Making Indonesia More Attractive to Foreign Investors: a Computable General Equilibrium Analysis of Reducing the Risk Premium in Central Java

This paper simulates the economic effect of a 10 per cent reduction in the risk premium in Central Java on investors in the chemical sector (scenario A) and a select range of sectors nominated by the Central Java government as representing investment opportunities (scenario B). The results suggest capital flows to Central Java increase, generating higher employment, labour productivity, real wages and GDP in Central Java. At the national level, real investment, aggregate capital stock and GDP increase for Indonesia as a whole. The policy implications are that greater transparency and consistency in the application of the rule of law, particularly between domestic and foreign companies, will result in a lower risk premium. This, in turn, will increase capital inflow and result in improved macroeconomic performance. * Department of Economics, Monash University 900 Dandenong Road, Caulfield East 3145, Victoria, Australia E-mail: [email protected] Telephone: +613 9903 2134 Fax: +613 9903 1128 † Part of this paper was completed while the second author was visiting the School of Economics at the University of the South Pacific (USP) in the Fiji Islands. He thanks the School of Economics at USP for their hospitality during the visit. We thank Mark Horridge for assistance with running the simulations and Paresh Narayan for helpful comments on an earlier version of the paper. All remaining errors are our own. © 2008 Djauhari Pambudi and Russell Smyth All rights reserved. No part of this paper may be reproduced in any form, or stored in a retrieval system, without the prior written permission of the author. MAKING INDONESIA MORE ATTRACTIVE TO FOREIGN INVESTORS: A COMPUTABLE GENERAL EQUILIBRIUM ANALYSIS OF REDUCING THE RISK PREMIUM IN CENTRAL JAVA