Introduction

The issue of whether the shift towards market-based credit policy has helped in directing credit to technically more efficient firms have been investigated in numerous studies. Do financial resources flow to more efficient firms after the removal of administrative controls in the financial market? Other things being equal, do more efficient firms receive more debt after liberalization that affect their capital structure? Is a higher proportion of investment carried out by firms that are more efficient, that is, firms with higher productivity?

This chapter investigates whether financial reform in Indonesia has indeed redirected credit towards more efficient firms, as suggested in financial repression literature. Firm-level efficiency is an interesting tool to compare market-based and government-directed allocation of credit. To explore this issue, an attempt is made to incorporate different measures of efficiency in explaining the distribution of credit and investment, before and after the reform. In particular, taking into account market structure issues, this chapter will explore a physical measure of efficiency derived from different specifications of frontier production functions. Whether a firm's technical efficiency plays a role in the allocation of credit, and whether its role changes before and after liberalization will be tested. It will also investigate whether there are specific characteristics of firms that can be identified as being potentially related to efficiency. The performance of measures of efficiency derived from the production function will also be compared with less structured measures of efficiency.

Literature Overview and the Measurement of Efficiency

How is efficiency measured? There are various concepts of efficiency available in the economic literature. The focus here will be on firm-specific technical efficiency, defined as how close a firm is to the production possibility frontier, given its quantity of capital and labour.

Farrell (1957) develops a method of measuring efficiency and characterizes the ways in which a production unit can be technically and allocatively inefficient.

Is there econometric evidence that liberalization has succeeded in relaxing financial constraints faced by individual establishments? This chapter investigates the issue by estimating a simple form of the investment function for the panel of individual establishments.

Introduction

Our basic theoretical view is that Indonesian manufacturing establishments increase their capital stock through investment in response to potential profitearning opportunities. Desired investment can be financed in a number of ways, the two most important being borrowing from the credit market and retention of cash flow (internal finance). If capital markets are perfect and taxes are absent, firms will be indifferent between various sources of funds. They will finance their investment at a constant marginal cost that is closely related to the risk-free market interest rate, and they will invest until the latter is equated with the expected marginal return to investment. In such a world, only the constant marginal cost of funds and rate of return to investment are important for the investment decision and the former should be closely related to the risk-free market interest rate.

However, even in perfect markets there will be constraints to borrowing because of asymmetric information, monitoring costs, and other factors, which make fixed-interest-rate lenders willing to lend a higher proportion of the costs of proposed investments only at increasing interest in order to compensate for the increased risk. The premium charged will depend on the value of the firm's assets that can be used as collateral. This is referred to in the literature as agency costs. Therefore, a negative association is expected between increasing divergence between average and marginal interest rates for individual borrower firms as the degree of financial leverage increases.

If markets are segmented so that some classes of firms have limited access to borrowing, they will be forced to rely on internally generated funds and may have to forego some desired investment because of financial constraints.

The general atmosphere at the Seattle meetings was very positive. Even the weather, unpredictable in that part of the country at best, co-operated and there was sunshine almost all of the time. Seattle is a mid-sized city in the American northwest. It is famous for its salmon, intellectual life and a damp and rainy climate. It is also a major U.S. gateway for trade with Asia. Its importance to Pacific trade, and the fact that Seattle is home to such international giants as Boeing, Microsoft, and Weyerhauser, made it an appropriate U.S. city to host the 1993 APEC Ministerial Meeting.

When President Clinton decided to host the APEC Leaders' Meeting there as well, the logistics became a little sticky. But the people of Seattle rose to the occasion, and their hospitality and warm welcome reflected the very best American qualities. Fortunately, two friends from the state Department, Chris Runkel and Pat O'Brien (who had helped me set up the secretariat in the early days) were in charge of a major part of the logistics and they did an incredible job. They also ensured that the secretariat was set up so that it could function efficiently.

Everywhere you looked, including the Space Needle, there were posters and “WELCOME APEC” signs. Even the local adult movie house joined in the act with a risque marquee welcoming the delegates. The local citizens endured the intrusive security measures, the VIP motorcades that tied up traffic and the overtaxed facilities with good cheer and humour. It seemed perfectly appropriate that the theatres in the city were showing “Sleepless in Seattle”.

In addition to the official APEC meetings, there was a customs fair, an international business forum, meetings of PBEC and PECC, and numerous bilateral diplomatic meetings, including the first high-level meeting between China and the United States since 1989. The three official APEC meetings were the SOM, the Ministerial Meeting, and the Informal Leaders' Meeting on Blake Island in Puget Sound, with President Clinton as host.

Summary

Thailand has been a latecomer to industrialization in general, and to clothing and textiles in particular, largely as a result of the free trade policies that followed the Browring Treaty (1850–26) and subsequent attempts at public investment in industry. The policy served the country well in developing agricultural and raw material exports in the 1950s and 1960s. Thailand concentrated on exporting agricultural products such as rice and teak, while it imported manufactured products. A change in policy in favour of promoting private investment in the 1960s was inaugurated with the introduction of tariffs, an Investment Promotion Act and subsidized credit for industry. Clothing and textiles were among the first industries to be affected by these policies. Initially, manufacturing was largely for import substitution.

Clothing and textiles have become increasingly important since the mid 1980s because of their successful export performance. They have become the highest foreign exchange earners and the major source of employment in manufacturing.

Government intervention in clothing and textiles has been considerable, but often confusing. There has been both promotion and protection, as well as attempts to restrict the industry's capacity.

Although tariff protection has been high, especially at the more capital intensive end of the industry (notably for man-made fibres), the level has been moderate when compared with many other developing countries. Promotion granted to the industry has been intermittent. The government has also tried to control the supply of textiles by prohibiting capacity expansion from 1978–86.

Fluctuations in clothing and textile policies reflect the effectiveness of lobby groups within the industry. From time to time interest groups have lobbied: for the prohibition of expansion, against the establishment of new textile capacity, for protection, for an export quota allocation system that favours large firms, and for other forms of public assistance.

The prohibition of expansion of textile capacity has a major impact on the organization of the industry and on the effectiveness of protection policy.

It gives me great pleasure to be here today and to have this opportunity to discuss Indonesia's financial development and prospects. At the outset, let me note that I have taken the liberty of changing the title that was suggested for my presentation, namely: ‘Financial Deregulation Too Much? Not Enough?’. The original title seemed to suggest a simple either/or answer to what is really a complicated set of questions. Although we often use the term ourselves, I felt that it was inappropriate to label what has happened in Indonesia, or in a number of other countries for that matter, simply as ‘deregulation’. A more accurate label might be ‘regulatory reform’.

Some of the early writers in the field of finance and development, such as Edward Shaw (1973) and Ron McKinnon (1973), emphasised almost exclusively the elimination of certain controls as the key to the development of the financial system. They called this process financial liberalisation. Today, we would call it deregulation. But as the experience of several Latin American countries in the late 1970s and the United States’ savings and loan industry in the 1980s have made clear, reforming a financial system is fundamentally a two-pronged process. On the one hand, it involves the removal of direct controls over prices, quantities and activities, combined with an easing of the process that governs the entry of new firms. The result should be that economic choices will be determined mainly through the interaction of market forces. On the other hand, it requires the imposition of prudential regulations that ensure that clear and sufficient information is available to all, reducing excessive risk and minimising opportunities for fraud and manipulation at the expense of the general public.

It is probably correct to characterise the very first steps taken by the Indonesian Government in June 1983 as deregulation. These initial steps consisted of the removal of direct central bank control over the state banks’ interest rates, and over credit allocation by all banks.

Overview

The prospects for peace and stability in the overall East Asian/ Western Pacific region for 1994-95 remain largely positive. A credible U.S. military presence will remain, Japan will still be anchored in the security alliance with the United States, and Russia preoccupied with domestic problems. China is likely to experience more domestic stresses but there will be no reversal of the policies of economic reform. North Korea remains the biggest uncertainty. In a much changed world, will change in North Korea, which is inevitable, be managed peacefully? And will North Korea be nuclear-armed?

While in the short term the strategic landscape will thus remain largely unchanged, with many familiar sign posts still in place, over the longer term a new balance of power will be shaping. It is clear that China wants to be a powerful military player and would want to acquire the necessary power projection capabilities. Japan sees this coming. Despite the reassurance provided by the Clinton Administration's new five-year defence plan, doubts remain as to whether the United States will retain credible military power or the will to carry the burdens of international security by the turn of this decade. If the economic sums do not work out as planned by a president elected to solve the country's domestic problems, the defence budget can easily become politically the least unpalatable target for more cuts. The anxieties of many countries in the Asia- Pacific region over such longer-term concerns were reflected in the establishment in 1993 of the ASEAN Regional Forum (ARF), an Asia- Pacific-wide forum for security discussions. Its purpose is to foster better understandings and confidence.

Yet such anxieties should not be unduly exaggerated for there are also positive longer-term trends. First, there is the economic dynamism and growing interdependence of the Asia-Pacific region. Secondly, the very establishment of the ARF in such a short time indicates that there is a will among the various countries to build a climate of confidence. Thirdly, there are indications that America sees its economic destiny increasingly linked to Asia.

It is a great pleasure to share the platform with such a distinguished economist and, could I say, valued friend. But it is with some trepidation that I comment on this paper, because not only was Pak Ali present at the creation of the Indonesian financial sector as we now know it, but he was mid-wife at its birth and its guardian as it grew up.

While on this subject of the Good Old Days, let me say that I resist the idea that the development of the Indonesian financial sector started with the regulatory reform of June 1983, because I believe its true origins go back further and can be found in the early days of the New Order.

Some highlights of the process of financial reform

The 1960s: early reform

The main achievement of this period, of course, was the halting of hyperinflation. Without this achievement, the financial sector could not have been built. McKinnon (1973:3) captures the essence of this when he says ‘[O]nce the monetary linchpin is put in place, appropriate strategies for liberalizing foreign trade and rationalizing domestic tax and expenditure policy follow naturally’. In this early period, also, came the removal of controls on foreign capital flows and the introduction of what, for its day, was a high- tech financial instrument—high interest rate time deposits.

Innovations in exchange rate policy

Also going back to this early period, Indonesia had a brief flirtation with floating exchange rates, long before they became fashionable. Just as others, in a later era, recognised the problems of a floating exchange rate, Indonesia moved to a greater degree of fixity during the 1970s. Then came the three bold devaluations. Not all commentators were quick to see the underlying logic of these changes, but many now see them as a great success in that they reoriented the economy towards export growth, driven by very favourable international competitiveness.

Parameter Lists and Data Sources

Demand and supply parameters are required for the model. The demand parameters are income elasticity of demand, price elasticity of demand, elasticity of demand for domestically produced products, elasticity of total demand for imports, elasticity of demand for imports from restricted and unrestricted products, and substitution demand for imports by source in restricted and unrestricted markets. The parameters have been gathered from this study's estimates as well as from several other studies. These include: Houthakker and Taylor (1970); Moshin (1974); Stern, Francis and Schumacher (1976); Tan (1978); Stone (1979); Lee and others (1980); Grossman (1982); Kirmani, Milajoni and Mayer (1984); Hufbauer, Berliner and Elliott (1986); Koekkoek and Mennies (1986); Cline (1987); and Erzan and Karsenty (1987). Where the elasticity of demand for a particular country is not available, a formula has been derived from the data available and market shares. Estimate of the elasticity of substitution is not available by source. It is assumed to be low (0.5) in developing countries, as there is limited access to these markets and thus low degree of substitution is allowed, and higher (2.5) for developed countries in both restricted and unrestricted markets, where a higher degree of substitution is allowed from different sources because these markets are more open despite the MFA.

Data on supply parameters were difficult to obtain. The elasticity of transformation between clothing and other products was close to 1 for industrial countries and the ROW, and lower in other developing countries. Other elasticities have been assumed to be equal to 1 in all countries/country groups following Cline (1987).

The Myanmar economy, according to official sources, grew by an impressive 10.9 per cent during the period 1992-93. As this rate I is derived from provisional data, it is more likely that real growth was between 7 and 8 per cent. Much of this good performance can be attributed to a 15 per cent growth in the agricultural sector brought about by increases in cultivated area and good weather. This is also partly explained by mobilization of the public sector for more efficient operations. Furthermore, the high growth rate is also partly a function of the low base from which economic growth has been moving forth. Although a recovery is under way, the gross domestic product (GDP) in real terms is still smaller (54,170 million kyats) in 1992-93 than it was (55,989 million kyats) in 1985-86.

Most of the economic sectors, with the exception of services, have achieved double-digit growth. The power sector grew by 17.2 per cent, mining by 15.5 per cent, and processing and manufacturing by 13.7 per cent. Nonetheless, this recovery was marred by high inflation and a continuing government deficit. Both these trends have been fuelled by a rapid rise in money supply of around 40 per cent each year since 1990. This has been accompanied by an overvalued exchange rate, which pegs the kyat at over twenty times the market rate. Prices for consumer goods rose significantly and confidence in the currency has been waning. While official consumer price index (CPI) figures indicate a 22 per cent rise in 1992-93, unofficial sources peg the increase at around 70 per cent. More unsettling has been the disclosure that some cities in Upper Myanmar have begun to import lowprice rice from China especially since Myanmar used to be the rice bowl of Asia. While 1992-93 appears to have been a period of unprecedented high growth it remains to be seen whether this can be sustained.

The history of the Indonesian capital market dates back to the period of Dutch colonisation. A stock exchange was established on December 14, 1912 in Batavia—or Jakarta, as the city is called today. It was considered sufficiently successful that two additional exchanges were set up in 1925—in Surabaya on January 11, and in Semarang on August 1. During this period, there were thirteen exchange members, and the number of listed securities totalled 250 (Usman 1990:186).

After the Proclamation of Independence in 1945, the Indonesian government attempted to re-activate the capital market through the issue of its own bonds in the 1950s. This activity was governed by the Emergency Law on the Bourse No. 13 of 1951, which was superseded by the Law on Bourse No. 15 of 1952 (Usman 1990:3). This law is still in effect, and governs the activities of all capital market practitioners, although a new law on capital markets is now being drafted, and is expected to be introduced to the Parliament before the end of the fiscal year in March, 1995 (Ruru 1994b). According to Article 3 of the existing law, the Minister of Finance is responsible for supervising the activities of the Jakarta Stock Exchange (JSX), while Article 5 delegates responsibility for organising its activities from the Minister to the Association of Money and Securities Traders (Perserikatan Perdagangan Uang dan Efek-Efek, or PPUE), with the assistance of the central bank (Bank Indonesia).

A sluggish revival: 1977-1988

After independence, the law and the association proved unable successfully to promote the further development of the capital market, which fell into decline—for reasons which included the nationalisation of Dutch and other foreign companies, political instability, and chaotic economic conditions in which inflation peaked at 650 per cent in the mid-1960s. In an attempt to revive the Jakarta Stock Exchange, the New Order government set up a Capital Market Executive Agency (Badan Pelaksana Pasar Modal, Bapepam) through a Presidential Decree (Government of Indonesia, 1976). Bapepam was established as a unit within the Ministry of Finance, with a mandate to organise the stock exchange and to act as the capital market supervisory agency.

World Trade in Clothing and Textiles

In 1986 clothing and textiles represented about 9 per cent of world merchandise trade and they grew at 5 per cent a year (GATT 1987d). Clothing and textiles had approximately equal shares of about 4.5 per cent each in this total, with values of $61 billion and $66 billion respectively.

World trade in clothing and textiles has been dominated by the industrial countries. In textiles, industrial countries are both major importers and exporters, with a share of 65 per cent in the world market in 1986. Half of the world textile trade takes the form of intra-industrial countries' trade. Industrial countries account for 85 per cent of the world clothing trade; 41 per cent is intra-industrial country trade.

The EC is the world's largest importer and exporter of clothing and textiles. It accounts for 42 per cent of world textile imports and 40 per cent of clothing imports. However, most of these imports take the form of intra-EC trade (Table 4.1). The United States is the second largest importer of clothing with an import share of 29 per cent.

For all the attention given to developing countries' clothing and textile exports, industrialized countries are still the major exporters. The EC is the world's largest exporter of clothing and textiles, accounting for 52 per cent of world trade, followed by the Asian NICs with 18.4 per cent. Italy is the world's largest individual exporting country (when aggregating both textiles and clothing) with a market share of 13.5 per cent (Table 4.2). For textiles, in 1986 the Federal Republic of Germany, Italy and Japan were the major exporters in the world market with shares of 8.1, 5.1 and 5.6 per cent, while for clothing Hong Kong, Italy and the Republic of Korea were the major exporters with shares of 8.4, 7.6 and 5.8 per cent (GATT 198d).

In the early 1980s, the geographic boundaries defined in the title of this paper would have been drawn very differently from today.

Then, as now, there would have been no ambiguity about the inclusion of the ASEAN economies, Japan, Hong Kong, Taiwan and the Republic of Korea. Then, as now, there would have been no ambiguity about the exclusion of the Democratic People's Republic of Korea. But that is the end of the consistency over time.

The People's Republic of China is now best considered as an Asian market economy. It was certainly not a market economy a decade ago. A large majority of production of goods and services is now independent of the state plan, and what is left of the plan scrambles to keep up with the signals emitted by powerful market forces.

When did the switch-over take place in China? There is no need, and no opportunity, to be precise. I would date it somewhere between the Thirteenth Communist Party Congress in 1987 and the Fourteenth in 1992 — between the Chinese Communist Party's acceptance of the doctrine of the “preliminary stage of socialism”, and its acceptance that China was a “socialist market economy”. If a journalist were pressing me for a single date, and I was too tired to resist, I would say May 1991, when large price adjustments for agricultural products including grain paved the path for market determination of food prices.

Are the economies of Indochina market economies? Vietnam's price and enterprise reforms are much younger than China's, but have proceeded more rapidly. The dynamic rural enterprises that have defined the “market-oriented” character of the Chinese economy since the mid-1980s do not so far have counterparts in Vietnam. The inflationary macro-economic environment is less conducive to smooth operation of markets than in China. But there is no doubt about the direction of change in Vietnam, and it is, as least, an Asian emerging market economy.

South Asia is hardest of all to define. Markets, relative to state power, are now less important in resource allocation in india than in China.

1 The reform process

The period of economic reforms from 1975 to 1992 may be divided into the following stages:

1. • 1976–79: unifying the country and turning the economy into an integrated whole in accordance with central planning principles;

2. • 1980–86: experimenting and readjusting economic policies to orientate the country towards trade liberalization;

3. • 1986–92: affirming basic orientations for the renewal of economic policies.

The main features of policy changes through these stages are given below:

The period 1976–79

When the Vietnam war ended in 1975, along with the unification of the country's political institutions, the integration of the economies of North and South Vietnam was set in motion.

North Vietnam's economic model from the 1950s was based on that of a centrally planned economy. Although the economy was altered by the decades of war the country went through, the following points generally characterized its economy then:

1. • The state determined all important economic activities of the entire country through a system of production plans and goods distribution; there were also strict regulations on pricing and interest rates.

2. • The state and the collectives constituted the foundation of the economy, the collectives being heavily subsidized in activities such as investment and credit loans and they quickly developed to become a sizeable part of the national economy.

3. • Large-scale private enterprises were not encouraged to expand further, but were instead singled out to be finally incorporated into either state or collective units.

4. • The market mechanism operated only in small businesses and the household economy, that is to say in only a part of the agricultural, handicraft, and consumer goods retailing sectors. Many capital goods used for production were not allowed to be bought or sold on the market but were allocated by the state's planned distribution system.

5. The state monopolized foreign trade. Due to historical circumstances, Vietnam's trade relations had been mainly with the former Soviet Union and East European countries through bilateral treaties. […]

The Asia–Pacific Economic Co-operation (APEC) forum is a regional, multilateral institution dedicated to trade and investment liberalization. The eighteen members of APEC are:

Australia Mexico Brunei New Zealand

Canada Papua New Guinea China Philippines

Hong Kong Singapore Indonesia Chinese Taipei

Japan Thailand South Korea United States

Malaysia Chile (November 1994)

The Region

With a population of two billion people, the Asia–Pacific region accounts for almost half of the world's population. The region has a combined gross national product (GNP) of more than US$15 trillion and contains the three largest economies in the world. The trade-driven economies of the region have the world's largest pool of savings, the most advanced technologies and the fastest growing markets. Just as the Western Hemisphere displaced Europe in economic importance in the twentieth century, the centre is shifting again, now to the Asia–Pacific region. That is why so many experts believe the twenty-first century will be the “Pacific Century”.

History of APEC

The idea of a Pacific economic organization has been around at least since the 1960s. Over the years, academicians in the United States, Japan and Australia promoted the idea. The Pacific Basin Economic Council (PBEC) and the Pacific Economic Co-operation Council (PECC) were precursors in the non-governmental sector. In November 1989, at the invitation of Australian Prime Minister Bob Hawke, trade and foreign ministers met in Canberra and created the Asia–Pacific Economic Co-operation (APEC) group. The original members of the APEC forum included Australia, Brunei, Canada, Indonesia, Japan, South Korea, Malaysia, New Zealand, the Philippines, Singapore, Thailand and the United States.

Owing to concern about the lack of progress in the GATT Uruguay trade negotiations and the growing interdependence of the economies of the Asia–Pacific, the new organization was formed to better co-ordinate economics and trade among the economies in the region. There was a degree of skepticism on the part of some of the Southeast Asian participants at Canberra who feared that the new grouping would eclipse their own organization, the Association of Southeast Asian Nations (ASEAN). They were also afraid that they would be overwhelmed by the giant economies in APEC.