1 Midterm Paper Assignment 3 TOPIC FOR GROUP SEMINAR: Lessons to be Learned from Indonesia Experience 5 Final Paper Assignment 11 Governance and Economic Crisis the Case of Indonesia: Day 1 17 Indonesia: At the Crossroad: Days 2: The Crisis 49 Indonesia: At the Crossroad: Days 3: On the Road to Democracy 87 Indonesia: At the Crossroad: Days 4 : Democratic Consolidation: The Unfinised Business 145 Indonesia: At the Crossroad: Days 5 : Group Seminar 251 Galeri Album Waseda 2004 301 I HOW TO PREVENT ANOTHER FINANCIAL CRISIS 311 1 SHOLIHAH (Indonesia): Preventing Financial Crisis in Indonesia: The Role of Banking Sector 315 2 SMITH, Benjamin (England): How to Prevent another Financial Crisis 321 3 PHETDAOHEUANG, Sysomphorn (Laos): How to Prevent another Financial Crisis 333 4 KIKALA, Stephen Philip (Papua New Guinea): How to Prevent another Financial Crisis 341 5 JAMALLUDIN, Jazman Azi (Malaysia): How to Prevent another Financial Crisis 351 6 ZHANG, Chen (China): What China should do to prevent financial crisis 359 7 JANDOS, Khalik (Mongolia): How to Prevent another Financial Crisis 365 8 HSU, An-chin (U.S.A): How to Prevent another Financial Crisis 373 9 LU, Yi-chen (China Taiwan): How to Prevent another Financial Crisis 381 10 WAN MOHD RADZI, Wan Ahmad (Malaysia): 385
MORE FOREIGN DEBT 391 1 NGUYEN, Thuy Bich (Vietnam): No more to foreign debt 395 2 WU, Hsinchang (China): Indonesia’s Post-IMF Program 405 3 TJUNG, Mei Ling (Indonesia): Debt-Free Strategy for Indonesia 411 III THE ROLE OF SME AND THE INFORMAL SECTOR 419 1 ALCANTARA, Levinson Caratiquit (The Philippines): A Concept Paper for Indonesia’s Future Policies on Small- Scale and Micro Establishments and the Informal Sector 423 2 OYUNKHAND, Namsrai (Mongolia): The Role of SME and the Informal Sector 439 3 BIRZINS, Artis (Latvia): Future Industrial Policy 447 4 HUANG, Bernice (U.S.A): The Role of SME and the Informal Sector 453 IV DECENTRALIZATION 459 1 COLLADO, Jaime Jr. Mupas (The Philippines): How to Make Decentralization Works 463 2 NARBOEV, Alisher Ibodullaevich (Uzbekistan): Decentralization 469 3 WIBISONO, Aditya (Indonesia): Indonesia & Decentralization: An Evaluation of Implementation Process 479 4 SILAVONGSITH, Nalinh (Laos): Decentralization in Laos 487 V LEADERSHIP DEFICIT 497 1 OTANI, Kyo (Japan): Leadership deficit 501
School of Asia and Pacific Studies Waseda University, 9-14 February 2004 Class Introduction Course Title : Governance and Economic Crisis, The Case of Indonesia Lecturer : Prof. Ginandjar Kartasasmita Office Hours : Monday-Saturday, 15.00-17.00 Waseda University International Conference Center 4th Fl., Room #7, Phone 3230-34141 ext 5717 Email : [email protected] Website : www.ginandjar.com Assistants : 1. Dadang Solihin, HP 08129322202 email: [email protected] website: http://dadang-solihin.blogspot.com/ 2. Yoko Aoki, HP 09040571466, email: [email protected] Course Description The Asian economic crisis of 1997-1998 was a singular and most dramatic event in the region’s postwar economic history. Countries, which had enjoyed rapid economic growth in the preceding decades, which were affected by the crisis, set their development s back several years. These countries responded to the economic crisis in different ways. This course will look into the fundamental changes brought on by the economic crisis with Indonesia as the case study. It is widely accepted that Indonesia’s crisis was the most severe. What factors influenced the ferocity of the crisis? How has the economic crisis interacted with political reforms? What are the prospects of consolidation of the economic and political reforms in term of the short and medium run? The aim of this course is to discuss issues in order to enhance understanding of the political economy of changes set upon by economic crisis. We will discuss the causes and consequences, and the national responses to the economic crisis. We will analyze the interaction between economic crises and political reforms. The course will attempt to discover what lessons are to be learned from
to the consolidation of democratic governance and sustainable growth. Method The course will be conducted through a combination of lectures and class discussions. The main requirements are attendance, completion of assignments, and active participation in class discussion and debate. Accordingly, grading will be based on 30% class attendance and participation, 35% class assignments and papers, and 35% final paper. Students are expected to come to the class prepared with the subject to be discussed at the respective session. The day will typically start and end with class discussions. As the numbers of students are relatively large, to facilitate more intensive discussions the class will be organized in groups. On the final day, the class will turn into a seminar to hear, and comments on, the presentation to be given by each group. Course material The course will draw its materials basically from a monograph Indonesia: A Country at a Crossroad. Students are required to read the basic materials as the course sessions will be conducted around the monograph. Students are also encouraged to look at other sources, among others (but not limited to) as listed in the selected bibliography of the monograph. Class Schedule: No Date Time Topics 1 February 9, 2004 09:10 -10:30 Course Introduction 2 10:40-12:10 Politics in pre-Crisis Indonesia 3 13:00-14:30 Indonesia under the New Order 4 February 10, 2004 09:10 -10:30 The Crisis 5 10:40-12:10 Explaining the Demise 6 13:00-14:30 Discussion 7 February 12, 2004 09:10 -10:30 On the Road to Democracy 8 10:40-12:10 Democratic Consolidation 9 13:00-14:30 Discussion 10 February 13, 2004 09:10 -10:30 Constitutional Reform 11 10:40-12:10 The Challenges Ahead 12 13:00-14:30 Discussion 13 February 14, 2004 09:10 -10:30 Seminar 14 10:40-12:10 Seminar 15 13:00-14:30 Conclusion
scholars, as represented by Haggard and Kaufman distinguish between the initiation and consolidation of reform. Linz and Stepan argue that in most cases after a democratic transition completed, there are still many tasks that need to be completed, conditions that must be established, and attitudes and habits that must be cultivated before democracy can be regarded as consolidated. What are characteristics of consolidated democratic governance? How are they applied to the present condition of Indonesia? Huntington posits these questions: after the transition is completed what then? What problems do the new democratic systems confront? Does democracy endure? Do the new systems consolidate or collapse? These questions are relevant because not all new democracies have endured; in fact many have collapsed or experienced reversals. The students will attempt to find answer to the questions. 2. Leadership Deficit In three year between 1998-2001 Indonesia had four Presidents. Except for the last one, who is still the incumbent, three were forced to leave the office before their term expired. It is evident that currently there is a leadership deficit linked to the persistence of so many of the problems faced by the country. The debate at the centre is played amid complex and shifting power relations—factionalism even within the main parties, some along ideological lines and others just based on political opportunism. To explain the disunity and fragmentary nature of its current politics, one might hypothesize that Indonesia lacks individual leaders with the right combination of vision, character, and political savvy. There may be positive effects to this lack of charismatic leadership because, as Haggard and Kaufman asserts, over the long term “executive authority must eventually be depersonalized”. However, the experience of Indonesia at the past few years show that inept leadership have led to more failures of policy than successes, more instability and “wasted” energy in political conflict than peaceful progress and coherence. Good leadership is needed
going through transition with a history littered with promises broken by uncommitted leaders. As such, not only should reforms install an effective and transparent set of rules-based institutions, they should also evolve rules-based mechanisms by which the best of each generation are brought into the political leadership. Put in simplistic terms: a good system is nothing without good people to run it. It is not to say that the system is less important than the persons who run it, on the contrary democratization entails first and foremost establishing the system—the institutions, the processes and procedures. However, at the end of the day, a system is as good as the people who run it. It may help to recall Huntington’s aphorism, that economic development makes democracy possible, but it is “political leadership” that makes it real.
in consolidating and solidifying the newly attained democracy TOPICS FOR GROUP SEMINAR: Lesson to be Learned from Indonesia Experience 1. The dynamics of regime transition 1. What kept the Suharto regime (or most authoritarian regime) in power for so long? 2. What accounts for the regime’s resilience? 3. To what extent are external macro economic and geopolitics responsible? 4. From theoretical perspective, was the fall of the Soeharto regime inevitable or could it be avoided? 5. What framework and benchmarks would serve best in understanding the rise and fall of the Suharto (or any other authoritarian) regime? 2. What went wrong? The 1997 Asian financial crisis affected a number of the so- called Asian Tigers but reserved its strongest, and most lasting, impact for Indonesia. That country’s economic implosion caught observers and analysts by surprise because few thought that the Indonesian economy was particularly vulnerable to a financial collapse. Admittedly, Indonesia’s economic performance did not match that of the early East Asian developers such as Singapore, Hong Kong, Taiwan and especially Korea, but its economic achievements, particularly in the latter half of the 1980s and through the early 1990s, earned Indonesia increasing praise. Indeed, when Thailand was showing the first signs of crisis, it was generally believed that Indonesia would not suffer the same fate. Indonesia’s economic fundamentals were believed to be strong enough to withstand the external shock of Thailand’s collapse. But it did suffer and suffered the most. Some might argue that the fast pace of economic liberalization is to blame for what happened in Indonesia. Some might even argue that had Indonesia not gone so far in liberalizing its economy, had it retained some basic elements of control such as limits on capital account transactions, the outcome of the crisis would have been different. They point out that those large
like China and India, were spared the fury of financial crisis. Only countries with open economies fell prey to the financial predators, and became victims of crisis, countries like Indonesia, Korea, Thailand, Brazil, Russia and even Hong Kong. Malaysia wizened up before it was too late. Some authors like Kelly and Olds (l999), for instance, suggest that the roots of the crisis can be viewed not as a reflection of domestic regulatory imperfections, but as a consequence of the level of globalization to which Asian economies have exposed themselves. They cite Bello (1997), who suggests that the exposure of Asian economies to global capital flows inevitably left them vulnerable to the vagaries of the international financial system. The students will explore those arguments and find the answer to those questions: What went wrong? Why some countries were affected by the crisis while others were spared? What caused the differing levels of depth and severity of the impact of the crisis? 3. Is there a better way? The financial crisis was the catalyst that caused the various forces that wanted political reform to come together. With the economic situation rapidly and drastically deteriorating, political tensions heightened. While the political change that was put in motion would have come sooner or later, a slower reform process might have achieved the same goals with less collateral damage. In a recent book, Fareed Zakaria (The Future of Freedom: Illiberal Democracy at Home and Abroad. New York: W.W. Norton and Company (2003) p. 118) summarized what happened as follows: Although they were not entirely to blame, the IMF and the U.S. government demanded immediate and radical reforms in Indonesia during its1998 crisis, thereby helping to delegitimize and topple the government. Had they recognized the political instability these reforms would produce, they might have moderated their demands and made do with a more incremental approach. Suharto was running a flawed regime, but one that had achieved order, secularism, and economic liberalization – an impressive combination in the Third World. Most important, nothing better was available to replace it. Gradual political reform rather than wholesale revolution would have been preferable,
the intended beneficiary of Western policies. The students will discuss the idea as proposed by Fareed Zakaria, to find the answer to the question: “ Is there a better or less traumatic route to democracy? 4. The relevance of cultural values By the time of the arrival of Huntington’s “third wave” of democratization in the 1970s, the institutional and procedural approach to defining democracies had gained almost unanimous adherence among scholars and is widely used as a basis for analyses of political systems and methods of governance. While Huntington includes Indonesia (under the New Order) with a group of non-democratic countries, he makes a rather ambivalent assessment of Malaysia and Singapore. In one argument, recognizing that there exists a continuum between democracy and authoritarianism he typifies Malaysia and Singapore as quasi- democracies or semi-democracies (1991: 19/295). On the other hand while applying democracy as dichotomous variable, he speaks of Singapore and Malaysia as authoritarian regimes (1991: 302). All the discussions above are based in the works of western scholar. Indonesia, under both Sukarno and Suharto insisted that culture was indeed the distinctive variable of any political system, and launched concepts for the political systems that would respond best to what they claimed to be the intrinsic values characterizing Indonesia’s society. Lee Kwan Yew, the former Prime Minister of Singapore, the founding father of the country and its political architect, has been making a very strong case about the Asian values as an important element in the political system of the East Asian countries. Hence enters the question of the role of culture or values. Many scholarly works have been devoted on the subject of cultural paradoxes in democracy. In the case of Asian countries there has been much serious discourse about Asian values being the determinant factor in the remarkable economic achievements of the East Asian countries. But in the wake of the economic crisis, the argument for the Asian values has somewhat loss its credence. Amartya Sen (2001: 6) for one dismisses the so-called “Lee (Kwan Yew) hypothesis” that disciplinarian states had faster economic
very selective and limited information. The students will discuss these questions: Is democracy a monopoly of the west? Are there no cultural variants of democracy? On the hand, is culture a legitimate (or genuine) justification or merely an excuse (or apology) for authoritarianism? How does culture support or impede sustainable economic development? 5. The Role of Civil Society Diamond (1999) describes the role of political elites in post democratic transition succinctly, saying that beyond transition, elites have profound and preeminent impact on determining whether the new democracy become, stable, effective and consolidate. The impact goes well beyond the cultural dimension of forging common commitment to democracy and its specific constitutional rules; it encompasses the types of institutions and rules that elites craft, and how government, party and interest group leaders exercise their power. He surmises, that in many of the third-wave democracies, competitive elections do not ensure liberty, responsiveness, and a rule of law. In such countries, democracy will not become broadly valued, and thus consolidated, unless it also becomes more liberal, transparent and institutionalized. In such circumstances of entrenched corruption and repression, the elites who come to govern have a stake in existing system, and those who favor real reform are too weak to accomplish it by themselves. Only the mass public can generate the political pressure and power necessary to bring about reform. The question is who are the public? “The public” like “ the people” is the term often used by politicians for their own ends, and demagogues manipulate it in attempting to grab power, and thus without organization, structure, and principles, the public may not matter for democracy, or its impact may be negative. Democracy requires a public that is organized for democracy, socialized to its values and norms, and committed not just to its owned myriad narrow interests—although they are important and are the raison d’etre for their existence—but to a larger, common set of civic ends, and such civic public is only possible with a vibrant ‘civil society.’ The students will discuss the role of civil society in the process of democratization from transition to consolidation. The students
a new democracy to a functioning and established democracy. The role of civil society in safeguarding human rights and in social development and poverty eradication should also be given particular emphasis.
crisis When Thailand was showing the first signs of crisis, it was generally believed that Indonesia would not suffer the same fate. Indonesia’s economic fundamentals were believed to be strong enough to withstand the external shock of Thailand’s collapse. But it did suffer and suffered the most. The Indonesian situation can be explained as follows. Between 1992 and July l997, 85% of the increase in Indonesia’s external debt was due to private borrowing (World Bank l998). This is similar to the phenomenon of other Asian countries that were struck by the crisis. In many ways, the country was a victim of its own success. Foreign creditors were eager to lend money to companies in a country, which had low inflation, a budget surplus, an abundant and relatively well-educated labor force, good infrastructure, and an open trading system. Attracted by these ‘dynamic economies’, net capital inflows (long term debt, foreign direct investment, and equity purchases) to the Asia Pacific region increased from $25 billion in l990 to over $110 billion l996 (Greenspan, l997). Much of the inflowing capital did not, however, find its way into productive agricultural or industrial sectors, but instead gravitated towards the stock market, consumer financing and, particularly in Indonesia and Thailand, real estate. These sectors boomed, while real appreciations caused commodity and manufactured product exports, the mainstays of the national economies, to become less competitive in the global market place. Financial institutions were making loans on the basis of already inflated assets in a circular process that led to further appreciation (Kelly and Olds, l999). While this ‘virtuous’ circle continued to inflate, financial institutions were borrowing in US dollars and lending in local currency (Radelet and Sachs, l998). To make matters worse, the average maturity of the credit to the private sector was shortening. The average maturity of private sector debt in Indonesia at the time of the crisis was 18 months, and -by December l997, $20.7 billion had to be paid in a year or less (World Bank, l998).
ensured that problems with external corporate debt would become a domestic banking problem. When the banking system was liberalized in the mid-1980’s, the supervisory and monitoring mechanism was not sufficiently effective and could not keep pace with the rapid growth of the banking sector. Worse yet, banking regulations were not adequately enforced, particularly rules covering intra-group lending, loan concentration and creditworthiness criteria. At the same time, numerous banks were seriously undercapitalized. All of this meant that when the rupiah began to depreciate, banks were poorly positioned to absorb the resulting further deterioration of their balance sheets, eventually, creating a panic situation. The panic situation was exacerbated by the domestic buying of dollars, some to hedge foreign currency exposure and others because of fear of domestic political instability and social unrest. Place yourself in the position of an advisor to policy makers in Indonesia, or in your own country or another country. What policy advices would you give for the country to prevent another financial crisis from recurring again? 2. No to more foreign debt You are an official of the Ministry of Finance that has been tasked to design a strategy to deal with the political decision to end the dependence on IMF and to avoid incurring further external debt. You will take into consideration that Indonesia’s economy in general, and the current fiscal condition in particular is heavily constrained. For instance, the cost of bank restructuring constitute a large item in the government budget. Another aspect burden to the central government is fiscal decentralization which call for substantial amount of the government budget to the dispersed to the regions. With the termination of IMF program in year 2004, there is a strong possibility that Indonesia would no longer rely on the Paris Club for debt rescheduling. It means there will be an additional $3 billion in debt servicing. In the absence of debt rescheduling, it will be challenging to found the budget deficit from domestic resources. As a member of the government economic team, you are asked to draw a plan for a post--IMF strategy, and to ensure fiscal sustainability while avoiding continued dependence on foreign
a percentage to the GDP 3. The Role of SME and the informal sector The World Bank reported that in May 2002 that out of a total of private corporate debt of $119.1 billion, $93.3 billion or 78 % was owed by large corporations, the rest owed by small and medium enterprises. Out of the total debt, $69.5 billion or 58 % was non- performing. However of all the non-performing debt, $65.8 billion or 96 % of debt was owed by large companies. The percentage of non-performing loans of large companies to its total loan was 72 %, while only 14 % of the debt of small and medium enterprises was bad debt . In fact, during the crisis it was significant how the SME and the informal sector had been supporting the economy, preventing it from total collapse. In the recovery period, while the manufacturing industry was still sluggish, the SME was doing better. At the height of the crisis there was retrenchment of employment in the formal sector while in the rural sector employment had increased, indicating that the informal and the small and medium scale of the formal sector had cushioned the impact of the crisis on the people. You are a member of an economic team that is responsible for designing the industrial policy of Indonesia or your own country. You are asked to design a concept for future industrial policy that should avoid the past mistakes of prioritizing large companies over small and medium ones in terms of access to credit and other facilities such as the provision of infrastructure. 4. Decentralization Decentralization is not merely political expedience to deal with rebellious regions. It has more basic value to democracy and democratic consolidation. Many scholars have presented argument that decentralization enhances the legitimacy and hence stability of democracy. Decentralization enhances the efficacy, quality and legitimacy of democracy; hence decentralization is a necessity for democracy. It is even more so for large—and particularly multiethnic and multicultural —countries such as Indonesia, as decentralization or regional autonomy will close the distance between the citizens, the stakeholder, and the power and the process of policy making.
necessity to keep the country from falling apart or to foster democracy; if managed well decentralization can bring important benefits to the communities and the economy as a whole. However if managed badly it could harm the people and squander resources and bring instability instead. As the result of decentralization, the central government has been under more pressure to meet its budgetary needs. Many observers, including those with the IMF and World Bank, had worried about the effect of fiscal decentralization on the still fledgling economy. With decentralization, some rich regions are doing fine, in fact they have more money that they can spend; there is a danger, and there are already some indications of the revenues not being used effectively and efficiently. On the other hand, poor regions are chafing under the new responsibility that comes with autonomy. And as pointed by the World Bank (2001) the risks of an increase in corruption following decentralization are high. It has been widely observed that so far that not only power and revenue that have been decentralized but also corruption. It seems that Indonesia is not the only country faced with this problem when it attempted to decentralize. On the basis of their observation of experience of some Latin American countries, some analysts comment that decentralization has strengthened the position of the local elites and their clientelistic networks (Huber, Rueschemeyer and Stephens, 1999: 182). Furthermore, many regions had increased local taxes and imposed new levies that have become a significant concern for investors. Because of the concern of the way decentralization is proceeding—unevenly, depending on the natural endowment of the district and the quality of the human resources available to the local government—there are some views that the process of decentralization should be slowed down, even rolled back. As an advisor to policy makers who are working in formulating a concept for decentralization, you are asked to give your advice on how to make decentralization works, optimize its benefits and minimize its weaknesses 5. Leadership deficit In three year between 1998-2001 Indonesia had four Presidents. Except for the last one, who is still the incumbent, three
expired. It is evident that currently there is a leadership deficit linked to the persistence of so many of the problems faced by the country. The debate at the centre is played amid complex and shifting power relations—factionalism even within the main parties, some along ideological lines and others just based on political opportunism. To explain the disunity and fragmentary nature of its current politics, one might hypothesize that Indonesia lacks individual leaders with the right combination of vision, character, and political savvy. There may be positive effects to this lack of charismatic leadership because, as Haggard and Kaufman asserts, over the long term “executive authority must eventually be depersonalized”. However, the experience of Indonesia at the past few years show that inept leadership have led to more failures of policy than successes, more instability and “wasted” energy in political conflict than peaceful progress and coherence. Good leadership is needed everywhere and always, but particularly so for a country going through transition with a history littered with promises broken by uncommitted leaders. As such, not only should reforms install an effective and transparent set of rules-based institutions, they should also evolve rules-based mechanisms by which the best of each generation are brought into the political leadership. Put in simplistic terms: a good system is nothing without good people to run it. It is not to say that the system is less important than the persons who run it, on the contrary democratization entails first and foremost establishing the system—the institutions, the processes and procedures. However, at the end of the day, a system is as good as the people who run it. It may help to recall Huntington’s aphorism, that economic development makes democracy possible, but it is “political leadership” that makes it real. The student will discuss the problem of political leadership in consolidating and solidifying the newly attained democracy
The dynamics of regime transition from Indonesia experience 2 MAZLAN, Abd Mutalib 3 WIBISONO, Aditya 4 WU, Hsinchang 5 WU, Wan-Tzu 6 OYUNKHAND, Namsrai 7 KIKALA, Stephen Philip 8 BABIKOV, Rafael Faridovich II 1 KUO, James Chanwei What went wrong? Why some countries were affected while others were spared? What caused the differing levels of depth and severity of the impact of the crisis? 2 KOUNADI, Maria 3 JAMALLUDIN, Jazman Azi 4 ZHANG, Chen 5 JANDOS, Khalik 6 SILAVONGSITH, Nalinh 7 HSU, An-chin 8 PHETDAOHEUANG, Sysomphorn III 1 TJUNG, Mei Ling Is there a better way to democracy for Indonesia? 2 BIRZINS, Artis 3 FADLINSYAH, Jerry 4 HUANG, Bernice 5 VOKHIDOV, Fakhriddin Bozorovich 6 HONG, Benjamin 7 MOCHIZUKI, Aiko 8 WANG, Yongjun IV 1 WAN MOHD RADZI, Wan Ahmad Is democracy a monopoly of the West? To answer this question, we bring the issue on Asian values vis-à-vis western values. 2 KUBRIKOVA, Yuliya 3 ALCANTARA, Levinson Caratiquit 4 OTANI, Kyo 5 COLLADO, Jaime Jr. Mupas 6 SHOLIHAH 7 SMITH, Benjamin V 1 ZHANG, Qingwen The civil society in a transition democracy. A Glimpse on the Civil Society in Indonesia 2 NAGASAWA, Hiroko 3 LU, Yi-Chen 4 NGUYEN, Thuy Bich 5 JI, Allison Haemin 6 NAITO, Takeshi 7 NARBOEV, Alisher Ibodullaevich
PREVENT ANOTHER FINANCIAL CRISIS When Thailand was showing the first signs of crisis, it was generally believed that Indonesia would not suffer the same fate. Indonesia’s economic fundamentals were believed to be strong enough to withstand the external shock of Thailand’s collapse. But it did suffer and suffered the most. The Indonesian situation can be explained as follows. Between 1992 and July l997, 85% of the increase in Indonesia’s external debt was due to private borrowing (World Bank l998). This is similar to the phenomenon of other Asian countries that were struck by the crisis. In many ways, the country was a victim of its own success. Foreign creditors were eager to lend money to companies in a country, which had low inflation, a budget surplus, an abundant and relatively well-educated labor force, good infrastructure, and an open trading system. Attracted by these ‘dynamic economies’, net capital inflows (long term debt, foreign direct investment, and equity purchases) to the Asia Pacific region increased from $25 billion in l990 to over $110 billion l996 (Greenspan, l997). Much of the inflowing capital did not, however, find its way into productive agricultural or industrial sectors, but instead gravitated towards the stock market, consumer financing and, particularly in Indonesia and Thailand, real estate. These sectors boomed, while real appreciations caused commodity and manufactured product exports, the mainstays of the national economies, to become less competitive in the global market place. Financial institutions were making loans on the basis of already inflated assets in a circular process that led to further appreciation (Kelly and Olds, l999). While this ‘virtuous’ circle continued to inflate, financial institutions were borrowing in US dollars and lending in local currency (Radelet and Sachs, l998). To make matters worse, the average maturity of the credit to the private sector was shortening. The average maturity of private sector debt in Indonesia at the time of the crisis was 18 months, and -by December l997, $20.7 billion had to be paid in a year or less (World Bank, l998). The flaws in Indonesia’s banking system ensured that problems with external corporate debt would become a domestic banking problem. When the banking system was liberalized in the mid- 1980’s, the supervisory and monitoring mechanism was not sufficiently effective and could not keep pace with the rapid growth of the banking sector. Worse yet, banking regulations were
concentration and creditworthiness criteria. At the same time, numerous banks were seriously undercapitalized. All of this meant that when the rupiah began to depreciate, banks were poorly positioned to absorb the resulting further deterioration of their balance sheets, eventually, creating a panic situation. The panic situation was exacerbated by the domestic buying of dollars, some to hedge foreign currency exposure and others because of fear of domestic political instability and social unrest. Place yourself in the position of an advisor to policy makers in Indonesia, or in your own country or another country. What policy advices would you give for the country to prevent another financial crisis from recurring again?
in Indonesia: The Role of Banking Sector by: SHOLIHAH (Indonesia) Introduction The basic premise of this paper is that financial crisis in Indonesia was as a consequences of immature domestic financial market, especially in banking sector and the limitation international financial sector1. Banking sector is financial institution that develops fast in Indonesia, especially since Deregulation Package had been released by the government in 1983 and 1988. As the main preference of financial institution for public, it can be said that banking sector has become an institution that influence most of economic activities of Indonesian people. Consequently, financial crisis that has attacked Indonesia since 1997 not only has decreased the performance of Indonesian economy but also has influenced the livelihood of Indonesian. It can be concluded therefore that bank restructuring needs to be the cornerstone to preventing financial crisis in Indonesia. Moreover international experiences show that only with the successful resolution of the banking sector and the construction of a sound financial sector have economies been able to emerge from crisis and reduce their vulnerability to further crisis. Based on this premise, this paper will focus on preventing another financial crisis by attacking the core problem that is domestic financial sector and international financial architecture. Structure of the paper will be organized as follows. After a brief review on Indonesian banking sector and banking situation prior to the crisis, then the discussion continues to discuss how to prevent financial crisis by strengthening Indonesian banking sector. The paper will be finalized by discussing the challenges ahead. Review on Indonesia Banking Sector 1Since the second factor is beyond domestic policy, this paper only discusses the policy option for international financial reform in brief. .
the vulnerable status of the banking sector before the crisis. This section attempts to discuss the development of banking sector development in Indonesia and how the rapid expansion of banking sector has created vulnerabilities prior to the crisis. a. Financial Reform in 1980s Prior to 1 June 1983, Indonesia had most of the characteristics of financially repressed system. The banking sector was heavily regulated and entry was very much restricted. The market was dominated by state banks, with Bank Indonesia alone accounting for 35% of the total assets of the entire financial system (Goeltom, 1995). The purpose of banking reform in 1983 basically was to increase the mobilization of domestic funds through financial sector and toward free market mechanisms in banking sector by increasing degree of competition in financial market. Finally the measures toward free market policies for financial sector reached its peak when the government announced a deregulation package in baking and capital market in 1988. The essential elements of the deregulation package were lowering most of the entry barriers and various restrictions and reduction of reserve requirement. Within a few years of the banking reforms, there was a dramatic increase in the number of banks and branches, many supply and credit. Between 1988-1991, the number of new banks entering the system increased from 101 to 182.2 b. Banking Sector: Build Up of Vulnerabilities Pangestu and Habir (2002) stated that there are three main factors contributed to the vulnerability of the banking sector prior to the crisis: (a) a rapid expansion of the banking sector (as a consequences of banking reform 1983 and 1988) that took place without the necessary strengthening of prudential regulations and supervision from central bank. (b) high concentration of ownership in the banking sector had led to weak corporate governance by banks. (c) economic boom and increase international financial integration in the 1980s amplified the structural vulnerabilities of Indonesian financial system. 2 www.bi.go.id
prior to the crisis, government finances were in balance but business and banks borrowed on short term in foreign currency and invested long term in uncertain domestic assets. This poor management of supervision for lender was amplified by unmanageable opening up of capital markets. These inflow of capital, were massively short term, speculative, and destabilizing in turn has deteriorated the Indonesian financial sector. Preventing Financial Crisis Financial crisis in Indonesia offers a number of policy lessons on preventing the build up of vulnerabilities during integration with international financial market. To date, the Indonesian government has implemented reforms rapidly and banking consolidation has been carried out on a relatively large scale. The Indonesian government3 and individual banks have made major progress in bank restructuring in the past several years. However, the optimal solution has yet to be found, many tasks that should be carried out to establish a sound banking system still remain. There are several conditions that needed to strengthen Indonesian banking sector: a. Financial liberalization needs to be proceeded or accompanied by a strengthening institutions and prudential regulations. These regulations must be enforced with sanctions in place for non-compliance. Although Indonesian banking sector principally has agreed with the 25 Basle Core Principles, however practically it is needed to implement all of the principles. b. Concentration of bank ownership in Indonesia made it difficult to monitor behavior and led to grow violations of prudential regulations. This implies a need to reduce single ownership and substantially improve prudential regulations, the qualification of owners and managers and corporate governance norms and regulations to strengthen information disclosure. 3 Government of Indonesia’s strategy for bank restructuring initially focused on closing insolvent commercial banks, stabilizing the banking system, dealing with remaining non viable banks, recapitalization and rehabilitation of weak but viable banks and enhancement of supervory and regulatory capacities. The tasks mainly conducted through IBRA (Indonesian Bank Restructuring Agency) and Bank Indonesia.
there are no clear exit mechanisms when banks are bailed out because they are “too big to fail”. This argument has been emerged in the analysis of how to restructure Indonesian banking sector. Moral hazard is invoked in situations involving human responses that tend to be uncontrolled if their consequences are guaranteed not to be penalized. d. Establishing appropriate the safety net system (Deposit Insurance System/LPS-lembaga Penjamin Simpanan). A more sophisticated deposit insurance system, such as that which charges a deposit insurance premium based on the risk of the banks, is crucial. Flat rate premium systems as proposed by some analysts cannot resolve problems of moral hazard, because risky banks take greater chances knowing there is no difference in insurance premiums regardless of the amount of risk they take. This kind of system also removes the incentive from depositors to monitor bank management. e. A sophisticated early warning system. Although the government has established corrective action to reduce the possibility of bankruptcy of financial institutions and to decrease the social costs of terminating unsound banking operation, however the government should establish a more sophisticated risk adjusted CAR than the simple BIS ratio.4 More sophisticated risk adjusted measures should be introduced, such as based on assets classification through on site examination. Also, in addition to CAR, other indicator such as value at risk (VAR), liquidity, maturity gap, should be introduced in evaluating overall bank soundness at an early stage. Challenges Ahead While there has been progress in domestic financial sector, serious problems remain in international financial level. Some argue that there is imbalance on how international community managing the financial crisis in East Asia and Latin America. The policies recommendation tended to put strong reform pressures on 4 Since 1988, BIS (Bank for International Settlements) has required the CAR (Capital Adequacy Ratio) to be above 8% for all internationally operating banks.
there are inadequate reforms at the international level. The focus of discussion and proposals therefore must be broadened to include the truly international aspects of the required architecture, in particular those that compensate for the asymmetries of the international financial system, as well as the structure of governance that characterizes existing institutions. Some analysts give strong argument on reforming international financial architecture. Jones (2003) for instance, stated that developing countries are being urged to adopt financial codes and standards to enhance transparency, however there are few if any corresponding obligations for disclosure by private financial institutions, including highly leveraged ones such as hedge funds. Calls for redesigning the international financial architecture with a view to preventing and containing future debacles also come from Ocampo (2003). Ocampo argued that market instability is clearly a broader phenomenon that is deeply rooted in the fundamental factors that determine financial volatility and contagion at the world level, including the great asymmetry in levels of sophistication between the liberalized international financial markets and the institutions that regulate them. In such an environment, developing countries are particularly vulnerable to volatility and contagion and are expected to behave as “business cycle/policy takers”, transmitting internally the externally- generated boom-bust cycles of international finance. In this context, “self-insurance” (or self protection) through domestic policies is certainly necessary, but has limited returns and is costly in the absence of an adequate international financial safety net. Ocampo (2003) therefore proposed the changes in the international financial architecture that must respond to three different problems that the current system faces: (1) financial market instability (2) basic macroeconomic and financial asyimmetries (3) the additional problems generated by the incomplete and asymmetrical nature of the current globalization process. Ocampo also criticized that in spite of the international character of these problems, most current proposals tend to emphasize the need to strengthen national macroeconomic and financial policies in recipient countries- i.e., the national financial architecture - but are weak on the truly international aspects of the architecture required.
From Asia to Argentina. Princeton University Press. New Jersey. Goeltom, Miranda S. 1995. Indonesia’s Financial Liberalization, An Empirical Analysis of 1981-1988 Panel Data. Institute of Southeast Asian Studies. Singapore. Jones, Stephany Griffith. International Financial Stability and Market Efficiency as a Global Public Good in Inge Kaul et al. 2003. Providing Global Public Goods, Managing Globalization. Oxford University Press. Oxford. Ocampo, Jose Antonio. International Asymmetries and the Design of the International Financial System in Indart, Gustavo and Albert Berry (eds). 2003.Critical Issues in International Financial Reform. Transaction Publishers. London. Pangestu, Mari and Manggi Habir. 2002. The Boom, Bust, and Restructuring of Indonesian Banks. IMF Working Paper no. 02/66. International Monetary Fund. Bank Indonesia’s official website: www.bi.go.id
another Financial Crisis By: Benjamin Smith (England) Introduction After nearly 3 decades of unprecedented growth, the seemingly inexorable rise of the East Asian economies was widely regarded as miraculous5. But in 1997 a comparatively benign currency devaluation in Thailand sparked off a furious financial crisis that crippled many of the East Asian tigers. The crisis toppled governments, devastated economies, created widespread civil unrest, and constituted the biggest setback for poverty reduction in the region for decades6. The East Asian Crisis also challenged conventional economic wisdom. One of its legacies is a contentious debate about causes of economic crises and suitable approaches for the prevention and management of such situations. With a particular focus on Indonesia, this essay considers the dynamics of the East Asian crisis and attempts to formulate answers to the crucial question of how to prevent another financial crisis. The treatment will first consider factors that trigger financial crises and, in turn, policies that may help in their prevention. The focus will then turn to an analysis of the management of the East Asian crisis, and will consider policy lessons to be learned from the region’s successes and failures. Crisis Prevention In order to identify policy choices that may help to prevent future financial crises, it is germane to identify the origins of the last. 5 The World Bank, The East Asian Miracle: Economic Growth and Public Policy, Oxford University Press 1993 6 World Bank, Poverty in East Asia, http://www.worldbank.org/eapsocial/sector/poverty/
a wide range of elements that contributed to the crisis, the IMF boldly states its principle causes: “Financial and corporate sector weaknesses played a major role in the Asian crisis in 1997. These weaknesses increased the exposure of financial institutions to a variety of external threats, including declines in asset values, market contagion, speculative attacks, exchange rate devaluations, and a reversal of capital flows”7. Without doubt, the financial and corporate sectors of many Asian economies were weak. Prior to the crisis Indonesia’s corporate sector, unable to productively absorb the enormous volumes of inflowing capital (at rates of between 30-40% of GDP), was tending to concentrate investment in an over-inflated real estate sector. Furthermore, a substantial build up of corporate sector short-term debt and a significant proportion of foreign investment (both equity and debt) meant that debt repayments became prohibitively expensive when the rupiah was devalued8. The corporate sector’s problem soon became the banking sector’s problem - due to what is now generally regarded as poorly sequenced and (perhaps) over-zealous liberalization of Indonesia’s financial markets, regulatory processes were unable to keep pace with the rapid growth of the banking sector, leaving it overexposed, undercapitalized and vulnerable in the event of crisis. In the words of Joseph Stiglitz: "The heart of this crisis is the surge of capital flows. The surge is followed by a precipitous flow out. Few countries, no matter how strong their financial institutions, could have withstood such a turnaround, but clearly, the fact that the financial institutions were weak and their firms highly leveraged made these countries particularly vulnerable"9. Although the preceding descriptions explain why Indonesia’s economic and fiscal condition deteriorated so quickly at the onset 7 Lindgren et al., Financial Sector Crisis and Restructuring – Lessons from Asia, an IMF Occasional Paper, Jan 2000 8 Bongini, Krugman, Berg, Kwack, Furman and Stiglits, as referenced in Georgiy Nikitin, Financial Crisis of 1997 in Indonesia: Who was hurt?, Boston University 2003, p. 3 http://people.bu.edu/nikitin/IndNikIEDwp.pdf 9 Joseph Stiglitz as quoted by David E Sanger, US and IMF Made Asia Crisis Worse - World Bank Finds, New York Times, December 3, 1998
it doesn’t adequately address the question of what precipitated the crisis in the first place. Speculative Currency Attacks The IMF report states that the crisis in Indonesia was triggered as a result of contagion from the crisis in Thailand (Lindgren et al: p.54). However, it conspicuously fails to offer an explanation of what caused the contagion. While Thailand was seen to have a number of identifiable macroeconomic weaknesses including, critically, current account and fiscal deficits, Indonesia’s macroeconomic indicators were relatively strong, “particularly as they pertained to exports and fiscal balance” (Lindgren et al: p.54). Furthermore, while the markets were quick to identify fundamental weaknesses in the Thai economy, there was no such evidence of disenchantment with the Indonesian economy, with the Jakarta stock exchange rising right up until July 1997 (Nikitin: p.2). The clarity of hindsight has allowed many commentators to identify the ‘fundamental’ causes of the crisis in Indonesia. However, prior to the crisis the same commentators were blind to the possibility of the Thai crisis spreading to the seemingly healthy Indonesian economy. IMF Managing Director Michel Camdessus said, "I don't see and reason for this crisis to develop further", and Bill Clinton dismissed Asia’s currency turmoil as “a few little glitches in the road”10. It is, unfortunately, entirely possible that reason the Indonesia crisis wasn’t predicted is because it was intrinsically unpredictable. Paul Krugman describes two kinds of currency crisis, a basic first-generation, or canonical model, and a more sophisticated second-generation model11. The canonical model describes a situation where a domestic economy is engaged in steady, uncontrollable issue of money to finance a budget deficit but also simultaneously trying to maintain fixed exchange rates by trading a stock of foreign currency reserves. In efforts to maintain the exchange rate, the domestic economy’s foreign currency reserves will start to dwindle and could eventually become exhausted. Should this happen, the price 10 http://pages.stern.nyu.edu/~nroubini/asia/fn7075.html 11 Paul Krugman, Currency Crises, National Bureau of Economic Research Conference Report Fall 2000
Astute investors will therefore attempt to sell off their domestic currency before the reserves are exhausted, thus bringing forward the time of the exhaustion of the reserves, causing other investors to sell even earlier and so on. This feedback effect means that when foreign reserves drop below a certain level, a wave of speculative attacks quickly use up all outstanding foreign reserves, forcing an abandonment of the (artificially) fixed exchange rate. Thus when an economy running budget deficits attempts to maintain fixed exchange rates (with a finite foreign exchange reserve), the question is not if they will run into crisis, but when. The first generation model explains how Thailand was forced to abandon its currency peg due to its current account and fiscal deficits (as mentioned earlier) but not the crisis occurred in Indonesia. In order to explain what precipitated the collapse of the Indonesian currency it is necessary to use the more sophisticated second-generation model. Unlike the first generation model, second-generation models of currency crises do not depend on weaknesses in macro- economic fundamentals. Rather, they rely on expectations. Take, for example, the case of a government that is maintaining a fixed exchange rate (even if it is doing so sustainably) but has some motive to devalue the currency in the future. Suspecting a devaluation, speculators will try to get out of the currency before it occurs. Such selling will put pressure on the fixed exchange rate, thus increasing the motive for the government to devalue the currency. Such a process will thus increase the incentive for other speculators to get out of the currency, adding further pressure to the fixed exchange rate and increasing the likelihood of a currency devaluation. As in the first generation model, a feedback mechanism is created that encourages rational investors to sell, rapidly leading to currency devaluation. The key point of the second-generation model is that it depends not on fundamental economic conditions but on expectations of a currency devaluation. Thus, even if a government has no intention of devaluing its currency, the expectations of the market can force a devaluation. Charles Wyplosz explains how second- generation crises represent a case of multiple-equilibrium: second- generation crises may or may not happen, and it is quite arbitrary whether the same fundamental economic conditions create of crisis
summarizes, “In a nutshell, second-generation crises occur because they are expected to occur”12. Domestic political, social and economic problems undoubtedly played a significant role in deepening and exasperating the effects of the crisis. However, the cause of the crisis (at least in Indonesia’s case) cannot be attributed to such factors. The failure of rating agencies, investors, and international organizations to predict the contagion from Thailand to Indonesia (and other countries) may not have been a case of myopic mis- assessment of the county’s fundamental economic situation. Rather, the troubles of Indonesian (and other countries affected by the crisis) may have been instigated by arbitrary changes in expectations that produced self-fulfilling crises. Crisis Prevention Policies The preceding observations can be developed into a number of policy recommendations for the prevention of the precipitation of crises: Firstly, corporate financing and the banking sector should be carefully regulated. The vicious circle of risky loans backed-up by over-inflated collateral leads to bubbles, which tend to burst. In order minimize possibilities of internal collapse (even in the absence of any external currency problems), corporate and banking regulation is absolutely necessary, particularly in newly liberalized economies. Contradictory government policies should be discouraged. The contradiction inherent in Thailand’s policies of maintaining a fixed exchange rate while simultaneously running ongoing fiscal and trade deficits led to the speculative attack that triggered the crisis in East Asia. In order to avoid first- generation currency crises, such contradictions must be eradicated. Second-generation currency crises are not necessarily caused by contradictory policies but by market expectations – in the words of Paul Krugman “the real cause of [second-generation] currency crises is not so much what you are actually doing, as 12 Charlez Wyplosz, International Financial Instability, in Inge Kaul, Isabelle Grunberg and Marc Stern (Eds.), Global Public Goods, Oxford University Press 1999, p161.
do”13. As such, policy transparency and clear signals to markets are essential to reduce the likelihood of speculative attacks creating self-fulfilling currency crises. Increased exchange rate flexibility should be encouraged. This does not necessarily mean completely free floating currencies14 but increased flexibility would remove the incentives for speculative currency attacks based on predictions of subsequent devaluation. International capital movements should be restricted. Although extensive capital controls are unlikely to be viable in the increasingly globalized economy, restrictions (such as the Tobin Tax) that focus on the hot money flows that drive economic crises would improve global financial stability. Crisis Management Taking the necessary steps to prevent a crisis is better than having to manage one. But preventative measures alone may not stave off financial crises. Many kinds of economies have faced crises in the last decade or so (in countries as diverse as Britain, Mexico, Argentina, Thailand, Indonesia and Russia) and the multifarious causes of crises imply that no preventative policy measures can ever be 100% effective. Furthermore, it is entirely possible that financial markets are intrinsically unstable, as Wyplosz explains: “The existence of multiple equilibria, deeply linked to uncertainty, opens the possibility that financial markets themselves are the source of a crisis” (Wyplosz: p 158). As such, policies are required which minimize the negative effects of the financial crises that appear to be an intrinsic and unavoidable feature of contemporary financial system. The following sections assess the aspects of crisis management and some of the lesson learned from the management (and mismanagement) of the East Asian Crisis. 13 Paul Krugman, as quoted at http://web.mit.edu/krugman/www/crises.html 14 There is, of course, a range of regimes between the extremes of fixed exchange rates and free floating currencies including soft pegs, crawling pegs and managed flexibility in the form of band regimes.
As mentioned previously, although strong macroeconomic fundamentals can help in the prevention of crises, ‘healthy’ economies can be still hit (see, for example, the case of Britain’s exit from the exchange rate mechanism of the European Monetary System in 1992). But while macroeconomic weakness is not a necessary condition for the onset of a crisis, countries that fail to demonstrate strong fundamentals tend to suffer deeper and longer lasting crises than countries with sound macroeconomic indicators (Wyplosz: p.163). Diagnosis and Prognosis Different crises have different causes and require different policy responses. The need to react quickly must be balanced against the need for correct assessment of the causes of the crisis and formulation of suitable responses. The IMF response to the crisis, particularly in Indonesia, has been widely criticized. The initial response was to introduce contractionary policies similar to those used to address the Mexican crisis of 1994/5. However, while the Mexican crisis was caused by an overheating economy, the root problem in Indonesia was an economy that was grinding to a halt. The massive short-term debt (often to overseas creditors) that had been accumulated by the corporate sector turned into a major problem when the currency started to drop and credit was discontinued. Although the IMF measures of interest rate hikes and fiscal austerity were intended to fix the currency problems by stemming capital flight and attracting capital back to the country, they actually exasperated the crisis. The corporate sector’s debt burden became unmanageable in the face of higher interest rates, and rather than address the crisis, the IMF’s initial policies hobbled the ailing economy. As McLeod comments, “the push was for contraction, when it was obvious that expansion was required if Indonesia was to regain its momentum”15 While admitting mistakes were made, the IMF defends its position, maintaining that quick action was absolutely necessary 15 Ross H. McLeod, Indonesia’s Crisis and Future Prospects, as quoted in Ginandjar Kartasasmita, Indonesia: A Country at a Crossroad, Waseda University, Feb 2004
concluded that fiscal austerity was the appropriate policy for the Indonesian crisis may be less to do with the conditions under which decisions were made, and more related to ingrained ideology. Stiglitz, for one, argues that (flawed) policies in East Asia were recommended not based on empirical evidence or economic theory, but were ideologically motivated16. Banking Sector Reform Without a working banking sector, modern economies cannot function. Financial crises, by definition, hit banks hard and pressurize banking systems. A defining feature of the East Asian crisis, particularly as it pertained to Indonesia, was the need for swift, decisive and far reaching bank reform. The crisis showed that the banks had borrowed too much (particularly in foreign currencies and short- term loans) and also exposed the regulatory shortcomings of the banking sector. Rationalizing banking sectors involves shutting down insolvent institutions, mergers and government control of failing banks. It also involves making the necessary regulatory reforms to ensure that banking sectors limit their exposure and vulnerability to future crises. Such reform is costly, both financially and politically. However, such costs are unavoidable and absolutely necessary to allow an economy to recover from crisis and provide long-term stability. Transparency and consistency are essential elements in successful bank reform. The contrast between Indonesia’s successful bank restructuring in April 1998 and the abject failures of the initial interventions in November 1997 demonstrate the importance of coherent and clearly articulated reform policies (Karmasasmita: p24). Corporate Sector Reform The need for banking sector reform is, of course, inextricably linked with the need for resolution of corporate debt. Government bail-outs to floundering corporate sector actors are undesirable given the moral hazard such policies would create. 16 Joseph Stiglitz, Globalization and its Discontents, Norton & Company, 2002
can take measures to promote successful resolutions to corporate debt problems. A satisfactory legal framework is necessary to adequately address the bankruptcies that crises generate. Furthermore, as described by Wyplosz, governments can introduce a number of measures that allow for orderly workouts and rescheduling of corporate debt repayments, both through legal procedures and informal, state supported initiatives (Wyplosz: p.180). Such actions, as implemented by the Habibie government in June 1998 (Karmasasmita: p68) ensure that outstanding debt issues are resolved as quickly as possible, investor confidence is maintained and the corporate sector is provided with the ‘breathing space’ necessary to drive the economy out of crisis. Open and Strong Working Relationships The potential for domestic crises to escalate into international problems was clearly seen when the Thai currency devaluation snowballed into a global problem. The internationality of the threat caused by financial instability, the difficulties associated with purely domestic crisis resolution, and the possibility of contagion gives good reason for international co-operation in the management of crises. Given the need for international co-operation, strong working relationships between affected countries and external (bilateral and multilateral) actors are essential. The conflict, mistrust and lack of transparency between Indonesia and the IMF hindered resolution of the crisis17. The IMF is widely criticized for a lack of transparency but the Indonesian government’s ‘Guerilla Warfare’ tactics in negotiating with the IMF cannot be said to have been conducive to a productive working relationship. Sub-optimal solutions will result from poor working relationships and conflicting interests. As such, co-operative, discursive, open forums are essential to enable proper crisis management. Additionally, open, transparent and productive working relationships between all parties involved in crisis resolution will provide clearer messages to markets, decrease suspicion and 17 For example, the IMF delayed a $3bn infusion in March 1998 as a result of frustration arising from the poor working relationship (Kartasasmita: p.20).
secrecy surrounding the contents of Letters of Intent and the ‘deals’ established between borrowers and the IMF is conspicuous. Political Stability Financial crises undermine governments and lead to political instability. Political instability, in turn, is detrimental to economic performance and undermines efforts at crisis recovery - the causal link between political instability and economic deterioration goes both ways. The negative effect that political instability has on economic performance was clearly highlighted by the World Bank report in November 2001 that noted, “Early slippages in [Indonesia’s] reforms and an increasingly uncertain political climate raised risk premiums and contributed to renewed downward pressure on the rupiah” (Kartasasmita: 92). Changes of leadership may be necessary to implement, or at least demonstrate intent to implement, reform. But these changes should be as controlled as possible. The ‘will he, won’t he?’ nature of Suharto’s exit, the constitutional uncertainty of the Habibie government, not to mention the calamity of the Abdurrahman presidency undermined efforts at economic recovery. In order to maintain political stability in the face of crises, a strong constitution and robust political system is invaluable. Furthermore, external actors who are insensitive to the need for political stability could find that over intrusive steps taken to promote economic recovery backfire, as was seen in the widespread civil unrest resulting from IMF interventions18. Crisis Management Policies An exhaustive catalog of suitable crisis management policies is unrealistic given the varied nature of crises - the need to adopt policies appropriate to the nature of the problem must be emphasized. However, a raft of basic policies can be inferred from the preceding discussion: 18 New violence in Indonesia, BBC News, May 20, 1998, http://news.bbc.co.uk/1/hi/events/indonesia/latest_news/87969.stm
with policies that have been designed for unconnected situations is inappropriate. A one-size-fits-all approach to crisis management will not work and a specifically tailored program must be adopted. As such, external agencies should perhaps rely more on local knowledge before applying their contextually biased experience to unfamiliar environments. This suggestion supports arguments of creating local knowledge banks in the form, perhaps, of regional versions of the IMF. Corporate and Financial sector reform needs to be swift, decisive, clear and transparent. Although politically and economically costly, government intervention is indispensable in resuscitating economic activity. Adequate regulation of both banking and corporate sector activities must be implemented and enforced, both to restore investor confidence and minimize the potential for future crises to occur. International Cooperation is necessary to resolve crises in the globalized economy. Open and equal working relationships facilitate such cooperation and minimize market distrust, therefore stimulating economic recovery. Although the usefulness of contingency plans is limited (given the multifarious nature of crises), having well-established, ongoing working relationships would allow for swift and efficient design and implementation of coherent crisis management and recovery programs. Political stability should be strived for even in the face of the most turbulent crises. Consolidated democracies with strong constitutional arrangements allow for the (potentially necessary) changes of leadership with a minimum of political instability to disrupt and undermine economic recovery. Conclusion Poor macroeconomic fundamentals invite financial crises. And although preventative measures can be taken, neither strong macroeconomic fundamentals nor any other conventionally acceptable policies provide absolute protection against financial crises19. 19 See Krugman’s descriptions of first-generation and second-generation crises, as described earlier.
Although understanding of measures to minimize the negative effects of crises and bring about their timely resolutely is improving, political, social and cultural factors mean that implementing adequate solutions will never be simple. The inherently unstable nature of the global financial system, the possibility for self-fulfilling crises to develop, and the difficulties in managing crisis situations imply that future financial crises and the terrible human tragedies that such crises entail are inevitable under the contemporary system. Such inevitability undermines the premise that the ‘invisible hand’ of the market will tend to advance public interests. To paraphrase David Korten, the suggestion that society’s best interest is served by everyone behaving as greedily as possible is highly questionable20. In order to prevent another financial crisis, overhaul of the global financial architecture may be necessary. 20 David Korten, When Corporations Rule the World, Second Edition, Kumarian Press, 2001
another Financial Crisis By: Sysomphorn Phetdaoheuang (Laos) Introduction: The East Asian experience has left in its wake an abundance of new research that allows us not only to better understand the nature of financial crises, but to begin to draw out generalized lessons for policy, associated trade-offs, and constraints to ready Implementation. In this paper it will be summarized on what we think are the interrelated and general policy lessons from the East Asian Crisis and it will be analyzed the difficulties encountered in establishing those policies. Abstracting general lessons is not easy because each crisis differs in its timing, its specific economic and political circumstances, its global economic conditions, and its associated policies causes and responses. This challenge compels us to raise the discussion to a higher level of generality than would satisfy policymakers confronting a crisis, but it will tease out the important variables, and indicate the literature and policy directions that they would have to consider. This paper will be examined the lessons of the Asian Financial Crisis in four sections as follows: 1). Preventing crises; 2). Managing crises; 3). Resolving the systemic consequences of crises and 4). Constructing a new international financial architecture, including a regional focus. This paper will not focus one specific country but it will discuss the policies to prevent financial crisis for all countries. Global and East Asian Financial Crisis: A private capital flows to developing countries surge in the 1990s, financial crises in emerging market economies have occurred with disturbing and increasing regularity. The sudden cessation and then reversal of capital flows to Mexico in 1994 caused the first tremors in the global economy, leading to the devaluation of the peso and deep recession, with direct spillovers into Argentina (the Tequila crisis). The major financial earthquake in East Asia soon followed. The currency crisis in Thailand was rapidly transmitted to Indonesia, Malaysia, the Philippines, and Korea, and its impact
markets have experienced a steady series of after-shocks: in 1998 and 1999 capital flow reversals induced currency devaluation in Russia, and Brazil, and most recently recession, devaluation, and default in Argentina and recessions and payments problems in Uruguay and Ecuador. Though the region has since recovered, East Asia’s crisis remains the most severe in its depth and regional breadth. Over six years since the crisis occurred, attempts to understand the East Asian crisis have provided a treasure trove of studies that illuminate various causes of financial crises. Though they differ in emphasis, an emerging consensus point to four mounting vulnerabilities in Thailand, Indonesia, Korea and Malaysia. First, the global economy spawned an unprecedently large surge in private capital flows in the 1990s, especially short- term flows, as deregulated banks in the rich countries scanned the globe for higher return opportunities, and East Asia looked particularly attractive with its low debt ratios, rapid growth, and stable exchange rates. Second, macroeconomic policies in East Asia tool advantage of this boom to facilitate large inflows of short-term, unhedged, foreign currency-denominated capital, fueling a domestic credit boom and even more rapid growth. Third, many countries had liberalized their domestic financial sectors, but without sufficient regulation, and domestic banks supplied cheap capital to already highly leveraged corporations that took on easily available credit. Finally, politic, at first stable, introduced new risks that culminated in important changes at precisely the time when internal financial vulnerabilities were becoming worrisome. The combination of first three factors led to over-investment in domestic non-tradable sectors-manifested as property price doubles especially in Thailand and Malaysia-and in selected inefficient manufacturing sectors-as was done by Indonesian group firms and Korean chaebol firms. Availability of cheap capital that was poorly intermediately through weakly supervised and governed financial institutions allowed corporations to add debt to their already highly leveraged balance sheets. As one country entered crisis, investors examined other countries for similarities and shifted portfolios, or were compelled to do so as the first country’s demise raised risk on the whole class of investment, producing contagion. The fourth factor aggravated this process that led to the most massive outflow of capital from any
human histories. More than 100 billion were withdrawn from the ASEAN countries and Korea in the space of 18 months after the Thai baht devaluation. Preventing crises: In a world of free capital mobility, speculative attacks on currencies can occur whenever the confidence is lost. Moreover, a currency crisis in foreign country can rapidly trigger a crisis at home. Crisis prevention attempt s to lower the probability of having a crisis and to reduce ex-ante the risk factor. 1. In order to avoid large current account deficit finance through short-term, unhedged private capital inflows: Several policy domains affect the next external liability position of a country and it propensity toward crises. In East Asia, it is instructive to review several interrelated macroeconomic policies: foreign exchange reserve, fiscal monetary policy, exchange rate policy, and policy toward account. a. Foreign exchange policy: as the capital movements have become large, foreign exchange reserves have become an increasingly important line of defense. The adequacy of foreign exchange reserves can be no longer be measured by their coverage of import but by the magnitude of potential capital outflows. To sum, the reserves should equal the amount of capital contractually due in the coming year. But reserves should arguable be large if current account deficits are large. b. Fiscal and monetary policy: in the case of the affected East Asian economies, fiscal policy was disciplined and monetary policy was non-inflationary until the mid-1999s. With the benefit of hindsight, it can be seen that to reduce vulnerabilities and the probability if crisis in Thailand, macroeconomic policy in 1996 should have reigned in aggregated demand, avoided excessive credit expansion in the domestic economy, and curtailed the external reliance on foreign savings. This would have slowed the expansion, but reduced the extent of real effective overvaluation and the current account deficit, and slowed the build up of short-term external debt relative to foreign exchange reserves. Monetary policy should have maintained
in the pre-crisis period. This policy would have implied lower credit growth and higher interest rates when capital inflows began to taper off. Restrictive monetary policy in the period immediately preceding the crisis, especially if coupled with a neutral or even contractionary fiscal stance, might have preempted the currency run that eventually came. c. Exchange rate policy: in the face of sudden shocks to capital flows and currency markets, the country may be forced to adopt a contractionary monetary policy and to curtail the economic activity sustained by capital inflows. It is therefore important to maintain a viable exchange rate regime, with a consistent monetary and fiscal policy framework in order to deter speculative attacks and thus avoid sudden stops. d. Capital account liberalization: some countries have adapted explicit controls as a way to isolate the domestic economy from the volatility of global financial cycles. Restrictions on capital inflows usually have the objective of curtailing excessive short-term inflows through: taxation of foreign loans with a short maturity; higher reserve or liquidity requirements; or imposition of outright controls. 2. Aggressively regulate and supervise financial systems to ensure that banks manage risks prudently: a. Financial sector resilience and robustness: having a resilient and robust financial sector is the key to avoid crises. First, as preventive measure, countries with resilient and robust financial sectors will probably suffer less from contagion. Second, these countries will have more flexibility to cope with external shocks and to take corrective measures during crisis. Countries with a solvent banking sector and low corporate leverage ratios will be able to raise interest rates to contain speculative current attacks. Countries with large foreign exchange reserves and access to contingent liquidity facilities will be able to inject liquidity in the system, avoiding credit squeeze and bank runs. Policies that can be achieved this financial structures include: prudential regulation of asset-liability mismatches and portfolio and loan standards that adhere to internationally accepted
regulations that, at a minimum, match those which are required under Basle standards; clear governance rules to prevent insider and group lending not subject to loan evaluation and creditworthiness and standards; transparency for investors and depositors through mandatory public disclosure of audited financial statements; and, finally, deposit insurance limited to a minimal share of private liabilities to bound government contingent liabilities in event of crisis, and share risk with investors and depositors. b. Pitfalls: the measure to manage the capital flows. Prudential regulation can be less distortionary and less subject to evasion than other tools like capital controls, but it also tends to le less comprehensive. As discussed below, prudential regulation over financial institutions does not prevent direct corporate borrowing of the type prevalent in Indonesia, but it does wall off the financial sector from the largest contingent risk to treasury. Another potential difficulty of supervising the financial system is that developing countries do not usually have the expertise or enough resources to hire good supervisors. To complement the oversight of the financial system by regulators and supervisors, countries can use markets by encouraging market discipline and other market participants like rating agencies. However, market discipline requires access and transparency of information, such that the problems of asymmetric information are minimized. Prudential regulation over financial institutions also includes cost. Important ones includes: less comprehensiveness without covering direct corporate borrowing; higher short-term interest rates; and possible evasion of the controls if imposed for a long period of time. Regarding deposit insurance, though government can set up limited deposit insurance schemes ex-ante, they are seldom credible in developing countries due to the systemic nature of crises and due to the limited funds available to back the deposit insurance schemes. 3. Erect an incentive structure for sound corporate finance to avoid high leverage ratios and excessive reliance on foreign borrowing:
the problems associated with bad corporate governance were exposed. Currency devaluation suddenly inflated the size of external debt-measure in terms of the domestic currency-and debt service obligation, and high interest rates also sharply increased domestic debt obligations of the corporations, both driving the domestic corporations into financial distress consequently. These vulnerabilities affected the banks with exposure to the corporations. This created a liquidity crunch and deepened the recessionary pressures, which in turn hurt the corporate sector even more. The presence of a disciplined corporate sector with sustainable debt-to-equity ratios is thus important to weather exchange rate and interest rate shocks. Several building blocks are essential to an incentive framework for sound corporate finance: clear rules of corporate governance, improved competition policies, deep corporate capital markets, and information transparency. a. Corporate governance: new rules of corporate governance must be established to reduce conglomerate structures, that is, concentrated holding n few families, corporate groups-a la chaebols-and amalgamated banks, which create a complex web of insider financial flows with minimal due diligence in lending and inadequate corporate oversight. Rules that require good accounting, auditing and information disclosure protect minority shareholders and strengthen creditor rights can prevent the build up of huge debt position on narrow capital positions. b. Competition policy: improvement of competition policies both in capital markets and in product/factor markets can also strengthen corporate discipline. In addition, creating and enforcing domestic bankruptcy legislations would strengthen corporate governance. Though greater competition does not completely eliminate corporate misbehavior-as evidenced by recent scandals in the US beginning with Enron-it calls for greater efficiency and better resource allocation due to market pressure for firm survival, thus limiting the extent of misbehavior. c. Corporate equity and bind market: one of the gap in financial governance regimes in crisis-affected East Asia was the stunted development of corporate equity and bond markets. Equity markets are an important source of capital, but the reluctance of
insiders to dilute their ownership share often fed their decision to seek easy bank financing, often from banks they controlled. At the same time, the absence of adequate disclosure and other protections for minority shareholders has led many investors to eschew investment in their domestic markets. Similarly, bond markets provide constant and instant market evaluation of debt value and, hence, provide an essential signaling function to financial investors. In the absence of bond markets, however, banks has no reason to market their loans to corporations, and corporations had one less reason to alter their performance to become more efficient. Corporations could thus develop unsustainable, high debt-equity ratios. The policies that might help develop corporate equity and bond markets include: regulatory capacity to implement full disclosure and contract enforcement, protection of minority shareholder rights and bondholder rights, and neutral tax policies to eliminate any bias in favor of bank finance over capital market finance. d. Information disclosure: much of the over-lending prior to the East Asian crisis might not have occurred had international lenders correctly appraised the actual balance sheets of borrowing corporations. Many investors tried to undertake due diligence, but without accurate information. Because it was costly to gather, many investors did not spend resources to obtain valuable information, relied on superficial reviews by others, and simply followed the herd. Better information disclosure can help mitigate this problem, particularly among relatively uninformed international investors, and can guide them to efficient investment decisions, if sufficient incentives are created to use such information. e. Pitfall: establishing policies for obtaining adequate corporate governance, fostering competition, developing capital markets. And encouraging information disclosure night be more difficult than it sounds. As many economists argue that well-established firms may oppose the development of the financial system, as it breeds competition and reduces their advantage. Moreover, in the post-Enron period, it is now clear that putting a reporting law in place, adopting accounting and auditing standards with international “best practice” and having competitive accounting/auditing industries would not be enough. Rather policy makers have to ensure adequate oversight and
both the auditors and the firms-and even these may mot be sufficient to guarantee full information disclosure. Finally, capital market-based finance in developing countries can lead to a short-term financial structure, which might reduce productive investment. Still, many emerging market economies are heavily bank-based and short-termism can also occur in a bank-based system. Conclusion: Financial crises in emerging market economies can originate either domestically or externally, and either from bad fundamentals or herd behavior. The global financial system has become more efficient in allocating capital and providing financial services. At the same time, the plethora of recent and prospective difficulties in financial systems worldwide indicates a troubling degree of instability. Crises associated with sharp reversals of capital flows are likely to be an enduring feature of the global financial landscape for some time to come. If policymakers paid attention in developing countries, rich countries, and international financial institutions, the policies mentioned above could significantly reduce the frequency and damage from capital flow reversals and contagion. However, implementing such policies is not easy tasks for the countries affected by East Asia crises. List of references T.J. Pempel: The politics of the Asian economic crisis. Cornel University, 1999. Marahiro Kawai, R. Nerfarmer, and Sergio L. Schmukler: Financial Crisis/Nine lessons from East Asia. Policy Research Institute, Ministry of Finance, Japan. May 2003. William R White, Economic Adviser, Bank for International Settlements: International financial crises: prevention, management and resolution, ww.bis.org/speeches/sp030320.htm.
another Financial Crisis By: Stephen Philip KIKALA (Papua New Guinea) The financial difficulties experienced by Papua New Guinea earlier during the South East Asian financial crisis of the mid 1997- 98 era, involved elements of poor financial and credit management undertakings, as was the case with Indonesia. Before advice may be composed for the Papua New Guinean Government to adhere, it is essential to identify the factors behind the financial downfall of Indonesia and her Asian neighbors, which originated from negative investor speculation, within Papua New Guinea included. But it is important to understand that PNG’s faults were inexcusable considering the more democratic and thus open market capitalist regime practiced since her independence. References to Malaysia’s financial success will be provided in advice. Pempel (pg 154: ’99) states that the key shared vulnerabilities shared between Indonesia and Thailand were the (1) open financial systems with weak prudential oversight; (2) an effectively fixed exchange rate; and (3) large and rapid inflows of foreign capital, most notably short- term debt. The similar traits shared between Papua New Guinea and Indonesia was that the two countries embarked upon massive injections of short-term capital inflows to fuel investments within their respective economies. But the Indonesian government portrayed mature prudence through proper management of statutory enterprises, which were privatized to ensure efficiency and effectiveness in their operations and resulted in repayment of massive foreign debt from proceeds gained. The fiscal undertaking of the Indonesian government was also in surplus after 1992 and public debt had fallen as a share of GDP. Inflation was stable and economic indicators proved successful and unfaultable, but the problem unfortunately for Indonesia, was aligned with Pempel’s mentioned factors. PNG’s problems were mainly due to excessive capital reliance of the private sector on the State. With state ownership and control within the banking sector, liquidity shortage erupted from increased domestic credit held by PNG’s major commercial bank
wide operations and possessed major state equity and asset ownership. Due to massive foreign and domestic debt undermining minimal credit repayment capabilities, the PNGBC has been liquidated since and merged to another foreign invested bank (i.e. Bank of South Pacific), which today is the largest operating commercial bank in PNG serving most transactions. But a major concern as raised by Dr. Moseley Moramoro (Chairman of the Privatization Commission come Independent Public Business Corporation) is the existence of State equity and control of BSP and other State-owned enterprises through board member and executive appointments (The National: Nov. 4:2003). This tradition of excessive State reliance with poor investment returns to finance domestic and foreign debt had contributed to the ineffectiveness of the fixed exchange regime since independence in 1975 until 1997 (during which one PNG kina currency was equal to one US dollar). The compounded problems of a 97% customary land ownership and annual on-going deficit fiscal policies by progressive governments had further contributed to poor collateral value and heightened credit crisis within the economy as the government sought funding from the Bank of Papua New Guinea without restrictions on behalf of the BPNG itself. Adherence to State prerogatives by the banking and private sector without clear managerial ethics, demonstrates the lack of transparency, dysfunctional directives, and national unaccountability towards democratic principles of integrity and independence of particular institutions (including BPNG). Such principles are originally intended to protect the financial and economic interests of the nation at large. Indeed there was neither warnings nor advice from the Governor of the Bank of PNG. For the Governor was duty bound to State directives due to his manner of appointment, which was based on approval by the National Executive Council (i.e. Prime Minister, Cabinet). Thus reforms providing further full empowerment, segregation and integration of institutional functions from State interests will be an essential trait of political democracy in PNG. “The heterodox mix of policies, backed by the vast power and prestige of a centralized polity, is what gives momentum to the reforms today.” (Pempel: pg130: 1999). Under Megawati, Indonesia has by no doubt enforced such reforms after the Asian financial crisis and Suharto’s authoritarian regime.
negative investor speculation had contributed to massive outflow of capital during Prime Minister Sir Julius Chan’s government in 1994. Balance of Payments proved negative has Papua New Guinea’s export volume consisting of primary produce from the agricultural sector and raw mineral extracts (i.e. gold, copper, aluminum, oil) proved expensive for international trade during the capital intensive era. This had contributed to the diminishment of PNG’s international reserves. The major problem in this capital-intensive era for both Indonesia and PNG was the misdirection of capital from investment competencies in productive agriculture or the industrial sector to the stock market and real estate. The experience for Papua New Guinea was the concentration of financing in public enterprises whereas Indonesia, Thailand and Japan had similar problems from real estate price inflation, though the market value of such investments were underestimate able. PNG faces a paradoxical situation for development wherein 97% of land is customarily owned for subsistence living and real estate value is overpriced due to shortages confined in urban areas, though potential lies for capital investment and utilization. Furthermore, Papua New Guinea has been lacking an effectively operating stock market to absorb the requirements of investor oriented financing through equity reliance. An integrated body (for equity financing operation to absorb credit shocks) was established in 1999 during the officiated opening of the Port Moresby Stock Exchange under the former Prime Minister Bill Skate. But it is possible to say that the wide diversity of equity portfolios and depths of investments through foreign direct investment is yet to be intensified due to prevailing barriers concurrent in the high tax regimes and unfavorable risks existent from social problems and investor distrust in managerial competence and accountability. Managing Director of the Investment Promotion Authority (Mr. Ivan Pomaleu) stated that “PNG has already some ingredients of a potential host of FDI country with its abundant resources that will supply raw materials for production and its strategic location to markets in Asia and Europe.’ ‘However, these two factors are not sufficient enough to attract into PNG FDIs that are normally conscious of cost and high returns.” (The National: Nov. 17: 2003) Therefore based on the experiences of the financial crisis within Asia, the following are policy advices that I believe would
of Papua New Guinea in the nation’s differing economic climate: 1) Promotion of foreign investments by installing healthy macro-economic platforms through prudent management of fiscal and monetary policies. For example, stable competitive exchange rate is favorable for international trade and reduced capital costs. Thus it would make every sense to introduce fiscal incentives to support an export-led growth strategy. This should help develop the industrial sectors in agriculture, mining, petroleum and other major projects detrimental to ensuring long-term sustainable economic growth. This may be achieved by following the Malaysian experience, involving a reduction in essential investment aspects of the government’s tax regime to zero. It would be an encouraging factor in attracting the much-needed foreign direct investments (FDI). Pomaleu (The National: Nov.17: 2003) states that the annual average FDI rate shows that from 1996 to 2000, PNG had achieved a low growth rate of 0-9.9% due to minimal FDIs. In the globalization process, countries of the world are taking advantage of the opportunities offered by investment. Such domestic policies should facilitate a free flow of trade. As re-iterated by a government economist (Isaac Lupari), Papua New Guinea has an abundance of natural resources but the country cannot realize its full growth potential unless a conducive environment is created through credential fiscal and tax incentives (Post Courier: Nov.21: 2003). 2) Promotion of employment opportunities by undertaking major capital works programs and encouraging more economic activities in both the formal and informal sectors. For example, establishing market infrastructure for selling primary produce in economically viable centre points. Or the creation and proper maintenance of road infrastructure to economically viable areas of the country is a major capital investment. The Highlands Highway and its road branches to viable areas should be revamped to enable transport of tea, coffee and pyrethrum, which are Papua New Guinea’s major cash crops produced by smallholder plantations. 3) Encouraging the expansion of the informal sector by creating credit schemes for the grassroots-type commercial activities.
an agricultural bank or small business entrepreneur’s development fund to support utilization of land from the informal sector. This will free up land for capital investment and create potential returns for valued real estate marketability in the future. 4) Legislation to encourage foreign companies to re-invest profits in new economic activities or expanding existing activities. For instance, from the case of Malaysia, a new ruling may set a levy on profit repatriated. Imposition of exit levy should only be imposed on investment in shares, bonds, and other financial instruments. But investment in properties should be excluded from levy. These measures should be aimed at encouraging existing portfolio investors to take a longer-term view of their investments, attract new funds into the country, while at the same time discourage destabilization short-term flows. (Atlas: pg3: 2003) 5) Encouraging the banking sector to be more pro-active and liberal in their lending for investments and creation of new businesses. For instance, the Bank of South Pacific should be empowered to make analytic forecasts on corporate cash flows for risky corporate debtors and freely decide the level of credit ceiling. BSP should be issued powers and freedom through legislations to provide shareholder transparency in directing managerial prerogatives in the private sector to suit debt portfolio management requirements (i.e. 100% share ownership through stock listing). During the mid-90s, the former Papua New Banking Corporation had issued K25 million to the national publicly owned airline (Air Niugini). The bank was forced (by the State) to extend another K8million (and liquidity shortage) after the airline agreed to place control of its operations and finances in the hands of the bank (Holt: Aug 27:1999). 6) Establishing clear policy and legal framework to address impediments to development such as landowner issues, corruption, law and order and political instability. Papua New Guinea has had impediments in its economic development from landowning associations and factions, which have taken a natural place in negotiations for investments. The world class mine in Porgera of Enga Province has a landowning association requiring direct payment of
development services and infrastructure provided. Compounded by theft, nepotism, tribal fights; bi-cameral multi- party system (involving corrupt power plays) and other negative atrocities will need to be controlled through appropriate legislations. 7) Targeting and directing foreign aid (e.g. AUSAID-Australian Aid, ADB-Asian Development Bank) to key impact projects, which will ensure maximum benefit to the economy. In addition, establish clear guidelines for the use of foreign aid. For example, the Department and Ministry of National Planning should initiative funding into downstream processing of agricultural produce. A pyrethrum factory is a classic example where value added production may be pursued to provide rubber, natural oil and other more finished products for exporting. Also, it would be a genuine opportunity to allow landowners to voluntarily utilize land in growing cash crops through capital intensive measures supported by credit schemes such as the proposed agriculture bank. Credit should be available in rural banks nationwide. 8) Create a one-stop-shop for processing of all statutory requirements for investment including work permit. A separate body (Investment Promotion Authority) under the Investment Promotion Act may be set by State legislation requiring foreigners to apply for work permit before employment in Papua New Guinea. (Considering the high unemployment rate, and massive expatriate transfers to home countries, it would be appropriate to legally require a training and localization program, in accordance with the Employment of Non-Citizens Act, for accompaniment with the work permit application.) This will allow national human capital to serve corporations in PNG and discourage foreign fund transfers by expatriate employees. 9) Corporate governance and sector reform to allow managerial competencies to be freely executive without political disturbance in achieving corporate valued growth and profitable investor returns and accountability. These reforms should establish guidelines, regulations for independent management holding it accountable to the interests of the
interests or control). This includes the accountability of business entities under the Privatization Commission, Port Moresby Stock Exchange, Securities Commission of Papua New Guinea, etc. In regards to the current on-going privatization of public enterprises and state organizations, the PNG Government has followed a partial- privatization measure allowing 49% state ownership. The Independent Public Business Corporation (formerly Privatization Commission) should sell 100% equity to the international market to provide investor confidence through reduced government involvement and enhance investor focus from managerial prerogatives. This has also contributed to less than potential proceeds amount to finance the existing domestic credit and the annually increasing foreign debt of up to US$2 billion. Allowing for 100% equity and foregoing cuts in fiscal budgeting from less State interests should allow concentration of funds in key areas whilst attracting international investment i.e. FDI (The National: Oct. 28: 2003). Malaysia’s current financial successes and Indonesia’s financial prosperity during the last years of Suharto’s rule was based on whole scale privatization schemes and timely coordinated by the establishment of an effective equities market. 10) Strengthen the financial sector by creating a conducive equity market through the expansion of the Port Moresby Stock Exchange (1999 birth). Establishment of an independent securities commission to provide it (through legislation) the power to regulate fair and transparent trading of stocks offered to the public. And to support the growth of the equity capital market providing proper market values of share prospectus issued by respective corporations and investor accountability. (In Papua New Guinea, the Securities Commission of Papua New Guinea “SCPNG” was established on March 2, 1998.) POMSoX has achieved a market capital rise of K9.7billion (US$3.3 billion) since trading started in June 1999. Market controller Vincent Ivosa stated that the increase in market capitalization represented 262 per cent of the gross domestic product (GDP) of the country in 2003. (Post Courier: 2004) But this achievement was mainly due to investment measures sought by the few corporations listed. (Zero tax incentives are needed to attract new FDI for listing.) In the bid to maintain a surplus budget through investment tax cuts and wholesale 100% privatization, compensation may be gained through the increase in tax on inelastic consumption goods such as gaming, log exports, petrol, alcohol, cigarettes, etc. This
that is worthy to minimize foreign and domestic debt reliance. It is a significant economic feature of the Malaysian experience involving the competitive currency regime and capital flow minimization. Malaysia has embarked on a rapid development campaign fueled by its initial stance against the IMF during the South East Asian crisis. Whilst other countries were maintaining appreciating currencies since 1998, Malaysia embarked on an export driven strategy by practicing sacrifices in fiscal cuts to control credit, but yet fuel capital investment in export-industrial activities. With fiscal legislations taxing capital flight, such initiatives proved valuable in the long run in maintaining capital and increasing international exchange reserves. Thus such practices where self- sustaining in itself though tax cuts and raised interest rates created sacrifice of inflation foregone in the name of development for the long term. It is no miracle and likewise, Papua New Guinea can follow in these similar steps by creating the necessary statutory reforms for supporting the Investment Promotion Authority and its quest to attract FDIs through major tax cuts; maintaining effective monetary policies to raise interest rates in decreasing domestic credit; increasing national employment through employment policy measures linked to foreign work permits; increase balance of payments surplus through competitive exports; empowered and expanded financial institution and market to cushion credit inadequacies of the banking sector; create credit schemes at the rural sector to promote informal employment and encourage capital intensification of the 97% customarily owned land capital; death penalty for law perpetrators from a social point; practice 100% privatization scheme to rid State interests and increase investor confidence and control; ensuring legislated empowerment and independent accountability of important institutions through legislations (e.g. Bank of Papua New Guinea, etc). Such measures will aid to control capital outflow created by investor speculation and withdrawal during the Asian Financial crisis. It will help to maintain a stable and growing investor capital base; encourage national employment to circumvent inflationary problems due to fiscal cuts and sourced tax raise, and allow national riches to increase nationally through international competition from a strong primary export industry, with promises for further investment in higher staged production, debt free!!
Of The Asian Economic Crisis”: Edited by T.J. Pempel: Cornell University Press, Saga House, 512 East State Street, Ithaca, New York Pennsylvania, USA (1999) “Market capital rise to K9.7-POMSoX”-Finance: Post Courier Newspaper -Viewpoint: www.postcourier.com.pg/20040126/business01.htm; (January 26, 2004) Post Courier Online (2004) Papua New Guinea “Overview of the Malaysian Economy”: Atlas Corporation Sdn. Bhd.: www.atlascorp.com.my/ profile.htm: Plaza Pantai, Kuala Lumpur, Malaysia (December 10, 2002) “Sale of 51pc stake to take place soon”: Baeau Tai; The National Newspaper; Business; www.thenational.com.pg/1028/business2.htm: (October 28, 2003) The National Online (2003) Papua New Guinea “PNG gets low share of FDIs”: Baeau Tai; The National Newspaper; Business; www.thenational.com.pg/1117/business2/htm:(November17,2 003);The National Online (2003) Papua New Guinea “Privatise all State business: Moramoro”: Colin Taimbari; The National Newspaper; Nation; www.thenational.com.pg/1104/nation12.htm: (November 4, 2003); The National Online (2003) Papua New Guinea “Fiscal incentives key to growth”: Isaac Lupari; Post Courier Newspaper- Finance:www.postcourier.com.pg/20031121/business04: (November 21, 2003); Post Courier Online (2003) Papua New GUINEA “Air Nuigini Sack Engineers”; Noel Holt; World Socialist Web Site; International Committee of the Fourth International (ICFI): August 27, 1999 (1998-2004): www.wsws.org/articles/1999/aug1999/png-a27.shtml “Foreign Direct Investment Update”: Presented by Managing Director Ivan Pomaleu-Investment Promotion Authority; Session 07-Foreign Direct Investment-A Vehicle for Strengthening Economic Partnership and Manufacturing Base; National Consultative Workshop On Export Driven Economic Recovery And Growth Strategy; 11-14 November 2003, Hideaway Hotel, Port Moresby “New PNG Government Implements IMF’s Economic Restructuring Demands”:
Crisis By: Jazman Azi Jamalludin (Malaysia) I. Introduction The extraordinary turbulence in East Asia during 1997-1998 has sparked a wide ranging debate on the causes of the crisis, lesson to be learnt, and desirable architecture of the international financial system. Among policy makers, international financial institutions and private organizations, and in academic circles, views are converging on the causes of East Asian crisis: It was the result of interactions between massive capital inflows and outflows facilitated by financial globalization and weak national institutions in the affected economies. Therefore, it is paramount to understand the nature of financial crisis and its causes, so that an effective framework of preventive actions can be formulated. II. Financial Crisis: A Definition Before any attempt to define “a financial crisis”, it is very important have clear understanding about the function of a financial system, the problems that confront any financial system worldwide and factors promoting financial crisis. Any financial system in the world performs the essential function of channeling funds to those individuals or firms that have productive investment opportunities. To do this well, participants in financial markets must be able to make accurate judgments about which investment opportunities are more or less creditworthy. Thus, a financial system must confront problems of asymmetric information, in which one party to a financial contract has much less accurate information than other party. Asymmetric information leads to two basic problems in the financial system: adverse selection and moral hazard. Adverse selection occurs before the financial transaction takes place, when potential bad credit risks are the ones who actively seek out a loan. For example, those who want to take on big risks are likely to be the most eager to take out a loan, even at a high rate of interest, because they are less concerned with paying back the loan. Thus, the lender must be concerned that the parties who are
outcome are most likely to be selected as borrowers. Moral hazard occurs after the transactions take place. It occurs because a borrower has incentives to invest in project with high risk in which the borrower does well if the project succeeds, but the lender bears the most of the loss if project fails. A borrower also has incentives to misallocate funds for personal use, to shirk and not very hard, and undertake investment in unprofitable projects that serve only to increase personal power or stature. The asymmetric information problems described above provides a definition of what a financial crisis is: A financial crisis is a disruption to financial markets in which adverse selection and moral hazard problems become much worse, so that financial markets are unable to efficiently channel funds to those who have the most productive investment opportunities. III. Factors Promoting Financial Crisis To flesh out how a financial crisis comes about and causes a decline in economic activity, we need to examine the factors that promote a financial crisis and then go on to look at how these factors interact dynamically to produce financial crises. There are four types of factors that can lead to increase in asymmetric information problems and thus to a financial crises: (1) deterioration of financial sector balance sheet, (2) increases in interests rates, (3) increases in uncertainty, and (4) deterioration of non financial balance sheets due to changes in asset price. IV. Dynamic of Financial Crises Financial crises in emerging markets undergo several stages. There is an initial stage during which a deterioration in financial and non financial balance sheet occur, and which promotes the second stage, a currency crisis. The third stage is a further deterioration of financial and non financial balance sheets that occurs as a result of the currency crisis, and this stage is the one that tips the economy over into a full fledged financial crisis with its devastating consequences. The initial stage has typically been a financial liberalization, which involved lifting restrictions on both interest rate ceilings and the type of lending allowed and often privatization of the financial system. As a result, lending increased dramatically, fed by inflows
Of course, the problem was not that the lending expanded, but rather that it expanded so rapidly that excessive risk-taking was the result which led to an increase in non performing loans. This occurred for two reasons, firstly banks and other financial institutions lacked the well trained officers, risk assessment system, and other management expertise to evaluate and respond to risk appropriately. Secondly, emerging market countries were notorious for weak financial regulation and supervision. The deterioration of financial and non financial sector balance sheets is a key factor leading to the second stage, a currency crisis. A weak banking system makes it less likely that the central bank will take the steps to defend a domestic currency because if it raises rates, bank balance sheets are likely to deteriorate further. Once investors recognize that a central bank is less likely to take the steps to defend its currency, expected profits from selling the currency will rise and the incentives to attach the currency have risen. The weakened state of the financial and non financial balance sheets along with the high degree of illiquidity in East Asian countries, then set the stage for their currency crises. With these vulnerabilities, speculative attacks on the currency could have been triggered by a variety of factors like unsuccessful attempts of the government to shore up the financial system, culminating in the failure of Finance One. The third factor linking currency crises with the financial crises is that the evaluation can lead to higher inflation. The central bank in an emerging market may have little credibility as an inflation fighter. Thus, a sharp depreciation of the currency after speculative attack can lead to dramatic rise in both actual and expected inflation. This is exactly what happened in Indonesia, where inflation surged to over 50 per cent annual rate after the currency crises. The rise in expected inflation led to sharp rise in nominal interest rate which given the short duration of debt, led to huge increases in interest payments by firms. The outcome was a weakening of firms’ cash flow position and further weakening their balance sheets, which then increase adverse selection and moral hazard problems in credit market.
Supervision Banks play a particularly important role in the financial systems of emerging market and problems in the banking sector have been an important factor promoting financial crises in recent years. To prevent financial crises, governments therefore need to pay particular attention to creating and sustaining a strong bank to reduce excessive risk taking activities in their financial systems through steps as below: (a) Prompt Corrective Action Quick action by prudential supervisors to stop undesirable activities by financial institutions and, even more importantly, to close down institutions that do not have sufficient capital is critical if financial crises are to be avoided. An important way to ensure that bank supervisors do not engage in regulatory forbearance is through implementation of prompt corrective action provisions which require supervisors to intervene earlier when a financial institution gets into trouble. (b) Focus on Risk Management In today’s world, financial innovation has produced new markets and instruments which make it easy for financial institutions and their employees to make huge bets quickly. In this new financial environment, an institutions that is quite healthy at a particular point in time can be driven into insolvency extremely rapidly from trading losses, as has been forcefully demonstrated by the failure of Barings in 1995 which, although initially well capitalized was brought down by a rough trader in a matter of months. Thus, an examination which focuses only on a bank’s or other financial institution balance sheet position at a point in time may not be effective in indicating whether a bank will in fact be taking on excessive risk in the near future. (c) Limiting Too-Big-To-Fail Limiting moral hazard from having financial institution that are too-big or too-politically-connected to fail is a critical problem for prudential supervision in emerging market countries. Thus, in order to reduce increased incentives to take on excessive risk by large institutions, prudential supervisors need to scrutinize them
than smaller ones and at a minimum, must impose losses on shareholders and managers when these institutions are insolvent. However, supervisors still have to face the quandary of not wanting to allow a failure of a large financial institution to destabilize the financial system while keeping the moral hazard problem created too-big-to-fail under control? One proposal to tackle this problem is announcing by supervisory agencies that there is a strong presumption that when there is a bank failure, uninsured depositors would not be fully protected unless there is a cheapest way to resolve the failure. (d) Adequate Resources and Statutory Authority for Prudential Regulators In many emerging market countries, prudential supervisors are not given sufficient resources or statutory authority (the ability to issue cease and desist orders and to close down insolvent banks) to do their job effectively. Without sufficient resources and incentives, supervisors will not monitor banks sufficiently in order to keep them form engaging in inappropriately risky activities, to have the appropriate management expertise and controls to manage risks, or to have sufficient capital so that moral hazard incentives to take on excessive risk are kept in check. (e) Independence of Regulatory/Supervisory Agencies Because prompt corrective action is so important, the bank regulatory/ supervisory agencies requires sufficient independence from the political process so that it is not encouraged to sweep problems under the rug and engage in regulatory forbearance. One way to ensure against regulatory forbearance is to give the bank supervisory role to a politically independent central bank. (f) Accountability of Supervisors An important impediment to successful supervision of the financial system is that the relationship between taxpayers and the supervisors creates a particular type of moral hazard problem, the principle-agent problem. This problem occurs because the agent (supervisor) does not have the same incentive as the principle (the taxpayer they ultimately work for) and so act in their own interest rather than the interest of principal. To avoid this problem, supervisors must be accountable if they engage in the regulatory forbearance in order to improve incentives for them to do their job properly. To do supervisors to do their job properly, they must also
taking bribes and must also be subject to penalties if they take job with institutions that they have supervised recently. (g) Restriction on Connected Lending Prudential supervision to restrict connected lending are clearly necessary to reduce banks risk exposure. It can take several forms. One is disclosure of connected lending Another are limits of the amount of connected lending as a share of bank capital. (ii) Accounting Standards and Disclosure Requirements Accounting standards and disclosure requirements for financial institutions, which are often particularly lacking in emerging markets and transition countries. Without the appropriate information, both markets and supervisors will not be able to adequately monitor financial institutions to deter excessive risk taking. One example is that, accounting and supervisory convention in many countries allow banks to make non performing loans looked good by lending additional money to the trouble borrower who uses the proceeds to make the payments on the non performing loan, thus keeping it current, a practice known as “evergreening”. (iii) Legal and Judicial Systems The legal and judicial systems are very important for promoting the efficient functioning of the financial system and the inadequacies of legal systems in many countries are a serious for financial markets. If property rights are unclear or hard to enforce, the process of financial intermediation can be severely hampered. For example, bankruptcy procedures in developing countries are frequently very cumbersome resulting in lengthy delays in resolving conflicting claims. Furthermore, slow resolution of bankruptcies can delay recovery from financial crisis because only when bankruptcies have been resolved is there enough information in the financial system to restore it to a healthy operation. (iv) Encouraging Market-Based Discipline This is the answer to the problem related to relying on supervisors to control risks taking by financial institution because of (i)
incentive to keep away information form bank examiners, and (ii) principal-agent problem. Two additional steps may help market discipline. One is to require that financial institution have credit ratings. Another way to impose market discipline on banks is to require that they issue subordinated debt (uninsured debt that is junior to insured deposits but senior to equity). Through this way, if the bank is exposed to too much risk, it is unlikely to be able to sell subordinated debt. (v) Entry of Foreign Banks Foreign banks have more diversified portfolios and also usually have access to sources of funds from all over the world through their parents company. This diversification means that this foreign banks are exposed to less risk and are less affected by negative shocks to the home country’s economy. Because many emerging markets are more volatile than industrialized countries, having a large foreign component to the banking sector is valuable because it helps insulate the banking system from domestic shocks. Encouraging entry of foreign banks is thus likely to lead to a banking and financial system that is less fragile to crisis. Another reason for encouraging entry of foreign banks is that this can encourage adoption of best practice in the banking industry. (vi) Capital Control Capital outflow have also been pointed to as a source of foreign exchange crises, which as we have seen can promote financial instability in emerging market countries. In this view, foreigners pull their capital out of the country and the resulting capital outflow is what forces a country to devalue its currency. However, a key factor leading to foreign exchange crises are problems in the financial sector which lead to the speculative attack and capital outflows. Thus, there is need to control capital to out of the country. (vii) Restrictions on Foreign-Denominated Debt The presence of foreign-denominated debt is also makes it far more difficult for a country to recover from a financial crisis. Industrialized countries with debt denominated in domestic currency can promote recovery by pursuing expansionary by
lead to the situation where asset prices and stock market value will increase, thus will cause an improvement in net worth and a reduction in adverse selection and moral hazard problems. (viii) Elimination of Too-Big-To-Fail in the Corporate Sector To contain incentives for the corporate sector to increase leverage and take on much risk that leaves them extremely vulnerable to adverse shocks, it is imperative that too-big-to-fail policies be eliminated. (ix) Sequencing Financial Liberalization Although deregulation and liberalization are highly desirable objectives, but if it is not managed properly it can be disastrous. The dangers in financial deregulation and liberalization do not imply that countries would be better off by not pursuing a liberalization strategy. To the contrary, financial liberalization is critical to the efficient functioning of financial markets so that they can channel funds to those with the most productive investment opportunities. However, proper sequencing of financial deregulation is critical to its success. Before financial markets are fully liberalized, it is crucial that the precepts on the issues such as provision of sufficient resources and statutory authority to bank supervisors, adoption of prompt corrective action provisions and appropriate focus on risk management, independence of banks’ regulator from short run political pressure, increased accountability of bank supervisors, limitations on too- big-to-fail, adoption of adequate accounting,/standards and disclosure, sufficient restrictions on connected lending, improvements in the legal and judicial systems, encouragement of market-based discipline encouragement or entry of foreign banks be specifically dealt with. References Frederic S. Mishkin, Financial Policies and the Prevention of Financial Crises in Emerging Market Economies, Graduate School of Business, Columbia University and national Bureau of economic Research Masahiro Kawai, Global, Regional and National Approaches to the International Financial Architecture: Lessons form the East Asian Crisis, The Japan Society of International Economics 2002
do to Prevent Financial Crisis By: Zhangchen (China) In 1997, the devaluation of Baht triggered the Asian currency crisis. Then Philippine, Malaysia and Indonesia were in trouble. Soon other East Asian economies became involved, Taiwan, Hong Kong, Singapore and others to varying degrees. Compared with other Asian countries, China successfully weathered the Asian crisis. The conservative capital account management and relatively tight control on foreign exchange account protected Chinese economy from external attaches. A combination of expansionary fiscal policy and interest rate reductions enabled the country to achieve robust growth and to contain the adverse effects of the Asian crisis. However, the lessons learnt from the Asian crisis are important for China to prevent another financial crisis. Furthermore, there are still some challenges that China must overcome to make the economy develop in a sustainable manner. 1. Lessons from the Asian Financial Crisis First, sound macroeconomic fundamentals do not suffice to achieve sustained economic growth. Structural factors have played a much more decisive role in the Asian crisis. Second, for developing economies to reap the benefits of an open capital account, greater attention should be paid to the institutional capacity in the financial sector and to the sequencing of financial sector reforms. Third, it is vital to develop a well functioned domestic capital markets in order to encourage more efficient allocation of resources under market direction and scrutiny. Fourth, current events highlight the importance of regional surveillance in preventing such a crisis from recurring. Regional surveillance can well be justified on the grounds of strong spillover effects within the region, cost effectiveness, and effective peer pressure. Finally, the Asian crisis poses a new challenge to the architecture of the international financial system. What is needed is essentially a system that enables International Financial Institutions
of liquidity, so that the governments can concentrate on restructuring of their weak financial and corporate sectors, without unduly contracting the real economies. There is also a need to prepare architecture to monitor international capital flows at which reversal has proved to be devastating for capital receiving countries. 2. Status of the Chinese economy In China, economic reforms have been advanced through a gradual expansion of the market economy since the transition to a track of reform and open-door policies in 1978, and in particular since 1992, when market economy mechanisms were introduced through a socialist market economy. Through the advance of reform and open-door policies, a high growth rate has been maintained since 1978, with the GDP growth rate in China marking an average of 9%. The recent astonishing development that has been witnessed in China is related to external economic factors such as foreign direct investment and trade. In particular, in the case of foreign direct investment, given the impetus provided by the “Southern Tour Lectures” in 1992, the number of contracts and their amount rose rapidly, and foreign companies that have entered the Chinese market are therefore playing a significant role in achieving sustainable economic growth in China. Although there are many challenges that are still to be overcome, including the income disparity between urban and rural areas, there is huge potential for the Chinese market to further expand, given the enormous population. Since March 2003, infections of SARS (Severe Acute Respiratory Syndrome) have spread rapidly, centered around Guangdong Province and the City of Beijing, and there is concern that, depending on the situation from then, this could have an adverse impact on the Chinese economy. Although affected by this factor seriously, the GDP growth rate for 2003 reached 9.1 percent, marking the largest increase since the Asian currency crisis of 1997. 3. Potential factors that may causing crisis In order to prevent Chinese economy from crisis, Chinese government should pay great attention to the following factors that may cause trouble:
The market share of state-owned enterprises, which were dominant in the period of the planned economy, has dwindled dramatically in terms of total industrial production through the process of reform and open door policies. In addition, the number of state-owned enterprises that are posting deficits is increasing. It could therefore be inferred that the reform of state-owned enterprises that has been implemented fully since the mid-1980s has failed to bring about any improvement in the management of state-owned enterprises. The background of this failure could be cited as increasing competition and the structural burdens of state- owned enterprises. Currently, the great majority of state-owned enterprises are heading towards privatization, and this has brought about two issues concerning corporate governance, in particular for large- scale state-owned enterprises that have reorganized into joint-stock companies and have been listed on the stock exchange. One involves the issue of a main body seeking corporate governance, the other issue concerns accounting systems that are adjusted to harmonize with recent trends in the capital market. (2) Non-performing loans The deterioration in management of state-owned enterprises has resulted in the emergence of large nonperforming loans, held by financial institutions that have provided funding to state-owned enterprises over many years, in particular the four major national commercial banks. Given the significant increase in nonperforming loans held by such financial institutions, the Chinese government has injected funds into the four major national commercial banks and has implemented sweeping measures to deal with non- performing loans. However, as of the end of April 2002, the proportion of non-performing loans of the four major national commercial banks still stood at a high level of 24.5 percent, indicating that the issue of nonperforming loans will be a long- term one in China. (3) Lack of development in the direct financing market The stock market in China is active due to the increase in the level of household financial assets and changes in the structure of financial asset savings. Notwithstanding this fact, the current
GDP is still at a low level, and is still at a developmental stage. At the same time, although the intermediary functions of indirect financing is decreasing, Chinese companies, in particular state-owned enterprises, are still in a situation of having to depend heavily on indirect financing. (4) Financial deficits The national finance of China remains in a chronic state of deficit, and the scale of deficit continues to expand, given the large- scale issuance of long-term construction bonds that have been issued as a measure to inflate domestic demand in the wake of the Asian currency crisis since 1998. In the future also large amounts of financing will be required for large-scale projects such as the western development strategy, and this plus the additional burden in the disposal of non-performing loans make it inevitable that the burden on national finance will further increase. In order to ensure the sustainability of economic growth, China is forced to rely on aggressive financial policies for the time being, and if the financial deficit continues to expand, there are concerns that it could constrict economic growth. (5) Regional disparities Income disparity is rapidly widening between those people living mainly in urban areas who are enjoying the benefits of economic development and those who live predominantly in rural areas and remain in poverty. The same phenomenon in economic disparity is being witnessed between the coastal (eastern) regions and the areas inland (central and western). In order to correct such regional disparities, the government has made a transition to a policy that focuses on the development of the central and western regions, including the “Western Development Project,” and has announced a policy that aims for balanced regional economic development. In implementing such a policy, the Government is required, over the short-term, to supply financing to the central and western regions and it is forecast that this will place a further burden on the national finance.
China there is a marked surplus production capacity in the manufacturing and other industries, and as a result of this being coupled with the economic slowdown that accompanied the Asian currency crisis in 1997, commodity prices experienced a period of deflation in 1998. Although deflation had been overcome once in 2000, at the start of 2002 another deflationary trend was witnessed. One of the factors cited for the deflationary phenomenon in China is that in addition to cyclical economic aspects, structural aspects contribute to deflationary tendencies, such as surplus labor resources in rural areas, surplus production capacity – mainly in state-owned enterprises, and supply of products that do not match demand. There are concerns that the continuation of deflation will retard the resolution of the non-performing loan issue, cramp consumption and lead to a downturn in economic growth.
Financial Crises By: Jandos Khalik (Mongolia) I think nobody would argue that, identifying causes of financial crises of the past is at least half answer to preventing similar financial crises in the future. The problem may arise if we disagree on the same causes of crises. Anyway, by surveying some literature on the financial crises that had occurred during last decades I would like to give some explanations by economists, and identify common patterns, on which many of economists and experts seem to agree to some extent. According to Jeffrey A. Frankel1 (2001), large current account deficit triggered the East Asian crisis in 1997-98. But he argues that large current account deficit or high level of debt are not necessary itself the real cause, more important is how it is financed and how the funds are used. East Asian countries in 1997 relied too much on short-term foreign-currency-denominated debt, as in Mexico in 1994. The main problem was structural, not macroeconomic. Deep flaws afflicted the financial system. They include excessive leverage, and a banking system based excessively on directed lending, connected lending and other collusive personal relationships (“crony capitalism”). Radelet and Sachs (1998), according to Paola Monti (2001), stress on instabilities intrinsic to the international capital market. It means such instabilities are inevitable, and countries should take correct actions immediately when needed, in order to prevent deeper financial crises. They point out number of missteps taken by Asian governments, and IMF, such as defense of the peg, failure to intervene against failing banks, restrictive monetary and fiscal policy, etc. Karl D. Jackson (1999) identifies 5 factors that presented simultaneously in countries affected by the Asian crisis in 1997-98: Capital account convertibility Fixed exchange rates Excessive expansion of domestic lending accompanied by gross 1 Professor Frankel was a member of President Clinton’s Council of Economic Advisors
of regulatory and supervisory capacities to control excesses in the financial sector Paralysis of political decision making at the onset of the crisis Thailand, Indonesia, and Korea manifested all five elements, whereas China and India shared several but not all of the same characteristics. Joseph E. Stylists2 (2003) digs even deeper. He believes that the single most important factor leading to the Asian crisis in 1997- 98 was premature liberalization of capital account. He criticize IMF’s policies that imposed such premature liberalization prior to the crisis. The reason why IMF pursued such policies were the influences from international bankers and financiers, who sought their own interests in the emerging market, IMF’s belief in textbook market economy, especially radical view on free market power. Roy E. Allen3 gives an explanation in terms of money creation process. There are two kinds of money: real and quasi. In old times gold was the real money and paper money was quasi- money. Even though paper money was convertible into real money (gold) total amount of paper money became actually significantly more than real money; full convertibility at one time was impossible. When paper money, coins are accepted as real money, other kinds of quasi-money were created based on those real money: various bank accounts, deposits, then electronic funds transfers, and even e-money today. And again, even they are convertible into traditional money they never can be converted at once fully. Also, in today’s complicated financial world it is becoming increasingly difficult to know how much quasi-money is being created. Global money and monetary-processes are further complicated by the role of the dollar (and to lesser extent the yen, euro, etc.) as the world reserve currency. Just as quasi-money supplies can be created on the basis of real money supplies within a national economy, ‘soft-currency’ supplies can be created on the basis of their convertibility into the US dollar. Many other national currencies became soft-currencies toward US dollar. Liberalization 2 Nobel Prize winner, a member of the Council of Economic Advisers during Clinton’s presidency; he was also an economist at the World Bank. 3 Roy E. Allen is Professor of Economics at St. Mary’s College of California, USA.
and liquidation of trade barriers increased dollar inflow (earned through trade or borrowed from abroad) into developing countries, which gave them an opportunity to create more money based on that inflow of dollar. But, many new loans and money accounts were not used profitably or effectively. For example, too much commercial real estate was built with borrowed money, and it could not be rented or sold. Businesses faced difficulty to pay back bank loans. In such shaky economic condition loss of confidence in the financial system, and sudden outflow of hard-currency or dollar may harm economy, and it usually happened. Failure to fully convert into dollar depreciated national currencies, drained out national reserve, and consequently dropt monetary base. High indebtedness of businesses brought strong pressure on them, and many of them bankrupted. That was the case in East Asia in 1998- 97. What is my view on the causes of East Asian crisis in 1997- 98? It seems to me that, those economists who’s explanation to financial crises I tried to explain here are generally correct, though they may differ in some or other (usually not so much significant) way, and approaching from different angles. I think, excessive amount of money created in the crisis countries and their ineffective use (too much money chasing too few investment opportunities) made those countries vulnerable to sudden currency attacks. Further, I agree with Joseph Stiglitz, who states that the main cause of East Asian crisis was premature liberalization of financial market. Also, pegging to dollar is another reason of the crisis; if countries peg their national currencies to dollar, they should follow all policy changes carried by USA carefully and take appropriate measures in time. If someone gains on crisis, then it would be hard-currency supplier; the fact that the US and other hard-currency countries constantly gained monetary wealth at the expense of less developed countries (i.e. quasi-money or soft- currency users) is the evidence (Roy E. Allen (1999)). What should be done? In my view there are two approaches: on national level and on international level. Even though national policy-makers’ have limited resources on taking broader measures to prevent financial and economic crises on international level, they still can contribute
countries to prevent future crises. This is very important, because true underlying reason of crises are hidden in the weaknesses and imperfectness of today’s international financial system, which dramatically changed in recent decades and was evolved into the form as it is today. If countries still fail to prevent another crisis on international level then an individual country can still work on its own in order to prevent crisis in its home or minimize adverse effects of crisis and overcome it in a short time. Listening to others (for example to IMF) is OK, but one should keep in mind that not all advices are acceptable and even may be wrong, even though intension to help is sincere. Malaysia case during the East Asian crisis clearly shows that. So, what to do on international level? Here are some suggestions by those economists I’ve cited in the paper, and with which I agree: 1. Reducing the number of currencies. Studies show that financial crises typically occur when one or more major currencies, after having been de facto but not de jure reserve currency, suddenly leaves the country through private channels. In that case, national authorities typically have no means to react except ad hoc international borrowing. In order to compete against strong currencies regional currencies can be developed. It will minimize exchange rate risk, and effectively support one strong currency together. Euro is good example. Asia, Latin America and other regions can follow that practice. Of course, the introduction of a regional currency can be destabilizing if not done carefully and gradually. “However, in order for the new currency region to gain liquidity premiums, reduced transaction costs, seigniorage benefits, and to protect itself against the money-merchantilism of the US and others, these risks seem worth taking” [3, p163]. 2. Reform of the international financial architecture. The need is obvious but there is no wider agreement on the reform. Recently, many international meetings have been held, and many proposals (often mutually incompatible) have been gathered. Key features of the strategy being developed are: to identify ex-ante rules that help both strengthen the system and provide mechanism for easier crises resolution; to envision ex- post measures to take when crises occur [1, p344]. Main
ex-ante strategy are the agreement on and the implementation of the international standards that aim at improving the quality of available information, soundness of policies and financial systems. Ex-post measures intended to be used in extreme cases (if ex-ante measures fail). 3. Role of international organizations. General suggestions are: their role should be changed that they provide a setting for more effective international surveillance and forum for discussion, the IMF should perform a sort of lender of last resort role. J. Stiglitz proposes transparency of those organizations. As some others advocated, I think, creation of other international organizations that perform similar roles should be welcomed, which may introduce more competence and democracy in this area. Chang Mei Initiative can be alternative to IMF for Asian and many other developing countries. 4. Maintaining money-liquidity. The US dollar remain dominant globally is fact. In the period after 1994, the US Federal Reserve conducted monetary policy with the main goal of maintaining non-inflationary growth in the US economy rather than concerning itself with world-money liquidity, and world money-liquidity shortages increased the risk of crises. That’s why G7 countries through their financial institutions should ensure that there is sufficient money-liquidity in the global economy. Next, I would like to describe several proposals that can be done on national level: 1. Controlling capital account. It is very arguable issue. My view is that financial market is far from being perfect and self- regulative; there should be some mechanism for controlling financial activities, at least the movement of “hot money”. R. N. Cooper [1] asserts that liberalization of capital account seems to be good idea – if certain conditions, like low barriers to international trade, well-developed and well-regulated (?) domestic financial market, and tax regime for capital that does not differ much from world norms are met. But these conditions are very demanding; it will take time to meet them. As to regulations, many incline to the argument that they should be more market-friendly instruments (taxes, reserve requirements), rather than being quantitative restrictions.
it should be solved through bankruptcy, not through an IMF-financed bailout, thus addressing moral hazard issue. Bankruptcy reform should recognize the special nature of bankruptcies that arise out of macroeconomic disturbances, and give greater presumption for the continuation of existing management. 3. Improved banking regulations. Weak bank regulations can lead to bad lending practices. For example, speculative real estate lending should be restricted. Banks should have proper mechanisms for controlling excessive financial leverage. It is difficult to ensure that weather lending is used in good investment projects, and to maintain appropriate level of money supply, which is just enough; but this is a task for which central bank and commercial banks exist after all. As to exchange rate policy, it is difficult to say something unarguable. Many economists advocate floating exchange rate, but it seems to me not an answer. Freely floating exchange rate can be even more destabilizing in this imperfect financial market world. To me, the strategy “fixed but flexible” is likely to remain in near future, until more advanced solution become available. Hal Hill suggests that some sort of currency board is worthy of consideration. But in that case, policy makers and community would have to fully understand, and accept, the loss of monetary policy independence. If it is adopted currency uncertainty would be transmitted not via exchange rate, but interest rate. And at last, I would like to say here one Mongolian proverb: “Rich if you have no debt”. That is not to say that one should reject money if borrowing is economically justifiable. In many East Asian countries savings rate was high in pre-crisis period. It is arguable weather those countries needed more foreign money in order to grow even faster. Also, there is no obvious evidence that free capital inflow will boost growth. So, it is better to use one’s own money in full capacity; if one needs more, one should borrow just the amount needed, and when it is economically profitable. I think, a country like Indonesia has a great potential to raise ample amount of money as well as to overcome consequences of the past economic and political crisis. Here I would like to finish my term paper with the best wishes, strong unity and greater economic prosperity to Indonesian people, and state.
by B.N. Ghosh, Global Financial Crises and Reforms: Cases and caveats, 2001, Routledge 2. Edited by Karl D. Jackson, Asian Contagion, 1999, Westview Press 3. Roy E. Allen, Financial Crises and Recession in the Global Economy, 1999, Edward Elgar, USA 4. Joseph E. Stiglitz, Globalization and its discontents, 2003, W.W.Norton 5. N. Gregory Mankiw, Macroeconomics, 2003, Worth Publishers 6. Hal Hill, The Indonesian Economy in Crisis, 2000, Institute of South-East Asian Studies, Singapore.
Another Financial Crisis By: An-Chin Hsu (U.S.A) For many years the economies of South East Asia were regarded as models for development. Among the countries in the South East Asia, the four tigers: Taiwan, South Korea, Singapore, and Hong Kong grew from low levels of income per head to among the highest in the world in just a few decades. In addition, during that period, the newly industrializing economies countries such as Indonesia, Malaysia, and Thailand had also started to grow in a rapid rate. However, the prosperous and successful economic conditions for these countries did not continue for a long time. In the latter half of the 1997, the financial crisis struck these countries’ economies. As a result, asset prices and exchange rate tumbled and the banking service sectors were put under severe strain. The financial crisis spilled over into the real economies and severe recession occurred. Although each country had its own characteristics while experiencing the financial crisis, but a number of common features or characteristics were presented for most of the countries. For example, many of the countries have been preceded by liberalization of the economy, especially the financial service sector. Currency instability have been started by a sharp increase in capital inflows followed by an equally sharp reversal for most of the countries. As a result, under such condition, international investors and creditors manifest herd-like behavior in exiting as well as in investing or lending. Increase in capital inflow is usually associated with internal or external policy changes that produce divergence in domestic financial conditions relative to the rest of the countries. Reversals of capital flows are frequently associated with deterioration in the macroeconomic conditions of the recipient country. This deterioration often results from the effects of capital inflows themselves and includes currency appreciation, current account deterioration, rapid domestic credit expansion, and speculative bubbles in asset markets. However, it is also notable that financial crises in emerging markets have occurred under varying macroeconomic conditions.
unsustainable, which is in the case of Mexico and Thailand, but also when such deficits were relatively small such as Indonesia and the Russian Federation case. Although significant overvaluation has often been characteristic of countries experiencing currency turmoil such as countries like Brazil, Mexico and the Russian Federation, all of which used the exchange rate as a nominal anchor to bring down inflation, but this has not always been the case; in most East Asian countries the appreciation of the currency was moderate or negligible. Similarly, while in some cases crisis were associated with large budget deficits, for example, Brazil and the Russian Federation, in others the budget was balanced or in surplus such as Mexico and East Asia. Finally, crisis occurred when external debt was owed primarily by the public sector or primarily by the private sector. Furthermore, the essence of the crisis was a huge, sudden reversal of capital flows. Starting in the early 1990s, there was a rapid increase in short-term lending by commercial banks to both banks and firms in the region. Most bank lending was non- syndicated and directed to non-financial private firms and to a lesser extent elsewhere, the financial sector was also an important recipient of funds. Clearly, such transactions must have been perceived to be profitable by both international lenders and the Asian borrowers. However, it turned out that more capital flowed into these economies than could be profitably used at modest risk. Economies that had been attracting large amounts of foreign capital suddenly became subject to withdrawals of short-term lines of credit, an exodus of portfolio capital, and offshore flight by domestic investors. The net private capital flows into the five most affected Asian economies (South Korea, Indonesia, Thailand, Malaysia, and the Philippines) jumped from $37.9 billion in 1994 to $97.1 billion in 1996. The bulk of these new inflows came as loans from private creditors (commercial banks plus non-bank creditors, such as bond-holders), which tripled in just two years from $25.8 billion to $78.4 billion. But in the last half of 1997, these inflows suddenly reversed themselves, with net private capital flows turning to an outflow of $11.9 billion. This turnaround of $109 billion in one year, from an inflow of $97 billion to an outflow of $12 billion, is equivalent to about 10% of the pre-crisis GDP of these five countries. One reason that such a large amount of capital was able to leave so quickly was that a substantial portion was
short-term maturities. In each of the severely- hit economies, short-term foreign exchange liabilities of the economy grew in excess of short-term foreign exchange assets of the economy, leaving the economy vulnerable to liquidity problems in the event of a sudden withdrawal of foreign capital. Presumably, foreign lenders (mainly banks) had made short-term loans under the assumption that they would routinely roll over such loans in the future. In the event, they pulled these loans abruptly in the second half of 1997. It is important to keep in mind that short-term debts owed to foreign banks are but just one type of short-term foreign liability. Portfolio capital, bank deposits held by foreign non-banks, long-term loans with conversion covenants, and hedging instruments can all be withdrawn very quickly, putting further pressure on foreign exchange reserves and the exchange rate. At the same time, there may be other forms of foreign exchange assets in addition to official reserves that can be drawn upon in the event of a foreign creditor panic. A priority for future research should be to measure in a more comprehensive manner the short-term cross-border assets and liabilities facing emerging market economies, and the role of various types of financial claims in the onset of financial panic. Aside from some of the financial problems that caused the entire crisis, perhaps one could also blame the governments for failing to prevent market failure. For example, in the Indonesia’s case, if President Suharto at the time could generate decisive action and plans to counter the crisis at its initial phase, and to evaluate and analyze IMF assistance package carefully, Indonesia would not have suffered that severely. However, for most countries that suffered the financial crisis, what the government might have done and its role is a complex question for some scholars. According to one view, the problem is not liberalization as such but the absence of effective prudential regulation and supervision of the banking system. There can be little doubt that prudential limits on bank lending, capital adequacy requirements and currency matching conditions for assets and liabilities that are properly enforced can help prevent excessive risk-taking by banks, thus containing the adverse effects of widespread defaults. However, it is not easy to prevent domestic credit expansion when capital inflows lead to a rapid liquidity expansion. As long as capital inflows and liquidity expansion remain unchecked, lending will eventually spill over from the financing of safe and productive
raises the collateral values of the assets financed by such lending, thereby encouraging belief in the appropriateness of these values. Such a process was experienced not only in Asia but also in Mexico in the early 1990s and in the US in the 1980s. In this process, as the investment boom continues, growth remains strong and the external balance deteriorates. But eventually loans become non- performing and banks are weakened. Thus, deterioration of the external balance and weakening of the financial sector are two sides of the same process of excessive capital inflows. The basic problem is the absence of instruments to restrict capital inflows and contain their impact on macroeconomic and monetary conditions. It is difficult to check this process solely through prudential banking regulations. In any case, such regulations cannot prevent excessive non-bank private borrowing abroad. This is not always appreciated, even though in East Asia an important part of private borrowing from inter-national banks is by non-bank firms: one-third in the Republic of Korea, around 60 per cent in Malaysia and Thailand, and even more in Indonesia. Nor do international financial markets impose the right kind of discipline over private borrowers in developing countries. All too often they manifest herd-like, pro-cyclical behavior in both giving and cutting back loans. The global reverberations of this boom-bust character of finance are further enhanced by greater integration of markets and increased mobility of capital. This is why governments need to be prepared to use a broad range of policy instruments, including but not restricted to prudential regulations. There are numerous aspects and issues that need to be taking into consideration for which that the Asian Financial Crisis had brought upon. However, as an advisor to policy makers in the countries affected by the crisis, I would suggest one important fact to be remembered. The East Asian financial crisis has definitely increased the awareness of the need for global governance of finance so as to prevent the recurrence of similar crises. Hopefully, the international community will be forced to reconsider whether or not existing arrangements regarding international payments and finance are compatible with stability and growth. To sum up the problems in the entire crisis, the main problem is that, even though financial markets are much more integrated than product markets and capital is much more mobile than other factors of production, there is no global governance of international financial transactions
found in the area of trade. Moreover, the present international arrangements are not only inadequate but also asymmetrical; they are designed to discipline borrowers rather than regulate lenders. This stands in sharp contrast with the way national financial systems are designed. Moreover, international arrangements are designed to manage rather than to prevent crises. And the measures to stave off international banking crises tend to be at the expense of living standards, stability and development in debtor developing countries. Second, with greater financial integration, the global impact of interest- and exchange-rate policies has become much more important. This is true not only for the major industrial countries but also for many developing countries, where policies are seen to have had serious regional or global repercussions. There is no effective surveillance in these areas and there is no way of preventing "beggar thy neighbor" policies affecting key monetary and financial variables. Moreover, there is no mechanism for dispute settlement regarding macroeconomic and financial policies, such as exists for trade policies. If a country puts up its tariffs on imports of cars from its neighbor, the latter can go to the WTO and complain, but no forum exists where a country can make analogous representations about a rise in a major country's interest rates and a consequent increase in its debt burden, or about a devaluation which has the same effect on its exports as higher tariffs. Third, there are no effective, rule-based and adequately funded arrangements for the provision of liquidity by an international lender of last resort. Finally, there is a need for a system of orderly work-outs based n rules and bankruptcy procedures governing international debtor-creditor relations. Furthermore, a positive adjustment to the crisis should include a number of components. First, loans should be rolled over and rescheduled to allow the countries concerned to service them from future export earnings and not through increased external borrowing at penalizing rates. This should be combined with the provision of external liquidity to support the exchange rate and enable a more accommodating monetary policy to be pursued while restructuring of the financial sector is under way. In this respect, there are important lessons to be learned from the policy response of the US Federal Reserve Board to the debt deflation of the early 1990s -- a response which played a major role in bringing about one of the country's longest recoveries following one of its
global growth to provide markets in which Asian countries can earn the foreign exchange needed to pay off their foreign currency debt. Thus, an important component of the solution is to remove the deflationary bias in the macroeconomic policies in those areas of the developed world running large trade surpluses. Until the surplus countries initiate domestic demand-led growth and reduce their external surpluses, the global economy will continue to be vulnerable to the risk of financial instability and recession, and the crisis in South East Asia will continue to contribute to the decline in global growth and to trade frictions. Also, the policies in the financial service sector need to be reformed in order to prevent for another future financial crisis. Lack of effective prudential regulation and supervision of the banking system is often mentioned among the major causes of the East Asian crisis. Indeed, despite the fact that the East Asian economies had started to improve their regulatory and supervisory systems far earlier than most other developing countries, these were ineffective in checking the excessive build-up of risk and fragility in the financial sector. However, this is as much a reflection of the well-known limits of prudential regulations in preventing real estate bubbles or exposure to market risk as institutional shortcomings. As seen in Europe in the early 1990s, attacks on currencies can come irrespective of the health of the financial system and the existence of effective prudential regulations. Indeed, Malaysia had effective prudential regulations in checking short-term foreign borrowing, but these did not prevent the attack on its currency and crisis. Moreover, much of the private borrowing from international banks was by non-bank firms, which fell outside the scope of banking regulations. In order to prevent future financial crisis, the following points should be continually undertaken, instead of only focusing on such issues when the crisis started to emerge. First, An efficient information system should be set up to closely monitor market sentiment, investment opportunities, prospective investors and their expected investments, their rates and formats of returns, underlying motives, consumption and saving patterns, prevailing and expected financial market conditions, export markets, and global economic atmosphere. This information system should help pinpoint the potentially wrong spots in the microeconomic context. Second, Macroeconomic management should aim at preserving or
because of the significance of confidence. Third, the authorities in the recipient country ought to ensure the consistency of all discretionary economic policies (including fiscal, monetary, exchange rate policies, and capital or exchange controls). Otherwise, their policies could be not only costly but also fruitless. Fourth, some early warning indicators should be adopted by the borrowing country to steadily evaluate its comprehensive macroeconomic status, debt servicing capacity, and financial stability. Fifth, once the information system and early warning indicators show any sign of possible problems, the authorities should design and impose specific preemptive measures on the particular spots or sectors which are stirring up misuses of resources or provoking dangers. This route is recommended since there is no cure-all medicine, and not any one across-the-board measure alone, like capital controls, will be able to prevent all problems on all occasions. Sixth, to build up immunity to capital flow volatility through regional cooperation. Examples of regional cooperation are fund recycling, reserve pooling, payment arrangement, and a currency index. This cooperation can help not only in real terms but also in terms of psychological impact against speculation. Cooperation can thus serve to stabilize exchange rate movement, which is a primary determinant of capital mobility. Seventh, Improved Transparency and Disclosure by improving the quality and timeliness of balance-of-payments statistics, especially as they pertain to the capital account, and building comprehensive databases of private sector—bank and non-bank—foreign-currency obligations, including obligations growing out of financial derivatives and other forms of contingent claims. Eighth, Risk Management which involves with an analysis of the history of major financial crises worldwide reveals the presence of huge amounts of short-term currency debt by banks, the government, and the corporate sectors accompanied by an astonishing amount of exchange-rate and interest-rate exposures. Managing the risks posed by these exposures require state-of-the-art risk management systems employed by international corporations. Even if such techniques can successfully identify and quantify the risks a country is facing, they are still no guarantee that the risk-taking behavior of a country’s constituents will change. And finally, build up greater market discipline and good governance. To mitigate contagion, systemic risks, and moral hazard, it is important that the behavior of both lenders and borrowers of funds be subject to
ways to curb their appetite for risks or they must incur the costs associated with financial adversities when they do come. The combined effect of the IMF’s "good governance" strategy for member countries, whether voluntarily adopted or imposed as a term of conditionality, may be to stabilize capital flows. Through "good governance," markets will be better informed and thus will invest more wisely. This should help prevent the type of sudden and massive exodus of foreign capital that crippled Mexico in 1994- 95 and now threatens the Asian economies Reference Esquivel, G., and F. Larrain. 1998. Explaining Currency Crises. Cambridge, Mass.: Harvard Institute for International Development. Kaminsky, G., S. Lizondo, and C.M. Reinhart. 1998. “Leading Indicators of Currency Crises.” IMF Staff Paper 45 (March): 1-48 Kartasasmita, Ginandjar. 2004. Indonesia: A Country at a Crossroad. Waseda University, Tokyo, Japan Poret, P. 1998. Liberalizing Capital Flows: Lessons from Asia. Paris: OECD Sung-Jo, Han. 1999. Changing Values in Asia: Their Impact on Governance and Development. Tokyo: Japan Center for International Exchange
Another Financial Crisis By: Yichen Lu (China Taiwan) East Asian countries have produced rapid economic growth and dramatic reduction in poverty. The spectacular growth of many economies in East Asia over the past 30 years has amazed the economics profession. Since 1960, Asia, the largest and most populous of the continents has become richer faster than any other region of the world. The western part of Asia grew during this period at about the same rate as the rest of the world, but, as a whole, the eastern half (ten countries: China, Hong Kong, Indonesia, Japan, Korea, Malaysia, the Philippines, Singapore, Taiwan and Thailand) turned in a superior performance. The worst performer was the Philippines, which grew at about 2 percent a year (in per capita terms), about equal to the average of non-Asian countries. China, Indonesia, Japan, Malaysia, and Thailand did better, achieving growth rates of 3-5 percent. This impressive achievement is, however, still modest compared with the phenomenal growth of Hong Kong, Korea, Singapore because of their powerful and intimidating economic performance. Those four countries have had annual growth rates of output per person well in excess of 6 percent. These growth rates, sustained over a 30-year period, are simply amazing. However, given so many years of outstanding economic performance, how could the crisis happen in East Asia? The financial deregulation in many East Asian countries started at a stage where the financial institutions were underdeveloped and were not ready to integrate themselves into the international financial system. After the financial sector has been exposed to the outside, it could no longer protect the poor investment. More important, the short-term debts were almost twice as much as national reserve at the time and were vulnerable to attack of international speculators. If economic growth stops and the creditors lose confidence, creditors would start to withdraw the money. In Thailand, standard economic indicators revealed large macroeconomic imbalances. The export growth had slowed
Financed increasingly by short-term inflows and the real exchange rate had appreciated to a level that appeared unsustainable. Substantial foreign borrowing by the private sector, an inflated property market, and a weak, over-exposed financial system are also some of the weaknesses shown. These weaknesses reflected undisciplined foreign lending, unfavorable movements in the yen- dollar rate, and weak domestic policies. Other countries like Indonesia, South Korea and Malaysia were facing the same problems affecting the Thai economy in degrees. Those countries also faced overvalued real estate markets, weak and poorly supervised banking sectors and substantial private short-term borrowing in foreign currency. The crisis was like a snowball affecting most of the countries in the region in a short period. Some matters even worsened the crisis than it would be. First, the pegged exchange rate was removed, which put foreign debts as a much heavier burden on the domestic currency. Therefore, it was harder for firms to pay off the debts; then less likely for creditors to roll over debts and to draw more money out; and then, exchange rate went down further and the bad cycle went on and on. Also, once the pegged exchange rate was eliminated, people rushed to the hedge instruments, which put more pressure on the currency. Moreover, outsiders, including many international agencies, after the problems happened, gave negative commendations without thorough understanding of the crisis, which hit the investment banks because of their internal rule that they had to pull out their money. My country, Taiwan, had not been seriously affected by the Asian crisis luckily. Taiwan did not suffer seriously because Taiwan economy had a sound fundamental and also because major foreign currencies have been allowed to trade freely in the market. Moreover, Taiwan’s financial institutions have been renowned for soundness and prudence. Banks’ exposure to risk has been effectively kept in check with sound governance and cautious loan approvals. In addition, foreign capitals flowing into Taiwan are mostly of the nature of direct investment in production activities, and less into stock market or real estate. A bubble phenomenon did not exist. This is the most notable difference between Taiwan and other Asian countries.
are ‘crises of success.’ The initial capital inflow that ultimately proves unsustainable is both a sign and a cause of economic promise and success. If we don’t learn the lesson how to prevent another crisis, success may lead to failure in the future. From the Asian Crisis, it shows that globalization of the world’s financial sectors offers uncertain opportunities. It gives chances to quicken the pace of investment and also lead to rapid growth, however, at the same time, it increase the risks. Because of the uncertainty, government needs to strengthen the international and domestic financial system. What needed are reforms that embrace a number of elements that harm the financial stability and economic growth. Government should not liberalize the capital account prematurely and indiscriminately and be wary of short- term capital inflows, especially bank and corporate foreign exchange borrowing. If an exchange-rate peg for stabilization is in place, think early about how to exit. If waits until the markets attack a nominal peg, it will invariably and inevitably be too late to avoid the crisis by floating. Also, weak bank balance sheets are a warning. Government need to aware of it and also try to avoid large non-performing loans. Strengthen the international and domestic financial system is the most important and basic way to prevent Taiwan from the future financial crises or to minimize the crises. Market doubts are compounded by the lack of transparency and accountability of information in government. Government should be more open about the underlying health of the financial sectors, about the links between banks, industry, and about the possible impact on economy policy. Now in Taiwan, the availability and transparency of information still need to be improved. Without transparency, markets tend to fear the worst and doubt the capacity of government. Furthermore, fund surveillance should be strengthened. Government need to monitor closely and perceptively to prevent the future crisis. Government also needs to establish more effective procedures to involve the private sector in resolving debt crises. Better ways must be found to involve private creditors at an early stage, in order to achieve equitable burden. The economies in crisis do have weak banking systems and start with overvalued exchange rates in most cases. Those are common features of financial crises. But the causes and current
crisis of 1994-95 was called the first financial crisis of the 21st century. After that, we have Asian financial crisis in 1997. Perhaps with more cases in hand, we can identify ‘early warning signals’ and take preventive measures. But it is more realistic to think that financial crises will recur. Investors should take risks, and risks mean that some proportion of investments will fail. It is highly possible that one or more countries will fail in the future financial crises. We should not expect to prevent them all but we do need to well prepare. Government needs to strengthen the international and domestic financial system in order to minimize the ruin from the crisis. Also, government needs to make policies and financial information more transparent to reduce investors’ risks. Closely monitoring the fund and establishing more effective procedures to involve the private sector in resolving debt crises are also some major steps that government needs to do to better prevent the future crises. Last but not the least; government should keep a watchful eye on the early warning crisis signals so that it could take precautionary measures to reduce the threat to minimize the crises.
Another Financial Crisis By: Wan Mohd Radzi Wan Ahmad (Malaysia) The East Asia financial crisis is one of the worse crisis that happened to the third world country. Thailand was the first country that show the sign of the crisis and later spread to other country such as Malaysia, Indonesia, Philipines and South Korea. The international establishment (IMF) blame that this crisis happened due to the wrong judgment of the banks and financial institution, over speculation in real-estate and the share market, the collusion between the government and the business corporation and the bad policy of having fixed exchange rates (the dollar) and high current account deficits. However, studies found that the emerge and spread of the crisis is due to the development of the global financial system that is the combination of financial deregulation and liberalization across the world, the increasing in the interconnections of markets and speed of transaction through computer, and the development of large institutional financial player (such as the speculative hedge fund, the investment bank and the huge mutual and pension funds) With this combination, has led the net capital flow across the borders in search of quick and high returns such as (long term debt, foreign direct investment, and equity purchase) to East Asian region increased from $25 billion in 1990 to over $110 billion 1996 (Greenspan,1997). Indonesia also is not exempted. Between 1992 and July 1997, 85% of the increase in external debt due to private borrowing (world Bank 1998). Much of the capital inflow did not invested in the productive agricultural or industrial sector but to stock market, consumer financing and real estate with the for quick and high returns. While the financial institutions were carried out a process of financial liberalization , where foreign exchange was made convertible with local currency (Radelet and Sachs 1998). With this short term debt, there was a sharp and sudden depreciation of the currency (rupiah). When the currency depreciated the burden of debt servicing increase correspondingly in term of local currency amount for repayment. Foreign reserve also fell in attempt to ward off speculative attack. Then, the short
to fall further until level or to level that cannot meeting the foreign debt obligation. As for Indonesia, in March 1998 the private foreign debt had reach $84 billion and the inflation rate rose from 40% to 70% in May 1998 and August 1998 respectively. The flaw in Indonesia’s banking system ensured that problems with external debt would become a domestic banking problem. After the banking system was liberalized in mid 1980’s the supervisory and monitoring mechanism was not sufficiently effective and cannot keep pace with the rapid growth of the banking sector. Banking regulation a also is not adequately enforced, particularly rule covering intra-group lending, loan concentration and creditworthiness criteria. As the bank were under capitalized, the rupiah began to depreciate causing export became very alluring. To prevent the financial crisis from recurring again the development agenda must be in place such as: i) Role of the central Bank The Central bank has to play a key role in approving short-term loan of foreign currencies. The loan given must only for investment that would generate sufficient foreign exchange receipt to service the debt. Companies are not allowed to raise external borrowing to finance the purchase of properties in the country. With this control might enables the country to meets its obligation for export earning. With this control the interest rate might be lower and ease the position of the debtors and banks. In addition, with the lower interest rate it will not affect the exchange rate. If the interest rates is high or increase during the crisis the companies might go bankrupt, increase the non- performing loan of banks, weaken the banking system, and dampen consumer demand. This also will led to the reduced in the government spending, will plunge the economy into deeper and deeper recession. In turn, it will cause the erosion of confidence in the currency and thus increase the risk of capital flight and depreciation. ii) The large inflow of foreign funds either as loan to the banking system and companies directly, or as equity investment in the stock market contributed to an asset price boom in property and the stock market.
sharp currency depreciation and share market declines, the debt is heavier for the bank in servicing the loan, companies and the government. Moreover, in order to reduce the current account deficit, the affected government (country facing crisis) reduced their budget expenditure. The fall in the share as collateral for the loan, the value of the building and other real estate will cause difficulties to the borrower. In addition, the higher interest rate caused by the liquidity squeeze and tight monetary policies have caused added financial burden on all firm as well as on consumers that borrowed. iii) Restoring macroeconomic stability. During the Habibie’s government, steps has been taken to improve governance and lying foundation for the establishment of the sound economic system supported by strong social and economic institutions. During the crisis the poverty rate, unemployment and inflation increased. Therefore, the government take steps to protect the poor from the worst of the crisis. The strategies taken is a right move, first and foremost is regulate policies that have impact on the poor and regulate policies that benefit the poor. The steps to improve the value of the rupiah and arresting inflation would substantially improve the economic condition of the poor directly or indirectly as the economic began to recover. By imposing the regulation of prevention on exporting several basic goods might reduce the costs of the goods. Thus, it will decrease the trade surplus causing the fall in export. In order to protect the poor the subsidized of goods especially rice by the government give the great impact of the crisis to the poor. The government also has improve the the purchasing power in the rural and urban areas by improve income of the poor, the unemployed and underemployed through the food-for work program in the drought stricken area. With the restoring of the macroeconomic the especially for the poor have created the recovery of the country from the crisis. iv) To restore growth. Growth should be something continuously achieve because through growth, new jobs will be created and the
be strengthened, and most importantly poverty declined. It is to maintain that the growth will not result in inequality. As for the past (during New Order) there were strong feeling of injustice at the pattern of development, there was perceived to be a widening gap between the rich and poor, among income groups, ethnics group and regions. By reducing the income inequality and poverty will provide the strong basis of sustainable growth in the future. In addition education also play an important role in sustaining long term economic growth. v) Continuing Structural Reform. During the Habibie’s government the administration is decentralization and regional autonomy to the province, districts, and cities to manage their own affairs and formulate their own regional laws as well as reaffirming the role of regional assemblies in regional autonomy. With the new decentralization the need for new private capital flow is important to finance for existing venture and new projects. Thus, the restructuring of corporate and corporate debt is crucial. In turn, transparent is needed in the banking system, improve legal and judicial infrastructure include the performance of the commercial courts in handling bankruptcy cases, and strengthen corporate governance are key ensuring foreign capital flow. The labor law also need ensure the right and welfare to the workforce and need to be condusive to the investment. There also need to clarify the rules and regulation regarding the decentralization that would affect the investor. There have to be a clear guidelines on the authority and responsibilities of the Central government, the provincial government and the district or city government with regard to investment. The infrastructure such as road, bridges, power supply, harbor water supply and telecommunication must not be neglected and be maintain. In addition the development of skills are needed in the new economy with hightened competition due to globalization and opening of new markets. vi) Role of Small Medium Industries (SME). Since the administration of Indonesia is enhance decentralization, macroeconomic stability is needed to
of the province, district and city. During the crisis it show that out of $119.1 billion, $93.3 billion or 78 % was owed by large corporation. Out of total debt $69.5 billion or 96% of debt are non-performing loan . However of all the non-performing debt, $65.8 billion or 96 % of debt was by large companies and 14 % of the debt of small and medium enterprise was bad debt. It is significant that the SME and informal sector had been supporting the economy. In the recovery period, while the manufacturing industry was still sluggish the SME was doing better. Through the reform of the macroeconomic stability, the government should emphasize more on SME include jobs opportunity and stable income to the public. This indicate that the public need has been fulfill and it is good for long term benefit. In conclusion, with stringent control of foreign capital in flow and outflow, the financial liberalization will enable a country to meets its external obligation from export earning. Furthermore, it will save the country from excessive short term private sector borrowing. With the capital control, the lower interest rate does not suffer the drop in currency level just like China who lowered its interest rate 4 times, and its bank fixed deposit rate still increased. But the currency which is not freely traded due to strict control by the government, has not depreciated. Thus, the domestic economy need to be generated by the government in order to improve the economic condition and recessionary pressures. References: 1. Lecture notes 2. Reinventing Indonesia by Ginandjar Kartasasmita and Joseph J. Stern 3. Article on Rethinking Capital Control by Masahiro Kawai and Shinii Takagi
official of the Ministry of Finance that has been tasked to design a strategy to deal with the political decision to end the dependence on IMF and to avoid incurring further external debt. You will take into consideration that Indonesia’s economy in general, and the current fiscal condition in particular is heavily constrained. For instance, the cost of bank restructuring constitute a large item in the government budget. Another aspect burden to the central government is fiscal decentralization which call for substantial amount of the government budget to the dispersed to the regions. With the termination of IMF program in year 2004, there is a strong possibility that Indonesia would no longer rely on the Paris Club for debt rescheduling. It means there will be an additional $3 billion in debt servicing. In the absence of debt rescheduling, it will be challenging to found the budget deficit from domestic resources. As a member of the government economic team, you are asked to draw a plan for a post--IMF strategy, and to ensure fiscal sustainability while avoiding continued dependence on foreign debt which has already reached a critical amount as a percentage to the GDP
(Vietnam) 1. Crisis affects the Indonesian economy Indonesia is by far the worst affected South East Asian economy. Its economy contracted by 13.6% in 1998. It was also the only economy to experience serious inflation in 1998. The Indonesia’s regional dynamics has altered significantly during the crisis. This has been a crisis first and foremost of the modern, urban economy of Java. Greater Jakarta, with its reliance on formal sector manufacturing, modern services, a large construction industry, and the public sector, is experiencing a painful contraction. The current account turned from deficit to surplus dramatically, primarily owing to the collapse of the imports, which fell by about $15 billion compared with the pre-crisis levels. From July 1997, the rupiah fell much further against the US dollar than any other internationally traded East Asian crisis. By 31 March 1999, its nominal value was just 28% of that in mid 1997, less than half that of region-wide average and any other crisis economy. The data also illustrate that Indonesia’s currency has been slower to rebound from the lows of early 1998 than its neighbors have. The decline in stock market in local currency terms was initially broadly similar to the crisis economies, but it displayed very little recovery through to early 1999. Owing principally to currency movements, Indonesia’s stock market decline in US dollar terms has been by far the greatest over this period. By 31 March 1999, its stock market index was still just 15% of that in mid 1997. 2. Causes of the crisis from financial factors. First of all, there was the rapid build-up, and volatility of private capital flows immediately prior to, and during the onset of Indonesia’s crisis. The switch in portfolio and short-term debt flows was particularly pronounced. Indonesia’s external debt as a percentage of GDP was at approximately 54%. By the end of 1998, it totaled $ 142 billion, with
more than the public. The share of public debt in total debt declined from 755 in 1991 to 42% in 1997. Private corporate external debt reached its peak in March 1999 corresponding to the peak of the financial crisis, reaching $62.8 billion or 68 percent of GDP. With debt resolution efforts initiated by the Habibie government, through the schemes under the Frankfurt agreement and the Jakarta initiative, the amount of debt has gone down; by the end of 2001, it had been reduced to $51 billion or 35 percent of GDP. (Ginandjar Kartasasmita, Indonesia: A Country at a Crossroad, pp:114) Much more problematic are the various estimates of short- term debts. Short-term debt doubled between 1995 and 1997. The ratio of external short-term debt to international reserves indicates that Indonesia was the most vulnerable in Southeast Asia, with a short-term debt almost double the level of reserves. Indonesia’s external debt, 1998 ($ billion, 30 September) Public 68.6 Private 73.3 Memo items -Corporate debt composition -Banking sector composition 72.1 11.1 Source: Bank Indonesia Portfolio investment can also leave the country at short notice, and Indonesia receives a large quantity of this capital when the stock market was deregulated in late 1988. Adding the stock of portfolio investment to the short-term debt produces still higher figures. Ultimately, almost all financial assets-foreign and domestic- might be regarded as internationally mobile. Thus, in sum, there was a build-up in the stock of “mobile capital”, including short-term external debt and portfolio investment. Secondly, for the macroeconomic management, at that time, Indonesian government try to pursue the monetary policy of quasi- fixed exchange rate with an open capital account, which facilitated rising capital inflows. Moreover, the government resorted tighter monetary policy to counteract perceptions of an over-heated economy.
to IMF’s policy In some recent years, there has been more and more criticism in IMF’s policy toward the developing countries. It emphasized that IMF only focused on the developed nations’ interest rather than developing ones that need much help from it, especially after the end of the Cold War as the result of Soviet Union’s collapse. It applied the same policies to various countries without considering the real economic situation of those countries. They mostly required fund-received countries accept currency floating, free trade, open capital policy, sectors privatization, and so on. In many cases, this mandatory policy made resident miserable. For example the Argentine case, Augmenting central bank reserves with new IMF and/or G-7 dollar loans could have ruled in dollarization. But Washington, and thus the IMF, remained firmly opposed to more lending unless Argentina first imposed more austerity measures to reduce the fiscal deficit. Dollarization proponents suggested devaluation first, followed by dollarization. But that fallback had no appeal to the Peronists in control, since dollarization would curb the financing of their expansionary fiscal programs. It might yet become an active option were repercussions from failed economic revival efforts to produce an explosive inflation and financial chaos sufficient to bring a rightist regime to power, by ballot or bullet. “But why should a sovereign countries ask permission of IMF for every action which it undertakes?”, “IMF felt countries reviving money from it had an obligation to report everything that might be germane; not to do so was grounds for suspension of the program, regardless of the reasonabless of the action” (Joseph Stiglitz, “broken promises”, pp: 30,31). Moreover, it is very difficult for a moderate-sized institution like the IMF to know a great deal about every economy in the world, so “IMF economists could ignore the short-term effects their policies might have on the country, content in the belief that in the long run the country could be better-off” (Joseph Stiglitz, “broken promises”, pp: 36). In fact, it brings about the adverse effects on the Latin American economies.
Indonesian crisis The gravity of the situation became apparent when the currency continued to depreciate and the measures taken by the Central Bank (Bank Indonesia)—first widening the intervention margins of the crawling peg regime in mid July 1997, and then free floating the rupiah in August—did not help. Besides floating the currency, Bank Indonesia raised interest rates and tightened liquidity by transferring a large amount of public sector deposits out of commercial banks. The decision to postpone the implementation of those projects was meant both to facilitate the necessary current account adjustment and to help rebuild international confidence by signaling the government’s determination to reduce dependence on capital inflows while improving governance. It was received by the market as a positive sign of the government’s determination to prevent further deterioration of the economy, especially as some of the projects were linked to the President’s family. The initial response of the Indonesian authorities to the threat of contagion was widely praised for its promptness and decisiveness. (By: Ginandjar Kartasasmita, Indonesia: A Country at a Crossroad, pp:16) Despite these corrective measures the currency continued to depreciate. In October l997 the Indonesian government turned to the IMF for assistance. The initial IMF program was based on the assumption that the crisis was essentially a moderate case of contagion --- an overshoot of the exchange rate (IMF, 2003: 78)--- and designed a program that was standard and conventional for such a “mild” crisis, allowing heavy emphasis on tightening money supply in order to raise interest rates and prevent capital from fleeing, and attract the already fleeing capital back into the country, did not help restore the value of the currency; on the contrary the loss of value became more severe than generally anticipated. In retrospect, many observers agree that there was a misjudgment by both the government and the IMF of the depth and nature of the crisis. (Ginandjar Kartasasmita, Indonesia: A Country at a Crossroad, pp:16) The first major policy mistake was the sudden closure of 16 banks on November 1st 1997 made by IMF and the government, since it immediately undermined confidence in the entire financial system.
first IMF agreement (of 31 October), particularly in protecting family business interest, it compounded the problem by stipulating a small fiscal surplus. There was also problem of how to finance the deficit. Then the government signed an impossibly ambitious agreement with IMF. This, together with political unrest, deepens the dispute with IMF. IMF’s policy had no much effect on Indonesian economy recovery after the crisis. In fact, some of its policy were not suitable for the economy. Moreover, IMF still decided to terminate debt servicing when it know that Indonesian government must face with serious budget deficit. Measures for this situation is necessary. 4. Financial measures 4.1. Problems For the banking system, the external debt is very large, its bureaucracy and institutions are not well prepared for dealing with the problem. The government decided to support 80% funds for recapitalization of the sound banks. However, funding remains an issue: the sale of the bonds, and the financing of the estimated “carrying cost”. Cost of banking restructuring constitutes a large item on the government budget, to ensure fiscal sustainability, every effort should be made to maximize asset recovery and minimize the fiscal cost of banking restructuring; and to do so asset recovery should be made transparent and competitive. For the investment, the World Bank notes, “it is not just new investors are avoiding Indonesia, but existing investors are losing hope for improvements soon”. Investment has not recovered “in part because enterprises are still deeply in debt and investment climate is deteriorating The exchange rate seems to have settled in the range 7000- 10.000. However, there is a sudden loss of international confidence in Indonesia ‘s social stability, political system, or the government ‘s capacity to manage the recovery, could see the renewed flight. The bankruptcy Law promulgated in 1998 has disappointed the financial community, in particular as its findings appear to consistently favor debtors over creditors. With the termination of IMF program in year 2004, there is a strong possibility that Indonesia would no longer rely on the Paris
It means there will be an additional $3 billion in debt servicing. In the absence of debt rescheduling, it will be challenging to fund the budget deficit from domestic resources. Maintaining fiscal sustainability will be one of the biggest challenges to the Indonesian economy in the years ahead. 4.2. Strategy With the termination of IMF program in year 2004, the current fiscal condition is heavily constrained, it is strongly possible that Indonesia will be challenging to found the budget deficit from domestic resources. Reducing government’s spending: To avoid dependence on the external factors, such as IMF, World Bank or any other powerful countries, Indonesia itself must mobilize the domestic energy. It could be from government or private. In fact, private demand, especially investment, has collapsed and thus a fiscal stimulus is necessary to avoid an even deeper contraction. Therefore, first of all, government should increase government saving, making investment increased (because I = Y – C – G), interest rate decreased (illustrated in the chart below).
creating a stable economic environment in order to encourage investment According to Solow model, economic growth (y) depends on saving rate (s). Saving = investment = s.y S S ’ I(r ) r S,I
economy will move to a steady state of higher y and higher capital (k) Debt management system Public sector external debt, including that of off-budget agencies and guaranteed loans, needs to be cleared by the External Resources Committee before it is committed. This is to ensure that borrowings are properly coordinated, and the approach to the market is orderly. All private sector external loans need the approval of an Exchange Control Department, which compiles a quarterly report of the amount outstanding and the interest and principal repaid during the quarter. Banks that borrow abroad also need to obtain the permission of the Department. In addition, they are required to submit returns on their foreign currency balances to the Exchange Control and the Bank Regulation Department of the Central Bank. Establishing cautious fiscal policy One of the mistakes in Indonesian economic policymaking is that having introduced financial liberalization. At present, The overriding requirement is that financial institutions are trusted and credible. Capital adequacy ratios need to meet minimum specified prudential standard Financial regulations needs to be all-embracing., including hedge funds Financial data must widely be repotted to and disseminated among the investing public. Financial institution need to be encouraged to maintain a diversified asset portfolio, by sector and by country. Related-party loans and insider trading obviously need to be prohibited. A set of legal institutions need to be in place Improvement in tax administration The challenge is to increase tax revenue by 20 to 25 percent, from 12 percent of GDP in year 2002, to 15 to 16 of GDP within
the large taxpayers who from past experience have been the source of the greatest leakages in tax revenues. (Ginandjar Kartasasmita, Indonesia: A Country at a Crossroad, pp:113) Monetary an exchange rate policy During the time for establishing a cautious fiscal policy, government should follow fixed change rate in the form of some sort of currency arrangement. When market has become stable, applying floating exchange rate is necessary. Keeping low inflation Engaging in international trading Government should support enterprises internationally trading in order to be against the contraction of business. At present, agriculture is still well performed in Indonesia, so pushing this industry is essential movement to encourage the other industries to be in the global market. To do it Finance ministry need to have plan to support it at the beginning. Reference Ginandjar Kartasasmita, February 2004, Indonesia: A Country at a Crossroad, Waseda University. Ginandjar Kartasasmita, Joseph J. Stern, John F. Kennedy; Reinventing Indonesia; Harvard University. Hassanalied Mehran edt., 1989, External debt management, International Monetary Fund, Washington D.C. Hall Hill, 2000, The Indonesian Economy, Cambridge University. Hall Hill, 2000, The Indonesian Economy in the crisis, Cambridge University.
Introduction: International Monetary Fund, or the IMF, is an international organization of 184 countries. It is established to promote international monetary cooperation, foster economic growth and high levels of employment, and provide temporary financial assistance to countries in need of balance of payments adjustment. It was argued that, during the Asian crisis, the financial advices and implementations provided by the IMF was insufficient and ineffective in many countries. Indonesia was one of them, as they failed to survive the crisis and became far worse than what they used to be before. The IMF provided loan that serves only to support foreign exchange reserves and, therefore, maybe not be used for productive projects. The head of the National Development Planning Board Kwik Kian Gie expressed that the government had a remaining debt of $8.7 billion to the IMF after the repayment of $4.1 billion in principal in November 2002. He said, “the loan from the IMF maybe not be used but we have to pay the interest. The IMF is like a loan shark. The question is do we need the IMF or the IMF needs us?” From the statement, it clearly showed the dislike of the IMF by the Indonesian officials, and it was no secret that the government would want to end the dependence on the IMF to avoid incurring further external debt. With the termination of IMF program in 2004 proposed by the current President Megawati Soekarnoputri, Indonesia is looking forward to lessening its relationship with the IMF and trying to find the budget deficit from domestic resources instead. In the following essay, a brief discussion of IMF and its proposed plan on the Asian crisis will be introduced first. Then, we will look at the current economic situation in Indonesia, and some of its economic and fiscal policies preparing for the end of IMF program. Some suggestions and outlooks will be discussed in the conclusion part of the paper.
Crisis and Result in Indonesia: The financial crisis that erupted in Asia in mid-1997 led to sharp declines in the currencies, stock markets, and other asset prices of a number of Asian countries. It threatened these countries’ financial systems, and disrupted their economies. The IMF was charge with safeguarding the stability of the international monetary system, and was determined to resolve the Asian financial crisis. Its priority was to help restore confidence to the economies affected by the crisis. When the Asian crisis occurred, the IMF immediately approved $35 billion of support in attempt to reform three countries in deep trouble, with Indonesia being one of them. IMF also offered intensive consultation to countries both within and outside of Asia. Some of the suggestions IMF made were: a temporary tightening of monetary policy to stem exchange rate depreciation; structural reforms to remove factors that were obstacles to growth such as monopolies, trade barriers… etc; assistance in reopening or maintaining lines of external financing; and a sound fiscal policy to support economic activity and expanding the social sector safety net. Along with the financial assistance and consultation, the IMF closely monitored the progress hoping the reform would be successful. However, it did not work well in Indonesia, as its GDP either declining or growing very slowing, inflation peaked close to 60% in 1998, and exchange rate against US dollars breaking the 10,000 mark in 2001. While no progress was being shown, Indonesia still had to pay the interest, which worsened the situation even more. All these factors showed the ineffectiveness of the IMF program. Moreover, George Shultz, William Simon, and Walter Wriston of the Wall Street Journal wrote, “the IMF’s efforts are. However, effective in distorting the international investment market. The IMF interferes with this fundamental market mechanism by encouraging investors to seek out risky markets on the assumption that if there investments turn sour, they still stand a good chance of getting their money back through IMF bailouts. This kind of interference will only encourage more crises”. This further proved that the IMF not only would not be helpful in some cases, but also hurtful in many ways.
were three changes of presidency in Indonesia, with three presidents resigning before the end of their terms. Despite that, the changes actually brought new life to Indonesia. With the current Presidet Megawati, the economy is becoming more stable now. The inflation rate has dropped from 60% to about 6% by the end of 2003; exchange rate has been stable at around Rp. 8,500 to 1 US$ in comparison to Rp. 17,000 in 1998. The three-month 581 interest rate has been averaging below 9%. The national reserves, which during the crisis was enough only to pay for three months of imports, has now reached $35 billion, which can pay for six months of imports. The stock exchange rate continues to improve, reaching above 580 points after suffering a fall of 300 points in 2000. Indonesia’s budget deficit has decreased from 4.8% of the GDP in 2000 to 1.8%. Similarly, official debt has decreased from 100% of the GDP in 2000 to below 70% of the GDP in 2003. Policies for Post-IMF Program: Although such improved macro-economic condition was partly contributed by the implementations and aids from the IMF, Megawati decided that it was better to lessen the relationship with the IMF, by terminating the program. Instead of relying on foreign debt, Megawati is trying to depend more on the domestic resources. With the stable economy, the Indonesian government proposed policies and implementations after the conclusion of its program with IMF. The policy package in general highlights three major points: maintaining macroeconomic stability; restructuring and reforming the financial sector; and increasing investments, exports and employment. To maintain macroeconomic stability, a few goals are to be achieved: a balance budget over the period of 2005 to 2006; reduction of government debt in reducing the debt to GDP ratio; reformation of tax collection system to stabilize and secure tax revenues; improvement of the efficiency of government expenditure; and development of an effective public debt management system. In restructuring and reforming the financial sector, Indonesian government is set to: construct a financial safety net,
of financial institutions, strengthen the monitoring of money laundering, improve capital market’s provision, improve the efficiency of state-owned enterprises and strengthen their governance, consolidate the insurance and pension industries, and develop a public accounting system. Lastly, by increasing investment, exports and employment, it means that Indonesia wants to: develop the investment environment and establish an investment and export promotion team, revise the Bankruptcy Law, improve the transparency of regional regulations and public services, develop infrastructure of electricity, transportation, telecommunications and water resources, and improve equity by eradicating poverty and creating jobs. Problems and Suggestions to the Post-IMF Program: The total national debt stands at almost $130 billion, with more than $70 billion owed by the government, and the rest by local companies. Successfully restructuring these billions of dollars of foreign debt without an IMF program will incur a significantly higher cost. Furthermore, the central bank has said total debt maturing in 2003 alone with reach $18.5 billion. Debt repayments of $5.16 billion in 2004 will exert pressure on the balance of payment. Interest charges for this debt badly impact on the country’s finances and waste large portion of taxpayer’s money without producing a single thing: no goods, no jobs, and no infrastructure. It is simply money thrown away. From the economic point of view, Indonesia is enjoying a more stable economy, but without too much money to spent. The government no longer has the money to support infrastructure development, therefore, private sector funds are very vital. The need for a positive Foreign Direct Investment (FDI) is very important for funding, while financial sector and capital market are recovering. Good attractions for foreign investors are the enormous labor force, still at the cheapest rates in the region, and an abundance of natural resources rich for exploitation. A good set of labor laws to settle labor disputes would be crucial because investors won’t have to worry about closure of plants and other negative results due to the labor dispute problems.
unclear and vague. The package covers many areas and contains many policies measures and actions plans; so many that the focus of the package is unclear. Many policies lack concrete details in comparisons to what the IMF was proposing before. The IMF did a better job offering plans and policies with clear targets and deadlines with regard to macroeconomic management. This shows the weakness in the government because of the conflicts of interest generating such unclear action plan. Another concern is the commitment of the government to the new economic policies. President Megawati was due to deliver executive orders on issues by the end of September 2003, but was not done by the expected deadline. Many other political reasons such as the general and presidential election in 2004 will stand in the way of some of these policies being implemented. Some of the actions to be done includes consolidating a new political system, reducing social stress and ethnic division, generating new jobs for Indonesia’s young and ensuring a fairer share of the national income and wealth for the average citizen backed by a system of transparent, open and affordable justice. Conclusion: The challenge for the Megawati administration will be to reinforce the new economic policies through cooperation with these support teams and to continue the work that was done under IMF management on strengthening the financial system, reforming the judicial systems, and tackling bribery and corruption. With that, Indonesia can finally survive without too much dependence on foreign debts from the IMF, and be able to reach prosperity that it always wanted, hopefully in the very near future. Bibliography: About the International Monetary Fund, IMF, Introductory Information. http://www.imf.org/ external/about.htm Asian Monthly November 2003, http://www.jri.co.jp/english/asia/2003/11/country.pdf Asian Outlook: A quarterly survey of political and economic trends, http://www.asiapacific business.ca/apbn/outlook/1oct2003/indonesia.pdf
economy: Everything but money, www.atimes.com/atimes/ Southeast_Asia/EJ16Ae04.html Asia Times - News and analysis from throughout Southeast Asia, http://www.atimes.com/ atimes/Southeast_Asia/EL11Ae01.html Fact Sheet – The IMF’s Response to the Asian Crisis, www.imf.org/External/np/exr/ facts/asia.HTM Indonesia: Anti-IMF Rhetoric Tailored for Muslins - 9/11 - Global Policy Forum, www. globalpolicy.org/wtc/analysis/2002/0605indonesia.htm Indonesia at a Glance, www.worldbank.org/cgi- bin/sendoff.cgi?page=%2Fdata%2Fcountrydata %2Faag%2Fidn_aag.pdf INFID’s Short News Overview No, http://www.infid.be/sno132- 030515.html Remarks by President Megawati Soekarnoputri of Indonesia at the Business Breakfast Meeting, http://www.indony.org/pressreleases/President%20Speech%2 0at%20CoC%2092303.pdf The Jakarta Post, http://www.infid.be/imf_after.html USINDO Brief – Indonesia’s Evolving Foreign Policy & Asean Leadership, www.usindo.org/ Briefs/2003/Hadi%20Soesatro%2004-22-03.htm Who needs IMF? WSJ 2/98, http://www.stern.nyu.edu/globalmacro/IMFSchultzWSJ298.ht m
(Indonesia) Background As Indonesia’s economy at the end of year 2003 has fully recovered from the earlier years’ crisis, GDP growth this year is expected to reach around 4 percent, which will bring the per capita income of the country to the pre-crisis level. Inflation has fallen to a record low of below 5 percent, while foreign exchange reserves reach a record high around US$ 33.6 billion. Monthly exports have reached the pre-crisis level of US$5 billion. While direct investment starts recovering, portfolio investment breaks record high one after another. As a result, all credit rating agencies have upgraded Indonesia’s rating. These have shown that the economic recovery is on the right track. The challenge ahead is how to maintain this momentum into year 2004 and beyond. Analysts said improved foreign exchange reserves and a more stable currency may have given Indonesia the confidence to give up the support coming from the IMF. In line with the People’s Consultative Assembly’s (MPR) Decree No. 6/2003, Indonesian government decided to graduate from the Extended Fund Facility arrangement and has chosen to go with the Post Program Monitoring (PPM) option with the IMF at the end of 2003. The cessation of the arrangement with IMF must be done with careful and comprehensive planning to avoid creating economic instability. Maintaining a high level of foreign reserves is imperative now, in view of uncertainty regarding the global economic condition and political turbulence the country may encounter in the 2004 general and presidential elections. The government is faced with challenge of raising additional resources, mainly domestic, to meet increased debt service payments. It will have to cope with the financing gap on its hefty debt, which stands at more than 70 percent of GDP, including about US$9.2 billion debt to the IMF. This financing gap is manageable if the government can keep down its budget deficit, which has improved considerably in recent years and is forecast at 1.2 per cent of GDP this year. This problem arose partly because,
will not have access to further IMF loans, will not be eligible for loan rescheduling under the Paris Club mechanism, and will have to begin to pay off its foreign debt. After-Graduation Policies There are three main policies that will support the government’s “graduation” from the IMF program, which are: 1. Maintain macroeconomic stability through measures on continued fiscal sustainability, low inflation, stability of the Rupiah and strong foreign exchange reserves with an efficient national payment system. The first policy would be to minimize the budget deficit step by step to finally become balanced budget, which lead to tight budget policy starting from 2004. There is still a deficit of 1.2 percent of gross domestic product, but this is lower than last year. Most of the deficit derived from cost of bank restructuring and fiscal decentralization. Classification system should be revised to improve budget performance with that can better reflect efficiency in the use of budget resources. The efficient use of decentralized resources for local developments can be achieved by improving the fiscal decentralization framework, which must be fully supported by the regions, including revisions to Law 22/1999 on Regional Autonomy, Law 25/1999 on Fiscal Balance and Law 34/2000 on Regional Revenue. In order to reinforce and sustain macroeconomic stability, the government and the parliament must have commitment to opt for prudent fiscal management. However, due to the need for fiscal consolidation and raising revenues from income taxes (in the face of falling oil revenues), and minimal increases in the development budget, there is definitely no hope of fiscal stimulus from the budget. If Indonesia wants to avoid its dependence on foreign debt, it must focus on its internal resources of financing. Its internal resources can be divided into three main areas: additional revenue, tax and customs reforms and improved debt management. In order to intensify its internal resource, there must be reorganization/restructuring in the line ministries, especially Ministry of Finance, to strengthen its budget operation, treasury function and debt management. In recent
natural resources or foreign debt, tax’s role as Indonesian source of revenue has been increasing. To enhance Indonesia's tax base, the government should pressing ahead with efforts to strengthen tax and customs administration. Some efforts can be done on the issue. The first one is improving the enforcement of tax collection, especially on large delinquent tax payers. The second one would be to expanding operation on tax collection. However, the two efforts must be facilitated with good economic and investment condition. As trade between countries has increased dramatically due to globalization, customs and excise has become more and more important in financing state budget. Some efforts must be made by the Directorate General for Customs and Excise to streamline its operations by facilitating commerce and reducing abuse. There should be a regulation to control the debt management office with its key functions on consolidating all the external and domestic debts, which is working closely with Bank Indonesia, to ensure prudent management including monitoring of all existing and new national debts. 2. Continuing the restructuring and reforming the bank and non- bank financial sectors including anti-money laundering and improve the operations and governance of state-owned enterprises. Additional financing comes from issuance of bonds, privatisation proceeds and the sale of assets under the Indonesian Bank Restructuring Agency (IBRA). Issuance of bond (domestically or internationally) would be a good financing source as long as the government can obtain investor’s confidence. The banking restructuring and reform program is a continuation of the ongoing program to strengthen the financial sector since the crisis. The IBRA's job is critical, since privatization proceeds from asset sales allowed the government to run a budget deficit of five percent during the rest of 2000. The IBRA currently owns more than 200 companies in many different industries. Its aim is not only to create revenues, but also to ensure that industrial assets are put to productive use and filtered into the private market. The government's current to do list includes: completing the
state banks, preparing these banks for privatization, accelerating the IBRA's asset recovery program, and strengthening the management of Bank Indonesia. These reforms are primarily aimed at restoring investor confidence. Given that much of the government's revenue budget is to be provided by asset sales by the IBRA, it seems likely that there will be a government funding crisis after IBRA’s mandate termination. With the divestment of many of the large private banks that were taken over during the crisis, the government and Bank Indonesia should focus on improving prudential management and promote soundness of the banking sector by strengthen regulation and supervision measure. The independent central bank, Bank Indonesia, should separately implement its monetary program but works closely with the government. The regulation and supervision improvement should also be applied in every industry. The government, comprises of authorized organizations (BAPEPAM, DG for Tax, DG for Custom and Tariff, DG for Financial Institution, National Police and Bank Indonesia), should consolidate its efforts and form cooperative arrangements to prevent money laundering activities. 3. Increase the level of investment, exports and employment by improving the investment climate, labor relations, industry and trade facilitation, legal reforms, security and governance. Unstable export, worsen by no longer available debt rescheduling, turn expected balance of payment in 2004 into deficit at around 1.12 billion dollar. The deficit caused by deficit on capital account (increase in foreign debt payment) of 5.3 billion dollar, which cannot be covered by surplus on current account of 4.179 billion dollar. The government should maintain stability of balance of payment by improving investment condition, increasing export (especially non oil and gas export) and enhancing tourism industry. If Indonesia wants to set itself free from foreign debt, investment (either foreign direct investment or domestic investment) would become a prospective choice, while at the same time it stimulates the economy. However, Indonesia must regain its attractiveness in investor point of view. Legal reform and greater anti-corruption measures, supported by
the confidence of investor. The improved investment regulatory framework and more stable labor and industrial policy would also contribute a long way to improve the investment climate. These regulatory and policy must be prepared in consultation with the relevant parties (investor and labor). With improvement of labor policy and increase of investment, the number of unemployment would decrease, which, in the end, will lead to increase in consumption and might become a stimulus to the economy. Because there is definitely no hope of fiscal stimulus from the budget, supporting policy from monetary sector is required. In this case, credit expansion policy to champion the real sector is needed. Support for small and medium enterprises should continue to occupy priority attention, especially to make their access to credit resources easier. Government should initiate program of infrastructure development in energy, telecommunication, transportation, and water resources to facilitate investment and trade. Conclusion Of course, all these measures depend on a number of preconditions, especially improvement of governance and transparency in public and private sector, strong national leadership, security, political stability, secure property rights, and effective rule of law. All of these policies must be done transparently by informing the public on the government’s efforts. Representatives from the Indonesian and international business organizations and donor agencies/countries are regularly brought up to date on its progress. The transparent manner in which the progress of the program is being implemented shows the government’s confidence in ensuring that the program will be kept on track. The recent upgrade of country rating by international rating agencies confirmed the government’s ability and dedication to implement its own economic program. There is now a consensus within the government that in the absence of the IMF close monitoring, they have to fully bear the responsibility for the implementation of an economic program that will ensure the macroeconomic stability, increase investment, create new jobs and improve governance.
be challenging but the government must remain committed and believe that they can overcome the hurdles before them to ensure a smooth transition from the IMF program and bring sustained macroeconomic recovery with new employment opportunities. Although Indonesia has graduated from IMF program, it still depends on foreign debt from CGI and the World Bank, which have been a crucial financial source for the country to help covering the annual state budget deficit. Last year, the donors have agreed to provide US$2.7 billion in fresh loans to fill the budget deficit gap estimated at 1.8 percent of gross domestic products (GDP). In short term, it would be difficult to be totally free from foreign debt, but if Indonesia implement all the policy measures with strong commitment, combined with political stability, it will lead to sustainable growth, which in the long run, will eventually make Indonesia autonomous from foreign debt. References Abed, George T., Sanjeev Gupta. 2002. Governance, Corruption and Economic Performance. International Monetary Fund. Stiglitz, Joseph E.. 2003. Globalization and Its Discontents. W.W. Norton & Company Inc. Lampiran Instruksi Presiden No. 5 tahun 2003. Paket Kebijakan Ekonomi menjelang dan sesudah berakhirnya program kerjasama dengan International Monetary Fund. Seda, Frans. Paket Kebijakan Ekonomi Pasca-IMF. Witular, Rendi A.. Don't expect business as usual next year. The Jakarta Post. Satish Mishra. Indonesia after the IMF: Business as usual. Djiwandono, J. Soedradjad. New Development Paradigm for Indonesia : Challenges after the crisis. Pangestu, Mari E.. Bracing for the high cost of life after the IMF. Centre for Strategic and International Studies, Jakarta. Guerin,Bill. Indonesia faces up to post-IMF reality. The Jakarta Post. Kwik calls for unilateral moratorium on debts.
June 5, 2003. Indonesia to leave IMF. The Jakarta Post April 30, 2003. Life after the IMF. Editorial. siteresources.worldbank.org/NEWS/PressRelease/20147455/pr12 112003-eap-indonesia.pdf http://www.kompas.com/utama/news/0309/15/133456.htm http://www.kompas.com/kompas- cetak/0301/28/opini/97764.htm
The World Bank reported that in May 2002 that out of a total of private corporate debt of $119.1 billion, $93.3 billion or 78 % was owed by large corporations, the rest owed by small and medium enterprises. Out of the total debt, $69.5 billion or 58 % was non- performing. However of all the non-performing debt, $65.8 billion or 96 % of debt was owed by large companies. The percentage of non-performing loans of large companies to its total loan was 72 %, while only 14 % of the debt of small and medium enterprises was bad debt . In fact, during the crisis it was significant how the SME and the informal sector had been supporting the economy, preventing it from total collapse. In the recovery period, while the manufacturing industry was still sluggish, the SME was doing better. At the height of the crisis there was retrenchment of employment in the formal sector while in the rural sector employment had increased, indicating that the informal and the small and medium scale of the formal sector had cushioned the impact of the crisis on the people. You are a member of an economic team that is responsible for designing the industrial policy of Indonesia or your own country. You are asked to design a concept for future industrial policy that should avoid the past mistakes of prioritizing large companies over small and medium ones in terms of access to credit and other facilities such as the provision of infrastructure.
Concept Paper for Indonesia’s Future Policies on Small-Scale and Micro Establishments and the Informal Sector By Levinson C. Alcantara (The Philippines) Introduction The informal sector used to be looked at with connotations of irregularity and at the extreme, being associated with the black market or underground trade. Most of the early policy efforts is to ultimately transfer to the formal side of the economy those activities which fall outside taxation and regulation mechanisms. Recent thoughts, however, are slanting towards developing policies that are responsive to the peculiarities of the sector and providing protection to the people involve in it as the sector’s unseen contribution to the economy becomes highlighted during periods of economic crisis. During the Balance of Payment crisis in early 1980s Philippines, where the GDP was negative for example, economists were appalled at how families survived at all. The answer was found somewhere along the lines of small-scale, unreported incomes made in informal sector. People were able to eke out means of livelihood in retail trade and other non-agriculturally- based activities not usually captured by Families Income and Expenditures Survey (FIES) as well as the ordinary Labor Force Survey (LFS). The same scenario occurs in the ASEAN region in the aftermath of the 1997 financial crisis as many people found livelihood opportunities outside corporations and into smaller units of income-earning activities. Apparently, small-scale and micro enterprises in the informal sector serve as a sponge which absorbs some of the shocks that an economy receives during crises and this light, better policies which cater to providing support to the sector. What is the informal sector? A simple definition of the informal sector is “small-scale, self-employed activities (with or without hired workers), typically at a low level of organization and technology, with the primary objective of generating employment and incomes”. The activities are usually conducted without proper
the administrative machinery responsible for enforcing laws and regulations. The informal sector has always been there in many cultures in the person of street vendors, home-based industry workers or other folks involved in traditional community endeavors which are paid either in cash or in kind. In efforts to capture the informal sector in labor surveys, the International Labour Organisation (ILO) has come up with an international statistical definition. The 1993 Resolution concerning statistics of employment in the informal sector conceives the informal sector as consisting of production units that "typically operate at a low level of organization, with little or no division between labour and capital... and on a small scale.... Labour relations - where they exist - are based mostly on casual employment, kinship or personal and social relations rather than contractual arrangements with formal guarantees." The units additionally possess the characteristics of "household enterprises", which are: fixed and other assets not belonging to the unit but to the owner; units cannot engage in transactions or enter into contracts nor incur liabilities on their own behalf; expenditure for production and capital goods are often indistinguishable from household purposes. Other proxy indicators used in trying to locate workers in the sector consists of “own-account workers (but excluding administrative workers, professionals, technicians and domestic workers), and unpaid family workers, and employers and employees working in establishments with less than 5 or 10 persons engaged”; non-wage employment; and with or without registration of establishments.21 Thus, while small scale enterprises may not be synonymous to the “informal sector” many of those who are in the sector are found in these kinds of enterprises as the relationship between them appear to be fluid and highly flexible. Definition of Indonesian SMEs. Small businesses are sometimes scaled according to their annual gross income or the number of the employees that they have. At any rate, they remain to be the largest source of domestic employment in most developed countries, and 21 The international and operational definitions are lifted from ILO website on the informal sector, at http://www.ilo.org/public/english/employment/skills/informal/who.htm .
non-agricultural employment in virtually all developing countries and serve as the socio-economic backbone of many societies (Asasen et al: 2003). In Indonesia, small-scale and micro establishments are used as gauge in approximating the number of establishments in the informal sector. They are defined as those enterprises that do not have legal entities, covering all economic activities except agriculture. In terms of number of workers, SMEs are those employing 1 to 4 workers (cottage industries) as well as those having 5 to 19 employees which are small industries (Indonesia BPS). In this sense, SMEs and informal sector are used interchangeably to refer to those establishments operating without the requirements set by local or trade laws. In terms of location meanwhile, Indonesian SMEs can also be considered as those with “fixed locations or unremovable equipments” which do not have Surat Ijin Usaha Perdagangan or (SIUP) and those establishments utilizing “unfixed location or located in fixed location but their equipments are removable”22. Finally, in terms of economic activities, SMEs are usually found in individually-owned mining, small-scale cottage industries; non- state-owned electric companies; individual construction activities; trade, restaurant and accommodation services; individual transport, storage and communication activity; saving and loan cooperative without legal entity, usurers, insurance supporting companies and money changing ran by individuals as well as in other services (ibid). This paper offers possible policy options that can enable Indonesian public administrators to look at the issue of SMEs and informal sector from an industrial and labor perspective and provide better services and thus contribute to the overall economic well-being of the country. It focuses on bringing the SMEs into the forefront of industrial and labor policies to render the economy 22 The SIUP literally means “trade license”. In Indonesia, business activities are subject to licensing by the appropriate authorities (Department of Trade and Industry or local government) and obviously it has trade license requirements. For business sector, SIUP is also a must to access credit from bank. Trade license is a kind of ID for business sector to verify that their activities are legal and is vital to prevent tax avoidance.
will be done by undertaking an examination of the past labor market in order to approximate which workers are already in the SMEs and informal sector, which industry are most likely to absorb workers and who are probably prone to falling into the sector if drastic negative changes occur in the economy. Subsequently, recommendations will be given starting with current linkage of industry and labor market enhancements so that the economy will be more prepared once that drastic change occurs. Indonesia’s Industries and Labor Market Scenario The consistently-leading labor-intensive main industry in Indonesia since 1997 to 2001 is the agriculture, forestry, hunting and fisheries group.23 In 1998, the industry group absorbed over 5 million workers as the 1997 crisis spilled workers into agriculture and related industries, workers who apparently could not find jobs elsewhere. Their number continues to grow as more of the population enters the age of employable workforce. Owing to the largely loose arrangement of employment relationship and the informal nature of acquiring manpower in agricultural activities, the distinction as to which jobs are completely formal or informal remains problematic in this specific sector. It is sufficient, for the time being, to suppose that a majority of small-scale farming requiring day-to-day manpower may be considered informal work. During the same period, the second job-providing industry is the wholesale, retail trade, restaurants and hotels group; followed by the community, social and personal services; the manufacturing industry and the transportation, storage and communication group. Among all these industries, only the transportation, storage and communication group posted continued increase in employment since 1997. The manufacturing industry suffered the biggest lose of about 2 million workers between 1997 and 1998 but is significantly increasing since. The wholesale, retail, restaurant and hotels industry as well as the services sector also suffered significant losses in 1998 and continue to fluctuate from one year to 23 The choice of time period is arbitrary in this paper for in as much as more recent statistics is desired, the most readily available update from Indonesian sources is as of the year 2001. Statistics disaggregated into sub-industries, by age group, education and sex is also not readily available.
next. For the period 1997 to 2001, the mining, quarrying, electricity, gas and water group is emerging to become a significant group in generating employment. According to data from the Integrated Survey of Small-Scale and Micro Establishments, there are significant portions of establishments without legal entity within each industry.24 From 1998 to 2001, the group of wholesale and retail trade, restaurants and accommodation services is composed about 47% establishments without legal entity. During the same period, the mining and quarrying, electricity, gas and water supply and construction group is composed of about 34% SMEs without legal entity. The manufacturing industry as well as the transport, storage and communication group is comprised similarly of about 20% small businesses with no legal entity. By comparing the total “working” in the labor force and those employed in establishments without legal entity in Figure 1, it becomes clear that almost one-third of those employed are in the SME/informal sector category. Note that in distinguishing SMEs those working informally in the agricultural sector are expressly excluded from this figure. Figure 1 Table Comparing Total Employment and Employment in Establishments without Legal Entity, 1998 to 2001. 1998 1999 2000 2001 Population Age 15 Years + 138,556,198 141,096,417 141,170,805 144,033,873 Working 87,672,449 88,816,859 89,837,730 90,807,417 Working in Establishments without Legal Entity 26,020,176 26,715,858 27,664,690 27,204,656 24 As earlier defined, the SMEs survey excludes the agricultural sector as locus of informal sector. Statistics on establishments without legal entity is being used as proxy indicator for approximating informal sector employment and number of SMEs. However, in 1997, no survey was conducted and that the statistics available from 1998 to 2001 is useful in looking only at the trend after the economic crisis in Indonesia.
observation is confirmed by further looking at the trend in main employment status figures as those “self-employed” and “self-employed assisted by family member or temporary help” consistently far exceeds the number of “employees” by about 11 million annually, despite the relative decrease of the number of both the number of self-employed and employees from 1997 to 2001. A comparison of total employment and employment in establishments without legal entity (SMEs) across industries further shows that on the average, the mining group is comprised of about 15% of people employed in the informal side of the industry from 1998 to 2001. Meanwhile, the manufacturing industry is comprised of informal activities by as much as 52% average; the wholesale and retail group by an overwhelming average of 88%; the transport, storage and communication group by 49%; and the financial institutions group averages at 23%. (See Annex 1.) When examined across major island grouping or at the provincial level, the employment of Indonesians in SMEs accounts for still significant percentages against the bigger national total employment. The lowest average employment in SMEs is in Maluku and Irian Jaya province which is around 230,000 (or 0.25% of the national figure) from 1998 to 2001. The highest, meanwhile, is in East Java, averaging around 5,390,000 over the same period (which is equivalent to 6% of the total employment in the whole of Indonesia). For all the provinces, trends suggest that no significant decline in the participation to work in SMEs is seen four years after the financial crisis. (See Annex 2.) Taken altogether, the statistics indicate that SMEs and the informal sector appears to be staying for quite a while in the industrial and labor market landscape of Indonesia. Across industries and among provinces, the informal sector is rooted as significant part of the economy. Trade and manufacturing are the industries where the concentration of SMEs and informal sector is high. They are the most absorptive industries when in comes to serving as host to informal workers. Similarly, other industries also have their share of informal SMEs and it is not difficult to conjure
they tend to proliferate in those sectors during disruptions in the economy. By geographical locations, the provinces of Sumatera, West Java, Central Java and East Java post the highest number of workers in SMEs. When this is compared against the statistics on the capital Jakarta where numbers of informal sector workers are decreasing, the flow of workers from urban to rural areas is suggested. Past economic experiences predicts that the said flow becomes even stronger when crises arise. Policy Recommendations The SMEs of Indonesia remains an important part of its economic strengths and accordingly, policy attention must be given to enhance it. Following are general and specific policy options that public administrators might want to consider in enhancing the role of the informal sector in economic revitalization. Government Industrial Policies. Offhand, the most crucial role of government in acknowledging and gathering sufficient knowledge on the extent of the informal sector is coming up with accurate and timely data of SMEs and informal sector. Data sets that reflect not only numbers but can be broken down according to sex, age, educational attainment/skills and other social indicators must become part of the regular statistical base of the country. The SME Surveys must be geared towards disaggregated data gathering and be institutionalized. In the presence of this data, the informal portion of the labor market can be closely monitored, and appropriately will facilitate referrals of workers in the informal sector with sufficient skills to move into the formal markets which match their abilities. SMEs and the informal sector is a very loose entity of the economy. The government should consider encouraging operators of SMEs to put up cooperatives that are designed to organize and enable members to build up a common fund that can revolve and be used for supplementing capitalization of the establishments in times of distress. The government can empower cooperatives by allowing them to be structured in such a way that they have the capacity to negotiate fair market prices for their products. In relation to the above policy on cooperativism, the government can also put infrastructures that will allow small
or retail trade, farm to market roads must link informal sector sources to their markets. Government construction projects in themselves can serve as pump-priming activities for manpower who seek additional incomes. Aside from public markets already constructed, the government can assign spaces to be used as common market areas for informal market. This way, their registration or the issuance of their permits can be facilitated. On the side of small- time traders, confidence can be built that they livelihood activities are not disrupted by apprehension while on the government’s side, revenue collection can be ensured. For SMEs in production, the government can help by improving market conditions for SMEs, developing technologies alongside the responsible development of indigenous materials. Textiles, potteries, and foodstuff made from local materials are gaining global commercial appeal. To make these products more marketable, the government can promote them by seeking new market outlets. Quality of ethnic-inspired products can be ensured by government by providing skills training in production, packaging and quality control. The Department of Trade and Industry and local governments can play crucial roles in providing these interventions. It is common knowledge that when times are hard, workers are willing to work in conditions that compromise their safety and health just to earn a living. SMEs, which primarily focus in income- generation and due to lack of money to provide safety installations in their workplaces, may overlook safety measures for its workers. A study of the Indonesian Ministry of Health, for example, reveals that most workplaces health problems result into “malnutrition, occupational asthma, skin allergy diseases, chemical poisoning, food poisoning, muscle and tendon diseases, chemical poisoning, skin melanoma” and many other diseases that can be avoided with ambient work environments (Joedoatmodjo, n.d.). The government can help in ensuring workers maintain their life and limbs by instilling a culture of low-cost but effective ways to make workplaces ensuring of occupational safety and healthy. Continuous awareness raising and stand-by health facilities must be incorporated in local government health programs or services. The National Occupational safety and Health Council and the
of Health of Indonesia must have a working group coordinating to bring measures that will not cause SMEs extra costs, but at the same compliant with standards of safety. While no sufficient data in Indonesia supports the fact that women become the first victims of crisis become more affected by crisis, cases in other countries suggest that women my take the brunt more heavily than men. The effects of gender-segmented workforces in manufacturing industries Indonesia, which may indeed lead to massive lay-offs of women during a crisis, can be mitigated by promotion of gender equality in industries. Equal pay for the same work done, merits in hiring and firing regardless of sex are basic principles that government must instill among companies, especially in the manufacturing sector. In financial and fiscal aspects of administration, Indonesian government must also allocate for a sort of fund in local banks that will allow micro-credit for SMEs without collateral and minimal interest. Enabling access to credit facilities with minimized documentary requirements and easier ways of repaying will make the funds reach more of its informal clients. In the aspect of registration, SIUP regulations must be relaxed among small businesses and micro establishments. One probable reason of avoiding registration is that SME operators may be finding documentary requirements and filing procedures burdensome. It must also be made clear among SME operators which benefits they can get from being registered in the rolls of SIUP. Tax exemptions for a certain period of time for certain establishment sizes ma be an option worth exploring to encourage the informal businesses to register. Policies for Big and Formal Companies. The downsizing strategy of companies always leads to massive unemployment and sudden entry of fired workers to the informal sector which might saturate the market and stagnate it. The effect of such will destabilize not only the formal economy but the informal economy as well. Big companies must then be encourage to make use of firing as last resort during crisis. Instead other labor flexibility measures must be utilized first like job rotation, job-sharing and allowing part-time work.
verge of being laid off must be informed of the exit opportunities which the company should provide. Severance packages for employees laid off due to economic reasons must be obligatory. Aside from giving severance pay, companies must be encouraged to educate workers to be laid-off to invest in income-generating activities, where to best put to use these lump sums. Re-training workers to be fired in order to enable them to become more employable is another option. Companies can also make schemes like pooling the lump sum severance packages into a starting capital for smaller business that will subcontract other services from its mother company. This scheme entails devoting the peripheral operations of a downsizing company to a new, smaller entity, assured of fair market price and at the same time, upholding social responsibility by providing livelihood to its former workers. Other exit opportunities that big businesses can be encouraged to make are prioritizing the re-hiring of laid-off workers once production requires added manpower, providing referrals to other possible companies. The minimum wage should be guarded well because worker informalization usually arises when incomes from formal employment becomes insufficient to support a certain standard of living. Companies should thus be encouraged to maintain rational wage setting where minimum needs of employees are met by the pay they receive. Conclusion The Asian financial crisis offers ways to learn the lessons in addressing the economic concerns connected with the informal activities. Concerning SMEs and the informal sector, administrators must acknowledge the fact that while guiding informal industries towards formalization is ideal, it must also be accepted that to do this, the benefit of formalizing them is also clear. Hence, strategies that provide simple and effective services for the informal sector must be put in place while the economy is regaining its strength. When SME capabilities are enhanced, there is very little doubt that their expansion will lead to eventual formalization. In order to achieve this, the budding industries must be nurtured and be invested on in a similar manner with which big companies are
treated by taxation and regulation procedures. Export processing zones are being accorded tax shelters for the reason that they provided employment. The same thinking can be applied in addressing informal sector issues because as shown in this paper, their contribution to the economy is just as important. The overall perspective that government must take when looking at the informal sector should be on the long-term, but dependent heavily on short-term measures as the sector is yet being nourished. Just like any investment, the immediate return of revenues while providing services by the government must be first overlooked in order to reap benefits in the future when small businesses have gained foothold and are ready to be regulated and contribute their share in the public coffers. References Asasen, Choompon, Kanchana Asasen and Nataya Chuangcham. 2003 A proposed ASEAN policy blueprint for SME development 2004-2014. Bangkok: Human and Organizational Potential Development Centre and Ariel Professional Management Services. Bruch, Mathias and Ulrich Hiemenz. Small- and medium-scale industries in the ASEAN countries : agents or victims of economic development? Boulder : Westview Press. Clapham, Ronald, Reiner Strunk, Heinz G.H. Schaldach, and Gisela Clapham. 1985. Small and medium entrepreneurs in Southeast Asia. Translated by Horst E. Schneider and Linda Mayes. Singapore : Institute of Southeast Asian Studies. International Labour Organisation. N.d. Skills development for the informal sector. Accessed from http://www.ilo.org/public/english/employment/skills/infor mal/who.htm . Irawan, Puguh B., Iftikhar Ahmed and Iyatanul Islam. 2000. Labour market dynamics in Indonesia: Analysis of 18 key indicators of the labour market (KILM) 1986-1999. Jakarta: International Labour Office. Joedoatmodjo, Soekotjo. N.d. Occupational safety and health in the informal sector: Seeking better solutions in Indonesia. Indonesia:
. Kazutaka, Kogi. 1985. Improving working conditions in small enterprises in developing Asia. Geneva : International Labour Office. Morrisson, Christian, Henri-Bernard Soliognac and Xavier Oudin. c1994. Micro-enterprises and the institutional framework in developing countries. Paris : Development Centre of the Organisation for Economic Co-operation and Development Washington, D.C. : OECD Publications and Information Centre. van Diermen, Peter. 1997. Small business in Indonesia. Aldershot : Ashgate. Wiebe, Franck. 1996. Income insecurity and underemployment in Indonesia’s informal sector. Washington D.C.: World Bank East Asia and Pacific Country Department III Indonesia Policy and Operations Division. Indonesia http://www.bps.go.id/sector/comser International Labour Organisation http://laborsta.ilo.org
without Legal Entity (SMEs), 1998 to 2001 (In Thousands) Main Industry Group Total Employment/SME Employment 1998 1999 2000 2001 Mining, Quarrying; Electricity, Gas and water Supply; Construction Total Employment 3,345 4,329 4,020 4,929 SMEs Employment 655 513 601 699 Percentage Share of SMEs to Total 19% 12% 15% 14% Manufacturing Industry Total Employment 9,934 11,516 11,642 12,066 SMEs Employment 5,287 6,116 6,291 6,110 Percentage Share of SMEs to Total 53% 53% 54% 50% Wholesale and Retail Trade, Restaurants and Accommodation Services Total Employment 16,418 17,529 18,489 17,469 SMEs Employment 15,626 15,523 15,735 15,417 Percentage Share of SMEs to Total 92% 88% 85% 88% Transport, Storage and Communication Total Employment 4,154 4,206 4,554 4,448 SMEs Employment 1,993 2,109 2,281 2,184 Percentage Share of SMEs to Total 48% 50% 50% 49% Financial Institutions, Real Estate, Rental Service and other Services Total Employment 12,394 12,225 9,574 11,003 SMEs Employment 2,457 2,454 2,754 2,793 Percentage Share of SMEs to Total 20% 20% 28% 25% Source: Indonesia BPS and ILO Laborsta webpages.
Oyunkhand Namsrai (Mongolia) Introduction: Definition of SME in General and in Indonesia To begin this essay on the role of SME and informal sector, and future concepts of industrial policy of Indonesia, let me refer to the question “Which enterprises are considered to be SME?” to make clear the focus area of the studies. From economic policy’s point of view the entrepreneurship sector can be divided into two segments: big enterprises on one side and small and medium-sized enterprises (SME) on the other side. Both segments have their specific feathers and roles. The appropriate classification and definition of SMEs ensures that SME related policies, conducted by either government or other institutions, evolve along with the growth and transformation in domestic economic activities and structure, as well as ensures that these policies are directed to the right area. SMEs can be defined by both qualitative and quantitative criteria. The qualitative criteria bring out the features that differentiate SME from big one. For example: the management is independent, as the manager of the enterprise is usually also the owner, etc. The quantitative definition is most commonly used. Generally there are three types of enterprises, which can be consolidated under the SME term. DEFINITIONS25: Micro enterprise: up to 10 employees; total assets are up to $100,000; annual sales of up to $100,000. Small enterprise: up to 50 employees; total assets are up to $3,0 million; annual sales of up to $3,0 million. Medium enterprise: up to 300 employees; total assets are up to $15,0 million; annual sales of up to $15,0 million. 25 Although these definitions are admittedly subjective and still under review, they are broadly consistent with those used by most other international financial institutions (World Bank Group – SME Department report, 2003)
definition used, because there are the significant differences in aggregate national income and its distribution, in production structures and capabilities, and in industrial and technological characteristics among economies. For Indonesia SME sector can be shown as follows (ASEAN Policy blueprint, 2003): Number of workers Assets Sales CHI26 1-4 N/A N/A Small 5-19 up to $20,000 less than $0,1 million Medium 20-99 $20,000-50,000 $0,1-5,0 million First: The Role of SME and the Informal Sector Competitive and innovative SME sector holds out enormous promise for an economy (a country, a region) in terms of: Higher income growth Fuller employment of domestic resources More efficient integration through global and regional trade and investment Greater possibility to provide an access to the national income, more equal income distribution for the vulnerable part of the population As World Bank Group states: “Vital contribution of SMEs is that SMEs remain the largest source of domestic employment in most developed countries, and of non-agricultural employment virtually in all developing economies. They are important vehicle for empowerment and participation, especially of women, the young, and other disadvantaged social segments. Their presence can also be found across industries and sectors, domestic regions and rural locations, and urban and peri-urban areas.” In other specific literature, three aspects have been brought out, pointing the importance of SMEs and the probable expansion of their role in a country’s economy (Pleitner 1993, p.13): 26 Cottage and household industries
There are a lot of fields where SMEs are more profitable than big ones; Many human needs (need for communication and pleasant working environment, need for acknowledgement) can be better met in small enterprises. Moreover, from Indonesian experience during the crisis SME and the informal sector had been supporting the economy, preventing it from total collapse. At the height of the crisis there was retrenchment of employment in the formal sector, while the employment in the rural sector had increased, indicating that the informal and SMEs of formal sector had cushioned the impact of the crisis on the people (Kartasasmita 2004, p.114). This fact shows that SMEs have more capability to resist the drastic economical changes due to their flexible structure, mobility, and ability to go on without significant investments and devotion of the owners to the business. Also SME’s more conscious of paying back loans (non-performing loan to total loan to the sector ratio is 14% for SMEs, while 72% for large companies). Second: Three Pillars of Small Business Development Various researches show that smaller companies in the developing world essentially have three basic needs. Supporting them to grow requires a broad range of inter-related initiatives addressing each of these key areas – action on any one in isolation from the others will seldom be enough. Access to capital: debt and equity financing on appropriate terms for working capital, start-ups and expansions, restructurings, international trade and other critical needs. Most SMEs among their needs give the biggest priority to the financing needs (as I can conclude from three year working experience as a Credit manager at Agricultural bank of Mongolia – commercial bank with the widest network throughout the country), because most financial institutions often don’t give loans to them, considering these SMEs too risky, too poorly collateralized, and too time consuming to consider. But there are reasons behind such an unequal treatment to SMEs: mostly underdeveloped management skills and improper bookkeeping at SMEs. This forces these businesses to depend on the personal,
much higher interest rates than the average rate on the financial market, causing the higher costs and lower returns for SMEs). This seriously constraints SME’s business potential. Business services: access to information, assistance to marketing, management, technology, strategic planning, and other critical business needs. Besides financial resources SMEs need stronger information (about regulations in the related sector, legislation, current market situation, etc.) and skills (managerial, financial, marketing, human resource management, etc.) – a powerful combination that helps them to better plan, manage, control funds and grow their businesses. Without these inputs the business potential is rarely reached, and the threat of bankruptcy increases. Business enabling environment: removing some of the difficult constraints that are proportionally much harder for small and mid-sized firms to overcome than for big ones. Income generation, job creation and etc. in the developing world are controlled and managed by the government policies and legal environments. Excessive regulation pulls down private sector development rather than helps it. The correlation between the country’s economic growth and high degree of government interference in business sector can be observed from the researches. Too heavy government regulation hinders business growth, involves high administrative cost, results corruption, and increases unemployment, low investment and productivity. Three: Concept of Industrial Policy Industrial policy is an effort by the government to alter the sectoral structure of production toward sectors it believes offer greater prospect for accelerated growth than would be generated by a typical process of industrial evolution according to static comparative advantage. Forms of industrial policy: Credit directed at the specific sectors with below-market interest rates for long-term and working capital, Sectorally differentiated profit taxes, Subsidized electricity rates,
R&D subsidies, Control of entry and exit of firms, Export targets, Highly differentiated tariff and non-tariff barriers. For industrial policy to be nation’s welfare improving, the policymakers must identify market needs for welfare-enhancing interventions, design and implement the appropriate interventions, and correct or terminate the applied policy as changing circumstances warrant. Also on the other hand, the government should consider the impact of industrial policy to a country’s economy, it is important to distinguish between the initiation of industrialization and its continuance once a higher level of growth had been achieved. The former is the interest of many of the least developed countries, while the latter to countries that have implemented many basic economic reforms but whose growth rate has responded slowly. Indonesian economy has already implemented the necessary economic reforms towards deregulated, globally oriented and integrated concepts. Therefore concepts of Indonesian industrial policy shall ensure that this process will continue in the same direction. The concept of industrial policy of the country shall provide equal support and fair treatment for both big enterprises as well as SMEs (not prioritizing large companies and monopolies). There should be systematic approach to the SME developing policies, in terms of. a. Access to credit and financial services. This factor mainly depends on the banking sector, the lending policies of the banks, even though the government shall stay away from the lending activities of the banks, not to push any of the sectors to prevail in the loan portfolio. Otherwise the banking sector can’t be restored; directed and non-performing loans will threat the banks’ liquidity and solvency. On the other hand, banks usually reluctant to lend to SMEs, therefore the government shall support micro-finance institutions by assisting them to obtain resources, technical assistance, and training and development programs (for instance, offered from IFC, ADB and other international organizations). Also promote, facilitate
and packages, such as leasing, factoring, credit guarantees. b. Environment suitable for business start-up and growth. Establish institutional structure, which decreases bureaucratic barriers related to the business start-up procedures, licensing, patenting and taxation. Thus besides supporting SMEs, the government will decrease corruption. Establish effective co- ordination between different programs and institutions, which are engaged in enterprise promotion system (for instance: the Family planning board -BKKBN and its small loan program for poor women –TAKESRA/KUKESRA; the social welfare programs; the cooperatives; the banks; the Ministries of Interior, Agriculture, Trade and Industry, and Labor all have had own schemes at some point). Support the network, where information is available to SME on markets, possible co- operation partners; technical assistance is accessible on management and marketing trainings. c. External policy or government’s role of a “doorman”. Determine priority industry and offer it favorable conditions to import advanced technology, equipment (for example: reduce or neglect custom duties for importing equipment) and protect domestic producers by setting proper tariff barriers. The government will be able to affect on sectoral resource flow and the composition of output. d. Laws and regulation. Industrial policy objectives shall be reflected in the legal environment. For example: provide tax on wage and income tax concession for enterprises providing new jobs for first 3-5 years, depending on the prioritized industries. Control the implementation of law on the fair competition, anti trust and anti monopoly. e. Government subsidies. Subsidies have to be specifically justified to meet identified market failures. As industrial technology is a key factor in SME growth; it requires government coordination and subsidy on research and development, extension and technology renewal to improve the competitiveness of small enterprises.
Outcomes of SME Supportive Policies SMEs are driven force of economic growth of a country, a government, which provides nurturing environment for SMEs can harvest from their development. Namely: national income increase (in macro economy level from the national income account identity: with increased income the saving rates will be higher, which will increase investment, which again will influence to the economic growth), unemployment and poverty decrease (this will influence to the reduction of illiteracy, enabling school age children to attend schools instead of helping their parents to get money for living as their parents will be able to support the families), increase in women involvement in the society, and others. Some other outcomes of SME supportive policies, particularly important for Indonesia: Placating increased influence of donors and foreign debts on the country’s economy. As supportive policy will attract new businesses to the market; it will broad the taxpayers’ base resulting in tax revenues increase (but not from the tax rates increase). It will support the country to face a challenge of going on without the foreign debts (if Indonesia can’t rely on the Paris Club debt restructuring in the future, the country will need more revenues to pay government expenditures and service its current foreign debts).27 As the country newly gained democracy and now in its transition towards democracy consolidation, economic growth and stability accelerated by the SME sector of the country will enable to support this consolidation (according to Adam Przewoski once a country has a democratic regime, its level of economic development has a strong effect on the probability of the democracy to survive).28 As supportive policies will encourage entrepreneurship countrywide, in the future these businesses would become the protégés of aid programs, foundations, or non-governmental 27 In 2002 total government revenue was 304,182 billion rupiah out of which 214,074 billion rupiah or 70.4% of the total revenues came from the tax revenues. 28 In 2002 GDP per capita was $3,100, indicating that the country stands higher from $1,000 level for countries considered to have fragile democracy.
ensuring the economic-social welfare of the country. References: Noland Marcus, “Industrial policy in an era of globalization/Lesson from Asia” (Washington DC, Institute for International Economics, 2003) A Proposed ASEAN Policy Blueprint for SME Development 2004- 2014 (REPSF Project 02/005) Thomas A.Timberg, The political economy of SME development policy in Indonesia (PEG Project November, 2000) SME support policy in European Union and Baltic states: Principles and Problems (report for the 41st Congress of the European regional science association) Ginandjar Kartasasmita, Monograph “Indonesia: A Country at a Crossroad”; World Bank Group – SME Department report 2003 Statistical Annex of Indonesia, provided by World Bank Group
Industrial Policy By Artis Birzins (Latvia) Development of the Industrial Sector: Some Issues and Challenges There is a general consensus that in order to generate accelerated economic growth a country will need to ensure structural shift favoring the industrial sector. The Industrial Policy may set a target contribution of 25 per cent of GDP coming from the manufacturing sector, as also a target of 20 per cent of employment to be created in this sector. Despite the immense importance of industrial growth, and a series of industrial policies undertaken by the government, development of industrial sector has been rather modest after the crises. Share of manufacture in GDP is still low. Within the industrial sector, it is the large industry which has come to play an increasingly important role in recent years. Industrial base in Indonesia has continued to remain rather narrow. The objective of industrialization should be to ensure a participatory development process by involving Indonesian labor so as to enhance social justice and equity. Industrialization strategy should aim at realizing the potential at every level. In a competitive world of globalization efficiency must be enhanced at every tier in industrial production. Government support in this regard is very important. SME has a disadvantage in receiving credit, or to take steps for their improvement on their own because of their small size. Even while SME receives lot of preferential support from the government and the Banking sector in many countries, it remained relatively neglected in Indonesia. Factors inhibiting industrial investment in Indonesia are rather common for domestic as well as foreign investors: poor infrastructure, sometimes absence of skilled labor and mid-level technical expertise, underdeveloped legal system, law and order situation, institutional weaknesses etc.
exchange and utilization Take measures for creating a comprehensive data-base on Indonesian industry. Working to develop a more comprehensive data base about implementation status of the registered investment. Measures to ensure systematic and regular information flow on registration, investment on the ground and progress of investment covering all units enlisted. A proper database on industry is essential for policy formulation. It also helps providing correct guide for new investment. To develop a complete listing of the industries in every sector information may be gathered from the concerned association and the local governments. Trade licenses may be examined to complete the listing of industries. A compulsory local body certification/registration may help to locate the units and thus have a proper listing of them. Stimulating Resource Mobilization for Industrial Development Create a new Investment Finance Company. The objectives of such a company would be (a) to mobilize funds for industrial term loan financing and SMEs, and (b) to actively engage in industrial investment promotion activities. Special tax incentives may be announced to promote investment. Enhance Competitive Strength and Encourage Technological Upgradation in both Domestic-Market and Export-Oriented Industries Upgradation of both skills and technology of export-oriented enterprises is essential for translating comparative advantage into competitive advantage. Stimulate investment in vocational training system and relate it to the requirements of textiles, agro-based, leather, engineering and other industries. The private sector should collaborate with the Government in setting up skill-training institutes. Support in-factory skill Upgradation and training activities through fiscal and other incentives would be advisable. Put in place adequate measures to stimulate technology transfer and Technology diffusion to local industries from foreign investors. More fashion and design institutes should be set up to
e.g. the garments exporters to move to higher value-added fashionable wear. Technology acquisition, adaptation and Upgradation must be given top priority and vocational education must be re-designed to cater to this need. Strengthen capacity of industries to conform with the increasingly stringent quality standards in the global market by strengthening quality control measures and related institutions. A central pool of technical resources could be created to provide such supports. Be actively involved in global initiatives in support of transfer of technology favoring the developing countries and the LDCs. Voluntary training institutions may be supported by the government through appropriate incentives. Promote Women Entrepreneurship Set up a fund to support women entrepreneurs. Make adequate provisions to provide women entrepreneurs with preferential access to support service. Implementation status: Nothing specific has been done in this regard. Indonesia can set up separate women entrepreneurs support cells in various organizations, provide special support to women entrepreneurs who are involved in export-oriented activities for promotion of marketing of their products in overseas markets. Incentives to Encourage Investment in New Export-Oriented Industrial Activities Zero import tariffs on capital machinery for export-oriented industries should be supported. Customs duty rates on basic raw materials and intermediate imports used by export-oriented industries should be further reduced and the existing anomalies removed. Further Actions to be taken Setting up Industrial Parks Indonesia is a country with land scarcity, inadequate infrastructure. It might be very problematic for an investor to procure land and arrange all the infrastructure and utility service. Law and order problem also makes investment insecure. While
the country, implementation of these will take much effort and long time to have noticeable positive impact. Development of industrial park could be very helpful to create a congenial environment for investment in selected areas even within the context of overall poor investment environment in the country. Availability of ready infrastructure along with some security support in an industrial park may attract both local and the foreign investor to invest in profitable ventures. Encourage Industrialization in the decaying industrial Cities and Towns Many of industrial cities are decaying because of the decline in the traditional industries. New industrialization may be encouraged in these decaying industrial cities and towns. The cities has existing infrastructure for industry. Small and Medium Enterprises Small and medium enterprises (SMEs) have a captive domestic market which mainly caters to the demand of the low and medium income groups. Employment generation capacity of these industries is also quite substantial. In many developing countries these industries are also important export-earners. However, support to these industries has tended to be neglected in the earlier industrial policies. Important action is to stimulate private investment through proper guidance and preinvestmentment counseling. The existing facilities provided in this respect by relevant agencies should be reviewed and improved through adequate logistic support. Rationalizing the tax structure is of importance I one more action needed. In terms of indirect taxes, there should be distinction between SMEs and their large-scale counterparts. Indonesia's fiscal policy needs to be particularly tailored to provide support to SMEs e.g. by raising the ceiling of exemption limits as regards taxation, and by lowering the VAT rates. Providing marketing assistance, to stimulate foreign exchange earning capacities of SMEs and ensure that they have adequate representation in trade fairs and support market
of their products abroad. Set targets for Indonesian Missions abroad in terms of exports of SMEs based products. Stimulate sub-contracting activities to support SMEs.
Bernice Huang (U.S.A) It is believed that small and medium enterprises (SME) and the informal sector had cushioned the impact of the financial crisis in Asia by supporting the economy and preventing it from collapsing. Employment in the informal sector and SMEs increased instead at the height of the crisis. In addition, SMEs performed better in the recovery period, while the demand in manufacturing industry remain sluggish. Asia Pacific Economic Cooperation (APEC) deems that SMEs occupy an important and strategic place in the Asia Pacific region, as they account for over nine-tenths of the region’s business firms. They create most new jobs and facilitate wealth creation. They also provide the essential business infrastructure for large enterprises and are the basic source of entrepreneurial activity. Given that it is often argued that governments should promote SMEs with their greater economic benefits in terms of job creation, efficiency, and growth, ensuring the viability, profitability, and growth of SMEs is, therefore, critically important in strengthening the regional business community. The World Bank has had a track record of lending more to large corporations, as 78% of its total private corporate debt was owed by large corporations as of May 2002. As 96% of its non- performing loans (NPL) was owed by large corporate and only 14% of which was from SME, it is clear that the policy to prioritize large companies over SMEs in terms of access to credit and other facilities such as the provision of infrastructure was mistaken. Therefore, future industrial policy should be designed to avoid the past mistakes of prioritizing large companies over small and medium ones. First, after the financial crisis, the banking system in Indonesia has to be rehabilitated. Adequate liquidity is needed in the short run to support a restoration of lending. In the medium term, capital positions should be improve, and eventually a more efficient, transparent, better-regulated and supervised system should be established in the long term. The international
has been working to support the continued rollover and stretch-out of debts owed by the domestic banking system to international banks and to help ensure that international short-term credits lines are reestablished, especially trade credits. With the help from the international community, monetary authorities and bank regulators in Indonesia should be able to work with domestic banks to ensure that credit lines are reestablished. Given the limited resources and credit lines that are able to be restored, the banks should focus on reestablish credit lines for corporate with better liquidity and future business and profitability prospects in order not to generate more non-performing loans on their balance sheet. This will prevent the banks from repeating its past mistake of allocating all of its capital resources to large corporations as whether or not to reestablish credit lines depends on whether the corporations demonstrate the capability to pay back the loans borrowed. Consequently, SMEs and firms in the informal sector, which have been doing better and had been supporting the economy, would not be disadvantaged in this system due to the size of their operations. Second, corporate debt restructuring also needs to be implemented to re-energizing the banking system. Failure to do so will delay the banks from resuming new lending, thus preventing SMEs and firms in the informal sectors from getting funds from the banks who have most capitals tied up in non-performing loans (NPL). The process of corporate debt restructuring currently lags far behind the rehabilitation of the banking sectors in Indonesia, as there is a lack of injection of public funds in the case of corporate debt restructuring. In addition, the corporate debt restructuring process inevitably requires a detailed case-by-case approach, which requires too much time and effort from the banks view. Furthermore, debtors and creditors play a war of attrition, as each side waits for the other to improve terms. These have resulted in widespread bankruptcies and insolvencies, which have wiped out the remaining value of many firms. Hence, guidelines for more efficient corporate debt workouts should be established by the debtor and creditor since the guidelines should satisfy both debtor and creditor. Debtor and creditor have to compromise on their interests and come up with arrangements which may combine a partial write-down of debts with a partial conversion of debt into
equity to reduce the non-performing loans on banks’ balance sheet. Taking Japan as an example, due to their own financial weakness, many Japanese creditors are reportedly reluctant to sign on to debt workout arrangements agreed by banks in other countries and this has resulted in a recession of over 10 years in Japan. Therefore, it is important to work toward a common standard for a fair and equitable sharing of losses, both among creditors and between creditors and debtors in order to speed up the process of corporate debt restructuring. Only after corporate debt restructuring is done will the banks be able to free up its capitals and have them available for new lending. After resuming lending, government should tighten credit control procedures by imposing stricter regulations, such as setting an upper limit for NPL ratio. Banks whose NPL ratio exceeds the upper limit should be punished to give them more incentives to keep NPL ratio at a low level. In turn, the banks would be more cautious and selective when approving new loan applications and set up comprehensive guidelines define the types of customers they will lend to, with what terms and with what security. Consequently, it will become more difficult for companies with existing non-performing loans at the banks to get new lending or credit line extensions, as there are higher probabilities that these new lending will become NPLs, further raising banks’ NPL ratios. Given that most of the NPLs on banks’ balance sheet belong to large corporations, it would be more difficult for them to get further new loans and credit lines from the banks unless they are able to take care of their old NPLs first. Transparency in the disclosure of financial situation will become critical for corporations in order to get new lending from the banks, as the banks would need these information to assess the profitability and ability of companies to pay interests and repay the loans borrowed before granting new lending or credit lines. With pressure and incentive to keep their NPL ratios at a low level, the banks would be reluctant to take the risks to approve new lending to companies with poor disclosure and transparency, despite the higher interest rate they may be able to charge these companies. In another word, banks will now focus more on the quality of loans they give out, rather than the quantity as they did before. This will in turn provide a fair way to how banks grant new lending. As a result, if SMEs and firms in the informal sector do perform better
more willing to allocate new lending and credit lines to them rather than to large corporations despite the sizes of loans SMEs and the firms in the informal sector need may be a lot smaller than the ones large corporations. Credit controllers should be carefully selected and should form a totally independent Credit Management Unit in the banks to avoid any conflict of interest. Lending executives should be held responsible for proposals that they have initiated or approved so that they have more incentives to be more cautious in granting new loans and credit lines. In addition to the lending executives and credit controllers, a Board Executive Credit Committee consists of the banks’ top management should be formed to review and approve all large credit facilities that have been granted by the banks, as large credit facilities, if becoming NPLs, will be a big burden for the banks. Through a stricter system of executing and granting loans, banks will be able to more fairly control the quality of their loan portfolios. In addition, the system will ensure more fairness in justifying who deserve the granting of loans, as the system helps to reduce the chances for large corporations, who usually have more capitals, to bribe these lending executives in order to get new loans or credit lines more easily. In conclusion, after restoring the credit lines and restructure the existing corporate debt, the banks should impose stricter rules on granting the new lending to corporations. Government would be able to help increasing the incentives for banks to do so by introducing policies to cap NPL ratios of banks at certain level. Consequently, given that SMEs perform better than large corporations, banks will naturally prevent themselves from prioritizing large companies over the SMEs, as approval of new lending will be based on financial performance and payback capabilities of companies rather than their sizes. References Roubini, Nouriel. “Global Macroeconomic and Financial Policy Site.” http://www.stern.nyu.edu/ globalmacro/. APEC Business Advisory Council. http://www.abaconline.org/library/default.asp.
World Bank Group. “Global Economic Prospects and the Developing Countries Beyond Financial Crisis.” 1998/1999. http://www.worldbank.org/prospects/gep98-99/.
deal with rebellious regions. It has more basic value to democracy and democratic consolidation. Many scholars have presented argument that decentralization enhances the legitimacy and hence stability of democracy. Decentralization enhances the efficacy, quality and legitimacy of democracy; hence decentralization is a necessity for democracy. It is even more so for large—and particularly multiethnic and multicultural —countries such as Indonesia, as decentralization or regional autonomy will close the distance between the citizens, the stakeholder, and the power and the process of policy making. Decentralization is not just a political necessity to keep the country from falling apart or to foster democracy; if managed well decentralization can bring important benefits to the communities and the economy as a whole. However if managed badly it could harm the people and squander resources and bring instability instead. As the result of decentralization, the central government has been under more pressure to meet its budgetary needs. Many observers, including those with the IMF and World Bank, had worried about the effect of fiscal decentralization on the still fledgling economy. With decentralization, some rich regions are doing fine, in fact they have more money that they can spend; there is a danger, and there are already some indications of the revenues not being used effectively and efficiently. On the other hand, poor regions are chafing under the new responsibility that comes with autonomy. And as pointed by the World Bank (2001) the risks of an increase in corruption following decentralization are high. It has been widely observed that so far that not only power and revenue that have been decentralized but also corruption. It seems that Indonesia is not the only country faced with this problem when it attempted to decentralize. On the basis of their observation of experience of some Latin American countries, some analysts comment that decentralization has strengthened the position of the local elites and their clientelistic networks (Huber, Rueschemeyer and Stephens, 1999: 182). Furthermore, many regions had increased local taxes and imposed new levies that have
concern of the way decentralization is proceeding—unevenly, depending on the natural endowment of the district and the quality of the human resources available to the local government—there are some views that the process of decentralization should be slowed down, even rolled back. As an advisor to policy makers who are working in formulating a concept for decentralization, you are asked to give your advice on how to make decentralization works, optimize its benefits and minimize its weaknesses
Collado, Jr. (The Philippines) “As an advisor to policy makers who are working in formulating a concept for decentralization, you are asked to give your advice on how to make decentralization works, optimize its benefits and minimize its weaknesses.” Background Decentralization can be defined as the transfer of responsibility for planning, management and resource raising and allocation from the central government and its agencies to the lower levels of government. Decentralization is closely linked to the concept of subsidiarity, which proposes that functions (or tasks) be devolved to the lowest level of social order that is capable of completing them. As the UNDP states: "Decentralizing governance is the restructuring of authority so that there is a system of co-responsibility between institutions of governance at the central, regional and local levels according to the principle of subsidiarity, thus increasing the overall quality and effectiveness of the system of governance, while increasing the authority and capabilities of sub-national levels." There are three broad types of decentralization: political, administrative and fiscal and four major forms of decentralization: devolution, delegation, de-concentration and divestment. Political decentralization normally refers to situations where political power and authority has been transferred to sub-national levels of government (i.e. elected and empowered sub-national forms of government ranging from village councils to state level bodies). Devolution is considered a form of political decentralization. Devolution refers to the full transfer of responsibility, decision-making, resources and revenue generation to a local level public authority that is autonomous and fully independent of the devolving authority. Administrative decentralization aims at transferring decision- making authority, resources and responsibilities for the delivery of select number of public services from the central government to
government line agencies. Administrative decentralization is often simultaneous with civil service reform. There are two major forms of administrative decentralization – de-concentration and delegation. De-concentration refers to the transfer of authority and responsibility from one level of the central government to another while maintaining the same hierarchical level of accountability from the local units to the central government ministry or agency, which has been decentralized. Delegation, on the other hand redistributes authority and responsibility to local units of government or agencies that are not always necessarily branches or local offices of the delegating authority. While some transfer of accountability to the sub-national level units to which power is being delegated takes place, the bulk of accountability is still vertical and to the delegating central unit. Fiscal decentralization is the most comprehensive and possibly traceable degree of decentralization since it is directly linked to budgetary practices. Fiscal decentralization refers to the resource reallocation to sub-national levels of government. Arrangements for resource allocation are often negotiated between the central and local authorities based on several factors including interregional equity, availability of resources at all levels of government and local fiscal management capacity. Divestment is when planning and administrative responsibility or other public functions are transferred from government to voluntary, private or non-governmental institutions with clear benefits to and involvement of the public. This often involves contracting out partial service provision or administrative functions, deregulation or full privatization. Decentralizing governance at the country level includes the whole system of the national legal and institutional framework and the empowerment of sub-national institutions at provincial, district, city, town and village levels in terms of fiscal, administrative and legal processes. In addition, effective decentralization involves the flow of information and resources between and among the various levels of governance from national to local and local to national. Some of the key modalities to effective decentralization include the full participation of the entire population, especially the poor, women, youth and ethnic minorities as well as the active partnerships of the various actors -
Organizations (CBOs), private firms and donors. Comments/Suggestions The very first step that a country should take if it embarks on decentralizing its system of governance is to choose the form of decentralization most appropriate to the political, social and economic idiosyncrasies of that country. Before developing elaborate plans for decentralization, policy and program planners must assess the lowest organizational level of government at which functions can be carried out efficiently and effectively. This may likewise entail reviewing the functions and responsibilities that can be readily transferred to sub-national entities, those that may be turned over in a later period, and those that should be retained by the central government. The specific services to be decentralized and the type of decentralization will depend on economies of scale affecting technical efficiency and the degree of spillover effects beyond jurisdictional boundaries. These are issues that need to be taken into account in the design of a decentralized system. In practice, all services do not need to be decentralized in the same way or to the same degree. In an important economic sense, the market is the ultimate form of decentralization in that the consumer can acquire a tailored product from a choice of suppliers. The nature of most local public services limits this option and establishes a government role in ensuring the provision of these services, but it does not automatically require the public sector be responsible for the delivery of all services. Where it is possible to structure competition either in the delivery of a service, or for the right to deliver the service, the evidence indicates that the service will be delivered more efficiently. In most countries an appropriate balance of centralization and decentralization is essential to the effective and efficient functioning of government. In may be noted that not all functions can or should be financed and managed in a decentralized fashion. Even when national governments decentralize responsibilities, they often retain important policy and supervisory roles. The central government’s function would then be to create or maintain the "enabling conditions" that allow local units of administration or non-government organizations to take on more responsibilities.
decentralization scheme is an assessment of the capacities of the sub-national entities (i.e. regional, local government bodies) to absorb the new functions and authority that can be vested to them by the central government. Upon this assessment, the central government can then design and implement necessary capacity- building programs for both the central government overseers and the would-be local administrators to ensure the continuation of service delivery. For decentralized administration, the success of decentralization frequently depends heavily on training for both national and local officials. Likewise, technical assistance is often required for local governments, private enterprises and local non- governmental groups in the planning, financing, and management of decentralized functions. Thirdly, decentralization requires a constitutional, legal and regulatory framework to ensure accountability and transparency. It also necessitates the restructuring of institutions and developing linkages with civil society and the private sector. Simultaneously, political decentralization necessitates universal participation and new approaches to community institutions and social capital. As such, decentralization planners should formulate the appropriate institutional, legal and regulatory framework based on the abovementioned assessments. Very often, the cause of confusion is in the extent of independence that can be exercised by the local entities and the level of intervention that can be exercised by the central government. This is particularly important in the area of investment, maintenance of infrastructures and the like. The constitution should therefore provide a clear delineation of authority and administrative functions and relationship between the central and the local government, and among the local governing entities themselves. The constitutional framework should also ensure equity and equal treatment by the central government in terms of the flow of funds, prioritization of flagship projects, etc.) of all the local governing bodies to avoid marginalization, discontent and unfair competition among them. The decentralization planners should particularly keep an eye on this concern because otherwise, the decentralization effort may only slip to secession and eventual fragmentation of the country. Further, the constitutional framework should enable the environment for decentralization and good local governance. It
and communication among the different stakeholders in the local community. Decentralized governance is effectively strengthened and rendered more accountable when participation is encouraged, facilitated and institutionalized. Communities, neighborhoods and individuals, more commonly known as Civil Society, can play a crucial role in ensuring that local government responds to their needs by participating in the planning, implementation and monitoring of activities and projects affecting their lives and eventually impacting the level of human development they maintain. It is, after all, the promotion of democratic practices and culture which is the very principle behind decentralization. On the other hand, this may also already address the other challenge that beset decentralization planners, that is the possible rise of local elites which would rather turn the political structure into a feudal type of system instead of a decentralized democracy. Finally, the decentralization framework must link, at the margin, local financing and fiscal authority to the service provision responsibilities and functions of the local government. This is to make local politicians bear the costs of their decisions and deliver on their promises. Meanwhile, the local community must be informed about the costs of services and service delivery options involved and the resource envelope and its sources - so that the decisions they make are meaningful. This can be done through participatory budgeting. A successful decentralization is closely related to observing the design principles of finance following (clear assignment of) functions; informed decision making; adherence to local priorities; and accountability. However, applying these principles in practice has not proven to be simple. Country circumstances differ, often in subtle and complex ways, consequently the policy and institutional instruments that establish decentralization have to be shaped to the specific conditions of individual countries. # References: “Overview of Decentralization Worldwide: A Stepping Stone to Improved Governance and Human Development”; A Paper Presented by Roberson Work (UNDP) during the 2nd International Conference on Decentralization, 25-27 July 2002 in Manila, Philippines;
A Brief Synthesis of Policy Lessons and Recommendations of Nine Country Case Studies on Service Delivery for the Poor”, Roberson Work; UNDP Publication; “Building Capacity to Support Decentralization – The Case of Indonesia (1999 – 2004)”; Rainer Rohdenwohld, 2004, German Ministry of Home Affairs “Governance for Sustainable Development,” UNDP Policy Paper Series 1997.
different types of decentralization facilitates the discussion of design and particularly impact. For example, the type of decentralization selected within a country will depend on its design--which will depend on the political structure and administrative issues of that country. The impact of decentralization will differ depending on what type of decentralization is taking place, (the political, fiscal and administrative arrangements which characterize the decentralization) and what the objectives of decentralization are. It is important to introduce consistency in any discussion of decentralization to avoid "comparing apples and oranges" and to ensure that we can draw lessons where applicable. What is Decentralization? The term "decentralization" embraces a variety of concepts which must be carefully analyzed in any particular country before determining if projects or programs should support reorganization of financial, administrative, or service delivery systems. Decentralization -- the transfer of authority and responsibility for public functions from the central government to intermediate and local governments or quasi-independent government organizations and/or the private sector -- is a complex multifaceted concept. Different types of decentralization should be distinguished because they have different characteristics, policy implications, and conditions for success. Types of Decentralization Types of decentralization include political, administrative, fiscal, and market decentralization. Drawing distinctions between these various concepts is useful for highlighting the many dimensions to successful decentralization and the need for coordination among them. Nevertheless, there is clearly overlap in
are not as important as the need for a comprehensive approach. Political, administrative, fiscal and market decentralization can also appear in different forms and combinations across countries, within countries and even within sectors. Choosing the Most Appropriate Form of Decentralization Under appropriate conditions, all of these forms of decentralization can play important roles in broadening participation in political, economic and social activities in developing countries. Where it works effectively, decentralization helps alleviate the bottlenecks in decision making that are often caused by central government planning and control of important economic and social activities. Decentralization can help cut complex bureaucratic procedures and it can increase government officials' sensitivity to local conditions and needs. Moreover, decentralization can help national government ministries reach larger numbers of local areas with services; allow greater political representation for diverse political, ethnic, religious, and cultural groups in decision-making; and relieve top managers in central ministries of "routine" tasks to concentrate on policy. In some countries, decentralization may create a geographical focus at the local level for coordinating national, state, provincial, district, and local programs more effectively and can provide better opportunities for participation by local residents in decision- making. Decentralization may lead to more creative, innovative and responsive programs by allowing local "experimentation." It can also increase political stability and national unity by allowing citizens to better control public programs at the local level. But decentralization is not a panacea, and it does have potential disadvantages. Decentralization may not always be efficient, especially for standardized, routine, network-based services. It can result in the loss of economies of scale and control over scarce financial resources by the central government. Weak administrative or technical capacity at local levels may result in services being delivered less efficiently and effectively in some areas of the country. Administrative responsibilities may be transferred to local levels without adequate financial resources and make equitable distribution or provision of services more difficult. Decentralization can sometimes make coordination of national
be captured by local elites. Also, distrust between public and private sectors may undermine cooperation at the local level. An advisor to policy makers together with project and program planners must be able to assess the strengths and weaknesses of public and private sector organizations in performing different types of functions. Before developing elaborate plans for decentralization, they must assess the lowest organizational level of government at which functions can be carried out efficiently and effectively and -- for functions that do not have to be provided by government -- the most appropriate forms of privatization. Even program planners who do not see ‘decentralization’ as their primary motive must carefully analyze the types of decentralization already present in a country in order to tailor policy plans to existing structures. The success of decentralization frequently depends heavily on training for both national and local officials in decentralized administration. Technical assistance is often required for local governments, private enterprises and local non-governmental groups in the planning, financing, and management of decentralized functions. Rationale for Decentralization The specific services to be decentralized and the type of decentralization will depend on economies of scale affecting technical efficiency and the degree of spillover effects beyond jurisdictional boundaries. These are issues that need to be taken into account in the design of a decentralized system. In practice, all services do not need to be decentralized in the same way or to the same degree. In an important economic sense, the market is the ultimate form of decentralization in that the consumer can acquire a tailored product from a choice of suppliers. The nature of most local public services limits this option and establishes a government role in ensuring the provision of these services, but it does not automatically require the public sector be responsible for the delivery of all services. Where it is possible to structure competition either in the delivery of a service, or for the right to deliver the service, the evidence indicates that the service will be delivered more efficiently.
most countries, fortunately, decentralization may be one of those instances where good politics and good economics may serve the same end. The political objectives to increase political responsiveness and participation at the local level can coincide with the economic objectives of better decisions about the use of public resources and increased willingness to pay for local services. At least five conditions are important for successful decentralization: The decentralization framework must link, at the margin, local financing and fiscal authority to the service provision responsibilities and functions of the local government - so that local politicians can bear the costs of their decisions and deliver on their promises; The local community must be informed about the costs of services and service delivery options involved and the resource envelope and its sources - so that the decisions they make are meaningful; There must be a mechanism by which the community can express its preferences in a way that is binding on the politicians --so that there is a credible incentive for people to participate; There must be a system of accountability that relies on public and transparent information which enables the community to effectively monitor the performance of the local government and react appropriately to that performance - so that politicians and local officials have an incentive to be responsive; and, the instruments of decentralization - the legal and institutional framework, the structure of service delivery responsibilities and the intergovernmental fiscal system - are designed to support the political objectives. Fulfilling these goals (or at least having local governments improve upon the central government’s record) is a tall order, but achievable. Successful decentralization is closely related to observing the design principles of: finance following [clear assignment of] functions; informed decision making; adherence to local priorities; and accountability. However, applying these principles in practice has not proven to be simple. Country circumstances differ, often in
institutional instruments that establish decentralization have to be shaped to the specific conditions of individual countries. Political Decentralization Political decentralization aims to give citizens or their elected representatives more power in public decision-making. It is often associated with pluralistic politics and representative government, but it can also support democratization by giving citizens, or their representatives, more influence in the formulation and implementation of policies. Advocates of political decentralization assume that decisions made with greater participation will be better informed and more relevant to diverse interests in society than those made only by national political authorities. The concept implies that the selection of representatives from local electoral jurisdictions allows citizens to know better their political representatives and allows elected officials to know better the needs and desires of their constituents. Political decentralization often requires constitutional or statutory reforms, the development of pluralistic political parties, the strengthening of legislatures, creation of local political units, and the encouragement of effective public interest groups. Constitutional, Legal and Regulatory Framework Constitution, laws and regulations codify the formal rules of the game by which a decentralized system is supposed to function. Structurally, the desirable architecture of these rules is quite straightforward: The constitutions should be used to enshrine the broad principles on which decentralization is to operate, including the rights and responsibilities of all levels of government; the description and role of key institutions at central and local levels; and, the basis on which detailed rules may be established or changed. One or more laws should define the specific parameters of the intergovernmental fiscal system and the institutional details of the local government structure, including, key structures,
series of regulations associated with each law should interpret and describe in detail the practices and measures by which the related law will operate. Laws that deal with tasks that are shared between national and sub-national governments should include sections on intergovernmental relations. Substantially greater detail and specificity is provided in moving down these three platform architectures from the Constitution to Regulations. Conversely, greater difficulty and a higher degree of authority (e.g., Minister, Parliament and Constitutional Assembly) are required to change the provisions when moving up from Regulations to the Constitution. As decentralization is a complex social experiment a good case may be made for there to be more flexibility in the ability to change the specificity of implementation instruments, while enshrining the political and philosophical principles in the Constitution and the operating structures in the laws. Some unitary systems may exercise extremely centralized control over local governments. In Indonesia, the Ministry of Home Affairs has had the authority to appoint (and remove) mayors and even village heads. The structural impediments in designing a decentralized system in this context are few, but that does not mean that the process of instituting such a system is without critical hurdles. Indonesia has had decentralization legislation on its books since 1974; the process there remains far from completion. Participation & Decentralization Citizen participation in some form is an essential part of successful decentralization. It is becoming a more common element in developing country political environments - 13,000 units of local government in Latin America are now elected, compared to 3,000 in 1973 - but the flow of information is by no means undistorted. Planning decentralization policies should take these informational imperfections into account and attempt to improve the depth and degree of citizen participation in local government action. Local government responsiveness, one of the main rationales for decentralizing can not be realized when there are no mechanisms
its constituents. Among several issues, five warning flags may deserve special attention. Issue 1: Local governments at the same nominal level and their capacity First, in many countries, local governments at the same nominal level may vary considerably in their capacities. West Bank and Gaza, for example, has municipalities which vary in population size from about 10,000 to over 1 million, with management capacities to match. Differences in fiscal capacity may be recognized in the equity component of the intergovernmental fiscal system. However, the fact that management and administrative capacities also may vary substantially is rarely accounted for. It is useful to have the legal/regulatory system recognize significant difference in management capacities by a classification of local government within levels. Policies and strategies to address these differences may then be coherently considered. Issue 2: Local government borrowing and the capacity to repay Second, local governments should have the ability to borrow when they have the capacity to repay. However, for moral hazard reasons discussed in greater detail in the borrowing subsection of the KMS every effort must be made to promote the perspective that local government loans are internal obligations of local governments and not of higher levels of government unless specifically stated otherwise. The importance as well as the difficulties of doing this is well illustrated by the circumstances of sub-national debt in Brazil. The legal and regulatory framework can support this message by specifying the conditions under which local governments may borrow, the limits of those borrowings, the reporting requirements for debt and debt service and the penalties for violating the rules. Issue 3: Local government laws inclusive to decentralized functions
options, including private participation and managed competition that may be pursued in the delivery of local public services. As a consequence legal barriers may inappropriately restrain the ability of local authorities to select the most desirable options for the delivery of decentralized services. China’s cities have been imaginative in innovating and delivering some services not anticipated in the legal and regulatory framework in which they operate; nevertheless, even under these circumstances rationalization is desirable. Inappropriate barriers and constraints should be avoided or corrected in the design and detailing of the legal and regulatory framework for decentralization. Issue 4: Voting democracy versus citizen participation and voice Fourth, voting democracy is often considered as satisfying the conditions for citizen participation and voice in the design of decentralized systems, but in practice this may not be sufficient. Meaningful participation requires that citizens be informed and that their voices have impact where consequences are immediate. The legal/regulatory system needs to provide for, at minimum, full, timely and easily accessible public disclosure of resource allocation decisions - in budgets, in procurements, and in expenditure programs. An output/outcome orientation to expenditure management would be even more desirable. In addition, there must be reliable, secure access by citizens to the means to enforce appropriate penalties for violations of rules. Issue 5: Terms of office for local political leaders and the issues of authority accountability Fifth, terms of office for local political leaders are closely related to issues of authority and accountability. Mayors need incentives to focus on at least the medium-term, rather the solely the short-term. This requires a long enough term or potential terms to be able to be seen to be accomplishing meaningful objectives. In practice, where multiple terms are allowed, three to four year terms are desirable. Where only single terms are permitted, then 5-6 years would be appropriate. The detailed design of authority, powers, accountability systems and procedures must be related to local circumstances, including issues which may range from cultural traditions to the state of accounting and auditing systems.
between preferences for room for aggressive leadership versus protecting the community from excesses - this latter choice is a matter of political taste, which is often a consequence of historical experience. Conclusion The democratic local governance initiatives currently under way in many countries hold much promise for developing effective systems of public accountability that will ensure that government servants are responsible to elected officials, and that the latter are in turn responsible to the public that elected them in the first place. In the process these systems of accountability should increase the pressure for more transparent local governance, in which corruption will be easier to bring to light and thus to curtail. But just as it took many decades for such efforts to make much headway in the industrial countries, so too quick results cannot be expected elsewhere. References Kartasasmita, Ginandjar. Indonesia: A Country at a Crossroad Hill, Hal. 1999. The Indonesian Economy in Crisis. Singapore: Institute of Southeast Asian Studies Pempel, T.J. 1999. The Politics of the Asian Economic Crisis. Ithaca and London: Cornell University Press Edited by Abed.T.George, Sanjees, Gupta. 2002. Governance, Corruption and Economic Performance. Washington, D.C. : International Monetary Fund The World Bank. 2000. East Recovery and Beyond Asia. Washington, D.C. : The World Bank
Aditya Wibisono (Indonesia) Introduction Whether Indonesia can sustain an energetic recovery and achieve longer-term social and economic goals will largely depend on how well it is governed. Governance in the region is undergoing profound change in response to new source constraints and increased demands for accountability. Government is being challenged to deliver better services at lower cost and to give more citizens more say in how public business gets done. The drive for more efficient, effective, and accountable government emanates from three main sources. The first is the immediate fiscal strain brought on by the crisis-a dramatic rise in public debt is squeezing public spending just when recession compels governments to assume more responsibility for protecting low-income groups. Globalization is the second source of pressure for governance reform. Indonesia must set the right condition for effective provision of education and health services, crucial to the future competitiveness of the region’s human resources. The third driver of governance reform is socioeconomic and political transformation. New, democratic, and more accountable governments have generated corollary demands for more probity and better performance of public officials. The pressure for decentralization n many parts of the world often is driven by the need for improved service delivery (Dilinger, 1994). However, in Indonesia, distinct ethnic and geographic factors have exacerbated the frustration with the central domination, and the demand for decentralization is associated more with control over resources and political and legal autonomy than with a perceived need to improve local service delivery. The Government of Indonesia seems committed to a major program of governmental decentralization, and has recently passed
22/1999 on Regional Government (UU PD) and Law No. 25/1999 on the Fiscal Balance between the Central Government and the Regions (UU PKPD). If fully implemented, these laws promise to transform intergovernmental fiscal relations in Indonesia. Many would see decentralization as a necessary response to the political situation. However, many details of the program have not yet been worked out, and there is even some question about the overriding goals that government wants to achieve with its decentralization policy. In many respects, Indonesia’s system of fiscal decentralization would seem to be making it an outlier. It has many of the characteristics of a country that typically chooses decentralization as an economic policy, but it has chosen to remain centralized state. Empirical work on this subject-the determinants of fiscal decentralization-points to a number of characteristics of countries, which have adopted political and fiscal structures. Generally, countries that have large populations and land areas tend to be decentralized. It is too difficult and too costly to govern effectively from the center when the population and land area are very large. Large countries are likely to have large variation among regions in climate, geography, and economic base, so that centrally mandated uniformity in the provision of government services is likely to be quite inefficient. Moreover, there are diseconomies of scale in trying to govern large countries, which relate to the manpower costs of bureaucratic red tape, the time required to approve local decisions, and the problems of communications. Countries that have diverse populations also tend to be more decentralized. If the population of a country is diverse, or if the regional economies are diverse enough that there distinct regional preferences for government services, then there is a strong case for decentralized governance. Indonesia certainly is characterized by such diversity. There are two reasons why diverse countries seem to decentralize. Firstly, is to accommodate regional differences in preferences for services, and secondly, to hold a potentially divided country together by providing appeasement via some degree of regional autonomy to potential breakaway regions.
economic development tend to be more decentralized. Empirical evidence suggests that countries at a higher level of economic development tend to be more decentralized. Strength and Weaknesses of Decentralization The meaning of decentralization should be a transfer of full responsibility to the region that will govern its government based on the aspirations of its people that will be carried out and implemented in a democratic manner. The regional government will have the authority to regulate and govern the interests of the local people according to their own initiative based on the aspirations of the people in accordance with rules and regulations. Autonomous region will have the authority to regulate and manage the interests of the local society according to their own initiative based on the aspirations of the people in the context of the Unitary State of the Republic Indonesia. As it also has been mentioned in the assignment case (Number 4), decentralization can enhance the efficacy, quality, and legitimacy of democracy; hence decentralization is a necessity for democracy. Decentralization will be able to close the distance between citizens, the stakeholder, and the power and the process of policy making, especially for a multiethnic and multicultural country such as Indonesia. Decentralization is not just a political necessity to keep the country from falling apart or foster democracy. It is so true that if the decentralization practices are managed well and properly, it will bring numerous important benefits to the people and the economy as a whole. However, if decentralization managed badly, it could harm the people and squander resources and bring instability instead. Law No. 22/1999 is a law that was formulated under a political situation that is characterized as transitional. As such, the results of this rules and regulations should also be characterized as temporary and not yet final. Law No. 22/1999 was also formulated during the time of President Habibie. The Habibie government had ruled for less than a year was known as government that was very active in issuing regulations. As such it is understandable if this law was made in a hurried manner. Aside from this, the formulation of this Law No. 22/1999 was forced because there are
which were exploited and treated unfairly during the Suharto regime. Because of this, we can say that the decentralization in Indonesia was implemented half-heartedly. Several weaknesses come along with the implementation of decentralization program. First, the delegation of authority by the central government was placed under the district of an autonomous region. This is in spite of the fact that experiences in implementing the decentralization have ever since indicated that there were difficulties in attaining the objectives of decentralization. Aside from this, the conflict of interest among districts in managing natural resources increases and become inefficient. Second, the strategy of decentralization that is based on the lowest level (district) has produced a number of negative impacts that has mostly affected the Central Government all these time, such as, the demoralization that is happening mostly in the Regional Government (District/Municipality). Examples are acts of corruption, collusion, and nepotism (KKN), factionalism, and the incompetence of the government that has been occurring all these time at the central level that later transferred to the district level. Third, some of the articles in Law No.22/1999 indicate that the authority of the central government is still too many. The pattern of homogeneity and the possibility that the central government or a higher government body can intervene are still too big. The condition of the homogeneity and the big possibility that the central government will intervene are very real if we discuss the Autonomy of the Village. Fourth, for the people in the regions outside Java Island that have abundant natural resources, like East Kalimantan the process of decentralization has provided big economic advantages because of the General Allocation Funds obtained by the people. However, for most of the people in Indonesia, the implementation of decentralization has not yet provided any changes n terms of the economic, social, cultural, and political aspect. On the contrary, what is being felt is the strengthening of primordial ties based on religion, ethnic, and territory. It has been proven that these primordial ties are one of the main reasons for the emergence of horizontal conflicts in many areas, such as, Kalimantan, Maluku,
the strengthening of primordial ties, particularly the feeling that the territory is becoming crowded, certain areas are also demanding for the establishment of Districts or new Provinces. The Process and Goals of Decentralization The Government of Indonesia has taken a politically expedient path in the development of its decentralization policy. The first step in most successful decentralization is the development of a general framework within which the broad goals of the reforms are articulated and agreed upon, in something that might be embodied in a government “white paper”. This step seems to have been completely skipped in Indonesia. Instead, the government has moved directly to drafting decentralization laws, and it is now beginning to think about drafting the implementing regulations that go with these laws. At present, there seems to be little intention to go back to the question of policy design. As noted, the first step in successful decentralizations is a clear statement of the objectives of the reforms. However, we could not find ant such statement until now. From interviews with various government officials, we learned that the current policy has been under discussion for two decades, mainly in the Ministry of Home Affairs, with an original policy paper apparently written in the 1970s. However, officials also reported that the policy paper was not widely disseminated. Also, there has been little advance preparation for the decentralization. We can identify only one common issue that is being addressed by the decentralization program: the need to move government decision making on taxes and expenditures to the provincial and the district level. It is not yet clear that this means “closer to voters”, and it is also not yet clear that central government ministries will resist the effort to impose regulations, and minimum standards on local government service delivery, all of which would reduce local autonomy. It is certainly that reforms do not extend any new significant revenue raising powers to the local governments. The process of decentralization, aside from opening opportunities for the emergence of conflicts that are based on primordial ties, can also make existing horizontal conflicts
ways to make these conflicts controllable by: (a) planning and immediately implementing rehabilitation programs that will reconstruct all the means and infrastructures destroyed by the conflicts; (b) allocating special funds, either from rich regions or central government, to implement the plan mentioned above; and (c) reduce the role of groups that are not from the said areas (outsiders), including the military, and relinquish the process of reconciliation to the local people themselves. The implementation of decentralization will make poor regions (like NTT) even more isolated. Because of this, it is necessary to have a special program that will manage these poor regions to prevent them from becoming more isolated. In this case, it is necessary to: (a) formulate a regulation concerning cross subsidies that are more fair and even; (b) eliminate restrictions on the transfer of the population among regions; (c) develop feasible public infrastructures; particularly transportation; and (d) create independent regulatory bodies that will supervise the management of these cross subsidies. Make efforts to settle conflicts over the management of natural resources among the regions, people, and/or between the authorities and the people by: (a) provide the local population in the concerned regions the right to manage the forests (or other natural resources that can be independently managed by the people themselves); (b) establish regulatory institutions (that will include the conservation of the environment) by developing customary institutions together with the government. Moreover, demoralization should be seriously prevented by: (a) providing shock therapy by punishing severely any person who are practicing corruption, collusion, and nepotism(KKN), such as, powerful elite groups (former authorities); (b) substantially revising(subject) the laws in Indonesia by including a minimum punishment; and (c) formulating laws that will regulate the public accountability of every government agency. Conclusion There are many implementation issues associated with the transition to a decentralized system in a country as large and as
not seem to be a detailed implementation plan. On the one hand, it seems clear that all local government in Indonesia is not able to absorb their new responsibilities because of their very different management capabilities. On the other hand, it is quite easy to hide behind this issue and create self-fulfilling prophesy that leads to conclusion that “local governments are not able to manage their own affairs”. An urgent need of the government now is to develop a transition plan for decentralization. A major stumbling block to successful decentralization in most developing and transition countries is the implementation. Sometimes, all the pieces are not in place, sometimes the speed of implementation is too fast or too slow, and very often the central government has no good ability to monitor or evaluate the process. In the meantime, there is no single best structure for fiscal decentralization. There are many versions, and the appropriate strategy for a country depends on what the country is trying to accomplish. When there is not a clearly articulated decentralization policy, and one that commands widespread support and consensus, then there is no road map for designing all features of the program-the laws, the regulations, the transition, the implementation, or the evaluation. Bibliography Huntington, Samuel P. 1991. The Third Wave: Democratization in the Late Twentieth Century. Oklahoma: University of Oklahoma Press Sung-Jo, Han. 1999. Changing Values in Asia: Their Impact on Governance and Development. Tokyo: Japan Center for International Exchange Hill, Hal. 1999. The Indonesian Economy in Crisis. Singapore: Institute of Southeast Asian Studies Far Eastern Economic Review, Responding to the Governance Challenge, February 17, 2000, p.20 George T. Abed, Sanjev Gupta.2002. Governance, Corruption, and Economic Performance. International Monetary Fund.
overview The Lao People’s Democratic Republic, with a surface area of 236.800km 2 , is a land-locked country. The population of Laos is currently estimated to be about 5.9 million people (July 2003). The population is composed of a large number of distinct ethnic groups, with the Lao Lum (Low land) being the largest and covered over 50% of total population. Ethnic diversity is highest in the more mountainous areas of the country, where linguistic diversity. However, most of ethnic groups can understand and speak Lao, which the official language in the country. With about 80% of the population living in rural areas, Laos is an overwhelmingly agrarian society. In terms of macro-economics, Laos remains strongly depend on agriculture, which makes up just 50% of GDP. Rice farming, which account for 78% of total areas under cultivation, is easily the most important component of the agriculture economy. Hydro-electric power has emerged as a growth sector in the recent years, and remains a significant export sectors. Laos is one of the least developed countries with annual per capital GDP of 350%. (Lao PDR: Fact-Finding Mission Report) Characteristics of Democratic transition in Laos After the proclamation of the nation in1975, the Lao government had tried central political regime under the leading of Lao People Democratic. Laos is currently trying to implement fundamental democratic transition by focusing on the change from a socialist economic system to a market-orientated system, and the transfer from subsistence economic to market oriented one. Special attention is given to the integration of Laos into ASEAN and that this integration is likely to be an important determining factor in the transformation of Laos into a successful market economy. Understanding that economic development provides the basic for democracy, and according to Huntington’s explanation that the economic growth and the resulting improvement in income per
Lao government is trying intensively to improve socio-economic development. Huntington agues that “in poor countries democratization is unlikely; in rich countries it has already occurred. In between there is a political transition zone; countries in that particular economic stratum are most likely to transit to democracy and most countries that transit to democracy will be in that stratum. According to this theory, it is difficult to say that Laos is likely to transit to democracy. However, I would say that the state is implementing fundamental democratic transition by protecting the freedom and democratic rights of the people which cannot be violated by anyone. The state respects and protects all lawful activities of the Buddhists and of other religious followers mobilizes and encourages the Buddhist monks and novices as well as the priests of other religions to participate in the activities which are beneficial to the country and people. Birth of decentralization in Laos Laos is similar to Indonesia in terms of population diversity with the sense of strongly being one nation. The fact is that Laos and Indonesia are multiethnic and multicultural countries make the task of keeping the countries from apart, a continuous effort in need of continuous watchfulness. However, because of disparities between cities and rural areas in terms of socio-economic development and income earning, a growing feeling of injustice and social tension begun broadening and the government was criticized. In order to solve this problem, the Lao government had tried intensely to decentralize the government structure and decision marking process. By mid-1980s, the vision of decentralizing authority to local governments began to undertake. The central government saw the need to make the necessary reforms, including the empowerment of the local governments, in order to pursue its development goal and priorities. One of the milestone reforms made by government was the passing of a new Lao Constitution by National Assembly in 1991. The Constitution has given executive, from governors, mayors, and district and village chief powers to administer their localities without having to obtain support from national government organization. Local government begins to benefit from a certain degree of autonomy in shaping its own social policies.
regulations were passed such as: - Instruction 01/PM dated 2000 stretches out a “new” planning and budgeting framework, aimed at increasing the responsibilities of the provinces, districts and villages, as well as at increasing revenue collection at the local level. Provinces are to build up as “strategic units”, districts as “planning and budgeting units”, and the villages as “implementation units” - Recommendation 128/SPC tried to build on Instruction 01/PM. Province are expected to draft their own 5-year socio-economic development plans according to the capabilities and budget need. - Recommendation 475/MF is almost entirely developed to allocating revenue collection and expenditure management responsibilities for provinces, districts and villages. It should be noted that these regulations would go some way toward providing “decentralization” with sounder of legal framework and seen as platforms for dialogue between local authorities, civil society and other community structures.(Lao PDR: Fact-Finding Mission Report, 2000) Political decentralization in Laos According to the provisions of the constitution, Lao PDR is “a unified and indivisible country belonging to all ethnic groups”. The political system is composed of: (1) the national Assembly, which has the right to decide the fundamental issues of the nation; (2) the president of the public and head of state; (3) the government headed by PM, with broad executive responsibilities and a five year term of office; (4) the local Administration-Province, municipalities, districts and villages; and (5) the judiciary. As mention above, the national government has tried to develop and decentralize its power to local governments and give the chance to all Lao people to participate in the political system. Given the ethnic diversity and quite particular history of Lao PDR, the party actively strives to foster national unity. One of the ways it does so is to ensure that ethnic minority groups are represented at the high levels includes several members who are from minority groups. National Assembly constituencies are provincial. Each province is
with total provincial representation being thereafter a function of the population size. National Assembly maintains offices in each province which are intended to facilitate contract between provincial parliamentarian and their constituencies. However, it is unclear to what extent National Assembly does consult their constituencies about legislative processes or inform them of National Assembly “oversight” of the government. The provincial governors are the heart of local administration. They report directly to the Prime Minister and enjoy the same rank as Ministers of the Government. District Governors are also key figures within their own authority. Decentralization in rural development According to the National Poverty Eradication Program, the Lao government has implemented decentralization aim “to quit once and for all the status of a least developed country by the year 2020” through the eradication of mass poverty and ensuring economic growth with equity, while safeguarding its social, cultural, economic and political identity. This vision is being pursued in the context of chin thanakaan mai (“new thinking”) and kanpatithup setthakit (“reform economy’), two essential concepts upon which the objectives of the 5-year National Socio-Economic Development Plan (NSEDP) and the related National Socio-Economic Priority Programs are based. The strengths of project design reside in the details of the participatory approach, conformity with government decentralization policies, and the focus on components addressing poor people's main constraints, namely rural infrastructure, the availability of paddy land, and livestock development (The national rural development program, 2001) Decentralization is a central component of this 2001-2005 NSEDP as a means to enhance participation and the local ownership of development processes. A key policy statement that has guided the implementation of decentralization is the Prime Minister’s “Instruction 01” (mentioned above), which assumes the form of government decree, calls for the “…building up of provinces as strategic units, districts as planning and budgeting units and villages as implementation units.” This means that the Annual and five-year Plans will be conceptualized, designed and approved by the provincial and district governments. Provincial
economic development, budget expenditures, revenue collection and the financial assistance generated from international cooperation. The central government will determine national development priorities and establish broad resource allocations among sectors; under this arrangement, provincial and district authorities will have to allocate a certain portion of the investment budget for rural development in order to qualify for support. Given these attributes, it is not surprising that rural development and decentralization are central themes in government development policies. Provincial authorities are now responsible for transmitting central government policy measures to district levels. The districts level administration is more directly involved with the implementation of new legislation and plays key role in local resource management and decision making, for example, in the allocation of land and related resources for various purposes at the village level. (The national rural development program, 2001) Obstacle of implementation decentralization in Laos It is true as many scholar have presented argument that decentralization enhances the legitimacy and hence stability of democracy. “Decentralization is no just political necessary to keep the country from falling apart or to foster democracy; if managed well decentralization can bring important benefits to the communities and the economy as a whole. However, if managed badly it could harm the people and squander resources and bring instability instead”. In some case, decentralization in Laos is quite similar to Indonesia in some extent. Despite the decentralization in Laos is implemented, it is still developing. It has to a certain extent defused the political pressure on the government coming from unhappy regions. In case of Laos, the process of decentralization still remains slow due to the government has been under pressure of budget constraint. Some rich regions are doing well. On the other hand, poor regions are annoying under the new responsibility that comes with autonomy. Another reason for slow process of decentralization is the lack of capacity in the provincial and local to assume greater responsibilities and more complex tasks. That means Laos still remains limited by it low level of human resources. Decentralization policies are making new demands on local government staff and on community-level
their new tasks. Likewise, the immense political power wielded by the governors and other local chief executives and the lack of formal avenues for beneficiary participation in shaping local polities further impede the full realization of local autonomy and people empowerment. Another obstacle would be that when the central government decentralizes its power to the local authorities without controlling properly, meanwhile not only power and revenue that have been transferred but also corruption. It seems to me this disease is very dangerous and would impede as well as destroy of socio-economic development as well as democratic transition in Laos. Recommended Policies for effective decentralization As mentioned above, decentralization would help the government to keep the country from falling apart and bring about the acceleration of socio-economic development. But if managed deficiently it could harm the people and waste resources and bring instability instead. In order to achieve a truly decentralization program set-up in Laos, it is evident that more effort is needed, not only on the part of central government, but also on the part of local official, and the active Lao population. In addition, some policies are recommended in order to implement decentralization more effectively: 1) Training need: It is clear that Lao government should first make sufficient preparation for each program before it can effectively implement its decentralization policies. To improve the local governance should be the priority in order to implement decentralization effectively. To do this the government should build capacity and management skills at the district level, most of this capacity-building would need to take the form of training, and would need to involve not only district officials but also village headmen, who are the only legally recognized representative of rural communities. At the provincial level, there would also be a need to undertake basic training; in addition, capacity-building at the provincial level would need to concentrate on developing coordination capacities in order to provide district with technical mentoring. Likewise, training should also be given for implementing, monitoring and evaluating locally based government programs.
decentralization effectively, functions and tasks of government would be initially reorganized in order to be suitable to the local circumstances and be able to employ whenever decentralization is implemented. Thus, sufficient and appropriate power would be transferred to the lowest governmental level where they can be efficiently performed. On the other hand, rational criteria for the decentralization program of the government must be suitable for the improving governmental innovation with consideration of governmental efficiency. Now let us consider the efficiency factor in governmental decentralization. It is obviously inefficient to decentralize some governmental functions such the military, foreign policy and monetary policy. Thus, the efficiency of decentralizing the government must consider both the efficiency of performing the task itself and its impact on the political economy. 3) Funding at all levels of government: The central government would fund most research promoting innovations in government activities at all levels of government. Lower levels of government with operational control over programs would then be able to select the most talented alternatives for implementation. On the other hand, the government should backtrack on given local governments fiscal autonomy in order to minimize corruption which may continue at the local level. 4) Transfer power as secure right: To encourage local institution and people to invest in new arrangement and to enable local people to be enfranchised as citizens rather than managed as subject, the government should use secure means to transfer power to local authorities. Secure transfers can create the freedom for local people to engage their representatives as citizens. 5) Transmitting central government policy: Since the district level administration is more directly involved with the implementation of the new legislation and plays the key role in local resource management and decision making, provincial authorities should be able to be responsible for transmitting central government policy measures to district levels. 6) Evaluation and support: The development of a decentralization plan must be based on efficiency and effective learning. For this
variation at lower levels of government than is the case today. In addition, the government should supply trained staff sufficiently to the local governments in order to enable all levels of government to obtain competent help. 7) Encourage motivation and leaning fro the past: The government should also encourage the formation of local civil service organization that could assist it in the implementation of its decentralization policies. It is also necessary for district and city government to rethinking their previous assigned authority and function in order to properly determine their essential or newly assigned authorities and function. 8) Anti-corruption: As we know that the obstacle of the road to decentralization is corruption called “awful disease”. In order to prevent this disease the government should monitor and control strictly. An anti-corruption commission should be set up and have full power to audit and control the governmental organization at all levels. Conclusion Decentralization is generally rationalized on several desirable potential outcomes such as improved efficiency, better governance and improved poverty reduction. In case of Laos, despite the decentralization in Laos is implemented, it is still developing. It has to a certain extent defused the political pressure on the government coming from unhappy regions and the process of decentralization still remains slow. Moreover, the most current decentralization reform in Laos characterized by insufficient transfer of power to local institution, under tight central-government oversight. Often, the local institutions do not represent and are not accountable to local communities. References Laos The Development Challenge, http://www.usaid.gov/ policy/budget/cbj2004/asia_near_ east/ Laos.pdf ASEAN Conference on South-East Asia: Concerning the situation in Laos http://servizi.
had four Presidents. Except for the last one, who is still the incumbent, three were forced to leave the office before their term expired. It is evident that currently there is a leadership deficit linked to the persistence of so many of the problems faced by the country. The debate at the centre is played amid complex and shifting power relations—factionalism even within the main parties, some along ideological lines and others just based on political opportunism. To explain the disunity and fragmentary nature of its current politics, one might hypothesize that Indonesia lacks individual leaders with the right combination of vision, character, and political savvy. There may be positive effects to this lack of charismatic leadership because, as Haggard and Kaufman asserts, over the long term “executive authority must eventually be depersonalized”. However, the experience of Indonesia at the past few years show that inept leadership have led to more failures of policy than successes, more instability and “wasted” energy in political conflict than peaceful progress and coherence. Good leadership is needed everywhere and always, but particularly so for a country going through transition with a history littered with promises broken by uncommitted leaders. As such, not only should reforms install an effective and transparent set of rules-based institutions, they should also evolve rules-based mechanisms by which the best of each generation are brought into the political leadership. Put in simplistic terms: a good system is nothing without good people to run it. It is not to say that the system is less important than the persons who run it, on the contrary democratization entails first and foremost establishing the system—the institutions, the processes and procedures. However, at the end of the day, a system is as good as the people who run it. It may help to recall Huntington’s aphorism, that economic development makes democracy possible, but it is “political leadership” that makes it real. The student will discuss the problem of political leadership in consolidating and solidifying the newly attained democracy.
required to maintain democracy. The one is the power of civil society. The other is the leadership accompanied by strong government. Is it the most important thing for its development that they keep their balance and extend their power? Linz and Stepan analysed more and brought the five concrete examples to be reinforced; The development of a free and lively civil society, an autonomous and valued political society, a rule of law, an effective state bureaucracy and an institutionalized economic society. The leadership is necessary in terms of political society, maintenance of law system, effective bureaucracy and institutionalized economic society among them. On the other hand, development of civil society and autonomy should be realized by the approach from civilians. However, no leader can become a leader without being elected by civilians. Moreover, in the maintenance of law system, the realization of making policies worked on by civilians that could not be fully promote at the era of Habibie in Indonesia is included. This is civilian that carry the institutionalized economic society on, either. Most of the elements could be shaped by taking advantages of both powers. Therefore I introduced the development of civil society and effective bureaucracy as the opposite notions. I would like to define “Civil society” and “ State” clearly here. “State” is defined that; the political society, which has the regular territory, the exclusive authoritative organization to governon the residents and integrity. In modern age, land, people and domination are regulated as three elements for its formation. Civil society is; The modern age that abolishes the privilege, domination built on rank and the subordinate relation and is consisted of the free and equal individuals. This notion was born in the enlightenment movement occurred in the 18th century in Europe. Enlightenment is the conception that advocates the independence of human and rational idea against religious authority and enables the progress of human life, improvement and increase of happiness through right legitimacy and education.
in religion, politics, society, education and law. However, state is the aggregate of civilians and civil society is also an indispensable element when we manage state as it is seen to be seeking for the new political order. It contains the common notion as the same as the other three elements though it seems to be the opposite notion at a first glance. Therefore we have to pay attention to the event that comparing these two should effect on the details of civil society and state in the case of concerning the relation between leadership and civil society. At the same time, we should take care of that the small transformation of society is connected to the current of democracy, either. Role of civil society come to be notable recently. There are three subjects: government, company and civil society. Above all, civil society asks the accountability against company and government. NIKE that locates headquarters in the United States, founded many factories in the South East Asia and imposed hard work on works there with low salaries. However, as the globalization proceeds, the more the actual condition comes to light and was denounced. Those factories were closed when the business situation became bad and the workers suddenly lost the means of life. The company didn’t prepare the alternative taking place of it and was taken up as the invasion of human rights. Some NGOs launched the boycott of world conference for free trade and buyer’s strike. In the cause of these movements, NIKE had to establish the original research institute in the company. As the power of civil society becomes stronger, the more number of NGOs is dramatically increasing. However, it is said to be difficult to recognize the real of all of NGOs because there are so many NGOs in the world including big organizations and very small meeting. Although government was once accused and distinguished by ambiguous deed of leader, is it the time that civil society also asked its accountability from now on? Samuel Huntington divided government and mentioned “Democracies become consolidated when people learn that democracy is a solution to the problem of tyranny but not necessarily to anything else”, but both must be remained as the space to hold the balance of civil society and government. Especially, what is important for the leader is; 1.The abolition of decent – We can see this phenomenon that the influence of Suharto
the transition. 2. The growth of opposition party – It is very dangerous to make one big political party if we desire the politics without autocracy. The opposition party get more power and oppose the ruling party even, which links to political stability. 3. The establishment of political system that urges civil participation – The political participation of civil society cannot be realized in the complicated system and the political interest declines. Habibie promoted the diversification of the political party and endeavour the humanitarian protection by consenting ILO charters. Moreover, he succeeded to divide police from army completely. He also undertook the revision of laws, fair election and the East Timor issue. However, longer period is required to give transparency to the relation between leaders and civil society. Huntington asserted that democracy is not the cure all for economic development. United Nations and the other international organizations are making every effort for the realization of democratic world every day. They display the democratization of developing countries as the principle, but is it a right thing? In many democratic countries, the dogmatism of the governments are standing out and the public voice is seems to be made little of. In Japan, democracy was corrupted as symposium named “The crisis of democracy” was held these days. From another angle, I may say that Japanese, who have never looked back politics initiated by the government, get interest in it through the development of civil society. Another opinion says that there were not such complaints in the time of economic growth because everybody was fulfilled with economic happiness. Thus, economic development may play an important role to keep balance of two elements. In this case, the third element was added in the middle of them and balance. The third element can balance because commits in both. Although alternative democratic society is needed, both are related to each other. In this society, leadership is not a personal problem and formulated in the society. Therefore, the role of leadership, which is made much of in democratic society, is increased among all the social development. The political decay occurs when we disregard it and the political leader brings his or her light into politics. As I mentioned
is spontaneous, not demanded so urgently if we go back to the alternatives between civil society and government. In the era of transition, wide perspectives, action and wheel are required for the leaders of arbitrator. References Ginandjar Kartasasmita “Indonesia: A Country at a Crossroad”
Nagasawa (Japan) Introduction In our class, we have looked at the cases of Indonesia’s leadership. We know that in peak times of crisis or transition, such as war, social, or economic crisis, it is more than important to have good, strong political leadership, that can keep the social and cultural fabric together, reduce divisions and factionalism in the political arena, and carry people in the right direction safely through the storm to a collective victory over the common “enemy”—be it a foreign country or a financial crisis. Indonesia has had two major leaders, but after that, the leadership has been weak, and there is a problem that needs to be solved here. Similar to the case of Japan, who played musical chairs with its prime ministers before the maverick Prime Minister Koizumi arrived on the political world stage, Indonesia has also had a succession of different presidents who were not able to maintain power, and who were weak, inefficient, or corrupt, and had to leave their positions before their terms expired. The question, then, is what kind of leader does Indonesia need in the coming elections to consolidate and solidify her new democracy—a big task at hand for the world’s third biggest democracy, after the United States and India. No ordinary leader should be chosen for this enormous responsibility. Two Past Leaders: Sukarno and Suharto What characteristics should a great Indonesian leader have in these times? Let us look at the two main leaders of Indonesia’s past who were able to maintain power for a long time—Sukarno and Suharto. What made Sukarno great? What led to Suharto’s downfall ? I think that by looking at these two leaders, we can see in a nutshell what characteristics the future leader of Indonesia should have, and more importantly, what kind of leader the Indonesian people want to see—because it was the people who supported Sukarno, and the people who pulled down Suharto. I
while keeping a watchful eye on the negative aspects of Suharto’s rule would give us a good combination of characteristics for the future leader of Indonesia. Looking at Sukarno: Man of Vision Sukarno was an enlightened man who had received some Dutch education in colonial Indonesia. He was a man with a vision who was a believer in Western ideas—especially in democracy, the Enlightenment, and the French Revolution. In his time these foreign ideas were popular among Indonesian intellectuals， along with Western economy and technology. Marxist doctrine and the idea of nationalism had also spread and taken root in his day. Sukarno: Charismatic Leader Sukarno was a man of the people—he was a charismatic and colorful figure who was able to provide a point of social cohesion for his people, despite their ethnic and social differences. He was able to raise the Indonesian people from their poverty and ignorance to their independence and give them a new sense of identity, solidarity, and purpose. He saw the Indonesian people as extensions of his family, and he reached out to the people with his heart, in a very human way. Because the people believed in and identified with him, he was able to carry people out of their former state of inertia, and lift them out from the ashes of four centuries of Dutch colonialism and three years of Japanese occupation, and to kindle within them an impetus for change, and a call for freedom. His talent lay in his ability to stir the masses to a new level of consciousness, to raise them to new beginnings, as one common people, with one common destiny. He put his talents as an orator to full use to wake his fellow countrymen up from their slumbers, and prepare them to fight for independence. Sukarno: Courageous Role Model Sukarno was also a role model for young heroes fighting for independence. He was a strong and courageous man, who had spent a lot of time fighting and risking his life for the independence of his people. He gave birth to Indonesian nationalism and pride. He was the kind of leader who was needed by the Indonesian
(Brother) Karno to the people. To other people of Asia, he was also a powerful symbol of Asian people who were able to throw off the chains of Western colonialism. For instance, Sukarno played an important role in the Asia-Africa Conference of Bandung in 1955. His speeches were masterpieces of oratory. Pramoedya Ananta Toer’s praises of Sukarno: Pramoedya Ananta Toer describes Sukarno: “He gave unity to Indonesia, dignity to the downtrodden, and anxiety to the powerful, who finally brought him down…what Sukarno did on August 17, 1945 was no different from what Thomas Jefferson had done for Americans on July 4, 1776. Perhaps even more: Sukarno was the only Asian leader of the modern era able to unify people of such differing ethnic, cultural, and religious backgrounds without shedding a drop of blood.” Toer goes on to defend Sukarno’s Guided Democracy, saying that although Sukarno was president for two decades, he did not really “rule” until the last six, and that Guided Democracy was a “political necessity. “ Looking at Suharto: Suharto was the opposite of Sukarno. Toer describes Suharto as a man who “hijacked” Sukarno’s “dreams of a free and peaceful Indonesia and replaced it with violent and stifling military rule”. He was bland as Sukarno was colorful, and he was not skilled in rhetoric nor did he have charisma. He took over from Sukarno in the chaos that took place at the end of the Sukarno regime. He did not serve at all as a model figure for his country—rather to the contrary, his downfall came about through his greed and shortcomings. He was not able to act quickly and decisively in the economic crisis, and this indecisiveness was one of the most devastating points of his career. A lot of damage could have been prevented if he had the wisdom to make a good judgment at the time. Suharto’s Other Weaknesses Another low point of Suharto’s career was his role in the suppression of the student movement, where young lives were lost and sacrificed, showing him as a cold-blooded leader with a lack of
and imprisoned many others. His rule was very dictatorial and authoritarian, dominated by fear, with strong use of the army to maintain control, and there was also a great deal of cronyism, nepotism, and corruption. He secured business deals for his friends, family, and supporters in the army and political arena, and some critics said that Indonesia was almost Suharto Incorporated. Although he was enormously corrupt, his anti-Communist was favored by the West, so there was no international pressure from outside, and the West looked askance at all his misdeeds. Thus, his abuse of power and his weaknesses finally drove him out of office in 1998 after three decades in office, when he was seventy-six. He had used his leadership for personal gain—the antithesis of Sukarno. But above all, he had breached the social contract of leadership and so lacked credibility in the eyes of the people. It is interesting to note that it was Sukarno’s daughter Megawati who won Indonesia’s first free general election in over fourty years, but her leadership, too, was lacking. So What Kind of Leader Are We Looking For? In his book Indonesia: A Country at a Crossroad, Professor Ginandjar Kartasasmita writes that, ”The years after the first democratic government has come to power are usually characterized by the fragmentation of the democratic coalition that had produced the transition, the decline in the effectiveness of the initial leaders of the democratic governments, and the realization that democracy in itself would not and could not offer solutions to major social and economic problems facing the country.” He adds that, “The challenge to democratic consolidation is how to overcome and not to be subdued by those problems.” Considering the above mentioned past weaknesses of Indonesian leadership and the many problems that Indonesia faces, it looks as though she needs a strong, charismatic leader again, who can carry Indonesia through economic crisis, political instability, and social disintegration--someone who has the characteristics of Sukarno, and who is careful to avoid the pitfalls of Suharto., especially his use of violence, military control and authoritarian strategies as well as his corrupt practices. Although Indonesia can and should be proud of being the third largest democracy, she has to overcome and conquer many problems that prevent her from moving quickly
those problems as follows:”.current issues include alleviating widespread poverty, implementing IMF-mandated reforms of the banking sector, effecting a transit to a popularly-elected government after four decades of authoritarianism, addressing charges of cronyism and corruption, holding the military and police accountable for human rights violations, and resolving growing separatist pressures in Aceh and Papua.”(as of 18 Dec 2003). Ideals in Leadership: I think that in spite of all the high and mighty things that have been written and said about leaders and the art of leadership, everything can be put simply in a few old-fashioned but simple words—brotherly love, belief in justice, and movement toward peace and progress.. A great leader for a new democracy must sincerely love his people, and want to help them, and lead them in the right direction. He must be a good actor—meaning that he can understand different people in different stratums and parts of society—he can fit into their shoes. He must put their interests above his own, and he must be ready to devote his time and energy for his people. And if that calls for sacrifice, then so be it. He must be a firm believer in justice and truth, and try to provide as much equality, justice, and opportunity to as many people as possible during his time. He must also believe in world peace and social progress-- for his country and for the world—for the maximum well-being, safety, and freedom of his citizens. It is unfortunate that we do not see such leaders anymore, but I still think there is some hope for it. Why have we run out of our supply of JFK’s ? Concluding thoughts: Perhaps all this sounds too naive and innocent in a world which has grown cynical, but I still believe that a leader should believe in these kind of ideas, but should have a savvy and realistic approach in carrying them out--which means understanding human behavior, human nature, and the processes of history, because these things are so obvious that they are often overlooked. He must never forget what G. Santayana said--that “those who forget the past are condemned to repeat it.” .A good leader should be a man of vision—he should have a thorough understanding of his country’s past as well as the history of other nations in order to
In other words, he must know where his people have come from, where they stand now, and where they will be heading to. (A hybrid form of what P. Gauguin said or wrote, if I recall correctly). He must be well- informed, and in tune with the world, and he must also have a good grasp of economics, as well as the trends of globalization and information technology. Above all, a good leader should have his head and his heart in the right place, and have a passion for the great power game. Then he will be ready to play chess with other world leaders, and he will not need an Ivy League MBA to be qualified, because running a business is not like running a country. Concluding Quotes: I would like to end here with some passages from Sukarno’s speeches—I think it is relevant to the world today and future leaders should take note. He said,”…We are living in a world of fear. The life of man today is corroded and made bitter by fear. Fear of the future, fear of the hydrogen bomb, fear of ideologies. Perhaps this fear is a greater danger than the danger itself, because it is fear which drives men to act foolishly, to act thoughtlessly, to act dangerously” He also said,” We can inject the voice of reason into world affairs. We can mobilize all the spiritual, all the moral, all the political strength of Asia and Africa on the side of peace.” And I’d like to close the curtains of the final act with a passage I like best. It goes like this: “Let us remember that no blessing of God is so sweet as life and liberty. Let us remember that the stature of all mankind is diminished so long as nations or parts of nations are still unfree. Let us remember that the higher purpose of man is the liberation of man from his bonds of fear, his bonds of human degradation, his bonds of poverty—the liberation of man from the physical, spiritual, and intellectual bonds which for too long stunted the development of mankind’s majority.” Applause. Lights Out. The End.
the New World Disorder. London: Mandarin, 1993. Hadi, Syamsul. Civil Society in Indonesia-- Conference on Civil Society in Asia, Waseda University, 2003. Huntington, Samuel P. The Third Wave: Democratization in the Late Twentieth Century. University of Oklahoma Press, 1991. Kartasasmita, Ginandjar. Indonesia: a Country at a Crossroad. February 2004 Kenworthy, Leonard S. Leaders of New Nations. New York: Doubleday and Co., 1959. Neher, Clark D. and Ross Marlay. Democracy and Development in Southeast Asia: The Winds of Change. Boulder, Co.: Westview Press, 1995 CIA World Factbook— www.cia.gov/cia/publications/factbook/geos/id.html Sukarno Biography: Pramoedya-Ananta-Toer, www.multiworld.org/m_versity/althinkers/ sukarno.htm
best when people barely know he exists, not so good when people obey and acclaim him, worse when they despise him. The great leader is he who the people say, ‘We did it ourselves.’ - Lao-Tzu Democracy is not what has been seen as the perfect and absolute stay of permanent development. It is rather contested term. The last decade of the 20th century saw the rise of a great number of regimes that cannot be classified exactly as either authoritarian or democratic. They basically have common features of both systems. Some scholars rather call them as semi- authoritarian29. After the collapse of former Soviet Union there was growing euphoria about newly independent states as the new democratic nucleus of the world. In fact roots of democracy became so weak that today we see rather return to authoritarian rule. This is actually the proof of conception that states: ‘when the system can deliver goods there would be no questions of what system itself represents’. Here arises the moot point about what conditions make state to be fully democratic or rephrasing Linz and Stepan to what state democracy is consolidated on the full scale. It is very relevant to new countries that became independents just a decade or so. It is claimed that democracy is government of the people, by the people and for the people. But it is in the same importance to have one who actually in power of the country. Democracy without leader is the same as ship without captain. Napoleon Bonaparte regarded state guidance as ‘A leader is a dealer in hope’. In order for any society to change, an individual must initiate the process. This is why political leadership plays such an important 29 29 For instance Marina Ottaway includes to the group of semi-authoritarian state such countries as Egypt, Venezuela, Croatia, Central Asian countries etc. (Ottaway Marina, Democracy Challenged: The Rise of Semi-Authoritarianism. Carnegie Endowment for International Peace, Washington, 2003)
in which direction the country will go, and what the outcome will be. Political leadership is the very complex thing for one important reason: when any person begins consolidating the power in order to fix the problems, he automatically to be regarded as dictator on the way to build his ‘empire’. On the other hand when there is no bright actual person on the political Olympus it creates even more distrust in state system as the whole, unless it is long last durable democracy. Thus, it creates the situation with zero winning. It affects mostly developing or undeveloped system. Today’s developing countries almost all arose from the authoritarian rule, which pictured them with some interesting peculiarities. It will be necessary to make some comparisons between Indonesian attempts to consolidating present democracy and the situation in countries of former Soviet Union, especially in focus of political leadership. Today almost all countries (with the exception of Baltic States) formerly belonging to the ‘Soviet brotherhood’ experience the reversal for authoritarian rule, some even are becoming no less than pseudo monarchies30. Many rulers in power prepare their successors from the family: some already implemented such scheme.31 As in Indonesia (just after declaring independence), early years of democracy were turbulent in post-soviet countries. In early 90th, population just a year ago experienced rather good life, suddenly faced vigorous crisis in every sphere. Hyper inflation, poverty rising, no own currency, no even basic democratic institutions: parliament, government bodies. Everything started from the very beginning. In these years, every country has its own leader who actually brought democracy to country: indeed they were ex-communist bureaucrats – former first secretaries of communist party. Obviously there was a necessity of one person who will be in charge to deal with abrupt problems and no one 30 Turkmenistan under the rule of Saparpurad Niyazov is now no more than monarchy. The rule of president (he even not called by president but Turkmenbashi – Father of all Turkmen) is legitimized until his death, no opposition, even months of the year now called in honor of Turkmenbashi. 31 Azerbaijan became the first country where after father, presidency regained his son. Aliyev’s family experience showed ‘men in power’ in other countries the way to continue their rule.
was known as these people were. It is interesting that many people do not even remember those first presidential elections on post-soviet area which actually show what crisis experienced countries, so for people on the early beginning on the first place was the question of survival, rather than participation in political life of the country. Thus, ex- communist party leaders regained the power but now in democratic countries. That how began not so successful process for transition toward democracy in post-soviet countries. Absence of political culture of citizens It is important to mention that the way how post-soviet countries achieved their independence directly affects to the emergence of present ‘no way out’ situation. As widely known the pivoting momentum in collapsing of the USSR was the demonstrations (mainly young people) in Moscow in August 1991. Particular crucial is that the outburst was in Russia and no other country has such experience. Moreover, Russia re-implemented the power of people’s movement in 1993 parliament crisis. It is very similar to Indonesia: along country’s history student movement was and is influential factor that finally overthrew Suharto’s dictatorship. The Asian economic crisis was one of the natural catalysts that led to outburst of people willingness and readiness to reform. Unlike Indonesia, CIS32 countries do not possess enough strong movement equal to the students in Indonesia. Russia is rather an exception. Thus, there is no obvious enough political awareness of citizen to claim democracy even in time of severe crisis. The political elite in Indonesia and post-soviet countries In three years - 1998-2001 - Indonesia had four presidents while most of the CIS countries had one or two presidents in almost 14 years. 32 CIS – Commonwealth of Independent States: actually an organization which includes all former soviet republics except Baltic States (Latvia, Estonia, Lithuania). In addition, CIS is regarded as the term which accounts 12 countries: Armenia, Azerbaijan, Belarusia, Georgia, Kazakhstan, Kyrgyzstan, Moldova, Russia, Tajikistan, Turkmenistan, Uzbekistan, and Ukraine.
is in turbulent situation of finding charismatic figure equal to Suharto. Many presidents in short period obviously add to the uncertainty and lack of trust in governing body. On the other hand it is feature of ‘ideal’ democracy: according Haggard and Kaufman’s definition of ‘depersonalization of executive authority’. Still one factor cannot overweight negative aspects. Fragmented Indonesian establishment often cannot act as one coherent unit. Although developments following the 1997 Asian crisis have been touted as offering opportunities for democracy to emerge, Indonesia’s uncertain governable conditions and sceptism even over new President Megawatie Sukarnoputri’s ability are tabled as evidence that the democratic process has indeed come to a full stop. Moreover, regarding other East Asian countries, we can point the same. Thailand’s willingness to elect a prime minister even though there was pending charges over his dishonestly in disclosing his wealth. In Malaysia, Mahathir’s management of leadership change by jailing his Deputy Anwar Ibrahim and using strong arm tactics to suppress dissent is peddled as yet another spot of evidence. Over in the Philippines, heir to deposed President Joseph Estrada, Gloria Magapacal Arroyo, is seen as held ransom to the traditional urban elites33. But still it is likely to have democratic chaos than the indeed nature of authoritarianism. The second case is obviously led toward re-creating either complete authoritarian or semi-authoritarian countries with the face of false democratic electiveness. There, the old communist system persists. The center in Moscow is gone and with it the parallel Party apparatus, but all else remains, with the state harnessed to the old ideological, organizational, and mobilization wagons that the Party used to pull. That in a case of vacuum of new leaders, the old elite simply renamed their ideals, abruptly becoming democratic ones. It is so called patriarchal leadership. This is a form of leadership where the people who will assume control are closely related to the present ruler, which is especially true in the cases and countries 33 James Gomez. www.thinkcentreasia.org
as if they have been given the right to lead and thus they almost unchangeable until voluntarily step down, death or finally, revolt. This raises a vital question: are the leaders who create an independent state the same leaders who have the vision to install democracy? A pro-liberal democrat would answer no in the case of Central Asia. After all, democracy seems to be only an empty word in the region, a ‘mantle of legitimacy’ in which to wrap authoritarian regimes in states ‘where leaders proclaim their adherence to the ideas of democracy but do everything they can to subvert the power of the people.’ What it is giving? Most importantly in the process of consolidating democracy there is a risk of happening or more likely remembrance of the ‘old times’ so called ‘authoritarian nostalgia’. And in this crucial moment it is the part of civil society not giving a chance for reversal. In addition, for instance, Haynes suggests that robust civil society is crucial for democratic consolidation. He uses Stepan’s explanation of what ideally civil society should be. For Stepan, civil society is the arena where social groups and movements, including full spectrum such as community associations, women’s groups, religious bodies and various professional organizations (lawyers, journalists, trade unions and so on), express themselves and seek to advance their interests vis-à- vis the state or leader, more importantly challenging the latter’s tendency to enlarge amount of power. Asymmetrical political leadership power in consolidated democracy There is a fundamental dilemma in political leadership as well as in consolidated democracy: the sources of power open to democratic actors are much more limited than those that are available to actors who willing to act undemocratically. The democratic parties and leaders are at serious disadvantage when trying to generate power, because the process is essentially asymmetric. Non-democratic organizations can use manipulation, coercion, and even open violence to further their goals. The democratic either ruling or opposition can only try to win elections. Even democratic opposition leaders that succeed in winning elections because of a temporary power vacuum can find it extremely difficult to continue the resources they need to govern,
they are not developing instantaneously. But when either democratically elected ruler or opposition try to use previous method, the country backs to authoritarian state, just because in latter countries, power is not generated through formal political institutions and processes. Leaders are elected but their power is rooted elsewhere. Since the power is not generated through elections, it cannot be taken and transferred through elections either. The greatest difficulty is structural one, namely the puzzle of how to transfer, through democratic process, without disturbing the first roots of democracy34. Simply, if power begins to be resided in a particular president, rather than in the institution of presidency, it cannot be transferred to others rightly. So in this situation it advantage to have the system of presidency with contested rivals although is not as charismatic as previous authoritarian ruler. There, it is a necessity to have Haggard and Kaufman’s ‘depersonalization of executive authority’. In political transition, the problem of generating power goes beyond the initial step of defeating the opposition, and extends to the challenge of governing. Generating power is an ongoing problem until a country stabilizes, and indeed until democracy consolidates to the point where other mechanisms for generating power become unthinkable. A new democratic government does not have the full benefit of relying on the institutions, because the institutions are rather new or need to be developed. In Indonesia, following spring-summer elections are the pivot for country on the crossroad, because they will be held according to new format of elections with new amendments to the constitution. They will show that how Indonesians ready to elect president and parliament directly. How durable is Indonesian consolidated democracy? The reality with no direct outcome or without clear favorite in the parliament and presidential elections bring additional burden to fragile system. There are some figures that can question Megawatie’s positions. For instance, Amien Rais, leader of the National Mandate Party (PAN), emphasize that country is still searching for a leader that could bring hope to the entire nation. Is Rais that person or still Megawatie? It is still too early to say. 34 Ottaway Marina, Democracy Challenged: The Rise of Semi-Authoritarianism. Carnegie Endowment for International Peace, Washington, 2003, p.175
will bring to country element of chaos, severe supporters can ruin roots of democracy by riots, what has been already seen, in time of regaining Wahid’s presidency. Even if she wins the elections it should be at least with two digit lead unless it still questions the strength of the system: in that case country would simply be divided. Moreover, in this scenario loose federal unity of Indonesia make to force the process of struggle for independence by some part of the country, for instance Aceh, due to growing inequalities and dissolution with government initiatives to cope with this issue. For instance, Habibie's decision to allow the referendum in East Timor in 1998 did not help Wahid in attempting to prevent further bloodshed; or demands for independence in various other provinces. Yet, it is uncertain whether Megawati will risk ‘sinking’ her presidency in a war of attrition in Aceh or Irian Jaya. It can be compared with India, being that it is the largest democracy on Earth. India became independent in 1947 after centuries of British domination, and has adopted the British system of Parliamentary Democracy. The country is divided into 25 states and seven union territories. Vast and loose territory possess danger with additionally that the Indian Constitution protects its inhabitants from all forms of discrimination, which was a major break from tradition (mostly from the Hindu Caste system), created severe hardships for the government. 2004 is an important year. This is the year when Indonesian democracy either opens its doors to a new wave of consolidation and reform or retreats along the historically familiar path towards a new kind of authoritarianism. These elections will decide whether Indonesian democracy will experience a rebirth or continue to suffer slow suffocation for a second time in fifty years. Yet it will testify of smooth political leadership in fragmented Indonesian politics. In addition, corruption is still cited as rampant and as having an impact on the proper dispensing of justice. The economic slowdown in the region is the final trump held up to dismiss the hopes of democracy advocates. Even though these events are taking place, it does not necessarily mean that the democracy process has been completely stalled with no hope of recovery or
contrary, the reverse is true. Democracy is very much alive, active and continues to grow. The central issue that proponents against democracy fail to understand is that the changes in leadership in the East Asia region actual show that democracy is fully functioning and that the emerging institutions are being used and tested. For Huntington, it will conclude ‘two-turnover test’. Democracy is however an ever- evolving state. As writes Zakaria: ‘Only in the late 1940s did most Western countries become full-fledged democracies, with universal adult suffrage’. References: Hanes Jeff, Democracy in the developing world. Polity Press, Cambridge, 2001. Huntington Samuel P. The third way of: Democratization in the late 20th century. University of Oklahoma Press, 1991 Linz, J and Stepan, A. Problems of Democratic Transition and Consolidation: Southern Europe, South America, and Post- Communist Europe, Baltimore, John Hopkins University Press, 1996 Kartasasmita Ginandjar. Indonesia: A country at a Crossroad. Waseda University 2004 Ottaway Marina, Democracy Challenged: The Rise of Semi- Authoritarianism. Carnegie Endowment for International Peace, Washington, 2003 Tan Gerald, Asian Development. Times Academic Press, Singapore, 2000
In Western societies there is a peculiar cultural orientation regarding the attitude of society towards democratic politics: this removes the leader from any pedestal of being ‘special’ and, as a consequence, there tends to be a social reluctance to acknowledge the very central role leaders play as catalysts of, or causes in, the occurrence of events. Haggard and Kaufman argue that in a democratic society, over the long term, that executive authority must eventually be depersonalized. During the past two decades, there was a remarkable resurgence of democracy all over the globe. However, democracy reverse did happen in some of them due to their inept and irresponsible leaders, who could not provide the country with good governance. In consolidating the democracy, therefore, must begin with the task of finding ept, responsible leaders to manage the affairs of the state for the overall good of the people. As we can see that what happened in Indonesia and other newly attained democracies fully illustrated this point. In this essay, I will Indonesia during and after the transition period as the case to illustrate some most important questions in analysis the role of a good leadership in consolidating the democracy. Indonesia Case As a newly attained democracy, Indonesia had been through a hard time in consolidating the democracy. During the 1997-1998 Asian Financial Crisis, the Suharto regime collapsed due to the inability to cope with the crisis, which triggered fierce social and political turmoil. His successor, Habibie initiated the democratic reform both in the political and economic field, and thus lay the foundation for democracy. However, Habibie was forced to withdraw from the president election due to rejection of his
what happened next was more dramatic and beyond imagination. Megawati, who was the leader of biggest party (DPI-P) in the parliament, lost the presidential election to Wahid, which was held only within the parliament. That is to say that even not all the DPI-P party member voted for her, because she is a women, which is a fatal weakness for women to participate in politics in any Islamic country. In other word, it was Megawati who elected Wahid. After Wahid took the office, as time went by, his incompetence was shown gradually. Just as Prof. Ginandjar Kartasasmita describes in his monograph, that “his (Wahid’s) daring departure from accepted political norms while endearing him to some elites and foreign admires had eroded his political support, which without Megawati was on the thin ice any way.” “His random firing of ministers without clear explanation antagonized the polity.” 35 What made thing worse was due to his physical condition. He could hardly see and thus “those around him may take advantage of this condition for their gain.”36In the economic field, his policies were also “ill-advised and irresponsible, as they were not based on careful consideration with the experts, but were intended mainly to advance his political popularity at the cost of the economy”.37 And thus cause the economic, political and security condition deteriorated. And all these reached the peak when the parliament set up a special commission to investigate the scandals indirectly related to Wahid. The findings of the commission indicated that the president was involved in the scandals. But Wahid, “instead of following the constitutional procedure to defend his presidency, chose to be aggressive.” After the special commission submitted the report to the parliament, he threat to issue a presidential decree to declare a state of emergency and dissolve the parliament if the parliament persisted with the memoranda process, and he did issue a decree to 35 Kartasasmita, Ginandjar, “Indonesia: A Country At A Crossroad”, 2004, “the political limbo” in chapter 2. 36 Ibid. 37 Ibid.
the parliament decided to proceed the process of investigation. Fortunately, because Wahid did not get the support from the military, and finally he failed in the struggle against the parliament and the democratic constitution and was impeached immediately. Megawati, at that time as the vice president, became the forth president. And thus the democratic reversal was avoided. But the country suffered a lot in its recovery from the financial crisis due to the policies adopted by irresponsible leader and turmoil caused by the political conflicts. Lessons to be learned Actually, what happened in Indonesia was not an extreme example, the same could be found in some countries such as Russia and Eastern European countries. So what we can learn from the case of Indonesia? I am going to discuss the following two questions, which are, to me, the most important questions we should have a clear answer in analysis the role of the leadership in consolidating the democracy. Firstly, is a democratic system the guarantee of democracy? As we can see in the case of Indonesia, there was a democratic system backed by the Constitution and the democratically elected parliament. Wahid became the president through the democratic process. But after he became the president, the democratic system did not affect him much in his daily operation of his duty, even in the case of executive abuse. Should he get the support from the military and declare the state of emergence, Wahid could be in a stronger position in dealing with the parliament, and it could be hard to predict the outcome. So it is safe to say that democratic system is only a guarantee for democracy, but not the guarantee. Just as someone said that a good system is nothing without good people to run it. To build a good democracy, leadership is also an important factor affected the quality of democracy, if not the most important. Leadership is a challenge at the best of times, but it is much easier to be a leader when all is going well; it is when things are going awry that leadership becomes an even bigger challenge, when those around the leader look up to him or her for guidance. By themselves, external events do not determine what happens in
those events that matter. The conduct of leaders, therefore, is crucial; how they receive, process, and respond to outside pressure can make a difference in both the pace and outcome of democratization. Secondly, What role should the emergency powers held by the political leaders play? As we know, the decision-making process in democracy slow and costly. So in most democracies, either the constitution or informal understanding provide executive with some emergency powers to respond to national crises in ways that “bypass the normal legislative procedures”38 in order to make a prompt response or to make efficient decisions. Most constitutions also endow executives with more routine forms of legislative authority. Such authority includes: veto, the power to introduce legislation, and the power to issue decrees subject to congressional approval, and in some cases, rights of dissolving the parliament and calling for a new election etc.39 These emergency powers can, on one hand, ensure the government perform more efficiently and flexible in dealing with different situation, especially in time of crisis; but, on the other hand, “the exploitation of broad emergency powers carries far more serious implications for democratic consolidation than does the routine and circumscribed delegation of decision-making authority in particular policy areas.”40 So in this regards, a good system is a balance between the democratic decision-making and quick responding to the crisis. The checks on power which democratic society has painfully evolved, “the avoidance of cataclysmic changes that produce anomic condition, are major safeguards against irresponsible and irrational leadership.” 41 This is extremely important in those newly attained democracies, such as Indonesia, because all these 38 Haggard, Stephan and Kaufman, Robert, “ the Political Economy of Democratic Transitions”, New Jersey: Princeton University Press, 1995, p.336 39 Ibid. 40 Ibid, p.338 41 Abse, Wilfred and Jessner, Lucie, the Psychodynamic Aspect of Leadership in Graubard, Stephen ed. Excellence and Leadership in a Democracy. New York: Columbia University Press, 1962. p.87
if we did not manage it carefully, the democratic reverse could happen. And lastly, I will discuss what the criteria of a competent leader are. The reason why I rise this question is because in most of the newly attained democracies such as Indonesia, as I mentioned above, had gone through a long history of authoritarian regime. The leaders of the country were regarded as heroes in the struggle of the independence. People respect them because they did a lot for the country. But the question is: are these leaders competent in the democratic system? As we all know that, man has since creation been identified as having an inherent passion for wrongdoing. A good competent leader ready to safeguard the democracy is, therefore, the one who, as the person entrusted with the serious business of making decisions that affect the lives of the people in his society, ensures that sufficient information on a given policy issue is obtained and adequately analyzed. A good leader, must, in making decisions that affect the lives of the people, conduct a thorough search for a relatively wide range of options, and must carefully evaluate the expected consequences of each option. He must possess the capacity to anticipate the problems, which are likely to arise in implementing the option under consideration. A good leader cultivates the trust of all the parties and interest groups through open, honest dialogue. Above all, he must remain receptive to clear signals that current policies are not working. He must, therefore, possess the capacity and willingness to learn quickly from experience. Of course, it is extremely difficult to find a leader with so many merits, so, the efficient and rule-based mechanism should be built by which the best of each generation are brought into the political leadership. Conclusion Through the above discussion, we can easily draw the conclusion that to safeguard and consolidate the newly attained democracy, good leadership should and must be built in line with the good democratic system. Someone may argue that the democratic system is the paramount guarantee in consolidating the democracy, while a strong leadership can more or less undermine the quality the
true, as Haggard and Kaufman pointed out that “a strong executive is not a reliable substitute for organized party support that can provide cohesive legislative and electoral backing for the government’s policy course”, and if “parties are weak and legislative majorities unstable, executives risk difficulty in sustaining reforms”42 and thus harm the democracy. So we must bear in mind that good systems do not surely guarantee the success of democracy, good governance back by the ept and competent leadership is an indiscerptible part of a good quality democracy, which is vital to those newly attained democracies to survive and have a sustainable development. Bibliography Haggard, Stephan and Kaufman, Robert, “ the Political Economy of Democratic Transitions”, New Jersey: Princeton University Press, 1995. Kartasasmita, Ginandjar: Indonesia: a country at a crossroad. Graubard, Stephen ed. Excellence and Leadership in a Democracy. New York: Columbia University Press, 1962. Stivers, Camilla ed. Democracy, Bureaucracy, and the study of Administration. Oxford: Westview Press, 2000 42 Haggard and Kaufman, p.165
About me and this paper First of all I would like to give a little background about myself. After living in the U.S. for 15 years, I was spoiled by democracy and was never a fan of politics; therefore I failed to pursue insights on exactly what democracy is, and how that there are many other countries in the world today striving hard to establish a democracy similar that of the U.S.. Indonesia is an example of a country consolidating and solidifying democracy. However, it was during this class that made me understand and realize more about what democracy is, and by history, many bloodsheds, reforms and compromises took place to pave the road to democracy. I knew nothing about Indonesia prior to taking the Public Administration class, other than that it is a country close to Malaysia. It was a pity that the class was too crammed into one week so I could only absorb a limited understanding of Indonesia’s history and system. My paper focuses on topic #5: Leadership deficit. I started by giving an introduction about Indonesia- about its features and history. Then, I proceed to talking about the country’s situations and its attempts to establish democracy. Thirdly, I started by giving a brief history as well as mentioning the weakness of each of the president- starting from Sukarno to Wahid. I did not talk about Megawati because she is still in incumbency, and there was limited information from the text about her term. Lastly, I went over and summarized the overall weaknesses that most of the leaders have- including corruption, arrogance, incompetence, or a mixture of three, and I mentioned about factors that made the political leadership hard in Indonesia. I am sorry that due to my limited knowledge learned from the class last week, my paper may not be as insightful and in-depth as others. However, writing this report is mandatory but I really enjoyed taking the class. I gained better understanding to
election this year. Final Paper Indonesia is the world's largest archipelago, with more than 13,000 islands, of which 5,000 are inhabited; the nation has a population of more than 220 million as of 200343. It is also the third largest democratic nations in the world, and a nation with diversified religions consisted but limited to Muslims, Protestants, Catholics, Hindu and Buddhists. During the Dutch colonialism, the Indonesia indigenous population was exposed to western concepts of freedom, justice, individual rights and democracy. Also, the offering of education led to the rise of a new class of elites among the people, which formed the seed of future leaders. Ever since it achieved independence from the Netherlands in 1949, Indonesia went through a series of great reforms towards democracy and trying to brining political, social and economic stabilities to the nation. The nation also went through a transition from authoritarianism started by Sukarno, to democracy. The transition to democracy, however, was difficult. The military had a lot of power, and at times were used abusively to dominate the situations. On the religious aspects, the Muslims strived furiously to include the Jakarta charter in the constitution, while other non-Muslim religious factions opposed. Economic disasters, particularly the Asian economic crisis of 1997-1998, seriously affected Indonesia. Banks were closing down, and inflations sky rocketed, while the national currency depreciated greatly. There were riots and extremist activities. People were in despair. The public tried to seek help from the government. They put their faiths and hopes on to the political leaders that would guide them and bring them out of the difficulties. Since the crisis- from 1998 until now, Indonesia went through four presidents. With so many changes in political leaderships in such a short period of time signified the public’s discontent with these leaders. Suharto, Habibie, and Wahid were all forced to leave the office before their term expired. Megawati is still incumbent, but an election is due later this year (2004.) Political leadership in 43 Kartasasmita, Ginandjar. 2004. Indonesia: A Country at a Crossroad: p.1
very difficult position. With the nation simultaneously confronting political, economic, and social crisis, political leaders were revered as the source and the solution to these problems. With each successive leader he/she often inherited and had to deal with the problems from the previous leader(s). Throughout the country’s history, many leaders had ambitious goals and ideals, but often left with broken promises. Sukarno, the country’s first president, assumed presidency for two decades, and is honored as the founding father of the nation. He united Indonesia and set it free. He liberated his people from a sense of inferiority and made them feel proud to be Indonesian. “What Sukarno did on Aug. 17, 1945 was no different from what Thomas Jefferson had done for Americans on July 4, 1776. Perhaps even more: Sukarno was the only Asian leader of the modern era able to unify people of such differing ethnic, cultural and religious backgrounds without shedding a drop of blood.44” In 1959 Sukarno proposed “guided democracy”, which, in my opinion, is just another way of saying authoritarianism. He ended liberal democracy in the country, and gained powers beyond what was stated in the constitution. It was also during Sukarno’s time that he started confrontasi, separating the nation’s relationship from the western world, refusing their aid, and Indonesia became the first country ever to withdraw from the United Nations. The result gave advantage to PKI, and thus intensified communist activities and political turmoil in Indonesia. His misguided policies lead the nation into further crisis and increased suffering for the people. He ruled in the form of limited dictatorship. However, despite the negatives sides, people still worshipped him. “He was regarded in many parts of the world as a great leader and a world statesman” (Legge, 1985: 370-371). Sukarno’s downfall came to play when he failed to act against PKI and showed reluctance to issue an order to deal with the rebellion that started a coup and attempted to take over the nation via military when they found out about Sukarno’s deteriorating health. His indecisiveness in dealing with the rebellion caused a public stir, and some even accused him of associating with the Communists. Sukarno did a fantastic job by obtaining independence for Indonesia; however, I think he is too 44 Toer, TIME MAGAZINE, Aug 23-30, 1999 Vol. 154 No .7/8
and the confrontasi as well as the decision to withdraw from UN- which broke the nation from foreign aid, and made Indonesia more prone to the rise of internal political turmoil- in this case the strengthening and enacting of Communist power and activities. With such great economic and political crisis and the lack of foreign support, Indonesia could only help itself due to Sukarno’s decision in trying to be too independent and too quickly. Suharto assumed the position as the second president, and enjoyed the longest presidency in the history of Indonesia for three deaces. He gained power and public support after mobilizing the loyal military forces after the communist coup attempt by PKI. MPRS eventually dismissed Sukarno and Suharto succeeded as the president. Suharto, however, had his side of problems as a leader. He abused his power from the start: he exercised nepotism- favoring family and close associates and giving them advantages, such as appointing his daughter and close associates to political positions, and even gave his son the priority for his bank. His endorsement towards exceptional treatments of first family assets led to the conflict between Suharto and the IMF when trying to resolve financial crisis. As time progressed, Suharto showed great discontent towards the IMF, and the conflict stirred the public. Upon the signing of LOI (also known as the 50-point plan) in 1998, Suharto agreed to sign by displayed obvious doubtfulness with the plan. He exercised a “guerrilla warfare” tactic with the IMF, and caused the Indonesia government’s relationship with the IMF to reach an all-time-low. Despite the public’s fear of the growing antagonistic relationship between the country and the IMF, they still decided to support Suharto during the crisis era, as they did not think changing the leadership was a good idea during the time of crisis. Suharto’s power grew even stronger. However, on the negotiation of fuel subsidies with IMF, Suharto made decisions against the advices of his economic team and instead on his own will. His support from the public began to erode, as he demonstrated obvious signs of anti-cooperation with the IMF and even his own economic team. Suharto’s poor health also weakened public’s faith for him. Suharto’s undemocratic control, with strong military support to enforce his power, appointing his family and close members to further strengthen his political dominance, distrusts in his team (including the vice president and his economic
contributed to his downfall and displayed obvious signs of dictatorship. Unlike Sukarno, Suharto was more merciless, and killed or imprisoned hundreds of thousands of people to establish his New Order regime45. Thus few dared to challenge him. Although in a way Suharto was thinking for the country, but beyond that he ruled like a dictator, and thought first for himself and his family. Many times he represented his self interest more than the decisions and wants of the public. Habibie started his presidency after Suharto resigned, but the country was in deep political turmoil. It was during his era that Indonesia’s economy was stabilized, the Central Banks got its independency, and the ending of Suharto’s dictatorship reigns to the initiation of democratic reforms with open political system and setting up infrastructure for the democratic government. However, he was publicly berated for bowing to international pressure and permitting the UN-sponsored referendum in East Timor, which caused Indonesia to have bad international relations; as well as being embroiled in the ongoing Bank Bali scandal and coming under fire for dropping investigations into the Suharto family's business empires46. In particular, the East Timor post referendum carnages and the Bank Bali affair had soured the relationship between Habibie and the IMF. The result also made Habibie lost his votes in the presidential re-election. Habibie withdrew from the candidacy for president when his accountability report was rejected by the MPR in late 1999. Abdurrahman Wahid was elected democratically by MPR as the third president. Wahid’s unorthodox approach to governance, though, brought him and Indonesia a lot of trouble: his promise of increasing the civilians’ salaries substantially without first consulting his financial advisor was one of the empty promises he made. His relationship with the military was further deteriorated when he tried to promote young progressives reformists in the military. His wait-and-see attitude to solving problems had exasperated many people. And a lot of his accusations and sayings were made without sufficient proof. An example is his accusing of his ministers and even Suharto of corruption without giving any 45 Toer, TIME MAGAZINE, Aug 23-30, 1999 Vol. 154 No .7/8 46 Synolds, Peter. World Socialist Web Site: October, 21 1999.
Megawati, and firing ministers without clear explanations, which started friction with the parliament. He also kept on changing and even reversing his policies, confusing the government. And, like Suharto, Wahid appointed cabinet members that benefited him, while dismissing other prominent figures. His economic policies were largely ill- advised, and mainly based on to better advance his popularity. Again, like Suharto, Wahid shown nepotism. And lastly, the two scandals of the “Buloggate and Bruneigate made the MPR dismiss Wahid, and made Megawati as the fourth president. Huntington foresighted the new leaders of democracy as “arrogant, incompetent, or corrupt, or some combination of all three” “(ibid: 256). Suharto, Habibie and Wahid all displayed combinations of the characteristics as what Huntington predicted. Many political leaders, when they assumed their position, started to wrongfully exercise their power as the president and used it towards their own motives- nepotism, illegal financial activities, big promises without enactment or realistic consideration, the act or attempt to dethrone or dismiss other political powers that are not standing on the same sides are some of the factors of corruption. The over confidence in thinking that his actions are right without careful observation and communication with team members is an example of arrogance as well as demonstrating incompetence when the decision made failed to alleviate or improve the situation. The first four presidents displayed a form of authoritarianism in one way, over-favoring personal judgments over his team’s and the public’s. However, it is also during the crisis that the country as a whole, and the government system, gradually approached the road to democracy. Indonesia comprised of various religious parties so it is difficult for a political leader to simultaneously satisfy all the religious groups and gain their support. For example, Muslims, the biggest religion practiced in Indonesia, favored in including the Jakarta Charter in the constitution. Other religious groups opposed. And it was after years of struggle and the embracement of democracy as the “freedom for all” that it was not included in the constitution. And, to gain the biggest religious support, the political leaders would need to support ideas that would favor or obtain the approval from the Muslims. Without the Muslim group for support, a political leader would be fragile in power. This could
doctrines or making decisions since the leaders would need to consider the possible side effects if their decisions are not supported by Muslims. As Huntington stated, “democracy does not mean that problem will be solved; it does mean that rulers can be removed; and the essence of democratic behavior is doing the latter because it is impossible to do the former” (ibid 210). Democracy does not solve the problem. Instead, it is a more liberal form of system that gives “equality of rights, opportunity, and treatment.47” In democracy, people vote for the government and the leader. The Third Amendment 2001 provided direct election by the people of the President and the Vice president, and the ability to impeach the president by assembly (MPR). The upcoming election in Indonesia this year will be the most democratic election to date, where as in the past the military and other authoritarian as well as religious regimes play the major role in forming the politics. And, unlike the Communist regime in which the leaders can’t be overthrown (to my knowledge), Indonesia showed examples of democratic practices when it impeached and dismissed a few of its presidents during history when the leaders showed obvious flaws, infringed the laws, or demonstrated incompetence. However, having an established democratic system does not guarantee that the nation will be peace and worry-free, and that factors such as the economic crisis would be solved. The public needs to understand this importance and not always blaming on the leaders if they failed to resolve a crisis. Corruption is a common and big problem that has been practiced not only by many of the leaders in Indonesia, as well as many other leaders and prominent figures all over the world. It is a natural tendency for a person to be greedy and become unjust once he or she assumes great power. Balancing the power between legislative, judicial and executive departments can help reduce corruptions, and with people voting and nominating the government, practices such as nepotism can be eliminated, and better representation and fairer rights to the people, for the people, and by the people can be achieved. 47 Webster’s New World Dictionary of the American Language, 1983.
close with his or her advisors. The leader should not be alone. Sukarno, Suharto, and Wahid demonstrated arrogance in making decisions mainly on own beliefs and thinking, and did not work with their advisors and team members. Democracy should represent people and the public, not at self interest. And, in the event that the leader believes strongly in his or her ideals and decisions, sufficient evidences should be obtained and presented and have the whole group decide. The political leader should be in reasonably good health. Suharto’s news of poor health caused a public stir, and instigated political instabilities and loss of faith in his group. In Sukarno’s case, the Communist took advantage and started a coup by obtaining to gain control by military. To reduce the likelihood of such problems from resurfacing, the political leader should possess good health. A good leader should possess good international relationships. In the case of IMF and the World Bank trying to salvage Indonesia from its economic crisis, if for any chance a leader does not agree with the world organization, he or she should not reject so boldly. Bad relationships with these world organizations would instigate fears in the public, and causing the economy to drop even more, and also causing further political instability. Also, breaking ties with UN during Sukarno’s regime was a very bad move, especially during the time that Indonesia was still going through a transition and the nation was still young and therefore infantile in economy and politics. Decentralization is taking place in the Indonesia political as well as financial structure. Fiscal decentralization as well as the brining down of military power in politics helped Indonesia to further decentralize with more fair justice. In the past, as can be seen particularly in Suharto’s regime, military support to the leaders were often seen as a big control and source of power because of military’s big role in politics. The Second Amendment 2000 brought further decentralization and regional autonomy. However, in my opinion, too much decentralization at a rapid pace may not be a good thing, as the country is still not trying to recuperate from the economic crisis, and with the recent political instability and frequent riots, I believe that decentralization should
of time. I, do, however, agree with the part that elections should be totally democratic- which has been practiced in the United States. This will give each citizen equal opportunity to vote and to voice their opinions without regarding ranks, nobility, and power. To transition from authoritarianism to democracy takes time, and can be a difficult process. From Sukarno’s authoritarianistic rule to Habibie’s consolidation of democracy, we see a big change and many reforms and problems in-between. However, the nation is on its course to solidifying the newly attained democracy. It takes time, as unsuccessful democracy can revert easily back to the traditional authoritarianism. More over, “the system is as good as the people who run it.”48 So to elect a fair, just, and capable leader representing the people would contribute to better democracy and the better of the nation. Bibliography Guralnik, David B. 1983. Webster’s New World Dictionary of the American Language. Warner Books. New York, New York Huntington, Samuel P. 1991. The Third Wave: Democratization in the Late Twentieth Century. Oklahoma: University of Oklahoma Press Kartasasmita, Ginandjar. 2004. Indonesia: A Country at a Crossroad. Waseda University, Tokyo, Japan Synolds, Peter. World Socialist Web Site: October, 21 1999, http://www.wsws.org/articles/1999/ oct1999/ind-o21.shtml> Toer, Pramoedya Ananta. Time Asia: August 23-30, 1999 Vol. 154 No. 7/8, http://www. time.com/time/asia/asia/magazine/1999/990823/sukarno1.ht ml> 48 Source: Essay #5: Leadership Deficits handout, by professor Ginandjar
Democracy is the form of government in which the supreme power is retained and exercised by the people. In Democratic Government, the principles of human rights, the freedom of speech and the principle of equality are declared. In all the democratic phases, before and after democracy is consolidated, leadership is considered to be of great importance. A capable leader is the one that will inspire the democratic principles to the people of his country. Nowadays, much emphasis has been given to the sense of the leadership. In consolidating and solidifying democracy, leadership plays the main role that will lead the whole nation into consolidated democracy. Indonesia, Democracy and Leadership At this point, it would have been very helpful for our research to identify the leadership skills and characteristics of the Presidents in Indonesia, as well as the leadership deficit. Indonesia has been into transitional democracy during almost the half of the 20th century. The 32 years rule of President Suharto is considered to be a long period where a person used to control many aspects of political life. It should be mentioned that he ruled through military control and media censorship, and controlled the finance by giving easy deals and monopolies to his relatives, including his six children. He purged the parliament of communists, crushed labour organizations and even increased press censorship. The Asian financial crisis of 1997 revealed many aspects of the political, economical and social situation as well as the corruption which became profound. However, after numerous demonstrations and political and army pressure against him, Pr. Suharto was forced to resign on May 21, 1998.
to convince as a leader. His political behavior was mostly self-oriented and even in the period of severe crisis when the nation has been really suffering, he continued the same kind of behavior. He was not opened to criticism or opposition, that is why he placed much control on the press. A leader is open-minded when he is willing to listen to other people’s ideas and opinions. A leader also cares about the consequences of his actions and decisions on the people. Therefore he is determined to accept criticism in order to improve himself and not to repeat the same mistakes again. The most of the times criticism is a feetback for the leaders in order to judge how effetive they are and in which points they should improve their policies. After the strong impact Suharto’s government policy and leadership had on the national consciousness, President Megawati’s party seemed to be the only solution to the political quagmire of the former leaders and the leadership deficit they caused. Megawati immediately became hugely popular, despite her lack of experience, mainly because of her name, but also because she was seen as free of corruption and having admirable personal qualities. From all the above-mentioned situation we can argue that ex- president Suharto was judged for his actions and his inability to bring Indonesia out of the crisis. His lack of democratic leadership has as a consequence social confusion and unrest. Under these circumstances President Megawati’s party was recognized as a savior, that would lead the country out of that economic and social turmoil. The effects of political leadership The experience of Indonesia at the past few years shows that inept leadership have led to more failures of policy than successes, more instability and wasted energy in political conflict than peaceful progress and coherence. We can understand that leadership deficit has played a great role in the political life of Indonesia. Unfortunately, the incapability of a president to take political decisions and his unwillingness to contribute to the social stability and good of his country is considered to be very negative for the process into consolidated democracy. The reason is that
and might lead to the fact that people will lose their faith in the democratic procedures. People’s loyalty to democracy will be strained. On the other hand there are several cases where political leaders during democratic transition managed to keep the nation united and inspire to the people of the country the democratic principles. For instance, Constantinos Caramanlis after the restoration of Democracy in 1974 managed to organize and establish democracy in Greece. As a conclusion, leaders play a significant role in how the democracy can be consolidated through their actions and political decisions during especially the democratic transition. Moreover, it should be mentioned that a capable and committed leader is considered to be the main factor in the progress of consolidated democracies as well. Two Types of Leadership The last years there is an expanded research of several scholars concerning the quality and effectiveness of political leadership. The scholar Erwin C. Hargrove refers to two kinds of leadership in the book “Leadership and Politics”. The first kind is transforming and the second kind is transactional; one changes the paradigm, whereas the other maintains it. The definition of transforming and transactional leadership is generally used in business management but its principles can find utilization in political leadership too. Transforming leaders articulate the principles of creation and renewal world. Transforming leaders during the democratic transition investigate what should be changed and how. They consider the problems of establishing the democratic procedures and forward the democratic transformations in order to set the basis on which the democratic institution will be sustained. Transactional leaders work within the stable confines of a mixed set of goals and purposes in a rational-choice world. Transactional leader helps the democratic institution to work effectively by providing the proper support to the newly attained democracy.
and Politics” defines the difference between the individual and political leader. Individual leaders need not to be skilled manipulators of rhetorical debates. Leaders focus on the most positive symbols associated with their policies, while avoiding those that might attract opponents. These strategies of policy making and consensus building are the means by which policy makers attempt to achieve their goals. On the other hand, political leaders’ position differs to that of individual leaders. Political leaders operate in situations of ambiguity or of rationality. The interaction of their leadership strategies, the cultural symbols that they are able to manipulate, and the institutional and social contexts within they operate determine their success. The ambiguity that is transparent in many situations creates the opportunity for leadership to emerge. Effective leaders thrive on ambiguity, since it creates choices and opportunities for them to portray their issues in different ways, seeking out the arena in which they will be most successful. Leadership is a function of individual skills and the manipulation of symbols, as the biological analogy notes, but it is severely constrained or enhanced by the institutional and social environment, as the physics analogy remind us. Characteristics of Political Leadership Above we mentioned the case of the leadership deficit. Now, it is time to talk about the characteristics of political leadership that fulfill its mission. Leadership in politics implies honesty, respect, motivation, vision, determination, communication, commitment, intellectual skills, mental and emotional health and finally, accountability. Each one of the above should be analyzed separately in order their meaning to be defined in the possible extent: Honesty has to do with the leader’s character. The honest leader does not hide the truth or the facts concerning political issues. He is willing to act in such a way in order to protect the truth at any cost. The leader also should respect the people to whom his political decisions and behavior will have an effect and act according to that.
and be in position to communicate his vision to the people of his country. The vision is very important for a leader while in case it does not exist it can cause problems in the way goals are set and how they are achieved. The vision clarifies the goals and informs the people in which direction a country is going. Citizens feel the need, especially in a transitional democracy, to have a capable leader who is determined to lead the country into change. The leader should have the ability to communicate the vision to the people of his country. The lack of it will cause many social and political disappointments, insecurity and instability. The leader should be committed to his vision because in this way he will be able to inspire the citizens and unite them. Intellectual skills, mental and emotional health are the leader’s characteristics that will contribute to better leadership. Leading a country is not a simple issue that is why the skills and health should accompany the leader. Accountability is another concept regarding leadership. The leader should be accountable for his actions, should not hesitate to recognize and admit his mistakes, view the future and move forward. The entire above are considered to be the characteristics of a leader who is able to overcome all the problems and contribute to the democratic consolidation. In this way the leadership deficit can be overcome and people can find the fulfillment of their democratic expectations in the face and the stable character of a leader. As the philosopher Solon said, “The best government is when the citizens obey to the leaders and the leaders obey to the laws”. This is how the balance can be sustained among the people of a country. In this way, the leaders set a good example and the citizens get inspired by them. Bibliography Samuel P. Huntington, “The Third Wave: Democratization in the Late Twentieth Century”, University of Oklahoma, Press Norman, Oklahoma, 1991 “Leadership and Politics” edited by Bryan D. Jones, University Press of Kansas, 1989
Brian McNair, “An Introduction to Political Communication”, Routledge, 2003 Douglas E. Ramage, “Politics in Indonesia, Democracy, Islam, and the Ideology of Tolerance”, Routledge, 1995 “Reinventing Indonesia”, Kartasasmita Ginandjar, Weatherhead Center for International Affairs, Harvard University and Joseph Stern, John F. Kennedy School of Government, Harvard University “Indonesia: A Country at a Crossroad by Ginandjar Kartasasmita”, Waseda University, February 2004 Haggard, Stephen and Robert R. Kaufman, “The Political Economy of Democratic Transitions”, Princeton University Press, 1995
in Indonesia By: Jerry Fadlinsyah (Indonesia) Historical Background Strong political institutions have not been a hall mark of Third World governments. With few exceptions, colonialism in Asia and Africa left a legacy of only undeveloped governmental institutions and even less-formed political party and interest group organizations. In these less-structured environments, personal rule has been the almost inevitable alternative. Strong individuals, typically supported by militaries, installed themselves in presidential palace (formerly the residences of governors-general, also originally installed by militaries) and swept away the fragile and hastily erected democracy scaffolding of late colonialism. Most of the newly independent states after colonialism in 1940s did in fact become representative democracies at the moment of independence. Representative democracies reflect self- determination which would be realized in the form of popular governance domestically as well as freedom from control internationally. Indonesia adopted a European-style parliament constitution, the Constitution of 1950, shortly after the transfer of sovereignty from the Netherlands at the end of 1949. Under this constitution, many Western scholars believe, Indonesians enjoyed the same freedoms of speech, press, assembly and so on as citizens of democracies elsewhere. In anticipation of elections, political parties emerged and began to organize throughout the country. When national parliamentary elections were held in 1955, the 91.5% turnout of registered voters displayed vividly the extent to which Indonesians had become politically mobilized citizens of the new country. On 1 July 1959, President Sukarno, in alliance with the army, decreed a return to the revolutionary 1945 Constitution, which enabled the executive to dominate the legislative branch. No elections were held during the brief period of Sukarno’s leftist
assassination of six top army generals in the coup d’etat held by Indonesian Communist Party in the early morning hours of 1 October 1965. The New Order government in some respects, notably foreign and economic policy, was indeed very successful. In terms of political structure, however, President Suharto also headed relatively a non-democratic regime that relied heavily on coercion to suppress the articulation of a wide range of political interests. Many analyzed the extraordinary leadership skills of President Suharto, who has managed for more than thirty years to accumulate and mobilize a winning combination of political resources of intimidation, exchange, persuasion, and organization. More specifically, President Suharto’s genius as a political entrepreneur; has been his ability to see that political order based on military dominance, with himself as the head, could be built and maintained with resources acquired through market-oriented economic policies. Nevertheless, the effective leadership of President Suharto eventually led to the fall of the New Order regime in the 1997-98 multi-crisis. I personally argue that rules-based mechanisms play an important role to achieve good leadership. Both previous regimes (Guided Democracy and the New Order) demonstrated that the 1945 Constitution was not a barrier to the accumulation of power in the hands of the president. I support many experts who have reasoned to blame the failure of Indonesian democracy on the original 1945 Constitution. It is hoped that with the weaknesses corrected, Indonesia may function better with an internationally accepted democracy. Reform Process Even though some underestimated him when he started the presidency, it was gradually more recognized that President Habibie was a key mover towards democracy in Indonesia. He administrated the taking apart of the political structure that for long period had characterized a political system that did not meet the generally democratic norms. He established a free and open political system and created the infrastructure for a democratic government. He transformed the society’s political culture by
respect for human rights. In his presidency, President Habibie initiated constitutional reform through some processes of amendment. The most important point achieved – related to this discussion – is a term limit of two consecutive five-year presidential terms. It means that the president will be eligible for reelection only once. I strongly value this point because it will secure the risk opened by the original 1945 Constitution for presidents to remain in power indefinitely. Non-democratic regimes usually abuse the power given by the people and have unreliable arrangements for legitimate transfer of power. There is widespread presumptions that countries ruled by for extended periods by authoritarian leaders degenerate into chaos when those rulers die or when their special personal status no longer holds the lid on their countries’ tensions. Some hypotheses see prolonged leadership as an obstacle to incremental change and hence it ends as likely to release pent-up forces and produce major political instability. Consolidating Newly Attained Democracy A good system is nothing without good leaders to implement it. After democratization requires an effective and transparent set of rules-based mechanisms which lead to the establishment of a system – the institutions, the processes and procedures, then what come next will be an excellent political leadership. Indonesia as a country going through transition with many problems facing, demands individual leaders with the perfect mixture of vision, integrity, and political savoir-faire. Indonesia had enough and does not need political opportunists who just want to satisfy their personal interests. Effective leaders have some distinguished characteristics both from heredity’s traits and career experience (Kotter, 1990). Traits from heredity may reveal in the forms of drive/energy level, intelligence/intellectual skills, mental/emotional health, integrity, continuous challenge and competitiveness, continuous learning or self-improvement. In the era of global network, sense of challenge and competitiveness are greatly required to bring Indonesia into a well-developed status and play an important role in the world.
assignments, experience of leading people, and having visible leadership models which are very good or very bad. The last part is worthy in order to take some valuable lessons successes and failures from the previous leaders. Leadership includes three crucial matters, as follows: Establishing direction: developing a vision of Indonesia in the future – both near and distant future – and strategies for producing the changes needed to achieve that vision. Aligning people: communicating direction in words and deeds to all of those whose cooperation may be needed so as to influence the creation of coalitions that understand the vision and strategies and that accept their validity. Committing to the spirit of a better condition: motivating and energizing people by providing egalitarian income distribution and welfare policies to overcome major problems in politics, security, defense, economics, social-welfare, culture, religious affairs, and so on. Conclusion Specific problems of political leadership with the purpose of consolidating and solidifying the newly attained democracy in Indonesia can be swept away by gaining both performance legitimation and symbolic legitimation. In what sense does performance legitimation institutionalize the newly established democratic regime? First, performance legitimation must not be understood in the context of repression of the opposition, which will also legitimize the particular regime for those inside it. Secondly, to the degree to which performance is complex, many-stranded system of benefits, should not be manipulated by any leaders of Indonesia. And the success with which it had been manipulated thus far was a powerful incentive to keep the mechanism running smoothly. Thirdly, the newly established democratic regime must understand the relationship between squeaky wheels and grease, between the demands of powerful social groups and the need to respond to them. Subsequently, the regime can vanquish any groups who are
only to get bigger share for them. Therefore, performance legitimation should be achieved based on the ways to improve the accomplishment of the newly established democratic regime. Regime performance can be perceived as both political outputs and the character of the regime as well as the material conditions it generates; it is simply about political as well as economic performance. Symbolic legitimation is more related to how preeminent to reinforce the political culture, extend democracy, and augment political institutionalization. A solid political culture will provide cognitive collaboration for remaining in democratic procedures. Extending democracy means the free competition for power – implies a whole list of freedoms and rights (including civil peace, reduction of political violence, basic civil liberties, temporal limits to power, possibility of accountability, and a margin of tolerance for government failure) which citizens do not enjoy in other political systems and that are in themselves valuable. Political institutionalization requires the consolidation of the institutions of political parties, legislatures, electoral system; horizontal accountability, constitutionalism and the rule of law; and the bureaucracy. Optimistically, Indonesia will maintain its newly attained democracy and keep the nation together regardless of the multiethnic, multicultural and multi-religion it owns. For that reason, it is a challenge for Indonesia’s newly attained democracy and political stability as well future economic performance to make a process of decentralization work. How decentralization policies are to be implemented will also be essential to the quality of public services and the accuracy of government finances. Decentralization is not just a political requirement to keep the country from falling apart or to foster democracy; if the new government managed it well, decentralization can bring significant benefits to the people and the nation as a whole.
Cambridge University Press. Friend, Theodore. 2003. Indonesian Destinies. Massachusetts and London: The Belknap Press of Harvard University Press Hadenius, Axel. 1997. Democracy’s Victory and Crisis-Nobel Symposium No.93. Cambridge: Cambridge University Press Haggard, Stephen, and Kaufman, Robert R. 1999. The Political Economy in Democratic Transitions. In Lisa Anderson, editor. Transitions to Democracy. New York: Columbia University Press Honna, Jun. 2003. Military Politics and Democratization in Indonesia. London and New York: RoutledgeCurzon, Taylor & Francis Group Kingsbury, Damien. 2003. Power Politics and The Indonesian Military. London and New York: RoutledgeCurzon, Taylor & Francis Group Liddle, R. William. 1996. Leadership and Culture in Indonesian Politics. Sydney: Asian Studies Association of Australia, in association with Allen & Unwin Co. Luhulima, James. 2001. Hari-hari Terpanjang: Menjelang Mundurnya Presiden Suharto, dan Beberapa Peristiwa Terkait. Jakarta: PT. Kompas Media Nusantara. Sharma, Shalendra D. 2003. The Asian Financial Crisis. Manchester: Manchester University Press. Zenzie, Charles U. 1999. Indonesia’s New Political Spectrum. The Regents of the University of California
occurs when courageous, skilful leaders seize the opportunity to change things for the better. Harry S. Truman I strongly support the idea that effective leadership makes the democracy real. Lack of leadership during the first years of democratization may result in turning the society into anarchy. To support the argument I would like to bring the example of Singapore and Malaysia, as nations that have developed very successfully, one can see the prominent role played by Lee Kuan Yew and Mahathir Mohammad as leaders who lead their nations into progress and prosperity. Both of two leaders suggest that a nation has to have a good leader who must satisfy needs of the mass; specifically Lee Kuan Yew constantly insisted in his speeches that for developing nations democracy can only bring progress if it is accompanied by discipline, which also means the rule of law. And, Doctor Mahathir stated in his closing remarks before leaving his leadership position that people must not be obsessed with democracy, because an obsession with democracy could mean anarchy. Why does Indonesia have a greater need for leadership? Up to now, Indonesia has had five presidents: Sukarno, Suharto, Habibie, Abdurrahman Wahid, and Megawati. Apart from Habibie, who was seen only as a transitional leader, Indonesia's first two presidents ended their terms in disgrace. Among the infinite problems that Indonesia faces, the lack of leadership is the main of them. Given the lack of systematic means to unravel the chaos, leadership is particularly important in its impact on the nation's ability to solve all other problems. The need for leadership is felt more strongly in Indonesia because as yet Indonesia has no stable public administration system in place. Even with a prime minister like John Howard -- not a particularly strong, charismatic or visionary leader -- the system in Australia works. Likewise in Japan, Italy, Israel, the Netherlands, prime
but the institutions of governance and the integrity and authority of the system, remains quite firm. Leadership is needed in Indonesia to assist in moving the nation's political system towards the type of institutionalized democracy that will act as a protection against the inconstancy, weakness and opportunism of (political) personalities, the vagaries of politics, and any crises. Neither Sukarno nor Suharto were elected democratically, even though formally both were elected by the People's Consultative Assembly -- although in Suharto's case by virtue of unfair elections. Nevertheless they were a reflection of the people, certainly given the absence of any alternatives. Indonesia has not been a democratic society before, but the drive for democratic change definitely exists in Indonesia, manifested by, among other things, the emergence of a number of civil society organizations, many of them small, striving for more permanent, structural changes, but which do not seem as yet to have any broad mass appeal, not even to the politicians. I think that in modern societies, leaders are created, not born. They are created by a system, a political and governmental system. A proper system could even contain the flaws of leaders. An effective system will also contain the capacity to withstand of their human failings to damage seriously the nation. To ensure that Indonesia doesn't repeat the mistakes it made in the past, it has to create a system which can withstand abuses of power and which truly reflect the characteristics of the nation: a plural society with no single majority, socially hierarchical, uneven human resources, uneven natural resources, in a geographically large and spread out area. Democratic system has to reflect the realities of the nation, in order to ensure appropriate representation and therefore the needs and interests of the people. Initially, Indonesia needs a national leader who has the long- term vision to know what the country needs, one who can be involved and detached at the same time. A robust system can make up for the inadequacies of individual leaders. There are two ways to run a country the size and diversity of Indonesia -- as an absolute dictator, or as a constitutional leader in a system subservient to an ultimately incorruptible law.
is not a charismatic or prepossessing leader, but he has always been determined that the democratic system shall prevail and that in any matter the process of law should be properly followed, even to his personal inconvenience. He lost power before, came back, and is set to lose again. However, he has gone a long way towards socializing and cementing a democratic system. In the U.S., what happened during the elections has elements of ridiculous situation, but no one is in any doubt that ultimately the problem will be resolved in the courts. Law is pre-eminent. No one is above it. In many other developing countries, unfortunately, anyone with enough money can be above the law due to strong ruts of corruption. And it is too easily manipulated any which way, for political convenience. This is what makes Democratic processes stick. Effective leader should eliminate this kind of “foreign materials” for smooth consolidation of young democracies. Unless law achieves the pre-eminent position as the strong arm behind democracy, the default position is that Indonesia will revert to subjecting herself to the control of the next strong man (or woman, though that will be much harder culturally) who comes along. I support Doctor Mahathir and in addition I propose that democracy that is accepted blindly can lead to anarchy. In other words democracy should be established considering specifics of countries. For Muslim countries there are norms and generally accepted morals that are supported by Koran. Shariah laws do not consider absence of morality. In Indonesia and Malaysia morality is important notion and it is very high. Many people in Indonesia, for example, are nostalgic for the much more stable and orderly situation of the Soeharto regime. People are tending to blame democracy as the cause of all these problems that Indonesia is facing today, because of the excessive freedoms that developed when democratic reforms began. Assumingly, task of any leader is to access the specific features of his country and implement policies that make nation satisfied with his policies. If they are satisfied that means that they are satisfied with person they have chosen. So this in its turn means
main postulate of democracy. “Many people in the West and democratic activists in developing countries do not recognize Singapore and Malaysia as democracies. They say that Lee Kuan Yew and Mahathir rule both countries as dictators. They entirely prefer to forget that both countries have democratic institutions that perform normally, including holding regular elections. They also do not take into consideration that the majority of people in Singapore and Malaysia are satisfied with the state of democracy in their countries. But the West is ambivalent, because it also praises Singapore and Malaysia for their development into industrial nations. Dr. Mahathir used to say jokingly that he might be the first dictator in the world elected by a democratic process”49. In democratic construction in Indonesia and in any developing countries should take these examples into consideration. Yet another argument that should be taken into consideration is the fact that in the West and in other developed democratic countries, the development of democracy was a gradual process. I order to uphold and guarantee a sound democratic process in developing nations like Indonesia; one cannot deny that leadership should accompany democracy. The role of leadership will make democracy a significant and healthy part of life, fostering progress, national unity and prosperity. In 2004 Indonesia will have to choose a new president by direct presidential election. This election will show whether Indonesia can give a birth to a new national leader that will be trusted this uneasy process. This leader must be able to establish the rule of law and social discipline. The economy, education and public health must be improved so that the majority of the people will feel and see that there are changes that benefit them. This will result in strong popular support that the leadership needs to make the necessary changes. The leadership must also have the strength and wisdom to end all the ethnic and religious divisions. 49 Source: TheJakartaPost.com
is a must. But there are other factors also that play an important role and assist leadership to achieve completion of the process. This factor assumes activation of democratic institutions. They can include opposition in the legislature and a free and responsible press. Strong leadership and the rule of law should take care that the freedoms of democracy do not harm the continuity of government, because only a government that can last long enough will be able to deliver significant results. The leadership should also prepare future leaders who can take the place of the present leadership when the nation has reached a point of stable and progressive development. That requires from the present leadership the ability to know when they should step down and make way for their groomed successors. Leaders like Deng Xiaoping, Lee Kuan Yew and Mahathir Mohamad have given the example; it is unfortunate for Indonesia that Sukarno and Suharto failed to do this. The important question Indonesia is facing is whether the presidential election in 2004 will result in the rise of a national leadership that can do the necessary job. So, accordingly it is important to find an answer to the following question. What sort of leadership does Indonesia needs if it is to succeed in its transition towards a more democratic state? Indonesia on its way to democracy experienced a crisis of leadership or we can call it “Leadership deficit.” It is explained by stepping down of three presidents in three year. Harvard’s Ronald Heifetz in his works explains the concept of leadership as “adaptive change.”50 According to him, like a trained psychiatrist, leadership is a process much like modern therapy in psychiatry. A country’s people (the patients) are helped by the leader (the therapist) to confront their problems and experience a breakthrough that allows them to come to terms with realities, problems, and truths about their lives and the state of their country. In the case of a nation, this “adaptive change” 50 Ronald A. Heifetz, Leadership without Easy Answers, (Cambridge, MA: Harvard University Press, 1994).
economic and moral progress. This type of leadership is inclusive, supportive and truthful. As Truman would have recognised, Heifetz’ leadership is intended to change the country for the better. Another question; How Indonesia’s leaders performed? The answer to question would be influenced by subjective estimation. So, based on Heifetz’s framework for effective leadership, Indonesian leaders from Sukarno through to Megawati appear to have failed to understand the country’s problems. From Sukarno to Megawati, leaders can be seen to have failed to diagnose the country’s problems correctly. Slogans and mobilisation have taken the place of thoughtful participation and have provided an easy path for Indonesia’s leaders to provide the illusion of leadership. The harder path of true leadership, according to Heifetz, would involve guiding Indonesians to confront their most deeply held differences and to develop a mechanism for resolving those differences. Leaders can be seen to be products of history, culture, institutions and their own personal characteristics and choices. In Indonesia’s case culture, which can be a quicksand of analysis, certainly seems to impact on Indonesians’ desires for harmony (lack of conflicting opinions) and strong leadership. Institutions allow certain leaders to emerge and others to be submerged. In the 1950s, the weakness of democracy allowed Sukarno to step to the fore to save Indonesia from what he diagnosed as “the disease of parties”. The military, Indonesia’s most powerful institution, allowed Suharto to rise to power. Personal factors matter, too. Using Heifetz’ framework to look at Indonesia’s past leaders, we see that Sukarno and Suharto both led the country through important changes and re-orientations, but in only some ways were these changes the positive, adaptive change that would have been favoured. Even though, the leaders could maintain relative stability in the country. The economy grew; for instance, GDP grew at 6-9 % per year. The country’s literacy level decreased sharply. These indicators show that that the people were satisfied with the type of governance they had. Besides, one of qualities of excellent government is putting national interest above personal. Suharto who put national interests above own in the beginning changed in the end. He failed to close his eyes to his own and his family
did not expect that the crisis will occur and it will hit the country. Even in early stage of crisis he did not asserted on it. So, as a result he was forced to step down. All other presidents who came after him to government failed to lead people. The concept of leadership plays, thus, an important role for all new transitional systems all over the world. The recent events in Indonesia, China, Venezuela, Colombia, Ecuador, Peru and Bolivia, including some Central American countries are the cause of growing concern because they jeopardize democratic advances made over the past years. While in some cases there is evidence of anti-democratic tides, in others the institutional fragility, absence of leadership that can convoke broad sectors of society, the rise of populist solutions, weakness of political parties and the fragmentation of civil society, rise of corruption and the lack of mechanisms that guarantee effective and efficient accountability, appear as obstacles for democratic consolidation. Still other countries that have demonstrated significant democratic advances like Chile, Argentina and Brazil, and most recently, Mexico, still must strengthen institutions and mechanisms of political participation and leadership to avoid reversals in the future. Concluding, I would like to add that strong leadership is basis for establishment of democracy in newly transited democracies. Strong leadership is especially needed during the first years of transformation because in contrast to developed and established democracies public administration system is not yet developed in new democracies. The leader should provide priority of law in the first place and fight for elimination of corruption because corruption is considered to be the main threat to young democracy.
guides, directs and influences a group of people, small from a family to a corporate, or large to a nation. A nation’s leader takes up great responsibility for its people, to provide a stable society in achieving higher living standards, to levitate the nation’s economy in competition with rest of the world, and in addition with various other important issues for the people and for the nation. Among with the many virtues the leader ought to have, he or she also need to be visionary, to visualize the future of the nation for the people, to set up plans to benefit the society. It is essential to have a strong and influential leader for a nation, which creates fair and equal treatment for his and her people. Without a strong leader, the nation will be like a pile of sand, when the nation’s people disperse and in which instability occurs. A good leader should not build individual commitment but for the nation’s capabilities. He or she must have the organizational capabilities to be account for his or her people, which refer to the processes, practice and activities, which will create the nation’s competencies. In 1997, when Asia’s financial crisis started to take place, many believe with Indonesia’s economical performance, it would be vulnerable to a financial collapse. However, Indonesia was affected by the crisis and damaged the most. With the collapse of Indonesia’s economical development, and the fall of Suharto, the following three years, 1998-2001, Indonesia had four presidents. Running Indonesia is said to be the most difficult job, in which Indonesia faces leadership deficit as well as an inerasable and unforgettable history of uncommitted leaders with broken promises. Unfavorable history marked instability of the people’s believes over the words from their leaders today, when many politicians are only looking for political opportunism and individual benefits. In account for Indonesia’s lack of leadership human capitals, instability caused the country’s economy in great depression, when investors and donors avoid the possibilities that could be achieve in this land. To recover and improve Indonesia’s economical power, it must have an influential leader that could
could persuade the people to follow the passage to Indonesia’s recovery. To present the right leader for Indonesia, we must go through elections. Election gives the nation’s people the ability to have selections, to choose their own leader in which that has similar ideas, changes and visions for their own country. However, since the people of Indonesia were overly damaged by the history of corruption in politics, the election must be planned and performed wisely. Before the presidential candidates are to be announced and elected, there are some plans that should be carried out first, and they are as follows: 1) Forming of political parties, which existing and potential parties with different views to reestablish Indonesia should carefully examine their potential candidates. There might be parties that focus on the development of agriculture that will make suitable job securities and competencies for the country’s farming business. Industry in technology will also have its plans and objectives to help recover Indonesia’s economy. The nation’s people will study the party’s objectives and believes, and refer to their thinking on what will bring out a better Indonesia. 2) Foreign political support, since Indonesia face a long history of corruption and uncommitted leaders, it is important to regain the people’s trust over the government. To rebuild this trust system is difficult, when only depending on the people of Indonesia is impossible. Indonesia should reach out and find foreign support in establishing its political system. Indonesia should ask for support and advices from countries with successful democratic governance experiences. These experts from democratic countries form an advisory board to view Indonesia’s political movement, to guide Indonesia to recover. 3) Establish a commission against corruption, which investigate possible corruption in association with scandals and bribery. To rebuild Indonesia is to rebuild the trust from the people. The formation of an anti-corruption organization will increase the trust from the people that the government is fighting to secure their society. Hong Kong has a good example of history in combating corruption, and its ICAC (Independent Commission Against Corruption), had a tremendous hard-earn
“Progressing Indonesia”, which healthy propaganda demonstrate Indonesia’s passage to prosperity. In collaboration with local industries and the government, promotion of Indonesia’s commitment to rapid economical growth must be represented to the public, using many formats. Through press and media, news and commercial ads, these message will travel into the nation’s people, to persuade to them the Indonesian government is determine to bring the change for its people, without corruption or individual benefits, but healthy living environments for the people. These promotions will effectively work in corporate and schools, when they can be educate about the potential of Indonesia’s economy recovery and prosperity. 5) Entrepreneurial support and promotion, which in collaboration with the campaign of progressing Indonesia, government also supports people that have entrepreneurial strength and have potential business plans. These promotions will create new economy progressiveness that will help recover Indonesia. However, the plans presented by the people are to be examined carefully before they are financially or beneficially supported. If the plans are not potentially satisfied and could not reach financial support level, government should provide alternate route for these people. For example, related corporate or industry that might have interest in working out a better plan. One will never know a potential business plan might carried up to be a competence of the country. 6) Stability control, which in time of a transition, chaotic riots and disorder are likely to take place, and control and stabilizing the people must be carefully examined. When the financial crisis occurred in the late 90s, riots in Indonesia took place, in which many innocent people were killed and sexually assaulted, especially to the Chinese society. Bloodshed incidents only feared and damage the society and its people and jeopardize the stability of the nation. In a transition of election for the right leader and right after a leader is born, it is most likely that riots and instability might occur. It is essential that the government will need help from the police force and military to have control over the people. The control must be soft and
ever riot takes place and rioters are caught, education must be provided to them while the government should also listen to what they have to say. Public rally and demonstration could be performed but under registration for such events. In order to have a great leader to be born, they are many issues that also need to be considered. For a country to develop in economy as well as levitate its society under democracy, the responsibility is not only the nation’s leader, but with the support from the nation’s people. A good example is a small country from Asia, Taiwan, which shared many similarities when compared with Indonesia. With its declaration of independence in the same year of 1945, and followed by martial law for more then 30 years, today, Taiwan’s economy had flourished greatly, with GDP of $18,000 (est. 2002) and poverty rate under 1%. All of Taiwan’s achievement could be related to its leader, President Chiang Chin- Kuo, the son of Chiang Kai-Shek, when he formed a strong fundamental basis for Taiwan, and continuously focus on the development of industrialization. The leader President Chiang was visionary for Taiwan’s future, and was closely in associating with the people of Taiwan, listening to their needs. The leader was not based for individual benefits and instead searches for benefits for his people. Today, Taiwan has the freest Chinese society in modern times, when multiparty democratic regime headed by popularly elected president and unicameral legislature. Indonesia is a big country with countless resources in raw materials as well as human capitals. It was once a country that has proven to the rest of the world its ability to have a strong economical power. The problem and question today is the ability to organize, to have an effective and influential leader that could guide his or her people. Before the leader is to be selected, the candidate must be presented to the public and his or her ideas and plans must be sent to the people. Along with the support and guidance from foreign countries and experts, it is possible to believe Indonesia’s human capital could generate a great leader to lead the people of Indonesia to recover from the crisis and walk into prosperity.
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