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Indonesia-The Politics of Economic Reform

Two main forces of influence within the New Order government battled to shapeeconomic policy: the technocrats--who favored market reforms and a limited role for the government in the economy--and economic nationalists--who argued that trade

protection and direct government investment and regulation were necessary tocontain foreign influence while mobilizing sufficient resources to modernize theeconomy. The technocrats were led by the original members of the "Berkeley Mafia,"who had gained cabinet posts in the late 1960s. Among the most influentialtechnocrats were Ali Wardhana, initially the minister of finance in 1967 andcoordinating minister of economics, finance, and industry from 1983 to 1988, andWidjojo Nitisastro, who headed the National Development Planning Board(Bappenas--for this and other acronyms, see table A), from 1967 to 1983. Althoughretired by 1988, both men remained influential behind-the-scenes advisers in theearly 1990s. Under the tutelage of Professor Sumitro Djojohadikusumo, a prominentintellectual and cabinet member in the 1950s who founded the University of 

Indonesia Faculty of Economics during the 1960s, these Western-trained economistswere the voice of economic liberalism. The economic nationalists included prominentofficials in the Department of Industry, headed by Hartarto; offices under the minister of state for research and technology, Bacharuddin J. Habibie; and the InvestmentCoordinating Board (BKPM; see The Executive , ch. 4). The balance of power between the economic technocrats and the economic nationalists was mediated bySuharto, who skillfully channeled the energies of both groups into separate arenas.

 After the New Order successfully countered the rampant inflation and financialcollapse of the Sukarno era, the technocrats gained credibility and influence in thedomain of financial and fiscal policy. As oil revenues grew in the 1970s, thosegovernment agencies responsible for trade and industrial policy sought to extendIndonesia's domestic industrial base by investing in basic industries, such as steeland concrete, and by erecting trade barriers to protect domestic producers fromexcessive foreign competition. Government regulations proliferated, and oil taxesfueled investment in development projects and state enterprises.

The private sector became dominated by large conglomerate corporations, oftenChinese minority-owned, which had sufficient wealth and know-how to assist thegovernment in large-scale modernization projects. Australian economist RichardRobison estimated that Chinese Indonesian capital accounted for 75 percent of 

private-sector investment in the 1970s. The two most prominent conglomerates, the Astra Group and the Liem Group, had substantial holdings in dozens of private firmsranging from automobile assembly to banking. The growth of these conglomeratesusually hinged on close ties to government. In exchange for monopoly privileges onproduction and imports of key industrial products, conglomerates would undertakelarge-scale investment projects to help implement government industrializationgoals. Political patronage became a vital component of business success in the early1980s as government restrictions were extended to curtail imports when oil revenuesbegan to decline.

By the mid-1980s, about 1,500 items representing 35 percent of the value of imports

were imported either by licensed importers or controlled through a quota system.Such nontariff barriers affected virtually all manufactured imports, but were

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particularly extensive for textiles, paper and paper products, and chemical products. As a result of restrictions on imports, firms in these sectors were effectively protectedfrom foreign competition or able to sell their products at a higher cost. Firms thatobtained import licenses were also highly profitable, but costs were borne by theentire economy because imports were often key inputs for many manufacturers.

Popular resentment grew as the gains from these restrictions enriched a privilegedminority. To the long-standing public sensitivity toward the prominence of theChinese minority was added dismay that members of Suharto's family were profitingfrom access to import monopolies.

Suharto's six children were the most visible beneficiaries of close governmentconnections. Each child was connected with one or more conglomerates with diverseinterests, and like their Chinese minority counterparts, they based their businesssuccess at least partly on lucrative government contracts. For example, sonBambang Trihatmodjo's Bimantara Citra Group, reportedly the largest familyconglomerate by the 1990s and Indonesia's fifth largest company in 1992, got its

start in the early 1980s selling allocations of overseas oil to the National Oil andNatural Gas Mining Company (Pertamina)--the government oil monopoly and thenation's largest company. Lower value middle East oil was thus used for domesticrefining and consumption while higher-grade Indonesian oil was used for export,primarily to Japan.

Two vital industries symbolized the intricate relationship between government andbusiness: steel and plastics. In the first case, the founder of the Liem Group, LiemSioe Liong, agreed in 1984 to invest US$800 million to expand a governmententerprise, Krakatau Steel, in Cilegon, Jawa Barat Province, to add production of cold-rolled sheet steel. In return, a company owned partly by Liem received amonopoly for the imports of cold-rolled steel. Once domestic production wasunderway, Liem's imports were restricted to assure demand for the Krakatauproduct. The World Bank (see Glossary) estimated that the scheme added 25 to 45percent to the cost of steel sheets in Indonesia, thereby raising costs of a wide rangeof industrial products that used this material. In the second case, the importation of plastic raw materials was monopolized through government license by PancaHolding Limited, on whose board of directors sat Suharto's son, Bambang, and hisbrother, Sigit Harjojudanto. As a result, in 1986 the company earned US$30 millionon US$320 million worth of plastics imports, adding 15 to 20 percent to the price of these materials for Indonesian users.

When oil prices plummeted in 1986, the growing dissatisfaction with the direction of trade and industrial policy became more vocal among small private businessesexcluded from the benefits (see Minerals , this ch.). A number of smaller businessesorganized the Chamber of Commerce and Industry in Indonesia (Kadin). Thesebusinesses became open critics of the "high-cost" economy of monopoly privilege,and in 1987 Kadin became the officially sanctioned channel of communicationbetween business and government. Other influential groups began to pressure thegovernment for trade reforms, including international lenders on whom Indonesiarelied to assist the government with balance of payments difficulties resulting fromthe decline in oil revenues (seetable 15, Appendix).

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Several major reforms were underway before the 1986 oil crisis, but without directaffect on trade restrictions, which although valued by influential beneficiaries, hadbecome costly to many businesses. Major trade deregulation began in 1986, but leftthe largest import monopolies untouched until 1988, a gradual approach to reformthat influential technocrat Ali Wardhana attributed to the limitations of the

government bureaucracy. He hinted at a broader political motive, however, inacknowledging that piecemeal reforms had the advantage of progressively winning anew constituency for further reform. The financial sector was the first sector to bereformed in the 1980s, as it was in the mid-1960s, when the New Order governmentfaced the excesses of the previous regime.

Data as of November 1992