Regions and Countries

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p. 14 of 15 BACK | NEXT Map Executive Summary I. Recent Economic Developments II. Short and Medium-Term Economic Prospects and Policy Issues III. Corruption as a Challenge to Development Appendix

Country Economic Review - Indonesia

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III. Corruption as a Challenge to Development

"Perhaps the weakest link in Indonesia's past development strategy was governance."
ADB. March 200. Country Operational Strategy Study: Indonesia.

56. Indonesia is routinely perceived to be one face some of the most corrupt serious corruption problems countries in Asia.¹² While corruption is often discussed as a moral or ethical issue, from a stand point of economic development, from the standpoint of it relates to other aspects of governance, in particularly to problems in the legal and judicial system, in an the unfinished agenda in civil service reform, and in inadequate public sector spending. In Indonesia cCorruption is sometimes intertwined with standard business practices. The exaction of illegal fees, for instance, provides the funds for routine office administration.¹³ The impacts of corruption on development prospects are two-fold:

1. Corruption, under evolving economic institutions, discourages private investment and, thus, long-term growth prospects.
2. Corruption limits public sector resource mobilization and lowers the return to society from public sector spending and investment.

57. Indonesia, despite the prevalentce of corruption before the financial crisis, in the pre-Crisis period, had managed to grow impressively. A major difference between then the earlier period and now is today how much is the degree to which investment could be funded from foreign borrowing. Before the financial Ccrisis, Indonesia received substantial inflows of private funds. Unlike other Crisis-affected countries, currently Indonesia still does not attract significant foreign investment. Compounding this change is the lack of confidence in the return to investment that has discouraged domestic investors. Thus, we witness continuing capital flight continues.

58. It is widely believed that mMuch investment before prior to the 1997 financial crisis is widely believed was not to have been based on sustainable market expectations, but was that of a classic '"bubble,"' ignoring in which economic fundamentals were ignored. Non-market investments were supported partly by the beliefs that corrupt payments would ensure enterprise profitability against adverse developments. Corruption fed unsustainable expenditures of real resources. While spending fueled growth in the short- run, all bubbles burst in the end,. and With the bursting of the bubble the extent of the earlier miscalculation became apparent, as did . Also, at the end of the bubble comes the need to assess the damage. The present costs of past poor governance are exacerbated by the weaknesses of the legal and judicial system, which have impeded a resolution of past debt problems and, thus, new investment. Some widely publicized cases suggest clear abuse of the legal system in resolving corporate disputes. In particular there is the perception that tThe judicial system is perceived as unreliable in cannot be relied upon to enforcinge contractual rights or relationships.

59. Corruption inhibits private sector development and also public sector resource mobilization;: a non-corrupt economy offers a larger tax base. The tax effort (tax--to--GDP ratio) has fallen in Indonesia since the 1980s and is lower than in comparable regional economies. Misdirected public funds may not have an impact on aggregate economic activity in the short- run. The income- generating effect of funds budgeted for education-unless they are sent abroad- may be the same whether spent to construct a school or a contractor's private house (unless it is sent abroad). In the long run, the impact is considerable, with less to show of public investment in quality service provision. Corruption has played a part in Indonesia's relatively poor showing in health and education indicators.

60. Looking to the future, tThe political decision-making processes have shifted away from the authoritarian and centralized regime of the past. In the political sphere there has been the emergence of aA vigorous Parliament has emerged and a great deal of power has been transferred profound transfer of power to local governments. Strictly speaking the shift to However, ddecentralized decision- making does not necessarily reduce the scope for corruption. but Indeed it may simply shift the 'rent-seeking' opportunities from the Ccentral Government to the local governments. To address this risk it will be necessary for tThe Ccentral Government must provide a context for provide a context for civil- society organizations and NGOs to monitor local government activities. The Ccentral Government, for example, is beginning to set minimum service standards in education and to set the procedures by which people can evaluate their local government's efforts against these standards.

70. In the economic sphere an equally profound change has occurred. The decline in the number of industrial development projects using public resources, and the limited public funds for such activities, have closed one important avenue for rent seeking by public officials. More positively, privatization, -transferring active management of enterprise assets to private management in the context of workably competitive markets and effective public regulatory institutions, -may also offers the potential reduce for reducing the scope for corrupt behavior. It is important that pPrivatization must be is accomplished in a transparent fashion. Without adequate market or regulatory safeguards, privatization may simply transfer the opportunities for corruption from the public sector to private hands. Indeed, it is because it is the presumption that privatization sales are presumed to themselves offer the opportunity for corruption that NGOs oppose opposition to privatization plans by NGOs.

71. Another important development that may, in time reduce the scope for corruption is that media and civil service organizations increasingly take part in the economic and political life of the country. They are These organizations provide '"watch dog'" services, noting and publicizing allegations of corruption. While legal and judicial system weaknesses prevent these allegations from being fully acted upon, over time these organization can provide pressure for change and may limit the ability of officials to be to exploit opportunities for corrupttion.

72. Improving the potential for economic development through the reducing in corruption will take time. -iIn this sense, Indonesia is a transition economy moving toowards the creation of viable democratic, market-based institutions. The Eexperience of from other economies going through similar changes such as those in the former Soviet Union suggest that the process will be difficult the difficulties and the need for time. However, determined Government policies can make the difference. The Bbox contains notes the conclusions of the ADB's recent Ggovernance Aassessment, suggesting a number of concrete steps that can lead to demonstrable reducetion in corruption and an improvement in governance.

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¹²Political and Economic Risk Consultancy (PERC) and Transparency International (TI) have each recently conducted a survey that suggested the scope of Indonesia's problems. Available for PERC: http://www.asiarisk.com and for TI: http://www.transparency.org. The extent of corruption in Indonesia is discussed in the draft Indonesia Government Assessment Report, supervised by S. Synnerstrom, Governance Advisor, Indonesia Resident Mission (IRM).
¹³Offices such as the Attorney General's are not routinely provided budgetary resources commensurate with responsibility or normal operating activities. PricewaterhouseCoopers. 2001. The Final Report of the Governance Audit of the Public Prosecution Services of the Republic of Indonesia. ADB. 2001. TA 3472-INO: Governance Audit of the Public Prosecution Service. Manila.

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