Avoid dependency on foreign capital

Avoid dependency on foreign capital

The year long economic crisis is getting worse, despite the
reform measures prescribed by the International Monetary Fund
(IMF). Economist Kwik Kian Gie looks at the elements behind the
crisis.

JAKARTA (JP): Indonesians need to thoroughly establish the
real cause of the current economic crisis to find an effective
solution.

An economic crisis is the upper turning point on the curve of
economic growth or a business cycle, which is usually followed by
a recession or even a depression. If it is accompanied by high
inflation, it is called stagflation -- a combination of stagnant
growth and high inflation.

According to economic theories, a crisis is caused either by
underconsumption or overinvestment. Underconsumption occurs when
the growth in consumption is slower than the growth in production
capacity. Capital owners are reluctant to make new investments
because the demand is too low.

Overinvestment happens when the economy, due to a lack of
domestic savings, is boosted by too much foreign capital. In the
case of overinvestment, a crisis generally occurs when the flow
of foreign investments declines.

The theory of underconsumption is supported by Samuelson,
Albert Aftalion, Hicks, Harrod, Haberler, Kaldor and Schumpeter,
while proponents of the theory of overinvestment include Machlup,
Lachmann, Spiethoff and Ropke.

The theories say that a crisis can be cured by boosting the
afflicted society's purchasing power -- for example, through the
introduction of a deficit state budget -- if it is caused by
underconsumption. But a crisis cannot be cured if it is caused by
overinvestment, and all the indications are that it is this
latter cause that lies at the heart of Indonesia's economic
crisis.

The signs of overinvestment could actually be detected a long
time ago, but the government did not take any early action,
allowing the symptoms to develop into a full blown crisis --
beginning in July 1997. The signs included a continual increase
in the country's current account deficit, an increase in the
private sector's foreign debts and the speedy expansion of
banking credits.

The crisis began when foreign investors abruptly stopped
investing in the country due to a lack of confidence. All
subsequent efforts to alleviate the crisis have therefore
concentrated on restoring confidence so that foreign investors
will return to Indonesia.

But is it realistic to expect the return of foreign
investments? We are now obediently implementing our reform
agreement with the IMF and its officials say that Indonesia is on
the right track.

But after implementing the agreement for 14 months, there is
no sign that confidence has been restored and the economy is
getting even worse. Malnutrition is affecting babies in Central
and East Java and the recent rescheduling of official debts is
indicative of the dire state of the economy.

If it is true that the crisis has been caused by
overinvestment and can therefore not be cured, any "medicine"
taken by Indonesia will only become poison.

Thus, it would be better to let the condition develop of its
own accord until a new equilibrium between domestic savings and
investment has been reached. Perhaps Indonesia would not be able
to reach a sharp equilibrium between domestic savings and
investment because it still needs foreign capital.

But we have to set a proportional balance between domestic
savings and foreign capital. Just like companies, Indonesia needs
loans to accelerate its economic growth but if the loans are
disproportionate when compared to domestic savings, the economy
will face disaster.

Now, what is the government's policy? Bank Indonesia has
raised interest rates on its promissory notes (SBIs) to over 65
percent per annum with the aim of strengthening the rupiah's
conversion rate to a realistic level -- Rp 10,000 per U.S. dollar
according to the IMF's calculation. But what is the use of such
an exchange rate if economic activities are on hold? Furthermore,
the exchange rate is still vulnerable to the whims of the market,
which feed off factors beyond those under the control of
government economic policy.

High inflation has also encouraged banks to raise their
interest rates to prevent capital flights.

Does the fact that macroeconomic factors are all interrelated
mean that the government must introduce a synchronized policy to
overcome the problems currently faced?

Since a crisis induced by overinvestment cannot be cured, I
believe it would be better to concentrate our attention on
meeting the country's demand for food.

However, efforts to date seem to have been directed towards
encouraging a return of foreign investors, who may in any case
only choose to return to Indonesia again when the assets of
thousands of bankrupt companies are sold off at discounted
prices.

If government policies are aimed at luring foreign investments
back into the country and perpetuating the country's dependency
on large volumes of foreign capital for economic development, we
might only be heading towards a repeat our old mistakes.