Indermit S. Gill coined in 2007 the concept of the middle-income trap (MIT), noting that the main cause that prevents middle-income countries from transitioning to high-income country status was stagnant economic growth. For a staggering 30 years, Indonesia has been ensnared in the MIT, a situation that demands immediate attention and action.
Statistics Indonesia (BPS) noted that Indonesia’s economic growth has not once exceeded 7 percent in the past two decades. According to the Word Bank, a country can be released from the MIT if its gross domestic product (GDP) per capita is more than US$13,845, meaning that at least one person’s income reaches Rp 18 million ($1,124)/month.
While it is true that until 2023, Indonesia’s GDP per capita has only touched $4,783, meaning that the average Indonesian is considered to have an income of Rp 5.9 million/month, there is still potential for growth and improvement.
Different from the GDP/capita data, BPS noted that the average minimum wage of Indonesian workers is a mere $189, equivalent to Rp 2.94 million. This wage is significantly lower than that of Malaysia ($359) and Cambodia ($194), highlighting the stark wage disparity.
And the fate of formal workers is not optimal. In fact, most of them receive a salary equivalent to the provincial minimum wage as the maximum wage they can get without periodic salary increases. These facts underscore the challenges Indonesia faces in escaping the MIT abyss, raising the question, “Can Indonesia break free from the MIT trap?”
A glimmer of hope has emerged. Since 2015, Indonesia has entered the demographic bonus era, which is expected to last until the 2030s. In 2022, BPS recorded that 69 percent (190.98 million people) of Indonesia’s total population of 275.77 million people were people of productive working age (14-64 years). Given that the demographic bonus has the potential to increase the number of workers, the country’s productivity will rise, and then the economy will grow. Economic growth will push up the average wage, and Indonesia is ready to get out of the middle-trap income trap.
Thus, the assumption is that the demographic bonus will be an opportunity for Indonesia to get out of the MIT. The reality is not that optimistic.
The majority of Indonesia’s productive workers are instead absorbed into the informal sector, a reality that comes with its own set of challenges. These workers often earn salaries below the minimum standard, lack social protection and are difficult to tax. BPS noted that in 2023, the workforce working in the informal sector reached 83.34 million people, 60.12 percent of the total national labor force.
This fact, confirmed by a World Bank report in 2023 paints a stark picture of the struggles faced by these workers, with the prevalence of decent work with middle-class standards falling significantly, from 14 to 9 percent during the 2019-2022 period.
The absorption of the majority of the workforce into the informal sector is proof that the quality of Indonesian labor still needs to improve to meet industrial challenges, especially in high-value-added sectors. BPS noted that the Indonesian workforce is dominated by elementary school graduates (40 percent), compared with only 9.31 percent of Bachelor graduates.
The lack of quality workers who meet industry qualifications affects their work productivity, which, in the long run, has the potential to hamper the growth of economic sectors that require specialized skills. As a result, fewer Indonesian workers have the opportunity to earn high wages due to the reluctance of high-value-added industries to invest in Indonesia.
To transition into a high-income country, Indonesia needs to learn from Brazil. Since the 1960s, Brazil has been trapped in the middle-income category while failing to maximize the momentum of the demographic bonus that has occurred since 1970. Brazil’s biggest mistake was its failure to transition from a low-value-added processing industry to a high-value-added industry oriented toward export activities. As a result, Brazil relies heavily on low-value-added processing industries to absorb labor. Although the products of the processing industry are Brazil’s export commodities, this sector tends to rely on low-wage labor.
As a result, the average wage of workers in Brazil has tended to stagnate, and Brazil has failed to maximize the opportunity of the demographic bonus.
What about Indonesia? The manufacturing industry’s contribution to Indonesia’s GDP is very large. The BPS report shows that throughout 2023, its contribution to the value of the Indonesian economy based on GDP at current prices reached Rp 3.90 quadrillion, becoming one of the largest contributors to the Indonesian economy (18.67 percent).
In terms of employment, the manufacturing sector, such as the food and textile industries, dominates by absorbing nearly 19 million workers (BPS 2022). But these two industrial sectors are very vulnerable to economic crises. This was proven when the COVID-19 pandemic hit, and many food and textile businesses collapsed. BPS reported that the manufacturing sector in 2020 contracted by 8.8 percent, falling way below its 15.35 percent growth in 2019.
Aside from Brazil, Indonesia also needs to learn from South Korea as an example of success. In the mid-1970s, South Korea’s economic growth was still below Indonesia’s, but in the last three decades, it has been transformed into a high-income country.
What did South Korea do? The South Korean government gave generous incentives to foreign investment activities in the high-value-added industrial sector in the hope that there would be a transfer of technology and, hence, innovation to support the modernization of the South Korean industry.
In addition, massive investment in the education sector has significantly improved the quality of South Korea’s human resources and enabled them to meet the needs of the world’s major high-value-added industries, which are oriented toward the research and development of cutting-edge technological innovations. South Korea’s GDP rose from $504 billion in 2001 to $1.64 trillion in 2019.
A 2017 report published by the Asian Development Bank (ADB), Escaping the Middle-Income Trap: Innovate or Perish, explained that stagnation in innovation development, rapid deindustrialization and low investment in improving workforce capabilities were the main causes of countries remain the middle-income trap.
Indonesia is currently experiencing a phase of deindustrialization but it comes a little bit premature. Although the contribution of Indonesia’s service sector has increased in recent decades, it is still too early to say that Indonesia is heading toward deindustrialization. Why?
Based on Indonesia’s economic structure, the dominance of the service sector to GDP is indeed quite high (54.4 percent), but this figure is dominated by the contribution of the transportation and warehousing service sector, which generates only low value. BPS noted that in the third quarter of 2023, the transportation services sector only contributed 0.61 percent year-on-year (yoy) to national economic growth.
The development of high-quality human resources that can answer industrial challenges is clearly a policy that needs to be prioritized, considering that only with qualified human resources can this problem be solved.
The demographic bonus can turn into a disaster if it is not balanced with efforts to improve the quality of the workforce.
Writer: Lambang Wiji Imantoro
This article was published in thejakartapost.com with the title “”. Click to read: https://www.thejakartapost.com/opinion/2024/05/22/indonesias-big-challenge-to-become-high-income-country.html.