Inequality in Indonesia: Trends, drivers, policies

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1 Inequality in Indonesia: Trends, drivers, policies Taufik Indrakesuma & Bambang Suharnoko Sjahrir World Bank Presented at ILO Country Level Consultation Hotel Borobudur, Jakarta 24 February 2015

2 Indonesia has enjoyed strong growth since the Asian Financial Crisis, with a growing middle class Real GDP Growth (%) Millions of People Strong economic growth with a rising middle class ,200 1, Trillions of Rupiah -15 Population Consumption Source: BPS Source: BPS

3 but vulnerability remains high, with small shocks easily sending households into poverty Percentage of Population Many live near poverty and enter poverty easily m Vulnerable 28m Poor 1 in 4 Indonesians in 2010 were poor at least once in the past three years Between 1.0x and 1.5x Poverty Line Below Poverty Line Source: Susenas 2013 Source: Susenas Panel, WB staff calculations

4 The rate of poverty reduction is slowing and the economic growth is not being shared by all Percentage Point Change in National Poverty Rate Percent Poverty reduction is slowing Source: BPS The rate of poverty reduction has been slowing Growth is unequal Growth in National Mean Consumption ( ) Household Per Capita Consumption Decile Source: Susenas, World Bank calculations Notes: Annualised real consumption growth (adjusted for spatial and temporal purchasing power)

5 Outline 1 Inequality is rising 2 and the drivers are.. 3 Lessons learnt from other countries 4 for policy discussion in Indonesia.

6 Inequality is increasing Gini Coefficient, inequality broadly stable, beginning to rise at the end of the period until the AFC, which affected the rich more than the poor however, the subsequent economic recovery and sustained period of growth has seen inequality rising again Asian Financial Crisis Source: Notes: Susenas Nominal consumption Gini coefficient

7 and it is felt by many Indonesians People believe Indonesia is unequal and that inequality has been increasing Almost all Indonesians think that Indonesia is more unequal than they would like Over 90 percent of survey respondents said that Indonesia was unequal 40 percent said that Indonesia was very unequal Source: Inequality Perceptions Survey (LSI) They also think that inequality has grown significantly in recent years Almost half of all respondents say that inequality has increased in the last five years Only 15 percent say that it has fallen On average, people believe that the incomes for the richest 20 percent have grown rapidly They believe that incomes for the next 20 percent have grown moderately They believe that incomes for the bottom 60 percent have stayed about the same

8 Inequality is not only increasing in Indonesia, but it is doing so at one of the fastest rates in the region Average Annual Change in Gini, 1990s and 2000s Note: Consumption Ginis for all countries except Malaysia, which uses income. The periods for each country are: Indonesia ; Malaysia ; Lao PDR ; China ; Vietnam ; Thailand ; the Philippines ; and Cambodia Source: Kanbur, Rhee and Zhuang (2014) Inequality in Asia and the Pacific, from PovCalNet; World Bank calculations.

9 Millions of People Moreover, Indonesian inequality is underestimated, with many wealthier households not in the data Household Consumption: Susenas Distribution (2011) Wealthier Households in Susenas (2011) >$10 a day (~Rp.2m/month) Only 5 million people 2 percent of population >$20 a day (~Rp.4m/month) Only 845,000 people < 0.5 percent of population <$1.25 $ $2-4 $4-10 $10-20 >$20 Source: Susenas and World Bank calculations Missing High Incomes does not mean the super-rich!

10 Outline 1 Inequality is rising 2 and the drivers are.. 3 Lessons learnt from other countries 4 for policy discussion in Indonesia.

11 Inequality is partly due to differences between districts, education and employment 100% Consumption Inequality: Contribution of Differences Within and Between Groups % 60% 40% 20% 0% Urban-rural Provincial District HOH Gender HOH Education HOH Sector HOH Formal Proportion in Agriculture Proportion Formal Within-group Inequality Between-group Inequality Source: Susenas, World Bank calculations Notes: Decomposition of Theil L Index (GE(0))

12 but it is the education and employment gaps which are widening, not geographical ones Change in Theil, Consumption Inequality: Change in Theil Index by Within and Between Components Within-group differences are behind nearly all of the recent increase in inequality Urban-rural Provincial District HOH Gender HOH Education HOH Sector HOH Formal Proportion in Agriculture Proportion Formal although formality and education are also leading to higher inequality Within-group Inequality Between-group Inequality Source: Susenas, World Bank calculations Notes: Decomposition of Theil L Index (GE(0))

13 Increases in inequality are partly driven by increase in skill premium Percent Percent Jobs are requiring more education Employment by Education Level Tertiary SMA SMP SD or less meaning workers with more education receive higher wages LHS: Source: Sakernas, World Bank calculations. RHS: Worker wage premium represents how much higher wages workers at each level of education receive compared with workers with primary or less education, controlling for experience, gender, work status, location and other factors. Household consumption premium represents the same thing for per capita consumption and head of household s education. Source: Sakernas, Susenas and World Bank calculations Worker Wage Premium SMP SMA Tertiary SMP SMA Tertiary Household Consumption Premium

14 Poor workers in Indonesia are only able to access low productivity jobs Value Added Per Worker (2005 PPP$) Indonesia s labour productivity significantly lags neighbours meaning most existing and new jobs are not productive 25,000 20,000 15,000 10,000 71% All Jobs 71% of all workers in low-productivity sectors: agriculture, retail & trade, social and personal services 5,000 0 Agriculture Manufacturing Retail & Trade 60% New Jobs 60% created in lowproductivity sectors: retail & trade, social and personal services Malaysia Thailand Indonesia Source: BPS (aggregate value added), Sakernas (worker #s), CEIC (Malaysia and Thailand) Source: Sakernas (2013), WB staff calculations

15 Changei ncpi (%) Minimum wage setting has neither protected workers nor rewarded their productivity Changein Value Added Per Worker (%) Minimum wage increases are not correlated with increases in cost of living Minimum wage increases are not correlated with productivity Provincial Min. Wage vs CPI Inflation Provincial Min. Wage vs Labour Productivity R² = R² = Change in real minimum wage (%) Change in Minimum Wages (%) Source: Sakernas, World Bank calculations. Source: Sakernas, World Bank calculations.

16 Increases in inequality are being driven by the skill premium and a greater impact of shocks Change in Gini Decomposed Key Changes Leading to Higher Inequality Percent of Total Change Explained Residual Structure (shocks and variance) 133 Increasing Returns to Education 28 Changing Returns to Sector of Work 12 Key Changes Leading to Lower Inequality Increased Endowments (e.g. urban migration, higher education, more formal work) Decreasing Urban-Rural Gap -23 Decreasing Provincial Gaps -16 Decreasing Work Type Gaps -8 Source: Susenas, World Bank calculations Notes: Counterfactual simulations of consumption distribution using Juhn-Murphy-Pierce method and an occupational choice model. Key results only shown -28

17 Outline 1 Inequality is rising 2 and the drivers are.. 3 Lessons learnt from other countries 4 for policy discussion in Indonesia.

18 Brazil has been effective in reducing inequality, albeit from a very unequal starting point Gini Coefficient, Brazil and Latin America Brazil Latin America* Source: Notes: World Bank (2012): Inequality in Focus Latin America is an average of 17 countries

19 This was achieved through macro-economic stability and educational expansion Macro-economic stability and growth have benefitted the poor Poor do not have access to financial instruments that protect them from inflation Economic expansion has driven job creation Expansion in primary and secondary expansion has changed the labour force profile Brazil s inequality in labour income had been driven by inequality in education Concerted policy effort to expand education for poorer households In 1993, a child of a father with no formal education would complete 4 years of schooling; now students complete 9-11 years, regardless of parents education As more workers become skilled, they benefit from higher wages At the same time, this means there are less unskilled workers Economic growth also increased demand for unskilled workers, so unskilled wages increased as well Wage differences between skilled and unskilled have fallen Changes in labour incomes represent 2/3 of inequality reduction

20 as well as pro-poor spending and better social policies More pro-poor incidence of social spending Nearly half of all government spending is social spending (cash transfers, health and education) Expansion in social assistance spending Increased contributory and non-contributory government transfers account for 30 percent of reduction in Gini from Bolsa Familia (CCT) Now covers 25 percent of households Single largest contribution to reaching the poor and reducing inequality Beneficio de Prestacao Continuada (non-contributory pensions) Greater benefit levels than CCT, but less contribution to reducing inequality However, generous formal and public sector social security programs have been highly regressive

21 Outline 1 Inequality is rising 2 and the drivers are.. 3 Lessons learnt from other countries 4 for policy discussion in Indonesia.

22 What can be learnt from the international experience for policy discussion in Indonesia? Sound macro and fiscal policies are the foundation of a fair and prosperous society Macro stability Effective Fiscal spending Invest in education and skill development Long term: Reform the education system to improve gains in quality Short term: Current provision of training both private and public is low Address productivity Formula-based Minimum Wage setting that is simple, certain and fair Explicitly tied with inflation, productivity and growth

23

24 EXTRA SLIDES

25 Both long-term and short-term solutions must be used in tandem to improve worker skills Gains in the quality of Indonesian education have been low Education improvements don t address short term concerns Current provision of training, both private and public, is low PISA scores, Indonesia Even if reforms were immediately made to basic and secondary education, the benefits would only be reaped by the year Firms that report offering formal training opportunities for their employees Large (100+) Medium (20-99) Small (5-19) Indonesia EAP World Non-exporter Exporters (>10% of sales) 360 Foreign (more than 10%) Domestic Share of firms providing formal training Reading Math Science Source: World Bank, Enterprise Surveys 2009 Education reforms should focus on quality and skills, not just expansion of access Education reforms must be complemented with reforms in skills training and upgrading A demand-driven skills training system, with employers heavily involved in the development of competency standards

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