2. A cultural approach to economics as a framework to analyze economic catch-up development

Fundamental to the economic analysis of economic change is the nowadays famous distinction between ‛formal rules’ and ‘informal constraints’ (North, Reference North1990; for a discussion, see Hodgson, Reference Hodgson2006).Footnote ⁴ This notion takes into account the fact that in reality social orders consist of legal and non-legal rules, explicit and tacit rules as well as planned and unplanned (i.e. spontaneous) ordersFootnote ⁵ and that the emergence of institutions depends significantly on people's shared mental models (ideologies, religion, etc.; Denzau & North, Reference Denzau and North1994). Those formal rules and informal constraints do not, however, exist independently from one another, rather, as a combination, they form the constraints for human interaction (Kingston & Caballero, Reference Kingston and Caballero2009: 170–172).Footnote ⁶ Following this distinction, formal rules are legal rules enacted at the political level explicitly codified by laws, while informal constraints are non-legal rules like norms and conventions. The compliance of such non-legal rules cannot be judicially enforced.

According to our understanding, culture is the ongoing interplay between formal rules and informal constraints that emerges in the historical development of every society and must be learned (and reflected) by every individual in the course of his or her socialization (see e.g. Goldschmidt & Remmele, Reference Goldschmidt and Remmele2005; Hodgson, Reference Hodgson, de Paula and Dymski2005, Reference Hodgson2006). Consequently, it is necessary to see the endogeneity of culture in its two consequences. First, informal constraints do not only relate to formal rules in a simple, causal manner of constraining or fostering the efficacy of formal rules. Rather ‘the complex interaction of formal rules and informal constraints . . . dominate[s] our lives’ (North, Reference North1990: 83). Hence, secondly, it is the specific quality of this interdependent relation that is put into focus in the cultural approach to economics. Accordingly, such an approach highlights the relevance of certain questions, such as how formal rules evolve over time, how they evolve out of informal constraints and vice versa, whether their functional relation exhibits, for example, complimentary or undermining characteristics, or how external developments are reflected and integrated into formal rules on the one hand, and into informal constraints on the other.Footnote ⁷

A starting point for an adequate understanding of culture can still be found in the evolutionary social philosophy of Friedrich August von Hayek. Hayek (Reference Hayek1973: 11) shares the view that rules govern the thoughts and actions of man and specifies, with regards to the character of these rules, that they are the ‘product of the experience of generations’. With this expression, he highlights the dynamic character of rules over time and sums up the process underlying the development of rules. As Hayek (Reference Hayek1979: 155) clarifies, the experience mentioned above represents the cultural evolution, which, in analogy to biological evolution, selects advantageous practices introduced for unknown or accidental reasons. However, cultural evolution differs in an important aspect from its biological counterpart: Acquired properties can be passed on in their institutionalized form to the next generation. Thus, cultural evolution is: ‘A decentralized process where, in a society or polity, different individuals or groups of persons experiment with alternative practices and where from these competing practices the ones that are perceived as more advantageous become more widely adopted’ (Vanberg, Reference Vanberg2001: 80). Hence, institutions and human rationality, as well as the competence of dealing with these institutions, are dynamically intertwined in the structural dimension. This complex connection leads once again to the issue of embeddedness (Granovetter, Reference Granovetter1985) and thereby emphasizes the insight that culture cannot be treated as an additive factor to the nature of human life and behavior. Instead, it needs to be seen as a central constituting element. Economic phenomena result from human activities, and do so over time. Furthermore, these activities are bound to rules formed within a cultural context, which also evolves through time. Combining both aspects elucidates why the examination of economic processes has to be understood as a cultural phenomenon.

Equally important is the adequate comprehension of how the accumulated cultural legacy is passed on to the next generation. The process of ontogenetic enculturation explains this. As discussed above, cultural learning concentrates on the strategy, hence the intention of the perceived pattern of behavior. Dux (Reference Dux, Vogel, Dux and Elvin2010, Reference Dux2011) emphasizes that this process is beyond mere transmission of content, requiring a constructive competence on behalf of the learner. Using this constructive mechanism, the individual develops, via the interaction with society, the ability to deal with its specific socio-cultural environment (Dux, Reference Dux, Vogel, Dux and Elvin2010: 103–104). Consequently, there is no absolute autonomy of the individual in respect to society and the economy, just as to their culture. Instead, individualization has to be understood as a process of enculturation. In fact, taking the insights of evolutionary anthropology seriously, the analysis of economic phenomena must necessarily take into account the cultural qualities of society, which appear to be so central to the evolution of the specific individual's economic reflections and behavior.

3. Catch-up development and society

In general, economists share a common understanding of development as a ‘catch-up’ process in which less developed countries take advantage of the technological paths previously forged by more developed countries (Burkett & Hart-Landsberg, Reference Burkett and Hart-Landsberg2003: 148).Footnote ⁸ Thus, catch-up development implies ‘that countries tend to imitate the economic behavior of more advanced countries and – if they want to reduce the gap – have to do so at a rapid pace’ (Zweynert, Reference Zweynert2006a: 183).Footnote ⁹ More specifically, there are three main factors determining the process of catch-up development. First, the developmental path a country pursues is strongly shaped by its cultural legacy. Second, one needs to consider the country in its economic as well as political and military situation when competing against other countries. And third, the interaction between newly imported formal institutions and persisting local informal constraints should be considered as well (see Zweynert, Reference Zweynert2006a: 183–185). The cultural legacy, in its historical emergence until the recent socio-political developments in Indonesia, provides the structure and content of Section 4 of this paper. It will be shown that a serious imitation of the Western economic modelFootnote ¹⁰ was not pursued until the end of the pancasila past in 1998.Footnote ¹¹ Competition-related aspects are therefore mainly discussed in the context of the transition to the democratization period in Section 5, as it marks the beginning for the catch-up development process in Indonesia.

Corresponding to this focus, the paper uses a theoretical framework to illustrate the cultural and historic influence on the specific social organization, in which the ontogeny of the ‘embedded’ individual takes place with all its consequences for economic development (Granovetter, Reference Granovetter1985). The illustration works along the comparison of two ideal types of social organization. On the one hand the holistic society is characterized by the general validity of a single moral logic for all spheres of society: Typically, religion or ideology can offer such guiding principles, unifying people according to one unquestionable kind of rationality. On the other hand, there is the extended order, also referred to as the functionally differentiated order, where multiple rationalities prevail in the different sub-systems of society. People in a functionally differentiated order act according to an economic, i.e. capitalistic, logic when buying and selling things, to a political logic when searching for solutions to political problems, to a juridical logic when judging a crime. Hence, the extended order frames the sub-systems of interaction, and, in its sub-sectors, competing kinds of spontaneous orders (cf. Zweynert & Goldschmidt, Reference Goldschmidt2006: 901).Footnote ¹²

Holistic societies often ensure the claim of universal validity of the one rationality via hierarchical structures. Furthermore, a strong hierarchical organization of society results in an increase in personalized social relations, as hierarchy with its aim for social control shows a much lower coverage when compared to abstract media of social interaction, like money. These factors cause people in holistic societies to be organized in relatively small groups, leading to a split in moral standards depending on whether one is dealing with group members or group outsiders. Max Weber (Reference Weber1923: 303–304) denotes the contrast between loyalty toward members of one's own group and disloyalty toward outsiders in terms of internal and external morals. Because an extended order, on the other hand, relies in large part on the abstract interaction with individuals that are not personally known, this moral dichotomy is confronted with the incentive to treat all other persons as equals and hence to overcome the gap. In the terminology of Mark Granovetter (Reference Granovetter1973, Reference Granovetter1985, Reference Granovetter2005), there are strong ties among individuals in the small groups of holistic orders and weak ties in the extended order connecting more individuals beyond personal acquaintances. The distinction between internal and external morals in a holistic order provides an explanation for the difficult acceptance of formal, imported institutions, as they fall, due to their external characteristic, under the less benevolent judgment of the external moral. Hence, the change from a holistic to an extended order is often accompanied by objections emphasizing the dissolution of ‘social unity’ and consequent fragmentation of society (Zweynert, Reference Zweynert2006a: 186). Due to these reasons, we consider it crucial to understand the degree to which a society is organized as a holistic or extended order, as this is an essential constituting factor regarding the quality of informal constraints and of the formal–informal institutional interplay. Having said this, it is clear that it is not ‘culture’ that shapes the transition from a holistic society toward an extended society, but rather that these country-specific patterns are a cultural characteristic themselves.

Source: Zweynert and Goldschmidt (Reference Goldschmidt2006: 902).

Just recently, North et al. (Reference North, Wallis and Weingast2009) suggested a similar concept to explain economic performance by distinguishing two kinds of orders, which differ in the way they control the threat of violence: A limited-access order is characterized by the compensation of potential violence with economic privileges. Those with access to violence form a coalition, within which, by specialization with regard to vital functions of a state, a rent-creating elite is protected from the competing efforts of others. In contrast, an open-access order, via a thorough democratic system, allows for any individual to compete for power in the political sphere. Moreover, such competition not only reduces rents but also, more importantly, increases the ability of the economic and political system to rapidly adapt to environmental changes and shocks, which naturally all societies face over time.

It must, however, be stressed that in reality no pure form of either type exists, and that societies do not exist somewhere in between, but rather that a coexistence of factors from both orders prevail. Nevertheless, this contrasting theoretical framework helps to analyze specific cultural and historical factors in terms of their compatibility with the Western economic model, which is based on a functionally differentiated order.

4. Indonesia from a cultural perspective

The focus of the second – more descriptive – part of this paper is on the identification of cultural factors in Indonesia's history and their analyses with regard to the compatibility with the Western economic model. Four major cultural categories can be distinguished: The Javanese worldview kejawen, Islam, colonialism and the regimes of Sukarno and Suharto, denoted as pancasila past. The first three categories refer to the cultural legacy and capture century-old cultural factors. Kejawen, Islam and colonialism are believed to provide nationally relevant cultural categories, significantly conditioning the economic behavior of many people in Indonesia.Footnote ¹³ However, they correspond to the concept of cultural legacy, as introduced above, and should therefore be understood in accordance to its theoretical implications, which makes clear that it cannot deliver an explicative pattern that fully determines or understands the behavior of the ‘Indonesian individual’.

5. Implications for economic development

Following the theoretical framework introduced in Sections 2 and 3, there are several indications found in the cultural legacy of Indonesia that characterize a holistic society. As the analysis of the idealized cultural factors in kejawen and Islam has shown, social relations are strongly shaped by some kind of morality based on family or tribal rules (Schwarz, Reference Schwarz1995: 133–161). Transforming formal rules into extended-order institutions while informal constraints still obey a holistic system will result in a large gap between internal and external morals. This is common for a system of morals evolving from relatively small personal networks and is perfectly in accordance with the theory of holistic societies. Moreover, these findings are in line with the prevailing type of ideology, especially the emphasis on divine rationality as the one absolute truth in Islam, constraining the possible interpretations of social reality, but this also applies to the logic of harmony in kejawen, which dominates all spheres of society. During the pancasila past, from Indonesia's independence until the end of Suharto's rule, holistic qualities continued to prevail and shape society. The absence of boundary between the political and economic spheres clearly proves this. Furthermore, pancasila, the unifying political ideology, proclaiming universal validity, supports the singular logic inherent in a holistic social order.

It has been mentioned that neither social order exists in its pure form, even under the patterns of idealized cultural factors, which leads us to examine the criteria that define an extended order in this particular context. While the religious ideology of Islam denotes a well and tightly defined path of divine rationality, the practical philosophy of kejawen, despite the all-embracing principle of harmony it pursues in its interpretation of social reality, is much more open. This arises not only from the integration of Islamic elements, but also through the general acceptance of pluralistic ideas helping to attain the abstract aim of harmony. Moreover, the Dutch exerted significant influence during colonization, introducing the Cultivation System, causing increased labor division and circulation of money, all of which are essential characteristics of an extended order.

Several other meaningful factors of the cultural legacy in terms of compatibility with the Western economic model have emerged from our case study. A number of adverse properties can be found, e.g. the informal constraints underlying kejawen, which, by emphasizing the inner sphere, generally devalue concerns about the outer material world, such as striving for material improvement. Furthermore, the implication of rukun, which subordinates individual concerns to the collective aim of social harmony, is an opposing tendency with regard to the culture of individualism necessary for the effective functioning of a market economy. This tendency appears to have become further consolidated during the pancasila past, in which collective and non-individual goals represented the way toward the development of society. During the colonial period, in which Indonesians were intensely and for the first time confronted with the institutions of a market economy, living standards declined throughout the larger part of the population. This obviously contributed to a general distrust and negative attitude toward Western market economy models. It has been highlighted that there are, however, further – beneficial – attributes of the cultural legacy with regard to a Western economic model. Therefore, hasty conclusions about a generally adverse attitude toward individualism in kejawen need to be seen with care, as the inward directed quality brings with it a focus on the individual, away from any social or collective considerations.

However, the persistency of holistic patterns has obviously been supported by their dual presence, both in the realm of informal constraints, as embodied in small social networks, and in the formal social order, thus posing the greatest challenge to establishing a Western economic model at the end of the 20th century.

6. Catch-up development in Indonesia

However, from 1967 to 1997 – because of the positive business environment established by Suharto's New Order – Indonesia experienced a sort of ‘economic miracle’ (Hofman et al., Reference Hofman, Rodrick-Jones and Thee2004: 11–13; Thee, Reference Thee, Lloyd and Smith2001). GDP grew by an average of 7% per annum. Rapid growth was accompanied by significant gains in the development of human capital and a structural modernization of the economy, away from agriculture and toward industrialization, while poverty was reduced significantly. Indonesia's success was built on strong macroeconomic policies combined with major investments in infrastructure, agriculture, education and health to link the poor population to that rapid growth. Yet, over the same period of time, the country's formal financial, legal and political institutions did not keep pace with the reforms or with Indonesia's increasingly complex and open economy.Footnote ²⁶

With the end of Suharto's regime and the beginning democratization in 1998, significant steps toward a successful economic development in Indonesia were undertaken, i.e. Indonesia pursued major reforms, this time of its institutions, including constitutional and electoral reforms, the establishment of an independent central bank and independent judiciary, decentralization, and liberalization of the press and civil society (Hofman et al., Reference Hofman, Rodrick-Jones and Thee2004). However, as pointed out before, what is accomplished on the institutions’ formal level will not bear fruit if informal constraints do not support their functioning. Thus, if the formal law changes, individuals must acquire new normative expectations and must learn new ways of handling these normative expectations (Engel, Reference Engel2008).

During the past decade, essential improvements have been made to prevent adverse informal constraints from impeding development. Accordingly, the formalization of democratic institutions has prevented both the coming into power of orthodox Islamic parties and the establishment of an institutional environment adverse to economic development. Moreover, the reform of the electoral system was successful in pushing many military officials out of office during the local elections in 2005 and 2006 (McGibbon, Reference McGibbon2006: 331). Their continuing presence in the polity along with their connections to the economy has posed a major obstacle to the functional differentiation of society. Furthermore, Western market economy institutions have met with increasingly beneficial tendencies toward materialistic appreciation in Javanese culture and the generally market-economy friendly characteristics of Islam. Mulder (Reference Mulder1992: 157) points out that the inward directed quality of kejawen has been evolving toward matters of the outer and material world. The experience of a failing protection and support by the elite has caused large parts of the population to lose confidence in the patrimonial hierarchy (Mulder, Reference Mulder1992: 132–133). He argues that economic security and opportunities – as can be found in the idea of a social market economy – are more important than the old idea of inner peace in the context of a dissolving system of social relations.

Gerke (Reference Gerke and Beng-Huat2000: 153), taking stock of the rapid capitalist economic development, also comes to the conclusion that hierarchical ideals are eroding: ‘[P]restige and status became negotiable values, depending mainly on a person's lifestyle and consumption patterns, and no longer based on traditional established values and hierarchies’. To clarify this argument, the following extract describes our own observations made throughout several visits to Indonesia's main university-city Yogyakarta on Java:

Although most students belong to the elite rather than to the poor masses, they are not extremely rich and often live in very poor housing, having to struggle with their daily expenses. Thus, the observation described above can be understood as a very conscious public demonstration of material wealth. The growing opportunities of social mobility due to the expanding education-system, as described by Magnis-Suseno (Reference Magnis-Suseno1989: 83), also serve to weaken the validity of the traditional hierarchical order.

In any case, there are major drawbacks in other settings where imported formal institutions clash with local informal constraints. Especially patron–client relationship patterns, which are part of the Javanese cultural tradition and which tightened during the pancasila past, are known for undermining the aims of formal governmental institutions by providing fertile soil for corruptive behavior.

A prominent example is the rule of law, which is institutionally formalized, but effectively non-existent (McGibbon, Reference McGibbon2006: 334; Webber, Reference Webber2006: 402, 409).Footnote ²⁷ To put it differently: Indonesians perceive the rule of law as being synthesized and externally imposed. Thus, it remains unused, contrary to inherited patterns of thought, in this case patronage and informal hierarchies. Legal disputes are frequently solved through social contacts involving both informal and formal (e.g. the police, the army, politicians) authorities. The one with the most powerful relations will win the dispute. Empirical results highlight this situation. For example, an elaborate Environmental Law having been formally adopted (Waddell, Reference Waddell2006), a provincial environmental agency included in our research has, according to a local consultant, intervened only once to deal with the polluting activities of a company in the past.

Several entrepreneurs have reported regular visits by the national police requiring them to pay special fees (bribes) in relation to – among other things – violations of the Environmental Law. Although the police draws on the law as a justification for demanding fees, which may indeed be interpreted as a way of enforcing legal norms as formulated in the law, such a practice is far from being a just and effective application of the rule of law. The local consultant further explained:

The information obtained demonstrates that, aside from the largely arbitrary commissions taken by the police, who in this fashion sideline the courts – bodies that, anyhow, would probably not ensure the proper application of the law (cf. Webber, Reference Webber2006: 408–409) – the patronage of powerful political figures is the dominating factor in the setting of rules. Therefore, the current situation still corresponds to the general finding of Rademakers (Reference Rademakers1998: 1,010) a decade ago: ‘Good relationships with state officials are regarded as more important for business success than co-operative inter-firm linkages’. The need to rely primarily on personal relations is closely connected to the lack of an effective legal system. A holistic order is characterized by the fact that personal relations secure the trust necessary for social and consequently economic interactions. This is the crucial difference with extended orders, which are based on interactions between mainly unknown individuals. Effective laws, as money, represent abstract media, which create trust beyond personal ties. Like money, the rule of law bestows more complex and impersonal social interactions with the necessary trust, a quality that is indispensable for economic development. The informal local rules of patron–client relationships thus continue to offset the efficiency of the imported formal institutions of law.

From a cultural point of view, this has to do with the offsetting power of patron–client relationships as well as the misuse of the legal system under Suharto. The rule of law is a crucial factor for enhancing the emergence of interactions between personally unknown individuals by providing trust – a central aspect of an extended order. When the functioning of the legal system is undermined by prevailing patron–client relationships, the absence of the rule of law causes continued reliance upon interactions with personally known individuals and thus strengthens such behavioral patterns. This situation must be viewed as an institutional trap with regard to the further process of economic development in Indonesia. Another aspect of informal constraints hampering essential conditions for successful economic development is the influential role of the army. Since the end of the pancasila past, the armed forces have maintained a powerful position in Indonesia's society (Mietzner, Reference Mietzner2009: 320). This military legacy has even caused political parties to recruit their own paramilitary forces (Mietzner, Reference Mietzner2009: 380). Despite the progress discussed earlier, the military continues to strongly interfere in the political and economic spheres. Hence, as long as the informal dominance of the army is not curbed, the formal separation of polity and economy will remain ineffective in reality (Azra, Reference Azra2006; Abu Dhabe Gallup Center, 2011; McGibbon, Reference McGibbon2006; Webber, Reference Webber2006).

7. Lessons for economic catch-up development in Indonesia

The implications with regard to economic policies, when applying a cultural approach, mainly revolve around two different concepts. First, in case of severe incompatibilities between formal rules and informal constraints, solutions explicitly accounting for the informal preconditions of formal settings should be introduced (Zweynert, Reference Zweynert2006b). Second, if the citizens wish to establish a market system modeled on a Western approach, politicians need to engage in marketing strategies, understanding ‘culture as a toolkit’ (Zweynert, Reference Zweynert2009: 346–354) in order to create a public climate conducive to the acceptance of institutions, which at first sight seems less appealing to the people. The politicians’ role as a ‘public entrepreneur’ (Schnellenbach, Reference Schnellenbach2007) and as a ‘cultural entrepreneur’ (Kubik, Reference Kubik, Ekiert and Hanson2003) further implies that prevailing cultural patterns beneficial to a compatible economic model need to be the focus of special support.Footnote ²⁸ At this point, a third dimension in terms of policy recommendations based on a cultural approach emerges. We have seen that it is crucial that some key formal institutions function well, and thus high priority should be placed on those specific institutions.

Consequently, Geoffrey Hodgson (Reference Hodgson, de Paula and Dymski2005: 95) argues that ‘institution building must involve a judicious combination of careful legislation with simultaneous efforts to encourage the development of habits and other informal cultural features that are consistent with policy goals. Legislation cannot go faster than the development of human habits and informal social norms’. A cultural approach can therefore make a contribution by clarifying priorities – thanks to its insights – with regard to sustaining reforms in specific sectors concerned with formal institutions.

We are first going to discuss the implications derived from this last aspect in the case of Indonesia. The analysis of recent catch-up development has shown that the lack of an effective formal law has far-reaching consequences on the persistency of adverse cultural factors.Footnote ²⁹ Institutional shortcomings cause people to continually rely on personal networks, which prevent the extension of the sphere of trust necessary to the creation of a functionally differentiated market order. Moreover, the de facto legal impunity allows the army to obtain political and, especially, economic privileges. Because of this, an essential condition for economic development, namely the separation of the economic and political spheres, cannot be attained. The progress initiated by reforms of the election system can only be sustained if the rule of law challenges the military's economic privileges. Another factor warranting the prioritization of policies with regard to formal law is the spread of an increasingly orthodox Islam, which threatens the pluralistic ideological basis of the state, and will continue to gain pace as long as the law is not seriously enforced, especially as concerns corruptive behavior (cf. Baswedan, Reference Baswedan2004). Thus it should be clear that, from the perspective of a cultural approach, political measures aimed at strengthening a functioning legal system are indispensable on the path toward economic development.

As for the second general idea of a cultural approach, namely the politician as a ‘cultural entrepreneur’ and its implications in terms of policy, the following options are suggested: A major issue opposing the evolution of an extended order and thereby hampering economic development is the family notion of Javanese morals. Suharto tried to project the idea of the family upon the state. By doing so, he strongly contributed to the manifestation of personalized patron–client relationships. Politicians therefore need to object to ideas that establish parallels between society at large or the government, on the one hand, and cultural references to family or patron characteristics on the other. A family-based moral code does not provide the necessary moral basis for orientation within the rather anonymous society that is to be created. Further research should analyze and determine how the interaction between unknown individuals can be promoted within the Indonesian cultural context.

The ‘cultural entrepreneur’ is faced with adverse qualities in Javanese culture. Many promising opportunities can be found and used to strengthen conductive elements. The democratic factors that form part of kejawen, particularly as specified by the principle of rukun, stress the value of mutual consultation and unanimous accordance. Referring to these ideas, which are deeply rooted in Indonesia's cultural legacy, politicians are offered a powerful tool to consolidate democracy. Suharto's decision to use ‘democracy’ as a label for his political system (pancasila democracy) perhaps did not only represent a strategic move toward the international community but also referred to a deeply rooted democratic desire in Javanese culture. Taking up these democratic principles in order to promote democracy may be one of the most effective means available to help control the persisting abuse of political and economic privileges.

Moreover there are other factors of kejawen supporting a Western market-economy model. In Section 2, we pointed out that the logic of harmony, despite its all-encompassing ideological aim, offers a multitude of interpretations of social reality. Suharto used this philosophy of kejawen to secure his rule and check Muslims’ aspirations toward establishing an Islamic state. In order to guard the pluralistic ideological basis of the Indonesian state from this resurgent threat, drawing on the specified attributes of the Javanese worldview continues to be a useful political instrument.

Only 50 years back, many Javanese were kept from engaging in the pursuit of material gains. It was said that this was due to the kejawen focus on the inner sphere and away from general concerns for the outer world. However, over the last decades, young Indonesians have increasingly defined their social status according to the valuation of consumer goods. This not only challenges the substance of the old hierarchical order and thereby patron–client patterns, but also helps to promote the functioning of the market economy in general (Inozemtsev, Reference Inozemtsev2009). Thus, the ‘cultural entrepreneur’ should aim to support this trend, directly by, for example, facilitating private enterprises to take these conditions into account and help people acquire new normative expectations (for a detailed discussion on cultural entrepreneurship in a different context, see Klamer, Reference Klamer2011).