Going for Growth 2021 – Indonesia

Indonesia

The COVID-19 crisis has brought to the fore the vulnerability of the population to economic shocks, notably due to extensive informality, lagging skills and low social security coverage. Reforms in areas of skills, labour market regulation and barriers to entrepreneurship are hence top priorities for a more resilient and equitable growth.

Performance prior to the COVID-19 crisis

Economy: Percentage gap with respect to the population-weighted average of the highest 18 OECD countries in terms of GDP per capita (in constant 2015 PPPs).

Inequality: The Gini coefficient for disposable income measures the extent to which the distribution of disposable income among households deviates from perfect equal distribution. A value of zero represents perfect equality and a value of 100 extreme inequality. The latest available data for Indonesia is 2019.

Environment: A high exposure to air pollution refers to above 10 μg/m3 of PM2.5.

Source: Economy: OECD, National Accounts, Productivity and Labour Force Statistics Databases; Inequality: OECD, Income Distribution Database and World Bank, World Development Indicators Database; Environment: OECD, Environment and Energy Databases.

Tackling informality is crucial for the recovery and medium-term growth

Improving outcomes in education is key as the economy becomes more digitalised. Sizeable progress has been achieved in education attainment in the past 20 years. Almost all children attend primary education now and enrolment in secondary and tertiary education is continuously increasing. However, many pupils leave school at 15 without basic skills, pointing to low quality of teaching (Panel A). In this respect reforms need to improve teacher evaluation and increase the availability of and incentives for teachers to take up training. Vocational education should have larger involvement of the private sector to ensure skills relevant for the job market while the enrolment of students from disadvantaged backgrounds could be incentivised through targeted cash transfers.

Education reforms need to go hand in hand with reforms of labour market regulations to reduce informality, which is particularly high. Minimum wages are high relative to average incomes and severance pay provisions are generous, even though compliance with these requirements is low. Building on recent reforms, greater flexibility in the labour market coupled with appropriate worker protection would lead to job creation in the formal sector, productivity enhancement and well-being of the population. In particular, pilot lowering of employment protection and minimum wages for youth in special economic zones should be rolled out, and if successful, extended more broadly. In parallel, the statutory minimum wages in each province should be better aligned with local characteristics.

An additional boost to formal job creation would come from continued easing of barriers to entrepreneurship and investment. Key barriers to address include those at the sub-national level, for self-employed and small businesses and restrictions on foreign direct investment (FDI), in particular by eliminating discriminatory requirements against foreign investors. The economy would also benefit from strengthening institutions to fight corruption (Panel B). The Corruption Eradication Commission (KPK) is well respected and needs to remain independent, which is particularly important in the context of COVID- 19, with massive discretionary public spending.

Vulnerabilities and areas for reform

1. The Corruption Perceptions Index aggregates data from different sources that provide perceptions of business people and country experts of the level of corruption in the public sector.

Source: Panel A: OECD, PISA Database; Panel B: Transparency International Database on Corruption Perceptions.

Indonesia: Summary of Going for Growth priorities and recommendations

Recent progress on structural reforms

The 2020 Omnibus law aims to simplify the regulatory framework and can be a milestone for boosting growth. Appropriate implementation will therefore be important to this end. Lifting restrictions on business operations can attract investors and create jobs, especially in the context of the Regional Comprehensive Economic Partnership (RCEP) agreement signed in 2020.

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