Sustaining economic growth in Indonesia

Sustaining economic growth in Indonesia

By Ali Wardhana

The following article is based on a paper presented at the
conference on "Sustaining Economic Growth in Indonesia: A
Framework for the 21st Century" held Dec. 17 by the United States
Agency for International Development, the University of
Indonesia's School of Economics and the American Committee on
Asian Economic Studies.

JAKARTA: This conference takes place against the background of
a severe financial crisis that has affected all East Asian
economies, reaching from Thailand as far north as Korea and
Japan. Over the coming years many opinions will be written on the
origins of the crisis. Some of the papers at this conference and
especially the discussions, both formal and informal, that follow
will begin our search for answers.

It is critically important that we develop a full
understanding of the economic events that led up to the crisis
and that we look at policy measures that might have been taken to
either prevent the economic storm or mitigate its impact. Of
course economic downturns are nothing new. But the current
crisis, if not thoroughly understood and analyzed, has the
potential of eroding much of the global support for economic
policies that have guided governments in developed and developing
countries for over two decades -- a period of unprecedented
economic expansion.

To begin, we should recognize that while the crisis is
regional in origin, its impact will be global. Import demand in
the affected economies will shrink, reducing exports from Europe,
Japan and the United States. At the same time, the more
competitive exchange rates that have now been established will
result in an increased export drive from Asia. Where can such
exports go? A large part of the exports from Southeast Asian
economies have always been sold to Japan and Korea. But the
economic growth rate forecasts for those two countries suggests
that their import demand will be low for at least a year or two.

That leaves Europe and the United States, the two economic
regions that are still growing at a relatively robust rate.
However, the increasing flow of imports into those two regions
has the potential of creating economic dislocations which may
erode the political consensus that has pushed for more open
markets for goods and capital.

We already see early warning signs that Europe and America may
once again move to protect their domestic markets rather than
lead the drive for more open global markets. If this happens, not
only would the recovery in Asian countries be retarded, but world
economic growth would slow with serious economic and political
consequences.

What are the issues we need to understand if we are to answer
the critics of global integration? Very briefly, I would focus on
three broad issues.

First, while countries with more open markets apparently have
higher rates of growth, critics of globalization have suggested
that the benefits of increased trade have not helped the poor and
have worsened income distribution. Yet a careful reading of the
evidence does not support these views. For example, a recent
study concluded that "there is a strong association between the
rate of growth in average living standards and the rate at which
absolute poverty has fallen" (Martin Ravallion and Shaohua Chen.
"What Can New Survey Data Tell Us about Recent Changes in
Distribution and Poverty?" The World Bank Review. Vol 11, No. 2,
1997).

Indonesia's experience bears this out. Our poverty rates have
fallen, from 40.08 percent in 1976 to 11.39 percent in 1996. Some
express disbelief in these results. They argue that there are
many "near poor", defined as those whose income is just above the
poverty line, and that a higher poverty line would not show such
an improvement in the poverty situation.

Our poverty line, based primarily on a minimum food
consumption level, is low but even if one adopted a higher
poverty line the trend in poverty reduction would not change,
although the number of people counted as poor would of course
increase. If one were to raise the official poverty line by 10
percent, one would raise the number of people classified as poor
in 1996 from the current official estimate of 11.3 percent of the
population to 16 percent of the population (Frank Wiebe. "The
Implications of Constructing a New Formulation of the Poverty
Line." Unpublished paper April 1997).

But the basic conclusion that rapid export-led growth in
Indonesia helped to raise a large number of our citizens out of
absolute poverty remains.

The issue of whether rapid growth and integrated global
markets worsen income distribution is less easily dealt with.
Recent data suggests that inequality levels appear to be rising
in a number of East Asian countries, with Malaysia the only
exception (Vinod Ahuja, et al., "Everyone's Miracle? Revisiting
Poverty Reduction and Inequality in East Asia." Unpublished world
Bank paper , April 1997).

Inequality rose in China, Thailand and Hong Kong and it
appears to have risen in the Philippines and Korea, although the
changes are small enough to be within the margin of error of the
measurement.

The same is true for measured income inequality in Indonesia
where the Gini coefficient, derived from per capita household
expenditure data, showed a decline from 0.35 in 1970 to 0.32 in
1990. Since then the Gini has risen to 0.34 in 1993 and to 0.36
in 1996, with the coefficient rising in both rural and urban
areas, although the rise in rural areas was small ("Pengeluaran
untuk Konsumsi Penduduk Indonesia: 1996. Survei Sosial Ekonomi
Nasional." Biro Pusat Statistik, Jakarta, Indonesia, February
1997).

It is difficult to say what has caused this increase in
inequality here and elsewhere or even whether it is a temporary
phenomenon or the result of a longer term trend set in motion by
the dynamics of economic reform. Before we can seriously debate
the relationship between global integration and income
distribution, we must look at this issue in depth, taking into
account different economic structures and political regimes that
characterize different countries.

Unless we can shed some light on this issue, opponents of
global integration will continue to argue that the benefits of
open markets and export-led growth disproportionately benefit the
rich while the cost of adjustment falls disproportionately on the
backs of the poor.

Second, there have been suggestions that government actions
could have prevented the crisis or helped control its regional
effects. We now know that one of the risks of global financial
integration is the rapid spread of a financial crisis from one
economic center to another. What might governments do to prevent
the spread of financial panic?

One obvious answer is to pull back and impose capital
controls. But the negative economic consequences of strict
exchange controls and closed financial markets are well
documented and do not need to be repeated here. Flat out capital
controls are an invitation to corruption and inefficiency. Less
extreme remedies, such as Tobin's call for a global transactions
tax that would serve to throw sand in the wheels of super-
efficient financial vehicles, have been proposed (Cf, Barry
Eichengreen, James Tobin, and Charles Wyplosz. "Two Cases for
Sand in the Wheels of International Finance." The Economic
Journal, Vol. 105, January 1995).

All of the proposed remedies are "second best" solutions. They
would make sense only if policy choices were so constrained that
only the use of non-optimal measures could increase public
welfare. The first question then is whether the constraints on
policy choices are, in fact, real.

If so, we could argue that while a tax on capital inflows
would reduce public welfare, a failure to ensure that rapid
capital inflows are invested properly would also reduce welfare.
We also must consider whether any proposed measure intended to
control capital flows would restrain domestic speculators, who
are also involved in currency dealings. And finally, we need to
judge whether the restraints, if effective, would be desirable in
a broader cost-benefit calculation.

Third, critics have suggested that exchange rate volatility
erodes, and perhaps totally eliminates, the benefits from
financial integration. It is reasonable to suggest that the
volatility that has characterized international financial flows
in the past will not go away any time soon. What role can the
international community play in moderating this volatility and in
mitigating the economic impact of rapid inflows and outflows of
capital?

Part of the difficulties now facing Asian economies can be
traced to the excessive flow of funds that were made available to
these markets. Unfortunately such funds were often invested
poorly. The same enthusiastic investors who poured their money
into Asian economies rapidly withdrew their funds when economic
weaknesses were exposed.

The rapid withdrawal of investment funds further damaged these
economies. As a recently completed study concluded, market
players must bear some of the blame for the financial crisis that
has swept Asia (William R. Cline and Kevin J.S. Barnes. "Spreads
and Risks in Emerging Market Lending." Institute of International
Finance, Washington DC, November 1997).

What remedies might one seek? At the very least, better
reporting on private capital flows would be useful. Even more,
one would hope for data that would flag any dramatic decline in
the risk-adjusted spread between yields on emerging market
securities and the yield on some international bench mark
securities.

Policy makers could then judge whether such a decline was
justified by the underlying economic conditions or reflected
unwarranted euphoria. Such information would allow governments to
take steps to ensure that there was neither an unjustified level
of capital inflow or a rapid outflow.

These are some of the questions that will be raised as the
past experience with increased globalization and especially
increased integration of financial markets is scrutinized. As
economists and as policy analysts, we must be ready to provide
answers.

Let me close with a prediction. Although the present economic
forecasts for East Asian economies are gloomy, the crisis will
pass and growth will resume. While there are numerous policy
measures that must be implemented before this can happen, my
optimism is based on the fact that all the affected Asian
governments have begun the process of policy reform, either under
their own initiative or with input from the International
Monetary Fund and other multilateral agencies.

Let there be no doubt that the Asian miracle was real. The
rapidly growing Asian economies did create a base of human and
physical infrastructure and that base remains intact. It is on
this base that we will eventually be able to resume our rapid
growth.

Dr. Ali Wardhana is an economic advisor to the President, and
a former finance minister and coordinating minister for
economics, finance, industry and development supervision.