Economic growth in Indonesia: the driving forces of the level and the growth rate of real per capita income: an econometric time series approach

An important policy goal for many governments is to increase the growth of real income. Real income is important because, it represents economic wellbeing. This study answers the question: how can Indonesia increase the growth rate of real per capita income in order to increase the welfare of the people. A three step process is used to discover the driving forces of the level and of the growth rate of real per capita income, namely: (i) Investigating if the long run growth characteristic is, exogenous or endogenous; (ii) Investigating and measuring productivity related to growth; and (iii) Discovering the driving forces of the level and of the growth rate of real per capita income. Econometric methodology, especially time series approach, confirms that the three step process is testable empirically. To investigate the characteristic of economic growth in Indonesia for the period 1960 to 2006, regression equation of time series and cointegration approaches are employed. To investigate and measure the productivity related to growth, technology and income level catching up are examined against two leading economies, namely Japan and USA. Technology catching up is examined using regression equation of time series, while income level catching up is examined utilizing cointegration and the polynomial time trend approach. To discover the driving forces of the level and the growth rate of real per capita income, a bound testing approach to cointegration is employed. The real per capita GDP has been used to reflect real per capita income in most empirical work. The results of this study suggest: • First that during the period of 1960 to 2006, Indonesia’s economic growth is characterized by the endogenous growth model. This implies that long run per capita income growth can be influenced by appropriate government policy. • Second, that during the same period, there was a process of adoption of technology or technology catching up by Indonesia from the frontier technology of the developed country Japan and USA. This process has empirically contributed to the acceleration of productivity and to the growth rate achieved by Indonesia of about 6 per cent annually. However, the growth rate of about 6 per cent is insufficient to catch up to Japan and USA in terms of income level in the long run, given that the empirical tests show no evidence of income level catching up. • Third, that during the period of 1970 to 2006, Indonesia’s real per capita GDP can be linked to: capital, labor, exports, external debt to GDP ratio, stock of FDI and population. These results further suggest that in the long run, the increase of capital, employment and export lead to the increase in real per capita GDP, while the increase of external public debt to GDP ratio, stock of FDI and population lead to the decrease in real per capita GDP. In the short run, the increase of the growth of capital, employment and export lead to the increase in the growth of real per capita GDP, while the increase of the growth of external public debt to GDP ratio and population lead to the decrease in real per capita GDP growth. Some policy implications can be drawn from these results are: • First, related to the outcome of the exogenous and endogenous investigation, the government should formulate an active development strategy, because the long run growth of real per capita GDP can be influenced by appropriate government policy. The government should also promote investment to boost real per capita GDP growth. • Second, related to the outcome of investigating and measuring productivity and the growth rate, the government should further develop adoption capacity factors, in order to support the process of adoption of technology for the purpose of accelerating productivity related to growth. This task could include (i) Reducing tariffs on the import for equipment and production machinery, (ii) Emphasizing human capital development, and (iii) Increasing economic performance. The goal of this task is to achieve high real per capita GDP growth so that Indonesia can catch up, in terms of, real per capita GDP to Japan and USA in the long run. • Third, related to the outcome of the driving forces of the level and of the growth rate of real per capita GDP, the government should essentially develop policies that directly address an increase in the level and the growth rate of real per capita GDP. These could include generating capital accumulation, creating new jobs to increase employment and increasing export volumes, being more selective to foreign direct investment so that it does not crowd-out domestic investment, reducing the external public debt to GDP ratio and reducing the growth rate of population. This study maps a new direction in discovering the driving forces of the level and the growth rate of real per capita income by employing three steps process. The process is explored from the properties of economic growth theories, analyzed with the well developed econometric methodology and utilized updated Indonesia’s data. This ensures that the outcome presents strong theoretical and empirical background. The findings and suggestions of this study provide input for policy maker for Indonesian development strategy formulation. It offers additional insight into the impact of government policy in the long run economic growth and the factors should be addressed to increase the growth rate of real per capita GDP in order to increase the welfare of the people of Indonesia.