Earthly Strip Economics

[2913] The Earthly Strip: Mak Cik Kiah’s recession

And The Earthly Strip makes a return.


[2912] Wisdom is knowing when prices failed

There are discussions — or rather venom exchanges as it goes on social media these days — about prices and price control of certain items. I think I am here to highlight the obvious because oftentimes the obvious is overlooked due to familiarity: prices are only a method of allocation out for many out there.

There are other various methods in our toolbox if we care to learn.

Prices as an efficient allocator of resources

Now, prices are usually the best (efficient) allocator of goods and services in a society under normal circumstances. The thing with prices is that it is a reflection of the underlying demand, supply, and the context those demand and supply. Prices encapsulate all the necessary information needed to allocate resources. And under normal circumstances, that is good enough to allocate resources efficiently.

“Normal circumstances” is a catch-all cheat phrase. It almost always includes the assumption of (near) competitive/efficient market. Efficiency needs to be defined further: net increase in societal welfare. If it leads to a net decrease, the efficiency argument would melt away, and so too the merit of prices. Never mind prices, in theory, are not the only way to clear the market.

I make it sounds as if the price assumptions are a set of flimsy conditions. They are not. They are quite robust and hard to break, really. More than that after the section immediately below. The point is, it takes an extraordinary circumstance for it to happen.

When prices failed

During a war for instance with staple items suffering from massive supply disruption, prices will shoot up to an astronomical level. It is unclear prices will be the best means of allocating resources in this case if it would lead to a majority dying out of hunger due to unaffordability instead of absence of food, or protection gears. Even more so when a panic strikes, and hoarding takes place. After all, prices are only a means to a end. We care a whole lot more than prices. We care about our welfare.

This is mainsteam economics: most people do learn about market failures, that is when market mechanism decreases societal net welfare due to private cost failing to account for public cost.

Augmenting prices

When prices failed, it does not mean prices as a whole failed. There are various designs available to counter such failure before prices become completely irrelevant to welfare concerns. We can do price discrimination for instance, even all the way to first degree if we have the technology. We can impose quota within price mechanism. We have taxes and subsidies, an even that could be handled through tax and subsidy discrimination. We can impose coupon within price mechanism for instance. There are price ceiling and floor. We can be creative within market mechanism.

Do not forget these truths: we know when market mechanism is superior, and when it is not. And there are degrees of failure. Do not let your politics blinds you to it.

Knowledge and wisdom

Knowledge is about knowing the tools of allocation available and all of its possible combinations. Wisdom is knowing which tool and its combinations are useful during which period. In the case of prices, wisdom is knowing instances of market failures and which tools are available to address it. Prices are not superior all the times. Remember its assumptions.

Now, we have a crisis on our hands and it is affecting some items in the market. Some items are more important than others. We have the tools. Perhaps we need to relearn our lesson and develop some wisdom.

This is especially so when we are so partial to a method of allocation that we forget the assumptions why it works in the first place. We cannot imagine that those assumptions can breakdown.

This failure of imagination is perhaps a flaw in our classrooms. We take for granted these assumptions for pedagogic reason at the entry level in economics classes. It is worse when it done thru rote learning. And these weaknesses form the basis of popeconomics that is sorely inadequate to address our supply-side crisis.


[2911] RM600 wage subsidies too small to prevent massive layoffs

I am happy with the inclusion of wage subsidies in the larger cushioning/protection policy announced by the government today. I use cushioning/protection because the supply-side context makes the definition of stimulus irrelevant. As announced, the government will implement RM600 per month wage subsidies for 3 months.

However, there is a big but. Is the RM600 per worker per month enough to prevent massive layoffs?

No. It is hard to say yes.

It is so small that it risks becoming irrelevant at preventing layoffs. It fails to protect minimum wage jobs fully, never mind those earning median wages.

In contrast, the government announced a big cash transfer program. From the perspective of protecting jobs and potential, prioritizing cash transfers over wage subsidies seems folly to me. Why?

Three factors I think:

  1. Wage subsidies are the first line of defense, while cash transfers are a safety net
  2. Wage subsidies depend on recent data, while cash transfers on last year’s data (recognition lag)
  3. Wage subsidies protect potential now and allows for faster recovery later

Wage subsidies are the first line of defense, cash transfers are a safety net

When wage subsidies and cash transfers work hand-in-hand, the former functions as a first line of defense with the latter a safety net. If the first line of defense fails, the safety net will kick in. Both need to be sufficiently big to be credible and effective.

To put it another way, the first line of defense (wage subsidies) is a proactive measure designed to protect jobs so that you do not have to rely on safety net. You want your first line of defense to work so that you do not have to suffer bigger and bigger demand for safety net.

Unfortunately from the policy design of the set of measures announced, it feels like we are skipping the first line of defense and going straight towards the safety net.

With only RM600 wage subsidies, I fear companies would have the incentives to fire even workers at the minimum wage. When the lowest earners not protected from job loss, I fear for the rest.

We have a specific statistics to measure the success or failure of this policy: the unemployment rate.

Wage subsidies depend on recent data, cash transfers on last year’s data (recognition lag)

And then there is a question of recognition lag.

When it comes to the labor market, wage subsidies rely on current data. If you have a job now, you will get the subsidy and this will encourage companies not to let you go because employing you is costless during this crisis of cash flow.

In contrast, cash transfers depend on last year’s data. Cash transfers have a one-year worth of recognition lag because it depends on yearly Internal Revenue Board data. If you lost your job this month but was paid wages above cash transfer qualifications, you would not qualify for the cash. This is purely a data and bureaucratic issue. This means cash transfers will be unable to help those in the need now, unlike wage subsidies.

So, it is quite clear wage subsidies address the now in terms of protecting potential.

Wage subsidies protect potential now and allow for faster recovery later

Wage subsidies are important because the labor market is a slow moving animal. The market can suffer immediate shocks, but recovery from the shock will be slow. And the labor market has a big influence on the economy. A post-shock slow-moving labor market will mean prolonged weak economic growth (if it could be called growth) for all of us. A prolonged weak economy means prolonged demand for safety net as jobs are hard to come by. And massive job losses can affect potential negatively in a big way.

Wage subsidies is supposed to preempt that shock and address it now in the short term immediately. It protects the potential now and removes big demand for safety net demand later. With potential protected now, there will be less ground to cover during recovery. That means there will be no need for many to suffer unemployment, and the time needed to find new jobs, go to interviews — all in all the long readjustment period. If wage subsidies are successful, it will allow for faster recovery without having to go thru the painful readjustment period.

But for it to be successful, it has to be meaningful for companies under pressure. Maximum RM600 wage subsidies do not even begin to work.

Meanwhile, cash transfers do not protect those potentials as much. It is designed to help if those potentials have collapsed. But our objective should be to prevent collapse in the first place, not wait for it.

Bigger wage subsidies needed

I have suggested for the government to provide 25%-50% subsidies for workers with wages up to RM4,600 with a joint statement that I wrote.[1] In retrospect (the statement was rushed out and I came on board at the very last minute), it should bigger: minimum subsidy of RM1,200, and beyond that, 25%-50% additional subsidy relative to income in excess of the minimum wage up to RM4,600.

This way, there is less incentive for companies to fire a lot of people. The subsidy size probably could grow bigger, but it may require more analysis to balance other needs.

Hafiz Noor Shams. Some rights reservedHafiz Noor Shams. Some rights reservedHafiz Noor Shams. Some rights reserved

[1] — Kabinet Rakyat calls on the government to provide larger direct cash transfers worth at least RM1,000 per month to all B40 households, and 25-50 per cent wage subsidies relative to total wages for SME employees earning up to RM 4,600 monthly (roughly 200 per cent of national median salaries) during the April-June 2020 period.

The large cash transfer programme will protect irregular job holders and those in the informal sectors unable to work due to the Movement Restriction Order (MRO), while the wage subsidy will lessen the temptation for SME companies to lay off its workers.

Urgent action must be taken to address the ongoing health and economic crisis. According to a Malaysian Institute of Economic Research (MIER) study, Malaysia’s real GDP may shrink by 2.9 per cent this year, with 2.4 million people losing their jobs. Massive job loss will exert prolonged adverse effects on the economy, as well as the social stability of the country, long after the health crisis is over.

The government has already announced some measures to cushion the impact of COVID-19 and the MCO. This includes cash transfer policies like the Employment Retention Program (ERP) providing RM 600/month up to six months for employees forced to take unpaid leave and a one-off additional RM 150 in Bantuan Sara Hidup (BSH). Meanwhile, Bank Negara Malaysia has introduced a massive monetary stimulus in the form of loan moratorium to address cash flow issues among companies, that hopefully will lessen the need for layoffs.

While these measures are welcomed, they are still inadequate.

The need for cash transfers is clear. Groups working directly with low-income communities have been overwhelmed by requests for cash assistance since the start of the movement control order (MCO).

Furthermore KRI, IDEAS, ISIS Malaysia dan REFSA as well as individuals including Nungsari Ahmad Radhi, Hamdan Abdul Majeed, and Muhammed Abdul Khalid have all argued that the cash transfer measures introduced so far (the ERP and the small increase in BSH) are insufficient. They all recommend additional cash transfers in some forms, by expanding coverage or increasing the amount of ERP or BSH, or both.

Other countries and jurisdictions have also responded to the crisis with substantial direct cash transfers. Hong Kong, Singapore, and Australia for example, have already done so. Concurrently, Denmark and the United Kingdom have introduced massive wage subsidies to protect jobs.

Our response to this crisis must include and prioritise those hit the hardest.

[Tharma Pillai, Yu Ren Chung, Hafiz Noor Shams. More direct cash transfers and wage subsidies needed to assist vulnerable and protect jobs. Malay Mail. March 26 2020]

Economics History & heritage

[2910] Few lessons from post-war 1940s Malayan supply-side crisis

We are experiencing a supply-side crisis. The lockdown is inducing labor shortage, and it has the potential of exerting lasting damage on the economy if not handled properly.

It seems to me that the last time Malaysia or any of its components had a supply crisis was in the 1940s during World War II and during the immediate post-war period. Productions of various kinds were devastated, leaving many without jobs and forced into subsistence. The war not only destroyed productive capacity, but also suppressed demand.

The end of the war brought demand back up quickly. Unlike demand however, production took time to get back to speed. Wars had destroyed all the equipment, and killed off many that worked at the mines, plantations, factories and shops. Rebuilding those and reemploying the workers took time.

That meant massive unemployment in the meantime.

Massive unemployment also meant employers had great bargaining power: wage growth was weak if any. Faced with unemployment, weak wage growth and spiking prices, social discontent was prevalent. This was one of many reasons the communist movement gained sympathy among the masses: industrial sabotage became a norm which worsened efforts to restore production.

There are a few lessons to take from the economics of post-war 1940s. Disrupted supply chain in the form of business failures and labor shedding took time to recover, and could not move as fast as demand. When demand returned with supply failing to do the same, that demand went unfulfilled. This led to massive shortages and subsequently, massive inflation. Never mind the social issues and the complex 1940s political situation.

In this sense, the negative economic effects of the war lasted beyond the war.

Coming back to today, our mines, plantations, shops, offices and other facilities obviously do not suffer similar war devastation. And the social reality is different and undeniably more stable though racial tension that originated from the war continues to linger.

But our current supply-side crisis, now lengthened to 4 weeks, is heightening the risk of business failures and job loss. That means reduced potential and once the crisis is over and demand back up, that reduced potential means shortages and significantly higher inflation, and higher prolonged unemployment. Growth could be depressed for some time until the potential returns to its pre-crisis period. The negative economic effects of this supply-side crisis would last beyond the actual crisis.

This is why we need to protect the potential now. Prevent business failures. Protect jobs. This is so that once the crisis is done, we could press on the demand paddle right away without having to wait for some time to repair the supply transmission. We do not have to suffer a lasting effect of this crisis.


[2908] Defund non-critical ministries to fund the Ministry of Health more

The public health system is in need of more resources to manage the Covid-19 pandemic. We all talk about flattening the curve but government’s incompetence that caused the Tuesday fiasco means the peak will likely get higher and higher and the time needed to fight this will go longer and longer.

This is the time to direct more resources towards the public health system. Specifically, the budget for the Ministry of Health needs to be enlarged significantly so that they can build whatever capacity they can and need in this short period of time ahead of the peak.

Raising the overall budget might be difficult, with the current balance likely collapsing and legal requirements in the way. These legal requirements maybe artificial, but it is a barrier that not many at the Treasury I would imagine willing to break (in any case, raising the fiscal deficit is inevitable and even preferable). The chart below shows the little fiscal space the government has with respect to current balance.

So, I am suggesting the second best solution is to defund non-critical ministries, and redirect those money towards the Ministry of Health, and other relevant ministries crucial in making health measures effective fast. I do not know which non-critical ministries should be defunded, but there are indeed many programs across various ministries, even overlapping programs, that exist out of political considerations, but little social and economic functions.

The reallocation may require parliamentary approval. So we may need emergency parliamentary sitting ahead of the May 2020 schedule.

I know the government fears a vote of no confidence, but in time of crisis I think both sides should come together as one, and pass such reallocation quickly. We can delay our political differences to after the crisis is over.