Total factor productivity in Indonesian manufacturing, 1975-1993

Abstract

This study uses quantitative techniques to estimate total factor productivity (TFP) growth for three-digit non-oil manufacturing industries in Indonesia over the period 1975 to 1993. The thesis begins with a review of growth and structural change in Indonesian manufacturing. Next, a literature review of various aspects of TFP and the theoretical framework is provided. TFP growth for individual sectors and aggregate. TFP growth are calculated and presented to demonstrate the effect of change in the policy regime on TFP growth. Then, the nexus between the economic environment and TFP is examined. The first part of the analysis is directed to measuring TFP growth in Indonesian manufacturing. A number of interesting findings emerged from the analysis. It is shown that periods of slower productivity growth coincided with periods of import substitution. It is also shown that economic deregulation from the mid 1980s enhanced TFP growth. Further decomposition of aggregate value added growth analysis reveals that, prior to the deregulation era; a considerable proportion of output growth was derived from , reallocation of resources and terms of trade gains, while TFP growth within sectors played! minor role. Conversely, during the deregulation era, reallocation of resources and term of trade gains no longer made substantial contribution to output growth, while TFP growth within sectors became more important. The second part of the analysis focuses on assessing the economic environment-TFP nexus. It was found that an increase in demand, whether it comes from import substitution or export expansion, has a strong influence on TFP growth. However, separate analysis for the pre and post-deregulation eras suggests that the importance of import substitution as a TFP growth stimulant diminished during the deregulation era, while export expansion was an important determinant of TFP growth for both periods. It was found that the higher the level of concentration, the higher the TFP growth. This seems to contradict the hypothesis that low competition is associated with high TFP growth. However, using a more accurate measure of competition - the market share instability index - it is shown that competition does positively affect TFP growth. The positive effect of competition on TFP growth is also supported by the finding that protection correlates negatively with TFP growth. The thesis also examined the effect of foreign and government ownership on TFP growth. However, the result is insignificant, probably due to data deficiencies in the estimation of the explanatory variables.