ECONOMIC INEQUALITY IN INDONESIA

TRENDS, CAUSES, AND POLICY RESPONSE

SATISHCHANDRA MISHRA

(with assistance from B. Bawono Kristiaji & Ricardo G. Perkasa)

During the last decade the subject of economic inequality has enjoyed something of a renaissance. But then interest in and concern with economic distribution has always had a chequered history. First it enjoyed centre stage in the classical economics of Ricardo and Marx, was moved to the sidelines with the emergence of neo-classicism with its emphasis on the efficiency of resource allocation only to be brought out of the shadows, although in a very different form, by Keynes and the politics of the New Deal.

 The emergence of communist states of the USSR and later China lent considerations of economic inequality a new paradoxical character. The economics of the welfare state recognised the popular appeal of universal entitlement to basic public goods and services in democratic regimes. Its politics carefully contained the more radical elements of socialist thinking by resisting wholesale nationalisation of key industries and banks which had become the opening song of new socialist revolutions world wide. The utopian appeal of Marx and his exhortation to create a society driven by the slogan “to each according to his needs from each according to his ability”, was increasingly replaced by the language of equality of opportunity, social inclusion and human rights.

In developing countries, fascinated by the political weight and early successes of the USSR, the distribution of income carried a continuing fascination. Again there were some interesting paradoxes. Many, if not most, post colonial governments wereinherently attracted to the idea of a “fair distribution” of income, not onlyamong different segments of the population within their borders but also in theglobal economy as a whole. Equality of opportunity seemed to be an appealingconcept not only for their own citizens as they struggled to build nationstates and create the technical expertise needed to replace departing colonialadministrations and businesses. It was just as relevant at the world stage asdeveloping countries struggled to find a place in the economic sun which shonebrightly for the rich industrialised countries and so dimly for the majorityless affluent nations.

 Lacking robust business enterprises and thetechnical apparatus that went with it, post colonial governments soon realisedthat the more just world that they sought could only be brought about by theagency of the state. Even the much admired Soviet Unioncould not escape the ironies of “primitive socialist” accumulation by whichpeasants were starved to feed the cities and build the economic scaffolding ofthe new socialism, the heavy industry and the entire new cities which went withthem.

Early models ofdevelopment emphasised the “big push” and the capital accumulation which only amodern industrial sector could provide. Inequality was just a step in thescheme of things. The engine of growth in the much quoted Lewis model turned onthe transfer of labour from the low productivity subsistence sector to the highproductivity modern one. Here was an early justification for the statisticalgeneralisations of economic inequality during the process of developmentcaptured in the much revered Kuznet’s U by which economic inequality wasexpected to rise and then fall during the course of development.

The Kuznets Usucceeded in generating more than its fair share of academic and policy relatedcontroversy[1]. Thepolicy message, as with so much of the work on the distribution of income wasalso two sided. First, there was the comforting conclusion that economicinequality is just a passing phase. Indeed, an acceleration of economic growthcan even shorten the length of the shift from widening to narrowing economicinequality. Too much preoccupation with radical programs of assetredistribution and nationalisations would be, on this view, redundant andsocially risky.

Second, asocially unacceptable rise of economic inequality as predicted by the Kuznets Umight well put a stop to the economic reforms needed in the early phases ofdevelopment as political support for such programs evaporated. Just asproblematic was the likely emergence of new economic and political elites whichmight slow down the process of income equalisation as development proceeds.This second possible implication of the Kuznets hypothesis raised thepossibility of deliberate government policy to limit the rise in inequalitythrough a very diverse policy mix ranging from progressive taxation tocountervailing powers of public enterprises and labour unions on businessenterprises on the other.

But all that wasbefore the remarkable economic performance of the Asian “Miracle”countries.  Their emergence as seriouseconomic players in the global market in the late 1970s onwards seemed toprovide living proof, quite distinct from the dry academic calculations of an armyof economic technicians that growth does not always imply a worseningdistribution on income. Here were economies which seemed to have achieved in ashort span of around three decades record rates of high growth with low andstable levels of economic inequality.

 The answer as provided by the World Bank’smuch quoted East Asian Miracle study was open economy, export orientation,investment in human capital and small states. They provided a salutary lessonfor the rest of the developing world. Economic protectionism, large inefficientpublic enterprises backed by dirigiste states operating behind high tariff andnon-tariff barriers were a sure way towards faltering growth, high incomeinequality and corrupt bureaucracies. The Kuznets U was not therefore aninevitable feature of economic growth. It could be avoided by prudentmacroeconomic and appropriate public expenditure allocations towards humancapital.

The “miracle” inEast Asia was not high economic growth. Thishad occurred in many other countries including the USSR. The miracle was in being ableto combine high economic growth with seeming stable and low inequality ofincomes. Such “growth with equity” outcomes were attractive not only from aneconomic standpoint of being able to chose policies which could raise livingstandards and lower poverty in short spans of time. They were just asattractive in the realm of politics. They seemed to have provided evidence, ina world of falling communist dominos, that small states, free markets andinvestment in basic education and health would provide the fastest way to raisethe majority of the population above abject poverty.      

The success ofthe East Asian economies from the 1970s to the advent of the Asian EconomicCrisis of 1997/98 carried another political message not ignored by policymakers of the advanced industrial countries, and by osmosis absorbed byinternational financial institutions which they funded. This was the conclusionthat economic growth may not only be income distribution neutral but alsoneutral with respect to political regimes. This was a comfortable assessment atthe time of the Cold War since it allowed developed countries of the West tosupport Asian dictatorships as long as they were anti-communist. The logic wassimple enough. If growth was distribution neutral and distribution could bemanaged by a mixture of macroeconomic and social service oriented policies,there was little to choose between dictatorships and authoritarian regimes interms of their ability to raise the absolute poor above the poverty line.

The fact thatEast Asian economies also sported small states was an icing on the politicalcake. It gave further boost to the intuitive appeal of the Reagan Thatcheronslaught on large government and protected markets. Rolling back the statethrough a mixture of fiscal conservatism, privatisation and the introduction ofmarket-like budget allocation mechanisms in public services all fitted wellwith this new brand of conservatism, one which gave primacy to economic growthand relegated economic distribution to the back burner. Issues related toincome distribution and hence economic inequality were either those which wouldbe settled during the growth process itself (a la Kuznets among others), orwere one where governments could only meddle at their own peril.  

Capital marketliberalisations of the early 1990s and the globalisation of financial marketscombined with the rapid growth of world trade, the collapse of the USSR and thebotched privatisation of Russian public enterprises, and the instability ofinternational capital markets signalled by the Mexican Financial Crisis (1994)and the Asian Financial Crisis only four years later, all began to illustratethe complexity of the new increasingly globalised world. Anti-globalisationprotests in Seattle and in WTO meetings later, the collapse of many a thirdworld dictatorship in favour of multi party democracy, the emergence of radicalIslam, the rise of China and India, and the current global financial crisisemanating from sub-prime mortgage defaults in the US and culminating with thelargest bail out in economic history, have all begun to illustrate thatmechanical modelling of growth and distribution linkages[2]leaves out a huge spectrum of the cause and effect of country based policymaking which affects who gains control over what and how much resources at anygiven moment in history. Economical modelling has to large extent given way tophilosophical discourse; from distribution of income to fairness and economicjustice, from percentage of population below the poverty line to capabilities,freedoms and deprivations, from planning and projections to participation andvoice, from technical certainty to political complexity, from human capital tohuman development, social capital and trust.

In this new fastchanging and less ideologically certain world, economic injustice and the needto arrive at a “fairer” more “equitable” division of resources has moved tonear the centre of policy making. This concern is present in the “hearts andminds” campaigns of an Iraq or an Afghanistan, it is there in the fears ofsocial instability in India and China as income disparities noticeably worsen,it is also there in the politics of climate change and the collapsednegotiations of the Doha round. It is no longer the simple analytics a KuznetsU which is driving this new found concern with an age old political economytheme.

It is thejockeying for political space, a larger share of the global economic pie andthe creation of a physically safe world friendly to open commerce and labourmovements which lie at the heart of this renewed fascination with the fairnessand social acceptability of a given pattern of income distribution. The adventof a democracy has merely added new domestic pressures to search for a bettersharing of economic growth. The frequency and escalation of social conflict inmany countries, combined with political democracy have also strengthened callsfor “socially inclusive” growth, and a fairer sharing of its environmental andinfrastructure related burdens.

The above seemsa very long winded and discursive introduction to a paper on economicinequality in Indonesia.Would it not have been better one might ask to delve directly into the data onLorenz curves and Gini coefficients, Theil indices, poverty indicators andasset distribution statistics which litter the quite considerable technicalliterature on economic distribution in Indonesia?

That would havebeen the more direct and easier option. It would have resulted in a review ofthe data and some carefully worded conclusions on the state of economicinequality in Indonesiatoday. It may also produce some good guesses about the future trajectory ofconsumption expenditure disparities in the future. However, it would havemissed some very critical questions relevant to an understanding of Indonesianpolitical economic and its prospects for the future. The most obvious of theseare summarised below.

First, is thefact that virtually all accounts of income distribution in Indonesia during much of the periodafter independence underscore both low levels of economic disparity, asmeasured by per capita consumption expenditure and their relative constancyover time.[3]This is true not only of aggregate Gini coefficients for Indonesia as a whole but seems tobe true of the provincial Gini as well. If this is taken for granted higheconomic growth beginning in the late 1970s combined with low income inequalitywould ipso facto, even in the absence of pro-equalising policy measuresproduced sharply declining poverty rates.

The East AsianMiracle and its subsequent variants also suggests the contribution of lowinitial levels of income and in some cases asset inequality[4](e.g through land reform in Taiwan) to the growth with equity achievementswhich lay at the heart of the region’s economic miracle. An added feature ofthe Indonesian income distribution is the fact that the partitioning ofaggregate inequality into inter and intra-regional segments shows a relativelyminor contribution of inter-regional inequality compared to intra-regional (andthus inter-personal ones). 

An obviouspuzzle in the Indonesian context is explaining the persistence of low levels ofeconomic inequality in an archipelago of over thirteen thousand islands. Aquotation from a well known work on Indonesian regional geography serves tohighlight the point:

“Indonesiais one of the most diverse and heterogeneous countries in the world. Theinternational debate of the 1950s and the 1960s on dualism originated in Indonesia, simulated by social and economicconditions in the colonial and early independence eras; and “regionalism” ---in a variety of manifestations—has been a preoccupation of all governments ofmodern Indonesia.Its economy comprises both the advanced technology of modern cities of Java andhighly capital-intensive extractive and processing industries, as well astribal groups in isolated regions barely exposed to the outside world. Itsecology ranges from the intensive wet rice cultivation of ‘Inner Indonesia’,supporting some of the most densely populated areas on earth, to lightlysettled regions in the OuterIslands in which swidden(slash and burn) agriculture is still predominant. In its culture and religionthe country is equally diverse containing about 300 ethnic groups and nearly asmany languages. And its geography is such that some outlying regions are closerto (and in the past had stronger economic ties with) neighbouring countriesthan with the national capital, Jakarta,and Java more generally” [5]

The constancy ofeconomic distribution against such economic and social diversity over a fivedecade period requires careful explanation. It cannot be just defined away byslicing the data in different ways to get time series distributions of thegini, its regional or sectoral partitioning or by engaging in a discussion ofwhether the Kuznetz U is or is not applicable to the case of Indonesiandevelopment.

Second, there isthe question of the impact of the political and governance system of thedistribution of income. Following the economic collapse in 1998 and thetransition to democracy much has been made of the governance shortcomings ofthe Indonesian economic and political system. These range from the systemiccorruption and cronyism which became the hallmarks of the New Order system, tosignificant differences in the administrative capacity of regional governmentsto make and implement development policy. Add to these the enclave-basedinvestment in much of Indonesia’snatural resource sector and one gets a picture of significant structuralinequality in income distribution. There is just one problem. They are notsupported by much of the published data on economic inequality.

Third, there isthe rather obvious question of the differences in income distribution broughtabout by a decade of intensive reform following the adoption of democracy. Ofcourse the arrival of democracy, in the middle of Indonesia’s most severe economiccrisis, means that not all the burden of poverty reduction and an improvementof income distribution or preventing it from rising sharply cannot be placed onthe shoulders of the new democracy. Nevertheless, the impact of the newpolitical system on the distribution of income is of interest in a countrystruggling to raise of the political legitimacy of this new system ofgovernment.

The Indonesiancase study in economic inequality is therefore of substantial interest not onlyfrom the point of view of data and its statistical variations. It is perhapseven more interesting from the point of view of resolving the gap between whatthe data seem to be telling us and what the logic of the development processwould indicate. Indonesiahas undergone one of the fastest rates of urban development in the world. Ithas a highly diverse geography. For much of its post independence years it hasbeen governed by authoritarian regimes without much public scrutiny orcriticism. Is has large pockets of natural resource enclave development. Itsindustrial sector is dominated by a very small number of super rich ethnicallydistinct families. By developed country standards it has a small state andcontinues to keep its markets open.

 How does such a country with over threedecades or more of record economic growth behind it generate and maintain arelatively low level of economic inequality. How does it ensure that itseconomic distribution indices do not show significant shifts over time as Indonesiasuffers a series of financial and economic shocks, natural disasters and atleast two major changes in its entire system of government and concomitantpolicy making mechanisms?

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