Indonesia development policy review : enhancing government effectiveness in a democratic and decentralized Indonesia

53451 Indonesia development policy review Enhancing government effectiveness in a democratic and decentralized Indonesia November 2009 Table of Contents Table of Contents 1 Acknowledgements ii Executive summary iv What the report is about and its central thesis ................................................................................................ iv Indonesia in 2008 is a glass half-full ................................................................................................................. iv Indonesia in 2008 is a glass half-empty because its post-crisis governance transition is still incomplete... ......................................................................................................................................... vi ...and because the tasks facing Indonesia, as an emerging middle-income economy are more difficult vii Looking ahead to the decade to 2018 and beyond, Indonesia's development agenda is clear ................. vii Accelerating growth ......................................................................................................................................... viii Making growth inclusive .................................................................................................................................... ix Ensuring growth is sustainable ........................................................................................................................ xi Building resilience............................................................................................................................................ xiii Enhancing government effectiveness is central to realizing the development agenda .............................. xv ...which will take time, but maintaining a sense of urgency--making haste slowly--is critical ............. xviii A. INDONESIA 2009: A GLASS HALF-FULL 1 1 . Indonesia has done well in terms of macroeconomic performance in the decade since the 1998 Asian crisis 1 1. a. Per-capita GDP has exceeded pre-crisis levels and growth has picked up..................................... 1 1. b. Prudent macroeconomic management has resulted in lower budget deficits and a much lower debt-to-GDP ratio .................................................................................................................................. 1 1. c. Inflation has generally been at manageable levels, although periods of rising commodity prices have pushed inflation significantly higher .......................................................................................... 2 1. d. The banking sector has largely recovered from the 1998 crisis and market sentiment, until recently, was positive ........................................................................................................................... 3 1. e. Foreign reserves rose to historic highs on ongoing balance of payments surpluses ................... 3 1. f. Investment, while still low by historical standards, is rising ............................................................ 4 1. g. The macroeconomic fundamentals strengthened over the last decade have helped Indonesia weather the current global economic crisis ....................................................................................... 4 2 . Indonesia has continued its remarkably stable transition from a centralized authoritarian regime to a decentralized democratic polity 5 2. a. The legal and institutional foundations of a decentralized democratic polity have been established ............................................................................................................................................ 5 2. b. Freely and vigorously contested direct elections to all levels of government have strengthened electoral accountability ........................................................................................................................ 6 2. c. Political stability has calmed separatist sentiments and regional conflicts .................................... 7 3 . But Indonesia is still a glass half-empty because there has been less progress on other important fronts ... 7 3. a. Higher levels of economic growth have not translated, to the extent hoped for, into greater poverty reduction .................................................................................................................................. 7 3. b. A large percentage of the population remains vulnerable to poverty .............................................. 7 3. c. Despite recent signs of progress, Indonesia lags behind its more prosperous neighbors in producing higher value-added non-agricultural jobs ........................................................................ 8 3. d. Human development outcomes continue to be uneven despite significant increases in public expenditures ........................................................................................................................................ 10 3. e. Environmental quality is deteriorating and natural resources are being unsustainably depleted12 4 . Why Indonesia, in 2008, remains a glass half-empty 13  4. a. In 1998, Indonesia underwent not only a severe economic crisis, but also a dismantling of the previous political order....................................................................................................................... 13 4. b. The priorities in the first five post-crisis years were to restore macroeconomic and political stability and put in place the basic framework of laws for the new polity ..................................... 14 4. c. In the last five years the fiscal space has been created and structural reforms initiated in pursuit of the broader development agenda but progress has been slow.................................... 14 4. d. Indonesia's governance transition is still incomplete in that electoral accountability has not yet translated into broader forms of accountability... ........................................................................... 15 4. e. ...and government effectiveness is further constrained by a lack of coordination mechanisms and capacity for formulating and implementing policy ................................................................... 16 4. f. The tasks facing the government have themselves become more difficult, in part because of Indonesia's own past successes... ................................................................................................... 17 4. g. ...and in part, because of the changed global economic environment Indonesia faces .............. 17 5 . While Indonesia is in a relatively strong position, the medium-term outlook is uncertain and there are significant downside risks 18 5. a. Indonesia should weather the global economic slowdown better than many countries but growth will be lower going forward ................................................................................................... 18 5. b. There is however considerable uncertainty about the medium-term outlook and Indonesia remains vulnerable on some fronts ................................................................................................... 18 5. c. ...and the economic slowdown will also slow gains in social outcomes ....................................... 19 B. INDONESIA 2014 AND BEYOND: THE DEVELOPMENT AGENDA 20 6 . Indonesia's development agenda--what Indonesia aspires to and what the broad challenges are--is clear 20 7 . Accelerating growth 20 7. a. Indonesia has the potential to achieve the rates of growth it achieved prior to the crisis ........... 20 7. b. Making the most of Indonesia's resource endowments while also developing globally competitive clusters elsewhere ......................................................................................................... 21 7. c. Alleviating infrastructure bottlenecks ............................................................................................... 26 7. d. Improving the investment climate by remedying weaknesses and inconsistencies in the regulatory and policy environment.................................................................................................... 28 8 . Making growth inclusive 31 8. a. Raising rural incomes by revitalizing the rural economy ................................................................ 32 8. b. Facilitating the transfer of labor from low-productivity activities in agriculture to higher-value added activities elsewhere ................................................................................................................. 34 8. c. Improving the poor quality of, and limited access to, water and sanitation services ................... 36 8. d. Restructuring the health system........................................................................................................ 36 8. e. Providing quality education for all..................................................................................................... 39 8. f. Improving the allocation and efficiency of expenditures in the context of a decentralized Indonesia, not financing, is the main challenge ............................................................................... 40 8. g. Community-based approaches such as the PNPM offer one means of addressing that challenge by enhancing voice and accountability............................................................................................. 41 9 . Ensuring growth is sustainable 42 9. a. Managing Indonesia's forestry and marine resources sustainably while providing adequate livelihoods ........................................................................................................................................... 42 9. b. Meeting Indonesia's energy needs without sacrificing Indonesia's environment ........................ 45 9. c. Making Indonesia's rapidly growing towns and cities livable growth poles ................................. 49 1 0 . Building resilience 51 10. a. Managing disaster risks and adapting to climate change ............................................................... 51 10. b. Enhancing security and protecting the poor .................................................................................... 55 10. c. Reducing vulnerability to financial sector shocks ........................................................................... 56 C. FROM 2009 TO 2014 AND BEYOND: REALIZING THE DEVELOPMENT AGENDA 59 1 1 . Furthering Indonesia's ongoing, and still incomplete, governance transition is central to realizing the development agenda 59 11. a. Furthering the governance transition means adapting and strengthening the institutions and mechanisms that govern the functioning of the state and shape state-society interactions ...... 59 1 2 . Restructuring and strengthening the core processes and institutions for formulating and implementing policy 62 12. a. Reforming public financial management systems ........................................................................... 62 12. b. Initiating civil service reforms ............................................................................................................ 63 1 3 . Making the most of decentralization: helping local governments realize their potential65 13. a. Improving the framework governing centre-local relations ............................................................ 65 13. b. Increasing the capacity and accountability of local governments ................................................. 68 1 4 . Increasing the legitimacy of the state and building consensus 68 14. a. Strengthening the rule of law and reforming the judicial system ................................................... 68 14. b. Building on the momentum gained in anti-corruption efforts ......................................................... 70 1 5 . How to approach strengthening public institutions and processes 73 15. a. There is no simple recipe for strengthening public institutions and processes and it will take time... ................................................................................................................................................... 73 15. b. ...and involve learning from experimentation, monitoring and evaluation and replicating existing pockets of success ............................................................................................................... 73 15. c. But maintaining a sense of urgency - making haste slowly - is critical ......................................... 74 LIST OF CHARTS Chart A: Why furthering Indonesia's governance transition matters for realizing Indonesia's development agenda xx LIST OF TABLES Table 3.1: Indonesia continues to under perform on some critical health outcomes 11 Table 5.1: Indonesia's recent and projected macroeconomic performance 18 Table 7.1: Commodities account for more than half of Indonesia's merchandise exports 22 Table 7.2: Export "discovery" has been minimal 26 Table 7.3: ...but Indonesia still does poorly in international comparisons 29 Table 7.4: Indonesia has taken some significant steps in investment climate reforms 30 Table 9.1: Why Indonesia's common property resources are being depleted: proximate and underlying causes 44 Table 9.2: Indonesia has abundant energy resources other than oil 48 Table 9.3: Indonesia's legal and policy framework for energy 48 Table 9.4: Indonesia's urban population is growing rapidly 49 Table 11.1: Why furthering Indonesia's governance transition matters for realizing Indonesia's development agenda 60 Table 14.1: Number of corruption cases concluded by apex agencies between 2004 and 2007 72 LIST OF FIGURES Figure 1.1: Per-capita GDP has exceeded pre-crisis levels and growth has picked up 1 Figure 1.2: Prudent macroeconomic management has resulted in lower budget deficits and a much lower debt-to-GDP ratio 2 Figure 1.3: Inflation has recently been at manageable levels periods of rising commodity prices flowed into higher inflation 3 Figure 1.4: Indonesia's balance of payments position has been strong up to the global financial turmoil 4 Figure 1.5: Fixed Investment in Indonesia is rising, but is still low by historical standards 4 Figure 1.6: Indonesia's GDP growth is expected to slow considerably in 2009 but the slowdown relative to 2007 is the mildest in the region 5 Figure 2.1: By 2010, all local governments in Indonesia will have directly elected heads 6 Figure 3.1: Nearly half of Indonesia's population in 2007 could be considered near poor or poor 8 Figure 3.2: Employment growth has failed to match population growth since the crisis 8 Figure 3.3: ...and unemployment rates, especially among youth, remain high 9 Figure 3.4: Over 40 percent of Indonesia's labor force is still in agriculture... 9 Figure 3.5: ...and unlike its neighbors, Indonesia is not moving its workers out of agriculture 10 Figure 3.6: Formal sector job creation has been sluggish till recently 10 Figure 3.7: Infant and child mortality rates vary widely across Indonesia's provinces 11 Figure 3.8: Indonesia's forests are being rapidly degraded 12 Figure 4.1: Indonesia's growth recovery compared to other countries that experienced economic or political crises 14 Figure 4.2: Prudent fiscal policy has increased the funds available for development spending 14 Figure 7.1: From Indonesia's current income levels, some economies achieved economic take-off, while others languished 21 Figure 7.2: Indonesia's growth in the last-quarter century has come primarily from manufacturing and services 21 Figure 7.3: Commodity prices are forecast to remain high for the next decade relative to 2000 22 Figure 7.4: Oil exploration activity in Indonesia has declined steadily since 2000 23 Figure 7.5: Indonesia has tremendous mineral prospects but little investment 24 Figure 7.6: Even when primary sectors contributed significantly to Indonesia's economic growth, manufacturing and services contributed most to labor income growth 25 Figure 7.7: Old stuff still dominates export growth: very little creation and very little destruction 25 Figure 7.8: Infrastructure investment, as a percentage of GDP, is about half what it was before the crisis 26 Figure 7.9: Perceptions of Indonesia's investment climate have improved since 2003... 28 Figure 8.1: Agricultural growth rates have been falling till recently 32 Figure 8.2: Per-worker value-added in Indonesian agriculture has not grown much in the last two decades and is low relative to other countries 33 Figure 8.3: Minimum wages rose substantially between 1999 and 2003 35 Figure 8.4: Mandated severance pay in Indonesia increased sharply between 1999 and 2003 35 Figure 8.5: ...and the severance pay rates Indonesia mandates are the highest in the region 36 Figure 8.6: Public health expenditures have risen in the last decade but are still a lower share of the budget than they are for Indonesia's neighbors ... 37 Figure 8.7: Spending on health and education has increased 41 Figure 8.8: The strategic framework underpinning Indonesia's poverty reduction efforts 41 Figure 9.1: Indonesia's demand for electricity is projected to grow rapidly in coming years 46 Figure 9.2: Indonesia relies more on expensive fuel for power generation than other countries 46 Figure 9.3: Indonesia's emissions per capita are higher than in other countries 47 Figure 10.1: Indonesia's fossil-fuel emissions have been growing rapidly 53 Figure 10.2: Indonesia's population is rapidly aging 55 Figure 14.1: Most Indonesians resolve disputes and seek justice through traditional channels 70 Figure 14.2: Perceptions of corruption in government have declined 71 LIST OF BOXES Box 4.1: The lack of mining investment, despite Indonesia's potential provides a particularly stark example of the lack of coordination and uncertainty about policy 16 Box 7.1: Delays and difficulties in implementing investment climate reforms: three examples 30 Box 8.1: Indonesia's BOS (School Operational Assistance Grant) Program 39 Box 10.1: Global financing for climate change mitigation offers opportunities for Indonesia 54 Box 12.1: The Bureaucracy Reform Initiative of the Ministry of Finance is a promising start 64 LIST OF ABBREVIATIONS AND ACRONYMS ASKESKIN Asuransi Kesehatan Miskin (Health Insurance for the Poor) Bakornas Badan Koordinasi Nasional Penanganan Bencana (National Disaster Management Coordinating Board of Indonesia) Bapepam LK Badan Pengawas Pasar Modal dan Lembaga Keuangan (Financial Institutions and Capital Markets Supervisory Agency) Bappenas Badan Perencanaan Pembangunan Nasional (National Development Planning Agency) BOS Bantuan Operasional Sekolah (School Operational Assistance) BPK Badan Pemeriksa Keuangan (Supreme Audit Agency) BPKP Badan Pengawasan Keuangan dan Pembangunan (Financial and Development Supervisory Board) BPN Badan Pertanahan Nasional (National Land Agency) BRR Badan Rehabilitasi dan Rekonstruksi (Aceh and Nias Reconstruction and Rehabilitation Agency) CCT Conditional Cash Transfer CDM Clean Development Mechanism DAK Dana Alokasi Khusus (Special Allocation Funds) DAU Dana Alokasi Umum (General Allocation Funds) DRR Disaster Risk Reduction DSM Demand-Side Management EAP East Asia and Pacific? ECD Early Childhood Development FDI Foreign Direct Investment GNI Gross National Income GoI Government of Indonesia IIEE Indonesian Institute for Energy Economics JAMKESMAS Jaminan Kesehatan Masyarakat (Public Health Insurance Program) KDP Kecamatan Development Program KKPPI Komite Kebijakan Percepatan Penyediaan Infrastruktur (National Committee on Policy for Accelerating Infrastructure Provision) KON Komisi Ombudsman Nasional (National Ombudsman Commission) KPK Komisi Pemberantasan Korupsi (Corruption Eradication Commission) LPKPP Lembaga Pengembangan Kebijakan Pengadaan Pemerintah (National Public Procurement Planning Office) LPS Lembaga Penjamin Simpanan (Deposit Insurance Corporation) MDG Millennium Development Goals MoA Ministry of Agriculture MoF Ministry of Finance MoH Ministry of Health Musrembang Musyawarah Rencana Pembangunan (Development Plan Consultative Forum) NBFI Non-bank Financial Institutions NCBR National Committee for Bureaucratic Reform NSSS National Social Security System NPL Non-performing Loan P4K Pembinaan Peningkatan Pendapatan Petani Kecil (Small Farmers Income Generation Improvement) PDAM Perusahaan Daerah Air Minum (Regional Water Utility) PISA Program for International Student Assessment PKH Program Keluarga Harapan (Family Hope Program) PLN Perusahaan Listrik Negara (National Electricity Company) PNPM Program Nasional Pemberdayaan Masyarakat (National Program for Community Empowerment) PPP Public Private Participation PPATK Pusat Pelaporan dan Analisa Transaksi Keuangan (Financial Transaction Analysis and Reporting Center) PSO Public Service Obligation RDA Regional Development Accounts REDD Reduced Emissions from Deforestation and Degradation Reksadana Managed Funds Renstra Rencana Strategis (Strategic Plan) RKP Rencana Kerja Pemerintah (Government Work Plan) RPJM Rencana Pembangunan Jangka Menegah (Medium-Term Development Plan) RPO Rural Producers' Organization RUEN Rencana Umum Energi Nasional (General Plan for National Energy) RUKN Rencana Umum Ketenagalistrikan Nasional (General Plan for National Electricity) RUPPN Rencana Umum Perminyakan dan Pergasbumian Nasional (General Plan for National Oil and Natural Gas) SLA Subsidiary Loan Agreement SME Small and Medium-size Enterprises UNCAC United Nations Convention Against Corruption UNFCCC COP United Nations Framework Convention on Climate Change