect costs to deal with legal regulatory issues and
procedures
Communication
Costs
telecommunication costs, internet fee
Coordination
Costs
timeliness indirect costs due to inadequateness of time delivery
uncertainty indirect cost due to uncertainty regarding coordination of a series of
activities from production to shipment of end productsSource: Kimura and Takahashi (2004)
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extended; tax incentives were reduced; and the number of foreign personnel was restricted
(Pangestu 1996).
The major government policy that supports the development of auto parts industry was Deletion
Program in 1976. By Minister of Industry Decree no 307/1976, government schedules the gradual
deletion of specific components from the imported CKD packs used in the assembly of commercial
vehicles but not in passenger cars. One objective of deletion program is to stimulate technology
transfer from Japanese auto parts industry to local manufacturer through stable, durable and intense
subcontracting relationship between large car assembling firms and the local auto parts supplier
firms. However, in reality many of components intended to be made locally was actually assembled
from imported parts and components (Aswicahyono, Basri et al. 2000). Therefore government
intention to develop local auto parts manufacturer was not achieved.
The rapid development of assembly activities started in the early 1970s because of the oil boom.
Indonesian automotive market expanded strongly at the early 1970s because of oil boom with the
increase of makes and models. The large number of varieties create very segmented and small
market for auto parts industry and unable them to reach economies of scale. In 1983, government
attempted to rationalize the automotive industry by requiring car assembler to reduce the number
of car brands and models they assembled to achieve economies of scale. The objective was to have
larger market share for each brand and to increase efficiency and lower production cost. However
this regulation was not implemented effectively because of strong rejection from vested interests in
the industry. Another decree was stipulated in 1983 on compulsory use of locally made
components. However this decree was not successful due to the lack of technology, capital and skills
in technical areas of the small and medium scale manufacturers. It resulted on reluctance of foreign
car makers to invest heavily in locally small and medium manufacturer and created shallow, short
term and non-exclusive relationship between assemblers and auto parts manufacturers.
Since there was a little success of deletion program in fostering the development of auto parts
industry in Indonesia, in 1993 government terminated the deletion program and replaced it with the
Incentive program. In this program, assembler are not forced to use locally made auto parts, instead
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In 1996, Soeharto signed a shocking decree appointing the Timor Putra Nasional (TPN) company
(owned by his son) as the sole manufacturer of the national car, Timor. TPN did not have one single
auto plant, with a joint venture with KIA Motor from Korea, they started to build factory in
Indonesian and meanwhile the cars were produced wholly in Korea and exported to Indonesia in
CBUs. As a national car, it received pioneer status with exempting it from import duties and luxury
sales tax. This national car program was heavily criticized by Japan, the US and the EU and they filed
complaint to WTO which then ruled that the program was a violation to WTO rules. Although the
national car program only last for a while it has big impact on automotive industry in Indonesia.
After the financial crises in 1998, Indonesia has to sign Letter of Intent under the IMF which requires
Indonesia to rapidly liberalize the market. Indonesian government introduced harmonized system
under WTO system in 1999. In this harmonized system, the local content programs were removed
and Indonesia signed the “trade-related investment measures” (TRIMS). The protectionist policy
toward automotive industry was replaced by market liberalization program. The June 1999 tariff
reform has significantly reduced the import tariff for CBU and CKD imports, but it remains relatively
high.
A frequent change in policies toward automotive industry in Indonesia creates uncertainty for both
domestic and foreign investments which in turn hampered the development of automotive industry
especially auto parts manufacturer. Transfer of technology from Japanese car makers to domestic
small and medium enterprises did not occur as expected since Japanese car makers are reluctant to
transfer the technology because they are unable to secure majority of ownership.
Automotive production network in Indonesia has developed rapidly for the last twenty years with
the increase number of car and motorcycle parts producers by three fold and four fold respectively.
The stronger local production networks are due to policies set up by Japanese car makers to
optimize local procurement for cost efficiency and minimizing exchange rate risk. However high
dependency on Japanese car makers hamper the development of domestic auto parts makers since
they are bind to a cooperation agreement which sometimes prohibit them to have cooperation with
other companies.
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and Indonesia are relatively caught at assembling the same products such as radio-broadcast
receivers and resource based products, i.e. tyres. This condition reflects that Indonesia has been
relatively left behind in the automotive global production network compared to other ASEAN
countries, although it has potentials such as abundant labour and a relatively large market size.
V. Analytical Framework
The empirical model employed in this paper is based on Jones and Kierzkowski (1990)fragmentation theory which states that fragmentation will occur when production cost per se
drastically falls and the cost of the service links connecting the production blocks become low
enough. The aim is to answer two research questions; the first is on the determinants of a country’s
participation in the global production network, and the second question is whether Indonesia is left
behind in the global production networks compared to other countries.
This research provides new contribution to the empirical studies on the global production network.
While the existing studies focused on selected countries and group of countries, this research covers
all countries in the world and cover long period from 1988 to 2007. One reason to include all
countries in this research is to enable comparison between developed and developing countries as
well as between regions. It also avoids selection bias problem which would occur if countries are
selected based on the trade value or regions.
The existing empirical studies has separately analysed the determinants of the global production
networks. Jones et al (2005) and Golub (2007) focused on the role of service link in the global
production network. Lowering of service link costs promotes fragmentation and outsourcing of
output. The first study uses the business telephone charges as a proxy of service link cost. They
compare three regions: East Asia, EU 15 and NAFTA for period 1990-2000. The result supports the
theory that lowering of business telephone charges increases the trade of parts and components.
The second study uses the index of service link quality and costs as a proxy of service links. They
construct the index consisting of consisting of transport, communications, and electric power
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Athukorala and Yamashita (2006) use the gravity model to examine the extent, trends and patterns
of the global production networks. They found that relative wage differentials are a significant
determinant of cross border trade in components (as well as the related final products).
In summary, the existing empirical studies find that global production network is explained by cost
differences among countries which consist of production cost and service links costs. The decision
on which country will specialize on which item depends not only on the comparative advantage bust
also on the relative cost and efficiency of service links.
V.1 Model Specification
The empirical model employed in this research is based on Jones and Kierzkowski (1990)
fragmentation theory which states that fragmentation will occur when production cost per se
drastically falls and the cost of the service links connecting the production blocks become low
enough. The decision on which country will specialize on which item depends not only on the
comparative advantage bust also on the relative cost and efficiency of service links. Therefore the
explanatory variables in the model can be grouped into production cost and service link costs. The
dependent variable is fragmentation index which is represented by the trade of parts and
components.
Production Costs
Production cost in this model consists of three variables: labour cost, quality of labour and
competitiveness. In the ideal model, the production cost should include capital cost as well.
However, capital cost is not included in the model because it is difficult to find comparable variable
for capital cost for all countries in the world.
Labour cost
As suggested by the standard international trade theory, comparative advantage is still relevant in
the fragmentation trade. Labour cost (RWages) is crucial in determining the location of production
bl k i d f i A i h l l b ill d i
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countries with similar aggregate factor endowments can explain the trade across industry
(Grossman and Maggi, 2000; Ohnsorge and Trefler, 2004). A country with higher technology
intensity is expected to attract more production blocks and will increase the fragmentation index.
Competitiveness
Traditionally, the appreciation of domestic currency raises import and lowers exports. However in
the production networks the relationship can reverse. The response of a country’s exports to the
exchange rate should decline as the share of imported components for use in the manufacture of itsexport rises. Therefore the impact of relationship between changes in exchange rate (RER) and
trade will be negative in the presence of production networks. Moreover, as suggested by Arndt and
Hummer (2004), the sensitivity of trade to exchange rate will decline with the more intensive
fragmentation trade among countries. Then the exchange rate would not be significant in
determining the global production networks.
Service links costs
Besides the production costs listed above, the fragmentation index depends highly on service links
which connect the production blocks and ensure that the production blocks interact in the proper
manner. Basically, goods and services are traded among the production blocks both domestically
and across the border. Therefore it is possible to categorize service link cost into two types of trade
barriers, one is at-the-border trade barriers and another is behind-the-border trade barriers.
At-the-border trade barriers
Across-the-border trade barriers are barriers that affect the flow of goods and services across
countries (borders) which include freight cost and tariff and non tariff barriers.
Freight costs
One explanation of the rise in the international trade is a decline in the international transportation
costs (Hummels, 2007). The decline in the cost is associated with the innovations in transportation
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Transportation costs co-vary with distance and it well explains the reason of countries trade with
their neighbours first. However distance is not a perfect measurement for the transportation cost
since it does not reflect the change in the quality of transportation. With the declining of air
transport cost and the technology development which enables parts and components to be relocated
in the smaller structure, long distance trade is relatively more attractive.
Therefore the expected sign of freight cost and value of trade can be either positive or negative
depends on the type of traded commodities.
Tariff
Vertical trade is more sensitive to tariff changes compares to final trade (Yi, 2003). Parts and
components are subject to a tariff every time they cross the border. Therefore any reduction in the
parts and components tariff will reduce the production cost, and the level of this reduction will
depend on how many times the fragmented product crosses the border. However, most of
production blocks are located in Special Economic Zone which might include Free Trade Zones
(FTZ), Export Processing Zones (EPZ), Free Zones (FZ), Industrial Estates (IE), Free Ports, Urban
Enterprise Zones and others. Therefore it is expected that the sign of Tariff is negative although it
might not be significant. Another type of trade barrier is Non-Tariff Barriers which are commonly
used by a country as a substitute of the abolishment of tariff barriers and are sometimes more
protective than the tariff barriers. Unfortunately the data on NTB is not widely available for allcountries; therefore it is not included in the model.
Behind-the-border trade barriers
Behind-the-border trade barriers refer to a variety of barriers that operate inside countries rather
than at the border, but that nonetheless can restrict trade. They include trade facilitation and
business and regulatory environment.
Trade Cost
Trade facilitation is generally defined as an improvement of efficiency in logistics and related trade-
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Business and regulatory environment
Most of the production blocks located in foreign countries conducted through Foreign Direct Investment (FDI), therefore business and regulatory environment related to the FDI is important
factor determining participation in global production networks (Jongwanich,2009). FDI openness is
crucial in the automotive industry because with the possibility of having full foreign ownership in a
country, foreign car maker is willing to bring the latest technology and improve managerial practices
and close supervision of assembly/production by bringing in foreign technicians and managers. It is
expected that the more open the FDI policies in a country the higher the participation in a global
production network, then the expected sign of FDI_Openness is positive.
Institutional quality is relevant in the process of production fragmentation which involves
establishing a complex relationship between two parties engaging in specific investment
relationship. Expansion of production fragmentation will be limited if the quality of institutional is
low. Two indicators are used in the model to represent quality of institutions in a country; fist is the
cost of starting a new business (Buss_Cost) and second is the cost of enforcing a contract
(Contract_Cost). Long and expensive process in attaining a license for new business will discourage
not only foreign investors but also domestic investors in establishing production blocks in a country.
Meanwhile the efficiency of the judicial system in resolving a commercial dispute also affects
investment decision in a country, especially in the automotive industry where most investment is
capital intensive. The expected signs of these variables are negative.
Other variables
Market size
Trade of parts and components depends on market size of export destination and import source
countries. With a larger market size, it is expected that the trade flow of parts and components
increased. Therefore the expected sign for market size (Market) is positive.
Dummy variables
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t it i
iit i
it it i
t it it it i
C T Market
Cost Contract Cost BussOpen FDI
Cost TradeTariff
Tech RER RWages FragIndx
,,10
98,7
6,5,4
,3,2,1,
_ _ _
_ Distanceln
lnlnln
ε ϕ β
β β β
β β β
β β β α
++∂++
+++
+++
+++=
where subscript i represents the i-th country, i = 1,2, .., 200, and t represent the year, t = 1988,
1989,… , 2007. The variables are listed and defined below with the expected sign of the coefficient
for independent variables in parentheses:
Frag_Indx Fragmentation Index – dependent variable
RWages Labour cost (-)
Tech Quality of labour (+)
RER Real exchange rate (-)
Distance Freight cost (+/-)
Tariff MFN tariff (-)
Trade_Cost Trade cost (-)
FDI_Open FDI openness (-)
Buss_Cost Cost for starting new business (-)
Contract_Cost Cost of enforcing the contract (-)
Market Market size (+)
T A set of time dummy variables
C A set of country dummy variablesα A constant term
V.2 Variable construction and Data
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The end point is 2007, since this was the latest year for which data for most of variables are available
and data for 2008 – 2009 are susceptible from global financial crisis.
Fragmentation Index (dependent variable)
Dependent variable is the real value of export and import of parts and components. The trade data
are sourced from the UN Comtrade database1 and the data is originally expressed in the nominal
US$. The real value is derived using the US import price index collected from the US Department of
Labor2. The automotive industry uses one import price index for the three groups, i.e. the import
price index for automotive Parts & Accessories.
The Athukorala 2009 list is with some modification by including other parts and components which
are considered as auto parts by the Japan Auto Parts Industries Association (JAPIA) and the
Indonesian Automotive Parts and Components Industries Association (GIAMM). Additional parts and
components include tyres, safety glass, electronics parts for automotive, brakes, and safety airbags.
Production Cost
Labour cost
Labour cost is represented by real wage which is calculated from the nominal wages of each country
in US$ deflated by the US Wholesale Price Index (WPI). Nominal wage from the ILO-Laborsta3
database is expressed in the country’s currency therefore it should be converted into US$ using
nominal exchange rate for each country sourced from the WDI website4. However, only 113 of 200
countries have wages data.
US P e
wage RWages
*=
Wherewage denotes nominal wage in domestic currency for each country, e denotes the nominal
exchange rate in the US$ and US P denotes the US Wholesale Price Index as a deflator.
Q lit f L b
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pharmaceuticals, scientific instruments, and electrical machinery. This ratio is available from the
WDI for 173 countries.
Real Exchange Rate
The real exchange rate (RER) is calculated by the following conventional formula:
e
w
eP
eP RER =
Where e denotes the nominal exchange rate measured in terms of foreign currency, w P is an index
of foreign price and d P is an index of domestic price. The producer (wholesale) price index is used
as proxy of w P and, the GDP Deflator is a proxy for d P .
RER based on the price index is not appealing in a pure cross-sectional context because the data only
reflect changes relative to the base year of the index used, with no indication of overvaluation or
undervaluation of a given currency. The alternative measurement is to use the deviation between
RER and the mean of RER over the period with the assumption that the mean of RER is the long-term
equilibrium of the RER (Soloaga and Winters, 2001).
Service links costs
Freight Cost
Some empirical models use distance (Distance) as a proxy of freight cost. Since this model use
unilateral trade instead of bilateral trade, the determination of distance (Distance) is not as
straightforward as in the gravity model. Therefore the distance is calculated between a country and
its major exporter and importer countries. First the major partner is determined for each region and
then each country in the region is assumed to have the same major partner. If a county is also a
major partner for the particular region then the distance is measured by the distance between that
country with its major partner.
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FOB
Freight
FOB
CIF +=1
CIF value is the import value of each country, while FOB value is the world export to each country.
Although the calculation of Freight value using matched partner method is frequently used in the
literature (Baier and Bergstrand, 2001; Limao and Venable, 2001) there is a well-known
measurement error associated with this approach (Anderson and van Wincoop, 2004; Hummels and
Lugovsky, 2006; Hummels, 2007). It has been found that the calculated freight cost do not
necessarily reflect the real shipping cost variation. In fact, the freight cost calculated during the data
construction stage turned out strange and only two percent of the data satisfy the above condition.
Therefore this variable is dropped from the model.
Tariff
The tariff variable is sourced from the average applied MFN import tariff for manufactured goods
from the UNCTAD database5.
Trade cost
Cost for export and import are collected from the World Bank’s Doing Business Survey which
conducted on 183 economies from 2004 – 2010. Cost for export and import is sourced from the
Trading Across Borders indicators which compile procedural requirements for exporting and
importing a standardized cargo of goods by ocean transport. The cargo is a dry-cargo, 20-foot, full
container load of the domestic private, limited liability company that has at least 60 employees. The
company is located in the economy’s largest business city but not operate in an export processing
zone or an industrial estate with special export or import privileges and exports more than 10% if its
sales. For exporting goods, procedures range from packing the goods at the warehouse to theirdeparture from the port of exit. For importing goods, procedures range from the vessel’s arrival at
the port of entry to the cargo’s delivery at the warehouse.
Trade cost ( XCost and MCost ) measures the fees levied on a 20- foot container in U.S. dollars. These
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The variable used to represent FDI openness is the Inward FDI Potential Index from World
Investment Report - UNCTAD which captures several factors (apart from market size) expected to
affect an economy’s attractiveness to foreign investors. The Inward FDI Potential Index is an average
of the values (normalized to yield a score between zero, for the lowest scoring country, to one, for
the highest) of 12 variables (see Appendix for detail). The expected sign for FDI openness is
negative since the higher the index means the lower the potential inward FDI.
Cost of Starting a New Business
The variable for measuring the cost of starting a new business is sourced from the from the World
Bank’s Doing Business Survey which conducted on 183 economies from 2004 – 2010. The cost
includes cost for all procedures that are officially required for an entrepreneur to start up and
formally operate an industrial or commercial business. These procedures include obtaining all
necessary licenses and permits and completing any required notifications, verifications or
inscriptions for the company and employees with relevant authorities. This definition only includes
procedures required of all businesses are covered. Industry-specific procedures are excluded.
Cost of Enforcing the Contract
This variable is also sourced from the World Bank’s Doing Business Survey. It measures the efficiency
of the judicial system in resolving a commercial dispute. The data are built by following the step-by-
step evolution of a commercial sale dispute before local courts and collected through study of the
codes of civil procedure and other court regulations as well as surveys completed by local litigation
lawyers and by judges.
Other variables
Market Size
Market size variable is different for export and import model. For export, market size is measured by
the real world import of auto parts which is sourced from the UN Comtrade database and the data is
originally expressed in the nominal US$. The real value is derived using the US import price index for
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There is a possible two-way causation between behind-the-border trade barriers and trade flows. It
is possible that higher trade flows will stimulate lower behind-the-border trade barriers since
exporter and importer have more power to lobby the government to improve the trade facilities as
well as better institutions. The Hausman-Wu specification test is conducted to judge whether this
causation is a problem in the data compiled in this study. The result reject null hypothesis that there
is causality from trade flows to trade facilitation. Therefore there is no evidence that trade flow will
improve the trade facilitation and better institutions. However, this test requires the instrument
variables for trade facilitation variable. Following Djankov et al. (2006), the instrument used here is
the number of signature required from custom officials for processing trade transactions, number of
procedures to be completed to get a new business license and number of procedures to trace the
chronology of a commercial dispute before the relevant court. In addition, quality of democracy and
political institution from Polity IV database6 is used as an instrument. The democracy variable is the
difference between the democracy and the autocracy scores in this database, averaged over the
period 9−t . It implies measures the competitiveness and regulation of political participation, the
openness and competitiveness of executive recruitment, and the constraints on the executive. These
instrument variables are directly correlated to the behind-the-border trade barriers variables but
not directly related to the trade flows.
There are two estimation techniques available for panel data regression, fixed and random effect.
Since the difference among countries is important, the fixed effect estimation is used for this model.The fixed effect estimator can be implemented in three ways; time demeaning (or within
transformation), the first-difference or least square dummy variable (LSDV). The first two cannot be
implemented in this model since they will eliminate the time-invariant variables such as trade cost,
cost of starting a new business and cost of enforcing contract which are important in the model. On
the other hand, the LSDV technique with country and time dummies can handle the time-invariant
variables. Finally to guard against heteroscedasticity problem, the heteroscedasticity-consistent
standard errors (i.e. the White correction) are used.
VI Results and Discussion
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parts as well as to determine whether Indonesia is left behind in the global production networks
compares to other countries.
From the diagnostic tests, the export model suffers from the endogeneity problems therefore LSDV
with two-stage least square is applied to correct for the endogeneity problems. Meanwhile the
import model does not have endogeneity problem hence the LSDV without two-stage least square is
applied.
Table 8 and 10 present the estimation results for export and import models respectively to answer
the first question which is the determinants of the global production networks. Table 9 and 11
present the estimation results to determine whether Indonesia is left behind in the global
production networks.
Table 6: Summary Statistics
Variable Variable Description Obs Mean Std. Dev. Min Max
FragIndx1 Real Trade Value (log) 2445 12.38 4.16 (0.66) 20.73
RWages Real Wages (log) 1245 7.91 2.31 (1.23) 13.99
Tech Quality of Labor (log) 2060 1.34 1.93 (10.87) 4.32
RER Rearl Exchange Rate (log) 529 0.07 3.10 (8.52) 8.61
Distance Distance to Major Partner (log) 2445 8.40 0.74 7.40 9.37 YWorld Real Value of World Import of Auto parts (log) 2445 22.44 0.37 21.33 23.11
GDPcap GDP per capita (log) 2249 8.13 1.58 4.45 11.55
Pop Population (log) 2012 15.82 1.98 10.91 21.00
FDI_Potential FDI Potential Index (log) 1734 3.81 1.00 - 4.95
Tariff MFN Tariff (log) 1795 1.83 0.97 (2.81) 4.72
Xcost Cost for export (log) 2093 6.89 0.46 5.97 8.43
Mcost Cost for import (log) 2093 7.04 0.51 5.91 8.42
Contract_Cost Cost for starting a new business (log) 2093 3.24 0.63 (2.30) 5.09
Buss_Cost Cost for enforcing contract (log) 2073 2.80 1.67 (1.61) 8.76
Notes: Appendix 3 summarizes the data sources
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32
Table 7: Correlation Matrix
RWages Tech RER Distance YWorld GDPcap Pop
FDI_
Potential Tariff Xcost Mcost
Contract
_ Cost
Buss_
Cost
RWages 1
Tech 0.1003 1
RER 0.5828 -0.1429 1
Distance 0.3563 -0.1216 0.3386 1
YWorld 0.2132 -0.1726 0.3435 0.158 1
GDPcap -0.0354 0.509 -0.5438 -0.4699 -0.1955 1
Pop 0.1415 0.0754 0.1291 0.4249 0.0163 -0.1853 1
FDI_Potential 0.1577 -0.5038 0.551 0.3893 0.3495 -0.7502 -0.0709 1
Tariff -0.081 -0.3848 0.261 0.4755 -0.1095 -0.6443 0.2728 0.4353 1
Xcost -0.133 0.0887 0.1393 -0.0982 0.0751 -0.1123 0.0501 0.0599 0.027 1
Mcost -0.1433 0.0193 0.1147 0.0354 0.0604 -0.1841 0.172 0.0749 0.1823 0.9348 1
Contract_Cost 0.2892 -0.1827 0.4574 0.383 0.1646 -0.4895 0.2536 0.3984 0.4372 0.0221 0.1288 1
Buss_Cost 0.1854 -0.3895 0.4672 0.3484 0.3156 -0.6308 0.2998 0.6775 0.3838 0.0929 0.1191 0.3298 1
Variable desription:
RWages
Tech
RER
Distance
YWorld
GDPcap
PopFDI_Potential
Tariff
Xcost
Mcost
Contract_Cost
Buss_Cost
Cost for export (log)
Cost for import (log)
Cost for starting a new business (log)
Cost for enforcing contract (log)
Real Wages (log)
Quality of Labor (log)
Rearl Exchange Rate (log)
Distance to Major Partner (log)
Real Value of World Import of Auto parts (log)
GDP per capita (log)
Population (log)FDI Potential Index (log)
MFN Tariff (log)
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VI.1. Export Side
Since export models suffer from the endogeneity problem for the behind-the-border trade barriers
then two-stage least square method is applied with quality of democracy and political institution and
the number of documents in export processing and the number of documents in the contract as the
instrumental variables. The analysis is separated into all countries, developed and developing
countries and three regions that have intensive production networks in the automotive industry as
presented in Table 8.
For first model where determinants are examined for all countries, the model resulted quite well
with 98% of the variation in the model can be explained by the explanatory variables. Most of the
coefficients have expected sign except for the FDI openness, Export Cost and Business Cost. From the
estimation result, labour cost, distance and market size determine country participation in the global
production networks as expected by the traditional trade theory. However business and regulatory
environment especially the certainty of business conduct in a country plays more important factor in
the global production networks than in the traditional trade patterns. This condition is well
explained by the characteristics of export in the global production networks where most of the
export is related to the intra-firm trade. Parent company sets up production blocks in a country to
produce parts and components which will be exported to other countries to be assembled. Although
a country has comparative advantage in the lower labour cost, but if business and regulatory
environment is not good, parent company will be reluctant to set up the production blocks because
of the high risk.
This condition is more apparent in the developing countries than developed countries. Coefficient of
labour cost in developing countries is negative as expected where lower labour cost will increase the
value of auto parts export while the coefficient for developed countries is positive. First this result
seems contradict with the theory however it actually explains the impact of heterogeneity of labour
in trade patterns. Developed countries are specialising in the high technology intensive product
which requires more skilled and higher paid labour therefore the labour cost in the developed
countries is positively correlated with the export value Business and regulatory environment is is
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34
Table 8: Determinants of global production network, 1988 – 2007 – Export Model
All Countries Developing Developed Asia Europe America
Real Wages -0.695*** -0.438*** 0.462*** -0.201 1.721*** -0.747***
(0.136) (0.134) (0.111) (0.181) (0.230) (0.057)
Quality of Labour 0.073 -0.029 -0.015 0.141 0.582*** -0.722***
(0.076) (0.090) (0.101) (0.148) (0.119) (0.214)
RER 0.017 -0.013 -0.028* -0.012 0.010 -0.191**
(0.023) (0.029) (0.015) (0.056) (0.029) (0.097)
Distance -6.766*** -2.366** -3.179*** -3.926*** 0.028 -0.342
(1.056) (1.093) (0.122) (0.564) (0.604) (0.787)
Tariff -0.027 -0.067 0.004 -0.266** 0.604*** 0.085
(0.072) (0.077) (0.148) (0.119) (0.151) (0.124)
Export Cost 8.455*** 2.854*** -3.175*** 4.672*** 4.828*** 1.521***
(2.030) (0.435) (1.000) (1.719) (1.665) (0.550)
FDI Openness 0.203* -2.540*** -1.344*** -1.456*** 0.134 13.195***
(0.113) (0.904) (0.147) (0.309) (0.375) (0.799)
Business Cost 4.489*** -18.858*** 0.794 4.309*** 21.104*** -24.664***
(1.612) (2.959) (0.774) (0.365) (5.581) (0.852)
Contract Cost -18.333*** -5.083*** -6.002*** -4.505*** 40.899*** -59.066***
(2.289) (1.197) (0.341) (0.599) (12.414) (3.553)
Market 1.289*** 2.136*** 0.439*** 0.824*** 0.114 0.998
(0.166) (0.769) (0.142) (0.137) (0.218) (1.220)
Number of observations 355 184 174 65 157 82
Adjusted R2 0.983 0.985 0.993 0.992 0.971 0.990note: *** p<0.01, ** p<0.05, * p<0.1
Dependent variable: Real Value of Auto Parts Export
Export
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Another comparison is among region which has intense automotive production networks namely
Asia, Europe and America. Asian region covers all countries in Asia plus Australia and New Zealand
because of their proximity to Asia. The estimation results are as expected.
In Asia, service link costs are more important than production cost in determining participation in
the global production networks. Labour cost is not significant while FDI openness and Contract Cost
are negative and significant. Tariff which is not significant in other model turns out to be significant
and negatively affects the export value in Asia. This unexpected result means that with the declining
in the tariff import, the export of auto parts from Asia is increasing. It is possible because most of the
exported auto parts use imported input in their production process therefore the declining in the
tariff import will increase imported input and in turn will increase the export. As expected the
coefficient for Contract Cost is significant and negative which means that participation in the global
production networks in Asia depends on the certainty of business activity in the country.
Meanwhile, automotive production networks in Europe depend on skilled and high paid workerswhich are consistent with the characteristics of developed countries explained above. Both real
wages and quality of labour have positive and significant coefficients. Tariffs, business cost and
contract cost are significant but with reverse signs. One explanation of these unexpected signs is
that parent companies in Europe locate their production blocks in their surrounding countries to
take advantage of the availability of skilled workers regardless of the service links costs related to
the production blocks.
On the other hand, America region which include the US, Canada and South Americans countries has
similar characteristics to developing countries than developed countries where service link costs are
more important than production costs in determining country’s participation in the global
production networks. The unexpected result is the positive and significant coefficient for FDI
openness which implies that country with less potential FDI condition will participate more in the
production networks.
The next research question is to determine whether Indonesia is indeed left behind in the
i d i k F hi d i bl f I d i i dd d i h
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Table 9: Determinants of global production network, 1988- 2007 - Export Model by Group
All Auto PartsHuman Capital
Intensive
Unskilled Labour
Intensive
Technological
Intensive
Real Wages 0.659*** 0.663*** 0.926*** -0.216
(0.083) (0.092) (0.137) (0.376)
Quality of Labour 1.206*** 1.250*** 1.201*** 1.168**
(0.105) (0.115) (0.138) (0.460)
RER 0.194 0.202 0.201 -0.393
(0.236) (0.229) (0.305) (0.273)
Distance 0.991 1.117 2.155 -7.246***
(1.185) (1.150) (1.769) (2.454)
Tariff 1.188*** 1.191*** 1.872*** -0.006
(0.196) (0.214) (0.347) (0.690)
Export Cost 1.314 0.919 1.185 8.336**
(0.846) (0.834) (1.326) (3.281)
FDI Openness -1.710*** -1.529*** -2.658*** -0.615
(0.381) (0.377) (0.552) (0.662)
Business Cost -0.615 -0.816 -1.710 7.687***(0.973) (0.958) (1.498) (2.565)
Contract Cost 2.117*** 2.328*** 2.694*** -4.084***
(0.411) (0.418) (0.574) (1.464)
Market 0.786*** 0.769*** 1.144*** -0.096
(0.282) (0.253) (0.432) (0.717)
d_Ind -5.692*** -6.259*** -6.903*** 13.354**
(1.784) (1.780) (2.510) (5.430)
Number of observations 65 65 65 64
Adjusted R2 0 915 0 912 0 839 0 840
Export
Dependent variable: Real Value of Auto Parts Export
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Automotive industry in Indonesia is a very protective sector as explained in the previous section and
a frequent change in policies towards the automotive industry creates uncertainty for both domestic
and foreign investments. With no majority of ownership before 1994, Japanese car makers were
reluctant to transfer the related technology to their partners in Indonesia which resulted in less
participation in production network compares to Thailand.
When comparing fragmentation determinants for different auto parts groups based on their factor
intensity, Human Capital Intensive (HCI) and Unskilled Labour Intensive (ULI) auto parts have
similar determinants with the overall auto parts and Indonesia is relatively left behind in these
groups. Meanwhile, Technology Intensive (TI) auto parts group has different determinants. The
coefficient for d_Ind is positive and significant which means that Indonesia is actually export more of
TI auto parts compare to the average of other Asian countries . Since most of the auto parts in this
category are relatively small therefore the distance is still significant.
In summary, country’s participation the global production network through the export of auto partsdepends more on the service link factors than production cost factors. Sound business and
regulatory environment is important since parent companies will be more willing to relocate their
production blocks to a country which can provide certainty for their business. This is more apparent
in the developing countries and Asian and America regions. Indonesia is indeed left behind because
of FDI policies in Indonesia are less open compares to neighbouring countries.
VI.2 Import Side
In addition to the export of auto parts, a country’s participation in the global production networks
can be analysed through the import of auto parts. Import of auto parts can be viewed as passive
participation in the global production networks. Car makers that relocate their production blocks in
a country usually require the inputs for the production blocks are sourced from their own country to
guarantee the consistency and quality of the products which will be sold domestically and for export
purpose. If most of the products are exported than the determinant of import part of the production
networks will be the same with the determinants of the export side of the production network. In the
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Table 10: Determinants of global production network, 1988 - 2007 - Import Model
All Countries Developing Developed Asia Europe America
Real Wages -0.002 -0.051 0.266** 0.023 0.300*** -0.085***
(0.058) (0.042) (0.110) (0.287) (0.097) (0.027)
Quality of Labor 0.027 -0.004 0.061 -0.024 0.135* -0.078
(0.047) (0.053) (0.098) (0.128) (0.078) (0.062)
RER 0.014 0.037 -0.008 -0.131 0.021 0.043
(0.011) (0.025) (0.014) (0.085) (0.013) (0.039)
Distance 2.419*** 2.842*** -0.898*** 0.504 0.777***
(0.114) (0.089) (0.105) (0.389) (0.298)
Tariff 0.013 0.021 0.026 -0.129 0.078 0.063
(0.042) (0.052) (0.079) (0.142) (0.097) (0.065)
Import Cost -3.727*** 0.130 1.042*** 0.635 2.889*** 1.700***
(0.236) (0.151) (0.185) (1.085) (0.189) (0.203)
FDI Openness -1.189*** 0.338 -0.576*** -0.820* -0.638*** -0.548***
(0.064) (0.330) (0.132) (0.421) (0.053) (0.091)
Busines Cost 1.907*** 4.774*** -1.262*** 0.271 -0.748*** -0.275
(0.195) (0.770) (0.219) (0.853) (0.119) (0.196)
Contract Cost 0.663*** 0.622*** -3.738*** 1.398 0.560***
(0.163) (0.158) (0.693) (1.040) (0.147)
Market 1.048*** 1.295*** 0.383** -0.224 0.239* 1.155***
(0.124) (0.156) (0.187) (0.578) (0.144) (0.239)
Number of observations 372 188 184 65 165 82
Adjusted R2 0.989 0.986 0.989 0.962 0.992 0.995
note: *** p<0.01, ** p<0.05, * p<0.1
Import
Dependent variable: Real Value of Auto Parts Import
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Labour condition, RER and import tariff do not significantly affect the import of auto parts in the
global production networks arrangement. It is because most of the trade under global production
networks is inter-firm trade where firms in host country are required to import the parts and
components from the parent country regardless of the labour condition, competitiveness and import
tariff. However, import of auto parts is determined by the import cost, FDI openness and the market
size of the country. Import cost and market size are the common determinants in the import model,
but FDI openness is specific determinants in import side of the participation in the global production
networks. FDI openness is important because the imported auto parts are used as the input for
production blocks established by the car makers and the decision of car makers to relocate the
production blocks in a country depends crucially on the investment climate. Business cost and
contract cost have positive and significant coefficients which imply that when it is more difficult for
foreign car makers to establish their own firms in a host country because of costly business practices
then local firms will establish their own firms and join the car maker as one of the production blocks.
One requirement imposed by foreign car makers to local firm to join their production network is toimport the auto parts from car maker’s production networks to guarantee the quality of the
products.
Comparing developing and developed countries on the import side, the estimation result for
developing countries reconfirms that when the business practices are relatively costly then the
import of auto parts will increase because local firms which join production network are required to
source their input from foreign car makers. Meanwhile, the estimation result for developed
countries is consistent with the theory except for the import cost. It is expected the import cost will
be negatively related to the import value but the estimation result is positive. Coefficient for labour
cost is positive since most of developed countries are endowed with the skilled labours therefore
imported input into the developed countries requires higher wages. Business cost and contract cost
are negatively related to import auto parts in developed countries which imply that better business
and regulatory environment in developed countries resulted in the higher import of auto parts.
Meanwhile, estimation results for three regions which have intensive production networks show
diff t d t i t f i F A i t i th ti ti lt l h
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Table 11: Determinants of global production network, 1988 - 2007 - Import Model by Group
All Auto PartsHuman Capital
Intensive
Unskilled
Labour
Intensive
Technological
Intensive
Real Wages 0.010 0.056 -0.021 -0.052
(0.067) (0.069) (0.068) (0.070)
Quality of Labor 0.125 0.122 0.128 0.201
(0.134) (0.135) (0.134) (0.132)
RER -0.047 -0.101* 0.003 -0.000
(0.059) (0.060) (0.060) (0.062)
Distance 0.626* 0.525 0.764** -0.191
(0.336) (0.343) (0.332) (0.357)
Tariff 0.177 0.324 0.042 0.274
(0.266) (0.278) (0.259) (0.303)
Import Cost 0.768*** 0.738*** 0.799*** 0.668***
(0.206) (0.219) (0.195) (0.244)
FDI Openness -1.872*** -1.775*** -1.983*** -0.873*
(0.510) (0.531) (0.497) (0.514)
Busines Cost -0.388 -0.269 -0.489 -1.275**
(0.550) (0.571) (0.538) (0.641)
Contract Cost -0.500* -0.465* -0.556** -0.636**
(0.267) (0.281) (0.262) (0.285)
Market 1.081*** 1.122*** 1.027*** 1.588***(0.227) (0.234) (0.225) (0.249)
d_Ind 3.687*** 3.858*** 3.566*** 3.592***
(0.615) (0.645) (0.604) (0.664)
Import
Dependent variable: Real Value of Auto Parts Import
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the production networks except for the Technological Intensive auto parts. In fact, the coefficients
are positive which mean that Indonesian imports are higher than the average of developing
countries. This condition is caused by the low quality of Indonesian auto parts production which do
not meet car makers’ standards and requirements therefore automotive firms in Indonesia have to
import most of their auto parts.
VII. Conclusion
Automotive industry experienced continuing transformation from European dominance in the
beginning of 20th century to the US dominance by the introduction of Fordism mass production in
early 20th century and to Japanese dominance in 1970s with the introduction of lean production
system. Saturated market in developed countries drives many carmakers to spread the market to
developing countries by setting up assembly and production base in individual country to serve the
domestic market. With the technology development and innovations in telecommunication andtransportation, automotive industry is able to fragment the production process into smaller
segments in which components of productions or assemblies can be relocated to different places
based on cost advantages. The relocation of segmented production process creates global production
networks. Product fragmentation enables developing countries to participate in the globalization of
automotive industry by focusing on their competitive advantage.
Indonesia as the largest economy in Southeast Asian also participates in the global automotive
industry. Automotive industry which was started in Indonesia in 1928 has shown slow development.
In comparative perspective, Indonesian position in the global automotive industry is quite weak. On
the production side, Indonesian position is below Thailand and Malaysia. While other ASEAN
countries have upgraded their auto parts industry from unskilled labour intensive to technological
intensive products, Malaysia and Indonesia are relatively caught at assembling the same products
such as radio-broadcast receivers and resource based products, i.e. tyres.
This study uses richer dataset than the existing studies since it includes all countries in the world for
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country regardless of the labour condition, competitiveness and import tariff. FDI openness is
important because the imported auto parts are used as the input for production blocks established
by the car makers and the decision of car makers to relocate the production blocks in a country
depends crucially on the investment climate. If a country has costly business practice then local
firms will establish their own firms and join the car maker as one of the production blocks and they
are required to import auto parts from car makers’ production networks .
Indonesia is indeed left behind in export side of the global production network because of FDI
policies in Indonesia are less open compares to neighbouring countries. The major factors whichaffect Indonesian condition are the low quality of institutions and legal certainty which discourage
foreign investor to invest significant capital in Indonesia which is required for the technological
intensive auto parts. Automotive industry in Indonesia is a very protective sector and a frequent
change in policies towards the automotive industry creates uncertainty for both domestic and
foreign investments. With no majority of ownership before 1994, Japanese car makers were
reluctant to transfer the related technology to their partners in Indonesia which resulted in less
participation in production network compares to Thailand.
However, Indonesia is not left behind on the import side of production networks except for the
Technological Intensive auto parts. High intensity of Indonesian participation on the import side is
caused by the requirements of car makers to still import the auto parts because of the low quality of
auto parts production which does not meet car maker’s standards.
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Appendix
Appendix 1: List of country
1 Albania
2 Algeria
3 Andorra
4 Anguilla
5 Antigua and Barbuda
6 Argentina7 Armenia
8 Aruba
9 Australia
10 Austria
11 Azerbaijan
12 Bahamas
13 Bahrain
14 Bangladesh
15 Barbados
16 Belarus
17 Belgium
18 Belgium-Luxembourg
19 Belize
20 Benin
21 Bermuda
22 Bhutan
23 Bolivia (Plurinational State of)
24 Bosnia Herzegovina
25 Botswana
26 Brazil27 Brunei Darussalam
28 Bulgaria
29 Burkina Faso
30 Burundi
41 China, Macao SAR
42 Colombia
43 Comoros
44 Congo
45 Cook Isds
46 Costa Rica47 Croatia
48 Cuba
49 Cyprus
50 Czech Rep.
51 Czechoslovakia
52 Denmark
53 Dominica
54 Dominican Rep.
55 Ecuador
56 Egypt
57 El Salvador
58 Eritrea
59 Estonia
60 Ethiopia
61 Faeroe Islands
62 Fiji
63 Finland
64 Former Fed. Rep. of Germany
65 Former Yugoslavia
66 France67 French Guiana
68 French Polynesia
69 Gabon
70 Gambia
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81 Guyana
82 Haiti
83 Honduras84 Hungary
85 Iceland
86 India
87 Indonesia
88 Iran
89 Iraq
90 Ireland91 Israel
92 Italy
93 Jamaica
94 Japan
95 Jordan
96 Kazakhstan
97 Kenya
98 Kiribati
99 Kuwait
100 Kyrgyzstan
101 Latvia
102 Lebanon
103 Lesotho
104 Libya
105 Lithuania
106 Luxembourg
107 Madagascar
108 Malawi
109 Malaysia
110 Maldives111 Mali
112 Malta
113 Martinique
114 Mauritania
125 Neth. Antilles
126 Netherlands
127 New Caledonia128 New Zealand
129 Nicaragua
130 Niger
131 Nigeria
132 Norway
133 Occ. Palestinian Terr.
134 Oman135 Pakistan
136 Panama
137 Papua New Guinea
138 Paraguay
139 Peru
140 Philippines
141 Poland
142 Portugal
143 Qatar
144 Reunion
145 Rep. of Korea
146 Rep. of Moldova
147 Romania
148 Russian Federation
149 Rwanda
150 Saint Kitts and Nevis
151 Saint Lucia
152 Saint Vincent and the
Grenadines
153 Samoa
154 Sao Tome and Principe
155 Saudi Arabia
156 Senegal
157 Serbia
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169 Sudan
170 Suriname
171 Swaziland172 Sweden
173 Switzerland
174 Syria
175 Tajikistan
176 TFYR of Macedonia
177 Thailand
178 Timor-Leste179 Togo
180 Tonga
181 Trinidad and Tobago
182 Tunisia
183 Turkey
184 Turkmenistan
185 Turks and Caicos Islands
186 Tuvalu
187 Uganda
188 Ukraine
189 United Arab Emirates
190 United Kingdom
191 United Rep. of Tanzania
192 Uruguay
193 USA
194 Vanuatu
195 Venezuela
196 Viet Nam
197 Wallis and Futuna Islands
198 Yemen199 Zambia
200 Zimbabwe
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Appendix 2: List of auto parts
No SITC FactorIntensity
Description
1 S3-6251 HCI Tyres, pneumatic, new, of a kind used on motor cars (including station wagons and racing cars)
2 S3-6252 HCI Tyres, pneumatic, new, of a kind used on buses or lorries
3 S3-62541 HCI Tyres, pneumatic, new, of a kind used on motorcycles and bicycles of a kind used on motorcycles
4 S3-62591 HCI Inner tubes
5 S3-62593 HCI Used pneumatic tyre
6 S3-69915 HCI Other mountings, fittings and similar articles suitable for motor vehicles
7 S3-69941 HCI Springs and leaves for springs, of iron or steel
8 S3-76211 HCI Radio-broadcast receivers not capable of operating without an external source of power, of a kind used in motor vehicles
(including apparatus capable of receiving radio-telephony or radio-telegraphy) incorporating sound-recording or reproducing
apparatus
9 S3-76212 HCI Radio-broadcast receivers not capable of operating without an external source of power, of a kind used in motor vehicles
(including apparatus capable of receiving radio-telephony or radio-telegraphy) not incorporating sound-recording or
reproducing apparatus
10 S3-76422 HCI Loudspeakers, mounted in their enclosures
11 S3-76423 HCI Loudspeakers, not mounted in their enclosures
12 S3-76425 HCI Audio-frequency electric amplifiers
13 S3-7841 HCI Chassis fitted with engines, for the motor vehicles of groups 722, 781, 782 and 783
14 S3-78421 HCI Bodies (including cabs), for the motor vehicles of groups 781,
15 S3-78425 HCI Bodies (including cabs), for the motor vehicles of groups 722, 782 and 783
16 S3-78431 HCI Bumpers, and parts thereof
17 S3-78432 HCI Other parts and accessories of bodies (including cabs)
18 S3-78433 HCI Brakes and servo-brakes and parts thereof
19 S3-78434 HCI Gearboxes
20 S3-78435 HCI Drive-axles with differential, whether or not provided with other transmission components
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21 S3-78436 HCI Non-driving axles, and parts thereof
22 S3-78439 HCI Other parts and accessories
23 S3-78531 HCI Invalid carriages, whether or not motorized or otherwise mechanically propelled
24 S3-78535 HCI Parts and accessories of motorcycles (including mopeds)
25 S3-78536 HCI Parts and accessories of invalid carriages
26 S3-78537 HCI Parts and accessories of other vehicles of group 785
27 S3-88571 HCI Instrument panel clocks and clocks of a similar type, for vehicles, aircraft, spacecraft or vessels
28 S3-71321 TI Reciprocating piston engines of a cylinder capacity not exceeding 1,000 cc
29 S3-71322 TI Reciprocating piston engines of a cylinder capacity exceeding 1,000 cc30 S3-71323 TI Compression-ignition engines (diesel or semi-diesel engines)
31 S3-71391 TI Parts, n.e.s, for the internal combustion piston engines of subgroups 713.2, 713.3 and 713.8, suitable for use solely or
principally with spark-ignition internal combustion piston engines
32 S3-71392 TI Parts, n.e.s, for the internal combustion piston engines of subgroups 713.2, 713.3 and 713.8, suitable for use solely or
principally with compression-ignition internal combustion piston engines
33 S3-71651 TI Electric generating sets with compression-ignition internal combustion piston engines (diesel or semi-diesel engines)
34 S3-7169 TI Parts, n.e.s., suitable for use solely or principally with the machines falling within group 71635 S3-74315 TI Compressors of a kind used in refrigerating equipment
36 S3-74363 TI Oil or petrol filters for internal combustion engines
37 S3-74364 TI Intake air filters for internal combustion engines
38 S3-7438 TI Parts for the pumps, compressors, fans and hoods of subgroups 743.1 and 743.4
39 S3-74443 TI Other jacks and hoists, hydraulic
40 S3-7481 TI Transmission shafts (including camshafts and crankshafts) and cranks
41 S3-74821 TI Bearing housings, incorporating ball- or roller bearings
42 S3-74822 TI Bearing housings, not incorporating ball- or roller bearings; plain shaft bearings
43 S3-7484 TI Gears and gearing (excluding toothed wheels, chain sprockets and other transmission elements presented separately); ball
screws; gearboxes and other speed changers (including torque converters)
44 S3-7485 TI Flywheels and pulleys (including pulley blocks)
45 S3-7486 TI Clutches and shaft couplings (including universal joints)
f h l f
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46 S3-7489 TI Parts, n.e.s., for the articles of group 748
47 S3-7492 TI Gaskets and similar joints of metal sheeting combined with other material or of two or more layers of metal; sets or
assortments of gaskets and similar joints, dissimilar in composition, put up in pouches, envelopes or similar packings
48 S3-74999 TI Other machinery parts, not containing electrical connectors, insulators, coils, contacts or other electrical features
49 S3-77812 TI Electric accumulators (storage batteries)
50 S3-77821 TI Filament lamps (other than flash bulbs, infrared and ultraviolet lamps and sealed-beam lamp units)
51 S3-77823 TI Sealed-beam lamp units
52 S3-77831 TI Electrical ignition or starting equipment of a kind used for spark- ignition or compression-ignition internal combustion
engines (e.g., ignition magnetos, magnetodynamos, ignition coils, sparking-plugs and glow plugs, starter motors); generators
(e.g., dy dynamos and alternators) and cut-outs of a kind used in conjunction with such engines
53 S3-77833 TI Parts of the equipment of heading 778.31
54 S3-77834 TI Electrical lighting or signalling equipment (excluding articles of subgroup 778.2), windscreen wipers, defrosters and
demisters, of a kind used for cycles or motor vehicles
55 S3-77835 TI Parts of the equipment of heading 778.34
56 S3-66471 ULI Safety glass, consisting of toughened (tempered) or laminated glass of toughened (tempered) glass
57 S3-66472 ULI Safety glass, consisting of toughened (tempered) or laminated glass of laminated glass58 S3-66481 ULI Rear-view mirrors for vehicles
59 S3-77313 ULI Ignition wiring sets and other wiring sets of a kind used in vehicles, aircraft or ships
60 S3-82112 ULI Seats of a kind used for motor vehicles
Appendix 3: Summary of data
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Appendix 3: Summary of data
Variables Data Data Source Period Expected Sign
Labour cost Real wage LABORSTA Varies among countries (-)
Technology level Share of High Tech Export WDI All period (+)
Competitiveness RER WDI All period (+) for export model
(-) for import model
Trade Cost Export cost Doing Business 2004-2005 (-)
Import Cost Doing Business 2004-2005 (-)
Freight Cost Distance to Major Partner Haveman’s Data All period (+) / (-) depends on type
of commodities
Tariff Manufactured Goods MFN
tariff
TRAINS All period (-)
FDI Openness Inward FDI Potential Index World Investment Report All period (-)
Administration Cost Cost of Starting a new
Business
WB Doing Business 2004-2007 (-)
Cost of Enforcing the
Contract
WB Doing Business 2004-2007 (-)
Country size GDP per capita WDI All period (+)
Market size Export equation: World
Import for Final Assembly
COMTRADE All period (+)
Import equation: GDP per
capita
WDI All period (+)
PRODUCTION COST
SERVICE LINKS COST – Border Trade Barriers
SERVICE LINKS COST – Behind-the-Border Trade Barriers
OTHER VARIABLES