THE FACTORS INFLUENCING ECONOMIC GROWTH IN INDONESIA PERIOD 1981-2014 ERROR CORRECTION MODEL APPROACH

FAKTOR- FAKTOR YANG MEMPENGARUHI PERTUMBUHAN EKONOMI DI INDONESIA PERIODE 1981-2014

PENDEKATAN ERROR CORRECTION MODEL

UNDERGRADUATE THESIS

Written by: NADYA ROSE .P

20130430276

FACULTY OF ECONOMICS AND BUSINESS

INTERNATIONAL PROGRAM FOR ISLAMIC ECONOMICS AND FINANCE (IPIEF)

UNIVERSITAS MUHAMMADIYAH YOGYAKARTA 2017

FAKTOR- FAKTOR YANG MEMPENGARUHI PERTUMBUHAN EKONOMI DI INDONESIA PERIODE 1981-2014

PENDEKATAN ERROR CORRECTION MODEL

UNDERGRADUATE THESIS

In partial fulfillment for the requirement for the degree of Bachelor of Economics (Sarjana Ekonomi) at International Program for Islamic Economics and Finance

(IPIEF), Economics Department

Written by: NADYA ROSE .P

20130430276

FACULTY OF ECONOMICS AND BUSINESS

INTERNATIONAL PROGRAM FOR ISLAMIC ECONOMICS AND FINANCE (IPIEF)

UNIVERSITAS MUHAMMADIYAH YOGYAKARTA 2017

Name : Nadya Rose .P Student Number : 20130430276

I declared that this undergraduate thesis entitled “The Factors Influencing Economic Growth in Indonesia Period 1981-2014, Error Correction Model Approach” does not consist of any content that ever being proposed for any degree in other university, ideas of any research and publication of others, in exception all quotes and ideas which are purposely taken are considered as the research references and listed in the reference list. Therefore, if any violation of intellectual right is found in this study, I agree to accept any relevant academic consequences.

Yogyakarta, March, 18th 2017

Good to People. Being Good to People is a Wonderful Legacy to Leave Behind –

This Undergraduate Thesis I dedicate to my beloved parents, my sister Alya, and my brothers Desmonth and Arief

In the name of Allah, the most Merciful, the most Gracious. All praise is due to Allah; we praise Him, seek His help, and ask for His forgiveness. I am thankful to Allah, who supplied me with the courage, the guidance, and the love to complete this thesis. Also, Peace and salutation always be to the Prophet Muhammad peace be upon him altogether with his accompanies.

This undergraduate thesis entitled “The Factors Influencing Economic Growth in Indonesia Period 1981-2014, Error Correction Model Approach” has made as partial fulfillment for the requirement to achieve the bachelor degree of economics (Sarjana Ekonomi). So that, I would like to thank all the people who contributed in some way in this thesis. In particularly they are:

1. A special feeling of gratitude to my beloved parents; Ibu and Ayah. Thank you so much for endless love, prayers and encouragement, trust, and all the things you have done to me since I was a little girl until I can finish my undergraduate studies.

2. I also thanks to my beloved brothers and sister: Desmonth, Arief, and Alya fortheir support, understanding and good wishes whenever I needed. 3. I dedicated this work and give special thanks to my best friend Salma, for

the support of my research, for her flawless grammatical editing of my thesis, tolerating my crazy habits, for being by my side in any situations. Thank you for everything ma, and no words can describe our friendship.

4. I should not forget to acknowledge to all my best friends that are far away from me; Tika, Putri, and Trisna for the trust, love, and support long this way.

5. Sincere thanks to my childhood friend, Mbak Lia who also still give me support until now.

6. I would like to express my sincere gratitude to Dr. Masyhudi Muqorrobin (Alm) for being a very good lecture as well as parent in this department. Thank you for all the lesson you have taught to me in this university. Al-Fatihah…

7. My thanks must go also to my IPIEF fellas batch 2013 for all the fun we had in the last 3 years together at class.

8. I would like to thank to my supervisors, Dr. Imamudin Yuliadi, SE,.M.Si and Dyah Titis Kusuma Wardani, SE., MIDEc for the continuous support of my undergraduate thesis, for the patience, motivation, enthusiasm, immense

10.I would like to express my wholehearted thanks to all my lecturers in IPIEF department who guide me from the beginning of university days until I can graduate from this university.

11. Last but not least, I’d like to congratulate myself for the sleepless night, the

ups and downs mood, eating too much, uncontrollably tears and all the efforts that I’ve done while making this thesis real in the end.

Yogyakarta, March, 18th 2017

SUPERVISORS AGREEMENT PAGE ... iii

AUTHORIZATION PAGE ... iv

DECLARATION ... v

MOTTO PAGE ... vi

TRIBUTE PAGE ... vii

ABSTRACT ... viii

ACKNOWLEDGEMENT ... ix

CONTENTS ... xii

LIST OF TABLE ... xv

LIST OF FIGURE ... xvi

CHAPTER I INTRODUCTION ... 1

A. Research Background... 1

B. Research Limitation ... 14

C. Research Questions ... 15

D. Research Objectives ... 15

E. Research Benefits ... 16

CHAPTER II LITERATURE REVIEW... 17

A. Theoretical Framework ... 17

1. Economic Growth ... 17

2. Foreign Direct Investment ... 30

3. Export ... 33

4. Infrastructure ... 34

5. Inflation Rate ... 37

B. Previous Study ... 40

C. Hypotheses ... 42

D. Research Framework ... 43

D. Operational Data of Variables ... 45

E. Analysis Method ... 46

1. Classical Assumption Test ... 47

a. Autocorrelation ... 48

b. Normality ... 49

c. Heteroscedasticity ... 49

d. Multicollinearity ... 49

2. Dynamic Test ... 50

a. Stationary Test ... 50

b. Integration Degree Test ... 52

c. Co-integration Test... 52

d. Error Correction Model ... 53

CHAPTER IV RESULT & ANALYSIS ... 56

A. Research Variable Overview... 56

1. Indonesian Gross Domestic Product Overview ... 56

2. Foreign Direct Investment (FDI) Overview in Indonesia ... 58

3. Indonesian Export Overview... 59

4. Indonesia Infrastructure Overview ... 61

5. Indonesian Inflation Overview ... 62

B. Classical Assumption Test ... 63

1. Autocorrelation Test... 63

2. Normality Test ... 64

3. Heteroskedasicity Test ... 64

4. Multicollinearity ... 65

C. Dynamic Assumption Test ... 67

1. Stationary Test ... 67

1. The Influence of Foreign Direct Investment (FDI) on

Economic Growth (GDP) ... 75 2. The Influence of Export on Economic Growth (GDP) ... 78 3. The Influence of Infrastructure (Road Length) on Economic

Growth (GDP) ... 80 4. The Influence of Inflation Rate on Economic Growth (GDP) 83 CHAPTER V CONCLUSION & SUGESTION ... 86 A. Conclusion ... 86 B. Suggestion ... 87 REFERENCES

1.2 The Foreign Direct Investment by Province in Indonesia ... 10

1.3 The Export and Import Growth in Indonesia in Million US$ ... 12

4.1 The Lagrange Multiplier Test (LM) Result ... 63

4.2 The Jarque-Bera Test (J-B test) Result ... 64

4.3 The White Heteroskedasticity Test Result ... 65

4.4 The Multicollinerity Test before being Transformed into First Difference Form (D) ... 66

4.5 The Multicollinearity Test Has Been Transformed into First Difference Form (D) ... 66

4.6 The Unit Root Test Result in Level Degree by Augmented Dickey-Fuller test Method ... 68

4.7 The Unit Root Test Result in First Difference Degree by Augmented Dickey-Fuller test Method ... 69

4.8 The Result of Co-integration Test in Long Term... 71

4.9 The Unit Root Test result toward the Residual Long Term Equation ... 72

4.10 The Result of Error Correction Model Estimation ... 73

4.11 The Accumulation of Dependent Variable Influence on Independent Variables in both Short and Long Term ... 75

1.2 The Contribution Growth of Several Sectors on GDP in Indonesia 1981-2014 .... 4

2.1 Aggregate Demand and Supply in a Balance Macroeconomic Situation ... 20

2.2 Theory of Harrod-Domar: TheRole of Investment in Economic Growth... 24

2.3 Neo-Classical production Function ... 27

2.4 Research Framework ... 43

4.1 Indonesian Gross Domestic Product in 1981-2014 ... 57

4.2 Indonesian Foreign Direct Investment in1981-2014... 58

4.3 Indonesian Export in 1981-2014 ... 60

4.4 Indonesian Infrastructure in 1981-2014 ... 61

Indonesia. The study employed the quantitative approach by using secondary data from 1981 to 2014. Analysis tool that is used in this study is Error Correction Model (ECM). Variables that are used namely Foreign Direct Investment (FDI), Export, Infrastructure (Road Length), and Inflation Rate, in which economic growth represented by Gross Domestic Product (GDP).

The result of this study indicates that Foreign Direct Investment (FDI) and export have positive and significant impact in short and long run. Meanwhile, both in short and long run, the inflation rate has negative and significant impact. The different result shows by infrastructure (Road Length) that has negative and insignificant relationship on economic growth in Indonesia, both in short and long run.

Keywords: Foreign Direct Investment (FDI), Export, Infrastructure (Road Length), Inflation Rate, Gross Domestic Product (GDP), Error Correction Model (ECM)

mempengaruhi pertumbuhan ekonomi di Indonesia. Penelitian ini menggunakan pendekatan kuantitatif dengan menggunakan data sekunder periode 1981-2014. Alat penelitian yang digunakan dalam penelitian ini adalah Error Correction Model (ECM). Variabel yang digunakan meliputi Penanaman Modal Asing (PMA), Ekspor, Infrastruktur (Panjang Jalan) dan Inflasi. Pertumbuhan Ekonomi diwakili melalui Produk Domestik Bruto (PDB).

Hasil Penelitian ini menunjukan bahwa penanaman modal asing (PMA) dan ekspor berpengaruh positif dan signifikan pada jangka pendek dan panjang. Sedangkan inflasi berpengaruh negatif dan signifikan di jangka panjang dan pendek. Hasil yang berbeda ditunjukan oleh infrastruktur yang tidak berpengaruh signifikan di jangka pendek maupun jangka panjang.

Kata Kunci:Penanaman Modal Asing(PMA), Ekspor, Infrastruktur(Panjang Jalan), Inflasi, Produk Domestik Bruto (PDB), Error Correction Model (ECM)

1

CHAPTER I

INTRODUCTION

A. Research Background

Economic performance is an assessment of its success in areas related to its assets, liabilities and overall market strength. Many countries take regular stock in either formal or less formal basis of the general economic performance of their countries to make sure that it remains on the right track financially. Economic performance can be seen from economic growth. Economic growth is an indicator to perceive a country’s performance whether in good or bad performance. The success of the development of a country can be seen from the level of economic growth. Therefore, each country always set target of high economic growth rates in the planning and development objectives. By high sustainable economic growth means as the main condition for sustainable development economy.

In the narrow sense, economic growth means the increase in total production of both goods and services. This is measured by the change in real gross domestic product (GDP) and by the change of real gross domestic product per capita. GDP is the total value of all final goods and services produce in a country in a one-year period. The value of GDP would give a view of how a country’s ability to manage and utilizing existing resources.

Indonesia is one of the developing countries in the world. As a developing country Indonesia has been joined as a member in G-20 major economies and classified as the newly industrialized country. Based on the data from world-bank in 2013, the gross domestic product of Indonesia reached 3,475.25 USD. Indonesia experienced a GDP growth of 5.8% per 2013, it is of course a good hope for the Indonesian’s government to realize the improvement of people's welfare.

Source: World Bank

The graph above explained about the development of economic growth in Indonesia for 34 years from 1981 until 2014. Given the fact from World Bank, it can be concluded that the economic growth in Indonesia moving into

-15 -10 -5 0 5 10 15

1970 1980 1990 2000 2010 2020

GDP growth (annual %)

FIGURE 1.1

fluctuation ways for 34 years. In the crisis 1998, the economic growth in Indonesia decreased dramatically around -13.12%. As for Indonesia, the main cause of financial crisis happens because of the internal source at that time. The crisis started when huge capital flight out from Indonesia. The direct result of capital flight that occurred in Indonesia, result in Indonesia's national currency (rupiah) then deteriorated against the US dollar. Moreover, many companies bankrupted and the national banking sector collapsed (Tambunan T. , 2010).

Indonesia has suffered a crisis in 12 years, for example, in 1997/1998 and 2008/2009. Because of those crises, Indonesia economy is exposed to economic shocks, either from internal sources or external sources, for the following main reasons. Firstly, Indonesia's economy becomes more open to other countries. Therefore, any volatility which happens in global economics will effect on Indonesian economic as well. Secondly, Indonesia is still depend on the primary commodities, especially agriculture sector. So when, the price instability happens in the primary commodities, became a shock for Indonesian economy. Thirdly, because of the instability of these commodities, it is also impact the domestic consumption and food security in Indonesia (Tambunan T. , 2010).

In fact, economic growth in a country cannot be separated from the role of government from policy makers both fiscal and monetary, and the role of society as a source of investment and production factors in running a country's

economic cycle. Hence, gross domestic product has become a measure of the ability of a society to produce a product that can enhance the economic growth of a country.

One of the important things by using of national income data is to determine the rate of economic growth which is achieved by a country year to year. Data from national income can also be an indicator to see the economic performance. By observing the growth of a country from year to year, it can be assessed achievements and success in controlling the country's economic activity in the short term and in the long term. Comparisons may also be made between the level of the country's success in controlling and build its economy achieved when compared with other countries. (sukirno, 2013)

FIGURE 1.2

The Contribution Growth of Several Sectors on GDP in Indonesia 1981- 2014

Gross domestic product cannot be separated from that contributions given by various sectors produced in Indonesia. With an area of 1,905 million km which is owned by Indonesia, there are a wide variety of sectors contributing. The figure 1.2 above shows the development contribution of several sectors on gross domestic product in Indonesia.

The income which is gained by the government come from three major sectors; agriculture, industry, and services. The development of the three sectors fluctuates for 34 years. The highest contributing sector is industry, followed by service, and the last is agriculture. The agriculture sector trend tends to decrease each tear although it once increases after the Asian crisis in 1997. The previous contribution is 16% increased to 19% after the crisis. In the beginning of 1995, the industry sector surpassed the service sector until 2014; while since 1981 to 1995 the service sector contributed the most to the national income

In macroeconomic analysis, besides explaining the supporting factor that possibly affect the economic growth, it also discusses on the issues such as; inflation. Inflation is a process of rising prices in general and continuous (continuous) for a certain time. In other words, inflation is also a process in which the declining in currency values continuously. Inflation is a process of an event, not the high-low level of a price. That is, if the high price level it has not conclusively point to inflation. If a process of price increase continues to

happen and influence each other means there is inflation. To achieve sustainable economic growth along with price stability continues to be the main objective of economic policy macro to most countries in the world today.

Based on the data from World Bank, the rate of inflation in Indonesia has fluctuated over the time. The highest level of inflation is happen when Asia financial crisis in 1997. Because of that problem, the inflation rate reach 58.3% and 20.48% in 1999. It became the hardest-hit country because the crisis not only had economic but also significant and far-reaching political and social implications. And after that, the inflation rate in Indonesia gradually back to normal.

There are three main components in the growth for each country, namely capital accumulation, population growth, and technological advances. As discussed above, the economic growth associated with the state's ability to produce goods and services and the increase in per capita income of the population. The accumulation of capital is reinvested earnings with the aim to increase output (Todaro, 2000).

In this globalization era, foreign direct Investment (FDI) plays an important role in international business. Economic integration occurs between the countries in the world encourage the emergence of cooperation in the economic, political, social and cultural. As the developing country in the world, Indonesiarequires substantial funds in implementing national development. It

is due to the undertakings in pursuit of the underdevelopment of the developed countries in the world globally. The fact that Indonesia itself is not able to provide the fund for development itself.

The sources of financing in development could come from domestic and abroad. One of the external types of is Foreign Direct Investment (FDI). According to (Panayotou, 1998) in (Sarwedi, 2002) tells that FDI is more importantto ensure the continuing development in a country compared to other funding streams such as, portfolio, because the presence of FDI will be followed by the transfer of technology, know-how, management skills, business risk is relatively smaller and productive (Sarwedi, 2002).

According to Jhingan (2004) In Agma tells that foreign investment in the need to build economic acceleration. This is because the foreign capital can help in the process of industrialization in order to create wider opportunities. Foreign capital could be aid technology.

Foreign investment in Indonesia, has become a funding source that can be used as financing for development and economic growth. By using foreign investment, it is intended to replace the use of foreign debt as a source of financing. Because with the increasing uncontrolled interest rates on foreign debt and the rupiah exchange rate against foreign currencies make Indonesia will decrease the difficulties in the repayment of the debt.

Based on the legal basis, Foreign Direct Investment has been regulated by UU No.1 year 1967 and UU No.11 year 1979. In this basis, FDI means that foreign investment activities directly undertaken by or under the provisions of this law and used to run a company in Indonesia, and the owners of the capital directly bear the risk of the investment.

The realizations of foreign direct investment in every country fluctuate every time. The following data is the development net inflows of FDI in Indonesia among the other ASEAN-4-Nations based on the World Bank from 2011 until 2014 in Million US Dollar:

Based on the table above, Indonesia has become the largest foreign direct investment realization among the ASEAN-4-Nations. The realization of

Year

2011 2012 2013 2014

Indonesia 20,564,938,227 21,200,778,608 23,281,742,362 26,277,377,236 Thailand 2,468,144,240 12,894,549,139 15,822,132,057 3,718,726,247 Malaysia 15,119,371,191 889,577,425 11,296,278,696 10,619,431,770 Philippines 2,007,150,725 3,215,415,155 3,737,371,740 5,739,574,024 Source: World Bank

TABLE 1.1

The Foreign Direct Investment from 4-Asean-Nation (in Million US Dollar)

foreign direct investment (net-inflows) in Indonesia always increase from 2011 until 2014. Similarly, the net inflows of FDI always increase over 4 years in Philippines. On the contrary, the foreign direct investment of the other countries fluctuates at that time. Surprisingly, for 4 years, the FDI of Malaysia decreased on 2012, and keep increasing in 2013 and 2014. The smallest foreign direct investment is Thailand among ASEAN-4-Nations.

Investors invest in Indonesia with various forms. Usually investors come to a province or region that have advanced development. This is because of the stability that the investors can have from that advanced province. Province in Java Island mostly become the choice from the investors to be the right place to invest. The difficulty is that not every province has the same growth and stability. So, there is the amount gap in each province.

Indonesia is an archipelago with many islands and is divided into 34 provinces. The investments that are in Indonesia are scattered throughout the area in Indonesia. Each province has its uniqueness to offer to investments. Indonesia is rich with the natural resources, so that the investors can choose to invest on this development. There are various types of industries in Indonesia that the investors can also choose. The following is an overview of the distribution of foreign direct investments in each region in Indonesia taken from the Investment Coordinating Board of the Republic of Indonesia in January- December2014:

TABLE 1.2

The Foreign Direct Investment by Province in Indonesia in 2014

NO PROVINCES INVESTMENT

(US$/Million) Project

1 West Java 6,561.90 1,671

2 Special Teritory of Jakarta 4,509.40 3,053

3 East Kalimantan 2,145.70 191

4 Banten 2,034.60 709

5 East Java 1,802.50 497

6 Central Sulawesi 1,494.20 58

7 Riau 1,369.60 129

8 Papua 1,260.60 42

9 South Sumatra 1,056.50 114

10 West Kalimantan 966.1 158

11 Central Kalimantan 951 126

12 West Nusa Tenggara 551.1 167

13 North Sumatra 550.8 249

14 South Kalimantan 502.5 78

15 Central Java 463.4 224

16 Bali 427.2 582

17 Riau Islands 392.1 128

18 South Sulawesi 280.9 58

19 Southeast Sulawesi 161.8 77

20 Lampung 156.5 50

21 West Papua 153.3 42

22 West Sumatra 112.1 72

23 North Kalimantan 108.3 18

24 Bangka Belitung Islands 105 34

25 North Maluku 98.7 23

26 North Sulawesi 98.5 69

27 Special Region of Yogyakarta 64.9 48

28 Jambi 51.4 42

29 Aceh 31.1 49

30 Bengkulu 19.3 17

31 West Sulawesi 16.2 7

32 East Nusa Tenggara 15.1 57

33 Maluku 13.1 33

34 Gorontolo 4.1 13

The table 1.2 above explains about the foreign direct investment based on the locations in Million US Dollar and the total project for each location. According the table above, in January- December period, the highest realization of FDI was located in West Java with the total Investment 6,561.9 Million US Dollar. On the other hand, the lowest realization of FDI was located in Gorontalo with the total investment only 4.1 Million US Dollar. Besides the total investment, the highest number of the total project was located in Special Territory of Jakarta with 3,053 project in 4,509.4 Million US Dollar total investment. At last, the lowest total project was located in West Sulawesi with only 7 project in 2014.As we have discuss previously, the size of the economic growth in each country, depending on the capital invested by each country. The need for productive investments in supporting social and economic necessity to carry out the process of development in a country

Beside investments, Export also play an important role in the economic activities of a country. Exports will generate income that will be used to finance imports of raw materials and capital goods needed in the production process that will create value-added. Aggregation value added generated by all production units in the economy is the value of products GDP (Sutawijaya & Zulfahmi, 2010).

TABLE 1.3

The Export and Import Growth in Indonesia in Million US$

Net exports is the difference between the value of goods and services export to other countries for goods and services imported from other countries. In this case, exports in Indonesia has fluctuated in the last 6 years. From the table 1.3 above, it conclude that the total import is greater than the total export in Indonesia. It means that the directions net export growth rate of Indonesia are in a negative direction within the last 6 years.

Through productivity gains, from the micro level, infrastructure can promote economic growth. Kuznets in his theory mentioned that the economic growth of a country is affected by the accumulation of capital, natural resources, human resources, with a view of quantity and quality. On the other hand, infrastructure can be categorized as capital accumulation. So, infrastructure can be used as inputs to production indirectly.

Year Export Import

2009 116510 96829.2

2010 157779.1 135663.3

2011 203496.6 177435.6

2012 190020.3 191689.5

2013 182551.8 186628.7

2014 175980 178178.8

The developing countries has made an investment of 200 billion US dollars each year for the construction of the new infrastructure (World Bank, 1994). With the investments were acquired, the expected increase value of infrastructure will be better in the future, in fact sometimes the performance of infrastructure is disappointing. One of the causes is an error in the allocation of funds. For example, the development of infrastructure continued without maintaining the existing infrastructure.

The effort to revamp the infrastructure conditions to realize an important role in reducing inequalities of income and long-term effects for gross domestic product is important. Improvements in infrastructure have contributed to increasing productivity and is expected to support economic growth in the long term (Maryaningsih, Hermansyah, & Savitri, 2014)

In this research, it focuses on the long road infrastructure in Indonesia in Kilometer units. By having the best quantity and quality road infrastructure in Indonesia, country will able to provide convenience in the distribution of economic activities in the community. Based on World Bank in 2013, Roads are the main transport in Indonesia, and the total road network recorded more than 477,000 km with an asset value of more than 15% of GDP. However, the number and quality of road infrastructure in Indonesia is still below neighboring countries. The Indonesian government has increased infrastructure spending

way to 70 trillion Rupiah per year (USD 7 billion per year), representing 40% of total spending on infrastructure.

However, the level of investment of this magnitude cannot pursue increased demand and growth in the last ten years. Productivity and efficiency management of national roads are still less than optimal. The spending of national roads has tripled in real terms between 2005 and 2011, but output which is generated in the road length only rose 20% whether if counted from the existing road or the road under construction.

With the progress that has been achieved, Indonesia still has to face the problems that are faced by other countries, especially developing countries, who are on development. The process of economic performance is affected by two kinds of factors, namely, economic factors and non-economic factors.

Based on the terms describe above, the need for scientific assessments of the factors that affecting economic growth in Indonesia is highly needed. In this case the factors that will be analyzed are the factors in economic which are foreign direct investment, export, infrastructure, and inflation rate.

B. Research Limitation

This research only limit in Foreign Direct Investment, Export and Infrastructure especially in Road Length (in Km2_{), and Inflation Rate on}

C. Research Questions

Based on the background, the researcher needs to formulate the problem as the ultimate goals of this research which includes:

1. What is the impact of foreign direct investment on economic growth in Indonesia in short and long run?

2. What is the impact of export on economic growth in Indonesia in short run and long run?

3. What is the impact of infrastructure on economic growth in Indonesia in short and long run?

4. What is the impact of inflation on economic growth in Indonesia in short and long run?

D. Research Objectives

Based on the research questions, thus the objectives of this paper are: 1. In order to know about the impact of foreign direct investment on economic

growth in Indonesia in short and long run.

2. In order to know about the impact of export on economic growth in Indonesia in short and long run.

3. In order to know about the impact of Infrastructure on economic growth in Indonesia in short and long run.

4. In order to know about the impact of Inflation on economic growth in Indonesia in short and long run.

E. Research Benefits

This study contributes useful information for parties which are interested in Economic performance in Indonesia. The detailed of research objectives will be explained below:

1. It can help to explain about the impact of foreign direct investment, export, Infrastructure, and Inflation on economic growth in period 1981-2014. 2. It can help to increase the knowledge, experience, and as a place to practice

and apply science sciences knowledge has been gained while studying on campus.

3. It is expected could be input analysis and comparison for the other researchers.

17

CHAPTER II

LITERATURE REVIEW

A. Theoretical Framework

1. Economic Growth.

a. The Definition of Economic Growth.

Economic growth can be defined as an increase in per capita real output. It also defined as a broad perception that refers to the process of economic growth that has capacity to raise the welfare of its people (Berg, 2001).

According to Boediono (1982) economic growth is the increasing of output per-capita in the long run. Economic growth is a process, not an economic condition at a time. In this case, the dynamic economic growth seen from the aspect of an economy, which is to see how an economy grow or change over time. It is emphasized in itself to changes or developments.

The economic growth represent as the development of the activity in the economy that causes the good and services produced increases in economic activity in the community, regarding growth and development dimensional measured by the increased production and income (Sukirno, 2002). It also can be said as one indicator is in seeing the development of a country. A growth is not synonymous with

development, growth is one of the conditions required in a development (Meier, 1989).

b. Measuring the Economic Growth.

Economic growth occurs when an increase in the production of goods and services. In the real world to record the number of units of goods and services is a difficult thing to do. This is due to a wide variety of goods and services produced in one period that have different sizes. Therefore, the calculation uses to estimate the change in output which is the value of money is reflected in the value Gross Domestic Product (GDP). Gross Domestic Product (GDP) is the market value of all final goods and services, produced in the economy in a country in a period (Mankiw G. N., 2006).

There are two approaches to see the amount of GDP. The first one is GDP as the total income from every person in the economic activity, the second one is by seeing the GDP from the total output (Mankiw G. N., 2007) . The income approach can be differentiated from 4 different types; wage or salary, rent and interest, and profit. While the spending approach from each sector, namely; Consumption (C) from household, Investment (I) from firm, Government Expenditure (G), and the Export (EX) from abroad (Soediyono, 1989).

Based on the explanation above, it can be concluded that the economic growth is the growth on economy activity from the increasing GDP and GNP in long-term without considering the population growth and the economic structure change.

c. Economic Growth Theory.

The theory of economic growth determine as an explanation of what factors determine the increase in output per capita in the long term, and the explanation of how these factors interact with each other, resulting in a process of growth. On these descriptions below are the theories on economic growth(Boediono, 1982):

1) The General Theory of Economic Growth.

Based on Tambunan (2001), the economic growth can be seen from two sources in which the aggregate demand from the aggregate demand side. Based on figure 2.1, the equilibrium can be reached if the demand curve and supply crossed on each other, where the economic equilibrium result in output aggregate (GDP) with the certain level. Next, the aggregate output will result in national income. On the figure below, it will describe the initial period (t = 0) output is the form from Y, that the economic growth is the output from the following period, which is output=Y1, where

Based on the picture, it can be seen that the economic growth occurred because the shift from the aggregate supply (AS) along with the demand curve (part A) or the movement from the aggregate demand (AD), along with the supply curve.

From the aggregate demand, the AD curve movement to the right shows the increasing demand in the economic due to the increasing factors of national income, including: consumers demand, company and government. While from the aggregate demand, the GDP usage namely; the household consumption, the investment (I), government spending (G), and net export means the goods and services export (X) minus the goods and services import

Source: Tambunan, 2001

FIGURE 2.1

Aggregate Demand and Supply in a Balance Macroeconomic Situation

(M). The aggregate demand in the economy can be describe by the equation below:

= � + ��+ + −

From the aggregate supply, there are two ways on describing the phenomenon, which are; neo-classic theory and modern theory. The neo classical theory regards the production function such as labor and capital are influencing the output growth. While the modern theory shows that the production functions are not only the influence but also other variables, such as technology, energy, entrepreneurship, and material. As an addition, the modern theory also regards the economic growth is influenced by; infrastructure, law, regulations, politic condition, the bureaucracy, and exchange rate.

2) Adam Smith’s Theory.

Based on Adam Smith’s Theory in Sukirno (2002) total output in the economy is affected by the factors of production. The factors of production namely capital, labor, and technology. From those factors, it can be seen from the formulas the following equation:

∆ = � �, , �

Y= Economic Growth C= Capital

L= Labor T= technology

Smith explains that country's production system consists of three elements namely, available natural resources, human resources or population, and the stock of capital goods. First, Natural resources provided a means that most fundamental of the production activities of a society. The second element is human resources or population. In the process of growth of output element is considered to have a passive role, in the sense that the population will adapt to the needs of the community labor. The last element is capital. Capital actively determines the output level. Smith give a central role to the growth of the capital stock or capital accumulation in the growth process output. In other words, the output level depends on what happens to the stock capital (Boediono, 1982).

3) Harrod-Domar Theory.

Harrod-Domar theory is the development of macro theory Keynes short-term into long-term macro theory. This theory was developed by Evsey D. Domar and Roy F.Harrord. This theory

describes a long-term economic growth, because the keynes theory is less complete in the long-term economic problems.

There are 4 assumptions in economic growth in Harrod-Domar Theory. Firstly, in the economy there are full employment and maximum use of capital. Secondly, the economy consists of two sectors, namely the household sector and the corporate sector. Thirdly is the amount of public savings is proportional to the amount of national income, which means saving function starting from the zero point. The last is the propensity to save in fixed amount, as well as the capital output ratio and the incremental capital output ratio (Jones, 1975).

In these assumptions explained that in order to increase the rate of economic growth, country must increase savings. However, economic growth is also seen in increasing the productivity of the output from investment activities. The productivity of investment is the amount of output that can be produced from one unit of investment generated, where productivity can be measured by the inverse of capital ratio output (∆�/∆� . Then, to determine the rate of growth of total output is by multiplying the level of investment that is contained in the savings ratio, s= I/Y with investment productivity 1/k.

The figure 2.2 above explaining the Harrord-Domar theory much further. The aggregate spending is the shape from AE = C + I. The equilibrium in the point E describes; (i) national income is Y and (ii) shows the national income from the economy reaches the maximum capacity. For example, the capital in this equilibrium is K0. Harrord-Domar theory shows that investment that invested in

the beginning of the year leads to the increasing value in the following year, which is the capital from K1 = K0 + I, where K1

results in national income; so that, the initial equilibrium can be reached again. This analysis shows the economic from two sectors

FIGURE 2.2

Theory of Harrod Domar: The Role of Investment in Economic Growth

that investment should always increase in order to increase the economic growth. The increasing investment is highly needed to increase the aggregate spending.

Harrord-Domar theory doesn’t focus the requirement to reach the maximum capacity if the economic is consisted with 3 sectors or 4 sectors. On that condition, the capital increases if AE1

= C + I1 + G1 + (X – M)1, where equal with I1 + G1 + (X – M)1. The

conclusion from Harrord Domar theory is that the theory completes the Keynesian analysis. Keynesian focuses on the short-term economic problem. While on Harrord Domar theory, it describes the long-run economic problem. It describes the long aggregate is needed to be reached to realize the economic growth. The robust economic growth can be reached if I + G + (X – M) increases significantly with positive relationship.

4) Solow – Swan Theory.

The theory developed individually by Robert Solow from MIT and Trevor Swan from the Australian National University and the model is known as the Neo-classical growth model. This model is similar to Harrod- Domar theory model that focuses on how the population growth, capital accumulation, technological progress

and outputs interact each other in the process of economic growth (Boediono, 1982).

Although the general framework of the Solow-Swan model is similar with Harrod- Domar model, the Solow- Swan model is more flexible. This is because the Solow- Swan models more easily manipulated algebraically.

This model connects the output, capital, and labor in the production function where the coefficients are unchanged (Qp = hK and Qn _{= nN). This growth theory used general production}

function, which can accommodate a wide range of possibilities for substitution between capital (K) and labor (L). This function can avoid the problem of instability and take new conclusions about the distribution of income in the growth process the form of the production function are:

� = ,

Assumptions used in the Solow model that tends to run into diminishing returns capital. When labor supply is held constant, then the accumulation of capital to increase output will always be less than the addition earlier, reflecting the product of capital is diminishing if it is assumed that there is no technological development or growth of the workforce, the diminishing return on

capital indicates that the one point, increasing the amount of capital (through savings and investments) is only enough to cover the amount of capital losses due to depreciation. At this point the economy will stop growing, because it is assumed that there is no technological development or growth of the workforce.

The Theory of Neo-classical illustrated in Figure 2.3. Production function indicated by I2, I2, and so on. In the form of

the production function, a certain level of output can be created by using various combinations of capital and labor. For example to create an output of I1, a combination of capital and labor which can

be used include (a) K3 with L3, (b) K2 with L2, and (c) K1 with L1.

Source: Arsyad, 2004

FIGURE 2.3

Thus, even though the amount of capital changed but there is a possibility that the output level unchanged.

Although the amount of fixed capital, the amount of output produced can be changed. For example, if the amount of fixed capital of K3, the amount of output can be enlarged to I2, if the

labors that work are added from L3 to L4.

In contradict to the Harror-Domar theory that assumes a constant return with raw coefficients, meanwhile the neo-classical solow growth model uses the concept of diminishing return from worker and capital amount, if the two use distinct analysis. When analyzed simultaneously, the assumption of neoclassical also use the concept of constant return to scale. The advances in technology are just set as residual factor to explain the long-term economic growth. High or low growth is assumed to be exogenous or not influenced by other factors.

d. The Factors that Determine Economic Growth. 1) Land and Other Natural Resources.

The wealth of a country includes extensive and good soil quality, climate and weather, the number of forest products and marine, and type of minerals produced. Natural wealth will be to facilitate efforts to develop the economy of a country, especially at the beginning of the periods of economic growth (Sukirno, 2013).

Although the above stressed the importance of the role of natural resources in the economic development of a country, especially in the early days of the growth process, it does not mean that economic development is highly dependent on the amount of wealth of a country.

2) The Number and Quality of the Population.

The increasing of population time to time can be the trigger or the barrier to the economic growth. The increasing the number of population will raise the amount of labor, so it can increase the amount of production. Another matter arising from population growth to economic growth is the development of the broad market and the goods produced by the company sector will increase. Therefore, population growth will be conducive to stimulate the increase in national production and the level of economic activity. If the additional labor cannot increase the national production level faster than the rate of population growth, per capita income will decline. Thus, the excess population will lead to decline in the people's welfare

3) Capital and Technology.

Capital is very important because it can improve the efficiency of economic growth. Capital and modern technology plays an important role for realizing high economic progress. If

capital is increasing, but the quality of the technology has not increased, the progress that occurs will not be significant.

4) Social System and Society Demeanor.

Social system and Society Demeanor is important in realizing economic growth. Traditional customs that might hamper the public to use modern producing system and increase the productivity. Therefore, economic growth cannot be brought forward.

2. Foreign Direct Investment.

There are two kinds of foreign investments in Indonesia which are foreign direct investment and foreign indirect investment. Foreign direct investment is the investment that apply in Indonesia territory by foreign investor which investment comes in form of building and buying a company or acquiring a company. Meanwhile, indirect foreign investment is made by the capital market instrument such as securities, stock, and bond.

Foreign Direct Investment based on UU No. 25 year 2007 is the planting of assets in the form of money or other forms that are owned by foreigners in the form of individual or business entity.

Foreign direct investment is direct investment that has done by an individual or company of another country, that focus into production or business either by buying a company or expanding operation of an existing business in that country (Kunle, et al. 2014).

According to (Macaulay, 2012) In (Kunle, et al. 2014) World Bank in 1996 states foreign direct investment as an investment that is made to promote a long-last management interest in an enterprise and operating in a country other than that of the investors (define based on to residency) the investor desire being an effective voice to earn long term capital as shown in the nation balance of payments. Based on the UU No. 25 year 2007 in (Agma) represent the purpose of investment as follows: increase national economic growth, to create a vocation, to Increase the sustainable economic development, to increase the capacity and capability of national technology, and to develop community economy.

Generally, there are three main sources of foreign capital in a country that apply open economic system, namely foreign debt, foreign direct investment and portfolio investment. According to Wuryaningsih, et al. 2008 foreign borrowing by the government bilaterally and multilaterally. Portfolio investment is investment made through the capital markets. Then, foreign direct investment is an investment made by a private foreign company to a particular country. The form can be a branch of a multinational company, a subsidiary of multinational companies (subsidiary), licensing, joint venture, or more.

Foreign capital inflows have been viewed by developing countries in recent years. Nowadays, foreign investment has become as a major source

of foreign technology. This viewed is relevant, especially given the failure of import substitution and the slowdown of technological progress in many developing economies. The developing countries coveted the foreign direct investment (FDI) by multinational enterprises (MNEs), FDI is seen as a major tunnel for technology transfer. MNEs are the firms that produce and market their products in more than one country (Berg, 2001).

FDI can also be divided into two types, namely Greenfield and Acquisition. Investments by type Greenfield will build a new production unit while FDI is a type of acquisition that buy part ownership of a company that already exists (Kurniati, et al. 2007).

In macroeconomics, investment has two important roles in the economy. First, investment is a major component of spending and provide changes in demand and the business cycle. Second, the investment is a form that leads to the accumulation of capital. If the additional shares of buildings and equipment, it can affect the country and increase potential output growth in the long term.

Based on the theory raised by Keynes, the investment amount is determined by the interest rate. For employers, the interest rate is considered to invest in a country. Then, the other factors that determine the behavior of entrepreneurs in investing that the current economic situation and the future to come.

3. Export.

Export is the activity of selling and sending goods from the origin country to other countries. These activities can bring the flow of expenditure will be flowed into the enterprise sector. Furthermore, the aggregate expenditure will increase, this is because the export activities of goods and services, and therefore the national income will also increase. If net exports in a positive state, the aggregate expenditure will increase. Then this will increase the national income and employment (Sukirno, 2013).

Exports are one of the component in aggregate spending on the open-economy. Aggregate expenditure in an open economy means that the household expenditure on domestic production, investment, government spending, spending on imported goods and foreigner who spend the export goods. The aggregate expenditure can be expressed by this following formula:

� = ��� + � + + −

Another theory that is used in the export is the basic theory of export. The basis theory is that the economic basis that is developing from the basis export becomes the city basis. From all of the theories, all are stressing on the demand from the external sides. On the city theory, there is a division which is its environment and external.

In export theory it can be described as the autonomic factor. It means that export is a factor to increase the income and economic growth directly. To reach the high export level, then it needs the strategy to increase the appropriate export value and appropriate investment with the high technology to be implemented punctually (Adisasmita, 2013).

4. Infrastructure.

Infrastructure is the capital stock that provides public goods and services. Infrastructure will affect the production activities and quality of life for the households. Infrastructure is a fundamental factor behind economic growth. This variable has shown its long-enduring significance (Yoshino & Nakahigashi, 2000).

Infrastructure refers to the physical facility and organizational framework, knowledge and technology that is essential to society and economic growth. Infrastructure includes laws, public health and education systems, distribution systems, and transportation systems and public utilities.

In the economics, infrastructure is a form of public capital, which formed from the investment made by the government. In this study, infrastructure including roads, bridges, and sewer system (Mankiw G. , 2003).

Infrastructure means that the relatively of large physical capital facilities and organizational, knowledge and technological frameworks that together become a fundamental to the organization of communities and the economic development of the communities. Besides that, legal, educational and public health systems, water treatment and distribution, garbage and sewage collection, treatment and distribution system, treatment and disposal, public safety systems, such as fire and police protection, communications systems, public utilities and transportation systems. The federal government’s principal involvement in infrastructure formation involves the military, legislative and judicial functions(Tatom, 1993).

Modernization of the economy requires modern infrastructure as well, due to various economic activities require the infrastructure to develop, such as roads and bridges, airports, ports, industrial estates, irrigation and water supply, electricity and telephone networks need to be developed. The various types of infrastructure is needed by the company to the efficiency of its operations.

Infrastructure development should be in harmony way with economic development. At a low stage of development, the necessary of infrastructure is still limited. At this level of development is based on the construction of roads, bridges, irrigation, electricity and other infrastructure in a simple level. Thus, developing the infrastructure must be in sync with

the economic development that has been achieved and realized and that will be realized in the future(Sukirno, 2013).

Based on the type, the infrastructure is divided into 13 categories as follows (Grigg, 1988):

- The water supply system: reservoirs, water storage, transmission and distribution, and water treatment facilities (treatmentplant), - Waste water management system: collection, processing,

disposal, and recycling,

- Facility waste management (solid),

- Facilities flood control, drainage and irrigation, - Inland waterways and navigation facilities,

- Facility of transport: road, rail, airports, as well as other complementary utilities,

- Public transit systems,

- Electrical systems: production and distribution, - Natural gas facilities,

- Public Buildings: schools, hospitals, government buildings, etc., - Public housing facility,

- Garden City: the park is open, plaza, etc., as well as - Communication facilities.

Based on the thirteen types of infrastructure above, then the type of infrastructure is grouped into seven major groups as follows:

- Transportation (roads, highways, bridges), - Transport services (transit, airports, ports), - Communications,

- Flooded (water, wastewater, flooded the system, including the water that rivers, open channels, pipes, etc.),

- Waste management (solid waste management system), - Building, as well as

- Distribution and production of energy. 5. Inflation Rate

Inflation is an increase in the general price level of commodities and services during a specific time period. Inflation is regarded as a monetary phenomenon due to the impairment of the monetary calculation unit to a commodity (Greenwald, 1998).

Inflation is one of the problems that need most attention by the government. The long term goal of government is to keep the inflation rate at the lowest level. The three kinds of inflation based on the causes of inflation that is demand-pull inflation, cost-push inflation, and imported inflation(Sukirno, 2013).

Demand-pull inflation occurred in the economy is growing rapidly. The higher employment causes high levels of income, and this will cause expenses that exceed the ability of the economy to pull out of goods and services. Excessive spending will cause inflation.

Cost-push inflation happens when the level of unemployment at the lowest level. If the company is still facing the increasing of production demands, they will keep increase the production cost by providing the higher salaries to their workers, and look for new workers with higher payments. Consequently, the increasing of cost production will increase the price level of goods.

Imported inflation occurs when the price of import goods increasing. This kind of inflation can be illustrated by the real problem in the world, the effect of increasing oil price on 1970s toward to western economies, and the other oil-importing countries.

Based on the rapidity of the increasing level of price, inflation can define as three categories such as, creeping inflation, moderate inflation, and hyperinflation. The creeping inflation occurred when the rapidity of the increasing level of price is slow. The increasing of price level does not exceed 2 or 3 per cent a year. Then, the hyperinflation is a process of the rapid level of increasing price. In the developing countries, the level of inflation cannot be controlled easily. They don’t experience the hyperinflation, and cannot decrease the inflation in lowest level as well. The

average level of the inflation is 5 until 10 per cent a year, and this is called as the moderate inflation.

The high inflation will not trigger the economic growth. The increasing of production cost causes the productivity is not beneficial. Usually, the owner of capital prefer to use their capital as the speculation. The increasing of price level can give bad impact on international trade. It causes the goods from that country in high inflation, cannot compete in international market. As the result, export will decrease and the price of import goods will decrease as well. The decreasing price of import goods will effect on frequently import activities. Finally, from those problem can cause the instability of the exchange rate circulation and the worsening of balance of payment.

Besides inflation give a bad effect on the country, inflation can also give a bad effect on the individual and society. Firstly, inflation will reduce the real income of the people who have a fixed income. Generally, the increasing of wage level not as fast as the increasing of price level. Therefore, inflation will decrease the individual real wage who have the fixed income. Secondly, inflation will reduce the amount of wealth (money-from). Thirdly, inflation makes the distribution of wealth unwell. As explained earlier, the fixed income will experience the degradation in the real-income, but the owner of the fixed asset such as; land, houses can maintain or increase the value of real asset.

B. Previous Study.

According to Pranoto (2016), simultaneously exports has a significant and positive effect on the gross domestic product, while foreign direct investment has a significant and negative impact in Indonesia 2004 until 2013. This analysis was performed using linear regression analysis.

Based on Irsania and Noveria (2014) in their research titled “the Relationship among Foreign Direct Investment, Inflation Rate, Unemployment Rate, and Exchange Rate to Economic Growth” reveals that FDI, inflation rate, and exchange rate has a significant influence towards economic growth. But FDI and unemployment have a positive correlation. The rest variables have negative correlation. This research used multiple regression as a method.

From the result of Koojaroenprasit (2012) by using the multiple regression, the findings shows that foreign direct investment has a strong positive impact on South Korean Economic Growth. Furthermore, this finding indicates that human capital, employment and export also have positive and significant impact, while domestic investment has no significant impact on economic growth in South Korea.

Research from Mofrad (2012) shows the study on The Relationship between GDP, Export, and Investment: Case Study Iran shows that there exist a positive and significant long-term and short-term relationship between investment and export with GDP in 95% confidence level. This study used the vector error correction model as the method period 1991 until 2008.

According to Sojodi, et al. (2012) the research that used ARDL Method indicated the transportation facilities distinctively length of railway. Roadway, and telecommunication infrastructure (fixed phone line) have positive and significant impact on economic growth.

Study from Wibowo (2016) explains that the road infrastructure has no significant impact on economic growth in Indonesia period 2006 until 2013. On the other hand, electricity, health, and education has positive significant impact on economic growth in Indonesia.

The development of infrastructure in a country is a major influence on economic growth in a country (macro and micro) and the development of a country. However, it is not easy to apply in Indonesia. Moreover, since the 1997 crisis which eventually widened into a multidimensional crisis impact can still be felt today (Haris, 2005).

The other study finds that foreign direct investment has significant impact on gross domestic product in Indonesia and vice versa. This study shows that there is two way relationship between FDI and GDP. This study used Engle Granger (EG-ECM) based on the theorem of granger’s representation (Wuryaningsih, Setyowati, & Kuswati, 2008).

Research from Kasidi and Mwakanemeda (2013) investigated that inflation has a negative impact on economic growth in Tanzania. There was no co-integration between inflation and economic growth during the period 1990 until 2011. In addition, no long-run relationship between inflation and

economic growth in Tanzania. This research used regression equation as the method.

Study from Acyumida and Eko (2013) employs that the Granger Causality of GDP has no causality relationship on inflation. On the contrary, there is a causality relationship between Inflation on GDP in Indonesia period 2000 until 2013.

From the result of Izuchukwu and Patricia (2015) noted in their study about the Impact of Inflation on Economic Growth in Nigeria period 2000 until 2009 that the inflation has a significant impact on economic growth in Nigeria. In addition, exchange rate has a positive impact on economic growth and that high interest rate discourages investment and hence forestalls economic growth. C. Hypotheses

On the paragraph below are the hypotheses based on the previous study and theoretical framework:

1) Foreign Direct Investment has a significant and positive impact on economic growth in Indonesia both in long-run and short-run.

2) Export has a significant and positive impact on economic growth in Indonesia both in long-run and short-run.

3) Infrastructure has a significant and positive impact on economic growth in Indonesia both in long-run and short-run.

4) Inflation has a significant and negative impact on economic growth in Indonesia both in long-run and short-run.

+

+

+

-

D. Research Framework

FIGURE 2.4 Research Framework

GDP (Economic Growth) FDI( Foreign

Direct Investment)

Export

Infrastructure (Road Length)

44

CHAPTER III

DATA AND RESEARCH METHODOLOGY

A. Research Object

This research used quantitative method, so this research using deductive approach. Quantitative method is a method that stems from numerical data to be processed into information. So that the quantitative method is a method that is numeric and statistical analysis and then processed into information (Kuncoro, 2003).

In quantitative research there are two variables that serve as a model, the independent variables and the dependent variable. In this study, there are five variables that will be used i.e. one dependent variable, and four independent variables. The dependent variable used is economic growth denoted as gross domestic product, while the independent variable is foreign direct investment, exports, infrastructure, and inflation.

B. Type of Data

This research used secondary data annually in times series data. The observation period is from 1981 to 2014. The data that used in this study are as follows:

1. The data of Indonesia economic growth using gross domestic product (GDP in current US$ which is collected from World Bank Publications.

2. The data of Indonesia foreign direct investment in this research using the net inflows in current US$ which is collected from World Bank and The Investment Coordinating Board (BKPM).

3. The data of export in Indonesia using the data of export in current US$ which is collected from World Bank publications.

4. The data of Infrastructure is focused on the total length of roads in Indonesia (kilometers) which is collected from Central Bureau of Statistics (BPS) publications.

5. The data of Inflation Rate in Indonesia using the percentage data which is collected from World Bank publications.

C. Data Collection Technique

Data collection technique that is used in this study was a non-participant observer, where researchers only looked at data that is already available without become part of a data system.

D. Operational Data of Variables

The definition of research variables is used to prevent errors in analyzing the data. The definitions of each variable is described as follows:

1. Economic growth Gross Domestic Product (GDP) is the market value of all final goods and services, produced in the economy in a country in a period 2. Foreign direct investment is direct investment that has done by an individual

by buying a company or expanding operation of an existing business in that country.

3. Export is the activity of selling and sending goods from the origin country to other countries.

4. Infrastructure is a form of public capital, which formed from the investment made by the government. In this study, infrastructure including roads, bridges, and sewer system.

5. Inflation is an increase in the general price level of commodities and services during a specific time period. Inflation is regarded as a monetary phenomenon due to the impairment of the monetary calculation unit to a commodity. E. Analysis Method

The analysis method in this research is Error Correction Model (ECM). By using descriptive quantitative approach, error correction model is used to determine the effect of independent variables on the dependent variable in the long term and short term. Short term is usually an economic behavior less than one year. It could be monthly, quarterly, or annually. Yet in this research, the short term could be define as the effect for one to two years. However, in the long term is usually an economic behavior for more than one year. The period is rarely determined by the researchers. This could be periods for more than two years. Especially in this research, the effect might occur during the periods of research (33 years).

The quantitative approach is used by using the econometric model calculations to test the stationary of each variable and see whether a variable is

stationary or not in a model. Then, to know the long-term equilibrium between the variables in the observation will be seen in the co-integration test.

Co-integration analysis was conducted to determine the equilibrium which is achieved in the long term, while the ECM (Error Correction Model) to correct imbalances in the short term (which is possible) toward long-term equilibrium. Therefore, this analysis uses time series data, then the stationary test data must be done first to ensure that the time series data is stationary. If the non-stationary data is still used, the result of regression data will be spurious.

Other than that, stationary test is absolutely necessary to meet the next assumption analyses are the co-integration and ECM. Once the data is stationary ensured, after it stationary at test level or degree of integration, the next test is a test co-integration. The co-integration tests will confirm whether the regression model co-integrated or not. Co-integrated models will show that the model are in equilibrium in the long run.

After co-integration test is done, the next analysis is developing ECM’s regression model. This analysis is conducted to correct the imbalances in short term to long term. To simplify and to reduce manual errors, data processing in this analysis uses software tools E-views 4.0. For further explanation, these are the steps to be done in this research:

1. Classical Assumption Test.

On estimate the linear equations by using OLS method (Ordinary Least Square), the assumptions of OLS must be proceeded. If the assumption are not

proceeded, then it will not be able to generate the parameter value becomes BLUE (Best Linear Unbiased Estimator).

Based on Gujarati (2003), BLUE assumptions can be achieved with the following criteria: The expected value of the average error is 0 (zero), fixed variance (homokedasticity), no autocorrelation in the disturbances, the variables that explain is non-stokastik, there is no multicollinearity among the variables that explain, and the assumption is normally distributed.

To determine whether it meets the assumptions BLUE or not, it needs to do some testing such as multicollinearity test, autocorrelation test, heteroscedasticity test and normality to ensure that the data are normally distributed.

After being tested DF is useful for testing residual generated, then if the critical value is less than the probability value it can thus be said that such data has co-integration and vice versa.

a. Autocorrelation Test.

Autocorrelation shows that there is a correlation between the variables observed. If the model has a correlation, the estimated parameters will be biased and its variations will no longer be a minimum and the model becomes inefficient. In this study, to detect autocorrelation in the model, then it uses the Lagrange Multiplier test (LM). If the value Obs* R-squared is less than the value of the table then the model can be said there is no autocorrelation. It also can be seen from the value of

obs-square probability, if the probability value is greater than the value of a selected it means there is no problem of autocorrelation.

b. Normality Test.

Normality test used to determine whether the residual is normal or not. To test whether the data were normally distributed or not, it can be done by using Jarque- Berra test (test J-B).

c. Heteroscedasticity Test.

Heteroscedasticity test aims to test whether the regression model occurred inequality residual variance from one observation to another observation. If the variance and residuals of the observations to other observations remain, then called as homoscedasticity and if the variance is different called as heterocedasticity.

In this study, the test used is a test of White Heteroskedasticity (no cross term) when the independent variable in small quantities, or White Heteroskedasticity (cross term) when the number of independent variables used in many models. If the probability of obs * R-Squared is smaller than the critical value; so that, there is heteroskedasticity occurred in the model. d. Multicollinearity Test.

One of the assumptions of classical linear regression is there is no perfect multicollinearity or there is no linear relationship between the explanatory variables in the regression model. The consequence of multicolinearity, if the significance of variables, the amount of variable

coefficients and constants are not vaild multicolinearity occurs when the yield estimation R squared value is high (more than 0.8), high F value, and the value of t-statistics, almost all of the explanatory variables were not significant.

So, multicollinearity can be detected in various ways, such as the F-statistically significant but the majority of the value of the t-statistic is not significant, correlation between the coefficient value of independent variables is greater than 0.8 means there is multicollinearity problem in the data.

2. Dynamic Test. a. Stationary Test.

In the data processing, the first thing to do is to test the stationary data. A stationary data is very important in data analyzes in the form of time series. A variable is said to be stationary if the average value and variance constant over time and the value of the covariance between the two time periods only depending on the difference or interval between the two time periods is not the actual time when the covariance is calculated (Gujarati, 2003).

The concept that used to test stationary time series data is a unit root test. If the data is not stationary, it can be said that data has the unit root problem.

In this study it will use Augmented Dickey-Fuller test to determine whether a time series data contains the root unit or non-stationary. To get a view of the unit root test, it can be explained by the following autoregressive models which is estimated by Ordinary Least Square:



    k i t i i t

t a a BX bB DX

DX 1 1 0



     k i i i i t

t a aT a BX d BDX

DX

1 2

1 0

Where, T = time trend, Xt = variable observed in period t. Furthermore, the next step is ADF calculation. The value of ADF is used to test the hypothesis that a1 = 0 and c2 = 0 is indicated by the value of t statistics calculated on BXT coefficients in the above equation. Number of inaction k is determined by k = n1 / 5, where n = total number of observations. Critical value (table) for the associated test can be seen in fuller, 1976; Guilky dan Schmidt, 1989 (Insukindro, 1999). The observed time series is stationary if the ADF has a value greater than the critical value.

The stationary decision on data is based on a comparison of the statistics obtained from the ADF t value coefficient with statistical critical values of Mackinnon. If the absolute value of the ADF statistic is greater than the critical value, the data Mackinnon stationary and otherwise the data is not stationary.

b. Integration degree test.

If the testing unit root in the time series is not stationary, then the next step is to do the degree of integration. It aims to determine an integration of data on the degree to how the data will be stationary (Basuki & Yuliadi, 2015).

Test the degree of integration is a test aims to see to what degree the observed data stationary. This test is similar to or an extension unit root test, carried out if the observed data was not stationary as recommended by the test unit roots. Common forms of regression are:



    k i t i i t t

t e eBDX f B D X

X D 1 0 2 2



     k i t i i t

t g gT g BDX hB D X

X D 1 2 1 0 2 2

Where, D2Xt = DXT-DXT-1, BDXt = DXT-1, further testing at the test unit roots. If the first degree of this data is still stationary, then the integration test needs to be continued at the next degree until obtaining a stationary condition.

c. Co-integration Test.

After knowing the data is not stationary, then the next step is to identify whether the data co-integrated. Co-integration test is required to provide an early indication that the model has a long-term relationship in this study.

The co-integration tests conducted to determine the long-term equilibrium between the variables observed. This test was developed based on the perception that the data model though individually not stationary but linear combination between two or more data time series and that will be stationary (Gujarati, 2003).

The co-integration tests are most often used is the Engle-granger (EG), augmented Engle-granger test (AEG) and Co-integration regression test Durbin- Watson (CRDW). To get the value of EG, AEG, and CRDW, the data used must be integrated at the same degree.

Co-integration test results obtained by forming a residual obtained by regressing the independent variable on the way leading independent variables OLS. Based on the regression result, residual has been obtained must be stationary at the level, so that can be said to have co-integration.

d. Error Correction Model.

Error Correction Model is a model that is used to correct an equation among variables that individually are not stationary. By using ECM, a variable that is not stationary will return to its equilibrium value in the long term with the main requirement is the existence of co-integration relationship between the variables of a constituent.

Dependent Variable: D(LOG(INFR),2) Method: Least Squares

Date: 02/02/17 Time: 07:34 Sample(adjusted): 1983 2014

Included observations: 32 after adjusting endpoints

Variable Coefficient Std. Error t-Statistic Prob. D(LOG(INFR(-1))) -0.859345 0.181240 -4.741483 0.0000 C 0.038798 0.010987 3.531382 0.0014 R-squared 0.428372 Mean dependent var -0.000831 Adjusted R-squared 0.409318 S.D. dependent var 0.052487 S.E. of regression 0.040340 Akaike info criterion -3.522500 Sum squared resid 0.048819 Schwarz criterion -3.430892 Log likelihood 58.36000 F-statistic 22.48166 Durbin-Watson stat 2.053594 Prob(F-statistic) 0.000048

INFLATION RATE

Null Hypothesis: D(INFL) has a unit root Exogenous: Constant

Lag Length: 1 (Automatic based on SIC, MAXLAG=9)

t-Statistic Prob.* Augmented Dickey-Fuller test statistic -6.970533 0.0000 Test critical values: 1% level -3.661661

5% level -2.960411 10% level -2.619160 *MacKinnon (1996) one-sided p-values.

Augmented Dickey-Fuller Test Equation Dependent Variable: D(INFL,2)

Method: Least Squares Date: 02/02/17 Time: 07:35 Sample(adjusted): 1984 2014

Included observations: 31 after adjusting endpoints

Variable Coefficient Std. Error t-Statistic Prob. D(INFL(-1)) -1.937928 0.278017 -6.970533 0.0000 D(INFL(-1),2) 0.441617 0.169486 2.605628 0.0145 C -0.336532 1.962741 -0.171460 0.8651 R-squared 0.736203 Mean dependent var -0.074978 Adjusted R-squared 0.717360 S.D. dependent var 20.54830 S.E. of regression 10.92427 Akaike info criterion 7.711617 Sum squared resid 3341.513 Schwarz criterion 7.850390 Log likelihood -116.5301 F-statistic 39.07106 Durbin-Watson stat 2.189782 Prob(F-statistic) 0.000000

APPENDIX 4

-

LONG RUN ESTIMATION

Dependent Variable: LOG(GDP) Method: Least Squares

Date: 02/02/17 Time: 07:36 Sample: 1981 2014

Included observations: 34

Variable Coefficient Std. Error t-Statistic Prob. C 2.162427 0.700476 3.087084 0.0044 LOG(FDI) 0.028365 0.006596 4.300244 0.0002 LOG(EX) 1.053247 0.087556 12.02936 0.0000 LOG(INFR) -0.223223 0.149462 -1.493518 0.1461 INFL -0.010121 0.002681 -3.775187 0.0007 R-squared 0.980389 Mean dependent var 26.03261 Adjusted R-squared 0.977684 S.D. dependent var 0.823049 S.E. of regression 0.122951 Akaike info criterion -1.219004 Sum squared resid 0.438394 Schwarz criterion -0.994539 Log likelihood 25.72306 F-statistic 362.4409 Durbin-Watson stat 1.526878 Prob(F-statistic) 0.000000

-

RESIDUAL TEST

Null Hypothesis: ECT has a unit root Exogenous: Constant

Lag Length: 0 (Automatic based on SIC, MAXLAG=9)

t-Statistic Prob.* Augmented Dickey-Fuller test statistic -4.512906 0.0010 Test critical values: 1% level -3.646342

5% level -2.954021 10% level -2.615817 *MacKinnon (1996) one-sided p-values.

Augmented Dickey-Fuller Test Equation Dependent Variable: D(ECT)

Method: Least Squares Date: 02/02/17 Time: 07:37 Sample(adjusted): 1982 2014

Included observations: 33 after adjusting endpoints

Variable Coefficient Std. Error t-Statistic Prob. ECT(-1) -0.794462 0.176042 -4.512906 0.0001 C 0.004862 0.019853 0.244897 0.8082 R-squared 0.396492 Mean dependent var 0.008155 Adjusted R-squared 0.377024 S.D. dependent var 0.144393

S.E. of regression 0.113968 Akaike info criterion -1.447111 Sum squared resid 0.402648 Schwarz criterion -1.356414 Log likelihood 25.87733 F-statistic 20.36632 Durbin-Watson stat 1.918417 Prob(F-statistic) 0.000086

APPENDIX 5

-

ECM ESTIMATION

Dependent Variable: D(LOG(GDP)) Method: Least Squares

Date: 02/02/17 Time: 07:39 Sample(adjusted): 1982 2014

Included observations: 33 after adjusting endpoints

Variable Coefficient Std. Error t-Statistic Prob. C 0.034813 0.023264 1.496471 0.1461 D(LOG(FDI)) 0.012275 0.004883 2.513597 0.0182 D(LOG(EX)) 0.557367 0.112073 4.973265 0.0000 D(LOG(INFR)) -0.052909 0.373788 -0.141547 0.8885 D(INFL) -0.011567 0.001310 -8.830922 0.0000 ECT(-1) -0.417701 0.137322 -3.041768 0.0052 R-squared 0.855998 Mean dependent var 0.071001 Adjusted R-squared 0.829331 S.D. dependent var 0.193346 S.E. of regression 0.079875 Akaike info criterion -2.053732 Sum squared resid 0.172262 Schwarz criterion -1.781640 Log likelihood 39.88658 F-statistic 32.09946 Durbin-Watson stat 1.456933 Prob(F-statistic) 0.000000

APPENDIX 5

-

AUTOCORRELATION TEST

Breusch-Godfrey Serial Correlation LM Test:

F-statistic 1.900620 Probability 0.170455 Obs*R-squared 4.355401 Probability 0.113302

Test Equation:

Dependent Variable: RESID Method: Least Squares Date: 02/02/17 Time: 09:07

Presample missing value lagged residuals set to zero.

Variable Coefficient Std. Error t-Statistic Prob. C -0.001996 0.022733 -0.087821 0.9307 D(LOG(FDI)) -0.000205 0.004753 -0.043127 0.9659 D(LOG(EX)) -0.030688 0.109824 -0.279426 0.7822

D(LOG(INFR)) 0.073243 0.367713 0.199186 0.8437 D(INFL) -0.000247 0.001341 -0.183799 0.8557 ECT(-1) -0.183432 0.163055 -1.124967 0.2713 RESID(-1) 0.448613 0.250035 1.794206 0.0849 RESID(-2) 0.081983 0.212537 0.385737 0.7030 R-squared 0.131982 Mean dependent var -3.63E-18 Adjusted R-squared -0.111063 S.D. dependent var 0.073370 S.E. of regression 0.077337 Akaike info criterion -2.074063 Sum squared resid 0.149527 Schwarz criterion -1.711273 Log likelihood 42.22203 F-statistic 0.543034 Durbin-Watson stat 2.029769 Prob(F-statistic) 0.793652

-

NORMALITY TEST

-

HETEROSKEDASTICITY

White Heteroskedasticity Test:

F-statistic 1.764043 Probability 0.156868 Obs*R-squared 24.62452 Probability 0.216175

Test Equation:

Dependent Variable: RESID^2 Method: Least Squares Date: 02/02/17 Time: 09:12 Sample: 1982 2014

Included observations: 33

Variable Coefficient Std. Error t-Statistic Prob. C 0.006850 0.005503 1.244714 0.2370 D(LOG(FDI)) -0.001045 0.002156 -0.484921 0.6365 (D(LOG(FDI)))^2 -4.21E-05 0.000180 -0.234497 0.8186 (D(LOG(FDI)))*(D(LO

G(EX)))

0.023274 0.030459 0.764092 0.4596 (D(LOG(FDI)))*(D(LO

G(INFR)))

(D(LOG(FDI)))*(D(INF L))

1.79E-05 0.000188 0.095057 0.9258

(D(LOG(FDI)))*ECT(-1)

0.006428 0.022271 0.288628 0.7778 D(LOG(EX)) 0.020407 0.038597 0.528708 0.6066 (D(LOG(EX)))^2 0.060218 0.176126 0.341904 0.7383 (D(LOG(EX)))*(D(LO

G(INFR)))

-0.278186 0.704724 -0.394745 0.7000 (D(LOG(EX)))*(D(INF

L))

-0.004599 0.003580 -1.284490 0.2232

(D(LOG(EX)))*ECT(-1)

0.018050 0.122394 0.147473 0.8852 D(LOG(INFR)) -0.129148 0.137772 -0.937405 0.3670 (D(LOG(INFR)))^2 0.370082 0.840159 0.440490 0.6674 (D(LOG(INFR)))*(D(I

NFL))

0.004114 0.014172 0.290298 0.7765 (D(LOG(INFR)))*ECT

(-1)

0.492528 0.817975 0.602130 0.5583 D(INFL) -0.000296 0.001051 -0.281421 0.7832 (D(INFL))^2 4.61E-06 3.77E-05 0.122486 0.9045 (D(INFL))*ECT(-1) 0.004069 0.007677 0.529944 0.6058 ECT(-1) -0.037189 0.048522 -0.766442 0.4582 ECT(-1)^2 -0.053599 0.129164 -0.414968 0.6855 R-squared 0.746197 Mean dependent var 0.005220 Adjusted R-squared 0.323193 S.D. dependent var 0.008767 S.E. of regression 0.007213 Akaike info criterion -6.764795 Sum squared resid 0.000624 Schwarz criterion -5.812472 Log likelihood 132.6191 F-statistic 1.764043 Durbin-Watson stat 2.143482 Prob(F-statistic) 0.156868