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Things look bad for Indonesia's economy, but don't expect rapid reform

Things look bad for Indonesia's economy, but don't expect rapid reform

Arianto Patunru and Sjamsu Rahardja's recent insightful Lowy Institute Analysis, Trade Protectionism in Indonesia: Bad Times and Bad Policy, invokes 'Sadli's Law', named for early New Order technocrat Mohammad Sadli.

Perhaps Indonesianists' most well-loved aphorism, it holds that 'bad times may produce good economic policies, and good times frequently the reverse'. It's an old friend for those at a loss to explain Indonesia's chronic ability to squander reform opportunities during its regular economic upswings.

Good times certainly seem to make for bad policies. Fuel subsidies consuming 20% of government spending during recent boom times or the non-enforcement of banking safeguards during the go-go years of the 1990s are but two examples.

But the axiom mischaracterises the contested history of Indonesia's economic policy, and the authors conclude that Sadli's Law is unlikely to hold in the near future, even as Indonesia faces a slowing China, inadequate job creation and depressed prices for its largely natural-resource-based exports.

They are right. Things look bad. The World Bank slashed its 2015 growth forecast from 5.2% to 4.7%, which would be the lowest rate since the global financial crisis. But protectionism and intervention have filled the gap as policymakers look to reduce imports, manage markets and promote domestic industries. So, when can we expect the good policy? 

Sadli's Law papers over the politics of the bad times. It's not necessarily bad times that make for good policies, but cathartic political times that make for the embrace of otherwise unpalatable economic policies. [fold]

The original 'bad time' was 1965, with Indonesia facing bankruptcy and runaway inflation as a result of Sukarno's 'extreme statist adventures'. By the time the New Order Government came to power virtually every foreign investor (save a troika of US oil companies) had been nationalised. New foreign investment was prohibited by law. Indonesia had over 1000 state-owned enterprises, mostly nationalised companies poorly run by military officers. The New Order, consolidating power amid an episode of wrenching political and social change, immediately redefined its relationship to the economy. Its first legislation (Law No. 1/1967) allowed foreign investment, while late-1966 provisional decrees liberalised policy and rationalised state control.  

Another 'bad time', the early-1980s collapse in oil prices, supposedly disciplined the government and led to the embrace of pro-market policies from technocrats whose influence increased in corollary to the oil price.

By the late 1970s oil revenues dominated the state budget (reaching nearly 60% in 1974, up from 20% in 1969), and the budding petro-state underwrote fantastic state-led industrialisation efforts. Like Fernando Coronil's celebrated description of Venezuela as The Magical Statethe Suharto-ist state possessed not only a monopoly 'of political violence but (also) of the nation's natural wealth'. Military men ran the most important state-owned enterprises, and other institutions were often powerless to exercise control over this parallel state. Even the Ministry of Finance and Bank Indonesia struggled to obtain information about Pertamina's revenues.

The price collapse created 'bad times', but it shut off the taps for both the state budget and the gestating oligarchy of entrepreneurs who were the prime beneficiaries of the heavy industries drive. Even then, the initial solution was an import licensing regime that economist Hadi Soesastro later described as 'creating a Frankenstein'. Monopolies and 'distributional coalitions' proliferated and rapidly flowed to the connected. It took several years (and only when high-cost imports threatened to kill off exports) for the strategy to be abandoned. Hardly a linear path to 'good policy'. 

More important changes occurred during 1979-1980, when a string of presidential decrees moved procurement for government projects from state enterprises to the State Secretariat. Even Pertamina, the cornerstone of the military-linked oligarchy, would lose control of its procurement in 1980, and the military itself in 1985. Until then the most powerful officials in Indonesia had been military men. From then on these ranks would include 'politco-bureaucrats' based around the State Secretariat.

Eventually, by mid-decade technocrats found space amid the economic deterioration and political change for their message of markets and liberalisation. Yet even as deregulation rolled out in the financial sector and for export-driven manufactures, 'bad policy' proliferated elsewhere. Macroeconomic deregulation was often backfilled with targeted protectionism in trade, and industrial policy. 

Veteran journalist Richard Borsuk describes the 'annual ritual' of technocrats convening several weeks prior to the meetings of Indonesia's international donors to announce reform packages to 'loosen the purse strings of foreigners'. Behind the scenes were intense struggles to win Suharto's approval for specific reforms, which might be shelved with little more than a word. Reform packages sometimes awkwardly coincided with non-reformist measures, such as the 1996 announcements of exemptions on import restrictions for Tommy Suharto's Timor national car.  

The most recent bad time, the 1997-1998 Asian financial crisis, brought a condition-laden IMF bailout aimed at attacking the roots of the 'governance issues and weak institutions' supposedly responsible for the crisis. The fate of projects like Timor, state aircraft company IPTN and the clove marketing monopoly became a tit-for-tat between the Fund and the government, one seemingly quite divorced from the foreign exchange and banking problems that triggered the crisis.  

The crisis eventually cashiered Suharto's Government and set Indonesia on the path to democracy. The IMF is bitterly remembered by many Indonesians who believe that seemingly innocuous neoliberal policies – like trade-account liberalisation or competition law – were actually cynical gambits to force open the market. Many 'reforms', as Patunru and Rahardja note , damaged the economy and have since been rolled back or replaced through non-tariff barriers and a protectionist legislative agenda.

As we have seen with this brief journey through important 'bad' moments in Indonesia's economic history, economic policymaking has always been politicised and contested. Bad times do not always make good policy. Instead, bad politics – in the form of deep changes or threats to the prevailing political power structure – provides a temporary opening for economic reform. Reform was often supplanted once a new power structure took hold and elites politically secure again.

This is a key reason why current troubles have yet to provoke 'good policy': even a growth slump to 4.5% does not threaten the prevailing political paradigm. Furthermore, as demonstrated both now and in the 1980s, policymakers' first instinct is to attack imports and champion domestic industries. Good policy sometimes needs a bit of bad policy first.  

Photo courtesy of Flickr user Asian Development Bank.

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