Capacity Utilization in Indonesia: Time to Invest

The capacity utilization rate is an important economic policy variable. Low capacity utilization implies the economy has idle capacity, and increases in demand would lead to higher production. In contrast, high capacity utilization implies that the economy needs additional investment to increase production, and increases in demand would lead to more imports and inflation. Existing survey-based data on Indonesia’s capacity utilization is weak, and does not necessarily reflect the underlying true capacity utilization. This paper estimates Indonesia’s capacity utilization based on the output-capital ratio. The results suggest that the present capacity utilization rate is far above the historical average. Moreover, low levels of investment have pushed up the average age of installed capital, which raises concerns about the quality and productivity of installed capital. The current levels of capacity utilization should cause investment to pick up. However, this is not the case for Indonesia, where low investment is at levels not seen since the early 1970s, suggesting that the country’s weak investment climate is holding back investment.