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Liberalization of trade in financial services is good (or not) for economic growth in developing countries.

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Bellow, I provide arguments to oppose the liberalization proposition.

As provided in 4a, the argumentation confronting the liberalization in financial service is basically based on the doubt that financial repressions by central bank over financial institutions is really exist. Just to repeat the argument, for instance, the worry that the financial repression will weaken the saving propensity of the people and therefore also weaken transferability of saving into investment but in fact, the demand for investment is not depend on the availability of accumulated saved money since there are always a central bank who can back up the commercial bank in the case of the excessive investment demand. The other argument is that the liberalization through high rate of interest in order to make saving attractive can have a boomerang effect on investment, when investor loosing their mood to invest even though the money have been accumulated through saving simply because the high rate of interest.

The other argument is something related to the situation in developing country itself. Since developing country need investment project to develop and since that investment project need a more stable and steady supply of money which is cannot be satisfied if the financial sector is being liberalized. In the deregulated financial sector, an investment agent is always has a full freedom to move their capital from one financial institution to another institution as they wish without any investment purposive regulation. In this way the availability of private saving is always in the form of “hot” money that can easy to come and easy to go.  This fast moving money is becoming faster in term of transaction by the aid of information and communication technology. Meanwhile, an to be successful an investment project need several condition that most of it need a long lasting commitment to invest since it happening in the real economy. Because, in turn, the investment project in developing country could also highly affects the real macroeconomic indicators such as income and unemployment which is hard if the money market is liberalized.

Written by ibu didin

February 13th, 2010 at 1:06 pm

Relation between Economic Growth and Inflation

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What is the theory and empirical evidence on the relationship between economic growth and inflation.

Economic growth and inflation are both positively correlated. This means that inflation is one of the inherent economic growth’s features. Along.  Hamilton (1952) claimed that inflation is an important stimulant for creating growth and Rostow (1960) also argued that inflation is necessary for developing industrial take-offs. The great support of inflationary policy is came from Keynes, compare to deflation Keynes is more tolerable to inflation he described both of inflation and deflation in negative term one is unjust and the other is inexpedient, but to have inflation is preferable because to provoke unemployment is worse than to disappoint the rentier.

Keynes argued that investment can generate its own saving by raising the level of income when the economy is not performed, and inflationary policy can redistribute income from wage earners with low propensity to save to profit earner with high propensity to save when economy perform at full capacity. The second argument of Keynes is, the inflation can encourage investment by raising the nominal rate of return on investment and reduce the real rate of interest.

However, there are some dangers of inflation that need to be considered. Just to mention one of them is that inflation can reduce the purchasing power of money if it is reaching excessive level. And it can put the society in a real resource costs and welfare losses.

Numbers of empirical studies show that inflation has a non-linier relationship with growth. Bruno (1995), at World Bank, who observe annually on 127 countries over the year 1960-1992 shows that inflation and growth are positively related up to 5 per cent inflation and then start to declining to inflation set. And it comes to negative relationship when the inflation rate reaching 30 per cent. The other study by Sarel (1996) at the IMF shows the similar result when he examined 87 countries over the period 1970-1990 and divide the observation into twelve inflation group using inflation of group 6 as reference show that in the inflation take a positive effect on growth for group 7 (averagely 8%) and start toward negative relationship when inflation is very high. The evidence of non-linearity and growth is also found by Stanners (1993) he studied 9 countries over the period of 1948-1986 and 44 countries over 1980-1988 that after divide the 44 countries into four groups the growth is highest for the second group.

The lesson from empirical data is, it is okay to have inflation an moderate level since it is an inherent feature of growth but what is need to be aware is when inflation rate reaches an excessive level which could create hyperinflation.

Written by ibu didin

February 13th, 2010 at 1:04 pm

Financial Liberalization

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From the perspective of economic development, provide two arguments in favour of AND two against financial liberalization?

The arguments that underpin financial liberalization are basically based on the idea that there are various kinds of financial repressions applied by central bank over financial institutions that can be harmful for development. The leading proponents for this view are represented by Mc Kinnon’s and Shaw. However they emphasize different aspect.

McKinnon argues that money holding and capital accumulation are necessary in the development process. Because the investment expenditure is always require the bigger amount and highly dependent on self-financing. Someone needs to accumulate money balances before investment. High interest is necessary to attract people to accumulate money balances, and then, this accumulated money balances will be transferred into investment when the rate of return on investment exceeds the real rate of investment. Shaw argues the importance of financial liberalization for financial deepening and the beneficial effect of high interest is to stimulate people to save and demotivate investor from investing money into inefficient (low-yielding) investment project, investor prefers to put money in industry that can serve bank interest.1

To summarize, those two arguments explain that whenever the financial repression exist in financial market it could leads to the condition namely unsatisfied demand for investment. The condition when the demand of investment cannot be fulfilled by available accumulated money.

On the contrary, the opponents of financial liberalization stem at the critical questions on the idea of liberalization supported by some empirical evidences. First critique is placed on the way the financial liberalization idea treats the bank as saving depositories that only deliver the loan into investment project once the saving accumulation is adequate. In fact, the commercial banks has an authority to create a credit under the condition that they are backed by central bank, and by then, the action of investment is not merely depend on the supply of deposit but also and strongly on the demand on investment itself. And by using this framework the supply of loan is something outside the system. Therefore this critique argues that incentives for investment is more important than incentive for saving. This view’s aligning with the keynesian and post keynesian views.

The other argument that opposes the idea of liberalization in financial sector comes from the case of Bank of Mexico studied by Fanny Warman over the period 1960-1990. It shows that there is an increase in private saving when interest rate is increased and it also shows that there is a positive flow from private saving into investment project. However, there is a negative influence of high interest rate (originally put in place to encourage saving) on investment. And this negative influence turning the net effect on investment into the other way. This empirical evidence shows that liberalization model ignores the negative effect of high interest rate on the investment in particular and generally on the economy. This situation can evoke another gloomy economic situation namely stagflation, the situation in which the inflation is high while the unemployment is also increasing. The real economic crisis is more likely to come.

The arguments that underpin financial liberalization are basically based on the idea that there are various kinds of financial repressions applied by central bank over financial institutions that can be harmful for development. The leading proponents for this view are represented by Mc Kinnon’s and Shaw. However they emphasize different aspect.

McKinnon argues that money holding and capital accumulation are necessary in the development process. Because the investment expenditure is always require the bigger amount and highly dependent on self-financing. Someone needs to accumulate money balances before investment. High interest is necessary to attract people to accumulate money balances, and then, this accumulated money balances will be transferred into investment when the rate of return on investment exceeds the real rate of investment. Shaw argues the importance of financial liberalization for financial deepening and the beneficial effect of high interest is to stimulate people to save and demotivate investor from investing money into inefficient (low-yielding) investment project, investor prefers to put money in industry that can serve bank interest.1

To summarize, those two arguments explain that whenever the financial repression exist in financial market it could leads to the condition namely unsatisfied demand for investment. The condition when the demand of investment cannot be fulfilled by available accumulated money.

On the contrary, the opponents of financial liberalization stem at the critical questions on the idea of liberalization supported by some empirical evidences. First critique is placed on the way the financial liberalization idea treats the bank as saving depositories that only deliver the loan into investment project once the saving accumulation is adequate. In fact, the commercial banks has an authority to create a credit under the condition that they are backed by central bank, and by then, the action of investment is not merely depend on the supply of deposit but also and strongly on the demand on investment itself. And by using this framework the supply of loan is something outside the system. Therefore this critique argues that incentives for investment is more important than incentive for saving. This view’s aligning with the keynesian and post keynesian views.

The other argument that opposes the idea of liberalization in financial sector comes from the case of Bank of Mexico studied by Fanny Warman over the period 1960-1990. It shows that there is an increase in private saving when interest rate is increased and it also shows that there is a positive flow from private saving into investment project. However, there is a negative influence of high interest rate (originally put in place to encourage saving) on investment. And this negative influence turning the net effect on investment into the other way. This empirical evidence shows that liberalization model ignores the negative effect of high interest rate on the investment in particular and generally on the economy. This situation can evoke another gloomy economic situation namely stagflation, the situation in which the inflation is high while the unemployment is also increasing. The real economic crisis is more likely to come.

Written by ibu didin

February 13th, 2010 at 12:55 pm

Intensification of international trade leads to environmental degradation and resource depletion in developing countries.

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Provide three arguments in favour AND three against this proposition.

Intensification of international trade leads to environmental degradation and resource depletion in developing countries because of: (i) developing countries tend to specialize in ‘dirty industries’ that Multi-national corporations (MNCs) transfer their pollution intensive production facilities to poorer countries, because of the uncontrolled environmental regulations or even non-existing environmental regulations in developing countries; (ii) comparative advantage of developing countries produces and export environmentally intensive goods to a greater degree than is efficient, and at prices that are below social cost (iii) deforestation for export crops, rain forest that rich in biodiversity in developing countries is destroyed to give way for the production of certain cash crops such as palm, timber, coffee.

However, there are arguments that international trade can bring beneficial effect for environment as: (i) Techniques or technologies shift to cleaner and environmental friendly, this happen when developing countries imports environmentally friendly products such as fuel-efficient autos.  Trade also brings technological innovation, or multi national corporation who bring global standards to where the domestic site is less friendly. (ii) Multilateral agreements for trade sanction, as in Montreal Protocol on ozone depletion, Kyoto Protocol.

Written by ibu didin

February 13th, 2010 at 12:49 pm

Transition Management: Indonesia Kerosene to LPG Conversion Program

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Didin Kristinawati

1. Introduction

The Indonesian energy system has been dominated by the use of fuels with 36 percents energy consumption for domestic household. The price of fuel in Indonesia is currently one of the lowest in the Asian region as the government policy to subsidy the use of fuels. High oil prices lead to higher revenues and expenditures. However, expenditures have risen faster than revenues and for the central government, when the oil price passed $100 per barrel, the expenditures exceeded revenues. The deficit would have increased by 0.3% of GDP assuming no expenditure cuts in other government programs. One solution would be to remove subsidies. Therefore, the government implements policy to convert the use of kerosene to gas in the form of Liquefied Petroleum Gas (LPG). This conversion program can be regarded as one of the major breakthroughs in overcoming energy development while reducing pressure on the national budget.

The long resisting use of kerosene for household which moved to the use of LPG as an affordable and clean energy is a real innovation system and can be seen in transition management frameworks. The institutional framework of the LPG industry changed dramatically. The transition to a new system required a process of interrelated actors. We will address the different phases and actors involved in the transition of kerosene to LPG.

This paper aims to contribute in the understanding of system innovation in developing countries with special case of Indonesia, and more specifically to depict the role of the government agencies and other actors to success the conversion of kerosene to LPG as a transition process which involve structural changes of society. Section two will resume theoretical frameworks of transition management. The kerosene regime will be explored in section three. Then the predevelopment and take-off phases of transistion will present in section four. Section five depict the role of the government and other actors. Concluding remarks will be presented in the last section.

2. Theoretical Frameworks of Transition Management

Transition is transformation processes in which society or a complex sub system of society changes in a fundamental way over an extended period. The term refers to a change in dynamic equilibrium in which an existing equilibrium is suspended by a new one. Transition consists of combination of system improvement and system innovation, involving multiple changes. The process of change in transition is non-linear, slow change is followed by rapid change when concurrent developments reinforce each other, which again is followed by slow change in the stabilization stage (Rotmans et al., 2000).

The transition can be distinguished into four phases transition process; (i) The predevelopment phase where there is very little visible change but a great deal of experimentation; (ii) The take-off phase where the process of change gets under way and the state of the system begins to shift; (iii) The breakthrough phase in which structural changes occur in a visible way through an accumulation of socio-cultural, economic, ecological, and institutional changes that react to each other, during the acceleration phase, there are collective learning processes diffusion and embedding processes; (iv) The stabilization phase where the speed of societal decreases and a new dynamic equilibrium is reached (Rotmans & Kemp, 2004).

When analyzing transformation in socio-technical systems, it is useful to use the multi level scheme which makes distinction between niches, regimes, and he socio technical landscape. The term regime refers to dominant practices, rules, and ensuing logic of appropriateness that pertain in a domain either policy domain or technological domain, giving it stability and guiding decision making (Geels, 2003). Here we have kerosene regimes that will be explained in section three. The second level is niche that refers to places in which new things are done or domains for specialized applications. The niche can be a market niche or niche created by a company or government. The third level is the landscape, the overall setting in which processes of change occur. The landscape consist of the social values, policy beliefs, worldviews, political coalition, the built environment such as factories, price costs, trade patterns and incomes. The distinction between niches, regimes, and socio-technical landscape helps to understand processes of structural changes that can be seen as the outcomes of interaction between multi level processes (Rotmans & Kemp, 2004).

A common mechanism is landscape factors that put pressure on a regime of production, whose practices and technologies are challenged by new solutions pioneered in niches, with regime actors initially fighting and resisting alternative solutions focusing their attention and money on improving existing technologies, but over time changing course by investing in radical solutions. This is currently happening with conversion of kerosene to LPG (Liquefied Petroleum Gas) in Indonesia, long resisting use of kerosene for household which moved to the use of LPG as an affordable and clean energy, the belief system and management strategies of key actors’ change, new developments gain momentum, and regime shift may occur, this process will be presented in the next part of the paper.

3. Former Kerosene Regime in Indonesia


The Indonesian kerosene regime was formed in the 19th century, as the first company Royal Dutch was formed in 1885, based on production from Pangkalan Brandan, island of Sumatra. The company grew rapidly as Sumatran output rose throughout the 1890s. British Shell Transport and Trading initiated its own oil production in Borneo shortly thereafter. By 1907, the two companies had joined to form Royal Dutch Shell. Since then, the exploitation of oil in the archipelago began. During Japanese occupation, efforts were limited to rehabilitation of damaged fields and wells as the impact of war. Oil production was discontinued during the war for independence. When it was over and the nation started to run more organized governance, control over oil business became less clear.

Numerous small companies spurted to take advantage of oil fortune thus causing disputes. To subdue the disputes, control over oil was given to the Army. To anticipate it, the government established a state owned oil company on 10 December 1957 namely Pertamina. The 1945 Indonesian Constitution had stated that “Land and water and the natural riches therein shall be controlled by the State and shall be exploited for the greatest welfare of the people.” Under the new mining law, oil and natural gas mining is only conducted by the State, and the State’s company is authorized to engage in oil mining on behalf of the State. This resulted in Pertamina to act as a regulator -as representation of state- for partners who were under Cooperation Contract mechanism in Pertamina mining areas.

During the oil price shock of 1973-1974, Indonesia gained boom in cash flow. Indonesia’s oil production peaked in 1977 at over 1.64 million barrels per day. By 1982, production had made a pronounced decline, reaching 1.26 million barrels per day. Strong economic growth, combined with under priced domestic fuels by subsidy caused Indonesian demand for refined oil products to rise rapidly throughout the 1980s and 1990s, and Pertamina was charged with the task of organizing new refinery capacity.

Figure 1 Production, Consumption, Export, Import of Oil. Source: Data Ware House ESDM (September 2009)

As early 1989, when domestic demand was still less than exports, the clashing trend lines of falling production and rising consumption generated an expectation that the country would cease to be a net oil exporter sometime in the late 1990s. The country became a net oil importer during 2005, and total consumption of refined products is now greater than domestic crude production. The country already relied heavily on imported crude for its domestic consumption. Declining oil production has led to stagnation in oil and gas revenues, oil and gas now play a smaller role in Indonesia’s public finances than they did in 2000, prior to the increase in global oil prices. Since the East Asian crisis, there has been very little investment in new fields in Indonesia, and the existing fields are aging.

Suharto’s New Order regime (1968 – 1998) inherited and continued fuel subsidies from former President Soekarno (1945 – 1967). These subsidy increased markedly in the period of the Asian financial crisis from 1998 to 2000 elected government of President Susilo Bambang Yudhoyono responded by increasing subsidy. The reasons are to keep stabilization and get votes for the next election. Kerosene subsidy becomes a political commodity. The candidates attract voters by promising of cheap fuel which means more subsidies, they neglect the current availability of oil production, and long term development prospects of energy. However, the government kept the subsidized prices of gasoline, diesel and household kerosene fixed rather than linked to global prices, even though gasoline prices approached international prices toward the end of 2005. Since 2005, the international oil price has once again doubled, while domestic fuel prices have been kept constant. Kerosene is the most heavily subsidized fuel product, with a subsidy of $0.40 per liter (at 2007 average prices), more than twice its administered price of $0.20 per liter. Even after the May 2008 fuel-price adjustment, subsidies remain the largest spending item in Indonesia’s budget (Hertzmark, 2007).

In 2008, government subsidies of energy products will almost certainly reach over 4% of GDP or almost 20% of central government spending. One factor influencing the volume of subsidized product consumed is the gap between the subsidized price and the cost of the unsubsidized product. As the gap widens, consumers have more reason to switch to the subsidized product, and smuggling becomes more profitable. As a result, consumption increases. Short of a significant drop in international crude oil prices, Indonesia’s policy makers have two options for limiting subsidy spending: raising retail prices of fuel products, or reducing the quantity of subsidized products consumed. Increasing the price of any fuel product will lead consumers to reduce their use of that product, and to switch to other products.

Figure 2 Energy Subsidies dominate 2008 government expenditure in billions of dollar.
Note: Assumes oil at $95 per barrel. Source: Ministry of Finance, APBN-P for social expenditure 2008.

Subsidies have direct and indirect effects on household real income. Households benefit directly from lower energy prices and indirectly through lower prices for other goods and services, as the fuel subsidy makes them cheaper to produce or distribute.

There are other reasons why fuel subsidies are an ineffective social safety net. First, subsidies reduce spending for public services and poverty reduction. Indonesia’s public services and infrastructure are in great need of upgrading, but subsidies crowd out these crucial investments. Second, subsidies undermine good macroeconomic policy. Spending on subsidies tends to rise when the global economy booms and fall during downturns. Third, subsidies hinder competitiveness. In Indonesia, Pertamina is the only company licensed to sell fuel at subsidized prices. Although new companies have entered the market recently, they are restricted to market- priced fuels which are almost double the main subsidized fuels. Firms and households make inefficient and uncompetitive choices, resources are used in ways that do not maximize their returns, and production processes are less efficient than they would be if producers faced the true cost of their activities. For example, consumers choose fewer fuel- efficient cars, or live further from their workplaces than they would if they faced the true costs of using fuel. This also increases carbon emissions that are damaging to the environment and harmful to the health of the population. Lastly, subsidies generate opportunities for corruption and smuggling of products. Fuel products can be bought domestically at below-market prices and smuggled to neighboring countries, or used for purposes not intended to benefit from the subsidy (Bulman et al., 2008).

High oil prices lead to higher revenues and expenditures. However, expenditures have risen faster than revenues and, for the central government, when the oil price passed $100 per barrel, so expenditures exceeded revenues. According to Ministry of Finance, assuming the price of crude oil is at USD 120/barrel for 2008, the fuel subsidy will exceed 200 billion rupiahs, while national budget which have been approved by the house of representatives, the maximum budget allocated for fuel subsidy is only 135,1 billion rupiahs. The deficit would have increased by 0.3% of GDP assuming no expenditure cuts in other government programs. However, the recent policy move will not be enough if oil prices remain at, or above, $100 a barrel, and if Indonesia continues to fix fuel prices. One solution would be to remove subsidies from the political process altogether by linking regulated fuel prices to the market price in such a way that Indonesians gradually accept the true opportunity cost of the fuel they use.

4. Shifting Kerosene Regime to LPG: Predevelopment and Take-off Phases

Kerosene is widely used as a major subsidized fuel for household cooking as market niches, its consumptions approximately 9.9 Million Kilo Liter per year. It is used by 60 percent of 230 million populations which means that subsidy expenditure equal to 4 billion USD per year (Bulman et al., 2007). Government subsidies are used to reduce the cost of a fuel to encourage its use. These subsidies policy becomes counterproductive as they are expensive for the government and eating up significant portions of the national budget because the kerosene demand is getting increase. In 2008, the kerosene subsidies estimated reach up to 7 Billion USD and tend to increase in the upcoming years.

Figure 3 Energy for Households Consumption. Source: World Bank Calculations From SUSENAS 2007

The rich are the main beneficiaries of the fuel subsidy. It is often argued that fuel subsidies protect the poor. As the chart shows, the top 10% of Indonesia’s income distribution consumes 45% of the subsidy, in sharp contrast to the poorest 10%, which receives less than 1%.

On the other hand, the domestic consumption of LPG is expected to continue increasing with the growing popularity of this type of gas among Indonesians. Liquid Petroleum Gas (LPG) or bottled gas comprises butane or propane which is hydrocarbon gases produced during the petroleum refining process mentioned above. They are gaseous at normal temperatures but when compressed become liquid. It is typically purchased in cylinders of various sizes: 3 kg, 5 kg, 12 kg, and 50 kg. LPG is used predominantly for cooking and is very easy to use, is efficient and burns cleanly. It is not commonly found in rural areas but is used amongst middle or high income groups in urban areas. The high initial cost of purchasing appliances and cylinders, relatively sophisticated technology, irregularity of supply and risk of explosion mean that it is not widely used in the majority of poorer areas. Cylinders are usually exchanged at filling stations and since there are few of these in rural areas and transport is poor, access to this fuel source is also difficult.

In Indonesia, LPG is consumed almost exclusively by households, including restaurants and hotels, and the annual rate of LPG consumption has continued to increase from year to year. As a matter of fact, popularizing the use of LPG is not a priority in Indonesia’s energy policy. According to this policy, for many years LPG is not intended to be a replacement for oil fuel but it is intended to be part of energy diversification. In practice, however, the use of LPG has continued to grow, especially among households. The predevelopment phase of transition already began where there are very little visible changes.

Responding to the increased price of oil, the government developed policies to reduce dependency on oil. To this end, the government reassessed the benefits of oil subsidies and showed its willingness to eliminate the oil subsidy. However, because this policy redirection may lead to changes in the structure and system of the Indonesian economy, it is being implemented gradually. Moreover, the focus of the subsidy, which had been on commodities, has been shifted from the benefits of the rich to the welfare of the poor. A National Development Program called Propenas started in 2000 stated that eliminating the oil subsidy was to be achieved by 2004. Unfortunately, external factors (the global economy and fluctuation in the oil price) and internal changes (rising poverty rates and unemployment) have constrained the government from implementing the policy completely until recently (Adam et al,. 2008).

In line with the elimination in the oil subsidy, the government has another scheme to compensate for the effect of rising oil prices. The policy was known as the ‘compensating program for oil subsidy elimination’ and was first implemented in 2000. Through this program, the government reallocates the oil subsidy to other programs, which are aimed at helping poor people and supporting other development programs. It is expected that the compensation program will also help the government to minimize its budget deficit. Like the oil subsidy, compensating programs are principally to maintain the purchasing power of the poor because rising oil prices decrease their domestic welfare. In 2000, there were eleven programs, including health, education, small business and other socially beneficial programs. In 2008, the programs were reduced to one only, that is, cash transfer or more popular with BLT (Bantuan Langsung Tunai).

However, there are difficulties to control the effect of rising global oil prices, and the government is forced to implement the option of fuel price increase and totally remove energy subsidies. This opens opportunity window for the government to implement policy to convert the use of kerosene to gas fuel in the form of Liquefied Petroleum Gas (LPG). The fact that national budget cannot afford kerosene subsidies became an advantage for the take off of LPG. This conversion program can be regarded as one of the major breakthroughs for reducing pressure on the national budget.

The reason to convert to LPG and not other form of energy is that Indonesian owns natural gas reserves of about 92.5 trillion cubic feet, in 2003 ranks the 10th of the world largest gas reserves. The reserves are scattered around the archipelago, with considerable of them can be found in East Kalimantan, North Sumatra, West Papua, and China Sea areas. The amount Indonesian natural gas reserves are quite larger than those of oil. Besides using flare resulting from oil-refining processes, LPG can also be produced using the hydrocarbon compounds of natural gases. However, only 0.53% of Indonesia’s natural gas output is processed into LPG while 54.41% is processed into LNG and 10.8% into energy for large-scale industries such as petrochemical, fertilizer, cement, and steel. In 2000, Indonesia produced 2.09 million metric tons of LPG, of which some 1.32 million metric tons (63.3%) came from gas plants and the other 766.6 thousand metric tons (36.7%) from oil refineries (Nugroho, 2004).

5. The Role of the Government and Other Actors

The government aims of conversion program are to reduce subsidy by 33 percents or 2.2 billion USD annually after program completion (as mentioned above, the kerosene subsidy is 4 billion USD annually), to reallocate kerosene for more profitable use such as jet fuel, and to promote cleaner energy. The master plan is 42 million LPG packages will be distributed to eligible households starting from May 2008 to end of 2009 while 4 million kilo liters of kerosene will be withdrawn. By conversion program, budget for subsidized fuel is expected to reduce considering that subsidy for 1 kg LPG (of 1.7 liter kerosene energy equivalent) is lower than subsidy for kerosene. In 2010 onward, the government plans LPG will be the main cooking fuel with estimated total volume 3.5 ton per year. 6 million kilo liters of kerosene will be withdrawn (Akbar, 2008).

Figure 4. Targeted Area for Kerosene to LPG Conversion Program.
Source: Pre-Conference Workshop Clean Cooking Fuel, 2008

Another important actor currently involved is state owned company PGN Ltd. who handled production of LPG. PGN sells LPG to Pertamina who pointed to distribute LPG in cylinder cube with capacity 3, 12, 50 kilograms. The price of LPG in the market is 10 percent higher than previous subsidized kerosene. However, kerosene is no longer subsidized so that people tend to buy LPG as it currently becomes cheaper. PGN who actually exist many years ago, now play important role with Pertamina to guarantee the availability of LPG.

Figure 5. LPG Conversion Package for free including LPG cylinder cube 3 kg, stove, connector pipe.
Source: Akbar Wahyudin, 2008

To replace the use of kerosene the government plan to give one package LPG for free including LPG cylinder cube and stove. This work began with survey to determine area and eligible household. The government will also address cases of defective gas stoves, which is considered as the only remaining problem hampering the program, after it resolved issued concerning the procurement of gas stoves and their LPG cylinders. The government also runs marketing and education program to educate end user, agents, and retailers. Most residents still keep the package until they are convinced that the use of LPG cylinders and stoves are safe. The government runs intensive campaign using public icon, celebrity, politician, and religion leader to educate people. At the same time, the government runs direct cash assistance program popular as BLT (Bantuan Langsung Tunai), compensate kerosene subsidy into cash money to afford basic living needs.

Pertamina said LPG consumption per January 2009 stands at 7,255 tons a day. This is a tremendous rise due to the conversion from kerosene to LPG. Increase is almost two fold and small families are using LPG in 3 kilogram tubes. In 2008, sales totaled 1.85 million tons. Increased LPG consumption will run parallel with increased infrastructure because distribution is done through a lot of stages involving production centers, imports, vessels, tankers, filling stations and trucks. Filling stations will likewise be run by private companies and licensing is very difficult to get. Pertamina hopes that regional governments simplify procedures for the obtainment of licenses.

Pertamina needs partners to distribute LPG cubes around the country and also company to produce new stoves. The government opens opportunity for tender, 11 firms had won the bidding for the procurement of the gas stoves for the program, with a total production capacity of 17 million stoves per year. Another 11 companies, meanwhile, will supply 13 million LPG cylinders (Pertamina, 2008). The government has divided the country into four distribution areas: area I covering Sumatra; area II covering Java and Bali; area III covering Kalimantan, Sulawesi, Papua and Maluku; and area IV covering West and East Nusa Tenggara. Distributors have to provide services in at least two different distribution areas. Thus, new institutional structures have emerged and at the same time their building capacity are challenged. In transition framework it is the breakthrough phase in which structural changes occur in a visible way through an accumulation of socio-cultural, economic, ecological, and institutional changes that react to each other.

6. Conclusion

The long resisting use of kerosene for households which converted to the use of LPG in Indonesia is a real innovation system and can be seen in transition management framework. It is radical innovation in terms of the effect that the institutional and the actors involved are influenced dramatically by the use of new LPG system for households.

Since 1967, the government has subsidized kerosene to keep stabilization and get votes for the next election. Kerosene subsidy becomes a political commodity for the candidates to attract voters by promising of cheap fuel, they neglect the current availability of oil production, and long term development prospects of energy. Unfortunately, the survey result showed that the rich are the main beneficiaries of the fuel subsidy. On the other hand, In Indonesia LPG is consumed almost exclusively by middle up households, including restaurants and hotels. In practice, the use of LPG has continued to grow, especially among households. The predevelopment phase of transition already began where there are very little visible changes.

However, the world trends indicate the continuous rising of oil price. High oil prices lead to higher revenues and expenditures. In fact, expenditures exceeded revenues. It became difficult to control the effect of rising global oil prices, this situation opens opportunity window for the government to implement policy to convert the use of kerosene to gas fuel in the form of Liquefied Petroleum Gas (LPG). The fact that national budget cannot afford kerosene subsidies became an advantage for the take off of LPG. The reason to convert to LPG and not other form of energy is that Indonesian owns gas reserves.

To replace the use of kerosene the government plan to give one package LPG for free including LPG cylinder cube and stove. Another actor currently involved is state owned company PGN Ltd. who handled production of LPG. PGN sells LPG to Pertamina who is pointed to distribute LPG in cylinder cube. Pertamina also needs partners to distribute LPG cubes around the country. The government also runs marketing and education program to educate the ciziten as user of the conversion program. We can see the breakthrough phases when new institutional structures have emerged and at the same time their building capacity and relationship between actors are challenged.

The conversion program itself still continues and the stabilization phase where a new dynamic equilibrium has not been achieved. However, this transition process has been considered a success as more than 5.3 million households across the country stopped using kerosene in 2008. Pertamina said, the program had saved the company 5.32 trillion rupiahs in fuel subsidies between 2007 and 2008. Pertamina has distributed more than 1.9 million units of gas stoves and LPG cylinders. Up to 2009, the program has covered 13 provinces where 6.3 million kiloliters of subsidized kerosene has been withdrawn, while 1.9 million tons of LPG have been distributed (Budiarto, 2009).

7. References

1. Adam, Latif et al., (2008), “The Years of Reforms: the Impacts of an Increase in the Price of Oil on welfare, Journal of Indonesian Social Sciences and Humanities,” Vol.1, 2008 pp.121-139
2. Akbar, Wahyudin. (2008), “Indonesia Kerosene to LPG Conversion Program”, Pre-Conference Workshop Clean Cooking Fuel Istanbul, 16 – 17 June 2008
3. Budiarto, Harry, Retrieved 01-01-2010, “The Successful Implementation of Kerosene to LPG Conversion in Indonesia”, from http://ezinearticles.com/?The-Successful-Implementation-of-Kerosene-to-LPG-Conversion-in-Indonesia&id=3478647
4. “Bisnis Gas Perlu di Gas,” (February 2008), Retrieved 5-10-2009, from http://www.pertamina.com/index.php?Itemid=507&id=3602&option=com_content&task=vie
5. Bulman, Tim et al., (2008) “Indonesia’s Oil Subsidy Opportunity,” Far Eastern Economic Rewiew
6. “Government Explanation On The Reduction Of Fuel Subsidy And Other Related Policies”, (24-05-2007), Retrieved 5-10-2009, from http://esdm.go.id/press-release/53-pressrelease/1757-government-explanation-on-the-reduction-of-fuel-subsidy-and-other-related-policies-.html
7. Grin, John; Rotmans, Jan; Schot, Johan. (2009), “Transition to Sustainable Development. New Direction in the Study of Long Term Transformative Change” in Collaboration with Frank Geels, Derk Loorbach. Netherlands: KSI.
8. Hertzmark, Donald, (2007) “Pertamina: Indonesia’s State-Owned Oil Company,” The James A.Baker III Institute for Public Policy Rice University
9. “Little luck in replacing kerosene with LPG” – The Jakarta Post (), Retrieved 5-10-2009, from http://www.thejakartapost.com/news/2007/07/31/little-luck-replacing-kerosene-lpg.html
10. Nugroho, Hanan, (2005),” Financing natural gas infrastructure (downstream) projects in Indonesia,” International Conference INDOGAS, Jakarta
11. “Our History” – Pertamina EP (5-10-2009), Retrieved 5-10-2009, from http://www.pertamina-ep.com/en/about-pep/our-history
12. “Produksi, Konsumsi, Ekspor, Impor Minyak Bumi per Tahun (Barrel)” – Data Ware House ESDM (September 2009), Retrieved 6-10-2009, from http://dtwh2.esdm.go.id/dw2007/index.php?mode=1
13. “System Innovation and the Transition to sustainability: Theory, Evidence, and Policy”. (2004), edited by Boelie Elzen, Frank W.Geels, Ken Green. UK: Edward Elgar Publishing Limited.
14. “Vice President Inaugurates World’s Largest LPG Bulk Filling Station” – Ministry of Energy and Mineral Resources Republic of Indonesia (20-03-2009), Retrieved 5-10-2009, from http://esdm.go.id/news-archives/oil-and-gas/47-oilandgas/2378-vice-president-inaugurates-worlds-largest-lpg-bulk-filling-station.html

What is meant by formal and informal regulation of environmental policy

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Under what circumstances can they be complementary to each other?

Formal regulation is environmental policy regulated by government institution which has formal (law & institutional) consequences. The first formal regulation is policy that seek to harness the positive links between development and environment including: (i) policy of building on the positive links which means many policies that good for efficiency are also good for the environment. For example policy to promote less consumption of raw material (papers) in state enterprise, it will reduce company’s spending for stationary and the same time saves consumption of woods for paper; (ii) policy of removing distortion, distorted incentives of government subsidy on energy. This will reduce government spending, and also promote efficiency in the use of energy.

The second formal regulation is targeted policies to change behavior including (i) policy based on incentives, which tax or charge polluters according to the amount of damage they do. This policy encourages those polluters with the lowest cost of control to take the most remedial action. Examples of this policy are fuel and vehicle taxes in most OECD countries, surcharges and stumpage fees to pay for replanting the forest in Indonesia; (ii) policy based on quantitative restrictions, such as specific regulations on what abatement technologies must be used in specific industries.

Informal regulation is ways to tackle environmental problem by non governmental policy. This informal regulations include (i) community pressure, improvement in the quality of life leads to stronger pressure on polluting facilities, public needs cleans sanitation, unpolluted air, access to clean water. This community movement to defend their rights and become powerful people power to fight environmental problem; (ii) Reputation, the company need to market their product in positive image, along with awareness amongst people of environmental problem, the more friendly product and company, the more likely consumers prefer to buy their products; (iii) involving local participation, neither government nor NGO are equipped to make judgments about how local people value their environment. Local participation also yields high economic and environmental returns in implementing program of forestation, park protection, water management, and sanitation. For example of local participation is a large irrigation project in Bali, Indonesia failed to recognize the advantages of traditional approaches, a follow up project that built on indigenous strengths succeeded.

That formal and informal regulation can be complementary under circumstances when government has conflicting social economic objectives, which allow them to use resource inefficient, or in case of weak government institution to face corporations, or inadequate data and knowledge for formal institution in finding solution with local people.

Written by ibu didin

February 12th, 2010 at 3:21 pm

Backwash and Spread Effect

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What are the causes and consequences of ‘backwash’ and ‘spread’ effects? What type of public policies can correct any imbalances between the two effects, inter-regionally within a country

Once economic and social forces occur in favored region, development produce tendencies toward disequilibrium, the differences in living standards may persist and even widen over time. Myrdal propose hypothesis of circular and cumulative causation, means once an economy obtains a growth advantage it will tend to keep it. Development proceeding more rapidly in certain region than other. The cumulative movements which tend to economically weaken region were termed backwash effects. Those caused by labor migration, capital movements, and trade. In free market, capital will tend to move to the site where prospective returns are highest.  Thus capital, labor, technology, and entrepreneurship will migrate together. The benefit of trade will accrue to the host region. As the results, the region experiencing the rapid growth will be able to increase its competitive advantage over the relatively lagging regions, the improvement in transportation, communication, education, healthcare facilities.

Myrdal also argues the spread effect or positive externalities, that such a new growth stimulus might induce other region, such as increased demand for backward areas product, diffusion of technology and knowledge. However, the spread effects are weaker than backwash effect, and interregional differences remain widen.

Hirchman argues that policies must be designed to reduce polarization and to strengthen spread effect. Type of public policies to imbalance between those two effect inter regionally within the country are: (i) fiscal policy, wealth taxes for redistribution of wealth and income; (ii) institutional reform against corruption, corruption is critical issue in development country. The World Bank defines corruption as the abuse of public office for private gain, including bribery, threats, and kickbacks. The existence of licenses, permits, regulations, subsidies, and taxes in the hand of politician or government officials, are open opportunity for corruption. The state has an obligation to reduce bureaucracy and regulation to allow markets to flourish. Corruption creates high cost economy because the cost in time, effort, and money in setting up business in developing countries are high with delay and inefficiency in bureaucracy.  Corruption discourages business, higher proportion of business operates outside the law, so the tax also lower, and corruption become acute. In the context of backwash effect, corruption affect distribution of allocation resource, when industry can get privileges to choose any place they want to operate their business, regardless the development planning for allocation of resources; (iv) balance between agriculture and industry, placing labor-intensive industry in rural area to attract circular cumulative causation in rural area, reduce rural-urban migration, and eradicate poverty both in rural and urban.

Why Technical change in developing countries is mainly ‘labour-saving’

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Technical change in developing countries is mainly “labour-saving”: how is this an outcome of and in turn shapes (i) core-periphery structure of the world economy, and (ii) relative factor endowments of developing countries themselves?

In developing countries, we expected the use of more labor intensive in industrial sector as labour more abundant than capital, thus labor’s price is relative lower than capital. However, in practice technical change in developing countries is mainly labor saving. It can be explained by the limitation of techniques available because of both factor endowment within developing countries and the structure of world economy.

Within developing countries, there is limitation of a domestic capital goods sector (machinery, used in the production of commodities, producer goods). On the other hand, the structure of world economy divides the world into industrial ‘core’ and ‘peripheral’ countries. The core nations are highly industrialized, produce manufactured and capital goods rather than raw materials for export. They are economically wealthy and powerful, with capacity in the forefront of R&D and innovation, the government or firms’ expenditure of developed country into R&D relatively higher than developing countries, because R&D is high risk sector with long term output. Also, to develop technology to save capital (spending to buy foreign technology) there should be existence of capital goods sector in developing country, which is in fact non exist or inadequate. There has been very little incentive to establish capital good industries because lack of domestic know how related with level of education, inadequate expenditure for R&D, and large interest for investment of capital goods from developed country.  In turn, the periphery nations become dependent to import labor saving of technology change from developed country.

When firms (multinational corporations) faced with competition for global market, they tend to adopt defensive innovation strategy which lowering labour intensity in production for global profit-maximizing motives. Through this process of foreign investment, labor saving technical progress widely used by developing countries.

Another endowment factor within developing countries is the tendency of developing countries to subsidy to scarce capital and paying high wages to its own employees.  So that they face conflict between output, saving, and employment in the choice of techniques. Government usually prefers to maximize output and saving so the more capital intensive (labor saving) techniques will tend to be the choices.  It is also a problem with productivity of labour in terms of cost per unit of output. Although labor abundant in developing country and wage relatively lower than developed country, it is not automatically less costly to employ, it’s productivity might be lower because the wage rate divided by the productivity of labour (efficiency wage) may differ slightly with developed country. This efficiency wage gives incentive for developing country to choose labor-saving technical change.

However, technical change of developing countries should consider the growth of both rural and urban unemployment, income inequality, and foreign exchange position. There is a new thinking to use intermediate technology with more labor per unit of capital and fewer foreign inputs. If developing countries need to do so, they should pay attention and investment in education and innovation.

How Can Development Worsen Inequality (for some) ?

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How can development worsen inequality and destitution (for some)? What role can public policy play in mitigating these negative impacts?

The development process tends to apply industrialization as the engine of growth. This is to be expected for increasing returns to scale in industry, both static economies of scale when mass production of commodities can be produced at lower average cost and dynamic economies of scale which are reductions in cost or increases in revenue per unit that arise from repeated and continuous production activity over time. The transformation of economies from a primary agricultural into industrial country comes with widening disparities in the personal distribution of income in the early stage, because some people are more industrious than others to accumulate wealth, opportunity and skill are not equal for all.  The work of Adelman and Morris shows that for developing countries inequality increases up to a certain stage of development and then declines, graphically showing an inverted U-shape similar to the work of Kuznets for developed countries.

Intensive industrialization strategy for development can worsen inequality and destitution along with these conditions: (i) inevitable dualism3 in geographic, technological, and social; (ii) urban bias4 in the allocation of investment resource. There have been many causes of urban bias; domestic cause of urban bias including colonial inheritance, severe market failures in agriculture, relatively weak political voice of rural poor. International cause of urban bias including relatively strong political voice of developed countries, Washington Consensus diminish attention to agricultural development.; (iii) inequality in the distribution of education facilities, particularly lack of facilities in rural areas where the poorest are concentrated; (iv) disguise rural unemployment, rural underemployment, open unemployment in urban areas created by rural-urban migration;  (v) a shortage of investment resources and inappropriate technical choices.  In this process, the degree of inequality in the developing countries appears largely due to the higher share of income received by the richest, and the vast mass of population is left behind. Rural and urban poverty are still widespread.

The public policy plays important role in mitigating negative impacts on how it brings about structural changes in favor of industrial activities if growth and development is to be accelerated. There are necessities for public policy to concern for allocation of investment resources for basic social services, infrastructure, and investment in human capital (education) because education improves the quality of labor and has positive spillover effects.  The policy should accommodate choice of projects of which a high weight should be given to projects that raise the income of the poorest in the income distribution.

The government also play important role in financial markets to lower the cost of capital and direct credit to strategic sectors, policies to promote export and protect domestic industry.  The policy must pay attention in rural development that has been neglected in industrialization development strategy. The policy of active opposition to urban bias should be taken. Agriculture is generally labor intensive and skill extensive, so that agricultural growth creates additional employment with low entry barriers. When agricultural productivity rises, the food prices in rural and urban will be lower. Agricultural growth is importance for poverty reduction.  It obviously needs targeted investment in agricultural which is so far being under estimated.

3 Geographic dualism is gap between income per capita is concentrated in one area, technological dualism is difference in technological means between subsistence sector and other sectors, social dualism is different social customs between subsistence and money sector

4 for further reading Bezemer, Dirk and Headey, Derek, (2008), “Agriculture, Development, and Urban Bias“, MPRA Paper No.7026, posted 6 February 2008.

Measuring Poverty and Inequality

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There are several kinds of poverty and inequality measuring tools, here are three ways to measure poverty and two measures of income inequality.

The World Bank defines poverty as inability to attain minimum standard of living.  The first way to measure poverty is by defining poverty line or poverty threshold which measures minimum living standards based on per capita income that is sufficient to provide a minimum acceptable level of consumption. The way to set consumption based poverty line is by PPP method and the food energy method. The PPP method reflects the cost to individuals to buy goods or services in the domestic market as a dollar in US. The PPP does not deal with intercountry differences in nutrition; because the composition of consumption is very likely differ in different countries. To handle this problem, the food energy method is used which defines minimum calorie intake using nutritional values of consumption goods. However, it’s still problematic as people in different countries may choose different combination of foods which require different incomes to meet nutritional requirements.

In practice, the World Bank assigned poverty line $1.251 which means the minimum level of income deemed necessary to achieve standard of living. This value comes from income or consumption data survey, estimation of PPP level, and World Bank comparison program. From the value of poverty line, the number of people under the poverty line can be measured using head count index.  The head count index ignores the extent to which the poor fall below the poverty line.  The third way to measure poverty is poverty gap index which measures the depth or intensity of poverty, how far the poor are below the poverty line.

The most used inequality measure is Gini index as a ratio of two areas in Lorenz curve2 diagrams values between 0 and 1.  A low Gini coefficient indicates more equal income or wealth distribution, while high Gini coefficient indicates more unequal distribution. 0 corresponds to perfect equality and 1 corresponds to perfect inequality. The problem with Gini index are: the measure will give different result when applied to individuals instead of households; it measures in certain time, ignores life-span changes in income; in some societies people may have significant income in other forms than money as in subsistence farming, the value of these incomes is difficult to quantify, thus will yield different Gini index.

Another inequality measurement is Theil index which is a weighted average of inequality within subgroups, plus inequality among those subgroups, means that Theil index has decomposability that Gini index doesn’t have. The Theil index is always positive, individual contributions to the Theil index may be negative or positive. But Gini index is more popular than Theil for it’s depicted on Lorenz curve which is more intuitive to understand.

1 The latest update, announced in March 2008 is $1.25 per day based on the latest available international PPP comparison for the year 2005. For further information in World Bank Report 1990, 2008.

2 The Lorenz curve is a graphical representation of the cumulative distribution function of a probability distribution; It is often used to represent income distribution, where it shows for the bottom x% of households, what percentage y% of the total income they have. It was developed by Max O. Lorenz in 1905 for representing income distribution.