Economic Freedom: Indonesia Underperforms

This article appeared in the October 2007 issue of Globe Asia.

Poverty is a scourge which leaves those in itsgrip to lead lives that are brutish, dangerous, andshort. Economic growth is a poverty elixir. From theworks of the earliest economists — Richard Cantillon(1680–1734), Adam Smith (1723–1790) and JacquesTurgot (1727–1791) — we have learned that economic liberty is acrucial precondition for sustained economic growth.

Metrics which serve asproxies for economic freedomhave been developed and arewidely used. For example, TheHeritage Foundation and TheWall Street Journal jointly publishan annual volume, The Index ofEconomic Freedom, which nowincorporates 157 countries. TheEconomic Freedom of the World,which includes 130 countries,is published by Canada's FraserInstitute. And the World Bankissues an annual, Doing Business,which reports on the ease of doingbusiness in 175 countries. Datafrom these annuals on economicfreedom show that there is astrong positive linkage betweenmeasures of economic freedomand economic growth.

To improve a country's economic freedom score, and inconsequence ratchet up its economic growth rate, governmentsmust make credible commitments to implement liberal economicreform programs. A commitment is made more credible themore one binds oneself to the achievement of an objective. At theextreme, on a battlefield when a commander orders his troops toburn all bridges behind them to cut off avenues for their retreat,his enemies will be confident that his intentions are to fight to thelast man.

A credible commitment is something that many politiciansare reluctant to entertain. That said, there have been numerouscases in which politicians have made credible commitments toadopt liberal economic policies. These have resulted in dramaticincreases in economic freedom and prosperity regardless ofthe type of political regime or stripe of the political party thatembraced reforms.

Several examples support this conclusion. In 1965, Singaporegained its independence when it was expelled from a two-yearfederation with Malaysia.At that time, Singapore wasbackward and poor — a barrenspeck on the map in a dangerouspart of the world. Its populationwas made up of a diverse groupof immigrants with a history ofcommunal tensions. However,Singapore had a leader withclear ideas on how to modernizethe country.

Lee Kuan Yew ruled outpassing the begging bowl andaccepting foreign assistance ofany kind. Instead, he embracedstable money and first-worldcompetition. Stable moneywas initially achieved with acurrency board. Competitionwas attained by light taxation,minimal regulation of businessand free trade. In addition, Lee Kuan Yew insisted on personalsecurity, public order and the protection of private property. Toaccomplish his objectives, his central principle for organizinga "small" government was to run a tight ship with no waste orcorruption. To implement that principle, Lee Kuan Yew appointedonly first-class civil servants and paid them first-class wages.

Today, Singapore is one of the freest, most flexible andprosperous economies in the world. Indeed, both the Index ofEconomic Freedom and the Economic Freedom of the Worldrank Singapore as the second freest economy, and in terms of theease of doing business, Singapore is ranked first.

Hong Kong, along with Singapore, ranks as one of the world'sfreest economies. Indeed, it ranks first on the two most widelyused economic freedom metrics and fifth in terms of the ease ofdoing business. Established as an entrepôt free port, Hong Konghas achieved its status as one of the freest economies in the worldby making a credible commitment to stable money (via a currencyboard), free trade, free markets, low taxes, non-intervention andpersonal liberty (via the application of the rule of law).

What makes Hong Kong so interesting is that it attained itseconomic freedom and prosperity in an absence of democracy.Ceded by China to the British Crown in 1841, Hong Kong becamea British Crown Colony — not a representative democracy. Itremained a colony until July 1, 1997, when it became a SpecialAdministrative Region of the People's Republic of China. HongKong illustrates that a representative democracy — while perhapsdesirable — is not a precondition for the application of the ruleof law and attainment of freedom in the economic sphere. Onthis important point, I agree with Nobel laureate Friedrich vonHayek who wrote: "Although there is good reason for preferringlimited democratic government to a non-democratic one, I mustconfess to preferring non-democratic government under thelaw to unlimited (and therefore essentially lawless) democraticgovernment."

Estonia is another country that has made a crediblecommitment to liberal economic reforms. Estonia — where Iwitnessed the birth of such a preeminent commitment —meritsattention because it has the highest economic freedom ranking ofany former communist country. It ranks twelfth on both of thestandard measures for economic freedom.

The USSR State Council conceded Estonia's fully independentstatus on September 6, 1991. The economy was in shambles andthe Estonians were left to use the hyperinflating Russian ruble. Atthe invitation of the Estonian parliament, in a presentation on May5, 1992, I laid out a blueprint to replace the Russian ruble with afreely convertible Estonian kroon, linked to the German mark ata fixed rate and fully backed by mark (and gold) reserves. Theparliamentarians wasted little time in committing to the proposedcurrency board blueprint. On June 24, 1992, the ruble was outand a currency board-issued kroon was in. Building on this initialsuccess, Estonia has steadfastly continued to embrace a liberalreform agenda.

Economic Freedom Rankings

When we move down — way down — on the economicfreedom ranking lists, we find Indonesia. In The Index of EconomicFreedom, it ranks 110th out of 157 countries. Indonesia is tied for83rd (along with Albania, Sri Lanka, Turkey and Azerbaijan) outof the 130 countries in The Economic Freedom of the World. Andout of the 175 countries studied by the World Bank, Indonesiaranks a dismal 135th in terms of the ease of doing business.A review of Table 1 shows just how poorly Indonesia stacks upagainst three countries that have made credible commitments toliberal economic reforms. And Table 2 proves the old adage thatthe proof of the pudding is in the eating. Indonesia's poor scoreson economic freedom translate, as expected, into a relatively pooreconomic growth (and inflation) performance.

Comparative Growth Rates 1996-2006

In closing, it is worth stressing that there is often a wide gapbetween a government's rhetoric and the reality of its reforms.For example, many governments in the former Soviet Union,Eastern Europe, Latin America and elsewhere have come topower on liberal reform platforms, only to be swept aside in thenext election. Why? The common thread running through allthese cases is that reform reality has not matched reform rhetoric.Indeed, commitments to reform have not been credible, reformshave been narrow and superficial, economic freedom has not beensignificantly enhanced, state-imposed burdens on doing businesshave remained onerous, and most importantly, the scope andscale of government activity has not been dramatically reduced.In consequence, corruption has gone unchecked and remains asystemic problem. All this amounts to a recipe for superficialreformers to discredit themselves, their political parties and theideas they have masqueraded behind.

(For a full treatment of this topic, see: S. H. Hanke and S. J. K. Walters,"Economic Freedom, Prosperity, and Equality: A Survey", The CatoJournal, Vol. 17, No. 2, Fall 1997.)

Steve H. Hanke

Steve H. Hanke is a Professor of Applied Economics at The Johns Hopkins University in Baltimore and a Senior Fellow at the Cato Institute in Washington, D.C.