Tricky test for recovery

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.