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2006-07-23,12:41 PM

Why regional governments are unfriendly to business

Owen Podger, Surabaya

The regional autonomy watchdog KPPOD has come out with its valuable annual assessment of the investment climate in regions, praising some reform, but decrying obstacles to investment everywhere. Why are there so many obstacles? Are the regional governments solely to blame?

Why do regional governments want to raise local taxes and charges (known as PAD)? On average PAD is only about 10 percent of total revenue, and a typical local government has to double its revenues just to add 10 percent to its budget. Wouldn't it be easier to cut costs? No, because there is almost no incentive!

Most of the budget is spent on salaries, so why not just sack the 10 percent of public servants who do least work? Alas, salaries come with the general allocation grant (DAU). Reduce the staff and you lose money next year! Increase staff, such as teachers, and you may get special additional funds from the central ministry that do not show up in your accounts.

Two government regulations affecting PAD have been voided by the constitutional court, but their legacy remains. These fixed the budget for operational expenses of the Bupatis, Mayors and local councils. Operational budgets in one third of regions were required to be exactly Rp 150 million (US$15,950), regardless of population size or geography. Thus the mayor of Sabang in 2003 was supposed to have a budget of Rp 53,000 per capita, and the mayor of Bandar Lampung a mere Rp 110. What determined this amount? The size of PAD. In order to raise their operational expenses-read flashy lifestyle-politicians had to raise PAD to the next level.

When the regional government laws required "performance budgets", why would the operational budgets of the leaders not be based on some standard of performance? Clearly because the central government did not believe they could be trusted. So they devised a system whereby they could not be trusted. The constitutional court threw out the regulations, but it did nothing to build trustworthiness.

Regional autonomy continues to be defined as local taxing and charging. A recent study in Aceh defined two indicators of fiscal capacity of regional governments, the ratio of PAD to gross regional product, and the ratio to total government revenues. Thus the higher the PAD the better the government. It concluded that Sabang had the worst fiscal capacity in Aceh, although it records the highest PAD per capita in the whole country! Its PAD is relatively low because it is the richest region with the highest budget per capita. It has a highly subsidized port and tourism.

The fixed component in DAU gives Sabang eight and a half times the average per capita. Its extra boost from revenue sharing of oil through Aceh's special autonomy is more per capita than Nias's whole budget. Why would it bother with any local taxes and charges when it has more that it can spend?

Many regions have found far more profitable way of raising their revenues than increasing PAD. The incentive of the large fixed component in the DAU formula is to divide. Since Nias was divided into two districts, its DAU has risen by almost 50 percent relative to others. To get the same increase it would have to raise its PAD five-fold.

Is local government culture so foreign to business culture? Let us look at local economies, and the role of government in them. There is only a handful of regions with a substantial economic base, where the local budget is a small proportion of it.

Surabaya is the most extreme case, where the local budget is around 2 percent of the Gross Regional Product (GRP). Not surprisingly, most business gets on with the job of serving markets. Only a small part of the business community attaches itself like a fungus to the government, such as the outdoor advertising industry. Most of the large-population rural regions of Java, the typical local government budget may be about 20 percent or more of the total economy. Traditional and new businesses still manage to survive, and even grow when they can tap into export markets.

But the "fungal economy" is more substantial. More businesses prefer government contracts to production. And the economic multiplier of that 20 percent of the economy is substantially bigger and more accessible than export markets. Service providers find their customers are nearly all public servants, well paid by comparison with most of the population on the edge of the monetary economy.

As the ratio of budget to economy goes up, the more business orients itself to the budget. And the more the young people aspire to be civil servants. The whole economy becomes fungal. There are regions where most of the PAD comes from the bus-fares of public servants going to work, from taxing restaurants where public servants having lunch, and from mining tax on the sand used to build their nice new homes. High PAD as a proportion of the total economy becomes an indication of the lack of a real economic base, not fiscal capacity at all. How could the economy of such regions be developed?

A better educated community should be better prepared for work. Most poor regions inherited few technical high schools with decentralization of education in 2001. They have general high schools designed to produce office workers and tertiary student. They have few offices or universities, so they are trained to become civil servants. Regions with a high ratio of technical high schools are generally those already well developed, with highest rates of university education.

The constitution requires each local government to allocate at least 20 percent of its budget to education. The law in Aceh calls for 30 percent. Sabang is required by law to allocate at least 50 percent more than South Nias. But South Nias has ten times more pupils. How is it to get ahead? They seek support from the national government, of course. They have just employed several hundred new teachers in a nationally-sponsored program-and nearly all have no qualification in teaching. Why? Because that is how the system works. Does Sabang also seek national support? Of course. Fairness in the system gives to rich and poor alike.

We could also comment on span of control in local government, which is so broad that local governments cannot be managed effectively. Or we could comment on the personnel management system and personal reward system which works against professional development. What is clear is that local governments and local civil servants, just like the business community, are working according to the incentives built into the system. The system is so distorted that few local governments or local businesses have any clue as to how build new incentives for the growth of a healthy economy.

The writer is a free-lance consultant on governance reform, and co-author of ADB's Country Governance Assessment Report of the Republic of Indonesia. He can be contacted at micah68@centrin.net.id

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