the factors influence foreign direct investment in indonesia
TRANSCRIPT
THE FACTORS INFLUENCE FOREIGN DIRECT
INVESTMENT IN INDONESIA
By
Han Yakai
ID No. 014200900067
A thesis presented to the
Faculty of Economic President University
in partial fulfillment of the requirement for
Bachelor Degree in Economics Major in Management
February 2013
THESIS ADVISER
RECOMMENDATION LETTER
The thesis entitled “The Factors Influence Foreign Direct Investment
in Indonesia” prepared and submitted by Han Yakai in partial
fulfillment of the requirements for Bachelor Degree in Economics -
Major in Management (Concentration: International Business), has been
reviewed and found to have satisfied the requirements for a thesis fit to be
examined. We therefore recommend this thesis for Oral Defense.
Cikarang, Indonesia, 12th Feb 2013
Acknowledged by, Recommended by
Irfan Habsjah, MBA, CMA Dr. Erwin Ramedhan
Head of Management Study Program Thesis Advisor
PANEL OF EXAMINERS
APPROVAL SHEET
The Panel of Examiners declare that the thesis entitled “The Factors
Influence Foreign Direct Investment in Indonesia” submitted by Han
Yakai Majoring in Management (Concentration: International Business),
Faculty of Economics was assessed and proved to have passed the Oral
Examination on 28th Jan, 2013.
T, Manivasugen, MBA
Chair - Panel of Examiners
Dra. Genoveva. M. M
Examiner 1
Dr. Erwin Ramedhan
Examiner 2
DECLARATION OF ORIGINALITY
I declare that this thesis, entitled “The Factors Influence Foreign
Direct Investment in Indonesia” is, to the best of my knowledge and
belief, an original piece of work that has not been submitted, either in
whole or in part, to another university to obtain a degree.
Cikarang, Indonesia, 12th Feb 2013
Han Yakai
Researcher
ABSTRACT
Foreign Direct Investment (FDI) is an important source of capital and economic
growth in developing countries. It provides a package of new technologies,
management techniques, finance and market access for the production of goods and
services. However, attracting FDI is a major challenge for host countries as it faces
the challenge of identifying the major factors that motivate and affect the FDI location
decision. After reviewing the literature we identify the most important major location
factors for FDI, which are the macroeconomic performance factors, human capital
factors, investment climate factors and infrastructure condition factors. However, the
previous studies lack the focus on Indonesia. Therefore, this study will fill the
previous studies gaps by studying both the positive and negative factors which
influence the FDI located in Indonesia.
This research can provide a guideline and consult for foreign companies who
intent to start investing in Indonesia. From this research, they can evaluate the
investment climate and balance the benefits and risks they have to take. Besides, this
research also provides them a way to reduce investment risk in their future operation.
Besides, the results of this study can also provide the government officers a rough
outline for how to improve its investment climate and increase its competitiveness in
attracting FDI inflow.
ACKNOWLEDGEMENTS
First and foremost, I would like to thank my parents for their love and support
throughout my life. Thank you both for giving me strength reaching for the stars and
chase my dreams. My brother deserves my wholehearted thanks as well.
I would like to sincerely thank Mr. Li and Ping Dingshan Federation of returned
overseas Chinese who provide scholarship for me to study at President University. I
would also like to thank my advisors Mr. Erwin and Ms. Farida for their guidance and
support throughout this study, for their patience, motivation, enthusiasm and immense
knowledge. Their guidance helped me in all the time of research and writing of this
thesis. I could not have imagined having a better advisor and mentor for my bachelor
study.
My sincere thanks also go to Mr. leo from COLUMBIA GROUP for his care in
the last three years and Mr. Si for offering me the internship opportunity in TIANJI
company.
To all my friends, thank you for your understanding and encouragement in my
many, many moments of crisis. Your friendship makes my life a wonderful experience.
I cannot list all the names here, but you are always on my mind.
Thank you, Xiangyu, for always being there for supporting me.This thesis in only
a beginning of my journey.
TABLE OF CONTENTS
Page
Thesis Adviser Recommendation Letter………………………………………..I
Panel of Examiners Approval Sheet ………………………………… ………...II
Declaration of Authority……………………………………………….…….....III
Abstract ………………………………………………………………………...IV
Acknowledgment…………………………………………………………….....V
Table of Contents ……………………………………………………………....VI
List of Tables …………………………………………………………………..VII
List of Figures…………………………………………………………………..VIII
1. INTRODUCTION…………………………………………………………1
1.1 Background of study………………………………………………………...1
1.2 Problems Identified……………………………………………………….....5
1.3 Statement of problems……………………………………………………….6
1.4 Research objectives………………………………………………………….6
1.5 Significant of the study……………………………………………………...7
1.6 Definition of terms…………………………………………………………...8
1.7 Limitation of the research…………………………………………………...10
2. LITERATRURE REVIEW……………………………………………….11
2.1 The reasons for FDI occurring………………………………………………11
2.1.1 Ownership Advantages Theory………………………………………….11
2.1.2 Internalization theory……………………………………………………12
2.1.3 Dunning’s Eclectic Theory………………………………………………12
2.2 The three forms of FDI……………………………………………………...14
2.2.1 Greenfield investment…………………………………………………...14
2.2.2 Brown-field investment…………………………………………………14
2.2.3 Mergers and Acquisition………………………………………………...14
2.3 Factors Influencing Foreign Direct Investment……………………………15
2.3.1 Macroeconomic Performance…………………………………………..16
2.3.2 Human Capital………………………………………………………….17
2.3.3 Investment Climate……………………………………………………..18
2.3.4 Infrastructure condition………………………………………………...20
2.4 Investors’ choice of location………………………………………………..25
2.4.1 Host Countries’ Enabling Environment………………………………...25
2.4.2 Factors Driving Investment Decisions………………………………….26
3. METHODOLOGY………………………………………………………..28
3.1 Research method…………………………………………………………....28
3.2 Research design……………………………………………………………..29
3.2.1 Data collection tool……………………………………………………...29
3.2.2 Research design………………………………………………………....29
3.2.3 Data analysis method……………………………………………………31
3.2.4 Data analysis tool……………………………………………………….36
4. ANALYSIS OF DATA AND INTERPRETATION OF RESULTS……..37
4.1 Data analysis…………………………………………………………………37
4.2 Macroeconomic performance………………………………………………..37
4.2.1 GDP (current Billion US$)……………………………………………...37
4.2.2 GDP Annual Growth………………………………………………….....39
4.2.3 Annual Inflation Ratio…………………………………………………..40
4.2.4 Exchange Rate Standard Deviation……………………………………..41
4.2.5 Foreign Direct Investment, Net Inflows (% of GDP)…………………...42
4.3 Human capital……………………………………………………………….43
4.3.1 Population……………………………………………………………….43
4.3.2 Average hourly wage……………………………………………………45
4.3.3 Labor force education…………………………………………………...46
4.4 Investment Environment…………………………………………………….47
4.4.1 Administrative efficiency………………………………………………..47
4.4.2 Easy of Doing Business………………………………………………….49
4.4.3 Business Environment Snapshot………………………………………...51
4.5 Infrastructure Condition……………………………………………………..53
4.5.1 Quality of overall infrastructure………………………………………....53
4.5.2 Strategic location………………………………………………………...58
5. CHAPTER VCONCLUSIONS AND RECOMMENDATIONS………..59
5.1 Conclusion…………………………………………………………………..59
5.2 Recommendation……………………………………………………………60
6. REFERENCE……………………………………………………………...65
LIST OF TABLES
Page
Table 1: Key Determinants and Factors for FDI Inflow………………………..23
Table 2: The main FDI location factors and sub-factors………………………..24
Table 3: Independent Variables-Expected Relationship………………………...31
Table 4: Indicators of foreign direct investment regulation 2011……………….47
Table 5: Ease of doing business world rank among 185 selected countries…….49
Table 6: Business Environment global rankings for Indonesia, China
and Vietnam…………………………………………………………….51
Table 7: main indicators of infrastructure………………………………………54
LIST OF FIGURES
Page
Figure 1: GDP (current Billion US$) form 2007-2011………………………......37
Figure 2: GDP Annual Growth form 2007-2011…………………………………39
Figure 3: Inflation, consumer prices (annual %) form 2007-2011…………….....40
Figure 4: Exchange Rate Standard Deviation 2007-2010………………………..41
Figure 5: Foreign direct investment, net inflows (% of GDP) form 2007-2010....42
Figure 6: Population from 2007-2011…………………………………….……...43
Figure 7: Average hourly wage, China vs. Vietnam, Indonesia and India
(US$ per hour)………………………………………………………...45
Figure 8: Labor force with tertiary education (% of the total)…………………..46
Figure 9: Infrastructure overall 2010-2011……………………………………...53
CHAPTER I
INTRODUCTION
1.1. Background of Study
The world economy is recovering slowly with growth tempered by the debt crisis
in developed countries, the uncertainties surrounding the future of the euro, and rising
financial market turbulence. Despite the economic and financial crisis, global foreign
direct investment (FDI) rose in 2011 by 17 percent compared with 2010. The rise of
FDI was widespread, including all three major groups of economies − developed,
developing and transition.FDI flows to developing Asia (Excluding West Asia) rose
11 per cent in 2011. By sub-region, East Asia, South-East Asia and South Asia
received inflows of around US$209 billion, US$92 billion and US$43 billion,
respectively. With a 16 percent increase, South-East Asia continued to outperform
East Asia in growth of FDI, while South Asia saw its inflows rise by one -third after a
slide in 2010. The good performance of South-East Asia, which encompasses the
Association of Southeast Asian Nations (ASEAN) as a whole, was driven by sharp
increases of FDI inflows in a number of countries, including Indonesia, Malaysia and
Thailand. (United Nations Conference on Trade and Development, UNCTAD)
China is the second largest location for attracting FDI in the world but in the
January-October 2012 period China see its FDI realization to fall 3.45 percent to
US$91.7 billion, as foreign investors started to doubt the prospects of the country’s
economy. India, which is also seen as Indonesia’s main rival in attracting foreign
investors, saw in the second quarter this year a 67 percent annual decline in FDI,
which stood at $4.43 billion, as investors grew concerned about India’s alarming
macroeconomic indicators, especially its high inflation.
While, driven by soaring investment and strong domestic consumption by its
population of 240 million, Indonesia's economy has proven resilient to the global
slowdown, helped by domestic consumption and foreign direct investment. GDP
annual growth reaches an estimated 6.1% and 6.4% in 2010 and 2011, respectively.
Indonesia outperformed its regional neighbors and joined China and India as the only
G20 members posting growth in 2009. Fitch and Moody's upgraded Indonesia's credit
rating to investment grade in December 2011. FDI realization in Indonesia jumped to
a new record high of $587.41 million in the third quarter of 2012, surging 22 percent
compared to a year earlier. Some analysts start to view the country as a worthy
contender to join the BRICS group which includes Brazil, Russia, India, China and
South Africa.
(http://www3.bkpm.go.id/mobile/content/news.php?i=113101&l=1&m=40)
Recent trends show that multinational corporations (MNCs) originating from
Japan, Korea and USA are reducing their investment share in China. Many companies
decide to shut down their manufacturing factories in China and move to its neighbor
countries like Vietnam and Indonesia to rearrange its resources all over the world. The
rising wages, increasing cost in labor and land are driving MNCs to move out of
China.
Seeing how such problems are unfolding in China and India, investors are now
turning to Indonesia, which they deem as attractive because of Indonesia’s stable
economic growth, lower labor cost and huge domestic market. In addition, Indonesia
offered huge opportunities for companies wanting to expand their output for the
country’s large population of 240 million who currently remained largely dependent
on imported goods to meet their needs.
Globalization of the world economy is gathering pace, with international
investment as the prime driver. Since the early 1980s, world foreign direct investment
(FDI) flows have grown rapidly faster than both world trade and world output. Today,
every country is aware of the fundamental role which international investment plays
in. It is through the channels of investment that technological interchange and free
circulation of capital, people and ideas take place.
Foreign direct investment (FDI) has been a key aspect of increased globalization
in recent decades. The growth in FDI has been higher than growth in international
trade; multinational firms have come to account for about 10 percent of world output
and 30 percent of world exports; and a large share of new technologies is developed
and controlled by these firms.
FDI has played, and continues to play, a large role in Asian development. China is
one of the world‘s largest recipients of FDI and Japan is a major source. Some
countries in the region, such as Singapore, have based much of their development
strategy on reliance on foreign multinational firms. Finally, Asia is a prime home to
multinational firms’ cross-country networks, where different affiliates of a firm
produce different parts and components, or assemble such parts and components
imported from abroad.
FDI often requires coordinating complicated operations over long distances: input
goods and services need to be shipped between different branches of the multinational
firm; and coordination and supervision requires visits by staff and a steady flow of
information. It is clear that the complexities of operations across national borders put
large requirements on the host country economic environment. Countries differ in
their ability to attract FDI, depending on characteristics such as infrastructure, trade
regimes, labor force skills, and institutional quality.
It should therefore not come as a surprise that inflows of FDI differ substantially
among countries in Asia. Indonesia is a country where FDI inflows have been
relatively modest, and lower than what would be expected from the size of the
country
In Indonesia, investment has also started to play an important role in contributing
to GDP growth – almost 33 percent of Indonesia’s economic growth at the second
quarter and 39 percent in the third quarter of 2012 which rank second after domestic
consumption, which contributed 50.5 percent. Foreign direct investment in Indonesia
jumped 22% in the third quarter from a year earlier to another record hitting 56.6
trillion rupiah ($5.9 billion) in the third quarter of 2012, breaking the previous
quarter's record of 56.1 trillion rupiah with more than half of total investments
targeted at Java.
All of this good news comes but we should also be aware of the fact that
Indonesia’s economic freedom score is 56.4, making its economy the 115th freest in
the 2012 Index and it is ranked the 128th of ease doing business in the world.
Indonesia still struggles with poverty and unemployment. The government faces the
ongoing challenge of corruption; bureaucrat, low supporting infrastructure, and labor
unrest over wages, protectionism and government regulations consistently which rank
as top concerns for investors. Further difficulties must be overcome in the human
resources area – in particular, improvements must be made to labor force quality.
Only after the Indonesia government keep improving its investment climate and
protect the investors’ right, it will attract much more FDI inflow to contribute its
economic growth and benefit its people.
1.2. Problems Identified
After the 1998’s monetary crisis, Indonesian economic growth has moved toward
a positive trend especially in the last few years with outstanding performance such as
Indonesia’s economy expanded by 6.5 percent in 2011, foreign direct investments
inflows to Indonesia amounted to US$ 19.7 Billion, with 48.2 percent growth rate and
Indonesia’s credit rating is upgraded recently.
This is a remarkable achievement in the midst of the global economic slowdown
and foreign direct investments are the most significant factors to boost economic
growth rate, all the performance cannot achieved without the contribution from FDI.
Besides, the foregoing technology development, product diversification as well as
relative export growth rate are among the most obvious results due to the existence of
foreign direct investments in Indonesia.
It should be awarded of the facts that Indonesia’s FDI inflows are still lower than
other neighbor countries such as India and China. And it has come to know that there
are obstacles to barricade the FDI inflow to Indonesian over the past few years, many
interrelated factors today are all added to prevent Indonesian from attracting more
investors and investment, frequently mentioned in mass media such as policy
uncertainty, labor violence, corruption and poor infrastructure situation. Indonesia’s
competitive advantages have been deteriorated even further.
FDI has benefitted the Indonesian economy in various respects and a natural
conclusion is that Indonesia would benefit from higher inflows. Therefore, learn from
the matters previously explained and find both the positive and negative factors
impacting FDI inflows to Indonesia can provide suggestion to improve Indonesia’s
investment environment and attract more investment to contribute to Indonesia’s
economy growth.
1.3. Statement of the Problems
1.3.1 What are the positive and negative factors influencing Foreign Direct
Investment inflow to Indonesia?
1.3.2 What steps should be taken to improve Indonesia’s investment climate to
attract more foreign investment in the future?
1.4. Research Objectives
The research objectives are:
1.4.1 To find out both the positive and negative factors impacting in Foreign Direct
Investment inflow in Indonesia,
1.4.2 To find the way to improve Indonesia’s investment climate and attract more
foreign investment to contribute the domestic economic growth.
1.4.3 It is hoped that this study will provide some useful insights, policy
implications and recommendations for the country and international business
community.
1.5 Significance of the Study
The research aims to contribute highly to the following institutions:
1.5.1 For President University
This research is about ‘the analysis of the Factors impact FDI in Indonesia’ which
the researcher chooses as thesis topic to fill the blank in FDI research area in the
President University. The research can show how to implement the class knowledge
into real research and get meaningful outcome. It also can provide some references to
the following students from President University and help them make better thesis.
1.5.2 For Foreign Companies
This research can provide a guideline and consult for foreign companies who
intent to start investing in Indonesia. From this research, they can evaluate the
investment climate and balance the benefits and risks they have to take. Besides, this
research also provides them a way to reduce investment risk in their future operation.
1.5.3 For Indonesia Government
This research analysis the strength and weakness of FDI in Indonesia and the
results can provide the government officers a rough outline for how to improve its
investment climate and increase its competitiveness in attracting FDI inflow.
1.5.4 For the Researcher
This research can enrich the knowledge of the researcher and it will make the
researcher understand clearly and deeply about FDI, especially the situation of FDI in
Indonesia. More importantly, it is very useful for the researcher’s career in the future
after graduate from President University.
1.6 Definition of Terms
FDI: FDI stands for Foreign Direct Investment is acquisition assets for the
purpose of controlling them. U.S government statisticians define FDI as “ownership
or control of 10 percent or more of an enterprise’s voting securities or the equivalent
interest in an unincorporated business.” FDI may take many forms, including
purchase of existing assets in a foreign country, new investment in property, plant, and
equipment, and participation in a joint venture with a local partner. It does not include
foreign investment into the stock markets.
(http://www.commercialdiplomacy.org/cd_dictionary/cd_glossary3.htm)
Globalization: Globalization is the process of international integration arising
from the interchange of world views, products, ideas, and other aspects of culture. In
particular, advances in transportation and telecommunications infrastructure,
including the rise of the Internet, are major factors in globalization and precipitate
f u r t h e r i n t e r d e p e n d e n c e o f e c o n o m i c a n d c u l t u r a l a c t i v i t i e s .
(http://en.wikipedia.org/wiki/Globalization)
G20: The Group of G-20 is the name given to the group of 20 finance ministers
and central bank governors from 20 of the world's largest economies, which includes
19 countries and the European Union. For countries, whose economies are large
enough to be included in the G-20 as individual nations thanks to their gross domestic
product, the G-20 represents two-thirds of the world's population, 80 percent of the its
trade and 85 percent of its global gross national product. Members of the G-20
include: Argentina、Australia、Brazil、Canada、China、European Union、France、
Germany、India、Indonesia、Italy、Japan、Mexico、Russia、Saudi Arabia、South
Africa 、 South Korea 、 Turkey 、 United Kingdom 、 United
States.(http://www.g20.org/docs/about/about_G20.html)
BRICS GROUP: BRICS is the title of an association of emerging economies,
arising out of the inclusion of South Africa into the original BRIC grouping in 2010.
The group's five members are Brazil, Russia, India, China and South Africa. With the
possible exception of Russia, the BRICS members are all developing or newly
industrialized countries, but they are distinguished by their large, fast-growing
economies and significant influence on regional and global affairs. As of 2012, the
five BRICS countries represent almost 3 billion people, with a combined nominal
GDP of US$13.7 trillion and an estimated US$4 trillion in combined foreign reserves.
Presently, India holds the chair of the BRICS group.
(http://en.wikipedia.org/wiki/BRICS)
MNC: A multinational corporation (MNC) or multinational enterprise (MNE) is
a corporation that is registered in more than one country or that has operations in
more than one country. It is a large corporation which both produces and sells goods
or services in various countries. It can also be referred to as an international
corporation. The first multinational corporation was the Dutch East India Company,
founded March 20, 1602.
(http://www2.econ.iastate.edu/classes/econ355/choi/mnc.htm)
ASEAN: The Association of Southeast Asian Nations (ASEAN) is a geo-political
and economic organization of ten countries located in Southeast Asia, which was
formed on 8 August 1967 by Indonesia, Malaysia, the Philippines, Singapore and
Thailand. Since then, membership has expanded to include Brunei, Burma (Myanmar),
Cambodia, Laos, and Vietnam. Its aims include accelerating economic growth, social
progress, and cultural development among its members, protection of regional peace
and stability, and opportunities for member countries to discuss differences
peacefully.
(http://www.asean.org/asean/about-asean/overview)
1.7 Limitations of the Research
The research has limited geographical focus, as it will focus only on FDI located
in Indonesia. Therefore, it is likely that the findings will not apply similarly to other
countries.
Another limitation is that the results may not represent every factors impacting
FDI in each industries. Therefore, the findings may not apply to each specific sectors
and industries.
CHAPTER II
LITERATURE REVIEW
There has already been a great deal of discussion about the factors that determine
FDI flows towards countries. The existing literature on the determinants of location
factors for Multinational Corporations (MNCs) when they choose their foreign market
location includes a large number of surveys and case studies and a number of
econometric studies. In general, they conclude that the main factors which have
driven FDI in countries here we present some of the studies.
It is widely believed that the trend towards globalized production and marketing
has major implications for developing countries' attractiveness to FDI. The boom of
FDI flows to developing countries since the early 1990s indicates that multinational
enterprises have increasingly considered these host countries to be profitable
investment locations. At the same time, various experts argue that the determinants of
and motivations for FDI in developing countries have changed in the process of
globalization. As a consequence, it would no longer be sufficient to offer promising
markets in order to induce FDI inflows. Policymakers would face rather complex
challenges in striving for location attractiveness to FDI (Kokko 2002).
2.1 The Reason for FDI Occurring
2.1.1 Ownership Advantages Theory
More powerful explanations for FDI focus on role of firms. Initially researchers
explored how firm ownership of competitive advantages affected FDI. The ownership
advantage theory suggests that a firm owning a valuable asset that creates a
competitive advantage domestically can use that advantage to penetrate foreign
markets through FDI. The asset could be, for example, a superior technology, a
well-known brand name, or economies of scale.
2.1.2 Internalization theory
The ownership advantage theory only partly explains why FDI occurs. It does not
explain why a firm would choose to enter a foreign market via FDI rather than exploit
its ownership advantages internationally through other means, such as exporting its
products, franchising a brand name, or licensing technology to foreign firms.
Internalization theory relies heavily on the concept of transaction cost. Transaction
cost are the costs of entering into a transaction, that is, those connected to negotiating,
monitoring, and enforcing a contact. A firm must decide whether it is better to own
and operate its own factory overseas or to contact with a foreign firm to do this
through a franchise, licensing, or supply agreement.
Internalization theory suggests that FDI is more likely to occur when the costs of
negotiating, monitoring, and enforcing a contact with a second firm are high. If the
transaction cost is low, the firms are more likely to contact with outsiders and
internationalize by licensing their brand names or franchising their business
operations.
2.1.3 Dunning’s Eclectic Theory
Although internalization theory addresses why firms choose FDI as the mode for
entering international markets, the theory ignores the question of why production, by
either the company or a contractor, should be located abroad. Under the theory of
John Dunning, eclectic theory which combines ownership advantage, location
advantage, and internalization advantage to form a unified theory of FDI. FDI will
occur when three conditions are satisfied:
1. Ownership advantage. The firm must own some unique competitive advantage
that overcomes the disadvantages of competing with firm firms on their home
turfs. This advantage may be a brand name, ownership of proprietary technology,
the benefits of economies of scale, and so on.
2. Location advantage. Undertaking the business activity must be more profitable in
a foreign location than undertaking it in a domestic location. For example, the
firms can enjoy lower labor costs and avoid high tariff walls on goods exports
from their home factories.
3. Internalization advantage. The firm must benefit more from controlling the
foreign business activity than from hiring an independent local company to
provide the service. Control is advantageous, for example, when monitoring and
enforcing the contractual performance of the local company is expensive, when
the local company may misappropriate proprietary technology, or when the firm’s
reputation and brand name could be jeopardized by poor behavior by the local
company.
FDI is one of several approaches that business enterprises can use to enter foreign
markets. The following is a common sequence that firms use to develop foreign
markets for their products:
1. Export of the goods produced in the source country.
2. Licensing a foreign company to use process or product technology
3. Foreign production, which is the production of goods and services in a country
that is controlled and managed by firms headquartered in other countries.
Step 3 and step 4 involved in FDI, the choice between exporting and FDI depends
on the following factors: profitability, opportunity for market growth, production cost
levels and economics of scale.
2.2 The Three Forms of FDI:
2.2.1 Greenfield investment, cross-border mergers and acquisition (M&As) and
Joint ventures. Greenfield investment occurs when the investing firm establishes new
production, distribution or other facilities in the host country. This is normally
welcomed by the host country because of the job-creating potential and value-added
output. Sometimes,
2.2.2 Brown-field investment is used to describe a situation where investments
that are formally an acquisition resemble Greenfield investment. This happens when
the foreign investor acquires a firm but replaces almost completely the plant and
equipment, labor and the product line. This concept has been used most to describe
acquisitions in transition economies (Meyer and Estrin, 1998).
2.2.3 Mergers and Acquisition: FDI may occur via cross-border mergers and
acquisition with an established firm in the host country. This mode of FDI has two
advantages over Greenfield investment: first, it is cheaper, particularly if the acquired
project is a loss-making operation that can be bought cheaply and secondly. Secondly,
it allows the investor to gain a quick access to the market. Firms may be motivated to
engage in cross-border acquisition to bolster their competitive positions in the world
market by acquiring special assets from other firms or by using their own assets on a
large scale (Hopkins, 1999).
Whether a firm would choose M&AS or Greenfield investment depend on a
number of firm-specific, host country-specific and industry-specific factors, including
the following (UNCTAD, 2000):
1. Firms with lower R&D intensity are more likely to indulge in M&As than those
with strong technological advantages
2. More diversified firms are likely to choose M&As
3. Large MNCs have a greater tendency to indulge in M&As
4. There is weak support for the proposition that advertising intensity lead to more
acquisition
5. Cultural and economic differences between the home country and the host country
reduce the tendency for M&As
6. Acquisitions are encouraged by capital market imperfections and financial crises.
7. MNCs with subsidiaries in the host country prefer acquisitions
8. The tendency towards M&As depends on the supply of target firms
9. Slow growth in an industry favors M&As
2.3 Factors Influencing Foreign Direct Investment
Given the complexity of global economy and the diversity of opportunity that
firms face in different countries, it is not surprising that numerous factors may
influence a firm’s decision to undertake FDI.
There has already been a great deal of discussion about the factors that determine
the FDI flows towards countries. The existing literature includes a large number of
surveys and case studies, and a number of econometric studies, In general, they
conclude that the main factors, which have driven FDI in countries here we present
some of that important studies:
2.3.1 Macroeconomic Performance
Until recently, there was a strong consensus in the literature that MNCs invest in
specific locations mainly because of strong economic fundamentals in the host
countries for example, large market size, stable macroeconomic environment etc.
(Dunning 1993, Globerman and Shapiro 1999; Shapiro and Globerman 2001).
The literature on the determinants of MNE decisions and FDI location is quite
substantial, though arguably still in its infancy. A more recent body of literature has
begun to frame such MNE decisions in a general equilibrium framework and
generates predictions of how fundamental country-level factors affect aggregate
country-level FDI behavior. A large body of literature examining determinants of FDI
begins with a partial equilibrium firm-level framework based in industrial
organization and finance to motivate empirical analysis. These studies then typically
examine how exogenous macroeconomic factors affect the firms FDI decision, and a
small body of literature focus on government infrastructure and MNC’s strategies in
host countries. (UNCTAD 1998)
Blonigen (2005) investigates the empirical estimation of the FDI determinants.
The paper surveys the literature that empirically examines the FDI decisions of the
Multi National Enterprises (MNEs) and the resulting aggregate location of FDI across
the world. The paper finds that the empirical literature is still at infancy; applying the
partial equilibrium approach of a MNE’s decision and analyzing the impact of
exogenous factor such as taxes, exchange rates etc. on firm-level decisions. Recent
literature using general equilibrium approach has not been able to capture the
interconnectedness of FDI behavior with trade flows and the underlying motivation
for MNEs behavior. Consequently, the paper argues that the broad generalization -
such as taxes generally discourage FDI - should not be expected.
Donges (2005) identifies the following factors as the major traditional
determinant of FDI viz. market size, trade related factors such as openness, wage rates,
human capital, political stability, infrastructure, policy variables including the general
economic fundamentals. He notes that the role and importance of these determinants
are changing due to globalization, which has not received adequate attention in the
literature.
2.3.2 Human Capital
Borensztein et al. (1998) carried out a cross-section empirical analysis to examine
the effect of FDI on economic growth. Their results suggest that FDI is an important
vehicle for the transfer of technology, contributing relatively more to output growth
than domestic investment. However, the higher productivity of FDI holds only when
the host country has a minimum threshold stock of human capital. Thus, they argue
that FDI contributes to economic growth only when a sufficient absorptive capability
of the advanced technologies is available in the host economy.
Labor costs depend on productivity as well as on wage rates. Productivity is
highly dependent on the educational level of the workforce and several papers find
education and skills of the workforce to be important in multinational firms’ location
decision. The level of education varies, of course, with the type of production, but
even relatively simple manufacturing typically requires at least basic literacy and
numeracy. For more sophisticated production, the skill requirement of the workforce
is higher.
Traditional economic determinants, such as natural resources and national market
size for manufacturing products sheltered from international competition by high
tariffs or quotas, still play an important role in attracting FDI by a number of
developing and developed countries. For foreign investors, the host country policies
on the repatriation of profits and capital and access to foreign exchange for the import
of intermediaries, raw materials and technology are particularly important.
Cost differences between locations, the quality of infrastructure, the ease of doing
business and the availability of skills have become more important (UNCTAD 1996).
2.3.3 Investment Climate
Reportedly, FDI are increasingly pursuing complex integration strategies. MNCs
"Increasingly seek locations where they can combine their own mobile assets most
efficiently with the immobile resources they need to produce goods and services for
the markets they want to serve" (UNCTAD 1998). This is expected to have two
related consequences regarding the determinants of FDI. The Host countries are
evaluated by FDI on the basis of a broader set of Policies than before. The number of
policies constituting a favorable Investment climate increases, in particular with
regard to the creation of Location-specific assets sought by FDI. The relative
importance of FDI location determinants have changed. Even though Traditional
determinants and the types of FDI associated with them have not disappeared with
globalization, their importance is said to be on the decline. More specifically, "one of
the most important traditional FDI determinants, the size of national markets, has
decreased in importance. At the same time, cost differences between locations, the
quality of infrastructure, the ease of doing business and the availability of skills have
become more important" (UNCTAD 1996: 97).
Likewise, Dunning (1999) argues that the motives for, and the determinants of
FDI have changed. According to Dunning, FDI in developing countries has shifted
from market-seeking and resource-seeking FDI to more (vertical) efficiency-seeking
FDI. It would have important policy implications if globalization had changed the
rules of the game in competing for FDI. The policy challenge may become fairly
complex; host country governments would have to provide and publicize a unique set
of immobile assets, pertinent to the types of economic activity they wish to attract and
retain Dunning (1999). Arguably, policymakers can no longer rely on the previous
empirical literature stressing the overriding role of some clearly defined factors
shaping the distribution of FDI.
However, with the growing integration of the world markets and increased
competition amongst the host countries to attract FDI, the host country’s economic
fundamentals may not be sufficient for inward FDI. Therefore it now becomes
important to study afresh what determines inflow of FDI. In this regard, there is a
need to focus on the role played by host government policies and investment
agreements in attracting Inward FDI.
Brewer (1993) discusses various types of government policies that can directly
and indirectly affect FDI through their effects on market imperfections. It is argued
that same government policy can increase and/or decrease market imperfections and
thereby increase and/or decrease FDI inflows.
The economic success of Singapore inspired other countries in East Asia to
liberalize their trade regimes and to encourage the entrance of foreign multinational
firms. The FDI regimes still differ among East Asian countries, with some being more
open than others, but all countries have become more open to FDI over time (Brooks
and Hill, 2004).
For instance, Gastanaga et al. (1998) find a general negative effect of corruption
on FDI in developing countries. Woo and Heo (2009) examines corruption in eight
Asian countries and find also a negative effect on FDI inflows. Hines (1995), in a
study on U.S. FDI, and Wei (1997), in a study on OECD, arrived at similar findings.
The negative effect of corruption on FDI might seem like a paradox considering that
large inflows of FDI and high levels of corruption coincide in many East Asian
countries.
The review of host country determinants is closely linked with the role of national
policies and especially the liberalization of policies, a key factor in globalization, as
FDI determinants. Location specific determinants have a crucial influence on a host
country’s inflow of FDI. The relative importance of different location-specific
determinants depends on at least three aspects of investment: the motive for
investment (e.g., resources, market or efficiency-seeking), the type of investment (e.g.,
services or manufacturing), and the size of the investors (small and medium MNEs or
large MNEs) (UNCTAD 1998a).
2.3.4 Infrastructure condition
Wheeler and Mody (1992) conduct an early and important study of foreign
investment determinants and found that agglomeration – measured by infrastructure
quality – is an important determinant while taxes are not a significant determinant.
The cost of production is particularly important for location of vertically integrated
production networks, and the cost depends on a host of factors including wages,
productivity and infrastructure. The authors in Ando et al. (2006) pay much attention
on FDI environments in host countries, especially to the presence of supporting
infrastructure, including costly communications and coordination infrastructure.
Electronics has been the most important sector for international production
networks. International electronic firms were already in the 1960’ and 70’ looking at
possibilities to locate labor intensive parts of the production in foreign countries. East
Asian countries were the prime location for these firms. For instance, Texas
Instruments, and National Semi-conductors, located production in Singapore have
already existed in the 1960s (Sjöholm, 2003a). They were attracted to Singapore by
subsidies but also by an efficient bureaucracy that, for instance, enabled Texas
Instruments to start production 50 days after their investment decision (Huff 1994, p.
325).
Kumar (2001) examines 66 countries and finds that quality infrastructure plays a
key role in attracting FDI. One of the important factors is the quality of hard
infrastructure such as roads, power, communication etc and the soft infrastructure
such as efficient bureaucracy and custom administration etc. Lipsey (2001) studies US
FDI into three regions as they experienced currency crises (Latin America in 1982,
Mexico in 1994, and East Asia in 1997) and finds that FDI flows are much more
stable during these crises than other flows of capital.
Globeman and Shapiro (2002) indicate that governance infrastructure is an
important determinant of both FDI inflows and outflows and they show Investments
in governance infrastructure not only attract capital, but also create the conditions
under which domestic MNCs emerge and invest abroad.
Dunning (2002), who suggest that for FDI from large developing countries
traditional economic variables remain more important, But, FDI from more advanced
industrialized countries is increasingly seeking complementary knowledge intensive
resources and capabilities, a supportive and transparent commercial, legal
communications infrastructure, and government policies favorable to globalization,
innovation and entrepreneurship. This, however, has not been empirically tested.
The pattern of recent FDI flows supports the conclusion that liberal policies on
technology, which tend to go hand in hand with more liberal policies in general, serve
to attract more and better foreign investments. It is a major task for a developing
country to implement all the policies discussed above. A number of East Asian
countries have tried to use export processing zones (EPZ) as a way to address this
difficulty. The idea behind these zones is that foreign firms are attracted to certain
geographic locations in a country where improvements in infrastructure can be
concentrated and where the firms often are given special treatment in terms of taxes
and regulations. Typical advantages of locating in EPS‘s include, lower levels of
import and export restrictions, less restrictive labor requirements, lower taxes, liberal
ownership regulations, liberal foreign exchange regulations, and access to superior
infrastructure and communication technologies (Madani, 1999).
Table 1 lists three key determinants and factors associated with the extent and
pattern of FDI in developing host countries: attractiveness of the economic conditions
in host countries; the policy framework towards the private sector, trade and industry,
and FDI and its implementation by host governments; and the investment strategies of
MNEs.
Table 1: Key Determinants and Factors for FDI Inflow.
Economic
Conditions
Markets
Size; income levels; urbanization; stability
and growth prospects; access to regional
markets; distribution and demand patterns
Resources Natural resource; location
Competitiveness
Labor availability、cost、skill、trainability;
management technical skills; access to
inputs; physical infrastructure; supplier
base; technology support
Host country
policies
Macro policies
Management of crucial macro variables;
ease of remittance; access to foreign
exchange
Private sector
Promotion of private ownership; clear and
stable policies; easy entry/exit policy;
efficient financial market and other support
Trade and
industry
Trade strategy; regional integration and
access to markets; ownership controls;
competition policies
FDI policies Ease to entry/exit; ownership; incentives;
access to inputs; transparent and stable
policies
Multi
National
Enterprises
strategies
Risk perception
Perception of country risk, based on
political factors, macro management, labor
markets and policy stability
Location,
sourcing,
integration
Company strategies on location, sourcing of
products/inputs, integration of affiliates,
strategic alliances, training, technology
Source: Lall(1997)
Table 2: the main FDI location factors and sub-factors
1 Market factors 1) Large size of host markets
2) Demand in host country
3) Level of competition in host market
4) Economic stability
2 Political and legal
factors
1) Political stability
2) International trade agreements
3) Tax reduction in host country
4) Benign environmental legislation towards FDI
3 Cost factors 1) Labor costs
2) Transpiration/ logistic cost
3) Low cost of raw materials
4) Return on investment
4 Infrastructure and
technological
factors
1) Level of infrastructure
2) High industrial concentration (Clustering)
3) Availability of well qualify of work force
4) Access to reliable and corporative suppliers
5 Social & Cultural
factors
1) Cultural distance
2) Attitude of the local community toward the firm
Source: by Fawaz Binsaeed 2009
2.4 Investors’ Choice of Location
Firms face many options when they extend operations abroad: FDI, exporting,
licensing or entering into a joint venture or strategic alliance. Traditional theories of
international business cite the advantages of ownership, location and internalization –
widely known as the OLI Paradigm, as described by Dunning in 1993 – to explain
why multinational enterprises (MNEs) choose FDI. Ownership advantages are those
assets of a firm that allow it to compete successfully in overseas markets, despite
having less knowledge of the local market than do local firms, and despite the costs of
setting up a foreign affiliate. Ownership advantages usually include superior
technology and management knowledge. Location advantages are those benefits that a
host country can offer a firm: large markets, low labor or production costs or both,
and a good infrastructure. Internalization advantages refer to transaction costs, and
occur when it is cheaper to exploit ownership and location advantages through FDI
than it is to export. While ownership and internalization advantages vary by the
investor, the location advantage is specific to the host country. However, this latter
advantage may have gained importance in investors’ decision-making process as host
countries compete increasingly to attract FDI:
2.4.1 Host Countries’ Enabling Environment
There is a vast literature on the location advantages of FDI. UNCTAD, the United
Nations Conference on Trade and Development, in 1998 presented the main ideas
now found systematically in this literature by categorizing the location determinants
of FDI into three main groups: economic determinants; the host country policy
framework for FDI; and business facilitation. Lee and Houde (2000) discuss the six
main location advantages of countries, along with the characteristics of the FDI flows
they might attract. These advantages consist of:
1) Market size and growth prospects,
2) Natural and human resource endowments –Including the cost and productivity of
labor,
3) Physical, financial and technological infrastructure,
4) Openness to international trade and access to international markets,
5) The regulatory and policy framework and policy coherence.
2.4.2 Factors Driving Investment Decisions
The above factors make certain groups of countries more or less likely to attract
FDI. However, actual investment decisions by MNEs are driven by more complex
strategic considerations, including the nature of the concrete gains that investors
expect from relocating abroad as opposed to investing in their home economy. At its
most general, integrated international production involves the allocation of any
component in the value-chain of an MNE to the locus where it contributes the most to
profitability.
Some of the most important “motivation factors” underlying FDI are listed below
(for an alternative breakdown, see UNCTAD, 1999): Resource-seeking FDI、Natural
resources、 Human resources、 Market-seeking FDI、 Efficiency-seeking FDI and
Strategic asset-seeking FDI.
Summary:
Foreign Direct Investment (FDI) is an important source of capital and economic
growth in developing countries. It provides a package of new technologies,
management techniques, finance and market access for the production of goods and
services. However, attracting FDI is a major challenge for host countries as it faces
the challenge of identifying the major factors that motivate and affect the FDI location
decision. After reviewing the literature we identify the most important major location
factors for FDI, which are the cost factors, market factors, infrastructure and
technological factors, political and legal factors, and social and cultural factors.
However, the previous studies lack the focus on the complexity of the relative
important of the location factors to a specific country. Therefore, this study will fill
the previous studies gaps by studying the relative important of location factors to the
FDI located in Indonesia
CHAPTER III
METHODOLOGY
3.1 Research Method
The research method is used in this study will be qualitative research. Qualitative
research is a naturalistic, interpretative approach concerned with understanding the
meanings of certain observed phenomena or actions. It examines, analyzes and
interprets observations for the purpose of discovering underlying meanings and
patterns of relationships in a manner that does not involve mathematical models.
Qualitative research is a method of inquiry employed in many different academic
disciplines, traditionally in the social sciences, but also in market research and further
contexts. Qualitative researchers aim to gather an in-depth understanding of human
behavior and the reasons that govern such behavior. The qualitative method
investigates the why and how of decision making, not just what, where, when. Hence,
smaller but focused samples are more often needed than large samples.
Qualitative methods produce information only on the particular cases studied, and
any more general conclusions are only propositions. Qualitative research is best used
when the researcher is looking to get real detail about a subject.
3.2 Research Design
3.2.1 Data collection tool
Secondary data is the data that have been already collected by and readily
available from other sources. Such data are cheaper and more quickly obtainable than
the primary data and also may be available when primary data cannot be obtained at
all. It has the following advantages such as: It is economical, it saves efforts and
expenses and it is time saving.
The World Development Indicator Report from World Bank Group serves as the
major source of data in this study. While it provides economic, social, and political
statistics on numerous subjects for every county, it also groups countries by economic
performance. Lastly, although theory points to the stability of a country’s regime or
government in explaining a country's level of FDI, exploring this topic was beyond
the scope of this paper.
3.2.2 Research design
It is important to know not only what factors to concentrate on in order to attract
FDI from MNCs, but also to determine the relative importance of these factors. This
study provides that knowledge. In addition, because a country has limited resources, it
is important to know what factors should be more of a priority compared to others.
Poorer countries will know what policies to concentrate on in order to best attract FDI.
Focusing on the factors that the government would have control over, this study
provides Indonesia with the knowledge concerning the direction and the importance
of major economic and societal factors that influence FDI.
In this study, the researcher will try to find out both the positive and negative factors
which influence FDI inflow in Indonesia. So in the next step we will classify the
dependent variable and independent variables.
Dependent Variable
The dependent variable in this study is FDI as a percent of GDP. There are
numerous ways that FDI can be measured depending on the purpose of the study. In
this study, we find it beneficial to measure FDI as a percentage of GDP. As it was
suggested before, FDI is a very efficient, desirable form of investment in many
countries, and may positively contribute to other areas of the economy as well. Based
on the positive economic characteristics brought by FDI, it is also safe to assume that
a country would want FDI to play a large role in its economy in order to stimulate
growth. It is for this reason that FDI is measured as a percentage of GDP. FDI is
essentially measured as the role FDI plays in the economy of a country. If a country is
a good long-term investment for MNCs, it will have a large FDI to GDP ratio.
However, if a country is a bad investment, FDI will play a lesser role in the economy,
and thus a smaller FDI to GDP ratio should exist. For the remainder of this study, we
will call the ratio of FDI to GDP simply the" % FDI."
Independent Variables
Based on the information above, we will chose twelve important factors emerge
as being strong influences on FDI in Indonesia:
1) GDP 2007-2011
2) GDP annual growth from 2007- 2011
3) Annual inflation ratio from 2007-2011
4) Exchange Rate Standard Deviation 2007-2010
5) Foreign direct investment, net inflows (% of GDP) form 2007-2010
6) Population in 2007-2011
7) Average hourly wage 2007-2011
8) Administrative Efficiency
9) Easy of Doing Business
10) Business Environment
11) Infrastructure Condition
12) Strategy location
3.2.3 Data Analysis Method
This study will begin by providing simple descriptive statistics and displaying the
basic nature of the dependent variable and each independent variable by providing
charts and figure. In this study, we choose three developing countries from Asia which
are Indonesia, China and Vietnam to analysis the nature between the capacity of FDI
and the factors impacting FDI through comparing the above 11 factors one by one.
Included in Table 3 below are the expected signs of the select variables used in
the study.
Table3. Independent Variables-Expected Relationship
Theoretical
Constructs
Variables Expected
sign
Quick Explanation
Macroeconomic
Performance
Annual GDP
Growth
+ If a country has shown growth
potential in past, MNCs can
expect in the future
Average Inflation + If a nation's government is
competent, it should be able to
keep inflation at a minimum
GDP + Measures overall economic
capacity
Exchange Rate
Standard
Deviation
+
High Exchange Rate Standard
Deviation means low Economic
Stability-Past. If exchange rates
are unpredictable, repatriation is
made much more difficult.
Human-capital
Population
+
Large population provides a
greater labor pool to choose from
and a larger market
Average hourly
wage
+ Low wages are more attractive for
MNCs
Labor Force
Education
-
Education leads to productivity
A larger pool of technologically
oriented people is desired
Investment
Environment
Administrative
Efficiency
_ Streamline procedures and
improve administrative efficiency
Easy of Doing
Business
-
Easier doing business environment
can reduce the operation cost
Business
Environment
_
Corruption has adverse effects on
economic performance and it will
increase the cost of investment
Infrastructure
Condition
Infrastructure
Condition
_ well infrastructure location, ease
of investment
Strategy
Location
+
Strategy location, easy of
transportation
The researcher now intend to describe each independent variable in the context of the
theoretical grouping that it represents.
Macroeconomic Performance and Stability
GDP average growth and average inflation serve to measure the macroeconomic
performance and measure consistency of Indonesia over the long run. It also measures
the government's ability to successfully manage the macroeconomic state of a nation.
If a country has consistently shown the propensity for growth, then it should attract
high levels of FDI. However, if the past growth of a country has been sluggish, it is
likely that future growth will be the same. As a result, the expected relationship
between average past economic growth and FDI should be positive. Also, if a nation's
government is competent, it should be able to keep inflation at a minimum. A negative
relationship should exist between the average inflation from 2007-2011 and FDI.
GDP measure the current economic capacity of Indonesia. The expected
relationship between these variables is positive. The larger the GDP of a nation, the
more diverse its economy should be.
Exchange rate variability serves to measure the stability of a nation's economy.
While other previous variables measure economic performance and capacity, these
variables measure a nation's economic consistency. For example, an MNC needs to be
able to predict the future economic conditions of a nation when considering
investment opportunities. If a country's growth is sporadic, it may be a risky
investment. In addition, many MNCs repatriate portions of their profits from FDI in
host country, thus relying on a nation's exchange rate. If exchange rates are
unpredictable, repatriation is made much more difficult. As a result, one would expect
a negative relationship to exist between FDI and the economic stability variables
(variability of growth and exchange rates).
Human Capital
Also, with a more populated state, a country has a greater labor pool to choose
from. In addition, it also provides a larger market for the MNC to sell the goods it
produces in the host country.
While basic macroeconomic conditions should be considered, labor issues need to
be inspected as well. A highly educated labor force with low wages is preferred by
MNCs. Obviously, MNCs desire maximum intelligence and competency, factors that
increase productivity and efficiency. The greater the illiteracy rate and the real
average wage of a nation, the less FDI it should have.
The percent of educated labor should also play a role in a country's FDI. For
example, if much of a country’s labor is in a low educated area, it is unlikely that
large quantities of labor could be pooled in order to operate a factory or large-scale
business. In addition, low educated labors generally do not contain the necessary
knowledge to accommodate the needs of an MNC. For these reasons, the relationship
between FDI and percent education population should be positive.
Investment Environment
Investment environment, regulatory framework, bureaucratic hurdles and the
extent of corruption in the host country are found insignificant as determinants of FDI
or have mixed influence on FDI inflow. Administrative efficiency is insignificant in
determining FDI. The cost of investment consists of not only the actual costs of inputs
but also non-economic costs such as bribery and time lost in dealing with local
authorities Investment climate is particularly important to attract market-seeking FDI,
especially in the service sector. The role good institutions play in attracting FDI to
developing countries is crucial. The probability that foreign investors get return of
their investments is fundamental in their decision to invest in a country or not.
Administrative efficiency and lack of corruption allow markets to properly
function; therefore attracting MNEs. So increase their chance of attracting the much
needed FDI to support development, if they instituted reforms to improve the
investment climate in their country through better business regulations that promote a
friendly business environment
Infrastructure
More FDI is likely to occur in countries with good physical infrastructure such as
bridges, ports, highways, etc. It also seems likely that there are some diminishing
returns in infrastructure, at least in infrastructure of a specified type. The first bridge
is more important than the second than the third … than the hundredth, and so on.
Therefore, especially for countries with poor infrastructure, investing in
improvements in infrastructure may be important for attracting FDI. Nonetheless,
some countries with poor infrastructure may be unattractive hosts for FDI for a
variety of other reasons, and even substantial investments in infrastructure might not
bring FDI pouring in. But all else equal, a country with more infrastructures would be
expected to attract more FDI
Well-developed infrastructure is critical to attract capital and promote economic
growth. Infrastructure availability is one of the key elements needed to run efficient
business. In manufacturing or services, good provision of infrastructure reduces
transaction costs by allowing entrepreneurs to easily connect with their suppliers and
customers. A great number of studies in developing countries have shown the
importance of infrastructure for private capital attractiveness.
Strategy location is important in attracting FDI, foreign investors benefit from its
unique location factor. The Strait of Malacca is one of the most important shipping
lanes in the world. The strait is the main shipping channel between the Indian Ocean
and the Pacific Ocean, linking major Asian economies such as India, China, Japan and
South Korea. Over 50,000 vessels pass through the strait per year, carrying about
one-quarter of the world's traded goods including oil, Chinese manufactures, and
Indonesian coffee. About a quarter of all oil carried by sea passes through the strait,
mainly from Persian Gulf suppliers to Asian markets such as China, Japan, and South
Korea. In 2006, an estimated 15 million barrels per day were transported through the
strait
3.2.4 Data analysis tool
The tool used in this study will be descriptive analysis and Microsoft Excel 2007
will be used during the data analysis for preparing data and making chat.
CHAPTER IV
ANALYSIS OF DATA AND INTERPRETATION OF
RESULTS
4.1 Data Analysis
This chapter will show the result of this study by providing charts and tables in
which the analysis including four parts divided into 12 important factors emerge as
being strong influences on FDI in Indonesia:
4.2 Macroeconomic Performance
4.2.1 GDP (current Billion US$)
Figure 1: GDP (current Billion US$) form 2007-2011, by researcher
Source: World Bank Group, world development indicators
Indonesia’s economic development has come a long way over the past decade.
The Gross Domestic Product (GDP) in Indonesia was worth 846.83 billion US dollars
in 2011 making it become the 16th largest economy in the world according to the
report published by the World Bank. The GDP value of Indonesia is roughly
equivalent to 1.37 percent of the world economy .Indeed, some predict it will be
among the world’s ten biggest economies around 2030.And before that happens,
Indonesia could become the second “I” in the BRIICS acronym of the group
composed of Brazil, Russia, India, Indonesia, China, and South Africa.
Market size has been the single most widely accepted as a significant determinant
of FDI flows (Chakrabarti, 2001). The larger the host area’s (country, region, and sub
region) total income and its potential for development, the greater the amount of the
FDI investment (Billington, 1999). A large market is necessary for exploitation of
economies of scale (Chakrabarti, 2001).
The huge economic capacity and dynamic economic performance will work as a
positive factor for attracting foreign investors.
0
1000
2000
3000
4000
5000
6000
7000
8000
2007 2008 2009 2010 2011
Indonesia
China
Vietnam
4.2.2 GDP Annual Growth
Figure 2: GDP Annual Growth form 2007-2011, by researcher
Source: World Bank Group, world development indicators
From the table, it can see that China is facing a probable hard landing after the
crisis happened in 2008 and its economic growth is slowing down. Vietnam’s
economic growth faces a high instability in the last few years. While, when we take a
look at the economic in Indonesia who has weathered the latest global economic crisis
remarkably well. GDP growth hit 6% in2008, 6.2% in 2010, and 6.5% in 2011 and in
2009—the height of the crisis— was still a robust 4.6%. In 2010, it was the third
0,00%
2,00%
4,00%
6,00%
8,00%
10,00%
12,00%
14,00%
16,00%
2007 2008 2009 2010 2011
Indonesia
China
Vietnam
fastest-growing G20 country.
Culem (1988) tests the impact of market size for 14 countries for the period of
1969-1982. A bigger market allows the benefits of large-scale production to be more
readily captured. Moreover, investors naturally prefer faster growing markets, which
offer more promising prospects. Indonesia’s strong economic performance in the last
few years will be a positive factor for attracting foreign investors.
4.2.3 Annual Inflation Ratio
Figure 3: Inflation, consumer prices (annual %) form 2007-2011
Source: World Bank Group, world development indicators
Through its effect on the cost of inputs and the price of outputs, inflation reduces
the real return on investment and firms’ competitiveness. Hence, countries that pursue
policies that reduce inflation rate have better chance in attracting FDI. Low and
predictable inflation rate is central for the long-term investment of both domestic and
foreign companies. Therefore, higher and unpredictable inflation will decrease the
inflow of FDI (Birhanu, 1998).
-5,00%
0,00%
5,00%
10,00%
15,00%
20,00%
25,00%
2007 2008 2009 2010 2011
Indonesia
China
Vietnam
Akinboade, Siebrits and Roussot (2006, p. 190-191) state that “low inflation is
taken to be a sign of internal economic stability in the host country. High inflation
indicates the inability of the government to balance its budget and the failure of the
central bank to conduct appropriate monetary policy.”
In 2011, Vietnam’s inflation rate reach 18.7% ranked 18th in the world, China’s
inflation rate is 5.5% ranked 82nd high in the world and Indonesia’s inflation rate hit
5.4% ranked 83rd high among 221 countries. Low inflation is taken to be a sign of
internal economic stability in the host country. High inflation indicates the inability of
the government to balance its budget and the failure of the central bank to conduct
appropriate monetary policy. Lower inflation coupled with other factors such as high
economic growth can attract foreign investors and increase the FDI inflow into
Indonesia.
4.2.4 Exchange Rate Standard Deviation
Figure 4: Exchange Rate Standard Deviation 2007-2010, by researcher
Source: World Bank Group, world development indicators
Regarding the relationship between FDI and exchange rate, firstly, when a
0
0,2
0,4
0,6
0,8
1
1,2
1,4
1,6
1,8
2
Standard Diviation
Indonesia
China
Vietnam
country’s currency devalues, it is viewed as an opportunity for foreign investors to
purchase assets at a reduced cost. This is especially true when foreign firms have
identified specific assets in their targeted markets. Secondly, exchange rate volatility
is one of the contributors toward external uncertainty in an economy that have a major
effect on FDI inflow. MNCs want to repatriate profits back to the home country; thus
consistent exchange rate is needed in order to retain value.
Erramilli and D’Souza (1995) find that exchange rate volatility is one of the
contributors toward external uncertainty in an economy that have a major effect on
FDI inflow. In a study in Ghana, Kyereboah-Coleman and Agyire-Tettey (2008) find
that volatility in exchange rate has a significantly negative impact on FDI inflow. Low
exchange rate volatility in the past few years helps to enhance foreign investors’
confidence to invest more in Indonesia.
4.2.5 Foreign Direct Investment, Net Inflows (% of GDP)
Figure 5: Foreign direct investment, net inflows (% of GDP) form 2007-2010, by
researcher
Source: World Bank Group, world development indicators
0,00%
2,00%
4,00%
6,00%
8,00%
10,00%
12,00%
2007 2008 2009 2010
Indonesia
China
Vietnam
From the figure above, it can see that FDI net inflow of GDP in Indonesia are
separately 1.6%, 1.8%, 0.9% and 1.9% from 2007-2010.The percentage keep a little
growth and the percentage is still smaller than other two neighbor competitors
Vietnam and China in attracting foreign investment Which means that Indonesia still
has much room to be improved in the future by keeping economic grow stably,
improving investment environment and clean off obstacles in the road.
4.3 Human-capital
4.3.1 Population
Figure 6: Population from 2007-2011
Source: World Bank Group, world development indicators
The 2000 official census found 242,325,638 Indonesians making Indonesia the
world's fourth most populous country after China、India and United States. An
estimated birth rate of 22.6 per 1,000 people and death rate of 6.31 per 1,000 people
means that the population is growing at an annual rate of 1.63 percent. The United
Nations Development Program predicts that the population will reach 250.4 million
by 2015. Like many developing countries, Indonesia has a young population, with
0
200.000.000
400.000.000
600.000.000
800.000.000
1.000.000.000
1.200.000.000
1.400.000.000
2007 2008 2009 2010 2011
Indonesia
China
Vietnam
30.6 percent of its people under the age of 15.
Human capital has been broadly quoted as principle engine for growth (Romer,
1986; Stokey, 1991). Several cross-country studies support the importance of human
capital in economic development (Barro, 1991; Benhabib and Spiegel, 1994).
Nunnenkamp and Spatz (2002) used a dataset that covers the 1980s to mid-1990s,
find that both the stock and flow measures of the human capital show statistically
significant and positive effects on FDI inflows and that the effects became more
significant over time
With the huge population, Indonesia has a greater labor pool to choose from. In
addition, it also provides a larger market for the MNC to expend their market and sell
the goods it produces in Indonesia. So the fourth largest population position in the
world will be considered as a positive factor in attracting FDI.
4.3.2 Average Hourly Wage
Figure 7: Average hourly wage, China vs. Vietnam, Indonesia and India (US$ per
hour)
As noted by neo-classical economists labor cost is one of the factors that affect
the investment decision of foreign investors and this fact has been proven in
numerous locations. UNCTAD (2004)
Global companies already have been facing higher labor prices in China over the
past year, despite a weak global economy, as workers demand a greater share of the
country's economic boom. In recent months, the pressure also has intensified in
countries across Southeast Asia that have marketed themselves as alternatives for
companies seeking to escape China's rising costs, leaving those companies now with
fewer places to move. From the chart, we can see the average hourly wage in
Indonesia is below USD 0.5 per hour which is much lower than the wage in China
and Vietnam. With no doubt that MNCs are considering Indonesia as their potential
destination for locating manufactory industry based on its lower-wage
competitiveness.
4.3.3 Labor Force Education
Figure 8: Labor force with tertiary education (% of the total)
Source: International Labor Organization, Key Indicators of the Labor Market
database
Labor force with tertiary education is the proportion of labor force that the labor
who has a tertiary education, as a percentage of the total labor forces. Labor force
with tertiary education (% of total) in Indonesia was 6.5% in 2007 and 7.10% as of
2008. Its labor force with tertiary education index is 6.5% in 2007 ranked 108th
among 121 selected countries which is far behind other developing countries such as
Malaysia got 20.3% ranked 59th and Mexico ranked 69th with 17.3%.
Recent trends in FDI show that MNEs invest in skilled-labor countries to
outsource white-collar workers. Non-tradable sectors such as bank, insurance,
credit-card, accounting, investment banking, high-tech, engineering, and design
companies extend their activity in skilled-labor-abundant developing countries
(Business Week, 2002).
In micro-based research out of Germany, Walkirch (2010) indicates that FDI
flows into skilled-labor abundant countries. The Foreign Direct Investment Survey
shows many Japanese MNEs considered availability of superior plant workers and
managerial personnel to be an important factor for future investment choice of
production bases among the critical factors of location choice (Miyamoto, 2003).
5,6
5,8
6
6,2
6,4
6,6
6,8
7
7,2
2006 2007 2008
Labor force with tertiary education （% of the total) in Indonesia
Labor force with tertiary education （% of the total)
Since advanced technology requires complementing human skills to operate
efficiently, it is often clear that skilled labor availability is one of the factors that
influence the location of FDI. Skilled and high educated labor force will play an
important role in attracting FDI.
4.4 Investment Environment
4.4.1 Administrative Efficiency
Table 4: Indicators of foreign direct investment regulation 2011 (Investing Across
Borders) by researcher
Countries
Indicators
Indonesia China Vietnam IAB
regional
average
IAB global
Average
Procedures(number)
12
18
12
11
10
Time(days)
86
65
94
64
42
Ease of establishment
index(1-100)
52.6
63.7
57.9
57.4
64.5
Source: Investing Across Borders
It takes 12 procedures and 86 days to establish a foreign-owned limited liability
company (LLC) in Jakarta, Indonesia. It takes shorter time to establish a LLC in
Vietnam but it is slower than both the IAB regional average for East Asia and the
Pacific and the IAB global average. In addition to the procedures required of domestic
companies, foreign companies must translate and notarize the documents of the parent
company in its country of origin. Foreign investors must then file for a foreign
investment license from the Investment Coordination Board (BKPM).
Wheeler and Mody (1992) and Singh and Jun (1995) found that administrative
efficiency is insignificant in determining FDI. It is, however, might be the case that
high communication, information and transportation costs. It can increase the
transaction costs and risks to the foreign investors and thus can affect FDI inflow
negatively.
So the Indonesia government will serve the foreign investors better if she can
streamline procedures and improve administrative efficiency.
4.4.2 Ease of Doing Business
Table 5: Ease of doing business world rank among 185 selected countries
No Countries
Indicators
Singapore Indonesia China Vietnam
1 Ease of Doing
Business Rank
1 128 91 99
2 Starting a Business 4 166 151 108
3 Dealing with
Construction Permits
2 75 181 28
4 Getting Electricity 6 147 114 155
5 Registering Property 36 98 44 48
6 Getting Credit 12 129 70 40
7 Protecting Investors 2 49 100 169
8 Paying Taxes 5 131 122 138
9 Trading Across
Borders
1 37 68 74
10 Enforcing Contracts 12 144 19 44
11 Resolving Insolvency 2 148 82 149
Source: World Bank Doing Business. The rankings for all economies are
benchmarked to June 2012.
The “Ease of Doing Business” report in 2012 was produced by the IFC Indonesia
Advisory Services and the Global Indicators and Analysis Department of the World
Bank Group. This report ranks 185 countries across a number of key areas important
to investors, including the ease of starting a new business, registering property, getting
electricity, paying taxes and obtaining construction permits. The report also measures
how well contracts are respected and enforced and the degree to which investors are
protected. From the report we can see Indonesia remains a very difficult place to do
business. Legal and regulatory uncertainties prevail. As one government official
recently stated, the only guarantee for an investor here is that there will be problems.
Unfortunately, there is very little good news in the report, especially where
Indonesia is concerned. While the country improved its overall ranking by two points
in 2012, moving from 130th to 128th, it continues to lag far behind most of its
Southeast Asian neighbors. Singapore is in first place globally, Thailand is at No. 18,
Malaysia is at 12, and China ranks No 91, Vietnam ranks 99th.
One bright spot in the report is in the area of electricity supply, where Indonesia
moved up 11 places compared with 2011. But even this improvement is qualified by
the fact that Indonesia remains in the last quartile globally in terms of electricity
supply with a rank of 147.
In the area of investor protection, Indonesia dropped three places to 49th this year,
and continues to provide significantly less protection than Singapore, Malaysia and
Thailand, which rank 2nd, 4th and 13th respectively but is higher than China and
Vietnam which rank No 100 and No 169. Contract enforcement has received
significant media attention during the past year, it doesn’t come as a big surprise that
Indonesia is still lag behind in the area of contract enforcement, with a ranking of
144th and again, far below its Southeast Asian neighbors.
4.4.3 Business Environment Snapshot
Table 6: Business Environment Snapshot global rankings for Indonesia, China and
Vietnam.
NO Indicator
world rank
Total
countries
selected
Country 2011 2010 2009 2008
1 Control of
corruption
202
Indonesia 146 157 138
China 114 125 118
Vietnam 134 127 151
2 Regulatory
quality
202
Indonesia 123 116 110
China 112 109 108
Vietnam 141 140 137
3 Country
credit rating
178
Indonesia 61 60 73 78
China 23 23 33 34
Vietnam 79 76 79 71
4 Index of
economic
freedom
178
Indonesia 116 114 131 122
China 135 139 132 123
Vietnam 139 144 144 134
5 Political risk
rating
140
Indonesia 96 89 96 89
China 81 72 67 60
Vietnam 70 70 71 63
Source: Business Environment Snapshot, World Bank Group
From the table, it can see that “control of corruption” in Indonesia ranked 135,
157 and 146 among 202 selected countries in 2008, 2009 and 2010. And this result is
higher than its neighbor countries like China and Vietnam. Due to the various forms
that corruption can take, including practices such as bribery, extortion, influence, and
fraud, and embezzlement, corruption has been defined in different ways. It has been
shown that corruption has adverse effects on economic performance and it will
increase the cost of investment. Corruption has a negative impact on the level of
investment and economic growth.
Recently, the level of corruption in the host country has been introduced as one
factor among the determinants of FDI location. From a theoretical viewpoint,
corruption—that is, paying bribes to corrupt government bureaucrats to get “favors”
such as permits, investment licenses, tax assessments, and police protection—is
generally viewed as an additional cost of doing business or a tax on profits. As a result,
corruption can be expected to decrease the expected profitability of investment
projects. Investors will therefore take the level of corruption in a host country into
account in making decisions to invest abroad. As one world, Indonesia should
increase its transparency and build up the control of corruption to attract more
investors.
Indonesia’ “regulatory quality” is ranked 110, 116 and 123 in 2008, 2009 and
2010 among 202 countries which show a decrease in regulatory quality. Regulatory
quality is one of the measures to evaluate government and institutions quality. A
friendlier business climate lowers the additional costs of doing business in a foreign
country.
It has been shown that corruption has adverse effects on economic performance.
Corruption has a negative impact on the level of investment and economic growth
(Mauro 1995), on the quality of infrastructure and on the productivity of public
investment (Tanzi and Davoodi 1997), on health care and education services (Gupta,
Davoodi, and Tiongson 2000), and on income inequality (Gupta, Davoodi, and
Alonso-Terme 1998; Li, Xu, and Zou 2000). All those factors are found to be
important determinants of FDI location. Therefore, foreign investors would tend to
avoid investing in countries with high levels of corruption.
It is obvious that lower regulatory quality and institutional environment from
Indonesia would make it less attractive for any type of FDI inflow.
4.5 Infrastructure Condition
4.5.1 Quality of overall infrastructure
Figure 9: Infrastructure overall 2010-2011
Source: The Global Competitiveness Report 2011-2012, World Economic Forum.
Note: [1 = extremely underdeveloped; 7 = extensive and efficient by international
0 1 2 3 4 5
Mean
Indonesia
China
Vietnam
Infrastructure overall Score
Mean
Indonesia
China
Vietnam
123 World rank
69
82
123
standards]
According the chart above, it can see that in the Infrastructure overall 2010-2011,
Indonesia got 3.9 score, China got 4.2 score, Vietnam got 3.1 score and the mean is
4.3. All of the three countries are below the world mean.
Extensive and efficient infrastructure is critical for ensuring the effective
functioning of the economy, as it is an important factor determining the location of
MNCs. Well-developed infrastructure reduces the effect of distance between regions,
integrating the national market and connecting it at low cost to markets in other
countries and regions. In addition, the quality and extensiveness of infrastructure
networks significantly impact economic growth and reduce income inequalities and
poverty in a variety of ways. A well-developed transport and communications
infrastructure network is a prerequisite for the access of less-developed communities
to core economic activities and services. Effective modes of transport, including
quality roads, railroads, ports, and air transport, enable entrepreneurs to get their
goods and services to market in a secure and timely manner and facilitate the
movement of workers to the most suitable jobs. Economies also depend on electricity
supplies that are free of interruptions and shortages so that businesses and factories
can work unimpeded.
Table 7: main indicators of infrastructure
NO Indicators Country Mean Score World rank
1 Quality of road Indonesia
4.0
3.5 83
China 4.4 55
Vietnam 2.6 123
2 Quality of
railroad
Indonesia
3.1
3.1 52
China 4.6 22
Vietnam 2.5 71
3 Quality of port
Indonesia
4.3
3.6 103
China 4.5 56
Vietnam 3.4 111
4 Quality of airport
transport
Indonesia
4.7
4.4 80
China 4.6 72
Vietnam 4.1 95
5 Quality of
electricity supply
Indonesia
4.5
3.7 98
China 5.5 49
Vietnam 3.3 109
Source: The Global Competitiveness Report 2011-2012, World Economic Forum.
Note: [1 = extremely underdeveloped; 7 = extensive and efficient by international
standards]
Khadaroo and Seetanah (2008) claim these gains rendered by infrastructure
growth are associated with greater accessibility and reduction in transportation costs.
Furthermore, public goods reduce the cost of doing business for foreign enterprises
which leads towards maximization of profit. Recent empirical studies also propose
that public goods have vital impact on cost structure and productivity of private firms
(Quere et al., 2007; Morrison and Schwartz, 1996).
Poor infrastructure causes increase in transaction cost and limits access to both
local and global markets which ultimately discourages FDI in developing countries.
(Mlambo, 2006).
Indonesia’s infrastructure, ranked 82nd, requires improvements across many
areas. It is well behind more advanced ASEAN members Singapore (2nd), Malaysia
(23th), and Thailand (47th), and also less developed than China (69th). Other
countries that also face infrastructure inadequacies are Vietnam (123rd), India (86th).
All large Asian economies are experiencing rapid economic growth, massive
urbanization, a rising middle class, and increased openness to trade. These trends
increase the demand for infrastructure and strain that which already exists, creating
bottlenecks and highlighting existing shortages. For instance, the number of vehicles
in Indonesia quadrupled over the past decade to reach 11.3 million. At the same time,
by some estimates, 40 percent of the population remains without access to electricity,
and the demand for it increases by 8 percent a year.
The insufficient supply and quality of transport、energy and telecommunications
infrastructures seriously limit Indonesia’s output capacity. The manufacturing and
export sectors particularly suffer as this state of affairs translates into limited
connectivity and handling capacity, high costs, delays in shipments, and production
loss.
Demand for infrastructure grows proportionally with the economy. In order to
meet this demand, investment must therefore increase. In addition, the costs of
maintaining and upgrading existing infrastructure should not be underestimated.
Unfortunately, Indonesia suffers from a protracted lack of investment in this area.
Further, the geography and the tropical climate of this country of some 17,000 islands
provide a challenging environment for infrastructure deployment. It is important to
note that the assessment has been improving over the years, with a gain of 0.7 since
2006 in the pillar, thanks to significant improvements in several of its components.
Yet Indonesia has been losing ground in relative terms, falling from the 78th to 82nd
position in the infrastructure pillar, given that other countries are moving more
quickly to improve their infrastructure The situation of Indonesia is not an isolated
case, and its performance is largely in line with the Developing Asia region and the
lower middle income group averages. Many developing countries struggle to add
infrastructure capacity to meet the needs of their booming economies. Looking at the
different modes of transport, Indonesia ranks a low 83th for the quality of its roads.
The World Bank estimates that only 55 percent of Indonesian roads are paved
compared with an average of 80 percent for Malaysia, the Philippines, Thailand, and
Vietnam as a group.
Ports in Indonesia also require improvements. They are ranked a low 103th,
compared with China (56th). This is of particular concern given the country’s
dependence on water transport. Even Cambodia ranks higher at 82nd, despite its more
basic stage of development.
As for the state of the country’s railroad infrastructure, it is equally mediocre.
Among the four main transportation modes, air transport infrastructure is the only one
that stands out positively with a score of 4.4, despite a middling rank of 80th. Airlines
in Indonesia have been adding capacity at breakneck pace, with Indonesia now the
21st largest market when measured in terms of available seat kilometers. Inadequate
energy infrastructure is also holding back the country’s competitiveness. The business
community has indicated increasing concern about the poor reliability and shortages
that characterize the network. Indonesia is ranked 98th in this indicator with a score of
3.7. The situation has been deteriorating over the years, as the state power company,
which operates 85 percent of generating capacity and has a monopoly on transmission
and sales, has struggled to meet demand. The government is stepping up its efforts to
improve power supplies. A law introduced in 2009 allows private investors and local
authorities to generate, transmit, and sell electricity without having to work with the
state firm.
Indonesia’s infrastructure requires improvements across many areas such as
improvement in road, port and electricity supply to attract more MNCs invest in
Indonesia.
4.5.2 Strategy Location
Indonesia is an archipelagic island country in Southeast Asia, lying between the
Indian Ocean and the Pacific Ocean. It is in a strategic location astride or along major
sea lanes from Indian Ocean to Pacific Ocean. Indonesia lies at the intersection of the
Pacific Ocean, along the Malacca Straits and the Indian Ocean. Over half of all
international shipping goes through Indonesian waters.
From an economic and strategic perspective, the Strait of Malacca is one of the
most important shipping lanes in the world. The strait is the main shipping channel
between the Indian Ocean and the Pacific Ocean, linking major Asian economies such
as India, China, Japan and South Korea. Over 50,000 vessels pass through the strait
per year carrying about one-quarter of the world's traded goods including oil, Chinese
manufactures, and Indonesian coffee. About a quarter of all oil carried by sea passes
through the strait, mainly from Persian Gulf suppliers to Asian markets such as China,
Japan, and South Korea.
Indonesia is playing a more dominant role in global affairs. It is Southeast Asia’s
only member of the G-20 and an active voice for developing world’s concerns.
Standard Chartered sees Indonesia’s inclusion in the G-7 by 2030, projecting that
Indonesia’s economy could be the 10th largest in 2020 and the 5th largest in 2030.
MNCs would like to invest in Indonesia because of its unique strategic location
and its important role in Southeast. Until recently, there was a strong consensus in the
literature that MNCs invest in specific locations mainly because of unique location.
(Dunning 1993, Globerman and Shapiro 1999; Shapiro and Globerman 2001).
CHAPTER V
CONCLUSIONS AND RECOMMENDATIONS
5.1 Conclusion
FDI has been important in Indonesia’s economic development. Multinational
firms have contributed to Indonesia’s development by bringing in new technologies
and providing access to foreign markets. The benefits have become increasingly
obvious for policy makers over time. Results of this study are meaningful and helpful
in the policy making for enhancing FDI inflows in order to promote economic
development. It has been acknowledged that FDI bring benefits to the recipient
countries by providing capital, foreign exchange, new technology and in such a way
bridging the gap between domestic savings and investment.
The empirical result revealed that the positive factors influencing FDI inflow in
Indonesia are:
1) Economy stability
2) Big market size
3) Large population
4) Cheaper labor force
5) Strategic location
And the negative factors worrying FDI inflow in Indonesia are:
1) Poor infrastructure condition.
2) Corruption
3) Low administrative efficiency
4) Poor business investment environment
5) Low regulatory quality
6) Low educated labor force
5.2 Recommendation
Multinational firms have invested heavily in the East Asia. Production networks,
where different parts of multinationals’ production chain are located in affiliates in
different countries, seem to be particularly important in East Asia.
Foreign direct investment in Indonesia jumped 22% in the third quarter of 2012
from a year earlier to another record, bolstering growth in Southeast Asia's largest
economy. All these outstanding performances profit from its world 16th biggest GDP
capacity position, big market size, world fourth largest population, stable economic
performance in the last few years and cheaper labor force. It is clear that FDI has
increased economic growth, wages, export, and employment in the Indonesian
economy.
Despite its outstanding performance in attracting FDI, Indonesia has not fully
participated in this development and attracts less FDI than what could be expected
from its size and growth in recent years. If faster growth is an important goal of
economic policy, it would seem to be in Indonesia‘s interest to increase inflows of
FDI considering the benefits FDI brings in terms of productivity growth, higher
wages and strong employment growth. What could be done if Indonesia wished to
attract more FDI? As global and regional competition for FDI has increased, an FDI
regime and an economic environment that were sufficient for attracting FDI some
years ago are not sufficient today.
Infrastructure is a related issue affecting the interest of foreign multinational
firms to locate in Indonesia. The importance of infrastructure is clear from the East
Asian experience where many countries have used improvements to infrastructure
deliberately to attract foreign firms and to integrate in international production
networks. It is also clear that many East Asian countries continue to invest heavily in
infrastructure and that such investments increased further in for instance China after
the outbreak of the global financial crisis in 2008.
Unfortunately, infrastructure is poor in Indonesia. Some analysis said that
infrastructure had become the top obstacle to doing business in Indonesia. Roads, port,
and airport are inadequate. Electricity generation lags demand. The Global
Competitiveness Report ranked Indonesia only as number 82 in terms of the quality of
infrastructure. Some signs of an improvement came in 2009 when the government
tried to balance a large drop in external demand by launching a program for major
infrastructure investments. However, insufficient public funding is only one of many
factors that restrain infrastructure development. Other problems that will be difficult
to solve include a lack of technical capabilities at responsible local governments, poor
coordination between central and local governments and between different regions,
and large problems with land acquisitions FDI might be one way to improve
infrastructure. Investments by foreign firms in infrastructure, and also in utilities,
finance, construction and other non-tradable are affected by various institutional
factors such as competition and pricing policies. Complex regulations are required to
carry out to attract investments in improving infrastructure condition in Indonesia.
The quality of institutions is also an important determinant to FDI. Indonesia is
plagued by rampant corruption, but with some signs of improvements during recent
years. Despite this possible slight improvement, corruption remains a real problem
and some recent reports indicate new setbacks. Corruption differs between provinces
and districts, is highly arbitrarily which increase the costs of production and therefore
more difficult for foreign multinationals to deal with.
Lack of administrative capacity, poor regulatory structures and corruption are
some of the main causes of failing attracting investments in Indonesia. It is suggested
that some policies to improve upon the investment regime: a closer look at
international best practices and an institutional arrangement where only one
government agency has the full responsibility to serve and manage the foreign
investors.
It is important to recognize that the business environment is poorer than in many
other East Asian countries. Indonesian institutions need to be improved further. The
government has since 2006 tried to reform the investment climate for foreign firms.
Some reforms of particular importance are the equal treatment of foreign and
domestic investors and the streamlined application procedures for investment
approvals. Poor institutions increase the costs of production. Multinational firms that
can choose between different locations will tend to stay out of Indonesia unless this
issue is addressed. To end the paper on a positive note, there are some provinces that
in recent years have been able to implement good policies and improve local
institutions. To use these good examples for reforms and changes at a national level
would increase inflows of FDI and thereby be fruitful for the continued development
of Indonesia. In addition, Indonesia as a country must also continue to strengthen its
regulatory and legal institutions, reduce corruption, and increase bureaucratic
efficiency.
Education is very poor in Indonesia. The exception is enrolment in primary
education which was keeping increasing in the last few years. However, enrolment in
tertiary and secondary education has been lower than in most other countries in East
Asia. Moreover, there are signs that the quality of education is relatively poor.
Labor force with tertiary education, as of 2008, is lower, on average, than in
many of the other developing countries like Malaysia and Mexico. The proportion of
the labor population and over with no schooling is far above that in any other of the
countries. Only 7.1 percent of the total labor has completed tertiary education and it is
ranked 108th among 121 selected countries, the lowest level among these countries.
Only in the completion of secondary education is Indonesia ahead of a few of the
other countries. The drop from the proportion completing secondary education to the
proportion completing tertiary education is 94 percent. Either little tertiary education
has been pursued or many of those that have pursued it have left the country.
Improved education is important for attracting FDI but it will also affect
Indonesia’s capacity; the better the level of education of the labor force the more
Indonesia will benefit from foreign MNEs. A higher education level would
encourages foreign MNEs to upgrade production to higher value added activities in
Indonesia, rather than placing such production in other countries, and it would also
increase spill over by facilitating knowledge transfers from MNEs to local firms.
This study of determinants of FDI in Indonesia gives some guidance: good
institutions, a skilled and high educated workforce, and good infrastructure. Some of
these are factors where Indonesia has shown improvements in recent years. These
improvements, if they are continued and intensified, will make Indonesia more
attractive for multinational firms, although it will take time before the improvements
have more widespread impact on the economy.
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