Bigger Deficit for More Growth — How Does That Happen?


JULY 19, 2016

In the last few years, the Indonesian economy is gradually weakening. Almost all the economic indicators such as inflation, growth, export-import, etc., show that Indonesia's economy is not burning at the right pace. But thanks to a large, and robust, domestic market, the Indonesian economy still manages growth of 4 to 5 percent.

Nevertheless, the growth is still lower than what Indonesia had reached under Susilo Bambang Yudhoyono's government, during which economic growth was at a steady 5 to 6 percent per year.

There are several options that the government can choose from to bring the Indonesian economy back on the right track. The easiest, and the most popular, way is the way of Keynes: lift the aggregate demand.

Aggregate demand in an economy comprises four aspects: consumption, investment, government expenditure and the export-import sum (trade balance).

But in the face of a weakening global economy and increasingly uncertain political situations, it is difficult to pump domestic economic growth through investment and trade balance. In Indonesia's case, consumption is still the main engine of economic growth.

Still following Keynes, there is only one thing left that Indonesia can use to increase aggregate demand: government expenditure.

In the last two years, Indonesia has faced a shortfall in government revenue due predominantly to an unexpected drop in world oil price and an overoptimistic tax revenue target. At the same time, the government seems reluctant to cut its expenditure.

The government has kept a very conservative expenditure structure, increasing the budget steadily despite falling revenue.

The thing is, the revenue shortfall would never have happened if the government had been more realistic when setting its annual budget plan. But what the government did in the last two budgets simply defied beliefs.

How could they — considering the sluggish economy and extremely low oil prices — set even higher tax and government revenue targets? The only reason, maybe, was that the government was counting on a great tax reform to take place, and soon, in particular in the way tax officers collect their money.

Unfortunately, such tax reform remains a pipe dream for the government. In fact, at the end of 2015 the head of the tax office was forced to resign because he had failed to reach the unrealistic tax revenue target.

Another challenge for fiscal expansion in Indonesia is the budget deficit limit: which must be kept at less than three percent of the national Gross Domestic Product (GDP). The spirit behind this policy is actually quite noble: ensuring fiscal discipline to support a sustainable fiscal policy.

However, in a sluggish economy the policy has seemed redundant if not totally irrelevant. The government is forced to "freeze" its own budget and prevented from giving economic stimulus. If the the three percent limit is lifted, the government would be able to offer more stimulus from its budget to revive the moribund economy.

If you don't believe it, take a look at EU countries, whose recommended budget deficit limit as stated in the Maastricht Treaty is almost the same as Indonesia's. The treaty requires all EU member countries to maintain a budget deficit of no higher than 3 percent — but this rule is ignored many times over. For example, last year the UK had a budget deficit of 4.4 percent and France 3.5 percent.

Yes, the Greek debt crisis gave us a very important lesson on how an unsuitable fiscal policy could lead a country to a severe and prolonged crisis. Greece has also taught us the terrible consequences of unwise spending, unreasonable budget and extremely high public debt.

Yet, in Indonesia's case, the budget deficit and debt ratio are still at a reasonable level. Indonesia still has room to maneuver and expand its fiscal power to jolt the economy back to life through more productive expenditures in infrastructure (seaport, electricity, roads, etc.).

But as long as the constitution still only allows a budget deficit of three percent, any government would find it challenging to conduct an effective fiscal policy. Just this time, less is not more — more is more.

Dzulfian Syafrian is an economist for Jakarta-based think-tank Institute for Development of Economics and Finance (INDEF) and a PhD Candidate at Durham University Business School (DUBS) in the United Kingdom.