From Capital Deepening to Productivity-Driven Growth: Reassessing the Quality-Quantity Debate in Indonesia

Abstract

This research examines whether economic growth is mainly caused by an increase in the amount of capital that is accumulated versus an increase in the quality of the capital that is used in the context of the long-term development of Indonesia. In this study, the ARDL model was used to analyse the differences between the effects of capital quantity, proxied by gross fixed capital formation and capital quality, proxied by total factor productivity (TFP), using time series data spanning the years 1967 to 2023. Labor is used as a control variable. The long-run equilibrium relationship between the variables has been established and is confirmed by the results. In the short run, the accumulation of physical capital has a significant effect on economic growth; however, in the long run, there is no statistically significant effect. In the long run, growth in TFP has a robust positive impact. While 19% of the short-run disequilibrium is corrected by the error correction term annually, indicating a stable adjustment mechanism. The results of this research indicate that the growth sustainability of Indonesia is highly dependent on an improvement in the productivity performance as opposed to the volume of the investment that is made. The results also indicate that productivity improvement is the most important factor, while the effect of capital deepening is reduced, and the productivity growth is sustained, thus the economic growth is sustained. This study aids the growth literature and Indonesia’s structural transformation challenges by empirically disentangling capital quantity from capital quality. Under the Indonesia Emas 2045 vision, the most important prerequisite for attaining high-income status is the transition to a productivity-driven growth regime.

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