INTRODUCTION

Scholars have had difficulty characterizing the economic orientation of the contemporary Indonesian state. Following the devastating Asian Financial Crisis (AFC) of 1997–98, the Indonesian government opened up many parts of its economy, and pursued a neoliberal economic model recommended by its lenders, the International Monetary Fund and the World Bank. At the same time, many sectors remained characterized by high levels of state intervention and market distortion. Despite the democratic transition and the new government's pursuit of liberal economic policies to ensure competition, transparency and accountability, old oligarchs and predatory state actors maintained much political and economic power. State capacity has also continued to vary enormously across ministries and regional governments, and problems of coordination and communication mean that different state bodies often pursue contradictory economic policy paths. As a result, since the end of the New Order, analysts have variously identified the new democracy as being “neoliberal” (Aspinall 2012), “quasi-developmental” (Sato 2017), “oligarchic” (Hadiz and Robison 2013), “nationalist” (Patunru and Rahardja 2015), or some combination thereof.

Yet, this chapter argues that over the course of the past decade, a discernible developmental model has (re)emerged. To advance this argument, the study draws upon a body of literature on the “new developmentalism” in middle-income and emerging economies. The new developmentalism is characterized by a normative commitment to an activist state, and a rejection of neoliberalism's blind faith in small government (Khan and Christiansen 2010; Trubek et al. 2013; Schneider 2015; Döring, Santos and Pocher 2017). Economic policy is underpinned by the idea that states should intervene in markets in order to stimulate economic growth, direct industrial upgrading, and ensure economic redistribution. The new developmentalism is heterodox and flexible, and state activism is supplemented by selective support for aspects of an orthodox and liberal economic strategy. It is a paradigm associated with emerging economies such as China, and often Brazil (at least during the first decade of the 2000s), where activist states seek to transform their country's comparative advantage, and graduate to a higher-income status.

Aspects of this model have deep roots in Indonesian history. But, a more self-conscious developmentalist agenda re-emerged during President Susilo Bambang Yudhoyono's second term in office (2009–14). The chapter suggests that under President Joko “Jokowi” Widodo, the new developmentalism has crystallized further and, arguably, become a defining feature of Indonesia's political economy.

INTRODUCTION

In January 2018, President Joko Widodo stated that his government would start to focus on improving the country's human resources (Kompas Daily, 3 January 2018). He added that improved human resources is a necessary condition to be able to take full advantage of Indonesia's demographic dividends and be globally competitive.

The president's assessment is correct. Hanushek and Woessmann (2008) find that cognitive skills have large and causal relationships with earnings, distribution of income, and economic growth. In addition, Hanushek et al. (2017) find that returns to these skills are larger in faster growing economies. Since strong economic growth is usually a sign of a dynamic and rapidly changing economy, the authors state that their finding is consistent with the hypothesis that highly skilled individuals are better at adapting to, and taking advantage of change.

The policy implication of the findings in the previous paragraph is straightforward: countries must ensure that their labour markets are highly skilled. From a policymaker's perspective, it means that increasing the educational attainment of the population is a necessity. And, overall, countries have largely succeeded in doing so (Pritchett 2001). The World Bank's Edstats show that the average educational attainment of adults globally has increased from 6.4 years in 1990 to 8.3 years merely two decades later.

The problem, however, is that learning levels remain low for many countries. Pritchett (2013) states that in India, over a quarter of fifth graders could not read a simple sentence while only slightly more than half could perform subtraction. Mullis et al. (2012) find that only 43 per cent of Indonesian eighth grade students have some understanding of whole numbers, decimals, operations, and basic graphs. In contrast, 99 per cent of Singaporean eighth grade students have this knowledge. Therefore, the amount of learning produced by Indonesian and Singaporean education systems in the eight years of schooling are vastly different. In addition, there has been very little improvement among the weak performers. For example, Suryahadi and Sambodho (2013) show that Indonesia's performance in eighth grade TIMSS mathematics has declined between 2003 and 2011. Hanushek and Woessmann (2008) conclude that merely increasing education attainment, without focusing on the amount of learning actually accrued by students, has no correlation with economic growth.

This chapter examines numeracy and literacy levels among fifteenyear- olds in Indonesia and put them in a global perspective.

The economic, political, strategic and cultural dynamism in Southeast Asia has gained added relevance in recent years with the spectacular rise of giant economies in East and South Asia. This has drawn greater attention to the region and to the enhanced role it now plays in international relations and global economics.

The sustained effort made by Southeast Asian nations since 1967 towards a peaceful and gradual integration of their economies has had indubitable success, and perhaps as a consequence of this, most of these countries are undergoing deep political and social changes domestically and are constructing innovative solutions to meet new international challenges. Big Power tensions continue to be played out in the neighbourhood despite the tradition of neutrality exercised by the Association of Southeast Asian Nations (ASEAN).

The Trends in Southeast Asia series acts as a platform for serious analyses by selected authors who are experts in their fields. It is aimed at encouraging policymakers and scholars to contemplate the diversity and dynamism of this exciting region.

THE EDITORS

Series Chairman:

Choi Shing Kwok

Series Editor:

Ooi Kee Beng

Editorial Committee:

Su-Ann Oh

Daljit Singh

Francis E. Hutchinson

Benjamin Loh

INTRODUCTION

Indonesia, comprising over 17,000 islands, is the world's largest archipelago and is blessed with a rich diversity of resource endowments, ecology and population. It extends about 6,000 km along the equator between the Indian and Pacific oceans, linking the continents of Asia and Australia. This fourth most populous nation in the world (about 260 million in 2016) is the largest member state of the Association of Southeast Asian Nations (ASEAN), accounting for nearly 40 per cent of its population and approximately 36 per cent of its gross national product in 2016 (CEIC Database). Considering these diverse characteristics, Indonesia certainly presents a challenging natural resource and environmental policy environment (Resosudarmo 2012; Hill 2014).

For a long time, particularly since the mid-1960s, Indonesia has been able to utilize its natural resources — gas, forest, coal and various types of ore, among others — to push for economic and human development in the country. Since the mid-1990s, the debate over whether the rate of natural resource extraction in Indonesia has been too fast and consequently over-exploitative, began to emerge as a top national issue. At the same time, the growth of economic activities, particularly in urban areas, has resulted in several alarming environmental issues, such as a high level of air pollution and a deterioration in river quality (Resosudarmo 2005; ADB 2013).

By the mid-2000s, the evidence of natural resource over-exploitation and environmental challenges in Indonesia attracted global attention. Among these issues were: the rate of Indonesia's deforestation was among the highest in the world (Resosudarmo et al. 2012b; Margono et al. 2014); several megacities in the country were experiencing alarmingly bad air quality; river water pollution was reaching levels that could seriously affect the health of the general public (Resosudarmo and Napitupulu 2004; Cochrane 2015); Indonesia being one of the top exporters of coal — despite its coal reserve being smaller than several other countries (Burke and Resosudarmo 2012; PwC 2012) and; over-fishing occurring everywhere in the nation's sea water areas (Resosudarmo, Napitupulu and Campbell 2009; Muawanah, Pomeroy and Marlessy 2012). The concern that shocked many Indonesians and people worldwide, however, was that Indonesia is one of the top three carbon dioxide (CO2) emitters in the world, just after China and the United States, due to its deforestation activities (PEACE 2007; Jotzo 2012).

INTRODUCTION

The costs of financial system failure in the form of a systemic banking crisis can be extraordinarily high, as illustrated by Indonesia's devastating financial crisis that began in 1997. It took many years for bank lending growth to resume and, by some measures, Indonesia's level of financial development has yet to return to pre-crisis levels. In comparison with this history, Indonesia's financial system has been working very well over the past decade. Government financial policy has the declared aim of promoting a financial system that facilitates economic growth, supports financial inclusion and safeguards financial stability. These goals require a balancing act that, so far, appears to have achieved a degree of success. Measures of growth and performance described in this chapter focus on the significant financial development over the past two decades and suggest a financial system that is more resilient than at any stage in the past. Notwithstanding potential costs and risks arising from increasingly interventionist financial policies and an inadequate financial safety net, the banking sector (to date) remains relatively robust in prudential terms. There is evidence of inefficiency arising from structural segmentation of the banking system, which has persisted despite foreign presence in the banking system. The financial sector as a whole has diversified as nonbank capital markets and the nonbank financial service sector have developed, albeit modestly.

The next section of this chapter presents basic data on the structure and performance of Indonesia's financial system. It goes on to discuss the policy framework governing the financial sector, with an emphasis on agencies and policies relating to banks, which remain the dominant players in the financial system. The third section identifies some of the policy conflicts and constraints affecting financial sector performance, with attention to the segmentation of the banking sector, the role of foreign ownership and the potential for financial sector diversification away from current levels of reliance on commercial banks. The final section concludes.

FINANCIAL SYSTEM STRUCTURE AND PERFORMANCE

Indonesia's financial system remains bank-dominated, with banks accounting for around 76 per cent of the assets of all financial institutions, as shown in Figure 5.1. Insurance companies, pension and mutual funds and all other financial intermediaries together thus account for less than a quarter of all assets held by financial institutions.

INTRODUCTION

Since 1990, rates of extreme poverty have fallen by more than half. With rapid income growth, a global middle class has arisen in emergent middle-income countries such as Indonesia. However, the majority of the global poor also reside in these middle-income countries (Sumner 2012), as sustained growth has not worked evenly to alleviate persistent poverty. In this context, social protection policies (SPPs) have emerged as the key response. Social protection encompasses all interventions from public, private, voluntary organizations and informal networks, to support communities, households and individuals in their efforts to prevent, manage and overcome a defined set of risks and vulnerabilities (Barrientos and Hulme 2008). In many respects, the turn to social protection represents a laudable move in social policy. With the state embracing the need to provide for its most vulnerable as a moral duty, we can see social protection as an effort to expand progressive social contracts to marginal groups (Hickey 2012).

In the case of Indonesia, rising inequality emerged as a critical political concern after the Gini coefficient increased from 0.33 in 2002 to 0.41 in 2016. After reducing the multibillion U.S. dollar fuel subsidy as soon as he stepped into office, President Joko “Jokowi” Widodo has overseen a rapid expansion of SPPs — publically distributing an Indonesia Health Card (KIS) that provides free healthcare services and the Prosperous Family Saving Card (KKS) in public events. Likewise, the health programme (Program Jaminan Kesehatan Nasional or JKN) is being expanded to cover 36 million families, the rice for welfare — Beras untuk Keluarga Sejahtera (Rastra) — programme will include 15.7 million families, while the Family Hope Programme (Program Keluarga Harapan, PKH) will provide cash transfer benefits to 10 million families. As depicted in Figure 13.1, the national expenditure for social protection programmes has increased more than ten times between 2005 and 2017. However, this does not represent aggregate growth in terms of GDP, as contributions have fallen from 0.9 per cent of GDP to 0.7 per cent of GDP over the same period (World Bank 2017). This is still far below the World Bank target for social spending and as a percentage of GDP is among the lowest worldwide (Samboh 2017).

INTRODUCTION

At the start of his presidency, Joko “Jokowi” Widodo promised that Indonesia would achieve a 7 per cent economic growth within three years of his administration. His plan was to achieve this through a combination of infrastructure development, improved budget allocation and efficiency of spending, increased private sector participation in the development and financial sector deepening. Four years later, the economy seems to be stuck at a 5 per cent growth rate, leaving the impression that the 7 per cent target is too hard to come by, if not impossible.

Jokowi's government, however, inherits the legacy of macroeconomic conditions from its predecessors, particularly those resulting from the substantial change post the devastating Asian Financial Crisis (AFC) 1997–98. Analysing the current government achievement without considering the conditions that preceded it will not be an objective approach. The AFC was a significant game changer to the management of the Indonesian economy. The economy underwent a series of economic reforms that provided it with better resilience when facing the Global Financial Crisis (GFC).

The Indonesian economy took a big hit during the AFC. GDP fell by over 10 per cent at the peak of the Crisis in 1998, inflation soared to above 50 per cent, and it took a while before the economy eventually recovered to the level of economic activity it had before the Crisis. In about a decade prior to the AFC, Indonesia massively liberalized its banking sector through its second banking liberalization package in October 1988 (Pakto 88) that brought substantial liquidity deepening impact to the economy. The financial deepening impact, however, came at a cost of the country's heightened vulnerability to financial shocks especially when coupled with inadequate financial supervision. Combined with a practically pegged exchange rate regime, the economy had quietly built up a substantial risk of financial vulnerability that culminated in late 1997 when authorities had to acknowledge defeat in holding its overvalued currency and had to go through a considerable overhaul in the banking sector.

Post-crisis, Indonesia went through a series of reforms. It underwent a rapid political democratization process which was both beneficial for the country's future but taxing to the economic recovery processes at the same time. A rapid move towards fiscal decentralization changed the ball game for fiscal interventions by passing more authority to the local government in decision-making.

I am pleased to be able to write the Foreword for this important and timely book on the Indonesian economy. As we know the country is currently entering the five-yearly elections cycle that will set the political stage for the subsequent five years.

The book aims to shed light on whether Indonesia has presently embarked on a new development model. In this piece I would like to share with you my reflection, inevitably quite subjective, on a related but somewhat narrower issue. The question I am going to raise is what Indonesia could learn from the experience of the East Asian countries. I will relate it to the changing environment of policymaking in Indonesia in the past six decades or so, half of which time I had had the privilege to observe the process from the ring side, so to speak, and subsequently found myself increasingly drawn into the ring. I will conclude with a tentative suggestion on how Indonesia could improve its policy performance in the coming years.

Let me begin by clarifying what I mean by the East Asian countries. In this group I include Japan, Taiwan, South Korea, Singapore, Hong Kong and, more recently, China and now perhaps also Vietnam. This group in my view is unique because in their quest for development they carried out similar strategies with similar outcomes.

I am aware that within that group individual countries differ in their experiences and in their specific policies with regard to their important sectors such as industries, trade and finance. Nonetheless, we can readily identify some basic commonalities in their approaches to development. For the purpose of this talk I will pick two of them.

The first is this. From the early stages of their development these countries consistently placed high in their agenda the upgrading of three strategic areas, namely, education, bureaucracy and infrastructure. The first two — education and bureaucracy — have roots in the Confucian precept about the basic role of the state, while the third is an enabling element. The pursuit of these three objectives constitutes a crucial part of their development stories.

Their strategy emphasizes the “supply side” development with the goal of progressively raising the country's “productive capacity”. In the literature three factors, namely, human resources, institutions and infrastructure, have consistently stood out as prime determinants of a country's development in the long run.

INTRODUCTION

In 2001, Indonesia embarked on a far-reaching decentralization reform that devolved core responsibilities such as health, primary and secondary education and infrastructure to the districts. While the centre retained authority over foreign affairs, defence, law enforcement, justice, fiscal and monetary policy, and religion, control of all other functions was transferred to the regions — at least in principle (Sjahrir 2016). This implied a huge shift of expenditure from the centre to the regions (districts and provinces), which now spend around a third of the consolidated state budget. Yet, fiscal decentralization, which was accompanied by political and administrative decentralization, has remained largely one-sided. While local governments have authority over their spending, they rely heavily on transfers from the centre to finance their expenditure (Schulze and Sjahrir 2014). This particularly concerns districts, which received only 10–16 per cent of their revenue from own sources (tax and non-tax) between 2011 and 2016. Transfers to local governments accounted for around 30 per cent of central expenditure in recent years (Figure 4.1), making the design of the intergovernmental transfer system crucial for the success of the decentralization reform.

From a normative perspective, intergovernmental fiscal transfer systems should fulfil three basic functions. First, they should internalize externalities created by regional spillovers, such as public goods that benefit people from multiple local jurisdictions (Oates 1999), cross-border pollution or the erosion of tax bases in the presence of interjurisdictional competition (Wilson 1999). Second, they should incentivize local governments to mobilize resources and spend their resources efficiently. And third, they should have an equalizing function through which differences in economic development across regions are counterbalanced (Shah 2006; Boadway and Shah 2007). In the case of a one-sided fiscal decentralization, transfers of course have a major financing function (Boadway and Shah 2007). In short, intergovernmental fiscal transfers are an instrument that allow benefitting from the advantages of fiscal decentralization while minimizing its costs in terms of fiscal inequity or negative external effects (Boadway 2007). Yet, in practice, the allocation of transfers is often determined by political considerations like rewarding core voters or targeting swing voters (Gonschorek, Schulze and Sjahrir 2018; Weingast 2009, 2014). Moreover, transfer systems are often designed as a result of lobbying for regional interests.

INTRODUCTION

Infrastructure investment has been identified as one of the key catalysts for unlocking a country's overall economic potential, promoting growth, creating jobs and reducing poverty. Efficient infrastructure is also needed to lower distribution costs, make prices of goods and services more affordable, and improve living standards (ADB 2017). Good infrastructure brings better social and economic mobility, leading to better living conditions. For Indonesia, a country with a large population and an archipelagic territory, developing efficient infrastructure is important for ensuring sustainable and inclusive growth.

Infrastructure investments have been traditionally financed by public funds (OECD 2014). After the 1997–98 Asian Financial Crisis, Indonesia's infrastructure spending fell from around 9 per cent of GDP in the mid- 1990s to around 2 per cent in 2001 (OECD 2015). By 2014, infrastructure spending had increased to 3.6 per cent of GDP. This level, however, was relatively low compared to Asia's other high growth economies, which spent around 6 per cent of GDP on this rubric (OECD 2015). The political decision to maintain fuel subsidies in the wake of rising world oil prices had shrunk Indonesia's limited fiscal space, thus preventing the country from adequately funding infrastructure investment. As a result, Indonesia's infrastructure crumbled, leaving much of the population with insufficient access to basic facilities, including electricity, water and sanitation. Lack of quality transport and logistics infrastructure has, in turn, constrained local businesses from competing globally.

Under President Joko “Jokowi” Widodo, Indonesia aims to boost its infrastructure development. Specifically, Jokowi's Nawacita (nine priority programmes) prioritizes accelerating infrastructure development to connect the peripheries with growth centres and, promoting connectivity between islands in the archipelago (KSP 2016). Moreover, President Jokowi has created the Committee for the Acceleration of Priority Infrastructure Delivery (KPPIP), a special task force that has a mandate to coordinate policies among various stakeholders and to unblock stalled national strategic projects and priority projects. Arguably, Jokowi's development strategy has narrowly focused on building infrastructure and attracting infrastructure investment to address inequality, reduce poverty and promote growth (Warburton 2016).

INTRODUCTION

Food policy goes far beyond simple agricultural production, encompassing issues such as food and nutrition security, poverty alleviation, women's participation, structural transformation and value addition. Food policy also has a macroeconomic dimension, as it has implications for inflation, fiscal policy, and affects the trade balance. Failure to manage food policy has the potential to disrupt politico-socio-economic stability.

This chapter discusses whether Indonesian food policy has failed, mainly focusing on rice policy, but also looking at cocoa, sugar and salt policies as an illustration. The same shortcomings and challenges apply to many other food commodities and hence some of the policy recommendations can be generalized, with minor adjustments depending on the food commodity.

While significant long-standing food policy challenges remain, such as striking a balance between consumer and producer welfare, in recent years many changes have been introduced. They are (i) the omnipresent use of enforcement officials (both military and civilian) to “discipline” the market (including “food mafias” or hoarders); (ii) the extensification of agricultural production by opening new rice fields outside Java and increasing the crop plantation index to increase production; (iii) putting a binding cap on retail prices of some food commodities to counter high prices; and (iv) the crowding-out of private investment by state-owned enterprises and the lack of market competition. While there have been significant improvements in some aspects of food policy, such as the development and rehabilitation of irrigation systems and dams (Kompas 2018b) and the use of Area Sampling Frames methodology to more accurately produce rice production statistics according to international best practices, these seem to be overshadowed by the continuing shortcomings.

This chapter discusses four main topics: (i) food policy goals; (ii) the performance of these goals; (iii) why they may have failed or succeeded; and (iv) policy recommendations.

FOOD POLICY GOALS

At the highest strategic level, the Nawacita — the vision and mission of President Joko Widodo and Vice-President Jusuf Kalla for their 2014–19 term — mandates that “food sovereignty” should be the ultimate goal of food policy in Indonesia. A passage in the Nawacita explains how to achieve food sovereignty. First is increasing on-farm production by improving irrigation systems, opening new rice fields and restoring soil fertility. Second is providing financial and capital access to farmers and micro, small and medium enterprises (MSMEs). Third is increasing the value-added of farmers’ products through post-harvest technology and capturing longer value chains.

INTRODUCTION

It is now more than twenty years since one of the most decisive and important turning points in Indonesian economic and political history. The year 1998 was one of exceptional turbulence, hardship and uncertainty. The seemingly impregnable thirty-two-year Soeharto presidency came to a sudden end on 21 May. The economy and the currency were in free-fall. An acrimonious relationship had suddenly emerged with international financial institutions. There were nasty conflict episodes, mostly with serious ethnic dimensions. Almost one million of its citizens were internally displaced. There were various “Yugoslav” scenarios of territorial disintegration. Most important of all, there was no institutional roadmap to guide the country through the vacuum that Soeharto's hasty exit had created.

Viewing the country through the gloomy lens of that era, it is perhaps no exaggeration to state that the economic and political developments over the intervening two decades have been little short of miraculous. Crises of this depth and severity have often set countries back for extended periods, but Indonesian per capita income had recovered to pre-crisis levels by 2004. The country is now regarded as one of the most vibrant democracies in Southeast Asia and in the Muslim world. It has maintained its territorial integrity. There have been four rounds of credible national elections, while democracy has also taken root in the more than 500 subnational jurisdictions. A far-reaching programme of decentralization has been implemented. The economy has returned to at least a moderate growth rate of around 5 per cent per annum. Inflation is well under control, and the macroeconomic framework looks secure. The authorities navigated the 2008–09 global financial crisis with little difficulty. The economy is in much better shape than the resource-exporting members of the much-hyped BRICS (Brazil, Russia, India, China and South Africa) group. Indonesia is recognized as a significant regional power through its membership of the G20 and other international fora.

Yet in important respects Indonesia is still a country in transition, and one that faces major development challenges. It is still a relatively young democracy, in the process of establishing durable institutions that will be needed to underpin an upper middle-income economy. Its ambitious decentralization programme is still being bedded down into an effectively operating system of government. Tens of millions of its citizens live below or precariously above a meagre poverty line.