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Monday, September 9, 2013

Overconfidence Effect in Economy

"Our country was too confident. We feel highly idolized by foreign countries. When in fact, they (foreigners) reluctant to engage with Indonesia ". This quote I heard about five years ago from my professor in class. He is one of the respected economic technocrats in this country.

The statement was said by Prof. Dorodjatun Kuntjoro-Jakti. He was Minister for Economic Affairs in 2001-2004. An era when Indonesia's economy is still full of problems, due to the debt pile of monetary crisis in 1998. No wonder he was dealing with a lot of foreign creditors who lend money to Indonesia, such as the IMF, CGI, and the Paris Club.

Actually at that time I did not agree with his words. I know that Indonesia is a big country with abundant natural resources. There is no reason to say that foreigners do not need Indonesia. But once I saw what happened later with Indonesia, I feel what he said is true.

The phenomenon of excessive self-confidence is actually explained in behavioral economics (finance) theory. This is one example of bias in human life called the overconfidence effect. It is a confidence level that exceeds the actual situation based on rationality. This behavioral theory is likely to ignore the basic assumption in economics that people are rational in economic decisions.

An employee tends to rate themselves higher, thus demanding a bigger paycheck. Bubble in the stock markets and commodity prices also triggered by excessive optimism. Every economic crisis is also often triggered by this phenomenon.

It also happens with Indonesian after investment grade rating. We believe Indonesia is a new idol in the world. Let’s call it the investor darling. The world praised Indonesia's economic strength from the influence of American and European crisis. Indonesia had felt above the wind. As a result, the government, consciously or not, made many painful policies about foreign. 

Politicians also inflaming the spirit of anti-foreign. Just for a simple reason: public loves anti-foreign issue. Politicians who seem anti-foreign will have greater opportunities to be chosen by innocent people in the next election.

Look at how we really ignore the warning that has been shown by economic indicators since Q2 of this year. Look at how we ignore the warning from S & P when revised Indonesia's outlook from positive to stable.

The results we can see today. Our economy is depressed when they do the small attacks by carried out the money from Indonesia.

I always say that we should build Indonesia with a clear perspective, not only on a narrow nationalism. Compartmentalization between foreign and local is very unfair. I have seen nationalism is nothing more than jargon is echoed by some local businessmen to take advantage personally or groups. After all, foreign companies are also more devoted than local companies when paying tax.

The foreign direct investment has also slowed. Although it was predicted to be the engine of economic growth, reduce dependence on domestic consumption. Protectionist policies in the name of nationalism to be the cause.

And now, they turn around suddenly. They scream negative. Some even equate this crisis to the 1998. This view is excessive in my opinion, and the government also became panicked. Too late, already ailing economy, though not yet severe.

Overconfidence effect is very dangerous. The companies will undertake an aggressive expansion financed by high leverage. Just look at now how the coal-based company covers the debt due to coal prices plummeted. It all started from their belief that coal prices will remain on sky level.

Stock investors will ignore fundamental factor. Supporting arguments later created as a justification in buying decision. Counter arguments will be ignored consciously or not. Every analyst will shout: "Buy!"

A retail investor will feel great in the stock market because he can make a profitable investment. In fact that is because the market in a bullish trend. So we can say: whatever you buy, you will get profit! So in a bullish trend, will emerge analyst or person who claims expert with the recommendation that is fairly decent. However, they will usually disappear when the market in a bearish trend. Sure, the crisis is a test for the skill.

What can we learn from this phenomenon? Be careful in making decisions.  Let us not be deceived by the illusion of confidence. Because when confidence is excessive, then the risk will begin to be ignored.

Anyway, I still want to share a little story from Prof.Dorodjatun. I remember that at that time he also criticized the mental and lifestyle of our government officials. When Indonesian negotiating team want to reschedule debt payments to Paris Club, they came up with luxury car and hotel. "We came to their country asking for mercy to delay of debt payments, but we did not show that Indonesia in some trouble!", He said. Pathetic!