An Empirical Test of a New Theory of Economic Reform:The Case of Indonesia

Analyses of the nature of debt—relying on the theory of rational expectations—conclude that the burden of public debt need not fall on future generations if the present one anticipates the higher taxes needed in future for debt servicing. However, there have been many instances where increases in budget deficits were followed by a decrease in the savings propensity of the private sector. Foreign exchange earnings also have to be set aside. The main problem for countries in an early stage of economic development is that, often, the borrowings are not productively employed resulting in national debt crises. Foreign lenders become increasingly reluctant to lend further amounts to a country which has been a net capital importer. This article puts forth, a methodology for testing a new theory of economic growth in Indonesia as it represents a case of faltering economic growth and financial instability resulting in a huge increase in foreign debt, depreciating currency and a dramatic increase in the percentage of population below the poverty line. The theory emphasizes on the key factors determining the success or failure of policies that change the underlying economic structures, leading to an intrinsic monitoring of “over-borrowing”.