Indonesia pushes for major policy reforms to combat the ‘middle-income trap’

Indonesia’s rising economy is the latest of Asia’s success stories. Still, the country’s Finance Minister Sri Mulyani Indrawati has cautioned that its yearly 5 per cent Gross Domestic Product (GDP) growth, higher than the global average of 2 per cent, is “not enough for the nation to achieve meaningful progress” needed to become a high-income nation as detailed in a report by CNBC.

Indonesia’s massive plan is a part of what it terms as the “Golden Vision 2045,” a grand plan aimed at transforming the country into a skilled workforce on high wages and a way to reduce poverty rates by the time it celebrates its 100-year anniversary.

“To continue our journey of high growth based on high productivity, we have to invest more in human capital,” the finance minister told CNBC’s “Squawk Box Asia” in an interview last week.

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A country report by the International Monetary Fund (IMF)published in August stated that the aspiration for Indonesia is to “increase value-added services by moving through the value chain from raw commodities, build a skilled population ready for the digital age, and accelerate infrastructure development and institutional reform to support balanced, green, and equitable growth.”

Political change has consolidated the ambition of Indonesia

Further, despite a change in political power earlier this year, Indonesia’s ambitions remain. More than 200 million voters in the world’s most populous Muslim country went to the polling booths in February, ending a decade of President Joko Widodo in power with the election of former army general and Defense Minister Prabowo Subianto. The new government will take office in October for a five-year term. The incoming President Subianto has promised to continue focusing on making Indonesia a high-income economy.

Economic reforms passed through by the outgoing president will make achieving Indonesia’s grand vision easier. “Widodo put in place a bunch of economic reforms, the most noticeable being making it easier to hire and fire new workers. And they also reformed land use rights,” Gareth Leather, a senior economist at Capital Economics, stated in a conversation with CNBC.

“Indonesia still does a few things wrong. The infrastructure is not great. Corruption is still a problem. But they’re heading in the right direction,” he added.

Finance Minister, Sri Mulyani Indrawati, is focused on avoiding“the middle-income trap” i.e., an economic development situation where growing economies stagnate at middle-income levels and are unable to advance to the ranks of high-income countries. Major policy reforms, she believes, will help Indonesia sidestep that. “A lot of government efforts, including our fiscal budget, are allocated significantly for education, health, and [the] social safety net,” she stated.The International Monetary Fund (IMF) agrees with the prominent Finance Minister, stating that broad and sustained structural reforms are required for Indonesia to achieve high-income status.

Indonesia will never be the next China

Taxation and labor reforms, making it easier for firms to hire and fire workers, are also a strategic part of Indonesia’s economic engineering. “They’re useful steps in the right direction,” said Leather.

“Under the old system, if you wanted to sack a worker in Indonesia, you had to pay them up to 60 weeks of severance pay. Which is way more than anywhere else. If you’re a manufacturing investor looking at where to set up shop in Asia, and you see how inflexible the labor force is, it could put you off.”

Leather feels “relatively upbeat about Indonesia,” though “it won’t ever be the next China,” he told CNBC. “If it continues growing at 5-6 per cent over the next decade, that’s a decent performance,” he added.

Finance Minister Mulyani Indrawati, meanwhile, remains cautious

“A lot of work still needs to be done,” said the minister, adding that a lot had been achieved “despite Covid and geopolitical fragmentation.”

The goal of Indonesia, according to the Minister is to stay politically neutral and focus on robust economic growth through making improvements in economic policies. The chip industry and electric vehicle battery production are the areas where the country can look to expand and help in nurturing domestic growth.