Manajemen | Fakultas Ekonomi Universitas Maritim Raja Ali Haji 00074910500117289
Bulletin of Indonesian Economic Studies
ISSN: 0007-4918 (Print) 1472-7234 (Online) Journal homepage: http://www.tandfonline.com/loi/cbie20
The struggle to regain effective government under
democracy in Indonesia
Ross H. Mcleod
To cite this article: Ross H. Mcleod (2005) The struggle to regain effective government
under democracy in Indonesia , Bulletin of Indonesian Economic Studies, 41:3, 367-386, DOI:
10.1080/00074910500117289
To link to this article: http://dx.doi.org/10.1080/00074910500117289
Published online: 18 Jan 2007.
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Bulletin of Indonesian Economic Studies, Vol. 41, No.3, 2005: 367–86
THE STRUGGLE TO REGAIN EFFECTIVE GOVERNMENT
UNDER DEMOCRACY IN INDONESIA
Ross H. McLeod *
a
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Australian National University
With Soeharto’s demise, Indonesia gained democracy but lost effective government. A return to sustained, rapid economic growth will require an overhaul of
Indonesia’s bureaucracy and judiciary which, along with the legislatures, the military and the state-owned enterprises, had been co-opted by the former president
into his economy-wide ‘franchise’—a system of government designed to redistribute income and wealth from the weak to the strong while maintaining rapid
growth. This franchise has disintegrated, its various component parts now working at cross-purposes rather than in mutually reinforcing fashion. The result has
been a significant decline in the security of property rights and, in turn, the continued postponement of a sustained economic rebound. To reform the civil service it
will be necessary to undertake a radical overhaul of its personnel management
practices and salary structures, so as to provide strong incentives for officials to
work in the public interest.
INTRODUCTION
Indonesia’s long-serving president, Soeharto, became more unpopular the longer
he remained in office. The economic crisis that began in mid-1997 provided the
conditions under which at last he was able to be forced out, only a couple of
months after he had been elected unopposed to a seventh five-year term. Since
then the country has been able to manage a relatively peaceful transition to a
more genuine democracy. The first stage of this began with the formal handover
of power by Soeharto to his deputy, B.J. Habibie, in May 1998. The second
involved the holding of elections for the parliament in June 1999, and the subsequent indirect election of Abdurrahman Wahid by the People’s Consultative
Assembly (MPR) as the first president of the new democratic era. The third saw
the dismissal of Wahid in July 2001 and his replacement by Megawati Soekarnoputri, also by the MPR. The fourth stage encompassed a further general election,
followed by Indonesia’s first direct presidential election, in 2004, resulting in the
appointment of Susilo Bambang Yudhoyono (SBY).
Macroeconomic conditions have stabilised after the astonishing upheaval of
the 1997–98 crisis, which saw GDP fall by 18% in the fourth quarter of 1998
α
∗ Much of this paper was written while the author was a visitor at the School of Advanced
International Studies, Johns Hopkins University. The author is grateful to John Bresnan,
Greg Fealy, Karl Jackson, Hugh Patrick, Bridget Welsh and two referees for their insightful comments, and to audiences at Columbia, Harvard and Johns Hopkins Universities to
which earlier versions of this paper were presented.
ISSN 0007-4918 print/ISSN 1472-7234 online/05/030367-20
DOI: 10.1080/00074910500117289
© 2005 Indonesia Project ANU
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Ross H. McLeod
compared with a year earlier. The exchange rate settled at close to Rp 8,500/$ in
the second half of 2003—having risen as far as Rp 15,000/$ in 1998—before
weakening somewhat; in the year to mid-2005 it ranged between Rp 9,000/$ and
Rp 9,500/$ for most of the time. Inflation, although still rather high relative to
that of Indonesia’s neighbours, is back to levels that had become the norm prior
to the crisis, and interest rates have declined to below pre-crisis levels. But current forecasts are for growth at around 6.0% per annum in 2005—somewhat
slower than the average rate maintained over three decades of Soeharto’s rule.
With population growth running at about 1.5% per annum, per capita incomes
seem likely to grow at only around 4.5% annually—three-quarters the rate of
6.0% recorded during the four pre-crisis years. At this pre-crisis rate, average
incomes double every 12 years; at the currently projected rate it takes a third as
long again. Accelerating economic growth further is therefore crucially important
for poverty reduction.
More important, it cannot simply be assumed that even this modest projected
growth rate can be maintained into the future. Two important economic indicators are the absolute and relative levels of investment. Seven years after the crisis
began, the former was languishing at just 80% of its pre-crisis level, and the latter at 18% of GDP, compared with 30% pre-crisis. Some improvement has
occurred more recently, raising the investment to GDP ratio to 22%, but this still
leaves a long way to go to restore this ratio to its pre-crisis level. Business investment’s slowness to recover suggests a lack of confidence that Indonesia’s new
democracy will give rise to an effective government capable of doing the things
needed to complement the functioning of the private sector.
Most of the discussion about how to return Indonesia to its previous highgrowth trajectory tends to propose lists of policies that would support this objective (and of those that would conflict with it). But this ignores the fundamental
reality that whether sensible policies will be chosen, and whether they will be
implemented effectively, depends on the quality of the bureaucracy.1 Bluntly put,
we cannot expect significant improvement in the policy environment if the
bureaucracy remains dysfunctional.
With these comments as background, the main aims of this paper are: first, to
explain why, and in what sense, Soeharto’s regime was effective, and why subsequent governments have been much less effective; and second, to suggest the
nature of reforms needed if its effectiveness is to be matched or surpassed, and to
discuss other kinds of reform initiatives already under way.
I shall argue here that with Soeharto’s demise, Indonesia gained democracy
but lost effective government. By gaining democracy I mean that the people now
have the genuine opportunity to vote out incumbent governments at regular
intervals, and I interpret effective government in a limited and purely economic
sense to mean doing what is needed to achieve rapid growth—with the expectation that the benefits of growth will be widely spread amongst the population, as
was the case during the Soeharto era. Specifically, I emphasise that rapid eco1 A further
consideration is the extent to which the legislatures, answerable to the general
public at national, provincial and district levels, hinder the operations of the bureaucracy.
Some mention of this is made below, but the main emphasis here is on the civil service
(including the judiciary), which is under the direct control of governments.
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The Struggle to Regain Effective Government under Democracy in Indonesia
369
nomic growth depends on a complementary relationship between the private
and public sectors, in which the public sector provides things desired by the public but which the private sector is not able to produce.
The provision and maintenance of physical infrastructure by the public sector
is clearly important, including roads, ports, airports, storm-water drainage and
flood control, sewerage and so on. Most of this was given considerable prominence at an infrastructure summit in Bali in mid-January 2005 after several years
of serious neglect (World Bank 2005: table 3.4; Soesastro and Atje 2005).2 Beyond
this there is room for debate as to what other things governments should provide.
There can be no doubt, however, that one of the most important tasks of the public sector is to ensure the rule of law and the security of property.3 In turn, this
requires the drafting and enactment of laws and the provision of the means to
enforce them: a judiciary, a legal bureaucracy (including a public prosecutor) and
a police force. The weaker the rule of law and the security of property, the weaker
is the incentive to invest and to work. As O’Driscoll and Hoskins (2003: 7) put it:
Once stated, the intellectual argument for the importance of property rights is compelling. Why does an individual invest unless to gain something for himself and his
family? How can he ensure that gains flowing from his activity be appropriated and
secured other than through a system of well-defined property rights?
In turn, since economic growth depends on investment and the supply of effort
by individuals, economic performance of an economy overall can be expected to
be, and is, strongly correlated with the security of property (Roll and Talbott 2003:
15–16).
THE FUNDAMENTAL DETERMINANTS OF ECONOMIC PERFORMANCE
It is a truism that the overall performance of any organisation or regime depends
on the performance of the individuals that comprise it, other things equal. In
turn, individuals’ performance depends on the strength of the incentives they
face, both positive and negative. I shall argue that the incentives for good performance in the public sector institutions during the Soeharto era were strong—
relative to Soeharto’s objectives, which happened to coincide largely, though not
entirely, with society’s objectives. By contrast, the incentives for good performance in those institutions subsequently have become weak—relative to society’s
objectives. The decline in Indonesia’s economic performance since Soeharto’s
demise can be explained by this change in the structure of incentives facing officials in the public sector institutions, such that they no longer have much motivation to do what is necessary to promote rapid growth of the economy.
Soeharto’s Franchise System of Government
Soeharto created incentives for effective government within what I have
described elsewhere as a ‘franchise’ system (McLeod 2000). A more descriptive, if
2
Flood control, drainage and sewerage systems were ignored, however (McLeod 2005a).
3 A similar argument has been put in relation to priorities that need to be followed in estab-
lishing a new democratic regime in post-war Iraq (McDougall 2003).
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Ross H. McLeod
FIGURE 1 The Soeharto Franchise
Soeharto
Beneficiaries
Tax targets
Franchise
(Public sector institutions)
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Conglomerates
Large
foreign firms
Legislature/
parties
Judiciary/
legal bureaucracy
First family
Domestic
firms/
individuals
Small
foreign firms
Military/police
Bureaucracy/
non-departmental
agencies
State-owned
enterprises
cumbersome, title would be ‘multi-branch, multi-level franchise‘ (figure 1).4 The
branches of the franchise included the legislature (MPR, DPR5 and tame political
parties); the judiciary and the legal bureaucracy; the military/police; the bureaucracy (including non-department agencies, especially the logistics agency, Bulog,
and the central bank, Bank Indonesia); and the state-owned enterprises (SOEs),
especially the giant oil company, Pertamina, and the state banks. Most of the
branches encompassed a number of levels. Legislatures existed at national,
provincial and district/municipality levels, while the bureaucracy extended right
down to the villages. The hierarchy of the judiciary extended down from the
Supreme Court through the High Court to the district courts. The army also had
regional divisions, as did the state banks.
Like franchises in the world of business, the Soeharto franchise was designed
to provide strong positive and negative incentives for its success. Key public sector officials could rapidly become wealthy if they lived by its rules, but they could
find themselves sidelined if they failed to perform well or if they worked against
it.6 It prospered by means of ‘private taxation’—that is, various forms of informal
taxation of individuals and firms. The ‘taxes’ imposed by franchisees were of two
4
Liddle (1985: 71) refers to the political structure of the New Order as ‘a steeply-ascending pyramid in which the heights are thoroughly dominated by a single office, the presidency’. Crouch (1991: 57) refers simply to ‘Soeharto’s patronage network’.
5
6
The DPR is the People’s Representative Council, or House of Representatives.
Liddle (1985: 74) refers similarly to ‘the building of performance-based support within
the pyramid’.
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The Struggle to Regain Effective Government under Democracy in Indonesia
371
main types: extortion, and rents generated by the public sector through its economic policies and harvested by cronies of the regime (the ‘conglomerates’),
members of the first family and large foreign firms7—these last three groups
being the major beneficiaries of the system (other than the franchisees themselves). By and large, this taxation was levied at a low rate on a wide ‘tax base’
that comprised a large part of the economy as a whole; it operated in conjunction
with economic policies that helped the private sector to generate rapid economic
growth in order that this tax base would also grow rapidly. Thus there was a close
correspondence between the interests of Soeharto’s franchise and the interests of
the general public, even though the effect of private taxation was to redistribute
some income and wealth from the weak to the strong: both the franchise and the
public stood to gain from broadly sound economic policies that generated rapid
growth.
To see this, suppose all individuals’ incomes rise by 5% prior to imposition of
a ‘private tax’ of 0.1% on the incomes of 99% of the population. The ‘tax revenue’
is then redistributed to the other 1% (i.e. the members and beneficiaries of the
franchise). If the latter small group had incomes, say, 10 times as great as those in
the large group to begin with, it is easy to show that their incomes will grow by
about 6% in total. But the large ‘poor’ group is also better off than before, with a
net gain of approximately 4.9%—notwithstanding redistribution from it to the
‘rich’. The growth of the economy—to a considerable extent the consequence of
sound economic policies—is beneficial to both groups.
Despite the legendary corruption and incompetence of the legal system and
the bureaucracy, the rules of the game enforced by the franchisor (Soeharto) were
such that property rights were relatively secure for the majority of the population. (This is not to deny many instances of effective expropriation of land, often
through violence or the threat of it, by politically well-connected real estate developers, plantation owners, and the like, but the number of individuals directly
affected by this would appear to be small relative to the total population.) Liddle
argues that periodic crackdowns on corruption ‘[encouraged] the public to
believe that the government [was] at least well intentioned‘ (Liddle 1985: 78). No
doubt there is something in this, but I would argue also that Soeharto appreciated
that excessive infringement of property rights by individual franchisees (i.e.
imposition of excessive levels of private taxation) was inimical to the interests of
the franchise as a whole. The replacement of the notoriously corrupt customs
service by a private company in 1985—which turned out to be temporary,
notwithstanding the obvious improvement in the functioning of Indonesia’s
ports—can be interpreted plausibly in this light (Elson 2001: 247).
THE DEMISE OF THE FRANCHISE
The 1997–98 economic crisis demonstrated that members and beneficiaries of the
franchise could no longer rely on it to deliver effective government, thus triggering its disintegration, and ushering in the era of democracy. In principle, if the
7 For example, a crony firm might be given a valuable concession to log natural forests, or
a monopoly on certain kinds of imports. Various rent generation mechanisms are discussed in McLeod (2000: 155–6).
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franchisees had been able to come together at the time to agree upon a replacement for Soeharto as ‘owner’ of the franchise, the system might have been able to
continue under new leadership. In reality, B.J. Habibie briefly succeeded Soeharto
as ‘owner’, but was under no illusion that he had the political skills, power and
ruthlessness that would be needed to rebuild the same kind of system, even if he
had wanted to do so: it was obvious that few if any of the franchisees were willing to defer to him as they had to the former leader (whether out of respect, loyalty, the hope of advancement, or fear).
Habibie could not rely on the hundreds of MPR members appointed by Soeharto, nor those representing the armed forces, to allow him to stay on as president. The only possible way to stay in office was to hold a general election in the
hope that the people would give him a mandate to continue in the job. By allowing a genuine contest for seats in the DPR among the existing political parties and
a plethora of other newly established ones, he destroyed the key feature of the
franchise—mutual support among its constituents in favour of a common cause.
Tainted by its close association with Soeharto, and without strong army backing,
the Golkar party (the government party under Soeharto) could not dominate the
1999 election as it had previous ones. It lost a large proportion of its seats in the
DPR to other parties—three of which each had credible candidates to take over
the presidency. Habibie failed to gain his mandate, and the franchise crumpled.
Outside the legislature, the other former branches of the franchise also began
to work at cross-purposes rather than as a multi-faceted but mutually supporting
whole. This soon resulted in increasingly high levels of private taxation in some
areas of the economy. In other words, property rights became less secure for both
firms and individuals, and this was manifested in the shift of capital offshore8
and the reluctance of the private sector to undertake new investment. Domestic
and foreign firms that previously harvested rents generated by the franchise
could no longer be confident of their ability to do so in an environment in which
the leadership of government had become genuinely subject to change at regular
intervals, and they therefore had much weaker incentives to invest in Indonesia.
Firms that previously put up with extortion because it remained relatively light,
and because these were times of steadily increasing prosperity, now found it
more threatening in the absence of centralised control. Banks that would have
liked to be lending more were afraid to do so because they could not rely on the
courts to enforce their loan contracts.
The flowering of democracy itself also imposed additional costs on the corporate sector. Like a monopolist with no need to spend heavily on advertising since
it has no competitors to keep at bay, Soeharto had relatively little need to ‘tax’ corporations to fund election campaigns: the whole election process was a charade
in which Golkar could not lose. But now there were several parties with enough
electoral support to be considered serious contenders for membership of governing coalitions, and the high value of the spoils of office meant that most were prepared to spend heavily on their election campaigns. The unpredictability of the
8 After years of strong private capital inflows, the crisis that emerged in 1997 saw a dramatic turn-around. Heavy capital outflow was experienced for the next six years before
net inflows returned in 2004 (McLeod 2005a: 136).
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The Struggle to Regain Effective Government under Democracy in Indonesia
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outcome, in stark contrast with Soeharto era elections, meant that many companies made contributions to some, perhaps several, of these parties in order to try
to secure their fortunes through each phase of the electoral cycle, as the infamous
Bank Bali corruption case suggests (Fane 2000: 42). And no doubt state enterprises were also privately taxed for the same purpose—hence the lack of political
support for privatisation, which was intended to be a key feature of the IMF’s crisis recovery program for Indonesia.9
There are many other examples of changing behaviour on the part of the
branches of the former franchise that show how they have lost their coherence,
and thus have become an obstacle to economic recovery, with the advent of
democracy. In addition to increasing the net rate of private tax imposed on firms
and individuals by corrupt officials, and increasing the degree of uncertainty
about property rights and the future course of development, the effect of the collapse of the franchise has been to increase the extent of uncontrolled, environmentally damaging exploitation of natural resources (see various chapters in
Resosudarmo 2005) and to constrain the ability of more conscientious members
of the government and the bureaucracy to implement sound economic policies.
Consider the following examples.
An Extortive Legislature
Since the fall of Soeharto the relationship between the legislature and the executive (at the national level) has changed dramatically (Sherlock 2003: 19–21).
Before, the parties and individual members owed their presence to Soeharto’s
favour. Their primary role was to re-elect him, in return for which they received
a modest share of the spoils of office. Now, with a new president in place—but
with parliament having the power to remove him—the relationship shifted from
cooperation to confrontation. It is one of the functions of legislatures in democracies to protect the interests of the public against mistakes and malfeasance on the
part of the executive, but in this case much of the new activism in the DPR was
intended to increase its members’ share of the cake.
The people’s representatives were not slow to seize upon the opportunity to
extort funds from the bureaucracy (and thus, indirectly, from the general public)
as it attempted to carry on the business of government—introducing new laws
and regulations; implementing budgetary decisions such as the removal or
reduction of subsidies and the divestment of state-owned enterprises; the
appointment of individuals to positions such as top military posts, ambassadorships and the governorship of the central bank; and, in particular, the attempts of
IBRA, the Indonesian Bank Restructuring Agency, to divest its large portfolio of
bank and corporate assets.10 It did not escape the media’s attention that members
of parliament quickly came to appear much better dressed, and to be driving
around in much more expensive vehicles, than before.11
9
Note that avoiding privatisation in order to maintain control of the state enterprise cash
cows condemns this significant part of the economy to sub-standard performance.
10
‘Corruption ”from State Palace to Political Parties”’, Jakarta Post, 23/1/2001.
11
‘Deep Pockets’, Tempo Magazine, 7/10/2002.
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Ross H. McLeod
A Judiciary Out of Control
The judiciary became much more prominent in the wake of the crisis, primarily
because so many firms and banks became insolvent—or merely stopped servicing their debts. Large-scale bankruptcy had rarely been an issue in the pre-crisis
era, but now many creditors suddenly began to file bankruptcy claims against
defaulting debtors, and the judiciary found itself in a position in which it had far
greater opportunities than before to benefit financially from the larger and more
numerous cases coming before it. The biggest creditor of all was IBRA. This new
part of the bureaucracy was established in 1998, and given the task of recovering
as much as possible of the government’s outlays on bailing out the banks. But it
found itself in an unequal contest of strength with the judiciary, which was only
too willing to exploit its position in order to extract large bribes from the defaulters—at IBRA’s expense. This, in turn, created enormous pressure on the budget,
seriously compromising the government’s ability to undertake the expenditures
necessary to keep the economy in good shape (Pangestu and Goeltom 2001:
144)—not to mention imposing huge costs on the general public.12
Another party to suffer has been the foreign investment community, which
used to rely heavily on the ‘franchise connection’ for the protection of its assets
and activities in Indonesia (Cole and Slade 1998: 65), but has found the going
very tough in the corrupt court system since Soeharto’s demise. One well-known
example is the Canadian insurance company, Manulife, whose former joint venture partner was able to persuade the court to declare Manulife Indonesia bankrupt, although it clearly was not.13 Eventually this decision was overturned, but
only after considerable pressure was brought to bear—amongst others, by the
Canadian government.14 A later case involved Tri Polyta Indonesia, which not
only sought to have the courts invalidate $185 million worth of bonds it had
issued overseas before the crisis began, but also sued the bondholders for more
than $600 million for the return of interest previously paid and for ‘emotional distress caused to the company management‘.15 The patent absurdity of this claim is
an indication of how dysfunctional the judiciary had become. Instead of protecting property rights it began to be used as an instrument of expropriation, as is
apparent from the later annulment of the entire Tri Polyta bond transaction by the
Serang (West Java) District Court (Donnan 2004; Bisnis Indonesia, 13/5/2004). In
cases such as these, this unholy alliance between the judiciary and domestic capital conflicts with the efforts of Indonesia’s economic policy makers to persuade
foreign capital to return, and thus to assist with economic recovery.
Newly Active Regional Governments
Since power and authority were so heavily concentrated at the centre under Soeharto, one of the first priorities of the reform movement was the devolution of
12
IBRA was wound up on schedule in February 2004, having recovered only about 25%
of the funds the government had put into the collapsed banking system (McLeod 2005b:
43–4).
13
‘Court Verdict on Manulife Upsets Canadians’, Jakarta Post, 14/6/2002.
14
‘Manulife Judges Exonerated’, Laksamana.Net, 22/1/2003.
15
‘Tri Polyta Indonesia Asks Court to Cancel Bond Claim’, Bloomberg, 9/4/2003.
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The Struggle to Regain Effective Government under Democracy in Indonesia
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some aspects of government to the regions—or ‘decentralisation’ as it is known in
Indonesia. By quickly seizing the initiative here, Habibie hoped to gain kudos that
would help him to retain the presidency (McLeod 2005b: 46). Just as allowing
numerous parties to contest the election had contributed to horizontal fragmentation of the franchise, devolving significant power and authority to lower levels of
government would have contributed to its vertical fragmentation. In the event,
the franchise had collapsed long before decentralisation began to be implemented.
Two laws on decentralisation were among the flurry of new statutes enacted
during Habibie’s term in office (Anwar 2001: 7–13): Laws 22 and 25 of 1999, on
Regional Government and Fiscal Balance between the Centre and the Regions,
respectively. A feature of the second of these was the extraordinary—and seemingly unconstitutional—decision to try to buy the support of resource-rich
regions by agreeing to return large proportions of natural resource revenues to
the provinces and districts where they originated.16 In the past, oil and gas revenues in particular had played a big part in financing government expenditure
throughout the nation, especially on the construction and maintenance of infrastructure (Ravallion 1988: 54). At face value, Law 25/1999 greatly reduced the
scope for a continuation of this, and thus provides a good example of parts of the
old franchise now going their own way, regardless of the impact on other parts,
and on the sense of nationhood in Indonesia.17
The devolution of some of the functions of government to provincial and district levels has meant that regional governments no longer regard themselves as
subservient to, and dependent upon, the central government. In other words,
they no longer see themselves as having to play by the rules of a central franchise—as indeed was the intention of the decentralisation reform. There are clear
indications that regional government officials, like members of parliament at the
national level, have adopted the attitude that the widespread opportunities for
personal enrichment enjoyed hitherto by their central government counterparts
have now shifted to the regional levels.18
One well-known example of this is the central government’s attempt to privatise its cement manufacturing company, PT Semen Gresik. A relatively small
shareholding in this company had been divested some years ago to the Mexican
company, Cemex (Cameron 1999: 25–6). At the time of this sale, Cemex was given
an option to purchase a majority stake in the company. But when it moved to
exercise this option, the provincial governments in West Sumatra and South
Sulawesi, where two of the company’s major plants are located, moved to block
the sale and, in effect, to seize control of the central government’s ownership
stake (Deuster 2002: 11). The case helped to dampen what little enthusiasm the
16
The spirit of article 33 of the constitution clearly requires that wealth derived from natural resources belongs equally to all Indonesians, regardless of where they live. This issue
seems to have been totally ignored so far.
17
In reality, the implementation of this aspect of the law seems to bear little resemblance
to what it appears to say (Fane 2003). Both the decentralisation laws were replaced with
new ones in 2004, but without any significant impact on the aspects of their operation discussed here.
18
See, for example, ‘Knives Are Out for ”Skewering” the People’, Tempo Magazine, 22–28
April 2003; ‘Six Into One Does Go’, Tempo Magazine, 29 April – 5 May 2003.
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Ross H. McLeod
Megawati government had for privatisation (Taufiqurrahman 2003), and was still
in deadlock at the time of writing, notwithstanding some positive signs that
emerged with the advent of the new Yudhoyono government (Kadga 2004).
In another case, regional (provincial and district) governments in East Kalimantan, apparently acting partly on behalf of domestic private sector interests,
have engaged in attempts to expropriate a majority stake in the foreign-owned
mining company, PT Kaltim Prima Coal (Callick 2002a; Dodd 2001, 2003). The
effective usurpation of the powers of the courts by these governments, and the
implicit threat of extortion by the army, as in both Aceh and Papua,19 have added
to the concerns of foreign investors generally. Domestic mining companies have
also been affected, and have cut back significantly on their investments. In such
circumstances it is not surprising that the mining sector has been stagnant for the
last several years.
The Kaltim Prima episode had even wider implications for the economy, however. The uncertainty created by the court attachment of the Tangguh natural gas
field in Papua, which was owned by one of Kaltim Prima’s original shareholders,
had the effect of preventing the sale or transfer of the gas field to any other party,
thus making it difficult to raise the finance needed for its development. This
action is plausibly blamed for the loss to Australia of a huge contract to supply
China with natural gas—even though the attachment was eventually overturned
after the then president intervened (Callick 2002b). It is interesting to note also
that in its efforts to overcome the malign impact of its own courts, the government moved even further away from its commitment to privatisation by agreeing
to purchase (through a state-owned mining company) 20% of the 51% share of
Kaltim Prima that was required to be divested under the terms of its establishment. The hope was that this would be more acceptable to the original owners
than allowing the regional governments to acquire a majority stake in the company. In the event, the owners took matters into their own hands and quickly sold
their entire interest to a company owned by the family of Aburizal Bakrie (later
to become coordinating minister for economics in the SBY government).
A further important aspect of the collapse of the franchise is the enthusiasm
with which regional governments have begun to impose a range of taxes within,
or at, their boundaries.20 In some cases this is well intended, but no doubt in others it is simply a manifestation of the fact that, by imposing formal taxes, the
opportunity is created for officials to generate income for themselves by negotiating effective reductions or exemptions for the taxpaying entities in question
(Kuncoro 2004: 336–9). In any case, there is no doubt that this has hindered recovery by making life more difficult for private firms.
Turf Wars between the Army and the Police
Another of the reforms of the Habibie era was to separate the police from the
armed forces. This has led to a more overt rivalry between these two parts of the
former franchise—in particular, between the police and the army—which bears
19
20
‘Charge Service’, Tempo Magazine, 25–31 March 2003.
SMERU Newsletter, No. 03, July–September 2002, SMERU Research Institute, available
at .
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an interesting resemblance to the gang wars of the prohibition era in the US. This
is not surprising. Both are involved with organised crime: gambling, prostitution
and drug dealing, and with the practice of extortion, which is a natural extension
of those activities (Weiss 2002). The competition between them from time to time
breaks into the open, as in a case involving drug dealing in Sumatra in which a
number of soldiers attacked a police station, killing several policemen.21 The business community can hardly ignore this kind of occurrence when it, itself, needs
to rely on the police to protect its property rights. A police force that is heavily
involved in organised crime is unlikely to perform this function effectively.
THE CHALLENGE OF REFORMASI:
REGAINING EFFECTIVE GOVERNMENT
It has become a cliché to observe that the strengthening of public sector institutions was given little emphasis during the Soeharto era. But it is important to
appreciate that this was no oversight. On the contrary, it was precisely this that
had helped make Soeharto strong and his extended family and cronies wealthy.
His intention was to make himself safe from any attempt to remove him from
office or to dilute his ability to make policy as he saw fit. Indonesia’s ‘democracy’
was a sham, in which there was no chance that Soeharto would be removed
through the election process. Nor was there any chance that the legislature, the
bureaucracy, the judiciary, the armed forces or the state-owned enterprises would
put the interests of the people before those of the franchise.
Though the legislature and the election processes on which it is based have
now been democratised, if ‘now’ is genuinely to become the era of reformasi, all
the other public sector institutions will also need to be reformed. Reformasi
requires not only getting rid of Soeharto, but also either getting rid of, or changing the behaviour of, a large proportion of his former franchisees. The difficulty
of doing so has been underestimated, however. For example, many seemed to
think that reforming the armed forces required little more than depriving them of
their quota of seats in the DPR. This change was achieved in the 2004 general election, but in practical terms the army remains as strong as ever22—indeed, it is
arguably even stronger, now that Soeharto is not there to keep it under control.
PERSONNEL MANAGEMENT PRACTICES AND SALARIES
AS THE KEY TO REFORM
Whereas the several consecutive Soeharto governments succeeded in generating
rapid growth over some three decades, the replacement of his franchise system
by a far more genuinely democratic regime has been followed by several years of
much less satisfactory economic performance. Although investment activity
21 ‘Nine Hours in Binjai’, Tempo Magazine, 14/10/2002. An earlier episode in which the
army attacked police stations in Madiun resulted in two civilian deaths and numerous
injuries (Jakarta Post, 18/9/2001).
22
The impending surrender of their seats in the DPR was not even mentioned by Liddle
(2003), who argued that ‘… nothing fundamental has in fact changed since 1998. … A government that does not pay its soldiers cannot control their actions.’
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Ross H. McLeod
finally began to pick up significantly around the end of 2004, it is too soon to
know if this will be reflected in sustained rapid growth in output at rates similar
to those achieved before the 1997–98 crisis. In the opinion of the writer this is
unlikely, unless the new government of Susilo Bambang Yudhoyono is able to
extend democratic reform beyond the first step of implementing reasonably fair
and open elections to encompass the creation of strong incentives for good performance in the public sector institutions, relative to society’s objectives.
It seems self-evident that the aims of any organisation will be best served if it
can appoint the best possible person available to each position within it.23
Accordingly, the emphasis in organisations such as sporting teams and private
sector enterprises is on encouraging fair and open competition for positions at all
levels within them. That, of course, is fundamental to the notion of democracy
itself, in which individuals and parties compete with each other to persuade voters that they will do the best job of governing. Successful reform of Indonesia’s
other public sector institutions (i.e. beyond the legislatures) will depend crucially
on the adoption of a similar approach—the creation of an environment in which
all individuals within them have strong incentives to compete by performing to
the best of their ability.
The discussion that follows ignores the state enterprises, whose poor performance mirrors that of the civil service. Suffice it to say here that the same broad
principles of reform apply to both, although the author’s preferred course of
action in the case of state-owned enterprises is to remove the problem by divesting them to the private sector. Reform of the military and the police is also highly
desirable, not least because both organisations are partly responsible for insecurity of property rights—and therefore for impairing Indonesia’s economic performance—as a result of acts of both commission and omission. Space limitations
do not permit adequate discussion of this issue here, however.
The inadequacies of Indonesia’s public sector institutions are a reflection of
Soeharto’s practice of encouraging his franchisee officials to manage them in such
a fashion that they could personally benefit by exploiting their positions. Within
the logic of the franchise framework presented above, it would have made sense
for him to keep basic salaries low, especially at the higher levels, in order to bring
people into these positions who would be unconcerned about their basic salaries
but would focus instead on the opportunities they would have to earn additional
income—often illicit—as franchisees.24 This has been manifested in the proliferation of additional regular allowances for individuals in particular positions; of ad
hoc payments for attending meetings, conferences and so on; of payments for
serving on a wide range of committees (in particular, those concerned with procurement); and of a range of benefits associated with special projects. Given a lack
of transparency, access to many of these additional payments, and to participation in straightforward graft and bureaucratic extortion, was conditional on the
individual in question playing by Soeharto’s rules. Thus the president was able
23 A more precise statement of this principle would take into account the trade-off between
recruiting ‘better’ people and the extra cost of doing so.
24
This was reflected in a well-known aspect of public sector culture—namely, a widespread awareness of differences in the availability of opportunities for graft; areas where
such opportunities were abundant became known as ‘basah’ (wet).
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The Struggle to Regain Effective Government under Democracy in Indonesia
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to co-opt officials within these institutions to serve his own interests by ensuring
they had a common interest in the effective functioning of the franchise.
Many young people who had every intention of working well for the benefit
of the public were also recruited to these institutions. Such individuals tended to
languish in the ‘dry’ areas, and for the most part they found that the path to promotion was heavily restricted unless they wanted to buy into the franchise. Some
of them did so, while others left to seek their livelihoods elsewhere. Many more
simply accepted their fate, enduring a low standard of living, and forgoing any
real opportunity for promotion to levels at which they were capable of functioning effectively.25 A few made their way up through the hierarchy by virtue of Soeharto’s recognition of the need for especial competence in at least some key areas
of policy making.
Reforming Personnel Management
Performance-based competition for each position in an organisation is very different from the process of automatic promotions, based on seniority, that is
presently a fundamental characteristic of the Indonesian civil service (including
the judiciary). When promotions are largely automatic, individuals have little
incentive to perform better than their peers. Overstaffing at higher levels
becomes the norm, since even poor performers are promoted rather than being
either kept in their present positions or encouraged to leave. Those who do perform well are frustrated by the lack of meaningful recognition of their efforts.
This may result in their leaving the organisation for private sector jobs where
they can expect to be rewarded appropriately, or simply becoming dispirited and
significantly less productive as a result. At the same time, there is little incentive
for individuals to increase their productivity by undertaking additional education and training, since in practice there is scant payoff in terms of salary
increases or promotions.
Thorough reform of the civil service therefore requires radical changes to personnel management practices, especially in relation to recruitment, promotion
and discipline. Recruitment from outside the civil service should no longer be
restricted to recent school and university graduates, and discipline should be
understood to include bringing criminal charges against those found to have
acted corruptly.26 It will be essential to put considerably more emphasis on performance appraisal27 and to reform the processes of recruitment and promotion
so as to make them transparent and fair. Presumably these processes will involve
formal selection and promotion committees, whose membership would be chosen so as to provide some element of outside scrutiny. Records would need to be
kept of advertisements for the positions in question, applications for those posi25
Thus the often heard argument that low salaries ‘force’ public sector officials to engage
in corruption is an insult to those who choose not to do so.
26 At present it is difficult even to discharge civil servants found guilty of corruption,
although there is now some suggestion that Law 43/1999 on public servants will be
revised in order to speed up this process (Witular 2005).
27
The current annual assessments of performance ‘are descriptive, and do not assess performance against targets and objectives. They … cannot be considered as an instrument of
accountability’ (ADB 2004: 59).
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Ross H. McLeod
tions, and justifications by committees for their decisions. A further aid to transparency would be to make promotions and appointments subject to appeal by
unsuccessful applicants. In other countries, procedures of this kind have taken
years, if not decades, to evolve, and to become part of the corporate cultures of
the organisations in question, so all of this clearly amounts to a massive and difficult undertaking.
Reform also requires a far-reaching restructuring of the Soeharto franchise
salary scales. Specifically, much more attractive salaries are needed at higher levels in the hierarchy in order to attract honest and well-motivated people, and to
give civil servants an incentive to perform well in order to achieve promotion to
higher levels. To a large extent this would merely involve rolling the complex
array of allowances and semi-regular additional payments now received, along
with basic salaries, into a single, transparent salary for each position. This has long
been advocated; the fact that it has never been achieved suggests that many individuals benefit from the utter lack of transparency in the current system.
The actual remuneration of many civil servants currently includes not only
these various formal and semi-formal components but also the proceeds of corrupt activity, and so may be far above the sum of formal salary plus identifiable
legitimate allowances. It is not necessary to set salaries that would match presentday official salaries augmented by typical earnings from graft and corruption,
however. There are many people who would be willing to work in these institutions provided that their salaries were broadly in line with those of people in similar professions working in the private sector, but it will be impossible to attract
a sufficient number unless this is so.28
Fiscal constraints do not constitute a reason for postponing the restructuring of
salaries. In the first place, it is not necessary to increase remuneration across the
board, but only at higher levels, where salaries fall well short of those for similarly skilled private sector managers and professionals.29 As we move up the
hierarchy of the relevant institutions the rapidly declining number of positions
means that it is not out of the question to finance large increases in remuneration.
More importantly, however, provided these increases are accompanied by
appropriate changes to personnel management practices, the cost of higher remuneration will be covered by bringing about a significant improvement in the quality of management. One of the most obvious areas where this can be seen is within
the Ministry of Finance, and specifically within the taxation directorate and the
customs service. It is well known that the ministry has failed to widen the income
tax base or to extract taxpayers’ full tax liabilities from them,30 and that the customs service is rife with corruption (Lingga 2002). Improving the quality of per-
28
Public sector salaries may be able to be kept a little below those in the private sector, to
the extent that employment in the former is seen to provide additional, non-pecuniary
benefits.
29 Filmer and Lindauer (2001) argue that the common perception that civil servants gener-
ally are greatly underpaid relative to the private sector is not supported by available evidence. They contend that low-level civil servants are actually somewhat better paid, in
which case there is no reason to increase their salaries further.
30
‘Jakarta To Jail Tax Dodgers without Trial’, Straits Times, 29/3/2003.
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ISSN: 0007-4918 (Print) 1472-7234 (Online) Journal homepage: http://www.tandfonline.com/loi/cbie20
The struggle to regain effective government under
democracy in Indonesia
Ross H. Mcleod
To cite this article: Ross H. Mcleod (2005) The struggle to regain effective government
under democracy in Indonesia , Bulletin of Indonesian Economic Studies, 41:3, 367-386, DOI:
10.1080/00074910500117289
To link to this article: http://dx.doi.org/10.1080/00074910500117289
Published online: 18 Jan 2007.
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Date: 19 January 2016, At: 19:50
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Page 367
Bulletin of Indonesian Economic Studies, Vol. 41, No.3, 2005: 367–86
THE STRUGGLE TO REGAIN EFFECTIVE GOVERNMENT
UNDER DEMOCRACY IN INDONESIA
Ross H. McLeod *
a
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Australian National University
With Soeharto’s demise, Indonesia gained democracy but lost effective government. A return to sustained, rapid economic growth will require an overhaul of
Indonesia’s bureaucracy and judiciary which, along with the legislatures, the military and the state-owned enterprises, had been co-opted by the former president
into his economy-wide ‘franchise’—a system of government designed to redistribute income and wealth from the weak to the strong while maintaining rapid
growth. This franchise has disintegrated, its various component parts now working at cross-purposes rather than in mutually reinforcing fashion. The result has
been a significant decline in the security of property rights and, in turn, the continued postponement of a sustained economic rebound. To reform the civil service it
will be necessary to undertake a radical overhaul of its personnel management
practices and salary structures, so as to provide strong incentives for officials to
work in the public interest.
INTRODUCTION
Indonesia’s long-serving president, Soeharto, became more unpopular the longer
he remained in office. The economic crisis that began in mid-1997 provided the
conditions under which at last he was able to be forced out, only a couple of
months after he had been elected unopposed to a seventh five-year term. Since
then the country has been able to manage a relatively peaceful transition to a
more genuine democracy. The first stage of this began with the formal handover
of power by Soeharto to his deputy, B.J. Habibie, in May 1998. The second
involved the holding of elections for the parliament in June 1999, and the subsequent indirect election of Abdurrahman Wahid by the People’s Consultative
Assembly (MPR) as the first president of the new democratic era. The third saw
the dismissal of Wahid in July 2001 and his replacement by Megawati Soekarnoputri, also by the MPR. The fourth stage encompassed a further general election,
followed by Indonesia’s first direct presidential election, in 2004, resulting in the
appointment of Susilo Bambang Yudhoyono (SBY).
Macroeconomic conditions have stabilised after the astonishing upheaval of
the 1997–98 crisis, which saw GDP fall by 18% in the fourth quarter of 1998
α
∗ Much of this paper was written while the author was a visitor at the School of Advanced
International Studies, Johns Hopkins University. The author is grateful to John Bresnan,
Greg Fealy, Karl Jackson, Hugh Patrick, Bridget Welsh and two referees for their insightful comments, and to audiences at Columbia, Harvard and Johns Hopkins Universities to
which earlier versions of this paper were presented.
ISSN 0007-4918 print/ISSN 1472-7234 online/05/030367-20
DOI: 10.1080/00074910500117289
© 2005 Indonesia Project ANU
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Ross H. McLeod
compared with a year earlier. The exchange rate settled at close to Rp 8,500/$ in
the second half of 2003—having risen as far as Rp 15,000/$ in 1998—before
weakening somewhat; in the year to mid-2005 it ranged between Rp 9,000/$ and
Rp 9,500/$ for most of the time. Inflation, although still rather high relative to
that of Indonesia’s neighbours, is back to levels that had become the norm prior
to the crisis, and interest rates have declined to below pre-crisis levels. But current forecasts are for growth at around 6.0% per annum in 2005—somewhat
slower than the average rate maintained over three decades of Soeharto’s rule.
With population growth running at about 1.5% per annum, per capita incomes
seem likely to grow at only around 4.5% annually—three-quarters the rate of
6.0% recorded during the four pre-crisis years. At this pre-crisis rate, average
incomes double every 12 years; at the currently projected rate it takes a third as
long again. Accelerating economic growth further is therefore crucially important
for poverty reduction.
More important, it cannot simply be assumed that even this modest projected
growth rate can be maintained into the future. Two important economic indicators are the absolute and relative levels of investment. Seven years after the crisis
began, the former was languishing at just 80% of its pre-crisis level, and the latter at 18% of GDP, compared with 30% pre-crisis. Some improvement has
occurred more recently, raising the investment to GDP ratio to 22%, but this still
leaves a long way to go to restore this ratio to its pre-crisis level. Business investment’s slowness to recover suggests a lack of confidence that Indonesia’s new
democracy will give rise to an effective government capable of doing the things
needed to complement the functioning of the private sector.
Most of the discussion about how to return Indonesia to its previous highgrowth trajectory tends to propose lists of policies that would support this objective (and of those that would conflict with it). But this ignores the fundamental
reality that whether sensible policies will be chosen, and whether they will be
implemented effectively, depends on the quality of the bureaucracy.1 Bluntly put,
we cannot expect significant improvement in the policy environment if the
bureaucracy remains dysfunctional.
With these comments as background, the main aims of this paper are: first, to
explain why, and in what sense, Soeharto’s regime was effective, and why subsequent governments have been much less effective; and second, to suggest the
nature of reforms needed if its effectiveness is to be matched or surpassed, and to
discuss other kinds of reform initiatives already under way.
I shall argue here that with Soeharto’s demise, Indonesia gained democracy
but lost effective government. By gaining democracy I mean that the people now
have the genuine opportunity to vote out incumbent governments at regular
intervals, and I interpret effective government in a limited and purely economic
sense to mean doing what is needed to achieve rapid growth—with the expectation that the benefits of growth will be widely spread amongst the population, as
was the case during the Soeharto era. Specifically, I emphasise that rapid eco1 A further
consideration is the extent to which the legislatures, answerable to the general
public at national, provincial and district levels, hinder the operations of the bureaucracy.
Some mention of this is made below, but the main emphasis here is on the civil service
(including the judiciary), which is under the direct control of governments.
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The Struggle to Regain Effective Government under Democracy in Indonesia
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nomic growth depends on a complementary relationship between the private
and public sectors, in which the public sector provides things desired by the public but which the private sector is not able to produce.
The provision and maintenance of physical infrastructure by the public sector
is clearly important, including roads, ports, airports, storm-water drainage and
flood control, sewerage and so on. Most of this was given considerable prominence at an infrastructure summit in Bali in mid-January 2005 after several years
of serious neglect (World Bank 2005: table 3.4; Soesastro and Atje 2005).2 Beyond
this there is room for debate as to what other things governments should provide.
There can be no doubt, however, that one of the most important tasks of the public sector is to ensure the rule of law and the security of property.3 In turn, this
requires the drafting and enactment of laws and the provision of the means to
enforce them: a judiciary, a legal bureaucracy (including a public prosecutor) and
a police force. The weaker the rule of law and the security of property, the weaker
is the incentive to invest and to work. As O’Driscoll and Hoskins (2003: 7) put it:
Once stated, the intellectual argument for the importance of property rights is compelling. Why does an individual invest unless to gain something for himself and his
family? How can he ensure that gains flowing from his activity be appropriated and
secured other than through a system of well-defined property rights?
In turn, since economic growth depends on investment and the supply of effort
by individuals, economic performance of an economy overall can be expected to
be, and is, strongly correlated with the security of property (Roll and Talbott 2003:
15–16).
THE FUNDAMENTAL DETERMINANTS OF ECONOMIC PERFORMANCE
It is a truism that the overall performance of any organisation or regime depends
on the performance of the individuals that comprise it, other things equal. In
turn, individuals’ performance depends on the strength of the incentives they
face, both positive and negative. I shall argue that the incentives for good performance in the public sector institutions during the Soeharto era were strong—
relative to Soeharto’s objectives, which happened to coincide largely, though not
entirely, with society’s objectives. By contrast, the incentives for good performance in those institutions subsequently have become weak—relative to society’s
objectives. The decline in Indonesia’s economic performance since Soeharto’s
demise can be explained by this change in the structure of incentives facing officials in the public sector institutions, such that they no longer have much motivation to do what is necessary to promote rapid growth of the economy.
Soeharto’s Franchise System of Government
Soeharto created incentives for effective government within what I have
described elsewhere as a ‘franchise’ system (McLeod 2000). A more descriptive, if
2
Flood control, drainage and sewerage systems were ignored, however (McLeod 2005a).
3 A similar argument has been put in relation to priorities that need to be followed in estab-
lishing a new democratic regime in post-war Iraq (McDougall 2003).
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Ross H. McLeod
FIGURE 1 The Soeharto Franchise
Soeharto
Beneficiaries
Tax targets
Franchise
(Public sector institutions)
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Conglomerates
Large
foreign firms
Legislature/
parties
Judiciary/
legal bureaucracy
First family
Domestic
firms/
individuals
Small
foreign firms
Military/police
Bureaucracy/
non-departmental
agencies
State-owned
enterprises
cumbersome, title would be ‘multi-branch, multi-level franchise‘ (figure 1).4 The
branches of the franchise included the legislature (MPR, DPR5 and tame political
parties); the judiciary and the legal bureaucracy; the military/police; the bureaucracy (including non-department agencies, especially the logistics agency, Bulog,
and the central bank, Bank Indonesia); and the state-owned enterprises (SOEs),
especially the giant oil company, Pertamina, and the state banks. Most of the
branches encompassed a number of levels. Legislatures existed at national,
provincial and district/municipality levels, while the bureaucracy extended right
down to the villages. The hierarchy of the judiciary extended down from the
Supreme Court through the High Court to the district courts. The army also had
regional divisions, as did the state banks.
Like franchises in the world of business, the Soeharto franchise was designed
to provide strong positive and negative incentives for its success. Key public sector officials could rapidly become wealthy if they lived by its rules, but they could
find themselves sidelined if they failed to perform well or if they worked against
it.6 It prospered by means of ‘private taxation’—that is, various forms of informal
taxation of individuals and firms. The ‘taxes’ imposed by franchisees were of two
4
Liddle (1985: 71) refers to the political structure of the New Order as ‘a steeply-ascending pyramid in which the heights are thoroughly dominated by a single office, the presidency’. Crouch (1991: 57) refers simply to ‘Soeharto’s patronage network’.
5
6
The DPR is the People’s Representative Council, or House of Representatives.
Liddle (1985: 74) refers similarly to ‘the building of performance-based support within
the pyramid’.
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The Struggle to Regain Effective Government under Democracy in Indonesia
371
main types: extortion, and rents generated by the public sector through its economic policies and harvested by cronies of the regime (the ‘conglomerates’),
members of the first family and large foreign firms7—these last three groups
being the major beneficiaries of the system (other than the franchisees themselves). By and large, this taxation was levied at a low rate on a wide ‘tax base’
that comprised a large part of the economy as a whole; it operated in conjunction
with economic policies that helped the private sector to generate rapid economic
growth in order that this tax base would also grow rapidly. Thus there was a close
correspondence between the interests of Soeharto’s franchise and the interests of
the general public, even though the effect of private taxation was to redistribute
some income and wealth from the weak to the strong: both the franchise and the
public stood to gain from broadly sound economic policies that generated rapid
growth.
To see this, suppose all individuals’ incomes rise by 5% prior to imposition of
a ‘private tax’ of 0.1% on the incomes of 99% of the population. The ‘tax revenue’
is then redistributed to the other 1% (i.e. the members and beneficiaries of the
franchise). If the latter small group had incomes, say, 10 times as great as those in
the large group to begin with, it is easy to show that their incomes will grow by
about 6% in total. But the large ‘poor’ group is also better off than before, with a
net gain of approximately 4.9%—notwithstanding redistribution from it to the
‘rich’. The growth of the economy—to a considerable extent the consequence of
sound economic policies—is beneficial to both groups.
Despite the legendary corruption and incompetence of the legal system and
the bureaucracy, the rules of the game enforced by the franchisor (Soeharto) were
such that property rights were relatively secure for the majority of the population. (This is not to deny many instances of effective expropriation of land, often
through violence or the threat of it, by politically well-connected real estate developers, plantation owners, and the like, but the number of individuals directly
affected by this would appear to be small relative to the total population.) Liddle
argues that periodic crackdowns on corruption ‘[encouraged] the public to
believe that the government [was] at least well intentioned‘ (Liddle 1985: 78). No
doubt there is something in this, but I would argue also that Soeharto appreciated
that excessive infringement of property rights by individual franchisees (i.e.
imposition of excessive levels of private taxation) was inimical to the interests of
the franchise as a whole. The replacement of the notoriously corrupt customs
service by a private company in 1985—which turned out to be temporary,
notwithstanding the obvious improvement in the functioning of Indonesia’s
ports—can be interpreted plausibly in this light (Elson 2001: 247).
THE DEMISE OF THE FRANCHISE
The 1997–98 economic crisis demonstrated that members and beneficiaries of the
franchise could no longer rely on it to deliver effective government, thus triggering its disintegration, and ushering in the era of democracy. In principle, if the
7 For example, a crony firm might be given a valuable concession to log natural forests, or
a monopoly on certain kinds of imports. Various rent generation mechanisms are discussed in McLeod (2000: 155–6).
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franchisees had been able to come together at the time to agree upon a replacement for Soeharto as ‘owner’ of the franchise, the system might have been able to
continue under new leadership. In reality, B.J. Habibie briefly succeeded Soeharto
as ‘owner’, but was under no illusion that he had the political skills, power and
ruthlessness that would be needed to rebuild the same kind of system, even if he
had wanted to do so: it was obvious that few if any of the franchisees were willing to defer to him as they had to the former leader (whether out of respect, loyalty, the hope of advancement, or fear).
Habibie could not rely on the hundreds of MPR members appointed by Soeharto, nor those representing the armed forces, to allow him to stay on as president. The only possible way to stay in office was to hold a general election in the
hope that the people would give him a mandate to continue in the job. By allowing a genuine contest for seats in the DPR among the existing political parties and
a plethora of other newly established ones, he destroyed the key feature of the
franchise—mutual support among its constituents in favour of a common cause.
Tainted by its close association with Soeharto, and without strong army backing,
the Golkar party (the government party under Soeharto) could not dominate the
1999 election as it had previous ones. It lost a large proportion of its seats in the
DPR to other parties—three of which each had credible candidates to take over
the presidency. Habibie failed to gain his mandate, and the franchise crumpled.
Outside the legislature, the other former branches of the franchise also began
to work at cross-purposes rather than as a multi-faceted but mutually supporting
whole. This soon resulted in increasingly high levels of private taxation in some
areas of the economy. In other words, property rights became less secure for both
firms and individuals, and this was manifested in the shift of capital offshore8
and the reluctance of the private sector to undertake new investment. Domestic
and foreign firms that previously harvested rents generated by the franchise
could no longer be confident of their ability to do so in an environment in which
the leadership of government had become genuinely subject to change at regular
intervals, and they therefore had much weaker incentives to invest in Indonesia.
Firms that previously put up with extortion because it remained relatively light,
and because these were times of steadily increasing prosperity, now found it
more threatening in the absence of centralised control. Banks that would have
liked to be lending more were afraid to do so because they could not rely on the
courts to enforce their loan contracts.
The flowering of democracy itself also imposed additional costs on the corporate sector. Like a monopolist with no need to spend heavily on advertising since
it has no competitors to keep at bay, Soeharto had relatively little need to ‘tax’ corporations to fund election campaigns: the whole election process was a charade
in which Golkar could not lose. But now there were several parties with enough
electoral support to be considered serious contenders for membership of governing coalitions, and the high value of the spoils of office meant that most were prepared to spend heavily on their election campaigns. The unpredictability of the
8 After years of strong private capital inflows, the crisis that emerged in 1997 saw a dramatic turn-around. Heavy capital outflow was experienced for the next six years before
net inflows returned in 2004 (McLeod 2005a: 136).
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outcome, in stark contrast with Soeharto era elections, meant that many companies made contributions to some, perhaps several, of these parties in order to try
to secure their fortunes through each phase of the electoral cycle, as the infamous
Bank Bali corruption case suggests (Fane 2000: 42). And no doubt state enterprises were also privately taxed for the same purpose—hence the lack of political
support for privatisation, which was intended to be a key feature of the IMF’s crisis recovery program for Indonesia.9
There are many other examples of changing behaviour on the part of the
branches of the former franchise that show how they have lost their coherence,
and thus have become an obstacle to economic recovery, with the advent of
democracy. In addition to increasing the net rate of private tax imposed on firms
and individuals by corrupt officials, and increasing the degree of uncertainty
about property rights and the future course of development, the effect of the collapse of the franchise has been to increase the extent of uncontrolled, environmentally damaging exploitation of natural resources (see various chapters in
Resosudarmo 2005) and to constrain the ability of more conscientious members
of the government and the bureaucracy to implement sound economic policies.
Consider the following examples.
An Extortive Legislature
Since the fall of Soeharto the relationship between the legislature and the executive (at the national level) has changed dramatically (Sherlock 2003: 19–21).
Before, the parties and individual members owed their presence to Soeharto’s
favour. Their primary role was to re-elect him, in return for which they received
a modest share of the spoils of office. Now, with a new president in place—but
with parliament having the power to remove him—the relationship shifted from
cooperation to confrontation. It is one of the functions of legislatures in democracies to protect the interests of the public against mistakes and malfeasance on the
part of the executive, but in this case much of the new activism in the DPR was
intended to increase its members’ share of the cake.
The people’s representatives were not slow to seize upon the opportunity to
extort funds from the bureaucracy (and thus, indirectly, from the general public)
as it attempted to carry on the business of government—introducing new laws
and regulations; implementing budgetary decisions such as the removal or
reduction of subsidies and the divestment of state-owned enterprises; the
appointment of individuals to positions such as top military posts, ambassadorships and the governorship of the central bank; and, in particular, the attempts of
IBRA, the Indonesian Bank Restructuring Agency, to divest its large portfolio of
bank and corporate assets.10 It did not escape the media’s attention that members
of parliament quickly came to appear much better dressed, and to be driving
around in much more expensive vehicles, than before.11
9
Note that avoiding privatisation in order to maintain control of the state enterprise cash
cows condemns this significant part of the economy to sub-standard performance.
10
‘Corruption ”from State Palace to Political Parties”’, Jakarta Post, 23/1/2001.
11
‘Deep Pockets’, Tempo Magazine, 7/10/2002.
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Ross H. McLeod
A Judiciary Out of Control
The judiciary became much more prominent in the wake of the crisis, primarily
because so many firms and banks became insolvent—or merely stopped servicing their debts. Large-scale bankruptcy had rarely been an issue in the pre-crisis
era, but now many creditors suddenly began to file bankruptcy claims against
defaulting debtors, and the judiciary found itself in a position in which it had far
greater opportunities than before to benefit financially from the larger and more
numerous cases coming before it. The biggest creditor of all was IBRA. This new
part of the bureaucracy was established in 1998, and given the task of recovering
as much as possible of the government’s outlays on bailing out the banks. But it
found itself in an unequal contest of strength with the judiciary, which was only
too willing to exploit its position in order to extract large bribes from the defaulters—at IBRA’s expense. This, in turn, created enormous pressure on the budget,
seriously compromising the government’s ability to undertake the expenditures
necessary to keep the economy in good shape (Pangestu and Goeltom 2001:
144)—not to mention imposing huge costs on the general public.12
Another party to suffer has been the foreign investment community, which
used to rely heavily on the ‘franchise connection’ for the protection of its assets
and activities in Indonesia (Cole and Slade 1998: 65), but has found the going
very tough in the corrupt court system since Soeharto’s demise. One well-known
example is the Canadian insurance company, Manulife, whose former joint venture partner was able to persuade the court to declare Manulife Indonesia bankrupt, although it clearly was not.13 Eventually this decision was overturned, but
only after considerable pressure was brought to bear—amongst others, by the
Canadian government.14 A later case involved Tri Polyta Indonesia, which not
only sought to have the courts invalidate $185 million worth of bonds it had
issued overseas before the crisis began, but also sued the bondholders for more
than $600 million for the return of interest previously paid and for ‘emotional distress caused to the company management‘.15 The patent absurdity of this claim is
an indication of how dysfunctional the judiciary had become. Instead of protecting property rights it began to be used as an instrument of expropriation, as is
apparent from the later annulment of the entire Tri Polyta bond transaction by the
Serang (West Java) District Court (Donnan 2004; Bisnis Indonesia, 13/5/2004). In
cases such as these, this unholy alliance between the judiciary and domestic capital conflicts with the efforts of Indonesia’s economic policy makers to persuade
foreign capital to return, and thus to assist with economic recovery.
Newly Active Regional Governments
Since power and authority were so heavily concentrated at the centre under Soeharto, one of the first priorities of the reform movement was the devolution of
12
IBRA was wound up on schedule in February 2004, having recovered only about 25%
of the funds the government had put into the collapsed banking system (McLeod 2005b:
43–4).
13
‘Court Verdict on Manulife Upsets Canadians’, Jakarta Post, 14/6/2002.
14
‘Manulife Judges Exonerated’, Laksamana.Net, 22/1/2003.
15
‘Tri Polyta Indonesia Asks Court to Cancel Bond Claim’, Bloomberg, 9/4/2003.
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some aspects of government to the regions—or ‘decentralisation’ as it is known in
Indonesia. By quickly seizing the initiative here, Habibie hoped to gain kudos that
would help him to retain the presidency (McLeod 2005b: 46). Just as allowing
numerous parties to contest the election had contributed to horizontal fragmentation of the franchise, devolving significant power and authority to lower levels of
government would have contributed to its vertical fragmentation. In the event,
the franchise had collapsed long before decentralisation began to be implemented.
Two laws on decentralisation were among the flurry of new statutes enacted
during Habibie’s term in office (Anwar 2001: 7–13): Laws 22 and 25 of 1999, on
Regional Government and Fiscal Balance between the Centre and the Regions,
respectively. A feature of the second of these was the extraordinary—and seemingly unconstitutional—decision to try to buy the support of resource-rich
regions by agreeing to return large proportions of natural resource revenues to
the provinces and districts where they originated.16 In the past, oil and gas revenues in particular had played a big part in financing government expenditure
throughout the nation, especially on the construction and maintenance of infrastructure (Ravallion 1988: 54). At face value, Law 25/1999 greatly reduced the
scope for a continuation of this, and thus provides a good example of parts of the
old franchise now going their own way, regardless of the impact on other parts,
and on the sense of nationhood in Indonesia.17
The devolution of some of the functions of government to provincial and district levels has meant that regional governments no longer regard themselves as
subservient to, and dependent upon, the central government. In other words,
they no longer see themselves as having to play by the rules of a central franchise—as indeed was the intention of the decentralisation reform. There are clear
indications that regional government officials, like members of parliament at the
national level, have adopted the attitude that the widespread opportunities for
personal enrichment enjoyed hitherto by their central government counterparts
have now shifted to the regional levels.18
One well-known example of this is the central government’s attempt to privatise its cement manufacturing company, PT Semen Gresik. A relatively small
shareholding in this company had been divested some years ago to the Mexican
company, Cemex (Cameron 1999: 25–6). At the time of this sale, Cemex was given
an option to purchase a majority stake in the company. But when it moved to
exercise this option, the provincial governments in West Sumatra and South
Sulawesi, where two of the company’s major plants are located, moved to block
the sale and, in effect, to seize control of the central government’s ownership
stake (Deuster 2002: 11). The case helped to dampen what little enthusiasm the
16
The spirit of article 33 of the constitution clearly requires that wealth derived from natural resources belongs equally to all Indonesians, regardless of where they live. This issue
seems to have been totally ignored so far.
17
In reality, the implementation of this aspect of the law seems to bear little resemblance
to what it appears to say (Fane 2003). Both the decentralisation laws were replaced with
new ones in 2004, but without any significant impact on the aspects of their operation discussed here.
18
See, for example, ‘Knives Are Out for ”Skewering” the People’, Tempo Magazine, 22–28
April 2003; ‘Six Into One Does Go’, Tempo Magazine, 29 April – 5 May 2003.
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Megawati government had for privatisation (Taufiqurrahman 2003), and was still
in deadlock at the time of writing, notwithstanding some positive signs that
emerged with the advent of the new Yudhoyono government (Kadga 2004).
In another case, regional (provincial and district) governments in East Kalimantan, apparently acting partly on behalf of domestic private sector interests,
have engaged in attempts to expropriate a majority stake in the foreign-owned
mining company, PT Kaltim Prima Coal (Callick 2002a; Dodd 2001, 2003). The
effective usurpation of the powers of the courts by these governments, and the
implicit threat of extortion by the army, as in both Aceh and Papua,19 have added
to the concerns of foreign investors generally. Domestic mining companies have
also been affected, and have cut back significantly on their investments. In such
circumstances it is not surprising that the mining sector has been stagnant for the
last several years.
The Kaltim Prima episode had even wider implications for the economy, however. The uncertainty created by the court attachment of the Tangguh natural gas
field in Papua, which was owned by one of Kaltim Prima’s original shareholders,
had the effect of preventing the sale or transfer of the gas field to any other party,
thus making it difficult to raise the finance needed for its development. This
action is plausibly blamed for the loss to Australia of a huge contract to supply
China with natural gas—even though the attachment was eventually overturned
after the then president intervened (Callick 2002b). It is interesting to note also
that in its efforts to overcome the malign impact of its own courts, the government moved even further away from its commitment to privatisation by agreeing
to purchase (through a state-owned mining company) 20% of the 51% share of
Kaltim Prima that was required to be divested under the terms of its establishment. The hope was that this would be more acceptable to the original owners
than allowing the regional governments to acquire a majority stake in the company. In the event, the owners took matters into their own hands and quickly sold
their entire interest to a company owned by the family of Aburizal Bakrie (later
to become coordinating minister for economics in the SBY government).
A further important aspect of the collapse of the franchise is the enthusiasm
with which regional governments have begun to impose a range of taxes within,
or at, their boundaries.20 In some cases this is well intended, but no doubt in others it is simply a manifestation of the fact that, by imposing formal taxes, the
opportunity is created for officials to generate income for themselves by negotiating effective reductions or exemptions for the taxpaying entities in question
(Kuncoro 2004: 336–9). In any case, there is no doubt that this has hindered recovery by making life more difficult for private firms.
Turf Wars between the Army and the Police
Another of the reforms of the Habibie era was to separate the police from the
armed forces. This has led to a more overt rivalry between these two parts of the
former franchise—in particular, between the police and the army—which bears
19
20
‘Charge Service’, Tempo Magazine, 25–31 March 2003.
SMERU Newsletter, No. 03, July–September 2002, SMERU Research Institute, available
at .
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an interesting resemblance to the gang wars of the prohibition era in the US. This
is not surprising. Both are involved with organised crime: gambling, prostitution
and drug dealing, and with the practice of extortion, which is a natural extension
of those activities (Weiss 2002). The competition between them from time to time
breaks into the open, as in a case involving drug dealing in Sumatra in which a
number of soldiers attacked a police station, killing several policemen.21 The business community can hardly ignore this kind of occurrence when it, itself, needs
to rely on the police to protect its property rights. A police force that is heavily
involved in organised crime is unlikely to perform this function effectively.
THE CHALLENGE OF REFORMASI:
REGAINING EFFECTIVE GOVERNMENT
It has become a cliché to observe that the strengthening of public sector institutions was given little emphasis during the Soeharto era. But it is important to
appreciate that this was no oversight. On the contrary, it was precisely this that
had helped make Soeharto strong and his extended family and cronies wealthy.
His intention was to make himself safe from any attempt to remove him from
office or to dilute his ability to make policy as he saw fit. Indonesia’s ‘democracy’
was a sham, in which there was no chance that Soeharto would be removed
through the election process. Nor was there any chance that the legislature, the
bureaucracy, the judiciary, the armed forces or the state-owned enterprises would
put the interests of the people before those of the franchise.
Though the legislature and the election processes on which it is based have
now been democratised, if ‘now’ is genuinely to become the era of reformasi, all
the other public sector institutions will also need to be reformed. Reformasi
requires not only getting rid of Soeharto, but also either getting rid of, or changing the behaviour of, a large proportion of his former franchisees. The difficulty
of doing so has been underestimated, however. For example, many seemed to
think that reforming the armed forces required little more than depriving them of
their quota of seats in the DPR. This change was achieved in the 2004 general election, but in practical terms the army remains as strong as ever22—indeed, it is
arguably even stronger, now that Soeharto is not there to keep it under control.
PERSONNEL MANAGEMENT PRACTICES AND SALARIES
AS THE KEY TO REFORM
Whereas the several consecutive Soeharto governments succeeded in generating
rapid growth over some three decades, the replacement of his franchise system
by a far more genuinely democratic regime has been followed by several years of
much less satisfactory economic performance. Although investment activity
21 ‘Nine Hours in Binjai’, Tempo Magazine, 14/10/2002. An earlier episode in which the
army attacked police stations in Madiun resulted in two civilian deaths and numerous
injuries (Jakarta Post, 18/9/2001).
22
The impending surrender of their seats in the DPR was not even mentioned by Liddle
(2003), who argued that ‘… nothing fundamental has in fact changed since 1998. … A government that does not pay its soldiers cannot control their actions.’
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Ross H. McLeod
finally began to pick up significantly around the end of 2004, it is too soon to
know if this will be reflected in sustained rapid growth in output at rates similar
to those achieved before the 1997–98 crisis. In the opinion of the writer this is
unlikely, unless the new government of Susilo Bambang Yudhoyono is able to
extend democratic reform beyond the first step of implementing reasonably fair
and open elections to encompass the creation of strong incentives for good performance in the public sector institutions, relative to society’s objectives.
It seems self-evident that the aims of any organisation will be best served if it
can appoint the best possible person available to each position within it.23
Accordingly, the emphasis in organisations such as sporting teams and private
sector enterprises is on encouraging fair and open competition for positions at all
levels within them. That, of course, is fundamental to the notion of democracy
itself, in which individuals and parties compete with each other to persuade voters that they will do the best job of governing. Successful reform of Indonesia’s
other public sector institutions (i.e. beyond the legislatures) will depend crucially
on the adoption of a similar approach—the creation of an environment in which
all individuals within them have strong incentives to compete by performing to
the best of their ability.
The discussion that follows ignores the state enterprises, whose poor performance mirrors that of the civil service. Suffice it to say here that the same broad
principles of reform apply to both, although the author’s preferred course of
action in the case of state-owned enterprises is to remove the problem by divesting them to the private sector. Reform of the military and the police is also highly
desirable, not least because both organisations are partly responsible for insecurity of property rights—and therefore for impairing Indonesia’s economic performance—as a result of acts of both commission and omission. Space limitations
do not permit adequate discussion of this issue here, however.
The inadequacies of Indonesia’s public sector institutions are a reflection of
Soeharto’s practice of encouraging his franchisee officials to manage them in such
a fashion that they could personally benefit by exploiting their positions. Within
the logic of the franchise framework presented above, it would have made sense
for him to keep basic salaries low, especially at the higher levels, in order to bring
people into these positions who would be unconcerned about their basic salaries
but would focus instead on the opportunities they would have to earn additional
income—often illicit—as franchisees.24 This has been manifested in the proliferation of additional regular allowances for individuals in particular positions; of ad
hoc payments for attending meetings, conferences and so on; of payments for
serving on a wide range of committees (in particular, those concerned with procurement); and of a range of benefits associated with special projects. Given a lack
of transparency, access to many of these additional payments, and to participation in straightforward graft and bureaucratic extortion, was conditional on the
individual in question playing by Soeharto’s rules. Thus the president was able
23 A more precise statement of this principle would take into account the trade-off between
recruiting ‘better’ people and the extra cost of doing so.
24
This was reflected in a well-known aspect of public sector culture—namely, a widespread awareness of differences in the availability of opportunities for graft; areas where
such opportunities were abundant became known as ‘basah’ (wet).
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to co-opt officials within these institutions to serve his own interests by ensuring
they had a common interest in the effective functioning of the franchise.
Many young people who had every intention of working well for the benefit
of the public were also recruited to these institutions. Such individuals tended to
languish in the ‘dry’ areas, and for the most part they found that the path to promotion was heavily restricted unless they wanted to buy into the franchise. Some
of them did so, while others left to seek their livelihoods elsewhere. Many more
simply accepted their fate, enduring a low standard of living, and forgoing any
real opportunity for promotion to levels at which they were capable of functioning effectively.25 A few made their way up through the hierarchy by virtue of Soeharto’s recognition of the need for especial competence in at least some key areas
of policy making.
Reforming Personnel Management
Performance-based competition for each position in an organisation is very different from the process of automatic promotions, based on seniority, that is
presently a fundamental characteristic of the Indonesian civil service (including
the judiciary). When promotions are largely automatic, individuals have little
incentive to perform better than their peers. Overstaffing at higher levels
becomes the norm, since even poor performers are promoted rather than being
either kept in their present positions or encouraged to leave. Those who do perform well are frustrated by the lack of meaningful recognition of their efforts.
This may result in their leaving the organisation for private sector jobs where
they can expect to be rewarded appropriately, or simply becoming dispirited and
significantly less productive as a result. At the same time, there is little incentive
for individuals to increase their productivity by undertaking additional education and training, since in practice there is scant payoff in terms of salary
increases or promotions.
Thorough reform of the civil service therefore requires radical changes to personnel management practices, especially in relation to recruitment, promotion
and discipline. Recruitment from outside the civil service should no longer be
restricted to recent school and university graduates, and discipline should be
understood to include bringing criminal charges against those found to have
acted corruptly.26 It will be essential to put considerably more emphasis on performance appraisal27 and to reform the processes of recruitment and promotion
so as to make them transparent and fair. Presumably these processes will involve
formal selection and promotion committees, whose membership would be chosen so as to provide some element of outside scrutiny. Records would need to be
kept of advertisements for the positions in question, applications for those posi25
Thus the often heard argument that low salaries ‘force’ public sector officials to engage
in corruption is an insult to those who choose not to do so.
26 At present it is difficult even to discharge civil servants found guilty of corruption,
although there is now some suggestion that Law 43/1999 on public servants will be
revised in order to speed up this process (Witular 2005).
27
The current annual assessments of performance ‘are descriptive, and do not assess performance against targets and objectives. They … cannot be considered as an instrument of
accountability’ (ADB 2004: 59).
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tions, and justifications by committees for their decisions. A further aid to transparency would be to make promotions and appointments subject to appeal by
unsuccessful applicants. In other countries, procedures of this kind have taken
years, if not decades, to evolve, and to become part of the corporate cultures of
the organisations in question, so all of this clearly amounts to a massive and difficult undertaking.
Reform also requires a far-reaching restructuring of the Soeharto franchise
salary scales. Specifically, much more attractive salaries are needed at higher levels in the hierarchy in order to attract honest and well-motivated people, and to
give civil servants an incentive to perform well in order to achieve promotion to
higher levels. To a large extent this would merely involve rolling the complex
array of allowances and semi-regular additional payments now received, along
with basic salaries, into a single, transparent salary for each position. This has long
been advocated; the fact that it has never been achieved suggests that many individuals benefit from the utter lack of transparency in the current system.
The actual remuneration of many civil servants currently includes not only
these various formal and semi-formal components but also the proceeds of corrupt activity, and so may be far above the sum of formal salary plus identifiable
legitimate allowances. It is not necessary to set salaries that would match presentday official salaries augmented by typical earnings from graft and corruption,
however. There are many people who would be willing to work in these institutions provided that their salaries were broadly in line with those of people in similar professions working in the private sector, but it will be impossible to attract
a sufficient number unless this is so.28
Fiscal constraints do not constitute a reason for postponing the restructuring of
salaries. In the first place, it is not necessary to increase remuneration across the
board, but only at higher levels, where salaries fall well short of those for similarly skilled private sector managers and professionals.29 As we move up the
hierarchy of the relevant institutions the rapidly declining number of positions
means that it is not out of the question to finance large increases in remuneration.
More importantly, however, provided these increases are accompanied by
appropriate changes to personnel management practices, the cost of higher remuneration will be covered by bringing about a significant improvement in the quality of management. One of the most obvious areas where this can be seen is within
the Ministry of Finance, and specifically within the taxation directorate and the
customs service. It is well known that the ministry has failed to widen the income
tax base or to extract taxpayers’ full tax liabilities from them,30 and that the customs service is rife with corruption (Lingga 2002). Improving the quality of per-
28
Public sector salaries may be able to be kept a little below those in the private sector, to
the extent that employment in the former is seen to provide additional, non-pecuniary
benefits.
29 Filmer and Lindauer (2001) argue that the common perception that civil servants gener-
ally are greatly underpaid relative to the private sector is not supported by available evidence. They contend that low-level civil servants are actually somewhat better paid, in
which case there is no reason to increase their salaries further.
30
‘Jakarta To Jail Tax Dodgers without Trial’, Straits Times, 29/3/2003.
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