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Indonesia's economic potential: a bright but complicated future

In this briefing, Freya Moorhouse explores Indonesia's economic background, progress and future. This article was edited by Kieran Hurwood.



The West has fixated on China as a growing economic and political competitor whilst Indonesia’s consistent success and potential has largely been neglected in mainstream discourse. Some recent predictions estimate that Indonesia will become the world’s 5th biggest economy by 2030, surpassing many Western nations in overall GDP (but not yet GDP per capita). The prediction seems feasible given relatively consistent economic stability, a healthy population size and abundant natural resources. The future for Indonesia seems optimistic; but domestic hurdles that could multiply after the February election, compounded by regional tensions and competition, could prevent Indonesia from achieving its eventual economic aspirations.

Strong foundations?

Indonesia has the potential to become a key economic player because of two innate advantages: demographics and resources. The nation is home to the world’s 4th largest population, the biggest in Southeast Asia and a relatively young one in comparison to China’s ageing population with China’s number of citizens over 60 set to rise from 200 million today to 500 million by 2050. Utilising this advantage of a massive and relatively young working population is a head start that Indonesia’s government would be foolish not to use. Indonesia is also rich in resources with the OECD reporting Indonesia is a leading explorer of nickel ore, steam coal, tin and copper. This gives Indonesia a degree of resource independence, especially in its industrial industries that it has increasingly been trying to shift towards. Coupled with its possession of ‘40% of the world’s geothermal energy reserves’, Indonesia is less reliant on its neighbours and fluctuations in global trade due to geopolitical events.

Unsurprisingly, optimism for Indonesia’s economic potential is hindered by fears of the return of international instability. The Asian financial crisis has left its mark on the Indonesian psyche: Thailand’s crisis had profound economic consequences for Indonesia with a 13% drop in GDP in 1998 that only returned to 1997 rates in 2004. Policy since the crisis reflects a continuing cautious approach to economic growth, prioritising security over riskier, unpredictable paths for rapid growth. This has meant even in the face of the COVID-19 pandemic, which set many nations back years of economic progress, Indonesia rebounded successfully with over 7% growth in GDP in the second quarter of 2021.

Unlocking Indonesia’s potential

This cautious approach of Indonesia towards growth has not meant sacrificing economic ambitions. Indonesia’s growth has been consistently healthy in the last few years with expected economic growth of 5% this year - Jokowi’s administration has been credited with much of this success in building Indonesia’s economic capabilities. Committed to opening up Indonesia and attracting investment, his government has sought to speed up the slow and unnattractive business permits to encourage foreign interest in the nation’s industry and infrastructure. Whilst some of his goals have been possibly too ambitious, notably the creation of a new capital in Borneo’s jungles, infrastructure has boomed, creating a more connected and developed nation despite its geographic fragmentation. However, poor infrastructure is still a setback Indonesia needs to fully address in order to boost exporting efficiency.

Indonesia, like Norway and other nations, has also profited off of Russia’s invasion of Ukraine through increased exports of coal and steel that transcended already positive economic predictions. But this could have been even higher with stronger transport links to cut supply chain lead times. There has been an increasing shift from agriculture to service sectors and manufacturing industry as Indonesia advances into secondary and tertiary sectors. Jokowi has sought to directly push this move away from primary exports by placing export bans on resources like bauxite and nickel in order to increase their value through domestic processing as part of his downstreaming policy. This has promoted the development of internal processing industries and has attracted a surge of investment post-ban, largely from Chinese investors, in these industries. There are some drawbacks of utilising such a drastic policy. Relations with the EU have been strained after the organisation stated European stainless steel industries had been damaged by resource bans, with the potential for future reluctance to rely on Indonesian resources in fear of another export ban.

Indonesia undoubtedly has a problem with corruption. This political defect bleeds into the economy, discouraging investment and squandering business opportunities with the government not deemed as trustworthy with funds. Jokowi has championed himself as firmly against the cronyism that was seen by some as characteristic of previous Suharto governments. His less affluent background, grassroots approach to governance and claim of being an honest politician as the first president from outside Jakarta’s elite initially gave credit to his anti-corruption initiatives after he was first elected. However, more recent developments have caused some international observers to suggest a decline in his commitment to this stance against corruption in favour of corruption as a necessary evil for economic growth.

Despite this protectionist risk and continuing slowing problems, Indonesia has seen significant improvements under Jokowi that have reflected both macroeconomically and in citizens’ daily lives. The growing middle class that now outnumbers the poor combined with the increased education of employed workers highlights Indonesia’s upwards trajectory. This is reminiscent of Indonesia’s academic fascination with the ‘kelas menengah baru (new middle class)’ in the 1980s that were seen as key to driving economic transformation after years of stagnation.

Relations with the region

On paper, the domestic capabilities and resources of Indonesia should give it a significant degree of independence. Yet under Jokowi, Indonesia’s relationship with China has become closer. China is Indonesia’s biggest trade partner by an impressive margin of over 12% more export share and over 22% greater import share than the US as its second biggest trade partner. This close relationship has prevented the island nation from expanding its trade elsewhere: the US’ reluctance to sign a nickel deal with Indonesia is rooted in worries about China’s economic presence in this industry. China’s relationship with Indonesia goes deeper than just economic ties. There are millions of ethnically Chinese citizens in Indonesia, totalling around 3.3% of the population. Since Suharto’s exit from office, cultural ties have become closer with Lunar New Year as a shared national holiday and decreased discrimination for this ethnic minority has encouraged a more favourable environment for relations with China.

But the friendship between these nations is by no means perfect or unbreakable. China’s growth into the South China Sea has not gone unnoticed. The destruction of coral reefs to build artificial islands in the South China Sea has strained the already fierce fishing industry in this region, damaging fish stocks that are already chronically depleted between Vietnam, Indonesia, Malaysia, Thailand and the Philippines. This is reflected in the Lowy Institute’s report of Indonesia's citizens’ declining admiration of China with a particular concern over China’s financial presence in Indonesia. Therefore, relations with China are likely to remain strong but imperfect, and will remain so as China seeks to expand its power regionally.

Building a strong export industry has been a gradual process for Indonesia with only 20% of its GDP being derived from exports, especially with substantial focus today on domestic economic success. Therefore, pursuit of regional economic opportunities is particularly important to compensate for resource scarcity in neighbouring countries. For example, the Philippines is expected to have depleted one of its major oil sources by 2024. Trade with Australia has also increased and in turn more investment and diverse economic interests are expected between the two nations in upcoming years. Although Indonesia may be a leading example of ASEAN development, it is not without competition from other members. Vietnam’s massively liberalised trade policies and strong incentives for foreign investors have led to its rise in international export market share whilst Indonesia has struggled to achieve the same results. This exemplifies how Indonesia needs to both collaborate and compete against its neighbours, which will be a difficult balance to achieve.

The future for Indonesia

The election of Indonesia’s eighth president to succeed Jokowi is set to happen in February 2024. The three candidates have recently been announced and this has led to scepticism over the political and economic future of Indonesia. The legacy of nepotism in Indonesian politics has been viewed by some as revived with the popular candidate and defence minister Subianto’s controversial selection of Jokowi’s son to act as his running mate. Subianto’s return may signal a revival of the Suharto-era to investors because of his role in the Suharto administration as well as being Suharto’s son-in-law himself.

The policy stances of the candidates also create uncertainty for the economic future of Indonesia. Key issues for this election are economic-related with a particular focus on ‘the candidates’ approach to infrastructure projects and investment incentives’. Whilst Subianto has been vague on his policy position, Prabowo has vowed to proceed with pre-existing policies of supporting downstream industries and infrastructure development alongside promoting self-sufficiency of basic necessities in Indonesia. Jokowi’s high approval ratings will mean his support will be a decisive factor in the election for any candidate. In this sense, there may be some hope for a continuation of previous economically successful policies to maintain Jokowi’s legacy.

With such strong foundations for Indonesia to become an economic powerhouse, how effectively policy maker’s overcome domestic and international challenges will determine Indonesia’s future. Jokowi’s administration has transformed Indonesia and the next leader will likely do the same. However, whether February’s successful candidate will continue the trajectory of economic success remains unknown.

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