Can we rely on our consumption for growth?

Can we rely on our consumption for growth?

Ari A. Perdana, School of Economics, University of Indonesia,
Centre for Strategic and International Studies, Jakarta

It was only half a year ago that Chief Economic Minister
Dorodjatun Kuntjoro-Jakti said the country's economic recovery
would depend on the external economy, particularly foreign
investment and loans. The economy requires foreign investment to
stimulate the private sector and create employment. Meanwhile,
foreign loans are needed to finance the government's budget
deficit.

However, as global economic prospects turn gloomy, external
factors can no longer be relied upon to stimulate a domestic
economic recovery. Responding to the situation, the government
has switched its strategy by focusing on domestic consumption as
the engine of next year's economic growth.

There are no ideological reasons for this policy switch; it is
purely pragmatic and logical. When the government budget and
private investment are inadequate sources of growth, domestic
consumption is the only remaining element of the Keynesian
macroeconomic equation.

There are reasons for relying on domestic consumption. In the
past two years, domestic consumption has been the main source of
economic growth, as measured by changes in gross domestic product
(GDP). This has been reflected in statistical data as well as in
the real world: for instance, the constantly crowded shopping
malls and electronic and automotive exhibitions. The reported
rise in electricity, fuel and telephone usage provides further
evidence.

Dorodjatun has also pointed out that robust domestic activity
has attracted smuggling and illegal imports.

But to what extent can economic recovery rely on domestic
consumption? There are three things to note before deriving a
conclusion.

First, the high consumption level for the past two years has
been driven by the consumption habits of the middle and high-
income groups. It has not been a general increase in the
purchasing power of the whole society.

During the crisis, these segments preferred to store their
wealth in banks or foreign currency. After the peak of the
crisis, and having earned additional income from interest and
foreign exchange, these groups resumed their postponed
consumption. It is questionable whether this level of consumption
can be maintained if the economy is still muddling along, or if
the rupiah remains weak.

Second, it is important to boost the consumption and increase
the purchasing power of the whole society, not only the middle
and high-income strata.

This suggests other types of policy, especially controlling
inflation and alleviating poverty. However, in reality there may
be policy conflicts. The main instrument for tackling inflation
is currently high interest rates, which are naturally a
constraint on high consumption and economic growth.

On the other hand, poverty alleviation strategies will still
depend on the government's fiscal policies, through subsidies and
other development spending. Nonetheless, the room to provide such
a fiscal stimulus is very small.

Third, also on the fiscal side, increasing purchasing power
requires a loose taxation policy. But at the same time the
government is desperate to boost its domestic revenue, including
income tax. This is another policy conflict, and clearly it is
hard for the government to set its priorities.

Hence, boosting domestic consumption may look simple in the
textbooks, but will not be so simple in reality. Furthermore, it
is important not to think of consumption as a possible long-term
solution for economic recovery.

We cannot expect consumers to increase their spending
infinitely. Besides, it is unrealistic to expect consumption to
grow if the economy does not produce. So, the long-term solution
is to increase the production capacity of the economy. To achieve
that, there are two immediate tasks that need to be addressed.

First, boost investment. New investments directly increase the
production capacity in the real sector, create demand for labor
and provide new jobs.

Second, accelerate the privatization and asset restructuring
process. This will generate revenue to finance the government's
budget deficit and provide greater room for fiscal stimulus. This
means more funds for subsidies and development spending. Too many
assets under the government's control burden both the government
and the economy as a whole, since it reflects an inefficient
allocation of resources.

In conclusion, boosting domestic consumption is a complement
to, not a substitute for, the long-term solution.