Indonesia: Selected Issues
Author: International Monetary Fund
Publication Date:
29 Sep 1997
eISBN:
9781451818260
Language:
English
Keywords:
ISCR; CR; bank; Indonesia; poverty; exchange rate; relief program; income distribution; poverty relief program; poverty program; household income; Income distribution; Income inequality; Global
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This Selected Issues paper on Indonesia explains through econometric analysis the contribution of different factors to export growth and assesses the prospects for its maintenance in the future. The paper reviews developments in Indonesian export growth since 1970. It develops a model of export demand and export supply, provides empirical estimates from the model, and the implications of the results. The paper also addresses medium-term prospects for export growth on the basis of the estimated model and the possible impact of exchange rate changes.

Abstract

This Selected Issues paper on Indonesia explains through econometric analysis the contribution of different factors to export growth and assesses the prospects for its maintenance in the future. The paper reviews developments in Indonesian export growth since 1970. It develops a model of export demand and export supply, provides empirical estimates from the model, and the implications of the results. The paper also addresses medium-term prospects for export growth on the basis of the estimated model and the possible impact of exchange rate changes.

V. Poverty alleviation, income distribution and implications for economic policy1

A. Introduction

1. Rapid and sustained economic growth in Indonesia over the past three decades—based on stable macroeconomic policies, high investment and saving rates, and structural reforms to liberalize markets—has been associated with substantial reductions in poverty. The authorities have also addressed poverty and income distribution objectives through specific measures, within this overall policy framework. Sustained growth and greater focus on programs targeted to the poor is expected to further reduce poverty and income inequalities over the medium term.

2. The paper is organized as follows: Section B reports on the progress achieved in poverty alleviation and improving social indicators and the resulting income distribution. Section C outlines the longer-term objectives of the government in these areas and reviews policy options that might be implemented to reach the targets. Proposed measures include higher spending on human resource development, a well-targeted social safety net, continued structural reforms and improved governance.

B. Progress in Poverty Alleviation and Reducing Income Inequality

3. The proportion of the population living below the officially defined poverty line declined from about 60 percent in 1970 to about 11 percent in 1996. This achievement is particularly impressive when judged against the increase in the population from 117 million to 200 million over this period. In absolute numbers, the incidence of poverty declined from 70 million people in 1970 to 22.5 million in 1996.

4. Indonesia’s strong record in reducing poverty can be attributed importantly to high aggregate growth, which averaged over 7 percent per year during this period and 8 percent during the 1990s. With annual population growth of about 2 percent, per capita GDP has risen by almost 5 percent per year and is now over $1,100. Although this is still well below income levels in several ASEAN countries, few other countries have achieved similar rates of increase during the last twenty-five years.

5. High investment rates and market-oriented policies have enhanced efficiency and contributed to rapid development. High national savings have enabled growth to be sustained without excessive recourse to foreign saving, thereby avoiding the need to periodically implement adjustment policies to address external imbalances. Prudent budgetary management has helped to avoid fiscal imbalances.

6. Economic growth has been broad based and labor intensive. During the 1970s and the early 1980s growth in the agricultural sector averaged over 4 percent per year, mainly as a result of rapid improvements in irrigation and rural infrastructure. The output of rice—a staple food item in large parts of the country—grew even faster. Since at the beginning of this period over half of the population and over 80 percent of the poor depended on agriculture, this laid the foundation for sustained poverty alleviation. From the mid-1980s, the expansion of labor-intensive manufactures has been the main source of economic growth and poverty reduction. The liberalization of foreign trade and the associated increase in foreign direct investment led to rapid growth in their share of total exports. This generated substantial employment in urban areas, thereby absorbing workers that migrated from the rural sector without impeding progress in poverty reduction.

Poverty alleviation

7. Gains in poverty reduction have been broadly equivalent across urban and rural areas, although the decline in the number of people living below the poverty line in urban areas appears less marked because of the substantial increase in urbanization. Between 1976 and 1996, the proportion of the poor fell by almost 30 percentage points in both urban and rural areas, but in absolute numbers, poverty in urban areas declined by only 3 million whereas in rural areas it declined by almost 29 million (Table 1). However, poverty in rural areas is still proportionately higher than in urban conurbations and is concentrated in the agricultural sector. Mason and Baptist (1996) find that average per capita expenditure is lowest and the incidence of poverty is highest among farmers in rural areas. These aggregate figures also mask variations both across and within regions. In parts of east Indonesia the incidence of poverty is still above 40 percent. In Java and Bali, which account for two-thirds of the total population, poverty levels range from 1.3 percent in the urban conurbation surrounding Jakarta to 25 percent in parts of central Java (Hill, 1996).

Table V.1.

Indonesia: Trends in Poverty Incidence, 1976-96

article image
Source: Data provided by the Indonesian authorities.

8. Although it is difficult to make cross-country comparisons, Indonesia’s experience in poverty reduction appears to compare well with Malaysia, the Philippines, and Thailand (Table 2). This comparison also shows that, with the exception of Thailand, reductions in poverty are closely related to per capita GDP growth. Nevertheless, this may overstate the extent of progress in Indonesia, in part because a large number of people live only marginally above the official poverty line. 2 Booth (1993) found that the purchasing power parity-adjusted poverty line was lower than in other ASEAN countries for the 1970s and early 1980s. Some recent estimates (Cohen, 1996) suggest that an increase in the poverty line by 10 percent would lead to an increase in the number of the poor by 30 percent.

Table V.2.

Selected ASEAN Countries: Poverty Reduction

(Annual percent change)

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Source: Data provided by the World Bank.

Social indicators

9. Poverty alleviation has been associated with improvements in human resource development. Universal primary school education was achieved in the early 1980s. Secondary school enrollment rates have increased almost threefold since 1970, although they are still only about 50 percent. School enrollment rates have risen in all provinces, although there are still wide disparities between regions. Basic social indicators have also improved (Table 3). In 1970, the infant mortality rate of 119 per thousand live births was almost twice that in the Philippines, whereas by the mid-1990s it declined to just over 50 per thousand live births, and is now only about 25 percent higher than in the Philippines. Further, life expectancy at birth is now broadly comparable to that in the other ASEAN countries, a substantial improvement relative to the early 1970s when Indonesia lagged considerably behind. The reduction in adult illiteracy stands out as another achievement.

Table V.3.

Selected ASEAN Countries: Social Indicators, 1970-94

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Source: World Bank, Social Indicators of Development.

10. Despite these gains, expenditure on human resource development remains relatively modest in comparison with other ASEAN countries (Table 4). Public expenditure on education of 2.3 percent of GDP is substantially lower than in Malaysia and Thailand, but it is broadly comparable to the Philippines. Public expenditure on health amounts to 0.6 percent of GDP, approximately one-third of the levels in Malaysia and Thailand.

Table V.4.

Selected ASEAN Countries: Education and Health Expenditure, 1994

(Percent of GDP)

article image
Source: IMF, Government Finance Statistics.

11. In addition, the broader measures maintained by the UNDP suggest that the benefits of economic growth may have been spread unevenly across the community. The Human Development Index is a composite measure based on life expectancy at birth; adult literacy and primary and secondary school enrollment rates; and real per capita income. According to this measure, health and education indicators have improved at a slower pace than would be warranted by Indonesia’s sustained per capita income growth. In a sample of 174 countries, Indonesia ranks at 88 in living standards but only at 102 in terms of the index (Table 5). The Capability Poverty Measure evaluates access to basic necessities measured by the percentages of children under five years of age who are fully nourished; births attended by trained health personnel; and women aged 15 years and above who are literate. This index is designed to overcome difficulties in comparing income levels across countries, as well as to measure shortfalls in the provision of basic services. In a sample of 101 countries, Indonesia ranks 62, below a number of Asian countries that have lower per capita incomes (Table 6).

Table V.5.

Selected Asian Countries: Human Development Index (HDI) and Real GDP Per Capita, 1993

(Rank out of 174 countries)

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Source: UNDP, Human Development Report,
Table V.6.

Selected Asian Countries: Capability Poverty Measure (CPM), 1993

(Rank out of 101 countries)

article image
Source: UNDP, Human Development Report.

Income distribution

12. The extent of inequality in income distribution in Indonesia appears to be lower than in other ASEAN countries (Deininger and Squire, 1996). In Indonesia, the Gini coefficient has remained broadly constant at about 0.34 since 1970. In Malaysia and the Philippines inequality declined through the 1980s, but the Gini coefficients based on the most recent data available were still higher at 0.48 in Malaysia for 1989 and 0.41 in the Philippines for 1991. In Thailand, where inequality has increased since the early 1980s, the Gini coefficient in 1992 was 0.49. However, inequality levels are not strictly comparable, in part because inequality measures in Indonesia are based on consumption expenditure rather than household incomes as in many countries. 3

13. Income inequality in urban areas has remained remarkably stable over the past three decades with the Gini coefficient averaging about 0.34, whereas in rural areas the Gini coefficient fell from 0.35 in the mid-1960s to 0.26 in 1993 (Table 7). This decline of measured inequality in rural areas is partly attributable to migration from rural to urban areas but also indicates the success of development programs that have been directed at raising living standards in the poorest rural areas. It is also notable that inequality in urban areas has not widened despite the substantial increase in urbanization.

Table V.7.

Indonesia: Trends in Gini Coefficient, 1970-96 1/

article image
Source: Data provided by the Indonesian authorities.

Based on consumption.

14. A comparison of consumption patterns across quintiles of the population confirms the improvement in income distribution in rural areas. The share of consumption expenditure of the bottom 40 percent—the lowest two quintiles—in rural areas has risen consistently over the last two decades. The ratio of this group’s consumption expenditure to the consumption expenditure of the top quintile increased from about 50 percent in the mid-1970s to over 60 percent in the mid-1990s (Table 8). The corresponding share of the lowest two quintiles in urban areas has remained broadly unchanged over the same period.

Table V.8.

Indonesia: Trends in Income Distribution, 1976-96 1/

article image
Source: Data provided by the Indonesian authorities.

Based on consumption.

15. The aggregate share of consumption expenditure of the lowest two quintiles in Indonesia has increased only marginally since the mid-1970s—from 19.6 percent to 20.3 percent—but it is higher than the respective shares of lower quintiles in the other major ASEAN countries. The consumption share of the lowest quintile in Indonesia of over 9 percent is well above the corresponding shares in Malaysia of 5 percent in 1989, the Philippines of 6.5 percent in 1991, and Thailand of 5.6 percent in 1990. The share of the top quintile is over 50 percent in all of these countries, whereas it is less than 45 percent in Indonesia (World Bank, 1996).

C. Long-Term Objectives and Policy Challenges

16. Poverty and income distribution concerns are now being given more focus in development planning. This is partly in response to rising aspirations which, in the context of a rapidly growing economy have, to some extent, outweighed the impact of actual progress in reducing poverty. The recent upsurge in social tensions may also be related to heightened awareness of differences in the concentration of wealth among different regions and ethnic groups. The next five-year development plan beginning in 1999 aims to eliminate poverty entirely by the year 2004.4 The authorities have indicated that the share of budgetary resources allocated to education and health will rise steadily during the plan period and that objectives will be specified in the form of explicit quantified targets.

Human resource development

17. Targets for education indicators have been outlined in conjunction with the second Twenty-Five Year Long-Term Development Plan. Over the next ten to fifteen years, the authorities aim to provide nine years of free schooling for all children with greater emphasis on targeting primary education resources to the poor. At the same time, they plan to substantially increase secondary and tertiary school enrollment rates to those prevailing in other advanced Asian countries, and to improve the quality of higher education. Further expansion of the private sector in secondary and tertiary education is expected to allow for larger public sector funding for primary education. The authorities are also intensifying their efforts to reduce the relatively high drop-out rate from primary schools—over 20 percent during the 1990s—and increase the number of primary school graduates who continue on to secondary education. Given the widespread empirical evidence on the positive association between completed education and household income (for Indonesia, see Tambunan, 1995), such a reorientation of expenditure would advance progress on poverty reduction and promote greater equity.

18. Specific targets for health indicators over the next five years include raising life expectancy to 65 years, reducing the infant mortality rate to 50 per thousand live births, and halving the maternal mortality rate. The quality of health care is to be improved by devoting greater resources to the provision of basic preventative services, especially in rural areas. Public funding of hospitals, which are located mainly in urban areas, absorbs a large proportion of the health budget. Moreover, because many nonessential hospital services are heavily subsidized and the average rate of cost recovery in public hospitals is only about 20 percent, public sector health expenditure does not benefit the poor proportionately. Deolalikar (1995) and Van de Walle (1995) find that almost 40 percent of health subsidies benefit the wealthiest 30 percent of households. These imbalances could be reduced by allowing fewer exemptions from hospital charges and introducing differential pricing for the poor.

Targeted poverty programs

19. While economic growth and human resource development will continue to be the most important determinants of poverty incidence, well-targeted assistance programs are also needed. Remaining poverty in Indonesia is increasingly localized by geographical location, particularly in rural areas, age, and gender, and the authorities are accordingly directing effective assistance to the underprivileged groups.

20. A major initiative was launched in 1994 to accelerate poverty reduction in the least developed villages.5 Assistance is given in the form of grants, to increase productive capacity and employment opportunities, to 20,000 selected villages (out of a total of 68,000 villages), identified on the basis of a survey of social and poverty indicators undertaken by the Bureau of Statistics. The total funds are distributed equally, rather than on the basis of per capita income, with each village receiving the equivalent of about $10,000.

21. The program is coordinated mainly by the ministries for development planning and home affairs. Use of the funds in each village is decided by community groups, normally comprising up to 30 households, which appraise competing projects and, with the approval of the head of the village, decide on those to receive funding. The groups have the responsibility for implementing projects which, in practice, have ranged from small-scale infrastructure projects to the establishment of small business enterprises and credit schemes operated by village residents. Although the initiative is only one of a large number of public sector programs to help the poor, it is unique in targeting assistance directly at the village level and entrusting local communities to determine priorities and the use of funds.

22. The program appears to be effective in terms of its modest budgetary costs, although a number of aspects are being reviewed to ensure that it provides assistance to genuinely poor villages and the most needy. A selection of villages based on other social indicators undertaken by the World Bank in 1994 did not overlap closely with the villages selected for the program. In addition, the allocation of an equal amount of funds to every eligible village implies that per capita assistance varies markedly between villages. In Java, many villages have populations in excess of 10,000, whereas in low population density provinces, they may comprise only 100 people and grants may in some cases be too small to make a material difference to poverty.

23. A new initiative to directly benefit the poor is contained in the presidential decree of August 1996, which requires relatively wealthy taxpayers—those with post-tax incomes in excess of Rp 100 million—to donate 2 percent of their after-tax income to finance a savings and loan program for poor households to start small business enterprises. The proceeds from this levy are paid into an account with a state-owned bank, which is subject to an independent audit, although the scheme will remain outside the central government budget.

Minimum wage policy

24. It is essential that minimum wage legislation does not inhibit the growth of labor-intensive industries and adversely affect competitiveness, in order to sustain employment growth, which in the past has been the main channel to reduce poverty. During most of the 1970s and 1980s, minimum wages in Indonesia were maintained at relatively low levels. Between 1990 and 1995, average minimum wages across the country increased about threefold in nominal terms and more than doubled in real terms. The motivation underlying this policy reflected the authorities’ concern that economic growth had failed to sufficiently benefit the poor.

25. In 1996, the government raised the monthly average minimum wage by a further 10 percent and mandated that daily wages would be paid for 30 days per month, rather than 25 days as previously. The recent increase will also raise employment costs because of wider coverage of the minimum wage legislation and efforts to secure greater compliance. In addition, increases in minimum wages may affect average wage levels throughout the economy as workers earning more than the minimum wage seek to maintain wage differentials. Rama (1996) finds strong evidence that increases in average wages in the 1990s have been positively affected by the level of minimum wages.

26. With the most recent increases, effective minimum wages are about 90 percent of officially estimated basic needs. It is therefore expected that increases in minimum wages will be more modest in future. Continued rapid rises—particularly in excess of productivity increases—could inhibit the economy from fully exploiting its comparative advantage. Low value-added industries, such as textiles and footwear, increasingly face competition from other Asian countries where wage levels are substantially lower.

Structural policies and governance issues

27. The growth of labor-intensive manufacturing and service industries in urban areas—both major sources of new jobs—has been spurred by deregulation of domestic product and financial markets, and reductions in trade barriers. A fast pace of structural reforms needs to be maintained to accommodate the large expected increase in labor supply due to population growth and demographic changes. The external environment facing Indonesia is likely to offer increased trade opportunities because of the trend toward globalization, but there is growing competition for export markets and foreign investment as more countries implement market-oriented economic policies.

28. Further deregulation would help to raise the living standards of low-income groups and improve equity. External agricultural trade is still largely prohibited and, consequently, prices of commodities—such as rice, soyabean, sugar, and wheat—are higher than would prevail under free trade. Protection of domestic industries by tariffs and quantitative import restrictions creates opportunities to earn economic rents, which impedes a fairer distribution of income. Application of the tax system in a more even-handed and transparent manner, by reducing exemptions and improving compliance, would help to reduce income disparities.

D. Conclusions

29. Indonesia’s strong economic performance over the last 25 years has resulted in rapid growth of per capita incomes, a substantial reduction in poverty, and a marked improvement in many health and social indicators. Indonesia’s progress in these areas has been faster than in other ASEAN countries. Unlike many developing countries, industrialization has been associated with rapid increases in productivity and growth in agriculture, which has released resources for manufacturing industries and the services sector.

30. The main challenge for policymakers is to sustain the successes of recent years, especially in the context of a rapidly changing global environment. Further reductions in poverty and improvements in income distribution may be more difficult to achieve than in the past. They will require not only a fast pace of structural reforms but also strong efforts to improve efficiency by minimizing policy-induced distortions.

31. The authorities will need to ensure that the benefits of growth are widely shared and some sections of the community are not permanently left behind. An expansion of well-targeted poverty relief programs, such as the special assistance to poor villages, can be financed by limiting the activities of the public sector in areas where private markets could operate efficiently. There is also greater scope for higher tax revenue to meet the increasing demands for education and health services.

References

  • Booth, A., 1993, “Counting the Poor in Indonesia,” Bulletin of Indonesian Economic Studies, Vol29, No. 1 (April), pp. 53–83.

  • Cohen, M., 1996, “Indonesia: Twisting Arms for Alms,” Far Eastern Economic Review, (May), pp. 25–27.

  • Deininger, K., and L. Squire, 1996, “Measuring Income Inequality: A New Data Base,” Development Discussion Paper No. 537 (Cambridge, Massachusetts: Harvard Institute for International Development).

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  • Deolalikar, A.B., 1995, “Government Health Spending in Indonesia: Impacts on Children in Different Economic Groups,” in Public Spending and the Poor. Theory and Evidence, ed. by van de Walle and Nead (Baltimore and London: The John Hopkins University Press), pp. 259–89.

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  • Hill, H., 1996, The Indonesian Economy Since 1966. Southeast Asia’s Emerging Giant (Cambridge, Massachusetts: Cambridge University Press).

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  • Mason, A.D., and J. Baptist, 1996, “How Important are Labor Markets to the Welfare of the Poor in Indonesia?” Policy Research Working Paper No. 1665 (Washington: World Bank).

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  • Rama, M., 1996, “The Consequences of Doubling the Minimum Wage: The Case of Indonesia,” Policy Research Working Paper No. 1643 (Washington: World Bank).

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  • Tambunan, T., 1995, “Poverty and Human Resource Development in Indonesia: A Brief Survey,” The Indonesian Quarterly, Vol. XXIII, No. 2 (Second Quarter), pp. 159–74.

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  • UNDP, 1996, Human Development Report 1996 (New York: Oxford University Press).

  • Van de Walle, D., 1995, “The Distribution of Subsidies Through Public Health Services in Indonesia, 1978-87,” in Public Spending and the Poor. Theory and Evidence, ed. by van de Walle and Nead (Baltimore and London: The Johns Hopkins University Press), pp. 226–58.

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  • World Bank, 1996, Indonesia: Dimensions of Growth (Washington).

1

The author of this chapter is Manfred Koch.

2

In Indonesia, persons with calorie intake below 2,100 per day are considered to be living below the poverty line. The Central Bureau of Statistics calculates the cost of calorie consumption on the basis of its household survey, in which respondents are asked about their consumption of 52 food items.

3

The Indonesian authorities consider that consumption expenditure surveys provide a better guide to living standards because surveys of household income typically understate income levels: consumption levels are found to be higher than would be consistent with reported income levels. This is because respondents do not report incomes from all sources.

4

Detailed macroeconomic and social policy targets are to be announced in mid-1998.

5

The program is named INPRES Desa Tertinggal (IDT).

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Cover IMF Staff Country Reports
Indonesia: Selected Issues
Author: International Monetary Fund
Volume/Issue:
Volume 1997: Issue 076
Publisher:
International Monetary Fund
ISBN:
9781451818260
ISSN:
1934-7685
Pages:
84
DOI:
https://doi.org/10.5089/9781451818260.002