Tag: stimulus

President-elect Barack Obama promises greater government spending to ward off the ongoing economic crisis in the United States. More than 1,000 miles to the southwest of the Aleutian Islands, the Japanese government proposes its largest ever budget. In it, Prime Minister Taro Aro incorporates record breaking government spending to ease the faltering Japanese economy. On the Asian mainland, China prepares to spend close to US$600 billion on public works to prevent its economy from cooling too fast.

These countries are important export destinations for Malaysian goods. In 2007, the US, Japan and China were the first, third and fourth most important export partners of Malaysia respectively. Combined, approximately 35.1% of Malaysian goods went directly to these three countries. This does not include items which find its way to third-party countries before reaching the three countries.

In discussing the global economic downturn, it is fashionable to cite the interconnectedness of the world where recession is contagious. Reduced economic activities in some foreign countries, especially in these three countries, adversely affects demand for Malaysian goods. In fact, Malaysian exports have been negatively impacted. As the cliché goes, when the US sneezes, the world catches cold. Malaysia, as proven, is no exception.

Less discussed is the reverse relationship, which is also true. Improved economic conditions of the major consumers of Malaysian goods will encourage exports. This realization is yet another important argument against greater government spending as fiscal stimulus in Malaysia.

It is important because the slowdown of the Malaysian economy is likely principally caused by the softening of external demand. The Malaysian economy only began to take a hit when the health of our trading partners went down south. With exports contributing to almost half of our gross domestic product, it is hard to imagine how the Malaysian economy could escape unscathed. Nevertheless, our internal demand remains resilient, as proven by the local retail and the automotive sector. Therefore, the problem plaguing our economy as with many export-oriented countries revolves around external factors and not domestic demand.

As much as I hate to say this, government spending may help in cushioning the impact of reduced exports in Malaysia. Given the current condition of the Malaysian fiscal deficit as well as the inherent policy lag of government spending as fiscal stimulus though, it may not be the best path to tread on. I continue to prefer long term tax cuts and tweaking the monetary policy as the way forward over government spending. The effects from these two policies could be felt relatively quicker than increased government spending. More importantly, it avoids the long term repercussions of Keynesianism, or, in all likelihoods, half-hearted countercyclical policies.

The Malaysian context notwithstanding, government spending may help the economy of China, Japan and the US. While these countries would suffer the side-effects of government spending as fiscal stimulus, they could experience shallower downturn and quicker recovery. This could prove to be beneficial to Malaysia.

This is where government spending of the three countries, the importance of the three countries to Malaysian exports and the cause of weakening Malaysian economic growth converge to petition against greater government spending as fiscal stimulus in Malaysia.

Malaysia could and should capitalize from increased government spending of its major exports trading partners while refraining from doing the same thing. It allows Malaysia to enjoy the benefits of the policy while evading the cost associated with the expensive solution. It circumvents the question of trade-off associated with greater government spending altogether.

Admittedly, this proposal is slightly guilty of free riding on others’ policies. Being a small economy compared to the three however, it is unlikely how a Malaysian policy to free ride would affect their policies. How can a matchbox toy car significantly affect a speeding prime mover is beyond the imagination of the sane. It is unlikely for these countries to complain about a Malaysian policy based on refrain and prudence.

The World Bank probably would not like this after issuing a statement to encourage governments all around the world to spend and spend till they drop. Ever since Paul Krugman won the Nobel Prize in economics not too long ago, almost everybody is a Keynesian nowadays.

Well, Keynesians love to flaunt the multiplier effect of government spending. What better time to test the magnitude of the multiplier effects other than right now? What better way to test the multiplier effect other than free riding?

This article was first published in The Malaysian Insider.

Pictures of resignation are all over the wall. It is a resignation among local policymakers that the government will spend amidst the current economic environment. The World Bank recently encouraged governments around the world to spend in order to cushion the impact of the economic slowdown while noting that East Asian economies will not suffer as badly as the rest of the world.

I, however, fear that this might cause panic spending by the government in its eagerness to re-read The General Theory. It is important to note that the expected downturn is primarily caused by the softening of external demand while the export component is almost as large as the Malaysian GDP. As reported earlier, exports for the month of October fell by 2.6 per cent on year-on-year basis. In absolute terms, it means a nominal drop of approximately RM1.4 billion.

The concurrent drop in imports is likely influenced by the drop in exports given that a considerable percentage of imported items are intermediate goods meant for the manufacturing of final goods for export. It is possible that the associated weakening of industrial output is also chiefly due to the trend of weakening external demand. What this means is that internal demand is holding largely steady amid the economic storm.

Proof of resilient internal demand is all around. The retail sector — supposedly the early warning sector of any trouble in internal demand — showed over 25 per cent growth in the third quarter compared to the same period a year ago. The sales of motor vehicles — yet another indicator of internal demand — also registered growth on year-on-year basis. Admittedly, this is likely to fall but as indicated in previous data, seasonal effects due to Eid ul-Adha, Christmas and New Year are likely to prevent any large decrease in growth in these sectors and, in general, internal demand.

Finally, the unemployment rate is still doing fine through it is reasonable to expect it will increase since the export sector is taking a bashing. Increase it might but I do not see how it would increase to an overly alarming rate.

This however is not to say that internal demand will be unaffected at all while the waves are rocking the ship. Not at all. On the contrary, this is to show that the cause of the problem revolves around external demand, not internal.

The differentiation between external and internal demand is important because before any action is taken, the problem needs to be identified first. To move forward without comprehending what is going on is simply a recipe for waste and possibly disaster.

Implication from the identification of the source of economic turbulence in the local economy may indicate the possible ineffectiveness of government spending as fiscal stimulus.

First of all, the emerging trend in the export component of the GDP is likely to continue into the future. How long the trend will persist is anybody’s guess but the magnitude in the drop in exports is likely to be beyond the capability of the government to match in terms of government spending.

In comparison, the 2.6 per cent year-on-year drop for the month of October 2008 is as large as 20 per cent of the RM7 billion fiscal stimulus announced earlier by the Finance Minister. That alone indicates that any serious fiscal stimulus would have to be much larger than the current RM7 billion, simply just to close the gap between the two scenarios of business-as-usual and reduced export. This has yet to even consider the spillover effect on internal demand due to reduced exports.

Consider also the fact that the budgeted government expenditure for 2009 is slightly over RM200 billion with fiscal deficit running at about RM30 billion. Any expansion of the fiscal stimulus will require the government to borrow more extensively. With the current level of fiscal deficit and the health of the global financial sector, any borrowing will come at a great cost.

If somehow the government manages to increase the size of the stimulus, a significantly enlarged government spending will only save the day unsatisfactorily when internal demand is not the issue. An enlarged government spending is likely to increase supply when demand is not there. The act of spending for the sake of spending itself is the path of waste.

How is it wasteful?

During the Great Depression in the 1930s in the United States, in the name of increasing government spending as recommended by the School of early Keynesianism, it was not unusual for anybody to witness a perfectly fine stretch of road being undone and reconstructed.

Already in the RM7 billion fiscal stimulus, RM2.1 billion of the money is being earmarked for refurbishment of police stations, army camps, government quarters, repair of roads, construction of community halls, small bridges and preservation of public amenities, on top of existing budgeted expenditure for the same purpose. Needless to say, the suspicion of this being the act of spending for the sake of spending is there.

Spending for the sake of spending alone could be the sign of panic spending as policymakers come to their wit’s end.

Wit’s end or not though, government spending is not the only option available on the table. Permanent tax cuts have the potential of improving internal demand. Moreover, unlike in the United States and the European Union, Malaysia still has room to maneuver with respect to its monetary policy. With lower interest rates, Malaysia could effectively address its falling exports by indirectly weakening the ringgit.

Others come in form of discouraging savings to encourage investment and spending. And just three weeks ago, economist John Taylor wrote in The Wall Street Journal of the need to have a permanent pervasive mechanism that predictably automatically reacts to changes in the economy. Admittedly, Taylor’s recommendation requires a slightly longer time to execute since it is a structural issue but the point is that the resignation to discretionary government spending is really an overly pessimistic stance to take. The policymakers clearly need a little dose of optimism and creativity to move forward.

Panic spending and other options notwithstanding, government spending does have a role to play in enhancing prosperity. It is important for the government to invest in public goods with a positive spillover effect which rarely attracts the interest of the private sector. Yet, forward-looking spending, or rather investment, in soft and hard infrastructures is not really something suitable for the purpose of fiscal stimulus which almost always concentrates on short-term solutions.

Such investments are supposed to be a continuous effort and not done at a moment’s notice which is typical of any fiscal stimulus with government spending as its pillar. Furthermore, we do not have to wait idle for an economic downturn before spending on among others the education system and communication infrastructures required for long-term growth. These expenditures need to be carefully thought through.

These kinds of carefully thought through investments which bring about returns in the future are the ones Malaysia needs. Government spending must be done with an eye for the future and not simply for the sake of spending.

Another factor which makes such spending unsuitable as fiscal stimulus is the length of time required to begin and complete them. There is a good chance that by the time that government expenditure on these items begins to positively affect the economy, the end of the downturn is already near and thus makes the spending irrelevant.

It is because of this, the need to hasten the effect of government spending in the economy will compel policymakers to divulge in instant gratification by spending on superficial items which could be initiated and completed with a snap of a finger. Spending on these items no doubt will smoothen out the trough but it is meaningless in building a brighter future.

What it does is instead to impose a burden on future generations. Not only will they have to bear the debt due to panic, their cost of borrowing will also be high.

In A Farewell to Alms by Gregory Clark, the author demonstrates how successful societies discount the future only by a small margin. The question is, how much do we discount our future?

This article was first published in The Malaysian Insider.