Sustaining economic growth in Indonesia<\/p>\n
By Ali Wardhana<\/p>\n
The following article is based on a paper presented at the
\nconference on \"Sustaining Economic Growth in Indonesia: A
\nFramework for the 21st Century\" held Dec. 17 by the United States
\nAgency for International Development, the University of
\nIndonesia's School of Economics and the American Committee on
\nAsian Economic Studies.<\/p>\n
JAKARTA: This conference takes place against the background of
\na severe financial crisis that has affected all East Asian
\neconomies, reaching from Thailand as far north as Korea and
\nJapan. Over the coming years many opinions will be written on the
\norigins of the crisis. Some of the papers at this conference and
\nespecially the discussions, both formal and informal, that follow
\nwill begin our search for answers.<\/p>\n
It is critically important that we develop a full
\nunderstanding of the economic events that led up to the crisis
\nand that we look at policy measures that might have been taken to
\neither prevent the economic storm or mitigate its impact. Of
\ncourse economic downturns are nothing new. But the current
\ncrisis, if not thoroughly understood and analyzed, has the
\npotential of eroding much of the global support for economic
\npolicies that have guided governments in developed and developing
\ncountries for over two decades -- a period of unprecedented
\neconomic expansion.<\/p>\n
To begin, we should recognize that while the crisis is
\nregional in origin, its impact will be global. Import demand in
\nthe affected economies will shrink, reducing exports from Europe,
\nJapan and the United States. At the same time, the more
\ncompetitive exchange rates that have now been established will
\nresult in an increased export drive from Asia. Where can such
\nexports go? A large part of the exports from Southeast Asian
\neconomies have always been sold to Japan and Korea. But the
\neconomic growth rate forecasts for those two countries suggests
\nthat their import demand will be low for at least a year or two.<\/p>\n
That leaves Europe and the United States, the two economic
\nregions that are still growing at a relatively robust rate.
\nHowever, the increasing flow of imports into those two regions
\nhas the potential of creating economic dislocations which may
\nerode the political consensus that has pushed for more open
\nmarkets for goods and capital.<\/p>\n
We already see early warning signs that Europe and America may
\nonce again move to protect their domestic markets rather than
\nlead the drive for more open global markets. If this happens, not
\nonly would the recovery in Asian countries be retarded, but world
\neconomic growth would slow with serious economic and political
\nconsequences.<\/p>\n
What are the issues we need to understand if we are to answer
\nthe critics of global integration? Very briefly, I would focus on
\nthree broad issues.<\/p>\n
First, while countries with more open markets apparently have
\nhigher rates of growth, critics of globalization have suggested
\nthat the benefits of increased trade have not helped the poor and
\nhave worsened income distribution. Yet a careful reading of the
\nevidence does not support these views. For example, a recent
\nstudy concluded that \"there is a strong association between the
\nrate of growth in average living standards and the rate at which
\nabsolute poverty has fallen\" (Martin Ravallion and Shaohua Chen.
\n\"What Can New Survey Data Tell Us about Recent Changes in
\nDistribution and Poverty?\" The World Bank Review. Vol 11, No. 2,
\n1997).<\/p>\n
Indonesia's experience bears this out. Our poverty rates have
\nfallen, from 40.08 percent in 1976 to 11.39 percent in 1996. Some
\nexpress disbelief in these results. They argue that there are
\nmany \"near poor\", defined as those whose income is just above the
\npoverty line, and that a higher poverty line would not show such
\nan improvement in the poverty situation.<\/p>\n
Our poverty line, based primarily on a minimum food
\nconsumption level, is low but even if one adopted a higher
\npoverty line the trend in poverty reduction would not change,
\nalthough the number of people counted as poor would of course
\nincrease. If one were to raise the official poverty line by 10
\npercent, one would raise the number of people classified as poor
\nin 1996 from the current official estimate of 11.3 percent of the
\npopulation to 16 percent of the population (Frank Wiebe. \"The
\nImplications of Constructing a New Formulation of the Poverty
\nLine.\" Unpublished paper April 1997).<\/p>\n
But the basic conclusion that rapid export-led growth in
\nIndonesia helped to raise a large number of our citizens out of
\nabsolute poverty remains.<\/p>\n
The issue of whether rapid growth and integrated global
\nmarkets worsen income distribution is less easily dealt with.
\nRecent data suggests that inequality levels appear to be rising
\nin a number of East Asian countries, with Malaysia the only
\nexception (Vinod Ahuja, et al., \"Everyone's Miracle? Revisiting
\nPoverty Reduction and Inequality in East Asia.\" Unpublished world
\nBank paper , April 1997).<\/p>\n
Inequality rose in China, Thailand and Hong Kong and it
\nappears to have risen in the Philippines and Korea, although the
\nchanges are small enough to be within the margin of error of the
\nmeasurement.<\/p>\n
The same is true for measured income inequality in Indonesia
\nwhere the Gini coefficient, derived from per capita household
\nexpenditure data, showed a decline from 0.35 in 1970 to 0.32 in
\n1990. Since then the Gini has risen to 0.34 in 1993 and to 0.36
\nin 1996, with the coefficient rising in both rural and urban
\nareas, although the rise in rural areas was small (\"Pengeluaran
\nuntuk Konsumsi Penduduk Indonesia: 1996. Survei Sosial Ekonomi
\nNasional.\" Biro Pusat Statistik, Jakarta, Indonesia, February
\n1997).<\/p>\n
It is difficult to say what has caused this increase in
\ninequality here and elsewhere or even whether it is a temporary
\nphenomenon or the result of a longer term trend set in motion by
\nthe dynamics of economic reform. Before we can seriously debate
\nthe relationship between global integration and income
\ndistribution, we must look at this issue in depth, taking into
\naccount different economic structures and political regimes that
\ncharacterize different countries.<\/p>\n
Unless we can shed some light on this issue, opponents of
\nglobal integration will continue to argue that the benefits of
\nopen markets and export-led growth disproportionately benefit the
\nrich while the cost of adjustment falls disproportionately on the
\nbacks of the poor.<\/p>\n
Second, there have been suggestions that government actions
\ncould have prevented the crisis or helped control its regional
\neffects. We now know that one of the risks of global financial
\nintegration is the rapid spread of a financial crisis from one
\neconomic center to another. What might governments do to prevent
\nthe spread of financial panic?<\/p>\n
One obvious answer is to pull back and impose capital
\ncontrols. But the negative economic consequences of strict
\nexchange controls and closed financial markets are well
\ndocumented and do not need to be repeated here. Flat out capital
\ncontrols are an invitation to corruption and inefficiency. Less
\nextreme remedies, such as Tobin's call for a global transactions
\ntax that would serve to throw sand in the wheels of super-
\nefficient financial vehicles, have been proposed (Cf, Barry
\nEichengreen, James Tobin, and Charles Wyplosz. \"Two Cases for
\nSand in the Wheels of International Finance.\" The Economic
\nJournal, Vol. 105, January 1995).<\/p>\n
All of the proposed remedies are \"second best\" solutions. They
\nwould make sense only if policy choices were so constrained that
\nonly the use of non-optimal measures could increase public
\nwelfare. The first question then is whether the constraints on
\npolicy choices are, in fact, real.<\/p>\n
If so, we could argue that while a tax on capital inflows
\nwould reduce public welfare, a failure to ensure that rapid
\ncapital inflows are invested properly would also reduce welfare.
\nWe also must consider whether any proposed measure intended to
\ncontrol capital flows would restrain domestic speculators, who
\nare also involved in currency dealings. And finally, we need to
\njudge whether the restraints, if effective, would be desirable in
\na broader cost-benefit calculation.<\/p>\n
Third, critics have suggested that exchange rate volatility
\nerodes, and perhaps totally eliminates, the benefits from
\nfinancial integration. It is reasonable to suggest that the
\nvolatility that has characterized international financial flows
\nin the past will not go away any time soon. What role can the
\ninternational community play in moderating this volatility and in
\nmitigating the economic impact of rapid inflows and outflows of
\ncapital?<\/p>\n
Part of the difficulties now facing Asian economies can be
\ntraced to the excessive flow of funds that were made available to
\nthese markets. Unfortunately such funds were often invested
\npoorly. The same enthusiastic investors who poured their money
\ninto Asian economies rapidly withdrew their funds when economic
\nweaknesses were exposed.<\/p>\n
The rapid withdrawal of investment funds further damaged these
\neconomies. As a recently completed study concluded, market
\nplayers must bear some of the blame for the financial crisis that
\nhas swept Asia (William R. Cline and Kevin J.S. Barnes. \"Spreads
\nand Risks in Emerging Market Lending.\" Institute of International
\nFinance, Washington DC, November 1997).<\/p>\n
What remedies might one seek? At the very least, better
\nreporting on private capital flows would be useful. Even more,
\none would hope for data that would flag any dramatic decline in
\nthe risk-adjusted spread between yields on emerging market
\nsecurities and the yield on some international bench mark
\nsecurities.<\/p>\n
Policy makers could then judge whether such a decline was
\njustified by the underlying economic conditions or reflected
\nunwarranted euphoria. Such information would allow governments to
\ntake steps to ensure that there was neither an unjustified level
\nof capital inflow or a rapid outflow.<\/p>\n
These are some of the questions that will be raised as the
\npast experience with increased globalization and especially
\nincreased integration of financial markets is scrutinized. As
\neconomists and as policy analysts, we must be ready to provide
\nanswers.<\/p>\n
Let me close with a prediction. Although the present economic
\nforecasts for East Asian economies are gloomy, the crisis will
\npass and growth will resume. While there are numerous policy
\nmeasures that must be implemented before this can happen, my
\noptimism is based on the fact that all the affected Asian
\ngovernments have begun the process of policy reform, either under
\ntheir own initiative or with input from the International
\nMonetary Fund and other multilateral agencies.<\/p>\n
Let there be no doubt that the Asian miracle was real. The
\nrapidly growing Asian economies did create a base of human and
\nphysical infrastructure and that base remains intact. It is on
\nthis base that we will eventually be able to resume our rapid
\ngrowth.<\/p>\n
Dr. Ali Wardhana is an economic advisor to the President, and
\na former finance minister and coordinating minister for
\neconomics, finance, industry and development supervision.<\/p>",
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