Report No. 2490-IND

Indonesia Cottage and Small Industry in theNational Economy(In Two Volumes) AdO3 311lVolume 1: The Main ReportNovember 9, 1979

Projects DepartmentEast Asia and Pacific Regional Office

FOR OFFICIAL USE ONLYf

Document of the World Bank

This document has a restricted distribution and may be used by recipientsonly in the performance of their official duties. Its contents may nototherwise be disclosed without World Bank authorization.

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-CURRENCY EQUIVALENTS

Before November 15, 1978

US$1.00 = Rp 415Rp 1.00 = US$0.0024

Rp 1 million = US$2,410

After November 15, 1978

US$1.00 = Rp 625

Rp 1.00 = US$0.00116Rp 1 million = US$1,600

ABBREVIATIONS AND ACRONYMS

ASKRINDO - Indonesian Credit Insurance CorporationBAPPEDA - Regional Planning AgenciesBAPPENAS - Badan Perencanaan Pembangunan Nasional - National Development

Planning BoardP.T. BAHANA - Public Equity Financing Corporation for Small and Medium-Scale

EnterprisesBIPIK - Guidance and Development of Small-Scale IndustryBPS - Biro Pusat Statistik - Central Bureau of StatisticsBUUD - Badan Usaha Unit Desa - Forerunner of KUD - Village Unit CooperativeKIK - Kredit Investasi Kecil - Small Investment CreditKMKP - Kredit Modal Kerja Permanen - Small Permanent Working Capital CreditNAFED - National Agency for Export DevelopmentREPELITA I - First Development Plan, 1969/70-1973/74REPELITA II - Second Development Plan, 1974/75-1978/79REPELITA III - Third Development Plan, 1979/80-1983/84UPPINDO - IDFC: Indonesian Development and Finance Corporation

DEFINITIONS BY EMPLOYMENT

CIs - Cottage and Household Industry Units, Employing 1-4 WorkersSIs - Small Industry Units, employing 5-19 workersMIs - Medium Industry Units, employing 20-99 workersLIs - Large Industry Units, employing 100 or more workersCSIs - Cottage and Small Industry Units, employing up to 19 workersSMIs - Small and Medium Industry Units, employing from 5-99 workersMLIs - Medium and Large Industry Units, employing 20 or more workers

FISCAL YEAR

Government - April 1 - March 31

Bank Indonesia - April 1 - March 31State Banks - January 1 - December 31

FOR OFFICIAL USE ONLY

This sector report is based on the findings of a mission whichreturned from Indonesia al: end-December 1978. The mission consisted ofthe following members:

Fateh Chaudhri - Mission ChiefRogelio David - Non-financial ProgramsHans Lesshafft - Financial ProgramsKeith Marsden - Policies and IncentivesVinod Prakash - General Economics and Statistics

The report was discussed with GOI officials in June, 1979 andincorporates the ideas expressed during those discussions.

The Report consists of two volumes:

Volume I : The Main ReportVolume II : Annexes and Statistical Tables

This document has a restricled distribution and may be used by recipients only in the performanceof their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

INDONESIA

COTTAGE AND SMALL INDUSTRY IN THE NATIONAL ECONOMY

TABLE OF CONTENTS

Page No.

BASIC DATA

SUMMARY AND CONCLUSIONS ........... .. . i-ix

1. INTRODUCTION . . . .................... . 1

2. THE SETTING . . . . ....... .. 2

The National Economy . . . . . . . . . . . . . . . . . . .2Population, Labor Force and Employment . . . . . . . . . .3The Manufacturing Sector. Structure of the Minufacturing Sector . . . . . . . . . . .5

3. CHARACTERISTICS OF COTTAGE AND SMALL-SCALEINDUSTRIES (CSIs) . . . . . . . . . . . . . . . . . . . . . . 7

A. Economic and Structural Characteristics . . . . . . . . . . 7Cottage (and Household) Industries (CIs) . . . . . . . . . 7Small Industries (SIs). 8Medium Industries (MIs). 9Large Industries (LIs) .10A Comparative Analysis of the Manufacturing Sector

by Scale of Operation . . . . . . . . . . . . . . . . . 10Productivity an,l Earnings . . . . . . . . . . . . . . . . 11Multiple Role PLaying . . . . . . . . . . . . . . . . . . 12Industry Location and Regional Concentration . . . . . . . 13Product Range . . . . . . . . . . . . . . . . . . . . . . 14Promising Subsectors .18Employment in CSIs .20

B. Social and Other Characteristics . . . . . . . . . . . . . . 21Entrepreneurship . . . . . . . . . . . . . . . . . . . . . 21Role of Cooperatives .23Marketing . . . . . . . . . . . . . . . . . . . . . . . . 23Competition in Marketing .24Relationship with Traders .25Terms of Credit .25Channelling of Credit through Selected Traders . . . . . . 26

4. SCOPE OF PRESENT FINANCIAL ASSISTANCE TO SMALL INDUSTRY . . . . 28

A. Introduction .28B. The KIK and KMKP Programs .29C. The Magnitude of KIK and KMKP Operations . . . . . . . . . 32

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Page No.

D. Constraints of the Existing Program and PossibleSolutions . . . . . . . . . . . . . . . . . . . . . . . . 35

E. Constraints Originating from Lending Institutions . . . . . 35F. Constraints Originating from the Program Itself . . . . . . 36G. Constraints Arising from the Relationship with

Other Institutions ... . . . . . . . . . . . . . . . . 38H. Constraints Attributable to Lack of Extension/

Consultancy Services ... . . . . . . . . . . . . . . . 38I. Assignment of Responsibility for CSI Lending . . . . . . . 39J. Hire-purchase and Leasing in the Context of CSI

Financing ... . . . . . . . . . . . . . . . . . . . . . 39

5. STRUCTURE OF TECHNICAL ASSISTANCE TO SMALL INDUSTRY . . . . . . 41

A. General Background . . . . . . . . . . . . . . . . . . . . 41B. The Institutional Framework ... . . . . . . . . . . . . . 42C. Institutional Coverage and Approaches . . . . . . . . . . . 43D. Sources and Functions of Technical Assistance . . . . . . . 44

BIPIK Project and Industrial Extension Services . . . . . 44Organizaton and Staffing . . . . . . . . . . . . . . . . 45BIPIK's Principal Activities . . . . . . . . . . . . . . 45The Delivery System ... . . . . . . . . . . . . . . . . 46- Regional CSI Development Centers . . . . . . . . . . 46- Service and Demonstration Centers . . . . . . . . . . 47- Management Assistance and Entrepreneurial Training . 48- Technological Institutes . . . . . . . . . . . . . . . 49

E. Other Technical Assistance Programs . . . . . . . . . . . . 51Role of the Department of Trade and Cooperatives . . . 51

Role of Other Government Departments . . . . . . . . . . 51F. Framework for Coordination .52

Criteria for Selecting Areas of Coordination . . . . . . 53Mechanism of Coordination .54Strengthening Extension Services . . . . . . . . . . . . 54Role of the Extension Worker . . . . . . . . . . . . . . 55

6. INCENTIVES AND POLICIES FOR THE DEVELOPMENT OF CSIs . . . . . . 57

Introduction . .. . . . . . . . . . .. . . . . . . . . . . . 57A. Problems and Constraints Facing CSIs . .. . . . . . . . . 57B. The Planned Industrial Development . .. . . . . . . . . . 57C. Policies and Incentives for CSI Promotion . .. . . . . . . 61

Removing Certain Constraints . .. . . . . . . . . . . . 62Increasing the Flow of Critical Inputs into CSI . . . 63

Technological and Extension Services . .. . . . . . . . 64Measures for Technological Improvement . .. . . . . . . 66Suggestions for Raising Skills . .. . . . . . . . . . . 68Measures for Greater Material Supplies . .. . . . . . . 68Marketing Improvement ... . . . . ..... . . . . . . 69

Public Sector Procurement ... . . . ... ...... . 71Linkages Between CSI and MLI . . .. .. . . . . . . . . . 72Scope for External Assistance and Project Ideas . .. . . 73

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LIST OF TABLES

Page No.

2.1 Manufacturing Sector in Selected East Asian Countries . . . . . 5

3.1 Rural-Urban and Sex Composition of Work Force inCottage and Household Industry, 1974. . . . . . . . . . . . . 8

3.2 Use of Electric Power by Size of Employment, 1974 . . . . . . . 9

3.3 Employment and Output in the Manufacturing Sector byScale of Operation, 1974. . . . . . . . . . . . . . . . . . . 11

3.4 Labor Productivity, Wages and Salaries by Scale ofOperation, 1974 . . . . . . . . . . . . . . . . . . . . . . . 12

3.5 Share of Java and Jakarta in Manufacturing Activity byScale of Operation, 1974 .... . . . . . . . . . . . . . . 13

3.6 Regional Concen:ration and Labor Productivity by Scale ofOperation, 1974 . . . . . . . . . . . . . . . . . . . . . . . 14

3.7 Industrial Structure of Manufacturing Sector by Scale ofOperation, 1974 . . . . . . . . . . . . . . . . . . . . . . . 15

3.8 Imports and Domestic Production of Selected IndustrialProducts by Scale of Operation, 1974 . . . . . . . . . . . . 18

3.9 Share in Gross Output and Relative Labor Productivity ofSelected Industries by Scale of Operation, 1974 . . . . . . . 19

3.10 Growth of Employment in CSIs, 1970-74 -Direct Estimate .... . . . . . . . . . . . . . . . . . . . 20

3.11 Growth of Emplo:ment in CSIs, 1970-73 . . . . . . . . . . . . . 21

6.1 Allocation of Development Budget for CSI. . . . . . . . . . . . 61

Page 1 of 2

INDONESIA

THE MANUFACTURING SECTOR - BASIC DATA

AnnualRecent years Growth Rate1970 1977 (%) 1970-77

GDP (bln. Rupiah, 1976 market prices) 9,771 16,622 7.89Value added in mfg.(bln Rp, 1976 market prices) 743 1,627 11.85% share of manufacturing in GDP 7.6 9.8

Employment 1971 1976Total (million) 39.47 55.31 6.98Manufacturing (million) 2.95 3.68 4.50Manufacturing/total (%) 7.47 6.65

Outstanding Bank financing (Bln. Rp.) 1974 1978Whole economy 1,574 4,334 28.82Manufacturing industry 359 1,320 38.47Manufacturing/whole economy (%) 22.81 30.46

Industrial KIK and KMKP loan approvals --- KIK Loans ---- --- KMKP Loans ----(as of September 30, 1978) Number Rp. mln. % Number Rp. mln. %

Food, beverage and tobacco 2,594 5,688 38.6 3,729 5,595 23.4Textiles, garments and leather 820 1,589 10.8 3,291 5,476 22.9Wood, wood products and furniture 700 1,898 12.9 2,781 4,748 19.9Nonmetallic mineral products 969 2,204 15.0 1,970 2,625 11.0Machinery, tools & other metal

products 417 949 6.5 1,040 1,684 7.1Others and unallocated 843 2,378 16.2 1,849 3,757 15.7All manufacturing sector 6,343 14,686 100.0 14,660 23,885 100.0

Whole economy 41,026 85,913 59,805 97,837

AbsoluteOverview of Manufacturing Activity level % of manufacturing sector

by Segments, 1974 CSMLI CI SI MLI

Number of establishments (thousand) 1,290 95.7 3.7 0.6- Using power 5 Nil 7.3 92.7

Number of persons engaged (million) 4.9 79.5 7.0 13.5- Unpaid (i.e. nonsalaried) 3.8 97.8 2.0 0.2- Paid (i.e. salaried) 1.1 16.1 24.4 59.5

Gross output (Rp. bln.) 1,653 12.2 9.5 78.3Value added (Rp. bln.) 613 13.5 8.6 77.9Wages and salaries (Rp. bln.) 120 8.4 13.6 78.0

BASIC DATAPage 2 of 2

Industrial Structure (paid employment) CI SI MLI CSMLI(%) (%) (%) (thou. no.)

31 Food, Beverages and tobacco 46.5 41.5 40.7 459.932 Textiles, wearing apparel & leather 7.7 17.2 26.2 231.533 Wood and wood products 17.2 12.5 3.4 86.234 Paper, printing and publishing 0.9 2.6 3.3 30.635 Chemicals and chemical products 2.9 4.0 12.7 99.436 Nonmetallic mineral products 16.5 13.9 3.7 91.037 Basic metals - 0.02 0.3 2.138 Metal products and machinery 5.9 6.6 8.5 83.939 Other manufactured products 2.7 1.6 1.3 17.6

Total: percentage 100.0 100.0 100.0

Total: thousand number 177.2 269.0 655.8 1,102.0

% Distribution of Value Added in ---- % by Segment ---- Rp. mln.Selected Product Lines by Segments CI SI MLI CSMLI

31179 Bakery products 31.7 37.6 30.7 4,37632214 Batik 26.9 31.2 41.9 6,57332400 Footware 13.6 12.5 73.9 4,22233210 Wooden furniture & fixtures 80.1 13.1 6.8 17,72838120 Metal furniture & fixtures 39.4 26.8 33.8 1,86638330 Electrical supplies - 1.2 98.8 7,54038450 Bicycles & becaks - 30.9 69.1 42739030 Sporting & athletic goods - 29.8 70.2 198

CI SI MLI CSMLI

Number of man-days per employee per year 110 213 246 135Value added per person engaged per day (Rp.) 193 934 2,930 943Wages salaries per employee per day (Rp.) 255 285 572 461

Share of Java in whole Indonesia (%)

Number of establishments 76.5 70.3 85.1 76.3Number of persons engaged 76.9 71.2 86.5 77.8

SUMMARY AND CONCLUSIONS

Introduction

1. This report presents the findings of a mission that visitedIndonesia in November-.December 1978 to assess the current situation andprospects for the development of the Cottage and Small Industry (CSI)/lsector. The draft report was discussed with various Indonesian officialsconcerned with this sector in June 1979 and their comments are reflected inthe present text.

2. The purpose of the mission was to:

(a) collect available data on the small-scale industry sector inorder to develop a broad statistical profile of CSIs inIndonesia;

(b) identify the basic problems and principal constraints hamperingthe growth of CSIs, looking particularly at financial issues,technical assistance, institutional arrangements, levels oftechnology and marketing problems;

(c) suggest pos;ible solutions to the problems identified;

(d) evaluate the existing policy incentives frame work within whichCSIs operate; and

(e) formulate recommendations on future assistance to support thegrowth and wider participation of CSIs in the manufacturingsector.

3. Despite the remarkable performance of the manufacturing sector interms of increased output, employment creation in the industrial sector fellconsiderably short of the Repelita II targets and the average capital/laborratio turned out to be extremely high in medium and large-scale industries.In its current effort3 to expand employment opportunities and generallyincrease productivity the Government of Indonesia is focusing on the growthpotential of CSI. The Third Five-Year Development Plan, Repelita III,launched in April 1979, stresses the urgency of promoting the CSI sectorwith the objective of generating some 434,000 new jobs over the five-yearperiod.

/1 For the purpose of definition, the Census of Manufacturing Industries(1974/75) classifies as Cottage Industry (CI) those units employing 1-4workers and as Small Industry (SI), those units employing 5-19 workers.

Manufacturing Environment

4. In order to understand the problems and prospects of the CSIs it isimportant to consider the wider context of the manufacturing sector and therole it has played in Indonesia's recent economic growth. During the firstfour years of Repelita II, when GNP was growing by about 7% annually, themanufacturing sector was expanding by about 12.5% annually. However, most ofthis development took place in large-scale, capital-intensive industries suchas fertilizer, petrochemicals, cement, etc., and only about 120,000 new jobsper annum were generated in the manufacturing sector. With the labor forceincreasing by some 1.44 million persons a year it is obvious that theGovernment must intervene promptly to improve the employment outlook.Indonesia is lagging behind neighboring developing countries not only inemployment but in manufacturing output. For example, manufacturingcontributed only 9.8% to GDP in 1977, about half the average of otherdeveloping countries in the region. Manufactured exports constituted lessthan 4% of total manufactured output, whereas in Malaysia such exportsrepresent 20% of output. In this situation the scope for growth and the needfor change in sources as well as patterns of growth is clear. A major taskfor the Government is to collect sufficient data on the present status of thevarious segments of the manufacturing sector in order to fully grasp thecurrent situation and to monitor the results of various actions it may taketo effectively direct and control the desired expansion in output, employmentand exports of the manufacturing sector.

Cottage Industry (CI)

5. From the data collected during the 1974/75 manufacturing census /1it is possible to identify the broad characteristics of the CI sector andthe constraints on its performance. According to the census about 1.3million establishments throughout the country are engaged in manufacturing;96% of them are considered cottage industries, employing 4 million persons or80% of all the workers in the manufacturing sector. Most of these units arelocated in rural regions, though concentrated in Java, like the populationitself. By and large, they are operated by household members, not as a full-time occupation, but as a supplement to seasonal agricultural work. Lessthan 8% of CI establishments hire labor and only 177,200 persons or 5% of theCI work force are employed as hired workers. A major share of cottageactivity involves wood products, food processing, textiles and brick/tileproducts. Labor productivity is extremely low (on average about 20% beloweven that of agriculture), except in footwear production, leather productsand tobacco processing. Overall, cottage industries represented about 12% ofgross output and just 14% of value added in the manufacturing sector.The value added per person working in the CI sector in 1974/75 was aboutUS$33 p.a.

/1 Published in 25 volumes at end-1978 and analyzed for the first time inthis report.

Small-scale Industry (SI)

6. Those units classified as small-scale industries resemble cottageindustries in some respects and larger medium-scale industries in others,e.g., some 75% of the 48,400 SI establishments have product lines similar tothose of cottage industries, while the other 25% are involved in highertechnology areas, such as structured metal products, electrical equipment andappliances, plastic and cement products, and bicycles. According to the1974/75 census most SIs are located in Java and employ about 343,000 persons,about 269,000 of whom are hired labor. Even though the number of estab-lishments in SI is only about 4% of that in CI, they employ about 50% morehired workers than CI. The annual value added per person is about US$250,nearly seven times that in cottage industries. Like most cottage industries95% of SIs use no electric power for production.

7. From the perspective of the overall manufacturing sector and ex-tensive plant visits by mission members, there appears to be considerablescope for the expansion of SIs in many fields including: knitted fabrics,garments, wearing apparel and uniforms; building materials and roofing tiles;furniture, fencing, wooden casing and carving, and classroom equipment;leather footwear; preserved and processed food, bakery products, tools andagricultural equipment; irrigation pumps, water and sewage pipes; electricalapparatus and supplies; forged and welded castings; cutlery; vehicle bodiesand parts; and varnish, paints and lacquers.

Constraints on Sector Expansion

8. The very nature of cottage industries puts them almost beyond therange of effective short-term government assistance. Dispersed in remoterural locations, CIs are not easily accessible, have only meager resources,few productive assets, and their small incomes make it almost impossible forthem to save and invest. Working only part time with traditional productionmethods, they face a very limited choice of product lines. As most CIoperators are craftsmen producing for local markets they lack theentrepreneurial skills which would generate an expansion of theiractivities./l Given this situation the most effective means of governmentintervention would appear to be in enlarging the market for CI products,establishing cooperatives and common facilities, extending credit through

/1 Evidence from other countries in the Region (e.g. Korea and Taiwan)suggests that the absolute number as well as the proportion of non-factory workers of the type described here gradually decreases overtime. The strategy suggested in this report is designed tosupplement the incomes and to minimize the hardships of CI craftsmenduring the transition period.

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traders and development banks and providing incentives to intermediariesdealing in CI products.

9. For SI the prevailing constraints are less intractable. Thepressing need is to broaden the base of SI establishments, equipping the morecapable ones with appropriate, labor-intensive technology, facilitating theflow of capital to them and expanding marketing opportunities for theirproducts. This should encourage a sustained transfer of employment of the CIand the surplus labor force in agriculture into more productive and betterpaid jobs in SI in the medium term. Specifically formulated governmentprograms in the areas of financial, technological, and managerial assistance,marketing improvement, and policy adjustments as well as increased insti-tutional support could initiate dynamic growth of products and employment inthe SI segment of the manufacturing sector.

Proposed Intitiatives

10. Financial Assistance. Estimating the financial requirements forpromising SIs will require further studies; however, a broad initial estimatecan be made on the basis of the existing government programs for loans ofworking capital and investment funds (KIK/KMKP). Credit to CSIs through thischannel by mid-1978 constituted only 3% of all manufacturing credit and wasextended to about 15,000 establishments - a resource allocation skewed tofavor the larger producers. In mid-1978 such loans to SIs averaged aboutUS$4,000 each for an average maturity of four years. Assuming similar fundswere available for loans to the 120,000 SIs currently employing hired labor,and therefore assumed to be prime vehicles for expanded production andemployment in the most "suitable" subsectors, then as much as US$500,000,000would be needed for initial project loans to these firms for a period ofthree to four years. Further analysis could determine the proportion ofthis requirement that might be provided through informal, nonbankingsources.

11. Even at this initial review stage there appear to be several imme-diate steps which should be taken to enlarge the KIK/KMKP programs to makethem more responsive to SI financial needs. These steps include:

(a) introducing wider use of group loans to clusters of neighboringhomogeneous small industries, supported by technical assistance,marketing help and advisory services;

(b) simplifying banking institutions' appraisal procedures andreducing their heavy reliance on collateral requirements;

(c) modifying the loan disbursement system by increasing itsflexibility, raising the individual loan ceilings, and extendingthe loan maturity; and

(d) changing the KIK/KMKP programs by introducing a two-tier system ofproviding small loans without collateral and larger amounts under

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normal procedures and increasing the repayment guarantee of theinsurance company, ASKRINDO.

12. The banking system at present has more than 600 branches ofprivate and public institutions participating in the KIK/KMKP program.While continuing and strengthening this approach, the Government shouldalso explore more efficient means of increasing the flow of capital toSIs. Supplementary approaches proposed for consideration include:

(a) gradually encouraging one of the existing state banks to specializein SI credit;

(b) giving financial and technical support to selected regional (pro-vincial) development banks and preparing them for more activeinvolvement in financing CSI credit needs in their respectiveregions;

(c) encouraging the establishment of cooperative banks in priority CSIareas;

(d) establishing hire-purchase companies specializing in simple indus-trial equipmen: and machinery as an adjunct to the financialsystem;

(e) increasing credit to traders who advance funds to CSIs which donot qualify for bank credit directly; and

(f) allowing foreign trading companies to set up export marketingagencies which would, inter alia, provide working capital bymaking advance payments to selected CSIs.

13. Technical Assistance. In 1974/75 the Department of Industry (DOI)launched a project designed to provide comprehensive technical assistance toCSIs called BIPIK. Half of the 148-member project staff are assigned to theprovincial offices as extension officers. Few of these officers work fulltime, however, because the project is not a permanent unit within DOI. Atotal of 410 full or part-time extension workers are operating in the country;yet, considering the total number of CSIs, it is clear that development of thesector cannot take place without a considerable increase in qualified,permanent staff./l Another top priority for BIPIK is the establishment of amonitoring system to assess the effectiveness of its channels of assistance:Regional Development Centers; Service and Demonstration Centers; and Centersof Entrepreneurial Education and Training.

/1 During Repelita III, about 2,500-3,000 additional extension workerswould be needed. Currently only 50 are being trained annually.

14. Immediate actions to improve the technical and delivery systemshould include:

(a) employing technical, banking and marketing experts to work inthree-man teams at service centers near clusters of CSI units;

(b) recruiting experienced CSI entrepreneurs or artisans to providepractical advice on technical/production problems; and

(c) limiting the target areas for extension workers to a few growth-oriented subsectors in designated areas.

15. Near-term improvements should focus on removing staff constraintsfrom the extension service, specifically by increasing the use of expertsfrom other departments for training, marketing and bulk procurement, andlimiting BIPIK's training work to plant-site instruction and to theintroduction of new equipment and techniques.

16. Over the long run, it is essential to establish additionalpermanent training facilities for industrial extension officers, offeradequate remuneration to obtain high quality extension staff, and developextension services for technological institutes.

Technological Development

17. The DOI maintains 14 technological institutes, but their researchactivities are oriented largely to medium and large-scale industries (MLI).Reform of these institutes should reemphasize their sectoral specializationand reorient them to the technical needs of CSI. Some may need additionalequipment; all will need technical consultants to update them on relevanttechnological developments outside Indonesia, and to assist them in devel-oping appropriate technology for CSIs. Close linkages must be establishedwith extension workers, first to understand CSI problems and to ascertaintheir needs and then to disseminate the research results. As a first stepthe procedures for getting experts from these institutions should besimplified. This "outreach" to CSIs is a vitally important link in theoverall growth prospects for CSIs.

Marketing Improvement

18. Several measures are needed to stimulate demand for CSI products.One high priority recommendation involves changing the public procurement

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system to assist small firms in meeting standard requirements. This couldbe done by appointing intermediaries to take charge of these functions, e.g.large firms which would 3ubcontract to small firms, traders, or CSI coop-eratives. CSIs should be able to meet government requirements at competitiveprices in the fields of office and school furniture, building materials,clothing and uniforms, footwear, tableware, irrigation pumps, bicycles, agri-cultural tools, simple cLassroom equipment, water and sewage pipes, fencing,vehicle repair and many Eood products.

19. Another high priority step would be establishing linkages betweenCSI and MLI to widen the market and to improve efficiency and productivity.This could be accomplished by:

(a) exempting large industry purchases from CSI from sales taxes;

(b) providing incentives to MLIs for the in-house trainingof CSI personnal as a means of establishing quality standards andintroducing improved techniques in their small enterprises;

(c) providing incentives to MLI firms supplying equipment to CSIon installment or hire-purchase arrangements; and

(d) establishing a subcontracting promotion office within theDirectorate General for Small Industry in the Department ofIndustry (DOI) to bring potential parties together, to identifyspecific products suitable for subcontracting and to establishprocedures for its implementation in the public sector agencies andto recommend incentives for its use in the private sector.

20. Subcontracting should be facilitated by the preparation of a listof potential subcontractors by banks, extension workers, and technicalinstitutes familiar with their work.

21. Fiscal, credit and other incentives or space in industrial estatescould be given to subcontracting parties to encourage their participation. Inthe engineering subsector, several items have been identified as particularlysuitable for subcontracting, e.g. parts of sugar and textile machinery,agricultural implements, spare parts of tractors, sprayers, and food-dryingproducts.

22. Domestic markets could be improved further by an intensivecompaign to promote the conspicuous use of local products for clothing andfurnishings and an effort to improve local shopping facilities. Foreignmarkets for CSI products could be expanded by allowing foreign tradingcompanies to establish export subsidiaries with appropriate incentives toencourage CSI exports.

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Institutional Support

23. Considering the present state of CSI development, it would appearthat primary emphasis in institutional support should be given to strength-ening cooperative arrangements among various CSI units, upgrading the levelof expertise and service in regional development banks, and expanding theindustrial extension service by providing appropriate training and adequateremuneration, and strengthening the technological institutes.

24. Coordination among the various agencies participating in CSI pro-motion is extremely important and should be confined to five key agenciesoperating at the national level and to project teams at the local level.These include the DOI, the Department of Trade and Cooperatives, Departmentof Education, local banks and the local governments. The DOI representativeshould function as the coordinator of extension services. To maximize theeffectiveness of this coordinated assistance in the next two to three years,it is suggested that attention be focused on selected clusters of CSIsengaged in activities identified as having the greatest potential for growthin employment and production. For coordination to be successful andeffective it is also important that clusters be selected on the basis ofcommonly accepted criteria. In the long run, the chances of coordinationbecoming effective would be enhanced: (a) by developing a consistent set ofobjectives and a common framework for assistance to CSIs offered by variousagencies; and (b) by having BAPPENAS and the Ministry of Finance, whichcontrol the budget, play a more active role in funding such coordinatedprograms.

Policy and Incentive Changes

25. According to the Third Plan, Repelita III (1979-84) the develop-ment goals for CSI include an annual growth rate of 7% (compared to 5%previously) which is expected to result in a 12% contribution to value addedin the manufacturing sector and creation of 434,000 new jobs during the Planperiod. The policies necessary to achieve these goals have not beenspecifically delineated. The Plan allocation of Rp 50 billion (or aboutUS$80 million) for the CSI sector (exclusive of credit assistance) reflectsconsiderable improvement over the past budgetary allocations but does notsupport the high priority being given to expansion of this sector.

26. If the CSI sector is to develop as outlined, then an activeinvolvement of the private sector is critical. Also certain policies andincentives need to be implemented in order to establish a climate conduciveto growth. A series of interlocking policies relating to marketing,financial, managerial, and technical matters is delineated in Chapter 6.Among them, the highest priority policy issues, briefly noted earlier, canbe summarized as:

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(a) establishing policies and procedures which encourage governmentagencies to prccure goods produced by CSIs;

(b) setting up a company to lease appropriate industrial equipment toCSIs on a hire-purchase basis;

(c) forging linkages between CSIs and MLIs, with larger firms supplyingsemiprocessed materials to the smaller firms for finishing, andexpanding the markets for CSI products by promoting subcontractingarrangements for selected CSIs.

(d) expanding the flow of critical inputs such as working and invest-ment capital; appropriate technical assistance; strengthening oftechnical institutions and consulting services; and

(e) removing regulations, levies, licensing requirements andadministrative procedures which inhibit the growth and expansionof SIs.

International Assistance

27. Among several promising opportunities for external assistanceperhaps the most urgentlv needed are:

(a) financial and technical assistance for selected regional develop-ment banks in those provinces where CSIs are concentrated;

(b) financing equipment-leasing companies;

(c) financing common machinery workshops in selected areas ofclusters;

(d) financing the establishment of regional consulting agencies forCSIs; and

(e) providing technical assistance for developing a government pro-curement system to promote CSI products, for generating reliableindustrial statistics, and for promoting subcontracting.

28. With appropriate financial, technical and marketing assistancethe Government will be able to pursue the policies and initiatives it hasalready launched in Repelita III to promote the growth of employment andproductivity in the CSI sector.

INDONESIA

COTTAGE AND SMALL INDUSTRY IN THE NATIONAL ECONOMY

1. INTRODUCTION

1.01 Indonesia launched the Third Five-Year Development Plan (RepelitaIII) in the spring of 1979. On the eve of the Third Plan, the majority ofthe over one million cottage industry units (CIs) and a substantial number ofsmall industry establishment (SIs),/l employing about four million personshave still to be brought into the main stream of the development process.

1.02 The importance of CSIs cannot be measured solely in statisticalterms. They provide an important element of industrial flexibility; producemany specialized and artistic products in small quantities; provide for localneeds and services quickly and cheaply; have advantages in lower overhead andlower cost per job; provide opportunity for individual initiative and aresometimes the source of new ideas and generally good grounds for introducingand improving the intermediate technology. It is therefore important toencourage what is most v:ital in these firms, namely, their enterprising andresilient spirit and the:ir desire to expand their enterprises which areelements not only of economic but also of social progress.

1.03 This report ascertains the current situation and prospects of CSIsin the Indonesian economy. The first introductory chapter is followed by anoverview of the national economy and the overall manufacturing sector inChapter 2 as a background against which the role of CSIs will be discussed.The mission, and the relevant government agencies dealing with CSIs inIndonesia, recognized the insufficiency of basic information for discussingthe operational, analytical and policy questions, and therefore gave highpriority to the task of collecting and presenting statistics on CSIs.This information was sought not only to present a broad statistical profileof CSIs but also to discuss policy questions. The results are presented inChapter 3 of this report. This chapter (together with a special annex inVolume II) also evaluates and suggests improvements in the data collectionand evaluation process in order to provide disaggregated data on a fairlyconsistent and regular basis for the timely analysis of growth performanceand the impact on CSIs of the various programs and policies designed tosupport them.

1.04 In order to understand the basic problems and constraints hamperingthe more rapid growth of CSIs, the mission evaluated the existing programs offinancial assistance to CSIs: the scope, coverage and nature of financialassistance schemes; procedures of financial services; terms, costs andsources of financing to CSIs and the amount of resources extended to them.The mission's assessment appears in Chapter 4 of the report.

/1 For definition see page 1 of Summary and Conclusions.

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1.05 The mission also reviewed in Chapter 5 the organization, scope,coverage and essential functions of the various institutions and agenciesproviding technical assistance and the principal thrust of their supportservices. In addition to the sources of such services this chapter alsoevaluates the strengths and weaknesses of the existing services (includingthe technical research and training institutions) in the light of theoperational and structural characteristics of the target CSIs and theirproblems.

1.06 Another important aspect of the mission's work was to reviewthe existing policy and incentives framework within which CSIs operate:government strategy for the promotion of CSIs; fiscal and financial incentives;procurement schemes and other measures to determine whether the existing bodyof policies and incentives supports the interest of CSIs. A discussion ofthese aspects of the mission's findings is presented in Chapter 6 of thereport. The last chapter also indicates the areas in which the Bank andother international institutions or bilateral donors interested in thepromotion of CSIs can play a useful and productive role in the next fewyears.

2. THE SETTING

The National Economy

2.01 Stretched along the 3,300 mile long sunny belt of the equator areseveral thousand islands of the most populous East Asian country - theIndonesia archipelago. The size, geographic spread and ethnic as wellas social diversity of the world's fifth most populous nation (estimated 134million persons in 1977)/i pose considerable difficulties for economic andsocial development. The material in this chapter describes briefly themacro-economic and overall manufacturing sector conditions which have aneffect on the CSI sector.

2.02 Following a brief but intensive period of stabilization measuresuntil the mid-1960s, during which stringent budgetary and monetary policieswere pursued vigorously, the First Five-Year Plan (Repelita I), April 1969 -March 1974, giving high priority to rehabilitation rather than new investmentand placing heavy emphasis on infrastructure and agricultural expansion, waslaunched.

2.03 During Repelita II, a substantial proportion of additional develop-ment expenditures was again allocated to agriculture (19%), regional develop-ment (11%) and socially oriented sectors (20%), but a considerable proportionalso went to relatively capital-intensive sectors, such as power, telecommu-nications, transport and heavy industry (a total of about 40%), intended tolay the basis for future growth.

/L 1978 World Bank Atlas, p. 30.

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2.04 The growth rate of GDP in the first four years of the Second Plan(1973-77) was about 7% p.a. with agriculture growing at 3% p.a. and manufac-turing activities at 12.5% p.a. While showing an impressive growth rate ofvalue added, the manufacturing sector generated only 120,000 jobs p.a. - halfof the rather ambitious PLan target - of which only a fraction was in large-scale industries. During Repelita II, the average capital/labor ratio inlarge projects (including electricity, mining, etc.) was US$250,000; inmedium sized projects, US$15,000 and in cottage and small industries aboutUS$500.

2.05 In 1977, GNP per capita was about US$300, clearly showing thatthe country still had a long way to go before the average living standardreached a satisfactory level. If Rp 3,000 (or a meager US$8 at 1976 pricesand exchange rates) is chosen as the real per capita cutoff point for monthlyconsumption, about 15% of the urban population and 45% of the rural population(or 50 million persons) were still below this point in 1976. Almost 45% ofall the households in rural areas derived some or all of their income fromnonagricultural, low productivity jobs mostly in the handicraft industry. Thisunderscores the great urgency and importance of nonfarm, high productivityemployment for the maintenance and improvement of rural incomes. Geographically,the majority of the poor in urban and rural areas are located in East andCentral Java.

Population, Labor Force and Employment

2.06 The 1976 Intercensal Population Survey indicates a total populationof about 131 million of which 82 million, or just over 60%, were living inJava (including Madura). The corresponding total labor force was about51 million in 1976 of which about 49.8 million were reported to have beenemployed. Broadly, about 62% of the labor force were employed in agriculture,forestry and fishing; about 10% in manufacturing, mining and construction;and the remaining 28% divided between services (11%), trade, banking andinsurance (15%) and transport, storage, communications, etc. (3%). Accordingto broad but rough indicators of value added per worker, labor productivitywas lowest in agriculture, followed by manufacturing, services, transport,construction, electricity and mining-quarrying. Within the manufacturingsector, the CI segment showed even lower value added per worker than that inagriculture in general.

2.07 The labor force growth has been pronounced, averaging 4.7% p.a.from 1971 to 1976, compared to about 2% p.a. increase in total population.While total employment has also increased at an annual average rate of about4.5%, open unemployment has gone up, particularly among workers under 25years of age, but more importantly, underemployment has become perhaps evenmore pronounced. Although employment in agriculture increased at about thesame rate as rural population - generating about 46% of the incrementalemployment - agriculture's share in total employment decreased from about 66%in 1971 to about 62% in 1976, implying a major expansion in nonagriculturalemployment. In spite of this, however, manufacturing employment did notexceed 10% of total employment by 1976. Also, the lower growth rate in urbanmanufacturing employment (6%) compared to that in rural areas (8.5%) mayreflect the lower employment increases in large-scale, capital-intensiveenterprises which are located primarily in urban areas.

2.08 Indonesia has yet to resolve the problems of a labor-surplus,low-productivity economy and the need for an employment-oriented strategy isobvious. This entails a massive resource mobilization effort including thefull support of the private sector, the thrust of which should be aimed atachieving a higher rate of industrial growth, but more importantly a changein the pattern of industrial growth and greater exports of labor-intensivemanufactured goods. Since the ongoing capital-intensive, heavy industry andinfrastructure projects would continue to claim a substantial portion ofpublic sector resources and its administrative capability for some years, thesupport of the private sector in labor-intensive, quick-yielding projects andpromotion of CSI activities becomes even more crucial.

2.09 The need for greater productive employment becomes even more urgentin view of the expected annual increase in the labor force of some 1.44 mil-lion persons in the next two decades. Consequently, the maintenance of thehigh growth rate with a labor-intensive pattern of development and increasedemphasis on raising the productivity of those already employed, are essentialfor further alleviation of poverty.

The Manufacturing Sector

2.10 Both the manufacturing and mining sectors have grown remarkablyduring the 1970s. According to national accounts' statistics, manufacturingactivities during Repelita I (1970-74)/L grew at an annual average rateof 11.8%. During the first four years of Repelita II (1973-77) the growthrate of manufacturing was 12.5% p.a. Since the growth rates for the wholeeconomy were 9.0% and 6.6% during these two periods, the relative share ofmanufacturing in GDP improved from 7.6% in 1970 to 9.8% in 1977. With lessthan 10% of GDP originating in manufacturing activities, however, Indonesiaremains one of the least industrialized among major developing countries ofthe East Asia and Pacific region. The comparative shares of manufacturing inGDP in 1975 were: Korea 25%; Philippines 25%; Malaysia 16% and Thailand 15%.

2.11 The following table shows various characteristics of Indonesia'smanufacturing sector in comparison with that of other East Asian countries.

/1 More precisely the years of Repelita I were FY69/70-FY73/74.The Government fiscal year starts in April.

Table 2.1: MANUFACTURING SECTOR IN SELECTED EAST ASIAN COUNTRIES

Annual Share (%) of Share (%)Share (%) of growth of manufactured of manufac-

GNP manufacturing real manu- exports in tured exportsper capita in GDP (cur- facturing merchandise in manufac-

(US$) rent prices) value added exports tured output1975 1975 1960-75 1975 1973

Korea 560 25 18.6 84 31.4Philippines 380 25 6.3 16 6.4Thailand 350 15 10.3 25 13.0Malaysia 760 16 12.2 24 19.8Indonesia 220 9 5.3 2 3.4

Source: Draft World Bank paper, "A Review of the Manufacturing Sector in theEast Asia and Pacific Region," 1979.

2.12 It is evident from the table above that the share of manufacturedexports in manufactured output is strikingly small in Indonesia compared withthat in other countries. This is perhaps partially responsible for the slowergrowth and narrowness of the manufacturing sector in Indonesia. While externaldemand, higher efficiency and factor supplies are important, the expandingshare of exports in a fast-growing manufacturing sector also signifies theimportance of manufactured exports as a source of growth of the sector andits employment performance.

Structure of the Manufacl:uring Sector

2.13 The only reasonably satisfactory source for ascertaining the pat-tern of manufacturing growth in Indonesia is the annual surveys of manufac-turing industries by BPS./1 The subsector distribution of manufacturingvalue added derived from these surveys for certain benchmark years indicatesthat:

(a) the structure of the Indonesian manufacturing industry is stillheavily dominal:ed by traditional agriculture and forestry-basedactivities such as food processing, beverages, tobacco manufactur-ing, leather and rubber products. Together with textiles and tex-tile products, these goods accounted for 84% of the manufacturingsector's total output in 1970, 76% in 1973 and over two-thirds inrecent years;

/1 Even in this case, the year-to-year comparability of these surveys isaffected by the overall and subsectoral coverage and definitional dif-ferences between different years. The surveys are also restricted tomedium and large industries (over 20 employees) and do not include CSIs.

(b) the shares of textiles and engineering industries improved sharplyin the 1970s followed by wood products, paper and printing indus-tries, chiefly at the expense of traditional agriculture-basedsubsectors; and

(c) a number of new products (principally fertilizers, industrialchemicals, glass sheet, steel cables, etc.) have also come intoproduction in recent years.

2.14 In per capita terms, manufacturing value added in Indonesia islowest - about a sixth of Korea's, a fifth of Malaysia's, a fourth of thePhilippines' and a third of Thailand's. In terms of the composition of themanufacturing value added, Indonesia-has the second highest share of textiles,clothing and footwear in total manufacturing value added; but lowest inmachinery and equipment, and second lowest in basic metal and metal productsubsectors in the five countries compared.

2.15 In general, manufacturing industry has been the fastest growingsector of the Indonesian economy. But, with per capita manufacturing valueadded only 16% of that in Korea, Indonesia still remains one of the leastindustrialized among major developing countries of the East Asia and Pacificregion. Also, medium and large-scale industries have provided very littleadditional employment and adequate links between the various segments of themanufacturing sector have yet to be created.

2.16 The results of another World Bank research study on patterns ofindustrial development also show that the relative size of the overallmanufacturing sector in Indonesia was only half of the "norm" indicated bythe study and that such subsectors as basic and fabricated metal products,chemicals, clothing and footwear, textiles, printing and publishing wereall much below the norm. The subsectors much above the norm were food,beverage and tobacco, wood and wood products and rubber products./l

2.17 With this perspective on the national economy and the overallmanufacturing environment, this report presents a more in-depth analysis ofthe cottage and small industries (CSIs). We will discuss not only thecharacteristics of CSIs as compared with other segments of the manufacturingsector but also their problems and constraints. The report also discussesthe policy issues and illustrates the possible approaches, including newinitiatives, to the development of CSIs so that their chances for greaterparticipation in the national economy can be improved.

/1 The World Bank, "Pattern of Industrial Development" (PRO: 671-05).

3. CHARACTERISTICS OF COTTAGE AND SMALL-SCALE INDUSTRIES (CSIs)

3.01 For a variety of purposes, including an assessment of CSIs' per-formance in terms of the employment generated in recent years; an examinationof CSIs' growth potential and the changing relationship between CSIs andmedium and large-scale industries (MLIs), it is essential to have reasonablycomparable, consistent, timely and accurate data over time. The availabletime series data do not warrant such analysis because they are incomplete.The mission has made a number of suggestions (see Annex II) on how the CentralBureau of Statistics (BPS) and the Department of Industry can improve andstrengthen the industrial data flows to provide a strong empirical base forformulating industrial policies and studying their impact on CSIs. Given theproblems with the time series data, the mission had to rely on other evidence,on manufacturing employment and number of establishments to ascertain thegrowth performance of CSIs in the recent past. The results of this exerciseare presented in this chapter.

A. Economic and Structural Characteristics /

Cottage (and Household) Industries (CIs)

3.02 The manufacturing activity is scattered widely and comprises almost1.3 million establishments, most of which (96% or more than 1.2 million) arecottage and household inclustries (CIs). Because of the large number of units,the statistical information was gathered through a stratified random sample./2These units are essentially run by artisans or craftsmen rather than byentrepreneurs. They are extremely small, a typical unit engages three persons,each person working only 110 man-days a year. Thus, most of the labor forceemployed in CIs works on a part-time basis mainly to supplement their meagerincome from other sources.

3.03 Most CIs (94%) are located in rural areas and they also employ94% of CIs' work force. The rural CIs contribute only 81% of value added ofall CIs and, therefore, labor productivity in rural Indonesia is even lowerthan the already low average of Indonesia as a whole. This is also reflectedin the smaller proportion of hired labor, the number of days worked and the

/1 Based mainly on the :information contained in the 25 volumes of the1974/75 industrial census reports published by BPS in 1978. In thiscensus, all the manuf-acturing establishments were subject to completeenumeration, except cottage and household for which a sample survey wasconducted. These reports, however, present only combined results formedium and large-sca:Le establishments. The mission made an attempt todifferentiate medium from large industry units through special computationsfrom statistics on various tapes.

/2 The survey was spread over a period of 12 months to avoid seasonaleffects which could have distorted the results, but low density ruralareas in 7 provinces were excluded. The population thus excluded wasapproximately 5%.

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smaller proportion of full-time /1 workers in the rural areas. Only 4% ofrural (CI) workers are hired compared with 14% of urban workers. The workintensity in manufacturing activities in the rural areas is very low, as aperson is engaged on average less than one-third of the year. The lowintensity in rural areas is partly explained by the seasonal nature of agri-cultural employment.

3.04 Another striking feature of the analysis of rural-urban areas is acomparison of the work force participation by sex. Whereas in the ruralareas the male-female proportion is around 3:7, it is reversed, 8:2, in theurban centers. The national average for females is only 81 days/year whilefor males it is 174 days.

Table 3.1: RURAL-URBAN AND SEX COMPOSITION OF WORK FORCEIN COTTAGE AND HOUSEHOLD INDUSTRY, 1974

Total R u r a 1 U r b a nabsolute Rural Urban Male Female Male Female

level ---------------- (%) ----------------

No. of persons engaged ('000) 3,900 94 6 28 72 78 22No. of hired labor ('000) 177 80 20 88 12 84 16No. of man-days worked by: (mln.)

- unpaid full-time persons 234 96 4 40 60 30 70- unpaid part-time persons 232 96 4 48 52 44 56- hired labor 39 77 23 84 16 86 14

--------------- (No.) ---------------

Man-days/person engaged 109 124 188 78 100 207Man-days/hired labor 213 260 209 244 260 260

Source: Annex Table 0.1 and 0.2.

Small Industries (SIs)

3.05 Small industrial units are often a hybrid of the traditional CIsand modern MIs. This characterization of SIs seems to be supported by theirproduct-mix. On the one hand, their manufacturing operations are dominatedby traditional industries such as food processing, textiles and wood products;on the other hand, they are involved in many modern industries (parti-cularly chemical and metal base industries) such as plastic and cementproducts, structural metal products, electrical equipment and appliances, andbicycles, which are not produced in CIs at all.

3.06 The number of SIs is quite small, about 48,000 units, as comparedto CIs. A typical SI unit engages seven persons. It generates an annualvalue added of Rp 1.1 million (US$1,760) as compared to the meager Rp 67,000

/1 Defined as those working five to eight hours a day.

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(US$110) in a typical CI. Almost all SIs employ hired labor (on average,five per establishment), whereas only one out of every 13 CIs hires labor./l

3.07 SIs share another characteristic with CIs in their extremelylow use of power: 95% of SIs do not use any electric power in their manu-facturing operations. Thus, a typical SI seems to have very low capitalintensity since the use of power is often taken as a measure of the capitalintensity when industrial investment data are not available, as in thepresent case.

Medium Industries (MIs)

3.08 A typical manufacturing establishment of medium size (employing 20to 99 persons) differs from a SI in many respects such as the greater use ofpower, larger extent of nontraditional products, more frequent use of moderntechnology, and greater division of labor. Consequently, it is not surprisingto find substantially higher labor productivity in a MI than a SI; although atypical MI employs only five times more labor than a SI, it manages to generatevalue added 13-14 times of that in SI. A MI pays only 30% more wages andsalaries to an employee, but it manages to improve the labor productivity by80% or more, mainly because the workers have better tools and equipment towork with.

3.09 There are 5,800 MIs which constitute only 0.5% of all manufacturingestablishments, they generate about 4% of manufacturing employment and almost16% of manufacturing value added. Almost half of the employment and valueadded are generated by only two industrial groups, namely, textiles and foodmanufactures. The same is true for the SI segment, but the two segmentsdiffer in detail. For example, both SIs and MIs produce some engineeringsector products, but with different importance of product lines. Machinery(except electrical), electrical apparatus and supplies, motor vehicles andcycles, structural metal products, metal containers, etc., are more common inMIs; agricultural equipment and hand tools, metal furniture and fixtures aremore common in SIs.

Table 3.2: USE OF ELECTRIC POWER BY SIZE OF EMPLOYMENT, 1974

SIs MIs LIs5-9 10-14 15-19 20-49 50-99 100-499 500+

No. of units - total 38,715 5,961 3,510 4,424 1,366 1,054 247- with power 150 93 98 2,256 932 873 247

Units with power/total (,) 0.4 1.6 2.8 51.0 68.2 82.8 100.0

Source: Annex Table 2.1

/1 Out of 1,234,000 CIs, only 97,000 employ hired labor, providing jobs for177,000 persons. The corresponding figure for paid jobs in SIs is269,000.

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Large Industries (LIs) /1

3.10 There are only about 1,300 LIs (large units each employing 100 ormore persons), and they are known for their high value added - Rp 303 million(US$500,000) per establishment as compared with Rp 1.1 million (US$1,760) in atypical SI and only Rp 67,000 (US$108) in a typical CI. Consequently, theyaccount for a larger share of manufacturing value added, but they providecomparatively little employment - only 455,000 as compared with 4.24 millionin CSIs. The labor productivity of LIs is also much higher than thatof smaller firms - Rp 860,000 (US$1,800) as compared with Rp 154,000 (US$247)in SI and Rp 21,000 (US$34) in a typical CI. On average LI employees receiveabout three times the annual wages of those employed in a typical CSI. Thehigher wage rate is probably largely due to higher levels of education andskill levels but also to more working days a year and greater discipline aswell as to the higher cost of living in urban areas where LIs are concentrated.

3.11 Another distinguishing feature of LIs is the generation of surplus,that is the value added minus the wages and salaries paid in cash or kind tothe labor. This is the compensation for using other productive factors suchas capital, technology, managerial, marketing or other services. Almost 80%of the value added in LIs is surplus, as compared with 40% in SIs and avirtually negligible amount in CIs./2

A Comparative Analysis of the Manufacturing Sector by Scale of Operation /3

3.12 The principal characteristics of the four manufacturing segments(CIs, MIs, SIs and LIs) by scale of operation are stated above. A comparativeanalysis of these segments, highlighting the operational significance ofvarious characteristics such as employment generation, labor productivity,work intensity, regional concentration, industrial structure, growth potentialand import substitution now follows. As stated above, 80% (or 3.9 million)of the industrial labor force is engaged in CIs, whereas only 7% (or 0.3million) is engaged in SIs, 4% (or 0.2 million) in MIs, and 9% (or 0.5million) in LIs. These and other data are presented in the table below.

/L Excluding petroleum refining and miscellaneous products of petroleum andcoal.

/2 Due to inevitable lack of accounting and dominance of self-employed personsamong CIs, it is virtually impossible to estimate their surplus unlessa special study is conducted for this purpose. Moreover, for similarreasons, the estimate for SIs is only approximate. There is, however,some evidence to suggest that self-employed artisans show a higherpropensity to save than other workers at a similar income level.

/3 The source data do not include petroleum refining, and miscellaneousproducts of petroleum and coal. Moreover, processing and manufacturingactivities taking place in the Estates Sector are not included. Finally,the nature and extent of nonresponse and underreporting are not known indetail so as to infer their implications for the comparative analysis.In particular, coverage of several industries such as rice milling,wearing apparel, leather footwear, rubber, and nonferrous metal may beincomplete.

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Table 3.3: EMPLOYMENT AND OUTPUT IN THE MANUFACTURING SECTORBY SCALE OF OPERATION, 1974

Totalabsolute % of Manufacturing Sectorlevel CIs SIs MIs LIs

No. of establishments 1,289,800 95.7 3.7 0.5 0.1- using power 4,649 nil 7.3 68.6 24.1

No. of persons engaged 4,904,800 79.5 7.0 4.2 9.3

- unpaid 3,802,800 97.8 2.0 0.2 -- paid 1,102,000 16.1 24.4 18.2 41.3

Gross output Rp 1,653 bln 12.2 9.5 12.3 66.0Value added Rp 613 bln 13.5 8.6 15.9 62.0Wages & salaries Rp 120 bln 8.4 13.6 15.9 62.1

Source: Annex Table 0.3; Special Tables 1A, 2A, 3A, 5A, 6A and 7A.

Productivity and Earnings

3.13 The labor productivity in CIs is so low that the 80% of the workforce engaged in this segment of the manufacturing sector contributes only13% of its value added. The average annual labor productivity (i.e. valueadded per person) in CIs is only 3% of that in MLIs, which amounts to ameager sum of Rp 193 (US$S34 p.a.) as compared with US$1,150 a year inMLIs. Labor productivity in SIs, where production and employment levelsseem to be more sustained throughout the year, reached nearly a quarter ofthe average in MLIs. The SI figure, US$250 p.a. in 1974/75, was appro-ximately 50% higher than the average value added per agricultural worker inthat year./l The difference in the productivity of CIs and SIs (which isabout seven to eightfold) is more difficult to explain because the skilllevel of hired labor in SIs and CIs is similar and there is little differencein the capital intensity in the two segments of the industrial sector (only4% of SIs use power). Oni the basis of field observations it appearsmanagement and marketing might be contributing to SIs' better performance.

/1 Labor productivity in cottage and small industries taken together(CSIs) is extremely :Low but it may perhaps be understated for the followingreasons: (a) underreporting by small producers who do not keep systematicrecords and whose production varies from season to season or perhaps from dayto day; (b) differeni: price structures in rural and urban areas: in thelatter, product prices/values are also inflated by higher overhead costs,transport, etc.; and (c) some proportion of the output of a household enter-prise may be for self-consumption and is, therefore, not included in thereported value of output or sales. Nevertheless, even after taking thesedistortions into account, a substantial difference in productivity levels in

small and large-scale industry remains, largely because of the difference in

their respective deg:ree of mechanization, and the irregularity and part-timenature of work in CSIs.

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3.14 Disparities in wages for hired labor in small and large firmsare much less pronounced than differences in productivity. Even in cottageestablishments, daily wage rates were 40% of the average wage/salary inlarge-scale firms (including the remuneration of managers in the latter).

Table 3.4: LABOR PRODUCTIVITY, WAGES AND SALARIESBY SCALE OF OPERATION, 1974

Manufacturing SectorAll CIs SIs MIs LIs

Per Person EngagedValue added/year (Rp'000) 125 21 155 402 863Value added/day (Rp) 944 193 928 1,700 3,450Man-days/year (No.) 135 110 213 236 251

Per Person EmployedWages & salaries/year (Rp'000) 109 57 61 95 163Wages & salaries/day (Rp) 461 255 285 390 650

% of Persons EngagedUnpaid persons 77.5 95.5 21.6 2.9 -Paid employees 22.5 4.5 78.4 97.1 100

Source: Annex Tables 3.1, 4.1 and 5.1; Special Tables 2A, 3A, 4A,9A, 10A, llA and 12A.

3.15 Incomes of family workers appear to be lower in general, butfor many households, manufacturing activities provide an additional, ratherthan the sole, source of income. As discussed below, the people in ruralareas pursue various activities at the same time.

Multiple Role Playing

3.16 The population/labor force surveys show that multiple role playingis common./l There are significant shifts from one occupational category toanother to compensate for seasonal variations in demand in different sectors.The peaks and troughs of the demand for labor in agriculture generally do notcoincide with those in industry.

/1 The size of the total labor force varies considerably from one time ofthe year to another (e.g. by as much as 5.5 million from March toSeptember 1976).

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3.17 There is also multiple role playing resulting from the diverseactivities of the household as a whole, particularly in rural areas. Itis not unusual for a single household to be the base of operations in thefarming, construction, local transport, trade and manufacturing (handicraft)sectors with individual members of the household switching from one toanother according to need. This is confirmed by the household expendituressurvey. In 1976, 45% of households in rural areas derived some income fromnonagricultural activities (mostly manufacturing or related services) and 26%received all of their incomes from these sources. Diversification of occupa-tional opportunities (even at low marginal incomes) has been a significantfactor behind the widely diffused growth of rural incomes revealed by theSUSENAS survey.

Industry Location and Regional Concentration

3.18 There is a fairly heavy regional concentration of population andindustry in Java. The fcollowing table illustrates Java's share in manu-facturing activity.

Table 3.5: SHARE OF JAVA AND JAKARTA IN MANUFACTURINGACTIVITY BY SCALE OF OPERATION, 1974

Java (whole) JakartaCIs SIs MIs LIs CIs SIs MIs LIs-------- (% of whole Indonesia) ------------

No. of establishments 76.5 70.2 84.5 83.2 1.3 4.1 11.0 16.8No. of persons engaged 76.9 71.2 84.2 87.1 1.5 5.4 12.0 13.2Value added 66.2 67.2 67.4 86.1 6.3 9.2 10.5 21.2Gross output 70.6 67.0 72.0 82.8 6.3 8.3 14.6 24.0

Source: Annex Tables 1.2, 3.2 and 5.2; Special Tables 18B, 19B, 20B,and 21B.

Variations in regional concentration by provinces within Java are also quitesignificant. In particular, not many CIs are located in Jakarta as theyabsorb only 1.5% out of CI's 3.90 million total work force in Indonesia,whereas the MIs in Jakarta absorb about 12% of their 0.66 milliontotal work force. Central Java, however, appears to have a greater con-centration of CIs: 42% In terms of both employment and value added.

3.19 The location of establishments tends to be more concentratedgeographically in certain product fields than in others. In the foodprocessing and wood product industries, SI establishments are widely dispersedthroughout rural areas irL the densely populated regions, reflecting scatteredsupplies of raw materials and the advantages of proximity to local markets.In some fields, however, producers are clustered together in relatively fewlocations depending upon the availability of raw materials and fuels (e.g.,bricks, metal implements, wood carvings) or traditional centers of demand(batiks, silverware).

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3.20 Although the 1.3 million CIs and SIs are scattered all over thecountry, 70-77% of them are located in Java, and another 10% are located inthe three provinces of South Sulawesi, North Sumatra and South Sumatra. TheCIs as well as the SIs in these eight provinces employ 85% of their workforce, and contribute 78-82% of their value added. Moreover, the industrialunits may be further concentrated in some regencies and municipalities. Foroperational purposes, certain regional areas can be selected to keep theadministrative task within manageable limits and to maximize the benefits forany given amount of administrative effort which is a scarce resource.

3.21 Another striking feature of CSIs is that the regional variations inannual labor productivity appear to be quite significant: the nationalaverage for CIs is Rp 21,200 (US$34), but provincial averages for fourprovinces (Jakarta, East Kalimantan, Irian Jaya and Maluki) are four to seventimes the national average. The regional variations among SIs and MLIs aremuch narrower, the maximum being only twice the national average./l

Table 3.6: REGIONAL CONCENTRATION AND LABOR PRODUCTIVITYBY SCALE OF OPERATION, 1974

% of Employment in Labor ProductivityWhole Indonesia (Rp'000/year)

CIs SIs MIs LIs CIs SIs MIs LIs

Central Java 41.9 21.6 22.9 22.2 14 131 257 635East Java 13.9 23.7 24.0 35.0 22 143 240 724West Java 12.1 20.9 23.1 14.7 24 136 412 925

East Kalimantan 0.08 0.31 0.40 0.03 95 367 635 877Irian Jaya 0.08 0.25 0.15 0.10 115 266 264 315Maluku 0.02 0.21 0.17 0.14 140 197 325 1,105

National (million) 3.90 0.34 0.70 0.46 21 154 379 837

Source: Annex Tables 3.2 and 5.2; Special Tables 19B.

Product Range

3.22 The structure of the four manufacturing segments shows that eachone is dominated by the same industry, namely, food, beverages and tobacco.This industry, together with textiles, wearing apparel, leather and leatherproducts, and wood and wood products including furniture, account for almost90% of the number of CI's and more than 70% of SI's or MLI's employment. Thedominance of these three industries in respect of the value added among CIs

/1 Only East Kalimantan is the outlier among SIs, Rp 367,000 (US$587)against the national average of Rp 154,500 (US$247); and only CentralSulawesi is the outlier among MLIs, Rp 1,476,400 (US$2,360) against thenational average of Rp 720,800 (US$1,150).

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and MLIs is somewhat less: 80% and 65% respectively. What is most apparentis the relatively low shares of the fabricated metal, machinery and equipment

industries in every segment of the manufacturing activity.

Table 3.7: INDUSTRIAL STRUCTURE OF MANUFACTURING SECTORBY SCALE OF OPERATION, 1974 /a

E m p 1 o y m e n t V a 1 u e a d d e dCIs SIs MIs LIs CIs SIs MIs LIs--------------- (% of total) -----------------

All manufacturing industries 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0

Food, beverages & tobacco 35.9 44.0 31.8 46.4 45.2 48.4 36.5 52.9Textiles, apparel & leather 11.2 16.1 30.4 23.5 8.6 11.8 24.7 12.6Wood products incl. furniture 42.2 12.1 5.7. 2.4 26.6 13.2 4.8 2.2

Chemicals & chemical proclucts 0.2 3.6 3.5 12.5 1.4 6.3 17.7 13.1

Base metal industries - - 0.2. 0.3 - - 1.4 0.9Fabricated metal, machinery& equipment 1.4 6.4 6.9 8.8 3.6 7.3 10.0 12.1

Source: Annex Table 8; Special Tables 19A and 21A.

3.23 Food processing accounted for 36% of CI and 44% of SI jobs.Production of raw sugar occupied as many as 736,000 persons, almost allin cottage establishment,, compared with 56,000 in larger sugar mills.This clearly indicates that a substantial number of jobs could be affected by

a shift in consumer tastes towards refined sugar and by investment plansfor sugar production./l Similarly, rice processing provided another 220,000jobs in SI. Medium and large-scale rice mills and rice product manufacturersaccounted for only 6% of employment in this sector.

3.24 In the wood and related industries, the largest sector in termsof employment is rattan, bamboo and pleated willow ware. About 1,454,000persons were making furniture, containers, household utensils, hats, matsand walling/roofing components for housing from these vegetable fibermaterials. Virtually 100% were employed in CI. In addition, 84,000 had jobsin saw and wood mills and 99,000 were making wooden furniture, mostly in CIestablishments.

/1 According to a study (see para. 5.03) about 165,000 workers in foodprocessing CSI establishments were laid off during 1971-73 partlydue to such a phenomenon. Other subsectors affected by this processwere textiles, paper products, etc.

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3.25 Textile products constitute a third major group (11% of SI employ-ment). Here small firms are subject to more substantial direct competitionfrom large-scale industry. Ir. 1974/75, CSI establishments employed 137,000workers making woven products compared with 100,000 workers in medium/largeweaving mills (spinning is predominantly large scale). Textile printing andfinishing, however, remains principally a small-scale activity. CSI batikproducers employed 169,000 workers whereas medium/large enterprises hadonly 13,000.

3.26 The coexistence of small weaving mills and the predominance ofsmall batik printing shops may be attributed to: (a) low labor costs offsettingthe economies of scale of fully mechanized mills; (b) significant regionalvariations in tastes, expressed both in fabric designs and colors and clothingdesigns, which tend to limit the market radius in which each manufacturer cancompete effectively; and (c) the demand for exclusiveness and intricatenessof design among high income consumers, putting a premium on handicraft techni-ques in the high price/quality brackets.

3.27 Against this, there are some strong forces running against thesmall textile producers and finishers. These include in particular theadoption of western dress codes (plain shirts, blouses and suits), byemployees of the public educational system and the public services whichreduces the market for batik producers immediately. The continued influenceof this on the tastes of the young and the elite groups could be detrimentalto the small-scale textile industries.

3.28 Within this sector, the current employment levels were relativelylow in garment making (27,000) and footwear (13,000). The growth prospectsin these two sectors should be substantial, especially if exports could bedeveloped and incomes are raised.

3.29 Building materials comprise the fourth major product group interms of employment. About 114,000 workers in CSI were engaged in producingroofing tiles and 76,000 in making bricks in 1974/75. In both cases, thegrowth potential should be considerable. The SUSENAS survey of 1976 disclosedthat only 13.7% of rural households and 35.1% of urban households had brickwalls in their houses, but the percentage increases progressively as incomesrise (to 70% of the highest urban income group).

3.30 One product group which is surprisingly inconspicuous is metalproducts and machinery. This category accounted for less than 2% of bothSI and total manufacturing employment. Yet this sector has been one ofthe main focal points of the Government's small-scale industry developmentprogram over the past 25 years./l Its natural tendency towards regional

/1 The basic framework of the program was already in place in the mid-1950sand the strategy has remained much the same since. See K. Nagaroja Rao:"Small-Scale Industry and Economic Development in Indonesia" in EconomicDevelopment and Cultural Change IV. No. 2., 1956.

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specialization and "clustering" of enterprises facilitated the formation ofcooperatives and the sett:ing-up of common production facilities (e.g., themachine shop serving the foundries at Ceper in Central Java). It ought tohave benefited from the attempts to promote the mechanization of SI generally(through technological institutes and credit facilities). These programsappear to have yielded l:imited growth in employment or output, however.Technology and working conditions in foundries and forging shops remainprimitive. Why? The answer seems to be that the inputs into the sectorhave not been accompanied by efforts to increase the demand for the industry'sproducts. The main factors which have retarded the growth of the market are:

(a) a structure of industrial incentives and tariffs favoring large-scale, capital--intensive technology in the modern sectors beyondthe experience and capacity of the indigenous engineering industry(local product:ion of nonelectrical machinery provided only 5% oftotal supplies in 1974/75);/1

(b) scarcity of capital in SI (inadequate access to institutionalfinance) to spend on better equipment, and in the engineeringindustry to finance the sale of their products;

(c) slow progress Ln rural electrification and the high costs ofinitial connect:ion; less than 2% of rural households had electricityin 1976;/2

(d) limited success of the Government's technological institutes andextension serv:Lces in disseminating appropriate technology;

(e) the low level of agricultural mechanization;

(f) prevalence of domestic cooking and storing utensils made fromceramic and wood on the one hand or extruded/moulded aluminumor tinplate on the other;

(g) no incentives or assistance to large-scale manufacturers tosubcontract their metal components to SI.

Action along all of these fronts will be necessary before the metal productsand machinery industries can realize their potential (in Taiwan they accountedfor 24.7% of manufacturing employment in 1971)./3

/1 Annex, Table 15.

/2 SUSENAS, 1976. Table 5.

/3 See Samuel P.S. Ho, v"Small Scale Industries in Two Rapidly GrowingCountries," World Bank, 1978 (mimeo).

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Promising Subsectors

3.31 From a long list of possible products, there are some which maybe "suitable" for promoting production mainly in SIs. To facilitate sucha selection one needs to analyze data on factor-intensities, factor andproduct prices, domestic resource utilization and costs, domestic demand,export markets, tariffs, etc. These data are not available. As a lastresort, possible reliance on the three standard sources of economic growth -import-substitution, expansion of domestic demand, and exports - comes tomind. On the basis of field observation and extensive discussions on therespective product lines regarding their comparative advantage, and capital-labor intensities, expected domestic resource utilization, and growth indomestic demand, export potential, etc., an illustrative table of subsectorsrepresenting possible candidates for import-substitution in which SIs arelikely to have an edge over their competitors in MLIs, is given below./l

Table 3.8: IMPORTS AND DOMESTIC PRODUCTION OF SELECTED INDUSTRIALPRODUCTS BY SCALE OF OPERATION, 1974

Value of Importsimports CIs SIs MIs LIs supply--(Gross output in Rp billion)-- (%)

Knitted or crocheted fabrics 7.7 0.1 1.0 2.9 3.7 50Paint, varnish and laquers 6.7 0.0 0.5 2.3 3.5 50Glass & glass products 4.6 0.0 neg. 0.8 5.1 45

Agricultural equipment and tools 11.1 1.7 0.9 0.3 0.1 80Vehicle bodies and parts 13.1 0.0 0.5 0.3 1.0 90Electrical apparatus & supplies 95.6 0.0 0.2 1.6 12.3 85Bicycles & becas 4.5 0.0 0.3 0.9 0.1 80

Source: Annex Table 15; Special Tables 5A.

3.32 In order to select product lines suitable for promotion in CSIs andfor which the domestic demand is expected to arise, the mission supplementedthe above-mentioned considerations with those of the International DevelopmentCenter of Japan (see below). While studying industrialization in Southeast Asia,the Center prepared a long list of manufactured products suitable for promotion

/1 Due to serious problems in the matching of international trade andproduction statistics, the numerical results should be interpreted withcaution.

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in small enterprises./I The following illustrative table (3.9) is the netresult of combining these two approaches and shows products having scopefor considerable expansion in the domestic market.

Table 3.9: SHARE IN GROSS OUTPUT AND RELATIVE LABOR PRODUCTIVITYOF SELECTED INDUSTRIES BY SCALE OF OPERATION, 1974

% share Relativein gross output labor productivityof all segments LI = 100 Total score

Products CIs SIs MIs LIs CIs SIs MIs for SMIs

Preserved & processedfish 24 7 9 60 21 25 48 6

Rice, cleaned andpolished 29 54 16 1 56 78 137 6

Bakery products 36 35 20 9 34 123 110 11Batik 20 35 32 13 4 43 66 8Wearing apparel 53 30 9 8 43 110 171 9Leather footwear 14 12 12 62 13 26 39 11Printing & publishing 3 22 37 38 14 47 88 10Roofing tiles 67 16 14 3 18 30 113 13Cutlery, nails,

screws, bolts, etc. 12 8 26 54 5 19 61 11

Source: Annex Tables 10, 16 and 21.

Two observations seem pertinent: first, despite various constraints inhibitingSIs, some SIs co-exist with MLIs, and if the constraints are removed theymay be able to exploit their full growth potential. Second, CIs and SIsshould not be always lum-oed together in a promotional effort because, interalia, labor productivity in some industries (such as coconut oil, batik,cultery, screws, etc.) in CIs is relatively so low that it is not self-evident that they can be made economically viable and self-supporting in thelong run even with substantial technical, financial and other assistance.

/1 The study rated industries at four-digit level of ISIC (Rev. 2) by the sixcriteria: anticipated growth in demand, degree of labor-intensiveness,amount of skilled labor, optimal production size, export, and domesticresource utilization. Every industry was assigned a one to five scorefor each criterion, one being the best and five being the worst. Thus,theoretically, an industry's total score could go up to 30, but inpractice it did not exceed 21. The score table is reproduced in theAnnex. For further details, see A Study of Industrialization in FiveCountries in Southeast Asia, International Development Center of Japan,March 1974.

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Employment in CSIs

3.33 To ascertain the growth of manufacturing activity by the scale ofoperation (or segments) is a particularly difficult task. The main problem,is the lack of comparability over time among the various data sets. Neitherthe manufacturing value added data by segments are available at constantprices, nor are the corresponding indices of manufacturing production.The way GDP generated by manufacturing activity is estimated, it is impossibleto disaggregate the growth of CSIs or MLIs.

3.34 The growth of employment in CSIs can be estimated both directly andindirectly. The direct estimates obtained from the Annual Survey of SmallManufacturing and Handicrafts show almost no growth during 1970 to 1974.These estimates are presented in Table 3.10. The mission has strong reser-vations about the validity of these data because they are quite inconsistentwith certain other variables reflecting growth of CSI as discussed below.

Table 3.10 GROWTH OF EMPLOYMENT IN CSIs, 1970-74 - DIRECT ESTIMATE('000 persons)

Rural Urban Total1970 1974 1970 1974 1970 1974

Total manufacturing 1,816 1,761 179 192 1,995 1,953of which:

- Food & beverages 567 550 65 81 632 631- Textiles & wearing apparel 214 138 31 8 245 146- Wood products including furniture 419 754 23 36 442 790

Source: Annex Table 18.

3.35 The above-mentioned direct estimate of the growth of employment inCSIs, however, is quite different from the indirect estimate, which isobtained by subtracting the employment in MLIs from the total manufacturingsector. The indirect estimate shows a gain of 327,000 jobs over the three-year period - a growth of about 5.2% p.a. which is more likely./l Also thegrowth in the number of SI establishments which commenced production duringthis period lends support to the indirect rather than the direct estimate.If one assumes the average size of the 15,589 additional SIs (which commencedproduction in 1971-73) to be the same as that of their entire set in 1974,these new SIs would have created 111,000 jobs (almost a third of the laborforce in SI in 1974/75 and about 10% p.a.). Thus, the remaining 200,000 jobsare more likely to have been created in CIs. In the mission's judgement, itis a reasonable estimate that the growth in employment, and perhaps valueadded and output, in CSI, was around 5% p.a. in the early 1970s. Moredetailed studies and research would be needed to refine these estimates.

/1 If total manufacturing employment data are adjusted by uniformly distrib-uting the employed persons whose economic activity was not adequatelyknown (4% in 1971 and 1.5% in 1976) then the jobs expected to have beencreated in CSIs between 1970 and 1973 would be 305,000.

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Table 3.11: GROWTH OF EMPLOYMENT IN CSIs, 1970-73('000 persons)

Changeduring

1970 1971 1972 1973 1971-73

Total manufacturing employment 2,811 2,950 3,082 3,221 410Employment in MLIs 849 972 1,229 932 83Employment in CSIs (indirect estimate) 1,962 1,978 1,853 2,289 327

Source: Annex Tables 17 and 20.

3.36 In order to determine the growth of employment in CSI in more recentyears (1974-77), once again one has to rely on the above-mentioned indirectestimation procedure./l During each of the three years (1975-77) the CSIsare expected to have created 60,000, 120,000 and 180,000 jobs respectively orabout 9% over the three year period./2 In order to further verify theindirect estimates the mission studied the enormous amount of data availablein the Department of Industry. In fact, in response to the mission's request(made well in advance), the Department assembled the recent years' data fromits provincial offices. But both the response rate and the quality of theassembled data were such that the mission was unable to use these data inthis report.

B. Social and Other Characteristics

Entrepreneurship

3.37 There is a widespread view that "entrepreneurship" is lackingamong the "economically weak" indigenous population. This is attributedto the lack of motivation, the cultural and religious values which emphasizesocial and ceremonial occasions rather than individualistic, profit-maximizingbehavior, the enervating climate and monopolistic practices by minorityethnic groups.

3.38 There may be an element of truth in all these points but one shouldbear in mind the limited resources, constraints on the people, the way theeconomic system works and the requirements of the division of labor and

/1 The estimate for employment in total manufacturing in 1974 obtainedfrom the population/Labor force census/surveys considerably differsfrom that obtained from the 1974/75 Industrial Census. The latterestimate exceeds the former by 1.5 million. It seems that the latterincludes a large number of persons engaged in cottage and householdindustries, whose principal economic activity is nonmanufacturing.

/2 It is not possible to disaggregate the growth rate between CI and SI.The general impressiDn, however, is that SI (in relative terms) grew morerapidly than CI in general.

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responsibilities between different members of the system. Such a perspectiveis helpful in understanding and appreciating the problems of entrepreneurship.

3.39 Seen in the context of Indonesia's stage of development, there isample evidence of an -innovative use of resources (e.g. the adaptationof bicycle parts for pedal taxis and batik designs and techniques). There isalso an eager search for market openings (e.g. producers and vendors ofprocessed foodstuffs)./l This is despite the difficulties created by certainrequirements such as licensing and taxation procedures which limit theirfreedom to pursue an activity or discourage the growth of very small establish-ments, and conservative banking institutions which restrict their access tocredit.

3.40 On the other hand, it is unrealistic to expect all or even most ofthe heads of 1.2 million cottage industry establishments to blossom into fullyfledged "entrepreneurs." Most are really craft workers whose skills andaptitudes are confined to a knowledge of traditional production techniques anddesigns and a familiarity with local materials and tastes.

3.41 In a more advanced economy, most of these artisans would be absorbedinto larger enterprises as hired labor. In a capital scarce/labor surpluseconomy like Indonesia's where handicraft making is a part-time activity itremains economic for them to perform their multiple roles within their ownhouseholds, leaving most of the entrepreneurial/managerial functions, finance,marketing (including design selection) and distribution to those with theexperience and resources to carry them out efficiently.

3.42 Such entrepreneurs are either the owners of small/medium manufactur-ing firms or traders. They supplement their own hired labor force throughthe "putting out" system,/2 providing materials, orders and even credit to(cottage industry) workers who remain in their homes. Although such workersare not formally part of the enterprise, their links with the entrepreneur maybe as durable as those of his own employees and the division of responsibili-ties may be the same.

/1 See Lea Jellinek's fascinating account of the petty producers/tradersof ice cream in Jakarta in "The Pondok of Jakarta" in Bulletin ofIndonesian Economic Studies, Vol. XIII, No. 3, November 1977.

/2 The economic advantages of this "putting out" system are considerable:(a) workers have the flexibility to set their work schedules according tothe other demands on their time; this is particularly useful for housewives(68% of CI workers are female) and farmers; (b) it saves capital costs onwork places, whereas an equivalent space within a factory is expensive;and (c) an out-worker is paid by the piece according to the quantity andquality of work done; with full-time hired labor, the entrepreneur has tospend more time on the shop floor supervising their work, or set upcomplicated control procedures.

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3.43 Entrepreneurial development programs trying to motivate craftsmenor inexperienced college graduates in the socioeconomic climate describedabove cannot be very successful. Attempts to instill basic managementtechniques into handicraft producers are also largely unproductive as theirjobs require little or no managerial functions while their, scale of operationremains family based and very small.

Role of Cooperatives

3.44 Another approach adopted by the Government to reinforce indigenousentrepreneurship is the creation of producers' cooperatives, with the aim ofincreasing their members' bargaining power vis-a-vis their suppliers anddistributors as well as achieving economies of scale in purchasing, production,finance and marketing. There are, however, many problems to be solved beforecooperatives could become effective instruments for CSS development. Theseinclude: conflict of interest between members; lack of strong leadership andqualified management; scarcity of capital and excessive burden of debtservicing if borrowed funds became large; conflict with existing traders anddifficulties with breaking into new markets.

3.45 None of these problems need deter the Government from promotingcooperatives as one of their development instruments. The Government hasundertaken a comprehens-Lve study of about 100 or more of the so-called"successful" cooperatives. Future government action programs, incentives andstructure of cooperatives as well as revision in their functions shouldbenefit from the conclusion of the study now under preparation. Also, thedesirability and feasibility of cooperative banks in promoting CSI developmentin nonurban areas, where they are concentrated most, should be explored.

Marketing

3.46 Many small producers are operating in highly localized marketsand are selling their products direct to the consumer from their own work-shops. This "forward integration" into retailing and transport activities iseconomically efficient when the output from each unit is very small and whenmaterial supplies are widely scattered throughout the country and markets arefragmented. It makes better use of the individual's or household's time,reduces transport costs and minimizes trading margins.

3.47 However, it :is clear that other producers, even relatively smallones, need diversified distribution channels for their inputs and/or outputsif they are to reach a wider market and expand their operations. The need isparticularly great for those producers whose markets are scattered but whosematerial supplies come from relatively few locations (e.g. imported materialsand certain agricultural crops). Repeat purchase products (e.g. processedfoods) need wider exposure to consumers through a greater number of retailoutlets than do those items which are purchased relatively infrequently andwhere the customer is willing to go out of his way to find a source ofsupply (e.g. furniture and industrial products and equipment bought by otherproducers).

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3.48 In some urban markets (particularly Java), small-scale producers doface some obstacles in reaching their ultimate consumers. Building controlsand the high cost of land have restricted the amount of space available in"formal" retail outlets and these traders prefer to recoup their high rentalor capital costs by concentrating on products with higher unit values (e.g.imported consumer durables) aimed at the higher income groups. In some casesthe municipal authorities have attempted to "tidy up" the city by imposinglicense controls on "informal" sector activities. The best-known case is"becaks" (tricycle taxis) which have been excluded from certain areas, withconsiderable negative effects on employment and income levels in thissector./l Similar restrictions might limit the outlets for some traditionalmanufactured products and their most serious effect might be to act as adeterrent to growth for CSI entrepreneurs (the larger their businesses, themore chance of inviting controls, license fees, and other forms of taxes).

Competition in Marketing

3.49 There seems to be no shortage of people eager to make a living bybuying and selling products and materials. The number of persons engaged inthe trade sector has expanded rapidly from 4.7 million in 1971 to 7.1 millionin 1976./2 Most are employed in small family businesses./3 This implies ahigh degree of competition in general. The figures suggest that the mono-polistic domination of a certain group in the trade sector is hardly feasible.There are just too many factors encouraging competition and too many alternativechannels and modes of distribution available to producers and consumers(including government-owned department stores, cooperative outlets and fairprice handicraft shops, industrial exhibitions, and trading houses) to allowmonopolistic practices to prevail for a long time. Nor is there any colla-borative statistical evidence to sustain the hypothesis of excessive profit-making. Average returns to capital and labor do not seem higher in tradethan in other comparable activities. National accounts and employment datashow that value added per person in trade is roughly the same as that inmanufacturing (Rp 365,903 and Rp 339,316 respectively in 1976). The input/output tables for 1975 indicate that the total costs of wholesale and retailtrade services add marginally to the final price to the consumer. Theyaccount for less than six cents in every dollar of aggregate public andprivate demand. Even if these data are heavily underestimated, still thecase of excessive profit making in general is difficult to establish.

/I See Gustav F. Papanek: "The Poor of Jakarta" in Prisma: IndonesianJournal of Social and Economic Affairs, No. 3.

/2 The World Bank, Employment and Income Distribution in Indonesia, ReportNo. 2378-IND, 1979.

/3 Only half a million are employed in businesses with more than two hiredworkers.

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3.50 It seems necessary to clarify these questions so that the role ofthe trading sector vis-a--vis SI can be properly evaluated. Small-scalemanufacturing units are not self-contained entities. They form part of aneconomic system made up of individual but complementary units. The survivaland prosperity of each member of the system depends as much on the efficiencyof the system as a whole as on the performance of its constituent parts. Thekey to an effective, smoothly functioning system is interdependence notindependence.

Relationship with Traders

3.51 Interdependence characterizes the relationships between the small-scale manufacturing and t:rading sectors in Indonesia. The trader performssome of the entrepreneurial functions which the small producer could notcarry out as efficiently himself. This applies particularly to CI producerswho are located at some (listance from their markets and/or raw materials.Traders often supply both the materials and the working capital needed tofinance work in progress.. They organize the transport of raw materials andfinished products and assume general responsibility for marketing in all itsphases - from the initial market research into consumer tastes and buying

behavior to the storage, display and promotion of the product at the point of

sale.

3.52 The trader in turn is dependent upon the producer for the flow of

goods of the right quality and price and at the right time to satisfy hiscustomers. He is dependent upon the producer's craft skills and technological

know-how and is often dependent upon the producer's ability to coordinate thework of others, whether f'amily members or hired labor.

Terms of Credit

3.53 The terms of credit provided by traders appear to be surprisingly

reasonable. Most of the CSI producers interviewed by the mission mentionedthat interest rates were around 2.5% per month /1 which is slightly above thecommercial bank rates. IBut the differential is justified consideringthat 98% of CI and SI producers do not have access to bank credit because of

the supposedly high costE and risks of lending to these sectors. The trader

has security for his loan in the form of materials or finished goods whereas

the producer usually has insufficient assets to act as collateral for thebank. The continuing relationship between trader and producer builds up

/1 The same figures were obtained by the Japanese team which has been

studying small-scale industry in Indonesia. See: Industrial Developmentin South East Asian Countries: Small and Medium-Scale Industries,Republic of Indonesia, Phase 1 (International Development Center ofJapan, 1978). It was not possible to ascertain whether the traders whoextended credit also used prices of raw materials and finished productsas a mechanism to conceal the real cost of credit to CSIs. Given theextensiveness of competition, however, the scope for such a phenomenon was

limited.

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confidence and trust and therefore reduces the risks of default. A bank,

however, may have had no previous contacts with a prospective SI client andwill be unfamiliar with his business./l Similarly, if a producer gets into

financial difficulty, the trader is in a better position to help his debtor

because of his knowledge of the trade and the opportunity to recover the loanby selling the products through his own outlets. Indeed he has a vested

interest in preventing such a situation from arising because his own success

as a trader depends upon his ability to turn over his capital and stockquickly and to ensure a fast and regular flow of goods from his suppliers.

Channelling of Credit Through Selected Traders

3.54 Studies in a number of countries have shown that traders' credits

are a more important source of capital for very small producers than the

banking system. This should not necessarily be interpreted as evidence of

neglect by banking institutions. Perhaps one of the most effective means of

injecting more capital into small-scale industry (in ways which diffuse the

benefits widely and avoid its conversion into capital-intensive, labor-replacing machinery) is to involve, to the extent political and social

realities permit, the trading enterprises specializing in CSI products andmaterials. The costs and risks of administering and supervising such a"re-lending" operation are likely to be less than those in alternative

schemes involving widespread relaxation of normal banking practices fordirect lending to producers or intervention by government agencies in the

supply/distribution network for their products. Large centralized institutions

(public or private) do not have the flexibility to meet the marketing or

financial needs of numerous, scattered CSI manufacturing units.

3.55 Lack of trade credit should not be allowed to become a constraint

to continued output and employment growth in CSI. There is some evidence that

this may happen. The share of the trade sector in total banking system

credits has declined from 40.4% in 1973 to 24.0% in mid-1978./2 The tradesector has been particularly squeezed in the allocation of bank credit

in the form of foreign exchange. Its foreign exchange credits declined fromRp 37.2 billion in 1973 to Rp 7.4 billion at mid-1978. As most CSI establish-

ments are too small to import raw materials or equipment directly, they depend

on supplies from traders. This source has been severely constricted by a

decree /3 banning the importation of goods using a merchant's letter of

credit. Even before this decision, traders were handicapped by having to pay

double the rate of withholding tax (16%) on imports compared with the tax levy

imposed on manufacturers importing directly (8%).

/1 Cooperative banks may be better placed in reducing the risk of defaultdue to greater familiarity with the clients' circumstances than anaverage commercial bank would have.

/2 See World Bank: "Indonesia's Growth Patterns, Social Progress and Develop-

ment Prospects," 1979, Annex Table 6.4. As the trade figures includecredits for hotels and food procurement (essential foods distributed

through government trading organizations) the share of the private traderhas probably declined more sharply.

/3 Decree No. 146/KP/V/1977 issued on May 17, 1977 by the Minister of Trade.

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3.56 One of the distinctive features of the Korean and Taiwanese indus-trial sectors is the high proportion of inputs of raw materials and partsacquired from abroad. A survey by the Korean Small and Medium Industry Bankshowed that 23.5% of total purchases by enterprises employing between 5 and199 workers were imported./1 About 20% of their output was exported, however.Despite relatively poor natural resources, Korea has achieved a high rate ofindustrial output and employment by making available competitively pricedmaterials and components for further processing or assembly by its enter-prising, hard-working, inexpensive labor force. Trading companies (domes-tically owned and foreign) have made an important contribution by providingessential inputs and serrices, particularly to small-scale industry.

3.57 In contrast, the weakest aspect of Indonesia's industrial perfor-mance is its reliance on protected domestic markets. Exports of manufacturesaccount for only 1.4% of total exports in 1976. The export potential of SIhas barely been tapped betcause critical inputs which would normally beprovided by traders (export marketing know-how and credits for importedmaterials) have been limited. Foreign investment has been barred from theforeign trade and domestic retailing sectors./2

3.58 The backwash ef'fects on SI have not been as great as they mighthave been because local nonindigenous traders have had access to externalsources of funds in other countries (e.g. Singapore and Taiwan). Their ownsavings/investment propensities have also been high./3 One of the fewexamples of successful export trading companies visited by the mission,concentrating on handicraft (mainly rattan and bamboo) products, combinednonindigenous capital anct their general trading experience with the salesflair of a dynamic, young Indonesian who had spent several years in Europe.They had tripled their exports in less than 2 years and were giving orders to35 suppliers in Java and other islands./4 Their suppliers were frequentlyvillage leaders who coorclinated the work of up to 1,000 craftsmen in eachdistrict.

/1 See Samuel P.S. Ho: "Small Scale Industries in Two Rapidly GrowingCountries - A Study cf Their Characteristics, Competitive Bases andProductivity". World Bank background paper.

/2 Banks have also been instructed to provide medium-term credit only tofirms with more than 50% of their capital owned by "indigenous" citizensin all sectors.

/3 It has been shown that the savings propensities of traders were consider-ably higher than those of government employees even though their averageincomes were lower. See A.C. Kelly and J.G. Williamson, "HouseholdSaving Behavior in the Developing Economies: The Indonesian Case."Economic Development and Cultural Change, Vol. 16, No. 3, April 1968.

/4 The particular enterprise could not provide exact sales figures butthe mission estimate is that the current order of magnitude was perhapsaround US$1 million.

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3.59 This trading company had found it necessary (and profitable) tosend a handicrafts expert to work in the villages (on a US$350 per monthsalary), selecting raw materials, setting precise design and quality standardsfor the craftsmen. The trading company set these standards according totheir knowledge of overseas requirements. Once mutual confidence was builtup and there was a regular flow of orders from this trading company, thecraftsmen demonstrated that they had the skills to respond to these changingnew market requirements. Further encouragement to such cooperative, tradingarrangements, through, for example, reimbursement or tax deduction of expensesspent on technical assistance extended to CSI enterprises or of expensesinvolved in export promotion, can be a productive way leading to greaterparticipation of CSI in the development process.

3.60 Relatively easy and widespread access to larger markets as well asavailability of financial resources remains a serious problem facing CSIs ingeneral. As discussed above, the traders have a role to play. Also, theGovernment has initiated, since 1973-74, a number of programs of financialassistance to CSIs. However, the institutional credit has touched only fewenterprises and its contribution to the growth of CSIs has remained limited.The next chapter, therefore, evaluates the existing institutional programs offinancial assistance to CSIs.

4. SCOPE OF PRESENT FINANCIAL ASSISTANCE TO SMALL INDUSTRY

A. Introduction

4.01 The cottage and small-scale industries (CSIs) are an unsophisticatedtarget group compared to medium and large-scale enterprises. In general,CSIs face great difficulties in obtaining funds from regular financialinstitutions because of many problems involved in complying with bank proceduresand requirements. The smaller and the newer the enterprise, the greater arethe obstacles generally encountered.

4.02 The widespread absence of bookkeeping in this segment of themanufacturing industry makes it exceedingly difficult to ascertain the actualassets and the profit and loss situation of most CSIs. This, together withthe general lack of registered deeds or certificates on land ownership andenterprise operations, poses a serious problem for organizing the flow offinancial resources from financial institutions. In spite of these diffi-culties the Government has, however, initiated a number of credit programswhich are specially designed to cater to the needs of small enterprises ownedby the economically weak segments of the indigenous population.

4.03 The primary source of financial credit for CSI is a governmentprogram for small loans for plant and equipment investment - KIK (KreditInvestasi Kecil) - and a similar scheme for working capital - KMKP (KreditModal Kerja Permanen). There are also some other programs such as MiniKredit and Kredit Candak Kulak. These schemes receive funds from theGovernment, supplemented by external sources and are generally administeredby the Central Bank. In addition, the lending banks also use their ownresources for the working capital (credit exploitasi) and investment (credit

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investasi) needs of enterprises not eligible for KIK/KMKP financing. Whilethe Mini Kredit (with a credit ceiling of US$160) and Kredit Candak Kulak (KCK:credit ceiling of US$24 only) play some role in the development of smallindustrial enterprises, the KIK/KMKP programs have become increasingly importantin meeting the financial needs of these enterprises since 1974./i

B. THE KIK and KMKP Programs

Main Features

4.04 The principal objective of both the KIK and KMKP programs is toprovide investment and permanent working capital credit to enterprisesin industry, agriculture, trade and services. Initially, no minimum equitycontribution is required from the borrower.

4.05 To ensure that only smaller enterprises obtain loans, maximumceiling requirements have: been established which require that the networth of borrowers does not exceed Rp 20 million (US$32,000) or that theirnet current assets are below Rp 10 million (US$16,000). In practice thesecriteria seem to be applied with flexibility by the handling banks.

4.06 The maximum amounts available for fixed assets financing (KIK)as well as working capital loans (KMKP) are Rp 5 million (US$8,000) each.This ceiling may be raised to Rp 10 million each. While borrowers need notprovide any self-financing for the initial Rp 5 million KIK loan, theirparticipation should be 10% or more in any supplementary KIK loan.

4.07 Implementation of the program is being handled by 600 branches ofthe banking system./2 To make the best use of each of the handling banks'specific expertise, Bank Negara Indonesia 1946 (BNI) was made responsible formanufacturing and related. services, and for construction, while Bank RakyatIndonesia (BRI)/3 focussed primarily on agro-based industries. However, theflexibility in allocating subsectoral responsibilities has resulted in BRI'sbeing the major lender in absolute terms of KIK/KMKP loans to the industrialsector. As a result, the primary responsibility for loans to small industrybecame diffused.

4.08 The share in KIK and KMKP lending of the various handling banks toCSIs is as follows.

/1 The structure of financial and technical assistance to CSI is discussedin greater detail in a separate background working paper.

/2 They include: (a) five state-owned commercial banks; (b) Bapindo underco-financing arrangements with 13 Regional Development Banks; (c) nineRegional Development Banks (independently); (d) five private commercialbanks; and (e) two additional private commercial banks under co-financingarrangements with the state commercial banks.

/3 BRI is mainly responsible for all agricultural KIK/KMKP lending including

livestock, fisheries and forestry.

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KIK AND KMKP LENDING OF STATE BANKS TO THE INDUSTRIAL SECTOR /a(Rp million)

% of total % of totalLending Outstanding KIK/KMKP lending KIK/KMKPschemes amount to industrial sector lending

Bank Rakyat Indonesia (BRI)KIK 5,915 45.0 14.6

KMKP 10,198 47.7 22.8

Bank Negara Indonesia (BNI)KIK 4,136 31.5 43.3KMKP 7,470 35.0 52.8

BapindoKIK 1,126 8.6 18.1KMKP 1,386 6.4 26.0

Bank Bumi Daya (BBD)KIK 1,042 7.9 9.5KMKP 1,128 5.3 14.2

Bank Ekspor-ImporIndonesia (BEII)

KIK 452 3.4 14.2KMKP 615 2.9 10.8

Bank Dagang Negara (BDN)KI1K 470 3.6 9.4KMKP 574 2.7 8.9

Total KIK 13,141 100.0 17.4KMKP 21,371 100.0 25.4

/a As of March 31, 1978. The five state banks and Bapindo cover almost 90%

of the total KIK/KMKP lending operations.

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4.09 The project itself, for which the KIK/KMKP loan has been extended,serves as the principal collateral and the total value of the collateralmust be no less than 100%t of the loan amount. BI also requires the handlingbanks to secure a guarantee from ASKRINDO /1 which insures 75% of the KIK/KMKPloans against a a 3% fee, of which 1.5% is borne by BI and 1.5% by thehandling bank.

4.10 Administrative Arrangements. The central administration of theKIK/KMKP program, within the BI's Credit Department (head office), coversareas such as: the monitoring of credit ceilings, handling of loans extendedon a group basis, analyzLng data, examining handling banks' rediscountapplications, verifying borrowers' eligibility, and assessing the performanceof the program. The organization in the handling banks regarding KIK/KMKPoperations varies, dependling partly on the type of bank and the number of itsbranches. A typical branch would have one to three loan officers, handlingKIK/KMKP applications. Ilost of these officers are high school graduates andtheir training is not alwqays applicable to the requirements of CSI financing.Control visits are made by special supervision officers but they are generallytoo overburdened to make such visits on a regular basis. Except for BDN,handling banks do not generally offer consultancy services.

4.11 Interest Rates and Rediscounting. KIK and KMKP loans carry interestrates of 10.5% p.a. and L2% p.a.; KIK's maturity is five years /2 with agrace period of up to two years and KMKP's maturity is three years. There isno commitment fee or service charge. Since February 1978, a penalty interestrate of 3% is applied on all KIK/KMKP accounts in default for more than 90days.

4.12 BI rediscounts 80% of all KIK lending at 3% p.a. and 75% of allKMKP lending at 4% p.a. The handling banks' repayment schedules wouldconform to the aggregate of the repayment schedules of their subloans.

4.13 Lending Procedures. KIK/KMKP loans are made either on an individualor group basis. When dealing with a group of borrowers, the program approachnormally calls for a morei extensive subsector analysis (e.g. availability ofraw materials, choice of technology and market demand), allows for a moreintensive provision of advisory services and tends to reduce the handlingbanks' administrative cost. Massal (Group) lending, which is widely applied

/1 P.T. Asuransi Kredit Indonesia (ASKRINDO) was established in 1971 toencourage bank lending to small and medium enterprises with insufficientcollateral. It is o7ned by the Government and Bank Indonesia but expectedto operate on a commercial basis.

/2 The maximum maturity on KIK loans for the purchase of market stalls hasbeen extended to ten years (May 1978).

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to agriculture, can also be applied to industrial clusters, several of whichhave already been identified. Although the "massal" approach has not yet beentested for industrial lending in Indonesia, the mission strongly suggests itsfurther use together with the existing method of individual KIK/KMKP financing.

4.14 Conventional project appraisal methods, face some obvious constraintswhen applied to CSIs; they are time-consuming and costly; depend on havingwell-experienced appraisal officers at the handling banks; and require longprocessing periods. However, most of the small entrepreneurs do not keeprecords of their operations, which makes it very difficult for appraisalofficers to establish the viability of KIK/KMKP projects. The appraisalbeing weak the handling banks rely too heavily on collateral. In spite ofthese limitations, handling banks have made reasonable progress on appraisalefforts. At this stage it would be desirable to look into alternative,simpler appraisal procedures such as point-scoring systems,/l which arewidely used in areas of consumer and personal credit. There are some othershortcut methods such as standard packages or loans primarily on the strengthof the market demand for the product concerned, internal management andinstitution support which could also be tested on an experimental basis.

C. The Magnitude of KIK and KMKP Operations

4.15 Actual Operations. Total KIK and KMKP loan approvals to allsectors have increased in 1978 /2 by approximately 27% and 10% respectively.KIK lending to the industrial sector (CSI) has also increased in absolute

/1 Credit-scoring models, widely applied in commercial lending (e.g., con-sumer credit), have not yet been introduced to CSI financing on a largescale. They nevertheless offer considerable promise as a means tofacilitate CSI loan evaluation. They are based on the premise that thereare distinctive but measurable differences in the characteristics of goodand bad loans. In such a model, scores are attached to critical informa-tion collected in connection with a loan application. The applicant'sscore is subsequently compared with a cut off criterion; high scores areassociated with low risks and vice versa. Criteria employed in credit-scoring models can be those referring to size (loan amount, assets,profit, cash flow, net worth); loan characteristics (ratios of loan tosales, net worth, assets, or collateral); liquidity ratio; profit tosales ratio; activity (ratios of sales to assets, inventory, etc.);leverage and entrepreneurial characteristics (age, history, experience,education), productivity and efficiency (sales to assets, sales to labor,value added to labor, cost per job, etc.).

/2 Annual figures have been based on the available data as of September 30,1978.

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terms from Rp 12.3 billion as of December 31, 1977 to Rp 13.5 billion as ofSeptember 30, 1978, representing 5,956 individual loans, while KMKP lendinghas increased correspondingly from Rp 20.3 billion to Rp 22.0 billion,representing 13,861 individual loans./I However, their relative shares intotal KIK/KMKP loans have declined to 15.7% and 22.5% respectively (comparedwith 21% and 31% in June 1976) in terms of loan amounts (for the likelyreasons for this development, see para. 4.24 below). The distributionbetween approved KIK and KMKP loans remained almost unchanged at a ratio of40:60.

4.16 By mid-June 1978, credit to the overall manufacturing sectoramounted to Rp 1,320 billion or 30% of total credit outstanding to thewhole economy. While total KIK/KMKP Loans (Rp 143.1 billion as ofSeptember 30, 1978) accounted for 3.3% of total credit, industrial KIK/KMKPloans accounted for only 2.9% of total manufacturing credit. By the thirdquarter of 1978, Rp 38.6 billion had been extended to about 15,000 CSIs oraround Rp 2.57 million (US$4,100) each./2 For projections of total resourcerequirements it has been assumed that this average actual individual loanamount per borrower, which compares with a potential maximum amount ofRp 10 million (US$16,000) for KIK and KMKP together, represents their actualfinance requirements./3

4.17 Projected Resource Requirements. Based on an analysis of import-substituting and export capability of CSI as well as potential for expansionin the domestic demand for their products, it is the mission's judgement thatonly a few of the existing CSIs would have growth potential and could becomea target group for concerted development effort. Assuming that the prospectiveclients require the same average loan and for the same average period asexisting CSIs, total resource estimates would be some US$600 million for aboutfour years, if the target group and projection were to be resricted to onlythose enterprises which employ hired labor (about 150,000 units or 12% of thetotal). If the target group were to be limited to potentially growing sub-sectors mentioned in Chapter 3, even then the target group would consist ofabout 120,000 units requiring about US$500 million. These resource require-ment projections,/4 rough as they are, to be fulfilled both by the formal andinformal sources of financing, demonstrate the magnitude of the task ahead.Further studies are needed to refine these estimates but the order of magnitudeis about right.

/1 See Annex Table 23 for more details.

/2 See Annex Table 24 for greater details.

/3 This simplification has been made for the purpose of projecting CSIs'total resource requirements. Actual individual loan requirementsare often limited by the availability of collateral.

/4 Statistics on CSIs are insufficient to put projections on a more relevantand elaborate basis such as structure of assets employed, net worth,capital-employed-per-job ratios.

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4.18 Repayment Performance. Total arrears / as percentage of outstandingportfolio on both KIK and KMKP loans were 15% (KIK) and 18.5% (KMKP) as ofSeptember 30, 1978. With arrears of about 11% on industrial KIK loans and8.4% (adjusted) on KMKP loans, the level of CSI loans in arrears is lowerthan for the rest of the program. The level of arrears is nevertheless acause for concern and reflects the high risk and low profitability of manyCSIs, the uneven quality of project appraisal, supervision and collectionefforts, and the absence of extension services for many problem-ridden enter-prises.

4.19 However, no attempt has been made by the handling banks to investigateand analyze the reasons for the defaults. It will thus be very difficult totake corrective measures and to prevent repetition of errors in futureproject appraisal reports. This is one of the important areas in whichsystematic effort is needed to comprehend the current situation beforepossible solutions can be suggested.

4.20 The handling banks use the Government's quasi-judicial collectionagency "PUPN" for foreclosure on delinquent accounts. This is a time-consuming procedure partly due to the large numbers of KIK/KMKP loansaffected./2

4.21 Rejection of Applications. As of September 30, 1978 some 26,500KIK loan applications and 36,500 KMKP loan applications have been rejected.This represents credit requirements of Rp 86.2 billion or 88% of total cumu-lative KIK approvals to all economic sectors and Rp 81.2 billion or 52.6%of total cumulative KMKP approvals./3 This shows substantial interest on thepart of CSI desiring to obtain financial assistance.

4.22 During discussions with several handling banks, it became apparent

that the rate of rejected formal CSI applications has been high, perhaps asmuch as 50% not including those rejections which took place at the initialphase of the project cycle where the project proponent was denied a formalapplication or was discouraged from pursing his project idea. In one casestudy, near Surabaya, loan applications were rejected due to: lack ofregistration certificates (40%); insufficient collateral (25%), bad repaymentrecord (20%) and poor management (15%).

4.23 The current information gap on rejected applications calls for theintroduction of a recording and reporting system (by sector) based on auniform definition. An analysis of information so collected would assist BIin its efforts to determine the real reasons for rejections, and to developworkable solutions. Also, some more studies of the type conducted in Surabayashould be undertaken in the short run.

/1 For BI's arrears definition (see footnote of Table 27, Volume II).

/2 Reflected by ASKRINDO's payments of claims between 1973-77 ofRp 2.1 billion (excluding recoveries) for 2,313 insured KIK/KMKPaccounts, of which Rp 0.3 billion for 255 cases accounted for CSI loans.

/3 These data also comprise rejected applications for group finance.

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D. Constraints of the Existing Program and Possible Solutions

4.24 Investment Opportunities. Since the inception of the program in1974, some 6,000 loans for investment purposes (KIK loans) have been extendedto CSIs, totaling Rp 13.5 billion (averaging Rp 2.5 million per borrower) andaccounting for 14.5% by number of accounts and 15.7% by amount of all indi-vidual KIK loans. Given the limited volume and the fact that the relativeshare of industrial KIK loans has steadily declined from 21.1% in June 1976to 15.7% in September 1978, the program has not achieved wide coverage duringits first five years, considering the large number of potential borrowers(see para. 4.17 above). The various banks interviewed by the mission attributedthe fall in investment finance to several constraints, the most important ofwhich was reportedly the limited demand for investment in the CSI sector.The reason for this development may be the small entrepreneurs' lack ofaccess to improved production technologies but also the extremely limited useof machinery and equipment in the cottage type enterprises. In addition tocombining technical assistance with finance, opening up of the market for CSIproducts was also considered an important factor which would induce demandfor finance.

4.25 The reluctance of small entrepreneurs to adopt a different approachand to make use of improved technology should partly be overcome by practicalbusiness training and technical in-plant consultancy. Technical assistanceis essential prior to any project formulation and bank involvement. Suchassistance should primarily be provided by technical extension serviceorganizations rather thani commercial banks but the two must work in closeunion.

4.26 Handling banks should support the technical extension efforts byintensifying promotional activities, which should also comprise: seminarsaimed at changing the apprehensive attitude of small entrepreneurs towardsbanks and bank credit; the identification of potential entrepreneurs orborrowers with the help of extension workers who require assistance; andremoving certain obstacles, such as obtaining licenses. Since complicatedcredit documentation procedures may discourage project sponsors, a workinggroup should be established to simplify and standardize the applicationprocess for CSI loans.

E. Constraints Originating from Lending Institutions

4.27 Reluctance to Finance New Entrepreneurs. In the past handlingbanks were reluctant to give loans to clients setting up new businesses, asthey normally did not have any performance records. Eighty-six percent andninety-nine percent of all industrial KIK and KMKP loans were approved forexisting entreprises whereas only 957 loans, amounting to Rp 2.3 billion(US$3.7 million), were extended to newly established small industrial ven-

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tures, which is not substantially different from the rest of the KIK/KMKPprogram.

4.28 To overcome the inhibition of lending institutions towards newenterprises, banks should be supported by subsector studies /1 indicatingthe growth potential and the entrepreneurial talents in various industries.The lenders' reluctance to give loans to new entrepreneurs may, however, alsobe attributable to their project staff's lack of confidence and experience incredit appraisal. An increase in ASKRINDO's repayment guarantee coverage -say to 90% of the loan amount extended - should also reduce lenders' discri-mination against new entrepreneurs.

4.29 Staff Constraints. Most banks approached by the mission are facedwith a severe shortage of sufficiently qualified and experienced staff forthe appraisal and follow-up of CSI projects. This has often resulted ininadequate or cursory appraisal work and exclusion of more complex cases andparticularly new entrepreneurs. Insufficiencies in project appraisal, on theother hand, are one of the contributing factors to a considerable rate ofdefaults which, in turn, tends to make handling banks apprehensive and morecautious regarding financing of CSIs.

4.30 Besides appraisal and staff shortcomings, CSI projects are neitherregularly supervised nor subject to special collection efforts. This ismainly due to the large number of projects handled by each bank officer,their dispersed locations and the cost involved. In this respect cooperativebanks catering to the needs of certain clusters and regional developmentbanks might do a better job of supervision or monitoring.

4.31 Most of the handling banks' staff will have to undergo intensivetraining in project appraisal and supervision of CSIs if the program is tosucceed. Notwithstanding these immediate training needs, lending institu-tions should intensify their supervision and collection efforts. Moreimportantly, all handling banks should be provided with a manual, containingappraisal and supervision guidelines, which may also serve as a trainingdevice for new and less experienced officers.

F. Constraints Originating from the Program Itself

4.32 Collateral Requirements. BI's instructions require that all KIK andKMKP loans be fully secured (100%) by collateral and by ASKRINDO's repaymentguarantee, which covers 75% of the loan amount. In their discussions withthe mission, several handling banks have cited the rigid collateral requirementas a constraint on faster expansion and a significant reason for rejection ofapplications for financial help in the industrial sector. The problem isaggravated by the absence of guidelines for the valuation of collateral,which is left to the offices' discretion.

4.33 A CSI loan application should not be rejected simply becauseof insufficient collateral but should be judged on its merits, such as theprospective cash flow. Such modification of the lending guidelines, whichdoes not preclude lenders from securing available collateral, should en-

Ll To be financed and undertaken by the Department of Industry itself orcommissioned out to universities.

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courage them to become more active, particularly if it is supported by anincrease in the ASKRINDO coverage to 85% for expansion projects and 90% fornew enterprises. The remaaining repayment risk is sufficient to discouragelenders from relaxing their supervision and follow-up efforts. In addition,leasing and hire-purchase arrangements which embody, in part, their owncollateral should be seeni as another modification of and complement toCSI financing efforts.

4.34 A modification of the collateral requirements, however, should be

accompanied by the introduction of guidelines which establish standardizedvaluation criteria for the various types of collateral on the basis of arealistic sales (liquidation) value concept. The suggested relaxation shouldbring to bear a desirable shift from lenders' preoccupation with collateralto the more vital aspects of CSI loan processing, such as appraisal, supervi-sion, collection, linkages with extension service organizations and closercooperation. The desirability of introducing a two-tier system in which theloan of a certain small amount is provided without collateral and loans ofhigher amounts are subjected to regular banking requirements should also beexplored in selected areas.

4.35 Credit Ceilings and Tranches. The KIK and KMKP programs provideloans to a maximum amount: of Rp 10 million each. However, maximum financefor both components may not exceed two loan tranches of Rp 5 million each.The second tranche may be obtained only after a minimum waiting period of twoyears, during which the borrower must have established his record of credit-worthiness. The strict adherence to this regulation has apparently constrainedlenders in their CSI financing efforts. Based on the rationale of theexisting loan tranche system a modification seems desirable to establish thelenders' authority to exceed these limits if necessary and justified, and toabbreviate the two-year probation period at their discretion.

4.36 Furthermore, the individual loan ceiling, particularly for invest-ment funding (KIK) should be raised to Rp 15 million (US$24,000) to accountfor the inflationary development during the past few years, which resulted insubstantially higher prices for most of the investment items and the morerecent devaluation of the rupiah.

4.37 Loan Maturity. Maximum loan maturities of the program frequentlydo not correspond with the actual lifespan of the financed investmentgoods and may consequently constitute a substantial strain on the borrower'scash flow. Consideration should be given to lengthening the KIK loan maturityto eight years, including three grace years, and KMKP maturity to four years.Il

4.38 Rediscount Arrangements. BI, which provides rediscount facilitiesfor the program, refinances 75% and 80% of all KIK and KMKP loans extended byhandling banks. BI may want to investigate whether an increase in its

/1 Fifty two percent of all KIK loans accounting for forty three percent oftotal loans extended had maturities of three years or less.

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rediscount plafonds to a uniform rate of 85%, which would result in an extraflow of resources to participating banks and simplify rediscounting procedures,would provide an incentive to more vigorous CSI financing, particularlyduring periods of resource constraints.11

4.39 Repayment to BI of the rediscounted amounts by handling banks is toconform to the aggregate of the repayment schedules of their subloans. Thisregulation appears unconducive to CSI financing, as it exposes handling banksto a perceptible liquidity risk, if, in turn, their borrowers' accounts arenot kept current. BI may want to consider whether a modification to therepayment schedules, requiring only conformity with actual aggregate collec-tions from their customers, would be more conducive to CSI financing.

G. Constraints Arising from the Relationship with Other Institutions

4.40 ASKRINDO. According to its policy ASKRINDO, which insures 75% ofthe KIK/KMKP loans against all commercial risks, pays compensation to handlingbanks if borrowers have been in default for more than three months after thedue date. The mission observed in its discussions with several handlingbanks, however, that they were often dissatisfied with the time required byASKRINDO for the settlement of claims. A standardization of collectionprocedures in the form of guidelines to be agreed upon between ASKRINDO andthe handling banks, recommending, inter alia, collection letters interspersedwith plant visits, should contribute towards a more rationalized and speediersettlement of claims. These problems should also be dealt with in the studyon ASKRINDO's policies and procedures with respect to KIK/KMKP operations,called for in the context of the Small Enterprise Development Project (CreditNo. 785-IND). Results of the study are expected to be available during1979.

H. Constraints Attributable to Lack of Extension/Consultancy Services

4.41 Managerial and technological levels of CSIs in Indonesia are stillrudimentary. Most of the small manufacturers do not even maintain simplerecords of their sales performance, for instance, to ascertain that theyoperate on a profitable basis. Handling banks are frequently faced with loanapplications for projects whose proponents are not yet able to solve theirmarketing, management and production problems. Since organizationsoffering advice and help on these matters are not widespread and those whichdo exist lack a concerted approach (para. 5.07), it would be unrealistic toexpect lenders to become more involved in CSI financing. Thus a furtherrelative decline in KIK/KMKP financing to CSIs might occur, unless extensionorganizations can provide the required services efficiently in the shape of apackage deal together with the financing. As discussed in the next chapter,effective extension services, essential to CSI growth, would require con-siderable effort and time to become available on an extensive scale. Initially,therefore, some of the procedural impediments can be removed with ease (seeparas. 4.32-4.39).

/1 An alternative to this would be allowing greater flexibility in sector-specific ceilings or greater freedom to the State Banks in setting theirown interest rates within broader limits.

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4.42 Industry Clusters. The already existing extension service facili-ties, in coordination with the available financial assistance programs, wouldbe most effective in the form of "program packages" for industrial clusters.Such clusters are defined as a substantial number of small individual estab-lishments with the same or similar product lines clustered in one particulargeographical area. Program packages for clusters should contain all theessential elements of assistance, ranging from joint raw material purchase,marketing, technical and management guidance to joint production facilitiesand financial assistance. A working group should be established to identifythe clusters with growth potential and the appropriate extension serviceinstitutions to guide them and to develop coordinated, relevant programscontaining the above elements.

I. Assignment of Responsibility for CSI Lending

4.43 Although Bank Negara Indonesia 46 has been assigned prime responsi-bility for all lending to manufacturing industries and related services andconstruction, its KIK and KMKP lending to CSIs only account for 32% and 35%respectively (as of March 31, 1978). Bank Rakyat, on the other hand, which isthe country's predominant source of agricultural finance, has the biggestshare (45% and 48% of all KIK and KMKP loans) in financing CSIs for thereasons mentioned in para. 4.07. The remaining 23.5% KIK and 17.3% KMKPfinance is distributed between the other three commercial state banks andBAPINDO. With its overall share of 2.7%, the KIK/KMKP portfolio accounts foronly a small portion of all outstanding lending to manufacturing industries.These modest achievements indicate that the KIK/KMKP program has not become awidespread activity in the handling banks. Nonetheless, the existingdependence in Indonesia on commercial banks as intermediaries has advantages,since their extensive branch network can be most responsive to small-scaleentrepreneurs. However, in the context of the KIK/KMKP program no institutionhas evolved so far to satisfy all aspects of CSI financing, including:(a) monitoring the performance of the industrial portion of the program;(b) initiating policy changes if and when required; (c) undertaking subsectorstudies; (d) promoting the program; (e) undertaking research work related toCSI financing; (f) developing program packages for industrial clusters; and(g) encouraging more coordination between financial and technical assistance.It appears desirable to explore the possibility of encouraging one of theexisting banks to become gradually transformed into a lending institution withprime responsibility for financing small industrial entrepreneurs and fortaking charge of the above-mentioned support and coordination functions,while others continue to lend as at present. Also, greater encouragementto cooperative and regicinal development banks for CSI financing in specificclusters and areas would be desirable.

J. Hire-purchase and Leasing in the Context of CSI Financing

4.44 Another channel of CSI financing, complementary to conventionalterm lending (KIK), such as hire-purchase and leasing should also beconsidered. However, not all lending banks should be encouraged to expand

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their scope of operation, as hire-purchase and leasing require specializedorganizational arrangements and training of staff. Consequently, the mostsuitable candidate to introduce hire-purchase and leasing in addition toconventional KIK lending would be the proposed specialized institution forlending to CSI (see para. 4.43). Alternatively, it could be a subsidiary ofthe specialized institution or one of the existing development banks. Inthis context a working group should be established to gauge the prospects andelaborate the details of hire-purchase and leasing for CSIs.

4.45 Hire-purchase may be an effective and appropriate supplement toterm lending, if a recurring demand for specific capital goods has beenidentified. Individual transactions between the dealers of such goods andsmall entrepreneurs would have to be based on a standardized master agreement,to establish the procedural framework for individual hire-purchase transactions(for details see the background papers to this report).

4.46 At first glance, CSI leasing in comparison with KIK lending doesnot necessarily achieve the usual range of benefits except perhaps thatit tends to resolve the collateral issue. The lessor (bank), however, whodoes not normally obtain additional collateral, is likely to be very alertto the lessee's (investor's) performance and wants to see him prosper asthis is his only warranty for repayment. Consequently, the lessor can beexpected to assist the lessee in implementing his project, monitoring hisoperational performance and arranging the necessary technical support.Thus, CSI leasing could be another way to achieve integration of financialand technical assistance as well as an effective adjunct to term lending.

4.47 The availability of technical assistance, in fact, is one of themajor problems facing CSIs. This is discussed thoroughly in the next chapterwhich reviews the existing institutional framework for providing such services,discusses the coverage and approaches of these institutions, evaluates thefunctions and delivery system of technical assistance to CSIs, discusses therole of technological institutes in this effort and provides suggestions forimproving coordination necessary to increase the effectiveness of theseservices to CSIs.

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5. STRUCTURE OF TECHNICAL ASSISTANCE TO SMALL INDUSTRY

A. General Background

5.01 Unfavorable competition between the modern, larger firms and theCSIs in recent years appears to have adversely affected CSI. The establish-ment of medium and large-scale manufacturing units in the early 1970s notonly failed to create the expected number of new jobs due to their capitalintensity, but also led to the dispossession of a significant number ofsmall-scale industries. During 1971-73, according to the Central Bureauof Statistics surveys,/L 54,102 small-scale food and beverage establishments,employing 165,000 workers were forced out of business partly due to the entryof larger firms. Similarly, nearly 15,000 small enterprises in the predomi-nantly indigenous textile sector were displaced with the entry of integrated,fully mechanized textile mills, causing the layoff of 67,488 workers. Othersmall plants engaged in producing miscellaneous products also ceased operationdue to this unfavorable competition, displaying a total of 191,678 workers.Although the rate of displacement may have slowed down somewhat throughincreased government assistance to the CSI sector since 1974, substantialadditional assistance is required to improve CSI's performance, in partthrough the upgrading of technology, technical assistance and by promoting"linkages" to the modern, large-scale firms.

5.02 Small enterprises in Indonesia generally use simple methods ofproduction. Only about 1% of CSIs use any electric power, they work withlocal materials, and produce goods mostly for local markets. CSIs scatteredthroughout the country are mostly owned by the indigenous population. Whilemost of the traditional small industries are family-owned and managed enter-prises, they provide empLoyment and incomes to a large segment of the indus-trial labor force, especially those living in the rural areas. Consequently,the Government intends to promote their development as a means of improvingthe productivity of existing enterprises, creating new jobs in those areasthrough low-cost investment and correcting disparities between rural andurban areas.

5.03 Of late a greater awareness of the unemployment problem has emergedand the need for a new approach is reflected in Repelita III. Recent appoint-ments have included new cabinet members and Director Generals more sensitiveto the needs of CSIs and their problems. To some extent also over the lastyear, some financial inst:itutions have, out of their own experience, begun toemploy extension and technical service workers in the preparation, appraisaland supervision of credit: to CSIs. This environment of concern indicates thedesire to consider how present institutions and programs could be improved tostimulate more rapid growth. The following chapter of the report describesthe present system of technical assistance and suggests ways of strengtheningthe present set-up.

/1 BPS "Surveys of Smal:L Scale Industries," 1971-73. Cited in Sritna Arief,"Indonesia: Growth, Income Disparity and Mass Poverty," 1977.

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B. The Institutional Framework

5.04 Government nonfinancial assistance to the CSI sector consistsmainly of budgetary support to government departments and technological insti-tutions to finance the cost of assistance programs within their respectivejurisdictions./I Technical assistance to CSI is carried out by a multitudeof publicly funded agencies: (a) 29 Departments (or Ministries) of which 14have direct CSI assistance components in their annual development programs;(b) 26 Provincial Governments and representatives of Central Departmentsassigned in the provinces; (c) technological and research and development(R&D) institutions run by the Departments and the Indonesian Science Institute(LIPI).

5.05 In addition, in the last few years, private sector organizationssuch as the Chambers of Commerce and Industry, business and trade associa-tions, local universities, and private consulting firms have begun to take amore active role in helping CSIs, some in collaboration with governmentprograms. The most prominent features of institutional technical assistanceare, therefore, the large number and variety of agencies involved and, asdiscussed below, of approaches adopted. The coordination that is essentialfor an effective delivery of technical assistance by such a vast network ofagencies has not yet developed and results in significant diffusion of itsimpact on CSI. In itself such proliferation is not bad if the work of theseagencies is guided by a consistent set of objectives (i.e. what is to bepromoted and where) and a common framework which would avoid duplication andenhance effectiveness. In the absence of this and proper coordination theaim of greater participation of CSIs in the development process will bedifficult to realize and cost effectiveness of these programs would bereduced.

5.06 The problem stems in part from lack of adequate interaction andcoordination. The overall task of providing financial advice and creditassistance belongs exclusively to the banking system which consists ofnumerous state commercial and development banks, P.T. Bahana (an equityfinance company), and P.T. Askrindo (a credit insurance company) whileassistance on marketing problems, particularly relating to export promotionis handled by the National Agency for Export Development (NAFED). Problemsrelating to entrepreneurial training, skills upgrading, and motivation areshared among the Department of Education (for longer term technological andvocational courses), the Department of Transportation and Manpower, and theDepartment of Industry (for short-term technical training and skills upgradingprograms). In addition, private universities led by the University ofIndonesia and a consortium of 23 universities in the provinces also offer avariety of courses designed to improve the management, business and technicalskills of Indonesian managers. Finally, since 1975, the Department of

/L No exact estimate of the cost of technical assistance outside of theDepartment of Industry's programs can be made, since most of the programsare funded as components of other non-CSI projects. Credit assistanceunder the small credit schemes, however, are presented in Annex I,and budget expenditures under DOI are presented in para. 5.15.

Industry through its project BIPIK ("Guidance and Development of Small-scaleTndus-tr -- II% has beer, as;ine -o nrvd 4 akg ftcncal assistance.L.IUUQ L.i L= J I1 Ut::MI C4M2JLLL1_U LU% IJiL)VV.LUt ji4L V~L. L~=%L L J_±L. 4 1. Lc IL

on production, management and marketing, in an integrated way, although manyof thI'bese f.unLctiLons conti--iLue to bLue perfLormedu b'y otihLer specialized ageric'Les.

5.0 Even w tVithWL th LLis e'labuorate dUegree ofL speciLa'LizatiLon amorLg manyagencies, however, technical assistance to CSI has not produced over timedesired improvement inr production and technology as is shown by extremely lowvalue added per worker in CSI. A combination of factors account for thissituation. Technical assistance programs aim at a natLonwide coverage.Target groups are too broad and diverse; they include both manufacturingand nonmanufacturing enterprises, services and professions. The tLrongemphasis on specialization of functions has prevented an integrated assistanceapproach that could address their problems in concert. This issue is discussed

in the succeeding section. The absence of coordination among the specializedagencies together with the general shortage of adequate staif, oi appropriatephysical facilities, and the poor organization of their functions exacerbatesthe problems and causes delays in the deiivery of assistance. Tnis in turnis influenced or aggravated by lack of a system of incentives - monetary andotherwise - available to those civil servants who are engaged in implementingassistance programs. As discussed below, the present corps of industrialextension service workers is small and lacks the proper motivation, trainingand practical experience to tackle the various problems assigned to it.There are no permanent training facilities for extension service workers.

C. Institutional Coverage and Approaches

5.08 In theory no small indigenous entrepreneur in Indonesia is excludedfrom the technical assistance offered to CSI by the Government. The onlyexclusions from both financial and technical assistance packages are "non-indigenous" (non-Pribumi) enterprises. Also, assistance is directed at allgeographic areas where CSIs are found. Organizing and delivering technicalassistance and consequent supervision on such an extensive scale obviouslymake it an impossible task because of staffing and budgetary constraints.Selectivity is, therefore, essential to achieve any success in this effort.

5.09 Technical assistance of varying extent is given at the central,provincial and municipal (Kecamatan) levels, depending on the type of indus-tries existing in a given geographic area. The scattered cottage industriesobtain assistance mainly from municipal agencies. However, technicalassistance programs are designed and funded almost entirely from the center(Jakarta) where all major decisions regarding the content and direction ofassistance, staffing, recruitment, etc., even at the municipal level, arealso made. This highly centralized decision-making process and policyformulation has often led to costly delays in expediting both funds andexpert help. The extension service should provide a substantial degree ofdecentralization and autonomy to regional offices and field agents in orderto improve the status and effectiveness of the field workers (see discussionin paras. 5.21-5.24).

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5.10 At the central and provincial levels, assistance programs concen-trate on the development of industrial clusters. Each cluster normally has50-100 members or production units. The Government's intention is to assistindividual members of these "clusters" by organizing them into producers'cooperatives. There are in existence an estimated 2,700 such cooperativeswhich the Government plans to strengthen in 1979-83. Once operational,these cooperatives could then act as channels of various forms of financial,technical, and other support./l

5.11 The emphasis placed on "clusters," however, does not precludeattention to the needs of more dynamic, "independent" small firms. TheGovernment is also anxious to assist these firms, which have good prospectsfor growing into modern industries. However, the limited manpower andresources of technical assistance agencies have not permitted increased aidto this category of small industries. Greater attention to this group ofenterprises is needed because they could set an example to weaker firms./2

D. Sources and Functions of Technical Assistance

BIPIK Project and Industrial Extension Services

5.12 The need to provide comprehensive technical assistance to CSIs ledto the formation of the BIPIK (Bimbingan dan Pengembangan Industri Kecil)project which was launched by the Department of Industry in 1974/75 with thebroad aim of helping the "economically weak" segments of the manufacturingsector. This broad objective involved the development of an industrialextension service that would cater to the special needs of CSIs throughoutthe country./3 The BIPIK project was designed to consolidate other agencies'assistance efforts by soliciting (not funding) support from those agencies asneeded. This was an ambitious undertaking in many respects. First theprogram tried to address the whole spectrum of CSI problems over a widegeographic front. Second, inasmuch as the Department of Industry had juris-diction over a relatively small sector of the economy, the Department'sleverage in coordinating and obtaining technical and financial support fromother departments and from banks was relatively weak. While BIPIK's generalapproach is basically sound, at least from a socio-political standpoint, it

/1 The principal functions of cooperatives are mentioned in the backgroundpaper to this report.

/2 Problems of individual and bigger SIs could be covered by direct advisoryservice (similar to the Small Business Advisory Centers in the Philippines)using the operational concept of "integrated plant surveys" (IPS) fordiagnosing problems of individual firms, developing solutions and assist-ing entrepreneurs in implementing suggested solutions. This approach isnaturally more suitable to businesses which are managed by entrepreneursrather than artisans and have growth potential. The effectiveness ofsuch a service is also relatively easier to monitor.

/3 For elaboration of BIPIK's principal functions, see the background paperto this report.

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lacks the organization, resources and "stature" to implement it. It covers awide range of subsectors and extends a variety of assistance to CSIs but overthe last three years its staff constraint has not permitted it to reach morethan a small proportion of the CSI sector. It needs strengthening as well as agreat deal of selectivity and focused attention in its approach.

Organization and Staffing

5.13 BIPIK has 148 staff members, half of whom are extension officersand assigned to field ofEices that are attached to the 26 regional offices(Dinas) of the Department of Industry (DOI). Because BIPIK is an annuallyfunded project and not a permanent unit within the DOI, it has limitedfull-time staff. Out of a total 410 industrial extension workers on a fullor part-time basis, only 160 are under BIPIK and do some extension workbesides other routine, regulatory functions, (and 100 of them are assigned toguide the development of selected clusters). Considering the number ofenterprises in the CSI sector or even the number of groupings or clustersof such firms (312 in East Java and 1,500 in Central Java alone), it is quiteclear that BIPIK does not have the required number of staff to cover itsobjectives. As almost half of BIPIK staff are engaged in extension work onlypart time, they are given "honoraria" ranging from Rp 10,000 to Rp 45,000 permonth which are in addition to their regular salaries. Extension workersworking full time and assigned to individual clusters get Rp 30,000 a month(less than US$50) on average. It is evident that with these conditions BIPIKfinds it difficult to attract and retain high quality staff. Even a limitedprogram of assistance would require a much larger number of trained extensionworkers than are now available.

5.14 BIPIK's sectoral coverage reflects the control and direction thatit receives from the Directorates General (DGs) of DOI. Although policyand program directives are issued by the Secretary-General of DOI, BIPIK'sbudgetary allocation is completely under the control of the DGs andhence coordination between them is essential to speedy authorization anddisbursement of funds for the regional offices. In practice this essentialcoordination of agencies takes time. With the recent formation of theDirectorate General of Small-scale Industries many of these structuraldeficiencies should be corrected, but the need for an increased number offield staff and improved delivery system will remain in the near future.

BIPIK's Principal Activities

5.15 The first three years (1975-78) of BIPIK were basically years ofpreparation and experimentation. BIPIK's budget allocation during thisperiod rose sharply by 73% from Rp 1.1 billion (US$1.76 million) in the firstyear to Rp 1.9 billion (US$3.0 million) in 1978/79. But it was perenniallyunderspent mainly because of difficulties encountered by the staff in designingand implementing suitable projects, in defining target groups, and otherproblems in introducing a new extension service system that relied heavily onthe support of other government agencies for its implementation. Not unusualfor complex projects of this kind, overhead expenses (vehicles, officeequipment, etc.) and operational travel accounted for 50 to 60% of expendituresin the initial years, and the provision of raw materials and equipment toentrepreneurs along with the cost of entrepreneurial training remained

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limited. The main achievement in this period is that for the first time anattempt was made to address CSI problems in a more systematic way. Also, asufficient number of surveys and project profiles have been completed. Theseachievements are in themselves an improvement over the past. It is stillpremature to measure the impact of BIPIK's first three years, and indeeddifficult to do so because there is no monitoring system established. Thisis an essential element that should be included in the project as early aspossible so that managers can learn from past experience and correct deficien-cies./I

The Delivery System

5.16 BIPIK has tried to get maximum use of its meager staff and resourcesby developing modes of delivering assistance to reach the largest number ofCSIs and entrepreneurs possible. These channels of assistance consist of:(a) Regional Development Centers; (b) Service and Demonstration Centers; and(c) Centers of Entrepreneurial Education and Training./2

(a) Regional Development Centers

5.17 The first two centers were located in Jogjakarta to cover CentralJava, and in Surabaya to cover East Java. These two centers are presentlyengaged in strengthening a certain number of clusters within their respectiveregions. One center is planned for each of the 24 remaining provincialcapitals during the Third Five-Year Plan./3

5.18 These centers serve as regional offices for providing raw materials,machinery and equipment combined with technical assistance to CSIs in theregion. These centers are useful as permanent facilities for trainingpurposes at the regional level for extension workers and could also

/1 Despite many practical and conceptual difficulties, initial steps shouldbe taken towards the establishment of a monitoring system. As a first stepthe baseline information on enterprises or clusters receiving TA shouldbe developed from the existing or new studies indicating their economiccharacteristics (e.g. output, employment, investment, productivity,profitability, sales), on fairly broad geographical and subsector activitybases. Then after a certain period of financial and technical assistance,the progress in these variables should be analyzed. Such a monitoringapproach works better if the area/project coverage is well defined and'typical' CSIs are selected for obtaining information over time.

/2 In addition, BIPIK has been asked by the Government to give assistancein other priority areas, such as the development of CSI in areas thathave fewer natural resources, the development of a low-cost fleet ofsmall (up to 40 DWT) cargo and fishing boats, and iodized salt production(paras. 5.22-5.23).

/3 Given the concentration of CSIs in six or seven provinces only, the goalof establishing one center in each of the remaining provincial capitalsis not very practical. It might be more cost effective to have more thanone center in areas/regions of CSI concentration and to improve thequality of their services.

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function as a planning and monitoring agency. Since the first two centersstarted operating with UNIIDO assistance only in 1976/77, it is too early toevaluate their performance.

5.19 Nevertheless, in the short run, the centers should concentrate ontraining extension workers and establishing working arrangements with variousother regional agencies based on specific but limited numbers of clustersinvolved. The clusters :ln which most agencies are interested should beidentified for coordinated action programs (para. 5.48-5.49). In the mediumterm, additional physicaL facilities such as buildings, office equipment, andteaching materials would be required. Technical assistance from local orforeign consultants to draw up and carry out the needed surveys and organizationof functions as well as training of extension workers would also be requiredin this phase.

(b) Service and Demonstration Centers

5.20 These centers are central points in the region where BIPIK'sextension workers conduct training courses for CSI entrepreneurs, providecommon workshop or processing facilities, operate bulk purchase schemes forraw materials, supply machinery for training and production purposes, anddemonstrate new technologies and machinery applicable to the local environment.The service facilities vary with the industries concerned. Nine servicecenters have been established in North and South Sumatra, East and West Java,Bali, Central Kalimantan, and South Kalimantan. These centers are locatednear clusters or groups of CSIs producing rattan products, essential oils,leather shoes, and wood carvings. In addition eight textile service centersand two clothing centers cater to the large clientele of batik and garmentmanufacturers scattered throughout Java, Sumatra, and Sulawesi./l

Evaluation of Service Centers

5.21 Visits to a number of service centers showed that extension officersassigned to these centers have gone little beyond motivating the clustermembers under their jurisdiction to organize into cooperatives. Advicerelating to credit procedures of banks is negligible. Also, advice onsimplified bookkeeping, cost/price analysis and marketing is rarelygiven.

/1 Specialized service and demonstrations centers to help in develop-ing specific products or processes have been set up, and more are beingestablished. In Ceper, Central Java, a service center was set up toprovide more sophisticated facilities for machining the casting producedby 104 small foundries in the district. The service center also obtainsorders and sometimes arranges financing for carrying out the orders.Similar centers are being formed in four other areas to improve thequality, design and marketing of ferrous and nonferrous metal products,electronic components, and forgings. There are also BIPIK-sponsoredspecialized service and demonstration centers for wooden-hulled boatmanufacturing and iodized salt production units.

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5.22 The courses offered at these centers tend to be general and do notfocus on the specific needs of CSI. Consequently, entrepreneurs' interest inattending training courses and seminars in the centers has declined sharply.Attendance fell from about 15,000 in 1975 to about 1,000 a year at present.Given the poor attendance in these training courses, it is now doubtfulwhether they should be offered at all.

5.23 These centers have done reasonably well in the provision of commonservice facilities and equipment too expensive for individual productionunits to purchase, the supply of raw materials and machinery, and basicinstructions on their use but much improvement is still needed to increasetheir effectiveness. Equipment in some centers is either in disrepair dueto lack of funds or replacement parts or is underutilized. No fees arecharged for the use of equipment. A system of partial cost recovery shouldbe gradually introduced to imbue some cost consciousness and financialdiscipline on the part of both extension officers and users.

5.24 The staffing of centers should depend on the type of industriesbeing serviced. The minimum staffing of a service center should be at leasttwo to three extension workers with practical experience in financing,technology and marketing. The team would assist the client directly orrequest the needed support from the Regional Development Center.

(c) Management Assistance and Entrepreneurial Training

5.25 Another constraint that impairs the efficiency, particularly of thelarger units of SIs, is the so-called "management and skills" problem. Formany SIs, rudimentary knowledge of business management is sufficient.However, lack of familiarity with basic concepts of bookkeeping, financialplanning, costing, pricing, etc. as well as lack of access to improvedtechnology that could be adapted to local use, have, among other factors,prevented many CSIs from expanding operations.

5.26 Similar to the organization of other technical assistance to CSI,an extensive network of institutions offer a wide variety of training forboth managers of enterprises as well as workers. As a result, considerableoverlapping takes place among them.

5.27 Among the agencies mentioned above the most extensive, in terms ofgeographic spread and subjects covered, are the nine Vocational TrainingCenters (VTCs) and seven Management Training Centers (MTCs) that are admi-nistered by the Department of Manpower. Since 1970 enrollment has risensharply in all cities. In Jakarta an average of over 2,000 trainees havebeen graduated annually since 1975/76.

5.28 Under the Department of Industry there are also several trainingprograms aimed at improving workers' skills and management capabilities at asecondary level but they suffer from lack of adequately trained and experiencedstaff, teaching materials and equipment due to low funding, and lack oforganization (they overlap functions with those schools operated by theDepartment of Manpower).

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5.29 Entrepreneurial training is also conducted under BIPIK through

short-term seminars and evening classes that cover basic principles of CSImanagement, marketing, technology and financing. Classes are given in

service centers and/or development centers, but those conducted on plant site(i.e. clusters) have been found to be more effective. Because most CSI

workers/owners do not have the time nor the willingness to attend regular

classes away from their place of business, attendance in BIPIK courses hasfallen sharply. In view of the longer experience and relatively betterfacilities, which could be expanded easily by an infusion of funds and

faculty training, of other more established institutions, such as VTCs andMTCs as well as local universities and institutes, BIPIK's training role

should be confined to plant-site instruction dealing with problem solving orwith the introduction of new equipment and techniques.

5.30 For the more progressive SIs, training and managerial needs could

be met better by the universities and institutes offering formal courses on

business and management. The consortium of universities has most recently

completed a series of fairly good project studies for BIPIK./l These couldbe used as case studies for actual field work by student-managers who are

taking the courses. By de-emphasizing the theoretical aspects of training infavor of actual case studies as well as development and demonstration work,involving "real" projects that are being assisted by a network of TA agencies,participants could gain a more structured, supervised, practical experience.

5.31 BIPIK could greatly supplement its manpower resources by using theexisting training facilities of these institutions. It could do this by:(a) channeling or mobilizing funds to different programs; (b) obtaining

foreign aid and TA required by the private institutions which by law would be

disqualified from obtaining such assistance directly; (c) bringing various

teachers to the plant sites or demonstration centers to give seminars and

lectures on specific topics; and (d) exploring other avenues which would"link" these institutions to other BIPIK activities.

(d) Technological Institutes

5.32 Major deficiencies in the CSI sector have been the lack of efficient

but simple production techniques which entrepreneurs cannot afford to buyfrom equipment suppliers and unfamiliarity of entrepreneurs with the various

uses of available local materials. The problem involves design, productquality, low cost but efficient technology, and to some extent marketing(unfamiliarity with consumer preference outside the immediate vicinity of theproduction areas). The G3overnment has recognized these problems and has

established a number of research and technological institutes to conduct bothpure and applied research. But with few exceptions the result of thisresearch does not filter down to the bulk of CSIs who need it most. The

absence of "outreach programs" to extend the services of these institutes isa major constraint to the less progressive CSIs' gaining access to this typeof assistance.

/1 These studies covered 4,158 CSIs engaged in producing rattan andwooden products, leather shoes, metal articles, essential oils, andbuilding materials.

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5.33 Over 100 technological institutes employing nearly 2,000 staff,of whom about 300 are university graduates, are administered by the Govern-ment under the various ministries. Fourteen of these are managed by DOI toprovide technical assistance to industries. A World Bank Report ("Problemsof Industrial Technology in Indonesia," 1973) which assessed these insti-tutions concluded that most are almost completely cut off from internationaltechnology, and from the industries they are supposedly serving. Thisobservation is still valid for the most part although there have been im-portant improvements in the organization, budgetary resources, and recruitmentof professionals by some of these institutes. (See Annex III for a descriptionof the principal activities of individual institutes and major problems facingthem).

5.34 In general the staffing of the 14 MOI-managed institutes wasadequate for the tasks at hand, but lack of appropriate equipment, exacerbatedby lack of contact with relevant technological development abroad and withsimilar institutes in other countries and their orientation to MLI problems,has kept many of these institutes unresponsive to the needs of the CSIsector. Moreover, most of them do not have any extension officers. Therefore,they could not identify CSI needs, find solutions to them, and disseminatethe technical know-how to meet those needs. Most technical assistanceavailable from these institutes is given at the institute itself. BIPIK/MOIextension officers working in the field sometimes request experts from them,but lack of incentives and budget as well as "red tape" often cause delays inthe arrival of these experts. As a result extension officers are reluctantto use these institutes as referral points for technical problems. Thereare, however, some exceptions e.g. the Metal Industries Development Centerand the Institute of Textile Technology of Bandung, the Batik Center inJogjakarta, the Electronic Research Institute in Bandung and to a certainextent the Leather Research and Batik Institutes in Jogjakarta have triedhard to cater mostly to the technical needs of CSI. However, even thoughthese institutes are more reponsive to CSI problems, their impact to date hasbeen limited because of insufficient budget and manpower to support widespreadpromotional and extension activities.

5.35 Any reform contemplated on individual institutes under DOI shouldreemphasize their sectoral specialization but this specialization shouldalso be reoriented to the technical needs of CSI. Assistance required toimprove individual institutes would include more equipment, technical consultants,and larger allocation of budgetary resources. In all instances workingarrangements with and support for extension workers who are in contact withCSI entrepreneurs must be worked out to facilitate dissemination of technicalinformation and feedback on the usefulness of such information to CSIs.

5.36 Close linkage with extension service workers should be given highpriority. Even with present staffing and facilities, most of the institutesare capable of answering questions and suggesting solutions to generaltechnical problems faced by CSIs. Hence, making this knowledge accessible isof prime importance. One of the ways to do this would be to simplify theprocedure for getting experts from these institutes; this is done presentlythrough the central office in Jakarta, whereas many of the institutes arelocated in the regional capitals. BIPIK could significantly shorten thedelays encountered in getting assistance by providing additional compensation

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for the services of experts. Another way would be to develop a corps ofroving extension workers among the institutes who would travel on call fromregional BIPIK offices to solve specific problems and to follow up on imple-mentation. These technical extension workers could also receive trainingwith other BIPIK workers so that personal contact, mutual confidence anduniform approaches could be developed.

5.37 The new consolidation of the research institutes under one singledirectorate in the Department of Industry should make it easier to developthe "outreach programs" suggested above.

E. Other Technical Assistance Programs

Role of the Department of Trade and Cooperatives

5.38 One major technical assistance program of the Department of Tradeand Cooperatives for CSI is the promotion of cooperatives in the field ofproduction, marketing, and material procurement. Assistance is focused onmarketing advice to members of cooperatives, subsidies for low cost, low rentmarket stalls, permanent exhibits, and management consultancy. At present,assistance to CSI by the agency is conveyed through the regional repre-sentatives of the Department. The impact of this assistance has been limited;1,163 CSI entrepreneurs received consultancy assistance in 1977. The numberof cooperatives established and in operation is even smaller because of theabsence of good managers and organizers.

5.43 The cooperative movement, nevertheless, could potentially serve asa good vehicle for assisting the weaker, more traditional segments of CSIsunder certain conditions. A first condition is a tighter organizationalstructure and operational procedure which implies some financial responsibilityfor the benefits derived from the cooperative. Another requirement is anexpert professional management set-up which would provide marketing servicesand arrange needed financial and technical assistance and be responsible forenforcing cooperative decisions. This is not being done at present. Theextension officer assigned to organize the cooperative is often unfamiliarwith market potentials, has no managerial ability and has little contactbeyond the confines of the cooperative. While adequate staff are beingrecruited and trained to help the formation of cooperatives, assistanceefforts in this respect may usefully concentrate on developing a few, care-fully selected clusters that could be developed both to provide neededexperience for extension workers and to serve as models for other cooperatives.

Role of Other Government Departments

5.40 There are other government programs that could provide greater helpin leading CSIs towards more active participation in the development process,if only they were coordinated or linked properly to other programs such asBIPIK. For example, the Directorate General (DG) of Construction (Department

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of Public Works) is undertaking regional and urban development projectssome of which have direct assistance elements for small construction companiesand small producers of lumber, brick, tiles and other materials. To assistsmall producers to meet the volume and quality of materials needed - 150,000low cost housing units are planned for 1979-1983. This DG could provide astrong stimulus and a potentially large market for the building materials andwood-based CSIs. Similarly the DG of Transmigration is stressing use oflocal materials in new areas. To develop this market, however, sufficientincentives are needed such as local preference (say 15% under the bids oflarger enterprises). There may also be a need to introduce a mechanismwhereby large orders can be negotiated and delivery of goods from severalcollection points may be assured. Discussion between BIPIK and the NationalHousing Corporation (Perumnas) on this matter should be resumed to explorepossibilities for bulk procurement from CSI producers.

5.41 Similarly, the DG of Land Transportation of the Department ofCommunications provides common workshops and repair facilities. More directlyit encourages the establishment of small body shops with the cooperation ofthe DG of Metal and Machinery of the Department of Industry.

5.42 The DG of Forestry in the Department of Agriculture is chargedspecifically with the development of the forestry sector which in additionto its major product - log exports - also supplies all rattan and lumberrequired by CSIs that manufacture furniture, wood frames, wood carvingsand other ornaments. Teakwood, which is a main raw material, is growing scarceand local carvers from Central Java (Jepara) and Bali compete with Japaneseimporters for the product. Transport costs and taxes raise the cost oflumber to prohibitive levels. Consequently CSIs in Java and other areasoutside Kalimantan face an ever-worsening prospect of raw material supplyshortages. Together with BIPIK, the DG of Forestry which is charged with thetask of ensuring the availability of lumber supplies for local consumptionshould look into this problem. Rattan and wood products are two productgroups in which Indonesia has a comparative advantage over neighboringcountries.

F. Framework for Coordination

5.43 It is now realized that providing technical assistance to CSIs overa wide front and addressing broad target groups that face different problemsin varying degrees is a much more difficult task than originally thought.This is due to the large numbers, variety, and wide geographic distributionof potential clients, the general skepticism of these clients (usuallyjustified on the basis of past experience) for government-sponsored assistanceprograms, the scarcity of qualified personnel, and the sheer size of thelogistical problems involved. The benefits would be considerably enlarged ifthe following two constraints are overcome: (a) lack of coordination amongagencies providing assistance, particularly between financial and nonfinancialinstitutions; and (b) the shortage of adequate staff with relevant quali-fications to "extend" the technical assistance.

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5.44 No specific mechanism for coordination was established, although

informal cooperation at the grassroots level took place in a number ofproject areas. An examination of this relatively successful informal coopera-tion reveals that in each case, the project was considered of high priorityby all departments concerned, the target group was well defined and theobjectives of assistance were specific. In all cases, the division of laboramong participating agencies was spelled out clearly and strong guidance and

direction was provided by one agency, in this case BIPIK. The cashew nutproject in Central Java, the salt projects in East Java and Madura and theCeper metals project in Central Java are some of the examples in which

effective though informal cooperation among various agencies took place.

5.45 Learning from these cases and considering that technical assistanceto CSI would continue to be provided by a number of institutions, it seemsmore realistic under the circumstances to try to develop a limited form of

coordination based on specific clusters or geographic areas. Simultaneously,while such grassroots coordination is being tried, grounds for a more systematicform of coordination at the highest levels should be prepared: (a) by analyzingin-depth the cases of successful coordination; and (b) by conducting a moredetailed and in-depth inventory of technical assistance programs offered byvarious agencies.

5.46 A limited appcoach to coordination means that the project/areafocus is specific as opposed to a nationwide approach, and involves a limitednumber of agencies. A sample of industrial clusters which have been studiedin depth shows that the average number of agencies directly involved inproviding assistance to industrial clusters is five. They are usually theDepartments of Industry, Trade/Cooperatives, Education, a local bank, and thelocal government. Although no formal coordination now exists this studyhas also found that in the development of clusters, an informal type ofcoordination actually takes place among these five agencies, and where thiscoordination among agencies concerned was strong, there was a quicker, moreeffective delivery of asSistance.

Criteria for Selecting Areas of Coordination

5.47 Selection of many more projects that should benefit from thislimited coordination should be based on a number of criteria. As a firststep adequate baseline information on the target group needs to be obtainedbefore working out the details and objectives of the coordination mechanism:(a) the cluster must be clearly defined; its location, number of units,workers employed, their problems and constraints must be analyzed; (b) thecluster must be as homogeneous as possible, consisting of similar SSI producers,manufacturing one or a few similar product lines since it eases definition oftarget groups and post evaluation of assistance results; (c) the cluster mustshow clear growth potentials; (d) the agencies to be involved must not be toonumerous; (e) development of the cluster must be replicable, i.e. it must becost effective and have high "demonstrative effects" (for both CSI and TAagencies); and (f) it must show potential for leading to linkages with mediumand large industries. If the majority of these criteria are satisfied by acluster then that cluster should become the target of a focussed and coordinatedaction program.

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Mechanism of Coordination

5.48 Even a limited coordination approach to be applied on a largerscale will require a number of major decisions. First, given the presentemphasis on developing various sectors of the economy in which CSI operate,and given the divergent interests of various government departments in thesesectors, GOI has to decide whether this selective approach and the criteriaon which it is based are acceptable. Approval by the highest authorities forsuch an approach is essential because it implies a basic change in policywhich must be followed by all departments involved. Second, one agency mustbe designated as a pro tempore chairman of the coordination committee thatwould be formed among the agencies involved. This agency would serve as asecretariat reponsible for funding and carrying out the necessary studies,surveys, and research needed by the committee. The studies must examine thecharacteristics, technical and financial needs, and growth prospects of theareas to be developed, the enterprises involved, and identify specificconstraints in order to achieve the target envisaged. They should alsoestimate the cost in terms of manpower and budget of the technical assistanceas well as the agencies that could provide such assistance. MOI, actingthrough the newly established DG for Small Industries can perform thistask.

5.49 The problem of mobilizing the funds and resources required todevelop the agreed project could be tackled at two levels: (a) by developinga consistent set of objectives and a common framework for assistance toselected CSIs; and (b) by having BAPPENAS or the Ministry of Finance whichcontrol the budget play a more active role in funding such coordinatedprograms. One way would be to earmark funds out of departmental allocationsspecifically for coordinated programs; another would be to give preferentialtreatment for budget requests based on such a coordinated approach.

5.50 While limited coordination would not reach the vast number of CSIswhich present government programming aims to reach with technical assistance,it could provide examples of effective coordination that would pave theway for a broader technical assistance coverage in the long run.

Strengthening Extension Services

5.51 The success of even a limited coordination approach would depend agreat deal on the effectiveness of extension workers who will "deliver" theneeded assistance to entrepreneurs. This implies a need to strengthen theorganization of present industrial extension services, improving the trainingand quality of extension workers by providing them with sufficient incentives,and increasing the number of such workers. Estimates of the number of addi-tional extension workers needed to carry out TA programs over the next fiveyears has ranged from 2,500 to 3,000. The Third Plan document estimates theneed for 2,650 to be recruited in 1979-1984. Not more than 50 a year can be

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trained under present arrangements. While permanent training facilities arebeing established a considerable part of this demand can be fulfilled byenlisting the support of what one might call "master craftsmen" who canactually teach ordinary craftsmen improved methods of producing articles.

Role of the Extension Worker

5.52 The role of the extension worker would have to be determined inlight of the problems facing CSI in Indonesia: (a) limited choice of technologyand solution to problems of quality improvement, standardization and othertechnical problems; (b) problems of management and work organization bothoperational and financial; (c) lack of access to adequate credit finance;(d) uncertain or restricted marketing prospects; (e) assistance in explaininggovernment regulations: registration, licenses, grants and legal questions.The extension worker, confronted with these problems, can only provide atbest advice of a general. or informational nature that applies to the majority.In defining the role of the extension worker, a few things are important:extension workers should not be overburdened with tasks (e.g. obtainingstatistics) that are not essential in the pursuit of their principal goals.Also, extension services may have to concentrate on problems such as technicalquestions (through referral service) and simple advice on management, book-keeping, etc. rather than on assistance with marketing problems.

5.53 Within this perspective, there are at least two roles that can bestressed, each to be considered depending on the nature and variety ofproblems faced by the particular cluster involved. One role is to have theextension worker play the role of problem solver on specific problems,including plant layout, technical processes, equipment maintenance, book-keeping, etc. These types of field workers are, however, hard to find and totrain in Indonesia, and therefore such a role may not be practical in theshort run, but initial steps must be taken to move in this direction.Another role is that of a referral agent who can diagnose problems, identifysources of assistance, and obtain the same on a timely basis. To a limitedextent this is done by present extension workers, but due to lack of adequatesupport from the various experts and institutions specializing in variousaspects of CSI problems and long procedural problems in getting them to thefield the system of referral does not function properly. The mission hasrecommended a number of ways to minimize difficulties in this approach. Inthe mission's judgement a combination of the two roles mentioned above isdesirable and possible: the extension worker should be able to identifyproblems in most of the areas mentioned above; should be able to do a simpleproblem-solving job in some areas such as work organization, and preparationof loan applications but: he should also know where to find the special advicerequired and how to obtain it. The extension worker should also providefeedback to the Government and technological institutes on the needs andproblems of CSIs so that: the right policy responses and work programs can beformulated.

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5.54 Simultaneously another experiment, although somewhat new toIndonesia, should be tried. This involves the recruitment of selectedsuccessful small entrepreneurs or craftsmen who either have been successfulbeneficiaries of past extension service or who achieved success on their own,to provide expert, practical advice as needed. These "experts" who have(presumably) encountered similar problems in the past, under more or less thesame conditions, and successfully overcome them could provide a substitutefor expensive consultant services. Because they are located in the sameregion, these entrepreneurs could also be mobilized more quickly than gettingan expert from Jakarta or some other Regional Technological Institution. Inorder to induce them to leave their companies or production units even onlyfor brief periods at a time, however, adequate incentives and compensationfor their services will have to be provided. Incentives could be in monetaryform (such as fees, expenses, per diems), but experience shows that nonmonetaryrewards symbolic of the official recognition and appreciation of theseexperts' services (e.g. an official certificate, publicity in local papers,TV, etc.) are also important and sometimes work even more effectively. As afirst step, the preparation of an inventory of qualified and interestedpersons willing to do the job is needed. In this effort, the artisans'organizations and private trade groups should also be involved. The potentialfor involving private groups and associations is considerable.

5.55 Since this scheme of recruiting experts from the ranks of successfulentrepreneurs or craftsmen is a new approach, it has to be tried on a limited,experimental basis at first. Its main advantage lies in its relatively lowercost; practical slant, its relevance to the task involved, and the closefamiliarity of these entrepreneurs with the problems involved. The firstexperiment should deal with a fairly limited cluster area that has cleargrowth potential. Preferably the entrepreneurial "experts" to be recruitedshould come from the same region or geographic vicinity so that they would befamiliar with local production processes involved (technologies vary byregion in some specific products such as brick-making, rattan, and woodcarving), sources and types of raw materials available, equipment suppliers,and local marketing channels. Because they are familiar with the businessthey could also advise on cost/price structures of specific products involved,product design, and consumer preference.

5.56 In addition to an assessment of the ongoing programs of financialand nonfinancial assistance to CSIs, which were the subject of this and theprevious chapter, the mission also evaluated the existing policy and incentivesframework within which CSIs operate. An understanding and evaluation of theexisting policy and incentives environment is essential because if theenvironment is favorable to the development of CSIs, they can progressmuch more than they would otherwise do with a given level of other supportprograms. This is the central theme of the next chapter aiming at recom-mendations on action programs and active government policies as well asadministrative set-up to ensure that CSIs have reasonable opportunities andconducive environment to actively participate in the development process.

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6. PROPOSED INCENTIVES AND POLICIES FOR THE DEVELOPMENT OF CSIs

Introduction

6.01 The first section of this chapter recapitulates the problems andconstraints confronting the majority of CSIs at present. This is followed bya brief discussion of the Government's development objectives in Repelita IIIand the contribution that CSIs can make to their achievement. In view of theproblems facing CSIs and the development objectives of Repelita III, the lastsection of this report outlines a strategy which, in the mission's judgment,would facilitate greater and more active participation of CSIs in the nationaleconomy.

A. Problems and Constraints Facing CSIs

6.02 In the previous chapters we have shown that the cottage industriescomprise about 1.23 million establishments, most of which (94%) are locatedin rural areas with very low productivity (only 3% of that in medium andlarge-scale enterprises). Only one out of every 13 CIs hires labor. Similarly,a typical small industry (SI) establishment engages only seven persons and95% do not use any electric power, showing very low capital intensity.Almost 86% of the industrial labor force is employed by cottage and smallindustries (CSIs) but they produce only 22% of the gross value added. Thissegment of the industrial sector has been lagging behind the rest of themanufacturing sector, but the problems involved in improving and bringinginto the main stream the mass of industry, consisting of numerous small unitsor artisans, are formidable and the report argues for selectivity in theprograms of support designed for such industries.

6.03 CSIs have numerous disadvantages: the establishments are extremelysmall in size; they follow mostly traditional technology; their manufacturingoperations are dominated by traditional industries most of which facestagnant or sluggish demand for their products; and they generate very little"surplus" for reinvestment or expansion of their activities. To overcomethese problems, therefore, the following areas require improvement: technologyand management (product design, production and work methods, materialselection, quality control, bookkeeping, etc.) and the arrangements toovercome technological deficiencies; the availability, access and suit-ability of finance that CSIs in general need but do not at present get; themarketing arrangements; the various inputs with which the CSIs work; andabove all, the existing policy and incentives framework.

B. The Planned Industrial Development

6.04 The overall manufacturing sector also shows a number of characteristicswhich have a bearing on CSI-related policies. They are: (a) the relativelysmall (10%) share of manufacturing in total employment and slow growth inindustrial employment; (b) the low share of manufactured goods in merchandise

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exports (2-3%) and the sector's heavy orientation to the domestic market;(c) the predominance of the consumer goods subsectors; (d) the over-concentration of manufacturing activities in Java and urban centers likeJakarta; (e) relative underdevelopment of the machinery and engineeringsubsector; (f) the big technological gap between the traditional small-scaleand the large, modern manufacturing sector and the lack of linkages betweenthe two; and (g) the high dependency on imported capital goods and rawmaterial of domestic manufacturing industries.

6.05 It is being increasingly recognized that while large-scale projectsin a resource rich country are required at some stage of development, theymust form part of the overall efforts and must be accompanied by developmentof other industries that contribute to the employment of a large part ofthe population. Without an employment-oriented strategy in the industrialsector, yearly additions of at least 1.44 million persons to the labor forcewould threaten the orderly development process and gains of past developmentefforts.

6.06 The Third Plan (Repelita III, 1979-84) synthesizes the Govern-ment's development objectives and outlines the contribution which each sectorcan make to their achievement. The chapter for industry defines four broadgoals as mentioned below.

6.07 Expansion of Employment. This has become the primary targetbecause of dissatisfaction with the performance of Repelita II in this area.Only half the previous, admittedly ambitious, target of 240,000 new jobs p.a.in industry was reached and the employment creation that did take place wasin the CSI segment of the manufacturing sector rather than the result ofprojects in large-scale industry. Employment creation is now recognized asan essential means of distributing the benefits of economic growth to a widecross section of the population. The plan aims to add 1,114,200 workers (ofwhich, 434,000 in CSIs) to the industrial labor force during the period1979-84.

6.08 Growth of Output. It is planned to increase industrial outputby 11% p.a. in real terms, increasing value added (at constant 1978 prices)by Rp 785 billion during the plan period. Only Rp 60 billion (or about 8%)out of the increment of Rp 785 billion is expected to come from CSI. It isanticipated that the share of manufacturing in GDP would reach 15% at the endof the plan period.

6.09 Balanced Expansion of Each Category of Industry. These categoriesare defined as:

(a) Strategic Industries: basic industries such as steel, chemicals,fertilizers, paper, cement and oil refining.

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(b) Consumption Industries and Final Product Industries: thiscategory would appear to cover all finished products soldto consumers, both consumption goods (e.g., processed foodsand textiles) and consumer durables such as television setsand cars.

(c) Traditional Industries, Artistic Crafts and Cottage Industries:

this category seems to overlap with the second in a number ofproduct fields; the only measurable distinction is the sizeof enterprise (less than 20 workers) and power/capital inten-sity (less than 20 hp per enterprise and less than Rp 250,000capital per worker).

6.10 In practice, it is difficult to define what should constitute"balanced" growth between these categories. The policies and programs devisedfor the promotion of each category should have a significant impact (bothpositive and negative) on the others [particularly on (b) and (c)]. The plansets the following growth targets for each category:

Incremental output Incremental InvestmentRp billion investment per job

ICOR 1979-84 Rp bln. US$/a US$/a

Strategic industries 3.4 276 976 2,351 50,000Consumption industries 3.0 438 1,314 3,166 5,000CSI 1.5 60 90 217 500

Total 785 2,380 5,734 not given

/a At old exchange rate of Rp 430 = US$1.

6.11 The goals and targets specified above raise a number of questions.What specific measures will be adopted to make the consumption goods indus-

tries more successful in generating employment than they have been in thepast? If this sector is defined to exclude CSI establishments making thesame or substitute products, it would seem that the new jobs which have beencreated in new industries and enterprises have been cancelled out by laborreplacement in existing firms resulting from further mechanization. If thesame incentives and pattern of investment are followed, is there a risk thata rapid expansion of output in the medium/large enterprises making consumptiongoods would be at the expense of employment/output levels in smaller firmsin the same product fields (see para. 5.01 above)?

6.12 Even if these substitution effects are avoided, can CSI reasonably

be asked to provide more than 434,000 new jobs? Should the strategic aim

be to begin to transfer labor from the household/cottage sector to the smallfactory sector so that its productivity and earnings are raised and thelonger term viability of the existing jobs is assured? If the estimated

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ICOR for the CSI sector is correct (1.5), it suggests that small firms couldcontribute a larger share to output with given levels of investment. Why,therefore, is it planned that less than 4% of incremental investment will goto the sector?

6.13 Are all the so-called strategic industries really of strategicimportance at this stage of Indonesia's development? They will absorb37% of industrial investment funds yet provide only 4% of the new jobs.Should a sharper distinction be made between those strategic industrieswhich could provide vital inputs into other sectors (e.g., engineeringindustries which happen also to be relatively labor intensive) and thosebasic industries for which Indonesia possesses no particular comparativeadvantages and where world competition is intense (e.g., petrochemicals,steel, plastics)? Would it be better to buy the latter type of basicmaterials from the cheapest international source and use the investmentcapital saved to equip a much larger number of workers in industrieswhich would transform these materials into competitive products to be soldon world markets and into products for domestic consumption which would becomplementary to existing traditional products? More detailed studieswould be needed before these questions could be answered with confidence.Such studies deserve high priority because the implicit assumptions lyingbehind some of the Repelita III targets are by no means self-evident.

CSIs and the Third Plan (Repelita III)

6.14 The Third Plan calls for a growth rate for the CSI sector of7% p.a., up from the 5% p.a. growth estimated by the Bank for the previousfew years, which would enable it to contribute 12% to the manufacturingsector value added and is expected to generate 434,000 jobs. The plandoes not elaborate the underlying assumptions, and more importantly, the poli-cies, to achieve these targets. This is perhaps due to the paucity of base-line data on which the projection is based. During the first year of the Plan,attempts should be made to assemble a statistical base to develop reliableand consistent time series that would show the growth trends and provideguidance for a rational direction of assistance programs. Another census in1979/80 might be desirable to determine the nature of structural shifts sincethe last census in 1974/75. But further research and statistical work shouldnot and cannot postpone immediate action. On the basis of existing knowledgeand government programs, what policies are likely to enhance the contributionthat CSI can make to Indonesia's basic development goals?

6.15 First of all, the development budget allocated for the CSI sector,amounting to Rp 50 billion (exclusive of the credit assistance) reflects onthe whole the new emphasis of the Third Plan but is inadequate for the taskinvolved. The budget allocations are presented below:

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Table 6.1: ALLOCATION OF DEVELOPMENT BUDGET FOR CSI(1979-83)

Third FYPbudget % share

Type of expendizures (Rp billion) of total

I. Extension Service:s 20.5 41.0(a) Production assistance 6.5 13.0(b) Marketing assistance 6.5 13.0(c) Entrepreneurial training 7.5 15.0

II. Raw material/machLnery assistance 21.7 43.4

III. Data collection & processing 2.0 4.0

IV. Training of extension workers 1.6 3.2

V. Overhead 4.2 8.4

Total 50.0 100.0

Source: Third FYP Document. Reclassification of expenditures was done bythe mission.

6.16 Although nearly 85% of the budget is allocated for extension servicesand raw materials support (as in the previous plan), there are increasedallocations for marketing assistance, data collection/processing and trainingof extension workers - three important areas in which the overall assistanceframework has been deficient. An additional 2,650 extension workers are goingto be trained over the next five years, an overly ambitious target whencompared with about 300 extension workers trained over the last five years andin view of the existing training facilities. Additional budgetary resourceswould be needed for this task as well as for marketing assistance.

C. Policies and Incentives for CSI Promotion

6.17 Even with the desired increase in the budgetary resources, themission feels that the policy and incentives framework is equally, if notmore, important for the success of promotional measures. The discussion andrecommendations below will incorporate some of the instruments alreadysuggested in the Plan. The approach suggested below is based upon thefollowing strategic considerations.

(a) General Considerations. There are too many CSI establishments intoo scattered locations for government assistance to reach morethan a small proportion of this target group directly. Governmentshould, therefore, seek to use the services of intermediaries

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already operating within the economic system to disseminate whateveressential inputs CSI producers need to improve their performanceand/or welfare. Only in this way can CSI be given adequate accessto resources.

(b) Improved access to critical inputs alone is not enough. The extentand effectiveness with which available inputs are used dependson the structure of incentives facing both CSI producers and theirintermediaries. Perhaps the most important role for Government isto design and implement policies which increase the demand for CSIproducts. If marketing opportunities expand, the response of theCSI producers and their intermediaries is not likely to be inhibitedby a lack of motivation.

(c) Direct government intervention would be most useful in the formof demonstration projects and common workshops. These could bethe means of trying out new approaches in few areas (both geo-graphically and sectorally) and of monitoring the effects of itsglobal policies. But if such projects are to be replicable on awider scale, it is essential that they have a built-in evaluationsystem which encompasses the indirect policy instruments andintermediaries as well as those inputs provided directly byGovernment. /l

6.18 The policy lines and measures suggested below do not representa fundamental reshaping of the incentives framework in Indonesia. However,emphasis is on giving serious consideration to the role that CSI shouldand can play, in its limited way, to contribute to the major goals of thenational economy and on taking appropriate actions to capitalize on thepositive strength of this segment of the manufacturing sector. This reportonly illustrates steps which should be taken if CSI's contribution is to bepositive and lasting. If new areas are to be singled out for highestpriority they are the elaboration and implementation of schemes relatingto the public procurement system, hire purchase companies and subcontractingmechanism all of which should broaden the demand for CSI products, inducelinkages between CSI and larger industrial units and facilitate CSI involve-ment in the development process through the "virtuous" circle of greaterdemand, larger profits, more investable surplus, greater production and moredevelopment.

Removing Certain Constraints

6.19 An easy and smooth access to finance and relevant technologyare important in determining the growth path of existing and new CSIs.These are discussed in the previous two chapters and integrated into abroader framework in this chapter. However, there are also some constraintson CSIs entering into particular sectors or locations due to:

/1 Ways of translating these broad strategic considerations into specificactions are discussed in paras. 6.20-6.46 below.

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(a) license regulations which restrict the number of firms engaged insome industries; in sectors where considerable excess capacityexists (e.g., jute bags), but they have also been applied inthe informal transport and food processing/vending sectors with theaim of reducing urban congestion. It is recommended that thesecontrols be employed very sparingly or abolished; they reduce thecompetitive stimulus to efficiency and encourage the misuse of thediscretionary power given to the licensing authorities;

(b) residential permits, designed to curb rural/urban migration, butwhich may also 'prevent migrant craftsmen and CSI entrepreneurssetting up manufacturing establishments in close proximity to theconsumers with the highest disposable incomes; by restricting thesupply of cheap, relatively unskilled labor to new large-scaleenterprises within urban areas, these residential controls may alsohave encouraged further capital/labor substitution; they are,therefore, incompatible with the Government's goals of reducingincome disparities and accelerating employment growth and should beremoved; and

(c) a foreign investor is not allowed to enter into partnershipwith "non-pribumi" Indonesians and joint ventures often findthat when selecting middle managers or other personnel, the choiceof a non-pribumi candidate is not encouraged; the opportunities andincomes of the "economically weak" will be enhanced by makingfull use of the skills available within the country and by extendingthe areas of collaboration between persons with relevant nationaland international experience even if on a limited and selective basis.

Increasing the Flow of Critical Inputs into CSI

6.20 Capital. One of the most important inputs needed by the majorityof CSIs is capital. There are a number of ways in which the flow of capitalto deserving CSIs can be improved. First of all, the major credit programsof the banking institutions - KIK and KMKP - can be improved by: (a) intro-ducing greater use of "program packages" or group loans supported by extensivesubsector analysis and intensive provision of advisory services to selectedindustrial clusters; (b) simplifying appraisal procedure, e.g., using point-scoring systems rather than conventional appraisal methods relying tooheavily on collateral; (c) simplifying and standardizing disbursementprocedures in accordance with the progress of the project; (d) increasingASKRINDO's (Insurance Company) repayment guarantee coverage; (e) removing asevere shortage of sufficiently qualified and experienced bank staff for theappraisal, supervision and collection tasks; (f) placing less reliance oncollateral (now 100%) and paying more attention to prospective cash flow;(g) raising the individual loan ceiling for investment funding; (h) extendingthe loan maturity; (i) making BI's rediscount coverage uniform for both KIKand KMKP; and (j) eliminating or' at least reducing banks' bias against newenterprises by encouraging subsector studies illustrating their growthpotential.

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6.21 In addition, the flow of capital to CSI can also be increased byencouraging one of the existing banks to gradually develop into a lendinginstitution with prime responsibility for financing small industrial entre-preneurs and serving as a financial services coordinating entity (para. 4.43).In this respect the relative advantages of cooperative banks should also beexplored.

6.22 Equipment Leasing/Purchase Arrangements. Similarly, the establish-ment of a hire-purchase and leasing company specializing in industrialequipment - perhaps as a subsidiary of a specialized CSI lending institutionor a development bank - could be an appropriate supplement to term lendingand another way to achieve integration of financial and technical assistance.Also, encouraging closer collaboration between the technical advisory services(including the technological institutes) and the banks in order to reduce therisk of lending to CSI would be extremely helpful in inducing a greater flowof resources from the financial institutions. Special legislation would beneeded to facilitate the establishment of hire-purchase and leasing companies.

6.23 In addition to the direct lending by banking institutions,the mission believes that selected traders can also be used to increasefinancing to CSI, if the banks increase the volume of credit to tradersproviding working capital to CSI enterprises (particularly cottage indus-tries) which cannot qualify for direct assistance from the banks becauseof inadequate collateral or lack of proper accounts. Also providing long-term loans to traders to facilitate their "backward integration" into small-scale manufacturing activities in product fields in which the integration ofproduction and distribution functions result in more efficient overalloperations would be helpful.

6.24 Finally, if foreign trading companies are allowed to set upexport marketing subsidiaries, perhaps under the supervision of NAFED, theyare likely to supply working capital to CSIs. One can also expect beneficialresults if contacts between manufacturers' associations in Indonesia andabroad are encouraged to form partnerships between foreign small industryenterprises and Indonesian CSIs. Some capital resources of big companiescan also be channeled towards the CSI sector by making it a precondition forBKMP approval of their large-scale projects that a certain proportion of theinvestment will be spent on equipment to be made available (on loan or hirepurchase) to small firms supplying semiprocessed materials and components bythe project; special incentives could be devised for this purpose, e.g.,higher investment allowances on such equipment or exemption from sales tax onthe inputs supplied by the CSI producer using this equipment.

Technological and Extension Services

6.25 The second most important input required to raise the productivityand performance of CSIs is improved technology. In this respect the need foran effective and better focussed technical extension service is urgent. Asubstantial part of Chapter 5 of this report is devoted to the discussion of:(a) weak coordination among technical extension services and technical

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institutes on the one hand, and lack of coordination between financial assistanceand technical assistance programs on the other; (b) inadequacy of personnelat all levels of assistance administration; and (c) the poor organization ofthe delivery system which diffuses its impact on CSIs.

6.26 On the question of coordination, it is proposed that:

(a) coordination should be confined to only the few (a maximumof five) agencies that are directly needed to meet the needsof a specific project or cluster of CSIs in a given area;

(b) DOI should be designated as pro tempore coordinator of theextension work carried out by many agencies;

(c) to achieve the above, the target of assistance should alsobe limited, given manpower and other constraints, to a fewselected CSI projects/clusters that show growth potential;

(d) this limited coordination approach should be further reinforcedat the highest levels through the normal budgetary process;and

(e) specific steps should be taken to prepare for longer term, morepermanent form of coordination as well as extension personnel.

6.27 Staffing constraints require both long and short-term solutions.In the long run, there is need to:

(a) establish permanent training facilities for industrial extensionofficers;

(b) introduce a system of remuneration and incentive that wouldpermit the recruitment and retention of good quality staff;and

(c) develop extension services for technological institutes.

In the short to medium-term:

(a) recruit a team of experts to be based in CSI Development Centersto serve "on call" the needs of field extension workers;

(b) assess the capability of various technical and other governmentagencies that could provide support to extension workers inthe field;

(c) phase out the general training functions of DOI's Service Centersand limit the training work to inplant training, demonstration andinformation; and

(d) strengthen linkages with, and rely more heavily on, the use ofexperts from other departments in matters of training,marketing, and bulk procurement.

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6.28 To improve the delivery system of technical assistance under presentcircumstances, short-term interim measures should be taken soon. The followingsuggestions are made:

(a) employ a team of 2-3 experts to man centers that are locatednear CSI units. These experts could include technical, marketingand banking experts;

(b) strengthen the support of service centers by the developmentcenters;

(c) recruit the services of experienced CSI entrepreneurs to providepractical advice on CSI problems; and

(d) limit the project/area targets of extension service workersto the growth-oriented industries so that technical and othermaterial assistance can be concentrated and reduced to manageablelimits.

Measures for Technological Improvement

6.29 In addition to the extension services managed directly by theGovernment, several other indirect incentives and measures can be introducedto reinforce the government assistance programs in this area. For example,the Government should consider providing the same infant industry protectionto the indigenous engineering industry as is given to other subsectors, byremoving duty and tax rebates on imported machinery and spare parts from thepackage of incentives provided to BKPM-approved projects and by increasingtariff rates up to the median for imports in general (say up to 20%)./1

6.30 Similarly, the Government can provide special incentives (tax con-cessions, etc.) for foreign engineering companies specializing in processingequipment for the industries in which CSI establishments predominate (foodprocessing, textiles, wood products and building materials) to establishjoint ventures with Indonesian engineering firms; this would make the histori-cal experience of these engineering companies more readily available and allowa wider range of technologies to be tapped; as a result of their direct exposureto the Indonesian environment, more appropriate technological choices would bemade, often (but not necessarily) in the direction of greater labor intensitythan current imported technology.

/1 The rationale for this proposal is that an indigenous engineering industrywould design and manufacture equipment better adapted to Indonesia'sfactor endowment than that presently imported, but it needs an initialboost before it can become established and realize its potential;a strengthened local engineering capacity could devote more resourcesto the task of raising technological levels in the traditional sectorsof the economy.

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6.31 The Government can also:

(a) provide fellowships for key personnel in Indonesian engineeringfirms to undertake training/study tours in other Asian developingcountries which have successfully developed technology suitable forCSI (e.g., Korea, Taiwan, Philippines, India and Pakistan);

(b) develop closer collaboration between the various technologicalinstitutes (e.g., metal, ceramic, leather) with R&D functions andthe engineering firms capable of solving the problems in prototypemodels and providing the commercial drive and technical know-howneeded to get the innovations installed and actually workingin CSI enterprises; and

(c) widen the market for power-driven machinery in rural-basedCSI by reducing the initial connection charges or recoveringthat cost over a longer period of time.

6.32 Other measures should aim at:

(a) increasing the relevance and effectiveness of programs undertakenby technological institutes by getting the more dynamic CSI entre-preneurs involved in their functions, and by imposing a 'Levy on themembers of manufacturers' associations (larger firms) to provideadditional funds;/1

(b) building up ext:ension training services provided by these insti-tutes /2 and giving adequate financial and professional incentivesto the staff to undertake the travelling that would be involved;and

(c) arranging for t:winning these institutes with their counterparts inother countries, to facilitate the exchange of know-how and experiencein specialized areas.

6.33 Yet another way to reduce the costs of transferring technical know-how is by utilizing mass communications such as radio programs teaching basicaccounting methods; mobile vans to tour villages demonstrating new designsand production techniques; programmed-learning texts for self-instructionby artisans and entrepreneurs; and a commercial trade press producing periodictechnical journals and information bulletins for specific subsectors./3

/1 If manufacturers have to pay part of the costs of the services providedby these institutes, they will ensure that they get adequate returns.

/2 By hiring technically competent staff with practical working experience.

/3 In developed countries, such journals are an important source of infor-mation about technical and marketing trends for busy entrepreneurs; govern-ment subsidies or other incentives may be necessary initially in Indonesiauntil the publishing houses can build up large enough circulations to beself-sufficient.

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Suggestions for Raising Skills

6.34 In general, there is a need to increase the quality and not justthe quantity of labor inputs to CSI. Formal, institutionalized training pro-grams for the CSI sector are discussed elsewhere in this report. Butmany small-scale entrepreneurs and employees in small firms have difficultyin finding time to attend training courses or cannot afford to sacrificeearnings for this purpose. Skill formation has generally to take placeon-the-job or in the home. In this case, the most effective agents forraising skill levels are intermediaries providing other inputs. New skillsare acquired most readily, and can be put to immediate use, when theyare linked to a new piece of equipment, new materials, a new design or a newloan. The suppliers of these inputs often prove to be the most capable"instructors" because they are not only thoroughly familiar with the inputin a variety of uses and situations but also have a commercial self-interestin seeing that each customer gets the most out of it. Even in the moreabstract area of management techniques, perhaps the best way to introducebasic accounting or production/stock control systems to CSI is via thesuppliers of office stationery (e.g., ledgers) and business machines (e.g.,cash registers and filing systems), rather than through classes given bygovernment extension officers who have never had occasion to put thesetechniques into practice

Measures for Greater Material Supplies

6.35 The majority of CSI producers are processing indigenous materialsat present. As we have noted, although considerable improvements couldbe effected, the distribution network for these materials appears to functionreasonably well. Supply constraints exist mainly in basic foodstuffs wherethe increase in agricultural output has not kept pace with the increase indemand and the shortfall is being met by imports which have already beenpartly processed (e.g., rice, soybeans). Policies which result in higheryields of the major crops are likely to have positive effects on output andemployment in small-scale industry in the long run. More immediate resultsmight be achieved by action to improve the flow of imported materials tosmall manufacturers:

(a) allocation of substantially larger foreign currency loans totraders importing such materials (e.g., cloth, scrap metal,plastics, metal fittings); and

(b) authorization for foreign companies exporting materials, compo-nents and equipment to Indonesia to set up a sales/distributionnetwork; at the moment, if they do not have a manufacturing faci-lity within Indonesia, they can appoint only one representativein one location - no branches are allowed; they cannot engage inactual trading activities; this provision restricts CSI's accessto competitively priced materials (and related know-how) whichthey need if they are to meet the competition of large-scalemanufacturers (who can import directly) or use their low-costlabor to break into export markets.

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Marketing Improvement

6.36 Any action taken to improve the supply of inputs into CSI or raisingtheir skill levels should also generate an increase in demand for its products,either by reducing relative costs/prices or improving quality. Demand can befurther stimulated by:

(a) widening CSI's access to domestic markets through

(i) provis:Lon of funds to municipal authorities to enlargethe public markets by building low-cost/low rental shops forsmall traders and producers; market facilities have not keptpace wLth population growth and high premiums (key money)have to be paid for existing space; there seems to be agross disproportion between the outlays on administrativeoffice buildings and what has been spent on amenities forlow/medium income shopping areas.

(ii) until these amenities are adequate, removal of restrictionson petty traders purveying their wares in residentialneighborhoods or along the main traffic arteries intocities; lay-bys could be designated for this purpose.

(b) removing "unfair" competition by

(i) charging the full economic price for leased factory buildingson industrial estates, for power and water supplies and forpublic freight transport provided for large-scale producers;

(ii) requiring public sector enterprises to progressively movetoward recovering their full costs and paying a positiveinterest rate on borrowed capital;

(iii) gradually replacing capital-linked incentives (e.g. invest-ment allowances and accelerated depreciation), which benefitthose with access to large capital sums, by labor-linkedincentives (e.g. training grants and payroll subsidies)which would be accessible to all sizes of enterprise indivi-dually or collectively.

(c) facilitating exports by:

(i) allowing foreign trading companies to establish exportsubsidiaries or partnerships in Indonesia;

(ii) granting import duty and tax rebates on CSI exportssold by trading companies;

(iii) reducing port handling charges by allowing privatesector competititon with the public forwarding agentsand other port services;

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(iv) encouraging open collaboration between traders (includingminority ethnic groups) and indigenous artisans in exportmarketing and providing both groups access to the creditfacilities of the public banking institutions;

(v) promoting international subcontracting by offering employment-related incentives to international firms and by givingadequate protection for their patents and designs within thedomestic market.

(d) raising the incomes of the poor who tend to have conservative tastesand a high income elasticity of demand for traditional manufactures;a variety of policy instruments, e.g. continued growth in agriculturalproductivity, could contribute to this goal; all the measures takento develop CSI should in fact help to create a "virtuous circle"which will lead to higher demand for its products./l

6.37 Furthermore, CSI producers would benefit substantially if measurescould be introduced to reduce product substitution among the higher incomegroups. CSI producers appear to obtain a small share of the disposableincomes of the upper income groups because of a shift in their preferencestoward "modern" products made by large-scale industry (abroad or domestically).In part, this arises from various subsidies indicated above. If this unfaircompetition were eliminated, there would still be many products which couldbe made more cheaply on a large scale, or which require modern technology ifthey are to be made at all. There are other product groups in which economiesof scale are less pronounced or can be offset by advantages of localizedproduction (e.g. saving in transport costs). But noneconomic factors tendto influence the pattern of demand in this area; the strength and persistenceof demand for traditional products capable of being made economically insmall-scale, labor-intensive units will often depend upon the extent towhich cultural traditions permeate the whole community and whether thebehavior of the elite tends to reinforce or to break down these traditions.It has been argued that the centuries of cultural isolation experienced byJapan before the Meiji restoration created a cultural homogeneity andsolidity which allowed indigenous producers with limited resources tosurvive the abrupt exposure to foreign technology and products. A "westerni-zation" of Japanese consumer tastes and way of life has certainly occurred.But the process has been sufficiently protracted to give time for traditionalproducers to adjust by adopting improved technology, diversifying intonewer product fields or finding employment in other sectors. This progressiveadjustment would not have been possible without the continued loyalty ofJapanese consumers and to some extent the commitment of their elites to smallindustry promotion.

6.38 It is difficult, if not impossible, for a government to reproducea Japanese-style development process by deliberate policies. Indigenouscustoms and tastes have, however, survived rather better in Indonesia than insome other countries. They may be strengthened (or, at least, the pace oferosion may be slowed down) by conscious "style-setting" behavior by politicaland social leaders, reinforced by advertising and the mass communications

/1 The Bank is currently designing a study which would provide some guidanceon this phenomenon.

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media. Thus, for example, batik dress may be adopted for everyday wear inoffices and schools and not just for ceremonial occasions; the decor andfurniture chosen for offices and classrooms could utilize rattan, bamboo andplaited fibres rather than prefabricated metal units; and some officialbuildings could be constructed with brick walls, ceramic floor and rooftiles and wooden doors and window frames - small industry products - ratherthan from concrete and aluminum alloys.

6.39 In these and other areas, the choice seems to be determined as muchby fashion or by simply adopting the design standards of foreign consultants(influenced by a quite different cost structure in the country of origin) asby considerations of price or efficiency. All of these "official" choicesshould be scrutinized by the planning authority (BAPPENAS) to make sure thatthe buying power of the public sector /1 is used to further national develop-ment goals (including greater employment generation) and set a good examplefor the rest of the society.

Public Sector Procurement

6.40 More importantly, the demand for CSI products could be increased ina substantial way by modifying government procurement practices to give equalopportunities to small-scale producers. CSI tends to get a small share ofgovernment purchases because most small firms, acting individually, cannotmeet the following requirements:

(a) standardized specifications, often needing an ability toread drawings and blueprints;

(b) tendering procedures, involving a lot of paperwork,detailed costings, readership of the official gazette, etc.

(c) large orders and bulk deliveries;

(d) advertising and "public relations" expenses to make the firmand its products known to the purchasing officers;

(e) after-sales service; and

(f) prompt delivery.

6.41 These barriers might be overcome by appointing intermediariesto take charge of these functions. Intermediaries could be:

(a) large firms which would subcontract some or all of themanufacturing operations to smaller firms (see below);

(b) traders; and

/1 Government consumption expenditure accounted for 10.9% of total GDP in1977. The share of government development expenditures in total domesticinvestment reached 65% in the period 1974-76. If the subsistence sectorwere excluded, the Government's share in total monetary expenditure wouldbe still higher. See the Bank report, "Indonesia's Growth Patterns,Social Progress and Development Prospects," 1979.

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(c) cooperatives formed among SSI enterprises for this purpose.

6.42 Small firms could supply a wide range of products given thetechnical capacity. Even in fields in which economies of scale are pro-nounced, these may be offset by the low overhead and direct labor costs ofCSI or by breaking down the product into separate operations or componentssupplied by specialized CSI producers. In Indonesia, CSI should be able tomeet government requirements at competitive prices in the fields of officeand school furniture, building materials, clothing and uniforms, footwear,tableware, food products, irrigation pumps, agricultural tools, classroomequipment (blackboards, rulers, etc.) water and sewage pipes, fencing, andvehicle repair.

6.43 Initially, it would be necessary to give some (price) preferencefor CSI products particularly if the competing products of large-scaleindustry continue to be subsidized. Those trading firms dealing speci-fically in CSI products could also be given financial or fiscal incentives.

Linkages Between CSI and MLI

6.44 Not only the demand but also the efficiency of production in CSIestablishments can be improved by establishing and nurturing the linkagesbetween CSI and MLI. Various linkages do exist in Indonesia but the extentseems to be limited. Two principal types of interrelationship can be identi-fied.

(a) From Large to Small. Supplies of semiprocessed materialsmade in large-scale industry to be made up into finishedproducts by small firms e.g. PVC for suitcases and shoes,cotton yarn for handloom cloth, machine-made unfinished clothfor batik printers, paper and cardboard for boxes andprinted materials, sawn-timber for furniture.

(b) From Small to Large. For example, castings to be machined andassembled into pumps, forged and welded castings for elec-trical switchboxes, wooden casings for television sets,bodywork and mechanical repairs for transport vehicles.

6.45 On the basis of European and Japanese experience, one might expectthat the greatest scope for CSI/MLI linkages in the long run would exist inthe metal products, machinery, electrical appliances and transport equipmentindustries. These are relatively undeveloped in Indonesia, for reasonssuggested in the report. But even at the present scale of output, thelinkages between CSI and MLI enterprises could be strengthened by:

(a) exempting inputs from CSI from sales taxes;

(b) providing incentives to MLI enterprises for the training of CSIpersonnel within their enterprises as a means of establishingquality standards and introducing improved techniques;

(c) providing special tax or other incentives for equipment suppliedby MLI firms to CSI on hire purchase or leasing arrangements;

and

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(d) establishing a subcontracting promotion office within the Ministryof Industry to bring potential partners together, to identifyspecific products suitable for subcontracting, to establishprocedures for its implementation in the public sector enterprisesand to recommend incentives for its use in the private sector.

6.46 Another way of increasing marketing prospects of CSI productsis through subcontractirTg - a channel least utilized and encouraged underthe existing arrangements. This approach can be applied to several productlines. Special consideration should be given to those CSIs engaged in themanufacturing of producl:s that can be used by or subcontracted from largerindustries or assembly plants e.g. the automobile, TVs, radios, assemblies,electrical appliances and other products, or those products sold as componentsabroad. Indonesia has the technological capability and institutions todevelop subcontracting and at least a selective approach must be initiated.First of all, a consolidated list of potential subcontractors among CSIproducers, with the help of extension workers and banking/technologicalinstitutes, should be prepared for the information of medium and largeindustries. A kind of "clearing house" can be established to perform thisfunction. If it is difficult for medium/large industries to rely onuntested CSI producers, some "prime subcontractors" can be promoted asintermediaries to work out subcontracting arrangements, undertake qualitycontrol, achieve standardization and assure reliable delivery schedules.Fiscal and credit incentives can be given to the subcontracting parties toencourage their participation in these arrangements. One of the problems isthat subcontracting arrangements are easier in the engineering industrybecause of greater standardization and quality control possibilities, thanothers but this is the Least developed subsector in Indonesia. Even then,certain products such as parts of sugar and textile machinery, agriculturalimplements, spare parts of tractors, sprayers, foundry products, etc. can beidentified as those suitable for subcontracting.

Scope for External Assistance and Project Ideas

6.47 At present the number of CIs and SIs not touched by the presentprograms remains very high. The country's development strategy (now underimplementation in connection with Repelita III) appears to be realizing theimportance of CSIs in the growth, employment and income distribution processesand there are a number of areas in which external assistance would be desirableto reinforce government efforts. For example, the Bank and other agenciesmay consider:

(a) more financial assistance to CSIs if a workable institutionalarrangement can be set up which integrates technical assistanceand financial resources with marketing assistance;

(b) working capital requirements of the trading firms (managedpredominantly by private entrepreneurs but with governmentsupport or equity participation in certain cases) dealingespecially with the marketing of CSI products, locally orabroad);

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(c) financing requirements of hire-purchase companies specializingin simple but improved equipment and machinery supplied toCSIs because this approach is one way to achieve integrationof financial assistance with technical assistance (in theform of machinery and transfer of know-how to operate andservice such machinery) to CSIs; this, together withfinancial help to local equipment manufacturers and engineeringfirms for the sale of their products on credit, might speedup the improvement and transfer of technology and its applicationto CSI establishments;

(d) financing and technical assistance to a number of selectedregional development banks in the regions where CSIs areconcentrated;

(e) financing common machinery workshops in a number of viableclusters where the quality of CSI products can be improvedfor greater access to wider markets. This may also includethe establishment of a number of "demonstration" unitswithin each cluster, showing growth potential, which canbe used to transmit improved technology at the grass roots,enterprise level and financial help to technologicalinstitutes;

(f) financing the building of mini-industrial estates, low-cost/low-rental market facilities and shops for small traders andproducers;

(g) recruiting, training and employing master craftsmen andother extension workers who can develop better prototypesand teach artisans better ways of doing their job;

(h) financing the establishment of regional consultingagencies for small industries in order to prepare mini-feasibility studies, provide advisory services and blendtechnical assistance with financial assistance (throughbanks) to more developed small industry establishments;

(i) technical assistance for using the government procurementsystem as a vehicle to encourage the use of CSI productsin government offices and certain projects;

(j) technical assistance for generating reliable industrialstatistics - particularly for CSIs - and the use of thosestatistics for operational and analytical purposes leadingto evaluation of the impact of the overall policy frame-work on the target groups and monitoring of trends inoutput, employment, incomes, etc. of the target groupsidentified in para. above; and

(k) technical assistance for promoting subcontracting.