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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