America and Our Political Economy
The Fed’s monetary tightening has and will continue to have a detrimental effect on developing economies. This policy has created global economic vulnerability.
Even though it seems a hyperbole, in the context of geopolitical-economic analysis, the “noise” of Indonesian politics in 2023-2024 is “indirectly” related to a dog named Woofie.
What’s the context? This relates to an analysis by the dog’s owner, United States economist and Nobel laureate Joseph E. Stiglitz, in “How Not to Fight Inflation in Post-Pandemic Economic Conditions” (The Jakarta Post, 31/1/2023).
Each time an airplane flies over his house, writes the Columbia University economics professor, Woofie barks. “He probably believed that by barking, he had scared them off.”
And, with hilarious logic, Stiglitz concludes: “... not barking would have increased the risk of the plane falling on him”.
He probably believed that by barking, he had scared them off.
Of course, Stiglitz is satirizing the perceived inflationary risk from the Federal Reserve, the US’s central bank. To justify raising its interest rates, the Fed created a series of boogeymen: rising inflation, rising wage-price spirals, and unanchored inflation expectations. In reality, there were no such ghosts, wrote Stiglitz. Not only had inflation fallen, wages had only risen slowly relative to prices (meaning, they were not spiraling) and inflation expectations remained under control.
Stiglitz isn’t even really worried about inflation. This mainly relates to the targeted inflation rate of 2 percent. For him, fluctuations in inflation of between 2 and 4 percent would not have a significant impact on the US economy. On the other hand, given the need for structural changes in the economy and strict reductions in prices, a slightly higher inflation target should be considered.
‘Cyclical tightening shock’
So, Stiglitz warns, the Fed had been “barking” wrong about inflation. Not barking does not mean the plane will crash or the imagined dangers from inflation will go “crazy”. What Stiglitz is actually worried about is the deepening effect of injustice resulting from this mistaken “barking”.
The Fed’s tight monetary policy has enriched bankers without having to work hard. The Fed has to pay commercial banks 4.4 percent interest on the more than US$3 trillion in its reserves, amounting to more than $130 billion a year. The problem doesn’t just end there. The Fed’s monetary tightening has and will continue to have a detrimental effect on developing economies. This policy has created global economic vulnerability.
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Not only has it prompted a global recession, but it has also precipitated further crises when debt-laden developing countries have had to face the triple whammy of a stronger dollar, low export earnings, and high interest rates.
All this has given rise to human irony and “geopolitics” at the same time. After allowing the deaths of many people due to its reluctance to share its intellectual patents for Covid-19 vaccines, continues Stiglitz, the US has instead adopted a policy that will sink the world’s most vulnerable economies. This, said Stiglitz, is not a smart strategy for a country waging a cold war with China.
However, the problem for developing countries, including Indonesia, appears to be more complex than Stiglitz describes.
This complexity can be approached through the phrase “cyclical tightening shock” (tight monetary policy shock cycle). This phrase, coined by Ozge Akinci, Gianluca Benigno, Serra Pelin, and Jonathan Turek in The Dollar’s Imperial Circle (2022), reveals the bad consequences of the US dollar’s increasingly dominant role in the global economy. Here, the four researchers place the structural problem on two key asymmetries between the US economy and the global economy.
First, a discrepancy can be seen from the use of the dollar in the international monetary system, which is disproportionate to the size of the US economy relative to the world economy. Second, due to the relatively limited influence of the US economy on world economic development compared to its trading partners, the sensitivity of the dollar to US foreign trade is relatively smaller. The strengthening or weakening of the US dollar therefore does not really affect the US’s domestic economy.
Conversely, this development is detrimental to its trading partners, especially developing countries. In sum, from the dominant currency paradigm (DCP) perspective, two main points need to be emphasized. First, companies in developing countries are more inclined to set their product prices in US dollars. (This has a major influence on our domestic politics and economy.)
Second, the US economy is increasingly shifting from the manufacturing to the service industry. This means that not only is the US de-manufacturing, but also, because it is shifting to the service sector, it is experiencing decoupling from developing economies, which, to escape the middle-income country trap, are relying more and more on manufacturing.
As a result, for developing countries, the US is no longer an engine of growth because a higher quality, service-based economy requires fewer products from developing countries. This is where the problem lies. Meanwhile, in the context of the real sector, the US is increasingly breaking away from the world economy, including developing countries, as the role of its currency deepens as a global means of payment.
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Quoting Mark Carney, the four researchers see the phenomenon of an unequal world monetary system of “the growing role of the dollar and the diminishing weight of the US economy”. Structurally, the imbalanced role of the US dollar and the real sector in the world economy creates a “darker” situation for developing countries. This happens because the dominant role of the dollar has infiltrated the entirety of the global economic network. US dollars are not only used for world trade transactions, but are also enforced intensively within the international network of credit systems.
All this, according to Akinchi, Benigno, Pelin and Turek, has created a contradiction of interests between developing countries that base their economy in the manufacturing sector and the inherent power interests of US dollar. “A stronger dollar rate,” they write, “undermines global manufacturing trade and global manufacturing output through these channels.” And the dollar has actually benefited from weakening development in global manufacturing.
This is where the significance of the “cyclical tightening shock” lies. While the US’s domestic economy is not affected by the fluctuations in the value of the dollar, the dollar’s dominance in various aspects of the global economy has caused it to be a driver of its appreciation. In other words, through its currency’s increasing dominance, the US not only has no interest in pushing the world’s manufacturing economy, but also benefits increasingly from the de-manufacturing process.
Indonesian politics-economy 2023
It is from this last perspective that we can understand Stiglitz’s triple whammy above. As long as the Fed is still “barking” because it has misperceived the “scourge” of the phenomenon of inflation in the country, the economies of developing countries will also suffer from its tight monetary policies.
Under the “Dollar Empire” (Dollar’s Imperial Circle), to borrow a term from Akinci et al, the Fed’s tight monetary policy will only lead to increasing the debt of developing countries. This is because, apart from being a consequence of its shift to the service sector, US economic development has not had a constructive impact on developing countries. This policy has also stimulated the appreciation of the US dollar and increasingly swelled developing countries’ debt, which is generally denominated in US dollars.
Away from the Russia-Ukraine war, the phenomenon of the Dollar Empire seems to be more “sedentary”. This has the potential to create political and economic problems in Indonesia in 2023 and beyond. In large part, this has to do with the limitations of our fiscal capabilities.
Nufransa Wira Sakti’s article, “APBN Works Hard for the People” (Kompas, 3/2/2023), shows the “brilliant” success in managing the allocation of fiscal power throughout 2022 to save the national economy under the pressure of the pandemic and the Russia-Ukraine war. However, this article also shows how dependent our economy is on the state budget.
The question is, in the midst of the Dollar Empire situation, which is almost constantly causing cyclical tightening shocks structurally, will the resources that sustain fiscal strength in 2022 continue this year and next?
In the context of ideology, Indonesia is relatively “lucky” in terms of fiscal policy. The absence of conflicting left- or right-wing views in our country has kept the country free from the dilemma of fiscal use. As described by Vitor Gaspar, Sanjeev Gupta, and Carlos Mulas-Granados in Chapter 1 of Fiscal Politics (2017), countries that are plagued by left-right disagreements must take great pains to convince their supporters to determine the scale of budgetary use.
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High public spending means increasing taxes, which suppresses the capitalists’ interests. Conversely, low public spending hits the interests of ordinary people. Nufransa’s illustration of the State Budget shows that President Joko “Jokowi” Widodo’s administration is not constrained by this ideological conflict. Nevertheless, under the regime of the Dollar Empire, which appears to be “sedentary” once again, three main points must be seriously taken into account.
First, the bite of the “empire” will be felt on the resilience of our foreign exchange. Along with the protracted war in Ukraine, imports of consumer goods and the cost of manufacturing support materials and services will be higher than last year. Second, even though the global growth forecast is not as bad as previously thought, there is potential for a decline in export demand related to the resilience of our foreign exchange.
Third, in relation to the two issues above, our economy theoretically has the potential to experience imported inflation (inflation from high import costs). Remember that rice, too, must be imported, so this imported inflation can spread to core inflation. It is in such a situation that the space for fiscal flexibility in 2023 and the following years might not be as large as it was in 2022.
Fiscal and political years
For the time being, there are at least two sources of our optimism for this year and the next. First, in the technical and professional context is Bank Indonesia (BI)’s economic growth forecast for this year. Our economy is healthier because its growth depends on not only exports, but also increased private consumption, while inflation is under control.
Second is politics and leadership. The influence of Jokowi’s leadership has actually increased during this political year. We hope that this influence can also be projected onto controlling fiscal power in 2023 and 2024. For theoretical reasons, this is important to note, especially because it relates to what Gaspar, Gupta, and Mulas-Dranados called “political fragmentation” in Fiscal Politics.
In that publication, they define political fragmentation as a coalition government or a big cabinet. Their research results show that within this coalition government, the biggest obstacle is disciplining fiscal use. Because each minister controls their ministry’s spending, there is a tendency for cabinet members that hail from various parties to reject fiscal adjustments that will affect the degree of their control over fiscal resources, and these are related to fluctuating support for their respective political parties.
Meanwhile, the need for funds in the “political year” has increased for cabinet members in the coalition government. Here, to safeguard the Indonesian economy, the influence of Jokowi’s leadership must be strengthened in controlling fiscal policy until 2024. This will be the “sweet” legacy he leaves for the new president who replaces him.
Fachry Ali, Cofounder of the Institute for the Study and Advancement of Business Ethics (LSPEU)
This article was translated by Kurniawan Siswo.
