Doing Business in Indonesia: legal and bureaucratic constraints Ross H. McLeod Indonesia Project Australian National University ross.mcleod@anu.edu.au - PowerPoint PPT Presentation

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Doing Business in Indonesia: legal and bureaucratic constraints Ross H. McLeod Indonesia Project Australian National University ross.mcleod@anu.edu.au

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Title: Doing Business in Indonesia: legal and bureaucratic constraints Ross H. McLeod Indonesia Project Australian National University ross.mcleod@anu.edu.au


1
Doing Business in Indonesialegal and
bureaucratic constraintsRoss H.
McLeodIndonesia ProjectAustralian National
Universityross.mcleod_at_anu.edu.au
2
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

3
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

4
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

5
Topic Component Indicators
Starting a business Procedures, time, cost and
minimum capital to open a new business Dealing
with licenses Procedures, time and cost of
business inspections and licensing (construction
industry) Hiring and firing workers Difficulty
of hiring index, rigidity of hours of index,
difficulty of firing index, hiring cost and
firing cost Registering property Procedures,
time and cost to register commercial real
estate Getting credit Strength of legal rights
index, depth of credit information
index Protecting investors Indices on the
extent of disclosure, extent of director
liability and ease of shareholder suits Paying
taxes Number of taxes paid, hours per year
spent preparing tax returns and total tax payable
as share of gross profit Trading across borders
Number of documents, number of signatures and
time necessary to export and import Enforcing
contracts Procedures, time and cost to enforce
a debt contract Closing a business Time and
cost to close down a business, and recovery
rate back
6
Calculating Doing Business index
back1
back2
7
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

8
Credit registries and bureaus
  • Why should the public sector be involved at all?
  • Is the private sector likely to put its trust in
    public credit registries?
  • Is the lack of private sector credit agencies an
    indication of market failure?
  • Or has the private sector taken the view that
    such an activity would not be profitable?

next
9
The legal rights index
  • What is the best way of dealing with insolvency?
  • Is Chapter 11 no good?
  • The US rates quite poorly on this measure only 7
    out of 10, and ranking behind 31 other countries,
    including Bangladesh, Nigeria, Zimbabwe, Kenya,
    Albania

back
10
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
11
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

12
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)

13
Problems with the Doing Business methodology (4)
  • Coverage of data doesnt 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

14
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?

15
Ease of Doing Business in Indonesia Selected
Sub-indices and Components
16
Ease of Doing Business in Indonesia Selected
Sub-indices and Components
17
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).
Well come back to this later
18
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.

19
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)

20
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)

21
Growth of Real GDP in Major Common Law and Civil
Law Economies
back
22
Growth of Real GDP in Major Common Law and Civil
Law Economies
back
23
Some developing country comparisons
24
(No Transcript)
25
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

26
Is legal heritage important?
  • In Indonesias 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

27
Soeharto built up a system that enabled him to
exploit the coercive power of government in his
own interest for more than three decades
28
He created and maintained a monopoly on political
power, through a franchise system of government
29
Soehartos franchise system
  • 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)

30
The franchise analogy
  • Important characteristics
  • Contractual relationship between a franchisor and
    multiple franchisees
  • Franchisor designs the product and sets the
    overall operating parameters
  • Other aspects of management delegated to
    franchisees

31
The franchise analogy
  • In this case, the product is the right to
    undertake private taxation
  • Imposed by public sector officials (franchisees)
  • But for their own private benefit

32
The franchise analogy
  • Product design
  • The best tax systems rely on low rates imposed on
    a large tax base
  • High rates tend to kill off the economic activity
    being taxed (Laffer curve)
  • and create strong incentive for opposition
  • Soeharto unusual among corrupt autocrats in
    understanding and applying this principle

33
The Soeharto Franchise
back1
back2
back3
34
Main forms of private taxation
  • (1) Rent generation and harvesting through
    insider beneficiaries
  • Elimination of competition for privileged firms
    (e.g. legal monopolies)
  • Exploitation of natural resources by privileged
    firms
  • Non-arms length transactions between public and
    private sectors
  • Harvested rents shared with franchisees
  • All these are equivalent to hidden forms of
    taxation of the general public income
    redistribution in favour of the rich

35
Main forms of private taxation
  • (2) Extortion of outsider firms and individuals
  • Bureaucratic extortion
  • Judicial corruption (auction of favorable
    decisions)
  • Military/police extortion by threat of violence
    or bogus charges
  • Illegally generated income often greatly exceeds
    formal remuneration
  • All this is equivalent to semi-hidden forms of
    taxation of the general public
  • but can be blamed on individual shortcomings,
    rather than an inherent feature of the system of
    government

36
Bureaucratic extortion (private taxation)
  • Bribes to obtain licenses to do business
  • Bribes for the provision of services when there
    is already an entitlement to them
  • Illegal levies on trucks and buses

back
37
Soeharto as franchise owner
  • 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

38
Incentives for franchisees
  • Opportunities to become very wealthy if they
    served the interests of the franchise well
  • Including opportunities to engage in nepotism
  • Right to support from (protection by) the
    franchise
  • Threat of exclusion, or worse, if they failed to
    do so, or worked against the franchise
  • In short strong sticks and carrots to work as
    part of a huge, mutually supporting group

39
Roles of the branches
  • 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

40
Roles of the branches
  • 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

41
Roles of the branches
  • 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

42
Returning to the Conundrum
  • 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?

43
Returning to the Conundrum
  • 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

44
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

45
Doing Business in Indonesialegal and
bureaucratic constraintsRoss H.
McLeodIndonesia Project, ANUross.mcleod_at_anu.edu.
au
46
End product
back
47
Recommendations
  • Drop two of the sub-indices altogether
    Protecting Investors and Getting Credit
  • Avoid double counting through inclusion of
    redundant measures
  • Think more carefully about the weights given to
    each component indicator
  • Focus on reality rather than what the rules say,
    including measures of public sector extortion of
    business

48
Ease of Doing Business in Indonesia Selected
Sub-indices and Components
49
Obligations of franchisees
  • Payment (in cash or kind) to join, and for
    continuing membership
  • Recruitment of lower-level franchisees
  • Promotion of high-performers
  • Termination of poor performers
  • Dealing with threats to the franchise

50
The regime provided effective government
  • The system provided strong incentives to
    franchisees to ensure the success of the
    franchise
  • The franchise prospered by lightly taxing a
    large, rapidly growing tax base
  • Rapid economic growth was essential to ongoing
    success (cf. Nigeria, Zimbabwe)
  • Close correspondence between interests of the
    franchise and interests of the public
  • Growth is good!
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