Indonesian courts create unemployment.

Indonesian courts create unemployment.

Sebastiaan Pompe
IMF Resident Legal Advisor
Jakarta

It is accepted theory that reliable law enforcement and legal
certainty are critical for investment recovery. This has been a
mantra of international donor organizations for almost a decade.
For Indonesia, it was reiterated recently by prominent
international journals such as the Asia Wall Street Journal and
The Economist, which in a recent issue says that "the culture of
legal confusion...is by far the biggest obstacle to investment".

It seems that this accepted theory of international agencies
is not shared by the Indonesian judiciary. In a recent debate,
some senior judges took the view that courts do not play a role
in this "legal confusion", and share no responsibility for
economic recovery or employment.

In their view, economic recovery and employment are a matter
of economics, or politics perhaps. To the extent that the law is
involved at all, it is the legal system broadly speaking, the
statutory framework, the administration, legal professions and so
on. The courts have a passive role at best and basically just
confirm the situation as they find it, so the judges argued.

Indeed, some judges said that the judiciary in reality
actually protects employment where it can, such as in bankruptcy
cases. They argued that since bankruptcy causes unemployment,
courts therefore should apply bankruptcy law restrictively.

If judges grant bankruptcy petitions, and courts act
effectively in liquidating bankrupt companies (or even in debt
restructuring), they stimulate unemployment, and hence go against
the national interest, it is said.

This view is misguided. Judges play an important part in
strengthening the economic climate and conversely, court failure
boosts unemployment. Let me set out some points here,
specifically in relation to bankruptcy.

o First, effective bankruptcy law helps improve employment.
Assuredly, bankruptcy cannot be described as a pleasant affair
for the individual company. It involves a liquidation of assets,
which is a legal euphemism for a process by which estates are
broken up, assets are divided and sold off, and employees are
laid off.

For the individual company, the individual manager or
shareholder, and notably the individual employee, bankruptcy can
be a nightmare. It is important to keep that in mind,
particularly for courts, and not to rush into bankruptcy
imprudently, or grant spurious claims.

Yet it also is important to lift the perspective beyond the
individual case, and consider how bankruptcy impacts on economic
structures generally. In this broader economic sense bankruptcy
is a form of re-distributing assets.

It is the mechanism by which assets are released from dead-
ends, which allows them to be invested elsewhere in more
profitable undertakings. This orderly redistribution of assets
stimulates economic activity, and supports employment. Effective
bankruptcy therefore is a critical ingredient to an efficient
economy in which employment is maximized.

This helps explain why in countries such as the U.S., Japan or
in Europe, economic growth and bankruptcy are not mutually
exclusive. Even a small country such as the Netherlands has on
average 630 court-imposed bankruptcies monthly. The Dutch figures
are more than 20 times the annual case load in Indonesia. The
Indonesian bankruptcy figures are quite outrageous, and point at
significant institutional and economic inefficiencies.

o Second, there is in fact a major demand for bankruptcy
services in Indonesia. Some Indonesian judges, pointing at the
very small number of bankruptcy cases filed in 2003, argue that
their services are no longer required, that they have basically
completed their job. Some of them even say that the commercial
court has outlived its usefulness. This misreads the situation
entirely.

The argument ignores official figures that show that a very
large number of Indonesian companies collapse outside bankruptcy.
According to the official statistic bureau (BPS) more than 1600
officially registered Indonesian companies (10 percent of the
total) either scaled down operations dramatically or closed their
doors entirely in 2002. (These are officially registered
companies, the figure of unofficial unregistered companies is
much higher.)

In the slow-motion and often incomplete collapse of these 1600
companies, their capital more often than not remains tied up in
the company one way or the other. Until it is freed, it cannot be
reinvested elsewhere; and it cannot serve to create new
employment.

The inability of these 1600 companies to go through an orderly
liquidation impairs the recovery of capital through for new, more
profitable investment. Employment recovery is handicapped
accordingly. Thus, BPS reported that the 2002 company collapse
caused an additional official registered unemployment of 145,000
persons; plus possibly half a million indirectly unemployed.

Unlike asserted by some Indonesian judges, BPS figures
demonstrate that there is in fact a major demand for bankruptcy
in Indonesia. The question is why such cases are not brought to
court. This has everything to do with the failure of the courts
to give a reliable, efficient and effective service. The judges
are wrong to hold that the problem is out there and that to the
extent that it affects them, they have solved it. In reality, the
problem is with the judges themselves.

o Third, unreliable courts boost unemployment. Courts that
are unreliable, inefficient, and ineffective will encourage bad
behavior in society. The worse courts are, the worse debtors will
be also. They will not pay their debts in time, they will default
intentionally, and will refuse to discuss alternative ways of
resolving disputes -- all because it is so easy and there is no
effective sanction. This is damaging to an economy, and to
employment. It is damaging on society at large.

The European Union some time ago completed a study on the
impact of court efficiency and intentional defaults on
employment. It demonstrates that as court inefficiency increases,
so do the number of intentional defaults, resulting in increased
company collapses and increased unemployment figures.

This is very much the story of Indonesia in recent years,
namely of how court ineffectiveness has boosted intentional
default beyond all proportions, and unemployment is shooting off
the charts as a result.

The misguided judicial focus on protecting debtor companies
fails to grasp that this in reality is a damaging and
counterproductive approach: It undermines the enforceability of
contracts, and ends up damaging the entire market. Sound
Indonesian companies or Indonesian banks have been dying because
outstanding debts are not repaid. As these cannot be recovered
through the court system, intentional defaults multiply, and
employment dies.

Despite the large number of company collapses in Indonesia
over past years, bankruptcy is little used in Indonesia. The
reason is that the courts are unreliable, inefficient and
ineffective. Capital remains tied down in dead-ends as a result.

Because it cannot be reinvested elsewhere, the resulting
economic inefficiency increases unemployment. Court
unreliability, inefficiency and ineffectiveness encourage
intentional defaults, which boost unemployment further. In sum,
courts directly contribute to unemployment in Indonesia.

The views expressed in this article are his own and do not in
any way reflect those of the IMF.