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Is Indonesia's growth rate balance-of-payments-constrained? A time-varying estimation approach*

Jesus Felipe, Matteo Lanzafame and Gemma Estrada

Keywords: balance-of-payments-constrained growth rate; Indonesia; Kalman filter; Thirlwall's law

This paper analyses the performance of Indonesia's economy since the early 1980s using Thirlwall's balance-of-payments-constrained (BoPC) growth model, estimated in state-space form to take account of the varying nature of the income elasticities of demand for exports and imports. Results indicate that after peaking in the mid 1980s at above 10 percent, Indonesia's BoPC growth rate has declined significantly, to about 3 percent in recent years. This is the result of changes in the three components of this growth rate: the income elasticities of demand for exports and imports, and the growth rate of world income, all three significantly lower. Especially worrisome for Indonesia's future is the decline in the income elasticity of demand for exports, a variable that summarizes the non-price competitiveness of its exports. This is the consequence of the lack of progress in upgrading the export basket and increasing its sophistication, with natural resources and low value-added manufacturing still dominating the country's exports. Focusing on the two income elasticities, the analysis shows that their determinants are variables that proxy the economy's structural changes (for example, the manufacturing employment share) and within-sector productivity growth (for example, complexity of the economy, gross fixed capital formation as a share of GDP).

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