Why (and How) Indonesia must Reduce its Economic Dependence on China

Indonesia and China relationship is perhaps one of the most important diplomatic relations in the Indo-Pacific. As the world’s most and fourth-most populated countries in the world, one would argue that Indonesia and China relationship is extremely important, even though there are many frictions in the relationship, most notably the South China Sea dispute. As a consequence, many experts in Indonesia believe that the Indonesia-China relationship must be augmented. I, however, beg to differ. Behind the strong rhetoric of friendship, cooperation, and other diplomatic jargons lie an unmistakable sign of economic dependency on China. As I have argued on the opinion page of Foreign Policy Community Indonesia chapter Universitas Gadjah Mada in 2021, Indonesia are in a state of chronic economic dependency on China and this dependency must be reduced to enhance Indonesia’s independence, especially in safeguarding the Indonesian territory. Things, of course, have changed since last year, one of the biggest changes being the Russian invasion of Ukraine in February 2022, and I believe my arguments must be updated. Still, the relevant evidence supports my argument that there must be a diminution of Indonesian dependency on China.

Indonesia-China Economic Relationship: Interdependence or Dependence?       

Firstly, one needs to remember that the current economic relationship is not of interdependence, but of dependence, meaning that Indonesia depends on China for its economic relations while the vice-versa is not necessarily true. According to the data published by the Observatory of Economic Complexity, China is the destination of nearly 30% of Indonesian exports while it is the origin of 18% of Indonesian imports in 2020. However, in the same year, Indonesia is the destination for only 1,54% of Chinese exports while it is the origin of only 2,1% of Chinese imports. Economic interdependence, by its very definition, means that two parties must be more or less equally dependent on one another. Seeing the data above, it is clear that Indonesia depends heavily on China for its trade while the vice-versa is not the case.

However, one could argue that Indonesia has many raw materials that China needs, such as nickel ore, that are necessary to fuel China’s growth and technological innovations. Again, the data does not corroborate this claim. Indonesia is the source of only 7,74% of China’s nickel ore, material that is heavily important in making electric cars and is touted by many Indonesian experts, politicians, and media as Indonesia’s leverage on world affairs. Furthermore, given that Indonesia exports nearly 90% of its nickel ore to China in 2020, one must ask the question whether China is dependent on Indonesia for its nickel ore or is it Indonesia that depends on China for nickel ore exports.

In addition, Indonesia is also fairly dependent on China for its foreign investment. According to the Investment Coordination Board of Indonesia, China is now the third-biggest foreign investor in Indonesia, behind Japan and Singapore. Admittedly, the Indonesian dependence on Chinese investment is not as chronic as Indonesia’s trade relationship with China. Still, there are some possibilities that the number of Chinese investments in Indonesia could be higher as some Chinese investment to Southeast Asia (including Indonesia) are routed through Singapore, resulting in a statistical distortion. However, Indonesia’s dependence on Chinese investment could grow as Indonesia and China has signed numerous investment development cooperation deals under the umbrella of the Belt and Road Initiative or other bilateral investment deals.

What is the Problem?   

One might ask why one must worry about Indonesia’s economic dependence on China? One answer is heavily relevant: China increasingly does not have hesitation to use its economic relations with other countries as a political economic weapon to achieve China’s objectives, often at the expense of its economic partner. In 2017, for example, when the South Korean government agreed to install the US-made Terminal High Altitude Area Defense (THAAD) missile defense system to defend South Korea against North Korean missiles, China retaliated by embargoing outgoing Chinese tourists to South Korea as China believed that the THAAD can theoretically be used to target Chinese missiles, thus mollifying Chinese nuclear second strike capability. More recently and blatantly, China put in place an unofficial embargo on Australian exports to China after the Australian government called for an investigation into the origins of the COVID-19 pandemic. Kishore Mahbubani succinctly describes the effects of Australian economic dependence on China:

Australia is the most vulnerable [among the countries of the Quadrilateral Security Dialogue]. Its economy is highly dependent on China. Australians have been proud of their remarkable three decades of recession-free growth. That happened only because Australia became, functionally, an economic province of China: In 2018–2019, 33% of its exports went to China, whereas only 5 percent went to the United States.

This is why it was unwise for Australia to slap China in the face publicly by calling for an international inquiry on China and Covid-19. It would have been wiser and more prudent to make such a call privately. Now Australia has dug itself into a hole. All of Asia is watching intently to see who will blink in the current Australia-China standoff. In many ways, the outcome is pre-determined. If Beijing blinks, other countries may follow Australia in humiliating China. Hence, effectively, Australia has blocked it into a corner.

And there are several points of friction in the Indonesia-China relationship that can lead China to wield its political economic weapon against Indonesia. The most notable one is the Indonesia and China dispute on the waters around the Natuna Islands. In this case, Indonesia’s legal Exclusive Economic Zone (EEZ) claim overlapped with the Chinese illegally-claimed nine-dash line. While Indonesia and China have successfully managed their dispute for years, China has gotten more and more brazen in recent years in upholding its illegal claim. In an unprecedented move, Reuters reported in December 2021 that China had sent a letter requesting that Indonesia withhold its oil and gas drillings in the Indonesia’s EEZ region that overlapped with China’s nine-dash line. Furthermore, in another unprecedented move, China protested Indonesia’s military exercises with the United States Army, even though the exercises took place primarily on land and far away from the South China Sea. Thus, it is increasingly clear that China is ever more willing to protest activities that are within the boundaries of Indonesia’s sovereignty. It is fortunate that China does not employ its extensive political economic leverage against Indonesia. However, given the increasing willingness to use its political economic relations as a weapon, it is not an irrational thought that China can one day impose an embargo on Indonesian exports to China unless Indonesia acquiesce to Chinese demands in the South China Sea or on other areas.

In spite of this, one can argue that the increasing Indonesia-China trade is essential for the maintenance of peace between Indonesia and China. In this iteration, if there is a high level of economic interdependence between Indonesia and China, then the parties involved will rethink the hostilities in fear of losing its economic benefits. There are some pitfalls with this argument. As I have explained previously, the economic relationship between Indonesia and China is not of interdependence, but of dependence. Secondly, even if Indonesia and China have economic interdependence, “high levels of economic interdependence do not make war impossible and thus do not free states from having to worry about what powerful rivals might do to upset the balance of power” as Stephen Walt argued in The Hell of Good Intentions: American Foreign Policy Elite and the Decline of US Primacy. This is because states will always pick political and security goals first over prosperity and economic goals. Indeed, the decades leading up to the First World War was widely considered as the belle époque of globalization, with trade and immigration moving at an extremely high level. In recent years, the high amount of Ukraine-Russia trade does not prevent the latter from invading the former in 2022 and 2014.

Logically speaking, if China is really sincere in upholding its economic relationship with Indonesia, then China should have abandoned its illegal claims over the South China Sea (at least the part where its claims overlapped with Indonesia) and not do provocative acts such as requesting that Indonesia suspend its gas and oil drillings in Indonesian EEZ. These moves would be logical as these frictions could escalate and destroy the hard-won Indonesia-China economic relations. Instead, evidence points to the contrary: China’s diplomatic doublespeak means that China continues to employ highfalutin rhetoric on trade and economic relations with Indonesia while doing political, military, and pseudo-military moves that can damage those trade relationship. Therefore, any Indonesian policymaker and expert must ask an inconvenient question: Is China really sincere in upholding its good relationship with Indonesia?

What Must be Done?

Therefore, what must be done to lessen Indonesia’s economic dependence on China? The word count imposes a barrier to explaining each solution in detail. However, several solutions can be glossed over. One solution is to impose a barrier to the export of Indonesian raw materials. This will allow Indonesia to hit four birds with one stone: break away from the chain of dependency of manufactured goods imports and become more independent, create Indonesian manufacturing jobs, invigorating Indonesian domestic industry, and inviting more foreign investment to build manufacturing plants in Indonesia. The Indonesian government’s ban on exporting raw nickel ore is a step in the right direction. This can set an example to break Indonesia’s dependency on foreign countries, with the Indonesian President Joko Widodo declaring in December 2021 that the government will continue to impose barriers in the export of other raw materials, including bauxite. Thus, the production plants must be built physically in Indonesia and that there must be a technology transfer mechanism so that Indonesia can operate and develop the industries independently in the future.

Secondly, Indonesia can also search for alternative market in ASEAN by utilizing the benefits enshrined in the ASEAN Free Trade Area (AFTA) rules. One might argue that ASEAN does not provide the necessary materials to Indonesia compared to China. Yet, it is important to note that many companies are now adopting the China+1 strategy to lessen their dependence on the Chinese economy and industry by opening up factories in other countries, most notably in Thailand and Vietnam. Indonesia will be able to utilize the tariff reduction that are signified in the AFTA rules if Indonesia source its manufacturing goods imports from ASEAN emerging industrialized countries. While this may seem inefficient and redundant, this step is extremely important to hedge the political risks and prepare for the possibility that China could use its economic relationship with Indonesia as a political economic weapon. If China bans a certain material from being exported to Indonesia, at the very least Indonesian industry would not be 100% crippled as they can still depend on imports from ASEAN countries. ASEAN countries can also be seen as a market potential for Indonesian exports to lessen Indonesia’s dependence on the China market, with an economic gravity model research identifying that Laos, Malaysia, Brunei Darussalam, and Thailand still have market potentials that can be exploited by Indonesian companies.

Other solution that Indonesia can implement is to take advantage of the recently-implemented Regional Comprehensive Economic Partnership (RCEP). The RCEP is way bigger and more ambitious compared to the AFTA, with the ASEAN countries, Japan, South Korea, China, Australia, and New Zealand being members of the RCEP. Even though the RCEP includes China, it also includes other more developed economies such as Japan, South Korea, Australia, and New Zealand. As such, under the umbrella of the RCEP, Indonesia can increase its exports to these countries as the tariff and non-tariff barriers have been dropped significantly. Furthermore, Indonesia can also attract more high technology investment from Japan, New Zealand, Australia, and South Korea as the RCEP provides the framework for a more “enabling investment environment in the region.” This step is also necessary to lessen Indonesia’s dependence on Chinese investment.

Finally, it is vital that the government reduce its dependence on Chinese investment by looking for other sources of investment, such as Indian, Russian, Saudi Arabian. Emirati, Qatari, or even Turkish investments, as well as looking for opportunities in the G7-made Build Back Better World Initiative and also investment opportunities under the umbrella of the Quadrilateral Security Dialogue. However, one could argue that gaining investment from the West is quite difficult as Indonesia must fulfil certain anti-corruption, human rights, and environmental standards. Still, these standards are worthy goals to pursue as stringent anti-corruption, human rights, and environmental standards will benefit the Indonesian people, especially those living near the construction site, in the long run. In addition, to ensure that the investment generates a reasonable return to make the project seem attractive to Western investors, Indonesia must do well to assess the usefulness and the projection of the benefit that the project will bring. Infrastructure project mishaps, such as the Kertajati International Airport in West Java, must be averted and white elephant infrastructure projects must be avoided.

               To conclude, while Indonesia and China hailed its achievement in diplomatic relation, one must also see the growing signs of Indonesian economic dependence on China. This is a big problem as China continues to use its economic relationship with other countries as a political economic weapon to achieve Chinese goals, often at the expense of its partner. Thus, it is important for Indonesia to be able to withstand this coercion by diversifying its economic relations. The solution that can be implemented by Indonesia includes restricting the export of raw materials, utilizing the ASEAN Free Trade Area, and taking advantage of the RCEP. The solutions offered are by no means exhaustive. However, it provides several ideas into what Indonesia can do to lessen its economic dependence on China so that Indonesia can remain independent in upholding its national security, sovereignty, and territorial integrity.

Trystanto Sanjaya
Trystanto Sanjaya
S.I.P (Political Science Bachelor) Candidate Department of International Relations, Faculty of Social and Political Science, Universitas Gadjah Mada