Ambon, 15–16 July 2024: The 19th Indonesian Regional Science Association (IRSA) Conference brought together leading economists, policymakers, and industry experts to discuss pressing economic issues. A key highlight of the conference was the special session on the impact and challenges of Local Content Requirements (LCRs) policy, organised by the Indonesia Bureau of Economic Research (IBER) and ERIA.

The event was opened by Dr Chatib Basri, Director of IBER, followed by a discussion session moderated by Dr Alin Halimatussadiah. The panellists included Prof. Mari Elka Pangestu from the University of Indonesia, Dr Yessi Vadila from ERIA, Assoc. Prof. Michelle Limenta from Universitas Pelita Harapan's Centre for International Trade and Investment, and Muhammad Zeqi Yasin, a lecturer at the Faculty of Economics, Universitas Jember.

‘LCRs policies can stimulate domestic industries, enhance technological capabilities, and foster innovation, but on the other hand, they may increase production costs and lead to trade disputes,’ stated Dr Chatib Basri in his opening remarks. Dr Basri explained that despite aiming to boost domestic production, implementing LCRs policies is highly complex and comes with numerous consequences, necessitating thorough and careful consideration.

Prof. Mari Elka Pangestu echoed similar sentiments, noting that the success of LCRs policies varies among countries. Indonesia itself abolished LCRs policies in 1995 but reinstated them after the global financial crisis in 2008. She emphasised that enhancing domestic value-added cannot be achieved by LCRs policy alone; instead, comprehensive economic engagement across all aspects is necessary for domestic industries to truly thrive under these policies. ‘We need complementary policies to accompany LCRs policy, such as building local industry ecosystems and providing incentives for domestic companies through subsidies and tax reductions,’ Prof. Pangestu concluded.

Prof. Michelle Limenta, Director of the Centre for International Trade and Investment at Universitas Pelita Harapan, cautioned Indonesia about its LCRs policy during the IBER-ERIA session. Prof. Limenta highlighted that LCRs policies run counter to the principles of the World Trade Organization (WTO), which generally aims to minimise their implementation globally. She argued against heavily relying on LCRs policies for developing domestic industries, citing potential legal challenges from other countries. ‘Indonesia previously faced challenges at WTO dispute forums when implementing LCRs policies, notably with Timor car production, which was found to violate the WTO's non-discrimination principle,’ Prof. Limenta pointed out. She emphasised that under current regulations, only government procurement can apply LCRs, subject to rigorous criteria.

As global value chains fragment, countries like Indonesia are implementing LCRs to boost domestic production and employment. Since 2010, Indonesia's LCR policies have aimed to reduce import dependence, protect local industries, and create jobs. ERIA presented two recent studies regarding the effects of LCR policy in Indonesia.

One of the ERIA studies, conducted by Dr Yessi Vadila and David Christian, examined the dynamic effects of LCR policy from 2004 to 2020 on Indonesia’s trade flows at the 8-digit HS product level. During the conference, both Dr Vadila (in the IBER-ERIA Special Session) and Christian (in a separate session) elaborated on the findings of this study. An important finding is that LCRs policy is weakly, yet positively associated with an increase in Indonesia’s imports, especially of high-tech products. Furthermore, the study also shows evidence of a loss in long-run export competitiveness arising from LCRs, which is consistent with another finding of the same study that exposure to LCRs is associated with poorer export outcomes in the medium run.

LCRs policy has also been implemented in the upstream oil and gas (OG) sector in Indonesia. The 2013 MEMR Regulation No. 15 mandates firms in the OG sector to prioritise domestic inputs, setting minimum local content percentages and imposing fees on non-compliant firms. This regulation affects a significant portion of Indonesia's economy, including 8.3% of gross output and 11.9% of value added in 2012.

An analysis by Dr. Lili Yan Ing and Dr. Rui Zhang quantifies the impact of these LCRs on Indonesian manufacturing. As presented by Dr Yessi Vadila, Trade Specialist at ERIA, the study incorporates LCR compliance decisions into an economic model, revealing a complex picture. Firms must weigh the costs of compliance, such as restricted imports and inefficiencies, against a 15% fee for non-compliance.

While LCRs cause a significant reallocation of sales within the OG sector – benefiting compliant firms and penalising non-compliers – the overall impact on aggregate sales, value added, and employment is modest. Compliant firms see a slight increase in employment and local content, but higher domestic input costs marginally decrease local content in other firms.

The findings suggest that while LCRs can shift market dynamics and support local industries, their broader economic benefits may be limited by unintended consequences, such as increased costs and inefficiencies.

Local Content Requirements: Promises and Pitfalls

Dr Lili Yan Ing's Presentation