Revised

August 22 2000

National development and economic transition under international governance: the case of East Timor

Jorge Braga de Macedo

Institute of Tropical Research and Nova University at Lisbon

José Braz

TEcFinance Ltd, Lisbon

Rui Sousa Monteiro

Nova University at Lisbon

Introduction

East Timor evolved as a nation over several centuries, with a strong spiritual identity making up for colonial neglect. The occupation by neighboring Indonesia also contributed to solidify the national identity of East Timor. In their intervention over the past year, international agencies have been slow in recognizing that this is an asset for the democratic governance of the new state that is unique in post-conflict situations.

Ignoring this initial condition of national development can have adverse consequences for the choice of an economic transition path. In the current international governance setup, military intervention may already have been excessive relative to the empowerment of the CNRT (National Council for Timorese Resistance). The consequence was a waste of time and financial resources.

The fact that East Timor already existed as a nation obviates the need for the manifestations of economic nationalism usually present in recently constituted nation-states. In their strategy for national development, democratically elected authorities can avoid the temptation to create an autonomous currency, to nationalize significant economic sectors or to implement other protectionist measures.

Such a national development strategy has direct implications on fiscal policy. Without a need to finance heavy government intervention in economic life, tax design can be guided by principles of simplicity and have relatively low rates. Rather than relying on a complex progressive personal and corporate tax collection system, the royalties from oil and gas exploration can then perform the distributive functions. If the international governance sees matters in this way, East Timor can take advantage of rapidly becoming a normal participant in the global economy.

Following this introduction, the paper is organized into four sections and a conclusion. Geography and history (section 1) and the prelude to independence (section 2) are briefly presented as background for the analysis. The dimensions of national development are dealt with in section 3, including cohesion factors, the nature of economic transition and international governance. A detailed analysis of current economic developments is beyond the scope of this paper but the severity of the inflation outlook requires urgent attention. Consequently, section 4 deals with macroeconomic stabilization, especially the exchange rate regime and the fiscal system.

  1. Geography and history

1.1. Insulindia

Sketching an arc between the Malaysian and the Korean peninsulas, Southeast Asia presents a set of several thousand islands: the Insulindia or Malaysian archipelago, the Philippines, and Japan. The Malaysian archipelago covers the westernmost islands, including the largest (Borneo/Kalimantan and Samatra/Sumatra, along the Malaysian peninsula) and the most populous (Java). Except for what was formerly called Portuguese Timor (East Timor), and for the northern strip of Borneo (comprising the Brunei sultanate and two states, Sarawak and Sabah, both integrated in Malaysia, the Malaysian archipelago (so called due to its predominantly Malay ethnic composition) constitutes the state of Indonesia. This country, with 1904 thousand square kilometers (1919 in official statistics, still considering East Timor) and 7900 thousand square kilometers of maritime economic zone, includes 17500 islands (in a region spanning 5 thousand by 2 thousand kilometers), 6000 of them populated. A volcanic region, it contains 128 volcanoes still active.

The islands have a tropical and equatorial climate, with two monsoons (from east during the dry season, from May to October; from West in the wet season, from November to April). Rainfall levels are high (nearing 1800 mm/year in Jakarta, with monthly averages ranging from 50 to 326mm; 3000mm/year in Balikpapan, Kalimantan), but lower and less regular in the Smaller Sundas (1400 mm/year in Kupang, West Timor). Temperature presents small variations (in Bali, monthly averages range from 30 to 32 degrees Celsius; in Jakarta, from 25 to 26).

The eastern island of the Smaller Sundas, Timor lies north of Australia, between the Savu and Timor seas. West Timor (15850km2) belongs to the Indonesian province of Nusa Tenggara Timur (literally, Eastern Southeast Islands). East Timor (with 14874km2), including the enclave of Okussi-Ambeno and the islands of Ataúro (Kambing) e Jaco (Jako), was occupied by Indonesia as a new province, Timor Timur (East Timor), from 1975 to 1999. Timor is a hilly island (Ramelau peak reaches 2960 meters), with some coastal plains intertwined by swampy mangrove fields.

The climate is dry during the Southeast monsoon, wet during the short and irregular West monsoon (December to March). The south coast suffers the influence of a southwest stream in the Timor Sea. This stream, the lack of safe harbors, and the unpredictable West monsoon made difficult the access to the south coast until mechanical navigation was adopted, so major cities developed in the north coast: Kupang (capital of West Timor), Lifau (the Portuguese capital until 1769, and then abandoned), Dili (East Timor’s present capital) and Baucau.

1. 2. Poverty and slow growth till the 19th century.

The eastern Smaller Sundas, including Timor, were always the poorest regions of Insulindia. As a matter of fact, the continuity of Portuguese presence in Timor was related to this poverty. After a century of regional dominance (due to a strong naval and commercial presence and the possession of the main trading center, Malacca, conquered by Afonso de Albuquerque in 1511 and lost to the Dutch in 1641) the Portuguese were gradually swept by the Dutch from all commercially profitable regions in Southeast Asia.

Timor's poverty was due to poor soil (volcanic soils in Java and Bali were much more fertile) and irregular weather (as the monsoons are affected by the proximity to the great Australian desert). Its only valuable product was sandalwood, but the Dutch finally occupied the main port, Kupang, and the regions where sandalwood was plentiful, in the western part of the island.

Unattractive to Portugal, East Timor was for centuries governed by the Dominican friars, warrior-missionaries that guaranteed its defense and formal Portuguese sovereignty. The main export products were sandalwood (increasingly scarce), wax and slaves (to Dutch plantations in Java). When, during the Napoleonic campaigns, the British occupied the Dutch East Indies (and tried to do the same in Macao) in order to prevent a French intervention, they left the Portuguese possessions in the Insulindia aside.

But the Napoleonic campaigns created a side effect: as the Portuguese crown moved temporarily to Brazil, Portugal felt the need to develop its colonies and dependent territories. During the 19th century, several development projects were considered in East Timor, as mineral surveys and rural development projects were financed by the Dili government, and as a wave of economic growth transformed large patches of Java, Sumatra and the Malaysian peninsula (where Singapore was established).

But those mineral and agricultural projects for East Timor were never implemented, due to political instability (cyclical insurrections) and inefficiency (under-qualified administration, headed by short-term governors, and dependent on the goodwill of local kings and chieftains). The European population consisted mainly of military and deported people, generally for political motives.

2.2. A coffee economy

Only at the end of the 19th century, in the process of imperialist competition among European nations, when Portugal reconsidered the value of its remaining overseas territories, were significant efforts made to "pacify" East Timor and promote exportable crops, as the Dutch had done for centuries in their insulindian islands. Using fiscal incentives and promoting the creation of commercial firms, some large plantations were established by the end of the century, expanding commercial and smallholders’ production of coffee, a crop that rapidly became (and remains) the main export product. Indigenous rural populations were at times required to pay taxes in kind (mainly coffee). The tax increased coffee production, and exports rose in this way.

In 1896, during the (relatively) developmentalist rule of Governor José Celestino da Silva (from 1894 to 1908, an unusually long mandate), Timor began reporting directly to Lisbon (instead of Goa or Macao). After military campaigns of "pacification", large patches of land were converted into commercial plantations. Public finance in Timor was always in deficit and the annual subsidy sent from Lisbon, sometimes supplemented by subsidies from Goa or Macao, was very important to the financial equilibrium of the colony, as well as for offsetting the trade deficit.

The administration of the territory was achieved, till the end of the colonial period, through traditional authorities, entrusted with keeping public order, promoting public works (repairing roads, for instance) and collecting taxes. But all the history of Portuguese Timor is marked by recurrent tribal wars and revolts against the Dili government.

During the 20th century the economy, dominated by coffee exports and by Pátria e Trabalho (the conglomerate created by Celestino da Silva), survived several insurrections (and a Japanese invasion), the balance of payments was financed with meager subsidies from Lisbon and development plans were never fully implemented. In the late 1960s and early 1970s, public expenditure grew, allowing basic education to be generalized to the whole territory and the first tarmac roads to be built. Mineral resource exploration was promoted and rural extension services implemented, as suggested by the questionnaire on subsistence agriculture reported by Vasco Fortuna (1966). Similarly Cruz e Silva (1976) notes the potential for cattle exports, provided that certain diseases were eradicated and better roads built.

In 1974, in a bloodless coup that signaled the end of the Salazar and Caetano regimes, Portugal abandoned its colonial empire and hurriedly gave independence to its overseas territories. In its poorest possession, the eastern half of Timor, a decolonization process was started, in a difficult context of low levels of income and of schooling and a generalized scarcity of infrastructures. In the last phase of the Vietnam war, the political conflict taking place in Lisbon between Marxist and non-Marxist political blocks was translated to Dili, engaging in a fratricidal struggle the few Timorese able to lead their country into self-government and independence.

The occupation of East Timor by the Indonesian Republic in 1975, a few weeks after the fall of Vietnam to the communists, was justified by the fear that an economically unsustainable country could trigger a communist takeover with foreign intervention and jeopardize the stability of Southeast Asia, and facilitated by the unwillingness of the new Portuguese government to continue administrating Timor.

But the centralist, interventionist and anti-democratic characteristics of Indonesia, added to East Timorese idiosyncrasies, blocked the integration of the East Timorese population, helping to keep alive the hope of self-government and independence.

2. Prelude to independence

2. 1. Indonesia and Timor

The other islands in Insulindia were administrated by the Dutch East Indies Company or VOC until the 19th century, and afterwards by the Dutch government. Both tried to extract profits from the territory, introducing new crops, building a communications network, compiling traditional law and integrating it in the colonial judicial system. All this in a heterogeneous colony, with some regions managed by the colonial civil service and others managed by sultans and chieftains. It was this mixed colony that, at the end of World War II, achieved independence after a sequence of brief episodes of armed struggle, adopting the designation of Indonesia.

From 50 million at the beginning of this century, Indonesia has now over 200 million inhabitants, including 3 million ethnic Chinese. The capital, Jakarta, houses 10 million people. Despite many years of a transmigration policy that sought to move people to less densely populated islands, 2/3 of the population live in the more fertile islands (Java, Madura and Bali), covering only 1/13 of the country's area.

The first years of independent Indonesia witnessed struggle between political, religious and regional factions, which reinforced the role of the armed forces. This led them to exercise power more efficiently in 1965, with General Suharto, initiating a period of greater stability, with economic management carried out by technocrats under military supervision and significant international assistance, especially from the United States.

The oil shocks of 1973-74 and of 1980 endowed the country with considerable foreign exchange reserves. Nevertheless, macroeconomic policy avoided excessive real appreciation of the currency, so that exports growth was sustained and state owned enterprises led a strategy of export diversification. In addition, a strong support for education (essential for building a new nation out of a multi-island, ethnically diverse and multi-religion country) led to massive building of schools throughout the country.

A regional lingua franca, the Malay, converted into Indonesian bahasa, became the national language, replacing several different local languages, including the Javanese. The investment in education contributed to national cohesion and helped promote stability and raise labor productivity. Attempts were made to attract foreign investment in high technology sectors, but the opening was limited.

According to the dwifungsi doctrine, the military have a modernizing role in Indonesian society. This explains why so many military in active duty or retired are managers in state owned and in private enterprises.

After the Portuguese departure in 1975, the legal status of East Timor remained different from the de facto situation of Indonesian annexation. Although Indonesia considered East Timor its 27th state, this was never accepted by the United Nations and was only ratified by Australia in an expedient to facilitate agreement on the delimitation of oil and gas reserves in the Timor gap.

The Timorese resistance continued active, despite the capturing of successive leaders. During the following two decades, international indifference to a small and distant unresolved issue was widespread. In the 1990’s, with the Santa Cruz massacre and the award of the Nobel Peace Prize to two East Timor leaders, international pressure intensified on Indonesia to allow self-determination.

This process was facilitated by the internal fragmentation of the Suharto regime and by the consolidation of the various independence parties in East Timor that constituted the CNRT.

2. 2. The UN transitional administration

In early May 1999 agreement was reached at the United Nations between Portugal and Indonesia with a view to the holding of a referendum which would measure Timorese support for an Indonesian proposal for greater autonomy within the Indonesian nation. The referendum was held in August and an overwhelming majority of East Timorese voted against autonomy and for independence.

The announcement of the results was followed by widespread looting, intimidation and killings, leading the international community to organize an emergency military intervention under the aegis of the United Nations to insure the replacement of Indonesian forces by an international military force.

The next step was the establishment of a United Nations transitional administration for East Timor (UNTAET), along the lines of previous operations in post conflict resolution situations. From the start, the Transitional Authority applied the traditional formula of seeking to set up a local counterpart body with representation of the different political forces in the territory. Even though CNRT already was such a multiparty body, the UN establishment initially insisted on treating CNRT as just another political party. Even though 79% of the votes cast in the ballot, in a 98% turnout, were for independence (symbolized on the ballot paper by the CNRT flag), UNTAET apportioned to the CNRT only 7 of the 14 positions on the National Consultative Council.

In terms of military presence, the peacekeeping force, based on the supposition that it would be necessary to control conflicting factions within the territory, was by far excessive for the needs of the territory. This supposition, in turn, derived from the architecture of the UN-brokered New York accord of May 1999, which had to take into account the Indonesian insistence that the East Timorese were about equally divided into pro-integration and pro-independence factions. In the event, even though the ballot results proved that supposition to be grossly off-the-mark and the wave of destruction presented the international community with a situation totally different from the New York assumptions, the UN machine was in pre-defined motion and nobody seemed able, or even interested enough to try, to reduce the military intervention to more appropriate (and less costly) dimensions.

The situation was diagnosed by the first international mission – the Joint Assessment Mission of November 1999 stated, in its Macro-economics Background Paper (World Bank 1999apage 2): "East Timor is different from other post-conflict situations in one very important aspect. There is no apparent need for pacification between different ethnic, cultural or religious segments of the population. The need – and it is enormous because the destruction was premeditated, thorough and massive – is for reconstruction. In a way, it would be more useful to treat the problem as a post-natural-disaster situation, where a vicious hurricane destroyed all buildings and most crops and removed all records and institutional memory".

The issue of excessive military presence is also raised in the final report of the Joint Assessment Mission (World Bank 1999b, page 1), albeit diplomatically: "Security is a critical pre-requisite for reconstruction. However, East Timor is fortunate in having avoided a situation of full-blown internal conflict, and security operations should be kept to a level appropriate to maintaining law and order, whilst minimizing the economic and social distortions consequent on a large scale military presence".

East Timor is a good example of the need to avoid packaged solutions to post-conflict situations and to design mechanisms for the UN to be more flexible and to respond with greater speed to changing conditions.

  1. National development

3. 1. Cohesion factors

3. 1. 1. Culture

The Portuguese created an administrative practice clearly different from the Dutch and generated a different relation between local populations and the European culture. There may be a paradox in that colonial neglect ultimately allowed a deeper penetration of European values.

VOC and later the Dutch United Provinces government tried to generate profits out of their far-away possessions in the East Indies (using forced labor, mandatory production of certain crops, monopsony for strategic crops, etc.). Instead, the Portuguese let the clergy rule East Timor softly and managed the relations with local chieftains on a basis of trust and stability (mixed with occasional demonstrations of military force); even during the coffee era, the government of the colony showed laxity and paternalism.

The easier mixing of Portuguese with local population contributed to this cultural convergence process. While this was certainly not enough to establish national identity, it certainly provided psychological roots, which became political with the Timorese resistance to the Indonesian invasion.

3.1.2. Poverty

Poverty is a characteristic held in common with neighboring Indonesia, mainly with the adjacent Indonesian province of Nusa Tenggara Timur. The political independence of East Timor means that this country can implement autonomous economic and social policies for growth. On the contrary, nearby Indonesian provinces are relatively marginal to Jakarta, due to their low population levels and due to the large transmigration policy that creates social stress.

The factors of communion with West Timorese --- geography, language, ethnic proximity, even religion --- are not factors of internal disaffection in East Timor, and can indeed be considered as characteristics that facilitate the economic take-off of the country, as they allow good relations with the adjacent country and induce improved economic transactions with the neighboring Indonesian province, one of the poorest in Indonesia.

Being ethnically-mixed and very sensitive to oppression, East Timor can attract those migrant populations like the ethnic Chinese that in Portuguese East Timor and elsewhere in post-colonial Southeast Asia were the main investors, fostering trade and growth.

3. 1.3. Reaction to external aggression and dominance

A quarter of century of Indonesian rule created a strong reaction, vividly reported in the results of the 1999 vote for independence.

The regime of Indonesia was centralist, corrupt and non-democratic. The military presence in the territory (not only in the barracks, but also in the corporate sector, mainly in the concessions of public works, in trading, and in natural resource exploitation) was strong. The organization of the Indonesian economy was oligopolistic or monopolistic, redistributing income in favor of a small number of Javanese.

These three factors created in East Timor a bond born of shared poverty, discrimination, and frustration, despite the large amounts of budget transfers to the "27th province".

3. 2. Nature of the economic transition

The fact that national cohesion evolved over several centuries and was reinforced by recent events means that the Timorese nation-state as a political reality is beyond doubt. This fact permits policy makers to concentrate on efficient and rational economic policies, avoiding the temptation to reaffirm nationalism through economic means. Economic nationalism was a feature of many new nations in Africa during the 1960s and 1970s; usually countries with artificially defined boundaries and containing great ethnic diversity.

The policies followed also reflected ideological influences, namely of the USSR and China, countries that had in many cases assisted the pre-independence liberation movements. In practice, the policies followed were those of economic centralization, nationalization of productive activities, insistence on nationals occupying all important posts regardless of aptitude, and a national currency - invariably overvalued - giving economic rents to those in power and usually transferring real income from rural to urban sectors.

The centralist tendencies of many officials trained in the Indonesian system over the past decades remain strong. This creates a risk of policy makers in an independent East Timor being tempted to translate these biases into protectionist and nationalist economic policies. Already, in informal contacts, one frequently comes across a desire to protect local entrepreneurs and to replace foreign banks and other operators by local state-run firms. If permitted to become practice, these biases would be as detrimental to Timorese wealth creation as they have proved to be in all other countries that have followed them.

As just one example, the recent estimates of losses through corruption and inefficiency in Pertamina, Indonesia's state oil monopoly, are huge. This is particularly relevant, as the oil and gas sector promises to be by far the major wealth generator in East Timor in the coming decades.

3.3. International governance

3. 3. 1. Political realities

As described in Braz and Saldanha (2000), which is followed in the rest of this subsection, UNTAET and the numerous NGOs recruited local staff mainly on the basis of their ability to speak English - in spite of early statements by leading members of the CNRT indicating a political preference for Portuguese as the official language and the Portuguese escudo as the official currency.

Commercial concessions and de facto authorizations (in banking, telecommunications and auto rentals, for example) were granted to Australian enterprises and the first Dili newspaper (the Dili Times) was in English, geared to the rapidly-growing Australian business community. Meanwhile, a Portuguese bank, Banco Nacional Ultramarino, proceeded to make payments to civil servants in Portuguese escudos in November 1999.

Delays in filling technical positions in UNTAET, namely in the area of economic policy, left the UN administration totally dependent on advice from the IMF mission to East Timor, as far as policy decisions in the areas of fiscal and monetary and exchange matters were concerned. The IMF mission members, probably constrained by a mission brief that defended the "sensible" solution of maintaining the rupiah as the official currency, strongly resisted the Timorese preference for the escudo.

In the end, faced with a refusal to accept the Indonesian or Australian currencies, the IMF mission proposed the Singapore dollar or the US dollar. In mid-January 2000, the US dollar (which is also the unit of account of the UN administration) was announced as the official currency of East Timor for the transition period.

In the immediate post-conflict situation in East Timor, there was no possibility of an autonomous monetary policy. All official and commercial buildings had been torched and there were no banks or civil service authorities to administer transactions or controls. Economic transactions were conducted by barter or with the remaining rupiah money stock. As foreigners began arriving with other currencies, these became parallel vehicles of exchange, frequently at cross-rates of exchange that facilitated calculations but differed significantly from international exchange rates.

The problem of off-market parities could have been solved by the establishment of exchange facilities, but neither the UN nor interested donors (notably Portugal and Australia) did anything effective to make this possibility a reality.

3. 3. 2. Comparative experiences

The model followed in East Timor may have been influenced by other recent cases of international governance, notably Kosovo and El Salvador. Recent research on governance in post conflict situations shows how inadequate the various solutions have been. This is in part because of unrealistic expectations about the capabilities of international organizations to act independently of their member states.

But it also reflects excessive preoccupation of international organizations officials with their "institutional egos", often presented as mandates from their member states. This is especially damaging when new challenges arise, the response to which calls for a co-ordinated approach. Castillo (2000b, p.9) writes: "In Kosovo and East Timor, as to some extent previously in Cambodia, the UN is having a more intrusive role by performing civil administration functions that are normally the prerogative of sovereign governments".

4. Macroeconomic stabilization

4.1. The exchange rate regime

4.1.1. A political choice…

In the longer term, an independent East Timor will need to decide on an exchange system. Unless it decides to use another nation’s currency, it will need to introduce a new currency of its own and, more importantly, decide how the value of its currency relates to that of other international currencies. To ensure the stability of the new currency, other macroeconomic policies, namely monetary, fiscal, and incomes policies, need to be established and conducted in a consistent manner.

In a low-income country such as East Timor, and especially in the post-reconstruction period when aid inflows can be expected to diminish, decisions regarding the new exchange system also need to take into consideration the likely impact of alternative options on development aspects such as poverty alleviation, income distribution, the promotion of exports and import-substitution.

The definitive choice of exchange regime, and currency, will be the responsibility of the first government of an independent East Timor, constituted, in all probability, mainly by CNRT members. Their autonomy of choice at that stage will be tempered by the fact that the population may have had to learn the very different characteristics of the US dollar (more stable than the rupiah, but with two units -- dollars and cents -- instead of the single rupiah, and with a unit value about 7 000 times that of the Indonesian currency) over a period of 1 to 2 years.

Ideally, the preparatory work for the definitive choice of exchange and currency system should be completed by the time the definitive government is elected. For that to happen, four issues would need to be resolved in turn.

Firstly, a decision needs to be taken regarding the timing and the mechanics of the changeover from transitional to definitive administration. Secondly, the candidate parties that intend to participate in the elections should agree to work together on preparing basic decisions such as the exchange system; if not, preparations for the definitive system will only start after independence, causing a delay of at least another year or two.

Thirdly, an assessment needs to be made of how the transitional period is likely to impact relative prices in the economy and of how best to deal with the readjustment of prices once the civilian personnel of the transitional authority and the peacekeeping forces depart. Finally, a consistent set of economic policies needs to be devised, introduced and maintained, to ensure that the relative stability of the transitional currency is maintained by the definitive currency.

UNTAET has taken several measures to address the issues of currency and exchange relations: it had established a payments bureau, licensed a currency exchange bureau and, most importantly, taken the decision to make the US dollar the official currency of East Timor during the transitional period. These policies provide the legal framework for monetary and financial operations in East Timor during the transitional period although, even without such a framework, Banco National Ultramarino (Portugal) and Westpac (Australia) had operated in Dili since November and December 1999, respectively.

The US dollar is a vehicle currency that is widely used to denominate international contracts made by parties who do not reside in the US. It can be argued, therefore, that having the US dollar as its official currency is of benefit to East Timor because its major exports (oil and coffee) and imports (especially capital goods) are denominated in dollars. Thus, transaction costs are reduced because East Timor does not have to deal with major regional currencies like Indonesian rupiah, Australian dollar, and Singaporean dollar.

Whether or not keeping the US dollar as its definitive currency is the best option for East Timor is another question, the answer to which will have to take into consideration the usefulness of an autonomous monetary policy in East Timor as well as its practical viability, given the probable institutional limitations of a new state.

Another important area for analysis concerns the likely effect of dollar-use on prices in East Timor. It can be expected that using the dollar will contribute to price stability insofar as exchange rate stability eliminates that part of inflation that is associated with imports. However, inflation will persist so long as there is excess demand for goods and services. Therefore, using the US dollar provides only a partial solution to the inflation problem until the problem of supply shortages is addressed.

Of related interest is the question of how the demand-supply balance is likely to be affected by the eventual departure of peacekeeping and administrative personnel and their purchasing power. The impact is likely to be quite different for different products and sectors, implying a significant readjustment of relative prices. To the extent that some prices, namely wages, may resist downward adjustment, an argument can be made in favor of the added flexibility of an autonomous currency.

East Timor’s major economic relations will probably be with Indonesia and Singapore (imports of goods), Australia (foreign direct investment, oil royalties and tourism) and the US (exports of coffee). The exchange rate of the US dollar with the currencies of these countries will influence the extent of trade. Using the US dollar will cause imports from Indonesia to become cheaper to the extent that there is real appreciation of the dollar against the rupiah, while the exchange rates of the Singapore and Australian dollars versus the US dollar are more likely to remain stable. The extent to which dollar-use is likely to affect the evolution of economic relations with the major trading partners suggests another topic for research.

The basic issue that needs addressing is what is the best exchange and currency regime for the country in the medium-term, given the growth and development objectives of East Timor.

4.1.2. …or an economic choice?

The fact that the national flag is well entrenched means that a currency arrangement can be chosen on economic efficiency grounds rather than on the need for the bank note and coin as another national symbol. Once the transitional effects of excess demand have been absorbed, a currency arrangement should be chosen with the objective of combining price stability and competitiveness of domestic production. Given the small size of the economy, the nature of its major existing and foreseeable exports, and its geographical context, the currency arrangement should be sufficiently flexible to permit East Timor to benefit from cheap regional imports without creating the "Dutch disease" type of overvaluation common to resource-rich exporters, which would eliminate any chance of efficient import-substitution and the development of a viable tourism sector.

Given that most consumption items are imported from Indonesia, it might seem rational to continue to use the Indonesian rupiah as the Timorese currency. This option should be excluded, both for political and for economic reasons. If political stability and fiscal prudence can be assured from the beginning, East Timor would not want to accept the exchange rate volatility of its closest neighbor; it can, and should, aim for greater exchange and price stability.

With a well-managed economy, East Timor probably would stand to gain most, in terms of price stability and investor confidence, from an early adoption of a strong regional currency, rather than opting for its own currency or even an intermediate solution such as a currency board or a peg. An apparently obvious candidate currency would be the Australian Dollar, already the currency of choice of expatriates in Dili.

From a longer term perspective, however, it would be preferable to opt for the Japanese Yen, likely to become the reference currency in the ongoing process of greater economic integration of the Pacific region, much as the Deutsche Mark was the reference currency in the process of creating the European Union and its Euro.

4.2. The fiscal system

Suggestions have been made for the East Timor administration to move rapidly towards a system of progressive personal and corporate direct taxation supplemented by a VAT on economic activity. For a poorly developed economy such as East Timor, where the vast majority of economic agents are barely literate and a bulk of economic activity is in the informal or subsistence sectors, these proposals do not seem appropriate. We would recommend instead the application of simple excise taxes on major imported consumption items (gasoline, beverages, tobacco) and domestic activity geared mainly to tourists and wealthy locals (hotels, restaurants, rent-a-car, airport usage) excluding where practicable products or activities that are predominantly purchased by the poor local population.

This proposal is theoretically less progressive than the more complex VAT and direct taxation systems, but the desired progressivity could be introduced by selective poverty-reduction spending on education, health and other public services targeted at the poorest segments of the population. Efficiency considerations also would argue for revenue maximization from oil and gas activities, via the negotiation of transparent concessions to competitive foreign operators rather than the creation of national state operators.

 

 

Conclusion

East Timor is endowed with a spiritual identity that provided psychological roots for nationalism solidified by the resistance to integration into Indonesia. International agencies have been slow in recognizing this national cohesion, in part because the situation differs from other recent post-conflict situations, such as those in El Salvador or Kosovo. The initial period of excessively military intervention has partly offset the benefits of tighter coordination between the United Nations and the Bretton Woods institutions that has been observed.

Cohesion factors facilitate national development in East Timor to the point that the manifestations of state intervention and economic nationalism usually present in recently constituted nation-states may be avoided. National authorities can thus resist the temptation to create an autonomous currency, to nationalize banking, petroleum, and other significant sectors or to implement protectionist measures.

If economic policy is guided by rationality and efficiency considerations, East Timor can take advantage of rapidly becoming a normal participant in the global economy. In particular, the scope for poverty alleviation will rise, which is essential given the current low standard of living, even when compared to neighboring Indonesian provinces.

 

 

 

References

 

 

Bergsten, Fred, Towards a tripartite world, The Economist, 15 July 2000

Braz, José and João Mariano Saldanha, Currency and Exchange in East Timor:Analysis and Preliminary Proposals, OECD Development Centre, March 2000

Castillo, Graciana del, Economic Reconstruction in Post-Conflict Transition: The Challenge of Kosovo, Columbia University, June 2000a

Castillo, Graciana del, Post-Conflict Reconstruction and the Challenge to International Organizations: The Case of El Salvador, Columbia University, (no date) 2000b

Doob, Leonard, Patriotism and Nationalism, their psychological foundations, New Haven: Yale University Press, 1964.

Fortuna, Vasco, Estruturas Económicas do Estado da Índia, Macau e Timor, in As Províncias Portuguesas do Oriente, 2º volume, Lisboa: ISCSPU, 1971, pp. 171-226.

Fortuna, Vasco, Modelo de Questionário utilizado no Inquérito Económico ao Sector Tradicional de Timor, Relatório do Chefe da Missão de Estudos do Rendimento Nacional do Ultramar, Vol II Documento nº 14, Lisboa: Ministério do Ultramar, 1966.

Macedo, Jorge Braga de, José Adelino Maltez and Mendo Castro Henriques, Bem Comum dos Portugueses, 2nd edition, Lisboa: Vega, 1999

Macedo, Jorge Braga de, Summary of panel on exchange rates, ABCDE, June 2000

Silva, J. A. Cruz e, Helmintoses dos animais domésticos de Timor e suas possíveis incidências em patologia humana, Garcia de Orta, Vol. 5, nº 1, 1976, pp. 1-46.

Smith, Gordon and Moisés Naím, Altered States: Globalization, Sovereignty and Governance, Ottawa: International Development Research Centre, 2000.

World Bank, East Timor – Building a Nation. A Framework for Reconstruction and Development. Joint Assessment Mission Macro-economics Background Paper. November 1999a.

World Bank, Report of the Joint Assessment Mission to East Timor. December 1999b.