President-elect Barack Obama promises greater government spending to ward off the ongoing economic crisis in the United States. More than 1,000 miles to the southwest of the Aleutian Islands, the Japanese government proposes its largest ever budget. In it, Prime Minister Taro Aro incorporates record breaking government spending to ease the faltering Japanese economy. On the Asian mainland, China prepares to spend close to US$600 billion on public works to prevent its economy from cooling too fast.
These countries are important export destinations for Malaysian goods. In 2007, the US, Japan and China were the first, third and fourth most important export partners of Malaysia respectively. Combined, approximately 35.1% of Malaysian goods went directly to these three countries. This does not include items which find its way to third-party countries before reaching the three countries.
In discussing the global economic downturn, it is fashionable to cite the interconnectedness of the world where recession is contagious. Reduced economic activities in some foreign countries, especially in these three countries, adversely affects demand for Malaysian goods. In fact, Malaysian exports have been negatively impacted. As the cliché goes, when the US sneezes, the world catches cold. Malaysia, as proven, is no exception.
Less discussed is the reverse relationship, which is also true. Improved economic conditions of the major consumers of Malaysian goods will encourage exports. This realization is yet another important argument against greater government spending as fiscal stimulus in Malaysia.
It is important because the slowdown of the Malaysian economy is likely principally caused by the softening of external demand. The Malaysian economy only began to take a hit when the health of our trading partners went down south. With exports contributing to almost half of our gross domestic product, it is hard to imagine how the Malaysian economy could escape unscathed. Nevertheless, our internal demand remains resilient, as proven by the local retail and the automotive sector. Therefore, the problem plaguing our economy as with many export-oriented countries revolves around external factors and not domestic demand.
As much as I hate to say this, government spending may help in cushioning the impact of reduced exports in Malaysia. Given the current condition of the Malaysian fiscal deficit as well as the inherent policy lag of government spending as fiscal stimulus though, it may not be the best path to tread on. I continue to prefer long term tax cuts and tweaking the monetary policy as the way forward over government spending. The effects from these two policies could be felt relatively quicker than increased government spending. More importantly, it avoids the long term repercussions of Keynesianism, or, in all likelihoods, half-hearted countercyclical policies.
The Malaysian context notwithstanding, government spending may help the economy of China, Japan and the US. While these countries would suffer the side-effects of government spending as fiscal stimulus, they could experience shallower downturn and quicker recovery. This could prove to be beneficial to Malaysia.
This is where government spending of the three countries, the importance of the three countries to Malaysian exports and the cause of weakening Malaysian economic growth converge to petition against greater government spending as fiscal stimulus in Malaysia.
Malaysia could and should capitalize from increased government spending of its major exports trading partners while refraining from doing the same thing. It allows Malaysia to enjoy the benefits of the policy while evading the cost associated with the expensive solution. It circumvents the question of trade-off associated with greater government spending altogether.
Admittedly, this proposal is slightly guilty of free riding on others’ policies. Being a small economy compared to the three however, it is unlikely how a Malaysian policy to free ride would affect their policies. How can a matchbox toy car significantly affect a speeding prime mover is beyond the imagination of the sane. It is unlikely for these countries to complain about a Malaysian policy based on refrain and prudence.
The World Bank probably would not like this after issuing a statement to encourage governments all around the world to spend and spend till they drop. Ever since Paul Krugman won the Nobel Prize in economics not too long ago, almost everybody is a Keynesian nowadays.
Well, Keynesians love to flaunt the multiplier effect of government spending. What better time to test the magnitude of the multiplier effects other than right now? What better way to test the multiplier effect other than free riding?
This article was first published in The Malaysian Insider.