Since the end of the commodity bonanza in 2012, Indonesia has been trying to maintain its momentum in economic growth. The Solow growth model suggests that an economy will achieve constant growth if capital and labor reach a balanced ratio, which is called the balanced growth path (BGP).
The BGP will become a trap if it is reached at low levels of per capita income. Adding to capital and/or labor as an additional factor of production will be redundant on its own due to the law of diminishing marginal returns (marginal benefits).
Several steps can be taken to avoid this trap. First, increase the savings rate to the gross domestic product (GDP) to increase income. The national savings rate in the second quarter of 2019 was 34.2 percent, lower than 35.2 percent in the first quarter, so there is room for improvement. The problem is that Indonesia needs an injection of demand from the people. Indonesians have reached lifestyle consumption that includes food, travel and entertainment at a lower level of per capita income than in East Asian countries, thereby making it difficult to drastically increase the savings rate. To maintain their lifestyles, the average savings rate has declined from Rp 4.5 million at the end of 2012 to Rp 3 million in the second quarter of 2019.
Second, if the savings rate increases, high growth requires efficient investment. Indonesia\'s investment efficiency, which is reflected in its high ICOR (incremental capital output ratio) as a result of extortion, lengthy land acquisition, changing regulations and complicated licensing, swells the cost of investment projects. Indonesia had an ICOR of 6.3 in the second quarter, while Vietnam had only 4.3. In such a business climate, additional investment does not substantially increase growth, so other creative efforts are needed.
Reorganizing production
The Solow growth model envisions an economy with capital and labor as the main factors of production. If the economy has reached BGP, attaining a higher growth path requires changes to the external environment. This can be done by changing the shifting parameter frequently symbolized as "A". Shifting parameter A indicates improvements to the business climate, such as simplifying licensing, improving civil service quality, improving the quality of physical capital, improving human resource quality through education, and innovations that spur economic transformation.
The expanding urban middle class, who seeks new products for self-actualization, enables the development of an inclusive economy in rural areas. Producers of women\'s bags like Gendhis and Dowa and Lurik Prasojo premium fabric in Central Java are models of inclusive growth that utilize information technology. The network uses online methods to introduce products, market and sell them. The offline method is to invite customers to visit production sites. Production sites in Central Java/Yogyakarta enable customers to combine a factory visit with cultural, scenic and culinary tourism.
Reorganizing production in this way expands the multiplier effect and inclusiveness of economic activities. Production is decentralized in rural households so that housewives can earn an income to support their families.
These new sources of growth are spreading in agriculture, manufacturing (including light manufacturing and the traditional handicrafts sector) and the service sector (including trade and inclusive tourism). The economic potential of these activities is estimated at around 19 percent of GDP.
The message implicit in the President’s presentation of the 2019 Financial Report in boosting the role of the creative sector requires the production function of innovation (Romer, 1989), that is, the two main pillars of quality education and research and development.
The curriculums at all levels of both public and vocational education must be redesigned to produce graduates that can adapt and participate in society by equipping them with the four literacies: basic literacy (reading, writing, mathematics), data literacy, technological literacy and human literacy.
Ari Kuncoro, Professor and Dean, Economics and Business School, University of Indonesia