Question 21N.2.HL.TZ0.d
| Date | November 2021 | Marks available | [Maximum mark: 8] | Reference code | 21N.2.HL.TZ0.d |
| Level | HL | Paper | 2 | Time zone | TZ0 |
| Command term | Discuss | Question number | d | Adapted from | N/A |
Free Trade Agreement between the European Union and Indonesia
- The European Union (EU) and Indonesia are currently negotiating a free trade agreement (FTA). The agreement will aim to increase trade, avoid trade protection and expand foreign direct investment (FDI). Indonesia has the largest economy and population in Southeast Asia. The EU is Indonesia’s third-largest trading partner.
- The FTA could see the clothing and footwear industry in Indonesia increase by over 10 %. However, the labour-intensive manufacturing industry has historically been known for poor working conditions and low wages. On the other hand, increased output could decrease the high unemployment in Indonesia (currently at 12 %). The EU expects its car industry to benefit from the FTA. The agreement would encourage the EU to specialize in cars, and Indonesia to specialize in clothing, therefore both countries could benefit from comparative advantage.
- Since Indonesia’s main competitors already have trade agreements with the EU, establishing an FTA is a priority for the Indonesian government. The EU has a potential market of 510 million consumers, and may offer areas for growth during a time of lower global trade and uncertainty due to the trade war between the United States and China.
- However, recent trade issues between the EU and Indonesia have slowed down negotiations. The EU announced that palm oil biodiesel is unsustainable and will phase these fuels out by 2030. Experts say that palm oil causes excessive deforestation and contributes to climate change. Indonesia is the world’s largest exporter of palm oil.
- The EU has imposed tariffs on biodiesel exports from Indonesia, which may result in Indonesia losing a market worth over US$450 million. Palm oil represents 12 % of Indonesia’s total exports, contributes approximately 2.6 % to gross domestic product (GDP), and the industry employs more than 15 million people. The EU is Indonesia’s largest palm oil customer. Additionally, some EU manufacturing businesses are unhappy with the tariffs as they rely on palm oil to produce their products, such as processed foods.
- In response, Indonesia filed a lawsuit with the World Trade Organization (WTO), stating that the EU’s policy on biodiesel is unfair and is damaging the international image of palm oil. Indonesia claims it is committed to sustainable production practices and to protecting its forests.
- To make up for losing the EU’s market, Indonesia is actively exploring other markets to boost its exports of palm oil. Other countries like China, India and Russia have a more relaxed policy on palm oil and have growing demand for it. Indonesia has also retaliated to the tariff through an investigation into whether EU dairy products exported to Indonesia benefited from subsidies, and has recommended a 20 %–25 % tariff on EU dairy products.
- However, the EU has tried to lower tensions by offering a US$17 million grant to improve trade conditions and capacity in preparation for the FTA. Experts have said that the FTA could support the development of legal and sustainable palm oil production through supporting good governance and capacity building. Indonesia has stated it would welcome help to decrease any market failure caused by palm oil.
[Source: Iswara, M. A., 2019. Indonesia gets Rp 232 billion grant from EU to ease trade negotiations [online]. Available
at: https://www.thejakartapost.com/news/2019/09/30/indonesia-gets-rp-232-billion-grant-from-eu-to-ease-tradenegotiations.
html [Accessed 27 October 2020]. Source adapted.]
Using information from the text/data and your knowledge of economics, discuss the economic effects on Indonesia of establishing a free trade agreement with the EU.
[8]
Examiners should be aware that candidates may take a different approach which, if appropriate, should be rewarded.
Do not award beyond Level 2 if the answer does not contain reference to the information provided.
Command term
“Discuss” requires candidates to offer a considered and balanced review that includes a range of arguments, factors or hypotheses. Opinions or conclusions should be presented clearly and supported by appropriate evidence.
Answers may include:
- definition of free trade agreement.
Economic models/theory may include:
- AD/AS diagram
- economies of scale diagram
- PPC
- market failure
- trade creation / trade diversion.
Positive economic effects may include:
- Larger market, increased output, leads to economies of scale (paragraph [3]).
- More exports increases aggregate demand which increases real GDP, which may help the unemployment rate of 12 % (paragraph [2]).
- Increased FDI, increases AD, increases real GDP (paragraph [1]).
- The EU wants to help Indonesia and has offered grants (17 million) help improve trade conditions and capacity, this could lead to improved quality and quantity of resources (paragraph [8]).
- Relationship could help with development of legal and sustainable palm oil production, decreasing market failure (paragraph [8]), allow for long term growth and development.
- To be competitive, as other main competitors already have an agreement (paragraph [3]). Indonesia may risk losing export customers if they do not establish an FTA.
- Comparative advantage gains (paragraph [2]), better allocation of resources.
- Buffers problems with trade war between US and China (paragraph [3]).
- Already the two countries appear to be engaging in the trade war. An agreement might help with relations.
- To avoid trade protection (paragraph [1]).
- Trade creation.
- Lower prices, more variety for Indonesian consumers.
- Allows Indonesia to get foreign exchange.
- Access better/cheaper technology.
Negative economic effects may include:
- The trade might be restricted by the EU’s stance on biofuel from palm oil (paragraph [5]). This may restrict benefits from the trade agreement as it is a large part of Indonesia’s economy.
- The areas of predicted growth from the agreement are industries that face low wages and poor working conditions, this may be further exploited (paragraph [2]).
- FDI associated problems (paragraph [1]).
- Could be a problematic negotiation (time consuming and costly), considering the trade war that appears to be occurring with the countries (paragraph [5] and [6]).
- Trade diversion.
- Infant industry argument.
Any reasonable discussion.
Overall this was disappointingly answered. Most students had some idea of a free trade area but relatively few were able to analyse the effects on Indonesia in joining such an area. There were, however, exceptions where students demonstrated not only a clear understanding of a free trade area in general but were able to apply its impact on the Indonesian economy using a wide range of economic concepts/theory such as trade creation/diversion, economies of scale and AD/AS analysis etc. Such answers were all too rare.
A significant number focused on the economic effects on the Indonesian economy and the EU (not asked for) while some only on the EU (which made these answers irrelevant). Many responses lacked analytical depth and others misused or misread the data in the extract. Many failed to recognise (from the extract) that the EU was phasing out their use of biodiesel by 2030 and based their answer on the expansion of palm oil production.
