Winter or a Snow Storm

HERYUNANTO

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“Shivering, frozen mid the frosty snow in biting, stinging winds; running to and fro to stamp one\'s icy feet, teeth chattering in the bitter chill,” reads the sonnet that accompanies Antonio Vivaldi’s Winter Concerto.

It was never discovered who penned the sonnet. Perhaps it was Vivaldi himself. In this extraordinary piece of music, we can truly feel Vivaldi’s expression of the bitterness of a freezing winter. After all, winters are typically seen as harsh, dark and unfriendly.

It is unsurprising, then, that President Joko “Jokowi” Widodo used this metaphor two weeks ago in his speech at the IMF-World Bank Group (IMF-WB) Annual Meetings in Bali. He reminded world leaders that “winter is coming”. He is right. His metaphor became even more relevant when we read US Vice President Mike Pence’s speech earlier this month. Pence did not only say that winter is coming – he said that a snow storm was imminent.

In reporting Pence’s speech, The New York Times used the gloomy headline, “Pence’s China Speech Seen as Potent of ‘New Cold War’”. Pence’s speech seems to imply that the problem between China and the US is more than a trade war. It is about the rivalry between two major countries. If this is indeed the core problem, then no end will be in sight for the Sino-US trade war. Furthermore, its tremors will shake the whole world, and Indonesia will feel its repercussions.

Impacts of the trade war

On the other hand, as I wrote in this daily (8/15/2018), the US will continue to normalize its monetary policies. Pressures on the rupiah will also continue. The US Federal Reserve may increase its interest rates once more this year, and twice or thrice next year. By the end of 2019, the Fed’s interest rate may be 3.25 percent or even 3.5 percent, depending on US inflation and budget deficit. I expect Bank Indonesia will also increase its interest rate to maintain interest rate parity (IRP).

All this means that we need to prepare for three things: the continuing rupiah depreciation, interest rate hikes, and rising inflation. Businesses will be under more pressure. On the one hand, the rupiah depreciation will lead to higher production costs; on the other, purchasing power will be pressured by higher prices. A slowdown in the economy can be expected in 2019 and 2020. This will not be easy.

What about Indonesia, then? First, we need to see how this trade war will impact the global economy. OCBC Bank, for instance, uses a quantitative simulation model. If the US imposes import tariffs on Chinese products worth US$250 billion, China’s economic growth will shrink 0.5 percentage points (say, from 6.5 percent to 6 percent. Through their quantitative model, Australian National University’s Warwick McKibbin and Andy Stoeckel have forecast a global recession if the US increases its import tariffs by 40 percent. McKibbin and Stoeckel show that China will suffer more than the US, and we are even beginning to see this trend today: China’s economy has slowed to only 6.5 percent in the third quarter this year.

Are these figures accurate? I am not an expert forecaster. However, we can be sure of one thing: the trade war will have negative impacts on global economic growth.

What about Indonesia? Here, I wish to exercise caution. The trade war will impact countries through trade. Countries enjoying a high level of trade with the US, China or the global economy will suffer the most.

We can thus expect that the trade war might have smaller impact on Indonesia that on Singapore, Malaysia, Thailand or Vietnam. Why? Trade only contributes 30 percent of Indonesia’s gross domestic product (GDP). Compare this to Singapore, with its trade-to-GDP ratio of more than 200 percent, or to Malaysia, Vietnam and Thailand, each with a trade-to-GDP ratio of more than 100 percent. However, this does not mean that our economy will be entirely unaffected. Why?

Herein lies the second reason: The trade war will still affect the Indonesian economy because of the country’s trade relations with China. Together with the Philippines, Indonesia is an important supplier of raw materials and intermediate products in China. The US tariffs on Chinese products may decrease China’s demand for Indonesian materials and products. Furthermore, over 40 percent of Indonesia’s exports to China are mining products, cooking oil and palm oil. As we know, the second-quarter improvements in exports, tax revenue and household consumption were due to an increase in the price of coal and palm oil. Declining demand for these products will affect our economy. Aside from this, the economic slowdown in China will lead to a slowdown in Japan, which will, in turn, affect Indonesian exports to Japan. In short, our exports will be affected.

Third, earlier this month, the US, Mexico and Canada signed a new trade agreement called the USMCA (United States-Mexico-Canada Agreement). Interestingly, Article 32.10 in the agreement stipulates a “punishment” for USMCA members for signing other agreements with countries deemed “non-market economies”. Despite the term’s vagueness, we can guess that “non-market economies” refers to China. If the US adopts this article in its other trade agreements, I can imagine how complicated things will become. The Regional Comprehensive Economic Partnership (RCEP) Agreement that Indonesia initiated, for instance, would become hard to implement because it involves China.

Fourth, Indonesia’s economy has grown steadily at 5 percent annually over the past four years. We must appreciate this amid the global economic challenges. The government has made the right decision to focus on infrastructure development. However, we need to be honest: 5 percent economic growth is far from adequate. We need faster growth, and sooner. We will have an aging population by 2060. Without accelerated growth, there is a chance we will grow old before we can prosper. Unfortunately, the trade war will affect our exports. Furthermore, the interest rate hikes, the rupiah depreciation and the risk of higher inflation will pressure the domestic economy.

Preparing for the storm

What can we do? Can Indonesia benefit from this trade war? Is there not a possibility of investors leaving China for better opportunities elsewhere, including Indonesia, to access the US market? Such possibilities will open only if we attend to several matters, such as improving the investment climate, especially in our regions. We also need to revise our Labor Law. A rigid law that mandates higher severance pay than our neighbors will drive away investors from labor-intensive industries towards the natural resource and other capital-intensive industries.

Consequently, the labor wage relative to capital owners will decrease, which more or less explains the existence of gaps. This also explains why the contribution of the manufacturing industry, especially labor-intensive ones, to GDP is declining. In contrast, Vietnam is growing more attractive in its labor-intensive industries. Our employers also prefer contract and informal workers – who are mostly unskilled women and children. Should we sacrifice our workers then? Absolutely not.

KOMPAS/HERU SRI KUMORO

Muhamad Chatib Basri

We can help our workers by protecting their real wages, for instance by lowering their living costs. Providing affordable apartments for factory workers could reduce their housing expenses. The issue is whether the government is brave enough to revise this law. Politically, it will not be easy, especially as we are heading into an election year. We still remember vividly how the fuel subsidy hike policy only lasted a few hours. A revision of the Labor Law will be equally sensitive. This is despite the fact that, if the law is not amended, investors will always pick Vietnam over Indonesia. The reason is simple: Vietnam has been preparing to enter the Trans-Pacific Partnership (TPP) that fully adheres to US standards – the US being a member of that partnership until recently. Or perhaps Chinese investment, especially in manufacturing, will go to Thailand instead.

As President Jokowi said, winter is coming; perhaps even a snowstorm. We may be heading towards a terribly long and cold night. We need to have the proper warm clothes. We need to maintain our routine and use our energy wisely so as not to lose our stamina quickly. We must be wise and daring in making hard choices. We cannot always rely on populist policies.

I am reminded of former UK Finance Minister Nigel Lawson’s words: “To govern is to choose. To appear to be unable to choose is to appear to be unable to govern.” Lawson is right.

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