Can Indonesia Escape the Middle Income Trap?

The Government of Indonesia, through its Ministry of National Development Planning (Bappenas), has launched the draft law of the National Long-Term Development Plan (RPJPN) 2025-2045. This document focuses on the vision of Indonesia 2045 for the country to reach developed status on the 100^th anniversary of Indonesia’s independence.

There are several strategic – albeit ambitious – targets that must be achieved by 2045, including achieving a per capita income equivalent to that of existing developed countries and reducing poverty to zero. By 2045, Bappenas estimates that Indonesia would reach an income per capita of around US$23,050 per annum (around Rp345 million) and become the world’s fifth-largest economy. This growth will be driven, among others, by Indonesia’s manufacturing sector, projected to account for around 28 per cent of gross domestic product (GDP), and the maritime-based economic sector (for 17.5 per cent of GDP). These sectors are optimistically predicted to provide the mass employment that will grow Indonesia’s middle class to comprise 80 per cent of the population.

The RPJPN 2025-2045 lists the critical barriers and corresponding strategies to overcome these challenges. This document is critically timed in two senses. First, by next October, Indonesia will have a new president and government. Second, the new president’s agenda would partly determine whether Indonesia escapes the middle income trap. The long-term development plan gives high-level guidelines for the next president, who must lead his administration in executing the details and following the timetable. Although the new government could conceivably introduce a separate development agenda apart from the RPJPN, when this document is legalised as a regulation later this year, the political process in parliament (or Dewan Perwakilan Rakyat, DPR) will be a tough hurdle. The passage of the RPJPN plan as law will secure the continuity of Indonesia’s overall development programme. In theory, however, the DPR can reject these new initiatives by not approving the RPJPN budget.

The next president will face many tough challenges on the development front. First, addressing poverty and creating a solid middle-class is an uphill task despite the number of Indonesians living in extreme poverty (defined as living on less than US$1.90 per day) dropping significantly in the last 20 years (from 19 per cent of the population in 2002 to just 1.5 per cent in 2022). A World Bank report from 2020 pointed out that expanding Indonesia’s middle class is vital to achieving its desired high-income country status. It also noted that approximately 115 million people in Indonesia were in the “aspiring” middle-class or were no longer considered poor but had not yet been able to reach middle class status. In times of crises, they remain vulnerable to economic shocks and fluctuations, like hikes in energy and food prices.

Second, providing sufficient levels of “massive decent work” through executing good industrial policy will be another challenge. Based on Statistics Indonesia (BPS) information, in the first quarter of 2023, GDP growth in tradable sectors such as manufacturing, agriculture, and mining was lower than the national GDP growth rate of 5 per cent, whereas non-tradable sectors such as transportation, information and telecommunication sectors grew more than the national GDP growth rate, a trend that has lasted for years. Such a situation contributes to the decreasing quality of growth where the elasticity of growth in job creation subsides. Indonesia may need a transformational strategy to find new growth engines for creating decent jobs.

Indonesia needs to transform its governance of industrial policy – alongside other economic institutions and issue areas, to increase transparency and to minimise rent-seeking in its the economic system, in its quest for a “golden” 100th anniversary.

One critical transformation would be to improve job quality in the services sector. This sector’s growth has been impressive, driven by strong growth in transportation and storage, and the information and telecommunications sectors. However, the contribution of manufacturing to GDP growth has declined from 27 per cent in 2002 to 18 per cent in 2022. Given this, the new government must find a good strategy to revive the labour-intensive portions of the manufacturing sector. There is an overall need to harmonise industrial policies in up-and-coming sectors, such as the digital economy and green economy.  

The new government must also encourage greater private participation in strategic infrastructure projects. While it could continue what President Widodo has done in developing critical infrastructure, there is room for improvement. There have been some unintended consequences of over-reliance on state-owned enterprises (SOEs) to accelerate infrastructural development. Some infrastructure-related SOEs, such as PT Wijaya Karya, PT Waskita Karya, PT Hutama Karya, and PT Adi Karya, were assigned to develop unprofitable infrastructure projects, which affected their cash flows. The pressure for capital injection in the absence of good governance has created other problems. Recently, the Attorney General’s Office named Wijaya Karya’s director as a suspect for misappropriating state funds from 2016-2020. The new government must improve the governance of SOEs and make them become more efficient and transparent. For the success of the RPJPN, ensuring that SOEs are free from political capture and corruption is critical.

Another important transformation is related to downstream industrialisation and localisation policy. This policy must be implemented with caution, considering existing domestic capability in terms of human resources, technology, and environmental concerns. If it can be implemented by minimising market distortion and maximising efficiency, there is a possibility of success. Unfortunately, existing strategies partly rely on SOEs, which is detrimental for domestic private sector growth. Following the nickel export ban in 2020, the government assigned key SOEs MIND.ID, PT Aneka Tambang, PT Pertamina, and PT Perusahaan Listrik Negara to lead the production of electric vehicle (EV) batteries. These SOEs however lack experience and capability in EV and battery production. In many cases, foreign investment participation has been carried out by encouraging partnership with SOEs, such as the joint venture between Indonesia Battery Corporation (IBC) and Contemporary Amperex Technology (CATL) from China.

While there is nothing wrong with Indonesia aspiring to be a global hub for EV battery production, it should first implement market-friendly industrial policies to encourage efficiency and private sector participation. Referring to infrastructural development, where the participation of SOEs is quite dominant, the next administration’s industrial policies should be more welcoming for private investment. Downstreaming and localisation policies and EV industry development would not be sufficient for Indonesia to fully escape its middle income trap. Indonesia needs to transform its governance of industrial policy – alongside other economic institutions and issue areas, to increase transparency and to minimise rent-seeking in its economic system, in its quest for a “golden” 100th anniversary.

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