The Economic Choices
Facing the Next President
Tough Reforms:
Business as Usual:
10 % Growth &
4 Million Good Jobs every year
5% Growth &
1 Million Good Jobs every year
Gustav F. Papanek, Raden Pardede, Suahasil Nazara
October 2014
3
The Economic Choices
Facing The Next President
The Economic Choices
Facing the Next President
Business as Usual:
5% Growth & 1 Million Good Jobs every year
or
Tough Reforms:
10 % Growth & 4 Million Good Jobs every year
Gustav F. Papanek,
Professor of Economics, Emeritus & President, BIDE
(Boston Institute for Developing Economies)
Raden Pardede,
Vice Chairman of National Economic Committee &
Co-Founder and Managing Partner of CReco Research Institute
Suahasil Nazara,
Professor of Economics, University of Indonesia
October 2014
The Economic Choices Facing the Next President
Copyright all rights reserved
ISBN 978-602-71480-0-0
Print 1 - October 2014
Published by :
Center for Public Policy Transformation
Supported by :
Rajawali Foundation
Author and editor :
Gustav F. Papanek,
Raden Pardede,
Suahasil Nazara,
Cover Design :
Pelangi Grafika & Transformasi Team
Printing :
Pelangi Grafika
Sanksi pelanggaran Pasal 44, UU 7 Tahun 1987 tentang Perubahan atas Undang-Undang No. 6 tahun
1982 tentang Hak Cipta
1. Barang siapa dengan sengaja dan tanpa hak mengumumkan atau memperbanyak suatu ciptaan
atau memberi izin untuk itu, dipidana dengan pidana penjara paling lama 7 (tujuh) tahun dan/atau
denda paling banyak Rp. 100.000.000,- (seratus juta rupiah)
2. Barang siapa dengan sengaja menyiarkan, memamerkan, mengedarkan atau menjual kepada umum
suatu ciptaan atau barang hasil pelanggaran Hak Cipta sebagaimana dimaksud dalam ayat (1),
dipidana dengan penjara paling lama 5 (lima) tahun dan/atau denda paling banyak Rp. 50.000.000,(lima puluh juta rupiah).
i
The Economic Choices
Facing The Next President
The Economic Choices
Facing the Next President
Business as Usual:
5% Growth & 1 Million Good Jobs every year
or
Tough Reforms:
10 % Groth & 4 Million Good Jobs every year
The Economic Choices
Facing The Next President
ii
A Once in a Century Opportunity
source: http://www.webpothi.com
Indonesia has a once in a century opportunity to improve
the lives of all Indonesians during the first term of the next
president by achieving a ten percent rate of growth of national
income and creating 21 million good, productive jobs.
The opportunity arises because China, which exports $1,500 billion
in labor-intensive goods, is losing competitiveness in these markets.
Indonesia can capture a share of China’s market.
In Indonesia, twenty million surplus workers now contribute little to
output. Moving some of these workers from the informal sector and
agriculture into jobs in labor-intensive manufacturing would increase
national income, reduce poverty and inequality and achieve a surplus on
the trade balance.
iii
The Economic Choices
Facing The Next President
In the past Indonesia has achieved spectacularly high rates of growth of
labor-intensive manufactured exports. With the right policies, Indonesia
can boost these exports by 22 percent each year to obtain a rate of
economic growth of ten per cent within the next five years.
Alternative strategies may seem easier to achieve but would
produce disappointing growth rates of around five percent and
just one million good jobs a year. In five years the difference between
“business as usual” and the reform package is striking: six million jobs
without policy change, 21 million jobs with change. With policy changes
that provide incentives for the rapid growth of manufactured exports, the
income of the average Indonesian would be nearly fifty percent higher
than under current policies.
A labor-intensive strategy is essential to increase the incomes
of the poorest forty percent. Our proposed strategy will not only
achieve higher growth but will ensure that the poorest forty percent are
the principal beneficiaries. These households have lost ground relative
to the top twenty percent during the commodity boom, during which
Indonesia has become a much less equal society primarily because of the
slow rate of job creation.
A Flexible Policy Package
Total costs of production must come down if Indonesia is to regain
competitiveness. But the more costs are reduced in one area, the less
they need to come down in others. Policy changes can be concentrated
on cost reduction which are most readily feasible.
The Economic Choices
Facing The Next President
iv
Reducing logistics costs through infrastructure improvements
is critical.
• Public investment must increase tenfold, financed in the early
years through the reduction of fuel subsidies and later through
tax reforms to generate revenues of 4.5 percent of GDP.
• Priority in infrastructure investment should be given to
regions that have succeeded in attracting new investment into
manufacturing.
• Adapt Indonesia’s innovative “production sharing model” to
infrastructure development and management, especially to
increase power production by 140 percent.
• Offering private companies an opportunity to develop
infrastructure to meet their tax obligations.
• Increasing oil and gas drilling and production by improving the
incentives.
• Converting commercial vehicles to run on natural gas to lower
the cost of transport
• Adoption of an effective matching grants program to induce
sub-national governments to use more of their resources for the
development of infrastructure.
Reducing the cost of labor to firms while increasing workers’
incomes is also critical.
• Devaluation of the currency is the most powerful tool for lowering
labor and other domestic costs to exporters and those competing
with imports. Stabilizing the prices of foods important to the
poorest forty percent will protect workers’ incomes and reduce
the inflationary impact of devaluation.
• Increasing labor productivity through industry-provided training
supported by government.
• Voluntarily changing the system of severance pay.
• Establishing export processing zones in low wage areas with
wages below the statutory minimum, compensated by subsidized
government services for workers.
• Reviving the tariff drawback system that provided a small
incentive for exporters and for firms supplying their inputs to
increase output.
v
The Economic Choices
Facing The Next President
Foreign Direct Private Investment will need to close the gap
between investment requirements and domestic savings.
The gap is now $60-80 billion, compared to net flows of only $10-15
billion at present. FDI also brings with it technical and managerial skills
and access to global markets, needed in some investments. There are
significant political costs to a larger role for FDI, but there are substantial
economic costs to a reduction in FDI. These economic costs translate into
political costs over time as the economy grows more slowly and fewer
good productive jobs are created.
Indonesia ranks poorly on corruption, ease of doing business
and cost of borrowing. The costs of corruption and doing business
could readily be reduced by: reducing the discretion which government
officials have in deciding whether an enterprise will be profitable, which
reduces the rewards of corruption; and promoting transparency to
increase the risk of being corrupt. A Guaranteed Rural Employment Program can provide
employment and income to agricultural laborers during the lean season
or whenever catastrophe sharply reduces their incomes. The program
would not only provide jobs but would also efficiently build highreturn local infrastructure, thus permanently increasing income and
employment. Finally it can be a major component of a Social Safety Net,
automatically expanding with increasing need. Guaranteed Employment
can provide immediate and tangible benefits and it would therefore help
to make the whole reform program more politically acceptable.
The Economic Choices
Facing The Next President
vi
CONTENTS
EXECUTIVE SUMMARY............................................................................ xiv
ACKNOWLEDGEMENTS....................................................................... xxviii
FOREWORD by the Honorable M. Chatib Basri, Minister of Finance,
Republic of Indonesia..................................................................................... xxx
PREFACE by Professor Jeffrey Winters, Northwestern University.............. xxxii
ABOUT THE AUTHORS......................................................................... xxxvi
A NOTE FROM THE PUBLISHER....................................................... xxxviii
PART I: THE CHOICE....................................................................................1
Chapter 1. Indonesia has a Window of Opportunity to Achieve
Double Digit Growth and Four Million Good Jobs Every Year............ 1
In the next five years the new president and his government can
transform the country, by achieving economic growth of ten
percent per year and by creating 21 million good, stable jobs....................1
Indonesia has a large pool of workers in low-productivity jobs. It
would benefit greatly from giving these workers a chance to get
high productivity manufacturing jobs......................................................... 2
Other activities that benefit from policy changes: Tourism,
agricultural exports and food production................................................... 4
The benefits of policy changes accrue slowly but are substantial by
the fifth year: An increase in average incomes of more than onethird and 21 million new good jobs.............................................................5
How realistic is a 22 percent rate of growth for labor-intensive
manufactured exports?................................................................................8
If the incentives are right Indonesian firms have responded and will
respond......................................................................................................10
Chapter 2. Alternative Strategies Will Result in Slow
Growth, Few Jobs and a Missed Opportunity............................... 12
Business as Usual: Without policy changes Indonesia’s income is
more likely to Increase by five than seven percent even if world
growth accelerates.....................................................................................12
vii
The Economic Choices
Facing The Next President
Expanding domestic demand.................................................................... 17
Restricting imports: Producing in Indonesia more of what Indonesia
consumes...................................................................................................18
The ASEAN Economic Community (AEC).............................................19
Giving priority to higher technology, more capital-intensive Industries...23
Alternative strategies can contribute to growth but all have strict limits... 25
Vietnam shows what can be achieved in a short period of time...............26
Chapter 3. Jobs, Poverty and Inequality – The Poorest
Forty Percent have Fallen Behind, the Richest Twenty
Percent have Prospered: Labor-intensive, Rapid Growth
will Enable the Poor to Catch Up......................................................28
The poorest forty percent have benefited from growth, but far less
than the richest twenty percent.................................................................28
The rising disparity between rich and poor is due in large part to
government policy, which has resulted in slow growth of demand
for unskilled and semi-skilled workers.......................................................31
The income of the poorest forty percent increases if there is
demand for their labor..............................................................................31
Labor and political organizations were not able to protect workers
when the economy stagnated; despite the absence of a strong trade
union movement or a political party representing their interests,
workers did well when demand for labor was strong................................34
Only the manufacturing sector can generate sufficient demand for
labor to increase labor incomes................................................................. 35
Why didn’t the poor benefit from the commodity boom?........................ 38
Increases in minimum wages and trade union activity pushed up
wages of industrial workers....................................................................... 40
The better off you were the more you gained during the commodity
boom: Income distribution became much less equal................................42
The Economic Choices
Facing The Next President
viii
Income distribution improved for twenty years but has become
worse since 2005....................................................................................... 44
What explains this sharp rise in inequality during the recent
commodity boom and why did it not occur during earlier
commodity booms?................................................................................... 45
Policies to reverse the trend and increase the incomes of the poor
more quickly than the rich........................................................................ 50
PART II: THE POLICY AND PROGRAM PACKAGE TO ACHIEVE
10% GROWTH AND 21 MILLION GOOD JOBS...................................... 59
Chapter 4. Measuring the Success of Policy and Program
Reforms..................................................................................................62
Chapter 5. Increasing the Incomes of Workers, Lowering
Labor Costs to Exporters................................................................... 69
A key problem for Indonesia’s competitiveness: Wages that are
absolutely low but well above those of its main competitors....................69
The high cost to workers of high dollar wages......................................... 71
Does Indonesia have “surplus” workers who can contribute to rapid
growth and development?......................................................................... 73
Surplus labor in agriculture – some striking statistics...............................74
Increasing labor productivity reduces the cost of labor to the
employer without reducing workers’ incomes........................................... 79
The basic education of workers and their training for specific jobs
affects labor productivity........................................................................... 80
Locating labor-intensive export industries where the need for good
jobs is greatest........................................................................................... 84
Managing the exchange rate – a powerful tool to keep labor costs
competitive................................................................................................84
Why compete with low wage countries for the market for shoes,
garments, toys?.......................................................................................... 90
A compensated devaluation: Stabilizing the cost of living for
workers, while reducing imports and increasing domestic production..... 92
The benefits of increasing the number of family members with
good, regular jobs...................................................................................... 95
ix
The Economic Choices
Facing The Next President
Reducing the cost of labor regulation: Current severance pay rules
are lose-lose, and a win-win, voluntary system would increase
benefits to workers and reduce costs to employers....................................96
Providing incentives for labor-intensive export industries......................... 99
Chapter 6. Improving Infrastructure and Reducing its
Cost is the other Critical Component of Competitiveness..... 105
Without more public investment improvements to infrastructure
will remain a dream................................................................................ 105
Using private investment to compensate for government shortfalls........106
Extending Indonesia’s clever solution, “production-sharing,” to
increase investment and efficiency in infrastructure................................107
Priority for infrastructure investment for industrial clusters outside
Jakarta where land and labor are cheaper but infrastructure is poor......110
Incentives to subnational units – The power of “matching grants”.......111
Private firms can also help overcome limited government
implementation capacity......................................................................... 113
Lower transport costs by providing low cost fuel to trucks and buses
but not to private vehicles: Converting commercial vehicles to run
on local natural gas at no initial cost to the owner.................................. 113
The paradox of electric power: subsidies that increase the real cost
to many manufacturers........................................................................... 115
Indonesia faces a major increase in the cost of fuel, which will
increase power costs................................................................................ 117
Expanding domestic fuel supply rather than importing expensive
LNG........................................................................................................118
Chapter 7. Additional Resources are Needed for the
National Government to Play its Crucial Role in Achieving
Double Digit Growth......................................................................... 123
Reducing the petroleum subsidy is the only way to secure sufficient
resources in the first two years to pay for essential programs..................124
Government revenues are inadequate to pay for critical programs.
They can and must be increased............................................................. 125
Increasing revenue and eliminating the fuel subsidy will make it
possible to expand spending greatly on social protection and
infrastructure...........................................................................................126
The Economic Choices
Facing The Next President
x
The elements of tax reform: Focus on expanding the base, not
raising rates.............................................................................................128
The potential of property or real estate taxes.........................................131
Tax holidays............................................................................................ 132
Mobilizing the funds of sub-national governments through
matching grants....................................................................................... 133
Government support for exports............................................................. 137
Chapter 8.
Investment, Savings, Foreign Private
Investment and Balancing Macro-Economic Objectives.........140
Economists do not agree on the rate of investment required to
achieve GDP growth of ten percent.......................................................140
There is a $60-80 billion gap between the rate of domestic savings
and the investment needed......................................................................142
Attracting foreign investment to fill the gap............................................143
FDI also brings with it managerial experience and an ability to
mobilize large amounts of capital and take big risks..............................145
Historical experience is clear: Foreign investors initially play a
large role in the expansion of manufactured exports, but their role
declines over time....................................................................................146
The risk of declining FDI....................................................................... 147
Changing from administrative restrictions to financial penalties
on foreign investors can provide equal benefits to Indonesian
enterprises, with greater efficiency and more government revenue........149
Trade-offs among inflation, growth and exports..................................... 150
Inflation matters if it increases the prices of goods important to the
poorest forty percent...............................................................................151
Dealing with deficit in the balance of trade and the balance of
payments: “Panadol” or the structural solution...................................... 153
Structural reform approach....................................................................155
Chapter 9. Reducing the Cost of Corruption, Doing
Business and Credit...........................................................................159
Changing a culture of corruption is difficult and takes time..................159
Corruption can be reduced quickly by reducing the scope of
discretion of officials; making decisions transparent; and testing the
honesty of different agencies................................................................... 161
xi
The Economic Choices
Facing The Next President
Total transparency will dramatically reduce corruption.........................163
Patronage vs corruption.......................................................................... 164
High cost and low cost corruption..........................................................165
The increasing use of import controls....................................................167
Making it easier to do business................................................................ 168
Distinguishing between resource intensive and labor intensive
investments.............................................................................................. 170
Inadequate and costly credit for investment...........................................171
Shortage of credit – Banks are reaching their lending limit................... 172
Chapter 10.
A Guaranteed Employment Program to
Assure Income in the Off-season and Transform the Rural
infrastructure........................................................................................176
Guaranteed Rural Employment: Turning uncertain, part-of-theyear employment into almost-good, more productive jobs..................... 176
Permanent improvement not a temporary hand-out.............................. 177
Why rural only........................................................................................179
Characteristics of PNPM that make it a good base for a Guaranteed
Employment Program............................................................................. 180
Turning PNPM into Guaranteed Employment......................................181
The PNPM Program will require additional funds................................. 182
Turning the Guaranteed Employment Program into an Integral
Part of the Social Safety Net...................................................................183
Conclusion................................................................................................... 185
Indonesia faces a stark choice..................................................................187
The Business-As-Usual Option Means Permanently Slow Growth.......188
A Flexible Approach to Competitiveness................................................ 188
A Guaranteed Rural Employment Program...........................................190
A Program for Economic Transformation..............................................190
References.......................................................................................................191
The Economic Choices
Facing The Next President
xii
Charts and Tables
Chart 1. Higher Growth and More Good Jobs from the Rapid Growth
of Labor-Intensive Manufactured Exports.........................................................5
Chart 2. Cumulative Benefits of Changes in Policies to Increase LaborIntensive Manufactured Exports, Import Substitution and Other
Activities, 2014-2019 and 2014-2024................................................................. 7
Chart 3. Comparative Asian Growth Rates for Exports of Manufactures
& Textiles & Garments (annual % change)......................................................... 9
Chart 4. Change in World Market Share for Manufactures, 1995-2013.........16
Chart 5. Real Value of Manufactured Exports from Indonesia and
Vietnam, 1997=100.......................................................................................... 27
Chart 6. Real Consumption of the Poorest 40%, Middle 40% and
Richest 20%, 1964/65-2013, Rp million at 2012 prices.................................. 29
Chart 7. Increase in Real Consumption by the Poorest 40%, the MIddle
40% and the Richest 20%, 1964/5-2013......................................................... 33
Chart 8. Real Wages Index for Construction, Manufacturing and Farm
Workers and Household Servants, 2008-2014 (2008 III = 100)....................... 41
Chart 9. Annual Growth of Real Per Capita Expenditures by Percentile
Groups, 2008-2012........................................................................................... 43
Chart 10. Gini Index 1964/5 to 2013.............................................................. 45
Chart 11. Educational Attainment by Consumption Groups, 2011................. 54
Chart 12. Increased Employment in Manufacturing, 1985-2013, Annual
Rate................................................................................................................... 72
Chart 13. Number of Political Strikes (Hartals) in Bangladesh........................79
Chart 14. Oil and Gas Wells Drilled Per Year................................................ 119
Chart 15. World Bank Logistics Performance Survey: Trade Related
Infrastructure (Scale 1 to 5).............................................................................134
Chart 16. Spending on Education as a Share of Gross National Income
and Mathematics Rank on the OECD Program for International
Student Assessment.........................................................................................135
Chart 17. Gross Rates of Domestic Savings................................................... 142
xiii
The Economic Choices
Facing The Next President
Table 1. Effect of Growth in GDP with a Decline in Exports..........................18
Table 2. Competitiveness of Six Asian Countries............................................. 26
Table 3. Increase in Per Person Consumption from 1964/65 to 2013 by
Poorest 40%, Middle 40% and Richest 20%....................................................30
Table 4. Wages, Exchange Rates and Income of the Poorest 40% During
Commodity Booms, 1976-2013........................................................................49
Table 5. Indonesian Workers by Expenditure Groups, Employment
Status and Sector, 2012 (%).............................................................................. 53
Table 6. Ownership of Bicycles and Motorcycles by Consumption
Groups, 2011.....................................................................................................55
Table 7. Measuring the Success of Failure of Policy and Program Changes...65
Table 8. Garment Workers’ Wages in Asian Countries (US$ per month
in 2014)............................................................................................................. 70
Table 9. Surplus Labor in Agriculture: Employment in Agriculture and
Manufacturing; Change in Value Added in Agriculture; 1986-2012............... 75
Table 10. The Exchange Rate and Cost of Labor for Exporters and
those Competing with Imports......................................................................... 87
Table 11. The Impact of Devaluation on the Profitability of Exporters.......... 90
Table 12. Electricity Tariff Comparison from 3 Asian Countries, 2013........116
Table 13. National Government Revenues and Expenditures with Policy
Changes, 2014-2024.......................................................................................127
Table 14. The Incremental Capital-Output Ratio (ICOR) 1985-2003.......... 141
Table 15. Corruption Perception Index: Indonesia Compared to other
Asian Countries............................................................................................... 161
Table 16. Ease of Doing Business: Indonesia Compared to other Asian
Countries.........................................................................................................169
Table 17. Infrastructure Built by PNPM, 2007-2011.....................................179
The Economic Choices
Facing The Next President
xiv
EXECUTIVE SUMMARY
Indonesia has an once-in-a-lifetime opportunity to improve the lives
of all Indonesians by: i) achieving a ten percent rate of growth of its
national income; and, ii) creating 21 million good, productive jobs in the
five years of next presidential term. Two facts have combined to create this opportunity:
i.
China exports $1,500 billion of labor intensive goods,
such as car parts, electrical and electronics products, garments,
textiles, shoes and toys. But it is no longer competitive in
producing these goods. Its labor force is shrinking and aging,
its wages are rising rapidly and so are other labor costs. Other
countries are competing to produce these goods.
ii. Indonesia has an estimated 20 million surplus workers
in agriculture and the informal sector who contribute
little to output. They often work long hours as shoe shiners,
becak drivers, family farm workers and waste paper recyclers.
They are in activities where fewer workers could produce the
same output. The additional workers have crowded in, sharing
work and income, because they cannot find formal sector work
and they must have an income to survive. If they could find good
productive jobs their contribution to national income will be pure
gain. And their income will increase as well as that of the nation.
The only activity which can generate productive jobs for millions of
surplus workers is the export of labor intensive manufactured goods.
When incentives were right Indonesia achieved growth in the most laborintensive manufactured exports at a rate nearly double the 22 percent it
needs to reach in the next five years (see Chart 2).
After two devaluations in 1986/87 made Indonesian goods highly
competitive, and other policies reduced costs further, Indonesia became the
champion exporter of manufactured goods. It outperformed other countries
xv
The Economic Choices
Facing The Next President
in Asia, including China. That is why we believe that with the right incentives
Indonesia can again reach a high rate of growth of manufactured exports.
Alternative Strategies Mean Fewer Jobs and Less Growth
Alternative strategies seem easier to achieve but will produce only a
disappointing growth rate of around five percent, and just one million
good jobs a year.
•
The easiest, most attractive proposition would be that no
reforms are needed to return to the six to seven percent rate of
growth reached from 2005 to 2011. But growth in those years
was driven in substantial part by a commodity boom which is
unlikely to return. Before that boom kicked in, growth averaged
only 4.5 percent. •
Another strategy often advocated is to expand domestic
consumption. But the scope for increasing domestic demand is
severely limited because higher levels of consumption inevitably
increase imports that have to be paid for by more export earnings. •
A strategy based on expanding the production of more
technologically advanced goods provides few jobs to surplus
workers with limited education. Also Indonesia will be hard
pressed to compete with India in such goods since Indian
engineers cost half as much as those in Indonesia. In five years the difference between business as usual and the reform package
is striking: six million jobs without policy change, 21 million jobs with change.
The difference in income growth per person growth is clearer over ten years:
forty percent without reform versus doubling with policy changes.
In the next five years, ten million new workers will be looking for jobs.
With business as usual or strategies that create only six million jobs,
millions will be forced to go abroad or become surplus workers. Tens of
millions will see their incomes decline. With reforms and 21 million new
good jobs, all of the additional workers will find productive employment
and the income of workers will rise. Without reforms, average income per person
would rise from Rp 34 million (US$ 2,900) a year in 2014 to Rp 48 million ($
The Economic Choices
Facing The Next President
xvi
4,100) ten years later. With policy changes that provide incentives for the rapid growth
of manufactured exports, average income would rise to Rp 69 million ($5,900). The
income of the average Indonesian would be nearly fifty percent higher.
Chart 1: Cumulative Benefits of Changes in Policies to
Increase Labor-Intensive Manufactured Exports, Import
Substitution and other Activities, 2014-2019 and 2014-2024
The Opportunity of a Generation
Indonesia has fallen behind for the last 25 years; if the government
does not act soon the country will miss a once in a century opportunity.
The same chart shows that since 1993 Indonesia has seriously fallen
behind other Asian countries. Indonesia’s share of the world market
for manufactured goods was cut in half from 1995 (1.2 percent) to
2013 (0.6 percent), while the share of Bangladesh doubled, Vietnam’s
increased eight times and China’s almost tripled. In short, Indonesia
is way behind in the race to take over the market that China is now
vacating. It if fails to catch up in the next five years the race will be over:
investors will have put their factories in other countries and Indonesia
will be left with thirty million surplus workers and slow growth of
national income. The demographic dividend will have turned into a
demographic nightmare.
xvii
The Economic Choices
Facing The Next President
Chart 2: Comparative Asian Growth Rates for Exports of
Manufactures and Textiles and Garments (annual % change)
Note: The four countries are Bangladesh, China, India & Vietnam. For 1986-92 we
lacked comparable Vietnam data so the comparison is limited to three countries.
The Bottom Forty Percent Have Been Left Behind
A labor-intensive strategy is in any case essential to increase the income
of the poorest forty percent of the population who have been left behind
since 2005. As Chart 3 shows, it is the richest twenty percent that have
benefited the most from rapid growth during the commodity boom and
the poorest forty percent who have benefited the least. As a result, income
distribution has become less equal. The data in Chart 3 already include
the benefits the poor derive from various government programs. After
The Economic Choices
Facing The Next President
xviii
taking account of administrative costs and leakages to the non-poor, the
benefits delivered by most of these programs are limited.
By far the best way to increase the income of the poorest forty
percent is to increase demand for their labor. From 1964/65 to
1990 when demand for low-skilled labor increased relatively rapidly, the
incomes of the poorest forty percent actually rose more rapidly than the
incomes of the richest twenty percent. As demand for low-skill labor
slowed, the situation was reversed. It was during the commodity boom
after 2005 that demand for labor stalled while profits rose, enabling
the richest twenty percent to pull ahead. Our proposed strategy will not only
achieve higher growth but will ensure that the poorest forty percent are the principal
beneficiaries by increasing demand for their labor.
Chart 3: Real Consumption of the Poorest 40%, the Middle
40% and the Richest 20%, 1964/5-2013, Average in Rp
million, 2012 Prices
xix
The Economic Choices
Facing The Next President
A Flexible Policy Package
There is nothing rigid about the policy package outlined in this
book. Costs of production must come down sufficiently to put
Indonesia back into competition in the world market. But as long
as total costs are reduced, it does not matter which costs fall. The
greater the reduction in infrastructure costs, the less labor costs
need to be reduced. The greater the reduction in corruption
costs, the less the reduction needed in infrastructure costs. For
Indonesia, there is no single policy, and no single cost that is the
key to competitiveness. The minimum wage in Jakarta is triple that in Bangladesh. Even
in Semarang, which has the lowest wage of any area in Indonesia
with a large supply of labor, the wage is seventy percent higher
than Bangladesh. Since the aim of the policy package is to increase
the incomes of the poorest forty percent, costs cannot be reduced
by reducing workers’ incomes. Costs will need to be attacked on
a broad front with reductions realized where possible in order to
reduce total costs enough to make Indonesia’s exports competitive
once again.
Infrastructure is Critical
High infrastructure costs are a major reason for high total costs.
Reducing them is therefore critical. The first and most important step
is to increase investment. Improving infrastructure will remain a dream
unless substantially more resources are committed to it.
Above all there needs to be a roughly ten-fold increase in
expenditures by the national government, from 0.6 to 6.5
percent of national income by 2019. The only way to fund increased
infrastructure investment in 2015 and 2016 is by sharply reducing and
then eliminating the fuel subsidy, and using the funds for infrastructure.
Tax reform can begin to make a contribution to increased resources in
2016 and will be the major source for public investment from then on.
Increased government revenues need to be supplemented by private
investment.
The Economic Choices
Facing The Next President
xx
Priority in investing limited infrastructure funds should go to
areas that have attracted new investment in manufacturing,
especially for exports, because: [i] with new productive investment in
place but poor infrastructure, investment in infrastructure can give a
high return; [ii] it provides an incentive for sub-national governments to
adopt policies and programs to attract investment and increase output. A
“Pioneer Exporter Fund” should be set aside for this purpose.
Increasing implementation capacity. Increasing investment in
infrastructure requires not only raising more resources but also an equally
massive increase in the implementation capacity of the government. For
instance, the electric company PLN needs to increase power generating
capacity by 140 percent. Such an increase is well beyond the financial
and implementing capacity of the power company.
Production sharing to increase both private investment and
private construction. Private-public partnerships were advertised as
the perfect solution, but have proved to be largely ineffective. For those
parts of infrastructure that generate income like power generation, a
good approach could be to use the production sharing concept which
Indonesia pioneered. The government would retain ownership but private
firms would provide both the funds and the implementing capacity. This
arrangement could only work, however, if the electricity or other rates
are raised sufficiently so that it becomes profitable to produce electricity
or perform other services. Production-sharing could also work for ports,
airports and possibly toll-roads. Unlike other methods of attracting
both private investment and implementation, it can make possible the
participation of foreign investors without violating the requirement that
infrastructure be owned by the national government.
Infrastructure construction by private firms instead of taxes.
Another method to get private firms to construct infrastructure which
does not yield a direct return is to offer tax forgiveness in return.
This method, used in Peru, is particularly useful in areas where such
construction is especially difficult. For example, firms would pay off their
tax obligations by constructing a road with a small bonus as an incentive.
xxi
The Economic Choices
Facing The Next President
Increasing oil and gas drilling and production by improving
incentives. In 2012 there were 95 wells drilled for oil and gas; in 2013
only 66 were drilled and the rate in 2014 was 21 wells. Production of
oil and gas in old fields is declining and plans are being made for a
facility to import LNG to make up the shortfall. Importing gas would
be expensive and would increase the cost of power production, the very
opposite of what is needed to increase the competitiveness of Indonesia’s
manufactured exports.
It would be far better to aim to increase domestic production of oil and
gas. This would require reversing the sharp decline in wells drilled by
making it more attractive to explore for oil and gas in Indonesia. If a
fifteen percent share is no longer a sufficient incentive, then it makes
sense to increase the share. With imported LNG, 100 percent of the
revenue goes to foreign companies; far better to offer them thirty or
forty percent of the revenue from new Indonesian wells under improved
production-sharing contracts.
Convert commercial vehicles to run on natural gas where
available to lower the cost of transport. Conversion of trucks and
buses should be done at no cost to the owners, paid for by commercial
loans. The loans would be repaid automatically as part of fuel cost. If
only the commercial fleet is converted then their fuel costs can be kept
low since they cannot resell natural gas to private cars or smuggle it
abroad.
Use an effective matching grants program to induce sub-national
governments to use more of their resources for the development
of infrastructure, health and education and less for administrative
overhead. Provinces, kabupaten and kecamatan now control expenditures of
six percent of GDP or almost Rp 600 trillion; by 2024 this will be nearly
eight percent of GDP and Rp 1,700 trillion ($145 billion at the current
exchange rate). A substantial part is currently badly spent. Matching
grants can provide a strong incentive for at least some of them to spend
more on infrastructure.
The Economic Choices
Facing The Next President
xxii
Reducing the Cost of Labor to Employers While Increasing
Workers’ Incomes
Devaluation of the currency is the most powerful means for
lowering labor and other domestic costs to exporters and those
competing with imports. By reducing the number of dollars, yen or
euro it takes to buy Rp. 1 million, it reduces the cost of domestic inputs
and especially labor. Since labor is up to one-third of the total cost of
labor-intensive industries, this can be a major reduction in total costs of
exports and an important incentive to use more labor-intensive methods of
production. Workers benefit as more find employment in manufacturing
where wages are higher than in informal sector jobs. Devaluation can
also raise savings by making imported luxury goods more expensive.
Stabilizing the prices of foods that are important in the consumption of the poorest forty
percent is important. If food prices are not stabilized, the benefits of devaluation
can be eroded by more rapid inflation. This can quite readily be done in the
case of rice where the Indonesian price is above the world market price as a
result of a tariff and import restrictions. Since a fifteen percent devaluation
has the same effect on prices as a fifteen percent tariff, rice prices can be
kept constant by reducing the tariff by the same percentage share as the
devaluation. The prices of vegetables important to poor households like
onions, garlic and chilies can also be stabilized by reducing import restrictions.
An acceleration of inflation from three to ten percent would reduce the
real wage by only 2.6 percent for one year. This negative effect can be
swamped by the positive effect of increased demand for labor. Therefore
a monetary policy which results in more rapid inflation and a decline in
the value of the rupiah can be a pro-poor policy if it results in increased
manufactured exports. Conversely, a tight monetary policy that uses an
overvalued exchange rate to reduce inflationary pressure harms the poor
because it slows the creation of good jobs.
Increasing labor productivity effectively lowers labor costs. Training
and general education programs can be financed by government or by
special levies on producers collected by government. But the actual
training should be carried out by the industry itself.
xxiii
The Economic Choices
Facing The Next President
Voluntarily changing the system of severance pay. The present
system is costly to large compliant exporters but in reality provides
minimal benefits to workers. Workers and employers should be able to
shift voluntarily to an insurance system with greater actual benefits to
workers and lower costs to industry. If the process is voluntary, it will take
some time to achieve substantial coverage but only a voluntary process
has a chance of being accepted.
Establish Export Processing Zones in low wage areas with
wages below the minimum, compensated by subsidized
government services for workers. Governments can legitimately
provide services such as: low cost housing; free schooling through high
school; free health services; transportation vouchers for workers living
away from the EPZ; and, subsidized food in EPZ canteens for workers
and for their children in school. By providing such services government
can indirectly subsidize labor working in export industries.
Revive an earlier drawback system that provided a small
incentive for exporters and for firms supplying their inputs.
The central feature was that the magnitude of the drawback was fixed in
advance for each good exported. There was no need to prove that inputs
had actually been imported or that tariffs had been paid.
Fiscal Policy
The national government needs to roughly triple its
expenditures to fulfill its role in achieving higher growth and more
employment. It needs to invest at least 6.5 percent of GDP in infrastructure
rather than less than one percent at present. In the first years of the new
president’s term the only source of additional resources is to reduce the
fuel subsidy which primarily benefits the wealthier groups. In later years
tax reform needs to generate additional revenue of 4.5 percent of GDP.
Reform of the VAT, primarily by expanding its base, can bring in two
percent. Improved tax compliance by the self-employed and professionals
and the use of benchmarks for specific sectors to increase corporate tax
collection can yield another one percent. The more rapid growth of the
formal and taxed sectors will contribute a further one percent.
The Economic Choices
Facing The Next President
xxiv
As discussed below, the government should also turn the current PNPM
labor-intensive program for infrastructure development into a guaranteed
employment program, at a cost of 0.4 percent of GDP.
Other essential government programs include services in Export
Processing Zones to reduce labor costs, and the re-introduction of a wellfunctioning duty drawback scheme for exporters. The creation of an
effective matching grants program to encourage local authorities to invest
more in infrastructure would require an additional two percent of GDP.
Savings-Investment Gap
Domestic savings are inadequate to finance the needed
investment. Foreign Direct Private Investment will need to close the gap
between an investment rate of about forty percent, required to achieve
ten percent growth, and domestic savings of 30-35 percent. FDI of $6080 billion will fill the gap but Indonesia has just attracted $10-15 billion
a year net in the past. If it attracts no more FDI in the future, growth will
be about 7.5 instead of 10 percent in the final year of the new president’s
administration. FDI also provides needed technical and managerial skills
in a few fields, the ability to mobilize and risk huge sums of money in
other activities and easier access to some global markets.
In attracting FDI Indonesia is in competition with other
countries. Some competitors have become more attractive recently
while investment in Indonesia is seen as more risky. The country needs to
strike a careful balance between giving preference to domestic investors
while attracting sufficient foreign investment to prevent an undue slowing
of growth and job creation. Giving an advantage to Indonesian investors
and professionals by taxes or fees on foreigners rather than through
rules and quotas is more efficient, reduces corruption and generates
government revenue.
There are significant political costs to a larger role for Foreign Direct Private
Investment. But it needs to be recognized that there are substantial economic costs to a
reduction in foreign investment. These economic costs translate into political costs over
time as the economy grows more slowly and fewer good productive jobs are created.
xxv
The Economic Choices
Facing The Next President
Corruption, Ease of Doing Business and the Cost of Credit
Indonesia ranks poorly on three aspects of competitiveness: corruption,
ease of doing business and the cost of borrowing. These are less important
than the cost of infrastructure and of labor, but the costs of corruption
and of doing business could readily be reduced.
The culture of corruption is well established as a result of a long
period when government officials could not survive without the income
that corruption brought. It is difficult and takes time to change such a
culture. But Indonesia has made some progress in reducing the cost of
corruption to business. It could do much more by reducing the benefits
of being corrupt and increasing its cost.
First, Indonesia can reduce the discretion that government
officials have in deciding whether an enterprise will be
profitable reduces the rewards of corruption. Instead of using
regulations administered by officials, government can discourage some
activities and encourage others by taxes or subsidies available to any
business. Less official discretion to reward or punish results in less
corruption.
Second, increasing transparency increases the risks associated
with being corrupt. If all judicial decisions or awards of government
contracts need to be posted on the internet together with the justification
for the decision, corruption will be reduced.
Indonesia has also improved its standing with respect to the ease of doing
business but it is still in the bottom forty percent of all countries. Many
of the steps to reduce corruption will also improve the ease of doing
business. One reason it is difficult to establish a business in Indonesia
is that the approval of many officials is required, all of whom have
substantial discretion and base their decisions on unclear criteria. If
instead there are specified fees for engaging in certain economic activities
and no fees or even subsidies for others, then doing business in Indonesia
would be simpler, faster and less subject to uncertainty and risk.
The Economic Choices
Facing The Next President
xxvi
To reduce corruption and improve the ease of doing business, direct
import controls should be abolished and replaced with currency
devaluation and taxes on specific imports. The beneficiary of import
taxes will be the government, while the beneficiary of import licenses
will generally be the official in charge of awarding them.
The difficulty of obtaining credit for investment and the high
cost of borrowing are another obstacle to the competitiveness
of Indonesia’s exports and import substitution industries. The
Indonesian banking system has a large spread between borrowing and lending
costs which is partly the result of a lack of competitive pressure to become
more efficient. It may help to provide a small subsidy for the investment
costs of providing banking services in areas where there are fewer than two
banks. In addition, credit is difficult to obtain, especially by medium-sized
and smaller enterprises. In part this is due to the fact that most banks can
expand their loan portfolio only as they expand their deposits or their capital.
Infusions of new capital from FDI should be encouraged.
A Guaranteed Rural Employment Program
A Guaranteed Rural Employment Program can prevent
millions from falling into poverty during the agricultural lean
season and build rural infrastructure. Building on the existing
PNPM-Rural program (Program Nasional Pemberdayaan Masyarakat
or the National Community Empowerment Program) a Guaranteed
Employment Program for the rural areas can be quickly in operation. It
would provide employment and income to agricultural laborers during
the annual lean season or whenever catastrophe sharply reduces their
incomes. In doing so, the program would alleviate forms of temporary
poverty that often turn into permanent poverty.
An important benefit of a Guaranteed Rural Employment
Program is that it would efficiently build high-return local
infrastructure which can, in turn, result in permanently greater
employment and higher incomes. The construction of farm to market
roads, repair and maintenance of irrigation systems and similar local
xxvii
The Economic Choices
Facing The Next President
projects generate employment opportunities and permanently increase
incomes by raising labor productivity.
The program would also make a significant contribution to a
Social Safety Net that automatically increases jobs and income when
and where they are needed. It will reduce the number of agricultural
laborers who drift into cities in desperate search for work and income,
driving down wages in general. It stabilizes the whole economy by
providing automatic work and income increases whenever there is a setback to an area or to the country as a whole.
Wages for workers must not exceed the agricultural wage in the area
to ensure that the program is self-targeting: in other words, since only
poor people will want to participate there is no need to expend time
and money identifying eligible beneficiaries and checking that noneligible individuals are not included. In addition, funding would need to
be flexible so that the program can automatically respond to changing
needs.
Unlike many of the proposed policies and programs Guaranteed Employment
can provide immediate and tangible benefits. It can therefore help to make the
whole reform program more politically acceptable.
The program should and can be extended for urban areas as soon as the
problems identified in the urban program by a major evaluation have
been dealt with. It is inherently more difficult to find labor intensive
projects in urban areas that will permanently increase employment and
income. Reducing flooding in Jakarta is an example.
The Economic Choices
Facing The Next President
xxviii
ACKNOWLEDGEMENTS
This effort would never have seen the light of day if it were not for the
courage and vision of Peter Sondakh and the Rajawali Foundation. The
usual procedure in doing a study of this kind is to ask the “experts” to
determine what goals are feasible and how they can be reached. It was
courageous and far-sighted of Peter Sondakh and the Rajawali Foundation
to tell the experts the goals that needed to be reached to transform
Indonesia. Indonesia had never reached a rate of growth of its national
income of double digits or more. And most economists if asked would
have said that such a goal was quite unrealistic. We are grateful that Peter
Sondakh insisted that we should address the question of how Indonesia
could join the select group of countries that have improved the well-being
of their population dramatically by achieving such a rate of growth.
Nugroho Wienarto, as the Director of Center for Public Policy
Transformasi, was responsible for seeing that the project and was well
executed and that the results were communicated to the public and to
policy makers. He was an efficient and helpful partner, ably assisted by
his Transformasi team, now too numerous to list here in full.
To be useful, our recommendations had to be based on a solid factual
foundation which required a great deal of data gathering, manipulation
and analysis. Much of that work was done by a sterling group of
research assistants who often worked long hours, weekends and holidays
without complaint: Rizki Nauli Siregar, Tita Ningtyas, Lionel Tien Lung
and Andika Pambudi. Hannah Cardosi handled all the research done
in Lexington, learning enough Bahasa to use the BPS website, helped
coordinate and manage the different pieces of this large effort and
remained amazingly cheerful even at times of great pressure
As we began wrestling with the problem of how to achieve not only
high growth but inclusive growth Dr. M. Chatib Basri participated in the
work until he joined the government. We benefited immensely from his
rare combination of world class analytical skills in economics, extensive
xxix
The Economic Choices
Facing The Next President
knowledge of the Indonesian economy and his understanding of the
political economy of decision making in Indonesia. Many of the ideas in
this book evolved in discussion with him.
In order to write intelligently about the potential of labor-intensive
manufactured exports, we needed to know more about the industries
that had the potential for significant expansion in Indonesia, and Benny
Soetrisno and Anton Supit generously gave us insights into most of these
industries drawing on their extensive experience and knowledge which
was invaluable to our work.
Jonathan Pincus, Agung Binantoro and Listiani Hermanto of the
Rajawali Foundation provided constant support and encouragement
from the first days of this project. Jonathan also kindly read early drafts
and helped to edit the final product.
Sofjan Wanandi commented on our ideas from the perspective of a
well-informed businessman, industrialist and public citizen. Dr. Hendri
Saparini of CORE Indonesia helped us to understand helped us to
understand the point of view of organized labor and civil society by
organizing and presiding over a meeting in which these groups were
well represented. Chairul Tanjung, Chairman and the Members of
the President’s Economic Council at the time, provided professional
comments on our ideas at an early stage which greatly helped us improve
our recommendations.
It should go without saying that none of these people have any
responsibility for our final analysis and recommendations.
The Economic Choices
Facing The Next President
xxx
FOREWORD
by the Honorable M. Chatib Basri,
Minister of Finance, Republic of Indonesia
I
t gives me great pleasure to write a few
words of introduction to this timely and
insightful study of Indonesia’s economic
opportunities and prospects for the coming
five years to ten years. The book argues
forcefully that the central economic issue
facing Indonesia is the creation of millions
of formal sector, productive jobs every
year for our rapidly growing labor force.
Achieving the international competitiveness
that we need to do so will not be an easy
task, but it is essential if we are to reduce
poverty and inequality and improve the living standards of the vast majority
of Indonesians. This book is commendable and very informative. I also
think that the policy recommendations that suggested by the authors are
particularly important for every decision maker in the field of Indonesian
economic policy. The authors of this book have produced a very clear and
useful summary of Indonesian economic development, and they have also
suggested some good policy recommendations. I would view this book as a
policy oriented book rather than a pure academic study.
In the interests of full disclosure it is incumbent upon me to mention that
the three authors of this important book—Professor Gustav Papanek, Dr.
Raden Pardede and Professor Suahasil Nazara—are friends and colleagues
with whom I have collaborated on numerous research projects over the
years. Like many of my colleagues, I consider Gus Papanek one of my
mentors in the field of development economics. Professor Papanek has been
studying the Indonesian economy for over five decades and he has taught
several generations of Indonesian academic economists, first at Harvard
and later at Boston University. When it comes to the Indonesian economy
xxxi
The Economic Choices
Facing The Next President
he has never wavered in his primary concern, which is to build an economy
in which all Indonesians can lead productive lives free from poverty. I have
been working closely with Professor Papanek for a long time, long before I
took my job in the government as Indonesian Chairman of the Investment
Board and later as Minister of Finance. I think of him as one of the best
brains in the field of Indonesian economic development policy. This is not
surprising, as Professor Papanek has been working with many presidents
and ministers in many countries in Asia and Africa. To me personnally, it
was a privelege to get a chance to work with him.
Indonesia is facing a crossroads. The resource boom that we enjoyed for most
of the past decade is over, and it is unlikely to be repeated any time soon.
We are now a richer country than we were at the turn of the millennium,
and millions have been lifted out of poverty. But now we need new thinking
to sustain economic growth, and as this book makes clear, create millions
of good jobs. Our so-called “demographic dividend” provides a window of
opportunity, but only if our people are productively employed in jobs that
create value and deliver a level of income to them that can sustain a decent
standard of living. Failure to create these jobs—especially for the bottom
forty percent of the population—would result in slow economic growth,
rising inequality and structural balance of payments problems. We must do
all that we can to avoid that undesirable outcome.
I commend this book to all Indonesians who share my dream of an Indonesia
that can take its rightful place as one of the leading economies of the world,
and a country in which no one has to suffer the indignity of poverty.
M. Chatib Basri, Ph.D
Minister of Finance of the Republic of Indonesia
The Economic Choices
Facing The Next President
xxxii
PREFACE
by Professor Jeffrey Winters, Northwestern University
T
he fundamental message of this excellent study
is that it is within Indonesia’s reach to achieve
double-digit growth, that the lives of over 100 million
poor Indonesians can be significantly improved by
creating good jobs in export-oriented and laborintensive manufacturing, and that a unique window
of opportunity is open for economic transformation
in Indonesia that appears perhaps once in a century.
The fundamental question is: Can Indonesia’s
leaders rise to the challenge of this moment, reach
beyond business-as-usual policies, and set a standard
of public service and commitment not yet seen since the nation’s founding?
An important part of meeting this challenge is a frank discussion of what
nationalism really means for Indonesia. Can Indonesians update and expand
the scope and meaning of nationalism from a narrow interpretation that
views the outside world with fear to one that says that the most nationalist
thing Indonesian leaders can do is dramatically improve the prosperity and
strength of their people, and thus of their country?
This means a shift from rhetorical nationalism to substantive nationalism.
One clear message of this study is that Indonesia will not be able to achieve
rapid gains in prosperity without embracing the international world and
engaging international actors.
I will say more about the study and the opportunities and challenges it
represents in a moment. But first it is important to understand the origins
of this focus on double-digit growth (DDG) in Indonesia. The year was
2004 and the presidential campaign was in full swing. It was in private
conversations with some of the candidates that an international group of us
started to discuss the idea of Indonesia reaching sustainable growth in the
xxxiii
The Economic Choices
Facing The Next President
range of ten to twelve percent per year. The candidates were very interested,
but ultimately they were not the ones who won the election.
The candidate and economic team that won represented the mainstream
in Indonesian developmental thinking – what might be called the “seven
percent mentality.” This mentality arose early in the New Order and it had
two aspects: first that seven percent growth was good enough for Indonesia;
and second, that it was all a country of such size, complexity, and diversity
could reasonably hope to achieve.
Goals and ambitions matter, and this mentality was wrong on both counts.
In the 1970s, China was far behind Indonesia, but proved that a large and
complex country could develop at a double-digit pace for decades. And the
continuing chronic poverty and growing inequality in Indonesia demonstrate
that a target of seven percent was simply not enough to achieve prosperity,
security, and basic human dignity for millions of citizens.
We argued in various forums that the seven percent mentality was a liability
and that planners and leaders had to aim higher and push harder. As this DDG
study shows, job creation has been far too slow and the bottom forty percent of
the population has been left out of the country’s development gains.
It was evident by the 2009 election that the discourse on growth was
changing. And by the 2014 campaign, double-digit growth was starting to
emerge as the new standard against which candidates were being judged.
This shift in mentality and goals is important. But it is only a first step. Informed
policy studies had to be written and concrete strategies developed to reach
such ambitious economic goals. Our first major contribution to this effort
was the 2010 publication, From Reformasi to Institutional Transformation: A Strategic
Assessment of Indonesia’s Prospects for Growth, Equity, and Democratic Governance, with
the Cambridge-trained development economist Jonathan Pincus as the lead
The Economic Choices
Facing The Next President
xxxiv
author of a joint Harvard and Indonesian research team. This influential study,
which was discussed in a special forum with the president and entire cabinet,
was also published by the Kompas Group as Indonesia Menentukan Nasib.
The key theme of that study was that the Reformasi movement had
lost momentum, and that a renewed effort to build strong, democratic
institutions was needed to arrest the drift towards economic stagnation,
inequality, and social conflict. The 2014 election, which included a call for a
“mental revolution,” signaled a deep frustration with business-as-usual and a
desire to usher in a different kind of political style and responsiveness. If the
incoming president and policymakers strongly push the mental revolution
agenda, there is hope Indonesia can adopt the policies needed for job
creation for the most vulnerable segment of the population.
This current study is the second major contribution to the goal of reaching
double-digit growth in Indonesia. Ideally, the two studies should be read
together to gain a full picture of the multi-dimensional challenges and
opportunities this great nation faces. Both studies draw on trans-national
teams of economists, political scientists, sociologists, and specialists in
comparative public policy. But perhaps most important of all, these studies
are written by scholars both from Indonesia and abroad who know the
country well, have extensive experience here spanning decades, and are
passionately engaged in the country’s efforts to raise the living standards and
human dignity of the Indonesian population.
Over a period of decades, I have read hundreds of studies that try to diagnose
the economic problems Indonesia faces and offer solutions and plans. In my
opinion, this work by lead author Professor Gustav Papanek, together with his
colleagues Raden Pardede and Professor Suahasil Nazara, is among the best I
have seen. Allow me to mention the main strengths of this remarkable study.
First, the authors redefine the meaning of successful economic development
for Indonesia: it is the ambitious creation of good jobs in the manufacturing
sector. They show that by making this the primary target for development
policy, the country will increase exports and achieve double-digit growth by
2019 and 21 million jobs that will change the lives of a large segment of the
Indonesian population and have beneficial effects for the overall economy.
xxxv
The Economic Choices
Facing The Next President
Second, the authors admit that these goals are ambitious. But they also
demonstrate that they are achievable. They do this in two ways. They provide an
important overview of the economic strategies that have already been attempted,
and point out many of the disappointing results that were produced. And then
they present an alternative set of policies that are clear, integrated, politically
realistic, and carefully tailored to the Indonesian context and experience.
The third strength of this study is that it is informed by a keen awareness of global
and regional economic trends, as well as a comparative perspective that looks carefully
and critically at what has been tried and what has worked in other countries.
The result of these components is a document that must be read, debated,
and digested by anyone seriously concerned about life-chances for the
Indonesian people and determined to make a difference for the country’s
future. Although this study is addressed to the incoming president, it is a fully
independent product of careful research by professionals at the very top of
their field who are non-partisan and who are motivated solely by the urgent
desire to bring rapid economic transformation to Indonesia.
I would like to close with a more personal word about Professor Gustav
Papanek. He came to Indonesia for the first time in the early 1950s, and
he has devoted the lion’s share of his professional career to working with
policymakers and economists in Indonesia and abroad to contribute
something positive and useful for this country’s development.
I have had the good fortune to interact with Gus, and I constantly learn
from his seasoned and thoughtful insights and analyses. No international
developmental agency attempting a policy study for Indonesia will ever bring
Gus’s level of knowledge and commitment to the research and proposals
for change. I hope Indonesia’s leaders and broader society study this work
closely and move quickly to adopt its recommendations.
Jeffrey Winters, Ph.D
Professor of Politics
Director of the Equality Development and
Globalization Studies (EDGS) Program
Northwestern University
The Economic Choices
Facing The Next President
xxxvi
ABOUT THE AUTHORS
Professor Gustav F. Papanek
Professor Gustav F. Papanek is Emeritus Professor of
Economics at Boston University and the President of
Boston Institute for Developing Economies (BIDE).
In an academic career spanning 25 years at Harvard
and 18 years at Boston University, he has published
eight books and fifty scholarly articles in some of the
leading journals of the profession. Concurrently he
provided practical policy advice to governments in more than twenty countries.
He has been active in Indonesia since the early 1960s when he was Director
of Harvard’s Development Advisory Service, the forerunner of the Harvard
Institute for International Development (HIID). From 1969 to December
1973 he was Head of the Harvard Advisory group to Bappenas and the
Ministry of Finance and from 1987 to 1988 the head of the BIDE advisory
group to Bappenas. As Professor of Economics and Chair of the Economics
Department at Boston University, he trained several generations of Indonesian
economists, many of whom have had distinguished careers in academia and
government. As an established authority in development economics, he has
continued to publish original research, for a decade in collaboration with Dr.
M. Chatib Basri, currently Minister of Finance of the Republic of Indonesia.
He also continued to advise governments and international organizations on
development strategy, poverty reduction and employment generation, among
other issues.
xxxvii
The Economic Choices
Facing The Next President
Raden Pardede
Raden Pardede is Co-Founder and Managing Partner
of CReco Research Institute and Vice Chairman
of the National Economic Committee, a body that
provides analysis economic analysis and advice to the
President of the Republic of Indonesia. He has held
several senior posts in government including Special
Advisor to the Minister of Finance, Special Advisor
to the Coordinating Minister of Economic Affairs and Secretary General of
the Indonesia Financial System Stability Committee. He is widely known as
an expert in macroeconomics, financial sector regulation, fiscal policy and
scenario and strategic planning. He serves as an independent commissioner
for several publicly listed companies. Dr. Pardede holds a bachelor degree
in chemical engineering from the Bandung Institute of Technology and
completed his doctorate in economics at Boston University, USA.
Professor Suahasil Nazara
Professor Suahasil Nazara is Professor of Economics,
Faculty of Economics, Universitas Indonesia (FEUI).
His expertise includes the economics of development,
regional economics, labor economics, economics
of poverty and social protection, econometrics
and input-output analysis. In addition to teaching
and supervising students at Universitas Indonesia,
Professor Nazara is also active in supporting the
Government of Indonesia in different roles. He is a member of the National
Economic Council and the Policy Group Coordinator at the Secretariat of
the National Team for the Acceleration of Poverty Reduction (TNP2K) in the
Office of the Vice President of the Republic of Indonesia. Professor Nazara
obtained a bachelor degree from the Faculty of Economics, Universitas
Indonesia and a master degree from Cornell University. He completed his
doctorate at the University of Illinois at Urbana-Champaign.
The Economic Choices
Facing The Next President
xxxviii
A NOTE FROM THE PUBLISHER
T
he Center for Public Policy Transformation,
commonly known as Transformasi, is a new
institution dedicated to promoting evidence-based
policy in Indonesia. Established just last year with
generous support from the Rajawali Foundation
and other donors, our mission is to help bridge
the gap between policy makers, researchers and
the public through support for practical policy
research and training activities.
Transformasi is proud to offer this book as a contribution to the national
debate on the future direction of economic and social policy. The
authors of the book—Professor Gustav Papanek, Dr. Raden Pardede and
Professor Suahasil Nazara—possess not only a deep understanding of the
Indonesian economy but, of equal importance, many years of practical
experience working with policy makers to develop and implement
economic policy. They have produced a remarkably insightful assessment
of the current situation in Indonesia and concrete proposals to accelerate
job creation and growth and to improve the lives of the vast majority of
Indonesian citizens.
The book raises issues that will remain vital to Indonesia’s development
and prosperity for many years to come. We are in full agreement with
the authors that good, productive jobs represent the most secure path
from poverty to income security. Moreover, increasing the proportion
of the labor force employed in good jobs accelerates growth, generates
additional exports and increases government revenues needed for
investment in infrastructure and social protection programs. In line with
the recommendations of the book, Transformasi will produce regular
Progress Reports or Report Cards to track key indicators, for example
the volume of labor-intensive exports, agricultural wage rates and per
capita consumption of the bottom forty percent of the population. We
hope that these Progress Reports provide timely and useful information
xxxix
The Economic Choices
Facing The Next President
to policy makers, and also help to build public awareness of the vital
importance of job creation to economic growth and equity.
On behalf of Transformasi, I would like to express our deep appreciation
to the authors and to everyone else who has contributed to the successful
completion of this study. In particular, I would like to thank the
Rajawali Foundation for financial support for this project and for the
deep commitment of Mr Peter Sondakh, the Foundation’s patron, to the
development of policy research and education in Indonesia. We share
with him the belief that even small improvements in public policy can
have a meaningful and lasting impact on the lives of ordinary people. We
hope that this book will stimulate debate among policy makers, scholars,
journalists and others on the best way forward for economic policy for
the next five years and beyond.
Jakarta, October 9, 2014
Nugroho Wienarto
Executive Director
Center for Public Policy Transformation
www.transformasi.org
1
The Economic Choices
Facing The Next President
PART I:
THE CHOICE
source: http://www.pdu4pm.com
Chapter 1.
Indonesia has a Window of Opportunity
to Achieve Double Digit Growth and Four
Million Good Jobs Every Year
In the next five years the new president and his government
can transform the country, by achieving economic growth of
ten percent per year and by creating 21 million good, stable
jobs.
The Economic Choices
Facing The Next President
2
A once-in-a-century opportunity exists because China, which has
dominated the world market for labor-intensive manufactured goods, is
no longer as competitive in that market as it once was. Its wages are
high and rising; its labor force is getting older and smaller; and political
tensions have increased between Japan—an important investor in the
manufacturing sector—and China. Therefore other countries are
beginning to supply the goods that China used to supply. Indonesia
is among the countries that are in a position to take over some of the
market that China is being forced to leave.
Indonesia has a large pool of workers in low-productivity jobs.
It would benefit greatly from giving these workers a chance to
get high productivity manufacturing jobs.
More than ten million Indonesian workers are working abroad or work in
jobs at home that contribute little to output because they cannot find good,
productive jobs. This supply of workers provides Indonesia with an excellent
opportunity to compete in the world market for labor-intensive goods.
Tripling export earnings. If Indonesia adopts policies to increase the
country’s competitiveness it could take over seven percent of China’s
market for labor-intensive exports over five years. This would add $110
billion (Papanek, 2014a) to manufactured exports, which totaled $65
billion in 2013. Increasing manufactured exports by $110 billion is not as
difficult as it may seem at first glance because the world market continues
to expand. Over the last four years:
• Chinese exports have grown at $150 billion per year;
• Chinese labor-intensive exports have grown at over $70 billion
per year; and,
• World trade in manufactured goods has increased at $250
billion per year.
Therefore even if Indonesia increases its exports by $22 billion per year
on average it does not mean that the exports of other countries would
not grow. Even China’s manufactured exports are likely to continue to
grow rapidly but they will be increasingly less labor-intensive.
3
The Economic Choices
Facing The Next President
Fewer imports, greater domestic production of manufactured goods or increased
“import- substitution.” Policies that provide incentives to export will also
increase the competitiveness of industries competing with imports. If
the cost of transport and power is reduced, if policies are more stable
and doing business is less costly, if a devalued rupiah makes exports
more profitable and imports more expensive, then the competitiveness
of exporters will increase and at the same time domestic firms
competing with imports will also enjoy a cost advantage. Indonesian
producers of shoes and nails, of cars and bicycles will be better able
to compete with imports. More value will be added in the country and
less will be imported. And more jobs will be created in Indonesia and
fewer in China, the United States or Japan.
The potential for import substitution—in other words, for producing
in Indonesia what has previously been imported—is much smaller than
for exports. Domestic manufacturers have benefitted from protection
at various times and much of what can be produced in Indonesia is
already produced here. A substantial part of imports consists of goods
like wheat and cotton that cannot efficiently be produced in Indonesia.
But we estimate that some $130 billion of imports in 2012 could have
been produced in Indonesia. By 2019 estimated imports that could
be produced in Indonesia will have nearly doubled to $240 billion. If
the recommended policy changes are carried out and producers are
more efficient we estimate that at least ten percent, or $24 billion,
will actually be produced in Indonesia rather than imported. The
$24 billion of import substitution, like the $110 billion of increased
exports, will increase national income and the number of good jobs.
Indirect effects of increased output of manufactures or the “multiplier.”
The indirect effects are substantial of employers investing in the
production of exports and goods previously imported, and of workers
and employers spending the additional income they have earned.
Income and employment in the construction industry will increase
as companies build factories and workers’ housing. Workers will buy
more street food, have more frequent haircuts, buy more bicycles
and spend more money on education. Higher levels of domestic
production will increase wholesale trade, shipping, transportation and
The Economic Choices
Facing The Next President
4
demand for port labor, communications equipment and the services
of freight forwarders. The indirect effects when added up are called
“the multiplier.” The size of the multiplier in Indonesia is estimated
at 1.85 (Schydlowsky, 2012). In other words, for every billion rupiah
in income generated directly, another estimated Rp. 850 million is
generated indirectly.
Of course, the entire sum of $110 billion in additional exports and $24
billion of import substitution is not pure gain. Producing these goods
requires imported inputs directly or indirectly. The technical appendix
(available at www.transformasi.org) shows how we have calculated the
value added and increased employment which results from additional
exports.
Other activities that benefit from policy changes: Tourism,
agricultural exports and food production.
Policies and programs that raise the competitiveness of manufactured
exports will also benefit agricultural exports and tourism. Obviously,
improvements that lower the cost of road transport will make Indonesia
more competitive in exporting flowers and fresh fruit and improve
access to tourist destinations. As discussed later, an exchange rate that
gives the exporter or the provider of tourist services more rupiah for
each dollar earned will make both more competitive.
There is considerable scope for import substitution in agriculture
as well. Indonesian imports of chilies, onions and garlic have
increased substantially although these commodities can be produced
in Indonesia. Meat, sugar and some other agricultural products are
also imported in significant quantities. A ten percent decline in the
value of the rupiah against the euro, yen and dollar is equivalent to a
ten percent tariff on the import of these goods. It will make it more
profitable to produce them in Indonesia and contribute to import
substitution.
It is difficult to estimate the impact of rising agricultural exports, import
substitution in agriculture and higher revenues from tourism on GDP
growth and employment. The positive effects of these changes will be
5
The Economic Choices
Facing The Next President
smaller than that of increased manufactured exports. We conservatively
attribute 1.45 percent of GDP growth and an additional 1.4 million
jobs in the fifth year to the improved trade balance in agriculture and
the growth of tourism.
The benefits of policy changes accrue slowly but are
substantial by the fifth year: An increase in average incomes
of more than one-third and 21 million new good jobs.
Chart 1 shows that it may take a couple of years for the full impact
of policy changes to be felt. However, Indonesia will be transformed
by the fifth year. The growth rate of income will have reached double
digits – ten percent. The basis will have been laid for continued high
rates of growth.
In the absence of policy change, economic conditions would improve
more slowly. Assuming a rate of population growth of 1.4 percent per
year, the rate of economic growth would be just 3.6 percent per person
per year; the income of the average Indonesian family would be about
19 percent greater in 2019 than in 2014.
Adopting the recommended policy package will result in more rapid
growth. Income per person will increase by 36 percent, almost double
the “business as usual” scenario.
Chart 1. Higher Growth and More Good Jobs from the Rapid Growth of Labor-Intensive Manufactured
Exports
Source: Papanek (2014b)
The Economic Choices
Facing The Next President
6
Of even greater importance than the rate of growth is the inclusiveness
of growth. The labor-intensive development which will result from the
proposed policy changes creates good jobs, especially for those who
now have very low incomes in the informal sector. Income will be
distributed more equally and the poverty rate will decline sharply. In
the five years of the next president’s first term, ten million new workers
will join the labor force and will be looking for jobs. Without policy
change, fewer than six million good jobs would be created during this
period. Therefore, another four million Indonesians would join the
twelve million or more unable to find good jobs since the Monetary
Crisis of 1997/98. With the supply of labor increasing more than
demand, the real wages of unprotected workers would decline, as has
happened in the recent past (see Chapter 3). Income distribution would
continue to become less equal and the pool of dissatisfied workers
would increase.
However, if the policy package is adopted and labor-intensive manufactured
exports grow rapidly, an estimated 21 million jobs will be created.
There will be jobs for the ten million who join the labor force and for
another eleven million who are now struggling to feed their families
with uncertain and low incomes in the informal sector or who have
gone abroad to work. With the demand for labor increasing about
twice as rapidly as supply, wages will inevitably rise and working class families
will benefit both from higher wages and from having more members of the family
earning a good and steady income in the formal sector.
By “good jobs” we mean those with an assured regular income, limited
hours and usually some benefits. They are also called “formal sector”
jobs. Workers who do not know whether they will have an income in
the next week or month and who do not know what that income will
be, do not have good jobs.
7
The Economic Choices
Facing The Next President
Chart 2. Cumulative Benefits of Changes in Policies to Increase Labor-Intensive Manufactured Exports,
Import Substitution and Other Activities, 2014-2019 and 2014-2024
Source: Papanek (2014b)
The benefits of rapid, labor-intensive growth will be even greater
in the next five year period from 2019 to 2024. Once Indonesia has
become competitive in the world market its exports will rise as these
markets expand. Incomes will increase as Indonesia’s exports move up
the value chain. Increased exports—and income earned from importsubstitution—will sustain high rates of growth.
If growth averages ten percent per year during this second period, average
income per person will roughly double between 2014 and 2024. As the goods
produced become more complex, their production is likely to become less
labor-intensive. The number of good, productive jobs created each year will
decrease somewhat from the 13.7 million projected for 2019. Nevertheless
we estimate that 77 million such jobs will be added in this ten year period. As
a result, Indonesia will be able to provide good jobs for most of the six
million or more forced to seek jobs abroad, the seven million unemployed,
the twelve to fifteen million “surplus” workers or disguised unemployed in
agriculture and other sectors, and the twenty million joining the labor force
over the ten year period. And there will still be some thirty million good
The Economic Choices
Facing The Next President
8
jobs for workers now in low-productivity, low-income work. With more than
seventy million good jobs made available over ten years, Indonesia will be
transformed from a country in which forty percent of the population lives
on average expenditures of less than two dollars per day to one in which
only ten percent suffer from such an extreme form of poverty.
How realistic is a 22 percent rate of growth for labor-intensive
manufactured exports?
These achievements may look quite attractive, but how realistic are they?
Can Indonesia achieve a rate of growth of manufactured exports of 22
percent a year, which is implied by going from $65 billion to $175 billion
in five years? The best answer to that question is provided by the record.
Chart 3 shows that record.
Optimists can cite the record from 1986 to 1992. Indonesia was the champion in Asia
with its manufactured exports increasing at forty percent a year, or doubling in
less than two years, well ahead of the other three large Asian exporters—China,
India, Bangladesh—whose manufactured exports were increasing at about onehalf that rate. And with respect to the most labor-intensive industries, textiles and
garments, Indonesia was equally far ahead. These exports were increasing at
the rate of forty percent for Indonesia and less than twenty percent for the other
three countries. On the basis of that experience the answer surely would be “why
not”; if relevant exports could increase forty percent in the past why could they
not increase 22 percent in the future?
Pessimists, however, might focus on the record from 1993 to 2012. Indonesia, the
former champion, was now far behind the other three. Manufactured exports
were growing at nine percent, slightly more than half of the rate in the other
three countries; garments and textiles grew at five percent in Indonesia, or onethird the rate of the other three. Moving from five percent growth of laborintensive exports actually achieved during this period to the 22 percent forecast
for the next five years would seem a difficult, or even impossible task.
Skeptics might refer to statistics for the most recent year. Manufactured
exports in the other three countries continued to increase at thirteen percent
on average, but Indonesia’s manufactured exports declined. Garments and
textiles had a bad year everywhere but the growth rate of the other three
9
The Economic Choices
Facing The Next President
countries was six times that of Indonesia. The comparison of Indonesia
with a simple average of Bangladesh, China, Vietnam and India shows
Indonesia regressing from its position as champion during the earliest period
to that of the worst performer in the most recent period. If Cambodia
were to be added to the comparison for 2013 the difference would be even
greater: the five country average for increased exports of garments and
textiles was nineteen percent versus one percent for Indonesia. Cambodia,
with a population of fifteen million, was exporting more than fifty percent
of the value of garments and textiles that Indonesia exported in 2013 with
a population more than fifteen times as great.
Chart 3. Comparative Asian Growth Rates for Exports of Manufactures & Textiles &
Garments (annual % change)
Note: The four countries are Bangladesh, China, India and Vietnam. For 1986-1992
comparable Vietnam data were not available, so the average is for the other 3 countries.
The average is a simple average.
Source: Papanek (2014c)
The Economic Choices
Facing The Next President
10
If the incentives are right Indonesian firms have responded
and will respond.
But neither pessimism nor skepticism is warranted. Manufactured exports
from Indonesia, as well as from its competitors, respond to incentives.
Indonesia was the champion after two devaluations in 1986/7 cut the
value of the rupiah in half, while food prices were stabilized and import
duties were cut to minimize inflationary consequences. Imported inputs
for exporters were made more freely available and foreign investment was
encouraged. Indonesia increased its manufactured exports twenty-fold
in twelve years from $1.1 billion in 1985 to $24 billion in 1997. There
were five-year periods in those years when exports increased three- to
five-fold in value. It should be possible to increase manufactured exports
by less than three-fold in the next five years.
The incentives facing exporters and those competing with imports will
need to change to achieve rapid growth of labor-intensive exports. But
the benefits of doing so are massive: above all 21 million good jobs for
workers and families who have barely scraped a living from various casual
jobs with uncertain income. The benefits for the country will be equally
great: these 21 million workers now contribute little to national income.
In decent jobs they will double the growth rate of national income from
five to ten percent and quickly move Indonesia to the level of a middleincome country.
With the right policies and programs Indonesia can achieve the following
objectives during the first the term of the next president:
1. Create four million good jobs per year on average.
Two million full time, regular jobs for workers added to the
labor-force each year;
• Another two million jobs for workers out of low
productivity, poorly paid jobs with irregular incomes
and no benefits; and,
• Employ some workers at home who now go
abroad to jobs where far too many are mistreated.
11
The Economic Choices
Facing The Next President
2. Achieve economic growth of ten percent per year, which means
that national income will double in seven years and the income
of the average Indonesian will double in just eight years.
3. Move ten million families from poverty to the middle class.
4. Put to productive work some three million workers with limited
education, virtually all of them among the poorest forty percent
of the population, and one million better educated workers,
including many of the 3.5 million educated unemployed.
The Economic Choices
Facing The Next President
12
Chapter 2.
Alternative Strategies Will Result in
Slow Growth, Few Jobs and a Missed
Opportunity
The goals set out in Chapter 1—a ten percent rate of economic growth
and 21 million good jobs—are clearly attractive. But the strategy
proposed to achieve them, based on 22 percent a year growth in laborintensive manufactured exports, requires policy changes that some
may consider too difficult or politically costly. There are a number of
alternative strategies that may be seen as preferable. Unfortunately, all of
the alternative strategies are likely to result in the same outcomes:
• A growth rate closer to five percent than to six or seven percent;
• Indonesia would miss the opportunity to achieve even higher
growth by taking over only a small part of China’s market for
labor intensive manufactures. Such an opportunity will not
come again in a lifetime;
• Indonesia’s demographic dividend would be wasted. Instead of
using its pool of able workers to increase output, almost half
of the ten million workers joining the labor force in the next
five years would not be able to find good, productive jobs. They
would join the estimated twelve million who became “surplus”
from 1997 to 2013; workers who contribute little to income
because they cannot find productive jobs.
Business as Usual: Without policy changes Indonesia’s income
is more likely to Increase by five than seven percent even if
world growth accelerates.
The belief is fairly widespread that GDP growth will quickly return to
the six percent rate that Indonesia achieved before the sharp reduction in
commodity prices after 2011 and that seven percent is readily attainable
13
The Economic Choices
Facing The Next President
with just minor adjustments in policy. But GDP growth from 1997 to
2013 averaged only 3.8 percent per year. Even if one leaves out the years
of the Asian Financial Crisis and begins the analysis in the year 2000,
GDP growth averaged only 4.5 percent until 2006.
The commodity boom added 1.5 percent to the growth rate. It was not until
the commodity boom brought a doubling in the value of exports—an
increase of $100 billion—that GDP growth averaged six percent. A large
part of the increase was simply due to higher prices which represented
a windfall of about five percent of GDP (Papanek, 2014d). Although
some of this windfall consisted of profits that were partly remitted out
of the country, some of it remained in country and had a multiplier
effect. We estimate that the commodity price boom added 1.5 percent a
year to GDP growth from 2006 to 2011. Without it growth might have
continued at less than five percent.
Another such commodity boom is unlikely. Two-thirds of the increase in the
value of exports from 2006 to 2011 was due to price increases. For
instance, copper more than doubled in price. Another such windfall is
possible but it is very unlikely in the next five years. It would require a
massive increase in demand. But China’s growth is inevitably slowing
down. Growth in India may speed up but it will take a while to reach
double digit rates. Another reckless expansion of credit will surely come
but not while the memory of the last one is still fresh. So it is unlikely
that another large credit expansion will fuel another commodity boom.
In the absence of another commodity boom and with present policies,
labor-intensive exports will stagnate. Some value will be added in the
mining sector owing to the export ban on raw minerals, but these new
regulations will also reduce investment. Whether the net effects are
positive or negative for national income is hard to say, but they will
not be large in any case. As investment opportunities improve in India,
the US, Japan and Europe, the flow of funds to Indonesia is likely to
decrease, especially if the country is seen as more hostile to foreign
investment. Without changes in policy it is difficult to see why growth
would accelerate under business as usual.
The Economic Choices
Facing The Next President
14
Slow growth means adding to surplus labor, not to productive workers.
The country would waste half its pool of additional workers, its
“demographic dividend.” Indonesia has never taken full advantage of
its greatest underutilized asset—its labor force. Two million new workers
have been added to the labor force each year since 1980. But since 1997
the country has created only about one million good, productive jobs a
year. From 1988 to 1994, when labor-intensive exports were booming,
manufacturing alone added almost 0.5 million good jobs a year, which
represented a fifteen percent rate of growth at that time. If that rate
of growth were to be achieved at present it would mean more than 1.5
million good, productive jobs a year in manufacturing alone.
But “business as usual” is likely to result in a five percent rate of growth,
with labor-intensive manufactured exports stagnant or declining.
As a result, the annual growth of employment in the formal part of
manufacturing would be barely above 130,000 workers, as it was on
average from 2000 to 2010. During this period total formal sector
employment increased by less than one million workers each year.
It is unlikely that all of these were productive jobs. Employment in
agriculture and manufacturing combined increased less than 100,000 a
year. With such a small increase in the two sectors that produce goods
it is implausible that an additional 670,000 workers would be needed in
trade and services to handle the increased output and to provide services
for the additional income generated.
Even if one takes the numbers at face value, fewer than one million
good, productive jobs were created at a time when two million people
were joining the labor force each year. Some of the remaining one
million people were forced to go abroad for work. But most of the
remainder found work in the informal sector in Indonesia, a sector that
is characterized by work and income sharing. They work on the family
plot or retail shop where additional workers are not needed, or as shoe
shiners, waste paper recyclers, and cigarette or magazine sellers where
there are already enough people doing these jobs. They share income
and work in these activities but their net contribution is small or even
zero. They are “surplus” because if they left their present work for a job
15
The Economic Choices
Facing The Next President
in manufacturing there would be little or no decline in output in their
former occupations.
With business as usual each year around a million additional workers
will not find good, productive jobs and will therefore be added to the
surplus labor pool. The country, instead of benefiting from their work,
from the demographic dividend of adding productive workers to its
economy, would instead add to the number of dissatisfied workers and
resulting social and political problems. The country is wasting a golden
opportunity to boost output because of the increase in the working-age
population. Indonesia is wasting half of its demographic dividend.
Most importantly, Indonesia would waste its once-in-a-lifetime
opportunity to take over part of China’s market for labor-intensive
exports. If Indonesia does not compete for its share, other countries will
attract investment and supply these markets. Such an opportunity will
not soon come again. Chinese exports in 2012 represented 36 percent
of the world market for garments and textiles and 17 percent of all
manufactured goods. Labor-intensive goods are about half of all exports.
If China surrenders only half of the labor-intensive market in the next
five years, this would means that other countries would together produce
$750 billion in exports, growing at $100 billion a year.
Indonesia will be competing with other countries with a sufficiently large
pool of labor to be able to provide a significant share of the goods China
used to supply: India, Bangladesh and Vietnam, and also Myanmar at
the low end and the Philippines at the high end. If Indonesia stays on the
sidelines for the next five years, investors will move into these countries
to supply the world market. “Business as usual” and slow growth for the next
five years could condemn Indonesia to slow growth for the next forty years or longer.
Without changes in policy Indonesia cannot hope to take back a significant share of
the world market. From 1995 to 2013 all of the Asian competitors increased
their shares of the world market except for Indonesia. In 1995 both India
and Indonesia’s share of world manufactured exports was 0.6 percent;
by 2013 India’s share was 1.6 percent but Indonesia’s was unchanged.
Vietnam’s share increased from 0.1 to 0.8 percent (Papanek 2014e).
The Economic Choices
Facing The Next President
16
Chart 4. Change in World Market Share for Manufactures, 1995-2013
Source: Papanek 2014e
Indonesia’s export performance in the labor-intensive goods category
was even worse. In the garments and textiles sector, five other Asian
countries increased their combined share from 14 to 46 percent;
Indonesia’s share decreased from 2.5 to 1.7 percent. While Indonesia’s
share was reduced by nearly one third, Bangladesh’s share more than
tripled and Vietnam’s rose from zero to 2.4 percent. Vietnam’s share
of the world market is now well above Indonesia’s despite the former’s
smaller population.
Indonesia’s poor performance in the world market is reflected in the rate
of growth of output and employment in manufacturing. Manufacturing
grew rapidly between 1986 and 1996 when employment in the sector
increased by seven percent each year. But since 1996 manufacturing has
been growing slowly, adding jobs at a rate of just 2.4 percent a year.
Chart 4 makes it clear that with Business as Usual Indonesia cannot secure a
17
The Economic Choices
Facing The Next President
significant share of China’s exports, a share it needs if it wants to grow rapidly and
to provide good, productive jobs to its growing labor force.
Expanding domestic demand
Indonesia has a large domestic market. In 2010 it ranked eighteenth in
the world just behind the Netherlands and way ahead of ASEAN partners
such as the Philippines at forty-second place. With such a large economy
why should it rely for growth primarily on increasing exports? Why not
simply increase domestic demand? Expanding domestic demand is far
easier to achieve than competing in world markets. Bank Indonesia can
generate additional funds to increase spending by domestic consumers
and additional domestic investment.
To the extent that increased domestic demand results in increased
domestic supply, and domestic supply is increased by putting people to
work who were otherwise surplus laborers, the strategy could work well.
Many readers will be familiar with Keynesian demand stimulus policies,
in which fiscal and monetary policies are used to generate domestic
demand, which mobilizes otherwise idle domestic labor, land and
capital. Under some circumstances this is an excellent way to increase
national income.
But currently in Indonesia some of the increased demand will spill
over into imports or demand for goods that would otherwise have been
exported. As their incomes rise, consumers will eat more rice, which
means either more imports or fewer exports. They will also buy more
imported soybeans and wheat. They will buy more clothing, which means
more imports of cotton and perhaps other kinds of cloth that are not
produced domestically. They will also buy more automobiles, take more
foreign vacations and use more gasoline. We have estimated the marginal
propensity to import to be twenty percent; that is, for every Rp.10 billion
increase in demand imports will rise by Rp. 2 billion. Obviously, these
imports have to be paid for, and the only way to pay for them over the
long-term is to increase exports.
The events of 2012 illustrate the problem. As national income rose,
imports increased as well by slightly less than twenty percent. But exports
The Economic Choices
Facing The Next President
18
actually declined so there was a small trade deficit. Indonesia has always
had a large deficit in services, covered by the surplus on trade. With both
in deficit Indonesia could pay for imports only by drawing down reserves
and taking advantage of short-term foreign capital inflows.
Of course, countries cannot draw down their foreign exchange reserves
every year, and counting on short term capital inflows is also a risky
proposition. In 2013 the economy continued to grow, exports continued
to decline but this time the books were balanced by an eighteen percent
decline in the import of capital goods, the machines needed to expand
production. Consumption was allowed to increase at the cost of
investment and future growth. In short, there are strict limits on the extent to
which a country can develop by expanding domestic demand, and these limits are set
by the balance of payments.
Table 1. Effect of Growth in GDP with a Decline in Exports
Source: Papanek, 2014f
Restricting imports: Producing in Indonesia more of what
Indonesia consumes.
The impact of higher incomes on imports has led inevitably to the
next proposed strategy: imposing limits on imports and producing in
Indonesia more of what is consumed in Indonesia. There is an obvious
and substantial potential for producing in Indonesia more of the goods,
19
The Economic Choices
Facing The Next President
including food, that Indonesia consumes. But in some commodities, the
opposite has happened: Indonesia has been importing a rising proportion
of what it consumes. Between 2009 and 2013 imports of cereals have
increased by 26 percent; rubber and rubber products by twenty percent;
sugar by 28 percent and seeds, fruits and plants by sixteen percent.
More dramatic have been periodic sharp increases in the imports of the
vegetables that give spice to Indonesian meals: garlic, chilies and onions.
There have also been controversial imports of meat and dairy products. There is also some scope for import substitution in manufactured goods.
When the value of the rupiah is high imports can make great inroads
into the Indonesian consumer market. A famous case was the bankruptcy
of Indonesian producers of nails, unable to compete with the imported
Chinese product. Nails are heavy and not valuable per kilogram and
therefore costly to transport. They are not complicated to manufacture.
It seemed absurd that Indonesian producers could not compete. A major
reason was the increase in the value of the rupiah which made exports
less valuable in rupiah terms and imports cheaper. We will come back to
the strategy of reducing imports after briefly considering the impact of
the ASEAN Economic Community.
The ASEAN Economic Community (AEC)
When the AEC comes into effect in 2015 it will increase competition from
imports for many Indonesian producers. The AEC will provide for close
to free trade within ASEAN. Indonesian producers fear that imports from
Singapore, Malaysia, Thailand and the Philippines will take some of their
markets. Many Indonesian producers have reacted to the advent of the
AEC by demanding higher levels of trade protection for their products.
If tariffs are no longer feasible there are proposals for Quantitative
Restrictions (QR) that prohibit imports or restrict their quantity or, at
a minimum, give preference to domestic producers in government
procurement. But all such measures will become increasingly difficult or
impossible under AEC for goods produced in the ASEAN countries.
Problems associated with protecting or subsidizing particular industries. There
will nevertheless be pressure on the government to limit imports and to
The Economic Choices
Facing The Next President
20
protect domestic producers from competition from lower-cost imports.
Politically it is attractive to respond to pressures for the protection of
particular industries. Those in the industry will be grateful while the
large numbers who pay higher prices as a result may not even be aware
of the fact that they have been harmed by government action. But there
are significant economic and eventually political costs associated with
trade protection:
i.
There are indirect effects which make Indonesia a high cost economy and
undermine its competitiveness. Take the case of fertilizer production.
In Indonesia, gas that is a by-product of oil production has
considerable value since it can usually be piped to local consumers
or liquefied and exported. A fertilizer plant therefore probably
has to pay full cost as it competes with other consumers for gas. In
some parts of West Asia gas that is a by-product of oil production
has no value since it is too expensive to ship to consumers.
Therefore, a West Asia fertilizer plant may be able to obtain
gas at virtually no cost. For this reason, imported fertilizer may
be cheaper than locally produced fertilizer. Indonesian fertilizer
plants would need protection from imports to survive. Providing
protection, however, raises the cost of fertilizer, which, in turn,
increases the cost of producing rice in Indonesia. Imported rice
could become cheaper than rice produced in Indonesia. Rice
producers therefore need protection from imports which raises
the price of rice. Rupiah or nominal wages must rise in order to
maintain the purchasing power of workers as rice prices increase.
The higher rupiah wage in turn undermines the competitiveness
of most Indonesian exports and therefore leads to slower growth
and fewer good, productive jobs.
ii. When protection or subsidies are provided to specific industries or
commodities by legislation or by decisions taken by government
officials, those receiving the most protection are usually people
and businesses with the greatest political influence or who are
willing to pay the largest bribes, not those who can make the
best economic case. The result can be big losses to the economy
as inefficient producers are enabled to continue in business.
21
The Economic Choices
Facing The Next President
iii. When firms’ profits depend on the protection they can
get through political connections or bribes, then investors
and entrepreneurs will devote their energy and creativity
to attracting favors from government rather than making
better products more cheaply. If political connections lead
to success and entrepreneurship and management do not,
then the biggest, most rapidly growing, fir ms will be controlled
by the cronies of those in power not by the best managers or
entrepreneurs. The net result will be an inefficient, high
cost economy, unable to compete in the world market and
condemned to slow growth.
The best solution: general protection or subsidies. If all enterprises receive
greater protection from competing imports or some subsidies for
competing in the world market, then these problems do not arise or are
at least much less serious. The policies we propose later in the paper to
increase the export of labor-intensive manufactured goods will in many
cases also strengthen the capacity of Indonesian producers to compete
against imports. For instance, if Bank Indonesia targets an exchange rate
of Rp. 12,500 per US dollar rather than Rp. 11,400, the effect would be the same
as a ten percent tariff on all imports into Indonesia. It will make all imports
more expensive in Indonesia and therefore domestic production more
profitable. But since it is not an explicit tariff it is prohibited neither by
the WTO nor by AEC. It is also equivalent to a subsidy for all exports,
but again it does not violate the rules of WTO or AEC since it is not an
explicit subsidy.
Government can also provide a variety of indirect subsidies that
can be justified as part of its normal role. Government can pay
for or subsidize education and training without falling afoul of
international rules. It can provide an education subsidy to all
Indonesian producers or concentrate on industries that are most
subject to foreign competition.
Giving priority in allocating infrastructure investment to areas that
are producing in competition with imports (or that are exporting) is
another indirect method of subsidizing these industries. Government
The Economic Choices
Facing The Next President
22
can subsidize technology acquisition, severance pay costs, the risk of
innovation, and a host of other indirect costs.
In addition a good case can be made for “infant industry protection,” in
which government imposes tariffs on the import of goods competing with
new domestic industries while their workers and managers learn new
technologies and develop new skills. There are two practical problems
with implementing such policies. First, some industries will claim
protection even if their problem is not that they are infant industries but
that they are not competitive in Indonesia at present. Second, “infant”
industries usually do not want to grow up, which would mean losing their
protected domestic markets. It helps to specify the weaning process clearly
from the start: for instance, for three years after starting production the
factory will be protected by a fifty percent tariff on competing imports.
Every year after that the tariff will be reduced by five percent until it is
eliminated after thirteen years.
There are very strict limits to what can be done in terms of reducing imports without
incurring huge costs. About a third of Indonesia’s imports cannot sensibly
be produced in Indonesia, including cotton, wheat, large aircraft and
nuclear power plants. There are other goods like soybeans and beef that
can be produced in Indonesia but at a substantially higher cost than the
import price. Beef is produced in Indonesia as a byproduct of dairying
or other uses of animals. To produce quality beef cheaply one needs
large areas of grasslands where cattle can graze. Indonesia has very little
such land.
Indonesia can certainly increase the production of rice and other
foodstuffs and reduce imports. But to expand food production efficiently
and at low cost is not easy to do. Producing food inefficiently and at high
cost would be a disastrous strategy. Periodically there are proposals for
growing rice in agro-ecosystems that are unsuited to the crop and where
it can be produced only at high cost. High priced rice in turn results in
demands for wage increases to meet the rising cost of living. This in turn
makes all exports from Indonesia less competitive. Rice self-sufficiency
makes sense if it can be achieved at reasonable cost. Achieving it by
growing rice on land that is unsuitable for rice and where it is expensive
23
The Economic Choices
Facing The Next President
to grow rice can undermine the ability of Indonesia to achieve high
growth and many good jobs by again becoming competitive in the export
of manufactured goods.
As part of a strategy to make the Indonesian economy more efficient
and competitive there is substantial scope for import substitution, for
growing and producing in Indonesia more of what it consumes. But as
an alternative strategy, trying to control and prohibit imports quickly
becomes self-defeating as it raises costs and reduces Indonesia’s
ability to export labor-intensive manufactured goods. It also risks
lowering the living standards of the most vulnerable households in
Indonesia by increasing the cost of basic necessities like food and
clothing.
Giving priority to higher technology, more capital-intensive
Industries.
Undoubtedly Indonesia can and should increase its production of
technologically advanced goods. Goods such as machines and petrochemicals are already being produced and indeed exported in increasing
quantities. But again there are strict limits to such a strategy:
i.
High-tech industries require many engineers, but Indonesian
engineers are two to four times more expensive than their
Indian counterparts. Few firms would be able to compete
internationally with such a handicap. In addition, India has a
larger number of highly trained engineers, the products of the
world-class Indian Institutes of Technology.
ii. These firms also tend to be capital-intensive. If growth depends
largely on capital-intensive industries then a ten percent rate of
growth will require a rate of investment of around fifty percent.
With domestic gross savings around 32 percent, this would
require attracting foreign capital on the order of $150 billion a
year, which is quite unrealistic.
iii. Indonesia lacks experience in managing technically complex
large-scale enterprises such as automobile assembly plants.
The Economic Choices
Facing The Next President
24
The record is quite clear: all of the countries that are mass
producing automobiles for the world market—including Korea,
China and Japan—began by producing textiles and car parts
for international markets and then gradually moving to more
complex operations. Ultimately they were able to master the
complexity of producing both automobile engines and to
assemble tens of thousands of automobiles. After nearly thirty
years of export success China is still not a significant producer
of cars for the world market.
iv. Global manufacturing has changed fundamentally since Korea
and Japan developed their capital and technology-intensive
industries. In some industries market share and technological
capabilities are concentrated in the hands of a small number
of global firms in part because spending on research and
development is so massive, and the pace of technological
change so rapid, that many incumbents cannot keep up. New
entrants would find it even harder. At the early stages of
industrial development countries like Indonesia will have more
success integrating into the supply chains of these industry
leaders than starting up firms to compete with them. Indeed
when Indonesian firms were included in the supply chains of
Japanese car companies exports shot up from $100 million to
$600 million in a relatively short period of time.
v.
Above all, capital-intensive industries will not provide
productive, stable jobs for the 21 million workers who have not
completed primary school and another fifty million who only
completed primary or middle school. At least ten million of
them are “surplus” workers in very low productivity jobs. For
instance, they work on tiny family plots that have more workers
than needed; or they shine shoes in a square which already has
enough shoe shiners. If these ten million surplus workers were
to find work in export industries they would increase national
25
The Economic Choices
Facing The Next President
income by nearly twelve percent. For the workers it would
mean higher and more stable incomes. But if the increase in
manufactured exports were to consist primarily of capital- and
technology-intensive goods the number of workers who would
find good jobs would be small. Instead of six million workers employed
in labor-intensive manufacturing for export, only 0.5 million workers
would be employed by industries producing capital-intensive manufactured
exports, such as automobiles.
Alternative strategies can contribute to growth but all have
strict limits.
No alternative strategy can offer good, productive employment to
all of the 21 million workers who now contribute little to national
income. Moving these workers from low or no productivity jobs to high
productivity jobs will enable Indonesia to reach ten percent growth.
The strategy advocated here of rapid expansion of labor-intensive
exports can succeed only if Indonesia can overcome its failure to
compete, a failure that has persisted for the last eighteen years (see Chart
4). Part II of the book addresses what needs to be done. But before
doing so it is important to point out that Indonesia is not competing against
countries that function perfectly; rather its competitors also have serious problems and
shortcomings. When all factors are taken into account, Indonesia is already ranked
quite highly as a competitor in many respects. Especially noteworthy is that its
overall competitiveness index ranking has improved from seventy-fourth
in 2005 to 38th in 2013. However, the index does not consider costs of
production. China outranks Indonesia in every aspect in Table 2, but its
higher labor costs make it possible for Indonesia to take away a small part
of its market share. Indonesia’s overall competitiveness ranking is higher
than the other countries in Table 2 largely because of the achievement of
macroeconomic stability. In other categories, such as corruption, labor
costs, logistics and bureaucratic obstacles to doing business, Indonesia
performs poorly or does not do better than its competitors.
The Economic Choices
Facing The Next President
26
Table 2. Competitiveness of Six Asian Countries
Sources: Transparency International for the Corruption Rank; World Bank for
Logistics Performance Index, & Ease of Doing Business; National Development
and Reform Commission (NDRC) for the Electricity Cost; Trading Economics for
Interest Rates; World Economic Forum “The Global Competitiveness Report 20132014” for other data.
NOTES: Lower numbers are better except for Infrastructure, for which higher
numbers signal better performances Figures in bold show Indonesia ranking ahead
of its competitors; for figures in italics and underlined Indonesian trails or is at par.
Logistics Performance Index includes: Infrastructure, customs, international
shipments, logistics competence, tracking and tracing, timeliness
Vietnam shows what can be achieved in a short period of time.
While the real value of Indonesia’s manufactured exports has doubled
since 1997, manufactured exports from Vietnam have increased twelvefold over the same period. Moreover, the rate of increase has accelerated
sharply in Vietnam since the global financial crisis of 2008-2009 as the
country has acquired capacity in electronics components and assembly.
From 1997 to 2001 the two countries achieved similar rates of growth
of manufactured exports. Then Vietnam “took off.” Several policy
differences explain Vietnam’s superior performance:
1. Vietnam frequently adjusted the Vietnam dong to US dollar
exchange rate to remain competitive; in effect, reducing the
value of the local currency.
2. Vietnam attracted and welcomed foreign private investment
especially in garments, footwear and electronics. Foreign Direct
Investment was consistently above four percent of GDP.
3. A series of trade agreements opened markets in Europe and the US.
4. Low rice prices made it possible to keep wages relatively low
and stable in real terms as the purchasing power of wages was
maintained.
27
The Economic Choices
Facing The Next President
Chart 2. Real Value of Manufactured Exports from Indonesia and Vietnam, 1997=100
Source: World Development Indicators and authors’ calculations
None of these four elements are beyond the capacity of Indonesia, which
has some clear advantages over Vietnam, as shown in Table 2. Vietnam’s
growth rate of manufactured exports was roughly the same as the one
that Indonesia would need to achieve in order to reach the goals of ten
percent growth of the economy and 21 million good, productive jobs. The
experience of Vietnam confirms that growth of 22 percent a year in manufactured
exports is quite feasible for a country like Indonesia.
The Economic Choices
Facing The Next President
28
Chapter 3.
Jobs, Poverty and Inequality –
The Poorest Forty Percent have Fallen
Behind, the Richest Twenty Percent
have Prospered: Labor-intensive, Rapid
Growth will Enable the Poor to Catch Up
It has been argued that without major changes in policy the growth rate
of national income or GDP is likely to be around five percent. Such a
rate of growth might be acceptable if growth were inclusive, meaning
that it benefits the poorest forty percent of the population at least as
much as the less poor. But that has not been the case in Indonesia.
In the nearly sixty years from 1964/65 to 2013, consumption for the
average person has increased nearly seven times after taking into account
increases in prices. All income groups have benefitted greatly from growth in income
and consumption. But the wealthiest twenty percent have benefited far more than the
poorest forty percent (Papanek, 2014g). This chapter examines when and why
the wealthiest benefited the most from growth. Indonesians are proud to
live in a relatively egalitarian society, a country where the gap between
rich and poor is small and not becoming larger. The main aim of the
chapter is to analyze what can be done to increase the consumption of
the poorest forty percent more rapidly in the next five to ten years to
restore a more equal distribution of income.
The poorest forty percent have benefited from growth, but far
less than the richest twenty percent.
As can be seen from Charts 6 and 7 and from Table 3, all income groups
have benefited from growth in national income since 1964/65 and the
resulting growth in consumption per person. But the consumption of the
poorest forty percent has grown less rapidly than the wealthiest twenty
29
The Economic Choices
Facing The Next President
percent. After adjusting for inflation, and looking at the whole period
from 1964/65 to 2013, the consumption of the average person among the poorest
forty percent has increased from roughly Rp 0.4 million to Rp. 2.6 million per year
or slightly over six times. The middle forty percent did almost equally well:
their consumption increased six times. But it was the wealthiest twenty percent
that benefited the most, with their consumption increasing 7.5 times.
In 1976, the average income among the wealthiest twenty percent was
less than 4.7 times that of the poorest forty percent; in 2013 this ratio
had increased to 5.7 times. The data we have are for consumption, not
income. But it is always the wealthier families that have higher savings.
They are better able to set aside more of their income for investment than
the poor, who usually are able to save little or nothing. The difference
in incomes is therefore even greater than the difference in consumption.
Chart 6. Real Consumption of the Poorest 40%, Middle 40% and Richest 20%, 1964/65-2013,
Rp million at 2012 prices
Source: Papanek, 2014g
The Economic Choices
Facing The Next President
30
Moreover, we also know that the wealthy understate their consumption.
For instance, the number of automobiles they report buying, which provide
the basis for the consumption data, are far less than the number of cars
sold in Indonesia (Dapice, 1980, 1987). So the actual consumption of the
top twenty percent is significantly understated. That understatement has
probably increased since the riots of 1998 when the wealthy, particularly
those of ethnic Chinese origin, were targeted. As a result they were inclined
to reduce their consumption in Indonesia and to further understate their
consumption to government officials. That underreporting is increasing is
supported by the observation that the share of national income accounted
for in annual consumption surveys has been declining since the 1970s,
and that the amount of the decline is too large to be explained by the
share of investment (Harvard Kennedy School 2010, p. 67).
Table 3. Increase in Per Person Consumption from 1964/65 to 2013 by Poorest 40%, Middle 40%
and Richest 20%
Source: Papanek, 2014g
Since the data in this chapter measure consumption, they take account of government programs
to benefit the poor. To the extent that the poor receive subsidies for food or free
health care this will largely show up in our data as increased consumption.
These data therefore confirm what studies of government transfer programs
or social safety net programs have also found: the actual benefits to the poor of
government pro-poor programs are quite limited because most the programs
are small and all of the programs have leakages. Some benefits go to the nonpoor, other benefits are lost to corruption and to administrative costs. It is
always difficult to increase greatly the size of these programs. Enlarging them
requires higher taxes on the non-poor to cover higher costs. Naturally the rich
and powerful resist higher taxes and in most countries they usually succeed in
keeping taxes and transfers to the poor quite small.
31
The Economic Choices
Facing The Next President
Therefore the best way to significantly raise the income of the poorest
forty percent is to increase the amount of money that they earn from
work. That requires increasing demand for their labor through the
creation of large numbers of jobs for workers with limited education.
The major conclusion of this section is that the poorest forty percent
benefited too little from the substantial increase in consumption that
has taken place since 1964/65 and that far too great a proportion of
the benefits were received by the richest twenty percent. To restore greater
equality, which has been one of the important values of Indonesia, the strategy for the
next five or ten years needs to be one that benefits the poorest forty percent.
The rising disparity between rich and poor is due in large part
to government policy, which has resulted in slow growth of
demand for unskilled and semi-skilled workers.
The fact that the wealthiest group in the population benefited the most
from development over the entire period is neither accidental nor due to
inevitable economic forces. Rather it was due to the pattern of development
and the policies pursued by government. From 1964/65 to 1984 the poorest
forty percent actually benefited significantly more from development than
the other two groups (Ibid). The average consumption of the poorest forty
percent increased almost three-fold while that of the other two groups
increased 2.5 times during this twenty year period. The poorest forty percent
fell behind when there were few good, productive jobs created after 1997 and
particularly during the commodity boom of 2005 to 2011, when the poorest
benefited little and the wealthiest twenty percent benefited a great deal.
The income of the poorest forty percent increases if there is
demand for their labor.
It is a central theme of this paper that in Indonesia and other countries
the income of the poorest forty percent of the population grows primarily
through increases in their earnings from work. Poor people do not own
much land or other property. If they have had access to education or
training for skilled work they would not be among the poor or near-poor.
They may own a small piece of land which provides some of their food
and income but most of their income will be from their labor. They
The Economic Choices
Facing The Next President
32
may own a food cart but most of their income will be derived from the
labor involved in producing and selling food, not from the value of their
property; and in fact they may not even own the food cart that they push
as it is probably rented from wealthier owners.
Government programs may supplement the income of the poor. But
none of the programs are large enough, have lasted long enough or are
very successful at targeting the poor. As a result they fail to make a major
difference to the 100 million people who constitute the poorest forty
percent. The income of the poorest forty percent has increased when: [i] they have
moved from casual, informal work in agriculture or in other sectors to a full-time
regular job with a reasonably assured income in manufacturing or other sectors; or [ii]
when wages or other labor income have increased in their current occupations. Both of
these have happened when demand for workers has increased rapidly.
Table 4 and Chart 7 provide evidence in support of the contention that
demand for labor is the most important factor in raising the incomes of the
poorest forty percent of the population. From 1968 to 1972, construction
grew at 25 percent per year and absorbed a considerable amount of labor.
Construction was stimulated by a massive effort to rehabilitate and extend
irrigation systems and other infrastructure. Indonesia’s infrastructure had
started to deteriorate during the Great Depression of the 1930s, was further
affected by war, Japanese occupation, the struggle for independence and
the neglect of the economy during the Soekarno era. Reconstruction
was initially highly labor-intensive. During the same period agricultural
value added increased at 4.4 percent a year, which is high for this sector,
and manufacturing value added rose at a respectable ten percent a year.
Therefore, both agriculture and manufacturing contributed to rising
demand for labor. Other parts of the economy also functioned more
efficiently, grew rapidly and thus added to labor demand.
In the next period from 1972 to the early 1980s, construction slowed
but still increased at fourteen percent a year, and the rate of growth of
value added in manufacturing rose to twelve percent, mostly in laborintensive goods. Data for 1964/65 are less reliable because of limited
coverage and the general turmoil of the time. But it is clear that the
period from the mid-1960s to the later 1970s was one in which some
33
The Economic Choices
Facing The Next President
sectors suddenly needed labor. Agriculture was doing well, construction
boomed and manufacturing, utilities, trade and services were all gaining
momentum and hiring. Between 1962 and 1982 an additional 6.8 million
workers were hired by manufacturing, construction and transport/
communications. This was a tripling in the number of workers in these
sectors, from 3.2 million to ten million workers. Trade and services added
nearly ten million workers, but one cannot be sure that all of these jobs
represented real demand for labor as distinct from work- and incomesharing. Clearly a substantial proportion was real demand for labor as
the two sectors expanded and modernized to achieve greater efficiency
and deliver more convenient services than had been possible under the
controlled economy before 1965.
Chart 7. Increase in Real Consumption by the Poorest 40%, the MIddle 40% and the Richest 20%,
1964/5-2013
Source: Papanek, 2014g
As far as we can tell, wages rose during this period of rapid increase
in demand for labor (Papanek, 1980, 1987). As a result, the incomes
of the poorest forty percent increased significantly more than that of
the other two groups (the middle forty percent and top twenty percent)
from 1965 to 1984. Indonesian incomes became more equal, but above
all the consumption of the poorest forty percent increased more rapidly
than the average of the whole population. The poorest forty percent
The Economic Choices
Facing The Next President
34
benefitted from rising average incomes and consumption and from an
increase in their share from 18.6 to 20.8 percent, which represents a
significant gain. As a result of the rapid growth in consumption shown
in Chart 7, the average consumption of the poorest forty percent nearly
tripled in the twenty years from 1964/5 to 1984.
Labor and political organizations were not able to protect
workers when the economy stagnated; despite the absence of a
strong trade union movement or a political party representing
their interests, workers did well when demand for labor was
strong.
The economy had been stagnant or declining for several decades by the
mid-1960s. The Great Depression of the 1930s hit the economy hard, as
did Japanese occupation, the Second World War and the long struggle
for independence. Recovery and reconstruction were limited during the
Soekarno period as the government subordinated economic growth to
political and foreign policy goals.
From 1961-67 the growth of GDP was just two percent per year,
implying stagnant or falling levels of per capita income. Trade and
services, including public services, supposedly contributed almost half
of that growth. Much of it may have simply been the hiring of more
government officials, which may not have added to national output but
functioned something like unemployment insurance. Workers’ incomes
declined substantially from already low levels as far as one can tell
(Papanek, 1980, 1987). Workers’ unions were strong and their interests
were well represented at the political level. The government’s rhetoric
was strongly committed to an egalitarian society. But when income
per person was stagnant or declining, workers’ incomes could not be
protected by these institutions. The politically powerful protected their
own interests and the poorer, politically weaker groups bore the brunt of
economic stagnation and decline.
From 1967 to 1973 annual GDP growth was nearly eight percent or
nearly six percent per person per year. The result was much more rapid
growth in the demand for labor after 1967. Agricultural output grew
35
The Economic Choices
Facing The Next President
rapidly with the overhaul of irrigation systems and the introduction of
high yielding rice varieties, which were quickly adopted in Indonesia’s
rice growing areas. Manufacturing grew rapidly, first producing for the
domestic market and then for export until the rupiah appreciated in the
early 1980s and export growth slowed. By 1985 manufactured exports
had reached one billion dollars (Papanek, 2014c). After the double
devaluation of 1986/7, when the value of the rupiah was cut in half and
other policies made exporting more attractive, manufactured exports
increased from one to twelve billion dollars in just seven years. Threequarters of exports were highly labor-intensive.
Labor unions were destroyed and workers’ political influence was
negligible. Minimum wage legislation was ineffective or ignored.
Nevertheless during this period of rapid growth in the demand for labor,
workers’ expenditures rose by an amazing ten percent per year on average from
1976 to 1984 (Table 3).
This is not to argue that unions, minimum wage legislation or political
organizations are ineffective. If workers had been organized and an
important political force it is entirely possible that their incomes would
have increased even more than ten percent per year. Rather, the argument
is that political and union power cannot protect workers from the negative
consequences of a stagnant or declining economy. Conversely, when the
economy is booming and growth is labor-intensive, workers will benefit
even in the absence of political or union power. If growth is capital or
resource-intensive, as during the recent commodity boom, demand for
labor will grow more slowly, as will workers’ incomes.
Only the manufacturing sector can generate sufficient demand
for labor to increase labor incomes.
Historically in Indonesia and in other countries, it is only the
manufacturing sector which is able to generate demand for labor that is
sufficiently large to make a difference to the incomes of the poor. The
agricultural sector remains the largest employer in Indonesia but it rarely
grows more rapidly than three to four percent per year. Even during
the period of the Green Revolution the highest growth rate that the
The Economic Choices
Facing The Next President
36
sector achieved was 4.6 percent per year for the short period 198186. Labor productivity, the amount of output that a worker can produce
on average, was also growing. The shift from hand pounding of rice to
mechanical rice hullers greatly reduced worker requirements. So did the
shift from the hand knife (ani-ani) to the sickle and from the hand hoe to
the mechanical cultivator. Greater productivity meant more output from
the same number or even fewer workers.
Moreover, agriculture has traditionally had surplus labor, particularly
in the rice agriculture of Java, Bali and major rice producing areas in
other provinces. So even during periods of relatively rapid growth in
agriculture, it did not generate additional demand for labor. From 1986
to 1997 when value added increased on average by 4.4 percent there
was no increase in employment. In fact there was a slight decline of
1.8 million workers (Papanek, 2014h). Because of surplus labor, the
agricultural labor force declined as long as there were jobs available
outside of agriculture. More recently the rapid growth of palm oil production has led to increased
demand for labor. Total labor employed in the industry is estimated at 3.7
million workers (Skinner, 2013) or roughly 230,000 workers per billion
dollars of exports in 2013. The labor intensity of palm oil is therefore
very similar to the most labor-intensive manufacturing sectors. With
exports of $16 billion in 2013 palm oil roughly matched the value of
exports of textiles, garments, shoes and furniture combined. In terms
of generating demand for labor, palm oil production is as important
as labor-intensive manufacturing; in fact it is more important since its
exports have increased more than 100 percent in volume from 2004 to
2013 while labor-intensive manufacturing exports have increased by only
25 percent. Palm oil generated an estimated 1.6 million jobs in the last
nine years and labor-intensive manufactured exports only 700 thousand
jobs. The jobs on palm-oil plantations are productive jobs and they
add to national income, but they are not “good” jobs in many cases.
Unlike jobs in manufacturing, many do not pay twice as much as the
agricultural wage. A majority of workers are not covered by minimum
wage regulations (Lim & Ismar, 2012). They are either contract workers
or are paid in part in the form of an allotment of land for their own
37
The Economic Choices
Facing The Next President
palm oil trees or food crops plus some compensation for plantation work.
Demand for palm oil has therefore helped to increase workers’ incomes
because it has increased demand for labor, but it did not provide many
good jobs on its own.
While agricultural value added increased at most 4.6 percent per year,
annual growth in the manufacturing sector reached fifteen percent from
1971 to 81 and fourteen percent from 1986 to 1996. From 1981 to 1986
the rupiah was allowed to appreciate in real terms and the growth of
manufactured exports and the production of manufactured goods slowed
markedly. Based on this history, growth of twenty percent per year for
manufactured goods seems quite feasible.
Labor intensive manufacturing will employ 30,000 workers per billion
dollars or Rp. 12 trillion equivalent of annual output. More capital
intensive manufacturing sectors employ as few as 5,500 workers per
billion dollars of annual output as do mining operations (Papanek,
2014b). If Indonesia were to increase manufactured exports by $110
billion in five years as proposed, and all of the expansion was laborintensive, then manufacturing would employ something like 750,000
additional workers in 2015 alone. In addition, the manufacturing
sector generates secondary and tertiary demand. When manufacturing
expands, there is additional demand for factories and workers’ housing,
which stimulates the construction sector and generates further demand
for labor from that sector. Increased output requires more transportation,
trade and services. Workers use their higher incomes to buy more food
from street vendors, use more transport, buy more kitchenware and go to
more wayang performances. All of these additional indirect activities will
increase demand for labor. Taking account of these indirect effects, the
proposed expansion of manufacturing would result in an additional 1.3
million good, productive jobs in the first year (2015). What is even more
important is that more than half of these jobs can be filled by workers
with limited education (see Statistical Appendix and Papanek, 2014i).
Labor-intensive manufactured exports include industries such as shoes,
furniture, automobile parts, garments and textiles, all of which use a
high proportion of workers with limited education. For manufacturing
The Economic Choices
Facing The Next President
38
as a whole about sixty to eighty percent of workers are those with limited
education depending on the composition of the sector. For labor-intensive
industries the percentage is 89 percent or above. On the other hand,
sectors like utilities and finance use a smaller percentage of workers with
limited education. We therefore assume that on average sixty percent
of the additional jobs created from 2015 to 2019 can be filled by those
with limited education. For 2015 that would mean 780 thousand jobs for
the poorer, less educated population out of 1.3 million total jobs, and by
2019 there would be over twelve million additional jobs for those with
limited education.
A model of wage determination (Papanek, Setiawan & Purnagunawan,
2013) concludes that for every ten percent increase in the demand
for labor with limited education there is a five percent increase in the
real wage. The analysis was done primarily using wage data from the
agricultural sector. They are the largest group of unskilled and semiskilled workers in the economy and the overwhelming majority are
among the poorest forty percent since their wages are far below those of
industrial workers. With sixty percent of new jobs filled by workers with
limited education, their employment would increase by 54 percent over
the five years from 2014 to 2019. This implies an increase of 27 percent
in the wage of agricultural workers, which would be a remarkable
turnaround. Since 2008 farmworkers’ real wages—the wage adjusted for
inflation so that it reflects purchasing power—has decreased by over ten
percent (see Chart 8). For farmworkers’ wages to go up by 27 percent in five years,
reversing a year decline, would be a remarkable achievement for the administration of
the next president.
Why didn’t the poor benefit from the commodity boom?
The main reason for the increasing gap in consumption between the
richest twenty percent and the poorest forty percent was the impact of
the commodity boom. From 2005 to 2011 the real consumption of the
poorest forty percent did not increase at all, while the consumption of
the richest twenty percent increased by 38 percent (Table 3). The gap
is similar if one compares 2005 to 2013: a nine percent increase for the
poor and a 49 percent increase for the rich. The explanation is the same
39
The Economic Choices
Facing The Next President
as for earlier periods: the boom produced large profits which benefitted
the rich but created little demand for labor and therefore did not benefit
the poor.
With the exception of palm oil, rapid growth in the value of commodity
exports generated very little direct demand for labor. For some commodities
the quantity produced or exported did not increase much. In fact, for oil/
gas and copper the quantity exported actually declined, while for rubber
it stagnated. Increased earnings came from higher prices, and not from
increases in output. With no increase in production volumes, there was
no need to hire additional labor or buy other inputs. With no increase
in costs and a big increase in income thanks to higher prices, profits rose
sharply. Some of the profits were sent abroad and some were saved. An
unknown amount was used for additional consumption in Indonesia.
Coal, nickel and palm oil were the principal commodities for which the
quantity exported increased as well as prices. These three commodities
kept the boom going even after prices fell in 2012. Coal and palm oil
remained profitable and so the quantity exported continued to increase
by twenty to thirty percent between 2011 and 2013 despite the decline
in prices (Papanek, 2014c). For nickel there was an additional incentive:
the prohibition on raw ore exports that came into effect in 2014. The
industry had a strong incentive to ship as much ore as possible in 2013.
Quantities more than doubled over 2011 levels. Coal and nickel are
produced largely with machinery and few workers. Higher volumes
therefore resulted in few new jobs. Palm oil has already been discussed:
demand for labor increased but the sector generated few good jobs.
In short, the commodity boom was primarily due to an increase in prices,
not in quantities exported. For a few commodities output and exports
increased but production relied primarily on machines, not human labor.
Rising prices in the absence of higher levels of production volumes or
higher costs generated a substantial rise in profits, but little increase in
direct demand for labor.
Indirectly, the higher incomes thus generated did indirectly increase
demand for labor, principally through the resulting rise in construction
The Economic Choices
Facing The Next President
40
of residential and commercial buildings. There was also growth in other
sectors to meet the demand for consumer goods from the expanding
middle class. During the period of the commodity boom from 2005 to
2011, 12.6 million formal sector jobs were added in the economy. But
nine million of these jobs were in sectors that used very few workers
with limited education: 5.5 million in the service sector, including
employment in public services; 1.3 million in finance; and 2.5 million in
trade (Papanek, 2014k). Of these nine million workers only about one
million were workers with limited education. With two million workers
joining the labor force each year, even during this period of rapid growth
the increase in supply of workers matched the increase in demand.
Fewer than one million jobs were added to the formal sector in
manufacturing over the six years from 2005 to 2011. Construction added
another 600 thousand. The two sectors that normally provide most
of the jobs for those with limited education contributed little to labor
demand during this period of rapid growth. During the commodity boom there
was little increased demand for workers with limited education. The increase in
labor income therefore was also small. This explains the stagnation in the
expenditures of the poorest forty percent.
Increases in minimum wages and trade union activity pushed
up wages of industrial workers.
Workers who are covered by minimum wage legislation can increase
their wages even if there is no increase in demand for labor. This is
clearly seen in Chart 8, which shows that the wages of industrial workers
increased roughly 27 percent after 2008. As the industrial wage was
pushed up to exceed wages substantially in competitor countries, the
number of jobs created in manufacturing declined. The labor intensive
sub-sectors of manufacturing grew slowly. The industries that increased
output were those producing for the Indonesian market and that enjoyed
protection from imports in the form of tariffs or quantitative controls, or
high transport costs.
Workers who already had jobs in manufacturing benefited from higher
wages. Their average wage was Rp 1.8 million per month at the end of
41
The Economic Choices
Facing The Next President
2013. This was equivalent to nearly $160 per month or $5.20 per day. If
only one person in the family worked and there were three dependents
then the family would be poor. But if two family members out of four
had manufacturing jobs they would be categorized in the lower middle
income group.
But the great majority of workers who could not get a manufacturing
job or other job in the formal sector were worse off as the result of the
increase in the wages of industrial workers.
Chart 8. Real Wages Index for Construction, Manufacturing and Farm Workers and Household
Servants, 2008-2014 (2008 III = 100)
Source: Papanek, 2014j
Given slow growth in demand for manufacturing sector labor, the great
mass of workers outside the formal sector suffered stagnant or declining
wages. This is seen most clearly in wage trends for agricultural workers
The Economic Choices
Facing The Next President
42
from 2008 to 2014. Agricultural workers were not covered by minimum
wage legislation. They were not organized and did not benefit from trade
union activity. The supply of labor increased by two million each year
while only one million new jobs were created. As a result of an increase
in supply of labor that exceeded demand, the real wages of agricultural
workers —that is, the purchasing power of their wages— inevitably
declined. From 2008 to 2014 their real wages declined by about ten
percent.
During the same period the wages of industrial workers increased by 27
percent and the economy as a whole grew by roughly 33 percent. During
this five year period, the average Indonesian had an increase in annual
income of around 4.5 percent, or 25 percent over five years. The wage
increase of workers who benefited from minimum wage legislation was
not too different from the increase in the income of the average person.
There is a stark contrast between the increase of 25 percent or more
for the average person and industrial workers on the one hand and the
decline of over ten percent for agricultural workers on the other.
Some construction workers benefited from minimum wage rules, but
most did not because they were casual or temporary workers or were
contract workers or hired by small firms. But construction grew at seven
percent per year from 2008 to 2012 so workers with some experience
and skills benefitted from higher wages. Data for household servants are
not reliable because part of their pay is in kind—for example, room and
board—but it appears that their wages have also been declining since
2009 and are now five percent below where they were in that year.
The better off you were the more you gained during the
commodity boom: Income distribution became much less equal.
Chart 9 provides a clear overview of what happened to the incomes of
different groups during part of the commodity boom. The wealthier a
person was, the greater the increase in their expenditures during the
commodity boom. The rich became much richer (by nearly fifty percent
from 2004 to 2012), while the expenditure of the poor hardly increased
(by less than five percent).
43
The Economic Choices
Facing The Next President
Chart 9 shows even more clearly the correlation between income level
and gains made during the commodity boom. Looking more carefully at
the expenditure characteristics of Indonesian households, four separate
groups are readily identified. The first group is normally identified as
“the poor,” the 28 million people who lived below the 2012 poverty line,
at the time almost Rp 250,000, equivalent to about US$ 0.88 per day.
The second is the “vulnerable group,” which is about seventy million
people. The poor and the vulnerable comprise the poorest forty percent
of the population and share one characteristic in the 2008-2012 period:
the growth of their real per capita expenditures was only around two
percent per year.
Chart 9. Annual Growth of Real Per Capita Expenditures by Percentile Groups, 2008-2012
Source: TNP2K, (2014)
The third group of 100 million consists of the middle classes or the middle
forty percent of the income distribution. For the middle classes annual
real expenditures increased more among the better off. The poorest in this
group recorded an increase in expenditures of two percent a year, while the
corresponding increase for the richest in the middle income group was five
The Economic Choices
Facing The Next President
44
percent. And finally, the richest twenty percent of Indonesians enjoyed real
consumption growth of five to eight percent a year, with the richest of the rich
showing the greatest increase in expenditures. The richest three percent recorded
growth in expenditures (nine percent a year) over four times larger than the poorest forty
percent (two percent). It is also remarkable that among the richest sixty percent,
those with higher incomes enjoyed the largest increases in consumption.
Considering the fact that annual household expenditure surveys usually
underestimate the consumption of luxury and durable goods, the actual
growth rate of expenditures may be even somewhat larger for the higher
income groups.
Income distribution improved for twenty years but has become
worse since 2005.
As one might expect, the differential growth rates during the commodity
boom had a dramatic effect on the Gini coefficient, a measure of income
distribution.1 Indonesia’s Gini in the 1960s and early 1970s was a relatively
egalitarian 0.34 to 0.35, typical of poor countries. There was a sharp
increase in the Gini in 1978 for reasons which are unclear (Chart 10).
As the demand for labor increased with the rapid growth of manufactured
exports after 1986/7, income distribution became more equal. The Gini
declined from 0.34-0.35 before 1984 to 0.31-0.33 for 1984-2004. In
that range Indonesia’s income distribution was comparable to that of
other Asian developing countries during the 1980s and among the more
egalitarian countries in the world.
There was one exception: in 1993-96 the Gini increased sharply. The
value of the rupiah had been allowed to appreciate, the rate of growth of
manufactured exports slowed and therefore the increase in employment in
manufacturing also slowed. Demand for labor, which had been growing at
an average rate of 7.5 percent a year in Java from 1987 to 1992, dropped
to 2.8 percent from 1993 to 96 (Papanek, 2014k). In addition, in 1995 there
was a spike in the rural index for inflation to 11.8 percent. Real wages
The lower the coefficient the more equal the income distribution. Perfect equality is
represented by a zero coefficient and perfect inequality (that is, one household receives
all of national income) would equal one.
1
45
The Economic Choices
Facing The Next President
for agricultural workers, which had increased by 9.4 percent in 1992,
increased only by an average of 2.4 percent in 1994 and 1995. The decline
in labor demand and in wage increases may not fully explain the increase in
inequality on 1993 and 1996, but it provides at least a partial explanation.
In 2005, with the beginning of the commodity boom, the Gini coefficient
became sharply less equal. By 2012 it had reached 0.41, a level of
inequality more typically associated with Latin American than Asian
countries. However, inequality in other Asian countries has also risen,
with the result that Indonesia’s Gini is not an outlier in the region.
Chart 10. Gini Index 1964/5 to 2013
Source: Papanek, 2014l
What explains this sharp rise in inequality during the recent
commodity boom and why did it not occur during earlier
commodity booms?
Income distribution worsened during the commodity boom of 2005 to
2011 for three main reasons. First, the appreciation of the rupiah, the
increase in its value against the dollar, yen or euro, together with the
increase in the minimum wage, drove up the cost of labor for exporters
and those competing with imports. Labor intensive manufactured goods
The Economic Choices
Facing The Next President
46
became uncompetitive and these industries hired very few additional
workers. As demand for industrial labor stagnated, the income of workers
who did not benefit from minimum wage legislation declined, and the
consumption of the poorest forty percent increased very little.
The increase in the value of the rupiah was largely due to the increase in
the prices of commodity exports. The value of commodity exports more
than tripled from 2004 to 2011 and the value of all exports nearly tripled
– an increase of $130 billion in seven years (Papanek, 2014c). In addition,
the boom attracted inflows of foreign exchange. There was an increase
in foreign direct investment to take advantage of rising purchasing power
in Indonesia. There was also an increase in the purchase by foreigners
of Indonesian government bonds and other securities attracted by
high interest rates compared to other countries. The increase in export
earnings and in capital inflows resulted in an appreciation of the rupiah,
which led to stagnant incomes for most workers.
Second, the commodity boom itself did not generate demand for labor,
especially for labor with limited education. Higher incomes derived from
exports of copper, rubber, nickel and so on were almost wholly due to
rising prices, not increased quantities. With little increase in production
there was no need for more workers. Coal and palm oil were the two
commodities whose output increased greatly. But coal is produced with
machinery and few workers. Palm oil was the commodity that generated
the most jobs. But with some two million workers added to the labor
force each year the supply of labor rose much faster than demand. Labor
income therefore did not increase much. As a result the income of the
poorest forty percent stagnated.
Third, at the same time many people in the upper income groups
benefited from the commodity boom. Those who owned shares in coal
companies, other mining companies, palm oil or rubber plantations or
in land producing pepper, coffee or cocoa benefited directly from higher
prices for these commodities. Some commodity-producing enterprises
also required additional professional and technical staff: managers,
accountants, bookkeepers, engineers to maintain the machinery and so
on. Those with the right skills or educational background, none of whom
47
The Economic Choices
Facing The Next President
were poor, also benefited from the boom. Finally there were others who
benefited indirectly from the increased income flowing into the country:
shopping mall operators and retailers of luxury goods, architects, airconditioning sales personnel and so on. There was also increased demand
for household servants. But with two million workers added to the labor
force the increased demand for workers with less education was swamped
by the increased supply.
In short, a substantial share of the upper income groups benefited and
very few of the lower income groups did so.
Why did income distribution become more equal during earlier commodity booms? Why
did the consumption of the poorest forty percent increase substantially during these
earlier booms? The commodity boom of 2005-2011 was not the only nor
even the largest commodity boom that Indonesia has enjoyed. An earlier
commodity boom began in 1973, reached its peak in 1978, and continued
to 1984 (see Table 4). That commodity boom was due to an increase
in the price of petroleum. Indonesia also exported rubber and other
plantation products, minerals (tin) and spices. But in the 1970s and early
1980s usually eighty to ninety percent of the income from commodity
exports came from oil. The importance of oil has steadily declined and by
2007 oil and gas combined accounted for only a third or less of the value
of commodity exports. Minerals, notably copper and coal, accounted for
one-third or more and agricultural products including rubber and palm
oil accounted for the remaining one-third. The commodities for which
quantities increased most rapidly were coal and palm oil, neither of which
had been of any importance in earlier commodity booms.
It is this difference in composition which explains part of the differential impact of increased
commodity prices on income distribution during the two commodity booms. In the 1970s
and 1980s the principal beneficiaries of the increase in the price of oil were
foreign oil companies and the Government of Indonesia. An increase in the
price of oil led to a rise in income and consumption by wealthy oil company
owners, who were mostly foreigners, and the government. Profits earned
by foreign oil companies were mostly spent in their home countries. Under
production sharing contracts the principal beneficiary of price rises was
often the government, which spent the windfall on a variety of purposes
The Economic Choices
Facing The Next President
48
including, at one time, introducing universal primary education.
Undoubtedly, some of the increase in income was received by wealthy
Indonesians in a variety of illegal or semi-legal ways. Because the income going
to private individuals was often not fully legal, some of it was parked in other
countries. If spent in Indonesia it might not be reported. The commodity
boom therefore benefited the government most of all, foreign companies and
individuals secondarily and private Indonesians to a limited extent.
But during the 2004 to 2011 boom a substantial proportion of the new coal
mines and palm oil plantations were Indonesian-owned, as were shrimp
farms, rubber plantations, tin mines and so on. Of the $107 billion increase
in commodity exports from 2004 to 2011, some $60 billion was in activities
with substantial Indonesian ownership. In addition, many of the managerial
and technical staff in the firms benefiting from the commodity boom were
also Indonesian. They also benefited from higher commodity prices, which
generated increased demand for their services. During the commodity
boom of the 1970s and 1980s there were only a handful of Indonesian
managers and technicians working in oil companies benefiting from higher
oil prices. In short, wealthier Indonesians benefitted much more from the
recent commodity boom than they had from the earlier ones, when the
government and foreigners were the main beneficiaries.
Workers benefitted from keeping the wage low in dollar or yen terms. There was
another marked difference between the earlier commodity booms and
the most recent one. During the most recent commodity boom the wages
of industrial workers almost tripled when translated into US dollars:
from $12 in 2004 to $35 in 2011. Wages of agricultural workers more
than doubled. As a result, Indonesian workers were more expensive than
those in competitor countries.
But in the 1970s and 1980s three massive devaluations, plus some smaller
ones, assured that while wage rates increased in rupiah and in terms of
domestic purchasing power, wages did not increase in terms of dollars
or yen. As the first commodity boom reached its high point in 1978 a 51
percent devaluation kept Indonesian manufactured exports competitive.
Devaluations of 44 percent in 1983 and 45 percent in 1986 followed.
49
The Economic Choices
Facing The Next President
As a result, the dollar wage for industrial workers in 1991 was twenty
percent below where it had been in 1982, despite the fact that the dollar
had declined in value as a result of inflation.
Table 4. Wages, Exchange Rates and Income of the Poorest 40% During Commodity Booms,
1976-2013
*Note: The commodity exports include minerals, agriculture and oil & Gas. The
agricultural wage is per day, the manufacturing wage per week.
Source: Papanek, 2014m
Many observers would assume that the massive devaluations during earlier
commodity booms would hurt workers by keeping their wages low when
converted into dollars or yen. But while the dollar wage did not rise, workers
benefitted from the rapid growth of labor-intensive exports which resulted
from stable or declining dollar wages. As a result, many workers moved
from low and variable-income informal sector jobs to higher, more stable
jobs in manufacturing or other formal sector activities. From 1976 to 1984,
while the value of the rupiah was cut by forty percent, the expenditures of
the poorest forty percent of the population nearly doubled. From 1984 to
1990 the value of the rupiah was again cut nearly in half and as a result
The Economic Choices
Facing The Next President
50
dollar wages declined by fifteen to twenty percent. But the real consumption
of the poorest forty percent increased by 18 percent.
Contrast that with the most recent commodity boom. From 2004 to 2011
the agricultural wage more than doubled and the manufacturing wage
nearly tripled in US dollar terms. But as demand for labor with limited
education stagnated, while some fifteen million workers joined the labor
force, the income of the poorest forty percent remained unchanged at a
time when national income increased at nearly six percent a year.
During earlier commodity booms the income of the poor increased, in part because
devaluations kept Indonesian exports competitive and demand for labor increased sharply.
The benefits to rich Indonesians were limited. For both reasons income distribution
became more equal. During the most recent boom wages measured in dollars, yen and
euros increased substantially, in part because of the appreciation of the rupiah. Demand
for labor stagnated and with it the expenditures of the poor. The income of wealthier
Indonesians increased quickly. Income distribution became much less equal.
While it is important to explain why the most recent commodity boom
led to much greater inequality, an even more important question is how
government policies and programs can reverse this situation. How can
government policies assure that income growth among the poor will be
at least as high as income growth for the rich?
Policies to reverse the trend and increase the incomes of the
poor more quickly than the rich.
Indonesia has a remarkable record of reducing the proportion of “the poor” defined as
those unable to buy an adequate diet. In March 2014 this group was down
to 11.25 percent of the population. The estimates for 1976 range from
forty to eighty percent (BPS, 2014). But whatever the starting point, the
reduction to eleven percent is a considerable achievement. The Indonesian
poverty line tends to be set at the equivalent of US $1 per day or less, well
below the $1.25 used to define extreme poverty internationally. According
to the World Bank, setting the poverty line at the equivalent of $1.50, below
the international $2 per day poverty line, would mean about 100 million
Indonesians—or forty percent of the population—are poor (World Bank,
2014a). This is the group that we have defined as “poor” in this paper.
51
The Economic Choices
Facing The Next President
Poor because the family has no workers. There are two distinct groups among the
eleven percent of the population defined as “poor” under the current BPS
poverty line. There are families with no members in the labor force, because they are
too old, too young or disabled. The lot of these families will not be improved
by higher wages in their present occupation nor by moving to a better-paid
job. They can only be helped by government transfer programs. If they have children
then “conditional cash transfers,” which provide funds to keep children in
school, can be most helpful in the longer term. By providing education to
the next generation as well as current income these programs can break the
cycle of poverty, the tendency for a family to remain poor for generations.
Poor because workers are poorly paid. The other group includes low-paid
workers, perhaps with many dependents. A farm worker with three
dependents earns less than the equivalent of $1 a day per person, even
when employed for 24 days per month. This group will be helped by increases
in labor compensation/wages and even more by the opportunity to move from an
informal to a formal sector job with higher and more regular pay and some benefits,
such as employer-supplied health facilities. This group will benefit
from a strategy that increases labor demand by making labor-intensive
manufactured exports more competitive. The 27 percent increase in real
wages that the strategy is estimated to produce in the next five years
would lift most of this group out of poverty and would substantially
reduce the proportion of those below the poverty line.
The fact that in the nine years from 2005 to 2014 the proportion of those below
the poverty line has only decreased by 4.7 percentage points—from 16 to 11.3
percent--reflects slow growth of labor demand and the resulting decline in the
wage rates of unprotected workers, notably agricultural laborers.
The group with some family members in the labor force would also benefit
greatly from a guaranteed employment program for rural areas. One reason
some farm laborers are among the very poor is that there are several months
during the year when they can find work for fewer than 24 days a month and
when that work is poorly paid because demand for labor is low during the slack
season. It is the low income in those months that forces them into poverty.
Increasing the income of the seventy million near-poor or vulnerable. Three factors will
be most important in increasing the incomes of most of the seventy million
The Economic Choices
Facing The Next President
52
shown as “vulnerable” in Chart 12, the 29 percent of the population that is
not defined as poor by BPS standards but is among the poorest forty percent
with a per person income between US$ 0.85 and $1.50 per day.
i.
In Indonesia as in most other countries the greatest increase in
income for the poorest forty percent results from workers moving from casual
employment in agriculture or in other occupations into a regular formal
sector job with an income assured from day to day and some
benefits. The average industrial worker earns Rp. 2 million per
month and the average agricultural worker earns about half
as much during those months when there are 24 days of work
available. But there are months when their incomes are even
less than that. Some rural and urban workers earn even less.
For casual workers, illness is a major catastrophe since it means
that income drops to zero and expenditures rise sharply to pay
for health care. If the employer provides some health care this
greatly reduces the risk of the family falling into poverty.
ii. The second source of increased income is a rise in wages or labor income
without a change in employment. From 1987 to 1997 the wage of
agricultural workers increased by forty percent as labor demand
increased rapidly (Papanek, Setiawan & Purnagunawan, 2013).
Over a slightly longer period the income of the poorest forty
percent increased by seventy percent.
iii. Guaranteed employment prevents low income families from suffering a
sharp drop in incomes during the agricultural off-season and falling into
poverty from which it is hard to escape.
Data on the poorest forty percent of the population show clearly why
demand for unskilled and semi-skilled labor is crucial to income growth.
Table 5 shows that lower-income workers are concentrated in three
employment categories: self-employed assisted by unpaid/family workers,
casual workers, and unpaid workers. These are categories which are mostly
in the informal part of the economy. Over fifty percent of the self-employed
assisted by unpaid labor come from the poorest forty percent. About 73
percent of employees and about eighty percent of the self-employed with
permanent workers are from the middle and rich classes. The bottom
53
The Economic Choices
Facing The Next President
line in terms of employment by status is that the poorer groups work in
the informal sector, while the richer groups tend to be in more formal
employment.
Table 5. Indonesian Workers by Expenditure Groups, Employment Status and Sector, 2012 (%)
Source: Nazara, 2014a
Note: a represent the poorest forty percent of the distribution,
percent middle group, and c represent the rich twenty percent
b
represent the forty
Rich and poor workers can be found in every sector of the economy.
However, two sectors stand out because of their close relationship to
income. Agriculture is dominated by the lowest income households with
nearly sixty percent of total employment in that sector. At the other
The Economic Choices
Facing The Next President
54
extreme, financial services are dominated by rich households, also with
nearly sixty percent of total sector employment. Public services provide
few jobs to the lower income groups and there are few rich people in
construction. Manufacturing is interesting: all three groups are represented
almost exactly in proportion to their share of the population. It is a sector
that provides mostly formal employment to the lower income groups as
production workers, to the middle group as technicians, skilled workers
and supervisors, and to the wealthy as professionals and managers.
The clustering of the poorest forty percent in agriculture, among casual
workers, the unpaid and the self-employed, is largely due to their limited
education. In the world of work, education serves as an important proxy of, or
at least signals the potential for higher labor productivity. Chart 11 shows the
educational attainment of households belonging to the poorest forty percent
and those in the less poor sixty percent. Of the population in the poorest ten
percent, more than three-fourths have either not finished or only finished
primary school. Among households in the second to fifth expenditure deciles
only 38 percent are handicapped by such limited education.
Chart 11. Educational Attainment by Consumption Groups, 2011
Source: Nazara, 2014b
55
The Economic Choices
Facing The Next President
Lack of access to education limits opportunities for the poor and vulnerable
to obtain better jobs. However, ownership of the rights kinds of assets can
reduce the negative impact of limited education. Among the most useful
assets are bicycles and motorcycles. They expand the horizons of the
poorest forty percent. They allow workers to reach the workplace more
efficiently and cheaply. Some workers spend as much as one-third to half of
their incomes on buses and other transportation. Ownership of a bicycle or
motorcycle can cut these costs to a fraction of what they otherwise would be
and also provide better access to markets. Ownership of either a bicycle or
a motorcycle is quite widespread even among the poorest twenty percent.
However, as urban areas expand and the roads become more congested,
bicycles may no longer be an adequate means of transportation. Since only
about half of the poorest twenty percent of households own a motorcycle
this will increase the handicap faced by the poor.
Table 6. Ownership of Bicycles and Motorcycles by Consumption Groups, 2011
Source: Nazara, 2014c; Decile 1 are the poorest 10%; 1-4 the poorest forty percent
Summing up:
The evidence is clear: the poorest forty percent have seen very little
improvement in their economic well-being since 2005, while the richest
twenty percent have done extremely well. A major part of the problem
is that the increase in the rupiah wage accompanied by an increase in
the value of the rupiah made Indonesia uncompetitive in labor-intensive
manufactures. The rupiah gained in value for two reasons:
i.
High prices for Indonesia’s commodity exports doubled the
foreign exchange receipts in US dollars in just five years.
ii. There was an inflow of foreign capital as Indonesia became an
attractive place in which to invest.
The Economic Choices
Facing The Next President
56
Because of the appreciation of the rupiah, investors who bought
Indonesian government bonds or other paper received back more yuan,
euros, yen, or dollars than they had paid. Moreover, Indonesian bonds
carried a much higher rate of interest than what it cost to borrow money
in Japan or elsewhere. Investors profited from both the difference in
interest rates and from the appreciation of the rupiah.
With the rupiah more expensive everything produced in Indonesia
became more expensive on the world market and everything bought
on the world market became cheaper to import into Indonesia. At the
same time the wages for larger firms producing exports were pushed
up by minimum wage regulations and labor action. Commodity exports
flourished because they were much in demand but labor-intensive
exports stagnated. As a result there was little demand for labor with
limited education.
With little demand for the principal source of income for the poor, their
labor, the consumption of the poorest forty percent increased barely
one percent per year from 2005 to 2013 while the consumption of the
wealthiest twenty percent increased more than five percent per year.
Income distribution became much less equal.
Active public policy interventions in the labor market are needed to make
up for the setback suffered by the poor during these years. Policies need to
promote economic activities that provide good, productive jobs to those
with limited education. The most important sector is manufacturing. It
alone can provide a large share of the three to four million jobs a year
that are needed to raise the incomes of the poor. A substantial part of the
increased production needs to be exported otherwise Indonesia cannot
pay for the additional imports that will be needed as inputs into increased
production and imported consumer goods.
Tourism can also generate jobs for those with limited education but on
a smaller scale than manufacturing. Finally, the government’s PNPM
program for labor-intensive construction of local infrastructure can
generate jobs in the slow season for agricultural employment.
57
The Economic Choices
Facing The Next President
Active intervention in the labor market also involves government
sponsorship of training and education to increase labor productivity;
much greater spending on infrastructure with priority to areas producing
labor-intensive exports; reducing the cost of labor while increasing the
income of workers; and reducing the cost of production in Indonesia by
reducing the cost of corruption and of government regulations.
With appropriate policies Indonesia can generate more than twenty
million good, productive jobs in the five years of the next presidential
term; sixty percent or twelve million would be for those with limited
education. As a result the wages of agricultural laborers would increase
an estimated 27 percent and those who leave informal sector jobs for
formal sector employment could see their incomes double.
Part II of the paper provides details on these and other essential changes
in policies and programs to achieve the ambitious goals of double digit
growth and four million good productive jobs a year.
59
The Economic Choices
Facing The Next President
PART II:
THE POLICY AND PROGRAM
PACKAGE TO ACHIEVE 10%
GROWTH AND 21 MILLION
GOOD JOBS
source: http://detakberita.com/
The rest of the book presents policy and program changes that, in
combination, are designed to achieve the goals outlined in Chapter 1:
a rate of growth of the economy of ten percent and four million good,
productive jobs per year. Realizing these goals requires, above all, rapid growth
of manufactured exports, which can only be achieved if Indonesian exports are
competitive. Competitiveness in turn requires reducing costs so that these goods can be
sold profitably at the price prevailing on world markets. Investors will obviously not
build factories in Indonesia unless they expect to produce at a cost that leaves them
with a profit at least equal to that obtainable in other countries.
The Economic Choices
Facing The Next President
60
Costs in Indonesia can be reduced in a variety of ways. Therefore there is nothing
rigid about the proposed policy package. The different components of the package
are mutually supportive and can also substitute for each other in reducing costs.
Greater progress in some respects means that less change is needed in others. For
instance, if infrastructure costs are significantly lower in Indonesia than
in Bangladesh, labor costs can be significantly higher.
If the cost of corruption is reduced, then the cost of electricity can
be increased. If infrastructure is substantially improved or corruption
reduced then wages can rise more rapidly; or if the cost of doing business
remains high then the cost of infrastructure needs to be reduced more to
bring down costs to a point at which it is attractive to invest in Indonesia.
If the political costs of one policy change are very great then they can be avoided
by implementing other changes that achieve the same cost reductions but are more
politically feasible.
It is important to remember that Indonesia’s competitors have their own
shortcomings. Indonesia does not need to be perfect; it only needs to lower some of
its costs sufficiently to bring its total costs for some labor-intensive goods below those
of its competitors. India’s experience of reform in the early 1990s provides
some useful lessons: with very limited reforms India increased the average
growth rate from five to eight percent for over a decade.
It is also clear that to return Indonesia to a competitive position requires attacking
high costs on a broad front. No single policy change will do. Some changes, such as
infrastructure development, will take several years. But some investors will not delay
their investment until the new infrastructure is fully in place They will decide to
invest as soon as they see enough reforms to confirm that Indonesia is a good place
for their investment. For example, investors concerned about the supply of
electricity might be encouraged by new policies to attract investment in
power generation and ground-breaking for a few strategic power plants.
They may not need to wait for the power to actually come on line before
deciding to invest. It is important, however, to make those policy changes quickly
that can be implemented quickly. The best example of an important change that
can be realized quickly is currency devaluation. For it to be effective it needs to be
accompanied by an announcement that that this was not a one-time action. Rather it
will be government policy to adjust the exchange rate in the future to stabilize the wage
61
The Economic Choices
Facing The Next President
in yuan, dollars, euro and yen. Indonesia is potentially a very attractive investment
destination. The policy changes that can turn potential into reality are spelled out in
the rest of the paper.
Whether the package as a whole is a success can be measured in terms
of the rate of investment in labor-intensive industries, the number of
workers hired and the value of exports or import-substitution achieved.
The most important measure of success is the increase in the incomes
of the poorest forty percent of the population, but that information is
available only with a lag. The progress report or report card that we
sketch out below to determine whether policy and program changes have
been successful or not therefore includes some data that are available
every month as well as data that are published only annually.
The basic thrust of our recommendations is to increase labor-intensive
manufactured exports. The same policies will also result in importsubstitution, in other words the domestic production of manufactured
goods that are currently imported. In subsequent chapters we will
address related policies or programs to increase the rate of growth and
to assure more regular employment and income to the poorest forty
percent. Chapter 10 deals explicitly with surplus labor in agriculture and
proposes a program to help provide farm laborers with adequate work
and income during the lean season.
The Economic Choices
Facing The Next President
62
Chapter 4.
Measuring the Success of Policy and
Program Reforms
It is critical to determine objectively and transparently whether policy and
program changes are achieving their aims. Without objective measures
established beforehand it is too easy for less courageous political leaders
to claim success while avoiding the tough decisions required to accelerate
job creation and economic growth. A periodic Progress Report or Report
Card would be a useful tool to inform both policy-makers and the public
about how Indonesia is doing in moving towards its economic goals;
where successes have been achieved and where there are weaknesses that
still need to be corrected. The Progress Report will serve these purposes
only if it is issued by an independent professional institution, not by a
government information body.
Some of the data that shed light on progress are available monthly,
and others less frequently. The most useful indicators, labeled Primary
Indicators in Table 7 are:
i.
the real wages of agricultural laborers, that is the wage adjusted for
changes in prices. Real agricultural wages are a good indication
of the supply and demand for labor. Minimum wages do not
apply to agricultural workers and they have no unions, so their
wages respond to supply and demand. If manufacturing is
growing rapidly and agricultural workers find jobs in factories,
fewer will be available for agricultural work and the workers
that remain will see their wages rise. On the other hand, if half
of the two million new labor force entrants looking for jobs each
year end up working in agriculture because they can find no
other work, then the wages of agricultural laborers will fall.
Agricultural laborers are also the largest group within the poorest forty
percent. The ultimate aim of more rapid growth of labor-intensive
63
The Economic Choices
Facing The Next President
exports is to reduce poverty. The wages of agricultural workers tells us
how well the program has succeeded with this group of the poor. Data
on farm wages are available every month for the prior month. But since
some policy changes take months or years to be effective the Progress
Report should cover at least three years.
ii. the volume and value of labor-intensive exports. Data on labor-intensive
exports directly measure the success of policy changes. Changes
in the value of all exports are of some interest because they are an
indication of the income that Indonesia is earning from exports.
But exports that create few jobs for those with limited education
are of little help to the poorest forty percent. What matters to
them are the exports that create demand for their labor. But that
depends on the quantity exported not on the value of exports.
If the quantities produced for export remain the same then no
increase in the number of workers is needed. When an increase in
the value of exports is entirely due to a rise in prices, then profits
will increase because factory owners will get more money for their
products. With no additional workers needed the only way workers
will benefit is if they can force employers to share some of their
higher profits. When there are ten applicants for every factory job
that is difficult. On the other hand, if the increased export income
is due to an increase in the quantity produced then more workers
will usually be hired to produce the additional exports. Workers
will benefit from higher incomes in factory jobs compared to
agricultural or informal sector labor. Therefore changes in the
value of exports need to be disaggregated into increases due to
price changes and those due to quantity changes.
Unfortunately such data are available only with a lag of two to four
months and with considerable work needed to allocate and compile data
for hundreds of commodities. But since these data are far more valuable
as an indicator of the success of the policy and program package than the
value of exports, data on export quantities should be included as a primary
indicator of success, with the value of exports as a secondary indicator.
iii. per capita real consumption of the poorest forty percent. This is the most
direct measure of the economic progress of the poorer segments
The Economic Choices
Facing The Next President
64
of the population. However it is available only twice a year and
with a lag of several months. This measure combines the effects
of the growth of national income and the share of the national
income that the poor receive. If the program is successful then
national income will increase rapidly and the share of the poor
will increase more than the share of the non-poor. As a result
their consumption will increase rapidly.
Wage data are included in the Progress Report because if Indonesian
wages in dollar, yen or euro terms rise too rapidly the competitive position
of Indonesia will be undermined. But note that rupiah wages can rise
without changing foreign currency wages as long as the exchange rate is
adjusted to keep the wage constant in foreign currency terms. This issue
is addressed at greater length in the next chapter. The average wage for
production workers is important but so is the minimum wage in Central
Java. Central Java is the province with the lowest average wage among
the provinces that are important for competitiveness. It has a substantial
industrial base and a large labor force which gives it potential for further
expansion of labor-intensive exports. The most relevant minimum wage
in Central Java is that for Semarang, the capital. Semarang has a port
and airport and is the most likely location for new investment in laborintensive industries. Its minimum wage is the highest in Central Java.
However, the Semarang minimum wage is not always readily available.
Therefore, Table 7 reports the average wage for Central Java.
What really matters, however, is not the wage in Indonesia but how
Indonesian wages compare to those of its most serious competitors. That
is the purpose of measuring the “gap between manufacturing wages in
Central Java and the lowest wage competitor in percentage and dollar
terms.” Central Java is chosen as a large province that has traditionally
paid the lowest wages. While there are provinces where wages are
lower, they have small labor forces and are not significant producers of
manufactured exports. But Central Java has attracted some garment
factories thanks to a minimum wage that is one-half the rate in Jakarta.
The wage in Central Java is compared with wages in the competitor
country that has the lowest wage. That currently is Bangladesh, and
has been for some years. However, in Bangladesh the minimum wage
65
The Economic Choices
Facing The Next President
has recently been increased by seventy percent from $38 to $68. As a
result, the gap between Bangladesh and Central Java has narrowed from a
nearly insurmountable $44 to a difficult but more manageable $26. When
the gap was $44 it would have been difficult for Indonesia to compete,
even with greatly improved infrastructure and other improvements. But
with the gap reduced to $26 competing in many labor-intensive products
should be quite feasible if Indonesia lowers other costs. However, for
manufacturers locate in Semarang, where the minimum wage is Rp 1.4
million or US$120, the gap is currently a daunting $52. While more
manageable than the gap of $142 between Jakarta and Bangladesh, it is
nevertheless a big hurdle.
Table 7. Measuring the Success of Failure of Policy and Program Changes.
Sources: Papanek, 2014n
NOTES: *Indicates that data are NOT available monthly. Black numbers indicate
no change or small improvement. Red numbers indicate negative movement. Blue
numbers indicate significant improvement. Quantities exported are value at constant
prices. This is the only way of aggregating quantities.
The Economic Choices
Facing The Next President
66
Table 7, which we present as a sample of the Progress Report table,
shows some other interesting results. Wages of agricultural workers
have consistently declined since 2009 and continued to fall in 2014.
This reflects the fact that labor supply has been increasing at two
million workers a year while demand for labor has only increased at
slightly more than one million a year. A major factor in the slow growth
of labor demand has been stagnation in the value of labor-intensive
manufactured exports and of all manufactured exports. The quantity of
labor-intensive exports has increased slowly but since labor productivity
has also increased the growth of total employment has been very small.
Slow growth in industrial employment was to a significant degree due to
the rapid rise in labor costs from 2005 to 2011. Wage increases over the
next two years were moderate but in 2014 there was a big jump in the
minimum wage. It even increased by 27 percent in Central Java.
The Progress Report demonstrates its usefulness by showing quite
clearly that Indonesia’s competitive position has improved despite a big
increase in the minimum wage. The major factor is that wages have
recently increased even more rapidly in the lowest wage competitor. The
minimum wage in Central Java increased by the equivalent of roughly
$12. In Bangladesh it increased by the equivalent of $30 after a short
delay. The wage gap between the two countries was first $44, then $56
and finally narrowed to $26. The other good news is that Indonesia has
moved up in the competitiveness rankings while most of its competitors
have moved down. One reason for the improvement was progress on
logistics.
But it is also striking that comparing 2011 and 2013 Indonesia has made
no progress or lost ground with respect to corruption and “ease of doing
business,” two factors for which gains are much easier to achieve than in
infrastructure or labor costs. In short, Indonesia’s labor costs are less of a
handicap than they have been in the past and the country has increased
its advantages in other respects.
Despite the huge increase in Bangladesh’s minimum wage it is still 38
percent or $26 lower than the average minimum wage in Central Java.
In comparison with the more relevant minimum wage in Semarang, the
67
The Economic Choices
Facing The Next President
gap is $52 or 76 percent. That is a huge gap covering the largest cost
component for labor-intensive exports. The importance of the wage gap
is shown by the fact that Bangladesh’s manufactured exports increased
by 100 percent from 2008 to 2013 while Indonesia’s have increased by
only 23 percent.
If Indonesia’s labor-intensive manufactured exports are to grow at 22
percent, the gap in labor costs probably has to narrow. A gap can remain,
with other aspects of cost and competitiveness to Indonesia’s advantage,
but it cannot be as large. How to reduce the gap, while increasing the
income of Indonesian workers is, discussed in the next chapter.
An important consideration in the decision of investors to locate
factories in Indonesia will be the question of risk. How likely is it that the
minimum wage in Central Java will rise more quickly than the minimum
wage in Bangladesh? How likely is it that foreign investment will achieve
greater acceptance and fewer restrictions as against the likelihood that
nationalist rhetoric will lead to investment restrictions? What is the
risk that the opposition in parliament will make it impossible for the
government to act? The actions of the government in the first six to
twelve months will substantially shape the appraisal of risk by foreign
and domestic investors.
Table 7 is a baseline Progress Report that shows just how far Indonesia
has to go to achieve rapid economic growth and jobs creation. This
should not be surprising: the changes in policies and programs that we
recommend have not yet been adopted. The two primary indicators for
which we have recent data point in opposite directions. Some factors
that will affect future growth of manufactured exports have improved—
most notably the competitiveness index, which shows a remarkable
improvement from 74th place in 2005 to 38th in 2013. On the other side
of the ledger is the rapid increase in the wage rate of production workers
in foreign currency terms. Wages have risen in competing countries as
well but generally much less, except for China. The weekly wage of
production workers in Indonesia was equal to $12 in 2001 and $38 in
2013. A major factor was that the exchange rate in the two years was
virtually the same. In contrast, during the shorter period from 2005 to
The Economic Choices
Facing The Next President
68
2013, the Vietnamese dong has become cheaper by one-third and the
Bangladesh taka by one-fourth. If there had been a comparable decline
in the rupiah, say by thirty percent, then industrial workers’ average
weekly wages would have been equal to $29 rather than $38, which is
quite a difference.
In short, a Progress Report or Report Card can provide a quantitative
overview of Indonesia’s progress in achieving Double Digit Growth and
creating four million good, productive jobs a year. It helps to highlight
areas of progress and of weakness that might otherwise be overlooked.
It can therefore be a useful tool in framing policies. The Progress Report
for 2011 to July 2014 shows, on the negative side, a very large increase
in the dollar wage for industrial workers; a continued decline in the
real wage of agricultural workers; and the fact that Indonesia’s ranking
remains very low with respect to corruption, ease of doing business,
and infrastructure. The most positive item is the wage increase in
Bangladesh, which exceeds that recorded in Indonesia. Rapid wage hikes
in Bangladesh narrowed the wage gap between the two countries and
therefore improved Indonesia’s competitive position. The other positive
result is that Indonesia has moved from 74th to 38th in the competitiveness
rankings, a remarkable improvement.
Updating this Progress Report every month will provide critical
information on whether the country is achieving its goals or continuing
with “business as usual” policies, slow growth and the failure to provide
productive employment that this implies.
69
The Economic Choices
Facing The Next President
Chapter 5.
Increasing the Incomes of Workers,
Lowering Labor Costs to Exporters
At first glance the proposed policy package contains two incompatible objectives:
to lower the cost of labor to exporters to enable Indonesia to compete in the
world market for labor-intensive goods; while at the same time increasing
the incomes of lower-income workers. The major purpose in reaching a ten
percent rate of growth and creating four million good and productive jobs a
year is to increase and stabilize the incomes of the poorest forty percent of the
population. It would therefore be pointless to improve the competitive position
of Indonesia by pushing down the incomes of workers. At the same time, it is
difficult for Indonesia to compete in the world market for labor-intensive goods
when wages are double or triple what they are in Indonesia’s main competitors.
While the two objectives may at first glance appear impossible to achieve
simultaneously, there are in fact policies that can increase the incomes of workers
while lowering the cost of labor to enterprises, especially those competing in
the world market. The most important step is to provide the estimated fifteen
to twenty million “surplus workers” with good productive jobs. Currently their
incomes are low and uncertain and their contribution to national income is
small or even zero because they do not have productive jobs. Providing them
with regular jobs would greatly increase their incomes, reduce the uncertainty
they now face as they try to feed themselves and their families, and increase
national income by an additional eighteen percent in the next five years. This
chapter deals with various steps to provide additional jobs to employ surplus
workers to benefit them and the nation.
A key problem for Indonesia’s competitiveness: Wages that are
absolutely low but well above those of its main competitors.
Wages for industrial production workers are low in terms of what workers can
buy. If there is one member working in manufacturing in a family of five then
The Economic Choices
Facing The Next President
70
a wage of $200 a month is just above the $1.25 a day per family member which
is the definition of “very poor.” Even if two members of the family are working
the minimum wage for the best paid workers in the Jakarta area leaves very
little for school fees or medical costs. The minimum wage in Central Java is
significantly lower than that in Jakarta at a simple average for the province of
Rp 1.1 million for 2014 or US$94.21
Yet in comparison to other countries the wage is quite high. Wages, of course,
differ by industry, so Table 8 compares workers in the garment industry or
uses the government–set minimum wages for all industries. Wages in China
are substantially above those in Indonesia, a major reason why labor-intensive
industries in China are expected to decline. But manufacturing wages are much
lower in the countries that compete with Indonesia for the markets that China
is now vacating. The minimum wage in the Jakarta area is roughly three times
the wage in Bangladesh in dollar, euro and yen terms, and roughly double the
wage in Vietnam and Cambodia. For industries like garments where wages are
roughly one-third of total costs, a large difference in the cost of labor makes it
difficult for Indonesian enterprises to compete. Moreover most of the workers
in Indonesian labor-intensive industries are paid at or just above the minimum
wage. Changes in the minimum wage therefore have an immediate and clear
impact on the cost of labor.
Table 8. Garment Workers' Wages in Asian Countries (US$ per month in 2014)
Note: Rp 1.4 million per month = $120 is the minimum wage in the Central Java city of
Semarang and Rp 2.4 million = Rp 205 in the Jakarta area. The average exchange rate for
the first 7 months of 2014 was Rp 11,700 / US$. The lower wage is for the city where most
factories are likely to locate. In the previous chapter the wage was the average for Central
Java which includes many rural areas and small towns where few factories are likely to locate.
Source: Papanek 2014o
The minimum wage is set at the district (kabupaten) level. The minimum for the province
is the simple average of the rates in the province’s twenty kabupaten.
2
71
The Economic Choices
Facing The Next President
At the other extreme from garment production are industries like chemicals
where labor represents only five percent of total costs. Moreover, most workers
are technicians, engineers and managers, paid well above the minimum wage
and not affected by changes in it. Whether these industries can compete is
little affected by the cost of labor. Many industries producing primarily for
the domestic market can tolerate relatively high wages if they are protected
from import competition by high transportation costs or the imposition of
tariffs or quantitative restrictions. Any expansion of manufacturing in the
Jakarta area with its high wages is therefore likely to be mostly in industries
that are not labor-intensive or that produce for a protected domestic market.
New investments in labor-intensive industries are beginning to locate in
areas with lower wages, and especially in Semarang, the capital of Central
Java. There the minimum wage is not quite sixty percent of what it is in
Jakarta, at $120. But even in Semarang the minimum wage is almost eighty
percent above that in Bangladesh and ten to fifty percent higher than in
Vietnam, India and Cambodia. Much of the rest of this chapter discusses
how Indonesia can overcome the handicap imposed by relatively high wages.
The high cost to workers of high dollar wages
Indonesia’s high wage for unskilled and semi-skilled workers relative
to other Asian countries competing to capture China’s market share in
labor intensive manufactures has several consequences that reduce the
number of jobs available for surplus workers:
i.
They discourage investment in labor-intensive industries. As can be
seen from Charts 3 (Chapter 1), 4 and 5 (Chapter 2), in the
last fifteen years labor-intensive industries have located not in
Indonesia but in Vietnam, Bangladesh and, to a lesser extent,
in India and Cambodia. If the new government in India
follows through on its promises during the election campaign,
India will become a much more effective competitor. It has
areas with very low cost production labor as well as low-cost
engineers. Investors have stayed away nevertheless because of
costly government regulations, aggressive labor demands and
inadequate infrastructure. If these and other problems are dealt
with, as they largely were in the State of Gujarat, investors will
consider India as a base for labor-intensive manufacturing.
The Economic Choices
Facing The Next President
72
ii. Labor-intensive enterprises already in Indonesia will not expand and will
not increase exports. They will limit their production to goods that
can be sold in the protected domestic market since their costs
would make them uncompetitive in the world market. Only
temporary surpluses would be exported. The slow growth of
labor-intensive industry in Indonesia as shown in Chart 3 is
evidence of this fact.
iii. Labor-intensive firms will over time become less labor-intensive. They
will reduce the number of workers employed and substitute
machines to the maximum extent possible. One such firm
reported that in order to keep its international market it needed
to reduce costs and prices. It did so by reducing its labor
force by twenty percent and increasing its use of machines. It
reduced the number of workers through normal attrition and
by offering an attractive severance package to workers to retire
early. Over time, these industries will reduce rather than expand
employment as they substitute machines for labor wherever it is
technically and economically feasible.
The result can be seen in Chart 12 which shows that the number of
additional workers employed in manufacturing from 1997 to 2013 was
pitifully small. Over sixteen years it increased at less than two percent a
year. In the twelve years to 1997 the increase was nearly six percent a year.
Chart 12. Increased Employment in Manufacturing, 1985-2013, Annual Rate
Source: Papanek 2014p
73
The Economic Choices
Facing The Next President
Does Indonesia have “surplus” workers who can contribute to
rapid growth and development?
It is strange but true that while Indonesia has workers who earn on
average Rp 3 million a month in Jakarta and other provinces, it also has
workers who are “surplus” and earn less than one-third that amount.
Workers with good, productive jobs produce goods or services worth
over Rp 200 million a year, or about US$19,000 per person on average.
Surplus workers may add little or nothing to national income. Every
million workers who shift from surplus to productive work in manufacturing adds
roughly US$19 billion or over two percent to national income.
“Surplus workers,” sometimes referred to as the “disguised unemployed,”
are engaged in extremely low productivity occupations that earn very
little money. As a result, their family incomes are also low and uncertain.
They are usually not part-time workers as they typically work more
than thirty hours a week. Rather, they often work long hours shining
shoes, selling cigarettes or working on tiny family agricultural plots. But
they are not really needed. If they were to find work in manufacturing,
the same number of shoes would still be shined, the same number of
cigarettes would be sold and the output of the family plot would not
decline significantly. If surplus workers could find good, productive
work the country would be better off and so would the workers. Their
incomes would be higher and above all, would come more regularly.
The income of the remaining shoe-shiners, cigarette sellers and farmers
would also increase because the same income would be shared among
fewer workers.
But what is the evidence that there are surplus workers and that they
number in the millions? The existence of excess labor is evident
throughout the economy. There are family-owned stores where four
sales persons wait for customers when even during the busiest time two
or three would do. In cities where they are still allowed one finds excess
becak (bicycle rickshaw) drivers waiting for customers even during the
busiest times of the day; in casual markets for day laborers there are
usually excess workers waiting for construction jobs who do not find
employment. Factory owners say that for every vacancy there are ten,
The Economic Choices
Facing The Next President
74
twenty or more applicants. Beyond the so-called anecdotal evidence,
Indonesia’s labor force statistics reveal a large and growing problem of
surplus labor in agriculture and other sectors.
Surplus labor in agriculture – some striking statistics.
The clearest statistical evidence for surplus labor is from agriculture.
In most countries experiencing rapid economic growth the number of
workers in agriculture declines even as agricultural output expands.
This was also true in Indonesia from the late 1980s to the mid-1990s.
Manufacturing employment grew rapidly during this period, at 600
thousand jobs a year, and so did good jobs more generally, at over one
million a year. During this period agricultural employment declined
by some five million workers, even as output or rather value added
increased at four percent, which is quite high for agriculture.
The Asian Financial Crisis (krismon) reversed these trends. Jobs in
manufacturing actually declined for one year and then grew more
slowly. Agricultural employment increased by five million from
1997 to 2000. No conceivable increase in demand for labor can
explain this increase in just three years. The increase was rather
due to an increase in the supply of labor, as two million workers
entered the labor force each year, combined with a decline in
employment in some sectors. Some of these workers, unable to find
formal sector jobs, crowded into agriculture to earn some income.
Agriculture is by far the largest sector where work- and incomesharing is widespread.32
T he poor cannot afford to be unemployed for more than a few days in a country
like Indonesia. In order to survive they need work and income virtually
every day. From the late 1980s to the mid-1990s on average 750
thousand or so workers would leave agriculture each year for jobs in
The term “work and income sharing” has been used by Papanek to describe a situation
in which additional workers are absorbed with little or no additional output. The same
work and income is shared among more workers. Essentially the same phenomenon
was labeled “shared poverty” by the anthropologist Clifford Geertz. Geertz describes it
as limited to agriculture, but Papanek argues that exists in many parts of the Indonesian
economy.
3
75
The Economic Choices
Facing The Next President
manufacturing, construction, and some parts of trade and services.
However after 1997, when few manufacturing or construction
jobs were available, additional workers not needed in agriculture
nevertheless continued to work in that sector. They worked on the
family plot and for neighbors who were willing to hire more workers
even if there was not more work to be done. They simply spread the
same work among more workers, paying each of them less. This
is “work- and income-sharing”. This appears to have happened
in 1997-2000: some two to three million workers who would have
left agriculture in good years for better jobs in manufacturing,
construction, transport, sales and services remained in agriculture
because there were no jobs in these other sectors.
In addition, many workers lost their good, productive jobs in
manufacturing, construction and some other sectors. Two to three
million recently unemployed returned to the agricultural labor
force because it is a sector characterized by low barriers to entry.
If the family owned a plot of land a family member could usually
participate in the work and share in the food produced there. In
some parts of Java anyone could participate in harvesting rice and
keep a portion of the rice he or she harvested. The more participants
the smaller the share each received, but everyone could at least
earn something.
Table 9. Surplus Labor in Agriculture: Employment in Agriculture and Manufacturing; Change in Value
Added in Agriculture; 1986-2012
NOTE: Employment is an average to smooth out great annual fluctuations.
Source: Papanek 2014q
The Economic Choices
Facing The Next President
76
The numbers in Table 9 tell the story. When there were jobs available in
manufacturing and elsewhere, most notably from 1989 to 1997, there
was a significant decline in the agricultural labor force of between five
and six million. When other jobs were scarce from 1997 to 2000 some
five million were added to the agricultural labor force. It is not logical
that these workers were added in response to a sudden, large increase
in demand. It is apparent that these were workers could not find a
regular job or had lost a job in manufacturing or construction and
were crowding into the largest work- and income-sharing sector. By
2013 there were over three million more workers in agriculture than
there had been in 1997.
Based on the experience of Indonesia before 1997, and of other
countries, agriculture should have continued to shed workers. At the
rate of 750,000 each year— the pace of decline before the financial
crisis— twelve million workers would have left agriculture over a sixteen
year period. Even using the more conservative estimate of 550,000 per
year, which is the average rate of decline in the two periods shown
in Table 9, the agricultural labor force would have declined by nine
million over sixteen years.
Taking account of the 8.8 million workers that the sector would have
shed on past trends and the three million that it added yields an estimate
of twelve million excess or surplus workers in agriculture in 2013 out of the
38 million working in the sector. As agriculture was adding workers,
output or value added grew more slowly than it had when the sector
was shedding labor. This provides additional evidence that there were
surplus workers in agriculture.
The increase in unemployment adds three million to the estimate of surplus workers.
From 1997 to 2013 there was an increase of over three million in the
number of unemployed. The truly unemployed do not contribute to
output. They are consumers, but not producers. If the 4.3 million
unemployed in 1997 represents a minimum level— that is, workers
temporarily unemployed while changing jobs, waiting for the results of
an exam or otherwise in transition— then the additional three million
unemployed in 2013 also are “surplus” workers. If they were to find
77
The Economic Choices
Facing The Next President
jobs in manufacturing their contribution to output or value added
would be a net gain to the nation.
There are probably millions of surplus workers in other sectors, but how many
millions is difficult to estimate. In 2012 in trade and services alone
there were almost twenty million workers in the informal sector.
Some of these are clearly workers who do not contribute much to
national income: four family members staffing a retail shop when
three would do; four street sellers where three could provide the same
service, and so on. There undoubtedly is surplus labor in some parts of
services and transportation: too many shoe shiners, becak drivers and
ojeg (motorcycle taxi) drivers, many of whom can be seen waiting for
customers even at the height of rush hour.
Without further analysis and field work it is impossible to know whether
three million of these twenty million are surplus or whether the actual
figure is ten million. But that some are surplus cannot be doubted
by anyone who has visited a small, family-owned retail shop or who
has been helped by an informal “traffic guide” earning small change
helping cars navigate Jakarta’s crowded intersections.
A rough estimate is that there are 5.5 million Indonesians working in
other countries, the great majority of whom have left because they
cannot find work at home that pays enough to support themselves
and their families. With the exception of a minority who would
prefer to work abroad even if they could find a good job at home,
this whole group could also be considered as surplus. However,
shifting these workers from overseas to good jobs in Indonesia
would not be a pure gain for the country as in the case of surplus
workers in the domestic economy. Repatriating these workers would
mean a loss of remittances which help close the savings-investment
and export-import gaps.
Two million additional workers will join the labor force each year or ten million
during the five years of the next presidential term. Under current
policies, roughly half would find productive work and half would wind
up as surplus labor.
The Economic Choices
Facing The Next President
78
Summing up on surplus labor. The estimate of an additional twelve
million surplus workers in agriculture since 1997 is quite well
grounded, but of course it is still an estimate. The addition of
three million workers to the ranks of the unemployed is definite.
The estimate of those who work abroad at three to seven million is
approximate; but most of them could be considered surplus. And
four to five million of the ten million joining the labor force are
likely to become surplus labor in the next five years. How many
more millions have been added to surplus workers in other sectors
it is difficult to say. It is equally difficult to estimate the number
of surplus workers in 1997. But it is reasonable to conclude that
with current policies the population of surplus workers in 2019 will
consist of the following:
•
•
•
•
•
in agriculture 8.8 million made surplus by greater labor
productivity plus three million added to the sector after 1997,
for a total of twelve million;
additional unemployed of three million;
three to four million working abroad but likely to return home
if jobs were available;
ten million joining the labor force from 2014 to 2019, with
only 5.7 million finding productive jobs, leaving a surplus of
four million;
surplus labor in 1997 and additional surplus labor in trade,
services and transport, which are both unknown.
The minimum estimate of surplus workers in 2019 is therefore twenty
million out of a labor force of around 114 million. If these workers
move from being surplus to productive jobs, national income per person would
rise from Rp. 39 million in 2013 to Rp 53 million a year in 2019, a 36
percent increase. This is obviously a huge gain for the nation as a whole.
The workers themselves would see their incomes double or triple and
stabilize. Workers as a whole would be significantly better off without
any increase in the cost per worker to employers in the manufacturing
sector.
79
The Economic Choices
Facing The Next President
Increasing labor productivity reduces the cost of labor to
the employer without reducing workers’ incomes.
But productive jobs for these twenty million surplus workers can be
generated only if Indonesia can compete in the world market, and
that requires reducing the cost of labor to employers to overcome
high wages. Obviously, if Indonesian workers are more efficient than
workers in other countries, then they can be paid a higher wage and
still be competitive. Labor productivity depends on a number of
factors.
Days lost to strikes reduces labor productivity in Bangladesh. The country with the
lowest labor costs, Bangladesh, is handicapped by a reduction in labor
productivity due to the large number of strikes called for political reasons.
Political strikes are in addition to normal labor disputes. They can last
from half a day to one or two days. Some cover the country as a whole,
while others are limited to one or more of the main industrial centers.
They are called by the party out of power to disrupt the government of
the party in power.
Chart 13. Number of Political Strikes (Hartals) in Bangladesh
Source: UNDP 2005
The Economic Choices
Facing The Next President
80
Usually they are only partly effective but they disrupt production in
major factories. Often workers are paid for these lost days since they
are not responsible for the stoppage. During the most recent period
for which we have data, there were over 100 of these strikes a year. It
is difficult to estimate the loss in output but it clearly is significant and
lowers labor productivity.
Indonesia has labor disputes but not political strikes. This helps raise
labor productivity in Indonesia relative to Bangladesh, and therefore
compensates in part for the higher wages in Indonesia.
As reported by investors, labor disputes are more frequent in India
than in Indonesia. No comparable data could be found to substantiate
this assertion.
The basic education of workers and their training for specific
jobs affects labor productivity.
It is logical and supported by studies that educated workers are more
productive up to a point. The percentage of Indonesians who have
completed primary or secondary schooling is not very different from
that of its competitors. In most of the competitor countries close to 100
percent of students in the relevant age bracket are in primary school.
There are no major differences between Indonesia and competitor
countries with respect to the percent of the relevant age cohort in
secondary or tertiary education.
In one respect, however, Indonesia lags substantially behind India: the
number and quality of engineers, managers and technically trained
personnel. India had a sizeable industrial sector 100 years ago. Indonesian
industrialization started only thirty years ago. Indonesia therefore
lacks organizations like Tata that have experience in managing large
enterprises that compete on the world stage. India also has a surplus
of engineers and therefore salaries for them that are about half of the
salaries of Indonesian engineers in dollar terms. India also has a large
number of high school and college graduates with good competence in
English. Last and perhaps most importantly, India has a system of elite,
world class educational institutions, which Indonesia lacks.
81
The Economic Choices
Facing The Next President
Causes and consequences of weak universities. In one ranking of universities
four Indian universities are listed among the top in Asia and none
from Indonesia. The top Indian schools in management, engineering,
technology and economics have faculty members who are known
internationally. There have been attempts in Indonesia to establish
one or two world class elite institutions in some of the same fields, but
the pressures from other universities to be included have proved too
great to permit the concentration of resources on one university that
would lift it into the upper ranks.
Developing world class universities, however, is not just a question of
concentrating additional resources in a few institutions. For society to
obtain the benefits that make these additional expenditures worthwhile,
the universities selected need to be exposed to international standards
and need to be held increasingly to these standards. For instance, to
receive special financial support they could be required to publish a
specified number of articles in international professional journals;
or to have some of their graduates accepted into PhD programs at
leading international universities. To meet such requirements some universities might be encouraged
to enter into partnerships with leading non-Indonesian universities
for faculty exchanges, faculty training and joint research to help
improve standards. The existing regulatory environment discourages
substantive partnerships by placing strict limits on the activities of
international scholars and institutions in Indonesia. Other countries
have taken the view that they should encourage foreign scholars to
take an interest in their country, rather than discourage them from
collaborating with domestic institutions. The Indian Institutes of
Management were helped in achieving their current high standing
by a cooperation agreement with the Harvard Business School. The
Indian Institutes of Technology similarly worked with MIT. Many foreign universities have set up branches in Asian countries. In
some cases these have been low-standard, money-making propositions,
but in other cases they have provided a high standard of competition
to the local universities. But Indonesia has never permitted such
The Economic Choices
Facing The Next President
82
competition. Cooperation and competition with foreign universities
may prove to be an essential ingredient for achieving world class
standards by some Indonesian universities. Arrangements with foreign
universities could improve the peer review system, which is particularly
weak. Requiring publication in international journals can help in this
respect.
Without greatly strengthened universities it will be difficult for
Indonesia to compete with India in some technical fields. India’s
position in the export of software and business services is solid. But it
is also potentially strong in fields such as the production of computer
chips which require a lot of engineering talent for maintenance and
some sophisticated engineers for design. On the other hand India
is vulnerable in fields such as textiles, which require only limited
engineering inputs, but where the industry is handicapped by rules to
protect the large handloom sector.
Over the longer term it would be highly desirable for Indonesia to develop
to world standards at least one university in the country in each field important
to development. This would require a change in current policy,
exposing the universities to competition, encouraging engagement
with the best in their fields and sending potential faculty to the best
graduate programs in their field. The Indian example is useful.
The fields they have developed are technology, largely engineering,
management, including public enterprise management, and
economics. Economics is a much smaller field than the other two.
Agriculture would also be important in Indonesia. In these fields
India has developed a limited number of world-class universities.
China’s universities have been transformed over the past two decades
by the provision of copious amounts of state funding combined
with policies designed to attract, retain and promote scholars who
have demonstrated a capacity to compete internationally in their
chosen disciplines.
Job-related training and education by industry, funded by government or by a
fee levied on industry. The experience from other countries as well as
83
The Economic Choices
Facing The Next President
Indonesia is that government training programs to enhance skills,
increase productivity and incomes tend to be ineffective. Teachers are
often out of touch with recent developments, are too theoretical and
lack access to the more sophisticated technologies in which training
is most needed. Private firms do not have these problems but are
reluctant to spend money on training workers who may leave for
competitors once they are trained.
The best combination is for the training to be done by the industry but
with the cost borne either by the government from general revenue or
from a small fee on each unit produced or exported. The full amount
of the fee is paid to the association or other unit to finance training
at all levels. Since the cost of training is borne by all firms or the
taxpayer, each firm will want to have its own workers, technicians
and engineers trained, knowing that at least some will stay with the
firm. In many cases training can be provided initially by a firm selling
new machines. That training is usually minimal but some sellers of
machinery will provide additional training at cost.
Firm-based general adult education. In addition to job related training,
larger firms can also effectively organize general education for workers
who never received much education in their youth. It is in the firm's
interest to do so because a literate and numerate worker is likely to
be a more productive worker. Firms, however, do not want to bear
much of the cost since workers may leave the firm at any time. Since
it is in society's interest that all citizens receive an education it is quite
reasonable for society, which means the government, to bear most of
the cost of general education. The firm would take responsibility for
organizing the classes before or after work and making sure that teachers
show up and provide the education for which they are paid. Providing
general education through the firms where workers are employed has
another great advantage: all of the students are adults and are already
in the place where the education is provided. It is therefore a very cost
effective and efficient way of providing adult education for those who
left school when they were very young.
The Economic Choices
Facing The Next President
84
Locating labor-intensive export industries where the need
for good jobs is greatest.
Several benefits are achieved by locating new labor-intensive export
enterprises where wages are currently among the lowest in the country:
1. Firms are better able to compete in the world market because of lower
labor costs. For garment firms labor is one third of total costs.
Such firms would find it difficult to compete with Bangladesh
garment firms at Jakarta’s minimum wage of Rp 2.4 million
or US$210 a month. Firms in Bangladesh pay their workers
one-third of that amount if they are law abiding and pay the
minimum wage of $68. A firm located in Semarang, where
the minimum wage is Rp 1.4 million or US$120, would still
find it difficult to compete but its problems with labor costs
would be less severe.
2. Manufacturers locating new investments where wages are
lowest are providing good jobs to the poorest parts of Indonesia and
to workers who most need jobs. Wages are low in Central
Java because there are few manufacturing jobs in that area
and few alternatives to even lower agricultural wages or other
informal sector occupations.
While labor costs are lower in Central or East Java than in West Java or
Jakarta, firms will be reluctant to locate there and will find it difficult
to compete because infrastructure costs are high.
To deal with that problem we propose a Pioneer Industry Development Fund
which would give priority to developing infrastructure in areas that have attracted
new investment in manufacturing, especially for export, or in tourism.
Managing the exchange rate – a powerful tool to keep labor
costs competitive.
Until recently Indonesia was unusual among Asian countries in
welcoming the appreciation of its currency. Other countries did their
best to reduce the value of their currency to improve the competitive
85
The Economic Choices
Facing The Next President
position of their exporters. For years China was accused of pushing
down the value of the yuan to expand its manufactured exports and
to provide employment for millions of additional workers. A major
reason why Indonesia became uncompetitive was the rising value of
the rupiah during the commodity boom, which increased the dollar,
yen and euro costs of Indonesian exports and made it cheaper to
import goods into Indonesia. Bank Indonesia (BI) no longer intervenes
actively in the foreign exchange market to increase the value of
the rupiah in the long term. But if Indonesia is going to succeed in
creating four million jobs a year for its surplus workers, BI will need to
follow policies that weaken the rupiah. That will make exports cheaper for foreign
buyers and therefore more competitive. At the same time it will make imports
into Indonesia more expensive and therefore less competitive. Both will result in
increased production of manufactured goods in Indonesia, increased employment
and income.
Devaluation, exports and imports. A ten percent decline in the value of
the rupiah against the yen, euro, dollar and yuan means a ten percent
increase in the rupiah cost of imports and a ten percent increase in
the rupiah value of exports. That will, first of all, reduce imports
and increase exports, thus helping to balance the foreign accounts.
Increasing the cost of most imports is a benefit of devaluation, not a
cost. It acts like a universal tariff of ten percent, increasing the cost of
imports and improving the competitive position of domestic producers
who are competing with imports. To a lesser extent it also improves
the position of producers who are not competing with imports: if the
cost of imports rises while the cost of purely domestic goods does not,
some demand will shift from imports to domestic goods and services.
This aspect of devaluation is especially important in the context of
the expected introduction of the ASEAN Economic Community (AEC).
Many Indonesian producers are afraid of being put out of business
by lower-cost producers in other ASEAN countries. They are seeking
tariffs and other protection that would undermine the purpose of the
Community and will therefore be difficult to achieve. A devaluation
will provide protection to all Indonesian producers and is perfectly
compatible with the AEC.
The Economic Choices
Facing The Next President
86
Second, devaluation discourages the consumption of foreign luxury
goods and of foreign travel and can therefore increase domestic
savings. An ordinary foreign car with a base cost of $20,000 will cost
an extra Rp 23 million as a result of a ten percent devaluation. A
luxury car at base cost $70,000 will cost an extra Rp 80 million.
It is sometimes argued that the bulk of imports are not consumer
goods but machinery and intermediate products. Raising these prices
will increase costs throughout the economy. This is correct. But to
the extent that these imports go into the production of exports or
the production of goods competing with imports, the higher price of
imported inputs does not matter because the value of the output will
also increase.
Devaluation and the cost of labor to exporters. Table 10 shows what happens
when the rupiah is allowed to appreciate, or increase in value against
other currencies. In the three years from 2008 to 2011 the nominal
wage increased 21 percent and the rupiah increased in value by eight
percent. The combined effect made for an increase of over thirty
percent in labor costs to exporters and those competing with imports.
As a result it became less profitable to expand labor-intensive exports.
But while labor costs increased the wages of workers barely improved.
On the other hand, from 2011 to 2012 wages increased by a significant
seventeen percent but the cost of labor increased by thirteen percent
because the rupiah depreciated to temper the effect of wage increases
on exporters.
The projected data for 2014 and 2015 illustrate interactions among
the nominal wage, prices and the exchange rate. At the exchange rate
which prevailed for the first seven months of the year, the minimum
wage in Semarang, Central Java of Rp 1.4 million was equal to $122.
This is $54 above the minimum wage in Bangladesh, a huge handicap
for Indonesian garment exporters. If the minimum wage is increased
to Rp 1.6 million in 2015, then it would take an exchange rate of Rp.
13,100 per dollar to keep the dollar cost of labor unchanged. The
difference between an exchange rate of Rp 11,500 and Rp 13,500 is $20
in the monthly wage paid by the Indonesian exporter. A depreciation
87
The Economic Choices
Facing The Next President
to Rp 13,500 in 2014 would narrow the difference between the current
Indonesian and Bangladesh wage by about forty percent and therefore
greatly improve the competitive position of Indonesian exporters.
Table 10. The Exchange Rate and Cost of Labor for Exporters and those Competing with Imports
Note: The nominal wage for 2008 to 2012 is the average wage for all Indonesia. Projected
wages are actual and assumed minimum wages for Semarang city in Central Java.
Source: Papanek 2014r
Currently Bangladesh is a competitor only in garments, the most laborintensive industry. But it is beginning to attract shoe factories as well.
Potentially it could be a formidable competitor in all highly laborintensive industries: toys, textiles, kitchenware and so on. For some
industries, such as car parts, India is likely to be the most important
competitor. The gap between wages in India and those in Central Java
is small. Competition will therefore depend on relative infrastructure
costs, the costs of corruption and doing business, openness to foreign
investment and other factors. But the gap in wages with Jakarta is large
and car parts are more likely to be located in that area. Therefore, the
exchange rate will again be crucial to the competitive outcome. Currently
in a wide range of goods the principal competitor is Vietnam, with labor
costs ten percent to fifty percent below costs in Central Java and 50 to
75 percent lower than Jakarta. A devaluation of fifteen to twenty percent
can narrow the gap in labor costs down to a manageable difference as
long as the comparison is with Central Java and not Jakarta.
The Economic Choices
Facing The Next President
88
Problems of devaluation. Bank Indonesia has been reluctant to see any
substantial depreciation of the Rupiah because of: [i] the impact on
the cost of living, addressed in the next section; [ii] the increased cost
of servicing foreign debt; and [iii] the fear that it would lead to panic
and a repeat of 1998 when the exchange rate reached Rp 17,500 per
dollar. But there was no panic when the rupiah recently fell from 8,500
to 12,500 to the US dollar in a rather short period of time. That fear has
therefore diminished, especially if the depreciation is a gradual process.
Foreign exchange indebtedness is much smaller than it was in 1998.
For exporters foreign indebtedness is not a problem. With devaluation
their debts require more rupiah to pay off but for each dollar’s worth
of exports they also receive more rupiah to cover the debt. The same is
true for enterprises that compete with imports. With devaluation the cost
of imports increases and therefore the domestic price of the good will
rise; a devaluation has the same effect as a tariff of the same magnitude.
The cost of debt servicing goes up but so does income. Foreign debt
is a problem primarily for enterprises like PLN that borrow in foreign
currencies but earn income in rupiah. A limited number of firms with a
serious problem may require special support.
It is the impact of the devaluation in increasing the cost of living that is
the main concern. That issue is addressed later in this chapter.
In short, the exchange rate can substantially lower the cost of Indonesian labor
to exporters without changing the rupiah wage received by Indonesian workers. A
major element in Vietnam’s rapid growth of manufactured exports was
its policy of devaluing the currency whenever export growth slowed
down. In order for Indonesia to compete in labor-intensive goods a useful
rule of thumb might be that when wages are changed into US dollar or other world
currency terms the cost of labor in the lowest cost large province should not exceed the
wage in the lowest wage competitor by more than fifty or sixty percent. It is difficult
to compensate for a larger gap. Concretely, this means that with the current
wage in Bangladesh of roughly $70 the wage in Semarang, Central Java
should not exceed $105 to $112. A wage of Rp 1.4 million would imply
an exchange rate of between Rp 12,500 to Rp 13,300 per dollar to bring the dollar
wage down to $105 or fifty percent above that in Bangladesh.
89
The Economic Choices
Facing The Next President
Does devaluation work when value added is small and imported inputs are a large
share of the cost of many firms? It is sometimes argued that devaluation does
not help Indonesian exporters because a large share of their inputs are
imported and these inputs will go up in price as well. Table 11 shows
that it does not matter whether value added is large or small or whether
imported inputs are important or not. The exporter and the firm
competing with imports will benefit from a devaluation, which will enable
the firm to increase its profits, lower its prices or some combination of
these adjustments.
Enterprise 2 in Table 11 is the type of firm that some analysts see as
making a minimal contribution to the economy because eighty percent
of costs are for imported inputs and value added is small. Even for this
firm devaluation increases profits or allows for a lower price to the buyer
without a decrease in profits. The increase in profits is smaller than for
Enterprise 1 because the gain from devaluation is only on expenditures
in rupiah, and the proportion of rupiah expenditures is less in the second
firm. The value added for a billion rupiah worth of sales in the second
firm is one quarter of that generated by the first firm. But value added
would be identical if the second firm had sales four times those of the first
firm. So there is no reason to reject firms with limited value added per
unit of output nor to assume that they will not be helped by devaluation.
How to devalue when the exchange rate is market-determined? Lowering the
value of the rupiah does not require abandoning a market-determined
exchange rate. Bank Indonesia, like other central banks, can achieve a
lot with standard central bank tools. Statements by the bank, sometimes
called jaw-boning, can have an effect. Traditionally BI has always
regretted any decline in the value of the rupiah and has promised to
strengthen it. If it welcomed weakening and promised to do its best to
reverse strengthening it would change the outlook of investors, reduce
the short-term inflow of funds and thus weaken the rupiah. It can also
buy up foreign exchange with rupiah, which will further weaken the
currency; or put a small tax on funds that are in the country for less than
a year or eighteen months.
The Economic Choices
Facing The Next President
90
Table 11. The Impact of Devaluation on the Profitability of Exporters
Source: Papanek 2014s
Any significant intervention that weakens the rupiah will, of course,
result in a higher rate of inflation. Since Bank Indonesia is principally
concerned with controlling inflation it will remain reluctant to see much
depreciation of the rupiah. That is why it is important that the Governor
of Bank Indonesia understands that the central task of economic
management in Indonesia is to provide productive employment to twenty
million surplus workers. That can only be achieved if Indonesia again
becomes competitive in exports of labor-intensive manufactured goods.
And that, in turn, can be achieved only if exchange rate management is
designed to keep the dollar, yen and euro wage of production workers
at a level that is not too high relative to wages in Bangladesh to enable
Indonesia to compete in labor-intensive exports.
Why compete with low wage countries for the market for
shoes, garments, toys?
Why should Indonesia not concentrate on the production of car
and motorcycle parts, machinery and petro-chemicals and leave the
manufacture of less sophisticated exports to countries like Bangladesh,
91
The Economic Choices
Facing The Next President
Cambodia, Myanmar and Vietnam? Indonesia should indeed compete in
these technologically more complex industries. Indonesia may become a
low-cost producer in industries like fertilizer and some chemicals that use
oil or natural gas as the major input. For automobile parts Indonesia’s large
market is a major advantage. The industry is doing well and has potential.
But a strategy that emphasizes technology-intensive goods and neglects
labor-intensive ones has problems:
i.
These industries require few workers so they will not provide
jobs to the millions who need them.
ii. They do require many engineers but Indonesian engineers are
two to four times as expensive as Indian engineers. Only some
firms will be able to compete internationally with that handicap.
iii. Above all, they will not provide productive, stable jobs for the
21 million workers who have not completed primary school
and another fifty million who have only completed primary or
lower secondary school. Of the six million additional workers
employed in manufacturing for export, five million would be
employed in the labor-intensive, lower technology industries.
At least ten million of the seventy million less educated workers are
surplus workers. If Indonesia does not greatly expand the shoe, textile,
garment, toy, electrical and electronic industries these ten million or more
surplus workers will continue making only a very small contribution to
national income and will continue to earn a low and uncertain income.
They are an integral part of the policy package to achieve double digit
growth and generate 21 million good jobs: employed in labor-intensive
export industries, they would account for half the projected increase in
national income.
They can find good, productive jobs only if Indonesia becomes more
competitive in labor-intensive exports. A weaker rupiah is part of that
and so is a more productive labor force. But reducing labor costs is only
a part of the needed cost reduction. Others are addressed below and in
other chapters.
The Economic Choices
Facing The Next President
92
A compensated devaluation: Stabilizing the cost of living for
workers, while reducing imports and increasing domestic
production.
The major reason Bank Indonesia and other policy makers resist
devaluation is that a weaker rupiah increases the rupiah price of imports
and exports and therefore raises the rate of inflation and the cost of
living. This is of special concern because it increases the cost of imported
goods consumed by workers and other lower-income families.
Their purchase of imported goods is a much smaller proportion of total
expenditures than is the case for wealthier families. By far the greatest
impact on the budgets of the poorest forty percent will be through their
purchases of food that is imported or exported and that make up a significant
share of total consumption: for example, rice, wheat (mostly for noodles),
soybeans, onions, garlic and chilies, meat, milk, and sugar. These families
also purchase cloth and clothing and a small part of their cost is imported
cotton. An increase in the cost of imported food will reduce the purchasing
power of workers’ wages and their economic well-being.
In 2008 food was about sixty percent of consumption for the urban poorest
forty percent and about 67 percent for the rural poor. This percentage
has declined over time. Tobacco is included and is a large item. So is
processed food, which includes a large labor component. Taking account
of these and of other items which are domestically produced and not
traded in the international market (most vegetables, eggs) one can
conclude that less than fifty percent of their consumption basket would
be affected by devaluation. Rice was the largest item, accounting for
nine percent of spending for the second quintile of the population and
urban households and twenty percent for the poorest quintile and rural
households. Rice is also critical psychologically, and thus an increase in
the rice price has a big impact even for those for whom it is only nine
percent of total expenditure.
Stabilizing the prices of staple foods of importance for the poor. Fortunately,
stabilizing the price of rice is easier than for other commodities. For
some time now the price of rice in Indonesia has been higher than the
93
The Economic Choices
Facing The Next President
world market price. This has been achieved by controlling and taxing
imports. Only BULOG, the government procurement, marketing and
price stabilization agency, is allowed to import most rice, and a tariff
has been imposed on imported rice. A devaluation is like a tariff or a
quantitative restriction: a ten percent tariff, if effective, increases the
price by ten percent, as does a ten percent devaluation. Reducing imports
also raises the price.
If the tariff is fifteen percent at the time of devaluation, then as long
as the devaluation does not exceed fifteen percent then the price can be
maintained without change by reducing the tariff by the amount of the
devaluation. If the devaluation is ten percent then reducing the tariff
from fifteen to five percent will ensure that the price does not change
much. What if the devaluation is twenty percent? Abolishing the fifteen
percent tariff will balance most of the price rise that would otherwise
occur. If the price of rice increases by the remaining five percent that by
itself would be a small problem: with rice ten to twenty percent at most
of consumer expenditures it would mean only a one percent increase in
the cost of living.
But a devaluation will also affect the prices of wheat, soybeans, milk
products, imported vegetables and so on. For a few of these goods the
Indonesian price tends to be above the world price because imports
are tightly controlled, for example chilies, garlic and onions. Removing
controls can stabilize the price. But there are more imports where the
Indonesian prices and the world prices are closely linked and there is
no simple solution to stabilize the price. For a few products it is possible
to distinguish foods eaten primarily by lower income groups from foods
eaten primarily by higher income groups: different qualities of rice, cuts
of meat, qualities of chili and wet cassava versus cassava chips. In these
cases government can subsidize the price of the imports of foods that
are primarily eaten by lower income groups and let prices rise for those
primarily consumed by the rich.
For foods like wheat it is not possible to link qualities to the income of the
consumer. Wheat is not consumed directly but is primarily an input into
noodles. For these foods there are three alternatives:
The Economic Choices
Facing The Next President
i.
94
Distribute subsidized food to poorer groups through such
programs as Raskin designed to help the poor. The record of
existing programs is mixed: a substantial share of the benefits of
subsidized food has gone to the non-poor and some of the poor
have not benefitted from the subsidy. Recently a huge effort was
made to register 100 million of the poorest individuals, and to
update the register periodically. Targeting should be better as a
result, but we do not as yet know how much better.
ii. Provide a universal subsidy that includes the non-poor in order
to be sure of benefiting the poor; or
iii. Conversely, allow the price of such goods as wheat to rise and
accept that the poor will also feel the impact of inflation.
The impact of inflation on the poor appears to be limited and short-lived. If
government can stabilize the price of rice and a few vegetables by reducing
tariffs and quantitative restrictions and of other goods by subsidies for
lower quality imports, we estimate that devaluation would increase the
price of one quarter of the consumption basket of the poorest forty
percent. A fifteen percent devaluation would then increase the cost of
living by less than four percent in the first year, or two percent in the
first six months and a further two percent in the second six months. That
increase in the CPI would reduce the real wage of agricultural workers
by less than 0.5 percent in the first year (see Papanek, M. Setiawan &
R. Purngunawan). A one-time increase in inflation would result in a
temporary decline in real wages for one year, which would be so small
that it would hardly be noticed.
In short, it is possible to carry out a compensated devaluation, one in which the cost
of living for workers rises very little as the result of devaluation. Government can
keep the price of rice from increasing by lowering or eliminating the tariff and can
subsidize some other imports primarily consumed by the poor.
The benefits of greater demand for labor can swamp the costs of inflation. As a
result of the policy changes of which devaluation is part, there would
be a major increase in the demand for unskilled and semi-skilled labor.
95
The Economic Choices
Facing The Next President
The same wage determination model which provides us with estimates
of the impact of inflation also provides evidence that every ten percent
increase in labor demand results in a roughly five percent increase in real
wages. An increase in demand from roughly one million to four million
jobs a year, expected from the policy package of which devaluation is a
part, would result in increased wages which will swamp the very small
decline as a result of accelerated inflation. Devaluation is an integral
part of the policy package to increase the competitiveness of Indonesia’s
manufactured exports and can therefore be justified despite its effect on
inflation.
The benefits of increasing the number of family members
with good, regular jobs.
It has already been mentioned that the most effective means of increasing
incomes for low income groups is to provide good, formal sector jobs
with a regular incomes to people previously in low-productivity, informal
sector occupations with low and irregular incomes. Industrial workers
on average receive a wage that is eighty percent above the average for
agricultural workers when they have 22.5 days of work a month. In some
months the gap is greater. Some other informal sector workers have
incomes below those of agricultural laborers. If one member of the
family manages to move from agriculture or other informal sector work
to a manufacturing job, the income of the family immediately increases
and is more stable. For a family of four members the increase in income
would be of the order of twenty percent per person.
If a second member of the family were to be hired by an industrial or
a construction firm, a wholesaler, a bank, or a cellphone operator, the
income of the family would increase again. The risk of being without
income in a particular week or month would be drastically reduced. If the
next president adopts the program to create four million good, productive
jobs for workers previously in the surplus category, the result would be to
increase the incomes of four million families without increasing the wage
rate. As wages rise in other countries Indonesia’s competitive position
would improve together with workers’ incomes.
The Economic Choices
Facing The Next President
96
Reducing the cost of labor regulation: Current severance pay
rules are lose-lose, and a win-win, voluntary system would
increase benefits to workers and reduce costs to employers.
There are numerous labor regulations which are of real benefit to
workers, especially in reducing the risks of injury. There are others that
seem to do little good but are mostly harmless. The present severance
pay arrangement is considered by workers to provide major benefits and
by employers to have major costs. In reality it is a lose-lose proposition:
workers gain limited benefits, employers incur major costs. But all
attempts to change it have failed.
The costs for workers and employers. In 2003 the rate of mandatory severance
pay was raised. Permanent workers, if dismissed, are to receive more
than twenty percent of the annual wage for every year worked. This,
like other labor regulations, is considered more onerous than those of
all major competitor countries. If the average worker in a firm has
worked there for ten years, then dismissing them costs 2.2 times their
annual wage. That would lead to huge losses if the factory temporarily
shuts down during a period of reduced demand. The danger is that the
need for severance pay or for paying idle workers may push firms into
bankruptcy or lead employers to abandon idle factories. The high cost
of severance also provides a strong incentive to minimize the number
of workers by substituting machines for labor.
Limited real benefits for workers. But in fact severance pay has provided
few real benefits to workers. According to a World Bank study (2010)
only eight percent of those entitled to severance actually receive the amount to which
they are entitled, another 25 percent receive partial benefits and an astonishing 67
percent receive none of the severance pay to which they are entitled. Since
these numbers apply to workers that are actually entitled to severance
pay, fewer than ten percent of the labor force benefits at all. That is
because many owners of unprofitable firms who plan to dismiss their
workers borrow as much as they can, sell their inventory and then
abandon the plant and disappear. Another trick used by employers is
to hire a few permanent workers but staff the factory with temporary
workers whose contracts expire before they have worked for three
97
The Economic Choices
Facing The Next President
years. New contract workers are hired again for less than three years.
With few permanent workers there are few entitled to severance pay.
Still others make sure that their enterprise does not increase in size
to the point at which it would be subject to various labor regulations.
Successful resistance to ending the system. But because the severance rules
promise substantial benefits to organized workers they understandably
will not give them up unless they are assured of something better.
Attempts to impose changes have been met by strikes, demonstrations,
political pressure and occasional violence leading to the hasty
withdrawal of these proposals by their government sponsors. Even if
the benefits are more theoretical than real, workers do not want to
give up their legal right to severance pay without winning something
in return. The real costs for some employers. While loss-making firms mostly avoid
their obligations to pay severance, large, successful firms must comply.
If they are export-oriented and need to maintain quality standards,
they will prefer permanent workers whose competence gradually
improves over time. The regulations impose a substantial cost even if
they never dismiss any workers. The firm is required to add severance
pay obligations as a contingent liability on its balance sheet. The
amount is equal to 22 percent of the wage bill every year that a
worker is employed. If most workers stay with the firm an average
of ten years this means that more than double the annual wage bill
becomes a contingent liability. This is a huge sum to carry on the
firm’s balance sheet and may well exceed the assets of the firm. Such
large contingent liabilities make it difficult for the firm to borrow.
Severance pay therefore is a deterrent to investment, and especially in
labor-intensive industries.
A possible win-win solution: a voluntary shift to an unemployment insurance system.
Many good ideas for dealing with the problem have been proposed but
none have been implemented because of union resistance. A reform which
is applied only in firms or industries where both workers and employers
agree may take a while to implement, but it may have a better chance of
implementation than one that is strongly resisted by the workers.
The Economic Choices
Facing The Next President
98
A successful alternative would be:
• voluntary and
• flexible in the sense that it could be adopted by some firms and industries
but not others
Imposing change on all firms and workers at the same time may not be
politically feasible. Instead, reform should begin in those large firms or
industries in which a majority of employers, unions and workers agree
to shift from severance pay mandated by law to a system of guaranteed
unemployment insurance. The amended law would need to specify that if
a majority of firms, unions and workers in an industry are in agreement
then the new system will come into effect.
Employers would pay a smaller percent of their wage bill into an
unemployment insurance fund than the 22 percent now required to be
set aside under severance pay rules. The exact amount would be the
subject of negotiation among workers, unions and employers. A ten
percent contribution would roughly double what employers now actually
pay but would be slightly less than half of their contingent liability now.
It would be half of what workers are now entitled to, but double what
they actually get on average. Both sides would be better off.
A government subsidy is justified, since society has an interest in ending
the current severance pay system to increase growth and job creation.
If the subsidy is large in the first year and declines in every subsequent
year it would encourage unions and employers to be the pioneers of the
new system.
Only when employers have paid in enough to cover the cost of severance
under the new system would they no longer have to pay severance
themselves. Such a provision is essential because otherwise firms and
workers will join the new program just before the firm goes bankrupt and
dump its responsibility for severance pay on the insurance fund.
Major advantages of this approach:
•
Employers pay less than they are now required to pay and to set aside as a
liability; workers get much more than they actually receive now.
99
The Economic Choices
Facing The Next President
•
Indonesia’s manufacturing sector is better able to compete in the world
market with the burden of severance pay reduced.
•
There is no longer any advantage to using temporary, contract labor,
since employers pay the same percent of the wage bill for these
workers as for “permanent” workers. A stable labor force results
in higher labor productivity and higher quality standards as
employers use permanent workers and gain from the experience
and skills that the workers acquire over time.
•
The labor market becomes more flexible as the amount of severance
pay no longer depends on workers staying with the same firm,
once most firms are part of the new system. The employers’
contribution is paid from the moment the worker is hired.
Workers lose no benefits if they move from one firm to another.
Providing incentives for labor-intensive export industries
Competing in the world market is a tough business. Governments have
historically provided a wide range of subsidies to help firms from their
country succeed. Open subsidies are no longer allowed under WTO and
other rules. But government can perform its traditional functions in ways
that support exporters.
The most effective incentives for Indonesia are those that encourage the
creation of productive jobs for surplus workers. Helping surplus workers
find productive employment is almost pure gain for the economy. They
currently add little or nothing to national income. So if it requires a small
subsidy to encourage employers to use them in productive work, this
can be justified on purely economic grounds. If the subsidy helps a new
enterprise to break into the export market, then it is of double benefit. 1. Export Processing Zones where free or low cost government services
make up for lower wages.
The national government should establish Export Processing Zones
in areas where wages are currently low because of widespread
poverty, such as in Central Java, parts of East Java, Lampung and
elsewhere. The EPZ would provide infrastructure and land for firms
The Economic Choices
Facing The Next President
100
that export at least sixty percent of their output. These zones would
have minimum wages that are below those of neighboring districts by
a specified percentage, thus lowering the cost of labor to employers. The national government would provide incentives for workers to
accept lower wages:
i.
The government would provide low cost housing for workers
and their families. Provision of low cost housing is a recognized
function of governments around the world. By providing
subsidized housing close to the EPZ, government would help
the lower wage go further.
ii. Government could also provide free health and education
through high schools for workers and their families.
iii. For workers who live away from the Export Processing Zone
and would need to spend substantial sums of money on
transportation, the government could provide transportation
vouchers to cover half or more of the cost of bus fares to and
from the EPZ.
iv. Government-subsidized food in the canteens of the EPZ and in
its schools.
These steps would lower the cost of labor to enterprises setting up
in the Export Processing Zone. The government would only be
performing functions which governments all over the world carry
out so they should be allowable under existing treaty commitments.
2. A Drawback System for taxes and tariffs that provides an incentive
for domestic production and for export. Indonesia at one time had a
drawback system which worked well and provided a small incentive
for both exporters and their suppliers. In the traditional drawback
system, the exporter who imports goods used in the production of
exports pays tariffs, taxes and fees up-front and collects information
on what has been paid. This documentation is then submitted to a
government official once the export has taken place for which the
various imports have been used. The official verifies that these are
legitimate imports; that they in fact took place; and that they were
101
The Economic Choices
Facing The Next President
used to produce the export. If everything checks out the official
authorizes the refund of taxes, tariffs, and fees that the exporter has
paid. It usually took a year between the time that the exporter incurred
the expense and the time at which he or she was reimbursed. How
long it took depended on the official who also determined how much
of the expenses were legitimate. Reports suggest that fifty percent
of the drawback was considered an appropriate fee to expedite
processing. On average then the exporter had paid interest for a
year and an expediting fee. The net repayment was thus something
like forty percent of the total duty paid.
The improved system differed in the following ways:
i.
The exporter was entitled to the drawback as soon as he or she
could present a Letter of Credit showing he or she had been
paid by a foreign buyer. There was no delay.
ii. There was no bribe. The drawback was paid by a bank, not a
government office. If a bribe was asked for all the exporter had
to do was use a different bank.
iii. The drawback was based on a standard coefficient worked out
in advance. To illustrate with hypothetical numbers: producers
of dress shirts could be assumed to have imported cloth worth
twenty percent of the value of the shirt plus imports of ten
percent for buttons. Total imports needed for the production of
shirts was therefore thirty percent. The tariff on imports was
twenty percent. The exporter was therefore assumed to have
spent six percent of the value of the shirt on tariffs on imported
goods. Exporters were therefore entitled to a drawback of six
percent of the value of the shirts exported. There was no need
to prove that they had actually imported anything and had paid
duty of a certain amount.
The expedited process and the small incentive to source in Indonesia
were helpful to the exporter and to potential domestic suppliers.
The Economic Choices
Facing The Next President
102
Summing up:
The key factor in achieving double digit growth is the existence in
Indonesia of an estimated twenty million “surplus” workers. They are
surplus in that their work contributes little to national income although
they may be working long hours. They work even though they are not
needed because poor people cannot afford to be unemployed. They
need work and income to survive. Because they cannot find productive
employment they join ‘’work -and income-sharing” activities where there
is always room for one more worker: on tiny family plots where they
share in the produce; as street peddlers, shoe shiners, paper scavengers,
or extra sales people in family shops.
If these twenty million surplus workers could find productive employment,
they would raise the per capita income in Indonesia from Rp. 39 million
in 2013 to Rp. 53 million in 2019 and their own incomes would double. A major obstacle to their productive employment is wage rates in Indonesia
that are two to three times higher than those in other Asian countries
competing for a share of China’s market in labor-intensive exports. Since
our aim is to increase the incomes of Indonesian workers, the gap between
Indonesian and competitors’ wages cannot be closed by reducing the real
wage, that is, the purchasing power of Indonesian workers. Policies that reduce the cost of labor to Indonesian businesses in order to
increase their competitiveness without reducing the incomes of workers
include:
i.
Increasing the productivity of Indonesian workers by using
government generated funds to support training and general
education by industry. Indonesian labor productivity is already
higher than that of workers in Bangladesh where factories are often
shut by political strikes.
ii. Stabilizing the wage rate in Indonesia while it rises in other countries
to reduce the gap between Indonesian wages and wages elsewhere.
Stabilizing the Indonesian wage rate may be possible if workers’
incomes increase as four million workers a year move from the surplus
category to good, productive jobs with almost double the income.
103
The Economic Choices
Facing The Next President
iii. A powerful policy for reducing the gap in labor costs is devaluation
of the exchange rate sufficiently to assure that the wage in Central
Java does not exceed that in Bangladesh by more than fifty or sixty
percent. Currently this would require an exchange rate between Rp.
12,500 to Rp. 13,300 to the US dollar. Such a devaluation would
increase the cost of imports and reduce the price of exports, thereby
reducing imports and stimulating exports while increasing domestic
production, jobs and incomes.
Devaluation also accelerates inflation. The poorest forty percent of
the population must be compensated so that the higher cost of living
would not reduce their real incomes. The prices of at least half of
the foods consumed by the poorest forty percent could be stabilized
by reducing the tariff on rice imports and by providing subsidies for
the foods that are primarily eaten by lower income groups.
With this compensation, a one-time fifteen percent devaluation
would raise the cost of living for workers by about four percent,
reducing their purchasing power by less than 0.5 percent for one
year. But the increased demand for labor as the consequence of
greater competitiveness for Indonesian exports would increase the
real wage by more than this. The impact of inflation would be
overwhelmed by increased wages due to greater demand for labor.
iv. Increase the competitiveness of Indonesian labor-intensive exports
through the establishment of Export Processing Zones in low wage
areas. EPZs would be permitted to pay minimum wages below those
of surrounding districts, compensated by subsidized government
services for workers which governments can legitimately provide:
• Low cost housing
• Free schooling through high school
• Free health services
• Transportation vouchers for workers living away from the EPZ.
• Subsidized food in EPZ canteens for workers and for their
children in school.
The Economic Choices
Facing The Next President
v.
104
Revive an earlier drawback system that provided a small incentive for
exporters and for firms supplying their inputs. The central feature
was that the magnitude of the drawback was fixed in advance for
each good exported. There was no need to prove that inputs had
actually been imported or that tariffs had been paid.
vi. A gradual, voluntary shift from the present severance pay system,
which is costly to compliant employers and provides few benefits
for affected workers, would reduce employers’ costs and increase
workers’ actual benefits.
105
The Economic Choices
Facing The Next President
Chapter 6.
Improving Infrastructure and Reducing
its Cost is the other Critical Component
of Competitiveness
Complaints about the inadequacy of infrastructure and its high cost
have been part of every analysis of Indonesian economic problems going
back twenty years or more. Some progress has been made as shown by
the improvement in the logistics score in Table 7. But the complaints
have persisted and quite rightly so. Significantly reducing the cost
of infrastructure would greatly increase Indonesia’s competitiveness.
Some steps to deal with the problem have been recommended for years
and there is not much point in repeating them here. The emphasis in
this chapter will be on changes in policies or programs that have not
yet been proposed or have received less emphasis.
Lowering the cost of infrastructure is critical to Indonesia’s ability
to compete. For the most labor-intensive industries the cost of labor
can be one-third of total production costs. Total infrastructure costs—
electricity and transport primarily—are usually the other big item.
Labor costs can be reduced without reducing the purchasing power of
workers, but only to a limited extent. Reducing infrastructure costs is the
principal method for reducing total costs and for increasing competitiveness.
Without more public investment
infrastructure will remain a dream.
improvements
to
The key problem is that the national government spends far too
little money on infrastructure development. This is well known but
the extent of the problem is sometimes not appreciated. Spending
by the national government to build roads or railway track, expand
airports or build new power stations is estimated in Chapter 7 to be
less than one percent of national income. Based on the experience of
The Economic Choices
Facing The Next President
106
other countries, the minimum amount needed is five percent. Given
Indonesia’s large backlog as a result of years of underfunding, this is
undoubtedly an absolute minimum, and we have recommended that
spending reach 6.5 percent by 2019.
The increase in expenditure that is needed is indeed massive. From less
than one percent of GDP in 2014 to 6.5 percent in 2019 is an increase
of Rp 840 trillion, equivalent to about US$70 billion. Yet this amount
should be considered the minimum increase because of the need to
compensate for many years of underfunding.
Using private investment to compensate for government
shortfalls.
Even if the national government carries out tax reform and ends the
fuel subsidy and thus gains control of large amounts of funds it will
take time before it can efficiently spend them on infrastructure. The
executing capacity of relevant government agencies is limited. Private
investment can supplement the government both in raising funds and
in implementing projects. But obviously private investors will do this
only if these investments generate returns high enough to be attractive
compared to alternative investments. At one time toll roads were quite
profitable and private investors were willing to incur the large initial
costs needed to build them.
A large share of infrastructure can potentially be privately built
because it can produce a market rate of return for the investor. Power
stations, power transmission, ports, airports, mobile phone systems
and courier services are among the infrastructure facilities that could
yield a return, and that can be and have been carried out by private
investors.
But little private investment and ownership of infrastructure facilities
has actually taken place because:
i.
Most infrastructure investments provide public services that
should be available to most or all of the public even if some
areas or groups cannot pay market prices. For example,
107
The Economic Choices
Facing The Next President
most governments have wanted to extend the electric grid to
sparsely populated areas or places where most people are poor
and cannot afford to pay the full cost of providing electricity
to them.
ii. Most infrastructure investments also have elements of natural
monopoly. For example it would be a waste of resources to
string two competing high voltage lines from a hydro-power
source to major towns. It would double the investment cost
for no gain in efficiency. Private monopolies, however, are
undesirable since they can charge exorbitant prices to earn
huge profits.
iii. In Indonesia, as in most countries, politics or law mandate
that some infrastructure services be publicly owned and there
are especially strict limits on foreign ownership. For example,
the electric grid in Indonesia is by law a virtual monopoly of
the national electric company, PLN.
Private-public partnerships were at one time advertised as the ideal
way to build a lot of infrastructure while dealing with the public
service and natural monopoly elements and assuring the required
public ownership. But in fact such partnerships have proved difficult
to manage and have not played a major role in getting adequate
investment for infrastructure development. A principal issue has
always been the rate to be charged to users of the facility. Extending Indonesia’s clever solution, “production-sharing,”
to increase investment and efficiency in infrastructure.
Indonesia devised the production-sharing contract in the oil industry
to attract private investment and technology. It was a clever way to take
advantage of the technical competence and managerial and financial
resources of private firms without giving up ownership or control
of pricing. It should be possible to devise equally clever ways to get
what is needed from private domestic or foreign firms while leaving in
Indonesian public hands decisions which law or politics dictate should
not be left with private or foreign firms.
The Economic Choices
Facing The Next President
108
Enlisting the private sector in a major way in infrastructure development
makes sense only if government policy recognizes the following:
1. Improving infrastructure and reducing its cost will bring huge
benefits to the economy and to Indonesian workers. The
two major reasons why Indonesia is a high cost economy are
infrastructure and labor costs. Labor costs cannot be reduced
much without hurting workers, so reducing infrastructure costs is
crucial for competitiveness.
2. It will be difficult to increase government expenditure on
infrastructure as quickly as desirable and it will be equally
difficult to increase government’s ability to execute a much
larger investment program. Using private firms to increase both
funding and execution is important to deal with infrastructure problems.
3. Involving private firms in infrastructure development may
have political costs, especially if they are foreign firms. But
there will be large political as well as economic benefits if better
infrastructure contributes to higher growth and the creation of millions
of good jobs.
There may be political benefits to be derived from anti-private enterprise
and especially anti-foreign-private- enterprise rhetoric and action.
But both political and economic benefits can be obtained by enlisting
private firms in accelerating the development of infrastructure.
The production-sharing approach could work for airports, ports, gas pipelines and
power-stations. It might also work, but less well, for power distribution.
The facilities would remain in government ownership or would
continue to be owned by State Owned Enterprises (SOEs) like PLN,
the electric company. Therefore there would be no legal or political
problem with private ownership of utilities. The private firm would
finance, build and operate the enterprise for a fixed period of time. It
would be entitled to a share of the revenue from the facility sufficient to
pay for the cost of investment and a reasonable profit, taking account
of the risks the investor incurs.
109
The Economic Choices
Facing The Next President
There are several risks: [i] exchange rate risk, since a substantial share
of the investment is usually in foreign exchange but all of the income
is in rupiah; [ii] the risk that the income will be less than forecast;
[iii] and the risk that a new government will change the terms of
the contract. The higher the share of the income that goes to the
investor the shorter the payback period and the smaller the risk. If
the break-even point—the time at which the investor has recouped the
investment—is in the distant future then all risks are more difficult to
forecast and the investor will need a higher return to compensate for
the greater risk. The government can lower the risk and thereby reduce
the cost of the facility by increasing the investors’ share of income but
shortening the period for which the investor receives income.
Of course, private investors will be interested only if the income from
the investment is sufficient to cover operating costs and interest costs
plus profit. This is not the case with electricity: currently the cost of
generating additional electricity and distributing it to the consumer
is higher than the price paid by many consumers. A subsidy from the
government covers the difference. This is not an attractive opportunity
for private investors unless the subsidy is absolutely guaranteed. This
issue is addressed further below. If the rate of return issue is addressed
then private investors could cover both the costs of investment and
take care of the construction of a substantial part of the infrastructure,
leaving the government to concentrate on those parts for which there
is no direct rate of return.
Competition to promote efficiency. Private ownership is not a magic formula
for assuring efficiency. Private monopolies are usually no more efficient
than public monopolies. What makes for efficiency is competition,
whether firms are private or public. If you fear being driven out of
business by your competitors (private firms) or losing your job (public
firms) because you operate an inefficient, money-losing firm, then you
will make an effort to increase efficiency.
Production-sharing contracts in the petroleum industry assure a
degree of efficiency by competitive bidding for production areas. The
The Economic Choices
Facing The Next President
110
same purpose can be achieved by competitive bidding for a particular
infrastructure project. For instance, all respectable firms in the field of
electric power production can be invited to bid on a particular plant.
The lowest cost bidder would usually be awarded the contract.
The government may want to favor Indonesian firms over foreign ones
in the execution of infrastructure projects. The best way of doing that
is to award Indonesian bidders a bonus to strengthen the domestic
industry. A ten percent bonus would mean that a domestic firm will
be awarded the contract as long as its bid is no more than ten percent
above the lowest foreign bid.
A ten percent margin for domestic firms would put a known and
transparent price on the community’s preference to have infrastructure
assets built and operated by nationals. At the same time it puts a limit
on the costs the community is willing to bear to have national rather
than foreign firms involved. It is far better than reserving parts of
infrastructure for domestic firms; that implies that Indonesia is willing
to pay double or triple for this infrastructure just to have it built and
managed by an Indonesian firm.
Priority for infrastructure investment for industrial clusters
outside Jakarta where land and labor are cheaper but
infrastructure is poor.
The Jakarta area, with high cost land and labor, will continue to attract
investment in technology- and capital-intensive industries and in those
producing for a protected domestic market. But it will find it difficult to
expand labor-intensive exports with wages that are close to China’s and
three times those in Bangladesh. Labor-intensive export industries, like shoes
and garments, are beginning to locate new plants in areas where labor and
land are less expensive. Areas with large pools of lower-cost labor and land
and the beginnings of needed infrastructure include the Semarang area of
Central Java. East Java’s costs are between those of Jakarta and Semarang.
Infrastructure, however, is poorly developed in both regions compared to
the Jakarta area. Semarang has the lowest production costs and the highest
infrastructure costs compared to Jakarta and Surabaya.
111
The Economic Choices
Facing The Next President
For Indonesia to compete in the world market, the areas that have attracted
new investment and especially those producing for export, should be given priority
for infrastructure investment. A “pioneer area infrastructure fund” could be set
up with additional funds that become available during the first year of reduced
energy subsidies to build the roads, to improve ports and airports in any area that
has attracted significant investment in manufacturing, with special attention to
manufacturing for export. Private investors in manufacturing should be
assured that if they invest in a new area and if they produce for export
that the infrastructure to support their investment will be quickly put
into place. Without a credible promise that the infrastructure will
quickly improve in areas where production costs are lower, investors
may decide that it is safer to invest in other countries.
Incentives to subnational units – The power of “matching
grants”
With the advent of decentralization, which areas become centers of
manufacturing for export depends in substantial part on the actions of
the governor, the district head (bupati) and the subdistrict head (camat)
in the area. Subnational government units control considerably more
resources and have more powers than they did before 2001. How they
use these resources and powers will broadly determine Indonesia’s
competitive position. If they use their powers to extract as much
income as possible from businesses during their time in office, and
spend their resources primarily on offices, cars, travel and staff, they
will undermine economic activities in their areas. It is even worse, of
course, if they are corrupt. The number of corruption cases pending
against sub-national government figures suggests that this is rather
widespread problem.
Conversely, sub-national officials can encourage economic activity by
using funds provided by the national government to invest in local
roads, better health care and education and local transportation.
They can also facilitate permit applications and approvals and can
work to moderate increases in the minimum wage so that labor in the
area is not priced out of the international market. The availability
of a “Pioneer Areas Infrastructure Fund” can provide an additional
The Economic Choices
Facing The Next President
112
incentive for local government officials to adopt policies and programs
that attract investment to their area, rather than adopting policies that
discourage further investment.
A special fund for infrastructure development in areas that have
attracted the most private investment therefore achieves two purposes:
i.
it develops infrastructure in areas where such improvements
can yield the highest return; and
ii. it provides an incentive for subnational government officials to
adopt policies and programs that will encourage investment.
The special infrastructure fund should give priority to investment in
export industries since they face the toughest competitive environment.
Other uses of “Matching Grants.” The infrastructure fund is an example
of a matching grant. In any decentralized system, the national
government can support and enhance positive policies and programs
of subnational units by a system of matching grants. For instance, if the
local government devotes a certain proportion of its expenditures to
health and education, the national government will provide additional
“matching” funds for these two activities. The greater the proportion
of local government funds going to these social sectors, the greater the
funds provided by the national government. The national government
can also provide matching funds for investment in roads and other
infrastructure facilities.
At present, the national government of Indonesia does not have
sufficient discretionary funds to use for a matching fund program. It
therefore cannot do much to address the problem of misallocation of
resources by some subnational units. In Chapter 7 we discuss measures
to increase the resources at the disposal of the national government.
Once it has additional discretionary funds, spending them on a
matching fund program to mobilize the much greater resources in the
hands of subnational government could make a major difference in
Indonesia’s ability to compete in the world market.
113
The Economic Choices
Facing The Next President
Private firms can also help overcome limited government
implementation capacity
Government not only lacks funds, it also has limited capacity to
build infrastructure, especially in areas distant from Jakarta and other
major population centers. Peru has allowed private firms to discharge
their tax obligations by building infrastructure that does not generate
a return, such as roads without tolls. A small subsidy can make it
attractive to participate: for instance the firm can write off Rp 500
billion for building a road costing Rp 475 billion. Competitive bidding
could assure that the government does not overpay.
This approach will work only if there is effective quality control. Private
expenditures need to be carefully verified to assure that the project
meets promised quality standards. To reduce the chances of bribery
and collusion between inspectors and private executors of the project
some established international quality control firms need to be used
initially. These firms’ long term success depends on their ability to
maintain their reputations and therefore their quality control work can
usually be relied on.
Since private firms finance the project initially and implement it as
well this approach can greatly increase the infrastructure that can be
built in any one year.
Lower transport costs by providing low cost fuel to trucks
and buses but not to private vehicles: Converting commercial
vehicles to run on local natural gas at no initial cost to the
owner.
This program can be carried out only where natural gas is currently
available. But it can be greatly expanded if additional natural gas
becomes available as pipelines are built. A major objective is to
continue to provide low cost fuel to buses, trucks and taxis while ending
the subsidy to private cars. The system described below has been fully
functional in Peru since 2005.
The Economic Choices
Facing The Next President
114
Commercial vehicles (buses, trucks and taxis) are converted to natural
gas at no cost to the operator. Natural gas is a perfect substitute
for gasoline but is much cheaper per BTU. The price of the gas
Indonesia now exports is low to take account of the cost of getting
it to the consumer. The heavy cost Indonesia bears includes the cost
of converting the gas to a liquid and then transporting the liquid to
the consuming country and reconverting it to a gas. Conversion and
transportation require high pressure and frigid temperatures and are
therefore expensive. Using the gas in a low pressure system saves much
of this expense. It also saves the expense of importing gasoline. In
short, the commercial fleet would operate on a low-cost domestic
resource instead of a high cost imported one.
The cost of converting the commercial fleet from gasoline to natural
gas can be fully covered by commercial loans with repayment
automatically added as a surcharge on each purchase of fuel. Since
repayment is assured the cost of borrowing to fund the conversion can
carry a low rate of interest. Conversion of gasoline engines is simple
and inexpensive. The computer technology for user identification is
available and tested. The standards for service station upgrading are
established. Developing a natural gas delivery system can be done
fairly quickly: twelve to eighteen months from decision to a system in
operation is reasonable.
The system has another great advantage: fuel for the commercial fleet
can be sold at a much lower cost than for private vehicles in order
to keep low fares for bus riders and low charges for goods transport.
The subsidized fuel cannot be smuggled abroad or sold to private
cars. Because it must be kept continuously under pressure, it is easy to
install a computer chip to verify the end user. This allows the market to
be segmented: different prices can be charged to subsidized and nonsubsidized users; subsidized users cannot transfer the gas to non-subsidized users.
This feature will be especially valuable as the subsidy for petroleum
products is decreased. The costs for poor people will not increase if
the commercial fleet is converted to natural gas which is low cost. At
the same time higher income car owners will pay full price.
115
The Economic Choices
Facing The Next President
The current subsidy encourages wasteful use of fuel for low priority
activities and the smuggling of gasoline. It deprives the government of
resources needed for infrastructure development and other important
social needs. There would be a gain in economic efficiency by shifting
some transport to natural gas. Because of a large increase in world
supply the price of natural gas is much lower per BTU than the price
of oil products. Indeed, it might well be that some sources of gas are
priced low enough to require no subsidy to maintain the current low
price of fuel for some users. In addition, natural gas burns much more
cleanly than gasoline, so an environmental benefit would be obtained.
The paradox of electric power: subsidies that increase the
real cost to many manufacturers.
Electric power is essentially supplied by PLN, a State-Owned
Enterprise (SOE) that has a virtual monopoly. As best one can tell the
cost to Indonesian households is substantially lower than in Vietnam
and China. For manufacturers power from the national grid seems
to be less expensive than in these other countries (Tables 12 and
2). Another estimate (Dapice & Cunningham, 2011) finds that on
average electricity is sold for eight US cents per kilowatt-hour (kWh)
but that to produce new electricity costs nine to eleven cents per
kWh. The difference in operating costs is made up by a government
subsidy. But the subsidy is not sufficient to also cover the cost of
investment.
New generating capacity has been increasing more slowly than
demand. The result has been unexpected blackouts and low voltage.
Firms that need to keep operating to meet deadlines for orders—which
includes most exporters of higher value goods—are forced to have
standby generators to use when PLN power is unavailable. Diesel
generation costs thirty cents per kWh (Ibid) or three times the cost
of electricity from PLN. That adds to Indonesian production costs
and reduces Indonesia’s competitiveness. Given the need for standby
diesels and their periodic use it is not clear that electricity in Indonesia
is lower cost than in other countries. It all depends on how frequently
a particular firm needs to use its diesel equipment.
The Economic Choices
Facing The Next President
116
Table 12. Electricity Tariff Comparison from 3 Asian Countries, 2013
Note: Indonesia tariff ranges are estimates as the tariff structure is not based
on block consumption as in other countries
Source: World Bank, n.d.
Demand is rising at a rate which is beyond PLN’s financial and construction
capacity. Supply was estimated to be short of demand by forty percent in
2009 (Ibid) and the shortfall increased further through 2014. Electricity
production will need to roughly double from 2014 to 2019 if GDP is
to increase by the 45.4 percent projected earlier. Electricity demand
117
The Economic Choices
Facing The Next President
increases at about twice the rate of GDP growth so a 45.4 percent increase
in GDP requires a 91 percent increase in power production. Taking account
of the backlog in 2009, the increase in demand from 2009 to 2014 and the
forecast increase to 2019, an increase of at least 150 percent in capacity is
needed over the next five years to meet the demand.
Given the record and the magnitude of the task, increasing power-generating
capacity by at least 150 percent is beyond the financial or executing capacity of PLN.
Production-sharing or other arrangements with private investors will be
essential to enable the system to keep up with the expected increase in
demand and, if possible, to reduce the backlog of unmet demand.
Bringing in private investors on a large scale will be difficult unless prices
cover their costs plus a profit. There is a consensus that poor consumers
should continue to receive subsidies. Dapice and Cunningham estimate
the cost for twenty million families at one billion dollars in 2011 when
total subsidies were six billion dollars. If the remaining subsidy is phased
out over two years it would add less than twenty percent to average PLN
charges per kWh in each year and 1.5 to two percent to total production
costs. Except for factories for which electricity is a major part of total
costs, such as aluminum producers, this will not be a major cost increase.
In the areas where higher prices for PLN power is accompanied by a
more reliable supply—thus eliminating the need for diesel generated
power—the cost will actually be reduced.
Indonesia faces a major increase in the cost of fuel, which will
increase power costs
If current policies are continued then Indonesia faces the prospect of
having to import Liquefied Natural Gas (LNG) to fuel some power stations
at double the cost of current sources of fuel. In the late 1970s Indonesian
exports of oil reached a maximum of seventy billion kg equivalent. By 2013
this was down to fifteen billion kilograms and decreasing. For a period of
time exports of natural gas were increasing more rapidly than exports of
oil were decreasing, and combined exports rose. The largest volume of
combined exports of oil and gas were recorded in 1994. Since then volumes
are down by forty percent. A substantial part of the decline in exports is
The Economic Choices
Facing The Next President
118
due to increased domestic consumption, but it is also due to declining total
production. Oil and gas as a share of GDP has been shrinking at constant
prices at a rate of about one percent a year. Shortages of natural gas have
appeared in both the domestic market and in contracted exports.
Imports of petroleum products and oil have recently increased at more than
five percent a year. Imports of natural gas have been negligible but plans
for the import of LNG are being actively discussed. Its cost will be almost
double the cost of Indonesian gas, because of the cost of compressing
the gas, transporting it under high pressure at low temperatures and then
reconverting it from a very cold liquid into a gas at normal temperature.
Electricity produced using imported gas as fuel will cost about forty percent
more than the electricity produced with local fuel (Ibid).
Expanding domestic fuel supply rather than importing
expensive LNG
Indonesia has substantial reserves of coal and untapped resources of
geothermal power and may have oil and gas resources that could be
developed. Before deciding to raise the costs of all manufacturers by
shifting to LNG imports, it would be wise to adopt policies to increase
the use of these resources.
Coal is inefficiently used at present. Producers are given a quota for
domestic use, primarily for coal-fired power stations. Fixed quotas lead to
games with coal quality, corruption on negotiations, and difficulties with
foreign customers. The same aim could be achieved more efficiently with
export taxes on coal, varying with quality. It gives the producers more
flexibility, enables them to increase revenue, and above all, generates
revenue for the government, while still assuring coal for domestic power
stations. It would be worthwhile to increase the price paid for the coal
by reducing the export duty if that will lead to increased production and
avoid LNG imports. The cost of domestic coal is currently significantly
lower than the cost of imported LNG per kWh produced.
Geothermal costs are potentially even lower. Indonesia’s geothermal
potential is comparatively great. The major obstacles appear to be
bureaucratic. With more than one ministry involved, getting the needed
119
The Economic Choices
Facing The Next President
permits can be a time-consuming and costly process. Since the alternative
is for Indonesia to become dependent on costly imported LNG it would
be worthwhile for the new administration to break through the logjam
and get geothermal projects approved before the huge investment is
committed to a plant for the import of costly LNG.
Perhaps the greatest potential lies in halting and preferably reversing
the decline in oil and gas production. As can be seen from Chart 6, a
major factor in the decline has been that old fields inevitably yield lower
quantities and new fields are not being discovered or developed because
Indonesia is not considered an attractive place for investment. This is a
combination of the physical potential and the legal/financial environment
in Indonesia. When the potential of oil/gas fields offered by Indonesia
was high and the likely cost of developing them was low, international oil
companies might be willing to invest in exploration and development in
return for a twenty percent share of production. If the potential of the oil
blocks offered is limited and the likely cost of developing any find is likely
to be high because they are in deep water, then even a forty percent share
of any resulting output might not be attractive enough.
Chart 14. Oil and Gas Wells Drilled Per Year
Source: SKK Migas
*2014 data is as of 25 April 2014, roughly one third of the year. The two productive
and five dry wells drilled so far were therefore multiplied by three to estimate the total
drilled for the whole year.
The Economic Choices
Facing The Next President
120
From 2005 to 2012 the number of productive wells gradually increased
from 32 to 64 per year, and the number of total wells drilled also increased
roughly by thirty. But in 2013 the number of productive wells and the
total number of wells declined by about twenty wells. In 2014 only seven
wells were drilled in the first four months of the year. At that rate the
number of wells for the whole year would be less than a quarter of what
it had been in 2012. The message is clear: international oil companies no
longer find Indonesia an attractive place to invest.
There are two reasons:
i.
from 2005 to 2011 fuel prices were rising but in 2012 they were
flat and the outlook for gas prices was for further decline;
ii. the Indonesian climate for foreign investors was seen to have
deteriorated and investment was seen as more risky, especially
with respect to raw materials.
Government can counteract the declining investment in oil/gas
exploration and development in various ways. Pertamina can be
allocated additional government funds to increase its drilling activity. But
this requires government funding and would leave less money for other
infrastructure investments. Moreover, much of the current and future
exploration will be in difficult terrain – in deep water for instance—
and the big international oil companies have the most expertise in
this area. Instead of paying these companies 100 percent of the cost
of producing LNG by importing the product, plus a profit and high
shipping costs, why not offer them a higher proportion of the output
under their production-sharing contracts to increase their drilling and
other exploration activities in Indonesia? It is better for Indonesia to
receive sixty or even fifty percent of whatever oil and gas they find and
develop than to receive eighty percent of nothing if they do not invest
much in exploration around Indonesia.
This is not a recommendation to improve the contracts available because
of what the oil companies say about the conditions in Indonesia. Almost
all investors will complain most of the time and demand better terms.
It is what these companies do or rather have done that leads to the
121
The Economic Choices
Facing The Next President
recommendation. Their drilling rigs have gone elsewhere. That is the
best indication that they expect lower returns in Indonesia than other
countries. Bringing the drills back, which is important to increase the
supply of oil and gas to Indonesia, requires a higher rate of return for
exploratory investment in Indonesia. Changing the production sharing
contract is the simplest way to increase the rate of return on investment
in Indonesian oil and gas development and, one would expect, to increase
the number of drills working in Indonesia.
Summing up: For Indonesia to be more competitive it needs to lower
either the cost of labor or of infrastructure, or preferably both, since
these are the principal reasons Indonesia is a high cost economy. Since
the aim is to improve the situation of workers there are limits on the
ability to lower the cost of labor. Lowering the cost of infrastructure is
therefore crucial.
Indonesia needs to increase national government spending on
infrastructure something like ten-fold to 6.5 percent of a larger GDP to
reduce the costs that inadequate infrastructure imposes on the economy,
and especially on those producing in competition with other countries.
Priority in investing limited infrastructure funds should go to areas
that have attracted new investment in manufacturing, especially for
exports, because: [i] with new productive investment in place but poor
infrastructure, investment in infrastructure can give a high return; [ii] it
provides an incentive for sub-national governments to adopt policies and
programs to attract investment and increase output.
Greater private investment in infrastructure and a greater role in
implementation can supplement the government effort. The production
sharing approach can be used to enlist the private sector in infrastructure
development without giving up government ownership.
It is especially important to increase the power supply by at least 140
percent. This is likely to be well beyond the financial and executing
capacity of PLN. Private firms can be used under production-sharing
contracts to achieve the needed expansion.
The Economic Choices
Facing The Next President
122
To the extent that natural gas is available it would be possible to
substantially lower the cost of transport by converting the commercial
fleet –trucks, buses, taxis—to operate on gas. Conversion can be funded
at no cost to the operator by loans repaid as part of the cost of fuel. After
conversion fuel can be sold to trucks and buses at a low price with no risk
that it will be resold to private vehicles or abroad.
If Indonesia uses imported LNG to fuel new power stations the whole
cost structure will be increased by the high cost of this fuel. Far better
to improve the incentives for additional production of coal, geothermal
energy, oil and gas in the country. The decline of oil/gas wells drilled
from 95 in 2012 to 66 in 2013 and an estimated 21 in 2014 shows clearly
that with prices stagnant and investment in Indonesia seen as more
risky, investing in oil/gas in Indonesia is not attractive. By improving
the contract terms for oil companies it should be possible to increase
investment and therefore oil/gas production in the country. With
imported LNG 100 percent of the revenue go to foreign companies; far
better to offer them thirty or forty percent of the revenue from new
Indonesian wells under improved production-sharing contracts.
123
The Economic Choices
Facing The Next President
Chapter 7.
Additional Resources are Needed for the
National Government to Play its Crucial
Role in Achieving Double Digit Growth
The resources available to the national government are totally inadequate for its
crucial role in reaching double digit growth. In previous chapters we discussed
important policies and programs that the national government needs to
execute which require significant resources. Others will be discussed in
this and later chapters:
i.
Increase expenditure on infrastructure from less than one
percent to 6.5 percent of a much larger national income.
ii. Expand the existing PNPM Program into a Guaranteed
Employment Program at an initial cost of Rp 30 trillion (US$
2.7 billion or 0.4 percent of national income).
iii. Start or expand Matching Grants programs to provide
incentives for sub-national governments to devote more
resources to health, education and infrastructure development
and fewer resources to offices, staff salaries and other
administrative expenses.
iv. Provide subsidized government services in new Export
Processing Zones to compensate for lower wages.
It is not possible to implement any of these on a worthwhile scale
unless government has the resources to fund them. Currently it has no
significant uncommitted funds for any of these crucial activities.
The Economic Choices
Facing The Next President
124
Reducing the petroleum subsidy is the only way to secure
sufficient resources in the first two years to pay for essential
programs.
A significant increase in resources for the national government will
require substantial tax reform. Implementing serious tax reform will
take the initial year or two of the new presidency. While tax reform
is being carried out, the government can secure additional resources
to fund the most urgent initiatives only through a reduction in the
petroleum subsidy. In recent years, the central government has spent
much less than one percent of GDP on infrastructure while it has
devoted about 3.5 percent to energy subsidies. Eliminating energy
subsidies while adequately compensating the poor is the only shortterm method to unlock financing for central government spending on
infrastructure and other urgent needs.
Reducing the fuel subsidy always generates opposition. It is therefore
best to do it during the first year of a new administration, during
its “honeymoon” period. For both political and economic reasons, it
makes sense to carry out the largest reduction in the subsidy during the
first year of the new administration.
Studies have shown that this subsidy primarily benefits the upper
income groups. The richest forty percent receive sixty percent of the
benefit according to the World Bank (World Bank 2006). The subsidy
can therefore be quickly and significantly reduced with some of the
savings transferred directly to the poor, but with most of the savings
used to begin funding high priority programs including infrastructure
investment and guaranteed employment programs.
Fuel subsidies are equal to 3.5 percent of GDP. Reducing subsidies
would save enough money to start critical programs in the first two
years of the new government, but would not generate sufficient
resources to finance these programs fully over the life of the
administration. Cutting subsidies would afford the breathing space
that the government needs to carry out a thoroughgoing tax reform
125
The Economic Choices
Facing The Next President
to raise the level of government revenues significantly over the long
term while at the same time improving incentives to save, invest and
produce competitive exports.
Government revenues are inadequate to pay for critical
programs. They can and must be increased.
At sixteen percent of GDP, which includes tax revenue of twelve
percent of GDP and non-tax revenues of four percent, Indonesia’s
total revenue is far below what is needed. It is also well below the
20 to 21 percent raised by countries like Malaysia and Thailand.
Moreover, the national government is obligated by law to transfer
one third of its budget to sub-national governments. Therefore,
it is essential that the central government succeed in raising more
revenue. Simply increasing rates would reduce incentives to invest
and create other distortions. A comprehensive tax reform is needed
to increase revenue generation and spending on infrastructure and
social protection programs.
The combination of enhancing tax revenue collection and reducing
energy subsidies will unlock substantial resources that can increase
spending in two crucial areas:
i.
Social protection programs, including health care, education,
food (mainly staples) price stabilization programs and
guaranteed employment. Social protection programs need to
ensure that the lower income groups—the poor and the near
poor—do not suffer a decline in living standards as a result of
the reduction in energy subsidies and other economic set-backs.
ii. Basic Infrastructure (power including new forms of energy, water,
sanitation, seaports, industrial zones, roads, irrigation, urban
infrastructure, airports) and other investments that will contribute
to productive jobs, especially for the poorest forty percent.
Tax reform has to be well planned and designed. Therefore it can only
begin to be operational in the second year of the new administration. As
The Economic Choices
Facing The Next President
126
increased tax revenues start to come in the benefits from decreasing the
fuel subsidy will be coming to an end.
Expected government revenues and expenditures are shown in Table
13. Decreases in the fuel subsidy are shown as revenue though they
are, of course, a reduction in expenditures. But from the perspective
of how to increase the resources available to the national government,
a reduction in the subsidy has the same effect as an increase in
revenue.
Non-tax revenue is assumed to stay at the same level of four percent
of GDP since it is not much affected by tax reform. Based on the
discussion of various tax changes below we assume that tax reform
will yield an increase in tax revenue of 3.5 percent of GDP in five
years and 4.5 percent in ten years. The energy subsidy is assumed to
be reduced from 3.5 percent of GDP to one percent in two years and
to zero in two more years.
Increasing revenue and eliminating the fuel subsidy will make
it possible to expand spending greatly on social protection and
infrastructure.
As a result of tax reform and subsidy elimination, the national government
will be able to increase spending on infrastructure and social protection
programs. Of course GDP will have increased substantially over the
ten years from 2014 to 2024. The resources available to the national
government would, under the scenario in Table 13, increase from Rp
1,700 trillion (US$140 billion) to Rp 2,900 trillion ($240 billion) in 2019
and to Rp 4,900 trillion ($410 billion) in 2024. This near-tripling of
its resources would finally allow the national government to implement
an infrastructure program that would significantly improve Indonesia’s
competitive position.
127
The Economic Choices
Facing The Next President
Table 13. National Government Revenues and Expenditures with Policy Changes, 2014-2024
NOTE: Exchange rate used was Rp 11.700 per US$
Source: Pardede, 2014
From a ludicrously small investment of Rp 57 trillion (US$ 5 billion)1 in
2014 infrastructure investment would increase more than fifteen times4 to
Rp 900 trillion (US$ 77 billion) in 2019 and almost double again from
2019 to 2024. Investment in infrastructure in 2024 would be 28 times
what it was in 2014. This clearly will provide a large boost to the economy.
Improvements to infrastructure will reduce costs and increase the efficiency
and competitiveness for producers, especially in manufacturing. More
industrial output will in turn generate more tax revenue and therefore more
resources to invest in further infrastructure development.
The 0.6 percent of GDP is an estimate that excludes overhead expenses, such as the
salaries of the Ministry of Public Works, which are usually included in government investment expenditures. The estimate in Table 13 is only for actual expenditures on road
building or harbor installations.
4
The Economic Choices
Facing The Next President
128
There would also be a substantial expansion of social protection programs.
The additional funds available for programs such as Guaranteed
Employment (see Chapter 10) and the stabilization of prices of food
primarily consumed by lower income groups (Chapters 5 and 8) would
increase more than ten-fold, from Rp 30 trillion to Rp 310 trillion.
National government expenditures on education would increase by more
than a quarter and health spending would also increase substantially. These
programs mostly benefit the poorest forty percent, in contrast to the energy
subsidy program which disproportionately benefits the better-off.
Our financing recommendations will support increased spending on
infrastructure and social programs without threatening the long-term
fiscal balance. It must be emphasized, however, that the achievement
of these fiscal goals depends crucially on an immediate, substantial
reduction of the fuel subsidy in 2015, and further reductions in the next
two years to free up funds for infrastructure investment. If the subsidy is
not quickly reduced and infrastructure spending cannot rise in 2015 and
2016, then growth will be slower, government revenue will not increase
at the rate projected and infrastructure spending will grow more slowly.
As a result, it is unlikely that the goals of ten percent growth and four
million new productive jobs a year would be achieved. We propose setting
up a virtuous circle which will be kick-started by diverting something like
Rp 100 trillion from fuel subsidies to infrastructure spending in 2015. If
this virtuous circle is not set into motion in 2015 then it will be difficult
to catch up in future years.
The elements of tax reform: Focus on expanding the base, not
raising rates
The priority reforms that need to be designed and implemented early on
include some that can yield substantial revenues rather quickly.
i.
Expanding the base of the Value Added Tax (VAT) and
improving collection is more important than raising the rate.
Most advanced countries have been increasing the VAT rate. It
is our view that Indonesia should expand the base of VAT before
raising the tariff rate. Indonesia needs to create an environment
that fosters voluntary compliance and deals robustly with those
129
The Economic Choices
Facing The Next President
who choose not to comply. At the same time Indonesia needs
to create an environment in which VAT fraud and avoidance
become less economically viable.
ii. Indonesia has the highest gap among emerging markets for
the VAT between the amount that should be collected, based
on economic activity, and the amount actually collected.
“Improving Collection-Efficiency” a CReco (2012) study,
concludes that reducing the VAT tax gap from 42 to 21 percent
would increase tax revenue by one to 1.5 percent of GDP over
the next five years. By implementing a broad based VAT with a
fairly high threshold (the turnover level at which the tax becomes
compulsory), base-broadening and improved compliance could
raise an additional 0.5 to one percent over 2019 for a total of
two percent of GDP within ten years from this tax alone.
iii. In order to reduce tax avoidance and tax evasion, the marginal
tax rates of the personal income tax (PIT) and Corporate
Income tax (CIT) should be the same or at least almost the
same. Other rates should also be comparable.
iv. The tax base of the Personal Income Tax should be broadened
to include self-employed professionals (lawyers, doctors,
auditors/accountants, actor/actress, and entertainers) and
small entrepreneurs. With better administration and collection
these professional groups can produce additional tax revenue of
about 0.5 percent of GDP.
v.
Continuing efforts to implement a simple but coherent regime
for taxing a significant number of micro and small enterprises
will add tax revenue of about 0.5 percent of GDP, mostly from
the Corporate Income Tax.
vi. We should avoid double taxation on dividends in order to
encourage more investment.
vii. Tax avoidance and tax evasion in the corporate sector can be reduced
significantly by using a good corporate tax payer as a benchmark
for each specific sector. Currently within each sector corporations
The Economic Choices
Facing The Next President
130
of roughly the same size and similar status pay significantly different
taxes. Using the benchmark as a guide of the amount of taxes that
should be paid, the Director General for taxation can improve tax
compliance and increase tax revenue. This measure is expected to
increase tax revenue by 0.5 percent of GDP.
viii.The policy package outlined in this paper will greatly increase
employment and income in formal sector activities and shrink
the informal sector. Higher labor productivity, and higher
incomes in the formal sector will enlarge the tax base and
improve tax collection substantially, by an estimated by one
percent of GDP.
ix. Critically important to an effective tax system that greatly increases
tax collection is a well-functioning tax office able to enforce tax law.
We therefore propose the establishment of a semi-autonomous
revenue authority. The semi-autonomous status would enable
the authority to pay higher salaries than possible for regular civil
servants. That would enable it to recruit staff with the education
and knowledge needed to examine complicated tax returns where
large sums of money are at stake. It would need, above all, to
strengthen the capacity of the large tax payer unit and to provide
for continuous capacity development through training.
x. In order to achieve an optimal result we need to improve
tax compliance by ensuring greater transparency and
accountability of the tax office. This will be easier to achieve
if the tax process is simplified.
The aim of the reforms, and especially the creation of a semi-autonomous
revenue administration, is to enhance revenue mobilization, improve service
orientation and staff quality, and fight tax related corruption and evasion.
In addition to our priorities, several ongoing initiatives will contribute
to increased tax collection: using simple segmentation to identify larger
collection opportunities; targeting collections in tax offices with the
largest outstanding debts; ensuring regular updates to the taxpayer
registry and follow up; assigning account managers to oversee the
131
The Economic Choices
Facing The Next President
accounts of large taxpayers on a continuing basis; introducing electronic
channels for simple transactions; simplifying the tax system to encourage
the shift from the, largely untaxed, informal sector to the, largely taxed,
formal sector.
The potential of property or real estate taxes
Intensifying the collection of taxes on property and real estate benefits
not only the local governments who receive additional revenue but also
reduces property speculation. Local governments need additional revenue
to finance basic infrastructure and services. Their current income tends
to fall short of meeting their most urgent needs. This is especially true of
the cities. Urbanization is taking place rapidly and cities often still rely
on the colonial infrastructure designed for a much smaller population.
In addition, the old infrastructure is falling apart, rotting away and
disappearing, inadequate even for the smaller population for which it was
designed. Additional resources are not all that is needed for a solution,
but without funds no solution is possible.
Real estate taxes can also help to dampen extreme rates of property
appreciation, especially in specific areas in some big cities (for example
Pondok Indah, Menteng and Kebayoran, in Jakarta).
We are not advocating an immediate increase in the tax rate; it can be
uniform or progressive. The crucial change is that the taxable value
of the property (NJOP) be based on current market value not on an
outdated assessment as it often now is. Currently the property tax yields
only Rp 28.5 trillion, which is just 0.3 percent of GDP, according to
the government budget of 2004. With new valuation assessments and a
progressive tariff in some wealthy areas within big cities, we expect this
number can be doubled, providing additional tax revenue of 0.3 to 0.4
percent of GDP.
Jakarta in 2014 introduced a new property tax, which can be emulated
by other big cities.
•
The tax is progressive. Jakartans who own land and buildings
worth less than Rp 200 million (US$16,400) will pay 0.01 percent
The Economic Choices
Facing The Next President
132
of the value in property tax, while owners of properties worth
between Rp 200 million and Rp 2 billion will pay 0.1 percent in
property tax. Those who own assets worth between Rp 2 billion
and Rp 10 billion will have to pay 0.2 percent, while the capital’s
richest inhabitants, with property worth Rp 10 billion or more,
will have to pay 0.3 percent.
•
The Jakarta Tax Agency predicted that after the increase in
rates the city’s potential income from the land and building tax
would surge by 82.2 percent to Rp 6.7 trillion, up from Rp 3.68
trillion in potential income last year.
A careful tax reform effort will undoubtedly come up with other steps
to increase government revenues. The policy changes suggested above
are estimated to produce an increase in revenues of 4.8 percent of GDP,
more than achieving the target of 4.5 percent over ten years.
Tax holidays
Many governments use tax holidays as incentives for investors and
particularly foreign investors. They have been frequently advocated in
Indonesia and enthusiastically endorsed as an excellent incentive by
potential investors. But in fact they have proved largely ineffective and
costly. The problem is that they provide benefits only if an enterprise is
profitable. If the business proves profitable the holidays exempts some or
all profits from taxation for a certain number of years. The reason tax holidays are not very effective is that the key question in
deciding on an investment is whether a particular enterprise is likely to
be profitable or not. That depends on the cost of investment, the cost of
operation, the sales price as well as the riskiness of the investment. What
matters most to the investment decision is the assessment of the odds that the
enterprise will produce losses or profits, and if profits whether at a rate of ten,
thirty or fifty percent. If it produces losses for several years, then exemption
from profit taxes is of no value whatsoever. Conversely, if it produces profits
of forty percent, then paying twenty percent in income tax still leaves the
entrepreneur with a more than satisfactory return. Of course, to be exempt
133
The Economic Choices
Facing The Next President
from taxes for a few years and to receive the whole forty percent is a nice
bonus, but it is unlikely to affect the investment decision in a major way. But
if even the most profitable enterprises pay no taxes because of the holiday,
then the cost to the government can be considerable.
Reducing the cost of making an investment, or the cost of doing business,
increases the chances that the enterprise will be profitable but costs the
government little or nothing. Yet these changes are likely to have a larger
impact on the investment decision than a tax holiday. Reducing the cost
of doing business usually only reduces the income of corrupt officials
and increases the income of the government. It is a far more effective
incentive to investment, particularly to foreign investment, than tax
holidays.
Mobilizing the funds of sub-national governments through
matching grants.
The decentralization legislation of 1999 mandated that a substantial
share of central government revenue go directly to sub-national
governments to be spent at their discretion. The provinces, kabupaten
and kecamatan are allocated roughly one-third of national government
expenditures or about Rp 600 trillion (US $50 billion) in 2014, equal
to six percent of GDP. How they use these funds obviously makes a
substantial difference. A large and increasing share of the funds have
been used to build office space and to hire administrative personnel as
well as for travel and other expenses of senior staff. In part this has been
the result of the proliferation of sub-national units at all levels. In 1997
there were 300 districts, and now there are over 500.
As central government revenues increase, the amount of money going to
sub-national governments increases as well. There is compelling evidence
that while some units spend money well it is clear that others do not.
Reportedly about half of all sub-national unit heads have been charged
with corruption, clear evidence that they have not used resources wisely
(Haryono, 2014).
The Economic Choices
Facing The Next President
134
Chart 15. World Bank Logistics Performance Survey: Trade Related Infrastructure (Scale 1 to 5)
Source: Pincus (2014 b)
Another piece of evidence comes from the periodic surveys by the World
Bank of freight forwarders on the quality of the infrastructure. They
report improvements in other countries, but deterioration in Indonesia
between 2007 and 2012. Responsibility for the condition of infrastructure
is shared between the national and sub-national governments but it is
the sub-national governments that often have greater flexibility with
respect to spending decisions. The great improvement in the Philippines
is especially remarkable. That country also showed a substantial increase
in exports of manufactured goods during the same period as well as an
increase in the rate of growth. It seems to have followed the strategy
outlined in this paper.
Another respect in which the performance of sub-national units
appears to fall short is with respect to the quality of education
provided. Indonesia’s expenditure on education is higher than that of
some neighboring countries and lower than others, but its students’
performance is among the worst in Asia. The contrast with Vietnam
is especially striking. Vietnam is a poorer country and spends a smaller
135
The Economic Choices
Facing The Next President
percentage of its national income on education. Yet its performance on
standardized mathematics tests puts it in the top third (seventeenth out
of 64) of countries included in the OECD’s Program for International
Student Assessment (PISA). 25
A great deal of responsibility for poor performance on these tests
rests with sub-national governments for which education is the largest
expenditure. One key problem is teachers who collect their pay but often
do not show up to teach. Another problem is corruption: students are
passed in return for bribes without having mastered the material. Dealing
with these administrative problems is more readily done at the local level.
Chart 16. Spending on Education as a Share of Gross National Income and Mathematics Rank on the
OECD Program for International Student Assessment
Source: World Development Indicators and OECD PISA. Philippines is not included
in PISA
Once the national government has discretionary resources available it can
do what most national governments in decentralized systems do: it can
provide matching grants as incentives for the sub-national governments. If
5
See http://www.oecd.org/pisa/.
The Economic Choices
Facing The Next President
136
they can be induced to spend a greater share of the resources under their
control for the construction of local roads, irrigation and drainage works,
public health and education that would make a substantial difference to
the total amounts of money available for these developmental purposes.
As national expenditures go from 17.5 percent of GDP in 2014 to 21
percent in 2019 and 22 percent of GDP in 2024, the amounts available
to sub-national governments will increase from about 6 percent GDP
to about 7.5 percent and then to nearly eight percent of a much larger
GDP. The increase would be from some Rp. 600 trillion to something
like a Rp.1,700 trillion at the end of ten years. It will make a huge difference to the well-being of Indonesia's population
how this increase of Rp 1,100 trillion (US$ 100 billion) is spent. It will not
do much to improve the well-being of most Indonesians if much of it is
used to establish more kabupaten and kecamatan with their requirements for
offices and personnel or if it is used for patronage appointments and perks
for the staff of the sub-national governments. But it can do a great deal of
good if most of it is spent on local roads, more and better schools, health
facilities, clean water and irrigation. The national government can influence
these decisions and can multiply its expenditures by using matching grants
to induce sub-national governments to spend their substantial resources to
benefit the population rather than to benefit primarily themselves. Some of the increased resources of the national government should be
set aside for a fund that matches desirable expenditures by sub-national
governments. One of the critical needs of the country is for better roads
and better maintained roads. The national government could offer to pay
fifty percent of the expenditures on kabupaten and provincial roads. It could
also provide similar matching funds, at various rates, for expenditures on
health or education. Finally it could provide matching grants as incentives
for better management. For example, funds could be made available to
kecamatan that are more successful in reducing teacher absenteeism.
The system would more effective if it were possible to limit the increase
in revenues that go to subnational units that exceed a specified rate of
expenditure on purely administrative expenses. Sub-national governments
that neglect the educational systems, health services and the infrastructure in
137
The Economic Choices
Facing The Next President
their area in order to spend more on administration and the perks of officials
would receive less of the increased revenue that will be flowing through the
system. It is a fundamental weakness of decentralized administration that the
sub-national units do not raise their own revenue. They therefore do not have
to incur the political costs of increasing taxes. They benefit without any effort
on their part from increases in revenue of the national government. This
leads to irresponsible spending in all countries in which local authorities
spend money but do not collect taxes. It would be desirable to structure some
of the additional revenue raised by the national government in such a way
that sub-national governments do not automatically receive a share of the
larger revenue. If getting a larger share requires them to spend some of their
own revenue for investment in people or in infrastructure, the effectiveness of
the national government spending could be substantially increased.
If it is not possible to withhold any of the increased revenue from subnational units, then the only way to influence their expenditure decisions
is through the allocation of discretionary national government funds.
If the national government uses one-third of the increased resources at
its command for matching grants, it will have about Rp 300 trillion to
disburse for this purpose a year by 2019 and Rp 800 trillion by 2015.
These are substantial resources which, if carefully deployed, can change
the spending patterns of at least some provinces, kabupaten and kecamatan.
These sub-national units command resources that are much larger than
the increase in revenue that tax reform can bring about. Even in 2019
the sub-national units will be spending almost 7.5 percent of GDP; the
increase in central government resources will be only 3.5 percent of GDP
(calculations in the technical appendix posted at www.transformasi.org).
Government support for exports
Once the national government has some discretionary funds it can
provide some direct support to increase competitiveness. Two related
initiatives can support manufactured exports.
1. Subsidies that indirectly enhance export performance
Outright subsidies are generally prohibited by World Trade
Organization (WTO) and other rules. But as noted earlier there are
The Economic Choices
Facing The Next President
138
actions which are generally accepted as part of government’s normal
role and therefore are practiced widely around the world without
violating World Trade Organization/Free Trade Agreements/
Economic Partnership Agreements:
• Subsidies for worker training (Fiscal incentives)
• Subsidies for improving management (Fiscal incentives)
• Technology, R&D, product development (Fiscal incentives)
• Privileged financial access for SMEs (Monetary incentives)
• Trade-related information, surveys, seminars, enterprise
consultation
• Support for marketing, branding, IT, insurance, joining trade
fairs and missions
• Cheap rent and one-stop services in industrial estates (Fiscal
incentive by providing all basic infrastructure for industrial
estates, industrial zones or industrial clusters)
•
Start-up and incubation support (Fiscal incentive)
2. Support demand-oriented exporters
In a market economy, demand dictates supply. Government can help
exporters by providing information and services that otherwise have
to be purchased:
• Providing market and industry information
• One-stop service for export assistance
• Introducing global standards and technology
• Business matching between buyers and sellers
•
Responding to private sector requests from foreign buyers.
Summing up: The National Government needs to roughly triple its
expenditures to fulfill its role in achieving higher growth and more
employment. It needs to invest at least 6.5 percent of GDP in infrastructure
rather than less than one percent
Turning the current PNPM labor-intensive program for locally managed
infrastructure development into a guaranteed employment program that
139
The Economic Choices
Facing The Next President
is an important part of the social safety net will require another 0.4
percent of GDP.
Providing enhanced government services in Export Processing Zones
to reduce labor costs, providing various services to exporters permitted
under WTO and covering the cost of a well-functioning drawback
scheme will require additional but limited resources.
An effective matching grants program would need at least two percent of
GDP. Sub-national governments now control expenditures of six percent
of GDP or almost Rp 600 trillion; by 2024 this will be nearly eight percent
of GDP and Rp 1,700 trillion. A substantial part is currently badly spent.
Matching grants can provide a strong incentive to use more of these
resources for the development of infrastructure, health and education
and less for administrative overhead.
In the first years of the new president’s term the only source of additional
resources is to reduce the fuel subsidy which primarily benefits the
wealthier groups. By the second year this source and tax reform will each
need to contribute one percent of GDP to additional resources. Reform
of the VAT, primarily by expanding its base, can bring in two percent of
GDP. Improved tax compliance by the self-employed and professionals
and the use of benchmarks for specific sectors to increase corporate
tax collection can yield another one percent. The more rapid growth
of the formal and taxed sectors will contribute a further one percent.
Our recommendations for tax reform are expected to produce additional
revenue of 4.5 percent of GDP.
To collect the additional taxes requires changing the tax office into a
semi-autonomous authority that can pay higher wages to attract and
keep the specialized talent needed to deal with large and complicated
tax cases.
The Economic Choices
Facing The Next President
140
Chapter 8.
Investment, Savings, Foreign
Investment and Balancing
Economic Objectives
Private
Macro-
To reach a ten percent rate of growth Indonesia needs to increase its
rate of investment. By how much depends very much on the pattern of
investment, but it would need to increase to something like forty to fifty
percent. Historically savings have been around thirty percent so there is
a gap that would need to be filled by foreign funds. This chapter takes a
look at the investment needed, the savings available to finance investment
and the controversial role of foreign investment to cover the gap. It also
considers the problem of achieving balance among the often conflicting
objectives of inflation control, maintaining high rates of economic
growth, increasing exports, reducing imports, promoting equality and
attracting foreign investment but limiting the role of foreigners in the
economy.
Economists do not agree on the rate of investment required to
achieve GDP growth of ten percent
Recent history supports the conclusion that a ten percent rate of growth
of national income or GDP requires a rate of investment at least equal to
fifty percent of GDP. From 2005 to 2013 the average rate of investment
was about 29 percent and the average rate of growth about six percent.
That is, Indonesia had an Incremental Capital Output Ratio (ICOR) of
nearly five. For every one percent rate of growth, a five percent rate of
investment was required. That is unusually high and is explained in part
by the high proportion of investment that went into coal mining and
palm oil production, both of which require a large initial investment but
only produce output with some delay.
141
The Economic Choices
Facing The Next President
Table 14. The Incremental Capital-Output Ratio (ICOR) 1985-2003
GDFCF: Gross Domestic Fixed Capital Formation or Gross Fixed Investment.
NOTE: The next to the last column is the usual way of calculating the ICOR: the
ratio between the rate of investment and GDP growth during the same time period.
The last column compares the GDFCF for one period with growth starting and
ending one year later, on the assumption that there is an average lag of one year
between investment and output.
Source: Papanek 2014t
Investment in oil palm, for instance, produces little or no return for up to
seven years. During this period the ICOR is infinite: for every billion rupiah
of investment the increase in output is zero. The delay between investment
and output is shorter for coal but the ICOR is still high because it is a capitalintensive activity. But the relationship between the rate of investment and
the increase in output which results is obviously not fixed, but depends on
the kind of investment that is made. Our recommendation is for investment
and growth to be concentrated in labor-intensive manufacturing with a
lower ICOR.
In the 1980s and early 1990s when investment was channeled into laborintensive manufacturing, the ICOR was 3.6 to 4.3. If investment in the
next five years is in labor-intensive manufacturing and other labor-intensive
activities, Indonesia can go back to an ICOR of around 3.5 to four. Indeed,
if some factories move from two shifts to three shifts because it becomes
The Economic Choices
Facing The Next President
142
profitable to pay the higher wage that is required for night work, then their
ICOR can be close to zero: zero investment but increased output. That
would help in lowering the ICOR for the economy as a whole.
On the other hand, the massive infrastructure investment that will be
needed will have a high ICOR and so will investment in palm oil and any
further investment in coal. More than doubling electric power production
will require a considerable investment with a low annual return. Taking
all these factors into account, a ten percent rate of growth would require a rate of
investment somewhere between 38 and 45 percent.
There is a $60-80 billion gap between the rate of domestic
savings and the investment needed
Indonesian savings are not adequate to fund such a high rate of investment.
The highest it has been was 36 percent from 2009 to 2011 in the brief
period of rapid growth thanks to the acceleration of the commodity
boom. Even during the period of rapid income growth from 2005 to 2012
the savings rate was just 32 percent, between six and thirteen percent
below what is likely to be needed. The higher rate of growth we expect to
achieve will increase the savings rate as well. If savings is between 32 and
36 percent with needed investment at 40 to 45 percent, the shortfall to be
covered by foreign investment would be between seven and twelve percent
of GDP. With GDP of about US$ 800 billion, foreign capital of $60 to 80
billion is a reasonable estimate of what would be needed.
Chart 17. Gross Rates of Domestic Savings
Source: Bank Indonesia (various years)
143
The Economic Choices
Facing The Next President
This gap between the investment needed to reach a ten percent rate of
growth and the rate of savings that has been achieved has a counterpart
in the gap between export income earned and the cost of the imports that
have to be financed. Foreign resources will simultaneously close both gaps.
Attracting foreign investment to fill the gap
Indonesia, like other countries and especially countries with a long
colonial history, wants to limit the role and influence of foreign investors.
It has given and undoubtedly will continue to give preference to domestic
investors, and indigenous managers and technicians as well. But in order
to reach ten percent growth and to create four million good jobs a year it
also needs to attract foreign investment and management in areas where
their participation is needed. In the integrated world economy in which
Indonesia, like other countries, operates, the role of foreign capital is
more important than it was fifty years ago. The “nationality” of capital
also means less today than it did in the past.
Indonesia has had an open capital account since 1970, and some of the
capital that is classed as “foreign” has some relationship to Indonesian
companies and individuals in the present or past. It has also become
increasingly difficult to label multinational corporations as “American”
or “Japanese” given their complex capital structures and international
management teams. Indonesians own shares in these companies, as do
Americans and Japanese investors.
Leaving the politics aside, inward investment can help fill various gaps
that would otherwise slow the growth of the economy. The biggest are
the gaps between domestic savings and required investment and the
corresponding export/import gap. Without foreign resources growth is
more likely to be around 7.5 percent rather than ten percent in the final
year of the president’s term, and the good, productive jobs generated
would be correspondingly lower.
The most secure and least expensive way of filling these gaps is through
public transfers, which consist of loans and grants from international
organizations and foreign governments. These transfers typically have a
twenty to thirty year repayment period and very low rates of interest.
Indonesia has continued to receive something like five billion dollars of
The Economic Choices
Facing The Next President
144
such funds a year. However, Indonesia also has to repay larger loans taken
out in earlier years. On a net basis public transfers recorded a small net
drain in 2013 and the first quarter of 2014 [$0.6 billion in fifteen months].
If, however, this source of funding should decline without a reduction in
Indonesia’s obligation to service its debts, then some domestic savings
would be diverted from investment to public sector debt repayments.
Foreign Direct Investment (FDI) is the least risky form of private foreign funds. Since
FDI is used to fund buildings, machinery and raw materials, it is not
readily made liquid and taken out of the country. It is usually invested
for the long term with the profits from the enterprise used to pay for the
investors’ funds and the risk taken in making the investment. It is therefore
a very good source of foreign funding for the investment-saving gap. Historically, inward FDI has been quite small relative to the savinginvestment gap. In 2004 for instance, FDI amounted to less than two
billion dollars. There was a substantial increase in the amount of FDI
beginning in 2005. The biggest factor was the commodity boom. It not
only attracted investment in extremely profitable commodity production
but also in providing goods and services for a rapidly expanding middle
class with a substantial increase in disposable income. Second, Indonesia became an attractive country for many international
investors in part because other countries were becoming less
attractive. Rates of return to investment in Europe, Japan and the United
States were unattractive and investors were looking to Asia for better
returns. Thailand was suffering from floods and political conflict. The cost
of labor is rising in China and anti-Japanese riots frightened away some
Japanese investors. The Indian economy was running out of steam with
a government that was seen as incapable of action, beset by corruption
charges and likely to lose office in the next election, with business-labor
conflicts reducing profits in many areas of the country. Indonesian
macro-economic policy was seen as competent and stable regardless
of which party was in power. FDI increased substantially and reached
eighteen to nineteen billion dollars in 2012 and 2013.
But it should be noted that these were gross numbers. If Indonesian
investment in other countries is taken into account, as it should be, then
145
The Economic Choices
Facing The Next President
the net inflow was about 25 percent or five billion dollars less. Second,
even during this period the flows in some years were considerably less.
The average for 2005 to 2013 was twelve billion dollars gross, or about
eight billion dollars net. At best under policies which prevailed in the
recent past FDI would have covered ten to fifteen billion dollars of a
savings-investment gap estimated at $60-80 billion. And in the last year
the tendency has been to make Indonesia less attractive rather than more
attractive to foreign investors. Only if Indonesia manages to attract two
or three times as much FDI as it has recently will FDI make a meaningful
contribution to closing the savings-investment gap.
FDI also brings with it managerial experience and an ability
to mobilize large amounts of capital and take big risks.
Foreign investors are also needed in some cases for knowledge and
skills that are otherwise difficult to access. There are obvious cases like
deep water drilling for petroleum or gas which is a technology that only
a limited number of large companies have fully mastered. But there
are less obvious cases such as the efficient management of large scale
and perishable food products and the establishment of universities
able to attain world class standards. The role of FDI in developing
technologically more complex industries will increase as Indonesian
exports become more sophisticated and technology-intensive (Rahmaddi
& Ichihashi, 2013).
FDI is also needed for some investments that require risking very
large sums of money, for instance in developing some oil/gas fields.
There are some companies in Indonesia able to invest one to two
billion dollars, but not many willing and able to risk two or three
billion dollars on drilling exploratory wells in an area that may
or may not have sufficient oil and gas to warrant the investment.
Foreign firms may also be needed to facilitate access to
markets.
Indonesian exports of car parts have increased greatly since Indonesian
factories were included in the production chain of some Japanese car
The Economic Choices
Facing The Next President
146
companies. Exports had ranged between $0.5 billion and $0.8 billion
from 1995 to 2003. Over the following ten years they have increased
seven-fold to $5.7 billion.
Other examples in which foreign companies connect local production to
international markets are fresh and frozen fruits, vegetables, flowers, and
marine products. There is substantial unexploited potential for increasing
the export of agricultural products from Indonesia. The country has
a year-round growing season and can produce fruits, vegetables, and
flowers at a time of year when producers in temperate climates can
only do so by using expensive hothouses. Moreover, agricultural labor in
Indonesia is low cost. But it is difficult for Indonesia to break into these
world markets without a tie-ups with foreign companies that guarantee
the safety and quality of food products.
Athletic shoes are another example. The market is controlled by a few
brands and Indonesian producers can break into the market only as
contractors or sub-contractors to these companies.
Historical experience is clear: Foreign investors initially play
a large role in the expansion of manufactured exports, but
their role declines over time.
Foreign investors played a role in innovation in other Asian countries, but
their importance varied. They were more important in China than in Korea.
In both Vietnam and Bangladesh they have played a very large role. In all
of these countries their role, however, has declined quickly. The Bangladesh
garment industry was set up by foreigners, mostly Koreans. As Bangladeshis
gained experience with operating firms they set up their own enterprises
to compete with the Koreans or they bought out Korean firms. Beginning
with an industry that was nearly 100% foreign owned and operated it has
become an industry with only one large Korean firm. There was no legal
requirement for divestment. The local people were just better able to deal
with the government and its regulations, with local labor and its unions, with
the inadequate infrastructure among other problems. They had to learn the
technology of the industry, marketing and sourcing of inputs, and they had to
establish relationships with the major buyers. It did not take long.
147
The Economic Choices
Facing The Next President
The Bangladesh story is interesting because it is such a clear example and
happened so quickly. Allowing Korean investors into the country greatly
accelerated the establishment and expansion of the industry. For a few
years foreigners were more prominent than nationals. But ultimately it
resulted in a bigger, Bangladeshi-controlled industry.
China too has done a good job of using foreign investors to advance
its industrial development. The presence of foreign investors introduced
new products, technologies and management systems. Chinese investors
and professionals acquired knowledge and experience working in foreign
firms and joining their supply chains. In a wide range of products
and sectors Chinese firms are now emerging as major competitors to
multinationals. Certainly as China opened to the world economy in
the 1980s there were domestic interests demanding strict limits on the
role of foreign investors in China. Fortunately they did not prevail. The
presence of foreigners and exposure to global markets and competition
has facilitated China’s emergence as an industrial power. Foreigners did
not exploit China; in many cases China exploited foreign investors.
The risk of declining FDI
There is a substantial risk that the amount of FDI flowing to Indonesia
will actually decline in the future. One important reason is the fact that
rates of return on investment in the United States have increased and are
likely to increase further. The same is true in parts of Europe and possibly
in Japan. The potential for dramatic change is greatest in India. If the
new prime minister makes only half of the changes he has promised,
then it will be a much more attractive place for all investors, including
foreign investors.
At the same time, Indonesia is seen as less attractive for investors. Labor
costs are substantially above those in competitor countries, reducing the
attractiveness of investment in labor-intensive manufacturing. A number
of policy steps have been taken that are perceived as hostile to foreign
investors. These include the requirement of divesting a substantial part
of the enterprise in a relatively short period of time. The rule increases
the risk to the firm that it will not cover its costs and make a profit before
The Economic Choices
Facing The Next President
148
it has to sell out. The expansion of the list of investments that are not
open to foreigners is perceived as a third negative factor.
Investors have less confidence than in the past in the stability of
macroeconomic policy with respect to FDI. Various conditions have been
imposed on foreign investors that make it less profitable to invest in Indonesia.
The election campaign produced a great deal of anti-foreign or nationalist
rhetoric that raises questions in the minds of potential investors about the
likelihood of policy shifts designed to discourage inward investment.
The requirement that mineral exporters refine their products in Indonesia
has no impact on the labor-intensive manufactured exports that are the
center-piece of our recommended strategy. From an economic perspective,
export taxes would have been a more efficient solution than a ban on
raw material exports, and would have also had the highly desirable effect
of generating revenue that the government could invest in much needed
infrastructure. Indonesian presidents, ministers and parliamentarians
are as eager to strengthen their nationalist credentials as politicians in
other countries. But if as a result Indonesia receives less foreign private
investment because it is seen as a more hostile place by foreign investors
then the economic cost of such political posturing can be very high: lower
growth and fewer jobs. These in turn have political costs.
Creating a stable environment for foreign investment reduces the
uncertainty that investors face and thus lowers the level of returns that
they require before risking their capital in Indonesia. Erratic changes
in policy increase the level of uncertainty and discourage good foreign
investors, leaving only those that expect super-profits from their
Indonesian projects.
The perceived changes in policy towards foreign investors have
unfortunately come at a time when foreign enterprises are less profitable
than they were five years ago. From 2005 to 2011 most enterprises were
extremely profitable and changes in the rules could have been absorbed
with less difficulty. Most enterprises are far less profitable now and any
changes which further reduce their profits are therefore resisted strongly
and create much more negative publicity for Indonesia.
149
The Economic Choices
Facing The Next President
The consequences can be seen quite clearly in the reduction in drilling
of oil and gas in Chart 14. In the first four months of 2014 the rate of
drilling, that is the rate of investment, was one-third of the rate in 2013
and one-sixth of the rate in 2012.
Changing from administrative restrictions to financial
penalties on foreign investors can provide equal benefits to
Indonesian enterprises, with greater efficiency and more
government revenue.
Like most other countries, Indonesia wants to limit the role of foreign
investors, technicians and managers and increase the role of Indonesian
investors and Indonesian personnel. But when this is attempted by
imposing rules and quotas with discretion in interpreting the rules given
to officials, it creates inefficiencies and opportunities for corruption. One obvious example is the permits that have to be obtained by foreigners
seeking to work in Indonesia. The officials administering the permit
system have a great deal of discretion, which creates a strong temptation
to expedite the process by bribery. Moreover, the officials making the
decision usually have only limited knowledge about the importance of
specific foreigners to specific enterprises. Inevitably some permits are
denied for technical or managerial personnel who are vital to a particular
enterprise and other permits are given to enterprises that could well have
substituted an Indonesian with little difficulty. A better system would be one in which an enterprise is free to use
as many foreign personnel as it wishes, but must pay a tax that
increases over time. This would provide a strong and increasing
incentive to train Indonesians and substitute them for foreigners as
soon as possible. If a particular foreigner is vital to the enterprise,
then the firm may be willing to keep paying the tax even as it rises
over time. This system would be a new source of revenue for the
government and it would be an efficient means to encourage the use
of Indonesian in place of foreign personnel. Investments could be
divided into two or three categories depending on the technical and
managerial complexities involved. Taxes would rise most rapidly for
The Economic Choices
Facing The Next President
150
firms using relatively simple technologies and systems, and would
rise more slowly for firms deploying more complex processes.
A similar system could work with respect to rules for divestment to
Indonesians. Rather than requiring that foreign enterprises sell a
specified amount of their equity to Indonesians at a specified time, the
government could impose escalating taxes on enterprises depending
on the extent to which they have divested. Currently foreign investors
have a substantial but unknown risk that they will be forced to sell their
enterprise at a very low price in order to comply with the regulations. If
they have the alternative of paying a known tax to delay the date of sale,
they can turn an unknown risk into an exactly known cost. If the tax
increases the longer they delay selling a share of their enterprise, then
they will have a strong incentive to sell as soon as possible.
Trade-offs among inflation, growth and exports
A tight monetary policy, which tends to be favored by Bank Indonesia,
helps raise savings and lower inflation by reducing demand from
both consumers and investors. It increases interest rates which makes
borrowing more expensive. As a result, it reduces demand for automobiles,
motorcycles, furniture and other goods that are generally financed in
part by borrowing. It also raises the cost of borrowing for investors and
therefore reduces the rate of investment. Lower levels of consumption
and investment also reduce the imports of parts and capital goods for
the production of automobiles and motorcycles as well as imports of
investment goods. By reducing imports, a tight money policy narrows
trade imbalances. By raising interest rates it encourages saving since the
savings earn a higher return.
At the same higher interest rates attract an inflow of foreign funds to
acquire Indonesian government securities. The result is an appreciation
of the rupiah, which makes exports more expensive and imports
cheaper. As exports fall and imports rise the trade balance will again turn
negative unless there is a further tightening of monetary policy. With less
demand from both consumers and investors, growth slows down and so
does the creation of good, productive jobs.
151
The Economic Choices
Facing The Next President
In short, inflation is controlled, the foreign accounts are balanced but at
the cost of slower growth, falling exports and fewer jobs.
The alternative is a more accommodating monetary policy. Making it
easier and cheaper to borrow results in a more rapid rise in consumer
demand and in demand from investors. The rupiah depreciates, which
stimulates exports and discourages imports, helping to narrow the
trade gap or generate a surplus. The resulting higher prices of imports,
together with greater demand for all goods, results in a higher rate of
inflation. Price rises will be especially great for imports and goods that
Indonesia exports. The price increase of imported luxury goods and
foreign travel should not be of concern for policy. Indeed if higher prices
for goods consumed by the rich discourages consumption and encourages
savings, it is a positive development.
Inflation matters if it increases the prices of goods important
to the poorest forty percent.
Inflation is of concern to the extent that it raises the prices of goods
important in the consumption basket of the poorer half of the
population. How to compensate for higher prices for imported foods as a
consequence of devaluation has already been discussed. If the government
can stabilize the prices of the major foods consumed by the poorest forty percent, the
impact of moderate inflation on their purchasing power can be minimized. Wages
tend to rise with a lag after prices rise and to catch up largely within about eighteen
months of the acceleration in inflation.61 If the devaluation of the currency
has contributed to the creation of more good, productive jobs for unskilled
workers, which is its aim, the resulting increase in the income of the poor will greatly
outweigh the costs of the higher rate of inflation.
This discussion has addressed the tradeoffs between a monetary policy
which results in a four percent rate of inflation versus one that results
in a seven to ten percent rate of inflation. It has not addressed the
Between 87 and 97 percent of the increase in the rate of inflation will have been made
good by increases in the nominal wage after eighteen months. Whether it is 87 or 97
percent depends on the specification of the model (Papanek, Setiawan & Purnagunawan,
2013)
6
The Economic Choices
Facing The Next President
152
consequences of monetary policy that results in much higher rates
of inflation on the order of, say, 25 percent. Nor has it addressed the
consequences of inflation that continues to accelerate over several years
and reaches high rates. High and/or accelerating rates of inflation over
several years create great uncertainty about future prices and price
relationships, and greatly increase the risk facing investors. Such rates of
inflation can therefore discourage investment, result in capital flight, a
sharp depreciation of the rupiah and undermine the fabric of society. In
the one year from June of 1997 to June of 1998 the rupiah depreciated
from Rp 2,500 to Rp 15,000 per US dollar, a six-fold increase. The rupiah
price of rice shot up. Those who sold rice and bought labor profited
handsomely; those who sold labor and bought rice were in despair. No
one wants to repeat that experience.
But by stabilizing the price of rice and other grains, which make up 24
percent of total expenditures of the poorest twenty percent and 18 percent
of the next poorest twenty percent, much of the sting can be taken out
of inflation. If soybean prices are added to those which are stabilized—
that is, soybean prices are allowed to rise more slowly—then inflation for
the poor would increase at about three-quarters of the average rate. As
inflation accelerates nominal wages also rise more quickly. As a result,
if inflation accelerates from three to ten percent on average and by
5.25 percent for the poor because of food price stabilization, then the
real wage of the poor will decline by 2.6 percent in the first year as the
result of inflation (Papanek, Setiawan & Purnagunawan, 2013). But if
at the same time new jobs increase by ten percent as Indonesian exports
become more competitive, then wages will rise by five percent as a result
(Ibid). The net effect will be a 2.4 percent increase in real wages.
More rapid inflation which results from bad harvests is unambiguously bad for the
poor. But if higher rates of inflation are the result of a devaluation which increases
demand for labor, then the net effect can be beneficial to the poor. Indeed as has been
shown in a previous chapter, during some periods of devaluation the poor benefitted
substantially.
The macroeconomic scenario outlined here is not just theory: it is in
its essence the path pursued by China and to a more limited extent
153
The Economic Choices
Facing The Next President
Vietnam, Japan, Korea and Taiwan. These countries followed a similar
strategy during the early stages of industrialization. They are not high
inflation countries. They have understood that ensuring adequate supplies of
essential commodities like basic foods at stable prices can help deliver the desired
combination of price stability and a competitive currency. Indonesia too has found the
right combination during some periods in the past.
For other periods, especially in recent years, Indonesia has done the opposite
of what is desirable. The currency has been allowed to appreciate, with an occasional
further nudge upward by the central bank, as a means of inflation control. This was
a major factor in the stagnation of manufactured exports, while rapidly growing
manufactured exports in other Asian countries provided jobs and income to millions
of families.
At the same time, food prices have been driven up by tariffs, cartels, import quotas
and inadequate infrastructure. Instead of allowing the depreciation of the currency to
provide protection to all producers, import controls provided windfall profits to those
given licenses to import. The controls also resulted in temporary shortages of such
important vegetables as garlic, onions and chilies.
The problem is that inflation was at least partly cost-push—that is, caused
by inadequate supplies that cannot readily be increased when prices rise,
as is the case of shortages of vegetables important for poor people who
subsist on an otherwise bland diet. In that case pushing up interest rates
to reduce consumer demand and thereby contain price inflation is the
wrong cure for the wrong disease. The problem is not too much total
demand, it is a shortage of a few key goods with highly inelastic demand.
The short-term solution is to introduce a flexible policy so that imports
automatically increase when shortages appear. The medium-term
solution is an agricultural policy that helps farmers to produce more
chilies, onions, garlic rather than concentrating solely on growing more
rice—which, by the way, is a commodity that can readily be stored to
smooth out fluctuations in supply.
Dealing with deficit in the balance of trade and the balance of
payments: "Panadol" or the structural solution.
Closely related to the problem of inflation is the deficit in the balance
The Economic Choices
Facing The Next President
154
of trade or the excess of imported over exported goods, which has
resulted in a large deficit in the current account of the balance of
payments. Export earnings more than doubled in the six years of the
commodity boom and imports increased proportionately. With the
end of the boom in 2011 export earnings declined by almost fifteen
percent in two years and a further four percent in the first five months
of 2014. But imports continued to grow in 2012 as national income
increased. The result was a deficit in the trade account as earnings
from goods exports no longer covered the cost of goods imports. Since
Indonesia has always had a substantial deficit in services, largely
because of substantial payments for shipping and insurance on imports
and exports, the current account of the balance of payments became
substantially negative.
The "Panadol" or short term solution: monetary tightening and short-term capital inflows.
Bank Indonesia dealt with the problem by using the tools at its disposal,
namely a tightening of monetary policy and an increase in the interest
rate. This was expected to have two effects. First by making credit more
expensive, it was designed to slow the rate of growth of both consumption
and investment. Less consumption would mean a decline in the import
of consumer goods; less investment meant fewer imports of machinery
and other investment goods and a decline in the import of intermediate
goods used in production in Indonesia. Monetary tightening reduced
the demand for imports by slowing the rate of growth of the economy.
In fact, the effectiveness of this tool turned out to be limited and imports
continued to increase in 2012. They finally decreased in 2013 but were
still above where they had been in 2011. The trade deficit continued
to increase in 2013 as exports declined by more than imports. In the
first seven months of 2014 the deficit finally narrowed as the economy
slowed further, which reduced imports. Monetary tightening and
increased interest rates were effective in reducing imports but even
after two years they had not achieved balance in the trade in goods.
And they had contributed to a slowdown in economic growth.
The higher interest rate had a second consequence: it attracted
more short term portfolio investment in stocks and in bonds. Short
155
The Economic Choices
Facing The Next President
term capital inflows financed the deficit in the balance of payments.
However short term capital can just as readily flow out as it flows
in. It is therefore like medicine that reduces the fever and makes the
patient feel better, but does not solve the underlying problem. Short
term foreign capital moves around the world in response to rates of
return on different assets. When rates of return in the US were kept
extremely low by the policies of the US central bank, the Federal
Reserve, and rates of return in Europe and Japan were even lower,
the rates of interest in Indonesia looked very attractive indeed. But as
long as Indonesia depends on short term capital inflows to balance its
accounts, it is at the mercy of policy changes in other countries. When the Federal Reserve Bank in the US raises interest rates, some
short term capital is likely to flow out of Indonesia in order to take
advantage of the higher rates of return and the greater safety of US
Treasury bonds. Increased returns in Europe or Japan would have
the same, although less pronounced, effect. To continue financing the
deficit in the balance of payments in the face of higher interest rates
in the US, Indonesia would need to raise its interest rate even higher.
As a result, it would further slow the growth of the economy. The short
term monetary approach to a solution therefore brings with it some
substantial medium term risks.
Structural reform approach
The alternative solution is to tackle the structural causes of the
imbalance and especially Indonesia’s heavy reliance on commodity
exports, the prices of which are extremely volatile. Structural reforms
which are advocated in this paper require above all a change in
incentives in order to encourage the production of exports and
the domestic production of goods currently imported. To achieve
these structural reforms in turn requires improving the competitive
position of Indonesian industry by reducing its costs in relation to its
competitors.
Dealing with the balance of payments deficit: combining monetary and structural
approaches. Both approaches for dealing with balance of payments
The Economic Choices
Facing The Next President
156
deficits have their strengths and weaknesses and a combination of the
two may be the best and most realistic policy. The advantage of the
purely monetarist policy is that it can be implemented quickly by action
of Bank Indonesia alone and can produce speedy results through its
principal instrument, the higher interest rate. Central bank action can
reassure investors that Indonesia is taking action and therefore help
in preventing capital flight. But it does not address the fundamental
problem of imbalance and leaves the country vulnerable to policy
changes elsewhere in the world over which Indonesia has no control.
Many, but not all, of the structural policy changes take time to
implement. Changes in the exchange rate that have a powerful impact
in stimulating exports and discouraging imports can be achieved as
quickly as changes in the interest rate. However, the effectiveness
of exchange rate changes depend on establishing that they reflect
a longer-term change in government policy. Investors will generally
not respond to a one-time devaluation of the currency. Since most
investments will take some time to produce a profit, investors will
respond to a change in policy which assures them that the exchange
rate will continue to be adjusted over time in order to keep local costs
relatively stable in foreign currencies, however much they increase in
rupiah. The full impact of exchange rate policy will therefore take
some time to be realized. Other structural changes will take even
longer to be effective.
A key element in structural reform will be measures to attract Foreign
Direct Investment to close the balance of payments gap. Unlike
portfolios investment, FDI cannot readily flow out again. It is invested
for the longer term and contributes to a permanent solution to the
problem.
A judicious combination of monetary tightening and structural reform
is often the most effective package to deal with a balance of payments
deficit. Monetary tightening without structural reforms is risky because
its effectiveness may depend on short-term capital inflows that are
easily reversed. And it may be effective only at a big cost in terms
157
The Economic Choices
Facing The Next President
of slower growth, fewer jobs and more misery. Structural reforms
without monetary tightening may be too slow to prevent capital
flight. Temporary tightening to avoid capital flight accompanied by
structural reform to deal with the fundamental problems can be a good
combination.
In short, there are significant political costs to a larger role for Foreign
Direct Private Investment. But it needs to be recognized that there are
substantial economic costs to a reduction in foreign investment. These
economic costs translate into political costs over time as the economy
grows more slowly and fewer good productive jobs are created.
Foreign Direct Investment is needed to:
i.
fill the gap between savings and needed investment. To achieve
ten percent growth Indonesia requires an investment rate of
about forty percent, but savings have been 30 to 35 percent. FDI
of $60 to 80 billion is needed a year to fill the gap. Indonesia
has just attracted $10 to 15 billion of FDI a year net in the
past. If it attracts no more in the future, growth will be about
7.5 percent instead of ten percent in the final year of the new
president’s administration;
ii. provide needed technical and managerial skills, and the ability
to mobilize and risk huge sums of money; and
iii. provide easier access to some global markets.
In attracting FDI Indonesia is in competition with other countries.
Investment in some other countries has become more attractive
recently while investment in Indonesia is seen as less attractive and
more risky. The country needs to strike a careful balance between
giving preference to domestic investors while attracting sufficient
foreign investment to prevent a slowing of growth and job creation.
It is more efficient to help Indonesian investors and professionals by
taxes or fees on foreigners rather than through the introduction of
rules and quotas. A system of fees/taxes would reduce corruption and
generate government revenue.
The Economic Choices
Facing The Next President
158
The policy package to increase the export of labor-intensive manufactures
will undoubtedly include a devaluation of the rupiah by ten to fifteen
percent in the short term. That will increase the price of imported and
exported goods and contribute to inflation. But it will help to balance
international trade by increasing exports and reducing imports. It can
also stimulate savings by making imported luxury goods more expensive.
Its impact on the poorest forty percent can and should be mitigated by
stabilizing the price of rice, wheat, maize and soybeans, and perhaps
onions, garlic and chilies. If that is done the impact of an acceleration
of inflation from three to ten percent would reduce the real wage by only
2.6 percent for only one year. This negative effect can be swamped by the
positive effect of increased demand for labor.
A monetary policy which results in more rapid inflation and a decline
in the value of the rupiah can be a pro-poor policy. Conversely, a
tight monetary policy that uses an overvalued exchange rate to reduce
inflationary pressure harms the poor because it slows the creation of
good, productive jobs.
159
The Economic Choices
Facing The Next President
Chapter 9.
Reducing the Cost of Corruption, Doing
Business and Credit
Surveys have shown that the cost of corruption, business regulation and
credit are of less importance than the cost of infrastructure and labor
in the competitiveness of Indonesian manufactured goods. However
these costs matter because Indonesia ranks near the bottom on two of
them. Moreover, they can more readily be reduced than the high cost of
infrastructure and labor. With some effort and some willingness to face
political opposition, substantial improvement can be achieved in a year
or two with respect to the cost of corruption and of doing business and
possibly the cost of credit. It would be worth harvesting this low-hanging fruit
early in the term of the new president to record some quick achievements.
Changing a culture of corruption is difficult and takes time
Corruption has been widespread and well entrenched in the Indonesian
government for at least fifty years. For a substantial period between
the time of independence and the early 1970s, it was difficult for civil
servants and their families to survive if they were honest and had no
source of income other than their government salary. During these
periods inflation of twenty to 700 percent reduced the salaries of most
civil servants even at the highest level to a fraction of their original
purchasing power. At various times the salary of even senior civil servants
was barely enough to buy rice and other staples for one week out of the
month. Rice provided by the government covered a second week. The
only way to purchase food for the remaining two weeks was to find some
other source of income. Civil servants who were sent on foreign missions
would save much of their travel allowances, and use the foreign exchange
to purchase rupiah in the grey market to finance their living expenses.
Officially the exchange rate was Rp 90 for a US dollar, but in the grey
The Economic Choices
Facing The Next President
160
market the rate was Rp 1,000. An official who was paid Rp 15,000 a
month and who saved $1,000 in travel allowances could exchange this
for one million rupiah, equal to more than five years of salary. Other
officials supplemented their salary with rental income from land and
houses or financial support from their families.
The large majority who did not have an outside source of income had
to find a way to supplement their government salaries by accepting
bribes, selling government property or other illegal activities. Workers
on plantations appropriated part of the output to sell in the market;
military commanders sold the managerial positions on plantations in the
area under their command. Government appropriations for the military
were clearly inadequate. Army units had to supplement government
allocations one way or the other and they did so by various legal, semilegal and not-so-legal means. Imports were licensed and the officials who
issued licenses had the power enrich or ruin businesses in every sector.
These officials were richly rewarded for awarding licenses to particular
enterprises.
By the mid-1960s a culture of corruption was well established and has
largely persisted to this day. The benefits of corruption were large, the
chances of being caught were small and the costs if you were caught
were just part of the overhead of corrupt business practices. The costbenefit ratio made corruption an attractive proposition for any but the
most ethical. Until the establishment of the Corruption Eradication
Commission (KPK) those in powerful positions were never charged with
corruption unless it was for political reasons.
For the first time in Indonesia’s recent history the KPK has made it
risky and potentially costly to be corrupt. Both the risk and cost of being
caught increased substantially. Government officials up to and including
the level of governors, ministers, members of parliament and senior
judges could go to jail and be deprived of their ill-gotten gains. As a
result, Indonesia moved up in the table of corruption perception to some
extent.
161
The Economic Choices
Facing The Next President
Table 15. Corruption Perception Index: Indonesia Compared to other Asian Countries
Source: Transparency International, 2002, 2005, 2010, 2013
In 2002 Indonesia was in the most corrupt six percent of all countries
covered, sharing with Bangladesh the dubious honor of being
perceived as the most corrupt in Asia. By 2013 Indonesia had moved
significantly ahead of Bangladesh in the corruption rankings and had
moved well up in the world rankings. But it was still barely ahead of
Vietnam and is in the most corrupt forty percent.
That is not in a good position to be in. If the KPK remains in
existence, if it remains staffed by honest and courageous persons, and
if it retains the backing of the president, then Indonesia’s position
on the Corruption Perception Index is likely to continue to improve
slowly but surely. But it will be a slow process just as it has been in the
past because a deep-rooted culture of corruption responds only slowly
to the threat of prosecution of a small number of cases.
Corruption can be reduced quickly by reducing the scope of
discretion of officials; making decisions transparent; and
testing the honesty of different agencies
Reducing the power of officials to benefit or hurt specific individuals or groups.
If an official has substantial discretion whether to award a permit or
license that is of considerable value to a business, then the likelihood of
corruption is great. The greater the area of discretion and the greater
The Economic Choices
Facing The Next President
162
the benefits that an official can give or deny, the greater the likelihood
of corruption. Conversely if there are clear rules for who gets a
license, permit or priority assistance that limit official discretion, then
the incentive to bribe officials will decline. And of course if approval
by an official is not required then there will be no basis for corruption.
The clearest historical example is the system of import licensing in the
early 1960s. Private imports required a license which authorized the
holder to receive foreign exchange at the rate of Rp 90 for each dollar
of imports. Demand for imports was such that one dollar was worth
Rp 1,000 in the grey market. In Hong Kong, where the rupiah was
freely traded, it took roughly Rp. 1,000 to buy one dollar. An import
license for a car that cost $10,000 meant a profit of 900 percent. The
merchant would pay Rp 900,000 for the $10,000 needed to buy the
car at the official rate of Rp 90 to the dollar. But the car was worth
Rp 10 million at the grey market rate of Rp 1,000 to the dollar. Both
the merchant who was awarded the import license and the official
awarding it became rich. Import licenses were a major source of
corruption. When import licenses were auctioned off to the highest
bidder this source of corruption disappeared overnight.
If no permit is required for establishing a business or a manufacturing
enterprise, expanding the business or entering a new area of
production, then a substantial source of corruption would disappear.
A new or changed enterprise could still be required to report for
statistical purposes, but that would be an automatic process with no
discretion involved.
Currently foreigners need a permit to work in Indonesia. Whether
to grant a permit gives the officials concerned some discretion and
therefore the opportunity to extract a bribe. If government were
instead to impose a tax on foreign employees which increases over
time, then the official would have little discretion or opportunity to
extract a bribe; the government would receive some income; and
companies would have an increasing incentive to replace foreign with
Indonesian staff.
163
The Economic Choices
Facing The Next President
Quotas on imports of beef and vegetables provide extra profits to those
lucky few allocated part of the quota and also tempts both the officials
controlling the quota and the traders seeking it to engage in mutually
profitable corruption. Corrupt officials and traders benefit. A tax or
tariff on the import of those goods would eliminate corruption and
transfer the benefit from the corrupt official to the government.
Another example: foreign companies need to sell off a share of the
company to Indonesian investors. In some cases the price offered is
inadequate but collusion with officials has kept others from bidding. If
the requirement to sell off a specified percent of assets is replaced by
a tax that increases over time and in proportion to unsold assets, then
the firm can look for other buyers by paying the tax.
While a tax that applies to everyone is better than a prohibition with
discretion in the hands of an official, the natural working of the
bureaucracy will always result in regulation. Officials always prefer a
system that gives them power and discretion even if they are totally
honest. Only if the president, the finance minister or the coordinating
minister for the economy is determined to reduce regulations that
spawn corruption is there a chance that regulations will not increase.
There needs to be a small unit whose sole purpose is to reduce
regulations that foster corruption. Since the recommendations of that
unit will be resisted by most ministries and officials, the unit to reduce
regulations is best located in the president’s office.
Total transparency will dramatically reduce corruption
In some areas it is impossible to reduce officials’ discretion. The courts
are the most important example. It is not possible to substitute clear
rules or taxes for judges’ discretion. Yet corruption in the judiciary is
a serious problem. It could be reduced by requiring that all decisions
be posted on the internet together with the justification or reasoning
behind the decision. Requiring public justification of decisions has
been effective in greatly reducing judicial corruption in other settings.
Another major source of corruption in many governments, including
Indonesia, is in the awarding of government contracts. Here again
The Economic Choices
Facing The Next President
164
it helps to require that all decisions are posted on the internet where
they can be accessed by the public together with a justification for the
decision. Such a requirement would make corruption more difficult
and risky. Delays in decision-making could be automatically flagged
so that delaying an action in order to extract a bribe would become
very visible.
Experience in Indonesia and other countries has identified other
steps that can be taken to reduce corruption. An extensive literature
on anti-corruption efforts has emerged in recent years that provides
plenty of examples of successful initiatives. The main point that we
would like to emphasize in this section is that reducing the discretion
of officials and greatly increasing the transparency of all decisionmaking would move Indonesia up the ranking table for corruption by
enough to increase the country’s economic competitiveness.
Patronage vs corruption
The Indonesian government, like most governments, needs to be able
to provide some patronage in order to function smoothly. Parties need
money to function and it helps to raise money if major contributors can
expect some financial reward if the party wins elections. Ambassadorial
appointments are a source of patronage in many countries. At
one time in the US the postmasters of major cities were patronage
appointments, with the campaign managers of the winning candidate
assuming the position of postmaster general. But ambassadorships are
rather small rewards in Indonesia. Parties in the winning coalition
have expected control of ministries that generate lucrative incomes
for those willing to take full advantage of their potential. But most
of that income would be regarded by most analysts as a product of
corruption.
There is no clear-cut dividing line between patronage and corruption.
At its best patronage is legal, transparent and limited while corruption
is illegal, hidden and unlimited. The distinction between limited and
unlimited needs explanation. The amount of patronage a person
receives should be limited by what is allocated to the particular
165
The Economic Choices
Facing The Next President
position the person holds, while corruption is unlimited in that the
official concerned can ask what he or she thinks the market will bear
in a particular transaction. Corruption depends partly on the greed of
the official and the number of permits or other scarce goods that he
or she controls.
One way of providing patronage that is legal, transparent and limited
is to provide discretionary funds to the president, ministers and
members of parliament which they can spend for purposes that they
consider useful. In some countries such funds can only be spent for
development. The more restrictions imposed on these funds the less
they will substitute for participation in corruption. Since ministers will
be from parties that supported the winning coalition, this is one way
of rewarding individuals and parties that support the government.
If such discretionary funds go with the job they do not require that
a minister is corrupt and will demand specific payoffs in return for
permits and licenses.
Parties could be allocated funding for their election campaigns
in proportion to the number of votes received in the last election.
Currently the government most probably cannot afford the sums of
money it would take to substitute fully for the funds that individuals
and parties now receive in deals which would be considered corrupt.
But establishing a system of legal allowances would in the first instance
make it easier for honest ministers and other senior officials to remain
honest and, over, time could gradually substitute increasing allowances
for lessening graft. The process will go faster if the KPK continues to
make taking bribes risky and costly.
High cost and low cost corruption
It is especially important to reduce, and if possible to eliminate,
corruption which imposes high costs on the economy. Low cost
corruption imposes a cost on the economy which is equal to the
funds received by the corrupt official. Consider the real-life example
of a commission given to a well-connected individual for oil sales
to a particular country. The person concerned was appointed as
The Economic Choices
Facing The Next President
166
the agent for oil sales to the country. He did little or no work as the
agent since the contracts had all been negotiated earlier. The cost to
the Indonesian economy was the cost of the commission paid. The
commission amounted to several million dollars a year, which was a
substantial amount for the individual but negligible relative to the size
of the Indonesian economy.
High cost corruption, by way of contrast, changes prices or results in
other distortions that reduce income or output for large numbers or
people and businesses. Examples include the clove monopoly imposed
during the Suharto government and the steel import monopoly. The
income received by the beneficiary of the clove monopoly may have
been quite small but the cost to the Indonesian economy was large. The
monopoly depressed the price of cloves paid to farmers and therefore
resulted in reduced production and exports.
Even more costly was the monopoly for the import of steel and
steel products. It resulted in a costly and uncertain supply of coated
steel needed for the production of cans used for exporting canned
fruits. As a result, the canned fruit export industry remained small
and uncompetitive. By virtually eliminating exports of canned fruits
and vegetables, the cost to the Indonesian economy of the monopoly
was a multiple of the benefit received by the monopolist. If the steel
monopolist had instead been given a commission for the export of
oil and gas, the beneficiary would have received more money at less
cost to the Indonesian economy. When the steel monopoly ended, the
export of canned fruits increased.
Barriers to domestic and international trade which require a permit
or license from an official are another form of corruption in which
the cost to the nation is a multiple of the benefits received by the
corrupt individual. Trade barriers generate risk and uncertainty, which
reduce production and exports and therefore impose high costs on the
economy. They also make it less likely that goods will be produced in
the areas most suited to producing them. When barriers are imposed
on the trade in rice between surplus and deficit areas then more rice
is grown in places unsuited to growing rice. Moving rice from high
167
The Economic Choices
Facing The Next President
productivity areas that produce rice cheaply and efficiently to places
where it is expensive to grow rice is made more costly. Uncertainty
with regards to rice prices and supplies increases because the bribe
needed to allow rice to be traded can be arbitrarily changed.
The increasing number of permits or licenses that foreign investors
have to obtain reduces the amount of inward investment. The cost of
obtaining these documents can be large. Moreover, there is the cost
of delay and the difficulty of predicting the outcome which raises the
cost of doing business as companies must have fallback plans in case
permits are not forthcoming. Finally mid-level officials of foreign
firms are afraid of incurring the anger of their CEO or other senior
official if he or she feels humiliated in their dealing with junior officers
of the Indonesian government.
Because of the potential cost to the economy of licenses, permits and
barriers to trade, it would be ideal if barriers to domestic trade could
be eliminated entirely and barriers in the form of licenses or permits
for imports or exports could be reduced or eliminated by the national
government. To achieve these objectives and reduce opposition to
reforms it may be worthwhile to find some other way to provide similar
levels of compensation to the individuals concerned so they are not
much worse off as a result of reform. For instance, customs officials
could be given a special hardship allowance based on the theoretical
possibility that they could be moved to another post. By eliminating the
distortions in the economy that the barriers created the country would
be better off even if the allowance is equal to the benefits previously
derived from corruption.
The increasing use of import controls.
There has been a particularly large proliferation of controls over
imports in recent years, mostly to protect domestic producers from
import competition. This leads to distortions since these selective
controls are imposed in response to influence, political pressure
and possibly bribes. The proliferation of controls in turn increases
opportunities for corruption. A fifteen percent decline in the value of the
The Economic Choices
Facing The Next President
168
rupiah would provide the same fifteen percent rate of protection to all
Indonesian producers competing with imports without discrimination
or distortion or opportunities for corruption. If a particular industry
requires greater protection, for instance because it is an infant industry,
then it can be given a special infant industry tariff that automatically
is phased out over a specified number of years.
In short, licenses tend to enrich those who receive them and those who award them;
tariffs enrich the government and therefore society. Licenses lead to corruption,
tariffs less so and devaluation not at all.
Making it easier to do business
With respect to business regulation, or “Ease of Doing Business,”
Indonesia is again well down in the rankings: 120 out of 189 in 2014.
There has been substantial improvement: in 2006 Indonesia was in
the worst 25 percent among countries; by 2014 it was in in worst
forty percent. Nevertheless it was still behind some of the countries
with which it competes, most notably Vietnam. Some of the primary
reasons for the low ranking would be dealt with by steps to reduce
corruption.
The overall rank for Ease of Business is an average of several factors.
On one of these, which ranks the difficulty of “Starting a Business,”
Indonesia’s rank is 175 th out of 189 countries—among the worst in the
world. This low ranking reflects the number of permits needed to start
a business, the discretion that officials have in delaying or denying
the permit, and the lack of clear-cut information on what determines
these decisions. To that must be added the perception of Indonesian
corruption. Management must decide whether to offer a bribe. If that
is illegal in the country of origin of the firm then the management has
to decide whether to break the home country’s law or to obey it and
wonder whether to enter a situation where competitors who do bribe
will have an unfair advantage.
169
The Economic Choices
Facing The Next President
Table 16. Ease of Doing Business: Indonesia Compared to other Asian Countries
Source: World Bank 2006, 2010, 2014
The steps suggested above to reduce corruption would, in most cases,
also make it easier to do business in Indonesia. If the discretionary
authority of government officials is reduced or eliminated, this would
facilitate investing in Indonesia. If, instead of getting several permits, the
new enterprise simply had to report its particulars on line, Indonesia’s
score on starting a business would greatly improve.
To the extent that the process is not automatic but requires a decision
by an official, then putting the decision and its rationale online would
speed the process and increase the confidence of all investors in its
fairness. If rules are clearly set out on what is permitted and what is not;
if permits can be issued on line as long as the rules are followed; so that
the process of establishing a new firm can be done quickly at low cost to
the enterprise; and without any need to pay a bribe; Indonesia would be
far more attractive as a destination for investment.
Enforcing contracts is the second sub-category where Indonesia falls short.
This is in large part a problem of judicial corruption. We have addressed
this issue earlier.
The Economic Choices
Facing The Next President
170
Resolving insolvency is the third area where Indonesia is seen to be weak.
Severance pay is a major factor making it difficult to deal with insolvency
or even with setbacks to a firm. When demand declines because of a
world recession firms need to be able to reduce their labor bill. Laying off
workers can actually increase the bill because of severance regulations.
Firms deal with the potential cost of severance by hiring fewer workers
and using machines, by using contract labor, or by simply not paying
severance. A system in which firms make regular contributions to an
unemployment insurance fund would greatly ease this situation. There
would be no extra cost to the firm if it temporarily or permanently
reduced the size of its workforce. The workers would be paid out of the
insurance fund to which the firm had contributed while it was operating
profitably.
Distinguishing between resource intensive and labor intensive
investments
Most of the criticism of foreign investors by Indonesian politicians
and in Indonesian media, and most of the proposals for restricting
their role have had to do with firms operating in the natural resources
sector. A policy designed to encourage investment in labor-intensive
manufacturing, especially for export or in competition with imports,
would need to encourage both foreign and domestic investment in labor
intensive manufacturing, even if this means drawing a clear distinction
between the treatment of foreign companies in this sector and the
natural resource sector. Indonesia is going to be in fierce competition
with other countries in producing manufactures for export. Part of the
reason for Vietnam’s success relative to Indonesia is that Vietnam has
attracted foreign investment in the production of labor-intensive exports.
Unless Indonesia also succeeds in doing so, it will fight with one hand
tied behind its back.
Favoring Indonesian investors. Indonesian investors can be provided with
special incentives or benefits, for example a facility that provides longerterm credit that is open only to them. This approach does not discourage
or limit foreign investment but encourages Indonesian investment and
results in higher levels of total investment.
171
The Economic Choices
Facing The Next President
Inadequate and costly credit for investment
Getting credit is another area in which Indonesia is considered to be
weak. Credit is relatively expensive in Indonesia because the banks enjoy
very high margins between the interest that they pay to depositors and
the interest they charge to borrowers. This makes banking very profitable
in Indonesia. In addition, the banks are reluctant to lend for the long
term to finance new investment and for expansion. This is a particularly
serious problem for some of the labor intensive industries that have not
generated enough internal returns to update their machinery.
The usual demand of various industries is for government subsidies,
hidden or open, to make it cheaper to install new machinery. But if
it becomes cheaper to invest in machines, then there is a danger that
industries will become less labor-intensive. For a country that has surplus
labor, adding to that surplus is not a good idea. However, there are
machines which supplement labor rather than replacing it. For instance,
one worker can tend more of the modern looms than of the older ones.
Installing new looms will replace workers. On the other hand, it may
require sophisticated machines to produce the most expensive embroidery.
Without these machines no additional workers will be employed. In this
case machines do not replace labor but actually increase employment.
Any policy for government subsidization of upgrading machinery
therefore needs to be quite sophisticated or it may do more harm rather
than good.
Reducing the cost of credit by reducing the spread and increasing the availability of longer
term credit. It would be desirable however to reduce the spread—the difference
between the rate of interest that banks pay depositors and the rate they
charge borrowers. Increasing competition among banks is one way to achieve
a lower spread. It is particularly important to increase competition in areas
that are served by a single bank. A small government subsidy to banks to
cover a part of the investment to expand to new areas of the country could
be helpful. This could cover part of the cost of computers or motorcycles
for new mobile banking units in rural areas or the establishment of banking
offices in small towns. The subsidy could be available for areas where there
are no banks currently or where there is only a single bank.
The Economic Choices
Facing The Next President
172
Subsidies to lower interest rates are a bad idea because they make it
cheaper to substitute machines for workers. But subsidies that increase
the availability of deposit facilities and of credit, make it easier to keep
money safely and encourage savings and therefore can lower the spread
and make for a more efficient economy.
International banks – part of the solution or adding to the problem? It is often argued
that the best way to reduce costs is to permit the expansion in the country
of efficient international banks that would introduce modern techniques
and lower costs. This does not always work. The international banks may
simply take advantage of their connections to large international firms
to get a share of the simple and easy business of financing international
trade. They may happily benefit from the high margins that prevail in
the country and enjoy large profits rather than competing on price and
bringing down margins.
There is no easy solution to this problem. One possibility is to specify in
the licenses for foreign banks exactly how much of their business can be
in trade financing. But these kinds of rules are difficult to enforce.
Some of the largest banks in Indonesia are owned by the government. The
government could use these banks to provide more long-term funding and
reduce the interest-rate spread. The state-owned banks could take the lead
in lending for investment and in bringing down the interest rates charged to
borrowers. But so far they have been content to participate in the current
system. Perhaps additional competition would serve to force down the
spread but since that would damage the profitability of the governmentowned banks, there may be some reluctance to see that take place. Since
the high cost of interest reduces the competitiveness of Indonesian
manufacturing, any steps that reduce the interest rate charged to borrowers
should be welcome. Government owned banks, like privately owned banks,
need to improve their efficiency in order to remain profitable with a more
normal spread between their borrowing and their lending costs.
Shortage of credit – Banks are reaching their lending limit
A looser monetary policy needs to be combined with appropriate fiscal
policy, especially an increase in government revenues as discussed in
173
The Economic Choices
Facing The Next President
chapter 7 and commercial credit policy discussed below. Fiscal and
monetary policy changes must be accompanied by the structural reforms,
which are the main subject of this paper.
Credit in Indonesia is not only expensive it is not readily available,
particularly to medium-sized and smaller enterprises. The large
enterprises can, if need be, borrow abroad, but medium-sized and smaller
enterprises cannot. They are dependent on credit from Indonesian
banks. Most of these banks cannot expand their lending unless their
deposits or their capital increase.
In order to provide finance for rapid growth of the economy, banks
should increase lending more rapidly than the increase in deposits. They
can only do this prudently if they can increase their capital. It is difficult
for them to raise enough capital in Indonesia, since those who control
substantial pools of capital—businesses and wealthy individuals—
generally prefer to invest in their own enterprises or those of their family
and friends.
Banks could expand their lending more rapidly if they were able
to obtain foreign capital. Even the state-owned banks have this
problem. The national government currently does not have resources
to inject into the banks without taking these resources from other
high priority needs. Indeed, as discussed earlier, additional resources
available to the national government should first be used for investment
in infrastructure. One solution for the banks, both private and public,
is to attract foreign direct investment. If foreign capital comes in the
form of minority share-holdings in Indonesian banks, it could bring
with it also some technical know-how that would be useful in improving
the efficiency of Indonesian banks as well as in expanding their capital
base. To attract foreign direct investment into the banks obviously
requires that foreign banks find in Indonesia a suitable environment
and one in which it is possible for them to be profitable without causing
great problems for themselves. Once again there is a substantial tradeoff between nationalistic rhetoric and policies that result in less FDI and
slower growth on the one hand versus policies that are more conducive
to FDI and more rapid growth on the other. The latter alternative would
The Economic Choices
Facing The Next President
174
certainly impose some political costs in the short term, but would also
generate substantial economic benefits that would translate into political
benefits with some delay.
Summing up: Indonesia ranks poorly on three aspects of competitiveness:
corruption, ease of doing business and cost of borrowing. These are
less important than the cost of infrastructure and of labor, but two
aspects could quite readily be improved and help improve Indonesia’s
competitive position.
The culture of corruption is well established in Indonesia as a result of
a long period when government officials could not survive without the
income that corruption brought. It is difficult and takes time to change
such a culture. But Indonesia has made some progress in reducing
corruption and the cost of corruption to business. It could do much more
by reducing the benefits of being corrupt and increasing its cost.
1. Reducing the discretion which government officials now have
in deciding whether an enterprise will be profitable or will
fail. The temptation to affect such decisions by corruption is
usually irresistible. Instead of using regulations administered
by officials, government can discourage some activities and
encourage others by taxes or subsidies available to any business
behaving in certain ways or by clear-cut regulations which leave
little discretion to the individual official. The less the discretion
of the official to reward or punish, the less the corruption.
2. Where discretion cannot be reduced or eliminated, as in judicial
decisions, corruption can be reduced by transparency. If all
judicial decisions or awards of government contracts need to
be posted on the internet together with the justification for the
decision, corruption will be reduced, especially in the judicial
system.
Indonesia has also improved its standing with respect to the ease of
doing business. But its rank is still low: in the bottom forty percent of all
countries. Many of the steps to reduce corruption will also improve the
ease of doing business. One of the reasons it is difficult to establish a
175
The Economic Choices
Facing The Next President
business in Indonesia is that the approval of many officials is required,
all of whom have substantial discretion and who base their decisions on
unclear and unspecified criteria. If instead of rules interpreted by officials
there are specified fees for engaging in certain economic activities and no
fees or even subsidies for others, then doing business in Indonesia would
be simpler, faster and less subject to uncertainty and risk.
To reduce corruption and improve the ease of doing business, direct
import controls should be abolished and replaced with currency
devaluation and taxes on specific imports. The beneficiary of import
taxes will be the government, while the beneficiary of import licenses
will generally be the official in charge of awarding them.
The difficulty of obtaining credit for investment and the high cost of
borrowing are another obstacle to the competitiveness of Indonesia's
exports and import substitution industries. The Indonesian banking
system has a particularly large spread between borrowing and lending
costs which is partly the result of a lack of competitive pressure to become
more efficient. The large government banks have not played a major
role in reducing the spread or in providing investment financing. The
solution to this problem is less clear-cut than in the case of the other two
problems. It may be that increased competition could force the system to
lower interest rates to borrowers and to provide more long-term loans.
In addition, credit is difficult to obtain, especially by medium-sized and
smaller enterprises. In part this is due to the fact that most banks can
expand their loan portfolios only as they are able to expand their deposits
or their capital. Deposits increase slowly and large infusions of new
capital can only come from FDI.
The Economic Choices
Facing The Next President
176
Chapter 10.
A Guaranteed Employment Program to
Assure Income in the Off-season and
Transform the Rural infrastructure.
A Guaranteed Employment Program can provide significant and
immediate benefits to a large proportion of the population and to an
even larger part of the poor population. Most reform programs have
costs in their early years and bring benefits in later years. This makes
their adoption a difficult political task. The Guaranteed Employment
Program, by providing benefits within the first two years, a can ease the
acceptance of other policy changes. It can be launched quickly because
it can build on the existing PNPM-Rural Program which covers virtually
every kecamatan or sub-district in the country. The existing program is
popular in the rural areas and could help get the reform package off to
a popular start
Guaranteed Rural Employment: Turning uncertain, part-ofthe-year employment into almost-good, more productive jobs
The Guaranteed Rural Employment Program does not provide good,
productive jobs as we have defined them in earlier chapters: jobs that
assure a year-round income, in many cases with some benefits. But what
it can and must do is to assure farm workers of income for eight to
ten months of the year. These are workers who now have a reasonably
assured income only for six to seven months, part-time employment
during several months and very little income for the “lean season” of two
to three months. During that period many families are forced to borrow
in order to have enough to eat. As a result, they can become permanently
impoverished as they struggle to pay back their debts at the high interest
rate that is common.
177
The Economic Choices
Facing The Next President
A guaranteed employment program can assure farm laborers that they will
have employment and income during the off-season. The guarantee can
help them avoid temporary periods of poverty, which can be converted
into permanent poverty if they are forced to borrow. For the program to
have an impact the initial guarantee would need to be for at least thirty
days. But it should be raised to sixty days as soon as possible in order
to cover a substantial part of the lean season. With experience it may
turn out that even sixty days is not enough. The best known guarantee
program, the one in India, is for 100 days. But that is expensive and may
be more than is needed to cover the lean season in Indonesia.
A Guaranteed Employment Program should also assure agricultural
laborers of income during periods of natural and economic catastrophe
when there is often no income as crops fail or are partly abandoned.
When drought, floods or pests hit an area or when prices fall for a crop
grown in a particular area, the lower income families in that area can be
hard hit. Work and income will suddenly be hard to find. The Guaranteed
Employment Program can serve as a Social Safety Net providing income
and employment during the resulting lean period.
The program does not provide good jobs but it does provide much better
jobs than if families are totally dependent on agricultural income. By
providing some assured income, not only during the lean season but
also when income is unavailable for other reasons, the Guaranteed
Employment program can prevent families from falling into poverty
during these periods.
Permanent improvement not a temporary hand-out
If the labor made available as a result of the program is used primarily
or exclusively for the construction of infrastructure that leads to a
permanent increase in income and employment, then the program
provides not only temporary assistance but can generate permanent
benefits. As can be seen from Table 17 on the PNPM program—which
would be the basis of Guaranteed Employment—by far the largest effort
has been the construction of roads, bridges and culverts. At one time, as
much as fifty percent of expenditures were for this purpose.
The Economic Choices
Facing The Next President
178
The economic internal rate of return of the projects built under the
predecessor program to PNPM-rural was over seventy percent (Papanek,
2011). This seems unbelievably high at first glance. But irrigation was
third most common among the projects constructed, and these projects
could yield rates of return of 100 percent or more by making it possible
to harvest two or three larger crops each year instead of one smaller
crop. Village roads too sometimes had rates of return above 100 percent
if, for example, a village that had once mostly sold dried cassava was
able to sell seasonal vegetables after the road was completed. The cost
of these locally planned and built projects was low and the returns were
high on the projects given priority by villagers themselves.
The all-weather dirt roads which were built under the program connected
villages to the existing road system. They can make a crucial difference
in a village’s ability to earn income and provide employment by making
it possible to grow perishable crops like tomatoes and other vegetables
that have a higher value than non-perishable staples like rice and
cassava. The roads can also enable villages to develop side incomes from
providing aggregate or sand for construction and they can lower the cost
of supplies to the villages, particularly for goods like fertilizer that are
difficult to transport in quantity by bicycle. These typically small rural
roads represent what can been called the ‘last mile’ in development.
The construction of drinking-water wells, which was the second most
important activity, reduced illness and saved the back-breaking work of
hauling water. Irrigation works were the third largest expenditure. They
produced higher and more assured yields than unirrigated crops and
often permitted double and triple cropping. The result was an increase in
income and employment double or triple what it had been.
Unlike other programs whose benefits lasted only as long as they
continued to spend money, the infrastructure development aspects of
the PNPM Program led to a permanent increase in employment and
income. The Guaranteed Employment Program can therefore be seen
as an integral part of development and particularly as an effective and
efficient way to improve rural infrastructure.
179
The Economic Choices
Facing The Next President
The PNPM program is not very popular among some officials since it
provides little opportunity for patronage because funds go directly to the
village. It is precisely because there is minimal diversion of funds that
it makes sense to provide the additional funding that can turn it into a
Guaranteed Employment Program.
Table 17. Infrastructure Built by PNPM, 2007-2011
Source: Project Support Facility (2011)
Why rural only
Initially, the Guaranteed Employment Program should be limited to the
rural areas for several reasons.
i.
The seasonal variation in income and employment is particularly
pronounced for agricultural workers. The lean season has some
impact on urban workers as well, as larger numbers of temporarily
unemployed agricultural laborers come to the city seeking work.
But it is agricultural laborers who are primarily affected.
The Economic Choices
Facing The Next President
180
ii. The effectiveness of the urban program has been much more
controversial than the rural program. The design of the urban
program was different and less effective, the evaluations were
less rigorous as it was being developed, and the periodic
improvements less far reaching. Increased expenditures on the
urban program may therefore be more questionable and it is
better to begin with the rural areas where there is less doubt.
iii. Opportunities to improve infrastructure are less obvious in urban
than in rural areas. There is no urban equivalent of village roads
that connect villages to the road system with massive benefits,
nor to irrigation works that double or triple crop yields. The
urban areas also need clean water and sanitation but it is more
difficult to build these in a decentralized way in urban areas
than it is in the rural areas. An urban system may require fullytrained engineers while methods of constructing rural wells or
sanitary facilities can be taught relatively quickly.
Once the rural Guaranteed Employment Program is functioning well it
would make sense to extend it to the urban areas if the weaknesses of the
urban program have been dealt with by that time.
Characteristics of PNPM that make it a good base for a
Guaranteed Employment Program
Guaranteed Employment could quickly be rolled out in the whole country
if it is based on an expansion and small modification of the existing
PNPM program. PNPM (Program Nasional Pemberdayaan Masyarakat
or the National Community Empowerment Program) now operates
throughout Indonesia, in 97 percent of all kecamatan or sub-districts.
Several characteristics important for any guaranteed employment
program distinguish it from other government programs:
•
Planning and administration are highly decentralized. Village
committees propose projects that are considered to have the
highest priority by the village population. Decentralization
provides flexibility and permits rapid expansion, and increases
the chances that the money will be spent on productive projects.
181
The Economic Choices
Facing The Next President
•
Funds go directly from the national treasury to villages, largely
eliminating the usual delays and opportunities for corruption at
earlier stages.
•
Emphasis, at least in a large part of the program, is on activities
that will increase income and employment over the long term.
•
Decision-making bodies are designed to make it difficult for
government officials to dominate decisions and to assure that
the voices of poorer villagers and of women are heard. “Elitecapture” has been largely avoided.
•
Mandatory transparent systems and community audits reduce
corruption, nepotism and other diversion of funds.
•
Above all the program is self-targeting. The daily wage rate is related
to the agricultural wage in the area. Since the program requires
physical labor generally outdoors to earn this low wage the
agricultural wage rate is attractive only to agricultural workers
who cannot find regular work. Demand for these jobs is limited to
poor people. PNPM has not become a patronage vehicle. There
is no need to screen job applicants to determine whether they
are poor – if they are willing to do the work at the wage offered
it is highly likely, indeed almost certain, that they are poor.
Turning PNPM into Guaranteed Employment
The key change in adding an employment guarantee to PNPM will be
flexibility to respond to increased demand for work. Currently whether
work is available under PNPM in a particular area at a particular time
depends on whether a project has been approved for that area at that
time and is still in need of workers. Demand for work and available jobs
therefore are not likely to match. If drought hits an area and as a result
there are suddenly large numbers of job seekers, including women and
older children, there is no mechanism to provide additional work.
For Guaranteed Employment to work the PNPM program needs to add
a mechanism that will enable it to respond flexibly to changes in the
demand for jobs:
The Economic Choices
Facing The Next President
i.
182
reserve funds to send to areas where there has been an
unexpected increase in the numbers seeking work;
ii. each area needs a stock of projects that have been approved but
not yet funded. That in turn requires some support for project
preparation and some assurance that approved projects will
eventually be funded. When they will be funded will depend on
how soon there is an increase in the demand for jobs under the
Guaranteed Employment Program.
The employment provided by PNPM tends also to be only for a few days
at a time, rarely for more than ten to fifteen days. While it is of some help
in enabling families to have some income during the lean season, it is not
enough to bridge that season.
The PNPM Program will require additional funds.
It is difficult to estimate in advance what the demand for PNPM jobs will be
and therefore how much the program will cost. One estimate is that to provide
thirty days of work to roughly 23 million workers at the average agricultural
wage of Rp. 43,000 a day would require about Rp 30 trillion (US$ 2.7 billion).
Some of that cost will be covered by existing PNPM budgets.
Even Rp 20-25 trillion may seem a large sum if thought of as a social
welfare expenditure. But if considered as a way to build rural infrastructure
efficiently that is a different matter. And if the expenditure is viewed as
an economic, rather than as an accounting, matter the real cost shrinks
even more. Something like forty to sixty percent of the expenditure will
go to labor directly or indirectly, based on past experience. Most of that
labor would be largely idle during the lean season. From the point of
view of society the labor is almost free. The workers will acquire income
somehow in order not to starve. Their work may not contribute to society
if left to their own devices: they may become the third shoe-shiner on
a corner where two can do the work, the fourth family member on a
tiny ploy that needs only two workers and so on. In economic terms
their opportunity cost is close to zero. Building infrastructure will make
a substantial contribution to society; alternative ways of earning money
for food may contribute little.
183
The Economic Choices
Facing The Next President
The average wage paid by the PNPM program of Rp 48,000 is actually
about eleven percent higher than the average agricultural wage. But the
average PNPM wage includes the wages paid in the urban areas by the
urban PNPM program. The urban wage is undoubtedly higher than the
rural wage. The wage paid in the rural areas may therefore not violate
the rule that it is not to exceed the prevailing agricultural wage.
Turning the Guaranteed Employment Program into an Integral
Part of the Social Safety Net
An important feature of a good Social safety net is that it expands
and contracts automatically in response to need. In wealthy countries,
unemployment insurance performs that function. During a recession,
more people are unemployed and receive unemployment insurance. This
increases their expenditures above what it would otherwise have been
and feeds much needed purchasing power into the system. All of this
happens automatically as people lose their jobs. No decision is required.
The Guaranteed Employment Program can serve the same purpose as
long as the wage is fixed to keep it self-targeting and a reserve fund has
been appropriated to permit its expansion in case of need.
With guaranteed employment, the program will automatically provide
more employment and income if there is an increased need for them.
It therefore can serve an important part of a social safety net program
by automatically providing employment and income when they are
most needed and providing the work and income to the people who
most need them. With a low rate of pay and physical labor required,
the program would be self-targeting: only the poor will take these jobs.
If more people show up in a particular area to take advantage of the
Guaranteed Employment Program, then it is an indication that the need
for supplemental income has increased.
Because the program is self-targeting and seventy percent of the
beneficiaries are among the poor (Papanek, 2011), it is an ideal Social
Safety Net program. One of the problems for other programs is that the
families that are poor are constantly changing. Some people who were
near-poor have suffered an illness, job loss or some other event that has
The Economic Choices
Facing The Next President
184
made them poor. On the other hand, some poor families become quite
well-off as a child finishes school and gets a good job, or there is an
exceptionally good harvest on their land. It is difficult for other programs
to keep track of those who have been poor, but no longer are and viceversa. A self-targeting program does not have to worry about this: if a
person shows up ready to work for the agricultural wage then they are
currently poor.
To sum up; if the PNPM program adheres to two major principles:
i.
a wage low enough so the program is self-targeting and attracts
overwhelmingly poor people;
ii. providing the wage in payment for labor on local infrastructure;
and the program is given needed flexibility to respond to changing needs
then it can:
•
Provide employment and income to agricultural laborers during
the annual lean season or whenever catastrophe sharply reduces
their incomes. It can prevent temporary poverty that often turns
into permanent poverty.
•
Efficiently build high-return local infrastructure which can, in
turn, result in permanently greater employment and higher
incomes.
•
Make a significant contribution to a Social Safety Net that
automatically increases jobs and income when and where they
are needed.
Unlike many of the proposed policies and programs it provides immediate
and tangible benefits. It can therefore help to make the whole reform
program more politically acceptable.
185
The Economic Choices
Facing The Next President
Conclusion
Indonesia faces a stark choice.
Indonesia’s new government faces a choice between the “business as
usual” scenario of five percent growth and fewer than one million new
jobs each year, and a once-in-a-century opportunity to transform the
lives of millions of its citizens.
This unique opportunity exists because China, which has dominated
the world market for labor-intensive manufactured goods, is less
competitive in these markets than it once was. Over the next five years
other countries will begin to export these goods in place of China.
Indonesia is well-placed to take over some of the market that China
is exiting. Whether Indonesia manages to do so is largely a domestic
policy choice.
We have all heard about Indonesia’s “demographic dividend,” in other
words the potential growth advantages that arise when a large share
of the population is neither too young nor too old to work. However,
the demographic dividend is wasted if there are not enough good,
productive jobs for these potential workers. At present Indonesia is
wasting its demographic dividend and enduring low rates of economic
growth because an increasing share of the labor force is stuck in low
productivity jobs.
More than ten million Indonesian workers are working in zero to low
productivity jobs in agriculture and the informal sector, or have been
forced to travel abroad in search of work. These people contribute
little or nothing to domestic output because they cannot find good,
productive jobs. This supply of workers provides Indonesia with
an excellent opportunity to compete in the world market for laborintensive goods.
The Economic Choices
Facing The Next President
186
If Indonesia adopts policies to increase the country’s competitiveness
it could take over seven percent of China’s market for labor-intensive
exports over five years. This would add $110 billion to manufactured
exports, which totaled $65 billion in 2013. More importantly, the growth
of export and import substituting industries, combined with the multiplier
effect from rising domestic demand, would accelerate economic growth
to ten percent and create 21 million good, productive jobs by the end of
the next presidential term in 2019. As a high proportion of these jobs
would go to people with limited education, poverty would fall and the
distribution of income would become more equal.
The Business-As-Usual Option Means Permanently Slow
Growth
The “business as usual” scenario would generate only six million
jobs in five years as opposed to 21 million with appropriate policy
changes. Average incomes would be fifty percent lower than under the
high-growth scenario. This would not just amount to a passing phase
of slower growth. As other countries take over China’s markets for
labor-intensive manufacturers, they—rather than Indonesia—would
accumulate the capacity, technology, infrastructure, skills, market
relationships and foreign exchange needed to develop their economies.
Bangladesh, India, Vietnam, the Philippines and even Myanmar
would overtake Indonesia in terms of job growth, export growth and
eventually income per person.
Moreover, the slow rate of job creation would hold bank increase
growth among the poorest forty percent of the population. The
best way to raise the incomes of the vast majority of people is by
increasing demand for their labor. Slack labor markets, particularly for
less skilled workers, will condemn millions of Indonesians to poverty
and vulnerability. Income inequality will increase, and with it social
tensions.
A Flexible Approach to Competitiveness
Total costs of production must come down if Indonesia is to regain
economic competitiveness. It is important to bear in mind that
187
The Economic Choices
Facing The Next President
Indonesia’s competitors are not perfect: they may have advantages
in some areas but in others they face similar or even more serious
challenges. Indonesia does need to make progress across a wide front,
but costs do not have to be lower than competitor countries in every
dimension. Policy should focus on areas where cost reductions are
most feasible.
Low rates of investment in public infrastructure have resulted in
congestion and high logistics costs. Improvements to infrastructure are
therefore an obvious place to begin. Public investment must increase
tenfold, financed in the early years through the reduction of fuel
subsidies and later through tax reforms that can generate revenues
equal to 4.5 percent of GDP. Public funds can be focused on high
priority regions that have succeeded in attracting new investment
into manufacturing. Production sharing contracts were an Indonesian
innovation in the oil industry that helped create appropriate incentives
for private sector involvement in a publically-controlled industry. The
model could be productively applied to the development and operation
of public infrastructure. Other possibilities include offering private
companies an opportunity to develop infrastructure to meet their tax
obligations; increasing oil and gas drilling and production by improving
the incentives; converting commercial vehicles to run on natural gas to
lower the cost of transport; and the adoption of an effective matching
grants program to induce sub-national governments to use more of
their resources for the development of infrastructure.
Reducing the cost of labor to firms while increasing workers’ incomes
is also a critical component of competitiveness. Devaluation of the
currency is the most powerful tool for lowering labor and other domestic
costs to exporters and those competing with imports. Stabilizing the
prices of foods important to the poorest forty percent will protect
workers’ incomes and reduce the inflationary impact of devaluation.
Other steps to reduce labor costs include: increasing labor productivity
through industry-provided training supported by government;
voluntarily changing the system of severance pay; establishing export
processing zones in low wage areas with wages below the statutory
minimum, compensated by subsidized government services for workers;
The Economic Choices
Facing The Next President
188
and reviving the tariff drawback system that provided a small incentive
for exporters and for firms supplying their inputs.
Foreign Direct Private Investment will need to close the gap between
investment requirements and domestic savings. The gap is now $60-80
billion, compared to net flows of only $10-15 billion at present. FDI
also brings with it technical and managerial skills and access to global
markets. There are significant political costs to a larger role for FDI,
but there are substantial economic costs to a reduction in FDI. These
economic costs translate into political costs over time as the economy
grows more slowly and fewer good productive jobs are created.
Indonesia ranks poorly on corruption, ease of doing business and
cost of borrowing. The costs of corruption and doing business
could readily be reduced by, among others: reducing the discretion
which government officials have in deciding whether an enterprise
will be profitable reduces the rewards of corruption; and promoting
transparency in government to increase the risk of being corrupt. A Guaranteed Rural Employment Program A Guaranteed Rural Employment Program can provide employment
and income to agricultural laborers during the lean season or whenever
catastrophe sharply reduces their incomes. The program would not
only provide jobs but would also efficiently build high-return local
infrastructure and make a significant contribution to a Social Safety
Net. Guaranteed Employment can provide immediate and tangible
benefits and it would therefore help to make the whole reform program
more politically acceptable.
A Program for Economic Transformation
The commodity boom from 2005 to 2011 boosted exports and
accelerated economic growth. Indonesia did not suffer serious
negative effects from the global financial crisis in 2008-2009.
However, Indonesia has emerged from the commodity boom with
a massive pool of unemployed and underemployed workers, an
overvalued exchange rate, dilapidated and outdated infrastructure and
189
The Economic Choices
Facing The Next President
a business environment that presents numerous obstacles to productive
investment, job creation and innovation.
The challenge facing the new government is to design and implement
policies that can turn the country’s liabilities into assets and capitalize
in this unique, transitional moment in the world economy. Laborintensive manufactures, including exports and import substitutes, can
transform Indonesia’s underemployed labor force into an engine of
growth and prosperity.
With the right policies and programs Indonesia can 21 million good,
productive jobs during the first term of the new president. These
would consist of two million full time, regular jobs for workers added
to the labor-force each year plus another two million jobs for workers
out of low productivity, poorly paid jobs with irregular incomes and no
benefits. Some of the people who now go abroad to find work because
there are no jobs at home would also be able to return to Indonesia to
good, productive jobs.
Moving so many people from zero or low-productivity jobs into good
jobs would raise national income. Economic growth would reach
double digits by the final year of the new president’s term. National
income would double in seven years and the income of the average
Indonesian will double in just eight years.
Most importantly, Indonesia would put to productive work some
three million workers with limited education, virtually all of them
among the poorest forty percent of the population, and one million
better educated workers, including many of the 3.5 million educated
unemployed. Ten million families would move from poverty to the
middle class.
These are ambitious goals. Achieving them will require creativity,
perseverance and considerable political courage. Encouragement can
be drawn from Indonesia’s own history: when faced with daunting
economic and political challenges, Indonesians have often found the
ingenuity and resources needed to devise timely and effective solutions.
The Economic Choices
Facing The Next President
190
The policy response to the end of the oil boom in the 1980s succeeded
spectacularly, achieving record job and export growth at a time when
many observers questioned the country’s capacity for change. The
rapid increase in the demand for labor in the manufacturing sector
lifted millions of people out of poverty, and the resulting growth in
productivity and incomes elicited a positive multiplier effect that
reinforced positive investment and job creation trends.
In the wake of the most recent commodity boom, Indonesia must
again strive for international competitiveness as a means of moving
millions of people from zero to low-productivity jobs in the informal
sector and agriculture to manufacturing and other higher-productivity
occupations. A confluence of international and domestic conditions
have afforded the government a once-in-a-century opportunity
to transform the economy, bringing an end to poverty, economic
vulnerability and natural resource dependence, and ushering in a new
era of prosperity and social equality. It is time for Indonesia’s leaders—
whether in government, business or labor—to seize this moment in the
interests of the Indonesian people.
191
The Economic Choices
Facing The Next President
References
Bank Indonesia (various) “Indonesian Financial Statistics” various issues.
BPS, (2014). “Number of Poor People, Percentage of Poor People and the Poverty
Line”, 1970-2013
CReco Consulting (2012) M. Chatib Basri & Raden Pardede (authors) and
National Economic Committee, “White paper on Tax Reform” N.p.
Dapice, David. 1980. “Trends in Income Distribution.” Pp. 73-74 in The
Indonesian Economy, G. F. Papanek (ed). Praeger Publishers. Re-published as
Ekonomi Indonesia, Obor and Gramedia 1987.
___________& Edward A. Cunningham (2011) “Squaring the Circle: Politics and
Energy Supply in Indonesia”, Ash Center, Kennedy School, Harvard University.,
N.p.
Harvard, Kennedy School. (2010). “The Sum is Greater Than the Parts.” Pp. 67
Harvard Kennedy School Indonesia Program and Gramedia Pustaka Utama
Haryono, Asep (2014) “315 Kepala Daerah Terseret Korupsi,” Pontianak Post,
February 25, 2014 (http://www.pontianakpost.com/nasional/13410-315-kepaladaerah-terseret-korupsi.html).
Lim Shie-Lynn and Andreas Ismar. (2012) “For Palm-Oil Firms, Indonesia Wage
Hike Worrisome.” Wall Street Journal. December 28 2012., Accessible at http://
online.wsj.com/news/articles/SB100014241278873246691045782067733702068
26
National Development and Reform Commission,(NDRC) PRC. “Zheijiang Power
Grid Sales Price”
Nazara, Suahasil. (2014a) Indonesian workers by expenditure groups, employment
status and sector in 2012., N.p.
_____________ (2014b) Educational attainment by consumption groups in 2011.,
N.p.
_____________ (2014c) Ownership of bicycles and motorcycles by consumption
groups, 2011., N.p.
The Economic Choices
Facing The Next President
192
Papanek, Gustav F. (1980) “The Effects of Economic Growth and Inflation on
Workers’ Income.” Pp. 82-120 The Indonesian Economy, G.F. Papanek (ed.), Praeger
1980. Re-published as Ekonomi Indonesia, Obor and Gramedia 1987
_______________ (2011) Community-driven Development: From Emergency Aid
to Development Success – KDP and PNPM Rural for TNP2K and the World Bank
________________ (2014a) 1a. Increasing labor-intensive manufactured exports,
in Statistical and Technical Appendix to “The Economic Choices Facing the Next
President” Based on International Trade Center data from “UN COMRADE
Statistics”
______________ (2014b) 1.b. Growth and Employment Estimates, in Statistical
and Technical Appendix to “The Economic Choices Facing the Next President.”
Based on BPS National Accounts data
_____________ (2014c) 1.c. Exports of Labor Intensive Manufactures, in
Statistical and Technical Appendix to “The Economic Choices Facing the Next
President.” Based on BPS Foreign Trade data
______________(2014d) 2.a. Impact of commodity boom on growth, in Statistical
and Technical Appendix to “The Economic Choices Facing the Next President.”
Based on various BPS data
______________ (2014e) 2.b. Comparative shares of the world market, in
Statistical and Technical Appendix to “The Economic Choices Facing the Next
President.” Based on International Trade Center data from “UN COMRADE
Statistics”
________________ (2014f) 2.c. The effect of Growth in GDP on the Balance of
Trade in Statistical and Technical Appendix to “The Economic Choices Facing the
Next President.” Based on various BPS data
________________ (2014g) 3.a. Changes in real consumption for different income
groups in Statistical and Technical Appendix to “The Economic Choices Facing the
Next President.” Based on Statistical Yearbooks, “Percentage Distribution of Gross
Domestic Product” and BPS, “Consumption and Expenditure”
________________ (2014i) 3.c. Education and employment in Statistical and
Technical Appendix to “The Economic Choices Facing the Next President.” Based
on BPS Statistical Yearbooks
_________________ (2014j) 3.f. Wages of Unskilled and Semi-skilled workers
2008-14 in Statistical and Technical Appendix to “The Economic Choices Facing
the Next President.” Based on various BPS data
193
The Economic Choices
Facing The Next President
________________ (2014k) 3.d. Formal and informal sector employment in
Statistical and Technical Appendix to “The Economic Choices Facing the Next
President.” Based on Sakernas data
_________________ (2014l) 3.g. Gini Coefficient Index 1964/65 to 2013 2013 in
Statistical and Technical Appendix to “The Economic Choices Facing the Next
President.” Based on BPS data on “Selected Consumption Indicators, Indonesia
1999, 2002-2013”
_________________ (2014m) 3.h. Wages, Exchange Rates & Income of the Poorest
40% during Commodity Booms, 1976-2013 in Statistical and Technical Appendix
to “The Economic Choices Facing the Next President.” Based on BPS Statistical
Yearbooks and BPS data on “
Percentage of Expenditure Distribution Growth 1976 to March 2013” and the
Bank Indonesia “Indonesia Financial Statistics”
________________ (2014n) 4.a. Measuring the Success of Policy and Program
Reforms in Statistical and Technical Appendix to “The Economic Choices Facing
the Next President.” Based on BPS Statistical Yearbooks, Sakernas data on formal
and informal employment, Competitiveness rank: World Economic Forum (2013),
Corruption rank: Transparency International (2013), Ease of doing business rank:
World Bank (2013), Logistics index: World Bank (2014), Bangladesh minimum wage
data: Newspaper report, Minimum wage in Central Java: Governor of Central Java
(2013)
________________ (2014o) 5.a. Garment Workers' Wages in Asian Countries
(US$ per month in 2014) in Statistical and Technical Appendix to “The Economic
Choices Facing the Next President.” Based on various Asian countries newspaper
reports.
________________ (2014p) 5.b. Increased Employment in Manufacturing, 19852013, Annual Rate in Statistical and Technical Appendix to “The Economic
Choices Facing the Next President.” Based on BPS Statistical Yearbooks.
________________ (2014q) 5.c. Surplus Labor in Agriculture: Employment in
Agriculture and Manufacturing; Change in Value Added in Agriculture; 1986-2012
in Statistical and Technical Appendix to “The Economic Choices Facing the Next
President.” Based on BPS Statistical Yearbooks.
________________ (2014r) 5.d. The Exchange Rate and Cost of Labor for
Exporters and those Competing with Imports in Statistical and Technical Appendix
to “The Economic Choices Facing the Next President.” Based on BPS wages data
and Bank Indonesia “Indonesia Financial Statistics”
The Economic Choices
Facing The Next President
194
_______________(2014s) 5.e. The Impact of Devaluation on the Profitability of
Exporters in Statistical and Technical Appendix to “The Economic Choices Facing
the Next President.” Hypothetical example
________________ (2014t) 8.a. The Incremental Capital-Output Ratio (ICOR)
1985-2003 in Statistical and Technical Appendix to “The Economic Choices Facing
the Next President.” Based on BPS Statistical Yearbooks and Bank Indonesia data.
____________, Maman Setiawan & Mohammad Purnagunawan. (2013) “What
Drives Wages of Unskilled Workers in Indonesia”. Support for Economic Analysis
Development in Indonesia (SEADI) n.p.
Pardede, Raden (2014) “National Government Revenues & Expenditures with
Policy Changes,
2014-2024” in Statistical and Technical Appendix to “The
Economic Choices Facing the Next President.” 2013 data based on the budget pf
the Government of Indonesia
Pincus, Jonathan (2014) based on World Bank “World Development Indicators,
2014” for exports in US$ deflated by US GDP deflator
______________ (2014b) using World Bank “Logistics Performance Surveys” 2007
and 2012
Project Support Facility - PSF (2011). PNPM program
Skinner, Benjamin E. 2013 "Indonesia's Palm Oil Industry Rife with HumanRights Abuses.” Bloomberg BusinessWeek., July 18 2013, Accessible at http://www.
businessweek.com/articles/2013-07-18/indonesias-palm-oil-industry-rife-withhuman-rights-abuses#p5
Schydlowsky, Daniel M. (2012) “Estimates of the Multiplier.” in Gustav Papanek,
Chatib Basri and Daniel Schydlowsky, The Impact of the World Economic
Slowdown on Indonesia. Asian Development Bank
SKK Migas, 2014 - IPA Technical Division Presentation, 30 April 2014
TNP2K (2014). "Upaya Khusus Penurunan Tingkat Kemiskinan", TNP2K
Publication. Accessible at
http://www.tnp2k.go.id/id/download/upaya-khusus-penurunan-kemiskinan-1/
Annual growth of
real per capita expenditures by percentile groups, 2008-2012
Trading Economics for Interest Rates (2013) Accessible at http://www.
tradingeconomics.com/country-list/interest-rate
195
The Economic Choices
Facing The Next President
Transparency International (2013). “Corruption Perception Index” Accessible at
http://cpi.transparency.org/cpi2013/results/
United Nations Development Programme (2005). “Beyond Hartals: Towards
Democratic Dialogue in Bangladesh” UNDP.
World Bank (2006) Making the new Indonesia work for the poor
__________ (2014) “Logistics Performance Index.”
__________ Indonesia (2014a) “Hard Choices” Indonesia Economic Quarterly July
2014
__________ (2013) “Economy Rankings.” http://www.doingbusiness.org/rankings
_________ Indonesia, (2010) “Indonesia Jobs Report: Towards Better Jobs and
Security for All”
_________ (n.d.) “Electricity Tariffs”
_________ (2006, 2010, 2014) “Ease of Doing Business”
World Economic Forum (2013) “The Global Competitiveness Report 20132014.” Accessible at http://reports.weforum.org/the-global-competitivenessreport-2013-2014/
THE ECONOMIC CHOICES
FACING THE NEXT PRESIDENT
A. Tony Prasetiantono, Ph.D.
Head of Centers for Economic Study and Public Policy, Gadjah Mada University
This book, in a clear and structured way, not only “provokes”, but also provide
guidance on how this nation can achieve 10 percent economic growth per year and
create 4 million good jobs (not just jobs in the informal sector) per year. In the case
of China, Deng Xiaoping had started economic reform since 1979, and began to
reap his rewards through double digit economic growth from 2001-2008, before put
to stop by the subprime mortgage crisis in the United States in 2008-2009. A series
of initiatives must be conducted to achieve the same in Indonesia, starting from
sufficient infrastructure provision; combating corruption to create a sense of fairness
among economic actors; improving bureaucracy, which in turn can reduce economic
costs – and promoting competitiveness through education and training that
enhances the quality of Indonesian people. Professor Papanek and Dr Pardede offer
a way to break through our stagnant economic growth that has recently been stuck
in just 5-6 percent.
Ninuk Mardiana Pambudy
Deputy Editor-in-Chief Kompas Daily
Despite being one of the 20 countries with the largest world economy, Indonesia has
suffered the worst prosperity gap since its independence. More than half of its labor
force are working in the informal sector, and half of those did not graduate from
junior high school. In order to escape this stagnant economic growth, policy
breakthroughs are needed. This book offers ideas on the development model that
can close the gap, decrease the number of poor people, and improve public welfare
through correct industrialization for Indonesia.
Ir Sarwono Kusumaatmadja
Senior Adviser of Transformasi, Center for Public Policy Transformation
For the next five years, the first presidential term of Joko Widodo-Jusuf Kalla
will face a momentous challenge. The government must not only fulfill
the public’s high expectations and pressure from the opposition, it must also
prepare steps to anticipate the arrival of the demographic bonus period. There
is no other choice for the government but to provide new jobs for
seventy percent of the population entering their productive age.
This book is a ray of light addressing serious economic challenges that will be faced
by Indonesia going forward. In a very systematic and direct way, Gustav Papanek,
Raden Pardede, and Suahasil Nazara argue that it is possible to convert the
demographic bonus into an economic blessing. The key is double digit economic
growth, and Indonesia is likely to achieve it through the correct industrialization
strategy. I think this book deserves to be a reference for economy policy makers in
the government of Jokowi-JK.
Supported by:
RAJAWALI FOUNDATION
Published by: