Indonesia's resources boom: Curse or blessing?

In the eight years after 2003, global prices, in real terms, for most energy and metals commodities and for some agricultural commodities, rose to their highest levels ever. Indonesian exports in inflation-adjusted US dollars more than quadrupled in value between 2003 and 2011 and the share of commodities in total exports rose from 52% to 68%. Indonesian average incomes grew strongly for a while, without a sustained focus on policies supporting economic growth.

Indonesia's resources boom fuelled growth in average incomes, after a difficult climb out of the 1997–98 Asian financial crisis. It also encouraged the emergence of economic structures and policies (and features of the new democracy's political culture) that made sustainable and equitable growth more difficult. With the resources boom having retreated since 2011, Indonesia faces major challenges.

The boom was caused by exceptionally strong resource-intensive growth in China. It continued, with only a brief interruption during the 2008 Global Financial Crisis, until 2011, when Chinese economic development began to show the influence of a new model of economic growth.

Resources, principally petroleum, had been the mainstay of early export growth under Soeharto's New Order government, from 1966. Enough oil revenue was used for public purposes to support broad-based development through the public provision of education, health, agricultural services and income support, and through the subsidised provision of agricultural inputs.

This all changed with the collapse of global oil prices in the mid-1980s. After the withdrawal of opportunities for economic growth based mainly on petroleum exports, Indonesia embarked successfully on reform to promote internationally oriented industrialisation of the kind that had underpinned development elsewhere in East Asia. For more than a decade, Indonesia's industrialisation supported sustained growth in economic output of 6–7% per year and higher. The benefits were widely distributed through the growth in demand for labour and the associated increases in employment and wages, supported by considerable public expenditure directed at improving rural services. The political and economic foundations of this rapid, broad-based growth were destroyed by the 1997–98 Asian financial crisis.

It was a great achievement of President Susilo Bambang Yudhoyono in his first term (2004–9) to demonstrate that it was possible to use economic policy to secure stable growth in democratic Indonesia. Then the global resources boom offered new opportunities for resource-intensive growth.

The challenges facing Indonesia now, after the resources boom, are in important ways similar to those that followed the fall in petroleum prices in the mid-1980s: for one, the boom encouraged economic interventions that damaged efficiency in resource allocation and prospects for long term growth. So was the boom a blessing or a curse, or both? Indonesia now has the opportunity to enter a new era of broad-based development, but only by implementing far-reaching reform.

The international environment after the resources boom should be conducive to the macroeconomic adjustment that Indonesia has to make if it is to maintain growth without risking an external financial crisis. The end of China's resources boom and the shift towards the normalisation of US monetary policy are helpful to exchangerate depreciation. The new pattern of growth in China offers expanded opportunities for exports of manufactures, high-value foodstuffs, and services. The dramatic fall in global oil and gas prices from mid-2014 has provided a congenial environment for the removal of energy subsidies, providing fiscal room for a large expansion of public expenditure on productivity-raising infrastructure and other public goods. The markedly lower international real interest rates on sovereign debt since 2000, and especially since the 2008 crisis, offer strong support for a government committed to increased expenditure on infrastructure. China's intentions to increase its funding of infrastructure in developing countries are reflected by its commitment to fund the Asian Infrastructure Investment Bank.

Substantial depreciation of the real exchange rate is required. Reform to accelerate productivity growth can assist real depreciation, but policy reform and reflection of reform in higher productivity take time. Firmer budgets and correspondingly easier monetary policy, supported by domestic cost and income restraint, are therefore the main supports for early depreciation of the exchange rate.

Maintaining reasonably strong productivity growth as a foundation for higher growth in the future requires the unwinding of distortions in the operation of markets. It also requires reform of the political system that shapes economic regulation and policy.