The Incremental Capital Output Ratio (ICOR) is gaining attention in Indonesia as a tool to evaluate capital investment efficiency and economic output. It is evident that a favorable ICOR result can significantly impact a nation's growth. However, an unfavorable ICOR result may present challenges to a nation, necessitating appropriate policy responses. Additionally, a comparative study may be needed to learn and implement key strategies from other countries as lessons learned. Find out more our insights about this topic in our Legal Brief publication.

1. Legal Brief
Reducing the Incremental Capital Output
Ratio (ICOR) from a Legal Perspective

2. BACKGROUND
ICOR Influences in Macro Economic Growth
The Incremental Capital Output Ratio (ICOR) is a ratio number representing investment to Gross Domestic Product and serves as one of the
macro indicators of an economy's efficiency level. The lower the ICOR value, the higher the efficiency level of investment and it needs to
be controlled in order to encourage economic growth.
The Importance of Efficiency in Macro Economic Growth
Efficiency in macroeconomic growth is of paramount importance as it plays
a key role in enhancing productivity and optimal resource allocation.
Efficiency allows for the more effective utilization of resources, which in turn
boosts productivity.
By maximizing output from every input used in the production
process, economies can produce more goods and services with the
same resources.
Origins of ICOR and Evaluation Overtime
• the Harrod-Domar Growth model suggested that the ICOR could be a key variable to
link investment requirements with targeted rates of economic growth. They stated that the
rate of growth of output is determined by the rate of saving and the ICOR,
• Some countries currently use the ICOR as a consideration in their economic decision-
making to gauge investment efficiency and prioritize projects with higher investment returns.
ICOR Condition in ASEAN Countries
ICOR Level: ICOR of Indonesia currently stands at 6.8 percent, higher than Malaysia's 5.4 percent, Philippines at 4.1 percent, or even
Vietnam at 3.7 percent.
ICOR Impact on Policymaking: Governments in ASEAN are increasingly focusing on enhancing investment efficiency, promoting
innovation, improving infrastructure, and addressing regulatory bottlenecks to lower ICOR values and achieve sustainable economic growth.
Causes of ICOR: Investments in infrastructure, manufacturing, and services sectors contribute to economic growth, but challenges such as
infrastructure gaps and regulatory constraints may lead to slightly higher ICOR values compared to developed economies.
Evaluation of ICOR in ASEAN: Developed economies tend to have lower and more stable ICOR values, newly industrialized and
developing economies may experience fluctuations in ICOR due to infrastructure challenges and policy interventions aimed at accelerating
growth and development.
(Walters, 1966)
(IMF, 2015)
(Walters, 1966)
A H R P L e g a l B r i e f

3. Criticisms about ICOR The Purpose of ICOR
According to several economic experts, there are
criticisms about ICOR. One of the criticisms is that its
utility is limited due to constraints posed by the varying
levels of technological advancement in different
countries. Critics argue that there is a ceiling on the
efficiency that countries can achieve based on their
current technological capabilities. For example, while a
developing country may be able to significantly boost
its GDP using a fixed amount of resources, a
developed country may struggle to achieve comparable
growth rates.
The objective of the ICOR is to measure a country's
investment efficiency in generating economic growth.
This is achieved by comparing the additional
investment required with the economic output growth
generated by such investment. The lower the ICOR,
the more efficient the utilization of capital to achieve
the desired economic growth.
Benefit of ICOR
Long-Term Economic Planning: By monitoring
ICOR, the country can make long-term economic
planning decisions. They can adjust their investment
policies to achieve economic growth targets in the
most efficient manner.
Evaluation of Investment Efficiency: ICOR assists
the country in evaluating their investment efficiency.
The lower the ICOR, the more efficient the utilization
of capital to achieve the desired economic growth.
Identification of Economic Issues: Fluctuations in
ICOR can indicate issues within a country's
economy. If ICOR significantly increases, it could
signal inefficiencies or structural impediments in the
economy that need addressing.
Policy Determination: Based on ICOR analysis, the
country can develop policies aimed at enhancing
their investment efficiency. This may include
incentives for specific sectors, infrastructure
improvements, or other policy reforms.
The Benefit of ICOR for National Economic Growth
Source: The Quarterly Journal of Economics
Source: BPS, 2019
Source: kompas.com
A H R P L e g a l B r i e f
01 02
03 04
Purpose, Benefits, and
Criticism of ICOR

4. A H R P L e g a l B r i e f
Input Factors for Annual Investment
Input Factor Annual Increase in GDP
ICOR Mathematical Representation
Adjusted ICOR*
Mathematical Representation
ICOR Calculation for Sectoral Analysis
ICOR Calculation for Sectoral Analysis is the process of measuring the relationship between capital investment and output
expansion within specific economic sectors. It involves collecting data on investment and output, calculating incremental capital and
output, and using the ICOR formula. The results are used to evaluate investment efficiency in specific sectors, compare sectors, and aid in policy
decision-making.
*Adjusted ICOR is a modified version of the traditional ICOR that incorporates adjustments to
account for various factors affecting investment efficiency and economic growth
Various components or determinants that contribute to
the increase or growth of the capital stock within an
economy over time such as investment, savings,
infrastructure development, and human capital.
Input Factors for Growth Rate of Capital
Input Factor for Growth Rate of Output
Various factors of production that contribute to the
expansion of an economy's output or Gross Domestic
Product (GDP) such as capital and labour.
Input Factor for Capital Output Ratio
Resource or component that is utilized in the
production process to generate output this includes
physical capital, human capital, and financial capital.
Change in Gross Domestic Product (GDP) over a specific time
period, typically a year.
Contains the amount of capital investment made within a specific
time period, typically a year, towards input factors such as
machinery, equipment, infrastructure, technology, and human capital.
(Walters, 1966)
Aspects in
Calculating ICOR

5. A H R P L e g a l B r i e f
Source: The Quarterly Journal of Economics
ICOR Level Influences Access to Credit
ICOR Level Represents Macroeconomic Stability
The Impact of ICOR on Investment Decisions by Business Actors
• The level of ICOR serves as an indicator of macroeconomic stability. ICOR measures the efficiency of capital investment in
generating additional output in an economy.
• A stable ICOR suggests a balanced relationship between investment and output expansion, indicating efficient resource allocation and
sustainable economic growth.
• Fluctuations or trends in ICOR levels can signal changes in investment efficiency, productivity, and economic performance, providing
valuable insights for policymakers and analysts to monitor and manage macroeconomic stability.
• Countries with lower ICOR values are often perceived as more attractive investment destinations by lenders and creditors, as
they demonstrate greater potential for generating returns on investment.
• Consequently, such countries may enjoy easier access to credit facilities, lower borrowing costs, and improved financial conditions,
facilitating economic growth and development.
• Conversely, higher ICOR values may deter lenders due to concerns about inefficient resource allocation and lower productivity, leading
to tighter credit conditions and higher borrowing costs for the country.
• Business actors, such as companies and investors, analyze ICOR as part of their investment decision-making process to
assess the efficiency and potential returns of capital investments.
• A lower ICOR indicates higher investment efficiency, meaning that less capital is required to produce additional output, which may
attract more investment.
• Conversely, a higher ICOR suggests lower investment efficiency, potentially leading to reduced investment interest.
Source: The Quarterly Journal of Economics
Source: The Quarterly Journal of Economics
The Implication of
ICOR

6. A H R P L e g a l B r i e f
ICOR as a Tool for Policy Development
ICOR’s Role in Evaluating Economic Development Strategies
Lesson Learned from ICOR in ASEAN
• ICOR serves as a quantitative measure enabling policymakers to assess the efficiency of capital investment in various sectors,
providing valuable insights into resource allocation and investment prioritization.
• By analyzing ICOR values, policymakers can identify sectors where capital investment generates higher output returns, allowing
for targeted policy interventions to stimulate economic growth and development.
• ICOR analysis empowers policymakers to formulate evidence-based policies aimed at improving investment efficiency, fostering
innovation, and enhancing productivity, thereby contributing to long-term economic sustainability and prosperity.
• ICOR also serves as a diagnostic tool, enabling policymakers to dissect the effectiveness of various strategies in translating
capital investment into tangible output. growth.
• Through ICOR analysis, policymakers can pinpoint bottlenecks, inefficiencies, or areas of success, fostering informed decision-
making and the refinement of development agendas.
• ICOR analysis serves as a reliable gauge, aiding in the calibration of policy instruments and resource allocation to drive sustainable
development outcomes
Capital per Worker have a negative and significant effect on ICOR
• ASEAN countries need to improve the quality of education through increased investment in education, both by the
government and the private sector, especially in professional education that is oriented to the world of work such as vocational and
vocational education.
• There is a need to harmonize the educational curriculum with the needs of the labor market. So that
unemployment, job mismatches, and weak technology diffusion processes that may occur
can be avoided and facilitate the process of investment efficiency.
Trade Openness have a positive and significant effect on ICOR
• There is a need for regulations to select FDI flows into economic sectors that are tailored to the needs and potential of the
resources they have, require technology transfer for multinational companies or provide license agreements to avoid monopolistic
practices in the domestic market in line with the entry of multinational companies.
• ASEAN are trying to increase promotion and competitiveness through monetary and fiscal incentives as well as creating
investment policies that are more transparent, attractive, and competitive.
(Walters, 1966)
(Walters, 1966)
(Utomo, 2023)
Application of ICOR in Policy Analysis

7. A H R P L e g a l B r i e f
Government Regulation Number 24 of
2019 on Provision of Investment
Incentives and Facilitation in the
Region
This Regulation is issued with the aim of
enhancing investment and ease of doing
business, supporting economic growth,
and encouraging the participation of the
community and private sector in regional
development through the provision of
investment incentives and/or facilitation
by the Regional Government. This
Regulation provides incentives in the
form of fiscal and non-fiscal incentives.
Fiscal incentives may include tax
reductions and the like, while non-fiscal
incentives are more related to providing
special treatment and services to
businesses.
Government Regulation In Lieu of Law
Number 2 of 2022 on Job Creation
This regulation aims to streamline
regulations related to the labor market and
investment, enhance economic
competitiveness, promote inclusive economic
growth, and create more numerous and
quality job opportunities. This regulation
covers 1) the enhancement of the investment
ecosystem and business activities; 2)
employment; 3) facilitation, protection, and
empowerment of Cooperatives and Micro,
Small, and Medium Enterprises (MSMEs); 4)
ease of doing business; 5) support for
research and innovation; 6) land
procurement; 7) economic zones; 8) Central
Government investment and acceleration of
national strategic projects; 9) government
administration implementation.
Government Regulation Number 5 of 2021
on The Organization of Risk-Based
Business Licensing
This regulation constitutes the implementation
framework within the investment sector. The
implementation of risk-based licensing
endeavors aims to enhance the investment
ecosystem and business activity by facilitating
the issuance of business licenses more
effectively and simply. This regulation
elucidates that a Business License constitutes
the legal authorization granted to business
actor to initiate and conduct their business.
Meanwhile, the risk denotes the potential for
injury or loss arising from a peril or
combination of possibilities and consequences
of danger. Furthermore, risk-based business
licensing refers to licensing based on the level
of risk associated with business activities.
Sri Mulyani
Minister of Finance
In evaluating Incremental Capital Output Ratio (ICOR), it's essential to consider various fundamental factors that
could influence its interpretation. Apart from the technological aspect, Human Resources (HR) play a pivotal role,
often constrained by educational deficiencies and limited skills. Hence, enhancing the quality of human resources
becomes imperative. To address this, the government is actively promoting fiscal policies aimed at prioritizing
human capital development. One strategy involves allocating a substantial portion of the State Budget (APBN),
specifically 20 percent, towards education expenditure. However, challenges persist, including inadequate
infrastructure and the complex and ambiguous nature of licensing processes.
High ICOR in Indonesia
Solution for Reducing ICOR
The Current Legal Framework in Indonesia concerning Efforts to Reduce ICOR
Increasing investment in and
construction of infrastructure
Regulatory reforms aimed at creating a
more investment-friendly climate
Improving the standard of
education and optimizing the
utilization of education incentives
Source: Economics and Finance in Indonesia Journal
Addressing High ICOR in Indonesia

8. Policy Implications of ICOR Analysis
and Challenges
Challenges Impacting ICOR Efficiency in Indonesia
Infrastructure Deficiencies
Inadequate infrastructure can lead to inefficiencies in
the economy, increasing the ICOR. Challenges such
as unreliable power supply, inadequate
transportation networks, and limited access to digital
technologies can hinder effective capital utilization.
Skill Mismatches
A mismatch between the skills of the workforce and
the needs of industries can lead to ineffective use of
investments. Despite high levels of education, the
workforce may not have the specific skills required
for the most productive sectors.
Regulatory and Bureaucratic Barriers
Complex regulatory frameworks and bureaucratic
inefficiencies can deter investment and slow down project
implementation, leading to higher ICOR. These barriers
can particularly affect sectors critical for economic
growth.
Regulatory and Bureaucratic Barriers
Complex regulatory frameworks and bureaucratic
inefficiencies can deter investment and slow down project
implementation, leading to higher ICOR. These barriers
can particularly affect sectors critical for economic
growth.
Strategic Directions for Optimizing ICOR
01
02
03
04 Policy and Regulatory Streamlining: Advocate for the
simplification of regulatory processes to facilitate easier
and more efficient capital investment, particularly in
business setup, expansion, and operational procedures.
Investment in High-Impact Sectors: Prioritize investments in
critical infrastructure, focusing on sectors that will yield the
most significant improvements in productivity and reduce
logistical costs. This includes transportation, energy, and
digital infrastructure.
Innovation and Research & Development (R&D): Foster a
culture of innovation through supportive policies for R&D
activities, including tax incentives, grants, and public-private
partnerships.
Education and Workforce Development: Reform the
education system to better align with industry needs,
emphasizing STEM (Science, Technology, Engineering,
and Mathematics) education and vocational training.
Partnerships with the private sector can help ensure that
training programs are relevant to the job market.
Actionable Policy Reforms
• Accelerated Infrastructure Development: Launch targeted infrastructure projects with clear timelines and accountability mechanisms to
address critical gaps in transportation, energy, and digital connectivity. Advocate for the creation and enforcement of legal frameworks that
support public-private partnerships (PPPs) in infrastructure projects.
• Skills Enhancement and Vocational Training Programs: Implement legal mandates requiring industry sectors to participate in national
skills development programs. This could involve amendments to labor laws to include provisions for continuous learning and upskilling.
• Comprehensive Regulatory Overhaul: Initiate a thorough review and simplification of existing regulations affecting business investments,
with a focus on reducing bureaucratic red tape and facilitating a more conducive business environment.
• Enhanced Financial Inclusion Strategies: Develop and implement financial reforms to improve access to capital for SMEs and startups,
including through non-traditional financing mechanisms such as venture capital, crowdfunding, and fintech solutions. Legal reforms should
also address collateral requirements, bankruptcy laws, and other financial regulations to reduce the risk for both lenders and borrowers,
encouraging a more dynamic and inclusive financial ecosystem.
A H R P L e g a l B r i e f

9. • Focused Industrial Policy: The government identified and
supported potential growth sectors with a mix of protective
measures and incentives for technological innovation.
• Technology and Productivity: Adopted a continuous
improvement philosophy (Kaizen) and effectively utilized
foreign technologies to improve industrial productivity.
• Capital Allocation Efficiency: The financial system, including
the main bank system, played a crucial role in efficiently
directing capital to productive industries.
Comparative Study: Analysis of Low ICORs During
Rapid Industrialization in South Korea and Japan
South Korea’s Industrialization
“Miracle on the Han River”
1960-1980
Japan's Economic Miracle
1950s-1970s
• The average annual GDP growth rate from 1962 to 1989
was approximately 8.6%, peaking at over 10% during
several years in the 1960s and 1970s..
• In the 1970s, the government focused on developing heavy
and chemical industries, including steel, automotive,
shipbuilding, and chemicals. This required significant capital
investment, which was efficiently utilized, reflecting in the
country's low ICOR during this period.
• Exports grew from a mere $33 million in 1961 to over $17
billion by the end of the 1970s. The export-oriented
industrialization strategy significantly contributed to the
efficient use of capital and economic growth.
• Post-WWII, Japan experienced extraordinary economic
growth, known as the "Economic Miracle," with an average
annual GDP growth rate of around 9.7% between 1955 and
1973.
• Emphasis on quality, innovation, and efficiency, particularly in
manufacturing (e.g., automotive and electronics industries),
played a critical role in Japan's industrial success.
• High levels of investment in education resulted in a skilled and
disciplined workforce. The system of lifetime employment in
large firms fostered company loyalty and facilitated on-the-job
training.
• Government-Led Industrial Policy: Directed investments
towards high-growth industries like steel, electronics, and
automotive, leveraging protectionist policies and export
incentives.
• Technological Advancement: Emphasized technology
adoption and R&D, fostering innovation and enhancing
productivity.
• Human Capital Development: Invested heavily in
education to build a skilled workforce, supporting the
demands of growing industries.
Facts
Key Strategies
Comparative Analysis
• Strategic Government Intervention: Both South Korea and Japan benefited significantly from strategic government intervention, which
identified and supported key industries for development through policies, subsidies, and infrastructure investments. Effective government
policy and support play a crucial role in guiding economic development and ensuring capital is directed toward sectors with the highest
potential for growth and efficiency.
• Investment in Technology and Innovation: Japan and South Korea prioritized technological advancement and innovation, investing
heavily in R&D and adopting technologies to enhance productivity and product quality.
• Human Capital Development: Both countries placed a strong emphasis on education and skill development, creating a highly skilled
workforce capable of supporting industrial growth and innovation.
• Focus on Export-Led Growth: Export-led growth strategies were central to the economic development models of both countries, enabling
them to penetrate international markets and benefit from economies of scale.
A H R P L e g a l B r i e f

10. We will continue to follow the developments on this topic and provide additional information as it
becomes available. If you have any questions on this topic, please contact:
This publication has been prepared by AHRP for educational and informational purposes only. The information contained in this publication is not
intended and should not be construed as legal advice. Due to the rapidly changing nature of law, AHRP makes no warranty or guarantee
concerning the accuracy or completeness of this content. You should consult with an attorney to review the current status of the law and how it
applies to your circumstances before deciding to take any action.
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