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Global Economic Environment and Policy

Rostow Theory of Economic Growth and Indonesia

Submitted under the guidance of:Prof. Ranajoy Bhattacharya and Prof. BibekRoychaudhuri

VINEET BAKSHI ANKIT SAKHUJA ARJIT JAIN ROHIT CJ AMIT KUMAR SHIVAJI YADAV

INTRODUCTION TO ROSTOW THEORY OF ECONOMIC GROWTH

According to W.W. Rostow, it is possible to identify all societies in their economic dimensions as lying within one of the five categories: the traditional society, the preconditions for take-off, the take-off, the drive to maturity, and the age of high mass-consumption.

1) The Traditional Society A traditional society is one whose structure is developed within limited production functions, based on pre-Newtonian attitudes towards the physical world. The economy is dominated by subsistence activity where output is consumed by producers rather than traded. Any trade is carried by barter where goods are exchanged directly for other goods. Agriculture is the most important industry and production is labour intensive using only limited quantities of capital. Resource allocation is determined very much by traditional methods of production. The level of output per head is limited and savings rate is low. Population fluctuates with harvest and disease. In terms of history, the whole pre-Newtonian world: the dynasties in China, the civilization of the Middle East and the Mediterrean, the whole world of medieval Europe come under the traditional society.

2) The preconditions for take-off The preconditions to take-off are that the society begins committing itself to secular education, that it enables a degree of capital mobilization, and that the secular concept of manufacturing develops. This leads to a take-off in ten to fifty years. At this stage, there is a limited production function, and therefore a limited output. There are limited economic techniques available and these restrictions create a limit to what can be produced. Increased specialization generates surpluses for trading. There is an emergence of a transport infrastructure to support trade. As incomes, savings and investment grow entrepreneurs emerge. External trade also occurs concentrating on primary products. The preconditions for take-off were initially developed, in a clearly marked way, in Western Europe of the late seventeenth and early eighteenth. Among the Western European states, Britain, favoured by geography, natural resources, trading possibilities, social and political structure, was the first to develop fully the preconditions for take-off.

3) The take-off Take-off then occurs when sector led growth becomes common and society is driven more by economic processes than traditions. At this point, the norms of economic growth are well established. After take-off, a country will take as long as fifty to one hundred years to reach maturity. Globally, this stage occurred during the Industrial Revolution.

Industrialization increases, with workers switching from the agricultural sector to the manufacturing sector. Growth is concentrated in a few regions of the country and in one or two manufacturing industries. The level of investment reaches over 10% of GNP. New techniques are adopted both in agriculture and industry. Agriculture becomes more commercialized and increasing number of farmers is prepared to accept new methods and changes. One can approximately allocate the take-off of Britain to the two decades after 1783; France and the United States to the several decades preceding 1860; Germany, the third quarter of the nineteenth century; Japan, the fourth quarter of the nineteenth century; Russia and Canada the quarter-century or so preceding 1914; while during the 1950's India and China have, in quite different ways, launched their respective take-offs.

4) The drive to maturity The drive to maturity refers to the need for the economy itself todiversify.This diversity leads to greatly reduced rates of poverty and rising standards of living. Technological innovation is providing a diverse range of investment opportunities. The economy is producing a wide range of goods and services and there is less reliance on imports. The make-up of the economy changes unceasingly as technique improves, new industries accelerate, and older industries level off. Approximately10-20% of the national income is steadily invested, permitting output regularly to outstrip the increase in population. It takes an economy some 40 years after the end of take-off to attain maturity. The economy which focused around a relatively narrow complex of industry and technology during the take-off has extended its range into more refined and technologically complex processes. For example, there may be a shift in focus from the coal, iron, and heavy engineering industries of the railway phase to machine-tools, chemicals, and electrical equipment. This was the transition through

which Germany, Britain, France, and the United States had passed by the end of the nineteenth century or shortly thereafter.

5) The age of high mass-consumption The age of high mass consumption refers to the period of contemporary comfort afforded many western nations, wherein consumers concentrate on durable goods, and hardly remember the subsistence concerns of previous stages. In the age of high mass consumption, a society is able to choose between concentrating on military and security issues, on equality and welfare issues, or on developing great luxuries for its upper class. Economic maturation inevitably brings on job-growth which can be followed by wage escalation in the secondary economic sector (manufacturing), which is then followed by dramatic growth in the tertiary economic sector (commerce and services). For the United States, the turning point was Henry Ford's moving assembly line of 1913-14; but it was in the 1920's, and again in the post-war decade, 1946-56, that this stage of growth was pressed to its logical conclusion. In the 1950's Western Europe and Japan appear to have fully entered this phase. The Soviet Union is technically ready for this stage.

INDONESIA

ECONOMY Indonesia has a market-based economy in which the government plays a significant role. There are 139 state-owned enterprises, and the government administers prices on several basic goods, including fuel, rice, and electricity.

In the mid-1980s, the government began eliminating regulatory obstacles to economic activity. The steps were aimed primarily at the external and financial sectors and were designed to stimulate employment and growth in the non-oil export sector. Annual real gross domestic product (GDP) growth averaged nearly 7% from 1987-97 and most analysts recognized Indonesia as a newly industrializing economy and emerging major market. The Asian financial crisis of 1997 altered the region's economic landscape. With the depreciation of the Thai currency, the foreign investment community quickly reevaluated its investments in Asia. Foreign investors dumped assets and investments in Asia, leaving Indonesia the most affected in the region. In 1998, Indonesia experienced a negative GDP growth of 13.1% and unemployment rose to 15%-20%. In the aftermath of the 1997-98 financial crisis, the government took custody of a significant portion of private sector assets via debt restructuring, but subsequently sold most of these assets, averaging a 29% return. Indonesia has since recovered, albeit more slowly than some of its neighbors, by recapitalizing its banking sector, improving oversight of capital markets, and taking steps to stimulate growth and investment, particularly in infrastructure. GDP growth steadily rose in the following decade, achieving real growth of 6.3% in 2007 and 6.1% growth in 2008. Although growth slowed to 4.5% in 2009 given reduced global demand, Indonesia was the third-fastest growing G-20 member, trailing only China and India. Growth rebounded in 2010 to 6.1% and is forecast to reach 6.2%-6.5% in 2011. Poverty and unemployment have also declined despite the global financial crisis, with the poverty rate falling to 13.3% (March 2010) from 14.2% a year earlier and the unemployment rate falling to 6.8% (February 2011) from 7.4% a year earlier.

Indonesias improving growth prospects and sound macroeconomic policy have many analysts suggesting that it will become the newest member of the BRIC grouping of leading emerging markets. Its solid track record has also resulted in credit upgrades from each of the major ratings agencies in the past year, with all three major credit rating agencies rating Indonesia sovereign debt one level below investment grade. An upgrade to investment grade is expected to occur within the next 18 months.

In reaction to global financial turmoil and economic slowdown in late 2008, the government moved quickly to improve liquidity, secure alternative financing to fund an expansionary budget and secure passage of a fiscal stimulus program worth more than $6 billion. Key actions to stabilize financial markets included increasing the deposit insurance guarantee twentyfold, to IDR 2 billion (about U.S. $235,000); reducing bank reserve requirements; and introducing new foreign exchange regulations requiring documentation for foreign exchange purchases exceeding U.S. $100,000/month. As a G-20 member, Indonesia has taken an active role in the G-20 coordinated response to the global economic crisis. In the face of surging portfolio inflows in 2010 and 2011, Bank Indonesia has implemented a number of measures to encourage inflows toward less-volatile, longer-tenor instruments.

Indonesia has a mixed economy in which both the private sector and government play significant roles. The country is the largest economy in Southeast Asia and a member of the G-20 major economies. Indonesia's estimated gross domestic product (nominal), as of 2010 was US$706.73 billion with estimated nominal per capita GDP was US$3,015, and per capita GDP PPP was US$4,394 (international dollars). June 2011: At World Economic Forum on East Asia, Indonesian president said Indonesia will be in the top ten countries with the strongest economy within the next decade. The Gross domestic product (GDP) is almost Rp.1 trillion ($117.6 million) and the debt ratio to the GDP is 26 percent. The industry sector is the economy's largest and accounts for 46.4% of GDP (2010), this is followed by services (37.1%) and agriculture (16.5%). However, since 2010, service sector has employed more people than other sectors, accounting 48.9% of the total labor force, this has been followed by agriculture (38.3%) and industry (12.8%). Agriculture, however, had been the country's largest employer for centuries. According to World Trade Organization data, Indonesia was the 27th biggest exporting country in the world in 2010, moving up three places from a year before. Indonesia's main export markets (2009) are Japan (17.28%), Singapore (11.29%), the United States (10.81%), and China (7.62%). The major suppliers of imports to Indonesia are Singapore (24.96%), China (12.52%), and Japan (8.92%). In 2005, Indonesia ran a trade surplus with export revenues of US$83.64 billion and import expenditure of US$62.02 billion. The country has extensive natural resources, including crude oil, natural gas, tin, copper, and gold. Indonesia's major imports include machinery and equipment, chemicals, fuels, and foodstuffs. And the country's major export commodities include oil and gas, electrical appliances, plywood, rubber, and textiles. In the 1960s, the economy deteriorated drastically as a result of political instability, a young and inexperienced government, and economic nationalism, which resulted in severe poverty and hunger. By the time of Sukarno's downfall in the mid-1960s, the economy was in chaos with 1,000% annual inflation,

shrinking export revenues, crumbling infrastructure, factories operating at minimal capacity, and negligible investment. Following President Sukarno's downfall in the mid-1960s, the New Order administration brought a degree of discipline to economic policy that quickly brought inflation down, stabilized the currency, rescheduled foreign debt, and attracted foreign aid and investment. (See Berkeley Mafia). Indonesia was until recently Southeast Asia's only member of OPEC, and the 1970s oil price raises provided an export revenue windfall that contributed to sustained high economic growth rates, averaging over 7% from 1968 to 1981.
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Following further reforms in the late 1980s, foreign investment

flowed into Indonesia, particularly into the rapidly developing export-oriented manufacturing sector, and from 1989 to 1997, the Indonesian economy grew by an average of over 7%. Indonesia was the country hardest hit by the Asian financial crisis of 199798. Against the US dollar, the rupiah dropped from about Rp. 2,600 to a low point of 14,000, and the economy shrank by 13.7%. The Rupiah stabilised in the Rp. 8,000 to 10,000 range, and a slow but significant economic recovery has ensued. However, political instability, slow economic reform, and corruption slowed the recovery. Transparency International, for example, has since ranked Indonesia below 100 in its Corruption Perceptions Index. Nevertheless, GDP growth averaged 5% between 2004 and 2006. The Growth, unfortunately, was not able to make a widely real impact toward unemployment and poverty, particularly due to the stagnant wages and rapid hikes in food, oil and gas price. Since 2007, however, with the improvement in banking sector and domestic consumption, the national economic growth has been 6% annually this helped the country weather the 20082009 global recession. As of 2010, an estimated 13.3% of the population was living below poverty line, and the unemployment rate was 7.1%.

FACTS: GDP (2009): $539 billion; (2010): $707 billion; (2011 est.): $823 billion. Annual growth rate (2009): 4.5%; (2010): 6.1%; (2011 est.): 6.2%. Inflation, end-period (2009): 2.8%; (2010): 7%; (2011 est.): 7.3%. Per capita income (2010, PPP): $4,394. Natural resources (11.2% of GDP, 2010): Oil and gas, bauxite, silver, tin, copper, gold, coal. Agriculture (15.3% of GDP, 2010): Products--timber, rubber, rice, palm oil, coffee. Land--17% cultivated.

Manufacturing (24.8% of GDP, 2010): Garments, footwear, electronic goods, furniture, paper products, automobiles. Trade: Exports (2010)--$158 billion including oil, natural gas, crude palm oil, coal, appliances, textiles, and rubber. Major export partners--Japan, U.S., China, Singapore, Malaysia, and Republic of Korea. Imports (2010)--$136 billion including oil and fuel, food, chemicals, capital goods, consumer goods, iron and steel. Major import partners--Singapore, China, Japan, U.S., Malaysia, Thailand and South Korea. Exports and Trade: Indonesia's exports were $158 billion in 2010, a rise of 35% from $116.5 billion in 2009. The largest export commodities for 2010 were oil and gas (17.8%), minerals (14.9%), textile and footwear (8.9%), crude palm oil (8.54%), electrical appliances (8.2%), and rubber products (4.7%). The top destinations for exports for 2010 were Japan (16.3%), China (11.6%), the U.S. (11.1%), Singapore (8.5%), and Korea (8.3%). Meanwhile, total imports in 2010 were $136 billion, up from $96.83 billion in 2009. Indonesia is currently our 28th-largest goods trading partner with $23.4 billion in total (two-way) goods trade during 2010. The U.S. trade deficit with Indonesia totaled $9.5 billion in 2010 ($6.9 billion in exports versus $16.5 billion in imports).

Oil and Minerals Sector: Indonesia left the Organization of Petroleum Exporting Countries (OPEC) in 2008, as it had been a net petroleum importer since 2004. Crude and condensate output averaged 944,000 barrels per day (bpd) in 2010, down slightly from 948,000 in 2009. In 2010, the oil and gas sector is estimated to have contributed $23.3 billion to government revenues, or 20.9% of the total. U.S. companies have invested heavily in the petroleum sector. Indonesia ranked third in world liquefied natural gas (LNG) exports production in 2010. Indonesia's oil, oil products, and gas trade balance was negative in 2008 with a $1.4 billion deficit, but became positive again in 2009 with a $29.4 million surplus, according to official statistics. Petroleum trade statistics are not yet available for 2010.

This is a chart of trend of gross domestic product of Indonesia at market prices by the IMF with figures in millions of rupiah.

Year GDP

USD exchange Inflation index Nominal Per Capita GDP PPP Per Capita GDP (rupiah) (2007=100) (as % of USA) (as % of USA)

1980 60,143.191

626.98

10

5.25

5.93

1985 112,969.792

1,110.58

11

3.47

5.98

1990 233,013.290

1,842.80

16

3.01

6.63

1995 502,249.558

2,248.60

24

4.11

8.14

2000 1,389,769.700 8,396.33

53

2.32

6.92

2005 2,678,664.096 9,705.16

83

3.10

7.51

2010 6,422,918.230 8,555.00

121

6.38

9.05

For purchasing power parity comparisons, the US dollar is exchanged at 3,094.57 rupiah only.