The Change in Store for Indonesia

At what time will someone have to say that, "hei, I messed up, my prediction was wrong?" So far Japan has managed to avoid cutting its foreign aid, the oil price has actually dropped, and the investment pullout back to Japan failed to materialize.

So what went wrong with my analysis?

First, the global economic slowdown is steeper than what I expected. I did not expect Chinese economy to get hit this early, leading to global slowdown in demands for raw materials, including oil. Plus, shutting down nuclear reactors take time, and it will take a while before the last nuclear rector will be shut down in Germany (and probably Japan) and until then, the demands for oil will remain quite stable. Then, things may get hairy.

Does this disprove my analysis? No, this tells us that we may need to look at a longer trend and I still think that both Germany and Japan are digging their own economic graves by shutting down all their nuclear reactors. What happened in Japan nuclear infrastructure was the failure of bureaucracy and regulation, not the failure of the technology itself, that is pretty reliable considering the total number of reactors and accidents in the past thirty years - including Three Mile Island and Chernobyl.

Second: the investment pullback failed to materialize because the Keynesian stimulus failed to make an impact. Political squabblings, the planned scrapping of the nuclear power plants, which will impact the reliability of the electric supply, and the graying population, etc caused investors to be wary to start investing heavily in Japanese industries, though it doesn't stop them to buy Yen as a safe haven asset. In essence, the problem is that Japan's economy is worse than abroad and strong Yen didn't help, making repatriation of their investment to be very costly.

Third, it may be a while before Japan's foreign aid will be reduced as Japan rely on its foreign aid to promote its foreign policy and to improve economic cooperations with other states. In essence, it is like subsidizing its export. I have to admit that I put the foreign aid part here simply for the shock value, though it is true that in a long run, should the Japan economy does run out of steam, its foreign aid may be affected.

Anyway, I'd love to hear what you think about this.

YS
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The Change in Store for Indonesia
Yohanes Sulaiman | March 19, 2011

In the aftermath of the earthquake and tsunami that devastated Japan last week, Indonesia needs to be prepared for a different kind of aftershock: the economic implications of the natural disaster.

In spite of the fact that China has surpassed Japan in terms of gross domestic product, Japan remains the world’s third-largest economy.

It is also one of the major global donors, contributing 12.5 percent of the United Nations’ annual budget — second only to the United States’ 22 percent. It provides a variety of foreign aid to the Asean and third-world countries through the Japan International Cooperation Agency and other institutions.

Such contributions will surely get cut as Japan tries to rebuild after the disaster. Goldman Sachs has estimated Japan’s losses at up to $200 billion, more than 3 percent of its GDP.

Though reconstruction will provide a Keynesian boost to the economy through massive government spending, Japan may not benefit from such a stimulus.

The reason why the Keynesian approach works is because the market is confident that the short-term increase in public debt will not hurt the economy in the long run. However, Japan’s long-term outlook is already horrid thanks to its sizeable debt, which hit 196.4 percent of its GDP last year.

Moreover, Japan’s senior-based employment system, its lack of willingness to accept immigrants, its closed market system and its graying population are detrimental to its economic growth.

The senior-based employment  system means that Japanese companies will try to keep their old workers rather than recruit young people — even though aging workers’ skills may be obsolete due to technological changes. As a result, the young work force will try to find job opportunities abroad.

Japan’s unwillingness to accept more immigrants, coupled with a low birth rate, keeps the work force old. This will add more burdens to the economy, putting a strain on welfare and social security systems.

It’s closed economy, meanwhile, makes Japan one of the most expensive countries in the world and one of the most difficult to invest in.

Worse, Japan does not have the political will to push for reforms due to an unstable parliamentary system. In the past 10 years, only Juinchiro Koizumi, a popular prime minister, was able to rule for more than two years — a feat for a revolving-door state. He used his popularity to push for economic reforms.

Unfortunately, succeeding prime ministers did not have the same charisma and popularity. Japan has had five prime ministers in five years — many of whom were unwilling to take risks that would usher long-term gains. They scrapped many of Koizumi’s reform policies.

Not surprisingly, even before the earthquake, Moody’s decided to cut Japan’s credit rating to AA — which meant the country would have to pay a much higher interest rate should it try to get loans from the international market.

Simply put, the Japanese economy will not benefit in the long run from the short-term Keynesian boost because economic confidence is already low and the government itself is unwilling to engage in drastic reforms.

The devastation of Japan will affect many trade partners, including Indonesia. Though Indonesia will benefit in the short-term from an increase in demand for raw materials and energy, the country may face long-term economic problems.

The first problem is the rising price of oil. As the Japanese race against time to prevent a nuclear meltdown at the Fukushima Daiichi power plant, the disaster has spooked several countries that rely on nuclear power to reduce their dependence on carbon-based fuel.

Already, concerns over the safety of nuclear facilities has prompted moratoriums in the decision to build more nuclear plants in the United States, Germany and Switzerland.

This means that people will demand more inspections and safeguards, as well as shut down old power plants — without any alternative energy source ready to replace nuclear power.

The energy crisis is exacerbated by the political crisis gripping the Middle East — especially because of unrest in oil-producing nations. This will drive up the cost of crude oil further.

Indonesia will have to either increase fuel subsidies — thus wrecking the national budget — or create drastic policies that cut subsidies and allocate more funds to mass transportation and improving fuel economy.

Unfortunately, given President Susilo Bambang Yudhoyono’s track record, it would seem that increasing subsidies is the likeliest option.

The second problem is a possible reduction in Japanese foreign aid.

Even though Hatta Rajasa, the coordinating minister for the economy, announced that Japan would not delay existing projects in Indonesia, the government might want to prepare for the possibility of reduced funds or investments from Japan in the future.

The likely reason that the yen has hit record highs against the dollar this week is because the Japanese government and companies are pulling out overseas investment and buying yen.

Indonesia’s saving grace is that Japan, one of its largest trading partners, still needs its raw materials. But considering the economic problems on the way, it is very likely that the Japanese will scrap other investment deals. The scale of devastation from the quake-triggered tsunami will naturally force Japan to focus its resources domestically.

While Japan may not completely stop assistance to the country, Indonesia must brace for the inevitable decrease in foreign aid.