On the Brink of Recession?

AFP/CHINA OUT

A Chinese bank employee counts new 50-yuan notes with a money counting machine at a bank counter in Hangzhou in China\'s eastern Zhejiang province on August 30, 2019, as the People’s Bank of China issues the newest 2019 edition of the fifth series of the yuan notes. - China\'s currency slid on August 26 to its weakest point in more than 11 years as concerns over the US trade war and the potential for global recession weighed on markets.

Flavio is his name, a taxi driver in Milan. He is below 40 year olds. He drove me from Malpensa Airport in Milan to Bellagio.

In a sad tone, he complained about the increasingly difficult economic condition, especially in Italy.  He did not mention the cause. We know that Italy entered a recession at the end of 2018. Italy\'s economy did improve a little last quarter, but with the stagnant economic growth, and debt more than 130 percent of GDP, Italy is vulnerable to falling back into recession.

I don\'t know if Flavio understands those numbers, but he is like millions of other world citizens looking at the future anxiously. And we see that there are the United States-China trade war, Brexit, global economic slowdown and political tensions in the Middle East.

I remember, almost a year ago I wrote an article in this daily ”Musim Dingin atau Badai Salju” ("Winter or Snowstorm") on 29 October 2018. At that time I hoped I was wrong. Unfortunately, my worries began became a reality. We began to feel the impact of the trade war.

Even though the Fed only lowered interest rates by 25 basis points, the Fed’s chairman Jerome Powell estimated the US economy was still strong.

The world economy, including Indonesia, is slowing. The US economy has also begun to slow down. The Fed estimates that the probability of recession in the US has risen to 35 percent. Of course, it is too early to conclude the US economy is entering a recession. I remember my conversation with Janet Yellen, former chair of the US Federal Reserve in her office at Brookings Institution, Washington DC, last April.

She said the US economy was still relatively strong. She did not expect a recession to occur in US as fast as people thought. She also said that the inverted yield curve (when long-term bonds have lower returns than short-term bonds) did not always reflect a recession as people feared.

And indeed, even though the Fed only lowered interest rates by 25 basis points, the Fed’s chairman Jerome Powell estimated the US economy was still strong. He signaled a further cut in interest may not be needed. The market was somewhat disappointed with his statement. Maybe it was because the market was too grim.

Counter cyclical policy

Apart from that, we in Indonesia have felt the economic slowdown. What can we do? First, in coping with the economic slowdown, the government needs to implement a counter cyclical policy. Unfortunately, we don\'t have much fiscal space. The fall in commodity and energy prices has affected tax revenues. As a result, the budget deficit will increase. Unfortunately the increase in the deficit does not have any impact in the economic expansion (push factor) because it is more caused by the decline in revenues.

Increasing teacher salaries did not have a significant impact on improving student quality.

A study I jointly conducted with Sjamsu Rahardja from the World Bank shows that government spending is procyclical (government spending actually decreases when growth slows). If the fiscal policy is procyclical, we cannot expect much it will drive growth. However, the study also shows that government expenditure excluding salaries and subsidies is counter cyclical in nature. What does it mean? The fiscal policy can be effective if the quality of spending is improved by allocating more budget to expenditures beyond salaries and subsidies (for example capital expenditure).

That is why I think it is very important for the government to review the effectiveness of government spending so far. One of them is the effectiveness of spending on education. Since 2009, we have allocated 20 percent of the national budget for education. But, the a result the PISA score (the ability of students in reading, mathematics, and science) is still relatively very low.

Increasing teacher salaries did not have a significant impact on improving student quality. And we know, the burden of government spending continues to grow for various social assistance programs, such as BPJS (health care and social security), healthcare cards, and pre-employment cards.

State owned companies (SOEs) that don’t have sufficient cash have  to raise financing through debt.

Not to mention the risk of debt repayment that can indirectly be borne by the government (contingent liabilities). The McKinsey study shows the risk of debt from Indonesian companies in the infrastructure sector is increasing.

State owned companies (SOEs) that don’t have sufficient cash have  to raise financing through debt. In the medium term, there is a risk of financial pressure and the government will have to bear it. Under such a condition, tax revenue must be increased.

My report jointly prepared with Ben Olken, Mayara Felix of the Massachusetts Institute of Technology (MIT), and Rema Hanna from Harvard at the National Bureau of Economic Research (NBER), last August, showed that structural factors in the economy indeed hampered tax revenues.

A long-term reform is needed to improve it. However, in the medium to short term, our calculation shows that improved tax administration can significantly increase tax revenue. How? One of them is to move the services to corporate taxpayers from the regular tax office to the medium tax office (MTO). Why? We suspect the regular tax office, due to limited resources, tends to focus on taxpayers (WPs) with higher income potential.

If the demand for goods and services is weak, why should the businesses ask for credit and expand production.

Resource limitations do not allow them to monitor all WPs. As a result, large business entities are difficult to grow because they are afraid of larger taxes. Business entities may also try to avoid paying taxes as the company\'s scale grows. If transferred to the MTO, with more staff, the treatment on business entities becomes more uniform. The tax burden is not only "borne" by several large companies. As a result, they can still grow.

Monetary policy

Second, what about monetary policy? With inflation under control, and the Fed\'s tendency of low interest policy, there is room for Bank Indonesia to further cut its interest rate. But keep in mind, a cut in interest will not necessarily be effective in increasing growth. Why? If the demand for goods and services is weak, why should the businesses ask for credit and expand production. In addition, my study shows that covering  the budget deficit through domestic debt (bonds), at a certain level, will move savings in banking to government bonds.

The implication is that the sources for credit expansion in banks are limited so that the amount of private investment that can be financed by banks is also limited. This is called the crowding out effect. With this condition, the liquidity is relatively tight and it is not easy for banks to expand credit.

Structural reform

Third, if the monetary and fiscal space is limited, what should we do? The answer is structural reform: abolishing complicated regulations, including the revision of the Manpower Law. With that, the investment will increase and we can benefit from the US-China trade war.

If a recession occurs, economic pressure will deepen. We can\'t let our guard down.

I can understand President Joko Widodo\'s anger because of the 33 companies that left China, none of them entered Indonesia. We know that poor infrastructure is a big obstacle, but our main obstacle is the problem of regulation and institutions.

The government\'s move to revise the Manpower Law must be appreciated. Unfortunately, to this day, the revision has not been completed. I know the revision is politically sensitive. To reduce political resistance, the revision must be accompanied by compensation for workers in the form of unemployment insurance. The source comes from the contribution of the company, the government and workers themselves.

Structural reform is indeed easier said than done. We can argue that Vietnam can benefit from this investment relocation because it has a different political system. But don\'t forget, investments are also relocated to Bangladesh, Malaysia and Thailand, where the political system is more democratic.

Investments were relocated to Vietnam because they had undertaken drastic structural reforms as part of their efforts to enter the Trans-Pacific Partnership. We must acknowledge our backwardness.

Encourage exports and investment

Fourth, we see the government\'s efforts to encourage exports and investment. This is the right step. One of the ideas that emerged was to integrate the Trade Ministry’s international trade department into the Foreign Ministry.

KOMPAS/RIZA FATHONI

Muhamad Chatib Basri

This is an interesting idea. The economic diplomacy must play an important part of our foreign diplomacy. However, what must be anticipated is that the merging of the two ministries in practice is not always easy.

Adjusting the work culture of two different institutions takes time. Unfortunately, we don\'t have much time. If a recession occurs, bureaucracy must be effective immediately. There\'s not much room for adjustments or trials. We might not be as worried as Flavio, the taxi driver from Milan. Our economy can still grow 5 percent or just under 5 percent. This must be appreciated.

However, if a recession occurs, economic pressure will deepen. We can\'t let our guard down. Our ammunition to face the recession is limited. Therefore, policy priorities are important. All things cannot be done.

We are indeed not as worried as Flavio. Indonesia is not as bleak as Europe. But,  remember the words of former US President Harry S. Truman: Recession is when our neighbors lose their jobs. However, recession will become depressed if we ourselves lose our jobs.

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