The Impact of Rising Inequality on Growth and Unemployment in Indonesia: What Does the Evidence Say?

Abstract

Consumption inequality has been rising in Indonesia over the last decade (see Figure 1). Before the onset of the Asian financal crisis (AFC) in 1997, Indonesia experienced little change in inequality. From 1980 to 1996, the Gini ratio (a standard economic measure of inequality), based on household consumption, fluctuated between 0.32 and 0.36.1 While the impact of the AFC brought down inequality to Indonesia's lowest level since 1980 (0.30 in 2000), this was largely because the crisis hit those who were relatively well-off in urban areas harder than it hit Indonesia's poor in rural areas. However, since recovering from the AFC in the early 2000s, the Gini ratio has increased rapidly and has reached new records of 0.41 in 2011 and 2012. Of course, rising inequality is not restricted to Indonesia; there is growing concern about the current trend of rising inequality across the world.2 Nonetheless, while some argue that inequality in income or consumption is necessary for the accumulation of assets or market incentive for long-term growth investment, our research3 finds that increasing inequality will actually lead to adverse growth. Consumption inequality is usually closely related to other forms of inequality, such as inequality in access to education, health, and public services. This often manifests as inequality of opportunity. These dimensions of inequality have significant detrimental effects on economic growth, and even political and social stability. Thus, in turn, it also poses substantial risk to human development