Part 1 of 2: When will investors give RI a break

Sisira Jayasuriya and Chris Manning, Canberra

The recent announcement by the Investment Coordinating Board Chairman that foreign direct investment (FDI) was down by one- third in the first half of 2004 is hardly news these days (The Jakarta Post, July 15). It is just further confirmation that investors continue to shun Indonesia, one of Asia's proud, "tiger" economies until the 1997 Asian Economic Crisis.

There is a widespread misconception that while the neighboring Asian countries have successfully pulled themselves out of the 1997 crisis, Indonesia remains in a perilous state, both politically and economically.

Both domestic and foreign investment is depressed. Gross domestic investment -- at less than 20 percent of GDP - is among the lowest in Asia, and capital outflows continue to significantly outweigh inflows, as they have for every year since the fall of Soeharto in 1998. Consequently, Indonesia is mired in a low investment -- low growth trap.

Without underestimating the major challenges and problems confronting Indonesia, we believe that widespread perceptions about its political and economic conditions are based on a superficial understanding of the political economy of development. Unfortunately misplaced international perceptions seem to have permeated the psyche of the domestic business and policy elite, discouraging both investment and bold initiatives.

In terms of most indicators of political and economic stability, Indonesia actually compares quite well with its neighbors, or with India, with which it shares many important similarities. When considered in the context of the economic and political problems it faced after the 1997 crisis, from an international perspective much has been achieved.

The casual outside observer, informed mainly by the international media, could hardly be blamed for assuming that Indonesian news has been almost entirely a story of internal (and international) strife since the downfall of Soeharto.

This dismal picture has been bolstered by reports of about the ineffectiveness of President Megawati Soekarnoputri, the lack of central authority and instances of policy indecisiveness. Jakarta, it would seem, has lost control over the far flung provinces and districts, particularly after the decentralization law brought in January 2001.

But a focus on these issues misses the bigger picture. First, lets consider political reform. From decades of authoritarian rule under the Soeharto, Indonesia achieved an almost bloodless transition to a functioning democracy, confounding most analysts who had predicted widespread violence.

And, it is no mean feat for a country of around 220 million, most of whom have no experience of ever voting in a free election, to have maintained a climate of open debate and a functioning democratic regime for 5 years, and hold a largely peaceful and, by developing country standards, relatively clean presidential election which has seen the incumbent president accept a situation where she has been beaten into second place in the first round.

The Indonesians have demonstrated a political maturity and a commitment to democratic processes and institutions that compare favorably with countries with much longer histories of democratic rule.

Second, what about economic recovery? On the economic front, too, Indonesia's steady but unmistakable recovery from the depths of the financial and economic crisis has received less credit than it deserves.

The exchange rate has been stabilized at around Rp 9,000 to the U.S. dollar, from Rp 10,000 in 2001; indeed the currency has appreciated by some 10 percent relative to its neighbors in the last 3 years.

On the domestic front, public debt has been drastically reduced, to less than 70 percent of GDP from 140 percent in 1998/99; on the external front, overall foreign debt -- of which public debt is around half -- is down to around 60 percent of GDP. Inflation has been brought down to 5 percent - figures in June suggested it may be as low as 3.3 percent, and interest rates have also fallen.

Of course major problems remain, with weaknesses in financial systems, and concerns about corruption high on the list. But perhaps the one essential difference between Indonesia and its neighbors is in their growth performance.

Indonesia's GDP growth (according to IMF sources) was 4.1 percent in 2003 and likely to reach 4.8 percent this year. It is certainly below what its crisis affected neighbors have managed to achieve in recent years (like Thailand, which returned to its pre-crisis per capita income in 2002).

But even here the differences can be easily overstated. Contrary to common perception, the average GDP growth rate of Indonesia over the three years 2000-2002 at 4 percent actually exceeded, though marginally, that of Thailand.

Thailand has really only pulled ahead only since last year, when it grew at 4.8 percent compared with Indonesia's 4.1 percent, while Thailand's 2004 growth is projected to be as high as 7 percent. The key to this difference in growth performance is investment: Thailand has started to attract investment while Indonesia has not.

Similar comparisons can be made with other countries, such as India or Vietnam. There are no persuasive reasons for arguing that short or even longer term prospects for investment in Indonesia are significantly worse than in India, or Thailand or Vietnam. On most counts Indonesia offers an investment climate that is at least as good, if not better.

Take the overall level of policy liberalization. Indonesia had achieved quite significant economic reform by the time of Soeharto fell in 1998, and these reforms have remained in place in the post-Soeharto era.

Despite the widespread application of minimum wages and the dinosauric, new labor law, labor markets remain more deregulated in Indonesia, compared to India where restrictions on firing and bankruptcies are significantly stronger. And, Indonesia has no equivalent to the entry barriers placed on many key industries, such as garments, which are reserved for small scale enterprises in India.

When it comes to government interventions in industry, Indonesia is surely no worse than India, Vietnam, or even Thailand, where Prime Minister Thaksin's government has a well earned reputation for frequent interference in economic affairs, to the detriment of competition and at the expense of independent private investors.

What about political stability and institutions? Again, Indonesia is not a "basket case" by any means. It is true that India, for example, has had a much longer history of democracy, a seemingly better functioning legal system and a more established bureaucracy inherited from the British. But is the government more stable or is the general "law and order" situation much better in India?

Today's Indian government is an unstable alliance of 12 parties, and depends on Communist parties that remain outside the government for a parliamentary majority. True investors recognize that policy stability has stronger roots, given broad consensus within the mainstream parties about the economic policy agenda.

Similarly, it is also not obvious that India is safer haven from "terrorist" threat, given India's history of frequent regional, ethnic and religious conflicts and terrorist incidents, including almost daily reports of bombs and deaths in Kashmir. With regard to legal institutions India probably has a clear advantage over Indonesia. But Indonesia's legal institutions are hardly much worse than in China until recently or in today's Vietnam.

Sisira Jayasuriya is Director of the Asian Economics Center, Department of Economics, University of Melbourne, and Chris Manning is Head of the Indonesia Project, The Division of Economics, Research School of Pacific and Asian Studies, the Australian National University).