Indonesia: A new Indo-Pacific partner?

This is one of the reasons why Indonesia has been growing at an average annual rate of around 5 per cent for two decades and has also coped surprisingly well with the crises of recent years. The infrastructure, such as roads and the railway network, but also the digital sector, has been greatly expanded. Widodo has prioritised economic interests and shown a great deal of enthusiasm for reform. This course has supported growth, even if various challenges remain, for example in the education sector or with regard to corruption.

With a population of over 277 million people, Indonesia is an important country in the Indo-Pacific region. This region plays an important role for the European Union (EU) when it comes to reducing its critical dependencies on China by diversifying its trade relations. However, Indonesia cannot replace China due to its limited economic importance. This is because the EU's trade with Indonesia only accounts for around 4 per cent of the EU's trade with China. Nevertheless, more economic exchange with Indonesia is an important building block for the de-risking from China that the EU is striving for. In addition to Indonesia, other countries in the Indo-Pacific region, Latin America and Africa must also be included in the EU’s de-risking strategy.

There is great potential in mutual trade between the EU and Indonesia. This is because the comparative advantages between Indonesia and the EU are very different: While Indonesia is specialised particularly in agricultural goods and raw materials, the EU’s specialisation lies in sophisticated industrial goods. In fact, estimates by the European Commission show that a free trade agreement between the EU and Indonesia could increase EU exports to Indonesia by up to 44 per cent in the medium term, while EU imports from Indonesia could increase by 18 per cent. An increase in trade with Indonesia of around 25 per cent, for example, could thus compensate for a fifth of an assumed 5 per cent decline in EU trade with China, which may result from de-risking vis-à-vis China.

At present, however, this potential cannot be realised because:

• Indonesia and the EU each impose relatively high tariffs on precisely those goods where the other partner has comparative advantages.
• Indonesia has already concluded free trade agreements with other Asian countries – especially China – so that the EU suffers from strong trade diversion effects because EU players are discriminated against in trade.

China in particular benefits from trade diversion in its favour and to the detriment of the EU. China has a similar trade specialisation in industrial goods as the EU and is therefore in close competition with European companies. This has contributed to China's large gains in exports and imports with Indonesia. China's share of Indonesia's total exports has risen from 11.4 per cent in 2012 to 22.6 per cent in 2022. On the import side, China's share was 15.3 per cent in 2012 and 28.5 per cent in 2022. In addition, China's investment in Indonesia as part of the Belt and Road Initiative is contributing to a further increase in trade with Indonesia.

In contrast, the importance of the EU as a trading partner for Indonesia has continued to decline over the last decade. Indonesia has also lost relevance from the EU's perspective: Between 2012 and 2022, Indonesia's share of total EU imports stagnated at around 0.35 per cent because imports from Indonesia grew less dynamically than EU imports as a whole. On the export side, the picture is even more alarming: While Indonesia's share of total EU exports was still 0.22 per cent in 2012, this share fell to just 0.13 per cent by 2022. During this period, the absolute value of EU exports to Indonesia barely increased. German exports to Indonesia even fell by around 5 per cent between 2012 and 2022.

The picture is similar for foreign direct investment. Between 2015 and 2022, the stock of foreign direct investment from the EU in Indonesia fell in absolute terms from around 47 billion euros to around 29 billion euros. This contributed to a significant decline in the EU's share of foreign direct investment in Indonesia. China, on the other hand, was able to increase its share from 2.2 per cent to 6.5 per cent during this period.

In terms of trade and foreign direct investment, the opposite of diversification with Indonesia has taken place in the last decade. From the EU's perspective, Indonesia's share should have increased for this to happen. Figuratively speaking, the train of diversification with Indonesia is not travelling forwards, but even backwards.

The EU should therefore urgently strive for a free trade agreement with Indonesia, which would make it possible:

• to exploit the trade potential indicated by the respective comparative advantages,
• to stop trade diversion to the detriment of the EU,
• to slow down China's advance in Indonesia by significantly increasing EU trade with Indonesia.

In addition, European companies should pay more attention to Indonesia and the opportunities available there. This should be flanked by trade and investment policy agreements in order to make the local investment conditions sufficiently attractive. This also requires economic partnership agreements with Indonesia that provide for the establishment of EU companies in Indonesia. In this respect, export processing zones, i.e. less regulated regions in which multinational companies can settle, should be considered.

In order to implement such agreements, it is important to understand that there is a clear convergence of interests between the EU and Indonesia: The EU has an interest in supporting industrial and technological development in Indonesia in order to promote Indonesia's role as a growing trade and investment partner, both for exports and imports. For example, the EU could work with Indonesia on de-risking by helping Indonesia to develop large-scale battery production for electric vehicles and possibly also in the solar panel production. These endeavours are also entirely in Indonesia's interests.