The Chinese economy attracts all the attention in the Asian Century, but Indonesia is right next to us, providing opportunities that are often more accessible and less crowded out by other foreigners. Thus a new McKinsey Report on Indonesia‘s economy provides a counterweight to the China obsession and a reminder of just how well Indonesia has gone over the past decade.



Of course, no country can match China‘s stunning pace of growth: more than 10% a year for the past decade. But this pace is unsustainable and the numbers now projected for China are not so different from Indonesia‘s past performance, or its realistic potential. Since the disaster of the Asian crisis in 1997, Indonesia has clocked up a steady 5-6%, speeding up a little in recent years. McKinsey shares a widely-held view that Indonesia could and should do better 7%, as it did during the three decades of the Soeharto regime.

Straight-line extrapolation should be taken with a grain of salt and inter-country GDP comparisons with a large spoonful, but McKinsey ranks Indonesia as number 16 in terms of GDP; 7% annual growth would take it to number seven by 2030, ahead of Germany and the UK.

The demographic bonus still has many years to run (no one-child policy in Indonesia to slow workforce growth) and both agriculture and the huge small-scale service industries have plenty of scope to release labour to do more productive things. Indonesian growth is largely driven by domestic demand and has been mainly unaffected by stagnation in Europe, the US and Japan.

Comparing the China growth debate with that in Indonesia shows some differences. In China, slower growth is seen as inevitable because they cannot go on investing 50% of GDP (or, nearly the same argument, they must be wasting a lot of investment by building fast trains to nowhere) and they can‘t raise consumption or net exports fast enough to compensate for a substantial reduction in investment.

In contrast, the optimism that Indonesia can sustain and even speed up its rate of growth comes from identifying myriad glaring possibilities to do better. Creating an excess supply of fast trains (or any other infrastructure, for that matter) is not a concern in Indonesia.

On the supply side, Indonesia could produce much more from the existing resources. The star performer in the agricultural sector, palm oil, has average yields only one quarter of best practice. Good infrastructure would slash the costs of getting domestic agriculture and fisheries to market. It‘s cheaper to import fresh fruit than to supply domestically.

On the demand side, McKinsey sees another 90 million people shifting into the ‘consuming class‘ by 2030. Let‘s by-pass the debate about exactly what the ‘consuming class‘ is and focus in the things that people buy when they get some discretionary income. There is no shortage of demand for airline travel, telecommunications, entertainment, health and education. Indonesians buy a million cars a year and eight million motor bikes. Unmet demand for public goods demonstrates the potential. One study says that only 17% of the population has piped water. The World Bank ranks Indonesia 161 out of 183 countries in ease of getting reliable electricity, behind the Congo.

Optimists look at these figures and see the potential for huge improvement in productivity and growth. Pessimists look at the same figures and wonder what has gone wrong to produce this yawning gap between actual and potential.

Some of the answer is found in the international surveys of governance, corruption and ease of doing business. Indonesia invariably rates poorly. McKinsey puts the challenge clearly enough, but doesn‘t say much about why Indonesia scores badly and how it might be changed.

The McKinsey report is very much of the ‘glass half full‘ variety, but it does lay down the challenge: productivity will have to increase by 60% in order to reach the 7% growth objective.

It is an economic truism that productivity improvements are almost all that matters for higher living standards, but a lot of detail is lost in this truism. As McKinsey notes, the productivity achieved so far has not been a result of the once-off structural transfer from overcrowded agriculture to higher-productivity manufacturing. Only a little over half of the population is urbanised, so those gains are still waiting to be reaped. In fact, the share of manufacturing is lower now than at the time of the Asian crisis, accounting for around 25% of output, compared with 40% in Vietnam.

Put differently, Indonesia is still to make the big structural jump that Clifford Geertz talked about 50 years ago, when he worried that Indonesia would experience ‘agricultural involution‘ (more intensive use of land, increasing output but not output per head) and miss the structural shift that had taken Japan from being a low-productivity agriculture-based country to a manufacturing powerhouse. Things haven‘t turned out exactly as Geertz foresaw and the service sector can be a bigger part of the structural change than Geertz envisaged. But the strongest gains of productivity are in manufacturing and services tend to be low productivity. McKinsey doesn‘t tell us why manufacturing expansion, stopped in its tracks by the 1997 crisis, has failed to revive.

This report sees lots of opportunities, but doesn‘t say much about why these haven‘t been seized so far. Why has the effort to fix corruption not been more successful? Why can‘t Indonesia get its act together on infrastructure? Why are they slipping the wrong way on protection? Economics is only a part of the story and the politics is missing here.

Photo by Flickr user 

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