Category: Economics

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Economics

[2213] Of taking undue credit from the growth

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.

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 24 2010.

Categories
Economics

[2212] Of fluctuations and market failures

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]

Categories
Economics

[2204] Of beware the tragedy of economic populism

The story in Greece is a result of intertwining plots. One major plot concerns economic populism. It is a reminder that populist measures tend to ignore scarcity. It highlights that the policy of spend, spend and spend and then hoping someone else will take care of it, is risky.

With a brick wall up ahead, the Greek government is frantically trying to change its course. It plans to raise taxes, combat tax evasion and cut the salary as well as bonuses of its bloated civil services. Massive cuts are in order. It has to do this urgently because not only Greece is on a collision course, but also because the International Monetary Fund and European governments have told the Greek government that if the country expects others to save Greece, Greece has to be serious about saving itself.

The policy as demanded by the IMF and EU is harsh, but Greece would not have reached this juncture if it had not spent to please Greek voters with impunity. At so many points, there were so many opportunities for the Greek government to stop indulging in immediate gratification. There were so many chances to cease appealing to crass populism.

But no. They wanted to keep the voters happy. Political expediency was more important than responsible fiscal policy. To finance its spending, Greece even misreported its statistics. Oh, what was that about government as the guarantor of transparency in the markets?

It is all too late now. Only hard choices are on the table. The party is no more.

Greece is in so great a wreck that the possibility of bankruptcy is very real. Funny that even in times of great distress, certain fractions within the Greek society are protesting against plans to address structural fiscal deficit suffered by the Greek government. Shockingly, they want the clearly unsustainable status quo to remain.

The Greek Communist Party for instance staged a protest against the austere fiscal policy, which the IMF and the EU demand in exchange for bailing Greece out. Perhaps, it is unfair to single out the Communist Party in such a manner. The outrage in Greece appears to be one shared by many outside of the Communist Party. It is popular outrage after all.

That popular outrage is a little amusing. Where was the outrage when outrageous demands were made and met? It was this populism that brought Greece to where it is today. Due to that, there is some sadistic value to the whole episode.

The Greek government has shown political will to see through reform that the country needs so far. It has no choice. A capitulation to populism at this point will prove to be more costly than the cost austere fiscal measures. The fact that a left-leaning government — typically a leading proponent of government spending — has now become the leading proponent of the austere measures is telling. They finally realize that their freewheeling spending programs invite disasters. It invited disasters.

Greece is so far away from Malaysia but the story of populism is relevant. Perhaps, a comparison between Greece and Malaysia is an overkill, especially as the memory of the Asian Financial Crisis — which is more or less thirteen years old — fades. Yet, the pressure of populism is present in Malaysia. It is not hard to name these populist pressures.

Expansion of the civil service, demand for special treatments, pork-barreling during election times, opposition to subsidy removal, opposition to introduction of goods and services tax to replace existing sales and services tax, call to nationalize highways and effort to provide water free of charge are among many examples that will surely increase government expenditure without raising the necessary revenue to fund it.

In fact, at least three of the pressures that exist in Malaysia contributed to the Greek fiscal mess.

We are not done with 2010 yet but at the rate Malaysia is going, 2011 is likely to be the 14th consecutive year that the government is running a fiscal deficit. Clearly, Malaysia is suffering from a structural deficit. Needless to say, cyclical spending, which is largely unavoidable, exacerbates the situation.

The size of government in Malaysia is wildly big. Its scope is maddeningly wide. Its cost is incredibly huge. Malaysia needs to address this. This is why the story of Greece is a compulsory reading for all public office holders. Beware: populist measures will not address this concern, even up to the very end.

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 11 2010.

n/b — there are multiple grammatical problems at the TMI article. That is entirely my bad. I was rushing the article through. I know, I look stupid now.

Categories
Economics

[2200] Of proposed tax cut on savings interest in Australia

Holding all else constant, I do not like tax. I do not think, too many people actually like paying tax.

I only rationalize the need for paying tax by holding on to classical rationale for the need of the state: that there is externality. The state is there to protect individual liberty which, generally, cannot be guaranteed in anarchic environment. I say generally because I am still reading Nozick’s Anarchy, State and Utopia and he has some idea how that maybe false. Yes, I am still reading it. But I am digressing.

Like I have mentioned earlier, I do not like tax. And some taxes are worse than others. One of the worst that can exist is tax on savings in one form or another. In Australia, much to my dismay, savings is taxed. More precisely, they tax interest gained on savings.

Tax on savings has its purposes. For one, it encourages spending to promote economic activities. Or allegedly. Islamic economics for one has this goal imbued in it due to its objection to the concept of time value of money, a concept which necessarily brings in the concept of interest. Without interest, there are less reasons to save for tomorrow and more reasons to spend it all today. Tax on interest earned on savings does that albeit to a lesser degree.

Whether that purpose is good or bad is a normative question that cannot be answered with the end set. And I know my end and I frown at the end of taxation savings. In promoting the economy, it penalizes prudent spenders and it penalizes effort to smooth out consumption by savers.

I say allegedly because savings can be turned into loans and that encourage economic activities. There are ways to promote economic activities without penalizing savers. Indeed, that is how the banking sector helps grease the economy. Fractional banking is a magnificent social technology that takes care of that.

In Australia now, there is a big discussion regarding tax reform. Called the Henry tax review, the report was released just days ago. It aims to reform the Australian tax system. One way it seeks to support those reforms is by proposing a large tax on miners. That is dominating the headlines. There appears to be a war between the big miners and the Rudd government right now.

Meanwhile, many other details slip away from public attention. One of the details is the proposed cut on interest earned on savings.[1]

I like that particular proposed tax cut. Hell, I always like tax cut. I hate giving away money that I earned just like that.

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

[1] — The review proposes a 40 per cent discount on all income from savings, as well as on all residential rental income and losses, and capital gains.

These recommendations were widely flagged prior to yesterday’s announcement, with critics saying the current system doesn’t give enough incentives for workers to put money in savings accounts. [The Henry tax review – what it means for you. Chelsea Mes. News. April 15 2010]

Categories
Economics Liberty Society

[2192] Of embrace a more holistic view on development

There is much stress on economic freedom these days. This is clear by the fact that the New Economic Model is advocating less government in various aspects. So excited are the document authors about the idea of free market that at its rhetorical climax, they highlight the phrase ”market-friendly affirmative action”, never mind the apparent contradiction that the phrase invites. That phrase is perhaps the hallmark of contradiction of the document in terms of economic freedom. The latter part of the document suggests various government interventions that do not tally with its rhetoric. Yet, the document does begin from a liberal point and that is a good starting line. It has to begin somewhere after all.

Truthfully, the goal of the document is development and not the creation of freer market. Without strong conviction to the idea of free market in pursuing its main goal, contradiction is only natural. To criticize the authors of such contradiction is an effort unlikely to impress them and others who share the same view on development vis-à-vis free market.

They primarily believe that the government has a role in development. Such idea is hardly a controversial one. The government can indeed play a role in development even while adhering to the concepts of limited government and free market.

The issue is that the goal of development set by the New Economic Model is unsatisfactorily limited in its scope. The document limits the idea of development to merely economic progress. It ignores the larger meaning of development, just as freedom takes a larger meaning well beyond the realm of business and economics.

Development is not merely about better infrastructures or higher income levels for us all. While income levels do indicate general well-being in many ways, it is not the only factor in development that needs to be taken into account.

Development must empower individuals in a comprehensive manner. More often than not, this means enhancing economic progress as well promoting individual liberty. Indeed, economic progress and individual freedom work hand in hand. Without the other, each feels empty even if each lifts one up from the gutter by a tiny margin. Both are required to catalyze the jump out of the gutter.

Without development as confined within self-limiting definition of economic progress, individual freedom itself is redundant. Individuals living in dire economic condition will be unable to reap the dividend of liberty for they are incapable of understanding virtues of freedom. Without such comprehension, they are unable to make full use of it for their benefits. As the Malay idiom goes, what is a flower to a monkey?

There are so many elementary concerns need to tend to that whatever freedom they have is meaningless. It is the excess capacity that will never be used up. For instance, what is free speech when the stomach growls endlessly? In fact, free speech with an empty stomach can easily descend into anarchy as the hungry and famished knock rule of law essential to the preservation of liberty down to the ground to satisfy their very basic desire while robbing somebody else’s rights and liberty.

Similarly, where there is economic progress without individual liberty, what use of those shinny sedans or overly big four-wheel drives, clean and smooth roads together with tall and richly decorated towers when they are merely a posh prison to keep the prisoners happy? After all, what is economic wealth while one is repressed, living in fear?

They have the all the means but if the means are prevented from reaching the ends by traditions or prejudices, economic progress become meaningless. Life must be one cruel joke if economic progress in the end only comes to naught.

Individuals have to become richer not only in monetary terms but also in terms of themselves. The set of what can be done must be enlarged and the set of what cannot be done must shrink for development to take its holistic meaning. Choices have to expand.

Their choices have to be well informed. That is only possible through the tradition of free enquiry that embedded in it the concept of free speech and free press, among others. They must be able to express themselves and to do so is to practice freedom of expression. We talk about how young graduates lack communication and social skills in general: can we blame them when the avenues for practice are limited and guided paternalistically?

This idea is not new. Nobel Prize Laureate economist Amartya Sen is the vanguard of the idea. Although it must be said that he goes farther than a classical liberal would, he articulated similar view much earlier and wrote Development as Freedom for wider consumption.

Development must focus on both fronts for it to be meaningful. It is in this sense that the New Economic Model is insufficient. Malaysia needs more than economic freedom.

This is not to say that the authors of the document are not doing their jobs. Their terms of reference are clear: focus on the economic front. And they are doing just that. They cannot be blamed for that.

The other focus on the social front where it involves individual freedom is the job of ordinary citizens.

And the government is in the way. Hopefully, the Prime Minister and his Cabinet embraces the wider meaning of development to enable Malaysia to progress at all fronts. Hopefully, they will realize that only a liberal democratic system can bring Malaysia forward in a convincing style.

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 April 12 2010.