Foreign direct investment in Indonesia

Abstract

This study addresses the needs of Indonesian policymakers, to not only investigate the determinant factors of FDI inflow in manufacturing sector across Indonesian provinces, but to also investigate the impact of FDI spillover on firm's total factor productivity growth (TFPG) through product and labour markets and the role of provincial human capital on FDI-TFPG nexus. This study addresses the questions; 1) what is the impact of FDI spillover on the TFPG of Indonesian manufacturing firms in product and labour markets across sectors and within a province by considering different kinds of job characteristics?; 2) what is the impact of provincial human capital on provincial FDI "" TFPG nexus in the Indonesian manufacturing sector?; and 3) what are the factors that influence FDI location decision in the Indonesian manufacturing sector by considering the cultural distance and provincial dependency between Indonesian provinces?. The main aim of the formulation strategy to attract more FDI should be in line with the measurement of FDI spillover effect on TFPG, not only through the product market but also through the labour market, by considering the role of provincial human capital. The first contribution of this thesis to FDI literature is measuring FDI spillover impact on TFPG through a labour market of the manufacturing sector by considering different job characteristics across industries and provinces. Using a dynamic panel regression model, two-step system GMM, the result shows that wage spillover from foreign firms influences the TFPG of Indonesian manufacturing firms. Such influence is affected by different job characteristics, production, and non-production jobs, and by geographic boundaries. Wage spillover in production jobs across industries positively affects the TFPG; wage spillover in non-production jobs within a province negatively contributes to the TFPG. This result has a policy implication whereby the Government should maintain and develop the competitive environment in which business and economic activities are mainly determined by the market mechanism. The Government also needs to provide an incentive for younger generations to pursue production-related jobs, such as engineering, and to undertake vocational high school degrees, as the finding of this study shows that competition in the labour market of production-related jobs (between local and foreign firms) positively affects the average TFPG of Indonesian manufacturing firms. The second contribution is in the measurement of provincial human capital threshold in a specific sector to generate a positive impact of FDI inflow on provincial TFPG. Using a dynamic threshold regression model, with maximum likelihood approach, the result shows that the threshold level of human capital exists indicating the role of provincial human capital on FDI - TFPG nexus in Indonesian manufacturing sector. The second regime, or the provinces that have human capital above the threshold level benefits, from the presence of FDI. This result has policy implications by which the Government should extend the completion years of compulsory education to a period of 12 years, supported by a free education policy during that period as the increased number in the labour force (with at least senior or vocational high school qualifications) generates a positive effect of FDI inflow on provincial TFPG of Indonesian manufacturing sector. The third contribution of this thesis to FDI literature is investigating the determinant factors of FDI inflow across Indonesian provinces, by considering cultural heterogeneity and different languages across these provinces. Using dynamic and non-dynamic spatial econometrics models consisting of spatial durbin model (SDM), spatial autoregressive (SAR) model, spatial error model (SEM), and spatial autocorrelation (SAC), the result shows that language distance after weighted by geographical distance, and cultural heterogeneity distance between Indonesian provinces are the most determinant factors in creating provincial dependency to decide FDI location across Indonesian provinces. This also shows that FDI location decision across Indonesian provinces is influenced by five key factors: 1) FDI inflow in a previous year in a certain province; 2) FDI inflow in neighbouring provinces that has relatively the same proportion of people using Indonesian language after considering the geographical distance; 3) Innovation capability in a certain province; 4) the provincial government expenditure for development including for infrastructure development, and 5) other factors not included in the model. The policy implications of this study are that the Government should continue to promote the transmigration program and to develop economic sectors and administrative systems equitably between the Indonesian provinces as a provincial dependency, in deciding FDI location, is also determined by economic and administrative distances between Indonesian provinces.

Date of Award	2019
Original language	English