Was the Busang Gold Debacle Predictable?

Michael Walker

Few business items have attracted as much attention in the last year as the machinations surrounding the discovery and move toward development of the Busang gold deposit in Indonesia. Combining intrigue, world ranking political figures, and a good dose of chicanery, the Bre-X saga is a story which will be told over and over again for generations to come. While one can be certain that the management of Bre-X was blind-sided by the developments in which they found themselves enmeshed, those developments were more or less predictable. From The Fraser Institute's point of view, the developments in Indonesia are a perfect example of the impact statism has on economic development.

This article explores the extent to which the Busang experience might have been predicted using a new index compiled by The Fraser Institute. It also offers lessons from the Indonesian situation.

Twelve years ago The Fraser Institute began an investigation of statism and the concept of economic freedom, and how economic freedom relates to other fundamental freedoms, such as political and civic freedoms, and how all of these freedoms were related to economic development. Over the twelve year period, the Institute has produced four books looking at different aspects of this topic. The first, Freedom, Democracy and Economic Welfare was a general scan of the broad philosophical issues involved in the measurement of economic freedom. The most recent, published in 1996, attempts to provide a comprehensive measurement of the extent to which people are free to make economic choices without intervention by the state.

This latest book, Economic Freedom of the World: 1975-1995, compiles an index of economic freedom based on measurements of 17 different aspects of the economies of 103 different nations. The 17 different factors are concerned with four different categories of ways in which economic freedom of individuals may be impinged upon by the state.

Categories of economic freedom

The first group of factors, the protection of money as a store of value and medium of exchange, deals with the extent to which governments infringe upon people's ability to use money to transact in markets. The second set of variables, the freedom to decide what is produced and consumed, concerns government operations and regulations. The third group of variables, the freedom to keep what you earn, focuses on the takings and discriminatory taxation policies of government. The fourth and final group of factors which the index measures, freedom of exchange with foreigners, is the extent to which there are restraints on international exchange.

Capitalist versus statist

From a theoretical point of view, a truly capitalist or market oriented society would be one in which all economic transactions were voluntarily conducted by private citizens. There would be no role for government and therefore no government involvement in economic decision making. In a capitalist society, the means of production are entirely privately owned and freely operating markets are relied upon to allocate resources and to determine the key decisions in the economy. Since government is not involved at all in economic decisions, all private wealth arises from voluntary contracting-what is sometimes called "capitalist acts between consenting adults."

At the other end of the spectrum lies the statist societies in which governments own all of the assets and make all of the decisions about the allocation of resources. In such economies, markets are suppressed and voluntary economic interaction is replaced by state directed activity. In a statist society nobody can get wealthy without having a connection to the government. In fact, in most statist societies, one's wealth will be directly related to the status one has in relation to the government.

Now while this capitalist-statist spectrum is a fine theoretical construct, the reality is very much more complicated. Countries that are notionally capitalist in character nevertheless have considerable involvement in their economies by governments as owners, regulators, controllers of markets, taxers, and decision makers. Countries of a notionally statist kind have always found that they have to rely on markets to accomplish many of their economic objectives and upon private ownership of one kind or another as a method of tenure.

All economies lie somewhere along the capitalism/statism spectrum. While there has always been a tendency to think about countries as notionally lying somewhere along the spectrum, it has not been possible to be precise in measuring the extent to which they lay at one end or the other. The economic freedom index gives us the ability to position countries along the spectrum according to the policies they follow.

In fact, the freedom index is ideally suited for doing this, since it is an explicitly comparative measurement. For example, in rating the extent of government expenditure as a percentage of the economy, countries are simply ranked relative to each other. The country having the smallest government sector in GDP is given the highest rating, and the country with the largest percentage of its GDP spent by government is given the lowest rating. Other countries are distributed in between. The index does not say that some level of expenditure is good or bad, but rather that the level of expenditure is high or low relative to government expenditure in other countries.

Looked at from the point of view of the capitalism/statism spectrum, countries that have a high degree of government ownership, together with a high degree of government involvement in decision making in the economy, will get a low score on the economic freedom index. Countries that have a relatively small amount of government ownership and a relatively small amount of involvement in economic decision making, will have a relatively high score on the economic freedom index.

Figure 1 provides the capitalism/ statism spectrum for a selection of countries which were analyzed in Economic Freedom of the World: 1975-1995. From Hong Kong on the capitalist end, which scores the highest on the freedom index, to Iran on the statist end, there is an interesting variety of countries with differing attitudes about the respective roles of government and the market. What is not evident from Figure 1 is the fact that countries change their attitudes and their policy regimes as time passes.

Freedom status changes

Changes in the freedom status of countries are more evident in Figure 2, which shows some of the deviations from the average freedom setting for the industrialized countries and the Asian Tigers between 1975 and 1995. Countries such as Germany, that were above average in 1975, have fallen to below average in 1995. Canada, which was distinctly above average in 1975, has slipped to just above average in 1995. The relative position of the United States, which was distinctly above average in 1975, has not changed much in 20 years.

Perhaps the most interesting countries are those like New Zealand, the United Kingdom, Ireland, and Chile, which have all dramatically improved their levels of economic freedom since 1975.

The Busang case

But what has all this got to do with Busang? To answer that, we have to focus more specifically on the position of Indonesia on the capitalism/statism spectrum. Indonesia earned a score of 6.1 on the 0 to 10 scale. That secured Indonesia the 28th position out of 103 countries overall.

This is not a particularly bad rating. Indonesia ranks in the top third of countries. On the basis of that assessment, one would not have expected the great difficulties that have surrounded the Busang affair. However, a closer examination of Indonesia's rating does sound alarm bells, and, indeed, makes it pretty clear that venturing into Indonesia was a relatively hazardous investment activity. The relevant facts are presented in Table 1.

First, a review of Indonesia's 1995 rating reveals that, while it is higher than it was in 1975, it is actually lower than its 1990 score. In 1990, Indonesia scored 6.6; by 1995 its rating had fallen to 6.1. Even more importantly, Indonesia did particularly badly in the area of government operations that might directly threaten private enterprise activities.

The existence of government enterprises is a key indicator of the attitude of governments toward capitalist or statist enterprises. Governments that are extensively involved in the ownership and operation of enterprises, either directly or indirectly, are governments that have a high taste for intervention. In categorizing countries according to their taste for public ownership, we assigned a top grade to countries in which government-operated enterprises produced less than one percent of the country's output. As the estimated size and breadth of the government enterprise sector increased, countries were assigned lower ratings. A rating of 8 was assigned when there were few government operated enterprises except for power generating or similar industries where economies of scale might reduce the effectiveness of competition. A rating of 6 was assigned when the government enterprises also spread into transportation, communications, and the development of energy sources, but private enterprises dominated other sectors of the economy. A rating of 4 was given when most of the economy's large enterprises were operated by the government and these enterprises generally constituted between 10 and 20 percent of the total non-agricultural employment and output. The assigned rating declined to 2 when government enterprises were estimated to comprise between 20 and 30 percent of the total non-agricultural employment and output, and down to zero when the estimated share of the public sector business exceeded 30 percent of the economy.

Indonesia scored a 2 in this important category. The average rating for this variable over the 103 countries we were able to rate was 4.5. In some sense, then, Indonesia was more than twice as likely to be involved in government ownership activities than the average country, and more than four times more likely than a country like Chile, which scored an 8 on this variable. (By the way, in this category, Canada scored 6.)

In the area of price controls, Indonesia scored a value of 3 compared to an average of 4.9 over the 87 countries we could rate for this variable. On the ability to enter into business and the freedom of businesses to compete, Indonesia scored 2.5 against an average of 6.5 over 103 countries. This compares to a Chilean score of 10, and a Canadian score of 7.5.

Perhaps the most devastating critique of the Indonesian situation lies in the variable that rates access to the legal system, and the extent to which individuals have access to an impartial judiciary for the settlement of issues. Indonesia scored 0, compared with an average of 3.7 over the 103 countries rated. Indeed, this should have been the major warning to anybody operating in the Indonesian climate that they could not expect to be treated "fairly," that is, according to law and impartially. The legal structure provides Indonesian public officials with a great deal of arbitrary authority, and this discretion effectively undermines the security of property rights and induces corruption as a way of life. Finally, regulation-free capital transactions with foreigners are rarely permitted in Indonesia, which scores a 2 in this area.

Recent developments predictable

Far from being a surprise, the recent developments with regard to the Busang gold deposit are exactly what the past conduct in Indonesia, as reflected in the very low scores that it receives in the economic freedom index in the important areas of government operations, would have led one to expect. While it has maintained a reasonably sound monetary system free of inflation, has kept formal taxes low, and permitted flexibility in international trade, Indonesia is fundamentally statist in the way it deals with economic decision making. Even though Bre-X, through its efforts, found the second richest gold deposit in history, whether or not it will benefit depends upon its closeness to the "crown," not on its economic performance.

References

Gwartney, James, Robert Lawson, and Walter Block, Economic Freedom of the World, 1975-1995, Vancouver: The Fraser Institute, 1996.

"Busang Affair Highlights Risks in Indonesia," Globe and Mail, January 8, 1997, p. B6.

Four Categories for Measuring Economic Freedom

Group 1: Protection of money as a store of value and medium of exchange

This group of factors deals with the extent to which governments restrict people's ability to use money to transact in markets. It includes measures such as the variability of the inflation rate, the extent to which governments use the inflation tax to finance their expenditures by reducing the value of the outstanding stock of money and the extent to which governments interfere with the ability of their citizens to own foreign money or to maintain bank accounts in foreign countries.

Group 2: Freedom to decide what is produced and consumed

This set of variables concerns government operations and regulations and is concerned with the freedom of people to decide what is produced and consumed. It includes a measure of government spending as a percentage of the total spending in the economy, a measure of the role and presence of government- operated businesses-so called crown corporations, a measure of the extent to which businesses are free to set their own prices-that is to say, the absence of price controls, a variable measuring the freedom of private businesses and co-operatives to compete in markets, the equality of citizens under the law, the access of citizens to a non-discriminatory judiciary, and finally, the amount of freedom from government regulations and policies that cause negative real interest rates. The latter is of interest since governments very often restrict the freedom of their citizens to borrow and lend, and consequently create artificial conditions in capital markets which, in conjunction with controls on their ability to move their money to other countries, can produce negative real interest rates. We use negative real interest rates as an indicator of countries which fundamentally interfere with the operation of their capital markets.

Group 3: Freedom to keep what you earn

The third group of variables focuses on the takings and discriminatory taxation policies of government. Transfers and subsidies as a percentage of the gross domestic product are a measure of the extent to which governments are engaged in taking from one group of citizens in order to give to another group. This redistribution reduces the ability of individuals to dispose of the fruits of their own labours, and therefore countries that have high transfer rates are given a lower ranking on the freedom scale. The top marginal tax rate and the income threshold at which it applies is another way of characterizing the takings behaviour of a government, and, in particular, this method looks at the extent to which these tax rates may be expropriative. Finally, we assess whether a country has a volunteer army which is paid out of general tax revenue, or whether the government engages in conscription (thereby imposing the costs of raising an army on a relatively small group in the society).

Group 4: Freedom of exchange with foreigners

The fourth group of factors that the index measures is the extent to which there are restraints on international exchange. A fundamental right of citizens is the ability to trade with the citizens of other nations. Inhibitions on this freedom are quite important. Therefore, we measure taxes on international trade as a percentage of exports and imports, the difference between the official exchange rate and the black market rate, the actual size of the trade sector compared to the expected size (taking into account the geographic size of the country, its population, whether the country is land-locked or has access to the sea, the proximity of trading partners close to its borders, and its centres of population). Finally, we measure the restrictions on the freedom of citizens to engage in capital transactions with foreigners.

The Failure of Foreign Aid:                                                        Why Good Intentions are Not Enough

Fazil Mihlar

Defenders of foreign aid always claim that there is a lot of public support for it. Much depends, however, on the question posed. When asked, "Do you think the Canadian government should help poverty-stricken people in developing countries?" most Canadians would probably answer, "yes." However, suppose you ask the question in the following fashion: "should your tax dollars go towards helping a dictator in Africa enjoy a fleet of 10 Mercedes-Benz and a couple of chateaux in France?" The answer, of course, would be a resounding "no."

Support for foreign aid is supposed to be one of the defining characteristics of "good people." Recently, an organization called Ten Days for Global Justice, which is sponsored by many church groups in Canada, called for Canada to restore its share of international assistance to 0.7 percent of GDP (the United Nations' recommended figure) from the projected figure of 0.24 percent of GDP for 1998. Canada's international assistance budget is expected to decline to $1.9 billion in 1998-99 from $2.9 billion in 1994-95. Ten Days for Global Justice argues that these spending cuts are placing an unfair burden on the poor peoples of the world. The reality is, however, that foreign aid has not been successful in raising poor people in developing countries from the miseries of poverty.

Canadian assistance comes in various forms. Grants and loans for bilateral projects, primarily through the Canadian International Development Agency (CIDA), as well as credit from Canadian-supported multilateral agencies, such as the International Monetary Fund (IMF) and the World Bank, underwrite development projects and provide aid for structural adjustment programs. Other programs provide peace-keeping activity and disaster relief. Obviously, some individual projects have worked. There is little or no evidence, however, to suggest that international assistance has helped developing countries to grow.

Between 1971 and 1994, Rwanda received $4.5 billion in total international assistance, Burundi received $4.1 billion, Zaire $7.8 billion, Somalia $8 billion, Mozambique $10.4 billion, Ethiopia $11.5 billion and Sudan $13.4 billion. These massive injections of goods, services, and money did not forestall economic decline and social breakdown in these countries. Indeed, all of them, along with Bangladesh, Egypt, and Tanzania, who were also recipients of a great deal of aid, have had the worst economic performance in the world. Of these countries, those that are included in The Fraser Institute's Economic Freedom Index, published in Economic Freedom of the World: 1975-1995, score failing grades.

A recent 100-country survey conducted by Professor Peter Boone at the London School of Economics confirms that more aid does not necessarily promote economic growth. In fact, foreign aid tends to entrench bad regimes and enables despotic leaders to pursue economic policies that erode their nations' standards of living. Instead of using aid constructively in productivity-enhancing activities, political leaders often use the funds to build monuments and buy machine guns. For example, in 1977, President Bokassa of the Central African Republic wasted $20 million on his own coronation, including the purchase of a crown which was made in London at a cost of $2 million.

Even humanitarian aid can have negative effects. Dumping large quantities of grain into poor countries drives down the price of food and kills domestic agricultural industries. In addition, large infusions of cash can contribute to higher inflation rates which is not helpful in creating a stable investment climate.

According to Peter Bauer, a respected development economist, foreign aid undermines and discourages the kind of behaviour that is necessary for economic growth to take place. Increasing government-to-government aid distracts people from productive economic activity and instead encourages them to focus on the struggle to obtain the levers of political power. Clearly, good intentions alone are not enough when it comes to international assistance.

The Fraser Institute's economic freedom research shows that economic freedom is the essential element for sustained economic growth and an higher standard of living. Economic Freedom of the World found that no country with a persistently high economic freedom rating during the last two decades failed to achieve a high level of income. The key to economic development in the developing countries appears to be greater economic freedom. Well-intentioned cash handouts have not and will not alleviate poverty.

The best policy direction that developed countries, including Canada, could pursue is to end all government-to-government assistance, which has often propped up dictatorships and reduced pressure for reform. At the same time, Canada and other developed countries should eliminate their trade barriers, which prevent developing countries from participating fully in the world marketplace. According to the World Bank, the developed world's protectionism reduces the developing world's GNP by about 3 percentage points annually. It is time to stop this misguided policy direction and adopt free markets and free trade policies that spur economic growth and that will genuinely help people in developing countries.

References

Bauer, P.T., Equality, the Third World, and Economic Delusion, Cambridge, Massachusetts: Harvard University Press, 1981.

Bandow, Doug, "Foreign Aid and International Crises," The Freeman, New York: The Foundation for Economic Education, December 1996.

Gwartney, James, Robert Lawson, and Walter Block, Economic Freedom of the World: 1975-1995, Vancouver: The Fraser Institute, 1996.

Law, Marc and Fazil Mihlar, "The Federal Liberal Government in Action: A Report Card Issued to the Chretien Government," Critical Issues Bulletin, Vancouver: The Fraser Institute, October 1996.

Whelan, Robert, ed., "Foreign Aid: Who Needs It?" Economic Affairs, vol. 16, no. 4, Autumn 1996, London: The Institute for Economic Affairs.

Technological Freedom

Mark Weller

What is the relationship between technological achievement and economic freedom? For anyone who understands the ways in which markets perform, the answer is unqualified: as economic freedom increases, growth in all sectors of the economy, including technological advancement, also increases. But it would seem not everyone is convinced . . .

I recently watched the CBC mini-series on the Avro Arrow. In this multi-million dollar production, the CBC was trying to make a point-that technological innovation can only happen in Canada if done in partnership with the state. The Avro, according to this line of thinking, is another example of the so-called National Dream, which is, at its core, an assertion that Canada's cultural identity is dependent on state sponsorship of specific industries of significance. Industries represented by firms such as Avro Air, or perhaps the CBC itself.

However, in the late 20th century as we look back on the mess of government sponsored mega projects that are beginning to show signs of their age, Canadians must take stock of this experiment. Was the National Dream a boost to Canadian identity, or did it serve instead to restrain those Canadians who had technological know how?

An interesting example of Canadians succeeding without government is the Internet. As a relatively unregulated part of the international economy, at least so far, it provides us with a sort of case study in technological development. If there is a relationship between economic freedom and technological advancement, then it should be evident here.

One measure of Internet growth is the number of domains registered within a specific geographic area. Domains are Internet sites, such as the Fraser Institute's (fraserinstitute.ca), which is one of 425,000 registered domains in Canada. Domain registrations can be seen as an indicator of how many Internet sites there are in a nation, which is a useful measure of overall Internet activity.

In terms of the number of domains registered, the following countries each have over 50 domains on-line for every 10,000 citizens: Finland, the United States, Norway, Australia, New Zealand, Denmark, Canada, Switzerland, the Netherlands, Hong Kong and Singapore. [Internet Domain Survey, July 1996, Network Wizards, http://www.nw.com/]

Each of the nations above ranked in the top 30 of the Economic Freedom Index published last year by The Fraser Institute. By comparison, those countries that ranked lowest on the Economic Freedom Index had no Internet connections whatsoever.

It is also interesting to note that this is not just a comparison of developed nations with the less developed. In the middle of the pack in Internet development is an unusual group of countries-nations like Slovakia, South Africa, Italy and Portugal. Each of these countries is endeavouring to build an Internet presence, but is having difficulty. The answer could lie in their comparative level of economic freedom, for although these are developed nations, they continue to have high levels of regulation and taxation, which is having a negative effect on the development of Internet architecture.

Canada has benefited from a comparatively high level of economic freedom, particularly with regard to telecommunications and the Internet. This is a clear example of an area where Canadian innovation has thrived in the global marketplace, with no government assistance whatsoever. This is a more pertinent and relevant national dream-economic success arising from our abilities, not from corporate welfare.

However, as is demonstrated by recent calls for the federal government to fund high tech industry, it is clear that the temptation to pick winners is always there for governments, but it must always be resisted. If it cannot be resisted, then laws should be passed to restrain governments from embarking on this course. The choice is clear-the future is for those nations that are best able to manage technological change, and the nations that are succeeding thus far are those that are most economically free.

The "Greedy '80s" and Other Myths

Craig Yirush

They say that old myths die hard. One of the oldest and most resilient must be the perennial belief that, in a free market, "the rich get richer and the poor get poorer." A recent manifestation of this myth is the nearly universal belief that, in the "greedy '80s," a rapacious few profited at the expense of the many; that Wall Street tycoons ran riot, wrecking entire companies and destroying the economy's manufacturing base in the process; that irresponsible tax cuts caused unsustainable government deficits to be racked up; and, finally, that the wealth that was created failed to "trickle down" to those on the bottom rung of the economic ladder. In short, those who got rich did so at the expense of the majority of the population.

This view of the '80s is so pervasive as to even reach the number 257: my daily bus to work in downtown Vancouver. One morning, I was intrigued by a heated debate taking place between two fellow commuters about the legacy of the 1980s. The discussants were employing a particularly pungent barnyard metaphor to describe the decade in question. I'll spare you the details, gentle readers, but the gist of it was that whatever "trickled down" to the poor in the free market '80s, it certainly was not money! This rather evocative description of recent economic policy not only woke me up, but led me to ask, conventional wisdom aside, just what did happen in the 1980s?

For those seeking a counterpoint to the standard doom and gloom view of the '80s, there is one very good guide: Robert Bartley's provocative 1992 book Seven Fat Years: And How to Do It Again published by the Free Press of New York.

Bartley, editor of the Wall Street Journal, and an ardent supply-sider, tries to set the factual record straight about the Reagan years. In the process, he offers us a powerful insight into the concrete benefits of free market policies.

Bartley begins by outlining the intellectual context necessary for understanding the 1980s. He argues that the economic reforms of the 1980s must be seen against the background of the 1970s: an era of big government, high taxes, record inflation rates, and soaring unemployment.

The response to this "stag-flationary" malaise was a growing realization, among a small group of economic and political thinkers, that what matters for economic growth is not government demand management, but a focus on the "supply side" of the economy. The central fact is that wealth is created by the productive efforts of millions of workers and entrepreneurs, and not by an interventionist government, spending, taxing, and regulating all activity to death. Bartley points out that this "supply side" approach was simply a revival of the common-sensical, pre-Keynesian idea that if a nation frees its citizens to produce, the result will be, not surprisingly, greater wealth.

As Bartley makes abundantly clear, the free market policies enacted in the U.S. between mid-1982 and 1990 worked. With lower taxes and stable money, companies like Micro-soft and MCI flourished, creating jobs, wealth, and a host of new and innovative products and services. Innovative financiers like Michael Milken revolutionized capital markets, providing funds for many fledgling enterprises that more conventional financiers would not touch.

Under the influence of this renewed appreciation for markets, America experienced a seven-year period of sustained prosperity. Bartley offers some impressive statistics to illustrate the decade's success. During these "seven fat years," America's GNP grew by 31 percent in real, inflation-adjusted terms. This meant that the resurgent American economy grew the equivalent of another Germany during the 1980s. Living standards showed an equally impressive rise. Over the seven years, real disposable income per capita grew by one-fifth. Labour productivity also grew, by 10.6 percent. The statistics on industrial productivity offer an equally rosy scenario. Manufacturing production grew by 48 percent between mid-1982 and 1990. Gross private investment also grew by 32 percent. In addition, despite a demographic surge, 18.4 million new jobs were created, an increase of 19.5 percent. Despite the "greedy" label, charitable giving during the 1980s increased at a rate of 5.1 percent per year. The record on tax revenues also confounds those who argue that the "supply side" tax policies were fiscally irresponsible. Despite Reagan tax cuts, federal government receipts grew by 99 percent between 1980 and 1990. The problem, of course, was that a Democratic Congress managed to outspend even this large increase in revenue.

This more accurate reading of the recent historical record contains an important public policy insight for all those interested in a free and prosperous society: the recipe for sustained economic growth is minimal government and maximum individual freedom. To the extent that Canada, Britain, and other countries followed suit, they too experienced an economic renaissance. As a result of the economic policies that the U.S. enacted in the 1980s, we are all wealthier than we were two decades ago.

Ultimately, the lesson of the '80s is a hopeful one: that prosperity is the result of free people, cooperating for their own self-interest. The experience of the 1980s explodes the myth that the market is a zero sum game. It is not. The 1980s made many millionaires, and also made many millions of people better off. If we have economic freedom, a rising tide will indeed raise all boats. A society that fails to grasp this point, and instead falls victim to the myth of the "greedy '80s," is in danger of emulating the slow growth and stagnation of the 1970s.

Are you listening fellow commuters?

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Last Modified: Wednesday, October 20, 1999.