Can Indonesia compete?

All the pieces are there to push Indonesia up the ladder before mid-century. Can the country put the puzzle together?

Can Indonesia compete?

We have discussed in a number of lectures Indonesia’s standing in terms of marginal productivity on a purchasing power parity basis as compared to that of neighboring Asean and Asian countries. What’s telling is not only how the country may be lagging behind some others, but also the abundant opportunity that lies ahead in view of how the global supply chain may change and become more decentralized.

Comparison of Competitiveness Indicators in Several Countries in Asean and Asean + 3

A country’s productivity is critical in positioning its competitiveness to the region and rest of the world. It is a yardstick commonly utilized by multinational companies before deciding upon where they build their next manufacturing base. Indonesia’s marginal productivity on a PPP adjusted basis at $23,541 is lower than that of Singapore, Brunei, Malaysia, Thailand, China, South Korea and Japan. These other countries have been able to focus on the higher end of the value chain in producing both goods and services that are typically of higher marginal economic value.

A country’s marginal productivity determines the degree to which it can produce competitively for both export and domestic purposes. Indonesia’s population and economy, which are approximately 49-45 percent, respectively, of those of Asean, will benefit from a higher marginal productivity both domestically and internationally.

The chart above, albeit improving in the last few years, is a reflection of how the country has been lagging in a number of factors.

Comparison of Labor Productivity in Asean and Asean + 3

First, Indonesia historically had stingily spent on education until it legislated a law in 2009 that would require spending 20 percent of its government budget on education. The historically low spending on education had adversely affected the country’s ability to adequately spend on education’s hard and soft infrastructures, including research and development.

Years of low rate of spending on education have been reflected in Indonesia’s poor performances in math, science and reading. This could arguably have been one of the primary reasons for the country’s inability to register as many patents and as much educational attainment as some of the neighboring Asean and Asian countries.

Percentage of Educational Achievement for Populations Aged 25+ and Number of Cumulative Patents

Programs for International Student Assessment (PISA) Ranking and Scores in Several Countries in Asean and Asean+3

The recent significant increase in percentage (from a low single digit) has also been supported by the steady increase in fiscal space, causing a disproportionately higher amount being allocated on education as of late.

Indonesia’s tax collection has significantly increased from a paltry 116 trillion rupiah ($7.9 billion) in the year 2000 to 1,786 trillion rupiah in 2019. With a tax ratio (ratio of tax revenues to GDP) of around 11 percent, the room for fiscal space, and inevitably educational budgetary space, improvement is warranted given continuing proactive fiscal policy as to increase Indonesia’s tax base.

Indonesian Fiscal Space (in trillion Rupiahs)

Second, the consistently low financial inclusion (at 49 percent compared to Singapore’s 98 percent) hasn’t helped many Indonesians attaching their great entrepreneurial ideas with access to capital. Access to capital has been a dominant factor in boosting not only a country’s entrepreneurship but also its productivity. The foray of technological capital providers into the country, coupled with the rise of internet capable mobile technologies, have helped fuel conversations and transactions that are expected to increase financial inclusiveness in the near foreseeable future.

A number of the tech players in the country, including those in the ride-sharing and also pure financial services spaces, have begun undertaking institutional and peer-to-peer lending on a measured basis. Although promising in augmenting financial inclusiveness, instances of higher than expected non-performing loans have caused some of these tech players to be cautious with respect to future directionality.

Third, the rampant liquidity in the world (approximately more than $100 trillion) has been more widely seen in the developed economies, doing injustice to many emerging economies that need such liquidity. The liquidity that managed to reach the emerging economies has unfortunately reached more of the financial, as opposed to real, components of each of these economies.

Digital Penetration in Asean Countries, 2018

This can be evidenced in the more than proportional inflation of financial assets (capital markets) than that of the real economy. This lack of well distributed liquidity within Indonesia’s economy has adversely affected not only the country’s productivity, but also its ability to better distribute welfare or equality (Gini coefficient).

Covid-19 has caused many governments to come up with different policy responses that combine both fiscal and monetary policymaking. Most of the developed economies have embarked upon modern monetary policymaking, including quantitative easing, that is likely to entail a greater amount of liquidity in their respective markets. Much of this newly created liquidity is targeted at both equity and debt instruments in the capital markets, likely warranting a further divorce between the real economy and capital markets.

Real and Financial Sectors Inflation (Indonesia and the United States)

The Indonesian government has, however, differed from many developed economies in its policy response, which is largely fiscal and targeted more at the demand side and less at the supply side of the economy. At this rate, the country may be at risk of weaker growth dynamics and lower productivity in the near foreseeable future.Fourth, aside from being invested in financial assets, foreign direct investment into the real economy has increased from $16.4 billion in 2010 to $28.2 billion in 2019. This capital formation has not only helped create employment and social stability, but also in Indonesia moving up the value chain. The FDI per capita of around $91.3 for 2019 does not compare favorably with that in neighboring countries, and has bearing on the direction of the Indonesia’s marginal productivity.

While Indonesia’s FDI per capita in 2019 is almost the same as that of the Philippines, a striking difference between the two countries is in their ability to source remittances from their respective citizens working overseas. The Philippines’ staggering inward remittances of $35.2 billion in 2019 (compared to Indonesia’s $11.7 billion) reflect upon their quality of education, which has helped Philippine citizens attain relatively higher employment compared to Indonesian citizens overseas.

Comparison of Foreign Direct Investment in Several Asean Countries

How will Indonesia compete?

The ongoing Covid-19 has further amplified Indonesia’s concerns with respect to its marginal productivity. The global collapse of aggregate demand is likely to cause weaker growth dynamics in the near future. This is coupled with disruptions in and efforts to decentralize supply chains, which are likely to entail lower productivity. 

Notwithstanding the above noted concerns, Indonesia invariably has a number of reasons to be encouraged with respect to the future.

First, taking a 25-year view to 2045, the accumulation of the government’s annual budget for education will be approximately $4 trillion. This is merely assuming allocating 20 percent for education per year and the country maintaining a tax ratio of 11 percent until 2045. Any upside on the country’s ability to expand its tax base and therefore tax ratio will only imply an accumulated amount higher than the aforementioned amount.

The key to this is Indonesia maintaining peace, and social and macroeconomic stability in the next 25 years. The country and Asean region have gone through so many tests in the last 2,000 years by way of showing resilience, while having been graced by different religious influences, colonialism, independence, democratization and financial/economic crises.

With the increasing role of digitization that is expected to further ease tax collection and higher political will as to lower tax rates, the country can reasonably expect to increase its tax ratio from around 11 percent to above 20 percent in the next 25 years. Not only will this likely further augment the quality and quantity of education, but also the country’s overall welfare.

Second, Indonesia should be able to frame its future educational narrative with broad-based disciplines that can include more focus on STEM (science, technology, engineering and mathematics), vocational skills, research and development, the ability to communicate with the international community, and measurability/accountability of educational spending by both the central and regional governments. Covid-19 has taught us a lesson in that human beings are shifting to a world that is likely to be less physical, less communal, and more digital or virtual in the near future. Whether or not this represents how the world will be in the long run, Indonesia needs to embrace the digital world much more wholeheartedly not only as a consumer, but also as a developer and owner.

A full embrace of STEM will require cadres of the best teachers from within and beyond to educate both the current and future generations. While potentially bereft or short of teachers of the best quality in STEM, an open-minded policy that would be able to attract the best talents from anywhere around the world is imperative.

Third, the country’s demographic profile is youthful (with 50 percent of the population being younger than 29 years old) and likely to stay that way for the next 20 years. With targeted investment in human capital development, such a profile could work to Indonesia’s competitive advantage in the medium to long term.

The labor force of Indonesia is approximately 130 million, and around 95 percent relates to the micro, small and medium entrepreneurship which falls in the youthful demographic category. The focus on further educating all parts of the demography is likely to not only help expand the labor force, but also help them expand internationally and also economically.

Demographic Profiles of Indonesia and the World

Fourth, unlike Indonesia, the world’s demographic profile is actually becoming more aged. As a result of which, the amount of savings will only increase globally. By way of the increase of savings around the world, while the number of investable classes of assets would remain relatively constant, the price of money or cost of capital is only likely to decrease over time. This is likely to benefit individuals, especially entrepreneurs who are in need of capital warranting the prospect of higher marginal productivity.

Fifth, in addition to allocating a significant amount for education, Indonesia is likely to continue allocating a meaningful amount of its government budget on infrastructure development (averaging 15-20 percent of the government budget for infrastructure development in the last few years). It is estimated that Indonesia will cumulatively spend up to $3 trillion at today’s exchange rate on infrastructure development in the next 25 years. This is expected to bring about a much higher degree of connectivity and, therefore, productivity.

English Proficiency Index Rankings and Ratings

Sixth, Indonesia has never been bereft of a proper narrative. What it needs going forward is someone or some group of people that can properly articulate the narrative to the world. This is key in a number of factors.

A good or compelling storytelling about Indonesia’s future will entail a rise in capital (financial, technological and human) flows that are necessary in building the country’s manufacturing and service capabilities, which can produce goods and services needed both domestically and internationally.

In conclusion, looking at Indonesia typically requires taking a long view. The Covid-19 development is an aberration that should not alter our long-term directionality as long as we are steadfast on both what is good and important. Good in that Indonesia’s higher marginal productivity will mean a much higher ability to engage its populace in producing goods and services that are well needed domestically, and hopefully desired internationally.

Importantly, a well-articulated narrative is likely to help connect the country with the rest of the world in terms of their geopolitical histories and future. As the world’s third-largest democracy, with its fourth-largest population, and potentially fourth-largest economy, Indonesia deserves a seat at the table to engage in and help shape conversations regionally and, potentially, globally.

Fulfillment of most, if not all, of the above items will most likely augment Indonesia’s marginal productivity, geopolitical presence and competitiveness.

Gita Wirjawan served as Indonesia’s minister of trade from 2011 to 2014, and is chairman of the advisory board of the School of Government and Public Policy Indonesia.

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