Avoiding Economic Slowdown
A few months ago, Larry Summer, the former secretary of the United States treasury, called this year as “the most dangerous moment since the 2008 Financial Crisis”.
Bloomberg Economics in October a model to determine the likelihood of a financial crisis in the next 12 months. According to its December calculations, the chance of the US heading into a recession in the next 12 months is 29 percent, up slightly from 27 percent in November.
Despite the increased risk of recession, the signs of negative returns that have haunted US financial markets have begun to subside. In fact, the latest developments indicate a positive trend, meaning that the yield on short-term debt securities is lower than long-term yields.
The pressures on financial markets have subsided, but not in the real (industrial) sector. The Purchasing Managers’ Index (PMI), an indicator of the real sector, is below 50, meaning that the economy is slowing down. Even if there is no recession in 2020, the global economy will still experience an acute slowdown.
The problem is that stimulus can no longer be provided because almost all the ammunition has been used up. Interest rates cannot be reduced anymore because they are already too low, while fiscal incentives can no longer be provided because government debt is already too high. In fact, some countries already have negative interest rates, such as minus 0.25 percent in Sweden, minus 0.75 percent in Denmark and Switzerland and minus 0.1 percent in Japan, as well as the European Central Bank (ECB) at minus 0.5 percent. Meanwhile, the ratio of government debt to the economy (debt-to-GDP) in developed countries is very high. For example, Japan has reached 238 percent, Greece 181 percent, Italy 134 percent and the US 106 percent.
Even when the interest rates are negative, the economy has remained stagnant. Under such circumstances, stagnation will cripple the supply side (supply side crisis), while the impact of the 2008 crisis that undermined the demand side has not been completely resolved. As a result, the global economic slowdown will be long and the future will be marked by uncertainty.
The executive director of the International Monetary Fund (IMF), Kristalina Georgieva, said in her inaugural address on 1 Oct. 2019 that the global economy was experiencing a slowdown as a whole (synchronized slowdown). The impact would spread to all countries, without exception.
Two disruptions
Why is the global economy stuck and barely moving? The US-China trade war is often cited as the core problem that has caused various and broad implications, starting from decreased trade flow, declining investment and slowing production, to the decline in global growth.
The protectionist stance of US President Donald Trump is apparently not an anomaly. On the contrary, it is a phenomenon that has emerged in many countries. Boris Johnson’s victory in the UK election will accelerate Brexit. The development of anti-globalization politics complicates global economic recovery because coordination is no longer possible.
Economic policy cannot overcome stagnation because the problem stems from the political situation. Since the 2008 crisis, the world has faced two major disruptions. First, ultra-nationalism continues to disrupt politics and spread to many countries, especially in Europe and Latin America. The crisis has dramatically changed the people\'s awareness of globalization, indicating that signs of deglobalization are emerging.
As the production and capital of labor can no longer be maximized, the reliance on technology is very high.
Second, the technology disruption has accelerated innovation and given birth to Industry 4.0. In developed countries, the crisis is a condition of declining economic productivity due to declining labor productivity as the result of an aging population. As the production and capital of labor can no longer be maximized, the reliance on technology is very high.
As a result of this crisis, the people in developed countries tend to distrust banks and financial institutions. This has resulted in the emergence of a type of intermediary (peer-to-peer) who is anti-technology.
These two disruptions have drastically altered the direction of the global economy and repositioned the globalization trend. First, globalization in the future will be accompanied by an economic slowdown. The Economist magazine (24/1/2019) refers to this phenomenon as “slowbalisation”.
Second, globalization in the future will be colored by a variety of technological developments, in paricular robotics. Richard Baldwin writes in The Globotics Upheaval (2019) that globalization and robotics will be more intensive going forward.
In fact, the role of technology as a factor of production can only be maximized if a sufficient innovation ecosystem exists to boost productivity.
In facing an economic slowdown, technology is often relied upon to overcome short-term problems. In fact, the role of technology as a factor of production can only be maximized if a sufficient innovation ecosystem exists to boost productivity. In developed countries, adopting technology has not led to an increase in national production output.
Technology has improved the quality of life, but it has not increased production output. What is the impact on developing countries? “The Innovation Paradox” (2017) by the World Bank book explains that technology will have a greater impact on developing countries through increased productivity that leads to an increase in production output.
However, the role of technology tends in developing countries has tended to be suboptimal due to limited skilled labor, unsupportive regulations and a less competitive environment.
As a result, the role of technology in developing countries appears to be a paradox. If we look at the condition of the domestic economy, there is doubt that technology in helping to drive economic growth.
Indonesia ranks 50th out of 141 countries in the 2019 Global Competitiveness Report, or lower by five ranks from 45th in 2018. Indonesia ranks 72nd in technological adoption, while it ranks 74th in innovation capability. It seems that the appropriate ecosystems have not been created, so technology cannot play a maximum role in boosting domestic productivity.
Anticipating impacts
The symptoms of the global slowdown are beginning to affect the domestic economy. Growth again slipped in the third quarter of 2019 to 5.02 percent, the lowest third-quarter growth rate since 2016.
Because of this pressure, growth in 2019 is unlikely to reach 5.1 percent. Indonesia has been stagnant in the range just 5 percent for more than five years of economic growth. Due to increasing global pressure, growth is expected to continue to decline in2020. Moody\'s projects that the economy will grow only 4.7 percent in 2020 and 4.8 percent in 2021.
The most important policy agenda in facing this situation is how to avoid the cycle of economic slowdown. Mitigation is needed so that growth stays above 5 percent. Fortunately, there is still relatively wide room for maneuvering in policy.
Bank Indonesia\'s benchmark interest rate is 5 percent and the debt-to-GDP ratio is 30 percent, while the budget deficit is below 2 percent of GDP. Thus, the monetary and fiscal policies can still be enhanced to pump-prime the economy for optimal growth.
Even so, the key is the real sector. Success in the real sector can be seen from an increase in economic output without altering the production inputs; in other words, an increase in productivity. Fiscal and monetary policies only facilitate improvements in economic productivity.
Increased economic productivity is determined by the factors of capital, labor and technology in production. Thus, the question is how the national policies are oriented towards increasing the supply of capital, along with increasing the skills of the workforce and accelerating the adoption of technology.
The government\'s plan to issue an omnibus law for taxation and job creation is actually a strategy to attract foreign investors to the country. The entry of foreign investors will bring in factors of production, such as significant amounts of additional capital, managerial skills and advanced technology. All three factors are expected to contribute to the dynamics that encourage increased national productivity.
Data from the Investment Coordinating Board (BKPM) show that investment realization in the third quarter of 2019 reached Rp 205.7 trillion (US$14.69 billion), up 15.4 percent from last year. The realization of foreign direct investment (FDI) rose 17.8 percent year-on-year (yoy) to Rp 105 trillion, while the realization of domestic investment (PMDN) rose 18.9 percent yoy to Rp 100.7 trillion. The issuance of the omnibus law is expected to increase both foreign and domestic investments further.
Foreign and domestic investments must both receive equal attention to continue their increased contribution to the domestic economy. In Q3 2019, investment grew 4.2 percent and contributed 32 percent to GDP. In comparison, consumption grew 5.1 percent and contributed 56.52 percent to GDP.
In Vietnam, which has been very aggressive in attracting foreign investment, total investment was only 26 percent of GDP at the end of 2018.
The role of investment in contributing to the Indonesian economy has been relatively large. By comparison, the ratio of total investment in Thailand declined from 27 percent of GDP in January 2019 to 21 percent of GDP in September. In Vietnam, which has been very aggressive in attracting foreign investment, total investment was only 26 percent of GDP at the end of 2018.
Our economy has two fundamental weaknesses. First, the trade deficit reflects the low competitiveness of national products. The balance of trade suffered a deficit of $1.33 billion in November, the worst since April 2019. Second, the dependence on foreign capital has resulted in increased obligations to external parties in the form of dividend payments, interest and debt service costs.
The current account deficit is evidence of these weaknesses. There is no quick fix for these weaknesses other than increasing national productivity and competitiveness. The problem is that overcoming these two problems is not easy at all and it also takes a long time, while the short- to medium-term threat is very real.
The key is to employ the monetary, fiscal and real sector policy instruments proportionately. We can see that the combination of monetary and fiscal policies has played out relatively well. However, policies in the real sector have yet to cause a dynamic impact. It seems like a great irony that President Jokowi talks a lot about developing the real sector, but the relevant ministries are filled with politicians. It could be that a successful economic policy must begin with a reshuffle in those ministries that manage the real sector.
A Prasetyantoko, The rector of the University of Atma Jaya, Jakarta