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His Excellency, The AmbassadorDr. Isamel M. ThajebDr. S. SurjotjondroDr. Zairin Zain

Mr. Djoko SoerotoMr. Usodo NotodirdjoDr. D. W. RengersMrs. Jo Kian TjayMiss R. A. Oetoyo

Center for International Studies

Dr. Benjainn HigginsDr. Douglas Paauwliss Priscilla Moulton

Mr. John RodriguesDr. Eugene GrasbergDr. Guy PaukerDr. Sioma Kagan

Others

Professor Everett Hawkins, Mt. Holyoke CollegeMr. A. Natanagara, Consul General, Republic of IndonesiaMr. Basri Hasnam, Consul, Republic of IndonesiaDr. Soetikno Slamet, Alternate Governor, International Monetary FundMr. Trasno Kaliprogo, Bank IndonesiaMr. Sujud, United Nations

Economic De velopientIndonesian ProjectDocument Control #C/55-5Douglas So Paauw

NOTES ON A !ING OF THE INDONESIAN Et!BASST AND THECENTER FOR INTERNATIONAL STUDIES

DECEMBER 20-21, 1954, WASHIITON, D. C.

PARTICIPANTS

Indonesian gasa

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1

Documentation

The following papers were circulated prior to the meeting:

Dr. Benjamin Higgins"Encouragement of Foreign Investment in Indonesia" and Supple-

mentary Remarks."Encouragement of Foreign Investment in Indonesia: Supplement II.

The Report of the Canadian Advisory Comittee on OverseasInvestment".

"Foreign Investment in Indonesia: Supplement III. Factorsimiting American Foreign Investment".

Dr. Eugene Grasberg"Indonesia's Investment Requirements"

In addition, an outline of the proposed study of the Standard-VacuumOil Company in Indonesia and a questionnaire for the Center study offoreign investment in Indonesia were circulated for discussion.

FIST SESSION*

The discussions were chaired by Dr. Benjamin Higgins, Director,Indonesian Project, Center for International Studies. Documentationand discussion focussed on conditions affecting foreign investment inIndonesia. The first item of discussion was concerned with the totalcapital needs of the Indonesian economy. Dr. Eugene Grasberg wasasked to sumnarize his conclusions and to present his recent refine-ments on his study of investment requirements. It was pointed outthat the amounts of capital required to produce significant increasesin per capita consumption are very great in terms of Indonesia'spresent rate of domestic investment. It was agreed that annual invest-ment of the order of Rp. 12 to Rp. 15 billion per year would be neededto raise per capita consumption by one or two percent per annum. In-vestment of this magnitude is perhaps double or triple the current ratenow taking place in Indonesia. This underscores the necessity forattempting to induce a flow of of foreign investment in order to reducethe amount of domestic sacrifice necessary to make economic progress.

A member of the Indonesian representation suggested that this typeof analysis is indeed useful in providing background for discussion ofthe foreign investment problem in Indonesia. However, he stressed thefact that the enlistment of the support of the Indonesian governmentand the Indonesian people to foster a program designed to attractforeign investment is a major problem. He suggested that the dis-cussions at this particular meeting might center around this generalissues What steps can be taken to make foreign investment moreacceptable to the Indonesian nation, while at the same time makingconditions of investment attractive to potential foreign investors?

1. I wish to thank Miss Priscilla Moulton for painstakinglyrecording these discussions as they took place and in assisting me inputting them together in meaningful sequence.

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This task involves demonstrating to the Indonesian people that a newconcept of foreign investment need not imply exploitation. Also, aclear and explicit foreign investment policy on the part of theIndonesian Government should be formulated Yet another requirementis a strong executive agency powerful enough to undertake necessarynegotiations and to effectively administer the program designed toinduce the flow of foreign investment.

The chairman agreed that this issue was most pertinent fordiscussion. He indicated that the original approach from the quantita-tive side had been intended only to set the sights as to the scale offoreign investment which might best fit Indonesia's developmentalneeds0 The first objective is to determine how large the job is 0There is agreement that investment must be increased several fold.Some of this increase could be obtained at home. However, in lightof the low level of private investment now taking place in Indonesia,it appears that an effective developmental program which would notinvolve sacrifices beyond the capacity of the Indonesian economy wouldrequire some external financing. Such external financing wouldideally be partly in the form of foreign investment and partly in theform of foreign aid.

An Indonesian representative asked whether the Center for Interna-tional Studies could, at the present stage of its research, providea rough estimate of the amount of foreign aid and investment whichwould be required to round out an Indonesian development program.A member of the Center team answered that on the basis of Dr. Grasberg'sestimates of the capital requirements of the economy and Dr. Paauw'srecent estimates of current investment resources, it appeared that aminimum of $1 to $2 million (roughly Rp. 1 to 2 billion) in foreigncapital would be required.

An Indonesian speaker indicated that in his opinion the Indonesiannation is not yet mature enough for a completely rational acceptance offoreign investment. The problem, therefore, is essentially one ofconstructively molding public opinion in Indonesia. How can this bestbe done? It was suggested that the government might first undertake aprogram of domestically financed investment. It would then becomeclear to the Indonesian people that the rate of economic progresscould be increased and the economic cost of development reduced ifforeign investment on a considerably expanded scale were accepted,Another Indonesian participant pointed out that awareness of thenecessity for foreign investment is growing among the Indonesianpeople, with the exception of the left win, which does not representthe dominant opinion. Indonesia's development depends in part oninducing a flow of foreign investment and highest priority should begiven to educating the Indonesian people more broadly on this score.As stated previously, the Government should assume the leadership byissuing a clear statement expressing its attitude toward foreigninvestment. Further research is needed on the question of what sectors

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are now remeative to foreign investment anid what can be done toimprove conditions for investment in those which are not now favorable.When foreign firms are adding to the productivity of the Indoresianeconomg, they should be given the right to transfer their gains. Itis also importent that Indonesians be granted a greater sense Qfresponsibility in the operation of foreign enterprises. To the extentthat qualifications exist in Indonesia, management and operation offoreign firms should be placed in Indonesian hands.

A Center participant inquired about the current status of Indonesiandraft legislation on foreign investment. Specifically, he askedwhether or not the forthcoming legislation intended to define certainfields of enterprise as open to foreign investors, while closirg otherfields. An Indonesian speaker replied that this was the intention. Inorder to increase Indonesian foreign exchange earnings, the governentintends to limit some fields of development to Indonesian investors.This speaker also mentioned that there is too sharp a gap between thelaws relating to foreign enterprise and those concerned with domesticenterprise. Relationships between the Indonesian Governant andforeign enterprise might better be conducted on an ad hoc basis ratherthan on a more narrowly legalistic basis. Questions pF~inent to theoperation of foreign firms-profit transfers, tax burden, employmentof Indonesian personnel-could then be negotiated with a foreigninvestment board.

An Indonesian representative asked how investors would feel aboutallowing Indonesians to occupy mmnagerial and other important posts inforeign firms, which imply a claim to a share of profits. A Centermember suggested that in his opinion some firms would not object tothis type of ara n, while a limited number might feel that thisprovision was too restrictive. However, he felt that the prevailingview among investors would be a willingness to accept an Indonesianstaff as long as profitable returns could be made on their investment.Few firms will insist on completely foreign owned and managed enter.-prises.

Two Center participants elaborated on their reactions to thesuggestion of negotiating foreign investment on an ad hoc basis. Theyagreed that it would be entirely within Indonesia'Ai to providethis basis for negotiating relationships between foreign firm andthe Indonesian Government. It was believed that foreign investorsfind this approach attractive. Most companies appreciate having roomfor discussion and welcome the opportunity to approach some definitegovernment agency on matters relating to their operations in Indonesia.Hence, it would be useful to have a foreign investment board, perhapswith foreign advisers, responsible for administering the foreigninvestment law. This would provide a place for a meeting of mindson such major questions as profit transfers, taxation, scope ofinvestment and other recurring problems such as land leases, visas,etc. Through such a board a formsla attractive to both the Indonesian

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Goverrnment and foreign investors might be sought. Foreign investmentshould not be strangled but should be encouraged in such a form thatit contributes to domestic Indonesian development. Indonesia shouldretain long-run control of Indonesian resources. Foreign investmentmight operate under the concept of non-permanent concessions todevelop particular industries, while reaping profitable returns oninvested funds. The new concept that foreign investment wouldeventuate as Indonesian industry, intended for Indonesia's owneconomic and political welfare, should be emphasised.

The role of foreign investment in the future development ofIndonesia can be expected to be more similar to the role that foreigninvestment played in development of countries like the United Statesand Canada than to foreign investment in a colonial context. In thecases of both the United States and Canada what began as foreignownership has usually ended as domestic ownership. Yet, even today,mining and power have ingredients of foreign control in Canada. Thissuggests that foreign investment in and of itself under non-colonialconditions should hold no fear.

Another Center representative further elaborated on the old andnew concepts of foreign investment. It was -true that the disappearanceof imperialism left in its wake suspicion that foreign investmentbrings abuse and exploitation. It is only recently that foreigninvestors in newly independent countries have tried to find new formsof investment and engender new attitudes towards such investment.Perhaps the process of natural selection will curtail the operationsof investors not yet disabused of the old philosophy of investment,making room for investors willing to accept the challenge of newconditions, Attitudes toward foreign investment are one of the majorproblems which must be solved in newly independent countries.Technical assistance and its contribution to the development of acountry like Indonesia has by and large been accepted. The nextstep, that of allowing foreign financing to play a part in thedevelopment of the country, is now in the process of being resolved.This resolution, however, implies that the domestic will for develop-ment should replace emotions which are now outmoded in the context ofindependence. It is agreed that the process of development must bebegun through domestic financing. When this is done, the people willsee the necessity for inducing a flow of foreign investment t6 com-plement the domestic program of sanrifice.

An Indonesian participant pointed out that this implied thatIndonesians and foreign investors should seek to understand the aims,purposes and values of each other. Since backgrounds are different,the basis for an understanding should be sought through what oneauthority has called "cultural mediation". There are many points ofmutual interest which suggest that mutually advantageous terms canbe concluded.

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In response, a Center speaker suggested that this implied thatforeign investors and students from countries undertaking foreigninvestment in Indonesia should make a serious effort to understqndthe politics and background problems pertinent to foreign investmentin a country like Indonesia. Efforts of the Indonesians to convert acolonial economy into a national economy should receive full sympatdyand understanding. The relationship between the standard of living andforeign investment should be made more explicit if planning for economicdevelopment were undertaken partly on a decentralized basis. This wouldallow people to see that economic progress requires local sacrificeand that the local burden could be reduced by financing developmentthrough inflow of foreign capital. These more positive attitudes, itwas painted out by another Center speaker, might be further engenderedif Indonesians were convinced that the development program was pre-dominantly Indonesian in flavor. As it became recognised that foreigninvestment was only a complementary factor in a mach larger Indonesiandevelopment program, Indonesian fear of foreign economic dominationmdight well subside.

SECOND) SEMSON

An Indonesian speaker opened the discussion of the second sessionwith a review of some of the most critical economic problem whichhave received government attention during the past few years. $n theearly years of the Indonesian nation, the government made severalattempts to stiwulate the interest of Indonesian nationals in theimport business. After the collapse of the Korean boom, however, itbecame clear that the development of an Indonesian business commuityto handle imports was not as critical as the expansion of exports toprovide foreign exchange for Indonesian development. It was immediatelyrecognised, however, that there are serious problems involved inshort.-run expansion of exports. Hence, the government began to turnits attention to the possibility of obtaining resources throughforeign investaent, but found that prevailing Indonesian attitudeslimited the adoption of aggressive policies designed to increase therole of foreign investment in Indonesia. In the next stage, attentionshifted to the necessity to plan imports in order to conserve foreignexchange for importing comodities essential to economio development.This prompted interest in the question of what goods could be plo.duced domestically. It is felt in Indonesia that small-scale andrelatively light industry are the best short-run solutions to theproblesa of replacing imports by domestic production. Hence, policyhas concentrated on encouragement of this type of industry throughcredit, and technical and organisational aid.

A Center participant suggested that the diversity of resourcesexisting in Indonesia makes it difficult to decide where the problemof developing indigenous industry should first be attacked. This pro--blem is compounded by the fact that during the colonial regime little

6

thought was given to this question. Thin ng was in terms of promotingthe production of exports rather than in term of promoting domesticdevelopment or production for local consumption. As a consequence, eventhe basic studies of the supply of resources for indigenous develop.ment do not exist. This is an important area for current research.Some attention has been given to this question by the natural resourcesexpert in the National Planning Bureau, but further work is needed.Plans for economic development mst be based on assessment of theresources pattern of the econouer. In fact, even discussion of thepotentialities of foreign investment should be related to develop--mental plans based on an appraisal of existing resources.

An Indonesian participant suggested that international agencies,such as the International Bank for Reconstruction and Development, havebeen giving increasing attention to financing the development of small-scale industry in Indonesia.

This prompted further discussion of the role that small-scaleindustry might assume in Indonesian development and its relationshipto foreign investment. A speaker from the Center felt that investmentin smmll-ecale industry could be effective in replacing imports. Highand quick returns on investment in this sector make it attractive forshort-run development objectives. The Center for International Studiesis undertaking a study to investigate the possibility of replacingimports now drawing on Indonesia's limited foreign exchange resourcesby domestic production.

A Center representative opposed this arguing that small-scaleindustry would have difficulty in attracting foreign investAment. More-over, economic development does not consist of proliferation of handi-wcraft industries.

An Indonesian speaker indicated that in his opinion Americanbankers and financiers are not greatly interested in financing small-scale industry which produces for Indonesia's domestic market. Theyare primarily interested in enterprises which produce goods which canbe used in their own country. In effect, this means that they areinterested in expanding the types of industries in which foreigninvestment is now active in Indonesia. Another Indonesian speakersuggested that there are arguments for expansion of small-sealeindustries notwithstanding the objections presented. In the firstplace, expansion of domestic production from these industries iswithin the investment means of the Indonesians. Heavy industryis obviously not within the financing capacity of private Indonesianentrepreneurs. The spirit of development can best be engenderedby small beginnings. Indonesian enterpreneurs must be convincedthat production for the domestic market can be a money maig pro-position. Because of the cheapness of domestic labor, it is believedthat domestic production can compete effectively with importedproducts, in spite of differences in quality. Once this process

7

took hold, the Indonesian people would become increasingly apprecia-tive of the benefits of local industrial development.

A member of the Center agreed with this line of argument. Observa-tion in Indonesia had convinced him that opportunities for profitabledomestic production, aimed at replacing import of consumer goods, wereabundant. It was apparent that these opportunities were already beingrecognised and exploited0 In several areas of Indonesia local govern-ments were engaged in small-scale productive enterprises, which con-sisted of processing goods for export as well as producing a number ofessential commodities for domestic consumption0 This trend should beencouraged by the goverment. As this observer saw it, the problem isthat these opportunities are ordinarily not seized upon by privateentrepreneurs, but go unexploited until some governmental body takesthe initiative in financing or encouraging the project.

Another Center participant argued that these small-scale industrialopportunities would not attract foreign investment. Hence, they shouldbe regarded as the logical outlet for private Indonesian capital.Larger scale industrial projects could then be left to foreign andpublic investment. Large-scale production for the domestic marketitself might indeed become an attractive area for foreign investment,A Center speaker elaborated by pointing out further that there is noreason why large-scale enterprise cannot evolve from small-scaleindustrial development, as it has done elsewhere. Indonesia shouldcommence diversified production at the scale which is most consistentwith its present labor, capital -and entrepreneurial resources.

An Indonesian representative suggested that the supply of entre-preneurship is just as short for small-scale industry as it is forlarge-scale enterprise. In response to this statement, a Centerspeaker suggested that the experience of Japan might be pertinent.When Japan began the process of its development it was also short inits supply of entrepreneurs. Yet the Japanese Government undertook toorganize industry on the basis of its own resources. Foreign expertswere imported for technical and managerial functions as well as totrain the Japanese in these roles. As these specialized abilitieswere developed in Japan, industry was turned over from public toprivate ownership. An Indonesian participant agreed that this patternof development would indeed be aopropriate for Indonesia. However, hedoubted whether foreign investment would be adequate to supply thetechnical and capital needs of a program of this type. Because of thepolitical and economic situation in Indonesia, the greater part ofthese costs would probably have to be met from state resources.

Some of the problems of implementing a development program in anewly independent country like Indonesia were emthasised by anIndonesian speaker. One of the most critical of these problems isthe current comrercial philosophy of the group (the merchant, middle-man class) which has the capacity to initiate indigenous development.

8

This group feels independence gave them the prerogative of makingmoney quickly in ventures which do not lead to productive employmentof their capital. This has been accompanied by efforts to transfersuch earnings abroad, putting pressure on the foreign exchange re-serves of the country. Secondly, among the Indonesian populationgenerally there is a demand for more and better quality consumer goods.However, the facilities to produce this type of goods domesticallyare not available in Indonesia, and it is difficult to get them fromabroad. Perhaps it would be a reasonable compromise to begin theproduction of those goods which do not require the most modern typesof machinery. Capital goods for Indonesian domestic developmentmust be adapted to the entrepreneurial and labor skills available inthe country0

A Center participant reiterated his objections to develop-ment with heavy accent on small-scale industry. He pointed out thatin the experience of Eastern Europe industrialisation of small-scaleindustry had little to contribute. Industry continued to producewith rather outmoded, unproductive methods, making little technologicalprogress* It was only when large-scale industries were introduced thatmore productive and efficient methods began to be used.

Issue was taken against this point of view0 It was pointed outthat even at the present stage of development in the United States, small-scale industry plays a very crucial role* Moreover, industry of thistype in the United States shows a good deal of initiative and invention.Some of the most fruitful innovations have been introduced at thislevel of industrial organisation. A Center member indicated alsothat there is not necessarily a conflict between large and small-scale industry; in fact, both are essential to economic development.He pointed out that Japanese experience showed that a superstructureof large-scale industry required the support of a diversity of small-scale industries. In Japan a good deal of the initial processing ofraw materials is accomplished through the use of small-scale industry,while large-scale industries serve the function of producing capitalgoods for the economy as a whole, as well as providing other externaleconomies.

The proponent for development through large-scale organisationreplied that most small-scale industry, even in Japan, produces gadgetsprimarily of a consumption nature. This sort of production plays nocritical role in economic development. Exception was taken to thisview and it was pointed out that neither in Japan nor in Indonesiais small-scale production anywhere near the margin in supplying"gadgets" which are essential to the livelihood of the population.An Indonesian speaker warned that the organisation of a large-scaleindustry might be beyond the administrative and entrepreneurialresources of Indonesia at the present moment. On the other hand,these skills are not as scarce in existing small-scale industry.It would be unrealistic to believe that the entrepreneurial talent

E

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available could be transfered to large-scale administration. A Centerparticipant submdtted that Indonesian baning agencies and interna.-tional institutions might be indnced to offer large-seale aid fordistribution to smallscale industries. This would then relatedomestic development on a seale which appears to be mst appropriatefor Indonesia to large-scale internal and external financing.

The chairman of the meeting suggested it aight be iell to turn to adiscussion of Indonesiats draft legislation regarding foreign invest-ment, and to consider the ways in which factors affecting foreigninvestment might best be haxded by legislation, He suggested thatthe question of the whole "olimate" of foreign investment in a tountrylike Indonesia was quite as important as specific legislative re-oamesdations. "Climate" is developed from the experience which all

firms now investing in Indonesia see fit to call to the attention ofthe world at large. The question of discrimination between old andnew firms is important since new investment is related to the em.perience of old firms. Clarification was asked on two particularitems: (1) the extent to which discrimination was implied in thelegislation now being contemplated, and (2) the basis on which thenegotiations between the Indonesian Government and foreign fir= wouldbe carried out. It was again emphasised that foreign investors wouldappreeiate opportunities for ad hoc discussions on relevant points.It is important that foreign rriwabe access to clearly definedchannels of authority to undertake discussions with the government.A secretariat or foreign investment board, adequately empoweredand accepted, might answer these needs. Further, it is importantthat uiformity of treatment be given to all foreign investors, andthat such regulations as the Indonesian Government deems necessaryshould fit the existing conditions for inducing a flow of foreigninvestment. Policies outlined in foreign investment legislation aswell as specific regulations should coincide with actions representingthe real conditions of foreign investment. Though an ad hoc basisfor negotiations is desirable, there is still room fora generalstatement of policy and regulations governing foreign investment.The foreign investment commmity is waiting for an Indonesianpronouncement on these general principles.

The Indonesian reply to this query brought out a number of points,In the first place, it was emphasised that the present draft legis-lation was not intended to provide legalistic regulations but rather toserve as the basis for progressive action to stimnlate foreign invest-ment. The general provisions of the legislation will open the way forad hoc discussions between existing and potential foreign investors

d"Fre Indonesian Government. The creation of a foreign investmentsecretariat representing top government personnel concerned with foreigninvestment is envisaged. This group would have full authority forspecifying in detail the conditions under which foreign investmentwould enter Indonesia. It would have the authority to overrule severalgovernment departments; such as those concerned with imdgration, land

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rights and financial regulations. The recomendations in the pro-posed legislation with regard to these specific points is indeedfavorable. The exact application of the law of course depends on theparticular individuals who are charged with carrying out the decisions,once the law comes into effect. At this point it is impossible topredict how the draft legislation will be received by Parliament.With regard to the distinction in regulations applying to old and newcompanies, the underlying philosopby of the legislation is that allcompanies will be treated the same, if the factors bearing on currentinvestment and investment status ar the same. The problem with re-gard to old investment is that most of the machinery now operatingin Indonesia is obsolete and new investments to replace depreciatedmahinery have not been undertaken. The initial investments whichsupported the construction of the now obsolete capital goods has byand large been repatriated. To the extent that rehabilitation andreplacement of the capital stock of these companies has been under.taken during the postwar period, it has actually been at the expenseof the Indonesian econoey, i.e. on the profits made in Indonesiarather than on the basis of new inflow of capital. Whether or notthis type of investment still has claim on Indonesian foreign awchangeresources for transfer purposes is an extremely delicate question. Itis clear that some investors have no such rights on the basis of oldinvestment long since repatriated.

This point was elaborated by another Indonesian speaker. Oldfirms cannot expect to transfer profits and dividends as they didwhen capital was legitimately being repatriated. If foreign exchangeessentially produced by the Indonesian econosW rather than by foreigninvestment is being utilised for replacement of obsolete and depreciatedfacilities, there is no justification for transferring profits fromsuch "investment". The point was also made that with the great dis..parity between the official and free exchange rates, repatriation atthe official rate is actually a levy on the economy. Hence, repatria-tion and transfer of funds on the basis of old investment no longer .entitled to these claims is a double levy on the econom's resources.

Various suggestions concerning the problem of further repatriationof old investment were made by members of the Center for InternationalStudies. It was agreed that some understanding should be reached withindividual companies as to the value of their investment still subjectto repatriation demand on foreign exchange. It was suggested that thiscould best be done on an ad hoc or expediency basis rather than on thebasis of infledble or legatermination. One of the Center memberssuggested that it night be well to initiate a capital tax which wouldbe applied to old investments. This would make it necessary for thecompanies to give an accurate evaluation of their existing investmentor pay a considerably higher capital levy. Another member from theCenter suggested that the problems of repatriation of prewar invest-ment largely pertained to Dutch investment. It might be best to con-sider this as a separate prolem since actually these transfer arrange-ments are not pertinent to investment now flowing into Indonesia(i.e. primarily from non-Dutch sources).

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THIRD SESSION

The third session began with the submission of the outlinesof the proposed Center-Starac and foreign investment studies for theconsideration of the group. The Indonesian participants, in particular,offered constructive suggestions for the formulation of these studies.In general, it was suggested that the foreign investment questionnairebe rephrased in order to provide the opportunity for responses in-dicating favorable conditions to foreign investment in Indonesia, aswell as those which are considered obstacles to the flow of foreigncapital. With regard to the Stanvac study, a number of speakersemphasized the importance of an objective appraisal. The uniquenessand comanding position of Starvac in the Indonesian econour shouldbe explicitly recognised; Stanvac should not be regarded as a typicalforeign firm. Hence, conparison with foreign firms of similar in-fluence in other economies would be helpful.

The greater part of this session was devoted to the presentationand discussion of a paper by Dr. Douglas Paauw. A revised copy ofthis paper, entitled "Financing Economic Development in Indonesia:A Suggested Program", 1 accomparies these notes.

1. This paper was originally entitled, "Observations on theFinancing of Economic Development in Indonesia".