Can Indonesian growth survive the end of the resources boom?

Author

Professor Ross Garnaut AO is a professorial research fellow in Economics at the University of Melbourne

One of the damaging side effects of the resources boom was that it lulled the Indonesian government into a false confidence that reasonable economic outcomes could be expected despite poor economic policy. Photo by Flickr user Parolan Harahap.
The resources boom lulled the Indonesian government into a false confidence that reasonable economic outcomes could be expected despite poor economic policy. Photo by Flickr user Parolan Harahap.

 

There is plenty of economic literature demonstrating that reliance on exports of resource commodities can be a curse for development. Resource booms are temporary and subject an economy to large adjustment stresses when they end. The test of the “resource curse” is how a country responds to the end of the boom.

 

The China resources boom was an ambiguous influence on Indonesian development. At best, it allowed strong economic growth through the first decade of democratic government, which was bound to be fraught with difficulties for economic management. At worst, it lulled the new democracy into a false confidence that reasonable economic outcomes could be achieved despite weak economic policy. It also burdened the young democracy with rent-seeking practices that made good policy less likely in future. And it introduced protectionist regulatory interventions, such as requirements for local metals processing, which require painful and costly readjustment now the boom is over.

 

Now Indonesia faces major macroeconomic challenges – but also the chance to deal with some longstanding problems of development. The final balance sheet will depend on how the government of President Joko “Jokowi” Widodo responds to these challenges.

 

One thing in Indonesia’s favour is that the international environment after the resources boom is helpful to the macroeconomic adjustments Indonesia must make to maintain growth. The end of the China resources boom and the tightening of United States monetary policy will lead to depreciation in the exchange rate, which will increase Indonesia’s competitiveness. The new pattern of growth in China, with greater emphasis on consumption, will offer Indonesia increased opportunities for exports of manufactured products, high-value foodstuffs and services.

 

The dramatic fall in global oil and gas prices from mid-2014 also gave the Jokowi administration the chance to remove wasteful energy subsidies. This, in turn, provided room for a large expansion of public expenditure on infrastructure and other public goods, which can raise productivity. The establishment of the Asian Infrastructure Investment Bank offers further opportunities to increase Chinese funding of infrastructure in Indonesia.

 

The hard part is what Indonesians must do themselves.

 

The scrapping of petrol subsidies and the substantial reductions in diesel subsidies are big steps toward successful adjustment after the boom. Unfortunately, the government is already facing political pressure to unwind these reforms, partially at least. These pressures must be resisted, and the energy reforms extended.

 

The other budget adjustment needed is daunting. Outside petroleum, Indonesia’s mineral leasing and taxation policies have been poorly designed. In the coal sector, legal obligations to pay tax have been avoided to an extent that has had macroeconomic consequences. Tax revenues have grown slower than the economy for several years and are likely to remain low for several years. Major public investment in infrastructure is essential but without the budget surpluses that would have been obtained from a more effective tax regime, it will be difficult to maintain public spending on infrastructure and keep budget deficits in check. This means funding public investment in infrastructure from long-term external loans will be necessary.

 

Indonesia needs substantial depreciation in the real exchange rate. Reform to accelerate productivity growth can assist real depreciation. Firmer budgets and correspondingly easier monetary policy supported by domestic cost and income restraint can help deliver early exchange rate depreciation.

 

Strong productivity growth requires the unwinding of distortions in the operation of markets. It also requires reform of the political system that shapes economic regulation and policy. This is a long-term project, and includes the removal of distortions introduced into the resources sector during the boom. That means dealing with the vested interests that have benefited from inefficient tax and leasing regimes in coal. Imposts on investment in marginally profitable activities must also be reduced – for example through divestment of foreign equity and domestic processing requirements.

 

None of this will be easy. The biggest challenges, however, relate to the political economy of policy-making. The flow of easy money from mineral and coal resources into private hands during the formative years of democracy meant private wealth had excessive influence over economic policy. The discussion of constraints on business funding of political parties and campaigns in the lead-up to and since the 2014 elections is encouraging. Reform in this area is, in fact, a precondition for successful policy adjustment to sustain and accelerate economic growth after the resources boom.

 

Robust policy debate among Indonesians who are concerned about policy because it is important – not because they want to further their own political or business interests – will be essential in the difficult years ahead. Unfortunately, there still seems to be little appetite for the tough reforms needed.

 

This post is an edited extract from the Ninth Sadli Lecture: “Indonesia’s Resources Boom in International Perspective: Policy Dilemmas and Options for Continued Strong Growth.” The lecture will be published in full in the August issue of the Bulletin of Indonesian Economic Studies.