Monday, October 19, 2009

Random Thoughts on Budget 2010

I'll be honest - I've never been good at reading the tea leaves when it comes to the budget, except in aggregate. Micro-level policy has never been my strong suit, and I'm far more comfortable diagnosing monetary policy and real indicators. Having said that, given the crossroads that Malaysia is at, it's such an interesting period to be an economics observer (or voyeur if you prefer), that I really can't pass this up. Be warned, this is going to somewhat of a stream-of-conciousness post, with no real point to make!

My macro-view of the economy has evolved, but not changed significantly in the last six months. I think the stimulus packages were on balance necessary and useful, if only to turn around consumer and business confidence rather than any real effects they may have on the economy. I suppose it'd be nice to have the morale boost without the financial outlay, but I'm not sure people (including politicians themselves) would accept that, especially in the heat of the crisis. The national debt is climbing rapidly, but not to any serious level as yet, and certainly well below any point where borrowing costs or domestic liquidity becomes a problem.

Real indicators are generally all creeping up, Aug/Sept slowdowns notwithstanding. As I've talked about before, this is a factor of Ramadhan/Eid el Fitri artificially crimping output. I've already recorded that the economy has already passed the recession stage and (because of the eccentricities of Malaysian statistical computations) we should see official confirmation next month when the 3Q figures are scheduled to be released. I'm still concerned that this recovery may turn out to be inventory-driven which may see us slowing again in the next couple of quarters, but I'd say a "W"-shaped recovery isn't a high probability at this stage.

So it's time to deal with the structural headwinds besetting the Malaysian economy, where fiscal policy is best effective (or least damaging, depending on your philosophical viewpoint). What are the key problems? In no particular order...

1. Caught in a middle income trap
2. Youth unemployment
3. Poor R&D spending
4. Quality education
5. Affordable healthcare and housing
6. Ineffective transport (and auto) policy
7. Subsidy mentality
8. Income inequality
9. Low-value added manufacturing
10. Declining oil reserves (and thus future oil revenues)
11. Narrow tax base

...and the list goes on. I'm sure I've left quite a few biggies off.

There's no way the government (or any government) will make headway in all these areas in one year, or even during the 5-year period of our development plans.

One key thing I am happy with is the shift to a services-based growth strategy. I've been talking about this as the way to go since around 2005, when it became obvious that export-led manufacturing had reached a dead-end - despite a global trade boom, Malaysian electronics exports flat-lined from that point on. A services-based strategy would be the logical evolution of the economy, one which other high income countries have already undergone. Because the labour market would be less affected by international arbitrage, incomes should rise independently of productivity as labour demand in the services sector rises. This shift should also help to resolve some of the problems in the list above, and incidentally put upward pressure on the exchange rate.

I remember reading Morgan Stanley's Global Economic Forum (good for a quick, intelligent view of economic happenings around the world - Stephen Roach was the Guru for me) back in 2005-2006, that Malaysia should explicitly follow a dual-track, hybrid strategy - both export-led manufacturing as well as export commodities-based. Thailand was put up as a good example to follow. I think that's a step sideways more than anything - you're depending on a lack of correlation between the two sectors to maintain domestic economic activity.

Still, that was a few years lost in getting a leg up the income ladder. One of the problems (of many) with a centrally directed strategy is that bureaucrats will tend to stick with a particular solution, even when it's obviously not working (like investment quotas). In this case, I'm wondering if we've left it too late. The increasing adoption of the internet as a business tool means that costs of communications has dropped rapidly, which reduces some of the barriers that hitherto have isolated domestic services sectors from foreign competition.

Oh, there certainly continues to be high barriers to labour mobility, especially in high-income professional services (lawyers) and in low-income services (think fast food), but for some things like shopping, the market is truly international. That complicates and makes more difficult gains from a services-based growth strategy, which depends in large part on restricted market access and labour market immobility.

Having said that, the alternatives are unpalatable - commodities are inherently volatile, even if it has supplemented export incomes in the last four years. High value-added domestic manufacturing isn't likely to take hold, unless we do something really drastic with our truly pathetic private and public R&D spending and poor corporate-academic cooperation.

So what do I expect from the 2010 Budget? Forget any bones for the consumer - adult unemployment has barely ticked up, real wages have continued to rise (except in manufacturing), and consumer spending is up. I don't think we will see any progress in implementing GST either, especially with the political bugbear of potentially higher prices. Civil service wages should continue to go up, although Cuepacs is whistling in the wind if they think they can get two months bonus. The boost in wages is necessary, to push up incomes especially for some of the lower paid civil servants as well as reduce the temptation towards venal corruption.

While I think the government will try to keep operational expenditure below expected revenue, that's a tough job in the present state of the economy. I don't think revenues will drop as much as people expect, but the operational budget should still be in the red. Which means after tacking on the development budget, we're still looking at a substantial fiscal deficit, I'm thinking in the range of 4%-5% of GDP. Whatever the planned figure however, I do expect actual 2010 expenditure to come in at a more palatable ratio, if revenues come in higher as I expect.

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