EAST ASIAN JOURNAL

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP03T02547R000100020001-9
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 19
• Document Creation Date: December 21, 2016
• Document Release Date: September 3, 2008
• Sequence Number: 1
• Publication Date: December 2, 1981
• Content Type: REPORT

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National Secret
Foreign
Assessment
(enter
East Asian Journal
State Dept. review completed
Secret
EA EAJ 81-023
2 December 1981
Copy 2 4 9
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Strategies for improving living conditions are increasingly limited: half the
population is under 16 and oil exports could drop by half in the 198OsF-
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Secret
Indonesia: Economic
Options and Constraints
in the 1980s
President Soeharto's strategies for reducing poverty,
creating jobs, and promoting more even distribution
of income are increasingly limited:
? With half of Indonesia's 154 million people under
16 years of age, labor force growth throughout the
1980s will reach unprecedented levels.
? Oil exports, the foundation of Indonesia's develop-
ment drive, could drop by half in the 1980s, as
rapidly rising domestic consumption bumps up
against a stagnating production ceiling of 1.6 mil-
lion b/d.
Keeping a lid on rising social and economic tensions
on Java, the archipelago's most populous island, will
be enormously complicated.
Soeharto's development strategy grafts populist
measures-such as subsidies on food and petroleum
products and quotas on exports to assure domestic
supplies of consumer items-onto a capital-intensive
industrial development program. This will aid his
drive for a decisive popular mandate in parliamentary
elections next May, but rapid labor force growth and
reduced oil exports make it an unsuitable long-term
strategy. If Soeharto takes the advice of his Western-
educated technocrats, he will shift to more market-
oriented policies after the presidential election in
1983. If he does not, only another substantial OPEC
price increase will spare Indonesia a severe balance-
of-payments squeeze that would drastically limit Ja-
karta's ability to remedy social grievances. As Java's
cities become more crowded and job creation lags,
racial riots and other urban violence could take on
increasingly antigovernment overtones
Economic Policy in the 1970s
The quadrupling of OPEC oil prices in 1973-74 and
the near tripling in 1979 provided Indonesia two
revenue windfalls. Although the Pertamina oil scan-
dal in 1975 dissipated much of the first windfall, the
Indonesia: Domestic Oil US Dollars Per Gallon
Product Prices
0.27
0.27
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second has been spent on rural infrastructure and
capital-intensive industrial projects, as well as on
consumer and farm subsidies. Subsidizing domestic
fuel prices rather than passing OPEC price hikes on to
consumers, however, has increased budget outlays and
slowed the buildup of foreign exchange reserves.
Worse, artificially low domestic energy prices have
promoted 12- to 14-percent annual growth in oil
consumption since 1970. 25X1
Nonetheless, cheap energy and oil export revenues
helped the economy record 7.4-percent annual growth
during the 1970s. Import substitution spurred even
faster expansion in manufacturing, as the economy
developed large textile, electrical appliance, and mo-
tor vehicle assembly industries. Outright bans on
imports of products such as television sets and light-
bulbs have protected markets for domestic producers,
but have also promoted inefficiency and corruption,
which have increased manufacturing costs and weak-
ened Indonesia's international competitiveness. By
1980 manufactures still comprised less than 5 percent
of Indonesia's exports despite the lowest manufactur-
ing wages in Asia.F__~ 25X1
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Continuing Social Strains
Notwithstanding the oil revenue windfall of the
1970s, Indonesia remains poor. Each $1 billion ad-
vance in export revenues raised per capita income by a
mere $7. It now stands at $420, about three-fourths
that of Egypt.
Oil revenues, moreover, have produced social strains
even though Soeharto's long-term economic objec-
tives-to reduce poverty, promote employment, and
share income more evenly-are aimed at promoting
social stability. The World Bank estimates that in-
come inequality worsened in the 1970s despite Jakar-
ta's attempts to transfer wealth from foreigners and
the relatively prosperous Chinese minority to ethnic
Indonesians. One study found that the poorest 10
percent of the population shared only 1 percent of the
decade's advance in income, while the wealthiest 10
percent enjoyed nearly half. Living standards in the
countryside grew only half as rapidly as those in
urban areas. Only large and rapidly growing remit-
tances from migrants at work in the cities to family
members remaining in the countryside prevented this
disparity from growing even worse.
Competing Views on Development Strategy
The mostly US-educated technocrats are Soeharto's
preeminent economic advisers and head key economic
ministries. Even so, they compete for influence with
top political advisers who favor strong central control
of the economy and influential groups outside the
government that advocate social welfare and equity
programs.
Within the government, Planning Minister Widjojo
Nitisastro and Finance Minister Ali Wardhana lead
the technocrats advocating market-oriented ap-
proaches to development. Since they began advising
Soeharto in 1966, the technocrats have alienated
populists by subordinating rising demands for equity
'Some 60 percent of the household income of rural migrants is
derived from remittances.
Outside of the government, several privately spon-
sored research institutes support a populist approach
to development policy. This case is probably best
articulated by Muslim activist groups, who advocate
rural development as an alternative to industrializa-
tion and large-scale foreign investment. Intellectuals
at Gajah Mada University, one of the country's
leading academic institutions, are equally vehement in
arguing the case for agriculturally based development
from the bottom up and are probably most attuned to
conditions in the countryside.
The World Bank remains the primary outside advo-
cate of a market-oriented development strategy and
economic diversification. Its April 1981 report called
for a restructuring of the economy, warning that
liberalization of trade policy and an overhaul of
Indonesia's often prohibitive foreign investment regu-
lations are required to avert both a sharp slowdown in
growth and serious balance-of-payments problems in
the medium term. Jakarta is resistant to such sugges-
tions in the present preelection climate and squelched
the scheduled May 1981 publication of an even more
critical Bank report that censured Jakarta's industrial
and trade policies. More recently, Jakarta signaled its
unwillingness to substantially simplify the complex
investment code by issuing a written rebuttal to
complaints voiced by a visiting team of potential
British investors)
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Secret
Oil subsidies
Food subsidies
Development b
35
50 39
a 1 April to 31 March.
b Includes fertilized subsidies.
Projected.
65 197 535 828 1,511
44 125 170 310
Economic Constraints and Options
Demographic trends and the near certainty of declin-
ing oil exports portend challenges to economic man-
agement in the 1980s even more formidable than
Soeharto has faced in the past. Half of Indonesia's
154 million people are under 16 years of age, with
many on the verge of entering the labor force. Net
labor force expansion during the 1980s probably will
reach 2 million workers a year versus 1.4 million in
the 1970s. Moreover, because the population age
groups which will produce the growth are already in
place, there is nothing Jakarta can do to slow the
expansion.'
Nor can Jakarta escape declining oil exports, a devel-
opment that will significantly reduce economic policy
options at a time of increasing demand for social
welfare programs. Maximum sustainable oil produc-
tion is stagnating at about 1.6 million b/d. Although
the surge in exploration activity under way since 1978
reversed three consecutive years of declining output
early in 1981, most of Indonesia's oil resources are in
small fields that are quickly depleted. Development of
natural gas, coal, and geothermal resources will prob-
ably not slow the growth of oil consumption below 10
percent annually before the late 1980s. Under these
circumstances, ballooning domestic oil consumption
could reduce oil exports to about 600,000 b/d by
1990, roughly half the current level. 25X1
Budget stringencies would by then force an end to, or
at least sharply curtail, domestic fuel and fertilizer
subsidies unless Jakarta can improve its poor record of
developing a nonoil tax base. Nonoil domestic taxes
are only two-thirds of 1970 levels in real terms.
Despite support from technocrats for reversing this
trend, shifting the tax burden to Indonesians would
prove enormously unpopular. Equally foreboding is
the other option if subsidies are eliminated: allowing
food prices to rise more rapidly than prices for
industrial goods in order to assure adequate produc-
tion incentives for farmers. This would squeeze politi-
cally strategic urban interests, a potentially dangerous
move for the government. In addition, increases in the
prices of oil products and electricity are opposed by
the rapidly growing and politically important urban
middle class.F___1 25X1
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Indonesia: Foreign Non-oil Investment
^ Total, current prices
Manufacturing, current prices
? Manufacturing, 1980 prices
Total, 1980 prices
Although Indonesia requires massive investment to
create jobs, the petroleum boom has helped dampen
foreign investment outside the oil sector. Nonoil for-
eign investment fell 26 percent in real terms during
1975-80 from levels recorded in the early 1970s and
has yet to repeat its 1975 level of $547 million.
Although corruption, bureaucratic inefficiency, and a
widespread resentment against foreigners are all re-
ponsible, Jakarta must also contend with a more
subtle obstacle to investment: as long as oil export
revenues remain large, balance-of-payments consider-
ations will work against an exchange rate that would
promote labor-intensive exports. For example, an ex-
change rate set to reduce the $3 billion balance-of-
payments surplus recorded in 1980 and the smaller
surplus expected this year would require appreciating
the rupiah, thus promoting cheap imports and dis-
couraging labor-intensive exports.
Looking Ahead
With an international reserve cushion of $7 billion in
mid-1981, the parliamentary elections in May 1982
and the presidential election in 1983 are shaping
Soeharto's decisions on economic matters. Assured of
electoral success by a pervasive network of political
control, Soeharto views the elections as a symbolic
device to extend his mandate and attaches consider-
able importance to an orderly election process. Out-
bursts of social unrest or controversy over the conduct
of the elections, although not a threat to the regime or
to its election prospects, would deny Soeharto the
decisive mandate he seeks. His decisions early this
year to maintain food and fuel subsidies at existing
levels and to raise the wages of civil servants under-
score this political view. Soeharto's actions carry a
heavy price, however. Including forgone foreign ex-
change earnings, the hold on domestic fuel prices
alone is costing Jakarta $3.5 billion this year-nearly
6 percent of GNP
Prospects for a preelection devaluation are remote.
When it became apparent last September that the
economy's nonoil exports fell 50 percent in volume
compared to the first half of 1980 because of de-
pressed international markets and Jakarta's own ex-
port quotas, a prominent member of parliament called
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on Jakarta to squelch rumors of a devaluation. Plan-
ning Minister Widjojo responded the following week
that no devaluation was under consideration.
Jakarta could reduce the financial pain of slower
growth in oil earnings by trimming a planned series of
resource-based heavy industry projects that would
require over $10 billion in capital outlays by 1985 or
by accelerating foreign commercial borrowing. Any
slowdown in construction of oil, liquefied natural gas,
petrochemical, or fertilizer projects, however, would
not only damage Soeharto's prestige but also impede
economic planning in other sectors that depend on the
program's completion. Increased foreign borrowing is
an attractive option. Jakarta has maintained an active
position in the Eurodollar market in the last few
years, and its most recent loan, a $300 million
syndication, reinforced its favorable credit rating.
Over the medium term, even the shift in economic
policies advocated by the World Bank and the techno-
crats would entail considerable risks. The moves
required to accelerate job creation and place govern-
ment finances on a surer long-term footing-devalu-
ation, phasing out subsidies, and boosting domestic
taxes-would be inflationary and thus politically dis-
ruptive in the short run. Jakarta nominally welcomes
foreign investors, but most Indonesians strongly re-
sent their role in the economy. Thus the regime 25X1
probably will not ease the complex regulations im-
posed on foreign investors or lower the barriers pro-
tecting state-owned or military-affiliated firmsF__1
more difficult to handle later in the 1980s.
Soeharto's mix of development policies contains the 25X1
seeds of a balance-of-payments squeeze by the close of
the decade that would limit Jakarta's ability to rem-
edy social grievances and meet rising expectations. As
more Indonesians crowd into Java's cities and fail to
find jobs, racial riots and other urban violence that
could easily take on antigovernment overtones will 25X1
increase. For now, the regime appears capable of
handling the security problem, but without another oil
windfall, social strains will almost certainly prove far
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East Asian
Briefs
The testing companies-both prime shippers across the Trans-Siberian line-have
been seeking a shorter route for containers from the Far East that now must enter
the Trans-Siberian system at the Soviet port of Nakhodka. In addition to providing
connecting rail service to container ships calling at Chinese ports, the overland
route could accommodate shipments of containerized goods to and from China.
When regular service is established, shipping costs, transit time, and cargo loss all
are expected to be less than on alternate sea routes. First, however, the Chinese
must develop container handling and distribution services, and the Soviets must
complete the Baikal-Amur rail line-scheduled for the late eighties. Only then can
the Trans-Siberian Railway significantly expand its container operations.F--]
form of public transport-carried 912 million passengers.
During October China added 64 new passenger trains and doubled the number of
express passenger runs. The new trains, which can carry up to 120 million
additional passengers each year, will just meet current demands. Rail passenger
traffic has averaged a 5.5-percent annual increase since 1975 and is expected to
rise at a 6-percent rate through 1985. In 1980 China's railroads-the predominant
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Beijing Cracks Down on Bonus Payments
In his economic report to the National People's Congress, which convened on
30 November, Premier Zhao Ziyang will urge greater restraint in issuing worker
bonuses-an action that could fuel future labor unrest.
Widespread abuses in the bonus system during 1981 have added to budget
problems and to inflationary pressures while the program has done little to lift sag-
ging productivity. To preclude a yearend surge in payments, China's leadership
issued new guidelines in early November aimed at restricting the size of the
bonuses and linking them to productivity
Beijing's directives to factory managers to adjust work quotas and bonus payments
will heighten tensions between workers and management. Although there have
been few actual work stoppages this year, production has suffered from high
absenteeism and lackadaisical work habits. The 40-percent increase in tobacco and
liquor prices, announced on 17 November, will add to worker dissatisfaction,
especially if they and the new restrictions on bonuses are seen as anticonsumer
policies.
Although Beijing recently signed its first loan agreement with the World Bank-
$200 million for educational projects-China's prospects for obtaining additional
concessional loans for port improvements and to expand energy production are
bleak, at least for the next two years. Low-cost funds administered by the
International Development Association, the Bank's soft loan facility, were already
heavily committed when China joined in 1980, and reductions in donor funds have
further dimmed Beijing's chances.
Beijing wants to sell a broad range of metals, including titanium, tungsten,
columbium, tantalite, and germanium, to private firms and to the US Government
for the strategic reserve. World prices for some of these metals are depressed. If it
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is to greatly expand exports of nonferrous metals, China will have to adopt a more
flexible pricing system and become better attuned to trading standards and
practices in the international metals market. 25X1
To this end, China recently transferred control of the nonferrous metals industry
from the Ministry of Metallurgical Industry to a new organization, the General
Administration for Nonferrous Metallurgical Industry, that reports directly to the
State Council. Under the old ministry, the nonferrous metals were greatly
overshadowed by iron and steel, which China produces in much larger volume.[
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The Chinese are now officially referring to the mission of their Navy as
"defensive" instead of their traditional reference to "coastal defense." A senior
officer in the East Sea Fleet said this could include offensive operations conducted
a significant distance from shore.F___1 25X1
The new line reflects the marked improvement in naval capabilities that has
occurred over the last five years. By building large ocean-going auxiliaries and 25X1
high-power communication facilities, the Navy probably can support open-ocean
operations almost anywhere.
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Southeast Asia
Philippine Foreign Debt Dilemma
Medium- and long-term debt repayments will rise by $480 million to $2.4 billion
next year-well above Manila's self-imposed legal limit of 20 percent of 1981
foreign exchange earnings. Prime Minister Virata told Philippine financial
executives in mid-November that foreign borrowing would have to be curtailed
next year to keep debt service within statutory limits, barring an unexpected
rebound in export earnings or foreign debt restructuring. Even a complete
moratorium on new foreign borrowing, however, would reduce next year's
repayments by only $19 million. Manila's solution will probably be to amend the
statutory ceiling, an option which it has used before and which many private
foreign bankers have already allowed for in setting their lending limits
Sabah Issue Again Clouding Philippine-Malaysian Relations
Philippine Defense Minister Enrile's allegations last month that an anti-Marcos
terrorist training camp is operating in Sabah, Malaysia, is being played down for
now by both governments. His charges followed the arrest of two members of the
leftwing Social Democratic opposition who were caught attempting to infiltrate
the Philippines from Sabah. Enrile claims that the terrorist training camp was
recently set up with the apparent blessing of Moro National Liberation Front
Chairman Nur Misuari. If the claims are true, this would be the first evidence of
cooperation between Muslim rebels training in Sabah and the non-Communist
opposition to Marcos. It would also represent a sharp shift in Malaysian policy,
which for many years has restricted use of Sabah as a sanctuary for Muslim
rebels. Although Enrile stopped short of accusing Malaysia of direct complicity in
terrorist activities directed against the Philippines, his statements provoked Kuala
Lumpur to state publicly that Malaysia would not allow any group to use its
territory to carry out clandestine activities against any government.F
Philippine Church Leader Criticizes US Policy
In a widely disseminated letter of 2 October, Cardinal Jaime Sin said that
Philippine youth "no longer see America in a liberating role but as one who arms
our soldiers to kill their fellow Filipinos.... I see a new generation of Filipino lead-
ers arising who, unlike my generation, will erase the long tradition of friendship
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between our two countries." Bishops and priests have recently complained to the
Cardinal that the US provides military assistance that is being used by the Marcos
government to "militarize" rural areas.
The Cardinal claimed that by giving priority to the Soviets, US policymakers have
shifted their focus away from the economic and political injustices that are the root
causes of problems in the Philippines. An outspoken moderate who espouses
cooperation with the Marcos government, Cardinal Sin's views are widely
respected by the majority Catholic population in the Philippines
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Secret
Calendar of
Coming Events
7-11 December
US-Japan Trade Facilitation Committee and Trade Subcommittee meet in Tokyo.
12 December
Second anniversary of the "headquarters coup" in which Chun Doo Hwan-then a
major general-and a group of key combat commanders seized control of the
South Korean Army, thus paving the way for Chun's ascension to the presidency.
14-15 December
Meeting of DOD-JDA Systems and Technology Forum in Tokyo.
Chinese Vice Premiers Gu Mu and Huang Hua lead delegation to Tokyo for
Japan-China ministerial talks; agreement will be announced on settlement of
controversy caused by Chinese plant cancellations 25X1
29 December
December 7-9 December
Australian Deputy Prime Minister Douglas Anthony to Washington.
15 December
22 December
Target date for presentation of budget to Japanese Cabinet
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Target date for Japanese Cabinet approval of the budget
Late December
Regular Diet session opens in Tokyo; before year's end expected to ratify annual
fishing agreement with USSR and to approve National Personnel Authority
recommendations on pay raises for public employees.
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