Thesis Submitted

Abstract

Resource Drain In Indonesia And The Need For Debt Renegotiation With Japan

The aim of aid is clear which is to help the developing countries to reduce its poverty level through economic development channel. But, the fact is a contradictory one, aid in the form of debt for the developing countries does not function as a savior, the debts are more like a burden to the developing countries. This paper tries to prove the fact that external debts do not serve to the benefit for the developing countries but it is merely a tool for draining resources in developing countries. The proof will be explained through the case of Indonesia and Japan, the first one represents the developing countries as the debtor while the latter represents developed countries as the creditor. The series of data to uncover the fact will be analyzed through Vector Auto Regressive Model, Cointegration and Error Correction Model to which it will explain the relationship between Indonesia trade balance with Japan; the number of Indonesian external debts payments; and the GDP of Japan. As a supportive means, I will also employ cross section and panel data analysis to describe the increasing level of unemployment in rural areas as a relation to the debt that were being given mostly to the agricultural sectors. The evidence of resource drain from a foreign debt payment will determine the conclusion of the need for debt renegotiation.

Key words: foreign debt, resource drain, vector auto regressive, Indonesia, Japan

Trade Institutionalization

From the above figure we might say that China is posing a threat to the Japanese Economy by its intense competition. The intensity more or less came from the import substitution strategy in China. With this policy, China eventually learn to produce the imported goods domestically in which threatened the sustainability of the Japanese Economy, or to make it simple: Chinese products are everywhere in Japan! This might lure the Japanese Economy wouldn't it?

With the precedent fact, will the triangular agreement between Japan, Korea and China in the form of EPA (Economic Partnership Agreement) give benefit to Japan?

To answer this question, I made a projection based from series of quarterly data ranging from 1985 to 2004. The variables in the research consist of the Japanese GDP, the Japanese Export to China and the Japanese Export to Korea.

In the case of Korea, there is a positive impact both in the short and the long run. The export to Korea will boost the Japanese GDP in a one way or another for a stable period of time.

What about China then?

In the short run, the Japanese Export to China leads to an overshoot in the Japanese GDP, suggesting that in the long run the Japanese Export to China will loose its significance to the Japanese GDP due to the rapid learning curve of the Chinese production capacity in which eventually leads to a lesser dependency from the Japanese products.

But, it is important to note that the adjustment rate from the equilibrium error ,that concludes the overshoot in the short run, is very small suggesting that the positive effect from the export will last in a considerable time.

The same positive effect is true from the Chinese and the Koreans point of view

Thus, the institutionalization of trade among Japan, Korea and China is a very constructive way to built fundamental growth in the region. This preliminary study serves as a complementary research with regards to the previous one.

Another question might be raised based one the Bhagwati's spaghetti bowl effects. The EPA might serve as a form of Preferential Trade Agreement, which according to him is a stumbling block toward integration. But, as you can see from the EPA, it is initially driven from the GATT and the WTO and it is even moving towards beyond it. So The EPA is not even a PTA because of the uniqueness. So, would you　mind cherish the EPA?

No country for old men

I was roaming around the news on the web when I was suddenly stunt by this shocking fact. We know that Indonesian policymakers are now being hustled and bustled by the year on year Inflation target of 6.5 percent. And we also now that it would become a very hard-hitting job since the year on year inflation rate on February has mounted up to 7.4 percentage points.

But the condition which I found on Zimbabwe was hilarious, it's way beyond imagination. A 100.000 percentage point of year on year Inflation rate, oh gosh. There is a massive gap between the amount of money and goods being circulated, a typical situation for a poor country but alas it is still very shocking.

This gloomy description desolately contributes to the decrease in the total well being. It was reported that the average life expectancy rate for this country is ranging only from 34-37 years old. Well then, it reminds me of an Academy award winner movie entitled "No country for Old Men"

Oil Price, Green House Gas and Economic Growth

The rising in oil price to its psychological level has undoubtedly created some growing concerns among the world’s society. Many solutions were being offered, from the most rational unto the irrational one. The concerns are mounting since the OPEC meeting has a very little impact on the price stabilization. Observers point out consumption rate as the main cause of the oil price surge. Restriction in consumption is viewed as a necessary condition to stop the oil price hike. This restriction is also viewed as a main condition to reduce the green house gas emission as a result for the abundant use of the fossil fuel. But is this restriction is necessary? Wouldn’t it only lead to a slower economic growth? Is it right to sacrifice a long term achievement to a short term shock? This article aims to answer all of these questions.

Restriction in consumption equals to impotent ion

From the weekly time series data ranging from 1997 until 2007, the trend in oil price hike will surely continue. An oil price projection using the Auto Regressive Integrated Moving Average (ARIMA) model which I had done in Asia Pacific Initiative Forum at Keio University, justifies the presumption. The oil price will go beyond its psychological level at US$ 100/barrel, and will continue to skyrocketing. Moreover, the oil price consumption growth rate is believed to play an important role in the oil price formation.

With the inelastic structure of oil price in terms of demand, this projection is making sense. The inelastic structure creates a huge inertia momentum so that the current hike in the oil price could not refrain the consumption level. In other words, if the presence of alternative energy that can be used massively is still vague, the oil price will continue to hike beyond imagination.

Restriction in consumption is most likely to correlate with the slower rate of oil price hike, but this action has a major consequence. With the restriction, every economic agents will be forced to refrain their economic activities especially which corresponds with the using of fossil fuel. This restriction, instead of becoming a solution, will create problems which have a long run impact. The most noticeable fixture is the obstruction in economic growth. Although it is not the only source of the society’s well being but economic growth is still viewed as a necessary condition for welfare.

The economic growth slow down will constrain the creation of new job opportunities. The discourage workers resulting from the lack of job will contribute to the rising in unemployment rate. These unemployed people will become poor because the absence of sustainable income. In aggregate terms, this will only hampers the community welfare. Restriction in consumption is a form of impotent ion, because it functions as a constraint in empowerment. In addition, the act of postponing oil consumption in current time will not shift the long term price structure. This hypothesis is a rational one since the fossil fuel is un renewable resource so that in the future, with the absence of alternative energy, the fossil fuel consumption will go back to its natural level and leads the price to continue rising.

The Solution

Question then arise; what policy is the most suitable to stop the rising in oil price? The answer is quite simple: do nothing! This answer surely raises one’s eyebrows but it turns out to be the most realistic solution. As describes earlier, every intentions to intervene the price through restriction in consumption will be in vain since the price will go back to its natural level.

There will surely be some sacrifice with the do nothing policy. The most apparent sacrifice is the collapse of industries, but it is important to note: this will only happens in the short run. In the long run, with the industry’s increasing economies of scale, industry will have the capability to substitute the fossil fuel with other form of energy that is cheaper and friendlier to the mother earth.

This process could go on even without government intervention since the forcing tools come naturally from the rising in oil price. It is surely a good news not only for a long run economic growth but also for the sustainability of the Mother Nature.

The Hypothetical Kuznets Curve

Nicholas Stern, a British economist and a former World Bank’s official, published a review which described global climatic change and its economic impact in the late 2006. In the review, Stern mentioned about the Kuznets Inverted U Curve.

The curve briefly describes the existence of a quadratic relationship between economic growth and the emission of green house gas. In a low level of income, the bigger the income the bigger the oil consumption which results a higher emission level. But the curve has a turning point whereas in a high level of income, the bigger the income the lesser the oil consumption which results in a lower emission level.

Based on the theory, I make an analysis through a Vector Auto Regressive model which aims to see the relationship between GDP growth, the oil consumption rate and the emission rate. The result is quite similar to the curve’s description whereas in the long run, with the rising in the world’s GDP growth, the oil consumption rate will be decreasing resulting in a lower level of emission.

With all the logic describes earlier, it is wrong to restrict consumption, because it will happens naturally with the rising in price. The ability to develop alternative energy will increase along with the world’s GDP growth. With the do nothing policy, in the long run we will have more stable economic growth and cleaner environments.

The Need for Debt Cancellation; the Fact of Resource Drain in Indonesia

For years, the Indonesian government has a dominant dependency on the foreign debt to cover the budget deficit in the national budget (APBN). These debts are basically aimed to reach the Economic growth through the budget deficit policy. But, one could understand that this massive dependency has become major sustainability problems in the recent years, Indonesia has fallen into a debt trap. Theoretically if the external debt as a proportion of GDP exceeds 20-25 per cent, there is no luxury of increasing foreign borrowing, particularly in circumstances where it is likely to be counterproductive. Further foreign borrowing, in order to achieve what would be a temporary interest rate advantage, would question the country's credit standing; would increase the drain on the economy from foreign debt service payments; and expose the country to any sudden change in international sentiment. The fact is, Indonesia are now facing over 45% debt to GDP ratio.

The ignorance from the government in term of reducing the dependency from the foreign debt has drained the revenue resource in Indonesia. The result is that Indonesia is no longer spending a large part of its yearly budget on the basic needs of its populations, due to having to use it to pay off its debts. The proportion of debt repayment compared with the tax revenue has clearly gave a clear description of how the domestic resource being drained.

In 2007, there are 41.45 percent of the tax revenue (PPh and PPN) being drained to cover the debt payments. The condition has resulted in the loss of suppleness in the national budget to use its domestic revenue for reaching the development goals such as reducing unemployment rate and eradicating poverty. In 2007, Indonesia spent 24.3 percent of its budget on servicing debt, compared with 3.08 percent on health, 0.06 percent on employment and 10.3 percent on education. The needs to pay its debt have undoubtedly driven the government to have a bigger proportion of natural resource based revenue. So, besides creating a problem in the people’s welfare, the burden of foreign debt has also created a massive depletion of the natural resource. The fact of deterioration of the natural resource because of the external debt burden has been sounded by WALHI on the CGI Forestry Meeting 26th Jan 2000. They said that The international and domestic macro-economies including public debt and international financing are intimately related to the shrinking of Indonesia’s forests. International aid and loans make the Government of Indonesia dependent on rich countries and tend to drain resources from the South to the North.

In other words, deforestation increases as a direct reflection of the pressure to pay back principle and interest on national debt and actually reflects national and international social injustice. The need for state revenues (foreign exchange) has driven many developing countries towards debt-orientated development modes for many years. The result is that these countries must now pay for their increased debt through exploiting their natural resources. Combined with the fact that financial institutions provide loans for environmentally damaging projects, such policies are yet another underlying cause of forest destruction and degradation. Besides that, financial demands often cause the accumulation of levels of loans for projects, which have a tendency to be beyond the government’s effective control. A case in point is the ADB and Japanese government loans for the Philippine forestry sector.

These loans must be repaid in foreign currency through increased exports which are typically linked to the over-exploitation of natural resources. In other words, foreign debt has created more problems by export-orientated natural resource management, which will almost certainly destroy the resource base. For the international scoop, this gigantic drain of resources operating for more than a quarter of a century has changed neither the status of the dependant economies, nor the nature of their relations with the developed countries of the North. It contributes, on the contrary, to the ever increasing concentration of wealth, at national level in favour of the dominant classes of the countries of the South and at international level in favour of the countries of the North. It explains in large part the dramatic increase over the last few years, in intra and international inequalities and in relative and absolute poverty.

International debt repayment constitutes one of the forms of transfer of surplus produced by the countries of the South to the North and of that produced by the workers of the South to the capitalists of their own countries and to those of the North. This has tended to increase the rate of labour force exploitation in the South. In this way, developing countries and newly emerging market economies have had to transfer to their creditors, an annual average of 3.68% of their GNP (Gross National Product) during the decade following the crisis (1980-1989). In the past six years (1997-2006), marked by a series of financial crises and a growing polarization of the international capitalist system, this transfer rose to 6.20% of GNP.

So, if the external debt can cause all the trouble, why does the Indonesian government make the debt for the first place? As the Harrod-Domar Model suggest, the rate of economic growth can be achieve by accumulating the capital. If there is a savings gap, or in other words the capital accumulation is less than needed, the gap should be filled by borrowings from abroad. But this model has a major shortcoming that is the dependency on foreign debt along with the economic growth. Our concern is, the government still uses this obsolete model which in fact creates problems as mentioned above. Besides the failure of the model, the Indonesian government is often has unclear purpose for making the debt.

For example, back in the early 70’s when Indonesia had a major windfall profit because of the oil boom, the number of external debt had also increased tremendously. One could understand that at that time the rate of economic growth can be boost even without making debt.

So at that time, the government had an ample amount of money, because of the debt and the oil revenue, without knowing the priority of development. This error has undoubtedly creates problems in present and future generations. The Need For Debt Cancellation All of this phenomena has triggered the idea of having a debt cancellation, as the Alternative Treaties that were being established by “Concerns and Pledges of Development and Environment Social Movements and Non-Government Organizations (NGOs)” in the Earth Summit on 1992 that says the foreign debt is the most recent mechanism of the exploitation of Southern peoples and the environment by the North, thus adding an extra burden to the historical, resource and cultural debt of the North to the South; the more Southern countries pay the debt, the more they owe -- has generated massive net financial transfers from the poor to the rich, thus perpetuating a process of decapitalization, impoverishment and environmental destruction that has devastating consequences for the South; there are also negative impacts to the peoples of the North with taxpayers' money bailing out banks, growth in unemployment and an increase in drug abuse; decisive action on the debt will make resources more available for the promotion of socially just and ecologically sustainable development models; the indebtedness of Southern countries is rooted in a development model which is not responsive to the needs of the majorities of their populations, but rather involves the harmful exploitation of people, resources and the environment of Southern countries, through adverse terms of trade, trade protectionism and the power wielded by international capital by, for example, transnational corporations.

The main idea is the foreign debt in Indonesia only functions as a burden in the economy. There are massive resource drains that create a major shortcoming for the people. This resource is transferred to the creditor country which benefit them most and has a negative effect for the Indonesia’s budget sustainability. In fact, the foreign debt originates in the continuing economic dependence from the creditor countries, from which they continued to acquire manufactured goods with the increasingly lower income from their agricultural and mining exports.

To cope with this imbalance, Indonesia were obliged to accept foreign capital loans, with which they also sought to construct infrastructures and achieve a first stage of industrialisation (both tasks naturally entrusted to companies from the creditor countries), endeavours which not only failed, but turned out to be far more expensive than expected, implying even greater debt.

The gradual and partial cancelling the Indonesian debt is the consequence to the evidence of resource drain. The cancellation is therefore the tacit recognition of the collapse of a perverse model of development aid that must be substituted by more efficient and truly fair measures ensuring the presence of poverty alleviation and the natural resource preservation program in Indonesia.

Wrapping Things Up: Solution without Debt

Although the external debts have more flaws than benefits, the Indonesian government still holds its initial standings that is making more of the debts and refusing all the possibilities for proposing debt cancellation. The fact of resource drain has been presented repeatedly but there is still no change in position. The argument of the governments is always the same, they argue that they don’t have any other alternatives in covering the deficits whereas the proposal for debt cancellation will clearly shut the doors of making new debts. As far as I concern, the problems do not solely rely from the debt strategy, but it depends heavily in the success of strengthening the revenue side. The dependency on the debt, the external debt to be more specific, is the consequence of the government incapability in increasing domestic revenues so that every time the government wants to increase its spending, the debt is always be the dominant source of financing. Besides that, the easiness of drawing more debts has cause the government to be infected by the lazy fiscal regime. So the most suitable remedy in curing the debt dependency illness is by the tax reform. This solution is might be not the best of all but for the time being it is the most possible solution.