THE CAUSES AND CONSEQUENCES OF

INCREASING INEQUALITY IN INDONESIA:

A LONG TERM VIEW

Asep Suryahadi, Ridho Al Izzati, Daniel Suryadarma

The SMERU Research Institute

Forum Kajian Pembangunan

Bank Indonesia Institute
Jakarta 20 February 2018
Overview
Post-crisis Indonesia: Economic growth is
positive and stable, poverty declines, but
inequality has increased
20 0.45
%

18 0.43
16 0.41
14 0.39
12 0.37
10 0.35
8 0.33
6 0.31
4 0.29
2 0.27
0 0.25

Economic Growth (L) Poverty Rate (L) Gini Ratio (R)

Source: BPS
3
Indonesia during the 1970s & 1980s: High
economic growth without increasing
inequality
Indonesia’s Inequality and Economic Growth, 1976-1990
0.50 10.0

0.45 9.0

0.40 8.0

0.35 7.0

0.30 6.0

0.25 5.0

0.20 4.0

0.15 3.0

0.10 2.0

0.05 1.0

0.00 0.0
1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990
Gini Ratio (left) Economic Growth (right, %)
Source: BPS
4
Actually inequality started to increase after
1990, but Asian Financial Crisis brought it
down again temporarily
Indonesia’s Inequality (Gini Ratio) Trend, 1976-2018
0.45
AFC GFC
0.43

0.41

0.39

0.37

0.35

0.33

0.31

0.29

0.27

0.25

Source: BPS
5
Had there been no crises, Gini Ratio of
0.41 would have been achieved by
2003
Actual and Hypothetical Gini Ratio
0.45
0.43
0.41
0.39
0.37
0.35
0.33
0.31
0.29
0.27
0.25

Actual Gini Ratio Hypothetical Gini Ratio

6
The Causes
 Conjectures on the driver of the increase in
inequality
Basri (2018):
• Labor saving technology, increasing skill premium
• Rigidity in the labor market due to labor law
• Financial market liberalization
• Commodity boom, Dutch disease
• Inequality in access to education, health, financial services,
infrastructure
• Poor quality of infrastructure
• Demography: aging population
• Corruption and high cost economy

Piecemeal analysis → Need a framework on the determinants of

increasing inequality
8
Kuznet hypothesis: Never applied in
Indonesia during 1970s-1980s. Does it apply
now?
Kuznet Curve

Equally Equally
poor rich

9
 Method for estimating the contribution of
structural factors to increasing inequality

• Structural Factors:
– Education level
– Economic sector
– Rural-urban location
– Informal-formal worker
• Effects:
– Endowment effect: The effect of change in composition of a
structural factor on inequality
– Price effect: The effect of change in return to a structural
factor’s component on inequality
• References:
– Bourguignon et al. (2001)
– Pieters (2011)

10
 Education expansion has increased the
average education level of Indonesian labor
force
Share of employment by level of education
100%

90%

80%

70%

60%

50%

40%

30%

20%

10%

0%
1986 1988 1989 1991 1992 1994 1996 1997 1998 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

No school Not completed primary school Primary school Junior high school Senior high school University

11
 The dominant sector of employment
has shifted from agriculture to services
Share of employment based on sectors
100%

90%

80%

70%

60%

50%

40%

30%

20%

10%

0%
1986 1987 1988 1989 1990 1991 1992 1993 1994 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Agriculture Mining Manufacture

Water and Electricity Construction Trade, hotels, and restaurant
Transportation and communication Finance and real estate Other services

12
More and more Indonesians live in
urban areas and work in the formal
sector
100

90

80

70

60

50

40

30

20

10

Share of urban residence Share of formal workers

13
More than 80% of the increase in inequality
during 1992-2011 was due to changes in the
structural factors

Contribution of Changes in the Composition of Structural

Factors on the Increase in Inequality, 1992-2011 (%)
Endowment
Factor Price Effect Total
Effect
Education level 30.03 4.71 34.73
Employment sector 5.05 7.06 12.11
Rural-urban location 18.64 -9.41 9.23
Informal-formal worker 14.12 14.12 28.24
Total 67.83 16.47 84.30

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The Consequences
Everybody benefits from economic growth.
Why worry about increasing inequality?

16
Increasing inequality will eventually (1)
reduces economic growth, …..
.1

Peak: 0.3
Mean: 0.29
.08
Fitted values
.06
.04
.02

.2 .25 .3 .35 .4
average 2000-2005 gini

Fitted values Fitted values

Source: Yumna et al., 2014

17
….. (2) reduces the power of economic
growth to reduce poverty, …..

r = -3,699 (1 - i) g + residual
r = rate of change in poverty
i = inequality (Gini Ratio) at initial
period
g = economic growth

Inequality and Growth Elasticity of Poverty

12
10 10
10 9.1
8.2
8
5% economic growth
6
4
2 Source: Suryadarma et al. (2010)
0
Baseline Perfect Gini Ratio 0.5 Perfect
Poverty equality inequality
18
….. and (3) increases violent social conflict

Source: Pierskalla & Sacks, 2014

19
Medium Term Outlook
Outlook: Structural factors will not yet bring
inequality down in the medium term

Actual and Projection of Inequality (Gini Ratio)

0.500

0.450

0.400

0.350

0.300

0.250

Actual Gini Ratio Projected Gini Ratio

21
A very large investment in cash transfer will
only have a limited impact on inequality
The Impact of Cash Transfer on Gini Ratio
0.500

0.450

0.407 0.407 0.407 0.406 0.403 0.400

0.400

0.387

0.350

0.300

0.250
Baseline Counterfactual Percentile 5 Percentile 10 Percentile 25 Percentile 40
1 x benefit 2 x benefit 3 x benefit

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 Conclusion

• The increase in inequality in Indonesia is mainly due to

development, which has brought changes in the
economic and social structure
• Given that Indonesia is still in the increasing trajectory of
Kuznet curve, a Gini Ratio of 0.4 or higher is the new
normal
• To reach the decreasing trajectory of Kuznet curve
sooner, where inequality will start to go down, Indonesia
needs to speed up the structural transformation through:
– Expanding education services further
– Fostering industrial development
– Facilitating formalization of economic activities
– Increasing the rate of urbanization
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