Infrastructure Development and Efficiency of Government Capital Spending

By: Abdurohman – Mofilink Canberra

Introduction

In the last two decades, Indonesia has been experiencing two financial crises; the Asian financial crisis (AFC) in 1998 and the Global financial crisis (GFC) in 2008. Although suffered an unprecedented fall, contracted by 13% in 1998, the economic growth trajectory has been very promising since then. Up to the onset of the GFC, the annual economic growth was well above 6%. However, the GFC which rooted from the financial sector debacle in USA hold back the economic performance. The economic growth slowed to 4.5% amidst the ongoing crisis in 2009, though still the third highest among emerging economies after China and India. Stronger economic fundamentals compared to periods before the AFC, relatively insulated from the financial contagion, less external demand dependent, and appropriate government policy responses are among the saviours. In 2010, the economy bounced back and recorded 6.1% growth.

One concern regarding the economic growth prospect of Indonesia is dealing with the infrastructure condition. It is widely recognized that poor infrastructure conditions has become one of the main obstacles for accelerating growth in Indonesia. According to David Ray, Director of Indonesia Infrastructure Initiative, inadequate infrastructures have been the main factor preventing Indonesia’s economy from growing at its potential rate which is believed around 8%. Well-functioning and extensive infrastructures play a fundamental role in enhancing the growth prospects of an economy. Both the extent and the quality of infrastructure are important in raising private-sector productivity and investment rates, particularly the adequate functioning of roads, railroads, ports, and air transport, as well as a reliable energy supply and telecommunications network.

According to the Global Competitiveness Report 2011, Indonesia’s infrastructure is ranked 82nd among 139 countries surveyed, requires improvements across many areas. It is well behind more advanced ASEAN members Singapore (5th), Malaysia (30th), and Thailand (35th), and also less developed than China (50th) and Brazil (62nd). Indonesia’s infrastructure position is worsening; falling from 78th previously, as many other countries are moving more quickly to improve their infrastructure. Within ASEAN, Indonesia is only slightly better than Philippine. Table 1 below describes Indonesia’s infrastructure condition compared to other ASEAN countries. Indonesia is only slightly better than Philippine, while Singapore is on the top followed by Malaysia and Thailand.

Table 1 Infrastructure Quality in ASEAN

Country Roads Rail road Seaport Air transport Electricity

Score (out of 7)*

Singapore

6.6

5.8

6.8

6.9

6.7

6.6

Malaysia

5.7

4.7

5.6

5.9

5.7

5.5

Thailand

5.1

3

5

5.9

5.7

4.9

Indonesia

3.5

3

3.6

4.6

3.6

3.7

Philippines

2.8

1.7

2.8

3.6

3.4

3.2

Source: The GCR 2011

The infrastructure challenges ahead are even bigger. Relatively high population growth, a raising middle income class, urbanization and rapid economic growth lead to the increase of demand for infrastructures, putting further risk of supply bottleneck and shortages. For instance, the number of vehicles in Indonesia quadrupled over the past decade to reach 11.3 million. At the same time, 40 percent of the population remains without access to electricity.

The insufficient supply and quality of transport, energy, and telecommunications infrastructures seriously limit Indonesia’s output capacity. The manufacturing and export sectors particularly suffer as poor infrastructure condition translates into limited connectivity and handling capacity, high costs, delays in shipments, and production loss. It is no doubt that inadequate infrastructure has become the top concern of doing business in Indonesia according to the GCR 2011.

In order to meet the increasing demand for infrastructures, or even overcoming the shortages, investment must therefore increase. Unfortunately, Indonesia suffers from a protracted lack of investment in this area. As most infrastructures are public goods, their development rely more on government funding. Lack of government financial capacity then has been pointed out as a major constraint of the infrastructure development in Indonesia. Though Public-Private Partnership (PPP) has been introduced lately, lack of institutional capacity as well as problem dealing with regulatory framework also failed to help further infrastructure development in Indonesia (Ramayandi and Bastaman, 2011).

Despite the limited government resources, efficiency of government capital spending which is the main source of infrastructure development has also become a concern. Weak budget execution, corruption through brokerage practices (budgeting and project bidding), and poor project management are all reflecting a lack of efficiency of government capital spending. With this in mind, total value of government capital expenditure will not necessarily be translated wholly into public investment. Therefore there will be a gap between actual government capital expenditure and actual government investment. This gap can be used as a measure of inefficiency. This paper is aimed to provide a qualitative as well as quantitative analysis of government capital spending inefficiency in Indonesia by adopting a newly developed index, called Project Inefficiency Management Index (PIMI) (Dabla-Norris et al, 2011).

Government Capital Spending Inefficiency

As indicated above, there are two major factors surrounding the efficiency of government capital spending; the weak budget institution and poor project management. It is widely recognized that weak budget execution of government capital spending has become factor behind its inefficiency. The weak budget execution of government capital spending is reflected two indicators; its annual budget absorption and its monthly distribution of its disbursement. The annual budget absorption measure the percentage of realization of government capital spending compared to its budget. While the monthly distribution measures the percentage of disbursement in each month to indicate whether the disbursement is even or skewed to the end of the year. If the disbursement is largely skewed to the end of the year, it indicates lack of efficiency.

Looking at Chart 1 below, it seem that since the AFC, the gap has almost been negative, except in 2003 and 2009, indicating that the realized government capital spending much lower than what has been initially planned. This negative gap indicates low absorption of the government capital budget that in turn reflects weak budget execution. The positive gap in 2009 was mainly due to the additional budget under the fiscal stimulus package (FSP) in response to the GFC.

Since the benchmark is the budget (APBN) not the revised budget (APBN-P), the gap not only reflects the weak budget execution but also the development of economic state. For instance, the positive gap during 1985 – 1995 reflects the high pro-cyclicality of government capital expenditure during high economic growth combined with cheap international credit periods (Little, et al, 1995 and Abdurohman, 2011). Within this period, the government tend to increase capital expenditure in the revised budget on top of what has been planned previously. Meanwhile, the negative gap in 1998 indicates the financial difficulty faced by the government during the AFC. As it is common in pro-cyclical countries, it is easier for the government to cut capital expenditure than to cut current expenditure (Abdurohman, 2011). Sudden changes in the middle of the budget course might results in less efficient project.

Chart 1 The Gap Between budget and Realized Government Capital Spending (%)

Note: the gap is the difference between planned and realized divided by the planned of government capital spending.

Source: Ministry of Finance RI

Meanwhile, the monthly disbursement of government capital expenditure could reflect efficiency in term of project management. The evenly disbursed budget in monthly basis may reflect how well the project being planned and managed. For the sake of simplification, in this article, quarterly disbursement of government capital expenditure will be presented to indicate the monthly pattern. Chart 2 below describes the average of quarterly disbursement of government capital spending during last 4 years.

Chart 2

Based on Chart 2 above, it is apparent that in the last 4 years, on average, more than 50% of the government capital spending is disbursed in the last quarter every year. This reflects “a rush spending”. As we do not adopt multi-year budget, project managers have to disburse in any way in order not to leave an undisbursed budget that cannot be carry over next year. Such spending will undermine budget efficiency principles. Compliance to the procurement procedures has been blamed causing this right skewed government capital spending disbursement. In additions, governance issues related to project management should not also be overlooked. Dirty practices of budget and project brokerage involving legislative members, executives, as well as project managers have been common recently Indonesia. The unfolding bribery scandals of athlete village construction in Palembang and transmigration facilities construction are among others to mention which reflect poor project management. These all will cause inefficiency of government capital spending.

Quantitative measure

Following the construction of the so called Project Investment Management Index (PIMI) by Dabla-Norris et al (2011), we can estimate the inefficiency of government capital spending which is defined as the gap between unadjusted government capital expenditure (investment) and adjusted government investment using PIMI.

The PIMI captures the institutional environment underpinning government investment management across four different stages; project appraisal, selection (bidding process), implementation and evaluation. These four components, which in total cover 17 indicators, represent efficiency criteria according to the standard literature. Each component is scaled between 0 and 4, with a higher score reflecting better public investment management performance[1]. The surveyed was conducted in 71 countries of low and middle income countries. Table 2 below summarizes the overall and the sub index of the PIMI.

Table 2 Public Investment Management Index (PIMI) in Selected

Low and Middle Income Countries

Rank

Country

Sub Index

Overall

Appraisal

Selection

Managing

Evaluation

1

South Africa

3.53

4.00

4.00

2.80

3.33

2

Brazil

3.12

3.00

2.80

3.33

3.33

3

Colombia

3.07

4.00

2.80

2.13

3.33

4

Tunisia

2.97

2.83

3.20

3.20

2.67

5

Thailand

2.87

2.83

2.00

3.33

3.33

6

Peru

2.61

2.83

3.60

2.67

1.33

7

Bolivia

2.44

2.83

2.00

2.93

2.00

8

Armenia

2.39

0.50

3.20

3.20

2.67

9

Kazakhstan

2.38

3.00

2.00

2.53

2.00

10

Botswana

2.35

3.00

2.40

2.00

2.00

29

Philippines

1.85

2.33

1.60

2.13

1.33

45

Indonesia

1.47

1.33

1.60

1.60

1.33

71

Belize

0.27

0.0

0.8

0.27

0.00

Notes: score ranges 0 to 4, with higher indicates better performance

Source: Dabla-Norris et al (2011).

Table 2 above shows the rank of government investment management index among selected 71 low and middle income countries. South Africa is on the top followed with Brazil, Colombia, Tunisia and Thailand, respectively. Indonesia is ranked 45th, the worst among ASEAN countries under the survey, even compared to Cambodia which is ranked 41st. If we look at the sub index, appraisal is scored lowest, 1.33. This may reflect poor performance in appraisal stages. Mark up practices due related to bribery could be the explanation. The relatively low score of project selection could also explain the poor compliance of standard procurement practices. For instance, practices of project brokerage in government funded investment in which ignores competitive bidding process.

The PIMI index enables us to calculate the PIMI-adjusted government investment by firstly normalizing the index. Chart 3 below presents the unadjusted actual government investment and the PIMI-adjusted government investment. The blue line represents the government investment, while the red line represents the PIMI-adjusted government investment. Looking at Chart 3, there are two high spikes in 1975 and 1982 in the dynamic of government investment. The government actual government investments in these periods were above 10% of GDP, the highest ever in the history following first oil boom in 1974 and second oil boom late 1970s. Since then the government investment is experiencing declining trend.

As discussed before, the PIMI-adjusted government investment represents total government capital spending which truly translated into government investment which has removed any inefficiency such as leakages due to mark up, bribery and other dirty practices within every project stages (appraisal, selection, execution and audit). The gap between the nominal government capital spending and the actual value of government investment is large especially during oil boom in 1975 and 1982. In the last 15 years, not only the magnitude is always below 2% of GDP, it is also steadily declining. This is somewhat ironic given government’s lack of resources to meet the rapid demand growth for infrastructure as well as resolve the existing shortages, such large inefficiency still persist in Indonesia takes in various form of dirty practices due to the weakness of project management.

Concluding Remark

As Dabla-Norris et al (2011) pointed out at the beginning of their paper, any effort of scaling-up government investment in a weak institutional environment runs the risk of potentially undermining its growth benefits as well as prospects for fiscal and debt sustainability. Country efforts to improve the investment process therefore can play a key role in raising its efficiency and rate of returns.


[1] More detail discussion can be read in Dabla-Norris et al (2011).

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