Political Economy of Indonesian Economic Reforms

Political Economy of Indonesian Economic Reforms: 1983-2000 Ari Kuncoro University of Indonesia Budy Resosudarmo Australian National University Introduction • Economic reforms in Indonesia under Suharto era and shortly after his fall in 1998 • Periods under investigation – 1983-1991: the start of economic reforms after the fall of oil revenues – 1994-1997: the second wave of reforms – 1998-2000: the start of post-Soeharto era Sources of Suharto’s political power • Came to power after political and economic crisis in 1966 • Maintaining public support by fixing the economy • Also he created a regime, well-known as the New Order based on Weberian patrimonialism – patron-client political structure (Crouch [1979]) • The regime needed economic growth to cling to power • Reforms were needed whenever economic growth was deemed as ‘threatened’ Incompatibility problems? • Seemingly incompatibility between market oriented policies and a political structure based on patron-client ties • The regime’s need for economic growth required bureaucratic values of predictability, regularity, order and rationality, while patrimonialism is characterized by favoritism and arbitrariness • How Suharto reconciled this incompatibility problem is the focus of this study Two Hypotheses • Economic reforms were influenced by three variables: the most important was economic crisis but always in the context of the other two factors, ideology (nationalistic) and the patrimonialistic nature of the regime Two Hypotheses • In a way, there is a compatibility between market oriented policies and patrimonialism in the initial stage of development of market economy (the first two major reforms). Both economic reforms and patrimonialism were the optimal choice for the elite and most likely the rest of stake holders. In the later stage market-oriented policy became incompatible with patrimonialism because it slowed reforms. But abolishing patrimonialism fragmented the political elite, hence the ability of political and cultural institutions to gain consensus became limited. Many more interest group needed to be compensated upfront. Methodological Approach • To be able to test the above hypotheses, the political structure and important players need to be investigated • For each major reform program, the analysis focuses on three central questions: – Why reforms were conducted – What were the factors affecting the shape of the reforms – How successful were the reforms Political Structure • Although the president’s office was a domineering force, the structure allowed the involvement of three other important players in the decision making process: the economists or the technocrats, the technicians and the patrimonialists • Political competition revolved around gaining favor with the president who determined the allocation of rewards. Important Players: Technocrats • A group of Western-trained University of Indonesia economists • The proponents of conservative market oriented policies and helped Soeharto in designing the economic stabilization policy in 1966 • Controlled the powerful offices of the Ministry of Finance and the National Planning Agency • Did not have a large domestic constituency outside the universities and state offices they controlled Important Players: Technicians • Mostly engineers-turned-managers with little training in economics and economist with structuralist inclinations • United by their belief in the general validity of the infant industry argument • Tend to favor more protectionist policy and rapid state-led development that usually involved very large capital investment • Largely controlled the Ministry of Trade and the Ministry of Industry Important Players: Patrimonialists • Consisted of military personnel (political generals), elite bureaucrats and the ruling GOLKAR party members • In charge of distributing rewards to those within the political elite and possibly to some outside this small circle. At the forefront of this small circle is the civilian bureaucracy • Mostly located in the State Secretariat and the administrative area of the presidential office Important Players: Military • Officially as an institution the Military stood outside the circle of policy-makers – Soeharto, technocrats, technicians and patrimonialists • Having some influence on policy making through some of its member holding cabinet posts • Helping to control regional politics – during Soeharto’s era the majority of of regional leaders were retired military personnel Sources of patronage funds • State own enterprises as cash cows • Giving the loyal key officials the authority to grant licenses in certain economic activities, which can be sold to private parties in return for substantial financial resources for themselves and the regime • The extensive use of foundations that held stake in dozens large private enterprises Political Parties • Political organizations are strictly controlled • GOLKAR was created as ‘the government party’ • All Islamic parties were merged into the United Development Party • Nationalist and Christian parties were grouped under the banner of Indonesian Democratic Party Budget allotment to mobilize popular support • Price of the staple food, rice, was kept stable – though largely tracked the world trend • Farmers were assisted through subsidization of agricultural inputs – fertilizers, seeds, and pesticide • The subsidy of kerosene eased the burden of urban and rural population alike • The social capital program called INPRES was created to improve infrastructure at the village level; roads, schools, health centers and markets 1983-1991 economic reforms • Cause: the fall of oil price • Politically: patrimonialist had no choice but to accept economic reforms • Goal: to develop and to diversify non-oil sectors in the economy: particularly manufacturing and agriculture • Measures: – Simplifying export-import procedures – Across the board tariff reduction – Approval procedures for foreign investment were simplified – Banking system deregulation 1983-1991 reforms: outcomes • Share of non-oil exports rose from 17.8% in 1981 to 56.9% in 1990 • GDP growth restored from as low as 2.5% in 1985 to 7.2% in 1990 • Share of manufacturing rose from 11.4% in 1983 to 19.4% in 1990 • Reducing the government’s dependency on the revenue from oil and gas 1994-1997 Reforms • Cause: no looming crisis as seen in 1982 but there was a concern of slowing down of non-oil exports • Measures: – The abolition of limitation on FDI – Reduction in trade barrier in the form of tariff cut • Outcomes – Influx of FDI resumed in 1994 – GDP grew about 8% per annum in 1994-1996 period Seeds of the coming troubles • Paradoxically the influence of technocrats began to wane as the economy improved. Suharto started to embrace more the advice of technicians i.e. more intervensionist industrial-trade-investment policies • Patrimonialist became more entrenched in upstream sectors, banking and construction • The banking sector deregulation had not been accompanied by a good supervisory function • A huge capital inflow in the form of corporate loans as well as through commercial banking to finance: – bubble sectors that contributed very little to foreign exchange generation – Projects in upstream sectors owned directly-indirectly by patrimonialist Economic Crisis • Thai’s economic crisis triggered doubts concerning Indonesia’s economic stability • Reversal of capital inflows brought currency crisis • Currency crisis caused banking crisis and corporate sector with high exposure to foreign debt 1998 (IMF sponsored) Reforms • Goal: to restore investor confidence - to stop capital outflow • Measures: – Financial restructuring program strengthening the weak banking system – involved the closure of 16 private insolvent banks including some controlled by Suharto’s family and his cronies – Liberalization of both trade and foreign investment Politics of 1998 reforms • Threatened the dominant position of the core interest group: Suharto-croniespatrimonialist • Faced strong opposition from the ruling elite by dragging the reforms but increasing uncertainties and deepening the crisis Economic crisis to political crisis • Economic crisis deepened • Because of the threat of a mass unrest or a revolution, for his supporters, patrimonialists, cronies also the military the stake became too high if Suharto continued to stay in power • In May 1998 Suharto resigned after about 30 years in power Post-Suharto era • With power much more diluted, without a dominant party – harder to get consensus on important matters such as economic policy making • The apparent better economic performance of Indonesia in the past, despite problem of corruption, might be attributed to the fact that corruption or rent-seeking activities were centralized and well managed and thus were more predictable Post-Suharto Era • With the departure of Suharto, this system is replaced by a more fragmented system with at least five dominant parties competing for power and financial resources. • The nature of corruption became a more fragmented bribe collection system where central government, ministry and local government officials and others like military/policy and legislative members, both at the national and local levels are demanding bribes Conclusion • Suharto believed that properly managed, a patrimonialistic system built by the combination of military and civilian bureaucratic process was not incompatible with macroeconomic liberalization. Economic development could serve as an effective legitimizing principle as well as a source of support from many groups • But as the economy became more matured it became harder to strike a right balance between market-oriented policy and patrimonialism