[2759] Dirty float is good, but actual floating is better

The government is getting a lot of flak for its decision to adopt the dirty float mechanism in determining petrol and diesel prices. Pakatan Rakyat, Rafizi Ramli especially, is attacking the government by highlighting the fact that the government is not passing the full saving from the falling crude oil prices to the consumers and pointing out that consumers are effectively being taxed for consuming petrol and diesel.

Politically, I am enjoying the show because Barisan Nasional politicians and their supporters are so fond of asking others to be thankful to the BN-led government for providing subsidies. Now that the government is actually taxing fuel consumption, the politicians and their supporters are trapped by their own rhetoric and suffocating logic. There are people like Tan Keng Liang who is trying to defend the government but his messages are incoherent and uninformed. So, he is not doing the government much favor and I dare say he is hurting the government instead.

But beyond the politics, I prefer that we tax both petrol and diesel and then completely float it. That would leave retailers to set the prices, and hopefully compete with one another rather than having the government sets the prices from above. So, in some ways, I do approve of Rafizi’s action because I see his campaign ending up pressuring the government towards a better floating system, regardless whether that is his intention.

But I think it must be said that the current dirty float system is better than the old one. It is still inefficient, but it is more efficient than before. There has been significant policy progress in the past year or two and I think we have to be fair to the government for having the political will to do so.

On to the dirty float system itself, while the current mechanism has its weaknesses, it also has its strengths. In fact, its weaknesses are its strengths depending on the direction of the price change, from consumer perspective. Its lagged nature does provides some kind of stability to consumers.

I will not describe the current system in full, but in summary, it uses the average market prices from the last period as the reference retail price for the current month. The information that the system uses is lagged by a month.

I have drawn a chart to illustrate this:

Dirty float

From the consumer perspective, in time of falling crude oil prices (I label as actual market prices), the dirty float is not ideal. This is because saving from the current difference between market and retail prices goes to the government. The government would pass some saving to the consumers eventually but as you can see, the saving passed is only a fraction of total saving the consumers would have gained under a pure floating mechanism. The area colored red is actually the taxes paid by consumers.

But in time of rising prices, consumers would prefer to have this lagged pricing exactly because the situation is reversed. Consumers will also pay less, essentially enjoying a subsidy, as represented by the blue area. Of course, right now, this scenario is a hypothetical. When prices rise, you can bet the rhetoric will be different and wanting this kind of system instead.

But this also highlights that the dirty float mechanism does not really do away with the subsidy regime despite all the hoo-ha that Malaysia has finally abolished petrol and diesel subsidies. The truth is that the government has changed its system from that which always subsidizes consumption to that which would subsidize it only when prices are rising (and taxing it when prices are falling).

I would like to see the abolition of subsidy. That means a complete floating system where retail prices correlate almost completely with market prices, with a slight tax on it. That imposition of tax should be considered alongside the cash transfer policy.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved
p/s — I have additional thoughts on the matter.

Apart from free-floating the prices to keep retail prices closely following the market prices with the view of passing the saving to the consumers, another way of improving the dirty float mechanism is to shorten the lag period.

Right now, the retail prices are dependent on the average prices of the previous month. What we could do is that make it dependent on average prices of the last two weeks, or the last week. The shorter lag would ensure the effective tax and subsidy be smaller than what it is right now. Here is another chart to show what I mean:


Here, I have added a new dirty float retail price with a shorter lag, superimposed on the first chart. You can see the amount taxed or subsidized is smaller compared to the original case. For clarity, area A+B is the total tax enjoyed by the government with the original month-long lag. With shorter lag, the total tax is just the area B.

It is also worth noting that if market prices are completely random, the total tax and subsidy would cancel out each other.

I also want to take this chance to clarify my ideal policy, i.e. free float with a slight tax on it. I figure the next chart will deliver my message crystal clear:

Free float taxed

I am showing a fixed tax version. There are other ways to do this, like through ad valorem, which is how the GST would do.


[2756] Press on with economic reforms

I do have complaints about various government policies but I do see improvement on this front at the federal level in the past few years. Two policies I am largely in agreement with and am advocating are the subsidy cuts and in its place, the cash transfer program.

After all the progress made however, my fear is that the government is losing its focus and it is taking a step backward. I will take such reversal as a betrayal to the earlier promise of economic reforms.

I write so because the government plans to introduce a complicated quota system for subsidized petrol and diesel in place of the current blanket subsidy regime, which given the current global crude oil prices, is at the brink of elimination. The prospect of elimination is good news but now the government wants to maintain the subsidy instead. It just cannot make up its mind.

Under the new convoluted system, each person would get some quota of subsidized fuel based on his or her income in the name of targeted policy: the higher your income, the fewer quotas you would get. Any consumption above the quota would be charged at market price. Full details have not been released yet but during the tabling of the federal government’s budget, the Prime Minister said he would announce the mechanism soon.

What makes the situation worse is that the government also plans to limit the cash transfer program we all know as Bantuan Rakyat 1Malaysia (BR1M) by restricting items that can be purchased by the program’s beneficiaries. The government is supposedly concerned that the recipients would abuse the cash from the program by buying luxury goods, like an iPhone 6 that a certain Minister is using now. After all the speech about the-days-of-government-knows-best-is-over by the Prime Minister when he first took power, here, the minister Ahmad Maslan is showing the government’s paternalistic side by attempting to dictate a person’s consumption pattern right up to the minute details.

I disagree with both proposals because they are bad policy. I would prefer the government to stick with a superior pure subsidy cut-cash transfer mix instead.

Quotas and coupons are inferior policies

The only way I can think of to make such consumption control as preferred by the minister possible is by converting the cash under BR1M into some kind of coupons. I am struggling to think of any other way to make such paternalistic policy possible. Maybe that is my imagination failure, but I would think any other way would be unnecessarily more complicated than the coupon setup, which is already complicated, risking abuse.

Why? The recipients can sell the coupons at a discounted price to get cash instead of buying items meant to be bought by the coupons. And what prevents them from using that cash to buy luxury goods? As you can see, it is a complicated system that reduces the potential amount received by the targeted person through leakage and does nothing to address the minister’s paternalism, assuming his paternalism is right in the first place.

By leakage, I mean the benefits meant for specific groups get leaked to the unqualified others through the discount. The coupon purchasers who are not meant to get the coupons get to enjoy the benefits of the coupons. How about a concrete example? It has happened with the 1Malaysia Book Voucher program where students did exactly that: they sold their vouchers at a discount for cash to a third party.

The same argument is also applicable to the quota system for subsidized fuel. What prevents a quota holder for selling his or her fuel to others at some price higher than the subsidized price but lower than market price? There is nothing ”targeted” about it.

Monitoring might be the key to the success of such system but with the government trying to balance its budget, does it make sense to create a whole new bureaucracy to police the effectiveness of the complicated regime?

Furthermore, the coupon system would require distributors. Just who will distribute the coupons, one might ask? The government would likely outsource it to someone else in private sector given that there are millions of households already benefiting from the cash transfer program BR1M. And with all the complicated supply chain of vouchers, who knows what would happen. Something can go wrong. Why creates an opportunity for corruption in the first place?

If  you want a clean targeted policy, then you would only need to wire in the necessary cash directly into the recipient’s account. It is precise, easy and clean. If the person has no account, establish one for him or her. This way, no third party gets to handle the cash, leaving little room for abuse. And we already have that system in place. Why change things that work?

A regression of policy

Subsidy cut and cash transfer work charmingly and that is enough. The proposed quota-coupon policy will instead undo the successes of the subsidy cut-cash transfer policy by complicating everything.

If indeed the quota-coupon policy mix will be implemented, then I would see it as a regression. It is a policy U-turn. The maintenance of the subsidy system will preserve the very inefficient system that the government wanted to get rid in the first place while the introduction of a coupon system introduces other kinds of new inefficiency.

We are already on the path to a superior policy mix compared to the one we had before. I would go further by arguing that the logical end of the current mix is the best one given the objectives of creating a more efficient market, lowering the fiscal deficit and at least preserving — it can even be enhancing — the welfare of Malaysian most affected by the cuts and elimination of subsidies.

Remember the cash transfer rationale

It must be remembered that both subsidy cuts and cash transfer should be seen side by side. They are not independent of each other. The cash transfer is meant to address the negative impacts of subsidy cuts, making the cuts more palatable to the low-income households. The cuts meanwhile finance the cash transfer.

If the government reduces the efficacy of the cash transfer by taking the cash element away, then whatever remains of it will be unable to play its role as a cushion at its greatest potential for the financially weakest households. At the same time, if the subsidy is being maintained, then we should not increase the cash transfer. I would even say that the maintenance of subsidies calls into question the existence of the cash transfer program in the first place.

The Prime Minister during the budget suggested that the revenue raised from the goods and services tax will finance BR1M in 2015. That is a really a dangerous statement that upends the ties between the subsidy cuts and the cash transfer. Maybe this is a sign that the government is getting itself confused about the rationale for the cash transfer, which can explain why we are starting to see economic reforms losing steam as various inferior policies proposed at the expense of superior ones.

Don’t fix it if it ain’t broken

My advice to the government is to press on with its earlier promised economic reforms. Ditch the inferior quota-coupon mix. Maintain the current policy. Press on by floating all fuel prices. We can move on to LPG subsidies once the business with petrol and diesel is done. Maintain and improve the cash transfer program. Do not change the cash nature of the program. Increase it whenever subsidy cuts save more.

Just no to quota. No to coupon. And no to Ahmad Maslan’s paternalism.

The government has all the political capital it needs to press on with the reforms. The general election is still so far away. All the political criticism against BR1M can easily be dismissed. And BR1M is a cheaper and better kind of populism backed by good economics compared to the old subsidies and all those complicated policies. What is not to like?

It would be a great shame if by 2017-2018, all the political capital the government has now is wasted on half-measures.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved
First published in The Malay Mail on October 21 2014.


[2737] Tiered fuel subsidy regime won’t work. Cash transfer is better

I rarely agree with Rafizi Ramli on policy matters. His advocacy for free tertiary education is an example; I think there has to be cost to education and if help is required, it has to be selective based on needs, not through blanket means which can have disastrous effect on public finances. His suggestion for the auctioning of approved permits for imported vehicle is another; auctions it will make things more transparent but it will not cut car prices down. But I do agree with him on some other issues and his position on the tiered vehicle-fuel subsidy regime as proposed by the government is reasonable.

He does not think well of it and I think the proposed system is horrible.

As reported in the papers, low-income consumers will enjoy full subsidy, mid-income consumers will get a quota of subsidized fuel and those in the high-income brackets will have to pay the unsubsidized price.[1]

Rafizi argues those enjoying full subsidy can resell their fuel to other groups at a price higher than the subsidized level but below market price. I think so too. The government can make such transfers illegal but being illegal does not mean it will not happen. And I cannot imagine the authority spending considerable resources to hunt down on a whole lot of Malaysians trying to benefit from such loophole in the tiered system. Rafizi has explained it rather well and so, if you want more explanation I suggest you give his blog a read.[2]

Because of the major loophole, I am not so convinced there will be any savings from the restructuring at all. In an efficient market faced with such tiered regime, people will buy subsidized fuel through the low income group (the new middle man) only. So, the cost of the government maintaining the proposed much-more-complicated system can be as expensive as, if not more than, the current simplistic blanket subsidy system. It can be as expensive because the quantity of subsidized fuel purchased will not go down in an efficient market. It can be more because you have to keep a more complex control system for the system to really work. If you want to fight post-sale transactions, then you will have to consider enforcement cost, on top of the actual fuel subsidy cost itself.

We do not live in an efficient market but I can easily imagine a lot of people doing it, if not all. This is already happening for subsidized diesel that companies enjoy from the government. The smuggling of fuel to outside of Malaysia is another proof that it is already happening. These two examples are example of tiered markets.

And remember, the beneficiary of the proposed tiered system is the lower-income households. They need the money. They have a strong incentive to resell their subsidized fuel to others who do not have access to it. Others in the mid-income brackets can be as saving-driven as others. There is an uncaptured producer (or is it consumer?) surplus there and it makes sense to internalize that surplus. The only who will not care are the super-rich who cannot be bothered with the hassle (unless they organize a smuggling business themselves, eh?).

It helps the low-income households, but that is such an expensive and a complex way to do it.

I prefer the plain old subsidy cut to the tiered subsidy (though I think Rafizi disagrees with this). Plain old subsidy cuts guarantees savings.

And if we want to help the low-income households, I prefer cash transfer, like I have always for the longest time. We already have the BR1M program. Just improve on the infrastructure. Cash it directly into the bank accounts of these low-income households. If they do not have an account, create one for them. Address the abuse and corruption instead. No need to get overly creative on this matter.

Mohd Hafiz Noor Shams. Some rights reservedMohd Hafiz Noor Shams. Some rights reservedMohd Hafiz Noor Shams. Some rights reserved

[1] — KUALA LUMPUR: Only those with a monthly income of below RM5,000 and cars with an engine capacity below 2,000cc will be entitled to unrestricted purchase of subsidised petrol under the new petrol subsidy system, according to a report by Sin Chew Daily yesterday. The report said the target is to launch the new system in the third quarter of this year. Those who earn between RM5,000 and RM10,000 per month will only be able to purchase 300 litres of subsidised diesel and RON95 petrol per month, the Chinese daily said in the report. Those with a monthly income of RM10,000 and above will have to purchase RON97 petrol, which will be based on market prices and without any subsidy. [Fuel subsidies to be means tested, says Sin Chew. The Edge. June 3 2014]

[2] — Berdasarkan maklumat yang dilaporkan setakat ini, saya khuatir sistem subsidi baru petrol dan diesel ini akan mewujudkan pasaran gelap yang menjual petrol dan diesel seperti berikut:

1. Kumpulan yang dibenarkan membeli petrol dan diesel pada harga subsidi boleh membeli secara kerap dan menyimpan petrol dan diesel ini;

2. Mereka kemudian menjual kepada ejen pasaran gelap yang membeli petrol dan diesel ini pada harga yang lebih tinggi;

3. Ejen pasaran gelap kemudian menjual petrol dan diesel ini pada harga yang lebih rendah dari harga pasaran kepada syarikat, pengusaha atau pun orang persendirian yang mahu mendapatkan harga petrol dan diesel pada harga yang lebih rendah. [Sistem Subsidi Baru Petrol & Diesel: Risiko Penyelewengan Dan Kesan Berganda Kenaikan Harga Barang. Rafizi Ramli. June 3 2014]


[2521] Subsidizing wages and business incompetence

In any kind of policy debate, there are always two elementary opposing opinions at work. One side subscribes to the ability of the state to produce outcomes better than society can if society is left to itself. The other is not so sure of that and prefers to err on the side of caution, ever mindful human fallibility. One is confident. The other is humble. Beyond opportunistic politics, that has always been the background behind the minimum wage debate in Malaysia. This tug of war in fact has been on the forefront of any general modern economic debate.

The side preferring the organic solution fears that the initial government intervention in the workings of natural everyday life will lead to unintended consequences that in turn will lead to further government intervention. From one preferred outcome supposedly guaranteed by the intervention, a very different reality will emerge to contrast our overconfidence in our ability to control everything that even the gods appear to struggle at times. From there on, more and more unexpected expensive tweaks are a must not only to push towards the preferred outcome, but also to make sure the post-intervention scenario is not worse than the status quo.

The unintended consequence of minimum wage is always higher unemployment among the general public compared to an economy sans minimum wage, whether one does not know of it, or one decides to consciously swallow up the trade-off wholly.

Call this a tired argument from a free-market advocate, but it is true no matter how old the statement is.

The nuance is that unemployment effect depends on the level of minimum wage. At the proposed minimum wage level in Malaysia which The Star has reported to be between RM800 and RM1,000 however, that qualification is academic. If it was low enough to have negligible effect on unemployment (or the cost of doing business, which is the other side of the coin), there would have been no real complaints to be made.

Now that government intervention is imminent, the trade-off is taking the limelight while previously it was ignored. There are calls to grant businesses some flexibility to adhere to the fiat from both sides of the aisle in the national Parliament.

Of particular note is a suggestion from three prominent members of Pakatan Rakyat — Rafizi Ramli of PKR, Liew Chin Tong of DAP and Dzulkefly Ahmad of PAS. They suggest that the government subsidizes businesses so that transition will be smooth. The Malaysian Insider quoted DAP lawmaker Liew Chin Tong suggesting, ”Funds from the federal budget should be allocated to a special facilitation fund to help entrepreneurs, SMEs and small firms retool, mechanize and adjust their operations to create new job. This is to address concerns of most SMEs that the minimum wage will make these businesses close down.”

Although the next step from here is unclear, the mood from both sides of the divide creates a suspicion that the government will intervene once again after the introduction of minimum wage on the pretext of a smooth transition.

In the context that the Najib administration has been copying policies advocated by Pakatan Rakyat quietly while publicly deriding the same set of policies as the height of irresponsibility, the suggestion from Pakatan Rakyat in particular is disconcerting. One has to remember the federal government only began to champion the minimum wage policy seriously after Pakatan Rakyat successfully placed the issue under the spotlight. Given the popularity of Pakatan Rakyat on this front, it is not too farfetched that the government will play the copycat yet again.

Already businesses, big and small, are heavily subsidized no thanks to various industrial plans put into effect by the federal government. Now Pakatan Rakyat wants a policy that will exacerbate the expensive incentive-twisting policy in time when what Malaysia requires is improvement in its efficiency. That efficiency, among others, requires businesses to stand on their own two feet without financial support from the government.

If this subsidy goes through, the next round of unintended consequence will be the creation of mostly incompetent businesses utterly dependent on government handouts. Look at some of the loss-making government-linked companies which are dependent on government largess and protection.

Now, imagine that economy-wide.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved
First published in The Malaysian Insider on March 18 2012.

Economics Politics & government

[2375] Reducing the political cost of liberalization

A price-control mechanism has its economic cost, on top of that associated with the current subsidy regime in place in Malaysia. There are also some political costs to the control. In tight times when commodities are becoming dearer, any government that dares to reset retail prices upwards invites public wrath.

There was talk of an early general election, but the rumor machines now suggest that the election will be held only later. The Barisan Nasional-led federal government needs room to maneuver before renewing its mandate.

The prime minister is under pressure to seek a mandate of his own. One has to remember that Najib Razak is running on the 2008 mandate secured by the highly unpopular Abdullah Ahmad Badawi. Not only that, the prime minister also needs Barisan Nasional to do better than it did in the last general election. He must get the two-thirds majority in Parliament to prove that his government is better than the one led by his predecessor.

That is one of the ways the political cost matters. The political cost can affect cold but rational economic calculations. This is especially relevant for those whose conviction is measured by their appetite for adventure, or lack of adventure rather. That makes it important to reduce the political cost of liberalization lest the liberalization agenda, however disappointingly incomplete it is in its current form, be left high and dry.

The local political cost that exists is unfortunate because global economic reality largely ignores local political reality. In many cases, the increase in retail prices is inevitable amid rising world prices of various commodities.

The factors fuelling the hike are real: growing population, growing affluence and therefore growing demand. That is the current long-term trend. Mere business cycles neither erase nor change long-term trends by much.

There are some institutional issues affecting local retail prices as well. Without hurting the trustworthiness of the government, these problems have to be solved.

Liberalize the market instead of granting monopoly power to specific firms. Make the market open instead of having deals made in the shadows. Stop signing contracts that are grossly lopsided at the expense of public money. All that can lessen the degree of the hikes in the long run.

Yet, local issues just like short-term fluctuations are unlikely to drown out long-term trends. Until new technology, new culture and new alternatives prevail over old ones — or if total world population drops — prices will generally go up to clear the markets.

Because of the dissonance between local political and global economic realities, the political cost should be reduced so that both run parallel to each other. The political cost is a disincentive to good economic policy.

Democracy coupled with entitlement culture is a recipe for irresponsible populism. This is especially true for the fuel subsidy regime where the subsidy fixes the price ceiling and in effect subsidizes everything between retail prices and world prices. Under this arrangement, the government risks hypothetically unlimited expenditure. The higher the world prices, the larger the subsidy bill.

So, how does one reduce the political cost?

The government can stop being the fall guy. To do so, the government needs to stop managing prices. Relax the control. Let prices float. Let the market take charge instead. Let those closest to the ground — the actual buyers and sellers — determine the prices.

Using the fuel subsidy as an example, the relaxation can exist together with fixed per unit subsidy regime rather than the current unfixed per unit subsidy. In this way, the subsidy burden shouldered by the government will remain constant given a consumption level. Any increase or decrease in retail prices will be due to market forces only.

This particular arrangement will reduce the political cost faced by a liberalizing government by making the link between prices and primary market participants clearer. Prices will no longer be linked to the government. With the government out of the way, then perhaps the government will receive less flak.

The question of subsidy reduction itself will not even surface because increase in world prices will not increase the subsidy bill given the level of consumption. Indeed, a typical model will suggest that an increase in world prices might actually decrease the total subsidy bill due to decreased consumption.

In the end with less flak, perhaps the liberalization agenda can go farther down the road without unnecessary undue erosion of political capital.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved

First published in The Malaysian Insider on June 2 2011.