Politics and Economics: Barriers to Change

President Joko Widodo earlier this year went on record as saying that even after 10 economic reform packages – including liberalization of the negative investment list – he is still not satisfied with the liberalization of the economy, and he intends to continue driving reforms to make the country attractive for foreign investment.

While Widodo’s commitment is praiseworthy, he is likely to face major obstacles from groups who currently benefit from the domination of the economy by privileged groups. The first such group is the bureaucracy, which is resistant to change, mainly because its actors benefit from control of a cumbersome and time-consuming process of anything connected to licensing. Then come the operators of monopolies, cartels and rent-seekers who benefit from the current situation.

In many ways these forces are interconnected. Bureaucrats create conditions which suit players within cartels and those who benefit from rent-seeking practices, and receive kick-backs in return. Politicians are also entwined within this nest of corrupt practices, as demonstrated most clearly by the 2014 scandal over beef imports that saw Prosperous Justice Party (PKS) chairman Luthfi Hasan Ishaaq sentenced to 18 years in jail for influence-peddling.

“It’s all politics,” World Bank country head Rodrigo Chaves commented to Concord Strategic following a discussion on the economy in February. Indonesia has to decide whether it wants to continue to defend the privileged position of business operators who trade in critical commodities and the bureaucracy that protects them or create an efficient economy. The decision will likely determine whether Indonesia gets stuck in the so-called middle income trap, unable to make the leap to a developed economy.

The people pay the bill
Given that many of the commodities that come under the control of cartels and rent-seekers are often food items, it is the people of Indonesia who are paying the bill. They either have to pay far more from their neighbors in the region for food or, if they cannot afford to pay for it, they are forced to eat less nutritious foods. Either way, there is a dramatic cost to the nation, both in current terms and in the longer term.

The price of chicken has emerged over the past few months as the latest example of highly questionable business practices by well-placed companies that operate effectively as a cartel. It is little surprise that a senior bureaucrat plays a prominent role in their current high profile.

The price of chicken in Indonesia, according to some sources, is the highest in the world. A kilogram of chicken meat costs between Rp36,000 ($2.65) and Rp39,000 in Indonesia, but only Rp13,500 in Malaysia – where average per capita incomes are much higher than in Indonesia.

In a report in Kompas on February 17, the head of the Local Chicken Farmers Association, Ade M. Zulkarnen, was quoted as saying that high prices occur “because there is no control over the operation of a cartel in the chicken industry that has been operating for decades.”

The Business Competition Supervisory Commission (KPPU) is now looking at allegations that major integrated feed and chicken companies are running a cartel that maximizes their profits at the expense of the consumer and the small producer. Such companies operate under the authority of Law No. 18 of 2009 on animal breeding and health.

It’s alleged that the companies deliberately destroyed as many as 40% of their breeding stock last December. This severely reduced the availability of day-old chickens (DOC), most of which were sold directly to other units of the major operators, while outside operators were forced to pay around 25% more for the young birds.

The integrated producers made money on selling the DOCs at the higher price and, because the supply of chickens was substantially reduced, prices rose rapidly, producing yet more profit, with the integrated producers dominating the supply to markets across the country.

The KPPU takes up the case
Three Indonesian subsidiaries of Singapore-listed Japfa have been caught up in investigations over alleged price-fixing and cartel activity in the beef and poultry industries.

Two of the Japfa units involved in the beef industry were due to appear before the Business Competition Supervisory Commission (KPPU) on February 12, Japfa said in a statement to the Singapore Exchange on February 8. However there have been no reports that the meeting went ahead or, if it did, what transpired.

In the February 8 statement, Japfa provided an unofficial translation of its response to a query on the broader issue from the Indonesia Stock Exchange. “Japfa Comfeed Indonesia, together with the other 16 poultry companies, was directed by the Director General of Animal Husbandry to cull six million poultry parent stocks in 2015,” it said.

“The company does not, therefore, expect an allegation report on any violation of the law for complying with the direction of the director general, who is part of the Agriculture Ministry.” So Japfa’s defense is that it was merely following orders. This of course raises the question of why the director general ordered such dramatic culling of breeding stock.

This is just one of many (alleged) cartels. Salt is another one that has recently seen a lot of publicity. Sugar has long been under the control of a group of powerful business interests known as the “seven samurai.” The result is high food costs for the average Indonesian, who has to live on an average per capita income of Rp36 million.

Will the KPPU follow through on the allegations of cartel practices in the chicken business? Will it investigate other cartels? The agency has a mixed record. Its major achievement was busting cartel practices that saw Indonesians paying extremely high rates for mobile communications but that was in 2007. Since then its achievements have been far more low-key.

The economic context
High prices for food that benefit a cabal of well-placed business interests and their buddies in the bureaucracy might not matter if everyone in Indonesia was well off, and the economy was rocketing ahead.

There is agreement among economists that the worst is not yet over for Indonesia amid an external climate full of risks. In just one gloomy reading of the world’s economic future, Albert Edwards, head of the global strategy team at Société Générale believes a trade war is on the way, together with “a more deadly phase of the global currency war.”

Edwards concludes that “we are set to slide into another global recession.” While not all economists are presenting such dismal forecasts, Indonesia, with its currency already weakened and its external trade in a very poor condition due to over-reliance on commodity exports, is in a tough position looking ahead.

In a presentation in January on Jakarta 20, World Bank country head Chaves delivered the following bullet points on Indonesia’s best course of action facing difficult times:

What is the best strategy for Indonesia?
§ Maintain macroeconomic stability
§ Enhance growth through structural reforms
§ Protect the people

The first and second points are being followed by the government. Macroeconomic stability has been sound, and reforms are being introduced to improve business conditions to boost economic growth. But with the third point, the question has to be asked whether Indonesia’s economic policy directions are really designed – and then implemented – to protect the people.

Indonesia faces severe public policy issues. There is a high level of inequity, low access to services, even in areas such as education which is now supposed to be free, but where many charges are still demanded of parents. There is inequality of opportunity and basic services such as water and sanitation are totally absent in many, if not most areas.

Chaves noted that job creation in 2014-2015 was very low at only 200,000 new positions. That compared very poorly with the period 2012-2014 when job creation was more than 10 times higher.




Given the circumstances, Indonesia had done well on the macro-economic level but the picture on equity was far less impressive, he said, adding that it was difficult to see how employment could be increased without growth in the manufacturing sector.

While the policy reform packages – now up to the tenth edition – had been positive, much remained untouched. There was still a need for better conditions for investment and barriers to entry still remained high.

Indonesia continued to host the most restrictive trade environment in Southeast Asia: some 205 restrictive trade regulations had been introduced since 2009. This was more than three times the number of such regulations as the next most protected market, Vietnam. The consequences, said Chaves, were that investment tended to move elsewhere.

At the same time there were severe problems with inequity, lack of access to services including education and sanitation and inequality of opportunity. These, said Chaves, were serious public policy issues.

The risk of inaction
Chaves asked how Indonesia hoped to avoid the middle-income trap, unable to move forward to developed economy status. He predicted that the country has only 10 years to find a solution to this dilemma. Indonesia needed to grow by 8.5% per year over the next decade to be able to move to the next level. Growth last year came in at 4.79%, a little over half the level Chaves sees as essential to avoid the middle-income trap.

Commodities were clearly not the answer. “Becoming a rich nation is going to take some pain for people who benefit from the current system. It is a political process and it is not going to be easy. Some people are going to have to give up things so that others can benefit.” That is the crux of the issue: can the privileged groups that enjoy unfair economic advantages be persuaded or forced to stop their practices for the greater benefit of the nation?

The situation is not entirely bleak. Chaves’ counterpart at the International Monetary Fund’s Jakarta office, Benjamin Bingham, is relatively upbeat. He sees the private sector starting to move in the second half of this year, stimulated by the implementation of reforms. The IMF describes Indonesia’s performance as ‘satisfactory’, he noted at the Jakarta seminar. “The IMF terminology is satisfactory, but that means pretty good,” he commented.

And, he noted, “Indonesia’s capacity to manage external volatility has improved significantly. (Bank Indonesia) has become increasingly confident.” The IMF, he said, remained “fundamentally bullish” on Indonesia’s economy, as long as it was able to move away from its dependence on commodities.

But at the end of the day the question of inequity remains a critical one if Indonesia is to move forward, a question that also has security ramifications. A lack of growth in jobs combined with high population growth and rapid urbanization present clear problems for the future. If Indonesia does get stuck in a middle-income trap, many will be left out, creating the pre-conditions for social conflict and even insurrection.

Lengthy supply chains
Another factor that pushes up prices for the public is the existence of ‘mafia’ who control supply chains for critical commodities. The Central Bureau of Statistics (BPS) commented after the release of inflation figures in January, when prices rose 0.51% on the month, that this figure could have been lower “if the government was capable of controlling the price of food commodities and cut the chain of trading that up until now has been extremely lengthy.”

BPS head Suryamin told a press conference that his agency had been studying supply chains for five ‘strategic’ food commodities: rice, red chili, shallots, corn and chicken. The journey from the producer could involve at least two and as many as nine traders. The most extensive supply chain systems occur in Central Java for red chili, shallots and corn, while rice and chicken suffer the longest supply chains in Jakarta.

On average, the cost of excessively long supply chains made food 10.42% more expensive than necessary, with chili prices pushed up 25.33% and corn as much as 31.9% because of such practices. Neither farmers nor consumers benefit, only middle-men.

“BPS is advising the government that supply chains are too long. Hopefully there will soon be changes in trading methods of strategic commodities because this without doubt influences inflation and the purchasing power of the public,” said Suryamin.

Poor institutional capacities
University of Indonesia political economist Faisal Basri has long been a critic of the political aspects of Indonesia’s economic environment. In his presentation to the same seminar, Basri stated that political power was fragmented at the same time as there was low institutional capacity.

Current government:
• High dispersion of political power
• Ineffective government (governance problems)
• High corruption
• High degree of local autonomy

This compared with the ideal situation in which institutional capacity was high and the following conditions applied:

Future government:
• Government effectiveness
• Low corruption
• High degree of local autonomy & competition
• Rule of law and rules of the game

In a blog post, Basri notes that smuggling of rice and other basic commodities appears to be underway. Concern over this year’s rice harvest has encouraged the forever-vigilant smuggling trade to jump into high gear. And there’s a clear economic incentive, as Basri notes:

“Based on data from the Central Statistics Agency, the average price of rice on the retail market in Indonesia in December was Rp13,217 per kg. The price of Thai rice (5% broken) in the international market was only $363 per ton or around Rp5,082 per kg (at an exchange rate of Rp14,000 to the US dollar). Vietnamese rice (5% broken) was a little higher, at $371 per ton or around Rp5,194 per kg.

“Since October 2015 the price of Vietnamese rice has been rising. This is very likely because Indonesia found itself confronted by shortages. In general the price of rice in the international market has tended to fall since September 2015, including Thai rice. The fall in the price of rice in the international market has been accompanied by a general trend among all food, energy and mining commodities.”

Indonesia has therefore suffered from policy failure and those who suffer most are the poor, for whom rice represents the single largest purchase out of their meager incomes. Yet in supporting an environment of high rice prices, Indonesia also provides opportunity to smugglers – yet another ‘mafia’ that breeds on poor policies. So trading in rice, chicken and plenty more food commodities become the playground of well-connected operators. The victims are the Indonesian people.

Without a commitment to changing the distortions in the Indonesian economy, the chances of the country benefiting from its much-toured “demographic bonus” appear slim. Instead, that bonus could turn into a disaster scenario.


A version of this article was first published by Concord Review on February 23, 2016. Free trial subscriptions are available.

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