President Prabowo’s challenging economic inheritance

Nice, catchy slogans are good for motivating a nation. But rather than obsess about the fantastic targets contained in the Indonesia Gold 2045 Vision statement the new government should be realistic about economic development goals. Faster growth is needed, not for achieving rich nation status, but for eradicating poverty. Today ten out of every 100 Indonesians are poor. That is 25 million people, about the entire population of Australia.

Prabowo inherits an economy from President Joko Widodo (Jokowi) worse than that Jokowi inherited from Susilo Bambang Yudhoyono (SBY) in 2014. Even after excluding the impact of the COVID-19 pandemic, economic growth under Jokowi is lower than under SBY. It is also less effective: Jokowi achieved slower poverty reduction than his predecessor.

Prabowo’s target of 8% annual growth is unlikely to materialise any time soon. He faces a difficult situation. Think trilemma: economic growth, financial stability, and industrialisation all demanding simultaneous attention.

As with all trilemmas, the pursuit of any two objectives results in at least the partial sacrifice of the third. Jokowi’s economic policy relegated the priority placed on financial stability. He aimed for fast growth, cemented in his Indonesia Gold 2045 project, while implementing an ambitious industrialisation policy, establishing national champions like the new capital city, Nusantara, and building many big infrastructure projects.

In doing so, he was more relaxed on financial and fiscal stability. Indonesia borrowed more and taxed less. The state budget was adjusted frequently to accommodate Jokowinomics. Everyone can see the rather remarkable infrastructure development, some of which turned out to be very costly and a serious burden on the state budget.

What course will Prabowo take? There are signs he will follow that charted by Jokowi. As noted, he wants to achieve 8% real annual growth. His team has hinted at the idea of removing the legislated caps of 60% debt-to-GDP and 3% budget deficit ratios—if true, he could put fiscal stability at risk, in contrast to the fiscally conservative SBY. While some of his plans make sense (improving human capital, for example), some are questionable (such as the food estate projects or continuing the Nusantara project). Prabowo also wants to expand secondary industry and manufacturing, presumably emulating one of Jokowi’s signature policies.

This brings us to the issue of industrialisation. As in many developing countries, in Indonesia the issue is often tied to the debate of ‘premature’ deindustrialisation. It is true that the share of manufacturing in GDP has gone down from almost 30% in early 2000s to less than 20% now. Yet many people inaccurately call this deindustrialisation; inaccurate because the sector is still growing, albeit at a slower rate. We should understand that the slower growth is the result of a complex process: a commodity boom that depressed the competitiveness of the manufacturing sector, tougher competition in the global market following the rise of China, and Indonesian’s high logistic costs.

The slower pace of manufacturing growth should not be too concerning, so long as other sectors pick up the slack. Recently, in the case of Indonesia, it is the services sector. However, the manufacturing sector still provides ‘better’ jobs for the abundant workforce – in the form of relatively stable, full-time incomes – while informal labour is more prevalent in the services sector. Jokowi’s so-called “downstreaming” industrial policy, which seeks to ensure Indonesia’s abundant mineral resources are refined and smelted at home via export controls, directs investment to a capital-intensive activity, leading to significant reduction in the ability of the economy to generate jobs. This situation risks wasting the remaining demographic dividend that will be gone in five-to-ten years.

Faster growth can be achieved if a strengthening of the manufacturing sector is combined with export orientation. No country in the history of development has grown rapidly by reliance on the domestic market alone. Even if Prabowo continues the downstreaming policy, there is only so much output that can be absorbed by the domestic market. Take nickel, for example. By banning the export of nickel ore, Indonesia has generated a wave of investment in smelters that have enabled production of nickel for batteries and stainless steel. But the next sector in the value chain is not yet ready to absorb all the production.  Most of the nickel industry product needs to be exported. Therefore, it is essential for domestic manufacturing to be able to link with the global value chain. Furthermore, domestic manufacturing needs high quality and affordable inputs. Often, they only can be imported. Denying access to higher quality or cheaper foreign inputs (through policies like local content requirements) only hinders competitiveness and further integration into global value chains.

All this means Indonesia needs to maintain open trade and investment policies. At present, the government gives mixed signals. On the one hand, it wants to join the global production network. On the other hand, the use of protectionist measures has been increasing. As president, Jokowi sponsored the passage of ‘big bang’ reforms to investment and labour markets in his Omnibus Law for Job Creation. It suffered from many weaknesses, including a flawed legislative and community consultation process. And while it has contributed to a better investment climate, the government’s import substitution strategy, embodied in mandated investment in downstream processing and minium local content requirements, limits its effectiveness.

The new government should reconsider how these policies are applied.  It also must improve the quality of the legal and regulatory system. Jokowi has tarnished this badly. Hoping for more FDI to come while allowing key institutions, such as the Corruption Eradication Commission, to decay is futile.

Yet the early signs for these kinds of reforms are not encouraging. Prabowo has announced his cabinet. Not since first president Sukarno have we seen a cabinet as large. It will be very costly, not just in terms of remuneration but also coordination. We can only wish Pak Prabowo good luck.

Arianto Patunru is a member of the ANU Indonesia Project, Australian National University and chairman of the Center for Indonesian Policy Studies

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