Indonesian manufacturing and the economic crisis of 1997/98

This study examines the responses of firms in the Indonesian manufacturing industry to the deep economic crisis in 1997/98. It utilises a rich annual data set on medium and large plants in the manufacturing industry from 1993 to 2000, which covers the high-growth pre-crisis period, the peak of the crisis and the early recovery period. Three aspects of the responses are the focus of this study: general performance and survival, export-supply response and firmentry response. The study begins with an overview of the development of Indonesian manufacturing in the three decades leading up to the 1997/98 economic crisis and the crisis period. This is followed by a summary of the crisis and a review of the relevant literature to provide a framework for the empirical analysis in subsequent chapters. The descriptive analysis of the impact of the crisis reveals that there is a substantial variation in the plant-level impact of the crisis. The evidence also shows that, while many firms contracted and recorded very weak performance, some actually expanded and improved during the crisis. This variation can be seen even at a very disaggregated level of industry and in the early recovery period. The analysis also shows that the crisis severely affected the demographics of plants. Exit rates, for example, increased to almost double the pre-crisis level during the peak of the crisis. The analysis shows that the firm responses and survival during the crisis were not simply random in nature. It finds that foreign ownership, sales orientation, size, factor intensity and product market competition are the major determining characteristics of the responses and survival. In the econometric analysis, the coefficients of the variables representing foreign ownership and sales orientation consistently show a positive relationship with respect to the various performance variables used in this study. The positive effect of foreign ownership was more significant in the early stage of recovery, suggesting that the role of parent companies was more important during this period. In contrast, the positive effect of sales orientation appears to have been weaker in the early stage of recovery. The analysis also found some interrelationship between some of the characteristics explaining the responses and survival. Several interesting findings emerged. In particular, the effect of sales orientation was higher at plants with a high foreign ownership share and did not necessarily weaken with the extent of plant financial leverage. The study extends to the investigation of factors determining the success in their export response. It is motivated by the findings of other studies which highlight the weak export performance of the crisis-affected countries, despite the increase in competitiveness from the sharp exchange rate depreciation during the crisis. The results, confirming the earlier findings, point to the characteristics of firms and industry as the determinants of the firm success in their export response. More importantly, the results reveal the significant role of sunk-costs into exporting activities in determining the export response. The descriptive analysis shows a strong trend for plants that were non-exporters before the crisis to remain so during and after the crisis. The econometric analysis reveals that the variables which are related to sunk-costs such as exporting history, an industry’s export intensity, and an industry’s prior export competitiveness are positively related to the probability to export during and after the crisis. In addition to the sunk-costs, the ability to compete in international markets and foreign ownership are the other important determinants. In particular, non-exporters before the crisis found it easier to become exporters in the crisis period if they are more efficient, able to produce goods to international standards and have some foreign ownership share. Finally, the analysis reveals that access to credit is important for successful switching by non-exporters. As for entry response, this study analyses the difference in the determinants of firm entry between the pre-crisis and crisis period. The analysis is motivated by the earlier finding which shows that the rates of firm entry in the industry had not begun to recover by 2000. The analysis provides several interesting findings. The extent of cost-disadvantages faced by entrants appears to have increased during and shortly after the crisis. The competitive pressure among firms also appears to have been much stronger in this period. This particular conclusion is supported by several findings: demand and profit opportunities seem to have become more important, the likelihood for collusive behaviour appears to have fallen significantly and the crisis seems to have pushed some less-efficient firms out of the industry. The crisis, finally, seems to have provided opportunities for some potential entrants, despite the unfavourable economic situation. For example, the results suggest that entry rates rose in export-oriented industries during and after the crisis.