An Evaluation of Some Key Economic Policies

Abstract

For roughly the past three years, Indonesia’s growth has maintained its slight upward trend while inflation has been broadly on target. The budget deficit has been kept under control and government debt is low relative to that of many other countries. Nevertheless, this sound macroeconomic performance is now under threat because the government’s aversion to depreciation of the currency has led it to introduce unnecessary contractionary fiscal measures—including cutbacks of spending on infrastructure on which output growth depends. Along with many other currencies, the rupiah has depreciated significantly throughout much of 2018—despite the attempts of Bank Indonesia, the central bank, to prevent this—partly because of rapidly growing imports, but also because of a reversal of portfolio capital inflow. This reversal reflects various factors, including Bank Indonesia’s policy, until recently, of pushing interest rates down while global interest rates have been rising; fear that rapid depreciation in poorly managed economies such as Turkey and Argentina may prove contagious; market recognition that expansion of the current account deficit is likely to require depreciation beyond that desired by the central bank; and concern that the forthcoming presidential election creates conditions in which it will be difficult to pursue sound economic policies. This survey discusses the rather unexpected currency depreciation and associated selling pressure in the stock exchange in detail before going on to provide evaluations of, and suggestions in relation to, a range of microeconomic policies, including infrastructure development; the provision of subsidised loans to small businesses; the fiscal aspects of decentralisation; minimum wages; and management of the bureaucracy. To a large extent, most of these policies can be characterised as reflecting a distrust of market forces, including a reluctance to adopt market-mimicking processes in the public sector—specifically, in relation to the funding of local governments, and to the staffing of the bureaucracy. From another perspective, the adoption of a wide variety of objectives for economic policy reflects the absence of any consistent analytical framework, making it highly likely that policies will turn out to be mutually inconsistent and, in particular, that they will conflict with the ultimate economic objective of increasing living standards, especially those of the poor.

Selama kira-kira tiga tahun terakhir, pertumbuhan ekonomi Indonesia bertahan pada tren yang sedikit meningkat, sementara angka inflasi cenderung sesuai target. Defisit anggaran berhasil dikendalikan dan utang pemerintah cenderung rendah jika dibandingkan dengan banyak negara lain. Meskipun demikian, kinerja ekonomi makro yang baik ini tengah menghadapi tantangan yang datang karena kekuatiran pemerintah akan depresiasi rupiah menyebabkan dikeluarkannya berbagai kebijakan fiskal kontraksioner yang tidak perlu—termasuk pemotongan belanja infrastruktur, yang justru sangat dibutuhkan untuk pertumbuhan output.

Seperti banyak mata uang lainnya, rupiah telah terdepresiasi secara signifikan sepanjang 2018— terlepas dari berbagai usaha yang dilakukan Bank Indonesia untuk mencegahnya—bukan hanya karena tingginya pertumbuhan impor, tapi juga karena pembalikan arus modal masuk. Pembalikan arus modal ini mencerminkan berbagai faktor, termasuk pertama, kebijakan Bank Indonesia yang ( sampai beberapa waktu lalu) berupaya menekan tingkat suku bunga pada saat suku bunga global sedang naik; kedua, ketakutan bahwa depresiasi yang tajam di negara-negara dengan perekonomian yang tak dikelola dengan baik, seperti Turki dan Argentina, dapat menyebar cepat; ketiga, kepercayaan para pelaku pasar bahwa melebarnya defisit neraca transaksi berjalan akan diikuti oleh depresiasi rupiah yang lebih dalam daripada yang diinginkan oleh bank sentral; serta keempat, kekuatiran bahwa pemilihan presiden yang akan datang menciptakan kondisi yang membuat pemerintah sulit melakukan kebijakan-kebijakan ekonomi yang baik.

Survey ini secara rinci mendiskusikan depresiasi mata uang yang tidak sesuai perkiraan dan kaitannya terhadap tekanan jual di pasar saham, sebelum melanjutkan dengan beberapa evaluasi dan usulan atas serangkaian kebijakan ekonomi mikro, termasuk pembangunan infrastruktur; pemberian subsidi kredit usaha rakyat (KUR); aspek fiskal pada desentralisasi; upah minimum; serta manajemen birokrasi. Sampai batas tertentu, sebagian besar kebijakan ini dapat dilihat sebagai cerminan ketidakpercayaan terhadap mekanisme pasar, termasuk keengganan mengadopsi mekanisme pasar di sektor publik—khususnya dalam hal pembiayaan pemerintah daerah, dan dalam hal penempatan tenaga kerja birokrat. Dari perspektif lain, penetapan sejumlah besar tujuan kebijakan ekonomi mencerminkan absennya kerangka kerja analitis yang konsisten. Alhasil, kebijakan-kebijakan yang muncul mudah sekali menjadi inkonsisten satu sama lain dan bahkan dapat berkonflik dengan tujuan ekonomi utama untuk menaikkan standar hidup, khususnya bagi mereka yang miskin.

Keywords:

• crisis
• eminent domain
• small business
• fiscal transfers
• minimum wages
• bureaucracy

JEL classification:

• E58
• F32
• G01
• H54
• H77
• J45

INTRODUCTION

‘Indonesia, you’re amazing!’ So read the front page banner headline of the national daily, Kompas, on 3 September, 2018, following the successful staging of the 18^th Asian Games over the previous fortnight. So great was the euphoria that the president immediately announced Indonesia’s intention to bid for the Olympic Games in 2032. A few months earlier, Bambang Brodjonegoro, the head of the national planning agency, Bappenas, had painted a similarly optimistic picture of Indonesia’s economic future. He said that he expected per capita income to grow from $3,377 to $28,934 in the 30-year period from 2015 to 2045, provided the economy could achieve an average GDP growth rate of 6.4% per annum.¹ Growth at that rate was last seen, briefly, in 2011, so this was more aspiration than prediction, but Bappenas clearly believes this is not out of the question, having made similar claims at least as far back as 2011.² Thus, it claims that Indonesia can achieve ‘advanced country’ status by moving into the World Bank’s high-income country classification by 2034.

These kinds of claims are typically accepted at face value, but it is instructive to look at them carefully. The country classification is actually based on gross national income (GNI), so the starting figure in 2015 was actually a little higher, at $3,430 per capita. Assuming the same 6.4% growth rate for GNI, continuation of recent population growth of around 1.1% per annum translates to 5.2% growth in GNI per capita, implying that the latter would rise to just $15,886 in 2045—little more than half the stated level—and that high-income status in fact would not be achieved until about 2040. To achieve this status by 2034 would actually require GNI per capita growth of 7.4% per annum, corresponding to GDP growth at about 8.6%—considerably higher than the rates achieved during the Soeharto years, let alone the more modest rates of the last decade and a half. More realistically, if Indonesia can achieve an average GDP growth rate equal to the recent level (5.3% p.a.), it will take 32 years rather than 16 for it to become an advanced economy. To achieve Bappenas’s imagined rate of 6.4%, much less the president’s target of 7%, will require significant modification of a wide range of current policies.

AN EVALUATION OF SOME KEY CURRENT POLICIES

In this survey we therefore evaluate several key economic policies to see if they support the aspiration to accelerate the growth rate and thus improve average living standards as quickly as possible. In reality, there is a plethora of other economic policy objectives: boosting exports, manufacturing, agriculture, fisheries, education, health, small business, infrastructure, public housing, development of outer and backward regions, and wages; stabilising the exchange rate; reducing the current account deficit; preventing increases in interest rates, and food, fuel, and electricity prices; reducing inequality and instability; and so on. Most of these objectives reflect superficial beliefs that these things are inherently desirable, or that the people involved in them are especially deserving, or that they are necessary if living standards are to improve. By contrast, there is much less support for imports, ‘non-productive’ sectors (i.e., services such as wholesale and retail trade), large-scale business, and higher prices. What is lacking here is any coherent framework for deciding what constitutes sound policy. The inevitable consequence is that policies are looked at in isolation without considering potential conflicts between them.

The purpose of subjecting economic policies to critical scrutiny is to be able to suggest changes to these policies—or perhaps to suggest their abandonment—if they conflict with what we consider to be the ultimate economic objectives of maximising the material well-being of the public and promoting the interests of the poor in particular. Space limitations allow us to consider just a few of these policies, each of which, no matter how well meant, seems to conflict with one or both of these goals.

The proliferation of economic policy objectives (in Indonesia and elsewhere) reflects a lack of debate as to the appropriate economic role of government. In our view, basic neoclassical economic theory provides sensible guidelines on the logical delineation of the respective roles of government and the private sector in economic activity. It starts from the observation that the private sector is perfectly capable of efficiently providing most of the goods and services desired by the public (given the finite productive capacity of the economy). But it also shows that there are specific cases of ‘market failure’ where it cannot do so—most importantly in the provision of public goods such as national security, domestic law and order, and protection against natural disasters, and when there are externalities involved such as air and water pollution.³ We argue that these crucially important areas of market failure are where governments should place their primary focus.

In short, we argue that the economic role of government is to complement the private sector in cases of market failure rather than to usurp its role or unnecessarily interfere with its activities. In reality, insufficient attention is paid to areas in which the private sector cannot or will not generate socially optimal outcomes, while a great deal of effort is expended in counterproductive interference with, or even displacement of, the private sector. The low esteem in which the public holds the entire legal system—from police officers to prosecutors and judges—is strong evidence that this field has been badly neglected by successive governments. The enormous damage and loss of life caused by frequent volcanic eruptions, earthquakes, and tsunamis suggest that much more effort needs to be put into improving preparedness for natural disasters. Ongoing problems with flooding in key cities is another area in which increased government effort would seem very likely to be socially beneficial. By contrast, a current concern is that in its haste to expand infrastructure rapidly, the government has been appointing state-owned construction companies directly rather than putting projects out to tender, thus forgoing the opportunity to identify private sector firms willing and able to do the work more cost-effectively. In general, it is not clear that anything is gained by having state enterprises compete with private sector firms, or by having the bureaucracy tell private firms how or what to produce.

The constitutional requirement (Art. 33 (2)) that branches of production that serve basic needs are to be controlled by the state implies that the private sector cannot be relied on to provide basic needs and that the government can be expected to do better. Both theory and empirical evidence suggest strongly that private sector outcomes will be superior, however, except in cases of market failure. The latter are the branches of production in which government intervention can make an important contribution. Other sectors supplying basic needs such as food, clothing, and shelter are not obviously in need of much, if any, government intervention.

The continued focus of the national planning agency on economy-wide planning epitomises the allocation of government resources to areas where they are not needed; such planning is the antithesis of trusting markets to allocate productive resources efficiently. The private sector, which accounts for about 90% of all goods and services consumed domestically, will make its own decisions about where to invest, regardless of what Bappenas sees in its crystal ball. The agency, meanwhile, could best apply its analytical resources to the remaining 10% share purchased or produced by the government on behalf of the public— for example, by undertaking cost-benefit analyses of potential infrastructure improvements and extensions.

Macroeconomic developments and policies

We begin by looking at the conduct of macroeconomic policy. The deceleration of GDP growth evident in the last years of the second Susilo Bambang Yudhoyono administration has been halted (table 1), but there seems little reason to expect annual growth much above the current (Q3 2018) 5.2% per annum in the near future. In particular, although investment spending grew quite rapidly from mid- 2017 through the first quarter of 2018, its average growth rate was noticeably lower in the next two quarters—albeit still exceeding that of GDP by some margin. The three key tradables sectors—manufacturing, agriculture, and mining—continue to be outperformed by non-tradables (mainly services). Inflation has remained on target at low levels (3%–4% p.a.) since the one-off effect of the jump in domestic fuel prices in November 2014 is no longer a factor.

Table 1. GDP Growth (% p.a. year on year)

Source: BPS (Statistics Indonesia) through CEIC.

Note: The sectors named above include the following sub-sectors: ^a repair of motor vehicles; ᵇ financial and insurance activity; real estate; business services; other services; ^c public administration, defence and social security; education services; health care and social work; ᵈ electricity, gas, and water supply; sewerage, waste, and recycling.

The budget deficit grew quite rapidly during the second Yudhoyono administration—both absolutely and relative to GDP—but under the Joko Widodo (Jokowi) administration the ratio to GDP has stabilised at around 2.5%, which is within the legal maximum (3% of GDP) (table 2). Central government debt outstanding began to accelerate noticeably from mid-2015—especially the rupiah-denominated part, which now comprises almost 60% of the total—but even though the ratio of public sector debt to annual GDP has been rising steadily over the past four years, it remains low by international standards, at about 29%.

Table 2. Budget Deficit and Government Debt

Source: BPK (Audit Agency) and BPS through CEIC.

On the other hand, from January to October 2018, the rupiah depreciated by about 14% against the US dollar, while share prices declined by about 12% (figure 1). The current account deficit (CAD) grew to 3.4% of GDP in the third quarter of 2018, while international reserves held by the central bank fell from $132 billion to $115 billion between January and October. Somewhat surprisingly, and despite repeated attempts by government spokespeople to assure the public that the economic fundamentals are currently sound, many commentators prefer to emphasise Indonesia’s purported vulnerability to destabilisation—if not crisis— as evidenced by this second group of indicators.

FIGURE 1 Exchange rate and Composite Share Price Index

Sources: BI and Indonesian Stock Exchange through CEIC.

Figure 1 shows a period of more than a decade, allowing us to put current trends into historical perspective. The recent depreciation is milder than that during the 18-month period to September 2015 and very modest by comparison with the rapid depreciations associated with the global financial crisis (commencing in Q3 2008) and the ‘taper tantrum’ (Q3 2013). Similarly, the share price declines in 2008 and 2015 were more severe than in 2018. In short, when seen in historical perspective, concerns about the recent deterioration in these financial indicators appear to be unduly alarmist.

Explaining the Perturbations

There have been several contributors to the depreciation of the rupiah and the decline of share prices. First, years of expansionary monetary policy in the US after the 2008 global financial crisis (GFC) ended in January 2015, causing interest rates in this key financial market to move slowly but steadily upward. Bank Indonesia (BI) chose not merely to ignore this new trend for more than three years but to reduce its own policy rates by even more than its US counterparts raised theirs, resulting in a significant reduction in Indonesia’s relative attractiveness as an investment destination. The narrowing gap between rupiah and dollar interest rates eventually began to reduce net foreign portfolio investment, and the consequent reduction in total savings available for investment began to push domestic market-based interest rates upward.

The central bank was slow and reluctant to respond, belatedly increasing its policy rates—by considerably smaller amounts—from around May 2018 (figure 2).⁴ By this time, BI was intervening as a seller in the foreign exchange market, shedding international reserves in an attempt to limit depreciation of the rupiah. The effect of this was to reduce liquidity and thus keep market interest rates higher than BI’s policy rates, but the central bank chose to offset this effect, partially at least, by intervening as a buyer in the market for government bonds (Wall Street Journal, 5 September 2018). Unwillingness to allow domestic interest rates to move in line with the global financial markets worked against restoration of portfolio capital inflows, which fell from $8.1 billion in the second quarter of 2017 to –$1.1 billion in the first quarter of 2018, ensuring continued pressure on the exchange rate.

FIGURE 2 Money Market and Policy Interest Rates (% p.a.)

Source: BI through CEIC Asia Database.

Second, a few developing countries (Turkey, Argentina, and South Africa, in particular) have been experiencing rapid currency depreciation (largely because of poor macroeconomic management). This has revived painful memories of the Asian financial crisis (AFC), which was triggered by a large, unexpected, and ultimately contagious depreciation of the Thai baht. Presumably some of the recent capital outflow reflects herd-mentality behaviour based on a fear that currency weakness in these other developing countries could spread to Indonesia, notwithstanding its lack of close financial links with them. Awareness, on the part of sophisticated investors, of the central bank’s demonstrated reluctance to allow interest rates to rise to levels consistent with exchange-rate stability would only have compounded this behaviour.

Third, non-oil and gas imports have been growing rapidly since late 2016 and by much more than exports, suggesting the need for depreciation in the absence of any reason to expect a change in this trend. Moreover, there is a move to greater protectionism in the global trading environment—to which Indonesia has been making its own contribution (Patunru and Rahardja 2015)—and, indeed, a threat of trade wars between the US and some of its major trading partners, leading to an anticipation of disruption of Indonesia’s export markets and possible further increases in the CAD. Such concerns also tend to generate speculative capital outflows. Finally, there are concerns about the potentially destabilising impact of the 2019 presidential election campaign. There is a vicious circle at work here, with the president’s opponents playing on fears of rising food prices and emphasising the return of the exchange rate to levels last seen during the disastrous AFC—even though the recent rate of depreciation has been quite modest, as we have just noted. Such tactics help to create a crisis mentality that itself encourages capital outflow, with the potential to make fear of depreciation a self-fulfilling prophecy.

Policy Responses

The central bank has sold off more than 10% of its international reserves in order to limit the extent of depreciation. For its part, the government has focused mainly on trying to reduce the CAD through fiscal policy, most significantly by delaying billions of dollars of infrastructure projects with a heavy import content, mainly in the electricity sector. The worrying implication is that it is now consciously sacrificing timely completion of its ambitious electricity-generation expansion program and the boost to economic growth this could have provided. The public may find it hard to understand this policy reversal in a context in which government spokespeople have been claiming that the economic fundamentals are sound.

On the revenue side of the budget, the government has made much of its newly imposed increases in ‘taxes on imports’, but these are unlikely to have a significant impact. The increases apply only to a narrow range of ‘non-essential’ consumer goods, and consumer goods in total account for only a small proportion of total imports, in any case. Moreover, the taxes are not customs duties but are withholding taxes paid by importers; since these payments will be credited against their future income tax liabilities, little more will be achieved than to modestly and temporarily interrupt importers’ cash flow. In addition, the government has announced its intention to require greater substitution of biodiesel for traditional fuel, thus reducing the need to import corresponding amounts of the latter, but the logistical difficulties of achieving much progress on this front in the short run appear to be considerable.⁵

Various other possibilities for reducing capital outflow have also been discussed, such as introducing measures to induce exporters to keep half their earnings in the country and convert them to rupiah—ignoring the fact that businesses do not generate revenue in order to accumulate money in the bank. For the most part, these suggestions seem more likely to strengthen the crisis mentality and thus exacerbate capital outflow than to turn it around. To the extent that various mooted tax breaks will be available only to exporters, and perhaps only to exports of particular products or in certain minimum volumes, the result would be akin to re-imposing the multiple exchange rate system Indonesia wisely abandoned decades ago (Arndt 1966, 8).

Growth Versus Stability?

Of particular concern is the notion that there is a trade-off between stability and growth (Bank Danamon 2018; Basri 2016 and 2018b; Rajah 2018; Juoro 2018), and that in view of these threats to stability it is necessary to sacrifice growth to some extent. By contrast, we argue that there is no such trade-off—provided the policy response is appropriate—and that there is therefore a danger that Indonesia will unnecessarily settle for slower growth than it could otherwise achieve.

How, then, can policymakers respond to increases in the CAD and/or reductions in capital inflow without endangering stability? Our advice is that, aside from ensuring ‘good communication with business communities’ (Basri 2018a, 27) and the general public, they should continue to maintain slow and steady growth of base money (at a rate of around 10% p.a.) as the nominal anchor for monetary policy, avoiding the temptation to try to control other monetary variables—in particular, the exchange rate and interest rates. In short, they should trust market processes to adjust these key prices to changing circumstances rather than try to prevent them from doing so.

If indeed foreign and domestic investors collectively decide to devote less of their savings to Indonesia, a matching reduction in the CAD will be required. In turn, this can be achieved without government intervention simply by allowing market forces to find a new exchange rate that balances the supply of, and demand for, foreign exchange. This will involve some depreciation of the rupiah, making it more profitable to produce tradables and more expensive to import them. A new, smaller CAD will therefore emerge, balancing the new, smaller capital inflow. In addition, the reduction of total savings available to finance investment will result in higher domestic interest rates that reflect the now higher rates in global financial markets.

The policy recommended here roughly matches that followed during the GFC, when the authorities largely trusted the financial markets, allowing exchange rates and interest rates to move freely. Indonesia weathered that storm easily, with only a slight and short-lived deceleration in growth (Kuncoro et al. 2009). Notwithstanding this experience, the currently dominant view in Jakarta presumes severe consequences for the economy if the exchange rate is allowed to depreciate freely and if strong measures are not taken to control the CAD. A key proponent of this view is former finance minister Chatib Basri. In his discussion of Indonesia’s response to the 2013 taper tantrum, he argues that the central bank

could not use the exchange rate alone to solve the problem of external imbalances. The memory of the trauma from the AFC led to worries of the rupiah falling too steeply because many feared a repeat of the AFC (Basri 2018a, 26).

The underlying argument here appears to be that during the AFC the authorities mistakenly allowed the exchange rate to be market-determined. The consequences were disastrous: an astonishingly large depreciation of the rupiah, very high inflation and interest rates, the collapse of the banking sector at enormous cost to the public, and strongly negative growth. The desire to avoid a repeat is perfectly understandable, but to attribute these dire consequences to the decision to float the currency is facile.

Prior to the AFC, BI’s nominal anchor for monetary policy was a de facto commitment to a steady rate of depreciation of the rupiah (Basri 2018a, 26). The decision to float the currency in August 1997 was sound, but no replacement anchor was adopted, so monetary policy became incoherent during the following 8–10 months. The consequence, as Basri (citing an IMF study) points out, was ‘a loss of monetary control, which … caused further drops in the rupiah’ (2018a, 25). To be precise, base money doubled in eight months, resulting in surging prices and a loss of competitiveness that could only be offset by depreciation. The expectation of depreciation generated rapid capital outflow, making the expectation self-fulfilling.

The loss of monetary control was a consequence of BI’s response to opportunistic behaviour on the part of the banks, which rapidly increased their lending to favoured entities wanting to pay down dollar-denominated debt or to purchase dollar-denominated assets (McLeod 2014, 222). When the recipients of these loans used the proceeds to purchase dollars—ultimately from BI—the banks’ deposits at BI fell correspondingly, rendering the banks illiquid and in need of central bank support if they were to continue to operate. BI’s willingness to restore lost liquidity amounted to financing speculation against its own currency. If it had stayed out of the foreign exchange market there would have been no loss of liquidity from the banking system, only a reallocation of reserves among banks as their customers bought and sold foreign exchange among themselves. It would have been a simple matter to identify banks that became illiquid because of financing currency speculation, and to bring this activity under control using BI’s authority as prudential regulator. To the extent it was judged necessary to restore the liquidity of such banks, BI could have borrowed the funds from other banks with liquidity surpluses, thus avoiding any impact on base money.

In short, the severity of the AFC for Indonesia was a consequence of policy responses on the part of the authorities. The implication is that current external imbalances can be dealt with by allowing the markets to determine exchange rates and interest rates, provided base money growth is kept under control. Moreover, there is no need to change fiscal settings to reduce the CAD. The supposed need to sacrifice growth for stability is illusory.

Infrastructure

The Jokowi administration set out a long list of strategic national projects in Presidential Regulation 3/2016, most recently revised in Presidential Regulation 56/2018. The current version of this list (table 3) includes more than 200 projects and a further three programs, with an estimated total cost of Rp 4,150 trillion (about $280 billion). Overall responsibility for realising these projects and programs is in the hands of the specially created Committee for Acceleration of Priority Infrastructure Delivery (the Indonesian acronym for which is KPPIP), rather than the coordinating ministry for economic affairs or the national planning agency. The committee is responsible for ‘coordinating the decision-making processes to encourage settlement of issues arising from the lack of effective coordination between the various stakeholders’.⁶ The name of the committee is somewhat confusing in that the ‘strategic projects’ include many that would not normally be thought of as public sector infrastructure, such as oil refineries; mineral smelters; aircraft manufacturing; natural gas extraction, liquefaction, and storage; a (non- state) university campus; an enormous housing program (‘one million houses’); and a number of programs aimed to help the poor in various ways.

Table 3. National Strategic Projects

Sources: KPPIP (2018). Laporan Pelaksanaan Proyek Strategis Nasional, Komite Percepatan Penyediaan Infrastruktur Prioritas (June); Presidential Regulation 56/2018 (appendix).

Notes:

ᵃ of which toll roads 64 (4,598 km), non-toll roads 5 (620 km; length of one project not stated)

ᵇ of which inter-city 9, intra-city 7

c including ‘technopark’ and multifunction satellite

ᵈ two types of aircraft.

A striking feature of the current list is that implementation depends on the private sector for no less than 59% of the required financing. Enterprises owned by the central and regional governments are expected to provide a further 31%, leaving a mere 10% to come from government budgets. Attempts by previous governments to involve the private sector in infrastructure through public- private partnerships have had very little success, so a significant change in approach would seem necessary. Also, getting government-owned enterprises involved may not always be easy. In particular, if state-owned oil and natural gas corporation Pertamina is expected to build new oil refineries, the government may need to stop requiring it to sell fuel at low prices without providing adequate compensation. One of the important implications of relying so heavily on profit- oriented firms, whether private or government owned, is that this will require them to impose cost-covering user charges when the infrastructure in question comes into operation. This would be entirely sensible, but it remains to be seen whether these firms will be persuaded that this is the government’s intention.

There is no easy way to evaluate the performance of the committee because the list does not include a timeline for completion of most projects/programs. In the case of toll roads, for example, three roads totalling 61 kilometres had been completed by the end of 2017, compared with a target list of about 64 roads totalling 4,600 kilometres to be completed sometime in the indefinite future. In its reports, for the most part, the committee tends to focus on the number of projects completed or at particular stages of development, such as planning, procurement, or construction. Since there are vast size differences in the various projects, this approach is not very helpful. An exception to these comments is the 35.8 gigawatt (GW) expansion program for electricity generation targeted for completion in mid-2019.⁷ By mid-2018, 6% of the targeted new generation capacity had been installed, while 47% was under construction; construction had not even started on the remaining 47%, so clearly the target will not be reached by 2019.⁸

The Land Resumption Issue⁹

One of the issues often mentioned in relation to delays in creating new public sector infrastructure is difficulty in the resumption of land,¹⁰ and the relevant laws and regulations have been modified several times in attempts to overcome this difficulty.¹¹ We conjecture that the main underlying problem is with the incentives facing the relevant parts of the bureaucracy: specifically, there are potential corrupt gains from delaying the process (Rosdaniah 2015, 167–8). In the remainder of this sub-section, we briefly outline a possible approach to redesigning the institutional aspects of compulsory land acquisition.

Government has an important role to play in managing property rights when a proposed change in land use is for some socially beneficial purpose, such as the construction of new toll roads or railways. It is not feasible to rely on voluntary market purchases of the land required, because each individual landowner is in a monopoly position and is therefore able to appropriate a significant share of the supernormal profit expected from such projects—thus removing most of the incentive to undertake them. In principle, the last landowner to sell would be able to capture the entire remaining supernormal profit because the road cannot be completed without this last strip of land. Likewise, for non-toll roads, the entire net social benefit could be captured by existing landowners if the government had to rely on voluntary land sales. For this reason, governments need to exercise their power of eminent domain to compulsorily gain control of the land in question.

Surprisingly, the various laws and regulations on compulsory land acquisition make no reference to the government’s power to resume land at its discretion for public purposes, as stated in Article 33 (3) of the Constitution: ‘land … is controlled by the state and used for the maximum benefit to the people’. Under present arrangements, landowners are effectively invited to lodge formal complaints about proposed resumption of their land, and there is a lengthy process by which such complaints are negotiated with a number of representatives of the government. In fact, the only significant practical issue that needs to be resolved in each individual case is the amount of compensation to be paid. It follows that the land resumption process need not delay infrastructure projects: land can be taken over and compensation paid almost immediately. Landowners dissatisfied with the amount of compensation could then appeal to the courts to have the amount adjusted without this holding back commencement of the project in question.

We therefore propose the establishment of a new land valuation agency and an associated special court for adjudicating compensation claims to deal solely with the compensation aspect of land resumption for public infrastructure purposes. This agency would recruit experts in valuing land and the fixed assets located thereon, and build up its in-house systems, database, and expertise over time. It would aim for compensation payments based on estimated market value plus a generous ‘compulsion margin’ (say, around 10%–20%) to reflect the fact that the value of land to its owner will typically be somewhat higher than its current market value, and that there will be unavoidable costs of relocation and disruption.

The sole objective of the agency would be to appraise the value of land being compulsorily acquired, relying as much as possible on price information generated by voluntary market transactions in comparable land. It would focus on rapid appraisal by experienced professionals rather than relying on the current system of negotiations between landowners and the bureaucracy: such ‘negotiations’ are essentially meaningless when one party has the power to determine the final outcome unilaterally and they are an open invitation to corrupt behaviour (analogous to negotiations on income tax liabilities between taxpayers and tax officials).

Once the appropriate level of compensation has been determined—and the land resumed—landowners would be able to appeal to the special court regarding the amount. Other than this court, no other government entity would have any role in determining the compensation amount, and the only parties involved in the appeal would be the landowner and the agency. The court’s finding would depend solely on the landowner’s ability to convince it that the agency’s analysis was faulty and, to ensure that landowners only made genuine appeals, the process could potentially result in either upward or downward adjustment of the amount initially offered. Those who wished to appeal the compensation amount might receive an initial payment of, say, 15% less than the provisionally determined amount, potentially forfeiting this margin if the court adjusted the final amount downward sufficiently.

The proposed agency and court would need to meet very high standards of competence and integrity. Because of the obvious scope for ‘capture’ by rent-seeking firms and individuals, it would be essential for its officials to be remunerated at levels broadly commensurate with those in the private real estate sector, where the necessary expertise currently resides, and from where most would be recruited. It would also be essential for its top management to comprise individuals of known high integrity. The highly respected Corruption Eradication Commission (KPK), along with the special Corruption Crimes Court (Tipikor), could serve as a model.

Small Business Finance

Subsidised credit for small business has been a staple of Indonesian economic policy since early in the New Order, reflecting a view that while micro, small and medium enterprises play a crucial role in the economy, their progress is hampered by lack of access to bank loans, mainly because they do not own substantial tangible assets that can be used as collateral (Tambunan 2018, 319).

Since 2007, government policy in relation to this issue has taken the form of the Loans to the People’s Businesses (Kredit Usaha Rakyat) program. In 2018 it was planned to channel Rp 120 trillion of loans to small firms, with a highly subsidised interest rate of 7% per annum.¹² By comparison, prime lending rates were around 10% per annum in mid-2018. Not only is the interest rate extremely low, but borrowers are also not required to provide collateral. Loans to finance working capital requirements may be for up to three years, while those for investment are for up to five years.

Some idea of the size of the program can be gained from table 4, although the picture is incomplete because the data refer only to loans disbursed in 2018, rather than to the amounts outstanding. Although there are nominally about 40 banks involved in the program, lending is totally dominated by three state banks—and by one in particular, BRI, which has a very wide network of village-based offices and a great deal of experience in small-scale lending. By contrast, involvement on the part of private banks and provincial government banks is negligible. The average loan size is Rp 26 million (around $1,700). The program’s website claims that there were about 58 million micro, small, and medium enterprises (MSMEs) in 2013; even if the number of borrowers on the books were to increase to 5 million by the end of 2018, it is clear that, even after decades, programs such as KUR in Indonesia reach only a small proportion of target firms.

Table 4. Subsidised Loans to People’s Businesses (Kredit Usaha Rakyat)

Source: Coordinating Ministry for Economic Affairs. http://kur.ekon.go.id/upload/doc/Penyaluran%20 KUR%20Tahun%202018-31%20Agustus%202018.pdf

Note: The data reflect cumulative totals for loans made in calendar 2018 through 31 August.

Perhaps because of the failure of subsidised lending programs to have much impact, the government also tries by various means to force banks to lend to MSMEs, from requiring preparation of detailed MSME business plans to mandating higher loan to deposit ratios and threatening to impose greater minimum reserve requirements for non-compliance (Rosengard and Prasetyantoko 2011, 291).

A recent study of small business financing in Indonesia observed that

SMEs perceive the lack of access to finance and the cost of loans to be greater obstacles to development and high profits than do large firms. [Several studies] show that finance shortages restrict development of small firms more than large firms. These general findings indicate an unmet demand for finance. (IFC 2017, 105).

Firms’ self-interested perceptions do not provide a sound basis for efficiency- improving economic policy, a prerequisite for which is the identification of market failure. The alleged ‘unmet demand for finance’ is not in this category.

Indeed, this label is not even an accurate representation of reality, since small firms actually have a range of financing options. McLeod (1992) notes, for example, that small firms do not need to own capital to be in business. Many productive assets, particularly land and buildings, can be rented instead: in effect, firms can borrow physical capital instead of funds, thus obviating the presumed need for bank loans. High profitability—necessary if the firm is to grow through reinvestment—does not depend on the ownership of such assets but on how effectively they are used.

Moreover, the perception that banks do not lend to small firms is greatly exaggerated in an economic sense. In reality, they do so indirectly through larger firms, which themselves use part of their own borrowings from banks to supply goods and services to smaller firms on credit—whether for just a week or two to allow small traders to purchase trading stock, or for a year or more to allow small firms to make longer-term investments in equipment, vehicles, and so on (figure 3). The ubiquity of such financing arrangements reflects the recognition by banks of their limited ability to compete in this segment of the finance market.¹³ Whether small firms obtain bank finance directly or indirectly is of little consequence. What matters is that the most competitive (i.e., most efficient) financing technique for any given circumstance comes to the fore.

FIGURE 3 Indirect Bank Funding of Small Business

It is argued that the intention of the KUR program is to improve the competitiveness of micro, small and medium enterprises and cooperatives so that they can graduate into sustainable, larger-scale businesses.¹⁴ If a single firm gains access to cheaper finance, its profit will of course increase, but if similar firms also obtain cheaper finance, temporarily elevated profits will be quickly competed away, just as they would if the cost of any other commonly used input fell. The argument is therefore an example of the fallacy of composition. It is unrealistic to expect that a large proportion of small firms can ever become large, because they are competing in the same markets. Those whose owners have inferior entrepreneurial skills will not go far, even if given access to cheap finance. If small firms are losing out in competition with large ones (for example, corner stores competing with supermarkets), the likely explanation is lack of economies of scale rather than lack of access to finance, in which case steady displacement of less efficient small firms from the industry in question is socially beneficial.

A notable aspect of the data on lending under KUR is the predominance of lending to finance working capital for trading activity. By contrast, there is very little for the purpose of investment in fixed capital, which would indicate an effort to transform the nature of the business in question. Rather, the loans do nothing more than reduce the cost of a particular input, temporarily increasing profitability as any subsidy would be expected to do. In short, there is no persuasive evidence of market failure in relation to the financing of small business. The seemingly never-ending procession of subsidised credit schemes favouring small businesses represents an unnecessary waste of effort and resources.

Decentralisation¹⁵

The basic rationale for decentralisation—or multi-level government—is ‘to bring government closer to the people’ (Oates 1999, 1,120). This is no mere cliché. Subnational governments located close to the populations they serve are best able to determine the nature and extent of the local services desired by their constituents and the amount they are willing to pay for these services; regular elections give voters the opportunity to choose political parties considered most likely to fulfil these desires. But Indonesia’s decentralisation arrangements fall well short of maximising these potential efficiency gains, for two main reasons.

First, local governments (LGs, comprising kabupaten and kota, or districts and municipalities) have been made responsible for delivering both education and health care services, but in these fields they respond less to the desires of their constituents and more to the commands of the central government, which determines the key objectives of education and health-care policy. For example, the laws on education and health were enacted by the central government, and there is a national curriculum and a national requirement for a minimum nine years of schooling for Indonesia’s children. The employment conditions of teachers and health-care professionals are also centrally determined. To a large extent, LGs operate, in effect, as contractors to the central government in these key fields.

Whether outsourcing education and health care to LGs yields superior outcomes is open to question: economies of scale are important to achieve efficiency, but many kabupaten have tiny populations. However, taking this choice as given, the key related decision is how these activities are to be funded. At present, LGs have to use block grant transfers from the centre to meet most of the cost of providing these services. The per capita amount of this funding varies enormously according to the size of the population of the LG in question (figure 4), but it is unrelated to demographic composition. Some LGs therefore have far less, per capita, to spend than others on education and health, making it virtually impossible to achieve anything like uniform national outcomes in these fields. In addition, any LG accused of failing to deliver services of the desired quality can always deflect blame to the centre for providing insufficient funding.

An obvious quasi-market solution to these problems is to formalise LGs’ role as quasi-contractors, and to ‘pay’ them accordingly for services rendered at predetermined rates per unit—just as construction contractors are paid specific unit rates for laying pipelines, building roads, and so on. For example, LGs could be paid specified amounts annually for each student enrolled in primary, junior secondary, and senior secondary school, and for each member of several demographic components of the population for whom they provide health care, such as infants, young children, teenagers, women of child-bearing age, persons of working age, and the elderly. The aggregate flow of funds to all LGs combined would not change, but the total would be allocated equitably across jurisdictions in proportion to the quantity of services provided. At present, there is no such link. Indeed, each LG is constitutionally obligated to spend at least 20% of its budget on education and 5% on health, but since the size of LG budgets varies over an extraordinarily wide range in per capita terms, this implies vastly different levels of expenditure per capita on these services.

Starting from the premise that each local government acts as agent for the representative individual within its jurisdiction, it seems desirable that fiscal transfers are broadly consistent with the principles of horizontal and vertical equity (i.e., equal treatment of equals and more generous treatment of the less well-off). With enormous variation in per capita revenues, it is unsurprising to find gross violations of these principles. Table 5 shows two pairs of cases in which jurisdictions that are equally well-off on the basis of either poverty incidence or their human development indices (HDIs) receive vastly different per capita transfers from the centre, along with other cases in which two pairs of jurisdictions with very different levels of either poverty or HDI receive similar per capita transfers. The pattern in figure 4 looks as it does, resulting in these violations of standard equity principles, for reasons explained in the appendix.

FIGURE 4 Local Government Total Revenue Per Capita (Rp million) and Population (million)

Source: World Bank, Indonesia Database for Policy and Economic Research.

Table 5. Gross Violations of Horizontal and Vertical Equity Principles (selected examples)

Source: World Bank, Indonesia Database for Policy and Economic Research.

The second major shortcoming of current decentralisation arrangements is in areas of activity where LGs act on behalf of their constituents rather than the central government—in particular, in the provision of public goods, and in dealing with externalities. Public goods such as stormwater drainage and flood control are local rather than national, and the same can often be said of externalities such as air and water pollution. LGs are much better able than the central government to discover what is important to their constituents, and therefore to provide the appropriate amount and type of these kinds of services. An essential aspect of this process, however, is estimating how much constituents value the package of services provided—and thus how much they are prepared to pay for them in taxes—because only when they are confronted with the cost of provision (as with private goods and services provided by the market) does their expressed demand for services have any real meaning.

The problem here is the decision to fund almost all LG expenditures from the central government budget. Since LGs therefore have very little need to raise funds, they are in no position to weigh up the cost of providing services against what their constituents are willing to pay for them. The alternative approach is to require LGs to generate their own revenue, most obviously by taxing land and buildings, as well as by imposing cost-based user charges where feasible. Land and buildings taxes were originally pre-empted by the central government, and although more recently these revenues have been handed to local governments, the authority of the latter to set tax rates is greatly circumscribed.¹⁶ Requiring LGs to fund their own provision of public goods and their efforts to deal with externality problems, while at the same time giving them the freedom to set their own rates of taxation on land and buildings, would force them to provide a package of these kinds of services for which local citizens would be prepared to pay.

These two market-mimicking suggestions regarding fundamental changes to the fiscal relationship between the central government and LGs would improve the efficiency and equity of decentralised governance by forcing the latter to be financially self-sufficient. To the extent it is desired to use transfers to LGs as an additional instrument of national income redistribution in favour of the poor, however, it would be sensible to retain a much-simplified untied transfer, with the per capita amount calculated to increase as per capita income declines and as poverty increases, along the lines proposed by Fadliya (2015, 33). A simplified version consistent with the principles of horizontal and vertical equity is

where T = per capita transfer; P = poverty incidence; C = per capita consumption (as proxy for income); α1 > 0 = adjustment factor for poverty; α2 > 0 = marginal rate of redistribution; j = 1, 2, … n denotes LGs; a denotes national average values; and Ta = per capita total amount of funds available for transfer. A jurisdiction with average levels of poverty and per capita consumption receives the average per capita transfer. Better-off jurisdictions receive less (for given poverty levels), and those that have higher than average poverty receive more (for given consumption levels).

Minimum Wages

Article 88 of Labour Law 13/2003 and its elucidation stipulate that employees are entitled to an income sufficient to provide a ‘decent standard of living’, interpreted as ‘the ability to meet the reasonable living needs of workers and their families, including food and drink, clothing, housing, education, health, recreation, and saving for retirement’. This closely reflects the official (BPS) definition of poverty: ‘the inability to fulfil basic food and non-food needs’.¹⁷ To achieve its goal, the government implements various wage policies, including fixing minimum wages (Art. 89 (2)). As Bird and Manning (2008, 917) put it: ‘An active minimum wage policy has been adopted partly as a tool to reduce poverty’. Minimum wage (MW) policy thus appears to reflect a belief—or perhaps a pretence—that it is possible to legislate poverty out of existence. The notion that Indonesia’s workers could enjoy increasing incomes in the absence of MWs seems never to be considered, notwithstanding that many countries have never introduced them (Manning and Roesad 2007, 74).

In the past when the MW was being reset, there was often debate about how much employers could ‘afford to pay’. Firms have little interest in this elusive concept, however. Their actual behaviour depends instead on a simple cost- benefit comparison. Specifically, no rational employer will recruit or retain a worker at a MW of $2 a day if that worker can only generate revenue of $1 a day, so the impact of a MW increase is for firms to reduce their employment of such workers: the law can determine the price of labour but not the quantity employed. Thus, although some workers gain from the higher wage, others lose access to these kinds of jobs, ending up working for less than they would otherwise in areas where the MW is not enforced.¹⁸ Thus, to describe MW increases during a certain period as ‘a fairly good outcome for labour’ (Manning and Pratomo 2018, 172) seems highly misleading, because the focus is only on workers who gain from the policy, ignoring those who lose. MW policy is not really about redistributing the economic pie between labour and capital: the long-term impact on the owners of capital is minimal, since the rate of return to capital in Indonesia is broadly determined in the global financial market. Rather, its purpose is to prevent low-skilled labour from competing with more highly skilled labour, to the advantage of workers in the latter group lucky enough to work in areas where the MW is enforced.¹⁹

Rapid increases in MWs in recent years have seen their levels rising close to, or even above, average wages—and far above the poverty line—in many jurisdictions (table 6). There were at least two main reasons for this. First, responsibility for setting MWs passed from the central government to the provinces—and on to districts and municipalities if these third-tier jurisdictions desired to move higher than the province minima (Manning and Roesad 2007, 75). Second, adjustment of MWs in line with objectively measured changes in the cost of living was discontinued in favour of bargaining between unions, employers, and governments.²⁰

Table 6. Minimum Wages Relative to Average Wages and Poverty Lines across Provinces

Sources: BPS and Ministry of Manpower and Transmigration, through CEIC Asia Database.

Note: Within any province, individual districts and municipalities may set higher minimum wages, so the actual maximum ratios are correspondingly higher than those shown in the table.

Promises of large MW increases were attractive to voters, as the only losers seemed to be the relatively few owners of firms in the formal sector (presumed to be well-off), while the potential beneficiaries seemed to be all those employees with wages below the promised new minima. Few would have understood that this policy would displace workers from the formal sector where MWs could actually be implemented, forcing them to compete against workers in agriculture and the informal sector, who would have their already low incomes reduced as a consequence. Most workers in the latter group, who comprise a majority of the workforce, were not protected by the MW—either because they were self- employed (i.e., non-wage earning) or because high administrative costs made enforcement infeasible in their workplaces.²¹ The policy therefore conflicts with the objective of reducing poverty.

We conjecture that additional support for higher MWs came from the bureaucracy. MWs set far above free market levels create incentives for bribery and opportunities for bureaucratic extortion, since firms that use relatively low-skill labour intensively have much to gain from non-enforcement. Wide gaps between union demands and employer offers created opportunities for sub-national governments to determine outcomes (Allen 2018, 206) closer to the former, thus providing greater incentives for employers to bribe regulators.

Poverty reduction and modernisation of the economy are likely to be held back needlessly by MWs, which reduce the profitability—and therefore slow the expansion—of large, low-skill, labour-intensive firms in the formal sector, condemning Indonesia to continued heavy reliance on small-scale, traditional activity such as agriculture and petty services. It was the rapid expansion of the more modern sectors in the late 1980s and early 1990s that allowed the economy to grow at annual rates of around 7%—well above the 5% rate of recent years— contributing to a rapid decline in poverty. Arguably, MW policy has played an important part in killing Indonesia’s golden goose.

Managing the Bureaucracy: The New Law on the Civil Service

Although Indonesia’s Corruption Eradication Commission (KPK) continues to be busy, recording many new arrests, prosecutions, and imprisonments of corrupt officials, corruption is still rife in the bureaucracy. Thus, Indonesia ranked only 96 out of 180 countries in Transparency International’s 2017 Corruption Perceptions Index, scoring just 36 on a scale of 0–100.²² But another problematic characteristic of the bureaucracy receives little attention by comparison: namely, its competence. For the government to optimise its contribution to economic growth, it will need to greatly improve the competence of its bureaucracy—a task that seems to have been largely overlooked hitherto. The current anti-corruption approach, focused on detection and punishment, is unlikely to contribute much to the objective of achieving an effective civil service.

Since private-sector personnel management practices work well, it makes sense to consider adopting similar processes within the bureaucracy, even though it is not motivated by profit. As agent of the public, it should have the same commitment to efficiency and to delivering services of the quality that its ‘customers’—the public—want, as do private sector firms. That said, it is precisely the fact that the bureaucracy has a monopoly position—with no threat of it being ‘forced out of business’ by more efficient competitors—that permits poor human resource management practices to persist almost indefinitely.

Until recently management of human resources in Indonesia’s bureaucracy differed greatly from common practice in the private sector. In particular, when filling positions, the pool of eligible applicants was extremely limited except at the levels of new school or university graduates. Above these levels, hardly anybody was hired from outside the civil service, or even from outside the department in question. Moreover, priority in promotion nearly always reflected seniority rather than capability or merit. Change began to become apparent, however, following the enactment of Law 5/2014 on the Civil Service. The law emphasises the need to get rid of corruption and political intervention, and to improve capacity to properly deliver services to the public. It notes that recruitment, placement, and promotion processes in the past failed to match individuals’ skills to those needed for each position. It expresses the intention to apply merit principles to human resource management, and it requires the government to pay fair and reasonable salaries to its employees, consistent with their workloads, responsibilities, and job risks (Art. 79). Of particular interest is the stipulation (Art. 60, 61, 95) that every Indonesian citizen has an equal opportunity to apply to become a civil servant.²³

As a codification of general principles for managing the civil service, the new law is a big improvement on past practice, but there is one glaring weakness. The reference to fair and reasonable salaries consistent with workloads, responsibilities, and job risks is unhelpful. There is no simple way to measure such things as workloads, responsibilities, and job risks, much less to attach a monetary value to them, so any salary structure established on this basis is necessarily subjective and arbitrary. Based on the view that nobody should be made financially worse off by choosing a career in the civil service, it seems preferable to interpret ‘fair and reasonable’ to mean ‘comparable with salaries available to individuals with similar skill sets within the private sector’. It is no simple matter to compare the skill requirements of positions in the private and public sectors, so a certain amount of subjectivity is unavoidable. But job-seekers themselves will compare jobs in the two sectors and come to their own conclusions as to whether the corresponding civil service salaries are indeed ‘fair and reasonable’, so it is important to get this right.

This has not been done thus far. Figure 5 compares remuneration in the government and private sectors at various management levels. There are four echelons of management in the bureaucracy, and we have taken these to be roughly comparable with junior managers, senior managers, directors, and chief executive officers (CEOs) within the private sector. In both sectors there is a range of salary levels, so we present low and high levels for both.²⁴

FIGURE 5 Remuneration in the Private Sector and the Civil Service (Rp million/month)

Source: Refer to footnote 24.

Clearly, private sector managerial-level salaries far exceed those in the civil service, especially at higher levels of management: the government fails to provide ‘fair and reasonable’ salaries to its high-level employees in our preferred interpretation of the term. The obvious conclusion to be drawn from these comparisons is that opening up applications for jobs within the civil service at these levels to all citizens is unlikely to have any significant impact, because potential applicants from the private sector would have to make huge financial sacrifices if they were to move between sectors.

One consequence of ignoring market salaries for managerial-level skills—and thus effectively severely limiting the pool of potential strong applicants for civil service positions—is illustrated by the attempt, initiated by the Megawati Sukarnoputri government, to reform accounting practices within the public sector (McLeod and Harun 2014). While such reform was long overdue, making it effective required much more than the mere introduction of new laws. Implementing these laws required high-level accounting skills that were largely absent in the civil service, so the reform turned out to be much less successful than hoped. The key obstacle was inability to recruit qualified and experienced accountants in the large numbers required to effect this reform, given that these kinds of skills attract quite high salaries in the private sector. Generalising this example to the civil service as a whole, we can say that the organisational competence of the bureaucracy depends directly on its ability to recruit from as large a pool of applicants as possible, in order to maximise the chance of appointing individuals who are both competent and of high integrity.

A second consequence relates to the behaviour of individuals within the bureaucracy. Indonesia’s civil servants are well aware of the significant financial sacrifice implied by choosing a career in the civil service rather than the private sector. They can hardly be blamed for being constantly on the lookout for ways to generate additional income so that they can enjoy a standard of living similar to that of their private sector peers. One example of this is the case of university lecturers, who typically limit their time spent with students in order to participate in much more lucrative consultancy projects, speaking engagements, and the like. Within the bureaucracy more generally, numerous perfectly legal ways have been found to generate additional income (the introduction of a wide variety of special allowances for attending meetings and conferences, participating in study tours, projects, and the like, and—for a lucky few—appointment as commissioners of state-owned enterprises). In addition, however, many officials choose to involve themselves in corruption. That this is a common practice is evident in colloquial references to ‘wet’ (basah) parts of the bureaucracy: those prized for their opportunities to engage in corruption.

In short, the attempt to reform the bureaucracy evidenced by Law 5/2014 on the Civil Service and its implementing regulations is unlikely to succeed in its aims because of failure to appreciate the importance of salaries in the market for skilled labour. To make substantial progress in improving the capacity of the civil service, while at the same time cutting back on corruption, it will be necessary not only to extend eligibility for high-level positions to the entire population, but also to make this meaningful by adopting a salary structure that is competitive with that in the private sector.

Notes

1 Presentation by Bambang Brodjonegoro at Australian National University, 9 March 2018.

2 Bappenas ‘has outlined an economic master plan that aims to lift the country to high- income status within 15 years’ (EIU 2011).

3 Limited space precludes discussion here of market failure arising from natural monopolies.

4 The lack of close correlation between policy rates and market rates suggests that monetary conditions are in fact mainly determined by BI’s transactions in the foreign exchange and bond markets, and by cash flows through the government’s account at BI; policy rates do not accurately reflect the stance of monetary policy.

5 Basri and Patunru (2006, 307–8) provide an extended discussion of arguments against the production of ‘bio fuels’.

6 https://kppip.go.id/en/about-kppip/.

7 ‘Presiden Jokowi Luncurkan Program ‘35 Ribu MW Listrik untuk Indonesia’ (President Jokowi launches '35 GW electricity program for Indonesia') Voice of America, 4 May 2015. https://bit.ly/2PPOf13.

8 Introduction of the much-discussed fast train connecting Jakarta and Bandung is running well behind schedule, according to Antara (18 May 2018), with only 20% of the needed land yet resumed. https://bit.ly/2RrM9S6.

9 This section draws heavily on Rosdaniah (2015).

10 Laporan Pelaksanaan Proyek Strategis Nasional KPPIP June 2018, 14.

11 Most recently by Presidential Regulation 148/2015.

12 Coordinating Minister for Economic Affairs Regulation 11/2017. The rate had been 9% in 2016 and 12% in 2015.

13 Rosengard and Prasetyantoko (2011, 276) assert that ‘lack of access to credit for viable MSMEs wishing to borrow is a significant constraint to their development’, but they make no mention of indirect lending through larger firms.

14 http://kur.ekon.go.id/gambaran-umum (authors’ translation).

15 This section draws heavily on Fadliya (2015).

16 Law 28/2009 imposes a maximum rate of 0.3% for the land and buildings tax (Art. 80).

17 https://www.bps.go.id/subject/23/kemiskinan-dan-ketimpangan.html.

18 Empirical support for this argument can be found in studies such as Suryahadi et al. (2003), Bird and Manning (2008), and Merdikawati (2018).

19 Allen (2018, 208) asserts that ‘the general purpose of the minimum wage is to militate against unduly low pay for unskilled and low-skilled workers’, seemingly confusing the nominal purpose of MWs with their actual impact.

20 The system later returned to an objective, formula-driven process (Hamilton-Hart and Schulze 2016, 282), but this did nothing to overturn the huge MW increases that had already occurred.

21 Allen (2018, 216–22) provides an extended discussion of non-compliance with MWs.

22 https://www.transparency.org/news/feature/corruption_perceptions_index_2017.

23 Implementing this would require a substantial change to the prevalent organisational culture.

24 Remuneration data for the civil service can be found in several presidential regulations (e.g., 156/2014). The amounts include the basic salary plus a performance allowance that varies across government institutions. Information on private sector salaries was compiled from a number of commercial sources, including Kelly Services Indonesia (https://www.kellyservices.co.id/), Robert Walters (https://www.robertwalters.co.id), and Michael Page (https://www.michaelpage.co.id/). The existence of such sources clearly indicates the importance to employers and job applicants of up-to-date information on private sector salaries.

25 See Martinez-Vazquez and Boex (2001, 22–23) for a full exposition of this kind of transfer. The Indonesian system of transfers is more complex than described here (see Fadliya 2015).

26 Other than population, the allocation factors are area, the Human Development Index, regional GDP per capita, and the Construction Price Index.

27 Boadway and Shah (2009: 362–3) appear to endorse the same kind of system—making no reference to the implications for per capita transfers.

APPENDIX

The formula for calculating transfers to each LG is dominated by a central component that aims to allocate funds in proportion to various factors that together form a proxy for so-called ‘fiscal need’, each of which is given a weighting to reflect its desired relative importance.²⁵ This component is expressed as

where α_n are the weights (summing to 1) for allocation factor n, x_n and X_n are the individual and either total or average values of the allocation factors,²⁶ respectively, and F is the total pool of funds available. Taking x₁ and X₁ to refer to population— now denoted p and P, respectively—and expressing the transfer in per capita terms, we obtain

That is, per capita transfers decline, asymptoting to zero, as population increases, all other things equal.²⁷ Two jurisdictions equal in all respects other than population receive different per capita transfers. A better-off jurisdiction that has a small, well- off population will receive a higher transfer than a sufficiently large one whose population is relatively poor.