Some observers believe that Indonesia will be the next economy to boom in Asia. With over 250 million people, the Island nation certainly offers a large potential consumer market. And with wages rising in Malaysia, China Thailand, and other Asian nations, many have believed that Indonesia could become a manufacturing and production hub. In fact, according to the World Bank Indonesia recorded an astounding 72 percent YOY increase in FDI in 2012, accounting for some 1.2 billion dollars in investment. On going pressure from civil society, however, could discourage FDI as thousands have been taking to the streets in recent days to protest low wages and poor benefits. Already, the governor of Jakarta has announced an astounding 40 percent increase in wages. These developments could derail FDI and slow the growth the Indonesian economy.

In an ideal world, Indonesia would be able to raise wages and benefits while still remaining an attractive location for overseas investments. Unfortunately as Malaysia, China, Japan, Singapore and numerous other Asian countries have proven, you have to start at the bottom and work your way up. Foreign companies are drawn to low wages and favorable local regulations that make production and investment easy to conduct. With so many nations in Asia now trying to replace China as the next low-cost manufacturing hub, the cost to keep wages low is all but a necessity for attracting foreign investment.

Wage increases may seem like a good populist move. Ideally people’s wages would increase,  and their consumer spending would go up which in turn would fuel more demand. For better or worse most of the companies that have the money to invest and the demand to meet are international corporations with business operations around the world. They are not as concerned about developing strong local markets as they are about keeping costs low. These MNC’s do not tend to hold any nationalistic views and simply go to where the cost models make sense.

For example, in Cina even most local or national companies still rely on demand from global MNC’s. These international companies are loyal only to their bottom line as they should be in a market system. If wages rise in one area, they simply ship production or find suppliers in other area. Indeed this on-going process is now observable in China as many companies are beginning to evaluate other options and increasingly shifting production to lower cost regions.

With populist sentiments rising in Indonesia and so many other competitors vying to attract FDI, there is a strong risk that the country will be passed over by international investors who will instead aim for Vietnam, Cambodia, or another Asian nations. Further, with rising fuel costs many companies are looking at production sites that closer are closer to their market, such as Latin America or Eastern Europe.

A loss of FDI would be a negative development for what has been a bright spot in Asia. Indonesia has been doing well in recent years; however, that success is not guaranteed. Indonesia posted strong growth rates of 6.1 and 6.4 percent in 2010 and 2011. Further, unlike many other nations has a strong and vibrant local consumption market. Compared to nations like Malaysia and Singapore, Indonesia is not nearly as dependent on export trade.

This is largely due to Indonesia’s use of the “Import Substitution” model throughout its modern history. Under this model, Indonesia protected its domestic markets and encouraged local companies to meet demand. In practice, this resulted in rampant cronyism and numerous inefficient companies, many of which have now gone out of business. While Indonesia is reforming its economy, it also finds itself in a position of being less reliant on overseas demand. Given current global market conditions this has turned out to be a blessing in disguise. In 2009 even in the midst of the global Financial Meltdown Indonesia managed to post respectable 4.5% growth rate while its neighbors Malaysia and Singapore actually experienced economic contraction.

Still, strong FDI could inject money into the local economy, raising demand and lower the nations 6.5% unemployment rate. Further, increased demand for labor would increase wages over the long run, as companies compete for skilled workers. If FDI is discouraged , however, aggressive hikes in minimum wages and benefits costs could chase away foreign investors and possibly even encourage domestic firms to consider overseas production or increased automation. If the government wishes to address the needs of society, subsidies on essentials such as fuel, or expanded public housing would be a better short-term remedy then increasing wages. In the long run, a dollar spent is a dollar that needs to be paid back, but in the short-term Indonesia should focus on attracting FDI to drive increased economic development.