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Imagine a new Indonesia: Spending to improve development

Wolfgang Fengler's picture

Imagine how the new Indonesia would prosper if everyone had affordable health insurance, every child completed secondary education and highways were in place connecting Indonesia’s three biggest cities: Jakarta, Surabaya and Medan.

The good news is that today Indonesia’s main challenge is not to save resources but to spend them wisely. This still remains the case, even in the face of the global financial crisis. Despite its position of relative strength, Indonesia has two main weaknesses: the allocation of funds and the implementation of its budget. Despite some impressive steps to rein in subsidies, significant resources are still being spent on subsidies that benefit the well-off, mainly on fuel, electricity and fertilizers. In 2008, subsidies consumed an estimated 23 percent of total government spending. Indonesia also spends a disproportionately large share on “government apparatus,” at 13 percent of the total budget (see chart 1). Interestingly, this is not due to a bloated central government civil service. Instead, it is driven by regional governments, who spend a staggering 32 percent on themselves.

Chart 1: Indonesia spends a disproportionately large share on “government apparatus,” at 13 percent of the total budget.

Indonesia is having a particularly hard time spending its budget, especially on infrastructure. Due to complicated budget approval procedures, it often takes the government six months into the budget year before it starts to implement its capital budget. In recent years, Indonesia has typically spent less than 20 percent of its capital budget in the first half of the year and 80 percent in the second half. In some years, 50 percent of the capital was spent in the final two months of the year – only to revert back to almost zero in January of each year! This stop-go approach to budgeting has been one of the reasons it has been so difficult to implement a more ambitious infrastructure program. But efforts to improve budget implementation are starting to pay off. After the first quarter of 2009, Indonesia had spent 10 percent of its planned capital budget – up from 5 percent in 2008 – but still below the norm of 25 percent.

The next five years will be very interesting indeed. Indonesia will have a new government by the end of this year and will also enact a new five-year development plan. If Indonesia continues to weather the global crisis as well as it has done thus far, its budget is expected to increase substantially – to about US$130 billion – making the five-year plan a US$550 billion package. Let’s hope the government succeeds in implementing some of the big development projects that Indonesia so desperately needs. If past trends continue over the next five years, Indonesia will expand education but fall short in health and infrastructure investment, both of which will receive substantially lower allocations than subsidies or “government apparatus” (see chart 2). If these trends change, there will be an enormous opportunity to spend a much larger amount of resources on Indonesia’s development, in particular health and infrastructure.

Chart 2: If past trends continue over the next five years, Indonesia will expand education but fall short in health and infrastructure investment.

Comments

Submitted by Petrarca Karetji on
Dear Wolfgang: Thank you for sharing your notes which I continue to follow with interest. I wanted to ask you on your thoughts on the need to expand infrastructure outside of Western Indonesia to draw increased investments to other regions in Indonesia and to decrease the pressure on the two islands connected to the three cities you mention in your first sentence (Medan, Jakarta and Surabaya). It seems that Indonesia has much more growth potential in recognized strategic locations. I say recognized as during the WWII, a number of locations were of immense strategic value and were hard fought for, such as Morotai (strategic for its location as a platform to North East Asia) and Biak (as a stepping stone to the Pacific). Neither have any substantial infrastructure to boast of, especially Morotai which seems to have been forgotten despite its vicinity to resource rich Halmahera. Would you agree that serious planning and development of other growth centers is critical for Indonesia's continued development?

Submitted by Wolfgang on
Dear Petra, thank you very much for your thoughts and I hope you are doing well in Australia. I would agree with you that Indonesia can only reap its growth potential and energize its potential growth centers if some planning and public investment is part of it. The continuous Jakarta flooding, the lack of good urban transport systems and the need for Surabaya to step up and become a hub that reflects its position as "second biggest city in the fourth biggest country" on the planet. In terms of Eastern Indonesia, the government has been very successful in transferring large amounts of resources. Slowly, some local governments start to spend it on core development needs, particularly education but also infrastructure. However, in line with the latest World Development Report of the World Bank I do subscribe to the idea that "economic activity will always be concentrated" and if anything, Indonesia needs to concentrate its growth even further. This will create opportunities to make "development balanced" (WDR) as extra resources could be transferred to poorer parts of the country which then can provide services to its population. All the best Wolfgang

Submitted by David Kiu on
Hi Wolfgang I appreciate your insightful blogs on Indonesia, which correct many of the misperceptions out there. I would be interested to know if you have seen much research on the progress of regional autonomy and decentralisation and trends regarding the disparity between the provinces. I think that will be an interesting challenge to manage for the government going forward. Best, David

Submitted by Lily on
Dear Wolfgang: I read your blog with much interest. You mentioned budget implementation is improved and 'Indonesia had spent 10 percent of its planned capital budget – up from 5 percent in 2008 – but still below the norm of 25 percent.' Can you tell me what you mean by the norm of 25%? Is about 25% of the national budget generally spent on infrastructure in the developing countries (countries in low and middle income categories)? I'd also like to know what sub-sector gets the larget share of the allocated budget to the infrastructure sector. Is a particular pattern or order observed? Say, roads get the highest share and then water supply and so forth? I hope you will keep your Indonesian blog from Kenya. Best, Lily

Dear Lili, thank you very much for your note and interest in my blog. The norm of 25% for the first quarter is very straightforward: If you were to spend each quarter the same amount you would spend 25% in each of the 4 quarters. Please note: This is about the spending rate of the agreed budget - not about the shares of budget allocations by sector (which you can also find in the same blog, figure 1). In terms of the infrastructure sub-sectors, transport is now consuming about of the infrastructure expenditures (which remain low). In the next couple of weeks the World Bank, together with government, will possibly issue a new report to provide more insights into these issues. I am copying Ahya Ihsan who is one of the lead authors and will continue to follow this subject. Best Wolfgang

Submitted by Lily on
Dear Wolfgang, Thank you for your prompt feedback despite your busy work schedule. So the ‘25% norm’ means that if the budget was disbursed at the beginning of the year, a quarter of the total budget would have been spent in every quarterly period. This implies the disbursement is the problem for bunching projects toward the late fiscal year. Late budget disbursement discourages large infrastructure projects, right? I understand that unspent budget cannot be carried over to the next fiscal year. But I do not think the disbursement problem is the main reason why Indonesia spends little on infrastructure. I’d love to hear your views. Do you think that the new MTEF would help promote infrastructure projects? I look forward to the new report you mentioned. Will it be posted on the WB web? I hope it will discuss how much should be spent on infrastructure to be par with other neighboring and attract more investments Indonesia deserves. Does the report discuss how infrastructure sub-sectors should be developed by region? Say, more water supply on Sulawesi, and railways on Kalimantan? Best regards, Lily

Dear Lily, on infrastructure, the budget system - and bunching - is part of the story. If you look back the last decade the other two factors were (i) post-crisis consolidation; and (ii) decentralization (we explained this also in our 2007 "Spending for Development Report". Have a look at the executive summary. On the MTEF, it could promote INF project but there are also many other factors at play. Better to speak with an MDTF expert. The report will eventually be on the web. However, the focus is on future spending priorities and options, including for infrastructure. For the last 10 years there is only a it will onoly provide a short update of the 2007 report. The best is to keep in touch with Ahya. Best and good luck Wolfgang

Submitted by Agung on
Good job Wolfgang. Continue to produce your best!!

Submitted by Katie on
Hi Wolfgang, Could you tell me what source you used to make these graphs? I would like to use them for a research paper. Thanks, Katie

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