Transition to Recession

History shows that global recessions have been preceded by these two symptoms: a global slowdown and the collapse of the world's major economies. Throughout 2022, the global economy has slowed down, particularly the economies of the United States, Europe and China. Fears of a global recession in 2023 are rising. That is one of the conclusions of a recent World Bank study entitled, “Is a Global Recession Imminent?”

The trigger for the recession is a simultaneous increase in interest rates in almost all countries to a magnitude that has not been seen in the last five decades. In the midst of high levels of government debt, this policy will cause an economic slowdown that has not occurred since the 1970s.

Also read:

> Recession and Economic Sustainability

> Analyzing Recession

Prior to the increase in interest rates by the US central bank, the Federal Reserve, by 75 basis points to 3.25 percent, Bank Indonesia raised interest rates by 50 basis points to 4.25 percent. An increase in interest rates has two main implications, namely an increase in lending interest rates and an increase in the government's burden of paying debt.

This figure increased from the third quarter of 2021, when it was still around 36 percent, and from only 25 percent in 2011.

Governments around the world, including Indonesia, have experienced a significant increase in debt due to the Covid-19 pandemic. By the middle of this year, the Indonesian government's debt ratio reached 42 percent of the gross domestic product (GDP). This figure increased from the third quarter of 2021, when it was still around 36 percent, and from only 25 percent in 2011.

When compared to neighboring countries, our government’s debt ratio is still relatively low. For example, in Malaysia, the government’s debt ratio is 70 percent, in Thailand 62 percent and in the Philippines 60 percent in the same period. Even so, an increase in interest rates will certainly put pressure on our economy.

Encouraging transition

In short, the domestic economy is not free from the impact of a world recession, although it will not be so significant. Economic growth can still be maintained in the range of 5 percent this year. It may slow slightly to 4.7-4.9 percent in 2023, especially if there is no improvement in the global geopolitical situation, which has affected global supply chains, such as the war between Russia and Ukraine, which has led to an increase in food and energy prices.

From history, we can also learn that recessions have led to various transitions to new orders. The rate of change and scope are largely determined by the main factors causing the recession itself.

Usually, there will be a massive transformation through various regulations on sectors that are considered to be the cause of the crisis. In the case of the 1998 crisis, banking was considered the main factor triggering the crisis, and after that, a transformation took place which has made our banking sector more solid now.

Similarly, there was a global recession in the 1970s. At that time, the main cause was the conflict in the Middle East, which made world oil prices soar dramatically. The US economy experienced great pressure on productivity and competitiveness, especially in the automotive sector.

This is one of the forerunners of the liberalization of the financial sector that has allowed for financial product innovation through securitization and the development of the derivatives market.

In order to improve productivity and competitiveness, the US government then liberalized the financial sector by releasing the convertibility of the US dollar to gold. Since then, the issuance of US dollar currency has no longer required additional gold reserves. This is one of the forerunners of the liberalization of the financial sector that has allowed for financial product innovation through securitization and the development of the derivatives market.

This financial sector innovation eventually led to the financial asset bubble that erupted in 2008. In other words, the solution to the 1970s economic recession had long-term implications that contributed to the global financial crisis in 2008.

The increase in world oil prices also caused the US automotive industry to collapse. At the same time, it became an opportunity for the emergence of a more business-efficient and energy-efficient Japanese automotive industry.

Learning from this experience, there are two important lessons. The first is that the policy response to the recession will change the landscape of the economic structure, both globally and nationally. Second, the implications of the policy response to a recession could pose a crisis risk in the long run. These two lessons are noteworthy in pushing for change in the face of the upcoming 2023 global recession.

Changing the landscape

A World Bank study shows that the current global recession is driven by factors of production rather than

factors of consumption. The concrete thing is that the price increase is not only caused by too much liquidity in the economy, but rather due to the reduced supply of goods.

Trade wars, pandemics and geopolitical shifts have changed global supply chains, increasing the cost of production and transportation of goods and services. The mobility of resources and production inputs is not as flexible as the previous period.

Therefore, to achieve price stability and quality growth, the World Bank recommends that all countries produce more and reduce consumption through reallocation of resources for investment.

Reallocation is the key word because during a recession resources are also limited. Therefore, efforts are needed to relocate the available resources in order to optimize quality growth, which is marked by reducing poverty and reducing inequality.

Investment in the health sector will also be high, in order to increase readiness to face pandemics in the future.

This policy direction will change the long-term economic and civilizational landscape. First, the government's role in the economy will still be large, through various allocations of social spending. Investment in the health sector will also be high, in order to increase readiness to face pandemics in the future.

Adoption of technology in the implementation of policies or practices of daily life is also unavoidable. The presence of a state with technological support has created an opportunity for the presence of a digital welfare state concept.

Second is increasing awareness of the balance of nature and sustainability. Investment in alternative energy, cars and environmentally friendly electronic devices based on new and renewable energy will increase in the future. Green economy funding sources are also increasingly needed.

A global recession, which seems inevitable, will usher in a transition to a new order. Our economy cannot be separated from the impact of the recession. It will not be severe, so we have wider space to prepare ourselves for the transition that accompanies the recession.

KOMPAS/HERU SRI KUMORO

A Prasetyantoko

A Prasetyantoko, Rector of Atma Jaya Catholic University.

(This article was translated by Hendarsyah Tarmizi)