Indonesia's infrastructure is in bad shape. [According to a recent article in The Economist (May 9th 2015): "companies spend 50% more on logistics than those in Thailand and twice as much as those in Malaysia."] The government of Indonesia cut fuel subsidies in 2014 and allocated half of the consequent savings to develop the country's infrastructure over the coming two decades. Research shows that in the range of infrastructure availability in Indonesia and far beyond that, infrastructure development has significant positive externalities that outweigh diminishing returns to capital.
- What is the likely impact of this policy shift on the real exchange rate of rupiah (the Indonesian currency) in the coming two decades? Explain.
- What is the implication of the policy shift for the growth of the economy in the coming two decades? Explain.