Such views, however, get the story backwards. Indonesian policymakers have consistently prioritised stability over growth. The more concerning issue is that the economy is now heading into its fifth consecutive year of subdued growth. The problems are structural. Indonesia is hemmed in by the need to protect stability while its growth model has struggled to deliver the productivity gains necessary to grow faster within this constraint. Doing better will require more than just pressing on. Indonesia cannot ignore the trade-off between growth and stability, but it needs to make it less binding, especially with the global economic backdrop becoming more difficult as liquidity tightens and protectionism potentially escalates.
Infrastructure investment needs to be substantially higher, public saving increased through a more comprehensive tax strategy, and business climate reforms recalibrated towards liberalising markets rather than just cutting red tape. Indonesia is widely seen as a future economic giant. Prevailing views of the Indonesian economy tend to oscillate between these two extremes. However, such views increasingly get the story backwards. Since the —98 Asian financial crisis, Indonesian economic policy has consistently prioritised stability over riskier pathways to rapid economic growth.
Conversely, with the waning of the China-fuelled commodity boom, the adequacy of economic growth has become the bigger concern. Indonesia is now looking at its fifth consecutive year of subdued growth at about 5 per cent, down from more than 6 per cent during the commodity boom and well below government ambitions to reach 7—8 per cent. Moreover, the slowdown has proven stubbornly persistent despite a strengthening global economy and the pro-growth efforts of President Joko Widodo Jokowi.
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Understanding why growth has been stuck and what needs to be done are the critical economic issues facing Indonesia today. The global economic environment is set to become more difficult, with liquidity conditions tightening and risks of escalating protectionism. Meanwhile, Jokowi is beginning his bid for re-election in His focus on infrastructure, fiscal reform, and improving the business climate are broadly what the economy needs to stimulate growth.
Yet the economy has been largely unresponsive. Will more of the same eventually deliver the faster economic growth Indonesia seeks? Or is something else needed? It also outlines the policies needed to realise faster growth while preserving stability. Over the past decade, Indonesia has been a consistent performer in an otherwise weak and volatile global economy. Growth has averaged 5.
Growth has, however, remained stubbornly low at about 5 per cent since , down from more than 6 per cent previously Figure 1. Such views have proven misplaced and expectations of a rapid shift towards manufacturing-led growth have been largely disappointed. Meanwhile, economic policy has continued to prioritise stability over growth.
Despite years of abundant global liquidity, government policy has been geared towards limiting external borrowing and keeping the current account deficit in check. Note: Reserve adequacy in Panel A is the ratio of foreign exchange reserves to gross external financing requirements defined as the current account deficit plus external debt maturing within one year. A ratio above 1 is considered adequate. In Panel B, reserve adequacy is considered adequate if the ratio is above three months of imports guarding against import financing risks , one year of gross external financing needs guarding against external financing risks , and 20 per cent of broad money guarding against domestic capital flight risks.
This trade-off has returned to focus in , with Indonesian financial markets again caught up in generalised capital outflows from emerging economies as US interest rates rise and the US dollar strengthens. Nonetheless, strong stability fundamentals mean Indonesia is well placed to manage, barring a far more serious dislocation in global markets.
Bank Indonesia has also acted decisively to shore up stability.
After intervening early in to support the rupiah, by mid-year it had switched to tightening policy — hiking interest rates by basis points and sending a clear signal that it intends to keep Indonesia firmly in the safety zone between growth and stability. In the most basic sense, this trajectory will not be enough to end widespread economic vulnerability, even by on current trends, poverty will persist and about half of Indonesian workers will still work in insecure informal sector jobs.
In a more ambitious sense, the current growth trajectory will not be enough to transform Indonesia into a true global economic power by For example, Indonesia has fewer top global firms than either country;  its total overseas direct investment holdings are half that of Malaysia and two-thirds that of Thailand;  the market capitalisation of its stock market is only marginally larger than either country; its high-tech exports are considerably smaller;  and it registers fewer international patents and trademarks each year.
For Jokowi, boosting economic growth has been a central policy priority. On taking office in late he inherited an economy under pressure. Growth was slowing, a large current account deficit had opened up, and the fiscal deficit was rapidly approaching the legal limit. Decisive early action to cut wasteful fuel subsidies successfully arrested this situation. 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.
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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. 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.
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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.
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. 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.
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