Preserving Indonesia’s Economic Optimism
By: Kiki Verico, Ph.D., Adviser on industry and international trade to the finance minister and lecturer at the School of Economics and Business at the University of Indonesia.
The Jakarta Post | (10/2/2020) – Statistics Indonesia (BPS) reported last week that GDP contracted 2.2 percent in the fourth quarter of last year, an improvement from the second and third quarters. However the economy suffered negative growth of 2.07 through out last year, the first since 1998.
The 1998 contraction was much deeper at 13.13 percent, accompanied by a skyrocketing deflator inflation rate at 75 percent, while inflation in 2020 was only 1.7 percent, demonstrating that the 2020 contraction was caused more by the aggregate demandside shock while the supply-side was just hibernating.
Many field surveys on economic development last year found that more than half of small and medium enterprises (SMEs) continued to buy raw materials and intermediate goods. This showed that their production operations continued so that their supply-side remained resilient. Nevertheless, the studies also found that the number of SMEs that suffered declines in revenue and profit was larger than those who still made profit. This again showed that the shock was in domestic demand.
If the supply-side was resilient but total revenue and profit decreased, then economic stagnation was caused more by, again, the demand side. The latter has been confirmed by other findings that savings increased and spending decreased. The demand side shock has been set off by the pandemic. But the demand-driven recovery will be boosted by mass vaccination and stronger herd immunity. After social mobility restrictions are removed, the demand side improvement will naturally increase spending, economic multipliers, and finally, decrease savings.
Demand-driven recovery will also increase labor absorption and imp row Indonesia’s output gap to the condition before the pandemic hit Indonesia. The hardest hit sectors were contactsensitive industries such as tourism, restaurants, construction, manufacturing and retail trading, which happen to be most labor intensive operations. These industries will recover immediately when the fight against the pandemic makes significant progress that allows for the significant easing of social mobility restrictions.
As production accelerates and ereates surpluses, enterprises will have to export some of their goods. Fortunately, the government last year launched a comprehensive set of structural reforms (omnibus law on job creation) to strengthen Indonesia’s economic competitiveness and this in turn will bolster the supply side domestic demand-side.
A developing and economic emerging country like Indonesia needs a competitive manufacturing sector as the backbone and source of its economic growth. Data shows that since 2005, Indonesia’s real manufacturing growth has been lower than the total real economic growth. Indonesia’s economy in the last 15 years has depended in the service sector. Nevertheless, further analysis indicates that the manufacturing sector remained the dominant sector in labor absorption.
According to Hodrick-Prescott and Baxter- King’s business-cyclical removal filters, from 2012 to 2019, the manufacturing sector remained positive in value-added. The manufacturing sector played a leading role in reducing unemployment as its labor absorption increased from 12.7 percent in 2011 to 14.1 percent in 2019 with a compound annual growth rate (CAGR) of 1.4 percent. The manufacturing sector is dominant as it meets two criteria. First, its labor absorption rate is above the national average labor absorption rate of 6 percent. Second, its CAGR is above 0.1 percent.
Indonesia’sĀ manufacturing sector needs to be more interconnected to the global value chains (GVCs). Referring to the Trade in Value Added indicators (TiVA-OECD), compared to its neigh-boring countries such as the Philippines, Malaysia, Thailand, and Vietnam, Indonesia is excellent in forward linkage but lags behind in backward linkage. This fact proves that Indonesiaās exports are competitive, mostly in primary products.
In Southeast Asia, since 2015, Vietnam has shown the biggest achievement in backward linkage. Vietnam is a Southeast Asian country that recorded positive economic growth in 2020.
In addition to its effectiveness in containing the pandemic, the global production network of GVCs has benefited Vietnam. Structural reform that Indonesia prepared in 2020 will be the gamechanger for Indonesia to move toward the backward linkage of GVCs. Potential possibilities in dude the green and sustainable economy, renewable energy usage, IR 4.0 machinery and environment-friendly transportation chains.
In addition to the GVCs that need multilateral economic cooperation, Indonesia can also benefit from its bilateral economic cooperation, such as the Comprehensive Economic Partnership Agreement (CEPA). For instance, the Indonesia ā Australia CEPA, which came into force in July 2020, is estimated to improve Indonesia’s food-related products and service sector network and competitiveness (Verico, 2020).
Indonesia can preserve its economic recovery optimism on two pathways. One is naturally from the improvement in domestic aggregate demand as the fight against the COVID-19 becomes more effective to allow the easing of mobility restrictions. Two is fundamentally from Indonesia’s increasing role in global value chains that result from the implementation of bold structural reform.
Source: The Jakarta Post. Edition: Wednesday, February 10, 2021.