An Early Article on Foreign Investment in Indonesia published in Quadrant Edition Sept-Oct 1969

Foreign Private Investment in a Developing Nation: An Indonesian Perspectiveⁱ

By Dr. Soedjatmoko

Dr. Soedjatmoko, who is presently Indonesia’s Ambassador to the United States, has served his government ever since 1945 – with a brief respite during the last years of Guided Democracy. The recurrent theme of his published writings – mostly short, concentrated essays – is the meaning of Indonesia’s history; a preoccupation to which he brings the critical methods of the social sciences as well as a constant awareness of the spiritual dimensions of man. His writings have had an influence out of all proportion to their slender bulk, both on the younger generation of intellectuals in his own country, and on Western scholars of Indonesia. In Australia, the text of his 1967 Dyason Memorial Lectures of the Institute of International Affairs has had a wide audience.ⁱⁱ

Introduction

The sub-title immediately raises a question. What makes Indonesian perspective on the problem of foreign investment so special? I believe, the fact that Indonesia is one of the few countries in the world that has moved full cycle from rejection of foreign private investment to a new acceptance may have some bearing on the general topic of this seminar. This shift has led to an unusual focus on Indonesia and its economic potentials as the new opening area of investment opportunity.

Starting from 1958, our conflict with the Dutch led the Indonesian Government at that time progressively to seize most of the foreign enterprises on Indonesian soil. Her growing emphasis on an anti imperialist struggle led her to recast the economy into what might best be called a ‘command economy’ that was supposed to operate by government fiat, in support of a radical foreign policy that was far beyond our national strength. It eventually led to Indonesia’s isolation from the rest of the world, a total breakdown of the economy, and in 1965 to the collapse of the governmental power structure. Out of the ensuing turmoil a government has emerged that is characterised by sobriety, a sense of realism and a commitment to the priorities of monetary stabilisation and economic development.

The New Political Orientation

The utopian fervour, the insistence on trying to build an ideal society for Indonesia is hostility to all the rich and powerful countries in the world, and the radical economic nationalism which masked an inflated xenophobia, have now been replaced by a general climate of economic realism and pragmatism, an openness to the outside world, an awareness of the importance of international economic co-operation, and a recognition of the vital role of private enterprise in the improvement of the economy. Hence a much more positive evaluation of the role private foreign capital could and should play in Indonesia’s economic development.

This, of course, does not mean that the basic attitudes that underlie the phenomenon of economic nationalism have all disappeared. The present economic leadership of the country is just as committed to prevent the re-establishment of foreign economic domination, and is no less intent on maintaining control over national resources and economic development and on securing the equality of Indonesia in her economic relations with the outside world. However, this leadership is guided by a realistic understanding of the basic laws of economics and of the dynamic of a modern global economy and fully realises the need for the assistance of foreign private capital, skill and experience for accelerated development. At the same time it has a much greater confidence in the possibilities of accommodating the sometimes conflicting interests of national development and the operations of private foreign enterprise as profit-making organisations. The return of the foreign enterprises taken over by the former regime to their original owners and the Foreign Investment Law promulgated in the beginning of 1967, are manifestations of this new, realistic orientation.

Before we go into a brief discussion of the legal aspects of this Foreign Investment Law, it would seem to me that one prior question should be answered, namely” how stable is Indonesia’s present political and economic course? The question can be answered in a number of ways. One could point to the firmness of the commitment to economic development priorities of the present leadership, or to the political courage that it has shown in putting through the painful stabilisation policies that were called for. One could also point to the organisational as well as ideological weakness of the oppositional forces in the country. But to me the most important factor that should be brought out is the emergence of a new post-independence, post-revolutionary generation into the political arena. It is this generation that has formulated, and is implementing and supporting the policies that emanate from this new economic orientation. Because they have never known the pain and humiliation of colonial subjugation, their outlook on the world is much freer and their self-confidence more natural. And equally important, this generation is fully familiar with modern science and technology and the possibility of their application to our problems.

Because the new economic realism is a very essential part of the new values that motivate this new generation of leadership, we can now look at the course that Indonesia has taken, both in its own economic and political development, and in its relations with the outside world, as a movement of growth – a growth of which the direction is stable.

Let us now have a look at some of the legal aspects of the Foreign Investment Law.

Main Issues of Interest to the Foreign Investor

In deciding whether to initiate investment in a given country after having carefully considered the business prospects, the prospective investor is concerned, in the first instance, with the safety of his capital and with the availability of protection against a variety of risks, including that of expropriation. A second broad category of issues which he must consider deals with the modes of entry, the organisational structure in which to carry on the venture, and the facilities made available to him for effectively managing his business operations. The third major area of interest concerns the facilities for the repatriation of capital profits and dividends.

I shall discuss the main points concerning these three broad categories of issues, but I think we must recognise that even more important than the specific legal provisions concerning these matters is the so-called investment climate, the state of government and public opinion on the role and the rights of the foreign investor in the host country. Many of the problems will not arise, particularly in the area of security of investment, if the investment climate is a hospitable one. Even if they do arise, it will not be difficult to reach a compromise or to find an interpretation of the laws of regulations which will fit the mutual needs of the parties if there is goodwill on both sides.

Nevertheless, it is important that the legal structure be reasonably adequate to permit the foreign investor to enter and carry forward his enterprise with the confidence that he will not likely encounter serious difficulties, as long s he comports himself in a reasonable manner and with full recognition of the fact that investment is a two-way street.

The legal safeguards provided by the host country, of course, do not operate in isolation from the safeguards provided by the capital exporting countries, such as investment guarantees, and those provided by the international community under both customary international law and international institutions or agreements. The international system may also include bilateral treaties between the host country and the capital-exporting country.

In considering the safeguards provided by the Indonesian legal system, I think you will wish to bear in mind that our commercial code is still fundamentally based on the legislation which the Netherlands introduced in Indonesia to deal with the problems of so-called Europeans and those assimilated to the European Group for legal purposes. There has been considerable discussion in Indonesian concerning the philosophy underlying our legal system following the abolition of colonialism. For example, there is a current of opinion which holds that there should now be only one legal system in Indonesia instead of the dualism which characterised our society in the colonial era and that the system should be based on adat (customary) law. However, the fact remains that our laws dealing with commercial and financial problems, particularly in so far as they affect foreigners and large-scale ventures, generally are clearly derived from Western models or at least have a strong Western component.

Thus, the Agrarian Act of 1960 introduced radical changes in land law, including unification of the law and the elimination of the dualism which had differentiated between land rights in the Western sphere and land rights in the customary law sphere. While the new Agrarian Act is purportedly based on customary law, it is in fact thoroughly modernised by the introduction of Western concepts, such as titles in land ownership, the distinction between real and personal rights and a system of compulsory registration which will ultimately be applied to non-/Western as well as Western-held land. The law also restricts the right of absolute ownership of land to Indonesian citizens.

The derivation of our commercial law from Western models is undoubtedly reassuring to potential foreign investors since it is easier for them to understand and to feel comfortable with a legal system which is familiar to them.

Returning to the problem of security of investment, you will find that our system provides for two basic safeguards on which investors tend to rely, namely laws governing the circumstances under which expropriation may be carried out and the right of access to an independent judiciary.

The Foreign Capital Investment Law (Law No. 1 of 1967, dated January 10, 1967) sets out the broad framework of conditions under which foreign investment is welcomed and protected in Indonesia. It governs the issues concerning entry, the establishment of a foreign entity, operation and management, and incentives for investment. It provides ample latitude for foreign investors to enter and operate without great difficulty.

The effect of the new law is to open most fields of business activity to foreign capital. The only fields of investment which are completely closed to foreign capital are those which fulfil a vital function in national defence (Article 6(2)). Other fields to which access is restricted, but may nevertheless be entered provided that the foreign investor does not exercise full control, are referred to in Article 6(1). These are fields of vital importance to the country, such as harbours, public utilities, atomic energy and mass media.

I need not emphasise that the new law has been designed to attract foreign capital to Indonesia for investment in projects which will contribute to the healthy development of the Indonesian economy. Accordingly, it offers a combination of incentives and accommodations which can stand comparison with those offered by other developing nations.

Part of the approach taken to attract new projects is to offer specific incentives, consisting of the following:

1. Exemption from tax on corporate profits for a period of up to five years, and exemption from the dividend tax on profits during those years;
2. Full authority to select management and recruit or use foreign technicians and experts for positions which Indonesian manpower is not yet capable of filling;
3. The offer of land at advantageous terms, carrying with it rights of building and exploitation formerly denied to foreign business enterprises.
4. Exemption from import duties for equipment, machinery, tools and initial plant supplies; and
5. Exemption from the capital stamp tax on the introduction of foreign capital for investment.

Profit transfer is guaranteed by law, and no restriction is imposed as to the amount. Also of great importance is the document entitled ‘Executive Directives for the Policy on Foreign Capital Investment in Indonesia’, issued by the Cabinet Presidium on January 27, 1967, which stipulates the order of priority of investments in the framework of the overall economic policy of the Government. Specifically, it provides for three general categories, (1) Foreign capital investment which may increase foreign exchange earnings, such as mining, agricultural export, etc; (2) investment which makes possible import substitutions; and (3) Investment which while not directly affecting the volume of foreign exchange nevertheless is of a quick-yielding character, increases employment opportunities, introduces new technology, or brings in modern equipment.

Current Investments

Although the new investment law has been in effect for a relatively short period (almost two and a half years) the response of foreign investors to Indonesia’s invitation to invest in that country has been encouraging. A large number of Australian, US, European, Japanese, and other companies have accepted the challenge and have started with their operations to assist Indonesia to build up the country. Some 20 foreign oil companies including major oil companies of the United States have concluded exploration and production contracts. It is estimated that by 1970 when these new contracts will have begun to show results, the total oil output should reach about one million barrels a day, as compared with 520,000 barrels a day in 1967. In the field of mining, five large companies are prepared to invest for the exploitation of copper, nickel, tin and bauxite. Twenty-five companies are working in the field of forestry and 55 in the manufacturing sector.

As of the first quarter of this year, 129 proposals from foreign investors had received the approval of the Government, representing a projected capital investment of $570 million including $236 million for mining (petroleum excluded), $99 million for forestry and $86 million for manufacturing. US investment accounts for 45 per cent of total projected investment ($273 million); 11 companies are operating in the field of manufacturing with an investment outlay of $26.7 million; three in the field of mining with an investment of $229.5 million; two companies in forestry with $3.3 million and nine others in various fields with an outlay of $14 million, making a total of 25 companies. This does not include the foreign bank branches and oil companies. Other countries following the US lead are: Canada, South Korea, the Netherlands, Japan and various other countries. It may also be interesting to note that out of the 129 ventures, 83 of those ventures are in the form of joint enterprises, 41 are straight investments and five are operating on the basis of contract-of-work.

We realise that foreign aid, foreign technical assistance and foreign private investment by themselves can never make a country a viable economy, but their role in a period of recovery can be crucial. Foreign investment is therefore expected to play an important role in the implementation of Indonesia’s Five Year Development Plan which was started in April this year. This Five Year Plan gives priority to (1) agriculture, particularly food production; (2) the development of mining and encouragement of industries which produce equipment and inputs for the agricultural products; (3) the strengthening of infrastructures, particularly transport and communication. The main objective of the plan is a simple one, namely to raise the standard of living for a future growth by way of food and clothing, improvement of infrastructure, provision of better housing and an increase of employment opportunities. In this plan emphasis is also given to rural and regional development.

This Five Year Plan will also provide the context within which the government-to-government aid to Indonesia provided by the Inter-Government Group on Indonesia, which includes Australia, the US, Japan, the Netherlands, Germany, France, the UK, Italy and Belgium, will be co-ordinated. The consultations on which Indonesia’s aid requirements are determined within the IGGI are based on assessments by the World Bank and the International Monetary Fund. In addition, the IMF has been most active in advising the Government on monetary and fiscal affairs while the Bank is assisting Indonesia in planning development programmes and preparing capital projects.

Transition and Evolution

Indonesia is a latecomer among developing countries in dealing with foreign investment. We are still in a transitional period and are still in the process of gaining the experience needed to guide us further in the area of codification and regulation. That part of our legal system that concerns modern economic activities of both domestic and foreign origin is, therefore, still in the process of readjustment and evolution. This process of adaptation to developmental goals is not only a theoretical one, but necessarily evolves in response to new problems and new experiences. We will also have to keep under constant review other laws that have a bearing on the general investment and business climate. At present this is the case for instance with Indonesian corporation law. With technical assistance from the International Monetary Fund, we are in the process of reforming our tax laws. Beside this, the agrarian law and the labour law will at some point have to be related more closely to our development goals.

Corporation Lawyers: Role and Style

While generally no American corporation makes a move without consulting its lawyers, the role Indonesian lawyers play in the activities of our business corporation is much less pronounced. The heavy reliance on legal counsel by foreign corporations is related to the importance of litigation and judicial procedures in the resolution of conflict in their country. In Indonesia, such conflict are most of the time resolve through administrative procedures and adjustments. This is, of course, not characteristic for Indonesia alone. It applies also to many European countries.

This difference in role may be one of the reasons why many Indonesian administrators are often somewhat puzzled when in the course of negotiations they are faced with elaborate stipulations raised by legal counsel of foreign corporations in anticipation of contingencies that might arise in the future. In part, this puzzlement stems from their unfamiliarity with the role legal counsel plays in the activities of business corporations in the US. In part, this may be the result of an important difference in societal setting. American business and their legal counsel are used to operate in a society that has been stable for quite some time, and there is therefore a considerable degree of predictability of future responses and implications once a particular course of action is decided upon. Lately, some doubts have arisen about this purported stability and predictability, but that is beside the point.

The attitudes that have been shaped by this condition still persist. Our people, on the other hand, are trying to build towards stability. They are working from a situation in which the horizon of visibility and predictability is still limited, though clearly expanding. And though these officials may be able to see the validity of the points raised, they are quite often not in a position to answer. Why? Not because they are lacking in goodwill or because they are technically incompetent, but often simply because no one can entirely foresee the broader setting that will eventually develop – partially thanks to the operations of foreign enterprises-and in which these problems will have to be answered. Any assurances given at this stage are bound to have only limited validity. Also, no government can afford to prejudice its future policy options by making premature commitments on the basis of hypothetical situations.

But even more important in this connection may be the differences in attitude that centre around the concept of ‘good faith’ in Indonesian commercial law. The central position of this concept in Indonesia has led to a lesser concern with protective clauses spelled out for specific contingencies than is the case in the American tradition.

An understanding of these differences may make it easier for an Australian or American lawyer to communicate while negotiating in Indonesia. Conversely, a greater familiarity on the part of the Indonesian government officials, businessmen and lawyers with Australian or other practices and the special role of legal counsel in business activities would be helpful too.

It should also be realised, however, that in the evolution of the Indonesian commercial legal system, adaptations will have to be made that will enable it to bridge differences with the legal systems and practices of other countries, like Australia, Japan and Western and Eastern Europe, each with their own legal culture. The tendency of some Australian and American lawyers to try to impose on us their own legal concepts with regard to such issues as corporate laws and tax laws, seems to us sometimes rather excessively one-sided. Often we are faced with demands for contractual guarantees as regards taxation, foreign exchange regulations and so forth, for the entire duration of the contract. There have been cases where we have indeed compromised on these points, as for instance in the case of certain mining contracts covering large investments. But it should be realised that the insistence on such waivers undermines the strength of the legal system as a whole, including the protection of foreign investments in general.

This would obviously be against the long run interests of foreign investors. For example, some of the waivers requested involved bypassing the foreign exchange system, which was developed in co-operation with the International Monetary Fund as an integral element of our economic stabilisation programme. It seems to us that the interest of foreign investors would not in the long run be served by weakening that mechanism.

We sometimes even find ourselves in the ironic position of having to explain to prospective American investors the reason why we object to the suspension of the operation of market forces and why we consider it important to keep competition open, when excessive protective measures are insisted upon. In order to meet this kind of problem more adequately we have asked the World Bank to help us in developing optimal criteria for both the investors and for Indonesia, that could be generally applied in this connection. All this, I hope, will explain why we take the position that would be investors should accept both the existing legal framework and the way in which it will develop in the future.

The long-range protection for foreign private capital lies in the stability of a favourable business and investment climate. This is only possible if, as in Indonesia, the incentives and accommodations of foreign investment are also made available on a non-discriminating basis to domestic investors. In fact, the rapid development of national business should be seen as directly in the interest of foreign investment as well.

Foreign Investment and the Political Climate

The stability and continuity of a political climate that is favourable to foreign investment will very much depend on the willingness and the capability of foreign enterprises to develop linkages with the environment in which they operate, with the business community, the universities and other teaching institutions, as well as with the intellectual community in general. By involving local business in some of the spin off activities of these enterprises, through technical assistance, through utilisation of local raw materials, the stimulation of local servicing facilities and of manufacturing of components and spare parts, through making available staff members for teaching purposes in order to accelerate the transfer of technology, organisational and managerial skills at all levels, and by taking an interest I the development of small and medium sized indigenous business firms in their localities, the foreign companies could very well become a catalytic ad accelerating factor in the development of the society in which they operate.

The positive contribution that foreign business could make, not only to economic development, but to a healthy political growth as well, without in any way assuming a political role, should therefore not be underestimated. I think it is quite possible for private foreign business to play this role without endangering its primary role as a profit-making organisation. In this manner, foreign private business will avoid the danger of becoming an alien enclave in a stagnant and increasingly hostile environment. It is in this kind of integration with the patterns of national development that its best protection lies.

If foreign investment comes to be seen by a majority of the political public as insensitive to national aspirations, as an obstacle to national development, or as an alien element pursuing ends that are contrary to the national interest, political pressures against the purely legal safeguards are bound to develop. It is of the greatest importance that private foreign business operating in an underdeveloped country should develop the capacity to identify with the developmental goals of co-operative endeavour with national business that it is regarded as an ally, an accelerator and a catalyst of national development whose continued presence is beyond doubt in the national interest as well.

Ultimately, the protection of foreign private investment lies in the rapid development of an indigenous commercial and entrepreneurial middle class and the development of a community of business interests between them and foreign enterprises in their country. Any contribution private foreign business could make to that end would provide additional long range security for their investment.

Foreign Investment in the Global Setting

There is, however, an even wider setting, almost within the same time span, within which security of private investment in developing countries inevitably will have to be considered as well. The determinants here are the population explosion, the question of international poverty and the need for generalising economic development throughout the world. I hope you will allow me in closing to say a few words about this.

It is, of course, a truism to state that the world is becoming increasingly interdependent. There are few economic or political decisions, taken in the national context, that will not evoke international repercussions and vice versa. The world is also rapidly becoming smaller and more and more crowded. The world population is expected to double in the next 30 years. The increasingly uneven density of population in various parts of the world, on top of widening inequalities in the distribution of wealth, is bound to create important shifts in the balance of forces as well as tremendous tensions in the world during the coming decades. But before everything else, mankind must be able to answer the very elementary questions of how are we going to feed that population; how to produce enough to clothe them and to meet other essential material needs the world over, if civilised life is to be maintained. The rapid population increase, especially in the poor nations, will therefore have to be met by an increased economic production capability and especially by a much more extensive involvement of the poor nations themselves in those productive processes.

If we, that is mankind as a whole, fail to organise ourselves for this purpose, the tensions that inevitably will develop in the poor nations will destroy the possibility of their evolution towards increasingly open societies capable of rational and creative relationship with the outside word. In this way, the international order itself, including the security of the rich nations, will be in danger. Our capacity to organise ourselves for this task will very much determine the shape and the quality of our life by the time we enter the 21^st Century, if we ever reach that point. This, however, will require a major redirection of world resources and the striking of a new balance-globally-between expenditure for armaments, and for the combating of domestic and international poverty. For this, a reassertion is needed of the political will to bring about such a redirection of world resources.

In this respect, the search that is now taking place the world over for those forms and methods that would be most advantageous to promote the transfer of private capital, skill and managerial capability from the developed countries to the new nations, is a crucial one. The experience of the first United Nations Development Decade has shown that unless there is such a greater flow of capital throughout the world, especially of private capital to the developing countries, there is little prospect of an adequate response to this problem. One can only hope that private business the world over can develop the capacity, the ingenuity-over and beyond short term considerations of profit-to develop the forms and modalities that will make such an expanded role possible as well as profitable. After all, business corporations are the natural repositories of the technology, the skills, the organisational and managerial capacity for this very task.

It is equally true that an increased application of private capital to generate world-wide development will by itself not be sufficient. Unless the flow of government-to-government development funds in the form of foreign aid is continued at adequate levels for some time, there is no prospect that infrastructure development in a number of new nations can proceed sufficiently so as to enable private capital to play its productive and socially creative role. Much will also depend on our conceptual and operational capability to move in this direction. We need to develop a more adequate and consistent system of rights and responsibilities, of incentives, safeguards and guarantees of various kinds on both the side of the developed as well as of the poor nations. We will have to search for more adequate forms and methods that can facilitate in a substantial way the transfer of capital and other resources. The scope and capabilities of existing multilateral development agencies like the World Bank and regional banks as well will have to be re-examined in this connection. Likewise, the access of underdeveloped countries to international capital and bond markets, and the development of an internationally coherent tax system related to international development needs. Attention should also be given to the role which international corporations are increasingly playing in internationalising development. The extra-national character of the decision centres of these companies poses important problems and, in the words of Philip de Seynes, United Nations Under Secretary General for Economic and Social Affairs, calls for the development of a new system of international law with greater economic content.

It may not be possible for the profit motive alone to bring about the substantially stepped-up role of private capital sufficient to deal with the population explosion and the problems of poverty that may tear the world apart. What may be needed as well as a clearer understanding of the magnitude and the urgency of the problems which the whole of mankind will have to face 20 to 30 years from now, and a clearer vision of the kind of world in which we do want to live. I think it is important for all of us, in discussing problems connected with the security of foreign investment and the legal safeguards for the protection of foreign investment in developing countries, that we do so with a full awareness of the magnitude and the urgency of the role that has to be played by private capital and the urgency for private capital and the governments of the developed as well as the underdeveloped countries together to create the conditions to make this possible. If we are to come to grips with the problems that will determine the total global environment in which all of us, including private capital, will have to live in the relatively near future.

Being myself totally innocent of a training in law, I will not presume to give you a breakdown of the challenges this poses to those in the legal profession who are involved in the activities of business corporations. This challenge certainly goes far beyond the legal aspects of foreign investment problems in the time frame of the present. Still, it is from this perspective that I invite you to look at the problem of investing in a developing nation.