Melbourne, October, 2015
Formulating economic policies is challenging task because the policies will affect the whole groups in society. It is common to find that certain policy is not giving the best outcome for the long term general public interests because certain groups are getting privileges at the expense of the rest of society members due to application of particular policy.
Henry Hazlit (1971), one of prominent US economist, in his book, “Economics In One Lesson”, proposed the idea of capturing the whole picture of what might happen if certain policy is applied. He argued that by understanding what happens to each group that affected by a certain policy, we could unravel biases in policy making and create the fairer policy outcomes for the whole society (Hazlit, 1971).
This short writing will analyze some real cases of Indonesia’s economy from the point of view of Hazlit’s idea. Indonesia’s economy is chosen because even though this economy has been undergoing many policy reforms since 1998 Asia financial crisis, but still, some bad policies often created because of failure in getting comprehensive picture of society’s net benefits.
The case study of Indonesian oil subsidy provides clear example of how particular policy can benefit certain groups and sacrificing valuable outcome that can be received by larger group society if such policy is removed. Indonesia was a net oil exporter country, but since 2004, its consumption has exceeded its production (see Figure 1). Oil consumption seems to continue to increase while oil production is declining. Therefore, it must import oil to cover domestic oil need especially for fuel. Meanwhile, since fuel are subsidized by government, per liter petrol price in Indonesia is much lower than market price. When the rapid increase of oil price happened in 2007-2008, government of Indonesia allocated much budget to pay oil subsidy. This had threatened primary balance as well as current account deficit in Indonesia (OECD, 2008).
Figure 1. Indonesia oil production and consumption. Source: BP Statistical Review, 2013
The budget allocation for fuel subsidy in Indonesia has consumed fraction of government budget that can be allocated to a more productive spending such as physical infrastructure (Bulman, Fengler and Ikhsan, 2008). This cost of subsidy is illustrated in red area of diagram of Figure 2. In addition, it is found that, in Indonesia, the top 40% of high income families benefit from 70% of the oil subsidies, while the bottom 40% of low income families benefit from only 15% of the subsidies (OECD, 2008). Lower petrol price due to subsidy increases quantity demanded, resulting in lavish use of petrol. Government has announced proposal to the public and house representative to cut fuel subsidy. However, harsh protest from public which is triggered by politicians and political parties, has made such policy becomes hard to be enforced (The Jakarta Post, 2014).
Figure 2.Cost of Subsidy. Source: Gans, Stonecash, Mankiw, Lybich, and Mankiw (2015)
During President Yudhoyono’s administration, government has successfully reduced amount of subsidy by 25-33% in May 2008 (The Economist Intelligence Unit, 2011), after facing harsh confrontation that resulted in declining popularity of ruling party. Joko Widodo, Indonesia’s next president cut fuel subsidy further, exploiting low world oil price (The Economist, 2015). This has made per litre price of petrol becomes close to market price. As a result, Indonesian government budget becomes healthier (The Economist, 2015) and there are more money could be allocated to physical infrastructure projects as well as direct payment for the poor (Ministry of Finance of Indonesia, 2015).
The second case can be presented is the restriction of beef import in Indonesia through quota which has involved corruption, rent seeking and vested group interests. Indonesia is never been able to meet its beef needs from its domestic livestock. Therefore, it must import beef from foreign countries, otherwise, the price will be much higher than world price. But, the quota has restricted import. In 2013, Luthfi Hassan Ishaq, President of Prosperous and Justice Party, a religion inspired political party in Indonesia, was alleged by Corruption Eradication Body of graft scandal from Indoguna Utama, a private beef importer to manipulate import quota (Tempo, 2013). Furthermore, the minister of agriculture, Suswono, who is also the political party cadre, was also alleged to be involved in such scandals. On the other hand, anti import and narrow nationalistic sentiments has been used by the politicians to provoke the public to maintain import restriction policies. From this case it’s obvious that import quota of beef in Indonesia has been exploited by politicians, resulting in corruption. The consumer surplus is also transferred to importers and rent-seekers such as depicted in area E’ + E” of diagram of Figure 3.
Figure 3. Effect of quota. Source: Gans et al. (2015)
The third case is about minimum wage policy. Bird and Manning (2008) have studied effectiveness of minimum wage policy in Indonesia between 2002 until 2003 in redistributing income and combating poverty. From simulation, it is found that only about 42% of the additional earnings from the minimum wage hike in 2003 were likely to flow to poor households living below $2 per capita a day, and the remaining 58% of the benefits flow to the non-poor (Bird and Manning, 2008). Moreover, from net benefits simulation, it’s found that only one in five poor households gain through higher income, this is the result of higher prices caused by increase of minimum wages (Bird and Manning, 2008). When loss of employment is taken into account, net benefits to the poor become smaller (Bird and Manning, 2008). Figure 3 illustrates how minimum wage that is higher than market equilibrium can create unemployment due to increasing supply of labor and declining demand for labor.
Figure 4. Minimum wages and unemployment. Source: Gans et al. (2015)
The fourth case can be discussed is Indonesian automotive industry. During 1970s until end of 1980s, the structure of local ownership in the automotive industry in Indonesia was controlled by a patrimonial patronage (Basri, 2009). The ambitious nationalist policy to nurture Indonesia’s domestic automotive industry resulted in a high level of trade protection through non-tariff barriers, tariffs, and local content arrangements (Basri, 2009). This has attracted rent-seekers (Basri, 2009). As a result, this industry failed to grow and becomes a“permanent infant industry”.
However, Indonesia started to liberalize its trade regime in 2000, whereas other country such as Malaysia continued to keep its protective policy. As a result, since 2000 onward, automotive industry in Indonesia enjoyed higher human resources, process technology, and research and development capabilities than arms in Malaysia (Rasiah, 2009).
From the first, second and third case study, we can see that certain economic policy can be enforced because of pressure from rent-seekers or particular groups who have vested interests. From the fourth case study, we find that when pragmatic approach in policy making is applied and vested interests are abolished, there will be much larger gain enjoyed by society. It is also found that popular rhetoric such as minimum-wage to combat poverty and redistribute income is in fact not always achieve the desired outcome. Hazlit’s idea incorporated in his book need to be shared to the general Indonesian public to educate their view toward policy. Therefore, the public can force the policy makers to make economic policy that free from biases and can create optimum net benefits for the whole society.
Basri, M. C. (2010). Comments by Muhammad Chatib Basri. Asian Economic Papers, 9(3), pp.123-125.
Basri, M. C., & Patunru, A. A. (2012). How to keep trade policy open: the case of Indonesia. Bulletin of Indonesian Economic Studies, 48(2), 191-208.
Bird, K., & Manning, C. (2008). Minimum wages and poverty in a developing country: Simulations from Indonesia’s Household Survey. World Development, 36(5), 916-933.
Bulman, T., Fengler, W. and Ikhsan, M. (2008). Indonesia’s oil subsidy opportunity. Far Eastern Economic Review, 171(5), 14(5).
British Petroleum (2013). BP Statistical Review 2013. Retrieved from https://www.bp.com/content/dam/bp/pdf/statistical-review/statistical_review_of_world_energy_2013.pdf.
Gans, J., King, S. Stonecash, R. Byford, M., Libich, J. and Mankiw, N. (2015). Principles of Economis (6th Ed), Cengage Learning. Melbourne: Australia.
Hazlitt, H. (1971). Economics in One lesson. Manor Books Incorporated.
Ministry of Finance of Indonesia (2015). Indonesia Government Budget 2015. Retrieved from http://www.kemenkeu.go.id/wide/apbn2015
OECD (2008). Energy Policy Review of Indonesia. OECD Publishing.
Rasiah, R. (2009). Technological Capabilities of Automotive Firms in Indonesia and Malaysia. Asian economic papers, 8(1), 151-169.
Tempo.com (2013). Beef Import Graft. Retrieved from http://www.tempo.co/topik/masalah/2944/beef-import
The Economist (2015). A Good Scrap. Retrieved from http://www.economist.com/news/asia/21638179-jokowi-abandons-wasteful-fuel-subsidies-fiscal-prospects-brighten-good-scrap
The Economist Intelligence Unit (2011). Indonesia Competition and Price Regulation.
The Jakarta Post (2014). View Point: From fuel subsidies to fuel entitlement: Why not a fuel card? Retrieved from http://www.thejakartapost.com/news/2014/11/16/view-point-from-fuel-subsidies-fuel-entitlement-why-not-a-fuel-card.html#sthash.ctFjzBZS.dpuf