HETERODOX REFORM SYMBIOSES

THE POLITIAL ECONOMY OF INVESTMENT CLIMATE REFORMS IN SOLO, INDONESIA

February 2009*

Abstract Much of the existing investment climate literature promotes a rule-based ‘good governance’ approach, in which less advanced economies are advised to adopt orthodox, OECD-type practices in order to facilitate higher investment and growth. While credible property rights, efficient bureaucracies, and low corruption are desirable objectives, it remains questionable whether orthodox prescriptions are the most promising pathway to get there. By taking a detailed look into the political economy of the Javanese city Solo, we find that informal, relation-based cooperation can provide a constructive platform for policy reform. In this paper we demonstrate that a ‘heterodox reform symbiosis’ – between a dedicated government leader and a diverse range of local firms – can bring about important regulatory and administrative reforms and provide important impulses for private investment. Keywords: Regional development, investment, informal institutions, transition countries JEL: H7, O17, O20, P25, P26, R11

* The authors wish to thank Hubert Schmitz, Mick Moore, John Humphrey, Abla Abdel-Latif, Alvaro Comin, Carlos Torres Freire, Lienda Loebis, and Eun Choi for their conceptual guidance and constructive comments. We are greatly indebted to Siti B. Wardhani for her excellent research assistance during this entire project; and to Ibu Hitifah and Pak Nino for their tireless logistical support in Solo. Moreover, administrative assistance from the University of Indonesia and the Asia Foundation in Jakarta greatly benefited this study. We gratefully acknowledge funding from the Centre for the Future State and the UK Department for International Development (DFID).

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I. Introduction

Investment climate reforms are at the center of recent policy debates. They have

become a key focus area of the World Bank and other donor’s global development program.1

But while some governments could gain additional investment and growth by applying

orthodox reform recommendations – such as securing property rights, liberalizing trade, and

deregulating government – others have been successful with decidedly heterodox policies,

including sectoral subsidies, special economic zones, and infant industry protection (Moore

and Schmitz 2008). Regardless of developmental (and often authoritarian) state interventions,

East Asian countries like China, Singapore, Korea, Indonesia, Malaysia, and Vietnam have

amassed an impressive record of economic reform and success over the past decades (Ahrens

2002; Li 2003). Rather than adopting a ‘laundry-list approach a la Washington Consensus’,

these countries have successfully responded to economic and political ‘binding constraints’ of

the time (Rodrik 2006:976-7). To understand these binding constraints it is important to take a

closer look into the political economy of reform and, in particular, the constellation of policy

actors, powers, and interests.

While existing political economy literatures have advanced the understanding of

national dynamics (Grindle and Thomas 1991; Krueger 1993; Rodrik 1996; Williamson

1994), the rapid expansion of decentralization and local democracy2 calls for a detailed

analysis of subnational policy reform. This paper seeks to contribute to this emerging research

area3 by focusing on a local economy in one of the largest and most decentralized

democracies in the world: the Republic of Indonesia. After the Asian crisis and General

Suharto’s resignation in 1998, Indonesia’s government put an end to thirty years of

authoritarian rule and implemented far-reaching political and administrative reforms. Since

1999, Indonesian citizens have elected roughly 1,600 national representatives, 30,000 local

council members, and 800 governors, mayors, and regents. Moreover, since the implementation

of decentralization in 2001, local tax and service responsibilities have been fully devolved to

more than 450 district governments.

It is important to note, however, that these formal reforms did not take place in a

historical vacuum. The introduction of free elections and administrative decentralization

needs to be placed against a long history of authoritarian rule: spanning from Javanese

kingdoms (13th-16th century), through Dutch colonialism (1630-1942), to Suharto’s New

Order (1965-1998). The New Order regime in particular was sustained by a pyramid-like

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patronage structure, in which national, provincial, district and village elites received well-

defined rewards for being loyal to the center (McLeod 2000). These extensive patron-client

networks ensured coherence and certainty, but also suppressed societal participation and

innovation in local polities. After the introduction of decentralization, many former elites

have managed to stay in power; whereas much of the civil society remains weakly organized

and entangled in local patronage networks (Hidayat 2000; Von Luebke 2008; 2009). Thus,

although Indonesia’s regime change has introduced formal good-governance structures, local

policy realities continue to be dominated by informal and particularistic relationships.4

But this persistence of informal relationships, we argue in this paper, does not

preclude effective policy reforms, investment climate improvements, and economic progress.

By taking a detailed look into the political economy of Solo City, a municipality that stands

out for its strong public-private relationships, we find that informal cooperation between local

officials and business people can be a driving force for policy improvements. These informal

alignments provide political support and direction for government leaders to identify reform

initiatives and ensure consistent bureaucratic implementation. Solo’s heterodox reform

symbiosis – between a dedicated mayor and a well-balanced group of local firms – has

effectively improved the local investment climate and contributed to the recent rise in private

investment.

II. Political Economy of Policy Reform - A Brief Review

Unconstrained public administrations tend to obstruct private economic activity by

enacting distortionary regulations, inflicting superfluous administrative requirements, and

capturing illegitimate rents (Batra et al. 2002; Djankov et al. 2002:35; World Bank 2006b).

This view, which marks the starting point of our analysis, finds support in three different

currents of thought: public-choice literatures suggesting that bureaucrats pursue private rather

than the public interests (Breton and Wintrobe 1975; Downs 1967; Niskanen 1971; Tullock

1965), state-failure literatures demonstrating how state regulations such as trade quotas,

permits and taxes, are misused for rent-seeking purposes (Krueger 1974; 1990; Srinivasan

1985) and corruption literatures showing that unrestrained bureaucracies are more susceptible

to gross misconduct (Klitgaard 1998; Shleifer and Vishny 1998). A common conclusion that

emerges from these schools of thought is that public administrations need to be kept in check

in order to provide efficient, responsive and non-corrupt public services. Political and

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economic scholars have proposed three performance-enhancing checks in particular:

(1) subnational competition, (2) interest group pressure, (3) and government leadership.

The argument that subnational competition enhances government performance finds

its roots in Tiebout’s (1956) prominent study on asset holder mobility. The basic proposition

is that decentralization makes regional tax and service differences more visible and, thereby,

motivates citizens to move to local governments that serve their preferences best. Over time,

this ‘exit option’ motivates local governments to compete for mobile asset holders by means

effective service provision and efficient revenue management. Besley and Case (1995) extend

Tiebout’s proposition towards local politics, arguing that decentralization induces more

political competition among local incumbents, as citizens increasingly base their vote on

regional policy comparisons. In order to remain in office, local politicians are thus required to

adjust their agendas to the political ‘yardsticks’ set by regional counterparts in other parts of

the country.

But even between elections, interest groups can organize and voice their concerns.

Instead of exiting from an unsatisfactory situation, Hirschman (1970) notes, citizens may

choose to lobby for policy changes. Especially those who are unwilling (or unable) to bear

migration costs can express their dissatisfaction in joint demonstrations, petitions, or signature

campaigns. According to Putnam’s (1993; 1995) research on social capital, these collective

initiatives are likely to be more successful in well-balanced, horizontal societies, in which

civic engagements cut across social, ethnic, and religious divides; and less successful in

hierarchical and clientelistic polities. Additional impediments to collective action, as Olson

(1965) reminds us, may arise from group-size-specific coordination problems. Since costs to

monitor and enforce compliance rise with group size, societal groups with large memberships

tend to be more constrained by free-rider problems and, therefore, less effective in voicing

their interests towards the government. The likely result of this group-size dilemma is that

particularistic interests dominate more encompassing ones. This caveat is also reflected in the

seminal papers by Grossman and Helpman (1994) and Bardhan and Mookherjee (2000)

indicating that highly concentrated interests – i.e. the absence of interest group competition –

tend to result in less favorable policy outcomes. Thus, an important message that emerges

from this body of literature is that interest group pressures are more likely to stimulate broad-

based government reforms, (1) the more they rest on horizontal, non-clientelistic society

structures, (2) and the more they encompass a wide spectrum of business sectors and actors.

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While subnational competition and group pressures constitute the demand side,

government leadership provides a supply side perspective to public reform. A common

finding in comparative policy analyses in Asia (Mahbubani 2007; Rodrik 1996; Williams

2002), Latin America (Grindle 2004; Grindle and Thoumi 1993) and Africa (Gray and

McPherson 2001; Rotberg 2004) is that public leaders shape policy outcomes by initiating

reforms and supervising bureaucratic practices. While the Asian experience – the first

(Singapore, Taiwan, Korea) and second generation (Thailand, Malaysia, Indonesia) of tiger

economies – suggests that the ‘public entrepreneurship’5 of national and subnational leaders

was instrumental for socio-economic progress, many accounts from Africa point in the

opposite direction. As Gray and McPherson (2001:728) summarize it, Africa’s long legacy of

corrupt and non-visionary leaders has proven to be ‘a serious impediment to policy reform’

that has left African populations ‘tyrannized, and impoverished …over the past four decades’.

The common theme that runs through these country experiences is that government leaders

have emerged, for better or worse, as key policy actors who make ‘a critical difference in the

introduction, scope and pursuit of policy reform’ (Grindle and Thomas 1991).

III. Conceptual Framework and Methodology

The conceptual framework of this study encompasses three stages (see Figure 1). In

Section 4 we decipher Solo’s political economy, by paying special attention to interest group

constellations, government leadership, and regional yardstick competition. Against this

contextual background, Section 5 then explores the nature of government-business relations

and their impact on Solo’s investment climate. In particular, we explore the degree of

inclusiveness (by focusing on the composition of policy actors) and reform orientation (by

looking at current practices and future planning) of public-private action. Section 6 explores

recent changes in Solo’s economic growth and private investment and proposes tentative links

between reform alignments and economic performance.

< Figure 1 around here >

Overall, the discussion is guided by two overarching questions. The first one, which

guides the analyses in Section 5, asks whether heterodox, relation-based governance can

stimulate investment climate reforms. The second question, which is addressed in Section 6,

goes one step further and inquires whether heterodox reform alignments between private and

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public actors also have observable effects on investment and economic growth.6 The methods

we use to address these two questions are threefold:

(1) In-depth Interviews: To gain important contextual information, we conducted 25 in-depth

interviews with local stakeholders. Interviews were semi-structured and covered salient issues

of public-private relations, government performance (efficiency, services, corruption), and

economic growth and investment. Key informants included public officials (finance,

development planning, industry and commerce), business people (retail, manufacturing,

public construction, service), NGO and media representatives, and academics. In a subsequent

step, local opinions were complemented by national perspectives. These included interviews

with policy experts at the World Bank, Asia Foundation, UN-CAPSA, Regional Autonomy

Watch (KPPOD), University of Indonesia, and the Center for Strategic and International

Studies (CSIS).

(2) Local Business Survey: During our fieldwork in February 2008 we conducted business

surveys with 64 local business respondents. The applied sampling frame was guided by

practical considerations. Due to the limited availability of reliable business data, respondents

were randomly chosen in local ‘yellow pages’ and evenly stratified across retail,

manufacturing and service sectors. Consistent with employment structures in rural Indonesia,

the vast majority of the surveyed respondents were owners of small firms with less than 20

employees.

(3) Secondary Data: As a third and final step, we collected a range of secondary data sources.

Official reports from government departments, business associations and local media offices

were useful to triangulate interview information and further enlarge our technical

understanding of district tax regulations, license requirements and business services.

Moreover, local news clippings proved a rich source of information on local business,

corruption, and politics.

IV. The Political Economy in the City of Solo

The city of Solo is the second largest municipality in Central Java. Located in the

eastern lowlands of the province, the city extends over an area of 44 km2. While official

statistics report a population of 550.000, daytime numbers can be three times as high, owing

to the large inflow of regional commuters. Similar to Yogyakarta, Solo developed around an

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ancient Javanese sultanate (keraton kasunanan), whose historical heritage has become one of

Solo’s main tourist attractions. While agricultural production is virtually absent, the economy

of Solo primarily rests on secondary and tertiary sectors.7 The local GDP In 2007 accrued

mostly from trade, hotel and restaurant services (24.2 percent), local manufacturing (24.1

percent), and physical construction projects (13.4 percent).

While economic structures remained relatively unchanged, administrative and political

structures have been strongly reshaped over the last decade. With the introduction of

decentralization, the municipal government no longer received national or provincial orders,

but manages local tax and service matters independently. Since 2001, decisions on public

education, health, physical infrastructure, and business licensing lie primarily in the hands of

Solo’s mayor and his administration.8 Moreover, with the introduction of direct mayor

elections in 2005, Solo’s citizens and interest groups have gained new opportunities to

influence local decision-making. In order to understand how these changes translate into

economic policy reforms, it is useful to take a closer look – consistent with the literature

discussion above – into the (1) the constellation of local business groups, (2) the significance

of government leadership, (3) and the presence of subnational checks and balances.

Constellation of Local Business Interests

Reform pressures from Solo’s private sector are more likely to emerge from informal

than formal channels. Our field observations suggest that formal business forums are often

ill-positioned to represent private-sector interests. A case in point is the local chamber of

commerce (KADINDA). Stripped from its former New Order privileges9, Solo’s local

chamber has lost much of its functionality since decentralization. According to the interviews

with local firms, there is little benefit of becoming a KADINDA member. For one thing,

KADINDA no longer acts as an umbrella organization that holds the mandate to coordinate

public contracts. For another, it has failed to build functional organizational structures that

provide members with adequate business services. Most interviewees concur that the chamber

provides neither a meaningful service portfolio nor an effective platform for business

advocacy. In view of these structural problems, which can be observed in many other districts

across rural Indonesia (von Luebke 2008: 202-7), Solo’s business chamber is facing declining

support and membership. According to local observers, these problems have been further

compounded by the 2005 mayor elections. Ever since the director of KADINDA (who was a

candidate of Suharto’s former state party GOLKAR) was defeated by the current mayor

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(representing Megawati’s secular-democratic party PDIP), the chamber of commerce has been

reluctant to cooperate with the incumbent government.

In contrast to KADINDA, sectoral business associations seem to have found more flexible

and effective ways to engage in constructive policy discussions. Representatives of various

business groups, including furniture (ASMINDO), tourism (PHRI), real estate (REI),

construction (GAPENSI), and batik (Laweyan) associations maintain close informal ties with

the municipal government. Instead of attending official business-government forums – which

are often fraught with ceremonial and inefficient procedures – local firms prefer to address

policy issues in private audiences with Solo’s mayor. According to one senior businessman,

“the mayor schedules informal meetings with private-sector representatives every evening …

He does not discriminate against anyone. He has an open ear for all private sector concerns.”

This informal exchange has clear advantages: it provides sectoral associations with a platform

to criticize inadequate government practices and, at the same time, provides Solo’s mayor

with additional performance measures of the local bureaucracy.

Thus, the absence of formal business dialogues – readily exemplified in a

dysfunctional chamber of commerce – does not preclude private sector groups from seeking

alternative communication channels. Adapting to the democratic regime change, sectoral

business groups have skillfully established new support networks with government and

society. The directors of the Chinese business group PMS, for instance, have not only

maintained continuous conversations with Solo’s mayor and senior officials, but also

provided funding for health centers, ambulances, and sport facilities in the community. This

strategic combination of government and societal linkages, which Abdel-Latif (2008) refers to

as ‘organizational capacity’, has helped sectoral groups to secure considerable policy

influence. As we will outline in greater detail below, these well-balanced private sector

interests provide effective checks for the performance of Solo’s mayor and his government.

Government Leadership

Solo’s mayor is widely regarded as a catalyst for reform. A large number of

interviewees, both in the private and public sector, stress that the head of the municipal

government is an important driving force for local economic development. According to local

respondents, Mayor ‘Jokowi’, as he is commonly referred to, has initiated policy reforms that

make Solo more safe10 and its bureaucracy more efficient. There is wide agreement that, since

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Jokowi’s election in June 2005, the amount of illegal extractions by local hoodlums and the

frequency of violent demonstrations have notably decreased. The reason for this improvement

has been the mayor’s tireless efforts to directly approach people and their problems in Solo’s

suburbs. Several business respondents also emphasize that Jokowi’s business experience has

been a valuable asset for his attempts to increase the performance of Solo’s bureaucracy.

The fact that Jokowi managed a successful business11 for several years before taking

office has convinced many observers of his determination to improve public performance. For

one thing, his strong financial background12 is seen to reduce the susceptibility to corruption.

According to several interviewees, his motivation for taking office was not monetary gain (in

fact he sacrificed ongoing business contracts), but rather the prospect of reducing

misstandards and gaining people’s respect.13 Our interview with the mayor indicated a

genuine concern for public reform and economic development. After outlining the key stones

of his economic agenda – such as the integration of Solo’s street vendors into the formal

sector, the rehabilitation of Solo’s traditional markets, and the support for real estate

developments and technology incubators – Jokowi acknowledged that many of his visions are

compromised by bureaucratic inefficiency and resistance. “Solo’s technical departments

adhere to lengthy administrative procedures. Bureaucrats do not operate like business people.

Many public officials do not implement my ideas or instructions because they are either

unwilling or unable to do so.”

Determined to create a more business-friendly government, the mayor has reportedly

made strong efforts to reduce administrative corruption and inefficiency. Interviews with local

officials suggest that bureaucratic compliance has been improved by Jokowi’s frequent visits

to administrative units. “We are never quite sure”, the head of Solo’s industry department

notes, “whether the mayor drops into our office. It is his habit to conduct unannounced

inspections and see if everyone is doing his job properly”. Apart from unannounced audits,

Jokowi has set performance-enhancing incentives by signaling that he is prepared to penalize

administrative misbehavior. According to local observers, the mayor has so far demoted two

senior bureaucrats (kepala dinas) for their involvement in corruption. Moreover, his initiatives

to hold monthly evaluation meetings and to disclose his mobile number for public complaints

has kept local bureaucrats on their toes. By combining random audits and additional

monitoring instruments, Jokowi has set credible incentive structures for more efficient and

less corrupt government practices. In light of these strategic efforts – which are informed by

his business experience and ongoing private sector dialogues – Solo’s mayor emerges as a key

promoter of investment climate reforms.

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Subnational Competition - Economic and Political Checks

The strong office powers of Solo’s mayor naturally raise accountability concerns.

Recalling the literature discussion above, there are basically two counterbalancing forces that

help to align government leaders with public interests: economic pressures arising from

interjurisdictional asset mobility, and political pressures arising from electoral competition.

Economic accountability checks, as outlined in the Tiebout (1956) model above, are yet to

evolve. The assumption that Solo’s mayor and his staff refrain from predatory practices

because they fear out-migration of mobile taxpayers would be misleading at this stage. Based

on our field observations, local firms are unlikely to leave the city because of bad government

policies. In view of economic and social investments, many of Solo’s business people are tied

to their current location. For one thing, moving into another district entails notable sunk costs,

especially for firms with immobile assets and established customer networks. For another,

Chinese business people, who are economically powerful but socially vulnerable actors,

refrain from moving to unfamiliar environments that entail new uncertainties. There are many

accounts of inter-ethnic conflicts in the region. According to our interviews, a series of local

riots in 1965, 1980 and 1998, resulted in severe casualties and property losses for the Chinese

Indonesian community. In order to prevent future hostilities, the association of Chinese firms,

PMS, has heavily invested in the local community, establishing additional health facilities,

youth scholarships, sport festivals, and fire-fighting units. Moving into a new district would

render these precautionary investments ineffective. Thus, due to the outlined mobility limits –

which affect both Javanese and Chinese firms – interjurisdictional competition á la Tiebout is

likely to play a minor role at this point of time.

More effective checks, however, arise from electoral pressures. The official

introduction of direct (‘first past the post’) elections provides local government heads with

strong incentives to attend to the voices of their constituencies. In the case of Solo, reelection

chances in 2010 undoubtedly hinge upon public performance levels over the next two years.

As a senior public official summarized it, “Jokowi should bear in mind that he only received

40 percent of the popular vote … Notwithstanding his victory in the 2005 elections, he

nonetheless needs to make continuous efforts to gain public approval.” To stay in office, the

mayor will require additional campaign funds and political support networks – both of which

can be provided by the private sector. The informal dialogue, between Jokowi and a broad

range of private sector actors, provides a useful platform in this regard. Since private sector

support is also conditional on performance and policy orientations, these informal

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government-business dialogues serve as an important political check on government

leadership. This accountability link is further enlarged by the rising media coverage of

regional government affairs. Many interview respondents were well aware of the mayor’s

policies and compared them to other reform efforts in the region (such as in Sragen,

Sukoharjo, and Yogyakarta). Thus, consistent with Basely and Case’s (1995) argument above,

Jokowi’s political success increasingly depends on whether his performance level is

compatible with regional yardsticks.

< Table 1 around here >

In comparison to the mayor, city council members (DPRD) have been exposed to far lower electoral pressures over the last years. Weak parliamentarian accountability has been primarily the result of misspecified electoral rules. Due to the peculiar redistribution of votes within party lists, nearly all parliamentary seats in the 1999 and 2004 elections went to top-listed candidates.14 List positions were ultimately decided by provincial or national party boards, and often depended on ‘voluntary contributions’ rather than local performance (Siregar 2006; Ufen 2008). As a result of these adverse incentives, Solo’s politicians have had more reason to attend to party headquarters than local voters. The weak accountability link between DPRD representatives and their electorates is also reflected in our business survey in Solo. As illustrated in Table 1, over 90 percent of the respondents state that they ‘rarely’ or ‘very rarely’ interact with local DPRD members.

In summary, government leadership is an important driving force of policy reforms in Solo. Mayor Jokowi, whose leadership qualities benefit from his long-term business experience and financial independence, has pushed for a more efficient and business-friendly administration. His efforts to supervise public officials and penalize gross misconduct pave the ground for better government performance. Less visible but equally important, however, are the forces that keep the mayor at check. Sectoral business associations, which maintain a close informal dialog with the mayor, have considerable influence on current and future policy decisions. Since 2005 mayors are elected by direct popular vote. In order to take or remain in office, government leaders require the assistance of private sector actors. Especially sectoral business groups that have the organizational capacity to mobilize political support – both in terms of campaign donations and advocacy – are therefore attractive allies for the incumbent mayor. Decision-making in Solo is thus not the result of single-handed leadership initiatives, but rather the product of an interest symbiosis between the government leader and a number of sectoral business groups.

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V. Government-Business Relations in Solo

After mapping the general political economy, we now take a closer look at

government-business relations and their impact on Solo’s investment climate. As outlined in

Figure 1, particular attention is given to aspects of (1) inclusiveness (2) and reform

orientation. Wherever possible, the analysis is complemented with investment climate

indicators from our business survey data.

Inclusiveness

An important aspect in the analysis of local investment climates is the constellation of

policy actors. Is the public-private sphere ‘inclusive’, in a sense that it encompasses a large

array of private sector actors, or ‘exclusive’, in a sense that it centers around a handful of

powerful business elites? Recent experiences from other post-authoritarian transitions

(Hellman et al. 2000; O’Donnell and Schmitter 1986; Shleifer and Vishny 1998), show that

polities with narrow, mono-sectoral interests are more prone to predatory extraction or

rent-seeking activities. In a similar vein, Grossman and Helpman (1994) and Bardhan and

Mookherjee (2000) remind us that a diversity of interest groups stimulates more competition

in policy arenas and, therefore, reduces the likelihood of government capture.

< Table 2 around here >

Solo’s policy arena exhibits a notable diversity of business interests. The findings

from our business survey indicate the presence of a wide and evenly spread range of business

associations – comprising multi-sectoral/scale/ethnic interests. As outlined in Table 2, nine

organizations are recognized as ‘key business associations’ by at least a quarter of the

respondents in our survey. The composition of these business associations reveals a wealth of

sectoral interests – including public construction, furniture, real estate, tourism, handicraft and

transportation. The results also signal a diversity of ethnic influences. According to our

observations, ASMINDO, ORGANDA and ASEPHI display a high membership of Javanese

firms, whereas REI, PHRI and PMS are strongly influenced by Chinese business interests.

Moreover, while some organizations represent primarily the concerns of large firms

(GAPENSI, REI, PHRI, and PMS), others exhibit strong ties with small-scale businesses

(ORGANDA, ASMINDO and ASEPHI).

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< Figure 2 around here >

The well-balanced diversity of interest groups can be best visualized in a relationship

chart (see Figure 2). Based on focus group discussions with local firms – where participants

were asked to position familiar business associations in relation (a) to the mayor and (b) to

each other – it became obvious that Solo’s business associations do not form clusters but

exhibit an even spread of interests. Although some groups are somewhat closer to the mayor

(e.g. ASMINDO and PMS) than others (e.g. KADINDA and HIPMI), the discussions with local

firms confirmed that there is a level playing field and considerable competition among

sectoral associations. Overall, the balanced influence of multi-sectoral and multi-ethnic firms

render the emergence of narrowly defined collusion arrangements improbable. As soon as one

group receives illegitimate benefits from the government, another equally influential group is

likely to intervene.

A high level of inclusiveness is also observable in the dialogues with Mayor Jokowi.

Business respondents unanimously agree that, compared to his predecessor, Solo’s current

mayor has created a communication platform for a wide spectrum of private sector interests.

Interviewees concur that Jokowi never discriminates in favor of certain business groups. As a

senior journalist emphasized, “the mayor stands out for his even-handed treatment … he

accommodates local business people regardless of their ethnicity, religion, and status.” The

overarching message is that the Jokowi’s open-house policy has widely benefited the private

sector. Although face-to-face consultations are mostly informal, they are not skewed towards

particular interest groups.

Overall, it seems that Solo’s mayor has been successful in striking the right balance

between different religious and ethnic fractions. On the one hand, he maintains close ties to

Javanese Muslim communities. As one business respondent commented, “Jokowi regularly

joins local Koran studies (Pengajian Islam) and uses the opportunity to discuss policy issues

with Islamic scholars and students”. He also reaches out to the wider Javanese society by

attending ‘mutual help associations’ (Arisan)15 in Solo’s suburbs. The business voices

emerging in these meetings, the mayor explained, are primarily those of small traditional

firms concerned about micro credits and business licenses. On the other hand, the Jokowi

administration maintains equally strong ties with the Chinese community. This is well

exemplified in recent collaboration efforts with the Chinese business association PMS. A look

into the PMS Bulletin (2007) reveals that Mayor Jokowi launched a Chinese heritage festival,

a Christmas market, and several PMS-funded sport events in 2006. Moreover, during our

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fieldwork in April 2008, the municipal government hosted a Chinese New Year celebration

(Imlek) which – given the historical frictions between Javanese and Chinese Indonesians –

constituted a symbolic gesture of reconciliation and cooperation.

Apart from inclusive communication structures, the Jokowi administration also

demonstrates an even-handed approach in its sectoral policies. The support program for two

distinctly different sectors – informal street vendors and real estate developers – provides an

illustrative example. The street vendor program has providing sheltered market spaces and

micro credits to over 5000 informal sector businesses.16 Over a period of two years, Mayor

Jokowi negotiated continuously with street vendor associations. As one businessman recalls,

“The mayor listened to the people with impressive endurance ... He attended over 70

discussion rounds with informal traders, seeking consensus for compensation and relocation

modalities.” Interviewees concur that the relocation program has brought several benefits for

Solo’s economy. First, most of the relocated street vendors enjoy more economic security, as

they now have access to credit and all-weather facilities. Second, the formalization of

thousands of new businesses has generated additional revenues for Solo’s budget.17 And

third, the relocation has made the inner city more accessible for urban restoration and property

development.

The support for street vendors has indeed benefited real estate investments. As one

entrepreneur summarizes it, “Jokowi’s policy sequencing was smart. He deliberately dealt

with street vendors and traditional markets first. Later, when he gave his permission to real

estate developments, resistance in the local community was low … mostly because his

support for small firms and traditional markets was widely recognized.” This sequential and

balanced strategy is summarized in the development vision of the mayor: “my objective is to

create a modern city that maintains its heritage … it is important to strengthen traditional

businesses and markets … but, at the same time, Solo is changing. It needs to accommodate

new investments and urban development.” Jokowi’s approach seems to bear fruit: after the

successful reallocation of Solo’s informal businesses to traditional markets, three large real

estate projects have sprung up in the city center.18

Investment Orientation

Does the high degree of inclusiveness translate into a better investment climate? To answer these questions it is useful to shed some empirical light on Solo’s government

15

performance in terms of its (1) regulatory environment, (2) administrative practices, (3) and developing planning. By and large, the regulatory environment under the current administration appears to be conducive to private investment. According to a nationwide assessment conducted by the Regional Autonomy Watch (KPPOD 2008:87), Solo’s local regulations are more business-friendly (score of 92 out of 100) than other cities in the region, including Yogyakarta (score of 78) and Surabaya (score of 57).19 This positive evaluation is confirmed by many local firms. There is substantial agreement among private sector respondents that Solo’s government has reduced (rather than increased) regulatory constraints over the last years. A good example is the current revision of the ‘urban construction’ bill. Guided by traditional principles, the former regulation (Perda 06/1991) stipulated that new construction projects were not to exceed the height of the sultanate palace (Sangga Buana). As this ‘height limitation’ rendered several hotel and real estate investments unfeasible, the government was called upon to abolish this regulation. As one real estate developer notes, “owing to the mayor’s initiative to revise the construction bill … three property developments are underway which will, eventually, be higher that the Sangga Buana palace … While local preservationists initially opposed the revision, Jokowi and the real estate association finally managed to advance the new bill in the city council.”

< Table 3 around here >

Improvements are also visible in Solo’s administrative practices. Most respondents

concur that license administration has become more business-friendly over the last two years. Responding to complaints of the business community, which had faced a myriad of administrative desks and paperwork, the government streamlined existing procedures by introducing a ‘one-stop-shop’ (OSS) for business licenses. As the head of Solo’s OSS unit explains, the reform initiative was inspired by Jokowi’s prior business experience. “Remembering the excessive red tape during his former business years, the mayor was determined to simplify licensing procedures. He first sought support in the local parliament and then approached technical departments … Initially many department heads rejected the initiative. But Jokowi either convinced or replaced them over the last years.” According to the mayor, streamlining administrative procedures has been an essential prerequisite for stimulating economic development: “prior to the establishment of the OSS, business people had to wait several weeks for their licenses, which provided ample leeway for corruption … Now citizens can obtain most licenses with 6 days or less”. The advantages of the new OSS unit extend to both small and large firms. Small and micro firms – such as street vendors formalizing their business – receive basic licenses within two days, free of charge. Large entrepreneurs, who used to experience convoluted procedures and delays, can get business projects approved in a matter of days. “I discuss with many business people every day”, the mayor emphasizes, “if they can demonstrate that their project is likely to stimulate employment and development, they will receive all necessary government permits right

16

away”. Overall, the introduction of streamlined licensing services are well-received by local business respondents. According to the results of our business survey (see Table 3), roughly 6 in 10 firms are satisfied with the access to licensing information (59.4 percent) and the ease of administrative licensing procedures (60.9 percent).

< Table 4 around here >

Among bureaucrats, Jokowi’s OSS initiative has naturally evoked divided reactions. While some support the idea of public service reforms, others have resisted far-reaching changes. Senior officials at the department for industry and commerce (Dinas Perindag), for instance, criticized the mayor for transferring licensing powers to the OSS unit without their consent. Undoubtedly the introduction of the one-stop-shop has sidelined technical departments and stripped them from valuable formal and informal income sources. According to critical observers, corruption still prevails in some parts of the bureaucracy. “Although illegitimate extraction has gone down significantly,” a Chinese businessman comments, “local government officials are still far from clean”. The extent of administrative corruption is closely linked to public recruitment practices. The phenomenon of illegal recruitment fees, which have become a problem in many Indonesian districts,20 is also confirmed in our interviews in Solo. A retired senior official, for instance, admits that several civil servant candidates have paid up to Rps 75 million (US 7500) for attaining a government position. Given that monthly public salaries rarely exceed Rps 1 million (Rachmadi 2005), government-internal bribe payments are likely to evoke administrative corruption: it is plausible that a swift ‘return on investment’ can be best achieved by illegal means. These adverse monetary incentives may also explain why a majority of Solo’s firms (see Table 4) have experienced considerable irregularities while obtaining standard business permits.

< Table 5 around here >

Interestingly, firms reporting high corruption were also those with little access to

licensing information (see Table 5). Since information sources are freely available at Solo’s OSS unit, these figures suggest that irregularities are more pronounced once firms deal with technical departments and external brokers. Overall, the introduction of the one-stop-shop, and the mayor’s decisiveness to penalize misconduct (see Section 4), have paved the ground for administrative improvements. Many local firms report that Solo’s licensing practices have improved over the last years. As one hotel manager summarizes it: “under the Jokowi administration, administrative procedures have become much more efficient. Under the former government we were still using informal brokers to avoid excessive red tape, but these days are gone.”

17

Solo’s development planning has also benefited from close government-business relations. The informal exchange between the mayor and an even spread of private interests has provided a fertile ground for investment-oriented planning. In general, Solo’s development plan can be summarized under the heading ‘tradition meets modernity’. As outlined above, the balanced support programs for traditional and modern business sectors (street vendors and real estate developers) extend to upcoming development priorities. A clear example is the plan to strengthen small-scale businesses by restoring three historical heritage sites. The upcoming budget contains earmarked funds for revitalizing Solo’s colonial market hall (Pasar Klewer), its traditional batik quarter (Laweyan) and its sultanate palace (Sangga Buana).

At the same time, Solo’s urban planning places a strong emphasis on modernization. For one thing, the government has advanced a plan to establish an innovative technology center. According to the economic head of Solo’s development planning board (Bappenas), the foundation stone of the center, commonly known as ‘Solo Techno Park’, was laid in 2007. The construction of a vocational school and a business incubator (with European co-funding) is underway. Although its completion may require several years, Solo’s technology park is likely to raise local labor and technology standards and, in doing so, make the greater Solo region more attractive for prospective domestic and foreign companies. Moreover, the development plan entails several infrastructure programs to raise the city’s investment attractiveness. Probably the most important stimulus arises from the construction of two inter-provincial highways (Trans-Java) which intersect in Solo. Although this highway project is managed independently in Jakarta, the interview data indicates that Jokowi’s visits to Jakarta have helped to accelerate the construction process. Another investment stimulus is given by the planned extension of Solo’s regional airport. The enlargement of runways and passenger terminals will likely attract larger carriers and stimulate regional tourism. Solo’s economy will also benefit from a series of (inter)national events, including a UN Habitat conference, a national food fair, and the annual municipality convention (APEKSI). As Jokowi summarizes it “if the image is good, investment will surely follow’.

< Table 6 around here >

All in all, current practices and future development agendas project a fairly positive

image. Current regulatory conditions, licensing procedures, and development plans suggests that close government-business relations, between Mayor Jokowi and private sector groups, have stimulated considerable investment climate improvements. There is wide agreement among interviewees that government practices have become more predictable, impartial, and efficient. Although administrative corruption prevails in certain parts of the bureaucracy, there has been substantial progress in making regulations and licensing procedures more business-friendly. Improvements are also readily observable in Solo’s development planning.

18

Benefiting from the continuous interaction with privates sector groups, the Jokowi administration has formulated a well-balanced stimulation package that benefits small firms in traditional sectors and, at the same time, paves the way for large-scale property investments. On the one hand, traditional traders and craftsmen will be supported by physical restoration programs, micro-credit schemes, and special development zones. On the other hand, the planned extension of public infrastructures – airport facilities, business incubators, and vocational training centers – will help to attract potential investors. Solo’s development agenda finds wide approval in the business community. Our survey results (Table 6) indicate that roughly 7 in 10 local firms feel that forthcoming government programs are well planned.

< Table 7 around here >

Solo’s overall good performance is also confirmed in Indonesia’s latest subnational

business survey (KPPOD 2008). In comparison with other Indonesian municipalities (see

Table 7), Solo stands out for the high anti-corruption efforts of its mayor (column 1) and the

high presence of business associations (column 2) and public-private forums (column 3).

Licensing procedures in Solo are slightly less corrupt (column 5), and markedly more

time-efficient (column 4) than the municipal average. Overall, 70 percent of Solo’s business

respondents feel that recent government policies have had a positive effect on their business,

one of the highest approval rates within the 10-city comparison.

VI. Changes in Economic Performance

Have investment climate reforms already induced better economic performance?

Undoubtedly, attributing economic progress to recent regulatory and administrative

improvements is a difficult endeavor. Two attribution problems in particular deserve

attention. First, improved local economic policies are by no means the only factor driving

growth and investment. There is a rich empirical literature that links economic progress to

differences in geography, factor endowments, historical heritage and institutional

architectures.21 These exogenous factors and other country-specific determinants – such as

changes in private consumption, credit lines, or macro-economic policies – cannot be

controlled for in a single case-study.22 Second, improved investment conditions and

observable investment realizations tend to be separated by considerable time lags. As

economic indicators are available up to 2006/2007, roughly one/two years after the Jokowi

19

administration took office, causal links remain tentative. Cognizant of these limitations, we

move forward to outline recent changes in private investment and growth.

< Table 8 around here >

A first proxy for business and investment activity is given by the number of registered

firms. Considering the period between 2003 and 2006, we find a continuous rise in local trade

licenses (SIUP). As outlined in Table 8, a particularly high increase occurred during the first

year of Major Jokowi’s office term: between 2004 and 2005 the number of registered trade

businesses rose from 749 to 1039, which implies a growth rate of roughly 40 percent.

Investment flows in Solo have also notably increased over the last years. The local department

of industry and trade (Dinas Perindag) reports that private investments have more than

doubled from 188 billion Rupiah in 2003 (approx. US$ 20 million) to 417 billion Rupiah in

2006 (approx. US$ 45 million). These official figures, which should be treated with a certain

amount of caution23, suggest that private investment has grown, on average, at a rate of 30

percent.

< Table 9 around here >

This increasing investment trend is also reflected in the subnational credit data

compiled by the Indonesian Central Bank. According to official estimates (see Table 9),

outstanding investment loans to micro to medium-sized firms (MSMEs) amount to Rps 183

billion in 2006 and have increased by 9.5 percent since 2003; while loans to large firms (Non-

MSME) add up to Rps 157 billion and display a growth rate of 32.8 percent during the same

period. Once these figures are compared to the wider developments in Central Java, it

becomes obvious that Solo’s credits to small firms expanded half as fast, whereas its credits to

large firms grew more than 40-times faster than the provincial average. The fast growth of

Non-MSME loans is well in line with our observation of the vast expansion of real estate and

retail investments over the last years. The ongoing constructions of three large apartment

buildings – the ‘Solo Paragon’, ‘Solo Center Point’, and ‘Kusuma Tower’ – and the

establishment of numerous shopping malls – including the ‘Grand Mall’ ‘Solo Square’ and

‘Ciputra Sun Mall’ – bear ample witness of these investment activities. Since Solo has

insufficient access to land, private investments expand vertically, in real estate and modern

retail, rather than horizontally in manufacturing industries. Moreover, our interview data

indicates that high minimum-wages and rising labor standards have made Solo’s

20

manufacturing sectors less attractive. As one businessman in the construction industry

explains it, “investors will stay away from labor-intensive sectors, as long as national labor

laws and minimum-wage policies remain prohibitive … so far investments in property

construction and retail are more profitable”.

There is broad agreement among local interviewees that close, and often informal,

interest alignments between Solo’s mayor and local firms have created a valuable momentum

for private investment. Above all, the continuous public-private exchange has helped to build

mutual trust and reform commitment. Apart from improvements in administrative procedures,

local firms gained a higher degree of certainty – due to more inclusive decision-making and

transparent planning – and were therefore more likely to make investment commitments.

Thus, while the effect of informal government-business relations on observable investment

flows cannot be quantified, its existence is widely confirmed.

< Table 10 around here >

Turning from investment activity to economic income, the statistical data indicates

moderate growth rates. As illustrated in Table 10, official figures indicate that Solo’s gross

domestic product, measured at constant prices of 2000, has increased between 5 and 6 percent

over the last years. While these estimates are slightly higher than the average growth rates in

Central Java during this period, they nonetheless remain relatively low in light of the

indicated investment flows. An explanation for this moderate GDP growth may be found in

the fact that financial assets have been mainly directed into retail and property sectors, which

have less pronounced income effects than investments in labor-intensive industries. While

productive investments in Solo’s cottage industries (including batik, textile, and small-scale

retail ) are likely to rise over the next years – supported by rising tourist flows and

government support programs – they are yet to translate into higher GDP growth.

VII. Conclusion

The findings of this study challenge the conventional wisdom that formal rule-based

governance is a precondition for successful policy reform. In the case of Solo, informal

government-business relations – between a progressive mayor and a diverse set of private

sector actors – have been the key to regulatory and administrative improvements. The success

of this heterodox reform symbiosis rests on two ingredients. The first ingredient is a dedicated

21

‘reform facilitator’. In the case of Solo, Mayor Jokowi assumes this role: he reduces collective

action problems by providing communication platforms and building trust; he overcomes

reform resistances by negotiating compromises among various groups; and he translates

common interests into administrative reforms. Apart from these strategic and operational

leadership skills, the mayor has clear incentives to attend to private-sector voices, as he

requires additional political support and funding for the upcoming elections in 2010.

The second ingredient is a well-balanced ‘reform group’. Our empirical findings

suggest that an even spread of business interests – in terms of sector, size, and ethnicity –

raises the likelihood of effective investment climate reforms. In the absence of an effective

chamber of commerce and city council, Solo’s business groups transmit their policy concerns

in informal discussions with the mayor. Private sector actors are strong enough to have policy

influence and, at the same time, diverse enough to keep each other in check. The colorful

diversity of business interests – encompassing traditional street vendors as well as large real

estate developers – stimulates an open competition of ideas. As a result of this balanced

setting, government-business interactions do not result in particularistic deals, but promote

broad- based reform agendas.

The field evidence indicates that the city’s investment climate has markedly benefited

from these public-private alignments. Four aspects stand out in particular. First, over the last

two years, Solo has become a more secure and predictable environment for business activities.

Our interviews confirm that Mayor Jokowi’s efforts to mediate between small and large,

traditional and modern, Javanese and Chinese firms, has reduced the degree of hostility and

violence in the city. Second, Solo has refrained from enacting market-distorting regulations.

In contrast to several other districts in Indonesia, the government has not used its regulatory

powers in arbitrary or market-distorting ways. Third, Solo has significantly improved public

services for local firms. The establishment of a one-stop-shop, with transparent fees and

procedures, has reduced waiting times and uncertainties for license applicants. And fourth,

the city has formulated a well-designed development plan. Informed by private sector

discussions, the Jokowi administration has drawn up a support package which benefits both

small traditional businesses (i.e. market restorations and micro-credit schemes) and large real-

estate and retail developers (i.e. infrastructure enhancements and location marketing). Thus,

the answer to the first question of this study – whether heterodox reform alignments can lead

to improved investment climates – is in the affirmative.

22

Have Solo’s close government-business relations also resulted in higher investment

and growth? Here the answer is less clear cut. Due to the short time horizon and external

effects, it is not possible to conclusively determine the link between reform initiatives and

economic progress. Keeping these qualifications in mind, we nonetheless find a tentative

positive relationship. Over the last years, Solo’s economy has seen a substantial rise in

business licenses, outstanding investment loans, and real investment. Rising investment flows

are readily observable in the emergence of several large property developments and the

expansion of traditional trade sectors. While current growth rates remains at roughly 6

percent, ongoing private and public investments are likely to induce a rising trend in the

years to come.

23

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27

Figures and Tables Figure 1: Conceptual Framework

Section 6 ECONOMIC PERFORMANCE

Changes in Investment and Growth over the Last Years?

Section 5 (1) Inclusiveness (2) Reform Orientation

(b) Is the future development planning transparent and strategic or arbitrary and ad-hoc?

Does the public-private sphere encompass a broad range of business interests or is it heavily skewed towards powerful business elites?

(1) Level of Certainty

Equal Access to • Security • Business Permits • Government Services

(2) Level of Efficiency

Absence of • Trade-Distorting Taxes • Administrative Red Tape • Corruption

 GOVERNMENT-BUSINESS RELATIONS

  

  

(a) Is the current focus on investment-enhancing policy reforms or on predatory extractions?

INVESTMENT CLIMATE INDICATORS

Section 4

(1) Interest Group Constellations (2) Government Leadership (3) Regional Yardsticks

POLITICAL ECONOMY OF POLICY REFORM

28

Figure 2: Constellation of Local Business Associations

ASMINDOKADIN

PHRI

PMS

REI

HIPMI

MM

Source: Authors’ focus group discussion with 20 business representatives in Solo. Source: Authors’ focus group discussion with 20 business representatives in Solo. Note: ‘M’ signifies the position of the mayor. Focus group participants were asked to position six familiar associations (see Table 2) in the policy arena, according to their relations towards the mayor (visualized by concentric circles) and towards each other (visualized by respective group distances).

Note: ‘M’ signifies the position of the mayor. Focus group participants were asked to position six familiar associations (see Table 2) in the policy arena, according to their relations towards the mayor (visualized by concentric circles) and towards each other (visualized by respective group distances).

MASMINDO

PMS

REI

PHRI

KADIN

IPM

H I

DA

29

Table 1: Perception of Parliamentary Representation (in Percent) Interaction with Parliamentarians

Very Often 0.0 Often 6.3 Rarely 19.1 Very Rarely 74.6

Source: Authors’ business survey with 64 randomly selected small- and medium-sized firms in Solo. Note: Based on the survey question ‘please evaluate how often local parliamentarians ask for your opinion”. Table 2: Recognition of Business Associations Business Organization Explanation Recall Rate (percent)

GAPENSI Public Construction 64.1 KADINDA Industry and Commerce 59.4 ASMINDO Furniture Export 54.7 REI Real Estate 40.6 PHRI Hotel and Restaurants 34.4 HIPMI Young Entrepreneurs 32.8 ORGANDA Land Transportation 28.1 ASEPHI Handicraft 26.6 PMS Chinese Entrepreneurs 26.6

Source: Authors’ business survey with 64 randomly selected small- and medium-sized firms in Solo. Note: Based on the survey question ‘please identity key business associations in the economy of Solo’. ‘Recall Rate’ reflects the share of respondents explicitly mentioning a specific business association.

Table 3: Access to Business Licensing - Information and Administrative Ease (in Percent)

Access to Information Administrative Ease Very Good 15.6 10.9 Good 43.8 50.0 Poor 26.6 25.0 Very Poor 14.0 14.1

Source: Authors’ business survey with 64 randomly selected small- and medium-sized firms in Solo. Note: Based on the survey questions ‘please evaluate the access to licensing information’ and ‘please evaluate the administrative ease to obtain business licenses’.

30

Table 4: Level of Corruption during Licensing Procedures (in Percent) License Procedures

Very Low 6.3 Low 31.3 High 51.5 Very High 10.9

Source: Authors’ business survey with 64 randomly selected small- and medium-sized firms in Solo. Note: Based on the survey question ‘please evaluate the level of corruption fees during licensing procedures’. Table 5: License Corruption in Relation to Information Access (In Percent) Access to License Information

License Corruption Very High High Low Very Low Total

Very Low 4 0 0 0 4 Low 3 13 2 2 20 High 3 15 11 4 33 Very High 0 0 4 3 7

Total 10 28 17 9 64 Source: Authors’ business survey with 64 randomly selected small- and medium-sized firms in Solo. Note: Based on the survey questions ‘please evaluate the access to licensing information’ and ‘please evaluate the level of corruption fees during licensing procedures’. Table 6: Evaluation of Solo’s Development Planning (in Percent)

Future government programs are…

Well Planned 68.8 % Poorly Planned 31.2 %

Source: Authors’ business survey with 64 randomly selected small- and medium-sized firms in Solo. Note: Based on the survey question ‘please evaluate Solo’s future city planning’.

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Table 7: Solo’s Performance in Comparison

City (1) Strong Anti-Corruption Efforts of the Mayor

(2) Presence of Business Associations

(3) Presence of a Public-Private Forum

Solo 72.6 35.3 35.3

Denpasar 66.0 28.0 10.0 Depok, Jakarta 26.0 20.0 24.0 Malang 37.3 21.6 5.9 Kupang 54.0 18.0 14.0 Makasar 62.0 20.0 36.0 Manado 37.3 11.8 29.4 Medan 30.0 10.0 16.0 Surabaya 22.2 31.5 16.7 Yogyakarta 64.0 38.0 40.0 Average 47.1 23.5 22.7

City (4) Processing Days for Trade Licenses

(5) Indication of Illegal Processing Fees

(6) Business-Friendliness of Government Policies

Solo 13 47.1 70.6

Denpasar 26 28.0 40.0 Depok, Jakarta 19 46.0 58.0 Malang 27 58.8 60.8 Kupang 14 44.0 70.0 Makasar 18 50.0 64.0 Manado 11 56.9 82.4 Medan 12 86.0 58.0 Surabaya 34 64.8 59.3 Yogyakarta 15 26.0 68.0 Average 18.9 50.8 63.1

Source: Authors’ estimates based on raw survey data from the Regional Autonomy Watch (KPPOD 2008). Note: Figures denote the share of 50 business respondents in each of the ten cities that (1) confirm the presence of strong anti-corruption efforts, (2) belong to a business association, (3) confirm the existence of an active public-private forum, (5) indicate illegal licensing fees, (6) and perceive current government policies to have positive business effects; column (4) denotes average waiting times to obtain standard trade licenses (SIUP). Table 8: Local Business Licenses and Private Investment

Trade Licenses Private Investment

Year Absolute (units)

Growth (percent)

Absolute (mill. Rps)

Growth (percent)

2003 719 187,546 2004 749 4.2 % 273,314 45.7 % 2005 1039 38.7 % 335,460 22.7 % 2006 1143 10.0 % 416,634 24.2 %

Average 17.6 % 303,238 30.5 % Source: Department of Industry of Trade, City of Solo, 2008.

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Table 9: Outstanding Investment Loans in Central Java and Solo by Firm Size

Outstanding Investment Loans (million Rps)

End 2006

Annual Average Growth (percent)

2003-2006

Central Java 5,883,869 7.7

MSME 2,791,908 18.1 Non-MSME 3,091,961 0.8

Solo 340,106 18.1

MSME 183,098 9.5 Non-MSME 157,008 32.8 Source: Bank Indonesia, 2008. Note: the term ‘MSME’ refers to micro/small/medium enterprises; whereas ‘Non-MSME’ refers to large firms. Table 10: GDP Growth in Solo and Central Java

Year GDP Solo

(mill. Rps)

Growth Solo

(percent)

Growth Central Java

(percent)

2004 3,669,373.45 5.80 5.13

2005 3,858,169.65 5.15 5.35

2006 4,067,529.94 5.43 5.33

2007 4,308,617.53 5.93 n/a Source: Central Bureau of Statistics (BPS) 2007. Note: figures are based on constant prices of the year 2000.

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Endnotes

1 See Worldbank (2004; 2005; 2006a; 2006b), UNCTAD (2007), and DFID (2008). 2 Since the mid 1990s more than 80 percent of all developing countries (with populations of more than five million) have decentralized administrative/political powers to local levels (Dillinger 1994:1). Moreover, between 1974 and 1997, the number of countries with democratically elected governments tripled from 39 to 117: a rise from 20 to 60 percent (Jaggers and Gurr 1995; World Bank 1997:111). 3 For recent political economy studies on decentralization see for instance Bardhan and Mookherjee (2005), Batterbury and Fernando (2006), Grindle (2007), Malesky (2008), Rodden (2004), Treisman (2007) and Treisman and Hongbin (2005). 4 For discussions of Indonesian subnational politics see Buehler and Tan (2007), Choi (2005) and Vel (2005). 5 Borrowing Schumpeter’s logic (1950), Roberts characterized public entrepreneurship as the ability of public leaders to find innovative solutions to a reform problem by strategically combining all resources at their command (1992:56). 6 Due to common attribution problems and policy time lags, this case study does not offer conclusive propositions, but rather presents tentative causal links, which need to be explored further in quantitative cross-district analyses. 7 In 2005, for example, secondary and tertiary sectors contributed 42 and 57 percent to Solo’s annual GDP, respectively. Further information is accessible at Central Java’s statistic bureau: see http://jateng.bps.go.id. 8 This is particularly true after the amendments of regional autonomy laws (UU 33) in 2004. While district and city councils (DPRD) were strong veto players between 2001 and 2003, their legislative powers were strongly reduced in the new legislation, due to repeated cases of political blackmailing and extortion. In their place, the central government introduced stronger electoral checks and gave citizens the right (since 2005) to directly elect local executives. The strong position of subnational leaders is readily observable in day-to-day policy making. Taking stock of the first five years of decentralization, a recent USAID assessment arrives at the conclusion that district regulations are mostly the brain-child of local executives; whereas local councilors, due to lacking expertise and experience, rarely make use of their ‘right of proposal’ (USAID 2006:117). 9 With the enactment of Kepres 18/2003 and 80/2003, KADINDA has lost its former key position: firms involved in public tender projects no longer require KADINDA membership or authorization. Today, a myriad of new construction associations have been set up. According to one government respondent, this has brought about an unhealthy competition of reducing implementation prices which, given the lack of monitoring and enforcement, results in fraudulent input management and unprecedented low project qualities. 10 Over the last decades, Solo frequently appeared in the news for its violent ethnic conflicts. According to our interviews, a series of clashes between indigenous (pribumi) and non-indigenous groups in 1965, 1980 and 1998, resulted in severe casualties and property losses in the Chinese Indonesian community. 11 After a brief assignment as forestry official in Sumatra, Jokowi established a furniture business with strong export links to Singapore and Eastern Europe. He was also the head of ASMINDO, the association for furniture producers in the Solo region. 12 According to the reports of the national election commission (KPU), Major Jokowi contributed Rps 600 million (roughly US$ 65,000) his electoral campaign in 2004. 13 It is a common phenomenon that government officials enjoy a high social status in Indonesia. Society at large still considers public-service positions as the most prestigious, secure employment. Arguably, ever since the Dutch established the first rural administrations by placing regional aristocrats in leading positions, holding a government rank has been widely recognized as a privilege; for a more detailed discussion on public sector prestige see von Luebke (2008:115). Considering that Jokowi grew up in a modest setting near Solo, as the son of a local security guard, his decision to run for mayor is likely to be influenced by prestige considerations. 14 For a detailed account on misspecified electoral rules see Sherlock (2004). Pursuant to election laws (UU 31/2002 and 23/2003) lower listed candidates can only take office if their votes exceed the threshold level for a direct seat; if they remain below this threshold (if only by one vote) their votes are transferred to the top of the party list. As critical media observers summarize it, the ‘current [election laws] authorizes political parties to determine the sequence on a list of running candidates … Under this scheme, potential candidates tighten their relationships with party leaders, while they ignore [the] voice of [local people]’ (Jakarta Post, February 11 2007). As Indonesia’s Constitutional Court has abolished the dysfunctional DPRD list system in December 2008, there is hope that future council members will become more accountable to local constituencies (Evans 2008). 15 For a detailed discussion of the Arisan phenomena in rural Indonesia see Geertz (1962). 16 Solo’s informal sector program has been widely covered by the national press (Kompas 2006; Sinombor 2008). Due to his tireless efforts to relocate Solo’s informal businesses by persuasion rather than force, Mayor Jokowi was selected as one of the top-ten subnational leaders in 2008 (Tempo 2008). 17 The national newspaper Kompas (Sinombor 2008) reports that the PKL formalization has raised the official income from traditional markets from 5 to 12 billion Rupiah (700,000 to 1,200,000 US).

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18 The first property is the ‘Solo Paragon’ developed by the Gapura Prima Group and Sunindo Prima; the second is the ‘Solo Center Point’ constructed by PT Duta Mitra Propertindo; and the third is the ‘Kusuma Tower’ built by PT Kusuma Mulia. 19 KPPOD’s regulatory scores are based on empirical assessments of legal, substance and principle problems. For a detailed description of the methodology and calculation see KPPOD (2008:85). 20 The Indonesian media has widely reported on public recruitment irregularities. Kompas, for instance, features a story of a civil servant candidate complaining to President Yudhoyono for being asked to pay Rps 40 million to enter the public service in the Javanese city Bekasi (Kompas, 29 October 2004, page 5). Other examples include: (1) ‘Penerimaan CPNS dinilai KKN’ (Corrupt Public Servant Recruitment), Waspada, 24 March 2006, page 12; (2) ‘Perlu Pelicin Rp. 40-75 Juta Untuk Jadi PNS Di Sum-Ut’ (In North Sumatra, You Need 40-75 Million to Become a PNS), Republika, 3 December 2001, page 11; (3) ‘Penerimaan PNS - Joko Terindikasi Langgar Disiplin Pegawai’ (PNS Recruitment – Joko under Disciplinary Procedure), Kompas 4 August 2006, page 24. A more detailed discussion on recruitment and promotion corruption is found in von Luebke (2008) 21 See for example Barro and Sala-i-Martin (1994), Barro (1997), Acemoglu et al. (2004), and MacIntyre (2003). 22 An interesting avenue for future research is therefore the construction of an in -country dataset (of Indonesian municipalities and districts) that helps to explore the effects of policy reforms on investment and growth in greater quantitative detail. 23 According to our interviews and observations, local government departments due not display a high rigor in the way they collect and verify investment data. Moreover, as several critical observers pointed out, much of Solo’s current investment is not reported in government statistics.