As an archipelago, Indonesia is dependent upon shipping for much of its internal trade. Just how geographically fragmented the country is can readily be appreciated from the map. Population, however, is not evenly distributed. Two-thirds of the population is concentrated in the small but amazingly fertile islands of Java and Bali. Of the remaining third of the population which is located in the Outer Islands, the large proportion is accounted for by Sumatra. Eastern Indonesia, which encompasses about half the country's total area of land and sea, contains barely 10 per cent of the total population. This distribution of population is reflected in the pattern of interisland trade. Most of the food production and manufacturing is located on Java, and the largest proportion of interisland trade flows between Java and Sumatra.

Because Java is overpopulated relative to its resource base while the Outer Islands are under populated, substantial real income gains could be expected to accrue from interisland specialization and trade. An efficient interisland shipping industry is essential, however, if those gains are to be realized. Any margin of inefficiency in the cost of providing shipping services resembles an interisland tariff over and above the natural level of protection involved in providing transport services at some unavoidable minimum cost. Such inefficiency frustrates economic integration and the economy sacrifices both current and future real income from interisland trade forgone.

In the late colonial period a very efficient and extensive network of interisiand shipping services was provided by a private Dutch company known familiarly as the KPM (Koninklijke Paketvaart Maatschappij or Royal Packet Company). By establishing a firm monopoly of the whole interisland network, apart from a few lines to Singapore, the KPM was able to use profits from the main trunk lines to cross-subsidize regular scheduled services to even the most remote corners of the Archipelago. By through-shipment arrangements, these interisland services were linked with deepsea lines to all parts of the world.