Evidence of Re-Industrialization or De-Industrialization in the manufacturing sector in Indonesia

What is it about?

Factors of Production expanded rapidly in Indonesia from year 2000 to 2015. Labor expanded by 35%, gross fixed capital formation expanded to 33% of GDP (up from 20% in 2000), energy consumption expanded more than twice, and trade liberalized allowing wider access to strategic inputs and larger markets abroad. With the large expansion of inputs this research questions how much are the booming factors supporting the expansion of output growth, how much is the rise in prices of inputs affecting total production costs, and if the inputs are ever being used more efficiently, reaching gains through non-conventional channels of growth -scale effects and Technical Efficiency-. This study estimates technical efficiency, the different components of total factor productivity (TFP) growth -technical efficiency change, scale effects, and technological progress, using a Stochastic Frontier Analysis (SFA) at firm level from 2007 to 2013. The study looks at how differences across firms’, including location, size, skills of workers, capital available, and technology intensity influence the levels of efficiency and productivity.

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Photo by Alev Takil on Unsplash

Photo by Alev Takil on Unsplash

Why is it important?

The Java island in Indonesia was proposed as a national industrial corridor under the Masterplan for Acceleration and Expansion of Indonesia's Economy (MP3EI) in 2011. The manufacturing sector experienced both the growth of inputs of production (labor, capital, energy, more raw material alternatives) and a sharp rise in the cost of inputs (especially wages and energy prices). While classically firms expand due to more inputs available, additional sources of growth can arise from more efficient employment of inputs and more convenient combinations of factors of production (increasing the scale effects). A country in continuous expansion on factors could largely benefit from it if the resources are well employed, while it could miss a chance to boost industrial activities (leading to faster development) if inputs are poorly employed or poorly allocated. The study finds that labor remains as the most important input of production (labor-intensive manufacturing), while capital and energy inputs contribute less to a more rapid expansion of industrial activities. Production cost within manufacturing has increased more rapidly than productivity leading to slow industrial growth (even negative within some activities) on a decade where inputs were abundant. Comparative advantage in Java remained within labor-intensive sectors, low-tech, less skill-intensive, and medium-sized firms. Nevertheless, evidence suggests that increasing skills in workers lead to higher efficiency and technological progress levels within low-capital intensive sectors (low production cost). Still, poor complementation of labor with energy inputs and capital is canceling out the effects of a sector that could be expanding more rapidly.

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