Indonesia was one of the “celebrities” from developing countries. It had been admired for its fast growing economic development for almost the last three decades (1971-1996), as shown in Table 1. During 1965-1985 alone, all major economies of East and Southeast Asia, including Indonesia, were among the “top twenty” in the world that showed the highest per capita real GDP growth rate (Islam and Chowdhury, 1997). In 1993, the World Bank labeled countries from East and Southeast Asia as the “miracle economies” of the world. In 1996, the IMF forecasted 7% growth rate of Indonesian economy assuming that it remained smooth to run (Abdulkadir, 1998). To wrap up the admiration, in its report on 30 May 1997, and at the brink of the Indonesia’s crisis, the Bank still praised the country’s economic performance with average economic growth of 7.5 percent and suggested that it will continue through the year 2005 (The World Bank, May 1997).
All of the sudden in the mid-1997, a financial crisis erupted in Indonesia, as occurred in Thailand, South Korea, and other countries in the region. Its effect has been contagious so far away to Russia that led to the devaluation of its rouble, following a currency crisis in August 1998, and also to Brazil as it faces economic recession recently (Montes and Popos, 1999; The Economist, 13 March 1999). Although it remains to be seen whether the financial crisis in Indonesia (and the region) will have short to medium or long run impacts, the “miracle” image of economic development that has been suggested by the Bank and others has come into a serious question. The crisis, which continues to unfold until this very moment, has different impacts on different countries. The deep impact of the crisis is quite amazing on countries such as South Korea, Thailand, Indonesia, and Malaysia, which once called “tigers or little dragons.” In Indonesia, it contributed to the fall of the 32 years of the authoritarian government and produced a negative economic growth. Political stability in Malaysia has been strongly questioned until recently following the crisis. The changes of political environment in South Korea and Thailand and its impacts on their economic recovery will be worth noting in the near future. As widely publicized, Indonesia has been the worst of the affected countries. As of 1998 estimated by IMF staffs (Lane, et.al., 1999), Indonesia’s external debt would be 130 percent of GDP compared to that of 50 percent in South Korea. In 1998, there were negative growth in real GDP for Indonesia (-16%), Korea (-7%), and Thailand (-8%). The decline in real GDP was closely associated with a decrease in domestic demand (25% in Korea, 18% in Thailand, and 17% in Indonesia) and a sharply reduction in investment (more than 25% in Korea and in Thailand, and more than 50% in Indonesia). Even in the middle of increasing external demand, net exports of Indonesia contributed only small positive number (less than 5% in 1998) of GDP than that of Korea (about 15%) and Thailand (about 10%). As of the third quarter of 1998, inflation rate in Indonesia was the highest in ASEAN-4 and NIEs, as shown in Table 2. Now, it comes to a very scary part of the crisis effects that has been spoken out by some analysts. With almost everything in Indonesia is undervalued to foreign currencies, the Indonesian economy and assets would be easily captured and dominated by foreign capital (Suryohadiprojo, 1998).
The crisis has pushed all affected countries into relatively similar deep recessions because of worsening the living standards and increasing unemployment following a quick drop in the values of the currencies, the prices of stock markets and the values of other assets. The worst part is that social dislocation is deepening. In Indonesia, racial tension and tribal conflict could blast the nation at any time and for any reason if hunger and injustice enlarge toward the sea of population.
The IMF (1999) argues that the difficulties in East Asian countries stemmed from the problems in financial system and governance, not just the result of macroeconomics imbalances. The IMF lists other combined factors that contributes to the crisis such as: inadequate financial sector supervision, poor assessment and management of financial risk, borrowing large amount of international capital for short-term, but investing in long-term, and without hedged. Lack of good governance such as heavy involvement of government in private sector, crony capitalism, and lack of transparency has long been viewed as parts of the problems.
The IMF and the affected countries have learned from the crisis the lessons in a hard way. What are the lessons of the experience? This paper sees two important issues that could be learned from the crisis. First, financial systems have become increasingly important in the economic development of nations, which previously heavily loaded with real sector issues. Krugman (1994) argues that rapid growth in East Asia countries was a product of rapid capital accumulation, which a large part of it was foreign capital. Instability in economic and political conditions of the host country would certainly induce unpredictable capital outflows. IMF believed that a sound macroeconomic framework and structural reforms in financial sector seems to be the best strategy to maintain economic stability. Stiglitz (1989) criticizes that issues in financial sector have too much given to its allocative aspects. It is significant to see that market failure is closely related to prudential, organizational and protective regulation of the sector. Second, Parkin (1993) and Islam (1992) argue that efficient institutional frameworks could facilitate to the better economic performances of nations. To Parkin, two obstacles could impede efforts to prosperity: (1) rent-seeking behavior, and (2) policy uncertainty and variability. The second indicates of what so-called government failure, whereas it is the product of political process that affects monetary and fiscal policies. Islam argues that obstacles to prosperity are actually the twins of government and of market failures. The sources of market failures are monopoly imperfections, externalities, public goods, imperfect information, and transaction costs. Since correction to market failure (such as to fix “fair” distribution of income) could lead to government failure, it is important to acquire government officials that are competent and professional. There are several sources on these issues. First, a public interest driven policy agenda could be the target of special interest groups for rent seeking. Second, the predatory behavior of government officials could lead to intervention that exceeds the level of socially optimal acceptable. Third, majoritarian democracies in voting behavior could lead to inefficient “political” business cycles (Islam, 1992).
Table 1: Growth rate of GDP, Indonesia, Thailand, and South Korea, 1971-1999
Sources: IMF, 1999; Islam and Chowdary, 1997; ADB Outlook, 1994. * Estimated by Islam and Chowdury; ** Estimated by IMF; *** IMF program
Table 2. Inflation Rates in selected countries, 1995-98
Source: Central Bank of Indonesia, 1999 * Third quarter; ** Second quarter
References:
Abdulkadir, A. (1998). A Computable General Equilibrium Model for Indonesia: Impacts of Strategic reform Policies. Unpublished Ph.D. Thesis, Oklahoma State University, Oklahoma.
World Bank (1993). The East Asian Miracle: Economic Growth and Public Policy. New York: Oxford University Press for the World Bank.
World Bank (1997). Sustaining High Growth With Equity. May 1997.
IMF. The IMF’s Response to the Asian Crisis (January 17, 1999).
Islam, I. (1992). “Political Economy and East Asian Economic Development.” Asian Pacific Forum Literature. 6(2):69-101.
Islam, I. and A. Chowdhury (1997). Asia-Pacific Economies: A Survey. London and New York: Routledge.
Krugman, P. (1994). “Of the Asian Tigers.” Foreign Affairs, November/December.
Lane, T., A.R. Ghosh, J. Hamann, S. Phillips, M. Schulze-Ghattas, and T. Tsikata (1999). IMF-Supported Programs in Indonesia, Korea, and Thailand: A preliminary Assessment (Preliminary Copy). IMF, January.
Montes, Manuel F. and Vladimir V. Popos (1999). The Asian Crisis Turns Global.
Pakin, M. (1993). “The Macroeconomic Requirements for Prosperity.” Australian Economic Review. 1st Quarter:11-20.
Soros, George (1998). The Crisis of Global Capitalism: Open Society Endangered. New York: Public affairs.
Stiglitz, J.E. (1989). “Market, Market Failure, and Development.” American Economic Review. May.
Suryohadiprojo, Sayidiman. Dominasi Ekonomi Asing. Gatra: 1 Agustus 1998.
To name some authors such as McCord (1991) and Linder (1986), the “Pacific century” has become a term to describe an excellent performance in economic development of the countries in Asia-Pacific. Islam and Chowdury (1997) classifies those countries that play important role in the region into three categories: NIEs (South Korea, Taiwan, Hong Kong and Singapore), ASEA-4 (Indonesia, Malaysia, Thailand, and Philippines), and China. Based on 1989 prices, the Asia-Pacific region accounts for 7.1 percent of world output, which become 25 percent if Japan is included. Japan itself accounts for about 67 percent of regional GDP. From these important countries, about half has been deeply affected by the financial crisis started in the mid-1997.
Since the 1990s the structure of Indonesian industry, as one may argue, has shifted into producing more non-traded goods (or for domestic consumption) instead of exports. Its industrial inputs have increasingly depended on imports. This is not the case for Korea and Thailand. Therefore, even though Indonesian currency was undervalued, this kind of structure has cut the industry’s leg to exports.
Soros (1998, p.148) criticizes that the IMF is also part of current global debt problems, not part of the solutions. The problems come from “the failure to tackle the debt problem resulted in currency overshoots and punitive interest rates that rendered the borrowers insolvent and plunged the countries concerned into deep depression.” In response, IMF (1999, p.18) explains “three major misunderstandings about the IMF-supported program in Asia.” First, “the IMF can only advise, not force governments to take steps.” Second, for currencies under attack, “temporarily raising interest rates both to make the currency more attractive to hold and to avoid a depreciation-inflation spiral has been a successful strategy. Regarding private sector debt, the IMF… is to deal only with sovereign governments.” Third, it is not true that only borrowers hurt, but lenders (investors) “have also made substantial losses. “The IMF also argues that typical foreign investors of local equities have to accept the decrease of their investment value to only one third to one quarter of the value before the crisis.
