Introduction

Private sector development and investment in the sense of tapping private sector efforts and investment for promoting economic development is crucial to spurring economic growth and reducing absolute poverty. Combined with public sector efforts, private investment, particularly in competitive markets, has great potential to contribute to growth (World Bank, 2005b: 273). Private markets function as the engine of economic growth, creating productive jobs and higher incomes. With the government playing a complimentary role of regulation, funding, and provision of services, private initiative and investment can help provide the basic services and conditions that empower the poor by improving health, education and infrastructure (World Bank, 2005b: 273).

Since the 1980s development thinking among the multilateral aid agencies, particularly the World Bank and the regional development banks, including the Asian Development Bank (ADB), has therefore shifted from an early emphasis on the central role of the state to the importance of the private sector to raising economic growth. This recognition of the importance of private sector development was based on the observation that market forces and competition turned out to be more efficient, more productive and more conducive to economic dynamism. Privatisation of state-owned enterprises (SOEs), strengthening market forces, increasing competition and refocusing the role of the state became the new catchwords among the policy recommendations offered by these multilateral aid agencies (Schulpen & Gibbon, 2002: 1).

Following in the footsteps of the multilateral aid agencies, a number of bilateral aid donor agencies were also attracted by the private sector development model. Consequently, they either adopted new aid programs aimed at strengthening the recipient country’s private sector, reworked and strengthened existing private sector development programs, or redesignated their aid programs as related to private sector development, which had earlier been classified under different headings. In fact, the private sector development programs of several individual donor countries have actually had a stronger focus on developing the private sector in the recipient developing countries, while the multilateral aid agencies have often focused more on structural reforms (Schulpen & Gibbon, 2002: 1)

1.1 Private sector development in Indonesia

In Indonesia the focus on private sector development came in fits and starts. The reason was that there was a long-standing distrust of private capital in Indonesia, which had arisen during the period of Dutch colonial rule (Hollinger, 1996: 8). During the early independence period in the first half of the 1950s, the Indonesian government introduced an affirmative program to promote the development of indigenous Indonesian entrepreneurs. With the introduction of ‘Guided Democracy’ and ‘Guided Economy’ in the late 1950s with its emphasis on ‘Indonesian-style socialism’, government focus shifted to building a national industrial economy around state-owned capital, that is state-owned enterprises (SOEs). State-owned trading firms were given a monopoly on the import of essential commodities and were provided with state credit. On the other hand, the private sector, including indigenous and ethnic Chinese firms, were excluded from the most lucrative trading monopolies, and were not provided with lavish credit as the SOEs were (Robison, 1986: 80).

The two oil booms of the 1970s, however, provided the government with considerable resource rent taxes, which enabled the government to make a start with an ambitious state-led industrialization. This industrial program involved the establishment of large-scale, capital-intensive, basic industries. However, the oil boom era ended in 1982 when the price of oil tumbled in the world oil market as a result of the recession in the advanced industrial countries.

With a considerably diminished fiscal capacity, the government once again attempted to promote the development of a more efficient private sector through the introduction of a series of deregulation measures to improve the investment climate for private entrepreneurs. This policy was maintained up to the onset of the Asian economic crisis in 1997.

The Asian economic crisis, which led to the fall of President Soeharto in May 1998, had a considerable adverse impact on private enterprises, including domestic as well as foreign, as they were burdened by huge foreign debts which they could not repay because of the steep depreciation of the rupiah. Export-oriented firms faced difficulties importing intermediate inputs, as foreign banks refused to accept the letters of credit issued by Indonesian banks.

With the recent mild economic recovery, private enterprises are in a position again to undertake some new investments, which are needed to sustain economic growth, although these investments are still much smaller than the investments during the boom times of the first half of the 1990s. However because the country’s investment climate has deteriorated considerably, encouraging new investment, both domestic and foreign direct investment (FDI), has been difficult, even though domestic and FDI has slightly increased since 2004.

Indonesian government policies towards the private sector have been a major determinant of this sector’s development and often been ambiguous, as outlined above. For this reason, an overview will first be given of these policies, which have greatly affected private sector development in Indonesia. This overview is important to understand how and why development of the private sector has occurred as it has.

To better understand these policies, it is helpful to distinguish between the three major elements of the private sector, including the conglomerates and large companies, mostly but not exclusively owned or controlled by ethnic Chinese businessmen; the small- and medium-scale enterprises (SME), mostly owned by indigenous (pribumi) businessmen, but also by a sizable number of ethnic Chinese businessmen; and foreign-invested enterprises.

Since independence policies towards the private sector have often been influenced by the consideration to promote the development of indigenous (pribumi) Indonesian entrepreneurship. These policies involved affirmative policies to promote pribumi entrepreneurship by restricting, occasionally even banning, the economic activities of the ethnic Chinese. For this reason a section in this paper will discuss the government policies on limiting the economic activities of the ethnic Chinese.

The rapid growth of large private conglomerates which emerged and thrived under the patronage of Soeharto’s ‘New Order’ regime has been discussed extensively by foreign and Indonesian writers, and will therefore not been discussed in this paper. Instead, the discussion will focus on the two other elements of the private sector, namely the foreign investment sub-sector in view of its expected role in revitalizing the Indonesian economy, and the SME sub-sector which, despite its great potential and importance for the Indonesian economy, has not developed as expected.

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Comment(s)

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1. Thee Kian Wee
   (posted 09 May 2006 / 01:39:20 PM)
   
   Dear Mr. Cabalza,
   
   You are absolutely right that the ethnic Chinese, both totoks and peranakans have played and are still playing an important rule in the Indonesian economy. I did not mention this in my paper, as my focus was on how the perception on the part of several Indonesian policy-makers of Chinese economic dominance have shaped various policies to curtail Chinese economic activities in order to promote indigenous Indonesian entrepreneurship. Most of these policies have not succeeded in substantially reducing the economic role of the Chinese, although over time a growing class of indigenous Indonesian entrepreneurs emerged during the New Order era without, however, substantially reducing the economic role of the Chinese.
   
   While during the late Soeharto era much resentment arose in response to the growth of Chinese-owned and -controlled conglomerates, it is often forgotten that the large majority of Chinese business consists of the large number of small- and medium-scale enterprises (SMEs) operating in manufacturing, trade, transportation, restaurants, and other services, such as the many shops all over Indonesia selling auto parts, electronic products, auto repair shops, and various other economic activities which keep the Indonesian economy running. The surge of manufactured exports after the deregulation measures and trade reforms after the end of the oil boom was to a large extent due to foreign-invested, export-oriented plants from Korea and Taiwan and to the Chinese run garment firms and other firms producing labor-intensive products.
   
   Thank you for your good comment.
   
   THEE Kian Wie
   Senior Economist
   Economic Research Centre
   Indonesian Institute of Sciences
   (P2E-LIPI), Jakarta
2. Chester Cabalza
   (posted 27 March 2006 / 08:14:46 AM)
   
   It would have been ok if you also highlighted the significant roles of the totoks and peranakans (of Chinese descent) in the economic progress of Indonesia. Despite, some persecutions experienced by this minority group, they have at least contributed a lot to the escalation of the largest economy in Southeast Asia.