Bank Indonesia and World Bank: How to Escape the Middle Income Trap?
The Governor of Indonesia’s central bank (Bank Indonesia), Agus Martowardojo, said that the Indonesian economy can grow more than six percent provided that several important structural reforms will be implemented in order to avoid the middle income trap. This trap occurs when rapidly growing economies stagnate at middle-income levels for many years, thereby failing to reach a high income level (as has been the case with Brazil, Mexico, South Africa and other middle income countries from the early 1980s to the mid-2000s).
Martowardojo made this statement in a response to the World Bank’s latest report, titled ‘Indonesia: Avoiding the Trap’ which was released on Monday (23/06). In the report, the World Bank said that Indonesia, Southeast Asia’s largest economy, is in need of reforms in six priority areas: close the infrastructure gap, close the skills gap, well-functioning markets, access to quality service for all, improve social protection, as well as natural risk management.
The Governor of Bank Indonesia stressed the importance of accelerated economic growth to become a high income level country. However, this year the central bank expects economic growth to be around 5.1-5.5 percent only. Bank Indonesia downgraded its forecast for economic growth after seeing the GDP growth result in the first quarter of 2014. In the first quarter of this year, Indonesia’s GDP grew by 5.2 percent (year-on-year), considerably lower compared to the 5.7 percentage point growth recorded in the previous quarter. Meanwhile, the Indonesian government also downgraded its forecast for the country’s economic growth to 5.5 percent. If realized, then it would mean that Indonesia’s economic growth would have slowed for the third consecutive year.
Gross Domestic Product (GDP) of Indonesia:
| 2006 | 2007 | 2008 | 2009 | 2010 | 2011 | 2012 | 2013 | |
| GDP (in billion USD) |
285.9 | 364.6 | 432.1 | 510.2 | 539.4 | 706.6 | 846.8 | 878.0 |
| GDP (annual percent change) |
5.5 | 6.3 | 6.1 | 4.6 | 6.1 | 6.5 | 6.2 | 5.8 |
| GDP per Capita (in USD) |
1,643 | 1,923 | 2,244 | 2,345 | 3,010 | 3,540 | 3,592 | - |
Sources: World Bank, International Monetary Fund (IMF) and Statistics Indonesia (BPS)
However, the central bank expects economic growth to accelerate back to the +6 percent zone provided that structural reforms are implemented. Of especial importance, according to Martowardojo, is the reliability of the country’s industrial sector and the ability of the economy to adapt to globalization, particularly in this era of free trade zones. Martowardojo stated that three structural reforms are required. Firstly, to enhance the competitiveness of Indonesia’s industries and economy. In particular he stressed the need to reduce the country’s dependence on low technology or raw materials (for example exports of unprocessed minerals), but instead modern technology should be used in order to produce value-added products.
Secondly, Indonesia needs to increase economic independence. Currently, the regions of Indonesia rely on imports resulting in the country’s large trade deficit and current account deficit.
Thirdly, Indonesia’s financial resources have to be improved. There should be a deepening of capital markets as well as a deepening of financial markets, and financing should not only originate from banks but also from the non-bank industry.
These three pillars of economic reform should be supported by food and energy security and the strengthening of the capital base which includes the construction of more and better infrastructure, human resources, and institutional and technological development. According to Martowardojo, Indonesia will reach +6 percent economic growth if these reforms are implemented. However, if not implemented then the economy will continue to slow as it has done in recent years.
On Monday (23/06) World Bank Economist Ndiame Diop said that Indonesia needs to chase +6 percent GDP growth in order to avoid the middle income trap. Diop sees great economic potential in Indonesia due to the country’s demographic bonus, urbanization, abundant commodities, and developments in China.
Currently, 50 percent of the 250 million Indonesians are below the age of 30 years (thus can provide abundant labour). This young population also becomes more and more educated and understands information technology. This is a good context to push for higher economic growth.
Meanwhile, urbanization in Indonesia is growing by 4 percent per year. In fact, Indonesia is currently one of the world’s most rapidly urbanizing countries. By 2025, the World Bank expects that 68 percent of the Indonesian population lives in urban areas. This is important as urbanization and industrialization are necessary to grow into the ranks of a high income country.
Indonesia can also benefit from current troubles in China. Minimum wages have increased rapidly in the world’s second-largest economy causing a less attractive investment climate for labor intensive industries.