Week 7 - Mishra - Indonesia's Ascent PDF

Indonesia’s Ascent
Power, Leadership, and the Regional Order
Edited by
Copyright material from www.palgraveconnect.com - licensed to University of New South Wales - PalgraveConnect - 2015-07-25
Christopher B. Roberts
University of New South Wales at the Australian Defence Force Academy, Australia
Ahmad D. Habir
Strategic Asia, Indonesia
Leonard C. Sebastian
Nanyang Technological University, Singapore
10.1057/9781137397416 - Indonesia's Ascent, Edited by Christopher B. Roberts, Ahmad D. Habir and Leonard C. Sebastian
Editorial matter and selection © Christopher B. Roberts, Ahmad D. Habir and
Leonard C. Sebastian 2015
Chapters © Contributors 2015
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Contents
List of Figures and Table xii
Acknowledgements xiii
Notes on Contributors xv
List of Acronyms and Glossary xviii
1 Ascending Indonesia: Significance and Conceptual 1
Foundations
Christopher B. Roberts and Leonard C. Sebastian
Conceptual foundations: The nature of power and influence 3
in international relations
Book structure 9
Notes 15
Bibliography 19
2 Leadership and Dependency: Indonesia’s Regional and 22
Global Role, 1945–75
Sue Thompson
Nationalism, revolution and independence 22
Guided democracy 24
Konfrontasi (Confrontation) 26
The New Order 29
Conclusion 34
Notes 35
Bibliography 38
3 The Economy in Indonesia’s Ascent: Making Sense of it All 40
Satish Mishra
Setting the stage: The polity 40
Indonesia and emerging international perspectives on 41
development policy
Indonesia: The economy in the midst of systemic transition 44
Indonesia: Taking the economic pulse 46
Post-election development policy in Indonesia 60
Conclusion 62
Notes 64
Bibliography 66
vii
viii Contents
4 Yudhoyono’s Third Way: Muslim Democracy, National 69

Stability, and Economic Development in Indonesia
Mark S. Williams
Introduction 69
Islam in the republic: National stability and economic 70
development
Islam as a revolutionary force and the discourse of a 76
revisionist state
Democratic stability, economic development, and an Islamic 81
ethics during the SBY era, 2004–14
Conclusion 86
Notes 87
Bibliography 90
5 Key Security Fault Lines—Unresolved Issues and 93
New Challenges
Bob Lowry
Introduction 93
The utility of violence 94
Militant Islam 94
Communism 95
Separatism 96
Aceh 96
Papua 96
Cathartic violence 97
TNI 98
Notes 106
Bibliography 109
6 Democratic Achievement and Policy Paralysis: Implications 112
for Indonesia’s Continued Ascent
Stephen Sherlock
Introduction 112
A decade of democratic achievement 114
Indonesia’s third transition: A time of uncertainty 117
Stalled reform and policy paralysis 118
Failings of the party system and the 2014 election 119
Conclusion 124
Notes 126
Bibliography 128
7 Politics, Security and Defense in Indonesia: The Pursuit of 130
Strategic Autonomy
Iis Gindarsah and Adhi Priamarizki
Introduction 130
Contents ix
Indonesia’s ongoing security landscape 130

Indonesia’s core interest and strategic approaches 133
Fundamental trends of Indonesia’s foreign policy 136
Indonesia’s defense policy direction 141
Conclusion 146
Notes 147
Bibliography 150
8 The Foreign Policy Nexus: National Interests, Political Values 155
and Identity
Avery Poole
Introduction 155
A ‘more activist’ foreign policy 156
‘Democratic identity’ in foreign policy 157
International role 159
Regional role 160
Public opinion and democracy 163
‘Democratizing’ foreign policy 164
Challenges to the democratic image 165
Economic growth and inequality 167
Post-2014 foreign policy 168
Conclusion 169
Notes 170
Bibliography 173
9 Indonesia and International Institutions: Treading New 177
Territory
Yulius P. Hermawan and Ahmad D. Habir
Introduction 177
Independent and active foreign policy 179
The roles of the G-20, NAM, and the UN: The Indonesian 180
perspective
Challenges in implementing vision and policy 185
Indonesia and international institutions: Beyond symbolism 187
Notes 188
Bibliography 192
10 Indonesia–Australia Relations: Progress, Challenges and 195
Potential
Christopher B. Roberts and Ahmad D. Habir
The evolution of political and security relations 196
Causal dynamics: The roles of perceptions, knowledge, and trade 204
Policy implications and the ways forward 208
Notes 210
Bibliography 218
x Contents
11 The Middle Power Moment: A New Basis for Cooperation 224

between Indonesia and Australia?
Mark Beeson and Will Lee
Middle power theory and practice 225
Is Indonesia a middle power? 228
The evolving relationship 230
Competing interests 232
Still strange neighbors? 234
Concluding remarks 236
Notes 237
Bibliography 240
12 Key Intra-ASEAN Bilateral Relationships: Opportunities and 244
Challenges
Yongwook Ryu
Introduction 244
Indonesia–Malaysia relations 245
Indonesia–Singapore relations 250
Indonesia–Vietnam relations 254
Conclusion 259
Notes 260
Bibliography 262
13 Indonesian Leadership in ASEAN: Mediation, Agency and 264
Extra-Regional Diplomacy
Christopher B. Roberts and Erlina Widyaningsih
Indonesia in intra-ASEAN conflict mediation and management 265
Indonesia as an agent of institutional and normative change 269
The global nexus between Indonesia’s ascent and ASEAN 273
Conclusion 277
Notes 279
Bibliography 283
14 Indonesia among the Powers: Will ASEAN Still Matter to 287
Indonesia?
See Seng Tan
Introduction 287
Indonesia rising: Domestic and external challenges 289
Relevance of hedging in a time of rebalancing 293
Frameworks for engaging the great powers 295
Multiple paths to Indonesia’s security 297
Conclusion: Indonesia driving and suffering the region? 299
Notes 299
Bibliography 304
Contents xi
15 Beyond the Archipelagic Outlook: The Law of the Sea, 308

Maritime Security and the Great Powers
Leonard C. Sebastian, Ristian Atriandi Supriyanto and I. Made
Andi Arsana
Introduction 308
Archipelagic Outlook: The evolution of a concept 309
Archipelagic sea lanes, maritime boundaries, and choke-points 312
How to designate East–West sea lanes 314
Sharing the ocean: Anticipating Indonesia’s completion of 318
maritime boundary delimitation
Maritime security and defense conundrums 322
Conclusion: Beyond the Archipelagic Outlook 324
Notes 327
Bibliography 331
16 ‘Consensual’ Regional Hegemony, Pluralist-Solidarist Visions, 335
and Emerging Power Aspirations
Leonard C. Sebastian and Christopher B. Roberts
Notes 345
Bibliography 346
Index 348
3
The Economy in Indonesia’s Ascent:
Making Sense of it All
Satish Mishra
Setting the stage: The polity
The 2014 presidential election in Indonesia was a celebration of 15 years of

democracy.1 During that time the country had recovered from economic
crises following the Asian Financial Crisis of 1997–98,2 multiple natural
disasters, separatist movements, and the occasional terrorist attack.
In addition, Indonesia has arrived on the world political and economic
stage with its entry into the G-20 and as the largest country in the new
post-2015 ASEAN Common Market. Forecast to be the sixth largest
economy in the world by 2030, it is on an accelerated track to join the
OECD. It has become a preferred market for new investment from large
Asian neighbors such as India and China, and its youthful workforce holds
promise of rising productivity and a demographic dividend in the next two
decades. Its high priority on education and human capital development, as
well as on industrial diversification into manufacturing and higher value-
added services such as IT, design and tourism allow Indonesian policy-
makers a measure of confidence about escaping the ‘middle income trap’.
Indonesian policymakers avoided the political polarization of the
destructive intensity witnessed in present day Egypt or the fragmentation
and discord seen in the post-Berlin War years in the former USSR and
Eastern Europe. The tendency to seek political coalitions, the absence of
political party platforms, and the preference for ‘transactional politics’
might have saved Indonesian democracy from fragmenting into highly
polarized groups with the potential to undermine democracy.
The economic foundations of the new democracy were also helped by
considerable good luck. First, it benefited from the international commod-
ity price boom of the mid-2000s that fuelled its consumption-based eco-
nomic recovery. Second, it largely escaped the onslaught of the global
financial shock of 2008–09 and may have actually benefited from it as
Indonesia became an attractive new investment destination of foreign
direct investment. Third, the combined result of political stability and eco-
40
Satish Mishra 41
nomic recovery was the emergence of a large middle class and the fastest
rate of urbanization seen anywhere in the developing world. This marked
rise of a class of young ‘non poor’3 also produced a constituency for demo-
cratic governance and a rising demand for new leaders who might be more
representative of public opinion and public preference. The growth of the
digital and social media helped to insert a new dynamic into Indonesian
politics whereby the young became an attractive constituency and voting
pool.
But more than anything else it was the dramatic political decentralization
introduced within the first year of the new democracy that defined the
political terrain of Indonesian politics. Whether out of political necessity or
group self-interest, Indonesia’s historically rather conservative leadership
managed to lay the foundations of a ‘big bang’ decentralization that has
changed its political dynamics forever. The evolution of decentralized gov-
ernance continues. Indonesia’s 298 districts in 2000 have now grown to
over 500.4 For all practical purposes its regional governments exercise public
expenditure authority almost as great as each state of the United States or
any of the Indian provinces. Indonesia has become a unitary form of gov-
ernment with a de facto federal political system. Moreover, decentralization,
while creating all kinds of management and economic difficulties and much
regulatory confusion, has also managed to rest historical Indonesian fears of
political fragmentation and territorial disintegration.
The world and the Asia region have not stood still while Indonesia has
recovered from its deep economic crisis in 1998. Nor have they been disin-
terested bystanders. First China and then India have become new power-
houses of manufacturing, technology and education. They have become
major trading partners not only of each other, but also of Indonesia and
more generally of ASEAN.5 The rise of the ‘rest’ in which China and India
are interconnected engines continues to shape Indonesia’s neighborhood
and its trading environment. Indonesia’s New Order government, created
partly as a reaction to the spread of communism in South East Asia in the
end gave way to multi-party democracy in an Asia characterized by deep
structural reforms in China and India, and systemic shifts in Cambodia and
Myanmar. Indonesia is an archipelago within a mosaic of structural trans-
formations breaking out across its own neighborhood.
Indonesia and emerging international perspectives on

development policy
It was not that long ago that effective economic policy, especially that
advocated by international financial institutions and aid donors, consisted
of one central recommendation: that of reducing the footprint of the state
on the economy. Much of that thinking vanished following the Asian
Financial Crisis in 1997–98, and any remaining doubt was removed by the
42 The Economy in Indonesia’s Ascent: Making Sense of it All
advent of the mortgage and financial market collapse in the United States
(US) in 2007–08 and the ‘great recession’ that was triggered in its wake.
As large corporations sued for government bailouts in the US and entire
countries in hitherto prosperous and technologically advanced Europe fell
into political disarray in the throes of fiscal austerity programs, the neat
separation of free markets and the democratic state could not be taken for
granted. Indeed they were intertwined systems of social and economic
management that could be pulled apart only at the risk of bringing down
both the free market and multiparty democracy. The result was inevitable.
Policymakers and academic theorists, not forgetting social activists and
party think-tanks, went back to the drawing board. The work is still
ongoing, but some significant conclusions are beginning to emerge. Given
the confusion and concern with austerity, it is not surprising that much of
the rethinking has begun with macroeconomic policy.
However, the recent global recession has served to underscore the impor-
tance of macroeconomic dimensions of development policy, especially in
the context of large structural or political changes as we witnessed in
Indonesia. This has been partly due to the role of the IMF as the leading
global advocate of macroeconomic stabilization, and partly due to the
debates from the 1980s onwards over the size and functions of the state in
developing countries.6 Another factor has been the concern with the
misuse of public funds for political ends, especially in countries still evolv-
ing politically stable systems of governance. The state in many countries
has been as much an arena for corruption and rent seeking, often
autocratic, rather than a vehicle for public participation and economic
inclusion.7
The attempt at rolling back the state where less state and more market
was seen to be the formula for development success has now been more or
less abandoned everywhere. The state is instrumental in the management
of social vulnerability caused by frequent and relatively unpredictable
financial shocks in both domestic and regional economies, and of the need
to create or support market institutions where they remain fragmented or
incomplete. In developing countries new agendas of inclusive growth, tech-
nological innovation and containment of horizontal inequalities and
violent social conflicts all gave a more comprehensive role for the state
than had been thought possible in the 1980s and early 1990s.8
The advent of democracy has been another driving element in the
rethinking of the appropriate role and size of the state in developing
economies. Contrary to popular views of the state in the 1980s, democratic
states tend to be larger and garner a larger proportion of total public expen-
diture than others. Of course, the size of the state varies considerably in
mature democracies, but on average it is much higher in the developed and
democratic North than it is in the politically evolving South.9
Satish Mishra 43
Yet no discussion of macroeconomic policy in the new world of the

smart or proactive yet democratic state can be undertaken unless close
attention is paid to the driving mechanics of government: what it can earn
and garner in the form of government revenue and how it chooses to allo-
cate the revenues it collects. Renewed interest in the State has naturally led
to a vigorous interest in the degrees of freedom it has in both revenue gen-
eration and public expenditure choices. Fiscal, not monetary policy lies at
the core of the current discussions on macroeconomic policy in developing
countries.
The underlying idea of creating fiscal space is straightforward: how to
enlarge freedom of movement for the government in fiscal policy while
maintaining macroeconomic stability. It is a response to the observation
that the state is in fact not too large but too small in developing countries.
It is engaged in both economic and human development, where the multi-
ple and simultaneous needs of economic growth, poverty and inequality
reduction, and building new institutions have to be met from very low
levels of government revenue and expenditure.10
Attempts to enlarge fiscal space therefore have focused on the revenue as
well as the expenditure sides of the public ledger. The former has con-
cerned itself with reform of tax administration and enforcement of tax col-
lection, including elimination of tax subsidies and holidays to foreign and
large domestic investors, enlarging the tax base, simplifying tax procedures,
and reducing corruption by the use of digital technology. The latter encom-
passes multi-year budgeting processes, more transparent public policy
processes that determine priorities for public spending, and removing waste
and inefficiency in budget allocation and use. Dispensing with inefficiency
has also involved the use of civil society and community based organiza-
tions to monitor the quality of public services funded by the budget as well
as ensuring that those entitled to public support in social welfare and pro-
tection programs are aware of their rights under these schemes.11
Clearly attempts to enlarge the fiscal space in a bid to meet competing
and growing demands—including those for public services, support to new
employment schemes and to SME development, the building of both hard
and soft infrastructure and public education—are not only technical issues
revolving around the efficiency of budgetary allocation or the prevention
of illicit leakages. They are core elements of what a development state does,
and constitute the architecture of its leading institutions. All this is far
from the concept of the ‘night-watchman state’: content to provide law
and order, regulate the currency and provide a ‘level playing field’ to a very
unequal set of corporate players.
All this is highly relevant to understanding economic policy priorities in
today’s Indonesia. The 1999 elections marked the first step in the creation
of a democratic state. Consolidation of this new democratic state and the
way it meets the expectations of those who elected it is perhaps the most
critical development priority of the day. Yet, without a resilient and
growing economy, with its benefits spread across the archipelago,
Indonesia risks rising horizontal inequality and renewed social conflict.
Fortunately—and unlike two decades ago—it is now considered perfectly
natural to examine a country’s economic health by taking into account its
political, financial and regulatory processes. New perspectives on the proac-
tive state, widening the fiscal space, and generating social consensus on
‘wicked problems’12 of economic fairness and justice are all highly relevant
to Indonesia today.13
Indonesia: The economy in the midst of systemic transition
Macroeconomic data conceal as much as they reveal about development

policy in Indonesia. Above all, they give little weight to the massive and
historically unprecedented transformation still underway in Indonesia fol-
lowing the Asian Financial Crisis and the implosion of the New Order.
Indonesian decentralization: One state or many?

Indonesia represents a case of systemic transition whereby a country under-
takes wholesale restructuring of virtually all its economic and political
institutions. The period between 2000 and 2012 falls within that period of
system-wide transition. During that period Indonesia reformed not only its
entire political system, but also recovered from the deepest economic crisis
in its post-independence history. From being a military supported, central-
ized autocracy, Indonesia transformed itself into perhaps the most decen-
tralized multiparty political and economic system in the world.
Indeed its system of direct fiscal transfer to over 300 districts in 2001
became even more decentralized as the number of districts increased to
over 500 by 2012. Public expenditure authority was thus dramatically
devolved to the districts, although most of them remained dependent on
the center for fiscal transfers, as only a minority of Indonesia’s natural
resource-rich districts could remain fiscally solvent without grants from the
center.
Two other factors characterize Indonesia’s public finance system. First,
fiscal transfers to sub-national levels of government are divided into two
components, the general funds allocation (Dana Alokasi Umum: DAU) and
the specific grants allocation (Dana Alokasi Khusus: DAK). The former is a
block grant essentially allowing largely recurrent expenditure allocations
for government, the schools, and the health service. The DAK is a grant
made to cover capital expenditure at the district level. A third component
is locally collected taxes and charges (PAD) on land and a variety of other
sources. With the large expansion of the number of districts the Indonesian
public finance system is grappling with the problem of how to increase
Satish Mishra 45
DAK allocations to allow poorer districts to cover capital expenditures from

such grants. One of the consequences of such an expansion of district
administrative entities is the sharp increase in public expenditures allo-
cated to general government services.
Economic inequality and the quality of growth

Faced with growing inequality as a result of rising public demand for
greater social protection, Indonesia launched a universal social protec-
tion/insurance scheme beginning in January 2014. This is an extraordinary
step for a relatively new political system to take, and by and large has
enjoyed backing across the political system. What makes Indonesia stand
out, however, is that even before the recent universal social insurance ini-
tiative, it was well known for implementing an internationally acclaimed
conditional cash transfer scheme following the Asian Financial Crisis.
While Indonesia’s social protection measures helped to reduce vulnera-
bility to absolute poverty, economic inequality—as distinct from poverty—
remains a significant and growing problem in Indonesia as well as in the
region.14 Indonesia’s Gini coefficients, based on household consumer
surveys, continue to rise, and if the experience of other Asian countries is
something to go by, these will only worsen. While the government is aware
of this trend, it has yet to introduce a targeted policy for inequality con-
tainment, except in the form of cash transfers and community grants to
poor households. Given the history of social conflicts, particularly around
natural resource use,15 the possibility of state capture16 at the sub-national
levels by dominant economic lobbies, and the robust analytical link
between horizontal inequality and social conflict, urgent attention needs to
be given to this inequality predicament. There is little evidence of this hap-
pening at present, especially since there is little research on the extent to
which inequality between regions or between urban and rural areas is rising
or falling, or if district GDPs and per capita incomes are converging or
diverging.
Human capital and tapping into the knowledge economy

Human capital development remains a major policy challenge in
Indonesia. Impressively, some 20 per cent of the total national budget is
now constitutionally required to be allocated to the education sector, thus
sharply raising the budgetary allocations to education. However, the
country faces a series of problems regarding the quality of education across
the archipelago, financial autonomy for its leading universities, the perfor-
mance of private education in the form of over 3,000 of the country’s 3,200
higher education institutions, and the mismatch between its skill sets and
demands from the labor market.17 The problem is complicated further by
the plan to develop six economic corridors across Indonesia, each of which
would concentrate on its own comparative advantage. This would require a
massive boost in Indonesia’s Technical and Vocational Education and

Training (TVET) program, and a more decentralized approach to education
policy with much closer cooperation between educational institutions and
private businesses.
Human capital development is also of crucial importance to Indonesia in
the near future if it is to reap a ‘demographic dividend’, as the McKinsey
Report suggests.18 Without being able to train and employ Indonesia’s pool
of youthful labor, the demographic dividend can easily become a demo-
graphic curse. That will undermine the dream of turning Indonesia into
one of the world’s dominant economies and a major driving force in the
economic engine of a post-2015 ASEAN.
Indonesia: Taking the economic pulse
Growth, saving and investment

Following the worst economic shock in its post-independence history,
Indonesia’s economy began to recover with political stabilization and
renewed consumer confidence. The result was a steady increase in its real
GDP from around $165 billion in 2000 to $427 billion in 2012 (Figure 3.1).
Indonesia suffered a growth shock, like much of the region in the wake of
the 2007 Global Economic Crisis, but the consequent fall in output was
short-lived. GDP growth fell from a peak of 6.2 per cent in 2007 to around
4.5 per cent in 2009, only to rise to 6.5 per cent two years later. Indonesian
economic growth decelerated in 2013, the currency depreciated and the
trade deficit rose sharply. Despite the growth slowdown there is consider-
able optimism that investment to GDP ratios—which fell in 2013—will rise
Real GDP and GDP Growth
7 Real GDP trend line 450

400
6
350
5
300
% Growth
Billions
4 250
3 200
2 150
100
1 50
0 0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
GDP growth (annual %)
Figure 3.1 GDP Indonesia from 2000 to 2012

Source: World Bank Development Indicators Online Database updated March 2014
Satish Mishra 47
Per capita GDP and its Growth
6 2
Real GDP trend line 1.8
5 1.6
USD Thousands
1.4
4
% Growth
1.2
3 1
0.8
2
0.6
1 0.4
0.2
0 0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
GDP growth (annual %)
Figure 3.2 Growth of per capita GDP in Indonesia (2000–12)

Source: World Bank Development Indicators Online Database updated March 2014
again with a new political mandate for the incoming President Joko
Widodo (Jokowi) in late 2014.
Figure 3.2 depicts trends in per capita real GDP at 2005 prices. As
expected, GDP per capita growth in Indonesia remained lower than total
GDP due to population growth, but the rise in per capita income over the
12-year period was nevertheless significant. This helped to sustain
Indonesian consumption-led growth for much of the last decade until
investment flows rose to accelerate growth further.
Figure 3.3 presents the sectoral composition of GDP growth. As in many
other economies of the region, highest growth was recorded in the services
sector, followed by industry and then agriculture. This is not unusual in the
context of Indonesia’s very rapid urbanization. Currently over half of the
country’s population live in urban areas: a proportion significantly higher
than in other large economies such as India and China.19
Figure 3.4 depicts savings and investment trends. First, despite two eco-
nomic shocks in less than a decade, savings to GDP ratios in Indonesia
remained high, peaking at over 34 per cent of GDP in 2012. This was a con-
siderable rise from a low of below 22 per cent in 2003. This is interesting,
since with the rapid growth of a middle class and urbanization, consump-
tion would be expected to rise and savings ratios to fall. This has clearly not
happened and the reasons require economic research, as do the movements
between gross domestic and gross national savings, a phenomenon impor-
tant in the Philippines due to the large overseas workforce. A similar effect
might be occurring in Indonesia, which has also been exporting labor to
neighboring countries and the Middle East.
Sectoral Growth Rates in % GDP 1995–2012
13.0
8.0
3.0
–2.0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
–7.0
–12.0
–17.0
GDP Agriculture Industry Services
Figure 3.3 Sector wise contributions in % GDP

Source: Asian Development Bank (ADB) Key Indicators for Asia and the Pacific 2013
Second, the investment to GDP ratios have been growing closer to

domestic savings to GDP ratios, ending at being almost identical in 2012.
The mirror image is reflected in the very low budget deficit in that year.
The state and public finance

Figures 3.5 and 3.6 present trends in revenue and public expenditure in
Indonesia between 1995 and 2012. Several aspects of Indonesia’s public
finances are worth noting. The most obvious is the very low level of
revenue to GDP ratios throughout the period. What is extraordinary is that
38.0
36.0
34.0
32.0
30.0
28.0
26.0
24.0
22.0
20.0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Gross domestic saving Gross national saving

Gross domestic capital formation
Figure 3.4 Savings and investment as % of GDP (2000–12)

Satish Mishra 49
22.0
21.0
20.0
19.0
18.0
17.0
16.0
15.0
14.0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Total revenue Total expenditure
Figure 3.5 Revenue expenditure gap as a % of GDP from 1995–2012

despite sustained economic growth and growth in per capita income, the
structure of revenue or of revenue collection needs considerable rethinking.
For instance, the 2012 revenue to GDP ratio was around the same level as it
was in 1996. Moreover, the rise in revenue to GDP ratios witnessed
between 2000 and 2008 when it rose from a low of 14.5 per cent to a high
of over 19 per cent went into reverse with the advent of the global financial
shock. While the Indonesian economy and its growth or investment levels
remained unaffected by, and may have even benefited from, the global
financial crisis, revenue to GDP ratios were clearly creating a massive fiscal
squeeze. This is not apparent in Figure 3.5, largely because Indonesia’s
Fiscal Balance % of GDP

0
2000 2005 2006 2007 2008 2009 2010 2011 2012
–0.5
–1
–1.5
–2
Fiscal Balance % of GDP
Figure 3.6 Fiscal balance in Indonesia 2000 to 2012 (% of GDP)

public expenditure also fell in proportion due to its very conservative

budget deficit stance. Nevertheless, it does constrain Indonesia’s large
public investment requirements for infrastructure, human capital and
social insurance, which would arguably help to consolidate its new
democracy.
Figure 3.6 summarizes Indonesia’s fiscal balance over the 2000 to 2012
period. It illustrates in sharp contrast to many other economies in the
region—including the Philippines and Thailand, and such countries as
India—the national preference for a low budget deficit. Macroeconomic
policy is very much characterized by budget deficits ranging from almost
zero (–0.1 per cent) to –1.8 per cent in 2012. Given the enormous disloca-
tion brought about by political implosion, decentralization, and the need to
contain poverty and raise education expenditure ratios to GDP, Indonesia’s
resolute adherence to low budget deficits is remarkable. It is even more
remarkable given the large share of public expenditure exhausted by energy
subsidies on fuel and electricity. These have been reduced in recent years,
but continue to occupy a lion’s share of total public expenditure. Anti-
corruption investigations and regulatory complexity have also contributed
to many regional governments not being able to spend what they have been
allocated by Central Government fiscal transfers.
Trends in revenue
Figure 3.7 presents government data on revenue and tax to GDP levels and
trends. It brings out two key features of the Indonesian revenue system.
First, as already noted, is the remarkably low tax to GDP ratio. Although
this ratio has risen close to 50 per cent from 2000 to 2012, it still stands at
Tax revenue and non-tax revenue as % of GDP

20
18
16
14
% of GDP
12
10
8
6
4
2
0
2000 2005 2006 2007 2008 2009 2010 2011 2012
Tax Revenue
8.3 12.5 12.3 12.4 13.3 11.1 11.2 11.8 11.3
(% of GDP)
Non-tax Revenue (% of GDP) 6.4 5.3 6.8 5.5 6.5 4 4.2 4.4 4.3
Figure 3.7 Tax and non-tax revenue share of GDP (2000–12)

Source: Badan Pusat Statistik
Satish Mishra 51
11.3 per cent. Second, non-tax revenue, composed mainly of contributions

from state enterprises, particularly in the energy and the commodity sector,
is declining in importance as exports of oil vanish and state enterprises
come under competitive stress with the end of monopolies.
Tax collection and structure

Indonesian taxation is based on Article 23A of the Indonesian Constitution
of 1945, where tax is an enforceable contribution imposed on all
Indonesian citizens, foreign nationals and residents who have resided for
120 cumulative days within a 12-month period. Indonesia has a
stratification of taxation including Income Tax, Local Tax (Pajak Daerah)
and Central Government Tax. As Figure 3.8 shows, value-added taxes par-
ticularly have seen strong growth from a very low base in 2000 and are
now the largest contributor to the overall revenue from goods and services
(Figure 3.9).
Since 2000, tax to GDP ratios have increased by four percentage points in
Indonesia (9 to 13 per cent). Taxes on incomes and profits are particularly
important in Indonesia, representing 44 per cent of tax revenues. This com-
pares with 30 per cent in both Japan and Korea and 34 per cent for OECD
countries. Consumption taxes represent 46 per cent of revenues in
Indonesia owing to a smaller collection of social security contributions
(Figure 3.9). The system is also characterized by a very low level of property
taxation, arguably one of the lowest in developing countries.20
Recently, to boost tax revenue the tax directorate general has delivered
solid reform in different areas of organization. Among several tax reform
issues, the organizational issue is one of the most important. Most impor-
tant among these are upgrading the placement of the tax office within the
Value added Taxes

400000
300000
Billion Rp
200000
100000
0
2000 2005 2009 2010 2011 2012
Years
Value added Taxes Linear (Value added Taxes)
Figure 3.8 VAT volume in Indonesia

Source: OECD (2014) Revenue Statistics in Asian Countries: Trends in Indonesia and
Malaysia, 1990–2012
Tax Revenue Composition

800000
700000
600000 Other Taxes

Billion Rp
500000
Taxes on goods and
400000
services
300000 Taxes on property
200000
On income and profits
100000
and capital gain
0
2000 2005 2009 2010 2011 2012
Years
Figure 3.9 Tax structure and composition, 2000–12

Source: OECD (2014) Revenue Statistics in Asian Countries: Trends in Indonesia and
Malaysia, 1990–2012
overall government structure, combining tax and customs offices, assigning

the responsibility for collecting social security contributions to the tax
office, introducing a functional organizational structure within the tax
office, creating data processing centers (DPCs), establishing large tax payer
units (LTUs) and establishing a tax administration organization. Out of
these, Indonesia has only incorporated three agendas: the tax office already
has both DPCs and LTUs, and the office has also introduced a functional
organizational structure.21
Apart from organizational reform, Indonesia requires a review of the fuel
subsidy in Indonesia and the GST (goods and services tax), particularly as
the economy continues to grow and experience structural transformations,
such as the expanding middle classes.
Trends in expenditure
Indonesia’s public expenditure as a percentage of GDP remained more or
less stable. It was at around 20 per cent of GDP during 2006–08 and then
declined to around 18 per cent of GDP. The reduction in public expend-
iture as a proportion of GDP did not translate into a reduction in absolute
terms (Figure 3.10).
Figure 3.11 and Table 3.1 show the distribution of government expend-
iture by sectors. Figure 3.11 covers general public services, defense, educa-
tion, health, social security and welfare; economic affairs (agriculture,
industry, transportation and communications and other economic services)
and other sectors, over a period of nine years from 2005 to 2013. Total gov-
ernment expenditure over this period grew dramatically, from 266,220
billion Rupiahs in 2005 to 1,154,381 billion Rupiahs in 2013.
Satish Mishra 53
Total Government Expenditure (% of GDP)

30
10
–10
1990 1995 2000 2005 2006 2007 2008 2009 2010 2011 2012
Total Government Expenditure (% of GDP)
Figure 3.10 Public expenditure as % of GDP, 2000–12

Government expenditure in sectors such as general public services, edu-

cation and economic affairs registered increases of more than 300 per cent
between 2005 and 2013, largely as a result of decentralization. The expen-
diture allocation to education grew by more than 355 per cent. The al-
location to economic services (agriculture, industry, transportation,
communications and other economic services) registered one of the highest
increases, growing by 338 per cent from 28,000 billion Rupiah (2005) to
122,888 billion Rupiah (2013). Most of the public expenditure in the years
between 2005 and 2012 went to general public services, with the highest
allocation recorded in 2012 of 590,841 billion Rupiah, and to education,
which in 2012 accounted for 103,667 billion Rupiah. The public expend-
iture for the health sector was 7,038 billion Rupiah in 2000. This value
Central Government Expenditure by Function
1400000
Social protection
1200000 Education
Religion
1000000
Tourism and culture
800000
Health
600000 Housing and community amenities
Environment
400000
Economic affairs
200000 Public order and safety
Defense
0
2005 2006 2007 2008 2009 2010 2011 2012 2013 General public services
Figure 3.11 Indonesia’s total expenditure by function (sectors)

Source: BPS
54
Table 3.1 Indonesia’s total expenditure by function (sectors)
2005 2006 2007 2008 2009 2010 2011 2012 2013
General public services 158559 263421 296828 372497 494766 495320 517167 590841 720060
Defense 22001 28278 32722 13986 12279 20968 47419 72473 81769
Public order and safety 15586 25294 29211 15237 14451 14926 22067 30196 36487
Economic affairs 28016 39644 51250 63672 56853 57359 101414 102734 122888
Environment 3105 4477 5478 6734 7035 7889 11070 11451 12446
Housing and community amenities 2280 6049 10659 14129 18135 20907 23425 26477 30722
Health 7038 12730 17467 17270 17302 18002 13649 15564 17493
Tourism and culture 920 1025 1676 1430 1490 1416 2901 2454 2509
Religion 691 1104 2208 922 830 913 1397 3562 4100
Education 25988 43287 54067 64029 89918 84086 91483 11037 118467
Social protection 2036 2289 3210 3525 3318 3457 4586 5578 7440
Total 266220 427598 504776 573431 716376 725243 836578 964997 1154381
Satish Mishra 55
Public Order and Tourism and

Safety, 3% Culture, 0% Housing and
Social
Community
Protection, 1%
Religion, 0% Amenities, 3%
Environment, 1%
Defense, 7%
Education, 11%
Health, 2% General Public

Services, 61%
Economic
Affairs, 11%
Figure 3.12 Percentage expenditure by function year 2012

Source: Badan Pusat Statistik
grew by 121 per cent in 2012, reaching a peak of 15,564 billion Rupiah.
Overall government expenditure during the period 2000–12 grew by almost
262 per cent.
Figures 3.10, 3.11 and 3.12 give a clear understanding of how the govern-
ment allocated public spending among different sectors. The common
element in these allocations is their relative constancy:
• Expenditure on the general public sector increased from 60 per cent of

the total public expenditure in 2005 to 61 per cent in 2012;
• Expenditure on education increased from 10 per cent in 2005 to 11 per
cent in year 2012;
• Expenditure on economic affairs constituted 10 per cent of the total
expenditure in 2005 and 11 per cent in 2012.
Notable has been the money allocated to defense, representing the 7–8 per
cent of the total expenditure during this period. Government funding allo-
cated to the health sector is still very low, accounting for only 2 per cent of
the total public expenditure. An overview of the overall allocation of the
budget across different sectors is given in Figure 3.14.
Other key macroeconomic indicators besides the fiscal balance relate to
financing the budget deficits. This is reflected in Figure 3.13 which presents
Indonesia’s current account deficit over time. It shows the fall in the
current account surplus, with considerable volatility since 2000 turning
from a surplus to a deficit by 2012.
Current account balance [% of GDP]

6
0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
–2
–4
Current account balance [% of GDP]
Figure 3.13 Current account balance as % of GDP

Source: World Bank World Development Indicators 2014
Indonesia’s public debt is depicted in Figure 3.15, while the net external
debt as a percentage of GDP is presented in Figure 3.14. Indonesia has
managed to bring down the burden of public debt from over 70 per cent in
2003 to just over 21 per cent in 2012, a remarkable achievement helped by
the high economic growth over the period. The external debt to GDP ratio
shows a similar downward trend. Taken together they demonstrate both
Indonesia’s fiscal conservatism and lessons from the harsh Asian Financial
Crisis, which badly affected the Indonesian economy and society.
The external debt (total) of Indonesia in 2012 was $251 billion with a
global rank of 32. Indonesia’s external debt (total) had a positive growth of
91.8 per cent in the last ten years (2002 to 2012). Indonesia had an average
external debt (total) of $163 billion in the last ten years (2002 to 2012).
Public debt (% of GDP) – Indonesia

80
60
40
20
0
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
public debt (Percentage of GDP) (% of GDP) – Indonesia
Figure 3.14 Public debt as % of GDP

Source: World Bank World Development Indicators 2014
Satish Mishra 57
Net external debt [% of GDP]

100
80
60
40
20
0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Net external debt [% of GDP]
Figure 3.15 Net external debt as % of GDP

Source: UNESCAP Data Explorer http://www.unescap.org/stat/data/statdb/
DataExplorer.aspx
Overseas development assistance has also seen a steep fall ever since 2005
after the Tsunami reconstruction in Aceh had taken place.
Indonesia spent IDR164.7 trillion (US$18.1 billion) subsidizing fuel prod-
ucts in 2011, of which IDR76.5 trillion (US$8.4 billion) was spent subsidiz-
ing petroleum. The rising cost of subsidies is placing a huge burden on
limited public resources and presents a fiscal liability, vulnerable to
increases in the international price of oil.
Following the 2005 and 2008 reforms, reductions in fuel subsidies were
recorded. The level of fuel subsidies dropped from 26 per cent to 15 per cent
of total public expenditure from 2005 to 2006, and from 20 per cent to 7 per
cent from 2008 to 2009 (Figure 3.17). The reduction in 2005 reportedly saved
ODA received [% of GDP]

1.2
0.8
0.6
0.4
0.2
0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
ODA received [% of GDP]
Figure 3.16 Overseas development assistance – Trends as % of GDP

Source: UNESCAP Data Explorer
http://www.unescap.org/stat/data/statdb/DataExplorer.aspx
300,000 32% 35%
Energy subsidies as a % of total expenditure

29% 29%
30%
Energy subsidies (Billion IDR)
250,000
26% 24%
23% 25%
200,000 21%
20% 20% 19%
19% 20%
17% 15% 17%
150,000 15%
13% 15%
12%
100,000
7% 10%
50,000 5%
0%
2005 2006 2007 2008 2009 2010 2011 2012 2013
Year
Fuel subsidy Electricity subsidy

Energy subsidies as a % of total expenditures Fuel subsidy as a % of total expenditure
Figure 3.17 Indonesia: Energy subsidies, 2005–13

Source: Fuel Subsidy Reform in Indonesia, Chung UNESCAP (2014)
USD16 billion in 2005–06. Both reforms, however, were followed by reap-

pearances of fuel subsidies, except in 2012. Fuel subsidies still constituted a
large proportion of government expenditure. The amount spent on energy
subsidies (fuel subsidy and electricity subsidy) has been substantially larger
than such public expenditure items as education, environmental protection,
health, housing and social production combined.
With growing public deficits and decreasing overseas development assist-
ance, it is time Indonesia has to re-prioritize and reform both taxation and
subsidies.
Overall macroeconomic direction

While Indonesia continues to register robust growth, it has experienced
some growth deceleration from 6.3 per cent on average, between 2010 and
2012 to around 5.8 per cent in 2013.22 There are clear signs of emerging
macroeconomic imbalances, with rising inflation, widening current
account deficit, and the depreciation of the Rupiah. Gross capital accumu-
lation fell from an average of 9 per cent per annum between 2010 and 2012
to 4.7 per cent in 2013. Fixed investment that had reached a record high at
32.7 per cent of GDP in 2012 also fell to 31.7 per cent in 2013. Part of the
reason for a slowdown in investment was the rise in interest rates and cur-
rency depreciation, which made imports more expensive.
Government policy contributed to supporting consumption growth,
which stood at 5.3 per cent in 2013 as a result of cash transfers to the poor
and tax reductions for lower-income earners. Government consumption
also grew by around 4.9 per cent. From the output side growth slowed across
the board: 7.1 per cent in services; 5.6 per cent in industry; 3.5 per cent in
Satish Mishra 59
agriculture. After the boom years and the confidence build-up in 2010–12,
the growth slowdown is troubling, especially in the context of increasing
public debate regarding economic nationalism.
The economy also encountered a surge of inflation due to the reduction of
fuel subsidies and a sharp increase in the price of selected food products. As a
consequence inflation climbed from 3.8 per cent at the beginning of 2013 to
8.2 per cent. Fiscal policy countered some of the growth deceleration. The
budget deficit rose from 1.9 per cent in 2012 to 2.3 per cent of GDP in 2013.
This is not a surprise, since Indonesia has historically been a fiscally conserv-
ative economy. The current account deficit also grew as a result of lower
export prices in Indonesia’s exports such as coal, copper and palm oil.
Meanwhile, import growth slowed due to currency appreciation and decreas-
ing investment rates. The result was a widening of the current account deficit
to 3.3 per cent of GDP. Indonesia’s trade surplus fell to $6.1 billion, the
lowest in a decade.
An important consequence of the growth slowdown is a weakening of
the labor market. Indonesia has lost over 10,000 jobs in the 12 months to
August 2013. What is more significant is that it is the first decline in
employment since 2005. It is still unclear whether falling employment will
be reversed due to pre-election spending in the second half of 2014.
The overall macroeconomic picture is thus of declining GDP growth,
rising unemployment, increases in the budget and current account deficits,
and depreciation of the Rupiah. However, the numbers as yet are not
alarming. There is policy uncertainty on issues such as public expenditure,
on the regulations governing mines and energy, and the fiscal implications
of the newly adopted social insurance law at the beginning of 2013. A new
government associated with an acceleration of economic, governance and
regulatory reform might well reverse the negative investment sentiment of
recent months.
However, warning signs continue to be signaled by several international
financial institutions, including the IMF and the World Bank. The IMF
argues that Indonesia’s fiscal policymakers continue to face pressures from
slower revenue growth and high energy subsidy spending, which in com-
bination could push up the 2014 fiscal deficit to 2.6 per cent of GDP in the
absence of further, needed reforms that would broaden the revenue base
and limit fuel subsidy costs.
According to World Bank estimates, the current de jure mineral export
ban policy will reduce the net trade balance by USD12.5 billion and gener-
ate a total loss in fiscal revenues (royalties, export taxes and corporate
income tax) of USD6.5 billion during 2014–17, including a USD5.5 to
6.5 billion drag on the trade balance in 2014. While the quantum remains
uncertain, negative impacts of this order arising from the ban, along with
the broader economic issues the policy raises, suggest it is worthwhile to
evaluate a wider set of policy options to ensure that Indonesia benefits to
the maximum extent possible from its considerable mineral wealth in a

socially and environmentally sustainable manner.
Post-election development policy in Indonesia
A. Economic and structural questions and policy priorities

Indonesia confronts many of the economic challenges above as it tries to
accelerate its overall growth of GDP and increase employment.23 Top in
this list are the elimination of the fuel subsidy and enlarging fiscal space for
much-needed infrastructure and human capital-related investment. Further
issues are: diversifying the economy by expanding the share of the manu-
facturing sector in the total output; promoting new investment by regula-
tory reform, legal certainty and revision of the labor law in line with other
countries; raising competitive advantage by developing new growth poles
along the lines suggested in the Economic Master Plan; promoting the con-
clusion of public–private partnerships in key areas of infrastructure, espe-
cially transport and energy; and raising the momentum on poverty
reduction as the economy reaches historical growth rates of over 7 per cent
by employment promotion, conditional cash transfers, and improved
access to health insurance.
While one should be wary of reading too much into fears of Indonesian
protectionism, there is much need to learn from economic trends and
policy experiences in the developing world as well as in neighboring Asia.
These reveal a string of structural and development issues that need to be
closely integrated into the political and economic agenda of the President,
as opposed to the Planning Agency or the Ministry of Finance. Here is a
very brief flavor of some of the most pressing of these lessons and their
implications for Indonesia’s future:
• First, the most critical development challenge in the near future is how
to combine economic growth with the containment of inequality. Education
has often been proposed as an instrument with which to rein in inequal-
ity, but cross-country studies suggest that as much as one-third of
inequality increase can be attributed to the skill and wage differentials in
the labor market. In general the policy space seems to be shrinking to
moderate and even contain the rise in consumption inequality, with the
possibility that FDI might even make wage differentials even greater
than at present.
On the growth end of the spectrum, policy space for the government
is limited due to the high dependence on foreign financing, either
through FDI or foreign aid. The latter is declining, partly due to the
Indonesian middle-income status, and FDI can be footloose and demand
fiscal and other incentives that a President sensitive to public opinion
might not want to grant.
Satish Mishra 61
• Providing jobs to Indonesia’s growing population is another key economic

concern. Employment absorption in high-technology international
firms is decreasing by the day, such that even high-growth economies
are facing the phenomenon of ‘jobless growth’. As in the case of poverty
reduction, the employment elasticity of growth is falling, signifying the
need to diversify the economy and promote new start-ups and SMEs as a
way to counterbalance this trend.
Rising capital–labor ratios also spell rising labor productivity and real
wages, and will be beneficial for those workers who have retained jobs.
But it will leave a large pool of workers who find it increasingly difficult
to secure decent jobs and who might have to be retrained and relocated.
This might in turn require heavy investment in fostering a future know-
ledge economy in Indonesia, giving greater priority to higher education
and vocational training and fostering new innovation networks with the
private sector and science and technology research centers.
Much is made of Indonesia’s sharply rising middle class as well as
the demographic dividend that is within its reach. In terms of policy, the
implication of the latter is clearer than that of the former. To attain the
demographic dividend Indonesia’s youth has to be skilled and
employed. Moreover, given the long lags in education and skill forma-
tion, policy changes have to be initiated today.
The rapid growth of the middle class is often used as bait for foreign
investors who might be attracted by the large domestic market this
implies as well as the pressure that this might generate for governance
reform and in the improvement of public services.
B. Governance and political stabilization

Despite its shortcomings Indonesia has laid the foundations of a new polit-
ical system, begun a sustained economic recovery, and generated optimism
at home and abroad.
The ripples of the big bang decentralization are still felt across the
Indonesian political system, yet it remains in the formative stage of estab-
lishing the necessary instruments and institutions. Whether this will
improve public services and financial and political accountability is yet to
be seen. Indonesia’s decentralization represents a mosaic of widely differing
regions, most of which are dependent on the center for money and tech-
nical support, united only in their suspicion that the government—and the
Ministry of Internal Affairs in particular—is engaged in an effort to recen-
tralize the state by giving greater powers to provincial governments.
Systemic corruption continues to define Indonesia’s image abroad and
confounds its citizens at home. Yet, there is little evidence that all the focus
on anti-corruption has changed public perception of Indonesia being a cor-
ruption-ridden polity, with the worst offenders in those very branches of
government—the courts, police, and the public prosecution services—that
are supposed to uphold the law and protect citizens. Another necessity
must be the creation of an effective Office of the President and the estab-
lishment of an effective and accountable policymaking process. It is not
simply the person of the President but the Office of the Presidency that has
in the end to deliver the policy goals of the future. It is the office that will
be tasked with providing the cutting edge of future public policy within a
constitutional democracy.
Finally, there is the often-ignored question of the consolidation of
democracy in Indonesia and finalizing the systemic transition that began
in 1998. Two issues are critical here. The first relates to the rights and
responsibilities of the citizenry. The second is the provision of public goods
to the whole population regardless of ethnicity, income, or location. There
is room for debate and building a national consensus here, as there is room
for different cultural elements to define variations across democratic states.
The determination and supply of public goods is crucial to a new demo-
cracy. If the New Order imploded as a consequence of a loss in political
legitimacy, the new democracy has to ensure that its own legitimacy—
begun with open and fair elections—is underscored by public services for
the general citizen.
It is a fallacy that democratic states are small states, despite what propo-
nents of the small, ‘night watchman’ state might claim. Mature democra-
cies register much higher public expenditure to GDP ratios than even the
most ardent dictatorships, and in general one would expect the state to
increase in size rather than shrink as democracy is consolidated, its govern-
ments keen to ensure a steady supply of public services and to plan to meet
the long-term challenges that a volatile globalized world produces. Natural
disasters and the impact of global warming in the vast Indonesian archipel-
ago add to the range of new services and investments that the state will
have to either deliver or manage. Indonesia will need to plan for this
enlarged state and higher social entitlements.
Conclusion
The 2014 presidential election in Indonesia and the inauguration of

President Jokowi, marked a major watershed in its systemic transition from
an authoritarian and centralized form of government, buttressed by a crony
driven market economy, into a multi-party, decentralized and competitive
economy. To understand Indonesian economic trends and future potential
we need to see it not through a linear, segmented lens of economic theory,
but by means of the political and social context in which both its systemic
transition and its economic development continue to evolve.
Seen in this light, Indonesia continues to face two sets of inter-related
problems. The first is the pressing need to consolidate a democratic state
such that both its formal and its political legitimacy are assured. Formal
Satish Mishra 63
legitimacy is a function of constitutional rules, the division of labor across

different branches of the state, and the freedom of expression and associa-
tion that help mature democracies to continue the business of government
on a daily basis. Political legitimacy is constituted by the ability of the
democratic state to supply necessary public goods including health, educa-
tion, food and physical security. Arguably, Indonesia has come a long way
in the procedural consolidation of democracy.
Turning this into long-term political legitimacy will require reaping a
democratic dividend. Raising the supply, access and quality of public ser-
vices across such a vast and politically diverse archipelago is a daunting
task, since it involves not only investment and additional resources, but
also the public monitoring and participation that are needed to ensure a
transparent and effective allocation process. Yet to a large extent that
would be what it takes to ensure that Indonesia’s young electorate appreci-
ates the core benefits of democracy and begins to be persuaded that it is the
preferable, most viable means of ensuring Indonesia’s future prospects.
It is for this reason that two interconnected strands in the interpretation
of Indonesia’s development story are interwoven in this chapter. First is the
question of political and systemic stability, with the conclusion that
Indonesia needs to both reform its policymaking processes on the one
hand and the operation of its decentralized government on the other. That
involves the creation of a permanent Office of the President, perhaps by
turning its present planning board into the technical support needed for
this new office. It also requires self-adjusting mechanisms, which make pol-
itics less ethnically polarized, for instance, by the creation of a new
Boundaries or Fiscal Commission to balance inter-regional fiscal and invest-
ment claims.
The second is to find the resources to make government more responsive
to demands of a democratic electorate, including safeguarding core civic
rights, provision of required public goods, and the institutional mechanism
for the peaceful resolution of disputes. Narrow fiscal space continues to be
a major economic problem for Indonesia, especially in the context of its
systemic transition. This requires the enlargement of the tax base, elimina-
tion of subsidies, and a transparent and easily understood process of public
expenditure allocation and management decisions. It also means working
closely with private business in joint ventures and programs, in ensuring
that foreign investment works to the good of both the enterprise and the
host country, and helps to deepen the human resource and the technolo-
gical pool of skills in Indonesia.
Indonesia also faces a new era in its international relationships. The
ASEAN Common Market after 2015, its membership of the G-20, its
growing trade and investment flows with India and China, and its ambi-
tion to emerge as a major archipelagic state with enhanced connectivity
across its islands and waterways all require some detailed thinking and
policy development. This is still at an early stage, more discussed and anti-
cipated than understood and implemented. Indonesia’s democratic consoli-
dation, its enlargement of its fiscal space and its involvement in the central
nerves of the new ASEAN common market will all help to shape a new era
of domestic economic and political development and international rela-
tionships in the coming decade. The sum of these challenges amount to
laudable circumstances for a country that only 15 short years ago seemed
on the precipice of both economic collapse and political chaos. Indonesia
could well emerge as a major role model not only for the polarized military
dominant regimes of the Arab Spring countries, but also for nearby
Myanmar, Cambodia, and to a lesser extent Thailand, which might realize
the need to confront their national confusions and dilemmas as they work
through their own large-scale development transformations.
Notes
1 See Colin Crouch (2004) Post-Democracy, Polity Press for an interesting discus-
sion of 21st century democracy where a sharp increase in the number of recent
established democracies is being counterbalanced by structural problems in
mature democracies. To appreciate the problems of stabilizing nascent democra-
cies see Samuel Huntington’s classic Political Order in Changing Societies (1968).
Huntington put forward a rather controversial rule of thumb that democratic
systems are likely to be sustainable only once they pass a per capita income level
of US$6,000. Both India and now Indonesia tend to prove that this is too hasty a
generalization. For a comprehensive discussion about democracy in Indonesia
see Edward Aspinall and Marcus Mietzner (2010) Problems of Democratization in
Indonesia: Elections, Institutions and Society, Institute of Southeast Asian Studies.
2 Satish Mishra (2000) ‘History in the Making: A Systemic Transition in
Indonesia’, UNSFIR Working Papers Series No. 01/02, UNDP.
3 The income range used to measure the middle class of around 3,000 dollars per
capita per annum is highly elastic. This is especially a problem given the fact
that income distribution data are derived from household rather than individual
expenditure surveys and the fact that they do not take into account remittances
or asset distribution. Another problem is the fact that a very large percentage of
non poor households are located just above the poverty line with the result that
any price shock in food or other essential consumer items can the non-poor into
the ranks of the poor. It is not clear how far the lower end of the middle class is
similarly vulnerable.
4 USAID (2009) Democratic Decentralization Strategic Assessment Indonesia, February,
http://pdf.usaid.gov/pdf_docs/PNADQ231.pdf
5 UNESCAP (2013) Economic and Social Survey of Asia and the Pacific: Forward
Looking Macroeconomic Policies for Inclusive and Sustainable Development, http://
www.unescap.org/publications/survey/surveys/survey2013.pdf
6 Vito Tanzi and Ludger Schuknecht (2000) Public Spending in the 20th Century: A
Global Perspective, Cambridge University Press; UNDP (2013) Human Development
Report: The Rise of the South: Human Progress in a Diverse World, http://hdr.undp.
org/en/2013-report
7 Susan Rose-Ackerman (1999), Corruption and Government: Causes, Consequences, and
Reform, Cambridge University Press; Satish Mishra (2009), Economic Inequality in
Satish Mishra 65
Indonesia: Trends, Causes, and Policy Response, Strategic Asia and UNDP, March,
http://www.strategic-asia.com/pdf/Economic%20Inequality%20in
%20Indonesia%20Trends,%20Causes,%20and%20Policy%20Response
%20-%20March%202009.pdf; Mushtaq Khan and K. S. Jomo (eds) (2000) Rent,
Rent-Seeking and Economic Development: Theory and Evidence in Asia, Cambridge
University Press.
8 UNESCAP (2013) op. cit.; Frances Stewart (2008) Horizontal Inequalities and
Conflict: Understanding Group Violence in Multiethnic Societies, Palgrave Macmillan;
Satish Mishra (2009) Is Indonesia Vulnerable to Conflict? An Assessment, Strategic
Asia and USAID, July, http://www.strategic-asia.com/pdf/Is%20Indonesia%20
Vulnerable%20to%20Conflict%20An%20Assessment%20-%20July%202008.pdf
9 OECD-DAC (Development Assistance Committee) International Aid Statistics
various issues, http://www.oecd.org/dac/stats/
10 Public expenditure to GDP ratio is the usual measure of the size of the State. See
Vito Tanzi and Ludger Schuknecht (2000), op. cit.
11 Government of South Africa (2013), A Framework for Strengthening Citizen-
Government Partnerships for Monitoring Frontline Service Delivery, August, The
Presidency: Department of Performance Monitoring and Evaluation; GTZ (2009)
‘Local Governance: Accountable Public Services in Indonesia’, http://www.insti-
tut-fuermenschenrechte.de/uploads/tx_commerce/promising_practices_local_
governance_accountable_public_services_in_indonesia.pdf; Michael Buehler
(2011) ‘Indonesia’s Law on Public Services: Changing State-Society Relations or
Continuing Politics as Usual?’, Bulletin of Indonesian Economic Studies, 47: 1,
65–86; World Bank (2004) World Development Report 2004: Making Services Work
for the Poor, https://openknowledge.worldbank.org/handle/10986/5986
12 Government of Australia (2007) Tackling Wicked Problems: A Public Policy
Perspective, Australian Public Service Commission, http://www.apsc.gov.au/
__data/assets/pdf_file/0005/6386/wickedproblems.pdf
13 UNDP (2013) op. cit.; UNESCAP (2013) op. cit.; Asian Development Bank (2012)
Asian Development Outlook: Confronting Rising Inequality in Asia, https://www.
tcd.ie/iiis/assets/doc/ADO%202012%20Book_13April2012.pdf; Satish Mishra
(2014) Memo to the President.
14 Asian Development Bank (2013) ‘Deepening Divide: Can Asia Beat the
Menace of Rising Inequality?’ Development Asia, April, http://www.adb.org/
publications/deepening-divide-can-asia-beat-menace-rising-inequality; Satish
Mishra (2009) Economic Inequality in Indonesia: Trends, Causes, and Policy
Response, Strategic Asia and UNDP, March.
15 See Paul Collier, V. L. Elliott, Håvard Hegre, Anke Hoeffler, Marta Reynal-Querol
and Nicholas Sambanis (2003) Breaking the Conflict Trap: Civil War and
Development Policy, World Bank and Oxford University Press; Satish Mishra
(2009) Is Indonesia Vulnerable to Conflict? An Assessment, Strategic Asia and
USAID, July and Frances Stewart (2008) op. cit. amongst many others.
16 Joel S. Hellman, Geraint Jones and Daniel Kaufmann (2000) ‘Seize the State,
Seize the Day: State Capture, Corruption, and Influence in Transition’, Policy
Research Working Paper 2444, The World Bank Institute, September, https://
openknowledge.worldbank.org/bitstream/handle/10986/19784/multi_page.pdf?
sequence=1
17 For a comprehensive assessment of Indonesia’s higher education sector see
Harris Iskandar and Nizam (eds) (2010) A Strategic Assessment of the Higher
Education Sector in Indonesia, Strategic Asia and AusAid.
18 Raoul Oberman, Richard Dobbs, Arief Budiman, Fraser Thompson and Morten
Rossé (2014), The Archipelago Economy: Unleashing Indonesia’s Potential, McKinsey
Global Institute, http://www.mckinsey.com/insights/asia-pacific/the_archipel-

ago_economy. The idea of the demographic dividend has now entered into the
development policy discussions in many South East Asian countries as outlined
in UNESCAP (2011) Population Distribution, Urbanization, Internal Migration and
Development: An International Perspective; Asian Development Bank (2014) Asian
Development Outlook: Fiscal Policy for Inclusive Growth, http://www.adb.org/publi-
cations/asian-development-outlook-2014-fiscal-policy-inclusive-growth; David
E. Bloom, David Canning and Jaypee Sevilla (2003) The Demographic Dividend: A
New Perspective on the Economic Consequences of Population Change, Rand; Satish
Mishra (2014) ‘The Economic Foundations of Security’, National Security College
Issue Brief No. 2, National Security College, Australian National University, May,
pp. 12–19, http://nsc.anu.edu.au/documents/indonesia-briefs-final.pdf
19 ADB ‘Asian Development Outlook’, various issues.
20 World Bank (2013) ‘Pressures Mounting’, Indonesia Economic Quarterly, March,
http://www.worldbank.org/content/dam/Worldbank/document/EAP/Indonesia/I
EQ-MARCH-2013-English.pdf
21 See John Brondolo, Carlos Silvani, Eric Le Borgne and Frank Bosch (2008) Tax
Administration Reform and Fiscal Adjustment: The Case of Indonesia (2001–07), IMF
Working Paper, International Monetary Fund, https://www.imf.org/external/
pubs/ft/wp/2008/wp08129.pdf
22 Figures referred to here are taken from the ADB (2014) Asian Development
Outlook.
23 Satish Mishra (2010) ‘Constraints on Policy Making towards the Informal
Economy in Indonesia: Lessons of the Current Decade’, Working Paper,
International Labour Organisation, October, http://www.ilo.org/jakarta/
whatwedo/publications/WCMS_145782/lang—en/index.htm; Emanuela di
Gropello, Aurelien Kruse and Prateek Tandon (2011) Skills for the Labor Market in
Indonesia: Trends in Demand, Gaps, and Supply, World Bank, http://
documents.worldbank.org/curated/en/2011/01/14027186/skills-labor-market-
indonesia-trends-demand-gaps-supply; Indonesia Investments (2014) ‘Youth
Unemployment in Indonesia: A Demographic Bonus or Disaster?’, http://
www.indonesia-investments.com/news/news-columns/youth-unemployment-in-
indonesia-a-demographic-bonus-or-disaster/item2005
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Indonesia’s Ascent

Power, Leadership, and the Regional Order

List of Figures and Table xii

4 Yudhoyono’s Third Way: Muslim Democracy, National 69

Indonesia’s ongoing security landscape 130

11 The Middle Power Moment: A New Basis for Cooperation 224

15 Beyond the Archipelagic Outlook: The Law of the Sea, 308

Setting the stage: The polity

The 2014 presidential election in Indonesia was a celebration of 15 years of

Indonesia and emerging international perspectives on

Yet no discussion of macroeconomic policy in the new world of the

Indonesia: The economy in the midst of systemic transition

Macroeconomic data conceal as much as they reveal about development

Indonesian decentralization: One state or many?

DAK allocations to allow poorer districts to cover capital expenditures from

Economic inequality and the quality of growth

Human capital and tapping into the knowledge economy

massive boost in Indonesia’s Technical and Vocational Education and

Indonesia: Taking the economic pulse

Growth, saving and investment

Real GDP and GDP Growth

7 Real GDP trend line 450

GDP growth (annual %)

Figure 3.1 GDP Indonesia from 2000 to 2012

Per capita GDP and its Growth

Figure 3.2 Growth of per capita GDP in Indonesia (2000–12)

Sectoral Growth Rates in % GDP 1995–2012

GDP Agriculture Industry Services

Figure 3.3 Sector wise contributions in % GDP

Second, the investment to GDP ratios have been growing closer to

The state and public finance

Gross domestic saving Gross national saving

Figure 3.4 Savings and investment as % of GDP (2000–12)

Total revenue Total expenditure

Figure 3.5 Revenue expenditure gap as a % of GDP from 1995–2012

Fiscal Balance % of GDP

Figure 3.6 Fiscal balance in Indonesia 2000 to 2012 (% of GDP)

public expenditure also fell in proportion due to its very conservative

Tax revenue and non-tax revenue as % of GDP

Figure 3.7 Tax and non-tax revenue share of GDP (2000–12)

11.3 per cent. Second, non-tax revenue, composed mainly of contributions

Tax collection and structure

Value added Taxes

Figure 3.8 VAT volume in Indonesia

Tax Revenue Composition

600000 Other Taxes

Figure 3.9 Tax structure and composition, 2000–12

overall government structure, combining tax and customs offices, assigning

Total Government Expenditure (% of GDP)

Figure 3.10 Public expenditure as % of GDP, 2000–12

Government expenditure in sectors such as general public services, edu-

Central Government Expenditure by Function

600000 Housing and community amenities

Figure 3.11 Indonesia’s total expenditure by function (sectors)

2005 2006 2007 2008 2009 2010 2011 2012 2013

Public Order and Tourism and

Health, 2% General Public

Figure 3.12 Percentage expenditure by function year 2012

• Expenditure on the general public sector increased from 60 per cent of

Current account balance [% of GDP]

Current account balance [% of GDP]

Figure 3.13 Current account balance as % of GDP

Public debt (% of GDP) – Indonesia