Title: Doing Business in Indonesia: legal and bureaucratic constraints Ross H. McLeod Indonesia Project Australian National University ross.mcleod@anu.edu.au
1Doing Business in Indonesialegal and
bureaucratic constraintsRoss H.
McLeodIndonesia ProjectAustralian National
Universityross.mcleod_at_anu.edu.au
2The 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
3The 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
4The 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
5Topic 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
6Calculating Doing Business index
back1
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7Problems 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
8Credit 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
9The 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
10Problems 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
11Problems 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
12Problems 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)
13Problems 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
14Doing 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?
15Ease of Doing Business in Indonesia Selected
Sub-indices and Components
16Ease of Doing Business in Indonesia Selected
Sub-indices and Components
17Indonesia 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
18The 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.
19The 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)
20The 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)
21Growth of Real GDP in Major Common Law and Civil
Law Economies
back
22Growth of Real GDP in Major Common Law and Civil
Law Economies
back
23Some developing country comparisons
24(No Transcript)
25Is 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
26Is 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
27Soeharto built up a system that enabled him to
exploit the coercive power of government in his
own interest for more than three decades
28He created and maintained a monopoly on political
power, through a franchise system of government
29Soehartos 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)
30The 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
31The 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
32The 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
33The Soeharto Franchise
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34Main 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
35Main 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
36Bureaucratic 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
37Soeharto 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
38Incentives 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
39Roles 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
40Roles 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
41Roles 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
42Returning 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?
43Returning 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
44In 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
45Doing Business in Indonesialegal and
bureaucratic constraintsRoss H.
McLeodIndonesia Project, ANUross.mcleod_at_anu.edu.
au
46End product
back
47Recommendations
- 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
48Ease of Doing Business in Indonesia Selected
Sub-indices and Components
49Obligations 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
50The 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!