We have a guarded optimism about Indonesia's economy in 2007. According to the available macroeconomic indicators from last year, there should be nothing to worry about in 2007: low inflation, falling interest rates, steady rupiah, rising stock prices and a higher rate of government spending. However, looking at the political realities, there is every reason to worry.
The year 2007 marks the third year in office for the current administration. In most democracies, the third year for an administration should be one of the best performing, but we doubt whether this applies in Indonesia. Although we are still two years away from 2009, when the country will have both legislative and presidential elections, many members of the government already seem to be focused on 2009, instead of working on the task at hand.
Therefore, we don't expect the government to make any daring moves to mend the structural problems in the country's economy, like it did in 2005 when it raised fuel prices by 143 percent to reduce subsidies. It remains to be seen whether the government will dare to touch on two of the most important but thorniest issues facing the economy: labor inflexibility and a rice import ban. These two issues are too important to ignore, especially if the country hopes to address the chronic problems of massive unemployment and rising poverty.
Despite improving economic growth last year -- as a result of higher-than-expected exports and government consumption -- the unemployment figure likely remained the same, or even rose, because, according to the World Bank, the current levels and sources of growth are not creating enough new job opportunities.
Available data show overall unemployment edging up from 10.3 percent in February 2005 to 10.4 percent in February 2006, and labor force participation falling from 68 percent to 66.7 percent, meaning that more and more people have been ejected from the formal sector into the informal sector. Worse still, youth unemployment, already high, rose even further from 28.7 percent to 30.6 percent. These unemployed young people represent a bulk of new voters, and therefore politicians wishing to ensure their support at the ballot box would be wise to figure out ways to provide them with jobs.
These troubling unemployment figures should sound an alarm for the government. The administration's failure last year to amend the 2003 Labor Law, which makes hiring and firing workers unacceptably expensive, penalized workers who do not have formal sector jobs, as well as investors. Such an investor-adverse labor law discourages investment in labor intensive sectors, which would otherwise provide a comparative advantage for the country.
It is therefore necessary for the government and the House of Representatives to address this issue. If they cannot amend the law, they should at least take measures to compensate for the legislation, like passing regulations that would provide more flexibility in severance pay and the outsourcing of labor.
Unlike labor issues, the ban on rice imports has a more direct and damaging effect on the poor. Maintaining the rice import ban means penalizing the 80 percent of the population who are net consumers of rice. Many of these people are poor, including rice farmers themselves. Keeping the ban, which only allows imports of certain amounts of rice and only by appointed importers, is a political move rather than an economic one, to protect political interests, likely for financing campaigns ahead of the 2009 elections.
If the government cannot or will not do anything about the rice import ban, it will have to work especially hard from the fiscal side to address the issue of poverty. Again, the government's almost heroic decision to cut a fuel subsidy that benefited the rich more than the poor, and to compensate the poor with direct cash transfers, was a good example of a fiscal move that benefited the poor. This policy marked a shift from a commodity-based to a direct subsidy.
We would like to suggest that the government continue shifting from commodity-based to direct subsidies. In the 2007 budget, subsidies account for 2.9 percent of gross domestic product. Many of these subsidies are commodity based, including the fuel subsidy and subsidies on electricity and fertilizers.
At the same time, the government should improve direct subsidies for the poor by refining the targeting and moving from unconditional transfers to conditional ones; for example transfers associated with educational attainment. This way, the government could kill two birds with one stone, reducing poverty and at the same time improving education.
As more and more people are lifted from poverty, and more and more unemployed people get jobs, it bodes well for the government and improves the chances of reelection in 2009. Jobs, food and low prices will make people happy, and will keep the government in office for another five years. Politicking will not do much to impress the people. After all, using a phrase from Bill Clinton, ""It's the economy, stupid.
