Indonesia’s pursuit of economic development has long been closely tied to robust industrial policy. This strategy has regained prominence amid the realignment of global supply chains and a push towards higher-value economic activities. Indonesia has adopted a subsidy-dominant approach — which is distortionary — to support the development of specific sectors, including in energy, agriculture, manufacturing and, more recently, the electric vehicle (EV) sector.

The effectiveness of this approach remains unclear.

The role of indirect subsidies in Indonesia’s industrial policy is multifaceted, serving as both a catalyst for growth and a source of distortion and economic waste. Tax incentives, subsidized loans and direct financial support have been deployed to attract investment in downstream processing of natural resources, most notably nickel ore for EV batteries.

The goal is to elevate Indonesia’s position in the value chain from a mere exporter of raw materials to a key player in global manufacturing networks. The government’s ban on nickel ore exports, coupled with incentives for domestic smelting and battery production, epitomizes this ‘resource nationalism’ approach, which effectively subsidizes the domestic processing industry by providing it with cheap, captive raw materials.

Downstreaming policy is not limited to nickel. Indonesia is applying a similar logic to other commodities — including bauxite, copper, and more than 20 other commodities — to build integrated domestic industries around its natural resource wealth.

These policies are driven by a potent mix of political and economic dynamics. Politically, subsidies are a powerful tool for gathering support from industry, especially firms that seek economic rent. Economically, the strategy seeks to emulate the success of East Asian countries by nurturing infant industries, creating jobs, and reducing reliance on imports. These two combinations influenced the Indonesian government to adopt an industrial policy.

Indonesia’s vision is to transform itself into a developed nation by 2045. This ambition has fueled a willingness to intervene heavily in the market, protecting domestic players, and using the state’s financial muscle to direct investment into strategic sectors like the automotive industry, electronics, and digital economy infrastructure.

But the effectiveness of this subsidy-driven industrial policy is questionable. While it has spurred investment in targeted areas — the nickel processing boom in Sulawesi is a prime example — it comes at a significant cost.

Subsidies consume a substantial portion of the state budget, crowding out potential spending in more productive areas. They often lead to inefficiencies, as protected industries may lack the incentive to innovate and compete on a global scale. This creates a risk of subsidy reliance, where firms prioritize lobbying for continued state support over genuine productivity improvements.

The rapid, state-driven expansion of processing facilities, especially in mining, has also raised significant environmental and social concerns. Issues including deforestation, water pollution, and the displacement of local communities represent the hidden cost of this industrial strategy, one which the government often overlooks.

Indonesia’s history is replete with examples where subsidy-driven industrial policy has failed to deliver sustainable and competitive industries. The national car programs of the Suharto era, for instance, absorbed significant state resources but never achieved commercial viability or technological independence, ultimately collapsing under the weight of inefficiency and cronyism.

Similarly, long-standing protections in sectors like steel and petrochemicals have resulted in high-cost domestic industries that struggle to compete with imports once trade barriers are lowered. These historical precedents serve as a cautionary tale, illustrating that without strong governance, clear performance metrics, and an eventual exit strategy, subsidies can
create dependent and uncompetitive industries.

Indonesia’s industrial policy has complex implications for its regional and global integration. On one hand, the development of an EV battery ecosystem positions Indonesia as a critical node in global supply chains, attracting foreign direct investment from South Korea, China, and beyond. This integration can bring technology transfer, create skilled jobs, and boost export revenues.

On the other hand, Indonesia’s protectionist tendencies and subsidy regimes are a frequent source of friction with its trading partners. Its nickel export ban, for example, prompted a complaint from the European Union (EU) at the World Trade Organization. Indonesia lost the initial ruling but has appealed, signaling a firm commitment to its strategy despite international pressure.

This assertive stance, while popular domestically, creates uncertainty for international investors. While it attracts those keen to access Indonesia’s resources, it can deter others who prioritize stable, rules-based trade environments. Within the Association of Southeast Asian Nations, Indonesia champions regional cooperation and development, but its industrial policy may be perceived as undermining the bloc’s goals of creating a single market and production base. This creates competitive friction, as Indonesia’s push for a self-sufficient EV industry directly challenges the established automotive hubs in Thailand and Vietnam, potentially fragmenting regional supply chains.