The structural transformation and the role of economists

C. Peter Timmer, Thomas D. Cabot Emeritus Professor of Development Studies, Harvard University

This previously unpublished article, written by C. Peter Timmer for a speech given by the late Professor Dr Saleh Afiff, Indonesia’s Coordinating Minister of Economic Affairs, to the Indonesian Economists Association on 21 November 1993, is compelling reading with some historically based policy messages still relevant more than three decades later.¹ Lightly edited and annotated by Professor Timmer in July 2025, this article draws on Professor Afiff’s experience as the last of the original ‘technocrats’ still in Suharto’s cabinet.²

Cognizant of the importance of policies for maintaining national unity in their multi-ethnic and predominantly rural populations, the focus of government national development planning at independence in Indonesia in 1945—also in Malaya in 1957—was mainly on growth, stability, and equity.³ A central objective was to reduce the high levels of absolute poverty and lessen the urban–rural socio-economic divide. The speech reflects on how the reduction in mass poverty via a successful structural transformation also transforms the role of economists serving in government office.

It is important to remember the global policy context at the time: the search for a new development paradigm after the collapse of the Soviet Union and the huge losses and bankruptcies of many European state-owned enterprises. What was the role of government when the private sector seemed to be the only game in town? A fierce debate arose in the development profession over the ‘Big Bang’ reforms attempted in the former Soviet Union and the ‘Gradualist’ approach implemented in China that involved ‘crossing the river by stepping on stones’.⁴

Professor Dr Saleh Afiff and Professor C. Peter Timmer in Jakarta, Indonesia, 1971.

For more than 150 years, economics has been known as the ‘dismal science’. The very definition of the field—the study of the optimal allocation of scarce resources to meet unlimited human desires—implies that economists must talk about trade-offs. More sugar means less rice. More consumption means less savings and investment. More money spent developing aircraft technology means less money to spend on health clinics or roads. The notion that everything produced and consumed in an economy comes at a price is deeply embedded in economists' methodology. For positions where scarce resources must be allocated carefully among competing groups—ministers of finance, for example, or deans of universities—economists are chosen more frequently than any other profession.⁵

By training and instinct, economists tend to be cautious about making promises, and they rely heavily on data and quantitative analysis of actual experience. By focusing on analysis of historical experience rather than future possibilities and promises, economists almost rule themselves out of the competition for leadership over the large issues confronting society, even the largest and most visible issue facing a poor country—how to develop its economy. Economists may head important ministries, they may conduct all of the background research that reveals the workings of the economy—its constraints and opportunities—and they may even hold the most important policy dialogues with international donors and investors. But seldom does an economist articulate a vision of a development strategy that deviates far from input-output tables and incremental capitaloutput ratios.

The structural transformation of the Indonesian economy since the beginning of the New Order government in 1966,⁶ and economists' role in that transformation, offer an opportunity to articulate that vision. I would like to take this opportunity to reflect on the role economists have played at various stages in the development process and to venture my own vision about the role of economics in the future

Looking backward

When the group of economists now known collectively as the technocrats joined the New Order government in 1967, very little was known about the structure of the Indonesian economy or what an appropriate development strategy would be. It is important to remember the prevailing development paradigm of the time. The basic model of economic development taught by academics and used by policymakers reflected a simple logic. The driving force of development was the mobilization of savings, which were then allocated to their optimal uses by a national plan. These savings were used to build the modern factories that increased industrial output. This higher output counted as ‘development’.

The most important source of savings to be allocated by the government, especially in the early stage of development when the country was poor, was the surplus from the agricultural sector. Agricultural surpluses were transformed into savings under the control of the government by direct taxes on exports, low agricultural prices, high prices for manufactured goods sold in the rural areas, and an overvalued domestic currency. In combination, these policies towards the agricultural sector kept wages low and imported inputs cheap for the manufacturing sector, much of which was controlled by the government to ensure that savings from agriculture and profits from industry were invested for optimal growth.

The structural transformation—the gradual decline in the share of agriculture as the economy grew—meant that increased profits from a rising share for industrial output would replace the important role of agricultural savings. But in the first stage, extracting fewer resources from agriculture would just slow the expansion of industry.

Later, as the industrial sector grew quickly to dominate the economy, and agriculture was no longer important, there was no point in using scarce resources to develop agriculture—it was a naturally declining sector anyway. In this simple but influential model, a powerful discrimination against the agricultural sector is revealed as the core of the development process itself. This early development model suggested that any efforts to help the agricultural sector would inevitably slow down the rate of economic growth, and that nearly all of the government's resources should go to the industrial sector.

Even in the early stages of the New Order's efforts to restart the development process, this paradigm was rejected by the technocrats as inappropriate for Indonesia. While the planning approach was retained, the economists focused it on rebuilding the rural economy, developing new agricultural technology, and improving the efficiency of rice markets. From the beginning, then, economic policy tried to stimulate agriculture, not tax it heavily. To do so, a delicate and changing balance was struck between the role for market forces and the necessary role of the government throughout the entire economy.

The Indonesian experience

What should that balance be now? The economics profession around the world is asking itself precisely this question, and I believe the Indonesian experience helps us understand an important part of the answer. The issue is whether there is a set of positive policies and public investments that will lead to and sustain rapid economic growth, or whether governments must step aside entirely in favour of market forces. Only in East and Southeast Asia have countries seemed to strike a successful dynamic balance. Quite gradually, these economies are becoming more responsive to private investors and consumers and less dependent on direct government support and interventions. The government's role is increasingly to maintain (and regulate) the overall environment for these private decisions. Naturally, this shift in balance also implies a shift in the role of economists in government, especially in Indonesia.

The Indonesian model of development has three objectives: growth, stability, and equity. Although much of the analysis of our economic success has focused on the obvious lessons of maintaining fiscal balance, a competitive exchange rate, and an outwardly oriented economy that is driven by exports, the importance of equity during the growth process has often been overlooked.

Also overlooked in the Indonesian case has been the positive role that economic and political stability play in stimulating rapid economic growth and in spreading its benefits to the poor. When the macroeconomic environment is favourable, economic and political stability generate positive expectations and the confidence to make long-term investments that lead to rapid gains in productivity. Historically, Indonesia (and other large Asian countries) has been able to generate an equitable distribution of income along with economic and political stability only when the government could guarantee food security.

Hunger and famine in rural areas and food riots in urban areas undermine any efforts to build a modern economy. Food security for individual households in rural areas and stable food markets in urban areas are essential to begin and maintain the process of economic growth. It is no coincidence that the 1970s and 1980s show a close correspondence between the rate of growth in per capita food supplies and growth in per capita incomes, not just in Indonesia, but in developing countries as a whole.

This close correspondence is likely to break down over the next two decades. Demand for rice, the basic food staple, is saturated or declining in most countries of East and Southeast Asia. With agriculture only one-sixth of the Indonesian economy, the sector cannot be the engine of growth that it was in the past, no matter what the technological potential for higher yields. Instead, the gap in labour productivity between rural workers and those in the industrial sector will widen, forcing a new set of policy issues onto the political agenda. A major role for economists will be to inform this political debate.

Looking forward

Since 1967 an important focus of economic policy has been on reducing the level of absolute poverty. This task required raising the incomes of small farmers, the rural landless, the underemployed, and the urban migrants working in the informal sector. No poor country has the resources to transfer incomes directly to these people in the form of subsidies. The economy must create enough jobs for unskilled workers that they obtain more secure and regular incomes. When wage rates in rural areas start to rise as underemployed labour is fully absorbed into productive jobs, the poverty rate drops very quickly.

Indonesia has a remarkable record in reducing the rate of absolute poverty, mostly because of the policy environment and investments that made agriculture more productive and raised wage rates in rural areas. Beyond this, the role of agriculture has been to stimulate economic growth through the establishment of linkages to the rest of the economy—supplying food, purchasing the output from new industries, and providing savings and labour to these factories. In the middle stage of development that Indonesia has now reached, when incomes are rising rapidly in the modern industrial and service sectors, the role of agriculture has shifted significantly. Now the sector must provide a buffer of income-earning opportunities for a large share of the work force not yet equipped with the education and skills to be productive in the modern sectors, nor the jobs at which to learn how.

This new role means the economic policies needed for agriculture will be quite different from those appropriate at a time when the sector was a leading contributor to rising output. Here is the real challenge to economists in the government who must consider the welfare of the entire society, not just the performance of one sector or industry. No successful Asian country has allowed the welfare of workers left behind in rural and backward areas to be determined by market forces alone. All governments have intervened to help this population when the engine of economic growth has switched to the industrial track.

The development trilogy

The reason is simple. All three objectives in the development strategy—growth, stability, and equity—must be pursued simultaneously if rapid growth is to be sustained for long periods of time. Economic growth itself depends on stability in economic policy and in political systems. Such stability, however, depends on standards of living rising fast enough to meet growing expectations, not only among well-paid urban workers and rich industrialists, but also among unskilled workers and small farmers.

Trade-offs are inevitable in satisfying these rising expectations. Choices must be made because economic constraints simply will not go away. Stability must not turn into rigidity in either economic or political affairs. The concern for equity in the development process must not turn into populist pressures for universal equality of incomes and immediate consumption at the expense of long-term investments. Economic growth must recognize the environmental as well as financial costs of resources, and these resources are limited. The role of political leadership in the development process is to seek a balance among these trade-offs and to articulate the role of the government in achieving this balance. But political leadership cannot identify and debate these tradeoffs without a clear understanding of economic dynamics.

Evolving stages

From this perspective, the role of economists has evolved through three stages:

from coordinating the planning process in the early stage when the government was directly involved in integrating the economy;
to deregulating the economy in the middle stage so that market signals provide the right investment incentives to a vigorous and competitive private sector; and
to providing the long-run analytical foundation for a political leadership actively seeking to sustain rapid economic growth on behalf of the entire society.

Increasingly, economists will not be needed to run the economy directly—the private sector will do that—but they will be needed to identify the key strategic choices facing the society and to calculate the costs of alternative choices.

These choices are often posed as agriculture versus industry; as modern technology versus labour-intensive manufacturing. Indonesia invested heavily in its agricultural sector and rural economy during the first twenty-five years of development planning. Large investments were made in rural infrastructure, heavy input subsidies were paid to stimulate learning and use, and prices of the most important commodities were stabilized. Perhaps more importantly, however, the agricultural economy received very careful attention from policymakers at the highest level. Indeed, many foreign analysts think Indonesia had a rural bias to its development policy over the past twenty-five years, and this may be one reason for its success.

Is it time to focus that policy attention and fiscal resources on the industrial sector, especially to foster the learning needed to make modern technology more accessible to Indonesian factories and workers? At one level the answer is clearly ‘yes’. Indonesia's future does not lie in rural society, but in mastering the new industrial and information technologies that will be the only route to higher labour productivity. But what should the government's role be?

The new global environment

With the collapse of socialist planning models, and huge losses by, and bankruptcies of, state-owned enterprises in Europe, no one believes any longer that the government should build, own, and manage the new enterprises that will use these technologies. At the other extreme, no one doubts that the government must take an active role in shaping the educational system so that it produces the skilled engineers, technicians, and managers needed to operate these plants. But there is still a vast, debatable area between these two extremes.

Economics provides the ground rules for this debate. The fertilizer subsidy was justified because it stimulated farmers to learn that fertilizer use led to higher rice yields, and these higher yields led to large financial benefits in relation to the budget costs.⁷ So too should subsidies to technologically advanced industries be examined for their contribution to economic growth. Honest analysts can differ over how to measure the costs and benefits, how far in the future they will occur, and what discount rate to use.

But their debate should take place within the common methodology of economic accounting. The government should invest in stimulating development of, and access to, new technology only when it meets this economic test. Government resources should be reserved for more pressing needs when it does not.

And there are many pressing needs in addition to stimulating modern technology. For policymakers concerned about maintaining rapid economic growth for long periods of time, perhaps the most important task of the government is to address the many dimensions of equity over time. The process of economic growth is measured not in years, but in decades and centuries. Unless the vast majority of the population participates in this process, they simply will not support the rigorous policies that are responsible for generating large savings and the directing of those resources to the most productive investment opportunities.

Redistribution by central governments is too expensive

Redistribution of existing incomes through taxes and subsidies is a poor way to solve this problem. Redistribution is bureaucratically expensive, politically divisive, and creates negative incentives for investors. It is better, as Indonesia has done since 1967, to structure the process of economic growth to help solve the problem of poverty. This approach inevitably means finding a strategy for raising productivity of rural labour. In most settings, such a strategy requires agricultural development with a focus on small farmers.

Indonesia ignored this approach for the first two decades of its independence while it concentrated on the political process of nation-building. But the fortunate coincidence of a new government, oriented towards economic growth, and a new agricultural technology that opened the potential for rapid gains in rural productivity, put the country on a sustainable path that can double per capita incomes every fifteen to twenty years.

In Indonesia, the political economy of staying on this path to economic take-off is fragile, and it is dependent on the goodwill and participation of all elements of society. To be successful in the long run, the development strategy must find productive jobs for all workers, not just the elite working in modern industrial factories. Economics offers the framework for creating these jobs because its concern for productivity across the entire economy is the key to ensuring widespread participation in higher living standards. Technology is the key to growth in productivity, but economics is the key to choice of technology.

This choice determines not just who participates in economic growth, but how fast that growth will be. Government economists should play a progressively smaller role in determining these choices directly, but economics will play a larger role in illuminating the consequences for growth, stability, and equity of alternative strategies of development.

***

Addendum

After his speech to the Indonesian Economics Society in 1993 and before his untimely death on 28 June 2005, Professor Afiff remained active and influential in Indonesian food policy issues. He had an opportunity to reflect on those experiences when he was invited by James Wolfensohn, President of the World Bank, to give the keynote speech at the Shanghai Conference on ‘Scaling Up Poverty Reduction’ in 2004. He agonized over what to say to such a distinguished and critical audience, but his speech stresses the themes and lessons he had learned since joining the Suharto government in 1967. The key messages were:

In summary, the three-tiered strategy for pro-poor growth linked sound macroeconomic policy to market decisions. These decisions were facilitated by progressively lower transactions costs that linked household decisions about labour supply to agricultural production and investments in the local economy. The result was a strong connection between the poor and economic growth, or, in the current jargon of the day, a high ‘poverty elasticity of growth.’

Unfortunately, this high elasticity also works in reverse. The impact on the poor of the events after 1997 was devastating. This impact was largely mediated by skyrocketing rice prices in late 1998, but was caused by the loss of faith in the Rupiah and its collapse earlier in the year. One of the papers given at the Conference examines in depth the institutional failures that made the Indonesian crisis so severe. The numbers of poor probably tripled at the peak of the crisis and most of the modern sector, including domestic banks, went bankrupt. The Government of Indonesia incurred huge debts bailing out these companies and keeping favoured banks solvent. Servicing these debts may be the most painful long-run effect of the crisis. We now know, of course, that building the institutions that provide ‘good economic governance’ is the hard, time-consuming, but absolutely essential foundation for long-run economic growth and a successful structural transformation.

Because of these experiences, and the country’s slow progress in filling the political and institutional vacuum created by President Suharto’s resignation in mid-1998, many are less optimistic about further reductions in poverty, whether through a return to rapid economic growth or through targeted government programmes aimed at the poor directly. There is no doubt that an important test is underway to determine if Indonesia’s pro-poor growth experience under a highly centralized and politically dominant regime has put down sustainable roots, or whether the very foundations of the strategy will collapse under political challenge and rent seeking.

In the short run, politics is always the master of economics. But in the long run, good economic governance, and the policies that flow from it, are essential for growth. Indonesia has experienced several reversals of fortune over the centuries, but the current challenge is unprecedented in the memories of most voters. The challenge now is to replicate the economic success of the past, managed by an economic team largely insulated from politics, in an environment of a politically responsive system that is only now building the institutions needed to let sound economic policy prevail over polemics. It is already clear that this challenge is both to economic growth and its connection to the poor, so it is no surprise that Indonesia’s recovery from the crisis is lagging in the region.

But there are also substantial reasons for optimism. In just six years, Indonesia has been through an historic drought, an unprecedented financial crisis, a political crisis where many were killed in widespread rioting that destroyed untold businesses, a transition to democratic government through fair elections, and the creation of the major institutions needed for modern governance, including an independent Central Bank, reforms of the judiciary, a massive decentralization of government authority, and so on. None of these institutions are working properly yet, but none of them were even in place a decade ago. So perhaps it is appropriate, here in Shanghai, to close with a Chinese proverb: ‘In crisis comes opportunity’. We intend to seize that opportunity.

Further reading:

Afiff, S. and Timmer, C. P. 1971. ‘Rice Policy in Indonesia’.Food Research Institute Studies in Agricultural Economics, Trade, and Development, 10/2, pp. 131–159.

Rosovsky, H. 1990. The University: An Owner’s Manual (New York: W. W. Norton & Company).

Timmer, C. P. 1986. Getting Prices Right: The Scope and Limits of Agricultural Price Policy. Ithaca: Cornell University Press. Translated into Chinese by Wen Simei, Jiage Zhengce Fenxi (Guandong: South China Institute of Technology Press, 1987). Translated into Chinese by the Chinese Academy of Agricultural Sciences, Nongye Jiage Zhengce Pousi (Beijing, 1988).

_____ 2025. ‘The Structural Transformation in Japan, Indonesia, and Malaysia from 1880 to 2010: Data Trends, Analysis, and Policy Implication’ in Sultan Nazrin Shah (ed.), Chronicling Themes in the Economic and Social History of Malaysia (Singapore: World Scientific Publications).

Timmer, C. P., Falcon, W. P., and Pearson, S. R. 1983. Food Policy Analysis. Baltimore: Johns Hopkins University Press for the World Bank, 1983. Translated into Chinese by Wen Simei and Zhang Xiaoyou, Shi Pin Zheng Ce Fen Xi (Guangzhou: China Publishing House for Finance and Economics, 1989).

Timmer, C. P. and Akkus, S. 2008. 'The Structural Transformation as a Pathway out of Poverty: Analytics, Empirics and Politics', Working Paper 150 (Washington, D.C.: Center for Global Development).

Endnotes

¹While his main historical focus on southeast Asian countries has been Indonesia’s development, Professor Timmer has also been engaged with Malaysian topics since he was a junior commodity economist working at W. R. Grace and Co. in New York City from 1964 to 1966. There he authored a report on the world tin market, which compared the prospects of Bolivia (chaotic) and Malaysia (promising), and offered an analysis of the likely political stability of Singapore’s inclusion in the Malay Federation (not promising). Among his many well received publications are Timmer, 1986, and 2025; Timmer and Akkus, 2008. Timmer started working with Afiff in 1970, the year he took leave from Stanford to join the Harvard Advisory Group in Indonesia, where he reported directly to Afiff. An early example of their collaboration is Afiff and Timmer (1971).

²Economists have never been noted as good forecasters of future economic and financial events, whether booms or busts. The speech by Professor Afiff did not see the Asian Financial Crisis coming just three years ahead; and many economists failed to foresee the populist pushback against open economies and globalization; the rise of social media, which has polarized the citizenry in many countries; or the ability of President Donald Trump, in his second term, to upend the domestic social contract while also throwing the global economy into chaos and possibly a serious depression. Still, the speech contains valuable lessons for economists serving in high-level government positions.

³As the recent review by Professor Hal Hill for the EHM website of the book by Terence Gomez, Misgovernance: Grand Corruption in Malaysia emphasizes, even reasonably enlightened governments feel the need to reward their major financial backers. Despite having the backing of the military, President Suharto also felt this need as acutely as his counterparts in Malaysia. As his children (and eventually grandchildren) came of age, the corruption became dominated by family interests.

⁴Professor Timmer and Professor Afiff were squarely in the ‘gradualist’ school. Professor Timmer joined a World Bank mission to the USSR in late December 1991. His passport has an entry stamp from the USSR and, two weeks later, an exit stamp from Russia. The team was assembled and led by Professor D. Gale Johnson from the University of Chicago. Over strenuous objections from Professor Timmer, the team recommended that food and agricultural production and marketing be privatized immediately and move to a ‘free market economy’. Of course, none of the institutions needed to support such an economy were in place, or even on the horizon. By contrast, China by that time was well on its way to returning the rural economy to household control and allowing private trading in local markets. In the early 1980s, Professor Timmer spent three weeks each summer teaching ‘market economics’ to a very eager class of young scholars from the Chinese Academy of Agricultural Sciences (CAAS). Two ambitious members of those classes translated Food Policy Analysis and Getting Prices Right into Chinese. Within three years, the Chinese editions had sold well over a hundred times as many copies as their English originals.

⁵The quintessential example was Professor Henry Rosovsky, the long-serving Dean of the Faculty of Arts and Sciences at Harvard University and the author of the influential 1990 book The University: An Owner’s Manual. Rosovsky was an important figure in Indonesia because he had chaired Professor Widjojo Nitisastro’s PhD dissertation at Berkeley.

⁶The easiest way to conceptualize the historical pattern of structural transformation and its impact on the entire economy via changes in sectors of employment and economic activity is visually. The figure below shows the long-run patterns of structural transformation for Japan, Indonesia, and Malaysia.

The figure shows all three structural transformation variables—Share of Agriculture in GDP (AgGDPshr), Share of Agriculture in Employment (AgEMPshr), and the Gap between the two shares (AgGAPshr)—for relatively long historical periods for Malaysia by decade, and these can be compared with equivalent measures for Indonesia and Japan from 1880 to 2010. The similarity of Malaysia’s structural transformation path to those of Japan and Indonesia is striking, yet so are the differences in development outcomes between the three countries. It is the nature of the agricultural transformation that helped to drive each country’s structural transformation—and that was simultaneously driven by it—that helps to explain both the commonalities and the sharp differences in economic performance over more than a century. The sharp difference in the path of AgGAPshr for Indonesia compared with the very similar paths of Malaysia and Japan stems from the importance of petroleum exports from Indonesia after the 1880s. Indonesia has only recently become a net oil importer. Petroleum exports add significantly to GDP but have very little direct impact on employment. Thus, Indonesia’s AgEMPshr is similar to that in the other two countries, but its AgGDPshr is much lower, implying that AgGAPshr is larger (in absolute terms).

Note: a Positive values of AgGAPshr (AgGDPshr – AgEMPshr) denote higher labour productivity in agriculture relative to non-agricultural sectors.

⁷The history of Indonesia’s subsidy on urea fertilizer to be used by rice farmers to raise yields is a textbook case of the complex outcomes that can stem from apparently simple policy initiatives—the textbook example appears in (Timmer, 1986). In brief, there was a heated debate in 1984 with a very high-powered team of economists from the World Bank who were in Indonesia to present a draft report for the government’s approval that would eliminate the expensive subsidy because of budget deficits caused by the sharp decline in oil prices. Professor Timmer’s analysis, presented to the World Bank (and accepted by the Minister of Finance) demonstrated that the existing fertilizer subsidy raised rice production by enough to make Indonesia a small rice exporter. Without the subsidy, it would be a significant rice importer, with an impact on the world rice market price because of the ‘large country effect’. No simple partial equilibrium models could capture these economy-wide (indeed, global) effects. The Indonesian government formally rejected the ‘yellow cover’ draft agreement presented by the World Bank team, and neither a ‘green cover’ nor ‘grey cover’ report was ever issued. Grey cover reports are approved by the World Bank executive council and become official policy.