(financial services). In fact, evidence increasingly suggests that service sector reform is a major potential source of gains in economic performance, including manufacturing productivity and the coordination of activities between and within firms. Efficient, low cost and high quality services generate economy-wide benefits. This is because goods production requires efficient services such as transport and logistics, telecommunications, business services, etcetera.

This paper explored for the Indonesian case, the role that service sector reforms, particularly in the form of reduced restrictions on FDI, played in the evolution of firms’ productivity in the manufacturing sector. We first constructed a service sector restrictiveness index for each manufacturing sub-sector by weighting the OECD restrictiveness index for FDI in the services sector in Indonesia with the intensities with which manufacturers relied on inputs from services sub-sectors – obtained from input-output tables. Then, we combined that restrictiveness index with firm-level data for over 20,000 Indonesian manufacturers, over the period 1997-2009, to understand the extent to which changes in service sector restrictiveness affected manufacturers’ TFP, and to shed light on which service sectors are particularly important for manufacturing productivity, which types of restrictions are particularly disruptive, and which types of firms are particularly harmed by these restrictions.

Our results reveal that the effects of service sector reform on Indonesian manufacturers’ productivity are economically meaningful. The changes in restrictiveness toward FDI that took place during the period under study explain about 8 percent of overall TFP growth in Indonesian manufacturing during the same period while the productivity gains were largely similar for domestic and foreign owned firms.

The gains do not accrue equally to all firms, however. More productive firms tended to benefit more from service sector reforms than less productive firms, although, controlling for the firm’s position in the distribution of TFP, those that carried out research and development investments, trained their workers, or produced more sophisticated goods tended to gain less from reform (because, perhaps, some sort of selection mechanism made them circumvent the existent restrictions in the first place).

Finally, not all reforms are equal. Specific service sectors, such as transport, and electricity, gas & water are particularly relevant for manufacturing performance, while it is restrictions related to foreign equity limits, screening and prior approval requirements, and other restrictions related to operations of foreign firms that have the greatest impact, those relating to the hiring of key personnel were not so relevant.

From these results, some policy recommendations emerge: Service sector reforms that reduce barriers to FDI – such as reducing equity limits on foreign ownership, reducing the burden of discriminatory screening procedures or, more generally, any discriminatory business regulation that introduces a bias against foreign firms – are likely to stimulate investments in the sector, which will in turn contribute to (i) improved services infrastructure, (ii) increased competition, and (iii) improved quality of services provided. From the evidence, the transport and logistics sector seems to be a priority to concentrate on. Although policy priority should be on adding infrastructure capacity, regulatory reform can also 17