Indonesia as a new pole of global growth

Indonesia as a new pole of global growth Lin Yan Ing ;  An Economist at the Economic Research Institute for ASEAN and East Asia (ERIA) and A Lecturer at University of Indonesia

JAKARTA POST,  11 Januari 2013

China’s growth pattern is changing as it moves up the income ladder. The nation is likely to rely more on consumption and less on investment and exports, and more on services and less on industry. This offers opportunities for emerging East Asian economies, notably Indonesia.  Indonesia could tap these opportunities, they encompasses unique potency of the so-called 3Ds: durable macroeconomics, domestic consumption and demographic dividends.  First, Indonesia is supported by durable macroeconomic indicators, as evinced by economic growth of 5.4 percent on average between 2000 and 2012. Despite the ongoing global economic crisis, Indonesia’s annual economic growth rates stood at 6.5 percent and 6.3 percent in 2011 and 2012, respectively.  This is coupled with improved consumer confidence and less dependence on debt. After recorded a low of 93 in the third quarter of 2008, consumer confidence increased to 111 in the third quarter of 2012; and after the 1997 Asian financial crisis, Indonesia — the most affected country — exerted great effort to manage its debt. Its ratio of debt to gross domestic product (GDP) decreased from 90 percent in 2000 to about 25 percent in 2010. Second, the Indonesian economy is largely supported by domestic consumption. The global economic outlook continues to deteriorate and financial markets continue to be volatile. Yet, Indonesia has been relatively less exposed to the world market, with its domestic market accounting for an average of 67 percent of GDP between 2000 and 2011, keeping the nation strong.  Third, Indonesia’s population is around 240 million and had a per-capita income of more than US$3,500 in 2011 as well as a growing middle-income class. This is coupled with the facts that 50 percent of population is in the labor force and that real wage growth in the nation has been lower than that of China since 2005. These factors have combined to make Indonesia one of the most promising investment destinations for the coming decade.  At the same time, Indonesia still faces three challenges to tap these opportunities: credit, competition and confronting inequality.  First, businesses, particularly domestic small and medium enterprises (SMEs) still have difficulty accessing finance. Indonesia has a relatively higher spread of lending rates minus deposit rates, with an average of 5.4 percent between 2005 and 2010, as compared to only 4.8 percent in the Philippines, 4.1 percent in Thailand, 3.5 percent in Vietnam and 3.3 percent in China.  Moreover, based on the 2009 Enterprise Survey, 48 percent firms in Indonesia said that access to finance was the biggest obstacle facing business, claiming that the proportion of their investment financed by banks was only 6 percent.  Second, learning from World Bank’s studies on Indonesian manufacturing and ASEAN investment integration, Indonesia still faces challenges in managing competition and facilitating innovation.  Indonesia was still relatively closed to foreign investment compared to peer countries in the region, which can be perceived as barriers to competition and innovation. Foreign equity caps in several sectors were relatively lower than the average for ASEAN and East Asia and Pacific (EAP) countries, including in agriculture, forestry, manufacturing and most of the service sector.  Third, Indonesia faces challenges in confronting inequality. It is true that the number of people living in poverty has been cut by half in the last decade in EAP. Poverty continues to fall, with the number of people living on less than $2 a day expected to decrease by 24 million in 2012.  Rising inequality, however, has been seen in developing economies, including Indonesia. Recent strikes pushing for better payment and treatment by Foxconn workers in China and by public servants in Brazil may occur in Indonesia in the near future. Rising inequalities can create social unrest, with consequences for overall economic growth and development.  In the short-term, government policy should focus, on lowering the cost of finance and improving access to finance. One quick-win could be providing incentives to good debtors in the form of competitive lending rates by improving information-sharing on their debt and credit history.  This should be accompanied by improvements in efficiency in the financial sector to reduce operating costs and thus provide competitive rates. At the same time, access to finance could be improved by providing temporary assistance for productive start-ups and improving the intermediation role of financial institutions.  Second, the government must improve the competition environment to enable innovation. The further opening of the economy to foreign investors should be pursued on a most-favored nation basis. More open countries tend generate more FDI flows. However, increased openness should be accompanied by improving labor quality, including incentivizing on-the-job training, designing labor quality certifications to ensure labor quality and promoting an apprenticeship system.  Last is confronting inequality. It is appropriate to ask if it might be better to have a bigger cake with unevenly divided slices or a smaller cake cut into equal but tiny pieces in the early stages of development.  An increase in inequality, measured by the skill premium, which is defined as the ratio of skilled to unskilled labor wages, could be an incentive for individuals to receive more education or to improve their skills. Policy should focus on how to encourage individuals to become more educated and more skilled, yet at the same time leaving the unskilled better off.  In the medium-term, investment should be more focused on higher value-added industries and more innovation-intensive activities. Indonesia should adopt a dual-track management in managing resource-based commodities while promoting the growth of high value added sectors. To do this, Indonesia must tap its large pool of labor and abundant natural resources, while progressively moving up the value chain in the manufacturing and services sectors. ●