Part 2 of 2: The Indonesian economy: Lessons from the past

Boediono, Jakarta

The third lesson is that there is a vital need for a coherent and credible strategy.

Another lesson we can learn from New Order economic management is the coherence of its strategy. The core of its macroeconomic and development policies basically derived from mainstream economics, with some Indonesian emphases added, especially to the development policies. Its strategy included prudent fiscal and monetary policies, reliance on markets, open trade and investment policies, provision of adequate infrastructure and, with an apparent Indonesian touch, special emphasis on agriculture, massive expansion in the provision of basic needs (food, health care, education, housing), population policies and a transmigration program.

One may agree or disagree with part or all of the strategy, but it was clearly a coherent one. Its "mainstreamness" helped assure its coherence, but in my view it was the presence of a strong intellectual leader within the team that was mainly responsible for that quality.

Moreover, the strategy was implemented with a high degree of consistency over a long period. This created a predictable environment and provided sufficient comfort for domestic and foreign investors to join in the action in great numbers. The strategy worked well until the 1997 crisis broke, when the economy's major shortcomings -- weak institutions and poor governance -- began to surface. I will return to this below.

The main point here is that a clear picture of how the various individual policies hang together, showing the broad direction in which the economy is being steered, is absolutely essential for both the government itself to coordinate its actions, and for economic actors to determine their responses. The strategy must also be perceived as credible, being backed by commitment to action on the part of the authorities.

In the present political setting it is probably more difficult to come up with such a coherent strategy, but it is not impossible. Much will depend on the clarity of the government's vision, its technocratic capacity to translate this into operational policies and its skill in maintaining the essential elements of the strategy and protecting its overall coherence, while accommodating elements thrust on it by political realities. Paradoxically, from the viewpoint of economic management, the need for a coherent strategy as a policy anchor is more acute in a democratic setting, where the risk of policy swings is often perceived by economic actors to be greater.

The content of the strategy basically involves political decisions. But as I implied above, its core must contain solid technocratic substance, or else it only serves as a wish list.

In my view, the basic thrust of the New Order economic strategy -- prudent fiscal and monetary policies, market-oriented microeconomic policies, open trade and investment regimes, adequate provision of infrastructure, emphasis on basic needs -- is realistic in the present global setting. It is also basically sound, as it proved capable of delivering results for so long.

However, in light of the experience of its implementation in the later years of the regime, and our experience since the crisis, it does appear to require adjustments, which in some areas may be very significant. Such areas include the strengthening of institutions and governance ("soft infrastructure"), financial sector strategy, domestic competition policy, management of natural resources and environment protection, a strategy on small-scale enterprises and perhaps more.

The fourth lesson is never take stability and the budget for granted.

It is a historical fact that, compared with its neighbors, such as Singapore, Malaysia and Thailand, Indonesia's performance in relation to economic stability has not been outstanding, even when we include the extended period of relative stability of the precrisis New Order.

It is an interesting question why Indonesia is more prone to instability than these other countries. I suspect that some of the explanations lie outside the realm of economics, but here I wish to highlight one main pillar of stability -- government finance -- which has served as a crucial link between political dynamics and economic performance in Indonesia.

When the New Order regime came to power there was a conscious attempt to begin insulating public finance from the vagaries of politics. The "balanced budget rule" was adopted to achieve just that and, as a result, the country was able to enjoy a long period of relative stability. But then in 1997 the crisis broke and the budget had to absorb an enormous burden resulting from that calamity. Large private debts were transformed into public debts.

Since the crisis, the goal of fiscal policy has evolved from survival to consolidation, and then to its reestablishment as an anchor of economic stability.

Looking ahead, formidable tasks await the present and future governments. Making fiscal policy the anchor of stability requires more than balancing annual budgets and reducing the debt ratio.

The first thing the government should do is to reestablish a firm compact about the basic rules of fiscal prudence (some variant of the balanced budget objective and the adoption of market-determined domestic fuel prices may be a good start). This will insulate fiscal policy from the most damaging political pressures.

Second, it should undertake a comprehensive reform of all aspects of the antiquated system of government finance administration. The reform and modernization of the tax administration should be given the highest priority, because of its critical role in securing fiscal sustainability in the long run. Some efforts have been initiated already along these lines.

Third, the government should transform its currently rudimentary debt management unit into a best-practice system for managing government debt, encompassing not only direct debts but also unfunded liabilities, the most important being the government's obligations to the civil service pension scheme, as well as its contingent liabilities, in the form of the implicit and explicit guarantees currently enjoyed by the enterprises it owns.

Fourth, the fiscal decentralization process should be completed, with adequate safeguards against fiscal indiscretion at the provincial and lower levels of government. Lastly, I would urge the government to be daring enough to set the goal of achieving, over the long run, a second political compact that further insulates fiscal policy from political vagaries by giving the fiscal policy authority more autonomy -- in similar spirit to, though not necessarily to the same extent as, that now given to the monetary policy authority.

The fifth lesson is never (again) neglect institutions and governance.

The 1997 crisis brought not only an acute awareness of how treacherous it can be to live in an interconnected world, but also a growing realization that institutions of society and the way they are run (governance) matter a great deal in such a world.

The first strategic step has been taken -- a change from authoritarianism to a democratic system. Democracy is supposed to provide a better environment for developing more durable institutions and improving their governance. The catch is that the transition to democracy itself is one that requires purposeful acts of institution building and standard setting.

Of the many exercises in institution building and reform, none is more fundamental, or promises a greater payoff, than in the legal sphere, including the judiciary and other aspects of law enforcement. For here is where society's rules of the game are actually played out. Alas, despite strong domestic and international support, these reforms progress very slowly.

Next in terms of urgency is civil service reform, for herein lies the hope for more effective government and better implementation of policies. This also provides a natural framework for the current anticorruption campaign. Like the judiciary and other legal institutions, the civil service has long suffered from neglect.

The writer is to be installed today as the new coordinating minister of the economy. This article was abridged version from a paper presented by former finance minister Boediono at the Indonesian Academy of Sciences in Jakarta on Saturday. The paper was also discussed in September at a seminar, Indonesia Update 2005: Indonesia, Australia and the Region, held at the Australian National University in Canberra.