Indonesia has the chance for stable economic growth

Osman Rzyttka, Research Fellow, Department of Geography, University of Bonn Germany

Indonesia's economy at the moment seems to be operating far below its potential. Higher growth and employment rates could be achieved, if more emphasis is put on the implementation of reform in the judicial, financial and political systems targeting corruption and collusion. Such behavior has negative impacts on common welfare and leads to suboptimal state revenues at the cost of constraining governing capabilities.

Indonesia has experienced difficult times since the economic crisis hit Asia in 1997. Massive capital flight and the drastic devaluation of the rupiah triggered roaring unemployment rates, whilst the GDP fell by 13.4 percent in 1998. Recovery is slow compared to its Southeast Asian neighbors: Reforms to restructure financial an decision-making mechanisms in the administration only started in the beginning of 2001.

Several factors seemed to have contributed to the Indonesian crisis in 1997/1998:

First, the monolithic structures of the Soeharto administration have proven incapable of providing balanced growth for all members of society. The resulting disparities caused social friction and an insecure business environment in the follow up.

Second, foreign financial institutions provided unhedged loans at relatively low interest rates to Indonesian businesses despite the weak financial supervising authorities. With import-based consumption remaining on a high level although productivity was decreasing, Indonesian foreign debts became critical, business confidence deteriorated and investors from abroad hurried to save their assets.

Third, the Indonesian banking system proved to be inefficient in administering the larger sums made available by the economic boom years. Rent-seeking behavior seemed to be widespread and supervising authorities were non-existent.

Provided that every percent growth in GDP creates one million new jobs, Indonesia needs jobs and thus investments to address its huge informal sector. With a GDP growth projection of 3.4 percent for 2003 and a population increase of a 2.9 million every year, the job surplus could siphon off the workforce from the informal shadow economy.

Since its non-transparent networks do not contribute to the state budget through taxes and levies, government policy should focus on minimizing informal activities as far as possible. As observers doubt that there will be significant investments in Indonesia prior to the elections in 2004, the time remaining can be seen as a period of scrutiny, opening the chance to quickly proceed with economic and democratic reforms and gain confidence.

As it seems, Indonesia has the options of a doom scenario of ongoing instability, low or even decreasing capital inflow, mainly restricted to infrastructure projects. On the contrary, larger FDIs creating jobs and higher government revenues in all sectors seem possible if the security situation improves and democracy is able to consolidate. Only this will bring back what has been deeply shaken by the Oct. 12 Bali bombing: Confidence, especially since Indonesia has chosen to end the IMF program.

Government policies like the decentralization program addresses the problems Indonesia has been facing: Regions are allocated a larger share of funds and competence in decision- making, whereas auditing institutions, regional councils and a free press should be able to check the application of funds in the sense of common welfare. This system of checks and balances could minimize the costs of using pressure groups to achieve political goals.

Resources then can rather be focused on education, infrastructure and social systems. All three are key factors for development: Recent research shows that significantly enhancing the quality of education just for primary and secondary school levels perhaps costs an additional Rp 10 trillion annually.

Infrastructure is another precondition for attracting investments: by balanced spatial planning, the growth of clusters for certain sectors according to potentials can be stimulated. Research needs to be done on available regional human and natural resources, what is produced out of the latter and how the overall Indonesian share in value-addition can be increased. Domestic capital to accomplish this can be either generated through labor or the exploitation of natural resources. Sustainable growth however, is based on labor, which tends to be more productive if social standards apply.

There are three elements as a precondition to enhance the reforms:

First the codes of conduct for institutions in general should change from predatory patterns to more cooperation and accountability, with common welfare and economic development as the main objectives. If some representatives of the government do not change their behavioral patterns in allocating and sharing funds, state revenue will remain low, as will salaries and budgets for administration, social services, education, infrastructure and defense.

Second, some minor adjustments in revenue sharing seem possible, allocating tax-generated funds from richer provinces to poorer ones. Also, the option of increasing funds for the Dana Alokasi Khusus (The Allocation of Special Fund) and specializing it for infrastructure projects in poor regions might have a balancing effect on development. These two instruments have the potentials to create a solid foundation for growth, with the stronger lending a helping hand to the weaker ones.

A lot has been already achieved: The foundation for sustainable and balanced growth has been set by decentralization. Now the larger framework for reestablishing business confidence worldwide can be addressed: Government policy should focus on creating an accountable supervising authority for the financial sector, a constitutional court to handle disagreements between different authorities, a fully computerized and accountable tax system. A precondition to all of the above are well-qualified civil servants.

A serious problem to be resolved is internal security: an end of the bombings, stability in Poso, Maluku, Papua and peace in Aceh would send the signal to the world that Indonesia is a safe country to invest and operate in. The work done by the Indonesian police in the Bali case already shows the right direction.

If Indonesia is able to create a stable and safe environment through continuing the reforms, increasing capital inflow from late 2004 or 2005 onwards seems possible.

The writer is also researcher at the Centre for Strategic and International Studies (CSIS) in Jakarta.