Monday, June 17, 2013

A crucial moment in Indonesia’s political economy

The next two years are very crucial for Indonesia’s political economy, next year will be the time for maintaining sustainable democracy and 2015 will witness the launch of the ASEAN Economic Community (AEC). As the clock keeps ticking, Indonesia must be prepared and ready

During the global financial crises of 2008-2009, the Global Economic Prospects (GEP) report by the World Bank in March 2009 highlights that Indonesia, China and India were among few countries that still maintained positive economic growth, above the average of other developing countries’ economic growth. Furthermore, during the crisis these countries were considered the core generators of economic growth in Southeast, East and South Asia respectively.

GEP’s subsequent report released in January 2013, still forecasted Indonesia’s economic growth for 2013 to remain both positive and above average among developing countries. This confirmed once again, that Indonesia has enjoyed stable economic growth in the five years since the financial crisis.

Indonesia’s middle class population has also doubled in the last 15 years since the reformation era of 1998 from around 45 million to more than 90 million and Indonesia is estimated to have a workforce of around 170 million in 2015.

What is the challenge? Indonesia has an estimated total employment elasticity range of 0.35 to 0.45 (Chatani, 2011), 0.5 (Aaron, et al, 2004) and 0.49 to 0.66 (Islam, Nazara, 2000). Assuming that total employment elasticity is 0.5 then 6.2 percent of Indonesia’s economic growth in 2012 can obtain a 3.1 percent employment growth rate, which is higher than the average growth rate of the labor force (age 15+) of 2.3 percent.

Technically, Indonesia’s economic growth can reduce its unemployment rate. Yet, due to the decline in youth participation in the labor force, Indonesia’s rate of youth unemployment remains high. In 2009, it was at 22.2 percent higher than that of Southeast Asia and the Pacific, which is at 13.9 percent and higher than that of the world average at 12.8 percent (ILO, 2011).

Are there any other challenges? Indonesia’s economic growth, on average, still depends on its non-tradable construction sector, trade sector, hospitality, transport and communication, as well as the financial services sector as opposed to the manufacturing sector that has high employment elasticity.

This situation will only get worse, after the fall of international prices for primary commodities, due to the decreasing global demand and diminishing labor productivity in the agricultural sector.

These decreases contribute to Indonesia’s current negative trade balance. Furthermore, in terms of the revealed comparative advantage (RCA) and constant market share analysis (CMSA), Indonesia’s manufacturing sector depends on agriculture and labor-intensive sectors (Verico, 2012). Service sector led-growth and sluggishness in manufacturing and agriculture economic growth have also influenced Indonesia’s expenditure gap. The latter can be seen from an increasing Gini Ratio in Indonesia since the global financial crisis of 2008.

How can Indonesia embrace these challenges? In order to boost its employment, Indonesia must increase its manufacturing productivity and competitiveness. Investment is defiantly needed including foreign direct investment(FDI) inflows and adequate physical infrastructure development.

On average, Indonesia’s investment share in GDP is much lower than 9 percent with negative trends since 2008. Compared to China where investment is over 11 percent of its GDP, Indonesia is left behind. Enlarging the infrastructure capacity needs a vigorous state budget by which governments must remove any popular-yet-unhealthy budget programs such as fuel subsidies.

As a figure, poorly allocated fuel subsidies has absorbed 2.1 percent of GDP that is in contrast to social welfare allocation totaling only 0.8 percent of GDP (Cornwell and T. Anas, 2013).

Besides that, from a public policy perspective, a recent study found that service sector reforms in particular, those that are directly related to the manufacturing sector such as the transport sector and utilities, will increase manufacturing productivity and competitiveness (Duggan, Rahardja, Varela, 2013). Streamlining of public policy and efficient government coordination are necessary to boost manufacturing productivity and attract investment inflows. On top of that, rational and appropriate economic policies, which might seem to be unpopular, need firm policy makers to defend its long-run positive impacts. It also requires public support and awareness.

Is democracy essential? Given its social economic structure, the most influential public voices are those of the upper- middle class, who work with certain skills and flexibility in labor market. Their political concerns and critics are required in the developmental process and if they become apathetic toward politics and public policy impacts, as a consequence social movements will become stagnant.

A necessary condition for this constructive situation is freedom of expression, by which democracy must always be in the forefront. Yet democracy as a market mechanism in economics is open to failures from misbehavior and moral hazard. Take serial corruption cases from Indonesia’s political parties for example.

Democracy is not immune to moral hazard, therefore in order to make it work properly and uncontaminated, Indonesia unquestionably needs the vital role of the Corruption Eradication Commission (KPK). Public awareness and the KPK are complementary and sufficient requirements to ensure that political and social economic movements are on the right track.

The next two years are very crucial for Indonesia’s political economy. 2014 will be a pivotal year for Indonesia’s democratic sustainability, having a newly elected president after subsequent terms of Susilo Bambang Yudhoyono’s Presidency, 2015 for Indonesia’s economy in ASEAN will launch the AEC by which each member state is supposed profit from its long-term investment windfall.

Again, both a sustainable democracy and high long-term investment inflows are very important for Indonesia’s political economic health.

The writer is co-editor of the Journal of Economics and Finance in Indonesia (EFI) of the University of Indonesia (LPEM). He obtained his PhD from Waseda University, Graduate School of Asia Pacific Studies (GSAPS).

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