与印尼之比较：中国发展的不平等性

ASIAN DEVELOPMENT STRATEGIES: CHINA AND INDONESIA COMPARED

Bulletin of Indonesian Economic Studies, Vol. 43, No. 2, 2007: 171–99

Bert Hofman and Min Zhao*, World Bank, Beijing

Yoichiro Ishihara*, World Bank, Jakarta

2007, 7, 16,

China’s and Indonesia’s development strategies have been compared with others, but rarely with each other. Radically different political contexts have produced both similar and distinctly different development patterns. Each using formal planning, Indonesia spurred radical reforms to promote growth, whereas China opted for incremental reforms to ‘grow out of the Plan’, as a political device and to discover what policies and institutions worked. Both strategies produced environments largely conducive to rapid development. Indonesia relied on a few economic technocrats to oversee development; China used decentralisation and party reforms to create a credible environment for non-state investment. Both shared concern for agricultural reform and food security; both opted to open up for trade—China gradually, Indonesia radically. Both did well in growth and poverty reduction following reform. China’s growth performance is in a league of its own, especially since Indonesia’s Asian crisis setback, but Indonesia had more equitable growth and survived a diffi cult political transition with, in hindsight, modest costs.

INTRODUCTION

In some ways, China and Indonesia are as different as countries can be. China is the emerging economic superpower with one-quarter of the world’s population, contributing 28% of world growth in purchasing power terms in 2005—a politically centralised state that has dubbed its economy a ‘socialist market economy’. Indonesia has only one-sixth of China’s population, has just found its feet economically after a major crisis, is now the third-largest competitive democracy on the planet, and has radically decentralised political power. Until recently their paths were almost separate, as trade and investment between them faced ideological and diplomatic barriers, but this is rapidly changing.1

There is large and growing attention to the China–India theme, and Indonesia is regularly compared with the newly industrialising economies and other ‘East Asia miracle’ countries (World Bank 1993), and even with India (Lankester 2004). Yet to our knowledge no comparison has been made between China’s and Indonesia’s development paths and strategies, although aspects of their policies and institutions have been compared before.2 Myrdal’s famous Asian Drama covers Indonesia, but leaves out China, the big unknown at the time (Myrdal 1968), while the monumental Indonesian Economy of Hal Hill (1996, 2000) compares data on the two countries, but focuses only on Indonesia’s development strategy.

* Opinions expressed are those of the authors and should not be attributed to the World Bank, its executive directors or its member countries. Thanks to Homi Kharas, Louis Kuijs, Ross McLeod, William E. Wallace and two anonymous referees for comments on an earlier version of the paper. Corresponding author: Bert Hofman, bhofman@worldbank.org.

1, The economic relationship between China and Indonesia has been stronger in recent times. For example, China’s share of Indonesia’s exports and imports rose from less than 3% in the late 1980s to 8–10% in the past few years.

A sceptic may argue that the countries are simply too different to make comparison useful. Look again, though, and similarities emerge. They are the two most populous countries and the two largest economies in developing East Asia. Both experienced rapid economic development after their reforms ‘took off’—in Indonesia in the 1960s and in China at the end of the 1970s. Both initiated reform after massive economic disruption—Indonesia after the hyperinflation and stagnation of the latter-day Soekarno reign, and China after the disastrous Great Leap Forward and the disruptive Cultural Revolution (1966–76). Each country started its reforms with a heavily distorted economy and, in the broadest sense, reformed by opening up the economy, introducing more market elements and maintaining macroeconomic stability. Both developed rapidly under non-competitive regimes (at opposite ends of the political spectrum), and both experienced rapid growth that dramatically reduced poverty—Indonesia even more so than China. Both countries have long-term and five-year plans, although these are very different and have varied considerably over time.

The paper compares China’s and Indonesia’s development strategies since the ‘take-off’ of reforms. This is taken to be 1966 for Indonesia, the year in which Soeharto established a firmer grip on power and a stabilisation plan was initiated. For China, year zero is 1978, the year of the path-breaking third plenum of the 11th congress of the Central Committee of the Communist Party of China (CCCPC). Of course, describing more than 60 years of economic history for two countries in a limited space forces undue selectivity, and this paper can touch only on key features of development strategy and sectoral reform. It focuses on areas where both countries underwent significant reforms. Mindful of BIES’s readership, it provides more detail on China than on Indonesia. While the paper focuses on economic reforms, these cannot be seen in isolation from political developments in the periods considered. The next section describes broad development patterns and outcomes, comparing the two countries with others where relevant. The third section outlines their broad development strategies, while the fourth compares major sectoral reforms. The final section offers some conclusions on what each country can learn from the other.

GROWTH PATTERNS

While both Indonesia and China are counted among the rapidly growing countries in Asia (IMF 2006: chapter 3), China is clearly in a class of its own. After reforms took off in 1978, its annual GDP growth averaged more than 9.5%, while Indonesia ‘only’ achieved a little over 6%. That difference in growth rates, combined with lower population growth in China, mattered a lot for GDP per capita over the course of the reform periods. While both started out almost equally poor—China had per capita GDP of $165 in 1978, and Indonesia $195 in 1966 (fi gure 1)3—China managed to increase this sevenfold within a quarter of a century, whereas Indonesia took a decade longer to ‘only’ quadruple its GDP per capita. China’s growth in recent decades is truly exceptional: of the 119 countries for which data are available from 1970, China ranks first in terms of growth in GDP per capita (fi gure 2), and only small, diamond-rich Botswana comes near—although Korea and Taiwan (China) experienced almost similar growth rates in the 25-year period after the early 1960s. But Indonesia ranks a very respectable 12th despite the crisis, and without it, it would have ranked 7th or 8th.

2, Zhang and Cooray (2004) make a comparison, but focus only on industrialisation strategy. Kong (forthcoming) includes a comparison of Chinese and Indonesian development policy in a study of the relationship between economic growth and political institutions.

FIGURE 1 Growing, But No Longer in Parallel (GDP per capita, $, 2000 prices)

China had consistently high growth in every decade of reform, despite significant slowdowns in 1981, 1989 and 1990; these years were followed by accelerated growth that recovered lost ground. Indonesia experienced much more variation in growth, but this is due solely to the Asian crisis years. Over the reform period as a whole, the standard deviation of China’s growth is 2.8, compared with 4.0 for Indonesia; however, measured over the first three decades (1966–96), the standard deviation of Indonesia’s growth is only 2.3. China, on the other hand, did better than Indonesia on inflation: even if its stabilisation years (1966–69) and 1998 are excluded, Indonesia’s annual inflation rate (calculated using a GDP deflator) averaged more than twice China’s modest 5.3% inflation.

3, There is considerable debate on the reliability of the numbers in both countries for the early reform period, but especially in China. Part of the explanation for China’sextraordinary growth may therefore lie in the under-estimation of GDP in the early years of reform (see Naughton 2006 for an extensive discussion of various data issues).

FIGURE 2 China in a League of Its Own Growth rate

Despite China’s higher per capita income, Indonesia has fewer people in poverty. Indonesia’s poor, as measured by the World Bank’s $1 per day purchasing power parity (PPP) consumption measure, represented 7.4% of the population in 2006, considerably lower than China’s 10.3% in 2004 (figure 3). In both countries poverty declined rapidly during the reform period. China’s poverty rate at $1 per day PPP consumption fell from over 60% of the population in the early 1980s to 10.3% in 2004 (Ravallion and Chen 2004; World Bank 2006a), although the early numbers probably overstate poverty because of deflator problems. Indonesia’s lower poverty rate is due to more equal income distribution. In China, inequality rose sharply over the reform period, whereas Indonesia’s income distribution barely changed (figure 3). Indonesia’s growth has thus been more pro-poor than that of China, and indeed of most countries (Timmer 2004).

The sharp rise in China’s inequality is due partly to the country’s rapid transformation,
which compressed Arthur Lewis’s process of modernisation and rising inequality into a few decades. Changes in measured inequality occurred in part because in-kind benefits under the planned economy—better housing, access to cars and domestic personnel—were monetised under the market economy. But rising inequality also resulted from the country’s development strategy: China’s coastal development strategy increased inter-provincial inequalities, while the household registration system hampered rural citizens in competing for higher-paid urban jobs.4 Finally, China’s heavy reliance on investment and manufacturing meant that urban formal sector jobs became rapidly more productive, and wages rose in line. As a result, agricultural incomes increasingly lagged behind average income per capita, contributing to inequality. China’s agricultural value added in 2002 was about one-third of GDP per capita, Indonesia’s about two-thirds. More recently, intra-urban and intra-rural inequality has been on the rise as well (World Bank forthcoming).

4, China’s household registration system, or hukou, has been in place since the 1950s. It tied most citizens to their place of birth, as health care, education, social security, housing and, previously, grain distribution were available only in a citizen’s locality of registration.

FIGURE 3 Poverty and Inequality a

How did the two countries achieve their high growth rates per capita? In accounting terms, GDP per capita is determined by labour productivity, the dependency ratio and the labour force participation ratio. China achieved the bulk of its increase in GDP per capita from an increase in labour productivity, with about 10% contributed by a decline in the dependency ratio. Almost one-fi fth of Indonesia’s growth per capita was due to demographic factors (the participation and dependency ratios), the highest among the rapid growers in Asia (table 1). China’s lower demographic contribution can be explained by the fact that a larger part of its demographic transition was already completed before reforms took off (figure 4), as a result of the population policy initiated in the early 1970s—well before the much-discussed one-child policy was introduced at the end of the decade. Indonesia started a more active population policy only after reforms began, so its effects were fully registered within the reform period. While demographics in China accounted for about 10% of output growth per capita, during the first decade of reform their contribution was almost one-sixth.

Labour productivity growth is due to increased human capital, increased physical
capital per worker, and growth in total factor productivity (TFP, a measure
of the overall efficiency with which an economy uses capital and labour). Physical
capital accumulation provided the largest contribution to labour productivity
growth in both Indonesia (about 60%) and China (55%). Contributions from
human capital (measured as average years of schooling in the labour force) are
small for both countries—9% for Indonesia and 5% for China. Both countries show
a considerable contribution of TFP to labour productivity growth throughout the
reform period; TFP growth accounts for a respectable one-third of labour productivity
growth in Indonesia, and a remarkable 40% in China. Over the whole
reform period, TFP growth contributed 3.0 percentage points to growth in China;
the reduction to a 2.2% contribution in the most recent decade may be related to
slowing growth following the Asian crisis (table 2).

The fairly even TFP growth pattern over the reform period reflects not only China’s consistent growth performance but also its more gradual reform process. Indonesia’s record on TFP is more mixed, but was still remarkably solid, especially in the first decade of the New Order and after the 1986 reforms in trade and industrial policies. In between, when reforms were reversed and trade and industrial policies turned inward, TFP growth was very modest, and GDP growth relied most on capital accumulation financed from abundant oil revenues. In the years after the crisis, which on net showed virtually no growth in GDP per capita, Indonesia’s TFP performance was dismal. In part, this can be explained by excess capacity created in the pre-crisis boom years standing idle as demand fell. Between 2001 and 2004, Indonesia’s TFP growth matches that of China, with a 2.2 percentage point contribution to growth.

The ratio of investment to GDP has been consistently higher in China (fi gure 5).
Driven by high domestic savings, China was already investing a great deal before
the reforms: on average gross fixed capital formation was above 30% of GDP, with
a rising trend throughout the reform period. Indonesia’s investment (and savings)
rate rose rapidly after stabilisation in the 1960s, and continued to increase
until the sharp drop after the crisis.

The contribution of human capital to GDP growth in China (0.4 percentage points) was similar to that in Indonesia (0.3 percentage points), but was unremarkable compared with that of other rapid growers in the region, and especially of stellar performers such as Korea, which rapidly expanded secondary and tertiary education from the late sixties onward (figure 6). This is no surprise—both countries are only just approaching Korea’s early 1970s per capita income. Indonesia’s rapid expansion of the education system in the 1970s accelerated the accumulation of human capital among workers, but this acceleration levelled off in the 1980s and 1990s. China, which started its reforms with relatively high human capital for its level of income, followed a similar trend to Indonesia through the reform period up to the year 2000 (Barro and Lee 2000). In recent years, China has rapidly expanded tertiary education, tripling cohort enrolments over the last decade; this should pay off in terms of future contribution to growth, but in the transition phase unemployment among young graduates is high.

Sectoral shifts in the economy, opening up to trade and competition, changes in the ownership structure of the economy, and urbanisation are all factors that can account for the considerable contribution of TFP to per capita GDP growth in both countries. Both countries experienced a sharp relative decline in agriculture over the reform period, but while China’s share of industry in GDP was already high in 1978, Indonesia’s reform period saw a rapid expansion of the sector (fi gure 7). For China, on net, the sectoral shift took place more from agriculture to services, which had been suppressed under the command economy and still lags behind what could be expected for an economy with China’s per capita income.

In both countries the share of agriculture in the labour force declined precipitously
(figure 8), raising the overall productivity of the economy. This accompanied
rapid urbanisation in both countries, which is remarkable especially for China, given
the household registration system, which discouraged rural residents from moving
to the city, and the one-child policy, which is better enforced in the cities than in
the countryside. Despite these policies discouraging migration, China urbanised
as rapidly as Indonesia (figure 8). Given its large floating population (estimated at
some 150 million people or 12% of the population), China’s urbanisation is probably
higher than Indonesia’s, and more consistent with China’s per capita income.
Besides migration and natural population growth in the cities, reclassifi cation of
rural areas into urban ones plays a significant role: in China, about one-third of
urbanisation is due to this phenomenon (Biller 2006), and estimates suggest an even
higher figure for Indonesia (World Bank 2006b: 92).

A second major structural change in both countries is the opening of the economy
(figure 9). China, with trade approaching 65% of GDP, is now exceptionally
open for a country of its size. Indonesia’s exports in the 1960s and 1970s were
dominated by oil, other natural resources and agriculture, but this changed after
the reforms of the early and mid-1980s, and manufacturing’s share of merchandise
exports jumped from barely 3% of total exports in 1980 to some 56% by 2004.
China had already achieved that level by the mid-1980s, and its share of manufacturing
in merchandise exports is now more than 90%. Indonesia’s trade as a share
of GDP peaked in the aftermath of the crisis, owing to the sharp depreciation of
the real exchange rate in 1998, but then settled at levels not too different from
those of China.

Indonesia was quick to adopt a very open capital account, and an active policy to promote foreign direct investment (FDI). By the early 1970s, FDI stood at some 2% of GDP, unprecedented for the time.5 After the 1974 Malari incident, when anti-FDI protests greeted Japanese Prime Minister Tanaka’s visit, enthusiasm for FDI waned, and the ratio of FDI to GDP did not reach 1970s levels again until the mid-1990s, only to reverse dramatically during the crisis years before making a hesitant recovery. FDI in China took off slowly, and was largely restricted to special economic zones (SEZs) until the early 1990s, after which Deng Xiaoping’s ‘Tour through the South’ triggered a sharp increase, with FDI peaking at 6.3% of GDP in 1993.6 Since then its importance has subsided, although China’s entry into the World Trade Organization (WTO) in 2001 saw renewed enthusiasm for investing in the country.

5, Indonesia’s defi nition of FDI differs from the international standard in including overseas bank loans to subsidiaries of foreign companies, which are usually included in ‘other capital fl ows’. This convention is the reason that Indonesia’s measured FDI turned negative after the crisis.

6, A considerable share of China’s FDI is likely to consist of money from Chinese investors trying to take advantage of the incentives that foreign investors receive (so-called ‘roundtripping’, Zhao 2006).

DEVELOPMENT STRATEGIES7

The two countries’ focus on rapid growth from the start of reform was quite similar. Some would argue that the political setting called for rapid growth as a key to the legitimacy of the regime. Deng Xiaoping’s ‘Development is the hard truth’ and Soeharto’s ‘Development yes, democracy no’ are remarkably alike in intent.8 Political circumstances differed quite sharply, though. Absence of political opposition and dire economic conditions in 1966 were conducive to the rapid reforms and pragmatic economic policies implemented in the Soeharto era (Lankester 2004). In contrast, although the Gang of Four and the Cultural Revolution had discredited extreme ‘leftism’, China can hardly be said to have embraced the market from the start, and ideological debates lasted throughout the 1980s. Only in 1993 did the ‘socialist market economy’ become mainstream ideology, suggesting an end to the ideological debate over the direction of economic reform.

China

China’s reforms had their tentative beginnings after the death of Mao Zedong in 1976. In a difficult political environment, Deng Xiaoping’s 1978 ‘Truth from facts’ speech at the end of 1978 (Deng 1991) became the breakthrough for reform; it was followed by the Communiqué of the third plenary session of the 11th CCCPC, which laid out a tentative program of reform to move away from the planned economy (table 3). But reforms developed only gradually, starting in agriculture with the household responsibility system and township and village enterprises, and some hesitant steps to open up the economy to foreign trade and investment, which took off in earnest only in the 1990s. Equally gradual were the moves on state-owned enterprise (SOE) reform, which were much discussed throughout the 1980s, but gained momentum only in the mid-1990s. Before that, the policy was to encourage entry of new non-state enterprises, rather than privatisation of SOEs, and to improve SOE efficiency through performance contracting and technological improvements rather than through retrenchment and privatisation.

In contrast with many of the former Soviet republics and Eastern Europe, China’s
planning system itself was not abolished overnight. Instead, the economy was
allowed to ‘grow out of the Plan’.9 Planning targets and material allocation grew
more slowly than the overall economy, while prices followed a dual track, one
within the Plan and one outside of the Plan, until well into the 1990s (table 4). This
preserved the level of production, while giving strong incentives to enterprises to
grow and receive the outside-Plan prices. The five-year plan still exists, although its nature has fundamentally changed, and it can now best be considered a strategic
plan for the government rather than a plan for the economy as a whole.

7, For Indonesia, extensive use is made here of Hill (1996, 2000); Hofman, Rodrick-Jones and Thee (2004); Timmer (2004); Schwarz (1994); and Booth and McCawley (1981). For China, key sources are World Bank (1981); Naughton (1995, 2006); Lin et al. (2003); Lardy (2003); Wu (2005); and Lou (1997).

8, However, for Deng, development was the focus of socialism, the first stage of communism,
which was needed to create the material wealth required to enable communism. For Soeharto, development was the alternative to the democracy of the early days of the republic.

9, ‘Growing out of the Plan’ was a phrase originally coined by Barry Naughton in 1984 to
describe the fact that within-Plan targets of output were almost flat, while overall economy-wide targets showed a large increase (Naughton 1995).

TABLE 3 Major Reform Steps in China, 1978–2006

Year Reform Step

1978 Communiqué of the third Central Party Committee (CPC) plenum of the 11th party congress initiating the ‘four modernisations’
1979 ‘Open door’ policy initiated, allowing foreign trade and investment to begin
1979 Limited encouragement of household responsibility system in agriculture
1979 Three specialised banks separated from the central bank
1980 First special economic zones created
1980 ‘Eating from separate kitchens’ reforms in intergovernmental fi scal relations
1984 Individual enterprises with less than 8 employees allowed
1987 Contract responsibility system introduced in state-owned enterprises (SOEs)
1990 Stock exchange started in Shenzhen
1992 Deng Xiaoping’s ‘Tour through the South’ re-ignites reform
1993 Decision of the third plenum of the 14th party congress to establish a ‘socialist market economy’
1996 RMB convertible for current account transactions
1997 Comprehensive plan to restructure SOEs adopted
2001 China’s accession to the World Trade Organization (WTO)
2003 3rd CPC plenum of the 16th party congress; decision to ‘perfect’ the socialist market economy
2004 Constitution amended to guarantee private property rights
2006 6th CPC plenum of the 16th party congress establishes the goal of a ‘Harmonious Society’
Sources: Wu (2005); Naughton (1995); Zhao (2006); and Zheng and Wang (2006).

Financial sector reforms were initiated in 1979, but commercialisation of the banks only started in earnest after 2000, in part because commercialisation proved impossible as long as unreformed SOEs needed financial sector support to perform their social functions, including provision of jobs, housing, health and education services.

‘Feeling the stones in crossing the river’ became China’s mode of economic reform, implementing partial reforms in an experimental manner, often in a few regions, and expanding them upon proven success. Only with the 1993 Decisions on the Establishment of a Socialist Market Economy did a broader overall strategy emerge; it too was implemented gradually and experimentally rather than comprehensively.

There were several reasons for this approach. First, gradualism was a means to circumvent political resistance against reforms (Wu 2005). Second, gradual, experimental reform was a pragmatic approach in a heavily distorted environment in which ‘first best’ solutions were unlikely to apply. Experimental reforms, confined to specific regions or sectors, allowed the authorities to gather information on effects that could not be analysed in advance. They were also necessary to develop and test the administrative procedures and complementary policies needed to implement the reforms. With proven success the experiment could be expanded to other regions and sectors. Third, experimental reform may have suited the Chinese culture well as a means to avoid ‘loss of face’: if an experiment did not work, it could be abandoned as an experiment, rather than considered a policy failure.

Combined with decentralisation to local government of ownership, plan allocation, investment approvals and other decision making powers after 1980, the experimental approach to reform became a powerful tool for progress: within the confines of central political guidance from the China Communist Party (CCP), provinces, municipalities and even counties could experiment with reforms in specific areas, and successful experiments then became official policy and were quickly adopted throughout the county.

Administrative and fiscal decentralisation distributed the benefits of reforms to a fairly large part of the population as well as to local government and party officials, who therefore had strong incentives to pursue growth and promote a market economy (Qian and Weingast 1997). On the administrative side, investment approval and detailed implementation of central policies was left largely to local governments. On the fiscal side, the tax contracting system gave a large share of the marginal revenues to local governments, topped up with ‘extra-budgetary funds’ they raised themselves, giving local governments wide discretion over the use of funds. Even the financial sector, through the local branches of the state banks and the central bank, was under the partial control of local officials, who could direct lending towards government-favoured projects and industries. Taken together, this environment provided a strong incentive for growth. A disadvantage was imperfect macroeconomic control and repeated bouts of inflation driven by local government loosening of investment and credit controls. Further, these conditions gave rise to local protectionism, which threatened to undermine China’s unified market and competition among domestic firms. When in 1992 reforms regained momentum lost after the 1989 Tiananmen Square events, and inflation re-emerged, the agenda became one of centralisation of policies, with major effects on macroeconomic conditions. The fi scal and financial reforms that followed were aimed at creating the tools for macroeconomic management in a market economy.

Why did gradual reform work in China while it failed in most other former
Soviet republics and Eastern Europe? Indeed, as others have pointed out,10 gradual
reform of the planning system is likely to fail because reforms lack credibility,
undermining positive responses to them by economic actors, and because rent-
seeking occurs in a semi-reformed system. This did not happen in China—at least
not to an extent that led reform to fail—for several reasons: the strong commitment
to reform expressed by China’s leadership; a gradual improvement in the
legal framework to protect private investment and property; and at times forceful
action against corruption.

Deng Xiaoping’s 1984 statements that reforms and opening up were to last for at least 50–70 years11 and his 1992 ‘Development is the hard truth’ are good examples of strong commitment to reform. This and consistency in reform actions at least in part substituted for the formal trappings of a market economy. More tangible were the rewards that officials within the party system received for delivering on key reform goals: growth, attracting FDI, creating employment, and maintaining social stability (apart from meeting targets on population control). Changes introduced in the 1980s to the rules of succession in party and state also helped to avoid political disruption—with the exception of the Tiananmen Square events (Keefer 2007). More recently, changes in the party constitution that refl ect former President Jiang Zemin’s ‘Three represents’, which opened up party membership for entrepreneurs, solidified the position of the non-state economy. Increasingly, the legal system included protection of property rights: the 1979 Law on Sino-Foreign Joint Venture Enterprises (JVEs) stipulated that the state shall not nationalise or expropriate joint ventures; the 1994 company law explicitly recognised private companies. But it was not until 1997 that the CCP recognised the role of private enterprises as being a useful force in the ‘early phase of socialism’, and not until 2004 that private property gained equal status with state property in China’s constitution. The property law passed in March 2007 establishes equal protection under the law for all ownership forms.

Finally, the often stern action against corruption probably limited opportunistic behaviour by insiders who could have abused the semi-reformed system. The numbers show that corruption was far from absent. Nevertheless, the considerable resources invested in the state and party apparatus and the numerous cases brought before the party’s disciplinary committee or prosecuted by the state procurator—even at the highest levels—suggest a seriousness in fi ghting corruption that is often lacking in one-party dominated states. Within the party, the Organisational Bureau is responsible for day-to-day monitoring of party member behaviour and the party disciplinary committee punishes abuse of power, party
indiscipline or corruption. Within the government, the Ministry for Supervision,
supported by supervision departments in every agency, investigates allegations
of corruption and imposes administrative sanctions, whereas the state procurator
is responsible for criminal investigations. The Supreme People’s Procurator is the
country’s highest anti-corruption body. In 2005, 41,449 government employees
(0.1% of the total) were probed by the procurator’s offices for corruption and dereliction
of duty; of these, 30,205 were brought to court.12

10, See World Bank (1996) for an overview of the arguments. Roland (2000) derives more formal models of transition that suggest gradualism may have lower uncertainty and reversal costs than ‘Big Bang’ reforms.

11 See, for instance, Deng Xiao Ping, ‘Our magnificent goals and basic policies’, in Deng
(1994).

China’s gradual strategy probably reinforced the credibility of reform. By making reforms one step at a time, and starting with those most likely to deliver results, the government built up its reputation for delivering on reform. With every successful reform, the likelihood that the next one would be a success undoubtedly increased.

Indonesia

Indonesia followed a very different path to reform. From its onset in 1966, reform
progressed in several waves of rather radical measures, followed by periods of partial
back-tracking (table 5). Reform opportunities occurred predominantly in times
of economic crisis, such as the aftermath of Soekarno’s failed ‘Ekonomi Terpimpin
(Guided Economy)’, the state oil company Pertamina’s foreign debt crisis of 1975
and the sharp drop in oil prices in the 1980s. In between, ambitious industrial
policies and protectionism emerged. Hill (1996) aptly characterised Indonesia’s
economic policies as ‘good policies in bad times’. Early reforms emphasised rural
development and food self-sufficiency, and were highly successful. The government
maintained its focus on macroeconomic stability throughout, and built some
strong macroeconomic policy institutions to do so. In times of macroeconomic
difficulty, the microeconomic policies pursued were largely aimed at liberalisation—
which was duly rewarded with renewed growth. But microeconomic policies
deteriorated in times of relative stability. On the one hand, they were under
threat from the heavy industry lobby and later the ‘technologists’ who aimed for
rapid state-led technological development. On the other, especially since the early
1990s, the threat to good policies came increasingly from the crony capitalism of
the first family and its affiliates. A liberalised but lightly supervised fi nancial sector
fed the boom in the early 1990s, while efforts to tighten domestic monetary
policy resulted in a rapid increase in corporate external debt. When contagion
from the Thai baht depreciation hit Indonesia in 1997, and Soeharto was seen to
be reneging on Indonesia’s letter of intent to the IMF, policies that had worked
well in previous crises (depreciation, sharp tightening of monetary policy, fiscal
retrenchment, structural reform) no longer did.

What had changed by the 1990s were the complexity of the economy, the external
environment and the nature of the Soeharto regime. The reforms of the 1980s
had made Indonesia a much more diversified, private sector-led economy with
a rapidly developing financial sector in need of a strong legal system and strong
supervisory institutions. Both were lacking. The surge in international capital
flows had made two cornerstones of macroeconomic policy less appropriate for the times: the managed exchange rate combined with an open capital account gave
firms strong incentives to borrow abroad and left the currency and the economy
vulnerable to speculative attacks. But perhaps most important was the change
in the nature of the regime, which had become increasingly prone to corruption.
This undermined its legitimacy and, in turn, the credibility of its policies. Weak
governance coloured the perception of how Indonesia would manage the crisis,
and this lack of confidence appears to be the main reason why Indonesia was hit
harder than other countries affected by the Asian crisis. Or, as Boediono (2005:
321) puts it: ‘The crisis brought not only an acute awareness of how treacherous it
can be to live in an interconnected world, but also a growing realisation that institutions
of society and the way they are run (governance) matter a great deal ...’.

12, Jia Chunwang, procurator-general, in his 2006 work report to the parliament.

TABLE 5 Major Reform Steps in Indonesia, 1966–2004

Year Reform Step
1966 Soekarno hands power to Soeharto; Economic Stabilisation and Rehabilitation
plan; first Paris Club rescheduling
1967 Foreign investment law; Indonesia co-founds ASEAN
1968 Soeharto sworn in as president; central bank law; foreign banks allowed
1969 First Five-year Development Plan
1970 ‘Commission of Four’ against corruption appointed. Removal of foreign capital
and exchange controls, exchange rate unified, 2nd Paris Club agreement
1973 First OPEC oil price hike
1974 Malari riots against foreign investment during Japan Prime Minister Tanaka’s
visit
1975 Pertamina crisis (state oil company unable to meet its foreign debt obligations)
1977 Jakarta Stock Exchange opens
1978 Devaluation of the rupiah by 50% against the dollar
1979 Second OPEC oil price hike
1983 Budgetary retrenchment; devaluation of rupiah by 38.5%; elimination of bank credit ceilings; VAT, global income tax introduced
1985 Soeharto honoured for Indonesia’s achievement of food self-suffi ciency; transfer of most customs functions to Swiss firm SGS (Société Générale de Surveillance)
1986 Pakem (6 May 1986 package) reforms include simpler investment approvals, more liberal foreign ownership, a duty exemption and drawback scheme. Devaluation of rupiah by 45%
1987 ‘Sumarlin shock’: banks required to buy back SBPUs (money market securities); state-owned enterprises required to put deposits at central bank
1988 Pakto (October package) major banking reform and deregulation. Pakdes (December package) II: NBFIs (non-bank financial institutions) authorised and regulated; foreign ownership in securities companies allowed; state-owned investment bank Danareksa’s privileges limited
1990 Bank Duta crisis; normalisation of relations with China
1991 Pakfeb (February package): tighter banking supervision measures issued; loan team established to limit overseas borrowing of state-owned firms; Bank Summa collapse
1992 Banking law enacted; Intergovernmental Group on Indonesia (IGGI) abolished
1993 Prudential regulations on banks relaxed; central bank head of supervision fi red
1994 New investment law allows 100% foreign-owned companies; new Tariff and Fiscal Team imposes ‘surcharge’ on imports
1995 Company law, capital markets law approved
1996 Customs takes back duties from SGS; ASEAN Free Trade Area (AFTA) tariff reduction schedule announced
1997 Rupiah floated; first IMF-supported program
1998 Indonesian Bank Restructuring Agency (IBRA) established; Soeharto resigns; new banking law passed (Law 10/98)
2001 Decentralisation law implemented
2002 Law on anti-corruption commission passed
2003 State finances law passed (Law 17/2003); graduation from IMF-supported program
2004 Closure of IBRA

Source: Hofman, Rodrick-Jones and Thee (2004).

Following the crisis, reformasi began to build institutions that put effective
checks on power. There has been remarkable progress over a short period, including
direct elections for president, governors and mayors; decentralisation of
power to over 400 local governments; creation of a host of new oversight institutions,
including an anti-corruption commission; and introduction of an extensive
legal framework for better management of state finances. Meanwhile a vibrant
civil society and unfettered media have emerged. Many of the new institutions
have teething problems, but they promise to become a solid institutional basis for
Indonesia’s future development.

MAJOR POLICY AREAS

Macroeconomic policy

From the onset of reform, macroeconomic stability was a key issue for both countries.
Indonesia was tainted by the hyperinflation of the latter Soekarno days,
while China’s memories of the Guomindang regime’s demise amid high inflation
were still vivid. Indonesia was prone to macroeconomic shocks because of its
commodity dependence in the first decades of reform, whereas China repeatedly
experienced bouts of overheating and inflation due to local governments’ drive
for investment and growth.

China’s economy showed a pattern of fluctuating economic growth and inflation
throughout the 1980s and 1990s. Each wave of reform was taken as a signal
by local governments to reduce controls over enterprises and credit. State enterprises
could at first obtain easy credit from the state banking system, and were
little concerned about profits and losses—a soft budget constraint like the one
found in other transition countries. Macroeconomic management was therefore
more a matter of accelerating or slowing reforms and decentralisation of investment
approvals, rather than one of using ‘modern’ tools of indirect aggregate
demand management. Monetary policy started to play a role in macroeconomic
management only after the mid-1990s when the central bank law was passed.
Until then, local governments’ influence on monetary expansion was large. Local
branches of the central bank were in charge of part of the credit plan, which was
often overtaken by local or central leaders’ desire to finance favourite projects
from state bank credit; this in turn was refinanced by the central bank (Hofman
1993). Expansionary periods were followed by periods of macroeconomic
retrenchment, which were largely managed through the planning system, notably
the fixed investment plan. Monetary policy played only a minor role in managing demand, and interest rates remained controlled well after 2000. But even a more
flexible interest policy probably would have failed to control investment demand
in the presence of state enterprises that were little concerned with the ‘bottom
line’. Changes in deposit interest rates were used on occasion, though, to reduce
consumer demand by luring deposits into the banking system.

Fiscal policy played a limited role in the first decades of reform, as it had in the
socialist planning period. Gradual price liberalisation, combined with entry of
non-state enterprises, had eroded the monopoly profits of SOEs and with them the
traditional tax base. The intergovernmental fiscal system had given strong incentives
for local governments to grow, but had also undermined the central government’s
share of revenue. By the mid-1990s general government revenues had
fallen to 10% of GDP, down from more than 30% in 1978, and the central government
share of these revenues was below 30%. Meanwhile, extra-budgetary funds
had become as large as budgetary funds, and although official budget deficits
remained small, quasi-fiscal operations through the banking system amounted to
some 5–7% of GDP in the early 1990s. At that time, China would have been highly
vulnerable to a financial crisis were it not for its closed capital account.

Since the 1993 Decisions of the CCCPC on Establishing the Socialist Market Economy,
China has gradually developed the instruments of modern macroeconomic
management. The central bank law and the reorganisation of the central bank system
recentralised control over monetary policy. The establishment of three bond-
financed policy banks reduced the need for the central bank to fi nance policy loans
with base money creation. And more rapid SOE reforms in the late 1990s reduced
the need for banks to continue to finance loss-making state enterprises. The 1994
reforms in the fiscal system, which included a VAT and a tax-sharing system to
replace tax contracting (Lou 1997), gradually increased the share of government
revenues in GDP (to some 19% in 2006), and the central government share of
those revenues from less than 30% in 1994 to almost 60% in 2006. The creation
of a government bonds market also allowed the government to pursue a more
active fiscal policy and seek non-inflationary means of financing the deficit.13 This
proved useful in mobilising a fiscal stimulus in the aftermath of the Asian crisis,
which did not hit China directly but lowered growth significantly in 1998 and
1999. Meanwhile, monetary policy gained in importance through the gradual liberalisation
of interest rates, starting with the interbank rate in the mid-1990s and
a gradual liberalisation in lending rates. Nowadays, lending rates in urban areas
are liberalised above the minimum rate set by the central bank, while restrictions
remain in rural areas, where interest rates are capped, as are deposit rates, in part
to avoid the weakest banks attracting most deposits.

Despite progress in creating indirect tools of macroeconomic management,
China still has to rely on the administrative system to manage demand. A key reason
for this is its exchange rate policy which, after unification of the exchange rate
in 1993, remains a tightly managed float with only limited flexibility and, some
would argue, an undervalued exchange rate. The consequence is that monetary
policy remains partially determined by balance of payments surpluses. Since the early 2000s, these surpluses have risen steadily, and abundant domestic liquidity
has fed an investment boom. In recent years the authorities have taken several
administrative measures to control investment demand, and have provided
banks with ‘guidance’ to contain lending.

13, China had issued government bonds to finance the deficit since the early 1980s. However, this often took the form of forced placement of bonds with banks, and even with individual state enterprise employees and civil servants.

Indonesia’s macro-management has relied on more familiar indirect tools. It used exchange rate, fiscal and monetary policies to reduce absorption in times of excess demand. But in doing so, the country employed some highly unusual methods, and created new institutions that lent credibility to its policies. During the 1966–69 stabilisation period, several core institutions of economic management were established that lasted throughout the New Order, including an open capital account, a competitive exchange rate and a balanced budget rule. The balanced budget rule and the open capital account de facto externalised the budget constraint, which served the country well in limiting excess demand. The exchange arrangement not only assured foreign investors that they would be able to repatriate their earnings, but also imposed a discipline on the government’s macroeconomic policies. After Pertamina’s 1975 foreign debt crisis and the drop in oil prices in 1981 and 1986, fiscal adjustments were used to control aggregate demand, usually on the spending side. In 1983, control of demand was achieved by means of major tax reforms that raised non-oil revenues. Monetary policy played its role from time to time, most famously with the 1987 ‘Sumarlin shock’ (named for the finance minister who implemented it), which engineered a sharp monetary tightening by moving SOE deposits to the central bank.

Indonesia is best known for its use of the exchange rate as a macro tool. The regular, radical depreciations that it used to adjust absorption and restore competitiveness are a remarkable feature of Indonesia’s economic management. Unlike other countries that resisted such measures until considerable loss of foreign reserves had occurred, Indonesia used this tool in a timely manner, even preventively. Woo, Glassburner and Nasution (1994) point out the important role the exchange rate played in Indonesia’s macroeconomic policy mix, as well as the benefi cial effects depreciation had on income distribution. Exchange rate policies also helped Indonesia avoid the ‘Dutch disease’ to which other resource- dependent economies were prone. Investments in infrastructure and agriculture financed from oil receipts played a part in this as well, as did subsidised energy for industry, which became fiscally unsustainable once the oil balance deteriorated.

Agricultural policies

Agricultural policies were central to the agenda from the start of reform in China
and Indonesia alike. In China, agriculture formed the first stage of the reform
process, whereas in Indonesia, the rehabilitation part of the stabilisation and
rehabilitation policies focused on agricultural facilities such as irrigation systems
and rural roads. Starting from different bases, China and Indonesia both managed
to increase agricultural production sharply, and much of this was achieved through
better agricultural policies and pricing, although input and output subsidies and
trade protection also contributed.

China’s agricultural policies were traditionally aimed at taxing agriculture to
fund rapid industrial development, and collectivisation in the 1950s had eliminated
individual land holding. China’s reforms took off with two fundamental
changes in agricultural policy—one planned, and one emerging from local initiatives (Du 1989). The Decisions of the 3rd Plenum of the 11th CCCPC at the end
of 1978 increased procurement prices for several agricultural products, including
rice, and reduced the mandatory state grain procurement quotas in order to grant
collectives more autonomy in managing their affairs. At the same time, however,
the Decisions explicitly condemned individual farming (Naughton 2006: 241). Yet
experiments with the household responsibility system (HRS) were already taking
place in several provinces, notably Anhui and Sichuan; these rewarded individual
households on the basis of their output, rather than on their inputs as had been
the case under the collective system. By 1980 the HRS had expanded from remote
areas to all areas with food shortages. In 1981 the policy became the official line
and by the end of 1982 more than 90% of agricultural households were subject to
some form of contracting. Land leases emerged during the same period, starting
with three-year terms, then five, and ultimately up to 30-year leases that steadily
shifted land user rights from the collectives to the farmer. The results of the new
policy were dramatic, with grain output increasing by one-third in the period
1979–84, and steadily rising thereafter. Even more remarkably, other crops like
cotton and oilseeds, and meat production, expanded more rapidly still (Naughton
2006: 242) as households diversifi ed away from rice, while, as shown above, the
share of the labour force in agriculture rapidly declined.

The rapid productivity increases in agriculture were due not only to the
changed incentive system brought about by the HRS. Increases in yield per hectare
of grain crops were, as in Indonesia, also due to higher fertiliser use and rapid
mechanisation, which resulted from the sprawling rural industry that emerged
after the reforms. By 1978, China had already introduced the hybrid rice of the
green revolution, and had expanded its irrigation network, but the HRS and rural
industrialisation allowed better use of it. From the mid-1980s, government was
still concerned about agricultural development for reasons of food security, but
also for reasons of income distribution. As off-farm and urban incomes started
to outpace agricultural incomes, the government gradually increased procurement
prices for grain. In the mid-1990s, food security policies boosted grain procurement
prices further, but by the early 2000s WTO entry had reduced many of
the tariffs that protected agricultural goods (although quota protection of grain
remains). Further, as planting policies relaxed, grain production came under pressure
from diversification toward non-grain crops with higher value added. In
reaction, the government began a program of grain production subsidies in 2003.
More importantly for rural incomes, the agricultural tax and many rural fees for
government services were abolished in 2004/05.

In its First Five-Year Development Plan (1969/70–1973/74), Indonesia gave first priority to agricultural development in general. In practice, agricultural policy
was focused on self-sufficiency in rice. Because of the large share rice had
in Indonesians’ diet, its price and availability were crucial to maintaining both
price stability and political stability. Hence, food policy during this period was
effectively rice policy. New rice varieties, investment in irrigation and other rural
infrastructure, agricultural extension, subsidised finance and price stabilisation
through the food logistics agency, Bulog, became the main tools for achieving
self-suffi ciency.

From virtually zero in the mid-1960s, the use of high-yielding rice varieties had reached 85% by the mid-1980s. Extensive government investment in irrigation financed from vastly increased oil revenues, and higher education standards, facilitated area expansion and rice intensification. These investments allowed for increases in the farm-gate prices without undue consumer price rises. Investment in physical infrastructure, in part financed by the successful Inpres Desa grants to villages, was complemented by development of public sector institutions that provided the rice economy with financial, marketing and extension services. These served as important links between expanding production possibilities and improved physical infrastructure by providing the financial and educational prerequisites for technological innovation (Tabor 1992: 173 –4). Bulog was charged with defending the rice floor price through government purchases, and with stabilising the consumer price by marketing stored or imported rice when prices rose too sharply. Carrying out these tasks required large and continuing subsidies from the government budget and through the credit system, but the verdict is that Bulog was successful in maintaining appropriate rice prices (Pearson and Monke 1991: 2 –3), although in later years the organisation became increasingly prone to corruption.

Trade and investment policies

Both countries started their reforms with very limited interaction with the international economy, but became very open economies in the course of reform. Indeed for China, ‘opening up’ was central to reforms, and Geige Kaifang (Opening Up and Reform) became the shorthand for China’s reform experiment. China opened up in its characteristic gradual manner—over time and across geographical space—while Indonesia did so in leaps and bounds when the opportunity arose. Each came up with its own successful innovations in opening up—China with its successful SEZs, and Indonesia with radical steps in customs reform and trade taxes. International commitments, Indonesia through early membership of the General Agreement of Tariffs and Trade (GATT) in the mid-1980s, and China through its protracted negotiations for WTO membership, were used to push through the necessary domestic reforms. And both used an active exchange rate policy to maintain their competitiveness while making trade reforms more palatable for those set to lose from reduced protection.

Until 1978, China was practically a closed economy, with very limited trade
and financial interaction with the rest of the world, and with self-suffi ciency as
a proclaimed policy goal. This situation had only started to change, at a glacial
pace, after Nixon’s visit to China in the early 1970s. The economic reform initiated
in 1978 brought rapid change, and over the last two and a half decades
China has become one of the most open countries in the world. China’s degree
of openness is rare among economies with population or GDP of similar size. It
has also been very successful in attracting FDI: China received about a quarter of
all FDI to developing countries between 2001 and 2005 and a record $60.6 billion
in 2004, some 9.9% of total global FDI. The reforms that achieved this included:

(i) gradual liberalisation of the trade planning system; (ii) gradual reforms in the
foreign exchange and payments system; and (iii) opening up to FDI.
Before reform, foreign trade was part of the Plan, and was conducted through
12 foreign trade companies (FTCs) which had a monopoly on trade and could
procure and sell goods for export and import at planned prices. With the start of
reform, these FTCs gradually lost their monopoly on foreign trade because their numbers were increased (by 1986 there were 1,200 FTCs) and because of the SEZs,
which allowed foreign-invested companies to trade completely outside the Plan
(World Bank 1994: 26). The foreign trade monopoly of the FTCs was abolished in
the mid-1990s.

Tariff reduction played a minor role in trade liberalisation during the fi rst 15
years. Average tariffs had only dropped from 56% in the early 1980s to 43% in
1992. In the run-up to its WTO accession, though, China implemented a major
reduction in tariffs and other trade barriers, with average tariffs falling from over
40% to 15% by the time of entry in 2001, and to 10% by end-2005. The reform of the
tax system, with the introduction of a VAT and rebates of VAT paid on exported
goods, further boosted trade, as did the unification of the exchange rate in 1994
and the current account convertibility of the renminbi (RMB) in 1995, which went
along with a de facto currency depreciation of about 10%.

The second pillar of China’s opening up was the gradual reform of the foreign
exchange system. Before the reforms, foreign exchange was allocated according
to the Plan, and all foreign exchange had to be handed over to the central bank.
At the start of reform, the Bank of China was the only bank that was allowed to
conduct business in foreign currency. To attract FDI, foreign banks were allowed
to set up branches in SEZs, but they were not allowed to conduct business in
RMB. In 1979 the authorities began to allow domestic firms and local governments
to retain part of their foreign exchange earnings. This share varied over
time and depended on the source of the exchange earnings. Entities could use
their foreign exchange retention quota to buy foreign exchange at the offi cial rate
and to import products with prior approval from the Ministry of Foreign Trade.
The foreign exchange retention quota was gradually increased. By end of 1993
when the retention system was abolished, total foreign exchange retention had
already reached 80% of export proceeds, leaving only 20% of trade within the
Plan. A dual exchange rate system introduced in 1979 provided additional incentives
for export. At introduction, the dual exchange rate used for exporters was 2.8
RMB/$, compared with the official rate of 1.5 RMB/$. The authorities gradually
devalued the official rate and partially unified the two rates in 1985. After that,
so-called swap centres were established to trade foreign exchange or retention
quotas at an exchange rate more depreciated than the official rate. In 1995, a fully
unified exchange rate was established.

The third pillar of the opening of China’s economy was SEZs. Enterprises in
these zones enjoyed tax exemptions and reductions as well as better infra structure
and often better government services. The evolution of FDI policies is the most
striking example of gradual policy across geographic space. In 1980, the fi rst SEZs
were established in four coastal cities. These zones were allowed to offer special
advantages to attract foreign investors and became an instant success in generating
trade: within four years (1981–84), the trade volume of Shenzhen SEZ has
increased 60-fold. The SEZ policy was extended to 14 coastal cities in 1984 and to
the deltas of the Yangtze, Pearl and Minnan rivers in 1985. In 1988, Hainan Island
and another 140 coastal cities and counties were included, and by 1999 all western
provinces were open to FDI. Foreign-invested enterprises outside SEZs enjoyed
considerable advantages over domestic enterprises as well, among them lower
income tax rates, and often lower prices for land and utilities granted by local
governments eager to attract FDI. As a consequence, much of China’s success in exports was due to foreign-invested firms, whose export share rose from 1% of the total in 1985 to more than 50% in 2005.

Indonesia’s opening up hardly followed a straight line: initial rapid liberalisation
was followed by back-tracking in the 1970s, renewed reforms in the
1980s, and selected protection of first-family interests in the 1990s. Indonesia’s
1966–70 reforms, including simplification of the foreign trade regime, a reduction
in preferential treatment for SOEs and the enactment of the foreign and domestic
investment laws, fostered broad-based industrial growth for the first time since
independence. In return, the government received extensive and vital tax revenues
on which it would depend over the next three decades. After the mid-1970s,
industrial growth began to slow as the limits to growth of the domestic market
were reached. The onset of the oil boom in the mid-1970s and the Malari incident
led to a phase of state-directed industrialisation (Hill 1996: 28). During this period
the government reversed its liberal trade regime, introducing more tariffs and
non-tariff trade barriers (NTBs). Effective protection rates increased (Hill 2000:
114) and foreign investment became more restricted.

After the oil boom ended, Indonesia returned to an outward-looking, export-
promoting industrialisation strategy, at first hesitantly, but in earnest after the
steep oil price decline in early 1986. The government introduced a series of trade
reforms in 1982 to reduce the ‘anti-export bias’, while reforming taxes to safeguard
revenues—introducing a VAT and a property tax in 1983. A major reform
was the introduction of a ‘duty exemption and drawback scheme’ in 1986, which
exempted export-oriented firms from all import duties and regulations on importing
their inputs—much like the arrangements for processing trade in SEZs in
China. Two institutional innovations helped Indonesia’s economic technocrats to
regain control over trade policy: the Tariff Team (Tim Tarif) and the outsourcing of
the customs service. Tim Tarif, set up in 1985, centralised controls over the tariff-
setting process, and average tariff rates were reduced in a number of steps from
27% in 1985 to 20% by 1994 and, after some slowdown in the mid-1990s, to a mere
6.4% in 2004 (Basri and Soesastro 2005; WTO 2003). A strikingly effective measure
was to transfer investigation and clearance of most import consignments from
the Directorate General of Customs to the Swiss firm Société Générale de Surveillance
(SGS): clearance costs dropped to one-fifth of their former level (Dick 1985:
10), boosting trade and tariff revenues alike. Flanking these trade reforms were
measures to re-liberalise the foreign investment regime, including a reduction in
the number of approval steps, introduction of a ‘one-stop shop’ (the Investment
Coordinating Board, BPKM, although it never functioned as such) and by the
early 1990s the move to a negative list of sectors in which foreign investment was
restricted. Renewed liberalisation commitments in 1996 fell victim to the crisis,
though, and reform momentum was not sustained in the post-crisis period, with
trade and investment policy diffused across different ministries.

Financial sector reforms

China and Indonesia started major financial sector reforms fairly late in the reform period. While each had initially taken a number of reform steps, notably to re-establish the role of the central bank, both were more than 15 years along the reform path before financial reforms accelerated. China’s reforms were traditionally gradual, whereas Indonesia’s, notably the October 1988 reform package (Pakto), were a‘Big Bang’. The reforms had very different outcomes: arguably, China’s reforms were conducive to growing out of the severe problems that plagued the financial sector by the mid-1990s, whereas Indonesia’s fi nancial sector was a catalyst for the 1997 crisis. China’s financial system was able to mobilise far more resources than Indonesia’s (fi gure 10): whereas M2 (broad money) as a share of China’s GDP rose from 24% at the start of reforms to more than 150% by end-2005, Indonesia’s comparable numbers are only 7% and 43%.

China’s financial sector reforms can be seen to consist of a gradual increase in the type and number of banks, combined with a gradual relaxation of restrictions on lending. Before reform, China’s financial system resembled that of other soviet-style planned economies. The People’s Bank of China (PBC) was the only bank in China under the planning system and functioned simultaneously as central bank, commercial bank and state treasurer. Most investment was financed from the budget, while the PBC provided working capital ‘loans’, which served as an accounting tool for the Plan. Households had almost no savings or financial assets, and were mostly limited to cash.

Reforms initially focused on breaking up the monobank system by creating four specialised banks from the PBC. These state-owned commercial banks (SOCBs) remained the mainstay of the banking system throughout reform, but their market share gradually declined from almost 100% in the mid-1980s to about 55% by end-2005. Entry of national joint-stock banks, urban cooperatives, city commercial banks and rural credit cooperatives gradually eroded the SOCBs’ market share. Competition from non-bank financial institutions, including Trust and Investment Companies (TICs) and security companies, added to differentiation in the financial sector—but also to the risks, and many of the TICs had to be resolved in the 1990s, including through closure. The 1994 reforms added the state-owned policy banks which, in principle, served to relieve the commercial banks of their policy function. Non-state share ownership was allowed after 1994, and foreign stakes in banks of up to 25% of total shares were allowed under the conditions of China’s WTO entry in 2001.

During the early stages of reform, the credit plan remained the dominant policy instrument. The plan allocated credit according to the state’s investment priorities, and with state-set interest rates that varied in line with priorities, leaving little discretion to the banks. The plan was gradually relaxed, first with a shift from direction of all individual credits to sectoral distribution within an overall credit limit; directed lending was refinanced by the central bank, which used its abundant seignorage to finance these policy loans. After the banking law was passed in 1994 and the credit plan abolished, banks were in principle free to lend to whomever they wanted. In practice, government—notably local government—influence on banks remained significant, and many banks continued to build up non-performing loans (NPLs). For the SOCBs this started to change after the 1990s, for four reasons: (1) the Asian crisis had brought home the point that a weak financial sector could trigger a crisis; (2) progress in state enterprise reform had reduced the necessity to keep lending to SOEs for social stability reasons;

(3) state development banks had gradually built up the capacity to take over the policy lending function from commercial banks; and (4) government revenues had started to recover, making the budget better able to absorb the costs of bank restructuring.

By 1998, financial sector reform began to take shape. SOCBs embarked on
major financial and operational restructuring, closing branches, centralising lending
authority to provincial and head offices, and shifting NPLs to newly created
asset management companies (AMCs). Banks were recapitalised on several occasions
to an estimated 25% of GDP, in part by using China’s international reserves,
and by issuing state bonds in return for NPLs that were moved to AMCs. Meanwhile,
interest rate liberalisation and widening of margins between the regulated
deposit rate and the minimum lending rate allowed a return to bank profi tability.
In addition, pressures from external competition committed to under the WTO
accession helped accelerate bank sector restructuring. Finally, bank supervision
had greatly improved by the early 2000s, through years of capacity-building
within the central bank.

Crucial to financial sector reforms were the SOE reforms that preceded them:
between 1996 and 2001, the SOE workforce was halved, social services were
shifted to local governments, housing was privatised and many SOEs were
merged or closed. Restructuring results have been impressive: the number of
commercial bank branches dropped from some 145,000 in 1992 to 80,000 in 2005
(World Bank 1995; China Statistical Yearbook 2006), while the share of NPLs in the
portfolio plunged. Although data from the early 1990s are hard to obtain, NPLs
were thought to be 40–50% of the portfolio, and official numbers suggest that
even as recently as 2001 the NPL ratio was almost 30%. By end-2006, the official
number was below 8%.14

Financial sector liberalisation was also a latecomer in Indonesia. Under Soekarno, one bank performed both central bank and commercial bank functions.

14, Data from the China Bank Regulatory Commission.

In 1968 the banking system was reconstituted with Bank Indonesia (BI) as the central bank. However, BI was dominated by the Monetary Board chaired by the Minister of Finance, and only gained independence after the crisis. Directed credit remained an integral part of the government’s industrial policy until the 1980s. Meanwhile, deposit interest rates were controlled, and sometimes negative in real terms, resulting in limited resource mobilisation through the banking system. The 1983 reforms and the 1988 Pakto reforms sought to enhance fi nancial sector efficiency by encouraging competition and by increasing availability of long-term finance through development of a capital market. Removal of entry barriers caused a rapid increase in the number of banks and in domestic credit. But weaknesses in the financial sector and policy reversal on banking reforms became the defining issue in Indonesia’s crisis. The extensive banking liberalisation measures required better regulations, which were enacted between 1990 and 1992 but never fully practised, and regulatory forbearance and political intervention became the norm. Under the November 1997 IMF-supported crisis recovery program, 16 banks were to be closed, while some 34 others were to continue their ‘nursing arrangements’ with BI. The bank closures themselves were carried out smoothly, but the trigger for the failure of the fi rst IMF- supported program was probably the effective reopening of one of the closed banks—the one owned by Soeharto’s son. This shed doubts on the authorities’ resolve or ability to tackle weaknesses in the financial system, doubts further fed by the finance minister’s end-November announcement that no more bank closures would take place. Uncertainty about banks’ health, combined with a limited deposit guarantee, caused massive withdrawal of deposits from private domestic banks; these were largely transferred to state-owned banks—seen as implicitly guaranteed by the state—or used for further speculation against the rupiah.

The bank restructuring plans of January 1998 included a blanket guarantee for all depositors and most bank creditors, limitations on access to central bank liquidity loans and the creation of the Indonesian Bank Restructuring Agency (IBRA). IBRA had the massive task of managing, restructuring and selling the banks and the NPLs taken out of the banking system. In the end, recovery on assets was some 28% of book value, similar to that in Thailand, and slightly better than the recovery on China’s NPLs thus far. Bank restructuring was quite remarkable: the number of banking institutions was slashed from 240 before the crisis to 138 in 2003 (Srinivas and Sitorus 2004), and many state-owned banks and banks taken over during the crisis were privatised, and prudential indicators vastly improved. While bank credit is still modest (some 25% of GDP) and growth in credit has remained subdued, this may be due more to lack of demand at prevailing interest rates than to weaknesses in the banking sector.

CONCLUSIONS

Some broad conclusions emerge from this review of the growth experience and development strategies of the two countries. China grew more rapidly than Indonesia, in part because it had already invested heavily in physical and human capital before reform began. Reforms then reallocated productive capacity to better use. Indonesia had to build more human and physical capital from scratch; it did this in the 1970s, and started to use it better in the 1980s after the trade reforms. China’s financial system was more effective than Indonesia’s in raising the substantial fi nance needed for its more capital-intensive growth, while a closed capital account and increasingly strong supervision avoided the type of financial crisis that Indonesia experienced after its attempt to reform the financial sector. At the same time, China’s financial sector reduced the pressures for reform in state enterprises, and some past investment would probably have been made more efficiently with less financial repression (Dollar and Wei 2007). China also grew more rapidly because it was able to sustain its reforms over long periods, whereas Indonesia’s reform process saw more swings of the pendulum. Part of China’s success in sustaining reform has been its ability to develop domestic capacity to design ‘home-grown’ reforms suited to its conditions, whereas throughout the Soeharto era this capacity remained limited in Indonesia, where reforms were produced by only a handful of good policy makers supported by outside advisers. Within a similar one party-dominated political setting, China avoided capture and concentration of power by building institutions within the party and government that put a check on power abuse and corruption, although the latter was not completely avoided. Power was also decentralised in a way that was by and large conducive to growth. In contrast, power in Indonesia became increasingly concentrated in the president, without the checks and balances imposed in China. China’s decentralisation gave strong incentives for local leaders to pursue growth; in Indonesia’s more recent decentralisation these incentives are weak on the revenue side, although democratic control over the executive may well overcome this disadvantage in the medium run. Indonesia experienced more equitable growth than China, in part because it avoided price discrimination against farmers, in part because it allowed freer movement of people, and in part because it invested early in infrastructure that connected rural areas with the growing economy (Timmer 2004). Indonesia also showed more savvy in the packaging of reforms, which, by design or by default, had ‘something for everyone’, or included creative means of compensating possible losers, such as by use of the exchange rate. As China grows richer, and policy objectives are no longer all aligned with growth, trade-offs between various policy objectives will emerge, and packaging measures to ensure that the benefits of reforms are spread will become more important.

REFERENCES

Barro, Robert J. and Lee, Jong-Wha (2000) ‘International data on educational attainment: updates and implications‘, CID Working Paper No. 42, April, Center for International

Development, Harvard University, Cambridge MA, available at <http://www.cid.harvard.edu/cidwp/042.htm>.
Basri, Chatib and Soesastro, Hadi (2005) ‘The political economy of trade policy in Indonesia’, CSIS Working Paper Series 92, Centre for Strategic and International Studies,

Jakarta. Biller, Dan (2006) Sustainable development on the urban fringe, World Bank, Washington DC, mimeo.

Boediono (2005) ‘Managing the Indonesian economy: some lessons from the past’, Bulletin of Indonesian Economic Studies 41 (3): 309–24. Booth, Anne and McCawley, Peter (1981) The Indonesian Economy during the Soeharto Era, Oxford University Press, Kuala Lumpur.

Deng, Xiaoping (1991) ‘Emancipate the mind, seek truth from facts and unite as one looking
into the future’, in Major Documents of the People’s Republic of China, Foreign Language
Press Beijing: ch. 2.

Deng, Xiaoping (1994) Selected Works, Volume III, Foreign Language Press, Beijing.

Dick, Howard (1985) ‘Survey of recent developments’, Bulletin of Indonesian Economic Studies 21 (3): 1–29.

Dollar, David and Wei, Shang-Jin (2007) ‘Das (Wasted) Kapital: firm ownership and investment efficiency in China’, NBER Working Paper No. 13103, National Bureau of Economic
Research, Cambridge MA, May.

Du, Runsheng (1989) Many People, Little Land: China’s Rural Economic Reforms, Foreign Language Press, Beijing.

Hill, Hal (1996) The Indonesian Economy, Cambridge University Press, Cambridge.

Hill, Hal (2000) The Indonesian Economy, 2nd edition, Cambridge University Press, Cambridge.

Hofman, Bert (1993) ‘An analysis of Chinese fiscal data over the reform period’, China Economic Review 4 (2): 213–30.

Hofman, Bert, Rodrick-Jones, Ella and Thee Kian Wie (2004) Indonesia: rapid growth; weak institutions, Paper prepared for the Shanghai Conference on ‘Scaling Up Poverty Reduction’, 28–29 May, World Bank, Jakarta, mimeo. IMF (International Monetary Fund) (2006) World Economic Outlook, Washington DC.

Keefer, Philip (2007) ‘Governance and economic growth’, in Dancing with Giants, eds L. Alan Winters and Shahid Yusuf, World Bank, Washington DC, and Institute for Policy Studies, Singapore.

Kong, Tao (forthcoming) Economic Growth and Political Institutions: Theories and Empirics,
Edward Elgar Publishing, Cheltenham.

Kuijs, Louis and Wang, Tao (2005) ‘China’s pattern of growth: moving to sustainability and reducing inequality’, World Bank Policy Research Paper No. 3767, Washington DC.

Lankester, Tim (2004) ‘Asian drama: the pursuit of modernization in India and Indonesia’,
World Economics 5 (3): 75–94.

Lardy, Nicholas R. (2003) China’s Unfinished Economic Revolution, Brookings Institution,
Washington DC.

Lin, Justin Yifu, Cai, Fang and Li, Zhou (2003) The China Miracle: Development Strategy and
Economic Reform, revised edition, The Chinese University Press, Hong Kong.

Lou, Jiwei (1997) ‘Macroeconomic reforms in China: laying the foundations for a socialist
market economy’, World Bank Discussion Paper 374, Washington DC.

Myrdal, Gunnar (1968) Asian Drama: An Inquiry into the Poverty of Nations, Twentieth Century Fund, New York NY.

Naughton, Barry (1995) Growing Out of the Plan: Chinese Economic Reforms 1978–1993, Cambridge University Press, Cambridge.

Naughton, Barry (2006) The Chinese Economy: Transitions and Growth, MIT Press, Cambridge MA.

OECD (Organisation for Economic Co-operation and Development) (2005) China Economic Survey, Paris.

Pearson, Scott and Monke, Eric (1991) ‘Introduction’, in Rice Policy in Indonesia, eds Scott Pearson, Walter Falcon, Paul Heytens, Eric Monke and Rosamond Naylor, Cornell University Press, Ithaca NY and London.

Qian, Yingyi and Weingast, Barry (1997) ‘Federalism as a commitment to preserving market incentives’, Journal of Economic Perspectives 11 (4): 83–92.

Ravallion, Martin and Chen, Shaohua (2004) ‘China’s (uneven) progress against poverty’,
World Bank Policy Research Working Paper No. 3408, Washington DC.

Roland, Gerard (2000) Transition and Economics: Politics, Markets and Firms, MIT Press, Cambridge MA.

Schwarz, Adam (1994) A Nation in Waiting: Indonesia in the 1990s, Westview Press, Boulder CO.

Srinivas, P.S. and Sitorus, Djauhari (2004) The role of state-owned banks in Indonesia, Paper presented at the World Bank/Brookings Institution conference on ‘The Role of State-Owned Financial Institutions: Policy and Practice’, 26–27 April, Washington DC.

Tabor, Stephen R. (1992) ‘Agriculture in transition’, in The Oil Boom and After: Indonesian Economic Policy and Performance in the Soeharto Era, ed. Anne Booth, Oxford University Press, Singapore: 161–203.

Timmer, C. Peter (2004) ‘The road to pro-poor growth: the Indonesian experience in regional perspective’, Bulletin of Indonesian Economic Studies 40 (2): 173–203.

Woo, Wing Thye, Glassburner, Bruce and Nasution, Anwar (1994) Macroeconomic Policies, Crises, and Long Term Growth in Indonesia 1965–90, World Bank, Washington DC.

World Bank (1981) Socialist Economic Development, Washington DC.

World Bank (1993) The East Asia Miracle: Economic Growth and Public Policy, Washington DC.

World Bank (1994) China: Foreign Trade Reforms, Washington DC.

World Bank (1995) China banking sector reforms, current status and issues, Washington DC, mimeo.

World Bank (1996) World Development Report 2006: From Plan to Market, World Bank, Washington DC, and Oxford University Press, Oxford.

World Bank (2006a) East Asia Update, Washington DC, November.

World Bank (2006b) Making the New Indonesia Work for the Poor, Jakarta, December.

World Bank (forthcoming) China Poverty Assessment, Washington DC.

WDI (2006), World Development Indicators, World Bank, Washington DC, electronic version, available at <http://devdata.worldbank.org/wdi2006/contents/Section4.htm>.

WTO (World Trade Organization) (2003) Indonesia Trade Policy Review, Geneva.

Wu, Jinglian (2005) Understanding and Interpreting Chinese Economic Reforms, Texere Press,
New York NY.

Zhang, Michael W. and Cooray, N.S. (2004) ‘China and Indonesia compared: sustainable industrialisation in large developing economies’, UNU/IAS Working Paper No. 108, United Nations University, Institute of Advanced Studies, Tokyo.

Zhao, Min (2006) ‘External liberalization and the evolution of China’s exchange system: an empirical approach’, World Bank China Office Research Paper No. 4, Beijing.

Zheng, Douglas Zhihua and Wang, Shuilin (2006) China and the knowledge economy: a SWOT analysis, World Bank, Washington DC, mimeo.

——————————————————————————————————————————————————————

北京大军经济观察研究中心

电话：86-10-63071372，传真：66079391，信箱：zdjun@263.net

地址：北京市西城区温家街2号，邮编：100031，

网站网址：www.dajun.com.cn