Indonesia: Ten Years After the Crisis

Lex Rieffel
Lex Rieffel
Lex Rieffel Former Brookings Expert

June 28, 2007

Most studies of the Asian financial crises in 1997 conclude that Indonesia suffered more than Thailand and Korea. Is it possible that Indonesia is the country that gained the most?

Assessments of the impact of the 1997 crises usually focus on economic indicators such as GDP growth, the unemployment rate, and the number of people living in poverty. Unfortunately social scientists have not yet invented equally good political indicators. If these existed they would show phenomenal improvement since 1997.

A first step in assessing the impact of what the Indonesians call their “monetary crisis” is to imagine what Indonesia would be like today if there had been no crisis. While this is a highly speculative exercise, it is easy to imagine that the Suharto regime would have survived in some form. Pressure on Suharto to transfer power to a successor was mounting visibly before the crisis, but he was sufficiently in control of the political system to assure his election to a seventh five-year term as President six months after the crisis. Suharto might have resigned before the end of his seventh term, or he might have engineered a succession to his hand picked candidate, but it is inconceivable that the Peoples Consultative Assembly in 2003 would have chosen by secret ballot a presidential candidate promising sweeping democratic reforms.

In this counterfactual scenario it is also hard to imagine that Indonesia’s economy would have remained healthy from 1997 to 2007. A sudden catastrophic meltdown might not have occurred, but a protracted period of economic contraction was almost inevitable. The country was experiencing an asset bubble that was not sustainable because too much investment was being directed to creating excess capacity in sectors such as high-rise office buildings and shopping malls. At the same time the ability of the technocrats to implement sound macroeconomic policies was being eroded as the business interests of Suharto’s family members and cronies became ascendant.

The crisis that forced Suharto to resign in May 1998 set the stage for a spectacular transition to a democratic political system. It may not be an exaggeration to say that Indonesia today has the most democratic system in all of Asia.

The political transition underway since 1998 has three outstanding features: electoral reform, decentralization of government authority, and freedom of the press. Under Suharto there was only one party of consequence, Golkar. Forty-eight parties competed in the parliamentary elections in 1999 and twenty-four parties in 2004. Most significantly, the constitution was amended to provide for the direct election of the President. Susilo Bambang Yudhyono (SBY), the first to be elected directly, was the candidate of a party that only won seven percent of the seats in the Parliamentary elections in 2004. Sixty-seven million people voted for SBY, the largest number ever in an open election anywhere in the world, and three million more than voted for President George W. Bush two months later. Since 2004, the heads of provinces and districts have also been elected directly in a well-orchestrated progression.

The decentralization of power from the central government at the beginning of 2001, bypassing the provinces, to Indonesia’s 440 districts and municipalities was possibly the most far-reaching decentralization of power seen in the modern world. As much as any other reform, this great leap broke the Suharto machine into pieces that are unlikely ever to be put back together because of the archipelago nature of the country and the wide dispersion of its rich endowment of natural resources.

With regard to press freedom, Indonesia may not rank above countries like India, Korea, and Japan, but it is on a par with them. And the contrast with more economically advanced countries such as Singapore, Malaysia, and Thailand is striking, not to mention China and the latest economic star in Southeast Asia, Vietnam.

The 1997 crisis produced a drop in GDP in 1998 of more than 13 percent, much larger than the drops in Thailand and Korea. Recovery from the crisis was also much slower. Remarkably, however, the fits and starts of the political transition did not interrupt a steady improvement, enabling Indonesia to exit from its IMF arrangement in 2004, reduce its public sector debt-to-GDP ratio to levels that make Italy and other European economies look unhealthy, enjoy easy access to international capital markets, and boost its foreign exchange reserves to unprecedented levels.

The democratic system in Indonesia is not yet consolidated. To move beyond this trial phase, the next Presidential election in 2009 will have to produce another strong mandate for the winner in a process as open and clean as the 2004 election. The economy has not yet moved up to the high growth path, above six percent per annum, that it followed for most of the Suharto era. Investment, especially in infrastructure, is below the level required to absorb new entrants into the labor force. Bureaucratic inertia and corruption remain Indonesia’s greatest challenges.

The bottom line is that the quiet revolution in Indonesia’s political system triggered by the 1997 financial crisis is the big story of the past ten years. It is a story that moved Indonesia far up the ladder relative to its Asian peers in the area of good governance. It is a surprising story that deserves much more attention than it is getting. Few Indonesians today seem inclined to argue that the political gains are greater than the economic costs that they bore in the aftermath of the crisis, but then how do you measure the value of good governance and freedom of expression?