In the course of this diagnostic, the following cross-cutting themes emerged with respect to CLIR and trade in Indonesia:
- The state of the informal sector is insufficiently understood and under-appreciated as a drag on future economic growth.
- The quality of business-related information is insufficient to meet the demands of a dynamic economy.
- Indonesia’s corps of professionals—lawyers, judges, economists, accountants, etc.—are insufficiently trained in the tools of a modern economy and are insufficiently organized to influence policy in the future.
- Corruption will continue to demand aggressive solutions at the lowest and most persistent levels.
a. The informal sector
Indonesia abounds in commercial sector reform efforts that aim to bring the country into compliance with international best practices. But most of these reforms—in Company Law, competition policy, corporate governance, banking and access to finance, trade facilitation, etc.—are directed at a segment of the economy to which many, and perhaps most, enterprises do not even belong: the formal sector. To benefit from many of the legislative protections currently under construction an enterprise must be legally recognized by the state. Legal recognition begins with company registration (as detailed in this report’s chapter on Company Law), which signals a willingness to comply with tax and licensing requirements, labor and employment law, land use and zoning rules, and other regulations. In return, an enterprise that registers with the state is granted the protection of limited liability.
But limited liability is an obscure benefit in the eyes of most small entrepreneurs, and the consequences of registration—in particular the regulatory hassles that most businesses in the formal economy face and the taxes they must pay—do not seem worth the associated costs and effort. As a result, Indonesia has a massive informal sector whose components are both visible and hidden.
In the street, small-scale entrepreneurship is obvious in an abundance of services and products for sale, from messenger services to tiny restaurants to stalls that sell produce, hardware, and household goods. Behind closed doors, Indonesian industrial entrepreneurs reportedly employ mostly female workers at very low wages in unsafe conditions. Although street vendors and tiny service-oriented businesses are the most visible informal players, more modern enterprises, including supermarket chains, auto parts suppliers, consumer electronics assemblers, and even large-scale industrial operations, can also use informal employment tactics. Interviewees reported that the “overwhelming majority” of Indonesian businesses do not register with the state that a great many of these informal businesses are operated by women, and that regulatory hassles from municipal and other agencies make operation in the shadows preferable to joining the formal economy. In spite of the widespread presence of “shadow” enterprises throughout rural and urban Indonesia, there has been no recent, clear, or reliable assessment of the extent of this presence. Various estimates of informal enterprises as a percentage of Indonesian GDP range from 19.8 percent to 38 percent to 75 percent.
What is clear is that high rates of informality in an economy are associated with poverty:
[Workers] enjoy no social benefits and cannot use pension plans and school funds for their children. Businesses do not pay taxes, reducing the resources for the delivery of basic infrastructure. There is no quality control for products. And entrepreneurs, fearful of inspectors and the police, keep operations below efficient production size.
When enterprises elect not to register, the state suffers in terms of sanitation, health, safety, prosperity, and productivity. In addition, unregistered enterprises are unable to borrow money from formal credit institutions and are unable to take advantage of many attractive investment opportunities. The products of unregistered enterprises are often of substandard quality and limited variety, and consumers are offered little protection in the event of malfunctioning products. Where rates of business informality are high, merchants may feel compelled to pay “protection money” to powerful local actors for the right to operate their unsanitary or non-tax-paying businesses.
Finally, businesses that have registered with the state and chosen to satisfy their legal obligations suffer in terms of profitability, productivity, and opportunity when forced to compete with businesses that have not chosen the formal path. In fact, everyone loses when enterprises refuse to pay taxes, because when the Indonesian government does not receive sufficient tax receipts, it may choose to raise taxes on those businesses that are already complying with the law, thus increasing the chances that other businesses will choose to remain informal. This diagnostic found that Indonesia has made almost no investment in power generation, roads, or port capacity since the financial crisis. Inadequate infrastructure continues to constrain operating efficiencies and discourage investors. Although the government plans to increase infrastructure spending in 2008, its available resources are diminished due to the country’s pervasive economic informality.
The World Bank recently identified increasing non-farm productivity as a key priority for reducing poverty in Indonesia. In the absence of a targeted endeavor to understand and address the roots of informality, increased productivity in Indonesia will remain elusive:
The notion that informal companies might grow and become more productive is unfounded. They can't borrow from banks or rely on the legal system to enforce contracts or resolve disputes, and they structure relationships with informal suppliers in ways that make it difficult to come clean. In fact, informal companies often shun opportunities to grow and modernize precisely so they can continue to avoid detection. As a result, informal businesses remain a persistent drag on national productivity and living standards.
Thus, while Indonesia endeavors to strengthen its legal regime in support of long-term economic growth, there is an equal need for comprehensive efforts to increase the rate at which enterprises join the formal sector so that they can benefit from these reforms. Indonesia has used assistance from the Asia Foundation to streamline certain regulatory and licensing requirements through “one-stop shops,” but additional required steps include: improving outreach and information provided to new and small entrepreneurs; reducing registration fees and costs (especially those associated with notary services); eliminating minimum capital requirements; reducing and simplifying taxes; and abolishing all unnecessary or duplicative regulations. Special effort should be made to understand and address the presence of a large percentage of women in the informal economy. Until the rate of formalization increases, the informal economy in Indonesia will limit the increase in productivity that the country desperately needs.
b. The need for more, better, and more accessible information
The absence of reliable information pertaining to the private sector undermines the entire Indonesian economy and diminishes productivity and the potential for growth. Rather than having adequate amounts of easily accessible data about company characteristics, credit information, collateral registration, court records, and trade, Indonesia has scant information that is difficult to access. Among the critical information accessibility problems found in this diagnostic are:
- There is a serious shortage of public information about companies, especially non-stock exchange companies, and what does exist is not easily accessible. Even the information contained in a company’s filed Articles is sometimes treated as “confidential” by the company registry and not made available without the company’s permission.
- It is extremely difficult to obtain information about ownership and other interests in real property (i.e., liens, mortgages, and easements) through the land registry, which refuses to provide that information to anyone but the landowner.
- The collateral registry’s records are not useful to prospective creditors and buyers of collateral who need information on the status of a debtor’s property. Because all security agreement information is entered by hand in the ledger, prospective creditors must either search each ledger entry manually for conflicting fiduciary guarantees or examine each of the file folders containing the original applications and supporting documentation. These burdensome and time-consuming requirements discourage lending.
- Court records are difficult to access and often cannot be retrieved without written permission from an unspecified number of judges. Courts do not harness the storage potential of their computers, generally using them for word-processing functions only.
- In bankruptcy proceedings, creditors have difficultly receiving information about a company’s assets and liabilities from the court-appointed bankruptcy curator.
- At borders, trade data is not effectively maintained.
Open, competitive economies require free flows of information that decrease the risks of doing business. Access to public information should be encouraged and facilitated rather than discouraged. Indonesia should institute measures that encourage better recordkeeping about commercial activity and find inexpensive ways to make that information available to people who need it.
c. Building and organizing a corps of professionals to meet the demands of a global economy
A paper-and-pencil, insular economy cannot meet the current demands of the global economy. In all aspects of commerce, the presence of technology and the needs of international trading partners raise the worldwide expectations of Indonesia’s institutional capacities. One cause of the financial crisis of 1997 was the mismatch between the sophisticated transactions already taking place and the lack of sophistication of the professional class.
Indonesia is still struggling to develop a corps of professionals that is sufficiently capable to administer an open, competitive economy. The country has increased the quality and range of topics covered in law schools, which now offer courses on topics such as secured lending and competition. Institutions like the Intellectual Property Center at the University of Indonesia will contribute to public dialogue about Indonesia’s standing on important global issues. However, these small steps forward have not been sufficient to create the large numbers of trained professionals that are required to drive economic transformation. Persistent issues include:
- Continuing education opportunities that would bolster the ability of judges to manage economic cases are not widely and routinely available. Although various donor-funded projects deliver judicial training, many judges are still unfamiliar with modern commercial law.
- Because of the tendency in Indonesia to regard court clerks as second-class staff, these workers have been largely excluded from the court reform process and from continuing education in administration and substantive law. Predictably, the job performance of court clerks has not improved.
- In the area of bankruptcy, creditors complain that curators (administrators) are insufficiently qualified. Although must curators receive legal training at Indonesian law schools, they are not trained in accounting or business management.
- Legal professionals, including lawyers, prosecutors and judges, lack experience with financial crimes, and Indonesia suffers from a general shortage of accountants and auditors.
The dearth of continuing education opportunities for professionals is compounded by general weaknesses in supporting institutions. For example, Indonesian bar associations do not provide meaningful training for their members or regulate professional standards or ethical conduct. Many of the competition-related associations formed in 1999 with the passage of the new competition law have since dissolved or become inactive due to lack of funding or frustration with the progress of competition policy implementation in Indonesia. In the area of international trade, associations have been hobbled by low membership and problems with dues collection. Many trade firms, fearful of losing their competitive advantage, are reluctant to fully engage in a collective framework to solve problems and discuss pending legislation because they do not wish to share confidential business data.
Academic programs must be strengthened, opportunities for continuing education must be increased, and the organizational capacities of professional, trade, and industry groups must be bolstered in order to create a more prepared and responsive Indonesia economy.
d. Petty corruption: Tackling cynicism and bad habits
Indonesian leaders have acknowledged the importance of reducing corruption and have taken a variety of related steps, including establishing the Commission to Eradicate Corruption, the Anti-Corruption Court in Jakarta, and new codes of conduct for various government officials (including judges). They also have begun to encourage better standards of corporate governance. Yet the tradition of informal “transaction fees” is so entrenched at the lowest levels in so many institutions—the courts, the Customs department, various registries, and large corporations—that it will likely take at least a generation to restore public confidence in the health of the overall system.
In general, average citizens, businesspeople, and many service professionals pay informal fees when engaging in legal or trade-related activities. Lawyers frequently circumvent the established administrative processes by paying unofficial “speed money” to court clerks to ensure that their clients’ cases are handled quickly, arguing that this bribery is ethical because it saves their clients money and forces the court system to work efficiently. At borders, traders accept that they will have to pay unofficial fees government officials, including the policeman on the highway, the gate attendant at the port, the port worker who loads and unloads cargo, and the Customs officer who moves the paperwork. All of this petty corruption slows Indonesian commerce.
A campaign of small, low-cost efforts to diminish petty corruption—e.g., signs posted in clerk’s offices bearing the warning, “Failure to give a receipt for any court fee is a criminal offense and should be immediately reported to the police”—could make a difference, but they will not be implemented until leaders acknowledge the problem of petty corruption. Then, private actors must agree to refrain from enabling corrupt practices. On this front, stronger supporting institutions could help raise expectations from service professionals like lawyers and brokers.
