Tricky test for recovery

Ari A. Perdana, Centre for Strategic and International Studies, Jakarta

An economics student was walking with his professor when he saw a US$100 bill on the sidewalk. As he reached down for it, the professor held him back. "Don't take it, it's fake! If the bill was real, somebody would have taken it already," he said.

The story epitomizes the market mechanism which, according to neoclassical economists, will eliminate opportunities for excessive profits. Big bills aren't dropped on the sidewalk. If they are, they are picked up very quickly.

Much of the literature on economic growth and development infers that excess capital in developed countries will be transferred to the developing ones, to seek promising returns. Hence the latter will catch up with the developed ones. However, the reality is different. There are things that prevent the big bills from being picked up.

The late Mancur Olson argued that one underlying reason for a country being unable to pick up the big bills is government policies and institutions. These factors are important where a perfect market mechanism does not always exist.

Good policies and institutions provide incentives for efficiency and lower transaction costs, and fixes market failures, such as the gap in information.

The quality of the economic policies and institutions of a country also influences expected returns on investment, hence they affect investment decisions. Inconsistent policies discourage investment since they create business uncertainties.

Investment climates are also harmed by weak and corrupt institutions. Security problems, bureaucratic lack of transparency, a high level of rent-seeking, and poor legal protection and enforcement are institutional problems that raise transaction costs, which may exceed potential benefits.

Indonesia still needs foreign capital to foster recovery. High and sustainable economic growth cannot rely only on consumption. The country cannot expect fiscal stimuli from the state budget either. Given the limited capacity of domestic capital formation, foreign investment is the pragmatic solution.

The prospect of global economic growth of 2.2 percent this year is good news for capital inflows. The recent stock market performance may indicate the return of global investors' confidence in the domestic economy. There is also a high level of interest among international investors in the domestic assets that are set to be sold or privatized.

The big bills are now on the sidewalk. But are we are able to pick them up? This all depends on how our investment policies and institutions provide incentives. A tricky test will be how the government manages the privatization and asset sales processes.

The government faces an urgent need to privatize some state- owned enterprises (SOEs) and sell the assets managed by the Indonesian Bank Restructuring Agency to cover the budget deficit. The 2002 state budget targets the deficit at 2.5 percent of gross domestic product, or around Rp 43 trillion. Privatization and asset sales are expected to generate some Rp 25.4 trillion to finance the deficit.

But the processes, especially those that involve foreign investors, face an emerging trend of opposition. The opponents are the employees and managements of the companies involved, who then receive political support from politicians. They then raise the nationalism issue, arguing that foreign ownership of domestic assets would bring a new form of colonialism into the country.

Such nationalistic sentiments may lose their relevance. The companies are still the subject of domestic laws after being sold to foreign investors. As long as the companies contribute to the domestic economy through taxes, providing quality services to local consumers and respect the rights of employees, ownership is not the issue that matters.

It is more likely that the opposition reflects the view of existing employees and managements, who consider the change of ownership as threat to their jobs. It becomes more complicated when it involves broader interests. Ownership transfer may terminate patron-client relationships, and reduce or even eliminate the opportunities for rent-seeking activities.

While the opposition's voice should also be taken into account, delaying or canceling privatization will only incur higher social economic costs. Fiscal sustainability will be the first thing to be affected, as the government will lose some of its sources for deficit financing. Consequently, the government will have to reduce its expenditure, including that on development and welfare. As a corrolary, it will have to be more aggressive in collecting tax.

Delays will also harm market confidence in the country's investment climate, which is a negative factor for economic recovery. It should also be understood that the long-term privatization objective is to bring better corporate governance and improved efficiency to public sector firms. Improved efficiency will benefit consumers through quality services and lower prices.

What is now needed is a strong political commitment on the part of the government to continuing with the privatization agenda. This means that the government must also remove itself from short-term political interests which oppose the agenda. But it also needs to ensure that the new owners are committed to protecting workers' and consumers' rights, and to minimizing the pain. No less important, the government must be more serious in explaining the need for and the benefits of privatization to the public, especially to those opposing it.