The Impact of Local Content Requirements on the Indonesian Manufacturing Industry

Abstract

Local content requirements (LCRs) are prohibited under the WTO law as they violate several WTO provisions including the national treatment principle. Nonetheless, many countries, including Indonesia, persistently use LCRs as part of their industrial policies. Countries implement LCRs for various reasons, including to protect local industries; to create employment; to boost export; to enhance local innovation capacity; and to support broader economic development in the country. This paper examines the impact of LCRs in manufacturing sector in Indonesia, with a particular interest on the machinery and transport industries. Since LCRs discourage foreign imports, hence it is expected they may affect firm’s use of imported inputs. The paper uses the Indonesian manufacturing census data, covering the period of 1990 to 2013. It finds the persistence impact of imported inputs on firms’ level of productivity, value added, output, export, and employment on the manufacturing sector in Indonesia. Our main finding indicates the ineffectiveness of LCRs in terms of reducing firm’s dependency on imported inputs. Given this finding, any unreasonably too restrictive LCRs may adversely affect industrial performance and thus its competitiveness.