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By: Muhammad Fakhryrozi, International Business and Economy Analyst

  1. Introduction

Productivity is a key role in determining living standards of nations. Higher country’s productivity means higher goods and services generated by the economy with efficient level of input. The more goods and services produced within country in an efficient way, the more income of everyone in a country can be derived. Better living standard then, can be achieved. As a prominent country in Southeast Asia that has experienced significant economic growth under several different political institutions, Indonesia is an interesting country to be analysed by economic students. The high growth of Indonesian economy in the past has enabled Indonesia to transform its economy from natural resources-based into manufacturing-based. Sectors that underpin largely productivity growth of Indonesia also has shifted from one sector to another specific sector. However, at the other juncture, economic crisis has tumbled productivity growth into a dramatic decline such as performed during 1998 Asia financial crisis where economy grew at -10%. This paper captures the trends regarding Indonesia’s productivity since several decades ago. The discussion begins with the theoretical framework of productivity and the analysis regarding Indonesia’s productivity during the period of Suharto’s regime that embraced authoritarianism. The up and down of the economy and the affecting factors are also included. The discussion continues to the analysis of past productivity performance in Indonesia. In the next part, the productivity trend during post-Suharto regime is explored. Current and future challenges of Indonesia’s productivity trends are included as well. Conclusions and recommendations then, are put at the end of this paper.

  1. Productivity of the Nation

Productivity refers to the quantity of goods and services produced from each unit of labor input (Mankiw & Carbaugh, 2012). There are some determinants that affect the productivity of a particular country. First is physical capital per worker, second is human capital per worker, third is natural resources per worker and fourth is technological knowledge per worker. In other words, the more those factors accumulated within country, the more each worker able to produce more output, which in turn increases country’s total productivity. In order to encourage country to achieve higher productivity, policy makers usually consider several aspects. The improvement in these aspects will nurture the improvement in country’s productivity. The example of these considerations are the amount of saving and investment from abroad, education which will support skill development, health an nutrition, property right and political stability, R&D and population growth. OECD has classified main productivity measures such shown in Table 1.

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Table 1 Overview of Main Productivity Measures Note. From “Measuring Productivity”, by OECD, OECD Manual, p.13.

At a macro-level, higher living standard as an outcome of higher productivity is reflected in a higher Gross Domestic Product (GDP). ‘GDP is the market value of all final goods and services produced within a country in a given period of time’ (Mankiw & Carbaugh, 2012). The more final goods and services can be produced, the more income can be generated. Higher income means higher living standard.

  1. Indonesia’s Economic Growth

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Figure 1. Indonesia’s annual GDP growth from 1965 to 1980. From World Development  Indicator, by world bank, Word Bank Data, 2014

During Sukarno’s leadership (1945-1967), the first Indonesia’s president, Indonesia’s economy is not properly managed due to political instability and nationalistic economic policies such as restriction toward foreign aids and FDI (van Zanden & Marks, 2012; Firdausy, 2005). As a result, slow growth, hyper inflation, poverty and budget deficit were characterising this severe period.

In 1967, Suharto to overtook the presidency seat from Sukarno. Under early Suharto regime -the period when Suharto rules usually named ‘New Order’ regime-, economic policies are set up by technocratic economists without bothered by political turbulence since Suharto enforced repressive political situation. The government then undergone stabilisation and rehabilitation policies such as agriculture and physical infrastructure reform combined with balanced budget and balance of payment. As a result, the economy recovered quickly as showed by an increase in GDP growth from 1% in 1967 to 12% in 1968. Then, the growth decreased to 7% in 1969 before continued to grow at the level of 8% in average until 1980 as shown by Figure 1.

According to Modjo (2006), Indonesia’s economy during New Order regime can be classified into two sub period, first is period prior to 1980 and second is period after 1980. Before 1980, Indonesia’s economy was underpinned by State Owned Enterprises (SOE) which supported by governments’s protectionist policies. The SOEs operate in manufacturing areas such as steel, fertiliser, cement, sugar, textiles and food processing and they heavily protected from external competitors through tariff and non-tariff barriers as well as raw material subsidy. Government also equipped the domestic industry with subsidised credits as well as undervalued exchange rates to protect domestic companies (Modjo, 2006). As a result, the manufacturing sector value added grew at a significant level during early Suharto regime until 1980 compared to previous regime, as shown in Figure 2.

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Figure 2. Indonesia’s manufacturing and agriculture value added 1965-1980. From World Development Indicator, by world bank, Word Bank Data, 2014. Note: red chart is reflecting manufacturing sector while blue chart is reflecting agriculture sector.

The growth of manufacturing sector value added outpaced the growth of agriculture sector value added during this period. Manufacturing value added (% of GDP) Agriculture value added (% of GDP). Another sector that has underpinned Indonesia’s productivity during the early period of New Order regime is oil export. Indonesia’s oil rents contribution to GDP grew significantly in 1970 to 1980 as shown by Figure 3.

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Figure 3. Indonesia’s oil rents from 1970-1980. (in billion US dollar) From World Development Indicator, by World Bank, Word Bank Data, 2014.

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Figure 4. Indonesia’s GDP growth and manufacturing value added from 1970-1980. From World Development Indicator, World Bank, Word Bank Data, 2014.

The fall of oil prices in 1981 ended the state-led industrial policies accompanied by oil boom. This situation was reflected by a dramatic decrease in GDP growth as well as manufacturing value added in 1982 as shown by Figure 4. Government then changed their development strategy from inward looking policies supported by oil revenue and protected sectors into outward looking and more internationally competitive policies (Hill & Hall 1998).

There were some strategies pursued by Indonesia’s government following the fall of oil price such as export promotion, tariff and non-tariff barriers reduction, liberalisation of financial market, and dismantling of previously closed sectors (Modjo, 2006). These policies were successful in maintaining spectacular GDP growth at a level of 13.4% in average from 1983 to 1992. Moreover, during this period manufacturing sector and export volume soared as drawn in Figure 5. The economic decline in 1986 was due to the second crash of the oil market.

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Figure 5. Indonesia’s manufacturing value added and export of goods and services from 1980-1992. From World Development Indicator, by World Bank, Word Bank Data, 2014.

The middle to end period of Suharto’s regime was also characterised by the liberalisation policy toward foreign aids as well as foreign direct investment. Figure 6 and 7 depict the jump in value of foreign aid and foreign direct investment respectively since 1985 to 1993.

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Figure 6. Indonesia’s foreign aid from 1980-1992 (current billion US dollar). From World Development Indicator, by World Bank, Word Bank Data, 2014.

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Figure 7. Indonesia’s foreign direct investment from 1980-1992 (in current million US dollar). From World Development Indicator, by World Bank, Word Bank Data, 2014.

Supported by tax derived from FDI and oil, government allocated the revenue into education. The government also launched notable policies in supporting nation competitiveness development through education such as making six years education compulsory for citizens in 1984 and extended to nine in 1994, education improvement in village as well as teacher improvement (Suryadarma, Daniel, Jones, Gavin, 2013). As a result, education has improved significantly. Figure 8 reflects the improvement in education in Indonesia from 1990 to 2010.

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Figure 8.Population aged 19 years or over by highest level of educational attainment and gender, 1990-2010 (million). Adapted from “Education in Indonesia”, by Suryadarma et al., Institute of Southeast Asian Studies, 2013, p.19.

Indonesia’s rapid growth which happened since 1968 came to an end because of the Asia financial crisis that exploded in 1997. As a result of this crisis, Rupiah depreciated hugely and interest rate increased by about 80% in less than 12 months (Pardede, 1999). The crisis also created political turmoil which forced Suharto to resign from his position after some riots happened in Jakarta and other several cities in Indonesia. Following this situation, the economy grew only at -0.1% in average from 1998 to 2000. Many economic indicators were experiencing contraction during that period which in turn, tumbled Indonesia’s productivity. Inflation rose to nearly 60%. (World Bank, 2014).

  1. Indonesia’s Productivity Performance

Even though Indonesia has experienced significant economic growth, labor productivity was not a fundamental factor that affect Indonesia’s economic growth. Firdausy (2005) has conducted quantitative analysis regarding productivity measurement in Indonesia in New Order Regime. She concluded that from 1972-1996, Indonesia’s GDP grew by 7.02% per year, but the TFP grew negatively (-0.83%). It means that the GDP growth was derived from input growth, not from the TFP. Figure 9 illustrates the trend regarding Indonesia’s TFP growth and GDP from 1972 to 2000. Revenue from oil, capital inflows from abroad and foreign aid that jumped in 1980-1990 have underpinned the GDP growth, however the role of TFP is negligible since the growth of TFP is very low even negative in several junctures. Table 2 and Figure 10 illustrate more detail about the trends of TFP, labor productivity, capital growth and GDP growth.

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Table 2 GDP Growth, Capital Growth, Labor Productivity Growth, Total Factor Productivity Growth Note. DY = GDP Growth, DKL = Capital Growth, DLP = Labor Productivity Growth, DTFP = TFP Growth. From “Productivity Performance in Developing Countries, Case Studies: Indonesia”, by Carunya Mulya Firdausy, 2005, UNIDO, p. 12.

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Figure 9. TFP growth and GDP growth. “Adapted from Productivity Performance in Developing Countries, Case Studies: Indonesia”, by Carunya Mulya Firdausy, 2005, UNIDO, p. 10.

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Figure 10. Sources of growth. Note. DY = GDP Growth, DKL = Capital Growth, DLP = Labor Productivity Growth, DTFP = TFP Growth. Adapted from Productivity Performance in Developing Countries, Case Studies: Indonesia”, by Carunya Mulya Firdausy, 2005, UNIDO, p. 10.

Moreover, as stated by van Der Eng (2009), the TFP of Indonesia on the basis of new estimates of GDP, education adjusted employment and factor income shares, during the period of 1971-2007 grew at -4%. So, even though Indonesia has high number of labor force due to large number of population (Figure 11 illustrates the trend of Indonesia’s labor force number) and education has improved significantly, but the quality of labor is still low. The political institution that has led Indonesia during New Order regime was centralistic, corrupt and repressive. These also contribute to the Indonesia’s low TFP. (Firdausy, 2005).

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Figure 11. Employment Trends in Indonesia. From Total Factor Productivity and Economic Growth in Indonesia, by van Der Eng, 2009.Current and Future Challenges in Raising Indonesia’s Productivity

Indonesia’s productivity growth in Post-Suharto era characterised by stabilisation rather than acceleration (Thee & Dharma Negara, 2010), since the average growth rate was below that growth rate under New Order regime. In 1999, the demand for institutional reform was mounting and Indonesia’s economic situation has recovered from dramatic crisis. It’s GDP growth reached 0.9% and then jumped to 4.9% in 2000. Following this recovery, the growth then maintained at a level of 5.44% in average from 2001 until 2013. This trend is captured in Figure 12.

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Figure 12. Indonesia’s GDP growth (annual %). From World Development Indicator, by World Bank, Word Bank Data, 2014.

In the period after the collapse of Suharto which has embraced democracy, productivity growth in Indonesia was no longer underpinned by oil revenue as reflected by the low contribution of mining sector in GDP due to decline in oil production (The Jakarta Post, 2013). The agriculture sector was stagnated and the manufacturing sector was increasing slightly. Finance, real estate and corporate services sector were increasing a bit faster than previously mentioned sectors. This also applied to construction as well as transportation and communication sector. Figure 13 illustrates these trends.

Screenshot 2015-05-16 10.03.31Figure 13. Indonesia’s GDP by sector (in Rupiah). From “Economic and Financial Data For Indonesia”, by Bank Indonesia, 2014.

Indonesia’s GDP from 2000 to 2013 was largely depending on domestic household consumption (Figure 14 illustrates this trend). Capital formation has shown significant increase during this period. This has made Indonesia was placed the 18th largest FDI recipient in the world in 2013 (UNCTAD, 2014).

Due to large number of population – Indonesia is the fourth most populous country in the world – and its achievement in terms of growth, Indonesia’s GDP was ranked 16th in the world.  Some pundits and notable organisations have issued optimistic predictions regarding the future of Indonesia’s economy (McKinsey, 2013; PriceWaterhouseCoopers, Financial Times, 2011, O’Neill, 2011). They rely their argument on things such as growing number of middle class, abundant and youthful workforce and maturing democracy. Moreover, even though TFP growth from 1971-2007 was -4%, but the TFP growth of Indonesia during 2000-2007 grew at 1.7% (van Der Eng, 2009). It shows that TFP growth has improved slightly.

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Figure 14. Indonesia’s GDP by components (in Rupiah). From “Economic and Financial Data For Indonesia”, by Bank Indonesia, 2014.

However, there are some challenges that should be addressed if Indonesia want to achieve higher productivity growth. Harvard Kennedy School report stated that current economic growth in Indonesia is characterised by jobless growth, rising inequalities and declining competitiveness (Ash Centre of HKS, 2013). Some prioritised efforts should be undertaken such as reducing economic cost through infrastructure development and bureaucratic reform, boosting human capital and R&D spending, higher education improvement and promoting effective decentralisation. All these hopefully will increase Indonesia’s TFP.

  1. Conclusion

The Indonesia’s economy had been growing rapidly under Suharto’s regime despite its authoritarianism institution. It also has enabled Indonesia to shift it’s economy from natural resources and agriculture based into manufacturing based. However, some scholars have argued that the achievements are not gained from competitive domestic situation. At the early stage, the productivity growth was largely underpinned by oil revenue and industrial protectionist policies under SOEs. The crash of oil price then forced government to make improvement to boost productivity such as liberalisation toward foreign investments and aids as well as financial system. Even though the growth has created improvement in terms of living standard such as poverty reduction and education level, but low domestic competitiveness as reflected by low quality of human capital and corrupt public institution still be major challenges. It was reflected in a negligible TFP contribution to GDP. Post-Suharto period was characterised by stable growth that has triggered optimism and confidence. Service and finance sector has been rising. However, old problems related to competitiveness was not tackled yet. Improving higher education, paying more attention on research and technological progress and lowering economic cost are examples of prioritised policies that should be undertaken by government to boost Indonesia’s productivity in the future.

Reference List

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Modjo, I. (2006). Total Factor Productivity in Indonesian Manufacturing: A Stochastic Frontier Approach. (Discussion Paper 2006.28). Seoul, South Korea: Seoul National University.

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