by Prof Nizam Jim Wiryawan Posted : 9 September 2018
Memperbaiki Dampak Defisit Current Account RI
by Prof Nizam Jim Wiryawan Posted : 31 August 2018
THE INTERNATIONAL MONETARY FUND’S ECONOMIC RESCUE OPERATIONS: IS THE "FUND" FRIEND OR FOE
by Prof Nizam Jim Wiryawan Posted : 18 August 2018
When the Asian economic crisis struck more than two decades ago, starting with Thailand and then contageously spreading to eight other countries in the region, there was no other solution available other than turning to the international economic and financial communities as suggested by Samuelson and Nordhaus (2005:581) that “If there are so many obstacles to finding domestic saving for capital formation, why not borrow abroad?” From the West, came the International Monetary Fund/IMF with its forceful armamentarium as moneylender. Within two years since August 1997, the IMF supplied $4 billion in credit to Thailand with a total rescue package with other world’s financial institutions amounting $17 billion; $11.6 billion to Indonesia with a total package of $21.9 billion; and a record-breaking $21 billion to South Korea out of $57 billion.The IMF total loan commitments then stood at $86 billion, and a subsequent authorized $18 billion increase in its capital base ensures greater lending capacity in future (Joko Siswanto, 2007)
The negotiations to obtain loan authorization placed the IMF in the role of a surrogate government affecting economic policy for national governments, which might remind their citizens with a memory reminiscent of the colonial times, dubbed often time as ‘neo-colonialism’, ‘neo-liberalism’ tied as a powerful arm of the Western global economic might, in particular the U.S.A (Yanuar Nugroho, 2002). This perception is raised as all the IMF-arranged assistance came with strict conditions like the discontinuation of subsidies on food and fuel prices, tightening of government pockets, the dismantling of local monopolies, rigid banking standard inclusive of bank closures, which impacted adversely on the Third World countries (Mahathir Mohamad, 2002). As a result, the economic crises brought about political costs in some Southeast Asian countries (Vincent Lingga, 2007); even to the extent of toppling longtime strong man such as president Suharto of Indonesia 1998
Given the high level of the IMF intervention in the world economy and in the Asian region during the peak economic crisis and the struggles for the borrowing countries (mostly the ‘emerging economies’), some basic questions linger: “Does the IMF promote international economic stability, as it posits, or does it produce financial chaos? Is the IMF friend or foe especially for the emerging and less-developed economies, and should it therefore be strengthened or abolished in anticipation of a better market-base alternatives?” This article attempts to examine these basic variables of the IMF’s mission, rescue operations, and conditionality effects vis-à-vis the real experience of some (Asian) nations.
THE BIRTH OF THE INTERNATIONAL MONETARY FUND
The first half of the twentieth century brought about two intractable World Wars and one global depression. The European continent was the continent which was impacted severely in both wars being the main theatre of these wars. The Unites States was also devastated by the Great Depression though its economy was relatively intact during the wars. Subsequently the U.S adopted a trade restriction policy by deliberating the “Smooth-Hawley Tariff Act” (1930), soon to be followed by Canada, France, Italy, Spain and Switzerland. In 1932, England and Ireland followed suit (Salvatore, 2007). From these adverse conditions arose a sober and clearer insight among some quarters to form a new international monetary system that would address balance of payments (BOP) deficits, substantially sustaining national economic independence but without the ‘robber attitudes’ or ‘beggar thy neighbor policy’ like the manipulative devaluation policy, high trade barrier; while encouraging stable exchange rates without extreme reliance on the gold standard to back national currencies.
As World War II raged across Europe and Asia, the leaders of England and the United States were aware that, in order to ensure a liberal, market-oriented world economy after the war, they need a multilateral institutions that could enforce rules favoring the free movement of capital globally (Salvatore, 2007). At the height of World War II, the initial step was taken in form of a gathering of 44 nations in July 1944 in Bretton Woods, New Hampshire, USA, to, among others, draft the Articles of Agreement for the “International Monetary Fund/IMF” and the “International Bank for Reconstruction and Development/IBRD”, a.k.a the “World Bank” dubbed the Bretton Woods Institutions. Another important agenda to create another world body to regulate international trade, the “International Trade Organization”, was later aborted since it was strongly opposed by the U.S Congress.(see, e.g: Hill, 2016; Griffin and Pustay, 2007; Shenkar and Luo, 2004). The agenda of the Bretton Woods conference was to create institutional structures to address the then burning issues like post war global prosperity based on free movement of capital-based economy. These two institutions would shape the world economy significantly for the next half of the 20th century (Kotabe and Helsen, 2008.
One of these two, the IMF, resulted from lengthy American, British, Canadian and French proposals drafted separately during World War II. The British “Keynes Plan” envisaged an international clearing institution that would create an international means of payment called “bancor”, where each country’s Central Bank would accept payment in bancor without limit from other Central Banks. Debtor countries could get bancor by using automatic overdraft facilities with the clearing institution. The limits to these overdrafts would be generous and would grow automatically with each member country’s total of imports and exports, with some charges of 1-2% p.a be charged on both creditor and debtor positions in excess of the specified limits. It might call for cover by an automatic American credits for the imbalances which perhaps amounting to many billions of dollars (Kotabe and Helsen, 2008.
The American proposal took its name from Harry Dexter White, then U.S Assistant Treasury under the U.S Treasury Secretary Henry Morgenthau. White rejected the overdraft and in particular the possibility of having an automatic American credits in vast with no limited amount. Instead, White proposed a currency pool to which members could make their definite contributions only; and from which countries might borrow over short-term BOP deficits. Both proposals looked forward to a substantially free of controls imposed for the BOP purposes.
Both also sought exchange-rate stability without resorting to an international gold standard and without destroying national dependence in monetary and fiscal policies. As it happened, economists of the 1930s and 1940s, particularly John Maynard Keynes (1883-1946), were greatly devastated by the economic crisis of the pre World War II period, and they were determined to avoid the economic chaos and the series of devaluations that had occured before the Great Depression. They believed that the gold standard was too inflexible causing deepening and lengthening business cycle (Salvatore, 2007; Samuelson and Nordhaus, 2005).
According to the common interpretation, the British proposal placed more emphasis on national independence and the American proposal on exchange-rate stability originating from the traditional gold standard. The compromise finally reached leaned on the American proposal more than the British. The Articles of Agreements of the International Monetary Fund, together with its twin institution the World Bank, were drafted and signed by the representatives of 44 nations at Bretton Woods in July 1944 (Hill, 2016). By the end of 1945, enough countries had ratified the agreement to bring IMF into existence. The board of governors first met in March 1946, adopted bylaws, and decided to locate its headquarters in Washington, DC. A year later the IMF was ready for actual operations.
According to its Articles of Agreements, the purposes of the IMF are:
1. Promote international monetary cooperation.
2. Facilitate the expansion of international trade for the sake of high levels of employment and real income.
3. Promote exchange-rate stability and avoid competitive depreciation.
4. Work for multilateral system of current international payments and for elimination of exchange controls over current transactions.
5. Create confidence among member nations and give them the opportunity to correct balance-of-payments maladjustments while avoiding measures destructive of national and international prosperity.
6. Make balance-of-payments disequilibrium shorter and less severe than they would otherwise be.
As these goals could not be achieved promptly and immediately, Article XIV of the agreement provided for a postwar ‘transitional period’ during which the member countries might escape the general ban on exchange controls over current account transactions. No definite length for the transition period was stated, but countries maintaining exchange controls more than five years after the start of the IMF operation (that is beyond 1952) were expected to consult IMF about it every year. In reality, consultations about general economic policies have become an annual routine with all members, not only with members in violations of the standard decontrol rules, requiring heavy and voluminous documentation and become the main activity of IMF using the most man-hours (Yeager, 1976)
Membership is open to every country that conducts its own foreign policy and is willing to adhere to the IMF's charter of rights and obligations. All major countries are now members of the IMF. The formerly centrally-planned economies of Eastern Europe and the former Soviet Union have also become members after completing their transition to market economies. Members can leave the IMF whenever they wish. Cuba, Czechoslovakia (now the Czech Republic and the Slovak Republic), Indonesia and Poland had in fact done so in the past, although except Cuba eventually they all rejoined the IMF. Indonesia was firstly registered under the Netherlands as Indonesia was still administered by the Dutch colonial government during the formation of the IMF; only to officially become a full member of the IMF later on April 15 1954. (IMF Booklet, 1998).
In fact, the IMF, which still administers the international monetary system, operates like a central bank for the central banks of the member countries (Samuelson and Nordhaus, 2005). Its ‘purposes’ (or ‘mission’) just mentioned are vague as the IMF provides drawing rights (which in effect means loans) to help its members meet temporary deficits without resorting to exchange controls, exchange-rate adjustment, or internal deflation. Member countries are supposed to live with or ride out purely temporary deficits, drawing on fund when necessary to supplement their own accumulated reserves of gold and foreign exchange. The IMF is not designed to use up its resources as a country facing fundamental international transaction deficit may seek a remedy by devaluing its currency.
An opposite situation of the fundamental BOP, surplus would presumably call for upward revaluation as is the case of disputes between China and the Western economies which insist that China’s huge accumulation of foreign reserves should lead to the appreciation of its currency, the yuan or renminbi; an unfavorable pressure for the Chinese policy makers (A. Tony Prasetiantono, 2018). Consequently, the West has accused that the Chinese government keeps the yuan undervalued to gain a trade advantage (Dieudonne, 2007; Rogoff, 2007; The Economist, January 22, 2005,, p. 74). Meanwhile the odds of having international currency adjustments were expected to be infrequent as it may create a world economic uncertainty
OPERATION PROCEDURES OF THE I.M.F
Since 1995, the IMF loan commitments have reached unprecedented levels. In February 1995, the IMF board agreed to a record-breaking loan of $17.8 billion for Mexico. Two months later, Russia was granted credits of $6.8 billion, followed by an another $10.1 billion in March 1996. The IMF then turned its attention to East Asia in 1997. The Philippines received $1.1 billion in July, Thailand $4 billion in August, Indonesia $11.6 billion in November and South Korea $21 billion in December, breaking the old record.
The IMF still continued to expand financing activities in 1998 with its second loan within a year to Indonesia and the Philippines, and its third loan in a little more than three years to Russia with a total loan of $11.2 billion. The IMF ended 1998 with its second biggest loan ever of $18.1 billion to Brazil.
Today Pakistan is seeking a US$12 billion bail out, which will be the 12th since the 1980s as well as being the largest bail out for one coutry by The IMF (Balding, 2018). Amid a stronger US dollars augmented by the anticipated increases in the US Federal Reserve's fund rate this year (2018) some currencies (like the Rupiah) have been heavily depreciated which may need special attention by the IMF if things turn to the worst.
The record level of loans from the IMF has caused indepth scrutiny of the IMF activities. Krueger (1998:2011) earlier argued that “the Fund and its staff have generally been viewed as doing satisfactory and competent job of dealing with individual countries’ difficulties”, but her assessment does not stand anymore. Although a group of the IMF supporters exists, increasingly observers and academic analysts are questioning the effectiveness of the IMF programs, viewing from the struggles of recipient countries vis-a-vis their record lending.
The concern leads to where all the funds came from and how is the standard of operations for the IMF’s loans disbursement with all the technicalities concerning these operations.
Source of Finance, Quotas and Voting
On joining the IMF, each member country contributes a certain sum of money called quota, similar to a credit union deposit. These quotas serve several purposes. First, they create a pool of money that the IMF can draw from to help members in need of financial support. Second, they are the basis for determining how much the contributing member can borrow from the IMF, or can receive from the IMF in periodic allocations of special assets known as SDRs (special drawing rights, like ‘bancor’). The more this member contributes, the more it can borrow. Third, they determine the voting power of the member. Quotas are set by the IMF through an analysis of each country’s wealth and economic performance for contribution. 25% of the quotas are due in gold and 75% in the member’s own currency (Salvatore, 2007)
The richer the country, the larger its quota. This will be reviewed once every five years and can be raised or lowered according to the needs of the IMF and the economic prosperity of the member. For the start, 35 members of the IMF paid $7.6 billion. The U.S, as the world’s largest economy and founding member, contributed most to the IMF, providing about 18% of total quotas (or $37 billion), with Palau, a member in December 1997, got the smallest quota, contributing about $3.2 billion. Indonesia’s first quota was registered at $110 million in 1954. Member nations subscribed by lending their currencies to the IMF; the IMF then re-lends these funds to help countries with problems in their trade imbalance. The main function of the IMF, therefore, is to help countries which have BOP problems or under specific dures in the financial markets (Samuelson and Nordhaus, 2005)
The founding nations reasoned in 1944 that the IMF would function very efficiently, and the Fund's decisions would be made most responsibly through member’s voting power related to the amount of money they contributed to the institution in form of quotas. Those who contributed most to the IMF were therefore given the strongest voice in determining its policies. The U.S owned therefore more than 265,000 votes, or about 18% of total, while Palau in contrast owned 272, or 0.02% of total votes. It goes without saying that this ‘might’ of the U.S voice has become the source of finger-pointing habits at everything socially unfavorable toward the IMF for certain groups in the developing countries.
As time passed, it became clear that the IMF’s resources for providing short term assistance to countries with monetary difficulties were not sufficient. To resolve the situation, and reduce upward pressure on the U.S dollar by countries holding dollar reserve, the IMF created special drawing rights in 1969. “Special Drawing Rights/SDRs” are special account entries on the IMF books designated to provide additional liquidity. The value of the SDRs is determined by a weighted average of a basket of five reserve currencies: These are the U.S dollar, the Japanese yen, the E.U’s euro, and the British pound, with the yuan or Renmimbi as the latest newcomer in 2015 (Balding, 2018). Although SDRs are just a form of fiat money and not convertible to gold, their gold value is guaranteed, which helps to ensure their acceptability earning its nickname as ‘paper gold’ (Salvatore, 2007)
Participant nations may use SDRs as a source of currency in a spot transaction, a loan for clearing financial obligation, security for a loan, and a swap against a currency or in a forward exchange operation. A country with BOP problem may use its SDRs to obtain usable currency from another country designated by the IMF (Kotabe and Helsen, 2008). Several recent changes have also evident in the operation of the IMF. Members are generally required to pay 25% of any increase in its quota in SDRs or in currencies of other members selected by the IMF, with their approval, and the rest in their own currency. New members can also pay in their quota in a similar way.
The IMF has also renewed and expanded the ‘General Arrangements to Borrow’ (GAB) nine times since setting them up in 1962; and in 1997 it extended it with the “New Arrangement to Borrow” (NAB) so that the IMF could lend up to SDR 51.0 billion (about $72.9 billion; $24.3 billion from GAB and $48.6 billion from NAB) to increase its regular resources. Central Banks also can expand their swap arrangements to over $54 billion and their standby arrangements to $50 billion. Borrowing rules were also relaxed at the IMF, and new credit facilities were added that greatly expanded overall maximum amount of credit available to a member nation. For the ‘low-income countries’ members, soft loan facilities have been made available through the ‘Poverty Reduction and Growth Facility’ (PRGF) and ‘Exogenous Shocks Facility’ (ESF).
For the non-concessional or non soft loans, the new credit facilities set up by the IMF include (1) the ‘Extended Fund Facility’ (EFF), established in 1974 for long-term assistance to support members’ structural reforms to solve BOP difficulties of a long-term character; (2) the ‘Supplemental Reserve Facility’ (SRF), established in December 1997 during the Asian Crisis, to provide short-term assistance for BOP difficulties related to crises of market confidence; (3) the ‘Compensatory Financing Facility’ (CFF), set up in 1963 to provide medium-term assistance for temporary export shortfalls or cereal imports excesses; (4) ‘Emergency Assistance’ to provide quick help for BOP difficulties arising from natural disasters or in the aftermath of civil unrest, political turmoil, or international armed conflict; and (5) the ‘Stand-by Arrangement’ (SBA) (Sri Endah Susilo Rini, 2007)
Some quarters view the IMF as an institution of solid authority and independence and that it decides the best economic policies for its member to pursue, dictates these decisions to the members and make sure its members conform (see, e.g: Danaher, 1994; Soedradjad Djiwandono, 2005). Contrary to this belief and far from being dictated to by the IMF, the membership itself dictates to the IMF the policies it will follow. The chain of command runs clearly from the governments of member countries to the IMF and not vice versa. In setting out the obligations of individual members to the IMF, or in working out details of lending arrangements with a member, the IMF acts not on its own but as an intermediary between the will of the majority of the membership and the individual member country (Cyrillus Harinowo, 2004).
The top echelon of the chain of command is the board of governors, one from each member, and an equal number of alternate governors. As these are of ministers of finance or heads of central banks, they speak authoritatively for their governments. An interim committee founded since the 1970s gives advice on the functioning of the international monetary system, and a joint IMF/World Bank Development Committee advises them on special needs of the poorer countries. Since governors and alternate governors are fully occupied in their own government duties, they gather only on the occasion of the annual meetings to deal formally and as a group with IMF matters. During the rest of the year, the governors communicate the voices of their governments for the IMF’s day-to-day works to their representatives who make up the IMF’s executive board at headquarter in Washington. This board rarely makes its decision on the basis of formal voting but relies on the formation of consensus among its members minimizing confrontation on sensitive issues and promoting acceptance of the decisions subsequently adopted (Cyrillus Harinowo, 2004; Sri Endah Susilo Rini, 2007).
In its early years, all IMF members followed the same construct of calculating the exchange value of their currencies. They did so according to what was called the par (equal) value system. In those years, the U.S defined the value of its dollar in terms of gold, so that one ounce of gold was deemed equal to exactly $35 during the Bretton Woods era (Hill et al, 2016). The U.S government would exchange gold for dollars at that rate on demand. On joining the IMF, all members had to define the exchange value of their money in terms of gold, or in terms of the U.S dollar. Members kept the value of their money within 1% of this value, and if they felt that a change would help their country economy, they discussed the planned change with other members in the forum of the IMF and obtained their approval before implementing it.
The par value system had the advantage of keeping currencies stable and predictable. It is also a standardized mechanism for currency's calcuation for international businessmen, traders and investors. Over the years it has also created a number of disadvantages, causing great political risks, when a government has to change the par value of its currency, and each change in the par value of a major currency tended to become a source of crisis itself for the whole system (Boediono, 2001). While the simple supply-and-demand concept for the foreign exchange market explained the major determinants, they did not capture the central importance of the international monetary system. After serving the world for about 20 years, this US-backed Gold Standard system designed by the Bretton Woods conference came to an end in the early 1970s.
Since the abandonment of the par value system, the membership of the IMF has agreed to allow each member to choose own method of determining the value of its money. The only requirements are that the members no longer base its currency on gold, and that it informs other members about how it is determining the currency’s value. Many large industrial nations allow their currencies to float freely; their money is worth whatever the markets are prepared to pay for them. Some countries try to manage the float by buying and selling their own currencies to influence the market (known as ‘dirty float’ practice). Other countries peg the value of their money to that of a major currency or group of currencies so that if that currency rises in value their own currency rises too.
The 1990s witnessed the crisis after crises in international finance: in Europe in 1991-92; in Mexico and Latin America in 1994/95; in East Asia and Russia in 1997/98; then back to Latin America in 1998-2002. Although the world, in particular the U.S, avoided most of the fallout from these crises from East Asia to Russia and South America (Hill et al, 2016), this period stresses the importance of a well-functioning international monetary system as crises prevention surveillance and crises resolution model (Sari H. Binhadi and Azhari Firmansyah, 2007).
The notion that a well functioning international monetary system is a catalyst for crises prevention surveillance and crises resolution leaves more questions than answers for some observers, since monetary crisis which developed into economic crisis is still evident everywhere. The US experienced a tsunami shock resulting from the subprime mortgage crisis in the late 2007 although the US did not request the help from the IMF in its economic rescue operations. In Asia, Pakistan is awaiting for another big bail out by the Fund following the Pakistan's debt crisis. In the wake of president Trump "America First" policy and its subsequent scenario of a possible Trade Wars among nations (Marie Pangestu, 2017; Andelman, 2018), the IMF needs to be wary of the fall out reminiscing the old - but now suddenly active again - policy of "beggar thy neighbor prior to the Great Depression era (Mukhisa Kituyi, 2018). The IMF should not handle the fallout from a "man-made" policy that goes wrong in considering the Fund's financial bail out in future.
International monetary system
The term denotes the institution under which payments are made for transactions that cross national boundaries. In particular, the international monetary system determines how foreign exchange rates are set and how governments can affect exchange rates. Earlier, Solomon (1982:1) said that “Like the traffic lights in a city, the international monetary system is taken for granted until it begins to malfunction and to disrupt people’s lives”. Subsequently, Solomon (1982:7) went further to describe that “A well-functioning monetary system will facilitate international trade and investment with smooth adaptation to changes. A monetary system that functions poorly may not only discourage the development of trade and investment among nations but subject their economies to disruptive shocks when necessary adjustments to change are prevented or delayed”
The core element of the international monetary system involves the arrangements by which exchange rates are set as described in the above illustrations. First, it is a system of fixed exchange-rates set by the government of the currency's country. Second, it is a system of flexible or floating exchange-rates where rates are determined by market forces with no government intervention. Third, it is a quietly managed exchange-rates in the event that nations intend to intervene to smooth exchange-rate fluctuations or to move their currency to a special zone.
The purpose of an exchange-rate system is to promote international trade and finance while facilitating adjustment to shocks. Under flexible exchange rates regime, the country’s exchange-rates could depreciate to offset domestic inflation. Under fixed exchange-rates, equilibrium must be restored by deflation at home or inflation abroad (Samuelson and Nordhaus, 2005) Many things could affect this equilibrium, like sharp rise in a country’s wages and prices so that its goods are no longer competitive in the world markets. An adjustment mechanism must then function.
An automatic adjustment mechanism in fact does exist as was demonstrated by David Hume (1711-1776) in 1752. Hume, who was closely befriended by “The Father of Modern Economy” Adam Smith (1723-1790), proposed what is known as “Hume’s Adjustment Mechanism” which set partly upon the quantity theory of prices. This is the theory of the overall price level analyzed in macroeconomics. This doctrine posits that an economic price level is proportional to the supply of money. Under the gold standard, gold was an important part of the money supply, either directly in the form of gold coins, or indirectly when governments used gold as backing for their paper money (Boediono, 2001).
If a country is losing its gold, the country’s money supply would decline either because gold coins had been exported or because some of the gold backing for the currency had left the country. A loss of gold would lead to reduction of money supply, and, the next step is that prices and cost would change accordingly to the change in the money supply where prices, costs and income subsequently fall down. This country will decrease imports (as it becomes too expensive), while exports increase (as it becomes cheaper).
The opposite effects would occur in the receiving country because it is receiving more gold from its exports. With more gold in its coffer, its money supply increases, driving prices up in line with the quantity theory. As its goods become more expensive its export volume declines. In the wake of higher domestic prices, it may choose for cheaper imports too.
This gold-flow mechanism means an improvement in the BOP for countries losing their gold and worsening for countries gaining gold. At the end an equilibrium of international trade and finance would be reestablished at new relative prices, keeping trade and international lending in balance with no net gold flow. This equilibrium is stable requiring no tariffs or other government intervention. Understanding the gold standard is important for two reasons. First, for its historical role. Second, as a pure example of a fixed exchange-rate system. This same analysis commonly applies to all fixed exchange-rate systems: “If exchange-rates are not free to move when the prices or incomes among countries get out of line, domestic prices and incomes must adjust to restore equilibrium”.
In the Hume’s mechanism, it is gold flows that move prices and wages and ensure equilibrium. In a liberal macroeconomic system, prices and wages would simply adjust through movements in output and employment. When a country adopts a fixed exchange-rate system, it faces an intractable fact: “Real output and employment must adjust to ensure that its relative prices are aligned with those of its trading partners” (for more readings of Hume’s mechanism, see e.g: Cooper, 1969: Reprinted excerpts of D. Hume’s “On Balance of Trade” in Essays, Morals, Political and Literary, Vol 1, London: Longmans Green, 1989; Eichengreen, 1985, ed,: The Gold Standard in Theory and in History, London: Methuen).
A flexible or floating exchange-rates system is one of the cornerstones of today’s international monetary system besides the fixed exchange-rates. A country has flexible exchange-rates when exchange-rates move purely under the influence of supply and demand of the market. In this system, the government neither announces an exchange rate nor takes steps to regulate it. Today, flexible exchange-rates are ‘supposedly’ used by the majority countries. For these governments, the movements of exchange-rates are determined almost entirely by private supply and demand for goods, services and investments (Hill et al, 2016). Many middle-size countries also rely upon flexible rates. In a freely flexible exchange-rate system, the government must allow the foreign exchange market to determine the value of its currency.
Consequently, it is possible to get significant swings in flexible exchange-rates over relatively short periods as so happened in most of the Southeast and East Asian countries some twenty years ago during the Asian Economic Crisis; and again today in the aftermath of the US sub-prime mortgage related to the US Federal Reserve's Quantitative Easing program. To up the ante, President Trump's "America First" policy by raising the tariffs of several imported products from ouside the US (see, e.g, Andelman, 2018) may weaken the value of these exporting countries' currency resulting in enormous swings in their exchange rates like the Indonesian Rupiah which has already hit its lowest unseen level (Prima Wirayani, 2018).
In between the two polars of fixed and flexible is the middle ground of managed exchange-rates, where exchange-rates are still determined by market forces but governments buy or sell foreign currencies or change their international money supplies to quietly manage their exchange-rates. This system is becoming less important as countries are increasingly settling toward either fixed or flexible exchange-rate systems. Unlike the earlier uniform system under either the gold standard or Bretton Woods, today’s exchange-rate system fits into no tidy mold: hence the word ‘supposedly’ was mentioned earlier.
Without a special design, the world has in real terms moved to a hybrid exchange-rate system with some behind the scene interventions. The E.U, while also adopting freely floating system, has intervened into the exchange-rates market mechanism amid the sharp falls on global stock markets, triggered by the multi-trillion-dollar U.S ‘subprime mortgage’ market toward a subsequent credit crunch. Though it constituted only 15% of the total mortgage loans in the U.S worth around $10 trillion, the subprime mortgage with its derivatives were in those years the rising stars as financial markets’ instruments (Agarwal and Ho, 2007) and its crunch has created catastrophic effects to the international financial markets similar to a ‘Black Monday’ when major global stock markets suddenly crashed due to the Dow Jones Industrial Average plunged on the negative outlook of the U.S economy (KOMPAS, October 23, 2007, p.1).
As it strove to salvage the U.S financial system, the U.S Federal Reserve pumped $81.25 billion into the market just within three days in the aftermath of the 9/11 terror attacks (A.Tony Prasetiantono, 2007); and another $65 billion in just two days in the wake of the subprime mortgage failures. The Frankfurt-based European Central Bank, the ‘guardian’ of the Euro, also swiftly pumped 155.85 billion euros ($212.98 billion) into the eurozone banking market. The Central Bank of Japan injected Yen 1 trillion to off-set the disruption of its exchange-rates also within days after these subprime mortgage debacles in the U.S. Central banks in Canada and Australia also took no time to inject liquidity into their own markets (Agence France-Presse/The Jakarta Post, August 13, 2007, p.16; Kompas, September 26, 2007, p.10). The possible credit crunch had actually been forewarned by Stiglitz as early as in 2006 when he cited the weak U.S fiscal structure attributed to its mamoth current transaction account deficit, huge general household loans, and a weak real estate sector which might start a ‘panic button’ among the global investors. (TEMPO, January 8, 2006, p.93)
The IMF even went further to confirm its willingness to salvage any country with heavy financial crisis resulting from the subprime mortgage crisis (www.detikfinance.com). This intervention goes without saying that, at best, pure market mechanism where exchange-rates are determined only by market forces, is still not yet completed 74 years after the foundation of the IMF in 1944
Exchange-rates and the Balance-of-Payments (BOP)
The BOP accounting system records international transactions and supplies vital information about the condition of a national economy and the likely changes in its fiscal and monetary policies. The BOP statistics can be used to detect signs of trouble that could lead to governmental trade restrictions, higher interest rates, accelerated inflation, reduce aggregate demand, or other general changes in the cost of doing business. (Salvatore, 2007)
With the assumption that exchange-rates are determined by the market's supply and demand without government intervention, there is a linear correlation between exchange-rates and adjustments in the BOP. Consider when a currency is in excess demand and people keep buying it, and – concurrently – selling other country's currencies. When the demand for this currency increases, it leads to an instant appreciation of the currency and a depreciation of others in the market.
These movements in the exchange-rate continuous until the financial and current accounts are back in balance. Here is where the exchange-rate plays its role as equilibrator where the equilibration mode for the current account is easiest to be understood: the appreciation of the currency makes the country’s products more expensive and will lead to a decline in its exports and an increase in its imports. Both of these factors tended to reduce the country’s current-account surplus. The exchange-rate movements, therefore, serve as a balancing wheel to remove disequilibria in the BOP (Boediono, 2001; Samuelson and Nordhaus, 2005)
By providing a procedure for international monetary cooperation, working to reduce restrictions to trade and investment flows, and helping members with their short term BOP difficulties, the IMF makes a significant and unique contribution to economic stability and improved living standards throughout the world as posited by Kotabe and Helsen (2008). According to the theory of international trade and BOP, a surplus or a deficit in a country’s basic balance should be self-correcting to some extent. This self-correction, in line with Hume’s adjustment mechanism theory, is accomplished through the internal and external market adjustments.
Financial assistance by the IMF
In the short run, market-determined exchange-rates can be highly volatile in response to monetary policy, political events, and negative changes in expectations as like during the financial crisis in Asia in 1997/98 (Ahjar Iljas, 2007). Over the long run, providing that the country’s economy is strong enough to repel such detrimental happenings, exchange-rates are primarily determined by the prices of goods in different countries to underline the importance of a well-functioning international monetary system as described in the above. A recurrent problem with exchange-rates is that a country becomes prey to speculative attacks when it runs low on foreign exchange reserves like during the Asian financial crisis, precipitated by the free exit of capital which started with the forced impromptu devaluation of these countries’ currencies (Cyrillus Harinowo, 2004; Mahathir Mohamad, 2002; Sari H. Binhadi and Azhari Firmansyah, 2007). How can a country improve the credibility of its exchange-rates system that will better withstand detrimental attacks?
Specialists in this area underline the need of establishing credibility. In this case, credibility may be enhanced by creating a system that will actually make it ‘hard’ for the country to change its exchange-rate. One solution is to establish a ‘currency boards’, which is a monetary institution that issues only currency that is fully backed by foreign assets in key foreign currencies, usually the U.S dollar. A currency board defends an exchange-rate that is fixed by law rather than by just policy, and this currency board is usually independent, and sometimes even private (The Economist, November 1, 1997, p. 80)
Under the currency boards, a payments deficit will generally trigger Hume’s automatic adjustment mechanism (Salvatore, 2007; Samuelson and Nordhaus, 2005; Soedradjad Djiwandono, 2005) where a BOP deficit will reduce money supply leading to an economic contraction and eventually reducing domestic prices and restoring adjustment. This system worked effectively in Hong Kong but was unable to withstand economic and political turmoil in Argentine and collapsed in 1992 (Hill, 2007). Under the then-president Suharto, Indonesia was for a while toying with the idea of establishing a currency board which was strongly opposed by the IMF during the 1997/1998 crisis (Hill, 2007).
To deal with this situation, the IMF can also lend money only to member countries with payments problems, which is, to countries that do not bring in enough foreign currencies to pay for what they buy from other countries. Usually, the money a country brings in comes from what it earns from exports, from providing services like banking and insurance, and from what tourists spend in the country. Additionally, foreign money also comes from overseas investments, and, in case of poorer countries, in the form of aid from better-off countries as donors. Countries, like people, however, can spend more than they make, causing to make up the difference for a time by borrowing until their credit is exhausted, as eventually it will be.
When it happens, the country must face unpleasant realities, like commonly loss in the buying power of its currency and a forced reduction in its imports from other countries, as posited by Hume in 1752. Hume’s arguments, though 266 years old, still offers important insights for understanding how trade flows get balanced in today’s international economy (see, e.g,: Kreinin, 2006; Samuelson and Nordhaus, 2005). The example Hume used to make this point is as follows: That is, it is futile to attempt to raise the accumulation of ‘gold’ or money above its natural level in some nation as long as the nation is connected with one another through international business (Salvatore, 2007).
A country in that situation can turn for assistance to the IMF if it is a Fund member, which will for a time lend the Fund's foreign exchange to help it right its macro economic life, with the intention to stabilizing its currency and strengthening its trade back to ‘normalcy’.
A member country with a BOP problem can immediately take back from the IMF the 25% of its quota that it had earlier paid in gold or a convertible currency. If the 25% of quota is insufficient for its needs, a member in greater difficulty like Indonesia (Sri Endah Susilo Rini, 2007) may apply for more money from the IMF. The country can request over a period of years cumulatively three times what it paid in as quota subscription. This limit, however, does not apply to loans under the IMF’s special facilities, including the supplemental reserve facility (SRF), created in December 1997 to provide short term financing to members faced with a sudden and disruptive loss of market confidence, like, again, happened to some countries during the Asian financial crisis in 1997/1998. Korea, a victim suffering from this crisis, was the first country to benefit from the SRF.
In lending to a member more than the initial 25% of quota, the IMF is guided by two rules. First, the pool of currencies at the IMF’s disposal exists for the benefit of the entire membership. Each member borrowing from the pool is therefore expected to return it as soon as its payments problem has been solved. In this way, the funds can revolve through the membership and are available whenever another need arises. Second, before the IMF releases any money from the pool, this member must demonstrate how it plans to solve its payments problem so that it can repay the IMF within its normal repayment period of three to five years, which in certain cases can be extended up to ten years.
The logic behind these rules is simple. A country with a payments problem is spending more than it is taking in. Unless a fundamental economic reform takes place, it will continue to spend more than it takes. Since the IMF has an obligation to the whole membership to preserve the financial quality of its transactions, it lends only on condition that the member use the borrowed money effectively. The borrowing country must therefore agree to undertake to initiate a series of reforms that will eliminate and dismantle the source of the payments difficulty and build up a healthier ground for ‘high quality’ economic growth. These IMF-imposed regulations are commonly termed ‘IMF conditionality’ (Griffin and Pustay, 2007; Soedradjat Djiwandono, 2005), like in South Korea, Thailand and Indonesia (Tongzon, 2002). The IMF is mandated by its charter to salvage members with payments problem; and, at that time, there were also some growing concerns that the Asian crisis would spread to the U.S.A and E.U (Kotabe and Helsen, 2008)
Along with its application for a loan, the candidate country borrower presents to the IMF: A plan of reform, typically undertaking to reduce government expenditure, tighten monetary policy, and deal with certain ‘structural’ weakness such as the need to privatize inefficient public enterprises, massive bank restructuring (Tan, 1999; Tongzon, 2002). To say in the same vein is that the macroeconomic policy of that particular country needs a complete overhauling under the auspices of the IMF. The IMF’s experience with its member countries’in these austerity adjustment efforts has shown that reforms need to be broader and deeper to achieve the ‘high quality’ growth. This means more attention to ensuring countries have adequate social safety nets in place to cushion the effects of adjustment on the poor segment of the population, good ‘equality government spending’ like more attention to spending on health and education, and good governance minimizing chance for corruption and with transparant fiscal and policy making. This conditionality have been many times overlooked by several critics of the IMF. At the same time these critics tend to focus mostly at the reform plan seen as the source of economic and social inequality when the IMF comes to help the country’s economic problem
Article I of The IMF’s charter mandates the IMF to make financial resources available to members, on a temporary basis and with adequate safeguards, to allow them to correct payments imbalances. In 1952, the conditionality mechanism was imperatively incorporated into the IMF’s lending policies. Conditionality was constructed to set into place policies that would make it likely for a member country to relief its BOP problems and to repay the IMF on time. The inception of the conditionality was accompanied by the ‘standby arrangement’. In its early years, the standby arrangement was meant to be a precautionary tool to ensure access on members who had no instant need for such resources in the immediate future. The standby arrangement, however, developed quickly into a device for linking macro economic policies to financial assistance. On September 20 1968, the IMF decided to incorporate conditionality explicitly into its charter that outlines the IMF’s position with respect to conditionality.
Until the mid-1970s, the conditions placed on the use of the IMF’s resources included policies that affect the level and composition of aggregate demand. During this period, excess demand was seen as the most important cause of inflation, currency overvaluation, and of payment difficulties. The elimination of excess demand was viewed as an essential condition for restoring payments equilibrium; a position that has often been referred to as the ‘monetarist approach’ led by Milton Friedman (Sumitro Djojohadikusumo, 1991).
This approach views excess demand as the main cause of inflation and of exchange-rate disequilibrium. Its goal is the rapid restoration, within one year or less, of inflation and of the exchange-rate disequilibrium vis-à-vis policies that alter the size and composition of aggregate demand as monetarist policies suggest: (1) control of the money supply, (2) reduction of government deficit, (3) exchange-rate devaluation, (4) deregulation of prices, (5) reduction of the consumer subsidies, and (6) elimination of tariff and non-tariff trade barriers. As can be seen, much of this monetarist policies is still recent albeit in the mid-1970s the monetarist strategy gave way to a more structural, longer-run approach. This new approach to payments adjustment was resulted from the growing recognition that payment imbalances could no longer be expected to be corrected only within one year. In 1974, the IMF established the ‘extended fund facility’ which was designed to provide members with up to three years of financial support.
Local politicians and interest groups often bitterly protested the IMF’s conditionality requirements, arguing that foreigners, working through the IMF, are taking advantage of the country’s short term problems to extract changes favorable to foreigners. At times, the situation can turn uglier. For example, as stated earlier, in 1998 Indonesia was wracked by rioting after prices and unemployment soared as a result of the austerity demanded by the IMF, with the longtime-serving President Suharto was ultimately forced to resign (see, e.g.: Asvi Warman Adam, 2006; Luhulima, 2001;Vincent Lingga, 2007)
Another significant point also to be overlooked is that the specifics of each IMF-supported adjustment program are selected by the members, and, therefore, the program of reform is the members’, not the IMF’s as described earlier in this article. The IMF’s ultimate concern is that the policy changes are sufficient to overcome the member’s payments problem and do no avoidable harm to other members. Depending on the seriousness of the BOP problem and the amount the member wishes to borrow, the IMF directors, as representstives of the entire membership, judge whether the reform measures are in fact sufficient and whether the IMF can reasonably expect repayment (Sri Endah Susilo Rini, 2007). Such measures are, besides in the formal agreement signed between the borrowing country’s highest authority with the IMF’s CEO, also in other documents known such as the “Letters-of-Intent” (LOI) etc, which may look as if the country has lost its authority in running the monetary and economic affairs vis-à-vis the IMF as a surrogate government (and, again, a source of dissatisfactions for some quarters).
A country borrows (or draws) from the IMF’s general resources account by using its own currency to buy (purchase) the currency of another member country at an exchange-rate dominated in SDRs which is the IMF’s own unit of account. A drawing on the IMF by a country raises the IMF’s holdings of the country currency and helps its position in the market, but reduces its holding of other currencies in equal amount. The composition of the IMF’s resources changes, but the “total absolute amount” as measured in SDRs stays. If the executive directors are satisfied that the reforms will solve the problem, the loan is disbursed in installments usually over one to three years, tied to the member’s progress in putting the reforms into effect judged by the various documents like the LOI etc. (Soedradjad Djiwandono, 2005). If all goes well, the loan will be repaid on time, and the member, having the necessary reforms in place, will come out of the experience economically stronger.
If a member borrows money from the IMF, it must pay various charges to cover the IMF’s operational expenses and to compensate the member whose currency it is borrowing, which is quite a normal practices in the international financial markets. Typically, a borrower pays in service charges and commitment fees about ¼ of 1% of the borrowed amount, and an interest charges about 4.5%. For the structural adjustment mechanism the interest charges are much less and for the supplemental reserve facilities the interest charges are considerably higher.
An IMF member earns interest on its quota contributions only if other members borrow its currency from the pool. How much the lending member earns varies, but usually has been about 4% of the amount of its currency that other members have borrowed from the IMF. Both the interest charges a borrower pays to the IMF and the recompense a creditor receives from the IMF are slightly below market rates in keeping with the cooperative spirit of the IMF.
THE SOCIO-ECONOMIC IMPACTS OF THE FUND CONDITIONALITY PROGRAMS
Khan (1990) stated that a question that is frequently raised in connection with IMF-supported programs is whether such programs have been effective in achieving their socio-economic objectives. Some writers (e.g., Danaher, 1994; Mahathir Mohamad, 2002), have argued that, IMF programs do little in improving the economic progress. Others say that programs worsen the situation by inducing stagflation (Binny Buchori, 2007; Danaher, 1994), with Soedradjad Djiwandono (2005:139) concluded it as “Very expensive lessons” related especially to the IMF-mandated bank closures in November 1997 in Indonesia.
As it is, the IMF does not put out fires, it starts them (Barro, 1998). Friedman (1998) cited the Mexican crisis in 1994-95 bail out by $50 billion financial aid by the IMF, as an example whereby the internal recession that followed the bailout was deep and long so that it left the ordinary Mexican citizen with higher prices for goods and services with reduced income disrupting the socio-economic conditions.
Friedman (1998) went further to say that the Mexican bailout, in effect, helped fuel the East Asian crisis that erupted two years later as the bailout encouraged individuals and financial institutions to lend to and invest in the East Asian countries, drawn by high domestic interest rates and returns on investment, and reassured about currency risk by the belief that the IMF would bail them out if the unexpected happened and the exchange pegs broke.
Providing a clear cut answer to this question is not an easy task. Khan (1990) stated further that there is at present little agreement about how to estimate the socio-economic effects of the programs, or about what impacts these programs have actually had on the socio-economic variables the IMF is concerned with. Although there have been a number of studies on the subject over the past decades with samples of countries receiving the IMF adjustment programs, it cannot be judged with certainty whether these programs ‘have indeed worked or not.
Salvatore (2007) listed several proposals which have been advanced to reduce exchange rate volatility and avoid large exchange rates misalignments like by: (1) Tobin, 1978, (2) Dornbusch and Frankel, 1987, (3) McKinnon, 1984, 1988, (4) Cooper, 1984, (5) and by Williamson, 1986. Kenen (1983), Goldstein (1995), Eichengreen (1999), Fratianni, Salvatore and Savona (1999), Salvatore (2000, 2002, 2005) and Truman (2006) have all been cited by Salvatore (2007) as to have suggested that reforming the present international monetary system is likely to involve improving the functioning of the present system rather than replacing in by establishing a brand new one.
Although the fundamental problem that led to these crises was different, the process was very similar (Salvatore, 2007). Each crisis started as a result of massive withdrawal of short-term liquid funds at the first sign of financial weakness in the country. While foreign investors poured funds into many emerging markets after these countries liberalized their capital markets to take advantage of high returns and to diversify their risk portfolio, they were the ones that immediately withdrew their funds on a massive scale at the first sign of economic trouble in these countries they were operating, thereby precipitating a crisis. Such crisis might spread to the rest of the world, including the industrial countries creating a clear and present danger for the international monetary system as is currently brewing with the losses of the value of the Turkish Lira today The currency had earlier lost more than 40% against the US dollar, but has since been rebounding (Daren Butler and Humeyra Pamuk, 2018)
In the final analysis, however, it must be realized that even if all reforms have been adopted, they would not eliminate all future financial crises; it is merely in the hope that these reforms reduce the frequency and severity of financial crises in the future. Some international financial instability and crises may be the inevitable result of the liberalized financial markets and the cost which has to be paid in return for the benefits provided in the name of the liberalized financial markets (Mahathir Mohamad, 2002). These problems are a reflection arising from today’s serious economic problems of the world: (1) trade protectionism in industrial advanced countries namely the U.S, E.U, Japan shown during the present Doha Round negotiations under the auspices of the WTO, (2) job insecurity and stagnant wages in most of these countries, (3) high structural unemployment and slow growth in the E.U and the need to restructure in Japan, (4) restructuring challenges of transition economies, (5) huge ‘dollar overhang’ or large quantity of dollars held which is ready to move from one monetary center to another in response to variations and expectation of exchange rate changes, (6) deep poverty in many developing countries and, recently (7) the US Adminstration-imposed import tariffs hike (Mukhisa Kituyi, 2018: Lily Yan Ing, 2018)
CONCLUSSION AND DISCUSSION
If a domestic lender of last resort is needed to deal with domestic financial crises, the globalization of financial markets means that a same lender of last resort is also needed to cope with international financial crises. The IMF may not be ideally suited as it has little power to regulate banks on a continuing basis like the Fed in the USA, or the Bank Indonesia in here, until a country plunge into crises itself. The IMF also makes mistakes; its program, in particular in Asia, has been bitterly criticized, but the IMF is all that is available and a lot better than nothing at all. So far, talks about the possible creation of the Miyazawa’s ‘Asian Monetary Fund' or the ‘Banco del Sur' as alternatives to the IMF in the Asian and South American regions still look gloomy to say the least.
Economists and historians will be debating the causes of some crises; especially the Asian financial crises may be for a longer more time. What is clear today is that a central element in spurring the crises was a loss of confidence on the part of both these countries’ own citizens and foreign investors. Confidence eroded for many reasons, including the belated recognition of severe policy errors, the accumulation of large debts, the changing global economic environment, the manipulative devaluation of currencies, and massive corruptions
The content of the IMF programs will be a matter of continuing debate and evolution, but an international lender of last resort is what the world's economy needs. Without the IMF, the world economy would not become an idealized of perfectly liquid, completely informed, totally unregulated international capital markets. Investors and lenders would still make decisions on the basis of imperfect information, and they would have to take into account the absence of an international lender of last resort, which would be a serious, and perhaps devastating, defect. In fact, there was no IMF in the 1920s and 1930s, and the results known included widespread competitive devaluation, trade wars in response to the BOP problems, followed by a plunge into the Great Depression and two World Wars as stated earlier in the beginning of this article.
In a world of open international financial markets, fundamentally good financial policies may run into temporary liquidity problems. In a world of flexible exchange-rates, such temporary problems can be augmented by accompanying drops in the value of the domestic currency as is currently seen in Indonesia attributable to the US Federal Reserve's "Quantitative Easing Program" and compunded by the "Trump Tantrum" (Putera Satria Sambijantoro, 2018). The IMF programs finance the adjustment necessary to give these countries time to let their fundamentals pay off to salvage their BOP problems. It imposes strict conditions on these countries to qualify for loans from the IMF. After all, a country with BOP problems has some kind of economic unhealthiness; thus requiring taking bitter pills and strict physical conditions for restoring its economy.
Some events in the emerging markets could have spillover effects on the world economy as a whole. Growing economies provide greater opportunities for investment and international business, so an institution like the IMF that sustains productive capital flow when needed by developing countries also sustains world economic growth. More importantly, countries that run into significant BOP problems would only have two options ‘without’ the IMF: default or devaluation. As seen in the interwar years, either of those could induce reactions by other countries that made a situation worse (like the Austrian Credit Anstalt failure; the protectionist U.S Smooth-Hawley Tariff Act); but together they can make the global economy rapidly and very dangerously spiral downward. This chain of events is precisely what the IMF was created in 1944 to prevent.
CORPORATE GOVERNANCE CHANGES IN SOME TRANSITION ECONOMIES REVISITED: LESSONS LEARNED FOR INDONESIA
by Prof Nizam Jim Wiryawan Posted : 2 August 2018
Transition economies, or “emerging economies”, are economies which are moving away from the centrally controlled economies to join an open market reforms generally through programs like deregulation, privatization of state-owned firms and further opening the country for foreign direct investments. Like the term “centrally planned economic” says, almost all of these centrally controlled economies used to have a State Agency for Economic Planning, like in the former USSR, North Korea, Cuba, Eastern Europe, Central Asia and the People’s Republic of China. These State Planners make ‘top down’ decisions about what goods and services are produced and in what quantities; consumers can then spend their money on what is available within the country where no imports are allowed.
Since not all ‘transition economies’ have economically emerged by undergoing impressive changes in their economies and, consequently, grow as vast markets, like e.g., Brazil, China and India in line with what Rostow’s (1971) argued as ‘state of economic development’ model, this article use to the more generic term of ‘transition’ rather than ‘emerging’.
Countries experiencing rapid economic expansion and industrialization are specifically commonly referred to as the ‘Newly Industrialized Countries/NIC’, like Singapore, South Korea and Taiwan, or the oil-driven ‘emerging MENA countries’ in the Middle East and North African regions, resulting in what Keegan (1989:7) termed as a ‘semantic jungle of terminology’.
China, for example, started its quantum leap changes in the macro-economic policy in 1978 during the era of Deng Xiaoping, from a ‘highly centrally planned economy’ to a ‘managed market economy’, two years after the death of Mao Zedong, the Chinese conservative helmsman. With a clear vision ahead on its economic strategy and the turn around programming of its lackluster, inefficient and massively corrupt Chinese bureaucracy into a relatively ‘cleaner’ civil service with a pro-business attitude, PRC had transformed its economy receiving more than $50 billion foreign investment every year coming from more than 500 largest world-class corporations. Deng’s popular phrase inciting social, political and economical transformation were: “Bu guan hei mao bai mao neng zhua dao laoshu jiu shi hao mao”- 不管黑貓白貓能抓到老鼠就是好貓 - (“It is irrelevant whether a cat is black or white as long as it can catch a mouse”)
In 2005, there were more than 250 million people classified as middle class in China, and the number is growing at the rate of 13 million per year. It is predicted that in 2020, China’s middle class will number more than 500 million people, attributable to its market transformation success story. Today, China's export to the US only worths US450 billion (Lili Yan Ing, 2018) which is mostly attributable to its transformation from a backward economy into a world-class economic Juggernaut within the span of almost four decades.
China opened its door to foreign investments in 1979 and now enjoying a yearly economic growth around 6-7%. Under PRC’s economic reform since 1979, massive institutional change has dismantled many barriers to modern business operations. Institutional change in PRC is highly complex because in this formerly very closed, very state-dominated, institutions had then developed into a hugely massive inter-dependent, powerful multi-level network whose logic of operation in its governance depended much on political influence and personal relationship as on concern for efficiency.
Because of the sensitivity of political and social influences, PRC has since followed a principle of ‘pragmatism’ with the aim of balancing the pace of reformative changes with social stability. This principle has enabled PRC to support fairly continuous economic reform without significant conflict between the country’s political and/or powerful military factions. It has, however, created uncertainties for both international and local firms as to the speed and direction of the reform during its early years, as is also seen in Indonesia today, twenty years after the fall of an autocratic regime in 1998 and the start of the so-called Reformasi. Additionally, a series of the trade liberalization and market deregulation programs in Indonesia has in effect already started in about the same time with China, i.e in the early 1980s, but lacking in ‘visioning, repositioning strategy and leadership’ to follow the successful paths of China and India.
To justify PRC’s transition to a market economy, its leaders like Hu Jin-Tao in the past and Xi Jin-Ping today creatively defined their goal as to develop a ‘market system with socialistic characteristics’ dominated by the State-Owned Enterpises. This has meant that some sectors and regions have been more exposed to market competition and have changed faster than others in a State Capitalism economic model. Nevertheless, by the early 1990s, most transactions in PRC had already been successfully enacted through the markets. They have moved increasing number of economic transactions from governance by personalized bureaucratic administration to impersonal contractual exchanges.
At the other side of the borders, the former USSR’s Republics have also undergone unprecedented economic, political and social transformation since the downfall of the USSR in 1989. Economic reform, deregulation, privatization and foreign direct investment have proceeded at varying rates throughout the region, altering the nature of competitive environment. There is evidence of increased levels of competition and of major changes in the nature of customer demand with significant advances in the sophistication of demand and intensity in competition in these countries too. Firms with a tradition of operating in a command economy with its notorious underlings like inefficiency, corruption and ineffectiveness, were suddenly faced with the necessity to change to command new skills, systems and governance to compete in a new market-driven environment.
Another transition economy successfully emerged as a robust world-class marketer is India. If PRC started its market liberalization during the Deng’s premiership at the end of 1970s, India started its own economic transformation during the era of Manmohan Singh in 1991 when he, as the then-finance minister, dramatically purged several socialistic rigid economic systems and changed them with a more market-oriented approach, rendering India a yearly economic growth of about 8% and, thereby, becomes one of the largest world exporter today. India has also 300 million middle class people to support its emerging market position
As a comparison, Indonesia’s economic growth is still below expectation with Gross Domestic Products/GDP growth slowed to 5.1%, with still a declining trend. Earlier, the International Monetary Fund/IMF had predicted Indonesia’s growth in the 5-6% range, only less than the growth in PRC or India as examples of successful ‘transition economies’ transforming themselves into ‘emerging markets’. Extant literature in international business on economic reforms in transition economies have by-and-large focused on PRC, India, Eastern Europe and Central Asian countries, with lesser attention to other transition economies; hence literature on Indonesia in the international business is also very scarce.
In the general term of management theories, in order to uphold and maximize efficiency, institutions ought to develop and govern their activities following standardized systems and organizational rules (Pearce and Robinson, 2003), to create and sustain competitive advantages (Dess, Lumpkin and Taylor, 2004). Institutions are social, economic and political bodies that articulate and maintain widely observed norms and rules in their governance (Scott, 1995). Any change in their governance may disrupt these routines and can be further seen as a threat to the establishments, making change very difficult because of the strong internal resistance as posited by Hannan and Freeman (1984) and by Granovetter (1985). Several other studies (Amburgey, Kelly and Barnett, 1993; Greenwood and Hinings, 1996; Greve, 1998; Miller and Chen, 1994; Rhenald Kasali, 2006) have all argued that organizations strongly resist change in most cases.
At the other end, however, Kanter, Stein and Jick (1992) and Kanter (1995) stated specifically that the third millennial label and transformational implications suggest the possibility of an equally profound change in the economic foundation and organization's structure. Since today’s (business) environment is increasingly more volatile and riskier than ever, there is a danger looming if and when organizations do not know how to adapt and change in time. The challenge is even more extreme in transition economies undergoing unprecedented changes in almost all fields like legal, social, culture and economic institutions in their quest for adaptation to the newly reformed environments. As Hoskisson, Eden, Lau and Wright (2000) posited, organizations in transition economies are facing strong environmental pressures for change, but these changes are neither smooth, automatic, nor uniform across markets.
Since change is definitely inevitable and organizations strongly resist change, it is therefore necessary to learn what facilitates and what inhibits organizational change, in particular in the transition economies. Extant organizational change theory, however, provides only limited insights into these questions. Until recently, organizational change studies in transition economies have focused more on state-level policies effected by liberalization and privatization with firm-level strategy relatively untouched.
CONCEPTUAL FRAMEWORK OF ORGANIZATIONAL CHANGE
Kanter et al (1992) stipulated that when people discuss “organizational change” they create more heat than light as a common experience, since certain words and phrases are full of ambiguity. It is at once a source of strengths and also of weaknesses. Even philosophers have been for centuries struggling with the concept and definition of ‘change’ though obviously not tied to business. One example is Heraclitus (circa 504-501 BC; some, like The American College Dictionary, 1961: 565, claim that he was born in c.a 535-475 BC), an Ephesians nobleman dubbed the ‘wheeping philosopher’, is known to many for the famous saying that “All things are in a state of flux” (Coplestone, 1985:39). Heraclitus does indeed teach that Reality is constantly changing (Panta Rei), that it is its essential nature to change.
But Heraclitus was emphatically not thinking of a deliberate change. Any idea of a deliberate and transforming change tampering with the basic character of things then was blasphemy to the ancient Greeks to say the least; if not a sure path to disaster which was fundamental to the Greeks’ great tragic drama.
The American social psychologist Kurt Lewin (1890-1947) was widely nominted as a pioneer of the systematic study of planned and deliberate change in the mid 1940s. His model was a simple one, with organizational change involving three stages: unfreezing, changing and refreezing. Lewin was also famous for being the originator of the ‘action research method’ marrying theory and practice by stressing that all general plans should be flexible, not frozen. Deliberate change is, therefore, a matter of grabbing hold of some aspects of the motion and steering it in a particular direction that will be perceived by key players as a new method of operating or as reason to reorient one’s relationship and responsibility to the organization itself, while creating conditions that facilitate and assist that reorientation.
This change occurs in a variety of forms: new technology and procedures, new products, new clients, new systems, new process, or anything else new to the organization. More recently, theorists (see: Brown and Eisenhardt, 1997; Feldman, 2004, Tsoukas and Chia, 2002) have argued that a continuous and evolving view of organizations is a more fitting description of the change phenomenon, given the highly uncertain and volatile markets like in the transition economies in particular.
Moreover, change necessity is not limited to the private sectors. Government agencies and public servants need to undertake reforms so comprehensively and lay the groundwork to improve government performance, though the profound differences in their purposes, their cultures, and the context within which the public sector operates quite different obstacles than the private sector like in the case of China. The greatest challenge in bringing about successful change and significant, sustained performance improvement in the public sphere is not so much identifying solutions, as working around some unique obstacles.
Substantial attention must therefore be devoted to motivated adaptation as a component of change. For example, it is often argued that consumer products, advertising campaigns, distribution policies -- and first and foremost the service industries like hospitals, schools/higher learning education -- are more likely to function more effectively when they are modified, or changed, to reflect local market dynamics as motivation. Existing normative advice focuses on criteria that lead adaptation as a change component, including differences in cultural motivations, consumer preferences, as well as in labor practices.
Other theorists conceptualize a firm’s learning capability as a major source of its adaptability to change phenomenon, like how organizational learning impacts a firm’s change capability in a multinational expansion (Makino and Dellios, 1996), diversification decisions (Pennings, Barkema and Douma, 1994), innovation (Cohen and Levinthal, 1990), and international joint venture survival (Barkema and Vermeulen, 1997). These theorists have by-and-large supported the central core of the organizational learning perspective in that learning enhances capability to (1) learn, and (2) absorb changes adapted to the environmental needs since change does not take place in a vacuum, but rather has “to cope with confusing experience” in specific environments (Levinthal and March, 1993:95).
Business expansion into transition economies like Brazil, China, India, Indonesia, or the former USSR, which are characterized by a tremendous amount of environmental turbulences, is perhaps more difficult in practice and necessitates greater efforts in organizational learning. Within each of these countries, unfamiliar organizational forms and inconsistent regulations have often forced firms to operate in a different corporate systems and regulations as mandated by these environments.
It is believed that ttransaction and agency costs are also high in these transition economies. Institutional changes, if adopted, are expected to reduce these transaction and agency costs in many ways. The development of efficient markets, with more transparent rules of the game, reduces transaction and information costs, while the institutional specifications and enforcement of property rights also reduce transaction costs. By properly honoring property rights it reduces the risks of unauthorized appropriation, and, hence, the costs of monitoring the use of technology, enhancing the range of technology that foreign organizations are willing to provide, especially the introduction of advanced technology which itself is a centrifugal mechanism for improvements in the efficiency of the organizations.
Many firms in transition economies also face conditions that provide neither specialized resources and institutional supports nor adequate financial, educational, political or legal infrastructure. In these transition economies, firms may play a vital role in addressing basic social needs like clean water, new farming techniques, jobs, but are not compensated by their wherewithals.
THE CORPORATE GOVERNANCE AS SYSTEM
Corporate governance and governance institutions are commonly concerned with the means by which a firm’s stakeholders control the decisions made by corporate senior management. Any stakeholder can try to use market exit and/or voice to influence firm’s decision (Noteboom;1999)
Corporate governance operates differently in two broad categories. In an Anglo-American environment the governance criterion is narrow, and usually restricted to shareholders, inclusive outside investors (like lenders), trying to ensure that they are not exploited by opportunistic senior managers within the firm. The monitoring of the management performance are based mainly upon carrots and sticks, where labor and capital employed by the firm usually show low levels of commitment.
Capital is often withdrawn from one firm for higher expected returns elsewhere (see, e.g Boston Consulting Group's Growth-Share Matrix), with the impact of this withdrawal may penalize and reward managers through a system called ‘market capitalism’. Here, stock price significant reductions may lead to hostile takeover threatening the service of the weak senior executives. Conversely, high stock prices may increase their pay. This variety of capitalism depends on high levels of information disclosure to outsiders to inform investment decisions and, concurrently, the laws that protect minority shareholders.
These individual elements work together to support a governance system, and radical attempts to change one element may be frustrated by a lack of needed additional changes. Indeed, one variant of the literature of governance systems sees global convergence on stock market capitalism as a clear possibility.
In a second category of corporate governance, however, beyond the Anglo-American environment, corporate governance usually refers to the means by which any of the firm’s stakeholders may control management’s decisions. These stakeholders are usually highly committed to the firm and are prepared to contribute to its good governance. The transition economies generally adopt this governance system. Business expansion into transition economies such as China, India, Brazil, Eastern and Central Europe, and Indonesia, which are characterized by a tremendous amount of turbulence, is perhaps more affected by these stakeholders’ governance system necessitating greater efforts in both organizational learning and governance change.
Within each of these countries, fragmented markets, unfamiliar organization forms, and inconsistent regulations have often forced firms to learn how to operate and adapt to different local markets. Using a meta-analysis of the ‘contingency theory’ literature on the PRC’s textile industry study, Wiryawan (2005), concluded that in a transition economy with shaky environmental dynamics like in China, a firm’s performance is significantly enhanced when top management welcome these changes since innovations in corporate governance in China are dictated by these environmental dynamics.
In Indonesia, for example, only small percentages of the total stock of large firms are in free float, trading volumes are relatively low, and information disclosure for outsiders is still quite weak (Kanto Santoso, 2003). Insiders such as employees, bank shareholders, and inter-locking shareholders are, however, well informed. It is their influence through a two-tier board system (i.e management and board) that control the behavior of the executives since these stakeholders are often represented on its boards or in the work council in the case of employees. They also function as opinion feeders to the boards. Rhenald Kasali (2006) stressed that full commitment from these stakeholders is a prerequisite motivation for any organization in attempting changes.
Within these two categories of corporate governance, (1) would the system in one country change be able to take advantage of, be learned from, adopt, innovate, developed in the other country? (2) must such innovations be rejected totally or subject to some degree of adaptation? To address these related questions, these hanging questions need to be investigated further to suggest fresh implications on firm level governance changes with specific reference to Indonesia.
THE DRIVERS OF CORPORATE GOVERNANCE CHANGE
The factors that commonly drive firms to change are ‘technical organizational changes’ (Brown and Duguid, 1991; Damanpour, 1991); ‘administrative organizational changes’ (Tsoukas, 1996), and ‘national cultures’ (Hofstede, 2002; McSweeney, 2002; Williamson, 2002). Some of technical organizational changes refer to products, services and production technology. Administrative organizational changes involve around organizational structure and administrative process specifically the way of recruiting and training personnel. National culture is categorically classify as a collective programming of the mind, where a national culture value is felt to be in the system of the country’s educational institutions.
From the point of contingency theory (which emphasizes the ‘fit’ between environmental contingencies and internal organization), it is argued that top management is implied as being professionally reactive, that they can take the initiative to adapt capabilities to changes to make the firms able to evolve together alongside the environment. Firms can therefore positively impact performance.
As organizational change is seen in general as a risky decision, managers ought to have legitimate reasons and compelling motivation to break their existing routines by ‘changing the rule of the game’ as stated by Rhenald Kasali (2006:11). Using the ‘sigmoid curve’, Rhenald Kasali (2006) cited several Indonesian firms as examples of local corporations that have lived their good and their bad years, the ‘ups’ and ‘downs’ throughout their corporate history (or past performance) necessitating to perform all kinds of efforts in managing the survival of the firms. The driving forces behind the changing rule of the game need strong reinforcement against the resistances if firms will succeed. Past performance is, therefore, one such motivator.
Existing literature, anyhow, have provided inconsistent predictions regarding the relationship between past performance and corporate governance change. Some scholars (Greve, 1998; Miller and Chen, 1994; Rhenald Kasali, 2006; Tushman and Romanelli, 1985) suggest that poor performance in the past widens the gap between managerial aspirations and achievements, thereby providing a strong incentive for firms to look for their own new ways to improve. Damanpour (1991) argued that past performance has only vague implications for future performance in administrative changes such as reforming the personnel management system and in restructuring business operation system. Some others argued that even good performance continuously motivates firms to change, especially in uncertain environment.
Change, therefore, may comprise continuous systemic, regulatory governance changes, perhaps imposing on firms changes borrowed from other governance systems, as well as the spontaneous, imitative diffusion at a firm level of specific governance innovations originating from another as a learning process.
In the context of the attributes of individual firm’s governance elements, it maybe useful to consider theories of ‘innovation translation’ as proposed by Law (1992) and by Czarniawska and Joerges (1996) who identified cooption where social systems absorb changes, in the sense that they defuse, dilute and recalcitrantly turn to their own advantage the energies originally directed toward change. This theory was developed in the context of innovations in applied science, and provides an intermediate position between technological determinism and social reductionism. Both can never be separated in a clean way as there can never be purely technical or purely social factors being arranged in a heterogeneous network (Biggart and Guillen, 1999; Law, 1992; McLean and Hassard, 2004). Moreover, the adoption of an innovation through a learning process leading to change in the governance depends upon the power, belief and commitment of the executives (Rhenald Kasali, 2006)
Firms can be aware of alternative methods of doing business through two sources. Firstly, the market environment in which firms locate offers vivid examples of how various competitors operate and perform, providing firms with the opportunities for organizational changes in a learning process (Greve, 1998). More specifically, Huber (1991:89) noted that ‘an organization learns if any of its units acquires knowledge that it recognizes as potentially useful to the organization’. Of particular importance is Mach’s (1991) distinctive category between ‘exploration’ and ‘exploitation’ in organization ways leading to organizational change. Exploration includes ‘things captured by terms such as search, variation, risk taking, experimentation, play, flexibility, discovery and innovation’, whereas exploitation includes ‘such things as refinement, choice, production, efficiency, selection, implementation, and execution’ (March, 1991:71).
While both are important in rendering changes, there is a trade-off between the two, since ‘exploration of new alternatives reduces the speed with which skills at existing ones are removed’ (March, 1991:72). Since knowledge incorporates implicit and tacit dimensions along with those which are explicit and codifiable (Kogut and Zander, 1992), organizations must see change as an opportunity permitting them to gain more tacit knowledge.
Second, organizations, especially business firms, can actively seek new alternatives by monitoring customers and competitors closely through a market orientation. In most transition economies like in the PRC as example, institutional reform has been non-linear and has displayed a mixture of progress and regress because of its sensitivity to political and social considerations (Park and Luo, 2001). Subsequently, out of consciously experimental reforms, different governance systems have emerged in different areas (Boisot and Child, 1996). Areas designated as reform zones have been the most affected. Inconsistencies in the reform agenda give rise to wide variations in the economic development, business atmosphere, and government policies across different areas (Lau, Tse and Zhou, 2002); as is seen in most, if not all, transition economies including Indonesia.
Accumulating knowledge on the reformative efforts in transition economies help firms overcome their initial concerns while reducing operational uncertainties and enhancing performance. In other words, due to ‘time compression diseconomies’ (Dierickx and Cool, 1989), firms in the transition economies may acquire a significant competitive advantage compared to firms that are not in that economy (Shaver et al, 1997). In general term, the longer firms operate in a specific transition economy, the more capability they tend to develop. As a result, lethal disadvantages due to the inexperiences or foreigness can be significantly compensated through their adaptability and willingness to change in their governance.
Firms with a greater length of local presence in the transition economies are also likely to have a superior position in selecting market segments, differentiating product offering, accessing promotion channels, and building up corporate and product image as concluded by Wiryawan (2005) in his study on the ‘Hongdou’ apparel industry experience in the PRC. This length is also positively related to cooperation with partner firms. Moreover, a long established presence in a transition economy such like China often results in a favorable image perceived by local customers, suppliers, competitors and governments (Child, 1994), well-established marketing and distribution networks (Shenkar, 1990), familiarity with culture-specific business practices (Luo, 1997), and greater ability to reduce operational uncertainties and financial risks (Luo, 1998).
The relationship between organizational learning, change capability and economic performance may be moderated by the organizational environment in the transition economies. Firms clearly need to pay attention to environmental forces as McCarthy, Puffer and Simmonds (1993) found out that firms often seem to be on a ‘roller coaster’ in these economies. Given that the institutional, economic and socio-cultural environment environments are dramatically different from those in the developed economies, it can be argued that environmental uncertainties can easily establish prior learning gained in these developed economies ineffective in such a dynamic new setting. Organizational learning is, therefore, a multidimensional construct imposing severe constraints on the firms’ ability to perform effective and efficient governance of the firms, which, subsequently, influences organizational performance.
While a number of conceptual dimensions of organizational environment have been proposed (see, e.g.: Aldrich, 1979), empirical research has concentrated on a set of three key features (Keats and Hitt, 1988), namely (1) hostility (i.e., importance and deterrence of environmental factors); (2) dynamism (i.e., predictability and variability of environmental factors); and (3) complexity (i.e., diversity and heterogeneity of environmental factors). In the transition economies, these factors not only concern competitors, customers, and suppliers, but also institutional and socio-cultural segments.
Tan and Litschert (1994) suggested that the environment in a transition economy, marked by an inconsistent regulatory regime, poorly developed markets, and low protection of property rights, is typically hostile. In such an environment, a firm’s experience may become more valuable if it can turn its governance through a change within its system to adapt to this hostile environment. Shan (1991), has argued that experience in dealing with strong environmental dynamism increases the firm’s ability to monitor the external environment, analyze changes, and seize opportunities. In short, in a fast-changing, dynamic context, experience gained in such an environment is likely to contribute more to the growth and survival of the firm.
The diversity of the market exposes firms to a variety of new ideas and process, which enable them to initiate changes. Moreover, in a highly competitive environment firms learn more about the operations of their competitors and the demand of the market. This helps firms generate insights about taking new actions such as obtaining state-of-the-art technologies and modern administrative systems to keep up with competition. In contrast, in less developed areas the legacies of the country’s planned economy are still seen: competition is minimal, government intervention is strong, and resources are limited. Even if they have strong motivations to pursue new opportunities, their limited exposure to new information sources constraints their ability to find new ways to initiate changes, and forces them to rely on special collusive and corruptive connections to compensate for such constraints and disadvantages.
This attempt, however, has been hampered by the entrenched routines and historical influence of the planned system. Peng and Heath (1996) argued that most of these SOEs executives are selected not on the basis of their technical expertise or managerial capabilities, but rather according to their ability to follow executive orders and political connection. Their inability to master modern technology and managerial efficiency greatly hinders the organization’s capability to change. In contrast, non-SOEs were born as market-based firms, so their managers tend to develop a strong sense of market competition and take quick actions to respond to market changes.
One difficult challenge in reforming the country’s economy in a transition economy is the rechartering of the SOEs. Most SOEs are infamously known for their inefficiency and lack of concern for profitability. Under the old planned economy, SOEs survived and grew through managing their socio-political networks in a manipulated economic system
For any business, SOEs and non-SOEs, one critical capability of change lies in the quality of the leadership, because change essentially requires leaders to create new system and institutionalize new approaches. Major changes are impossible if the leaders of an organization possess unfavorable attitudes, as they may cause one of the most important sources of political resistance. The leaders’ favorable change attitude can also facilitate organizational climate that support changes, disrupts existing bases of power, and overcomes internal political constraints.
The implementation of organizational change (ownership, systems, technology) is difficult because it may disrupt the existing stable work routines and requires that members of the firm learn new patterns of communication flow, integrate new members to fill new job functions, and establish new work routines to manage the altered work flow (Haveman, 1992). The success of organizational changes needs blanket acceptance and the support of employees at different ranks in the firm, suggesting the importance of a participative culture in implementing these changes.
This participative culture emphasizes the importance of unity, cooperation, and belonging among employees, promotes employees’ understanding of both the firm and the market, and encouraging their participation in decision-making.
In order to fully understand the business environment, it is best to consider important culture differences in a newly reformed market like China. National culture is defined as the values, beliefs and assumptions learned in early childhood that distinguish one group of people from another (Hofstede, 1991). This definition is consistent with Hofstede’s (1991) notion of national culture and common theories of shared behavior or mental programs. National culture is embedded deeply in everyday life and is relatively too rigid to change, especially in a ‘high-context’ society of the Confucian societies like China where this Confucian culture has been embedded for many thousands of years.
National culture is a core organizing principle of employees’ understanding of work, their approach to it, and the way they expect to be treated. National culture implies that one way of acting or one set of outcomes is preferable to another. When management practices are inconsistent with these deeply held values, employees are likely to feel dissatisfied, distracted, uncomfortable, and uncommitted. Consequently, they may be less able or less willing to perform well. Management which reinforces national culture values are more likely to yield predictable results, self-efficacy and better performance because congruent management practices are consistent with existing behavioral routines that are embedded in the workplace.
Never-the-less, very few countries in recent history have experienced the number and magnitude of societal changes that have occurred in China since the Qing Dynasty. Many of these changes were deliberately designed to radically reshape beliefs and attitudes which logically may have had marked influence on the cultural values of the Chinese workforce and, in particular, its executives.
The Republican Era (1911-1948) followed the Qing Dynasty's demise. During that era, Confucianism flourished and a Western presence was prominent in the commercial areas such as Shanghai. The People’s Republic Consolidation Era (1949-1965) which followed was characterized by violent purges against the educated, and an attempt to replace Confucian ideals with Maoist doctrine. During that period, anything Western was destroyed. The subsequent Great Cultural Revolution Era (1966-1976) only served to intensify the attacks initiated during the Consolidation Era earlier. The Social Reform Era (1977-present), initiated by Deng, saw a movement back to the acceptance of Confucian cultural values and commerce with the West, including some acceptance of the influence that would usually attached with this global commerce (Lin, 1995)
To understand the essence of the cultural evolution from the previous two periods under Helmsman Mao’s “work for the good of society” philosophy can be captured by Deng’s acknowledgment that ‘a few flies’ (or Western culture) would likely come through the open door economic policy, in the new and pragmatic ‘to be rich is glorious’ plan to modernize China by the early twenty-first century.
IMPLICATIONS FOR INDONESIA
The change in transition economies has three related implications for future developments of the Indonesian market. These concern (1) the way the transition is modeled, (2) the need to draw upon multiple perspectives, and (3) the concomitants of contextual approach.
In the modeling of the transition process the common view of transition envisages a process of institutional change coming from the exposure to global ideational forces. The exposure is seen as to foster the development of efficient markets, business governance and supporting competencies. Institutions defining the important rules for business operating in transition economies are expected, in effect, to intervene between global governance forces and the individual firms. This two-stage model of the change process in corporate governance is overwhelmingly consistent with the developments in China for example, but requires some reservation in other transition economies with still strong remaining sense of protective state paternalism in the sense that an open market economy is a derivative of global capitalism usually dubbed as Neoliberalism in Indonesia.
Viewed from the multiple angles, most attention to the logic of the economic transition has centered on economic and technological areas. This focuses on the creation of efficient markets and the conditions for technology transfer. Both economic theory and the theory of technological change are perspectives that soften the impacts of national distinctiveness.
In the sense of a contextual approach (Child and Tse, 2001), it is suggested that contextualization offers an opportunity for the further development of international business theory. Two inherent characteristics of the transition economies provide backlashes for such development, namely (1) state paternalism and (2) complexity in transition economies.
China, and to a lesser scale also other transition economies like the former USSR republics in Central Asia, Eastern Europe and Indonesia, exhibit a form of transition from centrally planned economies that retains considerable state power in the economy and state sponsorship of firms. State sponsorship involves a combination of political and economic motives. It has a long tradition that predates in the protective planned economy period. These states have consistently yielded to themselves a paternalistic role towards business since the incorporation of themselves as rulers.
Even after years of economic reforms, these old practices die hard. State paternalism remains a dominant feature to be reckoned with. Even as former SOEs convert formally into joint stock firms, the state retains much of its controlling role in the corporate governance as, again, in the case of Indonesia.
Another challenge is presented by the complexity of transition economies. From the above review it can be deduced that change in transition economies is not deterministic in nature, but involves an inter-play between source of forces operating at different system levels. This view is not only applicable in PRC but also in the former USSR republics and Eastern Europe. This complexity is being manifested by the way their leaders addressing change.
As noted, these leaders are endeavoring to change their countries institutional legacy through a policy of disequilibrium and non-linear progression intended to accommodate basic strains within the system, especially between the goals of reform (or REFORMASI for Indonesia) and social stability. The inability to apply a simple linear model of transitional change means that firms need new tools to function in dynamic and complex environments. The challenge for the managers is how to model non-linear complexity and analyze its implications.
Complexity-reduction capability (Boisot and Child, 1999) attempts to reduce complexity by bringing it under monitoring control through quality corporate governance applying standard policies commensurate with modern managerial system. The second option is to absorb the complexity by enlisting the support of local allies within the present government or outside. This follows a greater degree of participation in local relational systems and might, therefore, raises the transaction costs of social exchange. This is a theoretical corridor worths pursuing, particularly if it is combined with an examination of relevant variables. Historically it is also the approach adopted by Chinese firms to cope themselves with their environment.
CONCLUSION AND DISCUSSION
This article attempted to assess how firms adopt transformational organizational changes in the transition economies. Taking a continuous view of organizational change, this article examined the drivers of organizational changes in administrative and technical areas, and how these changes affect subsequent firm performance. As such, this article focused to examine firm-level adaptation issues in transition economies. Apart from that, this present article contributes to the extant literature in two additional ways.
First, the conclusions posited that continuous organizational changes are driven by a firm’s motivation, opportunity, and capability to change, and thereby add to literature that focuses primarily on episodic, eventful changes. In particular, this article concludes that past performance motivates firms to undertake administrative changes, whereas good past performance drives firms to make more technical changes. In a market experiencing unprecedented transitions, firms tend to embrace technical changes more actively, especially when they have the necessary resources (financial or allies).
Participative culture is also found to have positively moderated the effects of administrative changes on performance. Overall, the conclusion is that change plays a positive role in transition economies, supporting the claim from the continuous organizational change camp that change is necessary if not mandatory for firms’ success in volatile environments.
As organizational changes are by nature full of turbulences and tend to encounter strong internal resistance, firms must recognize and manage those factors that drive or inhibit organizational changes, adopting Lin’s (1998) pragmatism. Managers must know the differences of technical and administrative changes and be able to overcome the possible pitfalls of administrative changes and strengthen their effects on performance by eliminating the historical umbilical cord that was rooted in the era of planned economies.