Keynes in the countryside: The case for increasing rural public works expenditures in Indonesia

Indonesia is faced with a severe balance of payments constraint and a large volume of underemployed resources, particularly in rural areas. The balance of payments constraint is what currently prevents policy makers from attempting to attack the underemployment problem by expansionary policy. We argue that spending differentials between rural and urban households, coupled with a high degree of rural non‐farm activity or capacity for activity, give the government a chance to expand its rural expenditure programme (Inpres) in a way that will substantially increase employment and output in both the countryside and the city. The fundamental argument in favour of rural public works is that rural households spend most of their income on goods and services produced in the countryside. Little leaks out into imports. Since balance of payments constraints are the limiting factor on overall output, these spending differentials permit a relatively large expansion in both GNP and rural income per rupiah of rural government spending at a low cost in foreign exchange, roughly one‐half the original injection. The bulk of rural activity is limited by the level of rural demand. Government rural spending sets in motion a virtuous circle of secondary spending which generates a large overall increase in income. Using a simple model of the process, we show that if the government can borrow enough to cover the additional demand for foreign exchange, rural injections increase GNP by 3.3–3.6 rupiahs per rupiah of government spending. If the economy cannot increase imports, taxes must be increased to choke off induced import demand. But even in this least favourable case, GNP rises by Rp 1.2 per rupiah of injection. This makes rural expenditures by the government doubly profitable. Not only do they increase export capacity, health and education, they also permit a multiple expansion of employment and output.