INTRODUCTION

When in 1999, decentralization policies were being developed in post-Suharto Indonesia, West Sumatra was the first province that set out to restructure its administration. The region has received much attention for this, but it became particularly famous because it immediately used the opportunity provided by Law No. 22/1999 to reorganize village government. The territorial and administrative scale of village government was transformed from the rather small and purely administrative villages (desa) to the much larger nagari. The nagar had been the most important pre-colonial units of Minangkabau political organization and had served as the lowest unit of local government through colonial times and after independence. When the Law on Local Government of 1979 (that is, Law No. 5/1979) was implemented in Minangkabau in 1983, each nagari had been divided up into several much smaller desa. In 2000, the province “returned to the nagari” (kembali ke nagari). What has become known as “The Minangkabau way” of decentralization has also attracted much attention from outside West Sumatra. Going back to the nagari is understood by Minangkabau and other Indonesians as going back to older adat political traditions and as a revitalization of adat in general. Within Indonesia representatives of other Indonesian regions have initiated similar movements to revitalize older structures of village government. The international donor community such as the GTZ, USAID, and the UNDP Partnership for Governance has hailed the West Sumatra initiative as the most successful example of the new trend towards a decentralized government along traditional lines that is supposed to be more democratic, participatory and accountable (Asian Research Centre 2001; UNDP 2001).

This chapter analyses this development in its wider historical context. It will be argued that decentralization is not new in West Sumatra. Periods of centralization have followed periods of decentralization in the past, but previous policies of decentralization were usually relatively limited in scope. In contrast to these earlier policies, the current decentralization means a more fundamental shift in authority from the central and provincial government to the districts. The chapter focuses on two inter-related contradictions that characterize the decentralization process in West Sumatra. The process is contradictory because top-down regulation, in which the centre enacts higher legislation to be followed by implementing regulations on ever descending and smaller levels of administration goes hand-in-hand with the dynamics of relatively autonomous local politics and regulation.

INTRODUCTION

Habibie's 1999 governance reform — implemented and revised during the legislatures of Abdurrahman Wahid and Megawati Sukarnoputri, and supported by international donor agencies such as the Asian Development Bank, the World Bank, the German GTZ (that is, Gesellschaft für Technische Zusammenarbeit or Society for Technical Cooperation), the United Nations Development Programme, USAID, AusAID, the Asia Foundation and the Ford Foundation (see Holtzappel's introduction to this volume and also Lubis and Santosa 1999, pp. 345–46; Turner and Podger 2003, pp. xi, 129; Schulte Nordholt and van Klinken 2007, p. 16) — projected great expectations of enhanced administrative efficiency and accountability, political participation and transparency as well as macro-economic stability and equity against the bleak backdrop of the complete collapse of Suharto's rentier economy. Yet, at least for Bali, since decades one of the most developed provinces in Indonesia (see for example, Interim Consultative Group on Indonesia 2002, p. 2), the preliminary results of the still incomplete, if not inchoate, reform seem so far to have fallen rather short:

“Regional autonomy has come to us too early, we are not ready for it yet”, said Mertha Ada, a cosmopolitan Theravada-Buddhist meditation master of Chinese descent-cum-traditional healer of modern illnesses with a large clientele of discontent urban middle-class Balinese, Javanese and international expatriates. He was echoing a common belief among Balinese elite that blames the general preoccupation with parochial interests for the increasing fragmentation of the Balinese community. The growing fragmentation or decreasing sense of solidarity would quite obviously be detriment to the commonweal priorities suggested by the opportunities as much as by the shortcomings of the decentralization process.

At first sight, this belief seems to resonate with what has formed a major focus of attention for Pamela Allen and Carmencita Palermo (Allen and Palermo 2004; 2005), Michel Picard (Picard 2005), Henk Schulte Nordholt (Schulte Nordholt 2007) and Carrol Warren (Warren 2007): the prevalent obsession of the Balinese with their own distinctiveness and interests in the name of local identity (kebalian), local tradition (adat) and “true” Hinduism.

During the Conference organized by USAID-PEG and the Ministry of Industry and Commerce (Departemen Perindustrian dan Perdagangan) convened at Hotel Borobudur in Jakarta on 13 August 2003, a lot of complaints were heard, supported by surveys of credible research institutions, as regards new taxes, user charges (retribusi) and other levies that had been extracted by provinces, districts and municipalities (kabupaten & kota) in the past two years in which the laws on regional autonomy had been implemented. Many of those charges were levied on trade or on the movement of commodities in, or passing through, a certain territory. Such levies were depicted as having a distorting effect on the economy, as they would hamper the free flow of goods within national borders, an important economic policy principle to be upheld. The central government had tried to roll back such levies in 1997 by Law No. 18, but after the implementation of the laws on regional autonomy in 2001, especially Law No. 34/2000, they have come back. The legal status of some of them is, however, more than questionable.

Apart from charges on transportation of goods, there are also reports of exactions on enterprises by local governments, ostensibly as user charges, such as contributions for street lightings, even when the electricity is produced by the companies themselves. The practice of demanding “third party contributions” by local governments is also a new cost-increasing phenomenon making the affected enterprises less competitive or less profitable. According to a survey in fifty-five districts (kabupaten) by the research institute of the economics faculty of the Universitas Indonesia (LPEM) in Jakarta, such charges have sometimes amounted to up to 10 per cent of the costs since 2001, and impose a relatively heavier burden on smaller establishments. Other surveys presented in this anthology, however, concluded that the impositions have weighed more heavily on larger enterprises. Hence it is still not easy to form a firm conclusion. Perception surveys have also indicated that most companies do not report a larger change in impositions as compared to the situation before the year 2001. There are even respondents who perceive a slight improvement of the business climate after the implementation of regional autonomy. Whatever the direction, lighter or greater burdens, the changes are marginal (below 0.5 on a scale of 2).

INTRODUCTION

This chapter examines the many regulatory problems in local government in Indonesia and proposes simple models for regulatory reform. From the outset, it is important to stress that decentralization is not the major cause of regulatory problems in the regions. Many of the problems discussed in this chapter represent nothing new and have been documented elsewhere. For example, SMERU Research Institute (1999) and others identified a range of local government imposed tariff and non-tariff barriers in internal trade in the mid-late 1990s. The World Bank (1994) discussed the inappropriate use and pricing of user-charges in local government in the early 1990s. Goodpaster and Ray (2000) outlined the discriminative and anti-competitive nature of many local government regulations just prior to the commencement of the autonomy process.

Decentralization nevertheless does present new challenges and pressures. For example, under pressure to raise own-source revenues, local governments have turned to using a number of trade-distorting taxes and charges that were commonly found in the regions in the early-mid 1990s, but later banned through deregulation measures in 1997/98. Also under decentralization, new legislation on local taxes and charges (UU 34/2000) has lead to sub-optimal arrangements governing the supervision of local regulations. As a result distorting local taxes and charges are being implemented without effective review of their regulatory impact.

Monitoring and addressing the many regulatory problems in local government and policy-making has been an important focus for the USAID Partnership for Economic Growth (PEG) project based at the Ministry of Industry and Trade. This paper draws on, and builds upon the work by PEG and MOIT counterparts and includes the many regional and desk studies carried out under the PEG-USAID banner by local research groups such as the SMERU Research Institute, BIGS (Bandung Institute of Government Studies), KPPOD (Regional Autonomy Watch), LPPPM Sawala, AKADEMIKA, REDI (Regional Economic Development Institute), as well as a number of contracted individual researchers (see Table 6.l).

This chapter considers local regulatory problems at two levels. The first problem is at the process level. That is, the process by which a regulation (or other forms of government intervention) evolves from initial idea, to the design and review stage, through to final implementation.

INTRODUCTION

In 1999, interim President B.J. Habibie initiated an ambitious reform of Indonesia's regional autonomy based on of the decision of the 1998 People's Congress No. XV on the reorganization of regional autonomy. It provides rural districts (kabupaten) and municipalities (kota) with the freedom to regulate their internal as well as their external affairs with the consent of the provincial governor and president. Before 1999 these regions had autonomy only on their internal affairs, that is, the regulating and managing of their socio-economic household and raising of traditional taxes. This autonomy was called “real autonomy”. The 1999 reform endows local communities with autonomy also on external affairs like the implementing of national laws and policies and provision of services. These tasks are called “accountable autonomy” and are paid for by the government and thus are accountable to the government. Before 1999 these external tasks were handled by government offices in the regions, the so-called kantor wilayah or kanwil. The sum total of the two types of regional autonomy is called “broad regional autonomy”. The heads of region, that is, the bupati for the rural district and the mayor (wali kota) for the municipality, lead the reorganization and the implementation of the new tasks. The representative parliament of districts and municipalities has to be prepared for its new role in the regulating process. Village communities have been made part of the regional governments. Nomadic communities are not mentioned by the reform laws, nor by the constitution. Legally, they simply do not exist. The reorganization had become financially necessary because of the financial crisis of 1997 which had depleted the dollar reserves of the government and Indonesian banks considerably, forcing the government to rationalize its expenses. The reform was made politically possible by President Suharto's enforced abdication in 1998 and became financially feasible by the sponsorship of the World Bank and other domestic as well as foreign donors.

The main aim of the reform is to rebuild local government from a poor and backward stronghold of tradition, which had hitherto been excluded from doing government tasks, to a regional government which has the money and the capacity to regulate and manage its external affairs.

This quotation of an American anthropologist is referring to the political situation that prevailed at the beginning of the 1970s in Tana Toraja, a regency or district (kabupaten) in the province of South Sulawesi. After a long period of depoliticizing local customs and tradition by the New Order regime, it is not surprising that the Indonesian decentralization laws of 1999 induced a general resurgence of customs and tradition in Tana Toraja. In fact, adat (denoting customs and tradition) became a major factor by the time the national decentralization laws had to be implemented in the Tana Toraja district in 2001. At a village level, the regional parliament of Tana Toraja passed a regulation into law that prescribed the reorganization of territories and government structures, aimed at the re-establishment of the lembang.

The lembang is a political and administrative unit which is larger than the New Order village (desa) and supposedly existed before the Dutch colonial administration re-designed the region. The lembang covers a geographical area of a group of people that since generations have common ancestral origins and share a socio-cultural set of laws and values as well as a traditional form of government organization. The implementation of this far-reaching autonomous unit stirred the traditional elites — who had been marginalized by Law No. 5/1974 and Law No. 5/1979 — into action, as they started to compete for lembang leadership.

In line with the “return to boundaries defined by customs and tradition”, at a higher level, a particular group of Torajans have been striving for the subdivision of the district of Tana Toraja in a northern, southern and western district.3 Again, this division supposedly corresponded to traditional sociopolitical organization that existed before the arrival of the Dutch colonial administration. The political and administrative decentralization policy launched in Tana Toraja by the Indonesian Government in 2001 unfolded into two apparently opposite processes: amalgamation on a village (lembang) level and fragmentation on a district level (Donzelli 2002/2003, p. 35).

INTRODUCTION

In Indonesia, decentralization means more responsibility for provincial and district (kabupaten/kota) authorities in the formulation and implementation of a wide range of services and programmes including small enterprise development. This chapter concentrates on small and medium-scale manufacturing enterprises (SMEs). The provincial and district governments are becoming much more influential in the coordination of technical and financial promotion activities for SMEs and in the provision of a business environment and climate that is conducive to SME development. The decentralization process asks for new views on local governance. The chapter discusses the issues at stake and reviews some experiences in simulating public-private partnerships as a tool to stimulate participatory development at the local level in promoting SME development.

The chapter deals with SMEs in Java specifically. It is not about micro enterprises and it is important that this distinction is made right at the beginning. In Indonesia, the discussion on SME development is often blurred by the fact that micro enterprises are included in the analysis. Micro enterprises and SMEs have very different characteristics and need to be distinguished. This chapter refers to the classification of the Central Bureau of Statistics in Indonesia to make this distinction. Micro enterprises offer employment to one to four family and paid workers and play a main role in poverty alleviation by offering jobs to those that do not have access to better paid work elsewhere in the economy. During the economic crisis (Krismon), micro enterprises were important providers of jobs to those that lost their work in the formal sector. SMEs are different and have a stronger orientation towards growth and are participators in the process of economic development. The development of micro and SMEs in Indonesia will be discussed in more detail further below. Subsequently, the chapter will briefly look at a specific characteristic of SMEs, namely their tendency to cluster according to sub sector and location. In rural Java, there are a large number of villages which are specialized in the manufacturing of specific products only. It will then look at various programmes and projects of the Indonesian government to promote SME development at the national level which were executed throughout the country with little variation among provinces. The chapter will also discuss recent developments in SME promotion and review changes in programmes and projects now that provinces and districts play a bigger role.

INTRODUCTION

If we look back at the past six years of the present reform era, we recall that B.J. Habibie's rise to presidency was highly controversial, due to the fact that he had come to this office as vice-president of the last cabinet under Suharto's regime. Many high-ranking reform politicians in Jakarta therefore opposed Habibie's succession of Suharto as president. However, on 21 May 1998, he was inaugurated before the Supreme Court as third president of Indonesia. Just a few months after his appointment had been ratified by the DPR, President Habibie issued Law No. 22/1999 on Regional Autonomy. This law replaced Law No. 5/1974, which had become dated and obsolete.

Initially, Law No. 22/1999 provided local government with a fresh impetus for exercising its power in accordance with the will of the people in the region. Yet after a few months, some of the implications of Law No. 22/1999 made local government face new and unexpected challenges such as the issue of the interests, status and representation of the so-called “indigenous peoples”. Another unforeseen problem was the new status rivalry within the reorganized bureaucracy. The institution of governor as the head of provincial government, for instance, had lost out in prestige and status vis-à-vis the institution of the mayor as head of the municipal government and the institution of the bupati as head of the district government. Because the beneficiaries of the autonomy regulation are the districts and municipalities, and not the province, the mayors and bupatis have become independent from their governor with regard to the execution of their duties, for they no longer needed to consult him. This has led to tensions between those two offices, because governors have often felt to have lost their face.

The situation has become even more complicated, with more political players entering the regional stage as members of the local parliaments (Dewan Perwakilan Rakyat Daerah Kota/ Kabupaten, or DPRD Kota/ Kabupaten), who enjoy the prerogative of either accepting or rejecting the annual budget accountability report of the mayor and the bupati. In case of non-acceptance, the mayor or bupati would have to withdraw from office. Not only the mayors and bupati, but also the members of the DPRD Kota/ Kabupaten have thus become the new “little kings” (raja kecil) in Indonesia.

After the fall of Suharto in May 1998, an instantaneous wave of publications endeavoured to come to grips with what was going on under the label of “reformasi”, by taking stock with the achievements and failures of the rapidly waning New Order institutions. The first book in the English language to exclusively address the intricacies of the various processes of decentralization in independent Indonesia up to the present day was the anthology, Riding a Tiger: Dilemmas of Integration and Decentralization in Indonesia (2002), coedited by Coen J.G. Holtzappel, Martin Sanders and Milan Titus. It comprised the proceedings of an international workshop at the University of Leiden, The Netherlands, convened by Holtzappel in 2000.

In an effort to define the points of departure for the reform and to fathom out what might happen if Basic Law No. 22/1999 on regional governance and Basic Law No. 25/1999 on regional fiscal balance were to be implemented, the workshop had focused on the political and social dilemmas of the relation between government and regions and vice versa during the New Order regime. At the time, there was a debate going on about the feasibility of the 1999 legislation, and it was not certain at all that the implementation would start as planned in 2001. People were also commonly afraid that reformasi might fail, and that Suharto's military-backed system of top-down regional governance might be able to re-institute itself. Another issue of concern for many was the fact that the local village communities were excluded from the equity intention inherent in the 1999 legislation. Yet, according to Article 18 of the 1945 Indonesian Constitution, it was precisely these village communities which were to enjoy special autonomy status. The majority of Indonesians have after all been living in closely-knit local communities in the rural districts and municipalities. To many, the emphasis on the autonomy of regional municipalities and districts in the 1999 legislation seemed questionable.

Riding a Tiger is a collection of studies which naturally was influenced by these points of debate. Accordingly, it provides some valuable insights into the real-time state of affairs of the regions and local communities in 1999, simultaneously reviewing the post-independence history of regional governance.

INTRODUCTION

In the period of 2001–03, many independent steps were taken in regencies and cities to put decentralization into effect, including those which represent initiatives of regency or city governments, the Regional Representative Council (DPRD) and the various communities. The three quotations noted in the following boxes are a small sample to give a picture of such governmental initiatives. They were derived from the Indonesia Rapid Decentralization Appraisal (IRDA) which had been carried out every six months in order to monitor decentralization. Up to the Third IRDA, monitoring activities was carried out in thirty-one regencies and nine cities in twenty-seven provinces.1 The question that formed the focus of attention for IRDA research in each round of investigation was: How do regencies and cities carry on government in the setting of decentralization and manage the resources that they possess? However, there were many debates regarding decentralization, so that attention was adjusted to the needs of the stakeholders at a given time, in particular in order to meet the needs of debate on a certain policy that had to be formulated as quickly as possible so that urgent action could be taken.

Box 1.1: From the First IRDA Report, April 2002

Box 1.2: From the Second IRDA Report, November 2002

BACKGROUND ISSUES

The Implementation of Regional Autonomy according to Law No. 22/1999 (UU 22/1999) concerning local government has provided a new direction for managing decentralization. It has also entailed a complete overhaul of legal products that existed before it, specifically those that regulated regional autonomy. This study represents the first piece of research carried out by the Center for Local Government Innovation (CLGI), responding to the need to explore more deeply the legal issues that have arisen from the implementation of decentralization and regional autonomy which have been in operation since 1 January 2001.

In the first round of implementation, that is, 2001–03, decentralization and regional autonomy was put into effect in full by all areas in Indonesia. Even though regions which did not yet possess the ability to implement their autonomy in full were allowed to do this in stages in accordance with the ability they have (TAP No. IV/MPR/2000 on Policy Recommendations in the Implementation of Regional Autonomy, point 2c), not one region had postponed the implementation of decentralization and regional autonomy.

Among the various measures taken by the region, some were quite progressive and innovative, some were very cautious, and in other cases regional governments have taken steps that were ill-advised. Some local governments even tended to deviate from the intention of regional autonomy by issuing regulations in order to increase regional revenue, a move that has the effect of actually impeding economic growth nationally. As a result of observations in the field, it can be said that the root of all the problems that have arisen in the implementation of regional autonomy is the fact that the central government and the regional governments are not executing a number of obligations of a regulative and juridical nature in the context of adjusting their legal stipulations in keeping with the changes in the system, the implementation and the demands of new needs flowing from regional autonomy.

INTRODUCTION

During the time leading up to the second general elections of 2004, the issue of decentralization and regional autonomy had not been widely considered as a critical issue in nation-building, and hence failed to become a major issue in platform-building by the major political parties. There could be many causes for this development. First, the process might have been considered as quite successful. At least, there was no real chaos occurring as a result of the decentralization process. Second, regardless of the effects of the process itself, Indonesians have adjusted well to the new situation and therefore, everything related to decentralization becomes routine activity. Third, for electoral reasons the political parties could have been more attracted to other more popular issues than the decentralization issues, like corruption, law enforcement, and the economic recovery process. In the absence of media attention, decentralization was not yet very visible to many Indonesians. Fourth, and most importantly, there might be a tendency that central government and political elites at the centre and in the regions have either slowed down the decentralization process or, which would be even more extreme, have gone back to the centralization system of the past. There might be many causes to explain the relative inconspicuousness of the decentralization process, but the fact remains that only a few parties were interested to raise the decentralization issues as one of their campaign themes.

After three years of decentralization, it was still difficult to judge if the process was successful or not. The international community deemed the process as “still on the right track”, asserting that the Indonesians were able to manage the massive and drastic decentralization, and minimize the negative effects. The central government felt that it had managed the drastic change quite well but at the same time admitted that it still worried about the future and that much would have to be done in order to keep the decentralization on the right path, including the revision of Law No. 22/1999 and Law No. 25/1999.

The local governments, however, were less satisfied than the central one. They were still suspicious that the central government was not fully supporting the process and should the process be considered a failure, there would be a recentralization process. On the other hand, they admitted that they had experienced a “freedom” that had not existed during the previous centralist era.

INDONESIA'S DECENTRALIZATION

Indonesia is rapidly moving from a highly centralized system of government to a largely decentralized one (World Bank 2003a). Law No. 22/1999 on Regional Governance devolves most functions except for national defence, international relations, justice, police, monetary policy, religion, and finance. The local governments are obliged to perform a set of key functions, including health, education, environmental and infrastructure services, and can perform any function not explicitly reserved for the centre or the provinces. The province has only a minor role, mainly in coordination, and backstopping rural regencies and urban municipalities that cannot yet perform their functions. The province will also continue to perform deconcentrated central tasks, including supervision, on behalf of the central government.

Law No. 25/1999 sets out a revised inter-governmental fiscal framework. Through the introduction of a general allocation grant (dana alokasi umum, DAU) and stipulations on shared taxes and local tax bases, the system significantly increases financing for local governments. Moreover, it also moves largely away from the former system of subsidy for autonomous regions (Subsidi Daerah Otonom, SDO), and presidential instruction (Instruksi Presiden, INPRES) grants characterized by a high degree of earmarking and centralized control. Regional governments are now responsible for local public service delivery in areas previously executed directly by the central government through its deconcentrated regional agencies and civil servants. The deconcentrated agencies in the decentralized sectors have been largely merged into the local government apparatuses (pemerintah daerah, PEMDA), and over half of Indonesia's civil service — 2.1 million people — have been transferred to the local governments. While government spending has been regionalized to a substantial degree, taxation remains largely centralized and the regions depend in their financing on central government allocations.

The on-going decentralization process will bring about a fundamental change in the organization and functioning of Indonesia's government. It will also bring in new actors that are, at least in principle, accountable to their local electorate. The question that arises is how these changes will affect the quality of governance in general and the level and structure of corruption in particular. While it is far too early to give definite answers, we can identify the channels through which decentralization will affect the quality of governance and the extent of red tape and corruption in the regions. Moreover, there is some preliminary evidence on some changes in corruption following the devolution of authority towards lower levels of government.