Replacing Subsidies with Investment: Lessons from Jakarta

Last month Indonesia’s newly elected President Joko Widodo made the controversial decision to cut public fuel subsidies, which led to a 30 percent increase in the nation’s gas prices, prompting protests.

Yet, investors have cheered Widodo’s decision. The country’s stock market has risen, its currency has rallied, and its bond yields have fallen in the weeks since the announcement.

Behind this policy move, and the market’s reaction, lie lessons for U.S. economic leaders, including in metro areas.

For years Indonesia enjoyed some of the lowest fuel prices in Southeast Asia. The low prices held down transportation costs, reducing prices for just about anything that moves on the back of a truck.

Curtailing the subsidies will almost certainly hinder the nation’s growth in the near term. The higher fuel prices will likely increase the rate of inflation, which has prompted the nation’s central bank to raise interest rates in anticipation.

However, Widodo’s policy move is a big step towards putting Indonesia’s economy on a more equitable and sustainable growth path.

Though the subsidies had helped lower costs throughout the economy, they had done little to spur investment or lasting growth. Indonesia’s low costs have mattered less to investors than the poor quality of the nation’s infrastructure and human capital. The subsidies also did little to help lift up the 40 percent of the nation’s population that lives on less than $2 a day. In fact, the subsidies mostly benefited the wealthy car-owning, consumption class.

The costs of the subsidies had also become astronomical, totaling $20 billion per year in a national economy of just $900 billion. Slashing fuel subsidies will save the government between $8 billion and $10 billion in 2015 alone.

Crucially, President Widodo plans to divert these savings to the nation’s infrastructure, education, and health care systems. By investing in these assets that increase the nation’s productive potential and the earning potential of its citizens, the president is betting that the long-term dividends of more equitable growth—and therefore more sustainable growth—are far greater than the short-term dividends of faster growth.

The market reaction has shown that the private sector is making the same bet. That’s because today companies and investors tend to care more about the assets and amenities that make a place productive and wealthy in the long-term than they do about its present affordability.

Despite the differences between Indonesia and the United States, leaders in both counties are grappling with the same tradeoffs between faster growth and equitable growth. Like Indonesia, most U.S. metropolitan economies have rebounded since the global financial crisis. U.S. economic output grew at an impressive rate of 3.9 percent in the third quarter of this year. But the incomes of most individuals have not grown nearly as quickly. In fact, many people in both countries have fallen further behind since the crisis.

Here in the United States, leaders in metropolitan areas must make similar wagers as President Widodo. Previously some leaders might have subsidized jobs or stadiums. Today, many are investing in their distinctive economic assets based on local conditions. Tax breaks for new jobs moving into the region (regardless of their quality), subsidies for high-end retail development, and big bets on stadiums or entertainment districts must be weighed against long-term investments in things like community colleges, R&D and commercialization of ideas, or passenger and freight infrastructure. Longer-term investments may not be as sexy, but they are much more likely to benefit people and companies alike, making local economies more productive and attractive places for years to come.