Indonesia has signaled its intention to negotiate a critical minerals trade deal with the United States. Such a deal would allow Indonesia, the world’s largest nickel exporter, to benefit from the US tax credits in the Inflation Reduction Act (IRA) for electric vehicles (EVs) that extend to US free trade agreement (FTA) partners. The US needs Indonesia’s nickel to further its efforts to decarbonize.
But for Indonesia to reach a trade agreement, it would have to commit to limiting its use of export bans to force development of domestic nickel-processing industries and markets. If it makes such a commitment, the US could negotiate a limited FTA with Southeast Asia’s largest economy.
To meet its clean energy aspirations, the US can’t go it alone
Nickel is one of the mineral lynchpins of the industrial sector because it is used in stainless steel, lithium-ion batteries to power EVs, and other renewable energy technologies. It is also a mineral produced in only small quantities in the US (0.5 percent of global production) and the EU—albeit thousands of miles from Europe in France’s New Caledonia territory in the South Pacific. Accordingly, the US and EU have designated nickel a critical mineral/raw material.
As argued recently, the “Made in America" goal for many critical minerals, including nickel, is unrealistic. US reserves of nickel amount to less than 0.3 percent of the global total. New mining projects must overcome a regulatory environment that reflects well-founded environmental concerns and the complex, lengthy process of obtaining permits for new mines in a federal system. An interagency task force empaneled to tackle the latter does not change the political reality of the former. Imports are the only viable option in the short term.
To qualify for the IRA’s tax credits, the critical minerals (including nickel) in EV batteries must be sourced to varying degrees from either US producers or countries with which the US has an FTA. US FTA partners account for only 9.3 percent of global nickel production, covering none of the top three exporters (Indonesia, the Philippines, and Russia). Russia is out for obvious reasons. Both Indonesia and the Philippines deserve serious consideration. US Trade Representative Katherine Tai said recently that a traditional FTA with the Philippines, focusing on expanding market access, would not be “appropriate for the types of challenges and opportunities that [the United States] is facing right now.” Her response reflects the Biden administration’s aversion to new FTAS that would lower tariffs for countries that could compete with US manufacturing. But Tai’s comments left the door open for a narrower deal, of the sort concluded with Japan and being discussed as well with the EU.
Indonesia’s own industrial ambitions will complicate negotiations
Despite its status as the world’s largest nickel exporter, Indonesia is no free trader when it comes to its vast nickel resources. Like many countries with substantial mineral reserves, Indonesia has been eager to move up the value chain by building domestic refining and downstream manufacturing capacity. Unlike many other mineral exporters, however, Indonesia is also a member of the Group of Twenty (G20), has enormous industrial ambition, and has a large potential home market for steel and EVs.
For these reasons, it has been able to use export bans to force downstream development in ways other, smaller mineral-rich countries have not. And it has been successful. Raw nickel exports have been banned since December 2020; foreign buyers have instead been required to invest in smelters in Indonesia to process materials locally for export. A similar ban—with similar ambitions—is set for the country’s bauxite, cobalt, and tin exports in June 2023. Indonesia clearly sees these bans as pillars of its economic development plans. But the World Trade Organization (WTO) has found Indonesia’s export bans and domestic processing rules amounted to unfair trade practices—a decision Indonesia is appealing, albeit in a pro forma manner.
Export bans on commodities—whether on food or critical materials for industry—are market-distorting and often very disruptive. But the US is in a weak position from which to cry foul at other countries’ use of industrial policy to spur investment and develop supply chains, given the domestic content and assembly requirements in its IRA.
The success of Indonesia’s industrial policy may have the Indonesian government thinking about capturing value-added even further down the supply chain. Plans to develop a domestic EV battery industry include taxing ferronickel exports—a refined, higher value-added nickel product used in EV batteries—as a means of providing lower-cost inputs for Indonesian industry. Unlike outright export bans, such a tax would be WTO-compliant and, if the recently concluded US-Japan limited FTA covering critical minerals is any guide, also consistent with US goals for these limited trade agreements. The US-Japan agreement affirms both parties’ obligations not to restrict trade in critical minerals other than via recognized instruments like taxes and duties, per both countries’ obligations as elaborated in Article XI:1 of the General Agreement on Tariffs and Trade. But given Indonesia’s success with export bans in the past, it is fair to wonder if its government might pursue them in the future on value-added products like ferronickel.
Chinese involvement in Indonesia’s nickel industry can’t be a dealbreaker
In addition to concerns about export bans, a secondary challenge arises from Chinese investment in Indonesia’s nickel supply chains. Indonesia’s largest nickel producer is a subsidiary of Brazil’s Vale, but Chinese firms have invested in processing facilities in Indonesia to get around its export bans. As with US-Chinese partnerships for EV technology—like Ford’s and Tesla’s plans to license battery technology from Chinese battery titan CATL in US-based plants—a US-Indonesia limited FTA would open the door to Chinese firms benefitting indirectly from the IRA’s tax credits. This outcome could be viewed as violating the IRA’s provisions regarding battery technology or critical minerals sourced from “foreign entities of concern.”
But even in light of the government’s growing influence over the Chinese private sector, treating all Chinese firms as extensions of the Chinese government is wrong. If the goal is to make supply chains more resilient by building more capacity out of China, extending US tax credits to goods mined and refined in Indonesia satisfies that goal—even if Chinese firms indirectly benefit. If Washington is comfortable with CATL technology helping build batteries in Michigan and Texas, it should not have a problem with CATL’s investments in Indonesia’s mineral sector. Given the prevalence of joint partnerships involving Chinese firms in developing processing capacity, attempting to completely exclude Chinese firms is unworkable. Still, US negotiators should press for assurances that exports to the US will be allowed in the event of any attempts by the Chinese government to pressure China-linked smelters to not export to the US market.
Setting these issues aside, Indonesia would be a credible FTA partner
The Varieties of Democracy project assesses Indonesia to be more democratic than Mexico and vastly more democratic than several other FTA partner countries like Bahrain, Nicaragua, and Oman. Its human rights record, particularly with respect to labor, is again similar to Mexico and vastly surpasses that of China. Given the narrow ambit of a critical minerals deal—the recent US-Japan agreement is just 10 pages long—it should sidestep many of the thornier issues that emerge in comprehensive FTA negotiations. And there could be broader, indirect benefits to greater US-Indonesian cooperation in the arenas of regional security, maritime governance, and preserving biodiversity. These are all among the stated priorities of the Biden administration; even a limited FTA might be helpful in forging closer relations in these areas.
The IRA has catalyzed a wave of investments in US EV battery production, but sourcing the critical minerals needed to feed into these battery factories remains a challenge. The IRA stipulates that sourcing come from friends. US-Indonesian relations are already friendly. A US-Indonesia critical minerals agreement could further cement that friendship and help the US decarbonize its automobile sector, provided that Indonesia disavows further use of export bans as a tool of development policy.
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