Indonesia, a ticking time bomb.

Personal thoughts on trust and economy of Indonesia

Trust — the invisible glue to our economy

Imagine a situation where you work for a company in Indonesia and are resigning from your position. Generally, your manager would ask if you know anybody that you trust that you can refer to, to replace your position. Or put it the other way around, an employer is more likely to hire a new employee that is recommended by their internal employees. Twentieth-century economists would argue that labor market is an equilibrium as a result of supply and demand forces where wages communicated information about the excess supply and demand of the skills needed by each firm and those embodied in each worker.

Why do I talk about social interactions and trust? How would this relate to Indonesia’s economy and to even a ticking time bomb?

I believe trust is underrated, one factor that is neglected in many modern economic models. Many other studies also have confirmed that personal contacts are crucial for people to find job opportunities. An article in the New York Times reported that 45% of non-entry level placements in the accounting firm Ernst & Young were employee recommendations, while Deloitte got 49% of its experienced hires from referrals. We can say that the market for labor is embedded in the network of social interactions and trust is the component needed to form this social networks.

“perfect labor markets exist only in textbooks.”— Granovetter, Getting a Job

Therefore, trust is an essential component in forming labor market where companies accumulate its knowledge and knowhow, it is also essential in understanding social interactions (contracts) between businesses, where the knowledge and knowhow accumulated are turned into objects/products, and on a higher level, trust is the invisible glue to how our society is formed and functions.

Indonesia — a low trust society

Francis Fukuyama argues that there are two types of society based on the level of trust, high trust society and familial/low trust society. In high trust society such as the United States and Japan, it is easier to trust strangers and trust between businesses can be easily enforced through contracts and therefore pushing transaction costs between businesses to be relatively low. When trust is cheaply established, these societies are more likely to develop larger businesses/networks that are professionally run.

Familial societies/low trust societies like Indonesia, are less successful at creating associations among strangers and hence rely more strongly on family links. It is characterized by a large number of small businesses and a few dominant families controlling a few large conglomerates. In the absence of trust, creating business relationships would require costly and time-consuming contracts, insurance, enforcement procedures, and therefore forcing transaction costs to be expensive. Doesn’t this sound too familiar? Doesn’t it remind you of how hard it is to get licenses/certificates from governments/associations In Indonesia? Or to get a loan from banks for those in rural areas? These are just few of many cases.

Family at home and work in Indonesia

In Indonesia, we have uniquely developed a concept of “kekeluargaan”. It is derived from the word “keluarga” which means family in English. This word has a unique cultural meaning, it is used to describe family values, not only in the context of kinship, but is also extended in the context of business relationships and conflict resolutions.

Book of Familial Law in Indonesia by Sayuti Thalib

I want to highlight the period of the New Order, a 32 years period under the same government ruled by Soeharto. During this era (1966–1998), Indonesia grew its real GDP at 5.03%p.a. It was an impressive growth, but also was coincided by expansion of corruption, collusion, and nepotism. Although the history of corruption in Indonesia is rooted deep even before our independence, I believe this era is the “childhood” phase for Indonesia. For humans, childhood is the most important period of human’s life where a child develops their own perspective of seeing things. A child grasp everything that’s around him/her, curious of everything, quickly notice by people and get inspired by their surroundings. This is a stage where human’s personalities get molded and it is difficult to change during the later period of our life.

In this era, businesses that were close to the ruling family of Soeharto grew rapidly, trust was built in the smaller network between government and small group of individuals and hence creating a relationship between businesses and government where wealth and opportunities were centralized amongst the two. 32 years is a long period of time, which can fit 2 generations of family, more than 3 times the lifespan of a business, a period that has shaped how we form trust in our society. Briberies of government officials and bureaucracy have been normalized and naturally become part of transaction costs in creating the trust and relationships.

Implication of centralized low trust system on Economy

What are the implications to Indonesia when trust is expensive to build and the wealth and opportunities are centralized to only small group of people?

1. Expensive trust system, small network, and small output.

I would like to take Ford Motor’s River Rouge complex as en example, it had become the largest factory in the world in 1928. It was 2.4km wide and 1.6km long, it had 93 buildings totalling 1.5 km square of factory space, and housed more than 100,000 workers. The reason why it was so big, was to achieve economies of scale (per-unit cost of items decreases as we make more of them), and the division of labor (it is more efficient to have each worker focus on small part than to have each worker try build a car from start to finish).

Ford’s River Rouge Complex — From iron ore at one end and cars at the other. Sources (michelbaudin.com)

But why was a factory complex of this size emerged to manufacture cars but not to make pins?

It is due to larger networks are needed to hold and accumulate larger volumes of the knowledge and knowhow required to make cars than that needed to make pins. Larger networks are also built to eliminate transaction costs that would have otherwise occurs between firms/organizations.The larger the network, the larger the accumulation of the knowledge and knowhow, and hence the more complicated products it can produce.

In country like Indonesia with low-trust society, transaction costs are high not only because it requires negotiations, drafting of contracts, settling disputes, but also due to corruption and bureaucracy. The high transaction costs makes it harder for businesses/ organizations to establish relationship, to get licenses, and to enforce the contracts, among many other things. Indonesia ends up with “islands” of smaller network (firms) where the cost of market interactions/transactions between these “islands” are high and it hinders Indonesia’s potential ability to produce a more complicated products that require high volumes of knowledge and knowhow.

Take a look at our trade balance between Indonesia and Japan.

Indonesia’s Export to Japan in 2015 (Sources: atlas.media.mit.edu)
Japan’s Export to Indonesia in 2015 (Sources: atlas.media.mit.edu)

We have enjoyed positive trade balance of USD$7.2b with Japan in 2015, but we run a negative imagination balance to produce complicated products. We exported products that mostly come from exploitation of our natural resources and required little imagination to produce whereas Japan exported machineries and vehicles, much more complicated products that require larger volumes of knowledge and knowhow to build. Japan’s GDP per capita was USD$34,474.14 in 2015, 10 times of Indonesia’s GDP per capita, USD$3,336.11. The ability to turn our imagination into products is where economic value is generated. To do so, we need a trust system with ability to form larger networks to accumulate larger volumes of knowledge and knowhow.

2. Centralization of wealth and opportunities.

Thomas Piketty, the French economist in his book Capital in the 21st Century, demonstrated that when the rate of return on capital is greater than the growth of the economy as a whole, wealth inequality rises inexorably.

Money makes money.

Did you know that the interest earned in just one day by the richest Indonesian man on his wealth is more than what the poorest Indonesians spend on their basic need for an entire year? In a report by Oxfam, Indonesia has the sixth worst inequality in the world. In 2016, the wealthiest 1 percent of the country owned 49% of total wealth. Did you know that during the financial crisis that ended the New Order regime in 1998, doubled the percentage of population below the poverty line (11.3% in 1996 to 23.4% in 1999) and increased the share of gross income of the top 1 percent in Indonesia by about 40%?

Vulnerable — A woman walks across a railway track in a slum area in Jakarta. According to a recent World Bank report, only 20 percent of Indonesians benefitted from the growing economic wealth during the last decade, while 80 percent — or about 205 million people — were left behind. (Tempo/-)

According to Oxfam report, during this crisis, many of the richest people in Indonesia made their fortunes thanks to the exclusive government concessions and privatization that came with market fundamentalism. When public assets are privatized, their new owners can sell a more expensive product or service back to the state that sold off the business in the first place. Financial liberalization made more finance available to companies to expand commodities production, and those with investments in companies reaped the rewards. The palm oil sector is a good example. About US$ 12.5bn was invested in oil palm expansion in the period rewards. Most of the ten richest men in Indonesia have palm oil in their portfolio.

Economic inequality increases political inequality, as elites can use their heightened political influence to further entrench their advantages, while blocking policies that strengthen the rights of others. The concentration of wealth at the top in emerging economies also opens up opportunities for rent seeking (extracting wealth without creating new wealth).

Where to look ahead?

We have heard many times the phrase, that Indonesia is one of the biggest growing economies, that our GDP has been growing at a healthy rate in the past 15 years or so. The question for me is, If our economy is growing rapidly, then what sort of growth? And where are we going by growing? Growth without destination is a compass without a map.

Hence, not all growth is beneficial. Growth that benefits the rich and leaves the poor is harmful, the same is true for growth that damages the world by irresponsibly pillaging its natural resources. The challenge for us as a country, is not to grow bigger, but to grow better, for the people of Indonesia.

Plantations on Sumatra island and the Indonesian part of Borneo have expanded in recent years as demand for palm oil has skyrocketed, resulting in the destruction of vast tracks of jungle

It is time we need to step aside from the race to rethink our definition of a better economy. To me personally, a better economy would require a paradigm shift. Starting with building a greater foundation of trust, so that we as a country could form a bigger network of knowledge and knowhow to start producing more complicated high valuable products. Government institutions and corporates would need to start collaboration without controlling and creating market monopoly as the goal. Tools like internet and blockchain technology (I will write in more details) are to be utilized by government and corporates, to build the trust that has long been eroding due to centralization of wealth and opportunities, with goals to provide equal opportunities to many Indonesians. Lastly, we need to find better ways of measuring our growth, recording the flaws and successes, so that all that matters gets counted and included. Growth, should be the means to a greater purpose than to an end itself.

Without this paradigm shift, we are building a nation of a time bomb, where market of opportunities is centralised and controlled by the greed of the few, and our natural resources begs for a sustainable model.

As Charles Handy in The Second Curve argues,

“Capitalism and democracy are uneasy partners, that if the former is to survive it must be seen to benefit all not just a favoured few.”

This may be one of the most urgent problems facing our nation today, to restore a proper justice and trust to the creation and distribution of wealth.

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