Prerequisite to high growth

Prerequisite to high growth

Recent analysis by the National Development Planning Agency
and the Indonesian Chamber of Commerce and Industry (Kadin)
reiterates the need to improve the investment climate to put the
economy back on a high-growth path.

The agency, which is designing a transitional development
program for the new government that comes into power in October,
estimates Rp 379.8 trillion (US$44.6 billion) in new investment
will be needed to generate growth of 5 percent next year. Almost
80 percent of the investment needed would be derived from the
private sector, including foreign investors.

The uphill challenge though, as Kadin and foreign chambers of
commerce pointed out in a separate report, is the investment
climate in the country, which has remained poor since the onset
of the economic crisis in late 1997.

These weak investment conditions can be seen in the
persistently slackening rate of investment, increasingly eroded
business competitiveness -- as reflected in the decline of
exports -- and the threats by several foreign companies to move
their businesses from Indonesia to other countries.

A 5 percent expansion is higher than the average 4 percent
annual growth achieved in 2000 to 2003 but is barely sufficient
to absorb the large number of unemployed people, estimated at
around 40 million, let alone the 2.5 million new job seekers
entering the labor market annually. The analysis indicates how
challenging generating this level of economic expansion will be.

Analysts may be a bit surprised by the huge amount of
investment needed because it reflects a worsening incremental
capital output ratio (ICOR) -- the amount of capital investment
needed to generate one unit of value added -- from about 3.6 in
1996 to 5.5 to 6.0 at present. That means up to 30 percent of
gross domestic product has to be invested to generate 5 percent
growth.

The estimated increase in ICOR reflects the increasing
inefficiency in the overall economy, which is predominantly
caused by crumbling basic infrastructure in the provinces due to
an acute lack of maintenance. The government, which has faced a
severe liquidity crisis since 1997, cannot afford to conduct
proper maintenance of existing public works, let alone invest in
the building of new infrastructure.

The almost complete halt in the flow of new investment since
1997 has also eroded the market competitiveness of most
manufacturing companies, either because their production
technology is now obsolete or their plant machinery old and
inefficient.

Meanwhile, the increasingly stronger macroeconomic stability
in the country still fails to translate into high growth, which
from an Indonesian development perspective means an annual
expansion of between 6 and 7 percent.

The government is aware of the major barriers to investment
and early last year announced a new set of policy priorities
targeted at microeconomic development.

The reform measures set out in the government white paper
issued in September are designed to address major issues related
to incompetent and corrupt tax and customs services, too-rigid
labor rules, government red tape and corruption, uncertainty
about law enforcement and complications caused by the start-up
process of the new local autonomy rules.

However, there has never been strong leadership to push
through these badly needed reforms, nor a true spirit of teamwork
and a sense of urgency to act. Cabinet discussions seem more
often a formality rather than vigorous thought process about
policy instruments. Moreover, business leaders or
representatives from industrial associations who are the most up-
to-date with developments in the business world are rarely
invited to contribute to the policy-making process.

Since the problems encountered by businesses in a particular
sector usually fall under the jurisdiction of several different
ministers, there has long been a vital need for an effective
forum where different ministers, senior officials of various
agencies, leaders of business associations and top bankers can
resolve any issues brought up by industry. Such a forum focuses
on bureaucratic action and not on bureaucratic rigidities.

President Megawati Soekarnoputri issued a special decree last
year on the formation of a national Export and Investment
Promotion Team designed to work through two operational arms: the
National Export Promotion Taskforce to be headed by the minister
of industry and trade and the National Investment Promotion
Taskforce to be led by the chief of the Investment Coordinating
Board.

This team could have been effective in coordinating policy
measures to improve the investment climate. Unfortunately,
though, we have not learnt any follow up as regards the execution
of the executive order.

Whoever will take over the government later this year should
focus its attention on reinvigorating the investment climate
because private consumption, which has been generating almost 80
percent of the economic growth thus far, is now declining. It is
investment that creates jobs, which in turn produce wages,
generating purchasing power and consequently market demand and
additional sources of tax revenues for the government.

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