The Political Economy of Deregulation in Indonesia

The Political Economy of Deregulation in Indonesia
Author(s): M. Hadi Soesastro

Source: Asian Survey, Vol. 29, No. 9 (Sep., 1989), pp. 853-869
Published by: University of California Press
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THE POLITICAL ECONOMY OF
DEREGULATION IN INDONESIA
M. Hadi Soesastro
The 1980s will be recorded in Indonesia's history as

the decade of deregulation, a time when measures to deregulate the econ-
omy were undertaken as part of the broader effort toward economic struc-
tural reform. But the significance of the deregulation policy perhaps lies in
its systemic effects and longer-term implications for the country's eco-
nomic management and the equally significant influence these effects could
have upon the direction of the nation's sociopolitical development. Dereg-
ulation implies both a reduced role for government intervention and wider
and more creative participation by the public. In view of prevailing socio-
economic conditions in Indonesia, the task of accommodating increased
private initiative and activity is indeed a major challenge. Basically, Indo-
nesia still has a very thin layer of private entrepreneurs, the economy still
is dualistic in nature, and regional disparities have not been resolved.
Therefore, the success of the overall reform hinges on the ability of the
country's managers to diffuse any heightened political resistance to eco-
nomic liberalization that the process of deregulation may arouse. Experi-
ence thus far suggests that, by necessity, the deregulation process has been
managed in a gradual fashion, taking full account of its political feasibility.
Some observers question the wisdom of gradualism in deregulating the
economy, which over the years has produced a series of deregulation pol-
icy packages, issued piecemeal. Uncertainty about direction, timing, and
extent of policy changes that this process creates is seen to have an adverse
effect upon the behavior of the business community, and this can be detri-
mental to efforts to enhance the role and responsibility of the private sec-
tor, which the deregulation process is meant to promote. There also is
concern with the end result of this muddling-through and the lack of an
____________________ - M. Hadi Soesastro is Executive Director of the Centre for Strategic

and International Studies (CSIS), Jakarta. He was Visiting Professor at the East Asian
Institute, Columbia University, in 1988-89.
? 1989 by The Regents of the University of California
853
854 ASIAN SURVEY, VOL. XXIX, NO. 9, SEPTEMBER 1989
overall plan and strategy, but at the same time, one wonders whether a
technocratic blueprint for the deregulation process can be neatly drawn.
Ali Wardhana, former coordinating minister of economic affairs and one
of the forces behind Indonesia's deregulation drive, seems quite content
with the gradual nature of the process. He makes the point that the ex-
tended period of weak oil prices has made gradualism a viable option and
argues that "this is fortunate, because it has enabled policy makers and
implementors to work within their capacities to plan and execute reforms.
Moreover, gradualism has the advantage of progressively winning over a
new constituency for further reform."'
The deregulation policy in Indonesia is driven largely by necessity, and
its process is neither theory nor ideology driven. The universal trend in the
1980s toward deregulation (and privatization) may have provided an addi-
tional source of inspiration, but experience elsewhere suggests there is yet
no macro theory of deregulation that can, for instance, provide a guide to
the proper sequencing of structural reforms in an opening (as distinct from
an open) economy. The process and its success appear to depend on a host
of factors, including the country's initial conditions, economically and po-
litically, and a variety of external forces and conditions such as cyclical
movements or structural problems in the global economy as well as the
nature of existing international regimes.
In Indonesia the necessity-driven deregulation policy is aimed primarily
at a direct assault on the "high-cost," internationally uncompetitive econ-
omy. Thus, deregulation is not pursued for its own sake but rather as a
necessary component of the broader task of structural adjustment directed
at a more efficient allocation of resources. The economy's high depen-
dence on oil revenues, the drop in oil prices in the early 1980s, and the
continued uncertain international oil market since then have all created a
strong sense of crisis that was sufficient to keep alive the deregulation pro-
cess.
As outlined by Ali Wardhana, "a simple chain of economic reasoning
makes it clear why economic policy makers were drawn inexorably down
the path of structural adjustment." He notes that economic growth and
development require export growth to pay for imports and to service debt;
reliable export growth requires non-oil exports from agriculture and man-
ufacturing; non-oil export growth requires an efficient, productive econ-
omy, which needs a competitive domestic market; protectionist policies
and government controls are inimical to this competitive domestic market,
1. Ali Wardhana, "Structural Adjustment in Indonesia: Export and the 'High-Cost'

Economy," keynote address at the 24th Conference of South-East Asian Central Bank Gov-
ernors (SEACEN Governors), January 25, 1989, in Bangkok.
M. HADI SOESASTRO 855
creating instead the present high-cost economy, and these policies and con-
trols need to be dismantled, i.e., the economy deregulated; as a corollary,
non-oil government revenues also must be developed if government is to
play a constructive role in development; the benefits of deregulation and
economic growth must be widely and evenly spread and development of
the rural areas should receive continued emphasis.
It is believed that by now this chain of reasoning "is widely understood
and increasingly accepted in Indonesia, at least in its broad outline,"
Wardhana said,2 and economists of the University of Indonesia agree, ob-
serving that support for deregulation from within the government itself has
become much stronger. However, the latter have expressed some concern
over the widespread, simplistic notion of deregulation as a panacea that
will overcome the "high-cost" economy and its many prevailing ills and
inefficiencies.3 Several specific points were made: (1) deregulation, if sin-
gularly pursued to develop non-oil exports, would lead to new distortions
as the means by which non-oil export targets are achieved are as important
as the targets themselves; (2) deregulation that focuses heavily on manu-
facturing can result in a bias against the agricultural sector; (3) the overall
impact of deregulation so far has been positive primarily in psychological
terms, in the sense that it creates a new, more conducive business climate;
and (4) there is a need for a closer examination of the impact of deregula-
tion at the sectoral or industry level. Perhaps a useful theory of economic
deregulation can be developed in micro rather than macro terms. Its cen-
tral tasks could be identical to those of the microeconomic theory of regu-
lation, namely to explain who will receive the benefits or burden of
regulation/deregulation what form these will take, and what are the effects
upon the allocation of resources.4 A closer study on these aspects appears
to be highly desirable and necessary, especially in areas where the case for
deregulation remains highly controversial.
Deregulation in trade no longer belongs to this category of problems.
The benefits or burdens of regulation in trade and its effects upon resource
allocation can be readily identified and although problems still exist, the
instruments to regulate or deregulate are more or less well established,
both at the international and national levels. In the services sector-e.g.,
finance or transportation-deregulation still is universally controversial.
2. Ibid.
3. M. Arsjad Anwar and Iwan Jaya Azis, "Perkembangan Ekonomi Indonesia 1987 and
Proyeksi 1988," in M. Arsjad Anwar et al., eds., Ekonomi Indonesia. Masalah dan Prospek
1988/1989 (Jakarta: UI Press, 1988), pp. 5-9.
4. George J. Stigler, "The Theory of Economic Regulation," in George J. Stigler, ed.,
Chicago Studies in Political Economy (Chicago: University of Chicago Press, 1988), pp.
209-33.
The main problem here is not simply the absence of international norms or
rules but the uncertain impact of liberalization of such activities upon soci-
eties, particularly since a number of service activities are seen either as a
symbol of national power, as a manifestation of national sovereignty, or as
necessarily under full national control from a security perspective. The
central problem in the financial sector is insufficient knowledge of how to
make things turn out right. The issues are generically different in the area
of international transportation where ocean shipping and civil aviation are
already governed by international regimes. There is a strong contention
that developing countries are discriminated against by the international
shipping regime in which rate structures have been negotiated by cartels to
which a developing country's shipping has limited access. However, it is
also not well understood what forms of national regulation-and by the
same token, deregulation-and what kinds of instruments could effectively
promote developing countries' shipping industries in a more open and free
market.
The 1988 deregulation packages in Indonesia have been heralded as the
most sweeping measures so far. In addition to putting an end to the plas-
tics monopoly (seen mostly in light of its connection to members of Presi-
dent Soeharto's family) and other such measures in trade, the 1988
deregulation has been most notable for its attack on the highly regulated
financial sector and the shipping industry. Seen from this perspective, the
deregulation process-albeit undertaken gradually-already has affected a
number of areas, perhaps much more extensively than is generally appreci-
ated. Lately, however, growing concern is being expressed in terms of the
old fears and anxieties that deregulation might lead to "free-fight capital-
ism and liberalism," the sound of which alone would scare many Indone-
sians.5 Perhaps even this is not so surprising in light of the universally
common experiences where stronger nationalist sentiments tend to emerge
as a result of greater economic liberalization and international economic
interdependence.6 In Indonesia's case, deregulation and liberalization ap-
pear to run counter to its political tradition. Reflecting on this, a promi-
nent Indonesian scholar, himself a supporter of deregulation, has found it
necessary to admonish deregulators that their undertaking essentially is
culturally unacceptable.7
5. See Suara Pembaruan editorial, November 23, 1988, and concerns expressed by mem-
bers of Parliament reported in Kompas, November 25, 1988.
6. Robert Gilpin, The Political Economy of International Relations (Princeton: Princeton
University Press, 1987).
7. Nono Anwar Makarim, "Seperti Kuku Masuk ke Daging," TEMPO, November 5,
1988.
The question that is often raised now, both inside and outside Indonesia,
is how far deregulation will go. This article cannot satisfactorily answer
that question-things can evolve in many ways-and it needs to be recog-
nized that in the final analysis deregulation is a political process. But this
in itself makes it an interesting case to study, and although it is generally
assumed that as a political process it defies rational explanation, one can
gain some insight into the process by attempting to answer the following
simple questions: What indeed has driven the deregulation process? Who
are its initiators, its supporters, and its opponents? And what are the ef-
fects (real and perceived) of deregulation upon economic performance and
upon the society as a whole?
A Review of the Deregulation Process

A sufficiently large body of literature has become available on Indonesia's
deregulation policy that began in 1983 with the reform of the financial
(banking) sector.8 This review will focus on the process that has led to the
more recent developments, namely up to the issuance of the 1988 deregula-
tion packages that generally are seen as the most sweeping initiatives thus
far. A technical evaluation of these policy packages will not be attempted
here.
The rationale for deregulation has been well articulated by now. In fact,
concern with the heavy dependence on oil and the poor performance of the
non-oil export sector was expressed by some parts of the government as
early as 1978 and this, among other things, led to the decision to devalue
the rupiah in November of that year. More specific measures were intro-
duced in 1982 in response to the deterioration in the country's balance of
payments. Measures affecting exports, such as export taxes and restric-
tions on trade with the Socialist bloc, were relaxed. A scheme for counter-
trade, or more precisely counterpurchase, was also introduced as a way to
reduce the trade deficit incurred by continued high imports, which in large
part were attributable to various large government projects. Most of these
costly projects were subsequently rephased, and the counterpurchase deals
turned out to be far too insignificant to have any impact on the balance of
payments. Subsequently, greater reliance was placed upon a licensing
scheme that was introduced in late 1982 to curb imports.
The use of such import licensing proliferated very rapidly. Until Octo-
ber 1986, when serious efforts were begun to dismantle this system, close
to 1,500 important imported items came under some form of non-tariff
8. See the regular series, "Survey of Recent Development" in the Bulletin of Indonesian
Economic Studies, and the annual surveys on Indonesia in the February issues of Asian Sur-
vey.
barrier (NTB), usually a licensing restriction, that covered about 35% of

the value of total imports.9 The system became notorious both because of
the rent-seeking activities it encouraged and because of the groups that
were involved in, and dominated the activities. There was an alarming
emergence of what Mancur Olson called "distributional coalitions," and a
high-ranking government official involved in the designing of the system
soon recognized with regret that it was creating a Frankenstein monster. '0
Little hope was expressed that the system could reasonably be expected
to be dismantled in the foreseeable future, but since such import protec-
tion directly injured exporters who enjoyed little protection themselves,
stronger demands for dismantling gradually built up as the country moved
seriously ahead in promoting non-oil exports, especially in manufactured
goods.
The system was also seen as being misused to promote the development
of industries of questionable economic viability. This led to the growing, if
unorganized campaign to openly attack the system, which came into full
force at a seminar organized for the 35th anniversary of the Faculty of
Economics of the University of Indonesia. The issues were clearly set
forth in the keynote speech by Prof. Sumitro Djojohadikusumo, the
founder of the school. The seminar opened up a prolonged, and indeed
necessary debate but it did not produce any consensus on the relevant eco-
nomic policy issues. Instead, it heightened the conflicting arguments
among the opposing camps. The economic technocrats, namely the presi-
dent's macroeconomic advisors, have been clearly identified as the ones
spearheading deregulation. In his analysis of the political economy of de-
regulation in Indonesia, William Liddle identified two groups who basi-
cally compete with the economists in influencing the president in economic
policy making:
One group is the "engineers" or "nationalists" such as Ginandjar Kartasasmita,

[then] Junior Minister for Domestic Product Promotion and concurrently head
of the Foreign Investment Coordinating Board; B. J. Habibie, the state aircraft
industry head and Minister of Research and Technology; and Hartarto, Minis-
ter of Industry. These officials argue that it is worth paying the short-term costs
of protectionist policies to promote the development of state enterprises and
pribumi (indigenous, as opposed to domestic Chinese) entrepreneurs who can-
not as yet compete in either domestic or world markets. A second important
group consists of the politicians around the President, exemplified by the very
9. Anwar Nasution reported that the 1,484 items amounted to 28% of total items of com-
modity imports; see, "Tata Niaga Impor dalam Konteks Kebijaksanaan Makro," in M. Ar-
sjad Anwar et al., eds., Ekonomi Indonesia: Gambaran dan Prospek 1987/1988 (Jakarta: UI
Press, 1987), p. 101.
10. Personal communication.
powerful Sudharmono, [then] State Secretary and concurrently chairman of the

state party, Golkar (Golongan Karya, Functional Group). This group's interest
lies in a steady flow of patronage in the form of business opportunities and other
favors to New Order supporters.1 1
There are different ways of describing the opposing camps on the dereg-
ulation issue and in economic policy making in Indonesia but whatever
these may be, a number of interesting general observations can be made.
First, as aptly described by Liddle, "when times are lean, [the president]
listens to the advice of the economists, whose policies offer slower-but-
surer growth and the continued support of Indonesia's international credi-
tors. "12 Second, groups that oppose the deregulation policy have not
formed any kind of political coalition and, as will be seen later, they have
become more diffused over time. Third, groups outside the government
have also played some role, if mainly a supporting or what Liddle de-
scribed as an "indirect" role in influencing the process.13 These groups,
hereafter referred to as the "public," consist of academic economists, the
majority of whom support mainstream thinking; their views have been
widely publicized by virtue of the favorable coverage given and solicited by
the media. The business community, as can be expected, does not have a
united position because of differing interests; however, those in favor of
deregulation tend to be more vocal. Views from the Parliament have also
been mixed.
There is no doubt that the deregulation policy essentially was initiated
within the government itself, although pressures from the public in sup-
port of the reforms gradually exerted some influence and were useful in
maintaining the momentum. It is generally acknowledged that the drop in
oil prices in 1983 and again in 1986 was responsible for precipitating and
fueling a continued sense of economic crisis in the public's mind that al-
lowed drastic measures to be taken. However, perhaps one should also
give credit to the fact that the first major deregulation measure occurred in
the financial sector. This may have been a deliberate strategy on the part
of the deregulators, the technocrats, but it may just as well have been
purely accidental. Perhaps "bureaucratic pluralism," which appears to
have been pretty much at work then, is an explanation; there was no way
that a consensus-even a guided kind of consensus-could have been
reached through consultations and discussions on deregulation measures
affecting the real sector involving state agencies and ministers identified as
11. R. William Liddle, "Contending with Scarcity," Asian Survey 27:2 (February 1987), p.
207.
12. Ibid.
13. R. William Liddle, "The Politics of Shared Growth: Some Indonesian Cases," Com-
parative Politics 19:2 (January 1987), pp. 127-46.
belonging to the antideregulation camp. This left the financial sector,

which is well within the domain of the technocrats, as the first candidate
for the surgery. At the same time, financial reform in itself was long over-
due. 14
It was fortunate that this first step toward liberalization did not lead to a
financial disaster, the key to which could have been Indonesia's already
very open foreign exchange regime. Capital flight, which had not
originated with deregulation, did become a major problem, but it remained
well within limits the economy could cope with. In fact, the threat of
further capital flight of greater magnitudes could have been a decisive fac-
tor in forcing deregulation to take place in the real or goods-producing
sector. Pressures from the public began to increase as arguments were
advanced that liberalization of the financial sector would be futile, and
even would risk disaster if it was not followed by the significant deregula-
tion in the real sector that was clearly needed in view of declining invest-
ments and continued low competitiveness of Indonesia's manufactured
products in international markets. Some economists even held that dereg-
ulation of the real sector should have preceded that of the financial sec-
tor. 15
The subsequent dramatic measure that was taken was in the area of
institutional reform. With the issuance of Presidential Instruction
Number 4 of 1985 (Inpres 4/1985), the Indonesian customs service was
replaced by a Swiss-based surveying company, SGS. This was an impor-
tant step in the fight against the high-cost economy, but revolutionary as it
was, the public felt that the assault was not directed toward the core
problems, namely the structural weaknesses of the economy and the en-
trenched rent-seeking activities. The first package of trade and industrial
deregulation came only in May 1986, some three years after the "cam-
paign" had begun, and was confined to dealing with a few elements of the
"high-cost" economy that directly affected exports. Its essence was to al-
low exporters to procure imported inputs directly without going through
licensed importers and raising the costs. The package also replaced an
export subsidy program with a duty drawback and exemption program
that would allow exporters to escape import duties and sales taxes.
The September 1986 devaluation of the rupiah by 31% against the dol-
lar provided another incentive for further deregulation, and a package was
issued in October 1986 in which tariffs on 150 items and import licenses
14. The author acknowledges a valuable comment by Prof. Bruce Glassburner in which he
stressed the importance of this point.
15. Anwar Nasution reiterated this view in 1988 following the issuance of the October and
November 1988 packages. See "Kebijaksanaan Moneter Setelah Pakto 27," Kompas, Decem-
ber 1, 1988.
(monopolies) for 165 products were abolished and licensing restrictions on

110 items relaxed. During the 4th Development Cabinet (Kabinet
Pembangunan IV), which lasted until March 1988, two more packages
were issued. In January 1987 import duties were lowered on an additional
55 items, NTBs to imports were removed on more than 100 items, and
quota restrictions were abolished on approximately 140 categories of tex-
tile and steel products. The December 1987 package, together with the
preceding packages, also introduced new measures designed to promote
foreign investment and development of the tourist industry. In addition,
the packages amended industrial regulations and introduced measures to
revitalize the practically dormant capital market.
The encouraging performance of non-oil exports was seen as a signal
that the economy had responded well to the various structural adjustment
measures. This definitely strengthened the position of the deregulators.
Minister of Industry Hartarto, who over the years had painfully avoided
identification with either of the opposing camps and who expressed his
"neutral" position by propagating his "broad spectrum" industrial devel-
opment strategy, was soon to change his attitude. At the end of his first
term he became an active proponent of trade and industrial deregulation,
as these presumably had significantly contributed to the broadening of
manufactured exports that were to assume a prominent role in the coun-
try's non-oil export drive. Hartarto maintains his ministerial position in
the 5th Development Cabinet (Kabinet Pembangunan V), as does Habibie
(Research and Technology). Ginandjar (Domestic Product Promotion),
however, has been put in charge of the Department of Mines and Energy,
which makes him a less relevant participant in the deregulation process.
In his new position as vice president, Sudharmono also has lost any signifi-
cant influence over economic policy. Thus, the "opposition camp" in the
new cabinet has become a great deal weaker.
There was expectation that the new cabinet would swiftly produce fur-
ther deregulation packages, and considerable speculation that one would
be issued at the June 1988 meeting of the IGGI (Inter-Governmental
Group on Indonesia), an international consortium set up for the coordina-
tion of development assistance to Indonesia. Indeed, the banking commu-
nity was most impatient, since a package of financial reform was expected
to be announced earlier in April. When it did not happen, there was great
concern that the entire deregulation process "may have hit some political
snags,"''6 and fingers pointed at the palace as its most probable source and
the only effective remaining hurdle. The public's anxiety continued to in-
crease and in October 1988 it was finally "rewarded" with what was seen
16. Far Eastern Economic Review, October 6, 1988.
as a package of "sweeping" initiatives in the financial sector. The reform,

a follow-up to the June 1983 deregulation, was meant to further enhance
competition within the sector by removing some of the barriers to entry.
State enterprises would now be permitted to deposit up to 50% of their
funds in private banks, new foreign and domestic banks would be allowed
and foreign banks could open branches outside of Jakarta.
The fact that the first reform package issued by the new cabinet was also
in the financial sector may invite speculation about the strategy being pur-
sued. It should be noted that previous experience has shown that deregu-
lation of the financial sector creates pressures for deregulation of the real
sector. But whatever the compelling reason may have been, the financial
sector has remained as the prime target for reform, simply on grounds of
efficiency. As stated elsewhere, Indonesian banks undoubtedly have some
of the highest intermediation costs in Asia, partly because the banking sys-
tem is dominated by state banks that have a monopoly on mobilizing "cap-
tive" public sector funds and are protected from competitive pressures. 17
Overall, the package was applauded by the public, at least as reflected in
the press. But the praise was not unqualified. Several important issues
have emerged, the first regarding the question of competition. Can the
system cope with increased competition; what will be the rules of the
game; does Bank Indonesia, the country's central bank, have the capacity
to effectively control the liberalized banking sector?18 The second issue
focuses on the policy of, and the risks involved in granting greater oppor-
tunities to foreign banks.19 These concerns suggest that while less regula-
tion is generally desired, a strong feeling of uneasiness in dealing with
increased competition and accepting an increased role for foreign banks
prevails within the banking community and, perhaps even more so, among
the general public.
Two other issues deserve mention, relating to the deregulation process
itself. A Merdeka analysis found it disturbing that the substance of the
deregulation packages appeared to be broadly in line with proposals made
by, and according to demands of the business community.20 The other
theme was on the futility of deregulation measures in the financial sector
when the real sectors remain highly regulated.21 It appears that these two
issues did not emerge in isolation from developments that occurred in the
17. Sisira Jayasuriya and Chris Manning, "Survey of Recent Development," Bulletin of
Indonesian Economic Studies 24:2, August 1988.
18. Pelita, October 3, 1988; Suara Pembaruan, December 2, 1988; and Suara Karya, De-
cember 3, 1988.
19. Merdeka, October 29, 1988.
20. "Memahami Target Deregulasi Ekonomi," Merdeka, October 28, 1988.
21. Suara Karya, October 31, 1988.
preceding months. The strong drive for non-oil exports seemed to have
induced in some government quarters a tendency toward new regulation
or re-regulation either by restricting or totally banning the export of a
range of products, primarily unprocessed or semiprocessed goods. The
significant increase in the value of plywood exports following a policy of
export restrictions on logs some years earlier was cited as a successful ex-
ample to justify the policy of export restrictions as a means of encouraging
the development of downstream processing that would produce higher do-
mestic value added. The restrictions introduced on rattan exports in mid-
1988 was largely seen as a setback to the deregulation process. But more
importantly, in view of the questionable economic soundness of the propo-
sition, greater attention was given to the question of transparency in eco-
nomic policy making: since the technocrats would not be in favor of such
a policy, who was behind it? A more specific issue that emerged ques-
tioned the basis upon which the Association of Handicraft and Furniture
(Asmindo) was granted the authority to "coordinate" (i.e., to monopolize)
the purchase and distribution of raw rattan as well as the exports of rattan
products.
The public's demand for immediate deregulation measures in the real
sector as a follow-up to the financial package was useful to deregulators
who already appeared to have prepared a series of other packages. When
announcing the October 1988 deregulation, Coordinating Minister for
Economic Affairs Radius Prawiro explicitly stated that it would soon be
followed by a package to further promote non-oil exports (deregulation in
trade and industry), a package to promote investment, and a package on
the management of state enterprises. And indeed, another deregulation
package was issued in November 1988. Despite the hunger for further
measures, this package came as quite a surprise because it did at last dis-
mantle the country's most controversial monopoly, plastic imports, and
also ended many controls on steel imports. If implemented accordingly,
this package would be psychologically important; its effect would be posi-
tive "since these two sectors [plastics and steel] have been used by the
public as a barometer of the seriousness of the government to proceed with
deregulation. "22
The question now is whether pressures from the public will be greatly
reduced as a result of abolition of the plastics monopoly and whether the
new cabinet will become more complacent or relaxed after having pro-
duced those "sweeping" reform packages. On balance, during the 30-
month period of trade deregulation (May 1986 to November 1988), the
22. Suhadi Mangkusuwondo and Iwan Jaya Azis, "The Outlook for the Indonesian Econ-
omy, 1989-1990," mimeo, 1989.
country has seen a dismantling of about half of its NTBs. Textiles, agricul-
tural processing, plastics, chemicals, steel, machinery, and equipment all
have been affected. However, as Ali Wardhana notes, "trade deregulation
is an unfinished story," as a number of important pockets of protection
and restrictions on imports and exports still exist. He further suggests that
the future agenda will have to include more action on tariffs.23 Perhaps
the main achievement of the packages is that they have introduced greater
transparency in trade policy.
The other important area in the November 1988 deregulation involved
the complete liberalization of the heavily regulated shipping industry. The
measures also are aimed at achieving greater efficiency through enhanced
competition in the industry by simplifying and relaxing licensing require-
ments. The Indonesian National Shipowner's Association (INSA) chal-
lenged the wisdom of opening the industry to competition, arguing that
this would make the industry vulnerable since about 82% of Indonesia's
non-oil exports were already carried by foreign ships.24 In a quite remark-
able episode immediately after issuance of the deregulation, the Director-
ate General of Sea Transportation of the Department of Transportation
formulated its own interpretation of the policy that in effect amounted to
reintroducing heavy-handed regulations. However, these were soon with-
drawn at the instruction of the Minister of Transportation. Director Gen-
eral of Sea Transportation J. E. Habibie maintained that the regulation
was necessary and that it was made in response to the demands of INSA.25
This statement was supported by INSA's general chairman who contended
that, without regulation, the ensuing competition among national shippers
would not be fair and that national shipping companies were in no way
able to compete with foreign companies.26 While this fear of competition
was not shared by all INSA members,27 the idea that the association
should be allowed to "coordinate" the activities of Indonesian shipping
companies did receive some support from within the industry. Nonethe-
less, Minister of Transportation Azwar Anas made it clear that the gov-
ernment expects "free fight competition" to develop within the industry
and that "those who are not fit should step aside."28 In the Indonesian
context, this is truly a remarkable policy statement.
The subsequent deregulation package, announced on December 20,
1988, is aimed at the development of long-term sources of finance. It al-
23. Ali Wardhana, "Structural Adjustment."

24. Angkatan Bersenjata, December 10, 1988.
25. Interview with J. E. Habibie by Pelita, December 6, 1988.
26. Suara Pembaruan, December 9, 1988; Pelita, December 10, 1988.
27. Business News, December 5, 1988.
28. Kompas, November 23, 1988.
lows the development of private securities markets and encourages the de-
velopment of new financial services (venture capital, leasing, factoring, and
credit cards). This package is equally significant but it did not receive the
same level of attention as the two preceding ones. In fact, this was not the
package the public was eagerly expecting. By the end of November 1988,
there was a strong belief that the next deregulation would involve meas-
ures concerning the management of state enterprises. B. P. Messakh, a not
uninfluential member of Parliament, may have preempted the issuance of
such a policy package by expressing strong opposition to the privatization
of state enterprises, arguing instead that state enterprises should be given
greater legitimacy as an essential element of the Indonesian economy.29 It
is not clear why the promise to issue a deregulation package involving state
enterprises, as made earlier by Radius Prawiro himself, still remains unful-
filled. It would seem that of all the policy packages, this one would be the
most political in the sense that to be meaningful it would have to be based
on a new political consensus on interpretation of Article 33 of the Consti-
tution.
It may sound paradoxical to suggest that from a practical point of view
a possible reason for the apparent slowing down of the deregulation pro-
cess could be the limited capacity of the government apparatus to execute
the various deregulation policies. Indeed, there is considerable concern
with the execution of these policies at the lower levels of the bureaucracy
and at regional and local levels. This suggests that for the time being the
deregulators are well advised to focus their attention on implementation
rather than on the issuance of more deregulation packages; still, further
deregulation packages probably are necessary simply to keep the momen-
tum going, particularly so long as the price of oil remains unstable. But
this raises the question of whether the deregulation process should largely
be dictated by movements in oil prices.
The aim of deregulation is improved economic performance through a
more efficient allocation of resources, and the most immediate measure of
its success is the growth in non-oil exports. The past few years have seen
encouraging results, both in terms of the value of non-oil exports (now
surpassing the $1 billion mark monthly) and in terms of its structure (with
manufacturing now contributing about 50% of the total value). Would
further improvements in non-oil exports accelerate or put a brake on de-
regulation? Should the process be guided by some kind of a "pragmatic"
plan that involves concrete macroeconomic targets, such as a 15% growth
of non-oil exports annually for the next five years? Deregulation of the
financial sector has not as yet led to what is generally regarded as a more
29. Suara Karya, November 28, 1988.
appropriate (lower) interest rate, although it has resulted in financial deep-

ening. Thus, the question is how far financial deregulation should go?
Could a target rate of growth for the economy as a whole be used to guide
the process? Would it make sense to set a higher target rate than the 5%
stipulated in the current Fifth Five Year Development Plan (Repelita
V)?30
Although it makes a great deal of sense to formulate some "pragmatic"
targets, these may not adequately accommodate the concerns with deregu-
lation that are derived from normative considerations. In addition to alle-
gations that the accepted wisdom is being compromised or even violated
by the deregulation process, concerns have also been expressed from the
point of view of distributional equity (pemerataan). These concerns are
primarily derived from uneasiness with increased market competition, usu-
ally equated with "free fight liberalism." Be that as it may, it appears that
the society must now be ready to confront the challenges of freer and more
open competition. These issues will come more to the fore in the deregula-
tion debate in the years to come and will tend to heighten its political
nature. As proclaimed by the general director of P. T. Mega Eltra, the
state trading company involved in the plastics monopoly, the introduction
of import licensing was made at the request of the respective association,
and was meant to protect the smaller industries that cannot possibly gain
access to competitive imports that are more readily available to the larger
ones.31 At this juncture, perhaps the important question to ask is what
should be the future strategy to sustain the deregulation process. Could it
be kept at the pragmatic, "low-politics" level and if so, by what possible
means; or would it inevitably have to confront "high-politics" and there-
fore should the deregulation (or overall structural reform) policy be explic-
itly addressed within a defined set of economic principles and philosophy
that reflect a new national consensus?
"High Politics," "Low Politics," or What?

One could justifiably assert at the outset that the government is not likely
to bring the deregulation debate within the broader issue of economic sys-
tems. To do so would result in a political polarization even within the
government itself that would be of a much greater intensity than the
clashes of interests and development ideas that have characterized the op-
posing camps on the issue of deregulation in its initial years. Thus, it ap-
30. A similar discussion was proposed regarding Repelita IV in Hadi Soesastro, "Repelita
IV: The Political Economy of a Five Per Cent Growth Target," The Indonesian Quarterly,
11:4 (December 1983), pp. 26-38.
31. Suara Karya, November 22, 1988.
pears that the best strategy to keep the deregulation policy going is to keep
the debate at the level of "low politics." An earlier case of success in Indo-
nesia in turning an economic policy issue from "high" to "low politics"
was the highly controversial policy of domestic petroleum product pricing.
As observed in an editorial in a leading Indonesian newspaper some years
ago, "there is hardly any other event in the social life of [the] country
which has such a pervasive effect than the increase in petroleum product
prices."32 The basic problem is well known and will not be elaborated
here,33 but it resulted from the fact that petroleum product prices had
been highly regulated and distorted for political reasons, especially in the
early 1960s. When the New Order government came into power in 1966,
economic stabilization and reconstruction required price adjustments. Es-
sentially, subsidies had to be eliminated or drastically reduced. Adjust-
ment of petroleum prices that affected the prices of so many other basic
items, including public services, as well as the general price level provided
a powerful rallying point for student protests and demonstrations during
the early years of the Soeharto government.
As a result of the dramatic price increases in 1973-74, the effective (eco-
nomic) subsidy to consumers, especially of such basic petroleum products
as kerosene and diesel oil increased dramatically. However, initially no
budgetary support was involved because of the cross-subsidy scheme:
higher receipts from gasoline (the fuel for the rich) were more than suffi-
cient to cover the loss from sales of kerosene (the fuel for the poor) and
other highly subsidized fuels. As consumption of petroleum products in-
creased in line with the overall economic growth and as a result of their
declining real prices, especially of the heavily subsidized products, a sub-
sidy that had to be financed through the budget began to emerge. Deci-
sions to increase prices were opposed by a new generation that desired to
emulate the actions of the "1966 generation," and it has been said that the
military also was not in favor of such price increases.
A number of studies were made both on the microeconomic effects upon
various economic sectors and on the implications for the energy sector of
the price distortions, all pointing to the necessity of price adjustments.
These studies only received the attention of the experts in the field and did
not have an influence upon the debate within the general public. The pub-
lic concerns were mainly with the highly emotional and political issues of
the distribution of the burden of the adjustment between the rich and the
32. Sinar Harapan, January 5, 1982.

33. An extensive discussion on this subject can be found in Hadi Soesastro, "The Political
Economy of Petroleum Product Pricing in Indonesia," in Chan Heng Chee and Pang Eng
Fong, Political Economy of ASEAN's Development (Singapore: Institute of Southeast Asian
Studies, forthcoming).
poor as well as the broader issues of government corruption and

Pertamina's financial mismanagement which were seen as the main cause
for the price hikes. But since the latter part of the 1970s the government
has justifiably kept insisting that these price adjustments were necessary
from a purely budgetary perspective. This had the effect of reducing the
subsidy issue to a budgetary item. Furthermore, the government presented
a strong argument that unless this budgetary item comes under effective
control it would threaten to destroy one of the foundations of the New
Order's economic management: the principle of a balanced budget.
The "high-politics" nature of the problem indeed was transformed into
that of "low-politics." The parliament, which voiced its opposition in the
earlier period of the price increases, was effectively coopted by drawing its
Budget Commission into the making of petroleum product pricing. The
"balanced budget" was clearly made the context for the pricing policy, and
as such it was more readily accepted. It was also important that within the
context of budgetary constraints, distributional issues were sufficiently ad-
dressed and were manifested in a price structure of the various petroleum
products that economically was kept minimally distorted but socially still
considered fairly equitable. Thus, when in 1982 as a consequence of the
second international oil price increases, kerosene prices were only about
one-third of production costs and the budgetary subsidy reached a peak of
over $2 billion (slightly above the total amount of foreign assistance in that
year), the stage was set for a series of dramatic price adjustment in the
years that followed.
In a way, this process of eliminating the distortions in petroleum prod-
uct prices was a kind of deregulation. The new prices became largely dic-
tated by movements in the price of oil in the international market.
Perhaps, an analogy to the current deregulation policy cannot be drawn
beyond this very broad similarity. The "direct" link to the budget is not
obvious in the case of the current deregulation policy as it is with regard to
petroleum product prices. Although the need for deregulation can more
readily be derived from balance-of-payments considerations, there is not a
readily acceptable rule-of-thumb here that is analogous to the principle of
the balanced budget. One might suggest a current account deficit of $2
billion as some kind of a management tool, but its arbitrariness is much
too obvious. In addition, non-oil export targets alone have been found
insufficient as a guide since the manner by which they are achieved cannot
be ignored. The case of the current deregulation policy is far more com-
plex than petroleum product pricing policy. In the former case, the actors
are much more diverse, and a new, important policy parameter has
emerged-namely government-business relations. As the preceding exam-
ination suggests, the role of producers' associations appears to have been
elevated and can no longer be ignored. As yet little is understood about

the roles, structures, and dynamics of these sectoral, industrial associations
in influencing national policies and how they relate to Kadin, the Indone-
sian Chamber of Commerce and Industry.34
This new parameter seems to have become a crucial one in the deregula-
tion process from the present stage onward and will become an important
element in the country's economic management generally as the private
sector's role is augmented. The preceding examination shows that there is
a tendency that in practice the deregulation process will end up in some
kind of "self-regulation" by the industry through the respective sectoral or
industry associations. Would this not amount to re-regulation or even
cartelization? Government-business relations will definitely become the
primary focus of public attention: what will be the political and economic
nature of the relationship and how ought it develop? Business organiza-
tions or associations will be closely scrutinized as they evolve and they will
be required to become more professional and to function as viable eco-
nomic and social institutions. The bureaucracy must also change its mode
of operation. Nono Makarim has aptly pointed to the phenomenon of "in-
volution of bureaucracy" as a cause for the growing lack of understanding
on the part of the bureaucracy of how the economy (and perhaps also the
society) functions.35 Arifin Siregar, the Minister of Trade, may have had a
point in proposing a mechanism for the development of a sound basis for
government-business relations. Unfortunately, naming it "Indonesia In-
corporated" perhaps was a kiss of death to the idea, especially during the
euphoric mood of the new era of deregulation. But objections to this idea
may also have originated with the concern that it would legitimize the
practice of government-business collusions. No doubt, such relationship
already exists, even in the absence of "Indonesia Incorporated." Perhaps,
the proposition to be advanced should be one of transforming the relation-
ship from what is essentially a patron-client type to that of a transparent
and accountable working partnership.
34. A recent Ph.D. dissertation on this subject deserves mention and praise for its rele-
vance and insight; see, Andrew J. MacIntyre, Politics, Policy and Participation: Business-
Government Relations in Indonesia, submitted to the Research School of Pacific Studies, the
Australian National University, Canberra, September 1988.
35. Nono Anwar Makarim.

The Political Economy of Deregulation in Indonesia

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The Political Economy of Deregulation in Indonesia

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The Political Economy of Deregulation in Indonesia

Author(s): M. Hadi Soesastro

The 1980s will be recorded in Indonesia's history as

____________________ - M. Hadi Soesastro is Executive Director of the Centre for Strategic

? 1989 by The Regents of the University of California

1. Ali Wardhana, "Structural Adjustment in Indonesia: Export and the 'High-Cost'

A Review of the Deregulation Process

barrier (NTB), usually a licensing restriction, that covered about 35% of

One group is the "engineers" or "nationalists" such as Ginandjar Kartasasmita,

powerful Sudharmono, [then] State Secretary and concurrently chairman of the

belonging to the antideregulation camp. This left the financial sector,

(monopolies) for 165 products were abolished and licensing restrictions on

16. Far Eastern Economic Review, October 6, 1988.

as a package of "sweeping" initiatives in the financial sector. The reform,

23. Ali Wardhana, "Structural Adjustment."

29. Suara Karya, November 28, 1988.

appropriate (lower) interest rate, although it has resulted in financial deep-

"High Politics," "Low Politics," or What?

32. Sinar Harapan, January 5, 1982.

poor as well as the broader issues of government corruption and

elevated and can no longer be ignored. As yet little is understood about

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