Our report reveals that furthering President Widodo’s reforms to attract investment, develop infrastructure, and improve governance remains Indonesia’s greatest opportunity for enhancing future economic openness

New report reveals further reforms to investment, infrastructure and governance is greatest way for Indonesia to increase prosperity

A new report on Economic Openness in Indonesia, launched today by the Legatum Institute at an event with the Center for Indonesian Policy Studies, emphasises that furthering President Widodo’s reforms to attract investment, develop infrastructure, and improve governance remains Indonesia’s greatest opportunity for enhancing future economic openness.

The report reveals that Indonesia ranks 68th in the Global Index of Economic Openness. Its strongest performance is in Investment Environment, ranking 53rd in the world having risen 34 places over the last decade. This is underpinned by the country’s improving financing ecosystem, strong investor protections, solid banking system, and relatively high savings rate (34% of GDP, compared to a global average of 25%).

However, Indonesia’s history of protectionist policies has resulted in foreign direct investment accounting for just 2% of GDP – less than half of the global average. The consequence of these policies is a lack of foreign capital and foreign expertise entering Indonesia. It has also led to new domestic players struggling to compete against the preferential treatment received by state-owned enterprises (SOEs).

Dr Stephen Brien, Director of Policy at the Legatum Institute and author of the report, commented: “This report provides a timely opportunity to assess the economic and institutional challenges and opportunities that face Indonesia as President Widodo enters his second term. Indonesia is a country with extraordinary potential – with the world’s fourth largest population, one of the world’s largest democracies, and an economy growing 5% per year, there are many reasons to be optimistic about its future.

“However, Indonesia still lags behind some of its ASEAN peers when it comes to productivity and prosperity. This is largely due to the country’s legacy of economic nationalism that has sought to protect and promote Indonesian industry. This has resulted in a deficit of much needed capital, goods and expertise that foreign companies could bring to Indonesia. Our analysis suggests that increasing international investment would be the best way to improve the country’s prosperity.

“Some of the reforms required are not straightforward. Political courage is needed, which requires confronting vested interests in government and the private sector. But ideas and businesses need investment to develop and grow effectively; revising policies on the Negative Investment List, tariffs, quotas, and subsidies has the potential to open new markets and increase prosperity for Indonesia.”

Rainer Heufers, Executive Director at the Center for Indonesian Policy Studies, stated: “It is important that the Indonesian government makes regulatory reforms to attract foreign direct investment. For that purpose, Indonesia needs to make its market more accessible and establish strong international trading partners. Right now it is important that Indonesia concludes trade negotiations and ratifies partnership agreements with the EU and Australia. Ultimately, it is Indonesians who will benefit from the wealth created by the businesses and jobs that will grow out of trade and foreign investment.”

The report also shows that to achieve increased prosperity, an open economy also needs effective market access and infrastructure, healthy enterprise conditions, and strong governance.

Indonesia ranks 85th in Market Access and Infrastructure, a point of weakness for its economy. Poor infrastructure is preventing the supply of electricity, provision of communications, and movements of good and people across the country. Dependence on SOEs to deliver infrastructure projects to the archipelago has seen only partial success, with private investment crowded out by a combination of this over-reliance and burdensome regulations. Dwell times for cargo at Indonesian ports, for instance, are worse than surrounding countries due to poor infrastructure and administrative delays, in turn causing significant costs to importers. The report suggests that Indonesia could continue to remove protective measures so the necessary improvements to infrastructure can be made through competition and foreign investment.

Indonesia ranks 61st for Enterprise Conditions. In many industries the informal sector dominates. This is evidence of the high degree of regulation in the formal sector, which mostly burdens larger and international companies. The report shows that greater prosperity could be achieved if the government reversed this trend and made it easier to run a business by simplifying the registration process, improving the ease of paying taxes, and making it easier to obtain permits.

Indonesia ranks 63rd for Governance, having risen nine places over the last decade. Elections are free and fair, with a vibrant civil society, resulting in a large and diverse legislature. However, the government is constrained by corruption and a lack of policy making expertise at all levels. This has resulted in a failure to deliver services and projects in a timely and efficient manner. The report shows that a simplification of central government departments and greater coordination between ministries with local governments is needed to ensure policy can be delivered effectively.

Dr Brien remarked: “Prosperity is much more than material wealth; it also encompasses welfare, security, freedom, and opportunity. But without an open and competitive economy, it is very challenging to create lasting social and economic wellbeing.

“Indonesia has made many achievements over the past 10 years, but there are still opportunities for reform. Infrastructure development would benefit from the country opening up to foreign investment. Similarly, reducing burdens for firms entering the formal sector by improving tax administration and increasing market contestability would encourage private investment, both international and domestic. It is our conviction that greater economic openness will bring greater prosperity to Indonesia. We hope the country will seize the opportunities available to it.”

The Legatum Institute’s Indonesia Case Study is part of its Global Index of Economic Openness research programme.