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.