Inequality should receive greater attention in Indonesia

The rising tide

Inequality is an issue that has rising prominence in Indonesia. Several organizations and researchers have started to buoy the warning that rising inequality in Indonesia can be harmful to the nation’s development. In the past, President Jokowi has called rising inequality ‘dangerous’ (Chatterjee et al. 2015) and ‘might disrupt economic growth and social stability’ (KumparanBisnis 2017).

However, the state of inequality in Indonesia shows little sign of change, if not worsening. Looking at the consumption Gini from Sari (2022)[1], Indonesia is already on a downward trajectory from its peak in 2013 albeit very slowly. However, the latest data shows that this trend seems to halt in 2019. Since 2020, the trend seems to have reversed due to the COVID-19 pandemic which canceled Indonesia’s impressive poverty reduction achievements in the last decade (Suryahadi et al. 2020; Ing et al. 2022). Chancel et al. (2022) report that the top 10% in Indonesia earns 13 times more than the bottom 50%. In fact, the same report also mentions that the top 10% income share has barely changed since 1900. World Bank (2016), drawing on analysis from Zhuang et al. (2014), notes that Indonesia’s consumption inequality is higher than some of its neighboring ASEAN countries with relatively similar stages of development such as Thailand and Vietnam.

The landscape for wealth inequality is even more grim. Shorrocks et al. (2021) report that the bottom 50% in Indonesia only held 7.4% of the entire nation’s wealth in 2014. This is a meager increase from the 5.1% figure in 1997. Meanwhile, despite losing a major portion of their wealth from 1997 to 2014, the top 10% still holds a significant portion of the nation’s wealth: slightly more than a third.[2] Furthermore, my calculation using Shorrocks et al. (2021) database as displayed in figure 1 shows that households in percentile 10–30 only had their wealth grow by at most a quarter in the span of 17 years. Households on the lowest decile even lose their wealth. On the other hand, households in percentile 30–90, the middle to upper class, saw their wealth grow by at least more than half in the same period. We haven’t even begun to delve into inequalities in other dimensions, such as gender, education, health, and more.

Figure 1: Wealth growth by decile

Source: Author’s calculation based on Credit Suisse data

Given the direness of the situation, in this piece, I’d like to argue that the Indonesian government should drastically escalate its response towards rising inequality. I’ll discuss 3 reasons why rising inequality is a major obstacle in Indonesia’s development path. First, I’ll draw findings from various research that posit high inequality is a hindrance for growth and thus poverty reduction. Second, inequality is a multidimensional and intergenerational problem that obstructs an individual’s potential for social mobility in the future. Finally, I’d like to show that a high level of inequality destroys social cohesion and leads to conflicts.

No growth without equity

There are myriads of research highlighting that inequality is an unconducive environment for economic growth and poverty reduction. Interestingly, studies by the IMF were one of the first to raise the alarm. Through cross-country regressions, these studies found that high inequality reduces medium-term growth and leads to shorter growth spells — i.e., periods of continuing high growth which, the authors argue, is a crucial element in poverty reduction efforts (Berg and Ostry 2011; Berg et al. 2012; Ostry et al. 2014). Hill (2021) echoes this finding through his study of Indonesian data for the past 50 years. He found that periods of rising inequality have always been accompanied by lower responsiveness of poverty towards economic growth. As such, rising inequality has made the impact of economic growth towards poverty reduction suboptimal. Plenty of other studies also support the view that a reduction in inequality leads to faster growth (Marrero and Servén 2021; Brueckner and Lederman 2015; Suresh Babu et al. 2016) and greater poverty alleviation (Ravallion 2011; World Bank 2014; Gibson 2017; Zhuang et al. 2014). In other words, there is a huge opportunity cost to high inequality.

The claim that rising inequality will inevitably fall as countries develop further as proposed by Kuznets (1995) doesn’t seem to have much empirical ground. As documented by Berg et al. (2012), a relatively equitable income distribution is actually a prerequisite for sustained growth. Moreover, Yumna et al. (2015) provided the counterevidence that directly rebuts Kuznets’ hypothesis. They found that inequality can be harmful to growth once it passes a certain threshold; thus, implying a reverse relationship than what was suggested by Kuznets’.

The findings discussed above are hardly surprising as economic inequality can undermine an individual’s ability to reap the benefit of growth. To further investigate the channel in which economic inequality can do this, we turn to other dimensions of inequality, which are closely linked with economic inequality in itself.

Multidimensional and intergenerational problem

In their seminal paper, Heckman et al. (2013) found that many important adult outcomes can be traced back to conditions during childhood. In the same vein, many inequalities of outcomes can also be traced back to inequalities of opportunities during childhood. World Bank (2015a) and Indra et al. (2020) have shown that substantial factors outside the control of individuals during birth and childhood have contributed significantly to one’s access to basic services. Most notably, these studies pointed out that children born in urban areas or in higher-income households have better access to quality education, healthcare, electricity, transportation, housing, sanitation, and clean water.

The impact of these differences during childhood will gradually build up and accumulate over time. Kurniawati et al. (2019) show that there is a wide gap in education outcomes between socioeconomic groups which will eventually impact a person’s labor market prospects in the future. To back up that claim, Manning and Pratomo (2018) have shown that the wage growth of non-permanent workers, a work status that many low-income individuals bear, has fared worse than their permanent counterparts during Jokowi years.

Even further, Yumna et al. (2015) posit that huge disparity in education outcomes can lead to higher unemployment over the long term, possibly primarily due to the polarization of the labor market into high-skilled high-paying jobs and low-skill low-paying jobs (Hill 2021; Manning 2018; Manning and Pratomo 2018; World Bank 2016). Several studies further demonstrate the threat of unemployment by showing that it leads to earnings inequality (Tregenna 2011) and confounds the effect of high inequality in eroding growth (Castells-Quintana and Royuela 2012) and spurring poverty (Ogbeide and Agu 2015).

Other than education, some research also links childhood impoverishment such as stunting, which is more prevalent in lower-income households, to adult outcomes such as income (World Bank 2016, 2015a; Hoddinott et al. 2013; Galasso and Wagstaff 2019; Dewey and Begum 2011; McGovern et al. 2017). In sum, this evidence suggests that absent proper attempts to address inequality of opportunities in early life, we risk falling into a vicious cycle of reinforcing inequality of outcomes that could transcend generations.

Society divided

The danger of inequality apparently extends beyond the destruction of human capital and into the destruction of social cohesion. (ILO (International Labor Organization) 2011) asserts that many social unrests are driven by inequality and sentiment of unfairness. In Indonesia, there is a similar perception that some groups enjoy riding the wave of growth while others are left behind (World Bank 2015b). Unfortunately for some areas, that sentiment has morphed into anger and resentment. Several studies have presented compelling evidence that regions with high inequality are more prone to violent conflicts (World Bank 2016; Indra et al. 2019) and have higher crime rates (Tadjoeddin et al. 2021; Poveda 2011; Enamorado et al. 2016). High inequality also exacerbates social divisions in ‘high conflict’ regions (Tadjoeddin et al. 2021). In a more micro setting, Breza et al. (2018) found that wage inequality among manufacturing workers demoralized the group and boils resentment between them which in turn yields lower productivity. It is then not difficult to conclude that social and political instability is unfavorable for growth to take place.

Conclusion

There is a saying that economic growth is a ‘tide that lifts all boats’. For Indonesia, the tide, high it may be, lifts some boats more so than the others. While the country has witnessed impressive growth after the democratic transition, the proceeds of this growth have not been distributed equitably. As such, Indonesia is missing out on the potential to accelerate its poverty alleviation. This piece has also explored two other ways in which inequality is detrimental towards growth and poverty reduction. First, the effect of inequality of opportunities during childhood can ripple across time until adulthood and in turn, perpetuate further disadvantages for future generations. Finally, economic inequality is a fuse for social conflicts which is also a disabling factor for growth. Therefore, any efforts towards improving the welfare of the masses cannot be divorced from trimming the current high rate of inequality. As the current Indonesian administration has made combatting poverty one of its key targets (Yusuf and Sumner 2015), a focus on mitigating inequality is an imperative that we cannot ignore.

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[1] In Indonesia, consumption is commonly used as a proxy for income and well-being. See Priebe (2014).

[2] Chancel et al. (2022) however reports that the top 10% still holds 60% of total wealth in 2021. The difference can be traced to measurement method.