Analysis: Boosting the development of Indonesia’s eastern regions

The Jakarta Post | | Business | Wed, July 16 2014

In the past four years, Indonesia has shown steady economic growth, despite our domestic structural problems and global economic turmoil. Last year Indonesia suffered from a US$4.1 billion trade deficit, a 3.3 percent of gross domestic product (GDP) current-account deficit and the rupiah depreciated to approximately 12,300 per US dollar at the end of 2013 due mainly to the US Federal Reserve’s tapering off policy.

This brought a strong combination of difficulties, which tended to put downward pressure on the Indonesian economy. Responsive policy adjustments from the Indonesian government, however, have successfully provided a good cushion for the economy and despite the unfavorable global economic conditions, it may still have grown 5.8 percent in 2013.

In contrast with the relatively stable economic growth at the national level, growth at the regional level has more diverse figures. Indonesian economic growth was not distributed equally among its seven economic corridors, namely Sumatra, Java, Bali and Nusa Tenggara, Sulawesi, Maluku and Papua.

Based on the Herfindahl Hirschman Index, ranging from 0 to 1, we discovered that the index increased from 0.4 (2011) to 0.404 (2013), which indicates greater inequality in economic distribution. The index results show the imbalanced GDP contribution of Indonesia’s west (i.e. Java and Sumatra) versus east (i.e. Kalimantan, Bali, Nusa Tenggara, Sulawesi and Papua).

The graph shows that since 2011, economic contributions from the western regions gradually increased, while they steadily fell in the east. It also shows that more than 80 percent of the Indonesian economy is concentrated in the western regions.

Furthermore, this condition has remained more or less the same for a decade, recalling that in 2003 the west already contributed 82.3 percent of Indonesia’s GDP. To wrap up, the Indonesian macroeconomic condition represents largely the western regions.

Nonetheless, if we narrow it to the regional level, provinces in the east are the winners in terms of economic growth. Although it is clear that the low economic level of the eastern regions means they have more room to grown, enable them to reach high economic growth, but their growth is still a noteworthy accomplishment.

In 2013, the top 10 provinces, with the exception of Jambi, with the highest economic growth were located in the east. Those provinces are Papua (14.8 percent), Central Sulawesi (9.4 percent), West Papua (9.3 percent), Jambi (7.9 percent), Gorontalo (7.8 percent), South Sulawesi (7.7 percent), North Sulawesi (7.5 percent), Central Kalimantan (7.4 percent), Southeast Sulawesi (7.3 percent) and West Sulawesi (7.16 percent).

The economic growth gap with that of the national level is also significant. For example, Papua posted approximately 1.5 times greater growth than the national average. Noticeably, mining was the dominant sector in Papua as the engine of growth for the province. North Sulawesi, with trading partners in the US and Europe, enjoys a higher export rate for their agricultural products as the outcome of the global economic recovery. Hence, this implicitly brings the notion that maximize the region’s primary sectors will lead to higher national economic growth.

The discrepancy of high economic growth in the east and relatively low growth at the national level arises due to structural economic differences. At the national level, industries like manufacturing, hotels, trade and restaurants are key sectors, which contribute to almost 45 percent of Indonesian GDP.

Manufacturing, which is concentrated in Java, alone contributes nearly 23.7 percent.

The other corridors, mostly in the east, are still highly dependent on extractive industries, such as agriculture and mining, which add little value. The commodity boom in the early 2000s supported the eastern regions and did not motivate development of manufacturing.

For sure, in order to augment the contribution of the eastern regions, they need to develop manufacturing. A survey of medium and large manufacturing industries shows sluggish growth of manufacturing outside Java.

Over the last 13 years, only 17-19 percent of manufacturers build plants outside Java. In 2001, the proportion of medium and large manufacturers outside Java was roughly 19 percent, but in 2013 the number shrunk to a mere 17 percent.

This is not surprising since manufacturers outside Java only grow by 0.3 percent annually, as opposed to 1 percent in Java. Therefore, more incentives should be given to promote manufacturing in the east.

Infrastructure is a main driver for the private sector to expand operations to the east. Infrastructure development will give the largest positive externalities to the whole economy. Thus, incentives may not only come from, for example, a direct reduction in a form of tax holiday, but also from cheaper logistics costs due to infrastructure readiness.

In the short to medium term, the east needs immediate infrastructure to provide access to ports for distributing mining and agriculture products. Furthermore, in the long term the development of energy infrastructure is needed to help the east transform from an exporter of raw materials to an exporter of manufactured goods.

Nevertheless, from 2011 to the first quarter of 2014, 68.7 percent of the infrastructure groundbreaking realization in the government’s Master Plan for the Acceleration and Expansion of the Indonesian Economy (MP3EI) was actually in the western regions. Moreover, in 2013 the government spending for infrastructure, goods and services was higher in the west than in the east, with 48 percent and 43 percent, respectively.

Although it is right to say that infrastructure in the western regions is important, if the focus of development does not change the east will be left even further behind.

Another indirect incentive is abundant natural resources in the east. These natural resources, however, lack the support of manufacturing industries. With a lack of processing facilities, most of these resources are exported as raw materials.

Some examples of those main export products are rubber, palm oil, coconut oil, coal, nickel and iron ore. Related to this, products with revealed comparative advantage (RCA) index higher than 1, or those considered competitive, are dominated by raw materials. Thus, the government policy to stop nickel exports in order to enforce the building of smelters is one way to try to develop eastern manufacturing.

Given rich iron supplies, the east should develop integrated steel manufacturing. The steel industry is the mother of industry and a good parameter to evaluate manufacturing development in the region.

The need for infrastructure in the east will support the development of the steel industry and vice versa. Moreover, the majority of iron ore reserves are in eastern regions. Nevertheless, the development of integrated steel industries will need a large amount of investment and have a high demand for electricity.

However, there is one more essential manufacturing industry that offers high value added from its development: the food industry.

With the rising middle class in Indonesia, the food industry will be the star among manufacturing industries for many years ahead. Furthermore, compared to all other medium and large industries in Indonesia, the food and beverage industry has the highest value added, with approximately Rp 222 trillion ($18.9 billion) last year.

The development of the food industry in the easy might give immediate impact to the region and allow it to contribute more to the Indonesian economy. In addition, the food industry will absorb a large amount of workers, thus creating a big multiplier effect.

In the short to medium term, connectivity infrastructure is a priority followed by energy infrastructure in the long term. Additionally, low development of manufacturing industries also leads to lower eastern contribution to the Indonesian economy.

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The writer is a regional analyst at Bank Mandiri

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