Sources of Economic Growth in Indonesia, 1966-2003

This paper undertakes an empirical investigation of factors that contributed to economic growth in Indonesia for the period 1966 to 2003. A Cobb-Douglas production function is estimated with a time trend to capture the rate of technological progress within a cointegral and error-correction modeling framework. In the estimated production function, the coefficients on both capital and labor bear a positive sign and are statistically significant. As the sum of these coefficients appears significantly lower that one, by imposing the restriction of constant returns to scale, the production function is re-estimated in per-capita form. The estimated long-term parameter values are then used to compute the contributions of capital, labor and technology to economic growth for the periods 1966 to 2003, 1966 to 1981, 1982 to 1996, and 1982 to 2003. The computed sources of growth indicate that for the last 40 years the most important source of growth in Indonesia was capital accumulation, about 60 percent. The contribution of labor to economic growth during this period was about 32 percent, while technological progress contributed the remaining 8 percent. The dynamic behavior of output growth is examined by estimating an error-correction model of per-capita real GDP, which explains about 83 percent of the variations of productivity growth over the period 1967 to 2003. Within a Granger-causality framework, the impacts of key indicators of macroeconomic policies and external developments, such as budget deficits, inflation, trade openness, the growth rate of the real exchange rate and the growth rate of the external terms-of-trade, on per-capita output growth are also individually examined for the period 1967 to 2003. The test results suggest that trade openness, the real exchange rate depreciation and changes in the external terms of trade have a feedback causal relationship with per-capita output growth. However, inflation and budget deficits do not have any significant causal effect on productivity growth.