Probably the most important factor that makes Singapore a hub is that it has always been a politically stable country. Much of this has to do with 2 factors: a relatively small population making it easier to govern, and the competence of the dominating People’s Action Party set by Lee Kuan Yew. Political stability such a crucial ingredient in becoming a financial hub. Many big corporations would only choose to base their operations in a highly stable country with low corruption and a well enforced rule of law.
This is something very hard for Indonesia to achieve especially ever since the democratic reformations. There are many different parties continuously wrestling for power with their own vision. The long term direction of Indonesia is therefore not predictable with public sentiments continuously changing, some times the people want a free market economy, other times they want to be protectionist, much depends on which side is the most convincing at that moment. This will continuously hinder Indonesia’s prospects of being a financial hub as many businesses would always think twice before taking the risk of opening shop in Indonesia as they can never know what is going to change tomorrow. Unlike Singapore, that for many decades have a clear vision and therefore enjoys great stability.
What this also means for Indonesia is that they can’t have a financial sector as strong as Singapore’s. An advanced financial sector consists of many investment banks, wealth management and business consulting firms. Many of these firms can only prosper on a busy and stable business environment. This is a hallmark of the financial hubs as the establishment of these services places the city/country as one of the centers for money and investments in the world. Wealthy individuals from around the region would come and park their money or invest in instruments provided by these advanced financial institutions, thus bringing large sums into the country. Jakarta and Indonesia meanwhile simply do not have the ingredients to facilitate these levels of advancements in its financial sector. They would definitely grow to become a regional power in the future as they currently only have less than half the population that are using commercial banking services, thus great space and potential for growth. To be one of the hubs in global trade however is something else entirely. It’s one thing to get the common people to bank a bit of money in their savings accounts, it’s another to get billionaires from other countries to save and invest their money into the country, and thats where all the big money and investments come from. That’s what makes a hub.
There are two ways a country can find itself in a situation where it can’t repay it’s debts. Either the Government has been borrowing excessively for it’s fiscal policy and defaults on their short term obligations. The other way is when there is a systematic failure in the country’s banking system which leads to the Government having to bail out the banks. We are going to discuss the aftermath of both these situations.
Firstly the Government of the country will approach/be approached by the world banking institutions, the “lenders of last resorts” such as IMF and the World Bank. Several countries in Asia and Africa will also be negotiating with China’s Asian Infrastructure Investment Bank (AIIB) and Asian Development Bank (ADB). Meanwhile countries in the EU will also be negotiating with the European Central Bank. The indebted country will negotiate for new loans to service their short term obligations they couldn’t cover. Negotiations will be on how the country will restructure their economy to warrant these new loans. This includes providing plans on how the Government will increase their tax revenue and which Government spending will be cut. The IMF will usually propose several reforms for the country.
If the current debt levels are at a very critical level, there might be negotiations on the sales of the country’s national assets. The assets can literally be anything the Government owns from state owned enterprises or even Government owned buildings and properties. The Greece debt crisis resulted in several of their airports being sold to German firms.
After an agreement is met, the Government now has the funds to meet their short term obligations and prevent default. However, the hard work is just about to begin.
Impact on the economy
The first thing that will happen prior to default is foreign investors and investments will rapidly pull out of the country. Usually coupled with other external factors, all of this will cause the currency to weaken drastically, thus causing rapid inflation in the country. Riots and strikes would then follow causing most business activities to come to a standstill, halting the economy.
Asian Financial Crisis, Indonesia 1998
Greece Sovereign Debt Crisis
Most banks will close, either temporarily or even permanently as they cannot cope with the drastic amount of cash withdrawal caused by the panic of the population. Many businesses may not survive and go bankrupt resulting in the overall economy (GDP) to shrink.
Some countries such as present day Venezuela (above) is experiencing an economic crisis at such a critical level, the Government is forced to ration out goods for the people.
If resentment has been rising towards the incumbent head of state, calls for impeachment might occur as the people calls for drastic change on the system. The replacement then will bring messages of optimism and bring about major reforms. Slowly, with large sacrifices from higher tax rates and massive cuts in Government spending, the economy may gradually recover.
Indonesia Democratic Reformations, 1998
Greece’s Syriza Party led by new PM Alexis Tsipras
It is much harder for countries with a large population to overcome the middle income trap.
Manufacturing is an essential driver of growth when transitioning from an undeveloped to a developing economy. It adds more value than agriculture produce, it employs many people with decent wages, and it brings technological and capital intensive investments into the country. However, in order to overcome the middle income trap and make that jump to a developed economy, a country needs to add high value, and this is where some countries get it and some countries don’t. These are the 2 most important ingredients to overcome the middle income trap.
Indonesia currently has near full enrollment for primary school education. However, moving up to secondary school that number falls to around 66%, high school enrollment is even lower at 45%. As a result, only around 11.5% of Indonesian children makes it to University level . In order to become a high income country, the Indonesian Government must make higher level education available and possibly even compulsory to all. World Bank has set a benchmark of high income countries at USD12,500 GDP per Capita, Indonesia currently has a GDP per Capita of approximately USD3,800 therefore in order to beat the middle income trap and become a high income country, Indonesia must create a workforce that is capable of creating USD12,500 of value on average per Indonesian (rough representation). Education is the key ingredient as many high income jobs require higher level education.
Innovation & Entrepreneurship
Educating the people to be able to take on high value jobs is only half the work, the Government also needs to provide these jobs so that it is widely available to the people. However, a Government can try all they can to attract foreign companies and provide high paying jobs, ultimately, high income countries need to have strong innovation and entrepreneurship which can potentially create so much more value and employ many more people. Put simply, you cannot get rich working for someone else, then apply it on a national scale. This is what differentiates the successful high income countries to the middle income countries.
These are the 2 key ingredients to overcoming the Middle income trap. Now lets talk about why countries get stuck in the middle income trap for further insights.
Inflation: This will naturally happen to every developing countries. As countries develop, the income of the people increases and as income increases, domestic prices rise. When an undeveloped country transitions into a developing middle income country, there comes a time when foreign manufacturers that have been investing into the country and thus contributing heavily towards its growth, suddenly find it more profitable if they outsource their productions elsewhere because domestic prices have already increased. Suddenly the impressive growth that the country enjoyed, significantly slows down and will most probably never reattain that same level of impressive growth rate. This will happen long before the country reaches High income status. The worst thing about this is that it can lead to more serious problems. Investors tend to flock together so whenever there are signs of significant capital outflow, investors would jump ship together thus creating a possible recession.
Politics: This can come in many forms. First of all when a country’s economy develops rapidly, the gap in income inequality tends to widen. This is because many people may get rich in the process, prospering from new business opportunities. However the low income people would be left behind as domestic prices and living costs will increase. This may create dissent among the population. Best case scenario, the Government might have to spend a bit on welfare programs to assist the lower income demographics, which will be a dent on the National Budget that could have been invested elsewhere. Worst case scenario is a potential political crisis that will drag the economy down for years before it truly recovers. This was what happened to Brazil in the 1980s which triggered their long period of middle income trap.
Lack of Innovation and Entrepreneurship: Some countries just do not have a strong culture of innovation and entrepreneurship. For these countries, its much trickier because the fundamentals of the problem is so deeply rooted, the best the Government could do is to continuously ease business processes by removing unnecessary regulations that makes it hard for common people to do business. An example of this would be Thailand, a country that has been quite stagnant in their growth for quite a long time despite possessing a very strong manufacturing sector. The Asian Financial Crisis played its part for sure, but ultimately most of it has to do with their inability to transition their economy to be driven by the higher value sectors, which would have generated much higher income.
Currently Indonesia is just about to enter the middle income benchmark. One distinct characteristic in Indonesia’s present day economy is that Indonesia already has a huge service sector relative to the other sectors, and growth in this sector has shown no signs of slowing down. Is this a good thing? Economists are still divided on this issue. Big populations like Indonesia cannot emulate smaller countries like Singapore which straight away made the jump into a service economy. The conservative view in economics is that countries need to develop through the traditional stages in order to be well balanced and if the manufacturing sector were to be ignored, Indonesia might run into some serious problems in the future. Nonetheless there is a positive that can be taken from this. Indonesia seem to have the right environment to promote strong growth in the near future, especially in the higher value services industry. This can be attributed to 2 factors:
- Indonesians generally embrace technological advancements.
- Indonesians are generally consumptive in nature.
These are 2 very valuable traits to have for a strong economy. The positive attitude towards technology will generally help Indonesians move up as it provides them with endless opportunities. E commerce sites have helped in creating a larger competitive market that the lower income people can participate in. Many mobile applications such as Gojek have disrupt and enhanced the landscape of industries creating much value for the economy.
Meanwhile, the consumerist behaviour will facilitate the growth of entrepreneurship and businesses, big and small as they will always have space to grow and meet the unlimited demands of Indonesian consumers.
The Middle Income Trap is inevitable, especially for a large country like Indonesia. If i were to make a prediction though, i think Indonesia will do quite OK, potentially better than Thailand and even Brazil. Probably not as well as Malaysia did though simply because Malaysia’s much smaller population is easier to manage and transition. However it comes under these 3 terms:
- Fix lagging manufacturing sector
- Rapid improvements on the education system, improve enrolment and quality of education
- Remain politically stable for the next few decades
With a population of over 250 million people, Indonesia is the 4th most populated country in the world. Despite the abundance of human capital, Indonesia is severely underperforming economically with a GDP that is number 16th in the world rankings. Why is this the case? It is fair to say there are several major fundamental problems in Indonesia’s economy. Here are the top 3:
Lack of tax authority enforcement
Our tax revenue is very poor and ranks among one of the lowest percentage globally at 12% of GDP. To add some perspective:
Its no surprise considering we only have approximately 27 million registered taxpayers when there should be around 120 million citizens complied to the tax law. This is due to the severe lack of funding and manpower in our tax office, leading to many citizens having a completely lax attitude towards tax evasion as they probably wouln’t get caught anyway. Indonesia’s lack of tax authority enforcement leads to the Government having little money for serious developments.
Lack of infrastructure
This is an issue that is being addressed by the current Government. The fact is Indonesia is so far behind in terms of infrastructure. The most important of which is port capacity, roads and railway networks.
Indonesia’s port capacity is very poor. The largest port in Indonesia located in Jakarta has a capacity of 5 million TEUs (container units) and has not been subject to development since the Dutch colonialist era. Other ports in less developed region are way more poor in its capacity. To add some perspective, port of Singapore has a capacity of 32 million TEUs and they have a population less than Jakarta.
What this means is there is very little incentive for the private sector to make investments into shipping vessels as there is just not enough capacity to sustain it. This leads to Indonesians having to spend much more if they want to export goods to foreign markets as there is very little supply of container transportation. It is much more lucrative to base operations in Singapore which has ready made cheap transport for exports. As a result, Singapore has an export level of around USD23 Billion, which dwarfs Indonesia at USD12 Billion, despite having a small fraction of Indonesia’s population.
Many Indonesians find it more profitable to base and list their business in Singapore due to its infrastructure availability and ease of doing business.
Roads & Railway Networks
The island of Java is fairly developed in terms of roads and railway networks, although it is still behind other developing nations. Moving to other regions though, the developments are clearly very poor. Many regions in Indonesia can barely be accessed by heavy vehicles. This results in a severe disparity in prices between the regions as the private sector dont find it profitable to do business in inaccessible areas. There are many regions in Indonesia where basic commodities such as medicine are severely overpriced. This lack of access to goods hinders the developments of many regions.
Lack of development and socialization on the financial industry
Indonesia’s financial industry is underdeveloped and undersocialized. The lack of availability in financial instruments which could generate higher returns to investors and lack of financial literacy among the Indonesian population is costing Indonesia. As a result, Indonesians react to this in 2 different ways:
- Many wealthy Indonesians would choose to launder and park their money abroad (mainly Singapore), where they can invest in wide variations of financial instruments provided by investment banks.
- Other Indonesians with disposable income can only invest in traditional assets, most popular of which is property.
The first point is a broad discussion in itself so i am going to discuss the second point.
A developed economy typically needs to have a strong financial industry. This is because the financial industry enables a more efficient allocation of money and capital. With a solid financial sector, industries that have great potential for growth would have easier access to money and capital as investors have a platform to invest in that industry. Through the advanced financial sector, mainly investment banks and wealth management firms that would invest towards the growth of said industry. Put simply, a solid financial sector is a lubricant for growth as the allocation of capital in the economy is more efficient.
Indonesia, due to lack of availability and literacy among the population does not have an efficient allocation of capital. The typical wealthy Indonesian would choose to invest in property, owning more than one houses and apartments. This drives up prices and results in an overpriced property market especially in the more urbanized regions. Property prices in Jakarta right now is at unrealistic levels relative towards the average Indonesian income.
With the availability of advanced financial institutions, Indonesians could have invested in sectors that would have been more beneficial towards the overall growth of Indonesia’s economy such as tech and e-commerce. There is a severe lack of such medium right now.
Unfortunately, this is a tricky issue to manage due to the significance of private sector involvement. The Government needs to continue improving Indonesia’s business environment in hopes that the financial industry grows in its variations and level of sophistication.