- 3 – and examine data from Indonesia over the period 1997-2009.

Indonesia offers an interesting case. First, Indonesia is one of the largest economies in Asia, currently the world’s most dynamic growth pole. Its rapid rate of economic growth achieved during the last ten years suggests that the services sector will continue to grow in importance. Second, while Indonesia is relatively open in terms of trade in goods, restrictions on foreign participation in the services sector (either through trade or through FDI) are pervasive. Third, over the period of our analysis, changes in policy restrictiveness toward FDI in the services sector have been largely driven by commitments that the Government of Indonesia made to the International Monetary Fund (IMF) during the East Asian Crisis in 1997-8, and by other commitments to the WTO and ASEAN. This provides some comfort in the assumption we make in our empirical approach that the policy changes are not a consequence of the performance of manufacturers, but a cause. In other words, that policy changes are largely exogenously determined.

To gauge the effect of restrictiveness toward FDI in services, we combine manufacturing firmlevel data, from which we obtain a measure of total factor productivity, with the OECD indicator of policy restrictiveness toward FDI in the services sector weighted by the respective manufacturing sector’s reliance on inputs from each services sector, the latter piece of information being gleaned from Indonesian input-output tables. We include a comprehensive set of controls for other channels that may link reforms conducive to liberalization with manufacturing productivity, such as policy restrictiveness toward FDI in the manufacturing sector itself, tariffs on imported intermediate inputs, tariff protection on the same manufacturing sector and the share of output in the sector produced by foreign firms, plus firm-level fixed effects aiming at controlling for unobserved firm heterogeneity, and at capturing time-invariant effects specific to the industry and province wherein which the firms operate.

Our main finding is that, in Indonesia, relaxing policies toward FDI in the service sector was associated with improvements in perceived performance of the service sector, and to an economically meaningful increase in manufacturers’ TFP that accounted for about 8 percent of the observed increase over the period. The gains accrue largely to the most productive firms and are related to the relaxation of restrictions in both the transport, and in the electricity, gas & water sectors. TFP gains are associated, in particular, with the relaxation of foreign equity limits, screening and prior approval requirements, but less so with discriminatory regulations against multinationals to hiring key personnel.

This paper adds to the existing evidence on the links between service sector reform and manufacturing productivity, suggesting that substantial gains are yet to be obtained if countries move forward in their liberalization agendas in the service sector.

The remainder of this paper is structured as follows. Section 2 discusses the related literature. Section 3 presents some background of the services sector in Indonesia, discussing in

> 3 It is likely, however, that reforms affecting restrictions to FDI in services will be bundled together with other reforms affecting competition among domestic providers as well (see discussion below about the Telecommunications case in Indonesia). For these reasons, the estimated effects in this paper are likely capturing the effects of overall reform in the services sector on manufacturing performance.

3