Interregional Resource Transfer and Economic Growth in Indonesia

Abstract

Rapid economic growth in Indonesia starting in the 1970s was fueled by market-based resource transfers, which helped modernize regional economies, creating the driving force for industrialization; and more welfare-oriented, government-based resource transfers, or development spending, which favored the poorer outer islands.

In 1970, Indonesia was a poor agricultural state, with a per capita GNP of only US$80 - the lowest among Asian economies and substantially lower than such African countries as Kenya and Ghana. Agriculture - with about 50 percent of GDP and 66 percent of the labor force - the dominant sector. In the 1970s, however, Indonesia showed rapid economic growth (5 percent a year). Softened world oil markets brought a slowdown in growth in the early 1980s, but growth recovered and per capita GNP in 1994 was US$880, comparable with the Philippines and substantially higher than many South Asian and African countries. Agriculture had only a 22 percent share of GDP; industry, 41 percent; and services, 42 percent.

But Indonesia is enormously diverse and some parts of it did much better economically than others. As the country's economy grew, market-based resource transfers helped modernize regional economies, creating the driving force for industrialization. By contrast, government-based resource transfers, in the form of development spending, were more welfare-oriented, favoring the poorer outer islands (and did not contribute to industrialization).

In other words, economic growth was sustained by two driving forces, government- and market-based transfers, which complemented each other. The oil boom was a bonanza, producing new fiscal revenue, a luxury only oil-exporting countries could enjoy. It is not always a ticket to successful industrialization, as the tragic experiences of such oil-exporting economies as Mexico show.

This paper - a product of the Development Research Group - is part of a Japanese research project on the political economy of rural development strategies.