Why the West grew rich as the rest grew poor

Why the West grew rich as the rest grew poor

By Thee Kian Wie

This is the second of two articles on David Landes' latest
book The Wealth and Poverty of Nations -- Why Some Are So Rich
and Some So Poor. The 650-page book was published in 1998 by W.W.
Norton & Company, Inc., New York. N.Y.

JAKARTA (JP): Does Landes' book offer any insights into
Indonesia's modern economic history? Not directly and not
extensively, although Landes several times refers to Indonesia
during Dutch colonial rule and Indonesia's impressive performance
under the New Order government. However, it is his more detailed
discussion of the relatively sluggish performance of the Latin
American countries which may have some relevance to Indonesia.

To be sure, the Latin American countries have had almost two
centuries of independent nationhood, whereas Indonesia only
achieved its independence 54 years ago. Despite this age
difference, after almost 200 years of political independence
Latin America's sluggish economic growth and relative inability
to graduate to economic independence offer some important
warnings which Indonesia should heed, particularly in its current
economic predicament.

Landes attributes the pattern of arrested development of the
Latin American countries to the tenacious resistance of old ways
and vested interests, in particular their focus on land and
pastoralism. This focus, reinforced by social and political
privileges, bred powerful, reactionary elites ill-suited and
hostile to an industrial world. Industrialization nevertheless
took place in Latin America, although much later than their North
American neighbor, the United States. This lateness is not
necessarily a handicap, as the impressive industrial performance
of the East Asian newly industrializing economies (NIEs),
particularly South Korea and Taiwan, has shown. In these two NIEs
the government put a high priority on promoting highly efficient,
internationally competitive domestic firms, and developing
indigenous industrial technological capabilities. By pursuing an
export-oriented pattern of development during the early stages of
industrialization, these two countries were able to achieve these
two goals.

However, in most Latin American countries inefficient import-
substituting industrialization was pursued for too long. No
wonder that, with some notable exceptions, manufacturing
industries in most Latin America countries are not
internationally competitive. Moreover, these inward-looking
policies led to balance of payment problems, forcing these
countries to borrow large sums from the official international
lenders (the International Monetary Fund and the World Bank) and
from foreign commercial banks. A considerable amount of these
funds however, were "recycled" back to secret bank accounts in
Switzerland, the United States and other safe shelters.

The combination of public sector profligacy, widespread
corruption, mismanagement, and continuous overseas borrowing,
characteristic of many Latin American countries, fosters
development without efficiency constraints, and is therefore
fragile and not sustainable. An economic downturn may suddenly
cause overseas lenders and investors to reduce their risk
exposure to a certain country. If panic grips these lenders and
investors, capital will flow out of the country, as happened with
the Mexican peso crisis of 1994/1995. To deal with this crisis,
the Mexican government had to again borrow large amounts of
money. By resorting again to overseas borrowing, Mexico repeated
the old pattern, common to many other Latin American countries,
of foreign borrowing, often just enough to pay the interest of
older loans.

Indonesia's financial crisis of 1997/1998 resembles Mexico's
crisis in various ways. However, unlike the Latin American
countries where public sector profligacy had been the culprit, in
the case of the Southeast Asian countries, including Indonesia,
the major cause was private sector profligacy. But to resolve the
serious financial and economic crisis, the Indonesian government
too had to resort again -- and to a disturbing extent -- to
large-scale foreign borrowing. While public debt just before the
crisis (June 1997) amounted to only 24 percent of Indonesia's
Gross Domestic Product (GDP), it had risen to 60 percent of GDP
by the end of 1998, and is estimated to exceed 100 percent by the
end of 1999.

As this foreign borrowing intended to finance the large
government budget deficit cannot go on forever, the need for
fiscal sustainability requires a much higher priority on domestic
resource mobilization, that is a greater tax effort. Without a
more serious and efficient tax effort Indonesia will fall deeper
into a debt trap. It will have great difficulty extricating
itself from such a trap without a serious loss of economic
independence, or sacrificing of its goal of rapid economic
growth, which are essential to raising the standard of living of
Indonesian people.

Until Indonesia's economic meltdown occurred in 1997/1998,
senior government officials tended to dismiss concerns and
criticisms voiced by many Indonesian economists and social
scientists. While the government argued that the Indonesian
economy was growing at a brisk pace, many Indonesian analysts
pointed out the rampant corruption and its corrosive effects on
the investment climate, economic efficiency and public morale.

Certainly, Indonesia's economic record over the period 1967 to
1997 showed that after recovering from the economic decline and
hyperinflation in the early 1960s, from the late 1960s the
Indonesian economy experienced a period of high growth, which was
generally sustained during the following three decades. The
economic transformation which Indonesia experienced during this
period changed the country from its status as the "chronic
underperformer" among the Southeast Asian economies in the early
1960s into an emerging "newly industrializing economy" (NIE) in
the early 1990s. Rapid and sustained industrial growth
transformed Indonesia from an economy still largely dependent on
agriculture in the mid-1960s to one in which the manufacturing
sector played in the mid-1990s an increasingly important role.

Consequently, Indonesia, along with the other East Asian
economies -- including Japan, South Korea, Taiwan, Hong Kong,
Singapore, Malaysia and Thailand -- in 1993 was classified as one
of the "high-performing Asian economies" (HPAEs) by the World
Bank in its famous but controversial report on "The East Asian
Miracle".

Despite large differences between Indonesia and the other
seven HPAEs -- in terms of levels of economic development,
standards of living, size of economy and population, resource
endowments and cultural background -- it shared with these
countries characteristics which, by the World Bank criteria,
qualified it as one of the HPAEs.

To be sure, other developing countries at times have grown
equally rapidly, but never at such high and sustained rates.
Moreover, the high, sustained growth of the HPAEs was, in
contrast to most other developing countries, accompanied by a
steady reduction in the incidence of absolute poverty and
relative inequality.

All these HPAEs also experienced rapid demographic
transitions, strong agricultural growth, and very rapid export
growth, particularly of manufactured exports.

Nevertheless, in spite of the remarkable economic and social
progress under the New Order government, Indonesia before the
economic crisis of 1997/1998 was still a relatively poor country,
not only compared with Japan and the East Asian NIEs, but even
compared to its more prosperous neighbors, Malaysia and Thailand.

In the area of social development, Indonesia lagged behind its
more prosperous Southeast Asian neighbors, Malaysia and Thailand.
In his recent book on Indonesia's economic crisis, Prof. Hal Hill
of the Australian National University points out that Indonesia's
life expectancy was lower and its infant mortality rate was
higher than poorer Asian countries, such as China and Vietnam, or
a country with a comparable per capita income, such as the
Philippines.

Moreover, because of the "urban bias" in its development
policies, there were pronounced urban-rural economic disparities,
as well as inter-regional economic disparities, particularly
between the relatively more developed part of western Indonesia
and the less developed eastern part.

These economic disparities has led to serious discontent,
particularly in the four resource-rich provinces of Aceh, Riau,
East Kalimantan, and Irian Jaya. Many of these peoples feel that
the export proceeds of their natural resources have been mainly
transferred to the central government, just as Indonesia's export
proceeds during the Dutch colonial period were largely
transferred to the Netherlands (referred to as the "colonial
drain" by the Indonesian nationalists).

Despite rapid economic growth in the early 1990s, a growing
number of Indonesian economists began to voice serious concerns
about various economic policies which, in their view, threatened
to undermine not only long-term, efficient growth, but also the
cherished national goal of establishing a "just and prosperous
society" (masyarakat adil dan makmur). While macro-economic
policies were in general still sound, various micro-economic
policies, such as policy-generated barriers to domestic
competition and trade (for example barriers to entry into certain
economic activities, the establishment of monopolies and cartel-
like arrangements without economic rationale), had the effect of
rewarding unproductive "rent-seeking" activities rather than
truly entrepreneurial activities essential to long-term dynamic
and efficient growth.

Many of these policies were obviously intended to benefit
political powerholders and their cronies, despite the fact that
these policies were often justified on the flimsy grounds of
"national interest".

In her interesting study on the role of the state in Indonesia
in the 19th and 20th centuries, Prof. Anne Booth of the School of
Oriental and African Studies, University of London, has described
the New Order state as a "developmental state" dedicated to
rational economic planning. This "developmental state", however,
was showing features of the "predatory state" (particularly since
the late 1980s) as powerful vested interests, in cahoots with
political powerholders at the highest level, were using (with
increasing success) the power of the state to build personal
empires based on preferential access to lucrative government
contracts, licenses and bank credit.

Indonesia's descent into a deep economic crisis in early 1998,
more serious than the plunge by Thailand and South Korea, was
largely caused by the inability and unwillingness of its
political leadership to dismantle the "predatory state" by taking
the necessary structural reform measures as agreed upon in its
successive Letters of Intent to the IMF.

It was pointed out earlier that Landes identifies a few
crucial factors to account for the "rise of the West". These
factors were a cultural and social environment which fostered
scientific invention and technological innovations, and the
development of institutions, particularly a free market and
institutionalized property rights, which guaranteed inventors and
innovative businessmen would reap the fruits of their endeavors
without the intrusive interferences of a "predatory" government.

Hence, Indonesia's new and legitimate government, to be formed
in November 1999, should not only focus its attention on economic
recovery, but also lay the foundation of a sustained and more
efficient and equitable growth by developing the crucial public
and market institutions required to constrain the reemergence of
the "predatory state".

These institutions should include a competent and modern legal
and judicial system, an efficient and honest public service, and
free and competitive markets which constrain market players from
engaging in anticompetitive business practices harmful to the
public interest.

The Kian Wie Ph.D is an economics historian at the Center for
Economic and Development Studies, Indonesian Institute of
Sciences, Jakarta. His most recently published book is
Explorations In Indonesian Economic History (Lembaga Penerbit
Fakultas Ekonomi, Universitas Indonesia, Jakarta 1999).