Economics 9708/42 — May/June 2018

Infrastructure is restricting Indonesia’s economic development

One feature of Indonesia’s economy that has been hampering its economic and social development is the lack of quality and quantity of its infrastructure, whether it is ‘hard’ like roads or ‘soft’ like education.

In recent years the Indonesian government has given infrastructure a relatively small allocation of public spending. In 2011 only 2.1% of the country’s Gross Domestic Product (GDP) was reserved for infrastructure. In comparison, countries such as China and India spend almost 10% of their GDP on infrastructure. Since the late 1990s expansion of Indonesia’s infrastructure has not matched macroeconomic expansion, and as a consequence economic growth has not reached its full potential. It is estimated that GDP could grow at 1%–2.5% more than the current annual rate.

Lack of adequate infrastructure causes distribution costs such as transport and warehousing to rise steeply, thus reducing Indonesia’s competitiveness and attractiveness as an investment location. According to data published by the Indonesian Chamber of Commerce and Industry (Kadin Indonesia), around 17% of a typical company’s total expenditure is absorbed by such costs. In other south-east Asian economies this is below 10%. In particular transport costs are high; by land as well as sea. Despite Indonesia’s island geography, sea transport is yet to be developed substantially. Currently, sea transport is even more expensive than land transport. This results in inflationary pressures on domestically produced products. It partly explains why some domestically grown fruit is more expensive than imported fruit. It also leads to substantial regional price differences. Rice, for example, is much more expensive in eastern Indonesia than in Java or Sumatra. It also prevents businesses from expanding and profitable opportunities are lost.

Indonesia suffers from inadequacies in the country’s electricity supply, despite the abundance of energy resources. Part of the problem is that the state-owned electricity distributor, which has a monopoly on electricity distribution, is heavily dependent on government subsidies as the cost of production is higher than the fixed maximum selling price.

Soft infrastructure such as education, healthcare and social welfare is also under-developed. The government has made efforts to improve these areas in recent years. A new healthcare system is about to be introduced covering all Indonesians and spending on education has increased markedly.

Source: indonesia-investments.com, accessed 17 April 2016