. . . And From Boom to Bust

Between 1966 and 1996 Indonesia's economy grew on average by nearly 7
percent annually. In the first half of 1998 alone, its economy has
contracted by an estimated 12 percent, which, according to the
Financial Times, is the most dramatic economic contraction anywhere
in the postwar era. Indonesia's economy is now a smoldering wreck.
What went wrong? How could this be the fate of a country that was
held up as a model by the World Bank?

Recently it has been suggested that the Word Bank was wrong to tout
Indonesia as a model of success; that some dimensions of its economic
"miracle" were in fact fake; that the Bank was guilty of knowingly
endorsing inflated economic statistics to put Indonesia's record in a
better light; and that its operations in Indonesia were afflicted
with corruption (Wall Street Journal, July 14, 1998). There is
certainly some truth to these and kindred claims. The World Bank was
in an overly cozy relationship with Indonesia, there were real
problems of corruption in Bank projects, some of the statistics were
dubious, and some of the reporting was hyped. But the brouhaha about
Bank operations, its internal contradictions, and the way in which it
deals with its largest clients obscures what is, for present
purposes, a much more important point: even allowing for some fudging
of statistics (and where in the developing world has this not happened?),
Indonesia made stunning economic progress on many fronts. No serious
observer of the country would deny this. Of course there were
always real problem areas--again, where in the developing world were
there not?--but the larger truth is no less for this. Indeed, were
this not to be the case, then what is happening in Indonesia today
would not be universally regarded as an astonishing economic reversal.

Why then has Indonesia been so afflicted? Indonesia's currency
collapse has little to do with the World Bank. Clearly it was swept
up in the region-wide economic crisis that afflicted all of the open
Asian economies. And there can be no doubt that Indonesia, like a
number of other countries in the region, suffered from some notable
areas of policy weakness. But there was no necessary economic reason
that it should have suffered a reversal of fortunes so devastating.
Fundamentally, Indonesia's problem was a sudden loss of confidence on
the part of local and foreign investors which, as in Thailand and
South Korea, was a function of investor calculations about the
likelihood of the government of the day dealing effectively with the
problems at hand. In short, once the crisis got underway, investors
were making calculations about political circumstances as much as
economic circumstances. Although Thailand, South Korea, and Indonesia
all had serious political problems, Indonesia's became the most
dysfunctional and the most corrosive to investor confidence.

It is worth recalling that things did not appear this way during the
early months of the crisis. Where the Thai central bank spent an
estimated $23 billion of reserves defending the exchange rate,
hesitated in going to the IMF, and then had difficulty implementing
the program negotiated, Indonesia behaved quite differently. Before
the rupiah even came under serious speculative attack, the government
moved to widen the band within which the currency traded as a
pre-emptive measure. As the crisis intensified regionally, the
authorities cut the rupiah completely free, drove up interest rates,
scrapped foreign ownership limits on the stock exchange, reduced
tariffs, and froze a range of high-cost infrastructure projects. In
short, the Indonesian government moved quickly to contain the crisis,
and won praise in the financial community for doing so.

In this, the government's response was in keeping with its response
to past economic crises: swift, decisive, and effective action.
Unlike his Thai counterpart, Chavalit Yongchaiyuth, Suharto was able
to move so decisively because power within Indonesia's political
system was highly centralized. But a political system of this sort
also entails real economic risks, for if the leadership begins to
behave in ways that are damaging to investor confidence, there are no
institutional checks or balances to constrain it.

For many years investors found Indonesia attractive because of the
high rates of return to be had there, the regime's track record of
sound macroeconomic management, and the fact that they could always
get their money out easily (Indonesia has had an open capital account
since 1970). As 1998 began, however, these assurances were being
swept away. In early December Suharto suffered a stroke, triggering
serious doubt about his future and intensifying long-standing
uncertainty about the process of political succession. There was a
growing sense of doubt concerning Suharto's commitment to economic
reform. With members of his family and other crony business
associates making clear that they would not be subject to any
unwelcome restructuring measures promised by the government, economic
leadership appeared increasingly rudderless. Combined, these factors
pushed the rupiah down very sharply through December. Then in early
January of this year the government unveiled a budget that was widely
interpreted as being out of touch with economic reality. Investors
dumped the rupiah in a massive sell-off and panic set in among the
urban middle class, with supermarkets being emptied of essential
foodstuffs and supplies. At this point Suharto's economic credibility
was terminally damaged.

What followed was the slow but inevitable slide of the regime toward
destruction. With local and foreign investors no longer willing to
trust the government, there was no market demand to lift the
currency, and with the currency at a small fraction of its former
value (between 8,000-16,000 to the dollar compared to 2,500 prior to
the crisis) it was merely a matter of time before the collapsing
economy forced political change. This eventually came on May 21 when,
after mounting student demonstrations, seriously destructive rioting
and looting in Jakarta, and finally rapid elite defection, Suharto
stepped down. The New Order was over.

An important question in Indonesia's economic disaster concerns the
role of the IMF. An impressive array of people--ranging from leading
mainstream economists through prominent economic revisionists, and on
to nationalists and Muslim radicals of various sorts in
Indonesia--argues that the IMF bears heavy responsibility for
Indonesia's economic woes. The specific charges vary, but include: a
narrow ideological insistence on a fiscally austere one-size-fits-all
approach, a misguided focus on structural reform at the expense of
greater attention to the debt problem or the exchange rate itself, an
ill-advised requirement that sixteen weak banks be closed (which
triggered a run on some other banks), and the claim that the IMF
(presumably at Washington's behest) was really out to get Suharto and
ensured his demise through very high-level leaks that jaundiced the
market's reception of the January budget.

This is a diverse set of charges and opinions concerning their
validity vary widely. But even admirers of the IMF would probably
have to agree that its interventions in Indonesia from September 1997
through May 1998 were, at best, of uncertain benefit. But while these
interventions did little to make things better, it is a mistake to
lay the blame for Indonesia's economic catastrophe at the doorstep of
the IMF. Like the World Bank, the IMF is given too much credit by
both its enthusiasts and its tormentors. The real culprit was the
Indonesian government's own awful mishandling of the crisis from late
1997 onwards, and this mishandling was ultimately rooted in the
country's extraordinarily centralized political system. The same
political system that had facilitated the decisive handling of early
economic crises spelled disaster once the leader was perceived as
unwilling or unable to provide effective economic leadership. Any
sins of omission or commission by the IMF--and no doubt there are at
least some--fade into the background compared to the devastating
consequences for investor confidence of an unconstrained, aging,
ailing, and increasingly erratic autocrat.

The Road Ahead

In simplified terms, Indonesia now faces two daunting and intertwined
tasks: it must construct a new political framework that is workable,
and it must stabilize and then rebuild its economy.

Because Suharto so dominated the old regime, his departure has
removed the country's principal power referent. As a result, all the
people in key positions today--President Habibie, armed forces
commander Wiranto, and the various members of cabinet--are struggling
to find their own political feet and develop their own power bases.
All rose to influence on the basis of Suharto's support and all did
his bidding; now they must reinvent themselves politically if they
are to survive. To this end, Habibie has moved quickly to distance
himself from Suharto's regime by lifting controls on the press,
political parties, and labor unions. He has freed a range of
political prisoners and promised to present a set of major political
reforms for approval of the Peoples' Consultative Assembly by
November 10, so that fresh and genuinely democratic elections can be
held in 1999. Under the old New Order there was little room for
genuinely independent social organizations. Now, suddenly, civil
society is blossoming, with new organizations and movements popping
up each day--ranging from political parties, through labor unions, to
student action groups and voluntary associations to help Chinese and
other victims of the looting and raping that took place in the final
days of the old regime.

Essay Types: Essay