00074918.2012.694155
Bulletin of Indonesian Economic Studies
ISSN: 0007-4918 (Print) 1472-7234 (Online) Journal homepage: http://www.tandfonline.com/loi/cbie20
Economic growth and poverty reduction in
Indonesia before and after the asian financial
crisis
Asep Suryahadi , Gracia Hadiwidjaja & Sudarno Sumarto
To cite this article: Asep Suryahadi , Gracia Hadiwidjaja & Sudarno Sumarto (2012) Economic
growth and poverty reduction in Indonesia before and after the asian financial crisis, Bulletin
of Indonesian Economic Studies, 48:2, 209-227, DOI: 10.1080/00074918.2012.694155
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Date: 18 January 2016, At: 00:25
Bulletin of Indonesian Economic Studies, Vol. 48, No. 2, 2012: 209–227
ECONOMIC GROWTH AND POVERTY REDUCTION
IN INDONESIA BEFORE AND AFTER
THE ASIAN FINANCIAL CRISIS
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Asep Suryahadi, Gracia Hadiwidjaja and Sudarno Sumarto*
SMERU Research Institute, Jakarta
This paper assesses the relationship between poverty reduction and economic
growth in Indonesia before and after the Asian inancial crisis. The annual rate
of poverty reduction slowed signiicantly in the post-crisis period. However, the
trend in the growth elasticity of poverty indicates that the power of each percentage
point of economic growth to reduce poverty did not change much between the two
periods. In both, service sector growth made the largest contribution to poverty
reduction in both rural and urban areas. Industrial sector growth largely became
irrelevant for poverty reduction in the post-crisis period even though the sector
contributed the second-largest share of GDP. Agricultural sector growth, meanwhile, remained important, but in rural areas only. The indings suggest the need to
formulate an effective strategy to promote sectoral growth in order to speed up the
pace of poverty reduction.
Keywords: economic growth, poverty reduction, structural change
INTRODUCTION
In the late 1990s, the Asian economy was hit by one of the worst inancial crises
in modern history. The Asian inancial crisis of 1997–98 had long-lasting effects
in a number of Asian countries. In Indonesia, the crisis began in mid-1997 with a
sharp depreciation of the rupiah, which lost 85% of its value over the next year. In
1998 the economy contracted by 13.7% and the inlation rate rose to 78%, driven in
particular by escalating food prices, which rose by 118%. The crisis quickly spread
into the political sphere, igniting protests and mass riots against the incumbent
New Order regime in Jakarta and several other cities. The economic and political
chaos culminated in the resignation of President Soeharto in May 1998.
One of the most devastating consequences of the crisis for Indonesia was an
abrupt escalation in the poverty rate from 17.3% in 1996 to 23.4% in 1999 (see
igure 4).1 This marked a reversal in the poverty rate, which had been declining
* The authors would like to thank two anonymous referees for useful comments and suggestions, and Novita Maizir for assistance in preparing the igures.
1 In this paper, poverty is deined as monetary poverty and is measured using the current
consumption deicit approach. The poor are those whose per capita household consumption expenditure is below the poverty line.
ISSN 0007-4918 print/ISSN 1472-7234 online//12/020209-19
http://dx.doi.org/10.1080/00074918.2012.694155
© 2012 Indonesia Project ANU
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Asep Suryahadi, Gracia Hadiwidjaja and Sudarno Sumarto
continuously since oficial measurement began in 1976. Even though the economy
recovered relatively quickly from the crisis, and poverty again began to decline,
the rates of reduction did not return to those seen in the pre-crisis period when
Indonesia experienced one of the most rapid reductions of poverty in the world.
One hypothesis that has been put forward to explain the slower pace of poverty
reduction in the post-crisis period is that Indonesia has experienced a decline in its
growth elasticity of poverty – that is, a decline in the reduction in the poverty rate
associated with a percentage point of economic growth. It has been argued that
the main drivers of growth in the post-crisis period have been capital-intensive
sectors such as mining and telecommunications, which employ fewer people than
other sectors, hence depriving the poor of opportunities to beneit from a rising
economy.
This paper aims to assess the empirical evidence for the hypothesis that Indonesia has experienced a declining growth elasticity of poverty in the post-crisis
period. The analysis is based on a growth–poverty framework and focuses on
how both rates of sectoral growth and the sectoral composition of the economy
have affected poverty rates.
The remainder of the paper is structured as follows. The second section discusses the sectoral structure of the Indonesian economy. The third examines
poverty trends and the proile of poverty. The fourth evaluates the relationship
between economic growth and poverty reduction, and the ifth offers some policy
implications from the indings of the study.
THE SECTORAL STRUCTURE OF THE INDONESIAN ECONOMY
The sectoral structure of an economy can be assessed from the composition of
output or employment. In this paper, the term ‘sector’ refers to the three largest aggregations of economic activity: agriculture, industry and services.2 Over
the last decade, Indonesia’s agricultural sector has continued to absorb a signiicant share of labour but has contributed less to GDP than the other two sectors,
while the manufacturing sector has had the smallest share of employment but
the second-largest share of GDP. Driven by the rapid growth of the banking and
hospitality industries as well as a burgeoning informal sector, the services sector
now contributes the largest share of both GDP and employment.
Output
Figure 1 shows the transformation that has taken place in the Indonesian economy as the relative shares of the three sectors in GDP have changed. The share of
agriculture in output has declined continuously since the late 1960s. It fell from
46% in 1971 to 25% in 1980, a decline of 21 percentage points in just nine years,
then continued to decline to 22% in 1990 and 16% in 2000, before stabilising at
15% in 2010.
2 The agricultural sector comprises food crops, estate crops, animal husbandry, forestry
and isheries. The industrial sector consists of mining and quarrying, and manufacturing.
The services sector comprises electricity, gas and water supply; construction; trade, hotels
and restaurants; transport and communications; inance, real estate and business services;
and other services.
Economic growth and poverty reduction before and after the Asian inancial crisis
211
FIGURE 1 Share of GDP by Sector, 1971–2010
(%)
50
40
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30
20
10
0
Agriculture
1971
Industry
1980
1990
Services
2000
2010
Source: BPS, Statistik Indonesia, various years.
During the early phase of development, a clear trend of industrialisation could
be observed in the Indonesian economy. Between 1971 and 1980, the share of
industrial output more than doubled from 20% to 43%. By 1990, however, the share
had fallen back to 39%. It stabilised at 40% in 2000 but then declined once again to
reach 36% in 2010. The deterioration over the last decade can be attributed to an
unfavourable business climate for labour-intensive manufacturing industries, in
which new labour market regulations introduced after the Asian inancial crisis
created higher labour costs (Manning 2003; Bird and Manning 2008).
The services sector is clearly the leading contributor to GDP. After initially
declining from 35% in 1971 to 32% in 1980, the sector’s share of output increased
steadily to reach 39% in 1990, 45% in 2000 and 49% in 2010. This means that
around half of Indonesia’s total output is now produced by the services sector.3
Employment
Figure 2 shows structural changes in the Indonesian economy through the prism
of employment. The sectoral employment trends more or less mimic the trends
in output share described above. Relecting the decline in its share of GDP, the
share of the agricultural sector in employment fell continuously from 67% in 1971
to 41% in 2010. The pace of reduction in employment share, however, was much
slower than the pace of reduction in GDP share. As a result, labour productivity in
3 In absolute terms, both industrial and service sector output grew in the post-crisis period. But because service sector output grew much faster than industrial sector output, the
share of industry in total GDP stagnated while the share of the services sector increased.
The same was true of employment, discussed in the next sub-section.
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Asep Suryahadi, Gracia Hadiwidjaja and Sudarno Sumarto
FIGURE 2 Share of Total Employment by Sector, 1971–2010
(%)
80
60
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40
20
0
Agriculture
1971
Industry
1980
1990
Services
2000
2010
Source: BPS, Statistik Indonesia, various years.
agriculture, relative to that in the rest of the economy, also fell sharply, from 0.67
in 1971 to 0.37 in 2010.
The industrial sector expanded its share in employment from 9% in 1971 to
13% in 1980, as would be expected given its increase in GDP share. The sector’s
employment share then continued to rise to 17% in 1990 despite a decline in GDP
share, relecting the change in Indonesia’s industrial development strategy in the
mid-1980s from capital-intensive import substitution to labour-intensive export
orientation. With the sector hit hard by the Asian inancial crisis of 1997–98, industry’s share of employment declined to 14% in 2000 and remained at this level in
2010.
The share of the services sector in total employment has increased continuously
since 1971. Despite a decline in GDP share, it rose sharply during the country’s
early development phase, from 24% in 1971 to 32% in 1980. Even after a decade
of rapid expansion of manufacturing employment, the share of the services sector managed to remain stable at 33% in 1990. After the Asian inancial crisis the
sector’s share again expanded rapidly, reaching 42% in 2000. It then continued to
grow, but more slowly, to reach 45% in 2010.
Economic growth
The importance of a sector in an economy is related not only to its GDP and
employment shares, but also to its role in driving economic growth. Many studies
have emphasised the importance of economic growth in driving poverty reduction (see, for example, Dollar and Kraay 2002). In Indonesia, the rapid rates of
poverty reduction observed during the pre-crisis period are commonly attributed
to the strong economic growth at that time (Timmer 2004; Suryahadi et al. 2011).
Economic growth and poverty reduction before and after the Asian inancial crisis
213
FIGURE 3 Growth of GDP by Sector, 1984–2008
(% p.a.)
8
6
4
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2
0
-2
-4
-6
1984–96
Agriculture
1996–99
Industry
1999–2008
Services
Total
Source: Authors’ calculations based on the constant value of output in BPS, Statistik Indonesia, various
years.
In 1967 Indonesia was one of the poorest countries in the world, with a per capita income of just $50 (Agrawal 1996). But under a succession of ive-year plans
initiated in 1969, it was to become one of the world’s fastest-growing economies
over the ensuing decades. Hill (1996) has estimated that real GDP per capita in
constant 1991 dollars rose from $190 in 1965 to $610 in 1991, constituting annual
growth of 4.6%. In the late 1990s, however, the Asian inancial crisis brought this
stunning growth to a halt.
Figure 3 shows total as well as sectoral economic growth during three periods:
before the crisis (1984–96), during the crisis (1996–99) and after the crisis (1999–
2008). In the pre-crisis period, the economy grew on average by 6.8% per annum,
driven mainly by growth in the industrial and service sectors, which expanded
by 7.3% and 7.2% per annum respectively. The agricultural sector also grew at the
slower but nevertheless respectable rate of 4.7% per annum.
During the crisis, agriculture was the only sector not to suffer a contraction. It
managed to record low but positive growth of 0.2% per annum between 1996 and
1999, compared with a contraction of 3.0% for the industrial sector and an even
larger contraction of 4.6% for services. The whole economy suffered an average
contraction of 3.1% annually during this period.
In the post-crisis period, the economy rebounded to record average annual
growth of 5.1%. Much of this was driven by the services sector, which grew by
6.5% per annum. The industrial sector lost its position as a driver of economic
growth during this period, growing by only 3.9% annually, or just above the rate
for agriculture of 3.3%.
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Asep Suryahadi, Gracia Hadiwidjaja and Sudarno Sumarto
FIGURE 4 National Poverty Rate, 1976–2010 a
(%)
50
Old standard
40
New standard
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30
20
10
0
1976 1980 1984 1987 1990 1993 1996 1999 2002 2003 2004 2005 2006 2007 2008 2009 2010
a In 1998 BPS revised the method of setting the poverty line, resulting in an increase in the poverty
threshold. Recalculation of the data for 1996 using the new method raised the estimate of poverty in
that year from 11.3% to 17.3%.
Source: BPS, Statistik Indonesia, various years.
POVERTY TRENDS AND PROFILE
The rapid economic growth that occurred before the Asian inancial crisis resulted
in a steep reduction in poverty, and similar improvements in other welfare indicators such as the infant mortality rate, the school enrolment rate and life expectancy at birth. The crisis that engulfed Indonesia in 1997 and 1998 reversed these
improvements, as was apparent in particular in the large increase in poverty
recorded in 1999. After the crisis, the poverty rate resumed its downward trend,
but at a slower pace than during the pre-crisis period.
Long-term trends in poverty
The long-term trends in poverty in Indonesia are depicted in igure 4. The poverty rate is calculated by the central statistics agency, Badan Pusat Statistik (BPS),
using data collected through the National Socio-economic Survey (Susenas). BPS
bases its poverty line on the expenditure required to obtain 2,100 calories of food
per capita per day, plus an allowance for essential non-food items. The poverty
rate was calculated every three years until 2002 and has been calculated annually
since then.
Figure 4 shows a clear downward trend in poverty in Indonesia since data irst
became available in 1976. There is an apparent break in the trend around the time
of the crisis in 1997–98, however, heralding a slower pace of poverty reduction.
During the pre-crisis period (1976–96) the poverty rate fell from 40.1% to 11.3%,
a reduction of 28.8 percentage points over 20 years, or an average reduction of
1.44 percentage points per year. Leaving aside the volatile period of the crisis
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Economic growth and poverty reduction before and after the Asian inancial crisis
215
(represented by the 1999 igure), we see that the rate fell from 18.2% to 13.3%
between 2002 and 2010, a reduction of 4.9 percentage points over eight years, or
an average reduction of 0.6 percentage points per year. This means that the annual
pace of poverty reduction in the post-crisis period was only 42.5% of its pace during the pre-crisis period.
During the entire period from 1976 to 2010, there were only two occasions when
the poverty rate went up. The irst increase occurred between 1996 and 1999, as
a direct result of the Asian inancial crisis. The poverty rate rose from 17.3% in
1996 (based on the new standard) to 23.4% in 1999, as a combination of job losses,
declining incomes and hyperinlation pushed many near-poor Indonesians below
the poverty line.
The second uptrend in poverty occurred between 2005 and 2006, when soaring inlation propelled the poverty rate from 15.9% to 17.8%. This worsening of
poverty can be attributed to two factors: an increase in domestic fuel prices by an
average of 125% in October 2005, and a rise in the price of rice.
In Indonesia fuel prices are ixed by the government, with the gap between the
domestic and the international oil price covered by a government subsidy. When
the international oil price increased substantially in 2005, the amount paid out
in subsidies also rose inexorably. The pressure on the national budget became
unbearable, forcing the government to more than double domestic fuel prices in
order to reduce the fuel subsidy.
These reform measures yielded over $10 billion in annualised budgetary savings, a portion of which was allocated to additional health, education and infrastructure programs as well as an unconditional cash transfer scheme targeting
the poor and near-poor. Before the October price hike, the government allocated
Rp 5 trillion to education, Rp 3 trillion to health and Rp 3 trillion to infrastructure.
Between October 2005 and October 2006, it made payments of Rp 300,000 (about
$30) to over 19 million households, effectively embarking on the world’s largest
unconditional cash transfer program.
The other factor that has been identiied as a central cause of the increase in
poverty between 2005 and 2006 was the ban on rice imports in 2004 and the consequent increase in the domestic price of rice (World Bank 2006; McCulloch 2008;
Warr 2011). Despite the introduction of the unconditional cash transfer program
and an expansion of rice subsidies around the same time, many near-poor households were simply unable to cope with the increase in price of their single most
important consumption good, and this pushed them below the poverty line.4
Urban and rural poverty
Rural poverty still dominates the face of poverty in Indonesia, even though
around half the population now resides in urban areas. Figure 5 disaggregates
poverty by rural/urban area and shows the share of the poor residing in rural
areas. It is clear that the rural poverty rate has always been substantially higher
than the urban poverty rate. The difference has been at least six percentage points
4 Under the Rice for Poor Families program (Beras untuk Keluarga Miskin, or Raskin),
the government sells rice to poor families at heavily subsidised prices. In 2011, the oficial
Raskin price of rice was Rp 1,600 per kilogram, compared with a market price for mediumgrade rice of more than Rp 7,000 per kilogram.
216
Asep Suryahadi, Gracia Hadiwidjaja and Sudarno Sumarto
FIGURE 5 Urban and Rural Poverty Rates and
Share of the Poor Living in Rural Areas, 1996–2010
(%)
30
25
75
H
70
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20
H
H
15
H
H
H
H
H
65
10
60
5
0
1996
1998
2000
2002
2004
2006
2008
2010
55
Urban poverty rate (left axis)
Rural poverty rate (left axis)
H
Share of poor living in rural areas (right axis)
Source: BPS, Statistik Indonesia, various years.
in every year except 1998, when the Asian inancial crisis hit urban areas harder
than rural areas (Wetterberg, Sumarto and Pritchett 1999).
Between 1998 and 2010, the share of the poor residing in rural areas luctuated
around 65% (igure 5). This implies that the number of poor people living in rural
areas is almost double the number living in urban areas. Over the entire period,
however, there is some indication of an urbanisation of poverty. The share of the
poor residing in rural areas fell from 72.3% in 1996 to 64.2% in 2010, a decline of
just over eight percentage points in 14 years.
Sectoral proile of poverty
Given that poverty in Indonesia is largely a rural phenomenon, it is not surprising to ind that further disaggregation by sector indicates that it is very much
related to the agricultural sector (Alisjahbana and Manning 2006). Figure 6 traces
the share of the poor by sector of employment from 1999 to 2008. It shows that
more than half the poor worked in the agricultural sector and the majority of the
rest in the services sector.
Since the 1999 igure was affected by the Asian inancial crisis, which hit the
modern sector in urban areas hardest, trends in sectoral employment shares are
better depicted by comparing the igures from 2002 onward. They provide some
indication that poverty has been shifting out of agriculture into other sectors,
Economic growth and poverty reduction before and after the Asian inancial crisis
217
FIGURE 6 Share of the Poor by Sector of Employment, 1999–2008
(% p.a.)
60
50
40
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30
20
10
0
Agriculture
1999
Industry
2002
Services
2005
Not working
2008
Source: BPS, Statistik Indonesia, various years.
particularly services. In 2002, 57.7% of the poor were employed in the agricultural
sector but by 2008 this share had declined to 52.3%. Over the same period, the
share of the poor employed in the services sector went up substantially from 21.2%
to 31.8%. This probably qindicates that a rising share of the poor is employed in
the informal sector where around two-thirds of the Indonesian labour force work
(Alisjahbana and Manning 2006).
ECONOMIC GROWTH AND POVERTY REDUCTION
As we have seen, Indonesia experienced high economic growth and a rapid
reduction in poverty in the pre-crisis period, followed by lower economic growth
and a slower pace of poverty reduction in the post-crisis period. This section
uses a growth–poverty model to assess the possible causes of the slowdown in
poverty reduction. To achieve this objective, the analysis uses results from previous studies to examine the role of the three main economic sectors in poverty
reduction.
The growth–poverty model
In the literature on the connection between economic growth and poverty, a number of studies have focused on the relationship between the sectoral composition
of economic growth and rates of poverty reduction. These studies mainly address
the question of what kinds of growth are most beneicial for the poor and hence
most effective in reducing poverty. So far the results have been mixed, with some
studies claiming that one sector is better than others at reducing poverty and others claiming that any growth is good for the poor. Despite the different indings,
218
Asep Suryahadi, Gracia Hadiwidjaja and Sudarno Sumarto
however, there is a general consensus that the sectoral composition of economic
growth is important for poverty reduction, in addition to the rate of growth itself.
Ravallion and Datt (1996) formulated the basic model to estimate the impact of
economic growth on poverty as follows:
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dP = α + β y + ε
(1)
where P is the poverty rate and dP the change in the poverty rate; y represents
the rate of economic growth (that is, y = dy / Y , where Y is the level of GDP and dY
the change in the level of GDP); ε is an error term; and α and β are parameters.
The parameter of interest in this model is β , which shows the percentage point
change in the poverty rate associated with 1% of GDP growth.
Building on this basic model and using provincial panel data for the period
1984–99, Sumarto and Suryahadi (2007) developed a three-sector model for the
Indonesian context covering agriculture, industry and services. Suryahadi, Suryadarma and Sumarto (2009) extended the period to 2002, and split the three sectors
according to the urban or rural location of growth or poverty. This resulted in the
following six-sector model:
A A
I I
S S
A A
dPj = α + βUA ( HUj
yUj ) + βUI ( HUj
yUj ) + βUS ( HUj
yUj ) + β RA ( H Rj
y Rj )
I I
S S
+ β RI ( H Rj
y Rj ) + β RS ( H Rj
y Rj ) + γ dS j + δ Pj +
m Emj
(2)
+ε
where the superscripts A, I and S are the GDP shares (k) of agriculture, industry
and services respectively; the subscripts U and R denote urban or rural location
(l); and H ljk is the location and sectoral share of GDP in province j.5 Meanwhile,
dSj is the change in population share of province j, Pj is the initial poverty rate of
province j and Emj is a vector of initial conditions in province j.6
In equation (2), if βUA = βUI = βUS = β RA = β RI = β RS , then the location and sectoral
composition of economic growth do not have an impact on poverty. This implies
that equation (2) collapses to:
dPj = α + β y j + γ dS j + δ Pj +
m Emj
+ε ,
(3)
5 The independent variables in equation (2) are sectoral economic growth rates weighted
by sectoral GDP shares. This follows from the fact that when total economic growth in
equation (1) is decomposed into its sectoral components, they must be weighted by their
GDP shares, that is,
y j =
dY j
Yj
=
YUjA dYUjA
Yj
YUjA
+
YUjI dYUjI
Yj
YUjI
+
YUjS dYUjS
Yj
YUjS
+
YRjA dYRjA
Yj
YRjA
+
YRjI dYRjI
Yj
YRjI
+
YRjS dYRjS
Y j YRjS
.
6 The complete derivation of the model can be found in Suryahadi, Suryadarma and Sumarto (2009). Their results suggested that it was necessary to control for each province’s
change in population share and its initial poverty rate. Change in population share was
included to control for the effect of inter-provincial migration on poverty. (For more on the
importance of rural–urban migration for poverty reduction, see Resosudarmo et al. 2010.)
Following the suggestion of Datt and Ravallion (1998) and Son and Kakwani (2004), the
authors of this paper also included two control variables to account for initial conditions:
the Gini ratio as a measure of inequality, and the share of the labour force with at least nine
years of education as a measure of the level of human capital.
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Economic growth and poverty reduction before and after the Asian inancial crisis
219
which is an extended version of equation (1). But if equation (2) holds, then the
location and sectoral composition of economic growth do matter, because growth
in each sector affects poverty differently.
Using this growth–poverty model, Sumarto and Suryahadi (2007) found that
agricultural sector growth played a dominant role in poverty reduction during
the period up to and including the Asian inancial crisis (1984–99). Extending the
data to 2002, Suryahadi, Suryadarma and Sumarto (2009) found that service sector
growth had become the dominant factor in reducing poverty in both urban and
rural areas, while agricultural growth remained important, but in rural areas only.
Similar studies have been carried out for other countries. For the case of India,
Ravallion and Datt (1996) found that the agricultural sector was the most effective in reducing poverty, with 85% of the poverty reduction there attributable to
growth in that sector. Similarly, De Janvry and Sadoulet (2009) concluded that
rapid agricultural growth in Vietnam had opened pathways out of poverty for
many farming households. Cervantes-Godoy and Dewbre (2010) have argued
that agricultural growth is more effective than industrial or service sector growth
at reducing poverty in poor countries, where the majority of the poor live in rural
areas and are employed in the agricultural sector.
Other studies, however, have found that other sectors have a greater capacity to reduce poverty. Using a partial equilibrium, multi-market model for India,
Quizon and Binswanger (1986, 1989) discovered – in contrast to Ravallion and
Datt (1996) – that the agricultural growth effects of the Green Revolution had
not beneited the rural poor; they concluded that the main way to help the poor
was to raise non-agricultural rural incomes. However, Sarris (2001) has criticised
their analysis on the grounds that they only considered agricultural incomes
and did not take into account the spillover effects of agricultural growth on nonagricultural rural incomes. It is quite plausible that initial increases in agricultural
incomes would help raise non-agricultural rural incomes, which would eventually help the poor.
Based on pooled data from four Southeast Asian countries (Thailand, Indonesia, Malaysia and the Philippines), Warr (2006) found that growth of the services sector had accounted for the largest reductions in poverty in those countries.
In Taiwan, however, it was industrial sector growth that was found to have had
the greatest impact on poverty (Warr and Wang 1999).
Hasan and Quibria (2004) concluded that the sector whose growth has had the
greatest impact on poverty has differed across countries. Thus, agriculture was
the most important sector in South Asia and Sub-Saharan Africa, industry was
the most important in East Asia (including Indonesia) and services was the most
important in Latin America. In Latin America and the Caribbean, agricultural
productivity gains did not translate into lower rural poverty rates because the
gains were driven by capital, and hence created fewer employment opportunities.
Loayza and Raddatz (2010) argued that the common characteristic of povertyreducing sectors across countries was that they were labour intensive. Therefore,
any sector could drive poverty reduction as long as it was labour intensive. Based
on an analysis of data from a large number of countries, Dollar and Kraay (2002)
found that the average income of the poorest one-ifth in a country rose or fell at
the same rate as the average income of the overall population. Hence, they concluded that any growth was good for the poor.
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220
Asep Suryahadi, Gracia Hadiwidjaja and Sudarno Sumarto
Growth elasticities of poverty
In this paper, the growth elasticity of poverty refers to the percentage point change
in the poverty rate attributable to a percentage point change in economic growth.
To calculate this elasticity requires estimation of equation (2). However, the estimated coeficients are not themselves growth elasticities of poverty because the
independent variables in equation (2) are sectoral economic growth rates weighted
by sectoral GDP shares. This means that the coeficients indicate the percentage
point change in the poverty rate from sectoral economic growth of 1% multiplied
by the inverse of the sector’s GDP share. Hence, the growth elasticity of poverty
of a sector can be calculated as its estimated coeficient times its GDP share.
Suryahadi, Suryadarma and Sumarto (2009) estimated equation (2) for rural
and urban poverty separately using data from 1984 to 2002. Appendix 1 reproduces their results. Appendix 2 shows the GDP shares of agriculture, industry
and services for the period 1984–2008, as well as for the pre-crisis period (1984–96)
and the post-crisis period (2002–08).
The coeficients in appendix 1 show that there are strong cross-locational effects
of growth on poverty; that is, growth in urban areas helps reduce rural poverty
and vice versa. This is consistent with the indings of Suryahadi et al. (2009) on
the existence of strong growth linkages and multiplier effects across sectors and
locations in Indonesia. De Janvry and Sadoulet (2009) uncovered a similar phenomenon in Vietnam.7
The growth elasticity of poverty for each sector is calculated by multiplying
the coeficients in appendix 1 by the GDP shares in appendix 2. This calculation
assumes that the results shown in appendix 1 do not change if the end year is
extended from 2002 to 2008 (to align with the GDP shares for 1984–2008 shown in
appendix 2). Figure 7 shows the estimated growth elasticities of poverty in rural
areas for the whole period (1984–2008), the pre-crisis period (1984–96) and the
post-crisis period (2002–08). The period of the crisis itself is left out because of the
volatility of growth and poverty rates at this time.
For the whole period, the growth elasticity of poverty in rural areas is –0.31,
implying that 1% of economic growth reduces rural poverty by 0.31 percentage
points. Surprisingly, however, we ind that the elasticity for the post-crisis period
(–0.37) is actually higher than the elasticity for the pre-crisis period (–0.30). This
indicates that the change in the structure of GDP after the crisis did not reduce
the power of each percentage point of economic growth to reduce rural poverty,
as hypothesised, but in fact slightly increased it. Miranti (2010) also inds that the
growth elasticity of poverty in Indonesia was relatively stable during the 1984–
2002 period.
Turning to the sectoral components of growth, we see that growth in urban
services appears to have had the greatest impact on rural poverty in 1984–2008,
7 Rural–urban migration may be the mechanism by which growth in urban areas reduces
poverty in rural areas, and vice versa. The model controls for migration across provinces
but not for within-province rural–urban migration. The coeficients indicate that rural–urban migration responds to the location of sectoral growth, that is, that strong growth in
urban areas induces people to move from rural to urban areas, while strong growth in rural
areas dampens rural–urban migration. Resosudarmo et al. (2010) ind that rural migrants
generally experience improvements in welfare after moving to the cities.
Economic growth and poverty reduction before and after the Asian inancial crisis
221
FIGURE 7 Growth Elasticities of Rural Poverty, 1984–2008
0.0
-0.1
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-0.2
-0.3
-0.4
Urban
industry
Urban
services
1984–96
Rural
agriculture
2002–08
Rural
services
Total
1984–2008
Source: Authors’ calculations.
with an elasticity of –0.15, followed by rural services and rural agriculture (both
with around –0.07) and urban industry (–0.02). Growth in urban agriculture and
rural industry did not have a signiicant effect on rural poverty. Comparing the
elasticities before and after the crisis, we see that those of urban sectors slightly
increased, while those of rural sectors slightly decreased.
Figure 8 shows the estimated growth elasticities of poverty in urban areas over
the same three periods. For the whole period, the growth elasticity is –0.22, lower
than the rural elasticity of –0.31 (igure 7). Looking at the two sub-periods, we ind
that the elasticity for the post-crisis period (–0.23) is slightly higher than that for
the pre-crisis period (–0.20), as was the case for rural areas.
Turning to the sectoral components of growth in 1984–2008, we see that urban
services has the highest growth elasticity (–0.12), followed by rural services
(–0.04) and urban industry (–0.02). Comparing the pre- and post-crisis elasticities,
we again ind that the growth elasticities of urban sectors slightly increased while
those of rural sectors slightly decreased. The inding that service sector growth
plays the most important role in reducing poverty in Indonesia is similar to the
experience of Latin American countries (Hasan and Quibria 2004).
Contribution of sectors to poverty reduction
To calculate the contribution of each sector to total poverty reduction, the elasticities estimated in the previous section are multiplied by the actual growth rates
for each sector, and the results compared with the observed rate of total poverty
reduction.
Figure 9 shows the contribution of agriculture, industry and services to poverty
reduction in rural areas. It shows that around 55% of the fall in rural poverty over
222
Asep Suryahadi, Gracia Hadiwidjaja and Sudarno Sumarto
FIGURE 8 Growth Elasticities of Urban Poverty, 1984–2008
0.0
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-0.1
-0.2
-0.3
Urban
industry
Urban
services
1984–96
Rural
services
2002–08
Total
1984–2008
Source: Authors’ calculations.
FIGURE 9 Contribution of Sectors to Rural Poverty Reduction, 1984–2008
(%)
60
40
20
0
Urban
industry
Urban
services
1984–96
Source: Authors’ calculations.
Rural
agriculture
2002–08
Rural
services
1984–2008
Economic growth and poverty reduction before and after the Asian inancial crisis
223
FIGURE 10 Contribution of Sectors to Urban Poverty Reduction, 1984–2008
(%)
80
60
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40
20
0
Urban
industry
Urban
services
1984–96
2002–08
Rural
services
1984–2008
Source: Authors’ calculations.
the period 1984–2008 can be attributed to growth in urban services. Of the remainder, 25% was due to growth in rural services, 11% to growth in rural agriculture
and 9% to growth in urban industry. Comparing the periods before and after the
crisis, we see a notable increase in the contribution of rural services, from 28% to
41%, and a signiicant decline in the share of urban industry, from 10% to 2%, the
latter presumably because of the slowdown in industrial growth experienced in
the post-crisis period (igure 3). The contribution of urban services fell slightly
from 49% to 45%, and that of rural agriculture minimally from 13% to 12%.
Figure 10 shows the contribution of agriculture, industry and services to poverty reduction in urban areas. It shows that around 67% of the fall in poverty
experienced in urban areas during 1984–2008 can be attributed to growth in urban
services, with the remainder due to growth in rural services (19%) and urban
industry (15%). Comparing the periods before and after the crisis, we again see a
jump in the share of rural services, from 23% to 35%, and a fall in the contribution
of urban industry, from 16% to 4%. The contribution of urban services, meanwhile, remained stable at around 61%.
CONCLUSION AND IMPLICATIONS
This study has assessed the relationship between economic growth and poverty
reduction in Indonesia before and after the Asian inancial crisis. The annual rate
of poverty decline slowed signiicantly in the post-crisis period. However, this
study inds no evidence that the growth elasticity of poverty, that is, the percentage point reduction in poverty attributable to a percentage point increase in eco-
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224
Asep Suryahadi, Gracia Hadiwidjaja and Sudarno Sumarto
nomic growth, declined after the crisis. The slower rates of poverty reduction
observed since the crisis are therefore most likely caused partly by the country’s
lower rates of economic growth and partly by other factors such as increasing
income inequality.
When we split growth into its sectoral components, in both rural and urban
areas, we found strong cross-locational effects of growth on poverty. It appears
that each percentage point of economic growth in the urban services sector has
the greatest power to reduce poverty in both rural and urban areas. This was the
case both before and after the crisis, despite a slight decline in the sector’s contribution in the post-crisis period, and a sizeable increase in the contribution of rural
services.
Agricultural growth remains important for poverty reduction, but only in rural
areas where the majority of the poor live. Industrial growth has largely become
irrelevant for poverty reduction in the post-crisis era because of the sector’s continuing under-performance. Although it still contributes the second-largest share
of total GDP after services, industry does not absorb as much labour as either
agriculture or services. In fact, the sector’s share of employment has declined
steadily from its peak in the 1990s. The low and declining capacity of the industrial sector to absorb labour perhaps relects the increased use of labour-saving
technology, which has made industry more capital and skill-intensive since the
late 1990s (Hill 1997).
The indings of this study point to the need to formulate an effective sectoral
growth strategy to speed up the rate of poverty reduction. First, the rural services
sector has proved that it can make a very signiicant contribution to rural poverty
reduction, suggesting that it has the potential to become the leading sector for
poverty reduction in rural areas. Second, despite its relatively low growth rates,
the agricultural sector still plays an important part in reducing rural poverty. This
implies that a concerted effort to improve the sector’s performance would signiicantly increase its contribution to poverty reduction in rural areas. Third, if
the contribution of the industrial sector to poverty reduction in both urban and
rural areas is to be enhanced, not just its growth performance but also its capacity to absorb labour needs to improve. Finally, it is essential to maintain the good
growth rates of the urban services sector, which is the largest contributor to poverty reduction in both urban and rural areas.
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227
APPENDIX 1 The Impact of Sectoral GDP Growth
on Rural and Urban Poverty, 1984–2002
Rural Poverty
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Coeficient
Urban Poverty
z-value
Coeficient
z-value
Urban GDP growth
Agriculture
Industry
Services
–0.190
–0.099 **
–0.413 **
–0.83
–2.83
–4.52
0.058
–0.106 **
–0.344 **
0.32
–3.02
–4.75
Rural GDP growth
Agriculture
Industry
Services
–0.445 *
–0.102
–0.555 **
–2.19
–0.89
–5.37
–0.017
0.012
–0.294 **
–0.08
0.17
–3.81
Change in population share
Initial poverty headcount
Initial Gini ratio
Initial human capital
Constant
6.477 **
–0.143 **
–0.002
–0.264
0.138 *
3.43
–2.72
–0.01
–1.64
2.34
2.614
–0.106
0.043
–0.026
0.040
1.68
–1.86
0.30
–0.40
0.89
Number of observations
Wald chi-squared
Log likelihood ratio
132
91.43
140.88
132
51.94
176.83
** = signiicant at the 1% level; * = signiicant at the 5% level.
Source: Suryahadi, Suryadarma and Sumarto (2009).
APPENDIX 2 Share of Urban and Rural GDP by Sector, 1984–2008
(%)
Urban
Agriculture
1984–2008
1984–96
2002–08
2.22
1.72
2.68
Rural
Industry
Services
Agriculture
Industry
Services
23.26
21.69
24.75
36.19
34.18
38.61
14.79
16.56
13.00
10.32
11.28
9.02
13.21
14.57
11.93
Source: BPS, Statistik Indonesia, various years.
ISSN: 0007-4918 (Print) 1472-7234 (Online) Journal homepage: http://www.tandfonline.com/loi/cbie20
Economic growth and poverty reduction in
Indonesia before and after the asian financial
crisis
Asep Suryahadi , Gracia Hadiwidjaja & Sudarno Sumarto
To cite this article: Asep Suryahadi , Gracia Hadiwidjaja & Sudarno Sumarto (2012) Economic
growth and poverty reduction in Indonesia before and after the asian financial crisis, Bulletin
of Indonesian Economic Studies, 48:2, 209-227, DOI: 10.1080/00074918.2012.694155
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Date: 18 January 2016, At: 00:25
Bulletin of Indonesian Economic Studies, Vol. 48, No. 2, 2012: 209–227
ECONOMIC GROWTH AND POVERTY REDUCTION
IN INDONESIA BEFORE AND AFTER
THE ASIAN FINANCIAL CRISIS
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Asep Suryahadi, Gracia Hadiwidjaja and Sudarno Sumarto*
SMERU Research Institute, Jakarta
This paper assesses the relationship between poverty reduction and economic
growth in Indonesia before and after the Asian inancial crisis. The annual rate
of poverty reduction slowed signiicantly in the post-crisis period. However, the
trend in the growth elasticity of poverty indicates that the power of each percentage
point of economic growth to reduce poverty did not change much between the two
periods. In both, service sector growth made the largest contribution to poverty
reduction in both rural and urban areas. Industrial sector growth largely became
irrelevant for poverty reduction in the post-crisis period even though the sector
contributed the second-largest share of GDP. Agricultural sector growth, meanwhile, remained important, but in rural areas only. The indings suggest the need to
formulate an effective strategy to promote sectoral growth in order to speed up the
pace of poverty reduction.
Keywords: economic growth, poverty reduction, structural change
INTRODUCTION
In the late 1990s, the Asian economy was hit by one of the worst inancial crises
in modern history. The Asian inancial crisis of 1997–98 had long-lasting effects
in a number of Asian countries. In Indonesia, the crisis began in mid-1997 with a
sharp depreciation of the rupiah, which lost 85% of its value over the next year. In
1998 the economy contracted by 13.7% and the inlation rate rose to 78%, driven in
particular by escalating food prices, which rose by 118%. The crisis quickly spread
into the political sphere, igniting protests and mass riots against the incumbent
New Order regime in Jakarta and several other cities. The economic and political
chaos culminated in the resignation of President Soeharto in May 1998.
One of the most devastating consequences of the crisis for Indonesia was an
abrupt escalation in the poverty rate from 17.3% in 1996 to 23.4% in 1999 (see
igure 4).1 This marked a reversal in the poverty rate, which had been declining
* The authors would like to thank two anonymous referees for useful comments and suggestions, and Novita Maizir for assistance in preparing the igures.
1 In this paper, poverty is deined as monetary poverty and is measured using the current
consumption deicit approach. The poor are those whose per capita household consumption expenditure is below the poverty line.
ISSN 0007-4918 print/ISSN 1472-7234 online//12/020209-19
http://dx.doi.org/10.1080/00074918.2012.694155
© 2012 Indonesia Project ANU
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210
Asep Suryahadi, Gracia Hadiwidjaja and Sudarno Sumarto
continuously since oficial measurement began in 1976. Even though the economy
recovered relatively quickly from the crisis, and poverty again began to decline,
the rates of reduction did not return to those seen in the pre-crisis period when
Indonesia experienced one of the most rapid reductions of poverty in the world.
One hypothesis that has been put forward to explain the slower pace of poverty
reduction in the post-crisis period is that Indonesia has experienced a decline in its
growth elasticity of poverty – that is, a decline in the reduction in the poverty rate
associated with a percentage point of economic growth. It has been argued that
the main drivers of growth in the post-crisis period have been capital-intensive
sectors such as mining and telecommunications, which employ fewer people than
other sectors, hence depriving the poor of opportunities to beneit from a rising
economy.
This paper aims to assess the empirical evidence for the hypothesis that Indonesia has experienced a declining growth elasticity of poverty in the post-crisis
period. The analysis is based on a growth–poverty framework and focuses on
how both rates of sectoral growth and the sectoral composition of the economy
have affected poverty rates.
The remainder of the paper is structured as follows. The second section discusses the sectoral structure of the Indonesian economy. The third examines
poverty trends and the proile of poverty. The fourth evaluates the relationship
between economic growth and poverty reduction, and the ifth offers some policy
implications from the indings of the study.
THE SECTORAL STRUCTURE OF THE INDONESIAN ECONOMY
The sectoral structure of an economy can be assessed from the composition of
output or employment. In this paper, the term ‘sector’ refers to the three largest aggregations of economic activity: agriculture, industry and services.2 Over
the last decade, Indonesia’s agricultural sector has continued to absorb a signiicant share of labour but has contributed less to GDP than the other two sectors,
while the manufacturing sector has had the smallest share of employment but
the second-largest share of GDP. Driven by the rapid growth of the banking and
hospitality industries as well as a burgeoning informal sector, the services sector
now contributes the largest share of both GDP and employment.
Output
Figure 1 shows the transformation that has taken place in the Indonesian economy as the relative shares of the three sectors in GDP have changed. The share of
agriculture in output has declined continuously since the late 1960s. It fell from
46% in 1971 to 25% in 1980, a decline of 21 percentage points in just nine years,
then continued to decline to 22% in 1990 and 16% in 2000, before stabilising at
15% in 2010.
2 The agricultural sector comprises food crops, estate crops, animal husbandry, forestry
and isheries. The industrial sector consists of mining and quarrying, and manufacturing.
The services sector comprises electricity, gas and water supply; construction; trade, hotels
and restaurants; transport and communications; inance, real estate and business services;
and other services.
Economic growth and poverty reduction before and after the Asian inancial crisis
211
FIGURE 1 Share of GDP by Sector, 1971–2010
(%)
50
40
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30
20
10
0
Agriculture
1971
Industry
1980
1990
Services
2000
2010
Source: BPS, Statistik Indonesia, various years.
During the early phase of development, a clear trend of industrialisation could
be observed in the Indonesian economy. Between 1971 and 1980, the share of
industrial output more than doubled from 20% to 43%. By 1990, however, the share
had fallen back to 39%. It stabilised at 40% in 2000 but then declined once again to
reach 36% in 2010. The deterioration over the last decade can be attributed to an
unfavourable business climate for labour-intensive manufacturing industries, in
which new labour market regulations introduced after the Asian inancial crisis
created higher labour costs (Manning 2003; Bird and Manning 2008).
The services sector is clearly the leading contributor to GDP. After initially
declining from 35% in 1971 to 32% in 1980, the sector’s share of output increased
steadily to reach 39% in 1990, 45% in 2000 and 49% in 2010. This means that
around half of Indonesia’s total output is now produced by the services sector.3
Employment
Figure 2 shows structural changes in the Indonesian economy through the prism
of employment. The sectoral employment trends more or less mimic the trends
in output share described above. Relecting the decline in its share of GDP, the
share of the agricultural sector in employment fell continuously from 67% in 1971
to 41% in 2010. The pace of reduction in employment share, however, was much
slower than the pace of reduction in GDP share. As a result, labour productivity in
3 In absolute terms, both industrial and service sector output grew in the post-crisis period. But because service sector output grew much faster than industrial sector output, the
share of industry in total GDP stagnated while the share of the services sector increased.
The same was true of employment, discussed in the next sub-section.
212
Asep Suryahadi, Gracia Hadiwidjaja and Sudarno Sumarto
FIGURE 2 Share of Total Employment by Sector, 1971–2010
(%)
80
60
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40
20
0
Agriculture
1971
Industry
1980
1990
Services
2000
2010
Source: BPS, Statistik Indonesia, various years.
agriculture, relative to that in the rest of the economy, also fell sharply, from 0.67
in 1971 to 0.37 in 2010.
The industrial sector expanded its share in employment from 9% in 1971 to
13% in 1980, as would be expected given its increase in GDP share. The sector’s
employment share then continued to rise to 17% in 1990 despite a decline in GDP
share, relecting the change in Indonesia’s industrial development strategy in the
mid-1980s from capital-intensive import substitution to labour-intensive export
orientation. With the sector hit hard by the Asian inancial crisis of 1997–98, industry’s share of employment declined to 14% in 2000 and remained at this level in
2010.
The share of the services sector in total employment has increased continuously
since 1971. Despite a decline in GDP share, it rose sharply during the country’s
early development phase, from 24% in 1971 to 32% in 1980. Even after a decade
of rapid expansion of manufacturing employment, the share of the services sector managed to remain stable at 33% in 1990. After the Asian inancial crisis the
sector’s share again expanded rapidly, reaching 42% in 2000. It then continued to
grow, but more slowly, to reach 45% in 2010.
Economic growth
The importance of a sector in an economy is related not only to its GDP and
employment shares, but also to its role in driving economic growth. Many studies
have emphasised the importance of economic growth in driving poverty reduction (see, for example, Dollar and Kraay 2002). In Indonesia, the rapid rates of
poverty reduction observed during the pre-crisis period are commonly attributed
to the strong economic growth at that time (Timmer 2004; Suryahadi et al. 2011).
Economic growth and poverty reduction before and after the Asian inancial crisis
213
FIGURE 3 Growth of GDP by Sector, 1984–2008
(% p.a.)
8
6
4
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2
0
-2
-4
-6
1984–96
Agriculture
1996–99
Industry
1999–2008
Services
Total
Source: Authors’ calculations based on the constant value of output in BPS, Statistik Indonesia, various
years.
In 1967 Indonesia was one of the poorest countries in the world, with a per capita income of just $50 (Agrawal 1996). But under a succession of ive-year plans
initiated in 1969, it was to become one of the world’s fastest-growing economies
over the ensuing decades. Hill (1996) has estimated that real GDP per capita in
constant 1991 dollars rose from $190 in 1965 to $610 in 1991, constituting annual
growth of 4.6%. In the late 1990s, however, the Asian inancial crisis brought this
stunning growth to a halt.
Figure 3 shows total as well as sectoral economic growth during three periods:
before the crisis (1984–96), during the crisis (1996–99) and after the crisis (1999–
2008). In the pre-crisis period, the economy grew on average by 6.8% per annum,
driven mainly by growth in the industrial and service sectors, which expanded
by 7.3% and 7.2% per annum respectively. The agricultural sector also grew at the
slower but nevertheless respectable rate of 4.7% per annum.
During the crisis, agriculture was the only sector not to suffer a contraction. It
managed to record low but positive growth of 0.2% per annum between 1996 and
1999, compared with a contraction of 3.0% for the industrial sector and an even
larger contraction of 4.6% for services. The whole economy suffered an average
contraction of 3.1% annually during this period.
In the post-crisis period, the economy rebounded to record average annual
growth of 5.1%. Much of this was driven by the services sector, which grew by
6.5% per annum. The industrial sector lost its position as a driver of economic
growth during this period, growing by only 3.9% annually, or just above the rate
for agriculture of 3.3%.
214
Asep Suryahadi, Gracia Hadiwidjaja and Sudarno Sumarto
FIGURE 4 National Poverty Rate, 1976–2010 a
(%)
50
Old standard
40
New standard
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30
20
10
0
1976 1980 1984 1987 1990 1993 1996 1999 2002 2003 2004 2005 2006 2007 2008 2009 2010
a In 1998 BPS revised the method of setting the poverty line, resulting in an increase in the poverty
threshold. Recalculation of the data for 1996 using the new method raised the estimate of poverty in
that year from 11.3% to 17.3%.
Source: BPS, Statistik Indonesia, various years.
POVERTY TRENDS AND PROFILE
The rapid economic growth that occurred before the Asian inancial crisis resulted
in a steep reduction in poverty, and similar improvements in other welfare indicators such as the infant mortality rate, the school enrolment rate and life expectancy at birth. The crisis that engulfed Indonesia in 1997 and 1998 reversed these
improvements, as was apparent in particular in the large increase in poverty
recorded in 1999. After the crisis, the poverty rate resumed its downward trend,
but at a slower pace than during the pre-crisis period.
Long-term trends in poverty
The long-term trends in poverty in Indonesia are depicted in igure 4. The poverty rate is calculated by the central statistics agency, Badan Pusat Statistik (BPS),
using data collected through the National Socio-economic Survey (Susenas). BPS
bases its poverty line on the expenditure required to obtain 2,100 calories of food
per capita per day, plus an allowance for essential non-food items. The poverty
rate was calculated every three years until 2002 and has been calculated annually
since then.
Figure 4 shows a clear downward trend in poverty in Indonesia since data irst
became available in 1976. There is an apparent break in the trend around the time
of the crisis in 1997–98, however, heralding a slower pace of poverty reduction.
During the pre-crisis period (1976–96) the poverty rate fell from 40.1% to 11.3%,
a reduction of 28.8 percentage points over 20 years, or an average reduction of
1.44 percentage points per year. Leaving aside the volatile period of the crisis
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Economic growth and poverty reduction before and after the Asian inancial crisis
215
(represented by the 1999 igure), we see that the rate fell from 18.2% to 13.3%
between 2002 and 2010, a reduction of 4.9 percentage points over eight years, or
an average reduction of 0.6 percentage points per year. This means that the annual
pace of poverty reduction in the post-crisis period was only 42.5% of its pace during the pre-crisis period.
During the entire period from 1976 to 2010, there were only two occasions when
the poverty rate went up. The irst increase occurred between 1996 and 1999, as
a direct result of the Asian inancial crisis. The poverty rate rose from 17.3% in
1996 (based on the new standard) to 23.4% in 1999, as a combination of job losses,
declining incomes and hyperinlation pushed many near-poor Indonesians below
the poverty line.
The second uptrend in poverty occurred between 2005 and 2006, when soaring inlation propelled the poverty rate from 15.9% to 17.8%. This worsening of
poverty can be attributed to two factors: an increase in domestic fuel prices by an
average of 125% in October 2005, and a rise in the price of rice.
In Indonesia fuel prices are ixed by the government, with the gap between the
domestic and the international oil price covered by a government subsidy. When
the international oil price increased substantially in 2005, the amount paid out
in subsidies also rose inexorably. The pressure on the national budget became
unbearable, forcing the government to more than double domestic fuel prices in
order to reduce the fuel subsidy.
These reform measures yielded over $10 billion in annualised budgetary savings, a portion of which was allocated to additional health, education and infrastructure programs as well as an unconditional cash transfer scheme targeting
the poor and near-poor. Before the October price hike, the government allocated
Rp 5 trillion to education, Rp 3 trillion to health and Rp 3 trillion to infrastructure.
Between October 2005 and October 2006, it made payments of Rp 300,000 (about
$30) to over 19 million households, effectively embarking on the world’s largest
unconditional cash transfer program.
The other factor that has been identiied as a central cause of the increase in
poverty between 2005 and 2006 was the ban on rice imports in 2004 and the consequent increase in the domestic price of rice (World Bank 2006; McCulloch 2008;
Warr 2011). Despite the introduction of the unconditional cash transfer program
and an expansion of rice subsidies around the same time, many near-poor households were simply unable to cope with the increase in price of their single most
important consumption good, and this pushed them below the poverty line.4
Urban and rural poverty
Rural poverty still dominates the face of poverty in Indonesia, even though
around half the population now resides in urban areas. Figure 5 disaggregates
poverty by rural/urban area and shows the share of the poor residing in rural
areas. It is clear that the rural poverty rate has always been substantially higher
than the urban poverty rate. The difference has been at least six percentage points
4 Under the Rice for Poor Families program (Beras untuk Keluarga Miskin, or Raskin),
the government sells rice to poor families at heavily subsidised prices. In 2011, the oficial
Raskin price of rice was Rp 1,600 per kilogram, compared with a market price for mediumgrade rice of more than Rp 7,000 per kilogram.
216
Asep Suryahadi, Gracia Hadiwidjaja and Sudarno Sumarto
FIGURE 5 Urban and Rural Poverty Rates and
Share of the Poor Living in Rural Areas, 1996–2010
(%)
30
25
75
H
70
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20
H
H
15
H
H
H
H
H
65
10
60
5
0
1996
1998
2000
2002
2004
2006
2008
2010
55
Urban poverty rate (left axis)
Rural poverty rate (left axis)
H
Share of poor living in rural areas (right axis)
Source: BPS, Statistik Indonesia, various years.
in every year except 1998, when the Asian inancial crisis hit urban areas harder
than rural areas (Wetterberg, Sumarto and Pritchett 1999).
Between 1998 and 2010, the share of the poor residing in rural areas luctuated
around 65% (igure 5). This implies that the number of poor people living in rural
areas is almost double the number living in urban areas. Over the entire period,
however, there is some indication of an urbanisation of poverty. The share of the
poor residing in rural areas fell from 72.3% in 1996 to 64.2% in 2010, a decline of
just over eight percentage points in 14 years.
Sectoral proile of poverty
Given that poverty in Indonesia is largely a rural phenomenon, it is not surprising to ind that further disaggregation by sector indicates that it is very much
related to the agricultural sector (Alisjahbana and Manning 2006). Figure 6 traces
the share of the poor by sector of employment from 1999 to 2008. It shows that
more than half the poor worked in the agricultural sector and the majority of the
rest in the services sector.
Since the 1999 igure was affected by the Asian inancial crisis, which hit the
modern sector in urban areas hardest, trends in sectoral employment shares are
better depicted by comparing the igures from 2002 onward. They provide some
indication that poverty has been shifting out of agriculture into other sectors,
Economic growth and poverty reduction before and after the Asian inancial crisis
217
FIGURE 6 Share of the Poor by Sector of Employment, 1999–2008
(% p.a.)
60
50
40
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30
20
10
0
Agriculture
1999
Industry
2002
Services
2005
Not working
2008
Source: BPS, Statistik Indonesia, various years.
particularly services. In 2002, 57.7% of the poor were employed in the agricultural
sector but by 2008 this share had declined to 52.3%. Over the same period, the
share of the poor employed in the services sector went up substantially from 21.2%
to 31.8%. This probably qindicates that a rising share of the poor is employed in
the informal sector where around two-thirds of the Indonesian labour force work
(Alisjahbana and Manning 2006).
ECONOMIC GROWTH AND POVERTY REDUCTION
As we have seen, Indonesia experienced high economic growth and a rapid
reduction in poverty in the pre-crisis period, followed by lower economic growth
and a slower pace of poverty reduction in the post-crisis period. This section
uses a growth–poverty model to assess the possible causes of the slowdown in
poverty reduction. To achieve this objective, the analysis uses results from previous studies to examine the role of the three main economic sectors in poverty
reduction.
The growth–poverty model
In the literature on the connection between economic growth and poverty, a number of studies have focused on the relationship between the sectoral composition
of economic growth and rates of poverty reduction. These studies mainly address
the question of what kinds of growth are most beneicial for the poor and hence
most effective in reducing poverty. So far the results have been mixed, with some
studies claiming that one sector is better than others at reducing poverty and others claiming that any growth is good for the poor. Despite the different indings,
218
Asep Suryahadi, Gracia Hadiwidjaja and Sudarno Sumarto
however, there is a general consensus that the sectoral composition of economic
growth is important for poverty reduction, in addition to the rate of growth itself.
Ravallion and Datt (1996) formulated the basic model to estimate the impact of
economic growth on poverty as follows:
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dP = α + β y + ε
(1)
where P is the poverty rate and dP the change in the poverty rate; y represents
the rate of economic growth (that is, y = dy / Y , where Y is the level of GDP and dY
the change in the level of GDP); ε is an error term; and α and β are parameters.
The parameter of interest in this model is β , which shows the percentage point
change in the poverty rate associated with 1% of GDP growth.
Building on this basic model and using provincial panel data for the period
1984–99, Sumarto and Suryahadi (2007) developed a three-sector model for the
Indonesian context covering agriculture, industry and services. Suryahadi, Suryadarma and Sumarto (2009) extended the period to 2002, and split the three sectors
according to the urban or rural location of growth or poverty. This resulted in the
following six-sector model:
A A
I I
S S
A A
dPj = α + βUA ( HUj
yUj ) + βUI ( HUj
yUj ) + βUS ( HUj
yUj ) + β RA ( H Rj
y Rj )
I I
S S
+ β RI ( H Rj
y Rj ) + β RS ( H Rj
y Rj ) + γ dS j + δ Pj +
m Emj
(2)
+ε
where the superscripts A, I and S are the GDP shares (k) of agriculture, industry
and services respectively; the subscripts U and R denote urban or rural location
(l); and H ljk is the location and sectoral share of GDP in province j.5 Meanwhile,
dSj is the change in population share of province j, Pj is the initial poverty rate of
province j and Emj is a vector of initial conditions in province j.6
In equation (2), if βUA = βUI = βUS = β RA = β RI = β RS , then the location and sectoral
composition of economic growth do not have an impact on poverty. This implies
that equation (2) collapses to:
dPj = α + β y j + γ dS j + δ Pj +
m Emj
+ε ,
(3)
5 The independent variables in equation (2) are sectoral economic growth rates weighted
by sectoral GDP shares. This follows from the fact that when total economic growth in
equation (1) is decomposed into its sectoral components, they must be weighted by their
GDP shares, that is,
y j =
dY j
Yj
=
YUjA dYUjA
Yj
YUjA
+
YUjI dYUjI
Yj
YUjI
+
YUjS dYUjS
Yj
YUjS
+
YRjA dYRjA
Yj
YRjA
+
YRjI dYRjI
Yj
YRjI
+
YRjS dYRjS
Y j YRjS
.
6 The complete derivation of the model can be found in Suryahadi, Suryadarma and Sumarto (2009). Their results suggested that it was necessary to control for each province’s
change in population share and its initial poverty rate. Change in population share was
included to control for the effect of inter-provincial migration on poverty. (For more on the
importance of rural–urban migration for poverty reduction, see Resosudarmo et al. 2010.)
Following the suggestion of Datt and Ravallion (1998) and Son and Kakwani (2004), the
authors of this paper also included two control variables to account for initial conditions:
the Gini ratio as a measure of inequality, and the share of the labour force with at least nine
years of education as a measure of the level of human capital.
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Economic growth and poverty reduction before and after the Asian inancial crisis
219
which is an extended version of equation (1). But if equation (2) holds, then the
location and sectoral composition of economic growth do matter, because growth
in each sector affects poverty differently.
Using this growth–poverty model, Sumarto and Suryahadi (2007) found that
agricultural sector growth played a dominant role in poverty reduction during
the period up to and including the Asian inancial crisis (1984–99). Extending the
data to 2002, Suryahadi, Suryadarma and Sumarto (2009) found that service sector
growth had become the dominant factor in reducing poverty in both urban and
rural areas, while agricultural growth remained important, but in rural areas only.
Similar studies have been carried out for other countries. For the case of India,
Ravallion and Datt (1996) found that the agricultural sector was the most effective in reducing poverty, with 85% of the poverty reduction there attributable to
growth in that sector. Similarly, De Janvry and Sadoulet (2009) concluded that
rapid agricultural growth in Vietnam had opened pathways out of poverty for
many farming households. Cervantes-Godoy and Dewbre (2010) have argued
that agricultural growth is more effective than industrial or service sector growth
at reducing poverty in poor countries, where the majority of the poor live in rural
areas and are employed in the agricultural sector.
Other studies, however, have found that other sectors have a greater capacity to reduce poverty. Using a partial equilibrium, multi-market model for India,
Quizon and Binswanger (1986, 1989) discovered – in contrast to Ravallion and
Datt (1996) – that the agricultural growth effects of the Green Revolution had
not beneited the rural poor; they concluded that the main way to help the poor
was to raise non-agricultural rural incomes. However, Sarris (2001) has criticised
their analysis on the grounds that they only considered agricultural incomes
and did not take into account the spillover effects of agricultural growth on nonagricultural rural incomes. It is quite plausible that initial increases in agricultural
incomes would help raise non-agricultural rural incomes, which would eventually help the poor.
Based on pooled data from four Southeast Asian countries (Thailand, Indonesia, Malaysia and the Philippines), Warr (2006) found that growth of the services sector had accounted for the largest reductions in poverty in those countries.
In Taiwan, however, it was industrial sector growth that was found to have had
the greatest impact on poverty (Warr and Wang 1999).
Hasan and Quibria (2004) concluded that the sector whose growth has had the
greatest impact on poverty has differed across countries. Thus, agriculture was
the most important sector in South Asia and Sub-Saharan Africa, industry was
the most important in East Asia (including Indonesia) and services was the most
important in Latin America. In Latin America and the Caribbean, agricultural
productivity gains did not translate into lower rural poverty rates because the
gains were driven by capital, and hence created fewer employment opportunities.
Loayza and Raddatz (2010) argued that the common characteristic of povertyreducing sectors across countries was that they were labour intensive. Therefore,
any sector could drive poverty reduction as long as it was labour intensive. Based
on an analysis of data from a large number of countries, Dollar and Kraay (2002)
found that the average income of the poorest one-ifth in a country rose or fell at
the same rate as the average income of the overall population. Hence, they concluded that any growth was good for the poor.
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220
Asep Suryahadi, Gracia Hadiwidjaja and Sudarno Sumarto
Growth elasticities of poverty
In this paper, the growth elasticity of poverty refers to the percentage point change
in the poverty rate attributable to a percentage point change in economic growth.
To calculate this elasticity requires estimation of equation (2). However, the estimated coeficients are not themselves growth elasticities of poverty because the
independent variables in equation (2) are sectoral economic growth rates weighted
by sectoral GDP shares. This means that the coeficients indicate the percentage
point change in the poverty rate from sectoral economic growth of 1% multiplied
by the inverse of the sector’s GDP share. Hence, the growth elasticity of poverty
of a sector can be calculated as its estimated coeficient times its GDP share.
Suryahadi, Suryadarma and Sumarto (2009) estimated equation (2) for rural
and urban poverty separately using data from 1984 to 2002. Appendix 1 reproduces their results. Appendix 2 shows the GDP shares of agriculture, industry
and services for the period 1984–2008, as well as for the pre-crisis period (1984–96)
and the post-crisis period (2002–08).
The coeficients in appendix 1 show that there are strong cross-locational effects
of growth on poverty; that is, growth in urban areas helps reduce rural poverty
and vice versa. This is consistent with the indings of Suryahadi et al. (2009) on
the existence of strong growth linkages and multiplier effects across sectors and
locations in Indonesia. De Janvry and Sadoulet (2009) uncovered a similar phenomenon in Vietnam.7
The growth elasticity of poverty for each sector is calculated by multiplying
the coeficients in appendix 1 by the GDP shares in appendix 2. This calculation
assumes that the results shown in appendix 1 do not change if the end year is
extended from 2002 to 2008 (to align with the GDP shares for 1984–2008 shown in
appendix 2). Figure 7 shows the estimated growth elasticities of poverty in rural
areas for the whole period (1984–2008), the pre-crisis period (1984–96) and the
post-crisis period (2002–08). The period of the crisis itself is left out because of the
volatility of growth and poverty rates at this time.
For the whole period, the growth elasticity of poverty in rural areas is –0.31,
implying that 1% of economic growth reduces rural poverty by 0.31 percentage
points. Surprisingly, however, we ind that the elasticity for the post-crisis period
(–0.37) is actually higher than the elasticity for the pre-crisis period (–0.30). This
indicates that the change in the structure of GDP after the crisis did not reduce
the power of each percentage point of economic growth to reduce rural poverty,
as hypothesised, but in fact slightly increased it. Miranti (2010) also inds that the
growth elasticity of poverty in Indonesia was relatively stable during the 1984–
2002 period.
Turning to the sectoral components of growth, we see that growth in urban
services appears to have had the greatest impact on rural poverty in 1984–2008,
7 Rural–urban migration may be the mechanism by which growth in urban areas reduces
poverty in rural areas, and vice versa. The model controls for migration across provinces
but not for within-province rural–urban migration. The coeficients indicate that rural–urban migration responds to the location of sectoral growth, that is, that strong growth in
urban areas induces people to move from rural to urban areas, while strong growth in rural
areas dampens rural–urban migration. Resosudarmo et al. (2010) ind that rural migrants
generally experience improvements in welfare after moving to the cities.
Economic growth and poverty reduction before and after the Asian inancial crisis
221
FIGURE 7 Growth Elasticities of Rural Poverty, 1984–2008
0.0
-0.1
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-0.2
-0.3
-0.4
Urban
industry
Urban
services
1984–96
Rural
agriculture
2002–08
Rural
services
Total
1984–2008
Source: Authors’ calculations.
with an elasticity of –0.15, followed by rural services and rural agriculture (both
with around –0.07) and urban industry (–0.02). Growth in urban agriculture and
rural industry did not have a signiicant effect on rural poverty. Comparing the
elasticities before and after the crisis, we see that those of urban sectors slightly
increased, while those of rural sectors slightly decreased.
Figure 8 shows the estimated growth elasticities of poverty in urban areas over
the same three periods. For the whole period, the growth elasticity is –0.22, lower
than the rural elasticity of –0.31 (igure 7). Looking at the two sub-periods, we ind
that the elasticity for the post-crisis period (–0.23) is slightly higher than that for
the pre-crisis period (–0.20), as was the case for rural areas.
Turning to the sectoral components of growth in 1984–2008, we see that urban
services has the highest growth elasticity (–0.12), followed by rural services
(–0.04) and urban industry (–0.02). Comparing the pre- and post-crisis elasticities,
we again ind that the growth elasticities of urban sectors slightly increased while
those of rural sectors slightly decreased. The inding that service sector growth
plays the most important role in reducing poverty in Indonesia is similar to the
experience of Latin American countries (Hasan and Quibria 2004).
Contribution of sectors to poverty reduction
To calculate the contribution of each sector to total poverty reduction, the elasticities estimated in the previous section are multiplied by the actual growth rates
for each sector, and the results compared with the observed rate of total poverty
reduction.
Figure 9 shows the contribution of agriculture, industry and services to poverty
reduction in rural areas. It shows that around 55% of the fall in rural poverty over
222
Asep Suryahadi, Gracia Hadiwidjaja and Sudarno Sumarto
FIGURE 8 Growth Elasticities of Urban Poverty, 1984–2008
0.0
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-0.1
-0.2
-0.3
Urban
industry
Urban
services
1984–96
Rural
services
2002–08
Total
1984–2008
Source: Authors’ calculations.
FIGURE 9 Contribution of Sectors to Rural Poverty Reduction, 1984–2008
(%)
60
40
20
0
Urban
industry
Urban
services
1984–96
Source: Authors’ calculations.
Rural
agriculture
2002–08
Rural
services
1984–2008
Economic growth and poverty reduction before and after the Asian inancial crisis
223
FIGURE 10 Contribution of Sectors to Urban Poverty Reduction, 1984–2008
(%)
80
60
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40
20
0
Urban
industry
Urban
services
1984–96
2002–08
Rural
services
1984–2008
Source: Authors’ calculations.
the period 1984–2008 can be attributed to growth in urban services. Of the remainder, 25% was due to growth in rural services, 11% to growth in rural agriculture
and 9% to growth in urban industry. Comparing the periods before and after the
crisis, we see a notable increase in the contribution of rural services, from 28% to
41%, and a signiicant decline in the share of urban industry, from 10% to 2%, the
latter presumably because of the slowdown in industrial growth experienced in
the post-crisis period (igure 3). The contribution of urban services fell slightly
from 49% to 45%, and that of rural agriculture minimally from 13% to 12%.
Figure 10 shows the contribution of agriculture, industry and services to poverty reduction in urban areas. It shows that around 67% of the fall in poverty
experienced in urban areas during 1984–2008 can be attributed to growth in urban
services, with the remainder due to growth in rural services (19%) and urban
industry (15%). Comparing the periods before and after the crisis, we again see a
jump in the share of rural services, from 23% to 35%, and a fall in the contribution
of urban industry, from 16% to 4%. The contribution of urban services, meanwhile, remained stable at around 61%.
CONCLUSION AND IMPLICATIONS
This study has assessed the relationship between economic growth and poverty
reduction in Indonesia before and after the Asian inancial crisis. The annual rate
of poverty decline slowed signiicantly in the post-crisis period. However, this
study inds no evidence that the growth elasticity of poverty, that is, the percentage point reduction in poverty attributable to a percentage point increase in eco-
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224
Asep Suryahadi, Gracia Hadiwidjaja and Sudarno Sumarto
nomic growth, declined after the crisis. The slower rates of poverty reduction
observed since the crisis are therefore most likely caused partly by the country’s
lower rates of economic growth and partly by other factors such as increasing
income inequality.
When we split growth into its sectoral components, in both rural and urban
areas, we found strong cross-locational effects of growth on poverty. It appears
that each percentage point of economic growth in the urban services sector has
the greatest power to reduce poverty in both rural and urban areas. This was the
case both before and after the crisis, despite a slight decline in the sector’s contribution in the post-crisis period, and a sizeable increase in the contribution of rural
services.
Agricultural growth remains important for poverty reduction, but only in rural
areas where the majority of the poor live. Industrial growth has largely become
irrelevant for poverty reduction in the post-crisis era because of the sector’s continuing under-performance. Although it still contributes the second-largest share
of total GDP after services, industry does not absorb as much labour as either
agriculture or services. In fact, the sector’s share of employment has declined
steadily from its peak in the 1990s. The low and declining capacity of the industrial sector to absorb labour perhaps relects the increased use of labour-saving
technology, which has made industry more capital and skill-intensive since the
late 1990s (Hill 1997).
The indings of this study point to the need to formulate an effective sectoral
growth strategy to speed up the rate of poverty reduction. First, the rural services
sector has proved that it can make a very signiicant contribution to rural poverty
reduction, suggesting that it has the potential to become the leading sector for
poverty reduction in rural areas. Second, despite its relatively low growth rates,
the agricultural sector still plays an important part in reducing rural poverty. This
implies that a concerted effort to improve the sector’s performance would signiicantly increase its contribution to poverty reduction in rural areas. Third, if
the contribution of the industrial sector to poverty reduction in both urban and
rural areas is to be enhanced, not just its growth performance but also its capacity to absorb labour needs to improve. Finally, it is essential to maintain the good
growth rates of the urban services sector, which is the largest contributor to poverty reduction in both urban and rural areas.
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Economic growth and poverty reduction before and after the Asian inancial crisis
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APPENDIX 1 The Impact of Sectoral GDP Growth
on Rural and Urban Poverty, 1984–2002
Rural Poverty
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Coeficient
Urban Poverty
z-value
Coeficient
z-value
Urban GDP growth
Agriculture
Industry
Services
–0.190
–0.099 **
–0.413 **
–0.83
–2.83
–4.52
0.058
–0.106 **
–0.344 **
0.32
–3.02
–4.75
Rural GDP growth
Agriculture
Industry
Services
–0.445 *
–0.102
–0.555 **
–2.19
–0.89
–5.37
–0.017
0.012
–0.294 **
–0.08
0.17
–3.81
Change in population share
Initial poverty headcount
Initial Gini ratio
Initial human capital
Constant
6.477 **
–0.143 **
–0.002
–0.264
0.138 *
3.43
–2.72
–0.01
–1.64
2.34
2.614
–0.106
0.043
–0.026
0.040
1.68
–1.86
0.30
–0.40
0.89
Number of observations
Wald chi-squared
Log likelihood ratio
132
91.43
140.88
132
51.94
176.83
** = signiicant at the 1% level; * = signiicant at the 5% level.
Source: Suryahadi, Suryadarma and Sumarto (2009).
APPENDIX 2 Share of Urban and Rural GDP by Sector, 1984–2008
(%)
Urban
Agriculture
1984–2008
1984–96
2002–08
2.22
1.72
2.68
Rural
Industry
Services
Agriculture
Industry
Services
23.26
21.69
24.75
36.19
34.18
38.61
14.79
16.56
13.00
10.32
11.28
9.02
13.21
14.57
11.93
Source: BPS, Statistik Indonesia, various years.