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Doing Business in Indonesia: legal and bureaucratic constraints Ross H. McLeod Indonesia Project Australian National University [email protected] The Doing Business reports rationale ‘What gets measured, gets done.’

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Doing Business in Indonesia:legal and bureaucratic constraintsRoss H. McLeodIndonesia ProjectAustralian National [email protected]


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The Doing Business reports rationale

  • ‘What gets measured, gets done.’

  • Low rankings provide clear signal to policymakers of where scope exists for improvement in the business environment

  • And they provide useful ammunition for outsiders pushing for better government performance


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The Doing Business reports rationale

  • In principle, this seems a worthwhile exercise, but …

  • The methodology is not free from defects

  • Constructive criticism should lead to more meaningful measurement over time

  • This paper contributes to this effort


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The Doing Business reports methodology

  • Overall ease of doing business ranking is based on 10 broad topics

  • Each topic has 3-6 component indicators

  • After evaluating all countries, each is given a percentile ranking for each component indicator

  • Its score for a given topic is the simple average of its percentile rankings for each component indicator for that topic

  • Its overall ease of doing business index is the simple average of its 10 topic scores


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Problems with the Doing Business methodology (1)

  • Distinguishing legal/regulatory inputs and business outcomes:

  • Indicators such as the time taken to establish a standardised business are objective measures of red tape (albeit subject to measurement error)

  • Indicators such as the existence or lack of a public credit registry or private credit bureau to assist lending institutions reflect the researchers’ presumption that such things should exist, in all countries

  • Indicators such as measures of investor protection reflect the researchers’ presumption that such protection is necessary, and that the best form for it to take, in all countries, is similar to that in the US…


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Problems with the Doing Business methodology (2)

  • Arbitrary relative importance of topics and their components

  • Each topic carries equal weight

  • Each component indicator carries equal weight within its topic

    • But the number of components varies from 3 to 6 per topic

    • So the weightings of components vary by a factor of 2 (from 1/60 to 1/30), for no obvious reason

Score sheet


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Problems with the Doing Business methodology (3)

  • Some components are redundant

    • For example, if we know the total cost of a licence and the time taken to obtain it, the number of procedures is irrelevant


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Problems with the Doing Business methodology (3)

  • Some components are simply duplicated

    • In the Hiring & Firing Workers topic, one component (‘Rigidity of Employment’) is actually an average of three other components

    • In the Protecting Investors topic, one component (‘Investor Protection Index’) is actually an average of all other components

    • In the Getting Credit topic, the Credit Information Index will be zero if public/private credit bureaus do not exist (involving double penalty for countries without these)


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Problems with the Doing Business methodology (4)

  • Coverage of data doesn’t extend to extra-legal costs (bribes)

  • Overall time taken (e.g.) getting a licence might be greatly reduced with a bribe

  • Need to focus on actual (typical) times and costs, not those if we ‘play by the rules’


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Doing business in Indonesia: a closer look

If we focus more on the things that really matter to business, how does the legal and regulatory environment compare with that in other countries?


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Ease of Doing Business in Indonesia: Selected Sub-indices and Components


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Ease of Doing Business in Indonesia: Selected Sub-indices and Components


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Indonesia looks very poor on the important Doing Business indicators, yet it grew very rapidly for three decades under Soeharto. (These days it is not doing quite so well, although not too badly). We’ll come back to this later…


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The debate on legal heritage

  • The flavour of the law and finance literature

    • Common-law countries give both shareholders and creditors the strongest, and French-civil-law countries the weakest, protection.

    • French civil law countries have both the weakest investor protections and the least developed capital markets, especially as compared to common law countries.

    • The quality of law enforcement is lowest in French-civil-law countries.

    • Taken together, [the empirical] evidence describes a link from the legal system to economic development.


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The debate on legal heritage

  • This literature seems unpersuasive

  • Consider the relative economic growth performance of five countries representing the main families of legal heritage…

    • In the last three decades of the 20th-century, the US was the standout performer

    • But France outperformed the UK (slightly)

    • And both outperformed Germany and Sweden (with supposedly better legal systems than France)


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The debate on legal heritage

  • Breaking this into two equal sub-periods…

    • The US was still the standout performer

    • But France and the UK swapped their positions

    • And both still outperformed Germany and Sweden (which also swapped their positions)



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Is legal heritage important?

  • Probably not…

    • Relative growth performance not clearly related to legal heritage

    • Legal systems tending to converge over time?

    • Developing countries pick and choose from legal and regulatory approaches elsewhere

  • Doing Business findings biased by researchers’ views as to what is good law

    • What may work well in the US is not necessarily appropriate in countries at earlier stages of development


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In Indonesia’s case, the poor quality of the judiciary/legal system and the bureaucracy is much more a legacy of the ‘Soeharto franchise’ than of the Dutch colonial system (and French civil law) of six decades ago

Is legal heritage important?


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Soeharto built up a system that enabled him to exploit the coercive power of government in his own interest for more than three decades


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He created and maintained a monopoly on political power, through a franchise system of government


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Soeharto’s ’franchise’ system through a franchise system of government

  • Full title: ’multi-branch, multi-level franchise’

  • Branches:

    • Legislature (MPR/DPR/tame parties)

    • Judiciary/legal bureaucracy

    • Military/police

    • Bureaucracy (including non-department agencies, esp. Bulog, Bank Indonesia)

    • State-owned enterprises (SOEs)


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Soeharto as franchise owner through a franchise system of government

  • Election system rigged so that he could not lose: the essential political monopoly

  • Potential troublemakers in the army bought off with senior positions in bureaucracy, judiciary, SOEs, and by grant of privileged access to natural resources, especially timber

  • Harsh action against actual troublemakers

    • Jail, violence, banishment to backwaters


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Roles of the branches through a franchise system of government

  • Each branch of the franchise was nominally intended to serve the interests of the general public, and did so to some extent

  • But the interests of the franchise came first in cases where there was conflict

  • The main branch roles of relevance to the Doing Business reports involve the bureaucracy and judiciary:


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Roles of the branches through a franchise system of government

  • Judiciary/legal bureaucracy

    • Deflect legal challenges to the regime and the actions of franchisees

    • Impose legal sanctions on opponents of the regime

    • Protect the interests of privileged firms and individuals in the private sector


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Roles of the branches through a franchise system of government

  • Bureaucracy

    • Implementation of economic policies conducive to rapid growth

    • Implementation of policies to generate rents for privileged companies and individuals

    • Implementation of policies intended to generate mass support for the regime

      • e.g. Subsidy schemes for farmers, small business

      • e.g. Increasing access to education and health for the poor


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Returning to the Conundrum… through a franchise system of government

  • Indonesia ranks very poorly according to the recent Doing Business reports

  • And it probably would have ranked just as poorly during the Soeharto era

  • Yet during that era it maintained sustained high growth for decades

  • How to reconcile poor legal and regulatory environment with excellent growth performance?


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Returning to the Conundrum… through a franchise system of government

  • The Doing Business reports overlook the important distinction between ‘insider’ and ‘outsider’ firms, which still exists (albeit less clearly)

    • The low ranking of Indonesia on most indicators is relevant to ‘outsider’ firms

    • But ‘insider’ firms escape extortion by the bureaucracy/judiciary/military/police, and benefit from dealings with SOEs

    • And much of the economic action is with the ‘insiders’, which lead growth and structural transformation


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In Indonesia, at least, legal heritage is of little importance relative to the Soeharto legacy

  • In any case, the legal heritage aspect has disappeared from Doing Business reports beyond the first one (in 2004)

  • It is no longer even possible to download data on the classification of countries by their legal heritage


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Doing Business in Indonesia: importance relative to the Soeharto legacylegal and bureaucratic constraintsRoss H. McLeodIndonesia Project, [email protected]


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