Doing Business in Indonesia:
legal and bureaucratic
constraints
Ross H. McLeod
Indonesia Project
Australian National University
ross.mcleod@anu.edu.au
6 July 2007
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
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
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
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…
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
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
Indicator
Procedures (number)
Indonesia
19
Time (days)
224
Cost (% of income per capita)
311
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)
Problems with the Doing Business
methodology (4)
• Coverage of data doesn’t extend to extralegal 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’
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?
Ease of Doing Business in Indonesia:
Selected Sub-indices and Components
Indicator
Rank
(among 155 countries)
Ease of doing business
Matters relying heavily on the courts
115
Enforcing contracts
Time
Cost (% of debt)
Closing a business
Time
Cost (% of estate)
Recovery rate (% of amount owed)
145
570 days
127%
134
151
116
5.5 years
18%
13%
133
99
119
Ease of Doing Business in Indonesia:
Selected Sub-indices and Components
Indicator
Rank
(among 155 countries)
Ease of doing business
Matters involving the bureaucracy
115
Starting a business
Time
Cost (% of income per capita)
Hiring and firing workers
Difficulty of Hiring Index (0-100)
Rigidity of Hours Index (0-100)
Difficulty of Firing Index (0-100)
Hiring cost (% of salary)
Firing costs (weeks of wages)
144
151 days
102%
149
121
120
61
40
70
10%
144.8 weeks
122
63
131
53
150
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).
We’ll come back to this later…
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 Frenchcivil-law countries.
– Taken together, [the empirical] evidence describes a
link from the legal system to economic development.
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)
The debate on legal heritage
• Breaking this into two equal subperiods…
– 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)
Some developing country
comparisons…
Figure 10 Real GDP Growth in Select Developing Countries 1971-2003 (%)
Malaysia (E)
Thailand (E)
Indonesia (F)
India (E)
Algeria (F)
Brazil (F)
Nigeria (E)
Zimbabwe (E)
Congo, Dem Rep (F)
-100
0
100
E = English Common Law; F = French Civil Law
Data for Zimbabwe are for 1971-2002.
200
300
400
500
600
700
800
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
Is legal heritage important?
In Indonesia’s 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
Soeharto built up a system that
enabled him to exploit the
coercive power of government
in his own interest for more
than three decades
He created and maintained a
monopoly on political power,
through a franchise system of
government
Soeharto’s ’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)
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
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:
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
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
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?
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
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
Doing Business in Indonesia:
legal and bureaucratic
constraints
Ross H. McLeod
Indonesia Project, ANU
ross.mcleod@anu.edu.au
6 July 2007