Foreign Aid, Bussines,
and State Enterprises:
Counting the Cost
Book 3
Editor of English Edition
Richard Holloway
16 Studies on Corruption in Indonesia

“Stealing from the People”
Foreward to the English Edition
Stealing from the People is published by the Partnership for Government Reform in
Indonesia. The Partnership’s aim is to promote and support a program of governance reform.
The Partnership is governed by a Board consisting of senior government officials, private
entrepreneurs, and Indonesian citizens who have a clear perception of the meaning and purpose
of good governance. The World Bank, the United Nations Development Program (UNDP),
and the Asian Development Bank are both founders and members of the Partnership.
The purpose of publishing the book Stealing from the People is to present the Indonesian
public with a collection of research reports about how corruption has come about,
spread, and held hostage the entire social fabric of the Indonesian nation. The book also
aims at convincing the deeply concerned community of reform minded citizens in the country
that somewhere, behind a mountain of hard and smart work, there is hope for salvaging the
The editorial concept of the book emerged from the ranks of the Partnership. The
editors wish to thank Ms. Merly Khouw, a consultant to the Partnership, for the selection of
authors, and her persistent drive for precision, detail, and accuracy. Most of the reports
were written in Indonesian and have been translated into English. It is not an easy task and
the Partnership is grateful for the work done by translators and editors, particularly Michael
Soldner, who understood that each language carries with it its own syntax and idiom which
would result in distortion of intended meaning if translated literally.
The book’s cover represents the work of Dolorosa Sinaga, an Indonesian sculptor who
has generously permitted the Partnership to feature the fruits of her creativity at the front
of this most important book. To the Partnership, Dolorosa Sinaga’s sculpture symbolizes the
resolve and the desperation of Indonesias’s poor waiting for justice. Finally the editors thank
Mr. Khateeb Sarwar Lateef, Senior Adviser to the World Bank in Indonesia and Ms. Sri Urip,
Executive Director of the Partnership for their accessability and wise counsel.The book is up to date until April 2001. The findings, interpretations and conclusions
are those of the authors of each report and do not necessarily reflect the views of the Partnership.
Neither the Partnership, the members of the Governing Board, the organisations or governments
they represent, nor their affiliated organizations may be held responsible for the
accuracy of the facts and data in this publication, or any consequence whatever resulting from
their use.
Richard Holloway
Editor of the English Edition
Jakarta, January 02

“Stealing from the People” – Introduction
By Nono Anwar Makarim
The 16 essays in the 4 volumes of Stealing from the People report on research
conducted by the authors. The book is about what people have always suspected, but didn’t
know precisely. How did they steal from the people? From the presidential palace to military
headquarters, from state enterprise to national development planning boards, from foreign
aid projects to courts of justice, from banks to political parties, entire sectors were examined.
The result was a picture of systemic corruption. It is corruption conducted in an institutional
and organized manner, covering all political and economic sectors. Highly placed
government authorities cooperate with private businessmen, local government bureaucracies,
customs, and the state security apparatus in order to maintain and develop the art of
The constant theme emerging from the studies is that the government must be controlled,
that control cannot be done by government alone, and that those most entitled to
exercise such control are the corruption’s victims – who are the entire citizenry of Indonesia.
A warning that also arises from the 16 studies is that news about corruption in the media is
not about some distant crime occurring to some other person removed from ourselves. It is,
in reality, a prior notice to everybody that a bill is on the way to pay for the luxury of the
Stealing from the People cautions that isolated measures are not enough to begin
making a dent in the armour of corruption. Setting up anti-corruption task forces and watchdogs
only won’t do. When political pressure is strong, governments normally succeed in deflating
tension by feigning serious attempts at dealing with corruption. Most of the time they
get busy setting up commissions. In 1997, in Kenya, the government established 4 anti-corruption
commissions within the span of one year. There was no significant improvement in
the situation. During the rule of President Suharto no less than 5 anti-corruption committees
were installed. In 1970, at the time of establishing No.2 in this series, Suharto even pledged
to lead the fight against corruption himself. One of the cruel ironies of the anti-corruption
efforts during the New Order era is that the country managed to gain a prominent seat among
the most corrupt countries in the world.
Simply jailing the culprits won’t do either. Pursuing corrupt officials, even in countries
where the legal system has a tradition of working more or less effectively, has not produced
the desired results. In the 80s and 90s waves of successful prosecutions and convictions of
corrupt officials swept through the bureaucracies of India, Bangladesh and Pakistan. Soon thereafter,
their replacements were doing the very same things for which their predecessors had
been jailed. Law enforcement as a single anti-corruption policy tool in a broken down legal
system such as we find in Indonesia is disastrous for two reasons. It is ineffective and it erodes
what little social trust remains in society. Officials accused of corruption are interrogated,
held in detention, milked by investigating officers, prosecuted and then set free by the courts.
Arrests made by investigating officers against present or former government officials leave the
general public cold. People already know what the outcomes of the arrests will be.
The 16 research papers warn that, unless law enforcement and anti-corruption commissions
are accompanied by other policy reforms, efforts to reduce and eventually eradicate
the most flagrant forms of corruption are doomed at birth. Such policies include institutional
reform of the bureaucracy, the reduction of the public sector, privatization of state enterprises,
and the launching of successive campaigns to raise public awareness of the evil corruption
generates. The proposed policies may have big sounding names, but at closer inspection
contain down to earth prescriptions. Institutional reform of the bureaucracy, for instance,
calls for fit and proper criteria to be met by people joining the bureaucracy, and similar criteria
for people to be promoted. The ethos of selfless service to the public, no matter how far
removed from reality, must be inculcated and restored to each government agency in order for
its members to regain their self-respect. Law enforcement, the punishment of those found
guilty of violating the laws, is not merely a retributive measure, but aims at resurrecting the
basic moral code of right and wrong. It should correct the disproportionate adulation of rich
government officials and promote the embarrassment of association with persons whose wealth
was accumulated by corrupt means.
The reduction of the public sector should not be seen as a capitulation of selfless public
service to rapacious plunder by cut-throat capitalist monopolies. It is but a serious effort to
reduce the space of corrupt activities and, sometimes, even to increase public gain. An ex

ample of this would be the take-over of Indonesian customs functions by a Swiss-based surveyor
company. Government income increased, and the increase served as an indication of
what, in the past, would be lost to corruption. The same goes for the privatization of state
enterprises. Protests against these measures are cloaked in nationalistic jargon. In reality it is
but a political mask hiding the fear of losing resources from which to finance patron-client
relations and political loyalties.
Finally, there is the need for sustained campaigns to broaden the pressure faults and
include both domestic and foreign fronts in demanding a stop to the plunder of citizens. Foreign
pressure is much needed in a power structure dominated by a bureaucratic polity bent on
protecting the status quo. If threatened, the system either resorts to sabotage through inaction,
as we see today – or violence, as we saw in the past. This is why domestic pressure is not
enough to bring forth significant results. An important phase of the campaign should stress the
issue that good governance is not a sell-out of the national interest. On the contrary, corruption
is such a sell-out. Stealing is bad. It does not matter whether the thief is Indonesian or
Introduction to Volume 3
Foreign Aid, Bussiness and State Enterprise
Counting the Cost
The third volume in this four part series on corruption in Indonesia deals with the
way in which corruption sucks people into its grasp. When corruption is pervasive and
expected, and when corruptors seem immune to prosecution, then more and more people
join those already practising corrupt behaviour.
Mohammed Ikhsan first of all tries to estimate the economic cost of corruption
along several macroeconomic indicators including economic growth, domestic investment
and foreign investment. He points out that since corruption is an illegal activity, there is
no direct estimate of the cost of corruption on the economy and the empirical problems of
measuring corruption stem from unclear definitions of the phenomenon. This paper limits
the definition of corruption to the World Bank’s definition of “the use of public power for
private gain”.
Measuring corruption has traditionally relied on perception indices developed by
business risk organizations and the international NGO, Transparency International (TI).
Such corruption perception indices have been shown to be empirically robust, and this is
because all these indices have very strong correlations to each other. As Mohammed Ikhsan
points out, however, there are significant differences when the corruption ratios of two
countries are directly compared, thus affecting the estimation of the economic cost of
Utilizing an augmented growth model, the study has found that corruption has cost
Indonesia’s economic growth and investment significantly. This method consists of using
growth and investment equations to generate corruption parameters which are then used
to assess the macroeconomic impact of upgrades in a country’s level on a corruption
perception index to a better or lower score. The difference between the hypothetical
level and the actual level reflects the cost of corruption to the economy. The study finds
ratio would have been higher than its current level. Similarly, if Indonesia could reduce its

corruption level to that of Singapore, its ability to attract foreign direct investment
would be equivalent to a 10% subsidy. Corruption has also meant a deterioration in the
quality of capital inflows to Indonesia as it is dominated by short-term debt rather than
foreign direct investment.
Mohammed Ikhsan shows that corruption undermines the performance of the
Indonesian economy by (a) lowering levels of domestic and foreign investment; (b) distorting
public expenditures and investments and deteriorating physical infrastructure; (c) lowering
public revenues and lessening provision for the rule of law: and (d) hurting the poor as
result of reduced economic growth which in turn derives from increased corruption.
Paul McCarthy looks, in the second chapter at the role foreign aid has played in
stimulating or supporting corruption. He points out that the leakage of money from
projects funded through the Indonesian government’s “Development Budget” is common
knowledge. Projects supported through development loans are particularly vulnerable to
By examining the history of corruption within foreign aid projects, with a particular
focus on Indonesia’s three largest development creditors: the Government of Japan, the
World Bank and the Asia Development Bank, and by examining the factors that affect
rates of corruption from one project to another, Paul McCarthy demonstrates that leakage
rates are more complex than the popular notion that 30% of all foreign aid funding finds
its way into the pockets of corrupt civil servants and contractors and he offers a description
of the elaborate system of corruption and how leakage typically occurs within aid projects.
Mr. McCarthy points out that while longstanding observers of the Indonesian foreign
aid scene are convinced of the correlation between the increase in Overseas Development
Assistance (ODA) and the rise of corruption, and that there is a perception that KKN
(corruption, collusion and nepotism) took off primarily as a result of the emergence of
external donor agencies and their foreign aid packages, a closer analysis suggests that
there is no direct causal effect. The stage was already set in terms of a pre-established
set of well-practiced KKN mechanisms before this capital influx. More over, the increase
in aid flows would not have taken place in the absence of the economic and geo-political
conditions that had stimulated the increase in private investment in the first place. In this

sense, foreign aid was less a precursor to, than a consequence of pro-Western economic
growth and political stability. In this sense, foreign aid was less a precursor to, than a
consequence of pro-Western economic growth and political stability.
The author provides an analysis as to why key donor agencies, despite a widespread
awareness of corruption patterns, either ignored or took inadequate action to prevent
leakage of funds from within the projects they were supporting. The paper looks at how
Indonesian public and private sector officials managed to circumvent virtually every anticorruption
initiative put forward by donors.
An examination of the current foreign aid scenario is undertaken: whether or not
corruption is decreasing as it falls under an ever brighter public spotlight, the enhanced
measures donors are taking to safeguard their development investments and whether
they are likely to be effective. Finally, Mr. McCarthy offers brief suggestions as to what
more needs to be done in the ongoing battle.
In the third chapter of this book, Nasir Tamara discusses corruption in the
Indonesian private sector. He briefly reviews the business and entrepreneurial class in
Indonesia in the colonial and pre-independence period and then then moves to focus on
the corrupt practices that have taken place within the private sector since Independence.
Although corruption also occurs in small and medium scale businesses, the emphasis is on
the conglomerates which became large with help from the state through the influence big
companies have on the national and regional economy.
Nasir Tamara divides his chapter into three parts. The first part discusses the
relationship between the government and private business sector and details how the
corporate model of government in the Orde Baru cooperated with the western world in
controlling policies to build a strong private sector on the basis of political stability and
economic growth. The impact was that the private sector greatly depended on the
government which caused certain corrupt practices to occur.
The second part describes how parts of the private sector developed into
conglomerates under the New Order. It elaborates on the corrupt practices of conglomerates
in carrying out their business, and includes some case examples involving state-owned
enterprises as well as national and international corporations alleged or proven of corrupt

practices. These cases include the State Oil Company Pertamina, the State Electricity
Company (PLN), the State Logistics Agency (Bulog), Department of Mines and Energy,
Freeport, Balongan, the Timor “national car” project, Lippo, the Capital Market Supervisory
Board (Bappepam), Clove Marketing and Buffer Stock Agency (BPPC), Cimacan land case
and Tapos animal husbandry case, and the Indonesian educational Television (TPI) among
The third part describes the destruction and re-embodiment of conglomerates in
the Era of Reform and their continuing corrupt practices. This section analyzes how
corruption practices still in fact continue in an era of democracy with all of its freedoms
and the various laws and regulations that have been issued. It also discusses how such
corrupt practice works and who benefits from them. Nasir Tamara closes with a look at
how far corruption has become part of the Indonesian business culture and the appropriate
remedies for such corrupt practices.
Ahmad D. Habir, in the fourth chapter, looks at corruption and state enterprises
where there is a common public assumption that corruption is the rule rather than the
exception. Dr. Tamara agrees that corruption in the state enterprise sector is systemic
and his paper reviews the roots of state enterprise corruption in Indonesia and the
implications for reform. Emphasising the need for a historical perspective in understanding
corruption in state enterpreises, Nasir Tamara looks at state enterprise development from
the colonial period, through the early independence period, the period of State Sector
expansion, the Suharto New Order years, the early reform process and then into the 80s
and 90s reform processes. Two cases are provided of state enterprises with good governance
practices PT Tambang Timah and PT Rekayasa Industri.
The implication for reforming a patronage and crony-based system is that a political
system that is based on the maintenance of political power through distributing spoils to
clients and cronies has to be dismantled. Since the well-being of patrons, clients and
cronies are dependent on the survival of a patronage regime, any change to the regime
will be opposed. It is therefore unlikely that reform can occur without a shift in the
regime. The shift itself has to be accompanied by a shift in the aim of politics from

distribution of spoils to distribution of public services. Any such shift will of necessity be
a long-term process, given the need for developing a credible system of law that would
ensure the rule of law.
On a more macro stale, Nasir Tamara points out that supervision of state enterprises
has shifted between the Finance Ministry and the technical ministries depending on the
relative political strengths of the ministries as they struggle to control state enterprise
resources. Supervision has also been shared between the Finance and technical ministries
at times when political power has been balanced. Recently, a separate ministry with sole
responsibility for state enterprise supervision was established, only to be dissolved after
a few years of existence.
The reform process has therefore been piecemeal and ad hoc rather than systematic
and strategic. The reasons lie in the historical development of the state enterprise sector
as a national source of political power rather than as business entities. Nasir Tamara
points out that those opposed to past reform directions include the economic nationalists
and also those who view state enterprises as governmental instruments for achieving
economic and political objectives.
Richard Holloway

The main objective of this paper is to estimate the economic cost of
corruption along several macroeconomic indicators including economic growth,
domestic investment and foreign investment. Since corruption represents illegal
activities, there is no way to directly estimate those costs for the economy.
Utilizing the augmented growth model we found that corruption has had significant
costs for Indonesia’s economic growth and investment. If Indonesia could
1 The author would like to express his appreciation to Dr. Vikram Nehru for his constructive review. But
any errors and responsibilities belong to the author.
Measuring the Economic Cost of
Corruption in Indonesia
By Mohamad Ikhsan1
Editors Note:
This paper contains tenns more familiar to econometricians than the general public

reduce its corruption level to a comparable country -for example Malaysia, the per capita
PPP income could have been 5 times higher than the current level. With a higher growth
rate, Indonesia could actually cut its level of poverty by 4,2 percent in rural and 1.3
percent In urban areas. Corruption has also meant a deterioration in the quality of capital
inflows to Indonesia since its composition with corruption tends to be dominated by short
flows rather than foreign direct investment.
Studies on corruption during recent years have attracted the attention of policy
makers and development practitioners around the globe. Since there is no universally
accepted indicator that measures corrupt practice, it is less clear how models can capture
empirical information about corruption.
The empirical problems of corruption measurement originate with unclear
definitions of the phenomenon of corruption. Klitgaard (1998) defines corruption as a
result of weak state management that exists when individuals and organizations have
monopoly power over a good or services, discretion over making decisions, limited or no
accountability, and low levels of income. The World Bank (1997) defines corruption as the
“abuse of the public office for private interest”. This definition seems to mean that
corruption can only exist in public office, but we know it can also exist in the private
sector. We will follow, however, the World Bank’s definition limiting us to public sector
abuses. Corruption is also, of course, a problem of good governance.
Many authors agree that corruption is a “bad thing” but in the literature we find
two competing views on the effect that corruption has on the economy. The first view is
that corruption increases economic growth for a variety of reasons and this argued by
some authors like Leff (1964) and Huttington (1968). They say that corruption
• Acts as speed money ,which enables entrepreneurs to avoid delays. Lui (1985) using
game theory shows that bribing strategies form a “Nash equilibrium in a non-cooperative
game”. He suggests that corruption minimizes waiting costs there by reducing
inefficiencies in public administration.
• Reduces market distortions related to the poor pay structure in the bureaucracy, which

does not motivate civil servants to work properly and efficiently (Rose-Ackerman 1998),
May actually-improve economic welfare by offering opportunities for black marketeering
and smuggling (Bardhan, 1997)
• May increase efficiency if the private sector is more efficient in allocating resources
than the public sector through its tax structure.
On the other hand, there are vast theoretical works and empirical evidence, which
show that corruption is harmful to economic development. A great number of empirical
studies show the many ways that corruption may weaken the economic performance of a
particular country because corruption can:
• Lower levels of domestic and foreign investment (Mauro, 1997 and Wei, 1997)
• Distort enterprise development and growth of the unofficial economy (Johnson,
Kaufmann, and Zoido-Lobadon, 1999)
• Distort public expenditures and investments and deteriorate physical infrastructure
(Tanzi and Davoodi, 1997)
• Lower public revenues and make less provision of the rule of law as a public good
(Johnson, Kaufmann, and Zoido-Lobadon, 1999)
• Hurt the poor (Rose-Ackermann, 1997)
The list above is not alway relevant to Indonesia, particularly in the past. Even
though Indonesia has been categorized and recognized as a country where corruption has
been and is practiced extensively and intensively, its investment ratio to GDP was
comparable to East Asian countries and was high compared to Latin American countries
whose index of perceived corruption was relatively better than Indonesia. Similarly,
Indonesia was relatively successful in combating poverty across its regions during 1970s
right up to the crisis period of 1997.
Given those two competing views on the impact of corruption on the economy, the
purpose of this paper is empirically to scrutinize the impact of corruption on the macro
variables of economic growth, private investment, and foreign direct investment -and
together to assess the impact of corruption on the poor in Indonesia.
The paper is organized as follows: In the next section, we discuss the issue of the
measurement of corruption. Following that we look at the estimated costs of corruption
and the impact of corruption on Indonesia’s economy -which is the heart of the matter,
and finally, we summarize our findings in the last section.
There are two important things that we need to clarify before attempting any
estimate of the economic costs of corruption in Indonesia. First, we need to agree on the
definition of corruption. As said before we are following the World Bank’s defInition of the
abuse of power for private gains. This definition is quite broad: it can involve not only
public officials who legally grant monopoly power in governing the country, but also private
sector officials who misuse the special privileges granted to them for their special interests.
We can, however, see the difference between this and political corruption and/ or bribes
between private sector actors.
It is almost impossible to obtain information on corruption and its effect on the
whole economy for several reasons: first, because it is in the nature of corruption to be
secret and illegal; and second, the variation in definitions of corruption across countries
is quite large -in some countries, for instance, giving a gift to a public official is common
practice and acceptable, while in another country this practice is considered corrupt.
The second issue is related to corruption indicators or measures. As argued by Wei
(19971, corruption is difficult to quantify, although “you know it when you see it”. When
we try to quantify the magnitude of corruption, we find that we have to rely on measures
of perception of corruption. There are several organizations that conduct survey-based
measures of corruption perception. Among others are:
Business International Index (BII)
Their index is based on surveys of experts’ and consultants’ perception of corruption
practice in several countries. It ranks countries from one to ten, according to “the
degree to which business transactions involve corruption or questionable payments”. This
survey was terminated in 1983.
International Country Risk Guide Index (ICRG).
This index is produced annually by Political Risk Service -a private investment risk
company. As in BII, this index is also based on experts’ opinions and perceptions of the
demand of public official for special payment and other illegal payments.
Global Competitiveness Report Index: (GCR)
This is based on firm managers’ perception of corruption practice in anyone
particular country. The GCR corruption index for a particular country is the average of all
respondents’ rating for that country;
Transparency International index (TI):
This index has been produced by a International NGO, Transparency International
since 1995 and is based on a weighted average of approximately ten surveys of varying
coverage. It ranks countries on a one- ten scale.
Samples of the indices are given in Table 1 and Table 2 (which are at the end).
Additionally, in Figure 1 we present the development of Indonesia’s position in Transparency
International’s corruption index over the last 15 years even though the figures before
1996 may not be directly comparable to the years after since they were produced by
different surveys.
As has been shown in many empirical studies, applying any perception index is
practically robust in the sense that plugging any particular index into any corruption
equation seems not to produce any change in the magnitude of the estimates. All corruption
perception indices have very strong correlation with each other. But one will find a
significant difference when (directly) comparing the ratio of a corruption perception index
of two countries with each other. For example, if one applies a TI index of Indonesia and
Singapore and compares it with the ratio of the ICRG, one would find that a TI index has
a bigger gap (index of two countries) than the Index of the ICRG. A TI index will produce
a 5 point differential while the ICRG’s will give about a 2-3 point differential. This, of
course, will affect our estimation of the economic costs of corruption in Indonesia.

As depicted in both Table 1 and 2 and in Figures 1 and 2, corruption practices in Indonesia
are consistently high compared to other countries in the world. Figures 1 and 2 indeed show that
the practices tend to intensify over time -particularly during the 1990s even though we had
already moved towards becoming a more politically transparent country. This implies that a
moderate reduction in corruption should produce a significant impact on economic performance.
In order to quantify the magnitude of the impact of corruption on economic indicators
like growth or investment or other social indicators, one would normally apply a time series
econometric analysis. But as implicitly mentioned above, problems of data availability and
consistency constrain us in carrying out such econometric analysis. Alternatively, one may follow
a growth augmented model a la Barro (1985)2. This approach has been pioneered by Mauro
(1995)2 and expanded by Wei (1997) , Rahman (2000). In general, Barro’s framework
correlates the dependent variable in question to two other types of variable: the initial level of
state variables and a vector policy variable chosen by government and/ or private agents.
In practice we need a two step approach in order to estimate the cost of corruption in a
particular country. In the first step, we need to carry out estimations across countires to see the
2 There is another option to measure economic; cost of corruption i.e., one may use the findings of the
internal audit agency (BPKP) or the State Audit Agency (BPK) on the illegal or misuse practices of the
state budget and combine it as a rough estimate of cost of corruption in Indonesia. An anecdotal
fIgure comes up to a 30 percent of state budget has been corrupted in Indonesia. This figure then can
be used to calculate the implied Incremental Capital Output Ratio in order to estimate the economic
costs of corruption in Indonesia. For example, if the investment ratio is about 20 percent of the GDP
and the ICOR can be reduced about 30 percent lower then the implied economic growth is 5.7 percent
compared to 4 percent in the corrupted environment. This approach has serious drawbacks. First, the
30 percent misuse practice comes from the anecdotal figure and is very difficult to verify it. Second,
the ICOR itself is a poor indicator of aggregate efficiency. It tends to increase as the economy grows
and diversifies. Third, the corruption practice will not only affect the way we handle the economic
activities but also will affect the decision of investors to choose the location or the mode of production.
Thus, the corruption practice will affect the ex ante variables.

relationship between corruption and growth, and between corruption and investment.
For- mally, we can write the growth or investment equations as follows:
Growth model:
g = a+ b 1 (initial level of GDP per capita) + b2 (initial quantity of human
capital)+ b3 initial quality of human capital + b4 (corruption)+ wX’ + q (Z; Z e Z’) + e
Investment Model: I/GDP = d+g1 (initial level of GDP per capita) + g2 (initial quantity
of human capital)+ g3 initial quality of human capital + g4 (corruption)+ mX’ + q (Z; Z e Z) + e
where g and I/GDP are average annual economic growth and the investment to GDP
ratio, respectively, X’ is a vector of regional dummies, 2 is a vector of policy and
country characteristics and e is the error term.
Once corruption parameters (b4 and g4) are obtained, we then use them to
assess the macroeconomic impact of corruption if one particular country can upgrade
its corruption perception index to a higher level of corruption. The difference between
the hypothetical level and the actual level may reflect the cost of corruption to the
economy. The advantage of this approach is that findings can be further used to assess
the impact of corruption to – for example – the poor. Given the growth elasticity of a
poverty index, one may easily calculate the impact of losing the opportunity to grow
due to corrupt practices and the incidence of poverty.
For this paper, I will utilize the empirical work done by (2000) to
identify the corruption parameter. There are two reasons to follow their work. First,
this cross section equation was done using the current data including Indonesia as one
of the sample. Reestimating a new cross section growth equation would not give any
significant improvement to our study. Secondly, compared to the previous work done
by Mauro, in addition to the first reason above, this cross section equation is more
reliable for several arguments. Rahman (2000) has augmented their equation by
incorporating several combinations of variables that may explain the differences of
growth across countries. They also have tried to estimate those regressions using various
econometric techniques not only a standard ordinary least square but also others like
instrumental variable technique. Rahman also applied a more comparable

corruption index from ICRG than the one (discontinued) used by Mauro (1985).3 Their
model is also extended with regional dummy variables in an attempt to take account
of various region specific effects (i.e., the intercept heterogeneity in the regional
context). This strategy in turn is expected to reduce the extent potential omitted
variable bias. The results of growth or invest- ment regressions for various specifications
are presented in Table 4-5. As shown in those Tables, the sign of the coefficient for the
corruption variable is positive as expected and marginally significant at 5 confidence
level, controlling for a country’s initial conditions and geographic, demographic and
policy characteristics. The detailed interpretation of the econometric results will be
discussed in the sections below.
We hypothesize that corruption will reduce the investment level. There are many
ways corruption would reduce the investment level. First, it will directly increase
transaction and investment costs. The ballooning in project costs would have been started
before the project is realized. The investors would need to pay some money to get an
investment approval.4 After the project is realized and becoming operational, the producer
still needs to pay several other costs including bribery costs. Our latest industrial survey
shows that that cost consists of about 5-20 percent of total output of medium and large
manufacturing sectors (Box 1). Those numbers would be higher since many of illegal
payments would have been included in transportation costs5.
3 In his published paper, Mauro explained that his indices obtained by a hand collecting of hard printing at the
B1 office in New York. It is not clear whether the methodology used is consistent over times.
4 A LPEM’s study (1994) found that even though the government has abolished any costs for obtaining investment
licenses, the investor still need to pay about Rp. 5-30 million per license.
5 For example Kompas newspaper found that textile and garment exporters have to spend about Rp. 125-200
thousand per container when transported goods from their factory to the port. The manufacturers have also
to pay a substantial money to clear custom procedures.

How much do the firms pay for illegal payment?
The answer for that question is difficult because lack of factual information. There are
several (potential) sources of information about illegal payment paid by the firms in one
particular country. The most important source is its annual industrial survey. The survey
usually asks the detailed description of costs paid by the firm from labor, energy, and tax
payments to other costs. The illegal costs paid by a particular firm in the Indonesia’s annual
survey is aggregated into other costs item including interest cost, gift, royalties, management
fees, promotion and advertising cost, travel cost, research and development cost, training
costs, representation costs and other costs. We suspect that the Indonesian firms book
illegal payment either as “gift costs” or “other costs”.
Unfortunately, since 1998 BPS has not produced any disaggregated information of the
“other costs”. Instead, the BPS grouped all those costs into “other costs”. This classification
will not enable us to assess the illegal payment paid by the firm anymore. The other weakness
of using the industrial survey is that it only consists of large and medium manufacturing
companies. There actually is another source of information, which can be used to estimate
those illegal costs, i.e., the 1997 World Bank’s Survey on competitiveness. From that survey,
one can assess illegal costs more accurately paid by the firms in particular country.
Unfortunately, Indonesia -even though has been classified as a high corruption country -was
excluded from the survey.
With those constraints, the 1997’s industrial survey revealed that on average the
manufacturing pay about 5-25 percent of total output for other costs including illegal payments.
One recent study by Kuncoro (2000) shows that bribery costs significantly affect the
decision made by the investor when choosing the location. This evidence was applied for all subsectors
in manufacturing sector. Second, it will create uncertainties both on revenue and
expenditure streams, which make it difficult for the investors to calculate the exact net present
value of a particular project. By increased uncertainties, the investor may refuse to invest even
though he or she knows that project can produce a positive outcome. Third, corruption also
reduces the quality of infrastructures, which in turn will affect the business environment in that
country (Tanzi and Davoodi, 1997 and look at the next section for further explanation).

As mentioned above, in order to illustrate the impact of corruption practice
in Indonesia, we utilize the empirical work of Rahman, Risonko and Kapoor (2000).
They show that an improvement of 1 unit of ICRG corruption index will increase the
investment ratio by 1.63-1.97 percentage point depend on the specification of the
investment model being used. Thus, in Graph 2 we present the impact on investment
ratio if we can reach several levels (perception) of corruption in some comparable
countries. Here we pick Malaysia, Chile and Korea as comparable countries. For
example we can reach a Malaysia’s level of corruption-which means 1.27 point increase
in corruption index -then our investment ratio would have been 2.1-2.5 percentage
point higher than its current level. Similarly, if we were able to reach a Korea’s level
of corruption, our investment ratio would have been at an average of 34 percent of
GDP during 1990-1997 or about 4 percent higher than the actual level. Given those
achievements and an assumed 4 of ICOR, this means our growth rate would be 1
percentage point higher compared to the actual figure during 1990-97 period.6
That assessment is also consistent with other study by the DRI (2001), which
shows the probability of losing investment in Indonesia due to corruption is high or
about 60 percent (see figure 4). According to that study, Indonesia is the worst
among the East Asia countries or just better than Myanmar and Russia.
Corruption is bad for both international direct investors and creditors. Corrupt
borrowing countries are more likely to default, or to nationalize the assets of foreign
direct investors.
There are numerous studies that show evidences of the negative impact of
corruption on foreign direct investment. First, Rahman, (2000)’s study which
shows that the impact of corruption is statistically significant for a foreign investor.
For one unit increase in corruption
6Theoretically, improvement in corruption would not only increase the investment ratio but also improve the
efficiency of investment. Thus, the ICOR level would have been lowered if we were able to educe corruption
practices and hence a higher growth rate.
perception index will lead to 1 percentage point reduction in foreign investment ratio to
GDP. Taking that point of estimation one may find that Indonesia would have attracted
foreign investment ratio to the GDP by 1.27 percentage point if we were able to improve
our perception index on corruption to Malaysia’s level. Second, Wei (1997) found that the
point estimates of foreign direct investment on corruption and host country marginal tax
rate is -0.09 and -1,92, respectively. Again using those point estimates and the BI index
presented in Table 1, one will find that if Indonesia was able to reduce its corruption level
to that of Singapore, its effect on attracting foreign investment would be the same as
reducing its marginal corporate tax rate by 40 percentage point. [ 9.5-1)-x0.09/(0.01×1.92)]
This, in other words and other things being equal, means Indonesia would need to give a
10 percent subsidy to attract foreign direct investment at the Singapore’s level of FDI.
Third, another recent Wei (2000) study found also that the FDI -depressing effect
of corruption is significant not only statistically but also economically. A one step increase
in the TI corruption index is associated with a 20 percent reduction in inward FDI. If
Indonesia (TI index in 1998 is 8) was able to reduce its corruption to Singapore’s (TI index
value of 0.9) or Malaysia’ s (TI index of 5.3) level, the FDI in Indonesia would have been
rose by 310 percent and 71 percent respectively.
Interestingly, this study also shows that corruption also will change the composition
of capital inflows. A country with a high corruption practice would be characterized by a
lower FDI but a high debt ratio. Table 10 depicts that New Zealand and Singapore which
perceived as countries with low corruption have a relatively low loan/FDI and portfolio/
FDI ratios in one hand and in the other hand, Indonesia and Thailand which perceived as
high corrupt countries have a relative high loan/FDI and portfolio /FDI ratios.
The figure above is supported by the econometric evidence produced by Wei (2000),
which shows that the effect of corruption on the composition of capital inflows is robust
across different definition or measures of corruption and different econometric
There are at two economic explanations for that effect (Wei, 2000). First, FDIs are
more likely to be exploited by local corrupt officials ex post than foreign loans. Among
international investors, foreign direct investors may have informational advantage over
international portfolio investors. They can station their manager in the host country and
gather information about the economy of that particular country. However, the existence of
corruption could lessen that advantage. The need for international investors to pay bribery
and deal with extortion by corrupt officials is more likely to increase with the frequency and
the extent of their interaction with local bureaucrats. It is obvious that international investors
tend to have more interaction than do international portfolio managers. Furthermore, FDI
also involves greater sunk cost than bank loans. Once investment is realised and when the
local corrupt officials demand bribery, it is obviously that the international investors would
have a weaker bargaining position towards those bureaucrats compared to their counterparts
in international portfolios and loans. It is clear then corruption would be more detrimental
to FDI than other forms of capital flows.
The other reasons for that feature is related to the fact that this current international
financial architecture is more likely to produce moral hazard behavior by the portfolio or
loan flows than FDI. The evidence during the crisis -from the Mexican and Asian Crisis – show
that the international community mobilizes a large amount of funds to these countries to
prevent or at least to minimize the systemic massive default on bank loans. The concrete
example is shown by the evidence of international portfolio made by the Peregrine -an
international portfolio investors stationed in Hong Kong -to a bad reputation Indonesia
company Steady Save with- out any proper and adequate evaluations and supervisions only
because of the President Commissioner of that firm is Siti Hardianti Rukmana, a daughter of
President Soeharto. This some – how explains why capital flows still migrate to one particular
country despite its reputation on corruption practice. While on the other hand, there is no
such protection program for the FDI.
The question next, why do we have to worry about that composition of capital flows?
This composition of capital inflows is an important explanation of the existence of crony
capitalism and its responsibility for the onset and or the depth of the economic crises in
particularly country. (Wei, 2000). Several studies like Frankel and Rose (1996), Raveled and
Sachs (1998) and Rodrik and Velasco (1999) have shown that the composition of international
capital inflows is correlated to with incidence of currency crises. Specifically, the lower
share of FDI in capital inflows or the higher the short- term debt to reserve ratio, the higher
probability of that particular country may run into a currency crisis.

Corruption in the Indonesia’s
Private Sector
By Nasir Namara
There is a strong perception in the international community that the Republic of
Indonesia is one of the most corrupt U.N. member countries, and not without good cause;
Indonesia is ranked 96th out of 99 countries surveyed in the 1999 Perception Index on
Corruption issued by Transparency International. Corruption is also a cause for frequent
complaints from the World Bank, the international business community, and liberal free
market economists. Twenty years into former President Soeharto’s New OrderregiIne an
Australian researcher wrote:
Corruption constitutes a sizeable leakage of funds that may potentially be more
constructively invested. At the same time it imposes substantial costs and
frustrations on investors, particularly in strategic departments such as Customs
and the Capital Investment Coordinating Board (BKPM) itself; where ‘charges’ of
up to 20 percent of projected investment have reportedly been made for investment
licenses. Corruption also constitutes a major obstacle to an effective tax-gathering system,
an indispensable feature of any attempt to increase domestic non-oil revenues.
In real terms, corruption has haunted the entire spectrum of Indonesian society –
communities, the government, business circles, educators and civil society. Some have said that
corruption has become a part of Indonesian culture. This corruption has resulted in significant
economic losses to the country as is evident from the current collapse of the Indonesian economy.
Since the fall of the New Order regime, the cost of corruption has been estimated at 30 percent of
the annual State Revenue and Expenditure Budget (APBN).
Corruption is defined here as conduct that violates regulations or laws, is conducted
deliberately and is designed to gain illicit profits for entrepreneurs. The kinds of illegal acts
governed by the term include bribery, the payment of money and valuable goods to bureaucrats,
the presentation of excessive souvenirs to civil servants, mark-ups of project budgets, or the
imposition of pressure or influence on other parties through the power of money or authority.
During the colonial period corruption occurred in the government and private sectors
usually by employing middlemen, typically ethnic Chinese businessman, who acted as brokers
between the Dutch military and the indigenous Indonesian people. The role of the ethnic Chinese
as brokers was exploited by the Dutch, not just because of their skills but also because of the
social structure that enabled them to take on such a role (Sartono: page 80).
Other brokers -lower down the totem pole -were the indigenous local authorities, separate
from the leaders of the Indonesians of Chinese descent, who were given monopoly and business
concessions as well as the right to conduct tax collection and force labor. These people become
lords and formed the upper classes that governed the destiny of the commoners. The lords were
given official positions equal to that of Governor; official positions equivalent to Major, Captain or
Lieutenant were awarded to the ethnic Chinese.
At the time the privileges of ethnic Chinese middlemen were revoked -when the state
assumed the collection of taxes, the management of pawnshops, and the control of the opium
trade -the opportunities for corruption within the bureaucracy of the colonial government seemed
to disappear.
The pre-colonial feudal relationship, that has since become part of the Javanese social
system, is one where the people yield unconditionally to the authority of the officials appointed
by the king. This was a system employed by the colonial administration as a method to control
the general populace by using brokers and middlemen. This relationship was not easily terminated
when Indonesia achieved independence. Authority within a feudal society is unlimited and
unquestionable, and no distinction is made between private and professional needs. According
to an Indonesian historian, in the times of the traditional Javanese kingdom any person making
a request from an official was obligated to contribute a commission.
The rise of Indonesian entrepreneurs during the colonial period is attributable to their
close relationship with and political subjection to the governing authority as, only those individuals
who left their fate to the company (VOC) or who plundered it from within were able to build
considerable fortunes, a state of affairs as valid for the Dutch as for other inhabitants of the
town (Batavia), the Chinese included. Such was the situation in Java before the 1800s according
to a European historian.
Dutch, British, American, Japanese and other European enterprises controlled the
economic sector. Economic activity, which had previously been confined to rice cultivation,
expanded to commodities for export such as sugar and coffee and subsequently tobacco and
rubber. Not long afterward, tin mining; oil exploration and manufacturing were introduced
requiring investment capital from foreign countries other than Holland. Economic growth and
prosperity in the Dutch-Indies also prompted the emergence of a relatively large class of private
sector entrepreneurs mainly dominated by foreigners and ethnic Chinese.
Indigenous entrepreneurs were relatively inactive during this period, especially when
the Regents and ruling classes were put on the colonial payroll and their lands placed under the
control of the colonial government. As such, the accumulation of capital by land did was nearly
unheard of in the Dutch-Indies. It can be easily assumed that the causal factor in this modus
operandi was to keep the indigenous populace from fostering political aspirations against their
colonial masters.
According to history, the Filipino, Javanese and Malay people had merchant classes. What
happened to these merchant classes? The European colonists eliminated them. This
elimination process began at the beginning of the 16th century with the arrival of the
Portuguese (Alatas: 1988 page 255).
Dutch monopolistic practices in the sale and purchase of commodities caused the
disappearance of the independent, high level, and international indigenous trader. The
Dutch assumed their functions as traders. Other significant changes made by the Dutch –
which contradicted the development of strong indigenous trader classes – included the
change in authority and the role of the indigenous leaders to one of suppliers and
supervisors of Dutch interests. Dutch companies used the local authorities and royal
families simply as means to an end (Idem: page 274).
One successful ethnic Chinese trader, Oei Tiong Ham (1866-1924), was born in
Semarang and built the first conglomerate in SouthEast Asia, which operated for three
quarters of the 19th century. With a modernly managed business, he expanded his
commercial empire to Singapore, Malaysia, China, England, the Philippines, Thailand,
Hong Kong, India and the Netherlands. At the same time, Nitisemito, an ethnic Javanese
entrepreneur also met with great success in the kretek or clove cigarette business eventually
becoming recognized as the King of Clove Cigarettes. Both these men also knew each
other (Nitisemito: page 90).
Beginning with sugar production, Oei Tiong Ham established numerous peripheral
businesses and before long his company became a conglomerate that controlled several
upstream and downstream industries in various countries. His businesses, which operated
for nearly a century in Indonesia, were confiscated when President Sukarno’s anti-capitalist,
nationalist- socialist regime took power (8). Such an economic imbalance did not go
unnoticed by indigenous entrepreneurs who subsequently established the Islamic Trade
Union, later called simply the Islamic Union, which boasted such prominent members as
H. Samanhudi; Raden Mas TirtoadisoeIjo and H. Omar Said Tjokroaminoto.
To date, a great many Indonesians still live in rural regions under strong influences
of feudalism, tradition and history. In these areas education is limited as is exposure to
democratic concepts, therefore modern ideas regarding national organization and
A historical perspective is required to understand the problem of corruption in
Indonesia. As historian Fernand Braudel once said, business is a subset of a greater set,
and the most important elements of the greater set are the policies, attitudes and attention
of the government to the business sector, to what extent freedom and assistance are
given, and lastly the correlation between governmental political policy and business policy.
In this paper, I will examine the problem of corruption in the Indonesian private
sector. For the sake of brevity, this paper will broadly analyze corruption, as it has existed
since Indonesia became a sovereign nation, free of the colonization of the Dutch. This
period of independence began according to the Indonesian people on 17 August 1945,
although the Dutch and the United Nations only recognized the independent Republic of
Indonesia in 1949.
However, the models cited herewith are based on events that took place following
the emergence of the New Order (1966-1998) under President Soeharto’s administration,
which was followed by the Reform Era under Presidents B.J. Habibie (1998-1999) and
Abdurraman Wahid (1999-). Although corruption also occurs in small and medium scale
businesses, however because of their impact on the national and regional economy, the
models examined focus on the businesses malpractices of conglomerates that for the most
part became such with assistance from the state.
This seems viable as for the most part the companies that form conglomerates
have entered both the local capital markets (the Jakarta and Surabaya bourses), and the
international capital markets (The New York, London, Singapore and other exchanges).
Hence they have engaged in commerce that mobilizes public or corporate funds in Indonesia
or abroad, an activity that requires transparency,countability and public control through
independent agencies or a perfect market mechanism.
In principal, as is generally the case abroad, before a company conducts an Initial Public
Offering (IPO), the performance and financial status of said company must be examined by an
international public accountant company, such as one of the internationally recognized Big Five
namely, Price Waterhouse Coopers, Arthur Andersen, Ernst & Young, KPMG & Peat Marwick, and
Deloitte & Touche. That company must then be approved by the Capital Market Supervisory
Board (Bapepam) before being traded in the capital markets. Thereafter, in theory, so long 82
such a company is still listed, it will be under the supervision of the management of the
relevant capital markets.
I have divided this study into three parts, excluding the prologue and epilogue. The
first part discusses the relationship between the government and the private business sector.
In the first part, I explain in detail how a government of a corporate nature cooperates with
the western world in controlling its policies to build a strong private sector under an iron fist
on the basis of the need for political stability and economic growth. The impact of this is
that the private sector becomes greatly interdependent on the government so as to allow
for certain corrupt practices.
The topic of the second part is how the Indonesian private sector became a virtual
conglomerate under the New Order. This part elaborates on the corrupt practices of
conglomerates. I discuss several cases of corruption involving state-owned enterprises,
institutions, departments as well as national and international private sector companies
such as, Pertamina, the State Electricity Company (PLN), the State Logistic Agency (Bulog),
the Department of Mines and Energy, Freeport, Balongan, the Timor national car project,
Lippo Group, the Capital Market Supervisory Board (Bappepam), the Clove Marketing and
Buffer Stock Agency (BPPC), Tapos animal husbandry, Indonesian Educational Television (TPI),
the Cimacan land case and others.
The third part pertains to the destruction and re-embodiment of conglomerates and
their corrupt practices in the Reform Era. Here it is analyzed how corruption is propagated
in the current era of democracy with all its freedoms and the various laws and regulations
that have been issued to protect them, and who stands to benefit from such corruption.
With a historical and sociological method of analysis, it is expected that a
comprehensive description regarding the details, anatomy and the entire problem of
corruption in Indonesia can be obtained. To what extent corruption has become part of the
Indonesian business culture must be determined as a diagnosis, after which the appropriate
remedy must be prepared and administered. A study as brief as this is not sufficient to
provide a complete picture of the corruption phenomenon in the Indonesian private sector,
nevertheless it will at least offer an overall critical description of the matter.


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