Return of Paternalist Capitalism

A commonly held view of Indonesia's recent, more protectionist policy decisions (i.e. mineral export bans, beef and horticulture import restrictions, mining divestment rules) is that they are motivated by populist politics leading to the 2014 election.   Followers of this view say that once the election is over, Indonesian policymaking will somehow shift back to a more internationalist position.  That may be true, but it could also be wishful thinking.   A more accurate view may be that a more confident leadership –proud of the nation’s economic resilience in the face of global slowdown, has renewed their belief in paternalist capitalism, the notion that the private sector has a more limited role to play, and that economic development still needs to be controlled by a paternalist state.  Its not a new view for Indonesians, and certainly understandable given their colonial experience.   Some background: 

Since Indonesia's independence the state has accounted for huge swaths of the economy (i.e. agriculture, transportation, utilities, heavy industry, communications), allowing the private sector only to be involved in sectors it could not afford to develop on its own. (oil/gas, mining, distribution, light manufacturing)  President Sukarno attempted to combine socialism with nationalism and his successor President Suharto kept many socialist tendencies (5 year plans, agricultural cooperatives) while establishing a myriad of state mandated monopolies, some privately owned. Over time --and as various economic crises demanded-- the State deregulated, gave up key monopolies (steel making, media, rice distribution), reduced sole importer agencies, and began to partially privatize (through equity offerings, and public-private partnerships) some state owned enterprises (power generation, airlines, telecommunications), especially once capital markets opened to foreign investors in 1988.    A series of ever changing, and at times confusing, negative investment lists has been employed for decades, restricting foreign ownership in many sectors, as well as opening up others that were previously closed. One could argue that these policies (implemented by a vast bureaucracy) did more to reward well connected local business groups (and their bureaucratic enablers) than develop world class players and led to the inefficient allocations of resources as well as high logistical and bureaucratic costs. But, politically, these policies paid dividends to whoever advocated them.  

 Post 1998 democratic reforms and the political stability ushered in with the 2004 election (and 2009 reelection) of President Yudhoyono returned Indonesia to the strong 6%+ growth rates it had achieved in the Suharto era even amidst a world wide depression.  Yudhoyono’s administration implemented further reforms.   The private sector grew and with it, dramatic increases in local as well as foreign direct investment. 

During Yudhoyono’s s first term (2004-2009), government statements and initiatives were highly solicitous of foreign companies and investors; the private sector was in many ways unshackled. The state was moving to becoming much more of a regulator of markets rather than an intervener in them.   But his second term (2009-2014) has brought many of the restrictions mentioned above, the majority of which are based on creating more value-added industries.  Examples are:  ban on raw rattan exports to encourage local furniture production, export ban on minerals and requirements to build local smelters. The State here is saying, we think its better for the economy to have more local downstream production of our natural resources and since local and foreign investors aren’t doing it, we will mandate it. 

 I believe the policy shift resulted more from the 2008 economic crisis when Indonesia maintained its growth rather than politics.   Leaders saw that not having a fully open market economy buffered them and was a positive not a negative.   The world slow down and continuing high rates of poverty and less than optimal job growth became a context in which the government’s natural paternalist impulses could come to the fore. 

Representative of the renewed sense of state “paternalist” capitalism are remarks President Yudhoyono made on April 30 at a National Development Planning Meeting:

“For Indonesia, we all must do this: do not just let everything follow market mechanisms. [That is] very dangerous. The state must take part in having responsibility for the economic conditions of the country… Countries which are very capitalistic and which have surrendered all sorts of things to the market are now making corrections and improvements…When the world experienced an economic crisis, we tried as hard as possible for our economy to continue to grow and to possess sufficient resilience. In the middle of an economy that is still in crisis, if our economic resilience is low, our economy could easily falter. Many countries worry because their economic resilience is not strong –once buffered, it unravels, and the economy can collapse.”

Set in the policy arena, this “not too much capitalism” attitude leads to a recent decision not to allow the private sector to build toll roads in Sumatra. According to Coordinating Minister for the Economy Hatta Radjasa:  “Because this project is a [government] assignment, the view is that it [must be performed] by a state enterprise that is 100 percent controlled by the state,” he said. In fairness, the Minister also remarked that the private sector might be given subcontracts. 

Another example has been the government’s continuing commitment to energy subsidies that are approaching 20% of the national budget.  Believing that they are crucial to the support the millions on the edge of poverty, even though they mostly support the middle to upper class vehicle owners, political leaders face huge political risks to eliminate them or scale them back, although recently the government has been publicly discussing the need to charge more for gasoline.    Most leaders know that abolishing them would free the huge sums necessary to build a modern infrastructure that would lower logistics cost and accelerate development.  But, apparently here politics trumps paternalism. 

Will the 2014 mark a change from this recent tilt away from a more liberal trade and investment regime?  This is doubtful in my view.   Most Indonesians—including the huge base of young voters, respond to nationalist, broad side politics, whether it comes directly from politicians or from the mosque.    So, for example, students demonstrating in Riau have recently demanded the government not allow Chevron to extend its contract over the Siak block. Although Chevron’s share (10%) of the production is hardly “domination”, the prevailing view as articulated by the students and uncontested by the government or local politicians—is that “This foreign domination of our natural resources has increased in recent years thanks to our regulations, which support free competition. As a consequence, local companies must become ‘the step-children’ when it comes to exploiting the resources”.   

Although Indonesia will remain a strong destination for trade and investment, this return of paternalist economic decision-making will increase risks and may require work-around behavior on the part of foreign firms, similar to what was common in previous eras. 

(These opinions are solely those of the writer and do not necessarily express those of the members of the American Indonesian Chamber of Commerce)

Political Parties and the Next President of Indonesia

 

Political Parties

For many years I have been a member of Columbia University’s Southeast Asia seminar, a fantastic group of scholars, writers, and a few private sector representatives.  We recently hosted a young scholar from the Australian National University, Marcus Mietzner, who has lived in Indonesia and closely follows the development of political parties.   Mietzner is very concerned that although political parties have begun to mature, they still have a long way to go to operate as full representatives of the aspirations of their members.  Compared to other emerging democracies, Indonesia’s is doing fairly well.  Surveys indicate that people are still very confident of democracy as the their form of government, and as might be expected, since 1998, less identify with a political party.  Voter turnouts remain high, above 70%, but Islam has become a dividing line among parties and within parties.   Parties differ in how strong a role Islam should play in public life. 

The most pressing issue for Indonesia, according Mietzner, is party financing.  Up until 2005, the Indonesian government still appropriated funds to help parties with organizing their infrastructure for the large increase in the number of local direct elections.  Since then, the government has severely cut its support, and parties are now plagued by the outsized influence of wealthy patrons or the corruption of party leaders steering projects or government funds to party campaign funds.   President Yudhoyono is thought to have agreed to reinstate the party subsidy program but because his own party would be a leading beneficiary he backed away from the plan. 

The Next President of Indonesia ?

Mietzner asked a question that many Indonesians have been asking me recently: Is the US ready for Prabowo (a former top general and son-in-law of Suharto) as Indonesia’s next President ?  Prabowo tops most polls with 20% of the vote and is considered decisive and disciplined, the type of President many Indonesians say they would like.  But although his countrymen may overlook allegations of human rights abuses when he was an Army commander, US leaders in Congress may not.   Some have told me that he may be on a “do not enter” list.  

Indonesia’s first civilian Minister of Defense, Dr. Juwono Sudarsono, told Stanley Weiss, the head of Business Executives for National Security that  "Prabowo leads the pack because he projects grit, firm leadership and decisiveness--which are seen to be lacking in our current leadership."   In a September 2012 Huffington Post piece, Weiss recalls a conversation at the White House with General Wayne Downing, a top counter-terrorism official in the Bush Administration and a long time instructor of foreign soldiers at Fort Bragg who said “Of all the foreign soldiers he ever trained, two stood out. One was Abdullah II bin Al-Hussein, the reigning King of Jordan. The other was Prabowo Subianto." 

There is a long way to go until the Presidential elections next year.  First the country must go through Parliamentary elections.   From those numbers, it will be clear which parties can nominate candidates.  The current system is that a political party must have members and offices in all Indonesia’s provinces and achieve a certain threshold of seats in Parliament to nominate a Presidential candidate.  It is unlikely that Prabowo’s party, Gerindra, can nominate him on his own and they are seeking alliances with other larger parties.  Also, the slump in party identification among voters always leaves room for a “dark horse” candidate.  Even more popular than Prabowo in some current polls is the Governor of Jakarta, Jokowi, who is not currently a declared candidate.   Others will no doubt come forward in the months ahead.  For Mietzner and the legions of political observers of Indonesia, 2013-2014 will be a busy year. 

Outlook for 2013

Indonesia heads into 2013 with continuing questions for foreign companies within an overall atmosphere of solid 6% -6.5% economic growth.  The blemishes --if handled well--will not take away from the rosy complexion.  Those looking for stimulative reforms that would smooth the path for foreign companies may have to wait until the next Administration or look to innovative regional leaders.    It would be nice to be wrong here.  But, lets be clear, Indonesia remains in a solid position for long term growth.

Extractive
Although resource nationalism remains a concern and ambivalence towards the role of foreign companies continues to hamper needed investments, the economy is likely to pick up steam as growth returns to Indonesia’s export markets following the 2008-2010 period of de-leveraging.   We already see some retreating on the export ban for minerals but settling the contract renewals of key investments such as the Mahakam oil and gas project (Total) and Freeport’s Grasberg mine may be further delayed and await the change of leadership in 2014.  The unfortunate truth is that the ruling coalition, led by President SBY’s Partai Demokrat, may have difficulty sticking its neck out for foreign investors because to do so may make them appear weak in the next election cycle.  Of course, renewing contracts as early as possible will always lead to more investment and faster growth.  But as we near 2014 many decisions of the current Administration have a political overlay and require more calculation.   Wouldn’t it be great to just hit the “clear” button.

Consumer
The consumer sector is humming along and there should be little let up here.  Confidence is up and investment to serve this sector has blossomed and will continue.   Infrastructure and logistics remain a stumbling block and recent rises in minimum wages is a pressure many local businesses will have a hard time implementing.    Inflation, steady throughout 2012, is likely to increase.  On the other hand, the government has not backed changes to fuel subsidies (electricity rates may head up) and --even if it wanted to-- may not be able to get the votes in a fragmented Parliament. In Indonesia fuel rates are like taxes in the US. 

Infrastructure
Indonesia will make another push for infrastructure investment centered around an event in November when the country hosts APEC.   But, any strong policy changes such as better land clearing procedures or creativity in financing (municipal finance) will remain for the next Administration.  However, at the local level, we may see some innovations on the margins that may help alleviate the road  and power gridlock.  News on the effectiveness of last year’s new law on land acquisition will likely be muted.  Challenges remain to translate the government’s master plan vision (MPE3I) into achievable goals by the line Ministries, may of whose talented personnel find it confusing.

Investment
We will see some of the FDI investments made in the last 2 years open in 2013.  The growth story, and a predicted better balance of payments should lead to a strengthened rupiah. Indonesia will again have success in the international sovereign bond market. The nation’s credit rating may see some modifications based on concerns about some of the nationalist --dare I say protectionist-- policies.    Attention to the Churchill Mining dispute --now on the agenda of the World Bank’s Court for the Settlement of Investment Disputes-- will most likely minimally affect the overall investment climate as its already been factored in by most companies. 


Trade and Tourism
If China’s economy continues to recover Indonesia will see better numbers in these sectors.  Signs are good.  Uncertainty in government policy in the extractive sector  -- where yet again officials are warning the target for oil and gas exports will not be met-- as well as ethical purchasing behavior of consumers in export markets (paper, palm oil) also inhibiting factors.

Legal
The Constitutional Court ruling of November 2012 to dissolve the oil and gas regulator BP Migas may have offspring.  Those groups who believe in economic nationalism, looking to make a point with voters, may institute “copy cat” suits that could more directly seek to limit foreign ownership.   In 2013 we should begin to see draft revisions to the 2001 Oil and Gas law as mandated by the November court decision.  The vulnerability is the language of Article 33 or Indonesia’s constitution which states that all natural resources shall be used for the “people’s welfare”. 

Political
10 political parties will meet the threshold to field candidates in the June 2014 Parliamentary elections and September 2014 Presidential elections.  The corruption scandals tainting the Partai Demokrat are fueling the hopes of parties such as Golkar, whose share of votes has been declining.  Towards the middle to end of 2013 we will have a better idea of the shape of these elections but even then the picture will remain incomplete as some President/VP tickets may await the results of the Parliamentary elections.   With so many parties, coalition building, never a precise game in Indonesia, will be dominant, as will be the search for a candidate with star power who might feed into many Indonesians’ desire for a ratu adil, just leader.    Could it be the young charismatic Governor Jakarta, Jokowi, who is sure to be tested by this week’s floods. Or what of Suharto’s son-in-law Prabowo, who remains popular in polls for his perceived strength, but is also weakened by his track record as an Army commander.  Will SBY choose an heir from his own family or let the process occur more organically.  2013 may yield even more questions then answers.

Foreign/US-Indonesia Affairs
Indonesia hosts an important APEC Leader’s Summit in November in Bali (Obama is scheduled to attend), a chance to showcase its advancing position on the world stage, as well as lead the many discussion of implementing APEC free trade goals. Foreign Minister, Marty Natalegawa,  will no doubt be at the center of settling or at least cooling off the South China Seas dispute, which is mostly about access to deep ocean mineral resources.  President SBY is slated to return to the US in May 2013 for meetings at the UN.  There could also be a bilateral with President Obama.

Security
2012 ended with Indonesia’s anti terrorism command (Detachment 88) defusing a terrorist cell in Eastern Indonesia but with activity heating up in Mali and Algeria, one cannot be complacent that Indonesia’s has completely eradicated its terrorist practitioners.  The police uncovered a plot aimed at several US official facilities in 2012 and we can expect that vigilance will remain a necessity for the near term. For travelers, its generally recommended to consult US State Department websites that post alerts, warnings, and health information.

Final Comment
Short summaries are inherently marred by their incapacity to cover everything.  But the above notes should give readers a flavor of whats ahead for 2013.   (These comments may or may not reflect the interests of AICC members)

Heathcare Education For Sale

I recently read a disturbing report that indicates that training for nurses and doctors in Indonesia is for sale.  Admitted medical students are reportedly paying up to $2500 above tuition to gain acceptance with students with low grades paying more.  Once accepted under-performing students are paying to pass their exams.   Other reports indicate that doctors, nurses and midwifes are paying to secure scarce jobs in government clinics and hospitals.  They work in them in the mornings and retreat to their own private clinics in the afternoon where they can be paid fees.    Is it any wonder that Indonesians still mistrust their own medical institutions and doctors. They ask: have the best and brightest been educated ? Indonesia has actually created a wonderful, modern healthcare system.  Unfortunately, its just not in their own country; its in Singapore where Indonesians spend over $3 billion a year.  Those that have the means also seek medical care in Thailand, Malaysia, Japan, Europe and the US.  


It doesn't have to be this way.  In 2010, I visited the only internationally certified hospital in Indonesia, Siloam Hospital.  The excellent private facility, established by the Riady Group, is hoping to expand to other Indonesia cities and is looking at worldwide models for cost reductions.  They have an agreement with the Mayo Clinic for tele-diagnosis as well arrangements with an Australian medical schools that supplies faculty on short term assignments. You cannot tell the income level of their patients; they are given the same rooms and hospital gowns. Their staff seeks inspiration from a book, Fortune at the Bottom of the Pyramid, by C. Prahalad, that argues that commercial success can be reached serving the overlooked market of the world's poorest citizens.  Siloam's cardiac department is seeking to drive the cost of open heart surgery below $3000, a level achieved by an Indian hospital.  Whereas this would still be out of reach for most Indonesians, it would be affordable to the middle class, estimated to be 30-40 million people. 


Changes to Indonesian policy have begun to make it easier for foreign investment in healthcare, but nationalistic obstacles remain.  Foreign doctors cannot practice in the country and investment rules are still too restrictive.  But, a number of Indonesian private equity funds have begun to look seriously at the sector, giving rise to hope that combined with more foreign interest some deals can be arranged.  Why not give foreign educated doctors work permits for 5 years similar to the those that were created for foreign managers in Indonesia's oil industry.  Medical tourism would seem to be a natural for Indonesia.  A first class diabetes or cancer treatment facility in Bali or in the hills above Bandung or Bogor would be very successful. Establishing the public's trust will require overhauling medical school curriculums and hospital management, upgrading the continuing education of the current doctor pool through certification requirements (I have met US educated Indonesian doctors who confess they have no motivation to keep up their specialty certifications) and opening the sector to foreign investment and management.

The US is uniquely qualified to assist in meeting the healthcare aspirations of Indonesians because so much of our system derives from private capital and our medical science is world renowned.  Already organizations such as Johns Hopkins and Duke University are creating medical schools in Singapore and in Duke's case, consulting on the construction of hospitals in Dubai and India.  Indonesia should be courting them but they aren't or at least not yet.  The right conditions would bring a tremendous amount of private capital to this sector, freeing government resources to focus on healthcare for the poor.  I am convinced its a path that is good not just for Indonesia but for the US as well. Leaving things as they are,  with medical careers for sale to unqualified students and billions spent in Singapore,  will continue a perversion the country can ill afford.

New Indonesian Mining Divestment Rules

Is Mining Divestment Such a Benefit to Indonesia?
Indonesia is following a worldwide trend of pushing out foreign ownership of mining assets. A March 8 Reuters story began "Indonesia will take more of the profits from its vast mineral resources by limiting foreign ownership of mines". But, is that what necessarily happens when more of the share of an enterprise is owned locally? How can the government be so sure that it will benefit when it may not be the one owning the shares? How can it guarantee that a local company or shareholders on the bourse won't just invest their profits somewhere else, developing a new mine in Kazakhstan, or buying US real estate? I am troubled by divestment rules in Indonesia just as I was in the 1980's when the Japanese owned US landmarks like Rockefeller Center and there were shrill jingoistic demands that they be made to divest. (Turns out the Japanese bought high and had to sell low, and nothing changed with the properties or the revenues earned by the government)

The background to this is a Feb. 21 regulation that requires all foreign investors in mining to divest 51% of their shares within 10 years of starting commercial operations. "The aim is the state has to get more. For new investment it will be simple, but for existing investment there must be re-negotiation," Mining Minister Jero Wacik told Reuters. However, the Director General for Mining, Thamrin Sihite, stated that this new requirement would only be for new contracts and extensions of existing contracts. The Deputy Minister for Trade told reporters that this change shouldn't be an issue: "We still believe, even with only 49 percent, it (the mining sector) is still very alluring, still very lucrative for everybody." The Executive Director of the Indonesian Mining Association, Syahrir Abubakar, begged to differ: "I'm sure foreign investors will not invest in the mining sector anymore in Indonesia. This policy will threaten Indonesia's mining investment climate." Abubakar is probably right, ROI in mining often takes more than 10 years; giving up half your profits as well as control within that time frame may be unworkable for certain mining projects.

The government's two principal arguments for divestment are: more revenue for the state and more incentives for local companies. Clearly, who owns what number of shares in an enterprise should have little effect on government revenues. Aren't taxes and royalty payments the same whether the majority of a mining enterprise is owned locally or not. Assuming the mine was profitable, the only situation where the State would gain would be if it owned the mine itself. So a local province, state-owned company, or the national government would have to put up its own money (or borrow it) to buy shares and presumably, the foreign shareholders would have to agree on a "fair price". If one were looking for a simple mechanism for divestment as Minister Wacik explained in the above quote, this negotiation would be among the worst examples. Newmont Mining - whose existing contract best approximates the new regulation- has had a long and tortuous path to meet its 51% divestment obligation (and remains 7% short) and Freeport, with a much different contract, may have difficulty selling the 9.3% stake it has offered to sell locally. (It should be noted that Newmont has had 20 years to divest, not 10.) But is the potential revenue from owning shares -- the government still earns significant tax and royalty revenues--worth all the trouble and the uncertainty it breeds in the investment climate ?

The second reason for requiring a divestment, incentives for local companies, makes one wonder what kind of business community Indonesia is now trying to build. Is it one in which local and foreign investors are treated equally, as stipulated in the 2007 Investment Law, or one in which only local firms are allowed to do certain activities and foreign firms are penalized. How far has Indonesia moved from its post colonial mentality of distrust of foreign investment, and does it not recognize the positive role foreign companies have played in building communities, local businesses, training people, raising standards, and supporting the country in international forums. Cannot local firms be "incentivized" in a more neutral way, or is the politics of pride of ownership so overwhelming that grave risks to the investment climate and a sense of fairness are overlooked. Significant properties and businesses in NY are still owned by Dutch and English interests (part of our colonial heritage) but no one cares anymore. Finally, there are many Indonesian mining companies already in operation, mostly (but not exclusively) in coal. Over time, they are developing the expertise and financial clout to move into the hard rock major leagues (gold, nickel, copper, zinc etc.) where foreign ownership has been dominant. But why should the government enable them through divestment? Cannot it be allowed to occur naturally and through the principle of competitive advantage? What if they aren't ready to assume the mantle? Are divestment measures also a vehicle for politically connected local firms to buy into existing operations at a discount ? That might have been expected in a previous era, but Indonesia is now a functioning democracy trying to end such anachronistic practices.

One can understand the government's desire to keep more money in Indonesia through vehicles such as capping foreign ownership or requiring local processing of all mining products (a measure instituted in the 2009 mining law). But time and again, we have seen that such protectionist measures have unintended consequences. If over all investment drops in mining (especially in precious metals) because its not profitable to raise capital with a 10 year divestment period, how can that be good for the country? Mines, especially the large ones funded through foreign investment, have been proven to be huge employment and development engines and are among the highest taxpayers in the country. Also, if local processing has to be coupled with measures to limit imports of similar products (as may be expected), inflation will rise and Indonesian products will be less competitive and employment will sink.

Mining players from resource-hungry countries whose record on the environment, local community, labor relations, and human resource development is spotty, are willing to enter Indonesia on just about any terms. What a shame if that was the final outcome of these new rules.

This cautionary tale deserves to end on a positive note. That is, experience has taught that the Indonesian government has been practical in modifying new rules that are not working. Not in every case, mind you, but often enough for one to say that perhaps that will be the case here. I certainly hope so.

These views are those of the writer and do not necessarily reflect those of the American Indonesian Chamber of Commerce or its members.

Prof. Widjojo Passes Away

One of Indonesia's heroes has passed away. Professor Dr. Widjojo Nitisastro, leader of the "Berkely Mafia" (a group of young Indonesian economists educated at UC Berkely in the 1960's under Ford Foundation aegis, became the economic architect of President Suharto's New Order. Under his leadership Indonesia's economy not only averaged 7% growth, but significant segments of Indonesia's population rose above poverty. All of us in the business community owe him a great debt and we send our sincere regards to his family.

Regions Demand More

Indonesia’s fourth President Abdurrahman Wahid, (“Gus Dur”) once told a small group in NY that federalism in Indonesia was a “dirty word” but that Indonesia would have to implement it under different name. Gus Dur was referring to the first few years of Indonesia’s independence when it was called the United States of Indonesia and was using the federal system. The USI broke down quickly amidst secessionist demands (as well as other reasons too numerous to articulate here) and the country went back to its first model, a unitary republic with everything centralized in Jakarta. Gus Dur’s view is still the prevailing one: Indonesia is unlikely to create a federal model even though it could profit from having one. The perception of enduring secessionist tendencies remains in many policy maker’s minds. The pressure for local decision making was relieved following the passage of decentralization and revenue sharing laws in 1999 under President Habibie (who directly followed President Suharto) The implementation of these laws has brought more revenue and wealth to Indonesia’s resources rich provinces. As opposed to the Suharto era when over 60% of all bank deposits were in Jakarta, today its just the reverse. Habibie’s policies were visionary in that they understood that the country could not develop adequately with Jakarta calling all the shots. Today the growth evident in Indonesia’s regions is attracting investment but has also created regulatory confusion. The implementation of these laws has created a good deal of uncertainty in the extractive sector where legacy contracts created under a centralized authority can be in conflict with local regulations and interpretation. Indonesia’s regions, especially those endowed with natural resources, are demanding more of a share of revenue. They see huge infrastructure needs not being met with their restricted budgets. The battle has already begun with regions first wanting to own shares of mines and oil and gas fields and now a larger shares of royalties and tax revenues. Among the consequences for business are permit and contract renewal delays and more uncertainty. Drilling rates drop and production targets are not met. As regions and municipalities increasingly chart their own destinies Indonesia has to reconcile the many regional/central anomalies into a coherent system, of course, without using the word “federalism”.