Khalishah Mutiara Purnamasari (2022-23764)

Final Term Paper – Political Economy of Development Class

THE ANALYSIS OF INDUSTRIALIZATION PROCESS AND

CURRENT INDUSTRIAL POLICIES IN INDONESIA

I. Background

Indonesia is one of Asian region's emerging economies with significant potential and has been a
member of G-20 since 1999. Before COVID-19 pandemic, Indonesia's economy was relatively
stable, with an average annual growth rate of 5.4 percent from 2010 to 2019. (Figure 1). World
Bank (WB) reported that Indonesia's GNI per capita in 2019 was USD 4,050, placing it in the Upper
Middle-Income Country (UMIC) category. However, because of COVID-19 pandemic's adverse
effects, realization of GNI per capita fell once more into Lower Middle-Income Country (LMIC)
category in 2020 and 2021, for USD 3,870 and USD 4,140, respectively (Figure 2). The onGoIng
economic recovery process has yet to restore Indonesia's position to pre-pandemic levels.
Figure 1. Indonesia GDP Growth (percent, yoy) Figure 2. GNI per Capita, Atlas Method (current US$)

6.2 6.2 6.0 4,140

4,500
5.6
5.0 4.9 5.0 5.1 5.2 5.0 4,000

3.7 3,500
3,000
2,500
2,000
1,500
1,000
500
0
-2.1
1972

1978

1984
1974
1976

1980
1982

1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
2020
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

Source: Indonesian Statistical Agency, 2022 Source: World Development Indicator (WDI) WB, 2022

Regarding GDP by expenditure structure (Figure 3), household consumption accounts for more
than 50,0 percent of the contribution. Gross Capital Formation (GFCF) and Exports of Goods and
Services are two most significant components, accounting for 30,8 and 21,6 percent of GDP in
2021, respectively. Meanwhile for GDP structure by production (Figure 4), industry sector
contributes the most, with value of more than 19,0 percent. Non-oil and gas industries significantly
contributed more than oil and gas industries. Indonesia's other primary sector is agriculture, trade,
construction, and mining (Figure 4). According to Indonesian Statistical Agency (BPS), Indonesia
has 17 Sector Classifications in total; the remaining 12 rest of the sectors are as follows: electricity,
water, transportation, accommodation, information communication, financial services, real estate,
business services, government administration, education, health services, and other services.

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 Khalishah Mutiara Purnamasari (2022-23764)
Final Term Paper – Political Economy of Development Class

Figure 3. GDP by Expenditure Composition, 2021 Figure 4. GDP by Production Composition, 2021
13.3
18.86 Household Consumption
54.42 Agriculture
NPISH Consumption
35.1 Mining
9.0
Government Consumption
21.56 Industry
GFCF
Construction
Export of Goods and
Services 19.3 Trade
Import of Goods and
30.81 Services Rest of the Sectors
1.22 10.4
9.14
13.0

Source: Indonesian Statistical Agency, 2022

Industrial sector, which contributes the most to the Indonesian economy, has long history of being
able to advance to the modern industrialization process (Figure 5). Since Indonesia's
independence in 1945, industrial sector has progressed through three distinct stages. Until the
mid-1960s, industrial sector lagged behind Asian neighbors like China and India. Indonesia has
not experienced state-led heavy industrialization or industrial product export growth. After Dutch
colonialization period, several sizable state-owned enterprises predominated industrial sector
until it was finally nationalized in 1957–1958. Subsequently, industrial turning point was marked
by growth of the industrial sector that reached 10,0 percent for three decades in the late 1960s.
Government of Indonesia (GoI) policy that sped up this growth was import substitution; until the
middle of the 1980s, the shift to industrialization focused on exports was successful. However,
industrial sector's growth fell during the Asian Financial Crisis (AFC) 1997–1998. Afterward,
Indonesia needs some time to regain its industrial growth momentum. According to data,
industrial sector is still not experiencing high growth spikes as it did prior to the crisis, and growth
is stagnant.
Figure 5. Indonesia GDP and Manufacturing Growth (percent, yoy)

Started of export market

25.0
High growth due to low base
Oil boom
effect GDP Manufacturing Sector

15.0
Global Financial Crisis (GFC)

5.0

Covid-19 Pandemic
-5.0 Oil price fell sharply

Asian Financial Crisis

(AFC)
-15.0

Source: Indonesian Statistical Agency, 2022

Note: Due to lack of data available, the above graph only shows data history since 1972

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Final Term Paper – Political Economy of Development Class

II. Industrialization Process in Indonesia (focusing on, President Soeharto regime)

As previously mentioned, the following discussion is about the important period that marked the
process of industrialization in Indonesia. The discussion will start from the mid-1960s, late 1960-
1980s, until the 1997-1998 AFC.

Early 1960 to Mid-1960s

Literature review from Hal Hill (1997) book entitled "Indonesia's Industrial Transformation"
explaining industrial sector, until the mid-1960s, was wholly oriented towards domestic market
demand. Much of the output could be “non-tradeable”, consisting of simple resource-based
processing and essential consumer goods for domestic market. Technology employed was very
basic (often manual), reflecting its highly labor-intensive nature, so indifferent was the quality and
marketing channels were very limited. Without any surprise, there was no private investment. Nor
was there any foreign equity capital to speak of. The only international connection was with
Eastern bloc, which supplied technology, equipment, and finance through joint ventures and
profit-sharing agreements (Gibson, 1966). This poor condition raises issues of unstable political
conditions and economic disarray after Independence Day in 1945, so maintaining economic
conditions is not one of the issues concerns in the first place. During this time, the government
era was called the "Old Order," referring to Soekarno's regime (1945-1956). Political conditions'
instability is caused by many political parties, giving rise to many ideologies and interests of
government or specific groups (Putra, 2019).

Late 1960s to Mid-1990s

After being officially inaugurated in 1967, President Soeharto, the second president of Indonesia,
took office, marking the start of the "New Order" leadership era, with many initiatives for economic
reform and political change.

Putra (2019) outlined how President Soeharto reorganized political stability in several ways.
Indonesian Communist Party (PKI), an organization with social philosophy that conflicts with
Pancasila (Indonesian Ideology), was disbanded. People's demands were the driving force behind
this because the PKI's existence deeply disturbed public. Political party consolidation or
simplification is another policy regarded as the primary prerequisite for Indonesia's economic
development. Because, during "New Order" era, the emphasis was on economic programs rather
than ideology and politics.

Then, according to Hill (1997), from 1967 to 1973, there was rapid growth primarily brought by
liberalization and restoration of expected economic conditions. Domestic and international
market channels were reopened, and consumer spending started to rise quickly under influence
of strong economic growth. There was undoubtedly a shake-out of some traditional cottage and
labor-intensive industries, but their demise was more than offset by the broad-based expansion.

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 Khalishah Mutiara Purnamasari (2022-23764)
Final Term Paper – Political Economy of Development Class

Production in the manufacturing sector increased by almost 9,0 percent in 1968 and even more
(14,0 percent) in 1969. It was also the first year of planning document implementation, named
First Five-Year Plan (Repelita I).

Additionally, Aswicahyono, Hill, & Narjoko (2011) emphasized that during this time, economy was
moving in the direction of catch-up and import substitution, which were significant milestones in
Indonesia's industrialization. Foreign Direct Investment (FDI) is aimed to be attracted to specific
sectors through import substitution, which is defined as a policy that aims to replace import goods
with domestic production (Mahardika, 2020).

The 1973 oil boom and subsequent rise in oil prices forced an extensive reevaluation of industrial
policy goals. During this time, state-directed industrialization was characterized by rapid but
ineffective growth. Through the well-known "Dutch Disease1" effects, it might have been expected
that the boom would divert resources away from industries that produce tradable goods like
manufacturing. However, it did not work because of at least two distinct factors. First, government
started changing away from its liberal trade policies (introduced in the late 1960s, as mentioned
above). Non-Tariff Barriers (NTB) proliferated due to the addition of more tariffs. Second,
government started reinvesting a portion of the oil revenue in the sector of state-owned
enterprises. Thus, significant increases in domestic incomes over this period fed directly into
demand for domestic manufactures.

Tijaja & Faisal (2014) said that the abundance of rules and restrictions resulted in complex
licensing and investment approval procedures. Depending on the status of the firms—foreign,
domestic, or small-scale—sectors were either open to investment or closed to it. Only the sectors
on the investment priority list were given access to import facilities and were open to investment.
When a sector of interest is added to the list, potential investors frequently have to invest a
significant amount of money before the sector is open to other investors. This practice gave the
Investment Coordinating Body a great deal of discretionary power to approve investments based
on the "right" sector or industry rather than the project's economic viability.

Rise of political elites also affected the business world and the government. Favoritism in the
preferential allocation of lucrative import and distribution licenses, as well as the emergence of
patrimonial networks between government (or high-ranking government licenses) and Indo-
Chinese business community, are both primarily influenced by political factors (Rock, 1999). The
latter helped a select few conglomerates grow, giving the political elites access to resources.

Focusing on the industrial sector, which was the government's top priority, the government
direction are into heavy industries between 1975 and 1980, as evidenced by the rising shares of

1
Dutch disease: phenomenon in the economic field that refers to the impact that is usually caused by the
abundance of natural resources in a country.

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 Khalishah Mutiara Purnamasari (2022-23764)
Final Term Paper – Political Economy of Development Class

the metal goods and heavy processing industries, which account for 20,0 and 24,1 percent,
respectively in 1980 (from 12.8 and 20.3 percent in 1975 (Hill, 1997)). It is known that many
significant projects were started during this time, including steel and smelter projects. Strong
domestic demand growth and rising protection have also sparked growth in the automotive and
electronics industries. According to Hill (1997), this promotion of heavy industry was premature
because it came at such an early stage of industrialization.

Entering 1980, however, there has been turnaround, and output shares of heavy industry and
metal groups declined. On the other hand, share of labor-intensive group dominated by textiles,
garments, and footwear, increased significantly. Following period of an investment-focused policy,
Indonesia has now started exporting. This policy was sparked by significant customs reforms that
cut import costs and clearing times in half in 1985. The first deregulation package, which included
the Agency for Import Duty Exemption and Restitution and had drawbacks such as facilities and
tariff exemption to replace the export subsidy scheme, was adopted in May 1986. This program
gave businesses access to globally competitive inputs. Due to these reforms, Indonesia's export
competitiveness increased. The negative investment list replaced the investment priority list as
part of the GOI's reform of its investment regime. The reform initiatives sparked a long investment
boom, which caused the number of projects that the Indonesia Investment Coordinating Board
had approved to increase tenfold in just five years, from 1986 to 1991.

Asian Financial Crisis (AFC) 1997 to post AFC 2000

According to the working paper "Industrial Policy in Indonesia: A Global Value Chain Perspective"
(Tijaja & Faisal, 2014). Indonesia was among the most affected nations during the Asian Financial
Crisis (AFC) that took place in 1997. At its worst, the Rupiah declined from IDR 2500 per USD to
IDR 17500, and annualized inflation reached 100%. President Soeharto's resignation due to this
worsening economic crisis signaled the end of the so-called "New Era."

After the AFC crisis, Indonesia needed some time to regain its growth momentum; the economy
slowed in the following years, with industrial slowdown particularly severe. Recovery rates varied
for different industries; those whose demand was rigid and focused on exports, like food
processing and chemical-based goods, could recover more quickly. On the other hand, the
industry that relies on resource-based supply and non-metallic mineral products, where demand
is more elastic and better protected to support the domestic economy, suffered, and was hardest
hit.

Government gives macroeconomic stability top priority, with assistance from multilateral
organizations like the International Monetary Fund (IMF). Despite maintaining broadly open
economy at the time of AFC (following the reform of the 1980s), Indonesia's economy underwent
further liberalization in 1997 and 1998 as a result of IMF loan terms. By 2004, both macroeconomic
and political stability had returned.

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 Khalishah Mutiara Purnamasari (2022-23764)
Final Term Paper – Political Economy of Development Class

III. Analysis of Current Industrial Policies (focusing on, President Joko Widodo regime)
Long-Term National Development Plan (RPJPN) 2005-2025 introduction marked the beginning of
political reform's visionary and steady progress. This planning document, which was included in
Constitution Number 17 of 2007, was made under President Susilo Bambang Yudhoyono's regime,
also known as Unity Cabinet.

Then, through five-year Medium-Term National Development Plan (RPJMN), RPJPN's is being
breakdown into 5-year term. For ministries and government organizations, the latter forms the
basis for developing their strategic and budget plans. Discussion follows will focus on current
industrial sector policies during President Joko Widodo's regime with strategies outlined in
RPJMN's Third Period (2015-2019) and RPJMN’s Fourth Period (2020-2024).

President Joko Widodo First Period or RPJMN's Third Period (2015-2019)

Visionary political reform and introduction of RPJPN 2005–2025 trigger industrial sector to
recover. RPJPN identified the industrial sector as the primary driver of economic growth because
it also related to broad-based agricultural sector, mining industry, and efficient delivery of services.
The law also promises to implement management and industry best practices for solid economic
security.

In addition, Presidential Regulation Number 2 of 2015 concerning the Medium-Term National

Development Plan (RPJMN) 2015-2019, with the theme Indonesia as Sovereign, Independent, and
Based on Mutual Cooperation, ratified the development of the RPJPN into the Third Period of the
RPJMN.

The main challenges that serve as the foundation for developing strategic issues are described in
the 2015-2019 RPJMN document. Figure 6 shows that between 2000 and 2002, the industrial
sector's contribution to the total national GDP increased, with the non-oil and gas industrial sector
contributing the most. However, since 2003, the industrial sector's contribution has steadily
decreased.
Figure 6. Industrial Sector Share to Total GDP (percent, yoy)
35.0
Total Industrial Sector
30.0 Oil and Gas Industry
25.0 Non-Oil and Gas Industry
20.0
15.0
10.0
5.0
0.0
1983

2017

2020
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016

2018
2019

2021

Source: Indonesian Statistical Agency, 2022

Note: Data from 1994-2009 using year 2000 as base year, meanwhile data from 2010-2021 using year 2010 as base year

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 Khalishah Mutiara Purnamasari (2022-23764)
Final Term Paper – Political Economy of Development Class

Several factors that contributed to this decline include, 1) Analysis of commodity data shows that
it influences the oil and gas sector contribution, due to fluctuations in commodity price.
Meanwhile, non-oil and gas sector remained more stable and primarily influenced by domestic
demand, 2) Indonesia imports semi-finished goods but exports raw materials. Indonesia's primary
commodities' natural wealth has yet to be fully utilized, so direct exports to the global market do
not undergo a process of adding value, 3) Significant reliance on imports. Domestic economy
relies heavily on imported raw materials, components, and subassemblies, 4) Industrial structure
and population remained weak. Ability to absorb knowledge and technology required to develop
a business is very low because the industrial business structure is dominated by micro-scale
businesses (with a workforce of >= five people), and 5) Industry is concentrated on few Indonesian
islands, such as Java and Sumatra. There are gaps between islands due to the minimal
infrastructure and facilities available on other islands.

Because Indonesia's micro and small industries still have limited ability, industrial policy aims to
increase the number of large and medium-sized businesses. In order to accelerate the
development of the Industrial Area, it needs both domestic and foreign direct investment, thus
the industry policy direction was concern on gaining FDI and DDI. To attract investment, the first
strategy is to create industrial estates with all the necessary infrastructure, then focus grow
industrial population and boost productivity.

Hence, the direction of industrial development policies focuses on the following:

1. Expansion of Industrial Region Outside Java Island: (1) Industry Growth Center Region,
Particularly Inside the Economic Corridor, (2) Industrial Special Area, (3) Industrial Area, and
(4) IKM Center.
GOI identified potential industrial development areas inside and outside Java Island, their total
size (in hectares), and their primary products. From 2015 to 2019, GOI planned to develop at
least 34 industrial areas.
2. Growing Industrial Population resulted in the addition of at least 9,000 large and medium-
sized businesses, 50% of which were located outside Java Island, and 21,000 small businesses.
With the help of this strategy, Indonesia's industrial products will be more diverse, including
goods related to agriculture, oil and gas, and minerals. GOI also took advantage of this chance
to be present and visible in the Global Value Chain (GVC) market as an independent supplier,
subsidiary, or contract manufacturer.
3. Boost productivity and competition (export and labor value added)
GOI anticipated that this policy would improve domestic company innovation and new
product development while increasing labor capabilities, technological efficiency, and
knowledge transfer from foreign companies.

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 Khalishah Mutiara Purnamasari (2022-23764)
Final Term Paper – Political Economy of Development Class

President Joko Widodo Second Period or Fourth Period RPJMN (2020-2024)

RPJMN 2020-2024 was ratified in Presidential Regulation Number 18 of 2020 concerning the
Medium-Term National Development Plan (RPJMN) 2020-2024, with the vision "Realizing an
Advanced Indonesia that is Sovereign, Independent, and Based on Mutual Cooperation."

In this second term, President Joko Widodo become more determined and look forward to
realizing Indonesian Vision 2045, which aims to transform Indonesia into an Upper Middle-Income
Country by 2045, commemorate 100 years of Indonesia's independence. This vision being
specified in five distinct visions, one of which is Economic Transformation, which is defined as the
transition of the economy from dependence on natural resources to the production of services
that are highly valuable to public welfare. He explicitly stated that economic transformation should
begin in 2020–2024, serving as a strong foundation for an advanced Indonesia.

Domestic economy has been grown at an average annual rate of 5.0 percent since the Third
RPJMN's implementation (2015 – 2019). This economic growth exceeds the global average for
developing nations, which is 4,4 percent annually (IMF WEO, 2019). As evidenced by the
accomplishments of the processing industry, which grew by an average of 4,2 percent per year,
one of these achievements was driven by structural reform policies to encourage industrial
competitiveness.

Furthermore, structural change is essential for achieving sustainable economic growth. Rebuilding
structural transformations require revitalizing industrial sector, supporting downstream mining,
sustainable infrastructure development, and services sector transformation.

Moreover, to increase value-added, employment, real estate investment, and industrialization.

Several following plans are carried out:

1. Growing industrialization based on upstream-downstream integration of the agricultural,

forestry, fishery, maritime, and non-agro sectors. The upstream agro, chemical, and metal
processing industries and the processing industries with added value contributions and high
competitiveness are the main targets of the acceleration of agricultural and non-agricultural-
based industrialization. Policy coordination and synergy between the primary, secondary, and
tertiary sectors will support its implementation.
2. Promote industrialization by creating smelters and industrial zones (KI), particularly outside
Java. KIs outside Java Island are given priority for development, focus on facilitating licensing,
boosting investment, post-disaster revitalization, and public-private partnerships (PPP).
3. Strengthen the supply chain and the tourism ecosystem to make destinations and the tourism
sector more competitive, focused on enhancing accessibility, attractions, and amenities to
encourage visitors to stay longer and spend more money.

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 Khalishah Mutiara Purnamasari (2022-23764)
Final Term Paper – Political Economy of Development Class

4. Improve added value and competitiveness of products and creative and digital ventures in
coordination with policies and strategies for fostering entrepreneurship, cooperatives, and
MSMEs.
5. Enhance the business climate and boost investment, including labor reform, one of them is by
drafting regulations to amend Law No. 11 of 2020 Concerning Job Creation to enhance the
business and investment climate.

Political Aspects of Industrial Policies

According to Johansson (2014) working paper, “Political Change and the Business Elite in
Indonesia”, Indonesia's political elite in the industry has long been characterized by a small group
of business elites controlling a significant share of the country's combined wealth. As previously
mentioned, New Order era saw the rise of several Indo-Chinese business empires, including
monopolies in the import and distribution industries. The state even gave this type of businessman
preferential treatment. Many large corporations in Indonesia were still owned by government and
no evidence of privatization program.

Oligarchs and the rest of Indonesia's old business elite persisted after Suharto's government,
despite of political transition after his retirement. Furthermore, absence of a functioning system
for financing political parties led to increased parties' reliance on donations. One reason the
business elite gets involved in politics is to support political parties financially (Johansson, 2014).

Coal industry in Indonesia is one illustration of oligarchs and political elites (Greenpeace, 2018).
Corporations, bureaucrats, and politicians are the leading players in this industry. The term
"politically exposed persons" (PEPs) refers to this group of powerful elite politicians who have held
public positions (such as those of the head of state or government, senior politicians, or high-
ranking political parties) and have extensive connections among the elites. They then engage in
corruption cases in specific industries. One of the Ministers who are still in charged, as well as
President Joko Widodo's campaign team from before he became president, is currently involved
in PEPs in Indonesian coal industry.

Apart from being at the national level, the decentralization implementation in Indonesia provides
flexibility for regions, one of which is to manage natural resources in their territory. Regional
political elites have the power to issue mining permits, especially as part of political funding. As a
result, there was significant rise in the number of mining permits, high coal profit margins, and
significant state subsidies. Even in the early 2000s, several foreign businesses sold coal mining
company shares to powerful and connected Indonesian businessmen.

IV. Conclusion
Industrial sector has significantly contributed to Indonesian economy since 1960 (President
Suharto's regime) until the present (President Joko Widodo's regime). Political elites also play

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 Khalishah Mutiara Purnamasari (2022-23764)
Final Term Paper – Political Economy of Development Class

essential roles, such as Indo-Chinese businesses and oligarchs. In addition, several economic and
political takeaways from industrialization process and current industrial policies are as follows:
1. Industrial sector began to contribute significantly as the export market started in 1980. The
main products that Indonesia could produce were textiles, garments, and footwear. Despite
complex investment procedures, GoI import substitution could substantially impact the
domestic economy.
2. Political elite in the New Order regime came from Indo-Chinese businesses. GoI gave
preferential treatment to this business group, which led to monopolists in several industries.
3. Industrial sector policies during the administration of President Joko Widodo began to
emphasize, with a focus on developing industrial areas and prioritizing outside Java Island,
increasing productivity and economic transformation. Economic transformation into a
meaningful way forward for Indonesia to provide more added value to the Indonesian
economy.
4. Politically, the oligarchs and business elites control specific sectors, such as the coal business.
The political elite is not only in power at the national level but also at the regional level. Apart
from that, business elites are also involved in politics to support party financing.

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Final Term Paper – Political Economy of Development Class

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