Turning Point of Policy

It was reported in various media outlets that a meeting took place between President Joko “Jokowi” Widodo and Coordinating Minister for Maritime Affairs and Investment Luhut Pandjaitan.

After this meeting, Luhut gave a press statement. In the meeting, two important things were discussed. The first was to focus on what had to be done one thing at a time. If you expect too much, nothing will happen. The second was nickel downstreaming, which is contrary to the policy on mineral resources in the past.

I\'m not going to talk about nickel. However, I support Luhut\'s statement that "if there are too many expectations, nothing will happen".

For me, this statement cannot be separated from the economic recession that was exacerbated by the COVID- 19 pandemic. The economic recession we are currently facing is part of the rising tide economy (business cycle), which is a kind of “law”. The economy of a nation cannot continue to increase indefinitely, nor can it continue to decline indefinitely. To overcome the crisis, we must recognize the comparison between capital and labor. We can divide it into two conflicting structures, namely the overinvestment theory group and the underconsumption theory group.

Underconsumption

According to the underconsumption theory group, the origin of a crisis is a mismatch of consumer demand with production volumes. Demand may still be increasing, but the increase is not sufficient to cover greater increases in production. Since the demand cannot absorb the volume of production, there is no point in expanding capacity further and enthusiasm for investment declines.

This can be the beginning of a crisis of weakened enthusiasm for investment. Investment declines, which results in decreased income, leading to a decline in consumption. Decreased consumption means that the demand for consumer goods drops so that the enthusiasm for investment weakens further and so on. There is a downward spiral in overall economic activity and a decline in macroeconomic indicators. According to this theory, the main cause that consumption cannot expand to meet the expansion of production capacity.

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So, according to this group of theories, the cure is to spur consumption by increasing people\'s purchasing power, if necessary with deficit spending. The target is usually the construction of infrastructure projects by the government. If the pattern of crisis and recession is like this, investment in large projects will be highly appreciated.

The inventors or followers of these theories, with their respective nuances and variations, are Samuelson through the acceleration and multiplier theory; Aftalion by including the element of the gestation period; Hicks, Harrod and Haberler who point out humanity’s limits as a factor of production; Kaldor and Kalecki who consider the problem from a psychological perspective, namely the human saturation factor; and Schumpeter who discusses the relationship between innovation and investment.

KOMPAS/SUPRIYANTO

Supriyanto

Overinvestment

The essence of the overinvestment theory is that investments, which during a rising-tide economy are always greater than savings, are carried out using ever-growing credit from banks. That is, during the rising tide, the formation of equity capital lags behind investment opportunities and enthusiasm. Thus, investments are made with credit from banks, which gets bigger and bigger. The willingness and ability of banks to loan will not continue indefinitely. One day, bank credit will decrease.

Thus, investment will decrease, and the crisis will begin. This thought was evident to Machlup. Witteveen said as long as business or investment opportunities still existed, the increase in investment would result in a multiplier increase in income, even though investment was financed by bank credit. This increased income also generates increased savings, which are sufficient to cover investments that are initially financed with bank credit. So, as long one of the factors of production is not stuck, investment can continue.

However, the overinvestment theory group emphasizes that, although bank credit can be used for investment financing, there will definitely be production factors that become obstacles during a rising-tide economy. Such an issue with a factor of production can cause prices to rise. Thus, to maintain the volume of investment, more capital is needed because of the increase in the price of the factors of production that have become scarce. Thus, the need for bank financing will swell so that eventually the bank itself will stagnate in capacity.

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When the source of financing for this investment falters, the investment will stagnate as well, and with the decline in investment, the crisis begins. So, eventually the issue is the capital factor again. I myself would like to add that the profitability of all investments, the return on investment (ROI), is not always higher than the bank\'s interest rate. If the ROI is less than the interest rate, companies that use a lot of credit will either go bankrupt or be forced to reduce their business scale.

Now let\'s take a closer look at what exactly the core difference is between the two groups of theories. Overinvestment theory contends that the forerunner of a crisis appears during a rising-tide economy due to the strong desire for investment so that ultimately investment growth is stuck on financing, which is always covered by bank credit. There is a limit to bank credit, so when bank financing falters, a crisis occurs.

Therefore, this group is of the opinion that efforts to avoid a crisis must be carried out while the rising-tide is happening. We cannot wait until a crisis has occurred. In fact, many followers of this theory say that once a crisis has occurred, we can do nothing but leave the healing to a very painful natural process. This means that we can do nothing but allow the recession to reach its lowest turning point and the rising tide process to start again based on a new equilibrium point located at the level of “the lower turning point”.

In the underconsumption theory group, the forerunner of the crisis is a mismatch between a high volume of production and a low volume of consumption. Therefore, the way to address the crisis is to increase consumption after the crisis has occurred. So the crisis is overcome by increasing consumption.

In the overinvestment theory, a crisis should be softened by reducing consumption and investment in order to increase savings. The action must also occur early enough, while the rising tide is still going on. If it\'s too late, there\'s not much that can be done, except to go through a very painful process. An example for us today are the mega-projects that reach tens of billions of US dollars. We can see that some projects have been built half way. We want to finish them but there is no money. If the development of these projects is stopped, they will be abandoned. This, among other things, is what I mean by a painful process.

We see clearly that the therapy presented by the underconsumption theory is in contrast to the therapy presented by the overinvestment theory in both the instruments used and the timing of their handling. So, the most crucial question is: Which theory currently applies to Indonesia?

Before exploring further, let\'s first look at the relationship between these two groups of theories and our macroeconomic structure, because which theory applies to a country in a certain period of time is very much determined by the macroeconomic structure prevailing in the period concerned.

Business structure and cycle

In this analysis, what is meant by structure is the ratio between capital and labor. Economic activity or investment and production is the combination of the production factors of capital and human labor to process nature into consumer goods and means of production. It rarely happens that for a sufficiently long period of time, the amount of available labor is just enough to be combined with the amount of existing capital.

For long periods of time, more capital is available than labor. Such a structure we call the “scarce labor structure”. The opposite situation is that we lack the capital to be able to create jobs for the entire workforce. We call this structure the "capital scarce structure".

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Witteveen argues that with the scarce capital structure, what applies is the theory of overinvestment. In a period characterized by a scarce labor structure, the underconsumption theory prevails. Without further examination, this relationship is logical. Lack of capital means this factor will be stuck first. So, it fits with the overinvestment as described earlier. Less manpower means less mouths to consume. So, it fits with underconsumption.

We see that in underconsumption theory, the underlying structure of the crisis is the lack of opportunity to invest savings, because the labor factor has been used up. In a structure characterized by a scarcity of capital, we are faced with a strong and persistent tendency to invest in order to provide jobs to the people. This strong tendency was then enforced by financing through bank credit. As described above, this kind of financing cannot be sustainable indefinitely. Bank credit will stagnate, and investment costs will increase.

The case of Indonesia

Without further research, it seems that for Indonesia, like other developing countries, the general structure is capital scarcity, so overinvestment theory applies.

Based on this theory, there will be little benefit in increasing investment continuously by pumping or increasing people\'s purchasing power because the crisis occurs exactly because of overinvestment. What the government needs to do is simply to prevent the recession from getting too bad. Mentally, we must be ready with the natural process to achieve a new balance. What can be done is a tight money policy (TMP), rescheduling large projects regardless of who owns them, controlling commercial credit from abroad and all that has been done by the government.

Put the brakes on investment. By putting the brakes on investment, we are indeed entering a recession, which will be a painful process, but one that we cannot avoid. This is a cost that we have to pay from time to time because we want to have a non-centralized and non-authoritarian economy.

Moreover, such an economic system has proven to be bankrupt. We must face recession calmly and naturally because the economic tide is receding. We are consolidating for the “boom” that will surely come once we reach the lower turning point.

It is within this framework that we must see the government\'s determination to maintain the TMP, no matter what the risks. These risks include the bankruptcy of certain companies, layoffs, shrinking investment and so on. In short, all the symptoms that signal a recession.

The government needs to be ready with psychological breakthroughs at any time they are needed.

Entrepreneurs should not shout for a relaxation of the TMP, ask for lower interest rates, let alone do various tricks and manipulations. The postulates and causal relationships as well as interdependent relationships between various factors that apply to corporate affairs are very different from those of national affairs. If you don\'t want to know and therefore don\'t adjust your policies, you will be destroyed or you will destroy the national economy.

In the current economic system, which you definitely want to continue, understand the laws and mechanisms of the nation\'s household affairs. What you will understand are the laws and mechanisms of the company\'s household affairs. For companies that can afford it, start hiring macroeconomists and monetary experts.

As for the well-meaning bankers who want to lower interest rates, I just wonder to myself, do they understand what is going on with our national economic process? Do they understand the laws and the rising tide mechanisms of the macro and monetary economics that are inherent in our economic system?

Kompas

Kwik Kian Gie

What needs to be upheld is consistency in implementation and steel discipline without favoritism. What needs to be monitored and anticipated are the change in the psychological condition of the masses, which can suddenly reach a turning point at any time so that the theory of the rational expectations does not hold. The government needs to be ready with psychological breakthroughs at any time they are needed.

Kwik Kian Gie, Coordinating minister for economic affairs from 1999 to 2000 and national development planning minister/head of the National Development Planning Agency (Bappenas) from 2001 to 2004.

This article was translated by Kurniawan Siswoko