Ricardian equivalence – the _

I think the general consensus is that there will be a spending spree before the GST, which will be implemented on April 1. The idea is that a lot of consumers would expect price hikes of various degrees on or after April Fools’ Day. So, people would rush on to capitalize on current cheaper prices. This is much like how each time the government slashed petrol subsidies and hiked petrol prices previously, private vehicles would line up at the gas stations as consumers try to save the tiniest bits that they could.

I used to agree with that idea despite holding that the effects of GST would not be the same across all goods. A hike sounds likely for new homes but for some others, it does sound like a price reduction. In fact, I am unsure about a lot of stuff.

But in the end, it is expectations that affect current behavior and not actual future prices. The expectations might be wrong, but it will be wrong on the day consumers see the actual price, not before. So until then, expectations would still drive the spending spree. But of course, I am forming an expectation about people’s expectations, which can be problematic.

I am unsure about that spending spree now because I saw a piece of data from a survey at my workplace. I cannot reveal it because it is proprietary data. I would probably get into trouble for this (haha) but the result is quite different from my earlier expectation. I think all I can say is that more respondents expected to spend less instead of more before the GST!

The implications can be big. If you believe the consensus story, growth would be relatively strong in the first quarter and weak for the rest of the year. They spend first and spend less later.

Now, the survey result sounds like a straight up Ricardian equivalence, or at least close to it where consumers save to fund their near future spending (Ricardian is actually more than this but the saving story is similar). So, if the survey is right, there will be no spike in spending this quarter. Maybe even a slump.

There is strong expectation that fuel prices will increase after the expected upcoming general election and the impetus for such expectation is clear. The Malaysian government’s no-hike guarantee lapsed as 2007 regressed into history while crude oil prices have increased significantly since the last hike took place.^[1] Meanwhile, prices hike is a very unpopular move^[2] and it can be disastrous for any incumbent facing an election. While the reasoning does make sense, it somehow reminds me of the Ricardian equivalence. Indeed, I am inclined to say that given strong expectation of a hike, it does not matter when the hike will take place. In other words, assuming rational individuals with perfect information, fuel prices hike is irrelevant to the result of the expected Malaysian election.

First of all, while I mentioned Ricardian equivalence, the economic theory has only a hint of relevance to the issue at hand. I will not go into the theory in great detail but somewhere along its rationale, the concept suggests that it does not matter when the state raises funds through one-time taxation or debt.^[3] The effect will be the same with only one exception: timing difference. This is because individuals accommodate their expectation and shape their behavior accordingly. In either case, between raising debt or rising tax, individuals changes their saving and spending levels to make their lives less painful especially given the eventuality of taxation in the scenario. This is where the concept influences my thought on how fuel prices hike affects Malaysian election.

Honestly, if people greatly suspect that fuel prices hike will follow the election in the tradition of fatalism, assuming the incumbent stays in power, does it matter when the hike will occur?

There is a speeding train running on an unfinished track leading to a horrifying large canyon with no chance of halting the train. You know that the train will be at the bottom of the canyon within the next few minutes. Assuming you actually care for self-preservation, does it matter when you should jump off the train as long as you do not end up at the bottom of the gorge with your face rearranged?

The nature of fatalism is that it is unavoidable and one might as well accept it. Through interaction with a lot of people, I have the perception that they embrace fatalism as far as the fuel prices hike is concerned. There is a clear resignation that nothing could be done about it among them. I have to admit though that I am one of those fatalists and actually support a hike. In fact, I advocate taxation along with floating prices arrangement but that is another issue altogether.

Alas, not all of us are privy to complete information regarding the hike. On top of that, not all of us are a fatalist, either by ignorance or special knowledge. In an imperfect world unfortunately, fuel prices hike will affect the election to a certain degree.

While the conclusion may look like mere mental masturbation and irrelevant to the real world, it does inform policymakers, or rather, the incumbents on how to manage the general public expectation to the incumbents’ benefit, given belief in fatalism and imperfect information. I will share some thought on the matter later.

Mohd Hafiz Noor Shams. Some rights reserved

^[1] — KUALA LUMPUR, Nov 5 (Bernama) — The government has reiterated several times that there would be no increase in the price of oil or gas products for the year 2007.

But the reprieve is expected not to last long as we enter the new year and as global fuel prices continued to surge.

Oil prices added nearly US$12 a barrel since the start of October and reached US$93.80 (about RM313) a barrel last Monday (Oct 30) and US$96.24 (about RM321) on Nov 1. Some reports have also mentioned that oil prices could break the US$100 mark if risk factors influencing the sharp rise are to continue. [Bracing For Another Price Hike For Fuel Products. Bernama. Extracted November 5 2007]

^[2] — As expected, Malaysians reacted with shock, frustration and anger to having to pay 30 sen more for every litre of petrol and diesel.

Unexpected was the ferocity of sentiment on the ground a day after the biggest single petrol price hike. The common man, already feeling the pinch of the rising cost of living, spewed a litany of complaints and grouses. Consumer groups and trade unions warned the fuel price hike would set off a chain reaction across the board. [Price hike pain for RM4.4b gain. New Straits Times. March 1 2006]

^[3] — See Wikipedia for more on Ricardian equivalence.