Subject: WSJ: It's the Economy, Stupid

Also Learn some economics and search for the truth, stupid

It's the Economy, Stupid

By Paul Cleary Wall Street Journal, May 23, 2007

Before lapsing back into violence and political turmoil last April, East Timor had been held up as a success story in post-conflict reconstruction. In explaining how the newly independent nation went off the rails, the United Nations special commission of inquiry and the International Crisis Group's study, among others, have raised all manner of complex, internecine political factors.

In focusing on the immediate trigger for renewed conflict, however, analysts have largely overlooked East Timor's sharp and sustained decline in per capita GDP -- a sufficient condition for sending any post-conflict country back into conflict.

As the U.N. presence in East Timor was downsized from 2001 onwards, the economy contracted sharply for four straight years in per capita terms -- and this is in a country with a population growing at 4%-5%. Mass unemployment, especially among youth, created the precondition for a minor armed-forces dispute to trigger widespread gang violence.

In the lead-up to the conflict, and as it intensified, East Timor's savings -- held in an account opened in August 2005 with the U.S. Federal Reserve's New York branch -- piled up, hitting the $1 billion mark last December. Meanwhile, an inept administration was unable to roll out desperately needed spending, especially in public works. Total state expenditure was only $82 million in 2005-06, around two-thirds of the budgeted amount. East Timor's sad fate really is a case of "it's the economy, stupid."

Now, the two men contesting the first government's grip on power, Nobel laureate and president José Ramos-Horta, and outgoing president Xanana Gusmão, have called for a dramatic lift in spending. Mr. Gusmão has called for withdrawing the money invested in U.S. treasury bonds in order to address the overwhelming challenges facing one of the poorest countries on earth. East Timor has a population of around one million and per capita GDP of $600.

The incumbent Fretilin government, which took office in May 2002, has been dealt a resounding vote of no confidence after mismanaging the country's post-independence development and the armed-forces dispute. Fretilin is widely perceived as autocratic and insensitive, and was on track to turn the country into a one-party state.

Mr. Ramos-Horta, who stood as an independent, beat the Fretilin candidate, Francisco Guterres, in the May 9 poll for the ceremonial but influential role of president, with 69% of the vote. As interim prime minister he also proposed a huge cut in business taxation to stimulate the economy.

Mr. Gusmão, the poet, artist, pumpkin farmer and former leader of East Timor's resistance army, is outraged by Fretilin's poor administration and, after postponing his plans to retire, has formed a new political party, CNRT, to contest the June 30 poll. Mr. Gusmão spent 16 years in the mountains during the Indonesian occupation, and then six years in a Jakarta prison. He is also joined by the well-organized Democratic Party, which ran third in the presidential poll, and a group of reformist members from Fretilin.

Mr. Gusmão's plan to spend the savings, which hit $1.2 billion in the March quarter, reflects the frustration of the Timorese at seeing very few tangible signs of government activity after independence. The Fretilin government did very well at saving money, but badly when it came to spending it effectively.

In the two years that I worked and traveled in East Timor there was a palpable dearth of government activity throughout the country. Labor-intensive capital works were a rarity. Youths would stare blankly when asked when they last had a job; many had never worked. Some of the small towns had no shops because the people living there had no money. Barter still remained a form of exchange in some remote areas.

A lack of financial services was partly to blame for inhibiting the flow of money. Money spent in the districts had to be physically carted around the country because there was little access to banking services outside the capital.

But the root cause of the Fretilin government's inability to spend money was a cumbersome and highly centralized administration in which ministers were required to approve even the smallest expenditure items. Former Prime Minister Mari Alkatiri, who was forced to stand down in June last year, believed that his 13 district administrators could not be trusted to manage money. They were given an autonomous budget of just $2,000 month; all other spending was controlled in the capital. A more decentralized administration is clearly needed.

Mr. Alkatiri believed the Timorese people had developed a "dependency mentality" during the Indonesian years, and as a result he was averse to supporting any measure that could be construed as a handout. Political pressure to create a pension scheme for veterans was met with a tightly targeted response; only those who could prove they served continuously for 24 years would be eligible.

Rather than creating dependency, pensions can help to circulate and multiply money, provided that there is an effective financial system. As the financial system is now being slowly expanded though microfinance cooperatives, a more substantial pension scheme for mothers with children, for example, would be an effective way to reduce poverty in a country where 40% of children show the physical effects of under-nutrition. This could also be matched with incentives to arrest the booming birth rate.

The expansion of old-fashioned public works programs would be another means of getting the fiscal multiplier working in East Timor and soaking up surplus labor, especially in the capital where youth unemployment is manifested in gang violence. In 2004, U.N. representative Sukehiro Hasegawa privately urged a big expansion of public works but Mr. Alkatiri ignored this advice.

Greater funding for basic road maintenance and municipal services might ensure that roads stay open in the wet season, allowing farmers to get their produce to markets, while also making the country a more attractive place to visit. East Timor, with world-class diving and spectacular mountains, has enormous tourist potential yet the beaches and countryside are badly littered. Prospective tourists would be well-advised not to stroll down the sidewalks as they risk falling into deep crevices.

Perhaps the most significant spending target would be the expansion of credit to jump start private-sector activity, especially in rural areas. When billionaire investor George Soros visited the country in January 2006 he urged the government to create a rural credit bank. Mr. Ramos-Horta is a strong advocate of microfinance, having used some of the money he gained from the Nobel prize to start small programs.

But in reviving East Timor's sagging economy, Mr. Gusmão does not need to raid the savings in New York, which are the assets of East Timor's permanent Petroleum Fund. Spending the money that is available in the budget would be the place to start.

Under the Petroleum Fund Law of 2005 the government has a spending target of 3% of the present value of future petroleum receipts, together with the financial assets in the fund. This is the "sustainable income" which can be spent without prejudicing future generations. So far, spending has been well below this benchmark as revenue has poured in from the ConocoPhillips-operated Bayu-Undan project.

Modeled on Norway's mammoth oil fund, which after 10 years is worth $305 billion, East Timor's Petroleum Fund is a very transparent and prudent way of managing oil revenue in a developing country. All petroleum-related revenue flows directly into the fund, any withdrawal requires parliamentary approval, and the only place the money can move is from the fund to the budget.

The fund is an iconic achievement for East Timor. It remains an exemplary piece of public policy for resource-rich developing countries, but the achievement is overshadowed by the government's failure to strike the right balance between spending and saving.

Mr. Cleary, an Australian journalist, helped advise East Timor on the establishment of the Petroleum Fund. His book, "Shakedown: Australia's Grab for Timor Oil," is forthcoming from Allen & Unwin.


From Helen Hill

I have noticed some confusion among commentators on the Presidential election, including Paul Cleary, who argue that the percentage votes for the second round of the elections in some way represent the state of the parties. For example Paul here says 'The voters of East Timor recently expressed their verdict resoundingly on the management of the first independence government'. Is he fogetting that Jose Ramos Horta was an active and senior member of that government?

In reality the two elections are for very different purposes. Less informed observers even talk about Xanana Gusmao 'ruuning for Prime Minister'.  The fact is that the President is the only popularly elected position, the Prime Ministership needs to be allocated by the majority party or parties according to ability, not popularity, or the country will be in real trouble. For some reason the Presidential elections were held before the Legislative elections this time. I do not know the reason for this, but it has meant that most of the parties tried to use them as a try-out for the Legislative elections and the field was lacking in independent candidates 'above politics' which was the original intent of the position.

In the first round a member of FRETILIN and its oficial candidate, gained the highest number of votes.  In the second round, I can imagine many FRETILIN supporters actually voting for Jose Ramos-Horta, figuring that it might be easier to get a FRETILIN government elected if there was not already a FRETILIN President.  Furthermore, thanks to the move towards identity politics or even feudalism, by several parties, I can imagine some who voted for other parties in the first round voting for Lu'Olo in the second round on the grounds that he is of purely indignous descent. Whatever the case we can't know the real state of the parties until the actual vote in the Legislative elections as there are no reliable opinion polls in Timor-Leste.  I am just warning against using the Presidential vote as some sort of opinion poll on the state of the parties.

Helen Hill

Fitzroy, Victoria, Australia
author 'Stirrings of Nationalism in East Timor: FRETILIN 1974-78'  Otford Press, 2002.


From Damien Kingsbury

Helen Hill raises some interesting points about the status of the recent and coming elections. However, as I will try to briefly explain, it is indeed possible to extrapolate from the recent polls to that which is forthcoming.

First up, JRH was primarily foreign minister, which as Helen knows, is a non-economic portfolio. When he became PM, he was entirely politically isolated and in any case policy prescrptions had already been set and in very large part acted upon.

On a slightly different note, there are indeed debates about development economics, but speaking from the position of one who has worked in this field for the last 20 or so years, there is no final or absolute understanding of the subject, nor is any one interpretation necessarily correct. Perhaps the biggest problem in the field has been the shift to economic 'neo-liberalism' and structural adjustment programs. But again, there are arguments both for and against the appropriateness of this.

It is of course quite true that East Timor's first government inherited a destroyed infrastructure, a profound lack of organisational capacity and a dual-track economy. It is also true that the UN, for all its manifest faults and problems, along with the multitude of NGOs, actually ran the place for the first couple of years, and still underpin much of what happens. Further, while it is correct that Australia shafted East Timor over access to and allocation of oil and gas receipts (Shame, Australia, shame!), the ET government has not spent the funds that it has had available to it. The reasons are two-fold; lack of capacity to properly use the funds available, especially in the districts, and a consequent tendency towards micro-management at the center, exacerbated by a pre-existing tendency towards bureaucratic-centralism. So yes, more money would help, but so would spending all the money that has been available. Perhaps spending money badly is better than not spending it at all, assuming the humanitarian necessity of financial liquidity in the districts.

On the question of personality politics and feudalism, Helen is right in that these are important political characteristics. I agree with her inference, too, that they do not represent a higher state of political development. But East Timor is like that, for the time being; it remains hierarchical and as such  quasi-feudal, and driven by patron-client 'streams of influence' ('aliran', in Indonesian). Politics in developing countries is commonly like this, for reasons I do not have time or space to elaborate upon here.

On the issue of the prime ministership, the parliamentary system requires the election of the prime minister from among the majority and s/she appoints ministers. The prime minister is, in theory, 'first among equals'. In reality, however, individuals as heads of parties, coalitions or likely coalitions may announce their intention or desire to become PM, and hence in most parliamentary systems the office of prime minister is understood in relation to individuals leading parties. Thus Xanana is running for PM, even if the formality is that he will need to be elected to this position by a majority within parliament. Moreover, in such a coalition, if it eventuates, the PM does not alone appoint ministers, but rather negotiates on the basis of numbers of seats equating to particualr ministries, the largest coalition party taking the PM-ship. So, there is the technical theory, and then there is the reality of how parliamentary politics actually works.

In terms of who voted how, and the relationship between the presidential and parliamentary elections:

The presidency cannot be 'above' politics, as it is an inherently political position. That the canddiates for the presidency represented or were explicitly supported by parties confirms that basic fact.

The breakdown of voting behaviour, by district, village and candidate/party between the two rounds of the presidential election show a remarkable conformity. Anyone in East Timor at the time will know that despite Fretilin trying to make JRH's ethnicity an electoral issue, and his attempts to dispell that, it simply was not the issue upon which people voted.

In short, the first round gave a good indication of party preference, and the second round confirmed the status of the non-Fretilin vote (again appearing to conform to party-specific adherence). Fretilin may be the biggest party after the parliamentary elections, but it will only be by plurality, not by majority. Hence, as we have seen in very many other cases, having the largest plurality is a long way from securing power or, indeed, allocating such a right to power. Assuming 30 per cent of the vote, it may be reasonably construed that 70 per cent of the voting population not only want an alternative representative, they do not want Fretilin. This was confirmed by the second round presidential results.

So, I agree with Helen that we should be cautious of predicting absolute outcomes - crystal ball gazing assumes qualities of foresight that few of us have. However, it is possible to reasonably extrapolate from the presidential rounds a fairly coinsistent pattern of voter behaviour which, on balance, is likely to be closely repeated. To that end, Fretilin's vote might improve. But if it does so, it will probably be at the margins.

At this stage, rather than trying to predict absolute outcomes, what is more interesting is to consider the possible combinations that would comprise coalitions, the options for policy initiative within the context of a low capacity and a multi-lateral dominated economy, and the possibilities for future 'development'.




Timor Leste

Learn some economics and search for the truth, stupid

Paul Cleary's hysterical diatribe ­ It's the Economy, Stupid (Wall Street Journal 23 May 2007) - against the Fretilin led Government is only matched by his fundamental misunderstandings of development economics.

One of the ironies of Timor Leste's situation is that whilst conservative western journalists, fed by the Australian Embassy and the Australian Government, jumped on the bandwagon to blame Fretilin for all of the countries ills; the key international agencies such as the World Bank and the IMF were applauding the government for its successful management of the economy.

The first point is that you can't spend money that you don't have. The new Fretilin Government had few if any levers to rebuild the economy following the departure of the Indonesian military and its bureaucrats. The IMF estimates that 70% of the nation's capital stock was destroyed during the turmoil in 1999. A traumatized population, no public service, no funds in the budget, and indeed, no functioning economy apart from the 75% of the population engaged in subsistence agriculture.

The UN presence created and stimulated an artificial economy, which fell dramatically after the premature withdrawal of the UN in 2002. Few countries have experienced the traumas of East Timor and survived. As we know from the experiences of countries that have emerged from excessive brutality - in Timor's case losing one third of its population through murder and malnutrition - it takes many years to recover and the initial transition often results in economic uncertainty and social instability. Establishing a government, drafting a constitution, creating a legal framework for a new state, training a skilled bureaucracy, collecting data and information regarding needs, and developing and implementing policies and priorities are all labour intensive processes. But countries that don't go down the path of establishing the institutions of honest government and a sound legal framework quickly degenerate into chaotic and corrupt states dominated by egotistical despots backed by powerful commercial interests.

It was apparent to pretty well everyone that the Timorese really had only one card to play and that was to reclaim sovereignty over the country's significant oil and gas reserves. As we all know, this vast resource had already been carved up between the Australians and the Indonesian occupiers. The determination of Prime Minister Alkatari, backed by outstanding advisers including Norwegian representatives and Professor Peter Galbraith, resulted in Timor Leste clawing back a share of its resources from the rapacious Australian interests.

After protracted negotiations, and deliberate delays and pressure from the Australian side, the Fretilin led Government secured a long term revenue base for the people of Timor Leste. The Government enacted legislation to ensure that the democratically elected parliament determined expenditure priorities through the Petroleum Fund. In this the then Prime Minister Mari Alkatari was determined to learn the lessons of other oil rich states, and prevent the nation from deteriorating into demagoguery and corruption.

Having secured the country's economic future through partial success of the oil and gas negotiations, the Fretilin Government was for the first time in a position to implement its National Development Plan, which focuses on increasing growth to 7-8% per annum, reducing poverty and increasing investment in 17 sectors. The goals and objectives of the National Development Plan are now achievable with a secure revenue base and a society backed by the rule of law, vindicating Alkatari's approach throughout this period.

Of course it was no surprise that Timor Leste battled during this transition period. But it is important to recognise the achievements of the Fretilin Government. Important progress has been made. Improvements in adult literacy and provision of free education for children are critical first steps. The availability of primary health care at the village level, backed by the generous support of 250 Cuban doctors, has focused health priorities on the poorest members of the country. This is not to mention the long term benefits of 600 Timorese students studying medicine in Havana. It hardly needs mentioning that the Australian Government and United States Government would not be able to provide anywhere near this level of commitment to a country like Timor Leste.

The Timor Leste economy had little absorptive capacity following the departure of the Indonesian military, who of course took their managers with them. It is important to note that only about 12% of the East Timor workforce is employed in the formal economy. For those who want to "release the funds" it is important to warn of the dire consequences of releasing massive amounts of money quickly into an economy that can't absorb it. Resources must be released in a staged manner into the economy, through education and training of the population, increased business activity and work opportunities, particularly for young people, through the provision of basic infrastructure and services. Throwing money into villages without well designed and implemented projects will results in massive inflation and a deterioration of the economy. The main focus, as articulated by the Fretilin Government is to improve education, health and key sectors of the economy, particularly agriculture.

As for Jose Ramos Horta's enthusiasm for micro-credit programs, based on the experiences of the Bangladesh Grameen Bank, it is important to point out that there is no Bangladesh economic miracle. Bangladesh is as poor as Timor Leste. Although targeted programs to assist people establish small businesses have a role to play, they should not be the centerpiece of an economic strategy to build a modern economy. The key elements to alleviate poverty are to increase economic growth through sound management of the economy and wise expenditure of the petroleum funds, provide subsidies to poorer sections of the population, ensure that well off members of society pay tax, and invest in basic infrastructure and services to support the population. It is important to note that, under Fretilin, the Human Development Index, a composite measure of the society's well being in terms of health, literacy, food and shelter has significantly improved. This, rather than crude GDP figures, is that measure by which the Government should be judged.

Let's give Fretilin the big tick it deserves. An independent country, a functioning democracy, a secure revenue base to underpin the future of the country, a record of honesty in government and a commitment to the poorest members of this traumatized country. A record of achievement we could all learn from.

Graham Larcombe 24 May 2007

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