Pacific Money | Economy | Southeast Asia

Indonesia’s Local Content Requirements Are No Shortcut to Industrialization

Without more accountability and transparency, LCRs will remain a blunt protectionist instrument rather than a true catalyst for industrial transformation.

Buildings in the central business district of Jakarta, Indonesia.

When Indonesia signed the Agreement on Reciprocal Trade (ART) with the United States last month, one of the most contentious concessions was the exemption of U.S. companies and goods from the country’s complex system of local content requirements (LCRs). Under the deal’s Annex III, U.S. companies and goods are no longer bound by LCR thresholds, which are initially designed to stimulate industrial development by requiring foreign companies to use a certain percentage of local goods in local manufacturing.

The policy itself internationally gained urgency after the 2008 global financial crisis, when countries from Norway to Nigeria turned to domestic content rules as protective measures. Meanwhile, in Indonesia, the origins of this policy can be traced to Article 40 Paragraph (4) of Law No. 22/2001 on Oil and Gas, which encouraged business entities to prioritize the utilization of local labor and domestic goods and services in a transparent and competitive manner.

The policy continued to evolve until the latest issuance of the Ministry of Industry Regulation No. 41/2025 on December 31, 2025. Under this government’s 2025-2029 strategy, non-oil and gas manufacturing is expected to contribute 20.56 percent of GDP by 2029. With the current manufacturing sector’s share stagnating at around 18 to 19 percent over the past decade, questions remain over whether these targets can be achieved under the current LCRs framework. Moreover, the available evidence indicates that LCRs alone are insufficient to drive industrialization in Indonesia, particularly as the country grapples with the so-called premature deindustrialization.

The Institutional Divide: Lessons from Abroad

International experience shows that LCRs work only when protection is paired with strong institutional discipline. Norway’s LCR policy success came from close government–industry coordination, competitive procurement, and sustained investment in innovation, which allowed the establishment of globally competitive national champions like Statoil Hydro. China applied a gradual LCR approach in wind energy, raising the local content threshold to 70 percent between 2004 and 2007 as domestic capabilities improved. Similar strategies in South Korea and Taiwan linked protection to export performance and technology transfer, contributing to rapid manufacturing growth of 12 to 15 percent per year during what is often labeled as the “Asian Miracle” era.

In Nigeria and Angola, weak institutional design produced the opposite effect. LCRs in Nigeria’s oil and gas sector have been exploited by rent-seeking elites, leaving multinational firms to dominate without meaningful technology transfer while middlemen profit from import quotas. Similarly, in Angola, LCRs have favored politically connected elites, often through shell companies, systematically concentrating wealth rather than distributing industrial capacity.

Those divergences are not coincidental. It shows that the effectiveness of the policy hinges on the institutional capacity to implement, monitor, and enforce it. Where institutions enforced transparency, competition, and genuine capacity building, LCRs catalyzed industrial development; where they did not, the same policies became vehicles for rent extraction and economic distortion.

Indonesia’s Extractive Trap

This pattern reflects the core argument of the 2024 Nobel laureates in economics, Acemoglu, Johnson, and Robinson, that policies succeed or fail depending on the institutions that stand behind them. Inclusive institutions promote fair competition, clear rules, and innovation, while extractive institutions concentrate power among elites and use the state to serve narrow interests rather than broad economic progress.

Indonesia, unfortunately, appears to lean toward the latter. A recently published study in the Third World Quarterly underlined the role of Indonesia’s mining industry as a critical source of political funding, where bribes are exchanged for mining permits. Strategic sectors are also overseen by cabinet ministers who simultaneously hold personal business stakes in those same industries. The China Global South Project reported that nearly 30 percent of all nickel mining and processing operations in Indonesia have been implicated in or accused of corruption and illegal mining activities.

The consequences for technological development are equally telling. The domestic electric vehicle industry, for instance, still largely remains an assembly platform for imported components, indicating weak absorptive capacity and a failure to induce directed technical change. Foreign firms control roughly 90 percent of refined nickel capacity and an estimated 73-75 percent of direct profits are captured by foreign shareholders. Institutional incentives that prioritize short-term extraction over long-term capacity building have, therefore, systematically undermined effective transfer of technology to Indonesian firms.

In conclusion, LCRs may serve as a legitimate instrument to leverage industrial growth only if they are accompanied by an institutional shift toward greater accountability, transparent market signals, and genuine domestic capacity building. Without it, Indonesia’s local content requirements risk remaining a blunt protectionist tool that will fail to have a significant, let alone revolutionary, impact on the country’s industrial development.

The views expressed in this article are personal.

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When Indonesia signed the Agreement on Reciprocal Trade (ART) with the United States last month, one of the most contentious concessions was the exemption of U.S. companies and goods from the country’s complex system of local content requirements (LCRs). Under the deal’s Annex III, U.S. companies and goods are no longer bound by LCR thresholds, which are initially designed to stimulate industrial development by requiring foreign companies to use a certain percentage of local goods in local manufacturing.

The policy itself internationally gained urgency after the 2008 global financial crisis, when countries from Norway to Nigeria turned to domestic content rules as protective measures. Meanwhile, in Indonesia, the origins of this policy can be traced to Article 40 Paragraph (4) of Law No. 22/2001 on Oil and Gas, which encouraged business entities to prioritize the utilization of local labor and domestic goods and services in a transparent and competitive manner.

The policy continued to evolve until the latest issuance of the Ministry of Industry Regulation No. 41/2025 on December 31, 2025. Under this government’s 2025-2029 strategy, non-oil and gas manufacturing is expected to contribute 20.56 percent of GDP by 2029. With the current manufacturing sector’s share stagnating at around 18 to 19 percent over the past decade, questions remain over whether these targets can be achieved under the current LCRs framework. Moreover, the available evidence indicates that LCRs alone are insufficient to drive industrialization in Indonesia, particularly as the country grapples with the so-called premature deindustrialization.

The Institutional Divide: Lessons from Abroad

International experience shows that LCRs work only when protection is paired with strong institutional discipline. Norway’s LCR policy success came from close government–industry coordination, competitive procurement, and sustained investment in innovation, which allowed the establishment of globally competitive national champions like Statoil Hydro. China applied a gradual LCR approach in wind energy, raising the local content threshold to 70 percent between 2004 and 2007 as domestic capabilities improved. Similar strategies in South Korea and Taiwan linked protection to export performance and technology transfer, contributing to rapid manufacturing growth of 12 to 15 percent per year during what is often labeled as the “Asian Miracle” era.

In Nigeria and Angola, weak institutional design produced the opposite effect. LCRs in Nigeria’s oil and gas sector have been exploited by rent-seeking elites, leaving multinational firms to dominate without meaningful technology transfer while middlemen profit from import quotas. Similarly, in Angola, LCRs have favored politically connected elites, often through shell companies, systematically concentrating wealth rather than distributing industrial capacity.

Those divergences are not coincidental. It shows that the effectiveness of the policy hinges on the institutional capacity to implement, monitor, and enforce it. Where institutions enforced transparency, competition, and genuine capacity building, LCRs catalyzed industrial development; where they did not, the same policies became vehicles for rent extraction and economic distortion.

Indonesia’s Extractive Trap

This pattern reflects the core argument of the 2024 Nobel laureates in economics, Acemoglu, Johnson, and Robinson, that policies succeed or fail depending on the institutions that stand behind them. Inclusive institutions promote fair competition, clear rules, and innovation, while extractive institutions concentrate power among elites and use the state to serve narrow interests rather than broad economic progress.

Indonesia, unfortunately, appears to lean toward the latter. A recently published study in the Third World Quarterly underlined the role of Indonesia’s mining industry as a critical source of political funding, where bribes are exchanged for mining permits. Strategic sectors are also overseen by cabinet ministers who simultaneously hold personal business stakes in those same industries. The China Global South Project reported that nearly 30 percent of all nickel mining and processing operations in Indonesia have been implicated in or accused of corruption and illegal mining activities.

The consequences for technological development are equally telling. The domestic electric vehicle industry, for instance, still largely remains an assembly platform for imported components, indicating weak absorptive capacity and a failure to induce directed technical change. Foreign firms control roughly 90 percent of refined nickel capacity and an estimated 73-75 percent of direct profits are captured by foreign shareholders. Institutional incentives that prioritize short-term extraction over long-term capacity building have, therefore, systematically undermined effective transfer of technology to Indonesian firms.

In conclusion, LCRs may serve as a legitimate instrument to leverage industrial growth only if they are accompanied by an institutional shift toward greater accountability, transparent market signals, and genuine domestic capacity building. Without it, Indonesia’s local content requirements risk remaining a blunt protectionist tool that will fail to have a significant, let alone revolutionary, impact on the country’s industrial development.

The views expressed in this article are personal.

Achmad Hanif Imaduddin and Fitri Ika Pradyasti

Achmad Hanif Imaduddin and Fitri Ika Pradyasti are researchers at the Center of Reform on Economics (CORE) Indonesia.

Indonesia industrial policy

Indonesia local content requirements

Indonesia natural resources

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