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Indonesia Economy: A Misleading Focus


This is what first year university student says about the importance of human and physical capital as the main measures of economic development. To read the original article, please visit the writer's website. Enjoy the article!



Indonesia Economy: A Misleading Focus, by Sean Taher, Birkbeck University of London, major in Economics & Social Policy.


“We are able to produce millions of motorcycles, but we forgot to produce the roads.”


When I went to China for the first time as an intern for Red and White Consulting Partners LLP, I was assigned to research into China`s macroeconomic surface analysing the credit card market. Surprised by the data I observed, I began to compare these data with Indonesia`s economy. What I found was not surprising.


Most advanced economies have the component of consumption as the largest contributing factor to their GDP. The United States has consumption to be 68% of the GDP, the UK consists of 56% of their GDP, and Germany has a figure of 55%. But in the countries that are classified as “Emerging Market”, they too have a similar characteristic. Turkey and Mexico’s consumption level are 69% and 68% of their current GDP respectively.


Both have high level of consumption, which signifies as a growth of the consuming class which can possibly translate as a result of a higher standards of living. One would argue that it is an indicator of a developed economy, where there is a high level of consumer base and has become the main driver of growth. But can this consumptive model sustain in the long run that would be viable in creating, not just higher growth, but development in the economy?


Table 1. Cost Push Inflation Based on Aggregate Supply & Aggregate Demand Trend



Source: Sean Taher, August 2015



What do I mean by development? While it does include economic growth, it also measures other aspects of the economy that are usually overshadowed by GDP. Economic development includes the improvements in infrastructure and the human capital of the workforce two of which I regard to be the crucial foundations of an economy. It measures economic progress in the qualitative sense. In Robert E. Lucas’s paper, he stated that both human and physical capital are the main measure of economic development.


Economists will say that consumption increases economic growth and thus increases employment as businesses sees opportunity. But it does not equal to the development of new technology nor even push the economy to have higher capacity. Consumption consumes, not produces.


Indonesia has a consumption level of 56% of its GDP, making it one of the best place to invest. It has a fast growing number of consumer and middle class people. When economic growth is high, inflation rates in Indonesia are also high and can sometimes be higher. Many would accept this as it shows an economy is growing. A demand pull inflation will usually ensue when growth occurs. But it can be argued that it is a cost push inflation instead where it is due to a supply restraint. This may be due to the lack of capable infrastructure bottlenecks the activities of the economy which increases costs in the economy. It is one of the fundamental problem in Indonesia today, where logistics cost can make up to 25% of the production cost alone. The economy today is overusing the capacity of roads, ports, and train to transport.Trucks today are being used over its weight limit, increasing the maintenance cost and consuming more time thus it is cost push inflation.


Table 2: Inflation Rate in Indonesia Year 2004-2014




Source: Sean Taher, August 2015


Economic growth is then restraint due to the low quality of infrastructure and human capital that hinders productivity and growth. The government must create a shift from consumption towards investment, as it is required to solidify the progress of developing the foundations of the economy. Subsidy on fuel can be redundant as it only reduces expenditure of other parts in the economy, and it does not increase the capacity to produce fuel but only reduces the price, straining investment in the economy. Of course, if we sacrifice the production of consumer goods for capital goods, we will be worse off in the short run. But, in the long run it will create a larger benefit than the short run benefit of consumer goods.


If we take the example of China, its consumption level is only at 38% of GDP and has a higher contribution of economic growth from its investment. In theory, since investment increases the capacity of the economy, China’s ability to grow is then unhindered. Resulting in a lower inflation rate, consistently slower than GDP Growth Rate.


Table 3: Inflation Rate in China Year 2004-2014



Source: Sean Taher, August 2015


In my opinion, what I see in Indonesia today is that the indicator of progress and development is seen by the ability of the population’s purchasing power indicating higher living standards. Economic growth is then focused as it identifies the expenditure of an economy, reflecting the income of the individuals. But we must not forget that in order to have more of one thing, sacrifices must be made by the other. And so this is the problem where I see a large opportunity cost has been made, especially in Indonesia, where consumption is contributing more growth than investment.


Reference:

Lucas, Jr., R. (1988). On the Mechanics of Economic Development. Journal of Monetary Economics, 22, pp.3-42.

#MacroEconomy

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