Of the Asian crisis economies, Indonesia has suffered the longest and rebounded most slowly. Last month’s free and peaceful elections firmly established the country – the world’s largest majority-Muslim state – as a functioning democracy. But can it bounce back to its pre-crisis performance?

Indonesia was always different. Most of the Asian crisis victims – Thailand, Malaysia, South Korea – suffered sharp cutoffs in foreign lending, but investment dollars generally stayed put. Indonesia, by contrast, experienced spectacular capital flight.

Not at first. In the first two quarters of the crisis, inflows continued. And then, in three disastrous months in 1998, over $5 billion in equity capital fled the country. And in following months, more of the same.

What happened? The answer is that in May 1998, Indonesians set upon their ethnic Chinese countrymen in an orgy of violence that claimed over 1,000 lives. The Chinese were hated for their wealth. Though four percent of the population, they controlled an estimated sixty percent of the country’s assets.

And at that point, all these assets were sent offshore. Estimates of total capital flight top $20 billion. This triggered an economic meltdown far messier than anywhere else in Asia. South Korea, Malaysia and Thailand bounced back. But foreign direct investment into Indonesia actually turned negative and stayed that way into the new millennium.

So will Indonesia rebound? The odds are long. To be sure, Indonesia has just accomplished something extraordinary. The world’s largest majority-Muslim country has become a genuine democracy. The incumbent candidate, competent but uninspiring, lost to a secular challenger with a reform agenda. The Islamic parties that did best in the vote uniformly stuck to a moderate, clean-government agenda. Radical Islam was on offer but unpopular. And the campaign itself was peaceful. The voting carried off without a hitch; the results not seriously disputed.

On top of this, Indonesia turned a decades-long tradition of dictatorial presidency on its head. Not only did the incumbent lose, but between 1999 and 2003 a series of constitutional amendments introduced genuine checks and balances into the system. Including the devolution of power to the provinces, legislative reform, and a new – and evidently quite functional – electoral process.

Still, democracy is one thing. A rebound to previous performance – growth of over seven percent per year between 1970 and 1996 – is quite another. Thailand, South Korea and Malaysia have gotten close. But Indonesia is unlikely to join them.

The reason is that the bargains which made Indonesia work died in those riots, along with hundreds of Chinese. Suharto’s dictatorial authority was crucial to enforce the policies of his “Berkley Mafia,” the University of California-trained technocrats who made Indonesia safe for investment. Without this, Indonesia’s 6,000 islands have each gone their own way. Most notably, local courts, susceptible to local influence, have attacked investors. The most notorious case is that of the Indonesian arm of the multinational insurer Prudential, absurdly forced into bankruptcy.

Also crucial was Suharto’s relationship to the ethnic Chinese. Suharto cultivated ethnic Chinese businessmen as allies, enriching them with state favoritism, and they reciprocated with political support. They were ideal cronies: captains of industry who – because of their status as a hated minority – could never develop political ambitions of their own, and relied on Suharto for protection. (Suharto, who had deposed his mentor in a military coup, knew the difficulty of finding reliable allies.)

These crucial conditions of Indonesia’s boom years will never be restored. Some of the ethnic Chinese capital will return but – with the Chinese leery and no dictatorial protections on offer – Indonesian industry will need new leaders. The just-elected president, Susilo Bambang Yudhoyono, has won a substantial mandate, but he will be no Suharto-style dictator. His party has only 57 seats in the 550-seat parliament, and the two largest parties backed his opponent.

This is, in a sense, a great achievement. That the largest parties lost to an independent candidate reveals a determination to move on from the cronyism of the Suharto years. Throwing out an incumbent, peacefully, is the true test of a democracy – even Japan did not achieve this until the 1990s, fully forty years after it became “democratic” following World War II.

On the other hand, the system for protecting capital and nurturing growth that made Indonesia a star emerging market has also collapsed. Achieving that level of performance in the new Indonesia will not be easy. With power decentralized, the system itself must be made to work – the rule of law, protection of property, control of corruption. Indonesia is a true democracy now, but it is a long, hard, and, odds are, slow road that lies ahead.

This article was originally published on, before I sold the site to Roubini Global Economics.