Avoiding the Middle Income Trap
"Middle income trap" has appeared again in the first paragraph of the inaugural address of the 2019-2024 President and Vice President.
"Middle income trap" has appeared again in the first paragraph of the inaugural address of the 2019-2024 President and Vice President.
President Joko “Jokowi” Widodo has launched a vision of prosperity with a gross domestic product (GDP) per capita target reaching Rp 320 million per annum to mark the centenary of Indonesian independence. The GDP per capita target is a huge leap from the current Rp 56 million. The GDP is expected to surge to US$7 trillion in 2045 from US$1 trillion at present, and the poverty rate is expected to hover near zero percent to elevate Indonesia among the top five economies in the world.
When presenting the Indonesia Onward Cabinet, the President disclosed publicly that each Cabinet member must fulfill their duties to realize the vision and target of the primary mission. At the end of the presentation, the President even affirmed seven work instructions for the Cabinet in order to ensure this.
Severe challenges post-commodities boom
Based on the formula for calculating compound interest, an annual growth rate of 8.1 percent is needed to boost GDP sevenfold over the next 25 years. The US dollar-denominated GDP growth rate is certainly a great challenge amid the global economic slowdown, which was marked with an end to the commodities super-boom. In fact, the price hike in primary commodities was what helped Indonesia emerge from the 1998 monetary crisis.
The commodities boom era came to an end as an impact of reduced debt (deleveraging), which occurs as the population ages in developed countries. To simplify the deleveraging process, the US Federal Reserve (Fed) and the European Central Bank (ECB) appear to be following the Bank of Japan (BoJ) strategy again.
The challenge has become even more complicated, considering that we have had a current account deficit since 2012 that must be financed by debt issues.
Japan implements an ultra-loose monetary policy by purchasing extremely large amounts of government securities. The BoJ now controls 45 percent of government securities, a figure that surpasses the ECB (22.4 percent) and the Fed (12.9 percent).
Excess liquidity through quantitative easing (monetary easing) will prolong low interest rates without triggering inflation, but the currency war will trigger currency fluctuations. The currency war is colored by protectionism, and is triggering an increase in the price of assets (reflation) as is happening from gold and Bitcoins to securities in developing countries.
The challenge has become even more complicated, considering that we have had a current account deficit since 2012 that must be financed by debt issues. This is a necessity, considering that very few state assets can be privatized to finance the deficit as we did during the 1998 monetary crisis. The current account deficit shows that we have no problem in boosting short-term growth. This is understandable, because our population is relatively young and urbanization is continuing. What is challenging is financing the deficit through debt issues, which risks continued prosperity while fundamentally weakening the rupiah.
In observing the actions and advice of the Prophet Yusuf, his story should inspire state, businesses and society to follow the paradigm of universal prosperity. Prophet Yusuf was able not only to translate the king’s dream (read: vision) of lean cows eating fat cows in the era of poverty that followed one of wealth, but also to offer the ultimate advice in addressing this cycle of life.
In Genesis 41, the king dreamed about seven lean and fat cows and seven bare and heavy stalks of wheat emerging from the Nile. It is very possible that Prophet Yusuf actually concluded that the Nile was the source of an era of prosperity. The Nile, into which flows the Blue Nile from Ethiopia and the White Nile from Tanzania, is a river with an irregular flow and many bends. The areas through which the river did not pass became dry and killed life, while the areas it passed through risked flooding and crop losses. This was why Prophet Yusuf built canals and dams for flood control as well as irrigation. This ancient infrastructure that supports productivity and prosperity still exists today in the Egyptian city of Fayyum.
In the modern world, the state manages the nation\'s financial assets for growing prosperity through a sovereign wealth fund (SWF). Malaysia has Khazanah and Singapore has Temasek, while China has the China Investment Corporation (CIC) that invests intensively in foreign countries. The largest SWF is Saudi Arabia’s, sources its income from crude oil production. With the potential of natural resources from forests, oil, coal, gas, plantations and to the sea, Indonesia should also have an SWF.
Prophet Yusuf\'s advice is an inspiration for designing the best macroeconomic constellation to face the business cycle and for wealth planning through lifecycle investing.
It must be noted that Prophet Yusuf’s first suggestion refers to structural reforms that strongly emphasize mastering agricultural technology for increasing productivity.
Prophet Yusuf’s first suggestion refers to structural reforms that strongly emphasize mastering agricultural technology for increasing productivity.
His second suggestion underlines mastering post-harvest technology and strengthening the manufacturing sector to ensure that crop distribution remains sustainable with greater value added. Chili will quickly rot once it has been picked, but can be preserved in powdered or liquid form, while fresh milk can be preserved and its nutritional content increased by processing into cheeses, yogurt and kefir.
Meanwhile, his third suggestion corresponds to controlling domestic consumption (demand management) as per Keynesian economics. Our boldness in saving money leads to an abundance of high-quality export crops that is vital to turning the balance sheet into a surplus.
Wealth planners do not only analogize the dream of lean and fat cows with the business cycle of five to seven years that economists generally follow. It may be that the number seven symbolizes a longer period. Life will be bitter in retirement with only a lean cow that is on its last legs. It will even be more difficult if that individual has debts (debt burdens your death) and health problems (i.e. sadikin, becoming impoverished from a mild illness).
We must anticipate such misfortunes. Moreover, the World Bank\'s 2014 Indonesia report, "Avoiding The Trap", points out that the Indonesian population will start aging in 2030. Through aging and retirement, spending is no longer support by an income, but from asset yield and impairment.
Burden of aging population
To illustrate, let us calculate the asset value that Generation X needs to retire in the next 10 years. Referring to a $12,000 GDP per capita per annum of a rich country and assuming an exchange rate of Rp 20,000 per US dollar and a life expectancy of 20 years after retirement, they need Rp 4.8 billion (12,000 x 20,000 x 20). Most people will find this target intimidating, especially those who save regularly. However, what is clear is the very large risk of "tuwir sebelum tajir" (growing old before becoming rich).
Having a wealth target reminds us that more rapid economic growth is a necessary condition to prevent the middle income trap. Strengthening financial literacy in managing a variety of assets is also required. We must be honest and learn from our mistakes during the commodities boom, when extra income was spent lavishly on buying motor vehicles. Besides increasing congestion and damaging the environment, the surge in private vehicle ownership has pushed oil into a deficit. We have not been an OPEC country since 2004, because our crude oil production only meets half the consumption.
Lifecycle investing refers to the periodical allocation of investment to pay for the future (pay yourself first) and phased asset allocation that includes growth, protection and distribution.
The growth phase mainly occurs by periodically allocating a portion of one’s monthly salary to strengthen human talent, property assets and equity funds, which are promise more growth in the long run. Individuals can also apply the growth phase of asset allocation (at the age of 100). It has been suggested that 26-year-old millennials still starting out on their careers put 74 percent in property mortgages and equity funds. Principal payments and interest must be managed so they do not exceed 30 percent of the monthly income.
Not many people know that SBNs are investment options that have high returns and low risk.
As retirement age approaches, the risk of the above asset allocations is reduced by putting more into SBN (state securities) for protection, especially against credit risk, inflation risk and liquidity risk. Not many people know that SBNs are investment options that have high returns and low risk. In 2019, SBNs performed at 14 percent, far exceeding stock performance of only about 3 percent.
The final distribution phase is managing cash flow, when the benefits from all assets are spent during retirement until death. In controlling the current account deficit, the government can learn from the experiences of Singapore and China, which succeeded in distributing forced savings for housing, health and parental insurance.
Read more: Consistency of Priority Agenda Items
Political economy faces a difficult challenge in simultaneously achieving economic stability and intertemporal welfare. The poor management of haj funds before submitting them to the Haj Financial Management Agency (BPKH) is a valuable lesson, because it did not consider of the asset maturity and liabilities, asset growth and anticipating foreign exchange risk, such as having assets that generate foreign cash flow.
According to the BPKH, the real cost of the haj pilgrimage was estimated at Rp 70 million, double the Rp 35 million that the public had paid. The rupiah has weakened 48 percent over the last seven years, or 5.9 percent per year. The government must ensure the growth and safety of public funds for future prosperity, against both default risks and the rupiah’s depreciation, by encouraging transparency and competency in managing public funds.
Budi Hikmat, Investment advisor; Founder of Prophet Yusuf Community.