Category: Economics

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Economics Politics & government

[2373] Speak plainly about the price hikes

Subsidy reduction has its pros and cons, even as on the net in the long run, it is beneficial to the economy as a whole. There is no need to soften the negative aspects by putting them in a little colorful box with ribbon on top.

The series of subsidy reduction leads to price hike and in the immediate time frame, it is burdensome. It is painful. With all the lags that exist, it is an intertemporal problem. The pain comes early, the benefits come only later.

A price hike is a price hike. It hurts in one way or another. Nobody likes to pay more no matter how small the increase is, even if the increase is justified. I myself do grudge a little about having to pay more than I used to, despite largely supportive of the subsidy reduction initiative, or some call it as the rationalization program in the spirit of euphemism.

Yet, we have apparatchiks and their agents writing and suggesting that the series of price hikes currently undertaken by the Najib administration will not burden the consumers.

These consumers are not kids. They are not kids visiting the family doctor, about to face the needle. The story of how the needle only stings like an ant is not for the mature audience.

Instead of trying to convince these consumers that the pain they feel is an illusion, those in the government and their supporters should really stick to the plainly true traditional rationale: it is wasteful. It is inefficient. It is distortionary.

Break the message down to bits and pieces that laypersons can understand (What we have instead is that these messengers misunderstand those very economic concepts themselves! They use big economic jargons without understanding the basic concepts. And these people fancy themselves as the economic planners of the country. Pfft!).

Just speak plainly.

I think the majority will appreciate it, even if it angers them.

To manipulate words and then say things that the consumers can affirmatively see, feel and conclusively disprove will compound the anger. I mean, something must have gone absolutely wrong when I, a supporter of liberalization, become angry reading these manipulated messages in the media.

Worst, these untruths will only erode any support for liberalization. These apparatchiks will have themselves to blame when everything fails.

Categories
Economics

[2368] Subsidy is not the only thing

Subsidy reduction will allow market forces to allocate resources more efficiently. Prime Minister Najib Razak was reported saying so recently to justify his administration’s commitment to subsidy reduction in the long run. By doing so, the Najib administration claims to be an advocate of free market. A claim that is not necessarily true, however. At best, that claim reveals a selective belief in the free market.

The truth is that market forces are restricted not only through price mechanism. The restriction also comes in form of quantity control, among others. This is especially relevant in Malaysia where the government has introduced various regulations and institutions to control the price and supply of various items. Among those items are flour, diesel and sugar.

In fact, the government has wide discretionary power over this matter. Proof: the new Price Control and Anti-Profiteering Act grants the government the power to fix the price of any goods and services in the country. Yes, that is any goods and services. The net has been cast widely.

Despite the various channels where market forces are prevented from distributing resources efficiently, for some reason the price mechanism is receiving all the attention while the quantity side remains relatively untouched. As an example, look no further than the domestic sugar industry.

The government recently reduced sugar subsidy and effectively raised the retail price of sugar. All the liberal benefits of reduction have been thrown out in the open: fiscal deficit reduction, efficient resource allocation, investment over consumption, etc. You just need to name it.

At the same time and less discussed is the existence of the illiberal import quota system. The government through a quota system controls the importation of sugar. The government also grants the quotas only to several refineries ultimately owned by Felda and Tradewinds, which themselves are closely connected with each other.

It is not an understatement that the two companies control the sugar industry with a clear government sanction. As a side note, it will be interesting to see how the two companies will be subjected — if ever — to the new Competition Act, which has a highly questionable purpose.

If the government gets one point for liberalization due to subsidy reduction, then the government must lose a point from the import quota policy. Given how the import quota policy has created two related monopolistic companies — one being the favored entrepreneur of the government of the day and the other being a government-linked company — and that prices are controlled, the government must lose more than a point.

However one wants to keep the score, the inevitable conclusion is that this liberalization done through subsidy reduction is merely a half-hearted liberalization.

Whatever market forces are mentioned to justify the reduction in subsidy, it is stated insincerely. The liberal argument is just something convenient that the administration grabbed out of the air just because it fits its agenda of day. When one does not derive an argument from the first principle, one cannot expect anything less than inconsistency; the Gods of Inconsistency are staring straight into the eyes of the Najib administration.

The government can prove its credential as an honest advocate by deriving its policy from the first principle. That is, the whole industry must be liberalized. The removal of subsidy and price control must happen together with the loosening of the import quota system.

This goes not just for the sugar industry, but also for the relevant others.

It is only then that the prime minister can state that subsidy reduction will enable market forces to allocate resources more efficiently with a clear conscience.

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 May 23 2011.

Categories
Economics

[2366] Does the rounding mechanism contribute to inflation?

Does the rounding mechanism in Malaysia contribute to inflation?

Malaysia implemented the rounding mechanism in 2008. All prices are now rounded to the nearest five sen. The mechanism makes the one sen coins redundant although the coins themselves are legal tenders still.[1]

To answer the question, I have an anecdote to tell.

Australia also employs the rounding mechanism. The only difference between the Australian and Malaysian systems is that the Down Under version applies to cash transactions only. In Malaysia, prices are rounded regardless of transaction types.

I am a stingy person. In the case with the Australian system, I was literally penny wise, pound foolish. Well, more penny wise and less pound foolish. Considerably less for the latter.

Really.

Anyway, whenever I went out shopping in Sydney, I would check up on the price and see if whether it would be rounded up or down. If rounded up, then I would use my card so that I would save a couple of pennies. If down, I would use cash to get penny discounts.

I did that because I thought these firms were getting too much of the good stuff. I also thought they might have purposely priced their items so that prices would always rounded up in their favor. Hey, if I were the shopkeepers, I would do that too. And some of these businesses are big. I am not anti-business or anything but I sure do think they can make do just fine by not squeezing another penny out of me. Not when I am still alive damnit!

So, I would do that. After awhile, I thought maybe, it did not matter in the end. The saving from this little exercise was really small that if the whole two years worth of saving were combined, I could probably get a candy. One candy. That would not have impressed the ex-girlfriend by much.

The point is that even if the rounding mechanism contributes to inflation, I doubt it is significant.

But that is an anecdote. Here is something more scientific.

Chande and Fisher in 2003 wrote about the effect of rounding mechanism in Canada. They concluded that the expected impact was small. In fact, the effect of rounding on inflation is expected to be zero. Why?

They assumed the last digit that matters in rounding is uniformly distributed from 0 to 9. Therefore, the probability of each digit occurring is 10%. Since four digits will be rounded up, four digits will be rounded down and another two do not need to be rounded, the expected extra cost or revenue incurred or earned from the mechanism is zero. In simpler terms, the mechanism’s expected contribution to inflation is zero. On average, the sellers and the purchasers do not enjoy or suffer extra revenue or cost due to the rounding mechanism.

The authors ran a simulation and concluded that for purchases more than two items, the last digit of the price did distribute uniformly across the natural number line.

For purchases of less than three items, the digits did not distribute evenly. This suggests that this kind of purchases does contribute to inflation but since it is one or two purchases, its impact is likely small as suspected by Chande and Fisher.

How about strategic pricing?

Let me quote the paper I mentioned:

Thus, in order to take advantage of rounding, a retailer would need to know how frequently different combinations of items are purchased. While retailers like Tim Horton’s would have access to such data, Table 2 suggests that even if prices were strategically adjusted by firms to squeeze extra revenue from their customers, the amount per transaction would be so trivially small as to have little impact on consumer behaviour or welfare. Moreover, we have focused on price-setting by a single firm and ignored the reaction of other firms selling in the same market. It is an open question whether an oligopolistic market would lead to equilibrium prices that exploited rounding to the detriment of consumers. Indeed, anecdotal evidence from New Zealand suggests that such fears maybe unwarranted. Correspondence with the Reserve Bank of New Zealand, which in 1990 removed its 1- and 2-cent coins from circulation, revealed that some supermarkets at the time advertised they would always round in favour of the customer. [Dinu Chande. Timothy C. G. Fisher. Have a Penny? Need a Penny? Eliminating the One-Cent Coin from Circulation. Canadian Public Policy. December 2003]

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

[1] — The Rounding Mechanism is a method whereby the total bill amount (including goods and services subject to tax) is rounded upwards or downwards to the nearest multiple of 5 sen. In this regard, total bill amount that ends in 1, 2, 6 and 7 sen will be rounded down while 3, 4, 8 and 9 sen will be rounded up to the nearest multiple of 5 sen. [Frequently Asked Questions on Rounding Mechanism. Bank Negara Malaysia. Accessed May 19 2011]

Categories
Economics

[2364] Subsidy reduction and inflation expectations have to be managed more prudently

The Najib administration is committed to long-term reduction of subsidy. The Prime Minister said so.

I do support reduction and even elimination of subsidy. There are exceptions, but I do support anti-subsidy policy generally. So, I do take comfort from the Prime Minister’s statement.

Yet that does not mean I would support however the reduction is done. This is due to my concern for inflation expectations.

The Najib administration’s commitment to gradual reduction of subsidy is something that should be inspected closely. Gradual is the key word because the rate will create sustained inflation expectations. Inflation expectations itself will affect actual inflation in a big way.

It is not at all a problem if the gradual liberalization involves only small yearly increases. Such small increases will create limited inflation expectations. And a low inflation rate — as the economic wisdom goes and what goldbugs failed to understand — greases the economy.

But as I have shown earlier, sugar prices have increased by about 28% per year in the past two years. Other subsidized items like fuel that contribute to the Consumer Price Index have yet to be accounted for.

A sustained inflation expectation at that rate can be disastrous to the economy. I do not think anybody would want to see the Bank Negara playing a catch-up game with its monetary policy.

To prevent the sustaining of high inflation expectations, the rate of liberalization just has to slow down.

Alternatively, the government can eliminate all subsidies once and for all. That will create a one-off inflation. Yes, this is a crazy policy option but at least the inflation expectations will not be as bad as it is developing into right now. A one-off inflation spike is better than a sustained high inflation expectation because it will not leave a mark on the economy in the long run.

Categories
Economics

[2362] Consumer subsidy, corporate subsidy and… tax incidence

There is an argument in the Malaysian political sphere that goes like this: reduce corporate subsidy first and only then reduce consumer subsidy if need be.

It is a fair point. Yet, the validity of the point depends on which corporate subsidy.

This is due the tax incidence concept. I will not thoroughly go into it but I will summarily state that it does not matter who is taxed or subsidized. Whether it is the producer or the consumer, the answer to the question whose welfare will decrease or increase depends on a person’s — producer and consumer alike — sensitivity to price change.

If subsidy to sugar producer is removed, it is very likely that welfare of a person will go down the same way how a consumer subsidy removal will reduce the same welfare (assuming it is welfare enhancing to the consumers in the first place). That is to say that the removal of subsidy for sugar producer has the same welfare effect as the removal of subsidy for sugar consumer.

To put it more concretely, say a subsidy enhances consumer welfare and both producer and consumer are subsidized at the same time. If you reduce consumer subsidy, the consumer’s welfare will decrease. If you reduce producer subsidy, the consumer’s welfare will decrease all the same.

Removal of subsidy from anybody does not shift the welfare effect from one side to the other. It merely increases or reduces the effect.

This is a point those arguing “corporate subsidy first” need to be mindful because they are the ones whom oppose increase in prices and the eventual reduction in consumer welfare.