Indonesia’s path to prosperity lies in manufacturing

By Yizhe Daniel Xie and Eisha Maghfiruha Rachbini Source:Global Times Published: 2018/5/24 21:03:40

Illustration: Luo Xuan/GT

Indonesia is full of optimism, but much must be done to achieve its ambitions. Early last year, President Joko Widodo (Jokowi) set a goal for the country to become the world's fourth-largest economy by 2045, which will also be the 100th anniversary of independence.

If Indonesia achieves that goal, it will do so five years before the date forecast by the Economist Intelligence Unit and PwC.

The country is often seen as the next China or India. The archipelago, strategically located between the Pacific and Indian oceans, is home to 260 million people, the world's fourth-largest population.

It is already by far the biggest economy in Southeast Asia with nominal GDP of about $1 trillion, making it the 16th-largest economy on Earth and eighth in purchasing power parity terms. According to the World Bank, real GDP will expand at 5.3 percent in 2018.

Indonesia's economic might and political influence over ASEAN won Jakarta a seat at Group 20.

A huge young workforce and burgeoning middle-class has lured billions of dollars in foreign direct investment and portfolio investment from countries like Singapore, Japan, China, and the US.

However, premature deindustrialization may pose a serious challenge to unlocking the nation's potential. Industry occupied about 40 percent of GDP in 2016 but most of that was in the oil and gas sector, which has low added value and creates few jobs. Although the sector remains the largest source of growth, its contribution fell from 1.01 percent in 2014 to 0.92 percent in 2016.

The rest of the manufacturing sector comprised about 18 percent of the Indonesian economy between 2011 and 2016, well below the level of 30 percent that prevailed before the 1997-98 Asian financial crisis. There were structural changes in Indonesia's economy after the crisis. Manufacturing-sector output growth fell from 11 percent in 1996 to 4.3 percent in 2016. Output growth in the tradable sector, which the manufacturing sector dominates, fell to about 3.3 percent in 2016 from about 6 percent prior to the 1997-98 Asian financial crisis.

In contrast, the non-tradable service sector such as wholesale and retail trade, hotels and restaurants, and transport and communications grew 5.5 percent, which was above the annual growth rate of GDP.

Some may argue manufacturing is no longer important for Indonesia, since nearly half of the economy is in the services sector. However, much of the latter sector is either in low-productivity restaurants, retail, housekeeping services or the informal economy. White-collar jobs in high-end services sectors such as banking and marketing are scarce and can't provide work for the millions of less-educated employees.

Proponents of the services industry often say a growth engine can be found in the new innovative economy and startups such as e-commerce website Tokopedia and logistics provider Gojek. But most jobs in this sector are temporary positions featuring low productivity. Many require few skills, offer little training and don't provide a career path.

The experience of advanced economies suggests the decline of the contribution of the manufacturing sector is largely due to overcapacity and a loss of comparative advantage.

The diminishing marginal returns theory in economics posits that resources are diverted to sectors with a higher return - often in high-skilled services sectors such as banking and technology - after manufacturing reaches its optimal frontier. As a result, the contribution of manufacturing to GDP naturally declines.

However, Indonesia's manufacturing sector began to decline before this point was reached. The sector is dominated by resource-based products and more labor-intensive and low value-added commodities.

Even in export-oriented sectors such as textiles and clothing, Indonesia is losing or has lost its competitiveness to countries like Bangladesh or Vietnam. But the country hasn't gained ground in technology: electrical machinery and equipment production is stagnant in terms of growth and contribution to manufacturing.

History suggests manufacturing is an inevitable step to achieve high and sustainable economic growth for sizable developing countries if they aim to converge with high-income countries. As evidenced by the East Asian economic miracle and the recent rise of China, manufacturing is generally more productive and better able to absorb large numbers of low-skilled labor from the agriculture sector.

Manufacturing is associated with better hard and soft infrastructure, longer value chains and more economic spillover.

Indonesia has 37.8 million farmers who are potential for the labor pool and 130 million people below age 28. But the so-called demographic dividend can easily become a liability if not enough jobs are created.

It is said the highest unemployment rate is in the age group of 15-24, and another 2 million Indonesians enter the job market each year.

Urbanization-driven growth is not satisfactory. Urbanization is often seen as an alternative to create jobs and boost economic expansion. Labor movement from rural areas to cities is generally accompanied by high economic growth and structural transformation because of the difference of urban-rural productivity.

In the end, we can see that manufacturing is the only proven reliable path to long-term economic success. Indonesia needs to make itself a better place for foreign direct investment and production by improving its infrastructure and human capital and simplifying its bureaucracy.

A flourishing manufacturing sector will allow the country to benefit from the demographic dividend and achieve an economic miracle. Now it is time for "Make in Indonesia."

Yizhe Daniel Xie is a PhD candidate at Waseda University in Tokyo. Recently, he was a visiting scholar at the Institute for Economic and Social Research, University of Indonesia in Jakarta. Eisha Maghfiruha Rachbini is a researcher at Institute for Development of Economics and Finance in Jakarta.


blog comments powered by Disqus