Not long ago, The Economist and Financial Times also highlighted the future of the global economy. Their review relates to the International Monetary Fund's (IMF) semi-annual publication, World Economic Outlook (WEO), October 2023. The IMF highlights the trend towards global economic fragmentation and the economic costs arising from the growing collapse of global trade.
Globalization has brought positive benefits to the world economy, despite many criticisms such as those expressed by Joe Stiglitz (Nobel Prize winner in economics at Columbia University) and Dani Rodrik (Harvard University) . The global economy has been growing at 4-5% per year for the past 30 years, after declining to 2-3% per year in the early 1980s.
The world economy has also become multipolar with the addition of China as a new economic driving force. Economic growth has reduced poverty around the world, especially in China, India, and Indonesia. Previously isolated countries have been able to grow faster and significantly reduce poverty levels.
In 1990, the proportion of people living in poverty in China (purchasing power parity (PPP) poverty line is $1.9 per person) was 66%. In 2000, using the same poverty line, that number dropped to just 0.1 percent. The largest decline occurred after China joined the World Trade Organization (WTO).
Similar advances are occurring in India. The decline occurred after Prime Minister Manmohan Singh abolished the License Raj government and opened up the economy.
As Joe Stiglitz (a Nobel Prize-winning economist at Columbia University) and Dani Rodrik (Harvard University) have noted, globalization, despite its many critics, has brought positive benefits to the world economy.
Indonesia has experienced three waves of poverty reduction. The first wave occurred in his 1970s. The Green Revolution increased agricultural productivity, thereby reducing poverty in rural areas and indirectly reducing urban poverty through stable rice prices.
The second wave occurred with the labor-intensive Industrial Revolution. The expansion of labor-intensive industries to serve global markets will reduce poverty in both rural and urban areas through the job market (providing opportunities for graduates of Impress Primary and Secondary Schools) and increase the rate of female social participation. increased. job market. This second wave occurred from the mid-1980s until the end of the 1990s when the Asian financial crisis occurred.
The third wave will result from a combination of increased palm oil production and international trade. As in India and China, the reduction in poverty rates here is associated with economic opening.
economic cost
One of the consequences of the fragmentation of the world economy is the creation of duplication of production. Multinational companies are forced to have factories in multiple countries and regions, rather than concentrating their factories in specific countries where production costs are lowest.
This strategy makes sense, in part, for predicting natural phenomena such as global pandemics like Covid-19. However, there are costs that could actually be avoided if fragmentation did not occur.
This increase in production costs is due not only to missed opportunities to reduce average costs associated with economies of scale and “allocation inefficiencies” due to the need to build factories in countries with high production costs, but also to This is also due to increased monitoring costs from .
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This fragmentation also inhibits so-called creative destruction, as the great economist Joseph Schumpeter put it. The opportunities for new, more innovative companies to displace older, less efficient companies are shrinking. Some reasons include being too big to fail and political ties between former owners and authorities.
Will this fragmentation of the world economy lead to deglobalization? Some economists, such as Douglas Irwin of Dartmouth College in the US and former World Bank chief economist Pinerope Golberg, believe that this wave of fragmentation will lead to deglobalization. I doubt that we will ever reach an extreme point like globalization.
According to them, this wave of fragmentation will lead to further regional globalization, known as trade and investment blocs such as the European Union, the ASEAN Free Trade Area (AFTA), and the Regional Comprehensive Economic Partnership (RCPP). This trade blockade is an alternative option to ensure that the costs of regional globalization are lower than non-globalization, but still quite large. In its October 2023 WEO, the IMF estimates that economic costs will reach 7% of gross domestic product (GDP).
Obviously, increased volatility significantly increases costs. Global economic growth will decline, as empirical studies show that increased volatility is associated with lower economic growth rates. Volatility increases insurance costs and also reduces innovation as economic agents are generally risk averse.
Volatility is synonymous with rising global inflation, which ultimately increases interest rates and tends to divert capital flows back to their home countries (safe havens). This not only amplifies the effects of 'allocation inefficiency' (as capital should flow to countries with higher returns on capital), but also causes the increasing country costs in the supply chain to be obscured. .
Some economists, including Douglas Irwin of Dartmouth College and former World Bank chief economist Penelope Golberg, speculate that this wave of fragmentation will not reach extreme points such as deglobalization. are doing.
Some economists, such as Anne Krueger, point out that state involvement in the economy in the form of policy comes at historical costs. However, some economists, such as Dani Rodrik and to some extent Joseph Stiglitz, believe that state involvement is necessary due to market failures and coordination failures.
For example, the efforts made by European countries in the face of climate change. This can take the form of policies such as taxes on fossil fuels, subsidies for green fuels, and bans on fossil fuel-based vehicles. It can also take the form of government spending, in the form of incentives for any activity that improves the climate.
The US Inflation Control Act is another example of a policy aimed at addressing climate change. The response to the coronavirus pandemic would not have been possible as quickly as it was without government intervention, including guaranteeing pharmaceutical companies the purchase of vaccines. Although not all policies have been successful, these policies are considered successful, including restoring the global economy to its previous direction.
The idea that an “optimal” balance in globalization will be achieved through geopolitical changes, domestic political shifts, and the experience of a global pandemic appears to be no more than a theoretical fantasy. In risk management, companies will be forced to build factories in different locations and use inputs from different sources, even if such decisions are not the globally optimal solution. . Please do not translate if the original text contains prohibited words.
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From a domestic political perspective, keeping factories in the country (by providing certain incentives) is also a solution to overcome the generation of political transition costs. So, some fragmentation is certainly necessary to maintain the larger goal. (Note: There were no prohibited words in this article)
What Indonesia should do
For Indonesia, leveraging opportunities wisely is imperative for two important reasons.
First, Indonesia's demographic transition gap is very limited. Assuming that the total fertility rate (Total Fertility Rate/TFR) and female labor force participation rate (Female Participation Rate/FPR) remain the same as they are now, the population machine will only be able to contribute fully to economic growth until 2043. .
This means that by the time Indonesia reaches its 100th anniversary, it should be a wealthy country with a per capita income of $18,000. To achieve this, the economy would need to grow by about 6% over the next 20 years.
Second, we have largely succeeded in eliminating extreme poverty. However, vulnerable groups living near poverty still make up the majority of the population. Therefore, about 6% growth must be dominated by this group. To sustainably boost the growth engine, per capita income for this group needs to increase by more than 6 percent.
In this situation, what are the requirements that Indonesia should meet? First, world history and the above discussion show that the Indonesian economy must remain open.
The reasons for making economic opening a necessary condition are: (i) Economic growth requires capital. Indonesia's national savings are insufficient to cover investment needs, so foreign savings are needed to finance the expansion of the national economic capacity.
Another important source of growth is productivity. Increased productivity is related to technology. Indonesia's innovation capacity is still low, so it still has to rely on imported technology.
and (iii) depend on the world market and encourage Indonesian companies to always produce efficiently. (iv) An open economic system allows Indonesia to select (specialize) activities that yield the highest rate of return.
For Indonesia, leveraging opportunities wisely is imperative for two important reasons.
Second, the demographic dividend has a very short window of 20 years. There is no room for mistakes. Gambling and experimentation are risky and can lead to missed opportunities and time to make corrections.
We need better planning at the national level, all the way down to businesses. Having a policy integrator and a program integrator is essential during planning. Equally important is the role of project integrators and implementers in the field. Having an integrator from the planning to implementation level reduces pet projects (projects that are unnecessary or not yet needed) and cost overruns (project cost overruns).
Third, we need to actually use this fragmentation to our advantage. Indonesia's neutral status provides opportunities to attract foreign investors from different blocs. So far, we have actually attracted many investors from China who have taken advantage of our downstream program. Despite this, Japanese, American and European investors have shown no interest and are moving away from Indonesia.
These three non-Chinese investors still seem to think there are risks in investing in Indonesia. Policy changes and investment protection are among the reasons for not investing in Indonesia. Legal systems and security systems (law and order) must be developed at the same time.
Fourth, future changes are also related to climate change. All countries have entered new territory. We need to choose wisely the niches we painstakingly choose and pursue. We need to learn from Nordic countries such as Finland, which once grew rapidly alongside Nokia, and Denmark, where diabetes treatments have become mainstream worldwide and the pharmaceutical industry is highly developed.
Climate change presents an opportunity, as Indonesia is increasingly needed by the world as the world's oxygen factory. We must use this position well and wisely.
Also read: Continuous development
Also read: Disorganized justice and economic development
Mohammad Ikhsan Professor, Faculty of Economics and Management, University of Indonesia
