Indonesia has long aspired to achieve higher economic growth rates, yet the past decade reveals a consistent pattern of stagnation. From 2015 to 2023, the economy grew at an average of only 4.9% annually, even excluding the contraction caused by the COVID-19 pandemic in 2020. While this rate might be commendable compared to other emerging economies, it lags significantly behind regional peers like China, India, Vietnam, and the Philippines, whose growth ranged between 6.3% and 6.9% in the same period. This underperformance underscores the urgent need for Indonesia to reassess its growth strategy.
The government’s target of achieving an 8% annual growth rate over the next five years is ambitious. However, it raises important questions: Why does Indonesia need such high growth, and is it realistic? Additionally, what structural reforms and policies are required to attain this objective?
The Case for High Economic Growth
There are two compelling reasons why Indonesia must strive for elevated growth rates in the coming decade. The first is to capitalize on its demographic dividend. Indonesia has been experiencing a demographic bonus since 2012, a period characterized by a low dependency ratio and a large, productive workforce. This opportunity will peak around 2025 before the country begins transitioning toward an aging society. Countries like Japan, China, and India leveraged similar demographic trends to drive rapid economic expansion. Failure to maximize this demographic potential could turn the bonus into a liability, with an underutilized workforce becoming a burden on economic development.
The second reason is Indonesia’s aspiration to become a high-income country by 2045. Achieving this status requires sustained economic growth of at least 6% annually over the next 15 to 20 years. Historical evidence from advanced economies indicates that high growth in the early stages of development is essential before tapering off as incomes rise. For Indonesia, reaching the high-income threshold demands rapid expansion now, followed by a more moderate pace as the economy matures.
Challenges in Achieving 8% Growth
Achieving an 8% growth rate is far from straightforward. The first challenge lies in Indonesia's potential growth ceiling, which has hovered around 5% in recent years. Without substantial reforms, this ceiling will remain a barrier to higher growth. Structural issues, such as low investment rates, inadequate infrastructure, and regulatory inefficiencies, continue to weigh heavily on the economy. Moreover, global economic uncertainties and geopolitical tensions add further complexity.
Indonesia’s historical performance offers some hope. During the New Order era (1968-1997), the economy grew by an average of nearly 7% annually, demonstrating that high growth is achievable. However, replicating this success in the current context requires significant shifts in policy and governance. The challenge lies in transforming the economy’s potential from 5% to 7%, a task that demands bold and sustained reforms.
Strategic Priorities for Reform
To elevate growth, Indonesia must prioritize structural reforms aimed at enhancing productivity, attracting investment, and boosting exports. Lessons can be drawn from the deregulatory efforts of the 1980s, which simplified investment processes, reduced trade barriers, streamlined taxes, and encouraged economic diversification. These measures enabled Indonesia to reduce its reliance on oil and gas exports, setting the stage for broader economic development.
Today’s reforms must address key bottlenecks such as labor market rigidity, low technological adoption, and the inefficiencies in public spending. Investment in human capital is equally critical, as the quality of Indonesia’s workforce will determine its competitiveness in a rapidly evolving global economy. Additionally, improving governance and reducing corruption are essential to creating a business environment that inspires investor confidence.
Financing Growth and Closing the Investment Gap
Achieving 8% growth will require a substantial increase in investment. The incremental capital-output ratio (ICOR), which measures the efficiency of investment, was 6.5 in 2023. To reach the growth target, Indonesia needs to reduce the ICOR while significantly increasing gross fixed capital formation. By 2029, investment levels must exceed IDR 11,000 trillion, nearly double the 2023 figure. This calls for aggressive foreign direct investment (FDI) inflows, which currently average only 1.9% of GDP, compared to 5-6% in high-growth economies like China and Vietnam during their peak expansion periods.
Bridging the financing gap between savings and investment is another critical challenge. Domestic savings alone are insufficient to fund the necessary level of investment. Policies that attract external capital, particularly FDI, must be prioritized. This includes streamlining bureaucratic processes, offering fiscal incentives, and ensuring political stability to enhance Indonesia’s attractiveness as an investment destination.
Sectoral Focus: Investment, Industry, and Exports
Indonesia’s growth strategy should concentrate on three key sectors: investment, manufacturing, and exports. While other sectors cannot be neglected, these three have the greatest potential to drive overall economic expansion. Manufacturing, in particular, offers significant opportunities for value addition and job creation, while exports can generate the foreign exchange needed to sustain growth.
To meet the 8% growth target, these sectors must grow at unprecedented rates. For instance, real investment must expand by 10.6% annually, exports by 9.7%, and manufacturing output by 10%. Achieving these rates will require a coordinated effort to enhance productivity, diversify export markets, and integrate into global value chains. Policies that support industrialization, such as improving infrastructure and fostering innovation, will be essential.
The journey toward high economic growth is fraught with challenges, but the urgency cannot be overstated. By leveraging its demographic dividend, pursuing bold reforms, and focusing on strategic sectors, Indonesia can lay the groundwork for sustained prosperity. However, time is of the essence, and decisive action is needed to turn potential into reality.
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