Avoiding the Slow Growth Path

DIDIE SW

Didie SW

The wound is an experience. It is not knowledge. Those who have watched William Shakespeare\'s Romeo and Juliet may remember a line from Romeo: "He jests at scars that never felt a wound."

Romeo wanted to say: it would be easy to make fun of someone\'s pain if we didn’t experience it. He was right. We may have knowledge of previous pandemics, but we will only understand after experiencing one ourselves. Covid-19 leaves scars on our faces. We feel it. The scar will carry over for a long time. It will live in our behavior, as well as in our economy.

Optimism has started to build. People have begun to talk about economic growth in the second quarter of 2021, which could exceed 6 percent. The government even projects 7 percent. It is no exaggeration. There are two reasons for that. First, the growth in the second quarter of 2021 will be relatively high because it starts from a low base.

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Our gross domestic product (GDP) based on 2010 constant prices reached a total of Rp 2.58 quadrillion in the second quarter of 2020, while GDP in the first quarter of 2021 totaled Rp 2.68 quadrillion. It means that in order to obtain a growth rate of 6-7 percent in the second quarter of 2021, GDP (based on  2010 constant price) will only need to reach Rp. 2.74 quadrillion-Rp. 2.77 quadrillion. It needs only to grow 2.3-3.2 percent from the first to the second quarter of 2021.

That is quite possible. The economic growth, hand in hand with an increase in people’s mobility. Data from the Office of Chief Economist at Bank Mandiri shows that the shopping index has begun to increase, even higher than the pre-Covid-19 period. We have to appreciate that the financial stimulus introduced by the government has been able to narrow  the economic contraction and bring the economy back on a positive growth path.

The impact of Covid-19 on growth

I realize that if an economist is making a projection of economic growth, what he really wants is to show a sense of humor. Why? Because there is an important variable that is very decisive, but it’s hard to make predictions: the pandemic. Will there be a second wave? How long will this situation last?

I\'m not very good at answering them. Our real question is not whether it can grow 7 percent in the second quarter 2021. There is something much more important than that: What are the scars left behind by the Covid-19 pandemic on our economy? What is the long-term impact of this pandemic on our growth path? A 2.07 percent contraction in 2020 will reduce the future growth path.

If in 2021 the Indonesian economy can grow 5.3 percent, as targeted by the government, and future growth remains at 5 percent, the compound annual growth rate during 2019-2025 will only reach 3.8 percent. Or even if we can grow an average of 6 percent per year during 2022-2025, our growth path will only be at an average of 4.5 percent throughout the 2019-2025 period. Covid-19 has downgraded our growth path. It leaves a deep scar on our economy.

If we want to return the growth path back to 5 percent, as we had during the 2014-2019 period, the economy during 2021-2025 period must grow at least 6.75 percent every year. In fact, we know that with an average growth of just 5 percent, it is not easy to avoid the middle-income trap. It will become even more difficult, if the average growth during 2019-2025 is below 4 percent.

A few steps

Then what to do? To answer this, there are several things that must be considered. Keep in mind, this analysis is medium and long term on the assumption that the pandemic can be controlled.

First, if we want the economy to grow above 6.75 percent on average in the 2022-2025 period, household spending must grow above 5.3 percent, investment grows above 8 percent, government expenditure grows by 5 percent, and exports rose by more than 10 percent.

Of course there are many variations. For example if the growth in household consumption is lower, it must be compensated by higher growth in investment or exports.

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Second, there is a possibility that the household spending will grow high in 2022 due to the pent- up demand. The economic reopening in 2022 (assuming vaccination can be completed and the pandemic can be contained) has the potential to result in relatively high growth in household spending. If the pandemic can be overcome, the upper middle class will again spend their money on leisure, entertainment, traveling, and durable goods, such as cars and houses.

For the lower middle class, social assistance and government stimulus will also become  a driving force. In addition, we also see that the companies that can survive the pandemic are those who can carry out digital transformation.  Therefore, digital infrastructure support is very important. Future digital transactions will continue to increase. If it can be realized, we may see high growth in household spending in 2022 before finally returning to normal levels.

We remember that in the 2010-2014 period, the household spending grew by an average of 5.3 percent. However, the fall in commodity prices in 2013 reduced the household spending growth to an average of 5 percent in the 2014-2019 period. We must be able to push up the household spending growth back to an average of 5.3 percent or more. Relatively low interest rates also help to encourage the household consumption because the incentive to save is relatively small.

Third, the anatomy of Indonesia\'s economic growth in the pre-Asian financial crisis showed that the engines of the economic growth were investment and exports. In the period before the Asian financial crisis, investment grew by an average of 9.4 percent. The commodity boom that occurred until 2013 allowed investment to grow by an average of 8.3 percent in 2000-2012 and reached its peak of 9.8 percent in 2012. After the end of the commodity boom, investment growth in 2014-2019 fell to an average of 5.3 percent.

How to increase investment and export? The key is to increase the productivity rate. In 2019, the incremental capital output ratio (ICOR) was around 6.8 percent (I don\'t use the 2020 figure, because there is bias due to the pandemic). This means that 1 percent of economic growth requires an investment to gross domestic product (GDP) ratio of around 6.8.

If we want to grow by 6.75 percent, we need an investment to GDP ratio of 45.9 percent (6.75 percent x 6.8). Of course, this investment must be financed by domestic savings. The data shows that the domestic saving to GDP ratio is currently around 35 percent. In fact, the investment requirement is 46 percent of GDP. If we want to boost economic growth to 6.75 percent, there will be a deficit between saving and investment of more than 10 percent. This deficit reflects a deficit in the current account.

With the current account deficit of that size, there is a risk that it will bring pressure on rupiah exchange rate and trigger volatile financial markets. As a result, Indonesia\'s economic growth could be trapped in the current account deficit problem.

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To overcome this, there are several options or combinations: attracting direct foreign capital. I once wrote in this daily that the government actually didn\'t need to worry too much about the current account deficit, as long as it could be financed with foreign direct investment (FDI) in the export-oriented sector, and not by portfolio investment. If deficit financing is in the form of FDI, the capital outflow can be limited. For this reason, an important step that needs to be taken is the implementation of the Job Creation Law and  the success of the sovereign wealth fund (SWF).

Various implementing regulations such as government regulations, ministerial regulations, and so on have already been issued but I would like to remind you that the most important is their implementation. Our experience shows that there is a gap between the issuance of the regulations and their implementation.

Taking the analogy of text messaging mobile phones, President Joko “Jokowi” Widodo may have pressed the sent bottom, but the messages have not been  delivered.  This analogy is quite right. To ensure that they are delivered, not just sent them, field testing is needed, for example with a focus group discussion (FGD). I remember my experience as the head of the Investment Coordinating Board (BKPM ) in 2012. BKPM prepared a form that investors must fill in to apply for an investment permit. Everything looked good on paper.

However, I asked for an FGD. I asked investors to fill out the form in front of me. It turned out that investors had a difficulty in filing the form. The problem was simple: in the form there was a question about the volume of production of goods.  There were investors whose production consisted of solid and liquid products, whose units are different. Unfortunately, there is only one column on the computer. He asked whether it should be converted into one unit, or what?

The bureaucracy did not have the same ways in answering it because we did not anticipate this problem. Investors had a difficulty filling out their investment permit application. The problem was small, but could be used as a real example. In essence, all the regulations that have been issued must be tested in the field whether they work or not. Without the assessment, the Job Creation Law will remain difficult to implement.

What else? Increase our exports  of manufacturing goods and diversify our products and export destinations. We also have to be part of the global production network. Basri and Rahardja (2010) show that the main drivers of our exports are old products and old markets.  New invention? Less than five percent. Even the contribution of new products in new markets in our export growth is almost non-existent.

Covid-19 has indeed left wounds on the face of our economy and the scars will stay for a long time.

Innovation plays an important role. I was reminded with a discussion with economist Dani Rodrik at Harvard several years ago. Rodrik emphasized the importance of new product innovation. For that, entrepreneurs must adopt technology from outside for local needs. A process he called self-discovery.

However, there is a problem. If entrepreneurs fail in this experiment, they will bear all the losses, while if successful, other producers will imitate them and follow such activities. As a result, practically nobody is interested in self-discovery. Here, the role of the government is needed. Unfortunately, our R&D is weak. Technology cannot just be obtained from developed countries. Therefore, it requires R&D that is funded by the public.

And the most important thing is to increase productivity. How to produce the same output with smaller investment or capital (lowering the ICOR). If the ICOR can be lowered, for example to 4 or 5 percent, then to achieve economic growth of 6.75 percent, we only need an investment to GDP ratio of 27.0-33.5 percent.

Thus, we are able to spur growth without worrying about a current account deficit. Increasing the productivity can be done by a combination of increasing physical investment, simplifying licensing, and improving the quality of human resources. Perform training, re-training and skills improvement. For licensing simplification, the implementation of the Job Creation Law is very important.

Termination of the stimulus

Fourth, the above conditions imply that both the government and Bank Indonesia must see the right time to end the stimulus. It can\'t be too fast. Unfortunately, the normalization of policy in the United States may have already been carried out after 2023. This will affect the stability of the financial market and our economic recovery.

KOMPAS/RADITYA HELABUMI

Muhamad Chatib Basri

It\'s not easy, but there is a hope. Covid-19 has indeed left wounds on the face of our economy and the scars will stay for a long time.

The wound is experience, not knowledge. “I hurt and can run / run / until the pain disappears,” writes Chairil Anwar in his poem. He was right: we will take it until the pain goes away.

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

This article was translated by Hendarsyah Tarmizi.