Remarks by Angel Gurría, OECD Secretary-General for the launch in Jakarta of the OECD Economic Assessment of Indonesia.
Jakarta, 24 July 2008
Good morning, ladies and gentlemen.
It is a pleasure to be here to present the OECD Economic Assessment of Indonesia. I would like to thank Minister Mulyani Indrawati for her warm welcome and support for this endeavour. Special thanks also go to BI Governor, Dr. Boediono, with whom we interacted closely and fruitfully during most of the preparatory work for the Economic Assessment.
I am particularly proud to present this report, because it is the first comprehensive study by the OECD on the Indonesian economy, and the recognition of the importance of your country in the global economic landscape. Indonesia is a large economy with a large population of nearly 230 million; in the OECD area, only the United States is more populous than Indonesia! It is also the largest archipelago State in the world, spanning over 4500 kilometres from east to west. It has vast endowments of natural resources. Of course, sheer size creates opportunities for growth and development, but also poses challenges for policymakers. We took the need to understand these specificities very seriously and have done our best to reflect them in our work and policy dialogue with the Indonesian authorities.
This report is timely as it is linked to the recent decision by the OECD to strengthen its co-operation with a number of important non-member countries. We are proposing to develop a special relationship – which we call “enhanced engagement” – with five countries with a view to possible membership in the organisation. Indonesia is among these countries, together with Brazil, China, India and South Africa. Enhanced Engagement is a framework for a more focussed, comprehensive and mutually beneficial relationship with these select partner countries, Enhanced Engagement is also, more than anything, about working together towards improving the functioning of the global economy, which is the OECD’s core mission.
We are also strengthening our relations with South East Asia, as a region of priority strategic interest for OECD Members. At the same time, we are working with another five countries – Chile, Estonia, Israel, Russia and Slovenia – towards full membership over a shorter horizon.
Indonesia’s growth performance is improving. GDP has grown by over 5.5% per year since 2005, the highest rates since the Asian crisis. These are great achievements. But, as we often find for our own Members, Indonesia can perform even better. Our report argues that the country’s main policy challenge is to raise the economy’s growth potential and to sustain it over the longer term, in order to reduce poverty (presently at 16%) and unemployment (above 10%) at a faster pace. To meet this challenge, policy efforts are required in several domains. The report focuses on two of them: the business environment and the labour market.
Needless to say, a stable macro economy is essential for sustained growth. Our assessment of Indonesia is very positive on this score. Fiscal policy has been conducted responsibly and in an increasingly decentralised manner. Public debt has been reduced, and this is creating room in the budget to finance infrastructure development, human capital accumulation and social protection.
The authorities have taken bold steps to reduce the burden of fuel subsidies on the budget. We commend you for this. Fuel subsidies are particularly onerous now with historically high energy costs. They are also inefficient, because they demand scarce budgetary resources that could be used instead to finance growth-promoting programmes, for example to improve human capital and infrastructure development. And they are inequitable, because they do not benefit the vulnerable groups they aim to protect. According to official estimates, about two thirds of spending on fuel subsidies benefits people who are among the richest 40% of the population.
The report suggests that the government could consider the introduction of a formula based mechanism for setting domestic fuel prices. This would have make price changes transparent and less politically charged. It would also safeguard fiscal policy against fluctuations in energy prices. And it would create room in the budget to finance compensatory measures for those groups that are most at risk of income losses when fuel prices rise.
Let me now move on to monetary policy. Here the OECD’s key message is that all efforts should be made to strengthen credibility in the policy regime. Central banks around the world are now having to cope with rising inflation, essentially due to high food and energy prices. The central bank should act resolutely by raising rates in a forward-looking manner when the inflation outlook deteriorates This is essential for persuading market participants that the policy regime is credible and to underscore the central bank’s commitment to disinflation.
Turning to structural issues, we argue that the private sector can play a leading role in the growth process. But this will only happen if the business environment is improved and barriers to entrepreneurship are removed. The 2007 Investment Law makes investment regulations more transparent and ensures equal treatment for domestic and foreign investment. This is extremely important. But ownership ceilings remain for foreign investment in many sectors, including transport and telecommunications. This makes Indonesia’s FDI regime more restrictive than those in most OECD countries. It is in large part for this reason that Indonesia’s FDI-to-GDP ratio is among the lowest in Southeast Asia. We therefore think it would be a good idea to liberalise foreign ownership restrictions further to encourage foreign investment in sectors where barriers remain. The OECD Investment Committee is prepared to work closely with you to help achieving progress in this important area.
We also see a large potential pay-off from further liberalising state owned monopolies, especially in key network industries. This would open up opportunities for the private sector and help to resolve infrastructure bottlenecks. Indonesia has some of the weakest infrastructure development indicators in Southeast Asia. Despite recent deregulation, the government is still the major player in several sectors, including manufacturing, banking and insurance, transport and retail distribution. Here again, the OECD can support efforts by your government by sharing some of the good practices in regulatory reform.
Further liberalisation will only bring more investment and lower prices for consumers if there is an effective regulatory framework that combines price liberalisation and easy entry with independent regulators that can protect consumer rights.
Our report also analysed labour issues. In this area, the OECD advocates some liberalisation of the labour code coupled with strengthened social protection for the needy. Indonesia’s labour legislation is fairly rigid compared to most OECD countries, and even more so compared to your regional peers. Let me give you just a few examples: Procedures for dismissals are very bureaucratic for workers with regular contracts. There are restrictions on temporary work and the use of fixed term contracts. And severance pay and long term service compensation are very costly for employers. The minimum wage is also high in relation to average wages in Indonesia, more so than in most OECD countries.
The main problem of a restrictive labour code is that it penalises vulnerable workers, instead of protecting them. It makes it difficult for certain groups of workers, such as youths and the least educated, to be employed again once they have lost their jobs. Along with the relatively high minimum wages, it also discourages employers from hiring formally, which in turn constrains the expansion of productive activities in the long term. As a result, unemployment tends to be higher and more persistent, and labour informality more widespread. It is difficult to accurately measure informality, but about 80 to 90% of employment can be considered informal in Indonesia.
Policy efforts should be focused on building effective social protection while making the labour code more flexible. One option is to strengthen formal social insurance programmes. Indonesia already has Jamsostek to provide old-age pensions and health insurance, but membership in it is restricted to workers in the formal sector which is small, as we have seen. We argue that participation could be extended to the self employed and employees in smaller enterprises on a voluntary basis. Another option for the medium term would be to replace the existing dismissal and severance compensation requirements by unemployment insurance.
In any case, coverage by unemployment or social insurance will only be attractive to workers if they believe in the value of social protection benefits. Affiliation also depends on the affordability of contributions, which may be a constraint for individuals on low incomes. Designing correct incentives for workers to join is as important as making sure that programmes are credible, affordable and – where appropriate – fiscally sound.
Indonesia has a number of government-sponsored safety nets that could be strengthened. They include community based and targeted income transfers to poor individuals. These programmes are perceived to be working well. But, moving forward, conditionality for benefits could be improved in the main existing income transfer programme (Program Keluarga Harapan).
International experience, especially in Latin America, where many of these programmes pioneered, shows that the most effective requirements to receive income transfers are related to school attendance and use of preventive health care. This way, individuals at risk can be protected in the short run and at the same time equipped with the minimum skills needed to pull themselves out of poverty.
In closing, let me say that there is a lot of convergence of ideas between us on many policy areas. This is a good basis for deepening and broadening the policy dialogue between Indonesia and the OECD. But good policies can only bear fruit if they are implemented well. We understand – and do not underestimate – the scope for capacity constraints to undermine good policies. Our report therefore also argues that effort should not be spared to boost implementation capacity at all levels of government, and coordination between them, areas where we are also ready to share the experience of OECD Members.
I am confident that this first Economic Assessment will be followed by other reports and am looking forward to closer cooperation between Indonesia and the OECD. My colleagues and I look forward to your questions and comments.
Terima kasih banyak dan selamat siang! [Thank you very much and good luck]
Official visit of the Secretary-General to Indonesia (Jakarta, 24-26 July 2008)