Conference on Democratic Transition and Consolidation

CONFERENCE ON DEMOCRATIC TRANSITION AND CONSOLIDATION

Rahardi Ramelan

Economic Reforms During Transition to Democracy

The Lesson from Indonesian Case[1]

Rahardi Ramelan[2]

INTRODUCTION

Indonesia is a country with over 200 million populations. Stretch over 17000 islands from East to the West, 5000 km in length. Multi-cultural society of more than 150 ethnic groups. A republic since 1945 after 350 years of colony.
In the aftermath of a major civil conflict in 1965-1966. The government (New Order) embarked with priority in political and economic stability and national security. An economic reform has been launched and implemented.
The dramatic oil price increase in the 1970’s (Oil boom) has influenced the path of the reforms. Increasing state intervention in the economy. Import substitution policy, inward looking, and strategic industry and technological development have been pursued.
The 1980’s and 1990’s marked with adjustment and liberalization. Regional, international and globalisation pressure (ASEAN, APEC, GATT/WTO). During this period Indonesia enjoyed high growth.
Then came the Financial Crisis in 1997 and the peak in 1998. The evolving political situation was worsened by the crisis and in turn increasing the magnitude of the crisis. And in May 1998, President Soeharto stepped down and B.J. Habibie became the third Indonesian President.
President Habibie immediately embarked with reconstruction of the economy with the support of the international communities. The Habibie government also initiated political reforms and establishing the foundation for the world’s third largest democracy.
After the successful historic general election in June 1999 and the general session of the People Consultative Assembly in October 1999, Abdurrahman Wahid and Megawati Sukarnoputri was elected as the fourth president and vice president respectively.
Special session of the People Consultative Assembly in July 2001, has replaced Abdurrahman Wahid by Megawati Sukarnoputri as president and Hamzah Haz was elected as vice president.

Every country has its characteristic natural conditions - size and geographic, size of the population.
Socio-economic conditions – GDP and GDP/Capita, literacy rate, ethnic structure.
Historical and political conditions – colony/former colony, independent, autocracy/kingdom, democracy.
The process to democracy through people empowerment is a long way.
Constitution is necessary, but the role of leader is significant and decisive.
Learning process and time needed to democracy is important and should be considered, different approach of school of thought should be adapted to national/country socio-culture.

AFTER THE INDEPENDENCE

The time when colonial power left Indonesia, the social and economic situation in Indonesia consists of two different societies, namely the society of traditional economy and the society of firm-type economy. Whereas the firm-type economy dominated by Chinese ethnic group.
In the early 1950’s the government implemented different program to support indigenous (known as pribumi) to balance the dominant of the economy controlled by Chinese ethnic group and the Dutch companies, particularly the trading companies.
The nationalisation of the Dutch and British companies in 1957 and 1959 engendered the government/state dominating the economy.

After the Second World War many countries in Asia and Africa became independent.

A strong nationalism movement during that period forced the leaders to implement “nationalist” economic policy, specially the countries with rich natural resources. Nationalisation of colonial/foreign assets.
Promoting and supporting (with regulations and special financial scheme) indigenous entrepreneurs and ownership.
The economy controlled by state.

The problems encountered

Lack of professional managerial skill and international market knowledge.
Primary commodity were/are buyers market.

The economy worsened.

Clear concept of the state’s structureis necessary – centralised, autonomy or

federal

The look-to-the East (Eastern Europe) during the cold war and the implementation of a centralized economic and planning policy, the role of the state in the economy became stronger.

Political instability during this period, confrontation with Malaysia and the Netherlands, Indonesia encountered crisis in 1966 after the failed communist coup in 1965.

The cold war created “non aligned movement”. People democracy, social democracy and others couldn’t come with a clear economic policy. Autocracy and centralised economy was a common solution.

Unstable political situation

Nationalism versus federalism, autonomy and decentralisation.
Continuos debate on state “philosophy”
Ethnic group and religion conflict.
Government –

Stable (temporary) – powerful and authoritarian (mostly military)

Unstable – Weak leadership and immature democratisation process.

There were lack of attention on establishing economic framework, laws and regulations.

People’s welfare was declining.

What’s wrong? The system or the leader?

These conditions have lead to a social unrest and triggered economic, political and government crisis.

DEVELOPMENT PERIOD

After the crisis in 1966, with assistance of the World Bank, Asian Development Bank, International Monetary Fund, other multilateral institutions and friendly countries, Indonesia open its economic system.
The core of economic framework are: 1) To increase the role of private, national and foreign, in the economy; 2) Adoption of open capital account; 3) Balanced budget, with deficit permitted as long as compensated by foreign assistant; 4) competitive real exchange rate through periodic adjustment.
When the oil prices increased in the 1970’s Indonesia adopted Industrial and Technological Policy. Import substitution policy has been adopted, including 1) Deletion Program on car, motor cycle and heavy equipment industry, 2) Government Investment in upstream industry such as cement, fertilizer, aluminium, steel, refinery and others, 3) Increase technological capability through strategic industry, such as aerospace, shipbuilding, equipment for power plant, offshore technology and others. Numbers of Research Laboratories have been established, 4) Special Minister has been appointed to strengthen national awareness to use national product. A Government Procurement Committee has been established to implement the policy.

Protection from import for the “infant” industry has been implemented. High import duty/tariff or other Non Tariff Barrier/NTB has been applied.
The oil boom and the recovery period was marked by advancement in the economy and social life, such as 1) high economic growth, 2) manufacturing’s contribution to the GDP increased, 3) expansion and modernisation of economic infrastructure, 4) social and poverty alleviation program was strengthen.
The steep drop of oil prices in the 1980’s forced the government to make adjustment. The economy could not rely on oil income anymore

To deal with economic problem the “new government” has to decide on important issues

The role of private in the economy.
Opening the economy to the world economy. Increase the role of foreign investment.
Government budget and financial assistance (debt) from multilateral financial institutions and bilateral assistance.

The question – Is the country ready? Politically and socially?
How to make use of the windfall from high world price of oil and other primarycommodity?

Increase social welfare through direct intervention (increase salary, tax cut, housing program etc.) – Short time and temporarily.
Investment in social and economic infrastructure – should be followed by promotion of private investment.
Investment in human resources, technology and industry – Long term solution. The society has to be aware that it is a long-term and costly program.

Industrial Development

Inward- versus outward-looking strategies – The size of the population.
Protection for domestic industry – Temporary/Infant industry.
National movement – by national product/cultural approach. Quality and competition should be maintained.
Financial support scheme – Cost of money should be competitive with other countries. Special scheme for SME and export financing has to be established.

DEREGULATION AND GLOBALISATION

Tax reforms has been launched and implemented during the 1980’s and mid 1990’s. Various measures to deregulate the economy were adopted and the economy became part of the world market.
The economic adjustment included 1) deregulation of foreign trade: reducing of import tariff, reduction of NTBs, licenses and others, 2) reduction/removal of restrictions on foreign direct investment/FDI, 3) liberalization of financial sector including the banking and capital market sector, 4) simplification of tax system and introduction the value added tax.

Regional Economic Co-operation and IT development accelerate the Globalisation process.

Uruguay Round – GATT/WTO - create a severe world competition

Globalisation – competitive advantages

Low labour cost
Tax holiday for foreign investment
Opening domestic market
IPR implementation
Anti monopoly and fair competition

THE OUTCOMES - Asian Miracle and East Asia high performer

1965 – 1995 real GDP/capita grew with 6.6% rate and reached over US$ 1,000 by mid 1995.
After having hyperinflation during the crisis, Indonesia can manage single digit inflation rate.
Manufacturing share in GDP increased to 25% in 1995 from only 7.6% in 1973.
Non-oil export grew by average of 22% annually in the period 1985 to 1995.
Self-sufficiency of rice and stable price of rice increased the rural income.
Poverty incidences sharply reduced to only 11.5% in 1996 from 60% in1970.
According to the World Bank (1998), the real wages have grown as fast as per-capita GDP, women have benefited from the rapidly growing paid employment in the formal sector.
Other social indicators, such as school enrolment, fertility and infant mortality improved significantly.

Some countries have improved their economy.

GDP/Capita has been increased. Other economic indicators were good.
Unrest and crisis is still happened.
What is the problem? What’s wrong?
Regulation and supervision

Competition without existence of the regulation, Anti monopoly and fair competition law, created super conglomerate.

Policy based only on competitive advantages created imbalances and

widened the gap between regions and in the society.

Opening domestic market has driven out small and traditional economy, and local production (without export) from the market.
Implementation of IPR endangers the unprotected indigenous technology and tacit knowledge.
Industrialised countries still dominate international market. Industrialised countries confront late industrialised countries with protection policy ( Quota, IPR, Environment, Labour, US Super 301 etc.).

WTO cannot perform effectively. Special and Differential Treatment for

Developing countries has been never considered seriously. Dispute Settlement

Body (DSB) decisions are bias. Focusing only on trade issues and neglecting

development issues of developing countries.

THE CRISIS, RECOVERY AND TRANSITION

The economic growth before the crisis was 8.2% and 7.8% in 1995 and in 1996 respectively. In the beginning of the crisis in 1997 the growth fell to 4.9%. In the peak of the crisis the economy contracted by 13.6%. Inflation was 78%, the depreciation of exchange rate from Rp. 2.400 and collapsed to Rp. 16.000 to the dollar. Banking sector lost completely its credibility. Income from non-oil export fell by 2.4% in 1998 and 4.6% in 1999.
In May 1998, riots exploded. The riot and unrest lead to more capital flight and the breakdown of distribution system and deepen the crisis further.
The social impacts of the crisis are immense and complex and make the comprehensive recovery planning extremely difficult.
The number of the poor doubled from 11% in 1996 to 20% in 1998. The proportion of using public health service has declined. Spending for education has gone down as well. The number of unemployment increased to 38 millions or 34% in 1998.
And in this economic and social (also political) condition Habibie was sworn in as Indonesia’s third president. Immediately he instructed the economic ministers to stabilize the economy by 1) restoring the distribution system, 2) developing social safety net program and 3) undertaking restructuring programs mainly concentrated on banks recapitalization, corporate debt restructuring and privatisation.
Habibie government succeed 1) to stop the further deterioration of the economy, 2) restore the stability and 3) lay down the base for reconstruction.
By mid 1999 the economy bottom out. The economy grows by 0.2%. And after the successful democratic election, in October 1999 during president election, rupiah recovered to Rp. 6500- Rp. 7500 to dollar. Inflation was managed to reduce to 2%.
For the reconstruction of the economy a number of new law and regulation has been introduced. Anti monopoly and fair competition law has been enacted, as well as Consumer Protection Law. A new bankruptcy law was introduced. The law on the central bank that allows the Bank of Indonesia (Central Bank) to run monetary policy independently. The Indonesian Bank Restructuring Agency (IBRA) was established and plays important role in bank and domestic corporate debt restructuring. Foreign corporate debt restructuring was facilitated by JITF (Jakarta Initiative Task Force) and INDRA (Indonesian Debt Restructuring Agency). Commodity Trading Agency has been installed. A new Export Bank has been established.
They are important measures have been taken. First how to stop and recover the falling down economy, and second is how to put the ground for further reconstruction and development in more democratic society.
After 55 years of independent and dominant central government, the most serious problem for Indonesia is regional imbalances. Decentralization has to be implemented that the regions can develop their own resources. A new law of financial balance between the central government and regions addresses these economic imbalances.

Transition to democracy during the economy crisis is a colossal task, or to come out from economic crisis during transition to democracy is a myriad job.
Economy –

Stop the deterioration of national currency and control the inflation.
Special effort to relief the poor from the impact of the crisis.
Establish laws and regulations as a foundation for a strong market economy – anti monopoly and fair competition, fair taxation, bank and Central Bank, consumer protection.
Encourage private participation in the economy.

Politics –

Establish a productive synergy between government and the legislator/parliament.
Legislation for political activities and democracy should be process expeditiously.
Broad involvement of scholars, researchers, and mass media is important.
Public debate should be introduced before a new legislation will be enacted.

CONCLUSION

The improvement in social welfare was not followed by relaxation of political repressions. The development of modern economic state has to be together with political democratisation process.

The transition process to democracy in Indonesia takes place at the same time with the crisis. It is not only financial and economic crisis, but also a multi dimensional crisis. Distrust now is widely spread and hampers the productivity and reducing the social capital.
The slowdown of global economy and restrictions of import by several developed countries create further delay to the economic recovery.
The domestic situation and purchasing power cannot develop the domestic market. The burden of government budget for bank recapitalization is huge and reduces availability fund for social program.
Financial multilateral institutions have to understand the immense of the crisis to the social welfare of the people.

The regions in the country should have the right to decide on certain socio-economic and political matters. Avoid imbalances between the regions and groups in the society.
The transition to democracy should be initiated during the best economic years.
The improvement in social welfare should be immediately followed by relaxation in the politic life.
Consider sufficient time that democracy has to mature. Accommodate “all” idea from different schools of thought.
Globalisation is also the interest of developing countries. Experiences show that WTO is bias toward developing and newly industrialised countries.
Group 77 and UNCTAD could be considered as other vehicle for developing countries to speak out and advocate their interest.
Multilateral and bilateral financial assistance institutions have to understand the enormous impact of transition to democracy to the social and cultural life of the country.

References:

Hill, H - The Indonesian Economy in Crisis: Causes, Consequences and Lessons,

Institute of Southeast Asian Studies, Singapore 1999.

Hill, H – The Indonesian Economy Since 1966, Southeast Asia’s Emerging Giant,

Cambridge University Press 1996

Lisa A. Cameron – The Impact of the Indonesia Financial Crisis on Children: An Analysis using the 100 Villages data,

Bulletin of Indonesian Economic Studies, Vol 37 No 1, April 2001

Bilveer Singh – Habibie and the Democratization of Indonesia,

Crescent Design Associates, Singapore 2000.

Djisman S. Simanjuntak – The Indonesian Economy in 1999: Another Year of Delay Reform - in Indonesia in Transition: Social Aspects of Reformasi and Crisis (Chris Manning and Peter van Diermen, Eds.)

Institute of Southeast Asian Studies, Singapore 2000.

Anne Booth – The Impact of the Indonesian Crisis on Welfare: What do we know two years on? - in Indonesia in Transition: Social Aspects of Reformasi and Crisis (Chris Manning and Peter van Diermen, Eds.)

Institute of Southeast Asian Studies, Singapore 2000

Ginandjar Kartasasmita – The Globalisation and the Economic Crisis: The Indonesian Stories

Presented in Harvard University, Cambridge, MA, USA 2001.

B.J. Habibie – Revitalizing the Administration for Economic Recovery and the Promotion of Democracy: Governance Reform During Critical Years,

Speech Delivered on The Conferment of Honorary Doctorate Degree from Chungbuk University Korea. March 13, 2001.

Rahardi Ramelan – Foreign Investment and Cultural Change, The Case of Indonesia,

Presented at Research Institute for International Technical and Economic Cooperation (FIZ), Aachen University of Technology (RWTH Aachen), Germany, June 9, 2001

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[1] Presented in the Expert Group “Economic and Social Conditions” / Conference on Democratic Consolidation and Transition. Madrid, October 19 and 20, 2001.

[2] Professor, Institut Teknologi Sepuluh Nopember, Surabaya. Indonesia.

Visiting Scholar, MIT-Centre for Technology, Policy and Industrial Development, Cambridge, MA,USA