Economic Recovery: V, U or W-curve?

KOMPAS/RONY ARIYANTO NUGROHO

People brave the heat on Saturday (19/9/2020) as they queue to receive their cash aid at the Bondongan subdistrict office in South Bogor district, Bogor, West Java. At least 1,022 local residents are registered as social assistance recipients with the Bondongan office, which has implemented a scheduling system to serve the residents of three out of the subdistrict’s 20 community units (RW) per hour.

Staff writer Derek Thompson of The Atlantic once wrote that the most rational approach to studying human behavior was to assume that it was irrational.He wrote this in his article on Richard Thaler, the 2017 Nobel laureate in economics and a pioneer of behavioral economics at the University of Chicago. We can argue about this. Thompson seems to be scoffing, but he might be right.

Thaler indeed provides an interesting example using Spock and Homer Simpson. Economists, according to him, often assume that economic actors are like Spock, the fictional character in the Star Trek franchise who is cold, rational, and always makes careful calculations. Unfortunately, humans are generally more like Homer, the fictional character in The Simpsons cartoon. Homer is messy. He is fat because he eats junk food, he is lazy and prone to sudden bursts of anger. His decisions are not calculated.

This comparison seems to hold true in these times of the pandemic, when we often see people not being rational in following the various rules, even though their lives are at stake. Of course, this affects the decisions of economic actors.

Behavioral economics

Early in June, when the economy was about to reopen, I wrote in this daily (Kompas, 8/6/2020) that reopening the economy does not guarantee immediate recovery. The retail and consumer confidence indexes later supported this in their data, which showed a sharp increase in May-July, but stagnation in July-August.

Also read: Recovering from Slowdown

Even a Bank Indonesia survey showed that consumer confidence declined in August 2020. Not only that, but a sharp drop was also recorded in consumer confidence towards saving over the next six months.

Consistent with these, big data from Google’s Community Mobility Reports show that the movement of people going to retail stores, restaurants, shopping malls, and offices – which reflect economic activity – continued to decline through the end of August from the May-July period. I realize that we have to be careful with Google data: people going to retail outlets or grocery stores does not always mean they are shopping. However, the data so far has been quite consistent with other economic data.

Happily, the Purchasing Managers’ Index (PMI) began to improve in August, indicating recovery in the manufacturing sector. This is quite encouraging, although the signs of recovery are still unclear.

The behavior of economic actors also has an effect.

Weak demand may be the cause, in particular the low purchasing power of the lower middle class and the reluctance of the upper middle class to buy. However, purchasing power cannot be the only explanation. The behavior of economic actors also has an effect.

So, why did demand not increase sharply after the economy reopened? This piece intends to explain the economy and the need for the behavioral economics approach in understanding the current situation. Several things need to be considered.

First is a shift in behavior. Shopping and work patterns are shifting to online platforms. As a result, community mobility has decreased. A disruption is happening. However, we must also be realistic that this pattern cannot entirely explain the decrease in mobility.

Second, some people may be in a “wait and see” mode, so they are limiting their economic activities. This reflects the reluctance of the middle class for spending money. They are instead choosing to save.

Interestingly, the initial experiment I conducted together with Syarifah Namira Fitrania of CReco Research using big data from Google and the Humanitarian Data Exchange shows: that an increase in the number of Covid-19 deaths prompted more people to stay at home, but not for very long.

KOMPAS/TOTOK WIJAYANTO

A ship docks on Tuesday (22/9/2020) at the container port of Tanjung Priok in North Jakarta. Statistics Indonesia (BPS) records show that exports declined 8.36 percent year-on-year (yoy) in August 2020 from US$14.262 billion in August 2019, while imports nosedived 24.19 percent yoy from US$14.169 billion in August 2019.

In less than five days, people started going out again. Why? Is this an economic issue or a psychological issue? From an economic point of view, our study shows that the more severe the economic situation, the more people tended to head outside their homes. This correlation supports the argument that economics can explain people\'s decision to stay at home. People are able to stay at home only if they have savings or are receiving social assistance, like the direct cash transfer (BLT).

The implication is that the lower middle class, especially those working in the informal sector, has no other choice but to leave home to work.

Also read: Real Sector Key to Quick Recovery

Ironically, our study shows that the greater the number of people who head outside their homes, the greater the number of people who are infected with the coronavirus. There is a dilemma here: staying at home means making no income, while leaving the house risks being infected with the virus. The large-scale social restrictions (PSBB) will only favor the upper middle class if the government cannot provide social assistance, in particular the BLT.

Fourth, if the behavior of the lower middle class, especially those in the informal sector, can be explained through rational economics, what about the high mobility among some people of the upper middle class? Permanent employees may be bound by some company rule that forces them to keep heading to the office. But what about those who can actually choose between working at the office and WFH?

In this case, behavioral economics can offer an explanation. Aida Indradjaya, a behavioral economist who graduated from the University of Nottingham, reminded me about optimism bias and individual habits. Optimism bias refers to a bias that some people hold in believing that they will have a better chance at avoiding the coronavirus than others.

When others test positive for Covid-19, people with optimism bias assume that those people have not been careful, and that they are being very careful. Another example: If others are able to head outside without becoming infected, people with optimism bias – who feel healthier and believe that they are more careful than other – are sure that they will be evn safer. In terms of individual habits, people might be able to stay at home in the beginning, but in the longer term, they will go out – mainly because humans are social creatures.

Another explanation is how we assess risk. This has to do with the current bias, in which people are more focused on tangible and immediate benefits rather than long-term benefits.

It\'s easier if we look at it like this: The benefits of heading outside the home to earn an income are thought to be greater than the long-term benefits of staying healthy by protecting yourself from the virus. Another factor is the “status quo bias” that a UNDP study in 2020 referred to – the attempt to avoid changes in lifestyle. In the present circumstances, it is very difficult for people to alter their lifestyle and turn down invitations from their friends to go out together, especially for those of the younger age group, or to make other changes that relate to an individual’s social behavior, personal beliefs, and so on.

KOMPAS/AGUS SUSANTO

Children stand on the balcony of a makeshift stilt house on Tuesday (22/9/2020) along the bank of the Ciliwung River in Bidara Cina, Jatinegara, East Jakarta.

Fifth, the economy will not recover if the pandemic is not resolved. Why? As long as the pandemic continues, the government must implement the health protocol. Restaurants, malls, offices and factories cannot operate at 100 percent capacity while physical distancing is maintained.

As a result, it is difficult for them to achieve economies of scale. If only 50 percent of economies of scale is achieved, many companies will suffer losses because they are unable to cover their fixed costs. If a company is unable to achieve economies of scale, it cannot reach the break-even point, and the company will suffer more losses.

This is why the economy can recover only if the health emergency is overcome.

If this cycle continues, there is a risk that the company will become a zombie company: It is not shut down, but it is practically operating only to pay off its debts. It cannot invest in expansion. My calculations show that the lower the installed capacity, the lower the investment. Why increase investment amid overcapacity? This is why the economy can recover only if the health emergency is overcome.

Long road to recovery

Sixth, it seems that we must indeed be ready for a long road to recovery. Why? Look at the basic math: Let\'s say a vaccine is available in January 2021 and ready for public distribution. The government has a priority to provide vaccines to health workers, Covid-19 patients with comorbidities, and so on. This priority group totals 25 million people, which is relatively small compared to the Indonesian population of 270 million. Since there are 365 days in a year, this means that the government must vaccinate more than 68,000 people every day.

And this, even though we know that our capacity to run polymerase chain reaction (PCR) tests is only 20,000-30,000 per day. Even if we had the capacity, vaccinating 25 million people will still take a long time. The government must have extensive resources to run a vaccination program of this scale, not to mention that two vaccination rounds or greater immunization coverage might be needed.

KOMPAS/TOTOK WIJAYANTO

Tono repairs a rattan chair swing on Tuesday (22/9/2020) at his workshop, which also doubles as a store, in Grogol, Jakarta. The craftsman said that sales had dropped since the Covid-19 epidemic emerged in the capital, and that he had yet to receive Rp 2.4 million in emergency capital assistance from the Cooperatives and Small and Medium Enterprises Ministry’s targeted program for micro and small enterprises.

With these considerations, it is not impossible that the newly reinstated health protocol will be lifted only in 2022. Economic recovery may follow the U-shaped curve instead of the V-shaped curve. What must be ensured is that the pandemic does not continue to spread so that economic recovery will not follow the W-shaped curve.

An effective Covid-19 response strategy is needed while waiting for the vaccines to be ready for distribution. The PSBB will be effective only with the provision of social assistance, such as the BLT. If we cannot afford to provide social assistance, strict adherence to the health protocols must be made mandatory when people venture outside the house. Or as Nobel economics laureate Paul Romer proposed, testing all residents once every week or two to separate those who can be permitted to go out and who cannot, so that economic activities are not disrupted

I am not smart enough to offer an answer to this; epidemiologists have the greater authority. What is clear is that this is not an easy choice for a country as large as Indonesia. Public health and the economy must go hand in hand. The pandemic is not a single event; it is a continuous event. That is why its management must take various aspects into consideration, including health, psychology, sociology, culture, cognition, and emotional aspects that influence an individual’s decision.

Under these conditions, it is difficult to expect a sharp increase in private investment in 2021, because it is likely that the economy will still not be operating at 100 percent. The global economy will also be unable to provide any support. Therefore, the stability of the Indonesian economy will depend heavily on the government\'s fiscal capacity. This means that health programs, social assistance – including the BLT – credit guarantees, and relief support for businesses must be continued in 2021. The problem is that the government is still limited in its ability to disburse funds.

Through August, disbursements from the National Economic Recovery (PEN) program had realized just 27 percent of its budget; as of July, the state budget deficit was a mere 2 percent of gross domestic product (GDP), remaining far below the 6.3 percent threshold. Coordination problems, data limitations, poor program design, and legal concerns are still the main obstacles. We simply don\'t live in a perfect world. Thus, the critical question is: What policies can run amidst these obstacles?

KOMPAS/HERU SRI KUMORO

Chatib Basri

Maybe we need to be pragmatic. The PEN program data shows that the social assistance funds, especially the BLT, have been disbursed most effectively. Focus just on this program. In terms of data constraints, here, we need to be creative and innovative. Basri, Hanna and Olken (2020), for example, proposed exploring the possible use of the preemployment card program, mobile phone technology, and a community-based approach as "identification mechanisms" to provide social assistance for groups of the lower middle class that are at greater risk of Covid-19. This is, of course, imperfect.

We simply don\'t live in an ideal world right now. We are well aware that ideal policy a la Star Wars will be ineffective if the institution still resembles Jurassic Park.

Muhamad Chatib Basri, lecturer at the University of Indonesia School of Economics and Business.