Category: Economics

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.

Categories
Economics

[2361] 2011 sugar price compared to those in 1989 and 2009

I wrote two years ago that between 1989 and 2009, sugar price in Malaysia had increased on average less than 1% yearly within that period. To be slightly more precise, it rose on average by about 0.8% per year. In 1989, sugar was priced at RM1.20 per kg while in 2009, RM1.45 per kg.

With the current price hike, I want to update that post.

Today, sugar is priced at RM2.30 per kg. That means that between 1989 and 2009, the price has increased on average by approximately 3.0% per year.

What is the average yearly increase rate between 2009 and 2011?

Roughly 28.2%.

Categories
Economics Politics & government

[2360] Competition Act is a farce

Competition puts a downward pressure on prices. It is one of the forces behind innovation. It enhances welfare. Therefore, initiatives aimed at creating a competitive market are worth supporting.

For those who truly believe in a free and competitive market, however, the Malaysian Competition Act passed last year deserves neither admiration nor respect. It is worthless.

How can one respect the Act when the government itself is unimpressed with the spirit of the Act?

This question is especially pertinent after the Najib administration recently granted Bernas with another 10-year monopoly over rice imports in Malaysia.

The Act will be enforced in 2012. One would expect any government that is sincere or serious about encouraging competition to prepare the ground. What we are seeing instead is business as usual. Instead, the government continues to grant monopoly power to a specific company without any regards for the Act.

Government-sanctioned monopoly is not a phenomenon exclusive to the rice market. In the sugar market, the government awards import quota to a limited number of sugar producers. Here is something that makes it even more interesting. Tradewinds effectively monopolizes the sugar market, and it is related to Bernas.

In Sarawak, there is CMS Berhad, which has a disproportionate access to government procurements and tenders. It is the grand monopoly of Sarawak and it is a prime target for a proper anti-trust law.

One must not forget the various government-linked companies. They are so large and so powerful that their ability to distort the market is not doubtable. What makes it worse is that, one would rightly expect these companies to sleep in the same bed as the government, at the expense of consumer welfare.

The government after all has an interest to see that these companies are profitable because the government is the shareholder. For companies that it only has an indirect relationship with, bad performance is just bad politics.

In the name of competition, a respectable anti-trust law must subject everybody under the same rules.

Yet, ”activities, directly or indirectly in the exercise of government authority” are excluded from the Act. Companies that obtain their monopoly power through a government authority like Bernas easily fit the bill. It is also easy to argue that GLCs will enjoy the exemption as well.

Even if that stated exemption does not cover those companies, the Competition Commission as established by the Act has wide discretionary powers to exempt anybody from the Act. With a perverse incentive system that exists within the government, selective prosecution will likely be the norm. Private firms that attain large market share through sheer ingenuity will be prosecuted in the name of competition while GLCs and companies like Bernas continue to be shielded from market forces by the government.

In short, not only does the Act not encourage competition, it is a tool to make the market less perfect.  This Competition Act is no anti-trust law. It is a discrimination law.

The truth is that competitiveness of the Malaysian market can be enhanced without this Act, which shamelessly masquerades as an anti-trust law.

Government policy created these monopolies and because of that, it is arguable that a proper anti-trust law is like taking a sledgehammer to a nut. Instead of expanding the role of government, a reduction can be just as effective as a proper anti-trust law. Such a retreat will definitely be more effective than the farce that is the Competition Act.

This is how a retreat should look like: The government to divest away from most GLCs, to institute an open and competitive process to most of its procurements and to stop granting monopoly powers to the likes of Bernas. Do all that and with a little luck, even a real anti-trust law might be redundant.

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 4 2011.