[Analytics] Building Indonesia’s new capital

Indonesian President Joko ‘Jokowi’ Widodo’s announcement last August that a new capital would be built in East Kalimantan has been widely met with scepticism. While this scepticism is warranted, some of the project’s potential upsides are being overlooked by both outsiders and the government. Lex Rieffel, Michael Castle-Miller specially for the East Asia Forum.

Given the threat climate change poses to keeping Jakarta’s head above water, the case for building a new Indonesian capital is pretty strong. According to the United Nations’ population estimates, the Indonesian government faces the challenge of building a healthy, sustainable urban environment for another 92 million people over the next 30 years.

One advantage of building new cities, rather than expanding old ones, is that they can be located at elevations above the projected sea-level rise. A new city also provides opportunities to create better policies and administrative institutions, which may be more difficult with existing government arrangements.

Early descriptions of Jokowi’s project have raised concerns, particularly regarding people, land-value capture, and governance. In each of these areas, measures can be taken to reduce costs and create an attractive urban environment for residents. But implementation may exceed the Indonesian government’s ability to challenge deeply entrenched vested interests.

Official government statements about the new capital city project have emphasised the infrastructure and the buildings. Not much has been said about people — neither those who will be displaced in the process of building the new capital, nor those who will become its residents. A fair compensation policy for people displaced by development should include cash compensation for moving to new housing, guaranteed employment, and some form of equity in the project so that they can benefit financially if it succeeds.

A people-centred approach to building the new capital could be the key to its success. Civil servants, who are expected to experience the bulk of disruption, will develop positive attitudes toward the project if they are consulted and see steps taken to address their concerns. Construction workers and other government service providers will also do their jobs more effectively if they are treated as partners.

Jokowi’s announcement put the cost of building the new capital at US$33 billion. This figure was quickly criticised as an underestimate. But if the project is designed well, it will be a money-maker, not a black hole. The government can use ‘land value capture tools’ to ensure that rich and powerful ‘speculators’ don’t pocket the profits as land value goes up.

Historically, this rise in value has been linked to infrastructure construction, urbanisation and gentrification. Typically, elites buy land at a low price before construction and then sell again at a high price when construction is complete. To prevent this, the government can retain land ownership in the new capital. This would allow the government to lease parcels of land to occupants and gradually increase rents as infrastructure improves and the land becomes more valuable. The growing rent income can then be used to finance further improvements.

Alternatively, Indonesia could implement a Land Value Tax (LVT). Unlike a property tax, an LVT is imposed on the underlying value of land on a parcel. It does not tax the value of improvements made upon the land, such as buildings. The LVT rate can up to 100 per cent without any harm to the economy, it is relatively easy to administer and it aligns the government’s financial incentives with good governance.

Whether by retaining ownership of land or establishing an LVT, land value capture is how Indonesia’s new capital can be built without being a budget buster — especially if the capital is designed to encourage and facilitate private investment.

But perhaps the biggest threat to the new capital is obstruction from political parties. Allowing the new capital to become a political football will kill the project by creating uncertainty that discourages private investment and encourages inefficient, partisan distribution of budget resources.

One way to take party politics out of the process is to vest governance in a board of non-political technocrats administering a legally-constituted ‘sustainable development zone’. This management entity is granted temporary, limited authority for those aspects of governance necessary to sustain a dynamic and healthy city. It contracts for basic infrastructure construction, licenses and regulates businesses, adopts a building code, administers tax collection and carries out other public service functions.

Revenue is derived from land value capture and a portion of the income tax collected from residents, giving the management entity an incentive to support sustainable economic growth. The national government receives far more revenue than it otherwise would from businesses and residents in the zone through the greatly increased incomes being taxed and the higher land value being taxed. The zone’s management is accountable to residents through laws, inspectors general, ‘watchdog’ organisations, residents’ councils, impartial dispute-resolution and claims procedures that protect the rights of vulnerable groups.

Critics of Indonesia’s new capital raise legitimate concerns. It is normally unwise to adopt a ‘build it and they will come strategy’ because businesses need to be located where market forces naturally draw them. But in Indonesia’s case, there is great demand for new, well-governed, resilient urban space. If the new city in East Kalimantan has institutions that incubate good governance, it could exceed expectations.

Putting people at the heart of the process, capturing the increase in land value, and creating a trustworthy governance structure can make Indonesia’s new capital city a model for urban development elsewhere in Indonesia.

The COVID-19 pandemic seems likely to delay, if not kill, Jokowi’s plan for a new capital. When the time comes to re-examine the plan, one option could be to recast it as simply building a new model city and only making it Indonesia’s capital after it has demonstrated the ability to grow sustainably.

Lex Rieffel is a non-resident Fellow at The Stimson Center, Washington DC. Michael Castle-Miller is CEO of Politas Consulting, Los Angeles.