Indonesia: More infrastructure, skills, better market regulation needed for higher growth

June 24, 2014

JAKARTA, 23 June 2014 – Indonesia needs high economic growth rates to accommodate the 15 million new workers who will join Indonesia’s labor force by 2020, according to a report from the World Bank.

The report, entitled Indonesia: Avoiding the Trap, says that unless the economy grows much faster than the current five to six percent, Indonesia will not escape the so-called ‘middle income trap’, experienced by many economies which initially grow fast but then stagnate for more than a decade. But with growth rates of closer to nine percent, Indonesia can avoid ‘the midddle-income trap’ and join the ranks of the high income countries by 2030.

After years of high growth supported by the commodities boom in 2003-2011 and low global interest rates since 2009, Indonesia is now seeing growth slowing to a little over five per cent.

“The world is waiting for Indonesia to take its rightful place as a global economic leader. But to do so, Indonesia must improve its competitiveness, by closing its infrastructure and skills gaps and by improving the functioning of markets. These actions would have knock-on effects on raising productivity and incomes, and would require better government spending that cuts inefficiencies, such as fuel subsidies,” says Rodrigo Chaves, World Bank Country Director for Indonesia.

With its technologically-savvy youth and witnessing increased labor costs in China, Indonesia is well placed to attract more local and international investment in manufacturing.

But investors seek workers with better technical skills and stronger workplace behaviors. Indonesia compares unfavorably with other middle-income economies in learning assessments such as the Programme for International Student Assessment (PISA). Currently, half of all high school graduates end up working in unskilled and poorly paid jobs, because they lack the skills for higher-salary employment.

“Indonesia has significantly improved access to education. The challenge now is mostly to enhance the quality of this education. There is little training offered to employees and more modern training centers would help graduates obtain the skills to be competitive. However, on-the-job training is tied to the assurance that employers can retain trained workers at reasonable costs,” says Ndiame Diop, World Bank Lead Economist for Indonesia and lead author of the report.

Insufficient infrastructure also constrains growth. Total infrastructure investment from the past decade by the central government, sub-national governments, state-owned enterprises and the private sector, is less than 4% of GDP – about half of what is needed. The report estimates that Indonesia has lost at least 1% of economic growth each year over the past decade due to this low investment.

Phasing out massive fuel subsidy spending, which amounts to 2.6 percent of GDP and disproportionately benefits the affluent, would allow the government to spend more on infrastructure and other pressing needs, such as health-care, which is currently only 0.9 percent of GDP. Reallocation of spending and improving efficiency at the provincial and district level would also allow channeling more funds for infrastructure spending. Accompanied with improved local governance, this would help local service delivery, such as for health care, sanitation infrastructure, and waste management.

Along with improving infrastructure and skills, a more consistent implementation of regulations would help growth. “Mixed signals confuse rather than attract investors. Efforts are made to facilitate investment and licensing in many sectors. But at the same time, some new laws allow extensive discretions to specific line Ministries. International experience shows that policies that benefit citizens the most are those that are transparent, with minimal or zero discretion,” says Lead Economist Diop.

With implementation of reforms in the above areas, the World Bank is confident that Indonesia will be able to rise and avoid the ‘middle income trap’. “The risks of a ‘middle income trap’ are real and Indonesia’s technocrats are right to start worrying about them. Brazil grew fast in the 1960s and 1970s, but then suffered two decades of very slow growth after 1981, when it reached US$3,939 per capita income -- the same as Indonesia’s per capita income today,” says Lead Economist Diop.

Higher growth may help many segments of society, through greater work opportunities, including for the self-employed. However, to ensure that increased prosperity is shared with all citizens, further reforms are needed, including in improving the accountability of local governments for delivering better services, implementing an effective social security system, and enhancing the country’s capacity for disaster risk management.

Media Contacts
In Jakarta
Dini Djalal
Tel : +62-21-5299-3156