Indonesia is Losing Ground

“‘Well, in OUR country,’ said Alice, still panting a little, ‘you'd generally get to somewhere else—if you ran very fast for a long time, as we've been doing.’

“‘A slow sort of country!' said the Queen. ‘Bow, HERE, you see, it takes all the running YOU can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!’”

Lewis Carroll, Through the Looking Glass

Like Alice in the Red Queen’s race, countries attempting to boost their competitiveness at a time of rapid economic change often find that they have to run as fast as they can simply to stay in the same place. Indonesia is changing, but many of the dynamic economies of East Asia are changing faster. Indonesia is losing ground to China, Vietnam, Thailand, Malaysia, India and the Philippines in foreign direct investment flows, manufacturing, infrastructure and education. The only sector in which Indonesia is more internationally integrated than its peers is finance, but economists are divided as to whether early financial market integration is a good thing for development (Kose et al. 2006). Despite some progress, Indonesia’s basic social indicators still lag behind other middle income countries.

It is reasonable to ask why Indonesia has not done better. It lives in a good neighborhood, with several very fast-growing nations nearby. It has not had a major external or civil war since the 1960’s. Its natural resources generate income that could be used to educate the population, build and maintain infrastructure and improve health and productivity. Investment has been low since the late 1990’s and social spending has been miserly. While Vietnam has grown at nearly eight percent over the past two decades, Indonesia has averaged only 5.5 percent even if the large drop in output in 1998 is ignored. If the 1998 collapse is included, annual per capita growth is barely over two percent since 1990. Its share of world exports in 2007 was lower than in 1977 or 2000.

The evidence presented in this section is at odds with some of the more optimistic assessments of Indonesia’s economic situation. As we noted in the introduction to this report, the optimistic scenario is not incorrect but it is incomplete. Indonesia has grown faster than many middle income countries over the past decade, and has continued to do so over the past year. Indonesia has suffered less during the recent crisis because it is less dependent on exports than some of the more outward-oriented countries in the region. The commodity boom that began in 2003 has been a tremendous advantage.

But domestic consumption and high commodity prices are not an adequate basis on which to build a prosperous society. Indonesia must improve its hard infrastructure and its technological and managerial capabilities if it is to develop a wider range of competitive industries. It must adapt to the global business revolution and use foreign investment to link to global markets and acquire cutting edge technologies. It must learn to translate economic gains into social progress, to build an inclusive and more equitable society that
gives people a stake in stability and democracy.

This section makes the case that Indonesia has underperformed in economic and social terms. Over-reliance on natural resources and underinvestment in health, education and large-scale physical infrastructure have deep roots in the country’s political economy, stretching back to the colonial period and continuing through early independence and the New Order. What is surprising is that these long-established patterns have intensified during the reformasi era. The advent of a more open and democratic political system not been accompanied by a renewed emphasis on efficiency, equity and sustainability. We will consider some of the reasons for this continuity in later sections. Part of the problem is a political complacency that can be traced to lack of awareness within government and the wide public of Indonesia’s poor performance relative to other countries region. The main point of this section is that this complacency is not warranted, and that the evidence indicates that Indonesia is falling behind its main competitors in terms of economic preparedness and social progress.

The competitiveness of national economies can be measured in a variety of ways. Some indicators, for example “revealed comparative advantage,” look at trade outcomes. The World Economic Forum’s Global Competitiveness Report considers factors that promote or inhibit trade and investment such as skill levels, infrastructure, and the quality of regulation and government institutions. None of these approaches can be considered comprehensive in their own right, but each adds something to our understanding of the factors that strengthen an undermine competitiveness in individual countries.

Indonesia was ranked 54 out of 133 countries in the 2009-2010 World Economic Forum Global Competitiveness Report, which placed Indonesia considerably ahead of the Philippines (87) and Vietnam (75), but behind Malaysia (24), China (29), Thailand (36) and India (49). Less important than the rankings themselves are the individual indicators of competitiveness included in the report (see Figure 1).

figure.1

Indonesia ranks 16th in market size—reflecting the advantages of bigness discussed in the previous section—but is losing ground in five key areas: technological readiness (88), infrastructure (84), health and primary education (82), labor market efficiency (75) and higher education and training (69). We will have more to say about each of these four components of competitiveness later in this section and in the remainder of the paper. However, the main point is clear: Indonesia has underinvested in physical infrastructure and in health and education.

Like the other large economies of Southeast Asia, Indonesia relied almost exclusively on natural resource exports until the mid 1980s. At that time, a fall in global commodity prices combined with the Plaza Accord exchange rate adjustments led to a shift in strategy away from natural resource dependence and towards exports of labor-intensive manufactures based largely on inward investment from Japan, Korea and Taiwan. Exports of manufactures from Indonesia grew at an average annual rate of 16.5 percent from 1991 to 1996 (Table 1).


Although the statistics are inflated by the sharp rise in plywood exports (plywood is a manufactured good) following the ban on exports of raw timber, exports of other goods also increased quickly. The optimism resulting from the region’s newfound success in exporting manufactures was one of the factors motivating the overborrowing and overinvesting that ultimately led to the East Asian financial crisis of 1997.

Table 1 shows that growth of manufactured exports slowed during the crisis period and its immediate aftermath, which also covers the period of the 2001 economic slowdown in the United States. However, in most of the region the period from 2003 to 2007 was one of renewed expansion: growth of manufactures grew by 28 percent per year in China, 15 percent in Thailand and a remarkable 21 percent in Vietnam. Even India (17 percent) and Brazil (16 percent) made impressive strides in exporting manufactures.

Although Indonesia’s six percent growth was faster than that recorded during the crisis period, it was considerably slower than the country’s own pre-crisis record and inferior to other countries in the region with the exception of the Philippines.

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