INTRODUCTION

Indonesia's economic performance has been significantly less impressive in the democratic (post-Soeharto) era than previously. The key indicator is the average annual rate of output growth, which not only reflects general improvements in living standards but is also by far the most important factor in reducing poverty. The rate of output growth over the three decades of the New Order regime (through 1997) was 7.4 per cent, but since the turn of the century (marking the start of the period of recovery from the economic crisis) it has been more than one-third lower, at 4.7 per cent (Figure 5.1). In terms of growth rates of per capita income, the decline has been even larger. From an economic point of view, it is this decline in economic performance that demands that we speak only of democracy's promise of good governance in Indonesia; it is a promise yet to be fulfilled.

We seek explanations for the decline in Indonesia's economic performance in the literature on new institutional economics. Writers in this field suggest that poor public sector governance, resulting in slow or no growth and development in many developing countries, is largely due to the lack of an appropriate set of the institutions critical to economic growth and development–or to lack of enforcement of those institutions. In this literature, ‘institutions’ are defined broadly as constraints devised to provide a structure for political, economic and social interactions (North 1991). Since this rather abstract definition differs from everyday use of the term–note, in particular, that institutions are distinguished from organisations–we begin by elaborating North's concept in more detail.