Indonesia-Australia: Challenges and Opportunities (Part I)

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Christopher Findlay and David Parsons

This article is summarised from a speech presented by Professor Christopher Findlay, Executive Dean of Faculty of Professions the University of Adelaide at  AIBC SA Business Luncheon -Celebrating the anniversary of Indonesian Independence at Intercontinental Hotel Adelaide on 23 August 2012 derived from his paper co-authored with David Parsons.

This article focuses on two points. First, Indonesia, the world’s third largest democracy, is becoming bigger and richer, which is an important for Australia.  Second, but Australia and Indonesia face some similar concerns as well as some interconnected challenges and there is much to be gained by understanding those better and then working out a better long term strategy.

Economics background

The background is that real output in Indonesia has been growing at 5-6% in the last decade.  This is the highest rate in SE Asia.

Incomes per head last year were of the order of $3500 in US dollar terms, but closer to $4500 in purchasing power (PPP) terms (which is twice the level of a decade earlier).

The poverty incidence rate has fallen dramatically over the last 5 years, from closer to 40% to now near 30%.

The growth in Indonesia makes it a much more important economy.    In PPP terms, it’s the 4th largest economy in East Asia after China, Japan and South Korea.  In the last few years it has accelerated away from Australia in these terms.

Some forecasts have a very positive outlook for further growth.  Citibank recently suggested Indonesia could be, like its population, the 4th largest economy in the world in 30 years time (now about 16th).

Political context

The other important piece of background in Indonesia is the movement to a democratic political system since the late 1990s.

An assessment of progress in this extraordinary transition, which involves not just elections but also active civil society and a very busy media sector (traditional and social!), found that of the

‘five key elements of democracy: consensus, inclusion, competition, rule of law and good governance. …… issues involving the rule of law and good governance present the most significant challenges to the consolidation of democracy in Indonesia. Basic elements of consensus, inclusion and competition, on the other hand, have been realized since the beginning of the democratic transition. Although problems still exist in these areas, they are of lesser significance.[1]

The DFAT country brief on Indonesia reports that[2]

Since 2005, Indonesia has held over 350 local elections. Sub-district and district leaders and provincial governors win office through direct elections. Voters are also able to select provincial and district-level parliamentarians.

Indonesia has undergone a process of decentralisation since 1999, which has seen control of large amounts of public expenditure and service delivery transferred from the central government to over 450 provincial and local governments.

President Susilo Bambang Yudhoyono was elected to a second and final five year term in presidential elections in July 2009. Receiving around 61 per cent of the national vote and winning ballots in 28 of 33 provinces, President Yudhoyono was the first Indonesian president to be re-elected to officeby direct popular vote. .

The 2009 elections took place on a vast scale. There were 171,068,667 registered voters from 33 provinces, 489 districts and 77 electoral districts.

The elections were widely judged to be free and fair and were largely free of violence. The elections marked another important milestone in Indonesia’s successful transition to a vibrant, open democracy.

The next round of national and presidential elections will be held in 2014.

This transition on Australia’s doorstep is one of the extraordinary transformations to democracy in modern times. There is no going back.  It will wobble from time to time (just like Australia) but people are committed to democracy.

There has also been an extraordinary devolution of power within government to the provinces and regions.  This has swept away the worst of the “crony” capitalism and opened the way for many countries and players to do business and have relationships in Indonesia with a wide spectrum of interests in a way that you could not under Suharto.

The rapid move to democracy leaves gaps and deficiencies in the wide range of institutions which are the underpinnings of a modern democracy.  These institutions are usually developed and matured over decades.  Australia is still doing it.

In a democracy, developing these institutions is a function of all players in civil society not just government.

Australia has not giving enough credit to Indonesia for these changes and tends to take these developments for granted, while focused on the pessimistic and bad news stories with a short term horizon.

The communiqué from the leaders meeting in November last year did however refer to an important set of shared values, that is, ‘values of democracy, openness, mutual respect and tolerance’.[3]

These features of the political context in Indonesia as well as our shared values are important to recall in what follows.

Returning to the topic of economic conditions: where did this economic growth come from, what are its prospects and what are the implications for Australia and for the development of the relationship with Indonesia?

Contributors to growth

Some of the contributors to growth in Indonesia have been the following.

–          The lowering of barriers to trade and the greater integration of Indonesia with the rest of the world.

Trade barriers have been falling in Indonesia – the average tariff is around 7% now compared to 19% in 1990.

–          Benefiting from the resources boom

Indonesia compared to other East Asian economies has a large resource sector and has benefited from higher resource product prices in the last decade.   It faces, though, the same uncertainties as Australia about the outlook for those prices.

–          Urbanisation and the growth of manufacturing

An important contributor to overall economic growth is the transfer of labour out of low productivity jobs in agriculture to higher productivity work in manufacturing, along with which comes a rise in the rate of urbanisation.  Both are apparent in Indonesia though as we’ll see manufacturing is also under pressure from the resource sector and has never really regained the economic primacy it enjoyed before the Asian economic crisis in the late 1990s.

–          The benefits of the demographic dividend

Indonesia has a big population (242m, the fourth largest in the world) but the dependency ratio has been low, with a relatively large number of people entering the workforce, compared to the number of children and of the elderly.   This ‘demographic dividend’ however has reached its peak but Indonesia can still use its youthful population to great benefit.

–          Plus a better education performance

Along with the demographic dividend, education performance has improved.  Nearly all children now attend primary school, and 2/3 go to secondary school (that ratio was only 1/5th in three decades ago).  Tertiary enrolment rates are only about 25%.

–          Flows of foreign investment

In recent years, inflows of FDI to Indonesia have surged to $US18b in 2011 to be now about 2% of GDP.  Prospects are good, eg the AT Kearney FDI confidence index[4] has Indonesia ranked 9th in 2012, compared to closer to 20 only a couple of years earlier.

Implications for Australia.

A bigger Indonesian economy is a more important trading partner for Australia.    Currently at 2-3% of trade, and ranked 11th for exports and 13th for imports, those shares are expected to increase.

The mix of trade will change, as incomes rise. Consumption of goods (other than food) and services will rise.  Two way trade in services with Australia would diversify beyond tourism and education.

Indonesia will become more important in terms of regional security.  According to Hugh White[5] Indonesia will spend more on defense as it grows, responding to its own situation, but in the process challenging the position of Australia.  On the other hand, it could also become he says Australia’s ‘most important security partner’ in the region as that spending increases, depending on the other shifts underway and depending on the way the US sees its role in the region.

Challenges for growth

This is a good story but Indonesia faces a number of challenges to its continuing growth.

One may be the middle income trap, or working through the process of structural change while maintaining growth.   There is a great advantage in ‘starting from behind’ and catching up to global technology but at some point innovation and creativity have to become local in order to sustain growth.   The wider the application of innovation the better is the result.

While the manufacturing sector is now much larger than earlier decades, there is a concern that it is not contributing enough to growth. Its share of exports has actually been falling.  Its output share has also been falling.   Output tends to focus on food and tobacco as well as textiles rather than higher level products where productivity growth might be higher.  Nor is Indonesia well connected to regional supply chains.  Because of the growth of the resource sector, manufacturing is being squeezed.

The service sector is growing, but in the informal sector.  Wages there tend to be low and its growth leads to a risk of increasing inequality, a reason to focus on productivity growth in services.

Finally in agriculture, where Indonesia retains a relatively high share of output and employment compared to the rest of East Asia, the assessments are the productivity levels are relatively low but that they would respond to investment eg in irrigation.  This low productivity also contributes to the inequities of incomes across regions of Indonesia.

Other factors are important.

  • the performance of the education system

Despite the rates of participation in education, the performance of students remains relatively low.   So focussing on quality as well as quantity will be important.  In addition tertiary enrolments are low, as noted, and much lower than the rates at primary and secondary levels.  The connection of university research to industry will be critical to avoid the middle income trap.

  • infrastructure

Indonesia ranks low in the WEF measures of infrastructure quality (rank of 76, far below Malaysia and Thailand and China, but better than India and the Philippines): this is a problem for performance of manufacturing, in particular, but also for the integration of markets in Indonesia.  Indonesia’s geography makes this a harder challenge to meet.  The government last year released an important Masterplan with a focus on infrastructure investment.

  • the business environment

Indonesia continues to rank poorly on the World Bank’s doing business indicators and now sits at 129 out of 183.  Low scores apply to starting a business, enforcing contracts and resolving insolvency.   These low scores, and the continuing assessments of the presence of corruption, are linked to the manner of the decentralisation of powers to local governments, and to the earlier point about the rule of law and good governance.

  • the risk of protectionism.

There is anxiety in some quarters about the pursuit of policy for particular interest groups.  Examples are the growth of protectionism in Indonesia, using so-called behind the border measures, for instance, the new rules on horticultural imports, quotas on cattle imports and restrictions on raw material exports. Partly these policies are designed to protect local industry and promote local processing, but they are also related to targets to raise revenue.   The revenue targets are in turn driven in part by the persistence of fuel subsidies, which though designed for poor people actually benefit rich households who are large users of fuel.

Policy implemented in the private interest is not unusual.  Australians might express concern about those policies, particularly the ones that affect us, such as restrictions on food imports.  But Australians also have to think about their actions and how they might induce within the Indonesian political system a reaction (an export ban for instance).  It is important to think about what other actions or strategies we might adopt to try to shore up an open regime there.    The way Australia works with Indonesia now and in 2013 as it moves to chair of APEC will be a test of that capacity.

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2 Comments

Filed under Australia, Conference, Democracy, East Asia, Economic development, Economic Integration, Education, Food and agriculture, Income inequality, Indonesia, Infrastructure, Investment, Trade

2 responses to “Indonesia-Australia: Challenges and Opportunities (Part I)

  1. Pingback: Indonesia-Australia: Challenges and Opportunities (Part II) | GoLive Indonesia

  2. Yeri

    In terms of improving education quality, my school in Yogyakarta has established a partnership with our counterpart in Melbourne, Australia. We are one of the few schools in Indonesia who has such a privilege. Unfortunately, the abolition of international-standard school would make the continuation of such cooperation difficult due to the lower budget we would get to finance such a program. However, I hope the success of my school to host the visit of our Australian guests will pave the way for Indonesian teachers to teach Indonesian language and culture there. So far, Malaysian teachers dominated that teaching post. This way, Indonesian language and culture will gain more acceptance among the Australians which will help improve mutual understanding between the two countries.

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