MAKING INDONESIA MORE ATTRACTIVE TO FOREIGN INVESTORS: A COMPUTABLE GENERAL EQUILIBRIUM ANALYSIS OF REDUCING THE RISK PREMIUM IN CENTRAL JAVA

Indonesia aims to increase inward foreign direct investment. However, widespread discrimination in how investments are treated, the weak application of the rule of law and opaque regulations have increased the risk premium confronting potential investors and impaired foreign direct investment. This study employs a Computable General Equilibrium Model to simulate the economic effect of a reduction in the risk premium in Central Java on investors in the chemical sector and a select range of sectors nominated by the Central Java government as representing investment opportunities. The results suggest capital flows to Central Java increase, generating higher employment, labor 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, will increase capital inflow and result in improved macroeconomic performance.