Some lessons to learn from the economic crisis<\/p>\n
Arya B. Gaduh, Economist, Centre for Strategic and
\nInternational Studies (CSIS), Jakarta, abgaduh@csis.or.id<\/p>\n
With the crisis officially over at the conclusion of the IMF
\nprogram last year, it is time to reflect on lessons learned from
\nit about economic policymaking. Here they are, in an easy-to-
\nremember list of five.<\/p>\n
oCredibility: Easy to lose, hard to recover. Among any
\ngovernment's most precious assets to attract investment is its
\npolicymaking credibility. Yet, at the onset of the crisis when we
\nneeded it the most, this credibility was the first thing to go.<\/p>\n
President Soeharto reneged on his reform commitments early in
\nthe crisis. Pushed to reform banks and sectors affiliated to his
\nfriends and family, he reportedly said that he would "wage a
\nguerrilla war against the IMF." As "the war" raged, its first
\ncasualty was investor confidence, followed closely by Indonesia's
\nfinancial system.<\/p>\n
We still feel the impact of this war, as most of the capital
\nthat fled has not returned. But more importantly, the
\ngovernment's credibility has not fully recovered. So, in less
\nthan half a year, credibility was lost, yet six years later, its
\nharmful effects have lingered on.<\/p>\n
Have politicians learnt this crucial lesson? Apparently, but
\nonly partially. While calls to renege on international contracts,
\nonce a favorite among politicians, have subsided, we continue to
\nsee the government failing to honor its contracts. The recent
\nCemex case suggests that politicians still need reminding of the
\nimportance of credibility.<\/p>\n
oFirst things first. What accounted for the failure of the
\nearly IMF reform packages? A recent independent evaluation of the
\nIMF suggested lack of focus as a culprit. By wanting to reform
\ntoo much, the packages ended up achieving too little. Worse
\nstill, they ended up ignoring some of the crucial core reforms at
\nthe macro level.<\/p>\n
For a reform package to be successful, political economy
\ndictates that it has to have the necessary political support at
\ncritical decision points. Yet, structural reforms, like the ones
\nin the January 1998 reform package, tended to alienate
\npolitically connected vested interests.<\/p>\n
There is, then, a trade-off between the number of structural
\nreforms and the level of political support they might gain. As
\nthe number increased, there was a higher likelihood of sabotage
\nby vested interests. Without unreserved power, the inclusion of
\ntoo many structural reforms is a guarantee of failure -- and
\nfailure undermines the policymaker's credibility.<\/p>\n
Since unreserved power does not exist anymore in Indonesia,
\nhow should one push for reform? Prioritize: Bundle a few core
\nreforms into one package and implement it well. As success breeds
\ncredibility and support, a policymaker can gradually move toward
\na more ambitious package. In this sense, the narrow focus of the
\npost IMF-Program White Paper on building growth-sustaining
\ninstitutions is indeed commendable.<\/p>\n
oIn a democracy, stakeholders matter. Not all policies require
\nstakeholder consultations, but for some, they are indispensable.
\nMost macroeconomic policies require minimal consultations, while
\nmicro-level policies require extensive ones.<\/p>\n
Stakeholder consultations minimize the frictions that can
\nhamper their smooth implementation. They not only improve
\nownership but also help identify groups that stand to lose and
\ntherefore plan for the necessary compensations. While they tend
\nto be long and slow, consultations have increasingly become an
\nindispensable policymaking ingredient in a more democratic
\nIndonesia.<\/p>\n
This is especially true for unpopular measures. For instance,
\nthe absence of a well-designed compensation mechanism (and
\ncommunications strategy -- see below) has continually allowed
\nvested interests to portray the fuel subsidy removal as an anti-
\npoor policy. Intense prior consultations, combined with a better
\npublic communications strategy, might have mitigated such an
\noutcome.<\/p>\n
o A communications strategy is key. As previously mentioned,
\nfor reform to succeed, it needs political support. When coercion
\nis not an acceptable means of persuasion, an effective
\ncommunications strategy is the only way to garner that support.<\/p>\n
Full transparency is not always the best communications
\nstrategy. However, to be effective, the message must be delivered
\nby a credible communicator -- and opaqueness reduces credibility.
\nIndeed, among the things that reduced the IMF's effectiveness in
\nrestoring market confidence in 1997 was its policy (which was
\nlater revoked) not to publish the letters of intent. Therefore,
\nas a general rule, greater transparency is usually better.<\/p>\n
On this, the central government seems have learned more
\nquickly than regional governments. Even in Jakarta, the local
\ngovernment disregards these last two lessons. The governor still
\nmakes policies "the old way": Top down, without fully explaining
\ntheir rationale to the public and stakeholders. Recent
\ntransportation and waste management policies serve to prove this
\npoint.<\/p>\n
o People respond to incentives. This lesson is at the heart of
\nmodern economics, yet somehow policymakers tend to disregard it.
\nAnd when they do, very bad policies are formulated.<\/p>\n
The Lippo Bank debacle of early 2003 is an example. Why did it
\nhappen? Apparently, the government had agreed to allow the old
\nowner to maintain a majority stake in the bank's management in
\nreturn for injecting fresh funds into the bank back in 1998. At
\nthe same time, the old owner was not barred from buying back the
\nbank.<\/p>\n
Under such circumstances, the management had little incentive
\nto maximize the bank's market value -- especially if its old
\nowner really wanted it back cheaply. Hence, it is no surprise few
\ninvestors were willing to bid a high price for the bank. The loss
\nto the government from the mistake in its bank restructuring
\napproach was huge: For Lippo alone, the recapitalization cost was
\nabout 7.7 times the revenue had its upcoming sale been
\nsuccessful.<\/p>\n
In crises, policies are often made in an ad hoc way to respond
\nquickly to changing environments. Bank restructuring shows how
\nvery costly this can be when policymakers fail to notice the
\nimportance of incentive design.<\/p>",
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