Category: Economics

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Economics

[2963] Is inflation the reason behind BNM hikes, at a time when the output gap is big?

Bank Negara raised its benchmark rate yesterday, from 2.50% to 2.75%. While the general reasoning is fighting inflation, I am not that convinced of it. My primary reason is, Bank Negara’s own analysis shows inflation (demand-push) is not a problem. Yes, consumer price index has been rising high, but most of those price increases are not something monetary policy can address without exerting damage to the economy.

The central bank regularly published estimates of output gap in the economy. Looking at the output gap is the easiest way to understand the economy quickly. To put it simply, the gap tells us about the capacity utilization of the whole economy. It is the difference between total (or maximum) capacity, and capacity used. When the used capacity is well below max, then inflation should be relatively low with unemployment high. When resources are not used up, there will be slack in the economy which is reflected in inflation and unemployment numbers. The same is true vice versa.

And based on the latest estimates published by Bank Negara back in March 2022, there is a huge slack this year (and estimated to be bigger than last year’s):

When the gap is big and when there are no other concerns, you would want to encourage the economy to keep going. You would want to close the gap, and approach full capacity (which is another way of saying full employment). And you can do this without much concern for inflation. That means, rates could be left low.

When you raise rates in these circumstances (as Bank Negara is doing), it means widening the output gap. You would lower demand-pull inflation (if there any), but since you have no control over supply-push inflation, you are just targeting the wrong part of the economy. You are pulling demand down almost immediately, but do nothing to the supply side, which is out of your immediate control (in fact, low rates improve supply, but not in the short term). Hence, widening the gap.

Beyond domestic considerations and on top of the current gap situation, there are concerns the global economy will go into yet another recession so short after the last. The US economy is close to experiencing one although its growth resilience so far has surprised many economists (and demand-pull inflation is problem there). Europe is almost certain to enter recession next year (war and gas supply are exacerbating supply-push inflation). Growth in China has been weak but there is some hope it would provide some cushion in an otherwise sullen world. When we look ahead, Bank Negara’s rate hike feels even more jarring and lags behind expectations, when they should be ahead of the curve.

So, when I read the Monetary Policy Statement and the references to inflation, I am not so sure inflation is the primary driver for the hikes. I have been suspecting so for a while now.

In my opinion, there are two other things at work that convinced the Committee to do what they did yesterday:

  1. It is about the ringgit. The currency along with many others out there have been under severe depreciation pressure due to US Federal Reserve’s series of drastic rate hikes. The end of easy money is upon us. And domestic benchmark rates are a big lever to relief the pressure partially: rising domestic rates would keep the difference with those in the US smaller than it would have been otherwise. And smaller difference means less depreciation pressure on the ringgit.
  2. The problem of zero-interest rate policy (ZIRP) and liquidity trap. Many conventional economists (of the 1990s?) believe monetary policy loses its potency the lower the rates go. And since Bank Negara Rates is already low by historical standards, maybe they are concerned about losing monetary influence and hoping to build up ammo for the next crisis.

In both cases, the cost of pursuing the goals will widen the gap today.

The relevant question is (especially with respect to the ringgit), how big would the gap be if the ringgit is allowed to depreciate beyond what the rate hikes allowed? Supply-pull inflation does hurt demand after all, and weaker ringgit means more imported inflation. Comparing the two gaps would help determine which policy to take.

I would love to read the minutes and see references to the gap, if any.

Categories
Economics Politics & government

[2960] Election time: my preferred transport policies

Recently, I wrote election manifestos should have overarching themes, while avoiding the kitchen sink approach. While I focus on Pakatan Harapan, Barisan Nasional also had a kitchen sink approach before. Kitchen sink is the favorite way of doing things among political parties.

I do not have the energy to come out with a manifesto myself, but if I had to choose one area, then it has to be transport policy, which intersects with many other areas that includes fiscal, climate and urban development policy.

My ideal transport policy will be constrained by at least 3 factors:

  • Promoting responsible fiscal policy to rapidly build up government capacity in healthcare, education, defense and overall industrial policy
  • Reducing carbon emissions with respect to concerns for climate change
  • Improving connectivity across the country, especially in and around major cities where most of the population work and live.

These constraints mean, especially in the cities, fewer private vehicles on the road, and greater reliance on public transport.

This list is not comprehensive, but I think the areas it broaches are major concerns. Here are my preferred policies.

Fuel policy: Switch from petrol subsidy to cash transfer

Current fuel subsidy policy is expensive. It takes resources away from many other areas. As reported in the media, as of June, 2022 subsidy bill alone (not including other social assistance) was expected to hit RM78 billion. This is bigger than 2022 allocation for the Ministry of Health (RM32 billion), Ministry of Defense (RM16 billion) or Ministry of Education (RM53 billion). While subsidies alleviate short term pain, it does not build long term capacity: it takes resources away and weakens already underfunded health, defense and education systems, among others. Imagine what these systems would look like if they had an additional RM78 billion for their services and asset acquisition.

Here, I would like to return to the late-2000 policy of switching from fuel subsidies to cash transfers (before it was abused as goodies). It does not have to be a one-to-one switch since cash has higher value than fuel subsidies: the former has many more use cases than fuel subsidies.

Cash transfer implementation will have to be discussed elsewhere, together with the introduction of tax identification number.

Fuel policy: Tax petrol through SST (or GST)

Simultaneously, I advocate fuel tax. SST (or GST) should be charged on purchase of petrol. While I do not support ring-fencing income from fuel tax for any particular purpose, additional income here should be able to fund a large cash transfer program, as well as to introduce new public transport service while improving existing ones (more about public transport later).

Such tax will discourage excessive use of private vehicles, which will:

  • Improve journey time by taking cars off the road
  • Shift some traffic from private vehicles to public transport
  • Reduce carbon emissions

I would think removal of subsidies and introduction of fuel tax alone would provide the government with resources to build its capacity in multiple areas. And of course, in public transport too.

Specific subsidies (however the implementation is) can be provided to a limited number of people based on geographies or industries. I would imagine logistics service providers and other transport operators should have access to fuel subsidies. Small-time farming and fisheries probably should be subsidized too.

Public transport: government to fund rail transport directly

The current state of public transport is deplorable, and part of the problem is that rail service providers are putting financial rather than service performance first. That financial focus is part of the reason city rail policy in the country has become a bit of a real estate play, rather than about moving people around efficiently.

It is time we admit public transport, city rail in this current state especially, are financially nonviable. While admitting so, we must take into account those rail services are a public good.

With these two things in mind, the government should directly fund these rail services, and reform various rail service providers’ key performance indices from financial-based, to primarily performance-based. (Let us not play with paper-shifting accounting anymore and get serious about public transport).

Besides, for all intends and purposes, these services are already funded by the government indirectly through committed guarantees. It is just that too many people are in denial about public transport finances in Malaysia (see the chart below for the 2023 Fiscal Outlook report, which is the result of lasting reporting reforms made in 2018-2020. Observe commitment linked to DanaInfra, Prasarana and Malaysia Rail Link). They hide behind accounting standards to avoid the truth: the government is already funding these rail services through convoluted means.

This however does not mean public transport is free, but it should be cheap enough, particularly with respect to costs of private vehicle ownership.

Which rail services should under this? I am thinking primarily monorail, LRT and MRT in KL.

Public transport: Postpone MRT3 and HSR to later years when ridership demand is more appropriate, and improve existing rail services instead

Given the current state of rail transport usage and efficiency in Kuala Lumpur, I am unconvinced of the need for MRT3 at the moment. I rather wait until the current rail system nears full or even three-fourths capacity before moving ahead with MRT3. At the same time, with the ringgit weakening, it might be a good idea to control government-induced imports: MRT3 and HSR would definitely need large imports that would exacerbate the situation we are in.

I also am not too warm about having new city rail services in other cities. There are very few cities in Malaysia that have enough population to rationalize building a new city rail line.

As for HSR, I rather we strengthen and expand KTMB’s ETS.

For ECRL, it is too late to do anything about it. But I suppose, the long run goal is to integrate it into KTMB. We should streamline such rail service instead of fragmentizing them.

At the same time, improvement in services will require purchases of new assets. This, obviously, has to be done through open tender. No more sweet deal with China-based companies, which has proven to be overpriced in the long-term despite appearing cheap at the outset.

Furthermore, improving existing rail services would be a chance to further develop Malaysia’s industrial capacity, instead of importing from China technology that we already have.

Public transport: More bus services, and bus lanes in the cities

To improve public transport around in cities all around the countries, buses are likely the most cost-effective ways doing it. And it is flexible unlike rail. Focus on buses instead of rail should keep Malaysia’s transport policy from ballooning the way it has (without the associated improved performance) in the past decades.

Two things:

  1. For buses operated by Rapid, the same government-funded model used in rail applies. These are city-buses.
  2. For buses run by private entities, the government to subsidize fares given some service-level requirements. This is likely applicable in small cities, and interstate services, which do not compete with government-provided services. This should also help with rural buses, where low ridership might kill off services.

It is also time to consider dedicated bus lanes on existing roads. Here, we have Jakarta to learn from. More bus lanes will also discourage private car use in the city, by taking lanes away from private vehicles.

Highway: No new highways in the Klang Valley

With the exception of Sabah and Sarawak, and some parts of the East Coast, the Peninsular West Coast probably does not need new highways (particularly so the Klang Valley). So, no need highways in the Klang Valley.

Tolls: Congestion charges in the cities

I prefer to have congestion charges in the cities. This also means no abolition of tolls, or lower of tolls outside of congestion charges model (abolition of toll means the barrier of switching from private vehicles to public transport will be higher and we need to avoid that). The implementation of total congestion charges may have to come with stages and the easiest is probably to wait for all the concession to end and have the government, or the relevant city authorities take it over. This is probably most relevant for KL and its satellites, and possibly George Town too.

For interstate tolled highways, I am ambivalent. We could keep the current system, but refrains from seasonal toll discounts.

Tolls: payment methods

There are too many lanes for different payment methods.

Makes all lanes capable of accepting all payment methods. Also, no express lanes. Everybody should line up and wait for their turns.

Private vehicle ownership/etc

I am going to list down several items without much elaboration:

  • Doubling (tripling) of excise duties on luxury vehicles for carbon emissions
  • Banning of large vehicles (i.e. pick-up trucks) for individual uses for carbon emissions and safety concerns
  • Banning of white headlamps for safety concerns
  • Cash for clunkers program to address emissions and safety concerns
  • I am ambivalent about this, but we possibly need ideas on investment for electric vehicle infrastructure.

Aviation

Yes, refunds mean refunding in cash, not in funny credits. This shall be the law.

Categories
Economics Politics & government

[2959] Budget 2023 and Undi Banjir are examples of BN irresponsibility

Barisan Nasional believes the yet to be approved Budget 2023 is an asset to them, with their supporters are taking it as their election manifesto. Unfortunately for them, a yearly government budget is no replacement for a 5-year manifesto. To me, using Budget 2023 as a manifesto, with its process halted midway, is a sign of irresponsibility.

Irresponsibility, because we are no longer living in at a time when BN is assured of returning to power. It could be PH, PN or any other permutation out there. If a different government gets elected, the budget process will have to be recalibrated. Any government will want to execute their own agenda. Indeed, even if BN gets into power, there is no guarantee Budget 2023 will not change. Even BN PM candidate is uncertain, with assurance given incredible.

The smooth running of the government should sit beyond partisan politics, but BN places that below their political fortune. The risk of disruption to the budget process is of no cost to them, but only to the people of Malaysia at a time when the global economy is risking recession.

Such irresponsibility of course should be apparent to many in the past two years through various instances of double standard in the application of rules during the Covid-19 pandemic that brought so many unnecessary deaths.

But such irresponsibility should not be a surprise. After all, BN wants a general election during flooding season. Just like during the pandemic, they are willing to gamble our lives for their partisan benefits.

The Budget 2023, unapproved, and risked being redone, is just yet another example of BN irresponsibility.

Categories
Economics Politics & government

[2957] Pakatan Harapan should avoid kitchen sink manifesto

Election is nearing and among policy-minded voters, it is not difficult to spot manifesto discussions. As someone with some implementation experience in government, let me say the last Pakatan Harapan manifesto was difficult. I knew this before I was pulled into the whole business: I reviewed the manifesto and summarized it as the following: the economic plank was “difficult to stomach wholly” but the other parts, particularly the institutional agenda, were what we needed. Given my concerns were institutional in nature, I was willing to give a blind eye to the economic plank, and support the institutional aspect wholly.

Looking back, the economic manifesto rode on popular anger quite effectively. That explained the kitchen sink approach taken by its authors. GST, monopoly, living costs, corporate corruption and other concerns were all meshed into one big document, which did not jive together. The authors knew what they wanted.

Unfortunately, riding the wave, and actually executing the policies were two very different things. Mahathir famously said ‘we’ did not expect to win, and so did not expect to implement those promises. Manifesto bukan kitab suci; manifesto isn’t a holy book. That highlighted the difficulties associated with the economic aspects of the manifesto, especially after GST was abolished just weeks after the 2018 election, and more importantly, before the Finance Minister was sworn in to bring SST back.

The next election, Pakatan Harapan can do better. They need to do better because the same mid-2010s anger is no longer there. There is little to match that economic anger, save the stubborn but relaxing global food prices and rising recession risks.

If I were to write the manifesto all by myself, I would reiterate the institutional aspects and reuse a good chunk for the 2022/2023 general election, and come up with a new one for the economic side. On the economics, I would reject the 2018 kitchen sink approach. I would instead set up overarching national goals. What do I mean by that?

In the kitchen sink approach, almost everything economic-related concerns were siloed off with little concerns to bigger concerns. One way to put it simply is that the proposed solutions were necessarily single-minded and siloed that the same proposed solutions ignored their effects on other things, like government finances and economic growth. At the implementation stage, at times this left those solutions contradicting each other, leaving individuals implementing those siloed solutions fighting each other and accusing the other side as blocking manifesto fulfillment. For instance, when Pakatan Harapan abolished GST without regards to policy sequencing, notwithstanding the previous problem with refunds (truly, the additional government revenue was lowered than BN admitted), how exactly the government would finance other parts of its economic promises? PTPTN? Highways? Petrol subsidies?

As you can see, the kitchen sink approach works from funding supply first, and then effectively takes the funding demand as an afterthought. This caused the troubles Mahathir identified so early. You ended up with insufficient funding supply to meet rising funding demand.

In the overarching national goals, it should work the other way round: start from funding demand-side first, and then work the funding supply-side afterwards.

To do this, we have to ask ourselves, what do we want for Malaysia?

Do we want to maintain our largely free, government revenue-financed healthcare system?

Do we want a welfare system given the damage Covid-19 has done to the financial security of many Malaysians?

Do we want a good education system? What kind?

Do we want better cities? Transport policy?

Do we want stronger defense?

Do we want to climate change infrastructure? Energy policy?

What?

This requires deep discussions among many parties, from lay users to experts. It has to be multidisciplinary, exactly so to avoid the silo problem that the 2018 Pakatan Harapan manifesto suffered (and contemporaneously, the Ministry of Health’s ongoing white paper).

And this way, we can be honest when it comes to taxation: taxes have to rise.

The truth few willing to say loudly because it is unpopular is that the Malaysia government lacks funding to do a whole lot of things due to low taxation. We can raise the deficit ratio, but even so it would not be enough to meet various legitimate demand associated with basic functions of government like health and defense (let us not talk about unorthodox fairy tales about ‘printing money’). For a country aspiring to be a “first-world” with worsening demography (but still young), our tax (and the bigger government) revenue to GDP ratio is low. That fact has caused unnecessary outsourcing of basic functions to the private sector. The same fact is the reason behind a whole lot of off-budget borrowings and spendings, which are nontransparent and significantly raises corruption risk in an environment where underfunded institutions cannot play their check-and-balance role properly.

To tell this truth, you have to tell the funding demand-side story: what do you want?

Of course, not all wants can be entertained lest the same problems besetting the 2018 manifesto would come back. You cannot want a well-run public transport system while wanting blanket petrol subsidies and eye-roll-worthy car duties cut. You cannot want a working revenue-funded health system while supporting tax cut for private insurance and spending at private hospitals. You cannot want a fully-funded education system while supporting tax cut for private education institutions. You cannot want a healthy Malaysian population but keep sugar cheap. You cannot want a good road while wanting a low road tax and cheap petrol.

Manifesto authors have to choose instead of putting everything into the kitchen sink. Here is where leadership is needed: decide on the policy direction instead of a Hail Mary rush.

And also, of course, manifesto has to be popular. It has to have its hooks. But those populist promises can be brought in line with the overarching themes. For example, have public transport cheap, with discount and vouchers and everything, and admit the system will always be in the red, to which the government will have to fully fund it directly (leaving financial performance for public transport system second in priority to physical performance).

Be direct about the funding demand, and through that, we can be honest about funding supply, and taxation.

I should add that the institutional aspect of the 2018 manifesto worked because it had an overarching goal: improving the overall check-and-balance mechanism and all of them are linked to one another in one way or another. It was not a kitchen sink.

To summarize it all: the next manifesto should be driven by overarching goals, instead of a laundry list of grouses. In other words, do not throw everything into the kitchen sink.

Categories
Books, essays and others Economics Politics & government

[2955] Reviewing The Republic of Beliefs

Do laws matter? How do they matter? When do laws work? Why should a law work just because it is written on a piece of paper?

Kaushik Basu explores these questions in his 2018 book The Republic of Beliefs: A New Approach to Law and Economics. He utilizes game theory to answer the questions. Basu is an economist with wide experience in public policy.

By Hafiz Noor Shams

From the very start, he is skeptical of the power of the law as understood through Hobbesian lens. He largely rejects the idea that laws function primarily through the threat of force. In place of coercion, he places beliefs firmly at the center of the answers, with possibility of coercion working only to modify beliefs. We are governed more by beliefs, and less by coercion.

To convince his readers, he lays out the basics of game theory. Luckily for most of us, he does not write down too many formulae. In doing so, he avoids turning a good chunk of the book into a dense game theory textbook. Charts are aplenty to deliver the same messages mathematical formulae would. All I am saying here is that the book is quite readable.

The point of the crash course (or review for those familiar game theory) is to ease readers into the idea of focal points, a concept imported from psychology (was it? I am unclear here). Within the context of game theory, focal points are a subset of equilibria as understood in economics. It’s a signpost to coordinate responses. Once all prerequisites in place, Basu delivers his central thesis: laws work to push society towards a preferred equilibrium, out of many equilibria.

Laws alone do not create equilibrium. A law that forces society towards a non-equilibrium outcome will suffer from serious ineffectiveness. That ineffectiveness translates into frequent violations as rules are ignored, or circumvented via corrupt ways.

This is an important point to be learned by policymakers. I write so because I see lawmakers more often than not prefer non-equilibrium outcomes and propose complicated policy to address problems arising from such non-equilibrium. So complicated, that their proposals end up creating bigger problems (wink wink: chicken prices and palm oil subsidies in Malaysia).

Perhaps, this idea can be better explain through the problem of smuggling. Political commentators and even ministers (BN, PH, PN or whatever) have blamed the smuggling of something (cigarette, rice, gasoline, anything) on imperfect enforcement. And so, their solution is to put more money into greater enforcement. But the primary problem is not enforcement—though weak enforcement itself creates beliefs regarding (in)credibility of laws (but I will skip that part and encourage you to read the book for deeper treatment). It is about the law itself, which attempts to move society to a non-equilibrium outcome. And that non-equilibrium leads to corruption.

The prime problem, typically, lies in demand itself. Here, I believe Basu would claim, to fight smuggling, preference or behavior itself has to change. And behavior depends on beliefs.

More specific to Malaysian context, I think this is where attempt at ‘generational end-game’ for smoking will likely do more at curbing future tobacco smuggling than any ‘greater enforcement’ initiative would. There will be no cigarette to smuggle if people do not like smoking in the first place.

I think that (focal points) is the greatest insight from the book. But there are other points of interest.

One is the history of law and economics. The author goes back to Hobbes and Hume, but I am more interested in his treatment of modern history when Basu writes about neoclassical understanding of laws as provided by Gary Becker. Basu criticizes the modern economics approach towards law by stating a typical neoclassical model ignores the interest of law enforcers and other agents of the state (that include functionaries like judges and prime ministers). He zeroes in on the inconsistency of neoclassical understanding of law: citizens are assumed to be rational agents, but agents of the state taken as robots obeying everything they are told to do. In that way, neoclassical economists working on the intersection of economics and laws regularly sidestep the problem of corruption. Basu suggests, agents of the state should be considered as rational too, and their obedience should not be taken for granted. In that way, economists can tackle corruption problem more directly.

Despite his criticism of the neoclassical approach, Basu does not call for a complete culling of the school. Rather, he wants to improve those models by expanding it in a meaningful way. Indeed, the way he writes the book, it feels like a pioneering work built up on neoclassical approach.