In the 19th century, the Peruvian economy was riding high as the country had an abundance of guano, a substance used for fertilizer. However, in 1909, Peru’s edge vanished overnight as German scientists found a way to create ammonia artificially, which enabled them to produce fertilizers on a large scale. Similarly, in the 1970s, rubber was an important pillar for the Malaysian economy. When other countries discovered and commercialized synthetic rubber, it delivered a significant blow to our neighbor’s economy.
The story of guano, rubber, and many other commodities offers a cautionary tale for resource-rich countries including Indonesia, which has come to dominate the global nickel market. Nickel is neither guano nor rubber, and it is arguably more critical compared to many other commodities. Nonetheless, nickel is not immune to the obsolescence described above, given that EV battery manufacturing may shift to a different technology that requires less nickel.
This possible scenario doesn’t undermine the idea of “downstreaming,” the Indonesian government’s policy of adding value to its abundant natural resources, including nickel, but it does demonstrate that the need to do so more effectively. The policy’s economic benefits so far have been unmistakable. Downstreaming has led to windfalls in exports and investment, as well as double digit economic growth, in some Indonesian regions.
Moreover, beyond the macroeconomic statistics, downstreaming has been remarkably meaningful to the lives of many people. Tens of thousands of people in regions far from the country’s economic center, who used to be unseen and unheard of, are now clearly better off thanks to downstreaming. For instance, the average workforce income in Morowali and Halmahera, two of the downstreaming epicenters, was respectively 54 percent and 13 percent higher than the national average in 2022. For Indonesia, backpedaling on downstreaming policy would be akin to shooting itself in the foot.
In this regard, President Prabowo Subianto, who took office on October 20, was right to decide that downstreaming would continue to be a priority in his administration. There are areas of needed improvement where the government already has tools at its disposal. For instance, there are existing regulations on environmental protection and workers’ rights that the government should enforce better.
Nevertheless, tinkering at the margins is not enough. In order for downstreaming to live up to its utmost potential as an engine of transformative development, and to avoid Indonesia falling victim to technological changes, a paradigm shift is needed. Notwithstanding downstreaming’s positive impact, Indonesia’s role in the downstreaming ecosystem is still largely confined to the supply of ores, whereas the technology of the downstream industry remains monopolized by foreign investors. This status quo is untenable.
As highlighted in the World Bank’s 2024 global development report, in order to break free from the middle income trap, developing countries need more than investment they also need “infusion” – namely the spread of foreign technology throughout the domestic economy. Without infusion, investment’s effects toward long-term economic transformation will eventually run its course. Seizing technology would also future-proof our downstream industry. Although in the future EV batteries may need less or even no nickel at all, with technology, Indonesia would still have what it takes to manufacture EV batteries.
Again, this does not mean that Indonesia should abandon downstreaming; it means that the government should take it to the next level. Indonesia should harness downstreaming as a springboard for its people and enterprises to master the technology of downstream industries. In “Downstreaming 2.0,” Indonesian people – not the nation’s resources – should be in the driver’s seat.
Contrary to conventional wisdom, the infusion of technology is not only about R&D. What is needed is not just innovation, which many Indonesian researchers have proven to be quite capable of generating, but the commercialization of innovation including foreign technology. To that end, domestic enterprises are vital as the vessels of commercialization. The problem is, companies would rather stay in their comfort zone than diversify into new high-tech sectors. In the economic literature, diversifying into new sectors is replete with various market failures including information and coordination externalities. Thus, government’s intervention on this front is warranted.
For diversification to flourish, financing support is key. Based on the World Bank’s 2023 survey, access to financing is the biggest constraint on business in Indonesia. In the market, capital tends to be short-term oriented as risk-averse investors are keen to get quick returns. Thus, the government could strive to provide “patient” capital for companies to diversify, the kind of capital that the market is often not able to offer. This patient capital may include concessional long-term loans or equity injection for domestic companies that demonstrate their potential to be competitive in the new downstream industry sectors such as nickel refining or EV battery manufacturing. The policy should come with stringent evaluation and conditionalities, and companies that are unable to meet certain targets such as regarding investment or production must be cut off from government support.
This patient capital policy is something that the East Asian tigers often resorted to. For instance between 1962 and 1985, 58 percent of South Korean bank loans were concessional loans that the government directed toward strategic manufacturing sectors. With this patient capital and many other government supports, many Korean conglomerates eventually diversified, including Hyundai (from construction to automobiles), Samsung (from sugar-refining to electronics), and LG (from cosmetics to electronics).
This policy might draw flak from those who believe that government should get out of the way. But the criticism rings hollow at a time when many countries, developed and developing alike, are now embracing a proactive industrial policy. Furthermore, the criticism defies the reality that for many decades Indonesian companies have not diversified adequately from the country’s traditional sectors. Without a policy breakthrough, can Indonesia keep on doing the same thing and expect different results?
Downstreaming 1.0 has laid a solid foundation, but it’s time for Indonesia to step it up a gear to Downstreaming 2.0, in which the country’s comparative advantage is no longer only about natural resources but also the ingenuity of its people to make the most of them.