Development strategy, mental models and graft

Awan Wibowo Laksono Poesoro and Indriyanto Seno Adji, Jakarta

Among its neighbors in Southeast Asia, Indonesia was among the first to espouse a growth-oriented development strategy initially introduced in Western economies. Almost 40 years since its inception in this country, this market-led development approach has not yet brought the optimal results as have been delivered in such Western developed countries as the U.S. and in sundry Asian industrialized nations like Japan.

Economic indicators and human development indices show that even compared to its industrializing neighbors like Malaysia, Indonesia is being left behind. The severe malnutrition cases recently descried -- malnourished toddlers have even been spotted in the greater Jakarta area -- confirm the country's backwardness in development achievements.

Has Indonesia adopted an unbecoming strategy? Should we instead embrace a socialist development strategy to achieve prosperity? Considering the 6.6 percent (of GDP) budget deficit, a skyrocketing 594 percent inflation rate, a 1.1 percent output growth and a 70 percent (of population) poverty level it experienced under the left-leaning Sukarno regime in 1965, I do not think that a socialist command-led strategy -- where resource allocation is mostly determined by the government, not by buyers and sellers as in a market economy -- is the solution.

Socialism already had its share of fame. The Soviet Union is history and China has incorporated a market-economy approach into its development design. This leaves us with the market-oriented strategy. If this strategy is the answer, why have we not achieved the successes our neighbors have managed to attain?

We have to realize that the market economy works under the neo-classical assumption that all parties in the market act perfectly rational in maximizing their utilities, generating optimal results. The implication is that the market is free from any transaction costs and institutions. Here, institutions are not organizations. Instead, institutions are the society's rules, comprising formal rules such as laws and regulations; informal rules like social norms, ethics and conventions; and the rule enforcement features.

The neo-classical market economy emerged about two decades ago as the mainstream of development theories. Its expounders view the market-led development strategy as a means of achieving prosperity. It turns out that the market does not always work like the neo-classical economists want. It sometimes fails to function favorably due to several problems.

The first problem is imperfect information. In reality, information can be randomly incomplete or it can also be purposely insufficient and manipulated by agents in the market. Consequently, information is costly and less informed people will pay more for things than more informed ones, causing welfare losses.

The second is the free-rider problem. This problem has its roots in the provision of public goods. Because the consumption of public goods is non-rivalrous, meaning that any one person's consumption does not reduce the utility derived from anyone else's consumption, free-riders -- parties who evade making contributions to the provision of public goods, benefiting from the goods for free -- exist.

The third problem is externalities; namely, positive or negative impacts on agents not directly involved in market transactions. People are more involved in negative externality- generating activities instead of being involved in positive externality-engendering activities -- as negative externalities are usually costless, while positive externalities mean financial costs.

Furthermore, people do not hold the same notions -- mental models, so to speak -- as regards how things around them operate. Each person has his or her own perception and understanding of any problems that get in the way. As a result, he/she will come up with his/her unique solution in solving the problems. Why do people have different mental models? This could be attributed to the informal rules, religions, cultures, creeds, environments and political views to which they are exposed.

It is evident now that imperfect information, the free-rider problem, externalities and mental models lead to market failures. As a result, zero information and transaction costs, as well as free-institution conditions as assumed by the neo-classical model, are non-existent. In the real world, information and transaction costs do exist as people search for relevant prices and negotiate, conclude and enforce agreements, spawning uncertainty in the economy.

Ergo, the neo-institutional approach pioneered by Ronald Coase, the 1991 Nobel Prize winner for economics, could be used to find a solution. According to this approach, institutions are indispensable to overcome market failures. For example, Douglass C. North, the 1993 Nobel laureate, proposes property rights (an example of institutions) as a means to minimize externalities.

Since different countries have different market problems and mental models, the market-oriented development approach has procreated different outcomes for them. This explains why Indonesia has not been able to emulate its neighbors' achievements. To solve this, simply adopting pristine Western economic, social and political prescriptions will not bring much improvement in development. To promote development, Indonesia has to tune in not just the formal rules but also the informal rules and enforcement features.

In Indonesia, the most substantial problem stemming from our rudimentary mental model and flimsy formal and informal rules is corruption. The most destructive type is institutional corruption, as opposed to the less harmful individual corruption. Institutional corruption also infected the U.S. in the 1970s, undermining state government systems, including the executive, legislative and judiciary branches. A US$640,000 bribery case involving congressman Dan Rostenkowski proved that institutional corruption was severe in the U.S.

Power and bribery have been a steady couple in the bureaucracy of authority, setting a new trend of crimes by the government that is extensively related to institutional corruption. Moreover, institutional corruption has been related to public policy-making, causing economic and political uncertainty and instability. Institutional corruption is subtle and very hard to detect, so it is difficult to catch the perpetrators, as they can hide behind Indonesia's feeble formal and informal rules.

To get out from this mess, we need political bodies (like government agencies, political parties and the legislative and judicial branches) that are willing to enhance institutions in order to have major and stable political, social and economic reforms. To begin with, we cannot be ashamed to admit that our nation has a deficient mental model.

Only by admitting it can we start making significant alterations to our mental model, thus changing our ways of solving matters utterly. Thereupon, Susilo Bambang Yudhoyono, as our leader, has to be steadfast in pioneering and conducting this great endeavor. He cannot afford to be indecisive. There is no other way!

Awan Wibowo Laksono Poesoro is a graduate of the University of Southern California and a researcher at the Indonesian Institute.

Indriyanto Seno Adji is a lecturer at the School of Law at the University of Indonesia.