In 1825 a Javanese prince named Diponegoro touched off a five-year, ultimately unsuccessful, war of resistance against the Dutch colonial government. As detailed by Peter Carey in , one of the causes was a land-rent system imposed by the Dutch on the Javanese sultanate of Yogyakarta. Under this system, landowners were encouraged to rent their estates directly to European plantation owners for the production of cash crops. This had a disruptive effect on the local economy and the Governor-General ordered it halted. But there was a catch. As the land-rent system was unwound, the Javanese landowners were forced to buy out the plantation owners in order to get control of their land back.

Many had already used the rents to buy imported luxury goods, and they fell into debt paying out large and often inflated sums to the plantation owners. The sultan was expected to back-stop these debts using payments he received from the Dutch for granting them the right to collect revenue on the kingdom鈥檚 toll roads. This created a situation where a Javanese merchant travelling from Yogyakarta to Semarang had to pay fees to the Dutch toll road agents. A portion of those fees then went to the sultan, who used them to back-stop debts being incurred by Javanese landowners as they bought back their own land back from European plantation owners.

This circular system of financial exploitation in which nearly all the revenue somehow flowed to outsiders was imposed upon the sultanate and its princes nearly 200 years ago. Yet in some ways it still exists, only now in the more subtle form of international capital flows that often disadvantage emerging economies for the benefit of global creditors.

In the beginning of the Covid-19 pandemic there was widespread agreement that governments needed to get cash out the door and into the hands of businesses, healthcare systems and consumers as fast as possible. But this quickly revealed a structural inequality in the global financial system. Governments in the US, Europe and UK can tap their central banks to underwrite bottomless fiscal bazookas , where the central bank buys government bonds directly. This allows them to, among other things, borrow at extremely low rates of interest even as they run big deficits. Emerging markets, on the other hand, are still expected to observe rules 鈥� maintain balanced budgets, low debt to GDP ratios, modest current account deficits and healthy foreign exchange reserves.

There is a clear policy paradox here 鈥� emerging markets are being called on to pump cash into their economies to forestall catastrophe. But the reduction in economic activity means a big loss in revenue, leaving borrowing as the most immediate option to plug fiscal gaps. Capital markets typically punish emerging economies that borrow too much, forcing up the cost of borrowing or downgrading their credit rating based on the presumption that the investment is now riskier. The end result is that creditors receive a higher yield, while the borrower has to make critical decisions based on what the market will support rather than what is actually needed to prevent an economic or health catastrophe.

India is a case in point, announcing in May that it would at $60 billion to avoid a ratings downgrade. A month later, Moody鈥檚 . The logic of downgrading a country鈥檚 sovereign credit rating during a once-in-a-generation global pandemic requiring large outlays of short-term spending is questionable. But that is nevertheless the way the bond market is structured 鈥� for emerging markets the more you need, the more it costs. And as in 19^th century Java, there鈥檚 a structural inequality baked into the whole thing that keeps emerging market borrowers on the back foot.

Even the IMF appears to have accepted that emerging markets will be forced to finance their fights against COVID-19 by running deficits for the short-term. But this is still contingent on the willingness of creditors to absorb the debt. So far in Southeast Asia they appear willing to do so, with capital flows remaining relatively healthy. It would appear that for the moment investors concur with of the Council on Foreign Relations that increases in debt due to COVID-19 policies 鈥渄o not pose substantial risks to most of Asia鈥檚 key economies; only Indonesia may need support and the scale would be manageable.鈥�

Let鈥檚 take a closer look at Indonesia. The country is expecting to run a deficit of 6.34% of GDP this year (although that target keeps moving) and the puzzle for monetary authorities is how to pay for it. Conventional wisdom would be that if the government issues too much debt, investors will demand higher yields and at a certain point the ability to raise capital will reach a natural limit determined by market forces.

Indonesian policymakers looked at that state of affairs and apparently found it wanting. The government is now charting a more innovative course in dealing with this crisis, one that places it less at the mercy of investors. In April, Bank Indonesia began buying government bonds in direct auctions rather than on the secondary market, essentially embracing the same kind of monetization as central banks in more mature economies.

This did not sit well in some quarters, a even calling it 鈥渢errifying.鈥� If that was terrifying, than what they are currently doing must really be something. Those initial efforts were relatively small, likely as a way of testing the waters. Now Bank Indonesia and the Ministry of Finance have the program, reaching agreement on a 鈥渂urden sharing鈥� scheme in which the central bank will directly purchase up to $40 billion in government bonds in the second half of 2020, if the market cannot absorb them.

This makes clear that the technocrats at Bank Indonesia and the Ministry of Finance are serious about taking unconventional steps to plug the fiscal hole and equip the government with financial resources to combat COVID-19. And in some ways it is also a repudiation of the global financial system, in which central banks in mature economies can monetize their public debt in times of crisis, while emerging markets are expected to fight the same battle on a budget, and at the mercy of what capital markets will support. If the market demand isn鈥檛 there for these bonds, at the rates the government is willing to pay, then the Indonesian monetary authorities decided to simply do an end-around.

The fear is that by monetizing its public debt, Indonesia will unleash inflationary pressure and debase its currency, making existing dollar-denominated debt unsustainable, burning through forex reserves and creating economic mayhem. But there actually is a logic to all of this. Denominating these bonds in domestic currency ensures that Indonesia will not default 鈥� when a country borrows in its own currency it can always make the payments. And when millions are being devastated by business closures and job losses due to a pandemic, inflation should be way down on the list of concerns. That mainly leaves the risk of capital flight 鈥� that investors will be spooked by Bank Indonesia鈥檚 monetary experiment or unhappy with yields and dump assets, driving down the value of the rupiah.

Finance Minister Sri Mulyani and Bank Indonesia director Perry Warjiyo are taking a calculated risk here. They have likely concluded that given the low-yield environment in Europe and the US, there will be an appetite for Indonesian government debt where the is 4%, and that yields will remain low in traditionally 鈥渟afe鈥� markets for some time, reducing the risk of capital flight while Indonesia carries out this monetary experiment to underwrite its rescue efforts. If the rupiah does come under pressure Bank Indonesia鈥檚 reserves are , which will allow them to intervene to defend the currency in the event of a sell-off. In fact, some policy-makers likely consider a as they are looking to juice exports as part of the recovery.

Nevertheless, this is a gamble. If the rupiah does slide too far too fast as a result of the government monetizing its debt in this way, it would be disastrous for cash-strapped companies that owe a lot of money in dollars (such as, for instance, the ). But the truth is emerging market currencies are nearly always at risk of capital flight, often from events that are completely outside of their control. Interest rate movements by the US Federal Reserve or a global rush to buy dollars have touched off capital flight in Indonesia before. At least in this scenario, Bank Indonesia will be the architect of its own fate.

And that autonomy is likely an important element of this policy choice. The Indonesian government needs to get cash out to keep companies from going bankrupt and people from going hungry. They want to do so without placing themselves entirely at the mercy of market forces and foreign creditor sentiment. Under such conditions, it becomes almost a moral choice for the government to take matters into its own hands and push back against a system of global capital that, in some ways, hasn鈥檛 moved the needle all that much over the last two centuries.

James Guild聽is an Adjunct Fellow at the S. Rajaratnam School of International Studies in Singapore.

Nobel Laureate

A critique of this approach was compiled by Ingrid Harvold Kvangraven . The primary criticism is that the basic premise is flawed 鈥� we do not, in fact, have a very complete understanding of how the pipes come together. Often, we don鈥檛 even know where they are. The institutional architecture that determines economic outcomes can vary widely from one country to the next. With so much variation at the systemic-level the utility of 鈥渢inkering鈥� at the margins is questionable.

This blog series will interrogate some of the prevailing assumptions about the relationship between state and capital and look at why and in what ways some economies are deeply intertwined with the state. The structural conditions that actually exist in developing economies are often ignored in mainstream economic analyses 鈥� the prescription for countries with large state-owned sectors is usually some combination of more market liberalization, less protectionism, better enforcement of property rights. This ignores why the economy is structured that way in the first place, and therefore such prescriptions risk being disconnected from the reality on the ground, and thus ineffective.

Indonesia鈥檚 economic trajectory helps to illustrate this point. Despite a long history of sometimes violent anti-communist sentiment, massive portions of the economy are either partially or directly controlled by state-owned enterprises. According to Kyunghoon Kim 鈥�148 SOEs in Indonesia, and their total assets were equivalent to 56.9% of the country’s GDP.鈥� This includes the state-owned oil and gas company Pertamina, three of the four largest banks, the state-owned electric utility PLN which owns the entire national grid, airport operators Angkasa Pura I and II which operate every major commercial airport, the telecom giant PT Telekomunikasi Indonesia and the largest toll road operator Jasa Marga, to name just a few.

To understand why the state plays such an outsized role in the economy we first need to look at Indonesia鈥檚 history. In the 1950s as Indonesia was establishing itself as an independent nation-state, the government nationalized all foreign assets, such as the major shipping and railway companies, both as a knee-jerk reaction to colonialism and a way of establishing agency as a sovereign nation. There was thus no period of experimentation with the development of competitive private enterprise, as the country jumped straight from colonialism to mass nationalization.

When Suharto鈥檚 New Order came to power in the mid-1960s, the state became even more entrenched as the custodian of economic development. In the early years, Suharto鈥檚 signature economic policy was to make Indonesia self-sufficient in rice production, a goal which was achieved within a decade or so. This was during the 1960s and 70s, when the concept of the developmental state and import-substitution policies were very much in vogue. Economic policy in Indonesia was guided by a belief that it was the state鈥檚 duty to shepherd economic growth, intervening in markets as necessary to correct price imbalances and ensure that the citizenry had access to affordable staple goods like electricity, rice and fuel.

This state-led development became one of the defining features of the New Order regime 鈥� the state invested heavily in infrastructure and social services and generally protected domestic markets from foreign competition. The price of this state-led development was repression of dissent, muzzling of the media, and a rubber-stamp democracy that saw Suharto re-elected every five years like clockwork. Eventually, the cronyism and corruption embedded in this system were laid bare during the Asian Financial Crisis and Indonesia moved to a more decentralized governing structure, one that featured open and free elections for local and national legislative and executive positions.

From 2004 to 2014, economic growth continued at a steady pace, generally between 5-7%. This was mainly due to high global commodity prices, however, and deeper structural issues in the economy were papered over or ignored. When Jokowi became president in 2014 he inherited an impossibly cumbersome bureaucracy with redundant and often incomprehensible regulatory architecture. It could take years to get the proper permits and licenses to a start a business, and in the absence of an eminent domain law land acquisition could drag on indefinitely. Moreover, in the new decentralized governing structure, it was unclear who had the authority to break through these bottlenecks.

Jokowi鈥檚 solution was to re-concentrate administrative and legal authority with the central state government in Jakarta. Through a series of Ministerial and Presidential Decrees he equipped the central state with broad powers to issue financial guarantee for high-priority projects, circumvent regulatory requirements and acquire land in the public interest. He also found himself in an economic environment that was not very conducive to private investment, so he leaned hard into SOEs to do the heavy lifting of building roads, bridges, power plants, hospitals and airports.

The size of the state-owned sector, which was already large, has throughout Jokowi鈥檚 first term. The total assets of nine major infrastructure-oriented SOEs 鈥� airport operators Angkasa Pura I & II, the five largest state-owned construction companies, toll road operator Jasa Marga and state-owned railway company Kereta Api Indonesia 鈥� totalled Rp 119 trillion (US$8.5 billion) in 2013. By 2017, their combined assets had increased to Rp 432.5 trillion (US$30.8 billion), and that figure is still rising.

This metastasizing of the state-owned sector has produced concrete results. As exports have fallen as a share of GDP, fixed capital formation (including investment in major infrastructure projects) has increased to pick up the slack. To take just one example, from 2004 to 2014 around 250 km of new toll roads were built. From 2015 to 2018, that figure nearly tripled to over 700 km of new toll roads, virtually of which were built and are operated by state-owned companies. Given the narrow policy goal of building infrastructure quickly and given unreliable regulatory architecture and weak rule of law, the strategy of tapping SOEs to carry out major project development has .

The flip-side of this argument is that perhaps private companies would have fared better, and the dominance of SOEs is crowding out more competitive and sustainable private investment. Unfortunately, we cannot test this empirically as time moves in only one direction. But we can look at some sectors that were opened exclusively to private developers, such as renewable energy. Since 2013, Indonesia has been experimenting with various incentives to induce private investment in the renewable energy sector 鈥� yet, as I have written and , growth has been anaemic. Even with lucrative rates of returns, private developers just weren鈥檛 interested.

This is a complicated issue with many potential explanations, but the bottom line is that when private capital is left to fend for itself given the way Indonesia鈥檚 economy is currently structured, it often flounders. By contrast the state is uniquely positioned, for reasons of history as well as institutional design, to cut through the bottlenecks that can side-line private investment.

In his second term, Jokowi is focused on weaning the economy off state-led development and inducing greater private investment. Whether this will work or not is one of the in Southeast Asia over the coming years. There is also, of course, the question of whether state-led development is not simply a boondoggle for wealthy elites disguised as development. The CEO of state-owned airline Garuda was recently caught Harley Davidsons into Indonesia without paying the duty, and corruption scandals at SOEs are common.

But the purpose of this post is not really to weigh in on that question. It is to describe the political economy of a large and important developing country the way that it actually is. The state plays an outsized role in Indonesia鈥檚 economy because historically that has always been the case, but also because without invoking the power of the state it can be difficult to get big projects done.

This is ultimately why I find the idea of 鈥渢inkering鈥� at the margins to be somewhat limited. The political economy of Indonesia is structured so differently from what you might find in the United States or Europe, that any analysis of economic outcomes that doesn鈥檛 factor in these systemic considerations will be of little value. It is becoming increasingly apparent, at least in my view, that to move forward on big questions of economics and policy it is incumbent not to ignore such structural factors simply for the sake of a parsimonious model. Reaching a more subtle, nuanced understanding of how capital is intertwined with the state in different contexts seems to me to be a good starting point.