I just ran through the recently released Malaysian labor force participation rate for May 2010 and I find it odd to see a huge drop in the rate. I wonder what explains the drop. Why suddenly a lot of individuals decided not to look for jobs anymore in May?
Category: Economics
It begins with a good intention. Everybody deserves to consume fantastical juice. After all, everything is made out of it. It would be a grave injustice to limit its consumption only to those who can afford it.
Invested with executive power, a group of individuals with only the interest of the public at heart intends to make the fantastical juice available to everyone. They — the do-gooders —decide to introduce a policy to subsidize the production of the fantastical juice.
What follows is a production boom that lowers the prices of the fantastical juice to affordable levels. In fact, the fantastical juice sold here is the cheapest in the region.
On the breakfast, lunch, brunch, tea, dinner and supper menus, the fantastical juice is a star. Consumers are happy. The policy becomes popular. The do-gooders are popular.
All is fine and dandy until one little problem pops up: scarcity. They realize the subsidy policy demands a whole lot of resources. The policy is depriving resources from other programs. They begin to realize that good intention is expensive.
It is all the more expensive when the producers are guaranteed payment through the subsidy scheme. Producers of the fantastical juice just keep on producing even when there is no need for more fantastical juice. After all, who does not want free money?
The do-gooders complain, ”Oh those pesky producers. How dare they take advantage of this noble effort to make the fantastical juice available everywhere to everybody at affordable prices? Never trust them. They are only in it for themselves. They leave us no option. We must regulate them.”
And so, the do-gooders decide to have producers of the fantastical juice licensed. Quota is imposed on production.
The producers protest but not too hard. After all, the policymakers still pay them money. ”At least, we are still making profits.” Without the government and the subsidy program, they would have been left at the mercy of the market. ”We might make a loss if there was no subsidy!” They figure, better work with the government than be at the mercy of the greedy consumers.
That stops the cost of the policy from ballooning further. It solves one problem but it creates another: the fantastical juice mysteriously begins to disappear from shelves of grocery stores.
Consumers are infuriated. Consumers demand action.
The do-gooders panic. They need a scapegoat fast. No, they do not need a scapegoat. One cannot make scapegoats out of smugglers. It must be those greedy smugglers abusing a system designed to benefit all. ”We will double officers at the borders and we will triple the penalty.”
They catch those smugglers but fantastical juice still disappears into thin air. At some point, they realize that they cannot continue to blame the smugglers. If they still do so even after greater enforcement, they would send out a message of failure that there is something wrong with the good policy, and that it is not the smugglers after all. That would undo all good work they have done. Support for their policy would plummet with the slightest hint of admittance of failure.
”We need to identify the problem,” demand the do-gooders.
They conduct a thorough study of the supply chain of the fantastical juice and they find it. It is the retailers. ”These retailers are hoarding the fantastical juice and profiteering from our noble effort. They leave us with no choice. We must regulate them.”
And so, the do-gooders decide that only retailers with the special license can sell the fantastical juice. The do-gooders also introduce price control and ensure that there is a fat margin for retailers. This will encourage the retailers to be more honest because if they are caught, they will lose their license and, because of high demand for the fantastical juice, they will lose a guaranteed profit. The elimination of price variation eliminates the opportunity for retailers to indulge in profiteering as well.
The retailers register a protest, claiming that it is not their fault. ”Supply, being inflexible, is unable to match demand. We do not hoard it. We cannot sell what does not exist.”
”Oh, if that is the case, then you are not managing your inventory efficiently enough for the good of the people. There is enough production for the whole country. We will manage the supply for you.”
Just to keep it airtight, only government-owned transporters are allowed to deliver the fantastical juice in the country.
The do-gooders marvel at their new master plan for the fantastical juice. Their proudest achievement is this: the cheapest fantastical juice in the region is still here.
Alas, shortage persists. ”Someone must still be profiteering from this noble effort,” cry the do-gooders.
Being at their wit’s ends, the do-gooders approach several consultants. These consultants point out that the consumers are consuming too much of fantastical juice. ”That is why there is shortage. They are over demanding it.”
The do-gooders are angry. ”Those no good consumers! They are abusing the system! We want to help everybody, but everybody is abusing our trust! We must regulate them!”
And so, consumption quota is imposed on every consumer. With control at every point, the do-gooders match demand and supply to solve the problem of shortage.
At least, theoretically because those with low demand get too much quota and those with high demand get too little quota. To solve the problem, consumers participate in the black market. Consequently, crime associated with the black market flourishes as cartels are formed to profit from the unlicensed and hence, illegal trade.
”Criminals! All of them are criminals!” shout the do-gooders, ”Send in the police.”
First published in The Malaysian Insider on July 18 2010.
Malaysian national carmaker Proton celebrated its 25th anniversary yesterday. In conjunction of the celebration, Prime Minister Najib Razak said, as reported by The Star, “[i]f overcapacity is a limiting factor to the companies, should the process to merge automotive companies in Malaysia be done so that it will create a company that is stronger or bigger and more capable?“[1]
This has been interpreted by the media as a call for merger instead of a hypothetical question. The managing director of Proton echoes the call for merger.[2]
With the government having business interest in Proton — the government is likely to have the same interest in that merged entity — it inevitably raises the question of protectionism. It becomes the government’s interest to protect that giant local car maker.
The government of course does have interest in Proton but the larger the carmaker becomes, the harder it is for the government to resist the tide of protectionism.
There was a time when Proton was the monopoly in Malaysia, and backed by the government wholeheartedly in form of tariff on imported cars. The tariff was obviously introduced to protect Proton. Or in the words of protectionists and nationalists, to encourage the local automotive industry. Unfortunately for protectionists nationwide, the policy stunted the growth of local automotive industry and helped Thailand emerged as the ‘Detroit of Asia’.
Not that Detroit is the hallmark of the automotive industry…
The policy limited options for a majority of local consumers. What made it worse was that only not-so-high quality cars were available to a whole lot of us.
That is less of a case now due to ASEAN Free Trade Area Agreement that demands the abolishment of tariff between ASEAN countries.[3] Still, import duty on vehicles originating from outside of ASEAN is as high as 30%, signaling protectionism. The involvement of the government in the automotive business heightens the concern. There is no guarantee protectionism of the past will not repeat itself.
It may make business sense for local car manufacturers to merge but I am in the opinion that such call for merger should come from the industry, and not from the government. That means the government has to exit the industry first. Let the carmakers fight their own fights without dragging the taxpayers into it.
Once the government is no longer wedded to the carmakers, there would be less room and possibility for the government to protect the car industry. The consumers meanwhile would have the opportunity to make choices unadulterated by protectionism.
Whether there should be a merger or not later on, that is less of my business or that of the government. That would be entirely up to local car manufacturers, and probably the regulators if the anti-competitive bill is passed.
[1] — KUALA LUMPUR: Local automotive companies could merge to create a bigger and more capable company, proposed Datuk Seri Najib Tun Razak.
The Prime Minister said one of the ways to overcome the issue of overcapacity in production was for the industry to consolidate.
“The automotive industry in Malaysia needs to undergo a process of re-looking at its structure, to determine whether it can ride all challenges.
“If overcapacity is a limiting factor to the companies, should the process to merge automotive companies in Malaysia be done so that it will create a company that is stronger or bigger and more capable?” he said in his speech at the Proton 25th anniversary celebrations last night. [Merge automotive firms to create bigger and more capable company. The Star. July 9 2010]
[2] — KUALA LUMPUR, July 10 — Proton’s managing director Datuk Syed Zainal Abidin Salleh Mohamed Tahir said that the consolidation of local automotive companies is important to ensure that the industry remains competitive.
He said that mergers were a step forward in the liberalisation of the automotive industry.
“I think it is timely and it is the most natural thing to do. I think we need to sit down and discuss on how to do it properly. I think it is a good way forward to prepare the entire eco-system for liberalisation and it will make us more competitive. The government has already made the call and I think it is time for the people in the industry to sit together and decide what is best,” he told The Malaysian Insider. [Proton chief says mergers future of local car industry. Asrul Hadi Abdullah Sani. The Malaysian Insider. July 10 2010]
[3] — See Duties and taxes of motor vehicles. Malaysia Automotive Association. Accessed July 10 2010. For example, from the MAA, the following schedule for cars:
| Import Duty | Local taxes | |||||||
| CBU | CKD | MSP | CBU & CKD | |||||
| Engine
Capacity (cc) |
MFN | ASEAN
CEPT |
MFN | ASEAN
CEPT |
MFN | ASEAN
CEPT |
Excise
Duties |
Sales Tax |
| < 1,800 |
30%
|
0%
|
10%
|
0%
|
10%
|
n.a
|
75%
|
10%
|
| 1,800 – 1,999 |
30%
|
0%
|
10%
|
0%
|
10%
|
n.a
|
80%
|
10%
|
| 2,000 – 2,499 |
30%
|
0%
|
10%
|
0%
|
10%
|
n.a
|
90%
|
10%
|
| Above 2,350 |
30%
|
0%
|
10%
|
0%
|
10%
|
n.a
|
105%
|
10%
|
When the economy first began to tumble down in 2008, those within the government were eager to point out that weakened external demand caused it. The financial crisis that began in the United States hurt global trade. Being a highly trade-dependent economy, there was no escaping for Malaysia. To put the blame on those in the government was unfair and wrong.
Now that the economy is rebounding in a spectacular fashion, those within the government are eager to claim credit for it. Perhaps, way too much credit.
Although it is arguable that the stimulus spending did contribute to the encouraging 10.1 per cent year-on-year growth of GDP — controversial claim but let us leave it at that — it is likely that the growth was mostly due to the same external factor that caused the recession in the first place. Contribution by the stimulus package was probably very pale compared to contribution from external demand.
It helps to rewind back to 2008 and 2009 when it all began. We need to understand that the cause of the recession was the drop in international trade, as far as Malaysia and other trade-dependent countries were concerned.
Furthermore, it is crucial to remember that not all of the RM67 billion of the stimulus package announced was actual spending. For instance, some came in form of guarantees. This lessens the potential impact of the stimulus, unlike what the proponents would like to believe. When they speak of the stimulus, they almost always speak as if the whole RM67 billion was direct spending, which is not true.
Even if all of the RM67 billion were in form of direct spending, it would still not counter the effect of falling trade volume. The spending did very little to reverse the fall. At best, one could claim that it cushioned the impact of the recession.
Here is a digression. Fiscal stimulus proponents argued earlier that it was a cushion. It was not much of a cushion, as we all saw. Their narrative has changed. They now claim that it aids recovery. Funny how the story changes, is it not?
The reverse in trade trend was so great that it created a great chasm in any graph. No government spending could overcome that chasm. The fact that the country entered a recession despite what Prime Minister Najib Razak called unprecedented spending is proof enough.
Toward the end of 2009 and in the first quarter of 2010, world trade recovered as spectacularly as it had fallen during the so-called Great Recession. For high trade intensity countries like Malaysia, it was extremely good news simply because it signals normalization.
Nothing more. This is a crucial point. The 10.1 per cent is merely a sign of normalization rather a sign of actual rapid growth, in the bigger picture. More than that, it is about the normalization of trade.
The big picture is this: The big growth numbers in high trade dependent countries that suffered significant contraction — be it in Malaysia, Singapore or Taiwan — are due to base effect rather than proof of excellent economic management skill of the countries with respect to growth. That chasm in the graph allows base effect to take a prominent role in exciting growth.
What is base effect?
Consider a person investing RM100 in a fund for two years. At the end of the first year, suppose the fund makes a loss of 50 per cent and hence, the person has only RM50 now. At the end of second year, the fund makes a return of 100 per cent and hence, the person has RM100 again.
Notice that the person, after two years, makes no profits or loss. Yet, the person makes a staggering 100 per cent return in the second year, if the second year is taken in isolation. That 100 per cent return is only impressive if the full context is unaccounted for.
Consider the case of Malaysia for the past two years. The year-on-year growth for the first quarter of 2009 was terrible: -6.2 per cent. The year-on-year growth for 2010 was magnificent: 10.1 per cent. What does two-year growth from the first quarter of 2008 look like?
A mere 3.2 per cent.
If one takes a ten-year horizon, then one will realize the mediocre contribution of the first quarter of 2010 to the Malaysian economy compared to other years. Take an even longer view and January, February and March of 2010 become insignificant points.
The reason for its insignificance is that base effect is temporary.
This story is repeatable in other Asian countries badly affected by the recession. Singapore suffered 11.5 per cent contraction in the first quarter of 2009. In the first quarter of 2010, it registered 15.5 per cent growth. Taiwan contracted 10.2 per cent. It grew 13.2 per cent later. These are extraordinary numbers caused by extraordinary circumstances, not by extraordinary government.
The story of able administrators becomes weaker and weaker as more and more countries with high trade intensity — which Malaysia is one of — exhibit the same pattern of growth. There must be a reason why multiple countries that share similar characteristic with Malaysia are showing great growth.
That reason is base effect. It comfortably explains the phenomenon to a large degree.
Are you still unconvinced about the centrality of base effect?
Take Thailand. Despite all of its troubles, it is expected to achieve stellar growth of 8.9 per cent in the first quarter. It contracted 7.1 per cent a year earlier. It is hard to believe that the growth in Thailand was due to good economic management by the government. Base effect is able to explain it rather well.
Supporters and proponent of fiscal stimulus maybe unconvinced by the base effect argument. They may insist on multiplier effect from two previous stimulus packages. Unfortunately for them, increased trade dominates the celebrated statistics of the first quarter. This increased trade drives the base effect.
And what about the multiplier from trade? Surely, the benefits of trade spill to other sector of the economy.
If somebody or something deserves to take credit for exciting the economy, it is world trade. It is consumers of the world. It is not the government or the fiscal stimulus.
Lastly, the second and third quarter of 2009 registered lower levels of GDP compared to the respective quarters a year earlier for Malaysia. That means the base effect will likely disappear only in the fourth quarter of 2010. Opportunity for spectacular growth will diminish soon enough.
For his administration claim credit — or for somebody to credit the administration — for the performance of the economy, before the base effect peters out, especially as early as the first quarter, is premature.
First published in The Malaysian Insider on May 24 2010.
This model provides an example of an economy where real shocks drive output movements. Because the economy is Walrasian, the movements are the optimal responses to the shocks. Thus, contrary to the conventional wisdom about macroeconomic fluctuations, here fluctuations do not reflect any market failures, and government interventions to mitigate them can only reduce welfare. In short, the implication of real-business-cycle models, in their strongest form, is that observed aggregate output movements represent the time-varying Pareto optimum. [Real-Business-Cycle Theory. Advanced Macroeconomics. David Romer. 2006]