There's no incentive to do business here

Muhammad Chatib Basri, Associate Director, Institute for Economic and Social Research University of Indonesia (LPEM-UI), Jakarta

An economic report by IBAS, a Jakarta-based consulting company, said that 2001 was relatively good as long as you were not an investor. That may sound cynical, but there is some truth in it. Look at the report produced by the UN Conference on Trade and Development (UNCTAD).

In a report titled The World Investment Report 2002, it shows that Indonesia is the only country in East Asia to have suffered capital flight since 1998. All other victims of the East Asian economic crisis have continued to enjoy positive flows of foreign direct investment. Why does Indonesia continue to suffer from capital outflows?

Do we need a tax holiday to attract capital inflows? I doubt that the lower attractiveness of Indonesia to foreign investors is due to high tax rates.

Prices in Indonesia are still relatively low compared with others; nonetheless productivity is lower. Thus, a tax holiday policy will not necessarily be effective in attracting foreign investors.

A variety of recent studies show that capital flow is closely related to the stability of the financial sector, the degree of transparency in international trade, human capital and perceived low risks.

Recent theoretical developments give greater importance to the role of business certainty and risk as a variable that influences investment. The degree of capital mobility also explains why weak institutions characterized by poor governance and corruption exacerbated the crisis.

The lack of certainty that results from existing institutional weaknesses increases transaction costs. The implication is that economic decisions become inefficient. Weak institutions also encourage economic violations. Indonesian banks represent one of the most interesting examples.

As economist McKinnon argues, liberalization of capital flow for example, must be supported by banking reform, transparency and improved information. This support enables the market to provide information for decision making and to reduce the risks of capital outflow as a result of market sentiment. This implies the need for cleaner government.

In addition, transparency and democracy are important components of clean government. Indonesia suffers greatly from these weaknesses. The degree of uncertainty has increased, while corruption is rampant at a variety of levels. However, if that is so, why did the crisis wait until July 1997 to start? Corruption, collusion and nepotism (KKN) had been endemic for more than 30 years.

In addition, if KKN is the source of the problem, how do we explain the success of China, where corruption is as bad as in Indonesia? The answer usually put forward is that the crisis was triggered by weaknesses in the financial sector.

KKN does not lead immediately to crisis; however it hampers the economic recovery process, including capital inflows to this country.

Corruption and collusion still pervade many institutions, creating a number of uncertainties. But how does past experience differ? In the Soeharto era, it was evident that bribery worked as an efficient lubricant in business.

This explains why China, as well as Indonesia before the crisis, suffered from rampant corruption, yet could still register high economic growth.

China, with its widespread corruption, is still attractive for foreign investors because it is more predictable than Indonesia. What about Indonesia?

A study carried out by the Institute for Economic and Social Research of the University of Indonesia's School of Economics (LPEM-UI) shows that in 2001, bribery failed as an efficient lubricant for business. It failed to reduce the time spent in dealing with the bureaucracy. Instead, bribery increased with the time spent on negotiating the bureaucracy.

There is a tendency for the government to levy charges according to the ability to pay of the businesspeople concerned. Furthermore, parallel with the distribution of power in the bureaucracy, corruption has turned out to be less concentrated. Thus, following the argument of economist Pranab Bardhan, in decentralized corruption, the bribe per unit of transaction (and the consequent inefficiency) may be higher than centralized, or "one-stop corruption".

As a result, although the amount of bribery money may be less than in the Soeharto period, it has failed to reduce transaction costs due to the greater number of officials that must be bribed. Undoubtedly, business uncertainty has increased and the investment climate become less predictable.

Widespread corruption and a lack of regulatory tools are regarded as having a great influence on business certainty. In addition, it is considered that labor problems may also have increased the cost of doing business in Indonesia, especially since the economic crisis.

The study also argues that local taxes (both legal and illegal) have already created problems in the business climate, both in Java as well as other islands. The findings of this study concluded that it was important for the government to address business certainty and to settle labor problems as well as local tax matters.

If one looks at President Megawati Soekarnoputri's performance and the obstacles her government faces in implementing good governance, it is highly unlikely that the cost of doing business will drop in 2002 or even next year.

The implication is that foreign investment will not return, unless significant reforms are made in politics as well as in law and order. It therefore seems likely that business uncertainty will continue in 2002.

Thus, the ability of the government to attract foreign investors is highly dependent on business certainty and the ease of doing business in Indonesia. The LPEM study indicates that with business uncertainty, labor problems and local taxes can increase the cost of doing business here. Therefore, as long as the cost of doing business remains high, there are few incentives for investing in Indonesia.