Over-investment drives Indonesian economy to stagflation

The Indonesian government has finally reached an agreement with the International Monetary Fund (IMF) on a reform package aimed at stabilizing the country's monetary crisis. In the following interview, economist Kwik Kian Gie talks about the causes behind the economic problem.

Question: Businessmen complain that their sales revenues are declining, while prices are increasing. Can you explain such a phenomenon?

Answer: Such a phenomenon is called stagflation, a condition marked by declines in revenues, decreases in economic activities and recession that is accompanied by inflation.

Q: Does it mean that a recession has started in Indonesia?

A: I think so. I myself am sure that the aftermath of a monetary crisis is recession. But I did not anticipate that the recession would come so quickly as there is usually a time lag between one economic phenomenon and another, which is its impact.

The impact has occurred so quickly probably because people, in this era of globalization, are used to measuring their wealth against the U.S. dollar. The decline in the rupiah value has caused people to feel poorer and, therefore, they are trying to reduce their expenditures. This will cause a decline in sales.

On the other hand, as the level of import content in our products is high, the production costs of our goods are increasing. The prices of the nine basic commodities are also rocketing because of drought, which has delayed harvests and even destroyed planting areas. Thick haze from forest fires has also hampered the transportation of goods. All these have caused inflation.

Thus, we are now experiencing stagflation as inflation is accompanied by economic stagnancy.

Q: What can the government do to overcome or reduce the impact of stagflation?

A: I'm afraid there is nothing the government can do but economize on spending and adopt a surplus budget program. The government's recent decision to shelve government-related projects worth Rp 49.5 trillion (US$14.3 billion) will actually worsen the recession, but it has no other alternatives.

Q: Why doesn't the government try to prop up people's purchasing power to prevent consumption and sales from declining?

A: We will first have to recognize the autonomous force of the economic crisis, which is the upper turning point of a business cycle.

There are two autonomous forces that can cause an economic crisis -- under-consumption and over-investment. A condition is called under-consumption when the level of consumption is lower than production capacities. When this happens, industrial companies will stop making new investments and this will cause consumption to decline further. If industrial firms further reduce investments, spiraling reactions will cause all economic activities to recede.

As for over-investment, investments will decline not because of decreases in consumption but because of the unavailability of funds. An investment decline will mark the start of an economic crisis.

If the autonomous force is under-consumption, the government can help prop up people's purchasing power, but if it is over- investment, the government will usually slow the growth of consumption to encourage increases in savings. However, a slower growth in consumption can worsen the recession.

Q: Do you believe that the autonomous force of the current recession is over-investment?

A: Yes. Under-consumption can occur only in rich countries, where capital is abundant while manpower is limited.

In countries with huge manpower resources, big investments are usually made with debts. If debts are too large, they will usually go sour and banks will be more cautious in providing new loans. Thus, the economic crisis stems from a lack of capital, not low consumption.

Q: So, what may happen in the future?

A: We may witness the bankruptcies of many companies, the laying- off of workers, the abandoning of building activities, the decline of sales and low occupancy rates at hotels. Many traders will leave their outlets at shopping malls because they cannot afford to pay their dollar-denominated rents, unemployment will increase and economic growth will slow down.

Q: Then, what should the government and society do?

A: Wait patiently until the lower turning point of the economy is reached. The economy will revive and start booming again when a new equilibrium is reached at a lower level. While waiting for such a thing to happen, companies can take measures to improve their health and the government can remedy the rotting sectors, such as the banking industry, and improve the efficiency of the bureaucracy.

Q: Has Indonesia ever experienced a recession like this?

A: Yes. The growth of our Gross Domestic Product fell to 2.25 percent in 1982, 2.26 percent in 1985 and 3.21 percent in 1986 from an average of 6.9 percent per annum between 1969 and 1996.

Q: Does unemployment have the potential to cause social unrest?

A: I'm afraid so. In developed countries, where the social security system is good, unemployed people receive unemployment benefits. But Indonesia does not offer such benefits, so unemployed people will really go hungry.