Aspiring Indonesia —Expanding the Middle Class SEPTEM B E R 2019 Why should we care How can we expand about the middle class? the middle class? There are a number of reasons What will be required to bring the why the middle class matters to 115 million people who are no longer Indonesia. It is linked to economic poor into the middle class? The future growth in several important ways, of Indonesia lies partly in the fate of which we explore. But it also this aspiring middle class so that they plays important social & political can both share in & help to drive the roles, which have consequences country’s growing prosperity. not only for growth but also for governance & policy. © 2019 The World Bank Some rights reserved 1818 H Street NW, This work is a product of the staff of The Bank or the governments they represent. in this work do not imply any judgment Washington DC 20433 World Bank. The findings, interpretations, The World Bank does not guarantee the on the part of The World Bank concerning Telephone: 202-473-1000; and conclusions expressed in this work accuracy of the data included in this work. the legal status of any territory or Internet: www.worldbank.org do not necessarily reflect the views of The boundaries, colors, denominations, the endorsement or acceptance of the Executive Directors of The World and other information shown on any map such boundaries. Rights and Permissions Attribution The material in this work is subject in whole or in part, for non-commercial Please cite the work as follows: “World All queries on rights and licenses, to copyright. Because The World purposes as long as full attribution to this Bank. 2019. Aspiring Indonesia: Expanding including subsidiary rights, should be Bank encourages dissemination of its work is given. the Middle Class. © World Bank.” addressed to World Bank Publications, knowledge, this work may be reproduced, The World Bank Group, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522- 2625; e-mail: pubrights@worldbank.org. I Foreword O Rodrigo A. Chaves The World Bank Country Director, Indonesia ver 50 years ago Indonesia was one of the access better jobs, especially higher paid formal poorest countries in the world. With growth jobs in services, which can propel them into the averaging 5.6 percent annually since then, the middle class. And because almost 40 percent country has remarkably reached middle-in- of those in the middle class fall back into the come status. Alongside one of the more rapid aspiring class, it will also require a comprehen- reductions in poverty in history, we also wit- sive social protection system to buffer people nessed the emergence of a vibrant and growing from the effects of major shocks. middle class in Indonesia. Today, one in five Indonesians are middle-class and are free from There is no time for complacency. There is a worry about poverty. risk that Indonesia’s middle class may not play the transformative role that it could. Already A stronger and more secure middle class is cru- there are signs that they are choosing to opt out cial for continuing Indonesia’s upward trajec- of supporting Indonesia’s development. Most of tory. The middle class is an engine of economic the middle class does not pay personal income growth, accounting for nearly half of all house- tax and increasingly more are bypassing public hold consumption. Representing 43 percent services for private health services and schools. of business owners, they generate many of the new jobs that employ the growing workforce. To ensure the participation of all those who They are more likely to invest in human capital currently belong to the middle class as well as for future generations and they pay nearly half those who aspire to do so, Indonesia will need to of all indirect taxes that finance government agree on a new social contract: a new pact that investments for growth. binds the state and its increasingly prosperous citizens in a mutually beneficial arrangement. If Indonesia is to realize its ambitions of spur- By providing higher-quality public services, ring growth and someday becoming a high-in- promoting upward mobility through access come country, it will need a much larger middle to better jobs, and building resilience through class. This will require a focus on promoting more effective social protection, the state will the aspiring middle class that includes the secure continued participation of its citizens in 115 million Indonesians – 45 percent of the the services it provides. And, by paying their population – who are no longer considered fair share in taxes, the citizens will enable the poor or vulnerable but have not yet been able state to finance these services. to reach middle class status. Providing them with a pathway to the middle class will not only Our hope is that this report will stimulate a help drive the country’s growing prosperity much-needed conversation about how to in- but it will also help in further reducing poverty crease upward mobility and developing a new and inequality. model of inclusive growth for Indonesia. Bol- stered with a clear diagnosis of the challenges Lifting aspiring Indonesians into the middle and inspired by clear policy directions ahead, class will require more students finishing their it is possible for Indonesia to achieve anoth- secondary and tertiary education in schools er miracle: avoiding the middle-income trap that can equip them with the skills needed in and transforming itself into an inclusive and the modern economy. This will position them to prosperous country. II Acknowledgements mist, GPV02), Sailesh Tiwari (Senior Econo- mist, GPV02), and Ikuko Uochi (Economist, A GPV02). Important inputs were received from Javier Luque (Senior Education Specialist, GED02), Iene Muliati (Senior Social Protection Specialist, GSP02), Juul Pinxten (Research An- alyst, GSP02), Vikram Rajan (Senior Health Specialist, GHN02), Jaffar Al Rikabi (Econo- mist, GMTP2), Changqing Sun (Senior Econo- mist, GSP02), and Kathy Whimp (Lead Public Sector Management Specialist, GGO14) Excellent comments were received from the peer reviewers Derek Chen (Senior Economist, GMTP2), Caterina Ruggeri Laderchi (Senior Economist, GPV03) and Andy Mason (Lead Economist, EAPCE), as well as from Frederico Gil Sander (Lead Economist, GMTP2), Hans Anand Beck (Lead Economist, GMTP1), and Alkadevi Morarji Patel (Senior Social Devel- opment Specialist, GSUID). This report has benefited greatly from their comments. spiring Indonesia is a product of the World The report was edited by Peter Milne (Con- Bank’s Poverty and Equity Global Practice sultant, GPV02), Edgar Janz, Jonathan Lain, team based in the Jakarta office. The team, and Kara Monica (Research Analyst, GPV02). led by Vivi Alatas (Lead Economist, GPV02), Graphic design and data visualization of the provides technical and policy advice based on report was created by Muhammad Kamal. sound empirical research and analysis to the Government of Indonesia in support of national This report was produced under the overall poverty reduction goals. Funding for this re- guidance of Salman Zaidi (Practice Manager, port has been generously provided by the Aus- GPV02) and Carolina Sanchez (Senior Di- tralian Government (through the Department rector, GPVDR). Strategic guidance and key of Foreign Affairs and Trade). comments were provided by Rodrigo Chaves (Country Director, EACIF) and Camilla Hol- This report was prepared by a core team led by memo (Program Leader, EACIF). Matthew Wai-Poi (Senior Economist, GPV05) and included Hamidah Alatas (Research As- The report uses East Asia and Pacific sistant, GPV02), Taufik Indrakesuma (Econ- cross-country comparisons from Wai-Poi, M., omist, GPV02), Edgar Janz (Senior Poverty Purnamasari, R., Indrakesuma, T., Uochi, I. Specialist, GPV02), Jonathan Lain (Economist, and Wijaya, L. (2016) East Asia’s Rising Middle GPV02), Ririn Purnamasari (Senior Econo- Class, World Bank. III Contents 01 ES Executive Summary 67 01 Introduction 81 03 What Is the Middle Class & How Large Is It? 75 02 The Middle Class: Why Do We Care? 3.1 The Middle Class can be defined in different ways.... 84 2.1 Linking the middle class to economic growth.......... 78 3.2 Indonesia’s Middle Class: growing rapidly............ 87 2.2 Exploring the social and political roles of the middle class................................................ 97 3.2 The Middle Class as an urban phenomenon.............. 92 IV 97 04 The Middle Class & Economic Growth 4.1 Middle-class consumption............................ 100 4.2 Middle-class education & skills..................... 107 4.3 Middle-class entrepreneurship....................... 111 4.4 Middle-class female labor participation............. 112 113 05 The Middle Class, Amenities & Public Services The middle class has been growing faster than other groups; there are now at least 52 million economically secure 5.1 Unfulfilled prosperity: economic security with non-.... Indonesians, or one monetary poverty.................................... 100 Indonesian in 5.2 Public health and education: accessible every five but ndesirable?..................................... 107 5.3 Gated communities: the embodiment of middle-class self-exclusion......................... 111 5.4 Expanding the middle class and Chapter 3 delivering benefits to all.......................... 112 Page 87 V 127 06 Expanding the Middle Class 6.1 Taking advantage of new formal service jobs with higher wages............ 129 6.2 Completing high school and getting job skills........... 133 With Indonesia now at middle-income status, the development challenge is increasingly becoming less one of poverty reduction & more one of escaping the middle-income trap. Chapter 7 Page 146 137 07 The Middle Class & the Social Contract 7.1 Aspiring to more than just economic security............ 140 7.2 The role of central & local government in meeting aspirations.................. 145 7.3 Driving the social contract: votes & money................ 151 7.4 Middle–class influence: benefiting or harming others?...................... 153 7.5 A New Social Contract........ 157 VI 159 08 A Common Cause for All Indonesians 169 09 Conclusion 8.1 Quality public services: linking financing & performance......................................... 161 8.2 Enhancing economic mobility through entrepreneurism..................................... 165 8.3 Economic security through effective & comprehensive social insurance.................................... 167 173 10 How to Expand the Middle Class: Sectoral Diagnoses & Recommendations 200 Annex VII List of Abbreviations, Acronyms & Indonesian Terms TERM DEFINITION AMC aspiring middle class BCG Boston Consulting Group BOP-PAUD Bantuan Operasional Pendidikan PAUD (ECED operational assistance grants) BOS Bantuan Operasional Sekolah (school operational funds) BPJS Badan Penyelenggara Jaminan Sosial (Social Security Provider Agency) VIII TERM DEFINITION BPKP Badan Pengawasan Keuangan dan Pembangunan (Financial and Development Supervision Agency) BPS Badan Pusat Statistik (Statistics Indonesia) CAGR compound annual growth rate CPD continuous professional development CPI consumer price index DAK Dana Alokasi Khusus (special allocation fund) Dapodik Data Pokok Pendidikan (basic education data) DAU Dana Alokasi Umum (general allocation fund) DD Dana Desa (village fund) DGT Directorate General of Taxes DKI Daerah Khusus Ibukota (capital city special area) ECED early childhood education EFC error, fraud, and corruption EKPPD Evaluasi Kinerja Penyelenggaraan Pemerintahan Daerah (local government performance evaluation) ES economically secure GDP gross domestic product GMC global middle class Hibah grant HIV human immunodeficiency virus ICT information and communication technology IFLS Indonesian Family Life Survey IPL international poverty line IT information technology JKN Jaminan Kesehatan Nasional (national health insurance) IX TERM DEFINITION MAC middle Class and affluent customer MC middle class MenPAN Kementerian Pendayagunaan Aparatur Negara dan Reformasi Birokrasi (Ministry of State Apparatus Empowerment and Bureaucracy Reform) MoH Ministry of Health MoEC Ministry of Education and Culture MSS minimum services standards NCD non-communicable diseases NPL national poverty line OECD Organisation for Economic Co-operation and Development OM-SPAN Online Monitoring Sistem Perbendaharaan dan Anggaran Negara (Online Monitoring of Treasury System and State Budget) OOP out-of-pocket PAUD Pendidikan Anak Usia Dini (early childhood education) PDR performance development review Pemekaran district splitting Pergub Peraturan Gubernur (governor regulation) PFM public financial management PIP Program Indonesia Pintar (Smart Indonesia Program) PISA Programme for International Student Assessment PIT personal income tax PPP purchasing power parity PTKP Penghasilan Tidak Kena Pajak (non-taxable income) Puskesmas Pusat Kesehatan Masyarakat (community health center) QSDS Quantitative Service Delivery Survey RPJMN Rencana Pembangunan Jangka Menengah Nasional (National Medium-Term Development Plan) X TERM DEFINITION Sakernas Survei Angkatan Kerja Nasional (national labor force survey) SEZ special economic zones SJSN Sistem Jaminan Sosial Nasional (National Social Security System) STR student-to-teacher ratio Susenas Survei Sosial Ekonomi Nasional (national socio-economic survey) TB tuberculosis TKD Tunjangan Kinerja Daerah (regional performance allowance) UC upper class UHC universal health coverage UN United Nations UNDP United Nations Development Programme USD United States dollar VAT value-added tax WVS World Values Survey XI List of Figures No. Title Page Figure E.1 Real GDP and GDP per capita growth, 1967-2016 (percent) 4 Figure E.2 Poverty headcount ratio and Gini coefficient, 1980-2017 (percent/points) 4 Figure E.3 Consumption distribution by class, 2002-16 (percent of population) 9 Figure E.4 Share of total national household consumption, 2002-16 (percent) 14 Figure E.5 Breakdown of consumption, 2016 (percent of total consumption) 14 Figure E.6 Selected durable ownership by class, 2016 (percent) 15 Figure E.7 Access to technology and information by class, 2016 (percent) 15 Figure E.8 Urban-rural breakdown of Indonesian consumption classes, 2002 and 2016 (million) 19 Figure E.9 Urban agglomerations with largest MC and AMC populations, 2016 [million (LHS) and 19 percentage of Figure E.10 Educational attainment by class, ages 25-29, 2016 (percent) 25 Figure E.11 Educational attainment by class, ages 25-34, 2016 (percent) 25 Figure E.12 Average Indonesian and OECD* PISA scores by Indonesian socioeconomic decile, 26 2015 Figure E.13 Occupational status of head of household by class, 2016 (percent) 28 Figure E.14 Female employment rates by class, 2016 (percent) 28 Figure E.15 Middle-class female labor-force participation in East Asia (percent) 28 Figure E.16 Change in jobs, 2001-16 by formality, occupational status and sector (million) 32 Figure E.17 Mean monthly earnings for formal, employee and services jobs by education 33 Figure E.18 Highest educational attainment by class, 25- to 34-year-olds, 2016 (percent) 35 Figure E.19 Public education spending incidence by consumption decile (Rp trillion) 36 Figure E.20 Important skills identified by employers, and skill gaps (percent) 36 Figure E.21 Non-monetary poverty by class, 2016 (percent) 38 Figure E.22 International PISA scores, 2006-15 (points) 40 Figure E.23 Choice of health care by class, 2016 (percent) 41 XII No. Title Page Figure E.24 Choice of school by class, 2015 (percent) 41 Figure E.25 Indonesian population projections by age group (million on LHS and percentage of 45 Figure E.26 Contributors, beneficiaries and pension system dependency ratio of SJSN Pension 45 Figure E.27 Incidence of indirect taxes, 2015 (Rp trillion) 49 Figure 1.1 Real GDP and GDP per capita growth, 1967-2016 (percent) 69 Figure 1.2 Poverty headcount ratio and Gini coefficient, 1980-2017 (percent/points) 69 Figure 3.1 Consumption distribution by class, 2002-16 (percent of population) 88 Figure 3.2 Urban-rural breakdown of Indonesian consumption classes, 2002 and 2016 (million) 93 Figure 3.3 Urban agglomerations with largest middle-class populations, 2016 [million (LHS) 94 Figure 4.1 Share of total national household consumption, 2002-16 (percent) 101 Figure 4.2 Breakdown of consumption, 2016 (percent of total consumption) 101 Figure 4.3 Vehicle ownership by class, 2016 (percent) 102 Figure 4.4 Selected durable ownership by class, 2016 (percent) 102 Figure 4.5 Reason for travelling on last trip, 2016 (percent) 105 Figure 4.6 Annual real national account growth in private consumption, 2002-15 by source 106 Figure 4.7 Average educational attainment by age cohort by class, 2016 (years) 109 Figure 4.8 Middle-class educational attainment in East Asia and Pacific (EAP) (years) 109 Figure 4.9 Employment sector of head of household by class, 2016 (percent) 110 Figure 4.10 Enrolment of children by class and age, 2016 (percent) 110 Figure 4.11 Access to technology and information by class (percent) 110 Figure 4.12 Occupational status of head of household by class 111 Figure 4.13 Female labor force participation by class, 2016 112 Figure 4.14 Middle-class female labor force participation in East Asia 112 Figure 5.1 Non-monetary poverty by class, 2016 (percent) 116 Figure 5.2 Poor housing conditions for the economically secure in East Asian countries 116 Figure 5.3 Access to education by class, 2014 (percent) 117 Figure 5.4 Access to health facilities by class, 2014 (percent) 117 Figure 5.5 Puskesmas readiness to provide health services (percent) 118 Figure 5.6 Choice of health care by class, 2016 (percent) 119 Figure 5.7 Choice of school by class, 2015 (percent) 120 XIII No. Title Page Figure 5.8 Type of health facility used by class in selected East Asian countries (percent) 121 Figure 6.1 Change in jobs, 2001-16 by formality, occupational status and sector (million) 130 Figure 6.2 Education by formality, occupational status and sector, 2016 (percent) 131 Figure 6.3 Highest educational attainment by class, 25- to 34-year-olds, 2016 (percent) 134 Figure 6.4 Central government public spending on education by level, 2016 (percent) 135 Figure 6.5 Important skills identified by employers, and skill gaps (percent) 135 Figure 6.6 Enrolment by age by class, 2016 (percent) 136 Figure 7.1 Economic security and self-perceptions of middle class in Malaysia and Thailand 141 Figure 7.2 Share of population aged 65 and above, 1950-2070 (percent) 146 Figure 7.3 Incidence of indirect taxes, 2015 (Rp trillion) 148 Figure 7.4 Personal income tax revenue as a percentage of GDP 148 Figure 7.5 Political salience indicators, 2002 and 2016 (percent/points) 152 Figure 9.1 “How urgent is it for the government to reduce inequality?” 171 Figure 10.1 School enrolment rate of population aged 16-18 years old by family expenditure group, 176 2000-14 Figure 10.2 Evolution of PISA math scores and student enrolment, 2003-15 177 Figure 10.3 Evolution of enrolment among the poorest decile across selected PISA countries, 177 2003-15 Figure 10.4 Math PISA scores by socioeconomic decile 178 Figure 10.5 Reading PISA scores by socioeconomic decile 178 Figure 10.6 Coverage of key cost-effective interventions 184 Figure 10.7 Indonesia’s level of public expenditure is relatively low… 188 Figure 10.8 …which means spending on priority areas does not meet government needs 188 Figure 10.9 Indonesia suffers from low revenues 189 Figure 10.10 Tax collections are lower than both regional peers and countries with similar GDP per 189 capital Figure 10.11 Indonesia’s VAT registration threshold as a share of real per capita GDP is the highest 189 in the world Figure 10.12 Indonesia has one of the highest cigarette consumption levels in the world, with the 189 highest smoking prevalence Figure 10.13 Most of the middle class is exempt from paying PIT… 190 XIV No. Title Page Figure 10.14 …leading to low personal income tax revenues 190 Figure A.2.1 Probability curve of being poor next year given this year’s consumption 207 Figure A.2.2 Probability curve of being vulnerable next year given this year’s consumption 207 List of Tables No. Title Page Table E.1 Class definitions (2016 per-capita consumption) 9 Table E.2 Mobility matrix 1993-2014 (percent) 44 Table E.3 Mobility matrix 2000-14 (percent) 44 Table 3.1 Class definitions (2016 per-capita consumption) 88 Table 9.1 Three most important policies for addressing inequality by class (percent) 172 Table 10.1 School characteristics by socioeconomic conditions 178 Table 10.2 Health expenditure in Indonesia and selected countries, 2015 183 Table A.1.1 Summary of Middle-Class Definitions 205 List of Boxes No. Title Page Box E.1. Who are members of the middle class? 7 Box 3.1 The number of the wealthiest Indonesians is under-estimated in survey data; recent 89 work addresses this Box 3.2 Prospering on the land: economic security in Thailand, Vietnam, Cambodia and Lao 95 PDR Box 5.1. Middle-class opting out in China 122 Box 7.1. The Malaysian experience: from ‘economically secure’ to ‘aspirational’ 141 Box 7.2. Policy options to tackle aging in the East Asia and Pacific 147 Box 7.3. China’s middle class: reformers or co-opted? 155 Aspiring E X P A N D I N G T H E M I D D L E C L A S S A WORLD REPORT BANK Indonesia Overview ASPIRING INDONESIA XVII EXECUTIVE SUMMARY ASPIRING INDONESIA XVIII EXECUTIVE SUMMARY Over the past half century, Indonesia has While a continued focus on poverty and vul- middle class (AMC), and how its members contract for all, including providing higher are currently in it and those who will join— new jobs for others. Mobility can also be pro- seen strong economic growth and substan- nerability remains vital, Indonesia’s next differ from the many millions of middle-class quality public services and better tax policy can be secured from the shocks that can affect moted through economic reforms, including tial decreases in extreme poverty, enabling challenge is to bring many more millions of Indonesians who have not only emerged from and administration—the only way to ensure everyone. Finally, strengthening tax policies closing the infrastructure gap, improving how it to achieve middle-income status. In 1967, aspiring Indonesians into the middle class. poverty but, unlike the aspiring middle class, that Indonesia can pay for the transition from and compliance by the current middle class and decentralization is working, better leveraging Indonesia’s GDP was just US$657 per person, Despite the massive reductions in poverty, 35 have also achieved economic security. Final- middle-income to high-income status. The re- boosting new collections from an expanding urbanization, and targeted place-based poli- making it one of the poorest countries in the percent of Indonesians remain poor or vulner- ly, it examines what the government can do port finishes by looking at possible recommen- middle class mean that there should be ade- cies for lagging regions. Finally, effective and world. Over the next 50 years, with growth av- able, and sustained attention is required to li t to significantly expand the middle class to the dations for addressing the challenges in four quate financing for needed investments. sustainable health, employment and old-age eraging 5.6 percent annually, GDP per capita them out of subsistence and provide them with millions (the 115 million people in the AMC) main areas, namely education, health, taxation insurance can provide the safety net that the grew six-fold to nearly US$4,000. This sus- greater opportunities. However, action is also who aspire to join it. and regional government. Thus, a social contract that focuses on aspiring middle class needs to enter the middle tained and high growth rate resulted in one of the required for a further 45 percent of the popu- quality public services, economic mobili- class, and can protect the economic gains that most rapid reductions in poverty in history. For lation—115 million people—who, while free The structure of the report. To achieve these At its heart, the report makes a case for a ty, and social security for all would help to the middle class has already achieved. instance, extreme poverty—calculated using the from poverty, have yet to achieve the economic objectives, the report first looks at the recent new social contract and an Indonesia where expand the middle class and protect those US$1.90 per day international poverty line—at security and lifestyle of the middle class. rapid expansion of the middle class and asks public investments and policies benefit already in it. A new relationship between the This will reduce the risk that those outside 70 percent in 1984, fell to just 7 percent by 2016. why we should care about it. It then examines both the current middle class and those government and its people could focus on three the middle class become shut out, result- This report uses economic security to what makes the middle class different from the who aspire to join it. An arrangement for all areas. First, quality public services, especial- ing in a more fractured society. Instead, A vibrant and rapidly growing middle class define the middle class. The report moves aspiring middle class and what it would take Indonesians would be one in which public in- ly in health and education, but also water and social cohesion and stability will in turn has emerged, economically secure and beyond thinking simply of the poor or non- for the latter to join the middle class. There is vestments drive growth, growth is inclusive, sanitation, are necessary so that aspiring mid- drive further growth. Nearly half of Indone- growing in influence. There are now about poor divide and instead begins to consider the a focus on the importance of improving educa- and social insurance protects the gains of all. dle-class children can develop the health and sia’s population is in the group that aspires to 52 million middle-class Indonesians, or one middle class and the pathways toward it. The tional attainment for the aspiring middle class For the non-middle class, access to high-qual- skills they need to succeed later in life. Bet- join the middle class. This group includes the in every five. These mainly urban households main innovation used here is to take a more to access better jobs, as well as looking at how ity public services and good jobs can provide ter quality services may also mean that those median voter and, if they can join the middle have achieved economic security, are free from nuanced look at the consumption distribution to create more of these better jobs. We then opportunities to achieve economic security in the middle class use and appreciate them class, they will combine with the existing 20 worry about poverty and vulnerability, and in Indonesia. As such, we identify five different look at the growing middle- and upper-class and join the ranks of the middle class. At the more widely, generating broader support for percent of middle-class Indonesians to repre- their incomes are turning from subsistence to consumption classes: poor; vulnerable; aspir- trend of opting out of public services, while the same time, upward mobility of the non-mid- financing them. Second, access to livelihoods sent two-thirds of the country. Meeting their discretionary consumption. Living on between ing middle class; middle class; and upper class. aspiring middle class remains highly reliant dle class and investments in productivity and that allows those in the middle class to prosper aspirations and delivering economic security Rp 1.2 million and Rp 6.0 million per person per on them, before considering the shocks that infrastructure will drive greater economic and those below the middle class to enter can to many will help strengthen social cohesion month, the middle class is the fastest growing The report has three primary objectives. can hit both the aspiring and middle classes, growth, benefiting the existing middle class. help to ensure economic mobility for all. This and address rising inequality. In turn, greater segment of the population, at 10 percent an- First, it examines how the dynamism of the and why this makes social protection for all so Furthermore, stronger social insurance to pro- means a focus not only on better education, stability and lower inequality have been shown nually, and now accounts for close to half of middle class can be harnessed to drive devel- crucial. We then conclude by highlighting the vide employment and health protection, as well discussed earlier, but also on making it easier to drive economic growth. national consumption. opment without polarizing the country. Then dangers of polarization and growing inequality as pensions, means that the economic gains of to become an entrepreneur, which increases it tries to understand Indonesia’s aspiring if the government fails to provide a new social an expanding middle class—both those who the prosperity of the middle class and creates E ASPIRING INDONESIA S 01—66 EXECUTIVE SUMMARY ASPIRING INDONESIA 3 EXECUTIVE SUMMARY 1 Poor (P) Those living below the national poverty line, or around Rp 354,000 per person per month (US$2.20 per person per day in 2016 PPP-adjusted terms); Strong economic growth has led to 2 Vulnerable (V) Those living above the a massive reduction poverty line but with a non-negligible risk of falling into poverty, or between in poverty & Rp 354,000 and Rp 532,000 per person per month the emergence (US$2.20-3.30 per person per day) of a prosperous middle class 3 Aspiring Middle Class (AMC) Those no longer living in poverty or vulnerability but who are not yet economically secure, or between Rp 532,000 and Rp 1.2 million per person per month (US$3.30-7.75 per person per day) 4 Over the past half century, Indonesia has This report moves beyond thinking simply seen strong economic growth and substan- of the poor or non-poor divide and instead Middle Class tial decreases in extreme poverty, enabling it to achieve middle-income status. In 1967, begins to consider the middle class and the pathways toward it. The World Bank’s (MC) Indonesia’s GDP was US$657 per person in (2015a) Indonesia’s Rising Divide: Why In- Economically secure 2010 prices,1 making it one of the poorest equality is Rising, Why it Matters and What Indonesians with little chance countries in the world, and the country was Can be Done takes a comprehensive look at in- of falling into poverty or “accounted the number one failure among the equality in Indonesia, with an extensive policy vulnerability, or between Rp 1.2 major underdeveloped countries.”2 Growth focus on what can be done to pull households million and Rp 6.0 million per that year was an anemic 1.4 percent. Over the out of poverty and vulnerability. This report on person per month (US$7.75-38 next 50 years, growth averaged 5.6 percent an- the middle class is a companion report to the per person per day) nually, despite a crippling financial, econom- earlier one in the sense that it examines what 5 ic, and political crisis in the late 1990s (Figure happens once households have moved out of E.1). Per capita GDP is now six times higher, at poverty and vulnerability. The main innovation nearly US$4,000. This sustained period of high of this report is to take a more nuanced look at Upper Class (UC) growth resulted in one of the largest and most the consumption distribution in Indonesia. As rapid reductions in poverty in history. Extreme such, we identify five different consumption The wealthiest Indonesians poverty, calculated using the US$1.90 per day classes: who consume more than Rp 6 international poverty line, was 70 percent in million per person per month 1984. By 2016 it had fallen to just 7 percent (>US$38 per person per day) (Figure E.2).3 ASPIRING INDONESIA 4 EXECUTIVE SUMMARY 5.6 % Indonesia has sustained an average annual growth rate of 5.6 percent over the past half century. FIGURE E.1 Real GDP and GDP per capita growth, 1967-2016 (percent) 15 GDP 01 ES 0 GDP PER CAPITA —15 1967 1991 2015 Source: World Development Indicators. FIGURE E.2 Poverty headcount ratio and Gini coefficient, 1 In 2010 US$, from the World Development 1980-2017 (percent/points) Indicators. 80 45 2 Higgins (1968) Economic Development (2nd ed.), p678, cited in Hill, H. (2000) The Indonesian Economy (2nd ed.). INTERNATIONAL POVERTY LINE 3 Using the International Poverty Line (IPL, $1.90 at 2011 Purchasing Power GINI COEFFICIENT Parity prices) from the World Development (RHS) Indicators and the 2017 Indonesia Country Poverty Brief. Poverty using the national poverty line (NPL) has shown similarly considerable declines. The NPL is more appropriate for assessing poverty in Indonesia than the IPL as it adjusts for spatial differences in the cost of living and is based upon a reference basket of goods and services commonly used by the poor. The IPL is based on the poverty line of selected poor countries and is converted into local currency using Purchasing Power Parity (PPP) adjusted exchange rates. The IPL is best for international comparisons of poverty rates NATIONAL POVERTY NATIONAL POVERTY but does not best represent poverty in any 0 LINE (OLD) LINE (NEW) 20 particular country. The IPL trend shows greater falls in poverty than the NPL 1980 1998 2016 because of both differences in methodology and because it is inflated over time using Note: International Poverty Line is Source: World Development the CPI, which has risen more slowly, US$1.90 in 2011 Purchasing Power Indicators. especially in recent years, than the cost Parity prices. of a representative basket of the poor in Indonesia. ASPIRING INDONESIA 5 EXECUTIVE SUMMARY Below The middle class is the Right It is only those in the only class that spends more middle class who predominantly on non-food items than food, have the high school increasingly on entertainment, or better education required durables and vehicles. by better jobs, with increasingly large numbers having tertiary education. We define the middle class as some other way, often having poor with per-capita consumption of those who enjoy economic secu- roofing or other sub-standard Rp 1.2 million per month no longer rity. This means they are free from housing conditions. By analyzing worry about falling into poverty or worry about monetary poverty household survey data, the mid- vulnerability, at this level they are and, as a consequence, are turning dle-class threshold is set at the only just starting to move toward their disposable income toward point where there is less than a discretionary consumption or buy- discretionary consumption rath- 10 percent chance of being poor ing higher-quality goods and ser- er than subsistence (see Box E.1 or vulnerable next year, given this vices. As they become wealthier, for the advantages of this meth- year’s consumption levels. In prac- their behavior and investments odological approach). However, it tice, this means households con- change. Consequently, we look at is important to note that this does suming more than Rp 1.2 million two sub-groups within the mid- not mean they are necessarily free per person per month, or US$7.75 dle class, based on consumption from poverty on some non-mon- per person per day (PPP-adjust- levels of Rp  1.2-3.2 million per etary dimensions. Indeed, as we ed). Moreover, we look at two person per month (or US$7.75-20 shall see later, many of the eco- different sub-groups within the per person per day), and Rp 3.2- nomically secure are deprived in middle class. While households 6.0 million per person per month ASPIRING INDONESIA 6 EXECUTIVE SUMMARY (or around US$20-38 per person per day), to understand how those in the middle class evolve as they prosper further. An upper class that also lives in economic security is a sepa- rate category and is not a direct focus of this report. We classify those earning above Rp 6.0 mil- lion per person per month as upper class (UC), whose characteristics, as we shall see, are different again from those of the middle class. These wealthier individuals and households, most of which are not captured by the household survey data that underpin this re- port’s analysis of welfare, are not the focus of this report.4 How- ever, the relatively small upper class does highlight that those in the middle class in Indonesia are currently close to the top end of the distribution and, in this sense, are not “middle”. Nonetheless, as those who comprise the wealth- ier middle class graduate to the upper class, and the middle class expands from below as some aspir- ing middle class join it, over time the middle class will move more toward the middle of the distribution. 4 See World Bank (forthcoming) Estimating the Top End of Indonesia’s Consumption Distribution. ASPIRING INDONESIA 7 EXECUTIVE SUMMARY “There has been a surge of interest in the Indonesian middle class in recent years, BOX E . 1 Who are members of but little agreement on who the middle class? they are or how numerous they are.” There has been a surge of interest in the Indonesian middle class in recent years, but little agreement on who they are or how numerous they are. There have been at least four major reports on Indonesia’s middle class since 2010, highlighting the topic’s current interest.5 While they have all defined the middle class in terms of income or consumption, they have used a range of different thresholds, somewhat arbitrarily determined, and their estimates of the size of the middle class range from 30 million to 81 million people. The size of the middle class, the characteristics of its mem- bers and their roles depend on how we define them.6 Those in the middle class are indeed often defined by their incomes or consumption levels.7 In the global literature on the middle class, such definitions range from US$2-20 per person per day to US$10-100 per person per day, or use global benchmarks, such as poverty lines in middle- and high-income countries, to define its members.8 Others literally define the middle class as 5 See ADB (2010), BCG (2013), 8 See, for example, ADB comprising those lying somewhere in the middle of the distri- McKinsey Global Institute (2010), Banerjee and Duflo bution.9 The middle class can also be defined by households’ (2012) and Tempo Magazine (2008), Kharas and Gertz self-perceived position in the income distribution or certain be- (2012). See also The Economist (2010), Milanovic and Yitzhaki (2011) and Financial Times (2002), Ravallion (2010). haviors or characteristics, such as education and occupation.10 (2010, 2014). 9 See Birdsall, Graham, and There are advantages to defining the middle-class threshold as 6 See Wai-Poi, M., Pettinato (2000), Easterly free from economic vulnerability. One definition of the middle Purnamasari, R., Indrakesuma, (2001), OECD (2011). T., Uochi, I. and Wijaya, Birdsall (2007 and 2010) class is that it comprises those whose income level is sufficient L. (2016) for a broader uses an absolute threshold to allow them to enjoy economic security and who are safe discussion on different to bound the bottom of the from falling back into poverty or vulnerability.11 This has several definitions of the middle middle class, but a relative class, and World Bank (2017) threshold to bound the top. advantages. First, it is conceptually grounded in the notion of for a similar approach across economic security, unlike arbitrary thresholds that have no the East Asia and Pacific 10 See PRC (2008) and Amoranto basis. Second, what counts as economic security is developed region. et al. (2010) for examples of in the Indonesian context, rather than by using global bench- the former and Adelman and 7 Most countries’ household Morris (1967) for the latter. marks that may be less relevant. Third, it allows behaviors and surveys only collect characteristics of the middle class to be explored empirically, information on one of these, 11 See the World Bank’s (2013) rather than being pre-determined to define its members, as and they are often treated Economic Mobility and the Rise interchangeably, although they behavioral definitions do. should not be. of the Latin American Middle Class. ASPIRING INDONESIA 8 EXECUTIVE SUMMARY Below The aspiring middle class and the middle class have the size and economic influence to be politically salient; while the middle class has only half as many voters, it represents half of all consumption. 52 Million The middle class has been growing faster than other groups; there are now at least 52 million economically secure Indone- sians, or one Indonesian in every five. The middle class has been growing faster tween US$7.75 and US$20 a day (referred to rate of 10 percent annually. This is four times than other groups; there are now at least 52 as MC 1 in the charts), while the remainder faster than the aspiring middle class while, million economically secure Indonesians, (5 million) consume from US$20 to US$38 a over the same period, the share of poor and or one Indonesian in every five. Figure E.3 day (MC 2). The survey data find less than 1 vulnerable households in the population shrank shows the evolution of Indonesia’s consumption percent (1.3 million) who consume more than slowly (Figure E.3). Although rapid growth classes since 2002 and their current sizes. By US$38 a day, or Rp 6 million (the upper class, of the middle class was from a small base of 2016, based on the national household con- or UC). However, the national household con- only about 14 million in 2002, it also added sumption survey, there were 52 million mid- sumption survey (Susenas) is believed to ex- the most people in absolute terms (38 million dle-class (MC) Indonesians, representing 20 clude many richer Indonesians. Forthcoming compared with the 31 million for the aspiring percent of the population. This compares with work is trying to estimate the top end of the middle class). Nonetheless, growth in the pro- 11 percent who were poor (labelled P in charts) income and consumption distributions more portion of the economically secure classes in and a further 24 percent who were vulnerable accurately. While still missing many wealthy Indonesia was slower than in Thailand, and less (V). The largest segment of the population Indonesians, initial results indicate that the than half as large as seen in China, Mongolia, is the aspiring middle class (AMC), namely upper class is much larger and richer than the and Vietnam.13 those who have escaped poverty but are not survey data suggest.12 yet economically secure, with a greater-than- 12 World Bank (forthcoming) Estimating 10-percent chance of being vulnerable next The middle class is growing fast, expand- the Top End of Indonesia’s Consumption year (Table E.1). ing at 10 percent every year, although not Distribution. as quickly as elsewhere in East Asia. The Most of those in the middle class consume middle class is growing faster than most oth- 13 See World Bank (2017a). Figure 2. Note, this regional study uses the same less than US$20 a day, although many er segments of the Indonesian consumption economic security definition for the richer Indonesians are missing from the distribution, with the exception of the small middle class, but based on regional data data. The great majority of the middle class, upper class. The middle class tripled as a pro- and international poverty lines rather than just Indonesia’s. As such, the class despite being economically secure, are not that portion of the population between 2002 and definitions are not the same, although wealthy; 90 percent (47 million) consume be- 2016, during which time it grew at an average they are broadly consistent. ASPIRING INDONESIA 9 EXECUTIVE SUMMARY T A B L E E.1 Class definitions (2016 per-capita consumption) The middle class comprises those who have less than a 10 percent chance of being poor or vulnerable in the future, given their current consumption. Class P V A M C M C U C Poor Vulnerable Aspiring Middle Upper Middle Class Class Class Household status Below national >10 percent <10 percent <10 percent >17xPL poverty line (PL) chance of being chance of being chance of being poor next year poor but >10 poor or vulnerable (1.0-1.5xPL) percent chance of (3.5-17xPL) being vulnerable (1.5-3.5xPL) Per capita consumption Rp 6m —Rp is Monthly US$* is daily US$38 SUB-GROUPS: MC 1 (Rp 1.2-3.2m; US$7.75-20); MC 2 (Rp 3.2-6.0m; US$20-38) Note: Daily per capita consumption is Source: Susenas and World Bank measured in US$PPP, which are US dollars calculations. adjusted for purchasing power parity across countries. F I G U RE E.3 Consumption distribution by class, 2002-16 (percent of population) The middle class is the fastest growing major segment of the Indonesian population in both percentage and absolute terms, expanding at 10 percent per year and 38 million between 2002 and 2016. It now represents 20 percent of the population. 100 '02 '03 '04 '06 '07 '08 '08 '09 '10 '11 '12 '13 '14 '15 '16 UC MC AMC V P Note: CAGR is the compound annual growth Source: Susenas and World Bank rate from 2002-16. calculations. ASPIRING INDONESIA 10 EXECUTIVE SUMMARY OBJECTIVE 01 Examine how the dynamism of the middle class can be harnessed to drive development without polarizing the country OBJECTIVE 02 Understand Indonesia’s aspiring middle THIS class (AMC), and how its members differ REPORT HAS from the many millions of middle class THREE KEY OBJECTIVES: Indonesians who have not only emerged from poverty but, unlike those in the AMC, have also achieved economic security OBJECTIVE 03 Examine what the government can do to significantly expand the middle class to the millions who aspire to join it. The remainder of this Execu- at how to create more of these bet- that can hit both the aspiring and tive Summary summarizes the ter jobs. It then looks at how easy middle classes and why this makes findings on these three issues. or difficult it is to move from the social protection for all so crucial. It first looks at the recent rapid aspiring middle class to the middle We then conclude by highlighting expansion of the middle class and class proper, as well as asking how the dangers of polarization and asks why we should care about it. secure being in the middle class re- growing inequality if the govern- The summary then examines what ally is, underlining that economic ment fails to provide a new social makes the middle class different security does not always mean contract for all, including provid- from the aspiring middle class and freedom from non-monetary pov- ing higher-quality public services what it would take for the latter erty. We then look at the growing and better tax administration— to join the middle class. There is middle- and upper-class trend of the only way to ensure that Indo- a focus on the importance of im- opting out of public services, while nesia can pay for the transition proving educational attainment the aspiring middle class remains from middle-income to high-in- for the aspiring middle class to ac- highly reliant on such services, fol- come country status. cess better jobs, as well as looking lowed by considering the shocks ASPIRING INDONESIA 11 EXECUTIVE SUMMARY ASPIRING INDONESIA 12 EXECUTIVE SUMMARY A rapidly growing middle class risk-mitigating agendas, as well is good for its members and as public investments for growth. good for Indonesia’s economy. Third, growing the middle class is This report focuses on the middle closely related to reducing inequal- class for three main inter-related ity, as the agenda of improved de- 02 reasons. First, there are the ben- livery of public services required efits that a rapidly growing mid- to lift aspiring households into the dle class enjoys, as its members middle class will also help those achieve economic security and in the bottom 40 percent. Final- ES higher standards of living. Sec- ly, there are risks that the middle ond, there are broader benefits for class fails to expand to include the the country, as the middle class is a millions more who aspire to join key driver of consumption growth, it, or that the middle class favors is an influential constituency for policies that benefit only those in better governance, and will be by the middle class, but not others, far the largest provider of the in- resulting in a more polarized and come tax revenues that are need- fractious society. ed to fund poverty reduction and The middle class & its dynamism will be vital to Indonesia’s future as it stands at a cross-road The Indonesian middle class crossed the threshold of assets at has been a major driver of eco- which risk-taking becomes more nomic growth in recent years. likely and it can therefore become The expansion of the middle class a source of entrepreneurship and in the late 20th century has helped job creation.14 Finally, the middle to sustain Indonesia’s enviable class supports growth by strength- record of economic growth. A ening social cohesion and enhanc- large middle class (as opposed to ing political stability.15 The process a few rich and many poor) leads of growing the middle class also to higher domestic consumption supports economic growth be- because the middle class has a cause human capital investments 14 See Banjeree and higher marginal propensity to are key to acquiring the skills re- Newman (1993). consume than the rich, and more quired to obtain middle-class jobs, 15 See Lipset income than the poor. The middle and also to accelerating growth. (1959). class is also more likely to have ASPIRING INDONESIA 13 EXECUTIVE SUMMARY 12 % Middle-class consumption has grown at 12 percent annually since 2002 and now represents close to half of all household consumption in Indonesia. “The Indonesian middle class has been a major driver of economic growth” 16 There is a significant difference in the size of private consumption as measured by the national accounts (upon which GDP measures are based) and household consumption surveys (upon which our middle-class analysis is based). Household surveys exclude non-household private consumption such as institutions (like prisons and orphanages). They also fail to capture many richer households, Middle-class consumption has grown at tion growth in the national accounts, a key and so under-estimate household 12 percent annually since 2002 and now component of recent economic growth. consumption, particularly that of the middle class (see World Bank (forthcoming) represents close to half of all household Private consumption in the national accounts Estimating the Top End of Indonesia’s consumption in Indonesia. In 2002, mid- grew at 3.0 percent annually between 2002 and Consumption Distribution). In fact, total dle-class consumption was 21 percent of all 2015. Attributing this growth across the eco- consumption in Susenas represents only 40 percent of that estimated in the national private consumption in Indonesia. By 2016, it nomic classes is difficult, as total household accounts, which attempt to capture other was Rp 1,260 trillion, or 43 percent of total consumption in Susenas accounts for only 40 private consumption and large one-off household consumption (Figure E.4), having percent of private consumption in the national expenditures such as the Hajj. If we conservatively allocate the missing 60 grown at 12.0 percent annually in real terms. accounts. While there are differences of meth- percent of private consumption to the By comparison, total average household con- odology, and private consumption includes consumption classes according to their sumption growth was only 6.3 percent annually some non-household spending such as by insti- observed consumption in the survey, then we have a lower bound where the middle over the same period and just 4.6 percent for tutions such as prisons and orphanages, there class represents 1.2 percentage points of the aspiring middle class. Total poor household is still a large discrepancy between the two. Due the 5.6 percent annualized growth of the consumption actually declined by 0.4 percent to this, the role of middle class consumption in economy (and the upper class 0.2 points). However, the missing richer households and annually in real terms and grew at only 0.9 the growing national accounts consumption economic activity are much more likely percent annually for the vulnerable. This is a can only be estimated within a range. Under to be from the middle and upper classes; key reason that, despite the focus of this report certain assumptions, however, between 1.2 and if we allocate all missing private consumption growth to the middle and upper on growing the middle class, the government 2.0 percentage points of annualized growth in classes in proportion to their relative should also retain a strong focus on reducing national account private consumption came shares of observed Susenas consumption poverty and vulnerability. from middle-class consumption, with a further growth (84 and 16 percent respectively), then an upper bound of their share of 0.2 to 0.4 of a percentage point coming from growth increases to 2.0 percent for the This rapidly growing middle-class con- the upper class.16 middle class and 0.4 percent of the upper sumption has helped accelerate consump- class. ASPIRING INDONESIA 14 EXECUTIVE SUMMARY FIGURE E.4 Share of total national household consumption, Increasingly, the middle class is driving 2002-16 (percent) this growth by spending its growing dis- posable income on non-food items such Despite comprising just 20 percent of the population, the middle class makes up as health, education, and other services, close to half of total national consumption. as well as taxes and insurance. Most Indo- 100 nesians spend the majority of their money on food. Food represents 60 to 62 percent of all consumption for the poor and vulnerable, and 56 percent for the aspiring middle class. The middle and upper classes are the only groups where more is spent on non-food items than food (Figure E.5). However, for most mid- dle-class households, food still comprises 44 percent of consumption. Only for 10 percent of the middle class (MC 2) and the upper class is food below one-third of consumption. With greater affluence, the middle class is spend- ing more on health and education (combined, this represents 6 percent of MC 1 spending, 7 percent of MC 2 and 9 percent of upper class spending), and clothes, goods and other ser- vices (9 percent of MC 1 and MC 2 spending). '02 '03 '04 '06 '07 '08 '08 '09 '10 '11 '12 '13 '14 '15 '16 The middle class is also beginning to pay direct taxes and buy insurance (3, 4, and 5 percent of MC 1, MC 2 and UC spending, respectively). P V AMC MC UC Those in the middle class are also becoming big consumers of entertainment and dura- Note: The UC share is Source: Susenas and World Bank bles, with car ownership in particular being poorly estimated due to the calculations. a clear dividing line between the middle and small number of households upper classes, and those below. The middle participating in the survey data. class is spending more on entertainment (only 4 percent for MC 1, but increasing to 9 percent of total consumption for MC 2 and 11 percent FIGURE E.5 Breakdown of consumption, 2016 for UC). While many households are now buy- (percent of total consumption) ing more essential durables, such as refrigera- tors, the middle and upper classes are the only The middle class is the only class that spends more on ones starting to buy amenities more oriented non-food items than food, increasingly on entertainment, durables and vehicles. to comfort and convenience, such as air-condi- 0 100 tioners and water-heaters, especially in urban P areas (Figure E.6). In particular, almost no households below the middle class own cars, V while 20 percent of MC 1 and 60 percent of MC 2 own cars, marking it a clear class delineation; AMC most upper-class households own cars. In fact, vehicles account for 9 and 17 percent of total MC 1 consumption for MC 2 and UC, respectively.17 MC 2 UC Entertainment Goods/service Source: Susenas Tax/insurance Education and World Bank 17 Although BPS treats the stock of calculations. Vehicles Health vehicle purchases as consumption, whereas Durables (excl. Vehicles) common practice is to calculate the flow House (depreciation) of the vehicle and use this Clothes Food for annual consumption. ASPIRING INDONESIA 15 EXECUTIVE SUMMARY FI G U RE E.6 Selected durable ownership by class, FIGURE E.7 Access to technology and information 2016 (percent) by class, 2016 (percent) Household luxuries such as air conditioners and water Access to computers and the internet are uncommon heaters are non-existent below the middle class, while outside the middle class; thus middle-class children car ownership in particular divides richer middle- and are far more likely to gain exposure to the ICT that upper-class households from all other Indonesians. underpins the modern global economy. National Urban Rural National Urban Rural 100 100 98 Air Conditioners Cellphones 97 92 92 89 80 80 82 81 73 67 60 60 55 50 40 40 20 20 24 6.0 19 3.2 16 0.8 5 0 0 Poor Vulnerable AMC MC 1 MC 2 UC Poor Vulnerable AMC MC 1 MC 2 UC 100 100 Water Heaters Computers 80 80 69 60 60 66 46 45 40 40 41 20 20 26 23 5.0 1.8 4.5 17 3.2 16 1.4 1.0 15 9.0 11 0 0 Poor Vulnerable AMC MC 1 MC 2 UC Poor Vulnerable AMC MC 1 MC 2 UC 100 100 Cars Internet 80 80 79 76 60 60 61 60 60 60 55 54 40 40 39 37 29 26 20 20 25 6.7 5.5 22 20 4.5 0 0 Poor Vulnerable AMC MC 1 MC 2 UC Poor Vulnerable AMC MC 1 MC 2 UC Source: Susenas and World Bank calculations. ASPIRING INDONESIA 16 EXECUTIVE SUMMARY “The challenge now for Indonesia is to make growth more inclusive by providing economic mobility and growing the middle class” The challenge now for Indonesia is to make cial tensions and disharmony, which can in turn growth more inclusive by providing eco- create conflict. Indeed, districts with higher nomic mobility and growing the middle levels of inequality than the average in Indone- class. To become a high-income country and sia have 1.6 times the rate of conflict compared sustain or even accelerate historical growth with districts with lower levels of inequality.23 rates18—a challenge that is faced by much of Indonesians already think inequality is too high developing East Asia19—Indonesia will need and should be reduced.24 to develop a more inclusive growth model so that more of the population can both contrib- At the same time, aiming to become a ute to and benefit from that growth. Despite high-income country and increasing eco- low rates of poverty, many Indonesians remain nomic mobility will require new invest- vulnerable, with around one-third below the ments. The key to Indonesia’s closing the gap vulnerability line,20 while inequality, despite with high-income countries is a growth strate- 18 See World Bank (2014) Indonesia: Avoiding the Trap, recent moderation, has been rising rapidly gy that is based on improving labor productiv- Development Policy Review. (Figure E.2). Moreover, Indonesia’s popula- ity.25 To achieve this, in addition to improving tion will soon begin to age, creating further the functioning of product, labor, land, and 19 World Bank (2017a) Riding pressures. This means that Indonesia will face capital markets, significant investment is re- the Wave. a demographic burden, with a steep drop in quired to close the infrastructure gap (roads, 20 35 percent of the the size of its workforce and sharp increases ports, electricity, water and sanitation, and ir- population is below the in public spending on pensions, health care, rigation networks) and the skills gap (which re- national vulnerability line and long-term day-to-day care in the coming quires improving access to key public services (1.5 times the poverty line), while 32 percent are below the decades. This, in turn, will pose a challenge to for young children and improving the quality Lower Middle Income Countries sustained economic growth.21 and relevance of education for older children). poverty line of PPP US$3.20 in 2011 prices; see 2017 Indonesia Country Poverty The middle and upper classes pay tax- Brief. In terms of relative incomes, inequality es, and a new social contract is needed to has risen in Indonesia since 2000, as most grow tax collections from those already in 21 See World Bank (2015b) Live Indonesians have been left behind by the the middle class, and those joining it over Long and Prosper: Aging in East Asia Pacific, World Bank. middle class, with possibly significant con- time. Indonesia’s government revenues are sequences not only for growth but also for lower than many other middle-income coun- 22 Berg, A. and Ostry, J. social and political stability. High levels of tries and many other countries in East Asia. (2011) “Inequality and inequality may slow economic growth, while Total revenues are only 10.9 percent of GDP, Unsustainable Growth: Two Side of the Same Coin?” more equal countries may grow faster.22 High compared with 16.5 percent in Thailand, 16.1 International Monetary inequality may reduce economic growth for all percent in Malaysia, and 12.9 percent in the Fund Staff Discussion Note if poorer people are unable to properly invest Philippines. Low personal income-tax collec- SDN/11/08. in their children’s development, if people fail to tion (at just 1.1 percent of GDP) is due main- 23 World Bank (2015a). exit poverty and vulnerability, and struggle to ly to non-compliance. Increased income-tax move into the middle class, and if people fail to collection would significantly increase avail- 24 World Bank (2015c) A find productive jobs. Recent research indicates able funding for investment in infrastructure Perceived Divide. that higher inequality leads to lower and less and skills, but the progressivity of such taxes stable economic growth. High inequality can means they will predominantly be paid for by 25 See World Bank (2014a) Indonesia: Avoiding the Trap, also have social costs: when people perceive middle-class Indonesians. Development Policy Review. large differences in wealth, this can create so- ASPIRING INDONESIA 17 EXECUTIVE SUMMARY What makes the middle class different? Most of the middle class lives in cities… ASPIRING INDONESIA 18 EXECUTIVE SUMMARY Left Around 13 million middle- Below Despite having achieved class people live in Greater economic security, close to Jakarta alone, accounting for half of the middle class 31 percent of the urban middle is deprived on at least one class and 24 percent of the non-monetary dimension, middle class nationally. primarily poor housing conditions. Unlike all other classes (except for the up- middle-class people live in Greater Jakarta per class), most of the middle class lives alone (Figure E.9), accounting for 31 percent in the major urban agglomerations that of the urban middle class and 24 percent of the dominate the Indonesian landscape and are middle class nationally. The relatively low ur- mostly found in Java. There are more poor, ban poverty and vulnerability rates mean that, vulnerable, and AMC in rural areas than in while more of the AMC lives in rural areas, it urban areas.26 However, three-quarters of the also makes up most of the non-middle class in middle class live in urban areas (Figure E.8), cities. Only in a small number of cities is the with two-thirds of those urban middle class liv- middle-class rate similar to the AMC rate ( Ja- ing in major metropolitan agglomerations— karta, Bandung, Denpasar and Yogyakarta), the fastest growing urban areas.27 Although or significantly higher (Surabaya and Makas- some regions enjoy a higher percentage of mid- sar). This implies that policies to support the 03 dle class among the population—for example, expansion of the middle class will need to have in Sulawesi—the much greater population of a strong urban dimension, which is the focus of Java means that around two-thirds of the mid- a major ongoing research project.28 dle class live there. In fact, around 13 million ES 26 See main body of report. 27 See World Bank (forthcoming) Recent Trends in Urban Indonesia for more details. 28 See the World Bank’s forthcoming flagship report on Indonesian urbanization. ASPIRING INDONESIA 19 EXECUTIVE SUMMARY FI G U RE E.8 Urban-rural breakdown of Indonesian consumption classes, 2002 and 2016 (million) 76 % At about 76 percent, most of the middle class live in urban areas, many in the urban agglomerations of Java. 2002 MC 10.3 Million 3.5 Million AMC 41.1 42.3 Vulnerable 25.3 43 Poor 13.0 23.7 ‹Urban Rural› 2016 MC 40.6 Million 13.0 Million AMC 54.2 60.5 Vulnerable 27.5 34.1 Poor 10.3 17.7 ‹Urban Rural› Source: Susenas and World Bank calculations. ASPIRING INDONESIA 20 EXECUTIVE SUMMARY FIGURE E.9 Urban agglomerations with largest MC and AMC populations, 2016 [million (LHS) and percentage of population (RHS)] The middle class is largely an urban phenomenon and is clustered in the major Indonesian urban metropolises, mostly in Java. 30 70 AMC MC UC MC Rate AMC Rate 60 25 50 20 40 15 30 10 20 5 10 0 0 Jakarta Bandung Surabaya Medan Surakarta Semarang Malang Makassar Sukabumi Denpasar Yogyakarta Pasuruan Pontianak Palembang Probolinggo Magelang Blitar Mojokerto Salatiga Pekanbaru Bandar Lampung Banjarmasin Padang Samarinda Banda Aceh Balikpapan Bukittinggi Jambi Source: Susenas and World Bank 29 The definition of metropolitan areas follows that of the World Bank’s Flagship report on calculations. Urbanization in Indonesia, which is currently underway. Multi-district metropolitan areas are thus defined based on daily commuting flows between Indonesian districts using data from the August 2013-2015 rounds of Sakernas. Single-district metropolitan areas, meanwhile, are those which Note: Agglomeration definitions satisfy the following three criteria: (i) the district is classified as a Kota; (ii) the district of cities are based on World has a population of at least 500,000; and (iii) the district has an average population density Bank (forthcoming).29 which is at least 1,500 people per sq. km. ASPIRING INDONESIA 21 EXECUTIVE SUMMARY Right It is only as a household becomes middle class that it begins to own home amenities that are more oriented toward convenience and comfort. Expansion of the middle class will also re- While the sweeping decentralization reforms quire better leveraging of the potential of have provided greater autonomy to local gov- Indonesian cities to deliver on prosperity, ernments, including on matters related to the inclusion, and livability. More than half of provision of urban infrastructure and services, the Indonesian population lives in urban areas there are several overlapping provisions within that are already home to three-quarters of the the decentralization law that weaken outcomes middle class. On the other hand, while more of by reducing accountability and hampering co- those in the AMC live in rural areas, they also ordination. This compounds the well-recog- make up most of the non-middle class in the nized challenges of weak technical capacity of cities. Higher population density that comes local governments, especially outside of the with urbanization can boost productivity and major metropolitan areas such as Jakarta and growth. Density not only concentrates firms, Surabaya, in carrying out their mandated func- workers and consumers, but also ideas. This tions. Second, there is an urgent need to invest fosters innovation, specialization and great- in closing Indonesia’s large infrastructure gap. er opportunities to realize scale economies. This includes infrastructure related to the bet- However, density can also dampen these ag- ter provision of social and economic services, glomeration benefits of cities if the resulting such as education, health, drinking water, san- congestion, pollution, and other negative ex- itation, solid waste management, and so on, ternalities are not properly managed. At the as well as connectivity infrastructure such as same time, it will also be important to ensure roads, highways, and ports. This will enable that the prosperity of cities and the leading those in the AMC to invest in the human capital regions also benefit the AMC, together with of their children and to also better link up with the poor and vulnerable, in the less urbanized labor market opportunities generated in the lagging island regions of the country through growth poles. Third, targeted place-based pol- strengthened backward linkages. icies will be required to ensure that those in the AMC in the lagging island regions also have a Dealing with the urbanization challenges decent chance of joining the ranks of the middle that confront Indonesia has become in- class. Fine-tuning policies on special economic 30 A major World Bank report on creasingly important, especially from the zones (SEZs) and other incentive-based mech- urbanization is perspective of the AMC. The following anisms, for example, to attract professionals currently in three broad policy directions are aimed such as teachers and doctors to serve in these process and will address these at meeting these challenges.30 First, Indo- areas, based on evidence on what works and issues in far nesia’s decentralization needs to work better. what does not, is one way forward. greater detail. ASPIRING INDONESIA 22 EXECUTIVE SUMMARY ASPIRING INDONESIA 23 EXECUTIVE SUMMARY ASPIRING INDONESIA 24 EXECUTIVE SUMMARY Left Indonesian students do not have equal access to learning opportunities; comparisons of the characteristics of 04 schools attended by poorer and wealthier students in Indonesia shows important differences in the ES quality of service delivery. Being better educated is the key dividing line between the middle class & those below Most of the middle class is now completing completes high school, while one-third goes on high school and many go on to tertiary edu- to complete some form of tertiary education cation. Nearly half of the aspiring middle class (Figure E.10). Moreover, almost none of MC 2 aged 25-29 years old drops out of school before or the upper class fails to finish high school. In senior high school. At the same time, nearly fact, 60 to 67 percent of these two groups have 80 percent of the middle-class cohort at least some form of tertiary education (Figure E.11). ASPIRING INDONESIA 25 EXECUTIVE SUMMARY FI G U RE E.10 Educational attainment by class, ages 25-29, 2016 (percent) Education is the biggest dividing line between the middle class and those below. Younger middle-class cohorts complete high school and are increasingly going on to tertiary education. 100 80 MC 60 UC VUL AMC 40 POOR 20 0 1 2 3 4 5 6 1 2 3 1 2 3 No School Diploma I/II Diploma III Bachelor Primary Junior High Senior High School School FI G U RE E.11 Educational attainment by class, ages 25-34, 2016 (percent) P V AMC MC 1 MC 2 UC 0 20 40 60 80 100 No Schooling Diploma I/II/III Elementary Diploma IV/Bachelor Junior High School Master/Doctor Senior High School Source: Susenas and World Bank calculations. ASPIRING INDONESIA 26 EXECUTIVE SUMMARY The poor quality of Indonesian the same SES status, average In- value-added sectors, such as fi- education is a limitation for the donesian test scores significantly nancial services and information middle class, but progress is be- lag those of the OECD average in and communication technologies. ing made. While the level of years mathematics, reading, and sci- of educational attainment for the ence. This holds true even if we The middle class is also pro- Indonesian middle class is higher look only at the middle class (SES ducing the skilled workers of than for other East Asian middle deciles 9 and 10). In fact, the gap tomorrow, with more educat- classes,31 the low quality of Indo- between the Indonesian middle ed children who are more ex- nesian education relative to most class and OECD children of compa- posed to the technology that other countries undermines these rable SES levels is 47 to 63 points, drives the modern global econ- attainment levels. Test scores in where 30 points is equivalent to omy. The middle class has fewer Indonesia continue to lag those one year of education.32 Despite children but invests more heavily in OECD countries across the this, Indonesia has been closing in their education. Middle-class socioeconomic distribution, al- the gap. For example, those in the children start school earlier and though the gap has been closing middle-class SES range increased stay in school longer, increasing 31 World Bank in recent years. Figure E.12 com- their scores from 2003 to 2015 by the base of skilled workers for the (2017a). pares international test scores for 40 to 50 points.33 If this rate of future. Importantly, middle-class 15-year-olds between Indonesians progress continues, the middle children are much more likely to 32 World Bank across the national socioeconom- class could close the gap with the be exposed to the ICT that drives, (forthcoming) Growing Smarter: ic status (SES) distribution and OECD average within a decade or and will continue to drive, the Learning and the OECD average for the same so. Nonetheless, greater skills and modern global economy (Figure Growth in East Asia range (bearing in mind that these productivity in the future will re- E.7), particularly for children of Pacific. OECD students are relatively poor quire smarter public investment the urban middle class. 33 PISA data by developed country standards). in education to capitalize on mid- and World Bank Even when comparing children of dle-class employment in higher calculations. FIGURE E.12 Average Indonesian and OECD* PISA scores by Indonesian socioeconomic decile, 2015 (points) Test scores in Indonesia continue to lag those in OECD countries across the socioeconomic distribution, although the gap has been closing in recent years. 600 600 600 Mathematics Reading Science 500 500 500 OECD* OECD* OECD* 400 400 400 INDONESIA INDONESIA INDONESIA 300 300 300 1 10 1 10 1 10 Indonesian Socioeconomic Decile Note: *OECD excluding Mexico and Chile. SES deciles Source: Programme for International Student are based on the Indonesian SES distribution, with Assessments (PISA) and World Bank calculations. the mean OECD scores for the same SES ranges included for comparison purposes. ASPIRING INDONESIA 27 EXECUTIVE SUMMARY Due to greater education & skills, most of those in 05 the middle class have formal jobs, ES although female labor participation remains low While most middle-class work- However, Indonesia’s mid- Education plays a role in female ers have formal jobs, the re- dle-class women do not work labor participation rates, but mainder are increasingly run- much more than those in the this is not the whole story. Al- ning productive businesses, non-middle class and less than though only around 60 percent of which drives growth and cre- other middle-class women in middle- and upper-class women ates jobs for others. Over half of East Asia and around the world. work, this increases to 81 percent employed middle-class workers As more people in a country work, for those with tertiary degrees. are formal employees and salaried so its economy grows. In almost all As such, post-secondary educa- workers, rising to two-thirds for countries, most men work (or look tion plays a role in having more MC 2 and the UC, compared with for work) and the differences in women work.36 However, lower 34 See Banerjee and Newman (1993) just one-third of the AMC and total labor-force participation de- middle-class participation rates ‘Occupational one-quarter or less of the poor and pend on how many women work. are not strictly due to education; Choice and the vulnerable (Figure E,13). At the A recent paper, using a similar but as discussed earlier, the Indone- Process of Development’, same time, while many of those in slightly different definition of the sian middle class has similar or Journal of the middle class remain self-em- middle class based on economic better education rates than other Political Economy ployed, they are increasingly likely security, found that in East Asia middle classes in East Asia. More 101(2):274-298. to run a business with permanent Pacific, while only about 50 percent research is required to better un- 35 Wai-Poi et al. employees, rather than one with of non-middle class women partic- derstand this phenomenon, also (2016). Malaysia unpaid employees (likely family ipate, this rises to 70 percent for observed in Malaysia; possible is not included workers), as is the case for poorer the middle class.35 However, while explanations could be cultural in this regional comparison due to households. This indicates that middle-class Indonesian women are norms around child-rearing and data limitations, these enterprises are sufficient- slightly more likely to work than care, a lack of external childcare but has a similarly ly productive to sustain both the other Indonesian women (Figure options, discrimination in the la- low rate of female labor owner and paid workers. More- E.14), the rates remain much low- bor market, and a lack of good jobs participation. over, it may well be the case that er than those for other middle-class in some areas. they already enjoy sufficiently high women in East Asia (Figure E.15), 36 World Economic incomes, which give them the con- undermining a potential contribu- Forum (2016) Global Gender Gap Report fidence to take entrepreneurial tion to economic growth. 2016. risks.34 ASPIRING INDONESIA 28 EXECUTIVE SUMMARY FIGURE E.13 Occupational status of head of household by class, 2016 (percent) The majority of middle class workers are formal employees, while the rest are increasingly likely to be business owners who employ others. Family/non- Casual labor Worker/ Self-owned with Self-owned with Self-owned paid employee paid worker non-paid worker business 100 80 60 40 20 0 Poor Vulnerable AMC MC 1 MC 2 UC Source: Susenas and World Bank calculations. FIGURE E.14 Female employment rates by class, FIGURE E.15 Middle-class female labor-force 2016 (percent) participation in East Asia (percent) Middle-class women are slightly more likely to work …but they work much less than most East Asian than other Indonesian women… middle-class women, contributing less to the economy. National Urban Rural ES GMC 80 100 EAP GMC Average EAP ES Average 80 60 60 40 40 20 20 0 KHM PNG THA VNM PHL MNG VUT TON LAO IDN 0 Poor Vul AMC MC 1 MC 2 UC Note: ES are the Economically Secure, Source: Wai-Poi et consuming PPP US$5.50-15 per person per al. (2016). day, while the GMC are the Global Middle Source: Susenas and World Bank calculations. Class, consuming more than PPP US$15 a day. ASPIRING INDONESIA 29 EXECUTIVE SUMMARY 06 ES Making it easier for firms & entrepreneurs 72 nd to create good jobs… Indonesia is improving from 106th in the 2016 rankings to 91st in 2017 to 72nd in the Do- ing Business 2018 rankings. Almost half of the business owners who trading across borders, and enforcing con- employ others are from the middle class. tracts. However, with a goal of 40th by 2019, While most middle-class workers have well- the government now needs to move beyond paid productive jobs in the formal sector, a “quick-win” reforms and implement medi- significant number own their own business- um-term structural reforms to further improve es and employ others (Figure E.13). Despite Indonesia’s business environment. To this end, comprising only 20 percent of the population, it is important that the government continues they represent nearly half of all business own- with its plan for coordinating and monitoring ers with permanent employees. Policies that the reform process.38 support these entrepreneurs will increase their economic mobility, helping to drive economic In addition, more needs to be done to make growth, and create more jobs for the aspiring Indonesian firms less credit constrained.39 middle class. Two key areas are the regulatory There is ample evidence that firms in Indo- environment and access to credit. nesia are credit constrained, relying more on retained earnings than bank credit for Recent improvements in the ease of doing expansion. The credit constraints faced by business need to be sustained and deep- firms reflect the lack of depth in Indonesia’s ened. The investment climate and ease of financial markets. Public policy could help doing business has long been identified as a nudge the system toward greater financial constraint on firms in Indonesia.37 As recent- depth, through easing strict investment re- ly as 2013, Indonesia ranked 120th out of 185 quirements, building a more credible legal countries in the World Bank Group’s Doing system that allows for the effective enforce- Business rankings. However, a series of re- ment of contracts and property rights, and forms implemented by the government has providing greater investor protection. The 37 World Bank seen significant improvements and Indonesia recent reforms of the social security regime (2014a). has achieved one of the greatest gains in the further present an opportunity to deepen fi- 38 World Bank rankings in recent years, improving from 106th nancial markets, with the new National Social (2017d) Indonesia in the 2016 rankings to 91st in 2017 to 72nd in Security System (SJSN) expected to cover 10 Economic Quarterly: the Doing Business 2018 rankings. The World times the number of workers than the previous Sustaining Reform Momentum. Bank credits positive reforms in the areas of: body, multiplying assets under management, starting a business, getting electricity, regis- and presenting an opportunity to widen the 39 See World Bank tering property, getting credit, paying taxes, choice of eligible investments. (2014a). ASPIRING INDONESIA 30 EXECUTIVE SUMMARY Below About 28 million new jobs were created in Indonesia between 2001 and 2016. Of these, 85 percent were formal, 70 percent were fulltime employees and 77 percent were in services. ASPIRING INDONESIA 31 EXECUTIVE SUMMARY 28m 84% 70% 77% Of jobs created between 2001 and were in wage- 2016 in Indonesia were formal Jobs employment were in services …can help expand the middle class by allowing the aspiring 07 middle class to take advantage of the many ES new formal jobs in services with higher wages… Most of the new jobs created since 2001 However, most of these jobs require high have been formal, in wage-employment school or tertiary education. Sixty-nine and the services sector, and pay almost percent of formal workers have a high-school twice as much as informal and non-wage education or better, compared with just 18 per- jobs. About 28 million new jobs were created cent of informal workers. This percentage is 64 in Indonesia between 2001 and 2016. Of these, percent for wage employees and 50 percent for 84 percent were formal, 70 percent were in business-owners with permanent employees, wage-employment and 77 percent were in ser- but 30 percent or lower for other self-employed vices (Figure E.16), although job growth in the or casual workers. Fifty-nine percent of ser- past two years has been more informal. While vices sector jobs require high school or more, the strong legal protection of formal employ- compared with 37 percent in industry and 14 40 Indonesia has some of the ment is often not observed in practice,40 these percent in agriculture. Better and higher paid strictest labor regulations in jobs do pay more. Formal jobs pay 1.7 times jobs require better education. Moreover, most the world, but they are poorly observed, meaning they provide more than informal jobs on average, while wage of the new jobs being created require better ed- little protection for many employees earn 1.6 times more on average than ucation. For example, of the 21 million jobs creat- nominally formal workers. See the self-employed (without workers) and 1.7 ed in services between 2001 and 2016, 10 million World Bank (2015a). times more than non-agricultural casual workers. required a high-school education and a further 9 41 Sakernas and World Bank million required tertiary education, while just 2 calculations. million required junior secondary or less.41 ASPIRING INDONESIA 32 EXECUTIVE SUMMARY FIGURE E.16 Change in jobs, 2001-16 by formality, occupational status and sector (million) Most of the new jobs created between 2001 and 2016 were good on paper, mainly being formal, in wage- employment, and in services. These jobs tend to require high school education or better, but pay more. Formal Informal Formality (million) 23 4 0 10 20 30 -1313988 -878192 2563588 1591124 1866772 4526471 Employee 19248784 Occupational status (million) Own Employer assisted by Casual account permanent worker(s) worker in agricultural Casual worker Unpaid sector in non- family Employer assisted by agricultural worker temp worker(s) sector Agriculture Services Industry Sector (million) –1.9 8 21 Source: Sakernas and World Bank calculations. ASPIRING INDONESIA 33 EXECUTIVE SUMMARY …which will mean ensuring that they complete at least high school & obtain the skills required for these better jobs 08 FI G U RE E.17 Mean monthly earnings for formal, employee and services jobs by education required, 2016 (Rp million) ES Even among formal jobs, wage-employment jobs, and services sector jobs, the marginal returns to education, especially for completing high school or gaining a university degree, are sizeable. Diploma IV/ 3.0 University or higher Employee Formal Services 2.5 2.0 Diploma I/ General II high 1.5 school Diploma III 1.0 Elementary school Vocational No high Schooling school 0.5 Junir High school Did not complete/ not yet 0 completed elementary school Source: Sakernas and World Bank calculations. ASPIRING INDONESIA 34 EXECUTIVE SUMMARY Below Education is the biggest Higher education levels single those in the Moreover, tertiary education is a clear de- dividing line between the middle class and those below. middle class out from the aspiring middle marcation of the middle and upper classes. Younger middle-class cohorts class and other Indonesians, and qualifies Not only do the middle and upper classes have complete high school and are them for better jobs. As discussed earlier, better education, but better education is also a increasingly going on to tertiary education. the middle class has significantly greater ed- strict marker of the middle and upper classes. ucational attainment than the other classes, While only half of those who finish high school with the younger cohorts (up to 44 years old) are middle or upper class, almost all of those mostly completing high school and many going who have some tertiary education are middle on to tertiary education. Meanwhile, only about or upper class, making higher education both half of the aspiring middle class completes the an aspiration and a demarcation of the middle high-school education required for the high- class (Figure E.18). er-paying formal jobs in the services sector (Figure E.10). ASPIRING INDONESIA 35 EXECUTIVE SUMMARY FI G U RE E.18 Highest educational attainment by class, 25- to 34-year-olds, 2016 (percent) It is only those in the middle class who predominantly have the high school or better education required for better jobs, with relatively few not completing high school and increasingly large numbers having tertiary education. P V AMC MC 1 MC 2 UC 100 80 60 40 20 0 No schooling Elementary Junior High Senior High Diploma I/II/ Bachelor Master/Doctor School School III Source: Susenas and World Bank calculations. Thus, lifting aspiring Indonesians into the ing between secondary and tertiary. Only 10 The education system also needs to provide middle class means having more of them percent of central government spending on ed- the skills demanded by well-paid jobs in the finishing high school and ideally going fur- ucation goes to secondary schooling, compared modern economy. Not only have Indonesia’s ther. The government has been implement- with 24 percent on primary education and 33 education outcomes long been poorly ranked ing education reforms, including compulsory percent on tertiary. Moreover, vocational edu- in international scoring, recent changes to the and free primary and junior secondary edu- cation—a key alternative channel for developing national curriculum mean that less time is be- cation spanning 12 years, which should pro- skilled workers outside of general education— ing spent on subjects that have more relevance vide greater incentives for more students to receives only 9 percent of the Ministry of Educa- to skilled employment. In 2013, hours spent complete high school. Nonetheless, failure to tion and Culture’s (MoEC) budget.42 Meanwhile, on English, mathematics, physics, chemistry finish senior secondary school for the aspiring the imbalance of spending between secondary and biology were reduced, along with the re- middle class is generally due to dropout after and tertiary education disproportionately bene- lated ICT training, in favor of more time spent junior secondary. This can be because of family fits the middle and upper classes at the expense of on civics and religious teaching. This means pressures to earn an income, but it may also the much larger aspiring middle class. Although today’s children are spending even less time reflect low perceived returns to further schooling. they comprise only 20 percent of the population, developing the skills that firms have identified Improving the quality (or perceived quality) of the middle and upper classes benefit from 43 per- as gaps (Figure E.20). secondary education may help to increase edu- cent of all public spending on tertiary education cational attainment among this group. (Figure E.19). Although tertiary spending is 3.5 42 See World Bank (forthcoming) Spending times larger than secondary school spending, Better: Indonesia Public Expenditure More needs to be spent on secondary and only 44 percent of this spending benefits deciles Review 2016-2018. vocational education to make them more 5-8 (roughly the aspiring middle class). This im- 43 World Bank (forthcoming) Growing attractive to children of the aspiring middle balance between tertiary and other educational Smarter: Learning and Growth in East Asia class and to rebalance the fairness of spend- spending is a broader regional pattern.43 Pacific. ASPIRING INDONESIA 36 EXECUTIVE SUMMARY FIGURE E.19 Public education spending incidence FIGURE E.20 Important skills identified by by consumption decile (Rp trillion) employers, and skill gaps (percent) Public spending on tertiary education Many of the skills that employers identify as important disproportionately benefits the middle and are the same skills which current workers lack. These upper classes. same subjects are now being de-emphasized in the current national curriculum. Senior Tertiary Secondary Spending Spending Identifies as Identifies as "skill "very important" gap in staff" 16 60 12 8 30 4 0 0 1 2 3 4 5 6 7 8 9 10 Basic Thinking Behavioral Computer English Skills Skills Skills Skills Skills Household per capita consumption decile Source: Susenas, administrative budget data and World Bank Source: World Bank (2011) Skills for calculations, in the forthcoming update to World Bank (2015) the Labor Market in Indonesia. Taxes and Public Spending. “lifting aspiring Indonesians into the middle class means having more of them finishing high school & ideally going further” Greater investments in early childhood ed- reforms to the formal education system come ucation will also bring more children into too late. These workers will need additional education earlier and better prepare them training to ensure their skills remain relevant to take advantage of later schooling. The as job creation continues to tilt toward certain majority of middle-class children are enrolled elements of the services sector. Currently, pub- in early childhood education and development lic provision of vocational training is scattered (ECED), but only half of children aged 5-6 across several line ministries, making it diffi- years old in aspiring middle-class households cult to coordinate efforts to adapt and improve are enrolled in school, and only 20 percent of the skills of current workers.45 This issue is in- those aged 3-4. ECED is relatively inexpen- tensified because a relatively small proportion sive and has been shown to generate strong of Indonesian firms offer on-the-job training: just returns.44 Not only will greater enrolment in 8 percent of firms in Indonesia provide on-the-job 44 See World Bank ECED of children in aspiring middle-class fam- training to workers compared with 32 percent of (2015a). ilies make education more of a habit for them, firms in the East Asia and Pacific (EAP) region at it will also mean that they are better prepared large.46 Therefore, more can be done to establish 45 Ministry of to learn later when they go to secondary school. a unified and comprehensive system for providing Manpower (2017), ‘Grand design training to current workers, coordinated by the pelatihan vokasi At the same time, current workers need National Commission for Vocational Education nasional’. to be given the opportunity to adapt and and Training. improve their skills as the types of jobs re- 46 World Bank Enterprise Survey quired by the economy change. For those 2015 and World Bank Indonesians who are already of working age, calculations. ASPIRING INDONESIA 37 EXECUTIVE SUMMARY The aspiring middle class 09 is more likely to suffer from ES non-monetary poverty Right Nearly half of those Two-thirds of the aspiring mid- stunted—a much higher level quate housing conditions, primar- in the middle class lacks dle class suffer deprivation on than Indonesia’s regional peers— ily the latter (Figure E.21). Of the access to either clean water, at least one non-monetary di- and a key constraint on the chil- 20 percent of Indonesians who are proper sanitation, or adequate housing conditions. mension of welfare. Fifty-three dren of the aspiring middle class middle class, 11 percentage points percent suffer from lower-quality entering the middle class when are also free from non-monetary housing, 30 percent lack access to they grow up.47 poverty on these dimensions, proper sanitation, and 7 percent while 9 percentage points are not. do not have access to clean water However, despite economic This is predominantly driven by (Figure E.21). These deprivations security, half of those in the sub-optimal building materials for have significant consequences, es- middle class are also deprived floors, walls and roofs, although pecially for the children of the as- on at least one non-monetary nearly 20 percent of the majority piring middle class, as poor living dimension, mostly due to poor of the middle class also lack proper conditions growing up, combined roofing. The middle class enjoys sanitation.48 Even around 20 per- with inadequate feeding practices, current incomes that indicate eco- cent of upper-class households 47 See World Bank (2015a). can increase the risk of stunting. nomic security; those in the mid- suffer from poor roofing materi- Stunted children develop their dle class have a very low chance of als or, to a lesser extent, improper 48 Good roofing cognitive skills more slowly, reach being poor or vulnerable next year. sanitation. That is, while security materials are lower educational levels, and earn However, economic security does from monetary poverty means liv- considered to be concrete or tile. less as adults, compared with chil- not guarantee freedom from depri- ing above subsistence, it does not Sub-optimal roofing dren who grow up healthy. This is vation and non-monetary poverty. yet guarantee non-deprivation on is that which is one of the most important devel- Nearly half of those in the middle all dimensions of welfare. made from asbestos, tin, bamboo, wood, opment challenges for Indonesia, class lacks access to one of clean leaves, and other where 37 percent of children are water, proper sanitation, or ade- materials. ASPIRING INDONESIA 38 EXECUTIVE SUMMARY FIGURE E.21 Non-monetary poverty by class, 2016 (percent) Despite having achieved economic security, close to half of the middle class is deprived on at least one non- monetary dimension, primarily poor housing conditions. Water Poverty Sanitation poverty Housing poverty Poor on at least one dimension 82 73 67 65 54 56 53 50 41 40 34 30 28 26 16 17 14 9 9 11 7 3 1 0.5 P V AMC MC 1 MC 2 UC Note: Water poverty means a household does not have access to Source: Susenas and World Bank calculations. clean drinking water (bottled, piped or protected well/spring); sanitation poverty means no access to a toilet with septic tank; housing poor means a poor-quality roof (not concrete or tile), floor (dirt), walls (not brick or concrete). ASPIRING INDONESIA 39 EXECUTIVE SUMMARY 10 ES At the same time, growing affluence and Moreover, the middle limitations in public service delivery mean that significant proportions of the middle and upper classes are beginning to opt out & upper classes are of key public services. In addition to wanting proper water and sanitation, those in the mid- beginning to opt out of dle class also care about health and education. Access to public education and health is nearly public services & into universal for the middle class, but physical ac- cess is not enough to guarantee good service; private provision, while quality matters as well. Many local health fa- cilities do not have equipment or training to provide basic care or key services such as blood the aspiring middle class and urine tests, even in urban areas where most of the middle class live.49 In education, despite is still reliant on public increases in teacher numbers and teachers’ pay, as well as a certification program, learn- services ing outcomes have not improved.50 Indonesia’s education outcomes remain among the lowest in the world and far behind the OECD average (Figure E.22), despite recent progress. ASPIRING INDONESIA 40 EXECUTIVE SUMMARY FIGURE E.22 International PISA scores, 2006-15 (points) Indonesian 15-year-olds have some of the lowest test scores in core subjects undertaking PISA tests, reflecting the need for better quality education. 550 Math Reading Science 500 450 400 350 '06 '09 '12 '15 '06 '09 '12 '15 '06 '09 '12 '15 Indonesia Non–OECD OECD Source: Programme for International Student Assessments (PISA). Consequently, those in the middle class are likely to use private hospitals. Half of the mid- increasingly likely to turn to the private dle class and three-quarters of the upper class sector, particularly in health, while poorer use private hospitals for inpatient treatment, Indonesians rely upon the public sector. compared with just one-third of the aspiring Wealthier Indonesians are increasingly seek- middle class (Figure E.23). Similarly, the mid- ing private health care, despite near universal dle and upper classes are more likely to go to 49 See World Bank 50 See World Bank access to public services. The middle class is a hospital for childbirth than the local health (forthcoming) (forthcoming) much less likely to use local health centers for center or clinic, and they are more likely to be Spending Better: Spending Better: inpatient and outpatient care than less-wealthy attended by a specialized or general doctor Indonesia Public Indonesia Public Expenditure Review Expenditure Review Indonesians, who are more likely to use public rather than a midwife or nurse. 2016-18. 2016-18. hospitals and, for the upper class, much more ASPIRING INDONESIA 41 EXECUTIVE SUMMARY FI G U RE E.23 Choice of health care by class, 2016 (percent) As Indonesians get richer, they are increasingly seeking private health care… State Private Practice Clinic Puskesmas UKBM Traditional Others Doctor P V AMC MC 1 MC 2 UC 2 3 5 7 6 18 11 29 Outpatient 41 37 23 30 39 33 21 44 43 Inpatient 45 60 75 32 48 16 21 FI G U RE E.24 Choice of school by class, 2015 (percent) …while the richest of the middle class are often sending their children to exclusive private schools. Public School Private School – exclusive* Other Private School* P V AMC MC 1 MC 2 UC 14 14 15 25 33 32 34 SD 3 47 72 86 86 85 20 34 20 18 29 27 28 23 SMP 3 14 48 71 73 72 74 66 34 8 26 30 29 30 25 SMA 74 1 64 17 58 43 49 70 70 6 Note: Exclusive private schools are those whose tuition Source: Susenas and World Bank calculations. fees are in the top 10 percent of all schools. ASPIRING INDONESIA 42 EXECUTIVE SUMMARY The middle class, and especially the upper An extreme example of this opting-out be- 51 See Appendix 1 of World Bank (2017b) Revealing the Missing Link: Private Sector class, are also beginning to use exclusive havior that the middle and upper classes Supply-side Readiness for Primary Maternal private schools. In general, there is less opt- are beginning to display is the increase of Health Services in Indonesia and Table ing out of public education by the middle class. planned communities.55 Not only are many 4.9, based on the Quantitative Service Delivery Survey (QSDS) 2016. Despite historical issues with the quality of middle- and upper-class Indonesians opt- public schooling in Indonesia, there are many ing out of public services, but many mid- 52 See Table 4.2 of World Bank (2016) excellent public schools, especially in wealthy dle- and upper-class Jakartans are opting Indonesia Health Financing System neighborhoods of larger cities where the middle out of Jakarta. In one survey, Jakarta ranked Assessment: Spend More, Right & Better. class often lives. Nonetheless, we are beginning as the 35th best Asian city, behind its main 53 Quantitative Service Delivery Survey to see the middle class sending its children to regional competitors: Singapore (4th), Kuala 2016 and World Bank calculations. elite private schools. While less than 10 per- Lumpur (9th), Beijing (10th), Metro Manila cent of most middle-class children attend these (14th) and Bangkok (26th).56 Jakarta suffers 54 PISA data and World Bank calculations. schools, this increases to 14 to 20 percent for from air and water pollution well beyond Unit- MC 2 depending on schooling level, and for the ed Nations threshold levels; most wastewater 55 This summary is from Wai-Poi et al. (2016). upper-class group it reaches 34 percent for pri- is discharged without treatment.57 Traffic is mary and junior secondary, and 43 percent for crippling; Jakarta is the only major city in 56 Firman (1999) 'Indonesian Cities under senior secondary (Figure E.24). Southeast Asia without a mass transit sys- the 'Krismon'', Cities 16(2). tem of some kind. In response, many richer Some evidence suggests, however, that pri- Jakartans are choosing to live in planned com- 57 Hogan and Houston (2002) ‘Corporate Cities - Urban Gateways or Gated vate sector quality is not necessarily high- munities, or kota mandiri, as they are known Communities against the City? The Case er. It is difficult to measure the true quality of locally. Among the most well-known are BSD of Lippo, Jakarta’ in in T. Bunnell, LBW. the private health care that the upper class, City, Lippo Karawaci and Lippo Cikarang. BSD Drummond and KC. Ho (eds) (2002) Critical Reflections on Cities in Southeast Asia and some of the middle class, are beginning City had 200,000 residents in 201058 in a grow- Singapore Times Academic, 243-264. to use. However, on a number of indicators ing township that covers 1,300 hectares and is of service readiness, the private sector does planned to expand to 6,000 hectares by 2035, 58 Sharpe (2014) Meet Indonesia's not outperform the public sector. For exam- with 150,000 new homes being built in the next middle class (part 2): Jakarta's two cities. Retrieved 31 March 2016 ple, average service readiness among sampled decade and an expected population of 1 mil- from http://www.lowyinterpreter.org/ priority districts was 79 percent among public lion people by 2035.59 In 2002, Lippo Karawa- post/2014/02/20/A-tale-of-two-cities. health centers (Puskesmas) compared with ci had 30,000 residents (plus 40,000 workers aspx; Kompas (2010) Mengapa BSD Master Plan Perkotaan Terbaik? Retrieved March 68 percent among single-practitioner private and 50,000 transient day visitors);60 by 2015, 31 2016 from http://properti.kompas.com/ maternal health-providers and 71 percent 120,000 people lived in the three Lippo cities read/2010/11/13/17180782/mengapa.bsd. among multi-practitioner private maternal of Lippo Village, Lippo Cikarang and Tanjung master.plan.perkotaan.terbaik. health-providers.51 This means the private pro- Bunga.61 About 32,000 people reportedly live 59 Widjojo (2015) ‘BSD City: A Response to viders surveyed typically have reduced access in Alam Sutera62 and over 100,000 in Bintaro Jakarta’s Rapid Urbanisation’. Retrieved to medicines and commodities, but also poten- Jaya.63 These planned communities are in some March 31, 2016. http://www.citymetric. tially fewer staff with less adherence to clini- ways the embodiment of the richer middle class com/skylines/bsd-city-response-jakarta-s- rapid-urbanisation-1107; Kompas (2010). cal guidelines. While the middle class may be and upper class opting out of public services. opting for private hospitals rather than private They provide complete amenities such as se- 60 Hogan and Houston (2002). clinics and public providers,52 even comparing curity, clean drinking water, proper sewage, public and private hospitals there are some reliable power, malls and entertainment com- 61 Lippo Karawaci (2015) Annual Report indications that public provision outperforms plexes, parks, and golf courses. Many include 2015. Retrieved March 31 2015 from https://www.lippokarawaci.co.id/ private provision, for example in terms of HIV prestigious private schools, from kindergarten uploads/file/Publication/AnnualReport/ and TB services.53 Similarly, average interna- up to university. As an increasing number of AnnualReport%202015_IND.pdf. tional test scores for 15-year-olds in the mid- middle- and upper-class Indonesians begin to dle-class range of the SES distribution score live in these planned communities with private- 62 Alam Sutera (2014) Annual Report 2014. Retrieved March 31, 2016 from http:// on average 20 points higher if they are enrolled ly-provided services and amenities, the risk www.indonesia-investments.com/upload/ at a public school than at a private school, al- is not only that some of the louder and more bedrijfsprofiel/461/Alam-Sutera-Realty- though this does not distinguish between elite influential public voices will remain silent on Annual-Report-2014-Indonesia-Investments. pdf. private schools and other private schools as we public services, but also that those comprising do elsewhere in this report.54 It is not possible the class that bears a significant part of person- 63 Bintaro Jaya (2011) The Professional to separate out those attending exclusive pri- al income tax burden will become reluctant to City Bintaro Jaya. Retrieved March 31, vate schools who may have superior scores, but pay for poor quality public services that they 2016 from https://bintarojayashinta. wordpress.com/2011/07/14/the-proffesional- in terms of health and education it is not clear that themselves do not use. city-bintaro-jaya/. private means better quality. ASPIRING INDONESIA 43 EXECUTIVE SUMMARY Entry to the middle class is difficult for most, 64 The IFLS is a five wave panel while even the middle class is not immune to data set spanning 1993 to 2014, representative shocks, highlighting of 83 percent of the national population. As it the importance of more uses a different consumption aggregate than comprehensive & effective Susenas, applying Susenas poverty lines will not give social protection to help comparable poverty lines. Instead, the poverty rates for the provinces covered by IFLS are aspiring Indonesians into the middle class & then used to determine what an equivalent poverty line in keep them from each province would be to give the same rate. The different falling back class thresholds are then determined by the same multiple of this new poverty line as used in Susenas and elsewhere in this report. While using a fixed multiple of the poverty line ensures we are using a consistent living standard across time, it does not ensure we have the same Over the past 20 years, the majority of en back into poverty by 2014, although nearly rates of each of the poor and vulnerable have climbed out one-fifth had become vulnerable. However, the classes, as the shape of the of poverty and into the aspiring middle only one-quarter of the AMC had managed IFLS consumption class. Of those who were poor in 1993, 80 per- to become middle class over the two decades, distribution also cent were no longer poor by 2014, although while half of them remained in the AMC (Table varies from that one-quarter was still vulnerable. However, 44 E.2). This persists in post-Suharto Indonesia, 11 of Susenas. The results shown are percent had become AMC and 12 percent man- following the Asian financial crisis, democrati- from balanced aged to reach the middle class (Table E.2).64 zation and decentralization (Table E.3). pairs across the starting and ending Similarly, while 14 percent of the vulnerable waves; results for had fallen back into poverty and one-fifth re- At the same time, while those in the mid- ES balanced pairs mained vulnerable, half had climbed into the dle class are largely no longer vulnerable across all waves are very similar. AMC and 16 percent into the middle class. to poverty, they can still fall back down the See World Bank distribution. Since 2000, only 10 percent of the (forthcoming) However, for the aspiring middle class, middle class became poor or vulnerable (Table Economic Mobility in Urban Indonesia becoming middle class is far harder. Few E.3). However, only half stayed middle class, with for more details. of the aspiring middle class in 1993 had fall- 40 percent falling back into AMC status. ASPIRING INDONESIA 44 EXECUTIVE SUMMARY TABLE E.2 Mobility matrix 1993-2014 (percent) TABLE E.3 Mobility matrix 2000-14 (percent) Many have risen out of poverty and vulnerability in the Very few middle-class Indonesians have fallen back past 20 years, although moving up from the AMC to the into poverty and vulnerability, but around 40 percent MC has proved more difficult. have dropped into the AMC. 2014 2014 P V AMC MC P V AMC MC P 20 24 44 12 P 22 27 42 10 V 14 21 49 16 V 13 23 50 14 AMC 7 17 51 26 AMC 8 15 52 25 1993 1993 MC 3 9 44 45 MC 2 8 40 50 Source: Indonesian Family Life Survey (IFLS) and World Bank Note: The percentage of population in each class in IFLS is not calculations. the same as presented in the rest of the report as the IFLS only represents 83 percent of the population and uses a different consumption aggregate. Consequently, there are more MC and less V in the IFLS and IFLS matrix than in Susenas, used in the rest of the report. “Over the past 20 years, the majority 80 % of the poor and vulnerable have climbed out of poverty and into the aspiring middle class” Of those who were poor in 1993, 80 per- cent were no longer poor by 2014. A key reason why the aspiring middle ically does not provide enough support to fully class struggles to enter the middle class, cope and also fails to work when a shock such and why the middle class themselves can as a natural disaster hits an entire communi- sometimes fall back down, are the many ty. When informal borrowing is not enough, shocks that can erode household resources households may resort to steps that reduce and incomes. Households can be affected by their future income, such as selling productive economic, health, social and political shocks, assets or pulling children out of school. Thus, as well as natural disasters. As we have seen, shocks can reduce household income by either these shocks affect all classes of Indonesians. destroying or impairing the underlying assets Job loss or the death or disability of a key bread- that generate income (productive assets such winner can drastically reduce income. Many as equipment or human assets such as labor), 65 World Bank (2015d) Social of the urban areas in which the aspiring mid- or by forcing households to use or sell these Impacts of dle class and the middle class live are prone assets (savings or productive assets) to cope Temporary to flooding and earthquakes. Without formal with the shock. Unconditional Cash Transfers in protection mechanisms, people affected usually Indonesia. turn to family and friends.65 However, this typ- ASPIRING INDONESIA 45 EXECUTIVE SUMMARY FI G U RE E.25 Indonesian population projections by age group (million on LHS and percentage of population on RHS) Indonesia’s dependency ratio is set to climb sharply after 2040, as the proportion of individuals above retirement age grows. 0–14 15–Retirement age Retirement age + Dependancy ratio 350 50 300 40 250 30 200 150 20 100 10 50 0 0 '15 '16 '17 '20 '25 '30 '35 '40 '50 '60 '70 '80 Source: UNFPA. FI G U RE E.26 Contributors, beneficiaries and pension system dependency ratio of SJSN Pension (million on LHS and percentage of members on RHS) As the dependency ratio rises, the ratio of beneficiaries to contributors for SJSN pensions is predicted to increase substantially. Nominal Contributors Total Beneficiaries Dependancy ratio 60 100% 50 80% 40 60% 30 40% 20 30% 10 20% 0 0% '15 '16 '17 '20 '25 '30 '35 '40 '50 '60 '70 '80 Note: Pension system dependency ratio is the number of Source: World Bank calculations. beneficiaries compared with the number of contributors ASPIRING INDONESIA 46 EXECUTIVE SUMMARY Therefore, a key challenge in tiatives are underway to make the long run. Second, it must deal with expanding the middle class current eligibility and enrolment issues related to extending cover- and keeping new entrants in system more dynamic. For those age to both formal and informal the middle class is developing in the aspiring and middle class- workers. Third, not all risks are a comprehensive social protec- es, who in most cases can afford covered by SJSN programs. Final- tion system. There are two key to pay the contributions to the ly, coverage alone is not sufficient components to effective social country’s emerging social insur- to protect members from shocks; protection. First, social insurance ance schemes, such schemes offer the program also needs to pro- allows households and workers to the best protection from shocks. vide access to quality, especially contribute to insurance schemes in health care. that protect them from shocks, Indonesia’s new National So- both those that are predictable, cial Security System (SJSN) Indonesia’s changing demo- such as old age and retirement, intends to provide universal graphics mean that the fis- and those that are not, such as social insurance cover for all cal sustainability of SJSN is in illness and unemployment. Un- Indonesians by 2019. Sistem Ja- question. As Indonesia’s popula- der such schemes, workers pay minan Sosial Nasional, or SJSN, tion begins to age, the number of monthly social insurance premi- was introduced in 2014 to provide working contributors to SJSN will ums and in return gain access to health, employment and old-age begin to decline and the number health care, employment and dis- insurance to all Indonesians by of non-working beneficiaries who ability cover when they need it, as 2019. It replaced a previously frag- draw on SJSN will begin to in- well as ensuring an income when mented system that covered only crease. Between 2040 and 2080, they retire. Second, social assis- some of the poor, civil servants Indonesia’s dependency ratio— tance provides an important safety and the military, as well as around the number of young and elder- net for those who cannot afford to 25 percent of formal workers. This ly compared with the number of contribute to social insurance. meant that the majority of Indone- working age adults—is project- sians were left out. The previous ed to rise from 25 to 47 percent For the aspiring middle class system also had inadequate ben- (Figure E.25). This increase in and the middle class, effective efits, a weak legal structure, and dependents and reduction in con- social insurance is the key to poor supervision and control. tributing adults means the pro- economic security; social as- jected pension system dependency sistance can act as a last resort SJSN has been successfully in- ratio—the number of beneficiaries for some. While a small number troduced but faces four key compared with the number of con- of the aspiring middle class par- challenges if it is to offer the tributors—starts out near zero ticipates in some social assistance comprehensive and effective and increases to about 95 percent programs, these programs are protection the aspiring and by 2080 (Figure E.26). Without mainly targeted at the chronical- middle classes need and de- ensuring that current contribu- ly poor and vulnerable, and do not mand. Since 2014, the govern- tion levels match program ben- currently capture transient pov- ment has launched a comprehen- efits, SJSN may fail to look after erty—when the aspiring middle sive roadmap for the employment the growing middle class, which class suffer shocks. Clear recom- program of SJSN and completed will come to rely upon it in the fu- mendations for strengthening In- the design and financing strategy ture. Furthermore, premiums are donesia’s social assistance frame- for the pensions and old-age sav- paid, in practice, by both formal 66 World Bank work—a vital step in eliminating ings programs. It has also complet- workers and by the government on (2017c) Towards a Comprehensive, poverty and vulnerability—are ed the transformation of the legal behalf of the poor and vulnerable; Integrated, and addressed elsewhere.66 However, structure into two new adminis- government subsidies make up Effective Social social assistance programs are trators, one for SJSN Health (BPJS half of all National Health Insur- Assistance System in Indonesia. not as effective at helping aspir- Kesehatan) and the other for SJSN ance (Jaminan Kesehatan Nasi- ing and middle-class households Employment (BPJS Ketenagaker- onal, or JKN) revenues. However, 67 World Bank that suffer major shocks. It takes jaan). SJSN Health now covers 171 JKN does not cover the full costs (forthcoming) time and resources to bring new million members. However, SJSN of health care, which means that Spending Better: Indonesia Public households into social assistance faces four key challenges. First, it central and local governments Expenditure Review programs, although current ini- must be fiscally sustainable in the make up the difference.67 2016-2018. ASPIRING INDONESIA 47 EXECUTIVE SUMMARY “Introducing unemployment insurance Right Expansion of the middle class will also require better & fulfilling the ambitions of the SJSN leveraging of the potential of Indonesian cities to deliver framework can better protect workers on prosperity, inclusion, and livability. from job loss shocks” Extending SJSN coverage to ment. Although now being dis- severance system, can offer more both all formal salaried workers cussed, unemployment insurance reliable protection during unem- and informal workers is prov- is not currently part of the SJSN ployment, supporting workers’ ing difficult. SJSN Health targets Employment program coverage. mobility, while building on Indo- universal coverage by 2019, while This means a sudden loss of a job nesia’s institutional investment in SJSN Employment targets univer- can impede members of the as- SJSN.  sal coverage of salaried workers by piring middle class in their climb the same date. However, private to join the middle class, or it can Finally, SJSN has governance sector salaried worker participa- mean that even when they get issues…. The potential for er- tion is still low. Key reasons for there they can easily fall back. ror, fraud, and corruption (EFC) this that need to be addressed in- in social security systems is high. clude: employers failing to register Introducing unemployment in- OECD studies have identified that for the program (especially small- surance and fulfilling the ambi- the potential EFC loss in the im- er employers); employers regis- tions of the SJSN framework can plementation of these systems in tering some but not all workers; better protect workers from job developed countries ranges from and some employers evading con- loss shocks. The roll-out of SJSN 0.1 percent to 16 percent of the tributions entirely. At the same may have expanded the access and total budget. Given SJSN Health’s time, most non-salaried workers entitlement to social insurance. 2014 disbursement and payments remain outside the program for a This has not provided adequate of Rp 45 trillion, this implies that variety of reasons. Potential mem- protection for workers; obser- the potential EFC losses could reach bers often do not understand the vance of severance pay remains as high as Rp 7 trillion.68 Despite its programs and realize the value of low even among workers with an many supervisory bodies, SJSN does participation; programs are not employment contract, and many not yet have an integrated EFC mit- always designed for informal sec- do not receive it in the event of job igation strategy. tor needs; it is difficult to register loss. Although the current sever- workers, estimate income and ance pay system offers limited …and service delivery issues, enforce contribution compliance; support for laid-off workers, In- especially in health. SJSN fac- making payments and receiving donesia’s employment protection es a number of service delivery benefits can be time-consuming legislation, including severance issues. For example, SJSN Em- and expensive; the infrastructure rates and restrictions on the use ployment old-age savings claims for registering and collecting con- of temporary contracts and out- experience a long processing time. tributions from informal workers sourcing, ranks among the most However, the issues are most se- is limited; and irregular income restrictive in East Asia and com- vere in health, including limited for informal workers means it can pared with other middle-income hours, long queues, unavailability be difficult to make contributions countries. These restrictive reg- of doctors and rooms in hospitals, each month. Overcoming the dif- ulations can have the unintended delayed treatments, and limited ficulties of extending coverage to effect of discouraging formal em- services in more remote areas. informal workers is a challenge ex- ployment, which is a key pathway Improving health service delivery perienced by developing countries through which the middle class in Indonesia is critical to helping throughout the world. The most can be expanded. SJSN can pro- the aspiring middle class to cope practical solution is to increase the vide better protection against the with health shocks and expanding formalization of jobs and increase risk of job loss by introducing ben- the middle class. We address the the coverage of formal workers. efits for unemployment to workers key steps needed to make health through a centrally administered care more effective in Indonesia in 68 World Bank and Not all risks are covered by income support system. Such a a later section. Rand International SJSN, particularly unemploy- system, alongside a reform of the (2015). ASPIRING INDONESIA 48 EXECUTIVE SUMMARY ASPIRING INDONESIA 49 EXECUTIVE SUMMARY FIGURE E.27 Incidence of indirect taxes, 2015 (Rp trillion) The middle class—the richest two consumption deciles—already pays nearly half of all indirect taxes and almost all direct taxes. Excises VAT 12 ES 60 50 40 30 At the same time, 20 the government needs to avoid the risk of a polarized 10 Indonesia… 0 Poorest Richest Household per capita consumption decile As Indonesians become richer and more creases in aspirations and expectations affect Note: Excises are those on tobacco, which people become economically secure, those households all the way up the income distribu- make up 95 percent of total excises. in the expanding middle class will not only tion. A good example in East Asia is the case Source: Susenas and World Bank begin to think beyond economic security of Malaysia, which is now an upper-middle-in- calculations.70 but also how their incomes compare with come country, with almost no poor households others. We have been using the concept of eco- and where 86 percent of people are above the 69 See World Bank (2014b) Malaysia nomic security to capture the increasing num- regional economic security line. Despite this, Economic Monitor: Towards a Middle Class bers of prosperous Indonesians. However, what only 41 percent of Malaysians think that they Society. happens once most people are secure? As most are even lower middle class or better; hence, of a country’s population becomes economical- middle class has become a relative concept in 70 See the forthcoming World Bank update to the 2015 report Revisiting the ly secure, security itself is no longer sufficient Malaysia.69 Distributional Impact of Fiscal Policy in to be considered middle class. Continuing in- Indonesia: Who Benefits, Why Pays? ASPIRING INDONESIA 50 EXECUTIVE SUMMARY Above Almost half of the business owners who employ others are from the middle class. Policies that support these entrepreneurs will increase their economic mobility, helping to drive economic growth, and create more jobs for the aspiring middle class. Paying for investments in infrastructure, (Figure E.27) and, along with the small upper health, education and productivity to en- class, comprised almost all of Indonesia’s 11.8 able more Indonesians to meet their as- million income taxpayers in 2016.73 pirations means, in part, more income 71 World Bank (2014) tax revenue, which will be largely paid by Thus, Indonesia will need to make public and World Bank the middle class. Greater public investment investments and policies that benefit both (2017d) Indonesia Economic Quarterly: is needed not only to drive future economic the current middle class and those who as- Sustaining Reform growth and transform Indonesia into a high-in- pire to join it. With the upper class very likely Momentum. come country, but also to allow those below to opt out of most public services, retaining the middle class to gain economic security and middle-class support for public investments 72 World Bank (2017d). meet their aspirations.71 Even with greater pri- in areas needed for Indonesia’s development vate sector investment,72 the government will is vital. Not only do those in the middle class 73 Data on number need to increase spending in these areas, which need to appreciate public spending in areas of individual means increasing public revenues. With per- that matter to them, but they must also be income taxpayers who submitted sonal income tax collection very low, at only 1.1 prepared to pay to support public investments annual tax returns percent of GDP, it offers the potential to collect that provide upward economic mobility for the comes from the significant new revenue from those who can non-middle class, including the aspiring middle Directorate General of Taxes, Ministry afford it most and finance these critical invest- class, when they observe public spending and of Finance. The ments needed for Indonesia’s development and programs that benefit the latter. It will also be confirmed number stability. However, greater income taxes will important that all members of society are seen of filers in 2015 was 10.3 million; be largely paid for by the middle class, which to be paying their fair share of taxes. the 2016 number is already provides 42 percent of indirect taxes still provisional. ASPIRING INDONESIA 51 EXECUTIVE SUMMARY 13 ES …by developing a new skills they need to succeed later in life. Bet- ter quality services may also mean that those in the middle class use and appreciate them social contract based on more widely, generating broader support for financing them. Second, access to livelihoods the common interests that allows those in the middle class to prosper and those below the middle class to enter can of quality services, help to ensure economic mobility for all. This means a focus not only on better education, discussed earlier, but also on making it easier economic mobility & to become an entrepreneur, which increases the prosperity of the middle class and creates social security for all new jobs for others. Mobility can also be pro- moted through economic reforms, including closing the infrastructure gap, improving how decentralization is working, better leveraging urbanization, and targeted place-based poli- cies for lagging regions. Finally, effective and sustainable health, employment and old-age insurance can provide the safety net that the aspiring middle class needs to enter the middle class, and can protect the economic gains that the middle class has already achieved. An arrangement for all Indonesians would the shocks that can affect everyone. Finally, be one in which public investments drive strengthening income tax compliance by the Moreover, this will reduce the risk that growth, growth is inclusive, and social in- current middle class and boosting new collec- those outside the middle class become shut surance protects the gains of all. For the tions from an expanding middle class mean out, resulting in a more fractured society. non-middle class, access to high-quality public that there should be adequate financing for Instead, social cohesion and stability will in services and good jobs can provide opportuni- needed investments. turn drive further growth. Nearly half of In- ties to achieve economic security and join the donesia’s population is in the group that aspires ranks of the middle class. At the same time, Thus, a social contract that focuses on to join the middle class. This group includes the upward mobility of the non-middle class and quality public services, economic mobil- median voter and, if they can join the middle investments in productivity and infrastructure ity, and social security for all would help class, they will combine with the existing 20 will drive greater economic growth, benefiting expand the middle class and protect those percent of middle-class Indonesians to repre- the existing middle class. Furthermore, stron- already in it. A new relationship between the sent two-thirds of the country. Meeting their ger social insurance to provide employment government and its people could focus on three aspirations and delivering economic security and health protection, as well as pensions, areas. First, quality public services, especial- to many will help strengthen social cohesion means that the economic gains of an expanding ly in health and education, but also water and and address rising inequality. In turn, greater middle class—both those who are currently in sanitation, are necessary so that aspiring mid- stability and lower inequality have been shown it and those who will join—can be secured from dle-class children can develop the health and to drive economic growth.74 ASPIRING INDONESIA 52 EXECUTIVE SUMMARY Below Since access to computers and the internet are uncommon outside the middle class, middle-class children are far more likely to gain exposure to the information and communications technology that underpins the modern global economy. 74 For a comprehensive study of inequality in Indonesia see World Bank (2015a). See Gupta (1990), Keefer and Knack (2002) on the effects of political instability on economic growth, and Alesina and Rodrik (1994), Alesina and Perotti (1994) and Persson and Tabellini (1994) on links between political economy and economic growth. ASPIRING INDONESIA 53 EXECUTIVE SUMMARY 75 This discussion on public service delivery and quality is expanded Quality significantly in the main report and draws heavily public services can be on World Bank (forthcoming) Spending Better: Indonesia Public delivered by linking Expenditure Review 2016-2018. local government 76 On economic mobility, see World Bank (forthcoming) financing & ‘Economic and Social Mobility in Urbanizing performance Indonesia’, Urban Poverty background 75 paper, as well as the forthcoming Urban Flagship report. On social security, see World Bank (2017c) Towards a Comprehensive, Integrated, and Effective Social Assistance System in Indonesia, World Bank (2015e) Indonesia Economic Quarterly, October 2015 which discusses the A key element of a new social contract is quality public come country average of 14. At the same time, a teacher national health services. The other two elements of the proposed social certification program has expanded sharply and is reflected insurance system. A contract, namely economic mobility and social security, are in greatly increased teacher allowances. However, despite new flagship Social Protection report addressed in more depth in the body of the report, and in increased spending on educational inputs, learning out- is also underway other reports.76 This section looks further into how better comes have not improved, with little change in interna- in Indonesia, quality public services can be delivered, with a focus on tional PISA scores and no relationship between lower STRs which will provide a comprehensive health, education and governance. The following section and test scores. analysis of all discusses how the various investments needed to deliver elements of social the new social contract can be financed through improved Increasing the focus on continuous professional de- protection and formulate policy tax policy and administration. velopment and linking performance to rewards, both recommendations. at the teacher and local government level, could im- Despite significant investments in education, an in- prove the quality of teaching and education. There is a 77 World Bank creased number of teachers and higher teachers’ lack of continuous professional development (CPD) and the (forthcoming) Spending Better: salaries, learning outcomes continue to lag. Educa- School Operational Fund (BOS) spends three times more on Indonesia Public tion spending in Indonesia quadrupled between 2001 and honorariums (17 percent) than professional development Expenditure Review 2016 in real terms, and now represents 20 percent of all (5 percent). At the same time, there is no link between 2016-2018. public spending and 3.3 percent of GDP. The number of teacher performance and teachers’ allowances and pro- 78 See World Bank teachers has increased dramatically since 2005, with 15 fessional progression, so quality is neither developed nor (2016) Health percent more civil servant teachers and 40 percent more rewarded. Moreover, funding and spending are not linked Financing System temporary teachers by 2015. Indonesia’s student-to-teacher to performance either. Local governments are responsible Assessment: Spend More, Right, and ratio (STR) of 17 is far below the average for other lower for spending their education budgets to achieve minimum Better. middle-income countries, at 29, and is nearing the high-in- service standards, but spending is only weakly correlated ASPIRING INDONESIA 54 EXECUTIVE SUMMARY 14 ES “Total health spending in Indonesia is low relative to other countries in the region and much of it comes from consumers themselves” with these achievements, while BOS allocations spite increases in recent years, public spending deliver results; producing sufficient competent are generally not allocated based on school per- on health is among the lowest in the world at health workers and ensuring they are deployed formance. The World Bank currently pilots the just 5.9 percent of total public expenditures, to where they are needed; and scaling up and tying of teacher allowances with teacher per- which represents only 1.1 percent of GDP—far enforcing the accreditation system. formance through the KIAT Guru project. In lower than the 3.3 percent average for coun- this project, the payment of the remote area tries of similar income levels. Consequently, More broadly, improvements are needed in allowance to teachers in pilot schools is tied many health facilities lack the equipment and the way local governments deliver public with either teacher presence or service perfor- training to provide key services. Moreover, services. In a decentralized Indonesia, local mance, with inputs from parents and broader central government spending represents governments are critical for delivering pub- community members. Initial findings indicate only one-third of total health spending, and lic services, not just in health and education, significant improvements in teacher presence this is compounded by a disconnect between but also in areas such as water, sanitation and and service performance. Another example of local government spending and supply-side roads. And in an urbanizing Indonesia, service how reforms could tie spending to performance readiness. delivery in cities is failing, where only 33 per- is the reform introduced by the Jakarta Provin- cent of urban households have access to clean cial Government in 2015.77 In addition to increasing health spending, water, only 12 cities have piped sewerage net- Indonesia needs to focus on spending bet- works serving 2 percent of the urban population, Unlike education, there is insufficient ter. More spending on health could help to and 40 percent of urban residents do not have spending to ensure supply-side readiness reduce gaps in access. Moreover, the priori- access to proper sanitation. in the Indonesian health system.78 Total ty is improving the quality of health services. health spending in Indonesia is low relative Specific actions include targeted public in- to other countries in the region and much of vestments with built-in incentives for per- it comes from consumers themselves. De- formance to equip local health facilities to ASPIRING INDONESIA 55 EXECUTIVE SUMMARY Five strategies have been identified to maximize the effectiveness of local governments’ spending of transfers.79 To improve local government spending on service delivery, the government should: 1 Build a robust system to measure performance 2 Make the most of incentives 3 Address poor performance in graduated ways Relate inputs, processes and outputs to Remove bad incentives, such as the Issue letters to improve; provide outcomes; invest in higher quality data; general allocation fund (DAU) basic technical support; require performance combine finance and performance data share that encourages the hiring of more action plans; and reduce funding for a more meaningful picture; and utilize district staff; use financial incentives allocations. the Statistics Indonesia (BPS) and the in different ways, such as rewarding Financial and Development Supervision process compliance and paying for Agency (BPKP) in monitoring. outputs; use matching funding to drive ownership; and encourage positive competition, by publicizing local performance data 4 Use citizens to provide incentives for better 5 Fix systems & capacity performance Make budget and spending data public; Streamline subnational public financial involve citizens in the local decision- management (PFM) systems; measure making and development; and provide the performance of subnational PFM feedback mechanisms. systems to targeting capacity building; 79 World Bank modernize district financial management (forthcoming) accounting software; and develop Spending Better: a comprehensive capacity-building Indonesia Public Expenditure Review program for subnational governments. 2016-2018. ASPIRING INDONESIA 56 EXECUTIVE SUMMARY In addition, reforming Law (DAK) should address well-de- also means that large urban pop- No. 33/2004 on Fiscal Decen- fined national priority outcomes, ulations—where most of the mid- tralization’s comprehensive rather than broad functional ar- dle class and much of the aspiring intergovernmental financing eas. Second, getting the DAU right middle class live—lack sufficient framework could make decen- matters. The current formula ba- financing for their local infrastruc- tralization more effective. Two sis for DAU allocations is per dis- ture needs, undermining local ser- core changes would help. First, trict, not per person. This not only vice delivery. conditional transfers to regions encourages districts to split, but it Right A social contract that focuses on quality public services, economic mobility, and social security for all would help expand the middle class and protect those already in it. ASPIRING INDONESIA 57 EXECUTIVE SUMMARY ASPIRING INDONESIA 58 EXECUTIVE SUMMARY Left Tax revenues from the growing middle class will be critical to fund the investments in health and education, infrastructure and productivity necessary for 15 Indonesia to keep developing. ES class and all of the aspiring middle class are exempt from paying any income tax. Adding Improving tax policy more taxpayers to the tax base will not only generate greater revenues but will also have the benefit of increasing accountability and the & tax administration demand for services by the middle class, as more of those in the middle class start paying taxes. is also important to However, these policy reforms will also re- fund the investments quire significant investments in tax admin- istration capacity. Plausible tax-broadening measures include lowering the VAT registra- required to grow the tion threshold and replacing the non-taxable income threshold (PTKP) with tax credits for middle class taxpayers who are poor or vulnerable. Other needed tax policy reforms include increasing taxes on alcohol, tobacco and vehicles, and introducing more environmental taxes, such as on plastic bag consumption. The enabling Indonesia needs to invest more to grow the Indonesia can collect more taxes on goods and factor for successful policy reforms will be im- middle class, which will mean increasing services. Indonesia collects about the same proving the tax administration capacity of the its tax collection. Indonesia’s level of central share of GDP in VAT as Thailand and Malaysia, Directorate General of Taxes (DGT) and facil- government spending is lower than in other despite having a rate that is 30 and 40 percent itating a high degree of voluntary compliance. developing countries and is insufficient to build higher, respectively. This is in part because too Currently, DGT continues to rely heavily on and serve a growing middle class. Without in- few firms have to pay VAT; Indonesia has the paper filing due to limited IT capacity and staff creasing the level of spending and improving highest business revenue threshold for paying expertise, while business processes for regis- the quality of that spending, Indonesia will VAT in the world (relative to GDP per capita). tration, filing and payment remain too com- struggle to provide the services that are nec- This, combined with a policy of allowing for plex. Moreover, current regulations require essary to build and serve a growing middle many goods and services to be exempt from that all business requests for VAT refunds are class, namely health, education, housing and VAT, significantly reduces the VAT base. The audited, creating an undue burden on DGT and social insurance. However, spending more will government also has an opportunity to collect delays for businesses receiving back their VAT mean raising more revenue. Indonesia’s reve- more taxes and significantly broaden the per- refunds. To increase tax administration capac- nue-to-GDP ratio is low, at just 12.2 percent sonal income tax regime, which currently ex- ity, DGT requires significant investment in IT in 2017, compared with an emerging economy cludes about 98.8 percent of citizens. A high capacity, as well as reforms of human resources average of 27.8 percent, and tax collections are threshold narrows the income tax base and, and business processes. Moving to a risk-based lower than both regional peers and countries with as a result, only about 15 percent of employed approach for auditing VAT refunds is a criti- similar levels of GDP per capita. workers have an obligation to file income tax cal component. A major cultural shift at DGT returns, compared with rates of 50 percent will also be needed—one that entails treating Increased revenues will require substan- or higher in many advanced economies. In taxpayers as consumers and setting targets on tial reforms to tax policy, broadening the fact, the annual non-taxable personal income regular improvements in the ease with which tax base and raising rates for select taxes. threshold means that 94 percent of the middle citizens can pay their taxes. ASPIRING INDONESIA 59 EXECUTIVE SUMMARY Indonesia aspires to move from middle- to ger and develop the skills they need for better Right Mobility can also be promoted through economic high-income country status. Meeting these jobs. It also means expanding social insurance reforms, including closing aspirations will mean meeting the aspira- so that their newfound prosperity is protected the infrastructure gap, tions of its people and becoming a mid- from shocks. improving how decentralization is working, better leveraging dle-class society. The emergence of a pros- urbanization, and targeted perous middle class in Indonesia has been a key However, this also means a new social con- place-based policies for driver of recent economic growth. However, tract for Indonesia. Tax revenues from the lagging regions. to sustain and even accelerate growth and the growing middle class will be critical to fund public investments needed to transition into a the investments in health and education, in- high-income country, Indonesia will need to frastructure and productivity necessary for substantially expand the middle class, begin- Indonesia to keep developing. In return, those ning with the two-fifths of its citizens who have in the middle class will want to see high-qual- successfully escaped poverty and vulnerability, ity public services and continued upward mo- and now aspire to the economic security and bility if they are not to start to resent the tax prosperity of the middle class. Achieving this burden that will fall substantially on them means ensuring that they stay in school lon- in the future. 16 ES Conclusion ASPIRING INDONESIA 60 EXECUTIVE SUMMARY ASPIRING INDONESIA 61 EXECUTIVE SUMMARY Summarized Recommendations by Sector Recommendations Reform Details 01 Education Making the higher levels of spending Update the existing Teacher Performance Management System to more directly on teacher salaries and allowances link teachers’ allowances (DAK-Profesi Guru) with competency achievements, commensurate with similar gains in continuous professional development (CPD) and classroom performance. student learning outcomes. Commence a rigorous teacher re-certification process to ensure that certification is more directly linked to the achievement of key professional competencies, and that periodic re-certification becomes a condition for teachers to continue to receive professional allowances and opportunities for further career progression. Provide greater support for teachers to benefit from CPD. ASPIRING INDONESIA 62 EXECUTIVE SUMMARY Recommendations Reform Details Increasing student-teacher ratios Redistribute teachers across schools within districts: districts should identify to allow more resources to be made oversupply and undersupply of teachers in their areas of jurisdiction and create a available for other quality-improving redistribution plan. interventions. Redistribute teachers across districts and provinces: develop and implement a mechanism to enable such a redistribution to take place. Standardize the recruitment process for non-permanent teachers: MoEC and MenPAN should develop national guidelines for recruiting non-permanent teachers who can teach the main subjects and extracurricular activities. Distributing resources to schools Basic allocation: based on the number of students. based on equity, need and performance. Equity allocation: based on the school location/special needs. Performance allocation: based on the improvement in results in the national exams. Improving and expanding This will require The MoEC to increase the budget for ECED to allow for an expansion early childhood education and in the coverage and the unit cost of BOP (School Operational Assistance Grants development (ECED). for ECED) based on Dapodik data linking the use of BOP to meet national ECED standards. Specific reforms actions include: 1. At the national level: (i) issue MSS as a basis for districts to allocate and manage resources; and (ii) build district capacity to manage services based on ECED MSS. 2. At the district level: (i) establish ECED units in Dinas and provide funding for staffing support; (ii) build the capacity of supervisors (Penilik PAUD) to conduct quality assurance visits to ECED centers; and (iii) support the provision of incentives and training for community teachers. 3. Leverage Dana Desa as an alternative funding source: include ECED in the annual Dana Desa prioritization regulation to support village planning to identify early childhood education centers as priority programs for investment from Dana Desa. Ensuring that all aspiring middle- Strengthen the mechanisms to guarantee education quality. In particular, school class Indonesians who reach accreditation should be accelerated. secondary education have the necessary conditions to learn. 02 Health Increasing and diversifying the Increase government health expenditures to benchmark itself against countries of sources of revenue for a sustainable similar economic status, especially those that have progressed further along the path and equitable system. to achieving UHC. Pursue new revenue sources from increased taxation of tobacco and alcohol products, specifically earmarked for the health sector. ASPIRING INDONESIA 63 EXECUTIVE SUMMARY Recommendations Reform Details Targeting limited resources to Focus its limited resources on targeting the most cost-effective interventions, such cost-effective health services and as preventive and promotive interventions delivered at the primary health-care level. underserved populations, improving the quality of service delivery, and Improve the quality of service delivery, both in public and private facilities. introducing integrated care. Strengthen the preparation and implementation of national procedures, guidelines and standards to reduce inappropriate or low-value care, prevent avoidable costly adverse effects, decrease operational waste, and improve clinical and managerial performance. Ensure equitable access to quality services across Indonesia, especially in the eastern islands of Indonesia. Transform service delivery models that integrate and coordinate care across different care providers (such as hospitals, single specialty centers, diagnostic facilities and home-based care), while placing primary care in a central ‘gate-keeping’ role that connects all these various providers to cope with the increased burden of chronic diseases, such as NCDs. Improving JKN design and Defining an explicit benefits package and target population that is commensurate implementation to ensure fiscal with available resources, through a systematic and transparent process for sustainability of JKN, and improve prioritizing interventions. provider performance. Building government capacity to identify the incentives that encourage private sector engagement, while also ensuring public sector interests. Designing provider payment systems that incentivize and reward performance. This will need to include inter-fiscal transfers from the national to subnational governments, for example through designing DAK fisik and DAK non-fisik to be more results-oriented. Strengthening the purchasing functions of BPJS, such as contracting, performance monitoring, the processing and payment of claims, and auditing. Introducing incentives that reward institutional and provider performance in the DAK. Investing in the institutions, systems Strengthen the public sector management functions for health, including and processes that hold the health- encouraging planning and budgeting that links inputs to outcomes. care system together. Strengthen health management information systems that could be used to benchmark performance, and improve budget execution and other financial management functions such as procurement, financial reporting, internal controls and audits. Improve human resource management for the public sector, including improving managerial and clinical competencies and skills, and ensuring a more equitable distribution of human resources. ASPIRING INDONESIA 64 EXECUTIVE SUMMARY Recommendations Reform Details 03 Tax Broadening the tax base. Lowering the VAT registration threshold. Replacing the non-taxable income threshold (PTKP) with tax credits for taxpayers who are poor or vulnerable. Raising the rates on select taxes. Increasing taxes on alcohol, tobacco and vehicles. Introducing more environmental taxes, such as on plastic bag consumption. Investing in tax administration Making significant investments in IT capacity at the Directorate General of Taxes capacity. (DGT). Reforming DGT’s human resources and business processes. Moving to a risk-based approach for auditing VAT refunds. Cultivating a major mindset shift within DGT toward treating taxpayers as consumers and setting targets on regular improvements in the ease with which citizens can pay their taxes. This will facilitate a higher degree of voluntary compliance. ASPIRING INDONESIA 65 EXECUTIVE SUMMARY Recommendations Reform Details 04 Regional Government Re-balancing fiscal transfers. Quick wins Revising the formula for fiscal capacity (which informs the allocation of DAK and hibah) to use a per-capita transfer norm.a Developing and disseminating advocacy materials on the impact of the current DAU formula on the equity of fiscal transfers. Increasing the proportion of the Dana Desa allocated on the basis of the formula. More Introducing a revision of Law No. 33/2014 to include a shift to a ‘per- challenging client’ norm for the DAU formula. reforms Developing a more comprehensive approach to transition that is better aligned with local government incentives. Financing urban infrastructure. Quick wins Reforming hibah as a more flexible instrument for selective financing of larger, multi-year infrastructure projects by regional governments, including aligning with the incentives of both central ministries and regional governments. Developing a new government regulation to operationalize cross- regional service provision, including addressing the challenges of financing. Building the capacity of provincial governments to supervise and support development of subnational PFM capacity in larger urban areas. Introducing a PFM regulatory framework to address the asset planning and management challenges of larger cities. More Addressing the limitations on subnational borrowing through a more challenging equitable distribution of the annual limit on public sector borrowing. reforms Expanding the scope for cities to raise revenue, including through additional sources of revenue. Setting timelines in the next RPJMN for a transition to the full regional government implementation of larger urban infrastructure projects, including solid waste, wastewater treatment and mass transport. Revising and reforming subnational PFM arrangements to provide a simpler, more streamlined approach adapted to the different needs of large, medium and small district governments. ASPIRING INDONESIA 66 EXECUTIVE SUMMARY Recommendations Reform Details Developing and implementing an Quick wins Mandating the use of standard data sources and indicators, and incentive framework. building in verification to address the incentives to ‘game’ the data. Establishing rewards and sanctions for districts’ collection of accurate data, and using those data to better inform decision- making. Rationalizing the reporting requirements by local governments to minimize the transaction burden and ensure that the data are not only useful but also used. Expanding the use of OM-SPAN to report a broader range of performance information in relation to DAK and Dana Desa, and making the data available to line ministries. Developing the scope for greater results orientation in the monitoring the use of DAK and Dana Desa funds. More Developing a framework for subnational data governance to improve challenging the management and dissemination of data on district service reforms delivery that incorporates data quality assurance. As part of the next RPJMN, developing a framework for managing across levels of government that includes supervision, support, capacity-building, and rewards and interventions to address poor performance. ASPIRING INDONESIA 67 INTRODUTION ASPIRING INDONESIA 68 INTRODUCTION C H A P T E R 1 67—74 Introduction ASPIRING INDONESIA 69 INTRODUTION 5.6 % Indonesia has sustained an average Over nearly a half century, Indonesia has annual growth rate of 5.6 percent over seen strong economic growth and substan- the past half century. tial decreases in extreme poverty, enabling it to achieve middle-income status. In 1967, Indonesia’s GDP was US$657 per person,80 one of the poorest countries in the world, and the FIGURE 1 . 1 Real GDP and GDP per capita growth, country was “accounted the number one failure 1967-2016 (percent) among the major underdeveloped countries.”81 Growth that year was an anemic 1.4 percent. 15 Over the next 50 years, growth averaged 5.6 GDP percent annually (Figure 1.1), despite a crip- pling financial, economic and political crisis in the late 1990s. Per capita GDP is now six times higher at nearly US$4,000. This sustained pe- riod of high growth resulted in one of the most rapid reductions in poverty in history. Extreme poverty was 70 percent in 1984, but this fell to just 7 percent by 2016 (Figure 1.2).82 0 GDP PER CAPITA —15 1967 1991 2015 Source: World Development Indicators. FIGURE 1 . 2 Poverty headcount ratio and Gini coefficient, 1980-2017 (percent/points) 80 45 INTERNATIONAL 80 In 2010 US$, POVERTY LINE from the World Development Indicators. 81 Higgins GINI COEFFICIENT (1968) Economic (RHS) Development (2nd ed.), p678, cited in Hill, H. (2000) The Indonesian Economy (2nd ed.). 82 Using the International Poverty Line (PPP US$1.90 at 2011 prices) from the NATIONAL POVERTY NATIONAL POVERTY World Development LINE (OLD) LINE (NEW) Indicators and the 0 20 2017 Indonesia 1980 2016 Country Poverty Brief. Poverty using the national Note: International Poverty Line is Source: World Development poverty line has US$1.90 in 2011 Purchasing Power Indicators. shown similarly Parity prices. considerable declines. ASPIRING INDONESIA 70 INTRODUCTION Over this time, a new class has emerged This emergence has been accompanied by Birdsall, 2007, 2010 and 2015; Birdsall et al., within Indonesia, that of the middle class. a surge of interest by policymakers and 2000; Easterly, 2001; Kharas, 2010; World As more and more Indonesians escaped from the private sector in recent years. With its Bank, 2013). poverty and vulnerability in recent decades, growing income and disposable consumption, their children have enjoyed greater opportuni- policymakers have become interested in the At the same time, the challenge now for ties, with better access to education and health, middle class as an engine of economic growth, Indonesia is less one of poverty reduc- cleaner and safer living conditions, and have while the private sector sees a large and grow- tion and more one of providing economic entered the workforce with greater skills than ing market for higher-priced goods and ser- mobility and escaping the middle-income their parents. The thriving Indonesian econo- vices than has existed in Indonesia previously. trap. To become a high-income country and my has shown high demand for these relatively This interest is reflected in a range of recent sustain historical growth rates, Indonesia fac- few skilled workers and rewarded them well. reports and features on the Indonesian middle es a challenge that is common across much of They now represent the emergence of a new class, including BCG (2013), McKinsey Global developing East Asia (World Bank, 2017): In- class of Indonesians who enjoy higher incomes, Institute (2012) and Tempo (2012), as well as donesia will need to develop a more inclusive more consumption, freedom from insecurity coverage in The Economist (2011) and The Fi- growth model so that more of its population and vulnerability, and who are an increasingly nancial Times (2010, 2014). This attention has can both contribute to, and benefit from, that confident and visible part of Indonesia. The occurred against a backdrop of wider interest growth (World Bank, 2014a). Despite low rates emergence of this new middle class has oc- in the growing middle classes seen across de- of poverty, many Indonesians remain vulner- curred within a single generation. veloping East Asia (ADB, 2010; World Bank, able, with around one-third below the vulner- 2017) and the world (Banerjee and Duflo, 2008; ability line,83 while inequality, despite recent Below Over the past half century, 83 Thirty-five percent of the population lives below the vulnerability line (1.5 Indonesia has seen strong economic times the poverty line), while 32 percent are below the lower-middle income countries’ growth and substantial decreases poverty line of PPP US$3.20 in 2011 prices; see Jolliffe and Prydz (2016). in extreme poverty, enabling it to achieve middle-income status. ASPIRING INDONESIA 71 INTRODUTION “The emergence of Right Upward mobility of the non-middle class and this new middle class investments in productivity and infrastructure will drive has occurred within greater economic growth, benefiting the existing a single generation” middle class moderation, has been rising rapidly (Figure However, there is little agreement on who the gap with high-income countries is a growth 1.2 and World Bank, 2015a). comprises the middle class, or how large strategy that is based on improving labor pro- it is, other than that it is growing rapid- ductivity (World Bank, 2014a). To achieve Moreover, soon Indonesia’s population will ly. Recent reports on the Indonesian middle this, in addition to improving the functioning begin to age, creating additional pressures. class have used different definitions, such as of product, labor, and land and capital markets, Many high- and middle-income countries in the per capita daily consumption of US$2-US$20 significant investments are required to close East Asia and Pacific are already aging quickly (ADB, 2010), annual net income of more than the infrastructure gap (roads, ports, electricity, and face pressing challenges in managing their US$3,600 in 2005 PPP (McKinsey, 2012), and water, sanitation, and irrigation networks) aging societies (World Bank, 2015b). Indonesia Rp  2.0 million to Rp  7.5 million in monthly and the skills gap (which requires improving will soon join these countries, with the ratio household expenditure (BCG, 2013), and dis- access to key public services for young children of workers to young and elderly dependents posable household income of over US$3,000 and improving the quality and relevance of ed- projected to start declining from around 2030 per year (Nomura in The Economist, 2011). ucation for older children). onward. The country’s demographic and epi- Consequently, estimates of the size of the mid- demiological transitions will require proactive dle class have varied wildly from 30 million (AC Those in the middle class will bear much of policy responses on pensions, health care and Nielsen in Tempo, 2012) to 45 million (McK- the burden of funding these needed invest- labor markets. These policy responses will need insey, 2012) to 74 million (BCG, 2013) and to ments. But what will they expect in return? to mitigate the labor-supply and fiscal effects 81 million (ADB, 2010). Indonesia’s government revenues are lower of rapid aging through ongoing reforms of than many other middle-income countries and pension, health systems and labor policies to In addition, “middle class” means differ- those in East Asia. Total revenues are only 12.2 extend the working lives of urban and formal ent things to different people, covering percent of GDP in 2017, compared with 16.5 sector workers as they undergo rapid urban- economic, social and political dimensions. percent in Thailand, 16.1 percent in Malaysia, ization. Some are interested in the economic and mar- and 12.9 percent in the Philippines. Low per- ket influence the middle class has; its size and sonal income tax collection ( just 1.1 percent As the middle class continues to grow, it contribution to economic growth. Some are in- of GDP) is due mainly to non-compliance. In- will play an important part in delivering terested in its socioeconomic characteristics, creased income-tax collection can significantly economic growth that Indonesia needs to such as its members’ attitudes and behaviors. increase available funding for investments in transition to a high-income country and Others are interested in its political influence infrastructure and skills, but the progressivity cope with an aging population. The middle on governance, policies and public services. of such taxes means they will predominantly be class has played, and will continue to play, an paid for by middle-income Indonesians. What important role in Indonesia’s development, At the same time, escaping the middle-in- will they expect in return for paying more tax? representing an important driver of economic come trap and increasing economic mo- growth and this role is likely to become even bility will require new and considerable more important in this regard going forward. investments. The key to Indonesia’s closing ASPIRING INDONESIA 72 INTRODUCTION 1 2 ASPIRING INDONESIA 73 INTRODUTION How large is the This report Indonesian middle looks at Why does the middle class and how five main class matter? does it differ from the rest of questions. the consumption classes? 3 4 5 ASPIRING INDONESIA 74 INTRODUCTION What is the What role has What are the policy relationship it played in implications for between Indonesia’s Indonesia’s a growing middle middle class and economic growth? class? public services? ASPIRING INDONESIA 76 WHY DO WE CARE? T H E M I D D L E C L A S S : Why 2 do We Chapter Care? 76—86 2.1 2.2 Linking the middle class to Exploring the social & political economic growth roles of the middle class ASPIRING INDONESIA 77 THE MIDDLE CLASS Why should we care about the middle class? There are a number of reasons why the middle class matters to Indonesia. It is linked to economic growth in several important ways, which we explore. But it also plays important social & political roles, which have consequences not only for growth but also for governance & policy. 84 84 This section draws from Wai-Poi et al. (2016). Left Middle-class consumption has grown at 12 percent annually since 2002 and now represents close to half of all household consumption in Indonesia. ASPIRING INDONESIA 78 WHY DO WE CARE? Linking the middle class 2.1 to economic growth The middle class has been linked to eco- innovation that helps lower the price of new Moreover, a larger and more homoge- nomic growth in a number of ways. The mid- goods (Matsuyama, 2002). In the global con- nous middle class may also lead to social dle class has been seen as a key driving force text, growth of the middle classes in emerging norms on greater human capital invest- of economic development in Western Europe countries such as India and China is also likely ment. Easterly (2001) finds that countries (Adelman and Morris, 1967). There are a num- to drive future global consumption, offsetting that have a larger middle class tend to grow ber of channels through which the middle class falling demand among American and European faster, at least if they are not too ethnically di- has economic influence. consumers (OECD, 2010). verse. In the absence of “the middle-class con- sensus”—a situation of relative equality and The first channel is due to the importance The middle class also has greater means ethnic homogeneity—he contends that high of domestic markets for growth. The role to invest in and accumulate human and inequality means the few rich will refrain from of the middle class in economic growth can be physical capital, further boosting growth. investing in human capital for fear that they significant if its size is substantial, especial- Under imperfect credit markets, the poor may may be replaced. Similarly, the ethnicity or ly given the middle class’s higher purchasing not earn enough or have sufficient savings to class in power may not want to invest in human power and its demand for quality goods. Giv- overcome a minimum investment requirement capital for the majority out of power in case it en that industrialization has fixed costs and for the acquisition of human capital or produc- increases the political voice of the majority and international trade is costly, Murphy, Shleifer tive physical capital (Banerjee and Newman, weakens the elite’s hold on power. Conversely, and Vishny (1989) argue that a domestic mar- 1993; Galor and Zeira, 1993). The middle class, a large middle class that has a political voice ket of a certain size is necessary to overcome on the other hand, enjoys higher incomes and and influence would not have these concerns, such costs. When inequality is high, they argue is able to invest in both forms of capital, thus and so investment in human capital would be that there is insufficient demand to cover these increasing a country’s stocks and consequently encouraged, contributing to economic growth. costs, and thus a large middle class is required. economic growth; the larger the middle class, Moreover, middle-class consumers can play a the more capital is accumulated over time. catalytic role by providing a large market for ASPIRING INDONESIA 79 THE MIDDLE CLASS Below Nearly half of the aspiring middle class aged 25-29 years old drops out of school before senior high school. At the same time, nearly 80 percent of the middle-class cohort at least completes high school. Exploring the social & political roles of the middle class 2.2 There is also a link between the sociopo- post reform crisis is stronger and the benefits of litical role that the middle class plays, and reducing inflation are most evident,” but that economic policies and growth. A large mid- as reforms are implemented “the public, espe- dle class may result in policies focused on grow- cially those in the middle, becomes more crit- ing the economic pie, rather than in competi- ical and pays more attention to issues such as tion solely for the existing pie. “Societies that distribution, volatility, job insecurity” (p.18). are polarized tend to focus on redistribution between polarized factions that alternate in The middle class has also been perceived power,” while “societies that are not polarized to be more politically active and play a role are able to reach a consensus on public goods in democratization and improving insti- and overall economic development” (Easter- tutional quality. Using modernization theo- ly, 2001, p.318), meaning that a “middle-class ry, Lipset (1959) looks at the extent to which consensus facilitates higher levels of income more affluent societies favor the creation and and growth, as well as high levels of pub- consolidation of democracies and, more gen- lic goods” (p.319). One means of facilitating erally, good institutions. Easterly, Ritzen and higher growth is sustaining support for market Woolcock (2006) find that measures of social reforms. Birdsall et al. (2000) examine support cohesion, such as income inequality and eth- for market reforms across income groups. Us- nic fractionalization, endogenously determine ing cross-country public opinion data over 17 institutional quality, while Amoranto et al. countries in Latin America, they regress the (2010) show that “the middle class has a high- pro-market reform index against wealth and er tendency to take part in political activities country reform status, finding that there tends than both the lower and upper classes” (p.1). to be general support for market reforms “early Loayza et al. (2012) find that “when the size in the process, when the collective memory of of the middle class increases … social policy on ASPIRING INDONESIA 80 WHY DO WE CARE? health and education becomes more active and the quality of governance regarding democratic participation and official corruption improves,” but “not … at the expense of economic freedom, as an expansion of the middle class also implies more market-oriented economic policy on trade and finance” (p.444). However, this support for political and eco- nomic reform may only hold if it is aligned with the middle class’s self-interest. The World Bank (2013) examined seven Latin American countries and was unable to identify values that distinguish the middle class from other classes in a particular way. Therefore, it argues, the middle class does not necessarily need to have ‘good values’ to push for reforms, as its higher incomes may simply give it greater voice to push for reforms that are beneficial for its members. However, its push for reform is beneficial to society only to the extent that its needs are aligned with society as a whole. Nonetheless, a politically active middle class often tends to be centrist and support democracy, although it may be dissatisfied in how democracy is actually functioning. Mateju (1996) shows that in the Czech Republic and its Central European neighbors, respon- dents who consider themselves middle class (rather than working class or wealthy) are less likely to vote for extremes of the political spectrum. Moreover, analysis of the self-re- ported Latin American middle-class attitudes toward democracy, fiscal policy and redistri- bution shows that the Latin American middle class supports democracy, although it remains dissatisfied with how democracy actually func- tions (OECD, 2011). In addition, there is em- pirical support that democracy is strengthened through the middle class. A cross-country re- gression of over 100 countries covering 1960 to 1995 finds that democracy, as measured by a subjective indicator of electoral rights, in- creases with the middle-class (as measured by the middle three quintiles) share of income (Barro, 1999). ASPIRING INDONESIA 81 WHAT IS THE MIDDLE CLASS… ASPIRING INDONESIA 82 AND HOW LARGE IS IT? C H A P T E R 3 What Is the Middle Class & How Large Is It? 81—102 3.1 3.2 3.3 The Middle Class can be defined Indonesia’s Middle Class: The Middle Class as an in different ways growing rapidly urban phenomenon Above & Right The middle class is the only class that spends more on non- food items than food, increasingly on entertainment, durables and vehicles. ASPIRING INDONESIA 84 AND HOW LARGE IS IT? The size, characteristics and roles of the middle class depend on how it is defined. There are four common types of definition. The middle class can be defined by: (i) its income or consumption levels; (ii) against a global benchmark; (iii) by its behavior or perceptions; or (iv) by its economic security. Annex B: The Indonesian Poverty, Vulnera- bility and Economic Security Lines contains a comprehensive review of 3.1 different middle-class definitions. The middle class is often defined by its income levels. Perhaps the most common way to define the middle class is based on its economic welfare. This can mean either household or per-capita income or con- sumption, depending on the survey data in a particular country.86 The income or consumption threshold for the middle class can be either absolute or relative. An absolute threshold represents the minimum income or consumption a household needs to be considered middle class and is fixed, regardless of the incomes of other households. For exam- The ple, Kharas and Gertz (2010) define “the global middle class as those households with daily expenditures between US$10 and US$100 per person in purchasing power parity terms” (p.3). A relative threshold Middle defines middle-class income relative to that of others, such as those lying between the 20th and 80th percentile on the income or consumption Class distribution (Easterly, 2001). The middle-class income thresholds can be set arbitrarily or rel- can be ative to an international benchmark. These thresholds can be set arbitrarily, such as Easterly’s percentiles or the Asian Development defined in Bank’s US$2-US$20 per day (ADB, 2010), or relative to international benchmarks. For example, Milanovic and Yitzhaki (2002) define the 85 See Wai-Poi et middle class as comprising those between US$4,000 (Brazilian aver- different al. (2016) for a age income, or US$11 per day, which is also around the poverty line in broader discussion on different ways definitions of the middle class, and 85 World Bank (2017) for a similar approach across the East Asia and Pacific region. 86 Regional and global studies tend to treat income and consumption interchangeably due to data limitations, but they are conceptually distinct. Income can be saved or consumed, while consumption can come out of current income or savings. Income inequality is higher than consumption inequality because richer households tend to have higher savings rates than poorer households, leading to a wedge between income and consumption. ASPIRING INDONESIA 85 WHAT IS THE MIDDLE CLASS… the US and Germany) and US$17,000 (Italy’s There are also some who define the mid- average income) annually in 2000 PPP terms, dle class as comprising those who exhibit while Ravallion (2010) defines the middle class certain behaviors, often in their occupa- as comprising those who are not poor by devel- tion. Lawrence James (2006), looking at Eliz- oping country standards (household per-capita abethan England, defines the middle class as consumption above the median poverty line of comprising those who live by their wits rather 70 developing countries, or US$2 a day at 2005 than manual labor. In a more modern sense, PPP) but still poor by developed country stan- Adelman and Morris (1967) were among the dards (below the US poverty line of US$13 a day). first scholars to highlight the importance of the middle class, specifically the indigenous middle Within Indonesia, management consultan- class, and occupation. They define the middle cies have defined the middle class in abso- class as comprising those working in a partic- lute terms based on market size potential. ular occupation as evident in the way in which BCG (2013) divides the population into seven they construct the indicator of the importance categories, three of which are considered to of the indigenous middle class. To construct be ‘middle’. The upper middle comprises those this indicator, they divide countries into five whose expenditure is between Rp 3-5 million categories. A country categorized as having a per month (around US$600-US$1,000 adjust- relatively important indigenous middle class is ed for purchasing power), the middle between one with at least 20 percent of the active male Rp 2-3 million (US$400-US$600), and the population working in commercial banking, emerging middle between Rp 1.5-2 million insurance, or in technical, professional, mana- (US$300-US$400).87 In 2012, the combined gerial, administrative, or clerical employment. total of the population of these three groups Countries fulfilling this criterion, but that are was about 109.2 million people. The richest largely dominated by expatriates, are excluded four categories are called the Middle Class and from this category. Affluent Customer (MAC) group, which con- sists of middle, upper-middle, affluent and elite Nonetheless, income and behavioral defini- consumers. Meanwhile, McKinsey (2012) de- tions do not necessarily result in very dif- fines a ‘consuming class’ “with enough income ferent people being identified as belonging to purchase not just basic necessities such as to the middle class. Despite adopting an abso- food and clothing but also discretionary goods lute definition, some scholars, such as Kharas and services” (p27) as those with annual net and Gertz (2010), acknowledge that “the mid- income of more than US$3,600 in 2005 PPP. dle class is an ambiguous social classification, broadly reflecting the ability to lead a comfort- 87 Expenditure includes: food, Some studies looking at middle-class val- able life” (p.2), and recognize that “the middle utilities, ues in developing countries classify people class usually enjoy stable housing, health care, transportation, based on self-perception of either status or educational opportunities (including college) for communication, and regular position in the income distribution (PRC, their children, reasonable retirement and job se- household supplies. 2008; Amoranto et al., 2010)., although curity, and discretionary income that can be Discretionary self-reported status may be a poor predictor spent on vacation and leisure pursuits” (p.2). spending such as entertainment, of someone’s income, education, or occupation. restaurant dining, Amoranto et al. (2010) utilize the World Values Finally, an absolute threshold can also be and similar Survey (WVS) data to examine different per- based not on global poverty line bench- categories are excluded. spectives on class status based on self-percep- marks but grounded in the concept of tions rather than income or expenditure mea- economic security. The World Bank (2013) 88 Our approach sures. In the countries they studied, 2 percent report on Economic Mobility and the Rise of the differs slightly see themselves as coming from the upper class, Latin American Middle Class sets an income in that we use a lowess smoothing 45 percent from the lower class and 53 percent threshold of US$10 per day in PPP terms as method to estimate from the middle class. They find that “there is a lower-bound per-capita household income, the probability generally a wide range of variation in what peo- and an upper bound at US$50 for the middle curve, rather than the logistic ple consider middle class, but perceived class class. Thus, “according to these thresholds, a regression used status is largely related to higher education, family of four would be considered middle class in Lopez-Calva and more skilled and stable jobs, and the ability to if its annual household income ranged between Ortiz-Juarez. The result is very ‘save’, which are all characteristics of people US$14,600 and US$73,000” (p.2). The lower similar using with higher incomes” (p.1). bound was set by examining panel data in se- either method. ASPIRING INDONESIA 86 AND HOW LARGE IS IT? lected Latin American countries basis. Second, what counts as eco- The data show that households and determining a household’s nomic security is developed in the with a monthly consumption of probability of being poor next Indonesian context, rather than greater than Rp  1.2 million per period based on its income in this against global benchmarks, which person per month have less than period. The income level at which may be less relevant. Third, it al- 10 percent chance of being poor or a household was safe from falling lows behaviors and characteristics vulnerable the following year, and into poverty in the next period of the middle class to be explored can thus be considered economi- was averaged across countries to empirically, rather than being cally secure. Annex B: The Indo- develop the US$10 lower bound. pre-determined to define them, as nesian Poverty, Vulnerability and The report then used self-percep- behavioral definitions do. Fourth, Economic Security Lines contains tions of class membership in five the definition can be held constant the full details of the analysis. countries (Brazil, Chile, Colombia, in conceptual terms over time, al- Mexico and Peru) to validate this lowing a line that increases over However, as countries become lower-income threshold. Using time with inflation and growth but upper-middle-income and most this measure, the size of the mid- can be compared consistently over of the population is economi- dle class in the countries studied time. cally secure or better, ‘middle increased by half between 2003 class’ may come to be more of a and 2009, from 103 million peo- In Indonesia, the economic relative notion. When countries ple to around 152 million, so that security line begins at Rp  1.2 are still lower income and most the middle class now accounts for million of consumption per of the population are still poor, around one-third of the region’s person per month, or around then the economically secure are population—roughly the same as US$7.75 a day. We take the ‘poor’ among the richest. However, as a the poor. as comprising those below the country grows richer, the poorer national poverty line, currently end of the distribution may have This report adopts an economic monthly consumption of around become economically secure, but security-based definition of the Rp  350,000 per person. Using its members may not consider middle class. There are a number panel data that track the same themselves middle class at all, as of advantages to defining the mid- households over time (Susenas, they aspire to the greater wealth dle-class threshold as free from 2008-10), we look at how the level they see at the richer end of the economic vulnerability. First, it is of per-capita consumption in one distribution, as we see later in the conceptually grounded in the no- year predicts the poverty status in case of Malaysia. tion of economic security, unlike a later year (following Lopez-Cal- arbitrary thresholds that have no va and Ortiz-Juarez, 2014).88 89 89 World Bank analysis tested the creation of a comparable absolute class between Susenas and IFLS. The IFLS results were consistent in creating a comparable poor and aspiring middle classes with the 1993 Susenas. However, IFLS data produced a significantly larger middle-class than Susenas and a smaller vulnerable class. Nevertheless, these discrepancies diminish over time and, overall, the size of each economic classes using the multiples of the poverty line became more robust.  Economy Class 1993 1997 2000 2007 2014 Susenas IFLS Susenas IFLS Susenas IFLS Susenas IFLS Susenas IFLS Poor 19% 19% 17% 17% 18% 18% 16% 16% 11% 11% Vulnerable 35% 22% 32% 21% 36% 21% 29% 23% 26% 20% Aspiring 41% 43% 43% 43% 41% 43% 45% 45% 46% 49% Middle Class Middle Class 5% 16% 8% 20% 5% 18% 11% 16% 16% 20% Source: World Bank calculations based on Susenas and IFLS  1993, 1997, 2000 ,2007 and 2014. ASPIRING INDONESIA 87 WHAT IS THE MIDDLE CLASS… Indonesia’s 3.2 Middle Class: growing rapidly The middle class has been Indonesians are missing from quickly as elsewhere in East growing faster than other the data. The great majority of Asia. The middle class is growing groups; there are now at least the middle class, despite being faster than most other segments 52 million economically secure economically secure, are not that of the Indonesian consumption Indonesians, or one Indonesian wealthy; 90 percent (47 million) distribution, with the exception in every five. Figure 3.1 shows the consume between US$7.75 and of the small upper class. The mid- evolution of Indonesia’s consump- US$20 a day (referred to as MC 1 dle class tripled as a proportion of tion classes since 2002 and their in charts), while the remainder (5 the population between 2002 and current sizes. By 2016, based on million) consume between US$20- 2016, during which time it grew the national household consump- US$38 a day (MC 2). The survey at 10 percent annually. This is tion survey, there were 52 million data find less than 1 percent (1.3 four times faster than the aspir- 90 World Bank (forthcoming) middle-class (MC) Indonesians, million) who consume more than ing middle class while, over the Estimating the Top representing 20 percent of the US$38 a day, or Rp 6 million (the same period, the share of poor End of Indonesia’s population. This compares with upper class, or UC). However, the and vulnerable households in the Consumption Distribution. 11 percent who were poor (la- national household consumption population shrank slowly (Figure belled P in charts) and a further survey (Susenas) is believed to 3.1). Although rapid growth of the 91 See World Bank 24 percent who were vulnerable exclude many richer Indonesians. middle class was from a small base (2017) Figure 2. (V). The largest segment of the Forthcoming work is trying to es- of only about 14 million in 2002, Note, this regional study uses the same population is the aspiring middle timate the top end of the income it also added the most people in economic security class (AMC), namely those who and consumption distributions absolute terms (38 million com- definition for have escaped poverty but are not more accurately. While it still pared with the 31 million for the the middle class, but it is based yet economically secure, with a misses many wealthy Indonesians, aspiring middle class). Nonethe- on regional data greater-than-10-percent chance initial results suggest that the up- less, growth in the proportion of and international of being vulnerable next year (Ta- per class is much larger and richer the economically secure classes in poverty lines rather than just ble 3.1). than the survey data suggest.90 Indonesia was slower than in Thai- Indonesia’s. As land, and less than half as large as such, the class Most of those in the middle The middle class is growing growth seen in China, Mongolia definitions are not the same, although class consume less than US$20 fast, expanding at 10 percent and Vietnam.91 they are broadly a day, although many richer every year, although not as consistent. ASPIRING INDONESIA 88 AND HOW LARGE IS IT? TABLE 3.1 Class definitions (2016 per-capita consumption) The middle class comprises those who have less than a 10 percent chance of being poor or vulnerable in the future, given their current consumption. Class P V A M C M C U C Poor Vulnerable Aspiring Middle Upper Middle Class Class Class Household status Below national >10 percent <10 percent <10 percent >17xPL poverty line (PL) chance of being chance of being chance of being poor next year poor but >10 poor or vulnerable (1.0-1.5xPL) percent chance of (3.5-17xPL) being vulnerable (1.5-3.5xPL) Per capita consumption Rp 6m (Rp is monthly and US$* is daily) US$38 SUB-GROUPS: MC 1 (Rp 1.2-3.2m; US$7.75-20); MC 2 (Rp 3.2-6.0m; US$20-38) Note: Daily per capita consumption is Source: Susenas and World Bank measured in US$PPP, which are US dollars calculations. adjusted for purchasing power parity across countries. FIGURE 3.1 Consumption distribution by class, 2002-16 (percent of population) The middle class is the fastest growing major segment of the Indonesian population in both percentage and absolute terms, expanding at 10 percent per year and 38 million between 2002 and 2016. It now represents 20 percent of the population. 100 '02 '03 '04 '06 '07 '08 '08 '09 '10 '11 '12 '13 '14 '15 '16 UC MC AMC V P Note: CAGR is compound annual Source: Susenas and World Bank growth rate from 2002-16. calculations. ASPIRING INDONESIA 89 WHAT IS THE MIDDLE CLASS… SURV EY BOX 3.1 The number of the wealthiest NO. 25XX Indonesians is under-estimated XXXX X in survey data; recent work addresses this In many developing countries, richer data are incorporated. As household size households are often more likely to be is not captured in the top-income data, excluded from household survey data on only total household consumption can be income and consumption, or to under-re- compared, not per capita consumption. port. In Indonesia, the World Bank has Consequently, direct class size compari- been collaborating with Bank Indonesia sons cannot be made, but rough approx- and the Ministry of Finance to estimate imations can. For example, in 2011 prices how many richer households might be and assuming an average household size excluded. This work uses Bank Indone- of 4, then Rp 10 million is roughly equal sia’s consumer credit database, which to US$18 per person per day, making the includes home mortgages and vehicle category roughly the upper group of the loans. Income models are applied to the middle class (MC 2) and upper class (UC). credit and debt servicing data to estimate This category is 12 percent higher when household incomes and consumption, we adjust for the top-income data. Es- and the resulting households combined imates of the richer households (those with the survey data to derive a more ac- above Rp 20 million monthly household curate consumption distribution. consumption, or roughly US$38 per day, which is UC) increase by 42 percent, with The table below presents the number of the largest proportional increases com- households in different consumption cat- ing for the very richest households. egories before and after the top-income NUMBER OF INDONESIAN HOUSEHOLDS Monthly household Survey estimate Hybrid survey-Top Increase in consumption range income estimate households (%) (Rp million) >10 2.8 million 3.1 million +12% >20 553,000 772,000 +42% >50 22,000 163,000 +773% >100 0 61,000 — Source: Household survey data, Ministry of Finance and World Bank consumer credit database and World (forthcoming) Estimating Top Incomes in Bank calculations. From Bank Indonesia, Indonesia. ASPIRING INDONESIA 90 AND HOW LARGE IS IT? Below Inequality has risen in Indonesia since 2000, as most Indonesians have been left behind by the middle class, with possibly significant consequences not only for growth but also for social and political stability. ASPIRING INDONESIA 91 WHAT IS THE MIDDLE CLASS… Below Aiming to become a high- income country and increasing economic mobility will require new investments. ASPIRING INDONESIA 92 AND HOW LARGE IS IT? The 3.3 Middle Class as an urban phenomenon Most of the middle class live in population—for example, in Su- eas, they also make up most of the the major urban agglomera- lawesi and Kalimantan—the much non-middle class in cities. Only in tions that now dominate the In- greater population of Java means a small number of cities is the mid- donesian landscape, mainly in that around two-thirds of the mid- dle-class rate similar to the AMC Java. Three-quarters of the mid- dle class live there. In fact, around rate ( Jakarta, Bandung, Denpasar dle class currently live in urban ar- 13 million middle-class people live and Yogyakarta), or significantly eas, the same fraction as in 2002 in Greater Jakarta alone (Figure higher (Surabaya and Makassar). (Figure 3.2), with three-quarters 3.3), accounting for 34 percent of This implies that policies to sup- again living in cities with more the urban middle class and 25 per- port the expansion of the middle 92 See World Bank than 5 million people, the fastest cent of the middle class nationally. class will need to have a strong (forthcoming) growing urban areas.92 Although The relatively low urban poverty urban dimension, which is the Recent Trends in Urban Indonesia for some regions enjoy a higher per- and vulnerability rates mean that, focus of a major ongoing research more details. centage of middle class among the while more AMC live in rural ar- project. ASPIRING INDONESIA 93 WHAT IS THE MIDDLE CLASS… FI G U RE 3.2 Urban-rural breakdown of Indonesian consumption classes, 2002 and 2016 (million) 76 % At about 76 percent, most of the middle class live in urban areas, many in the urban agglomerations of Java. 2002 MC 10.3 Million 3.5 Million AMC 41.1 42.3 Vulnerable 25.3 43 Poor 13.0 23.7 ‹Urban Rural› 2016 MC 40.6 Million 13.0 Million AMC 54.2 60.5 Vulnerable 27.5 34.1 Poor 10.3 17.7 ‹Urban Rural› Source: Susenas and World Bank calculations. ASPIRING INDONESIA 94 AND HOW LARGE IS IT? FIGURE 3.3 Urban agglomerations with largest MC and AMC populations, 2016 [million (LHS) and percentage of population (RHS)] The middle class is largely an urban phenomenon and is clustered in the major Indonesian urban metropolises, mostly in Java. 30 70 AMC MC UC MC Rate AMC Rate 60 25 50 20 40 15 30 10 20 5 10 0 0 Jakarta Bandung Surabaya Medan Surakarta Semarang Malang Makassar Sukabumi Denpasar Yogyakarta Pasuruan Pontianak Palembang Probolinggo Magelang Blitar Mojokerto Salatiga Pekanbaru Bandar Lampung Banjarmasin Padang Samarinda Banda Aceh Balikpapan Bukittinggi Jambi Note: Agglomeration definitions 93 The definition of metropolitan areas follows that of the World Bank’s Flagship report on of cities are based on World Urbanization in Indonesia, which is currently underway. Multi-district metropolitan areas are thus Bank (forthcoming).93 defined based on daily commuting flows between Indonesian districts using data from the August 2013-2015 rounds of Sakernas. Single-district metropolitan areas, meanwhile, are those which Source: Susenas and World Bank satisfy the following three criteria: (i) the district is classified as a Kota; (ii) the district calculations. has a population of at least 500,000; and (iii) the district has an average population density which is at least 1,500 people per sq. km. ASPIRING INDONESIA 95 WHAT IS THE MIDDLE CLASS… BOX 3.1 Prospering on the land: economic security in Thailand, Vietnam, Cambodia and Lao PDR Within these larger cities, the more prosperous city core has higher middle-class rates than the sprawling suburban periph- While economic prosperity tends to be an urban phenomenon in countries ery. Most urban growth has come such as the China, Indonesia and the Philippines, there are just as many, if in the suburban periphery of ma- not more, economically secure people living in rural Thailand, Vietnam, Cam- jor urban agglomerations, with the bodia and Lao PDR. population in the peripheries now 1.6 times larger than the core.94 In the case of Vietnam, the significant reduction in poverty and an increase in Consequently, the urban periph- economic security has been predominantly a rural affair, driven by Vietnam’s ery has around 1.3 times more rural investments and agricultural transformation. The agricultural sector middle class than the core. How- includes crops, livestock, forestry, aquaculture and fisheries, and in 2005 ever, the core population is richer, accounted for 22 percent of GDP, 30 percent of exports and 60 percent of with 42 percent of the core urban employment (World Bank, 2005). Vietnam’s success in the agricultural population middle class, compared sector is largely driven by the Doi Moi or ‘renovation policies’ introduced in with 35 percent in the periphery. Vietnam in 1986, which have shifted Vietnam from suffering from a chronic food deficit to becoming the world’s second-largest rice exporter, as the The urban nature of a highly country moved from a centrally planned economy to a socialist-oriented urbanized middle class is also market economy. Key policies introduced to tap the growth potential of rural seen in China and the Philip- Vietnam include farmland allocations to individual households in the early pines, but less so in Thailand 1990s and market-based incentives such as commodity trade liberalization and Vietnam. Similar to Indone- (World Bank, 2005). Furthermore, in 2005 Vietnam had a higher rural road sia, the large majority of the Phil- access (at 76 percent) compared with other countries with similar income ippines’ and China’s middle class levels (at 43 percent), which improves rural access to markets and lowers also lives in cities (World Bank, distributional costs (World Bank, 2005). 2017). However, entering the middle class need not be mostly an In Thailand, most of the middle class lives in Bangkok, but the rural econom- urban phenomenon. There are as ically secure have always been larger in number than those in urban areas, many if not more economically se- both in 2002 and 2012. This partly reflects the fact that Thailand has histor- cure people living in rural areas of 94 See World Bank ically had a lower urbanization rate than either Indonesia or the Philippines, Thailand, Vietnam, Cambodia and (forthcoming) but also the role of rural-urban migration (see the urbanization discussion Lao PDR. Understanding how up- Recent Trends in later); living standards in rural areas have been boosted by significant re- ward economic mobility has led to Urban Indonesia for more details. mittances to rural areas in the North and Northeast from workers in Bangkok prosperity in each of these coun- (Osaki, 2003) based on a web of family obligations (Rindfuss et al., 2012), tries could hold lessons for boost- 95 World Bank while rural wages are driven higher by a smaller workforce (UNDP, 2010). ing economic security in rural ar- (forthcoming) eas of Indonesia as well (Box 3.2). Recent Trends in Urban Indonesia; Cambodia and Lao PDR are poorer than Thailand and Vietnam, and they At the same time, new research is World Bank have only a small number of economically secure. However, despite a mainly looking at how the middle class (forthcoming) rural population (and rural poverty), the economically secure are almost has achieved economic security Urban Economic Mobility; World equally divided between the country and city, and the increase in both has in Indonesia’s cities, where two- Bank (forthcoming) been similar over 2002 to 2012 (Wai-Poi et al., 2016). thirds of the population are ex- Indonesian urban pected to live by 2035.95 flagship report. ASPIRING INDONESIA 96 AND HOW LARGE IS IT? GMC = Global Middle Class ES = Economically Secure V = Vulnerable EP = Extremely Poor MP = Moderately Poor 20 Thailand, 2002 Thailand, 2012 15 Urban 10 Rural 5 0 –5 –10 –15 –20 GMC ES V MP EP GMC ES V MP EP 20 Vietnam, 2002 Vietnam, 2012 10 0 –10 –20 –30 GMC ES V MP EP GMC ES V MP EP C H A P T E R 4 97—112 The & Middle Economic Class Growth 4.1 4.2 4.3 4.4 Middle-class con- Middle-class Middle-class Middle Class sumption education & entrepreneurship female labor skills participation ASPIRING INDONESIA 99 THE MIDDLE CLASS… The middle class can potentially contribute to growth through four main channels. There is strong evidence that it is contributing significantly through the first three. 01 As the most affluent Indonesians, their consumption drives a large part of the economy. 02 Middle class parents can provide better skills to their children, so growth of the middle class leads to greater investments in human capital. 03 At the same time, they have sufficient assets to take more risks and some of them become successful entrepreneurs whose enterprises drive growth and create jobs. 04 Greater female labor participation; the more workers there are, the greater the size of the economy. However, Indonesian middle-class women are only slightly more likely to work and participate in the workforce than non-middle-class women, and they do so much less than in other countries in the region. ASPIRING INDONESIA 100 AND ECONOMIC GROWTH Middle-class 4.1 consumption Middle-class consumption has grown at 12 growing in population, the share of the aspiring percent annually since 2002, a much fast- middle class has fallen from 48 to 38 percent, er rate of increase than any other class. By while that of the poor and vulnerable collapses comparison, average household consumption from 8 to 3 percent and from 22 to 11 percent, growth was only 6.1 percent per year over the respectively, over the period. same period, 5.8 percent for the aspiring mid- dle class and only 0.7 percent for the vulnerable Unlike the other classes, the majority of (Figure 4.1). Total poor household consump- this consumption by the middle class is tion declined by 0.2 percent per year in real not on food, with increased spending on terms. Moreover, given that household size de- discretionary items such as entertainment. creases with income, the difference in per-cap- Most Indonesians spend most of their money ita growth rates in consumption between the on food; this represents 60 and 62 percent of middle class and the other classes is even all consumption for the poor and vulnerable, greater, which is reflected in Indonesia’s much respectively, and 56 percent for the aspiring higher rate of inequality over the period.96 middle class. The middle class is the only group where more is spent on non-food than food The middle class is now responsible for (Figure 4.2). However, for most middle-class nearly half of all consumption in Indone- households, food still makes up 44 percent of sia. These sharp differences in consumption consumption. Breaking out the middle class, it growth between the classes mean that the is only MC 2, as well as the upper class, where 96 See World middle class has rapidly expanded how much food is below one-third of consumption. As dis- Bank (2015a) for a comprehensive of national consumption it enjoys. In 2002, posable income increases for these groups, it discussion on middle-class consumption was 22 percent of is being spent more on entertainment (9 and the drivers and all private consumption in Indonesia. By 2016, 11 percent of total consumption for MC 2 and implications of rising inequality it was Rp 1,380 trillion, or 47 percent of total UC, respectively). in Indonesia. household consumption (Figure 4.1). Despite ASPIRING INDONESIA 101 THE MIDDLE CLASS… F I G U RE 4.1 Share of total national household consumption, Switching from motorcycles to 2002-16 (percent) cars is one of the key hallmarks of the middle class. The majority Despite comprising just 20 percent of the population, the middle class makes up close to half of total national consumption. of Indonesian households own a motorcycle; even among the poor, 100 motorcycle ownership is close to 50 percent (Figure 4.3). However, car ownership is perhaps one of the most visible and starkest divides between the middle class and all others. The poor and vulnerable do not own cars, while less than 5 percent of the aspiring middle class do. Around one-quarter of the middle class own cars, with this reaching 60 and 80 percent for MC 2 and UC, respectively. MC 2 and UC spend 9 and 17 percent of total consumption, respectively, on vehicles (Figure 4.2). Durable ownership is higher '02 '03 '04 '06 '07 '08 '08 '09 '10 '11 '12 '13 '14 '15 '16 among those in the middle class, especially as they transition from home essentials to home conveniences. As households be- P V AMC MC UC come richer, they begin investing *CAGR: Compound Average Growth Rate. Poor: -7% in household durables, beginning Calculation based on the actual total Vulnerable: -5% consumption changes for 2002-16 Aspiring Middle Class: -2% with more essential items such as Middle Class: 7% refrigerators. One-third or less of the poor and vulnerable have Note: The UC share is poorly estimated Source: Susenas and World Bank due to the small number of households calculations. a refrigerator, but 50 percent of participating in the survey data. the aspiring middle class do, rising to 80 percent for the middle class F I G U RE 4.2 Breakdown of consumption, 2016 (Figure 4.4). Rates for purchased (percent of total consumption) drinking water are similar, in a country in which piped water is The middle class is the only class that spends more on limited in supply and usually not non-food items than food, increasingly on entertainment, durables and vehicles. safe to drink. However, it is only as a household becomes middle P class that it begins to own home amenities that are more oriented V toward convenience and comfort. The use of more convenient and AMC unsubsidized large volume gas can- MC 1 isters for cooking and ownership of water heaters and air conditioners MC 2 are almost non-existent outside the middle class. UC Entertainment Goods/service Source: Susenas Tax/insurance and World Bank Education calculations. Vehicles Health Durables (excl. Vehicles) House Clothes Food ASPIRING INDONESIA 102 AND ECONOMIC GROWTH FIGURE 4.3 Motorcycles Cars Vehicle ownership by class, 2016 (percent) 100 100 Car ownership is one of the most visible and starkest divides between the middle class and lower classes. 80 80 National 60 60 Urban 40 40 Rural 20 20 0 0 P V AMC MC1 MC2 UC P V AMC MC1 MC2 UC FIGURE 4.4 Refrigerators Purchased Drinking Water Selected durable ownership by class, 2016 (percent)(percent) 100 100 Middle-class households begin to own home amenities that are more oriented to convenience and comfort. 80 80 60 60 National 40 40 Urban 20 20 Rural 0 0 P V AMC MC1 MC2 UC P V AMC MC1 MC2 UC High Volume Gas Cooking Air Conditioners Water Heaters 100 100 100 80 80 80 60 60 60 40 40 40 20 20 20 0 0 0 P V AMC MC1 MC2 UC P V AMC MC1 MC2 UC P V AMC MC1 MC2 UC High volume gas cooking means using non- Source: Susenas and World Bank subsidized 12kg LPG canisters. calculations. ASPIRING INDONESIA 103 THE MIDDLE CLASS… Left Indonesia’s government revenues are lower than many other middle-income countries and many other countries in East Asia. Increased income- tax collection would significantly increase available funding for investment in infrastructure and skills, but the progressivity of such taxes means they will predominantly be paid for by middle- class Indonesians. Right Almost no households below the middle class own cars, while 20 percent of Middle Class 1, 60 percent of Middle Class 2, and most upper- class households own cars, making it a clear class delineation. ASPIRING INDONESIA 105 THE MIDDLE CLASS… F I G U RE 4.5 Reason for traveling on last trip, 2016 (percent) The middle class likes to travel more, and more often for pleasure. 100 80 60 40 20 0 P V AMC MC 1 MC 2 UC Others Education Source: Susenas and World Bank Sport Meeting/Seminar calculations. Family/friend visit Business Pilgrimage Holiday Health/Treatment The middle class is also more likely to trav- dle class can create structurally higher con- Under reasonable assumptions, middle el, and more often travel for pleasure. Those sumption growth, as it has greater disposable class consumption may be responsible for in the middle class travel around 40 percent income than the poor and a higher marginal up to two-thirds of total national account more frequently than other Indonesians, at propensity to consume than the upper class. private consumption. Total consumption in around 1.4 trips every three months. More- Private consumption in the national accounts Susenas can be allocated directly out to each over, they are much more likely to do so for grew at 3.0 percent annually between 2002 economic class. As a lower bound, the con- pleasure. Half of all non-middle-class travel and 2015. Attributing this growth across the sumption gap between Susenas and the nation- is to visit friends or family, while only around economic classes is difficult as total household al accounts can be allocated out to the classes in one-quarter to one-third is on holiday (Fig- consumption in Susenas accounts for only 40 the same proportion as is observed in Susenas. ure 4.5). This ratio is switching for the middle percent of private consumption in the national However, it is likely that much of this missing class, with around 40 percent of middle-class accounts. While there are differences of meth- consumption would be due to the middle and travel being for holiday, rising to nearly half for odology, and private consumption includes upper classes, who may be under-represented richer households, while visits to friends and some non-household spending, for example by in the survey data. An upper bound can be con- family fall to 40 percent. institutions such as prisons and orphanages, structed which allocates the missing consump- there is still a large discrepancy between the tion entirely to the middle and upper classes in Rapidly growing middle-class consumption two. Due to this, the role of middle class con- their relative Susenas proportions. On these has helped accelerate consumption growth sumption in the growing national accounts con- assumptions, between 1.2 and 2.0 percentage in the national accounts, a key component sumption can only be estimated within a range. points of annualized growth in national account of recent economic growth. A growing mid- private consumption came from middle-class ASPIRING INDONESIA 106 AND ECONOMIC GROWTH FIGURE 4.6 Annual real national account growth in private consumption, 2002-15 by source (percent) The middle class may be responsible for up to 68 percent of all national accounts private consumption growth in the past 13 years. 0 20 40 60 80 100 P V AMC MC UC 3.77 9.43 33.96 45.28 7.55 Lower Bound AMC MC UC 13.21 68.15 12.98 Upper Bound Note: Real national account private observed class shares (lower bound) or P V consumption growth has been decomposed entirely to the middle and upper classes 1.89 3.77 into growth in consumption by economic in their Susenas proportions (upper class. Total Susenas household consumption bound). is allocated by class directly. The private consumption gap between the Source: Susenas (2002-2015), BPS and World national accounts and Susenas is allocated Bank calculations. either proportionally to the directly 97 There is a significant the Top End of Indonesia’s growth of the economy consumption, or 68 percent of total growth difference in the size of Consumption Distribution). (and the upper class 0.2 (Figure 4.6), with a further 0.2 to 0.4 of a per- private consumption as In fact, total consumption points). However, the centage point coming from the upper class.97 measured by the national in Susenas represents missing richer households accounts (upon which GDP only 40 percent of that and economic activity are measures are based) and estimated in the national much more likely to be The consumption patterns of the middle household consumption accounts, which attempt from the middle and upper class and its role in economic growth have surveys (upon which our to capture other private classes; if we allocate all consumption and large missing private consumption important implications for growth in the middle-class analysis is based). Household surveys one-off expenditures growth to the middle and future. Many growth-oriented consumption exclude non-household such as the Hajj. If we upper classes in proportion patterns belong only to the middle class, or private consumption such as conservatively allocate to their relative shares institutions (like prisons the missing 60 percent of of observed Susenas become prevalent only among the richest and orphanages). They private consumption to consumption growth (84 and middle-class households. This suggests that also fail to capture many the consumption classes 16 percent, respectively), sustaining and increasing consumption-led richer households, and so according to their then an upper bound of under-estimate household observed consumption in their share of growth growth in the future will require not just grow- consumption, particularly the survey, then we have increases to 2.0 percent ing the middle class by making more people that of the middle a lower bound where the for the middle class and economically secure, but also ensuring that class (see World Bank middle class represents 0.4 percent of the upper (forthcoming) Estimating 1.2 percentage points of class. economic mobility continues beyond this to the 5.6 percent annualized reach even higher incomes. ASPIRING INDONESIA 107 THE MIDDLE CLASS… Middle-class education & skills 98 In 2013, hours Skilled workers in high value-added sec- educational attainment for the Indonesian mid- spent on English, tors are also more likely to come from the dle class is higher than for other East Asian mathematics, physics, chemistry middle class, although the quality of Indo- middle classes, using slightly different class and biology were nesian education limits this. Focusing on thresholds (Figure 4.8),98 but the low quality reduced, along with the youngest two cohorts of Indonesians who of Indonesian education relative to most other the related ICT training, in favor have finished education, those aged 25-34 and countries undermines these attainment levels. of more time being 35-44 years old, the poor and vulnerable on Consequently, while two- to three-fifths of the spent on civics and average complete only primary education, non-middle class work in agriculture, less than religious teaching. This means today’s while those in the aspiring middle class only one-fifth of the middle class does, and those in children are complete junior secondary. The younger mid- the middle class are much more likely to work spending even less dle-class cohorts, however, generally complete in higher value-added sectors such as finance, time developing the skills firms have secondary school, while MC 2 and UC have services and information and communication already identified tertiary education (Figure 4.7). This level of technology (ICT) (Figure 4.9). as gaps. 4.2 Right It is only those in the middle class who predominantly have the high school or better education required by better jobs, with increasingly large numbers having tertiary education. ASPIRING INDONESIA 108 AND ECONOMIC GROWTH ASPIRING INDONESIA 109 THE MIDDLE CLASS… However, the poor quality of Indonesian FIGURE 4 . 7 FIGURE 4.8 education means that the country’s pro- ductivity lags that of other countries in the Average educational attainment by Middle-class educational attainment region. The low quality of Indonesian education age cohort by class, 2016 (years) in East Asia and Pacific (EAP) (years) relative to most other countries undermines the Younger middle-class cohorts generally The low quality of Indonesian higher middle-class educational attainment lev- complete secondary school, while MC 2 education relative to most other els. For example, three-quarters of all Indone- and UC have tertiary education. countries undermines these attainment levels. sian 15-year-olds do not meet even the basic proficiency level for mathematics, the fifth- Global middle class 16 worst performance among all countries in the 25-34 35-44 45-54 Economically Secure dataset (World Bank, 2015a). Greater skill and 14 55-64 >64 productivity in the future will require smarter public investments in education to capitalize on 0 02 04 06 08 10 12 14 16 12 middle-class employment in higher value-add- ed sectors such as finance, services and ICT. 10 P The middle class has fewer children, but 8 middle-class children start school earlier and stay in school longer, increasing the 6 base of future skilled workers. Fertility is higher among the poor and vulnerable, in part because of deteriorating access to family 4 planning.99 On average, poor and vulnerable households have 1.5 children aged under 15 V 2 years at home. This falls to 1.0 for the aspir- ing middle class before stabilizing at 0.6 for 0 the middle class at all income levels.100 Having EAP CAMBODIA INDONESIA LAOS MONGOLIA PHILIPPINES THAILAND VIETNAM fewer children allows those in the middle class to invest more in each child’s health and edu- cation, which they do. Middle-class children are considerably more likely to be enrolled in AMC early childhood education, especially at the earliest ages of 3-4 years old (Figure 4.10). Primary school enrolment is near universal for Note: EAP is East Asia and Pacific average all classes. This continues for the middle class and includes all countries shown plus into junior secondary school but drop-outs and Papua New Guinea, Tonga and Vanuatu. ES non-transition begin in the non-middle classes is Economically Secure under the EAP definition, which is consumption from and, while over 80 percent of the middle class US$5.50-US$15.00 per person per day; GMC MC1 enroll in senior secondary school, the gap with is Global Middle Class and is consumption the other classes increases. By the ages of 19- above US$15 per day. 22 years old, those in the middle class are over Source: Wai-Poi et al. (2016). twice as likely to still be studying. They are also more exposed to the technol- ogy that drives the modern global econo- my. In addition to receiving more education, MC2 and education that is likely of a higher quality, middle-class children live in an environment where they are also more exposed to modern ICT. Cellphone ownership is near universal in mid- dle-class households (smartphone ownership data are unavailable), and around half have ac- cess to computers and the internet, significantly MC3 99 See World Bank (2015a) for a discussion higher than for the poor and vulnerable (Figure of changes in family planning in Indonesia and its differential effects across the 4.11). This access means they are more likely to consumption distribution. be familiar with the ICT skills that are increas- Source: Susenas and World Bank ingly demanded in the modern global economy. calculations. 100 Calculated from Susenas 2016. ASPIRING INDONESIA 110 AND ECONOMIC GROWTH FIGURE 4.9 Employment sector of head of household FIGURE 4.11 by class, 2016 (percent) Access to technology and Those working in agriculture decline rapidly in the information by class (percent) middle class, while those working in services increase. Cellphone ownership is near universal in middle-class households and around half have access to computers and the internet. P National Urban V Rural AMC MC1 100 Cellphones MC2 80 UC 60 Others Service Source: Susenas 40 Finance Transport/ITC and World Bank calculations. Trade/Hotel/Restaurant Construction 20 Elec/Gas Manufacture Mining Agriculture 0 P V AMC MC 1 MC 2 UC FIGURE 4.10 Enrolment of children by class and age, 2016 (percent) 100 Computers In the oldest age group of 19-22 years old, 80 those in the middle class are over twice as likely to still be studying. 60 40 100 20 80 0 P V AMC MC 1 MC 2 UC 60 40 100 Internet 80 20 60 0 03-04 05-06 07-12 13-15 16-18 19-22 40 AGES 20 0 P V AMC MC UC P V AMC MC 1 MC 2 UC Source: Susenas and World Bank calculations. Source: Susenas and World Bank calculations. ASPIRING INDONESIA 111 THE MIDDLE CLASS… Middle-class 4.3 entrepreneurship The majority of those comprising the mid- or self-employment. About 33 percent of the workers continue to be self-employed or own dle class are salaried workers. Only 20 per- aspiring middle class work formally, increas- their own business, more and more of them cent of the poor and vulnerable are formal, ing to over half for the middle class, and two- run productive businesses that are capable of salaried employees. The rest work as casual thirds for the richest sub-group; almost no employing other paid workers. For the large laborers or as small business owners, either middle-class workers are casual. majority of the middle class who are self-em- with no employees or unpaid family ones (Fig- ployed (those under US$20 a day), only one ure 4.12). Workers from wealthier households The remainder are increasingly running in six is this successful. However, this rises to are increasingly more likely to have formal productive businesses that employ oth- one in three for MC 2 and nearly one in two for employment, with decreases in casual labor ers. While just over one-third of middle-class the upper class. FI G U RE 4.12 Occupational status of head of household by class (percent) The majority of middle-class workers are formal employees, while the rest are increasingly likely to be business owners who employ others. Family/non- Casual labor Worker/ Self-owned w Self-owned w non- Self-owned paid employee paid worker paid worker business 100 80 60 40 20 0 Poor Vulnerable AMC MC 1 MC 2 UC Source: Susenas and World Bank calculations. ASPIRING INDONESIA 112 AND ECONOMIC GROWTH 4.4 Middle-class female labor participation Indonesian middle-class women do not women work. A recent paper, using a similar 4.13), the rates remain much lower than for work much more than the non-middle- but slightly different definition of the middle other middle-class women in East Asia (Figure class women and are much less likely to class based on economic security, found that 4.14),101 undermining a potential contribution work than other middle-class women in in the East Asia and Pacific region, while only to economic growth. East Asia and around the world. As more around 50 percent of non-middle-class wom- people in a country work, so its economy en participate, this rises to 70 percent for the grows. In almost all countries, most men work middle class. However, while Indonesia’s mid- 101 Wai-Poi et al. (2016). Malaysia is not included in this regional comparison due (or look for work) and the differences in total dle-class women are slightly more likely to to data limitations but has a similarly labor force participation depend on how many work than other Indonesian women (Figure low rate of female labor participation. FIGURE 4.13 Female labor force participation by FIGURE 4.14 Middle-class female labor force class, 2016 (percent) participation in East Asia (percent) Middle-class women are only slightly more likely to …and they work much less than most other East-Asian work than other Indonesian women... middle-class women, contributing less to the economy. National Urban Rural Global Economically Middle Secure Class 80 100 EAP GMC Average 60 EAP ES Average 80 40 60 40 20 20 0 0 Poor Vul AMC MC 1 MC 2 UC KHM PNG THA VNM PHL MNG VUT TON LAO IDN Note: ES are the Economically Secure, Source: Wai-Poi et consuming PPP US$5.50-15 per person per al. (2016). day, while the GMC are the Global Middle Source: Susenas and World Bank calculations. Class, consuming more than PPP US$15 a day. The Middle C H A P T E R 5 Class Amenities & Public 113—126 Services 5.1 Unfulfilled prosperity: economic security with non-monetary poverty 5.2 Public health and education: accessible but undesirable? 5.3 Gated communities: the embodiment of mid- dle-class self-exclusion 5.4 Expanding the middle class and delivering benefits to all ASPIRING INDONESIA 115 THE MIDDLE CLASS, AMENITIES… Despite economic security, half of those in to clean water, proper sanitation or adequate This is higher than in many other countries the middle class are deprived on at least one housing conditions, primarily the latter (Figure in the region, mostly due to poor housing non-monetary dimension, mostly due to 5.1). Of the 20 percent of Indonesians who are conditions. As Figure 5.1 indicates, poor hous- poor housing conditions. Those in the middle middle class, 11 percentage points are also free ing conditions are the main reason for mid- class enjoy current incomes that indicate eco- from non-monetary poverty on these dimen- dle-class households to suffer from non-mon- nomic security; they have a very low chance of sions, while 9 points are not. Even around 20 etary deprivation. Across the East Asia region, being poor or vulnerable next year. However, percent of the wealthiest middle-class house- Indonesia’s economically secure people are economic security does not guarantee freedom holds suffer from poor housing or, to a lesser much more likely to have poor housing condi- from deprivation and non-monetary poverty. extent, improper sanitation. tions than those in the Philippines, Thailand Half of those in the middle class lacks access and Vietnam (Figure 5.2). Unfulfilled prosperity: economic 5.1 security with non- monetary poverty Left Only 33 percent of urban households have access to clean water, only 12 cities have piped sewerage networks serving 2 percent of the urban population, and 40 percent of urban residents do not have access to proper sanitation. ASPIRING INDONESIA 116 AND PUBLIC SERVICES “Half of those in the middle class lacks access to clean water, proper sanitation or adequate housing conditions, primarily the latter” FIGURE 5.1 Non-monetary poverty by class, 2016 (percent) Despite having achieved economic security, close to half of the middle class is deprived on at least one non- monetary dimension, primarily poor housing conditions. Water Poverty Sanitation poverty Housing poverty Poor on at least one dimension 82 74 67 65 54 56 53 50 41 40 34 30 28 26 16 17 14 9 9 11 7 3 1 0.5 P V AMC MC 1 MC 2 UC Source: Susenas and World Bank calculations. FIGURE 5.2 Poor housing conditions for the economically secure in East Asian countries (percent) Poor housing conditions affect the middle class and aspiring middle class far more in Indonesia than its regional peers. 40 Economically Secure 30 Global Middle Class 20 10 0 Indonesia Philippines Thailand Vietnam Note: ES are the Economically Secure, which are those consuming Source: Wai-Poi et al. (2016). between PPP US$5.50-US$15 per person per day, while the GMC are the Global Middle Class, consuming more than PPP US$15 a day. ASPIRING INDONESIA 117 THE MIDDLE CLASS, AMENITIES… P V AMC MC1 MC2 UC FIGURE 5.3 Access to education by class, 2014 (percent) Ninety percent or higher of the middle class have access to education. 0 100 Public health ECED within 1 km & education: accessible but SD within 1 km undesirable? 102 SMP within 6 km SMA within 6 km FIGURE 5.4 Access to health facilities by class, 2014 (percent) Access to primary and secondary 5.2 health care is near universal for the middle class. 0 100 Access to any primary care 102 This section draws upon Wai-Poi Almost all those in the mid- enough to guarantee service; et al. (2016) Box dle class have access to public quality matters as well. We have 10. health and education. Most In- seen that the quality of Indonesian Access to 103 For a summary donesian children of all income education is problematic. If there of changes in secondary care levels have access to early child- is a school nearby a child, that does Indonesian family hood centers, and primary and ju- not mean he or she will receive a planning, see World Bank (2015a); for nior secondary schools with rea- good education; if the teacher greater detail see sonable facilities. This reaches 90 does not turn up or if the curric- Jones and Adioetomo percent or higher for the middle ulum does not support the devel- (2014). For a discussion of water class (Figure 5.3). Access to pri- opment of the skills needed in the and sanitation, see Access to mary and secondary health care is modern economy, children will be delivery World Bank (2017) facili- near universal for the middle class less prepared to seek a well-paid Improving Service ties Levels and Impact (Figure 5.4). skilled job when they leave school. on the Poor: A Similar issues exist in many other Diagnostic of Water However, access to good qual- sectors, including health, family Supply, Sanitation, Hygiene, and ity public services is not guar- planning, and water and sanita- Poverty in Source: Susenas and Podes 2014 and World anteed. Physical access is not tion.103 Indonesia. Bank calculations. ASPIRING INDONESIA 118 AND PUBLIC SERVICES FIGURE 5.5 For example, many local health facilities worker practices and traditional healers. Of Puskesmas readiness to provide do not have the necessary equipment or these, the private hospitals and doctors can health services (percent) training to provide basic care or key ser- be considered privately provided. For outpa- vices, even in urban areas where most of tient care, the poor and vulnerable mostly use But while access may be high, most local health centers struggle to provide basic the middle class live. Reviews of the readiness Puskesmas and medical workers, with some care facilities. of local health centers (Puskesmas) to provide use of doctors or clinics (likely where public a range of services show that many lack the access does not exist). The use of private doc- training or equipment required, and that there tors expands considerably for the sub-groups Rural Urban has been little improvement since 2011 (World of the middle class, and they are the only ones Bank, 2016). For example, only 62 percent of to use private hospitals in any significant num- 100 Puskesmas mandated to provide basic emer- ber (7, 23 and 30 percent for MC 1, MC 2 and gency obstetric and neonatal care had any staff UC, respectively; Figure 5.6). For inpatient trained in this area in the past two years. Only care, one-third or less of the poor, vulnerable 39 percent of public hospitals maintained all and aspiring middle class use private hospitals, 23 basic obstetric care tracer items. Only 54 relying instead on state hospitals. However, the percent of Puskesmas had the ability to con- use of private hospitals rises to 48 percent for duct blood glucose tests for diabetes diagnoses, most of the middle class (MC 1) and to 60-75 and 47 percent had the ability to conduct urine percent for the MC 2 and UC. Childbirth can be tests. These deficiencies were apparent in ur- performed by a doctor, a midwife, a paramed- ban, as well as rural, areas (Figure 5.5). ic, a traditional healer or a family member. As doctors and midwives can work in both public Consequently, the middle class is seeking and private facilities, we cannot determine the higher quality care, often by opting out extent of the public-private provision for child- of public services and into private health birth deliveries, but the increasing use of doc- care. We look at the types of facility used by tors by the middle and upper classes (50 and each class for inpatient and outpatient care, 80 percent, respectively) points to the desire and for giving birth. Inpatient and outpatient and access to more expensive health care, com- options include state and private hospitals, pri- pared with the non-middle classes, two-thirds vate doctors and clinics, Puskesmas, medical or more of which use a midwife. 90 Most Indonesian children of all income % levels have access to early childhood cen- 50 ters, and primary and junior secondary schools with reasonable facilities. This reaches 90 percent or higher for the mid- dle class. Medicine (e.g., Metformin) Measurement Tape Blood Glucose Test BP Apparatus Stethoscope Adult Scale Urine Test Training 0 Source: IFLS 2014 ASPIRING INDONESIA 119 THE MIDDLE CLASS, AMENITIES… FI G U RE 5.6 Choice of health care by class, 2016 (percent) As Indonesians get richer, they are increasingly seeking private health care… State Private Practice Clinic Puskesmas UKBM Traditional Others Doctor P V AMC MC 1 MC 2 UC 2 3 5 7 6 18 11 29 Outpatient 41 37 23 30 39 33 21 44 43 Inpatient 45 60 75 32 48 16 21 Hospital Clinic Puskesmas Home Others P V AMC MC 1 MC 2 UC 1 4 Facility 16 21 6 32 Giving 12 55 Birth 15 77 75 18 Special General Midwife Nurse Other Maternity Others No One Doc Doc Paramedics Healer P V AMC MC 1 MC 2 UC 12 17 Who 27 25 18 45 Assisted 50 72 65 81 69 71 Source: Susenas and World Bank calculations. ASPIRING INDONESIA 120 AND PUBLIC SERVICES Those in the middle class are also beginning to use exclusive pri- 104 Private schools exist senior secondary schools is for various reasons. Some more problematic in many parts vate schools, particularly in the wealthiest sub-group (MC 2). In of Indonesia; at this level, are religious, which can be general, there is less opting out of public education by the middle class. good or bad in quality. Some there are still religious and Despite historical issues with the quality of public schooling in Indo- are exclusive, focusing on a exclusive schools, but there higher quality alternative to are also private schools nesia, there are many excellent public schools, especially in wealthy which exist because there is public schools. Some provide neighborhoods of larger cities where those in the middle class often live. an option where a public no public school. Finally, Nonetheless, we are beginning to see those in the middle class send their one does not exist. Primary at the tertiary level, the schools are available nearly top universities are elite children to elite private schools.104 While less than 10 percent of most public ones, while most everywhere in Indonesia, middle-class children (MC 1) attend these schools, this increases to 14- meaning most private schools private universities are of 20 percent of MC 2 depending on schooling level, and for the upper class at this level are either lower quality, with a few religious or exclusive (a exceptions. To determine it reaches 34 percent for primary and junior secondary and 43 percent exclusive private schools, high-quality alternative, for senior secondary (Figure 5.7). sometimes religious as well). we examined the level of Junior secondary schools are tuition fees being paid by not as universally available the household and after 3% 17% 36% as primary schools, but visual inspection of the national access is still distribution, classified the relatively good. Consequently, 10 percent most expensive as most private schools at exclusive. MC 1 children attends elite MC 2 children attends elite UC children attends elite this level are also either private schools private schools private schools religious, exclusive or both. However, access to public FIGURE 5.7 Choice of school by class, 2015 (percent) …while the richest of the middle class are often sending their children to exclusive private schools. Public School Private School – exclusive* Other Private School* P V AMC MC 1 MC 2 UC 14 14 15 25 33 32 34 Elementary 3 47 72 86 86 85 20 34 20 18 29 27 28 23 Junior High 3 14 48 71 73 72 74 66 34 8 26 30 29 30 25 Senior High 74 1 64 17 58 43 49 70 70 6 Note: Exclusive private schools are those whose tuition Source: Susenas and World Bank calculations. fees are in the top 10 percent of all schools. ASPIRING INDONESIA 121 THE MIDDLE CLASS, AMENITIES… The opting out by the Indonesian middle class of public services reflects a regional trend. Across East Asia there is evidence that as households become wealthier they are opting out of public services. For example, those who are economically secure are more likely to seek private health care not only in Indonesia, but also in Vietnam, Cambodia and Lao PDR (Figure 5.8), as well as in China (Box 5.1). Right Non-communicable diseases (NCDs), including complicated co-morbidities, are now exploding among middle-aged Indonesians, due to unhealthy lifestyle choices and health systems that are underfinanced, and unprepared to diagnose, treat or adequately manage chronic conditions. FI G U RE 5.8 Type of health facility used by class in selected East Asian countries (percent) Across East Asia there is evidence that as households become wealthier they opt out of public services. Public Private, modern Private, Missionary/ Other traditional NGO healers Indonesia Vietnam Cambodia Lao PDR 100 EP MP V ES GMC EP MP V ES GMC 0 EP MP V ES GMC EP MP V ES GMC Note: EP is Extreme Poor under PPP US$1.90 per day; MP is Source: Wai-Poi et al. (2016). Moderate Poor between PPP US$1.90-US$3.10; V is Vulnerable between PPP US$3.10-US$5.50; ES is Economically Secure between PPP US$5.50-US$15; GMC is Global Middle Class above PPP US$15. ASPIRING INDONESIA 122 AND PUBLIC SERVICES BOX 5.1 Middle-class opting out in China 105 There are signs that the Chinese middle class is demanding higher quality education and health services and is willing to pay for it. The importance of education is becoming more instrumental in China since the implementa- tion of the Ministry of Education’s policy of expanding high education en- rolment. This policy is supported by a huge investment in terms of capacity but less so in its quality (Jing, 2010). Having made children’s education as their main priority, 39 percent of Chinese parents are willing to pay 50 percent more in order for their children to study at a university abroad, which they believe will provide a better education, in turn making them more competitive in the domestic labor market (HSBC, 2015; Jing, 2010). A similar attitude is being observed in relation to good quality health care. Results from a PricewaterhouseCoopers (2008) study on the behavior of middle-class consumers regarding their health care needs in three major cities (Beijing, Shanghai and Chengdu) show that the Chinese middle-class consumers are willing in some circumstances to pay more for health care to meet their higher expectations. In addition, middle-class consumers also expect greater privacy and dignity in the care-giving process. This new standard of demand is not being met by the existing Chinese public health-care system, where many medical institutions have lower staffing levels and efficiency compared with international ones. In part, not oper- ating as a normal business may be limiting the ability of Chinese public medical institutions to respond to consumer demand relative to interna- tional ones; McKinsey projects that in the next two decades annual private 105 From Wai- health expenditure by urban consumers will increase by at least 11 percent Poi et al. to capture middle-class consumers likely to opt out of public health care. (2016). ASPIRING INDONESIA 123 Right Planned communities are 5.3 in many ways the embodiment of the middle and upper classes opting out of public services; they provide complete amenities, from security to clean drinking water and proper sewage to reliable power to malls and entertainment complexes to parks and golf courses. Gated communities: the embodiment of middle-class self- exclusion 106 Not only are many middle- and upper-class (plus 40,000 workers and 50,000 transient day Indonesians opting out of public services, visitors) (Hogan and Houston, 2002); by 2015, many middle-and upper-class Jakartans 120,000 people lived in the three Lippo cities are opting out of Jakarta. According to one of Lippo Village, Lippo Cikarang and Tanjung survey, Jakarta ranks the 35th best Asian city, Bunga (Lippo Karawaci, 2015). About 32,000 behind its main regional competitors: Singa- people reportedly live in Alam Sutera (Alam pore (4th), Kuala Lumpur (9th), Beijing (10th), Sutera, 2014) and over 100,000 in Bintaro Jaya Metro Manila (14th) and Bangkok (26th) (Fir- (Bintaro Jaya, 2011). man, 1999). Jakarta suffers from air, water and pollution well beyond United Nations These planned communities are in many standard threshold levels; most wastewater ways the embodiment of the middle and up- is discharged without treatment (Hogan and per classes opting out of public services. Houston, 2002). Traffic is crippling; Jakarta is They provide complete amenities, from securi- the only major city in Southeast Asia without a ty to clean drinking water and proper sewage to mass transit system of some kind. In response, reliable power to malls and entertainment com- many richer Jakartans are choosing to live in plexes to parks and golf courses. Many include planned communities, or kota mandiri (in- prestigious private schools, from kindergarten dependent cities), as they are known locally. up to universities. As an increasing number Among the most well-known are BSD City, Lip- of middle- and upper-class Indonesians be- po Karawaci and Lippo Cikarang. BSD City now gin to live in these planned communities with has between 100,000 and 200,000 residents privately provided services and amenities, the (Sharpe, 2014; Kompas, 2010) in a growing risk is that not only will some of the louder and township that covers 1,300 hectares and is more influential public voices for better quality planned to expand to 6,000 hectares by 2035, public services remain silent, but that the same with 150,000 new homes being built in the next middle class that will bear the majority of the decade and an expected population of 1 million personal income tax burden could become re- people by 2035 (Widjojo, 2015; Kompas, 2010). luctant to pay for poor quality public services 106 From Wai-Poi et In 2002, Lippo Karawaci had 30,000 residents that its members themselves do not use. al. (2016). ASPIRING INDONESIA 125 THE MIDDLE CLASS, AMENITIES… Expanding the middle class & 5.4 delivering benefits to all Below Indonesia’s future development depends in part on both expanding the middle class and delivering benefits to all ASPIRING INDONESIA 126 AND PUBLIC SERVICES Indonesia’s future development depends prosperity for the aspiring middle class and in part on both expanding the middle class driving future economic growth in Indone- and delivering benefits to all. One in five In- sia. We focus on policy initiatives and reforms donesians is now economically secure and this that provide the aspiring middle class with the segment forms the rapidly growing middle skills to be productive workers, and the jobs class, although some still suffer on non-mon- that will bring them prosperity. etary dimensions while others are opting out of public services. At the same time, another Second, we look at a new social contract two-fifths have escaped poverty and vulner- that would unite and not divide the coun- ability but aspire for more. Earlier work has try. How will Indonesia finance the necessary focused on addressing poverty, vulnerability investments to expand the middle class and and inequality;107 the remainder of this report grow into a high-income country without focuses on the middle class and those who as- the current middle class opting out of pub- pire to join it. lic services and resisting tax contributions? That is, what would a new social contract look First, we ask how the Government can like that benefits all sections of society but in expand the middle class, creating greater different ways? We focus on 3 main issues 1 Delivering quality public 2 services to all Supporting economic mobility for all 3 Providing economic security for all. 107 World Bank (2015a). EXPA N D I N G T H E Chapter 6 127—136 6.1 6.2 Taking advantage of Completing high new formal service school and getting jobs with higher job skills wages M I D D L E C L A S S ASPIRING INDONESIA 129 EXPANDING THE MIDDLE CLASS 6.1 About 28 million new jobs were created in Indonesia be- tween 2001 and 2016 85 % Formal Taking advantage of new formal service 70 % Fulltime jobs with higher wages 77 % Services Most new jobs created since 2001 are for- In addition to the at least nominal protections mal, employee jobs in the services sector, of formal employment,108 these jobs pay more. which pay close to twice as much as in- Formal jobs pay 1.7 times more than informal 108 Indonesia has some of the formal and non-employee jobs. About 28 jobs on average, while employee jobs pay 1.6 strictest labor regulations in million new jobs were created in Indonesia be- times more on average than self-employment the world, but they are poorly tween 2001 and 2016. Of these, 85 percent were (without workers) and 1.7 times more than observed, meaning they provide little protection for many formal, 70 percent were fulltime employees non-agricultural casual work. nominally formal workers. See and 77 percent were in services (Figure 6.1). World Bank (2015a). ASPIRING INDONESIA 130 EXPANDING THE MIDDLE CLASS FIGURE 6.1 Change in jobs, 2001-16 by formality, occupational status and sector (million) Most of the new jobs created between 2001 and 2016 were good on paper, mainly being formal, in wage- employment, and in services. These jobs tend to require high school education or better, but pay more. Formal Informal Formality (million) 23 4 0 10 20 30 -1313988 -878192 2563588 1591124 1866772 4526471 Employee 19248784 Occupational status (million) Own Employer assisted by Casual account permanent worker(s) worker in agricultural Casual worker Unpaid sector in non- family Employer assisted by agricultural worker temp worker(s) sector Agriculture Services Industry Sector (million) –1.9 8 21 Source: Sakernas and World Bank calculations. ASPIRING INDONESIA 131 EXPANDING THE MIDDLE CLASS The majority of these jobs require high- percentage is 64 percent for fulltime employ- high-school or higher education, compared school or tertiary education. Sixty-nine ees and 50 percent for business owners with with 37 percent in industry and 14 percent in percent of formal workers have a high school permanent employees, but 30 percent or lower agriculture. Better and higher-paid jobs require education or better, compared with just 18 for other self-employed or casual workers. Fif- higher levels of education. percent of informal workers (Figure 6.2). This ty-nine percent of services sector jobs require FI G U RE 6.1 Education by formality, occupational status and sector, 2016 (percent) Most new jobs since 2016 have been good on paper: formal, employee and in services; jobs that tend to require high school education or higher, but pay more. Diploma IV/university or higher Middle school Diploma III Elementary school Diploma I/II Did not complete/not yet completed elementary school Vocational high school No schooling General high school Formality Occupational status 100 80 60 40 Agriculture Non–Formal 20 Industry Services Formal 0 Sector 100 Casual worker in non-agricultural sector Employer assisted by permanent workers Casual worker in agricultural sector 80 Employer assisted by temp workers 60 Unpaid family worker 40 Own Account 20 Employee 0 Source: Sakernas and World Bank calculations. ASPIRING INDONESIA 132 EXPANDING THE MIDDLE CLASS Bottom Formal jobs pay 1.7 times more than informal jobs on average, while wage employees earn 1.6 times more on average than the self-employed (without workers) and 1.7 times more than non-agricultural casual workers. ASPIRING INDONESIA 133 EXPANDING THE MIDDLE CLASS 6.2 Thus, lifting aspiring middle-class In- donesians into the middle class means having more of them finish senior sec- ondary school. The Government has been implementing education reforms, including Completing high compulsory and free primary and junior sec- ondary education (spanning 12 years), which should provide greater incentives for more school & getting students to complete high school. Nonethe- less, failure to finish senior secondary school for the aspiring middle class is generally due job skills to dropout after junior secondary. This can be because of family pressures to earn an income, but it may also reflect low perceived returns to more schooling. Improving the quality (or perceived quality) of secondary education may help increase educational attainment among this group. Greater educational attainment singles out some tertiary education; for MC 2 and the up- More needs to be spent on secondary and those in the middle class from other Indo- per class of the younger cohorts, the majority vocational education to make these more nesians and qualifies them for better jobs. have tertiary education (Figure 6.3). Howev- attractive to children of the aspiring mid- As we discussed earlier, the middle class has er, not enough of those in the aspiring middle dle class. Only 10 percent of central govern- significantly greater educational attainment class complete high school, which is required ment spending on education goes to secondary than the other classes, completing high school for most of the higher-paying formal jobs in schooling, compared with 24 percent on prima- on average with many going on to tertiary ed- services that are being created by the econo- ry education and 33 percent on tertiary (Figure ucation. For the youngest cohort aged 25-34 my. Only around half have a senior secondary 6.4). This is indicative of spending needs, even years old, only one-quarter of MC 1 fails to education or better. though the bulk of basic and secondary educa- complete high school, while 30 percent have tion spending is at sub-national level. More- ASPIRING INDONESIA 134 EXPANDING THE MIDDLE CLASS FIGURE 6.3 Highest educational attainment by class, 25- to 34-year-olds, 2016 (percent) It is only those in the middle class who predominantly have the high school or better education required for better jobs, with relatively few not completing high school and increasingly large numbers having tertiary education. P V AMC MC 1 MC 2 UC 100 80 60 40 20 0 No schooling Elementary Junior High Senior High Diploma I/II/ Bachelor Master/Doctor School School III Source: Susenas and World Bank calculations. Central government spending on education Left Lifting aspiring middle- 24 10 33 class Indonesians % % % into the middle class means having more of them finish senior secondary school. Primary education Secondary education Tertiary education “lifting aspiring middle-class Indonesians into the middle class means having more of them finish senior secondary school” over, vocational education—a key the modern economy. Not only and biology were reduced, along alternative channel for developing have Indonesia’s education out- with the related ICT training, in skilled workers outside of general comes long been poorly ranked favor of more time being spent on education—receives only 9 per- by international scoring, recent civics and religious teaching. This cent of the Ministry of Education changes to the national curricu- means today’s children are spend- and Culture’s (MoEC) budget.109 lum mean that less time is being ing even less time developing the 109 See World Bank spent on subjects that have more skills firms have already identified (forthcoming) The education system also relevance to skilled employment. as gaps (Figure 6.5). Spending Better: Indonesia Public needs to provide the skills de- In 2013, hours spent on English, Expenditure Review manded by well-paid jobs in mathematics, physics, chemistry 2016-18. ASPIRING INDONESIA 135 EXPANDING THE MIDDLE CLASS FI G U RE 6.4 Central government public spending on education by level, 2016 (percent) Only 10 percent of central government spending on education goes to secondary schools, compared with 24 percent on primary and 33 percent on tertiary. BASIC E C D 24 Y AR O ND EC 27 S 10 OTHER 4 33 TE RM AL RT AL IA FO RM S RY IN FO OU Source: Source: World N- GI NO Bank calculation using LI & MoF data RE FI G U RE 6.5 Important skills identified by employers, and skill gaps (percent) Many employers are identifying particular skills as important and also representing a skill gap to current workers. These are some of the same subjects that are now being de-emphasized in the current national curriculum. Identifies as "very important" Identifies as "skill gap in staff" Basic Thinking Behavioral Computer English Skills Skills Skills Skills Skills 47 47 48 41 38 31 32 24 14 11 Source: World Bank (2011) Skills for the Labor Market in Indonesia. ASPIRING INDONESIA 136 EXPANDING THE MIDDLE CLASS At the same time, greater investments in and development (ECED), but only half of chil- enrolment in ECED of children from aspiring early childhood education will bring more dren aged 5-6 years in aspiring middle-class middle-class families make education more of children into education earlier and better households are enrolled in school, and only 20 a habit for them, it will also mean that they are prepare them to take advantage of later percent of those aged 3-4 (Figure 6.6). ECED better prepared to learn later when they go to schooling. The middle class has a majority of is relatively inexpensive and has been shown to secondary school. children enrolled in early childhood education generate strong returns.110 Not only will greater “Greater investments in early 110 See World Bank (2015a). childhood education will bring more children into education earlier and better prepare them to take advantage of later schooling” FIGURE 6.6 Enrolment by age by class, 2016 (percent) The middle class enrolls most children in ECED, but only half of children aged 5-6 years in aspiring middle-class households are enrolled in school, and only 20 percent of those aged 3-4. Aged 3–4 0 50 100 POOR 16 VULNERABLE 17 AMC 21 MC 1 30 MC 2 42 UC 38 Aged 5–6 0 50 100 POOR 40 VULNERABLE 44 AMC 50 MC 1 56 MC 2 56 UC 62 Source: Susenas and World Bank calculations. The Middle Class 7.1 Aspiring to more than just economic 137—146 security 7.2 The role of central and local government in meeting aspirations 7.3 Chapter 7 Driving the social contract: votes & money 7.4 Middle-class influence: benefiting or harming others? & 7.5 A new social contract the Social Contract ASPIRING INDONESIA 139 THE MIDDLE CLASS & THE SOCIAL CONTRACT ASPIRING INDONESIA 140 THE MIDDLE CLASS & THE SOCIAL CONTRACT Aspiring to more than 7.1 just economic security As a country leaves absolute poverty be- Left Those in the middle class hind, poverty becomes defined relative to the incomes of those higher up the income travel around The argument for relative poverty lines 40 percent more distribution.111 We have been using the concept frequently than comes from the perspective of how incomes other Indonesians, of economic security to capture the increasing at around 1.4 trips of a reference group affect the well-being of numbers of prosperous Indonesian households. every three months, households. Once basic needs have been met, However, what happens once most or all of a and they are much country becomes economically secure? For ex- more likely to do the argument goes, deprivation is measured so for pleasure. ample, almost no person in a developed country relative to the income of the reference group, would be living below the Indonesian economic which is generally taken to be the median, or security line, yet all these countries have their ‘typical’ household in a society. The argument own absolute poverty lines, often defined rel- ative to the rest of the distribution (typically further notes that in the context of most 40-60 percent of the mean or median income; high-income economies such a definition Ravallion, 2010). That is, as countries become would require relatively limited transfers to richer, the minimum level of welfare consid- 111 This section focusing on the eliminate even such relativepoverty ered socially acceptable increases as well, and social contract is usually defined in relation to the welfare of draws from Wai-Poi a reference household (World Bank, 2014b): et al. (2016). —Marx & van den Bosch, 2007. ASPIRING INDONESIA 141 THE MIDDLE CLASS & THE SOCIAL CONTRACT Similarly, as most of a country’s population day. Do the 86 percent of Malaysians who becomes economically secure, security it- are economically secure consider themselves self is no longer sufficient to be considered middle class?112 middle class. A similar increase in aspirations and expectations affects households all the way As Figure 7.1 shows, the percentage of Ma- up the income distribution. A good example laysians who consider themselves lower in the East Asia region is the case of Malay- middle class, upper middle class or upper sia, which is now an upper-middle-income class is only 41 percent, compared with 112 This discussion of the country, with almost no poverty and where 70 percent in Thailand. As the economical- Malaysian middle class is 86 percent of the population are above the ly secure begin to compare themselves rela- taken from Wai-Poi et al. economic security line, 40 percent are in the tive to a mean or median household income, (2016), which summarizes World Bank (2014b) Malaysia Economic global middle class of US$15-US$50 per day, they no longer consider themselves middle Monitor: Towards a Middle- and 7 percent live on more than US$50 per class. In fact, they aspire to more (Box 7.1). Class Society. FI G U RE 7.1 Economic security and self-perceptions of middle class in Malaysia and Thailand The percentage of Malaysians who consider themselves lower middle class, upper middle class or upper class is only 41 percent, compared with 70 percent in Thailand. Self Reported middle class 0 25 50 75 100 7. 0 Malaysia UC 41 E S 3 6.6 G M C 3 9.8 2.2 Thailand Note: ES is Economically UC Secure between PPP US$5.50-US$15; GMC 70 is Global Middle Class between PPP US$15-US$50; UC is Upper Class above US$50 a day. Source: PovcalNet, World Values Survey and World Bank calculations from ES 54.4 G M C 2 9 .7 Wai-Poi et al. (2016). ASPIRING INDONESIA 142 THE MIDDLE CLASS & THE SOCIAL CONTRACT BOX 7.1 The Malaysian The middle class may also be defined as a set of aspirations. For example, a study by the US Department of Commerce (2010, p. 1) describes middle-class families in the experience: from US, noting that they “want economic stability, a home and a secure retirement. They ‘economically secure’ want to protect their children’s health and send them to college. They also want to own cars and take family vacations.” In Malaysia most households own a house and a to ‘aspirational’ 113 car, as well as basic appliances. Retirement balances are generally low, however, and relative to advanced economies few children of families from the bottom 60 percent The World Bank (2014a) examined attend university. While the aspirational definition reflects a subjective perception of what it means to be middle class in members of each society, partly based on the reference income of their peers, by itself Malaysia in Towards a Middle-Class it provides little guidance to arrive at an income cut-off that may be used for policy. Society. The following discussion and figures come from that report. Percentage of households with access to: REFRIGERATOR 96.2 PIPED WATER INSIDE HOUSE 93.7 FLUSH TOILET 80.1 CAR 77.8 OWN A HOUSE 74.5 PAID TV 57.4 LAPTOP 46.3 AIRCON 37.6 TABLET 15.3 A definition of the middle class (and above) is proposed that includes those households earning more than the mean income. According to this definition, 33 percent of all Malaysian households with a monthly income of more than RM 5,919 in 2014 fall into the middle class or higher. The motivation for focusing on households below the mean income is twofold. First, as argued above, the mean income is a reasonable ‘comparison income’ in a given society. It is especially compatible with the upward asymmetry of reference incomes. Second, perception data from surveys suggest the figure is plau- sible in the Malaysian context and not inconsistent with perceptions of what it means to be middle class. Those who do not regard themselves as middle class are less likely to be satisfied with their finances, and it is only when one arrives at the seventh decile of the income distribution that more than half of the respondents report being middle class, and among the total number of individuals who report being in the middle class, more than half are at the top 40 percent of the distribution. One stark (and potentially undesirable) feature of using mean income is that distribution-neutral growth, no mat- ter how rapid, will not increase the size of the middle class. As with vulnerability, the emphasis here is not on the specific measure but its features, namely that it is: (i) based on a simple aggregate; and (ii) compatible with society’s own perceptions and beliefs.114 reduced, a fraction The main distinguishing feature of the middle and upper classes from the aspirational 113 All discussion and figures are of average income group is post-secondary education. The educational difference between the upper and from World Bank or a range around middle classes, and the aspiring middle class is starker: 55 percent of the middle and (2014b). This median incomes may become closer to upper classes have a post-secondary education (including 29 percent with a bachelor’s summary from Wai- Poi et al. (2016). perceptions and degree), compared with just 16 percent of the aspirational group (3.7 percent with a more appropriate. bachelor’s degree). Looking from the other perspective, 83.5 percent of those house- This suggests that 114 Therefore, any definitions holds with a bachelor’s or post-graduate degree belong to the middle- and upper-class as income grows groups. This is strongly suggestive that higher education is a key to the middle class should be further and inequality is periodically and above. reviewed. ASPIRING INDONESIA 143 THE MIDDLE CLASS & THE SOCIAL CONTRACT Right 40 percent of Malaysians are in the global Percentage of each income decile regarding themselves as 'middle class' middle class of US$15-US$50 per day, and 7 percent live on more than US$50 per day. 100 50 0 1 2 3 4 5 6 7 8 9 10 Educational attainment: Class contributions 0 50 100 MASTERS/DOCTORATE/POS BACHELOR POST SECONDARY UPPER SECONDARY LOWER SECONDARY NO EDUCATION/PRIMARY Poor Vulnerable Aspirational Middle-high Aspirational and middle- and upper-class households tend to work in the same broad sectors, but informality is still relatively high among the former group. Sixty-two percent of aspiring middle-class households work in the services sector (compared with 67 percent for middle- and upper-class households), followed by 16 percent in manufacturing. Only a minority (12 percent) work in agriculture, compared with nearly half of poor households and one-quarter of vulnerable households. Aspiring mid- dle-class households are also more likely to have more formal and secure employment opportunities. Fifty-four percent are led by heads of household who work as private employees, 12 percent are public employees. Compared with poor and vulnerable households, which are almost never led by employers, a small percentage of aspir- ing middle-class households are entrepreneurs, generating employment for others. Informality, proxied by the number of ‘own account workers’, is lower in the aspiring middle class compared with the vulnerable group, but this is still 10 percentage points higher than among the middle- and upper-class groups. ASPIRING INDONESIA 144 THE MIDDLE CLASS & THE SOCIAL CONTRACT ASPIRING INDONESIA 145 THE MIDDLE CLASS & THE SOCIAL CONTRACT The role of central & local 7.2 government in meeting aspirations As Indonesia went from impoverished na- greater freedoms have been given up, but there velopment, countries could benefit from both tion to middle-income status, the expecta- has been a public focus on service delivery in investment and the transfer of technology tion was that the government would deliver addition to jobs, at least in urban areas. China from developed countries. This enabled some growth, jobs and an exit from poverty. Mass aside, in many ways the Indonesian and East countries, such as Brazil, China, India, Indo- support for historical Indonesian regimes, as Asian experience has been in stark contrast nesia, Malaysia, the Philippines, Thailand and in much of East Asia, was based on an implicit to the social contract in many Latin Ameri- Vietnam, to sustain strong growth for 20 to 30 social contract by which the government would can countries, which emphasized services and years, largely eradicating poverty and achiev- deliver economic growth, create millions of jobs rights over jobs. ing middle-income status. However, only a few for a young and growing population, and lift countries managed to sustain growth for longer most out of abject poverty. In return, political However, with Indonesia now at middle-in- and become high-income countries. These suc- and civil rights were often sacrificed, and the come status, the development challenge is cess stories include Japan, Singapore, the Rep. emphasis on the economy was sometimes at increasingly becoming less one of poverty of Korea, and Taiwan, China. the expense of public and social service deliv- reduction and more one of escaping the ery. A regional exception is China, where even middle-income trap. In earlier stages of de- ASPIRING INDONESIA 146 THE MIDDLE CLASS & THE SOCIAL CONTRACT FIGURE 7.2 Share of population aged 65 and above, 1950-2070 (percent) Only 5 percent of Indonesia’s population is aged over 65 years old, but just over a decade this will double, and by 2050 it will reach 20 percent, bringing Indonesia into line with other countries in the region. 30 China Vietnam Indonesia 20 Thailand Philippines 10 0 1950 1970 1990 2010 2030 2050 2070 2070 Source: UN population projections in World Bank (2016). At the same time, Indonesia, as well as East (24 percent).115 The fast pace of aging will lead Asia, is aging much faster than the rest of to a steep drop in the size of the workforce and the developing world. Currently, a little over sharp increases in public spending (China alone 5 percent of the Indonesian population is aged will have around 90 million fewer workers). over 65 years old. In little over a decade, this Without reforms, pension spending is project- will double, and by 2050 it will reach 20 per- ed to increase by 8 to 10 percent of GDP by cent. This will bring Indonesia’s aging in line 2070. Furthermore, the developing East Asia with other countries in the region, including Pacific region is getting old before getting rich. 115 This paragraph China, Thailand and Vietnam (Figure 7.2). In In particular, largely middle-income countries, draws from World Bank (2016); see fact, in 2010, the East Asia and Pacific region such as China, Indonesia, Thailand and Vietnam, the report for had about 36 percent of the global population of have been aging rapidly at much lower per-capita a comprehensive the ages 65 and above, and by 2060, its average income levels than did high-income countries. discussion of aging in the East Asia share of older population (22 percent) is ex- Pacific and policy pected to approach that of the OECD countries recommendations. ASPIRING INDONESIA 147 THE MIDDLE CLASS & THE SOCIAL CONTRACT Addressing the middle-income trap, as well delivery as critical in avoiding the middle-in- tobacco excise) and resource rents (either as as an aging population, will mean signifi- come trap. At the same time, tackling aging royalties or through corporate taxes). There- cantly greater public investments. The tran- in Indonesia will require increased labor force fore, increased investments will call for greater sition from a middle-income to a high-income participation by women, establishing a com- public revenues from personal income taxes, country requires significant increases in pub- prehensive and sustainable social protection which are relatively low as a percentage of GDP lic investment. In Indonesia, the World Bank system including pensions, and controlling compared with developed countries throughout (2014a) has identified a need for an increase health costs through a switch in strategy (Box East Asia (Figure 7.4). However, greater reve- in productivity and competitiveness through 7.2). Funding these investments will likely nues from income taxes will be largely paid for improved functioning of product, labor, capital mean raising new revenues through personal by the middle class, which already provides 42 and land markets; and increased or redirected income taxes, currently very low in Indone- percent of indirect taxes (Figure 7.3) and con- public spending toward key development pol- sia relative to both the region and developed tributed to almost all of Indonesia’s 11.8 million icies, such as closing infrastructure and skill countries. But at present, Indonesia still relies income taxpayers in 2016. gaps, strengthening health and social assis- heavily for public revenue streams on corporate tance system, and improving public service taxes, consumption taxes (such as VAT and BOX 7 . 2 Policy options to Many high- and middle-income countries in the East Asia and Pacific (EAP) region are already aging quickly and face pressing challenges in managing their aging societies. The EAP region’s tackle aging in the demographic and epidemiological transitions require proactive policy responses on pensions, East Asia & Pacific health care and labor markets. They will need to mitigate the labor supply and fiscal effects of rapid aging through ongoing reforms of pension and health systems, and labor policies to extend the working lives of their urban and formal sector workers as they undergo rapid urbanization. In the labor market, countries can encourage more women to join the labor force, es- 1 pecially through childcare reforms. Meanwhile, countries such as China, Vietnam and Thailand can remove incentives in pension systems that have encouraged some work- ers, especially urban women, to retire too early. Countries at all income levels will also need to keep improving the quality of their workforces by strengthening education and lifelong learning. 2 Developing countries in EAP can take steps to reform their existing pension schemes, including considering gradual increases in retirement age. Such changes would also make it possible to expand currently low pension coverage to include those working in the informal economy. For countries with relatively young populations, governments need to prepare for the future rapid aging and put in place sustainable pension systems. To meet the higher demands on health and long-term care systems in a financially sustainable way, health systems should shift their focus from hospital-centric care to 3 primary care and promote more efficient management of patients with multiple chronic conditions. This structural shift will require changes in pharmaceutical and technology procurement, and how health providers are paid. It also will require a new health work- force that can provide good-quality primary care. The challenge in long-term care is to develop affordable models that combine family support with community- and home- based approaches. Source : World Bank (2015b) Live Long and Prosper: Aging in East Asia East Asia and Pacific. ASPIRING INDONESIA 148 THE MIDDLE CLASS & THE SOCIAL CONTRACT FIGURE 7.3 FIGURE 7.4 Personal income tax revenue as a percentage of GDP Incidence of indirect taxes, 2015 (Rp trillion) Indonesia achieves relatively low public revenues from personal income taxes. The middle class—the richest two consumption deciles—already pays nearly half of all indirect taxes, and almost all direct taxes. Excises VAT 60 Denmark 26.4 Iceland 13.3 Finland 12.9 Belgium 12.7 Sweden 12.3 50 New Zealand 12.2 Italy 11.6 Canada 11.3 Australia 10.7 Norway 10 40 United States 9.8 Germany 9.6 Ireland 9.3 United Kingdom 9.2 Austria 9 Luxembourg 9 30 Switzerland 8.6 France 8.4 Portugal 7.7 Netherlands 7.3 Spain 7.3 20 Greece 6.9 Israel 5.6 Japan 5.6 Estonia 5.5 Slovenia 5.3 10 Hungary 5 Poland 4.5 Turkey 4.1 Czech Republic 3.7 Korea, Republic of 3.7 0 Slovak Republic 2.5 Poorest Richest Malaysia 2.4 Mongolia 2.1 Household per capita consumption decile Philippines 2.1 Thailand 1.6 Myanmar 1.5 Note: Excises are those on tobacco, which make up 95 percent of total excises. Indonesia 0.8 Cambodia 0.5 Source: Susenas and World Bank Vietnam 0.5 10 20 30 calculations.116 116 See the forthcoming World Bank update to the 2015 report Revisiting the Distributional Impact of Fiscal Policy in Indonesia: Who Benefits, Why Pays? Source: IMF Government Finance Statistics in Wai-Poi et al. (2016). ASPIRING INDONESIA 149 THE MIDDLE CLASS & THE SOCIAL CONTRACT Right Government policy can play an instrumental role in expanding the middle class. The main payers of these taxes ing the economic gains they have will be those in the middle class. made and using their newfound What will they expect in return, income to enjoy better health, ed- and what does this mean for a ucation and other social services. new social contract? Unlike con- Consequently, it seems possible sumption taxes, which are at best that a new social contract will be- neutral and often regressive, per- gin to be negotiated in Indonesia. sonal income taxes are usually very This section examines the role of progressive and the majority are a rising middle class in developing paid for by the wealthier citizens a new social contract, considering in a country.117 However, the in- the economic and social discus- terests of those in the middle class sions earlier: will increasingly focus on protect- 1 2 117 See the discussion on different taxes in World Bank and Indonesian Economic Social Ministry of Finance (2015c) and Jellema et al. (2017). However, note that while consumption taxes are often regressive in Growing economic Sometimes unmet non-mon- terms of relative incidence, that is, numbers & influence etary needs with respect tax collection as to services and amenities, a percentage of the growing aspirations of the eco- income/consumption, the middle class nomically secure to be global accounts for a middle class, possible opting disproportionately out of public services when their large share of total consumption, quality is inadequate and mid- and would therefore dle-class consumers can afford account for most private provision. of the consumption taxes collected. ASPIRING INDONESIA 150 THE MIDDLE CLASS & THE SOCIAL CONTRACT ASPIRING INDONESIA 151 THE MIDDLE CLASS & THE SOCIAL CONTRACT 7.3 Driving the social contract: votes & money 118 Above There are risks that the middle class favors policies that benefit only those in the middle class, but not others, resulting in a more polarized 118 This section 119 See Wai-Poi et and fractious summarizes Wai-Poi al. (2016). society. et al. (2016). ASPIRING INDONESIA 152 THE MIDDLE CLASS & THE SOCIAL CONTRACT with consumption unbounded from above. To FIGURE 7.5 Political salience indicators, 2002 the extent that the aspiring middle class re- and 2016 (percent/points) ally does just aspire to be middle class, as the Malaysian example (Box 7.1) shows it does, its The aspiring middle class and the middle class have the size and economic influence to be politically salient. members are unlikely to really represent a cat- egory of people with a distinct economic class Aspiring Middle Class Middle Class consciousness. Thus, we focus on the number of people and the share of consumption that 47.80 47.20 each class represents when considering wheth- 44.50 er they are potentially catalytic classes with 41.18 political voice. 38.30 In Indonesia, currently both the aspiring middle class and the middle class have the 26.30 potential for political saliency. The aspir- 22.68 ing middle class and the middle class have the 22.28 20.80 size (numbers) and economic influence (share 16.39 of total consumption) to be politically salient 13.39 (Figure 7.5). Currently, the aspiring middle class has a smaller but still significant econom- 6.96 ic clout, with a consumption share 38 percent compared with the middle class’s 47 percent, 2002 2016 and there are more than twice as many aspiring middle class (44 percent of all Indonesians) as there are middle class (21 percent). At the POPULATION INCOME WITHIN- POPULATION INCOME WITHIN- same time, while the middle class has only half SHARE SHARE CLASS SHARE SHARE CLASS as many voters, it represents half of all con- GINI GINI sumption. Which classes will have more political in- people (measured by population share); (ii) However, in the future, as the middle class fluence depends on the country context. In enough income (measured by income or con- grows, so will its number of voters, while it poorer countries with a very small middle class, sumption share); and (iii) shared class identi- will come to dominate national consump- it may be the aspiring middle class with larg- fy (measured by within-class Gini coefficient; tion. Growing in numbers much more quickly er numbers and a greater consumption share that is, all of the class have similar economic than the aspiring middle class (10 percent per that will be more influential. In richer countries means). We look at this combination of fac- year between 2002 and 2016, compared with where the middle class has grown to sufficient tors for Indonesia and compare it with other only 2 percent for the AMC), the middle class size, and whose consumption share will be even countries in the region. Birdsall discusses the will approach the AMC in size. However, the larger, middle-class consumers may wield more importance of economic homogeneity for polit- middle class will quickly dominate national influence. One way to assess which class may ical saliency and looks at the within-class Gini consumption, having more than doubled its be more influential is to consider each class’s as a proxy. On this basis, the aspiring middle share of consumption from 22 percent to 47 political saliency. class has greater homogeneity than the mid- percent over the same period, while the AMC dle class, with a Gini of 13 compared with 26 actually fell from 48 percent to 38 percent. The political saliency of a class of people (Figure 7.5). However, this is by construction: This combination of a large number of voters depends on their size, their economic clout by bounding the classes between narrower con- commanding most of the economic resources and their homogeneity. In examining the sumption levels for the poor, vulnerable and the will make the middle class the most influential Latin American middle class, Birdsall (2014) aspiring middle class, the within-class Ginis group of the future. In this respect, Indonesia identifies a number of factors required for a are by definition going to be smaller than that will come to look more like Thailand and Ma- class to have ‘political saliency’: (i) enough of the middle class, which includes households laysia do now.119 ASPIRING INDONESIA 153 THE MIDDLE CLASS & THE SOCIAL CONTRACT How the middle class uses this for this large potential market; if growing political saliency could industry does not respond in time, affect the rest of Indonesia it risks losing the middle-class in both positive and negative market to foreign products that ways, as the example of the Chi- are perceived to benefit from high- nese middle class shows. Will er production and quality control Indonesia’s growing middle class processes (Rein, 2009). be a positive or negative force? There are both positive and neg- The Chinese middle class, par- ative examples from China. ticularly the young and middle aged in urban areas, is increas- Food safety has become a major ingly concerned with some is- concern for the Chinese middle sues related to non-excludable class, which will benefit all seg- goods, such as environmental ments of society through stron- degradation and pollution, ger regulations. The 2000s saw particularly those that may di- a number of food safety scandals: rectly affect living standards the sale of illegal cooking oil that (Ekman, 2015a). Recently, more recycles waste animal oil (China than one thousand people took to Middle–class Daily, 2011); sick children and the streets of Shanghai to protest infants from powdered milk con- against the construction of a new taining melamine, a chemical from chemical plant. A similar number influence: plastics production (US News, gathered in the suburbs of the 2008); and deaths at Ramadan northern industrial city of Tian- due to vinegar contaminated with jin claiming that pollution from a benefiting antifreeze (Guardian, 2011). In response to these scandals and an nearby steel plant was carcinogen- ic. Residents in Wuchuan, a city or harming outcry from the Chinese middle in southern Guangdong, marched class, tough new laws were intro- on government offices to oppose duced in 2015 that mean tougher plans to build a waste incinerator others? safety standards, tighter approv- near their homes. Such protests 120 als and licensing, and heavi- have successfully triggered Pres- er civil and criminal sanctions ident Xi Jinping’s response, who (Balzano, 2015). pledged that the Chinese govern- ment would “punish with an iron Furthermore, the middle class’s hand any violators who destroy willingness to pay for safer China’s ecology or environment”. products could also improve Since the beginning of this year, domestic supply for all. It is pollution fines were imposed on estimated that 83 percent of Chi- 26 companies, plants belonging to nese middle-class consumers are 527 companies were closed, and willing to pay more for safe food a further 207 businesses were or- products as a result of increased dered to suspend operations. awareness of potential health hazards (AT Kearney, 2007). The However, polluting or prob- China Market Research Group lematic projects are often not finds that shoppers who are moth- canceled but simply moved to ers are willing to spend about 20 areas with poorer households percent more for food products, and less voice. Middle-class pro- clothing and related toiletry items tests have often been moderately for their babies if they were fully effective in stopping local proj- confident that those products are ects, but not yet so in reforming safe. Such consumption prefer- overall environmental policies. ences and concerns could stim- Controversial projects are rarely ulate domestic industry—which canceled and are instead simply also serves poorer consumers—to relocated to areas with a more sub- produce better quality products missive population. For instance, ASPIRING INDONESIA 154 THE MIDDLE CLASS & THE SOCIAL CONTRACT thousands of people in Xiamen, tween the middle class and the an affluent wealthy city on the Chinese Communist Party, and eastern coast, forced the Chinese a conservatism among the older government to suspend the pro- generation of the middle class that posed construction of a chemical may make it unlikely to push for factory producing paraxylene. change. At the same time, a more Faced with unprecedented num- confident and modern younger bers of protesters from among the generation of the middle class is 7.4 urban middle class, the provincial finding opportunities to express government reallocated the plant its views. The degree to which this to poorer, smaller Zhangzhou, the younger generation feels that the site of a recent accident with dis- current political regime is listen- enfranchised farmers (Hoffman ing to its opinions may influence and Sullivan, 2015). the degree to which its looks to re- form the system from within, or Moreover, in the case of China to challenge it. Moreover, while it is unclear whether the mid- those in the middle class are more Below 83 percent of dle class will push for reforms likely believe that growth in per- Chinese middle-class consumers are willing or be concerned that change sonal wealth does not come at the to pay more for safe will threaten its economic in- expense of others, when their eco- food products as a terests (Box 7.3). The existing nomic interests are threatened, as result of increased awareness of potential political literature points out the in the case of the hukou reform,121 health hazards. close traditional connection be- they may be resistant to change. 120 Taken from Wai- Poi et al. (2016). 121 The hukou system designates a resident’s status as being either rural or urban based on their registered birthplace. This means a migrant worker from the countryside is not entitled to public services in a city, despite working and living in a city. China’s government has announced a goal of expanding urban hukou or residency permits to 100 million migrant workers by 2020 as part of its plan to rebalance the economy. ASPIRING INDONESIA 155 THE MIDDLE CLASS & THE SOCIAL CONTRACT BOX 7 . 3 China’s middle class: reformers or co-opted? The Chinese middle class traditionally order. If there is criticism, it is more as a The middle class appears to be more has a strong connection with the Chi- desire for greater efficiency and social jus- open-minded regarding the pursuit of nese Communist Party and may not be tice within the current system (Goodman, profit to sustain economic growth but may the group most inclined to support some 2013) and, despite social policy reform, be resistant to reforms that threaten its forms of political change. Glassman the force of democratization is unlikely to interests. Utilizing the 2006 China Gen- (1997), on an early assessment of the become strong (Jing, 2010). eral Society Survey (CGSS), Jing (2010) economic restructuring in China, argues finds that the middle class supports im- that democratic change will follow from However, a younger generation may look posing taxes on the rich to help the poor the emergence of new entrepreneurial to influence policy from within the Party. (the WVS data also show broad support classes. Subsequent research, howev- The older generation of the Chinese mid- for this, but not more so than among the er, shows the intertwined relationship dle class holds relatively conservative po- non-secure). Nevertheless, since most of between the new entrepreneurs and the litical views and is more likely to support those in the Chinese middle class hope to Communist Party (Pearson, 1997; Chen state authoritarianism for fear of losing benefit from economic growth and main- and Goodman, 2013). According to some its own socioeconomic stability, while the tain their current lifestyles, they tend to be non-official estimates, around 40 percent younger Chinese middle class prioritizes more submissive to an authoritarian state of entrepreneurs are members of the Party career advancement and household pros- for economic security and socio-political (Chen and Goodman, 2013). This is partly perity over political participation (Ekman, stability. Based on survey data from three because those in the middle class have 2015b). However, while the older middle major cities (Beijing, Chengdu and Xi’an), more desire for political participation than class tends to be more mindful of its fi- Chen and Lu (2011) find that, while most of their less well-off counterparts (Fewsmith, nancial situation and less conscious of those in the middle class are in favor of the 2007). We see in the WVS data that the fi- social inequality, the new middle class individual rights of a democratic system, nancially secure Chinese are slightly more shows a more democratic consciousness they are not supportive of political liber- likely to belong to a political party than the and its members are often recruited into ties and democratic institutions, particu- non-financially secure (9 to 7 percent). In think-tanks or invited to join consultation larly if these could disturb social order. At addition, since Jiang Zemin’s leadership, committees to advise or voice opinions the same time, while the majority of the the Communist Party has opened its doors (So, 2013). While its opinions may not middle-class survey respondents support to the private sector with the aim of ensur- be accepted by the Party-State, the new competitive, multicandidate elections of ing the loyalty of all segments of society. middle class feels that it has a chance to government leaders, they do not support Many of middle class are therefore gener- participate in the decision-making pro- multiparty competition, suggesting con- ally connected in one way or another to the cess and believes it can influence poli- sent to the current one-party dominance Party, especially when Party connections cymaking through the existing political and controlled election system. Moreover, and membership are perceived as signs of channels (So, 2013). Whether the rising the Chinese middle class appears to be success. However, political connections middle class continues as a supporter or reluctant to accept some of the ongoing and participation do not necessarily trans- a challenger to the political regime will socioeconomic reforms, such as making late into a demand for political change. depend on whether the political system the hukou system more flexible, especially Ekman (2015a) argues that the majority of is able to accommodate its political de- when its position will be less favorable as China’s middle class is unlikely to demand mands (Li, 2008). a result (Solinger, 2005). change or question the current political Below It is unclear whether China’s middle class will push for reforms or be concerned that change will threaten its economic interests. ASPIRING INDONESIA 157 THE MIDDLE CLASS & THE SOCIAL CONTRACT 7.5 A new An arrangement for all Indo- nesians is one where public in- expand the middle class and to protect those already there. A social vestments drive growth, such relationship between the govern- growth is inclusive, and social ment and its people could focus on contract insurance protects the gains three areas. First, quality public of all. For the non-middle class, services, especially in health and access to high quality public ser- education, but also water and vices and good jobs can provide sanitation, are necessary so that opportunities to achieve economic aspiring middle-class children can security and become middle class. develop the health and skills they At the same time, upward mobil- need to succeed later in life. Bet- ity of the non-middle class and ter quality services may also mean investments in productivity and that the middle class uses and ap- infrastructure will drive greater preciates such services more wide- economic growth, benefiting the ly, generating broader support for middle class. Furthermore, stron- financing them. Second, access to ger social insurance to provide em- livelihoods that allows the middle ployment and health protection, class to prosper and those below as well as pensions, means that the to enter can help ensure economic economic gains of both the current mobility for all. This means a fo- middle class and those entering it cus not only on better education, (from the AMC) can be secured as discussed earlier, but also on from the shocks that can affect making it easier to become an Right Effective and sustainable health, everyone. Finally, strengthening entrepreneur, which increases employment and income-tax compliance from the the prosperity of the middle class old-age insurance current middle class and boosting and creates new jobs for others. can provide the safety net that new collections from an expanding Finally, effective and sustainable the aspiring middle class mean that everyone is health, employment and old-age middle class needs paying their fair share. insurance can provide the safety to enter the middle class, and net the aspiring middle class needs can protect the Thus, a social contract that fo- to become middle class and, at the economic gains cuses on quality public services, same time, protect the economic that the middle class has already economic mobility and social gains that the middle class has al- achieved. security for all both helps to ready achieved. ASPIRING INDONESIA 158 THE MIDDLE CLASS & THE SOCIAL CONTRACT Chapter 8 159—168 A 8.1 Common Quality public services: linking financing & performance Cause for All 8.2 Enhancing economic mobility through entrepreneurism Indonesians 8.3 Economic security through effective & comprehensive social insurance ASPIRING INDONESIA 161 A COMMON CAUSE FOR ALL INDONESIANS Quality public services: linking financing & performance 122 Below Indonesia’s public spending on health is well below regional and lower middle-income country averages, with a recommended benchmark of US$86 per capita needed for low and 8.1 middle-income countries to be able to deliver a limited set of key health services. ASPIRING INDONESIA 162 A COMMON CAUSE FOR ALL INDONESIANS could tie spending to performance is the reform introduced by the Jakarta Provincial Govern- ment in 2015.123 Unlike education, there is insufficient spending to ensure supply-side readiness in the Indonesian health system.124 Total health spending in Indonesia is low relative to other countries in the region and much of it comes from consumers themselves. Despite increases in recent years, public spending on health is one of the lowest in the world, at 5.9 percent of total public expenditures, and rep- “Unlike education, there is resents only 1.1 percent of GDP, far lower than the 3.3 percent average for countries of similar insufficient spending to ensure income levels. Consequently, many health fa- cilities lack the equipment and training needed supply-side readiness in the to provide key services. Moreover, central gov- Indonesian health system” ernment spending represents only one-third of total health spending, and this is compound- ed by a disconnect between local government Despite significant investments in education, an increased num- spending and supply-side readiness. ber of teachers, and higher teachers’ salaries, student learning outcomes have not been improving. Education spending in Indonesia In addition to increasing health spending, quadrupled between 2001 and 2016 in real terms and now represents Indonesia needs to focus on spending bet- 20 percent of all public spending and 3.3 percent of GDP. The num- ter. More spending on health could help to re- ber of teachers has increased dramatically since 2005, with 15 percent duce gaps in access. However, only one-third more civil servant teachers and 40 percent more temporary teachers by of public spending comes from the central gov- 2015. Indonesia’s student-to-teacher ratio (STR) of 17 far exceeds the ernment; improving the efficiency of hospitals average for other lower middle-income countries of 29 and is nearing and health centers is also important. Moreover, the high-income country average of 14. At the same time, a teacher the priority is improving the quality of health certification program has expanded sharply and is reflected in greatly services. Specific actions include targeted increased teacher allowances. However, despite increased spending on public investments with built-in incentives for educational inputs, learning outcomes have not improved, with little performance to equip local health facilities to change in international PISA scores, and no relationship between lower deliver results; producing sufficient competent STRs and test scores. 122 This discussion health workers and ensuring they are deployed on public service to where they are needed; and scaling up and delivery and Increasing the focus on professional development and linking per- quality is expanded enforcing the accreditation system. Moreover, formance to rewards, both at the teacher and local government significantly in public health spending can be made more effi- level, could improve the quality of teaching and education. There the main report cient, with Indonesia’s relative technical efficien- and draws heavily is a lack of continuous professional development (CPD) and the School on World Bank cy in transforming inputs into outputs lagging Operational Fund (BOS) spends three times more on honorariums (17 (forthcoming) other countries such as Sri Lanka and Vietnam. percent) than professional development (5 percent). At the same time, Spending Better: Indonesia Public there is no link between teachers’ performance and their allowances and Expenditure Review More broadly, improvements are needed in professional progression, so quality is neither developed nor rewarded. 2016-18. the way local governments deliver public Moreover, funding and spending are not linked to performance either. services. In a decentralized Indonesia, local Local governments are responsible for spending their education budgets 123 World Bank governments are critical for delivering public (forthcoming) to achieve minimum service standards, but spending is only weakly Spending Better: services, not just in health and education, but correlated with these achievements, while BOS allocations are generally Indonesia Public also in areas such as water and roads. And in not allocated based on school performance. The World Bank is piloting Expenditure Review an urbanizing Indonesia, service delivery in cit- 2016-18. tying teacher allowances with teacher performance through the KIAT ies is failing, where only 33 percent of urban Guru project. In remote pilot schools under the project, payment of 124 See World Bank households have access to clean water, only 12 the remote area allowance is tied with either teacher presence or ser- (2016) Health cities have piped sewerage networks serving 2 vice performance, with inputs from parents and broader community Financing System percent of the urban population, and 40 per- Assessment: Spend members. Initial findings indicate significant improvements in teacher More, Right, and cent of urban residents do not have access to presence and service performance. Another example of how reforms Better. proper sanitation ASPIRING INDONESIA 163 A COMMON CAUSE FOR ALL INDONESIANS Five strategies have been identified to maximize the effectiveness of local governments’ spending of transfers.125 To improve local government spending on service delivery, the government should consider implementing the following: 1 Build a robust system to measure performance 2 Make the most of incentives 3 Address poor performance in graduated ways Relate inputs, processes and outputs to Remove bad incentives, such as the Issue letters to improve; provide outcomes; invest in higher quality data; general allocation fund (DAU) basic technical support; require performance combine finance and performance data share that encourages the hiring of more action plans; and reduce funding for a more meaningful picture; and utilize district staff; use financial incentives allocations. the Central Bureau of Statistics (BPS) in different ways, such as rewarding and the Financial and Development process compliance and paying for Supervision Agency (BPKP) in outputs; use matching funding to drive monitoring. ownership; and encourage positive competition, by publicizing local performance data 4 Use citizens to provide incentives for better 5 Fix systems & capacity performance Make budget and spending data public; Streamline subnational public financial involve citizens in the local decision- management (PFM) systems; measure making and development; and provide the performance of subnational PFM feedback mechanisms. systems to targeting capacity building; 125 World Bank modernize district financial management (forthcoming) accounting software; and develop Spending Better: a comprehensive capacity-building Indonesia Public Expenditure Review program for subnational governments. 2016-18. ASPIRING INDONESIA 164 A COMMON CAUSE FOR ALL INDONESIANS In addition, reforming Law conditional transfers to regions person. This not only encourag- No. 33/2004 on Fiscal Decen- (DAK) should address national es districts to split, it also means tralization’s comprehensive priority outcomes, not adminis- large urban populations—where intergovernmental financing trative functions. Second, getting most of the middle class live—lack framework could make decen- the general allocation fund (DAU) sufficient financing for their local tralization more effective. Two right matters. Current DAU allo- infrastructure needs, undermin- core changes would help. First, cations are per district, not per ing local service delivery. Right There is broad support across all classes for a social contract that benefits all Indonesians. ASPIRING INDONESIA 165 A COMMON CAUSE FOR ALL INDONESIANS Right While just over one-third of middle-class workers continue to be self-employed or own their own business, more and more of them run productive businesses that are capable of employing other paid workers. Enhancing economic mobility through entrepreneurism 8.2 Most business owners who employ others forcing contracts. However, with a goal of 40th are from the middle class. While most mid- by 2019, the government now needs to move dle-class workers find well-paid productive beyond “quick-win” reforms and implement jobs in the formal sector, a significant number medium-term structural reforms to further own their own businesses and employ others improve Indonesia’s business environment. To (Figure 4.12). Policies that support these en- this end, it is important that the government trepreneurs will increase their own econom- continues with its plan for coordinating and ic mobility, help drive economic growth, and monitoring the reform process. 127 create more jobs for the aspiring middle class. Two key areas are the regulatory environment In addition, more needs to be done to make and access to credit. Indonesian firms less credit-constrained.128 There is ample evidence that firms in Indonesia Recent improvements in the ease of doing are credit constrained, with firms relying more business need to be sustained and deep- on retained earnings than bank credit for ex- ened. The investment climate and ease of pansion. The credit constraint faced by firms doing business have long been identified as a reflects the lack of depth of Indonesia’s financial constraint on firms in Indonesia.126 As recent- markets. Public policy could help nudge the ly as 2013, Indonesia ranked 120th out of 185 system toward greater financial depth, through countries in the World Bank Group’s Doing easing strict investment requirements, build- Business rankings. However, a series of re- ing a more credible legal system that allows forms implemented by the current adminis- for the effective enforcement of contracts and tration has seen significant improvements and property rights, and provides greater investor 126 World Bank Indonesia has seen one of the greatest gains in protection. The recent reforms of the social se- (2014a). the rankings in recent years, improving from curity regime further present an opportunity to 127 World Bank 106th in the 2016 rankings to 91st in 2017 to 72nd deepen financial markets, with the new body (2017) Indonesia in the just released Doing Business 2018 rank- expected to cover 10 times the number of work- Economic Quarterly: ings. The World Bank credits positive reforms ers it had previously, multiplying assets under Sustaining Reform Momentum. in the areas of: starting a business, getting management and presenting an opportunity to electricity, registering property, getting credit, widen the choice of eligible investments. 128 See World Bank paying taxes, trading across borders, and en- (2014a). ASPIRING INDONESIA 166 A COMMON CAUSE FOR ALL INDONESIANS ASPIRING INDONESIA 167 A COMMON CAUSE FOR ALL INDONESIANS The final component in ensuring millions of Indone- 8.3 sians can enter the middle class and remain there is social insurance. We have looked at the investments and policies needed to strengthen the opportunities for the non-middle class to increase their incomes and move into the middle class, achieving their aspirations and driving greater growth. However, protecting the economic gains as households enter the middle class is just as important. This means establishing a social insurance system that pro- tects households from health and employment shocks, and provides income in old age, while providing the right mix of benefits in a fiscally sustainable manner. It also means providing social assistance to poorer households that cannot afford to pay the premiums themselves, so that they have a better chance to climb into the middle class.129 Economic There are many shocks that can erode household re- sources and incomes; many Indonesians rely on friends security through and family to cope rather than formal mechanisms. Households can be affected by economic, health, and social and political shocks, as well as natural disasters. Civil ser- effective & vants and some of the middle class have access to health and employment insurance that they can rely on during shocks. While the government covers health insurance premiums comprehensive for the poor and vulnerable, for many workers from the aspiring middle class who work in the informal sector, the social insurance expansion of health and especially employment insurance coverage to these households may be many years away. When people do not have access to formal coping mech- anisms in times of shock, they usually turn to family and friends. However, this typically does not provide enough support to fully cope and does not work when a shock such as a natural disaster hits an entire community. When in- formal borrowing is not enough, households may resort to steps that reduce their future income, such as selling productive assets or pulling children out of school. Thus, shocks can reduce household income by either destroying or impairing the underlying assets that generate income (productive assets such as equipment or human assets such as labor), or by forcing households to use or sell these assets (savings or productive assets) to cope with the shock. Shocks hurt the incomes of all Indonesians, but the middle class is more resilient.130 With vulnerability 129 See World Bank high in Indonesia, small shocks can easily reduce incomes; (2015a) and World Bank (2017b). around half of the poor each year were not poor the year before. Those in the aspiring middle class can also be badly 130 World Bank affected by shocks such as illness and disease or unemploy- (2015a). ment if they do not have access to insurance or other coping mechanisms. As a consequence, over a 14-year period, most 131 World Bank (forthcoming) Indonesians have experienced considerable ups and downs Spending Better: in terms of their income. In contrast to this common sit- Indonesia Public uation, the majority of the middle class have been able to Expenditure Review 2016-18. remain middle class over the same period of time. ASPIRING INDONESIA 168 A COMMON CAUSE FOR ALL INDONESIANS Left Indonesia is also rapidly aging—with the share of population aged 65 years and older expected to double from 5 to 10 percent between 2015 and 2030. Therefore, expanding the middle class also tions deducted by their employers from their 60 requires expanding and strengthening In- salaries, enrolling and collecting from informal % donesia’s social insurance system. In recent workers—who largely represent the aspiring years, Indonesia has been implementing a mas- middle class—has proven difficult. Those in- sive social insurance framework, which covers formal workers who do enroll are those with an both health ( JKN) and employment and retire- incentive to do so, meaning adverse selection ment (SJSN Employment). The policy goal is threatens JKN sustainability; there is little bar- universal coverage of the two schemes, which rier to enrolling when sick and no way to bring includes both contributing (from non-poor informal workers in ex ante. Moreover, the cost workers) and non-contributing (premiums of the benefits package exceeds the cost of con- subsidized by the government) members. tributions, further compromising long-term The national health insurance scheme sustainability, which affects both the middle (JKN) is the largest single payer system The national health insurance scheme class and those who aspire to join it. in the world but it is far from universal and ( JKN) is the largest single payer system in does not cover its costs. JKN now covers the world but it is far from universal and Improvements in sustainability, account- 163 million people, or over 60 percent of does not cover its costs. JKN now covers 163 ability, efficiency and effectiveness are the population. million people, or over 60 percent of the pop- required for JKN to provide true security ulation. In practice, premiums are paid both to the middle class and beyond. To address by formal workers and by the government on sustainability, the basic benefit package needs behalf of the poor and vulnerable; government to be commensurate with the financing and subsidies make up half of all JKN revenues. moving to strategic purchasing of services However, JKN does not cover the full costs of (from passive purchasing) could improve val- care, meaning that central and local govern- ue for money. A lack of checks and balances in ments have to make up the difference.131 the implementation of JKN means inefficiency and a lack of accountability, which needs to be Extending coverage to informal workers, addressed. Furthermore, JKN payments can many of whom come from the aspiring mid- be used as incentives for district-level health dle class, has proven difficult, and the long- performance. Finally, there is a need to clarify term sustainability of JKN is under threat. the roles and responsibility of different agen- While many of the poor and vulnerable have cies implementing JKN, including the Ministry premiums paid by the government, and civil of Health and BPJS. servants and formal workers have contribu- Conclusion Chapter 9 169—172 ASPIRING INDONESIA 171 CONCLUSION Indonesia aspires to move from middle- for better jobs. It also means expanding social greater public investments, funded by taxes to high-income country status. Meeting insurance so that their newfound prosperity is built on a new social contract that provides these aspirations will mean meeting the protected from shocks. At the same time, tax protection and higher-quality services for all. aspirations of its people and becoming a revenues from the growing middle class will Moreover, not only is a new contract required middle-class society. The emergence of a be critical to fund the investments in health for a brighter future, without one even today’s prosperous middle class in Indonesia has been and education, infrastructure and productivity prosperity may become vulnerable if Indone- a key driver of recent economic growth. How- necessary for Indonesia to keep developing. In sia’s growing inequality and middle-class opt- ever, to sustain and even accelerate economic return, those in the middle class will want to ing out result in a socially and politically polar- growth and the public investments needed to see higher-quality public services and contin- ized country that cannot agree on a vision for transition to a high-income country, it will need ued upward mobility if they are not to start to shared prosperity. Nowhere has this been more to substantially expand the middle class, be- resent the tax burden that will fall increasingly dramatically illustrated than in Thailand over ginning with the two-fifths of its citizens who and substantially on them. the past decade. After the strongly re-elected have successfully escaped poverty and vulner- Thaksin Shinawatra was forced from power in ability, and who now aspire to join the econom- Transforming Indonesia into a middle-class 2006, Thai politics have stumbled through a ic security and prosperity of the middle class. society is also vital to prevent political and decade of a deeply divided electorate, inflamed Achieving this means ensuring that they stay in social polarization. As we have discussed, by the actions on both sides, snap elections, the school longer and develop the skills they need escaping the middle-income trap will require ejection of popularly elected prime ministers, “Indonesia aspires to move from middle- to high-income country status. Meeting these aspirations will mean meeting the aspirations of its people & becoming a middle-class society” FI G U RE 9.1 “How urgent is it for the government to reduce inequality?” There is broad support across all classes on the need to reduce inequality. Not urgent at all 0 20 40 60 80 100 45.9 41.3 9.99 2.83 Poor NOT VERY QUITE VERY URGENT URGENT URGENT Vulnerable 44.7 43.2 9.75 2.33 NOT VERY QUITE VERY URGENT URGENT URGENT 48.0 2.35 Aspiring Middle 39.8 9.78 Class NOT VERY QUITE VERY URGENT URGENT URGENT 48.2 40.8 8.50 2.43 MC NOT VERY QUITE VERY URGENT URGENT URGENT Source: Lembaga Survei Indonesia Inequality Perceptions Survey and World Bank calculations. See World Bank (2015c) for details. ASPIRING INDONESIA 172 CONCLUSION widespread and persistent street inequality. Nearly 90 percent said demonstrations and violence, cul- “very urgent” or “quite urgent”, minating in a military coup. Thai- a figure that was constant across land remains trapped in a political all consumption classes, including impasse between the emerging the middle class (Figure 9.1). They rural economically secure and the were also asked what the most im- Bangkok-based urban global mid- portant policies were. All classes dle class and elites. This impasse agreed on jobs, credit for small has many roots,132 but is in part businesses, education and health due to a failure to establish a broad care for all, social protection and social contract that benefits all. eradicating corruption. While sup- port for higher taxes on the rich is There is broad support across low, this can be addressed with a all classes for a social contract strong communications strategy that benefits all Indonesians. A explaining what these taxes buy 132 See Box 15, Wai-Poi et al. recent survey asked Indonesians and sustained commitment to de- (2016). how important it was to address livering these policies. TABLE 9.1 Three most important policies for addressing inequality by class (percent) Regardless of economic class, all Indonesians agree that the best way to address inequality is through social assistance, better jobs and less corruption. Poor Vulnerable Aspiring Middle Class Middle Class Social assistance 54 52 48 40 More jobs 43 46 50 49 Eradicating corruption 34 33 38 44 Free education 30 30 30 31 SME credit 27 27 27 25 Free health care 18 18 17 18 Infrastructure 16 14 12 17 More subsidies 13 14 15 11 Raising minimum wages 12 16 19 22 Village grants 10 9 6 6 Improving school quality 9 11 10 10 Non-business loans for the poor 8 8 8 5 Equitable asset ownership 3 1 3 2 Unemployment insurance 2 3 2 4 Taxes on the rich 2 3 3 4 Source: Lembaga Survei Indonesia Inequality Perceptions Survey and World Bank calculations. See World Bank (2015c) for details. 173—198 Sectoral Chapter 10 H O W T O E X P A N D the M I D D L E C L A S S : Diagnoses & Recommendations ASPIRING INDONESIA 175 HOW TO EXPAND THE MIDDLE CLASS: 10.1 01 Motivation Improving Evidence of the importance of education in improving the wellbe- ing of individuals and helping to boost economic growth is over- the quality of whelming. Through education, individuals increase their productivity, earn higher wages in the labor market, and become more fully developed citizens better able to make a contribution to society, among other de- education sirable outcomes. At the aggregate level, countries with higher levels of education post higher rates of economic growth over the long term. Nonetheless, for education to deliver on its promise, two elements are crucial: first, individuals must be able to enroll in the education system and, second, once in the education system, students need to acquire the necessary cognitive and socioemotional skills to allow them to join the labor force and make their full contribution. Over the past 15 years, Indonesia has launched several major re- forms to improve the educational outcomes of its population, aim- ing to increase school attendance and the quality of learning. In 2002, Indonesia amended its Constitution to make it mandatory for all Indonesian children to follow elementary education and requiring the government to fund this by allocating 20 percent of the budget to edu- cation. Following this constitutional amendment, two important laws were enacted, namely Law No. 20/2003 on National Education and Law No. 14/2005 on Teachers and Lecturers, to improve access and quality of education to all Indonesians. In addition, two major programs were launched by the government to reduce the financial constraints limiting the access of aspiring middle-class Indonesians to the education system: starting in 2005, the Bantuan Operasional Sekolah (BOS) program, which provides schools with resources on a per-capita basis and reduces the need of schools to charge fees and, starting in 2009, the Program Indonesia Pintar (PIP), which provides financial support to students from low-income families to help cover the costs related to participating in school, such as transport, uniforms and books, were implemented. Indonesia has made important progress in enabling aspiring mid- dle-class Indonesians to access the education system, successfully closing enrolment gaps. Total enrolment expanded by about 25 per- ASPIRING INDONESIA 176 SECTORAL DIAGNOSES & RECOMMENDATIONS 327 02 Diagnosis cent between 2001 and 2015, from 43.3 million Between 2001 and 2015, Indonesia’s education system expanded to 53.3 million students, mostly at the lower- rapidly. In 2001, total enrolment was 43.3 million students, comprising and upper-secondary education level. As a re- 29 million and 14 million in primary and secondary education, respec- sult, educational attainment of students grew tively. By 2015, while enrolment in primary education remained relative- from an average 6.8 years of schooling in 2000 ly static at about 29 million students, there was a significant expansion to 11.0 years of schooling in 2017. However, in secondary education to 24 million students, giving a total of 53 million student learning outcomes are lagging and still students in all—a 22.4 percent increase over 15 years. low by international and national standards. While learning outcomes have seen a modest Improvements in access to education have been focused on the improvement in recent years, nonetheless, at poorer segments of the population. Between 2000 and 2014, en- the current rate of progress, it will take Indo- rolment of 16- to 18-year-olds increased for all socioeconomic groups, nesia 48 years to reach the OECD average level growing on average by between 50 and 73 percent. Students in the lowest in mathematics and 78 years to reach the aver- quintile saw the largest increase in enrolment, almost doubling their age OECD rate in reading (although the OECD participation from 30 to 57 percent in the period. Meanwhile, student average level can be expected to improve in enrolment in the wealthiest quintile rose from 73 to 81 percent. As a the interim). On average, most of the young- consequence, the gap in enrolment between the poorest and wealthiest est cohorts of Indonesian students now finish quintiles decreased from 43 to 24 percent over the same period—an upper-secondary education. However, once this impressive and important achievement. level of educational attainment is adjusted to take into account Indonesia’s low education quality, FIGURE 10.1 School enrolment rate of population these students’ learning outcomes are only equiv- aged 16-18 years old by family expenditure group, 2000-14 alent to completing lower-secondary education. For education to deliver its full promise to 2000 2006 2009 2014 Indonesian students, especially those in the aspiring middle class, the necessary and 81 76 successful expansion of enrolment must 73 74 73 72 65 66 66 also be accompanied by improvements in 61 57 57 55 student learning outcomes. Unless schools 50 44 46 succeed in delivering significant improvements 41 31 34 32 in student cognitive and socioemotional skills, they will be failing to serve their purpose. Im- provements in student learning outcomes are linked to many elements, the most important Q1 Q2 Q3 Q4 Q5 Q1 Q2 Q3 Q4 Q5 Q1 Q2 Q3 Q4 Q5 Q1 Q2 Q3 Q4 Q5 of which is teaching quality. Source: Susenas, several years. ASPIRING INDONESIA 177 HOW TO EXPAND THE MIDDLE CLASS: FIGURE 10.2 Evolution of PISA math scores and student enrolment, 2003-15 100 Change in Population (Percentage) TUR Indonesia 50 LUX MEX BRA URYESP NZL USA DNK AUS KOR IRL NOR NLD ISL CAN ITA 0 FIN FRA CHE THA PRT GBR JPN GRC SWE AUT DEU HUN HKG TUN MAC CZE SVK POL -50 RUS Change in Math Test LVA -20 0 20 40 In the context of the rapid ex- Indonesian students do not pansion of educational attain- have equal access to learning FIGURE 10.3 Evolution of enrolment among the ment, Indonesia increased its opportunities. Comparison of poorest decile across selected PISA countries, 2003-15 PISA math score between 2003 the characteristics of schools at- and 2015 by about 25 points, tended by poorer and wealthier equivalent to almost one year students in Indonesia (proxied by FIN KOR BRA MEX USA TUR IDN of learning. This is an important the number of students who are achievement, as countries often eligible for PIP attending a school) 39 experience a decrease in learn- shows important differences in the ing scores as access to education quality of service delivery. In ba- increases. Among the PISA 2003 sic education, although poorer and and 2015 participants, Indonesia wealthier students have teachers registered the second-largest in- with similar qualifications in terms crease in enrolment of 15-year- of a bachelor’s degree (S1), poor- olds. Moreover, Indonesia is the er students enjoy a lower share only PISA participant country in of classrooms that are in good the 2003 and 2015 PISA tests to condition (19 vs. 36 percent) and see an increase in enrolment for their schools are less likely to be students from the poorest house- accredited (13 vs. 35 percent). -4 holds. These differences across socio- -11 economic groups increase as stu- The improvements in PISA dents reach upper-secondary ed- scores differ markedly depend- ucation: the share of classrooms in ing on socioeconomic group. good condition is 31 vs. 52 percent, For math and reading, there are respectively, while accreditation significant differences in the is 14 vs. 55 percent, respectively. evolution of the wealthiest four Schools attended by poorer stu- deciles compared with those in dents tend to be smaller, probably the poorest four deciles. reflecting the geographic location -55 of the school, making it more chal- These unequal results in stu- lenging to have larger class sizes. -68 -67 dent learning outcomes linked Likely reflecting the former, stu- to socioeconomic status in- dent-teacher ratios tend to be low- -75 dicate that, despite equal ac- er in schools attended by poorer cess to the education system, students. Source: www.pisa.oecd.org ASPIRING INDONESIA 178 SECTORAL DIAGNOSES & RECOMMENDATIONS FIGURE 10.4 In the context of the rapid expansion of educational attainment, Indonesia increased its PISA math score between 2003 and 2015 by about 25 points, equivalent to almost one Math PISA scores by year of learning. socioeconomic decile 25 450 Wealthiest Pisa Math Score four deciles 400 PTS Poorest four deciles 350 -3 Index socio 0 economic conditions FIGURE 10.5 TABLE 10.1 School characteristics by socioeconomic conditions Reading PISA scores by socioeconomic decile   SD - SMP SMA - SMK   450 Top Bottom Total Top Bottom Total quintile quintile quintile quintile Wealthiest Pisa reading Score four deciles Size 277 124 191 499 183 368 400 Poorest four 36% 19% 25% 52% 31% 40% Good classrooms (%) deciles 350 Teachers with bachelor degree 86% 84% 86% 94% 93% 94% -3 Index socio 0 (%) economic conditions Student-teacher ratio 19 15 17 19 14 17 District size (students) 155,521 111,966 127,728 60,924 32,238 41,293 ‘A’ accreditation (%) 35% 13% 21% 55% 14% 34% Source: www.unesco.org Source: Dapodik 2017. ASPIRING INDONESIA 179 HOW TO EXPAND THE MIDDLE CLASS: 1 Improving the available information to allow for more #34 comprehensive analysis and informed decision-making. #25 Better decision-making in the education sector requires better information on resources used in the sector and data on the results posted by students. The quality of data on spending #07 (by levels of government, by education function and level, and by type of spending) should also be improved. Meanwhile, performance data, for example student results from the national test, should be socialized to local governments and then used subsequently to set education sector priorities. 2 Spending on teachers’ salaries and allowances has risen sharply in recent 03 years but this has not been associated with similar gains in learning Recommendations outcomes. Overall, teacher compensation, including teacher base salaries and special allowances, represents about 49 percent of the Indonesia’s education system has seen significant improvements total education budget, but the relationship between teacher over the past 15 years, mostly in expanding access to secondary payments and student results is weak. It will therefore be education. However, for the education system to deliver its full promise important for the MoEC: to Indonesian students, especially those in the aspiring middle class, and fulfill the requirements of a growing and modernizing economy, major To update the existing Teacher Performance Management System improvements in student learning outcomes will be essential. to more directly link teachers’ allowances (DAK-Profesi Guru) with competency achievements, continuous professional development As mandated by the Constitution, while the government now allo- (CPD) and classroom performance. cates 20 percent of its budget to education, there is evidence that the efficiency in the use of these resources is low.133 The following To commence a rigorous teacher re-certification process to ensure recommendations would help to improve the overall efficiency of the that certification is more directly linked to the achievement of key education system and thereby help to provide better opportunities to professional competencies, and that periodic re-certification becomes all Indonesians, especially those in the aspiring middle class. a condition for teachers to continue to receive professional allowances and opportunities for further career progression. To provide greater support for teachers to benefit from CPD. To leverage and explore the opportunities for the scaling-up of existing initiatives. For example, KIAT Guru is a promising initiative that promotes community empowerment and pay-for-performance. Another example is the Regional Performance Allowance (Tunjangan Kinerja Daerah, or TKD) for teachers in DKI Jakarta. This enables teachers to receive an extra allowance that has a fixed allocation (70 percent) that is affected by presence, and a variable allocation (30 percent) that is affected by job functions and related variables. 133 World Bank (forthcoming). Spending Better: Indonesia Public Expenditure Review 2016-18. ASPIRING INDONESIA 180 SECTORAL DIAGNOSES & RECOMMENDATIONS 3 5 Student-teacher ratios in Early childhood education Indonesia are too low, reducing and development (ECED) the resources available for other should be improved and quality-improving interventions. expanded. The deployment of the teacher workforce should be maximized This will require the MoEC to increase the budget for ECED to by redistributing teachers within districts, and also across allow for an expansion in the coverage and unit cost of BOP districts and provinces. In order to do so: (School Operational Assistance Grants for ECED) based on Dapodik data linking the use of BOP to meeting national ECED Redistribute teachers across schools within districts. Districts standards. should identify oversupply and undersupply of teachers in their areas of jurisdiction and create a redistribution plan. Strengthening support to deliver quality early childhood education will involve the following: Redistribute teachers across districts and provinces. Develop and implement a mechanism to enable such a redistribution to take National level 01 Issue MSS as a basis for districts place. to allocate and manage resources. Standardize the recruitment process for non-permanent 02 Build district capacity to manage teachers. The MoEC and MenPAN should develop national services based on ECED MSS. guidelines for recruiting non-permanent teachers who can teach the main subjects and extracurricular activities. These guidelines should District level 01 Establish ECED units in Dinas cover the selection process, selection criteria, payment (payroll, and provide funding for staffing budget source), contract terms and other requirements. support. 02 Build the capacity of 4 Resources to schools supervisors (Penilik PAUD) should be distributed to conduct quality assurance based on equity, need visits to ECED centers. and performance. 03 Support the provision of Currently, the BOS program provides about Rp 40 trillion incentives and training for (roughly US$3 billion) to schools, but most schools do not community teachers. achieve their minimum services standards (MSS). Looking ahead, it will be important to link BOS allocations to equity, need and performance. One methodology used to achieve this Leverage Include ECED in the annual Dana Desa has been applied by DKI Jakarta since 2015, based on a formula Dana Desa as prioritization regulation (Ministerial comprising three components (Pergub No.59/2016): an alternative Regulation No. 22/2016, as amended by funding source Ministerial Regulation No. 4/2017) to support village planning to identify early Basic allocation Based on the number of students. childhood education centers as priority programs for investment from Dana Desa. Equity allocation Based on the school location/special needs. Performance Based on the improvement in results in the To ensure that all aspiring middle- allocation national exams. class Indonesians that reach 6 secondary education have the necessary conditions to learn, the mechanisms to guarantee education quality should be strengthened. In particular, school accreditation should be accelerated. ASPIRING INDONESIA 181 HOW TO EXPAND THE MIDDLE CLASS: 10.2 Indonesia is undergoing rapid demographic, epidemiological and health-financing transitions that have major implications for the government’s 01 ambitions of achieving universal health coverage (UHC), providing greater financial risk protection Motivation from health shocks, and promoting inclusive and sustainable economic growth. Achieving Demographic transition 134 As the fourth-most-populous country in the world, and one that has yet universal health to complete its demographic transition, Indonesia’s human capital po- tential is substantial, with about 28 million new entrants expected to join the workforce between 2015 and 2030. In the “economic miracle” coun- coverage tries of East Asia in the period 1960-90, the demographic dividend—the period of economic growth driven primarily by the increase in the share of the working-age population—contributed between one-third and 44 percent of economic growth (Bloom & Williamson, 1998). However, these benefits are not automatic. They are dependent upon substantial investments in expanding the delivery of education and health-care services to produce a healthy, educated and productive workforce. A second important feature of the demographic transition is that Indonesia is also rapidly aging—with the share of population aged 65 years and older expected to double from 5 to 10 percent between 2015 and 2030 (United Nations , 2015). Attaining and sustaining UHC in the context of such rapid aging will also put pressure on public budgets trying to deepen coverage and transform a health-care system that is ill-equipped to deal with the long-term health-care needs of older patients. Epidemiological transition Non-communicable diseases (NCDs), including complicated co-mor- bidities, are now exploding among middle-aged Indonesians, due to unhealthy lifestyle choices and health systems that are underfinanced, and unprepared to diagnose, treat or adequately manage chronic con- ditions. Whereas in 1990 only 37 percent of morbidity and mortality 134 In general in Indonesia was due to NCDs, they now account for the largest share terms, the of the burden of disease (67 percent in 2016), with strokes, heart dis- demographic transition is a ease, depression and diabetes among the most prevalent conditions. shift from high The 2016 Indonesia Quantitative Service Delivery Survey reported low levels of mortality service readiness for NCD services at primary health-care facilities, and fertility to low levels of particularly for cardiovascular and chronic respiratory diseases. Only mortality and 5 percent of Puskesmas (public primary health-care facilities) and 3 fertility in a percent of private primary health-care facilities met all cardiovascular population. ASPIRING INDONESIA 182 SECTORAL DIAGNOSES & RECOMMENDATIONS 327 02 Diagnosis disease service readiness tracers (guidelines and training, equipment Out-of-pocket health expenditures remain a dominant source of and medicine), while for chronic respiratory diseases, only 1 percent of health financing because the generous benefits provided under Puskesmas and not a single private primary health-care facility met all JKN are unaligned with the level of resources available. In 2015, tracers. Estimates of lost GDP from NCD deaths, absenteeism and loss of government health expenditure was 1.1 percent as a share of GDP and 5.7 productivity due to illness in Indonesia is expected to rise from US$34.1 percent as a share of government expenditure, amounting to just US$38 billion (4.8 percent of GDP) in 2010 to US$113.6 billion (5.5 percent of per capita. This level of government spending on health is well below GDP) in 2030 (Sweeney, Rasmussen, & Sheehan, 2015). regional and lower middle-income country averages, with a recommend- ed benchmark of US$86 per capita needed for low and middle-income Health financing transition countries to be able to deliver a limited set of key health services (Ta- In nearly all countries, growth in incomes is accompanied by growth ble 10.2). This low level of health spending in Indonesia contributes to in total health expenditure—particularly through pre-paid or pooled facilities often lacking trained staff, equipment, diagnostic capacity mechanisms—and a decrease in out-of-pocket (OOP) spending as a and the medicines needed to deliver basic services. This, along with an share of total health expenditure. This is usually accompanied by an open-ended benefits package, has limited the expansion of cost-effective increase in government health expenditures as a share of total health interventions with the universal health service coverage index—defined expenditures, and as a share of GDP. Meanwhile, access to develop- as the average coverage of tracer interventions for essential UHC—at ment assistance falls as eligibility criteria are frequently tied to income just 49 percent (Figure 10.6). thresholds. These two trends are sometimes referred to as the “health financing transition”. However, Indonesia has struggled to manage this transition smoothly and build health-care financing systems that provide UHC—that is, affordable access for all to quality health-care services. In 2014, it introduced Jaminan Kesehatan Nasional ( JKN)—the sin- gle-payer social health insurance scheme providing a generous benefits package—and committed to fully rolling out UHC by 2019. However, despite rapidly expanding coverage to more than 70 percent of the pop- ulation, OOP expenditures remain significant (Table 10.2). There are also wide variations in health outcomes across districts, especially in hard-to-reach areas. ASPIRING INDONESIA 183 HOW TO EXPAND THE MIDDLE CLASS: TA B L E 10.2 Health expenditure in Indonesia and selected countries, 2015   Govt. health Govt. health Govt. health Govt. health Social Health External financing OOP expenditure expenditure as % expenditure as % expenditure per expenditure as % Insurance as % of as %THE as % of THE GDP of budget capita (US$) of THE THE China 3.1 10.4 234 55.8 12.2 0.0 32.0 Indonesia 1.1 5.7 38 37.8 15.2 1.1 47.0 Lao PDR 0.9 3.4 16 50.5 10.5 31.8 39.0 Malaysia 2.3 6.5 252 55.2 9.8 0.0 35.0 Philippines 1.6 10 46 34.3 11.7 1.4 54.0 Thailand 5.6 23.3 310 86.0 6.0 0.0 8.0 Vietnam 3.8 14.2 77 54.1 8.9 2.7 37.0 EAP 5.1 12.5 674 69.3 6.7 20.7 24.0 LMIC 3.3 10.1 81 54.4 7.6 14.4 38.0 Source: World Bank (2017). World Notes: THE=total health expenditure; Development Indicators. OOP=out-of-pocket; EAP=East Asia Pacific; LMIC=Low and Middle Income Countries Underinvestment in health is further 02 The lack of performance-orien- 03 Poor coordination among key in- compounded by weak governance and tation in health-care financing makes ac- stitutions also leads to the duplication of accountability, as well as JKN design is- countability difficult. On the supply side, tasks and a lack of overall accountability sues that significantly undermine service Dana Alokasi Khusus (DAK)—the main sup- for the sector. On the one hand, there are con- delivery. Persistent regional inequalities in ply side inter-governmental fiscal transfer that flicting guidelines for service delivery, quality access to primary health care, poor quality is earmarked for health—is linked partly to standards and referral protocols set separately of care at Puskesmas and private sector pri- need but not performance, resulting in a wide by the MoH and BPJS. On the other hand, there mary health-care facilities, and a ballooning variation in facilities’ ability to deliver services. is no clarity from either institution on who is Badan Penyelenggara Jaminan Sosial (BPJS) On the demand side, the current provider pay- responsible for monitoring and ensuring pro- deficit—the JKN fund administrator—all find ment arrangements and infrequent supervision vider performance. As a result, health workers root in system-wide weaknesses in governance under JKN give little incentive to increase the often find themselves without the means, skills and accountability, as well as JKN design issues quantity and quality of care. In the absence of and incentives to deliver health services to the that handicap performance on the ground. In a strongly enforced or monitored ‘gatekeep- population. particular, these systemic weaknesses com- ing’ system, primary care providers have an prise the following: incentive to refer patients unnecessarily to 04 JKN design features hinder the the hospital sector and under-deliver outreach quality of health expenditures. A com- 01 Fragmented health information services, avoiding expensive treatment that prehensive benefits package with no caps or systems and the absence of a formal mech- would come out of their fixed or ‘close-end- co-payments, short waiting periods to access anism to coordinate and consolidate infor- ed’ operating budgets. In a weakly monitored services following enrolment, low collectabil- mation on health resources, the cost and hospital sector, and a lack of a ‘close-ended’ ity of premiums among the informal sector, use of health services, and health outcomes hospital budget, hospitals are incentivized to and provider payment rates that do not cover across the tiers of government (i.e., cen- both treat more patients as well as ‘up-code’ to the full cost of services, have led to the implicit tral, provincial and district) and the various charge codes that have higher payment rates rationing of health services, adverse selection ministries, departments, and agencies (i.e., and discharge patients early for later re-admis- among the informal sector, and a growing the Ministries of Health, Home Affairs, Na- sion. This has important policy implications, budgetary deficit that threatens the financial tional Development Planning [Bappenas] and not only because the cost of treating simple sustainability of the JKN scheme. Finance, as well as BPJS Health) responsible cases in hospital settings is significantly higher, for the delivery of health services. This frag- but also because primary health-care services mentation limits the ability of the Ministry of become under-utilized and tertiary hospitals Health (MoH) to effectively oversee the sector overburdened, not to mention the avoidable as a whole and target limited resources to the disease progression in individuals due to a lack interventions and populations that would ben- of early diagnosis and treatment at the primary efit the most. care level. ASPIRING INDONESIA 184 SECTORAL DIAGNOSES & RECOMMENDATIONS FIGURE 10.6 Coverage of key cost-effective interventions Mongolia UHC-service coverage index (40,50) (50,60) China (60,70) (70,80) Myanmar Laos Thailand Philippines Vietnam Cambodia Malaysia Indonesia ASPIRING INDONESIA 185 HOW TO EXPAND THE MIDDLE CLASS: 1 Increasing and diversifying the sources of #34 revenue for a sustainable and equitable system. The government needs to increase government health #25 expenditures to benchmark itself against countries of similar economic status, especially those that have progressed further #07 along the path to achieving UHC. This would depend upon tax system reforms to raise tax revenue as a percentage of GDP and further prioritization of health in the overall budget. New revenue sources from increased taxation of tobacco and alcohol products, specifically earmarked for the health sector, should be pursued. While voluntary contributions to social health insurance (SHI) can provide a large and stable revenue base, the expansion path is slow and also dependent on the capacity to enforce contributions from the informal sector 03 universal (Cotlear, Nagpal, Smith, Tandon, & Cortez, 2015). Recommendations Typically, countries similar to Indonesia that have chosen a voluntary contributory path (as opposed to non-contributory tax-financed systems) have needed to supplement insurance contributions with tax-based financing that pays for poor and vulnerable groups, and heavily subsidize contributions from the Achieving UHC, providing greater financial protection, and pro- informal sector. moting inclusive economic growth will require not only that the government spends more on health but also spends it on the right Targeting limited resources to 2 interventions, and in a more effective way. The most impactful com- bination would be if it does this together, i.e., increase government cost-effective health services and spending on health in combination with health systems reform. In par- underserved populations, improving ticular, this could be achieved through the following: the quality of service delivery, and introducing integrated care. Indonesia will need to focus its limited resources on targeting the most cost-effective interventions, such as preventive and promotive interventions delivered at the primary health-care level (promoting healthy behaviors, strengthening primary prevention, such as immunization, and early diagnosis, management and treatment of risk factors and diseases). In addition, there is a need to improve the quality of service delivery, both in public and private facilities. There is also an urgent need to strengthen the preparation and implementation of national procedures, guidelines and standards to reduce inappropriate or low-value care, prevent avoidable costly adverse effects, decrease operational waste, and improve clinical and managerial performance. The recently introduced primary care accreditation system is a first step in this direction. There is also a need to ensure equitable access to quality services across Indonesia, especially in the eastern islands of Indonesia. Finally, with the increased burden of chronic diseases such as NCDs, compared with the episodic care required for acute illnesses, this will also require transforming service delivery models that integrate and coordinate care across different care providers (such as hospitals, single specialty centers, diagnostic facilities and home-based care), Right While access may be high, most while placing primary care in a central ‘gate-keeping’ role that local health connects all these various providers. centers struggle to provide basic care facilities. ASPIRING INDONESIA 186 SECTORAL DIAGNOSES & RECOMMENDATIONS Improving JKN design 3 and implementation to ensure fiscal sustainability of JKN and improve provider performance. First, this will entail defining an explicit benefits package and target population that is commensurate with available resources, through a systematic and transparent process for prioritizing interventions. Second, it will also involve building government capacity to identify the incentives that encourage private sector engagement, while also ensuring public sector interests. Third, it will require designing provider payment systems that incentivize and reward performance. This will need to include inter-fiscal transfers from the national to subnational governments, for example through designing DAK fisik and DAK non-fisik to be more results-oriented. Fourth, strengthening the purchasing functions of BPJS, such as contracting (especially those that link the payment of individual providers or institutions to improved performance— coverage, quality of care, and efficiency), performance monitoring, the processing and payment of claims, and auditing, will be required. Finally, similar incentives that reward institutional and provider performance should be introduced in the DAK. Investing in the 4 institutions, systems and processes that hold the health-care system together. This will include strengthening of the public sector management functions for health, including encouraging planning and budgeting that link inputs to outcomes, strengthening health management information systems that could be used to benchmark performance, and improving budget execution and other financial management functions, such as procurement, financial reporting, internal controls, and audits. There is also a need for better human resource management for the public sector, including improvement of managerial and clinical competencies and skills, as well as enabling a more equitable distribution of human resources for health. ASPIRING INDONESIA 187 HOW TO EXPAND THE MIDDLE CLASS: 10.3 01 Motivation Undertaking Indonesia’s level of central government public expenditure is insuf- ficient to build and serve a growing middle class. At 14.6 percent of taxation reform GDP in 2017, central government spending is less than half the average of other emerging markets, which was 35.4 percent in 2016 (Figure 10.7).135 Without increasing the level of spending and improving the quality of that spending, Indonesia will struggle to provide the services that are necessary to build and serve a growing middle class, namely health, education, housing and social insurance (Figure 10.8). Tax reform will require the middle class to pay more taxes and this will need to be in exchange for wider access to better quality services. Tax reform will mean that the aspiring middle class and the middle class will be required to pay more taxes, but the premise of rais- ing more revenues is to allow the government to spend more on priority services that will build and serve the growing middle class. To use Albert Hirschman’s categories, two outcomes are possible: voice or exit.136 If the middle class trusts the government to work for it, then it will voice its demands and agree to pay taxes in exchange for better-quality ser- vices. If the middle class distrusts the government, it will seek to exit from government services, and also taxation, at great cost to the large population segments of poor and those who aspire to join the middle class but who need good quality government services to do so. Indonesia can collect more and spend more and better in order to build trust in government and give a growing voice to its middle class. 135 IMF Fiscal Monitor: 136 Albert O. Hirschman, 138 Total revenues fell by 140 For more, see “Policy October, International Exit, Voice and Loyalty: about 1.6 percentage points Brief: The Economics of Monetary Fund. The average is Responses to Decline in Firms, of GDP in 2014-15 due to the Tobacco Taxation and calculated using 39 emerging Organizations and States, oil price collapse. For more, Employment in Indonesia,” markets excluding Indonesia. Harvard University Press see Box 4, Indonesia Economic The World Bank (2018, For more analysis on how (1972) Quarterly: Decentralization forthcoming). Indonesia can spend more and that delivers, World Bank better to support growth, see 137 IMF Fiscal Monitor: (December 2017). “Collecting more and spending October, International better for inclusive growth,” Monetary Fund. The average is 139 Prior to January 2014, Indonesia Economic Quarterly: calculated in the same way as this threshold was at Rp 600 Towards Inclusive Growth, above. million. World Bank (March 2018) ASPIRING INDONESIA 188 SECTORAL DIAGNOSES & RECOMMENDATIONS FIGURE 10.7 Indonesia’s level of public expenditure is relatively low… 60 General government spending, percent of 50 GDP, 2016 BRAZIL 40 327 30 MALAYSIA 20 COLOMBIA PHILIPPINES THAILAND 10 02 INDONESIA 0 Diagnosis 8 9 10 11 12 log GDP per capita in 2011 PPP Source: Indonesia Economic Quarterly, World Bank (March 2018); Insufficient spending is primarily due to low government revenues, Data from IMF Fiscal Monitor. which are driven by low tax collections. Although higher spending on areas that build and serve the middle class can be financed by reallocat- ing expenditures from lower priority areas, notably subsidies, such real- FIGURE 10.8 …which means spending on priority areas does not meet government location will not be sufficient to meet the needs of a growing middle class. needs (Percent of GDP) Indonesia will simply need to collect more. Indonesia’s revenue-to-GDP ratio is low, at just 12.2 percent in 2017, compared with an emerging economy average of 27.8 percent137 (Figure 10.9). Tax collections are Current level of spending lower than both regional peers and countries with similar levels of GDP Estimates level of spending per capita (Figure 10.10). Moreover, annual tax collections as a share of GDP have declined every year since 2013, reaching 9.9 percent in 2017 Health Social Assistance Infrastructure, (according to preliminary realization data). The declines are partly due incl. housing to cyclical factors, most notably the fall in commodity-related revenues after the oil price collapse in 2014.138 4.9 To increase revenue collections, Indonesia can collect more taxes on goods and services. Indonesia collects about the same share of GDP in VAT as Thailand and Malaysia, despite having a rate that is 30 and 40 percent higher, respectively. This is in part because too few firms have to pay VAT. According to government regulations, manda- tory filing for the purposes of charging value-added tax (VAT) is only required for businesses with annual gross turnover in excess of Rp 4.8 billion.139 For businesses with turnover below this threshold, registra- 2.3 2.4 tion and filing is voluntary. Compared with international standards, this threshold relative to real GDP per capita is the highest in the world (Figure 10.11). This high VAT threshold is combined with a policy of 1.4 allowing many goods and services to be exempt from the VAT regime. Moreover, some goods and services consumed by Indonesians that have 1.1 negative externalities on both health and the environment are taxed at 0.6 lower rates than in many other countries. A stark example is tobacco, where Indonesians consume more cigarettes than in most countries in the world (Figure 10.12). While taxes on tobacco have increased incre- mentally in recent years, the current tax burden on tobacco is still lower Source: Indonesia Economic Quarterly, World Bank (March 2018); than many countries and is insufficient to have any significant impact Data from Ministry of Finance. on consumption levels.140 ASPIRING INDONESIA 189 HOW TO EXPAND THE MIDDLE CLASS: FI G U RE 10.9 Indonesia suffers from low revenues FIGURE 10.11 Indonesia’s VAT registration threshold as a share of real per capita GDP is the highest in the world (VAT threshold as a share of GDP per capita) 60 General 100 government revenue, 90 percent of 50 80 GDP, 2016 70 40 60 SOUTH 50 AFRICA PHILIPPINES* 30 40 INDONESIA SINGAPORE 30 MALAYSIA MALAYSIA THAILAND PHILIPPINES VIETNAM 20 20 THAILAND 10 PERU 10 SINGAPORE 0 INDONESIA Notes: GDP per capita is 2016 PPP; Philippines ratio is 0 calculated using the threshold of PHP 3 million, which only 8 9 10 11 12 came in effect in January 2018; previous threshold was PHP 1.9 log GDP per capita in 2011 PPP million; Vietnam has no minimum VAT threshold. Source: Indonesia Economic Quarterly, World Bank (March 2018); Source: Indonesia Economic Quarterly, World Bank (March 2018); Data from IMF Fiscal Monitor. information on VAT thresholds from vatllive.com. FI G U RE 10.10 Tax collections are lower than both FIGURE 10.12 Indonesia has one of the highest regional peers and countries with cigarette consumption levels in the similar GDP per capital world, with the highest smoking (Percent of GDP) prevalence for adult males 40 Total Revenues Country Adult male smoking prevalence (%) Total Tax 35 67% Indonesia INDONESIA'S T A X 30 RATIO IN 20 1 5 : 10.75 (68.1% in 2016) 25 Russian Federation 61% 20 Bangladesh 58% 15 China 53% 10 51% Greece 5 50% Ukraine 0 Philippines 49% INDONESIA MALAYSIA PHILIPPINES THAILAND VIETNAM PERU AFRICA Turkey 48% India 48% SOUTH Notes: Data are for 2015. Total revenues include social security Source: Table from “The Economics of Tobacco Taxation and contributions. Total tax excludes social security contributions Employment in Indonesia: Policy Implications A Technical Brief”, but includes taxes from resources. World Bank (May 2018). Data sources used in table: Asma S, Mackay J, Song SY, Zhao L, Morton J, Palipudi KM, et al. 2015. Source: ICTD GRD. The GATS Atlas. CDC Foundation, Atlanta, GA. ASPIRING INDONESIA 190 SECTORAL DIAGNOSES & RECOMMENDATIONS FIGURE 10.1 3 Most of the middle class is exempt from paying PIT…(Percent) PTKP PTKP 2013-15 2017 88.4 6.0 3.2 MC3 2.4 MC2 NON-EXEMPT MC2 EXEMPT MC1 Notes: PTKP refers to the non-taxable income tax threshold. For FIGURE 10.14 leading to low personal income tax 2017, this was set at Rp 54 million, whereas in 2015, it was revenues (Share of income taxes Rp 24.3 million. coming from taxes on income, profits Source: World Bank staff calculations. and capital gains of individuals, percent) The government has an opportunity to collect more taxes and significantly broaden the personal income tax regime, which cur- 2011 2012 2013 2014 rently excludes about 98.8 percent of citizens. In 2015, the annual 80 non-taxable income (PTKP) threshold for personal income tax (PIT) was 70 Rp 24.3 million. This threshold implies that about 66.2 percent of the OECD AVERAGE 60 middle class were exempt from paying any PIT, although this threshold 50 was increased by 48.1 percent YoY in 2016 to Rp 36.0 million, and by a further 50.0 percent YoY in 2017, to reach Rp 54.0 million. A high PTKP 40 threshold narrows the tax base of the income tax regime. As a result, 30 only about 15 percent of employed workers have an obligation to file 20 income tax returns, compared with rates of 50 percent or higher in many 10 advanced economies.141 For the middle class, the high PTKP threshold INDONESIA means that 94.4 percent of them are exempt from paying PIT: the entire 0 AMC and MC 1, and 65.4 percent of MC 2 (Figure 10.13). This, in turn, Notes: The percent of income taxes coming from income, profits is one factor behind the lower contribution of PIT to total income taxes and capital gains of corporates is 100 percent, less the shares depicted in this chart. in Indonesia relative to other countries (Figure 10.14). Source: OECD; World Bank staff analysis. Adding more taxpayers to the tax base will not only generate great- 141 Data on composition of UK 1989); and Richard er revenues but will also have the benefit of increasing account- the number of tax revenues,” A. Musgrave, ability and the demand for services by the middle class, as more of Indonesians with Institute of Fiscal “Schumpeter’s obligation to file Studies Briefing crisis of the those in the middle class start paying taxes. The link between taxes, come from the Note BN182, 2016. tax state: an increased accountability and better services is well-established in the Directorate General essay in fiscal academic literature.142 A conventional political-economy explanation of Taxes for 2016; 142 Notable work sociology,” Journal data on the number of Evolutionary is that tax-reliant governments are compelled to bargain with citizens, in this area of employed workers includes: Douglass Economics (Vol. buying quasi-voluntary tax compliance in return for more accountable in 2016 come from 2, Issue 2, June C. North and Barry and democratic institutions, and/or policy concessions, such as increased the National Socio- R. Weingast, 1992). For more Economic Survey recent literature, services. “Constitutions (Susenas). In the and Commitment: see for example: UK, as one example The Evolution Lucy Martin, As the size of the middle class grows and as more middle-class cit- of comparison, 56.2 of Institutions “Taxation and percent of the Accountability: izens grow wealthier, so will their capacity to pay taxes. Expanding Governing Public adult population Choice in Experimental the tax base to include more of the MC and the AMC encourages citizens (that is, both Evidence for Seventeenth-Century who will not contribute much tax revenue today to grow accustomed to, workers and non- England,” The Taxation’s Effect workers) paid tax on Citizen and develop a habit of, paying taxes. As these citizens grow wealthier in Journal of Economic in 2015-16. See History (Vol. XLIX, Behavior,” Yale line with the continued growth of the Indonesian economy, so will their “The changing University (May 12, No. 4, December contributions to tax revenues in the future. 2013). ASPIRING INDONESIA 191 HOW TO EXPAND THE MIDDLE CLASS: #34 #25 #07 03 Recommendations Reform of the Indonesian tax system should focus on broaden- ing the tax base and raising rates for select taxes. However, these policy reforms will also require significant investments in tax ad- ministration capacity. Plausible tax-broadening measures include lowering the VAT registration threshold and replacing the non-taxable income threshold (PTKP) with tax credits for taxpayers who are poor or vulnerable. Other needed tax policy reforms include increasing taxes on alcohol, tobacco and vehicles, and introducing more environmental taxes, such as on plastic bag consumption. The enabling factor for suc- cessful policy reforms will be improving the tax administration capacity of the Directorate General of Taxes (DGT) and facilitating a high degree of voluntary compliance.143 Currently, DGT continues to rely heavily on paper filing due to limited IT capacity and staff expertise, while busi- ness processes for registration, filing and payment remain too complex. Moreover, current regulations require that all business requests for VAT refunds are audited, creating an undue burden on DGT and delays for businesses receiving back their VAT refunds.144 To increase tax admin- istration capacity, DGT requires significant investment in IT capacity, as well as reforms of human resources and business processes.145 Moving to a risk-based approach for auditing VAT refunds is a critical compo- nent.146 A major cultural shift at DGT will also be needed—one that entails treating taxpayers as consumers and setting targets on regular improvements in the ease with which citizens can pay their taxes.147 143 It is recommended that in “Indonesian Pocket Tax Book system, as part of a broader 147 Efforts to shift behavior a comprehensive compliance 2017” PricewaterhouseCoopers transformation of business of citizens through ‘nudges’ improvement plan be designed (2017) pp 91-97 processes and organizational – small changes in how that includes all these reform. governments operate – will features. For more on this, 145 DGT’s existing IT systems help, as evidence from other see Russell (2010). are out of date and much of 146 For more on this, see countries show. For more on the revenue administration Khwaja, M. S., R. Awasthi and the impact of behavioral 144 For more on rules regarding remains reliant on paper. To J. Loeprick. 2011, “Risk- initiatives on improving VAT audits, see: ‘Tax Audits address this, the government Based Tax Audits: Approaches tax compliance, see Kettle, and Tax Assessments’ chapter plans to procure a commercial and Country Experiences,” The Hernandez, Ruda and Sanders off-the-shelf (COTS) IT World Bank (2011) (June 2016). ASPIRING INDONESIA 192 SECTORAL DIAGNOSES & RECOMMENDATIONS Above Regional governments are responsible for delivering many of the key public services that affect the quality of life of Indonesia’s aspiring middle class, including health, education, and water and sanitation. ASPIRING INDONESIA 193 HOW TO EXPAND THE MIDDLE CLASS: 10.4 01 Motivation Strengthening Regional governments are responsible for delivering many of the key public services that affect the quality of life of Indonesia’s as- regional piring middle class, including health, education, and water and sanitation. This is especially so in rapidly expanding urban areas, where those in the middle class and aspiring middle class are most likely to live. government The quality of regional government service delivery, and the ability of regional governments to meet the changing needs of an aspiring middle service delivery class, depend in very large measure on central government policies. These policies are, in particular, related to the financing of subnational governments, the regulatory framework that enables and constrains them, and the incentive framework for encouraging better service de- livery performance by regional governments. Right Many local health facilities do not have the necessary equipment or training to provide basic care or key services, even in urban areas where most of the middle class live. ASPIRING INDONESIA 194 SECTORAL DIAGNOSES & RECOMMENDATIONS 327 02 Diagnosis population—districts with large populations have significantly lower Rebalance the allocation of fiscal revenues per-capita than districts with smaller populations. transfers to address growing needs in urban areas The largest districts population-wise in Indonesia are the ‘dormi- tory kabupaten’—districts that are being absorbed into rapidly The fiscal capacity of district governments to address service de- growing metropolitan cities. These districts are absorbing most of livery can be measured by the per-capita revenues available to the population increase that rapid urbanization brings and they also them from all sources to deliver services. In almost all countries, have the largest infrastructure gaps. This is because they started with the per-capita fiscal need of different local government jurisdictions is a relatively low stock of urban infrastructure when they were still rural affected by factors including the demand for public services, and the areas, but now need to provide urban standard infrastructure to address diseconomies of scale involved in delivering services in more remote and the agglomeration effects of their rapidly expanding populations. sparsely populated locations. The purpose of fiscal equalization arrange- Addressing the imbalance in distribution of per-capita revenues ments is to ensure that different subnational jurisdictions are in a similar will require fundamental changes to several formulae embedded fiscal position—taking into account their different per-capita needs—to in intergovernmental financing arrangements. The most import- deliver a similar range and quality of public services to their citizens. ant of these will be changing the DAU formula. This formula should However, the spread of per-capita total revenues across districts in Indo- be revised to remove the basic allocation—which funds the district nesia varies much more than is the case in other countries—even coun- governments’ wage bills and encourages fiscally unsustainable district tries with highly variable per-capita needs across jurisdictions. To take hiring practices—and to shift to a ‘per client’ norm as the basis for equal- an example, Australia has what is considered one of the most equalizing ization. Other formulas based on similar ‘per region’ norms include the intergovernmental financing systems in the world, and the spread of formula for distributing the village fund (Dana Desa) and the formula per-capita revenues varies 2.5 times between Victoria—a geographically for measuring the relative fiscal capacity of districts. These changes small, mainly urban state with a large population—and the Northern pose political-economy challenges because increasing the transfers of Territory—a very small population spread over a large and remote land some districts axiomatically involves reducing transfers to other dis- area, and significant social needs among its population. By comparison, tricts. These challenges need to be managed with a carefully designed across Indonesia’s districts the spread of per-capita revenues is almost 40 transition strategy. times. Meanwhile, Nigeria—considered a highly unequal country—has a spread of 17 times, and Peru—an international outlier—is 21 times. Ensure that institutional and The main reason for these imbalances in Indonesia is the formula financing mechanisms facilitate for the distribution of the Dana Alokasi Umum (DAU), the main regional governments to address equalizing intergovernmental transfer that is supposed to equalize infrastructure gaps these biases. The formula is based on an assumption that all districts have the same absolute needs to provide services to their citizens, re- Today’s Indonesia is a highly decentralized country, in which most gardless of the size of their populations. The effect of the formula is urban infrastructure is the responsibility of regional governments. that total per-capita revenues are highly correlated with total district As Indonesia’s urban areas expand, infrastructure needs (roads, water, ASPIRING INDONESIA 195 HOW TO EXPAND THE MIDDLE CLASS: sanitation and flood mitigation, in particular) become more complex, the asset to regional government control after it has been constructed. while connective infrastructure such as public transport becomes in- This is the model that has been preferred up to now. This approach has creasingly important. It falls to regional governments—and mainly to the advantage of mobilizing central government line-ministry capacity district governments—to address these challenges. to design and procure complex infrastructure, but it has very significant drawbacks in terms of sustainable management of the infrastructure. Three impediments undermine the capacity of Indonesia’s region- In the case of solid waste projects, for example, the lengthy delay in the al governments to respond adequately to address infrastructure transfer of assets to regional government control means that regional gaps: (i) sustainable sources of financing for medium-sized infra- governments cannot properly finance the recurrent operational costs structure projects; (ii) mechanisms for cross-regional collabora- from their own budgets, resulting in expensive infrastructure lying unused. tion in service provision; and (iii) planning and asset management systems suitable for the needs of large cities. A preferable approach is to gradually shift responsibility for im- plementing infrastructure projects to local responsibility, financed 01 Sustainable financing for medium-sized infrastructure through large selective transfers. Dana Alokasi Khusus (DAK) has not proven to be a suitable vehicle for larger infrastructure provision, Around the world, the recurrent revenues of local governments are not least because of the limited mechanisms for holding regional govern- rarely sufficient to address the financing needs for medium-sized ments properly accountable for how they implement projects. Hibah, infrastructure. In most countries, city governments meet these needs which is designed as an output-based grant, provides more flexibility by borrowing, allowing the costs of infrastructure provision to be spread and accountability. At present, the incentives for line ministries to shift over the lifetime of the asset. In the absence of sufficient access to debt, resources off their budgets and into the hibah mechanism are not well- or if the infrastructure gap is too large, central government needs a aligned. The need for pre-financing by regional governments and the more targeted financing mechanism to selectively finance medium-sized challenges of obtaining local parliamentary approval for pre-financing infrastructure projects. limits the take-up of hibah by local governments. Two factors limit access to borrowing by regional governments. 02 Mechanisms for cross-regional service provision First, under Indonesia’s conservative subnational borrowing framework, subnational borrowing is limited to a low multiple of untied revenues. Since decentralization in 2001, a process of pemakaran, or dis- Low per-capita revenues not only hamper Indonesia’s regional gov- trict splitting, has resulted in the sub-division of districts from ernments from providing an adequate level of services, but they also the original 348 to 514 districts in 2014. Meanwhile, the number of compromise the ability of regional governments to borrow to finance provinces expanded from 28 to 34. At the same time, urbanization is medium-sized infrastructure projects that are more critical in urban driving a process of agglomeration, where districts increasingly func- settings. Second, annual total public-sector borrowing is limited to 3 tion as multi-district metropolitan areas. To achieve more efficient percent of GDP, which is distributed between the three levels of gov- and effective service provision, it should be possible to provide larger ernment. Central government borrowing leaves little scope for regional infrastructure for purposes such as water treatment, sewerage treat- governments to finance their infrastructure needs through additional ment, solid waste treatment, flood mitigation and mass transport across borrowing. multiple districts. In the absence of local debt as a source of financing for medi- um-sized infrastructure, central government will need to finance Although Law No. 23/2014 on Regional Autonomy authorizes this infrastructure itself. One option is to finance projects directly from cross-regional collaboration, it is not clear how this might be op- the central government’s budget through line ministries, transferring erationalized. Since all regional governments are financed on the as- ASPIRING INDONESIA 196 SECTORAL DIAGNOSES & RECOMMENDATIONS sumption that they have identical responsibili- ties, financing of cross-regional infrastructure Build systems to align regional provision is a particular concern. This could be incentives to improve, and robustly addressed through arrangements that allow measure, district government cross-charging of operating costs to those re- performance gional governments whose citizens receive the benefits of the infrastructure, or by improving tariff frameworks to allow some or all of the costs of infrastructure provision to be recov- ered directly from users through tariffs. 03 Public financial management systems suitable for implementing and managing complex assets Cities have very specific needs in terms Managing across levels of government is a so they can be held accountable; (ii) streamlin- of public financial management (PFM) challenge for all multi-level governments. ing the regulatory framework to enable rather systems. Spatial planning to ensure orderly The conventional approach to managing across than constrain them to deliver effectively; (iii) development is critical and helps to identify levels of government is dominated by a top- providing effective capacity-building to sup- the need for investment in public infrastruc- down approach in which highly prescribed port them to improve their performance; (iv) ture. Infrastructure in cities is usually larger, centrally-designed programs are specified providing rewards as incentives to improve; (v) more complex and has a longer lifespan, which in lengthy regulations and introduced to the increasing constructive interventions in cases in turn means more complex multi-year level of implementing staff through cascaded of poor performance; and (vi) stimulating more planning for capital investments, multi-year socialization programs. This top-down com- effective functioning of political markets, in project implementation, more complex pro- pliance-oriented approach is no longer a good which citizens choose leaders in a robust con- curement, and the need for multi-year asset fit—either with the political design of decen- test based on full information, with more trans- management planning. tralized government, or with the complex and parency focused on performance. Central to an increasingly heterogenous challenges of devel- improved focus on results (in place of upstream One-size-fits-all subnational PFM systems opment across Indonesia’s regions. controls focused on inputs and compliance) is are not addressing these needs. Regulato- more robust ways of measuring performance. ry reform is needed, as well as developing the A more effective approach to managing capacity of district (and city) governments across levels of government would be not 01 Measuring performance to implement these more complex manage- only to hold district governments more ac- ment systems. Capacity-building of third-tier countable for the results they deliver, but The focus of performance measurement governments in PFM is the responsibility also ensure that they have sufficient re- in fiscal transfers is currently limited to of the provinces, which in turn raises issues sponsibility and flexibility to deliver those performance in terms of inputs. These are about the capacity of provincial governments results. Achieving this transformation would measured in terms of the absorption of funds. themselves. involve six sets of reforms: (i) better defining However, performance should be more com- district governments’ expected performance prehensively defined and measured, not just in ASPIRING INDONESIA 197 HOW TO EXPAND THE MIDDLE CLASS: terms of inputs but also in terms of processes, 03 Responding to poor performance outputs and outcomes. District governments should be held accountable for results they While a great deal of information is now control. Independent survey data provide the being collected on local government perfor- best source of credible data, but only through mance, it is less clear how this information proxy indicators (for example, measures of is being used to drive better performance. enrolment may indicate how effectively edu- The Ministry of Home Affairs’ performance cation services are delivered but might also re- measurement system (Evaluasi Kinerja Penye- flect the take-up of private education services). lenggaraan Pemerintahan Daerah, or EKPPD) Ultimately, administrative data systems need allows action to be taken against local leaders to be improved, which will depend on higher who fail to perform, but this only focuses on standards of data governance and improved elected leaders and not on specific sectors. As mechanisms for independent verification. the World Development Report 2004 identi- fies, long-route accountability mechanisms 02 Reinforcing incentives through posi- (via electoral systems) should be comple- tive rewards mented by short-route accountability that strengthens the clients’ ability to hold service Fiscal transfers provide the most obvious providers accountable.148 In many countries, mechanism for rewarding well-perform- a range of graduated responses, including the ing district governments, but not the only imposition of a performance improvement plan one. Matching-funding conditions stimulate (identifying areas of performance weakness, local commitment and crowd in local funding. possible ways to improve, and monitorable Output-based grants, such as hibah, pay on the actions by the local government to strengthen basis of verified performance. The publication performance), is available to central govern- of comparative performance achievements of- ment authorities, as a way to respond to poor fers incentives for improvement and also pro- performance. vides citizens with evidence of their leaders’ effectiveness. 148 World Bank. 2003. World Development Report 2004: Making services work for poor people - Overview (English). World Development Report. Washington, DC: World Bank Group. Page 49. http://documents.worldbank.org/curated/en/527371468166770790/World- Development-Report-2004-Making-services-work-for-poor-people-Overview ASPIRING INDONESIA 198 SECTORAL DIAGNOSES & RECOMMENDATIONS #34 #25 #07 03 Recommendations 1 Rebalancing fiscal (iii) setting timelines in the next RPJMN for transition to full regional transfers government implementation of larger urban infrastructure projects, including solid waste, wastewater treatment and mass transport; and (iv) revising and reforming subnational PFM arrangements to provide simpler, more streamlined approaches that are adapted to the different In the short term, this should involve: (i) revising the formula for fiscal needs of large, medium and small district governments. capacity (which informs allocation of DAK and allocation of hibah) to 3 one that uses a per-capita transfer norm; (ii) developing and dissemi- Incentive framework nating advocacy materials on the impact of the current DAU formula on the equity of fiscal transfers; and increasing the proportion of the Dana Desa that is allocated on the basis of the formula. In the longer term, more challenging reforms might include: (i) revising Law No. 33/2014 to include a shift to a ‘per-client’ norm for the DAU formula; and (ii) in- In the short term, this should involve: (i) mandating the use of standard corporating into those revisions a more comprehensive approach toward data sources and indicators, and building in verification to address the transition that is better aligned with regional government incentives incentives to ‘game’ the data; (ii) establishing rewards and sanctions for districts’ collection of accurate data, and using data to inform de- 2 Financing urban cision-making; (iii) rationalizing the reporting requirements by local infrastructure governments to minimize the transaction burden and to ensure that data are not only useful but used; (iv) setting timelines in the next RPJMN for transition to full regional government implementation of larger urban infrastructure projects, including solid waste, wastewater treat- In the short term, this should involve: (i) reforming hibah as a more ment and mass transport; and (v) developing scope for greater results flexible instrument for selective financing of larger, multi-year infra- orientation in monitoring of DAK and Dana Desa. In the longer term, structure projects by regional governments, including better aligning more challenging reforms might include: (i) developing a framework for hibah with the incentives of both central ministries and regional govern- subnational data governance to improve the management and dissemi- ments; (ii) developing a new government regulation to operationalize nation of data on district service delivery that incorporates data quality cross-regional service provision, including addressing the challenges of assurance; and (ii) as part of the next RPJMN, developing a framework financing; (iii) building the capacity of provincial governments to super- for managing across levels of government that includes supervision, vise and support the development of subnational PFM capacity in larger support, capacity-building, and rewards and interventions to address urban areas; and (iv) introducing a PFM regulatory framework to ad- poor performance. dress the asset planning and management challenges of larger cities. In the longer term, more challenging reforms might include: (i) addressing limits on subnational borrowing through a more equitable distribution of the annual limit on public sector borrowing; (ii) expanding the scope for cities to raise revenue, including through additional sources of revenue; ASPIRING INDONESIA 199 ANNEX ASPIRING INDONESIA 200 ANNEX Annex A B Defining the Middle Class The Indonesian Poverty, Vulnerability and Economic Security Lines ASPIRING INDONESIA 201 ANNEX Defining Defining the Middle Class in A Absolute Income Terms ANNEX the Middle Class 149 Absolute and relative definitions are often used when the middle class is de- There Are Different Approaches to fined in terms of its income or consumption. Much of the existing literature Defining the Middle Class defines the middle class in absolute terms. This could be globally, across developing countries, or specific to a country. Kharas and Gertz (2010) provide an example of a globally defined and arbitrary middle class. They define “the global middle class as The size of the middle class, its characteristics and the those households with daily expenditures between US$10 and US$100 per person in roles it plays depends on how it is defined. There are purchasing power parity terms” (p.3) and estimate the size of the middle class in 145 many ways of thinking about the middle class, in terms countries which account for 98 percent of global population. Using this definition, of income, consumption patterns, occupational status, or they estimate the world’s middle class as around 28 percent, with the poor and the even by using self-identification. Furthermore, there are rich at 70 percent and 2 percent respectively. different approaches to defining the middle class, namely the use of absolute income/consumption definitions, rel- Other use global benchmarks to set absolute middle-class thresholds. As ative income/consumption definitions, behavioral-based Kharas and Gertz (2010) do, Milanovic and Yitzhaki (2002) divided the world popu- definitions and vulnerability/economic security-based defi- lation into the rich, the middle class, and the poor. The middle class here is between nitions. This section reviews each approach and proposes US$4,000 (Brazilian average income, or US$11, which is also around the poverty an income/consumption-based definition grounded in the line in the US and Germany) and US$17,000 (Italy’s average income) in 2000 PPP concept of economic security. terms. They estimate that 11 percent of the world is rich, 78 percent poor, and only 11 percent of people are ‘world middle class’. In this section we consider four different approaches to defining the middle class: The Asian Development Bank (ADB) sets middle-class thresholds for the de- veloping East Asia region using both arbitrary and global benchmarks. The ADB (2010) defines the middle class as “those with per capita daily consumption 1 Arbitrary: based on arbitrary income or of US$2-20 in 2005 PPP US$” (p5). Under this definition, in 2008, 56 percent of consumption levels in absolute or relative developing Asia’s population, or nearly 1.9 billion people, were considered to be part terms. of the middle class.150 Meanwhile, the poor, defined as those living under US$2 per person per day represented 43 percent, and the high class, defined as those with per 2 Global Benchmark: measured by looking capita daily consumption more than US$20 per day only represented 1 percent of the at the cross-country distribution of Developing Asian population. The ADB further divides the middle class into three income or consumption, often with different groups: the lower-middle class, who consume between US$2 to US$4 per respect to developed country poverty day and are very vulnerable to slipping back into poverty; the middle-middle class lines. (US$4 to US$10), who live above subsistence and have some disposable income; and the upper-middle class, who consume between US$10 and US$20 per day, or 3 Behavioral: based either on occupational roughly the poverty lines of Brazil and Italy, respectively. status, or on household socioeconomic profile: consumption behavior, leisure Ravallion (2010) proposes two middle-class definitions for developing coun- activity, saving and investment, tries, based on global benchmarks, examining 116 developing countries employment, asset ownership, housing throughout the East Asia and Pacific, Eastern Europe, Central Asia, Latin status, education and health utilization, America, the Caribbean, Middle East, North Africa, South Asia, and Sub-Sa- use of social media, and so forth. haran Africa. He broadly defines the middle class as those who are not poor by developing country standards (household per capita consumption above the median 4 Vulnerability: taking vulnerability as poverty line of 70 developing countries, or US$2 a day at 2005 purchasing power economic insecurity, the middle class parity) but still poor by developed country standards (below the US poverty line of as those who are safe from falling into US$13 a day). Under this definition, Ravallion finds one in three people in devel- poverty and vulnerability. oping countries was middle class in 1990, rising to one in two by 2005; most of the additional 1.2 billion people joining the middle class over this period came from Asia The rest of the section discusses the literature on each generally (four-fifths) and China in particular (half). Ravallion also adopts a nar- in more depth, and Table A.1.1 summarizes these ap- rower definition which increases the lower bound to US$9, meaning a middle-class proaches. person would not be below the poverty line in any developing country. Under much ASPIRING INDONESIA 202 ANNEX stricter definition, only 100 million of the 1.2 also discretionary goods and services” (p27) billion additional middle class broadly defined as those with annual net income of more than would still be considered newly middle class. US$3,600 in 2005 PPP, having 45 million mem- bers in 2010, potentially rising to 135 million by Banerjee and Duflo (2008) examine abso- 2030. This increase of 90 million would be the lute measures across countries and asso- largest increase in the world outside of China ciate them with relative measures in de- and India. Moreover, they find “the global con- veloping countries. They use two alternative suming class will increase by 1.8 billion in the absolute measures of the middle class, those next 15 years, of whom more than 75 percent with daily per-capita expenditures between are likely to be in Asia” (p.4). US$2 and US$4 and those with daily per capita expenditures between US$6 and US$10. In all Finally, an absolute threshold can also be 13 of countries that they analyzed, “except for based not on global poverty line bench- the rural parts of India, Pakistan, and Panama, marks but grounded in the concept of the US$2 to US$4 per day category comprises economic security. The World Bank (2013) between 23 and 40 percent of the population, report on Economic Mobility and the Rise of and is primarily composed of those between the Latin American Middle Class sets an in- the 20th and the 80th percentile of income” come threshold of PPP US$10 per day as a (p.5), while the US$6 to US$10 group is small- lower-bound per capita household income, and er in most countries, and “those belonging to an upper bound at PPP US$50 for the middle 149 Taken from Wai- this group are above the 80th percentile of in- class. Thus, “according to these thresholds, a Poi et al. (2016). comes” (p.6). family of four would be considered middle class if its annual household income ranged between 150 Developing Asia Within Indonesia, management consul- USUS$14,600 and USUS$73,000” (p.2). The includes: Armenia, Azerbaijan, tancies have defined the middle classes in lower bound was set by examining panel data Bangladesh, absolute terms based on market size poten- in selected Latin American countries and de- Cambodia, People’s tial. BCG (2013) divides the population into termining a household’s probability of being Republic of China, Georgia, seven categories, three of which are considered poor next period based on their income this India, Indonesia, to be “middle”. The upper middle comprises period. The income level at which a household Kazakhstan, Kyrgyz those whose expenditure is between Rp 3 and was safe from falling into poverty next peri- Republic, Lao PDR, Malaysia, Mongolia, Rp 5 million per month (around US$600-1,000 od was averaged across countries to develop Nepal, Pakistan, adjusted for purchasing power), the middle the US$10 lower bound. The report then used Philippines, Sri between Rp  2 an d Rp  3 million (US$400- self-perceptions of class membership in five Lanka, Tajikistan, Thailand, 600), and the emerging middle between Rp countries (Brazil, Chile, Colombia, Mexico, and Turkmenistan, 1.5 and 2 million (US$300-400).151 In 2012, Peru) to validate this lower income threshold. Uzbekistan, and the combined total of the population of these Using this measure, the size of middle class Vietnam. three groups was approximately 109.2 million in the countries studied increased by half be- 151 Expenditure people. The richest four categories are called tween 2003 and 2009, from 103 million people includes: food, the Middle Class and Affluent Customer (MAC) to around 152 million, so that the middle class utilities, group, which consists of middle, upper-mid- now accounts for around a third of the region’s transportation, communication, dle, affluent, and elite consumers. They expect population, around the same as the poor. and regular that the MAC population in Indonesia will in- household supplies. crease from 74 million in 2012 to 141 million Discretionary spending such as in 2020, driven mostly by the growth in the entertainment, middle and upper-middle population. Mean- restaurant dining, while, McKinsey (2012) defines a ‘consuming and similar categories are class’ “with enough income to purchase not just excluded. basic necessities such as food and clothing but ASPIRING INDONESIA 203 ANNEX Defining the Middle Class in Absolute-Relative Hybrids Relative Terms One set of relative approaches ing on Latin America. The OECD A hybrid definition combines percentile in their own country to defining the middle class is (2011) defines ‘middle sectors’ “as absolute and relative defini- (2010). She justifies the absolute based on a fixed middle pro- households with income per cap- tions, which allows it to set a and global lower bound on the ba- portion of the distribution. ita between 50 percent and 150 minimum global threshold, sis that people with consumption For example, Easterly (2001) de- percent of the national median” while at the same time consid- below this level are too poor to be fines the “middle class” as those (p.11), meanwhile referring to er differences in welfare across considered middle class in any so- lying between the 20th and 80th “those with income below 50 per- countries. Birdsall (2007) com- ciety, while the relative and local percentile on the income or con- cent of the median household as bines absolute and the relative upper bound is to exclude people sumption distribution. He then ‘disadvantaged’, and those with approaches, by defining the mid- who are considered rich in their conducts a cross-country analysis incomes higher than 150 percent dle class as those individuals who own society. Among the countries on 175 countries to understand the of median income as ‘affluent’” consume the equivalent of US$10 studied, “only Russia, Mexico and impact of the total income share (p.17). This definition, often used or more per day, but who fall below Brazil have more than 25 million of the middle three quintiles on for the analysis of the middle class the 90th percentile in the income people in the middle class, urban various dependent variables of in OECD countries, was applied distribution in their own country China has not quite 20 million” interest. to 11 Latin American countries.152 (she later revised this upper bound (Table 7).153 They argue that this definition has to be those who fall below the 95th Others have defined the mid- “important advantages in terms dle class relative to the median of comparability and consistency income. Birdsall, Graham, and across countries, and between the Pettinato (2000) define as those middle sectors and the relatively between 75 and 125 percent of more disadvantaged and affluent median per capita income, focus- groups of society” (p.17). 152 Uruguay, Mexico, Chile, Brazil, Peru, Urban), Morocco, China (rural and urban), the United States. Costa Rica, Ecuador, Argentina, Columbia, Thailand (rural and urban), Turkey (rural Bolivia, Venezuela and urban), South Africa, Mexico, the 154 This chapter also uses the WVS data Russian Federation, Honduras, Bolivia, to look at opinions and values, but Paraguay, Columbia, Ecuador, Brazil, it constructs a more objective class 153 Countries studied are: Ghana, India Venezuela, Argentina, Chile, Sweden and category. (Rural and Urban), Indonesia (Rural and ASPIRING INDONESIA 204 ANNEX Defining the Middle Class in Defining the Middle Class in Terms of Its Behavior and Indonesia and East Asia and Perceptions Pacific: Economic Security Some studies looking at middle class val- (2006), looking at Elizabethan England, de- This report adopts an economic securi- ues in emerging countries classify people fines the middle class as those who live by ty-based definition of the middle class, as based on self-perception of either status or their wits rather than manual labor. In a more is done regionally for East Asia and the Pa- position in the income distribution (PRC, modern sense, Adelman and Morris (1967), cific (World Bank, 2017). There are a num- 2008; Amoranto et al., 2010)., even though were among the first scholars to highlight the ber of advantages to defining the middle-class self-reported status may be a poor predictor of importance of the middle class, specifically the threshold as free from economic vulnerabil- someone’s income, education, or occupation. indigenous middle class, and occupation. They ity. First, it is conceptually grounded in the Amoranto et al. (2010) utilizes the World Val- define the middle class as those working in par- notion of economic security, unlike arbitrary ues Survey (WVS) data to examine different ticular occupation as evident in the way in which thresholds which have no basis. Second, what perspectives on class status based on self-per- they construct the indicator of the importance counts as economic security is developed in the ceptions rather than income or expenditure of the indigenous middle class. To construct this East Asian regional context, rather than glob- measures.154 In the countries they studied, 2 indicator, they divide countries into five catego- al benchmarks, which may be less relevant. percent see themselves as coming from an up- ries. A country categorized as having a relatively Third, it allows behaviors and characteristics per class, 45 percent from the lower class and important indigenous middle class is one with of the middle class to be explored empirically, 53 percent from the middle class. They find that at least 20 percent of the active male population rather than being pre-determined to define “there is generally a wide range of variation working in commercial banking, insurance, or in them, as behavioral definitions do. Fourth, the in what people consider middle class, but per- technical, professional, managerial, administra- definition can be held constant in conceptual ceived class status is largely related to higher tive, or clerical employments. Countries fulfilling terms over time, allowing a line which increas- education, more skilled and stable jobs, and the this criterion but which are largely dominated es over time with inflation and growth but can ability to ‘save’, which are all characteristics of by expatriates are excluded from this category. be compared consistently over time. people with higher incomes” (p.1). Nonetheless, income and behavioral defi- However, as countries become upper-mid- There are also some who define the mid- nitions do not necessarily result in very dle-income and most of the population are dle class as those who exhibit certain be- different people being identified as middle economically secure or better, ‘middle haviors. A concern with this approach is that class. Despite adopting an absolute definition, class’ may come to be more of a relative it often makes it very difficult to objectively some scholars such as Kharas and Gertz (2010) notion. When countries are still lower income measure the middle class, as most of the anal- acknowledge that “the middle class is an am- and most of the population are still poor, then ysis conducted using this approach often uses biguous social classification, broadly reflecting the economically secure are among the rich- self-reporting mechanisms or subjective obser- the ability to lead a comfortable life” (p.2), and est. However, as a country becomes richer, the vations. Currently, there are no cross-country recognize that “the middle class usually enjoy poorer end of the distribution may have become analysis that have been able to conclude what stable housing, health care, educational op- economically secure, but may not consider general behavior identifies the middle class. portunities (including college) for their chil- themselves middle class at all, as they aspire dren, reasonable retirement and job security, to the greater wealth they see at the richer end Occupation is a key behavior used by some and discretionary income that can be spent on of the distribution. We examine this later in the to define the middle class. Lawrence James vacation and leisure pursuits” (p.2). case of Malaysia. ASPIRING INDONESIA 205 ANNEX TA B L E A.1.1 Summary of Middle-Class Definitions Source Original Range US$ PPP Range (2005) (all PPP are 2005) (daily per capita) Absolute definitions - Global Kharas and Gertz (2010) US$10-US$100 PPP (daily) US$10-US$100 PPP Milanovic and Yitzhaki (2002) US$4,000-US$17,000 PPP (annual) US$11-US$47 PPP Absolute definitions – Developing Countries ADB (2010) US$2-US$20 PPP (daily) US$2-US$20 PPP (1) Lower MC: US$2-US$4, (2) Middle MC: US$4-US$10 (3) Upper MC: US$10-US$20 Ravallion (2010) US$2-US$13 PPP (daily) US$2-US$13 PPP Banerjee and Duflo (2008) (1) US$2-US$4 PPP and (2) US$6-US$10 PPP (daily) (1) US$2-US$4 PPP and (2) US$6-US$10 PPP Absolute definitions – Indonesia BCG (2013) (1) Emerging MC: Rp 1.5-2 mil (1) Emerging MC US$1.9-US$2.5 (2) MC: Rp 2-3 mil, (3) Upper MC: Rp 3-5 mil (2) MC US$2.5-US$3.8 (monthly HH) (3) Upper MC US$3.8-US$6.3 PPP* McKinsey (2012) > US$3,600 PPP (annual) > US$10 PPP Tempo (2012) US$2 - US$20 PPP (daily) US$2 - US$20 PPP Relative definitions Easterly (2001) 20th-80th percentile N/A Birdsall et al. (2000) 0.75 to 1.25 times of the median per capita income N/A Hybrid definition (Absolute + Relative definition) Birdsall (2007) US$ 10 per capita consumption - 90th percentile in N/A the income distribution World Bank (2013) US$10-US$50 PPP (daily) US$10-US$50 PPP Behavior Definitions (Middle class characteristics) Amoranto et al. (2010) Self-reported perception of class status from the World Values Survey data. Adelman and Morris (1967) Middle class as those working in commercial banking, insurance, or in technical, professional, managerial, administrative, or clerical employments. Kharas and Gertz (2010) Use an absolute definition, but also acknowledge that “the middle class is an ambiguous social classification, broadly reflecting the ability to lead a comfortable life” (p.2) and recognize that “the middle class usually enjoy stable housing, health care, educational opportunities (including college) for their children, reasonable retirement and job security, and discretionary income that can be spent on vacation and leisure pursuits”. ASPIRING INDONESIA 206 ANNEX Income/ Expenditure Rationale Expenditure Global benchmark: The lower band reflects the average poverty line in Portugal and Italy, while upper band is chosen as twice of median income of Luxemburg Income Global benchmark: Range between the average annual income in Brazil and Italy in 2000 PPP. Brazilian average income (US$11) is almost equal to the poverty line of US & Germany Expenditure Semi-arbitrary: US$4-US$10 is living above subsistence and able to save and consume nonessential goods. US$10-US$20 is roughly poverty lines of Brazil and Italy, respectively Expenditure Global benchmark: Range between the median poverty line (US$2) from a sample of 70 developing countries to the US poverty line (US$13) in 2005 Expenditure Semi-arbitrary: Based on their estimates of a lower and upper middle class from 13 developing countries. Those living on more than US$2 have a base amount of consumption that can contribute economically to growth Expenditure excluding discretionary spending Semi-arbitrary + Behavioral: Based on BCG consumption survey and middle-class definitions from precedent works Income Arbitrary Income Arbitrary Expenditure Arbitrary in relative terms Income Arbitrary in relative terms Expenditure & Income Arbitrary: Exclude people who are too poor to be middle class in any society and some people who are, at least in their own society, “rich” Income Regional benchmark: The lower band reflects the average economic security line in countries such as Argentina, Columbia, and Costa Rica, at which Latin American households have only a small probability of being poor next period based on this period’s income, while the upper band separates the middle class from the top 2% of the Latin American population. ASPIRING INDONESIA 207 ANNEX The FIGURE A.2.1 Probability curve of being poor next year given B this year’s consumption ANNEX Indonesian Poverty, VULNERABLE Poor Vulnerability & Economic Security 10% CHANCE Lines POOR OF FALLING BELOW PL Non—Poor 0 Monthly per-capita Consumption (RP) 2000000 Source: Susenas 2008-10 Panel and World Bank calculations. Indonesia sets separate urban and rural poverty lines for each province. The national average in 2016 was Rp FIGURE A.2.2 Probability curve of being vulnerable next year 355,000. Each poverty line is based on the cost in that lo- given this year’s consumption cation of obtaining 2,100 calories, based on prices and food types eaten by a reference group of the poor. A non-food component is included to cover basic non-food subsistence Poor items such as health and housing. MIDDLE CLASS The probability of falling into poverty is then used to set the vulnerability and economic security lines. Pan- el data track the same households for multiple periods. A probabilistic function can be estimated that represents the chance of a household falling below the poverty line next pe- riod based on their per capita consumption this period (fol- lowing Lopez-Calva and Ortiz-Juarez, 2014). Our approach 10% CHANCE OF FALLING BELOW differs slightly in that we use a lowess smoothing method Non—Poor VULNERABILITY to estimate the probability curve, rather than the logistic regression used in Lopez-Calva and Ortiz-Juarez. The result is similar using either method. The first period consumption 0 Monthly per-capita Consumption (RP) 2000000 level which corresponds to a 10 percent chance of being poor next year is taken as the vulnerability line (Figure A.2.1), while the first period consumption level which corresponds Source: Susenas 2008-10 Panel and World Bank calculations. to a 10 percent chance of being poor or vulnerable is taken as the economic security line (Figure A.2.2). The Susenas 2008-10 panel data are used to determine a vulnerability line of Rp 530,000 in 2016 and an eco- nomic security line of Rp 1.2 million. The 2008-10 panel data indicated a greater than 10 percent chance of being poor next year if this year’s consumption was below 1.5 times the poverty line (Rp 530,000). Similarly, households above the vulnerability line but below 3.5 times the poverty line (Rp 1.2 million) had a greater than 10 percent chance of being below the vulnerability line next year. ASPIRING INDONESIA 208 ANNEX References A.T. Kearney. (2015b). Food Safety in China: What it means for global companies. Retrieved from Forbes. Adelman, I., & Morris, C. (1967). Society Politics and Economic Development: A Quantitative Approach. Baltimore: Johns Hopkins University Press. Alam Sutera. (2014). Alam Sutera Realty Annual Report 2014. Alesina, A., & Perotti, R. (1994). Income distribution, political instability, and investment. European Economic Review 40, 1203– 1228. 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