Category: Economics

Categories
Economics

[2773] Convergence versus middle income trap

There are always chatters in the background how Malaysia is growing slower now compared to years ago, mostly with the 1990s in mind. The general sentiment and popular line parroted is that country is stuck in the middle income trap as growth is too slow for Malaysia to break from the middle pack and become part of the developed world . For good measures, some would cite Indonesia and the Philippines as growing faster now, though that is not strictly true all the time.

So, the idea is that we are in for a bad time in some quasi-permanent way. Growth is slacking behind some preferred rates. Some have courageously applied the term secular stagnation, as if the troubles faced by the US, Europe and Japan are the same as Malaysia’s. I dislike using the term within domestic context.

But I have wondered for a long time now. Is Malaysia really in a trap or is it merely the plain old convergence brought by the forces of diminishing returns as explained by the orthodox growth theory.

I am leaning towards the latter answer.

An economy can never grow at a high rate forever. At the heart of the mainstream growth theory taught at most respectable universities is the idea of diminishing returns (even with the AK model and its variants, which are a step up from the famed Solow one, you can see diminishing returns given some parameters). Beyond the savings, (human) capital, technological progress and population growth that complicate the models, at the center is the idea that growth will slow down eventually as an economy becomes bigger and richer: this is diminishing returns.

Why poorer countries tend to grow faster than richer countries? Why richer ones find it harder to grow in contrast? Poorer economies have an easier time at growing because of weaker diminishing returns factor. Build a bridge and you would grow the economy by a lot. For more advanced economy, you might need to build a lot more bridges to see some growth: the bigger you are, the harder is it to grow. In the same vein, you do expect a country to grow slower the richer it becomes.

Granted, there are challenges to the mainstream theory. The convergence predicted always needs to be qualified but it is still one reason why we should be careful with the idea of middle income trap. There are alternative, in fact I think stronger explanation, to the so-called middle income trap.

Through experience, most casual proponents of middle income trap narrative in Malaysia are ignorant about the mainstream idea of growth and its links to diminishing returns. With the belief that there is no alternative explanation given ignorance about mainstream growth theory, it makes it easier for them to take the slower growth rate automatically as the proof that Malaysia is in such a trap and so we need to do something to push growth higher and faster. A politically convenient story as well, if you know what I mean.

I do not think the rate is a proof in itself. There has to be something deeper to justify the allegation that we are in such trap (with secular stagnation) instead of just because the average growth rate now happens to be lower than those registered in the booming 1990s. Before believing in the middle income trap hypothesis, we have to ask ourselves, are there something causing economic growth to slow and stuck at a low rate, or is it a natural growth process — the diminishing returns — described by the orthodox growth theory?

Because of this, I have come to think the middle income trap is at best a heterodox side note to the orthodox growth theory and at worst, an irrelevant lemma: it is a ”just so” statement that is true within the larger model to trivially prove the idea of diminishing returns, rather than being a special problem by itself.

Categories
Economics

[2769] Cab riders would not like frequent, regular fare hikes

Beginning April 1, cab fares as regulated by the government will increase from RM0.10 per 115 m to RM0.25 per 200 m. That’s about 43.8% fare increase. The flagfall cost remains at MYR3.00 for the first kilometer. There are other hikes but I want to focus on this particular case.

Nobody likes a fare hike. Whatever sense it makes, paying for something extra for the same thing is not something I enjoy. But cab fares have not been hiked for six years and I think, it is only fair to the drivers to hike it, especially when their real wages have definitely come down.

I do take cabs from time to time and I do talk to them, asking them about when do they wake up, when do they finish, how much do they make, how much rent do they pay for the car, do they own the car, etc. It is not an easy job. So, I will not complain too much about it and I do not think I have the right to say anything bad because as a consumer, I have benefited from the six years of no hike.

But Institut Rakyat thinks otherwise and they failed to notice the effect of compounded rate. From The Malaysian Insider:

“Having failed to conduct a fare review for the last six years, SPAD has now opted for a sharp and sudden increase,” Yin said in a statement.

He said this steep increase represented a regulatory failure on SPAD’s part, as the agency was supposed to conduct fare reviews every two years with focus on small and manageable increments of 10%.

Yin said SPAD should have considered a gradual increase in fares to balance both consumer and business interests, which would help promote the use of public transport in the country.

He said a gradual phase-in of the overdue fare increase, at 10% at regular intervals over a period of one to two years, would be fairer than making up for six years in one fell swoop.

He reckons it would be fairer for the consumers if the authority does a small hike at regular intervals instead of what will be done now. [The Malaysian Insider. Fare hike too sudden, steep, says think tank]

He thinks it is better for the consumers if the authority “does a small hike at regular intervals instead of what will be done now.”

I think his analysis is wrong. Here is why.

If you look at the mathematics, for passengers, it is quite clear a frequent rate increase of 10% every one or two years is actually a worse hike-mechanism versus a 44% increase after six years. Worse in the sense that total fare paid in the former case is larger than the those paid in the latter one. There is a compounded effect here that makes the seemingly small 10% increase more expensive than the 43% hike.

Here is a graph where I demonstrate just that:

Compounded rate

The light blue line indicates how much total cab fare you would have paid if the rate had increased by 10% every second year.

The red line is the current scenario, explaining the total cab fare you have paid.

The assumption here is that you travel 5,000 km per year. The flagfall cost is ignored for ease of calculation. Having flagfall cost included does not change the analysis by much; remember, the flagfall cost does not change and only the rate changes. Also, just one person passenger with no other charge like baggage, toll, whatever.

As you can see, the blue line is consistently above the red line. That means you would have paid more if the rate was raised 10% every two years instead 44% once in the sixth year. In fact, the dark blue bars show exactly how much extra you would have paid in total.

For instance, in Y6 which is 2015, under the 10% increase every 2 year regime, you would have paid MYR3,976 fare in total over the six years. Under the 44%-hike-done-after-6-years regime, your total would be MYR3,715 in the same period, MYR261 lesser than the 10% case. You can see that in the chart.

So, the right conclusion here is that the 2-year-hike regime would be fairer to cab drivers but the riders would not like it by one bit. The 6-year-hike regime would be unfair to the cab drivers but it saves riders money.

The 44% figure is of course huge compared to a mere 10%, and superficially, it is easy to say we prefer 10% to 44% rise. But that is falling into a psychological trap prepared by the gods of compounded rate. Our job is to resist that psychological temptation.

Mohd Hafiz Noor Shams. Some rights reserved
p/s — if you are interested, I have posted the simple model here (updated. Please read the second postscript). There are at least one or two more dynamics I have left unexplained. You can figure that one yourself. I want to go home.

pp/s — And it is the day after. I ran further modelling (see tab Model 2 in the spreadsheet) and I have to say the conclusion is specifically true for the last six years. If we put the two 10%-2-year and the 44%-6-year series head to head and run it up long enough (unlikely to happen because the authority’s plan is to hike it once every two years), the compounded effect of 44% eventually catches up with the more frequent 10%: to be exact, 12 years later in 2027. But the 44% hike seems like a one-off event, and so, the failure to hike it once every two years is a boon for riders. Thus, as a passenger, on the balance over the past six years, I would not complain too much. And just to satisfy the cat, I also added a yearly increase in the model: a yearly increase at 10% makes the total fare paid zooms away, if I may exaggerate, exponentially, and never to look back. Clearly, a yearly hike is the worst option here and if it is to work to riders’ liking, the yearly increase has to be much, much lower for it to make sense.

Categories
Economics

[2768] Just a debt redefinition and deplorable reporting

And so, in the media, it is reported that Malaysia’s external debt (some were more careless by giving the impression that it was total debt, just to make a sexy, alarmist headline for the clicks) increased by more than three folds. This is one of those deplorable reporting:

Malaysia’s external debts grew by more than three-fold in less than a year, from RM196 billion at the end of 2013 to a whopping RM740.7 billion in the third quarter of last year. In a written reply to William Leong (PKR – Selayang), Finance Minister Datuk Seri Najib Razak attributed the spike to “new definitions” for external debts in 2014. Almost two-thirds of the increase was due to foreigners holding on to Malaysian bonds, now considered as part of the external debts. Leong warned that this is the scenario currently taking place with debt-laden 1Malaysia Development Berhad (1MDB) where a huge chunk of its RM42 billion debt is allegedly being held by foreigners. [Eileen Ng. The Malaysian Insider. Malaysia’s external debt tripled to RM740 billion last year]

From there on comes various accusations by a whole lot of laypersons, at a time the government is already under severe attacks for the fiasco that is 1Malaysia Development Berhad. I am not a fan of this government but in this particular case, the focus is misplaced and the criticism on external debt is based on a misunderstanding. The supposedly massive rise in the external debt is a non-issue, unless you are a wonk excited about the most technical of things. This is what it is, a technical matter.

The truth is that there is really no increase of that magnitude in Malaysia’s debt, totally, externally or internally. Malaysia has always owned all of those debts. What happened was that the term “external debt” was redefined to include all debts held by foreigners. Previously, the term was used to describe all Malaysian debts denominated in foreign currencies, regardless of ownership. The former is big, the latter is small. If you need a Venn diagram to understand them, here it is (the graph does not exactly correspond with the definitions but it is good enough to highlight the difference in definitions):

Malaysia's new external debt definition

This redefinition exercise had been recommended by the International Monetary Fund for the longest time and Malaysia only recently decided to adopt the proposed nomenclature. This in fact was announced last year, as early as March. When I first learned that last year, I made a joke that somebody would scream murder. Indeed, a year later, here we are. MP William Leong definitely fell into the layman’s trap, and a whole lot of others too.

There was only an increase if you used one definition at one point and then switched to another definition at the next point, and pretend the two definitions refer to the same thing. This is wrong. You need to compare points from the same definition for the growth figure to make sense. The supposedly dramatic jump-growth as reported in the media is just a garbage figure of no value. It was calculated by including a significant, large structural break.

While the media is utterly in the wrong and clueless even as they wrote the word “redefinition” in quotation marks as if it is a meaningless term, the Ministry of Finance is the cause of this misunderstanding. While it mentioned the redefinition exercise, the ministry compared the old definition with the new one and voila, a drastic increase just because they naively calculated the growth rate, despite, knowing a redefinition had occurred. So, it is a horrible answer, as horrible as the way the Finance Minister is handling the 1MDB issue. The media was just playing the role of a loudspeaker here, with no thinking in the middle.

I repeat. There is no increase as reported. If you keep the old definition and apply it forever, you will find any change from that will not come anything close to the sensationalist headlines featured by Malaysiakini and The Star all the way to, disappointingly, The Edge, which I consider as the most economic-financially literate Malaysian publication. I like The Edge but a mistake is a mistake. If you use the new definition and then stretch it backward, there will be no big change as well. Just keep the definition consistent if you want to calculate the growth.

Finally, there is really nothing sinister about the redefinition.

The reason for the redefinition has something to do with the evolution and the maturity of the Malaysian debt market. Twenty or thirty years ago, Malaysia did not have a big bond market and it was relatively unimportant to the economy, especially compared to today. So the old definition made sense then, in some ways. But since the 1990s, the Malaysian bond market has expanded rapidly to become one of Asia’s biggest. Foreign ownership of government debts also shot up as foreign investors searched for relatively safe assets. The debt market has become so large, that the newer definition becomes the more attractive one to use.

As in a lot of stuff out there, which definition to use really depends on your purpose. Just understand the data before using it.

So, ladies and gentlemen, please do not get too excited here. On this front, there is nothing to see really. Go, instead, to the next stage right across the road. Yes sir. A much more entertaining play called 1MDB is running there. Get your tickets. Sit back, and… be angry with 1MDB and not with the technicalities of debt redefinition.

Categories
Economics

[2767] Deflation is coming to Malaysia. Is it bad?

January inflation clocked at only 1.0% from a year ago while in December it was 2.7%. That was a pretty drastic slowdown that I bet someone will cry deflation wolf somewhere soon.

The cause of the slackening is easy to explain. It is unambiguously due to the drop in retail petrol and diesel prices. RON95 fuel price, the most popular fuel in Malaysia by far, in January dropped from MYR2.26 per liter to MYR1.91 in December. Diesel went down 30 sen to MYR1.93 per liter in the same period. In January 2014, RON95 was MYR2.10 per liter.

At this rate, Malaysia might be seeing actual deflation this month. In February, both RON95 and diesel went down further to MYR1.70 per liter. The drop in yearly terms in February 2015 is greater than that seen in January because in February 2014, RON95 was MYR2.10 still. In January 2015, it fell 9% YoY. In February 2015, it decreased 19% YoY.

In fact, on monthly terms, we are already in deflation. This is not your monthly, seasonal price fluctuation that people usually ignore and say, ah, it is nothing. This is a clear deflation.

Is this deflation something to worry about?

No. I do not think so.

Deflation these days connotes bad news. Japan and Europe are trying hard to avoid deflation. In Singapore, deflation played a role in convincing the monetary authority there to loosen up its forex policy, which is their monetary policy. And the last time Malaysia had a deflation, it was during the 2009 recession.

But not all deflation are the same.

In Japan and Europe and Singapore today, and Malaysia in 2009, deflation came about from reduced economic activities. There was less demand and so, price pressure was weak and that pulled prices down. It was demand-driven. In fact, we really are worrying about demand rather than price itself. Price changes — inflation or deflation — are usually a symptom of something else.

Unlike in 2009, the (possible) February deflation would be supply-driven. The weakening in prices has been supply-driven in the sense that technological improvement — all the talk about shale mining that is turning the US into the world’s largest oil producer — has created oil glut in the market.

I do not worry because this is the same pressure that forced computer prices down over the decades. It is a kind of pressure that makes a typical person feels richer because he or she could now buy something else with the same amount of money and still afford the same quantity of fuel or more. Or save them. I do not see a price-wage spiraling down out of control here. The price deflation does not make them feel poorer because the deflation does not come about from them losing them job or suffering a pay cut. There are news of some retrenchment in the oil and gas sector but the size is small so far, as far as I know and besides, the sector is not the biggest contributor to the Malaysian economy. Indeed, the biggest sector, electronics, is having swell of a time and being ignored by the press.

I also do not worry about deflation because fuel is not something a typical consumer can live without for too long. Deflation can be disastrous to the economy in the sense that people would stop buying or postpone their purchases until prices fall further to stabilize at some low prices. But with fuel, I do not think you can do that to the point it would adversely affect growth. Fuel is an essential good and you just have to use them, especially in a society that is so dependent on combustion-type vehicles. If you do wait out, then you might not be able to drive or get to somewhere at all. You just need them and you will keep buying it even when you know prices are falling.

More importantly, the postponement of purchase is dangerous to growth especially when consumers do not know when prices would bottom out. So, they keep holding back and then not making purchases at all. This can be particularly devastating for fixed assets like homes and durable goods. In the case fuel prices, it does appear prices have bottomed out, especially since the prices used for the determination of petrol prices in Malaysia is lagged by a month, as I have explained previously. If global crude prices hold at the current level at about $60 per barrel compared to $45 in mid-January, it is very likely that retail petrol prices will be higher in March next month. So, a February deflation will be temporary. This also means people would line up at the gas stations at the end of this month preempting the loophole that comes with Malaysia’s imperfect dirty float system. So, instead of being encouraged to postpone purchases, they will hoard them instead.

Before I end, I am not saying there is no problem with demand. I still worry that consumption growth is slowing despite the surprisingly strong expansion last quarter. But the possible deflation in February is very much driven by the supply-side, and not demand.

So, do not worry about the deflation.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved
p/s — I am tempted to say yet another reason why I was not worried about deflation, but decided the argument is problematic. That argument goes: core inflation is still more than 50 basis points above headline inflation. Since core inflation is more reflective of demand, and since it strips fuel away and therefore free from supply-driven inflation/deflation seen in January, it suggests demand is going well. But I checked the data from 2008-2009 and core inflation was somewhat healthy despite the fact there was a recession. This probably shows core inflation is an imperfect measurement of demand change.

I am putting it at the postscript to catalog my own thoughts on the matter and revisit it later.

Categories
Economics

[2765] If pre-GST spending was that high, how low would it be post-GST?

The Malaysian GDP figures released yesterday suggest there was indeed a pre-GST spending spree.

Private consumption growth was phenomenal especially if you consider the fact that previous quarterly growth figures have been slowly dropping gradually over the past year from 8% year-on-year to all the way down to mid-6% in the third quarter of 2014. The latest consumption figure grew 7.8% year-on-year, which is crazy. It is so red hot that if the overall situation had not been so gloomy, Bank Negara would surely have panicked and raised its rates by another 25 basis points. This is quite a surprise even if you had believed the pre-GST spending spree hypothesis.

As a result, 2014 growth was at 6%, which is higher than most (well, all) economists watching Malaysia had projected.

But the central bank would not hike rate because the feeling is that the jump is temporary. I think it would last into this quarter before growth takes on a drowsy mode. The GST should depress consumption growth from April onwards. This is the danger. If consumption could jump so high pre-GST, how low would it get post-GST?

That is a scary thought.

This also gives more proof that consumers do expect prices to increase post-GST. I should add ceteris paribus, I guess, because the low retail fuel prices could make the net effect somewhat a wash. As for the recent electricity tariff cut, do not bother. I did a simulation and it hardly changed my headline projection.

Regardless of expectations, I am unsure there would be an actual net price hike. Last year, somebody told me the authorities expected (ranging from the Department of Statistics to the Treasury) inflation would hit 6% with GST, after months of official drive by the mainstream press that inflation would rise. Then it fell to about 4%. (You could understand why most banks are projecting about 4% inflation previously. They took the government’s guidance to heart) Now? I was informed the government expected it to be about 2%, mostly because of fuel prices. My own projection is about 3.3% YoY monthly average where I assume the GST will hit the economy in full force without any exception-zero rated stuff, but I keep several projections in the spirit of scenario analysis with the lowest at about 1.5% YoY where I pretend GST is the spoon in The Matrix.

My confidence in my models is  at an all time low and I have resigned to the fact that we will only know it in June or July when the Department of Statistics will release the April-May inflation figures. The crazy demand fluctuation, the retail fuel flotation and the GST make projections go everywhere.