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The word economyMaking trade policy in a new democracy after a deep crisis: Indonesia1. IntroductionHow do deep crises affect trade policy in developing countries? The conventional historical view is that economies turn inward, in an attempt to protect firms and employment, to restore trade balances, and in response to the perceived negative consequences of globalisation. As a corollary, it is argued that governments find it easier to reform during good times, of strong economic growth and low unemployment.However, over the past two decades, an alternative view has arisen, based on the observed behaviour of countries in crisis. This is what Little et al. Termed the new liberalisation. That is: the balance of payments crisis creates the shock environment in which trade liberalization and other radical policy changes become possible. Lal and Myint developed this argument more generally with their crisis hypothesis, that major reforms are often triggered by a significant event: a major economic crisis, a military defeat, the cessation of external support or a natural disaster.The political economy explanations for this changed behaviour are complex, and include both generic and country-specific factors. The purpose of this paper is to add to our understanding of the nexus between trade policy and crises with reference to a study of the Indonesian experience since the late 1990s. After three decades of mostly rapid economic growth, accompanied by liberalisation in the late 1960s and mid-1980s,the country experienced a deep economic and political crisis in1997-98.in 1998, the economy contracted by over 13 per cent, the government signed on to a highly controversial International Monetary Fund programme, and the 32-year rule of President Soeharto came to an abrupt end. Authoritarian political structures gave way to a weakened state, a new and fragile democracy and major changes in political and institutional structures.Our main conclusion is that, perhaps unexpectedly, the Indonesian economy remained largely open over this period. However ,in some instances, holding the line on trade reform has had more to do with the personalities involved in trade policy rather than the institutional processes for formulating that policy. Thus ,openness is precarious, and not deeply embedded in either supportive institutionalised policy-making structures or widespread popular opinion. Moreover,barriers to domestic trade have risen significantly and now pose a substantial threat to the country economic integration. This latter issue has received relatively little attention in the literature on trade policy and crises where central government authority is greatly weakened.We are unaware of a substantial literature on this subject for other developing countries, addressing both international and domestic trade policy. But we conjecture that the Indonerien experience has wide general applicability. This is therefore an issue that other developing countries and international development agencies will need to address in post-crisis environments.The rest of the paper is organised as follows. Section 2 provides some context on Indonesia, including brief reviews of the evolution of trade policy, the severe economic crisis of 1997-98, and the new post-crisis policy-making framework. Section 3 examines international trade policy since the crisis, while Section 4 investigates the changing domestic trade policy regime. Section 5 provides an analysis of the bureaucracy ill-fated attempt to develop a new trade policy law in this new political economy environment. Section 6 sums up our arguments and discusses some broader implication.2. THE INDONESIAN CONTEXTA. Trade Policy under SoehartoIt is sometimes observed that Indonesia was made by God for free trade. This is a reference to its status as the world largest archipelagic nation, its porous international borders, 13000 islands, sometimes rampant smuggling, and proximity to free-trade Singapore and the major international sea lanes of the Malacca Straits. However, the official trade policy pendulum has swung over its six decades as a nation state from virtually complete commercial isolation to very open regimes.There have been major changes in Indonesia trade policy regime since the 1960s. By 1965, the country had disengaged from global trade and investment, and withdrawn from the United Nation, the IMF and the World Bank. The political turbulence of 1965-66 then ushered in a radical shift towards economic orthodoxy, including prompt and effective macroeconomic stabilisation, and an open commercial policy. This period of liberalism was short-lived, however. By the early 1970s, there was a nationalist resurgence. Tariffs were increased, but, more importantly, the government embarked on an ambitious programme of heavy industrialisation underpinned by increased resort to non-tariff barriers.It was only in the early 1980s, and more decisively in the mid-1980s as oil price continued to fall, that key economic policy-makers the so-called technocrats were able to arrest the trend, and then embark on a series of major trade reforms. The second half of the 1980s constituted the high point of the reforms. This was a highly successful case of law politics, in Soesastro. The technocratic reformers largely eschewed high politics, in the sense of engaging in grand ideological debates. Rather, they developed a strategic reform programme and, partly with the assistance of low-profile foreign advisors, persuaded the president that, in view of the falling international oil prices, the country faced a Mexico scenario of debt crisis and IMF intervention if the liberalisations were not effected. Once Soeharto was convinced, reform was swift and effective. There was limited public debate.The most complete set of estimates of the trade policy regime in the late Soeharto regime are those computed by Fane and Condon. Employing a consistent estimation methodology and database, they concluded that the weighted average rate of effective protection for manufacturing declined from 59 per cent to 16 per cent over the period 1987-97,while the dispersion fell from 102 to 39. The coverage of NTBs fell even faster: the percentages of non-oil manufacturing value added affected by NTBs declined from 77 per cent to 17 per cent.Thus, at the time of the crisis, Indonesia was a broadly open economy, and most sectors received quite low protection. By international standards, Indonesia reforms since 1980 have been incremental rather than big bang. Rajapatirana accurately charaterises the country as a mild reformer since the 1980s. According to the Sachs-Warner methodology, Indonesia was open for a few years from the late 1960s and for most of the period since the late 1890s. Moreover, importantly, and borrowing Jagdish Bhagwati terminology, the reforms were a case of genuine unilateral liberalisation. They were not part of an World Bank programme, though these actors played a peripheral role. Nor were they conditional upon reciprocity, although shortly afterwards Indonesia was to enter into several regional trade agreements, principally involving the Association Southeast Asian Nations.B. The Economic Crisis of 1997-98Indonesia experienced a deep economic crisis in 1997-98. Its economic contraction in 1998, of over 13 per cent, was the sharpest among all four crisis affected East Asian economies. Triggered initially by the run on, and subsequent collapse of, the Thai baht, Indonesia began to experience large-scale capital flight in the third quarter of 1997, resulting in a sharp depreciation of the rupiah and financial distress. At the peak of the crisis, the dollar exchange rate had fallen from Rp2500 to Rp17500, and credit in the modern financial sector had effectively dried up. In the first half of 1998, there was a loss of macroeconomic control, and inflation on an annualised basis exceeded 100 per cent.The economic crisis also precipitated a political crisis, culminating in May 1998 at the end of 32-year authoritarian Soeharto regime. This created a political and institutional vacuum, heightened social and ethnic tension, and for a period threatened the country territorial integrity. Investment, both domestic and foreign, also collapsed. In the six years prior to the crisis, net annual foreign direct investment inflows averaged $2.7 billion,whereas there were net annual outflows of $1.4 billion for the five years after the crisis. Since 2004,modest positive net FDI inflows have been recorded.Reflecting its twin crises, both economic and political, Indonesia also recovered more slowly tan its East Asian neighbours. Growth was negligible in1999, but recovered to nearly 5 per cent in 2000. For the period 2000-6, growth averaged 4.7 per cent, in contrast to the 7.3 per cent recorded in the pre-crisis period 1990-96. In the immediate post-crisis period, exports responded significantly to the exchange rate depreciation, with a lag. However ,in spite of buoyant commodity prices in the early years of the twenty-first century,export growth since 1998 has been sluggish, compared to both neighbouring East Asian economies and the country pre-crisis record.C. Post-Crisis Institutions and Policy MakingAs a result of the crisis and regime collapse, Indonesia political environment has changed radically. There has been a shift from a hand, authoritarian, corrupt but growth-oriented state delivering broad-based, rapidly improving living standards, to a messy, weakened, democratic,corrupt state, with the political leadership not yet able to provide a clear and unambiguous commitment to growth. The economic policy-making environment has changed, in some cases profoundly, in at least eight key respects. As we shall see below, these changes have major implications for how trade policy is formulated and implement.The first is a weakened presidency, a deliberate outcome of the anti-authoritarian sentiment in the wake of the Soeharto regime. Second, there is significantly weaker cabinet unity. Third ,the parliament has been transformed from a moribund rubber stamp into a powerful, assertive, legitimate but unpredictable political force. The proliferation of policy platforms, and low levels of economic literacy have all resulted in a strong inclination towards populist politics, reflecting a general community reluctance to embrace liberal economic policies.Fourth, and as a corollary, the newly liberated political parties face the imperative of campaign funding. Inevitable, as we show in the next section, this has spilled over to economic policies as votes are purchased in exchange for the allocation of rents, including in trade policy. Fifth, the long suppressed civil society has suddenly become noisy and influential. Almost invariably, these protests are populist in nature.Sixth, there has been a marked shift in labour market policies and outcomes from the Soeharto era of low regulation, trade union suppression, but high productivity and wage growth to one of free labour association, but in other respects an unfriendly employment environment. In consequence, employment in the modern sector has declined, while informal sector employment, typically lower pain and less secure, has been rising.Finally, in an effort to preserve the nation territorial integrity, a big bang decentralisation reform was hastily passed by the parliament in May 1999, and introduced in January 2001. This involved a significant devolution of power and resources from the central government to the second tier of regional governments.These changes have far-reaching implications for trade policy. The national government is weakened, and there are many more policy actors. The framework for making economic policy has changed significantly. In particular, the low politics strategy of the Soeharto era, that is, one which involves a unifies team of economists with a shared policy outlook devising a reform programme and convincing the president of the case for reform, aided by adverse external circumstances and low-profile foreign advisory inputs, is no longer viable. The reformers now have to win over a constituency, in the parliament, the press and civil society, in generally unfavourable ideological circumstances and where money politics plays a larger role. Labour policies have weakened competitiveness in export-oriented sectors, and in the process diluted the constituency in favour of a liberal trade regime. In light of these factors, we now examine trade policy outcomes since the crisis.3. TRADE POLICY AFTER THE CRISIS: INTERNATIONAL A. An overviewAs Indonesia became ever more deeply engulfed in the economic crisis of 1997-98, the government signed a series of Letters of Intent with the International Monetary Fund. While most of the conditions in these LOIs pertained to macroeconomic and financial policy, there were a number of trade-related provisions. Several of the trade provisions involved the removal of special privileges granted in highly controversial circumstances to members of the Soeharto family. These included a clove monopoly and a so-called national car programme. Monopolies in the cement and forest industries, and in the distribution of several agricultural commodities, were substantially dismantled.B. Aggregate trendsAlthough the government formally exited the IMF progrmme in late 2004, it also announced its intention to proceed with continuing trade liberalisation, te tariffication of most remaining NTBs, and a commitment, in principle, to unify tariffs and reduce them to around 5 per cent by 2010. Thus in 2005 the government began what it called a tariff harmonisation programme with the objective of adopting a uniform tariff rate. Team Tariff, an inter-ministerial team housed in the Ministry of Finance was responsible for the programme. It established criteria for setting tariff rates. these included lowering the average tariff rate, and reducing the number of tariff bands. The programme was carried out in two stages. The first stage cover about 1900 tariff lines, mainly affecting agriculture commodities, and was implemented in early 2005. The second phase, covering more than 9000 tariff lines, was completed in February 2006.The new tariff harmonisation programme specifies a tariff reduction schedule from 2005 to 2020. By 2010, 94 per cent of all tariff lines would have rates at or below 10 per cent. The remaining 6 per cent of tariff lines would have their rates reduced to 10 per cent by 2020. Team Tariff provided recommendations on the tariff harmonisation changes to the Minister of Finance, who then issued a decree implementing changes to the tariff schedule.In sum, the tariff harmonistion effort resulted in the following six outcomes. First, a reduction in the weighted average MFN tariff rate from 8.7 per cent in 2004 to projected 7.7 per cent in 2010. Second, an increase in the actual number of tariff bands form eight to nine. However, by 2010 about 87 per cent of all tariff lines are likely to fall into two hands the 5 per cent and 10 per cent bands. The tariff harmonisation programme also resulted in fewer tariff line subject to a zero import duty: the percentage of tariff lines subject to a zero duty falls from 22 per cent in 2004 to 5.5 per cent in 2010. Third, the dispersion of tariff rate is projected to increase from 2.6 in 2004 to 3.1 by 2010, indicating that the government initial goal of a smaller dispersion in tariff rates will not be achieved. Fourth, an exemption list of products subject to import duty of 35 per cent or more accounts for about 6 per cent of all tariff lines. These products will not be subject to reduced rates until 2020.Fifth, the sectors are treated differently. The simple average tariff rate for agriculture goods remains relatively high and with only a small decline from 14.9 per cent in 2006 to 14.6 per cent by 2010. Rice is subject to a specific tariff of Rp450/kg and sugar to Rp750/kg. Rice and sugar are subject to import quotas as well. Non-agricultural goods are subject to a lower average tariff and bigger declines over the schedule period: the simple average falls from 9.2 per cent in 2006 to 8.1 per cent in 2010.Finally, the effective tariff rate is much lower than the average MFN tariff rate. For example, customs data suggest that the average, effective tariff rate is in the range of 3-4 per cent. This arises for two reasons. One is that most common effective preferential tariff lines have rates ranging between 0 and 5 per cent. The other is that a substantial proportion of imported intermediate goods are exempt from duty under Indonesia various export facilitation programmes.The above analysis refers just to tariff policy. The picture is less clear in the case of non-tariff barriers, and this illustrates the precarious nature of Indonesia trade openness. During the last decade of the Soeharto era, Indonesian trade policy was broadly consistent and unilateralist, both across sectors and with reference to trade policy instruments. In particular, both the average tariff and the number of NTBs declined. However ,since 2001, trade policy has become inconsistent. This is indicate by the trends in various trade policy measures.Measuring NTBs is inherently difficult. By definition, their proponents have an interest in ensuring that they are opaque. In Indonesia, the Ministry of Trade generally issues three types of importer licences. An importer-producer licence means that only the producer of that commodity can also import it. The restricted import licence importer of a listed commodity register with the MOT. In principle, this does not involve any restriction on who can register or how much they can import, apart from the inevitable costs of dealing with the bureaucracy. In addition, the MOT occasionally issues inter-island trade registration licences. We give some illustration of the design of these NTBs in next sub-section.Figure w provides an estimate of the number of tariff lines subject to IP or IT restrictions in 2002 and 2004. It is beyond the scope of this paper to quantify their impact. But the overall picture is clear enough: tariff rates under the control of the MOF remained relatively low at a median tariff rate of around 5 per cent. However, import licence requirements, which are under the control of the sectoral ministers and authorised by the MTO, proliferated, their number rising by almost 40 per cent in just two years. This is the crux of Indonesia trade policy challenge: no minster or agency has control over the full array of trade policy instruments, and is able to adopt an economy-wide public interest viewpoint. The MOF controls tariffs, while sectoral ministries are able to introduce specific NTBs.C. Case studiesSince most NTBs lack transparency, this sub-section provides a brief overview of some recent trade policy measures. They are consistent with what Basri and Soesastro have termed Indonesia creeping protectionism since 2001. Many of the barriers have been in agriculture, with rice, sugar, wheat flour, soybean and cloves commonly targeted. Anti-dumping has also come to be used as a protectionist instrument.One example is that in 2001 the MOT established an importer-producer licensing scheme for imports of 26 categories of textile fabric, with the stated objective of preventing smuggling. The scheme appears appears to have succeeded as official import statistics recorded a drop in fabric imports between 2001 and 2004. However , these data do not account for imports into bonded zones, where most clothing exporters operate. Export statistics from major foreign suppliers of fabric reflec these unrecorded imports.Furthermore, in 2003 the MOT introduced importer registration licences for selected commodities. More than 500 tariff lines at the nine-digit level were subject to this scheme. Again, its