1. Introduction

One of the most discussed issue by policymakers in Indonesia is the debate on the “pie” of economic growth: should they focus on enlarging the pie, or focus on evenly dividing the pie? There are continuous suggested pros and cons of both side of the arguments, between choosing to focus on enlarging the pie or to put greater focus on equally dividing the pie. However, such debates could have been wasteful if the country does not have to trade-off between high growth and low inequality. This paper try to unveil the relationship between economic growth and income and wealth inequality in Indonesia, the choice of redistribution policy, possible impact of inequality on the country’s development, possible regional disparities, re-evaluation of the inequality measurement method, and the policy implications occurred.

2. Literature Review

Previous Research on the Empirical Relationship

Most research on the relationship between economic growth and inequality have not been clear yet, due to the complex mechanism in which they interact (Castelló-Climent, 2010, Simangunsong and Kuang-hui, 2018). There arguments for both side of the coins; with the earlier findings being a negative relationship, that higher inequality will reduce growth (Persson and Tabellini, 1994, Deininger and Squire, 1996, Ravallion, 2001). Such relationship is channelled through credit-market imperfections, political economy, socio-political unrest and saving rates (Barro, 2000).  Nevertheless, more recent works have tried to challenge the view by suggesting that economic growth and inequality have positive relationship (Li and Zou, 1998, Forbes, 2000, de Dominicis et al., 2008), implying that government face a trade-off between growth and inequality.

The Role of Redistribution Policy

To explain the sharp contrast of the findings, it will be necessary to analyse the mechanism of the relation – that is through the income redistribution policy. Arestis and Troncoso (2017) emphasized the post-Kaleckian theory that a country can implement either pro-profit or pro-wage income redistribution policy, but the result on economic growth depend on the country’s economic regime; as the increase of wage share will increase consumption, but decrease investment. Hence, total impact on growth is determined by the magnitude of the two contradicting effects. In a small open economy, however, it is most likely that pro-wage redistribution might hurt the economic growth – because increased wage will increase import consumption due to low competitiveness of the local firms, therefore reducing growth (Blecker, 2015). Another explanation proposed is by the trickle-down effect. De Silva and Sumarto (2014) showed that the non-poor actually gain more benefit from the trickle-down effect compared to the poor.

Evidence of Kuznets Curve

Another explanation of the mixed findings might be due to the Kuznets inverted-U curve, that the relationship is positive during early stage of development and became negative as a country become more developed. While this might be true, Azzoni (2001) found evidence of the theory if the analysis of the country is divided into rich and poor regions within the country itself, but not at the national level, implying that the unit of analysis, is not necessarily limited to country level but could be based on regions. Kuznets curve is further criticized that it mainly depend on cross-country analysis (de Dominicis et al., 2008) to justify the theory; but if one is to look at individual country, growth-inequality nexus is more influenced by the country’s conditions and policies rather than complying to a single general rule of thumb, therefore it will be better to avoid aggregate analysis (Delnigner and Squire, 1998).

3. The Case of Indonesia

Choice of Redistribution Policy

Before discussing further on the relationship of growth and inequality in Indonesia, there are some other factors affecting the decision whether Indonesia choose to adopt redistribution policy or not.

Political Environment

Theoretically by the median voter theorem, within a society where the average income is higher than the median income will cause the voting majority to push government toward income redistribution policy (Barro, 2000). Looking through Figure 1, the increase in GDP per capita growth is almost always lower than the national growth, indicating that such population structure is presence in Indonesia.

Figure 2. Indonesia’s GDP growth and Inequality, 2011-2017

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Source: Indonesia National Statistics Bureau (BPS)

Coupled with Indonesia’s democracy nature, with The Economist Intelligence Democracy Index of 6.97 in 2016 marked Indonesia as ‘flawed democracy’. Supported by the democratic system and 16 political parties, the median voter theorem might hold. Consequently, as suggested by Persson and Tabellini (1994), society who deem inequality as important tends to tax growth-promoting activities for the purpose of income redistribution. The existences of various income redistribution policy in Indonesia seem to be the result, one of them being the development of ‘Inclusive Economic Growth Index’ by the Ministry of Economic Development and Planning.

The Down Side of Inequality

There are various debates on the negative effect of high inequality. In Indonesia, inequality reduce the ability of economic growth to reduce poverty, making poverty alleviation programmes and policies less effective that what it could have been with less inequality (De Silva and Sumarto, 2014, Miranti et al., 2014). Furthermore, Simangunsong and Kuang-hui (2018) emphasized that even though higher inequality may increase economic growth, the issue of social justice will arise along with other conflicts.