OECD Economic Surveys: Indonesia 2024

Chares Dennery
OECD

Indonesia has maintained steady overall economic growth over the past quarter of a century. Indeed, the country’s share of global GDP increased from 0.3% in 1998 to 1.3% in 2022. The rise in GDP per capita has been substantial (from USD 6 100 to USD 14 100, in PPP terms (constant 2021 USD), between 2000 and 2023), although this increase has not been as large as in some peer countries. Consequently, Indonesia has progressively fallen behind the other emerging economies in the G20, and China in particular. Correspondingly, economic convergence (Kremer, Willis and You, 2022[1]) towards richer economies in the OECD has largely stalled over the past decade (Figure 2.1). Indonesia’s GDP per capita has hovered around 25% of the OECD average since the early 2010s.

Socio-economic progress on other fronts has been strong. Indonesia has made significant advancements in reducing extreme poverty. While the rate of poverty increased temporarily during the pandemic, it has since receded, and decline in multidimensional poverty has been steady despite the pandemic (Figure 2.2, Panel A). This has been due in part to higher labour participation and employment levels, a rise in minimum wages, and expansion of social assistance programmes. On the other hand, the share of informality and self-employment is higher than before the pandemic, and the boom in commodity exports has not been shared evenly; these two factors have contributed to increasing inequality in urban areas in 2020-23, but it has receded in 2024 (Panel B).

The following sections of this chapter first underscore that weak productivity has played a role in Indonesia’s limited catch up in average GDP per capita. The chapter also emphasises the potential role that further integration in global trade and value chains could play in improving economic performance. The remainder of the chapter considers policy options for strengthening long-run economic performance under two themes: employment and skills, and the business environment.

Productivity is the main determinant of long-term GDP growth and Indonesia lags behind its peers. Contrary to other ASEAN countries, total factor productivity has been decreasing (Figure 2.4, Panel A). Also, GDP per worker is relatively low compared with some peers, including Thailand and Malaysia. Labour productivity has also grown more slowly than in the rest of ASEAN5. With such considerations in mind, the government has established a National Productivity Institute (LPN) in 2023, with a mandate to promote productivity-enhancing reforms as in several OECD countries (Renda and Dougherty, 2017[3]). The decomposition of labour productivity growth reveals the relevance of non-ICT capital deepening (Panel C). However, this does not mean that digitalisation is irrelevant as non-ICT investment often requires good digital infrastructure.

Indicators suggest Indonesia has scope for deeper, and more technologically advanced, trade. Exports and imports together represented 45% of GDP in 2022, versus 72% in the Philippines. Values substantially above 100% are seen in some other ASEAN peers. Similarly, foreign direct investment (FDI) inflows were equal to 1.9% of GDP, as against 4.4% in Vietnam and 3.6% in Malaysia. While the first indicator may reflect the large size of the domestic market, this very factor should make investing in Indonesia particularly important in the global strategy of MNEs. Additional evidence of scope to strengthen participation in globalisation is provided by the high-tech share of Indonesia’s manufactured exports (Figure 2.5, Panel A). Indeed, the share has declined. In 2010, 12.1% of Indonesia’s exports were high-tech; by 2019 the share was 8.1%. Other South-east Asian countries like the Philippines and Vietnam have, respectively, the highest share and the fastest growth of medium- and high-tech manufactured exports. Also reflecting relatively low participation in globalisation, the foreign content of Indonesian exports has long remained smaller than the ASEAN and OECD averages (Panel B). This share decreased from 15% to 11% between 2008 and 2020. Similarly, the share of domestic value added that is exported in the form of intermediate goods (natural resources) and is used in final goods production abroad shows a ‘de-integration’ trend. An enterprise survey by the World Bank points to relatively low engagement in foreign trade (Panel C and D). Meanwhile, the potential to further develop tourism is large, Indonesia having 10 out of the 27 ASEAN5 sites on the UNESCO World Heritage List (Box 2.2).

Indonesia has room to increase labour force participation and to boost human capital. Key challenges include reducing labour-market informality, closing gender gaps, and improving education and training.

Informal employment in Indonesia remains widespread. Despite a declining trend in past decades, around 60% of the workforce is estimated to be in informal types of employment, a higher share than in neighbouring countries. Informal employment includes unpaid household workers, employees in the informal business sector, as well as informal workers in formal firms. Informality is particularly high in agriculture and low-skilled services, and for women (Hapsari et al., 2023[6]). Productivity and salaries tend to be lower in informal firms, and provinces with greater informality also tend to be poorer. Social insurance programmes (old age, work accident, unemployment) have been introduced in recent years, but many of them only cover employees in larger firms. Informal and small-firm workers must rely heavily on family or community assistance, and during the COVID-19 pandemic some of them have left the labour market or moved to more informal occupations. More generally, Indonesia has long been characterised by a strongly dual labour market, with extensive employment and social protections in large firms, but with broad exemptions or enforcement difficulties in smaller firms and the informal sector.

An Omnibus Law on Job Creation was issued in March 2023, after the initial 2020 law had been suspended by the Supreme Court in 2021. The law includes measures to encourage the formal sector by making labour regulations more flexible in formal firms (and thus reducing the incentives to operate informally). In line with past OECD recommendations (Table 2.1), the law replaced municipal (and often also sectoral) minimum wages with provincial ones, based on inflation and economic growth; the law also brought greater flexibility for part-time work and overtime. Oversight for terminating employment was reduced, and the maximum severance pay was reduced from 32 to 19 months, with an additional six months paid by a newly created unemployment insurance scheme. While the law rightly aims at reducing labour market duality, it is too early to gauge the scale of its positive impacts. The Omnibus law also included provisions to reduce business regulation (see below).

The gender gap in labour force participation remains significant in Indonesia, and higher than in some other EMERG20 and most OECD economies (Figure 2.6). Women remain over-represented in informal jobs, and underrepresented in more qualified formal jobs, despite substantial improvements in education attainment.

In the short run, promoting formal entrepreneurship opportunities – notably through financial education, micro-lending, and ease of business – can increase female labour force participation and formalisation of the self-employed (Mukhlisah, 2024[7]). In particular, efforts to develop and formalise the care economy can empower women and make societies more resilient (OECD, 2024[8]). Improving women’s education and skills is key for access to formal, better-paying, jobs. Enrolment in tertiary education is already higher for women than for men, and it is all the more important to ensure women have avenues to deploy their skills in the workplace. Adapting cultural norms is important as in Indonesia men are often still seen as more legitimate breadwinners and therefore deserving hiring priority (OECD, 2024[8]).

Strengthening support for maternity leave and childcare services are part of the solution to increasing the employment of women. While the law provides for three months of maternity leave with full wages, the cost of this benefit is fully borne by the employer. This contributes to low compliance, especially in small firms (Setyonaluri et al., 2023[9]). Also, workers in the informal sector receive some maternity health coverage, but no maternity leave. Shifting the financing of maternity leave to the government, in part or in full, would help increase coverage. Also, by making maternity less costly for employers, women may be more likely to be offered jobs. Policy should also ensure that mothers are not unduly penalised when they resume working after pregnancy or childcare leave. Early Childhood Development (ECD) was introduced within the 2003 National Education System Law but progress has been limited; the enrolment rate has been less than 40% (UNICEF, 2020[10]). Greater access to affordable early childhood education facilities would help in this respect, when combined with enhanced efforts to guarantee the quality of both education institutions (accreditation is still optional) and teaching personnel.

As elsewhere, learning deteriorated during the pandemic. The OECD’s Programme for International Student Assessment (PISA) assesses the learning performance of 15-year-old students in mathematics, reading, and science. According to the latest results (OECD, 2023[11]), performance declined in Indonesia between 2018 and 2022, as in most OECD countries. This is largely due to pandemic-induced school closures, though a decline was already observable in Indonesia before 2018 (Figure 2.7). In 2022 as in previous years, Indonesian students scored significantly worse than the OECD averages in mathematics, reading, and science. Variance by province is large: in 2018, average performance was about 40 to 50 points higher in Jakarta and Yogyakarta than the national average, across all three subjects (OECD, 2019[12]).

Historically, infant malnutrition has contributed to poor education performance in primary schools, with intellectual abilities permanently scarred by stunting (Box 2.1). The strong push towards ending malnutrition, including through the free school lunch programme, will better prepare children for learning and growing. But improving education will also require large investments in infrastructure, teacher training and retention, as well as reducing the number of students dropping out of school. As such the free school lunch programme should not be funded by cuts elsewhere in the education budget.

Recent education reform has aligned with recommendations detailed in the 2021 Survey of Indonesia (OECD, 2021[13]) (Table 2.2). Measures underway include a roll out of an ambitious curriculum reform (Merdeka Belajar, or emancipated learning) that relies on digital teaching tools (OECD, 2024[14]). It aims to shift education towards student-centred learning, critical thinking, creativity, problem-solving abilities, and holistic development. All secondary and post-secondary levels must introduce the reform’s new curriculum by end-2024. The teachers’ digital platform, Platform Merdeka Mengajar includes tutorials and resources on the new curriculum along with management and planning tool. A programme that trains “learning leaders” is being used as part of the campaign to ensure teachers are familiar with the new system.

Yet differences in student achievement at the national exam (Ujian Nasional, UN) remain significant across regions, between rural and urban areas, between public and private schools, and between secular and religious schools (World Bank, 2020[15]). Implementing the curriculum reform uniformly across schools will be key to ensure that all pupils share a broader core knowledge to succeed (Box 2.3). Past efforts have lifted educational attainment but, as of 2022, only 57% of Indonesians aged 25 and above had completed a lower secondary degree. Public education is free and funded by local governments through grants from the central government. However, out-of-pocket expenditures remain considerable (these include books, stationery, school uniforms, and transport), especially in secondary schools. Sending one child to secondary school can represent 24% of household average expenditure (World Bank, 2020[15]). Increasing resources available to schools and making education more affordable is among the key reasons why tax revenues should be lifted over time (Chapter 1). Further progress in digitalisation would also help in improving school performance (Chapter 3).

Indonesia has a relatively high share of youth that is not in education, employment or training. While the youth unemployment rate declined from 26% in 2005 to 13% in 2023, it remains above ASEAN peers such as Malaysia (10%), the Philippines (7%), and Thailand (5%). Data from the OECD’s Programme for the International Assessment of Adult Competencies (PIAAC) show that Indonesian adults have some of the lowest skills across all countries surveyed (OECD, 2016[16]). For instance, they are the lowest scoring of all adults surveyed for information-processing skills, which are among the most required in the future of work. To make sure Indonesia remains competitive and productive, adult learning should become one of its priorities, as the country does not have yet a strong skills development system. As argued in the 2021 Survey, local governments and businesses should be more involved in designing vocational courses so that these better reflect local labour market needs (OECD, 2021[13]). Skills anticipation exercises help policymakers identify skills in need (OECD, 2023[17]), and information collection can focus first on priority sectors, as in Finland (CEDEFOP, 2019[18]). As in Malaysia (OECD, 2019[19]), the government should centralise information and list occupations that are skilled, in high demand and of strategic importance.

Improving tertiary education, both in universities and vocational schools, is important for making the workforce more productive, skilled, and adapted to the needs of the modern economy. The enrolment rate in tertiary education increased from 8.4% in 1990 to 42.6% in 2022 and is close to other middle-income countries. However, low past enrolment means the share of the adult population with tertiary education is small. As of 2022, the share of 25-64 year-olds who have completed tertiary education was 13%, the lowest share in the G20 (on a par with India). Attainment for women has been increasing rapidly; between 2015 and 2022 it increased from 15% to 21%. Further increasing tertiary enrolment among school leavers and widening access to tertiary education in the adult population will be important. More broadly, Indonesia has scope to raise the quality of its tertiary institutions. There are nine Indonesian universities among the world’s top 1000, fewer than in any other EMERG20 country, with relatively poor research output and weak ties with the business sector (see the section below on innovation).

Pro-competition regulation, easier conditions for doing business and success in combatting bribery and corruption, can facilitate firms’ entry and exit, encourage innovation and allow more efficient firms to succeed and grow. In turn, this can increase investment and employment, thereby lifting aggregate productivity, output per capita and living standards. For countries like Indonesia where many businesses are far from technological frontiers, the adoption of know-how and technology through diffusion and spillovers is a key channel for moving towards higher productivity.

The 2023 OECD Product Market Regulation (PMR) data point to a number of improvements in Indonesia’s business environment (Figure 2.8). There have been several pro-competitive reforms implemented over recent years, often echoing recommendations of past Surveys (Table 2.3). In particular, barriers to trade and foreign investment have been reduced, as well as the administrative and regulatory burdens. Nonetheless, in most dimensions of the PMR, the business environment in Indonesia remains less favourable than in the average of OECD members. Much of this reflects a relatively high degree of state involvement in the economy (Figure 2.8). Barriers to entry and conduct are widespread in network sectors and many professional services and the regulation of lobbying activities remains very limited (Box 2.4). Furthermore, state ownership is widespread. This potentially ramps up market distortions, especially as the governance of state-owned enterprises (SOEs) is not fully aligned with OECD best practices aimed at ensuring a level playing field between SOEs and private firms (Asian Development Bank, 2022[20]).

The Omnibus Law on Job Creation not only increases labour market flexibility (see above), it also streamlines regulations in some sectors, and reduces restrictions on foreign direct investment; some of these elements were implemented as early as 2021. Furthermore, the law introduces a new risk-based assessment, relaxing environmental certification for a medium-risk business and requiring a business license for high-risk business. The authority for granting permits was handed from the local level to the central government. Initial impact assessments suggests that domestic and foreign direct investment – realised and planned – significantly increased in sectors liberalised by the reform (Montfaucon, Senelwa and Doarest, 2023[21]).

State-Owned Enterprises (SOEs) continue to play a substantial role in Indonesia’s economy. The scope of their activities and market share is higher than the OECD average, and often higher than comparable emerging market economies. As of 2021, SOEs overseen by the Ministry of State-Owned Enterprises (MSOE) held USD 600 billion in assets (52% of GDP in 2021). There are also numerous smaller enterprises owned by provincial or municipal governments. The SOEs are spread across many sectors, including manufacturing and four of the five largest banks. Notable SOEs include PLN (electricity), Pertamina (oil and natural gas), Garuda Indonesia (air transport), Telkom, Bank Mandiri, Bank Rakyat, Krakatau Steel, Pupuk (fertilisers), and Waskita (construction). The legislation on SOEs distinguishes between those that operate for profit and those conducting business on behalf of government. SOEs fall under two main types: perum (fully state-owned and expected to conduct business on behalf of the public interest) and perseo (for profit limited liability company with full or majority state-ownership). Perseo SOEs are expected to act as profit-maximising companies rather than government agencies.

Weak and declining financial and operational performance among SOEs is a key concern (Asian Development Bank, 2020[22]). In 2019, 43 out of 114 of Indonesia’s SOEs failed to meet even low thresholds for financial viability and the COVID pandemic and the global energy crisis have likely further aggravated the problems. One explanation is that, even when defined as “for profit”, the SOEs are often the instrument of government policies, for instance, providing goods, services or employment at subsidised rates. Compensation from government for these activities is sometimes delayed, weakening the SOEs financial position. Other concerns revolve around SOE investment and financing and the relation of these with government accounts. Using SOEs to raise funds for infrastructure investment can partially reduce pressure on the government’s borrowing capacity, but the implicit or explicit state guarantees on SOEs borrowing represent a liability. Also, the role of government as shareholder can bring risks of moral hazard, especially when the firm is tasked with implementing some of the government’s policies, rather than being free to pursue profit-maximisation.

SOE exemptions from antitrust law also raise issues. Under article 51 of the 1999 Competition Law, SOEs are exempted for activities tied to social assistance or national development objectives. While this exemption normally does not apply when SOEs or their subsidiaries engage in activities unrelated to their core national development business, SOEs can nevertheless cross-subsidize their operations in other competitive markets. This distorts competition and gives SOEs an unfair advantage over their privately-owned competitors. SOEs should be subjected to stronger scrutiny under competition law and the scope of exempted activities should be narrowed. Apart from the risk of abusive cross-subsidisation of activities, horizontal diversification can also lead to inefficiencies if the business logic of such diversification is poor. SOEs should refrain from entering or staying in markets that are poorly related to their core business.

There has been a welcome consolidation of the SOE sector. The authorities have long pledged to “rightsize” the SOE sector, largely through mergers. Past progress has been limited; in 2019 there were still 142 central government SOEs. However, a major consolidation in January 2023, shrunk the number to 41 and the goal is to reduce the number to 30 SOEs over the next decade. These SOEs are grouped into 12 clusters (telecoms and media, energy, tourism, insurance and pension funds, banks, food and fertilisers, infrastructure, plantation and forestry, mining, manufacturing, logistics, health). This consolidation has potential to increase the performance of the merged companies, though it requires a thorough and transparent assessment of their business and financial situation. However, consolidation will not resolve all the challenges of the SOE sector. As argued in past Surveys, there is value in developing a national ownership policy to guide the partial or full listing of more SOEs (OECD, 2021[13]). At present there is no active privatisation programme, but the incoming President has signalled a desire to make progress on this front, notably for state-owned hotels. In addition, stricter application of global standards such as the OECD Guidelines on Corporate Governance of SOEs (OECD, 2024[23]) would help SOE performance. Best practice in SOE’s has multiple dimensions (OECD, 2024[24]). As regards monitoring performance, Korea, New Zealand and Sweden have been cited as among the most advanced, with comprehensive performance agreements that extend across their entire SOE sectors (Brumby and Gökgür, 2021[25]).

Fighting corruption is a long-standing government priority, although perceptions of corruption and challenges to public integrity remain prevalent (Figure 2.9, Panel A). A key institution has been the Corruption Eradication Commission (KPK), which deals with high-level corruption cases. The Commission has been key in changing public perceptions about graft (Box 2.5).

Legislation transforming the KPK from an independent authority to an executive agency in 2019 has raised concerns. The law placed the KPK under the oversight of a supervisory body, which must be notified (but does not authorise) activities such as wire-tapping, searches and seizures. The supervisory body can also hear complaints on ethics violations by employees of the KPK. The law also stipulated that KPK employees were part of the civil service. The KPK is free to select its employees but only from the pool of civil servants; in 2021, more than 50 KPK employees were removed after failing a civic knowledge test that was required to become civil servants. The legislation has been criticised by some as a move to politicize the agency and weaken its ability to prosecute corruption (Transparency International, 2021[27])

Overall, the loss of operational autonomy of the KPK seems to be of greatest concern, and ex post oversight would likely be more warranted than ex ante supervision. In order to address these concerns:

• The KPK should be free to hire the most suitable and qualified personnel and investigators, if need be, outside the pool of civil service employees; unless nepotism or irregularities are suspected, these decisions should rest with the Commission.

• Allegations against KPK employees (including police officers and prosecutors working for the KPK) could perhaps be better addressed by the Ombudsman than a multi-member board.

• While it is crucial that the KPK works efficiently with police agencies and prosecutors, this is better achieved by subjecting them to the KPK’s authority in corruption cases than subjecting the KPK to the supervision of these agencies and their representatives.

• More generally, in the appointment of members of courts and independent authorities, parliament and government bodies should respect the independence of the appointees.

There is scope to also strengthen anti-corruption measures in the areas of international business transactions and lobbying. As argued in the 2021 Survey (OECD, 2021[13]), Indonesia should criminalise the bribery of foreign public officials and enact corporate liability for corruption offences as a party to the UN Convention against Corruption and as a G20 member. These legislative changes are also part of the OECD Convention on Combating the Bribery of Foreign Public Officials in International Business Transactions (the Anti-Bribery Convention). Clearer definitions and regulations on lobbying and conflicts of interest should also be introduced, notably for members of Parliament and local politicians; currently direct bribery is prosecuted while trading of political influence is often not a criminal offence. As shown in the PMR lobbying indicator (Figure 2.8), Indonesia currently stands far from international best practice. In addition, increasing fines for corruption or ethics violations, and making convicted politicians ineligible to run for office, at least for a few years, could strengthen deterrence.

Indonesia is engaging in a number of new trade agreements (Box 2.6), but considerable regulatory and policy-driven obstacles to trade will remain even if these are successfully concluded. Evidence suggests Indonesia’s tariff and non-tariff measures hurt firm’s productivity and employment, with a more severe impact on smaller firms (Gupta, 2023[28]).

Tariff barriers are low in Indonesia while the evidence is mixed for non-tariff barriers. According to the World Bank’s World Development Indicators, Indonesia had an unweighted average tariff of 6% across traded goods, and a weighted average of 1.8%. Both averages are similar to the world averages and have been relatively stable over the past 20 years. As elsewhere, non-tariff restrictions can impede trade; for instance, unintentional (or perhaps otherwise) barriers in technical standards or in border processing. An estimate of the ad-valorem equivalent of non-tariff barriers (Cadot, Gourdon and van Tongeren, 2018[29]) suggests, overall, they are relatively low in Indonesia (Figure 2.10, Panel A). As regards more specific non-tariff barriers, Indonesia applies only a small number of anti-dumping trade restrictions, fewer than the US or the EU (Figure 2.10, Panel C). However, Indonesia imposes a relatively large number of local content policies and criteria for public procurement (Figure 2.10, Panel B).

Indonesia is endeavouring to fine-tune its system of import and export licences. Import licenses have historically been used to promote import substitution industrialisation. More recently, export restrictions have been used to lower the price of food commodities and promote downstream processing industries (see below). A Commodity Balance Mechanism (NK), introduced under Presidential Regulation n° 32/2022, aims to balance the country’s supply and demand for certain commodities (including meat, fishery, rice, salt, and sugar). Data provided by businesses are used to identify excess supply or demand and adjustments to quotas and licenses for exports and imports are made accordingly. One potential advantage of the NK system is shorter and more transparent permit processes. However, accurately identifying the state of demand and supply and responding in a timely way is inherently challenging, not least as past data may not be relevant for ongoing and future needs. In a welcome move, the authorities decided recently not to go ahead with a planned extension of the Mechanism to certain types of plastics. Plans for extending the Mechanism to other goods should also be reconsidered. A more open trading system, where demand and supply adjustment are largely driven by price movements, would be more efficient and transparent.

Indonesia has scope to reduce barriers to trade in services. Boosting trade in services, particularly in high-value-adding sectors, can bring addition benefits through knowledge transfer, for instance. The OECD Services Trade Restrictiveness Index (STRI) provides information on regulations affecting trade in services in 22 sectors. According to this indicator, Indonesia’s international services trade is more restricted than that in other ASEAN economies such as Singapore, Malaysia, and Vietnam, and significantly more than the OECD average (Figure 2.11, Panel A). Furthermore, the OECD data suggest restrictions have increased between 2014 and 2023 across many sectors. Restrictions are particularly heavy in legal services, accounting, and telecoms. Restrictions on foreign entry feature in many sectors. Barriers to competition specifically hinder trade in telecommunications and air transport (Figure 2.11, Panel C).

There has been an encouraging reduction in the scope of direct restrictions on foreign-direct investment (FDI). Inward FDI is relatively low in Indonesia, when compared to other ASEAN nations such as Malaysia or Thailand (Figure 2.11, Panel B). Prior to 2020, direct restrictions on FDI applied to numerous sectors of the economy. The Omnibus Law on Job Creation (see above) significantly narrowed the scope of direct FDI restrictions. Notably, heavy restrictions were lifted as regards investment in airports, mining, and construction services. Direct FDI restrictions now only apply to six fairly narrow product categories (cannabis, gambling, fishing of endangered species, coral extraction, alcohol, industries using ozone-depleting materials and chemical weapons). Inward FDI flows have increased substantially in recent years in some of the liberalised sectors, notably in the extraction and processing of base metals, though in other sectors results have been mixed (Montfaucon, Senelwa and Doarest, 2023[21]).

However, there remain many indirect discriminatory impediments on foreign direct investment that are not tackled by the 2023 Omnibus Law or by other measures. Impediments include increased capital requirements, local content rules (as mentioned above), and unequal access to public procurement (OECD, 2020[30]). For example, in mining foreign investors are required to sell 51% of holdings to local investors within ten years. FDI restrictions in services sectors (see above) are also often indirect discriminatory impediments. The Indonesian economy would greatly benefit from reducing these discriminatory measures.

As part of the national medium-term development plan (RPJMN) 2020-2024 (Indonesian Presidency, 2020[31]), the Indonesian authorities have been providing tax and non-tax incentives and imposing export restrictions to encourage downstream processing of Indonesia’s commodities, notably nickel. The aim is to reduce dependence on global commodity buyers, as well as to boost regional development and manufacturing employment. Indonesia accounts for nearly half of global output in nickel ore, which has been the primary focus of such initiatives. Policy has oscillated between tariffs and export bans, in search of a formulation that prompts downstream processing while also continuing to attract investors’ interest. An export tariff was introduced in 2012. An outright export ban was introduced in 2014 and replaced again with tariffs in 2017. The export ban was reinstated in January 2020, along with a domestic processing requirement on raw nickel ore. The export ban and domestic processing requirement appear to have had greater effect. FDI has increased substantially with numerous new nickel smelters operating, or under construction. Much of the investment originates from China. Exports of ferronickel and processed nickel have surged in value from USD 4.5 billion in 2019 to USD 19.6 billion in 2022, while nickel ore exports have stopped. The IMF estimates that less than one third of this increase is due to higher global nickel prices, with the rest plausibly coming from higher value added from smelting activities and higher export volumes (IMF, 2023[32]). The authorities are contemplating policies to incentivise deeper nickel down-streaming – notably the production of electric batteries and vehicles – and extending down-streaming polices to other commodities (copper, bauxite, tin or agricultural goods).

Though the down-streaming strategy pursues some worthy goals – and industrial policies have played a major role in the industrial development of some countries like Korea in the past (Box 2.7) – the cost and benefits for the Indonesian economy should be thoroughly assessed and periodically reviewed. Evaluation of industrial policies is key to ensure they reach their intended impacts (Criscuolo et al., 2022[33]): targeted industrial strategies can achieve structural transformation and growth, but evaluation and regular re-assessment of these strategies are needed. On average, fiscal incentives for extraction and processing has amounted to about 0.4% of GDP between 2016 and 2022; while this is small, it represents about 10% of the government’s annual discretionary spending. The risk of building significant overcapacity in the targeted sectors is also sizable. This has, for instance, happened in the global steel industry subsidies from numerous countries have led to excess capacity (Mercier and Giua, 2023[34]). Against the risk of resource misallocation and rent-seeking, the down-streaming strategy should include provisions such as sunset clauses to minimise any possible detrimental impact on competition. Another risk of this policy is reaction from trading partners (IMF, 2023[35]). This has already happened in the case of nickel; the European Union has challenged the export ban and domestic processing requirement at the WTO (the case remains undecided).

More broadly, policy towards business should adhere to sound principles. The objectives of industrial policies supporting specific sectors, such as support for down-streaming, should be defined narrowly but also sensibly (Goldstein, 2002[36]). Notably, there are risks in aiming for specific shares of employment in manufacturing or processing sectors as this can push business excessively towards using low productivity (but high employment) production techniques (Rodrik, 2015[37]). Also, industrial policies should not detract from efforts to improve the general business environment, including through creating better jobs in services through pro-competition business regulations. This can be a more promising growth strategy than heavy manufacturing for absorbing new workers into middle-class occupations (Rodrik and Stiglitz, 2024[38]).

Indonesia generally ranks poorly in terms of innovation readiness. In the World Intellectual Property Organisation’s (WIPO) Global Innovation Index, Indonesia has climbed from 72^nd in 2010 (INSEAD, 2011[47]) to 61^st in 2023 (WIPO, 2023[48]). However, it remains the worst ranked ASEAN5 country and is also surpassed by Vietnam. Patenting activity in information and communication technologies is relatively low (Figure 2.12, Panel A). Meanwhile, expenditure on research and development (GERD) has grown from 0.09% of GDP in 2013 to 0.28% in 2020 (Figure 2.12, Panel B) but this is significantly below the ASEAN average of 1.07%. GERD has predominantly been government driven—public sector shares of GERD is 84.6%, whereas the private sector share is 7.3% (Figure 2.12, Panel C). Very little private R&D activity is undertaken in the manufacturing sector, except in large companies (Hill and Tandon, 2010[49]).

Indonesia’s low level of R&D is echoed in its research skill base. There were only 400 R&D personnel per million inhabitants in 2020, compared with 7 225 in Singapore, 2 024 in Thailand, 779 in Viet Nam, and 726 in Malaysia (Panel D). The number of STEM tertiary students remains low, thought this is expected to increase. Indonesia is projected to produce 3.7% of global STEM graduates by 2030, making it one of the highest producers in the world (Oliss, McFaul and Riddick, 2023[50]). In terms of scientific research, proxied by peer-reviewed academic publications, Indonesia has grown from 0.03% of the world total in 2003 to 0.96% in 2022, although mostly thanks to large increases in conference proceedings and low-impact publications. On the other hand, participation of women in R&D and innovation is relatively strong, although it can be further improved. Women comprise 44% of R&D personnel, 38% of researchers in business enterprises and in government, and 21% of researchers in higher education. Female researchers with doctorate qualifications stand at 36% and female researchers with master’s qualifications at 49% (UNESCO-UIS).

There is scope to strengthen Indonesia’s protection of intellectual property rights (IPRs), including for software and other digital services. The 2016 Patent Law improved the general framework, although the patentability criteria for incremental innovations are ill-defined and the grounds and procedures for issuing compulsory licenses fail to fully protect the interests of innovative firms (US State Department, 2023[51]). Overall, holders of intellectual property rights in Indonesia face challenges in protection and enforcement, as testified by widespread piracy and counterfeiting and the presence of the country in the European Commission’s priority 3 watchlist (European Commission, 2023[52]). Poor enforcement is of particular concern regarding dangerous counterfeit products (such as pharmaceutics and spare parts) and should be addressed through deterrent-level penalties for IPR infringement in physical markets and online.

R&D funding has been criticised for being compromised by uncompetitive and opaque allocation mechanisms and ineffective management, as well as for being spread too thinly across projects (2018 study by the Corruption Eradication Commission). The R&D funding system, and in particular the Indonesian Science Fund, has also been compromised by slow disbursement, cumbersome administrative procedures, and single-year funding (Asian Development Bank, 2020[53]). Science and technology have received increasing attention in the national policy agenda. In 2019, the law on the National System of Science and Technology (2019) introduced new tax incentives for R&D. In 2021 a new Ministry of Education, Culture, Research, and Technology (MoRTHE) was established, along with the new National Research and Innovation Agency (Badan Riset Dan Inovasi Nasional, BRIN). In 2023, BRIN received IDR 6.39 trillion (USD 408 million) from the state budget, equal to 0.03% of GDP. It will be crucial to avoid undue political pressures in BRIN’s governance and programme of work. Also, the time taken to fund research needs to be shortened.

In addition to developing R&D funding support the Indonesian government has introduced a range of measures to encourage innovation and entrepreneurship. These include tax incentives, simplified business registration procedures and funding support for early-stage startups. A 300% super tax deduction for R&D activities was introduced in 2019, but uptake of the incentive has been very modest (Kristanti and Saptono, 2024[54]). The “1000 Digital Startups National Movement” programme, launched in 2016, includes awareness, tutoring and mentoring support for digital startups. Other programmes for start-ups include Startup Inovasi Indonesia and Startup Studio Indonesia. The latter aims to nurture 150 early-stage businesses by 2024. Help with financing includes the Merah Putih Fund, a government-backed financing vehicle bringing together five state-owned venture-capital companies.

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