Asian Development Outlook 2011

Indonesia Rising, Philippines Waning

What could be the reason for their divergent paths?

The September update of the Asian Development Bank’s Asian Development Outlook 2011 painted a contrast between the two most liberal ASEAN democracies Indonesia and the Philippines. Based on these countries’ first half performance, the Bank gave a slight upgrade to Indonesia and issued a slight downgrade to the Philippines.

Here is what the ADB had to say about Indonesian prospects:

Forecasts for economic growth are edged up from April’s Asian Development Outlook 2011 reflecting a strong performance in the first half of 2011 and a positive outlook through this year and next. Increases in fixed investment, private consumption, and net exports boosted the first-half result [emphasis added].

Meanwhile, its report on the Philippines was summarized as follows:

Growth for the first half of this year was hampered by weaknesses in exports and government spending, though private consumption and private investment remained strong. A better overall performance is projected for July–December, but the GDP growth forecast for the full year is trimmed from April’s Asian Development Outlook 2011 [emphasis added].

The update concludes that Indonesia’s economy is set to grow by 6.6% in 2011 and 6.8% in 2012, meanwhile the Philippines is set to experience a rise of 4.7% in 2011 and 5.1% in 2012. In assessing the risks, the Bank noted the preparedness of Indonesia to manage the impact of any sudden reversal of foreign capital, while it highlighted the weakness of investor sentiment in the Philippines if “no progress is seen on the government’s reform efforts, including public-private partnerships.”

It was not too long ago, that Indonesia was considered a basket case. The pain it suffered after the Asian financial crisis with riots erupting in the streets, the independence of East Timor, the secession in Aceh, a tsunami and the terrorist activities of Jemaah Islamiyah left the growth and stability of the Suharto years in tatters at the start of the third millenium.

The Philippines in contrast experienced a second “peaceful revolution” in 2001 and was for once outperforming until recently its southern neighbor in the pace of its economic uptick (see Figure 1). Ten years later, Indonesia is once again outperforming the Philippines on many fronts. It joined the Group of 20 nations that convened at the height of the Global Financial Crisis and is considered to be the only other country in our region to have considerable clout in economic affairs after China and India.

So what was it that changed the fortunes of Indonesia in the latter half of the previous decade that has allowed it to regain its stature in the world community while the Philippines remains locked into a slower growth trajectory?

Some would say it was the emphasis on anti-corruption and good governance that produced such sterling results. The election of its president Susilo Bambang Yudhoyono back in 2004 (the first directly elected president after ammendments were passed in Indonesia’s constitution) on the back of an anti-corruption platform, many say heralded a new era of clean and honest government, which is credited with restoring Indonesia’s fortunes. If this is true, it would provide some reassurance to the current Philippine president who was given the same mandate in 2010.

To assess the validity of this argument, we would have to turn first to investments in both countries during this period. Figure 2 shows gross capital formation as a percentage of GDP for both nations from 1960 to 2009. What we find is that after falling off a cliff following the 1997 crisis, Indonesian investments were already on an upward V-shaped trajectory even prior to 2004 having gone from 11% in 1999 to 26% in 2003. In 2009, investments were simply restored to their previous levels in the 1990s during the height of Suharto’s crony capitalism.

Investments in the Philippines on the other hand tracked a continuous descent from 1997 onwards. Even during the high growth years of the Arroyo administration, it continued to plumb the depths not seen since the mid-1980s after the Aquino assassination.

While it is true that during SBY’s first term from 2004 to 2009, a very vigorous anti-corruption campaign was launched which successfully prosecuted many high profile figures including a former central bank deputy governor and the president’s son’s father-in-law, corruption continues to persist. In fact since his re-election, some of the powers of the anti-corruption agency have been clipped or put under the supervision of their legislative assembly.

Recent US diplomatic cables uncovered earlier this year by Wikileaks in fact seem to indicate that Yudhoyono’s reputation for cleanliness and good governance may not be as justified as the public thinks (although none of this is substantiated with evidence at this point). Given all these factors, why is it that investor sentiment does not seem deterred?

Mining and Military

The usual suspects in explaining this are the growing demand for minerals and greater political stability. Unlike the Philippines whose electronics sector comprises the bulk of its exports, the Indonesian economy is still heavily dependent on oil and other commodities. Mining projects account for a large bulk of capital formation in the latter, while expansion into higher value sections in the electronics supply chain has been hindered by a highly liberal trade policy and incoherent investment incentives in the former.

The military establishment from where both Suharto and Yudhoyono hailed has served to steady political institutions in the past and provide a measure of coherence in government policy despite the high incidence of corruption. After a spell of political risk and uncertainty following Suharto’s fall, stability has been restored with a strong elected executive. Meanwhile in the Philippines political instability continued to hound the presidency of Mrs Arroyo.

While some regard the period between 1986-1997, the era of “freeing markets” in Indonesia as the peak in investments, it should not be overlooked that it was the period of “reform through planning” from 1965-1986 that improved Indonesia’s position from a poor investment destination in the early 60s to an attractive one in the 90s (see Figure 2).

In other words, a more robust and coherent state successfully steered Indonesia to take advantage of its natural endowments better during the early stages of its development. In fact, Figure 1 clearly demonstrates the superior growth performance of Indonesia prior to 1986 compared to the period after it.

Although a high level of inequality still persists, Indonesia with a population of 230 million has a poverty headcount ratio about half that of the Philippines (13% compared to 26%). It has an average per capita income of $2,300 compared to $1,752 for the Philippines. It is ranked 44 out of 139 in the Global Competitiveness Index compared to 85 for the Philippines.

Long-term Vision

In August the maiden issue of the Strategic Review ran as its cover story a piece by SBY entitled Indonesia in 2045: A Centennial Journey of Progress. It outlined his long-term vision for the country. This is perhaps the non-technical version of the government’s Master Plan for the Acceleration and Expansion of Economic Development 2011-2025. The time frames of these documents indicate just how far-sighted the government is.

In this statement, SBY identifies three basic pillars on which to build a national development project. These pillars are: (1) a strong and just economy (poised to become the world’s fourth largest economy of around $20 trillion by 2045), (2) a stable, strong and mature democracy adhering to the rule of law (achieving “geopolitical maturity” with a strong military), and (3) a thriving civilization and an open society having adopted the world’s major civilizations (Islamic, Oriental, Hindu, Buddhist and Western) and exporting its unique blend of culture.

From reading the document, one senses a quiet confidence of a nation unafraid of the challenges posed by increasing globalization and eager to take on the reins of regional and global influence presented to it. This expansive view contrasts with the very introspective and paranoid one that presently occupies the Philippines. There is no sense of animosity towards the dispensations that preceded it. Although it talks a lot about change and reform, one gets a sense of continuity rather than disjointedness.

Divergent Histories

Of course one could hypothesize that the reason for this divergence of temperament arises from the different colonial experiences of both countries. At the time of the European Renaissance, Java and Sumatra had been the site of Hindu and Buddhist states for over a thousand years. Their conversion into Islam only strengthened the cohesiveness of these states.The Philippines was merely a hinterland of these sultanates at the time of Magellan’s arrival.

The relative weakness and lack of cohesiveness among the tribal chieftains in the Philippines made it much easier to colonize. In contrast, the Portuguese failed to extend their influence across much of Indonesia beyond present day East Timor. Only with improved military technology did the Dutch extend their rule in the 19th century over the Javanese states.

One could argue that in Indonesia a strong state was present all along. After having had such a proud tradition of statehood, Indonesia is only now beginning to introduce reforms that strengthen the rule of law and accountability of government. The Philippines on the other hand is still building a coherent and effective state despite the outward trappings of formal democracy.

Although Suharto was just as corrupt, perhaps even more so than Marcos, governance by the state still led to sustained economic growth because corruption did not prevent the state from implementing coherent plans and policies. In the Philippines, the centralization of authority by Marcos did not produce a similar outcome. So Filipinos tended to scorn the state for failing to provide solid economic growth and sought to increase the rule of law and government accountability without creating solid foundations for the state.

This is perhaps why the Philippines finds itself in its present predicament. Even with all the best intentions in the world at instituting rule of law and good governance, it will still fall short of its dream of delivering a better future for its people because it still lacks what the Indonesians already have, and that is a strong and dependable state.