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Half-time in Indonesia’s Economic Growth

September 12, 2012

Last week, Washington, D.C. was the site for two big events on Indonesia and its economic prospects. The events featured speakers from the Asian Development Bank, The World Bank, Castle Asia, The National Bureau of Asian Research and The United States-Indonesia Society, all of whom point to an increasingly important role for Indonesia in the global economy and to the characteristics that make the country a peculiar case in development.

As largest economy in Southeast Asia with around 250 million people, Indonesia has enjoyed continuously high GDP growth rates (the latest announced this month still show surprisingly high growth). It distinguishes itself as its growth has been driven by domestic demand, not western demand that is seen in many other Asian countries such as Thailand or Vietnam. Domestic demand has in turn provided padding for Indonesia while demand from western countries has slowed down.

Despite the booming growth in recent years, the Indonesian economy is now at a crucial point. So far, the high growth rates have been spurred by an influx of unskilled labor to the work force. Productivity has hardly improved in the last five years and wages are still rising at an agonizingly slow pace with 61% of the workforce is employed in the informal sector.

Indonesia runs the risk of falling into a “middle-income trap”. A condition in which fast-developing countries slow down as their GDP per capita reaches middle-income levels as seen in Latin American countries in 1980’s and 90’s. This is not uncommon in economies such as the Indonesian where growth in large parts has been resource driven and dependent on cheap labor and capital. They now face the challenge of switching to a growth path based increasingly on higher education and innovation.

Mr. Douglas Brooks and The Asian Development Bank’s newly conducted study suggests some key policy initiatives that would help Indonesia on its path to continued prosperity:

-          Better infrastructure

-          Higher labor efficiency

-          Reform of labor market rules and social security system

The relationship between infrastructure and growth has been thoroughly debated in economic circles. However, it is plausible that investments in this sector would not only serve as a prerequisite for growth, but would also bring more people into the work force; especially when considering the very fragile state of the Indonesian infrastructure.

Furthermore, The US and Indonesia enjoy strong diplomatic and security relations, yet the investment and trade between the two countries is minimal.  Opening the country to investments and establishing public-private cooperation could benefit the Indonesian government by sharing the burden of financing the projects as well as the risks, which have been some of the speed bumps on the road to better transportation.

Higher efficiency goes hand in hand with improved education. Recently, the public education system has come under fire. While the country has a relatively good primary school system calls have been made to improve the secondary and tertiary education enrollment. The Asian Development Bank has worked closely with the Indonesian government in an effort to improve education by providing loans and guidance.

Finally, labor market regulations must be reformed. Steep severance pay and administrative inefficiency hinders the willingness to employ people and the possibility to optimize businesses. Along with the lack of social security, executives are having a hard time shaping businesses the way they want and workers cling fiercely to the rights they have. A more flexible yet secure system is needed to encourage businesses to hire people to the formal sector and keep a net under the people that lose their jobs. The distance from employed to extreme poverty is not great in Indonesia.

This however might be the biggest challenge Indonesia faces. The election in 2014 is already affecting Indonesian lawmakers. Any reform that makes workers more expendable is  not a prospect until calmer political times resurface.  Also, the government is taking increasingly protectionist measures in their economic policies.

This is a crucial time for a country that has enjoyed steady growth ever since the Asian financial crisis in 1988.  Reforms will be demanded and are needed to help Indonesia be a story of continued success.

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One Comment leave one →
  1. September 27, 2012 3:59 pm

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