New working paper

Zooming Out Indonesia's Supply Constraints

M. Chatib Basri, Arianto A. Patunru, Masyita Chrystallin
University of Indonesia, 2008

The paper argues that Indonesia's main problem that impedes its economic growth (and lackluster performance of export) lies on the supply side rather than the demand side. That is, in the aftermath of the economic crisis, the aggregate supply has become less responsive. This problem is traced back to problems of exchange rate appreciation, high cost economy (esp. bribery and logistic costs), and the change of investment pattern. To help ensure a sustainable economic growth, therefore Indonesia needs to resolve the problem of supply constraints which itself is closely related to the issue of investment climate. The paper, however, is careful not to over-emphasize the role of investment climate in explaining the performance of Indonesian industries. It summarizes the recent discussions of investment climate given such qualification and elaborate on its most important factors, namely regulatory framework, governance, and infrastructure. In doing so, it also gives an assessment to the ongoing regulatory and policy reforms with a highlight on the policy areas where improvements are needed the most. The paper ends with a discussion on the 'dilemma of reform': reforming the bureaucracy is pivotal, but at the same time it is likely to be much more difficult than reforming the policy, because the former will encounter strong political challenges from various interests and groups; its benefits come later while the costs are immediate; and there is always a lag of time between implementation and results. The paper suggests that in countries as complex as Indonesia, reform in a 'piece-meal' approach focusing on the most binding constraints is more sensible than a 'wholesale reform'.