Oil Be Damned! The Curse that Built an Industry

Oil Be Damned! The Curse that Built an Industry

A Curse that Never Was

Indonesia is often portrayed as a victim of its own natural wealth, too comfortable living off what lies underground to build a productive and diversified economy. In this view, resource abundance breeds laziness and dependency.

Such is the tale of our nation. Yet the 1970s oil boom tells a different story. Rather than succumbing to complacency, the New Order used its oil windfall to finance an ambitious industrialization drive. So if oil wealth was supposed to curse Indonesia into economic complacency, why was it instead financing one of the country's most ambitious industrialization drives? And if Indonesia was ambitiously industrializing, why is the nation still a far cry from being an industrial powerhouse? The truth may be more uncomfortable than the simple verdict of eternal damnation for Indonesia’s resources.

The Harsh Truth of Lotteries

“We come from the desert, and we have been living on camel milk and dates and things, and we can easily go back and live in the desert again."

• King Faisal of Saudi Arabia

It was a gloomy October of 1973. The Yom Kippur War triggered an oil embargo by the Organization of Arab Petroleum Exporting Countries (OAPEC) against countries supporting Israel. Production cuts by OAPEC members resulted in a quadrupling of oil prices globally (Thee, 2012). The chain of events would later be known as the 1973 Oil Crisis. A crisis in which Indonesia became a winner.

The oil boom, as it was in Indonesia’s point of view, had become a much needed solution to the country’s chronic double deficit of government expenditure and balance of payments (Boediono, 2016). At the peak of the boom, oil accounted for roughly 70% of government revenue and 80% of exports (Chant & Pangestu, 2010). Through profit-sharing agreements of then-Ibnu Sutowo-led Pertamina with various foreign oil companies, had found a treasure trove of black gold. Facing this newly found wealth, the country did not just sit back and become lazy. It invested in domestic manufacturing industries. This period built the various fertilizer and petrochemical industries that drove Indonesia’s green revolution and eventually resulted in the country’s rice self-sufficiency in 1982. Notable heavy industries, such as Krakatau Steel, Asahan Aluminium, and the infamous Industri Pesawat Terbang Nurtanio (IPTN) were also developed in this period (Thee, 2012).

Contrary to laziness, Indonesia did something called the Big Push. It was quite rational on the surface. The conventional wisdom of the era was that industrialization is a necessary condition for economic development. However, these ambitious industries require huge upfront capital that a country with limited domestic savings simply couldn’t afford. Indonesia’s case wasn’t unique. Countries that received huge oil windfalls, such as Algeria and Nigeria, also attempted Big Push policies during this period (Gelb, 1988). The results were considerable as manufacturing grew an average of 10.3% per year between 1972 and 1980, the fastest between any sector (Boediono, 2016).

Table 1. Economic Growth by Sector, 1967–1972 and 1972–1980 (Annual average growth rates, in %)

Source: Van Zanden & Marks (2012, p. 169), as cited in Boediono (2016, p. 133).

Interestingly, Indonesia also managed to avoid the Dutch disease that often accompanies an oil boom. As Usui (1996) explains, the government’s exchange rate devaluations helped reverse real appreciation and maintain the competitiveness of tradable sectors, particularly manufacturing. At the same time, the government accumulated budget surpluses as deposits, limiting the inflationary pressure that could have undermined these adjustments. Rather than allowing oil revenues to simply crowd out other industries, Indonesia used careful macroeconomic management to protect and strengthen its non-oil tradable sectors.

Illustration 1. Illustration of Weak Industrial Structure (Hollow Middle)

Source: Bappenas, 2023, Figure 2, p. 16.

But the harsh truth of lottery wins, including Indonesia’s, is also quite simple: they are often unsustainable. The state has focused on funding efforts for upstream, such as steel and aluminium, and downstream industries, such as IPTN. However, in the grand scheme of things, the midstream industries such as precision tools and specialized component parts are missing–resulting in a “hollow middle”. This caused manufacturing firms to still import 50% of their intermediate inputs and raw materials, not quite removing the import dependency that was targeted by Indonesia’s import substitution industrialization (ISI). Of course this is all fine if the black gold continues to flow as the state has the capability to bankroll ambitious industries with subsidies upon subsidies. If.

Revelations from a Field of Struggle

“Before us lies a difficult and arduous field of struggle,” declared President Soeharto before the DPR in January 1986. Throughout the 1980s, an oil glut drove prices downward before finally reaching their nadir in 1986. This forced the Indonesian government to cut the proposed state budget by 7% compared to the previous year. The implications are massive. The years of bankrolling industries deemed as strategic and prestigious could no longer be afforded.

Yet crisis breeds adaptation, adaptation breeds survival, and survival breeds prosperity. As President Soeharto himself said optimistically, “We shall enter this field of struggle with a realistic outlook [...] there is no obstacle we cannot overcome.” His words would prove rather prophetic. Indonesia’s previous ISI policies were not inherently bad. However, it was not tailoring industrialization towards Indonesia’s endowment of abundant labor. Additionally, Indonesia was doing an industrialization policy that was inherently inward-looking, aimed at replacing what it could not produce, instead of outward-looking, aimed at producing something that it was actually competitive at.

Verico & Pangestu (2020) creatively mapped this dynamic through a framework rooted in Sadli’s Law, which states that ‘bad economic conditions drive good (outward looking) policy and good economic conditions drive bad (inward looking) policy’. The 1970s oil boom had insulated inefficient industries and encouraged heavy trade protection. Such an inward-looking policy of the oil boom didn’t impose much needed market discipline to manufacturers. Only when the bad economic conditions of 1986 removed that financial cushion did the government do a banting setir or U-turn of its previous policies (Boediono, 2016). The field of struggle has brought much needed revelations, bringing forth a period of outward-looking policies.

Graph 1. Indonesia Manufacturing Exports by Major Commodities, 1981-96

(In percent of GDP)

Source: IMF (1997), chart 1.

This outward-looking shift realigned Indonesia’s industrial strategy with its true endowment of an abundant and competitive labor force. Deregulation, foreign investment, and increasingly export-oriented policies had encouraged the growth of labor-intensive manufacturing, particularly in garments, footwear, textiles, and consumer electronics assembly. Lower tariffs for raw materials and intermediate inputs that Indonesia was reliant upon would open access to higher quality materials for Indonesian firms, thus improving competitiveness in quality and price (Verico & Pangestu, 2020).

The results were striking. Between 1986 and 1996, non-oil exports sextupled, rising from $6.5 billion to $39.6 billion. Spearheading this explosion is manufacturing of the aforementioned goods, with garments growing 5.9 times and textiles 9.4 times. The rising star is electrical equipment, which grew 54.8 times from a mere $65 million to a respectable $3.56 billion export industry (Boediono, 2016). With GDP growth averaging at 7.3% per year, Indonesia seems to be achieving its previous industrial dream not by producing the most advanced goods, but rather by producing goods that it could actually compete in. Steady progress was also being made on moving up the global value chain. As such, the field of struggle has given birth to the Asian Tiger of Indonesia.

The Long Shadow of Rent

Unfortunately, that period is now long gone for Indonesia. The country’s ambitious industrialization projects, both the inward-looking and outward-looking ones, ultimately failed to end its dependence on natural resources. In quite a cliché, the government of today is betting the economy heavily on downstreaming, particularly in the nickel industry, to move Indonesia further up the global value chain. Rather than simply exporting raw nickel ore, the ambition is to develop an ecosystem of smelters, batteries, and eventually electric vehicles. Yet Indonesia’s broader economic structure remains heavily tied to commodities. The IMF (2024), for instance, notes that Indonesia faces persistent productivity and diversification challenges, with its manufacturing sector continuing to lag behind ASEAN peers in complexity and value added.

Why then does Indonesia’s more sophisticated form of resource-funded industrialization still show a lack of diversified industrialization? Warburton (2024), in her study of Indonesia’s nickel industry, describes the emergence of what she calls nationalist enclaves: industrial complexes that satisfy the government’s ambition to develop domestic processing industries but remain economically disconnected from much of the domestic economy. Their growth relies heavily on narrow networks of politically connected capital, with limited benefits spreading beyond these networks. As a result, their incentives are increasingly tied to what the state could provide instead of what is competitive in the market.

Perhaps, then, the problem is not resource wealth itself, but what political and economic actors can gain from controlling it. These resource rents–the economic surplus generated from exploiting natural resources–incentivize rent-seeking behavior: pursuing economic gains through political influence and access. Such behaviors have plagued Indonesia since the days of the oil boom. Robison (1988) illustrates how the emergence of Indonesia’s capitalist class was closely tied to its relationship with the state. Preferential licences, monopolies, subsidies, and protection from foreign competition created opportunities for politically connected conglomerates to accumulate wealth. The outcome is that maintaining access to state-granted privileges could be more profitable than improving efficiency or technological capabilities.

The true scale of this rent-seeking environment was catastrophic. By the mid-1980s, over 200 SOEs and inner-circle cronies held exclusive import monopolies, subsidized bank credits, and high tariff protection across strategic sectors (Verico & Pangestu, 2020). The quintessential symbol of this institutional breakdown was the 1975 Pertamina crisis, where unbridled expansion into non-core ventures, ranging from steel plants to airlines and luxury real estate, led the state oil monopoly to accumulate an astounding $10.5 billion in total debt (Boediono, 2016). This debt exceeded the entire state budget and the total sovereign external debt of the Republic of Indonesia at the time, forcing the government to dedicate 25% to 40% of its total foreign debt servicing between 1976 and 1979 just to absorb the bailout. The state was forced to pay the price of rent-seeking behavior.

When access to state-allocated rents generates returns that vastly outweigh market-driven innovation, corporate success becomes a matter of whom they know. This was one of the enduring weaknesses of Indonesia's oil-funded industrialization, and it remains a concern in today's resource-driven ambitions. The industries may have changed, but the challenge of turning resource wealth into lasting productive capabilities has not.

The Curse That We Chose

Perhaps, then, oil itself was never Indonesia's curse. It was a fortune buried beneath its soil, one that could have laid the foundations of an industrial powerhouse. It financed an industrial dream that seemed within reach. Yet fortunes can turn these factories into unsustainable white elephants, empowering only the few who control the wells. Indonesia's tragedy was never that it struck oil, but that it failed to turn enough of that wealth into lasting productive strength. The wells will eventually run dry. The smelters may one day fall silent. And when the last barrel is gone, what will remain? A nation that built an industry or one that merely learned how to live off its next windfall?

References

Boediono. (2016). Ekonomi Indonesia: Dalam lintasan sejarah. Mizan Pustaka.

Chant, J., & Pangestu, M. (1995). An assessment of financial reform in Indonesia, 1983–90. In G. Caprio, I. Atiyas, & J. A. Hanson (Eds.), Financial reform: Theory and experience (pp. 223–275). Cambridge University Press. https://doi.org/10.1017/CBO9780511571879.011

Gelb, A. H. (1988). Oil windfalls: Blessing or curse? Oxford University Press.

International Monetary Fund. (2024). Indonesia: Selected issues (IMF Staff Country Reports No. 2024/271). https://doi.org/10.5089/9798400284663.002.A001

Robison, R. (1988). Authoritarian states, capital-owning classes, and the politics of newly industrializing countries: The case of Indonesia. World Politics, 41(1), 52–74. https://doi.org/10.2307/2010479

Thee, K. W. (2012). Indonesia's economy since independence. Institute of Southeast Asian Studies.

Verico, K., & Pangestu, M. E. (2020). The economic impact of globalisation in Indonesia (ERIA Discussion Paper Series No. 338). Economic Research Institute for ASEAN and East Asia. https://www.eria.org/uploads/media/discussion-papers/The-Economic-Impact-of-Globalisation-in-Indonesia.pdf

Warburton, E. (2024). Nationalist enclaves: Industrialising the critical mineral boom in Indonesia. The Extractive Industries and Society, 20, Article 101564. https://doi.org/10.1016/j.exis.2024.101564