Introduction
Despite the mixed research findings about relationship between infrastructure and economic growth, the majority concludes that there is a positive and significant link between the two particularly in developing countries (Straub 2008, p. 33). In Indonesia, according to some facts, infrastructure affects economic growth through the level of private sector investment and their business development. Japanese companies operating in Indonesia rank the underdeveloped infrastructure as the main problem in investment in manufacturing and non-manufacturing industries (JETRO 2009, p. 27). This supports the perception of more than 12,000 businesses spread out in about half of Indonesia's districts which confirms that the low quality of infrastructure become the primary constraint of business development (KPPOD & TAF 2008, p. 2). As a result, Indonesia's economic growth during the period of 1990 to 2007 was below the average of developing Asia, and certainly below China and India (Garnaut et al. 2009, p. 90). Economic growth is very important for Indonesia because it is the main driver of human development in the country (UNDP 2010, p. 56).
The five year development plan 2010-2014 states an ambitious infrastructure development plan throughout the country. That requires investments as high as IDR1,429 trillion which is equivalent to nearly one and a half times of the government's annual expenditure (Alisjahbana 2010, p. 5).
Key Issue
The key issue for the national government is the lack of infrastructure funding in Indonesia. The public authorities are faced with the dilemma: either to fully finance the infrastructure facilities—by borrowing more—in order to secure its control, or to attract private financing in order to accelerate infrastructure development.
Indonesia's infrastructure relatively legs behind in terms of quality and quantity in the region. Among the ASEAN five, Indonesia's infrastructure quality is just better than the Philippines but far below Singapore, Malaysia, and Thailand (Schwab 2010, pp. 18-19). However, in terms of quantity, the length of Indonesia's roads per arable land area in 2003 was even below the Philippines as well as other Asian countries such as Lao PDR, Mongolia, and Vietnam (World Bank 2005, p. 15).
There is a great imbalance between the increase of vehicle number and the expansion of road. At national level, the increase of paved road during 1998-2005 was 28 per cent, whereas the rise of motor vehicle number at the same period was 80 per cent (World Bank 2007, p. 77). The situation is even worse in Jakarta. The growth rate of Jakarta roads is 0.9 per cent a year, whereas vehicle growth rate is nine per cent per year. Unless something is done, this would lead to total gridlock in Jakarta by 2014 (Cochrane 2009).
The poor infrastructure facilities are mainly a result of underinvestment in infrastructure particularly after the 1997/1998 Asian financial crisis (AFC). Investment in infrastructure in Indonesia, both private and public including from the state owned enterprises, fell from 5-6 per cent of gross domestic product (GDP) before 1997 to 1-2 per cent of GDP in 2000, and was stable at 3.4 per cent of GDP in 2007 (World Bank 2007, p. 74). The private sector investment in infrastructure has declined sharply before and after the AFC, from 30-40 per cent to less than a quarter of government spending on infrastructure (World Bank 2007, p. 74). The latest figure shows a small increase in the government budget allocation. In 2010, infrastructure budget allocation was close to two per cent of GDP. That is still below the pre-AFC level (as average of the period 1994 to 1997) which was 2.4 per cent of GDP (World Bank 2007, p. 80).
Solution options
Indonesia’s public sector performance is poor relative to private sector counterparts (Arif & Viverita 2004: 22). Therefore, the question is no longer whether private sector should be involved in infrastructure development, but rather which form of private participation suitable in the Indonesian context. This paper is going to outline two possible options.
Option-1: Full state financing
The Indonesian government has fair credibility to borrow money either from domestic financial institutions, foreign countries, or multilateral agencies. Indonesia's sovereign credit rating has been improved over time. The Standard & Poor’s rates Indonesia's sovereign credit for local and foreign currency at ‘BB+/positive’ (Standard & Poor’s 2011), while Moody’s just upgraded the Indonesian government’s foreign and local currency bond rating to 'Ba1' (Moody’s 2011). Improved ratings mean a lower country risk premium and thus reduced costs of financing (Wie & Negara 2010, p. 294). The Indonesian government need not to be concerned about borrowing money because its debt to GDP ratio is 27 per cent at the end of 2010, which is less than the average of G20 countries both for the advanced and the emerging economies (Departemen Keuangan 2010, p. 30). By borrowing money, government will declare the debts clearly in its financial statement as opposed to financing partnership which tempts undervaluing the liabilities by not recording them in the balance sheet (Webb & Pulle 2002, p. ii).
Indonesian government must have strong control over the making and the operation of the infrastructure facilities to secure public value[1]. With the full state financing option, government has better power to control the contractors. It will also mean government has full ownership of the facility which provides it the right to use, to change the form and substance, and to appropriate returns from the facilities (Furubotn & Pejovich 1972, p. 1140).
The state full ownership model is also in line with the traditional democratic structure. If the users (which are also citizens at the same time) want to complain about public infrastructure facilities, they can do so through the existing democracy structure—such as the Ombudsman Commission, the Administration Court, or to their representative in the parliament—in addition to the direct complaint to the facility operator. Those institutions can pressure government who own and control the facility directly. That would lead to a more pressure to government to impose citizens' aspirations to its contractors under a principal-agent relation (Teisman & Klijn 2002, p. 199).
There are several options of mode of delivery of public-private cooperation under the full-state-financing approach. The range starts from construction manager at fee (CM-at fee) to the Design-Build-Operate-Maintain (DBOM) (Pakkala 2002, pp. 10-12). The more works are bundled in the contract the more complexity of the contract and therefore the more difficult for the government—as the principal—to control the contractor (Seddon 2004, p. 23). That is because the contract will not be specific enough in determining the result and conditions due to the bounded rationality which lead to the increase of opportunism (Williamson 1985, p. xiii).
In order to have a strong control over the contract implementation, government must go for the segmented mode of delivery by preparing contract per each work segment and limit the contract period to a relatively short term. That would allow more certainty in predicting the future and therefore reduce the bounded rationality effects. That allows the government to specify results in the contract in order to monitor and control its contractors (Donahue 1989, p. 86). The sharp description on results would simplify the dispute resolution mechanism so that both parties can just rely on court (Williamson 1985, p. 32).
Although government has strong control over the contract implementation in option-1, there is no guarantee it can secure public value. Government will rely on courts in dispute resolution which is often costly and ineffectual (Klein et al. 1978, p. 71). The simple contract may not be helpful because of the bad credibility of Indonesia's justice system (MacIntyre 2003, p. 3). Government is more likely to lose in court because of two reasons: (a) government is strongly requested to behave impeccably (Seddon 2004, p. 14), (b) public officials have less incentive to win the disputes because their private interest will not be much affected.
Option-2: Private Financing Initiative (PFI)
Considering the limitation of fiscal capacity, instead of borrowing more, Indonesian government must go for PFI. Indonesia's public spending is only 17.7 per cent of GDP (Departemen Keuangan n.d, pp. 1-12). Indonesia's tax revenue is among the lowest Asia's non-OECD countries (IMF 2008, p. 11).
Despite some constraints in private sector investment (Kalinova 2010, p. 18; Prasetowo et al 2010, p. 1), various indicators reveal some opportunities. Together with key Asian countries, Indonesia has been constantly registering a more than 30 per cent saving since mid-1980s (Jha et al. 2009, p. 11). The average annual growth of market capitalization in Indonesia's Stock Exchange after the 1997 Asian Crisis is close to 25 per cent (ISE 2010, p. 2). Indonesia gained 10 places in the Global Competitiveness Index rank of 2010-2011 compared to the 2009-2010 rank (Schwab 2010, p. 29). Moreover, high demand to the pay-facilities can be expected due to the improvement of Indonesian prosperity (Euromonitor 2010; Ahniar 2011).
PFI is one among many forms of public-private partnership. In this case the firms should finance all the construction, operation, and maintenance costs in return for payment from the users and—when eligible—from government subsidy. Government must independently do the design and the plan which represent public interests such as user safety and environment standard. The plan must be made by contractor through a design competition. The plan that represent the public interests the most with the least costs requirement for construction and maintenance should be the winner, to be paid by government. Once the plan is ready, government must put it into a transparent tendering process. The private firm who bids with the lowest user charge rate and lowest guaranteed net sales[2] (for the same design of facility) is the most efficient firm therefore should be the winner. The contract between government and the private firm bundles all the building, operation, and maintenance works which will last for 30 to 35 years of the operation before transferring the ownership to government (BOOT).
This partnership approach will allocate the risks efficiently; that is 'to the party that is best able to manage them' (EIU 1999, p. 2). There are three kinds of risk in public private partnership, being construction risk, availability risk, and demand risk (Blöndal 2005, p. 22). The first two risks should be transferred to the partner because private firms are the best in handling them (U.S. Department of Transportation 2007, p. 21). The government must share the demand risk by paying the gap between the actual and the guaranteed net sales when the former is lower than the latter (the subsidy)[3]. In order to attract investments, it is also important for the government to share the pre-construction risk by handling the land acquisition works. At the moment, Indonesia is considered to be high risk in pre-construction which is mainly caused by land acquisition issues (Khan 2009, p. 13; Pisu 2010, p. 5). The public sector can take most of the pre-construction risk because the solution depends more on the political context (Wie & Negara 2010, p. 291).
The level of control of government over the partner under the PFI is not as strong as in option-1. Therefore, there is a potential for the private interests to undermine the public interests (Hodge & Grave 2010, p. s16; Hellowell & Pollock 2010, p. p. s26). One obvious source of the threat is the difficulty to specify results and conditions in a long term contract (Hodge & Greve 2007, p. 549). Partnership needs more flexibility in its contract governance to identify unforseen risks in a sensible way (Seddon 2004, p. 23). It requires private ordering rather than legal centralism (Williamson 1985, p. 31; Birnhack 2004, p. 2). However, the public sector has limitations in doing private ordering due to its unique accountability system compared to private organizations.
Nevertheless, although the power to control the private partner is lower, a long term PFI partnership has the potential to satisfy public value with a lower transaction cost. Partnership is a collaboration process of cross boundary partners where risks and resources are efficiently shared in mutual trust for collective benefit (O'Flynn 2009, p. 115). In collaboration process, instead of using power to control, government must negotiate and persuade its partner (Pollitt 2003, p. 47). Many infrastructure facilities—such as road and water infrastructure—have asset specificity in terms of location and physical; that is the asset that the benefit can be realized only if the partnership is maintained (Williamson 1979, p. 240). Specific asset enhances trust and cooperative behaviours among partner (Lui et al. 2009, p. 1218). The long term reliance and cooperative behaviours—such as exchange information—are examples of relational norms which reduce transaction costs (Artz & Brush 2000, p. 356). The partnership strengthens contractual relationship through interest alignment (Domberger et al. 1997, p. 777). Therefore, in partnership, private firm executive has interest to satisfy the concern of the public sector manager: that is to create public value (Moore 1994, p. 296)
Proposal
By applying two criteria: a) allocative efficiency, and b) value for money, option-2 is chosen to overcome the infrastructure backwardness in Indonesia.
Option-1 puts the entire financial burden to the government. That could accelerate the infrastructure development—as outlined in the five year development plan 2010-2014—only by sacrificing other government programs including the basic services for human development (such as health and education) or by significantly increasing government debts. Both consequences should not happen in current circumstances. Indonesia's human development index (HDI) rank in 2010 is still below 100 and is the lowest of the ASEAN Five countries (UNDP 2010, p. 145). Government debt is highly sensitive in Indonesian politics. This is particularly for foreign debt which embodies sovereignty issue as a result from the Asian crisis experiences when IMF dictated the bad recipe causing the country into a deeper crisis (Radelet & Sachs 1999, p. 14). In contrast, option-2 would allow the government to accelerate infrastructure development neither by disturbing financial support to other important programs nor by putting pressure on the public finance cash flow. That means option-2 not only allocates the risks better but also allocates the resources more efficient than option-1.
In option-1 tax payer money is more likely to be spent for less value either for citizens or clients. That is because in option-1 public funds are used to pay for construction and operation which involves huge risks before the users can really get benefit from the facilities. In contrast, in option-2 government only pays for value: that is to pay the top-up of the rate paid by the clients who gain benefit from the infrastructure facilities. One may argue that option-2 will just satisfy the client/user (private value) but not the citizens (public value). The argument is not convincing because of two reasons: (a) citizens who need but cannot access the facility still enjoy a better access to the ordinary facility—such as public roads (not the toll road)—because less users can be expected, whereas citizens who do not need the facility still enjoy the better economic development as the impact of better infrastructure; (b) Public value concerns such as externalities, public safety and transparency—as commonly argued by scholars (Flinders 2005, p. 232; Hodge & Greve 2007, p. 551; Erridge 2003, p. 94)—still possible to be achieved in option-2 because the private firms have a long term interest for their current and future investments. Therefore, they will have incentive to build good image and therefore to align their interest into public interest.
In short, option-2 allocates public resource and risks efficiently and provides better value against public money both for users and citizens. Therefore option-2 is recommended.
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[1] Despite the need to distinguish ‘public value’ and ‘public interest’ (Alford & O’Flynn 2009, p. 176), for the purpose of this paper the two phrases will be used interchangeably.
[2] That is the annual net sales that guaranteed by the firm. That means the private firm cannot claim subsidy when the actual net sales are equal or exceed the guaranteed level. Government must have power to determine the user charge rate in order to achieve certain level of citizen access over the facilities.
[3] The rate charged to the users is fixed, but the rate paid to the partner depends on the actual demand which affect to the net sales. If the net sales less than the guaranteed level, government will pay the gap which basically the top-up of the rate paid by the actual users. This kind of flexibility is required in such a long term contract (Crocker & Masten 1991, p. 96)
