Rising divide: why inequality is increasing and what needs to be done

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In 2014, the richest 10 per cent of Indonesian households consumed as much as the poorest 54 per cent.  Image by Google Maps.

Since the 1990s, inequality has risen faster in Indonesia than in any other East Asian country apart from China. In 2002, the richest 10 per cent of households consumed as much as the poorest 42 per cent. By 2014, they consumed as much as the poorest 54 per cent. Why should we be worried about this trend? What is causing it, and how is the current administration addressing rising inequality? And what still needs to be done?

Inequality is not always bad; it can provide rewards for those who work hard and take risks. But high inequality is worrying for reasons beyond fairness. High inequality can impact economic growth, exacerbate conflict, and curb the potential of current and future generations. For example, recent research indicates that, on average, when a higher share of national income goes to the richest fifth of households, economic growth slows—whereas countries grow more quickly when the poorest two-fifths receive more.

Poorer households may lack the means to send their children to school and keep them healthy, reducing how productive they become as adults. They may also lack the means to start small businesses. These wide disparities in living standards can lead to social tension, political uncertainty and increased conflict. In Indonesia, districts with higher inequality report 60 per cent more conflict than districts with lower inequality.

Inequality is rising in Indonesia for four main reasons. First, many Indonesian children, especially those from poorer households and in rural areas, do not get the same start in life as those from wealthier families. As a result, they grow up less healthy and less skilled. One third of all differences in adult Indonesians’ living standards today can be explained by factors beyond their control: their parents’ education, where they were born, and their gender.

Second, because only a lucky few leave school with the skills valued in a modern economy, they enjoy high wages from formal jobs. Conversely, the majority of unskilled workers find themselves trapped in low productivity, low wage and informal jobs. This wage gap between skilled and unskilled workers has led to increasing wage inequality over time.

Third, ownership of financial and property assets in Indonesia is increasingly concentrated in the hands of the wealthiest. By one estimate, 50 per cent of all such assets are owned by the richest 1 per cent of Indonesians – this concentration of wealth is among the highest in the world. These individuals enjoy significant incomes from these assets, leading to more inequality. Their children inherit this wealth, growing up more advantaged and benefitting from better jobs.

And fourth, only civil servants and richer households have health and employment-related insurance and pensions, as well as significant savings. When shocks strike – whether related to illness, job loss, or natural disasters – most Indonesians are forced to borrow from friends and family, sell income-creating assets such as livestock, or pull their children out of school to save costs and earn money. This vulnerability means that many Indonesians fall into poverty each year. More than half of all poor in Indonesia this year were not poor the year before.

Ordinary Indonesians, when asked by a national survey how much of the national income should go to the richest fifth of Indonesians, responded that ideally it would be 28 per cent. They estimated, however, that it may be 38 per cent. The reality is more extreme. According to official data, 49 per cent of all consumption is enjoyed by the richest five per cent of the population.

Indonesians support better policies that can reduce inequality: 88 per cent of survey respondents agree that the government should urgently address inequality, and suggest programs that can bolster social protection, job creation, and reduce corruption. There is less enthusiasm for proposals to improve schools and infrastructure, and to increase taxes for the rich.

There are strong signs the administration of President Joko Widodo wants to reverse rising inequality. The recent World Bank report on Indonesian inequality(link is external) was presented to a full cabinet meeting, and formal targets for reduced inequality are included in the Medium-Term Development Plan (RPJM). Key actions have taken place. Wasteful fuel subsidies enjoyed mainly by richer households have been largely eliminated and the funds redirected to better spending for social assistance, health care, and infrastructure investment. Job creation is being eased through simpler business and labour market regulations. New initiatives to increase tax compliance have the potential to reduce inequality both directly (by reducing income disparity) and indirectly (by funding public spending that benefits the poor).

More action can be pursued. While access to health care and education has improved for poorer and rural children, they often receive poorer quality services. This has contributed to Indonesia ranking near the bottom of the international student assessments(link is external). Efforts to ensure more equal access to quality education should be strengthened. More action is also needed to improve the skills of those already in the labour force, through second-chance and on-the-job training. Increasing workers’ skills is not enough. Better jobs can be created through regulations that encourage higher-paying formal jobs and increased worker productivity through better infrastructure. In addition, unfair accumulation of wealth, whether through corruption or cronyism, warrants greater scrutiny. And even when income is fairly gained, proper taxes need to be paid.

Finally, more can be done to cushion the poor and vulnerable from shocks. High food prices can be mitigated by improving agricultural productivity and logistics, as well as allowing imports to reduce local prices in times of short supply. And social safety nets – social insurance and social assistance – can be strengthened.

International experience shows that a comprehensive strategy across many areas, combined with determined political will, can make significant progress now and in the future. Indonesia is taking steps towards preparing this strategy. Reversing rising inequality will be difficult, but it is critical to Indonesia’s future.

This post was adapted from Matthew Wai-Poi’s presentation at the “Who is benefiting from Jokowi’s economic policies” seminar, delivered at the Asia Institute on 21 April. View the original presentation here

This blog was first published by Indonesia at Melbourne


Matthew Wai-Poi

Lead Economist, World Bank

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