Growth Strategies for a

Rising Indonesia:
Reducing Inequality and
Promoting Inclusive Growth
Joseph E. Stiglitz
Bali
October, 2014

Brief assessment of the

situation
Indonesia has made an impressive recovery from the AFC, and
has been one of the best performing large emerging markets
Succeeded in reducing poverty

But
Benefits of growth have not been equally sharedgrowing
inequality
And there are questions about sustainability of this growth
On both the demand and supply sides

Sustaining growth
In a world with an insufficiency of global aggregate demand
And likelihood of significant slowdown in China, most
important customer
In the context of supply constraints posed by
Inadequate infrastructure
Inadequate human capital
Questions about economic structure and financial system?

Most important lessons from

countries that have been successful
The government needs to play a critical role
The development state
Markedly different from neoliberal model, and Washington
consensus policies based on that model, which have, by and
large, been a failure

Sound monetary policy

But this does not mean an excessive focus on inflation
Managing exchange rate is key

Lessons.
Sound macro-policies
But this doesnt mean deficit fetishism
It does mean making key investments
And requires sufficient public resources

Industrial policiesan active role in shaping the economy

But this does not mean single-minded focus on manufacturing
It does mean managing resources well
It does mean managing structural transformation

.Lessons
Paying attention to distribution (equality)(inclusive growth)
Countries with more equality perform better: higher growth and more stability
Inequality affected by every aspect of public policy

Financial sector development

But wary of the excesses that have been evidenced in so much of the world
Implying a well-regulated sectorprotecting the rest of the economy against the
abuses of the financial sector
Major source of inequality and instability

And ensuring that the financial sector fills its role, e.g. providing credit to SMEs

Good governance
Poor governance major source of developmental failures
Poor governance major source of inequality
Good governance especially important in context of development state

Overall perspective: Indonesias

structural transformation
While manufacturing has been the basis of growth for many of the
successful countries in the past, its role is changing
Declining global employment in manufacturing
Increasing importance of robots and other technical changes leading to
some relocation of high value-added manufacturing

In the short run, some scope for expansion of manufacturing, as high

wages in China may lead to some relocation

Question is, to where will they be relocated

Labor force productivity and infrastructure will be key
So will real exchange ratemonetary policy will be crucial
Need not rely on FDIbut for local firms to flourish (especially SMEs) access
to credit will be crucial

Globally increasing role of

service sector
Even true in emerging markets
Citizens want health, education, housing, telecommunication
Globally, huge demand for tourism

A carefully managed natural

resource sector
Major lesson of resource curse
Countries with more resources typically grow more slowly and
have more inequality
Partly because of overvalued exchange rate
Partly because of difficulty of managing volatility of commodity
prices
Partly because of corruption

A carefully managed natural

resource sector
Indonesia needs to be mindful of all of these problems
Responsibility of central bank to prevent overvalued exchange rate
Must design good auctions and good contracts to ensure citizens get full value of
resources
And redo tax structures to ensure that remaining value of rents are captured
by state, and not by others, whether domestic or foreign
Revenues essential for public investments for growth, especially shared growth

And there must be transparency in spending, to ensure that money is spent in

way that ensures interests of all citizenstoday and in the futureare served
With carefully managed sovereign wealth fund
And investments at least equal to value of resources taken out
Otherwise, Indonesia risks becoming poorer (as wealth from natural resources
diminishes)

Specific issues: foreign exchange

rate management
Essential to maintain competitive, relatively stable exchange
rate
Cannot rely on market forces
Government needs to use full panoply of instruments
Interest rate policy
Direct intervention
Capital account management
Even the IMF recognizes the importance of this today

Not only can be done, must be done, especially if Indonesia

wants to have a strong manufacturing sector

Other aspects of monetary policy

Inflation targeting now recognized to be a mistake
Did not ensure growth and stability
Detracted attention from more fundamental issues

Credit availability is as or more important than interest rate (even real

interest rate) for macroeconomic performance
Access to credit, especially for SMEs

And this entails focusing on ensuring that there are institutions focused
on this issue
And not on speculation

Important lesson of this crisis and recovery

Failure to restore credit system one of explanations of slow US recovery
Including limited effectiveness of QE

Helping create an effective financial

system
Good financial markets necessary for successful growth and
development
Now well recognized that central banks have a responsibility not only for
macro-management in the traditional sense, but for financial stability
But there is also a responsibility to help ensure that the financial system
is efficient and inclusive, with access to credit, non-discriminatory
lending
Especially in emerging markets, a focus on lending to smes and other
growth-enhancing lending (not consumer lending or land speculation)
Indonesia has much higher spreads and higher real interest rates than
China

Fundamental rethinking of
monetary policy
Away from single mandate to multiple mandates (inflation,
unemployment, growth, financial stability)
Away from single instrument (short term interest rate) to
coordinated use of multiple instruments
Micro- and macro-prudential regulations

As well as better coordination between monetary and fiscal

policies

Creating an effective financial

sector
One of responsibilities of monetary authority
Most of focus in policy debate after crisis is preventing
financial sector doing harm

Not just from excessive risk taking

Abusive lending practices
Market manipulation
Ubiquitous problem in all countries
Which is why there need to be strong regulations on capital, risk
taking, transparency, competition, etc.

Creating an effective financial

sector
But real challenge is creating a financial sector which performs the
functions which it is supposed to serve

Lending, including to SMEs

Managing risk
Low cost payments system
Efficient savings system

Success of a financial system not measured by financial depth as

much as by how well it performs these functions
Excessive depth can be sign of excessive lending
High spreads sign of monopoly power and/or inefficiency

Creating an effective financial

sector
Capital and financial market liberalization can lead to slower
growth and more instability
Apparent in both AFC and GFC
Mounting evidence
Well developed theory explaining why this is so
Even though theory and evidence go against neoliberal model and
special interests
Even though US Treasury and USTR continue to push old agenda
IMF has finally recognized many of these lessons

Industrial policies
All governments have industrial policies
Laws and regulations, expenditure patterns benefit some sectors,
technologies over others
Only difference is that some countries dont publicly recognize that
they have industrial policies
Leaving the field open to special interests

US had an industrial policy to promote speculative financial sector

much to the cost of the country
Much of US industrial policy embedded in defense sector, some
quite successful
Internet

Industrial policy
Cant be based on static comparative advantage
In dynamic world economy, cant be based on simply following
strategy of earlier successful countries
Must take into account current strengths of the country, and
how they can changed: dynamic comparative advantage
Must take into account changing global scene
Thats why one has to have a view about the overall direction
of the economy

Multiple objectives
Not just growth
But also employment, environment, equality, strategic
concerns

Multiple tools
Promoting research/access to technology
Access to credit
In addition to standard tools of taxes, subsidies, trade policy

Inequality
Increasing problem in most countries
But not all
Showing that it is not just economic forces

It is policies and politics

Affected by every aspect of policyregulatory, tax,
expenditure
And the political processes by which those policies are
determined
E.g. the provision of public services at every level of government

Multiple dimensions of
inequality

Across different groups

Income and wealth
Health and access to justice
In many countries, growing inequality in all dimension
More going to the top
Less going to the bottom
Weakening of the middle class

Success in fighting poverty is important

But it is not enough

Inequality
Affects not just the nature of society, democracy
It is an objective in its own right
But it is also affects economic performance
Major new insight of last decade

There is not a trade-off between growth and equality

Rather, they are complements
A society pays a high price for inequality

Opportunities for Indonesia

Consolidation of democracy after 3 peaceful presidential
elections (2004, 2009, 2014) affords Indonesia a unique
opportunity
To pursue an inclusive growth strategy
To pursue a growth trajectory that can find a balance between
special interests
Especially the interests of the financial sector that excessively
focuses on short-term returns at high risks, and the interest of
the real sectors, especially agriculture and manufacturing

Indonesia has grown into a model of tolerance, pluralism

Concluding comments
Great challenges facing Indonesia
A country that has had marked successes
But this should be a time of great optimism, of a new
democratically elected government in meeting these
challenges