Contributors: Macroeconomic, Finance, and Political Economy Research Group

Introduction

Indonesia’s middle class has long been viewed as a pillar of economic stability and growth. Characterized by higher consumption patterns and an emphasis on quality of life, the middle class plays a crucial role in supporting Indonesia’s economic resilience and social stability. However, a recent study from the Indonesia Economic Outlook Q3-2024 report highlights concerning trends: the middle class is not only shrinking but also experiencing a loss of purchasing power, posing challenges to the nation’s growth prospects and broader economic goals.

The contraction of the middle class, alongside an increase in the vulnerable and aspiring middle class segments, indicates underlying economic challenges. Understanding this trend is essential for policymakers aiming to achieve Indonesia’s long-term development goal of becoming a high-income nation by 2045. The report’s findings offer insights into these dynamics and suggest the need for transformative policy measures to reverse the middle class’s downward trajectory.

Defining the Middle Class in Indonesia

In Indonesia, the middle class is more than just an income bracket—it represents economic stability and security. The Indonesia Economic Outlook report adopts the World Bank’s definition, which describes the middle class as individuals with less than a 10% chance of falling into poverty or vulnerability, given their current consumption levels. This classification includes those who can allocate income to discretionary spending beyond basic needs, encompassing a diverse group with aspirations for upward mobility.

While definitions may vary, most scholars agree that a robust middle class is essential for sustainable economic growth. The middle class is associated with entrepreneurship, human capital accumulation, and consumer demand for quality goods, all of which drive innovation and wealth creation. The shrinking of this group signals not just economic risk but also a setback for Indonesia’s broader goals of reducing inequality and enhancing quality of life for its citizens.

A Concerning Trend: The Shrinking Middle Class

The report reveals a sharp reversal in middle-class expansion. Between 2014 and 2018, the middle class grew significantly, adding 21 million people and increasing its share from 15.6% to 23.0% of the population. However, this trend did not persist. By 2023, the middle class had contracted by over 8.5 million people, dropping its share to 18.8%. In contrast, the aspiring middle class, those who are close to economic security but remain vulnerable, grew consistently, now representing more than half of Indonesia's population. This shift indicates that many previously middle-class individuals are slipping back into lower economic brackets, highlighting a troubling decline in upward mobility.

The Erosion of Purchasing Power

One of the most striking findings of the report is the decline in the purchasing power of the middle class. The combined consumption of the middle and aspiring middle classes accounts for 82.3% of household spending in Indonesia, underscoring the critical role these groups play in driving domestic demand. However, recent trends show a divergence: the aspiring middle class has been increasing its share of consumption, while the middle class’s share has been declining since 2018. This suggests that the economic security and spending power traditionally associated with the middle class are deteriorating, with many families now focusing their budgets on necessities rather than discretionary spending.

Engel’s Law posits that as household income decreases, a larger proportion of spending is allocated to essential goods like food. Reflecting this principle, food expenditure among the middle class has increased from 36.6% in 2014 to 41.3% in 2023. For the aspiring middle class, food spending remains high at 55.7%. This shift is a worrying indicator that as disposable income dwindles, households are forced to allocate more funds toward essentials, leaving less for goods and services that drive economic diversification and growth.

Structural and External Factors Behind Middle-Class Decline

Several factors contribute to the shrinking middle class in Indonesia. Internally, structural challenges, such as limited job opportunities in high-value sectors, and a reliance on low-productivity sectors, particularly agriculture and low-value services, hinder upward mobility. Approximately 73% of the aspiring middle class and middle class work in low-productivity sectors. This trend limits wage growth and economic stability for these groups, further straining their economic security.

External pressures, including inflationary trends and a depreciating Rupiah, have exacerbated these issues. Rising costs of essentials and the growing reliance on imports due to local supply constraints mean that middle-class families are experiencing reduced purchasing power. This situation also has implications for the broader economy, as a weaker middle class limits the government's ability to raise tax revenues and finance public services.

Implications of a Shrinking Middle Class for Indonesia’s Economy

The contraction of the middle class has far-reaching implications. A smaller middle class can lead to lower tax revenue, given that the middle and aspiring middle classes collectively contribute 85.2% of Indonesia's tax receipts. Indonesia’s tax-to-GDP ratio remains low at 9.1%, and any decrease in middle-class income will likely reduce tax contributions further, limiting the government’s ability to invest in critical areas like infrastructure, healthcare, and education. Additionally, shrinking middle-class purchasing power could dampen overall economic growth, as household consumption is a major driver of GDP.

Moreover, the decline in economic security impacts social stability. The middle class has been a key player in fostering democratic governance and supporting social programs. If this group continues to shrink, it may weaken Indonesia’s social fabric, with potential repercussions for political stability and public trust in institutions.

Recommendations for Rebuilding and Expanding the Middle Class

Reversing the decline of Indonesia’s middle class requires transformative policies that address the root causes of economic insecurity. The following recommendations can serve as a roadmap for policymakers aiming to rebuild the middle class and support sustainable economic growth:

1. Promote Job Creation in High-Value Sectors: Investing in sectors such as high-value manufacturing, technology, and renewable energy can provide middle-class jobs and support wage growth. Creating incentives for companies to establish operations in these sectors could help improve job quality and stability.

2. Enhance Access to Education and Vocational Training: A well-educated workforce is crucial for moving up the economic ladder. Expanding access to secondary and tertiary education, particularly in rural areas, can equip individuals with the skills needed to secure higher-paying jobs and contribute to economic productivity.

3. Implement Social Safety Nets and Economic Support Programs: Expanding social assistance programs, including unemployment benefits and paid parental leave, can provide a safety net for those at risk of falling back into poverty. By enhancing economic security, these measures can reduce the likelihood of individuals slipping from the middle class into lower economic categories.

4. Address Housing and Living Quality Issues: According to the report, more than half of the aspiring middle class live in poor housing conditions. Developing affordable housing policies, including subsidies and low-interest loans, can improve living standards and reduce the financial strain on middle-class families.

5. Tackle Informal Employment and Promote Formalization: Over half of middle-class workers are in informal jobs, which often lack job security and benefits. Encouraging formal employment through tax breaks, subsidies, and simplifying labor regulations can make formal employment more attractive to businesses and improve economic security for employees.

6. Control Inflation and Stabilize the Currency: Effective monetary and fiscal policies are essential for managing inflation and stabilizing the Rupiah. Ensuring price stability for essential goods and reducing reliance on imports can help protect middle-class purchasing power.

Conclusion

The contraction of Indonesia’s middle class signals a critical economic challenge that, if left unaddressed, could impede the nation’s journey toward high-income status. With the middle and aspiring middle classes making up 72.2% of the population and driving a majority of household consumption, the health of these groups is essential to sustaining economic growth and social stability. Policymakers must prioritize strategic interventions that address both short-term challenges, such as inflation, and long-term structural issues, including labor mobility and job creation in high-value sectors.

The findings from the Indonesia Economic Outlook Q3-2024 report underscore the urgency of protecting and expanding the middle class. By fostering an environment that supports economic security and upward mobility, Indonesia can pave the way for a resilient, inclusive economy that benefits all citizens.

Acknowledgment: This article is based on insights from the Indonesia Economic Outlook Q3-2024 report by the Macroeconomic, Finance, and Political Economy Research Group. Special thanks to Jahen F. Rezki, Ph.D., Teuku Riefky, Faradina Alifia Maizar, Muhammad Adriansyah, and Difa Fitriani for their invaluable contributions to understanding the dynamics of Indonesia’s middle class.