A Country Private Sector Diagnostic
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CREATING MARKETS IN INDONESIA UNLOCKING THE DYNAMISM OF THE INDONESIAN PRIVATE SECTOR Country Private Sector Diagnostic October 2019 Unlocking the Dynamism of the Indonesian Private Sector: A Country Private Sector Diagnostic A Joint Study by the World Bank and the International Finance Corporation October 2019 A Country Private Sector Diagnostic i Table of Content Table of Content ........................................................................................................................................ i Abbreviations and Acronyms .................................................................................................................... ii Acknowledgements ................................................................................................................................. iii Executive Summary ................................................................................................................................. iv 1. Country Context .................................................................................................................................... 1 2. The Limited Competitiveness and Domestic Orientation of Indonesia’s Private Sector ...................... 5 2.1. The Composition of the Indonesian Private Sector....................................................................... 5 2.1. The Limited Integration of Indonesian Firms into the Global Economy ....................................... 7 2.2. The Low Productivity Levels of Indonesian Firms ......................................................................... 8 2.3. Deteriorating Competitiveness: The Case of Manufacturing ........................................................ 9 3. Cross-Cutting Constraints on Private-Sector Growth ......................................................................... 13 3.1. The Competition Gap .................................................................................................................. 13 3.2. The Human-Capital Gap .............................................................................................................. 21 3.3. The Infrastructure Gap ................................................................................................................ 25 3.4. The Financial Gap ........................................................................................................................ 31 3.5. Gaps at the Sector Level .............................................................................................................. 34 4. Reforms to Accelerate Private-Sector Development ......................................................................... 39 4.1. Closing the Competition Gap ...................................................................................................... 39 4.2. Closing the Human-Capital and Infrastructure Gaps .................................................................. 41 4.3. Closing the Financial Gap ............................................................................................................ 44 4.4. Closing the Sectoral Gaps ............................................................................................................ 45 References .............................................................................................................................................. 53 Appendix ................................................................................................................................................. 58 Unlocking the Dynamism of the Indonesian Private Sector ii A Country Private Sector Diagnostic Abbreviations and Acronyms APINDO The Indonesian Employers Association ASEAN Association of Southeast Asian Nations BIT Bilateral Investment Treaty BPS Indonesian Central Bureau of Statistics CPSD Country Private Sector Diagnostic DNI Negative Investment List EAP East Asia and Pacific Region ECED Early Childhood Education and Development EU European Union FDI Foreign Direct Investment FTA Free Trade Agreements GDP Gross Domestic Product IFC International Finance Corporation KADIN The Indonesian Chamber of Commerce and Industry KBLI Indonesia Standard Industrial Classification KPPU Business Competition Commission MSME Micro, Small, and Medium Enterprise NCD Noncommunicable Diseases NRP Nominal Rate of Protection NTM Nontariff Measure OECD Organisation for Economic Co-operation and Development PLN Indonesian State Electricity Company SOE State-Owned Enterprise STRI Services Trade Restrictiveness Index UNIDO United Nations Industrial Development Organization Note: All dollar amounts are U.S. dollars unless otherwise indicated Unlocking the Dynamism of the Indonesian Private Sector A Country Private Sector Diagnostic iii Acknowledgements This Country Private Sector Diagnostic (CPSD) for Indonesia was prepared by a team led by Massimiliano Calì and Philip Chang, which included Rachita Daga and Gautam Vishram Mehta. The report was prepared under the guidance of World Bank and IFC managers Ndiame Diop, John Nasir, and Paramita Dasgupta. The team would like to thank Mohammed Ali Khan, Simon Andrews, Stefan Apfalter, Jonathan Coony, Sandro Diez-Amigo, Aufa Doarest, Frederico Gil Sander, Mary Hallward-Driemeier, Arturo Herrera, Lamtiurida Hutabarat, Imran Hussain, Rubin Japhta, Bertine Kamphuis, Carlos A. T. Katsuya, Tomio Komatsu, Rebecca Konrad, Asif Mustaqim, Andrew Myburgh, Lazeena Rahman, Harmish Rokadia, Matthew Saal, Jack Sidik, Francesco Strobbe, Andreas Sylverius, Daria Taglioni, Ralph Van Doorn, Pui Shen Yoong, and Yongmei Zhou for their comments and suggestions. The team is also grateful for the excellent research assistance provided by Muhammad Hazmi Ash Shidqi, Taufik Hidayat, and Nabil Rizky Ryandiansyah. The report draws on elements of three sectoral analyses carried out in collaboration with Vikram Rajan and Dev Terway (Health Services); Riaz Bhardwaj and Noah Yarrow (Education Technology); and Miguel A. Soriano, Matthew Saal, and Francesco Strobbe (Financial Technology). This work was carried out at the request and under the guidance of IFC and World Bank senior management, with active support provided by Mona Haddad, Vivek Pathak, Rodrigo A. Chaves, and Azam Khan. The report benefitted from useful feedback provided by peer reviewers Sarvesh Suri, Wolfgang Fengler, David Nellor, and Sabine Schlorke. The team would like to thank the report’s editor, Sean Lothrop, as well as Arsianti, who was responsible for the graphic design, layout, and formatting. Finally, the team is grateful to the countless IFC and World Bank experts, government counterparts, private sector representatives, and civil society leaders who generously shared their time and insights. The photograph on the cover is by prometeus_86 from Pixabay, on the Executive Summary by Christine Wehrmeier from Unsplash, and on section 1 by Arsianti. Unlocking the Dynamism of the Indonesian Private Sector iv A Country Private Sector Diagnostic Executive Summary international trade and weak integration into global value chains have slowed the growth of the non-commodity tradable sectors. Consequently, most new jobs are in agriculture and low-value-added, low-wage services. However, the country’s nascent digital sector is generating a small but rising share of employment and income, and this trend could spark the development of a wider range of high- value services if sectoral growth patterns remain on their current trajectory. The Indonesian economy’s reliance on commodity production has also exposed it to balance-of-payments risks and environmental vulnerabilities. The weakening of commodity prices since 2011 has slowed export growth, and declining manufacturing competitiveness and accelerating import growth have compounded its impact on the balance of payments. The resulting current-account deficit has increasingly Three decades of robust economic growth have been financed by volatile short-term capital substantially reduced poverty in Indonesia, yet flows, creating external vulnerabilities that have the vast majority of Indonesians still lack the intensified since 2018. Meanwhile, the country’s economic security that marks a sustainable commodity-based economic model, dominated transition into the middle class. Real GDP by plantation agriculture and extractive growth has averaged 5 percent per year since industries, has contributed to high levels of 1990, supported by high commodity prices, deforestation, forest degradation, and air favorable demographic trends, and a sound pollution. The resulting environmental and macroeconomic policy framework. As a result, health costs underscore the urgent need to GDP per capita increased six-fold between 1990 develop more sustainable production methods and 2018, while extreme poverty fell from 57 and shift toward less resource-intensive sectors. percent to just below 6 percent. Nevertheless, about 30 percent of Indonesians could be Low levels of human capital limit Indonesia’s pushed back into poverty by a relatively modest ability to move into higher-value-added financial or nonfinancial shock, and less than activities, boost productivity, and improve one-quarter of Indonesians enjoy the relative household welfare. According to the World security from monetary poverty associated with Bank’s human capital index (HCI), Indonesia’s middle- or upper-class status. health and education outcomes compare poorly to those of countries at similar income levels. Enabling more Indonesians to join the middle Moreover, the country’s commodity-based