Indonesia’s economic growth has been praised for its resilience during a time of global economic slowdown. However, for a nation rich in natural resources much of that growth has been driven by high commodity prices.

The situation is not that different from India, where growth is propelled not by commodities but by the services industry.

“In neither case was manufacturing the primary driver of growth,” economist Vikram Nehru of the Carnegie Endowment for International Peace, wrote in a newly published paper by the World Bank office in Indonesia.

Nehru presented his paper at the Seventh Sadli Lecture, an event sponsored by the Australian National University and the Institute for Economic & Social Research, Faculty of Economics, University of Indonesia (LPEM-FEUI) at the Hotel Borobudur in Jakarta last month.

The point, Nehru said, is that both India and Indonesia are growing economies in which the share of GDP from manufacturing is declining. This can have disturbing consequences.

“Labour productivity in manufacturing displays unconditional convergence; that is, it tends to converge towards the technology frontier irrespective of country-specific conditions,” Nehru said.

Secondly, “both India’s and Indonesia’s economies have a young population and a labour force expected to grow rapidly in the coming decade.”

“Labour-intensive manufacturing holds the best chance for both countries to increase GDP growth as well as generate employment, but they cannot respond to both challenges alone.”

“Manufacturing generates demand for inputs and complementary outputs from other sectors such as agriculture and services; which, in turn, boosts growth and employment.”

The goal is to move labour out of low-productivity agriculture and informal services, he said.

Nehru looked at four policy areas: trade and foreign investment, infrastructure and urban development, human-capital development and policies promoting factory-market flexibility.

In general, both countries are more similar than different. They face the need to encourage growth while achieving more equitable outcomes.

Complex political structures; namely fragile coalition governments, make it hard to take the bold initiatives needed for a strategic trade or industry policy, he said.

Marginal parties have more power than their relative electoral strength indicates and special interests dilute the dominant party’s plans when necessary. In these situations, populist policies are more likely to prevail because they tend to appeal to a broad spectrum of coalition interests.

Nehru said that this feature of the political economy in both countries explained some of the protectionist policies that have emerged in both democracies; although in general he believes that trade, investment and infrastructure policies in both countries are imperfect but on the right track.

Of particular focus is protectionism. Indonesia, while having a much lower effective rate of protection than India (estimated at 30 -40 % in comparison with Indonesia’s 5-9 %), has many non-trade barriers.

Indonesia employed about 40 major non-trade measures in 2011, compared with India’s 14. Indonesia also has non-trade barriers on more than 500 manufactured products that are subject to licensing and pre-shipment inspection. Some 200 iron and steel products can only be brought into the country by licensed importers and are subject to pre-shipment inspection.

Nehru believes the two nations can learn from each other.

For example, he said that India could learn from Indonesia’s experience with multi-brand retailing, which has demonstrated that openness to foreign investment can significantly improve the efficiency of the value chain in the retail sector.

Indonesia’s primary and secondary education sectors have also been far more successful in boosting the literacy and marginal productivity of labour than in India.

On the other hand, India is an example of how to increase the number of private-public partnership (PPP) projects, which often bridge infrastructure financing gaps from foreign investment.

In India, a PPP can receive a grant from the central government of up to 20 % of the project’s cost from an infrastructure facility. PPPs in India can also be financed entirely by foreign investors, without the need for government approval.

Indonesia must also find a way to depoliticize annual increases in minimum wages, which India, an older democracy with a longer history of powerful-trade union activism, has seen decline in recent years due to the rise of casual labourers, the willingness of employers to replace striking workers, and some favourable Supreme Court decisions.

India’s federal structure also encourages economic competition among sub-national entities to drive growth, thus leveraging the decentralized system. Indonesia could possibly imitate this lesson in its own decentralized system, Nehru said.

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Indonesia Snapshot

Capital: Jakarta
Population: 259 million (2016)
Currency: Indonesian Rupiah
Nominal GDP: $936 billion USD (IMF, 2016)
GDP Per Capita: $3,620 USD at Current Prices (IMF, 2016)
GDP Growth: 5.0% (2016)
External Debt: 36.80% of GDP (BI, Q2 2016)
Ease of Doing Business: 91/190 (WB, 2017)
Corruption Index: 90/176 (TI, 2016)

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