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LONG TERM TRENDS IN THE INDUSTRIAL AND ECONOMIC GROWTH IN INDONESIA
Tulus Tambunan
Kadin Indonesia & Center for Industry and SME Studies, University of Trisakti
Indonesia 1
ABSTRACT
Before the 1997/98 economic crisis, Indonesia was included as a new Asian Tiger together with Malaysia and
Thailand Tiger and was a model to other developing countries for her achievements in rapid and sustained
economic growth and rapid structural change. This study is an analysis of the long terms trends in Indonesian
economic growth during the period 1970-2000. It is concerned with the growth of the different sectors of the
economy, especially manufacturing industry, and the sources of growth. What is observed is that during that
period, the Indonesian economy has undergone the massive structural transformation from an economy where the
agricultural sector played a dominant role in the country’s GDP to an economy where the sector’s contribution
becomes much less important, replaced by secondary and tertiary sectors with manufacturing industry as the
leading sector. In conclusion, manufacturing industry has played an important role for the rapid economic growth
during that period. In other words, this analysis of structural transformation in the Indonesian economy suggests
that structural change with the increasing role of manufacturing industry has been strong enough to bring about a
major change either in terms of the growth centre of the economy or the main contributor to the growth of the
country’s economy.

Key words: economic growth rates, the New Order era, sectoral shares, manufacturing industry, agriculture,
structural transformation

1

Bahan Seminar Intern, ISP-Pusat Studi Industri dan UKM, FE-USAKTI, 28-9-2006.

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Background

Economic development in Indonesia before the 1997/98 economic crisis has been considered successful by
any macroeconomic indicator. Until that crisis, the country experienced almost three decades of continuously
rapid economic growth, the first such period in its history. For that reason, Indonesia has been grouped as one of
the miracle economies in East Asia as it had a high growth rate at an average 7 per cent from 1967 to 1997 (just
before the crisis emerged) with a low inflation rate. This rapid economic growth of Indonesia has been subject of
heated debate and scrutiny in both academic and policy society.
From theoretical perspective, there are two groups of theory that generally used to explain economic growth.
The first group emphasizes the importance of growth in Total Factor Productivity (TFP). Economic growth is
contributed by the use of more inputs, such as labour, increases in the skill of workers and in the stock of physical
capitals (land, building, machines, roads, and so on), or by increases in outputs per unit input. Both sources will
produce more output. However, the second source of growth may result from better management or better

economic policy. But in the long run it is primarily due to the advancement in knowledge and/or technology. The
basic idea of separating the two sources of growth is to discover how much of the growth is due to inputs and how
much is due to increased efficiency.
The second group of theory is about the relationship between economic growth and structural change. The
basic idea is that the prospect for long term economic growth as well as its sustainability depends significantly on
the changes in the structure of an economy and its evolution over time- economic structure defined as the sectoral
composition of output, employment and labour productivity.
While there had been many studies conducted in examining the sources of Indonesian economic growth. there
are not many studies which have specifically examined the relationship between the changes in the sectoral
composition of output and the long-term trends in the growth of the Indonesia economy. This study tries to fill
this gap. It is an attempt to study the growth of the Indonesian economy over the period 1960-2000. More
specifically it is an analysis of the growth of output in manufacturing industry and the economic growth in
Indonesia
The organization of this paper is as follows. Section 2 presents an overview of Indonesian economic growth and
structural change. Section 3 deals with development and growth of manufacturing industry. Section 4 then estimate the
effect of output growth in manufacturing industry on economic growth. Finally, summary and conclusions are
provided in section 5.

Overview of Indonesian Economic Growth and Structural Change
As a result of regional insurgence and President Sukarno’s inept economic management, the first two decades of

economic development in Indonesia since independence in 1945 produced negligible results. Since 1950,

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production and investment had been stagnant, or even fallen, and real per capita income in 1966 was probably
below that of 1938 (Booth and McCawley, 1981). In the beginning of the New Order (NO) era in 1966 led by
President Soeharto, the average Indonesian earned only roughly US$50 a year; about 60 per cent of adult
Indonesian could not read or write; and close to 65% of the country’s population lived in absolute poverty.2
Facing this condition, the NO government launched five-year economic development plans, with the first plan
started in 1969, and made several crucial economic reform policies in the 1970s and 1980s, including
liberalization in investment, capital account, banking and external trade. During that era, industry was the most
priority sector. To support development of national industry, the government adopted two subsequent
industrialization strategies. Started first with an import-substitution strategy in the 1970s up to early 1980s,
focusing on labor-intensive industries such as textile and garments, footwear, wood products, and food and
beverages, followed latter by development of assembling industries of automotive. Then the strategy gradually
shifted to an export promotion strategy by reducing some import tariffs and export restrictions, also focusing on
labor-intensive industries.
The industrialization strategies supported by the economic reform policies produced dramatic results beyond
the most optimistic expectations: a rapid and sustained economic growth especially in the 1980s up to 1997, just

before the economic crisis occurred in 1997/98. This raised per capita income more than ten-fold from $70 in 1969
to $1100 in 1997 (current prices) (Figure 1). The growth success was matched by similar success on the distribution
side. The percentage of people living below the poverty line was reduced from about 40 per cent in 1976 to about 11.3
per cent in 1996 (Figure 2).

From mid 1997 up to 1998, the Indonesian economy came to an abrupt halt with the advent of the economic
crisis. This crisis began with the collapse of the Thai baht and ultimately impacted several other countries in the
region including Indonesia, the Philippines and the Republic of Korea. From mid 1997 when the Indonesian
currency, rupiah, started to depreciate, to mid 1998 the value of rupiah fell to more than 500 per cent.
Consequently, many companies, especially large-scale enterprises/conglomerates, which heavily depended on
imported materials and components and foreign loans stopped their production, and as a result, the Indonesian
economy grew at minus 13 per cent in 1998.
In 1999 the country’s economy started to recover, and in recent years, Indonesia has reached a healthy degree
of macroeconomic stability; although in 2005 the growth rate was about 5.5 per cent, which is lower than the
expected of 6.5 per cent. The reduction in government fuel subsidies in October 2005 as a logical consequence of
the rapid increase of oil in the world market up to more than US$ 50 per barrel led to a fuel price increase of more
than 100 per cent, sparking a huge spike in the inflation rate. Also because of this subsidy cut in fuel, it is
expected that the growth rate in 2006 will be less than 6 per cent.

2

See e.g. Arndt (1974), Arndt and Hill (1988), Asra. (1988), and Booth (1989).

3

Figure 1. GDP PER CAPITA AND GDP GROWTH RATE IN INDONESIA: 1970-2002

Source: BPS

Figure 2. Poverty (Headcount), Inequality (Gini) and Income (GDP/capita), 1975-2004

Source: BPS (SI; various issues)

The estimates of economic growth of a country have for long been accepted as an important indicator of the
overall performance of its economy. These aggregates can be further broken down by sector to obtain sectoral
contributions and growth. While the estimates of economic growth covering a long period of time reveal the
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magnitude and direction of the growth of a country, its sectoral composition throws light on the relative position
of the different sectors in the economy. An analysis of the changes in the growth and contribution of the sectors

over time provides a measure of structural changes in the pattern of production and services
Remarkably, during the NO era, Indonesian economy has been undergone a massive structural change from
an economy where the agricultural sector played a dominant role in the country’s GDP to an economy where the
sector’s contribution becomes much less important. The agricultural sector, which once dominated the economy,
declined from 56 per cent in 1965 to 16 per cent in 1997, a third of its 1965 share (Figure 3). Meanwhile, the
manufacturing industry has grown tremendously at around 13 per cent per annum over the 1975-97 period. As a
result, the manufacturing share, which was a mere 8 per cent in 1965, surpassed the agricultural sector in 1991,
and in 1995 manufacturing value-added contributed 24 per cent of GDP, three times its 1965 level.
Figure 3: Structural Change (% of GDP)

Source: Carunia, et al. (2000).

The strategies and economic reform policies specifically targeted to promote exports of non-oil and gas,
particularly manufactured goods. Figure 4 depicts the pattern of Indonesia’s exports since 1965. Until the late
1970s, manufacturing exports constituted no more than 4 per cent of total exports. By 1987 the share of
manufacturing exports had surpassed the share of agricultural exports, and in 1992, overtook the share of oil,
mineral, and basic metal exports. As the share of agricultural and primary product exports declined and the share
of manufacturing exports increased, Indonesia became less prone to external terms of trade shock. The figure
shows a large swing in the share of agricultural and other primary commodities. This is a common feature in
primary product exporting countries like Indonesia that face large fluctuations in commodity prices.

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Figure 4: Composition of Indonesian Exports, 1965-1999

Source: Carunia, et al. (2000).

As a comparison, Table 1 gives the basic data on growth rates of real GDP of Indonesia and other three big
developing countries, i.e. India, Brazil, and China, and developing countries as a whole for the period 1970-2000.
Taking the 30 year period as a whole, Indonesia’s average annual growth at 5.7 per cent is a much higher than for
all developing countries, but significantly slower than China. India grew slower for the first 10 years, when
Brazil’s average growth rate was very high and Indonesia’s growth rate accelerated significantly. The situation
reversed in the 1990s, when India’s growth rate increased and that of Indonesia declined.
Table 1. Growth rate of real GDP in Selected Big Developing Countries, 1970-2000
(average annual growth rates in per cent)
1970-1980
Indonesia
India
Brazil
China

7.9
3.2
8.5
5.4

1980-1990
6.4
5.6
1.6
9.2

1990-2000
4.3
5.8
2.5
10.4

1970-2000
5.7
4.6

4.8
7.1

Developing countries
5.5
3.2
3.2
4.4
Source: World Bank (World Development Indicators CD-ROM 2001) and BPS

Development and Growth of Industry
Not only because of its rapid and sustained high economic growth, but also of its rapid development of
manufacturing industry, Indonesia was once one of the high performing East Asian economies that created the
“East Asian economic miracle.” (Hill, 1996). Even among this group of economies including Hong Kong, Japan,
Malaysia, the Republic of Korea, Taiwan, Thailand and Singapore, the Indonesian economy was emerged as
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particularly impressive for its achievement in development of industry. Also, Indonesia was different among oilproducing countries for its strong manufacturing sector. During the 1980s and 1990s, the country became a
leading player in a wide variety of industries, from palm oil to apparel to electronics (USAID & SENADA, 2006).
Thus, it can be said that rapid development and growth in manufacturing industry has been the landmark of

Indonesia’s NO era.
Industrial growth became and remained dynamic throughout the New Order period up to 1997, just before the
1997/98 economic crisis. Prior to the New Order era (1966) the Indonesian economy had entered a period of
standstill with virtually no GDP or industrial growth, skyrocketing inflation and declining per capita income.
Thereafter GDP growth took off with rates of at least 5 per cent until the oil price fall of 1982 (Figure 5). Slow
GDP growth until 1986 (except for a jump in 1984 due to oil and gas investments coming on line) was followed
by growth returning to nearly 6 per cent by 1988 onwards. It subsequently never fell below 7 per cent until the
1997/98 economic crisis. Industrial contribution as seen through manufacturing growth consistently averaged at
least 9 per cent in all but three years from 1969 to 1992, these years being the oil price induced recession in the
first half of the 1980s (Banerjee, 2002).
A generalization in such manufacturing data is due to its inclusion of oil and gas processing. A consideration
of non-oil and gas manufacturing is only possible after 1978. It is seen to exhibit growth higher than 10 per cent
consistently since 1984. In this period its rate of growth is also greater than the oil related manufacturing sector.
Non-oil industry thus had a disproportionate influence on economic growth certainly since the mid-1980s. It has
allowed the economy to move away from its dependence on oil and gas and permitted the high GDP growth
observed in the presence of the slower agriculture sector. Agriculture has displayed growth rate of greater than 5
per cent only a few times in the past few decades (Banerjee, 2002; Hill, 1997).
Figure 5. Growth of GDP, Manufacturing and Agriculture, 1970-2000 (%)
25
20

15
GDP
Manufacturing
Agriculture

10
5

20
00

19
98

19
96

19
94

19
92

19
90

19
88

19
86

19
84

19
82

19
80

19
78

19
76

19
74

19
70

-10

19
72

0
-5

-15

Source: BPS and Banerjee (2002)

No doubt, the remarkable development and growth in Indonesian manufacturing industry has been the results of
not only the adopted industrialization policies started with import substitution and gradually shifted to export
promotion policies, and various economic reform policies. In the early period of the NO era, the government adhered

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to reasonably open trade and investment policies. However, by the late 1970s, the government had embarked on a
more interventionist path, especially in the area of industrial policy. There were at least four major channels through
which government intervened during this period: first, through domination of state owned banks, which provided
subsidised credit to favored clients; second, the direct involvement in production through state own enterprises, mainly
in heavy industry; third through rising barriers to imports; and, finally, through a complex set of regulation aimed at
promoting various industrial policy objectives, such as, spatial dispersion, small industry development and

indigenous business development (Carunia, at al., 2000).
As a comparison, Table 2 gives the basic data on growth rates of output of industry (non-manufacturing (oil
and gas) and manufacturing) in Indonesia and other three big developing countries, i.e. India, Brazil, and China,
and developing countries as a whole for the period 1970-2000. It is striking how much faster is the growth of the
industrial sector in Indonesia compared to other countries, except China for the last three decades. During the first
decade of the period, the growth in Indonesia was slightly more than 10 per cent compared to 6.3 per cent for the
whole developing countries or China at around 9 per cent. But, after that that period, the growth of Indonesian
industrial sector declined while that of China accelerated, especially during the 1990s.
Table 2: Growth rate of Industrial Sector in Selected Big Developing Countries, 1970-2000
(average annual growth rates in per cent)
1970-1980
Indonesia
India
Brazil
China

10.4
4.1
9.9
9.2

1980-1990
7.1
7.1
0.5
9.6

1990-2000
6.0
5.6
2.0
14.1

Developing countries
6.3
3.3
3.8
Source: World Bank (World Development Indicators CD-ROM 2001) and BPS

Table 3 compares the evolution of GDP shares of three main important sectors over time in Indonesia and
the other same countries. As can be seen, the pattern in Indonesia is noticeably different than in India, but more or
less the same in Brazil and China. Indonesia displays little increase in the share of services; however, the share of
industry increases sharply which is partly reflecting the increasing role of the oil sector, while the output
contribution to GDP of agriculture declines steeply from levels comparable to India in 1970. In Brazil the shares
of both industry and agriculture decline with the services climb above 60 per cent by 2000. China shows no rise in
the share of services over the whole period; agriculture’s share decreases by a modest amount, matched by an
equivalent increase in the share of industry to 49,3 per cent by the end of the period. India, by the end of the
period, in 2000, has more than a quarter of its GDP originating in agriculture, about double the share for all
developing countries, three times the share in Brazil and significantly more than in Indonesia and China. Part of
the explanation lies with India’s high share of agriculture, about 46.3 per cent in 1970, and part must be attributed
to the relatively slow growth of output in industry, especially in the first decade. During that period India’s
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sectoral shares evolve in a manner similar to all developing countries, i.e. a modest increase in the GDP share of
industry, a substantial drop in agriculture and a sizable increase in services.
Table 3. Sectoral Shares in GDP, 1970-2000 (%)
Period

Country

Sector

Indonesia

Agriculture
Industry
Services

1970
44.9
18.7
36.4

1980
24.0
41.7
34.3

1990
19.4
39.1
41.5

2000
19.5
43.3
37.3

India

Agriculture
Industry
Services

46.3
21.7
32.2

39.7
23.7
36.6

32.2
27.2
40.6

25.2
26.7
48.1

Brazil

Agriculture
Industry
Services

12.3
38.3
49.4

11.0
43.8
45.2

8.1
38.7
53.2

8.6
30.6
60.8

China

Agriculture
Industry
Services

35.2
40.5
24.3

30.1
48.5
21.4

27.0
41.6
31.3

17.6
49.3
33.0

15.8
38.1
46.1

12.4
35.0
52.6

18.4
23.8
Agriculture
40.1
33.7
Industry
41.5
42.5
Services
Source: World Bank (World Development Indicators CD-ROM 2001) and BPS
Developing countries

Previously, Hayahi (2005?) has made a study on the development of industry in Indonesia during. The
findings are shown in Tables 4, 5 and 6. Table 4 shows the Indonesian experience in structural transformation
during the three decades before the onset of the 1997-98 economic crisis. The role of agriculture in terms of
output decreased, while that of industry increased. In terms of exports, Table 5 shows that the share of primary
products decreased from nearly 100 per cent in the 1960s and 1970s to roughly 50 per cent in the 1990s, while
that of manufactured exports. Table 6 shows the growth pattern of real value added in the non-oil/gas
manufacturing industry since 1971. Before the economic crisis in 1997/98, the manufacturing industry as a whole
was expanding at an annual average growth rate of 14.1 per cent during 1976-96.
Value added of the machinery industry (ISIC 38) expanded faster than that of manufacturing as a whole,
except for some periods including the crisis. In the first half of the 1990s, the machinery industry contributed
more to the growth of manufacturing value added than any other sector. All subsectors of the machinery industry,
metalworking (ISIC 381), general machinery (ISIC 382), electrical machinery (ISIC 383), transport equipment
(ISIC 384) and precision equipment (ISIC 385) grew rapidly during the 1970s and during 1985-96. Particularly
since 1986, the economic boom, supported by a series of deregulation measures, accelerated the expansion of
production in these machinery subsectors. For example, after its single-digit growth during 1980-85, the transport
equipment subsector including automobile and motorcycle production recorded a high annual growth rate of more
than 18 per cent.

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Table 4: Growth and Sectoral Share of GDP in Indonesia, 1966-2000

Notes: 1) Industry includes manufacturing, mining, utilities and construction; 2) The growth of GDP represents average annual growth
rates based on 1983 constant prices in each period; 3) The sectoral share is calculated as an average for respective years in each period;
4) The contribution of each sector group to GDP growth is weighted by respective sectoral GDP shares.
Source: Table 1 in Hayashi (2005?)(Calculated using van der Eng (2002: 172-3), updated for 1999 and 2000 with data from BPS’s
National Income of Indonesia

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Table 5: Sectoral Share of Export and Import Commodities in Indonesia, 1966-19991)

-----------------------------------------------------------------------------------------------------------------------Notes: 1) The sectoral share of commodities in merchandise exports (at current US$ prices) is calculated as an average of
respective years in each period; 2) Agriculture includes food and agricultural raw materials; 3) Mining includes fuels
(oil/gas), ores and metals.
Source: Table 2 in Hayashi (2005?) (calculated from World Bank, World Development Indicators 2001)

Table 6 also shows that the composition of manufacturing value added changed markedly since 1971,
reflecting the different rates of growth among the sectors. The machinery industry (ISIC 38) accounted for 21 per
cent of manufacturing output in the second half of the 1990s, more than doubling its share in the past 30 years. It
has become the second largest value added generator after the food processing industry. More specifically,
electrical machinery (ISIC 383) and transport equipment (ISIC 384) substantially increased their output share,
occupying respectively 7 and 8.7 per cent in the late 1990s.

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Table 6: Growth of and Sectoral Share in Real Value Added in Indonesia's Non-Oil/Gas Manufacturing
Industry, 1971-19991)

Notes: 1) This table uses the data for manufacturing firms with 20 or more employees, except for those between 1971 and 1973, where
firms with 5 or more workers with use of power equipment or firms with 10 or more workers without use of power equipment are
included. Oil and gas subsectors (ISIC 353 and 354) are excluded; 2) The numbers in parentheses indicate ISIC (International Standard
Industrial Classification) code; 3) The growth indicates average annual growth rates in each period. Value added data in this table are
deflated by the implicit GDP deflator for manufacturing (1993=100) from BPS's National Income of Indonesia, due to a lack of adequate
and long-term sectoral and subsectoral deflators; 4) Other includes miscellaneous (ISIC 39) and non-metal/mineral (ISIC 36) products;
5) The (sub)sectoral share of value added is calculated as an average for respective years in each period. The observed periods for this
share are: 1971-75, 1976-80, 1981-85, 1986-90, 1991-96, and 1997-99.
Source: Source: Table 3 in Hayashi (2005?) (Calculated from BPS, Large and Medium Manufacturing Statistics).

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The History of Indonesia’s Industrial Policies

Indonesia, under Soekarno, had pursued inward-oriented industrialization with strong State ownership of
manufacturing enterprises from 1945 to the mid-1960s. State-owned manufacturing enterprises had enjoyed
favorable access to subsidies, credit and foreign exchange. Thus, as in many other new born (developing)
countries, early industrialization in Indonesia was State-led and blocked foreign ownership. Strong anti-foreign
sentiments, including anti-local Chinese feelings, played a major role in the exclusion of private business from
State support. Indigenization efforts translated into the State bypassing the evolving small-scale business, which
were dominated by ethnic Chinese control. The lack of local indigenous capabilities led to direct State
participation in manufacturing industry. Serious government failure, however, during this period debilitated
manufacturing development and growth in the country. Soeharto’s succession in 1965, marking the New Order
era, was followed by immediate stabilization programs that helped economic order. The government allowed
private ownership in manufacturing and liberalized foreign investment and foreign exchange control. The
cumbersome multiple foreign exchange mechanisms were streamlined (Palmer, 1978). The government began
abolishing subsidies to State-owned enterprises and promoting the private sector, which grew following the
introduction of incentives. Indonesia has, however, continued to retain State control of strategic mainly heavy
industries. The lowering of captive rents in the domestic economy obviously undermined some enterprises, so that
the share of manufacturing in GDP fell from 12% in 1960 to 10% in 1970 (Rasiah, 1998). 3
Following the industrial policy assessment approach by such as Hill (1996, 1997), Banerjee (2002), and
UNSFIR (2004), from the New Order era until know Indonesia has followed four broad approaches to industrial
development: the first three phases were during the New Order era up to the economic crisis in 1997/98, and the
fourth phase after the crisis. The first three phases have been an element of the country’s three waves of distinct
economic policy-making: 1966-1974, 1975-1981, and 1982-1997. These can be characterized as the oil boom and
the years before and after it. The first period was the period of the first five-year plan (Repelita I). During this
period, the government stimulated resource-based, large-scale but labor-intensive industries. This phase involved
a primary preoccupation with controlling inflation through responsible fiscal policies, and it was considered to be
one of the most open periods in Indonesia’s economy with the government trying to attract foreign direct
investment (FDI) to rebuild the economy. This was also the period when loans from the international private and
public sectors started to flow into the country to finance together with foreign investment import, infrastructures,
and natural resources projects. However, FDI was dominated by a number of large natural resource projects and
remained low in aggregate throughout this period, never exceeding 2% of the country’s GDP.
The second policy period evolved due to the high oil prices beginning in the late 1973. This was also the
period of the Repelita II during which the government imposed a system of protection and local content rules in a
3

See also Huib et al. (1991) and Palmer (1978).

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umber of industries not only upstream industries but also downstream industries such as machinery, electronics
and the automotive industry as part of import substitution policy. The government was also involved in heavy
industries such as steel, natural gas, oil refineries, petrochemicals, fertilizers, cement, basic chemicals, capital
goods, shipbuilding, and aluminium. Habibie’s grandiose projects expanded the state’s involvement in heavy
industries, including aircraft-making. These industries were heavily protected and provided with subsidized
credits through state banks. The main aim of this policy was to encourage industrialization in the country and also
to encourage a pattern of industrial development that followed the industrial pyramid model from Japanese.
However, industrial development in Indonesia did not follow the same pattern as in Japan. On the contrary, the
local content policy resulted in a vertically integrated production system within large scale and capital intensive
industries.
The economic rationale behind the local content policy was to create a captive market for domestic products
in order to increase the economic scale of production and thereby to increase efficiency. However, government
interference went too far. The government decided which products were to get priority in this policy, and
introduced fiscal incentives in line with the type of priority recipient products.
The government utilized the oil export revenues to pursue its import substitution policy. This strategy
prevented the so-called ‘Dutch Disease’ effect of a decline in the manufacturing sector due to lower external
demand from appreciation of the rupiah against the US dollar. Non-tariff barriers (NTBs) and the channeling of
oil revenues into state-owned companies ensured that much of the large increases in domestic incomes over this
period fed directly into demand for domestic manufacturing industry (Banerjee, 2002). 4
The declines in oil prices in 1982 and 1986 led to a deteriorating fiscal situation, and this accompanied by the
fall of the dollar following the 1985 Plaza Accord, necessitated the third phase of industrial policy. This phase
marked by a dramatic change in the industrial approach with a liberalizing of the trade regime for tariffs and
NTBs and investment regime. This was also the period when the government shifted its strategy from import
substitution into export-oriented industrial policy. This was enacted through a series of deregulation packages
from 1985 onwards. However, the trade and investment regime was not completely open during this phase. A
large list of industries especially heavy industries remained closed to FDI. Although these industries failed to
contribute much to industrial growth during this phase, they were remained heavily protected and managed by
state-owned enterprises and conglomerates. These included the automotive, cement, steel and heavy engineering,
metal fabrication and pharmaceutical industries (UNIDO, 2000).
The trade reform package of 1988 allowed steel and plastic raw material imports, which had previously been
produced and supplied by state monopolies. The government, however, left control of steel imports of the stateowned steel industry and that of polystyrene and polyethylene to a state owned trading company, so that only
demand in excess of production was allowed to be imported. Hence in the 1980s the Indonesian manufacturing
4

See also Hill (1997), Roemer (1994) and Timmer (1994).

14

industry has remained highly concentrated (Hill, 1996). Tariff ceilings on most products were reduced to 40% in
1990. Opposition from the politically connected have, however, stifled some of the reforms. For instance, the
automotive industry, which enjoys ownership control by even the President’s family, experienced a reversal in
tariff cuts n 1990 (Rasiah, 1998).
Gradual ownership liberalization from the early 1980s led to a fall in the share of state-owned enterprises in
total manufacturing enterprises from 28% in 1975 to 20% in 1983 (Balassa, 1991).
During the 1990s before the economic crisis, the government again introduced various trade and investment
reform policies included in June 1991 deregulation package. In this package, NTBs were further reduced and
replaced them with tariff and export taxes, reduced general tariff levels, and reopened several business areas,
which are previously included in the negative lists (lists of industries closed to foreign investments), to new
domestic and foreign investment. The removal of NTBs included the abolition of import bans on cold-rolled steel
and sheets and tin plates. The reforms also abolished export bans on copra and palm oil as well as the exclusive
rights of several companies to export palm-oil based products.
The above package was followed by a series of trade and investment reforms in July 1992, June and October
1993, June 1994, May 1995, and June 1996. The main elements of these packages were a range of tariff
reductions, changes in trading arrangements for certain commodities (the removal of NTBs), improvement in
trade facilitation measures such as duty draw back scheme and procedures on bonded zones, and shortening of the
lists of activities closed to domestic and/or foreign investment (Carunia, at al., 2000).
In this period, the emphasis of national industry policy was on development of a number of high-technology
industries through government interventions. Ten ‘strategic’ state-owned industries were emphasized, particularly
the aircraft industry. It was felt that Indonesia could not rely on its then labor-intensive production in the longer
run. It therefore attempted to break into higher value added production beyond its existing resource base,
particularly in human resources (Banerjee, 2002). World Bank (1992) mentions the weaknesses in higher level
technical education and the quality of training at that time as well as skill shortages across Indonesian industry.
In the fourth phase, after the 1997/98 economic crisis, the government passed several policy documents on
national industrial development strategy. The Ministry of Industry and Trade released the Industrial Revitalisation
Program by the end of 2001 to take effect up until 2004. This document espoused an employment-focused
sectoral approach, identifying key sectors with high employment impact in the short run. The document identified
industries for exports such as textile and garment, electronics, footwear, wood, pulp and paper products to be
revitalized. Industries to be further developed include leather and its products, fisheries, palm oil, fertilizer,
agricultural machineries, software, and jewellery. Key supporting industries include engineering components,
accessories, and leather processing (UNSFIR, 2004).
Earlier, the National Development Planning Agency (BAPPENAS) released the National Development
Programme (PROPENAS) in 1999 and followed by the release of the Medium-term and Long-term Plans in 2004.
15

In both the Medium-term and Long-term Plans, the approach on industry is through the development of industrial
clusters using non-distortionary policy measures.
With respect to export promotion policy, export orientation in Indonesia involved heavy state promotion and
subsidies. Selective promotion influenced by resource endowments helped Indonesia to achieve substantial
exports of, respectively, plywood and timber products, palm oil and timber products, and food and jewellery.
Apart from these resource-based industries, whose value-added chains were not technology-intensive, foreign
capital generally dominated most other manufactured exports. Participation by local enterprises in non-resourcebased products was generally restricted to low value-added assembly and processing activities whose designs and
markets were controlled by foreign companies. Substantial export promotion with credit and tax subsidies assisted
local firms to operate as subcontractors (Rasiah, 1998).
Textiles, garments and footwear and wood-based products were the first policy priority products for export
and so these items among the early export-oriented activities to have grown a lot in Indonesia from the late 1970s.
The share of export of these products in overall manufactured exports rose from 22.7% in 1980 to 27.3% in 1986
and 38.6% in 1991. The export growth of Indonesian textile and garments to a larger extent has to do with
Japanese and Asian NIE companies relocated production in Indonesia to access the county’s quotas allocated
under the MFAs. Much of Indonesian export of textile and garment was dominated by foreign capital operating in
joint ventures and local subcontractors performing low value-added activities. The labor intensity and low
technical content of production of textile and garment favored relocation to Indonesia because of its abundant
labor supply and low wages. In the case of wood-based products (especially plywood), besides also the labor
intensity and low technical content, a ban on log exports in the 1980s was the prime push that forced downstream
low value-added activities in the timber value-added chain. Also Indonesia’s control of over 50% of the world’s
plywood market has ensured some leverage in sustaining external demand. The share of plywood exports in
overall manufactured exports grew from almost 11% in 1980 to more than 37% by the end of the 1980s (Rasiah,
1998).
However, foreign equity ownership in Indonesia has been relatively low due to the uncertain ownership
regulation in that time (that were improved in the second half of the 1980s), and the preference of foreign capital
for using Indonesian firms as putting-out subcontractors (Rasiah, 1998).

The Effect of Growth in Manufacturing Industry on Long-Term Economic Growth
There are various methods to estimate the importance of growth in manufacturing industry for long-term
economic growth. The first approach is simply by comparing the growth in Total Factor Productivity (TPT)
growth in manufacturing industry relatively to those in other sectors and GDP growth. Studies on economic
growth in Indonesia using this method are very limited. The recent one is by Carunia, et al. (2000). There are two
approaches to the measurement of TFP growth in manufacturing industry: the econometric estimation of a
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production function (or, alternatively, the cost function), and growth accounting approach. Their study used the
second approach. It simplifies the tedious estimation procedures required in the econometric approach. This
approach begins with a set of assumptions. It assumes output and inputs markets are competitive and that firms
maximise profits subject to constant-returns-to-scale production function and market prices that are taken as
parameters. The assumptions led to an important result that in equilibrium output elasticity of inputs are
equivalent to the observed cost share of factor inputs. TFP growth can be calculated using discrete time series
data of prices and quantities of output and inputs; it equals the difference between output growth rates and costshare-weighted input growth rates.
The results are presented in Table 7 which provides a summary of several episodes and for sectors.
Comparing real GDP growth and TFP growth by sector in this table, a positive correlation between the growth of
manufacturing TFP and GDP growth is immediately observable, especially during the crisis period of 1997-2000.
In other words, output growth in manufacturing industry has been the most important engine for economic growth
in Indonesia.
Table 7. GDP Growth, Capital Growth, and TFP growth by sector, 1971-1996

Source: Carunia, et al. (2000).

To estimate the importance of growth of manufacturing industry for GDP growth, this study uses a simple
equation, i.e. a decomposition of GDP growth to three main sectors, i.e. industry manufacturing, agriculture and
service, for the period 1970-2000 as follows:
%ΔGDP = a0 + a1xM %ΔYM + a2xA %ΔYA + a3xS %ΔYS + a4%ΔGDP lag (one period) + σ
Where %ΔGDP, %ΔGDP lag, %ΔYM, %ΔYA, and %ΔYS are percentage changes in real GDP (current and lag),
and value added in the manufacturing, agriculture, and service sectors, respectively; and xM, xA and xS are value
added shares in GDP of the three sectors, respectively.
Descriptive statistics are shown in Table 8, the regression result is presented in Table 9, and the model
summary and ANOVA are given in Tables 10 and 11, respectively. As can be seen, the regression result shows
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that among the three sectors, output growth in industry manufacturing appears to have the strongest and
significant relationship between sectoral growth rates and GDP growth. The null hypothesis that the sectoral
composition of growth does not influence the rate of GDP growth was rejected by t statistic and F-test at the 95
per cent confidence level. All regression coefficients are positive, as generally expected, but, for service and GDP
lag, the coefficients, statistically, are not significant from zero (α = 5%). The proportion of the total variation of
GDP accounted for by the explanatory variables in the model, as illustrated by the value of adjusted R2 is not so
high, suggesting that there are other variables that may have important influences on GDP growth which are not
included in the model. The values of F-statistic suggest that all the independent variables together influence the
dependent variable.
Table 8: Descriptive Statistics (n=31)
Variables
%ΔGDP,
%ΔGDP lag
%ΔYM
%ΔYA
%ΔYS

Mean

Std. Deviation

5.5613
5.6419
183.0439
99.3342
278.7300

4.2362
4.2469
117.6502
63.2658
161.9524

Table 9: Regression Coefficients
Model
Constant
%ΔYM
%ΔYA
%ΔYS
%ΔGDP lag

Unstandardized coefficients
B
Std. Error
.796
-1.750
.004
2.737E-02
.006
1.445E-02
.003
1.152E-03
.092
9.662E-02

R

R2

.915

.837

Standardized Coefficients
Beta

.037
.000
.018
.695
.302

-2.200
7.654
2.534
.397
1.054

.760
.216
.044
.097

Table 10: Model Summary
Adjusted R2 Std. Error of Estimate
.812

Sig.

T

1.8365

Durbin-Watson
2.099

Table 11: ANOVA
Model
Regression
Residual
Total

Sum of Squares
450.663
87.690
538.354

Df
4
26
30

Mean Square
112.666
3.373

F
33.405

Sig
.000

18

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