Relying on firm-level data from Statistik Industri this note analyzes the evolution of productivity dynamics of Indonesian
firms over the past 20 years (1990-2009). Economy-wide and sectoral productivity changes are decomposed into their
two main components: changes due to the evolution of average productivity and changes due to “allocative efficiency”.
This decomposition shows that while during the 20 years both components have increased, the changes in allocative
efficiency have been mainly driven by average productivity growth and less by increases in allocative efficiency, even
if the latter has also improved during the period under analysis. Interestingly, the note shows that both average TFP
growth and allocative efficiency improvements are especially driven by a few sectors: electronics, machinery and
instruments, and textiles, clothing and footwear. Limited improvements in both allocative efficiency and average TFP
have occurred instead in natural-resource-based sectors — sectors characterized by more limited competition and
higher rents. This note emphasizes the importance of “allocative efficiency” for productivity evolution because, in
a context where firms are very different in their productivity, it becomes crucial how resources are allocated in the
economy. This series of policy notes suggests that regulatory reforms, exposure to foreign competition and access to
imported intermediate inputs are important determinants of allocative efficiency. The problem of a “missing middle”
is closely related to that of sub-optimal allocation of resources across firms: a strong feature of Indonesian firm-size
distribution. Going further, the note suggests that burdensome regulations and imperfect financial markets are two
important causes of this missing middle. To complement the focus on productivity, the note also analyzes firm-level
job dynamics and points to the crucial role of “start-ups” and new companies as a key driver of job creation. This
finding suggests that the focus of policymakers on SMEs may be misplaced and that this focus should start realigning
towards supporting more dynamic “start-ups” rather than SMEs.