Indonesia’s economic performance is impressive. Over the past ten years, under the watch of President Susilo Bambang Yudhoyono, growth has averaged 5.8 percent a year—well above the figure for the previous decade. Indonesia’s international reserves are a comfortable $93 billion, giving the country a buffer against possible economic shocks. The poverty rate has declined steadily. And, according to a recent United Nations survey, Indonesians consider themselves happier than the Turks, the Chinese, and even the Portuguese.
No developing economy has reached high-income status since 1950 without a strong manufacturing sector and a diversified production base. Manufacturing productivity in developing countries tends to catch up rapidly with that in advanced economies, and this makes manufacturing a powerful driver of growth. Unfortunately, the Indonesian economy remains reliant on the production and export of commodities, the prices of which are likely to be volatile. In fact, Indonesian manufacturing is shrinking as a share of GDP, exports, and employment.
One reason for this shift is trade barriers—not tariffs or quotas at the border, which are discouraged by the World Trade Organization, but a growing number of behind-the-border barriers that impede trade, restrict competition, and depress investment. Some investment regulations make matters worse. For example, among 185 countries, Indonesia ranks 166 in the ease of starting a new business. And Indonesia’s labor laws place tight constraints on the dismissal of workers and impose one of the world’s highest severance payments.
By protecting firms from international competition and hindering the movement of capital and labor between firms and sectors, these policies discourage labor-intensive manufacturing, dampen growth, and lock out the bulk of the Indonesian workforce from high-quality jobs in the most dynamic part of the economy—manufacturing.
The next Indonesian president will need to reverse these policy directions. Indonesia needs higher investment, greater productive efficiency, and more employment. All three objectives can be achieved if Indonesia has an internationally competitive labor-intensive manufacturing sector—which, in turn, can be encouraged through streamlined investment regulations, increased domestic and international competition, and flexible labor markets.
Stay in Jakarta for a day and it becomes immediately apparent that inadequate infrastructure is choking productivity. Traffic congestion alone costs the capital city $1 billion in productivity each year. And infrastructure problems are not limited to Jakarta. A quarter of Indonesians across the country live without access to electricity, two-fifths lack basic sanitation, and half the roads are unpaved. As incomes rise, the demand for infrastructure is expected to soar.
The government has many plans to build more infrastructure, but implementation has fallen persistently short. The next president will need to ensure the government consistently hits its infrastructure targets. This can be done by attracting private financing for infrastructure development through effective public-private partnerships and building skills within the government to manage the complex issues of risk sharing and risk management in infrastructure projects. The government must also vigorously implement the country’s new land-acquisition law, which is designed to reduce delays when building infrastructure by imposing time limits on different phases of the process and clarifying the rights and responsibilities of the different government agencies involved.
Higher incomes have also increased pressures on Indonesia’s natural environment. With further growth, these pressures will only mount. Fish stocks are already declining. Shortages in safe drinking water are becoming acute. The demand for carbon-heavy fossil fuels is soaring. And the agricultural sector, which is expanding in response to rising demand for food, is contributing to deforestation and land degradation at an alarming rate. Unchecked, these trends will slow and eventually stall growth. Good economic policy must include good environmental policy.
The Yudhoyono administration has attempted to address this growing environmental crisis by introducing an impressive set of laws, policies, and programs and by decentralizing many aspects of environmental management and protection. But the next president will need to redouble those efforts because the gap between environmental goals and actual accomplishment continues to expand.
Energy policy should be much more aggressive in eliminating fuel subsidies and stressing low-carbon alternative energy sources, including geothermal, hydroelectric, biomass, wind, and solar energy as well as unconventional gas. The price of natural resources more generally should reflect not only their scarcity but also their social and environmental costs. Public investment in agriculture should focus on increasing yields and higher-value crops while reducing waste and spoilage between the farm and the consumer. And the budget allocation for environmental protection and conservation programs needs to be increased further.
As in other fast-growing Asian countries, income inequality in Indonesia has climbed in the last decade. A key reason is the rising inequality of opportunities to access healthcare, education, jobs, financing, and the justice system. Not only does this exacerbate social tensions as the poor see the rewards of growth accrue largely to the better off; it also wastes human potential by denying the poor avenues for upward economic and social mobility.
The next president’s goal should be to ensure that all Indonesians have access to the same quality of government-financed health and education services. This access should be granted to everyone equally, whether the person is young or old; was born to poor parents or rich; resides in urban or rural surroundings; or lives on or off the island of Java, which is home to most Indonesians. Reducing inequality will require reexamining the distribution of fiscal resources across the country and determining how effectively they are used. And it will require expanding social assistance programs, improving their targeting, and increasing their efficacy through improved design and delivery.
The experiences of developing economies that have achieved high-income status show how central education is to sustained and rapid growth. Indeed, Indonesia recognizes this too. The Indonesian constitution requires that at least a fifth of the national budget must be devoted to education. This policy has helped ensure that enrollment in primary and secondary education is almost universal in Indonesia and that 92 percent of adults are literate. But learning outcomes still compare poorly with other countries. In an international program to assess learning outcomes, for example, Indonesia ranked 56 out of 65 assessed countries. And despite growing numbers of graduates from Indonesia’s rapidly expanding tertiary education system, employers complain of a severe shortage of skills.
Arguably, improving Indonesia’s education system should be the next president’s highest priority. Left unaddressed, the mounting shortage of skills will impede the growth of firms and companies and eventually of the economy. The thrust of future education policy will need to emphasize quality, not quantity, by attracting the best possible teachers, increasing school budgets, tightening quality control, introducing peer review for academic research, building links between universities and international research networks, and focusing relentlessly on pedagogic outcomes at every level of the education system.
Even when the next president’s policy priorities are reduced to five, it is clear that a steep road lies ahead. Indonesia is a large country with enormous potential, but it also confronts immense challenges.
When Indonesians vote for their next president, they will need to choose a leader who has the vision and the skills to address these challenges steadily and relentlessly. The economic future of the country will depend on it.
The Carnegie Asia Program in Beijing and Washington provides clear and precise analysis to policy makers on the complex economic, security, and political developments in the Asia-Pacific region.
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