2021: Between Pandemic and Economic Recovery
"This is an economic recession that we designed ourselves.” This statement was made by Gregory Mankiw of Harvard University in his interview with Michael Klein of Tufts University.
President Joko Widodo held a meeting with ministers and Coordination Task Force for Covid-19, Doni Monardo at the Merdeka Palace, Jakarta, Monday (20/7/2020). The meeting discussed the formation of the Covid-19 Handling Committee and the National Economic Recovery.
"This is an economic recession that we designed ourselves.” This statement was made by Gregory Mankiw of Harvard University in his interview with Michael Klein of Tufts University.
Mankiw is right. To overcome the economic crisis triggered by this pandemic, we have intentionally asked, even forced the people, as much as possible, to stay at home. This is a crisis that we have designed ourselves. However, we had to do it to prevent coronavirus transmission.
As a result, the economy has slowed down. We are indeed starting to see a reversal and signs of economic recovery. Optimism has also arisen because of the availability of vaccines. However, we still have to prepare ourselves if the vaccination process takes time.
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The implementation of health protocols and the adoption of testing, tracing and isolation methods remain important. Addressing the health sector is the key. The economic recovery will depend on our ability to cope with the pandemic. Under such conditions, how will the economic recovery progress in 2021?
Three patterns of recovery
There are three possible patterns of economic recovery going forward. First, the recovery pattern in the form of a swoosh shape (Nike shoe logo), in which the economy reaches its lowest point in the second quarter of 2020 and then begins to improve and will achieve growth in the first quarter of 2021. The economic recovery is likely to accelerate in the second half of 2021 on the assumption that the pandemic will not get worse so that the government will not need to impose large-scale social restrictions (PSBB) again.
The bottom line: recovery will take place unevenly, some will go up and some will fall down, like the letter K.
Second, in the context of sectors and income groups, the economic recovery will probably in a K-shaped pattern, a term popularized by Peter Atwater of the United States’ William & Mary university in April. The bottom line: recovery will take place unevenly, some will go up and some will fall down, like the letter K.
The sectors that are improving are mainly technology companies, healthcare companies or those with savings. However, there are sectors that have fallen, for example micro, small and medium enterprises (MSMEs) or marginalized groups who have no savings.
Third, for the financial sector (equity and bond markets), we see that the recovery pattern may take a V-shape, in which the recovery occurs quickly. We may have a K-shaped recovery pattern in 2021.
Multi-storey building project in the Cempaka Putih area, Central Jakarta, Sunday (6/28/2020). Bank Indonesia projects that the process of economic recovery will strengthen in the third quarter of 2020 along with the relaxation of large-scale social restrictions since mid-June 2020 and the policy stimulus launched
To see this more deeply, there are a number of things that should be considered. First, more than 80 years ago, in a cold December in Cambridge, John Maynard Keynes, the greatest economist of the 20th century, introduced a simple concept: average propensity to consume (APC) or average consumption of total income. According to him, having saving is a luxury. The implication is that the rich will have a higher savings-to-income ratio than the poor.In other words, if income increases, the share of savings out of total income will increase. The implication is that the portion of consumption will decrease when income increases. A Bank Indonesia (BI) survey corroborated Keynes’ theory. The survey showed that a group (as a proxy for income) with expenditure of under Rp 3 million has an average consumption share of 69 percent of total income (October 2020). The share of consumption to total income for the group with expenditures of Rp 5 million and above is 66 percent.
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A more detailed observation shows that the largest decrease in the portion of savings out of total income occurs in the group with expenditures of Rp 3 million and below. Their incomes fall so they have to spend their savings. What about the upper-middle class (with expenditures of Rp 5 million and above)? The savings to total income ratio increases by almost 8 percent. This group has reduced the consumption of non-essential goods – because many activities have been conducted from home – so that the portion of savings has increased further.
This explains why third party funds (DPK) in banks have increased. Data from the Deposit Insurance Corporation (LPS) shows that the highest growth in deposits occurred in the savings group of Rp 5 billion and above. Here, there is a potential problem of income inequality. The upper-middle class may be able to get out of the crisis. They have savings and have digital access. On the other hand, the welfare of the lower middle class is at risk of continuing to decline due to depleted savings and limited digital access. This condition will result in a K-shaped recovery after the pandemic.
Second, a study from the Office of the Chief Economist at Bank Mandiri shows that by November, spending in the upper middle class was lower than before the pandemic. Meanwhile, the shopping index for the lower-income group had returned to its prepandemic condition. This means that the people who shopped were those in the lower-income group. Why is the upper-middle class still holding back on spending? The World Bank in its report, Aspiring Indonesia: Expanding Middle Class, shows that groups with expenditures above Rp 6 million per month are the main buyers for entertainment, housing and durable goods. We know that in the pandemic many entertainment activities have stopped because of health protocols.
The implication, as long as health problems have not been resolved, is that upper-middle class spending will be restrained.
Consistent with this, Bank Mandiri shows that in Java, the lowest spending index as of the end of November was recorded for travel, entertainment and airlines. This explains why the decline in spending of the upper-middle class is deeper than that of the lower-middle class. Did the upper-middle class reduce their consumption because of health awareness? Not necessarily. Consumption has been reduced as entertainment activities have practically stopped due to health protocols. The implication, as long as health problems have not been resolved, is that upper-middle class spending will be restrained.
It is true that the upper-middle class has looked for alternative things to spend on, for example by buying hobby items, such as bicycles, ornamental fish, ornamental plants and collectibles. Bank Mandiri\'s OCE shows the current shopping index on hobbies is above even the pre-COVID-19 period. There has been a sharp increase in spending on hobbies but the increase cannot compensate for spending on entertainment, travel and so on.
Also read: 2021 Challenge: Adapting and Collaborating or Defeated by the Pandemic
Third, my initial calculations show that there are differences in the behavior of the expenditure group above Rp 5 million and the expenditure group of Rp 3 million and below in terms of future income expectations and mobility. I am aware that there are data limitations. Therefore, the results of these calculations must be interpreted carefully. After more data is available, it will be necessary to conduct a deeper study with a better methodology. However, as an early indication, it helps us explain the current behavior of economic actors.
These findings indicate that for the expenditure group above Rp 5 million, the decision to leave or stay at home is not influenced by future income expectations (BI’s Income Expectation Index). This has occurred because they have enough savings. Therefore, this group has the luxury of choosing to stay or leave the house.
Workers assemble trucks at a plant of JAC Motors in Fuyang in central China\'s Anhui province Monday April 17, 2017. China\'s economic recovery is gaining momentum, with growth ticking up to a 6.9 percent annual pace in the first three months of the year, lifted by government stimulus and a property boom.
What about the expenditure group of Rp 3 million and below? My findings show that when the income expectations decline, the mobility of people increases. Conversely, when mobility increases, the income expectation for the income group of less than Rp 3 million also grows. These preliminary findings support an argument that I have presented before: the lower middle class does not have enough savings to stay at home for long.
When their income expectations decrease, they have to leave the house to earn money. That is why PSBB sides with the upper-middle class if the government does not provide social assistance in the form of direct cash assistance to the lower-middle groups.
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Fourth, I wrote in this newspaper (11/11/2020) that as long as health protocols are still implemented because the pandemic has not ended, the economy cannot operate at 100 percent. The implication is that if economies of scale are not met, companies will be reluctant to add new investments because they risk losing money. My preliminary calculations support that indication: there is a strong relationship between installed capacity and mobility. The higher the number of people living in the house, the lower the production capacity is used. And the lower the production capacity used, the lower the additional investment will be. The implication is that investment will not increase if mobility has not returned to normal.
Aggressive fiscal stimulus
Fifth, under these conditions, it is likely that the economic recovery in 2021 will depend on government spending, particularly social assistance. From the start, I said that social assistance should be provided in the form of cash.
As the preferences and needs of each household are different, the assistance should not be in the form of in-kind assistance such as basic necessities.
That is why the form of the social assistance will determine its effectiveness for the lower-middle class.
The government must provide assistance that is flexible in nature. Cash assistance provides flexibility for the recipient. Nobel laureate in economics Milton Friedman say that cash assistance is superior to in-kind assistance because the cost is lower. Cash assistance is more beneficial for the poor because it gives people the freedom to decide what they need and cash transfers can cut bureaucratic chains so that there is less risk of leakage. That is why the form of the social assistance will determine its effectiveness for the lower-middle class.
In relation to this fiscal policy, the risk of the K-shaped recovery requires the government to design fiscal policies to be more pro-equity, for example by giving priority to infrastructure and digital literacy to overcome digital inequality; investment in education and vocational training to upgrade skills and retraining; access to health, especially related to the COVID-19 vaccine; and improved social protection systems.
Traders work during the closing bell at the New York Stock Exchange (NYSE) on March 18, 2020 at Wall Street in New York City. - Wall Street stocks plunged again March 18, 2020 as the economic toll from the coronavirus mounts and economists warn of a deep recession.The Dow Jones Industrial Average tumbled 6.3 percent, or more than 1,300 points, to close the day at 19,903.50. The index sank by as much as 10 percent earlier in the session, which saw trading halted yet again.
Sixth, the government\'s projection in the Macroeconomic Framework and Fiscal Policy Principles (KEM PPKF) in 2021 shows that tax revenue will be in the range of 8.4 to 9.1 percent of gross domestic product (GDP) in 2023. In fact, as I discussed above, we need aggressive fiscal stimulus for economic recovery. The implication is that the budget deficit will increase.
I understand that there is a risk that debt will increase. However, the theme of current fiscal policies around the world to cope with COVID-19 is "whatever it takes". We know that Law No. 2 of 2020 states that the state budget deficit must fall back to below 3 percent by 2023. To achieve the budget deficit target of below 3 percent by 2023, the government must start reducing its budget deficit by 2022.
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I advise the government to do this with caution. If the tightening is applied too quickly or too drastically, there is a risk of contraction. If the economic recovery is slow due to limited fiscal expansion, the debt-to-GDP ratio will not decrease because GDP growth is weak. In this condition, efforts to improve tax revenues by reforming tax administration are important. In addition, it is important to improve the quality of expenditures so that more budget spending can be alloca.
Chatib Basri
There is a hope that the economic recovery will occur in 2021. The question is: how fast will it happen, and will this recovery lead to a better economic structure? It will depend on our ability to cope with the pandemic. Without it, we are forced to continue struggling with a recession that we designed ourselves, due to the necessity of implementing PSBB and health protocols. The handling the health crisis is the key. It reminds me of what Mankiw said in his interview: the current economic crisis requires more microbiologists than economists. He certainly exaggerated. Coping with a pandemic is a task for all of us. However, there is truth in his words.
Muhamad Chatib Basri, Lecturer at the University of Indonesia School of Economics and Business
