There's no incentive to do business here

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.