A decade of struggle

In 1942, the armed forces of imperial Japan swept through British Malaya, Indonesia and the Philippines, inflicting humiliating defeats on the colonial governments and armies. The myth that European colonialism was invincible was destroyed in a few weeks of conflict. In many parts of Indonesia the Japanese were greeted as liberators and especially in Java there was little overt opposition until 1944 (Abdullah 2010). Nationalists were released from prison; Sukarno and Hatta cooperated with the Japanese, mainly ‘in the interest of the greater goal of independence’ (Ricklefs 2001: 251). Other prominent nationalists, including Sjahrir, avoided overt cooperation with the Japanese, and built up an underground network based on former colleagues. For their part the Japanese promoted many Indonesian government officials into more senior posts to replace Dutch nationals who had either fled or been imprisoned.

The Japanese placed considerable emphasis on mobilising and indoctrinating youth. Following Japanese policy in both Taiwan and Korea, the school system was used to instil Japanese values into children along with a sense of nationalism. The evils of Dutch colonial policy were also stressed (Kurasawa 2010: 323). On the economic front, the Japanese gave top priority to the petroleum sector, where they urgently needed supplies to replace imports from the USA and elsewhere. Technicians quickly repaired the damage inflicted on the oilfields in Sumatra and Kalimantan by the departing Dutch. Crude oil production doubled between 1942 and 1943. Rubber production was also encouraged, but other export crops including sugar, spices, coffee and tea were not accorded high priority. Sugar was procured from Taiwan, and scarce shipping capacity could not be used to transport luxury goods such as coffee and spices to the Japanese mainland.

The Japanese paid little attention to the colonial borders and governed Southeast Asia according to their own strategic needs. Sumatra along with peninsular Malaya was governed from Singapore, while Borneo and most of the eastern islands were controlled by the navy. Problems of food supply rapidly emerged across the archipelago (Sato 2010: 267–79). Indonesia as a whole had been a net rice importer prior to 1942, relying on Thai, Burmese and Vietnamese imports to supply deficit areas in Sumatra, Java and elsewhere. These supplies were greatly reduced, partly because the Japanese needed the rice to supply to their own troops and partly because it was decreed that regions should be ‘self-sufficient’.

Challenges facing Suharto's New Order

By the mid-1960s, most economists were painting a dismal picture of the Indonesian economy. In one of the most widely read textbooks of the decade, Higgins characterised Indonesia as the ‘chronic dropout’ and claimed that the country ‘must surely be accounted the number one economic failure among the major underdeveloped countries’. He pointed out that all the available evidence pointed to prolonged stagnation throughout the colonial era, the Japanese occupation and the first two decades of independence and argued that such stagnation

At the time these words were written, few expected that there would be any dramatic improvement in Indonesia's economic fortunes. In September 1965 an attempted coup resulted in the murder in Jakarta of six senior generals. This provided an excuse for the military to begin to purge members of the Communist Party and ultimately Sukarno himself. In March 1966, the hitherto obscure Lieutenant-General Suharto together with the former diplomat Adam Malik and the Sultan of Yogyakarta assumed effective power. The new regime was backed by most of the army and also had the support of many groups within the intelligentsia, the student body and the Islamic community. Its anti-communist complexion guaranteed the new government considerable support from major Western bilateral and multilateral donors, support which had been spurned by Sukarno. But Indonesia's ‘New Order’ faced daunting tasks in rehabilitating the economy.

Per capita GDP in 1967 was lower, in real terms, than in 1941, and lower than in many other Asian and African countries (Table 4.1). Gross domestic capital formation had sunk to 6 per cent of GDP in 1962, and remained at below 10 per cent until 1968 (CBS 1970: 47). The failure to invest was evident not just in the absence of new infrastructure and productive enterprises, but also in the poor condition of existing factories, roads, railways, electricity generation facilities, ports, airports, irrigation systems and so on.

Estimates of poverty and income distribution after 1965

In Chapter 3, it was argued that there was considerable evidence that poverty and malnutrition were widespread in Indonesia by the mid-1960s, although the Sukarno government appeared to be in denial about the problem. The Indonesian Communist Party had drawn support from both the rural landless and employees in the estates sector and in the urban economy, but had no clear strategy for improving living standards beyond redistribution of land. The party supported the occupation of former estate land in parts of Java, but most Indonesians, even those on the left, realised that there was insufficient land in Java to give all rural households even one hectare, let alone the two hectares which the 1960 Basic Agrarian Law stipulated should be the minimum holding size. When pressed about the problem of ‘too many people and not enough land’, Sukarno and his ministers tended to fall back on the old colonial solution of moving people from Java, Bali and the eastern islands to the supposedly ‘empty lands’ in Sumatra, Kalimantan, Sulawesi and the newly acquired West Irian, later to become Irian Jaya, and now the two provinces of Papua and Papua Barat.

After power was wrested from Sukarno in 1966, economic policy was concerned primarily with macroeconomic problems. It was expected that a reduction in inflation and a return to growth would alleviate the problem of poverty, and lead to a general improvement in living standards. The first Five Year Plan of the Suharto era placed most attention on the agricultural sector, especially on increasing rice production. The Plan also stressed the need to rehabilitate and extend rural infrastructure, especially roads and irrigation. But it was criticised for its neglect of non-rice food crops, including both corn and cassava, as well as soybean and vegetables, which are important sources of protein and vitamins for the poor. By the early 1970s, some academic commentators, worried about the evidence of widespread and persistent poverty and malnutrition in Indonesia, were arguing that economic growth alone would not be sufficient to reduce poverty in Indonesia.

At this time there was a growing international debate over ‘redistribution with growth’ encouraged by the World Bank, the International Labour Organization and by a number of well-known academics in various parts of the world.

Economic nationalism after 1945

It was argued in Chapter 3 that the terms of the financial agreement finally agreed in 1949 were considerably harsher than those negotiated with the former colonial powers by other newly independent governments in Asia, including India, Pakistan and the Philippines. An Indian economist pointed out that, along with an impoverished economy, newly independent India ‘also inherited some useful assets, in the form of a national transport system, an administrative apparatus in working order, a shelf of concrete development projects and substantial reserves of foreign exchange’ (Vaidyanathan 1983: 948). Independent Indonesia had few such assets after almost four years of Japanese occupation followed by four more years of war against the Dutch army. The terms under which power was transferred caused bitterness among even the more moderate leaders, and after 1950 the continuing Dutch economic presence fuelled nationalist sentiments in the parliament and in the business community. An issue which was bound up with resentment against the Dutch was the position of the Chinese, whose economic role seemed to many nationalists to be way out of proportion to their relatively small numbers compared with the indigenous population.

The 1930 Population Census had enumerated 1.233 million Chinese in the whole country, which was only about two per cent of the population of 60 million. The percentage was probably slightly higher after 1950, as in-migration from China, although restricted, did continue until 1940. In addition, the Chinese tended to have large families and lower rates of infant and child mortality than most indigenous Indonesians. Mackie (2005: 98) suggested that the ethnic Chinese could have numbered around two million, or 2.5 per cent of the total population, in the early 1950s. As a result of their better access to education in the late colonial era, and the emphasis that many assimilated, Dutch-speaking Chinese families placed on professional qualifications, the Chinese were over-represented in occupations such as medicine and law. It was also widely believed that Chinese owned many of the medium- and large-scale businesses not controlled by the Dutch or other foreign interests. Those Chinese who had migrated to Indonesia in the 1920s and 1930s often went into business using contacts with other members of their extended families or dialect groups.

Assessing Indonesia's economic progress over more than a century is fraught with pitfalls. There have been both remarkable achievements and major disappointments. Different analysts have tended to give greater weight to either the achievements or the failures with the result that their work is often criticised as being either too optimistic or too pessimistic. This study has tried to avoid both extremes, but might at times have appeared rather inconclusive. So it might be useful to summarise the progress which has undoubtedly occurred while drawing attention to the problems which remain.

This study has argued that Indonesia inherited some advantages from the Dutch colonial period, but also many disadvantages. In the early decades of the twentieth century, the Dutch built up a diversified export economy, and an effective fiscal state which promoted a range of policies in infrastructure development, education and health care, and land settlement in the less populated regions outside Java. While public expenditures were not exceptionally high on a per capita basis, there was considerable infrastructure development in Java and parts of Sumatra; some progress was also made in health and education although here the achievements were well behind Taiwan, the Philippines and British Malaya. There can be no doubt that some in the early post-1949 governments wanted to build on the Dutch legacy, but failed to mobilise the necessary resources. By 1965, the Indonesian state was far weaker than it had been in 1941, whether one looks at fiscal and monetary policy or administrative control over the vast archipelago.

That the thirty-two years when Suharto was in power saw substantial economic and social progress in Indonesia is undeniable. Admittedly he came to power after more than a decade of economic stagnation and mounting inflation, when living standards for many Indonesians had been declining. As far as we can judge from the available evidence, in the mid-1960s the great majority of the population were living below a modest poverty line, malnutrition was widespread, and infant and child mortality rates were much higher than in neighbouring countries. Over the next three decades there were considerable improvements not just in per capita GDP, but also in non-monetary indicators based on health and education.

Indonesia's three watersheds

Many countries have had, at some point in their history, watershed moments when the opportunity seems to arise to wipe the slate clean and make a new beginning. Such moments often arise after wars or after revolutions or some other political upheaval which lead to a regime change, and the chance to start afresh. Typically at such times, new policies are introduced which seek to bring about political, economic, constitutional, administrative or social change, or some combination of all these. Not infrequently, reforms which most observers would have thought impossible under the old regime are implemented with surprising rapidity and apparently with little opposition. In many parts of Asia and Africa, such a watershed moment occurred with the granting of political independence. Beginning with the decision by the American government to grant the Philippines full independence in 1946, all the major states of Asia had achieved either self-government or full political independence by 1960.

The Indonesian struggle for independence began in the immediate aftermath of the Japanese capitulation to the Allied powers in August 1945. Two key leaders of the independence struggle, Sukarno and Hatta, under considerable pressure from younger, more radical activists, declared Indonesia's independence on 17 August 1945, a date that has been enshrined as Indonesia's national independence day ever since. But in the aftermath of this declaration, the transfer of power to an independent government in Indonesia did not take place smoothly. The Dutch officials who had fled to Australia when the Japanese armed forces swept through the archipelago in 1942 returned in the wake of the British army in the latter part of 1945. Even the more progressive among them were determined to re-establish Dutch control over the entire archipelago and regarded the leaders of the independence movement, especially Sukarno and Hatta, as little more than lackeys of the Japanese who had no support among the Indonesian masses. These opinions were supported by almost the entire population of the Netherlands who feared that ‘the loss of the Indies’ would spell ruin for the Dutch economy, already severely weakened by the German occupation. It took more than four years of armed struggle and negotiations brokered by foreign powers and the infant United Nations before the Dutch finally recognised that they could no longer withstand the winds of change sweeping across Asia.

The colonial era: towards a modern fiscal state?

As was argued in Chapter 2, the ethical policy led to a rapid growth in government expenditures on public works, including irrigation, harbour works, post and transport and railways and tramways (de Jong and Ravesteijn 2008: 66). By 1921, public works amounted to around 40 per cent of the colonial budget. The Minister of the Colonies, Idenburg, doubted that an ambitious programme of public works could be funded from current revenues, and thought that loan authorisation powers were essential if these projects were to be completed. After 1915, borrowing increased and by the early 1920s, government debt had risen relative to national income and exports. The debt service ratio (debt service charges as a ratio of export earnings) was almost 6 per cent in 1923 (Booth 1998: table 4.4). By the standards of the late twentieth century, this was hardly a high figure. But it caused concern in the Netherlands, especially in the central bank, and among critics of the ethical policy who argued that it was an extravagant welfare programme that the colony could not afford, and whose longer term benefits were unclear. Government expenditures did grow in real terms until the end of the 1920s, but fell in the first part of the 1930s.

The increased reliance on loan finance was in part due to a perception on the part of colonial officials that it would be difficult to raise more revenues from the indigenous population. Several studies were carried out over the 1920s into tax burdens in both Java and other parts of the country, and concluded that it would be difficult to squeeze much more out of even the better-off elements among the native population. Chinese businesses were often difficult to reach through the income tax, given that their records were often kept in Chinese rather than Dutch. Both the Chinese and European populations were taxed through excises and import duties, and by the end of the 1930s, personal and corporate income taxes accounted for 22 per cent of all government revenues, which was a higher percentage than in most other parts of Southeast Asia (Booth 2013a: table 4). Government borrowing increased sharply after 1930 and by 1933, the debt service ratio had increased to 20 per cent, although it fell later in the decade.

Colonial exploitation: some definitions

As was the case in many other former colonies, in Indonesia many people in the immediate post-independence era blamed most, if not all, of their problems on the legacy bequeathed to them by the colonial power. Many politicians, civil servants, academics and journalists took it as axiomatic that the Dutch had ‘exploited the wealth of the Indies’ and that this exploitation was the reason for the country's poverty. But what was meant by colonial exploitation? Landes (1961) suggested that a useful definition would link colonial exploitation to coercion, which leads to the employment of workers at wages lower than would prevail in a free labour market, or the purchase of products at prices lower than would obtain in free markets. More generally, according to Landes, colonial exploitation must imply constraints on the free operation of markets within the colonial territory.

This is a definition which has in fact been widely used in the literature in the decades since Landes suggested it; its relevance to Indonesia will be further discussed later. It can be extended to include the use of colonial markets as protected outlets for the surplus production of industries in the metropolitan countries. By the end of the nineteenth century, radical critics of Western colonialism attributed it at least partly to the need of industrial capitalism for ever larger markets. Metropolitan politicians wanting to justify colonial adventures to sceptical domestic electorates often used the argument that colonies could serve as captive markets for home produce (Landes 1998: 429–30). To what extent industrialisation in the metropolitan economies depended on colonial outlets remains a contested issue, with some economic historians denying the importance of colonial markets as an important factor in the industrial growth of the metropole (Bairoch 1993: Chapter 6; Lewis 1978: 30).

What seems more certain is that in most colonies, the metropolitan powers had little interest in fostering industrial growth, and indeed often pursued policies which led to de-industrialisation. The most famous example is the demise of the textile industry in India in the nineteenth century, which lost not only most of its domestic market to foreign competition, but also its export markets. Williamson (2011: 64–5) has argued that similar de-industrialisation occurred in the Ottoman Empire, Indonesia and Mexico.

Promise of a new dawn

The disenchantment which many Indonesians felt with the reform process, and with the leadership of President Megawati Soekarnoputri, was reflected in the results of the parliamentary elections held in April 2004. The political party which emerged with the largest number of votes, 21.6 per cent of the total, was Golkar, which had dominated the political scene through the Suharto years. The Indonesian Democratic Party of Struggle (PDIP), the party of Megawati, managed to come second with 18.6 per cent of the votes, but this was a sharp decline from 1999 when the party gained one-third of the total vote. The remaining votes were spread among a number of parties, some of them Islamic in orientation and some secular (Marks 2004: 152). These results reflected growing frustration on the part of many Indonesians with the slow economic recovery since the crisis of 1997/1998, and a nostalgia for the greater economic progress during the Suharto years.

The presidential election which was held in July 2004 marked a historic shift away from the past practice of indirect presidential elections through an augmented parliament, the Peoples’ Representative Council (MPR). For the first time, Indonesia would have a directly elected president and vice-president. The strongest ticket was widely considered to be that of Susilo Bambang Yudhoyono (SBY), a retired general and former cabinet minister under Megawati, and Jusuf Kalla, a businessman from South Sulawesi and member of Golkar. SBY had come up through the military under Suharto; he had graduated from the Magelang Officers’ Academy in the 1970s and had also studied in the USA. He was widely considered to represent the moderate, secular wing of the armed forces, which had opposed the spread of Islamic views in the military in the last years of the Suharto regime. Fluent in English and well travelled (he had commanded the Indonesian contingent to the UN Peacekeeping Force in Bosnia in the 1990s), he presented himself with considerable success as a ‘thinking general’, who was well informed about world events and also capable of implementing much-needed reforms at home. Even while he was a cabinet minister, he had continued to study economics at the Bogor Agricultural University, and had set up his own think tank (the Brighten Institute) to advise him on policy issues.

The onset of the economic crisis

By early 1997, episodes of ethnic and religious violence were erupting in several parts of the country, while the ongoing problems in Aceh, Irian Jaya and East Timor appeared incapable of resolution. Many were wondering for how much longer Suharto could continue to rely on the loyalty of the army in carrying out brutal and unpopular ‘pacification’ activities in far-flung parts of the country. But to most observers, both within Indonesia and abroad, the economy still appeared strong. Both domestic and foreign economists, including respected economic journalists and multilateral lending organisations such as the World Bank and the Asian Development Bank, praised the Indonesian government for its adherence to sound macroeconomic management. Budget deficits had been kept low, inflation was well under control, and the balance of payments deficit at around 4 per cent of GDP seemed far less worrisome to most observers than the much higher deficits in Malaysia and Thailand. Certainly there was some concern that there was a growing reliance on short-term capital inflow to fund the current account deficit but again this trend did not seem nearly so pronounced as in Thailand. It was known that some conglomerates were borrowing large sums offshore but this was not seen as something the government could or should concern itself with.

The problems in Thailand came to a head in early July 1997, when the Thai authorities were forced to float the baht, which then depreciated rapidly. The rupiah came under pressure soon after the Thai decision to float the baht, and after apparently futile attempts by Bank Indonesia to stabilise the rupiah, it was decided that from 14 August, the rupiah could float freely. This was a decisive break with previous exchange rate management in Indonesia, and IMF officials were quoted as applauding the move. The president and other senior officials stressed that economic fundamentals in Indonesia were sound, and that there was no reason for panic (Lindblad 1997: 5–8). But by early October, serious problems were emerging. Capital outflow was accelerating, and the rupiah was trading at 3,600 to the dollar, compared with 2,500 in July. The government then turned to the International Monetary Fund (IMF) for a standby loan.