Indonesia’s incomplete industrial strategy

Industrial policy has come back into vogue in recent years. But simply reviving old approaches will not be enough to achieve the outcomes countries are seeking, especially within an increasingly high-tech global economy. Indonesia is a case in point.

The most populous country in Southeast Asia, and a prominent member of the Association of Southeast Asian Nations, the G20, and the BRICS grouping of major emerging economies, Indonesia has been working hard to lay the groundwork for long-term development. This has included a concerted effort to leverage its natural endowments – including 42% of the world’s nickel reserves, as well as substantial reserves of copper, gold, and tin – to support industrialisation.

By banning the export of unprocessed nickel (nickel ore) – first in 2014 and, following a loosening of restrictions, again in 2020 – the government sought to attract foreign direct investment (FDI) into domestic processing facilities, thereby spurring job creation and increasing local value-added. The plan worked. Major Chinese firms like Tsingshan, Huayou Cobalt, and Contemporary Amperex Technology Co., Limited (CATL), as well as French and South Korean companies, poured investment into Maluku province and Sulawesi island. In 2023, Indonesia was the largest recipient of investments linked to China’s Belt and Road Initiative, with most of the $7.3 billion directed toward Indonesia’s nickel smelters alone.

As a result, Indonesia’s share of the global refined nickel market grew from 23% to 27% between 2020 and 2023, and the country now accounts for more than 50% of global nickel production. Moreover, local value-addition has increased sharply: whereas Indonesia was initially exporting a low-grade input known as nickel pig iron, it now produces refined mineral products, including nickel sulfate, thanks largely to Chinese FDI. This has enabled the rapid emergence of an ecosystem for even higher value-added activities – namely, electric-vehicle (EV) and battery production.

But critical gaps and inconsistencies continue to burden the effort to enhance local production of these high-value-added goods. In 2019, Indonesia’s government began discouraging imports of fully assembled EVs, in order to give an advantage to domestically assembled EVs, which used locally produced NCM (lithium, nickel, cobalt, and manganese) batteries. Thanks to high import taxes and other restrictions, sales of EVs produced in Indonesia by the South Korean company Hyundai began to rise.

In December 2023, however, Indonesia’s government began issuing exemptions to companies planning to establish local manufacturing plants by 2026. China’s BYD was among the firms that took advantage of the exemption, and its vehicles – which use LFP (lithium, iron, phosphate) batteries – soon began to gain a foothold in the Indonesian market. Sales of Hyundai’s IONIQ 5 dropped from 7,176 units in 2023 to just 1,561 units in 2024. BYD’s Indonesian manufacturing plant is still under construction.

As for EV-battery production, Indonesia lacks the capacity to produce cathode materials – a critical intermediate input, comprising cobalt, nickel, and manganese. That means firms must export refined nickel from Indonesia, produce the cathode materials elsewhere, and import them to complete battery production. While an LFP cathode facility was inaugurated in October 2024, and two foreign companies have agreed to build a nickel cathode plant, uncertainty around the EV market continues to haunt such projects.

But perhaps the most glaring gap in Indonesia’s industrial strategy is that the incipient value chains are controlled largely by foreign companies, and no policy has been proposed to change this. When Malaysia’s government sought to increase the value-added of its palm-oil sector, it not only introduced export taxes on unprocessed palm oil – production of which had been controlled by British firms – but also promoted local ownership of the processing systems that emerged.

The same cannot be said of Indonesia. The ban on nickel-ore exports has not been complemented by any provisions to promote the involvement of locally-owned companies, such as through joint ventures with foreign firms or domestic firms producing with licensed foreign technologies. The same is true of the plan, announced by Indonesian President Prabowo Subianto last year, to attract $600 billion in investment in sectors like renewable energy, fisheries, oil and gas, agriculture, and mining to increase output of high-value products.

To see the problem, consider the authorities’ effort to boost local production of mobile-phone components. Indonesia currently requires local production of 40% of the “content” of smartphones and tablets sold in the country. Last year, after it banned sales of Apple’s iPhone 16 for failing to meet this standard, the company announced that it would consider investing in local production facilities. But, even if these investments materialise, Indonesia has put forward no strategy for promoting the involvement of local firms.

To be sure, Indonesia is also restricting imports of light manufacturing products to protect local small and medium-size enterprises (SMEs) from foreign competition. For example, it has banned online shopping on social-media platforms, and plans to impose tariffs of up to 200% on a range of Chinese goods, including textiles and cosmetics. But here, too, there is a problem: such protections cannot be maintained forever, and Indonesia has not taken any steps to enhance SMEs’ technological capabilities so that they can compete when the walls come down.

Ultimately, Indonesia’s industrial strategy is well-intentioned but incomplete. Most of its components will do little more than attract traditional FDI. This can work for advanced economies: the United States, for example, is seeking FDI to bolster its semiconductor industry, but all the elements of the value chain – design, software, fabrication, and marketing – are already in place, and controlled by US companies. In Indonesia, however, this approach will leave local value chains under foreign ownership.

No economy has achieved high-income status without generating some critical mass of locally-owned big businesses. Indonesia’s leaders envisage a sovereign, advanced, fair, and prosperous country by its centennial in 2045. Realising that goal will require going beyond requiring local content to requiring local ownership.

Keun Lee, a former vice chair of the National Economic Advisory Council for the President of South Korea, is Distinguished Professor of Economics at Seoul National University, a fellow at CIFAR, an editor at Research Policy, and the author, most recently, of Innovation-Development Detours for Latecomers: Managing Global-Local Interfaces in the De-Globalization Era (Cambridge University Press, 2024).

Marco Kamiya is United Nations Industrial Development Organization Representative for Indonesia, Timor Leste, and the Philippines.