Public Disclosure Authorized -06- 961-w 2 , ' b ~~~~~~~~~~~~I3lTnmtTEDl :'iv1l 1oll ymi| --; S _ , ~~- .-. X .. TlPr --- "--- :-* w -- X' II- - Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized ~~~~ i-~~~~~~,, , - n Sn s XIX 11 9__ I_ 0_N_O_D_33 W 0 R L D B A N K COMPARATIVE MACROECONOMIC STUDIES Macroeconomic Pocies,Crises, andLong-Term GrowthinIdoesia, 1965-90 J. Macroeconomic Policies,Crises, andLong-Term Growthm Idonesia 1965-990 WING T H YEW WOO B R U C E GLASSB-URNER AN WA R NA S U T I O-N -THEWORLD BANK, WASEilNGTON, D.C 0 1994 The Intemational Bank for Reconstruction and Development / The World Bank 1818 H Street, N.W., Washington, D.C. 20433 AU rights reserved Manufactured in the United States of America First printing June 1994 - The World Bank Comparative Macroeconomic Studies series emerges from a research project that reviewed the macroeconomic experiences of eighteen developing countries over a period roughly from 1965 to 1990. So that the studies might be published with relatively little delay, the books have been edited outside the World Bank's Office of the Publisher by the Macroeconomic Research Departnent The findings, interpretations, and conclusions expressed in this publication are those of the authors and should not be attrlbuted in any mannerto the World Bank, to its affi- ated organizations, or to the members of its Board of Executive Directors or the countries they represent The material in this publication is copyrighted. Requests for permission to reproduce portions of it should be sent to the Office of the Publisher at the address shown in the copyright notice above. The World Bank encourages dissemination of its work and will normally give permission promptly and, when the reproduction is for noncommercial purposes, without asking a fee. Penrission to copy portions for claswoom use is ganted through the Copyight aeance Center, Suite 91O0222 Rosewood Dr., Danvers, Massa- chusetts 01923, U.SJA The complete backlist of publications from the World Bank is shown in tie annual -Index of Publications, which contains alphabetical:title ist and indexes of subjects, authors, and countries and regions. The iatest edition is available free of chage from Distribution Unit, Office of the PFiblisher,The World Bank, 1818 H Street, N.W., Wash- ington, D.C. 20433, USA., or from Publications, The World Bank, 66, avenue d'Ima, 75116Paris, France. Coverdeign by Sm Fea. Wing Thye Woo is associate professor of economics and Bruce Glassbumer is professor emeritus of econonmcs at the University of California, Davis. Anwar Nasution is a lectuer at the Bank Duta, Jakarta. All were consultants to the World Bank for the writing of this book. Lbranry of Congress Cataloging-in-PubaficationData Woo, Wing Thye. Macroecnomic policies, crises, and long-term growth in Indonesia, 1965-90 / WmgThye Woo, Bruce Glassburner, &Anwar Nasution. p. cm. -(The World Bank comparative macroeconomic studies) EIcdudesbibliographical references. ISBN 0-8213-2212-5 L Indonesia-Economnic policy. 2. Indonesia-Economic conditions-1945- .L Glassburner, Bruce, 1920-. -I. Nasution, Anwar. IIL Title. IV. Series. HC447.W66 1994 338.9598-dc-O 93-10909 - - ' -. CIPD? Contents Foreword ir Acknowledgements xi Acronyms xii Data Notes xiii Chapter 1. TheIndonesian Growth Experience, 1965-90 - Chapter 2. A Profile of the IndonesianEconomy 5 NanatalResources S Human Resources 6 Ehniacity 7 'Religion 8 State-OwnedEnterprises 9 - The Private ManufacturingSector 10 Te Role of Economic Plamuing 11 The Annual Stare Budget 11 - - Government Employment 11 The ForeignLDebt Situation I3 The Banking System 13 The Jakarta Stock Market -7 Informal Credit 18 The Foreign-ExchangeMarket 18 The Labor Market: I9 Agricultural Markets 23 Chapter 3. The Chaotic Years: 1949-65 24 The Years-of Living Dangerously: 1959-65 26 Chapter 4. An Overviewof MacroeconomicDevelopments: 1965-90 29 The flation of 1972-73 31 The First Oil Shock, 1973-74 31 The PermrninaCrisis of 1975 32 The 1978 Devaluation 32 Adjusting to Low Oil Prices, 1982-90 33 :~~~~~~~~ vi Contents Chapter 5. The Political Eoonomyof Policymakingin the New Order Govremment 35 The Nature of the Indonesian State 35 The Variablesin the Economic PolicymakingEquation 36 Political Interestsand the DecisiomnmakingPrcess 40 Chapter 6. The First Crisis: Restoring Stability and Growth 42 Stabilizationand Rehabilitation, t966-70 45 ManagingExtemal ResourceFlows 46 Trade and ExchangeRates 48 Monetary and Fiscal Reforms 49 The Effectivenessof the Stabiization Program 51 Chapter7. TheSecondCrisis: ThePetaninaAffair 54 The Origins of Pertmina 54 The Pertamina Crisis 57 Roots r£the PeraminaCrisis 57 Pramina Is Bmught under Control 62 Impact of the Ptaina Crisis on ExtnemalBorrowing 64 Impact of the Pertmina Crisis on Short-Term MacroeconomicPerformance 67 Conclusion e 72 Chapter 8. The Third Crisis: The Dutch Disease 73 The Basic Theory of the Dutch Disease 74 TheTransmission Mechanismsof the Oil Boom 77 - The Linkbetween Monetary Control and the Dutch Diseas 79 Documentingthe Dutch Disease 82 The Decision to Devalue 85- The Efficacyof the Devaluation 87 Monetary Policy After the Devaluation 93- An Assessment of the 1978 Devaluation 96 Chapter9. The Fourth Crisis: Negative ExternalShocks in the 1980s 97 lnvoking Efficiencyon the Slippery Slope 98 ReducingState Expendituresto Cope with Revenue Shortfall -99 Conscpences of Fiancial Repression 100 The 1983 Fmancial Market Reforms 103 The 1988-90 FmancialReform Padkages 105 Assessing the Post-1982 Fiancial Reform Packages 105 Mobilizing Public Resources 107 TheTax Reforms 108 A Serious RLmainingProblem in Public Resource Mobilization 109 Managementof the Exchange Rate 110 The September 1986 Devaluation -II Was RevenueEnhancezrnt the Motivationfor Devaluation? 1I2 Conterms VwI The Proliferationof Import Licensing,198245 113 Trade-LiberalizingMeasures, 1986-90 115 The EconomicResponse to the Devaluationsand Trade Deregulation 117 Chapter 10. The Impact of MacroeconomicPolicies on Growth 118 AggressiveMacroeconomic Policies and Growth 118 The IndonesianGrowth Record 120 SectoralPerformance 121 The GrowthImplicadons of the 1966 StabilizationProgram 123 The GrowthImplicadons of the PercaminaAffair and the 1978Devaluation 124 The GrowthImplications of the StructuralAdjustnent Program of the 1980s 127 ;. Assessing Fiscal and Monetary Policy during the Oil Boom 131 Prospects; Indonesia at the Crossroad 139 Chapterll. SummanryandConclusions 143 Policy Mistakes 146 Corrective Actions 147 Enhanced Economic Minagement 148 FourGeneralTheoreticalIssues 149 Notes 151 Appendix 157 - -Bibliography 203 Index 213 Foreword- This volumeis the productof a WorldBank projecton macroeconomicpolicy that reviewedthe recentexperience of eighteencountries as they attemptedto maintain economic stability in the face of internationalprice, interest rate, and demand shocksor domesticcrises in the forms of investmentbooms and relatedbudgetary problems.The project paid particular attentionto the 1974-79 period (whichin- ciuded the first and secoridoil priceshocks), the 1980-82period of worldwidere- cession and extemal debt problems for many developing countries, and the 1983- 90 period of adjustment to economic difficulties and the resumption of growth. The objective of the project was to glean instructive lessons by analyzing the stabilizadon and adjustnent policies pursuedby these countries and assessing the outcomes.The authorsof each country study were asked to deal with a common set of questionsconcerning the nature of the shocksor crises:their originand de- gree of seriousness;the fiscal,monetary, exchange rate, and tade policiesadopted in hopes of preventing permanentharm to the economy;and the results of the policies. No singlecomputable macroeconomic model was used in the project,but the frameworkof the open-conomy macroeconomicmodel was followedto ensure consistencyin generalizng about results.This intensive study of many episodes generatedideas and suggestedrelationships showing the cause and effect behind policies, the nature of the shocks and crises, and the governmentalresponse to them. The overallfindings of the projectare presented in a synthesisvolume by L MLD. Little, Richard N. Cooper, W. Max Corden, ard Sarath Rajapatirana- Boom, Crisis, and Adjusment: The Macoronodc Experience of Developing Countries.- The-Indonesianeconomy did very well in the 1965-90period. Per capita in- come growth averaged 4.3 percent a year despite four economiccrises: hyper- inflationin 1965and 1966,the 1975 defaultby Pertamina(the state oil company)," the serious weakening of Indonesia's nonenergy tadable sector by "Dutch disease" between 1973and 1978,and the post- 1982fall in the price of oil, one of Inddnesia's chief exports.All four crises were handled competentlyand had no adverse consequencesfor long-termgrowt.: Of specialinterest are the resultsof the strucnuraladjustment programs imple-. mented to cope with the first and fourth crises. The quick subduingof hjperinfla- tion in 1965-66 was followedby substantialand immediate economicgrowth. it x Foreword The post-1982 adjustmentprogamm involved an increase in investmentas a share of expenditures and reoriented the economy toward the manufacturing sector while raising the income of the poorest segmentsof the population. Indonesia's experience challenges two conventionalviews about macroeco- nomic management. It challenges the claim that "announcementeffects" makeP price stabilizationeasier when a credible program is undertaken by the govem-