Liberals confidently assumed that, just as freedom of enterprise would maximize welfare at home, so the application of European capital to the task of developing colonial resources would gradually improve the lot of colonial peoples. By the end of the 19th century, the 30 years of the Liberal Policy in Indonesia did not appear to have achieved that miracle. By the end of the century, growing criticism of the Dutch record in the Indies was given particularly influential expression by C.T. van Deventer, a Liberal Democratic member of the States General, who argued that The Netherlands had been draining wealth from the Indies and had incurred thereby a "Debt of Honour" that should be repaid. His suggestion was that The Netherlands should turn from its strictly laissez-faire policy in the Indies and pursue instead a positive welfare program supported by funds from the metropolitan treasury. In 1901 a change of government in The Netherlands provided the opportunity for a new departure in policy along the lines suggested by van Deventer. According to the Ethical Policy, as it was called, financial assistance from The Netherlands was to be devoted to the extension of health and education services and to the provision of agricultural extension services designed to stimulate the growth of the village economy.

The Ethical Policy was seen by its most fervent supporters as a noble experiment designed to transform Indonesian society, to enable a new elite to share in the riches of Western civilization, and to bring the colony into the modern world. Its ultimate goals were, of course, not clearly defined. Van Deventer looked to the emergence of a Westernized elite who would be "indebted to the Netherlands for its prosperity and higher Culture" and who would gratefully recognize the fact. Others hoped for the growth, by "cultural synthesis," of a new East Indian society based on blending of elements of Indonesian and Western cultures and able to enjoy a large measure of autonomy within the framework of the Dutch empire.

Despite these rather grandiose visions, the achievements of the Ethical Policy were much more modest. It neither checked declining living standards nor promoted an agrarian revolution. It did, however, provide agricultural assistance and advice, but this was directed to the improvement of techniques of irrigation and cultivation within the existing wet-rice technology of Java. Its effect, therefore, was to confirm the gulf between the European economy of the estates, mines, oil wells, and large-scale commerce and the traditional, largely subsistence, Indonesian economy of wet-rice or shifting cultivation. In education, a little was done to provide a greater degree of opportunity at primary, secondary, and even tertiary levels, but at the end of the 1930s only a handful of high school graduates was produced locally, and the literacy rate was calculated at just over 6 percent.

The goals of the Ethical Policy were set too high, and the devices adopted to implement them were too modest. Given the inertia of traditional societies, it was not to be expected that a new order would be created as easily as the proponents of the policy had hoped. Nevertheless, during the years of its operation, the Indies did see the release of tremendous forces of social change. These resulted, however, not from the conscious plans of the Ethical Policy but from the undirected force of Western economic development. Java's population, which had risen from about 6 million to almost 30 million over the course of the 19th century, increased to more than 40 million by 1920. The population increase, together with urbanization, the penetration of a money economy to the village level, and the labour demands of Western enterprise combined to disrupt traditional patterns. Where the Ethical Policy was most effective, despite the limitations of its educational achievement, was in producing a small educated elite who could give expression to the frustration of the masses in a society torn loose from its traditional moorings. Western currents of thought had their impact also within Islamic circles, where modernist ideas sought to reconcile the demands of Islam and the needs of the 20th century. It is against this background that a self-conscious nationalist movement began to develop.