Overcoming the Main Obstacles to Economic Growth

Author: M. Chatib Basri, Lecturer, School of Economic and Business, University of Indonesia

Dhaka, for those born in the 1960s, might be like a memory of Jakarta during their childhood. A dirty city, blazing sun, dilapidated huts on the riverbanks and chronic poverty. Not only that, the city also has traffic jams.

Dhaka, however, is not deterred by disorder. The capital city of Bangladesh is indeed not a city in Europe where historical sites greet in green parks or neat urban settings. It is not even Jakarta with its various problems. I remember a joke made by Gustav Papanek, economist from Boston University, “If you complain about traffic or infrastructure in Indonesia, go to Dhaka, Jakarta looks like heaven.”

Papanek is correct. The World Economic Forum’s 2018 Global Competitiveness Report records Bangladesh as the 109th of 140 countries in terms of infrastructure quality, worse than Indonesia, which is the 71st. The Financial Times daily wrote, to send cargo from Dhaka to the main port in Chittagong, it took 24 hours, even though the distance was only 240 kilometers.

But — with all of its messiness — Bangladesh is the second-largest apparel exporter in the world after China. In the past five years, Bangladesh’s economic growth has always been above 6 percent, even reaching 7.9 percent in 2017/2018. It is interesting to see Bangladeshi ‘s experiences.

Learning from Bangladesh

Indonesia’s ability to maintain economic growth of 5.0-5.2 percent in the past five years certainly deserves appreciation. In 2018, Indonesia was able to overcome the financial sector commotion well. Despite the fiscal and monetary tightening, the economy grew 5.2 percent. This is clearly quite an achievement. Not many people realize that without the right policies, the situation in Indonesia could be worse than last year.

Data also shows that economic growth has succeeded in alleviating problems related to poverty and open unemployment. Indonesia was also able to reduce the number of young unemployed (15-24 years) from 22 percent (2014) to 20 percent (2018). However, as I wrote in Bisnis Indonesia daily (18/2/2019), the number of young unemployed with vocational education rose from 23 percent (2014) to 33 percent (2018). Likewise ,for unemployed students with diploma and undergraduate education, its number was up from 4.4 percent (2014) to 10 percent (2018).

It means that the percentage of young unemployed did indeed decline, but that was for those who had junior high school education and lower, especially elementary schools and below (down from 55 percent in 2014 to only 10 percent in 2018). The economic growth that was recorded did not fully absorb the young age group with high school education and above. Why? Maybe because not too many jobs with decent wages were available. Or maybe because of increasing expectations for work.

It was relatively early for young people who are less educated to get a job. The reason was that their expectations were not too high. They were more able to accept “any work” or lower wages as long as

they could live. However, those who had education — especially high school and above — tend to find it harder to find work. The reason was that they were looking for better incomes and status.

Then, how can Bangladesh become the number two apparel producer in the world with poor infrastructure? Logically, good infrastructure will reduce logistics costs, which in turn will increase competitiveness. Does infrastructure development have no impact on competitiveness, economic growth and investment? It is good to see some of the following.

First, infrastructure is not a single entity to explain economic growth. There are various factors that influence economic growth and competitiveness. For example, the investment climate, macroeconomic stability, education, capital, labor and productivity. More than that, export competitiveness depends not only on physical infrastructure but also on soft infrastructure, such as the business environment.

Export competitiveness, for countries like Indonesia and Bangladesh, for example, are very sensitive to labor policies. Look at the Global Competitiveness Index 2018: in terms of the costs of employment termination (PHK), Indonesia ranks the 134th out of 140 countries. Compare this with Bangladesh, which is in the 125th place.

In the term of the time to start a business, Bangladesh (101st), is slightly better than Indonesia (108th). The ease of business, a more flexible labor market, has increased the competitiveness of their exports. As a result, many of the world’s major brands make Bangladesh a production base. The main advantage of Bangladesh is the relatively cheaper labor costs. On the contrary, Indonesia has very high costs of layoffs.

Therefore, investors avoid labor-intensive sectors and prefer natural resources and capital intensive sectors. This is one factor that explains why the role of the manufacturing sector, particularly labor-intensive, in gross domestic product (GDP) continues to decline. In fact, manufacturing industry is the key to economic growth. In the contrary, Vietnam and Bangladesh are becoming more attractive for labor-intensive industries.

They can even enjoy the impact of the United States trade war with China. Demand for apparel exports is increasing in Bangladesh, while in Vietnam the growth of foreign investment (FDI) has increased significantly. In us, data from the Investment Coordinating Board (BKPM) shows that investment only grew 4 percent, where the realization of FDI actually decreased 8.8 percent in 2018. Exports also slowed. Of course it should be noted, with per capita income as of now, Indonesia can no longer rely only on cheap labor wages. However, we need to improve our employment rules.

 

Second, the data shows that the ratio of infrastructure capital stock to GDP is still very low, namely less than 40 percent. Therefore, even though infrastructure development has been carried out quite massively in recent years, the gap between the need and availability of infrastructure is still very large. This infrastructure has not been able to leverage growth immediately.

Third, due to such a huge gap, infrastructure development cannot only be dominated by state-owned enterprises (SOE). Funds are limited. It is impossible for the SOEs to continuously get injections the state capital participation (PMN) from the State Budget (APBN). The government needs to make priorities. The state budget should focus on projects that are not commercially feasible (such as ports or roads in remote areas in eastern Indonesia). Make room for the private sector if the projects are commercially feasible.

Indeed, SOEs are starting to look for financing outside the state budget. Its implication is that SOEs that do not have enough cash will look for sources of financing through debt. In the medium term, there is a risk of financial pressure. And, this risk will become a burden that must be borne by the government. Therefore, the involvement of the private sector must be expanded.

Then, how to deal with unemployed people of the young and educated brackets? The answer is work in the formal sector. Data from the Statistics Indonesia (BPS) shows that the increase in the young unemployed occurs among vocational school graduates. The reason might be because what is learned in vocational schools does not match the needs of the companies. If that is the problem, ask the companies to do their own training. How? Provide incentives for multiple tax deductions if the companies conduct training to improve the quality of their human resources through vocational education. More than that, boost the economic growth above 6 percent. Also investment. How to do it?

Regulation and institution

The focus of infrastructure development has been correct and needs to be continued. The problem is that it takes time. In reality, time is limited. Therefore, we need to see what can be done immediately. Richardo Hausman, Dani Rodrik, and Andres Velasco from Harvard University came up with the idea to focus on fixing the most binding constraints. We must carry out reforms that have the immediate and greatest impacts.

In this context, it is interesting to see the initial findings of the study of the National Development Planning Agency (Bappenas), which shows, even though infrastructure is a big obstacle, our most binding constraints are regulatory and institutional problems. In the case of electricity, for example, Bappenas shows, even though the availability of electricity needs to be increased, it is not a major obstacle for the manufacturing industry. The reason is that many manufacturing industries are centered in Java, which has higher electricity availability. However, the regulation is indeed a major obstacle.

I agree with this study. Business costs, including severance fees, are relatively high. This inefficient regulation puts a burden on the business world. Only large companies can bear this burden. Small and medium enterprises choose to be informal. This is one of the factors that explains why formal employment is limited.

Besides than, coordination between the central and regional regulations is also a problem. The delegation of authority has the potential, which in game theory is known as the principal agent problem. There is a risk that the parties given the authority (agents) do not act according to the wishes of those who give authority (principal).

Decentralization has given authority from the central government to local governments. Regional heads are directly elected by their constituents. The central government cannot dismiss them unless there are serious violations. As a result, regional governments do not have to follow the rules of the central government. Theoretically, the principal agent problem can be overcome if the principal can provide penalties or incentives so that the agents follow the principal’s wishes. The problem is that the Constitutional Court even canceled the authority of the central government to overturn regional regulations.

With such a condition, coordinating rules between the central government and regional administrations is increasingly difficult. For example, the central government could have made significant deregulation, but its implementation is in the regions. If the regulations in the regions remain complicated, investment will remain difficult and the central government cannot change that.

Incentive instruments and penalties

What is the solution? Create incentive instruments or penalties. For example, increasing and activating special allocation funds (DAK). Then, give this DAK to regions that carry out improvements in the investment climate. Or conversely, the withdrawal of DAK from regions that are unable to maintain the investment climate. Another effort to improve the investment climate is to revise the manpower law, especially in terms of severance rules and revise the negative investment list. We do have to focus on overcoming the main obstacles.

I remember the story of Dani Rodrik at the Legal Seafoods restaurant in Harvard Square, a few years ago. In a flat voice, he spoke of a country in Latin America that had a very long list of reforms. Ironically, its economic growth has never been impressive. The word reform has indeed become a mantra. Like a sidewalk drug, it is considered to be able to solve everything. Then, we compete to make a long list. Unfortunately, that does not always help. Our time is limited. Our resources are limited. Prioritize improvements to problems considered the main obstacles. And, Rodrik is right.

 

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