A Look into Indonesia’s Regional Disparity

To overcome disparity, Indonesia should focus on developing its cities, especially the ones outside Java

A few months ago, I joined a virtual discussion with academics and practitioners on Indonesia’s infrastructure development. A professor of civil engineering, from the country’s best university, made a good statement that this should be designed according to the region’s comparative advantage. Infrastructure has a purpose to support industrial growth in key sectors, otherwise it would not generate optimal economic returns. He then shared past research from the university that the government has made part of the foundation for Indonesia’s long term development plan. It was a map on the economic corridors for each region, as shown below.

An updated version from the Ministry of Development Planning (Bappenas) has designed Sumatra as the center of new manufacturing industries and the gateway to Asia while the rest remain the same. My initial thought on this was highly problematic: setting Java as the center for innovation and services while the rest for either processing, resource extraction and tourism. In other words, Java is designed to always have the highest quality employment and continue to extract the wealth of other regions. Such extractive activity from central institutions are the reason for national failure, as stated by Daron Acemoglu and James A. Robinson in their book: Why Nations Fail. Currently, Java covers 60% of both the country’s population and GDP, with Greater Jakarta accounting for 10% population and 20% GDP. The map above shows that the government seeks to maintain the status quo.

In theory, there are three stages of regional economic development : (1) agriculture or resource based, (2) manufacturing, and (3) services. The Service Sector includes corporate headquarters, technology, and business services like advertising and accounting. This sector provides relatively high-wages since it requires university-level education and specific skills, therefore attracting the best talent. The spillovers from this are high demand for essential needs such as quality housing, education, retail and leisure. This would mean even more employment and investing opportunities, increasing the economic outcome. For Indonesia’s case, the vast majority of this sector is in Java and mainly Greater Jakarta, even if the core activities are in the other regions. This has resulted in overpopulation, urban poverty, inadequate social infrastructure and reduction of farmland for real estate. Maintaining the whole region as the center of services continues to increase population from migrants seeking such economic incentives.

For my perspective, we should focus on a deeper geographic level: cities. The map previously shown positions Java as if it is a large city and the surrounding regions are rural areas. For a large archipelago country like Indonesia, every region should all have agriculture, manufacturing and service sectors. Cities are the main economic drivers for these sectors, a hub for the service sectors workforce that creates demand for manufacturing goods from sub-cities and agricultural produce from rural areas. Further developing our cities into more attractive places for business and living that would increase productivity in sectors of comparative advantage and distribute prosperity to the surrounding suburban and rural areas.

Since there is a high number to develop, Indonesia could start with transforming a number of cities into metropolitans, large cities that create spillovers for medium size cities. The metropolitan’s role is usually the business center, while other cities functioned as centers for research and development/education, manufacturing, and logistics. Instead of just making Sumatra the center of new industries and logistics, why not have cities like Medan and Palembang function as host to corporate headquarters for companies in that sector? Cities like Padang could be the center of R&D that fosters further innovation. For Kalimantan, why not move headquarters for petroleum and mining companies from Jakarta to Balikpapan? Java itself could solve its disparity within as it is dominated by Greater Jakarta. Tech startups, including the unicorns that are all based in Jakarta, could centralize in Bandung or Yogyakarta which is home to the best universities for computer science. Reducing industry density can help Jakarta focus on strengthening its role in financial services, like New York to the US.

So why are almost all corporate headquarters, technology and other service sectors based in Java, particularly in Jakarta? There are several reasons, I would highlight four. First is the institutional capacity, local governments do not have strong authority, technical and fiscal capacity for incentivizing firms to set up business in their city. The state government requires several administrative processes to be done in Jakarta hence firms prefer to stay in the capital. Fiscal budget is also handled by the state government before being distributed to each province. Lack of proper knowledge and resources limit local governments’ ability to become more entrepreneurial to raise external funding. Moreover, their over-complicated bureaucracy slows down administrative processes hence creating disincentives. The new omnibus law aims to reduce this bureaucracy to ease the flow of foreign direct investment, however it also removes authority from local governments. This could be considered as a FDI shortcut that further limits local capacity. Second is infrastructure, access to energy and connectivity is key in doing business. The low accessibility discourages firms to extend operation in parts outside Java. Besides supporting business, infrastructure also attracts residents. Amenities such as adequate housing, public service and mobility is key in choosing a place of residence. Third is education, the quality in Java has generated better overall talent. Those in other regions that excel academically would most likely move to Java after graduating high school or university to seek the more attractive employment opportunities. Fourth is land ownership. In most areas, land in strategic locations is predominantly owned by the local elite that often withhold its productive use for future value speculation. Instead of land being developed for creating business and employment, it would be left empty or used for informal activities while the owner waits for the right buyer. These informal activities are also an interesting topic for another discussion.

Some may argue that developing small and medium-sized enterprises (SMEs) is the most viable solution to reduce disparity as they are the main contributors for Indonesia’s economy. However, from the World Bank’s research, SMEs has not proven to increase employment. This is because the main motivations for entrepreneurs is survival. If given a choice, they would prefer a steady office job compared to facing the stress and uncertainty of running a business. Some local businesses can thrive and grow to employ thousands, but these are the few that had exceptional leadership. The level of wages could not compete with firms in Java, especially Jakarta. Another thing to look at is the nature of SMEs, over 60% are in the field of distribution which simply transfers values instead of creating it. I have seen such distribution companies that have experienced tremendous growth, however they do not invest much in people as it does not require a highly skilled workforce. The SMEs that do create value are those with innovative products or business models. However, they would need a strong customer base to grow, so serving the Java market is more appealing. The rise of e-commerce in Indonesia has helped demand for SMEs outside Java, but consumers would prefer sellers with more proximity for lower logistics cost.

The government has also focused on tourism development to address regional disparity. Indonesia does have so many beautiful locations that deserve more recognition. However, the pandemic has proven the unsustainability of this sector. More importantly, it does not bring the same quality of employment as the commercial and finance sector.

A grand scheme that many have been talking about is moving the capital city from Jakarta to East Kalimantan. This would have the region as the center of public sector employment and create job and business opportunities to serve the new population. However, this project is set on a new land so it does not help an existing population. And again, it is the service sector that generates quality employment. So as appealing as the idea sounds, moving the capital would not solve the main cause of regional disparity.

While writing this, I remember how the pandemic has made us realize something: technology enabled us to work remotely and remain productive. Corporate headquarters and other business services may no longer need a physical office space. People can work from anywhere they want without having to deal with ridiculously long commutes. It could sound more appealing to work from a cafe overlooking a beach compared to the high-rise buildings in Jakarta. Does remote working take away the need for a city as a host for the service sector? Can we replace Jakarta’s central business districts with a bunch of co-working spaces across the country? Physical interactions are important for Indonesians, a lot of people are still longing to return to the office again, unlike me who is forgetting what it feels like. Many companies have also started to return to their offices, so this hypothesis would be unlikely.

So how can we best tackle this issue of regional disparity? The key solution would be to develop or even transform our institutions, both local and central. We need inclusive economic and political institutions that are able to create economic incentives for businesses that foster innovation and provide quality employment. Such institutions would also generate investments for infrastructure, improve quality of education and pressure or incentive owners for productive land use. This in return would create the equality in economic opportunities and increase quality of living for the overall population.

Achieving this would require action from the four sectors: government, private sector, academia and society. Politicians that represent and serve the best interest of the overall population could transform institutions from within. Local businesses with the best interest of their city can push the government into giving more support for their growth, such as collaborative institutions. Academics from multiple sectors work on models that prove the economic benefits of regional parity. Lastly, society can pressure the government for more equality. An example would be people of Kalimantan and Papua to actively demand for the same economic opportunities as those in Java and the end of extractive institutions.

In conclusion, my main argument is Indonesia should not be concerned with Java’s (especially Jakarta’s) status quo and focus on developing other cities to become attractive places for business and quality service sector employment. More importantly, it should eliminate the idea of islands outside Java as the center of natural resource extraction. Inclusive institutions, both from the local and central government, that best serve the overall population is key to achieve this.