Technology Disruption, Public Expectation, Policy Credibility
In the language of economic science, the term of technology disruption or Industrial Revolution 4.0, which is marked by advances in information technology, computing, smart robots, and genetic engineering, can be translated as technological changes or advances that can give birth to widespread behavioral changes in economic activities, industrial organizations and public policy making processes.
This revolution is actually a repetition of previous industrial revolutions. In the first industrial revolution, the invention of steam engines shifted the portion of human and animal power use to engine power. The second industrial revolution was marked by the invention of electrical energy and an external combustion engine. This invention changed the face of transportation and communication with the emergence of automotive vehicles, airplanes and telephones. The third industrial revolution was marked by the emergence of digital technology and internet, whose use has triggered an industrial management reorganization that threatens the continuity of conventional industry/business in the Industrial Revolution 4.0.
Disappearing market and public policy
In algebra there are simple rules. If there are, for example, five unknown numbers, five equations (or more) are needed to find the value of each unknown variable (fully identified). In public policy practice, this rule is often referred to as Tinbergen Rule (1952). If, for example, there are only four equations (underidentified), one variable must be determined freely outside the (exogenous) system arbitrarily.
This comprehension was used by Dornbusch (1976) to describe the fluctuation of currency values beyond its "fundamentals" with its Overshooting model. This model explains that currency exchange rates can roam everywhere before settling on their true balance.
The problem is that it is difficult to know the value of its real balance because both the demand and supply of foreign exchange currencies contain a component of expectations. The currency value will be highly depreciated before strengthening again, like the movement of rupiah over the last eight months which shows description of this phenomenon.
The overshooting phenomenon has frequently been debated simply by seeing the nominal exchange rate as a crisis even though the movement of the exchange rate from Rp 2,500 to Rp 15,000 per US dollar in 1998 was clearly different from the movement from Rp 13,400 to Rp 15,200 per US dollar in October and November.
The disappearance of one equation in the overshooting model, where an arbitrary solution of one endogenous variable, which is made exogenous, is needed, implies the existence of a problem of a missing market. The rupiah exchange rate in the domestic market has always been at the mercy of the non-deliverable forward (NDF) market in Singapore. NDF is a hedging tool for business people against exchange rate fluctuations. As a proxy for future exchange rates, NDF in Singapore affects the spot rate in the country through the expectation path. The action of Bank Indonesia to introduce domestic NDF (DNDF) with a range (spread) lower than 50 rupiah is very proper in overcoming the "missing market" so that the future value of the rupiah is no longer like a wild ball.
The weaknesses of Indonesia\'s economic structure in the service sector and in the industry producing inputs and semi-finished products for the downstream industry is also analogous to the missing market problem. This missing market is filled with short-term capital inflows, which rise and fall and go in and out, affecting the rupiah exchange rate. The lesson from the above description is that a credible anchor is badly needed to overcome the missing market. Resolving the missing market problem can also be done by making policies that are considered credible (agreed upon) by various interest groups (time consistency).
The time consistency problem was first introduced by Kydlan and Presscot (1977), who won a Nobel prize in 2004. Every policy planning and policy implementation is an interaction of various interest groups, especially the government and those to be potentially affected by the policy. In the language of game theory, the balance is determined by the meeting of the reaction functions of all players.
The time inconsistency problem happens if there is a change in the preference of one or all parties in the interest groups in any part of the policy cycle, starting from planning, declaration, implementation, supervision, to evaluation. The Negative Investment List (DNI) case shows that a policy modification is needed if there are parties who feel the time is not right or disagree with it. This case shows that a feedback can occur in any part of the policy making process.
Double balance
In the 1960s the rational expectation concept was introduced by John Mut (1961). After being enriched by Robert Lucas in 1972 (winning the Nobel in 1995), the hypothesis of rational expectations challenged the concept of adaptive expectations which at that time was still the main stream of economic science literature. The concept of rational expectations considers the economic actors as a portable computer which can use all available information to look forward.
Unlike the adaptive expectations that only look information backward from the variables that are being sought for expectations, the rational expectations that look forward act like a mathematical formula to describe the behavior of people in the "future." At that time, it was difficult to imagine that economic actors were able to carry out economic disruption simply because of something that had not happened yet, which was still in the mind. However, now, with the advancement of communication technology where practically everyone holds a small computer in the hand, which has been mistakenly called a mobile phone, the realization of the rational expectations which was postulated by the theorists in the 1980s is commonplace.
Different from the model with the missing equation above, what is happening now is too much information so that it has to be filtered out which is really relevant. Public information being received is analyzed personally with different reactions according to their ability to absorb and process information. In the simple language of algebra, there are more equations (over-identified or redundancy) of the variables whose values must be searched for. This condition is called multiple equilibria or double balance, which is reflected in the habits of several institutions, for example, to issue projections of growth in a wide range.
The large amount of information can cause confusion (multiple equilibria) as happening in the US stock market in October and November 2018. Usually there was an inverse relationship between interest rates in the US and stock prices, but as anomalies also occurred even though the interest rate had been raised, there was an oddity in the US stock market with the increase of the Dow Jones Industrial (DJI)
index. This phenomenon occurred because of euphoria that the US would again become the main force of the world manufacturing industry after the new US, Mexico and Canada (USMCA) trade agreements were signed.
The increase in the interest rate of the US central bank (The Fed) subsequently triggered a rise in mortgage interest rates to the highest in the past seven years in the US. This is in accordance with the predictions of economic theory. What is interesting then is that these two contradictory cases have caused confusion among investors in the US about the relationship between interest rates and stock prices. As predicted by the hypothesis of rational expectations, investors look forward (forward looking), but due to the large amount of information obtained through their electronic gadgets, they are confused whether to sell, buy, or hold their shares. High interest rates are a sign that the higher cost of funds will lead to a slowdown in economic growth.
As an addition, even though macro data, such as the rate of unemployment, economic growth, and inflation, shows the economy is in good condition, they still feel uncomfortable. Besides the mortgage interest rate that is considered too high, a part of the investors feel uncomfortable with how the government is run.
This confusion was recorded by several online media headlines that questioned whether there would immediately be a recession with such a high mortgage rate. As is known, the housing sector with a broad forward and backward linkage is a sign of the beginning of where the economy will move.
Led by the fall in prices of technology stocks, this concern came into reality when on October 10, 2018, the DJI\'s average index dropped more than 800 points in one day. The fall in share prices happened again on October 23 when the DJI dropped again by 500 points. It seems that the investors were balancing their portfolios from the fact that they had flocked to the US due to the prospect of escalating trade war between the US and China, but started to turn back to emerging market countries, including Indonesia. The victory of the US Democratic Party in the House in the midterm elections in early November 2018, which was interpreted as bad news by US portfolio investment investors, also helped strengthen this trend.
The next interesting thing is that bad news in one country can be good news in other countries. With various domestic factors, such as the increase in BI\'s benchmark interest rate, which tried to move ahead of the curve, the maintained growth and inflation made the rupiah be positively affected. The rupiah strengthened from around Rp 15,200 in mid-October 2018 to around Rp 14,300 per US dollar at the end of November.
The series of planned increases in the Fed\'s interest rate and the fall of the US stock price index in October-November 2018 make several financial institutions in the US predict that US economic growth will slow down significantly from 3.5 percent in 2018 to 1.75 percent in 2019, which of course will have an impact on world economic growth. This has got attention from President Trump who has an interest in the US economy to experience expansion as long as possible. Trump then criticized the head of the Fed openly through Twitter, stating that as president he regretted promoting someone like Powell, who is proven to be "happy" to increase interest rates.
This statement is considered quite credible because Trump is listed as a president who often replaced his subordinates who were considered not in line with him. The Central Bank Act does open the opportunity for a president to replace the central bank governor with "certain reasons." This certainly
disturbs the tradition of US central bank independence. However, what happened later was that at the end of November 2018 Powell signaled that the series of interest rate increases in the US would soon be over.
The US stock market gave a positive response with the DJI index increasing 617 points a day after Powell\'s statement, thereby erasing the previous point decline. Other countries, including emerging markets, are also exposed to the positive sentiment. Unlike the previous case, capital continued to flow to other parts of the world because investors began to balance their portfolios again. The lesson which can be obtained here is the progress of information technology, which makes investors in the US confused due to the uncertainty caused by the Fed\'s planned increases in the interest rates, was challenged by a statement (announcement) using technology, which is produced by the technological disruption as well. Public communication like this has never happened before.
Policy credibility and basic capital (”initial condition”)
The world, which was imagined by the hypothesis of rational expectations 40 years ago, arrived here with the help of electronic gadgets. Lucas (1972) warned that with the amount of information that exists now makes rational expectations can create a situation of policy irrelevance where a policy becomes ineffective. In more recent cases, too much information can cause confusion that has the potential to create multiple equilibrium that can also make a policy ineffective.
Therefore, the government must be able to move ahead of the curve or expectation realignment with expectations from various interest groups which are already aligned (time consistency). The government or private sector requires monitoring units that have data analytical capabilities using available real time data in the form of big data. Its goal is to be able to identify the seeds of expectation that develop in the community, if necessary to take preemptive action to provide information to guide the expectations and distinguish between the right and the hoaxes. Such units must be filled by human resources who have quantitative (mathematics) reasoning, which is verbal, innovative, problem solving, looking forward, and able to work together in groups. Human resources like this should be produced by the national education system.
The concept of reputation and policy credibility (Barro and Gordon, 1983) extends the concept of rational expectations towards the importance of determining credible policies. As an illustration, in the example of strengthening the current account structure, for example, the policy of making new tourist destinations outside Bali must be linked to good basic capital. The travel balance in 2017, for example, reached a surplus of US$4.2 billion. One of the initial implementations was the launch of the Joglosemarkerto round-trip train, whose routes cover big cities in Central Java and Yogyakarta across a variety of attractive tourist destinations which are a combination of various aspects, such as culture, culinary, history and natural scenery. A concrete example like this will help strengthen the credibility of a long-term target of generating foreign exchange from tourism.
As in developed countries, inclusive tourism is an effort to improve the standard of living of the surrounding community. Therefore, the toll roads that have been inaugurated need to be equipped with maps (print and electronic) and road directions to tourist, culinary and lanes to destinations with beautiful scenery for scenic driving. For example, alternative paths from former colonial plantation roads to the east of Mount Merbabu to Boyolali and surrounding areas have beautiful scenery that is not yet known to the public.
In the next example, secondary income in the service balance sheet is good capital to strengthen the current account. In 2017 secondary income recorded a net surplus of $4.5 billion. This is the secondary income from Indonesian workers (TKI) abroad, including migrant workers. To increase the surplus, Indonesia needs to change the structure of migrant workers towards vocational staff, such as nurses, welders, cooks, and crew members. The credibility of the policy to improve the quality of Indonesian human resources by improving the quality of education will be more credible if it is associated with efforts to strengthen the service balance sheet.
In other cases in neighboring countries, such as Singapore, Malaysia and South Korea, the international ranking of higher education is used to improve the name of the state and nation, increase national productivity, and generate foreign exchange by receiving international students. Accreditation and assurance of quality of learning, basic and applied research, transparent career paths, collaboration with reputable universities, the use of information technology in planning and learning, curricula relevant to the world of work and autonomy are the keys to the success of policies for the credible quality improvement for human resources. (Ari Kuncoro, Professor and Dean of the Economic and Business School, University of Indonesia)
