Inter-Economy Comparisons: A Case Study: A Comparative Study of Industrial Development, Currency Devaluation, and Inflation

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INTER-ECONOMY COMPARISONS

A CASE STUDY

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INTER-ECONOMY COMPARISONS

A CASE STUDY

A COMPARATIVE STUDY OF INDUSTRIAL DEVELOPMENT, CURRENCY DEVALUATION, AND INFLATION

by Leonard A. Doyle

UNIVERSITY OF CALIFORNIA PRESS 1965

BERKELEY AND LOS ANGELES

University of California Press

Berkeley and Los Angeles

Cambridge University Press

London, England

A research study under cooperative arrangements among the following:

In the Republic of Indonesia: P. N. Pabrik Semen Gresik, Surabaja, East Java; Bank Pem- bangunan Indonesia; Department of Basic Industry and Mining; State Accounting Office, Department of Finance

In the United States of America: Institute of Business and Economic Research, University of California, Berkeley, under a grant from the Rockefeller Foundation; The Permanente Cement Corporation, Kaiser Center, Oakland, California

© 1965 by The Regents of the University of California

Library of Congress Catalog Card Number: 65-12925

Printed in the United States of America

Institute of Business and Economic Research

University of California, Berkeley

Hyman P. Minsky, Chairman

K. Roland A. Artie

James M. Carman

John W. Cowee

John M. Letiche

Tibor Seitovsky

Joseph W. Garbarino, Director (on leave)

Lee E. Preston, Acting Director

The opinions expressed in this study are those of the author. The functions of the Institute of Business and Economic Research are confined to facilitating the prosecution of independent scholarly research by members of the faculty.

Acknowledgments

This study was made possible by the encouragement of many individuals associated with the agencies listed, as well as by others in Indonesia and in the United States. President-Director Soe- manang of Bank Pembangunan Indonesia, Dr. Darmawan Man- gunkusumo, Chairman of the Board of Directors, PresidentDirector Sarimin Reksodihardjo of P. N. Pabrik Semen Gresik, and Mr. Paul Rogers, Vice-President and Controller of the Permanente Cement Corporation, all approved the project and authorized full access to the records and personnel of the two cement enterprises which are the subject of this investigation. The study itself is a part of a larger study of industrial development in Indonesia. The major study represents a cooperative venture among several agencies of the Government of Indonesia. For the larger study I am particularly indebted to Mr. Chaerul Saleh, Minister of Basic Industry and Mining; Dr. Zakaria Raib, of the Bureau of Industrialization of the Department of Basic Industry and Mining; Professor Sumardjo, Head of the State Accounting Office in the Department of Finance; Ir. Saksono, President-Director of the State Agricultural Enterprises; and Mr. Sardjoe Ismunandar, President-Director of the Nationalized Manufacturing Enterprises. Dr. Mohammad Sadli, Acting Director of the Institute for Social and Economic Research at the Faculty of Economics of the University of Indonesia at Djakarta, was most generous and helpful in encouraging and supporting my research on industrial development problems in Indonesia.

My debt to the executives of P. N. Pabrik Semen Gresik [vii] could be acknowledged properly only by a full roster of names, for I have imposed on technical and administrative personnel and on the accounting and sekretariat group at all levels. President-Director Sarimin not only authorized the staff to give me all assistance possible, but provided help and counsel as the study progressed. I should like particularly to acknowledge the help and counsel of Ir. Padjo Soerjodiningrat, Production Manager of Gresik during the period of the field work and now PresidentDirector; Sdr. Mohammad Arifin, Administrative Manager; Sdr. Soeriokoesoemo, Legal Advisor; and Sdr. Tony Dano, Chief Cost Accountant. Special thanks and appreciation are due Mrs. Mar- jatoen Winarto for the arduous task of typing the tables and preparing the stencils for the original draft of the study. Members of the sekretariat at Gresik were unfailingly generous and cooperative in making arrangements with officials and in assisting with correspondence and other details. Sdr. Arifin gave me the benefit of his counsel and experience at every stage of the investigation, read preliminary drafts of the manuscript, and made many helpful suggestions for improving the presentation. A special word of thanks and appreciation is due Gresik for the extraordinary hospitality of the staff of its Guest House.

Mr. C. MacArthur Carman, Technical Advisor of P. N. Pabrik Semen Gresik, helped me at every stage with his enormous technical knowledge of Gresik in particular and of the cement industry in general, and provided the fine hospitality of his home during my stay at Gresik. Mr. Louis Wheeler, Project Manager of the Morrison-Knudsen International Corporation, contractor for the original Gresik plant and its expansion program, was most helpful, as were members of his engineering and administrative staff, in providing information and in showing me the plant during construction and the initial operations when I visited the plant in 1956 and in 1957.

In the United States I imposed greatly on a long and pleasant professional and personal association with Mr. Paul Rogers, VicePresident and Controller of Permanente Cement Corporation, and on the manager and controller of the Cushenberry plant of Permanente at Lucerne, California. When I returned to the United States to revise the draft prepared in Indonesia, Mr.

Ronald Hohnsbeen, who succeeded Mr. Rogers as Vice-President and Controller of the Permanente Cement Corporation when Mr. Rogers retired, was most generous in providing additional information about Cushenberry and in taking time from a busy schedule to read the first draft of the study. The work of photographing and multilithing the tables for the study was done by Permanente Cement Corporation.

My colleague in the Graduate School of Business Administration, Professor William Vatter, read the first draft and made many valuable suggestions for revising and improving the manuscript.

Particular thanks are due the Rockefeller Foundation; Professor Richard Holton, Director of the Institute of Business and Economic Research of the University of California at Berkeley; Professor E. T. Grether, former Dean of the Graduate School of Business Administration at Berkeley; and President Clark Kerr for making possible the somewhat unusual Faculty Fellowship which permitted me to return to Indonesia for the cooperative research program of which this study is a part.

It is a pleasure to acknowledge the work of Mrs. Jan Seibert, who planned the form of the tables and typed them, and of Bob McIlroy, who checked the computations and footings of the tables and the text references to the tables. My wife has encouraged and assisted me at every part of the larger study of industry in Indonesia, and of the study of Gresik and Cushenberry. What may be good and useful in this study is due to the help and encouragement I have received from so many persons. The errors of fact, computation, and interpretation are mine.

Leonard A. Doyle

Walnut Creek, California

Contents

Contents

I Introduction

II Investment in the Two Cement Plants

GENERAL DETERMINANTS OF SIZE OF THE GRESIK PLANT

SOURCES AND NATURE OF THE INVESTMENT COST DATA

ECONOMIC CONSEQUENCES OF EXPENDITURES IN LOCAL CURRENCY

PROBLEMS IN THE RATE OF EXCHANGE

COSTS NOT INCLUDED IN INVESTMENT IN THE Two CEMENT PLANTS

SOCIAL CAPITAL AT GRESIK

COST OF THE EXPANSION PROGRAM AT GRESIK

TREATMENT OF IMPORT DUTIES ON CAPITAL GOODS

III The Costs of Capital—Depletion, Depreciation, and Interest

DEPLETION PROBLEMS OF THE TWO PLANTS AND THEIR RELATION TO THE ECONOMIC SYSTEMS OF THE TWO COUNTRIES

DEPRECIATION ACCOUNTING UNDER INDONESIAN SOCIALISM AND UNDER UNITED STATES PRIVATE ENTERPRISE

TIME AND RATE FOR DEPRECIATION UNDER INDONESIAN SOCIALISM AND UNDER PRIVATE ENTERPRISE IN THE UNITED STATES

USE OF AN INTEREST CHARGE AS A COST OF OPERATION FOR THE STATE ENTERPRISE

COMPUTATION OF REPLACEMENT COST FOR THE GRESIK AND CUSHENBERRY PLANTS AND OF THE CHARGES FOR DEPRECIATION AND INTEREST

RECOGNIZING THE ANNUAL REVALUATION IN THE ACCOUNTS

DEPRECIATION AND INTEREST CHARGES IN RELATION TO PRICE DETERMINATION UNDER PRIVATE ENTERPRISE AND UNDER STATE ENTERPRISE

IV Cost Accounting for Cement Production

METHODS AND PROBLEMS OF DETERMINING THE COST OF PRODUCTION

WHAT IS PROCESS COST ACCOUNTING?

PLACING DEPARTMENTAL COSTS ON A COMPARABLE BASIS FOR THE Two PLANTS

MEANING AND TREATMENT OF INDIRECT COSTS

DIFFERENCES BETWEEN THE GRESIK AND THE CUSHENBERRY SYSTEMS OF DISTRIBUTING COSTS

TENTATIVE CONCLUSIONS ON THE MAJOR ELEMENTS OF COST FOR THE Two PLANTS

THE COST FLOW SHEET AND ITS USE IN DETERMINING THE COST OF CEMENT PRODUCED

DETERMINATION OF COSTS AFTER THE CEMENT IS PRODUCED

CASH COSTS AT GRESIK

A Theory and Technique for Inter-Economy Cost Comparisons Under Inconvertible Currency

IMPLICATIONS OF THE METHOD FOR RELATIVE CURRENT EXPENDITURES

SUMMARY AND WARNINGS

VI Production and Production Costs at Gresik and Cushenberry

TOTAL COSTS AND CASH COSTS

BEHAVIOR OF SEPARATE ELEMENTS OF COST IN 1959

BEHAVIOR OF SEPARATE ELEMENTS OF COST IN 1960

COMPARING LABOR AND ADMINISTRATIVE COSTS

SIZE AND COMPOSITION OF MANAGERIAL AND LABOR FORCES

FACTORS INFLUENCING THE SIZE OF THE WORK FORCE AT GRESIK

CAPITAL COSTS AS A DETERMINANT OF TOTAL COST PER METRIC TON OF CEMENT PRODUCED

VII Contributions of the Gresik Cement Plant to the Economy of Indonesia

CONTRIBUTIONS TO THE FOREIGN EXCHANGE POSITION OF THE GOVERNMENT

EARNINGS OF THE GRESIK CEMENT PLANT

FLOW OF FUNDS AT THE GRESIK PLANT

SOCIAL AND PSYCHOLOGICAL CONTRIBUTIONS OF GRESIK TO THE INDONESIAN ECONOMY

VIII Financial Policy and Organization Theory in Relation to Operating and Financial Responsibilities of State Enterprises

ORGANIZATION ASPECTS OF THE EIGHT-YEAR DEVELOPMENT PLAN

FINANCIAL RELATIONS BETWEEN THE OPERATING CORPORATIONS AND BANK PEMBANGUNAN

FINANCIAL ARRANGEMENTS BETWEEN THE OPERATING CORPORATIONS AND BANK PEMBANGUNAN

THE FORM OF INVESTMENT BY BANK PEMBANGUNAN

Postscript

APPENDIX 1 Supplementary Tables for Chapters 2, 3, 6, and 7

INDEX

I

Introduction

In the future the number of independent developing countries that were former colonies of Western nations will increase. If the recent past is an indication of the future, many of the new countries will select some form of socialism for industrial development rather than private enterprise. This will be done because there is not enough private national capital and management for the large industrial projects with political and economic appeal, and because private foreign investment and management will be regarded as perpetuating the colonialism recently cast off. The newly developing countries may be expected to prefer foreign Ioans and grants from governments or international agencies to private foreign investment. If these predictions are accurate, the Western private enterprise countries may feel that they are being asked to encourage and subsidize an economic and political system too close to that of their opponents in the cold war. But to refuse to provide assistance for socialist projects may be to risk the loss to the communist bloc of many otherwise neutralist countries.

Economic aid to developing countries as a matter of political strategy is of recent origin, and it is fair to say that it is still an experiment that has not been vindicated by satisfactory progress in most recipient countries. To a large extent economic aid is more a political factor in the cold war than a program to be evaluated in terms of the presumed objective of development in the recipient countries. We do not yet know how to provide really effective assistance to developing economies. The Marshall Plan in Europe was very successful in rebuilding industrial economies, but it was intended to rebuild physical capital and reinvigorate an existing system of enterprise. It did not have to develop a system of industrial or commercial enterprise out of a primitive agricultural or nomadic grazing economy, nor did it have to solve the problem of developing a political structure suitable for a system of industry and commerce. The plants and machinery and utilities that were built or repaired in Europe were, for the most part, integral units of the oldest industrial nations of the world. The European authorities knew what they needed, and how to use it to advantage once it was in operation.

The fact that an effective mechanism for economic development of nonindustrial countries has not been found is one of the major challenges of our time. In the effort to find one or more workable programs we need both general theories of development and factual data about specific projects. Factual data concerning specific development projects must be related to general theory for the purpose of testing its adequacy and usefulness, and to see where additional theoretical work is necessary. Studies of specific projects, however, should not be regarded as social or industrial laboratory experiments to test specific theories. The investigator has no control over the experiment; rather it is his task to discover and evaluate the facts. These are not always easy to acquire in a complex industrial situation, and in a newly developing country the difficulties are likely to be more numerous than in an industrial society.

The present study represents the first of what is hoped will be a series of cooperative international industry studies. It is, first of all, an attempt to compare the capital cost of two modern plants, one in a newly developing country, Indonesia, and the other in an industrial economy, the United States. Second, it is an attempt to compare the operating costs and output of the two plants for the period July, 1957 through June, 1960. Third, it is an attempt to measure and evaluate the contributions of the Indonesian plant to the economy of Indonesia.

The study is concerned with the Gresik cement plant of the Department of Basic Industry and Mining of the Republic of Indonesia, and the Cushenberry plant of the Permanente Cement Corporation in the United States. The Gresik plant is located at Gresik near Surabaja in East Java. The Cushenberry plant is near Lucerne in the Mojave Desert of Southern California. Both plants were completed and began operation in 1957, and are of United States design and manufacture. The United States plant started production in April and the Indonesian plant started production in July. The two plants use the same process of making cement, the wet process, and each was originally constructed to operate with two rotary kilns. The United States plant had a larger original capacity than did the Indonesian plant. Although there would be definite advantages in comparing the investment required and the production costs of two plants of the same capacity, the fact that the United States plant was of larger capacity does permit some useful analysis of the extent of the economies of scale and the relevance of this for the most suitable capacity to be sought for the first plant in a particular industry in a newly developing country.

Indonesia inherited a substantial number of state enterprises from the Netherlands with the transfer of sovereignty at the end of 1949. In addition to such public utilities as post and telegraph, railroads, electricity and gas, and a national airline, the government operates tin mines, coal mines, solar evaporation salt beds, and a number of agricultural estates. From the beginning of its independence it was expected that the Government of Indonesia would play a major role in financing industrial development, but the form of ownership of new industries was not definitely fixed. It was hoped and expected that national enterprises would play an important role in industry, and a special bank, Bank Industri Negara (State Industrial Bank), was established to provide investment capital to national enterprises. The national enterprises could be either private, government, or mixed enterprises, and might also be a combination of central and provincial government participation. Bank Industri Negara, in general, provided long-term capital, but on occasion also provided working capital.

The new Government of Indonesia assumed the general position of the former Netherlands Indies government with respect to foreign investment of nationals other than those of the Netherlands, and established new regulations concerning Dutch private enterprises, which also assumed the status of foreign enterprises with the transfer of sovereignty. Indonesia thus inherited a legal and government system based on private enterprise but with a large amount of state industrial and mining enterprises. When sovereignty was transferred most private businesses were Dutch or Chinese, or other foreign, chiefly United States or Western European. Indonesian citizenship was made available to both Dutch and Chinese residents. Relatively few Dutch availed themselves of the opportunity to become citizens, but many of the Chinese engaged in business in the cities and larger towns became citizens as soon as possible.

The new government sought to redress the balance between foreign and national enterprises by legislation and regulations designed to restrict or curtail the position of foreign enterprises and to encourage the development of new national enterprises and the expansion of old enterprises. Private enterprise and parliamentary democracy were the economic and political bases for development following independence, and within this framework the Gresik cement plant was planned and built. The plant was completed and began operation in the middle of 1957. In this year, however, major changes in the Indonesian political, economic, and social structure were set in motion. In 1957 guided democracy was introduced by President Sukarno, and at the end of November Dutch private property in Indonesia was taken over and Dutch nationals were required to leave Indonesia. The take-over of Dutch enterprises was followed by their nationalization and the development of the concept of guided economy as the economic counterpart of guided democracy in political affairs. Some form of socialism is the vehicle for industrial development in Indonesia in the future. A rebellion in West Sumatra and Northern Sulawesi in 1958 was suppressed quickly, but sporadic guerilla activity continued in a number of provinces and security expenditures continued to represent an important part of the government budget at the time of the field work for this study late in 1960.

The entire period of operation of the Gresik plant with which this study is concerned, from July, 1957, through June, 1960, was one of great political, economic, and social change in Indonesia. The Gresik operating experience therefore has not been that of a plant conceived, built, and operated in a peaceful socialist society, but rather that of a plant conceived and built under one political and economic system and operated from the start under conditions of significant political and economic change, of which not the least was that of continuous and rapid inflation. In an important sense the Gresik plant is a microcosm of the problems of industrial development in Indonesia in its recent critical years. The fact that the plant was successful from the start led to a 50 per cent expansion program that was well under way at the time of the study. This expansion program, as we shall see, provided valuable evidence of the extent of increases in the cost of construction over the time interval involved, and insight into the financial problems to be expected in future major industrial development projects in connection with a new Eight-Year Development Plan adopted in the second half of 1960.

The Gresik cement plant is typical of the financing arrangements preferred by the newly independent countries. Virtually all the dollar exchange was provided by the United States ExportImport Bank under a 25-year loan at 5% per cent interest. All expenditures requiring local currency were provided by the Government of Indonesia. The government also provided the foreign exchange required for certain of the initial exploration and planning, for the salary and expenses of the technical advisor, and for much of the imported material used in work done directly by local contractors for the government. Assistance funds for the training program and the related operating-training contract were provided by the International Cooperation Administration in Indonesia.

The chief purpose in comparing the investment in a modern plant in a developing country with the investment required in an advanced industrial country was to obtain factual data on the nature and importance of social