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First Things First: Budget Reform!

By webadmin on 11:23 pm July 3, 2011.
Category Archive

Wijayanto

The theme of economic news in various national media recently is the need for better infrastructure if Indonesia is to be competitive in the global economy. The lack of reliable infrastructure has dampened Indonesia’s ability to realize its full economic potential. It is heartbreaking to know that we are behind most of the neighboring countries in infrastructure quality and logistic efficiency.

If we expand our radar beyond economic news, we will find various important and urgent issues. Access to quality education and health services is still a luxury for most Indonesians. The majority of Indonesians, even those who live in big cities, have no access to clean water. Other basic facilities and services are not available or are available only at a very low standard.
 
This situation is contradictive given the fact that the government budget (APBN) is expanding. The APBN has grown from Rp36 trillion in 1990 to Rp224 trillion in 2000 and reached Rp1.3 trillion in 2011. Over the past two decades, the APBN increased almost 40-fold. Even after taking into account inflation of 6% to 8%, this is a staggering increase.

Priority, not size
Over the past decade the central government has gradually increased its transfers to local government. These transfers increased from Rp129 trillion in 2004 to Rp393 trillion in 2011. Despite the increase, several provinces and a handful of districts have experienced budget deficits. Weak public administration remains a problem.

How local governments spend their budgets is another interesting phenomenon, since budget allocation indicates government priorities. Recently, Coordinating Economics Minister Hatta Rajasa stated that around 95% of local government budgets go to personnel expenditure, when the level was around 65% in the past. It seems that local governments put the interest of those in power before the interest of taxpayers; a classic example of agency problem.

At the national level, the government budget also shows interesting changes. In 2011 development expenditure only represented 10% of the APBN, much lower than the 35% during the Suharto era and 20% in the early 2000s. At the same time, the allocation for subsidies and transfers to local government has increased gradually to reach 66% of the 2011 APBN. This is significantly higher than the figures in APBN 1990 and in APBN 2000 of 51% and 56% respectively.

In short, the APBN is moving toward a stronger consumption focus rather than an investment focus. Expenditure for short-term interest increases at the expense of the decrease in expenditure for long-term interest.

Minimizing agency problem
In the spirit of regional decentralization, local governments have the flexibility of designing their budgets. The central government has no influence, despite the fact that it supplies 80% of the funds. One of the outcomes is a budget that is heavily concentrated on personnel expenditure.

In the same spirit, it is possible for local governments to run budget deficits, with the permission of the central government authority. Problems then arise. Most deficits happen not at the design stage but at the implementation stage, due to cost over-runs and the like. Often the central government has no option other than to approve it. In reality, the central government provides loan to the local governments.

In reality, even though local government has the responsibility to repay the loan, the limited capability to raise revenue combined with the tendency to shift the burden to the next generations has made debt repayment very unlikely. Consequently, as a last resource, the central government should take care of this debt and incorporate it into the APBN.

The central government provides too much flexibility with very limited control and without any mechanism for punishment. It is a “carrot without stick” policy, an incentive for the agency problem to flourish.

A more stringent budgeting guideline is needed. At least this would provide a ceiling for certain allocations, such as personnel expenses and the like. A rigorous monitoring mechanism is crucial, including punishment for those who manage the budget recklessly.

Ending subsidy addiction
From the size point of view the APBN has shown tremendous improvement. Reasonably, it should provide the government with the opportunity to provide better service to the public. Unfortunately, the composition of the APBN is far from ideal. There is an imbalance between expenditure for short-term and long-term. It is too short-term focused.

The long-term aspect of the APBN is represented by development expenditure, while the short-term aspect is represented by salaries, subsidies, debt servicing and transfers to local government. Reducing expenditure on salaries, on debt servicing and on transfers to local governments is impossible since these expenses are fixed. Shifting subsidy expenditure to development expenditure is the most viable way.

Fuel and electricity subsidies, by nature, are a temporary policy. They were implemented by the government in 1998, in response to the financial crises. Unfortunately, as time has gone by we have become addicted to them and can not live without them. Combined with the lack of political will to end this populist policy, the temporary policy has become permanent, creating inefficiency.

The purpose of fuel and electricity subsidies is for people to be able to travel and to enjoy affordable electricity. Subsidies will also reduce the cost of transportation and production, benefiting economic players from industrialists to farmers and fishermen.

However, what happens at the moment is contrary to the original purpose of the subsidies. Cheap fuel means nothing if there are no roads that we can drive on. If there are traffic jams everywhere, logistic costs increase. Similarly, affordable electricity is not helpful if there is no new power plant to ensure reliable supply of electricity. Reallocating subsidy expenditure to development expenditure is the road we need to take.

Wijayanto is a vice rector at Paramadina University. He is also the co-founder and managing director of Paramadina Public Policy Institute. He can be reached at wijayanto@paramadina.ac.id

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First Things First: Budget Reform!

By webadmin on 11:23 pm July 3, 2011.
Category Archive

Wijayanto

The theme of economic news in various national media recently is the need for better infrastructure if Indonesia is to be competitive in the global economy. The lack of reliable infrastructure has dampened Indonesia’s ability to realize its full economic potential. It is heartbreaking to know that we are behind most of the neighboring countries in infrastructure quality and logistic efficiency.

If we expand our radar beyond economic news, we will find various important and urgent issues. Access to quality education and health services is still a luxury for most Indonesians. The majority of Indonesians, even those who live in big cities, have no access to clean water. Other basic facilities and services are not available or are available only at a very low standard.
 
This situation is contradictive given the fact that the government budget (APBN) is expanding. The APBN has grown from Rp36 trillion in 1990 to Rp224 trillion in 2000 and reached Rp1.3 trillion in 2011. Over the past two decades, the APBN increased almost 40-fold. Even after taking into account inflation of 6% to 8%, this is a staggering increase.

Priority, not size
Over the past decade the central government has gradually increased its transfers to local government. These transfers increased from Rp129 trillion in 2004 to Rp393 trillion in 2011. Despite the increase, several provinces and a handful of districts have experienced budget deficits. Weak public administration remains a problem.

How local governments spend their budgets is another interesting phenomenon, since budget allocation indicates government priorities. Recently, Coordinating Economics Minister Hatta Rajasa stated that around 95% of local government budgets go to personnel expenditure, when the level was around 65% in the past. It seems that local governments put the interest of those in power before the interest of taxpayers; a classic example of agency problem.

At the national level, the government budget also shows interesting changes. In 2011 development expenditure only represented 10% of the APBN, much lower than the 35% during the Suharto era and 20% in the early 2000s. At the same time, the allocation for subsidies and transfers to local government has increased gradually to reach 66% of the 2011 APBN. This is significantly higher than the figures in APBN 1990 and in APBN 2000 of 51% and 56% respectively.

In short, the APBN is moving toward a stronger consumption focus rather than an investment focus. Expenditure for short-term interest increases at the expense of the decrease in expenditure for long-term interest.

Minimizing agency problem
In the spirit of regional decentralization, local governments have the flexibility of designing their budgets. The central government has no influence, despite the fact that it supplies 80% of the funds. One of the outcomes is a budget that is heavily concentrated on personnel expenditure.

In the same spirit, it is possible for local governments to run budget deficits, with the permission of the central government authority. Problems then arise. Most deficits happen not at the design stage but at the implementation stage, due to cost over-runs and the like. Often the central government has no option other than to approve it. In reality, the central government provides loan to the local governments.

In reality, even though local government has the responsibility to repay the loan, the limited capability to raise revenue combined with the tendency to shift the burden to the next generations has made debt repayment very unlikely. Consequently, as a last resource, the central government should take care of this debt and incorporate it into the APBN.

The central government provides too much flexibility with very limited control and without any mechanism for punishment. It is a “carrot without stick” policy, an incentive for the agency problem to flourish.

A more stringent budgeting guideline is needed. At least this would provide a ceiling for certain allocations, such as personnel expenses and the like. A rigorous monitoring mechanism is crucial, including punishment for those who manage the budget recklessly.

Ending subsidy addiction
From the size point of view the APBN has shown tremendous improvement. Reasonably, it should provide the government with the opportunity to provide better service to the public. Unfortunately, the composition of the APBN is far from ideal. There is an imbalance between expenditure for short-term and long-term. It is too short-term focused.

The long-term aspect of the APBN is represented by development expenditure, while the short-term aspect is represented by salaries, subsidies, debt servicing and transfers to local government. Reducing expenditure on salaries, on debt servicing and on transfers to local governments is impossible since these expenses are fixed. Shifting subsidy expenditure to development expenditure is the most viable way.

Fuel and electricity subsidies, by nature, are a temporary policy. They were implemented by the government in 1998, in response to the financial crises. Unfortunately, as time has gone by we have become addicted to them and can not live without them. Combined with the lack of political will to end this populist policy, the temporary policy has become permanent, creating inefficiency.

The purpose of fuel and electricity subsidies is for people to be able to travel and to enjoy affordable electricity. Subsidies will also reduce the cost of transportation and production, benefiting economic players from industrialists to farmers and fishermen.

However, what happens at the moment is contrary to the original purpose of the subsidies. Cheap fuel means nothing if there are no roads that we can drive on. If there are traffic jams everywhere, logistic costs increase. Similarly, affordable electricity is not helpful if there is no new power plant to ensure reliable supply of electricity. Reallocating subsidy expenditure to development expenditure is the road we need to take.

Wijayanto is a vice rector at Paramadina University. He is also the co-founder and managing director of Paramadina Public Policy Institute. He can be reached at wijayanto@paramadina.ac.id

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