Publications

1. Income Poverty Assessment

18. Indonesia's record in reducing poverty in the two decades preceding the crisis is exceptional.⁶ From a country with widespread poverty it rose to the ranks of a middle- income country in two decades (Appendix 2). The incidence of poverty fell from 40.1 percent in 1976 to 11.3 percent in February 1996. However, the recent economic crisis threatens to unravel the long-term gains in poverty reduction. Using a new methodology for measurement,⁷ poverty incidence soared from 17.7 percent in February 1996 to a peak of 24.2 percent in late 1998. At its peak, the crisis pushed perhaps an additional 15 million people below the poverty line. The sharp descent into poverty of so many in just over a year shows the vulnerability of the poor to economic shocks in Indonesia. The recent shock originated from the external sector—steep exchange rate depreciation causing runaway inflation and spiraling food prices.

19. As the recession receded, the situation improved: a survey in August 1999 showed that poverty had declined to near precrisis levels of 18.2 percent. The depth and severity of poverty, however, also increased during the crisis. Before the crisis, an income transfer of 3.5 percent of GDP would be needed to raise those below the poverty line; at present, a transfer of 5.5 percent of GDP would be needed for the same purpose. The surge in poverty during the crisis left a very heavy social burden and a large segment of the population in a depleted and vulnerable state. By the Human Development Index (HDI) Indonesia is 105 out of 174 countries, largely as a consequence of the income impact of the crisis.

20. The social impacts of the crisis have not been uniform—the most vulnerable have been seriously affected. During the crisis, poverty increased 60 percent in urban areas and 31 percent in rural areas. (However, overall and corresponding to underlying structural features, poverty incidence is higher and poor people more numerous in rural areas.) During the crisis, the number of street children⁸ also increased. Severe malnutrition increased in some areas.

21. Basic poverty and development indicators showed a wide dispersion across regions (Figure 1). Metropolitan Jakarta, with its infrastructure and its role as a center of manufacturing and high value-added services, has broader access to basic services and a much lower incidence of poverty than other areas. In sharp contrast, Nusa Tenggara Timur (NTT) and Irian Jaya have incidences of poverty more than 10 times that of Jakarta. NTT and Irian Jaya, however, are dissimilar. People in NTT, for example, are much more likely to live in insubstantial housing or to lack electricity than those in Irian Jaya.

22. In some areas, social tensions and outbreaks of sectarian or political violence have aggravated the challenges of development. The independence of East Timor has left an unsettled peace and order situation in West Timor. As of mid-2000, about 120,000 refugees wait in camps for repatriation or resettlement, in some circumstances amid an absence of control by Indonesian authorities. The poor are often the first and abiding victims of social upheaval, with few resources to resettle themselves or to restart their lives. That the worst social tensions occur in regions that benefited relatively less from the significant social improvements of the past decade repeats the pattern seen in other countries—lack of economic and social development feeds, and in turn is fed by, lack of political stability.

23. Table 1 charts Indonesia’s progress toward international development targets issued by international funding organizations to benchmark achievements and plan assistance programs.

2. Social and Human Development

24. From the mid-1970s through the mid-1990s, Indonesia made substantial progress in human development as the Government expanded and improved basic social services: education (primary and junior secondary), health (especially primary health care and reproductive health), family planning, and nutrition. Female literacy increased from 54 to 83 percent, primary education participation increased from 75 percent to near universal participation, and compulsory education was extended from six to nine years to include junior secondary education (grades 7-9). Malnutrition and the infant mortality rate declined. The national fertility rate dropped from 5.6 percent to 2.8 percent and population growth fell from 2.3 in the 1970s to 1.5 percent at present. Despite this, many chronic problems remain, including low completion rates and inadequate quality of basic education, stubbornly high rates of infant and maternal mortality, and malnutrition.

25. Other basic social services such as access to safe drinking water and sanitation also expanded rapidly in the two decades preceding the crisis. Water supply coverage increased to 67 percent of the population and basic sanitation coverage increased to 52 percent. These indicators show that many people go without water and sanitation services. Moreover, shelter remains a serious problem for both urban and rural populations, reflecting both low income as well as lack of institutional support for housing finance.

26. The economic crisis in 1997 hampered the delivery of essential social services to poor and vulnerable groups. Urgent and well-targeted action was needed to reduce the impact on education, health, and nutrition of the poor, especially to control the reemergence of severe malnutrition and communicable diseases. But while the crisis posed significant challenges, it also provided an opportunity for the Government to depart from established procedures and to accelerate the pace of sector reform. Measures introduced and tested through the social safety net programs provide a robust framework for decentralized sector development. To a significant degree the 1997 crisis promises to be a watershed in Indonesia’s social (as well as economic) development.

27. Over the longer term, improvements in social services and social infrastructure will demand greater public commitment and resources. Indonesia’s education and health expenditures are low compared with its neighbors. Government spending on education dropped to 2.7 percent of GDP in 1990/91 and has changed little since then. Spending on health currently accounts for only 1.5 percent of GDP compared with 2.4 percent in the Philippines, 3 percent in Malaysia, and 5.3 percent in Thailand. From the onset of the crisis, the Government aimed to protect expenditures in key social sectors such as basic education and primary and reproductive health care with the assistance of aid agencies.⁹ Scholarships helped retain children in basic education. Contraceptives and basic medicines were made available at controlled prices. These programs have effectively prevented a major decline in enrollment in basic education and maintained access to public health care.

28. Decentralization poses major risks to the provision of social sector services and social infrastructure. Services will need to be maintained during a difficult transition. Local governments will need substantial capacity strengthening. The legal and regulatory framework for providing basic services under the decentralized system and for involving the private sector needs improvement. A poor incentive structure constrains investment in these services, and weak financial management practices undermine their sustainability.

a. Education

29. Precrisis Trends. Increased access to education at all levels was one of Indonesia’s main achievements between the mid-1970s and the mid-1990s. Recognizing that investment in education is one cornerstone of both social and economic development, Indonesia gave high priority to the sector. The results were impressive: universal access to primary education was virtually achieved, enrollments in junior secondary schools increased from 18 percent in the 1970s to around 70 percent at the end of the 1990s, senior secondary and vocational training expanded dramatically, and postsecondary institutions increased. This rapid quantitative expansion was greatly enhanced by policies that encouraged the participation of the private sector. In the late 1990s nearly one quarter of junior secondary enrollment was in private institutions, and the private sector has become the main provider of vocational training. Gender equity has been maintained in primary and junior secondary education, although females are still underrepresented at higher levels.

30. While access to primary education was high, achieving high primary school retention rates and reducing high repetition rates were continuing challenges. In 1995, 16 of every 100 children who entered primary school in 1989 had dropped out before completing grade 6. The transition rate from primary to junior secondary education and the dropout rate at that level also remained unsatisfactory. The major reason for dropping out of school is the inability or unwillingness of the family to pay the costs of schooling. Data from the 1996 National Socioeconomic Survey (SUSENAS) show that the enrollment rate for junior secondary education in the lowest income quintile was only 40 percent. Addressing the problem of high repetition rates will require raising the quality of education.

31. A further challenge was the inadequacy of basic education. Factors included (i) insufficient instructional materials and supplies, especially among schools in poor communities; (ii) ineffective school management; and (iii) institutional arrangements that reduced schools’ responsiveness to local needs. Overall, quality was constrained by excessive overhead expenses and funding delays and misdirection at each level of administration.

32. The private sector plays a significant role in providing junior secondary education, to both poor and wealthy students in Indonesia. SUSENAS 1996 data indicate that the percentage of students attending private schools did not vary significantly by income quintile. In fact, most students enrolled in private madrasahs (Islamic schools) under the Ministry of Religious Affairs (MORA) were, and are, girls from low-income families.

33. Crisis and Response. Lessons from earlier economic crises suggested that the 1997 experience would (i) increase dropout rates and reduce transition rates, because of reduced capacity to pay school fees; and (ii) diminish quality due to shortage of essential instructional materials. Private schools—especially those operated under the supervision of MORA—which cater to children of low-income families were expected to suffer greater losses of enrollment. Confronted with the crisis, the Government concentrated on current enrollments and quality.

34. With the assistance of external aid agencies, principally ADB and the World Bank, the Government rapidly designed and implemented a Scholarships and Grants Program (SGP). The impact of this and other crisis programs has been significant (Box 1). Overall, secondary enrollment rates increased between school years 1997/98 and 1999/2000, and primary enrollment stayed relatively constant.

b. Health and Family Planning

35. Pre-Crisis Trends. Since 1970 the Ministry of Health (MOH) had followed a basic community health model, employing a network of puskesmas (health centers) and implementing immunization programs. By 1999 the primary health system included 7,271 health centers, with about 320 district hospitals serving as first-level referral facilities. The health centers provide essential basic health services and are the usual entry point into the health care delivery system, especially in rural areas. This system is supplemented by health subcenters headed by a nurse or midwife, and community outreach programs delivered through posyandu (village health posts).

36. Despite efforts to provide basic services through public health facilities, Indonesia’s health indicators lagged behind its neighbors. Access improved but disparities remained. The infant mortality rate (IMR) remained high, and was unevenly distributed among regions, urban and rural areas, and income groups. The MMR, among the highest in SE Asia, was very high by international standards.¹⁰

37. Child malnutrition rates in Indonesia are high. In 1992, about 30 percent of children under 5 years were undernourished. In 1995 about 29 percent of children aged 6-23 months suffered from protein deficiencies. Micronutrient deficiencies (iron, iodine, or vitamin A) were common before the crisis. Iodine deficiency is endemic to mothers and children, and is particularly severe in the eastern provinces. Iodine deficiency in pregnant women and their infants results in goiter, cretinism, and mental retardation.

38. Through the mid-1990s, use of public health facilities was low and declining. National performance standards did not exist. There was little pressure on the health center to respond to the needs of the community or to improve the quality of services. Drug prescription practices were economically inefficient, often ineffective and sometimes unsafe. Moreover, many village health posts, the backbone of rural health, had ceased to function.

39. Historically, the Government budget allocated to health was low compared with that in neighboring countries or countries of similar per capita GDP. Only 30 percent of national health expenditure is borne by the Government and the rest by the household. Less than 2 percent of health expenditure comes from insurance mechanisms as most people lack health insurance. Although Government health services are heavily subsidized, fees collected by health centers for a consultation (generally about Rp2,000) are significant barriers for the poor. Despite efforts to improve health services to the poor, Government health subsidies for the richest 10 percent of households in 1990 were still almost three times the subsidies going to the poorest 10 percent.¹¹ This is mainly because public spending has been skewed toward higher-cost hospital services utilized relatively more by better-off urban groups.

40. Crisis and Response. During the economic crisis, malnutrition and tuberculosis, malaria, dengue, and other communicable diseases were expected to rise, particularly in crowded urban slums. Indeed, surveys in Central Java in mid-1998¹² revealed that maternal malnutrition had increased and the body mass index among women of reproductive age had dropped, reversing the gains of the past decades. Further surveys in January 1999 showed modest improvement in the rural areas following the rice harvest, but a continuing deterioration in the congested urban slums of Jakarta and Surabaya.¹³ Cases of severe malnutrition among children, not seen in the previous decade, were found in urbanized areas of East Java.

41. Supported by its development partners, the Government adopted a social safety net for the health sector to alleviate the impact of the crisis on the most vulnerable, while laying the foundation for longer term sector reform. Policy reforms were designed to safeguard access of the poor to basic health services and to strengthen management of health services delivery through decentralization. The reforms concentrated on maintaining access to essential health, nutrition, and family planning services; maintaining quality of services; enhancing decentralized management; and improving efficiency.

42. An innovative block grant mechanism was introduced to enable health centers to maintain their services to the poor. The block grants enabled village midwives to better target their services. MOH ensured that a package of essential services, including vaccination, antenatal consultation, and micronutrient supplements, was made widely available. Family planning services were protected by providing contraceptives and intensified training to upgrade field workers’ counseling and technical skills.

c. Rural Development

43. Agricultural growth in Indonesia averaged about 3.8 percent annually in the 1980s, approximately 2 percent higher than the rate of rural population growth. Between 1990 and 1995, however, the rate of agricultural growth slowed to 2.9 percent, and was negative during the economic crisis and under the impact of successive occurrences of El Niño. Labor productivity (and income) gap between the agriculture and nonagriculture sectors widened over that period, contributing to an underlying structural poverty problem in the country. Per capita GDP in the nonagriculture sector in 1995 was almost five times higher than it was in agriculture. The decline in average farm size, and the low level of capital available to such small farms are major problems that complicate efforts to improve productivity. Within agriculture, half of value-added comes from food crops; 17-19 percent from tree crops and horticulture; fisheries, forestry, and livestock products each contribute 9-12 percent.

44. In part, poor productivity reflects past policies that constrained agricultural growth: a top-down, command-oriented approach to development; an extremely high degree of bureaucratic fragmentation; inappropriate environmental policies; and nonmarket-oriented decisions with respect to crop and technology selection. Recent developments, including those with respect to the tariff on sugar and rice support prices, confirm continuing policy problems. Compounding this, rural infrastructure development has often been carried out with only minimal links to farmers and agriculture. Irrigation in particular permitted the widespread introduction of high-yielding rice varieties and large increases in yields and production, but this was achieved through top-down processes aimed largely at engineering and short-term production targets determined by Government structures not themselves responsible for agricultural or farmer outcomes. The result has been lack of farmer involvement and persistent failures in operation and maintenance.

d. Urban Development

45. Currently, the urban population accounts for 40 percent of Indonesia’s total population and is projected to surpass 45 percent by 2010, increasing 5 percent per annum. Eight metropolitan cities have a population of over 1 million and 74 with over 100,000. The rapid increase in the urban population poses difficulties, not only for improvements to basic infrastructure and shelter but also for maintaining existing support. Over the last 15 years, basic service provision has increased from 29 to 40 percent for water supply and similarly for the proportion of adequate sanitation and solid waste services. This still leaves the majority of the urban population without these basic services. There are serious impediments to provision of shelter for low-income families with reasonable proximity to employment centers, and lack of institutional financing mechanisms for low-cost housing. There are also serious environmental problems, including solid waste disposal, water and air pollution, traffic congestion, and depletion of groundwater.

46. In the past, the major driving force behind urban development was integrated urban infrastructure development projects (IUIDPs) that included water supply, paved road networks, drainage systems, and community and market infrastructure improvement. In recent years, however, it has become increasingly evident that the unified design and top-down approach of IUIDPs, without local input, resulted in weak project sustainability. In particular, the medium-term Government plan to increase urban household coverage of water supply and sanitation services is difficult to implement. Public sector resources are strained and most metropolitan water supply utilities remain unattractive to private investors.

3. Governance

47. Perhaps the weakest link in Indonesia's past development strategy was governance¹⁴ (Appendix 3). Decades of unaccountable and centralized administration have degraded the quality and efficiency of public institutions. Strong growth and rising prosperity for two decades before the crisis gave rise to unwarranted complacency and delayed urgently needed governance reforms. A state structure narrowly focused on wealth creation or capital accumulation was eventually caught in the quicksand of corruption, collusion, and nepotism, known widely in Indonesia by the vernacular abbreviation KKN. Most sectors of the economy were affected by KKN, which seriously weakened public institutions.¹⁵ Similarly, business practices by Indonesian enterprises do not always meet international standards.¹⁶

48. The poor were overwhelmingly the main victims. Bad governance harms the poor disproportionately because they depend much on public services and because the way out of poverty is the opportunity and access that bad governance systematically denies. In Indonesia, poor governance led to large reductions in efficiency, misdirected financial and fiscal resources, and distorted market incentives, wasting resources that could otherwise be utilized to reduce poverty. An equally important impact of prolonged and endemic KKN is loss of the citizenry’s confidence in their public institutions.

49. Virtually every sector of the economy faces governance challenges. The Government has declared a serious commitment to governance reform and has taken a number of measures including passage of laws and regulations. However, genuine commitment to reform must be reflected in forceful implementation. This is critically needed to restore public trust and investor confidence, and ensure continued support by Indonesia’s development partners.

50. The law on regional autonomy and the law on fiscal balances between the central and local governments offer major opportunities for reform. Decentralization provides a potential antidote to decades of overcentralized government and a way to meet widely differing needs. Managing this process effectively will test the new Government’s administrative and economic management capacity as well as its nascent democratic institutions. Administrative decentralization will be difficult since local government capacity is weak. Transferring revenues to local governments, without well-defined expenditure obligations, monitoring, and administrative safeguards, could encourage the spread of corruption to lower tiers of government. In the 2001 budget, transfers to local governments will account for roughly one quarter of total public spending. Other governance reform priorities include combating corruption, improving corporate governance, legal and judicial reform, civil service reform, public financial management, natural resource and environment management, and strengthening civil society institutions. It must be recognized that reform in some of these areas is likely to meet longstanding resistance from entrenched vested interests.

4. Gender Issues

51. Women of the household are the last resort in caring for children, the sick, and the elderly. Their contribution to the economic welfare of poorer households is often not duly recognized. Women's concerns have also not been sufficiently highlighted during the crisis. Declining purchasing power has pushed increasing numbers of women into the labor force or marginal activities. Spot surveys during the crisis indicated a decline in the nutritional well-being of pregnant women and lactating mothers as well as children. These impacts could take years to reverse, and the impact on children may not be reversible.

52. As noted, the gender gap has closed in basic education, but remains significant at the senior secondary and tertiary levels. Unresolved health issues are reflected in the high MMR. Women are not treated equally in the labor market and there is evidence of discriminatory wage and benefits practices. Women are over-represented among the unemployed and underemployed and their wages are generally lower than men’s. Women often are not adequately informed about their workplace rights and these rights have not been well enforced. Women also tend to be underrepresented at higher levels of economic and political decision making. Indonesia ranks 90th out of 165 countries in the gender development index (GDI) of the United Nation Development Programme (UNDP) and it is behind its regional comparators in gender achievements and empowerment.¹⁷

53. In the aftermath of the crisis, the Government has encouraged women's active involvement in social safety net work programs. New programs for women are being pilot-tested. Currently, gender concerns are being addressed more systematically through the incorporation of these concerns in the Government’s medium-term development program (Appendix 4).

5. Private Sector

54. The private sector led Indonesia's economic transformation. Deregulation, reform, and a shift toward market-based resource allocation, especially in the 1980s, paved the way. The boom in the export-oriented manufacturing sector, which underpinned growth, was largely due to the private sector's response to external trade liberalization. Structural reforms and privatization of SOEs also enhanced the private sector’s role. However, the pace of reforms fell well behind the rapid economic expansion. Critically needed reforms in the financial sector, legal and judicial system, and corporate governance were not made.

55. Other weaknesses also hindered private sector development. Private participation was not permitted or was greatly restricted and overly regulated in some key sectors where state monopolies dominated, such as oil, power, plywood, and the external trade in rice. For perspective, the energy sector alone represented 10 percent of GDP in 1999. In other sectors, excessive regulation stifled private sector development and created economic rents allowing for widespread corruption. Those who benefited from this fought moves toward good governance and a more open economy. Consequently, competitive markets could not emerge in certain important sectors of the economy.

56. The Government began to address these issues in the aftermath of the crisis. Substantial structural reforms to support the growth of competitive markets, dismantle monopolies, privatize SOEs, and strengthen corporate governance in particular and governance in general have been undertaken since 1998. However, more remains to be done especially in the areas of privatization and corporate governance. The crisis has had serious negative impacts on the private sector, due to the sector’s substantial foreign exchange exposure prior to the crisis and the weak financial system. The massive exchange rate depreciation caused private external debt to balloon, and this debt shock was quickly transmitted to the domestic banking system. Corporate debt restructuring is urgently needed to restore the battered private sector to sound health.

6. Environment

57. Indonesia’s performance in natural resource management has been poor (Appendix 5). In part, this reflects neglect of environmental concerns under a growth-focused strategy with serious inadequacies in both governance and transparency. Indonesia’s vast endowment of natural resources was a major source of government revenues. While still substantial, these resources are now heavily depleted. All natural resources—land, forests and mangroves; water, wetlands and fisheries; and air—are under severe stress. About 30 percent of Indonesia’s 4.3 million-hectare of coastal mangrove forests, a biologically and economically crucial ecosystem, has been lost since the mid-1960s. Perhaps the most serious environmental problem is the loss of Indonesia’s vast forests—some of the last remaining and richest biosphere reserves in the world. More than five million hectares of forest burned during the 1997-1998 fires. With harvesting estimated at 33 million cubic meters (m³) per year, against a sustainable yield of about 22 million m³ , the forests will be exhausted in the next two decades. Non-transparent methods of auctioning and transferring forest concessions not only diverted public revenues to inadequately regulated private concessionaires, but also encouraged overexploitation. In addition, there has been a lack of procedures to properly price these resources. Similar problems are found in fisheries, coral reefs and fresh water resources.

58. Air, water, and solid waste pollution are serious problems in most urban centers, particularly near industrial areas. In the last 20 years, the increase in air pollution—due mainly to vehicle emissions—has averaged approximately 9.5 percent annually. Industrial and domestic effluents are the main sources of water pollution. About 20 rivers have been categorized as acutely polluted. Solid waste is also a serious problem, with about 15-40 percent not collected properly. Hazardous and toxic wastes are also not properly managed. Only one facility to treat hazardous waste serves the Jakarta region. Anti-pollution policies heavily reflect a “command and control” orientation, but enforcement is weak and there is little encouragement for polluters to comply with regulations. This is compounded by a focus on treating rather than preventing waste, for instance, by internalizing the external costs of pollution.

59. The Government has started addressing environment and natural resource management more seriously since the crisis. As a major step, the off-budget reforestation fund has been audited and transferred to the Ministry of Finance. This will establish more transparency and accountability in environmentally supportive operations. Market-based incentives to encourage industrial polluters to meet environmental standards have been introduced through a business performance rating, but this has yet to be institutionalized. Sustainable resource management is also a priority of Indonesia’s medium-term development program. The challenge is to develop systemic incentives, including those for polluters to reduce pollution, to mainstream environment management across sectors, to enforce realistic regulation, and to improve the environment and sustainable resource management. A particular need is to set prices for natural resources that reflect values that encourage sustainable resource usage—currently most natural resources are undervalued. These tasks will require the concerted involvement of all stakeholders. They will also require a substantial increase in budgetary allocation for monitoring and enforcing environment regulations. Moreover, it is likely that significant progress will require the transfer of technology from abroad to improve productivity and reduce the stress on the environment in manufacturing and services. While carrying risks, the decentralization process could provide for effective implementation of the country’s environment reform agenda.

60. Over the longer-term more emphasis should be given to developing renewable energy sources. A past preoccupation with oil and gas development did not encourage other forms of energy. Investment in mini-hydroelectric facilities, and solar and wind power sources could help to develop remote areas. Enhancement of energy efficiency should also have priority. These efforts would also reduce emissions of greenhouse gases, and can be reinforced through additional financial resources and technology transfer through the United Nations Framework Convention on Climate Change (UNFCCC) and the Kyoto Protocol, i.e., the Global Environment Facility and the Clean Development Mechanism.