Speed up reform, avoid return to protectionism

Imelda Maidir, Centre for Strategic and International Studies (CSIS), Jakarta

The government of Megawati Soekarnoputri throughout this year has kept the IMF-supported program on track, but macroeconomic targets fared better than structural reforms. The process of reforms is being reverted to protectionism. More recently, there have been considerable delays in the removal of tariff control hiding behind protectionist barriers and in the privatization of state assets and enterprises. Indonesia's new democracy has added to the delays, and in this, the legislature has also prolonged the process of reform.

Moreover, the public, including workers, have added to the pressure in the attempts at policy reform made by the government. The Semen Gresik sale, for example, was canceled following regional pressure against the inclusion of two operating units of Semen Gresik, Semen Padang and Tonasa, in the bid, and in turn, the Semen Gresik workers' demands. With an injection of at least US$ 530 million, about 85 percent of the privatization target this year, the Semen Gresik deal would have subsequently enabled the government to raise its capacity.

It has become clear that the full benefits of reforms will not be realized until the country has adopted a more assertive competition policy. This policy, however, should fit hand-in- glove with other measures to liberalize the economy by completing the vigorous deregulation of cross borders and entry barriers, as well as streamlining.

Trade liberalization in the 1990s had already subjected the manufacturing sector to heightened competition, but there are still inconsistencies and non-transparent means of protection.

Raising import tariffs on sugar and other main farm commodities could indeed help protect local farmers from unfair competition resulting from dumping practices by foreign producers. This trade policy instrument alone is not effective in decreasing the country's dependence on imports. So far the local sugar industry is only able to meet 53 percent of local consumption.

Another case in point is partial liberalization and reform, particularly in the service sector. While law No.20/2002, a reform designed to create competitive wholesale and retail markets for electricity was enacted on late September, primarily to ensure sustainable growth of the power sector, the remaining control over distribution became a non-tariff barrier to competitive service.

Customers are still not allowed to have the choice of using competitive retailers or continuing to procure services from their local utility at a regulated rate. Likewise, the law does not mention whether consumers will eventually be free to choose any retail agent from whom they will buy electricity.

Competitive electricity markets cannot work properly if consumers are completely insulated through regulations, from variation in wholesale or retail market prices. Similarly, the experience of California in America may be regarded as a partial liberalization and proved to be unsustainable. In the California case, the regulator allowed for the wholesale price to vary according to market supply and demand, but put caps on retail prices.

However, the introduction of competition has to be preceded by a wide range of appropriate sequencing to ensure that, once introduced, the competition will work as intended. A hasty introduction of competition without all the necessary institutions in place may be harmful for the industry itself. This has been the case in the State of Victoria, Australia, where an introduction in its Electricity Supply Industry (ESI), at least initially, faced problems partly because there was no liquid electricity market to enable efficient transactions.

Regulatory uncertainty during or immediately before the transition may have a negative impact on investment, as potential investors would delay their decisions until the new framework has been defined. Regarding the long-standing regulatory process in the "duopoly" of the telecommunication sector, the government seems to lack efforts to ensure the policy to liberate the industry. Should the deal not go through, not only will Telkom lose the opportunity to get a much larger share of the cellular phone industry, but Indosat will, in turn, enter full throttle into the local fixed line industry, while the government will miss the opportunity to foster good competition.

There is much work to be done at home in order to liberalize trade and investment, not to mention curbing the rampant smuggling that might be considered anti-competitive. According to the Association of Indonesian Electronic Producers, the different taxes levied on electronic goods, now reaching 52.2 percent, has stunted the growth of electronic producers.

In addition, local producers are finding it difficult to compete with cheaper goods smuggled into this country. The Sony Corp. case illustrates that these practices were a turn-off for foreign investment. Accordingly, it is important to remove unnecessary administrative barriers that hinder the speedy completion of reforms.

However, experience also shows that introducing greater competition, whenever they have materialized, has a large negative impact on the public perception of reforms. Thus, governments have a key role during the transition in ensuring that the appropriate safeguards are in place to sustain the reliability of these reforms, and they also have a great responsibility in minimizing risk.

Finally, when market problems do emerge, government officials should act quickly and decisively to fix the problems.