The Indonesian Crisis: A Human Development Perspective

4. Modelling the Repercussions of Financial Shock on Socio-economic Indicators

76 Iwan J. Azis© 2003 Institute of Southeast Asian Studies, Singapore MODELLING THE REPERCUSSIONS OF FINANCIAL SHOCK ON SOCIO-ECONOMIC INDICATORS m n IWAN J. AZIS Introduction Despite the obvious deterioration of some socio-economic variables after the crisis, it is still not clear how the financial shock has transmitted into the social conditions. Almost all analyses on the subject have used socio-economic indicators “before and after”, and concluded that any deterioration detected was due to the financial crisis. Such an approach clouds the understanding of the real impact of the financial crisis. More seriously, it is methodologically inaccurate. While attempts to improve social conditions are always necessary, regardless of whether or not there is a crisis, it is equally important to disentangle the real causes of the damages. This is particularly so when policies to counter the crisis-driven damages are to be designed under limited resources, which is the usual condition in a crisis situation. Moving from a “before and after” approach to a “with and without” one, however, would call for the use of some sort of model. The model should be capable of mapping out the mechanism through which various shocks in the financial variables are translated to selected socio-economic indicators, by taking into account the direct, indirect, and feedback effects. The primary goal of this chapter is to show how such a model can capture the important events (shocks) during the crisis, and disentangle 4 76 Reproduced from The Indonesian Crisis: A Human Development Perspective, edited by Aris Ananta (Singapore: Institute of Southeast Asian Studies, 2003). This version was obtained electronically direct from the publisher on condition that copyright is not infringed. No part of this publication may be reproduced without the prior permission of the Institute of Southeast Asian Studies. Individual articles are available at . Modelling the Repercussions of Financial Shock on Socio-Economic Indicators 77© 2003 Institute of Southeast Asian Studies, Singapore the impacts of different shocks on some socio-economic indicators. Obviously, the model contains a fairly detailed specification of the financial sector. First, an economy-wide model of the structural path analysis type will be used to measure the total effects of the falling production in selected sectors as a result of the crisis. In the subsequent section, a more comprehensive model featuring endogenous prices is constructed and used to evaluate the sequence of the crisis period in Indonesia. The ultimate purpose of the study is to analyse the impacts of the crisis on selected socio-economic variables.1 General Equilibrium Impacts of Production Shocks The contraction of economic production caused by the crisis could result in severe retrenchment of demand for labour, causing unemployment to increase. In turn, the collapsed demand for a certain type of labour would affect the income and welfare of various household groups differently. Through feedback effects, the resulting income distribution would eventually affect the production structure. Hence, a circular causation between production, factor income, and household income is created. As the primary interest of this study is to come up with a model that can be used to evaluate the impacts of the crisis on social indicators, this section focuses only on a subset of the problems. More particularly, the question to be raised is: which socio-economic group was hardest hit, and through which path did the transmission of influence take place? The general equilibrium model adopted in this section falls under the category of structural path analysis (SPA), drawing most information from an extensive data system known as social accounting matrix (SAM). As SPA has been discussed elsewhere (Azis 2000a; Azis 2000b; Defourny and Thorbecke 1984), the following discussions are devoted only to the results of simulations. The first task is to determine in what sectors the shock should be introduced. National income data suggest that there are only three sectors which registered positive growth during 1997–98: agriculture, mining, and electricity. Of these three sectors, only agriculture and electricity managed to maintain positive growth in 1998–99. Obviously, there has been a massive contraction in most other sectors, causing a major recession, with a drop of more than 13 per cent in real gross domestic product (GDP) in 1998. The four hardest hit sectors were construction 78 Iwan J. Azis© 2003 Institute of Southeast Asian Studies, Singapore (labelled Pconst in Figure 4.1A), trade (PTrade), financial (PBank), and manufacturing. The set of simulations in the following analysis is...