Dynamics of Income Inequality, Investment, and Unemployment in Indonesia

Abstract

This paper examines the effect of per capita income, investment, and unemployment on income inequality in Indonesia from 2011 to 2019. We use both static and dynamic panel data approaches covering 34 provinces in Indonesia. The results support the Kuznets hypothesis, whereby a more significant per capita income growth is associated with more substantial income inequality in a short period; however, this decreases over time (sign change). Furthermore, a larger real per capita income is associated with lower inequality when accompanied by progress in human capital. Alternatively, foreign direct investment (FDI) and infrastructure expenditure positively relate to income inequality, although FDI eventually helps lower inequality. Similarly, increases in domestic private investment can help to reduce income disparity. Meanwhile, unemployment is negatively associated with income inequality, suggesting that better jobs (rather than more jobs per se) are needed to improve income distribution in the country. Although per capita income, investment, and employment have improved substantially and helped Indonesia raise overall income, economic progress does not seem to have been inclusive. We argue that the panel dynamic model helps to capture the persistence effect of income distribution, suggesting a more precise estimation of income inequality issues than static models.