One day, three news, one story

News one: infrastructure development lacks funding 

News two: hefty amount for fuel subsidy is allocated

News three: fuel smuggling increases

What's the story? Allocative inefficiency is a good recipe for under-development and black market.

Stupid gun fetish

In the aftermath of yet another shooting spree in US (may the victims rest in peace), the gun fetishists again argue foolishly against stricter gun control. They say that had the teachers been armed, such mass killing could have been prevented (e.g. here, here, here).

That's ridiculous. Teacher's job is to teach students, not to shoot a gun. They should be able to devote their time to improve their teaching skill, not their shooting skill. If they now have to arm themselves with guns, they need special training, a lot of practices, and of course guns and ammunitions. Now, there are hundreds of thousand of schools in US. (Sounds like a good business for gun sales; but that's not the point). 

At the same time, knowledge keeps growing, teachers need to update themselves with all that, so they can teach better. That's where they are better at, teaching. Not shooting.

Rage against the machine, Platini edition

Michel Platini doesn't like the idea of inviting technology into sports. He strongly opposes goal-line technology, as, according to him, it is too expensive.

He said it's cheaper to have referees with "good glasses" standing close to the goal-line. Platini surely advocates the idea of replacing all traffic lights with policemen. Technology too expensive? Well, the first time human civilisation invented television, telephone, and what not, people thought they were too expensive. Or of course, the standard fallacy: technology leaves people unemployed. Who invents technology?

I guess Luddism never dies.

(Possible) Distributional Impact of Cutting the Science

Suppose the government decided to slash (or integrate, or reduce, or ... whatever) science subjects out from elementary schools curriculum. What would the private elite (read: expensive) schools do?  They would follow government's plan, yes?

I don't think so. More likely, they will provide additional hours for science with additional fee (rich) parents are more than happy to pay. 

Or, private sectors will spot market for private course on science, especially for those wealthy parents whose kids are enrolled in public schools that have to follow the instruction. 

By the end of the day, well-off kids get more science -- so much for a new curriculum that cuts science.

Buy one get the second one for 25% off

Dear Kate,

Holiday is coming and I am so going to the beach (yay!). I need to buy a new swimsuit. This one I have now I bought three years ago - it looks outdated. Yesterday I went to this mall and they had a big promo. It says you can buy one swimsuit and you get 25% off for the second one. You think this is good?

Beachlover @ Surabaya

Dear Beachlover,

It depends. If you're really a beachlover like your name, go get them. But I doubt it, 'cause you said your current swimsuit is three years old already. You don't go to beach that often, do you?

Now, if I am right (that you are no beach frequenter, just occasional happy beacher), don't fall into that marketing gimmick. You would waste your money. Just buy one. Chances are, the interest rate on your saved money for three years will actually outweigh the promised discount of that second swimsuit.

Unless. Unless you have a BFF who also likes beach (frequently or occasionally) and you want to give her a christmas gift. Then that second swimsuit might worth it. Just don't tell her that you got it for a discount.

Happy bitch- I mean beaching.

Kate

Admirable way of debating

First, Deschenes and Greenstone (2007, AER - all gated) debunked hedonic approach:

This paper measures the economic impact of climate change on US agricultural land by estimating the effect of random year-to-year variation in temperature and precipitation on agricultural profits. The preferred estimates indicate that climate change will increase annual profits by $1.3 billion in 2002 dollars (2002$) or 4 percent. This estimate is robust to numerous specification checks and relatively precise, so large negative or positive effects are unlikely. We also find the hedonic approach—which is the standard in the previous literature—to be unreliable be- cause it produces estimates that are extremely sensitive to seemingly minor choices about control variables, sample, and weighting. 

Then Fisher, Hanemann, Roberts, and Schlenker (2012, AER) criticised them: 

Conceptually, DG are correct in noting that omitted variables can in principle cause bias in a hedonic regression and that fixed effects can control for time-invariant idiosyncratic features of the unit of observation, in this case the county. However, it is also possible that fixed effects can increase the bias due to omitted variables if time-varying omitted variables (or data errors) are more strongly correlated with the treatment than time-invariant omitted variables that have been removed via the fixed effects. These fixed effects increase bias stemming from both endogeneity and measurement error. We have identified some important data errors and time-varying omitted variables, like storage, that are strongly correlated with both weather (the treatment variable) and DG's dependent variable, reported sales minus reported expenditures. These data errors and omitted variables bias toward zero results obtained by regressions that use sales as a proxy for production value. 

Then Deschenes and Greenstone (2012, AER) replied:

Fisher et al. (2012) (hereafter, FHRS) have uncovered coding and data errors in our paper, Deschênes and Greenstone (2007) (hereafter, DG). We acknowledge and are embarrassed by these mistakes. We are grateful to FHRS for uncovering them. We hope that this Reply will also contribute to advancing the literature on the vital ques- tion of the impact of climate change on the US agricultural sector. 

Look closely, how they exchanged data and computer code to get better understanding from both directions.

We remember, not long ago, a debate between Acemoglu-Robinson and Sachs were up. Very different kind - with the former got surprisingly uncool and even nasty.

6000 in 2016? Wow! - and the Gini ratio

So, according to an economist from Deutsche Bank in Jakarta, Indonesia's GDP/capita can reach USD 6,000 by 2016. Now it's about USD 3,500.

That's amazing. Because, if we assume a growth rate of 6.5% per annum, we will only get to USD 6,000 in nine years from now, that is 2021. Or, maybe he thinks we will have a far higher growth rate? Let's try 10% then (yes, that's ambitious!). Well, according to the growth formula, we'll get to USD 6,000/capita in mid 2017.

Understandably, some people criticise the number. This one goes further to say, even if the per capita income jumps, we still face a worsening inequality. She is right (although her definition - or Kompas' definition? - of Gini ratio is not exactly right). But to be fair, we can say our inequality (that is, represented by, among all, the Gini ratio) has been worsening, compared to ourselves in the past periods. In 2007 the Gini ratio was 0.33. By first quarter of 2011 it was 0.41 (Gini ratio goes from 0 i.e "perfect equality" to 1 i.e. "perfect inequality"). As for comparison to other countries:, e.g. China 0.44, Malaysia 0.46, US 0.47 - we're better. Of course there are many other measures of inequality, not just this Gini ratio.

The drafts with 10MB file

Dear students, once again. If you send your thesis draft, please consider a smaller file size. Sometimes we want to download, read, and review them on the go, but your files are way too big, they make us lazy.

Trust me, just because your curves and graphs are all fancy with bright colours and shades, they don't impress us so much that we give extra credit for them. So don't waste your time fancy up those tables, flowcharts and what not.

And this is not just us. Some journals don't even want colourful graphs in papers they would publish.

Blue rondo a la Turk

That's the title of the first track in the most famous The Dave Brubeck Quartet's Time Out (whose other compositions include the widely known Take Five).

The chief, the genius pianist Dave Brubeck, died yesterday. He was 91. 

Needless to say, to honour the legend, we are playing his music in the Cafe non-stop today.

Listen to the opening of Blue Rondo. It's like a wakeup call (I'd love to have it as my alarm default). Then it transforms to a nice, smooth dialogue between Brubeck and Paul Desmond on alto sax - and Eugene Wright on bass and Joe Morello on drum. They take us to the little street in Turkey, with a strange yet beautiful composition.

Right after the track Take Five (arguably the most famous one, covered by many artists, including a bad take by Al Jarreau), they have Three to Get Ready. I'm feeling poignant - Brubeck, Desmond, and Morello have passed away. Bless 'em all.

He's such a pig, but...

Hey! Back from a long traveling, I was struck by this news about a regent in Garut, West Java. He married a young woman only to divorce her four days later via an sms. Because he found out - or he thought - she was not a virgin. What a prick, this regent.

Apparently this has made into the headlines, invited public anger, and become topic du jour. Even the president who usually shies away from important issues, comments. Some activists made a petition calling for impeachment of the naughty public official. Underage, illegal marriage, said them.

I asked some friends who know laws and regulations. I was told that the minimum legal age for women in Indonesia is 17 years old. If this is true, than it is not an underage marriage - according to the news, the poor lady was 18 when she married him.

Some accused the bastard of committing a child trafficking - they said there was some money involved in making sure the marriage happen. Again I asked around. I haven't found a clear answer. But isn't trafficking a two-side transaction? If the regent was really buying her out, I would think the "seller" deserved punishment, too (even more). That's her parents.

So what I'm saying is, as much as I hate this guy, it seems that the legal case against him is weak. I just hope the poor woman sues him for, say, defamation or something like that. (I read his derogatory comment equalling his ex-wife to some merchandise that you could return when "the spec isn't right". My goodness!).

On wage increase

This never-ending tug-of-war between businesses and workers has been so frustrating. After the government bowed down to two demands (wage raise, ban on outsourcing), the workers asked for social protection - for free.

Now the business association pleads to the government to postpone the raise.

The recent minimum wage raises have been indeed dramatic. Jakarta, for example, set an increase of about 45%, Bogor 60%, and Bekasi 30%.

It's the workers' right to ask for pay increase, obviously. But we should understand that there's always two sides of a transaction. While the increase in wage benefits the existing workers, it suppresses the incentive for business to employ more workers (in fact, it creates incentive to lay off some of the existing workers) - so it is bad for those who are still looking for jobs. This especially hurts the SMEs whose labor costs can add up to 25% of total production costs (compared to less than 10% in the case of bigger firms).

Yes, we are still competitive in terms of labor wage, compared to countries like China, Philippines, or Thailand. But I'm not sure if the minimum wage keeps increasing in the order like those in the past weeks. Also, it's not just a matter of wage component. Presumably other labor-related costs will increase, for example severance payment (whose formula is a function of wage level). In the end, firms might shift the burden onto the product price. And hence creates inflationary pressure.

I'm not against wage increase (as a worker myself, I love a pay increase!). But as any econ-101 book tells us, wage should be a reflection of productivity. In the case of Indonesia, however, an increase in unit labor costs of 8% has induced a decline in export growth rates of 1.6 percentage points (World Bank 2012). Which means the wage bill has increased faster than productivity. OECD (2008) also calculates that since 2002 real minimum wage in Indonesia has been hovering above labor productivity. In fact if one takes the ratio of minimum wage to median wage, Indonesia has ratio higher even compared to the OECD countries.

I don't really understand why the government has been so lenient to these demands. Once in 2006 they attempted to revise the labor law but then backed-off following a big protest. And silent since then. I thought they were still fighting hard to cut down the unemployment rate. Maybe not so seriously.

Flipflop, the umpteenth time

Just when we thought the government finally had the guts to fix the erroneous fuel subsidy regime, the coordinating minister of economic affairs again launched the opposite signal, followed by the regulating agency. 

This keeps going on and on.

Sorry, Y

X is a worker. He is not happy with his wage. He gathers his fellow workers and together they demand for increased wages. Under pressure, the government says alright. The minimum wage is increased. A lot.

Y is X's cousin. She is unemployed. She's been hoping, after she finishes his SMP she could find a job to help her family. She wants to work in a garment manufacturing in her village, like her cousin X - even if she is paid below the minimum wage.

Now, thanks to X's demand, the minimum wage has increased - significantly even. All X's fellow workers are happy, too.

But Y and her fellow unemployed friends suffer. No business dares to hire and pay them below the now too high minimum wage. Y insisted, it's OK, she's willing to accept lower wage. "Please, you can even put me on weekly contract - not permanent". But the businessman said outsourcing and sub-contracting are illegal, too.

They can work here - but we also can work there

Kompas is wary of the ASEAN+6. The headline says "Foreign Workers Aim Indonesia".

Nowhere in the article says something about "this too can be a good opportunity for Indonesians to work abroad". Maybe we are too low of quality?

Fuel, again

Ministry of Finance offers 3 solutions to help ease the budget burden: 1) raise the fuel price by IDR 500/liter, 2) impose transition from fuel to gas for all (public?) transportation, 3) prohibit private cars to buy subsidized fuel.

Kudos for the first two (although, if the price is right, the transition should go automatically). But I'm confused with the last one. If private cars may not buy subsidized fuel and public buses should only buy gas, then whom the subsidized fuel are for? Supposedly motorbikes. But they're not the biggest consumers. Furthermore, who can guarantee there is no black market.

So I applaud the strong signal from the Ministry of Finance that the first option is the best.

Competition

Still on the rising price of beef meat in Jakarta. Kompas again runs a headline on it, saying that the market for beef in Jakarta is "vulnerable". Apparently this refers to the oligopolistic nature of the market, as indicated by a resource person.

Another article on the same subject again calls for "self-sufficiency" to overcome the problem. In fact, the author argues, this is the best time to impose self-sufficiency.

Which reminds of a good piece in the same newspaper that I overlooked yesterday. As the author said, competition is not always a bad thing. He gave examples of how competition brought good outcomes.

Once upon a time, the flour market in Indonesia was so distorted by a monopolist. The price went skyrocketing. The government finally decided, the only way to calm down the price was to open up the market to imported flour. Within days, the price was tamed. Search "Bogasari".

Price increase "abnormal"

The headline of Kompas today reads "The Price Increase [of Beef] Not Normal". It is reported that by the third week of November the price hit IDR 150,000/kg - while it had been hovering around IDR 80,000/kg in the foregoing six weeks.

The resource persons interviewed reason that 1) self-sufficiency should be achieved and import should be further restricted, 2) the domestic stock is actually sufficient.

The two explanations contradict each other. If the domestic supply is sufficient, then we don't need the call for self-sufficient anymore. We're there already. Secondly, if we are self-sufficient, there's no reason for foreign sellers to ship their meat here.

And both explanations contradict the title of the headline. If now the price increase is "not normal", then an increase in the supply should push it downward. Self-sufficiency and import restriction are likely to have the opposite effect. As for the second assertion, if the domestic supply is sufficient, price should be normal. Apparently, as the headline says, it is not.

Few Updates

I must have been either very busy or very lazy (most likely the latter) lately that I don't serve anything in the Cafe or realize that a truly excellent and readable book on development economics has been around since April 2011. The title is More Than Good Intentions by Dean Karlan and Jacob Appel.

I just read the Introduction, but because I need to work on something else now -- like reading Karlan's article on Observing Unobservables -- , I'll be back soon for more review. I may also write about the current state of economics education in our universities which share a theme with a report on how (the plan for filming) James Bond in the country was turned down by those in power due to some deep ignorance.

In the meantime, we will play jazz in this cafe. This time, Fall by Miles Davis Quintet (youtube).

We Found Love

Heck, I'm bored of econ. Wanna talk about Rihanna and her song We Found Love.

I believe Rihanna was a gladiator in her previous life. Not just your regular gladiator. But she's like the king, I mean queen, of all mean, cold-blooded gladiators in the history of mankind.

No seriously. Listen to this song We Found Love. Don't tell me you don't think of violence as you listen to the beat. Frankly, whenever I catch this song on the radio, I imagine Rihanna is sitting on a surrendered big bull, hurt the poor thing with something that looks like a leather whip. Or maybe an ice pick.

Like: We found love in a hopeless place (one poke on the bull's ear), We found love in a hopeless place (second poke on the bull's back), We found love in a hopeless place (third one on the belly), We found love in a hopeless place (by this time, Rihanna makes a crawl jump and lands on the bull's head).

Then the song repeats again.

Twice. No actually four times.

So, bulls, run for your life.

Update: So @acopatunru thought I confused "gladiator" and "matador". Ah, potato potahto. But wait, think of Rihanna as a gladiator, who, after knocking down her opponents in the stadium, goes for extra fun torturing bulls. That would do it.

About Our Tempe #657

Apparently for some people it doesn't make sense that while most of Indonesians love to eat tempe, the country keeps importing soybean, its main raw material, since 1970s.

Yet, our friend Haryo Aswicahyono (@Aswicahyono) shows that our love for tempe is actually quite feeble. Our soybean and its related product consumption is only about 2.5 percent of total food consumption. But, if you insist, let's assume that tempe is a must dish most Indonesian households need to consume, why we import soybean?

That's probably a wrong question to ask. Tempe is widely available on our dining table (in other words, affordable for many of us) because we can import (cheaper) soybean, rather than produce them domestically -- not to mention that soybean itself originally is not a tropical crop.


Regardless you like it or not, our love for tempe can grow thanks to imported cheap soybean. 

Readings on Indonesian Economy

Prompted by a discussion with a friend who is interested in Indonesian economy and by my recent task of reviewing a new book on the same subject, below is a list of a must-read (relatively recent) books I recommend to understand the (contemporary) Indonesian economy. Of course this list is just a fraction of the literature out there, including the many individual articles and papers in journals. But for undergraduate students (e.g those taking "Perekonomian Indonesia" - Indonesian Economy - course in FEUI, these are nice first reads I would suggest). My co-baristas and I will try updating the list.

• Basri, M. Chatib and P. van der Eng (Editors). 2004. Business in Indonesia: New Challenges, Old Problems. Singapore: Institute of Southeast Asian Studies.
• Booth, Anne. 1998. The Indonesian Economy in the Nineteenth and Twentieth Centuries: A History of Missed Opportunities. London: Macmillan.
• Dick, Howard, Vincent J.H. Rouben, J. Thomas Lindblad, and Thee Kian Wie (Editors). 2002. The Emergence of a National Economy: An Economic History of Indonesia, 1800-2000. Leiden: KITLV Press.
• Hill, Hal. 1996. The Indonesian Economy Since 1966: Southeast Asia's Emerging Giant. Cambridge: Cambridge University Press [Second, Updated Version: Hill, Hal. 2000. The Indonesian Economy. London: Cambridge University Press].
• Manning, Chris and Sudarno Sumarto (Editors). 2011. Employment, Living Standards and Poverty in Contemporary Indonesia. Singapore: Institute of Southeast Asian Studies.
• Pangestu, Mari. 1996. Economic Reform, Deregulations, and Privatizations: The Indonesian Experience. Jakarta: Center for Strategic and International Studies.
• Reid, Anthony (Editor). 2012. Indonesia Rising: The Repositioning of Asia's Third Giant. Singapore: Institute of Southeast Asian Studies.
• Thee, Kian Wie. 2003 (Editor). Recollections: The Indonesian Economy, 1950s-1990s. Singapore: Institute of Southeast Asian Studies. 
• Thee, Kian Wie. 2012. Indonesia's Economy Since Independence. Singapore: Institute of Southeast Asian Studies.

Related: Rizal's note on Development Economics

Marhaban, ya inflation

As always the case, prices are hiking up as the fasting month is coming. In the month of Ramadhan, muslims restrain from eating and drinking from dawn till dusk. One would expect a drop in demand for food and beverages.

But this is never the case. Instead, prices soar in response to a jump in demand. Because actually most people want better or even more extravagant meal to break the fast. Furthermore, events like "buka bersama" (breaking the fast together - usually with rich variety of food, in restaurants or otherwise) are pervasive. Some people have twice in one evening. Nearing the end of the fasting month, not only food's prices are high, but those of clothes also rise. Because people want new, fancier dress in the Lebaran Day. Then there is "mudik" (homecoming, special in Ramadhan for its massive flow of people - and money), where migrant workers go visit their hometown, bringing presents and usually, some good dose of cash. Some even buy new motorbikes, ship them with train, and have happy time in their villages.

Now, with these information, how do we not expect higher inflation?

But people and the media always blame the government for not being able to halt the soaring prices in this particular time. As a result, the government officials always appear in defensive mode. Some come up with funny arguments ("stop eating chilies", "we will punish sellers who raise prices too much", etc).

In fact, hiking prices are good in the above situation. They need to go up to respond to the large increase in quantities demanded. Otherwise, the filter effect of price is dead: we will see even more extravagant fiestas in the holy month - not that it's a bad thing.

So if any, the government should do something on the supply side, not on the demand side. And that's not by punishing the sellers who now see opportunity to reap extra profits. No. But by improving the logistics and infrastructure condition of the country. That is, keep working on tackling the most constraining factors in our economy. Yes, that's more like longer term program to address the economy as a whole, rather than a short term solution to the Ramadhan-led inflation. But why should it be the latter?

Two New Members

Hi all. Been away for a while. But partly because I'm out looking for nice and sweet things to decorate the cafe. Why? Because we're welcoming two pretty babies: Agatha (Aco's daughter, born May 7th) and Sekar (Rizal's daughter, born July 9th).

You wanna study violin? You'd better buy an expensive violin

One of my most favorite musical instruments to hear - not to play, I can't - is violin. I admire this guy Ngatmin from Kudus, Central Java who produces hand-made violins and sells them at IDR 1-2 million a piece (Kompas, 11/7). He also sounds very confident: "Our quality is better [than competition from China]. I guarantee you that. We'll also keep the handmade process, instead of turning into machinery. Because we know our products will still be sought for. We'll not lose our market".

So it is at odds that Kompas suggested to "block importation, for local producers need protection". They reported that Chinese massly-produced violins sell here at IDR 500-750 a piece. Again, a Ngatmin's violin, a better violin that is, sell at a higher price. So what's the problem? As Ngatmin himself says, the qualities are different. Isn't it just so natural that the one with higher quality is more expensive?

Kompas also wrote that those who purchase violins in bulk prefer Chinese made to local ones. Supposedly these are for schools or music training centers. I don't see any reason to complain. In fact, I hope more and more Indonesian kids (including the not-so-rich who can only afford Chinese violins) can play violin. Later, some of them who are serious and talented will sure buy the better one: Ngatmin's violin.

On Our Development Economics

Last week, I had a lunch with an economist who has published some articles in leading journals of the profession using Indonesia as data source. It was a nice conversation on various things Indonesia from what a Professor title really means (no easy answer on this) to why there are so few Indonesian economists to who's who in Indonesian economists (small) circle.

Then he asked this: "How do you guys teach Development Economics?"

It took me probably four or five seconds of awkward silence -- the time for me to recall syllabus of my undergrad's Development Economics and some more recent courses related to Development Economics in the Department that I knew, and reconcile them with syllabus of the same courses in classes in his Department or other Department in another side of the river that I am also familiar with.

I had to do some jujitsu to make our current state of Development Economics not look too terribly lagged behind, only to, in the end, admit that we in Indonesian universities badly need an upgrade and update on the issue.

I think the current Development Economics no longer so much discuss structural transformation or long run growth or inequality from macro perspective, but moves toward on how to make marginal improvement for effectiveness of (credible) public policies at micro level. The contemporary Development Economics also makes extensive use of now more widely available micro data and/or feasible experiment/surveys equipped with now much better (microeconometrics) tools.

And this is perhaps what Department of Economics in Indonesian universities need to catch up with.

It's OK to burn books. If they are yours.

It is saddening to hear that Gramedia, a major publisher and bookstore in Indonesia had to burn one of their newly published book, because some hoodlums don't like it. Long time ago I offered this solution to Playboy fiasco (involving, yes, you got it right, the same hoodlums): buy the magazine and burn it, if you like (see here and here). This Gramedia case is a bit different. Or not? No one buys the book and the store owner burns it themselves. Well, they are effectively the same. There is no violation of property rights. Gramedia owns that book*. They have the right to burn it. Just like I have the right to burn my OWN books, that is, the books that I already purchased and hence the property right lays on my hands.

I'm not saying that this situation is of no concern. We are concerned. By the fact that the community where we live in has been so colonized by some thugs who always act as the moral police ready to ransack whoever disagrees with them. And ransack they do. The problem here is the absence of the state in protecting its citizens from freedom of fear.  

--

* Yes, there might be some complication. Depending on how Gramedia deals with the author, some degree of property right might still belong to the latter - however, I would assume Gramedia (should) pays for some compensation, in one way or another.

(Probably) Some Philosophical Suggestions

1. You don't confuse between the idea of free market and (US) government intervention.

For example: The US sanction against Iran, that our philosopher condemn as raising oil price at the cost of oil importer countries, is not a free market idea. It is a government (political) intervention.

2. You don't set double standard.

If you condemn the US unfairly manipulate its exchange rate (which I don't get why, because the US is also major importer), you should also applies the same level of condemnation against China.

.. and more to come

Argumentum ad confusion #743

"... Because a rich person pays more tax, he/she deserves for receiving higher fuel subsidy than what a poor person receives..."

This argument came up to justify a very disturbing fact that more than 40 % of fuel subsidy in Indonesia is received by top 10% of the riches..

But, isn't this line of argument crazy? You don't pay tax as one-on-one payment for subsidy you get. Tax is to finance public goods production -- goods/services you can not exclusively consume and would not decrease if other also consumes, so that market price (supply and demand) will produce below optimum quantity.

Does gasoline falls into the category of non-excludables and non-rivalrous goods? Hell, no.

Even more puzzling to me, the other purpose of tax is actually to reduce consumption/production -- because there are some goods/services that produces negative externalities to the bystanders, like pollution.

How come then paying tax justifies for more consumption?

This is really an upside-down logic fueled by lack of very basic economics, which brings me to a question: when you complain (in twitter, facebook, on TV, and on the street) about tax and subsidy, do you really understand what you're talking about?

An Alphard buying subsidized fuel is rational

Statement: "Look, that Alphard buys a subsidized fuel! Shame, shame, shame!"

Why it is a fallacy: Is it illegal? No? Is it shameful if a rich guy eats in a warung Padang in a kakilima, instead of in a flashy mall? No? Case closed. [On a more serious note: people respond to incentive. It is on every consumer's instinct to find cheaper price. Now you offer two commodities that are close substitutes with significant price gap. It shouldn't be surprising that some people choose to buy the cheaper one, despite the slightly lower quality. My point is, if you let the BBM price shows the scarcity of the oil correctly, hence the price gap not too big between the substitutes, you might see rarer case of subsidized-fuel-drinking Alphards, because now the owners think it is not worth the switch, given the different qualities. So point is: correcting the incentive is more helpful than cursing at the "rational fool" - if you permit the term.

Addendum: a friend @NickyYuventius just tweeted me that the analogy to warung Padang is not accurate, for the warung is not subsidized. He offers another analogy: rich people buys/owns a unit of apartment in rusunawa (subsidized apartment). While it is possible that a designated location for street vendors incl. warung Padang kakilima are subsidized (like those in Solo, so rental fee of space is cheaper), I think his example is more useful. Thanks, Nicky!

OK, this is not about BBM price, we just can't stand the govt anymore

Statement: "You don't get it. You can go all nerdy on the numbers and what not on the BBM price and on the subsidy. But hey, this is actually not about BBM price. You can adjust it whatever you want. But the reason why we oppose the price hike is simply because we can't stand the government anymore. They have been very disappointing to us lately"

Why it is a fallacy: Because it is akin to a mother whose son is in a serious illness and she refuses a treatment from the only certified medical doctor in town, simply because the mother doesn't like the doctor. [On a more serious note: by adjusting the price closer to its economic price, aka market price, you actually give less room to the government to interfere in your life. Isn't that what you want?]

The Baptists, The Bootleggers, and The Fuel Subsidy by Pram Oktavinanda

Hi all, here's another contribution by Pram Oktavinanda. Today Pram looks at the fuel subsidy debate. Enjoy! - Kate

The Baptists, The Bootleggers, and the Fuel Subsidy

By Pramudya A. Oktavinanda

There is a very interesting case study in Public Choice literature. Once in the United States there was a law called Sunday Blue Laws which basically prohibited the sale of alcohol in Sunday. One of the supporting groups for this law, we call them "Baptists", was a group consisting of people who wanted to prohibit such sale of alcohol based on moral and religious values. The other group, "Bootleggers", was the seller of illegal alcohols. They also supported such law but not based on altruistic or moral values, rather it was because such restriction increased their profits. The stricter the restriction is, the less the supply for the alcohol, the bigger the price that they can charge for their illegal products.

It goes without saying that these two groups are ideological opponents, but with respect to political matters, they were in the same side and their cooperation as interest groups allow them to provide the necessary voting power in the legislative to support the promulgation of the Sunday Blue Laws, effectively prohibited the sale of alcohol even though both groups have completely different reasons to support such laws. Public Choice theorists also use the same analytical structure when they review a very famous case in the United States, i.e. the Lochner case which dealt with whether New York may legislate the maximum working hours for workers in bakery shops.

New York argued that the law was passed to protect the health of the workers since during the beginning of the 20th century, the working condition of many bakery shops was so poor and many workers work for a very long hour in order to compete with each other. Some politicians support this law on the basis that they need to protect the interest of their citizens, giving protections to relatively weak workers from the capitalists. But the researchers also found out that the other supporters of this New York law are groups of major bakeries that already comply with such law and want to cut the competition by imposing a law that will destroy the business of many small bakeries that depend on immigrant workers.

Again, we can see how the cooperation between Baptists and Bootleggers worked very well in this case. The US Supreme Court finally deemed the law unconstitutional although after the passing of the New Deal by Franklin Roosevelt, more paternalistic laws were issued and the Supreme Court was pressed by the President to support those laws. But that will be another topic of discussion. For now, let us focus with the case of fuel subsidy in Indonesia.

We can quickly see two groups rejecting the reduction of fuel subsidy. The first group argue that reducing fuel subsidy will harm a lot of poor people. The fact that most of the time the subsidy is enjoyed by those who actually do not deserve it does not matter since once the subsidy is reduced, it will affect the overall price of goods in Indonesia and the poor people will suffer. There is a grain of truth here. You do not need to be a genius economist to understand that when you increase the fuel price, since it affects the price components of many other products, producers will most likely also increase their prices as a response. Consumers will be the victim here.

The second group reflects the people who enjoy the existence of fuel subsidy, those who buy the cheap fuel and those who illegally export the cheap fuel to other countries for considerable profits. For those who buy the cheap fuel, it is simply a rational choice, at least for the short term. Whether there will be huge inflation and whether it damages the environment are things that will happen in the future and discounting the probability of having such catastrophe in the near future, they might conclude that in the long run, all of us (this generation) would already be dead when the Earth is being struck by such catastrophe. So, why the heck should we care anyway? It's the problem of future generations, not us.

Combined these two groups, and you will find that they consist of the majority of Indonesian people. They might have different agendas, but they have the same goal, preventing the fuel price from going up. As such, I do not see why I should be surprised with the recent political maneuvers in our legislative board. Politicians, considering their rational incentives for maximizing their own interests, would always consider the present condition in making their decision. And the future for them would always be about the next election, meaning that they are very short sighted. Whatever beyond the election period is another issue to be solved when they reach another election.

Of course in the context of Indonesia, it also means that the idea of reducing the fuel subsidy will never be a popular one. You can't argue about the needs to conserve the energy or to pursue alternative energy sources in a country where most of the people have bleak futures. They don't care about such issues. If they are pessimistic with their futures, how could they appreciate the fact that our environment is in danger? For them, whether the environment will be destroyed or not in the future will not alter the fact that their life sucks now and most probably also sucks in the future.

The question is, how could we avoid this vicious cycle? One thing that might happen is to wait until the fuel price has reached a point of no return where it would be impossible for the government to maintain the subsidy. I note that this might be the political compromise made a couple of days ago. At least when you need to take an unpopular policy, you take it after you are in a desperate condition. Might actually work, but I can't predict whether the end result would be beneficial for all of us, since it might also be too late.

You see, the problem of this kind of policy is that in the end it is made to support certain groups at the expense of other groups. Right now, the Government supports both of the Baptists and Bootleggers groups at the expense of tax payers money, though I will argue that the Bootleggers are the ones who enjoy most of the policy. From Game Theory perspective, it is also a prisoner's dilemma game. I personally for sure will buy the cheap fuel. It is paid by my tax without my consent, and I will enjoy it to the fullest. I bet that many other people will also think the same. It will turn out into the tragedy of the commons and everybody will eventually suffer.

The Baptists group may produce a nice argument on the need to support the poor. It is a valid argument, but it fails to see the overall human incentives. Rational choices of many people may produce a bad result, that is the essence of the tragedy of the common. Everyone will be better off had they conserve the energy, but in a situation where every people can benefit themselves at other people expenses and there is a lack of supervision, the rational choice will be to spend the resources as soon as possible before other people take the resources for themselves. Why bother conserve the energy if we can't be sure on whether everybody will do the same? See the irony?

Is this a premonition for a bleak future for us? Who knows? We can hope that suddenly a miracle will occur, maybe someone will be able to produce energy from water and humanity will eventually survive. But until that day comes, you better cross your fingers and hope for the bests. After all, we are all together in this situation.

PS: I only provide a positive analysis of our current condition. There are many other people who have provided excellent normative analysis on the policies that should be taken on fuel subsidy and I don't think that my thoughts on the normative aspects will give an additional value so I decide not to dwell on it.

Inconvenient consequence #23

Suppose I am an owner of an SPBU (fuel station). The government and DPR (parliament) has decided to not adjust the price of "premium" (subsidized fuel), but let the price of "pertamax" (non-subsidized fuel) free. What would I do? Well, because the price gap is too yummy not to take advantage of, I'll sell less premium and more pertamax. So be prepared that you'll often find "sorry premium is out of stock"-sign on my gas station. I know that my location is strategic and many of you coming here to buy premium will have no choice except to buy my pertamax. Sorry. And ow, I see a long line now; I can even increase the price! (Actually if I can even be more evil: I would mix the two types of the fuel underground and sell them both under the name "pertamax" on the nozzle - how many of you would check my tanks?). 

Did I forget to thank the DPR and protesters?

Argumentum ad hominem #965

I think it is now indeed a good time for taking stock of fallacies that came up around fuel-subsidy removal debate.

My favorite, because it is so funny I can not stop laughing at, is an argument that went, "..you support fuel subsidy removal because you got scholarship abroad..."

Hello? What if I got scholarship for studying biology or religious study?

In other words, another Jaka Sembung Naik Ojek moment for me.

Argumentum ad confusion #422

Statement: "I should have raised the price last year because the world price was increasing dramatically. But because I was very concerned with the people I didn't raise it"

Why it is a fallacy: 1) If you really care about the people, you don't act as if the supply of the good in question is abundant, 2) You knew that the world price was increasing and you knew that it was a reflection of a supply shortage (or else, increased demand given the same level of supply), but you didn't want the domestic price to transmit this signal; instead you put a subsidy to mask it, or else ration the limited amount of supply (forgetting the fact that the best tool for rationing is price, not quantity allocation by the government)

Conclusion: You were either not concerned about the people or you were in denial of what you knew.

Argumentum ad confusion #337

Statement: "Energy crisis? What crisis? Solving it by reducing subsidy? LOL"

Why it is a fallacy: 1) We're talking about entering an expected energy crisis given the current pattern of consumption, 2) Which means the energy at stake, non-renewable, is in decreasing stock, 3) A decreasing supply, given demand, should be reflected in a higher price, 4) But forcing the price so as not to move up, kills the function of the price as a messenger that otherwise tells us that the stock is vanishing; putting a subsidy on top of it kills it even more - consumers would think the stock is actually abundant, hence consumption may even increase 5) This is not just about one market, namely the particular energy at stake, but also about another market: the alternative energy, 6) Letting the price functions well in the market for the non-renewable energy, results in a price increase in that market, induces an increase in the demand for the alternative energy, and creates an incentive for firms to supply in response to the expected increase in the demand.

Conclusion: He who ridicules with that statement is either lying, just teasing,  or simply does not get the basic logic of supply and demand.

The speech in my dream

A twitter @andidio said something about his dream about SBY announcing the fuel price hike, and apologizing to the people about the possible impact of it. Suddenly I wanted to write my own hypothetical dream. With an apology to the President, I would like to dream. So here goes.

Dear my fellow countrymen,

I am standing here in front of you to tell you that I have decided to make an adjustment on the prices of BBM, or fossil fuel. I apologize because this issue has created a rising tension among you. I understand that students and many others oppose the plan. But let me explain.

First off, I have to bring to you some inconvenient facts. Sorry to tell you, we are not an oil-rich country. We have to quit the OPEC because we are no longer eligible as a member of “petroleum exporter countries”. Our oil reserves now hover around 4 billion barrels – the proven ones are below that. Our lifting capacity is below 1 million barrels per day – not all of this is ready to consume: we have to export the crude and import the refined, because our technology is limited and our production is short. At the same time, our consumption keeps increasing – now it almost reaches 1.5 million barrels per day. And this is rising: our young people are abundant, but so is their energy need. If nothing is done to reduce the dependency on fossil-based BBM, if nothing is done to right the incentive for technology to improve our production, we will exhaust our reserves in 12 years down the road. Good if by that time we have alternative energy ready. But if we now keep holding the BBM price well below its market price, nobody will have the incentive to start developing the alternatives. Think about it: if you are an investor, would you put your money on an industry whose product’s expected price can not beat the existing alternative? So, my friends, if nothing we can do to adjust the BBM price, we are exposing ourselves to an energy crisis. Again, let’s face it: we are not an oil-rich country.

My fellow countrymen,

I am aware that out there some heated debates on the budget numbers, allocation, and all the nitty-gritties have been escalating. I thank Kwik Kian Gie and others who brought this up again. I appreciate my ministers and their staff who responded and clarified. And I embrace constructive reminders from students and activists.

But deficit or surplus is, my friends, only a small part of the big picture. It is good to be transparent on the budget details and to conduct thorough assessment on the numbers or the assumptions used. So I welcome any scrutiny from ICW and others. I have asked my staff to check all the numbers again very, very carefully. Let us improve the transparency and accountability for that matter. Nevertheless, may I humbly ask everyone to start looking at the bigger problem of this current subsidy scheme? This is not really a deficit or surplus issue. We are today facing at least three crucial issues: the lack of infrastructure, the mis-distribution of subsidy, and the harm to the environment.

First, let’s talk about infrastructure. It saddens many of you that in Jakarta, the price of Pontianak oranges are far more expensive than those imported from China. The cost of transporting goods on our land is almost 50% higher than that of the average ASEAN’s. Due to difficult access, the prices of cement or even staple goods turn exorbitant as they reach Yahukimo, Paniai, and other remote places. Now, one might say that because Indonesia is an archipelago, it would have been less expensive if we relied more on water transportation. Sounds logical? Well, as it turns out, the cost is even higher, at 150% higher than ASEAN’s average. Why? It is because the ports are not yet efficient. Isn’t it ironic that a country of thousands of islands doesn’t have a single hub port in par with those in Singapore or Hong Kong? Exporters complain. When they want to ship their products via ports, their container trucks have to compete with your cars and motorbikes just to get into the toll way. And that toll way is jammed, too. They also have problem entering the port. Let alone the still-heavy bureaucratic procedure in the port. Some rational firms shift these burdens on to the consumers. How? By increasing their prices. That explains, to some extent, why we are not very competitive in the international market. So we have to do something on all this. That is, we should improve our infrastructure and logistic system. Hence the heavy emphasis on these issues in our planning documents. But of course this needs a lot of money. The government budget can only cover 30% of it, while the private parties will come only when, understandably, they perceive good returns on investment. In the meantime, we keep allocating more money to subsidize the energy consumption than to build infrastructure. This is not productive.

Secondly, the intention of all this subsidy business is to help the poor. Unfortunately, we now realize that the major bulk of the fuel subsidy is actually consumed by the not-so-poor. In fact, almost half of it goes to the high-income group; while less than 2% goes to the bottom 10%. This is regressive – we don’t want a subsidy scheme like that. Even worse, the resulting price gap creates an incentive to smuggle. Or, oplos. You may have read in the media that the government warns against speculators and irresponsible traders who take advantage of the price gap by buying low and sell high, or by mixing the different types of fuels and sell them at the price of whichever is higher, for a handsome additional profit. Now this practice is actually a form of entrepreneurship. In the ideal time, I would have encouraged this. But this is no ideal time. We are talking about security of energy, a necessary good whose stock is steeply decreasing amidst the absence of its alternative.

My third but in no way the least concern is about the environment. Climate change is happening. Yes, debates are still ongoing on the degree and the risk of it, but it does happen. We are one of the biggest carbon emitters. Our deforestation is one major culprit. But the contribution from energy sector that includes transportation is increasingly worrying. This is because the energy source is still dominated by highly-polluting fossil fuel. And the consumption of such energy is what we keep subsidizing. In other words, we actually encourage higher pollution. As I said above, the alternative, cleaner energy can’t compete against the dirty energy since the latter is protected by our subsidy.

My fellow countrymen,

With those three factors – infrastructure, poverty, and environment – accounted for, I hope we can now see the bigger issue beyond simply budget deficit big or small. By fixing the current subsidy regime, we hope to be able to improve our infrastructure, fine-tune our poverty eradication programs, and to help better up the environment. I’m fully aware that this might create a shock in the economy, especially to the poorest. But I hope the shock will be short-lived, as our experience has shown. We will also employ some temporary compensation to those at the bottom of the pyramid.

Dear friends,

That was long already. But let me close with some final remarks. Some of you said that I should have made this price adjustment last year. I cut the price two times in 2008 and another once in 2009 – in an attempt to follow the world price dynamics, as promised when I increased the price big time in 2005. I should have been consistent by raising it again in 2010 and especially in 2011. But I didn’t. I hope this time I can do better. Keep reminding me. If I somehow fail to improve the infrastructure after doing all this, you be the judge.

Looking for the right incentive

Below is an excerpt of my talk in the International Conference on Adaptation to Climate Change, Brussels, February 28, 2012. I think this has some relevance to the ongoing debate on fuel subsidy in Indonesia. In particular, as I have talked much about infrastructure, now it's time for the environment. Cheers. Aco.

Cooperation in Adaptation and Mitigation - Southeast Asia

by Arianto A. Patunru (University of Indonesia)

Managing the climate change is a public good issue. That is, it is not economically attractive to any private party to do it alone, despite the fact that the benefits of doing it will spread out to many parties. Therefore, it is prone to the problem of free riding.  On the other hand, what one does will affect the others, such that if left uncompensated the latter will be forced to move down to a lower utility, hence the negative externality. Furthermore, climate change problem is not contained only in one isolated place. It is almost impossible to localize the problem within a small range neighborhood. Due to these characteristics of climate change problem, it is imperative for all the parties affected to cooperate.

The idea behind many internationally arranged cooperation in terms of environmental causes such as climate change mitigation and adaptation is how developed countries help developing countries to reduce emission levels by proper compensation. One of the important aspects of international cooperation is that the fund involved often times requires a loop process where assistance is given with conditionalities. This is normal and in fact can be used to help the recipient country developing its own structure or system to support global initiative of green economy.  Cooperation for environmental cause can also be conducted using the already existing organization. In fact many of these organization already have initiatives addressing environmental problems in a coordinated way. In addition to developed-developing countries cooperation, there needs to be cooperation system between developing countries. Most naturally this would be formed on the basis of geographical proximity e.g Southeast Asian countries, for each country is prone to the externality originated from any other country in the region (for example on NO_x and SO_x pollution).

One of the areas that need cooperation especially among developing countries is clean energy. It is a fact that energy demand is always rising in a developing country. But the demand is often times met with a supply of energy that produces negative externality to the economy. That is, the supply of clean energy has been limited. Many Southeast Asian economies are victim of high oil prices, but they continue to pervasively subsidize energy. Countries spend even up to 25% on energy subsidies, for example Malaysia (USD 15 billion in 2009), and Indonesia (USD 15 billion in 2010). In 2008 the overall fossil fuel consumption subsidies amounted to USD 557 billion, of which non-OECD countries responsible for USD 400 billion.  These energy subsidies distort prices, and have negative effects on the environment as it can support pervasive activities that lead to environmental degradation or encourage overconsumption.  Although in developing countries energy is subsidized for economic development and poverty alleviation, subsidies for oil and other energy sources mainly benefit higher income groups and capital-intensive industries.

While pursuing cooperation with other countries, each individual country should continue improving its own domestic policies and development practices. For example, in Indonesia agriculture is still the most important sector in terms of the large share of population working in it, as well as the high concentration of the poor. Hence any policy regarding this sector should take poverty issue into account. Simply requesting a low carbon agricultural practices might not tackle the root of the problem. The fact that many poor Indonesians are stuck in agriculture sector is also related to the rigidity of the labor market where the movement across sectors (for example for agriculture to more value-adding manufacturing) is relatively hindered. Furthermore, the ratio of land per farmer is very small (currently majority of Indonesian farmers are landless peasants and farmers who own less than 0.5 hectare of land) – and keeps reducing due to fixed resource of land versus increasing labor force in the sector. This leads to the problem of low productivity and sustainability. Therefore, it would be more logical if the policy in this sector aims to increase productivity (in a more sustainable manner) and to improve farmers’ access to wider opportunities like manufacturing. This also applies to peat and forestry sector.

With regards to energy and transportation, the governments' attempt to reduce dependency on fossil fuel and instead move towards renewables is commendable. However, the key culprit of the dependence of fossil fuel is the heavily subsidized price. The cheap price of gasoline has made riding private vehicles is far more attractive than using public transportation. On the other hand, the availability and reliability of mass transportation are still low. Therefore, the incentives for consumers to reduce their use of private vehicles (and hence fossil fuel) are scarce. On the producer and business side, the same incentive problem takes place. Because the fossil fuel is heavily subsidized, there is little incentive for business to develop renewables for their product will not be able to compete against the subsidized fuel.

***

Good Intention Gone Bad -- or Argumentum ad confusion #785

Following Aco's earlier posting, let me add another fallacy on fuel subsidy removal in twitland.

What about this: ".. I am against fuel subsidy removal because (poor) fishermen still buy fuel at exorbitant price..".

I fail to understand this logic at many levels. Fuel subsidy shall make the price low, not high. If our fellow fishermen pay high price, there must be some sort of fuel supply shortage.

One of them is probably the failure of government to deliver fuel through its distribution network. But the solution is to fix the distribution and it has nothing to do with fuel subsidy inefficiency removal -- in fact, this is more reason for liberalizing fuel retail business.

But even so, if the government can deliver the fuel to the buyers, at low subsidized price there is big incentive to smuggle it. Why? Because once you're out of Indonesia water, you can resell the fuel at higher international price and seize the margin. At the same time, it reduces fuel supply for local fishermen.

Now I hope you can see the bigger picture that boils down into this: Higher fuel subsidy raises incentive/profit margin for smuggling the fuel. (Domestic) fuel supply in places near international water declines. The fishermen are forced to buy even higher than international price.

Is that really what you want by asking for higher fuel subsidy?

Argumentum ad confusion

Some cause-versus-effect confusions circulate the Twitterland. Here's a few:

• Attack and destroy the "Mafia Migas" (apparently this refers to some mafia who takes advantage on the current fuel and gas market in Indonesia), before removing the fuel subsidy. I'm dumbstruck. The main reason why mafia exists in the first place is to take advantage of price difference. Holding the fuel price well below it's corresponding market price is the best recipe for smuggling and hence a good reason for a mafia to form. You want to discourage the mafia? Cut the incentive. That is, reduce the price gap.
• Develop alternative energy before reducing the fuel subsidy. Eh? What makes an investor attracted to a particular line of business? The expected price of the goods or services it will sell. Now, who wants to invest in renewable or alternative energy when the current fossil-based fuel - the competitor - is sold at a price too low? One might say, well, since the private will not be interested, the government should be the one developing the renewable energy. Great. So, the government should keep the huge subsidy now for fossil fuel. And in addition to that, the government should also allocate yet another bulk of subsidy on renewable energy. Au revoir, infrastructure. Good bye poverty eradication. Never mind basic education and health.
• The government should wipe out corruption before adjusting the fuel price. This one is not so controversial, actually. I'm all for fight against corruption. But why wait until all corruption has been eliminated, then do the right thing on fuel price? The government should do both. In fact, the fight against corruption is an infinite task of the government. Here I can understand people's frustration to the President. This was one of his signature promise during the election campaign: to fight corruption. Now that his party is so tarnished with corruption allegation, unfortunately he doesn't seem to make an effort enough about it. But again, fighting corruption is one thing. Fixing the dire distortion in fuel market is quite another.

Finally, I was dumbfounded, when somebody tweeted about countries where gasoline prices are so cheap. "Oh, how fortunate them people living on those countries", said him - or something to that effect. Now, look at the list of those "fortunate countries". Many of them just experienced political turmoil aka Arab Spring. Some of them are authoritarian countries. Some are too rich and with state-of-the-art infrastructure and probably they can just waste their oil money to subsidize their people. Oh, there is of course Venezuela with a confused leader  - oops, I think I just offended his fanboys here. Sorry.

Anyways.

Addendum: Oh, I forgot to mention. The last time I checked, we're no longer sitting in OPEC, that is, the organization of petroleum exporter countries. Why? of course because we're now a net importer. So, wishing our country selling cheap oil like those exporters (setting aside infrastructure, poverty and other issues) sounds like a bad comparison, no?

Some number-play on BBM's subsidy

Rizal emailed me yesterday, telling me that this "debate" on fuel (BBM) subsidy with KKG has been going nowhere since 2005. KKG uses his accounting with "convenient" assumptions to debunk anything government says about the subsidy and the budget. We have said repeatedly in the Cafe, that KKG's calculation is erroneous. Others have done the same. Teguh Dartanto has his take here. Ari Perdana has one here, and Arya Gaduh here.

But of course KKG goes on and on. And many media love his style. Many pundits and commentators use his argument without reservation. Politicians send message broadcasting KKG's numbers - people re-broadcast them, of course.

I think this debate is getting more and more off the mark. And the government (and DPR) should also share the blame. They're all trapped in the debate about surplus and deficit in the budget. Which is beside the point.

But fine, since I received so many questions about that KKG's piece, here's some thought. KKG says the government actually still has a "profit" of almost IDR 100 trillion from "selling BBM". Now I don't want to debate how he got this number (but see my PS below). In fact, let's assume KKG is right. In fact, let us even "help" him by doubling his claim to IDR 200 trillion a year (are you happy now, Pak Kwik?)

Now, what is the most important obstacle in Indonesia economic development? Yes, infrastructure. How much money do we need to allocate for infrastructure development in 2011-2014? IDR 4,000 trillion - or roughly IDR 1,000 trillion per year. Now, how much is the current capacity of the government to finance this? Thirty percent. That is, 70% must come from private parties (more specifically: 50% from pure private financing and 20% from public-private financing - PPP). Can we safely assume that private money will come "just like that"? Unfortunately, no. So long as our investment climate is still lousy, private money will find better places. As long as we still have not found a good risk-sharing mechanism for PPP, do not expect too much. Let's just assume that from IDR 500 trillion expected from pure private financing, 50% materialize. So we are still short IDR 250 trillion a year. What was KKG's surplus? IDR 200 trillion (that is, after we give him a bonus of IDR 100 trillion). Oops: still short!

So my point is, isolating the debate on surplus versus deficit can be useless. Because even if you have budget surplus, it still doesn't make sense to go ahead with the current subsidy regime. And in this post I only look at one aspect: infrastructure. As I said here, there are other two pressing factors: environment and poverty eradication.

PS: It's not that I never tried to check KKG's method. Here is my excel from long time ago, trying to replicate KKG's calculation. You can see that many of his assumptions are very shaky (changing the parameters a bit - scenarios to the right of KKG's numbers - lead to significant implications). These numbers are from old time debate (of course magnitudes of the parameters have changed, but I just want to show how I think KKG thinks)  - you can adjust it as you like, using the more update data on oil lifting, crude price, et cetera. But again, if I were you, better not wasting all your time with this.

PPS. Another tone used in the current debate is that government may as well keep the current subsidy system, if they do their homework well on budget efficiency, corruption eradication, et cetera. Woah, are these even subsitutes? Of course the government should make the budget more efficient and should keep fighting corruption. But while doing all that, why keep a wrong subsidy practice?

Addendum: I made a mistake in the infrastructure fund needed in 2011-2014. The number above (IDR 4,000 trillion) is for total investment needed. Infrastructure share is about IDR 1,800 trillion. Annually this translates into IDR 450 trillion. That means, using the story above (assuming 50% of the expected pure private financing materialize), IDR 112.5 trillion is needed. This is above KKG's IDR 100 trillion "profit.

Widjojo #289

In a meeting in his office in the old Littauer, a senior Harvard Econ faculty told me, "Widjojo is the best technocrat I know in my entire career". Some years ago, in a centuries-old college in another Cambridge, England, Widjojo's name came up as a prime example on how to run economic development.

When I told him Pak Widjojo passed away, another faculty here, familiar with contemporary Indonesian political economy said, "I wish history did better justice to him". This is how I know Widjojo -- through other respectable people's high appreciation. Unlike Aco, I've never had an opportunity to even directly talk to him.

But, you don't have to know him in person to recognize that he must have had done something right. The easiest way is by comparing all Indonesian economic indicators in late 1960s to now. You may say that we don't have counter-factual evidence, but if one said he worked to make Indonesia more prosperous and the data says so, this is the least uncertain fact we can take. Widjojo deserved the credit and, for me, no doubt about it.

Widjojo strongly believed in the strength of economics analysis in development. If Gary Becker proposed an economic approach to human behavior in 1978, Widjojo wrote in his inaugural speech as Guru Besar FEUI, on the importance of economic analysis on development planning, back in 1963. He also wrote on the role of research in universities. Fifty-years ago, very few in Indonesia thought about it and the words "economics", let alone "research" was very foreign to us.

Widjojo knew and, without so much fuss, showed that economics and research can make a big difference to human lives and well-beings. He quietly showed us, especially at FEUI, perhaps indirectly, that proper economics matters a lot.

And this is why Pak Widjojo will be sorely missed.

It's not really about deficit

So as usual, KKG is again spreading his attack against the plan to cut fuel subsidy. Politicians like Dyah Pitaloka happily embrace his elaborate take and broadcast it all over. Their argument is, the current budget deficit is not as bad as the government claims, will not explode, and there should be enough money to keep subsidizing the fuel consumption.

Which misses the point. Look, even if we have a budget surplus, the current fuel subsidy is still wrong. This is not about deficit big or small - or even (very unlikely) surplus. This is about misallocation, mistargeting, and misincentive. The budget is misallocated because the money spent to cover the subsidy would have been in better use if otherwise spent on infrastructure development. The subsidy is mistargeted, for the major bulk of it is enjoyed by the top rich. And the subsidy system is suppressing the incentive for the development of renewables, for the environmentally-friendly energy products will not be able to beat the price of the heavily subsidized gasoline.

In short, the current fuel subsidy practice is unproductive, pro-rich, and environmentally harmful. Too bad, the government is also focusing the debate too much on the deficit issue.

RIP: Sajogyo

Rest in peace, Prof. Sajogyo, the quiet man behind the poverty line measurement. You are deeply missed.

Widjojo (1)

Widjojo (1)

He was loved and he was hated. Now he’s gone. No doubt, we in The Café are in the group who loves him dearly. We are aware that Kwik Kian Gie, Rizal Ramli, and the likes hate him. We don’t care. For us, Pak Widjojo is eternal. He lives in our way of thinking, way of seeing things. It’s not only economics. It’s about how one should deliver an idea. How to argue civilized way. How to respect even the unknown. We are way his juniors. Our experience is a tiny fraction of his. But if there is a model we would like to follow, that’s him.

But what really is this concept called Widjojo? Unlike that of prolific economic writers such as Chatib Basri, Sadli and Emil Salim, Widjojo’s writings were dry, almost boring. But the messages were strong and important at the same time. Read his 1963 professorial inauguration speech 1963. That was dry and dismal. But it was incisive and contemporary. At the time, Robert Solow’s 1956 seminal paper on neo-classical growth model was a big thing. One of the model’s predictions is growth convergence between rich and poor countries that share the same steady state (current textbook example: Germany and Japan in the aftermath of World War II). This is theoretically neat. But empirics do not always confirm: some poor countries remain poor, rich keeps progressing. It took some time before the profession agreed that the convergence that goes with the empirics is conditional convergence. That is, a country will converge to its own steady state. Or, if any, countries with similar starting points will meet. But what if this similar starting point is nowhere to find? What if savings rate or technological rate of a less developing country never catches up with that of the developed? Almost two decades after Solow’s paper, Krugman came along with an inconvenient truth: it is possible that a rich country keeps leaving the poor behind due to increasing returns and economies of scale. And of course, from more micro-perspective we are now familiar with poverty-trap, et cetera. Today, ground researches by members of the younger bastion like Banerjee and Duflo attest this. But Widjojo, among a few, had warned us in 1963. He wrote that a big gap in initial levels of income might not be neutralized simply by equal rate of growth in income. In order to overcome this situation, he added, less advantageous countries need a rational planning with economic analysis – and implement it vigorously and consistently. Then he explained in greater details what he meant by planning – in that inaugural speech. Two years ago, Widjojo admitted in his book, that that speech went against the tide: people were unconvinced that economic issues were important. Worse yet, people were skeptical to economics as a “text-book thinking” approach.

Now, this same person, the text-book-thinking Widjojo was no blind supporter of heavy state planning. He was actually more pragmatic. In 1955 – he was 28 years old – he debated Wilopo, the former influential prime minister. The event was the fifth anniversary of Department of Economics, University of Indonesia. Wilopo, the key-note speaker, presented an argument against economic liberalism. In particular, Wilopo disapproved private initiatives and individual property rights. Widjojo called this contradiction – that Wilopo treated private initiatives as necessary evil in development. Instead, according to Widjojo, private enterprises should be given a role in economic development. He also warned that by “private” we should not just mean big enterprises (to name a view, he mentioned a Dutch-owned oil company BPM and an American Stanvac), but also the small ones. As he put it, “the little farmers with a piece of land of no more than 0.1 hectare are also private”.  (Note that Widjojo’s stand with regards to private role in economic development had shaped even before he went to UC Berkeley in 1957).

(this might be continued).

A Tribute to Widjojo by Pram Oktavinanda

Dear cafe patrons, our friend Pram Oktavinanda shares his tribute to Pak Widjojo. This is cross-posted at his blog too. Being a lawyer and legal scholar, Pram highlights Widjojo's contribution to the economic analysis of law in Indonesia. Enjoy. - Kate.

An Introduction to Economic Analysis of Law - A Tribute to Prof. Widjojo Nitisastro

by Pramudya A. Oktavinanda

It was a sad day indeed for Indonesia as one of its greatest economists, Prof. Widjojo Nitisatro, passed away yesterday. What a great loss! Although I have never met him in person, I know him through his splendid articles and books about him, especially the Kesan dan Pesan Sahabat-Sahabat Widjojo Nitisastro. Two of my favorite articles of him deal with the economic analysis for national development and the economic analysis of Article 33 of the 1945 Constitution (which discuss the correct economic structure for Indonesia). I consider those articles as the classical example of economic analysis of law in Indonesia and they have significant impact on inducing me to pursue the art of Law and Economics.

While I have been writing about law and economics for many times in my blog, I have never formally written about an introductory article on economic analysis of law itself. I guess this is the right time to do so as a tribute to the late Prof. Widjojo Nitisastro. You will surely be missed and may you rest in peace. God bless you.

Economic analysis of law or law and economics is a school of thought primarily developed in the United States that uses the powerful tool of economics to analyze various legal issues. It discusses three primary questions: (i) What is law? (ii) Why law exists in the society and can have binding power? (iii) What can be considered as a good law? Two prominent scholars can be considered as the early developers of law and economics, Gary Becker, a prominent economist who won Nobel prize in 1992, and Richard Posner, a prolific legal academician who is also considered as one of the best judges in the United States. Both teach at the University of Chicago and contribute significantly to the development of law and economics.

Why economics can be a useful tool in analyzing the law? The primary notion used in this school of though is that men act rationally. Not in the sense that they can always make perfect calculation at all times but in the sense that they respond to incentives and pay attention to the costs and benefits of their actions, even when they are subject to various limitations in doing so. This is the basis of positive law and economics which deals with descriptive analysis on the law and how it will affect human behavior.

The second notion in law and economics is the pursuit of efficiency and welfare maximization of society. This is used by normative law and economics which believes that law should be designed to maximize the welfare of the society, whereas to reach that goal, law must be designed as efficient as possible. The more efficient the better, since it means that we can save costs while produce the biggest benefits to the society.

Interestingly, despite the fact that law and economics has reached a very strong position in the United States, dominating the legal thought there, it is relatively unknown in Indonesia which sadly, still focuses its law teaching with classical legal thought. I guess this should be changed if we really want to improve our Indonesian legal system.

Why law and economics is helpful for developing our legal system? I have three main reasons. First, by paying attention to how the law can shape the incentives of the people, we can shape our law to effectively affect the behavior of the people. As an example, I once argued on limiting the use of prison as a sanction for corruptors and instead using the sanction of assets confiscation. Assets and money are the bloodline of corruptors, the ones that significantly induce them to do the crime in the first place. If we only send them to prison but fail to secure the assets back, that will allow the criminal defendant to use the money to buy his way through the legal system (remember the case of luxury prison).

Second, by paying attention to the notion of efficiency, we will also pay attention to the costs and benefits of having regulation. Only regulate if the costs of doing so are lower than the benefits. Do not try to regulate everything because we cannot have an effective regulation without effective enforcement. And enforcement can be costly, the bigger the scope of the enforcement, the bigger the costs. Classical legal thoughts believe that law should be obeyed because it is promulgated by the relevant authorities. This is completely wrong. It is obeyed either because we find a mechanism to enforce it or the general society believe unanimously that such law is useful. Hence, the need of enforcement.

One good example of this would be laws that deal primarily with regulating private behaviors that do not produce clear harms such as how to dress publicly. On the one hand, regulating those kind of things will be costly, imagine the price for enforcement and the potential social unrest that it will create since it will give legitimation to people to violate other people on the basis of dress. On the other hand, there is no clear benefit of regulating such behavior in the first place other than to serve the idea of several people about morality. We've seen a lot of these absurd laws, such as laws that try to regulate how to name your child. I wonder how these laws could even exist if not only for the purpose of political maneuver.

Finally, by putting the goal that laws should always aim to maximize the welfare of the society, we will have a good guide in developing laws that will be useful for the society. And there are a lot of things that we can discuss here. Some good examples that I have once discussed: how to efficiently regulate liability of people in tort cases (such as whether we need to establish good samaritan liability), whether we should maintain death penalty (do the benefits justify the costs?), how to prevent rape crimes effectively, the extent to which we can limit foreign investment in Indonesia, how to share the legal risks of infrastructure development in order to induce more investors to come to Indonesia, how to reduce courts burden by cutting unnecessary costs for judging petty crimes (the latest Supreme Court regulation is a nice example of this), and many more.

I believe that it is important for law makers and legal enforcers to always strive for welfare maximization in rendering and interpreting the law. You do not enforce the law for the sake of the law itself. Law is not holy, it is not untouchable, it is not derived from the sky, rather it is made to serve men and should be made in view of men needs. Prof. Widjojo Nitisastro has started the idea of using economic analysis in shaping our national development and making sound economic policy long time ago. It was a great contribution, something that we, youngsters, must also strive to achieve. The least thing that I could do is to introduce law and economics to Indonesia and contribute in offering good public policy for our nation.