Indonesia's industrialization during the 1970s and early 1980s was accompanied by a growing web of trade restrictions and government regulations that made private businesses the hostage of government approval or protection. The dictates of the market had little bearing on profitability, and evÍÍÍÍen the most inefficient firms could prosper with the right government connections. As a consequence, almost all of Indonesia's industrial production was sold on domestic markets, leaving exports dominated by oil and agricultural products.

Major trade policy reforms, introduced in the mid-1980s, went a long way toward disentangling the government from the marketplace. These reforms proved very successful in promoting the growth of new export industries. Still, the large conglomerates that had emerged under heavy regulations also had the resources to benefit most in the more competitive environment. By the early 1990s, the government still confronted widespread popular concern over the distribution of gains from economic development.

The industrial and trade policy favored by government through the early 1980s was characterized by development economists as import-substitution industrialization. As illustrated by the steel industry example discussed above, the typical pattern was to encourage domestic producers to invest in a priority sector, selected by the Department of Industry, that could substitute domestic production for products previously imported (see The Politics of Economic Reform , this ch.). The enticement offered to the domestic investor often included sole license to import the product and restrictions on other potential domestic producers. The Department of Trade issued import licenses, and BKPM, which had jurisdiction over investment by all foreign firms and most large domestic firms, provided the constraints to potential domestic competitors. The overall direction of industrialization was framed in five-year development plans, but political influence often led to a more capricious pattern of benefits. In addition to almost 1,500 nontariff restrictions, such as import license requirements, tariffs ranging up to 200 percent of the value of an import were in place on those imports not affected by licensing.

The inefficiencies that plagued this strategy were documented by Department of Finance economists who were preparing for a major tax reform implemented in 1985 (see Government Finance , this ch.). Case studies of firms in import substitute sectors showed they generated 25 percent of employment opportunities that investment in potential exports would have supplied, and that shifting investment from an import substitute to an export product would generate four times the foreign-exchange earnings. Indonesia thus was left out of the substantial regional growth in manufactured exports during the early 1980s. In Thailand and Malaysia, manufactured exports accounted for 25 and 18 percent of exports, respectively, by 1980, whereas manufactured e 200xports ts generated only about 2 percent of total IndoneÍÍÍÍsian exports that year.

The complexity of trade regulations provided a rich opportunity for corruption within the Customs Bureau, which administered policies and assessed the value of imports to determine the appropriate tariffs. In April 1985, the Customs Bureau was released from its responsibilities, and a Swiss firm, Société Générale de Surveillance, was contracted to process all imports valued over US$5,000. Société Générale de Surveillance determined the value of imports into Indonesia at their port of origin and shipped the products in sealed crates to the Indonesian destination. Importers within Indonesia reported that their import costs fell by over 20 percent within months of the reform.

The first measure to directly curtail high trade barriers came in the form of an export certification program designed to offset the high costs for exporters who purchased imported inputs. This was abandoned, however, when the United States threatened to curtail textile imports from Indonesia because of the alleged subsidy from the certification scheme. In response, Indonesia agreed to sign the General Agreement on Tariffs and Trade (GATT-- see Glossary) Export Subsidy Accord in 1985. This provided a further impetus for more substantial trade reform since the agreement prohibited government compensation for export costs created by nontariff barriers to imported inputs.

In May 1986, the first in a series of more substantial trade reforms was announced. The reform package provided duty refunds for tariffs paid on the imports of domestic producers who exported a substantial share of their products. To overcome the problem of nontariff barriers, such as licensing restrictions on imports, exporters were granted the right to import their own inputs, even if another firm previously had exclusive privilege to import the product. Restrictions on foreign investment were reduced, particularly to stimulate production for export (see Industry , this ch.).

Although these reforms improved profits of exporting firms, they did not help to encourage exports from firms that preferred to supply the protected domestic market. In November 1988, a major trade reform began to dismantle the extensive nontariff barriers and to lower and simplify tariffs rates. By eliminating the influential plastics and steel import monopolies, government indicated the seriousness of the new policy direction. The 1988 reforms brought the share of domestic manufacturing protected by nontariff barriers to 35 percent from 50 percent in 1986.

Deregulation continued in a series of reform packages affecting both direct trade barriers and government regulations that indirectly influenced the "high-cost" business climate. By 1990 nontariff barriers affected only 660 import items, compared with 1,500 items two years earlier. Tariffs, still charged on almost 2,500 different imported items, had a maximum rate of 40 percent. BKPM adopted a new policy in 1989 to list only those economic sectors in which investment was restricted the negative list replaced a complex Priority Scale List that had controlled investment in virtually all sectors. In 1991 the contract with Société Générale de Surveillance was renewed under new provisions mandating that the Customs Bureau be trained to eventually replace the foreign firm.

Most of the substantial reforms that began in the mid-1980s and continued through the early 1990s reflected a new orientation to market-led economic development. In some cases, however, important new policies reflected the longstanding government concern that the private marketplace could not be trusted to ensure politically desirable outcomes. This was particularly true of policies concerning the processing of Indonesia's valuable natural resources and the sensitive area of pribumi business development.

Indonesia was the world's leading exporter of tropical logs in 1979, accounting for 41 percent of the world market. Concerns about environmental degradation and the lack of domestic log processing capacity led to restrictions on log exports beginning in 1980, culminating in a complete ban on log exports in 1985 (see Forestry , this ch.). The intent was primarily to foster the nascent plywood and sawmill industry, which could in turn export its output and expand employment and industry within the country. By 1988 Indonesia supplied almost 30 percent of world exports of plywood. The success of this policy led to other similar initiatives, including a ban on raw rattan exports in 1988 to foster the domestic rattan furniture industry and a substantial export tax on sawn timber in 1990 to promote the domestic wood furniture industry.

Many benefits that fostered the growth of large conglomerates were reduced or eliminated, but the conglomerates adapted quickly to the new environment. For example, the Bimantara Citra Group, operated by Suharto's son Bambang, lost its plastics import license held through Panca Holdings in 1988 but gained new interests in sectors that had previously been closed to private investment. The group became the first Indonesian company permitted to establish a privately owned television station--Rajawali Citra Televisi Indonesia (RCTI)--and, in the early 1990s, was poised to invest in petrochemical plants, long a government stronghold (see Post and Telecommunications, this ch.). Another son, Tommy Suharto, had a major holding in Sempati Air Services, the first private Indonesian airline permitted to offer international jet service in competition with the government airline monopoly, Garuda Indonesia (see Transportation , this ch.). An extensive review of Suharto family holdings published in the Far Eastern Economic Review in April 1992 noted that public resentment of family business gains was growing, although government officials and businessmen refused to voice their concern openly.

The government took some measures to curtail the continued dominance of large conglomerates. In 1990 Suharto himself publicly called for large business conglomerates to sell up to 25 percent of their corporate shares to employee-owned cooperatives on credit supplied by the conglomerates themselves, to be repaid with future stock dividends. The request was not legally mandated, but the attendant publicity that clearly identified the major Chinese minority firms involved was viewed as pressure to comply. Within a year, 105 companies had sold much smaller shares of stocks, diluted by special nonvoting provisions, to the cooperatives. A further initiative in 1991 called for large firms to become the "foster fathers" of smaller pribumi businesses, which would serve as their suppliers, retailers, and subcontractors.

Large, state-owned enterprises faced greater competition, but privatization of these operations did not seem likely in the early 1990s. During the late 1980s, however, several measures were undertaken to prepare for possible eventual privatization, including a thorough independent assessment of the profitability of each enterprise and a review of management compensation in relation to performance criteria. In 1988 the Department of Finance issued a new regulation outlining measures that could be taken to improve the performance of state-owned enterprises. The measures included management contracts with the private sector, issuing private ownership shares on capital markets or direct sale to private owners, and liquidation.

Another government policy initiated in 1989 suggested that at least some state-owned industries would be protected from possible privatization. A Council for the Development of Strategic Industries was established, headed by Minister of State for Research and Technology Habibie. The council gained control of ten major state enterprises, including severa l mu l munitions plants, the state aircraft firm Archipelago Aircraft Industry (IPTN), and Krakatau Steel. Under Habibie the industries' long-term development would be coordinated with continued government funding. This policy, viewed as a concession to the economic nationalists in the midst of government cutbacks, assured a major role for state-owned industries in Indonesia's most technologically sophisticated sectors.

Data as of November 1992