Indonesia is now racing against the clock to boost its manufacturing sector and strengthen its supply-side economy as the nation is on the brink of falling into the middle-income trap, a state that has afflicted other emerging market economies.
Government officials have acknowledged that Indonesia now needed bold policy measures to prevent the country from falling into the middle-income trap.
"Is there a risk that Indonesia will get trapped in the middle-income group? Unfortunately, the answer is yes. Indonesia has grown to become a lower middle-income country since the 1990s, and we are still there now," Finance Minister Chatib Basri said Thursday in his keynote speech delivered during an international seminar held in Nusa Dua, Bali.
With its gross domestic product (GDP) per capita of US$4,790, Indonesia is now classified as a lower middle-income country and — just like its peers at this level — is aspiring to become a high-income country, classified as the one with GDP per capita of more than $11,750.
However, some countries never get there, and instead see stagnation in GDP growth due to rising labor costs and decreasing productivity, leaving their citizens' income "trapped" in the middle level.
A study from the World Bank showed that out of 101 middle-income countries in 1960, only 13 graduated to become high-income countries by 2008.
Countries that were seen as case studies for falling into the middle-income trap were South Africa and Brazil. Both countries used to post strong economic growth, yet recently have seen a significant drop in GDP growth. In the third quarter, South Africa expanded by only 0.7 percent while Brazil contracted by 0.5 percent.
"Brazil and South Africa stayed at the middle-income level because they, just like us, continued to depend on natural resources and cheap labor," Chatib said. "If Indonesia wants to climb up the ladder, then we have to give more support to innovation and technology."
Signs that Indonesia might be falling into a middle-income trap have been apparent, with the economy already having slowed for five consecutive quarters to touch 5.6 percent in the third quarter, its slowest growth rate in nearly four years.
The slowdown has been attributed to Indonesia's weak supply-side economy, which is beleaguered with insufficient infrastructure and an underdeveloped manufacturing sector that cannot cope with increased demand from the growing middle class.
To fill the gap between supply and demand in the domestic economy, Indonesia has been forced to depend on imports, causing a large deficit in the current account that has created economic instability and prevented the country from posting higher GDP growth.
To deal with the issue, Chatib said that he had prepared a slate of possible tax breaks for companies that produced intermediate goods, seen as the missing link in Indonesia's industry, as well as for firms allocating funds to research and development, which could generate more skilled labor in the domestic economy.
Indonesia is also preparing to ban raw mineral exports starting next year, a move that is aimed at developing the local manufacturing sector, which would be expected to produce more value-added goods and fewer raw resources.
Deputy Finance Minister Bambang Brodjonegoro highlighted the need for Indonesia to push down burdensome energy subsidies, which have prevented the government from allocating more spending for productive use.
"To avoid the middle-income trap, we need to have enough fiscal space — if we have enough fiscal space in the budget, we can do everything from expanding infrastructure to improving productivity," Bambang said in the seminar.
"The dependence on subsidies, which are more a political tool rather than fiscal tool, has become a big burden," he added.
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