FOREIGN DIRECT INVESTMENTS FROM JAPAN AND REPUBLIC OF KOREA AND THEIR ROLE IN TECHNOLOGY TRANSFER THROUGH SUBCONTRACTING TO MANUFACTURING SME IN INDONESIA Tulus Tambunan Indonesian Chamber of Commerce and Industry & Center for Industry and SME Studies, University of Trisakti, Jakarta-Indonesia Visiting Fellow Center for Northeast Asian Economic Cooperation (CNAEC), Korea Institute for International Economic Policy, Seoul, August 2007 I. Introduction in the last few years, ASEAN, probably the most ‘living’ trade bloc within the developing world, has expanded their market by establishing bilateral or multilateral free trade areas (FTAs) with many strong economies outside the bloc, including two in Asia, i.e. Japan and the Republic of Korea (ROK). Since foreign direct investment (FDI) is strongly linked to external trade, it is then generally expected that the economic integration between ASEAN and these two economies will improve not only trade between the two parties but it will also encourage FDI to increase from Japan and ROK into ASEAN, including Indonesia. In Indonesia, it is generally assumed that the increase of FDI inflows from these two countries will bring net benefits, not only in the form of employment creation and export growth but also in the form of transfer of technology, 1 especially to small and medium enterprises (SMEs), through subcontracting production linkages. In the literature on development of SMEs in developing countries it is often argued that a key to increasing the competitiveness and productivity of these enterprises is to build their capacities through improved technology. This technology development can take place internally (inside the firm) or can be fostered through access to outside sources, such as transfer of technology from multinational companies (MNCs), technical licensing agreements and imported capital goods. Technology here is defined broadly including product, process, as well as management skills. The main aim of this study is to examine empirically the role of FDI from Japan and ROK in technology transfer to local manufacturing SME in Indonesia. Specifically, it addresses the following simple question: how important are Indonesian based companies from ROK and Japan in technology transfer to SME in manufacturing industry in Indonesia? Methodologically, this study is based on: 1) a review of key literature on FDI with respect to its role in transfer of technology; 2) secondary data analysis on the development of FDI from ROK and Japan in Indonesia 1 As generally realized, there is no universally accepted definition of technology. The most common approaches define technology as a collection of physical processes that transform inputs into outputs and the knowledge and skills that structure the activities involved in carrying out these transformations (Kim 1997, page 4), or as stated in Rosenberg & Frischtak, (1985) that technology is a quantum of knowledge resulting from the accumulated experience in design, production and investment activities that is retained by individual teams of specialized personnel. This knowledge is mostly tacit and often (is) not made explicit in blueprints or manuals. So, technology and knowledge will be used interchangeably in this study. 1