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).