Indonesia Downgrades: Should Indonesia transform industrialization?

Illustration of Indonesia’s Economy Class (Source: Tri Saputro/CIFOR)

In 2019, Indonesia had become part of an upper-middle-income country. Unfortunately, in the following year, Indonesia’s Gross National Income (GNI) fell to USD 3,870 per capita. This caused Indonesia to be downgraded to a lower middle-income country on July 1, 2021, by the World Bank. This predicate can only be felt by Indonesia for no more than 1 year. According to the Ministry of Finance, the decline in Indonesia’s per capita income was caused by the COVID-19 pandemic. But is this the only reason Indonesia downgrades?

First of all, to find out Indonesia’s journey to grade up started from GNI per capita starting in 2016 which always increased. At its peak in 2019, the country managed to reach a value of (USD 4,050), placing Indonesia in the position of an upper-middle-income country.

Based on the GNI per capita classification, countries can be grouped into the following classes:

• Low Income: Countries whose income is less than USD 1,046
• Lower-middle Income: Countries whose income is between USD 1,046–4,095
• Upper-middle Income: Countries whose income is between USD 4.96–12,695
• High Income : Countries whose income is more than USD 12,695

When compared with the GNI of other Southeast Asian countries, Indonesia ranks fourth-highest, behind Singapore (USD 54,920), Malaysia (USD 10,580), and Thailand (USD 7,050). This means that the figure obtained by Indonesia is still far from solid in bearing the title of Upper Middle Income when compared to Thailand and Malaysia, which are upper-middle-income countries.

Graph.1 ASEAN Income Per capita 2020 (Source: Databoks, 2020)

If we take the view from the fourth quarter of 2019 Indonesia only has a growth of 4.97 percent (y-o-y). This achievement decreased compared to the third quarter of 2019 which grew by 5.02 percent. This has indicated that the decline in growth at the end of 2019 is a signal of Indonesia’s status as a lower middle-income country. Coupled with the World Bank statement that Indonesia’s GNI per capita is very close to the classification threshold when this country is recognized as an Upper Middle Income Country. Thus, it is very vulnerable for Indonesia to fall back into the lower middle class. The case of a pandemic at the beginning of 2020 made the world economy worse. As a result, the Indonesian economy is getting worse. Economic observers argue that the decline of Indonesia as a low-middle-income country is not only due to the pandemic but also due to inconsistent industrialization factors. This opinion is reinforced by the fact that not many countries have dropped out during the Covid-19 pandemic.

Indef’s Senior Economist, Didin S Damanhuri, explained that in the 1970s Indonesia had a per capita income that was almost the same as South Korea’s, which was around US$70 per capita. However, South Korea has grown considerably compared to Indonesia. South Korea is one of the poorest countries after World War II. In Graph 2, it can be seen that South Korea and Vietnam have skyrocketed growth. Highlighting the fast-growing economies of the two countries is none other than the result of consistency in carrying out industrialization strategies.

Graph 2. GDP per capita growth in US dollars (Source: World Bank)

Korea’s growth can be faster than Indonesia’s due to the high number of Korean GDP which is reflected in the productivity of its citizens. According to an IMF study, the economic growth of Korea and Taiwan depends on technological innovation by local companies. Which means the strategy carried out by South Korea and Vietnam focuses on optimizing industrial development. Such as building a state-owned company engaged in energy and construction, improving the quality of human capital, improving the performance of public companies and other supports that are more export-oriented. So that these countries can quickly transform industrialization in several regions as a transformation of development and become developed countries.

In the results of the 2020 Population Census recorded by BPS, Indonesia has a population in the productive age of 70.72%. This number makes Indonesia classified as still in the demographic bonus period. Indonesia can take advantage of this demographic bonus to boost productivity to support economic growth. Seen from the graph of Indonesia’s productive age, it is recorded that there is always an increase. This is a potential that Indonesia has that needs to be optimized to achieve sustainable growth. However, when the state fails to take advantage of it will lead to an increase in unemployment. Therefore, the productive age population needs to have education and skills in order to increase productivity. Employment must also be developed to become a forum for the productive age population.

Graph 3. Productive Age in Indonesia

Reflecting on the countries of South Korea and Vietnam, Indonesia really needs to transform its industry. Optimizing resources and capital is an important factor accompanied by technological innovation. Three things in determining a country’s productivity include labor, capital, and something known as total factor productivity (TFP), which represents efficiency and technology. Based on the Total Factor Productivity (TFP) Growth of various countries, Indonesia is one of the countries that still has a value that is close to zero. So that it can be said that Indonesia has not been efficient in utilizing capital (input) in carrying out production. Finance Minister Sri Mulyani, said that a low level of productivity would result in 1% economic growth. This means that if Indonesia wants to optimize output, it needs much larger inputs. Therefore, much larger capital is needed to increase productivity.

Industrial Transformation is considered capable of improving the structure of the trade balance and employment absorption to increase per capita income. This increase in per capita income will have an impact on sustainable economic growth. To achieve a solid Upper middle-income predicate, Indonesia needs much greater economic growth than it is today. At least to balance the countries on the same classification. It would be even better if Indonesia could get out of the Middle Income Trap. The long-term solution for Indonesia to get out of the Middle Income Trap is to downstream the industry and take advantage of the demographic bonus. This will increase the productivity of Indonesia’s potential to improve people’s welfare. Strong industrial capabilities will encourage Indonesia to become a country with a high-income classification.

Penulis:
Asyadia Haq Zahra Wijaya
Muhammad Fajar Dito Prakoso
Editor:
Asyadia haq zahra wijaya