Budget 2012: Lim Guan Eng Has A Point

The Chief Minister of Penang wants the Budget’s handouts made permanent (excerpt):

Make one-off payments an annual affair, says Lim

GEORGE TOWN: Penang Chief Minister Lim Guan Eng has called on Prime Minister Datuk Seri Najib Tun Razak to make eight “one-off payments” in Budget 2012 an annual affair.

“This is an election Budget. The payments should be given yearly and not once in every five years,” he said…

…Lim said the Budget would result in a higher deficit as the Government's revenue collection would drop by more than RM1bil.

“It is impossible for the deficit to be reduced with dropping commodity prices and lower revenue collection,” he said.

If the intention was truly to reduce the burden of the people because of the higher price level, then unless you expect the price level to fall in absolute terms, these windfalls payments are just a band-aid. The main impetus for inflation – as it has been since 2008 – is in food and in oil & gas. Both item groups have solid fundamental grounds for being higher, with the development of China and India being a primary cause – rising oil intensity and changing diets among a collective population 2.5 billion will do that for you. This would have been true even if peak oil doesn’t happen.

So a one off payment should – if people are full rational (in an economic sense) – cause most of this windfall to be saved, not consumed. Inasmuch as the transfers are going to lower income groups with a higher propensity to consume and because people aren’t fully rational, some if it will be spent. But since nobody should seriously expect the price level to retreat i.e. full bore deflation, not just disinflation, then the transfers will only provide temporary support. And since the transfers come with an incentive to actually save, then transferring the funds from the government (who will spend it) to the people (who are less likely to spend it), will reduce total spending in the economy, and thus total incomes.

In that sense, the Chief Minister is correct, though I’m not sure from the way it’s written if Pakatan’s budget actually contemplates a permanent transfer. A permanent transfer means homo economicus would treat the windfall as permanent income, and spend based on his/her marginal propensity to consume. Still not ideal in terms of economic stabilisation, but better than a temporary windfall situation would be, though of course the tax payer gets stuck with a much bigger bill.

The excuse, from both sides of the hall, is that these measures are temporary, pending raising the people’s incomes through other means, such as via the minimum wage, and the  ETP and NEM.

But there’s a problem with this conception. Plenty of people have been trying to puzzle out how the government’s initiatives will actually raise incomes, especially for professions that don’t require a great deal of skill or knowledge. My view is that it won’t, not really – what we’re likely to see is an increase in nominal incomes, and possibly (but not probably) real incomes, but not relative incomes. If your conception of an increase in welfare is how you’re doing relative to your colleagues and neighbours, I’m afraid you will be doomed to disappointment – and the empirical evidence shows that this is how people judge the level of their own welfare. Achieving high income status does not mean we’re all going to be rich.

Nor do I necessarily think that there will be an increase in quality of life, especially in the lower middle class on down. Rising incomes also mean rising costs, mostly cancelling each other out. In a closed economy, incomes always equals output; in an open economy the difference between the two shows up in the trade balance.

There will be a change, but it will be in the distribution of incomes and costs – material goods, especially imported ones, will become more affordable (not cheaper mind you), but any kind of service-oriented industry will become much more expensive. Education, health, tourism – all these will be much less affordable. So while you might be materially better off, whether you will be better off in total depends on how materialistic you are.

I don’t see either Pakatan or BN seriously addressing this issue. A minimum wage for instance establishes a floor for wages, but research suggests that relative wages won’t change much. That’s due to the hierarchal nature of societies and businesses – if you handle a more demanding job than the next man, you’re going to demand and command better pay. It’s only fair right?

A minimum wage will thus eventually have a cascading effect on the wage structure, simultaneously pushing costs up. In a closed economy, this will result in status quo ante; in an open economy such as ours, the manifestation will be in a stronger exchange rate and a declining trade balance, but still with relatively unchanged relative incomes. And that suggests that most of the income gains in absolute terms will be at the higher end of the income distribution.

In other words, I don’t see anything from either side that will result in a  fundamental change in the distribution of income. Which means that no matter how much better we become in nominal terms, nobody’s going to be satisfied.