We don’t understand “Knowledge Transfer” enough to get the most out of it
A way out of the middle-income trap we’ve yet to master
The author is a policy analyst in the Coordinating Ministry for Economic Affairs. He works in the area of economics, international relations, and sustainable development. This article reflects the author’s own analysis and views and does not necessarily represent those of The Reformist.
Whenever an agreement is signed, whether for a trade deal, Foreign Direct Investment (FDI), or defense procurement, there is almost always a clause on knowledge transfer, capacity building, or what some call ‘offsets’. It has become customary among negotiators, officials, and delegations alike, while ministers often announce it as a major win.
But what of its implementation? In practice, the clause may shrink to a mere operational training program. Or to a group of engineers spending two weeks at a foreign factory before returning home to operate the same machine with the same instructions. This is where the real question begins: what is knowledge transfer actually supposed to achieve, and why should Indonesia revisit it as both an engine of economic growth and a pathway out of the middle-income trap?
Learning to “catch up” from East Asian countries
For developing countries, the importance of knowledge transfer lies within the convergence hypothesis. Economists often refer to it as the “catching-up effect.” The basics are simple: developing countries begin with low income levels, then they grow faster for several decades than countries that are already developed, eventually narrowing the gap. How? These developing countries absorb and adopt technologies that advanced economies spent decades building.
We have witnessed this pattern before. Japan rebuilt its industrial base after World War II by licensing foreign technology, systematically building domestic R&D capacity, and graduating from imitation to innovation within a generation.
Or, as the saying goes: “amati, tiru, modifikasi” — observe, imitate, modify.
South Korea followed a similar path through state-directed industrial policy, investment in human capital, and efforts to push up the value chain, from textiles to semiconductors and automobiles. More recently, China rose by leveraging market access to extract technology transfer commitments from foreign firms while simultaneously building domestic capabilities.
All of them displayed a familiar economic arc: poor beginnings, decades of high-speed growth, and eventual convergence toward the more stable, though slower growth patterns characteristic of developed economies like those in Europe
But what about Indonesia? Our country has started this journey as well. Indonesia entered upper-middle-income status in 2023, with a GNI per capita of approximately US$ 4,810 (the high-income threshold is around US$ 13,935). With growth hovering around 5 percent in recent decades, the catching-up effect remains, but is not strong enough. To escape the middle-income trap, Indonesia likely needs growth above six percent, which means we need stronger and more sustainable growth engines.
An engine that actually drives growth: Total Factor Productivity
According to basic economic theory, output is driven by capital, labor, and a residual factor that cannot be fully explained by the first two, which economists now call Total Factor Productivity (TFP), where knowledge, technology, innovation, and institutional efficiency reside.
This is where the Indonesian story becomes interesting. Data from the Penn World Table (PWT) show that Indonesia’s output per worker has remained sluggish (hovering below 2 percent) since 2019, while TFP growth has largely stagnated. A study published by Universitas Indonesia also found that Indonesia’s human capital growth has been among the weakest among peer countries, while economic growth has remained concentrated in a limited number of sectors.
This is deeply connected to our discussion on knowledge transfer. Put simply, when we talk about improving productivity, we essentially talk about raising TFP. Physical capital like toll roads, factories, ports, and machinery will eventually face diminishing returns. Labor expansion also has limits. But TFP, if managed correctly, can continuously raise the productivity of both capital and labor. Knowledge transfer, when done properly, is one of the mechanisms that drive TFP growth.
Knowledge flows like water, but our “pipe” is narrow…
There is, however, an important caveat in the catching-up literature: technology does not transfer automatically. Even if foreign parties are willing to transfer it freely, which many are not, the knowledge behind any technology flows like water through a pipe. The width of that pipe can be understood as absorptive capacity: the ability of a country’s firms, workers, and institutions to receive, understand, adapt, and build upon foreign knowledge. A country with weak absorptive capacity may receive massive inflows of FDI and still extract very little meaningful knowledge or technological gain from it.
Absorptive capacity itself rests on at least three foundations: human capital; R&D investment; and institutional quality.
A technically skilled workforce improves the ability to absorb knowledge. Firms and universities engaged in active research can adapt technology tailored to local conditions. Strong institutions can create incentives for innovation through legal, regulatory, and market frameworks.
Indonesia still faces significant challenges in all three areas.
On R&D spending alone, Indonesia allocates only around 0.28 percent of GDP, roughly the same level as in 2019 and 2020. Compare this with South Korea at 5.32 percent, Japan at 3.4 percent, and China at 2.65 percent. Even Thailand, our peer in the upper-middle-income group, allocates more than 1 percent.
Some studies also find an uncomfortable reality: R&D spillovers from multinational corporations (MNCs) can negatively affect domestic firms’ TFP due to intense product-market rivalry. In other words, foreign firms do not automatically create learning effects for local industries. Without domestic capability, they may simply dominate the market instead.
What are we missing?
The simplest diagnosis is that Indonesia is underinvesting in its ability to absorb knowledge transfer.
The discourse on knowledge transfer in Indonesia has remained fixated on the operational and managerial capability. How do we run this turbine? How do we follow these safety protocols? These are important questions, but they are questions about operating technology, not creating it. The deeper layer that separates a technology-adopting country from a technology-creating one involves understanding why the machine works the way it does. This includes the ability to modify it for local conditions and eventually design a better one ourselves.
Most training programs, operational courses, and manuals only transfer codified knowledge: procedures, modules, instructions, and technical documentation. But tacit knowledge is different. It lives inside the minds of engineers, researchers, doctors, and practitioners who have spent years solving problems in the field. It cannot be transferred through a two-week training session alone.
Tacit knowledge moves through deep collaboration, co-research, joint ventures, and sustained local involvement in real problem-solving processes. This is where the core ideas actually reside. Yes, Indonesia demands training programs from foreign firms, but often captures only the codified layer of knowledge and leaves the tacit layer untouched.
Decades later, despite numerous investment agreements, we may still find ourselves dependent on expatriate engineers for the most technically demanding operations within our own strategic industries.
What should we do?
This brings us back to the original point: Indonesia must revisit what actually constitutes knowledge transfer under agreements. Should the standard simply be operational training, or should it require measurable transfers of technical capability? There should be a stronger emphasis on joint R&D provisions, co-authorship in patents, localization of core engineering functions, and long-term collaboration between foreign firms and Indonesian researchers.
Indonesia’s downstreaming agenda is a promising start. But the goal should not stop at smelting nickel in Sulawesi (onshoring). The long-term objective should be to ensure that Indonesian engineers are eventually capable of designing the smelting process itself.
Scaling up R&D investment is also essential. Reaching at least 1 percent of GDP should be treated as a minimum target. We agree we have fiscal constraints, but incentives for private-sector R&D can be expanded, for example, through tax policy. Institutions such as BRIN should also be more closely aligned with industry-linked research that has clear commercialization pathways.
At the same time, Indonesia must better utilize its demographic bonus while addressing the mismatch between universities and industry. Prioritizing which technologies to pursue is equally important. As the World Bank has repeatedly argued, escaping the middle-income trap requires combining investment with both the absorption of foreign technology and the development of domestic innovation.
Thus, Indonesia cannot, and should not, attempt to catch up across every technological frontier simultaneously. Instead, we need a technology prioritization framework built around sectors where Indonesia possesses natural endowments, market scale, and demographic leverage: green energy technology, agri-food processing, and digital infrastructure.
In short, capital multiplied by labor becomes far more productive when boosted by TFP.
The knowledge transfer clause should be seen as an entry point, an institutional mechanism through which TFP can be seeded. But this only works if knowledge transfer is treated seriously, not as a diplomatic gesture or a checkbox requirement. It must instead be understood as a vehicle for one of the most consequential transformations available to a developing country: the shift from importing other people’s technology to creating our own.
Our founding fathers’ dream of a prosperous Indonesia will not be realized through the accumulation of machines and workers alone. It will be realized when Indonesian engineers, researchers, and entrepreneurs produce the knowledge that future agreements will require others to transfer.
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