Analysis of Investment Efficiency by using ICOR Approach to
Economic Growth in All Provinces of Sumatera Island
Anna Yulianita, Feny Marissa, Fera Widyanata, Annisa Fitriyah, Monica Marcheline
Faculty of Economics, Universitas Sriwijaya, Palembang, Indonesia
 fenymarissa, annayulianita 
Keywords: Investment Efficiency, ICOR, Economic Growth, Sumatra Island
Abstract: This study aims to describe the effect of investment efficiency through ICOR approach to the economic
growth of provinces on Sumatra Island between 2007 and 2016. Using the data panel and Fixed Effect
Model, this study confirms that ICOR has a negative correlation with the level of economic growth like has
been expected in the theoretical model and it also found that the ICOR coefficient is -0.21. The coefficient
shows the meaning that the increasing in investment efficiency through the decreasing one percent of ICOR
will boost the economic growth of ten provinces in Sumatra by 0.21 percent. Based on the ICOR project of
Sumatra Island 12,762 - 0,2144 * ICOR shows that investment use is more efficient in increasing economic
growth in 2007-2016. This research also shows that for the Province of North Sumatra, Riau Province,
Jambi Province, Bengkulu Province and Lampung Province have grown better than other provinces in
Sumatra Island in the same development stage without an increase in the proportion of investment to Gross
Domestic Regional Product.
1 INTRODUCTION
Ccommunity welfare in a region can be seen from
the high and low economic growth in the region. By
increasing the economic growth of a region, it is
expected that the income of the people in the region
will increase so each region will always make an
effort to reach the optimal economic growth to bring
its people to a better life.
The factors that determine a country's economic
growth are determined by four factors namely: (i)
capital accumulation, including all new investments,
such as land (land), physical equipment (machinery),
and human resources (human resources); (ii)
population growth; (iii) technological progress; and
(iv) institutional resources (institutional system)
(Arsyad, 2010).
The several factors that influence economic
growth above, Indonesia is one of the broadest
developing countries who have that all factors and
Indonesia is rich in natural resources, both marine,
forest and mining. and others. The abundance of
natural resources is widespread in all provinces in
Indonesia.
The Indonesian economy has experienced a
fluctuating growth in one windu. Since 2010,
Indonesia's economic growth has decreased from
6.81 percent and continues to decline each year to
reach 4.17 percent in 2015. However, in the
following years, the economy in Indonesia: a began
to make improvements. This was marked by an
increase in economic growth in 2015 and 2016
which was 5.02 percent and increased again to 5.07
percent. This condition can be seen in Figure 1
Source: BPS, 2017
Figure 1: Indonesian Economic Growth 2010-2017
(percent)
In terms of production, economic improvement
was driven by growth in almost all sectors of the
708
Yulianita, A., Marissa, F., Marcheline, M., Fitriyah, A. and Widyanata, F.
Analysis of Efficiency Investment by using ICOR Approach to the Economic Growth in All Provinces of Sumatera Island.
DOI: 10.5220/0008444307080714
In Proceedings of the 4th Sriwijaya Economics, Accounting, and Business Conference (SEABC 2018), pages 708-714
ISBN: 978-989-758-387-2
Copyright
c
 2019 by SCITEPRESS – Science and Technology Publications, Lda. All rights reserved

business sector in the economy. Sector that provides
a large portion of Gross Domestic Product, namely
the information and communication sector, other
services and the transportation and warehousing
sector.
In terms of expenditure, economic improvement
can be seen from the start of increased investment
and exports and imports. If seen from the spatial
economic structure, it is still dominated by
provincial groups in Java and Sumatra. In 2017, the
provincial group in Java made the largest
contribution to Gross Domestic Product, which
amounted to 58.49 percent, followed by Sumatra
Island at 21.66 percent.
Sumatra Island which has quite unique
characteristics and has a significant contribution to
the Indonesian economy because it is supported by
the availability of raw materials, energy sources,
labor, national markets and exports and the superior
location close to the shipping lanes in the Malacca
Strait.
According to the Indonesian Investment
Coordinating Board (BKPM) (2015), there are at
least some potential investments in Sumatra.
prepared by the government as a buffer for national
economic growth. Therefore, in line with the above
conditions, to optimize the use of natural resources
on the island of Sumatra, of course, sufficient
additional capital (investment) is needed to achieve
the targeted economic growth. This investment is
based efficiency in the use of investment in the
resources that are owned will only produce
economic growth that is not optimal. For this reason,
in order to achieve certain economic growth targets,
it is very necessary to estimate the investment needs
properly.
Harrod Domar's model relates the influence of
additional capital stock on output known as ICOR
Incremental Capital-Output Ratio. ICOR aprroach is
really needed in determining how much investment
needs at the level of economic growth that is
expected to grow and with ICOR approach, it can
see the efficiency of investments which has invested
in a certain period. The lower of the ratio means the
higher level of investment efficiency. The amount of
ICOR generally ranges from 2.0 to 5.0 with a
median value for more than 70 developing countries
between 3.0 to 3.5 (Arsyad, 2010).
Based on the above introduction, this study aims
to determine the effect of efficiency investment by
using ICOR indicator to economic growth in
provinces on the island of Sumatra. This research is
important in the economic development planning
process in Sumatera Island, so the author is
interested to discusses and analyzes "Investment
Efficiency in Provinces on Sumatra Island".
2 THEORETICAL FRAMEWORK
2.1 Adam Smith's Growth Theory
According to Smith (Arsyad, 2010), the main
elements of a country's production system are three,
namely:
1. The availability natural resources, which are
presented by the availability of land. According
to Smith, the available natural resources are the
most basic container of a society's production
activities. The amount of available natural
resources is the "maximum limit" for the growth
of an economy.
2. Human resources, represented by the
population. Human resources play a passive role
in the process of increasing output.
3. Accumulated capital owned. According to
Smith, the stock of capital plays the most
important role in economic development. Stock
capital can be identified as a development fund,
the rapid pace of economic development
depends on the availability of development
funds. In addition, capital stock is an element of
production that actively determines the level of
output. Its role is very central in the process of
output growth. The amount and growth rate of
output depends on the growth rate of the capital
stock in accordance with the "maximum limit"
of natural resources. In other words, output
growth will slow down if the "carrying
capacity" of natural resources is no longer able
to keep pace with the pace of economic
activities of the community.
Smith said, capital must be done first than the
division of labor. Smith considers capital
fertilization as an absolute condition for economic
development, thus the problem of broad economic
development is the ability of humans to save more
and invest more. "The capital of a nation increases in
the same way as increasing individual capital by
cultivating and continually increasing the savings
they set aside from income. Therefore, the fastest
way is to invest capital in such a way that it can
provide the greatest income to the entire population
and also influence savings. Thus the level of
investment will be determined by the level of
savings and savings fully invested (Jhingan, 2012).
Analysis of Efficiency Investment by using ICOR Approach to the Economic Growth in All Provinces of Sumatera Island
709

2.2 Harrod-Domar Model
Harrod and Domar provide a key role for investment
in the process of economic growth, especially
regarding the dual character of investment. First,
investment creates income and both investments
increase the production capacity of the economy by
increasing the capital stock. Therefore, as long as net
investment continues, real income and output will
always increase. However, to maintain the
equilibrium level of income in full employment from
year to year, both real income and output must both
increase at the same rate when the productive
capacity of capital increases. If not, any difference
between the two will cause excess capacity or idle
capacity. This forces employers to limit their
investment expenditures so that it will ultimately
adversely affect the economy, namely lowering
income and employment in the next period and
shifting the economy out of the path of steady
growth in balance. So if work is to be maintained in
the long run, investment must always be enlarged
(Jhingan, 2012).
The center of attention of Harrod revolves
around economic growth which can take place
continuously in a pattern of stable equilibrium.
Harrod's theory has general growth criteria and
economic assumptions, namely:
1. The rate of economic growth is defined as g =
∆Y / Y;
2. The desire to save is a proportional part of
national income, s = S / Y;
3. Additional capital for a given period is the same
as the existing investment, ∆K = I
4. All savings are channeled in net investment, S =
I = ∆K so that s = S / Y = I / Y
5. ∆K / ∆Y is defined as ICOR (Incremental
Capital Output Ratio), denoted by k;
6. Then growth can be formulated as
𝑔 =
∆𝑌
𝑌
=
∆𝑌/𝐼
𝑌/𝐼
=
𝐼/𝑌
𝐼/∆𝑌
=
𝑆/𝑌
∆𝐾/∆𝑌
=
𝑠
𝑦
Which means that economic growth depends on
the tendency to save society (s) as well as measures
of economic efficiency (k) (Hakim, 2014).
2.3 Neoclassical Growth Theories
According to the Solow-Swan theory, economic
growth depends on the availability of factors of
production (population, labor, and capital
accumulation) and the level of technological
progress.
The Neoclassical model states that the mobility
of production factors, both capital and labor, at the
outset was not smooth. As a result, at that time
capital and skilled labor tended to be concentrated in
more developed areas so that development
inequality tended to widen (divergence). But if the
development process continues, with better
infrastructure and communication facilities, the
mobility of capital and labor will be smoother. Thus,
later after the country concerned has advanced, then
development inequality will decrease (convergence).
This estimate is known as the Neoclassical
Hypothesis (Tambunan, 2009).
2.4 Endogenous Growth (New Growth
Model)
Endogenous growth theory is the beginning of a
revival of new understanding of the factors that
determine long-term economic growth. In this case,
endogenous growth theory explains why capital
accumulation does not experience diminishing
returns, but instead experiences increasing returns
with specialization and investment in the field of
human resources. The difference with the Solow
model is that in Solow growth, savings will
encourage growth temporarily, but decreasing return
to capital will ultimately drive the economy in
steady state where growth depends only on
exogenous technological advances. Conversely in
endogenous growth models, savings and investment
can encourage sustainable growth (Nanga, 2005).
2.5 Investment Theory
Investment is the first step in production activities.
With such a position, investment in essence is also
the first step in economic development activities.
The dynamics of investment affect the high and low
level of economic growth, reflecting the widespread
lack of development. In an effort to grow the
economy, every country is always trying to create a
climate that can stimulate investment. The target is
not only the public or domestic private sector, but
also foreign investors (Dumairy, 1996).
The issue of investment in the era of regional
autonomy needs to be assessed in terms of the issue
of investment carried out in the regions, how the
regulation and control is carried out as well as the
issue of budget (budget) issued.
Since the enactment of Law No. 1/1967 jo. No.
11/1970 concerning Foreign Investment (PMA) and
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710

Law No. 6/1968 jo. No. 12/1970 concerning
Domestic Investment (PMDN), investment tends to
increase from time to time. However, in certain
years there was also a decline. The increasing trend
not only takes place in investments by the public or
the private sector, both PMDN and PMA, but also
investment by the government. This means the
formation of gross domestic capital increases from
year to year (Dumairy, 1996).
To get an overview of the development of
investment from time to time, there are three types
of methods (based on three clusters of data) that are
commonly done. First, by highlighting the
contribution of gross domestic capital formation in
the context of aggregate demand, namely seeing the
contribution and development of variable Investment
(I) in the national income identity Y = C + I + G +
(X-M). Data Investment (I) is the overall data on
gross domestic investment, including both
investment by the private sector (PMDN and PMA)
and by the government. The second way is to
observe PMDN and PMA data. In this way, we only
observe investment by the private sector. The third
way is to examine the development of investment
funds channeled by the banking world (Dumairy,
1996).
2.6 Investment Efficiency
Efficiency is an activity to use resources
appropriately, there is no waste of existing
resources. Companies usually make efficiency in
order to reduce costs and facilitate the process of
managing the company to easily achieve company
goals. Investment activities carried out by the
company must be efficient in order to give benefits
to the company. Investment efficiency is the optimal
level of investment from the company, where the
investment is a type of investment that is profitable
for the company (Suryana, 2014).
The indicator commonly used to measure
investment efficiency is Incremental Capital Output
Ratio or ICOR. According to the Central Bureau of
Statistics, (ICOR) is a quantity that shows the
amount of additional new capital (investment)
needed to increase / increase one unit of output. The
ICOR magnitude is obtained by comparing the
amount of additional capital with additional output.
Because unit capital forms are different and diverse
while output units are relatively not different, then to
facilitate calculation both are valued in terms of
money (nominal).
The ICOR concept was originally developed by
Harrod and Domar which later became known as the
Harrod-Domar model. This model basically shows
the relationship between output (regional income) of
an economy with the amount of capital stock
needed. Capital stock is the condition of the stock of
capital (capital goods) available at a certain time.
If you want to increase regional income by 1
unit, you need an additional capital stock of ICOR.
The capital stock in year t is basically the
accumulation of investment (capital goods) from a
given year (year (t-s)) where s = 1,2,3, …… up to
the t-year. Suppose an investment starts in the t-year
and continues until the year (t + 1), that is, the
condition is assumed to consist of only two years,
then the capital stock in the t-year and year (t + 1).
In calculating ICOR, the investment concept
used refers to the concept of the national economy.
Definition of investment referred to here is fixed
capital formation / formation of fixed capital goods
consisting of land, buildings / construction,
machinery and equipment, vehicles and other capital
goods. Meanwhile the calculated value includes: the
purchase of raw / used goods, large manufacturing /
repairs carried out by other parties, major
manufacturing / repairs carried out on its own, sales
of used capital goods. Fixed Capital Formation or
the formation of fixed capital goods in this case is
the formation of gross fixed capital goods (PMTB)
(BPS Calatog, 2008).
3 METHODOLOGY
The scope of this study is to analyze the investment
efficiency with ICOR approach in all provinces of
Sumatera Island and the impact on economic
growth. The study will be analyzed by using panel
data regression method. The data used is a
combination time series and cross section in the
form of annual data.
Observation period is adjusted to the availability
data from 2007 to 2016. The data will be analyzed in
this study include Gross Domestic Regional Product
(GDRP) data, Gross Fixed Investment and the rate
of economic growth of ten provinces in Sumatera
Island; Aceh Province, North Sumatera Province,
West Sumatera Province, Riau Island Province, Riau
Province, Jambi Province, South Sumatera Province,
Bangka Belitung Province, Bengkulu Province, and
Lampung Province.
This study analyzed the correlation of investment
efficiency by using ICOR approach to the economic
growth in all provinces of Sumatera Island. In this
case, investment efficiency which measured by
using ICOR approach can affect the economic
Analysis of Efficiency Investment by using ICOR Approach to the Economic Growth in All Provinces of Sumatera Island
711

growth. The lower value of ICOR means that
investment used more efficient. The impact of
efficiency investment used is the higher economic
growth.
This research plan will analyze the problem
based on the framework as in the following scheme:
Figure 2: Correlation of Investment Efficiency and
Economic Growth
In this study, the equation form is:
G
it
= β
0
+ β
1
COR
it
+ e
it
Where :
a : Constanta
G
it
: Economic growth in all provinces of Sumatera
Island
ICOR
it
: Incremental Capital Output Ratio in all
provinces of Sumatera Island
e : Error term
3.1 The Stages of Analysis
The steps of data panel analysis in this study are:
1. Estimating panel data regression using the fixed
effect model.
2. Perform the Chow test
a) If accepted, then the common effect model
(continue step 5).
b) If rejected, then the fixed effect model
(continue step 4).
3. Perform the Hausman test
a) If accepted, then the random effect model
(continue step 5).
b) If rejected, then the fixed effect model
(continue step 4).
4. Test assumptions on the selected model.
5. Conduct test of the significance of parameters
which include simultaneous test and partial test
with improved regression equation.
6. Dispose of several research variables that are not
in accordance with the theory.
7. Interpret the final panel data regression model
with the selected model.
3.2 Variable Operational
The limits of the variables contained in this study
are:
1. Economic growth
Economic growth is an increase in GRDP minus
the previous year's GRDP. Economic growth
used in this study is economic growth from 10
provinces in Sumatra, namely Nangroe Aceh
Darussalam, North Sumatra, West Sumatra,
Riau Islands, Riau, Jambi, South Sumatra,
Bangka Belitung, Bengkulu and Lampung in the
2007-2016 research period.
2. Investment Efficiency
Efficiency in this study is measured by the
calculation of the Incremental Capital Output
Ratio (ICOR) in 10 Provinces of Sumatra ICOR
approach shows the amount of additional
investment needed to increase one unit of output
(Central Statistics Agency, 2009). The lower
ICOR indicates an increase in efficiency.
3. Investment
The amount of investment is reflected by the
amount of Gross Fixed Capital Formation
(PMTB) and Stock Change (Central Statistics
Agency, 2009). Investment in this study is
PMTB in provinces (10 provinces) on the island
of Sumatra in 2007-2016. PMTB is the
procurement, manufacture, purchase of new
capital goods from within and outside the
country, minus the net sales of used capital
goods while stock changes are the difference
between the ending inventory with the initial
inventory at a certain period and which is
included in the stock calculation intermediate
goods in various economic sectors that have not
been used in the production or consumption
process.
4 RESULTS AND DISCUSSION
Equation obtained from the data analysis are:
G
it
= β
0
+ β
1
ICOR
it
+ e
it
Based on the results of all tests that have been
carried out, as in the Chow Test and Hausman Test
ICOR
Economic Growth of Provinces (10
Provinces) on Sumatra Island
Efficiency
Investment
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712

the results obtained are Fixed Effect Model. From
the regression results, obtained by the following
equation:
G
it
= 12.76245 – 0.21446ICOR
it
+ e
it
Based on the regression that has been done, the
constant C = 12,76245 showed that if the
independent variable is 0, then the economic growth
in all provinces of Sumatera Island still increase
12,76245 percent. ICOR coefficient indicates the
number -0,21446 which means when the other
variables equal to zero, an increase of one percent in
ICOR figures will have an impact on decreasing
economic growth of 0,21446 percent.
The estimation results for the variable economic
growth show the value of t-test probability is of
0,0922 < alpha 10% or 0,10, meaning ICOR
partially have significant impact on economic
growth.
Determination coefficient R
2
is used to calculate
how much variance of the dependent variable can be
explained by the independent variables. The R
2
value obtained by 0,270305. That is, the economic
growth amounted to 27,03 percent variable
community in the province of Sumatera Island (the
dependent variable) can be explained by the
independent variable in the model. While the
remaining 72,97 percent is explained by other
variables outside the model are held constant (ceteris
paribus).
The results of this study indicate that there is a
relationship quite significantly between investment
efficiency that measured by using ICOR approach to
economic growth in all provinces of Sumatera
Island. The mutually beneficial relationship between
investment efficiency which measured by using
ICOR approach and economic growth is caused by
the utilization of government budget for investment
produce optimal output so productivity is high and
hence a high economic growth in the provinces of
Sumatera Islands.
Based on Table 1, the individual effect each
provinces reflected from last intercept (C + Ci) by
using Fixed Effect Models. It shows that the value of
intercept each province in Sumatera is different.
This situation explains that the investment efficiency
variable which measured by ICOR approach has a
different level of influences to the economic growth
of each provinces in Sumatera Island. It shows that
for the Province of North Sumatera, Riau Province,
Jambi Province, Bengkulu Province and Lampung
province have grown better than other provinces in
Sumatera Islands in the same development stage
without an increase in the proportion of investment
to Gross Domestic Regional Product.
Table 1: Individual Effect of Province in Sumatera Island
Fixed Effects Cross
Coefficient
Individual Effect
(C+Ci)
_ACEH--C
-6.497783
6.264667
_SUMUT--C
0.317095
13.079545
_SUMBAR--C
-0.312264
12.450186
_RIAU—C
1.798647
14.561097
_JAMBI--C
2.427833
15.190283
_SUMSEL--C
-0.209247
12.553203
_BENGKULU--C
0.100765
12.863215
_LAMPUNG--C
3.015841
15.778291
_BABEL--C
-0.389937
12.372513
_KEPRI--C
-0.25095
12.5115
Source: Processed Data
5 CONCLUSION AND
IMPLICATION
The conclusions from the results of the study
include: (1) The relationship between ICOR and the
economic growth of Sumatra Island is negative; (2)
This research shows that for the Province of North
Sumatra, Riau Province, Jambi Province, Bengkulu
Province, and Lampung Province have grown better
than other provinces in Sumatra Island in the same
development stage without an increase in the
proportion of investment to gross Domestic
Regional Product.
It is expected that the government more concern
to the use of appropriate technology in order to give
the positive impact to employment and economic
growth.
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