Fetishes obscure policy debates

Fetishes obscure policy debates

James Castle, President, American, Chamber of Commerce, Jakarta Office

After years of following the economic debates in Indonesia and other developing economies, I have become convinced that there are a number of fetishes which obscure rational debate on several important public policy issues. These issues are export policy, currency strength and ownership control.

A fetish is defined in the Oxford dictionary as something that is "irrationally reverenced" or, in psychological jargon, an "abnormal stimulus".

Indeed, in discussions about Indonesia's economic development, it seems as though most policy development debate both in domestic form and in the rarified atmosphere of IMF and World Bank sentence, exports are far and away the primary focus of development efforts and policy targets.

Indeed, one will search in vain in the World Bank's recent publication "East Asian Miracle Revisited" for any serious discussions of the role domestic consumption can and should play in the economic development of, not only the larger developing economies like China, India and Indonesia, but also the high income, medium population countries like Taiwan and Korea.

One side of the "export argument" is an undeniably useful. This is a justification of regulatory reform to break down protected markets on the grounds that economies must be efficient, to compete globally.

The lowest cost inputs must be available to domestic manufacturers to allow them to compete efficiently and aggressively in the international arena. This is a absolute principle of economic development and competitiveness. Lost in the argument is that all industries, not just export industries, must be efficient, otherwise the total economy cannot be efficient. Why is competitiveness only good when its supports exports ? Any distortion to support exports is a tax on domestic consumers.

Surely moribund Japan is the best example of the ultimate consequences of an excessive reliance on exports. Indeed, Japan was a fabulous export machine for nearly 40 years. Ironically, however, its improved living standards and high domestic per capita income plateaued very rapidly into a high cost economy which penalized individual Japanese, first as consumers, then as savers.

Japanese consumers, of course, have been legendary in the recent past both for their appetite for high-priced luxury brand names and cramped apartments. Now that Japan has fallen into a vicious deflationary cycle. Interest rates are near zero for savers and the value of family real estate holdings have often dropped far below their mortgage balances.

This is occurring at the same time Japan's highly efficient and globally respected manufacturers are being pushed out of many markets because of new competition from developing countries. The manufacturers that are not destroyed by this competition are, often, forced to move manufacturing offshore to remain competitive.

This, in turn, serves to weaken the domestic industrial base which is not being rebuilt by a modern service economy because of the protected nature of domestic service, particularly, utilities banking trade and distribution, or by consumer demand where citizens rightly fear for the future and the value of their hard- earned savings.

More broadly, the superficially logical but inherently irrational drive to create selected sector export machines, inevitably leads to the inefficient allocation of capital. The danger of such policies and the benefits of "efficient allocation of capital -- driven by consumers who borrow as well as save" was recently pointed out and an excellent recent article by David Roche in Forbes magazine.

As Roche notes, "the traditional economic model in Asia is based on massive domestic saving rates and an even greater investment rate -- 30 percent to 40 percent of gross domestic product". This has resulted in "Asian consumers (living) in bondage, saving lots and enjoying little."

Even worse, according to Roche, "huge slugs of household savings were channeled by Asian, and foreign, bankers into crony property companies. Or in the case of Korea, savings were plowed into unprofitable ego investment in Chaebol (monopoly) industrial assets. The result was that productivity of capital was zilch. And the banks, acting as intermediaries between savers and investors, were left with heaps of non-performing loans". Surely this is an apt description of Indonesia. Unfortunately, Indonesia's "corporate crony borrowers" have not become history.

Roche also notes that in a consumer-driven economies, capital allocation will become more proficient, enabling these economies to attract new investors. If the consumer drives the economy in terms of what is being produced and what makes money, the market can replace "the circle of bank, tycoon, Chaebol and government as the allocator of resources".

And, as Roche also points out, capital becomes scarce and has to be used productively in response to dictates of the markets, which means that rates of return on capital will rise.

In a virtuous consumer-driven circle, "less capital has to produce more things and sell them at lower margins, but at a higher return on assets".

Indonesia is ideally placed to generate internal capital investment because of its large affluent, urban consumer base (perhaps as many as six million families containing 25 million to 30 million high and medium income consumers) and the export revenue floor provided by its significant production of internationally traded commodities like oil, natural gas, gold, copra, tin, palm oil, etc.

Instead of bank-rolling well-connected cronies, Indonesia's financial institutions would do better providing a broad range of consumer lending and credit services, which generally offer much better quality credits and better margins than "your average real estate tycoon".

Even when consumer goods are imported from efficient producers, be they in Boston, Beijing or Bombay, they provide wide range of profitable domestic service activities and production employment through distribution and retail trade, whether or not the ultimate retail outlets are owned by Carrefour, Walmart or Matahari.

The countries of Southeast Asia will recover over the next two decades by taking advantage of a clear human resource edge in various service industries from health to leisure. In resource- poor areas like eastern Indonesia, sustainable wealth can be generated not by government subsidies and projects, but by the Asian vacationer. The new investment story in Indonesia is the consumer story. The major flaw in Asia's old model is its inability to allocate capital efficiently.

The drive to increase exports is a worthy goal. As a policy instrument, however, its main benefit is to ensure rational economic policies and the elimination of protection across all industries which make the domestic economy more efficient whether it is servicing the export manufacturer or the global tourist.