Citation
Economic development, welfare, and income distribution in Indonesia

Material Information

Title:
Economic development, welfare, and income distribution in Indonesia 1965-1985
Creator:
Hassan, Arselan
Place of Publication:
Denver, CO
Publisher:
University of Colorado Denver
Publication Date:
Language:
English
Physical Description:
iv, 88 leaves : illustrations, map ; 29 cm

Subjects

Subjects / Keywords:
Since 1945 ( fast )
Public welfare -- Indonesia ( lcsh )
Income distribution -- Indonesia ( lcsh )
Economic history ( fast )
Income distribution ( fast )
Public welfare ( fast )
Economic conditions -- Indonesia -- 1945- ( lcsh )
Indonesia ( fast )
Genre:
bibliography ( marcgt )
theses ( marcgt )
non-fiction ( marcgt )

Notes

Bibliography:
Includes bibliographical references (leaves 85-88).
Thesis:
Submitted in partial fulfillment of the requirements for the degree, Master of Arts, Department of Economics
Statement of Responsibility:
by Arselan Hassan.

Record Information

Source Institution:
|University of Colorado Denver
Holding Location:
|Auraria Library
Rights Management:
All applicable rights reserved by the source institution and holding location.
Resource Identifier:
22839464 ( OCLC )
ocm22839464
Classification:
LD1190.L53 1989 .H37 ( lcc )

Downloads

This item has the following downloads:


Full Text
ECONOMIC DEVELOPMENT, WELFARE, AND INCOME -DISTRIBUTION
IN INDONESIA, 1965 1985
by
Arselan Hassan
B.Sc., University of Gajah Mada, 1964
M.B.A., University of Gajah Mada, 1967
A thesis submitted to the
Faculty of the Graduate School of the
University of Colorado in partial fulfillment
of the requirements for the degree of
Master of Arts
Department of Economics
1989
i A f f
f


This thesis for the Master of Arts degree by
Arselan Hassan
has been approved for the
Department of
Economics
by
Date )une V / /99^


Hassan, Arselan (M.A., Economics)
Economic Development, Welfare, and Income Distribution.
Thesis directed by Professor Dr. W. James Smith.
This study attempts to investigate the relationship
between economic growth and income distribution in
Indonesia, from 1965 to 1985.
The first objective of this study is a cross
sectional analysis of income distribution, which is
evaluated from the year 1965 to 1985. This part of the study
is considered the most important aspect of this thesis work.
The second objective is to review the economic
growth rates of the GDP (Gross Domestic Product) to conclude
the impact of economic growth on income distribution in
Indonesia.
The results are then linked to analyze the impact of
the development on the income distribution in Indonesia from
1965 to the present and, thereafter, to propose
recommendations aimed at improving the distribution of
income.
i
Economic development fostered by the New Order
Government produced rapid economic growth during the period
1968-1981. This growth is due in part to the priority of
Indonesian government on economic improvement and to the oil
boom starting in 1973. This shows that the economic growth
in this period spurred greater equality in income


i v
distribution as demonstrated by the Lorenz dominance
techniques.
In 1981 the oil boom ended. Government revenue,
which was closely tied to the oil and natural gas sectors,
started to slowly decline as oil prices dropped. This
retarded economic development.
This study finds a positive relationship between
economic growth and income distribution. For this reason,
the government of Indonesia should attempt to diversify
their revenue base to further promote both equity and
efficiency.
The form and content of this abstract are approved.
Signed
of thesis


ACKNOWLEDGEMENT S
It is with gratitude that I acknowledge the valuable
guidance, time and encouragement given to me throughout this
entire study by Dr. W. James Smith, Professor, University of
Colorado at Denver, my thesis advisor; Dr. John R. Morris,
Professor, University of Colorado at Denver; and Dr. John P.
Formby, Professor, University of Alabama.
It is with regret that I cannot acknowledge one by
one the contribution of many friends who have been very
helpful. To all of you my sincere thanks.
My gratitude and appreciation also are due to the
Governor and the Board of Directors of Bank Indonesia who
gave me the opportunity to undertake advanced study at the
University of Colorado. I hope that, after obtaining this
privilege, I can further dedicate myself to Bank Indonesia
and the motherland, Indonesia.
My thanks are also due to my wife, Tjut Tharsina,
and my children, Aulia and Amelia, who not only lost
countless hours of my time, but also gave me prayers,
understanding and encouragement. Indeed, it has been a hard
time for them. I place you all deep in my heart. Also I
thank God for the many blessings bestowed upon me and my
family.
Boulder, the warmth of Summer 1989
Arselan Hassan


CONTENTS
CHAPTER
I. INTRODUCTION .................................... 1
II. REVIEW OF THE LITERATURE......................... 7
III. THE ECONOMIC DEVELOPMENT OF INDONESIA............19
Background....................................19
Before PELITA...............................21
During PELITA...............................23
A Detailed Analysis of Economic Growth in
Indonesia during the PELITA Programs .... 25
Period 1968-1981 .......................... 26
Period 1981-1986 .......................... 35
Summary................................ . 42
IV. INCOME DISTRIBUTION MODEL:
CROSS SECTIONAL EVALUATION .................... 45
The Model.....................................45
Size Distribution.............................45
Functional Distribution ..................... 65
Model Results.................................75
V. POLICY ANALYSIS..................................78
Limitation of Data............................78
Discussions...................................79
VI. CONCLUSIONS......................................84
BIBLIOGRAPHY
85


TABLES
Table
1. A Hypothetical Size Distribution of LDC Personal
Income by Income Share ............................ 12
2. Average Annual GDP Growth, 1960 1986 ............ 19
3. GDP by Sector of Origin as a Percentage Total GDP
1960 1986 20
4. Expenditure Components of GDP as a Percentage
Total GDP, 1960 1969 ............................ 22
5. Expenditure Components of GDP as a Percentage
Total GDP, 1969 1986 ............................ 24
6. GDP Estimates, 1965 1986 ........................ 27
7. Employment, Income, and Capital, 1965 1981 . 29
8. A Detailed Breakdown of GDP Components of Growth,
1973 1981 32
9. Gross Domestic Investment, 1973 1986 ............ 36
10. Government Revenues, 1973 1986 .................. 38
11. Government Revenues and Expenditures as Percentage
of GDP..............................................40
12. Debt Service Payments, 1973 1986 ................ 41
13. Average Income by Provinces, 1965 1985 .......... 46
14. Population by Provinces, 1965 1985 .............. 47
15. Size Distribution of Income in 1965 (Lorenz) ... 49
16. Size Distribution of Income in 1970 (Lorenz) ... 50
17. Size Distribution of Income in 1975 (Lorenz) ... 51
18. Size Distribution of Income in 1980 (Lorenz) ... 52
19. Size Distribution of Income in 1985 (Lorenz) . ... 53


viii
20. Mean Income Distribution, 1965 1985 ........... 60
21. Cumulative Proportion of Income, 1965 1985 ... 61
22. Generalized Lorenz Ordinates, 1965 1985 .... 63
23. Functional Distribution of Indonesia in 1975 ... 73
24. Functional Distribution of Indonesia in 1985 ... 74
25. Average Income, 1965 - 1985 76
26. A Relation between Economic Growth and Income
Distribution, 1968 - 1986 80
27. 1988 Social Indicator Data Sheet Indonesia .... 81
28. 1988 Social Indicator Data Sheet Indonesia .... 82
29. Income Distribution in Indonesia: Absolute Poverty
Line................................................83


FIGURES
Figure
1. Map of Indonesia................................... 3
2. Study Diagram...................................... 6
3. Lorenz Diagram 1965.............................. 54
4. Lorenz Diagram 1970.............................. 55
5. Lorenz Diagram 1975.............................. 56
6. Lorenz Diagram 1980.............................. 57
7. Lorenz Diagram 1985.............................. 58
8. Composite Cumulative Proportion of Income,
1965 - 1985 62
9. Composite Generalized Lorenz Ordinates,
1965 - 1985 64
10. Rank Order Function 1965 - 1970 66
11. Rank Order Function 1970 - 1975 67
12. Rank Order Function 1975 - 1980 ........ 68
13. Rank Order Function 1980 - 1985 69
14. A Simplified Diagram of a Competitive Market
Functional Income Distribution
70


CHAPTER I
INTRODUCTION
The study of economic development generally focuses on
the key variables that determine the level and growth rate
of per capita income. Economic development invariably
implies fundamental changes in the structure of the economy.
There is also an important question that should be raised
regarding the relation of economic growth to income
distribution. Does rapid economic growth imply a less or
more income distribution? The answer is believed to vary
across developing countries.
This study attempts to investigate the relationship
between economic growth and income distribution from 1965 to
1985 in Indonesia. We analyze income distribution are from
1965 to 1985 with census data from 1965, 1970, 1975, 1980,
and 1985. The study relies on Lorenz dominance techniques to
track the trend of income distribution over the twenty year
period.
The second objective of this study is to review on
economic growth rates over the period from the GDP (Gross
Domestic Product) performance to analyze the impact of
economic growth on income distribution in Indonesia. This
part of the study will evaluate the sectoral breakdown to
determine the progress of economic development of each
sector and thus, the sectoral role of the process of
Indonesia's economic development. The results of this part
of the study are then linked to the first objectives to


2
determine changes in the income distribution in Indonesia
from 1960 to the present and therefore, to suggest policies
necessary to improve future income distribution.
Background
Economic development in Indonesia is more complex than
development in many other countries. Indonesia is the
largest archipelago in the world. It has five main islands,
about thirty smaller islands and a total of some 13,677
islands and islets of which 6,000 are inhabitated. The
archipelago extends 3,200 miles from East to West and 1,100
miles from North to South along the equator. Indonesia has
27 provinces. Figure 1 is a map of Indonesia. It indicates
the strategic location of this country being located between
the continent of Asia and Australia and between the Pacific
Ocean and Indian Ocean.
Economic development in Indonesia after 1960 can be
divided into two phases, before and after PELITA I (the Five
Year Development Program I). The economy of Indonesia before
PELITA was characterized by an average growth rate at 2.5%
per year. During the next ten years, the average growth rate
rose to 7.7% per year. In the early 1980s, the economy
slowed with an average growth rate at 3.5% per year. The
impact of these fluctuations in economic growth rates on
income distribution in Indonesia is the focus of this study.


3
Figure 1: Map of Indonesia


4
Basic Concept
The study consists of six chapters. Chapter One is the
introduction. Chapter Two reviews the Lorenz dominance
literature. Chapter Three constitutes the time series study
of economic growth rates of the GDP. Chapter Four focuses on
the size distribution of income from 1965 to 1985. Chapter
Five is an analysis of the results in Chapter Three and
Four. This chapter combines the time series and the cross
sectional studies to provide a more complete picture of the
income distribution in Indonesia over time. This chapter
also presents the limitations of the study and how the
government of Indonesia set its policies for income
redistribution. Chapter Six (conclusions and
recommendations) discusses how Indonesia might improve its
income distribution in the future.
The basic data available for the study as of December
1986 were obtained from the Central Bureau of Statistics
(CBS), Republic of Indonesia; the Department of Finance,
Republic of Indonesia; the Bulletin of Indonesian Economic
Studies; The Central Bank of Indonesia. All available data
on economic development, especially on income distribution
and interpretation made by others, were reviewed and taken
into consideration.
Figure 2 is a flowchart of the thesis. The first
step is to gather data. The basic idea of this study is
to combine a time series and a cross sectional studies
which will provide a complete view of economic development


5
in Indonesia and its impact on income distribution. On the
basis of past performance which is considered as the result
of existing policies, the study will then produce
recommendations on how the government of Indonesia should go
about improving the income distribution of the country.


6
INPUT DATA
1. BASIC VARIABLES
2. ECONOMIC DATA
i
| TIME SERIES STUDY |
| OF ECONOMIC GROWTH |
| 1965-1985 |

| INCOME DISTRIBUTION |
| (CROSS SECTIONAL STUDY)|
| 1965-1985 |
I
| RESULTS FROM TIME SERIES |
-| AND CROSS SECTIONAL STUDY |
I
I
4
POLICY ANALYSIS
I
CONCLUSIONS
Figure 2: Study Diagram
Income Distribution in Indonesia


CHAPTER II
REVIEW OF THE LITERATURE
The income distribution model employed in this study
has a long history. In this chapter, the discussion is
focused on the specific literatures used to construct the
model.
A descriptive time series study was reviewed in D.
Salvatore and Edward Dowling's Theory and Problems of
Development Economics (Schaum's Outline Series in Economics,
McGraw-Hill, 1977) to provide a method for the evaluation of
GNP performance in Indonesia. The theory states that
economic development has been defined as the process whereby
a country's real per capita Gross National Product (GNP), or
income, increases over a sustained period of time through
continued increases in per capita productivity. Thus, a
study of economic development in Indonesia from 1965 to 1985
should be closely related to economic growth, which is
represented as Gross Domestic Product (GDP) per capita.
However, this kind of study is insufficient because of
conceptual and practical problems connected with it. Per
capita GDP statistics says nothing of the income
distribution within the society nor of the level of general
well-being.
A review was then also made of Gerald M. Meier's
Leading Issues in Economic Development, Chapter I (Oxford
University Press, 1984). Chapter I of Meier suggests that an
indicator of development is not only related to the


8
measurement of development via per capita GDP, but also to a
theory of distribution and growth. This would then lead to a
discussion of the income distribution.
A review was also made by M. Gillis and others in
Economics of Development, Chapter 4 (W. W. Norton & Company,
1987). The authors present the concepts and measures of
income distribution, inequality and poverty in the
developing countries. The most common method in measuring
income distribution is the Lorenz curve. To draw a Lorenz
curve, income recipients are ranked from those with the
lowest income to the highest along the horizontal axis. The
Lorenz curve itself shows the percentage of total income
accounted for by any cumulative percentage of recipients.
The method is similarly described by Todaro and Shorrocks.
The degree of overall inequality is presented in the Gini
concentration ratio which is derived from the Lorenz curve.
The theoretical range of the Gini ratio is from zero
(perfect equality) to one (perfect inequality). While
inequality is clearly a matter of relative incomes, the
concept of poverty implies that households are poor in an
absolute sense. Measurement of the amount of poverty
existing in a country usually begin with the drawing of a
poverty line which is defined as household income per
capita. Households with per capita incomes below the poverty
line are defined as poor while those with incomes above the
line are not poor. The World Bank uses a poverty line of 100
Rupiah/month for Indonesia. However, the authors also


9
\\
\
suggest that the simplest measurement of poverty is the
percentage of poor households in the total.
The issue of income distribution was also broached by
Michael P. Todaro in Economic Development in the Third
World (Longman Group Limited, 1978, 161-165). Todaro
observed that in poor countries the main concern is focused
on the question of economic growth versus income
distribution. Many third world countries that experienced
relatively high rates of economic growth in the 1960's began
to realize that such growth had brought little in the way of
significant benefits to their poor. Since Indonesia is among
them, the focus of the study should incorporate income
distribution analyses. According to Todaro, the principal
measure of income distribution is the "personal" or "size"
distribution and the functional of income. The personal
income statistics are generally derived from the Lorenz
method and percentage share in total income. Todaro suggests
a welfare function which apparently appeals to a number of
development economists. Todaro weights the growth rate of
each income group and sums them to obtain the welfare index:
G = w1g1 + w2g2 + w3g3 + ... + w5g3
G = Lw^g^ i = 1,2,...,5
where: G = a weighted index of growth of social welfare,
g^ = the growth rate of income of the ith quintile,
w^ = the welfare weight of the ith quintile.
As long as the weights add up to unity and are nonnegative,
the overall measure of the growth of social welfare, G, must


10
fall somewhere between the maximum and minimum income growth
rates in the various quintiles.
Todaro critizes the standard practice of merely
looking at growth rates to judge an economy's performance.
The use of unweighted GNP growth as an index of improvements
in social welfare and development accords to each income
group a welfare valuation that corresponds to their
respective income shares. It follows that the best way to
maximize social welfare growth is to maximize the rate of
growth of the incomes of the rich while neglecting the poor.
An alternative to using a simple rate of GNP growth index of
social welfare would be to adopt equal weights or a poverty
weighted index. An equal weights index weighs the growth of
income in each income class not by the proportion of total
income in that class but rather by the proportion of the
total population. Although, as Todaro acknowledges, the
choice of welfare weights in any index of development is
purely arbitrary it does represent important social value
judgments about goals and objectives for a given society.
Todaro's concept is attractive but arbitrary. It would
certainly be interesting to know if the "real" implicit
welfare weights of the various development strategies of
different third world countries. As long as the growth rate
of GNP is explicitly or implicitly used to compare
development performances a wealth weighted index is actually
being employed. If a weighted welfare index is used to
measure economic development, then it is not only possible


11
but may even be desirable for a lower growth rate of GNP to
be associated with a higher rate of economic development, at
least in terms of the value judgments of an egalitarian
society. The reformulation of the indices of development to
take account of alternative social weights for different
income groups takes us a long way toward a better
understanding of the relationship between economic growth
and income distribution.
For example, consider growth rate based on wealth
weights:
w^ = 0.05, W2 = 0.09, W3 = 0.13, w4 = 0.22, and w^ = 0.51.
In the extreme case of all income accruing to one individual
or one group of individuals in the highest quintile and
where the welfare weights the income shares, as they are
with GNP growth calculations, the equation becomes:
G = Og^ + 0g2 + Og^ + 0g4 + 1.Og^ = 1.Og^
The growth of social welfare would, therefore, be associated
exclusively with the growth of incomes in the top quintile
of the population. Table 1 shows a hypothetical size
distribution of LDC (Less Developed Countries) personal
income classes by income shares.


12
Table 1
A Hypothetical Size Distribution of LDC Personal Income
by Income Share
Individuals Personal income (money units) Percentage share in total income Quintiles Deciles
1 0.8 _
2 1.0 - 1.8
3 1.4 - -
4 1.8 5 3.2
5 1.9 - -
6 2.0 - 3.9
7 2.4 - -
8 2.7 9 5.1
9 2.8 - -
10 3.0 - 5.8
11 3.4 - -
12 3.8 13 7.2
13 4.2 -
14 4.8 - 9.0
15 5.9 - -
16 7.1 22 13.0
17 10.5 - -
18 12.0 - 22.5
19 13.5 - -
20 15.0 51 28.5
Totals 20 (National 100.0 100 100.0
Income)
Measure of inequality Ratio of bottom 40% to top 20% =
14/51 = 0.28.
In the example derived from table above, the GNP
income share weighted index of social welfare would be
written as:
G = 0.05g^ 0.09g£ + O.lSg^ t 0.22g^ + 0.51g^
Now suppose the income growth rate of the bottom 60% of the
population is zero (g^ = 92 = 93 = 0) while that of the top


13
40% is 10% (g4 = 95 = 0.10). The equation could be written
as:
G =0.05 (0) + 0.09 (0) + 0.13 (0) + 0.22 (.10) + 0.51 (.10)
G = 0.073
and the social welfare index would rise by over 7%, which is
the rate of growth of GNP ( GNP would rise from 100 to 107.3
if the incomes of the 4th and 5th quintiles grew by 10%).
Thus, an illustration of a case where GNP rises by 7.3%,
implying that social well-being has increased by this same
proportionate amount even though 60% of the population is
not better off than before. These bottom 60% still have only
5, 13, and 22 units of income respectively. Clearly, the
distribution of income would be worsened (the relative
shares of the bottom 60% would fall) by such a respectable
growth rate of GNP. The numerical example given by the above
equation illustrates the basic point. The use of the growth
rate of GNP as an index of social welfare and as a method of
comparing the development performance of different countries
can be very misleading, especially where countries have
markedly different distributions of income.
Consider a developing-country that is genuinely and
solely concerned with improving the material well-being of,
say, the poorest 40% of its population. Such a country might
wish to construct a poverty weighted index of development,
which places subjective social values only on the income
growth rates of the bottom 40%. In other words, it might
arbitrarily place a welfare weight on w^ of 0.60 and on W2


14
of 0.40 while giving W3, W4, and W5 zero weights. Using the
same numerical example, the social welfare growth index for
this country would be given by the expression:
G = 0.60g-L + 0.40g2 + Og^ + O94 O95
which, when substituting 9i = ?2 = g3 = anc* 9 4 = 9 5 = -10'
becomes:
G = 0.60 (0) + 0.40 (0) + 0(0) + 0(0.10) + 0 (0.10) = 0
The poverty weighted index therefore records no improvement
in social welfare even though recorded GNP has grown by
7.3%. An alternative and more rigorous way to examine the
issue revolves around the welfare dominance theorems first
introduced by Atkinson (1970).
A review is made of W. James Smith, John P. Formby,
and John A. Bishop in "Stochastic Dominance, Income
Distribution Function and Economic Development" (preliminary
paper on Economic Development) to evaluate the size
distribution from the rank order dominance. Economic growth
and development are frequently accompanied by increases in
inequality. Inequitable growth has been and remains a
principal focus of inquiry for development economists and a
serious concern of development analysts and policy makers.
The issue is whether the societal benefits accruing from a
rise in the standard of living in a nation exceeds the
societal costs resulting from an increase in inequality. The
question is a vexing one and, until recently, there has been
no rigorous and generally acceptable method for analyzing
and addressing this important issue. Recent developments in


15
applied welfare economics now make it possible to focus the
powerful stochastic dominance theorems on the fundamental
question raised by inequitable growth.
The purpose of applied welfare analysis is to rank
alternative economic and social states. Inequitable growth
is difficult to rank because it is necessary to compare two
economic systems, one with greater mean income and the other
having a more equal distribution. Contemporary applied
welfare analysis is able to address this issue because it
rests upon an explicit social welfare function of a general
class which embodies widely acceptable ethical principles.
Stochastic dominance embodies this approach and provides a
means for rigorously analyzing the welfare consequences of
inequitable growth and development.
A paper by A. B. Atkinson, "On the Measurement of
Inequality" (Journal of Economic Theory 2, 244-263', 1970)
shows that the use of conventional methods in measuring
inequality in the distribution of income, such as the Gini
coefficient and the relative mean deviation, can be
misleading.
Atkinson attributes the original insight and call for
an explicit welfare function to Dalton (1920) who emphasized
that all comparisons of summary measures of inequality
correspond to some concept of social welfare. Dalton argued
that a fruitful method of studying inequality and income
distributions is to explicitly specify the characteristics
of the social welfare function. As a reasonable and


16
generally acceptable social welfare function, Dalton
proposed the requirements of additivity, symmetry, and
strict concavity in incomes. Welfare functions of the Dalton
class are utilitarian and anonymous in the sense that
welfare is unaffected if two persons exchange positions in
the income distribution. In addition, strict concavity is
sufficient to guarantee that the principle of transfers
holds; that is, the social welfare function is equality-
preferring. He suggested stochastic dominance as a method
for partially ordering income distributions and drawing
welfare inferences. Given Dalton's social welfare function
and assuming populations of equal size and mean incomes, he
showed that Lorenz dominance is equivalent to stochastic
dominance. Under these assumptions distribution A will be
preferred to distribution B by all additive, concave social
welfare functions if, and only if, the Lorenz curve of A
lies everywhere inside the Lorenz distribution of B. Lorenz
dominance exists if distribution A's Lorenz curve is
completely inside B's or on top of B's at one or more points
and inside of it at other points. Thus, for equal
populations and means, the income distribution which is
unambiguously more equal in the Lorenz sense reflects
stochastic dominance and generates greater social welfare.
If Lorenz curves intersect, social welfare of the two
distributions cannot be ranked without more information
concerning society's specific welfare weights. Thus,
Atkinson's result provides only a partial ordering of


17
distribution functions because concensually valid welfare
conclusions cannot be drawn unless Lorenz dominance exists.
Rank dominance can be illustrated with a graph with income
on the ordinate and the cumulative proportion of income
recipients on the axis. The distribution functions are for a
single country at two points in time, F(xl) and F(x2), with
F(x2) being the most recent period. An analysis of F(xl) and
F(x2) would lead to a conclusion of the change in welfare
over time.
A paper by A. F. Shorrocks entitled "Ranking Income
Distributions" (Economica, 50, 3-17, 1983) examines the
problem of ranking distributions using a social welfare
function with unequal means. The ranking distribution is
obtained through a generalized Lorenz curve. Generalized
Lorenz curve is obtained by scaling up the ordinary Lorenz
curve by the mean of the distribution. Shorrocks proves
that generalized Lorenz dominance implies preference by all
increasing, equality-preferring social welfare functions.
Thus, assuming the principle of transfers, generalized
Lorenz curves can be used to rank income distributions and
make welfare comparisons of countries experiencing
inequitable growth across time. This method was then applied
to compare income distribution in 20 countries which
produced conclusive results in 84% of the pairwise
comparisons. Shorrocks' study attempts to calculate a
ranking distribution from the ordinary Lorenz curve,


18
weighted average income, and rank order dominant methods, in
which Shorrocks'method can be incorporated.


CHAPTER III
THE ECONOMIC DEVELOPMENT OF INDONESIA
Background
The economic development of Indonesia after the 1960's
can be divided into two phases, before and after The Five-
Year Development Program I, or PELITA I (1969-1974). The
economy of Indonesia before PELITA I was dismal. During the
next ten years, economic growth was substantially greater.
In the early 1980's, the economy began to slump (Table 2).
Table 2
Average Annual GDP Growth, 1960 1986
Period Number of Years Average Annual GDP Growth (%)
1960 - 1967 8 2.5 3.0
1968 - 1981 14 7.5 7.7
1982 - 1986 5 3.5 4.1
Sources : 1. Bank Indonesia, Indonesian Financial
Statistics.
2. The Indonesian Central Bureau of Statistics
(BPS).
3. Author's estimates.
The annual rate of growth of GDP from 1968 to 1981 was
higher than in the earlier and later periods, caused, it is
believed, by a new set of economic priorities and rapid
structural changes in energy industries.


20
A detailed description of economic development during
those periods isshown in Table 3, giving sectoral shares of
GDP for the period of 1960-1986. The sectoral share,
measuring GDP through the production approach, is summarized
in this study to present a quick review of the sectoral
change from 1960 to 1986 in Indonesia's economic
development.
Table 3
GDP by Sector of Origin as a Percentage Total GDP,
1960 1986
(in 1973 constant prices)
Sector 1960 1965 1970 1975 1980 1985 1986
Agriculture 53.9 52.4 47.5 36.7 30.6 24.2 24.1
Mining 3.7 3.7 5.6 10.9 9.3 17.5 17.1
Industry 8.4 8.3 8.9 11.1 15.3 12.6 12.6
Public Utilities 0.3 0.4 0.5 0.5 0.7 0.7 0.7
Construction 2,0 1.7 2.6 4.8 5.7 5.7 5.6
Transport and Communication 3.7 3.5 3.2 4.0 5.5 5.8 5.8
Trade & Other Services 28.0 30.0 31.7 32.0 32.9 33.5 34.1
Sources: 1. Bank Indonesia, Indonesian Financial
Statistics.
2. The Indonesian Central Bureau of Statistics
(BPS) .
3. Authors estimates.


21
Although the average rate of growth of agriculture rose from
1.4% per year during the first half of the 1960's to 3.8% in
the six years to 1971 and then fluctuated around 3.5%
through 1986, the share of agriculture in GDP has fallen
from over 50% to less than 25%. Sectoral data through 1986
suggest that the share of the agriculture sector is still
quite dominant in Indonesia. During the same period, the
shares of mining, industry, and trade and other services
sectors increased via foreign investment and the rapid
growth in revenue from oil and natural gas production. The
share of construction, transport, and communication sectors
showed more modest increases. Trade and other services
include five sectors: trade (wholesale and retail), banking
and other financial intermediaries, ownership of dwellings
(houses and hotels), public administration and government,
and services.
Before PELITA
The Indonesian economy during the period 1960-1968,
before PELITA I, was sluggish. Gross domestic capital
formation and government consumption expenditures declined.
Government budget deficits reached 50% of government
consumption expenditures. Export earnings slumped in the
mid-1960's and deteriorated the balance of trade. These
economic conditions led private consumption expenditures to
rise to a peak of 95.9% of GDP in 1966 and, inflation turned
into hyperinflation. The share of industry was less than 10%


22
of GDP and could not be expected to support the development
process during this period.
Table 4 is a breakdown of expenditure components of
GDP into four main aggregates for the period of 1960-1969.
Table 4
Expenditure Components of GDP as a Percentage Total GDP,
1960 1969
(in 1973 constant prices)
Component of GDP 1960 1965 1968 1969
Private Consumption Expenditure 78.3 83.7 84.6 86.9
Government Consumption Expenditure 11.3 6.8 7.9 7.3
Gross Domestic Capital Formation 9.6 10.5 12.3 12.9
Export - Import 0.8 -1.0 -4.8 -7.1
Sources: 1. Bank Indonesia, Indonesian Financial
Statistics.
2. The Indonesian Central Bureau of Statistics
(BPS) .
In this table, the balance of trade (export import) was
corrected for term-of-trade changes.
The change of government in 1966 provided a change in
attitude toward development priorities. The new government
emphasized economic priorities, particularly the need to
increase production and income.


23
During PELITA
The failure of Indonesia's economic development in the
/1960's resulted in a new approach to long-range development
planning, covering a period of 25 to 30 years. The plan is
broken down into several Five-Year Development Plans
(REPELITA). Each stage of development contains different
objectives and lays a firm foundation for the next
development stage.
PELITA I (1969-1974) emphasized food production and
infrastructure rehabilitation. PELITA II (1974-1979) and
PELITA III (1979-1984) emphasized employment and
distribution of equity as well as economic growth. PELITA IV
(1984-1989) sought to improve and make more equitable the
living standard, education, and welfare of the nation.
Major structural changes characterize the period 1969-
1986. During PELITA I, the foreign exchange position
improved due to increased exports and an improvement in
export prices. Capital inflow increased through foreign aid,
government borrowing abroad, and substantial inflows on
private accounts and direct investment. Foreign exchange
receipts from energy exports became the dominant source
after 1973, accounting for 65% of total foreign exchange
receipts during 1973-1981. Direct revenues from energy
exports, mainly oil, supported economic development and
allowed Indonesia to further industrialize. Government
consumption expenditures also increased because of increased
revenues from energy taxation. Structural change occurred


24
again in the early 1980's when oil prices began to decline,
directly affecting foreign exchange receipts and balance of
payments. By 1986, the oil price decline had affected the
Indonesian economy in various ways. Economic growth was low,
the balance of trade had declined steadily and the current
account deficit was estimated at about $4.5 billion. In
September 1986, the government devaluated the rupiah from
1,134 rupiahs to 1,644 rupiahs per U.S. dollar in the belief
that this was a necessary adjustment to the Indonesian
economy. Although the composition of GDP improved from 1970
to 1980 (Table 5), in the early 1980's the composition of
GDP was again unfavorable owing to the declining balance of
trade (export import). Increasing the share of
Table 5
Expenditure Components of GDP as a Percentage Total GDP,
1969 1986
(in 1973 constant prices)
Component of GDP 1970 1975 1980 1985 1986
Private Consumption Expenditure 79.2 69.2 63.5 68.4 71.6
Government Consumption Expenditure 8.6 10.2 10.7 10.9 10.9
Gross Domestic Capital Formation 15.3 20.1 20.7 18.7 19.6
Export Import -3.1 0.5 5.1 2.0 -2.1
Sources: 1. Bank Indonesia, Indonesian Financial
Statistics.
2. The Indonesian Central Bureau of Statistics
(BPS).


25
consumption led to an increase in inflation. The growth rate
of GDP in the period 1982-1986 declined substantially.
A Detailed Analysis of Economic Growth
in Indonesia during the PELITA Programs.
It is worthwhile to study the economic growth after
the New Order Government was established (1966), when the
first Five-Year Development Program (PELITA I) began in
1969. This study will focus on a detailed evaluation of the
period from 1969 to the present so that the cause of
economic growth in this period can be determined. This study
will break down the evaluation into two different periods as
follows:
1. The period of 1968-1981, in which the oil boom occurred
in Indonesia. In this period, the economic growth was
spurred due to the oil price increase, which increased
the GDP of Indonesia. This tremendous economic growth
should be evaluated in detail to achieve conclusions from
the study.
2. The period of 1981-1986, which reflects the oil slump
occurring in Indonesia. In this period, the economic
growth was low, believed to be due to the oil price drop.
This effect was obvious in Indonesia. A detailed
evaluation should be made to derive conclusions from the
study.
Because there are two distinct eras, this section is
divided into two different discussions to cover the period


26
of 1968-1981 and 1981-1986. Table 6. is a GDP estimate from
1965 to 1986, reporting growth rates.
Period 1968-1981
From the establishment of the New Order until the
early 1980's, Indonesia experienced a long period of rapid
economic growth together with a dramatic improvement of the
terms of trade. However, it cannot be concluded that the
rapid growth was entirely due to the improvement in the
terms of trade. The analysis suggests that three types of
relationships were involved between the terms of trade
improvement and economic growth, one in which the
improvement in the terms of trade played a significant part
in promoting growth, another in which there was no such
effect, and a third in which a certain amount of growth
occurred which did not depend crucially on the improvement
in the terms of trade.
One way in which the improvement in the terms of trade
contributed to economic growth was through the expansion of
the public administration sector, which contributed as much
as 1.1 percentage points of the overall average growth rate
of 7.5% per annum. The improvement of the terms of trade
contributed to this part of the overall growth by
strengthening the financial position of government. The
expansion of the public administration system may have
contributed to increasing the productivity of resources in


27
Table 6
GDP Estimates: 1965-1986
(at 1973 constant prices)
Year Billions of Rupiah Rate of Growth
1965 3901 1.06
1966 4010 2.79
1967 4066 1.40
1968 4345 6.86
1969 4819 10.90
1970 5182 7.53
1971 5545 7.01
1972 6067 9.41
1973 6753 11.31
1974 7269 7.64
1975 7631 4.98
1976 8156 6.88
1977 8882 8.90
1978 9567 7.71
1979 10165 6.25
1980 11169 9.88
1981 12055 7.93
1982 12325 2.24
1983 12890 4.58
1984 13722 6.45
1985 14223 3.65
1986 14669 3.14
Source: 1. Bank Indonesia, Indonesian Financial
Statistics.
2. IMF, International Financial Statistics.


28
the rest of the economy, but a considerable part consisted
only of increased employment and higher salaries and fringe
benefits for public servants. However, most of the expansion
of the public administration system was included in the
current growth of GDP, because of the conventions of
National Income accounting.
Another way in which the improvement of the terms of
trade contributed to economic growth was by increasing the
volume of investment. The estimates proposed in Table 7
suggest that the high rates of investment in this period led
to growth of the capital stock of about 8.2% per annum.
However, apart from the extent to which investment provided
for the widening of capital, rough estimates indicate that
investment contributed only about 1.86 percentage points
towards the overall rate of growth.
The third way in which the terms of trade improvement
contributed to overall growth in the 1968-1981 period was by
enabling the economy to import more producers' goods. Some
of these imports consisted of raw materials and intermediate
products; especially before 1973, when much of the growth
was due to rehabilitation of the economy, even a relatively
small amount of such imports had a considerable effect on
growth by enabling existing capital stock to be utilized
more fully. There were also increasing imports of capital
goods, which not only promoted growth by more investment,
but also by improving technology to the extent that it was
embodied in the imported capital goods.


29
Table 7
Employment, Income, and Capital, 1965-1981
(billion Rp. at 1973 constant prices)
Year Employed (millions) GDP Investment Depreciation Capital Stock
1965 34.58 3, 901 389 254 6,720
1966 35.06 4,010 438 263 6, 855
1967 35.56 4,066 357 265 7,030
1968 36.05 4,345 498 294 7,122
1969 36.56 4,819 562 314 7,326
1970 37.07 5,182 747 338 7,574
1971 37.59 5,545 867 360 7, 982
1972 38.78 6, 067 1, 032 394 8,489
1973 40.01 6,753 1,208 439 9,126
1974 41.28 7,269 1, 440 473 9, 895
1975 42.59 7, 631 1, 650 496 10,863
1976 43.94 8,156 1,749 531 12,017
1977 45.33 8, 871 2, 028 570 13,236
1978 46.77 9,483 2,333 611 14,694
1979 48.25 10,165 2, 436 664 16,416
1980 49.78 11,169 2, 896 729 18,188
1981 51.36 12,055 3,219 786 20,356
Source: Bank Indonesia, Indonesian Financial Statistics.


30
Improvement in the terms of trade did not lead to much
growth. The simplest illustration of this relationship is
where the increased supply of foreign exchange was used
primarily for importing consumer goods. In Indonesia,
expenditure of this type occurred to some extent, mainly
because a considerable part of government expenditures
raised the incomes of the upper income groups, with a
propensity to consume imported goods..
The terms of trade improvement contributed to growth
through the increased importation of raw materials and
intermediate products, which was the main reason for the
rapid growth of value added in the domestic manufacturing
sector. However, in the course of time, especially after the
early rehabilitation phase, there was a substantial rise in
the import content of the output of the manufacturing
sector, and further, a large part of the output of this
sector consisted of durable consumer goods. Because a large
part of the increased import capacity was used to produce
consumer goods with a high import content, the effect of the
terms of trade improvement in promoting domestic growth was
much less than it might have been.
Hence, to conclude, a considerable part of the gains
from the improvement in the terms of trade was used in ways
which did not contribute to growth, and the extent to which
these gains were used to promote growth was quite limited.
This means that a significant part of the growth which
actually occurred in Indonesia was due to factors other than


31
the improvement in the terms of trade. The agricultural
sector contributed over 1.2 percentage points to overall
growth in the period 1973-1981.
Part of overall growth was due to the growth of
employment. According to Table 8, this was one of the major
sources of growth in the period 1973-1981 partly because of
the improvement in the terms of trade, which permitted
higher levels of investment in the form of capital widening.
However, a large part of the growth of employment was due to
increased demand for goods and services, especially in
construction and in the trade and transport sectors.
The growth of demand can be largely attributed to the
government's domestic budget deficit. One of the main
problems with budget deficit is that they lead to inflation,
as was amply demonstrated in the later years of the Old
Order Government. The memory of this experience still
remains vivid in the minds of Indonesian policy makers,
making them particularly concerned and cautious about the
inflationary consequences of their policies, and hence
rigidly adherent to a balanced budget policy.
However, in spite of the balanced budget policy, there
were some inflationary episodes, due mainly to cost-push
effects of the rice crisis of 1972-1973 and the rupiah
devaluation of 1978, rather than to demand expansion. One
reason why the expansion of demand in the 1968-1981 period
was not the main cause of inflation was that special


32
Table 8
A Detailed Breakdown of GDP
Components of Growth, 1973-1981
(in billion Rp at 1973 constant prices) *
Reflecting Sector Growth of GDY Growth of Employ- ment Effect of Invest- ment Technological Progress Total
Agriculture - 384 199 300 883
Mining 179 - 59 - 238
Manufacturing - 609 419 200 1,228
Utilities - 30 29 - 59
Construction - 377 41 40 458
Trade - 664 131 130 925
Transport - 184 118 118 420
Finance Ill 19 18 - 148
Public Administration 503 84 84 - 671
Other Services - 44 - 11 55
Dwellings - - 216 - 216
Total 793 2,395 1,314 799 5,301
Percentage Shares i 14.9 45.2 24.8 15.1 100.0
Contribution to Overall Growth Rate 1.12 3.39 1.86 1 1.13 7.5
* The period in which high oil prices have been in effect in
Indonesia.


33
attempts were made to stabilize the price of key
commodities, such as rice. Furthermore, a considerable part
of the potential inflationary effects of the demand
expansion was offset by the growth of domestic production,
particularly the growth of agricultural production, which
increased the supply of basic foods, as usually it is
shortages of such essential wage goods which trigger a cost-
push process. The Indonesian experience is therefore a
striking example of the extent to which demand expansion can
be used to promote growth of employment and output, without
serious inflationary problems, so long as there is an
elastic supply of wage goods.
The other major problem with the use of budget
deficits is that they would normally lead to balance of
payments difficulties. In the period reviewed here, this was
not a major problem for Indonesia because of the abundant
supply of foreign exchange. In fact, a large part of the
increased supply of foreign exchange was used up in a
significant rise in the propensity to import. Therefore,
only a part of the improvement in the terms of trade was
needed for the growth of employment and output that was
actually achieved, the remainder having been used to finance
the rise in the propensity to import. One consequence of
this argument is that, without this rise in the propensity
to import, the size of the domestic budget deficit need not
have been limited to the government's foreign exchange


34
surplus, and a higher domestic deficit could have been used
to promote an even faster growth of employment and output.
This argument has an important implication for
policies after 1981, when the terms of trade started to
decline and reduced the growth of foreign exchange receipts
and public revenues, and when the government, following the
spirit of its balanced budget policy, reduced its domestic
expenditures. The consequence has been a sharp fall in the
rate of economic growth. To the extent that a higher level
of government expenditure can promote further growth of
employment and output, it is highly desirable in an economy
in which there is still so much poverty and unemployment.
Past experience has shown the extent to which government
expenditures can have such an expansionary effect.
The real problem is that the oil boom has left
Indonesia with a reliance on imports, greatly limiting the.
extent to which fiscal policy can be used to promote growth
without immediate and substantial leakages into imports.
Therefore, one of the challenges to policy makers is to take
measures to reduce the propensity to import from the high
level it reached during the oil boom period to a lower level
more appropriate to the current situation. Particularly
important in this connection are taxation, and pricing and
expenditure policies which redistribute income toward those
with lower propensities to import. But such measures will
take a considerable period to have their effect. In the
meantime, there is still some scope for an expansionary


35
fiscal policy to the extent, for example, that international
reserves can be used to close any balance of payments
deficits that may arise. In this way, the reserves
accumulated during the oil boom period can be used to buy
time for the adjustments needed to reduce the propensity to
import.
Period 1981-1986
The slower growth of the economy after 1981 is
ultimately related to the fall in the export earnings of the
country. However, export earnings do not effect the
country's growth performance directly. They do so only
through other variables, such as investment, government
expenditures, and imports. Therefore it is important to
consider the change in each of these variables in the period
after 1981 compared with the period before 1981.
The data on investment trends since 1973 are
summarized in Table 9. The Table shows the data up to 1986
at 1973 constant prices. The estimates at 1973 constant
prices refer to total investment. However, the changes in
stocks became significant only after 1980; they were quite
small, about 1%, in 1978 and 1979. Therefore, the estimates
of gross investment before 1980 can be taken as roughly
equal to gross fixed investment.
It was found that investment grew rapidly during the
earlier period of rapid growth, and declined during the
later period of slow growth. One possible explanation is


36
Table 9
Gross Domestic Investment
(at 1973 constant prices)
Year Amount (billion Rp) % of GDP
1973 1,208 17.9
1974 1, 440 19.8
1975 1, 650 21.6
1976 1, 749 21.4
1977 2, 027 22.8
1978 2,333 24.4
1979 2,436 24.0
1980 2, 896 25.9
1981 3,219 26.7
1982 3, 637 29.5
1983 3, 656 28.4
1984 3, 464 25.2
1985 3,231 22.7
1986 3,263 22.7
Average 1973-81 - 22.7
1981-82 - 26.1
1982-86 25.9
Source: Bank Indonesia, Indonesian Financial Statistics.


37
that it was the level of income which influenced the level
of investment, rather than the other way around. This is
because the increase in income due to the terms of trade
improvement in the earlier period increased government
revenues substantially. A considerable part of the increase
in government revenues was in turn spent on investment; a
part was also distributed to those groups who spent a high
proportion of their incomes on investment, especially in
construction. In the later period, the deterioration in the
terms of trade seriously affected government revenues, and
thus led to a decline in investment by both government and
private sector.
In addition to the supply effect of investment in
increasing productive capacity in the long run, investment
expenditures also have the effect of increasing demand in
the short run, thereby leading to a fuller utilization of
existing productive capacity. To the extent that investment
has such a demand effect, we would expect a relationship
between the growth of income and the growth rate of
investment. The data in Table 11 suggest that the slower
growth of GDP in the later period may have been due partly
to weaker aggregate demand, due in turn to the decline of
investment.
Government revenues as a proportion of GDP rose
steadily until 1981, and declined thereafter with some
fluctuations (Table 10). The rise in revenues up to 1981 was
mainly due to some increase in the output of the mining


38
Table 10
Government Revenues
1973-1986
Year Total Revenues as % of GDP Oil Revenues as % of GDP in Mining Sector Other Revenues as % of GDP in Other Sectors
1973 12.9 37.1 9.6
1974 14.5 34.4 8.9
1975 16.8 47.5 9.3
1976 17.7 52.1 9.7
1977 17.8 51.9 9.8
1978 17.0 52.1 9.4
1979 17.7 54.9 8.4
1980 19.1 56.3 8.0
1981 20.1 62.2 7.7
1982 19.7 68.2 8.1
1983 18.9 65.7 7.9
1984 17.7 63.8 7.5
1985 19.5 71.2 9.4
1986 17.5 70.2 10.9
Sources: Bank Indonesia, Indonesian Financial
Statistics, various issues.


39
sector, and a rising rate of taxation of that output. After
1981, the volume of output declined but the rate of taxation
continued to rise. The rate of taxation of the output of
other sectors was much lower, declined until 1984, and then
rose as a result of the tax reforms introduced at that time.
Part of government expenditures were spent at home and part
abroad. Most government receipts were from sources abroad,
some from the tax on the oil companies and some from aid and
borrowing, but only a part of these foreign receipts were
spent abroad. Therefore, the government's foreign exchange
budget was always in surplus. As government was balancing
its overall budget, there was a deficit in its domestic
budget corresponding to the surplus in its foreign exchange
budget.
Government foreign receipts as a ratio of GDP rose
steadily during the oil boom to about 17%, and continued at
only slightly below that level even after 1981. Government
foreign expenditures have, however, kept rising steadily as
a ratio of GDP. The net result was that the foreign exchange
surplus rose until 1981, and declined after that. Because
the overall budget was balanced, the changes in the foreign
budget ratio were also reflected in the domestic budget
ratio. However, these changes were quite small for most of
the period; the domestic budget ratio fell sharply only in
1986 (Table 11).


40
Table 11
Government Revenues and Expenditures
as Percentage of GDP
Year Foreign Revenues Foreign Expendi- ture Surplus of Foreign Budget Domestic Revenue Domestic Expendi- ture Deficit in Domestic Budget
1973 7.4 4.4 3.0 0.4 11.3 2.9
1974 9.7 4.5 5.2 6.9 12.1 5.2
1975 12.7 6.5 6.2 7.4 13.6 6.2
1976 14.5 0.7 5.0 7.0 13.5 5.7
1977 13.9 0.2 5.7 7.9 13.6 5.7
1970 13.3 0.4 4.9 7.0 12.7 4.9
1979 14.0 0.5 6.3 6.7 13.0 6.3
1900 15.9 0.1 7.9 6.2 14.0 7.0
1901 16.9 0.1 0.0 6.0 14.0 0.0
1902 16.2 0.3 7.9 6.5 14.4 7.9
1903 17.1 10.5 6.6 6.4 13.0 6.6
1904 15.7 9.0 5.9 6.1 12.0 5.9
1905 19.5 12.9 6.6 10.0 16.6 6.6
1906 13.2 10.0 2.4 9.7 12.1 2.4
Source: Bank Indonesia, Indonesian Financial
Statistics, various issues.


41
One component of routine expenditures needs special
consideration, namely debt service payments, shown in Table
12. Debt service payments increased steadily in the years up
to 1981 until they reached approximately 13% of routine
expenditures, 7% of total expenditures, and 1.5% of GDP.
Table 12
Debt Service Payments
1973-1986
Year Amount (billion Rp) As Percentage of
at Current Prices at 1973 Constant Prices Routine Expendi ture Total Expendi ture GDP
1973 67 67 10.4 6.3 1.0
1974 73 50 7.8 4.1 0.7
1975 77 47 6.1 3.0 0.6
1976 162 85 10.4 4.7 1.0
1977 219 102 10.8 5.3 1.2
1978 458 183 17.6 9.1 1.9
1979 647 192 17.3 8.8 1.9
1980 760 173 14.2 7.0 1.6
1981 894 184 13.4 6.7 1.5
1982 1,151 227 16.5 8.1 1.8
1983 1,883 330 23.4 10.9 2.6
1984 2, 608 409 28.4 13.6 3.0
1985 3,186 481 28.1 14.5 3.4
1986 4, 624 703 35.1 20.9 4.8
Sources: Bank Indonesia, Indonesian Financial
Statistics, various issues.


42
Since then, debt service payments have been rising much more
steeply, by 1986, reached 35.1% of expenditures, and as much
as 4.8% of GDP.
Summary
This section summarized the various developments that
occurred in the Indonesian economy during the slow growth
period 1981-1986 and the rapid growth period 1968-1981, and
particularly the period of the oil boom 1973-1981.
From 1968-1981, the improvement in Indonesia's terms
of trade greatly strengthened the financial position of the
government. The government then used its improved financial
position to expand the productive capacity through an
increase in development expenditures in the public sector,
an increase in government's routine expenditures, which led
directly to higher investment in the private sector. The
growth of these investments was associated with the adoption
of new technology, especially, in the manufacturing sector.
Further, government also used its improved financial
position to promote rapid technological progress, especially
in the agricultural sector. The result is a rapid growth of
the productive capacity of the economy.
At the same time, there was a rapid growth of
aggregate demand. To some extent due to higher levels of
investment and faster technological progress. In particular,
higher levels of investment raise demand for output in some
sectors, especially in manufacturing and construction. In
addition, the growth of demand was also due to the


43
expansionary fiscal policy of the government. During this
period, the government earned a sizeable surplus in its
foreign exchange budget. But because of its commitment to a
balanced budget policy, as interpreted above, the government
incurred a corresponding deficit in its domestic budget,
which helped to increase aggregate demand and maintain it at
a high level, relative to GDP.
On the other hand, the abundance of foreign exchange
led to a rapid growth of imports. Part of it was used to
build up the productive capacity of the economy, but a
considerable part was also used to meet the growth of demand
directly. Therefore, a considerable part of demand leaked
out in the form of imports. But the increase in imports was
less than the increase in demand, so there was a net
increase in demand for domestic production. These effects on
demand were most clearly indicated by the changes in money
supply, which grew at an average annual rate of 33% during
this period. Because this was accompanied by a rapid growth
in productive capacity, the growth of demand indicated by
the growth-of money supply did not lead to a corresponding
rate of inflation. Although there was a high rate of
inflation, it was mostly due to other factors of a broadly
cost push type. The actual growth of money supply was faster
than the rate needed to validate the rise in prices due to
these cost push factors, and reflects the growth in
aggregate demand. This growth of demand combined with the


44
expansion of productive capacity is the main explanation of
the rapid growth of the period 1973-1981.
In 1981, the economy was still in a strong position to
sustain further growth. The country had built up a high
level of productive capacity during the rapid growth period.
Further, in spite of the deterioration in the country's
terms of trade, levels of investment, foreign exchange
earnings and government revenues remained high compared with
the position during the early years of the rapid growth era.
As in the earlier period, the growth of demand was
influenced by the three main factors: investment, government
expenditures, and imports. The net effect of the changes in
these three factors was to depress the growth of demand as a
whole, and hence to reduce the average growth rate.
In 1984, there was a sharp fall in the level of
imports. Combined with the high levels of investment and
government's net domestic expenditures, there was a
significant rise in domestic demand. The result was a much
higher growth rate in that year. Part of this increased
growth may also have been due to the stimulus given to
exports of manufactured goods by the 1983's devaluation.
Imports continued to decline in the years 1985 and
1986. However, in these years there was also a fall in
investment and in government expenditures, especially in
1986. The net effect of these changes was again a slower
growth of demand, which led to a fall in the growth rate of
GDP in 1985 and 1986.


CHAPTER IV
INCOME DISTRIBUTION MODEL:
CROSS SECTIONAL EVALUATION
The Model
This chapter will discuss an income distribution
model based on the cross sectional data from 1965 to 1986.
The model will consist of size distributions. The size
distribution model incorporates Lorenz curves, income
shares, and rank dominance.
Chapter III suggests that the economic development of
Indonesia is still in the agriculture stage; thus, the total
percentage of labor income in this sector is of interest in
the study. On the basis of the cross-sectional model, the
study will be able to derive the Lorenz curve, Gini
concentration ratio, income share for different groups of
population, and the rank dominance for different time
periods. From the functional distribution, the study will
also be able to show the share of income of each sectoral
component in the national income.
Size Distribution
In this section a Lorenz curve for five different
times (1965, 1970, 1975, 1980, and 1985) are constructed.
The data have been collected for each province in Indonesia.
The income data are averages for each province. Because
Indonesia has 27 provinces, the data cover the average
income and population for 27 provinces as indicated in
Tables 13 and 14. The data are arranged from the lowest to


46
Table 13
Average Income by Provinces
(in 1973 constant prices and in billions Rp.)
No. Province 1965 1970 1975 1980 1985
1. D.I. Aceh 39.2 63.8 132.5 189.5 265.8
2. Sumatera Utara 114.3 186.3 388.6 554.4 669.3
3. Sumatera Barat 50.9 82.9 171.0 243.9 302.0
4. Riau 35.4 57.5 119.7 171.2 219.7
5. Jambi 22.2 36.3 75.4 107.4 127.8
6. Sumatera Selatan 72.8 118.3 246.9 352.2 414.8
7. Bengkulu 10.8 17.5 36.3 52.1 73.1
8. Lampung 52.3 85.4 178.5 254.7 289.7
SUMATERA 397.9 648.0 1,348.9 1,925.4 2,362.2
9. D.K.I.Jakarta 154.6 251.7 524.8 748.6 1,080.3
10. Jawa Barat 361.3 588.8 1,228.2 1,752.3 2,254.9
11. Jawa Tengah 265.7 432.9 903.3 1,288.9 1,421.6
12. D.I.Yogyakarta 34.2 55.8 118.1 168.8 194.4
13. Jawa Timur 312.2 508.8 1,061.5 1,514.5 1,823.0
JAWA 1, 128.0 1,838.0 3,835.9 5,473.1 6,774.2
14 . Kalimantan Barat 32.7 53.3 111.2 158.5 195.1
15. Kalimantan Tengah 15.5 25.0 51.8 73.6 89.9
16. Kalimantan Selatan l 32.1 52.5 109.6 156.2 184.8
17. Kalimantan Timur 23.4 37.9 79.1 113.0 165.7
KALIMANTAN 103.7 168.7 351.7 501.3 635.5
18. Sulawesi Utara 36.5 59.6 124.5 177.8 171.8
19. Sulawesi Tengah 18.1 29.6 61.5 87.7 78.6
20. Sulawesi Selatan 65.2 106.3 221.3 315.7 425.0
21. Sulawesi Tenggara 10.2 16.7 34.7 49.2 66.6
SULAWESI 130.0 212.2 442.0 630.4 742.0
22. Bali 28.9 47.1 97.8 139.8 167.4
23. Nusa Tenggara Barat26.3 42.9 89.3 127.6 145.2
24. Nusa Tenggara Timur25.7 42.1 88.2 125.7 134.6
25. Timor Timur 66.6
NUSA TENGGARA 80.9 132.1 275.3 393.1 504.6
26. Maluku 17.8 29.2 60.9 87.2 111.0
27 . Irian Jaya 26.7 42.8 89.3 127.5 158.5
INDONESIA 1, 885.0 3,071.0 6, 404.0 9,138.0 11,288.0
Source: The Indonesian Central Bureau of Statistics (BPS).


47
Table 14
Population by Provinces
(x 1,000)
No. Province 1965 1970 1975 1980 1985
1. D.I.Aceh 1,768 1, 966 2,244 2, 611 2, 972
2. Sumatera Utara 5,551 6,427 7,311 8,361 9,422
3. Sumatera Barat 2,495 2,740 3,040 3,407 3, 698
4 . Riau 1,379 1,594 1,846 2,169 2,548
5. Jambi 836 975 1,170 1,446 1, 745
6. Sumatera Selatan 3, 018 3,365 3, 898 4,630 5,370
7 . Bengkulu 448 506 610 768 943
8. Lampung 2, 020 2, 630 3, 418 4, 625 5, 905
SUMATERA 17,515 20,203 23,537 28,016 32,603
9. D.K.I.Jakarta 3,503 4,375 5,299 6,503 7, 885
10. Jawa Barat 19,088 21,172 23,925 27,454 30,830
11. Jawa Tengah 19,704 21,492 23,312 25,373 29,945
12. D.I.Yogyakarta 2, 338 2,462 2,599 2,751 2, 930
13. Jawa Timur 23,211 25,111 27,038 29,189 31,262
JAWA 67,844 74,612 82,173 91,270 99,852
14. Kalimantan Barat 1,740 1, 969 2,207 2,486 2, 819
15. Kalimantan Tengah 567 677 798 954 1,118
16. Kalimantan Selatan i 1,558 1, 674 1, 846 2,065 2,273
17. Kalimantan Timur 616 712 902 1,218 1,512
KALIMANTAN 4,481 5, 032 5,753 6,723 7,722
18. Sulawesi Utara 1,456 1, 671 1, 878 2,115 2, 313
19. Sulawesi Tengah 771 888 1, 055 1,290 1,511
20. Sulawesi Selatan 4,770 5,108 5,542 6, 062 6, 610
21. Sulawesi Tenggara 616 696 802 942 1,120
SULAWESI 7, 613 8,363 9,277 10,410 11,554
22. Bali 1, 909 2, 082 2,263 2, 470 2, 649
23. Nusa Tenggara Barat1,954 2,159 2,412 2, 725 2, 995
24. Nusa Tenggara Timur2,091 2,259 2,474 2,737 3,061
25. Timor Timur 631
NUSA TENGGARA 5, 954 6,500 7,149 7, 932 9,336
26. Maluku 895 1, 054 1,216 1, 411 1,609
27. Irian Jaya 819 904 1, 022 1, 174 1,371
INDONESIA 105,121 116,668 130,127 146,936 164,047
Source: The Indonesian Central Bureau of Statistics (BPS)


48
the highest income. The table presents a calculation of
cumulative income and recipients, and the percentage of
cumulative income and the percentage of recipients. From
these data, Lorenz curves can be constructed to show the
percentage of total income occurring to cumulative
percentages of recipients. Tables 15 through 19 present the
size distributions for the years 1965, 1970, 1975, 1980, and
1985.
From these tables (Tables 15 through 19), Lorenz
curves are constructed to indicate the degree of inequality
in the income distribution. Perfect equality is represented
by the diagonal from zero to one hundred percent. Figures 3
through 7 present Lorenz curves for five different time
periods. The curve should be interpreted as showing that the
inequality of the distribution curve is greater the further
it bends away from the line of equality. From the Lorenz
curve, a Gini ratio can be calculated to present a single
numerical measure of inequality.


49
Table 15
Size Distribution of Income
Lorenz Curve
Year 1965
No. Population (x 1,000) Average Income (billions Rp)
Cumulative Cumulative
Pop. Total % Avg. Total %
1. 616 616 0.58 10.2 10.2 0.5
2. 448 1064 1.01 10.8 21.0 1.1
3. 567 1631 1.55 11.5 32.5 1.7
4. 895 2526 2.40 14.8 47.3 2.5
5. 771 3297 3.13 16.1 63.4 3.3
6. 836 4133 3.93 17.1 80.5 4.2
7. 616 4749 4.51 20.0 100.5 5.3
8. 2091 6840 6.50 22.2 122.7 6.5
9. 819 7659 7.28 23.4 146.1 7.7
10. 1954 9613 9.14 24.1 170.2 9.0
11. 1909 11522 10.96 25.7 195.9 10.3
12. 1558 13080 12.44 26.7 222.6 11.8
13. 1740 14820 14.09 28.9 251.5 13.3
14 . 2338 17158 16.32 29.7 281.2 14.9
15. 1379 18537 17.63 32.1 313.3 16.6
16. 1456 19993 19.01 32.7 346.0 18.3
17. 1768 21761 20.70 34.2 380.2 20.1
18. 2495 24256 23.07 35.4 415.6 22.0
19. 2020 26276 24.99 36.5 452.1 23.9
20. 4770 31046 29.53 39.2 491.3 26.0
21. 3018 34064 32.40 40.3 531.6 28.2
22. 5551 39615 37.68 42.3 573.9 30.4
23. 3503 43118 41.01 55.2 629.1 33.3
24. 19704 62822 59.76 59.1 688.2 36.5
25. 23211 86033 81.84 72.8 761.0 40.3
26. 19088 105121 100.00 1124.0 1885.0 100.0
27.
Source: Author's calculation based on Table 13 and 14.


50
Table 16
Size Distribution of Income
Lorenz Curve
Year 1970
No. Population (x 1,000) Average Income (billions Rp)
Cumulative Cumulative
Pop. Total % Avg. Total %
1. 696 696 0.59 16.7 16.7 0.5
2. 506 1202 1.03 17.5 34.2 1.1
3. 677 1879 1.61 24.4 58.6 1.9
4. 1054 2933 2.51 25.5 84.1 2.7
5. 888 3821 3.27 26.2 110.3 3.6
6. 975 4796 4.11 30.6 140.9 4.6
7. 712 5508 4.72 32.4 173.3 5.6
8. 2259 7767 6.65 36.1 209.4 6.8
9. 904 8671 7.43 37.2 246.6 8.0
10. 2159 10830 9.28 39.0 285.6 9.3
11. 2082 12912 11.06 40.4 326.0 10.6
12. 1674 14586 12.50 42.8 368.8 12.0
13. 1969 16555 14.18 44.6 413.4 13.5
14. 2462 19017 16.30 46.1 459.5 15.0
15. 1594 20611 17.66 52.8 512.3 16.7
16. 1671 22282 19.09 53.0 565.3 18.4
17. 1966 24248 20.78 54.1 619.4 20.2
18. 2740 26988 23.13 62.2 681.6 22.2
19. 2630 29618 25.38 63.7 745.3 24.3
20. 5108 34726 29.76 68.4 813.7 26.5
21. 3365 38091 32.64 71.0 884.7 28.8
22. 6427 44518 38.15 88.5 973.2 31.7
23. 4375 48893 41.90 120.1 1093.3 35.6
24 . 21492 70385 60.32 122.8 1216.1 39.6
25. 25111 95496 81.85 165.9 1382.0 45.0
26. 21172 116668 100.00 1689.0 3071.0 100.0
27.
Source: Author's calculation based on Table 13 and 14.


51
Table 17
Size Distribution of Income
Lorenz Curve
Year 1975
No. Population (x 1,000) Average Income (billions Rp)
Cumulative Cumulative
Pop. Total % Avg. Total %
1. 802 802 0.61 34.7 34.7 0.5
2. 610 1412 1.08 40.5 76.8 1.2
3. 798 2210 1.69 51.8 128.6 2.0
4 . 1216 3426 2.63 60.9 189.5 2.9
5. 1055 4481 3.44 61.5 251.0 3.9
6. 1170 5651 4.34 75.4 326.4 5.1
7 . 902 6553 5.03 79.1 405.5 6.3
8. 2474 9027 6.93 88.2 493.7 7.7
9. 1022 10049 7.72 89.3 583.0 9.1
10. 2412 12461 9,57 89.3 672.3 10.4
11. 2263 14724 11.31 97.8 770.1 12.0
12. 1846 16570 12.73 109.6 879.7 13.7
13. 2207 18777 14.42 111.2 990.9 15.5
14. 2599 21376 16.42 118.1 1109.0 17.3
15. 1846 23222 17.84 119.7 1228.7 19.2
16. 1878 25100 19.28 124.5 1353.2 21.1
17. 2244 27344 21.01 132.5 1485.7 23.5
18. 3040 30384 23.34 171.0 1656.7 25.9
19. 3418 33802 25.97 178.5 1835.2 28.7
20. 5542 39344 30.23 221.3 2056.5 32.1
21. 3898 43242 33.23 246.9 2303.4 36.0
22. 7311 50553 38.84 288.6 2592.0 40.5
23. 5299 55852 42.92 324.8 2916.8 45.5
24. 23312 79164 60.83 353.3 3270.1 51.0
25. 27038 106202 81.61 1061.5 3336.5 52.1
26. 23925 130127 100.00 3067.5 6404.0 100.0
27.
Source: Author's calculation based on Table 13 and 14.


52
Table 18
Size Distribution of Income
Lorenz Curve
Year 1980
No. Population (x 1,000) Average Income (billions Rp)
Cumulative Cumulative
Pop. Total % Avg. Total %
1. 942 942 0.64 49.2 49.2 0.6
2. 768 1710 1.16 72.1 121.3 1.3
3. 954 2664 1.81 73.6 194.9 2.1
4 . 1411 4075 2.77 87.2 282.1 3.1
5. 1290 5365 3.65 87.7 369.8 4.0
6. 1446 6811 4.63 107.4 477.2 5.2
7. 1218 8029 5.46 113.0 590.2 6.5
8. 2737 10766 7.73 125.7 715.9 7.8
9. 1174 11940 8.12 127.5 843.4 9.2
10. 2725 14665 9.98 127.6 971.0 10.6
11. 2470 17135 11.66 139.8 1110.8 12.2
12. 2065 19200 13.06 156.2 1267.0 13.9
13. 2486 21686 14.75 158.5 1425.5 15.6
14. 2751 24437 16.63 168.8 1594.3 17.4
15. 2169 26606 18.10 171.2 1765.5 19.3
16. 2115 28721 19.54 177.8 1943.3 21.3
17. 2611 31332 21.32 189.5 2132.8 23.3
18. 3407 34739 23.64 238.6 2371.4 26.0
19. 4625 39364 26.78 260.3 2631.7 28.8
20. 6062 45426 30.91 301.6 2933.3 32.1
21. 4630 50056 34.06 365.5 3298.8 36.1
22. 8361 58417 39.75 402.1 3700.9 40.5
23. 6503 64920 44.18 466.0 4166.9 45.6
24. 25373 90293 61.45 511.8 4678.7 51.2
25. 29189 119482 81.31 1060.0 5738.7 62.8
26. 27454 146936 100.00 3399.3 9138.0 100.0
27. ~
Source: Author's calculation based on Table 13 and 14


53
Table 19
Size Distribution of Income
Lorenz Curve
Year 1985
No. Population (x 000) Average Income (billion Rp)
Cumulative Cumulative
Pop. ~ Total % Avg. Total %
1. 631 631 0.38 66.6 66.6 0.6
2. 1120 1751 1.06 66.6 158.0 1.4
3. 943 2694 1.64 85.8 243.8 2.2
4. 1511 4205 2.56 106.1 349.9 3.1
5. 1118 5323 3.24 107.3 457.2 4.1
6. 1609 6932 4.22 129.8 587.0 5.3
7. 1745 8677 5.28 146.7 733.7 6.5
8. 3061 11738 7.15 152.4 886.1 7.9
9. 2995 14733 8.98 152.4 1038.5 9.2
10. 1371 16104 9.81 158.5 1197.0 10.6
11. 1512 17616 10.73 165.7 1381.7 "12.2
12. 2649 20265 12.35 198.6 1580.3 14.0
13. 2313 22578 13.76 199.8 1780.1 15.8
14. 2273 24851 15.14 202.1 1982.2 17.6
15. 2930 27781 16.93 207.7 2189.9 19.4
16. 2819 30600 18.65 208.8 2398.7 21.3
17. 2548 33148 20.20 237.0 2635.7 23.4
18. 2972 36120 22.01 304.8 2940.5 26.1
19. 5905 42025 25.61 316.1 3256.6 28.9
20. 3698 45723 27.87 372.5 3629.1 32.2
21. 5370 51093 31.14 451.5 4080.6 36.2
22 . 6610 57703 35.17 496.7 4577.3 40.6
23. 9422 67125 40.91 575.7 5153.0 45.7
24. 7885 75010 45.72 868.0 6021.0 53.3
25. 26945 101955 62.14 921.1 6942.1 62.8
26. 31262 133217 81.20 952.7 7894.8 69.9
27. 30830 164047 100.00 3393.2 11288.0 100.0
Source: Author's calculation based on Table 13 and 14.


cumulative x or income
54
Figure 3: Lorenz Diagram 1965


OUIIIU IOU I
55
Figure 4: Lorenz Diagram 1970


Cumulative % of Income
56
Figure 5: Lorenz Diagram 1975


Cumulative x of Income
57
Cumulative X of Recipients
Figure 6: Lorenz Diagram 1980


Cumulative X of Income
58
Figure 7: Lorenz Diagram 1985


59
A summary of mean income in Indonesia is presented in
Table 20, which shows the mean income for each decile from
1965 to 1985 (five data points). For each year, an average
mean income and the percentage changes of average income per
year over the period of the study are calculated. The Gini
ratio is also reported in this table to show the inequality
of income distribution from year to year.
Table 21 is a tabulation of cumulative proportion of
income. From this table, the ratio of income share of the
richest 10% to the poorest 10% for the period of 1965 to
1985 can be seen. The ratio of income share will be
evaluated together with the Gini ratio to guide the study in
making conclusions in Chapter VI. Figure 8 is a composite
cumulative proportion of income from 1965 to 1985.
Table 22 presents generalized Lorenz ordinates. A
generalized Lorenz ordinate is derived by scaling an
ordinary Lorenz ordinate by the distribution's mean income.
This basis, a composite diagram can be made of generalized
Lorenz ordinates from 1965 to 1985, with average mean income
for each year falling at the 100% cumulative population in
the horizontal axis. Figure 9 is a composite of generalized
Lorenz ordinates from 1965 to 1985.
Generalized Lorenz Ordinates show both efficiency and
equity. Efficiency is reflected by the magnitude of mean
income, which is given by the end-point on the right-hand
side of the generalized Lorenz curve in Figure 9. Equity is
incorporated by the curvature of generalized Lorenz curves,


60
Table 20
Mean Income Distribution
1965 1985
Decile 1965 1970 1975 1980 1985
1 30.16 58.66 194.04 449.59 624.23
2 31.10 65.19 244.63 512.64 695.34
3 35.06 73.62 260.01 516.30 730.33
4 42.04 108.71 274.09 620.47 767.58
5 48.82 122.19 303.55 636.92 938.04
6 64.66 152.94 443.79 758.45 1,152.50
7 101.97 228.48 621.83 945.78 1,281.19
8 170.60 303.72 803.70 1,176.06 1,453.89
9 266.91 452.06 1,243.02 1,512.34 1,629.99
10 1,094.68 1,505.40 2,015.34 2,009.45 2,014.91
Average 189.00 307.00 640.00 914.00 1,129.00
Percentage changes - 0.62 1.08 0.43 0.23
Gini Ratio 0.66 0.59 0.43 0.28 0.21
Sources: 1. The Indonesian Central Bureau of Statistics
(BPS).
2. Author's calculation based on data available.


61
Table 21
Cumulative Proportion of Income
From 1965-1985
Decile 1965 1970 1975 1980 1985
1 1.60 1.91 3.03 4.92 5.53
2 3.25 4.03 6.85 10.53 11.69
3 5.11 6.43 10.91 16.18 18.16
4 7.34 9.97 15.19 22.97 24.96
5 9.93 13.95 19.93 29.94 33.27
6 13.36 18.93 26.86 38.24 43.48
7 18.77 26.37 36.57 48.59 54.83
8 27.82 36.26 49.12 61.46 67.71
9 41.98 50.98 68.53 78.01 82.15
10 100.00 100.00 100.00 100.00 100.00
Ratio of income share of the richest 10% to poorest 10% 36.29 25.66 10.39 4.47 3.23
Sources: 1. The Indonesian Central Bureau of Statistics
(BPS).
2. Authors's calculation based on data available.


62
196$
+ 1970
Dicili
o 197$
A 1960
x 196$
Figure 8: Composite Cumulative Proportion of Income
1965 1985


ci
1
2
3
4
5
6
7
8
9
10
63
Table 22
Generalized Lorenz Ordinates
From 1965-1985
1965 1970 1975 1980 1985
3.00 6.00 19.00 45.00 62.00
6.00 12.00 44.00 96.00 132.00
10.00 20.00 70.00 148.00 205.00
14.00 31.00 97.00 210.00 282.00
19.00 43.00 128.00 274.00 376.00
25.00 58.00 172.00 350.00 491.00
35.00 81.00 234.00 444.00 619.00
53.00 111.00 314.00 562.00 764.00
79.00 157.00 439.00 713.00 - 927.00
189.00 307.00 640.00 914.00 1,129.00
1. The Indonesian Central Bureau of Statistics
(BPS) .
2. Author's calculation based on data available.


64
0 1955 + 1970
* 1975
A 1980
X 1905
Figure 9: Composite Generalized Lorenz Ordinates
1965 1985


65
which, like an ordinary Lorenz curve, are convex from below.
Thus, the height of the generalized Lorenz curve reflects
efficiency and curvature shows income inequality. An
evaluation of the above models will be made in the following
sections. Generalized Lorenz dominance is equivalent to
second degree stochastic dominance.
A final criterion to evaluate size distribution is
first degree stochastic dominance. This is equivalent to
Pareto optimality under certain conditions (see paper by W.
James Smith et al on Stochastic Dominance, Income
Distribution Functions and Economic Development. Figures 10
through 13 are Rank Order Functions for 1965 and 1970, 1970
and 1975, 1975 and 1980, and 1980 and 1985, which can be
plotted from Table 20. The plot is made for income on the
ordinate and the cumulative proportion of income recipients
on the abscissae. The rank dominance can be used to
implement welfare evaluation and has important implication
for poverty.
Functional Distribution
The other common measure of income distribution is the
functional or factor share distribution, which will attempt
to explain the share of total income that each factor of
production receives. Figure 14 shows a basic concept of a
functional income distribution in a market economy. This
simple model indicates only two factors of production: labor
and capital. The simple model shows that in a competitive


66
Figure 10
Rank Order Function, 1965-1970


67
1970 t 1975
Figure 11: Rank Order Function, 1970-1975


68
1975 + I960
Figure 12: Rank Order Function, 1975-1980


(Ttiouaknda)
69
Figure 13: Rank Order Function, 1980-1985


70
Figure 14: A Simplified Diagram of a Competitive Market
Functional Income Distribution


71
market economy with constant returns to scale production
functions, factor prices are determined by factor supply and
demand curves. Income is distributed by function: labor
receive wages, the owners of land receive rent, and
capitalists obtain profits. This theory will be expanded to
apply to the case of Indonesia.
In Indonesia, the relevance of the functional theory
is greatly influenced by government policy, which therefore
distorts the theory of a competitive market. Although a non-
competitive market exists in the Indonesian economy, it is
worthwhile to investigate how income is distributed among
the production factors. On the basis of the study of
functional distribution, this study can recommend to the
government of Indonesia to alter the functional distribution
of income through policies designed to change relative
factor prices. Since factor prices are assumed to function
as the ultimate signals and incentives in any economy,
including that of Indonesia, getting these prices right
would increase productivity and efficiency.
As shown in Chapter III, the national income of
Indonesia is broken down into seven sectors, each of which
has factors of production. Data from the Indonesian Central
Bureau of Statistics (CBS) shows that these factors of
production would receive salary & wages, profits,
depreciation, and indirect taxes. These data can only be
found in the national input/output table, which is
available for 1975 and 1985, and is known as the Gross Added


72
Value Composition of GDP. The input/output Indonesia is
built to break down GNP from three different approaches: the
production approach, income approach, and expenditure
approach. Generally, the government of Indonesia reports
annually the national income via the expenditure approach;
however, the payment to factors of production is officially
reported from the input/output table of Indonesia.
The study of functional distribution from two
different time periods, 1975 (Table 23) and 1985 (Table 24),
would lead to the conclusion of how a sectoral component of
GNP improves factors of payment or income within a decade.
As we concluded in Chapter III that the agriculture sector
is still dominant in the economic growth of Indones'ia, the
study will focus on the change of factors of payment to the
labor in the agriculture sector. In addition, various
sectors such as the industrial and service industry will
also be scrutinized to support results of this study. Tables
23 and 24 represent factors payment to each sector in the
Indonesian economy.


73
Table 23
Functional Distribution
Income Share in the Sectoral GDP
Nominal Value 1975
(billions of rupiah)
No. Sector Estimate Employ- ment Wages & Salaries Sectoral Income Percentage Sectoral Income
1. Agriculture 27.13 1,797 3,403 52.81
2. Mining 0.19 58 2,112 2.75
3. Industry 3.60 861 955 59.09
4 . Public Utilities 0.18 26 59 44.07
5. Construction 1.09 _ *) 502*) -
6. Transport and Communication 1.19 289 443 65.24
7. Trade & Other Services 10.61 2,196 3,272 67.11
National Income 5,227 10,746 48.64
Sources: 1. Bank : Indonesia, Indonesian Financial Statistics,
(various issues).
2. The Indonesian Central Bureau of Statistics,
(BPS) .
*) Sector no. 5 is incorporated in sector no. 3.


74
Table 24
Functional Distribution
Income Share in the Sectoral GDP
Nominal Value 1985
(billions of rupiah)
NO. Sector Estimate Employ- ment Wages & Salaries Sectoral Income Percentage Sectoral Income
1. Agriculture 31.17 3,319 19,691 16.86
2. Mining 0.93 346 13,533 2.56
3. Industry 6.51 19,667 32,323 60.85
4 . Public Utilities 0.09 N/A 686 N/A
5. Construction 2.80 _ *) 4,658*) -
6. Transport and Communication 1.91 11,667 16, 982 68.70
7. Trade & Other Services 16.09 _ *) _ *) -
National Income 34,999 83,217 42.06
Sources: 1. Bank : Indonesia, Indonesian Financial Statistics,
(various issues).
2. The Indonesian Central Bureau of Statistics,
(BPS).
*) Sector no. 5 and 7 are incorporated in sector no. 3.
(Input-Output Data, National Account of Indonesia does
not breakdown those sectors).


75
Model Results
It can be seen that over time (from 1965 to 1985) the
Gini ratio has become smaller. This leads to the conclusion
that the inequality of income has been declining during the
20-year period and thus, the equality of income distribution
has increased. It is worthwhile to note that the Lorenz
curves have crossed each other at approximately 90% of
cumulative population. This is an indication that income
distribution cannot be ranked for the years 1965 and 1970.
However, the curves are ranked thereafter, from 1970, 1975,
1980, and 1985. The Lorenz curves have consistently
increased from 1965 to 1980, and then only slightly
increased from 1980 to 1985. It is believed that these
conditions can be used to draw inferences about the effects
of the oil boom on the poverty line. The slump economic
condition in the 1980's has a major influence on inequality
from 1980 to 1985. It can be conclude that the Lorenz curve
dominates the previous year's Lorenz curves.
It can be seen that over time (from 1975 to 1985) the
nominal average income has increased; however, the real
average income can be seen to decrease from 1975 through
1985 (Table 25).
The Gini ratio supports the conclusion of decreasing
inequality in income from 1965 to 1985 as indicated by the
smaller area of the numerator in the Gini ratio, over time.
However, the Gini ratio constructed with the result of
average income calculation during 1980-1985 shows the


76
Table 25
Average Income
1965-1985
Year GDP Deflator*^ Average Income
Nominal (1973 Real constant price)
1965 71.22 189 265.37
1970 80.79 307 379.99
1975 112.99 640 566.42
1980 165.00 914 553.94
1985 205.60 1,129 549.12
*) GDP deflator in this study is used to indicate an
inflation index of Indonesia, which believed to be
superior than CPI (Consumer Price Index) and PPI
(Producer Price Index).
percentage change has declined. The generalized Lorenz
curves indicates a decreasing order of the ratio of income
share of the richest 10% to the poorest 10% from 36.29 in
1965 to 3.23 in 1985.
Two possible explanations can be made for this case:
first, the income share of the richest is decreasing, and
second, the income share of the poorest is increasing. The
result is a decreasing order of the ratio. The end point of
the right hand side of generalized Lorenz curves as shown in
Table 22 (in nominal value) shows a decreasing value in real
terms and therefore inefficiency of welfare. In the equity
aspect, the generalized Lorenz curves are shown as convex


77
curves in the earlier years of 1965, 1970, and 1975.
However, in 1980 and 1985, the curves are flatter than those
previous curves.
We can infer that the social policy in Indonesia since
the New Order Government was formed has raised income as
indicated by the changes in both the height and curvature of
the generalized Lorenz curves (see Figure 9).
An interpretation of functional distribution is made
for two different periods, 1975 and 1985. In this study,
wages and salary in the agricultural sector are observed in
detail. Tables 23 and 24 show that the percentage share of
salary and wages declined from 52.81% to 16.86%. A drastic
decline was caused primarily by the priority given to the
non-agricultural sector, which would indirectly affect the
government budget allocation to this agricultural sector.
The government of Indonesia had to adjust its revenue due to
the oil bust period in the 1980's by keeping the nominal
salary and wages constant over several years. The data also
suggest that in all sectors the percentage sectoral income
has declined in 1985. Overall, the percentage income of all
sectors has declined from 48.64% in 1975 to 42.06% in 1985.
To conclude this section, the size and functional
distributions suggest that after the New Order Government
and especially during the oil boom, Indonesia progressively
altered its income distribution over time. The march toward
greater equality slowed in progress between 1980 and 1985.


CHAPTER V
POLICY ANALYSIS
Limitation of Data
Indonesia has no national statistics on income
distribution. The income tax covers only a small percentage
of the population, and wage and salary data are fragmentary
and unreliable. National income data are subject to many
problems of interpretation, and however reliable, can only
be used to trace broad changes in sectoral shares over time.
Labor force and employment data are subject to all the
pitfalls in interpretation and again can only be used in
conjunction with national income data, to analyze broad
shifts in sectoral shares.
To glean any insight into trends in the distribution
of personal or household income both between and within
sectors of the economy one is forced to rely on partial
data. Such data are usually restricted by sector, or by
geographical region, and some caution is needed in
interpreting them. Even more caution is needed in making
intertemporal or international comparisons of the kind that
have become rather fashionable in the literature of
development economics in recent years.
The major household consumption surveys (Susenas) have
been concerned with household expenditure patterns. There
have now been six of these, carried out in 1963/64, 1964/65,
1967/68, 1969/70, 1976/77, and 1985/86 by the Central Bureau
of Statistics (CBS). Some problems of comparability arise,


79
although they are probably less severe than with the earlier
surveys, which were based on small samples and were
conducted under very disturbed circumstances. Additional
evidence will be taken from other sources, in particular the
Population and Agricultural Censuses of 1971 and 1973, and
the 1976 by the Sakernas (National Labor Force Survey). The
study then considers indicators of levels of poverty in
Indonesia and how these appear to have changed over time.
Finally we examine policy options available to government to
improve distribution of income and wealth in Indonesia over
the next decades.
Discussions
As concluded from Chapter III, that economic growth is
closely related to the income distribution. This positive
correlation has suggested that Indonesia consistently
implemented its program in economic development. High
economic growth leads to the decreasing Gini ratio or an
increase in average income of people from 1965 to 1985. The
historical relation of economic growth and income
distribution can be summarized in Table 26 as follows:


80
Table 26
A Relation between Economic Growth
and Income Distribution
1968-1986
Year Average Annual GDP Growth Average Annual Percentage Changes Average Income
1968-1981 7.5 7.7 0.71 *>
1982-1986 3.5 4.1 0.23 *>

*) Percentage changes in average income are derived from
Table 15 for 1965 to 1980 (four data points) in the first
row and for 1985 in the second row.
In the case of Indonesia incentives of economic growth
would also seem to provide incentive for a more equitable
income distribution. The results of this study show a clear
movement toward greater equality. A crossing point between
Lorenz curves in the years 1965 and 1970 is the only
anomaly. The crossing occurs at 90% of cumulative
population which show a better distribution in the year 1970
compared to the 1965. In general, however, there will be
improvement in the income distribution from 1965 to 1985.
An important set of social indicators for Indonesia is
presented in Table 27 and 28. From this table, it can be
seen that one of the important factors that slows economic
growth is population growth. Total population growth on
average is 2.2% per year.
The poverty line set by the United Nations at
$ 130 per capita for urban population and $ 109 per capita


81
for rural population would make an arithmatic average of $
119.50 per capita. It is assumed that the poverty line is
constant over the period of the study and only changes due
to varying exchange rates.
Table 27
1988 Social Indicator Data Sheet
Indonesia
Most Reference Groups
Lower Upper
Recent
1965 1975 Estimate mid mid
Income Income
AREA Total land area 1, 919.3 1,919.3 1,919.3*)
Agriculture (%) 15.5 16.7 17.0
GNP PER CAPITA ($) 30 210 450 730 2,510
POPULATION Total Population 104.8 130.2 169.7**)
Urban Pop. (%) Pop. Growth Rates: 16 19 26 38 64
Total (%) - 2.2 2.3 2.5 2.0
Urban (%) - 4.3. 5.0 4.2 3.2
Pop. Projection in 2000 - - 212.9 - -
' in thousand square km.
) in million.


82
Table 28
1988 Social Indicator Data Sheet
Indonesia
Reference Groups
Most ------------------
Recent Lower Upper
1965 1975 Estimate mid mid
Income Income
INCOME, CONSUMPTION,
AND POVERTY:
Energy Consumption per
capita (kg of oil eq) 130 219
Percentage of Private Income received by (households): Highest 10% 34
Highest 20% 49 -
Lowest 20% 7 -
Lowest 40% 14
Est. absolute Poverty Income level ($ p.c.) Urban 136 124
Rural 112 106
Est. Pop. below absolute Poverty Income Level (%) Urban 28 26
Rural 51 44
351
1,313
-) data not available.


83
On the basis of this absolute value in Table 29, the
income distribution would be increased. This absolute can
only be used as a guidance to indicate the change in income
distribution over time in absolute term, and do not really
provide an absolute answer to the income distribution
problem. From this table, it can be conclude that as the
Rupiah poverty line increase, the percentage of total
population below poverty line decrease.
Table 29
Income Distribution in Indonesia
Absolute Poverty Line
Year Below Poverty Line % Total Above Poverty Line % Total Poverty Line (x 1, 000 Rp.)
1965 32 68 36.45
1970 8 92 45.17
1975 2 98 _49.59
1980 2 98 74.69
1985 2 98 134.44
Source: Author's calculation from data available.


CHAPTER VI
CONCLUSIONS
Economic development after the New Order Government
took place in 1966 suggests rapid growth in the early part
(1968-1981), due to the priority of Indonesian government on
the economic restoration and the oil boom starting in the
year 1973. During that period (1968-1981) economic growth
stood at an average of 7.5 7.7% per year. Economic growth
in this period spurred greater income equality as can be
seen from Lorenz curves. This is consistent with Generalized
Lorenz Curves. All of the analyses, show a positive
correlation between economic growth and income distribution
for the period after the New Order Government until 1981.


BIBLIOGRAPHY
Albrecht, William P., Jr. Economics. Englewood Cliffs, New
Jersey: Prentice-Hall, Inc., 1983.
Atkinson, A. B. "On Measurement of Inequality." Journal of
Economic Theory, 2, 1970.
Bank Indonesia. Indonesian Financial Statistics, Jakarta:
Bank Indonesia, various issues from 1965 to 1987.
__________ Report for the Financial Years. Jakarta:
Bank Indonesia, various issues from 1965 to 1987.
__________ Weekly Report. Jakarta: Bank Indonesia,
various issues from 1965 to 1987.
Bails, Dale G., and Larry C. Peppers. Business
Fluctuations: Forecasting Techniques and
Applications. Englewood Cliffs, New Jersey:
Prentice-Hall, Inc., 1982
Baumol, William J., and Alan S. Blinder. Economics
Principles and Policy: Macroeconomics. San Diego,
California: Harcourt Brace Jovanovich, Publishers,
1988.
Blaug, Mark. Economic Theory in Retrospect Cambridge:
Cambridge University Press, 1987.
Box, George E.P., and Gwilym M. Jenkins. Time Series
Analysis Forecasting and Control. Oakland,
California: Holden- Day, Inc., 1976.
Branson, William H. Macroeconomic Theory and Policy. New
York: Harper & Row, Publishers, 1979.
Cairncross, Alec, and Mohinder Puri. Emp1oyment, Income
Distribution and Development Strategy: Problems of
the Developing Countries. New York: Holmes & Meier
Publishers, Inc., 1976.
Central Bureau of Statistics. Penduduk Indonesia 1985
Menurut Propinsi. Seri Supas 85 no. 3. Jakarta,
Indonesia, 1986.
Central Bureau of Statistics. National Income of
Indonesia: 1983-1985. Jakarta, Indonesia, 1986.
Department of Information Republic of Indonesia. REPELITA
I IV. Jakarta, Indonesia, 1969 1989.


86
Dolan, Edwin G. Basic Macroeconomics. Hinsdale, Illinois:
The Dryden Press, 1980.
Dornbusch, Rudiger, and Stanley Fischer. Macroeconomics.
New York: McGraw-Hill Book Company, 1984.
Dornbusch, Rudiger. Open Economy Macroeconomics. Basic
Books, Inc., Publishers, 1980.
Eltis, W. A. Growth and Distribution. New York: John Wiley &
Sons, 1973.
Fields, Gary S. Poverty, Inequality, and Development.
Cambridge: Cambridge University Press, 1980.
Friedman, Lee S. Microeconomic Policy Analysis. New York:
McGraw-Hill Book Company, 1984.
Gelb, Alan, and Associates. Oil Windfalls Blessing or
Curse? Washington D.C. (A World Bank Research
Publication): Oxford University Press, 1988.
Gillis, M., Dwight H. Perkins, Michael Roemer, and Donald
R. Snodgrass. Economics of Development. New York:
W.W.Norton & Company, 1987.
Glahe, Fred R. Macroeconomics: Theory and Policy. San
Diego, California: Harcourt Brace Jovanovich,
Publishers, 1985.
Glahe, Fred R., and Dwight R. Lee. Microeconomics:-Theory
and Applications. New York: Harcourt Brace Jovanovich,
Inc., 1981.
Glassburner, Bruce. The Economy of Indonesia. Ithaca, New
York: Cornell University Press, 1981.
Goode, Richard. Government Finance in Developing
Countries. Washington, D.C.: The Brookings
Institution, 1984.
Gwartney, J. D., J. R. Clark, and Richard Stroup.
Essentials of Economics. Orlando, Florida: Academic
Press, Inc., 1985.
Harris, Laurence. Monetary Theory. New York: McGraw-Hill
Book Company, 1981.
Heilbroner, Robert L., and James K. Galbraith.
Understanding Microeconomics. Englewood Cliffs, New
Jersey: Prentice-Hall, Inc., 1987.


87
Higgins, Benjamin. Indonesia's Economic Stabilization,
and Development. Westport, Connecticut: Greenwood
Press, Publishers, 1981.
Higgins, Benjamin. Economic Development: Principles,
Problems, and Policies. New York: W.W. Norton &
Company, Inc., 1968.
International Monetary Fund. International Financial
Statistics. New York, 1966 1987.
Laidler, David E. W. The Demand for Money: Theories,
Evidence, and Problems. New York: Harper & Row,
Publishers, 1985.
Mallakh, Ragaei El, and Carl McGuire. Energy and
Development. Boulder, Colorado: The International
Research Center for Energy and Economic
Development, 1974.
Meier, Gerald M. Leading Issues in Economic Development.
New York, Oxford: Oxford University Press, 1984.
Miller, Roger Leray. Economics Today: The Micro View.
Cambridge: Harper & Row Publishers, Inc., New York,
1988.
v
Mishkin, Frederic S. The Economics of Money, Banking, and
Financial Markets. Boston and Toronto: Little,
Brown and Company, 1986.
Nasution, Anwar. "The Indonesian Economy as an Open
Economy: A Theoretical and Policy Approach."
Prisma, no. 44, Jakarta, Indonesia.
Papanek, Gustav F. The Indonesian Economy. New York:
Praeger Publishers, 1980.
Phillips, James A. Economics. Pacific Palisades,
California: Goodyear Publishing Company, Inc.,
1975.
Pindyck, Robert S. The Structure of World Energy Demand.
Cambridge, Massachusetts, and London: The MIT
Press, 1979.
Prachowny, Martin F. J. Money in the Macroeconomy.
Cambridge: Cambridge University Press, 1985.
Ritter, Lawrence S. and William L. Silber. Principles of
Money, Banking, and Financial Markets. New York:
Basic Books, Inc., Publishers, 1986.


88
Salvatore, D. and Eugene A. Diulio. Theory and Problems
of Principles of Economics. New York: Schaum's Outline
Series, McGraw-Hill Book Company, 1980.
Salvatore, D. and Edward Dowling. Development Economics.
New York: McGraw-Hill Book Company, 1977.
Shorrocks, A. F. "Ranking Income Distributions." Economica,
50, 1983.
Smith, W. James, John P. Formby, and John A. Bishop.
"Stochastic Dominance, Income Distribution Function
and Economic Development." Preliminary Paper on
Economic Development, Denver, Colorado: 1989.
Tobin, James. Policies for Prosperity. Cambridge,
Massachusetts: The MIT Press, 1989.
Todaro, Michael P. Economic Development in the Third
World. London and New York: Longman Inc., 1978.
Todaro, Michael P. The Struggle for Economic Development.
New York and London: Longman Inc., 1983.
World Bank Publication. Social Indicators of Development
1988. Washington, D.C., 1988.


Full Text

PAGE 1

ECONOMIC DEVELOPMENT, WELFARE, AND INCOME DISTRIBUTION IN INDONESIA, 1965 -1985 by Arselan Hassan B.Sc., University of Gajah Mada, 1964 M.B.A., University of Gajah Mada, 1967 A thesis submitted to the Faculty of the Graduate School of the University of Colorado in partial fulfillment of the requirements for the degree of Master of Arts Department of Economics 1989

PAGE 2

This thesis for the Master of Arts degree by Arselan Hassan has been approved for the Department of Economics by JJohn R. Morris Date :1;; ne .Y, 199 J

PAGE 3

Hassan, Arselan (M.A., Economics) Economic Development, Welfare, and Income Distribution. Thesis directed by Professor Dr. w. James Smith. This study attempts to investigate the relationship between economic growth and income distribution in Indonesia, from 1965 to 1985. The first objective of this study is a cross sectional analysis of income distribution, which is evaluated from the year 1965 to 1985. This part of the study is considered the most important aspect of this thesis work. The second objective is to review the economic growth rates of the GDP (Gross Domestic Product) to conclude the impact of economic growth on income distribution in Indonesia. The results are then linked to analyze the impact of the development on the income distribution in Indonesia from 1965 to the present and, thereafter, to propose recommendations aimed at improving the distribution of income. Economic development fostered by the New Order Government produced rapid economic growth during the period 1968-1981. This growth is due in part to the priority of Indonesian government on economic improvement and to the oil boom starting in 1973. This shows that the eccnomic growth in this period spurred greater equality in income

PAGE 4

iv distribution as demonstrated by the Lorenz dominance techniques. In 1981 the oil boom ended. Government revenue, which was closely tied to the oil and natural gas sectors, started to slowly decline as oil prices dropped. This retarded economic development. This study finds a positive relationship between economic growth and income distribution. For this reason, the government of Indonesia should attempt to diversify their revenue base to further promote both equity and efficiency. The form and content of this abstract are approved. Signed thesis

PAGE 5

ACKNOWLEDGEMENTS It is with gratitude that I acknowledge the valuable guidance, time and encouragement given to me throughout this entire study by Dr. W. James Smith, Professor, University of Colorado at Denver, my thesis advisor; Dr. John R. Morris, Professor, University of Colorado at Denver; and Dr. John P. Formby, Professor, University of Alabama. It is with regret that I cannot acknowledge one by one the contribution of many friends who have been very helpful. To all of you my sincere thanks. My gratitude and appreciation also are due to the Governor and the Board of Directors of Bank Indonesia who gave me the opportunity to undertake advanced study at the University of Colorado. I hope that, after obtaining this privilege, I can further dedicate myself to Bank Indonesia and the motherland, Indonesia. My thanks are also due to my wife, Tjut Tharsina, and my children, Aulia and Amelia, who not only lost countless hours of my time, but also gave me prayers, understanding and encouragement. Indeed, it has been a hard time for them. I place you all deep in my heart. Also I thank God for the many blessings bestowed upon me and my family. Boulder, the warmth of Summer 1989 Arselan Hassan

PAGE 6

CONTENTS CHAPTER I. INTRODUCTION 1 II. REVIEW OF THE LITERATURE 7 III. THE ECONOMIC DEVELOPMENT OF INDONESIA. 19 Background . . 19 Before PELITA. 21 During PELITA. 23 A Detailed Analysis of Economic Growth in Indonesia during the PELITA Programs . . 25 Period 1968-1981 Period 1981-1986 Summary IV. INCOME DISTRIBUTION MODEL: CROSS SECTIONAL EVALUATION The Model Size Distribution Functional Distribution Model Results V. POLICY ANALYSIS Limitation of Data . Discussions VI. CONCLUSIONS BIBLIOGRAPHY . . 26 35 42 45 45 45 65 75 78 78 79 84 85

PAGE 7

TABLES Table 1. A Hypothetical Size Distribution of LDC Personal Income by Income Share . . . . 2. Average Annual GDP Growth, 1960 -1986 . 12 19 3. GDP by Sector of Origin as a Percentage Total GDP 1960 -1986 . . . . . . 20 4. Expenditure Components of GDP as a Percentage Total GDP, 1960 -1969 .............. 22 5. Expenditure Components of GDP as a Percentage Total GDP, 1969 -1986 . . 24 6. GDP Estimates, 1965 -1986 . 27 7. Employment, Income, and Capital, 1965-1981 ... 29 8. A Detailed Breakdown of GDP Components of Growth, 1973 -1981 9. Gross Domestic Investment, 1973 -1986 10. Government Revenues, 1973 -1986 ... 32 36 . 38 11. Government Revenues and Expenditures as Percentage of GDP . 4 0 12. Debt Service Payments, 1973 -1986 . 41 13. Average Income by Provinces, 1965 -1985 . 46 14. Population by Provinces, 1965 -1985 . . 47 15. Size Distribution of Income in 1965 (Lorenz) 49 16. Size Distribution of Income in 1970 (Lorenz) 50 17. Size Distribution of Income in 1975 (Lorenz) 51 18. Size Distribution of Income in 1980 (Lorenz) 52 19. Size Distribution of Income in 1985 (Lorenz) ... 53

PAGE 8

viii 20. Mean Income Distribution, 1965 -1985 60 21. Cumulative Proportion of Income, 1965 -1985 61 22. Generalized Lorenz Ordinates, 1965 -1985 63 23. Functional Distribution of Indonesia in 1975 . 73 24. Functional Distribution of Indonesia in 1985 . 74 25. Average Income, 1965 -1985 . . . 76 26. A Relation between Economic Growth and Income Distribution, 1968 -1986 . . 80 27. 1988 Social Indicator Data Sheet Indonesia 81 28. 1988 Social Indicator Data Sheet Indonesia 82 29. Income Distribution in Indonesia: Absolute Poverty Line . . 83

PAGE 9

FIGURES Figure 1. Map of Indonesia 2. Study Diagram 3. Lorenz Diagram 1965 .. 4. Lorenz Diagram 1970 .. 5. Lorenz Diagram 1975. 6. Lorenz Diagram 1980 .. 7. Lorenz Diagram 1985 .. 8. Composite Cumulative Proportion of Income, 1965 -1985 . . . . . . . . 9. Composite Generalized Lorenz Ordinates, 1965 -1985 . . . . 10. Rank Order Function 1965 1970 . . 11. Rank Order Function 1970 -1975 . 12. Rank Order Function 1975 1980 . . .-. 13. Rank Order Function 1980 -1985 . . 14. A Simplified Diagram of a Competitive Market . . . 3 6 54 55 56 57 58 62 64 66 67 68 69 Functional Income Distribution . . . 70

PAGE 10

CHAPTER I INTRODUCTION The study of economic development generally focuses on the key variables that determine the level and growth rate of per capita income. Economic development invariably implies fundamental changes in the structure of the economy. There is also an important question that should be raised regarding the relation of economic growth to income distribution. Does rapid economic growth imply a less or more income distribution? The answer is believed to vary across developing countries. This study attempts to investigate the relationship between economic growth and income distribution from 1965 to 1985 in Indonesia. We analyze income distribution are from 1965 to 1985 with census data from 1965, 1970, 1975, 1980, and 1985. The study relies on Lorenz dominance techniques to track the trend of income distribution over the twenty year period. The second objective of this study is to review on economic growth rates over the period from the GDP (Gross Domestic Product) performance to analyze the impact of economic growth on income distribution in Indonesia. This part of the study will evaluate the sectoral breakdown to determine the progress of economic development of each sector and thus, the sectoral role of the process of Indonesia's economic development. The results of this part of the study are then linked to the first objectives to

PAGE 11

2 determine changes in the income distribution in Indonesia from 1960 to the present and therefore, to suggest policies necessary to improve future income distribution. Background Economic development in Indonesia is more complex than development in many other countries. Indonesia is the largest archipelago in the world. It has five main islands, about thirty smaller islands and a total of some 13,677 islands and islet.s of which 6,000 are inhabitated. The archipelago extends 3,200 miles from East to West and 1,100 miles from North to South along the equator. Indonesia has 27 provinces. Figure 1 is a map of Indonesia. It indicates the strategic location of this country being located the continent of Asia and Australia and between the Pacific Ocean and Indian Ocean. Economic development in Indonesia after 1960 can be divided into two phases, before and after PELITA I (the Five Year Development Program I) The economy of Indonesia before PELITA was characterized by an average growth rate at 2.5% per year. During the next ten years, the average growth rate rose to 7.7% per year. In the early 1980s, the economy slowed with an average growth rate at 3.5% per year. The impact of these fluctuations in economic growth rates on income distribution in Indonesia is the focus of this study.

PAGE 12

3 : PACIFIC OCEAN .. INDIAN OCEAN Figure 1: Map of Indonesia

PAGE 13

4 Basic Concept The study consists of six chapters. Chapter One is the introduction. Chapter Two reviews the Lorenz dominance literature. Chapter Three constitutes the time series study of economic growth rates of the GDP. Chapter Four focuses on the size distribution of income from 1965 to 1985. Chapter Five is an analysis of the results in Chapter Three and Four. This chapter combines the time series and the cross sectional studies to provide a more complete picture of the income distribution in Indonesia over time. This chapter also presents the limitations of the study and how the government of Indonesia set its policies for income redistribution. Chapter Six (conclusions and recommendations) discusses how Indonesia might improve its income distribution in the future. The basic data available for the study as of December 1986 were obtained from the Central Bureau of Statistics (CBS), Republic of Indonesia; the Department of Finance, Republic of Indonesia; the Bulletin of Indonesian Economic Studies; The Central Bank of Indonesia. All available data on economic development, especially on income distribution and interpretation made by others, were reviewed and taken into consideration. Figure 2 is a flowchart of the thesis. The first step is to gather data. The basic idea of this study is to combine a time series and a cross sectional studies which will provide a complete view of economic development

PAGE 14

5 in Indonesia and its impact on income distribution. On the basis of past performance which is considered as the result of existing policies, the study will then produce recommendations on how the government of Indonesia should go about improving the income distribution of the country.

PAGE 15

I INPUT DATA I ---------1 1. BASIC VARIABLES I I 2. ECONOMIC DATA I I I ------------------------I ---------------------I I TIME SERIES STUDY I I I OF ECONOMIC GROWTH I I I 1965-1985 I I ---------------------I I INCOME DISTRIBUTION I (CROSS SECTIONAL STUDY) I 1965-1985 I I I I RESULTS FROM TIME SERIES I AND CROSS SECTIONAL STUDY I I I POLICY ANALYSIS I I CONCLUSIONS Figure 2: Study Diagram Income Distribution in Indonesia 6

PAGE 16

CHAPTER II REVIEW OF THE LITERATURE The income distribution model employed in this study has a long history. In this chapter, the discussion is focused on the specific literatures used to construct the model. A descriptive time series study was reviewed in D. Salvatore and Edward Dowling's Theory and Problems of Development Economics (Schaum's Outline Series in Economics, McGraw-Hill, 1977) to provide a method for the evaluation of GNP performance in Indonesia. The theory states that economic development has been defined as the process whereby a country's real per capita Gross National Product (GNP), or income, increases over a sustained period of time through continued increases in per capita productivity. Thus, a study of economic development in Indonesia from 1965 to 1985 should be closely related to economic growth, which is represented as Gross Domestic Product (GDP) per capita. However, this kind of study is insufficient because of conceptual and practical problems connected with it. Per capita GDP statistics says nothing of the income distribution within the society nor of the level of general well-being. A review was then also made of Gerald M. Meier's Leading Issues in Economic Development, Chapter I (Oxford University Press, 1984) Chapter I of Meier suggests that an indicator of development is not only related to the

PAGE 17

8 measurement of development via per capita GDP, but also to a theory of distribution and growth. This would then lead to a discussion of the income distribution. A review was also made by M. Gillis and others in Economics of Development, Chapter 4 (W. W. Norton & Company, 1987). The authors present the concepts and measures of income distribution, inequality and poverty in the developing countries. The most common method in measuring income distribution is the Lorenz curve. To draw a Lorenz curve, income recipients are ranked from those with the lowest income to the highest along the horizontal axis. The Lorenz curve itself shows the percentage of total income accounted for by any cumulative percentage of recipients. The method is similarly described by Todaro and Shorrocks. The degree of overall inequality is presented in the Gini concentration ratio which is derived from the Lorenz curve. The theoretical range of the Gini ratio is from zero (perfect equality) to one (perfect inequality) While inequality is clearly a matter of relative incomes, the concept of poverty implies that households are poor in an absolute sense. Measurement of the amount of poverty existing in a country usually begin with the drawing of a poverty line which is defined as household income per capita. Households with per capita below the poverty line are defined as poor while those with incomes above the line are not poor. The World Bank uses a poverty line of 100 Rupiah/month for Indonesia. However, the authors also

PAGE 18

(\\ \ ) suggest that the simplest measurement of poverty is the percentage of poor households in the total. 9 The issue of income distribution was also broached by Michael P. Todaro in Economic Development in the Third World (Longman Group Limited, 1978, 161-165). Todaro observed that in poor countries the main concern is focused on the question of economic growth versus income distribution. Many third world countries that experienced relatively high rates of economic growth in the 1960's began to realize that such growth had brought little in the way of significant benefits to their poor. Since Indonesia is among them, the focus of the study should incorporate income analyses. According to Todaro, the principal measure of income distribution is the "personal" or "size" distribution and the functional of income. The personal income statistics are generally derived from the Lorenz method and percentage share in total income. Todaro suggests a welfare function which apparently appeals to a number of development economists. Todaro weights the growth rate of each income group and sums them to obtain the welfare index: G = i = 1,2, .. ,5 where: G = a weighted index of growth of social welfare, gi = the growth rate of income of the ith quintile, wi = the welfare weight of the ith quintile. As long as the weights add up to unity and are nonnegative, the overall measure of the growth of social welfare, G, must

PAGE 19

10 fall somewhere between the maximum and minimum income growth rates in the various quintiles. Todaro critizes the standard practice of merely looking at growth rates to judge an economy's performance. The use of unweighted GNP growth as an index of improvements in social welfare and development accords to each income group a welfare valuation that corresponds to their respective income shares. It follows that the best way to maximize social welfare growth is to maximize the rate of growth of the incomes of the rich while neglecting the poor. An alternative to using a simple rate of GNP growth index of social welfare would be to adopt equal weights or a poverty weighted index. An equal weights index weighs the growth of income in each income class not by the proportion of total income in that class but rather by the proportion of the total population. Although, as Todaro acknowledges, the choice of welfare weights in any index of development is purely arbitrary it does represent important social value judgments about goals and objectives for a given society. Todaro's concept is attractive but arbitrary. It would certainly be interesting to know if the "real" implicit welfare weights of the various development strategies of different third world countries. As long as the growth rate of GNP is explicitly or implicitly used to compare development performances a wealth weighted index is actually being employed. If a weighted welfare index is used to measure economic development, then it is not only possible

PAGE 20

11 but may even be desirable for a lower growth rate of GNP to be associated with a higher rate of economic development, at least in terms of the value judgments of an egalitarian society. The reformulation of the indices of development to take account of alternative social weights for different income groups takes us a long way toward a better understanding of the relationship between economic growth and income distribution. For example, consider growth rate based on wealth weights: w 1 = 0.05, w 2 = 0.09, w 3 = 0.13, w 4 = 0.22, and w 5 = 0.51. In the extreme case of all income accruing to one individual or one group of individuals in the highest quintile and where the welfare weights the income shares, as they are with GNP growth calculations, the equation becomes: G = Og1 + Og2 + Og3 + Og4 + l.Og5 = l.Og5 The growth of social welfare would, therefore, be associated exclusively with the growth of incomes in the top quintile of the population. Table 1 shows a hypothetical size distribution of LDC (Less Developed Countries) personal income classes by income shares.

PAGE 21

12 Table 1 A Hypothetical Size Distribution of LDC Personal Income by Income Share Percentage share in total income -------------------Individuals Personal income Quintiles Deciles (money units) 1 0.8 2 1.0 1.8 3 1.4 4 1.8 5 3.2 5 1.9 6 2.0 3.9 7 2.4 8 2.7 9 5.1 9 2.8 10 3.0 5.8 11 3.4 12 3.8 13 7.2 13 4.2 14 4.8 9.0 15 5.9 16 7.1 22 13.0 17 10.5 18 12.0 22 .. 5 19 13.5 20 15.0 51 28.5 Totals 20 (National 100.0 100 100.0 Income) Measure of inequality -Ratio of bottom 40% to top 20% = 14/51 = 0.28. In the example derived from table above, the GNP income share weighted index of social welfare would be written as: G = 0.05g1 + 0.09g2 + 0.13g3 + 0.22g4 + 0.51g5 Now suppose the income growth rate of the bottom 60% of the population is zero (g1 = g 2 = g3 = 0) while that of the top

PAGE 22

13 40% is 10% (g4 = g 5 = 0.10). The equation could be written as: G =0.05(0) + 0.09(0) + 0.13(0) + 0.22(.10) + 0.51(.10) G = 0.073 and the social welfare index would rise by over 7%, which is the rate of growth of GNP (GNP would rise from 100 to 107.3 if the incomes of the 4th and 5th quintiles grew by 10%) Thus, an illustration of a case where GNP rises by 7.3%, implying that social well-being has increased by this same proportionate amount even though 60% of the population is not better off than before. These bottom 60% still have only 5, 13, and 22 units of income respectively. Clearly, the distribution of income would be worsened (the relative shares of the bottom 60% would fall) by such a respectable growth rate of GNP. The numerical example given by the above equation the basic point. The use of the growth rate of GNP as an index of social welfare and as a method of comparing the development performance of different countries can be very misleading, especially where countries have markedly different distributions of income. Consider a developing-country that is genuinely and solely concerned with improving the material well-being of, say, the poorest 40% of its population. Such a country might wish to construct a poverty weighted index of development, which places subjective social values only on the income growth rates of the bottom 40%. In other words, it might arbitrarily place a welfare weight on w 1 of 0.60 and on w 2

PAGE 23

14 of 0.40 while giving w 3 w 4 and w 5 zero weights. Using the same numerical example, the social welfare growth index for this country would be given by the expression: G = 0.60g1 + 0.40g2 + Og3 + Og4 + Og5 which, when substituting g 1 = g2 = g 3 = 0 and g 4 = g 5 = .10, becomes: G = 0.60(0) + 0.40(0) + 0(0) + 0(0.10) + 0(0.10) = 0 The poverty weighted index therefore records no improvement in social welfare even though recorded GNP has grown by 7.3%. An alternative and more rigorous way to examine the issue revolves around the welfare dominance theorems first introduced by Atkinson (1970). A review is made of w. James Smith, John P. Formby, and John A. Bishop in "Stochastic Dominance, Income Distribution Function and Economic Development" (preliminary paper on Economic Development) to evaluate the size distribution from the rank order dominance. Economic growth and development are frequently accompanied by increases in inequality. Inequitable growth has been and remains a principal focus of inquiry for development economists and a serious concern of development analysts and policy makers. The issue is whether the societal benefits accruing from a rise in the standard of living in a nation exceeds the societal costs resulting from an increase in inequality. The question is a vexing one and, until recently, there has been no rigorous and generally acceptable method for analyzing and addressing this important issue. Recent developments in

PAGE 24

15 applied welfare economics now make it possible to focus the powerful stochastic dominance theorems on the fundamental question raised by inequitable growth. The purpose of applied welfare analysis is to rank alternative economic and social states. Inequitable growth is difficult to rank because it is necessary to compare two economic systems, one with greater mean income and the other having a more equal distribution. Contemporary applied welfare analysis is able to address this issue because it rests upon an explicit social welfare function of a general class which embodies widely acceptable ethical principles. Stochastic dominance embodies this approach and provides a means for rigorously analyzing the welfare consequences of inequitable growth and development. A paper by A. B. Atkinson, "On the Measurement of Inequality" (Journal of Economic Theory 2, 244..:263-, 1970) shows that the use of conventional methods in measuring inequality in the distribution of income, such as the Gini coefficient and the relative mean deviation, can be misleading. Atkinson attributes the original insight and call for an explicit welfare function to Dalton (1920) who emphasized that all comparisons of summary measures of inequality correspond to some concept of social welfare. Dalton argued that a fruitful method of studying inequality and income distributions is to explicitly specify the characteristics of the social welfare function. As a reasonable and

PAGE 25

16 generally acceptable social welfare function, Dalton proposed the requirements of additivity, symmetry, and strict concavity in incomes. Welfare functions of the Dalton class are utilitarian and anonymous in the sense that welfare is unaffected if two persons exchange positions in the income distribution. In addition, strict concavity is sufficient to guarantee that the principle of transfers holds; that is, the social welfare function is equalitypreferring. He suggested stochastic dominance as a method for partially ordering income distributions and drawing welfare inferences. Given Dalton's social welfare function and assuming populations of equal size and mean incomes, he showed that Lorenz dominance is equivalent to stochastic dominance. Under these assumptions distribution A will be preferred to distribution B by all additive, concave social welfare functions if, and only if, the Lorenz curve of A lies everywhere inside the Lorenz distribution of B. Lorenz dominance exists if distribution A's Lorenz curve is completely inside B's or on top of B's at one or more points and inside of it at other points. Thus, for equal populations and means, the income distribution which is unambiguously more equal in the Lorenz sense reflects stochastic dominance and generates greater social welfare. If Lorenz curves intersect, social welfare of the two distributions cannot be ranked without more information concerning society's specific welfare weights. Thus, Atkinson's result provides only a partial ordering of

PAGE 26

17 distribution functions because concensually valid welfare conclusions cannot be drawn unless Lorenz dominance exists. Rank dominance can be illustrated with a graph with income on the ordinate and the cumulative proportion of income recipients on the axis. The distribution functions are for a single country at two points in time, F(x1) and F(x2), with F(x2) being the most recent period. An analysis of F(x1) and F(x2) would lead to a conclusion of the change in welfare over time. A paper by A. F. Shorrocks entitled "Ranking Income Distributions" (Economica, 50, 3-17, 1983) examines the problem of ranking distributions using a social welfare function with unequal means. The ranking distribution is obtained through a generalized Lorenz curve. Generalized Lorenz curve is obtained by scaling up the ordinary Lorenz curve by the mean of the distribution. Shorrocks proves that generalized Lorenz dominance implies preference by all increasing, equality-preferring social welfare functions. Thus, assuming the principle of transfers, generalized Lorenz curves can be used to rank income distributions and make welfare comparisons of countries experiencing inequitable growth across time. This method was then applied to compare income distribution in 20 countries which produced conclusive results in 84% of the pairwise comparisons. Shorrocks' study attempts to calculate a ranking distribution from the ordinary Lorenz curve,

PAGE 27

18 weighted average income, and rank order dominant methods, in which Shorrocks'method can be incorporated.

PAGE 28

CHAPTER III THE ECONOMIC DEVELOPMENT OF INDONESIA Background The economic development of Indonesia after the 1960's can be divided into two phases, before and after The Five-Year Development Program I, or PELITA I (1969-1974). The economy of Indonesia before PELITA I was dismal. During the next ten years, economic growth was substantially greater. In the early 1980's, the economy began to slump (Table 2). Table 2 Average Annual GDP Growth, 1960 -1986 Period 1960 -1967 1968 -1981 1982 -1986 Number of Years 8 14 5 Average.Annual GDP Growth (%) 2.5 -3.0 7.5-7.7 3.5 -4.1 Sources: 1. Bank Indonesia, Indonesian Financial Statistics. 2. The Indonesian Central Bureau of Statistics (BPS) 3. Author's estimates. The annual rate of growth of GDP from 1968 to 1981 was higher than in the earlier and later periods, caused, it is believed, by a new set of economic priorities and rapid structural changes in energy industries.

PAGE 29

20 A detailed description of economic development during those periods isshown in Table 3, giving sectoral shares of GDP for the period of 1960-1986. The sectoral share, measuring GDP through the production approach, is summarized in this study to present a quick review of the sectoral change from 1960 to 1986 in Indonesia's economic development. Table 3 GDP by Sector of Origin as a Percentage Total GDP, 1960 -1986 (in 1973 constant prices) Sector 1960 1965 1970 1975 1980 Agriculture 53.9 52.4 47.5 36.7 30.6 Mining 3.7 3.7 5.6 10.9 9.3 Industry 8.4 8.3 8.9 11.1 15.3 Public Utilities 0.3 0.4 0.5 0.5 0.7 Construction 2,0 1.7 2.6 4.8 5.7 Transport and Communication 3.7 3.5 3.2 4.0 5.5 Trade & Other Services 28.0 30.0 31.7 32.0 32.9 Sources: 1. Bank Indonesia, Indonesian Financial Statistics. 1985 24.2 17.5 12.6 0.7 5.7 5.8 33.5 2. The Indonesian Central Bureau of Statistics (BPS) 3. Author's estimates. 1986 24.1 17.1 12.6 0.7 5.6 5.8 34.1

PAGE 30

21 Although the average rate of growth of agriculture rose from 1.4% per year during the first half of the 1960's to 3.8% in the six years to 1971 and then fluctuated around 3.5% through 1986, the share of agriculture in GDP has fallen from over 50% to less than 25%. Sectoral data through 1986 suggest that the share of the agriculture sector is still quite dominant in Indonesia. During the same period, the shares of mining, industry, and trade and other services sectors increased via foreign investment and the rapid growth in revenue from oil and natural gas production. The share of construction, transport, and communication sectors showed more modest increases. Trade and other services include five sectors: trade (wholesale and retail), banking and other financial intermediaries, ownership of dwellings (houses and hotels), public administration and government, and services. Before PELITA The Indonesian economy during the period 1960-1968, before PELITA I, was sluggish. Gross domestic capital formation and government consumption expenditures declined. Government budget deficits reached 50% of government consumption expenditures. Export earnings slumped in the mid-1960's and deteriorated the balance of trade. These economic conditions led private consumption expenditures to rise to a peak of 95.9% of GDP in 1966 and, inflation turned into hyperinflation. The share of industry was less than 10%

PAGE 31

22 of GDP and could not be expected to support the development process during this period. Table 4 is a breakdown of expenditure components of GDP into four main aggregates for the period of 1960-1969. Table 4 Expenditure Components of GDP as a Percentage Total GDP, 1960 -1969 (in 1973 constant prices) Component of GDP 1960 1965 1968 1969 Private Consumption Expenditure 78.3 83.7 84.6 86.9 Government Consumption Expenditure 11.3 6.8 7.9 7.3 Gross Domestic Capital Formation 9.6 10.5 12.3 12.9 Export Import 0.8 -1.0 -4.8 -7.1 Sources: 1. Bank Indonesia, Indonesian Financial Statistics. 2. The Indonesian Central Bureau of Statistics (BPS) In this table, the balance of trade (export -import) was corrected for term-of-trade changes. The change of government in 1966 provided a change in attitude toward development priorities. The new government emphasized economic priorities, particularly the need to increase production and income.

PAGE 32

23 During PELITA The failure of Indonesia's economic development in the /1960's resulted in a new approach to long-range development planning, covering a period of 25 to 30 years. The plan is broken down into several Five-Year Development Plans (REPELITA) Each stage of development contains different objectives and lays a firm foundation for the next development stage. PELITA I (1969-1974) emphasized food production and infrastructure rehabilitation. PELITA II (1974-1979) and PELITA III (1979-1984) emphasized employment and distribution of equity as well as economic growth. PELITA IV (1984-1989) sought to improve and make more equitable the living standard, education, and welfare of the nation. Major structural changes characterize the period 1969-1986. During PELITA I, the foreign exchange position improved due to increased exports and an improvement in export prices. Capital inflow increased through foreign aid, government borrowing abroad, and substantial inflows on private accounts and direct investment. Foreign exchange receipts from energy exports became the dominant source after 1973, accounting for 65% of total foreign exchange receipts during 1973-1981. Direct revenues from energy exports, mainly oil, supported economic development and allowed Indonesia to further industrialize. Government consumption expenditures also increased because of increased revenues from energy taxation. Structural change occurred

PAGE 33

24 again in the early 1980's when oil prices began to decline, / directly affecting foreign exchange receipts and balance of payments. By 1986, the oil price decline had affected the Indonesian economy in various ways. Economic growth was low, the balance of trade had declined steadily and the current account deficit was estimated at about $4.5 billion. In September 1986, the government devaluated the rupiah from 1,134 rupiahs to 1,644 rupiahs per U.S. dollar in the belief that this was a necessary adjustment to the Indonesian economy. Although the composition of GDP improved from 1970 to 1980 (Table 5), in the early 1980's the composition of GDP was again unfavorable owing to the declining balance of trade (export -import) Increasing the share of Table 5 Expenditure Components of GDP as a Percentage Total GDP, 1969 -1986 (in 1973 constant prices) Component of GDP 1970 Private Consumption Expenditure 79.2 Government Consumption Expenditure 8.6 Gross Domestic Capital Formation 15.3 Export -Import -3.1 1975 69.2 10.2 20.1 0.5 1980 63.5 10.7 20.7 5.1 Sources: 1. Bank Indonesia, Indonesian Financial Statistics. 1985 68.4 10.9 18.7 2.0 2. The Indonesian Central Bureau of Statistics (BPS) 1986 71.6 10.9 19.6 -2.1

PAGE 34

25 consumption led to an increase in inflation. The growth rate of GDP in the period declined substantially. A Detailed Analysis of Economic Growth in Indonesia during the PELITA Programs. It is worthwhile to study the economic growth after the New Order Government was established (1966), when the first Five-Year Development Program (PELITA I) began in 1969. study will focus on a detailed evaluation of the period from 1969 to the present so that the cause of economic growth in this period can be determined. This study will break down the evaluation into two different periods as follows: 1. The period of 1968-1981, in which the oil boom occurred in Indonesia. In this period, the economic growth was spurred due to the oil price increase, which increased the GDP of Indonesia. This tremendous economic growth should be evaluated in detail to achieve conclusions from the study. 2. The period of 1981-1986, which reflects the oil slump occurring in Indonesia. In this period, the economic growth was low, believed to be due to the oil price drop. This effect was obvious in Indonesia. A detailed evaluation should be made to derive conclusions from the study. Because there are two distinct eras, this section is divided into two different discussions to cover the period

PAGE 35

26 of 1968-1981 and 1981-1986. Table is a GDP estimate from 1965 to 1986, reporting growth rates. Period 1968-1981 From the establishment of the New Order until the early 1980's, Indonesia experienced a long period of rapid economic growth together with a dramatic improvement of the terms of trade. However, it cannot be concluded that the rapid growth was entirely due to the improvement in the terms of trade. The analysis suggests that three types of relationships were involved between the terms of trade improvement and economic growth, one in which the improvement in the terms of trade played a significpnt part in promoting growth, another in which there was no such effect, and a third in which a certain amount of growth occurred which did not depend crucially on the imppovement in the terms of trade. One way in which the improvement in the terms of trade contributed to economic growth was through the expansion of the public administration sector, which contributed as much ?S 1.1 percentage points of the overall average growth rate of 7.5% per annum. The improvement of the terms of trade contributed to this part of the overall growth by strengthening the financial position of government. The expansion of the public administration system may have contributed to increasing the productivity of resources in

PAGE 36

Year 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 Source: 1. 2. Table 6 GDP Estimates: 1965-1986 (at 1973 constant prices) Billions of Rupiah 3901 4010 4066 4345 4819 5182 5545 6067 6753 7269 7631 8156 8882 9567 10165 11169 12055 12325 12890 13722 14223 14669 Rate of Growth 1. 06 2.79 1. 40 6.86 10.90 7.53 7.01 9.41 11.31 7.64 4.98 6.88 8.90 7.71 6.25 9.88 7.93 2.24 4.58 6.45 3.65 3.14 Bank Indonesia, Indonesian Financial Statistics. IMF, International Financial Statistics. 27

PAGE 37

28 the rest of the economy, but a considerable part consisted only of increased employment and higher salaries and fringe benefits for public servants. However, most of the expansion of the public administration system was included in the current growth of GDP, because of the conventions of National Income accounting. Another way in which the improvement of the terms of trade contributed to economic growth was by increasing the volume of investment. The estimates proposed in Table 7 suggest that the high rates of investment in this period led to growth of the capital stock of about 8.2% per annum. However, apart from the extent to which investment provided for the widening of capital, rough estimates indicate that investment contributed only about 1.86 percentage points towards the overall rate of growth. The third way in which the terms of trade improvement contributed to overall growth in the 1968-1981 period was by enabling the economy to import more producers' goods. Some of these imports consisted of raw materials and intermediate products; especially before 1973, when much of the growth was due to rehabilitation of the economy, even a relatively small amount of such imports had a considerable effect on growth by enabling existing capital stock to be utilized more fully. There were also increasing imports of capital goods, which not only promoted growth by more investment, but also by improving technology to the extent that it was embodied in the imported capital goods.

PAGE 38

29 Table 7 Employment, Income, and Capital, 1965-1981 (billion Rp. at 1973 constant prices) Year Employed GDP Investment Depreciation Capital (millions) Stock 1965 34.58 3,901 389 254 6,720 1966 35.06 4,010 438 263 6,855 1967 35.56 4,066 357 265 7,030 1968 36.05 4,345 498 294 7,122 1969 36.56 4,819 562 314 7,326 1970 37.07 5,182 747 338 7,574 1971 37.59 5,545 867 360 7,982 1972 38.78 6,067 1,032 394 8,489 1973 40.01 6,753 1,208 439 9,126 1974 41.28 7,269 1,440 473 9,895 1975 42.59 7,631 1,650 496 10,863 1976 43.94 8,156 1,749 531 12,017 1977 45.33 8,871 2,028 570 13,236 1978 46.77 9,483 2,333 611 14,694 1979 48.25 10,165 2,436 664 16,416 1980 49.78 11,169 2,896 729 18,188 1981 51.36 12,055 3,219 786 20,356 Source: Bank Indonesia, Indonesian Financial Statistics.

PAGE 39

30 Improvement in the terms of trade did not lead to much growth. The simplest illustration of this relationship is where the increased supply of foreign exchange was used primarily for importing consumer goods. In Indonesia, expenditure of this type occurred to some extent, mainly because a considerable part of government expenditures raised the incomes of the upper income groups, with a propensity to consume imported goods. The terms of trade improvement contributed to growth through the increased importation of raw materials and intermediate products, which was the main reason for the rapid growth of value added in the domestic manufacturing sector. However, in the course of time, especially after the early rehabilitation phase, there was a substantial rise in the import content of the output of the manufacturing sector, and further, a large part of the output of this sector consisted of durable consumer goods. Because a large part of the increased import capacity was used to produce consumer goods with a high import content, the effect of the terms of trade improvement in promoting domestic growth was much less than it might have been. Hence, to conclude, a considerable part of the gains from the improvement in the terms of trade was used in ways which did.not contribute to growth, and the extent to which these gains were used to promote growth was quite limited. This means that a significant part of the growth which actually occurred in Indonesia was due to factors other than

PAGE 40

the improvement in the terms of trade. The agricultural sector contributed over 1.2 percentage points to overall growth in the period 1973-1981. 31 Part of overall growth was due to the growth of employment. According to Table 8, this was one of the major sources of growth in the period 1973-1981 partly because of the improvement in the terms of trade, which permitted higher levels of investment in the form of capital widening. However, a large part of the growth of employment was due to increased demand for goods and services, especially in construction and in the trade and transport sectors. The growth of demand can be largely attributed to the government's domestic budget deficit. One of the main problems with budget deficit is that they lead to inflation, as was amply demonstrated in the later years of the Old Order Government. The memory of this experience still remains vivid in the minds of Indonesian policy makers, making them particularly concerned and cautious about the inflationary consequences of their policies, and hence rigidly adherent to a balanced budget policy. However, in spite of the balanced budget policy, there were some inflationary episodes, due mainly to cost-push effects of the rice crisis of 1972-1973 and the rupiah devaluation of 1978, rather than to demand expansion. One reason why the expansion of demand in the 1968-1981 period was not the main cause of inflation was that special

PAGE 41

Table 8 A Detailed Breakdown of GDP Components of Growth, 1973-1981 (in billion Rp at 1973 constant prices) Sector Reflecting Growth of GDY Agriculture Mining Manufacturing Utilities Construction Trade Transport Finance Public Administration Other Services Dwellings Total 179 111 503 793 Percentage Shares 14.9 Contribution to Overall Growth Rate l.i2 Growth of Employment 384 609 30 377 664 184 19 84 44 2,395 45.2 3.39 Effect Technological of Progress Invest-ment 199 59 419 29 41 131 118 18 84 216 1,314 24.8 1.86 300 200 40 130 118 11 799 15.1 1.13 32 Total 883 238 1,228 59 458 925 420 148 671 55 216 5,301 100.0 7.5 The period in which high oil prices have been in effect in Indonesia.

PAGE 42

33 attempts were made to stabilize the price of key commodities, such as rice. Furthermore, a considerable part of the potential inflationary effects of the demand expansion was offset by the growth of domestic production, particularly the growth of agricultural production, which increased the supply of basic foods, as usually it is shortages of such essential wage goods which trigger a costpush process. The Indonesian experience is therefore a striking example of the extent to which demand expansion can be used to promote growth of employment and output, without serious inflationary problems, so long as there is an elastic supply of wage goods. The other major problem with the use of budget deficits is that they would normally lead to balance of payments difficulties. In the period reviewed here, this was not a major problem for Indonesia because of the abundant supply of foreign exchange. In fact, a large part of the increased supply of foreign exchange was used up in a significant rise in the propensity to import. Therefore, only a part 'of the improvement in the terms of trade was needed for the growth of employment and output that was actually achieved, the remainder having been used to finance the rise in the propensity to import. One consequence of this argument is that, without this rise in the propensity to import, the size of the domestic budget deficit need not have been limited to the government's foreign exchange

PAGE 43

34 surplus, and a higher domestic deficit could have been used to promote an even faster growth of employment and output. This argument has an important implication for policies after 1981, when the terms of trade started to decline and reduced the growth of foreign exchange receipts and public revenues, and when the government, following the spirit of its balanced budget policy, reduced its domestic expenditures. The consequence has been a sharp fall in the rate of economic growth. To the extent that a higher level of government expenditure can promote further growth of employment and output, it is highly desirable in an economy in which there is still so much poverty and unemployment. Past experience has shown the extent to which government expenditures can have such an expansionary effect. The real problem is that the oil boom has left Indonesia with a reliance on imports, greatly limiting the extent to which fiscal policy can be used to promote growth without immediate and substantial leakages into imports. Therefore, one of the challenges to policy makers is to take measures to reduce the propensity to import from the high level it reached during the oil boom period to a lower level more appropriate to the current situation. Particularly important in this connection are taxation, and pricing and expenditure policies which redistribute income toward those with lower propensities to import. But such measures will take a considerable period to have their effect. In the meantime, there is still some scope for an expansionary

PAGE 44

35 fiscal policy to the extent, for example, that international reserves can be used to close any balance of payments deficits that may arise. In this way, the reserves accumulated during the oil boom period can be used to buy time for the adjustments needed to reduce the propensity to import. Period 1981-1986 The slower growth of the economy after 1981 is ultimately related to the fall in the export earnings of the country. However, export earnings do not effect the country's growth performance directly. They do so only through other variables, such as investment, government expenditures, and imports. Therefore it is important to consider the change in each of these variables in the period after 1981 compared with the period before 1981. The data on investment trends since 1973 are summarized in Table 9. The Table shows the data up to 1986 at 1973 constant prices. The estimates at 1973 constant prices refer to total investment. However, the changes in stocks became significant only after 1980; they were quite small, about 1%, in 1978 and 1979. Therefore, the estimates of gross investment before 1980 can be taken as roughly equal to gross fixed investment. It was found that investment grew rapidly during the earlier period of rapid growth, and declined during the later period of slow growth. One possible explanation is

PAGE 45

Year 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 Average 1973-81 1981-82 1982-86 Table 9 Gross Domestic Investment (at 1973 constant prices) Amount (billion Rp) % of GDP 1,208 1,440 1,650 1,749 2,027 2,333 2,436 2,896 3,219 3,637 3,656 3,464 3,231 3,263 17.9 19.8 21.6 21.4 22.8 24.4 24.0 25.9 26.7 29.5 28.4 25.2 22.7 22.7 22.7 26.1 25.9 Source: Bank Indonesia, Indonesian Financial Statistics. 36

PAGE 46

37 that it was the level of income which influenced the level of investment, rather than the other way around. This is because the increase in income due to the terms of trade improvement in the earlier period increased government revenues substantially. A considerable part of the increase in government revenues was in turn spent on investment; a part was also distributed to those groups who spent a high proportion of their incomes on investment, especially in construction. In the later period, the deterioration in the terms of trade seriously affected government revenues, and thus led to a decline in investment by both government and private sector. In addition to the supply effect of investment in increasing productive capacity in the long run, investment expenditures also have the effect of increasing demand in the short run, thereby leading to a fuller utilization of existing productive capacity. To the extent that investment has such a demand effect, we would expect a relationship between the growth of income and the growth rate of investment. The data in Table 11 suggest that the slower growth of GDP in the later period may have been due partly to weaker aggregate demand, due in turn to the decline of investment. Government revenues as a proportion of GDP rose steadily until 1981, and declined thereafter with some fluctuations (Table 10) The rise in revenues up to 1981 was mainly due to some increase in the output of the mining

PAGE 47

38 Table 10 Government Revenues 1973-1986 Total Revenues Oil Revenues Other Revenues Year as % of GDP as % of GDP as % of GDP in Mining Sector in Other Sectors 1973 12.9 37.1 9.6 1974 14.5 34.4 8.9 1975 16.8 47.5 9.3 1976 17.7 52.1 9.7 1977 17.8 51.9 9.8 1978 17.0 52.1 9.4 1979 17.7 54.9 8.4 1980 19.1 56.3 8.0 1981 20.1 62.2 7.7 1982 19.7 68.2 8.1 1983 18.9 65.7 7.9 1984 17.7 63.8 7.5 1985 19.5 71.2 9.4 1986 17.5 70.2 10.9 Sources: Bank Indonesia, Indonesian Financial Statistics, various issues.

PAGE 48

39 sector, and a rising rate of taxation of that output. After 1981, the volume of output declined but the rate of taxation continued to rise. The rate of taxation of the output of other sectors was much lower, declined until 1984, and then rose as a result of the tax reforms introduced at that time. Part of government expenditures were spent at home and part abroad. Most government receipts were from sources abroad, some from the tax on the oil companies and some from aid and borrowing, but only a part of these foreign receipts were spent abroad. Therefore, the government's foreign exchange budget was always in surplus. As government was balancing its overall budget, there was a deficit in its domestic budget corresponding to the surplus in its foreign exchange budget. Government foreign receipts as a ratio of GDP rose steadily during the oil boom to about 17%, and continued at only slightly below that level even after 1981. Government foreign expenditures have, however, kept rising steadily as a ratio of GDP. The net result was that the foreign exchange surplus rose until 1981, and declined after that. Because the overall budget was balanced, the changes in the foreign budget ratio were also reflected in the domestic budget ratio. However, these changes were quite small for most of the period; the domestic budget ratio fell sharply only in 1986 (Table 11)

PAGE 49

40 Table 11 Government Revenues and Expenditures as Percentage of GDP Year Foreign Foreign Surplus Domestic Domestic Deficit Revenues Expendi-of Revenue Expendi-in ture Foreign ture Domestic Budget Budget 1973 7.4 4.4 3.0 8.4 11.3 2.9 1974 9.7 4.5 5.2 6.9 12.1 5.2 1975 12.7 6.5 6.2 7.4 13.6 6.2 1976 14.5 8.7 5.8 7.8 13.5 5.7 1977 13.9 8.2 5.7 7.9 13.6 5.7 1978 13.3 8.4 4.9 7.8 12.7 4.9 1979 14.8 8.5 6.3 6.7 13.0 6.3 1980 15.9 8.1 7.9 6.2 14.0 7.8 1981 16.9 8.1 8.8 6.0 14.8 8.8 1982 16.2 8.3 7.9 6.5 14.4 7.9 1983 17.1 10.5 6.6 6.4 13.0 6.6 1984 15.7 9.8 5.9 6.1 12.0 5.9 1985 19.5 12.9 6.6 10.0 16.6 6.6 1986 13.2 10.8 2.4 9.7 12.1 2.4 Source: Bank Indonesia, Indonesian Financial Statistics, various issues.

PAGE 50

41 One component of routine expenditures needs special consideration, namely debt service payments, shown in Table 12. Debt service payments increased steadily in the years up to 1981 until they reached approximately 13% of routine expenditures, 7% of total expenditures, and 1.5% of GDP. Year Table 12 Debt Service Payments 1973-1986 Amount (billion Rp) As Percentage of at Current at 1973 Routine Total GDP 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 Prices Constant Prices Expendi-67 73 77 162 219 458 647 760 894 1,151 1,883 2,608 3,186 4,624 67 50 47 85 102 183 192 173 184 227 330 409 481 703 ture 10.4 7.8 6.1 10.4 10.8 17.6 17.3 14.2 13.4 16.5 23.4 28.4 28.1 35.1 Expenditure 6.3 4.1 3.0 4.7 5.3 9.1 8.8 7.0 6.7 8.1 10.9 13.6 14.5 20.9 Sources: Bank Indonesia, Indonesian Financial Statistics, various issues. 1.0 0.7 0.6 1.0 1.2 1.9 1.9 1.6 1.5 1.8 2.6 3.0 3.4 4.8

PAGE 51

42 Since then, debt service payments have been rising much more steeply, by 1986, reached 35.1% of expenditures, and as much as 4.8% of GDP. Summary This section summarized the various developments that occurred in the Indonesian economy during the slow growth period 1981-1986 and the rapid growth period 1968-1981, and particularly the period of the oil boom 1973-1981. From 1968-1981, the improvement in Indonesia's terms of trade greatly strengthened the financial position of the government. The government then used its improved financial position to expand the productive capacity through an increase in development expenditures in the public -sector, an increase in government's routine expenditures, which led directly to higher investment in the private sector. The growth of these investments was associated with the adoption of new technology, especially, in the manufacturing sector. Further, government also used its improved financial position to promote rapid technological progress, especially in the agricultural sector. The result is a rapid growth of the productive capacity of the economy. At the same time, there was a rapid growth of aggregate demand. To some extent due to higher levels of investment and faster technological progress. In particular, higher levels of investment raise demand for output in some sectors, especially in manufacturing and construction. In addition, the growth of demand was also due to the

PAGE 52

43 expansionary fiscal policy of the government. During this period, the government earned a sizeable surplus in its foreign exchange budget. But because of its commitment to a balanced budget policy, as interpreted above, the government incurred a corresponding deficit in its domestic budget, which helped to increase aggregate demand and maintain it at a high level, relative to GDP. On the other hand, the abundance of foreign exchange led to a rapid growth of imports. Part of it was used to build up the productive capacity of the economy, but a considerable part was also used to meet the growth of demand directly. Therefore, a considerable part of demand leaked out in the form of imports. But the increase in imports was less than the increase in demand, so there was a net increase in demand for domestic production. These effects on demand were most clearly indicated by the changes 1n money supply, which grew at an average annual rate of 33% during this period. Because this was accompanied by a rapid growth in productive capacity, the growth of demand indicated by the growthof money supply did not lead to a corresponding rate of inflation. Although ther.e was a high rate of inflation, it was mostly due to other factors of a broadly cost push type. The actual growth of money supply was faster than the rate needed to validate the rise in prices due to these cost push factors, and reflects the growth in aggregate demand. This growth of demand combined with the

PAGE 53

44 expansion of productive capacity is the main explanation of the rapid growth of the period 1973-1981. In 1981, the economy was still in a strong position to sustain further growth. The country had built up a high level of productive capacity during the rapid growth period. Further, in spite of the deterioration in the country's terms of trade, levels of investment, foreign exchange earnings and government revenues remained high compared with the position during the early.years of the rapid growth era. As in the earlier period, the growth of demand was influenced by the three main factors: investment, government expenditures, and imports. The net effect of the changes in these three factors was to depress the growth of demand as a whole, and hence to reduce the average growth rate. In 1984, there was a sharp fall in the level of imports. Combined with the high levels of investment and government's net domestic expenditures, there was a significant rise in domestic demand. The result was a much higher growth rate in that year. Part of this increased growth may also have been due to the stimulus given to exports of manufactured goods by the 1983's devaluation. Imports continued to decline in the years 1985 and 1986. However, in these years there was also a fall in investment and in government expenditures, especially in 1986. The net effect of these changes was again a slower growth of demand, which led to a fall in the growth rate of GDP in 1985 and 1986.

PAGE 54

CHAPTER IV INCOME DISTRIBUTION MODEL: CROSS SECTIONAL EVALUATION The Model This chapter will discuss an income distribution model based on the cross sectional data from 1965 to 1986. The model will consist of size distributions. The size distribution model incorporates Lorenz curves, income shares, and rank dominance. Chapter III suggests that the economic development of Indonesia is still in the agriculture stage; thus, the total percentage of labor income in this sector is of interest in the study. On the basis of the cross-sectional model, the study will be able to derive the Lorenz curve, Gini concentration ratio, income share for different groups of population, and the rank dominance for different time periods. From the functional distribution, the study will also be able to show the share of income of each sectoral component in the national income. Size Distribution In this section a Lorenz curve for five different times (1965, 1970, 1975, 1980, and 1985) are constructed. The data have been collected for each province in Indonesia. The income data are averages for each province. Because Indonesia has 27 provinces, the data cover the average income and population for 27 provinces as indicated in Tables 13 and 14. The data are arranged from the lowest to

PAGE 55

46 Table 13 Average Income by Provinces (in 1973 constant prices and in billions Rp.) No. Province 1. D. I. Aceh 2. Sumatera Utara 3. Sumatera Barat 4. Riau 5. Jambi 6. Sumatera Selatan 7. Bengkulu 8. Lampung 9. 10. 11. 12. 13. SUMATERA D.K.I.Jakarta Jawa Barat Jawa Tengah D.I.Yogyakarta Jawa Timur 1965 39.2 114.3 50.9 35.4 22.2 72.8 10.8 52.3 397.9 154.6 361.3 265.7 34.2 312.2 1970 63.8 186.3 82.9 57.5 36.3 118.3 17.5 85.4 1975 132.5 388.6 171.0 119.7 75.4 246.9 36.3 178.5 1980 189.5 554.4 243.9 171.2 107.4 352.2 52.1 254.7 1985 265.8 669.3 302.0 219.7 127.8 414.8 73.1 289.7 648.0 1,348.9 1,925.4 2,362.2 251.7 588.8 432.9 55.8 508.8 524.8 1,228.2 903.3 118.1 1,061.5 748.6 1,752.3 1,288.9 168.8 1,514.5 1,080.3 2,254.9 1,421.6 194.4 1,823.0 JAWA 1,128.0 1,838.0 3,835.9 5,473.1 6,774.2 14. 15. 16. 17. Kalimantan Barat Kalimantan Tengah Kalimantan Selatan Kalimantan Timur KALIMANTAN 18. Sulawesi Utara 19. Sulawesi Tengah 20. Sulawesi Selatan 21. Sulawesi Tenggara S U L A W E S I 32.7 15.5 32.1 23.4 103.7 36.5 18.1 65.2 10.2 130.0 22. 23. 24. 25. Bali Nusa Tenggara Nusa Tenggara Timor Timur 28.9 Barat26. 3 Timur25.7 NUSA TENGGARA 26. Maluku 27. Irian Jaya 80.9 17.8 26.7 53.3 25.0 52.5 37.9 168.7 59.6 29.6 106.3 16.7 212.2 47.1 42.9 42.1 132.1 29.2 42.8 111.2 51.8 109.6 79.1 351.7 124.5 61.5 221.3 34.7 442.0 97.8 89.3 88.2 275.3 60.9 89.3 158.5 73.6 156.2 113.0 501.3 177.8 87.7 315.7 49.2 630.4 139.8 127.6 125.7 393.1 87.2 127.5 195.1 89.9 184.8 165.7 635.5 171.8 78.6 425.0 66.6 742.0 167.4 145.2 134.6 66.6 504.6 111.0 158.5 INDONESIA 1,885.0 3,071.0 6,404.0 9,138.0 11,288.0 Source: The Indonesian Central Bureau of Statistics (BPS).

PAGE 56

47 Table 14 Population by Provinces (x 1, 000) No. Province 1965 1970 1975 1980 1985. 1. D.I.Aceh 1,768 1,966 2,244 2,611 2,972 2. Sumatera Utara 5,551 6,427 7,311 8,361 9,422 3. Sumatera Bar at 2,495 2,740 3,040 3,407 3,698 4. Riau 1,379 1,594 1,846 2,169 2,548 5. Jambi 836 975 1,170 1,446 1,745 6. Sumatera Selatan 3,018 3,365 3,898 4,630 5,370 7 Bengkulu 448 506 610 768 943 8 Lampung 2,020 2,630 3,418 4,625 5,905 S U M A T ERA 17,515 20,203 23,537 28,016 32,603 9 D.K.I.Jakarta 3,503 4,375 5,299 6,503 7,885 10. Jawa Barat 19,088 21,172 23,925 27,454 30,830 11. Jawa Tengah 19,704 21,492 23,312 25,373 29,945 12. D.I.Yogyakarta 2,338 2,462 2,599 2,751 2,930 13. Jawa Timur 23,211 25,111 27,038 29,189 31,262 JAWA 67,844 74,612 82,173 91,270 99,852 14. Kalimantan Bar at 1,740 1,969 2,207 2,486 2,819 15. Kalimantan Tengah 567 677 798 954 1,118 16. Kalimantan Selatan 1,558 1,674 1,846 2,065 2,273 17. Kalimantan Timur 616 712 902 1,218 1,512 KALIMANTAN 4,481 5,032 5,753 6,723 7,722 18. Sulawesi Utara 1,456 1,671 1,878 2,115 2,313 19. Sulawesi Tengah 771 888 1,055 1,290 1,511 20. Sulawesi Selatan 4,770 5,108 5,542 6,062 6,610 21. Sulawesi Tenggara 616 696 802 942 1,120 S U L A W E S I 7,613 8,363 9,277 10,410 11,554 22. Bali 1,909 2,082 2,263 2,470 2,649 23. Nus a Tenggara Barat1,954 2,159 2,412 2,725 2,995 24. Nusa Tenggara Timur2,091 2,259 2,474 2,737 3,061 25. Timor Timur 631 NUSA TENGGARA 5,954 6,500 7,149 7,932 9,336 26. Maluku 895 1,054 1,216 1,411 1,609 27. Irian Jaya 819 904 1,022 1,174 1,371 ---------------------------------------------INDONESIA 105,121 116,668 130,127 146,936 164,047 Source: The Indonesian Central Bureau of Statistics (BPS)

PAGE 57

48 the highest income. The table presents a calculation of cumulative income and recipients, and the percentage of cumulative income and the percentage of recipients. From these data, Lorenz curves can be constructed to show the percentage of total income occurring to cumulative percentages of recipients. Tables 15 through 19 present the size distributions for the years 1965, 1970, 1975, 1980, and 1985. From these tables (Tables 15 through 19), Lorenz curves are constructed to indicate the degree of inequality in the income distribution. Perfect equality is represented by the diagonal from zero to one hundred percent. Figures 3 through 7 present Lorenz curves for five different time periods. The curve should be interpreted as showing that the inequality of the distribution curve is greater the further it bends away from the line of equality. From the Lorenz curve, a Gini ratio can be calculated to present a single numerical measure of inequality.

PAGE 58

Table 15 Size Distribution of Income Lorenz Curve Year 1965 49 Population (x 1,000) Average Income (billions Rp) No. ----------------------------------------------------Pop. 1. 616 2. 448 3. 567 4". 895 5. 771 6. 836 7. 616 8. 2091 9. 819 10. 1954 11. 1909 12. 1558 13. 1740 14. 2338 15. 1379 16. 1456 17. 1768 18. 2495 19. 2020 20. 4770 21. 3018 22. 5551 23. 3503 24. 19704 25. 23211 26. 19088 27. Cumulative Total 616 1064 1631 2526 3297 4133 4749 6840 7659 9613 11522 13080 14820 17158 18537 19993 21761 24256 26276 31046 34064 39615 43118 62822 86033 105121 % 0.58 1. 01 1.55 2.40 3.13 3.93 4.51 6.50 7.28 9.14 10.96 12.44 14.09 16.32 17.63 19.01 20.70 23.07 24.99 29.53 32.40 37.68 41.01 59.76 81.84 100.00 Avg. 10.2 10.8 11.5 14.8 16.1 17.1 20.0 22.2 23.4 24.1 25.7 26.7 28.9 29.7 32.1 32.7 34.2 35.4 "36 .5 39.2 40.3 42.3 55.2 59.1 72.8 1124.0 Cumulative Total 10.2 21.0 32.5 47.3 63.4 80.5 100.5 122.7 146.1 170.2 195.9 222.6 251.5 281.2 313.3 346.0 380.2 415.6 452.1 491.3 531.6 573.9 629.1 688.2 761.0 1885.0 g, 0 0.5 1.1 1.7 2.5 3.3 4.2 5.3 6.5 7.7 9.0 10.3 11.8 13.3 14.9 16.6 18.3 20.1 22.0 23.9 26.0 28.2 30.4 33.3 36.5 40.3 100.0 Source: Author's calculation based on Table 13 and 14.

PAGE 59

Table 16 Size Distribution of Income Lorenz Curve Year 1970 50 Population (x 1,000) Average Income (billions Rp) No. ----------------------------------------------------Pop. 1. 696 2. 506 3. 677 4. 1054 5. 888 6. 975 7. 712 8. 2259 9. 904 10. 2159 11. 2082 12. 1674 13. 1969 14. 2462 15. 1594 16. 1671 17. 1966 18. 2740 19. 2630 20. 5108 21. 3365 22. 6427 23. 4375 24. 21492 25. 25111 26. 21172 27. Cumulative Total 696 1202 1879 2933 3821 4796 5508 7767 8671 10830 12912 14586 16555 19017 20611 22282 24248 26988 29618 34726 38091 44518 48893 70385 95496 116668 % 0.59 1.03 1. 61 2.51 3.27 4.11 4.72 6.65 7.43 9.28 11.06 12.50 14.18 16.30 17.66 19.09 20.78 23.13 25.38 29.76 32.64 38.15 41.90 60.32 81.85 100.00 Avg. 16.7 17.5 24.4 25.5 26.2 30.6 32.4 36.1 37.2 39.0 40.4 42.8 44.6 46.1 52.8 53.0 54.1 62.2 63.7 68.4 71.0 88.5 120.1 122.8 165.9 1689.0 Cumulative Total 16.7 34.2 58.6 84.1 110.3 140.9 173.3 209.4 246.6 285.6 326.0 368.8 413.4 459.5 512.3 565.3 619.4 681.6 745.3 813.7 ,9,. 0 0.5 1.1 1.9 2.7 3.6 4.6 5.6 6.8 8.0 9.3 10.6 12.0 13.5 15.0 16.7 18.4 20.2 22.2 24.3 26.5 28.8 31.7 35.6 39.6 45.0 884.7 973.2 1093.3 1216.1 1382.0 3071.0 100.0 Source: Author's calculation based on Table 13 and 14.

PAGE 60

Table 17 Size Distribution of Income Lorenz Curve Year 1975 51 Population (x 1,000) Average Income (billions Rp) No. ---------------------------------------------------Pop. 1. 802 2. 610 3. 798 4. 1216 5. 1055 6. 1170 7. 902 8. 2474 9. 1022 10. 2412 11. 2263 12. 1846 13. 2207 14. 2599 15. 1846 16. 1878 17. 2244 18. 3040 19. 3418 20. 5542 21. '3898 22. 7311 23. 5299 24. 23312 25. 27038 26. 23925 27. Cumulative Total 802 1412 2210 3426 4481 5651 6553 9027 10049 12461 14724 16570 18777 21376 23222 25100 27344 30384 33802 39344 43242 50553 55852 79164 106202 130127 % 0.61 1.08 1.69 2.63 3.44 4.34 5.03 6.93 7.72 9,57 11.31 12.73 14.42 16.42 17.84 19.28 21.01 23.34 25.97 30.23 33.23 38.84 42.92 60.83 81.61 100.00 Avg. 34.7 40.5 51.8 60.9 61.5 75.4 79.1 88.2 89.3 89.3 97.8 109.6 111.2 118.1 119.7 124.5 132.5 171.0 178.5 221.3 246.9 288.6 324.8 353.3 1061.5 3067.5 Cumulative Total 34.7 76.8 128.6 189.5 251.0 326.4 405.5 493.7 583.0 672.3 770.1 879.7 990.9 1109.0 1228.7 1353.2 1485.7 1656.7 1835.2 2056.5 2303.4 2592.0 2916.8 3270.1 3336.5 6404.0 % 0.5 1.2 2.0 2.9 3.9 5.1 6.3 7.7 9.1 10.4 12.0 13.7 15.5 17.3 19.2 21.1 23.5 25.9 28.7 32.1 36.0 40.5 45.5 51.0 52.1 100.0 Source: Author's calculation based on Table 13 and 14.

PAGE 61

Table 18 Size Distribution of Income Lorenz Curve Year 1980 52 Population (x 1,000) Average Income (billions Rp) No. ----------------------------------------------------Pop. 1. 942 2. 768 3. 954 4. 1411 5. 12 90 6. 144 6 7. 1218 8. 2737 9. 1174 10. 2725 11. 2470 12. 2065 13. 2486 14. 2751 15. 2169 16. 2115 17. 2611 18. 3407 19. 4625 20. 6062 21. 4630 22. 8361 23. 6503 24. 25373 25. 29189 26. 27454 27. Cumulative Total 942 1710 2664 4075 5365 6811 8029 10766 11940 14665 17135 19200 21686 24437 26606 28721 31332 34739 39364 45426 50056 58417 64920 90293 119482 146936 % 0.64 1.16 1.81 2.77 3.65 4.63 5.46 7.73 8.12 9.98 11.66 13.06 14.75 16.63 18.10 19.54 21.32 23.64 26.78 30.91 34.06 39.75 44.18 61.45 81.31 100.00 Avg. 49.2 72.1 73.6 87.2 87.7 107.4 113.0 125.7 127.5 127.6 139.8 156.2 158.5 168.8 171.2 177.8 189.5 238.6 260.3 301.6 365.5 402.1 466.0 511.8 1060.0 3399.3 Cumulative Total 49.2 121.3 194.9 282.1 369.8 477.2 590.2 715.9 843.4 971.0 1110.8 1267.0 1425.5 1594.3 1765.5 1943.3 2132.8 2371.4 2631.7 2933.3 3298.8 3700.9 4166.9 4678.7 5738.7 9138.0 0.6 1.3 2.1 3.1 4.0 5.2 6.5 7.8 9.2 10.6 12.2 13.9 15.6 17.4 19.3 21.3 23.3 26.0 28.8 32.1 36.1 40.5 45.6 51.2 62.8 100.0 Source: Author's calculation based on Table 13 and 14.

PAGE 62

53 Table 19 Size Distribution of Income Lorenz Curve Year 1985 Population (X 000) Average Income (billion Rp) No. ---------------------------------------------------Cumulative Cumulative Pop. ------------------Avg. ---------------------Total % Total % 1. 631 631 0.38 66.6 66.6 0.6 2. 1120 1751 1.06 66.6 158.0 1.4 3. 943 2694 1.64 85.8 243.8 2.2 4. 1511 4205 2.56 106.1 349.9 3.1 5. 1118 5323 3.24 107.3 457.2 4.1 6. 1609 6932 4.22 129.8 587.0 5.3 7. 1745 8677 5.28 146.7 733.7 6.5 8. 3061 11738 7.15 152.4 886.1 7.9 9. 2995 14733 8.98 152.4 1038.5 9.2 10. 1371 16104 9.81 158.5 1197.0 10.6 11. 1512 17616 10.73 165.7 1381.7 12.2 12. 2649 20265 12.35 198.6 1580.3 14.0 13. 2313 22578 13.76 199.8 1780.1 15.8 14. 2273 24851 15.14 202.1 1982.2 17.6 15. 27781 16.93 207.7 2189.9 19.4 16. 2819 30600 18.65 208.8 2398.7 21.3 17. 2548 33148 20.20 237.0 2635.7 23.4 18. 2972 36120 22.01 304.8 2940.5 26.1 19. 5905 42025 25.61 316.1 3256.6 28.9 20. 3698 45723 27.87 372.5 3629.1 32.2 21. 5370 51093 31.14 451.5 4080.6 36.2 22. 6610 57703 35.17 496.7 4577.3 40.6 23. 9422 67125 40.91 575.7 5153.0 45.7 24. 7885 75010 45.72 868.0 6021.0 53.3 25. 26945 101955 62.14 921.1 6942.1 62.8 26. 31262 133217 81.20 952.7 7894.8 69.9 27. 30830 164047 100.00 3393.2 11288.0 100.0 Source: Author's calculation based on Table 13 and 14.

PAGE 63

100 90 80 70 u 60 c .... 0 50 .. > 40 .. .., ., 30 E :J 20 10 0 10 20 30 40 50 80 70 Cumu 1 at i ve .-of Rec r p 1 enta Figure 3: Lorenz Diagram 1965 80 54 90 100

PAGE 64

55 100 90 80 70 ) 60 .. 50 ) t I) 40 .. J 30 5 J 20 10 0 10 20 30 40 50 80 70 80 90 100 Cumulative of Recipients Figure 4: Lorenz Diagram 1970

PAGE 65

56 100 90 80 70 u c .... 60 0 -., 50 > ,.. ..., II 40 E CJ 30 20 10 0 10 20 30 40 50 60 70 80 90 100 Cumulative of Recipients Figure 5: Lorenz Diagram 1975

PAGE 66

57 100 90 80 10 u c:: 60 0 50 M G > 40 II -i 30 :t CJ 20 10 0 10 20 30 40 50 60 70 80 90 100 Cumulative 1 of Recip;enta Figure 6: Lorenz Diagram 1980

PAGE 67

58 100 90 80 70 60 u c .... .... 50 0 M 40 > 'P" -30 i :1 (.) 20 10 0 10 20 30 40 50 60 70 80 90 100 cumulative I of Recipienta Figure 7: Lorenz Diagram 1985

PAGE 68

59 A summary of mean income in Indonesia is presented in Table 20, which shows the mean income for each decile from 1965 to 1985 (five data points) For each year, an average mean income and the percentage changes of average income per year over the period of the study are calculated. The Gini ratio is also reported in this table to show the inequality of income distribution from year to year. Table 21 is a tabulation of cumulative proportion of income. From this table, the ratio of income share of the richest 10% to the poorest 10% for the period of 1965 to 1985 can be seen. The ratio of income share will be evaluated together with the Gini ratio to guide the study in making conclusions in Chapter VI. Figure 8 is a composite proportion of income from 1965 to 1985. Table 22 presents generalized Lorenz ordinates. A generalized Lorenz ordinate is derived by scaling an ordinary Lorenz ordinate by the distribution's mean income. This basis, a composite diagram can be made of generalized Lorenz ordinates from 1965 to 1985, with average mean income for each year falling at the 100% cumulative population in the horizontal axis. Figure 9 is a composite of generalized Lorenz ordinates from 1965 to 1985. Generalized Lorenz Ordinates show both efficiency and equity. Efficiency is reflected by the magnitude of mean income, which is given by the end-point on the right-hand side of the generalized Lorenz curve in Figure 9. Equity is incorporated by the curvature of generalized Lorenz curves,

PAGE 69

60 Table 20 Mean Income Distribution 1965 -1985 Decile 1965 1970 1975 1980 1985 1 30.16 58.66 194.04 449.59 624.23 2 31.10 65.19 244.63 512.64 695.34 3 35.06 73.62 260.01 516.30 730.33 4 42.04 108.71 274.09 620.47 767.58 5 48.82 122.19 303.55 636.92 938.04 6 64.66 152.94 443.79 758.45 1,152.50 7 101.97 228.48 621.83 945.78 1,281.19 8 170.60 303.72 803.70 1,176.06 1,453.89 9 266.91 452.06 1,243.02 1,512.34 1,629.99 10 1,094.68 1,505.40 2,015.34 2,009.45 2,014.91 Average 189.00 307.00 640.00 914.00 1,129.00 Percentage changes 0.62 1.08 0.43 0.23 Ratio 0.66 0.59 0.43 0.28 0.21 Sources: 1. The Indonesian Central Bureau of Statistics (BPS) 2. Author's calculation based on data available.

PAGE 70

61 Table 21 Cumulative Proportion of Income From 1965-1985 Decile 1965 1970 1975 1980 1985 1 1.60 1.91 3.03 4.92 5.53 2 3.25 4.03 6.85 10.53 11.69 3 5.11 6.43 10.91 16.18 18.16 4 7.34 9.97 15.19 22.97 24.96 5 9.93 13.95 19.93 29.94 33.27 6 13.36 18.93 26.86 38.24 43.48 7 18.77 26.37 36.57 48.59 54.83 8 27.82 36.26 49.12 61.46 67.71 9 41.98 50.98 68.53 78.01 82.15 10 100.00 100.00 100.00 100.00 100.00 Ratio of income share of the richest 10% to poorest 10% 36.29 25.66 10.39 4.47 Sources: 1. The Indonesian Central Bureau of Statistics (BPS) 3.23 2. Authors's calculation based on data available.

PAGE 71

62 J965 i Jt'ID Dlc:ilt 0 J9'15 6 J980 X J985 Figure 8: Composite Cumulative Proportion of Income 1965 -1985

PAGE 72

63 Table 22 Generalized Lorenz Ordinates From 1965-1985 Decile 1965 1970 1975 1980 1985 1 3.00 6.00 19.00 45.00 62.00 2 6.00 12.00 44.00 96.00 132.00 3 10.00 20.00 70.00 148.00 205.00 4 14.00 31.00 97.00 210.00 282.00 5 19.00 43.00 128.00 274.00 376.00 6 25.00 58.00 172.00 350.00 491.00 7 35.00 81.00 234.00 444.00 619.00 8 53.00 111.00 314.00 562.00 764.00 9 79.00 157.00 439.00 713.00 --927. 00 10 189.00 307.00 640.00 914.00 1,129.00 Sources: 1. The Indonesian Central Bureau of Statistics (BPS) --2. Author's calculation based on data available.

PAGE 73

64 J.2 1.1 1 o.g 0.8 I O.J
PAGE 74

65 which, like an ordinary Lorenz curve, are convex from below. Thus, the height of the generalized Lorenz curve reflects efficiency and curvature shows income inequality. An evaluation of the above models will be made in the following sections. Generalized Lorenz dominance is equivalent to second degree stochastic dominance. A final criterion to evaluate size distribution is first degree stochastic dominance. This is equivalent to Pareto optimality under certain conditions (see paper by W. James Smith et al on Stochastic Dominance, Income Distribution Functions and Economic Development. Figures 10 through 13 are Rank Order Functions for 1965 and 1970, 1970 and 1975, 1975 and 1980, and 1980 and 1985, which can be plotted from Table 20. The plot is made for income on the ordinate and the cumulative proportion of income recipients on the abscissae. The rank dominance can be used to implement welfare evaluation and has important implication for poverty. Functional Distribution The other common measure of income distribution is the functional or factor share distribution, which will attempt to explain the share of total income that each factor of production receives. Figure 14 shows a basic concept of a functional income distribution in a market economy. This simple model indicates only two factors of production: labor and capital. The simple model shows that in a competitive

PAGE 75

66 1.6 1.5 J.t. J.3 1.2 J.J J 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 O.J 0 0 Cumula.tin Propor tioD or IDe om 0 J965 +-J970 Figure 10: Rank Order Function, 1965-1970

PAGE 76

67 2.1 2 1.1 1.1 1.7 .us 1.$ .... ... 1.3 I a 1.2 a 1.1 I J 0 0.9 "' 0.8 J 0.7 0.6 0.5 o ... 0.3 0.2 0.1 0 0 Cumulatin ProporUon of lncom1 o + Figure 11: Rank Order Function, 1970-1975

PAGE 77

68 2.J 2 J.t .. ., J.S J.5 .. J.3 J.2 J.J J 0.9 0.1 0.7 0.6 o.a o., 0.3 0.2 O.J 0 0 Cumulalin ProporUon of 1Dcom1 0 J!t75 + J980 Figure 12: Rank Order Function, 1975-1980

PAGE 78

69 2.1 2 J.t u 1.7 1.5 1.5 J.' "" 1.3 I 1.2 1.1 I :1 1 0 0.9 s: f-4 OJ \J 0.7 o.s 0.5 0., 0.3 0.2 0.1 0 CumulaUn Propor UoD of Income c 1980 t-198& Figure 13: Rank Order Function, 1980-1985

PAGE 79

70 0 c E lnPioyment Figure 14: A Simplified Diagram of a Competitive Market Functional Income Distribution

PAGE 80

71 market economy with constant returns to scale production functions, factor prices are determined by factor supply and demand curves. Income is distributed by function: labor receive wages, the owners of land receive rent, and capitalists obtain profits. This theory will be expanded to apply to the case of Indonesia. In Indonesia, the relevance of the functional theory is greatly influenced by government policy, which therefore distorts the theory of a competitive market. Although a noncompetitive market exists in the Indonesian economy, it is worthwhile to investigate how income is distributed among the production factors. On the basis of the study of functional distribution, this study can recommend to the government of Indonesia to alter the functional distribution of income through policies designed to change relative factor prices. Since factor prices are assumed to function as the ultimate signals and incentives in any economy, including that of Indonesia, getting these prices right would increase productivity and efficiency. As shown in Chapter III, the national income of Indonesia is broken down into seven sectors, each of which has factors of production. Data from the Indonesian Central Bureau of Statistics (CBS) shows that these factors of production would receive salary & wages, profits, depreciation, and indirect taxes. These data can only be found in the national input/output table, which is available for 1975 and 1985, and is known as the Gross Added

PAGE 81

72 Value Composition of GDP. The input/output Indonesia is built to break down GNP from three different approaches: the production approach, income approach, and expenditure approach. Generally, the government of Indonesia reports annually the national income via the expenditure approach; however, the payment to factors of production is officially reported from the input/output table of Indonesia. The study of functional distribution from two different time periods, 1975 (Table 23) and 1985 (Table 24), would lead to the conclusion of how a sectoral component of GNP improves factors of payment or income within a decade. As we concluded in Chapter III that the agriculture sector is still dominant in the economic growth of Indonesia, the study will focus on the change of factors of payment to the labor in the agriculture sector. In addition, various sectors such as the industrial and service industry will also be scrutinized to support results of this study. Tables 23 and 24 represent factors payment to each sector in the Indonesian economy.

PAGE 82

Table 23 Functional Distribution Income Share in the Sectoral GDP Nominal Value 1975 (billions of rupiah) No. Sector Estimate Employment Wages & Sectoral Salaries Income 1. Agriculture 27.13 1,797 3,403 2. Mining 0.19 58 2,112 3. Industry 3.60 861 955 4. Public Utilities 0.18 26 59 5. Construction 1.09 -*) 502*) 6. Transport and Communication 1.19 289 443 7. Trade & Other Services 10.61 2,196 3,272 National Income 5,227 10,746 Sources: 1. Bank Indonesia, Indonesian Financial (various issues) 73 Percentage Sectoral Income 52.81 2.75 59.09 44.07 65.24 67.11 48.64 Statistics, 2. The Indonesian Central Bureau of Statistics, (BPS) *) Sector no. 5 is incorporated in sector no. 3.

PAGE 83

Table 24 Functional Distribution Income Share in the Sectoral GDP Nominal Value 1985 (billions of rupiah) 74 No. Sector Estimate Employment Wages & Sectoral Salaries Income Percentage Sectoral Income 1. Agriculture 31.17 2. Mining 0.93 3. Industry 6.51 4. Public Utilities 0.09 5. Construction 2.80 6 0 Transport and Communication 1. 91 7 0 Trade & Other Services 16.09 National Income 3,319 346 19,667 N/A -*) 11,667 -*) 34,999 19,691 13,533 32,323 686 4,658*) 16,982 -*) 83,217 16.86 2.56 60.85 N/A 68.70 42.06 Sources: 1. Bank Indonesia, Indonesian Financial Statistics, (various issues) 2. The Indonesian Central Bureau of Statistics, (BPS) *) Sector no. 5 and 7 are incorporated in sector no. 3. (Input-Output Data, National Account of Indonesia does not breakdown those sectors)

PAGE 84

75 Model Results It can be seen that over time (from 1965 to 1985) the Gini ratio has become smaller. This leads to the conclusion that the inequality of income has been declining during the 20-year period and thus, the equality of income distribution has increased. It is worthwhile to note that the Lorenz curves have crossed each other at approximately 90% of cumulative population. This is an indication that income distribution cannot be ranked for the years 1965 and 1970. However, the curves are ranked thereafter, from 1970, 1975, 1980, and 1985. The Lorenz curves have consistently increased from 1965 to 1980, and then only slightly increased from 1980 to 1985. It is believed that these conditions can be used to draw inferences about the effects of the oil boom on the poverty line. The slump economic condition in the 1980's has a major influence on inequality from 1980 to 1985. It can be conclude that the Lorenz curve dominates the previous year's Lorenz curves. It can be seen that over time (from 1975 to 1985) the nominal average income has increased; however, the real average income can be seen to decrease from 1975 through 1985 (Table 25) The Gini ratio supports the conclusion of decreasing inequality in income from 1965 to 1985 as indicated by the smaller area of the numerator in the Gini ratio, over time. However, the Gini ratio constructed with the result of average income calculation during 1980-1985 shows the

PAGE 85

Year GDP Deflator*> Table 25 Average Income 1965-1985 Average Income Nominal Real 76 (1973 constant price} 1965 1970 1975 1980 1985 71.22 80.79 112.99 165.00 205.60 189 307 640 914 1,129 265.37 379.99 566.42 553.94 549.12 *} GDP deflator in this study is used to indicate an inflation index of Indonesia, which believed to be superior than CPI (Consumer Price Index} and PPI (Producer Price Index} percentage change has declined. The generalized Lorenz curves indicates a decreasing order of the ratio of income share of the richest 10% to the poorest 10% from 36.29 in 1965 to 3.23 in 1985. Two possible explanations can be made for this case: first, the income share of the richest is decreasing, and second, the income share of the poorest is increasing. The result is a decreasing order of the ratio. The end point of the right hand side of generalized Lorenz curves as shown in Table 22 (in nominal value} shows a decreasing value in real terms and therefore inefficiency of welfare. In the equity aspect, the generalized Lorenz curves are shown as convex

PAGE 86

77 curves in the earlier years of 1965, 1970, and 1975. However, in 1980 and 1985, the curves are flatter than those previous curves. We can infer that the social policy in Indonesia since the New Order Government was formed has raised income as indicated by the changes in both the height and curvature of the generalized Lorenz curves (see Figure 9) An interpretation of functional distribution is made for two different periods, 1975 and 1985. In this study, wages and salary in the agricultural sector are observed in detail. Tables 23 and 24 show that the percentage share of salary and wages declined from 52.81% to 16.86%. A drastic decline was caused primarily by the priority given to the non-agricultural sector, which would indirectly affect the government budget allocation to this agricultural sector. The government of Indonesia had to adjust its revenue due to the oil bust period in the 1980's by keeping the nominal salary and wages constant over several years. The data also suggest that in all sectors the percentage sectoral income has declined in 1985. Overall, the percentage income of all sectors has declined from 48.64% in 1975 to 42.06% in 1985. To conclude this section, the size and functional distributions suggest that after the New Order Government and especially during the oil boom, Indonesia progressively altered its income distribution over time. The march toward greater equality slowed in progress between 1980 and 1985.

PAGE 87

CHAPTER V POLICY ANALYSIS Limitation of Data Indonesia has no national statistics on income distribution. The income tax covers only a small percentage of the population, and wage and salary data are fragmentary and unreliable. National income data are subject to many problems of interpretation, and however reliable, can only be used to trace broad changes in sectoral shares over time. Labor force and employment data are subject to all the pitfalls in interpretation and again can only be used in conjunction with national income data, to analyze broad shifts in sectoral shares. To glean any insight into trends in the distribution of personal or household income both between and within sectors of the economy one is forced to rely on partial data. Such data are usually restricted by sector, or by geographical region, and some caution is needed in interpreting them. Even more caution is needed in making intertemporal or international comparisons of the kind that have become rather fashionable in the literature of development economics in recent years. The major household consumption surveys (Susenas) have been concerned with household expenditure patterns. There have now been six of these, carried out in 1963/64, 1964/65, 1967/68, 1969/70, 1976/77, and 1985/86 by the Central Bureau of Statistics (CBS) Some problems of comparability arise,

PAGE 88

79 although they are probably less severe than with the earlier surveys, which were based on small samples and were conducted under very disturbed circumstances. Additional evidence will be taken from other sources, in particular the Population and Agricultural Censuses of 1971 and 1973, and the 1976 by the Sakernas (National Labor Force Survey) The study then considers indicators of levels of poverty in Indonesia and how these appear to have changed over time. Finally we examine policy options available to government to improve distribution of income and wealth in Indonesia over the next decades. Discussions As concluded from Chapter III, that economic growth is closely related to the income distribution. This positive correlation has suggested that Indonesia consistently implemented its program in economic development. High economic growth leads to the decreasing Gini ratio or an increase in average income of people from 1965 to 1985. The historical relation of economic growth and income distribution can be summarized in Table 26 as follows:

PAGE 89

Table 26 A Relation between Economic Growth and Income Distribution 1968-1986 80 Year Average Annual GDP Growth Average Annual Percentage Changes Average Income 1968-1981 1982-1986 7.5-7.7 3.5 -4.1 0.71 *) 0.23 *) *) Percentage changes in average income are derived from Table 15 for 1965 to 1980 (four data points) in the first row and for 1985 in the second row. In the case of Indonesia incentives of economic growth would also seem to provide incentive for a more equitable income distribution. The results of this study show a clear movement toward greater equality. A crossing point between Lorenz curves in the years 1965 and 1970 is the only anomaly. The crossing occurs at 90% of cumulative population which show a better distribution in the year 1970 compared to the 1965. In general, however, there will be improvement in the income distribution from 1965 to 1985. An important set of social indicators for Indonesia is presented in Table 27 and 28. From this table, it can be seen that one of the important factors that slows economic growth is population growth. Total population growth on average is 2.2% per year. The poverty line set by the United Nations at $ 130 per capita for urban population and $ 109 per capita

PAGE 90

81 for rural population would make an arithmatic average of $ 119.50 per capita. It is assumed that the poverty line is constant over the period of the study and only changes due to varying exchange rates. Table 27 1988 Social Indicator Data Sheet Indonesia Reference Groups 1965 AREA Total land area 1,919.3 Agriculture (%) 15.5 GNP PER CAPITA ($) 30 POPULATION Total Population 104.8 Urban Pop. (%) 16 Pop. Growth Rates: Total (%) Urban (%) Pop. Projection in 2000 *) in thousand square km. **) in million. 1975 1,919.3 16.7 210 130.2 19 2.2 4.3. Most Recent Estimate 1,919.3*) 17.0 450 169.7**) 26 2.3 5.0 212.9 Lower mid Income 730 38 2.5 4.2 Upper mid Income 2,510 64 2.0 3.2

PAGE 91

82 Table 28 1988 Social Indicator Data Sheet Indonesia Reference Groups Most ----------------Recent Lower Upper 1965 1975 Estimate mid mid INCOME, CONSUMPTION, AND POVERTY: Energy Consumption per capita (kg of oil eq) Percentage of Private Income received by (households) : Highest 10% Highest 20% Lowest 20% Lowest 40% Est. absolute Poverty Income level ($ p.c.) Urban Rural Est. Pop. below absolute Poverty Income Level (%) Urban Rural -) data not available. 130 34 49 7 14 136 112 28 51 219 124 106 26 44 Income Income 351 1,313

PAGE 92

83 On the basis of this absolute value in Table 29, the income distribution would be increased. This absolute can only be used as a guidance to indicate the change in income distribution over time in absolute term, and do not really provide an absolute answer to the income distribution problem. From this table, it can be conclude that as the Rupiah poverty line increase, the percentage of total population below poverty line decrease. Year 1965 1970 1975 1980 1985 Table 29 Income Distribution in Indonesia Absolute Poverty Line Below Poverty Line % Total 32 8 2 2 2 Above Poverty Line % Total 68 92 98 98 98 Poverty Line (X 1_, 0 0 0 Rp ) 36.45 45.17 49.59 74.69 134.44 Source: Author's calculation from data available.

PAGE 93

CHAPTER VI CONCLUSIONS Economic development after the New Order Government took place in 1966 suggests rapid growth in the early part (1968-1981}, due to the priority of Indonesian government on the economic restoration and the oil boom starting in the year 1973. During that period (1968-1981} economic growth stood at an average of 7.5 -7.7% per year. Economic growth in this period spurred greater income equality as can be seen from Lorenz curves. This is consistent with Generalized Lorenz Curves. All of the analyses, show a positive correlation between economic growth and income distribution for the period after the New Order Government until 1981.

PAGE 94

BIBLIOGRAPHY Albrecht, William P., Jr. Economics. Englewood Cliffs, New Jersey: Prentice-Hall, Inc., 1983. Atkinson, A. B. "On Measurement of Inequality." Journal of Economic Theory, 2, 1970. Bank Indonesia. Indonesian Financial Statistics, Jakarta: Bank Indonesia, various issues from 1965 to 1987. Report for the Financial Years. Jakarta: Bank Indonesia, various issues from 1965 to 1987. Weekly Report. Jakarta: Bank Indonesia, various issues from 1965 to 1987. Bails, Dale G., and Larry c. Peppers. Business Fluctuations: Forecasting Techniques and Applications. Englewood Cliffs, New Jersey: Prentice-Hall, Inc., 1982 Baumel, William J., and Alan S. Blinder. Economics Principles and Policy: Macroeconomics. San Diego, California: Harcourt Brace Jovanovich, Publishers, 1988. Blaug, Mark. Economic Theory in Retrospect. Cambridge: Cambridge University Press, 1987. Box, George E.P., and Gwilym M. Time Series Analysis Forecasting and Control. Oakland, California: Holden-Day, Inc., 1976. Branson, William H. Macroeconomic Theory and Policy. New York: Harper & Row, Publishers, 1979. Cairncross, Alec, and Mohinder Puri. Employment, Income Distribution and Development Strategy: Problems of the Developing Countries. New York: Holmes & Meier Publishers, Inc., 1976. Central Bureau of Statistics. Penduduk Indonesia 1985 Menurut Propinsi. Seri Supas 85 no. 3. Jakarta, Indonesia, 1986. Central Bureau of Statistics. National Income of Indonesia: 1983-1985. Jakarta, Indonesia, 1986. Department of Information Republic of Indonesia. REPELITA I -IV. Jakarta, Indonesia, 1969 -1989.

PAGE 95

86 Dolan, Edwin G. Basic Macroeconomics. Hinsdale, Illinois: The Dryden Press, 1980. Dornbusch, Rudiger, and Stanley Fischer. Macroeconomics. New York: McGraw-Hill Book Company, 1984. Dornbusch, Rudiger. Open Economy Macroeconomics. Basic Books, Inc., Publishers, 1980. Eltis, w. A. Growth and Distribution. New York: John Wiley & Sons, 1973. Fields, Gary S. Poverty, Inequality, and Development. Cambridge: Cambridge University Press, 1980. Friedman, Lee s. Microeconomic Policy Analysis. New York: McGraw-Hill Book Company, 1984. Gelb, Alan, and Associates. Oil Windfalls Blessing or Curse? Washington D.C. (A World Bank Research Publication): Oxford University Press, 1988. Gillis, M., Dwight H. Perkins, Michael Roemer, and Donald R. Snodgrass. Economics of Development. New York: W.W.Norton & Company, 1987. Glahe, Fred R. Macroeconomics: Theory and Policy. San Diego, California: Harcourt Brace Jovanovich, Publishers, 1985. Glahe, Fred R., and Dwight R. Lee. Microeconomics:-Theory and Applications. New York: Harcourt Brace Jovanovich, Inc., 1981. Glassburner, Bruce. The Economy of Indonesia. Ithaca, New York: Cornell University Press, 1981. Goode, Richard. Government Finance in Developing Countries. Washington, D.C.: The Brookings Institution, 1984. Gwartney, J. D., J. R. Clark, and Richard Stroup. Essentials of Economics. Orlando, Florida: Academic Press, Inc., 1985. Harris, Laurence. Monetary Theory. New York: McGraw-Hill Book Company, 1981. Heilbroner, Robert L., and James K. Galbraith. Understanding Microeconomics. Englewood Cliffs, New Jersey: Prentice-Hall, Inc., 1987.

PAGE 96

Higgins, Benjamin. Indonesia's Economic Stabilization, and Development. Westport, Connecticut: Greenwood Press, Publishers, 1981. Higgins, Benjamin. Economic Development: Principles, Problems, and Policies. New York: W.W. Norton & Company, Inc., 1968. International Monetary Fund. International Financial Statistics. New York, 1966-1987. Laidler, David E. W. The Demand for Money: Theories, Evidence, and-Problems. New York: Harper & Row, 1985. Mallakh, Ragaei El, and Carl McGuire. Energy and Development. Boulder, Colorado: The International Research Center for Energy and Economic Development, 1974. Meier, Gerald M. Leading Issues in Economic Development. New York, Oxford: Oxford University Press, 1984. Miller, Roger Leray. Economics Today: The Micro View. Cambridge: Harper & Row Publishers, Inc., New York, 1988. \ 87 Mishkin, Frederic S. The Economics of Money, Banking, and Financial Markets. Boston and Toronto: Little, Brown and Company, 1986. Nasution, Anwar. "The Indonesian Economy as an Open Economy: A Theoretical and Policy Approach." Prisma, no. 44, Jakarta, Indonesia. Papanek, Gustav F. The Indonesian Economy. New York: Praeger Publishers, 1980. Phillips, James A. Economics. Pacific Palisades, California: Goodyear Publishing Company, Inc., 1975. Pindyck, Robert S. The Structure of World Energy Demand. Cambridge, Massachusetts, and London: The MIT Press, 1979. Prachowny, Martin F. J. Money in the Macroeconomy. Cambridge: Cambridge University Press, 1985. Ritter, Lawrence S. and William L. Silber. Principles of Money, Banking, and Financial Markets. New York: Basic Books, Inc., Publishers, 1986.

PAGE 97

88 Salvatore, D. and Eugene A. Diulio. Theory and Problems of Principles of Economics. New York: Schaum's Outline Series, McGraw-Hill Book Company, 1980. Salvatore, D. and Edward Dowling. Development Economics. New York: McGraw-Hill Book Company, 1977. Shorrocks, A. F. "Ranking Income Distributions." Economica, 50, 1983. Smith, w. James, John P. Formby, and John A. Bishop. "Stochastic Dominance, Income Distribution Function and Economic Development." Preliminary Paper on Economic Development, Denver, Colorado: 1989. Tobin, James. Policies for Prosperity. Cambridge, Massachusetts: The MIT Press, 1989. Todaro, Michael P. Economic Development in the Third World. London and New York: Longman Inc., 1978. Todaro, Michael P. The Struggle for Economic Development. New York and London: Longman Inc., 1983. World Bank Publication. Social Indicators of Development 1988. Washington, 1988.