Policy drift Ten years after Suharto, the economy is not recovering fast enough

Policy drift
Ten years after Suharto, the economy is not recovering fast enough

Anne Booth

The economist Benjamin Higgins, writing about Indonesia in the mid-1960s, saw ‘signs of genuine distress, reminiscent of Calcutta or Bombay – people with bloated stomachs and deficiency diseases who live under sacks and pick over garbage in the streets in hopes of finding something edible.’ On most economic and social indicators, Indonesia was moving inexorably backwards. Pessimism about future prospects was widespread.

After the 1965 coup, General Suharto, with the backing of most of the armed forces and the assistance of expert economists, immediately set about tackling the grave economic situation. His main goals remained until 1998 what they had been when he took power in 1966: to restore and maintain tight political control over the vast Indonesian archipelago, to accelerate the pace of economic development, and to improve the living standards, defined in terms of material consumption, of the Indonesian people. In each of these goals he achieved considerable success.

By the early 1990s, the former ‘chronic dropout’ was being hailed as a successful example of relatively painless structural adjustment in the wake of a commodity boom. Indonesia seemed to be following in the footsteps of South Korea and Taiwan. By 1996, the proportion of workers with less than completed primary school had fallen to 30 per cent.

The New Order had many critics. In the early years, the press was reasonably free. Early observers, taking China as their model, missed an egalitarian ‘peasant-centric’ ethic, and they criticised Jakarta’s high-living elite. By the early 1990s, their concerns had moved to environmentalism, human rights, the rule of law, and greater government support for small enterprises owned and managed by indigenous Indonesians. In the early 1990s the government began to publish official poverty figures, which indicated that the percentage below the poverty line had dropped from around forty per cent in 1976 to only eleven per cent in 1996. But critics pointed out that the official poverty line was much lower than that used in Malaysia and the Philippines.

Despite a troubled political situation in early 1997, with increasingly open anti-government protests, virtually all observers thought the economy remained strong. As the rupiah exchange rate began to fall, the World Bank’s chief of mission in Jakarta was quoted as saying: ‘There is no economic reason for what is going on.’ In fact the reason was quite plain. Many Indonesian companies had substantial foreign short-term debts to service. As the rupiah fell, it was becoming clear as well that the government was losing the confidence of its own business class.

The IMF assistance package announced at the end of October pledged US$33 billion. In return, Indonesian technocrats announced reforms. Most threatened the interests either of Suharto’s family or of his key business associates. Although critical of the IMF, after his re-election as president in April (by a compliant Peoples’ Consultative Assembly, MPR), Suharto immediately implemented the harsh measures of a third IMF package. Steep increases in prices of electricity, fuel and transport, and further budget cuts, triggered more protests. On 21 May Suharto resigned in favour of his vice-president.

Total GDP contracted by over 13 per cent in 1998. A severe drought made things worse. Prices rose alarmingly. After thirty years, commentators again began to question whether Indonesia could long survive as a single political entity.
Slow recovery

By the latter part of 1999 it was clear that the most pessimistic predictions of 1998 had been too alarmist. But the pace of recovery was slow. Only in 2003 did both GDP and national income per capita return to 1996 levels. Between 2003 and 2006, economic growth quickened. By 2000 poverty levels were trending downwards. One estimate had poverty at 15.3 per cent in mid-1997, just before the crisis began. It then jumped to 33.2 per cent in late 1998, implying that the crisis had pushed around 35 million people into absolute poverty. But by early 2002, the headcount measure dropped again to around 13 per cent, lower than before the crisis.

These national estimates masked considerable variation by region both in the impact of the crisis and in the extent of the rebound after 1998. The crisis was worst in the relatively well-integrated parts of the country, which were vulnerable to an economy-wide crisis. The poor and isolated were less badly affected precisely because they had benefited less from the boom. On the other hand, the less developed districts were more likely to experience deadly ethno-communal conflict between 1997 and 2003.

Despite the post-crisis improvements, in September 2006 the Central Board of Statistics announced that the headcount measure of poverty had increased to 17.75 per cent, up from 16 per cent in 2005. This was an embarrassment for the Yudhoyono government, which had set ambitious poverty reduction targets for 2008. Commentators blamed rising rice prices, a result of the rice import ban imposed in late 2005.

Data on unemployment have also been disappointing. Rates of open unemployment increased after the crisis, and in 2007 they stood at 9.8 per cent or 10.5 million. Of these, over 40 per cent had at least senior high school education. Growth of new jobs was slow, especially outside agriculture. High unemployment has been blamed on the 2003 Manpower Act, which gives workers greater protection, including generous minimum wages and severance pay, as well as limitations on hiring workers on short-term contracts and on outsourcing. Labour-intensive sectors such as textiles, garments and footwear, had also begun to shed labour since 2001, before the Manpower Act. Indonesia competes with China and Vietnam in the international market for labour–intensive products such as shoes. Though supposedly socialist, these countries have fewer labour protection regulations than Indonesia.

Indonesian exports have more than doubled in value terms in the decade to 2006, but much of this growth has come from processed primary products such as vegetable oils. Indonesia is not participating vigorously in regional production networks for electronics and computer components, automotive parts and other manufactured inputs. Foreign investors in manufacturing have been deterred by both the labour legislation and the problems of congested infrastructure. Road and port facilities in Java, let alone the other islands, are badly in need of improvement, but so far efforts to secure private investment in infrastructure development have not been very successful.

While Indonesia’s economic ‘reversal of fortune’ since 1997 is no worse than that of Thailand, the Yudhoyono government has repeatedly stressed that faster economic growth is essential for ensuring greater prosperity of the growing population, predicted to reach by 294 million by 2050. But to achieve sustainable growth of six to seven per cent per annum, the reform agenda must be tackled more aggressively. Although most of the large conglomerates were forced to divest at least some of their assets to settle debts, the divestment process was often far from transparent. The problems of ‘corruption, collusion and nepotism’ that provoked student protests in 1998 have not gone away. Powerful groups have been able to influence the decisions of regulators, including the courts, in favour of business groups from the Suharto era. World Bank economists can show that the control of corruption actually deteriorated between 1996 and 2005. Decentralisation since 2001, which has given more responsibility to lower levels of government, has also given local officials more scope to use funds for personal enrichment.

Government spending on health and education relative to GDP is lower in Indonesia than in most other Asian countries. Over the past decade richer households are increasingly resorting to private providers. Combined spending by central departments on health and education in the 2008 budget is only eight per cent of GDP, less than the amount devoted to energy subsidies. This may even get worse as oil prices continue to rise.

Although the great majority of Indonesian children now have access to six years of basic education, enrollment ratios at higher levels fall sharply by income group. To the extent that children from better-off households have access to better health care, are better nourished, and better educated, they are more likely to find better-paid employment. Social mobility could become more difficult, perpetuating inequalities over generations.

The reform agenda facing the Yudhoyono government in the final year of its first term remains a formidable one. The minister of finance announced on May 7 that fuel price adjustments in the range of 20 to 30 per cent are being considered and will likely be implemented within a few weeks. These will not be popular and the challenge for the government will be to explain the necessity of such measures, at a time when food prices are also rising. These price hikes will aggravate poverty problems at least in the short run, although the government has pledged to give cash subsidies to an estimated 19.1 million households when it raises fuel prices further. More painful medicine may be needed later in the year, especially if world oil prices continue to rise. Whether these policies will damage the government's re-election chances is still unclear. The onus is now on those critics who have complained in the past of government vacillation to put forward plausible alternative policies. ii

Anne Booth (ab10@soas.ac.uk ) is professor of economics at the School of Oriental and African Studies (SOAS) of the University of London. She has written numerous books and article on the Indonesian economy. This article is from a presentation at the Amsterdam conference 'Ten Years After', 22-23 May 2008 (KITLV, University of Amsterdam, Inside Indonesia).

Inside Indonesia 92: Apr-Jun 2008