Indonesia: An Inevitable Choice of Economic Transformation

Indonesia’s growth rate is expected to slow down in the next coming years from an average rate of 6.5% per year in the last decade to a rate of 5% to 5.5% and there is the risk that Indonesia fall into the middle income trap. Indonesia has the potentiality to meet the ambitious growth rate of 7% targeted by government for the period up to 2025 but it is facing some significant challenges which have hampered its economic development and growth. Alongside infrastructural bottlenecks, Structural problems in the economy and low productivity are the main issues which Indonesia should address these issues in order to meet its growth targets.

To achieve the economic goals targeted in Indonesia’s master economic development plan, share of productivity should increase to 4.6% of GDP growth from the current share of 2.9% which requires a 60% increase in the productivity level.

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Indonesia owns substantial amounts of natural resources which can be used to accelerate and sustain economic development of the country. Indonesia is the world’s largest producer and exporter of palm oil, the second-largest exporter of coal, and the second-largest producer of cocoa and tin, and it has large reserves of nickel and bauxite. But over dependency on natural resources has increased risk of “Dutch disease” for Indonesia. Around 60% of Indonesia’s export is constituted of these natural resources which has the least contribution to employment of the country. Dependency on natural resources has covered the need for a growing and productive manufacturing sector and the exchange appreciation resulting from that has hurt competitiveness of manufacturing sector of the country. If Indonesia wants to reach to its goal of high-income status by 2025, it must create a strong manufacturing sector with a diversified production base. Unfortunately, as it was mentioned before Indonesian economy has remained reliant on the production and export of commodity goods with low value-add, volatile prices, and low demand elasticity.

Indonesian manufacturing is shrinking as a share of GDP, exports, and employment. Today Indonesia’s Non-commodity exports account for only 11 percent of GDP which is about one-third that of Thailand and Malaysia. Manufacturing sector accounts for 25 percent of Indonesia’s GDP which has decreased from 28 percent in 2000. Part of this weak performance can be explained by the protection policies which government has implemented to support domestic companies. As a result of these policies competition is restricted, productivity growth is stalled, and FDIs are depressed.

Besides protection policies, a combination of low labor productivity, inefficient investments, and strict labor regulations have badly hurt manufacturing sector of the country. To address low labor productivity, Indonesian government has tried to improve the condition by initiating some changes in the education system of the country but no significant improvement has been achieved yet and education system still is not able to arm young generation with sufficient skills and know-how. This is while increasing labor productivity would have a very significant role in the future prosperity of Indonesia.

Being the forth populist country in the world with 105 million workforce Indonesia will enjoy a demographic bonus in the form of a large working force (40 million new workers) which will reach to its pick in 2030. While this number of work force will created a labor bonus and will increase competitive edge for the country, to efficiently utilize this large number of young work force has remained a big challenge for the government. Government should provide young generation with adequate education and expand labor-intensive manufacturing sector by generous investment, encouraging and flexible business regulations and labor laws.

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Inefficient investment regulations and strict labor laws have discouraged domestic investments, entrepreneurship activities, and FDIs. Among 185 countries, Indonesia is ranked 166 in the ease of starting a new business. Indonesia’s labor laws have placed tight constraints on the firing and hiring of workers and impose one of the world’s highest severance payments. Such regulations has made difficult for corporations to mobilize capital and labor to more productive activities between firms and sectors. This condition discourages labor-intensive manufacturing, dampens growth, and locks out the bulk of Indonesian workforce from high-quality jobs in manufacturing.

The efforts of President Bambang Yudhoyono’s government to relax such regulations in 2006 were left fruitless after labor unions brought people to streets and opposed the government decisions to reform labor market regulations. In fact the government of democrat party of Indonesia that could get the power after making a coalition with 6 other parties has been very weak in imposing structural reforms. Besides strict labor laws, an ever increasing wage rate has also hurt the manufacturing sector through increasing input costs of the firms that has caused manufacturing sector lose its competitiveness. Government of Jakarta under pressure of labor unions increased the minimum wage rate by 44% in 2013. This while country’s per capita worker productivity has lagged behind the ASEAN average and increased by only 3.4% between 2000 and 2011 while wages rose by 5.5%.

Indonesia needs both, more investment in firms, factories, its people, and its infrastructure and simultaneously, to follow and implement the required reforms in business regulations and labor laws. To ensure a sustainable and broadly shared growth the future government of Indonesia should be ready to make tough decisions at this critical stage in the development of the country.

 

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