What is wrong with economy’s performance?

The economy is still unable to show a satisfactory performance, although the government has issued as many as 12 policy packages since September last year.

The latest data showed that the economy grew only at a rate of 4.92 percent in the first quarter of 2016, down from 5.04 percent in the fourth quarter of 2015. It is also down from Bank Indonesia’s growth target of between 5.1 percent and 5.2 percent.

What is wrong? Initially the packages raised high expectations as it was believed that the government under President Joko “Jokowi” Widodo would miraculously drive up economic growth. Why did the initially bullish climate turn sour? This is of course a delicate question taking into account the global economic malaise, but the Indonesian economy does not only depend on exports.

The 12 economic packages introduced by the Jokowi government can be divided into two groups: one meant to enhance the puchasing power of consumers and the other to boost investment and raise industrial competitiveness. They are very important because the two sides of the economy, namely demand and supply, should be balanced and work hand in hand.

The 12 packages consist of new regulations or replacements for old ones. The question is, since the regulations have been in place, are there any other economic activities that could be run efficiently and effectively? In other words, has the economy been managed according to economic laws?

Let’s start with the agricultural sector. By observing this sector from one province to another, it is clear that most of them produce similar products. For example, almost all provinces produce rice, without considering the soil characteristics of the respective regions. It is well known that specialization will increase productivity.

From the statistical data published by the Central Statistics Agency (BPS), it was found that rice productivity was different from one region to another. Java and Bali had the highest rice productivity, almost 6 tons per hectare, while in West Kalimantan it is only around 3 tons per ha. Why is the principle of comparative advantage not applied as it is in international trade? If agricultural specialization is implemented, the sector could contribute a higher proportion of gross domestic product (GDP).

This is a picture that could mirror the larger context of the Indonesian economy. From GDP data for 2015, it was found that the tradable sectors contributed 41.2 percent to GDP, while the nontradable sector contributed 58.8 percent in current prices, but a publication of Bank Indonesia for 2015 shows that the tradable sector obtained only 28 percent of the total credit, while the nontradable sector obtained the lion’s share of 72 percent.

The figures hide the economic incentive of the whole economy. The nontradable sector consists of, among others, housing, commercial buildings, apartments and real estate in general. The potential profit in this sector is usually higher compared to other sectors. The public works and housing ministry’s data show that the demand for housing is very high, making the housing sector a “producers’ market”.

Such a situation enables the developers to enjoy the rent by raising the prices of their products, which become a barrier for the general public to buy the offered housing or flats.

This is a vicious circle leading to economic inefficiency. The continuous rise of housing prices, flats and real estate in general become a source of economic attractiveness for investors. Unfortunately it has a negative impact for the economy as a whole, distorting the investment.

In the case of Indonesia, many people buy apartments or houses not to use them immediately, but just for investment, expecting high capital gains.

The lion’s share of bank credits going to the nontradable sectors, such as the construction sector and housing, has partly contributed to the poor economic situation.

The high interest rates in the country would only be suitable for activities with a potentially high return on investment. Such an expectation would be fulfilled by the real estate sectors in general.

How can such negative prospects be improved? A deep and detailed economic analysis should be conducted before an appropriate economic policy is implemented to ensure that the new policies would be able to make a positive impact on the real sector.

A policy or a policy package that is not based on analysis of the real sector, but just derived from another economic setting, will be doomed to failure.

The role of an efficient price formation for all products, accompanied by an appropriate tax system, should be emphasised so that there will be no economic rent component in the prices of any products leading to misallocation of resources. The land component in housing and construction activities in general are usually susceptible to malpractice.

A low capital gains tax in real estate as proposed by the Financial Services Authority (OJK) will boost the potential profits in that subsector, raising its attractiveness to investors. The OJK head several times proposed a one-percent capital gains tax on real estate. This is distortive, because there will be a reallocation of funds from other sectors to this sector, lowering the potential growth in the economy. Why so? Because the majority of the cost component of real estate is just land.

Hence the lack of attention by the policy packages to the internal structure of activities that would be influenced by the intended regulations could be a source of their ineffectiveness. Without knowing exactly what is inside the activities to be regulated and the interaction between the activities, the regulations could be doomed to fail.

Fulfilling the World Bank’s criteria about the ease of doing business is not a panacea for success.

by Djamester Simarmata 

source The Jakart Post, Monday, June 20, 2016