INDONESIA ECONOMICS
May 8, 2007 at 2:08 am | Posted in Asia, Economics, Financial, Globalization, Research | Leave a comment
Bulletin of Indonesian Economic Studies
Volume 42, Issue 3 December 2006
pages 295 – 319
SUMMARY
The growth of Indonesia’s GDP accelerated in the second quarter of 2006, thanks to the buoyant performance of the communications, construction, transport and agriculture sectors.
From the demand perspective, growth was supported by increased government spending and net exports. Macroeconomic stability has continued to improve, and Jakarta’s stock exchange has been outperforming others in the region, reflecting positive market sentiment in response to stable government, the improved growth rate, and the steady decline in inflation and interest rates. With these positive macroeconomic signs and high commodity prices in international markets, a sense of optimism has started to emerge in some sectors, but there are also concerns that economic reform has stalled. The challenge for the government is to balance its political need for short-run ‘wins’ with the imperative for long-run macroeconomic stability. Among the ideas for generating a quick win, the ambitious proposal for development of a large-scale bio fuel industry has gained much attention, but it is very unlikely to be a short-term panacea for the problems of high unemployment, poverty and dependence on increasingly costly fossil fuels.
The government has had to deal, once again, with the highly controversial issue of rice imports. The rice import ban imposed by the government last year was the main cause of surging rice prices in 2006. These in turn – not the 2005 fuel price rises, as has often been claimed – were the primary trigger for the significant increase in poverty reported in September. Removing the rice import ban is therefore likely to help reduce poverty.
The announcement of a number of policy packages intended to boost lagging investment, particularly in infrastructure, may well reflect genuine intentions on the part of the government, but what really matters is implementation. There seems to have been a loss of momentum in this regard for various reasons, including a lack of capacity in the bureaucracy, and the fact that many officials have a clear incentive to oppose reform.
This strongly suggests the need for a major civil service overhaul, extending far beyond the present focus on anti-corruption efforts. The need for such an initiative is also apparent in the failure of the bureaucracy to prevent or deal adequately with the mud flow disaster in Sidoarjo in May. Reform is also necessary in relation to the legislatures, where delays in enacting or amending key laws often reflect a pay-off to members from being able to frustrate governments’ legislative intentions.
THE POLITICAL AMBIENCE FOR ECONOMIC REFORM
The economy has long since recovered from the severe economic crisis of 1998-99 and is now relatively stable, but there is growing scepticism about the government’s capacity to implement reform. Moreover, decentralisation has created tensions between central government objectives and policies and the roles played by local governments, which have become far more important than previously. The government’s increasingly apparent inability to deliver on its well-publicised reform agenda means that hopes that it could restore economic growth to pre-crisis levels have proven unduly optimistic. In these circumstances managing expectations has become a key issue, as by now public debate seems dominated by pessimism. Good news and stories about government successes hardly ever appear in the media, reflecting the low level to which confidence in the government has fallen. Interestingly, criticism is most often directed at min-isters – particularly those in the economic team – and rarely at the president. This may be because trust in the president, although declining, remains high. Alternatively, critics may only be aiming to bring down particular ministers, rather than the government itself.
Improving macroeconomic stability is easier than implementing micro economic and institutional reform, because the former is in almost everyone’s best interest, whereas the latter always faces challenges from groups whose interests are harmed by reform.
Moreover, the benefits of reform generally materialise in the medium or long term, while the political cost that potential losers from reform can impose on governments is often immediate.1
In fact, the government has been successful in handling a number of difficult issues that previous administrations were not able to resolve, including bringing peace to Aceh, settling the dispute with ExxonMobil over the Cepu oil field (Sen and Steer 2005: 299; Manning and Roesad 2006: 159-60), and finding a way to end the impasse with Cemex over its stake in PT Semen Gresik.2 Yet it has not been able to exploit these success stories so as to convince the public that significant progress is being made. Although commentators concede that macroeconomic stability has improved, their primary criticism is that this has not resulted in job creation on the scale needed to reduce unemployment and poverty.
Growing public impatience for reform, combined with strong opposition from those who stand to lose from it, has left the president feeling under strong pressure to register some ‘quick wins’ in order to gain public trust. The challenge for the economic team, therefore, is to achieve this without jeopardising macroeconomic stability. If it fails, there is a risk that pressure for populist economic policies will build, further weakening the government’s commitment to reform. Such pressure is likely to generate only inferior quick fixes aimed at maintaining public support for the government.
In a retreat at Losari, Central Java, in early July, the president gave a presentation entitled ‘(Post Crisis) New Deal and Bio Energy Action Plan’, based on the notion that Indonesia needs a major initiative that will create a large number of jobs within a short period. We discuss the bio fuel initiative in detail below; suffice it here to note that it envisions a quick pay-off in terms of reduced unemployment and poverty, without the need to introduce reforms that would generate strong political resistance. But the threat to macroeconomic stability is great. The scale of the proposal is enormous, and it seems potentially more appropriate for dealing with long-run rather than short-run objectives.
In our view there is no quick fix for the unemployment problem; solving it without confronting the politically painful process of labour market reform will be impossible (Manning and Roesad 2006: 163-9).
GROWTH AND MACROECONOMIC TRENDS
Economic growth
Sectoral performance. After declining steadily for five consecutive quarters, GDP growth rebounded in the second quarter of 2006 to grow by 5.2% year-on-year (y-o-y), up from 4.7% in the previous quarter, and somewhat better than predicted by many observers (table 1). The upturn in growth overall was significantly affected by unusually high growth in agriculture, which is unlikely to be sustained.
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