Sustainable Development Impacts of Investment Incentives: A Case Study of the Chemical Industry in Indonesia

Foreign direct investment inflow has assumed great importance for the Indonesian economy, especially after the 1997 economic crisis, as a means of stimulating job creation, poverty alleviation and economic growth. In order to attract foreign investment, Indonesia offers various investment incentives to potential investors. Using the chemicals industry as a case study, this paper provides an overview of incentives and assesses the likely role they have played in attracting foreign investments and generating employment. In addition, a field study of Banten province highlights some of the social and environmental impacts of investments in the chemical sector.

Key findings:

• Indonesia has recently stepped up efforts to attract investors through incentives, with a focus on promoting investments in certain products and regions. FDI in the chemical and pharmaceutical industry is the second largest (after transportation services industry, warehousing and telecommunications), attracting 16 percent of total FDI in 2007, primarily from Singapore, the UK, Japan and South Korea.

• Investment incentives do not seem to have had a major impact on chemical companies' decisions to invest in Indonesia, with other factors, notably the large Indonesian market, having played a more significant role. Nevertheless, foreign investors welcomed the incentives (especially reduced import duties) as a means to cut costs.

• In comparison with other industries such as textiles, and metal, machinery and electronics, the chemical industry does not provide as many employment opportunities. Most technologies and inputs are imported, limiting opportunities for backward linkages to the wider economy.

• Communities in Banten province welcomed the infrastructure improvements brought by the chemical industry and the indirect jobs created to service the industry. However, direct employment opportunities remain limited for local residents due to low levels of education.

• The chemical industry is the main polluter in Indonesia. In Banten, foreign chemical companies generally outperformed their domestic counterparts in terms of environmental performance. Some residents raised concerns over air and noise pollution, but felt that such effects were within tolerable limits.

Key recommendations:

• Foreign direct investment as a source of foreign capital inflow is important in fostering economic growth. The Government of Indonesia has many tasks to accomplish if it is to enhance its attractiveness to foreign investors, including improving legal certainty and investment security guarantees, as well as the provision of public services and good infrastructure.

• Incentives and policies should be tailored to promoting the development of input industries for the chemical industry, which would help promote industrialization and, in turn, raise Indonesia's value added. Furthermore, to increase the spillover effect generated by the chemical industry to the local community, human resources must improve.

• The government should increase pressure on the chemical industry to build up their waste processing facilities to reduce the negative impact on the surrounding community. There is also a need for incentives tailored to encouraging better environmental quality in areas where chemical industries carry out their operations.