Category: Economics

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Economics Education Society

[2931] If affirmative action is to end in Malaysia, spending on public service has to increase

Discussions on affirmative action in Malaysia have never gone away but interest in it has increased in recent weeks. The first exciting interest in the topic was Hwok-Aun Lee’s book Affirmative Action in Malaysia and South Africa: Preference for Parity. I have not got my hands on the book (I hope to buy it soon), but I listened in to one of Lee’s webinar on the book and the subject earlier this year. Most recently, is Nazir Razak stating the New Economic Policy—Malaysia’s affirmative action—no longer works.

My thinking of affirmative action has softened over the year. Softened in the sense that while in the past I think I could be labeled as anti-NEP, I have adopted a show-me-the-result position. In fact, I have concluded there has to be a balance between economic and social imperatives. As a relevant side note, I am writing a book (a never-ending project) and in a segment of it, I outlined why I thought NEP might have a role in created a shared identity in Malaysia (perhaps Bangsa Malaysia as a shorthand for this) for a short while in the 1990s. It was a decade or two-long process coupled with rapid industrialization and globalization, that was unraveled during the late-1990s Asian Financial Crisis and later, China’s entrance into the global marketplace. My current thinking is that, though NEP-styled affirmative action worked in the 1970s and the 1980s (dare I say the 1990s despite its official expiry?) situation in the 2020s have changed dramatically that the way Malaysia does it affirmative action need to be rethought. It requires a rethinking because NEP did not work in isolation during the years and the factors (high growth and absence of China) that made NEP work are no longer present today.

Last week, I somehow got pulled into a Clubhouse discussion about NEP where Nazir Razak stood on a soapbox. Near the end, riding on an acquittance’s train of thought, if I remember correctly, Malaysia needs to invest in its public services more. I would like to clarify and expand that idea further.

If affirmative action is to end, then I think it is imperative that public service be expanded further. This is not to say the public service expansion and affirmative action are mutually exclusive. But it is probably good to understand that most beneficiaries of affirmative action probably rely on public service more than others. Removing affirmative action would likely require expansion in other parts of government in order to maintain the beneficiaries’ general welfare.

Here, the maintenance of general welfare is importance for social stability, which in turn is crucial to creating the environment for long-term economic growth, which itself is important to the maintenance of welfare. It is a loop.

By public service, I refer specifically to public education and public health system. By expansion, I mean by making it more accessible cheaply at a higher quality and while this may sound fluffy, I think the best proxy to this is government spending in these areas.

And Malaysia lags in terms of public spending in these two areas when compared to other countries. I have written a short advocacy paper on this matter under REFSA earlier and you can access it here.

A brief look at the World Bank database containing data from most countries will show that Malaysia is a middling when it comes to government spending in education relative to its GDP, while under-spends in public health services.

Malaysia’s government spending on education and health relative to nominal GDP

Malaysia’s 2018 government spending on health was 1.9% of GDP and this compares badly with upper-middle income countries’ average of 3.2%.[1] Malaysia does better in public education, spending 4.7% of GDP in 2017, versus upper-middle income average of 4.1% in the same year (year 2017 and 2018 are chosen because those are the latest year available for year-to-year comparison between Malaysia and upper-middle income average).[2]

So, if ever affirmative action, or NEP in whatever form it persists now, is to be dismantled, I feel is it crucial to boost public spending in government services. Boost spending alone, of course, is not enough. How you spend it matters too.

Hafiz Noor Shams. Some rights reserved

[1] — Domestic general government health expenditure (% of GDP). Open Data. World Bank. Accessed April 7 2021.
[2] — Government expenditure on education, total (% of GDP). Open Data. World Bank. Accessed April 7 2021.

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Economics Society

[2930] The biggest losers in this recession: the young

All recessions have its losers and to claim so is to state the obvious. It is more interesting to know who the losers are. Data from the Department of Statistics shows that the biggest losers in this recession are the young.

From the chart below, it is quite clear the job market for 35 years old and younger is doing badly relative to the market for older cohorts:

The chart is drawn by comparing total employment by age for each quarter relative to a pre-pandemic benchmark. In this case the benchmark is the final quarter of 2019, the last quarter before the pandemic. To illustrate:

  • there were 31,800 fewer employed persons among 15-24 years olds in the first quarter of 2020, relative to the last quarter of 2019
  • there were 202,600 fewer employed persons among 15-24 years olds in the second quarter of 2020, relative to the last quarter of 2019

So, if the number goes down, then it is bad because it shows fewer people are employed relative to the benchmark. If the number goes up, then it is good because it shows more people employed.

The data is from the Quarterly Report of Labour Force Survey. The 2020 fourth quarter report, which is the latest report, was released on February 8 2020.

Increased underemployment among younger cohorts

The change in total employment does not indicate change in employment quality. Here, I am referring to underemployment. Once again, the young are the most badly affected:Unlike in the first chart, an increase here suggests more people working less than 30 hours per week, which could be considered as a definition of underemployment (there are other underemployment definitions). They work less than 30 hours because they are likely unable to work fulltime. Therefore, an increase in this chart points to a worsening situation.

This is relevant because a person is considered employed in official statistics if he or she works for at least an hour per week. As you can see, it is a loose definition. During normal times, it is alright to use it because it works. But the situation we are in are quite abnormal and it challenges our traditional definitions.

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Economics Society

[2927] M40 classification mischaracterizes the middle class, weakens the middle class and in doing so, weakens democracy in Malaysia

Who are members of the middle class in Malaysia?

Theoretically, they consist of those in the middle income distribution. The middle class is a relative position between the poor and the elites, however both are defined.

But it is not that simple. On Wikipedia alone, there are plenty of dimensions to be considered beyond income. Among the factors are education, nature of employment, social status and even as fluffy a factor as lifestyle. Wealth is another marker, which is related to income but perhaps better except its data is not as easy to get.

In Malaysia, perhaps for over 10 years now, we have chosen a specific way to define it. We do it through income distribution. We have the bottom 40 percentile households in terms of income distribution defined as the poor (the B40), the next 40 percentile households are understood as the middle class (the M40), and the top 20% household income earners are taken as the rich (T20).

The classification is needed to operationalize certain policies like conditional cash transfer that Malaysia has. Household income, whatever its weakness, is an easy proxy of status. It is needed for targeting purposes. You lose something, but it does the job. Arbitrary, but convenient and it works.

Our problem is that the same convenient arbitrary classification that works is beginning to have an unintended negative effect on social discourse. Familiar to the definitions used by the government for implementation convenience, the public is beginning to associate the M40 as the middle class, and the middle class as M40, when in fact, there are middle class people falling outside of the M40 group. Additionally, there are people inside the M40 who are not really members of the middle class. The shorthand of B40-M40-T20 is dividing the middle class crudely and consider some members of the middle class as members of the elites.

It creates a class war against the middle class just through misattribution arising from arbitary statistical definition.

The middle class is special because they are largely the flagbearers of progressive values. With such values, they function as a check-and-balance mechanism in any society. Members of the middle class are not poor and that allows them to spend more time on matters other than livelihood issues. Things like corruption, environment or something that is well above something that is similar to the bottom of Maslow’s hierarchy of needs. At the same time, they individually are not rich enough to have outsized influence on society like few elites. Yet collectively, they check the power of the elites thanks to their education level. They are the bulwark preventing the elites from abusing power. They are the ones crucial in keeping a democracy from becoming crass majoritarianism.

When members of the middle class are considered as elites, middle class values would be condemned as elitist. Once identified as so, the same values would be rejected by the majority because they feel the values are meant for the few.

This is the danger of the M40 classification. The misattribution makes the middle class alien to the poor as the elites are, but without having the same influence the elites have. This weakens the roles of the middle class in protecting democracy from abuse by the elites, and from majoritarian excesses.

That is one of the costs of the B40-M40-T20 classification. It breaks the middle class, and then artificially and implicitly labels middle class values as elitist. With that, the roles of the middle class as the moderating force in our society gets weakened.

In short, the M40 classification mischaracterizes the middle class, and weakens the middle class’s role in moderating Malaysian democracy.

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Economics

[2924] Would a rule-based progressive corporate income tax be better than an arbitary windfall tax?

I would think yes. A long answer follows:

Malaysian glovemakers have reaped quite a fortune from the Covid-19 pandemic. Top Glove’s 2020 financial year net profit soared to nearly RM2 billion from RM400 million the year before (approximately 5 times higher). It is not the only one striking gold. Another large glovemaker Hartalega had its half-year net profit for 2020 rising close to RM800 million compared to slightly below RM200 million in the same period last year (about 4 times higher).

The extraordinary profit has made windfall tax a popular notion among some crowd. Member of Parliament Syed Saddiq Syed Abdul Rahman and his party MUDA are lobbying the government to impose windfall tax on Top Glove and other glovemakers.

Top Glove paid nearly RM400 million worth of tax in the 2020 full financial year. For Hartalega, they paid almost RM200 million out of their half-year revenue. A proper windfall tax could easily double that. That is a lot of JASAs that could be funded.

Windfall tax is arbitary and carries corruption risk

I am not all too comfortable with windfall tax. The problem is its arbitrariness and with arbitariness, corruption risk. At the very least, its arbitrary nature creates room for negotiation between businesses under the microscope and the authority exerting the tax. The bigger the business, the stronger the concern for corruption is.

Rule-based approach addresses corruption risk

Assuming we are merely interested in getting that additional revenue only, I think there is a better way to do so. We can possibly design a rule-based approach mimicking windfall tax. That is progressive corporate income tax.

In search of a mimic

Currently, the Malaysian corporate income tax is flat, with rate imposed at 24%. (Well, it is not that simple. Our corporate income tax is somewhat progressive, but only for SMEs. SMEs pay 17% income tax on the first half a million of net income, and then 24% for any profit above that. Yes, two brackets.)

There are some debates on why corporate income tax is flat and not progressive. I will not be going there and it is a whole other debate to be had.

But strictly from tax collection perspective and for the purpose of finding a mirror policy, I would think progressive corporate income tax would be better than an arbitrary windfall tax. Better in the sense that it mirrors windfall tax collection while minimizing corruption risk.

The challenge is to finding such a mimic is this: how could we generalize the brackets and the tax rates so that it could capture supernormal profit across industries fairly, while not punishing the others?

That is a difficult question to answer because each company or sector has its own typical profit level. For instance, a supernormal profit level as currently enjoyed by glovemakers are terrible figures for giants like Petronas during normal times.

In any case, theoretically, a progressive corporate income tax mimicking windfall tax would have a J-curve (or even an L-curve): mostly flat rates for most income brackets, but rises dramatically for supernormal bracket.

Hybrid?

Alternatively, we could add an if-then function to the corporate income tax code: if your yearly net profit is above a certain level and it grows by more than 400% (or some superprofit benchmark) compared to the previous year, then you would face a tax rate higher than 24%. This would be a hybrid between progressive corporate income tax and a windfall tax, and it would still be rule-based.

Categories
Economics

[2923] Watch out for the current balance in Budget 2021

The fiscal balance gets a lot of attention from the press on Budget Day. It is usually in deficit (it has been so since the 1990s) and the theme has always been fiscal consolidation. Even when Pakatan Harapan was in power, reassessed the government’s fiscal goal and raised its 2018 fiscal deficit from a projected 2.8% of GDP to 3.7%, the consolidation narrative was intact and bought by credit rating agencies.

This time the fiscal deficit will be much larger. Understandably so given the current economic condition brought by extraordinary circumstances. I would think any mention of fiscal consolidation would be inappropiate.

But the more important figure this time around would likely be a different kind of balance: the current balance.

Definitions

For the uninitiated:

  1. Fiscal balance is the product of all of government revenue subtracted from all of government expenditure. Here, total expenditure is the sum of operating and development expenditures.
  2. Current balance is all of government revenue minus only the operating expenditure.

By definition, operating expenditure involves the day-to-day running of government, like paying wages, interest payment, grants, subsidies and various supplies and services. Development expenditure involves investment into some kind of long-term assets.

There is a logic behind the division between the two expenditures (although it is being increasingly questioned in the past year). As the reasoning goes, the government’s daily operating concerns should be fully funded by the government revenue. This prevents the government from borrowing for non-capacity improving purposes.

Accounting and law, but not economics

But it feels the distinction between the two expenditures is blurry because money is fungible. More than anything else, the distinction exists in concrete terms only because of accounting definitions operationalized by the law. In Malaysia, all borrowings (specifically MGS, GII and Treasuries as I understand it) must be used for the purpose of development expenditure. This is specified by the Loan (Local) Act 1959 and the Government Funding Act 1983. In the 1959 act, it is written so in Part II and in the 1983 act, Article 4. More precisely, any borrowing raised must be deposited into the government’s development fund, which is used for development expenditure, and not operational spending.

If that is wordy, the bottom line is this: the law demands that the current balance must never be in deficit.

Indeed, in the whole modern history of Malaysia, for the most parts, the government has maintained current surplus. The last time Malaysia had a current deficit was in 1987. See the following chart.

The thing with laws like this is, when it comes face to face with economic forces, the economics usually win. If the laws are to be followed down to the letters in this regard, the government would probably be forced to resort to some extraordinary measures.

Current deficit likely for 2020

For year 2020, regular revenue has been falling dramatically, while expenditure has likely gone up. The spending is not developmental in nature too. Things like wage subsidies sound more operational than developmental. As a result, it is likely for the government to face its first current deficit in more than 30 years and it should be big, if nothing is done.

Strict adherence to current balance restriction is one of the reasons why Malaysia is considered as having limited fiscal room to maneuver. Refer back to the chart and observe the small surplus since the late 2000s.

Change the law, loosen the artificial limit

The truth is, the restriction is artificial and it only exists because of the law and given the crisis we are facing, the law is counterproductive to the maintenance of our welfare and the health of the economy. The crisis that we are facing is just out of this world and traditional tools are inadequate to handle the situation well.

Here is a proposal: amend the Local (Loan) Act 1959, Government Funding Act 1983 and other relevant laws to allow for borrowing for operational spending. This will give the government greater flexibility, and more fiscal room to act.

Safeguards could be put in place if the restriction removal is too radical. For instance, we could demand the sum of 5 years’ worth of current balance must be in surplus. Such 5-year instead of yearly schedule could enable government finance to accommodate economic cycles better, and allow for more effective counter-cyclical spending.

Other current balance things to look out for

Finally, here are a set of things we should look out for when it comes to current balance:

  1. Extraordinary revenue measures. I probably mean something like extra dividend. The government has demanded and will be receiving an extra RM10 billion worth of dividend this year. Other entities we should look out for are the central bank and Khazanah. There are other entities with sizable reserves and money doing nothing that potentially could be given out as dividend to the government.
  2. Reclassification of spending. Despite the distinction between operating and development expenditure, the actual classification between the two can be fluffy. So, watch out for some operating expenditure being reclassified as development expenditure for accounting purposes. You know the joke about accountants. No? See the notes.[1]
  3. Off-budget spending done by companies owned by the Ministry of Finance Inc. Pakatan Harapan tried to rein in on this by making it more transparent and slowly bringing it into the book proper. The shift toward accrual accounting should make off-budget spending less controversial and irrelevant. But with this new government in place, progress toward accrual accounting is in doubt and commitment toward not using off-budget spending is likely non-existent.

Hafiz Noor Shams. Some rights reservedHafiz Noor Shams. Some rights reservedHafiz Noor Shams. Some rights reserved

[1] — For the fun of it:

A businessman was interviewing job applications for the position of manager of a large division. He quickly devised a test for choosing the most suitable candidate. He simply asked each applicant this question, “What is two plus two?”

The first interviewee was a journalist. His answer was, “22”.

The second was a social worker. She said, “I don’t know the answer but I’m very glad that we had the opportunity to discuss it.”

The third applicant was an engineer. He pulled out a slide rule and came up with an answer “somewhere between 3.999 and 4.001.”

Next came an attorney. He stated that “in the case of Jenkins vs. the Department of the Treasury, two plus two was proven to be four.”

Finally, the businessman interviewed an accountant. When he asked him what two plus two was, the accountant got up from his chair, went over to the door, closed it, came back and sat down. Leaning across the desk, he said in a low voice, “How much do you want it to be?”

He got the job.

Haha.