Muhammad Chatib Basri on stimulating economic growth

Thee Kian Wie Distinguished Professor Dr Muhamad Chatib Basri

By Muhammad Chatib Basri

This article was first published in Kompas newspaper 16 June 2016.

We noted that the Indonesian economy in the first quarter of 2016 grew only 4.92 percent. What followed it appeared were many reactions and questions about the effectiveness of the government’s policy packages.

I think, we must be careful in our conclusions. Most of the government policy packages are oriented to the supply side, which will have a long-term impact. And we need that. However, it seems that we also need to give the economy a push now. Therefore, existing policies have to be combined with efforts to boost short-term demand.

This situation reminds me of a quote by the economist, John Maynard Keynes, who in 1923 said “the long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is past the ocean is flat again.” In his intelligent writings, he essentially argued economic policies will be useless if they cannot answer short-term problems and only talk about the long term.

Stimulating economic growth in Indonesia by Muhamad Chatib Basri

Supply-demand

Through his works, Keynes also criticized classical economist Jean-Baptiste Say, who believed that supply would create its own demand. Jean-Baptiste Say held the belief that: By producing, someone will earn income, which will enable him to buy goods. By this logic increasing production (supply) will push demand. This is the premise of supply-side economics.

This school of thought believed that economic growth can be created through increasing capital investment, and combined with the application of various barriers (deregulation, tax incentives) in the process of production of services and goods. It is interesting to see, given this economic recipe is very similar to the infrastructure development strategy, economic deregulations, interest rate cuts to encourage investment and tax incentives, among other policies, which have been implemented by the present government.

However, Keynes on the other hand said: In the short term it is the demand which creates the supply. Essentially, this means if there is demand for goods and services, then the business world will see business opportunities. They will increase production, which then will subsequently get the economy moving. On the contrary, if production increases while there is no demand, goods cannot be sold. If stocks are increasing, what is the need to expand businesses? The economy would stagnate and unemployment would rise. Therefore, according to Keynes: The effective solution, in the short term, is government intervention through increasing demand and purchasing power.

This debate is very relevant to our economic situation at present. How do we explain it? First, we live in an interconnected world. Slowdown of the global economy and Chinese economy, of course, affects Indonesian exports. China is the largest consumer of commodities and energy. And we know that more than 60 percent of Indonesian exports are related closely with commodities and energy. As a result, our exports tumble with lower Chinese demand.

Although, given the current situation, Indonesia’s economic growth of 5 percent in recent years alone has been relatively good. Compare it with other natural-resource producing countries like Brazil, Russia, South Africa, Malaysia and Australia. But, of course if we ask about Vietnam and the Philippines, we should not feel satisfied. That is why growth has to be encouraged. With the current global condition, domestic growth sources have to be boosted.

Second, most of the government policies are oriented to the supply side. To be effective, these policies need time. Infrastructure, for example, will create job opportunities when the projects start to be built and run. But it is a slow process, especially with matters concerning land clearance. So is economic deregulation. The deregulation will encourage investors to start expanding their businesses. However, with gaining investment, building factories and manufacturing products, all this needs time. In addition, deregulation at the central government level can only settle a small portion of the problems. Why? Because most licensing problems are in the regions. Without deregulation in the regions, investment will remain stagnant.

What about the interest rate cut? The interest rate cut does not encourage investment as quickly as one would expect. Undisbursed loans in the first quarter of this year have increased, even. Here Keynes’ argument becomes important: If demand for goods and services is weak, what would the business world need to make them ask for credit to expand production? Even though licensing is simplified, if there is no demand, what is the point of a business expansion? The supply side approach will only help the economy in the long term but it does not settle short-term problems. The economy will stagnate, exactly like Keynes’s statements above.

In the case of Indonesia, quantitative calculations by Basri, Fitrania and Zahro (2016) reveal interesting findings. Causality between consumption and investment occurs where consumption affects investment and not the other way around. This study shows that an increase in consumption will encourage investment in the next quarter. On the contrary, an increase in investment does not significantly increase consumption. Its implications: Deregulation efforts and interest rate cuts do not necessarily produce demand as predicted in Say’s law. Instead, an increase in consumption will encourage production in the short term. So if we want to move the short-term economy, increase consumption. The quantitative study supports Keynes’ arguments in the case of Indonesia.

Third, it is true the government fiscal expansion will increase the budget deficit. However, we have to see its dynamic effects. Fiscal expansion is financed by taxes. When the economy slows down, tax increases will likely cause contractions. Indeed, this money is injected back into the economy in the form of infrastructure spending. However, the new infrastructure spending will only generate output later. So what happens in the short term is the economic contraction instead. As stimulus through spending can only be felt in the long term, its immediate impact is predictable: a stagnating economy.

Long term-short term

Then is it wrong to be orientated to the supply side? I do not think so. It is simply a matter of time. It takes a long time. Unfortunately, the economy cannot wait. Therefore, the current supply-side policies need to be combined with increasing short-term demand (less than one year). What can be done? The solution is fiscal stimulus. The problem is, however, with tax revenues being hit sharply due to the current economic slowdown and declining commodity prices, how will fiscal expansion occur?

Moreover, in the draft revision of the 2016 state budget (RAPBN Perubahan 2016), government spending has even been cut by Rp 47. 8 trillion (US$635 billion). This means that there is the obstacle of the budget. Under such conditions, fiscal stimulus should be directed to the community, which has a high and immediate marginal propensity to consume. It means an increase of income for the lower-middle class. If they gain income, domestic consumption can be encouraged. The government has indeed planned to disburse the 13th and 14th salary, and also has raised the limit for not-taxable incomes so as to increase consumption.

However, this only covers civil servants or those working in the formal sector. Of course this is not enough. As I have said in this newspaper: Allocate funds to expand cash transfer programs and cash for work. Create short-term labor intensive projects that can provide income immediately for people, such as cleaning rivers, ditches, building village roads. Its project value is not too big, so that it will not affect the current account deficit and the budget deficit. The expenditure will be worth it for its large multiplying effect. Once they receive income, consumption will increase. As soon as the consumption increases — like the findings of the aforementioned study — investment will rise. The economy will start moving.

It is true that increasing purchasing power is being attempted through village funds. The problem is that it takes time for village officials to be ready. Village officials do not have the experience and may be apprehensive to make expenditures. As a result, impacting demand does not happen at the village level. To resolve this, village infrastructure can be built through the National Program for the Empowerment of the Community (PNPM), whose management system has relatively been steady. Unfortunately, this program is no longer being conducted. What else? Make sure that inflation and food prices can be controlled so as to maintain purchasing power. By doing so consumption will encourage the short-term economy.

The policies that have been issued so far are in the right direction, but they are for the long term. The fact is that the economy has to be boosted immediately with short-term policies. Time is not with us. “In the long run we are all dead,” said Keynes. And I think, Keynes is correct.

Dr Muhamad Chatib Basri is The 2nd Thee Kian Wie Distinguished Visiting Professor at ANU Indonesia Project. He was Indonesia’s Minister of Finance during the Yudhoyono’s presidency. Read more about The Thee Kian Wie distinguish visiting professorship.