Survival of New Order economics

Survival of New Order economics

By Mohammad Sadli

JAKARTA (JP): March 11, 1966, is one of the auspicious days
Indonesia commemorates, in this case the passing of an old regime
and the advent of a new one, often called the New Order and
associated with President Soeharto.

New Order economics may not have started at that time.
Professor Widjojo Nitisastro and his group anticipated the change
a long time before, when they started thinking about policy
alternatives, even when they were studying at Berkeley,
California, in the early 1960s.

The previous policy regime was a command economy. The high
inflation was like a wartime economy requiring many direct
controls. Hence, ideology and necessity produced an all-pervasive
(price) controlled economy, but because production stagnated, it
became an empty shelf economy. Rationing of goods was supposed to
render greater fairness but with too few goods to go around only
city and privileged groups were secured. The rural folks resorted
to a barter economy.

The team of economists helping President Soeharto was in favor
of restoring economic and political ties with the West
(previously denounced by President Sukarno) because it realized
that quick recovery of the economy depended on an injection of
foreign resources since domestic savings was at an all time low.

Foreign aid was forthcoming soon enough as the international
political situation worked to the advantage of the new
government, which saved the country from falling completely into
the communist camp.

The amount of the first such aid was small compared to later
figures of US$5 billion in annual commitments from the Inter-
Governmental Group on Indonesia and Consultative Group on
Indonesia, but in those days a few hundred million dollars of aid
went a long way to restoring the economy of an otherwise richly
endowed country.

Apart from foreign aid, foreign direct investments were given
encouragement. The link between the two sources was perceived by
the new policy makers. The speculation was that western
countries, and Japan, would be more interested in giving aid to
Indonesia if they could see that their businesses were also
welcome.

Exploration and early production of crude oil would also
strengthen the balance of payments and hence provide an
additional guarantee that the aid and loans would be repaid. U.S.
and French oil companies moved in quickly and oil production soon
went up.

Mining investments took a lot more time to mature and provided
longer-term support for the balance of payments. Freeport copper
mining in Irian Jaya came into production fast enough to profit
from the commodity boom. It took more time for PT International
Nickel Indonesia.

Logging was a quick-yielding proposition. The environmental
risks were probably not realized in the beginning because of the
belief that "selective cutting for sustainable yield" could be
implemented without great troubles. That turned out to be a naive
proposition.

Foreign investments in manufacturing came a bit late because
in 1967 and 1968 the Japanese were not ready yet for overseas
investments. The only bank that was allowed to venture overseas
was the Bank of Tokyo and the government never had troubles in
1967 selecting only one Japanese bank for entry.

At that time, the policy was to allow only 10 foreign banks to
establish branches in Jakarta. The U.S. got four because of the
difficulty to say no to more than one. The U.S. was then also the
strongest supporter of the new government, at one time even
twisting the arms of Japan to give as much aid as the U.S. (one-
third U.S. aid, one-third Japanese aid, and the remaining third
from the rest of the world). In those days the World Bank did not
loom as large as it does now.

The runaway inflation, reaching some 600 percent in 1965, was
curbed by the "balanced budget doctrine" initiated by the new
government. The government budget was not really balanced, but
the deficit should be as large only as the amount of incoming
foreign aid. The purpose was that the government should not go to
the printing press (as it did before) to finance a deficit.

Foreign aid buys rupiahs from the central bank and the latter
sells the foreign exchange to importers. This method is not
inflationary and it imposes discipline on the government to limit
its deficits. The formula worked and triple digit inflation was
brought down to double digit and single digit levels.

This doctrine still is upheld today and that is the inertia of
politics. Economically, it did not make sense even in the 1970s,
at the height of the oil booms. Swelling levels of expenditures,
although balanced by revenues, have an inflationary impact by
themselves. Inflation during the oil booms reached double digit.

Today, inflation is close to 10 percent annually. The
government budget is still nominally in balance, but the monetary
effect is contractive because of the large outpayments for debt
service. These payments amount to $7.5 billion annually, whereas
new aid is $5.5 billion.

Moreover, present day inflation is not caused by the
government budget proper, but by the booming private sector and
an expansionary banking system. Government enterprises are often
also engaged in expansionary outlays, requiring fresh money from
the banking system.

There is often criticism that "extra-budgetary" activities
promoted by the government have been partly responsible for the
inflation. On the other hand, there is a boom in the country, as
well as in Southeast Asia, in property development, industrial
investments and spending for consumer durables enticed by credit
cards and bank financing.

Hence, the task of the New Order government's economic
management has changed from managing a scarcity and ruined
economy with pervasive poverty to managing prosperity. In many
respects the tools and concepts are still the same and sometimes
hopelessly outdated, such as the balanced budget doctrine as an
anti-inflationary tool.

The new source of inflation is not the government budget any
more. The completely free foreign exchange regime, working to
great advantage before, is now a source of monetary instability
as large and footloose flows of foreign funds go in and out of an
"emerging market", creating havoc with the balance of payments
and producing headaches for central bank governors unable to
decide what to do with those less-welcome guests.

We now live in a much different world of globalization and
interdependence, with completely different rules set by the World
Trade Organization. A developing country can't engage any more in
inward looking industrialization with high protection, much less
currency controls. The new pressure is to "export or die". To be
able to export, the economy has to be free of "high cost
impediments", usually the product of protection and regulation.

How should the New Order economics be transformed? Well, by
the way everybody else in the world has to. But old teachings die
hard. Protectionist sentiments never die, as we see it now in the
U.S. In the meantime, a new generation of government economists
have taken the posts of the old stalwarts, like Widjojo and Ali
Wardhana. They have to find the balance between continuity and
change according to the requirements of the time.

One old problem never goes away: finding the balance between
economic growth and equity. The fruits of development should be
widely distributed and enjoyed not only by a small minority.

The first rumblings of student protests occurred in December
1973 when they went to the streets and buildings got burned. In
1974, the order of the Development Trilogy was reversed:
distribution comes before growth.

After more than 20 years the problem is still acute, perhaps
even more so. It is not enough that the number of people below
the poverty line is reduced. City people and intellectuals worry
about relative poverty. If I now earn two times more than before
but my neighbor looks like earning 20 times more, that makes me
(feel) very poor. But the same phenomenon exists in Thailand,
Malaysia and Singapore. Those countries are far more prosperous
than Indonesia but some of the people are as unhappy as their
counterparts in Jakarta.

In countries like Korea, Japan and even India, political
corruption and collusion between politicians and money moguls are
drawing the ire of the political public. Similar seeds are in the
ground in Indonesia.

Will the New Order Economics survive all this adverse weather?
Probably yes, in the end, because a prosperous nation has greater
resilience power, unless the political leadership really commits
a series of grave political stupidities.

The writer is a several-times member of the New Order
government's cabinet.

Window: The task of the New Order government has changed from
managing a ruined economy with pervasive poverty to managing
prosperity.