How should we prepare for local economic recovery after the COVID-19 pandemic? The answer lies in the economic diversification strategy: avoiding an overreliance on one economic sector, goods or services. The pandemic has taught us that reliance on only one economic sector is not always good.  It is similar to the global commodity bust that hit East Kalimantan province and other commodity-reliance regions a few years ago. Consequently, any global shock that could hinder local economic developments should be avoided so that we can increase the resilience of our economy.

Aside from resilience, economic diversification could provide a greater chance for a country to secure a higher income status if it enables it to export “better” (higher-value) products. A study by Hausmann, Hwang, and Rodrik (2006) suggested that the type of goods you export matters for your long-term economic performance. The government has realized the issue by adopting economic transformation for development visions in the current administration. Economic diversification could be a complement strategy for the economic transformation vision that the government is implementing.

As one nation, Indonesia might be praised for its diversification success because we were able to develop the manufacturing sector in the 1980s and avoid the resource curse of the oil bonanza. But if we look deeper at the local level, some regions are still facing an imbalance in their economy. For example, according to gross regional domestic product (GRDP) data from 2017, about 25 percent or more of the regional economies in East, North and South Kalimantan have been backed by mining and quarrying activities. For the case of East Kalimantan, the figure went up to almost 45 percent in 2019. Furthermore, if we check other parts of Indonesia, using export data, it is estimated that West Nusa Tenggara scored a 9942 on the Herfindahl Hirschman Index (HHI) for measuring concentration, indicating a very high reliance on a small number of export commodities.

If we agree that economic diversification (in addition to the transformation vision of the government) should be implemented, the following question is: How do we formulate the strategy to achieve it? In general, there are two paradigms on how to diversify the local economy. The first paradigm assumes the more active role of the government to manage the coordination failure in the economy, such as providing fiscal incentives for specific industries. By this logic, the government should pick “the winners”.

The second approach advocates a more neutral role of the government, like providing a sound education system, public infrastructure, as well as a supportive regulatory environment and financial system. This approach questions whether the government is the correct entity to decide which business activity should be pursued and to what extent they have the public policy instruments that are able to encourage innovation of private businesses. Business dynamics might be beyond the governments’ reach, to acknowledge asymmetric information issues.

Despite ongoing debates on formulating the right strategy for economic diversification, one crucial issue should be addressed by the government, especially in Indonesia: the trade-off between short versus long-run benefits. An ongoing study by Article 33 Indonesia found that economic diversification enables regions to achieve a more robust long-run economic performance, yet the impact in the short run is negligible.

On the other hand, there might be high financial and economic costs for attempting to diversify the economy. We cannot simply force the current generation to bear all the costs and leave it to the bequest motive to achieve long-run objectives. A compensation mechanism to “smoothen” the spending of the current generation should be addressed as well.

One idea is to create an institution to manage the economic windfall in a commodity boom period and utilize the funds to compensate for any losses from policy experiments for economic diversification. The idea is similar to Indonesia’s sovereign wealth fund plan, though it is very late.

However, we may face another commodity boom in the future, and we are surely going to face a challenging economic recovery. We cannot wait for another crisis to hit our local economy if we act as if everything is business as usual.

This is the right time to develop our economy in a resilient way.

 ***

The writer is researcher of Article 33 Indonesia and graduate student of Hitotsubashi University in Tokyo.

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