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Batam: Life after the FTZ?

Siwage Dharma Negara and Francis E. Hutchinson

ISEAS-Yusof Ishak Institute

October 2018

Abstract

Once an island of high-tech production and turbo-charged growth, Batam’s economic fortunes have

waned of late. The traditional pillars of the manufacturing sector have contracted, investment levels

have fallen, the island’s growth rate is below the national average, and unemployment has increased

sharply. In response, policy-makers are promoting the development of new sectors to diversify the

island’s economic base. There are debates on whether Batam’s status should be changed from a Free

Trade Zone (FTZ) to a Special Economic Zone (SEZ) to draw in more investment. This paper aims

to contribute to the debates on how to revitalize the island’s economy. Using data from the

Manufacturing Survey of Large and Medium-Sized Firms, this study analyses the growth and

performance of Batam’s three largest manufacturing branches (electronics, electrical goods, and ship-

building) over 2008-2015. These results are then compared with those from firms in the same sectors

in Java and Sumatera. An econometric analysis is undertaken to determine whether the island’s FTZ

status is related to improvements in productivity, output, and exports. The results of these exercises

are then evaluated in light of these policy choices.

Keywords: Indonesia, Batam, FTZ, electrical & electronics, ship-building, productivity

JEL Classification: O14, R11, R12

________________________________________________________________________________

No. 2018 - 5

1

Batam: Life after the FTZ?

Siwage Dharma Negara and Francis E. Hutchinson

1. Introduction

In the 1990s, Batam enjoyed growth rates in the teens and was the fastest-growing part of Indonesia.

Leveraging its proximity to Singapore, strategic location along major shipping routes, superior

infrastructure, and high-level political backing, the island’s economy developed quickly following

key liberalization reforms enacted in 1989.

Over the next two decades, from virtually no industrial production at all, Batam developed

into one of Indonesia’s key centres of manufacturing, with substantial investment from Singaporean,

Japanese, and European firms. By 2009, the island housed some eighty electrical and electronics

firms, many with facilities employing thousands of workers. From the mid-2000s onwards, this was

complemented by scores of ship-building companies who were attracted by the same attributes. At

the industry’s height in 2011-2013, almost half of Indonesia’s 250 ship-yards were located in Batam.

Due to these two sectors, along with tourism, the island has become a key source of foreign exchange

for Indonesia.

This outward-oriented production has been a boon to Batam, enabling it and its mother

province, the Riau Islands, to enjoy higher than average growth rates. In the 1990s, the island’s

economy grew at stellar levels, well above 10 per cent p.a. From 2000 to 2010, while expanding at

more modest rates, nonetheless Batam and the Riau Islands grew considerably faster than did

Indonesia as a whole (Figure 1).

This trend continued until 2015, with both entities growing 1-2 per cent faster than the national

average. Despite experiencing massive inflows of people from other parts of the country, economic

growth has outpaced population increase, with the result that the Riau Islands is the wealthiest

province in the country – Jakarta excepted (BPSc 2017). However, the days of rapid growth may well

be over. In 2016, the island and the province experienced lower growth rates, roughly at the national

average. In 2017, the economies of Batam and the wider Riau Islands grew at a mere 2 per cent,

substantially below Indonesia’s aggregate growth of 5 per cent (Figure 2). Available projections

indicate that this trend will continue in 2018.

2

Figure 1: Economic Growth 2000-2010

(% year on year)

Source: BPSc, various years

Figure 2: Economic Growth 2011-2017

(% year on year)

Source: BPSa, various years

0

1

2

3

4

5

6

7

8

9

2 0 0 0 2 0 0 1 2 0 0 2 2 0 0 3 2 0 0 4 2 0 0 5 2 0 0 6 2 0 0 7 2 0 0 8 2 0 0 9 2 0 1 0

PE

R C

EN

T

Batam Riau Islands Province Indonesia

0

1

2

3

4

5

6

7

8

9

2010 2011 2012 2013 2014 2015 2016 2017 2018

Riau Islands Batam Indonesia

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As with the island’s meteoric rise, the reasons for this downturn lie largely with Batam’s

manufacturing sector. On one hand, the electrical and electronics (E&E) sector has been stagnant

since 2010, when a record thirty firms left in one year following a major industrial relations dispute

(van Grunsven and Hutchinson 2016). Since then, the remaining base of E&E firms has further

dwindled, with large factories such as Panasonic, NIDEC, and Sanyo closing down. New investments

have been rare, and have generated fewer jobs than in the past (Hutchinson 2017).

This has been compounded by a massive downturn in the ship-building sector. In the 2011-

2012 period, Batam’s 115 shipyards employed some 250,000 formal sector workers, and produced

200 tugboats and 700 barges per year. However, due to excess capacity, a sharp drop in oil prices,

and domestic regulatory changes, the sector contracted sharply after this. In 2013, only 11,000

workers were employed in ship-building (Negara 2017).

This downturn has spread to other parts of the manufacturing sector, too. According to

Batam’s Manpower Agency, in 2015-2016, more than 110 firms closed operations (Straits Times, 2

November 2017). This trend has continued unabated, with fifty-three firms closing in the first half of

2017. As to be expected, this has had an impact on unemployment levels. In 2015 and 2016,

unemployment in the Riau Islands was 9 per cent, substantially above the national average of 6 per

cent (BPSb 2016).

These trends are also mirrored in flows of investment into Batam. Foreign direct investment

(FDI) slowed down after the end of the commodity boom in 2012. In relative terms, the Riau Islands

has lost ground to other provinces such as Central and West Java, which have begun to develop their

industrial bases on the back of increasing levels of FDI (Figure 3a). Likewise, relative to other parts

of Indonesia, Batam’s small size and recent development means it lacks a large private sector with

deep pockets to invest in local projects. Consequently, domestic direct investment (DDI) in Batam is

dwarfed by the quantum of investment in other locations such as West, Central, and East Java (Figure

3b).

4

Figure 3: Realized Investment in Selected Provinces

Source: BKPM via CEIC

1,032 1,061

2,373

5,143

1,567

4,595

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

Riau Islands Riau Central Java West Java East Java Jakarta

3a. FDI by province (US$ million)

2015 2016 2017

104

808

1,483

2,865

3,362 3,528

-

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

Riau Islands Riau Central Java West Java East Java Jakarta

3b. DDI by province (US$ million)

2015 2016 2017

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Exports from the Riau Islands fell year-on-year from US$16.8 billion in 2013 down to US$10.4

billion in 2016 (Figure 4), albeit with a slight recovery to US$12.3 billion in 2017.

Figure 4: Export-Import Value in Riau Islands Province

(US$ billion)

Source: BPS via CEIC

Consequently, the only bright spark on the horizon is the tourism industry. International

visitors to the Riau Islands have continued to climb, from some 1.5 million in 2008 to 2 million in

2015 – with three quarters going to Batam (BPSb 2017).

There are a number of reasons for this state of affairs. First, Batam presents a less compelling

case for business than in the past. Labour costs have increased substantially, with the island having

the second highest minimum wage in the country. Batam and the Riau Islands Province as a whole

fare poorly in comparison to Central and East Java, which offer much lower wage levels and better

logistical connections to population centres in Java and Sumatera. By way of comparison, in 2015

the minimum wages in Batam and the Riau Islands Province were Rp2.9 million and Rp2.2 million

respectively. The corresponding figures for both Javanese provinces were under one million (BPSb

6.97.5

8.3

12.7

16.5 16.216.8

15.7

11.6

10.4

12.3

-5.0

0.0

5.0

10.0

15.0

20.0

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Export

Import

Trade balance

6

2016). An important contributory factor has been the island’s combustible industrial relations

situation (Hutchinson 2015).

Second, it appears that the overall regulatory environment in Batam is less favourable than it

used to be. Local-level administrative dysfunctions and overlaps between the municipal government

and centrally-run investment authority, BP Batam, have led to slower response times, inefficient

processing of licenses and permits, as well as investor uncertainty. For example, some 22,000 land

titles are in legal limbo, due to disparate rulings between these two agencies (Jakarta Post, 15 January

2015). This is further complicated by the relative newness of the Riau Islands provincial government,

which was established only in 2004. Investors have consistently ranked the province’s government

and institutional quality poorly (Tan et al. 2013, 2015, 2017).

Third, recent trends indicate that the nature of manufacturing investment into Indonesia is

changing. Reports such as the 2012 McKinsey report The Archipelago Economy: Unleashing

Indonesia’s Potential have argued that, given prevailing growth trends, the country will be the

world’s seventh largest economy by 2030. The country’s “consuming class” will expand, driven by

rising incomes and increasing urbanization. Corporate strategies have changed in response, away

from merely viewing the country as a site for production for export, to seeing it as a market in its own

right. For example, data released in 2016 by JETRO, the Japanese research agency, indicates that

more than 80 per cent of Japanese firms present in Indonesia anticipate earning more profits from

sales in the local market, versus a mere 20 per cent who see exports as driving profits. This pattern is

mirrored by Japanese firms operating in other major Asian markets such as China and India (JETRO

2016).

The declining appeal of Batam relative to other locations in the country is compounded by

another issue – the island’s legal status. In 2009, President Yudhoyono declared the island, along with

parts of Bintan and Karimun, as Free Trade Zones. This status entails privileges such as: suspension

of import and export duties; exemptions on income tax on imported goods; exemptions or reliefs from

local taxes; a reduction in land and building taxes; as well as a reduction in income taxes for projects

above a certain threshold (EIU 2017).

However, while the FTZ status means that imported equipment and vehicles are available

more cheaply in Batam, it also means that it is more expensive to procure local staples such as rice

and sugar, which legally need to leave the domestic market to reach the island. Furthermore, firms

based on Batam wanting to sell on the domestic market need to pay a 20 per cent tariff (Riau Bulletin

7

17 January 2012). This is further compounded by weak transport connections between Batam and

other parts of the country. Indeed, it is often quicker and cheaper to route shipments to Jakarta through

Singapore.

The economic downturn has had a number of impacts on Batam. In 2016, the central

government reasserted its authority and prerogatives over BP Batam, the agency charged with

investor liaison, marketing, and infrastructure management on the island. In contrast to previous

practice, when the provincial government was allowed input into personnel selection, that year the

top management tier of the organization was replaced with a team of experienced officials from

Jakarta named exclusively by President Joko Widodo (Antara 14 March 2016). The incoming team,

led by Hatanto Reksodipoetro, a former WTO negotiator and ambassador to Norway, carried out

internal checks and audits of finance processes as well as land sales.

A mere eighteen months later, Hatanto and his team were replaced with a second group of

centrally-appointed officials, this time led by Lukita Dinarsyah Tuyo, formerly the secretary of the

Coordinating Minister for Economic Affairs. He is accompanied by a team of four senior civil

servants, each heading one of BP Batam’s departments, namely: finance; planning and development;

business facilities; and general affairs and resources.

The new team has a number of tasks. First, restoring Batam’s industrial competitiveness and

attaining a growth rate of 7 per cent within two years. Second, revitalizing links between the

government and the private sector. Third, overseeing the island’s transition from an FTZ to a Special

Economic Zone (SEZ).

The economic downturn and the ensuing leadership changes have been accompanied by two

related sets of policy discussions. The first regards Batam’s economic strategy. Should the island

retain its focus on traditional manufacturing activities or should it re-orient itself towards new and

more service-related sectors such as airplane maintenance and repair, logistics, and the digital

economy (Juoro 2013)?

The second question pertains to Batam’s status, and specifically whether it should: retain its

FTZ status; relinquish it altogether; or transition to an SEZ. This latter arrangement would involve

specific areas within Batam being designated as customs-free areas, and the remainder being re-

incorporated into the domestic economy. This would bring the island more in line with a number of

zones being established elsewhere in the country. However, the transition raises questions regarding

the FTZ status bestowed on firms already present on the island, whether companies and industrial

8

parks will have to be relocated to specific enclaves, and which central government ministry would

ultimately be responsible for supervising the new SEZ.

Using data for the 2008-2015 period from the Manufacturing Survey of Large and Medium-

Sized Firms, Indonesia’s largest and most comprehensive data source, this paper aims to contribute

to these two policy debates.

First, the study compares employment, output, exports, and labour productivity in the three

largest and most important manufacturing branches in Batam – electrical goods, electronics, and

shipbuilding – with firms in these same sectors in Java and Sumatera. This is done to see whether

Batam retains a comparative advantage in any of these sectors. Should the island constitute a pocket

of high output, exports, and productivity in one or more of them, then this would suggest that policy-

makers should retain the sector(s) in future plans. The case to the contrary, this would then support

initiatives to move Batam’s towards alternative activities, particularly services.

Second, this paper complements the abovementioned comparison with an econometric

exercise to explore the underlying drivers of industrial performance in the three locations. A variable

pertaining to Batam’s FTZ status is included to determine whether this has been a determining factor

in the island’s past economic performance. Should this not be the case, then this would suggest that

changing Batam’s FTZ status would pose fewer issues for its underlying attractiveness as a site for

investment.

After this introduction, the next section will use survey data to compare Batam’s industrial

performance overall and in the selected industry branches with Java and Sumatera. The subsequent

section will carry out the econometric analysis. The fourth and final section will conclude and draw

out implications for policy.

2. Batam’s Comparative Advantage

The main data source used in this paper is the Manufacturing Survey of Large and Medium-Sized

Firms (Statistik Industri (SI)) from Badan Pusat Statistik (Statistics Indonesia). The SI data provides

establishment-level information on all large and medium manufacturing firms in the country on an

annual basis. The SI questionnaire asks each firm information about its: overall production; exports;

imports; employment; wages; capital; and foreign ownership, inter alia.

9

On average, some 24,000 firms are covered by the survey. However, it does not cover micro

or small enterprises, defined as establishments with fewer than twenty employees. That said, data

from the survey can still capture key dynamics in Indonesia’s manufacturing sector, since large and

medium firms account for around 60 per cent of the country’s GDP (Amiti and Davis 2011).

For this exercise, data pertaining to the 2008-2015 period is evaluated. This period is long

enough to capture prevailing trends and also maximizes the availability of recent data. The BPS

changed industrial classification codes in 2010, consequently the time series before and after has been

homogenized to ensure comparability.i While Batam was awarded FTZ status in 2009, it enjoyed a

largely comparable status prior to this – entailing no significant break in incentives and related

provisions (Wong and Ng 2009).

In the subsequent paragraphs, firms in Batam are compared with their counterparts in Java

and Sumatera. Following a comparison of the number of firms, the number of workers employed, and

the proportion of females employed and their evolution over time in each of the three locations, the

performance of firms is compared in terms of: average output; exports and imports; and productivity.

For ease of analysis, focus remains on three manufacturing activities that are of vital importance for

Batam: electronics; electrical goods; and the shipbuilding & ship repair industry.

Based on the Survey’s main findings, some 21,460 (or 83 per cent) of the 24,000 firms

surveyed are located in provinces on Java and 2,785 (or 8.8 per cent) on Sumatera. With only 494

firms, the Province of the Riau Islands (PRI) accounts for only around 1.5 per cent of the total firm

population. Within PRI, 84 per cent of firms (415) are based in Batam, the most industrialized part

of the province.

Table 1 depicts the relative importance of these three sectors in each location in 2015 by firm

number. As can be seen, while these firms are more numerous in the other two locations, they are

proportionately more important for Batam’s firm base.

Table 2 sets out the proportion and number of firms exporting and importing over the 2008-

2015 period in the three locations. With regards to international linkages, approximately 18 per cent

of firms nationwide reported that they export some portion of their outputs and 20 per cent reported

that they import some portion of their inputs. Batam is clearly more integrated in international

production networks as the proportion of firms engaged in international trade, be it exporting or

importing, is noticeably higher than in Java and Sumatera. This could indicate that FTZ status has

contributed to Batam’s high export-import intensity.

10

Table 1: Sectors of Interest (2015)

Sectors Batam Java Sumatera Indonesia

Electronics 59 (14.2%) 248 (1.2%) 31 (1.1%) 317 (1.2%)

Ship-building 57 (13.7%) 62 (0.3%) 96 (3.4%) 200 (0.76%)

Electrical Goods 20 (4.8%) 312 (1.5%) 69 (2.5%) 345 (1.31%)

Total 415 21,460 2,785 26,322

Source: Authors’ calculation based on Statistik Industri

Table 2: Number and Proportion of Firms Exporting/Importing to Total Establishments

Batam Java Sumatera Indonesia

Exporting Importing Exporting Importing Exporting Importing Exporting Importing

2008 110 176 2,805 3,707 542 492 3,771 4,416

2009 116 164 2,887 3,532 600 464 3,925 4,135

2010 137 153 3,163 3,613 690 413 4,387 4,151

2011 142 167 3,359 3,742 725 458 4,573 4,327

2012 140 167 3,426 4,172 743 491 4,630 4,907

2013 140 179 3,497 4,803 773 497 4,758 5,532

2014 141 191 3,240 5,004 625 499 4,308 5,742

2015 134 281 3,225 5,562 529 634 4,174 6,612

Batam Java Sumatera Indonesia

Exporting Importing Exporting Importing Exporting Importing Exporting Importing

2008 37.3% 59.7% 13.2% 17.5% 20.8% 18.9% 14.7% 17.2%

2009 40.4% 57.1% 14.2% 17.3% 24.5% 18.9% 16.0% 16.9%

2010 48.4% 54.1% 16.2% 18.5% 29.7% 17.7% 18.8% 17.8%

2011 51.8% 60.9% 17.3% 19.2% 30.2% 19.1% 19.6% 18.5%

2012 49.5% 59.0% 17.5% 21.3% 30.3% 20.0% 19.6% 20.8%

2013 46.8% 59.9% 17.9% 24.5% 31.5% 20.3% 20.1% 23.3%

2014 45.3% 61.4% 16.0% 24.7% 24.8% 19.8% 17.6% 23.4%

2015 32.3% 67.7% 15.0% 25.9% 19.0% 22.8% 15.9% 25.1%


11

As regards exports versus imports, in Batam the proportion of firms importing keeps

increasing, but the proportion of firms exporting has been declining since 2011 (Table 2). This

suggests that, despite its export orientation, the domestic market is increasingly important for a

growing proportion of firms in Batam. Firms in Java demonstrate a similar trend of increasing imports

and decreasing exports. Conversely, more firms in Sumatera export rather than import over the period

under study, with the exception of 2015.

Table 3 shows the number of firms in the three industries in Batam, Java and Sumatera. It can

be seen that Java has the largest number of firms in both the electrical goods and computer &

electronics sectors. Meanwhile, Sumatera has more firms in its shipbuilding and shipyards sector than

Batam or Java.

Table 3: Total Number of Firms in Key Industries in Batam, Java and Sumatera, 2008-2015

Electrical goods Electronics Shipbulding & repair

Batam Java Sumatera Batam Java Sumatera Batam Java Sumatera

2008 14 242 24 62 136 78 16 53 44

2009 16 222 25 55 160 65 20 50 44

2010 13 274 23 58 189 71 19 45 43

2011 17 276 26 51 187 63 17 50 43

2012 18 279 26 51 191 64 20 49 48

2013 17 305 27 52 232 64 37 49 63

2014 20 306 29 48 230 58 39 53 69

2015 20 312 31 59 248 69 57 62 96


Turning to employment levels, Table 4 illustrates the number of manufacturing workers in the

three locations during 2008-2015. It shows that employment levels have been relatively stagnant in

Batam over this period, at around 140,000-150,000 workers. In contrast, employment levels in Java

have been growing steadily from around 3.6 million in 2008 to 4.4 million in 2015. Manufacturing

employment in Sumatera has also been growing steadily, climbing from 497,000 in 2009 to 565,000

in 2015.

12

It is interesting to note that Batam has a high concentration of female workers. Due to the

island’s early development of the E&E sector, the island has been a reputed centre of employment

for women. However, Table 4 also shows that the share of female workers to total employment in

Batam declined from around 60 per cent in 2008 to 50 per cent in 2015, converging to almost the

same level as Java. Meanwhile, the share of female workers to total employment in Sumatera has

been continuously declining from around 38 per cent in 2008 to around 30 per cent by 2015.

Table 4: Total Number of Manufacturing Employees and of Female Workers

in Batam, Java and Sumatera, 2008-2015

Batam Java Sumatera

Female % Total Female % Total Female % Total

2008

90,504 59.3%

152,538

1,800,670 49.1%

3,664,190

203,356 37.5%

541,903

2009

77,983 60.0%

129,985

1,797,510 49.6%

3,622,195

180,894 36.4%

497,503

2010

81,078 54.2%

149,682

1,820,425 48.3%

3,768,500

178,888 34.2%

522,806

2011

81,193 55.0%

147,593

1,864,075 48.4%

3,850,595

185,105 32.7%

565,529

2012

74,257 53.3%

139,297

2,007,482 48.8%

4,115,023

184,779 33.4%

553,984

2013

69,404 50.6%

137,277

2,051,371 48.9%

4,194,992

178,686 32.1%

556,325

2014

69,766 50.1%

139,337

2,118,672 48.8%

4,342,849

179,190 32.2%

555,711

2015

72,832 50.9%

143,057

2,185,583 49.7%

4,393,566

175,501 31.0%

565,551 Source: Authors’ calculation based on Statistik Industri

With regard to average employment per establishment, Figure 5 shows that firms in Batam,

on average, employ considerably more workers than their counterparts in Java and Sumatera.

However, in all three sectors of interest, this trend is narrowing, indicating that over time firms in

Batam are employing fewer workers. The decline in employment level in Batam was started in the

electronics industry around 2011, then followed by the shipbuilding & repair in 2012. Meanwhile,

the employment level in the electrical industry experienced a big decline only around 2015.

13

Figure 5: Employment Trends in Selected Industries, 2008-2015


As mentioned above, firms in Batam have a relatively high concentration of female workers.

In particular, Figure 6 shows that in the electronics and electrical goods industries, firms in Batam,

on average, employ more female workers than their counterparts in Java and Sumatera. However, this

is not the case in ship-building, where all three locations demonstrate low levels of female

participation (below 1 per cent). When seen in aggregate, the overall share of women employed in

the three sectors has progressively declined in Batam and Sumatera, but has remained stable in Java.

200

300

400

50

060

0a

ve

rag

e e

mp

loym

en

t

2008 2010 2012 2014 2016

Batam Sumatera

Java

All industries

14

Figure 6: Share of Female Employment in Selected Industries, 2008-2015


Turning now to output, exports, imports, and productivity, Figure 7 compares the trends of

output production (in logarithmic) between firms in in the three sectors in Batam, Sumatera and Java.

The data shows, on average, firms in Batam have higher output compared with their counterparts in

Java and Sumatera, but that output levelled off in 2014. With regard to the specific sectors, firms in

Batam produced more outputs than firms in Java and Sumatera, particularly in the electrical goods

and electronics sectors, and this trend is increasing. In the shipbuilding and repair industry, while still

higher than their counterparts in Java and Sumatera, the average output of firms in Batam has

declined, particularly since 2014. Meanwhile, firms in Sumatera and Java are showing increasing

levels of output, possibly due to the growth of the domestic market.

.3.3

5.4

.45

sha

re o

f fe

male

work

er

of to

tal w

ork

er

2008 2010 2012 2014 2016

Batam Sumatera

Java

All industries

.2.3

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.6.7

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ork

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tal

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2008 2010 2012 2014 2016

Batam Sumatera

Java

Electrical goods

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.09

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of

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ale

wo

rker

of

tota

l w

ork

er

2008 2010 2012 2014 2016

Batam Sumatera

Java

Shipbuilding & repair

15

Figure 7: Output Production Trends in Selected Industries, 2008-2015


Looking at manufacturing as a whole, firms in Sumatera export the most, followed by Batam

and then Java. Looking over time, while exports in all three locations have increased, those from

firms in Batam levelled off in 2014. Regarding the specific sectors, Figure 8 shows that for the

electronics and electrical goods sectors, firms in Batam perform better than those in Java and

Sumatera. In the shipbuilding industry, in line with declining output, the average export of firms in

Batam has declined since 2014 (see Figure 8, bottom left). It is noteworthy that even though exports

of shipbuilding industry in Java have declined sharply since 2012, their output has been increasing

since 2013 (Figure 7, bottom left). This is because, unlike Batam, the shipbuilding industry in Java

mostly caters to the domestic market, which has been experiencing increased demand due to the

government’s maritime projects and cabotage rulesii.

15

15

.51

61

6.5

17

17

.5lo

g o

utp

ut

2008 2010 2012 2014 2016

Batam Sumatera

Java

All industries

16.5

17

17.5

18

18.5

log o

utp

ut

2008 2010 2012 2014 2016

Batam Sumatera

Java

Electrical goods

15

16

17

18

19

log o

utp

ut

2008 2010 2012 2014 2016

Batam Sumatera

Java


16

Figure 8: Export Trends in Selected Industries, 2008-2015


Another interesting fact about manufacturing firms in Batam is the high import content of

their production inputs. Figure 9 shows that, on average, firms in Batam imported around 50 per cent

of their total inputs. This is much higher compared with firms in Java and Sumatera, at around 10 and

4 per cent, respectively. This corroborates the finding of Amiti and Davis (2011), namely that only a

fraction of firms in Indonesia are linked up to global production networks.

Particularly for electronics firms in Batam, their dependence on imported components is very

high, approaching 90 per cent of the total inputs and this trend is relatively stable. In contrast, if we

look at the levels of imports of components for the electrical goods and shipbuilding industries, they

are lower at around 60 per cent and the trend is declining.

15

.516

16

.51

71

7.5

18

log

exp

ort

2008 2010 2012 2014 2016

Batam Sumatera

Java

All industries

12

14

16

18

20

log e

xpo

rt

2008 2010 2012 2014 2016

Batam Sumatera

Java

Electrical goods

10

12

14

16

18

log e

xp

ort

2008 2010 2012 2014 2016

Batam Sumatera

Java


17

Figure 9: Share of Imported Inputs in Production in Selected Industries, 2008-2015


The trends in productivity levels across the three locations are striking. Despite their greater

incorporation into global production networks, their greater number of workers and higher output and

export levels, Total Factor Productivity (TFP) levels in Batam are the lowest. When viewed in relation

to TFP levels in Java and Sumatera, it is evident that productivity levels in Batam are lagging by a

significant margin. In addition, despite a fall following the Global Financial Crisis and a short period

of stagnation, productivity levels in Batam are actually increasing, overtaking Sumatera in 2015

(Figure 10). This finding is puzzling and worth further examination.

Turning to the three specific sectors, firms in Batam have relatively comparable labour

productivity level compared with their counterparts in Java. Particularly in the electrical and

electronics industries, labour productivity of firms in Batam increased in 2015 (Figure 10). On the

contrary, labour productivity in shipbuilding & repair has declined in the same year.

0.2

.4.6

.8share

of im

port

ed inpu

t of to

tal in

put

2008 2010 2012 2014 2016

Batam Sumatera

Java

All industries

.2.4

.6.8

shar

e o

f im

po

rted

in

pu

t o

f to

tal

inp

ut

2008 2010 2012 2014 2016

Batam Sumatera

Java

Electrical goods

0.2

.4.6

.8sh

are

of

imp

ort

ed i

np

ut

of

tota

l in

pu

t

2008 2010 2012 2014 2016

Batam Sumatera

Java


18

Figure 10: Productivity Trends, 2008-2015


As mentioned above, one factor that may account for lower productivity levels and declining

employment levels in Batam is the island’s higher wages. Figure 11 shows that firms in Batam on

average pay higher wages than their counterparts in Java and Sumatera - particularly for electronics

and shipbuilding. With declining output and export levels, wage increases place high pressure on

profit levels, pushing firms to reduce headcount.

17

17

.21

7.4

17

.61

7.8

log

TF

P

2008 2010 2012 2014 2016

Batam Sumatera

Java

All industries

11

.512

12.5

13

13.5

log

ou

tput pe

r w

ork

er

2008 2010 2012 2014 2016

Batam Sumatera

Java

Electrical goods

11

12

13

14

log

ou

tput per

wo

rker

2008 2010 2012 2014 2016

Batam Sumatera

Java


19

Figure 11: Average Wage per Worker in Selected Industries, 2008-2015


3. Econometrics Findings

This section examines the factors driving the industrial performance of firms in Indonesia. The

hypothesis is that firms located in FTZs receive advantages such as specialized facilities as well as

expedited approvals and additional financial incentives. Consequently, it is hypothesized that these

firms perform better compared to those located outside FTZs. To test this, a reduced-form function

(1) is estimated using ordinary least squares (OLS) with firm fixed effects, µi, to control for

unobserved firm-level heterogeneity:

8.5

99.5

10

10.5

11lo

g w

age

2008 2010 2012 2014 2016

Batam Sumatera

Java

All industries

9.5

10

10

.51

1lo

g w

age

2008 2010 2012 2014 2016

Batam Sumatera

Java

Electrical goods

99.5

10

10

.511

log w

age

2008 2010 2012 2014 2016

Batam Sumatera

Java


20

Outcomeit = f (Outcomeit-1, FTZ_dummyi, Xit, µi, εit ) (1)

The outcome variables are the log of firm-level total factor productivity (TFPit), output per

worker (yit), exports (xit), and employment (nit). The key variable of interest is the FTZ dummy, which

is equal to one if the firm is located in Batam. Other control variables, Xit, include wage level (wit),

firm age (ageit), foreign participation dummy (FDIit), firm exporting dummy (exportit), and firm

importing dummy (importit). Finally, a lagged dependent variable is included to capture dynamic

effects in the data and deal with autocorrelation (Keele and Kelly 2005).

Equation (1) is estimated as an unbalanced panel for the years 2008–2015 using OLS

estimation. Summary statistics are provided in Table 5.

Table 5: Summary Statistics

N Mean St. dev

ltfp

ly

lx

ln

lw

fdi

xport

mport

age

batam

log (total factor productivity)

log (output)

log (export)

log (number of worker)

log (wage)

Dummy FDI=1 if Foreign share>0

Dummy export=1 if export>0

Dummy import=1 if import> 0

Firm age

Dummy FTZ if Batam=1

14,614

181,285

34,458

195,018

195,012

195,018

195,018

195,018

195,018

195,018

17.5

15.86

16.30

4.19

9.55

0.09

0.76

0.20

2.99

0.01

1.73

2.17

2.37

1.19

1.12

0.29

0.43

0.40

2.29

0.11

Source: Authors’ calculation

Table 6 shows the correlation matrix among variables of interest. It can be seen that there is a

weak correlation between FTZ status and the control variables.

21

Table 6: Correlation Among Variables


Table 7 shows the estimation results of the reduced form equation (1) using OLS with firm

fixed effect. Surprisingly, the FTZ dummy variable is not significant in accounting for the observed

performance of Batam-based firms. This then suggests that FTZ status does not provide significant

economic advantage for firms on the island in terms of output, exports or employment.

Conversely, factors that are driving the performance of firms are: wage level; foreign

participation; exports; imports; and firm age. Wage level has a positive and significant effect on the

level of output, productivity and exports, but no significant effect on employment. This finding is in

line with the finding of Tadjoeddin et al. (2017) on efficiency wage hypothesis, which argues that

higher wages are associated with increases in firm productivity or efficiency, or they reduce costs

associated with turnover in industries where the costs of replacing labour are high.

22

Foreign participation has a positive and significant effect on the level of output, exports and

employment.iii The export dummy has a positive and significant association with levels of

productivity, output and employment. Meanwhile, the import dummy also has a positive and

significant association with firm’s output and employment. Firm age has a positive and significant

association with productivity, output and export levels. However, it has a negative and significant

association with firm’s level of employment. Arguably, more experienced firms tend to be more

capital intensive.

Table 7: Estimation Results (Level)

Output TFP Export Employment

Lag output (t-1) Wage Dummy FDI Dummy Export Dummy Import Firm age Dummy FTZ Lag TFP (t-1) Lag Export (t-1) Lag employment (t-1)

0.225*** (0.003)

0.122*** (0.003)

0.150*** (0.024)

0.064*** (0.007)

0.170*** (0.015)

0.072*** (0.001) -0.064 (0.561)

0.061*** (0.009) 0.062

(0.051) 0.078** (0.029)

0.022*** (0.004)

0.192*** (0.011)

0.110*** (0.008) 0.090* (0.044)

0.034 (0.033)

0.052*** (0.004) -0.029 (0.645)

0.212*** (0.007)

-0.001 (0.001)

0.056*** (0.010)

0.034*** (0.003)

0.028*** (0.006)

-0.008*** (0.001) 0.331

(0.208)

0.492*** (0.002)

R-squared Within

Between Overall

0.14 0.87 0.74

0.06 0.90 0.78

0.08 0.89 0.74

0.24 0.97 0.89

N 146,576 10,271 26,784 159,641 Notes: All estimation include constant term and they are all statistically significant.

Robust standard errors are in parentheses. * p<0.05, ** p<0.01, *** p<0.001


23

To test the robustness of the model, the dependent variables are replaced with the growth rate.

Table 8 shows the estimation results of the reduced form equation (1) using the growth variables as

the outcome variables (output growth, productivity growth, export growth and employment growth).

The results are mostly similar to the regression results in level (Table 7).

Table 8: Estimation Results (Growth)

Output TFP Export Employment

Lag output (t-1) Wage Dummy FDI Dummy Export Dummy Import Firm age Dummy FTZ Lag TFP (t-1) Lag Export (t-1) Lag employment (t-1)

-0.392*** (0.003)

0.054*** (0.002) 0.103** (0.033)

0.087*** (0.022)

0.108*** (0.021)

0.010*** (0.002) 0.813

(0.752)

0.040** (0.008) 0.001

(0.077)

-0.005 (0.006)

-0.434*** (0.013)

0.046*** (0.007) 0.050

(0.062)

0.028 (0.049) 0.015** (0.005) 0.823

(0.876)

-0.401*** (0.007)

-0.000 (0.001)

0.044*** (0.014)

0.027*** (0.009)

0.034*** (0.009)

-0.008*** (0.001) 0.324

(0.267)

-0.319*** (0.003)

R-squared Within

Between Overall

0.16

0.008 0.10

0.18 0.02 0.11

0.16

0.002 0.08

0.10 0.07 0.03

N 117,351 7,421 20,934 128,971 Notes: All estimation include constant term and they are all statistically significant.

Robust standard errors are in parentheses. * p<0.05, ** p<0.01, *** p<0.001


24

It is found that factors that are driving firms’ industrial growth are wage, foreign participation,

export, import, and firm age. Wage growth has a positive and significant effect on firm’s output,

productivity and export growth but no significant effect on employment growth. Foreign participation

has a positive and significant effect on the output and employment growth of firms. Both export and

import dummy variables have a positive and significant association with firm output and employment

growth. Meanwhile, firm age has a positive and significant association with output growth but a

negative and significant association with employment growth.

Overall, the estimation results are consistent with the findings from previous studies (Takii

2004, Aswicahyono 2009, World Bank 2012) that firms which are foreign-owned, export-oriented,

and particularly both, have higher productivity. There are at least two possibilities why the FTZ

variable is not significant in determining the industrial performance of firms in Batam. First, it may

be the case that the FTZ advantage has been captured by the other significant variables, such as

foreign ownership, export and import dummies. Because FTZ status enhances those variables, it may

have an indirect effect on firm’s performance. However, this indirect effect is not captured in the data.

Second, there are Bonded Zones and Warehouses in operation in other parts of the country. Firms

located within these areas enjoy similar benefits to those provided by Batam’s FTZ status.

Consequently, the “FTZ effect” could, in fact, be operating in all three locations.

The results of this study indicate that access to foreign participation and imported inputs is

very important for firm competitiveness. With improved access for foreign participation and imported

inputs, firms have access to global value chains (Amiti and Davis 2011). A higher share of imported

inputs in the manufacturing production in Batam indicates that firms located there have been

continuously integrating with global value chains more than firms in the other locations. That said,

overall firms productivity in the manufacturing sector in Indonesia in general and in Batam in

particular remains low. There are a number of factors contributing to low firms productivity,

including credit constraints, quality of human resources, regulatory barriers, and so on (Javorcik et

al. 2012, Kuncoro 2018). Unfortunately, the dataset that is used cannot control those variables.

However, most of these issues are frequently raised by businesses operating in the country.

25

4. Conclusion

Since about 2010, investment, firm numbers, and employment levels in Batam have dipped in key

areas such as electrical goods, electronics, and ship-building. This state of affairs has prompted

considerable introspection with regard to Batam’s future, particularly which economic sectors to

promote and whether the island’s FTZ status is a boon or a bane – particularly in today’s economic

climate.

This paper has sought to contribute to this discussion through comparing and contrasting

Batam’s overall industrial performance with Java and Sumatera. This has been complemented by an

in-depth analysis of three specific sectors: electrical goods; electronics; and shipbuilding, and an

econometric exploration of the impact of Batam’s FTZ status on firm performance.

These operations have revealed several findings. First, while relatively small in number, firms

in Batam in the electrical goods, electronics, and ship-building sectors employ more workers per

capita and have higher output levels, as well as a greater proportion of exports and imports relative

to their counterparts in Java and Sumatera. Surprisingly, relative to firms in these other two locations,

in general firms in Batam show considerably lower levels of productivity. Only in a select sectors,

i.e. electrical and electronics industries, firms in Batam show comparable productivity levels with

those in Java.

Second, despite more firms being established in Batam of late, the proportion of firms

exporting has been declining and the proportion of firms importing has been increasing. This suggests

that more and more firms in Batam outsource their intermediate inputs from imports and sell their

products on the domestic market. A similar pattern can be seen for firms in Java and Sumatera, in

which a growing proportion of firms sell on the domestic market as opposed to overseas. This

indicates that, over time, the domestic economy is more important for firms based in Batam.

Three, with regard to the three specific sectors studied, firms in the electronics and electrical

goods industries in Batam produce more outputs than their counterparts in Java and Sumatera.

Consequently, the island still has a strong comparative advantage in these two sectors. In contrast,

indicators pertaining to the ship-building sector paint a less positive story. Looking forward, these

results indicate that the first two sectors should remain central to strategies for the island, but that

further promotion of or investment into the ship-building sector may need to be re-evaluated.

Four, the number of workers in medium and large establishments in Batam has been relatively

stagnant at around 140,000-150,000 workers during 2008-2015. In contrast, employment levels in

26

Java and Sumatera have been growing. Given an increase in firm numbers in Batam, it is possible

that manufacturing is becoming more capital-intensive and less labour-intensive. In addition, the

share of female workers is declining in Batam, converging to almost the same level as in Java. This

suggests that either existing firms are altering their worker demographic or that the new activities on

the island are distinct.

Turning to the econometric exercise, FTZ status is not associated with higher levels of output,

exports or productivity. In contrast, contributing factors to better performance are: foreign ownership;

export orientation; use of imported inputs; wage levels; and firm age. It would appear that firms based

in Batam benefit from their inclusion into global production networks, rather than due to any specific

features provided by the island’s FTZ status. Even when indirect causality was explored, the findings

were not significant. This indicates that either it is other attributes that are driving investment into

Batam, or that the availability of similar investment incentives elsewhere in the country negates the

specific benefits available on the island. Consequently, there may be some leeway to alter Batam’s

investment framework without negatively affecting investment flows.

27

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29

Endnotes

i For the period before 2010, BPS uses industrial classification or ISIC rev 3 (KBLI 15-37). From

2010 onwards, it uses ISIC rev 4 (KBLI 10-33).

ii Cabotage rules regulate shipping activities which takes place within a country's waters and

particularly restricts the activities of foreign vessels operating within its waters. The Indonesian

government has implemented the Cabotage rules through the Maritime Law No 17 of 2008, which

aims to limit the number of foreign vessels operating in Indonesian waters and to give greater

market share to Indonesian companies. The law requires companies to establish and licence

themselves as "Indonesian Sea Carriage companies". It must be incorporated in Indonesia and must

observe the 49 per cent foreign ownership limit.

iii However, Blomstrom and Sjoholm (1999) show that the degree of foreign ownership does

neither affect the level of labour productivity in foreign establishments, nor the degree of spillovers

in the Indonesian manufacturing.

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