Indonesia: Progressing, But not Fast Enough

Asked about his view of the Indonesian economy, Angel Gurria, the head of the Organization for Economic Co-operation and Development, harks back to an old Avis rental car ad campaign.

“When you’re not the biggest,” said Avis in the campaign, conceding the top spot to its rival Hertz, “you have to try harder.”

The OECD released its first-ever economic survey of the Indonesian economy in Jakarta this week, a first step along the road to full membership. There are four other countries on a similar track: China, India, Brazil and South Africa.

Despite economic growth above 5.5 percent for the past three years, more than double the average rate of OECD member countries, it’s not fast enough to reduce poverty or unemployment, Gurria said. Some 35 million of Indonesia’s 230 million people earn less than US$20 a month, while the unemployment rate is still above 10 percent.

“I think the country has been growing rather nicely,” Gurria said in an interview this week. “To say it is going to grow 6 percent in 2008 is almost incredible. The problem is it’s coming from behind and as I said you need to do like Avis and try harder.”

For Indonesia’s poverty and unemployment rates to improve the OECD says its economy would need to grow about 8 per cent a year.

And for that to happen, there would need to be some big policy changes. The OECD urged Indonesia to relax its ‘rigid’ labour laws, abolish or at least reduce fuel and electricity subsidies and scrap the so-called negative list, which sets foreign ownership restrictions for each industry sector.

These ideas are not new. But Gurria is hoping that because they are coming from an independent organization, which is not trying to get its money back, they will resonate.

Of particular concern for Gurria is the amount of money Indonesia spends on fuel and electricity subsidies. This year the subsidy bill is expected to reach US$30 billion, about a quarter of total government spending and more than the government spends on health and education combined.

“It’s a huge amount,” he says.

“We think we are making a contribution by coming and saying for heaven’s sake do you realise what you could do with this money. If you have better roads, better ports, better schools, better health, it is a truly competitive edge.”

The government has already made some adjustments. In October 2005, fuel prices were more than doubled, sparking riots and a spike in inflation. Two months ago, they were lifted again by just under 30 per cent. But there is no formula linking the domestic increases to international markets.

“This would make price changes transparent and less politically charged,” says Gurria. “It would also safeguard fiscal policy against fluctuations in energy prices and it would create room in the budget to finance compensatory measures for those groups that are most at risk of income losses when fuel prices rise.”

But the policy change is unlikely to be introduced any time soon. Earlier this month, the country kicked off its parliamentary election campaign, with polling scheduled for April 9 followed by a presidential vote within three months.

The secretary general of Indonesia’s ministry of finance, Mulia Nasution, put it this way on Thursday.

“The government is aware of this difficult policy legacy and is committed to address it. However it must be done in a careful and sensitive manner and consider all of the social, economic and political difficulties in changing a subsidy policy that has been in place for decades.

“Moreover, experience from other countries in a similar situation shows that a too radical shift in government policy can often result in social unrest.”

This close to an election, changes to Indonesia’s labor laws are also improbable. A review of the 2003 Manpower law has been promised but never undertaken.

The legislation was set up to protect workers rights in a relatively new democracy but the OECD argues that the laws are too onerous and costly and as a result, they have fostered the development of a “non-formal” sector where there is little protection or regulation of working conditions.

Dismissal procedures are lengthy and complex. Companies have to issue three warning letters to workers, six months apart, and then apply for permission to go ahead with the sacking from the local Manpower Department.

Standard severance pay is one month’s salary for each year of service, capped at nine months, much higher than other countries in the region. And that is doubled if the dismissal is due to economic reasons, retirement, death or disability.

The OECD also argues that Indonesia’s minimum wage – at 65 per cent of the median wage – is too high and “out of step with productivity.”

Rather than ensuring low-skilled workers are paid well, it pushes them into the non-formal sector where there are usually no arrangements for severance or long-service pay.

Indonesia’s overall macroeconomic management was given a tick of approval from the OECD, which praised its low budget deficits and falling debt to GDP ratios.

But Gurria is clearly worried about inflation across the region and cautioned Indonesia to act “preemptively” and “resolutely.”

He said Indonesia, where inflation is running at more than 11 percent, was not alone in facing these pressures. Vietnam’s inflation rate has rocketed to 27 percent, Malaysia's hit a 27-year-high of 7.7 percent in June and even Australia announced this week annual inflation was at its highest rate in eight years. China and India are also battling rapidly increasing prices.

“I am very concerned about this wave of inflationary pressure,” Gurria says.

“I am also concerned that people are trying to disguise the origin because everyone is blaming oil and food because it’s so obvious that they are increasing quickly but they are not 100 percent of the basket.

“In some cases credit has been very lax and in other cases fiscal policy has not been tightened.

“I say to everyone look at every angle of inflation and be as tough as you need to be.”