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Economics

[2905] Stimulus is about expectation setting too

There are criticisms that some of elements of the stimulus announced by former Prime Minister Mahathir Mohamad do not have immediate impacts, and so it should be replaced with more immediate responses. Responses like bigger cash transfer and bigger spending now. And the new Cabinet seems on course to enlarge the stimulus.

I am here to say, this stimulus needs to address several time horizons. The present as well as the near future. And this is why medium run elements are crucial.

One aspect why it is important is the need to encourage the hoarding of labor in order to minimize job losses. It is about building expectation justifying that hoarding.

I have a simple chart to explain how that is possible:

The chart shows the level of employed labor for 3 types of period. There are two lines signifying a stimulus without medium term expectation setting (blue) and a stimulus with one (red).

A stimulus without medium term expectation setting: companies faced with an negative economic shock will shed labor. This will increase the national unemployment rate. Increased unemployment will affect income negatively and that in turn will adversely affect consumption growth, and inevitably the GDP growth. Companies will shed labor because they do not have a clear view of the medium-term horizon and will optimize their labor size now given current situation.

In constrast, a stimulus with medium term expectation setting will provide these companies with clearer view of the medium-term. It tells them they will need the labor soon, but not now. So, rather than shedding labor, they would try to conserve it and in doing so, not reduce their capacity (by too much). In effect, it will help cushion the unemployment rate from rising as fast as it would under a stimulus without medium term expectation.

So in theory, a stimulus with medium term elements will shed fewer workers than a stimulus without.

Here is the thing: we can do both immediate and medium term elements in a stimulus. There is little reason to decide which one should come in and which one should go out. Both time horizons can be addressed. Both need to be addressed.

There is also another element in play to justify medium term plans: while we are facing both demand and supply disruptions, stimulus is not good at handling the latter. Pumping more money will not solve the supply-side. This gap can be addressed by expectations.

Categories
Economics

[2904] Reintroducing GST now means austerity

Is this the right time to reintroduce the GST?

No.

It is definitely the wrong time to reintroduce the GST at the previous rate of 6%.

Why is it the wrong time?

Because in time when economic growth is dropping off the cliff, having GST at 6% is essentially having an austerity program. It will exacerbate the situation. If you are worried about government finance, remember, government finance is not the economy. Do not forget that.

Why is it an austerity?

The current SST level is approximately equivalent to 4% of GST. Possibly slightly higher than 4% as the new SST has been improved to cover new items. Having GST at 6% is effectively a tax hike from the status quo.

And a tax hike in time of economic slowdown will make the downturn worse. A tax hike is austerity.

How about GST at 4%?

No. Just do not mess with it at this time. There will be an appropriate time to do so. Do not be so noob about it.

Categories
Economics

[2903] The 2015 revenue diversification was not due to GST per se

Because this entry is long, I will say it upfront: the diversification of 2015-2018 at its core was due to:

  1. Collapse in crude oil price, with Brent dropping from around $110 per barrel in early 2015 to about $40 per barrel by late December 2015. Half of the reduction in petroleum share of government revenue was due to the drop in petroleum prices, not GST.
  2. Higher taxes. The other half was due to higher taxes that came in the form of GST. Here, it is crucial to understand the difference between GST as a taxation system and the rates imposed. It is not GST per se that helped with the diversification. It was the higher tax rate. Indeed, the same could be imposed with SST with changes in tax rates.

Now…

The TL;DR version

Now that crude oil prices have collapsed, there are growing public concerns over the state of government revenue and louder talks for revenue diversification. Some groups have blamed the state that the government finds itself in now on the abolition of the GST.

They cite the 2015-2018 revenue diversification trend when the GST was in force, and the increased petroleum revenue share in 2018-2019 when the GST was no longer in place, as proofs that GST helped with diversification. And from there, their policy recommendation is clear: bring the GST back.

But such blaming and policy recommendation are simplistic. They breeze through the logic behind it without close inspection, and ending up misreading history and the factors at play. Needless to say, the policy recommendation problematic, at least it is made without eyes wide open.

Their logic is largely driven by reading the following chart while ignoring all the context:

A simple reading with GST firmly in mind (GST was introduced in 2015 to replace SST) would suggest GST was entirely responsible for the government’s reduced reliance on petroleum income, hence diversification of income. This is indeed the claim made.

But there were more than GST at play and the full context needs to be assess properly instead of being lazily stated via tweets.

Let us go through these two items in greater detail.

1: Falling share of petroleum income was due to fall crude oil prices

The first thing we need to realize is that the so-called diversification achieved in 2015 was in large part due to the drastic collapse of crude oil prices.

The best way to prove this is to go back to the 2015 Budget that provided a clearer picture how GST was supposed to diversify government revenue:

To do this, we need a 2-step comparison.

First, we need to compare the actual 2014 revenue share versus the budgeted 2015 revenue share to truly understand how much GST (we deal with the per se rationale in the next section) was planned to contribute to diversification. One as to remember that the 2015 Budget and all of its documents were prepared and released before the crude oil price dropped in a spectacular fashion by more than halving in less than 10 months.

Second, we need to compare the budgeted 2015 revenue share versus the 2015 actual revenue share. This will allow us to see how much of the diversification was due to collapse in crude oil prices, instead of GST per se.

To make it clearly, below is the items that need to be compared:

  1. Actual 2014 revenue share
  2. Budgeted 2015 revenue share
  3. Actual 2015 revenue share

First comparison. Judging from difference between actual 2014 revenue share and the 2015 budgeted figures, the plan was to diversify away from petroleum revenue by 4.3 percentage points (30.0% minus 25.7%). But remember, the collapse of crude oil prices had not been accounted for the 2015 budget. The assumed average Brent crude oil prices for 2015 made by the Najib administration was $105 per barrel, a start difference from the actual average price of $53 per barrel.

Second comparison. The drastic drop in petroleum prices put the 2015 Budget out of whack. So, instead contributing 25.7% of total government revenue, petroleum income share went down to 21.5% instead. (BN supporters had wrongfully claimed that the reduction of petroleum contribution from 30.0% to 21.5% had all been due to GST.) But as you can see, about half of that reduction was due to petroleum price collapse and nothing to do with GST. Meanwhile, SST/GST share grew above projection only because petroleum revenue fell. To double down on the argument, the 2015 actual total government revenue fell to 0.7%. That was how much petroleum was important to the government, even with GST in place.

The point here is that, collapse in petroleum price had a bigger role that many GST proponents cared to admit. In fact, many denied it altogether.

The oil prices slowly improved over the years, and you could see this in the increase in petroleum share in 2017 relative to 2016.

2: Higher tax, not GST per se, helped diversification

Now that we have determined that half of the reduction of petroleum contribution to government revenue from 2014 to 2015 was due to the collapsing petroleum prices instead of anything to do GST, we now can move on to the second point. That is, it was higher tax rate that helped the diversification, not GST per se.

This is a corollary from the old fact that we know and released by the previous government. That is, 4% of GST was equivalent to the current level of SST. With the GST introduced at 6%, this suggests that there was an effective 2 percentage points increase in consumption tax rate. It does not matter what form the tax hike came in, but the switch from SST and GST involved a tax hike worth 2 percentage point.

Indeed, the same increase in indirect tax revenue could be achieved with a hike in SST rates. There is always an equivalence between SST and GST.

Conclusion

So as you can see, stripped down to the very components of the revenue diversification of 2015, it was not the GST per se that contributed to it. Half of the diversification was purely due to collapse on petroleum prices and the rest very likely due to tax hike, and not the GST itself.

And this before accounting for refunds that were unpaid, which points to the fact that the GST net collection was lower than whatever reported under the cash-basis format that the government used.

Before I end, I would like state that I am pro-GST. I made this clear when reviewing Pakatan Harapan’s 2018 manifesto. And in fact, to accommodate the anti-GST sentiment (really, anti-tax hike sentiment) I had proposed that the GST rate be reduced to 4% from 6%. But the abolition promise was hard to overturn, and it was the price to pay for institutional reforms Malaysia badly needed after years of abuse.

Categories
Economics

[2902] e-Tunai Rakyat under Stimulus 2020 is gravely flawed

For the most parts, the point of having a stimulus is to encourage spending, especially domestically. Someone’s spending is someone else’s income. This is a corollary to the necessacity of a stimulus being timely in order to be effective.

The Ministry of Finance under Lim Guan Eng has been working on all of the measures, but with the political maneuvering over the weekend, he did not get a chance to defend them. Near the end of the stimulus preparation sprint, the PMO had full control of the process though they had no real time to revamp anything, except by cancelling measures or quibbling with minor details. Some of the quibbling involved unenlightened changes to the e-Tunai Rakyat design.

The e-Tunai Rakyat in its current stimulus form as announced by the Prime Minister will like fail to meet any stimulus purpose. As revealed yesterday, cash transfer recipients under the Bantuan Sara Hidup or BSH would receive RM50 in the form of e-Tunai. Given the qualification, that means up to potentially 3.9 million people would receive the RM50.

Here is the qualification, based on the exact wording from the stimulus measure book:

30. In the spirit of shared prosperity, the Government will enhance BSH as follows:

i) bring forward BSH payment of RM200 scheduled by May 2020 to be paid in March 2020;
ii) additional one-off cash payment of RM100 will be made to all BSH recipients in May 2020; and
iii) a further RM50 will be subsequently channelled through e-tunai.

There is one big problem here: giving e-Tunai to BSH recipients would very likely result with little of that money being spent. The fact is many of BSH receipts who are largely members of the bottom 40% of Malaysians in terms of income do not own mobile devices capable of facilitating mobile and electronic transactions. Without such devices, there can be no transactions.

For a better policy design, we should look no farther than the first e-Tunai Rakyat program executed by the Finance Ministry in January 2020. That government program could benefit up to 15 million Malaysians aged 18 and above, who earned less than RM100,000 yearly. With the program ending in mid-March 2020, the current statistics have it that 6.9 million people have claimed the money. That translates into a use rate of 46% out of total eligible recipients after nearly 2 months of operation.

Remember, it reached 46% utilization, likely hitting 50% by the end of the program, because the money with an expiry date (policy innovation!) went to many whom use smartphones. If we limited it to a group that has very low smartphone penetration rate, that utilization rate will come down. Now, you can encourage the program among the low income groups, but this is not the right way.

Therefore, the stimulus form of e-Tunai Rakyat, mutilated as it is, with its smaller reach among the low-income demography would likely struggle to follow the same trajectory and success. It has been mistargeted to the point of irrelevance. This defeats the purpose of having e-Tunai Rakyat as a stimulus. It is a grave design flaw, making the program incapable of hitting any stimulus objective. It is not even a good signalling.

The solution to this: return to the original MOF design, or repurpose the money to something else.

Categories
Economics

[2901] We are incentivizing the wrong people to save

Who does not love big dividends that could be gained through low-risk instruments?

For many Malaysians capable of saving, either voluntarily or otherwise, low-risk investment with high returns of 5%-8% yearly or even more for some, is something that has been taken for granted. This is thanks to years of expectation settings made by a set of institutions the government has put in place to encourage saving.

So much so that in the case of Tabung Haji when the fund could not even pay its depositors high dividend anymore, the previous administration felt compelled to manipulate its accounts so that it could sustain its dividend level and avoid the political backlash from its base. In fact when ASB under PNB announced a reasonable dividend of 5.5% for 2019, enough Malaysians expressed unhappiness how that was unacceptably low and how that it would remove arbitrage opportunity that existed through low-cost borrowing to invest in higher yielding but low-risk investment, like those provided by PNB.

I for one believe the way and quantum these dividends are given need to change.

The reason: the state is encouraging the wrong people to save. Specifically, the existing system encourages those that do not need to save more to save further. This in turn places a downward bias on consumption growth and the size of funds available for productive investment (not the financial ones). I have a suspicion that if we stop encouraging the wrong (and rich) people to save, we could bump consumption growth and possibly funds for productive investment up, and boost economic activities on the ground. I am suggesting the economy could grow faster if we correct this flawed incentives.

What do I mean by encouraging the wrong people to save?

This is plain to see from the distribution of wealth in two big funds in Malaysia.

Based on the latest annual report from the EPF, that is the 2018 publication, the top 10% biggest depositors owned approximately half of all of EPF fund. And EPF is the biggest fund in Malaysia, and one of the biggest in the world.

It is worse in Tabung Haji. Based on data contained within the TH Recovery and Restructuring Working Plan document, about 1% of depositors owned half of the fund. A particular news report went on to cite that one depositor (likely the top depositor) had RM190 million saved in Tabung Haji. He or she could afford to live in Mecca luxuriously just on the Tabung Haji dividends alone!

With so much money, it is a no-brainer to put excess cash into these relatively high-returns low-risk funds. And dividend rates do spike up when it comes to election times previously, which indicates that the government do have a say in determining the dividend rate if it wants to through various means.

I am arguing that the high dividend for low-risk instruments is unhealthy to the wider economy. The relatively high-returns low-risk fund creates artificial incentive to save, which leads to excessive saving behavior by the rich. That artificial incentive to save translates into artificial disincentive to spend and invest in actual economic activities beyond financial instruments.

If we could rationalize and structure the dividend in a more reasonable way – such as reducing the dividend rate progressively the higher the size of savings is or capping the amount of savings at a reasonably high but not too high level – I think we can correct this, and unleash more money for spending by the rich, or encourage them to be more adventurous with their money by investing in real economic activities, like productive start-ups and new businesses, instead of things like the stale old and safe banking and other GLC stocks.

And after all, the financial-type people are complaining that Malaysian stocks are overpriced. Is it a wonder why that is so when the size of EPF funds is outgrowing the size of assets available for investment in Malaysia?

We could still encourage people to save. But let us incentivize the right people to save. My favorite way of doing so is to raise the dividend rate for the bottom and mid-savers, and progressively cut for the top ones (after passing beyond a certain level).