Bill Guerin, Jakarta – Indonesia's prolonged transition to democracy may have distracted it from issues tied to its Association of South East Asia Nations (ASEAN) membership and lessened its political weight and influence there, but after last week's ASEAN summit in Laos, the country's sixth president, Susilo Bambang Yudhoyono, has grabbed the ASEAN free-trade ball and is running with it.

After the ASEAN pact with China was penned in the Laotian capital, Vientiane, Yudhoyono said, "We will move forward with globalization. In the past, we failed to take full advantage of free trade and to curtail or minimize the excesses of globalization. We're not going to make that mistake again."

Indonesia, the 10-member ASEAN's biggest economy, has not only been left behind in the scramble by its neighbors to cut separate bilateral trade deals in the past, but now appears singularly unprepared for the intense competition likely to be unleashed by the free-trade zone with new regional powerhouse China that grabbed world headlines last week.

In a recent study of 60 economies by the World Competitiveness Yearbook, Indonesia was ranked last of 15 Asia-Pacific countries. Poor human resources and the associated poor productivity will leave Indonesia exposed in the expanded regional markets of the grand alliance, the study added. Almost 70% of the country's workforce are only elementary and high-school graduates, or school dropouts. Greater levels of competition may also lead to bankruptcy for inefficient companies, both state-owned and private that have hidden safely behind protectionist barriers in the past.

Diversity in unity

Indonesia's national motto is "Unity in Diversity", but it is difficult to imagine a more diverse lot than its fellow ASEAN members. Democracies in Indonesia, Malaysia, Thailand and the Philippines; a military dictatorship in Myanmar; an absolute monarchy in Brunei, a country whose wealth is solely based on oil; communist regimes in Laos and Vietnam, and free-wheeling capitalism in Cambodia. These link together in the same trade deals as tiny, wealthy Singapore, the only truly developed country, but too small to dominate regional trade.

Trade agreements locking in countries with such vastly different levels of productivity cannot bring manna from heaven for all. When the promised growth is not forthcoming for some weaker nations, protectionism could lure them back into their safe bolt holes, far from the madding crowd of free trade.

According to ASEAN statistics, average per capita gross domestic product (GDP) among ASEAN's four poorest nations – Cambodia, Laos, Vietnam and Myanmar – in 2003 was US$356; that of Brunei, Indonesia, Malaysia, the Philippines, Singapore and Thailand was $1,626. Singapore's Senior Minister and former premier Goh Chok Tong pointed out last week that the Middle East's combined GDP exceeds ASEAN's.

A McKinsey report commissioned by ASEAN highlighted a lack of integration, non-tariff barriers and disparate policies that favor competitiveness of single nations at the expense of the group as just some of the problems. "Companies would rather pay more than put up with the red tape and delays that they would encounter if they applied for preferential treatment under AFTA [ASEAN Free Trade Area]," Goh, Singapore's then-prime minister, told regional business leaders in Bali in October before China was formally signed up. "It makes ASEAN uncompetitive," he said. "ASEAN must be disciplined in the implementation of agreements."

The diverse economic circumstances of ASEAN's member countries highlight another problem. "Even if China can reach a common understanding with ASEAN as a whole, the varying interests of its member countries and the different social and economic developments may impede ASEAN members to have consensus in most issues," warns Professor Zhao Zhongxiu, an international trade guru at a Beijing University.

All roads lead to China

China entered the World Trade Organization (WTO) less than three years ago, but now accounts for a large slice of the global market. Its growth has been the engine the region needed after Japan drifted into deflation in the 1990s. In the first eight months of this year alone total trade volume between China and ASEAN was $65.60 billion, up 37.5% over the same period last year. Imports from the grouping amounted to $39.66 billion, leaving Beijing with a deficit of $13.72 billion.

China is Indonesia's fourth-largest export market – after Japan, the United States and the European Union – and takes oil and gas, coal, rubber, timber, pulp and paper, palm oil, organic chemicals, fish, electronics and steel. Trade between the two steadily increased to $10.2 billion last year, giving Indonesia a tidy $1.27 billion trade surplus on the year's trading.

The ASEAN-China pact aims to bring tariffs below 5% in most of the 11 countries by 2010, but excludes thousands of "sensitive goods", many of them major items such as cars, steel and sugar. Restrictive non-tariff barriers are excluded from the deal. The four poorest ASEAN members have been given an extra five years to come on line.

By lowering tariff rates, ASEAN expects to force industries into boosting their trade competitiveness and lure foreign investment back into the region. Proponents of the giant free-trade area (FTA) claim it will mitigate China's competitive impact on the nations of ASEAN, as collectively they stand a better chance of competing against the might of China than if they try to compete individually.

The free flow of production goods among ASEAN countries is attractive to companies wanting to set up a global production base, they argue. China, the world's seventh-largest economy, is attracting billions of dollars in investment that could have gone further south, in theory, but perhaps not to Indonesia.

Strong commitment by Indonesia

Yudhoyono, speaking at the ASEAN summit, declared, "A country where property rights are absent, trade policies are highly restrictive and corruption is rampant, is unlikely to enjoy rapid economic growth." Could he possibly have been describing Indonesia? "Governments, and I am speaking for my own country as well, need to increase the efficiency of all economic transactions in the region," he went on, delivering a strong message about Indonesia's commitment to free trade and open investment.

To make good on this grand commitment he will have to alter Indonesia's domestic business climate, so businesses can operate efficiently, by remedying many of the failings that have slowed economic recovery and discouraged investment: corruption, legal uncertainties, inflexible wage policies and worker-friendly labor laws that cause conflict and rising labor militancy, all wrapped up in a poor economic infrastructure.

Numerous levies imposed by regional governments and the widespread practices of extortion by local officials have greatly increased since the implementation of the autonomy law three years ago, and high interest rates demanded by local banks, even those few who agree to lend, are further obstacles to manufacturers. Lending rates in Indonesia are around 16%, while rates in Malaysia, Thailand and Vietnam average 6%.

APEC and the WTO

The Asia-Pacific Economic Conference (APEC) was formed in 1989 to advance cooperation among Asia-Pacific economies as fears grew that protectionism would increase when the old General Agreement on Tariffs and Trade was phased out in favor of the WTO.

Home to the 1994 Bogor Conference and the lofty goals set by APEC 10 years ago to fully open trade by 2020, Indonesia has been actively lobbying for better access for the developing world in WTO talks.

Major developed nations have frequently invoked the "injury clause" permitted under WTO rulings that effectively permits protectionism when industries and jobs are threatened by the scale of specific imports. Indonesia plans to increase its use of the mechanism to protect its industries and workers

The 21 APEC economies, including Indonesia, already account for around 60% of global trade, but once prospects for reviving the Doha round faded after the meeting in Cancun, Mexico, last year, APEC members boosted trade prospects through a series of bilateral and regional free-trade deals. Indonesia did not follow suit.

Last year's Singapore-US trade pact acted as a catalyst for other ASEAN members to seek similar agreements with the US and other countries outside ASEAN, such as Japan, Australia and India. Thailand is in the process of setting up its own FTA with the US, while Malaysia has decided to proceed with initial negotiations for a US-Malaysia FTA. Indonesia is not even on the starting grid yet.

Most of the other ASEAN countries, unlike Singapore, have major agriculture sectors, which they need to do their best to protect. The agriculture sector stalls free-trade negotiations because the US is the world's largest exporter of agricultural products and protects its farmers by preventing farm products from Indonesia and other ASEAN countries from expanding their presence in the US market. Broader market access for other manufactured products from Indonesia will only be granted if Indonesia concedes more market access to US agricultural products.

US trade representative Robert B Zoellick, when inking an FTA with Bahrain in September, said "a contest for the soul of Islam" is raging, and "we can help" by striking trade deals that generate jobs and reduce poverty. Indonesia is still waiting. The US has so far showed little interest in Indonesia's importance as the largest economy in the region, preferring instead to sign the trade pact with Singapore and another one with Australia.

Nonetheless, the US is still Indonesia's second-largest trading partner, after Japan, with a healthy bilateral annual trade of around $12 billion.

Japan invests in Indonesia

Indonesia is the biggest recipient of Japanese aid after China. In his first meeting with Yudhoyono, Prime Minister Junichiro Koizumi pledged more investment and economic support to provide "full cooperation in developing the country's economy under the new president". The two agreed to set up a new business and government forum to help improve Indonesia's investment climate.

Spurred by rivalry with China, Japan's campaign to sign free-trade pacts with its Asian neighbors gathered momentum in Vientiane. It already has a pact with Singapore, which excludes agricultural products, and is negotiating agreements with Malaysia, Thailand and South Korea, though not yet with Indonesia.

Japan and the Philippines also are on the verge of a major accord, which will be Japan's first FTA with an Asian country to address the politically sensitive matter of farm tariffs. According to Japanese media, the two sides have already agreed that Tokyo will slash its tariffs on bananas from the Philippines and reduce its barriers to tuna and poultry from the country. The issue of Japanese tariffs on sugar, which protect farmers in southern Japan, was set aside for discussion in four years' time.

Japan and ASEAN plan to negotiate architecture for a comprehensive economic partnership by 2005. It would cover free trade in goods and services, investment facilitation, labor movement, human-resource development and overall development cooperation. Officials from ASEAN and Tokyo said tariff-cutting talks on their Japan-ASEAN trade zone would start in April and be wrapped up in two years.

Strong support for free trade

Trade Minister Maria Pangestu, an Australian-educated Chinese-Indonesian economist, and Minister of National Development Planning Sri Mulyani Indrawati are both strong free market supporters. Pangestu thinks any regional agreement should be seen as a stepping-stone toward the "multilateral trading system".

"Facing the FTA is not a matter of whether we are ready or not. The question is, when will we be ready?" Pangestu commented on her return from Laos. She wants Indonesia to "fit into China's fragmented production processes" rather than compete with it head on and is keen on setting up Chinese-style free-trade zones in existing industrial centers.

Chief Economics Minister Aburizal Bakrie, former head of the prestigious Indonesian Chamber of Commerce and part owner of the family's conglomerate, the Bakrie Group, also supports free markets. He says that at the end of the day, the benefits of free trade still outweigh the risks and argues that the 1997 Asian financial crisis would have happened all the same, with or without Indonesia first moving toward trade liberalization in the 1990s. Opposition to free trade stems from smaller businesses and labor groups. Dita Indah Sari, leader of the Indonesian Workers National Struggle Front, paints a doomsday ASEAN plus China scenario, warning that if Chinese products flood the market, most small and medium enterprises will face collapse and hundreds of thousands of workers thrown on the scrap heap.

Clothing the world

China excels in manufacturing cheap garments and textiles, once the major export revenue earning enterprise in Indonesia. When international textile and apparel quotas expire on January 1, China's textile industry may flood world markets with cheap goods. Some WTO countries are expected to continue imposing protectionist measures, further damaging recovery prospects for Indonesia's textile producers.

When the quota phase-out was first agreed to in 1995, during the Uruguay Round of trade talks, China did not figure in the equation. Now, warns Neil Kearney, general secretary of the International Textile, Garment and Leather Workers' Federation, "China has the capacity to clothe virtually the whole world at the present time. Its textile industry is like a tap that is about to be turned on to full strength."

No pain, no gain

Export wise, Indonesia is doing surprisingly well at the moment. Exports account for a fifth of its $208 billion economy and could hit a record $65 billion this year. Third-quarter exports rose 19.9% from the same period a year ago, and 12.3% from the previous quarter, amid soaring oil prices and sales of palm oil, nickel and coal to Japan and China.

Yudhoyono has no doubts about the need for ASEAN to deepen its integration into a single market. "Why?" he asked. "Two words: India and China." If his administration can boost exports even further and increase market share in the ASEAN single market and the ASEAN-China mammoth, it may eventually deliver greater wealth for Indonesians. But in the short term, the shocks could be very sharp and painful.

As Goh pointed out to a US-ASEAN Business Council seminar in Singapore last week, integration and change are not just economic requirements for ASEAN. They are necessary for survival, he said. And not to change means being thrown out of the economic arena by powerful centrifugal forces generated by China's and India's growth.

[Bill Guerin, a weekly Jakarta correspondent for Asia Times Online since 2000, has worked in Indonesia for 19 years in journalism and editorial positions. He has been published by the BBC on East Timor and specializes in business/economic and political analysis in Indonesia.]