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.