Martin Manurung, Norwich

There is a growing concern that foreign investment in Indonesia is flying out to other more ‘attractive’ countries, such as Vietnam and China. Cheap labour and labour market 'rigidity', according to the pro-market economists, are the very reason of why investment is shifting away from Indonesia. The proposal is, of course, obvious: liberalisation of labour market.

“[The] progress [of economic reform] has been slower than expected in other areas, including resolving investor disputes and improving labor market flexibility… [The IMF Board of] Directors underscored the critical importance of structural reforms to help boost investor confidence… In this context, they welcomed the authorities' emphasis on tax and labor market reforms …” (The IMF, 2006. Emphases added.)

Somehow, this issue is like a déjà vu for me. If we look at the history of Indonesia’s industrialisation, the concern is not new. Liberalisation as a solution, although in a different context, was also put forward by pro-market economists (including the IMF) in 1994. JB. Sumarlin, the then minister of finance, introduced tight monetary policy aimed at reducing money supply due to an increase in aggregate demand. ‘Sumarlin shock’, that is how the policy was called.

The pro-market scholars argued that the policy was threatening foreign investors’ confidence and that might lead to shifts of foreign investment to China and Vietnam, whose markets were emerging in the late 1990s. Indonesia needed to relax the limitations on capital flows to keep its market attractive, they said.

What happened next? The government bought the argument and liberalised the capital flow. It then led to huge capital inflow and made foreign capital relatively much cheaper than domestic capital. Indeed, Indonesia’s economy then enjoyed an economic boom for a while until the Asian currency crisis emerged and started in Thailand in early 1997. The currency crisis soon affected Indonesia. ‘Contagious effects’, they called it.

We all know the rest of the story. Indonesia’s economy became vulnerable to external shocks because more than 90% of the capital inflows were short term capital. The cheaper foreign capital also led to foreign short term debt surge. When Indonesia’s currency dramatically dropped, it made the country’s industry suddenly fell into a debt crisis. Furthermore, the IMF also imposed Indonesia to increase domestic interest rates from 20% to 80% to reduce speculative attacks against the currency. However, it also made Indonesia’s domestic debts became insolvent and led to massive bankruptcy. The industry then reduced its production, massively dismissed their labour in the name of efficiency, and it further brought stagnation in the midst of an excess demand. The spiral of inflation because of supply push inflation and demand pull inflation was inevitable.

That was the cost of liberalisation. Now, after the flawed prescriptions, do you still follow the same doctor?