The only choice left: Go with the right policy

The only choice left: Go with the right policy

Riyadi Suparno, Jakarta

The much-criticized new economic team has an uphill battle to
prove to the skeptics and the lackluster market that they can
deliver results, especially over the next 100 days.

The new team, and even President Susilo Bambang Yudhoyono, all
recognize the challenges ahead: high unemployment, widespread
poverty and slow economic growth.

In addition, they have set the appropriate priorities to
address these problems: stimulate the economy to achieve high
growth, enhance productivity and competitiveness and lure
investment.

These priorities are, however, surely easier said than done.
To achieve them, the government must have the required tools of
money and the right policy.

In terms of money, this administration has less than the
previous administrations did.

The government cannot write checks at a whim anymore and rack
up an overdraft in the budget without worrying about penalties
from the market, as it does not have a large windfall profit from
surging oil prices like Soeharto enjoyed during his early days in
office in the 1970s.

Although oil prices have soared to US$55 a barrel -- a level
unimaginable even during the 1970s -- Indonesia's oil output is
much lower now than before.

Indonesia's crude oil output has decreased to about 950,000
barrels a day from 1.3 million barrels a few years ago. Much of
its oil-based income is used to import crude for domestic
refineries, as well as to cover fuel subsidies that have risen
along with oil prices.

Unlike the administrations of B.J. Habibie, Abdurrahman Wahid
and Megawati Soekarnoputri, the Susilo administration is not
privy to foreign aid in the form of stand-by loans from the
International Monetary Fund.

Furthermore, the new government has inherited huge debts:
US$68.6 billion in foreign debt as of January and the much
greater domestic debt of Rp 622.7 trillion ($72.4 billion) as of
July.

The Susilo administration has practically nothing it can sell
to pay off these mounting debts, as most assets appropriated by
the government during the late-1990s crisis have already been
sold by previous administrations.

Worse still, it must confront all the negative images
Indonesia has accumulated thus far, from its shame as one of the
most corrupt countries in the world as ranked by Transparency
International, to its disgrace as one of the most difficult
places in the world to do business, according to the World Bank's
Doing Business in 2005: Removing Obstacles to Growth.

So what's left for the newly installed government?

What the Susilo administration has that previous ones did not
is the popular support enjoyed by the President, who was directly
elected by the people -- a first for the country.

Thus, the much-criticized economic team could stand behind the
President and drive the country out of the dragging crisis with
credible, market-friendly policies -- as opposed to
nationalistic, protectionist policies.

In order to do so, the team could learn from the research and
studies presented by this year's Nobel prize winners for
Economics, Finn Kydland of Norway and Edward Prescott of the
United States.

Two practical propositions that can be taken from their work
are the establishment of an independent central bank and the
adoption of a bottom-up, microeconomic approach in public policy
to turn the economy around.

We will not discuss the first proposition here because it is
not applicable to the current economics team, following the
legalization of the independence of Bank Indonesia. Instead, we
will focus on the second proposition.

A microeconomic policy is best understood by contrasting it
with a macroeconomic policy, which has dominated economic
policies across the globe since World War II.

A macroeconomic policy seeks to change demand, such as in
investment and consumption, to stimulate growth. Such a policy is
based on theories developed by English economist John Maynard
Keynes, who advocated an expansionist fiscal policy during an
economic downturn to drive up demand.

A rise in demand would in turn stimulate producers to increase
output by optimizing their spare capacity or investing in new
capacity. In the end, it would create growth, although often at
the expense of inflation.

This theory does not always work, especially in developing
countries like Indonesia, where spare capacity is almost non-
existent -- or only exists in uncompetitive industries.
Therefore, driving up demand often results in rising import, thus
creating unsustainable growth.

This is exactly what occurs in Indonesia, where economic
growth in the past few years has been driven by domestic
consumption. Therefore, increasing demand by fiscal expansion
would not help much.

Adopting a microeconomic approach as advocated by the
Economics Nobelists could provide a different insight into
Indonesia's economic crisis, i.e., an insight from the supply
side.

Unlike Keynesian, who explained economic recession in terms of
demand, Kydland and Prescott views the crisis from the supply
side, such as advancements in technology, fluctuating oil prices
and other "supply shocks". Most economists now recognize the
importance of these supply shocks in explaining the business
cycle.

Unlike the Keynesian macroeconomic policy, which takes a top-
down view, microeconomic policy takes a bottom-up view, starting
with the millions of consumers and producers who are often
aggregated as "the market".

However, reading the market is as hard as knowing the
interests of millions of economic players. Nevertheless, there
are tools to understand them, such as surveys conducted by non-
partisan institutions. The National Economic Council that Susilo
plans to set up, drawing upon an American model, is another.

This council could be helpful in encouraging the rational
application of economic principles to policy, which should give
economists some clout among politicians.

The author is a staff writer for The Jakarta Post.