Jakarta, July 2, 2010 - Famed business strategist Michael Porter once quizzed a group of around 100 graduate students in his fantastically popular course on competitiveness at Harvard Business School. Opening a case on foreign direct investment (FDI) in Indonesia for the class to discuss, he asked: “If Indonesia is so rich and fertile, that you could plant something in the ground and it will grow, then why is it poor?”

The flurry of responses that followed—some tentative, others cocksure—turned up the usual culprits, ranging from entrenched corruption to unfriendly investment regulations to a disparate concentration of wealth in a few hands. By the end, the perception of Indonesia for these rising business leaders was one that prevails in the mainstream: a country too risky, despite its potential, to do proper business.

As often is the case, simple observations tend to unpack rich nuances. But sometimes the explanation to a curious situation can be rather straightforward. To answer Porter’s puzzle, Indonesia has yet to live up to its economic potential because it continues to be short on smart capital.

Simply stated, smart capital is long-term, value-additive investment. I use the adjective smart because investors who bring this type of capital are sophisticated enough to know that to fully tap Indonesia’s potential, investing must take a long view, execute bold strategies and prioritize foundational sectors.

Admittedly, Indonesia is a large and complex country, littered with its share of problems. At the same time it is gathering momentum for an economic take-off, fueled by its abundant natural resources, prudent fiscal management, young and technically trained demographic pool, large domestic market and increasing global integration. By 2020 Indonesia’s nominal GDP is expected to at least quadruple.

Recognizing the economic boon potentially in store for Indonesia, smart capital strives to ride that wave until it reaches its crest. But to stay in Indonesia for the long haul, investors must act as model corporate citizens and take initiative and some ownership for addressing Indonesia’s development woes, including poverty, unemployment and a lack of competitiveness.

They must invest with a view to create jobs, raise living standards and introduce new technologies and best practices to be seen as committed partners for shared prosperity. Forging such a partnership with the intent for it to last demands vision and executing strategies that may go against the grain.

Smart capital sees downstream integration as an opportunity to achieve this. Often companies integrate operations along the value chain when it makes commercial sense. Typically this is a decision born out of managerial consensus about the benefits accrued from economies of scale.  

However, smart capital realizes that downstream integration offers more than just reduced operational cost. By increasing the number of locally owned supporting businesses, the number of new jobs created and the amount of additional tax revenue from value-additive business to host economies, downstream integration also reduces transactional cost.

Companies that integrate operations along the value chain, especially where rule of law remains young, gain implicit investor protection, encompassing contractual extensions and buyer-supplier relationships, because their presence is considered essential for the growth of host economies. 

 
Smart capital also introduces new technologies and improves local managerial knowledge. It knows that, to be globally competitive, its labor force must be of a high caliber and have access to efficiency-raising platforms and systems. This in turn will trigger a natural economic transition toward a knowledge-based economy, which is critical for ongoing industry innovation and further value-creation. 

Downstream integration, technology transfer and the sharing of best practices can increase value for all stakeholders in Indonesia’s natural resource sector, by far its largest state budget contributor. Indonesia historically exports its commodities. It then imports finished goods from those inputs at premium prices. This has caused significant hemorrhaging of value.

For instance, Indonesia’s cocoa producers could earn 19 times more value if operations were integrated and production capacity improved, while its bauxite producers could capture 30 times more value if the same were done.

Given that virtually everywhere in the world, what physically comes out of the ground is believed to be owned by the people, smart capital protects the interests of investors by showing host economies that value erosion is not unduly borne by their treasured natural resource sector.

At the same time smart capital looks beyond the natural resource sector and scans the economic terrain to find high-impact opportunities wherever they are. In Indonesia, foundational sectors, which are those such as education and healthcare that are critical to human development, are particularly promising.

Indonesia has a young and growing population and, as their affluence grows, they will want to be better educated and in better health. Indonesia loses around US$1 billion per year in the health sector because many Indonesians visit Malaysia and Singapore for medical service. Smart capital recognizes this gap and seeks to address it by investing in health and health support businesses in Indonesia. 

Lastly, smart capital looks to the future. Climate change is a real, clear, present and pernicious danger. In terms of carbon emissions, Indonesia at present ranks third among the world’s worst offenders. It is now getting an increasing amount of donor attention to assume a higher profile in combating climate change and it is rising up to the challenge. Smart capital sees the political will of governments to fight this global commons problem as an opportunity to create unimaginable value in close cooperation with them.    

I describe smart capital as strategic, inventive, inclusive and forward-looking. It is what Indonesia needs to shed its well-worn image of being a poor country because it fast-tracks development and establishes investors as indispensible partners who will be rewarded many times over for taking the long, pioneer and comprehensive view of its growth prospects.

Gita Wirjawan wrote for Kompas.