Indonesia: Sustaining Growth During Global Volatility


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Jokowi then launched an ambitious pro-growth agenda focused on large-scale infrastructure development, fiscal reform, and dramatically improving the business climate. Progress has been made by several objective standards.

A number of high-profile infrastructure projects are being completed, particularly in and around Jakarta. However, deeper structural problems are also holding the economy back. Investment growth has been notably weaker since the end of the commodity boom. In fact, it has remained at a higher level than during the commodity boom, hovering at about 32 per cent of GDP compared to 25 per cent on average over — The problem, rather, is that elevated investment is now translating into less economic growth.

This is illustrated by the incremental capital-output ratio ICOR , which measures how much investment is needed to generate a given amount of economic growth.

Indonesia: Sustaining Growth During Global Volatility

However, the trend deterioration in investment efficiency predates the current economic slowdown and has been persistent, meaning cyclical factors cannot be the primary explanation. Structural explanations seem more relevant. Investment quality appears low in several important ways. For example, the vast majority of investment goes towards constructing buildings rather than public infrastructure or machinery and equipment, where the returns are likely to be higher.

Also, very little investment is intermediated by the financial system. Moreover, economic growth in Indonesia has been heavily capital-intensive, pointing to risks that diminishing returns will persist or even worsen. As Figure 5 shows, economic growth in Indonesia has been more capital-intensive than elsewhere in the region. From to , capital deepening accounted for 73 per cent of Indonesian labour productivity growth compared to 29 per cent in Philippines, 51 per cent in Thailand, and 66 per cent in China, where very high investment has nonetheless been accompanied by solid productivity growth.

A key source of productivity growth in developing economies is moving workers from traditional agriculture to more modern sectors of the economy where labour productivity valued-added per worker is higher and grows faster. Indonesia experienced manufacturing-led growth during the mids through to the mids. Agriculture has continued to shed surplus workers but around two-thirds have moved into low-end services jobs such as drivers and domestic helpers rather than into more modern sectors of the economy Figure 6.

Note: Bubble size represents the share of the workforce in each sector following the nine industry classifications used by the Indonesian Central Statistics Agency. The two sectors labelled low-end services are: personal, public and social services; and trade, restaurants, and accommodation services. Modern sectors include: mining and quarrying; industry; electricity, water and gas; construction; transportation, warehousing and communication; and finance, real estate, rental business, and company services.

Relative labour productivity is calculated as the ratio of value-added per worker in each respective sector to the non-agriculture average in This creates two problems.

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First, this shift only provides a small boost to output because low-end services jobs are only slightly more productive than agriculture. More problematic is that it creates a legacy effect, which can depress future growth as a larger share of workers are now in a relatively stagnant part of the economy.

The pattern of low-quality structural change has worsened since the end of the commodity boom. As Panel A in Figure 7 shows, economic growth has become more reliant on an expanding workforce while the contribution of structural change has shrunk dramatically as employment gains in higher productivity sectors notably mining, manufacturing, and modern business services have slowed.

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Labour productivity growth has nonetheless decelerated sharply Figure 7, Panel B. However, productivity in low-end services — where around 40 per cent of workers are located — has stagnated. As a result, the low-end services segment acts as the default sector of employment. The problem is this creates a surplus labour type situation, where additional influxes of workers only weighs on productivity growth even further.

Capital-intensive growth is giving way to diminishing returns while the benefits of an expanding workforce are faltering as more workers find themselves stuck in low-productivity jobs. The problems are not yet acute. Ostensibly progress has been made. Inadequate infrastructure is the most widely cited constraint to faster economic growth. Roads, ports, and airports are all heavily congested, power shortages are common, and access to modern water and sanitation systems is limited.

A common refrain is it is cheaper for Jakarta to get its oranges from China than nearby Kalimantan. Despite various difficulties, sustained attention has seen a number of high-profile projects, notably in and around Jakarta, either completed or on track for completion. Of national strategic projects, 26 have been completed while seven top priority projects are to be completed by A systematic way to consider how far this has gone in closing the infrastructure deficit is to examine the size of the total stock of infrastructure — that is, taking into account the accumulation of past investment while adjusting for the physical depreciation of these assets over time.

Figure 8 shows estimates for the infrastructure stock and annual investment since based on data for realised investment in core infrastructure subsectors energy, telecoms, transport, water and sanitation, and irrigation financed by the government central and subnational , state-owned enterprises SOEs , and the private sector. The adequacy of the infrastructure stock-to-GDP ratio has fallen consistently since the Asian financial crisis, with investment failing to keep pace with physical depreciation and rising demand measured by real GDP growth.

Recent efforts have increased investment from about 3 per cent of GDP in to 4 per cent of GDP in and likely slightly higher in However, ongoing economic growth means this has only been enough to stabilise the infrastructure stock-to-GDP ratio. Meaningfully closing the infrastructure deficit will therefore require a further substantial increase in investment. Note: The rise in the stock-to-GDP ratio for both measures in and reflects the sharp drop in GDP due to the Asian financial crisis, which more than offset a simultaneous decline in investment.

Similar institutional problems plague most emerging economies. Empirical studies nonetheless tend to conclude that the economic returns on infrastructure investment are still strongly positive even in the presence of such inefficiencies although returns are of course lower than they could otherwise be.

Key Findings

To fund its infrastructure drive, the Jokowi administration has relied on a strategy of redirecting funds within the government budget, stepping up tax enforcement and allowing the fiscal deficit to widen. Despite some good achievements, fiscal reform has been uneven and all three elements of the existing strategy are reaching their limits. However, finding additional savings will likely be more difficult.

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With the most obvious policy changes already largely in place, further progress will require more effective planning and budgeting. On the revenue side, the results have been much more limited. The initial strategy of coupling ambitious revenue collection targets with aggressive enforcement by the tax office proved counterproductive, damaging business sentiment and resulting in revenue shortfalls that eventually necessitated destabilising mid-year budget cuts. Yet, despite stepped-up efforts and the one-off boost from the tax amnesty, the tax-to-GDP ratio has now slid to just under 10 per cent of GDP — abysmally low for an emerging economy let alone a future global economic power.

Meanwhile the fiscal deficit has been allowed to widen slightly and has been hovering at around 2. Initial acceptance of a larger deficit was warranted to avoid putting further pressure on a slowing economy. Fiscal solvency is also not in doubt given low public debt. However, while the fiscal deficit is not excessively large, it is uncomfortably close to the 3 per cent of GDP legal limit seen as important to maintaining fiscal discipline and market confidence.

The budget therefore has little space to manage potential negative shocks, including risks of revenue shortfalls, higher debt-servicing costs, or if stimulus was needed to support the economy. The current fiscal strategy is thus reaching its limits in terms of financing the higher development spending widely seen as required for Indonesia to improve its underlying growth trajectory.

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The overall result has been that total government development spending — on capital, education, health, and social assistance — remains low and has even fallen slightly relative to GDP since as weak revenue collection has forced the government to contain overall expenditure Figure 9. Whereas the average emerging economy in Asia invests more than 14 per cent of its GDP on development, Indonesia still only invests about half that amount. This has been pursued through a series of reform packages aimed principally at cutting red tape and attracting FDI. The extent of genuine change is less clear.

Perhaps predictably, anecdotal evidence suggests that while formal processes have been streamlined, actual service delivery has been slow to improve although administrative corruption has declined. A major limitation has been that implementation has been very uneven, both horizontally across different parts of the central government and vertically between the central and subnational government levels. To date they have principally concerned cutting red tape rather than facilitating greater market openness and effective competition, where the economic benefits are likely to be much higher.

In particular, the Jokowi administration is yet to reverse the protectionist trajectory that characterised the latter years of the previous government. That period saw the introduction of protectionist laws governing mining, agriculture, trade, and industry, leading to numerous market interventions including a ban on raw mineral exports, divestiture requirements for foreign mining companies, tighter restrictions on imported food, and local content requirements for electronic products.

This is followed by what appears to have been a policy shift. However, while more liberalising measures were introduced in , these efforts have since dropped off, leaving the total net number of additional protectionist measures since still elevated. Note: Net cumulative protectionism refers to the cumulative number of protectionist measures less the cumulative number of liberalising measures.

Liberalising reform has been limited in other areas. Despite the emphasis on attracting foreign investors, revisions to the foreign investment negative list have been marginally liberalising on net, with some areas opened up even as others have faced tightened restrictions. The response from foreign investors has consequently been positive but limited, with FDI inflows recovering from a low of 0.

Progress with labour market reform has followed a similar pattern of capping problems, rather than resolving them. In , the government introduced a new formula for setting minimum wages, linking increases to the rate of economic growth and consumer price inflation. Despite some significant shortcomings, the new system has brought more certainty and restraint to the previously escalating problem of politicisation and excessively large wage increases.

When Jokowi came to power he inherited a worsening infrastructure deficit, a rapidly deteriorating fiscal situation, and a business climate that remained difficult and increasingly protectionist.


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Indonesia: Sustaining Growth During Global Volatility Indonesia: Sustaining Growth During Global Volatility
Indonesia: Sustaining Growth During Global Volatility Indonesia: Sustaining Growth During Global Volatility
Indonesia: Sustaining Growth During Global Volatility Indonesia: Sustaining Growth During Global Volatility
Indonesia: Sustaining Growth During Global Volatility Indonesia: Sustaining Growth During Global Volatility
Indonesia: Sustaining Growth During Global Volatility Indonesia: Sustaining Growth During Global Volatility
Indonesia: Sustaining Growth During Global Volatility Indonesia: Sustaining Growth During Global Volatility
Indonesia: Sustaining Growth During Global Volatility Indonesia: Sustaining Growth During Global Volatility
Indonesia: Sustaining Growth During Global Volatility Indonesia: Sustaining Growth During Global Volatility

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