A Failed State?

The

metric of terror measures losses far beyond the killing zone of a car bomb. In the week following the Bali explosion that killed nearly 200, Ramlah Yasin sat on the floor of an office at a shuttered factory on the outskirts of Jakarta wondering if she, too, should be counted as a victim. Yasin, 30, worked for 11 years as a cloth cutter on the assembly lines of a shoe manufacturer, but a month ago her employer was forced to close after U.S. athletic gear giant Nike stopped ordering sneakers. Yasin has been looking for work, but now she has begun to despair. "Many orders from America could be moved away from Indonesia" she says, in the wake of the Bali blast. "It could make it more difficult for me to find a job. I don't know how I'm going to send money to my mother if I don't get paid."

The economic cost of the Sept. 11 attacks in the U.S. was estimated to be tens of billions of dollars. But as Indonesians like Yasin begin to assess the damage of the terrorism that has slammed into their homeland, some fear their cost ultimately could be far greater than the toll in America—that it could turn Indonesia, the world's fourth most-populous country, into a failed state. Just four years after the dictator Suharto was run out of office, the sprawling archipelago is struggling to emerge as a stable democracy. It hosts a full complement of developing-country ills: endemic corruption, erratic courts, reform-resistant corporations, crippling national debt, a barely functioning banking sector and falling investment. Psychological shock waves surging outward from Kuta Beach are bound to intersect with the nation's fragile social and political ecosystem in unpredictable ways, testing the allegiances and resilience of an ineffective government, and dealing a body blow to a sputtering economy that has yet to fully recover from Asia's 1997 economic crisis. "The bomb blast in Bali hurts a situation that is already bad," says Muhammad Chatib Basri, an associate director at the Institute for Social and Economic Research at the University of Indonesia in Jakarta. "There are a lot of things the government has to do, and it's a lot harder now."

The attack places Indonesia at a crossroads. From here, deterioration could accelerate, plunging the country into bloody sectarian violence, divorcing the economy even more from the international community, and turning its far-flung islands into increasingly fertile grounds for terrorism. If that occurs, Indonesia could sink to the status of countries such as Pakistan or the Congo, where economies are chronically dysfunctional and central leadership is largely incapable of governing. It doesn't have to go that way. The attack could strengthen the hand and the resolve of Indonesia's do-nothing chief, President Megawati Sukarnoputri, allowing her to stand up to terrorism and begin seriously addressing the country's economic problems. "Will this wake her into decisiveness and action?" asks Tom Lembong, a former official at the Indonesian Bank Restructuring Agency. "That's really the multi-million dollar question."

The immediate fallout will not help her cause. Prior to the attack, the country's economy was growing modestly. Analysts now are cutting their forecasts. Chatib Basri sliced his 2003 GDP forecast from 4.4% to 3.7%. (The World Bank estimates that Indonesia needs at least 6% growth to create enough jobs for its burgeoning workforce.) Daniel Lian, an economist at investment house Morgan Stanley, says economic revival throughout Southeast Asia could be jeopardized if investors shun the region. As a result, he says, "Economies would be further marginalized and geopolitical risks raised in a vicious cycle."

The business community in Indonesia has had to deal with random violence in the past—two years ago, a bomb exploded in the building housing the Jakarta Stock Exchange, killing 15. But the Bali blast has dragged Indonesia into the war on terror. Foreign businessmen "knew Indonesia was unsafe, but they still came," says Harun Hajadi, managing director of property developer Ciputra Group. "After this one, I don't know if they will come. Maybe they won't want to deal with Indonesians anymore."

The country's $5 billion tourism industry—which contributes about 3% of GDP—is expected to be devastated, possibly for years to come. The Mandarin Oriental Hotel in Jakarta saw 700 room cancellations in the days after Bali. Markus Schneider, the hotel's executive assistant manager says that the blast has taken hotel traffic "back to Sept. 11 figures. We were just getting back to normal." Last week, a regional high school soccer tournament, scheduled to take place in Jakarta, was hastily moved to Malaysia, taking scores of families and probably thousands of tourist dollars with it. But the real pain may come in lost jobs, since tourism supports 12 million Indonesians. "A drop in a million tourists potentially means a million unemployed," says Alistair Speirs, chairman of the Indonesian chapter of the Pacific Asia Travel Association. The country is already hard pressed. The unemployment rate is about 8%—and two million young Indonesians enter the job force each year.

A far greater worry than tourism is the long-term damage that could be done to Indonesia's flagging economic competitiveness. The country depends heavily on foreign investment to develop infrastructure, build and run factories, extract oil and gas, and create jobs. But due to the perception that Indonesia is a hostile environment for business, foreign direct investment (FDI) has already plunged from its pre-crisis level of $6.2 billion in 1996. Investors seeking low-cost operations are avoiding the country; most are relocating their factories to China. Last year, Indonesia registered a net FDI outflow of $5.9 billion, making it "the only country hit by the Asian financial crisis that still suffers a great capital outflow," says Hans Vriens, managing director of PT APCO Indonesia, a consulting and research firm.

Money still gets pumped into oil and gas—Indonesia's largest export industry—but there are considerable operational risks. In August, Caltex Pacific Indonesia, a subsidiary of ChevronTexaco, was forced to turn over management of an oil field in Sumatra to a joint venture between a local government and Pertamina, the country's big domestic producer. Caltex ran the field for 30 years, but when its production contract expired, the company was unable to get a standard extension. Under Suharto, Jakarta controlled the country's natural resource industries. But now, power is devolving to the provinces and local politicians want a cut of the wealth. The government in Riau, the province where the field is located, demanded it get a stake in the field; it formed a joint venture with Pertamina. Caltex was left out in the cold. The industry is "caught in this era of regions wanting a greater role," says one foreign executive. "When a contract comes up, it's over."

Social unrest, militant unions, wrongheaded economic policy and rapacious local businessmen out to gain by hook or by crook contribute to what global investors call "political risk." It's something Indonesia has in spades. In June, in an apparent power struggle with its former Indonesian partner, a local unit of Canadian insurer Manulife Financial Corp. was declared bankrupt by a domestic court despite the fact that the operation was solvent and profitable. The inexplicable decision, made because Manulife didn't pay a dividend to shareholders in 1999, was later overturned, but not before the case received international publicity. Partly due to the experiences of companies like Manulife and Caltex, investment in some key sectors has effectively dried up. In mining, an important source of exports, many smaller foreign companies have fled and new exploration has practically ceased due to confusion over the laws governing the industry and uncontrolled illegal mining.

Security concerns, too, continue to dog foreign operators, who are targets for myriad Indonesian groups with grievances and agendas. Last year, ExxonMobil closed its gas field in Aceh for four months due to safety concerns as violence escalated in the region, where separatist rebels are fighting a guerrilla war against the government. Now 3,000 government troops guard the site, but turmoil continues. Earlier this year, a bicyclist carried a pipe bomb to within a few hundred meters of the front gate of the gas field operation when the bomb detonated prematurely, killing him. "Indonesia is becoming the Nigeria of Asia," says Vriens.