Growth dynamics and policy choices facing Indonesia

Ganeshan Wignaraja 21 February 2013

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Growth slowed in Indonesia in 2012, indicating that the global financial crisis and economic slowdown had indeed had an effect on ASEAN’s biggest economy. Indonesia grew at 6.2% in 2012, down slightly from 6.5% in 2011. Overall, this remains a respectable figure. Bear in mind that Indonesia's annual average growth in the previous decade was below 6% (see Figure 1). Developing Asia as a whole grew at 6.1% in 2012. A slight dip – notwithstanding a turnaround – seems to be continuing in commodity-rich Indonesia, once seen as a basket case of crony capitalism during the 1997 Asian financial crisis (Basri and Hill 2011). Unfavourable geography – an archipelago of over 27,000 islands – coupled with fragmented markets and variable infrastructure connectivity has also acted as a drag on Indonesia’s growth in the past.

Figure 1. Growth in Indonesia 1997-2012

Source: IMF World Economic Outlook and Statistics Indonesia.

Explaining Indonesia’s growth

Three factors help explain Indonesia's respectable growth over the past decade:

  • A strong demand for commodities (e.g. coal, oil and palm oil) – the mainstay of Indonesia’s economic activity – from rapidly growing China and India;
  • Buoyant domestic consumption.

Around 60% of Indonesia's GDP comes from domestic consumption. Indonesia has a thriving middle class of about 120 million people who are hungry for consumer goods including food, cosmetics, white goods and cars.

  • A pickup in manufacturing activity by large foreign companies focussing on the rising middle class and domestic consumption.

This has been led by expansion in production capacity by Japanese car makers Toyota and Nissan as well as French cosmetics company L'Oreal. Consequently, inward investment has surged to a record $23 billion in 2012.

The modest fall in growth in 2012 reflects a slowing in fourth-quarter growth. This is partly linked to a tapering demand for coal imports from China and India and uncertainties among Indonesian consumers reflecting the lingering global economic slowdown and upcoming national elections in 2014.

Signs of dirigisme

Alongside the dip in growth, there are concerns that Indonesia is implementing more restrictive economic policies that have a hint of dirigisme. In 2011-2012, several new measures were introduced, risking a backsliding on past outward-oriented policy reforms (Anas 2012, Bland 2012). One was an export tax of 20% for 65 mining commodities such as nickel, tin, copper, bauxite and iron ore. This was coupled with new restrictions on ownership of mines which may have shut off the sector to new inward investment. Another was an export ban on unprocessed raw commodities like rattan (a kind of palm tree used to make traditional furniture). Additionally, a regulation was introduced that horticultural imports can only enter at selected ports (which excludes the business port of Tanjung Priok in Jakarta) and that horticultural importers require approval from the Ministry of Agriculture. Finally, new regulations have been adopted for imports of finished goods and imports of fruits and vegetables.

Politics

Many motivations appear to underlie Indonesia's emphasis on such policies:

  • Continuing uncertainties in the global economy and a slowdown in growth in Indonesia inevitably means more unemployment;

With 12% of the population in poverty (Miranti 2010) and elections approaching in 2014, politicians wish to limit the impact of external shocks and job losses.

  • Second, with a budget deficit approaching 4% of GDP, macroeconomics dictated boosting government revenue through higher taxes such as trade taxes.
  • The government seems to be deploying import restrictions to engineer a structural shift in economic activity from low value added to high value-added production.

The country's nascent manufacturing sector – made up of a few large domestic business groups and a notable base of small and medium enterprises – is viewed as a future engine of growth and diversification.

Lessons from east Asia

It makes economic sense to pursue diversification and structural change in commodity dependent economies like Indonesia. This can reduce economic vulnerability to fluctuations in international commodity prices and impacts on government revenue. Furthermore, industrialisation is associated with technological change, rapid growth and poverty reduction. The industrial success of Japan, the four east Asian tigers (South Korea, Taiwan, Singapore and Hong Kong) and China illustrates that markets and governments working together can create evolving comparative advantages over time (Lall 1996, Wignaraja 2011 and 2012). A key lesson from east Asia is that arbitrary protectionist measures do not work in fostering internationally competitive industrialisation.

Policy choices

Instead, the recipe for success is to create the conditions for enterprises to enter and upgrade in global value chains. This process can be supported by a combination of outward-oriented policies with complementary measures to create world class infrastructure, invest in skilled workers required by industry, acquire industrial technological capabilities, deepen the sources of industrial finance, and improve government capacity. Clearly, no one-size-fits-all economic strategy exists for growth and tailor-made solutions geared to national circumstances are important. But Indonesia should curb its dirigiste tendencies and refocus policy on connecting its enterprises with global value chains and developing a closer public-private sector partnership for sustaining growth.

References

Anas, T (2012), “Indonesia’s New Protectionist Trade Policies: A Blast from the Past”, East Asia Forum, 18 June, available at www.eastasiaforum.org.

Basri, M C and Hill, H (2011), “Indonesia Growth Dynamics”, Asian Economic Policy Review, 6(1), 90-107.

Bland, B (2012), “Protectionism Hits Indonesia’s Reputation”, Financial Times, 12 June.

Lall, S (1996), Learning from the Asian Tigers: Studies in Technology and Industrial Policy, Basingstoke, Macmillan Press.

Miranti, R (2010), “Poverty in Indonesia 1984-2002: The Impact of Growth and Changes in Inequality”, Bulletin of Indonesia Economic Studies, 46(1), 79-97.

Wignaraja, G (2011), “Economic Reforms, Regionalism and Exports: Comparing China and India”, East-West Center, Policy Studies No. 60.

Wignaraja, G (2012), “Engaging Small and Medium Enterprises in Production Networks: Firm-level Analysis of Five ASEAN Economies”, ADBI Working Paper Series No. 361, Tokyo, Asian Development Bank Institute.

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Topics:  Development Politics and economics

Tags:  trade, natural resources, East Asia, state capitalism