Indonesia’s Aerospace Industry: Victim of Economic Vandalism?

In April I had the opportunity to visit the aircraft manufacturing facility of PT Dirgantara Indonesia (‘Indonesia Aerospace’, formerly IPTN), in Bandung. The enterprise is a shadow of its former self, although not without optimism for the future. In 1997 when the crisis hit Indonesia, the company was well on its way to commercial production of the new N250 prop-jet passenger aircraft, and was in the process of developing the N2130 passenger jet.

IPTN had for long been an object of derision on the part of economists, myself included, who could not see the sense in a country like Indonesia—with its abundance of low-skill labour and acute scarcity of high-level engineering and managerial skills—being in the business of producing something as technologically demanding as aeroplanes. For many Indonesians, however, the very fact that Indonesia could produce both fixed wing aircraft and helicopters was a source of considerable national pride. (Recall that an earlier generation of economists could not see the sense of Indonesia investing in the first Palapa communications satellite, but fortunately the then president Soeharto was not dissuaded from this important nation-building exercise.)

When the crisis came along, this particular state enterprise found itself a prime target within the government’s negotiations with the IMF and the international community. As far as I am aware, no other state-owned enterprise was treated in similar fashion. The flow of government funding to it was abruptly cut to zero through the January 1998 Letter of Intent to the IMF, forcing the company suddenly to be completely dependent on its sales revenues for cash flow, with the effect that it was forced to cut its workforce from around 16,000 to, eventually, less than 4,000.

Seemingly nobody from the economics community, domestic or international, shed any tears over this—not least because it was Habibie’s baby, and Habibie was regarded as the enemy of sound economic policy. In retrospect, however, I have little doubt that the economic losses that could be attributed to Habibie’s various pet engineering-oriented projects would be quite small by comparison with the tens of billions of dollars of banking sector losses that resulted from the crisis responses implemented by policy makers in the central bank and the economics ministries. This is rightly regarded with bitter irony by the remaining band of true believers at PTDI, who remain optimistic that the company’s fortunes can be revived—this time relying on bank finance rather than budgetary appropriations to finance its investments.

It came as a surprise to learn that the company continues to produce the CN235 and NC212 fixed wing planes and the NAS332 and NBO-105 helicopters that had been its bread-and-butter before the crisis—albeit in much smaller volumes than its production lines are capable of handling. But there was a much greater surprise in store. I was totally unaware that the company is now quite deeply involved in producing aircraft parts for various Airbus aeroplanes—not seats or oxygen masks or meals containers, but some key structural components: most notably the leading edge of the wings where they attach to the fuselage. Parts like this, for some of the most technologically sophisticated passenger aircraft in the world, need to be manufactured to extremely high standards and exacting tolerances, for which the company relies on some massive, computer-guided pieces of equipment.

It is also something of a surprise to the layman that the whole process is extraordinarily labour-intensive. At every stage of production of every single item, the individual responsible for the work involved is required to attest to properly completing the task in question, which must be electronically recorded and documented. This is quite different from the mass production techniques used in the production of, say, motor vehicles, and the process is reminiscent of a whole chain of artisans applying his or her own bit of skill to the component in question.

With this in mind, the idea that Indonesia can be globally competitive within the aircraft manufacturing industry seems not so far-fetched as it did when Habibie was trumpeting Indonesia’s new involvement in the development of jet aircraft. Like a vast range of manufacturing activity these days, large aircraft are assembled from components produced in a wide range of countries, and the fact that the kinds of skills needed to manufacture some aircraft components are available relatively cheaply in countries like Indonesia suggests that it may indeed be able to compete on the global stage.

Although PTDI argues that it can produce technologically sophisticated components at a healthy profit, my guess is that this profit might be overstated, not least because salaries of its workforce, especially its highly skilled engineers, appear to be well below private sector levels. The company’s buildings were constructed decades ago, using budgetary funds; likewise, the major components of the overall investment—the massive machinery required to stretch and bend and sculpt aluminium sheets and blocks into aircraft wings—were purchased long ago, and it is not clear that the full opportunity cost of all of this capital (not to mention the extremely valuable land on which the manufacturing facility is located) is allowed for when calculating costs.

All that said, it is precisely the magnitude of these earlier fixed investments that suggests that cutting IPTN off at the knees at the height of the crisis was an act of gross economic vandalism. Recall first that the crisis was not a consequence of fiscal imprudence. On the contrary, budget deficits under Soeharto were generally relatively small and able to be financed by international aid flows and modest offshore borrowing. Government debt was well under control. Moreover, IPTN already had orders for 120 of the new N250 aircraft it had developed to the stage of advanced testing. It had already invested more than $200 million in the equipment needed to begin manufacturing these aircraft.

Perhaps the economic policymakers at the time had analysed the potential profitability of this investment and found it to be low or negative. But, as every first-year economics student should know, a business should only be closed down if it would be unable to cover its variable costs by continuing to produce. So long as prospective sales revenue exceeds variable costs, then there is at least some contribution to covering the sunk costs of investments already undertaken. It seems highly unlikely that the company could not have easily covered its variable costs of production, given the orders already on its books.

The forced abandonment of what PTDI’s current directors regard as a line of business that would have been profitable and a source of pride for Indonesians reminds me strongly of the precipitate closure of many of the private sector banks at the time of the crisis. The decision to kill off these banks should have been based on estimates of their potential future profitability, not on the degree of their insolvency, which was the consequence of past lending decisions. Most of the bank closures also amounted to economic vandalism, because this implied the loss of all of those banks’ investments in building up their brand name, their customer base, their workforce, their computer systems, and so on—not to mention the sudden loss of income on the part of the thousands of employees who suddenly found themselves without jobs. The simple fact of the matter is that it is usually not sensible to close down a business just because it is insolvent. What is required is for stakeholders to absorb the losses from past mistakes, but then for them or others to move on and maximise the value available from the remaining assets.