A tale of two former European colonies : institutions and economic development in Indonesia and Malaysia

A  tale  of  two  former  European  colonies:  

Institutions  and  economic  development  

in  Indonesia  and  Malaysia  

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MSc  Thesis  International  Relations  

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Student:  Aldert  Bergstra  (10106359)  

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Supervisor:  Dr.  S.  Krapohl  

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Second  reader:  Dr.  M.  P.  Amineh  

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Page  count:  53  

Abstract

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This thesis argues that unequal development among former colonies is mainly caused by institutio-nal differences. Legal, bureaucratic and political institutions determine to a large extent the level of corruption, the amount of Foreign Direct Investment (FDI), the economic policies, the level of poli-tical and economic freedom. These factors in turn influence GDP growth and poverty levels. In this thesis, the cases of Malaysia- a former British colony and a relatively rich country, and Indonesia- a former Dutch colony and a relatively poor country, are compared. First, the importance of the iden-tity of the former colonial master is demonstrated by showing differences between British common law and Dutch Civil Law, differences between the Dutch and British bureaucratic legacies and dif-ferences in checks and balances during colonial rule and thereafter. Then, the impact of extractive and inclusive institutions is demonstrated. This thesis puts forward the claim that only a combinati-on of theories about inclusive and extractive instituticombinati-ons combinati-on the combinati-one hand, and theories about diffe-rences in between British and other colonial powers can explain the gap in development between different post-colonial countries.

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Table of Contents

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Abstract

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1.1 Introduction

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1.2 Theoretical Framework

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1.3 Variables

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1.4 Research design, method

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1.5 Case selection

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2. Analysis

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2.1 Law traditions in Indonesia

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2.2 Law traditions in Malaysia

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3.1 Political system and bureaucracy in Indonesia

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3.2 Political system and bureaucracy in Malaysia

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1.1 Introduction

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Development theorists have long argued about the question whether the identity of the colonizing country matters for post-colonial economic growth and development, or whether mainly internal, pre-colonial factors, like climate, culture, and location are more important determinants (Grier 1997-2: 317). Authors like Fieldhouse (1966) have argued that the identity of the colonizing country does not have a significant influence, because colonial governments were in many respects quite similar. Acemoglu & Robinson (2012) also argued that the identity of the colonizing country is not important, and that only the existence of ‘extractive’ (benefiting the minority) and ‘inclusive’ (bene-fitting the majority) institutions matters. They believed that these institutions were shaped by the aforementioned factors, not by which country conquered the colony. A second group of scholars have linked differences in post-colonial development to cultural and political differences between colonizing countries (Grier: 1997-1; Bertocchi & Canova: 1996; Hanson 1989; Harrison; 1985).

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To understand the link between colonial origins and subsequent development, it is necessary to use an institutional approach. Institutions are the means by which colonial legacy influences political economic developments and policymaking in developing societies (Grier 1997-1: 319). Although the concept ‘institutions’ is used in many different ways, in this thesis only legal, bureaucratic and political institutions (checks and balances) are taken into account. In order to be able to look at the effect of institutions alone, a most-similar cases comparative design is used. On the surface,

Malaysia and Indonesia share many characteristics but, they differ completely when it comes to the institutional framework and the colonial history (Osborne 2013: 38).

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From 1960 until 2000, the average GDP growth per year was 5,1% for Indonesia and 6% for Ma-laysia (World Bank 2015). Between 1970 and 1998, the poverty rate went down from 50% to 7,5% in Malaysia, and from 50% to 24% in Indonesia (IMF 2015). It is very important to consider the fact that Malaysia was, when it became independent, richer than Indonesia by a considerable mar-gin. Drawing on the work of Barro (1996) it would be reasonable to expect that Indonesia would have grown at a faster pace than Malaysia, because the level (initial economic situation) was much lower than that of Malaysia, and there is a negative correlation between the level and growth. On average, poor countries grow faster than rich countries, so Indonesia should have grown faster than Malaysia- based on the theory of convergence that Barro (1996) backed with an extensive dataset. When this is considered, the empirical puzzle becomes even more ‘puzzling’ and the difference in growth even more significant. The question is: to what extent do institutions, as part of a colonial legacy, explain the difference in economic development between Malaysia and Indonesia?

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This thesis hypothesizes that the difference between Malaysia and Indonesia is caused by: -A tradition of extractive institutions in Indonesia vs. inclusive ones in Malaysia;

-a lack of checks and balances on those in power in Indonesia vs. many checks & balances in Ma-laysia;

-a weak legal tradition in Indonesia vs. a strong legal tradition in Malaysia.

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Furthermore, it is expected that these differences can be traced back to the different colonial origins, in an attempt to contribute to the debate between those who believe only extractive vs. extractive institutions matter, and those who only consider the identity of the colonizing country. Identity of the colonizing country and the inclusive/extractive approach are both needed in equal measure to understand differences in post-colonial development. To test these hypotheses, the (colonial) ori-gins, incentives, and consequences of the different institutions are analyzed using the method of process tracing.

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1.2 Theoretical Framework

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Theories that deal with post-colonial development often show a one-sided approach. They either rely on the premise that all factors in play are ‘external’ or on the idea that all causes for growth or underdevelopment are ‘internal’ (Szirmai 2005: 64). What many of the theories share, however, is the focus on institutions. When studying former colonies, it is necessary to study the origins of in-stitutions that influence the economy. Historical institutionalism provides a framework for this ap-proach (Weir 1992: 190). Three kinds of institutions are especially economically significant:

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1). Legal institutions. Constitutional economics deal with the economic consequences of different law traditions (North 1990; La Porta e.a. 1999; Mahoney 2000).

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2). Bureaucratic institutions. The quality of the bureaucratic system influences economic develop-ment in different ways (Du Gay 2000; Evans & Rauch 1999).

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3) Political institutions. Theory about this deals with the incentives of checks and balances and poli-tical and economic freedoms (or the lack thereof) (Harms & Ursprung 2002; Barro 2006; Rivera-Batiz 2007).

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Acemoglu & Robinson (2012) agree that institutions to a large extent determine economic devel-opment. However, they do not take into account the identity of the former colonial master and they do not clearly define ‘institutions’. Instead, they distinguish between ‘inclusive’ and ‘extractive’ in-stitutions. Combining theories about legal, bureaucratic and political institutions with the inclusive/ extractive-divide as described by Acemoglu & Robinson is necessary to understand the complex reality of different post-colonial development paths. Describing legal institutions or political institu-tions as ‘inclusive’ or ‘extractive’ can help to understand differences in outcome. To at the same time keep in mind the colonial origins of different legal and political traditions, makes the compari-son even more convincing. Acemoglu & Robincompari-son also provide insights on why extractive political

institutions can lead to economic growth in the short run, but eventually often lead to economic meltdown.

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Finally, theories about the the causes and the effects of corruption tell more about the causal me-chanisms involved. Poor, ‘extractive’ institutions can lead to corruption, and corruption can lead to a decline in economic activity, both domestically and via Foreign Direct Investment (FDI).

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Historical institutionalism

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Historical institutionalism deals with the question how ‘policy legacies’—the consequences of ear-lier decisions—constrain what possible policy choices can be made in the subsequent period (Muc-ciaroni 1990; Weir 1992). This also means, to a certain extent, that choices made by colonial governments have determined what happened in former colonies, long after independence. It is, however, very important to underline that in hindsight, developments might seem linear and logic, whereas it did not seem to be that way when things proceeded (Pierson & Skocpol 2002).

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When institutions that used to be in place during colonial times persist, one can speak of path de-pendency (Pierson 2004: 53). Moments, or events, that influence the evolution of institutions and thus the economy, can be described as ‘critical junctures’. These can be revolutions, wars, economic crises but also seemingly small events with a profound impact in the long run (2004: 51). Critical junctures can lead to stable dynamics in which healthy institutions prosper, or can have the opposite effect.

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History does not mean destiny, but often the institutional framework that has been in place in a cer-tain country, still persists long after the people that implemented it are out of power. It is important to conceptualize ‘institutions’, as the meaning of this concept can be very broad. Institutions can be more broadly defined than just easily recognizable legal entities like parliaments and central banks. In this thesis, the following definition will be used: an institution is a generally accepted procedure that governs the interaction between members of a society (North 1990: 360).

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Legal institutions and development

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Of all the institutions that could influence the economic development of former colonies, legal insti-tutions are among the most important (Yusuf & Stiglitz 2001: 244). Political instiinsti-tutions can be in-clusive and extractive in many ways, and legal institutions can provide incentives for either extrac-tive of inclusive behaviour by policy-makers. In short, strict checks and balances could lead to more stability, and thus more prosperity, and the protection of property rights, contract rights and labour rights lead to more stability and inclusiveness (more people benefit, not just the elites).

When it comes to attracting Foreign Direct Investments (FDI), which is especially important to de-veloping nations such as the ones in Southeast Asia, it is imperative to create an institutional ‘struc-ture of expectations’. Foreign companies will need to know what they will encounter when they en-gage in trade with a certain country. This structure of expectations can be divided into 4 parts:

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1) The law underpins and conceptualizes the liabilities, rights and obligations of all business par-ties;

2) the laws allow business partners to pursue transactions with a high degree of of predicability and certainty;

3) the law makes sure there is legal recourse and due process;

4) the law sustains and promotes, in various ways, a high level of business confidence.

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Law is important when it comes to attracting FDI, but also when it comes to the protection of peop-le in the country itself, as unrest and inequality not only endangers international trade but also do-mestic economic dynamics. In this thesis, the rule of law is important to assess, as it is an important variable in post-colonial development (Rajenthran 2002-1:5).

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Two major law systems were implemented by the colonial masters throughout the world: common law and Civil Law. The British implemented common law in their colonies, and other countries, like France and the Netherlands, Civil Law. Hayek argued that common law and Civil Law have diffe-rent assumptions about the role of the state and the individual. According to LaPorta e.a., ‘Civil Law tradition is a proxy for an institution to further the power of the state, and the common law tra-dition is a proxy for an institution to limit this, and to empower the individual (La Porta 1999).

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The reason for this divergence is historical. The British common law was developed from the 13th century onwards by merchants and aristocrats in order to limit the power of the King to interfere in markets. Civil Law, on the other hand, was founded by the revolutionary generation in France at the end of the 18th century, and by Napoleon afterwards. Here the objective was for the state to be able to alter property rights and to make sure the judges could not interfere. According to Locke, the government’s foremost function is to protect property. In the common law tradition, the security of economic rights played a central role. In the Civil Law tradition, the security of the executive power from judicial force was seen as much more important (Mahoney 2000).

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Many have stated that the institutions in French colonies were extractive in nature and that the bu-reaucracy only served the interests of the ruling elite, making it less effective in the long run. In ad-dition, they argued that France, as a colonial master, intervened in every aspect of the personal life of the people in their colonies. Interventionalism does not always solely have bad effects, but in the case of France this seems to be the case. The fact that British colonies were run in a different man-ner is not surprising, as Britain was a pluralistic democracy (although not many people were eligi-ble to vote until the 20th century) and France, under rulers like Louis XI and Napoleon, was very

autocratic, serving a small elite (La Porta e.a. 1999). Whether a country is under Common law, like the British colonies, or under French Civil Law, like the French colonies, does, according to La Por-te e.a., have an influence on the economic development of a country.

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As we can see, property rights are usually better secured in a common law system, where the indi-vidual plays a central role and the government is not in the position to grab private property, but only to protect it (La Porta 1999: 225). Protecting property rights can be beneficial to the economy in many ways. From a domestic perspective, it can be argued that citizens will only start enterprises or farms when they can trust that their property is secure, which leads to more economic activity and a higher GDP (and more tax revenues).

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Civil Law countries are, across the board, more interventionist, have worse regulation and have less effective governments as measured by tax compliance and bureaucratic delays. It has also been found that countries with a Civil Law tradition have, across the board, less political freedom and significantly less provision of public goods, which is a necessity for a well functioning government (La Porta 1999: 230).

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Bureaucratic quality

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Corruption is closely related to a weak bureaucracy, in which everyone engages in rent-seeking, and officials of every rank take bribes. But a high quality of bureaucratic institutions is also seen as in-herently beneficial to economic development.

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Max Weber started the tradition of scholars that stressed the importance of bureaucratic quality when it comes to economic growth. Although this tradition has been powerful, there has always been a rivalry between those who argued that a good bureaucratic system leads to prosperity and those who argue that government intervention is always the enemy of growth, the ‘Smithian’ view. la

It is important to determine which factors within a bureaucratic organization lead to growth and which do not. Unsurprisingly, countries with a big, inefficient and corrupt bureaucratic system do not outperform countries with a small, labourextrensive bureaucratic system, as the former does more harm than good. A predatory government could, for instance, also be a very bureaucratic government, which does not mean that the bureaucracy has a high quality. According to Weber, me-ritocratic recruitment and long-term career prospects would lead to a bureaucratic system that was beneficial to the economy (Du Gay 2000).

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Meritocratic recruitment in governing bodies is good for the effectiveness of the government and thus for the economy for a number of reasons. Firstly, hiring people on the basis of their abilities and not on the basis of connections of family ties in theory means that the chance of minimal com-petence is increased. People who are better at their job make the bureaucratic system simply better.

Secondly, having people that are chosen on merits helps generate corporate coherence and esprit the corps which can be, in turn, very motivating for the other people in the same organization (Du Gay 2000).

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Good career prospects, as Weber argued, are also important to the organization. Firstly, because employers that experience satisfaction are better workers and therefore better at providing services that help economic development, but also because workers that receive a fair wage and have good conditions feel less urged to take bribes, because they can provide for themselves. Long careers will also help to achieve corporal coherence (Weber; Evans & Rauch 1999).

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The causal mechanism explaining how a good bureaucracy leads to economic growth consists out of many elements. If jobs in the bureaucratic sector pay well and the prospects are good, people will rather advocate public-sector infrastructure investment instead of, what can be the case in countries with weak institutions, consumptive expenditures. Those will lead to more gains in the short run, but will be less profitable in the long run. (Evans & Rauch 1999: 750).

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The political system and economic growth

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Although it is often said that multinationals choose countries that disregards civil liberties and poli-tical rights, this appears not to be the case, as empirical studies show. Harms & Ursprung (2002) have found that FDI decreases when there is an increase in civil and political oppression, instead of the other way around. Some have argued that authoritarian regimes are better at protecting property rights, hence promoting investments, whereas others refute this argument by saying that authoritari-an rulers have no interests in protecting capital rather thauthoritari-an labour. It has also been said that coun-tries in which labourers are not allowed to organize themselves, it is ‘safer’ to invest. However, this has not been backed by any credible proof. It is just as easy to follow the line that in an authoritari-an regime where no good labour rights exist, there is a greater risk of unrest authoritari-and violence, as their are no official ways to make sure that the rights of workers are protected. This seems to be backed by the findings of Harms & Ursprung (2002).

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As times have changed, the division over labour has become different from what it was, in the sense that physical and human capital have an increasingly symbiotic relationship. Workers may now sha-re some of the profits of the organizations and sha-repsha-resent these intesha-rests in the democratic process. Towards the end of the 20th century, this has made it less appealing for foreign companies when governments deprived workers of rights; the modern workforce benefits from inclusive, instead of extractive institutions. Political oppression has a negative impact on economic growth, and in that way the economy is negatively influenced (Barro 1996).

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In a broader sense, the lack of political freedom can have negative consequences on the economy, as oppression is a sign of ‘bad governance’, the inability to resolve political issues through the

means of a sound political process, with the right checks and balances. It is often argued, however, that it is more important that governments actually govern than that they do not govern at all, as is the case in countries like Somalia and Yemen (Huntington 1966; Rivera-Batiz 2007). But when governance is important, ‘good’ governance even more so (Dick e.a. 2002: 238). Democracies give populations the means to regularly and peacefully do away with inefficient and corrupt admini-strations, while at the same time allowing populations to reelect good, efficient

regimes, in the long run leading to better governance. Some authoritarian leaders might perform well, but if they do not deliver, only the use of force can make them go away, a process that may take months, years or even decades longer than when democratic institutions are in force (Rivera-Batiz 2007).

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Many post-colonial societies have known extensive times of non-democratic rule. Often, this can be ascribed to the ‘rapid mobilization of new groups into politics coupled with slow development of political institutions’ (Huntington 1966: 4). In other words, when a society changes from an extrac-tive, colonial state to a modern nation-state, chances are that this transition leads to the concentrati-on of power around a small group of people. Like the lack of a good bureaucratic- and legal system, an autocratic regime can enhance corruption.

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Inclusive and extractive institutions

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Colonial legacies do not matter in the same way according to Acemoglu & Robinson (2012). Some colo-nies had inclusive institutions, and some inclusive ones. But, they add, any colonizing country could have implemented inclusive and extractive institutions: cultures and traditions do not play a role, what matters, they argue, is the condition a colony was in when the Europeans settled. They attach great value to factors like climate and geography.

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Acemoglu and Robinson use a broad definition of inclusive and extractive institutions. Inclusive institutions can secure property rights, allow indigenous people to trade for themselves, make sure courts are in place- a judicial system, and, in a broader sense, pluralism. Inclusive institutions are, according to Acemoglu & Robinson, ‘sufficiently centralized and pluralist (2012: 81).

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Extractive institutions, on the other hand, offer extractive policies (the indigenous people do not benefit) top-down governance and absolutism. According to Acemoglu & Robinson prosperity and poverty are determined, to a great extent, by incentives created by institutions. Power relations are fundamental in explaining economic development.

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As we have discussed, path dependence plays a strong role when it comes to the development of institutions in former colonies. This can take the shape of a vicious circle: inclusive political institu-tions make inclusive economic instituinstitu-tions, exclusive economic instituinstitu-tions undermine inclusive political institutions (Margolis &Liebowitz). Path dependencies can lead to virtues and vicious cir-cles, positive and negative feedback loops (Acemoglu & Robinson 2012).

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Inclusive gives people incentives to work, extractive institutions deprive people of power over their own lives and are demotivating and harmful in the long run. When extractive institutions are in pla-ce, this usually means that property rights hardly exist and that a type of neo-feudal system is still there.

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It is clear that guarding property rights as a part of good legal institutions can benefit long-term economic growth and that democracy can, under certain circumstances have a positive effect on the maintenance of property rights, making sustainable growth possible. Inclusive institutions can also make foreign investors more keen to invest in a certain country. Also, sound economic institutions can, under certain circumstances, lead to more sustainable economic development. When there are inclusive institutions in place, political power is distributed widely in a pluralistic manner, and vio-lence- if necessary- is legitimately used by the state.

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In this thesis, institutions that benefit a small number of people instead of a large number, are regar-ded as extractive. From this, it follows that a system in which the number of people to decide on important policy matters is small, the political institutions are extractive (2012: 156).

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The causes of corruption

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Although the aforementioned institutions can have an influence on the economic development, the causal mechanism is not immediately clear. One important factor is the degree to which these ele-ments influence the level of corruption. Corruption can be defined as the ‘misuse of public office for private gain’ (Treisman 2000).

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Because countries with a common law tradition (former British colonies) have known a system in which the procedures (so not the hierarchies) are very important, many of the former British colo-nies are now relatively democratic, just and effective governments compared to countries with a Civil Law tradition. In a country where hierarchy is more important than the adherence to procedu-res, corruption has been found to be significantly higher.

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So, in the case of corruption, it matters what legal tradition (common or civil) and what colonial master (British or French/Dutch) has been in power before the country gained independence. The legal culture that has derived from these traditions makes corruption more common in former French/Dutch colonies than in former British colonies (La Porta e.a. 1999; Treisman).

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Other possible causes of corruption include religion, which is not entirely convincing, as there is a significant difference to be found between islamic countries that have experienced British rule and common law, and islamic countries that have experienced French/Dutch rule and and Civil Law. The idea behind this was that islam and catholicism lead to a more hierarchical political and legal

culture, compared to protestantism, so that corruption becomes more common (Treisman 2000, La Porta e.a. 1999). This is, however, a weak theory as the causal mechanism is not very clear and is-lam could also be seen as not-hierarchical. There is not an ‘isis-lamic pope’ and there are also no car-dinals: there are almost no similarities between islam and catholicism in this regard, and almost all catholic countries have become democratic in the last decades, whereas one would expect this not to happen because of the hierarchical tradition (Weigel 1989: 10).

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Although democracy does not in itself lead to economic growth (many undemocratic countries are very rich, and vice versa), the level of democracy can have an influence on the level of corruption, and in that sense have an influence on economic development. In an open, democratic system, cor-ruption is more likely to be exposed. If there is greater civil engagement, and people have the free-dom of association, instances of corruption will not likely remain hidden from the public (Treisman 2000).

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Ades and Di Tella (1996, 1999) have argued that countries that are more open to foreign trade tend to be less corrupt. This could be true, although it is difficult to distinguish what is the cause and what the effect. A country that is able to attract large sums of foreign capital, is likely to be percei-ved as less corrupt in the fist place, as foreign investors tend to chose countries that are less corrupt than other countries, as corruption poses a risk.

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What can be taken from the research on the causes of corruption in the context of former colonies, is that most of it can be traced back to the colonial heritage of a country, since common law and Ci-vil Law have derived from the colonial past, common law and CiCi-vil Law traditions have had great impact on the other factors that were credited with having a significant influence on the instance of corruption. (Habib & Zurawicki 2002).

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Corruption and economic development

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Now that we have established which factors contribute to corruption, it is important to understand in which ways corruption can have an influence on economic growth. Although some have argued that corruption can have a positive influence on economic growth, the majority of the literature points in a different direction (Mo 2000).

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The first, and arguably most important way in which corruption can lead to less economic growth, has to do with foreign investments. Mauro (1995) has found that corruption has a significant nega-tive effect on the ratio of investment to the GDP. When foreign investors have the impression that a country is highly corrupt, they shun away from investing in the country. This can have different rea-sons. Firstly, people and companies might find that corruption is morally wrong, and therefore choose another country. This is hard to measure, and it might therefore (and because ethics usually do not play a dominant role in economic activities) not be the strongest explanation. The second

explanation is that potential investors find it too risky to invest, might find it too costly (bribing people can be costly) or might find it too difficult to manage, which can be due to the fact that in-vestors usually come from countries that have different rules, ethics and traditions. This brings us to the last reason, and that is that a great disparity between levels of corruption between the home country and the host country can be very unappealing to investors from abroad, as it requires study and extensive knowledge, which, in turn, can be costly.

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The human capital factor should also be taken into account. In a situation where there is a lot of cor-ruption, rent-seeking is more attractive than innovation and creativity. Human capital be be defined as social and personality attributes, knowledge and habits, creativity to perform labour in order to produce economic value. From this, it follows that a system in which human capital is taken se-riously and people have the chance to develop in a way that makes them more productive. A system that suffers from serious forms of corruption, is expected to produce less human capital, as it does not support innovation but merely short sighted gains for people in public office.

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According to Mauro (2004) a situation in which talented people have an incentive to engage in rent-seeking behaviour, will lead to slow economic growth. The reason talented people choose rent-see-king activities over creative, innovative and productive behaviour can be that in some countries, everyone with talent resorts to corruption. In such a situation, it becomes difficult for ‘honest’ talen-ted people to play a significant role in creative, innovative activities- it does not pay as much and the institutional framework to secure the process is not available. The misallocation of talent makes individuals less productive. Nothing really new will be made, the existing structures will only be used for ‘extractive’ behaviour, rent-seeking.

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1.3 Variables

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The dependent variable is: economic development. The economic development will be measured by the GDP growth per year, from independence until today, and by looking at the poverty rate. Of course, there are many other ways to measure economic development, but these are the most impor-tant.

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The independent variables in this thesis are the colonial origin: British or Dutch. Intermediate va-riables, that follow from this difference, are: legal institutions, the political system, the quality of the bureaucracy. It is important to deal with those possible explanations for the difference in devel-opment between the two countries. This is also important because Acemoglu & Robinson’s theory is weakened by the absence of other variables than only ‘institutions’.

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1.4 Research design, method

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Process tracing is defined as the systematic examination of diagnostic evidence selected and analy-zed in light of research questions and hypotheses posed by the investigator (Collier 2011). In this thesis, the hypothesis followed from institutionalist theory. Process tracing is often applied to study within-case inferences. In this case, process tracing is not only used within one case, but it is done within two cases.

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In this thesis, the smoking-gun test will be applied. This means that if the test passes, the hypothesis can be confirmed, but if it fails, the hypothesis is not immediately eliminated, as the variable that plays a central role in the hypothesis can still have some explanatory power.

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The benefit of process tracing are clear: the method can provide a profound insight in the causal mechanism of a certain phenomenon (economic development caused by quality of institutions), it should however be noted that it is hard to extrapolate the findings, as it is very case-specific. The findings will tell us something about the economic development of former colonies in Southeast Asia, but it is unclear whether the same will apply to countries in other regions.

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Of course, some would argue that comparing two countries is comparing apples with oranges. In this thesis, the variables are compared over four periods: the colonial era, the period of decoloniza-tion and nadecoloniza-tion-building (roughly post-war until 1970), respectively the period of the New Order in Indonesia and the New Economic Policy (NEP) in Malaysia (1970-1998), and the aftermath of the Asian crisis (1998-today). Different, but comparable policies are studied, as the nature of policies are the result of incentives presented by the institutional framework in the respective period. These policies, in turn, have an impact on the economy.

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In order to study the effect of different variables on the dependent variable, the analytical part is structured around the intermediate variables: the institutions. First the origins of the institutions are studied. This explains whether the institutions can be traced back to colonial rule, or whether criti-cal junctures have caused discontinuity. Secondly, the incentives that come from the institutions are assessed. The influence of the (quality of the ) institutions on the level of corruption, the inflow of foreign capital and the policies that are laid out. Lastly, the consequences of these incentives on the economy are researched in order to understand whether the difference in institutions can be used to explain the difference in economic development.

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Because the historical scope of this research is so big, in some cases only recent statistical data are used in order to illustrate a trend over the last decade (in many cases, institutional quality indicators were not measured systematically and indexed before 2000). However, these data show the level the countries were on shortly after the Asian crisis, and indicates in which direction institutional devel-opments are going.

1.5 Case selection

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In this thesis, most similar cases are compared. Indonesia and Malaysia share many characteristics, mainly when it comes to climate, culture, geographical location The countries are both predomi-nantly islamic-the countries both have a Sunni Muslim majority- used to be colonies of European powers and achieved independence at more or less the same time (1949 and 1957). The Malay lan-guage and Bahasa Indonesia are similar, and the climate and the natural resources (palm oil, rubber, petrol) are more or less the same. The countries both have a long coast line, and both border the Malacca-strait, one of the most important straits on earth (Osborne 2013). Still, the GDP per capita in Malaysia is roughly three times higher than that of Indonesia (World Bank 2015; IMF 2015).

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Of the 20 richest countries in the world, when it comes to GDP per capita, 15 are European or have never been under European rule. 5 of the countries have been a foreign colony of a European coun-try, all of them used to belong to the British empire (IMF 2015). Malaysia used to be British, Indo-nesia used to be Dutch. Therefore, looking at colonial heritage seems reasonable.

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However, it is important to shortly address other, non-institutional factors that could explain the dif-ference in prosperity. Of those alternative explanatory variables, the presence of natural resources and the amount of foreign aid given are the most important (Cebrales & Hauk 2010; Dick 2003; Drabble 2000).

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Natural resources

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Some of the former colonies that have developed quickly and effectively, have done so because of a vast amount of natural resources. The fast-growing economy of Angola, a former Portuguese colo-ny, is a good example of this. If a big difference in resources could be found between the two coun-tries, it would contest the hypothesis. Because it is hard to have a good historical overview of the number of exported natural resources since independence, we start by studying the most recent estimates of the CIA World Factbook.

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As the geographic characteristics of Malaysia and Indonesia are so similar, the kinds of natural re-sources also show similarities. Both countries have substantial quantities of tin, petroleum, timber, copper, natural gas and bauxite. Malaysia has iron ore, which Indonesia has not. Indonesia, on the other hand, also has substantial amounts of nickel, fertile soils, coal, gold and silver. As of 2014, we can conclude that Indonesia has more different types of natural resources, which would allow the country to diversify and therefore, one would assume that Indonesia would become richer for it. Of course, these data do not tell us about the amount of resources and about the percentage of the in-come from natural resources in the GDP. When one looks at these percentages, it turns out that it does not play a significant role, neither of the countries can be described as rentier states. In 2014, 9.1% of Malaysia’s GDP came from natural resources. This is not necessarily a small percentage,

but it could not- at least not in 2014- explain the significant gap in the GDP per capita between the two countries. In Indonesia, on the other hand, the revenues from natural resources make up 7.1% per cent of the GDP. This does not tell us much about the future; it may well be that there are large unexplored fields of natural gas, but for now, the variable of natural resources does not have a big influence on the difference in development (CIA World Factbook 2015).

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Both Malaysia and Indonesia have used the oil exports to cover the expenses. Especially Indonesia had much to gain during the two oil booms during the seventies. Although these earnings did not immediately help to make the economy stronger, it did help president Suharto in executing the poli-cies of the New Deal. Since the 1970s, the percentage of oil exports in the GDP has steadily decli-ned, making the economy more diverse.

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What is important to point out, is that a country can only benefit from its national resources when the institutions in the country are making for a stable environment. Although it was once the idea that natural resources are always a blessing, the ‘resource curse’ has become an increasingly impor-tant concept. The growth of countries that rely heavily on natural resources is in many cases slower than that of countries that manage their resources well and aim at diversifying their economy. In that sense, the institutions have a profound influence on the allocation of natural resources and their overall effect on the economy (Cabrales & Hauk 2010).

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Foreign Aid

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Both Malaysia and Indonesia have the potential to become economies of a considerable size, and in many ways they already are. Indonesia has surpassed its former colonial master, the Netherlands, in the top 20 of biggest economies in the world. Still, the countries both receive development aid from the western world. In 2014, the aid amounted 67,8 bn for Indonesia and 15,3 bn for Malaysia, which is per capita more for Malaysia, but not that much more (World Bank 2015), when one re-gards the fact that Indonesia has a population of 250 mn people, and Malaysia a population of 30 mn.

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Over the course of history, Indonesia has been an very large recipient of development aid. After in-dependence, many different Western countries sought to help the low-income country of Indonesia with different means. In 1967, when the Indonesian society and economy were in turmoil, the IGGI was founded, the Intergovernmental Group on Indonesia. This group was initiated by the Nether-lands in order to help Indonesia meet its requirements (Posthumus 1972: 56). The IGGI was the most important supplier of foreign aid from 1967 until 1991. During the reign of Suharto, the eco-nomy grew at a fast pace, but was also helped tremendously by the IGGI. The countries that partici-pated in IGGI were, of course, willing to help Indonesia, but there were strict conditions to the aid. On many occasions, food aid was supplied, meaning that the Indonesian government could not

allo-cate the help in any other way. Project aid was another form of aid that was often given to the Indo-nesians, but help without conditions was highly unusual.

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It can not be denied that the vast amounts of foreign aid have had an influence on the economic en political situation of Indonesia. However, the fact that it has been the largest receiver of aid in the world, could also tell us something about the situation that led to the large donations that have oc-curred. If anything, the vast amount of development aid should have helped the economy of Indone-sia as it was given with clear restrictions and purpose, so that it could not weaken, but only streng-then, the economy and the political institutions. In 1970, Indonesia ranked as the second largest re-cipient of foreign aid, after India, by 1990, they were the largest aid-rere-cipient country in the World. (Dick 2003: 206).

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When we look at the amount of aid per capita, the difference between Indonesia and Malaysia is almost non-existent. The aid given to Malaysia since 1958 totals 38 billion, whereas the total amount of aid that Indonesia received since that date was 285 billion, making the allocation of aid per capita almost exactly equal (aiddata.org). Hence, I conclude that the difference in economic de-velopment between the two countries is not caused by a difference in dede-velopment aid.

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2. Analysis

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2.1 Law traditions in Indonesia

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In Indonesia, the law system is diverse and complex. In different places, there are different laws (adat), and the in general, the law is a mix between Roman Dutch Law and customary law, based on the Civil Law (Freedom House 2012; Thee 2011) . The influence of Colonial rule on the law system is significant, as are the consequences of the rule of law on the economic situation of many people in the country.

Origins

The Civil Law that was implemented in the Dutch East Indies, directly derived from the French Civil code, as the Netherlands were controlled by the French in the exact period that the Nether-lands gained control over the archipelago of the Indies. The French Civil Law is quite similar to Roman Law, which still exists in the Netherlands (Osborne 2013: 20: Fasseur 1992).

In modern Indonesia, many laws have remained in place, especially laws that have to do with labour contracts, property rights and even the conditions of plantation workers (Sakumoto & Juwana 2007: 134). A law like the bankruptcy act, that was implemented as the

‘Faillisse-mentsverordening’ in 1905, remained in place, unchanged, until 1997 (Juwana 2005: 80). This is an example of the slow changes in the the legal system happened. The reason for this continuity can be found in the Constitution of the Republic of Indonesia, in article 2: ‘All existing [colonial] institu-tions and regulainstitu-tions of the State shall continue to function so long as new ones have not been es-tablished in conformity with this constitution.’ (Republic of Indonesia 1945). This shows that deci-sions that were made before, have an influence on the rule of law in modern times. Hence, that we can speak of path dependence.

Labour protection laws did exist, but other laws were not beneficial to the workers in the Dutch East Indies. The ‘Koelie Ordonnantie’ and the penal sanction against Coolies (Javan workers) who ran away from plantations, existed until the late 1930s, only to be abolished under pressure from the US, who excluded imports produced with forced labour (Thee 2011). This is in line with the notion that contract rights and property laws are weaker in Civil Law-counties.

Incentives

The legal institutions laid out by the Dutch often encouraged extractive behaviour by the ruling elite, whether this was intentional or not. In relation to slavery, for example, the judicial process was interesting. Formally, the Dutch colonial government ended traditional slavery- something that had been in place centuries before the Dutch arrived- in 1860. Although in practice, this was not ended until 1921, this can be seen as an attempt to protect the population against the elites, hence as ‘inclusive’. However, parallel to this development, Forced Labour was introduced, also known as ‘Rodi’ (Thee 2011; Fasseur 1992). In the beginning of the 19th _{century, when the British governor}

Raffles, who can be placed in the Common Law-tradition, was in charge of the East Indies, Forced Labour was not allowed, as it ‘disturbed and sarcificed’ the lives of common people (Dick e.a. 2003: 126). As soon as the Dutch took over, Forced labour, commanded by colonial or military rule, started to become popular. Forced labour was used to build forts, roads, buildings etcetera (Sakumo-to).

The Dutch tradition of Civil Law gave the incentive for policies that benefitted the colonial master rather than the population of Java, and to a lesser degree, the rest of Indonesia. Apart from the prac-tice of Forced Labour, the Cultivation System was introduced. The Cultivation System (cultuurstel-stel) was a state-lead ‘institution’ for the production of agricultural products such as sugar and cof-fee, indigo, pepper and tea. In return for a (low) planting wage that was fixed, the Javanese people (poor farmers) were effectively forced to produce the aforementioned crops. ‘Cultivation percent-ages’ were paid to civil servants and Javanese officials who, in many cases, badly mistreated the farmers in order to stimulate production. The Dutch state-owned trading firm (the Nederlandsche Handel-Maatschappij, NHM, established in 1824) was responsible for the the trading the goods, and did so throughout the world (Touwen 2010). This was clearly very extractive in nature. The local population had little influence over their own lives, and even at the level of villages (kampongs) the command structure was often organized top-down. The Cultivation System was very important to the Dutch economy. From 1851 until 1860, it constituted 31.8 percent of the total Dutch public rev-enues, in some years, it was nearly half (Fasseur 1992: 150).

Towards the end of the 19th century the institutions changed slowly, and they became slightly more inclusive. This had two main reasons. First, liberal ideas that gained popularity in Europe, also found their way to the colonies. Secondly, private enterprises worked more efficiently, and there-fore, a tyrannical regime was no longer needed in order to make a profit (Touwen 2010). More than in any other South East Asian colony, however, the laws in Dutch East India were favorable towards big plantations. Big plantations would offer bigger revenues, and that was what the colonial master was after. This meant that small farmers, who were discriminated against by the law, had a hard time making a living. So, although the Cultivation System was abolished at the end of the 19th

cen-tury, the Dutch laws still gave incentives for extractive behaviour in the form of weak property rights and a weak position for workers. Forced labour was only abolished in 1938, as the US de-manded this (Thee 2011).

On the Outer islands (all the islands outside Java and Madura) people were not allowed to harvest crops for their own use, and sometimes harvests were destroyed in order to keep the prices high in international trade. The reason the influence of the Dutch colonial regime strengthened over the years is twofold: on the one hand, the growing business in tropical products in Europe required a stricter control over the areas in the archipelago, on the other hand, competition by other European forces in the region had to be resisted (Dick e.a. 2003: 84). This means that also outside of Java ex-ploitation did occur due to weak property rights and theft.

Post-colonial incentives

During colonial times, Dutch Roman/Civil Law lead to extractive policies. After independence, however, much of the dynamics remained in place. As was discussed, much of the laws regarding property and plantations stayed the same, and labour rights were not altered significantly or re-mained vague.

During the rule of president Sukarno, the economy was very instable and not much growth was achieved. The tradition of weak property rights under Civil Law allowed Sukarno to serve not the individual, but the state. This is completely antithetical to the ideals of the British common law, in which the individual plays a central role, but in line with French Civil Law. Sukarno thought that the State, that embodied of the society as a whole, had the right to regulate matters regarding prop-erty, and that the State should be able to redistribute land. Property rights, Sukarno argued, were subservient to the interests of the State, or society as a whole, and foreign companies could be na-tionalized (Nelken 2001: 206).

Both during colonial times and the rule of Sukarno and later Suharto, the role of the Law in Indone-sia can be regarded as a ‘controlling tool’, instead of a means to protect the people from the gov-ernment. The governments, that can be described as feudalistic (in colonial times) and authoritarian (1800-1998) were not respected by everyone in the population, as can be taken from the massive protests in 1998, and neither were the laws that these governments put forward. Human rights viola-tions were the result, as well as rampant corruption (Sakumoto: 158).

During the Sukarno years, chaos was common. When Suharto took office, however, things changed. The president called in help from western countries, and made economic growth the main goal. What emerged was a military, technocrat government that- for decades- showed impressive growth rates (Clague e.a. 1999). When the Asian crisis hit, however, the economy came to a standstill. Suharto used 5 year plans to develop the economy. Workers were not regarded as people with rights (contract rights, property rights) but as ‘tools’ for economic growth. Once again, the collective good was more important than individual rights. Excessive intervention in the workplace and high politi-cal power have led to social dissatisfaction and, as mentioned, human rights abuses (Sakumoto 148).

Under the reign of president Suharto, Indonesia changed from a development state in a predatory state, meaning that power holders and their cronies in various businesses gained access to dispro-portionate amounts of capital (Thee 2011). The children of Suharto owned businesses and had mo-nopolies, and his wife was nicknamed ‘Tien Percen’, which is Bahasa Indonesia for ‘Ten percent’, a commission of ten percent she asked of every project that could be realized because she made it possible.

During the New Order, the proliferation of policy-generated barriers to domestic competition, mo-nopolies, and cartels occurred (Thee 2011). Foreign investors, to whom Indonesia was relatively

friendly, often complained about the corruption in the country. In order to accommodate the in-vestors, Suharto promised to do something about it. He prohibited officials from accepting commis-sions and ordered them to report their total income. Also, an anti-corruption force was put in place. Many argue, however, that nepotism, corruption and related phenomena are generally admitted to exist in ‘the East’ (in this case, Southeast Asia) whereas in the West, corruption is legislated against (which does not prevent it from happening, it happens less openly) (Neill 1973: 374; Dick e.a. 2003).

After Suharto lost power in 1998, much was done in order to get rid of the barriers, monopolies and cartels. Although the country did not become a democracy overnight, the country seems to have left the path of extractive institutions and widespread corruption and exploitation. The current president, Joko Widodo, has pledged to attack corruption, with the installment of a corruption eradication commission, that faces much resistance. Changes do not come about easily, but high-ranking offi-cials will find it to be increasingly difficult to extract resources from the population. President Widodo recently said about the Corruption Eradication Commission (KPK) that ‘building a com-prehensive system to prevent corruption is as important as upholding the rule of law to prevent cor-ruption.’ (Parlina 2015).

Table 1: Regulatory quality (2015)

What can be taken from this table, is that in 2003, 5 years after Suharto stepped down, regulatory quality in Indonesia was extremely low, as the institutions had not developed for 32 years. In the years that followed, however, progress has been made. In Malaysia, the situation has remained roughly the same. Overall, the picture looks much better for Malaysia than Indonesia.

Consequences

The tradition of Civil Law in the Dutch East Indies, and later Indonesia, paved the way for extrac-tive polities and institutions. This was possible because Civil Law is aimed at securing the execu-tive power from judicial force, like in post-revolutionary France, instead of securing the property rights and labour circumstances of the people, as is the case in Common Law (Mahoney 2000). The consequences of the Cultivation System, which forced farmers to produce 20 percent of their crops for the colonial government, were even more significant. Officially, the farmers were paid to produce other crops, which made the deal not entirely hazardous to the local population. However, some problems did arise. It is more efficient to only produce one crop per plot of land, which was not the case in the Cultivation System, as everyone was assigned to a certain crop by the govern-ment. Inefficiency leads to less economic success.

Index 2003 2008 2013

Indonesia 21 43 46

Although the Culture System was eventually abolished and Forced labour as well (be it much later), the incentives that were not in favour of the individual but in favour of the State (the elite) were still in place. As discussed, the ‘guided democracy’ of Sukarno did not protect people’s property rights, which not only led to foreign investors losing their companies, but also to Indonesians losing their lands. This, in turn, led to turmoil, uncertainty and overall economic instability.

The New Order, implemented by Suharto, led to three consecutive decades of economic growth, which, in itself, can be regarded as a big success. Many were lifted out of poverty, and big im-provements were made in the sphere of education. At the same time, however, public interests were sacrificed for Suharto’s family and cronies (Weatherbee :182). This did have consequences on the FDI, which-of course- influenced the economy in a very negative way. When Suharto left office in 1998, the reforms were made but not all the problems were solved and the lack of sound institutions remained to be a problem. In 2001, FDI dropped with 42 percent as political instability, social un-rest, legal uncertainty and violence made other countries in the region, like Malaysia, more attrac-tive (Weatherbee 185).

Indonesia is still struggling with the 32-year Suharto-era, in which the legal (as well as other) insti-tutions have not developed like they have in other countries, like Malaysia. Since 1998, the situa-tion has improved, but-as can be seen looking at FDI-statistics, foreign companies have had their doubts about investing, because business confidence has been low, although it is currently on the rise, even more than in Malaysia (Trading Economics 2015). Whether this implies that Indonesia and Malaysia have left their respective paths of development remains to be seen.

Table 2: Economic growth per decade per year (World Bank 2015).

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2.2 Law traditions in Malaysia

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Origins

As the British expanded their empire in the 18th and 19th century, they implemented their law sys-tem in most of the colonies. The common law, that existed in England well before the Civil Law in other countries, was- in part- founded on the belief that people (at that time mainly merchants and aristocrats) should be protected against the greediness of the King and the State. Judges were law-makers via the principle of precedent, making the State less important in the process of producing laws (Mahoney 2001). In colonial times, this led to the fact that Britain chose a different approach to colonies than countries like France, Spain, and the Netherlands. The British Common Law was more inclusive in nature, with substantial safeguards and property rights for the indigenous people in the colonies (Chung 2003: 530: Osborne 2013).

Although the Dutch and the Portuguese have been the colonial power before Britain took over, Bri-tain has had a much bigger influence on the legal system in British Malaya. Charters of Justice were already enacted in 1807, and renewed multiple times (2003: 533). Although the British implemen-ted their Charters, English law was not really powerful until the Civil Law enactment of 1937 . The federation of Malaya was granted independence in 1957, and was expanded and renamed Malaysia in 1963, shortly before Singapore seceded (Vere Allen 1970; Dabble 2000).

The first binding laws were made when there were three groups of Malay states. After the war, the states were unified, and post-war law was made. In this period, most of the British Common Law was implemented. Like in Indonesia, there still exists a number of laws established during the colo-nial era that are still in force and applicable with certain minor changes in according to local and current circumstances. Like in Indonesia, not all laws derive from colonial times, as customary law and islamic law is also applicable in some fields and some regions. One notable difference, apart from all the Common Law-Civil Law differences, is the fact that the Federal State and the different states have different authorities when it comes to law-making (Chung 2003).

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Incentives

Compared to the situation in colonial in which the (French) Civil Law was in place, the incentives created by the British Common Law are relatively favorable towards the individual rather than the state, and towards the indigenous population rather than the colonial ‘settlers’.

Like the Dutch in Indonesia, the British were actively involved in e.g. tin-mining and rubber pro-duction, and sought ways to gain more control over the colonies, in order to secure these activities. In contrast to the Dutch however, this was done in ways that would not automatically extract mon-ey, land or labour from the local population.

The British imported Brazilian rubber trees, and planted these in vast plantations in peninsular Malaya and North Borneo. The rubber farmers did not ‘steal’ the land from peasants or other

in-digenous people, but made sure the land grants were provided from areas that were considered to be a part of the forest reserve that was part of the state. The policies that were pursued were not the same in every part of what is now peninsular Malaysia, Sarawak and Sabah (Byerlee 2013), but generally speaking, the policies were not just extractive. Although regulations in British Malaya were favorable towards big farmers rather than small farmers, this was not nearly as ‘bad’ as in In-donesia. Small farmers were discriminated against, but not as badly as in InIn-donesia. The British colonial recognized local land rights under customary law, this could happen via formal titles that were already in use, or by issuing occupation licenses. This was already the situation at the end of the 19th century. This can be considered to be in line with British Common Law (Chung 2003). Smallholders from India or China used parts of the forests that were seen as wastelands to engage in commercial agriculture. Already in 1883 the British established formal land rights and made sure that the the lands could not easily be alienated for plantation purposes. However, in some cases, the resources were granted to big companies for prices deemed too low by the local population. The indigenous population filed complaints about this in 1914 and 1919. So, although the British made efforts to act in a fair way, and conflicts about plantations were still successfully avoided. In 1954, the rights of forest dwellers were formally recognized (Byerlee 2013).

very important difference between British Malaya and the Netherlands Indies was the fact that Ma-laya itself was not a big source of labour, whereas Java, the most populous island in the world, offe-red so much labour that the price of it became extremely low. Exploiting the workforce was very common on Java. In British Malaya, workers from China and India came to work, making the dy-namics completely different. (Yeoh 2006: 23).

Post-colonial incentives

Although the modern state of Malaysia relies less heavily on the British Common Law today than it did right after independence, the effective elements have remained in place to a significant degree, and verdicts by judges in Malaysia are held in high esteem by fellow judges active in Common Law jurisdictions.

Like Indonesia, Malaysia has been under autocratic rule for decades. However, this does not mean that the process of law-making and regulating economic activity was automatically inferior to other, democratic countries. Malaysia engaged in an open, consultative process for reviewing, changing or modifying established rules, which makes the law-system more inclusive, as more people get to de-cide which rules are good and which rules are not (Rajenthran 2002: 6) Furthermore, the govern-ment was, to a large degree, accountable for the legal framework, and the effectiveness of the pro-grammes was periodically evaluated. (Rajenthran 2002-2: 6). In the process of policy making, the interests of the ethnic Malays and indigenous people were always taken into account, which was important, as much of the economic activity in Malaysia was (and still is) in the hands of foreign entrepreneurs. Although many policies that have been put forward during the New Economic Policy and before are not always, strictly speaking, legally binding, they all derive their legitimacy from the constitution. When it comes to the treatment of workers, labour laws in Malaysia are satisfacto-ry, minimizing protest and problems.

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As property rights are deemed important by Common Law principles, article 13 of the constitution guarantees that the government has no right to expropriation of property without compensation. In the history of Malaysia, there are no records of nationalization of foreign companies, in sharp con-trast with the situation in Indonesia, where, in 1957, countless Dutch companies were nationalized by the Sukarno government (Rajenthran 2002-2: 22). This makes Malaysia relatively safe and relia-ble to foreign investors and foreign companies. Due to many safeguards, Malaysia is, within ASEAN the country that offers the most extensive range of investment incentives (24). The liabili-ties, rights and obligations of all business parties in Malaysia are strictly conceptualized and rein-forced.

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Since (and even before) independence, the law system in Malaysia has been very predictable and certain, there have been no moments in history when companies were suddenly taken from people or when rules just did not apply.

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And, although the process is not perfect and Shariah law is gaining influence in Malaysia (not in itself a threat, but it could change the dynamics), the business confidence in the country in the coun-try is high. Although business confidence decreases slowly, over the last 5 years it has been higher than in Indonesia (Trading Economics 2015).

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Consequences

And overall, the colonial administration in pre-War British Malaya was not corrupt. The British did- of course- gain much from the tin and rubber in the colony, but they adhered to a code of conduct and were usually loyal to the rules that were in place (Stubbs 15).

Whereas in colonial Indonesia parts of the population were practically enslaved, this did not happen in British Malaya, as the rights of the indigenous population were usually respected and the state was not more important than the interest of the individual. Because the population in British Malaya was not enslaved and hence not as severely impoverished, Malaysia was in a much better shape, economically speaking, at the moment of independence (Drabble 2000; Dick e.a. 2003).

Because the labour laws and contract rights are taken seriously in Malaysia, and disputes between employers and employees are usually resolved by the use of conciliatory techniques (negotiation, fact finding, conciliation, mediation and arbitration) instead of strikes and unrest (as can be the case in Indonesia, where millions of workers can resort to strikes) (19). The fact that there is a legal framework for good negotiations and therefore unrest is unusual, makes Malaysia an attractive country to invest in, which is good for the economy. The stable legal system in Malaysia that was inherited from the British, in general made for a stable environment to do business. This stable en-vironment was not only beneficial to foreign investors, but also for (domestic) entrepreneurs who tried to have a business in the country (Freedom House 2012).

Even when Malaysia became less democratic, in the 1980s, the rule of law in the country was up-held, and the property rights were respected so that good conditions for foreign and local investors continued to exist. When the Asian crisis hit, the regulations in the financial sector and other sectors were, because of the good incentives brought by the sound implementation of the common law, a force for quick recovery. The GDP quickly started to rise again, and poverty levels remained under control, at 7,5 percent (World Bank 2015; IMF 2015; Drabble 2000: 299).

As we can seen, there has been no moment in Malaysian history where the disregard for the rule of law has been as big as in the Indonesia on various moments. The legal stability has been good for business and sustained economic growth.

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3.1 Political system and bureaucracy in Indonesia

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In the post-colonial history of Indonesia there have been two decades in which the economic growth was significantly less than that of Malaysia. The first is the 1960s, during which the economic growth in Indonesia was 3,9 percent versus 6,5 percent in Malaysia. Between 1960 and 1965 real GDP per capita in a desperately poor Indonesia fell by roughly 10%. The second decade is the 1990s, when economic growth was about half of Malaysia’s, mainly due to the Asian economic cri-sis that hit Indonesia much harder than it did Malaysia (Dick e.a. 2003: 244; World Bank 2015; IMF 2015).

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The interests of the Dutch East India Company were extractive in nature. The aim was to make mo-ney from the resources that could be found, not to build a political structure or sound bureaucratic system that would benefit the whole population. When the Dutch government took over in 1800, political interests remained secondary to economic interests, but- as discussed- in order to pursue material gains, there needed to be an institutional framework and a clear command structure.

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The head of the colonial government was the governor-general, who was relatively powerful. Abo-ve him, the Queen. In the beginning of the 20th century, a parliament (Volksbond) emerged, and even city councils were established at the local level. After independence, the role of the queen and the role of the governor-general were combined in the position of the president. Sukarno, the first president, therefore became very powerful (Lane 2008: 33).

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The role of the army that was very important during colonial times, remained important in the early days of the republic of Indonesia and this continued to be the case until the resignation of Suharto in 1998, but even after that. The army was so visible, that it can be considered to be ‘a state within a state’ playing an important role in almost every aspect of society (Rock 2003).

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One of the aspects was the bureaucratic system. The bureaucracy that the Dutch had founded in the 19th and 20th century, was in some respects highly functional: well-qualified Dutch civil servants worked along with servants from the local population. Although the ‘extractive goals’ of the Dutch colonial government were being served, the bureaucracy did function to a large degree. Some critics have argued that the officials during were under supervised and that corruption was accepted by the Dutch and the Javenese nobility, and that abuses were rife (Fasseur 1992). In that sense, the colonial bureaucracy has not been of great help to reduce corruption. Like in Malaysia, the bureaucracy was staffed by highly educated young men from the colonizing country, but because of systems like the culture system, the incentives led Dutch bureaucrats to engage in corruption. A long career, on the other hand, could be guaranteed and a good salary and excellent conditions as well. In that sense, the Dutch bureaucracy was one of the finest civil services in any colony (1992: 32).