Impacts of Corruption on Foreign Direct Investment in Indonesia

1.0.0 Introduction There is adequate empirical literature to prove that corruption has great impacts on foreign direct investment. A majority of the investigative studies conducted by scholars regarding the impacts of corruption on a nation’s business environment reveal that such impacts vary from one country to the next depending on the extent of the corruption and the manner in which relevant governments respond to it. The economic growth potential of Indonesia brought about by commercial enterprises is greatly hampered by corruption, political interference and investment regimes which discourage any efforts towards the dynamic growth of the nation’s financial systems. By the end of the first six months of the year 2012, the Indonesian government had reestablished huddles to trade and investment which restricted the ownership of export taxes, mines and banks. In addition to this, the business environment in Indonesia is characterized by insidious corruption; the situation is made worse by the weak nature of the country’s judicial systems. The first part of this paper will discuss in detail the impacts that corruption has on foreign direct investment on Indonesia. The second part will be a self reflection which will elucidate on the impacts of lack of infrastructure on foreign direct investment in Indonesia. After a thorough literature review, a summative conclusion of the paper will be drafted followed by an alphabetical list of the references cited in this paper. 2.0.0 Literature Review FDI in Indonesia The nation of Indonesia is the largest financial system in Southeast Asia. Bansal (2012) reveals that foreign direct investment has always been a very important aspect of Indonesia’s history. In the present day Indonesian industries such as transport and communications and mining continue to draw a great number of foreign investors in the country. Companies that invest in Indonesia are attracted by the nation’s large domestic market, vast natural resources and low costs of labor. Foreign direct investment in Indonesia makes up for an estimated 71% of all the investments in the nation. According to the Indonesian Central Statistics Agency foreign direct investment in the nation accounts for an estimated 39% of the Indonesian’s growth evidenced in its financial systems. In spite of the prevalence rates of corruption in Indonesia, Sentana (2013) claims that the foreign direct investment in Indonesia has been increasing in the last few years. In the third quarter of the year 2012 the FDR realization in Indonesia increased to a records $587. 41 million; this was a 22% increase from the realization in the year 2011. In the whole of the year 2012 the foreign direct investment in Indonesia increased by an estimated 26.7% to $22.8 billion. When the accumulative totals from both the foreign and domestic investments for Indonesia in the year 2012 were amalgamated they beat the Indonesian Investment Coordinating Board’s target of $29.2 billion and reached $32.4 billion. In the fourth quarter of the year 2013 the nation has been able to attract a host of foreign commercial organizations to invest in the nation. Sentana (2013) argues that the major factors that have increased the attractiveness of the Indonesian commercial markets to foreign direct investors is the high demand by the Indonesian consumers for goods and services offered by foreign direct investment enterprises as well as financial systems of Indonesia that have grown and increased in stability in the last half a decade. As the purchasing power of the consumers in Indonesia increases it is predicted that the nations of Indonesia presents very attractive prospects for investors in spite of the corruption that characterizes a majority of the nation’s political and financial systems. Corruption in Indonesia As indicated by Bansal (20120 the nation of Indonesia ranks 100th out of the 183 nations investigated by Transparency International in terms of corruption. According to Platzdash (2011, p. 1) the nation of Indonesia was under dictatorial rule until the year 1998 when the nation’s authoritarian leader General Suharto fell and democracy was introduced in Indonesia. Since the year 1998, the government in Indonesia has exerted great effort to do away with the political and financial limitations that were imposed on the nation’s systems by the previous regime. Nevertheless, political interference and corruption in the country continue to pose great problems for any business investors that want to engage in foreign direct investment in Indonesia. Rinaldi et al (2007) reveals that there are a number of factors that facilitate corruption in the Indonesian country. These factors include a vast amount of public resources that emanate from the nation’s natural resources, networks with political ties and regulatory qualities that are very low. In addition to this, the civil servants in Indonesia are very lowly paid and the judicial system in the nation is weak. These factors work together to exacerbate corruption in the nation (Martini, 2012, p. 2). King (2000, p. 603) reveals that a great majority of the successful commercial enterprises in the nation of Indonesia are those that attained their success through establishing associations with the former dictatorial president of Indonesia- President Suharto- or other powerful political leaders that were in office then. Impacts of Corruption on Indonesian FDI Kendall and Zhou (2008, p. 2) point out that an estimated 85% of all investigated multinational corporate are “always” or “mostly” confronted with the issue of corruption in their dealings with the public sectors of the nations in which they invest. According to Glass and Wu (2002) there are two main theoretical models that can be utilized in the description of the impacts that corruption may have in a country such as Indonesia. The first theoretical model is “Grabbing hand” corruption; this theoretical framework describes the kind of corruption, bribery and other corruption related activities that are costly for foreign direct investors. The second theoretical model describing the impacts of corruption on the foreign direct investment is the “Helping Hand” model of corruption. According to Kaufman et al (2005) this model perceives corruption as the “grease” or “oil” that lubricates the wheels of business and trade activities especially when the host government has failed in the fulfillment of its roles (Glass and Wu, 2002). The helping hand model of corruption describes the benefits of a commercial realm characterized by corruption such as that in Indonesia while the grabbing hand model describes the negative impacts that such corruption may have on foreign direct investment process. As indicated by Egger and Winner (2006, p. 932) there are a number of ways in which corruption may impact upon FDI in Indonesia. Many economists have investigated the manner in which corruption in any host nation may impact upon FDI. Firstly, in a nation as corrupt as Indonesia the state- through the public sector- undertakes a dominant role in the nation’s financial systems at the expense of the private sector. As is the case in Indonesia, the state is responsible for producing a great majority of the goods consumed by the general population; this implies that there is minimal competition from the private sector. Corruption also impacts FDI in Indonesia due to the fact that the state has formulated excessive policies with the intention of regulating the nation’s financial systems. Moreover, as indicated by Tanzi (1998), effective systems of ensuring accountability and transparency in the public sector are absent or ineffectual and public officials are allowed high levels of indiscretion in the execution of state regulations governing the economy. Egger and Winner (2006, p. 934) point out that the corruption in Indonesia is very damaging for the nation’s financial systems. This is more so due to the fact that such corrupt activities have a propensity to impose a great burden in carrying out commercial transactions as all business related dealings with public officials require the investors to pay huge sums of illegal payments (Robertson-Snape, 2000). Kendall and Zhou (2008, p. 2) point out that according to the “grabbing hand” theory on corruption, the corruption that characterizes the Indonesian commercial arena tends to increase the costs encountered by foreign direct investors in the country. This in turn serves to lessen the amount of profits derived from investment projects. Such a reduction of the projects profitability consequently discourages investors from establishing commercial enterprises in Indonesia. In addition to this, high level corruption such as that which typifies the nation of Indonesia acts as a barrier for prospective FDI investors as well as newly established commercial enterprises that have little or no political ties with the public officials in the host nation. On the other hand, rather than decrease the FDI inflow into Indonesia, corruption has served to increase it. There are scholars that have conducted investigative studies and gathered enough evidence that corruption in host countries such as Indonesia serves to increase the rate of FDI. Another feasible example that is commonly cited is China. Regardless of the Republic of China being amongst the most corrupt nation in the world, the China-Britain Business Council (2005) reveals that since the last decade of the 20th century China has indicated a drastic increase in FDI inflows and is quickly rising to become one of the most desired regions for FDI in the world. Saha (2001) claims that this counter intuitive phenomenon is as a consequence of corruption being very effective in eroding the rigid financial regulations and red tape imposed on foreign investors by the Indonesian government. Through offering bribes to the host government a majority of the multinational commercial organizations are able to circumnavigate such regulations and red tape and obtain hefty profits, rewarding contracts and increased access to markets usually inaccessible through exporting (Kendall and Zhou, 2008, p. 3). 3.0.0 Impacts of Lack of Infrastructure on FDI in Indonesia In comparison to top competitors in Asia, for instance Malaysia and Thailand, the nation of Indonesia is way behind in terms of its fundamental physical and logistics infrastructure. Bansal (2012) points out that in order for the nation of Indonesia to sustain and increase foreign direct investment inflow, it is important that the Indonesian government engage in efforts aimed at further developing the nation’s infrastructure capacity. This is because the poor infrastructure capacity in the country increases the costs encountered by investors and thus serves to discourage some foreign direct investors from investing in Indonesia. The Indonesian government is already responding to the infrastructure issue. The current leader of Indonesia, President Susilo Bambang Yudhoyono has already formulated plans aimed at increasing the budgets allocated to roads, airports and seaports from the current $75 billion to $150 billion before the end of the year 2014. In addition to this, Bansal (2012) claims that the prime Minister of the republic of China- Wen Jiabao- has already committed to offering the Indonesian government $ 19 billion of investment credit and $9 billion of business and soft loans aimed at enhancing the infrastructure capacity of Indonesia (Bansal, 2012). In addition to this, the Indonesian government needs to put in place frameworks that will ensure that the regulatory models utilized in the country are more supportive of foreign direct investment (Bardhan, 1997). The reconstruction of the regulatory framework should be designed to lessen the amount of time and monetary resources required to establish business enterprises in Indonesia and respond to issues such as acquisition of construction permits by investors as well as the obtainment and registration of property in the country. This is more so after the “Do Business” survey by the World Bank indicated that the nation of Indonesia had declined from position 126 to rank 129th in the year 2012 (Bansal, 2012). Indonesia also stands to benefit from its foreign direct investment inflow particularly if it diversifies its investment industries from the palm oil and mining industries to others with the potential of attracting foreign investors. 4.0.0 Conclusion This paper has elucidated upon the impacts of corruption and the influences that lack of effective infrastructure has on FDI activities in Indonesia. As is already indicated in this paper the Indonesian nation has for a very long time been confronted with the menace of corruption in many of its systems. The roots of this corruption run back to the years even before the nation attained independence and the dictatorial regimes that reigned in the nation until the year 1998. This paper has discussed the impacts that corruption has on FDI in Indonesia by elaborating upon the models of “helping hand” and “grabbing hand” models of corruption in commercial realms. The impacts that infrastructure has on FDI in Indonesia have also been deliberated upon in detail. Currently there are a number of strategies that have been put in place by the Indonesian government so as to reduce corruption and enhance competitiveness in the Indonesian business environment. These include higher salaries for public officials, anti corruption legal decrees and the establishment of “watch dog” groups and associations. Since the Indonesian government is doing a lot to enhance its image to potential foreign direct investors, the future in FDI for Indonesia looks bright and promising. 5.0.0 References Bansal, A., (2012), “Indonesia Must Do More to Attract Much Needed Foreign Direct Investment”, Jakarta Globe Bardhan, P., (1997), “Corruption and Development: A Review of Issues”, Journal of Economic Literature, Vol. 35, pp. 1320-1346 China-Britain Business Council, (2005), “CBBC: Helping you do Business in China”, China Britain Council, 1M Warwick Row, London Egger, P. and Winner, H., (2006), “How Corruption Influences Foreign Direct Investment”, European Journal of Political Economy, Vol. 21, pp. 932-952 Glass, A. J. and Wu, X., (2002), “Does Corruption Discourage Foreign Direct Investment and Innovation?”, Unpublished Manuscript, Texas A&M University Kaufman, D., Kraay, A. and Mastruzzi, M., (2005), “Measuring Governance using cross-Country Perceptions Data”, World Bank Working Paper, Washington, DC: World Bank Kendall, T. and Zhou, Y., (2008), “The Impact of Corruption on FDI”, Department of Economics, University of Birmingham King, D. Y., (2000), “Corruption in Indonesia: A Curable Cancer?”, Journal of International Affairs, Vol. 52, No. 2, pp. 603-616 Martini, M., (2012), “Causes of Corruption in Indonesia”, Transparency International, No. 338, pp. 2-11 Platzdash, B., (2011), “Indonesia in 2010: Moving on from the Democratic Honeymoon”, Southeast Asian Affairs Rinaldi, T., Purnomo, M. and Damayanti, D., (2007), “Fighting Corruption in Decentralized Indonesia”, The World Bank Robertson-Snape, SF., (2000), “Corruption, Collusion and Nepotism in Indonesia”, Third World Quarterly, Vol. 20, No. 3, pp. 589-602 Saha, B., (2001), “Red tape, Incentive Bribe and the Provision of Subsidy”, Journal of Development Economics, Vol. 65, pp. 113-133 Sentana, M., (2013), “Indonesia Foreign Direct Investment Hits High”, The Wall Street Journal, January 22nd 2013 Tanzi, V., (1998), “Corruption around the World: Causes, Consequences, Scopes and Cures”, Washington, DC: International Monetary Fund