Thursday, August 30, 2012

Mythbusting: Government Debt Edition Part II

Well, I’m back from my break and had a lovely time with family and friends – back to regularly blogging again.

Nevertheless, this wouldn’t have been my chosen topic, but with the budget little more than a month away, I suppose its understandable.

In a column yesterday at the Malaysian Insider, Azrul Mohd Khalib repeats all the same old myths about Malaysia’s government debt (excerpt; emphasis added):

Maxing out the national credit card

…Every national Budget over the past few years has had a deficit. When total national expenditure exceeds the revenue collected, a budget deficit then exists. The only way for the government to pay for this deficit is to borrow.

But like everything else in life and like you and me, contrary to what some people may believe, there is an actual limit as to how much debt that the Federal Government of Malaysia can accumulate…

…For Malaysia, the national legal limit is clearly stated under the 1983 Government Funding Act and the 1959 Loan (Local) Act and is 55 per cent of the country’s gross domestic product (GDP). Under these two Acts, the government cannot legally have debt beyond this ceiling.

The 2011 economic report indicated that government debt had reached RM456 billion. This represented 54.3 per cent of the country’s GDP, which was also 0.7 per cent under the limit permitted under the law. That was in 2011…

…In 2011, the government received tax revenue of RM185.4 billion. But the original 2012 Budget was RM232.8 billion. So, the tax income alone is insufficient.

Therefore, the government has borrowed. But Malaysia prides itself on not borrowing from international sources such as the International Monetary Fund or from other countries. Therefore, 90 per cent of debt is domestically funded; it is borrowed from us, from the Employees Provident Fund (EPF).

Last year, the Ministry of Finance stated that the government had borrowed RM79.4 billion from the EPF. In fact, the government actually owes us more than RM240 billion. Yes, that is how those bonuses, numerous cash hand-outs and special projects are being paid for. With your EPF money…

The same principle governs our debt ceiling of 55 per cent. The only way to increase it and legally allow the government to spend more than the limit is for Parliament to amend the two laws mentioned. As far as I know, we have not done so.

If the government is spending more than the debt ceiling, then the spending is not legal. Seeing how in 2011 government debt had already reached 54.3 per cent of the GDP and RM20.5 billion is needed each year to service the country’s debt commitments, the question must be asked and answered: where are we today? Do we even care?

Financial agencies are already warning of a possible downgrading of Malaysia’s credit rating if the government doesn’t rein in its debt.

Short of very optimistic economic growth rates, it is almost certain that the government’s current spending levels have breached the debt ceiling this year. This could be a historical year. For the wrong reasons…

…The government has been adamant that there is sufficient revenue. Yet, it’s borrowing like mad.

The Auditor-General’s report is bound to reveal yet again the extent of wastage and mismanagement that is endemic in the system which cost taxpayers millions of ringgit. We will moan, groan and complain. And things will stay the same…

The people responsible for today’s debt will not be the ones paying for it. Instead it is our children and grandchildren who will be forced to pay.

They and we deserve better.


My FAQ addresses all these issues and more and the original Mythbusting post adds further insights, but to save some time here are the key points in relation to the myths in this particular article:

1. The legal limit on debt

Neither the 1983 Government Funding Act nor the 1959 Loan (Local) Act actually mentions a limit, much less make a “clear statement” of it. The 1959 Act was amended in 2005, but the amendment does not mention a legal limit either. The limit is actually adjusted by government gazette with consent by the Agong. No parliamentary approval is required, nor is there any necessity to amend the acts themselves – the limits on debt are purely at the discretion of the Minister of Finance.

This is totally unlike the US, where the mandate for changing the debt ceiling is specifically under Congress. If you want to sight the Acts and the relevant gazettes, I’d encourage dropping by satD’s blog.

2. Calculating the 55% legal limit

I’ve only just come to understand this myself. The 2005 (Amended) Act governs issuance of MGS, while the 1983 Act governs issuance of GII and Islamic Treasury Bills. There are actually two other laws that regulate government borrowing – the External Loan Act 1963 and the Treasury Bills (Local) Act 1946. The total current gazetted limits (reproduced from a Treasury presentation) are set out below:

Legislation Limit
External Loan Act 1963 RM35 billion
Treasury Bills (Local) Act 1946 RM10 billion
Government Funding Act 1983 Not more than 55% of GDP
Loan (Local) (Amended) Act 2005 Not more than 55% of GDP

The latter two are calculated in conjunction i.e. the calculated level is the sum of MGS, GII and Islamic Treasury Bills. Note the critical distinction here – the 55% limit refers to MGS, GII and Islamic Treasury Bills alone, and not total government debt collectively.

Far from approaching the 55% limit, the current aggregate outstanding issuance of MGS, GII and Islamic Treasury Bills is under 45% of GDP. The idea that Malaysia’s government debt is approaching some kind of legal limit has no basis in fact.

3. Commitment to 55% total debt to GDP

While there’s no danger of Malaysia breaching its legal debt limits, the government has made a commitment to keeping total debt below the 55% ceiling. This however is an internal target and is not legally binding.

4. The government is borrowing from EPF

Yes it is, but Azrul is mischaracterising this relationship. The Employees Provident Fund is a defined contribution pension fund for the benefit of private sector employees. As a pension fund, its primary mission is capital preservation, and as any fund manager worth his or her salt can tell you, the basis of any such investment portfolio is government securities because from a market risk perspective they are safer than anything else. Any pension fund, here or elsewhere, will have the bulk of its portfolio in government securities i.e. “lending to the government”.

In fact, since we’re talking about legal limits, Section 26a. of the EPF Act (Amended) 1991 specifically states the following (emphasis added):

“Subject to any variation which the Minister may make under subsection (2), the Board shall invest or re-invest at least fifty per centum of the moneys belonging to the Fund and invested or reinvested during any one year, in securities issued by the Government of Malaysia, provided that the total amount of moneys so invested in such securities at any one time shall not be less than seventy per centum of the Fund’s total investments." 

If Azrul’s numbers are correct, then the EPF is actually in breach of its own Act based on EPF’s 2011 portfolio size of RM442 billion, which gives a ratio of about 54% – well below the 70% minimum level. Instead of asking why EPF is lending to the government, perhaps the more pertinent question would be why is EPF taking on more risks with our money by not “lending” as much to the government as it is required to.

(Digression: in Singapore, they avoid questions like this by making it mandatory for the CPF to invest all member funds into government securities. EPF on the other hand is allowed considerably more discretion and leeway in where to invest member funds).

Another pertinent point here is that EPF’s portfolio at the end of 2011 was about 1.56 times greater than the value of member funds i.e. it’s not necessarily “our” money being lent to the government.

5. Where the money goes to

Another administrative (not legal) rule that the government tries to abide by is to fund all operational expenditure out of collected revenue, and only borrowing to fund development. In technical terms, what’s being aimed for is that the operational budget should always be either in balance or in surplus, a principle that has been kept to all but three times in the last forty years. Borrowing is only utilised for development purposes (again technically, using the Development Fund under the government accounts).

In other words, civil servant bonuses, handouts etc, actually come out of tax and non-tax revenue, not out of borrowing.

6. Semantic issues

My nitpicking for the day. The government revenue quoted (RM185 billion) is actually total revenue and not tax revenue. Tax revenue for 2011 only amounted to RM135 billion.

7. RM20 billion for debt service

As an absolute number, it sounds like a lot; in relative terms it isn’t. As a ratio to the operational budget – which remember, is supposed to be in balance – the government’s interest payments for 2011 are actually the third lowest on record. In fact, the debt service ratio to operational expenditure the past four years has been at an all time low, averaging below 10%.

In 1990s when we were running a budget surplus, debt service averaged 23% of the operational budget, with the lowest level at 14.4% (1997).

8. Our children and grandchildren will be forced to pay for our debt

This is actually a tale of two hats, and the statement above comes from wearing only one of them. There’s an important and vital reason why borrowing from domestic sources only is preferred because when you’re able to do that, there’s actually no inter-generational transfer of aggregate welfare. In Econo-english – the future burden on tax payers is offset by the future revenue stream from debt repayment.

Since debt liabilities are owed primarily to domestic institutions (such as EPF, insurance companies, banks and the like) who are in turn either tax payers or acting on behalf of taxpayers and citizens, debt repayment effectively goes back to the payers of tax. In other words, the monies aren’t going anywhere, although there might be some redistribution of the proceeds.

If I wearing my taxpayers hat am liable for debt repayment of maturing debt incurred by my forebears, I wearing my EPF member, insurance policy owner, and unit trust investor hat am also at the same time the beneficiary of the government’s current debt repayment. And this is true at any given point in time, irrespective of when the debt is incurred.

Given that there are less than 2 million individual taxpayers and over 12 million EPF members, there’s also possibly a (small) transfer of wealth from the rich to the poor in the process.

The idea that government borrowing now is thus a net aggregate tax burden on future generations of citizens is mostly bunk. It would only be true if the borrowing is external, hence the reason why we try to keep government borrowing domestic and why external debt limits are far more stringent than the domestic limits.

Summing up

I suppose I’ll be repeating these points again (and again) in the future, but I think its worth the effort to do so. There’s so much misunderstanding of the unique position of government in an economy, and how significantly different governments are in economic terms from households. Imperfect understanding leads to skewed public discourse, which in turn leads to bad policy.

And we have enough problems as it is without having to invent fictitious ones that don’t actually matter.


  1. Hi Hisham,

    All excellent points. Was just wondering if we've been misreading the issue when it comes to government spending and revenue. In the long term, how sustainable is the reliance on oil-based revenues, and at which point should be worried about contingent liabilities given that the large amoungts of government-guaranteed debts to finance large-scale ETP-linked projects (the MRT, KLIFD) as well as corporate bond issuances (MAS, PLUS)?

  2. Thanks for the article Hisham.
    Glad there is more than one side telling the story.

    P.s. Hope the 49ers will have another good year. :-)

  3. @Nadia,

    In terms of oil related revenue, it should be recognised that it isn't just oil but also natural gas. While oil production is expected to decline, natural gas reserves are slated to last 50 years or more. in other words, we won't have to worry about it for some time.

    As far as contingent liabilities are concerned, from a credit perspective I'd be more worried if it were for non-infrastructure projects which won't have asset backing which can be liquidated. None the examples you quote would fall in that category, except possibly MAS. Even PKFZ has some assets to cover their debts.


    Really tough schedule this year and the Seahawks look really competitive (Russell Wilson is the real deal). I'm also not sold on the Randy Moss, Mario Manningham experiment as they haven't done anything in the preseason. We're about to find out if Alex Smith is going to ever become more than a glorified game manager.

    But hell yeah, go Niners!

  4. That's an erudite analysis, Pak Hisham

    A couple of questions (using the favourite bête noire Singapore as a reference):

    - if your analysis of Malaysia's debt situation (especially government debt) is correct, then why are the rating agencies rating Malaysia (A-) and Singapore (triple A) differently? Shouldn't they be using the same criteria in their evaluations?

    - following on from the above, why is it that Singapore government bonds carry lower coupon rates than equivalent Malaysian government bonds? For example, a 2-year Singapore government bond has a coupon rate of 0.25%, a 5-year bond a rate of 2.375% and a 10-year bond a rate of 3.125%.

    To me, it appears that the Singapore government is able to borrow funds at lower interest rates than the Malaysian government can.

    Is this a valid and factually correct conclusion?

  5. I would love it if you talked about something else too :)

    Looking forward to your next non-fiscal blog post. Heck I wouldn't even mind if you talk about corporate debt, I agree that you'd probably covered this topic (Malaysia sovereign debt) to death....and then some.

    1. @Jason,

      My cross to bear unfortunately. I can't let stuff like this article go without trying to correct the misinformation.

  6. @Jasper,

    Singapore carries a higher rating because while they carry a higher debt load, they have also striven to achieve an overall surplus in the government budget. In other words, they're not borrowing for consumption purposes and are constantly generating excess cash.

    They're also sitting on a truly enormous pile of cash - at last count (May 2012), about SGD170 billion, of which SGD154 billion is at the central bank. Combined with assets under management (under Temasek and GIC), Singapore can pretty much pay off their debt in a blink.

    So there's virtually no credit risk at all, hence the higher rating which in turn helps drive down the cost of borrowing.

    Another factor is that Singapore is currently flush with liquidity, both from internal (high credit growth exceeding 20%) and external (portfolio and investment flows) sources arising from their function as regional finance hub. That drives down costs even further.

    Note that Singapore's interbank interest rates pretty much track the Fed Funds rate, which is currently 0-0.25%.

    However, how Singapore's budget surplus is achieved is more than a little troubling, as it's mainly derived from under-spending on public services, and the manner in which Temasek and GIC operate are far more opaque than EPF. High liquidity also brings its own dangers.

    1. Hi, Hisham

      I would agree with most of your analysis.

      However, a significant factor is, I believe, subsidies (or the lack thereof in Singapore).

      It is arguable if Malaysia needs to maintain a subsidy regime of around RM30 billion annually (and counting).

      You have commented on this before, so I will let the manner rest for now.

      But I would argue that the Singapore government does spend on subsidies for education and public healthcare, which as percentages of GDP, are comparable (or maybe even better) to that in Malaysia.

    2. Singapore does not have universal healthcare, a large portion of public healthcare are paid by singaporean themselves from their CPF pension fund.

      Malaysian public healthcaren is provided almost free with minimal token fees. Medical care is also fre for senior citizens.

      Singapore spending on healthcare and education is the lowest among developed economies. In fact, singaporeans pay so much in everything that the lifestylemof many middle class singaporeams do not reflect that of a $50k per capita citizens.

      There are as many ill informed who sing the praises of singapore mythical perfect social economic relaity as there are who thinks that malaysia will be bankrupt the next year without analyzing data that leads to mindless judgement on a country.

    3. Besides CPF, Singaporeans contribute to Medisave too for healthcare.

      See here:

  7. Good write. It's write like this which makes reading blogs satisfactory. Unfortunately the bias partisan negative propaganda on our debt has set the minds of many- unable to discern what's good or bad. When point out these things they censor or ban.And TMI is at the forefront. Views like these will be buried so that they can manipulate the truth.. Hakbersuara.

  8. Back from a personally enlightening and spiritually energizing sojourn to Qom and a short detour to cooler climes elsewhere, I found your article refreshingly forthright and informative sans the load of hogwash and hokum that often litter our socio-economic cyber landscape lately driven as they are by partisan political leanings.

    My foray in here is epistemologically decoupled from my previous intrusion which was essentially targeted at the perils of debt monetization (more on that elsewhere when the data is ready). Nevertheless, a few observations will help clarify certain issues:

    1.Yes there is no diminution in the living standards of future generations. The uninitiated would like to refer to the link below to obtain an informed perspective:

    Nevertheless, if certain parameters like ageing populations give way, than the repercussions will be damningly horrible as this link below will attest:

    Hence, the above scenario explains, to a large extent, the general trepidation permeating certain polities (which to my delight will afflict those peopled by a certain ethnic............ ; > )…hahahahaha) whose knowledge of their impending fate is fueling outward immigration and the emergence of a hawkish mentality:

    Indeed, I am smacking my lips in anticipation of the demise of the above fraudulent state (a banana money laundering entity planted in our midst ala-Israel) although the geo-political threat to Johore would be temporarily heightened (a militarily expansionist ideology is currently gaining ground in a certain republic wherein a strategic strike on and the excision of Johore for land and a bigger demographic base is an idea being floated around although policy formulation of it has yet to take off….Najib beware. You have been forewarned)

    3. A commentator above mentioned about subsidies which I have previously raised on numerous occasion here and elsewhere. I think subsidy rationalization, civil service crimping/technology infusion, tax reform, turning off the tap for vernacular schools, national service etc + reining in wastage would contribute significantly to fiscal consolidation along with other measures I have suggested in other posts here.

    4. I would caution into reading too much into the 1990s operational budget figures as the expenditure was slashed drastically during that time by a prig bent on destroying Malay ascendancy. Hence that would distort certain percentages.

    5. Singapork spending less on education, health etc is a well-known fact that has raised concern among policy wonks there:

    But then again, they are adept at stealing talent from us while running down the MALAYsian education system…so what else is new…hahahahahahaha. But their comeuppance over the short and long-term is pretty much inevitable….

    Warrior 231

  9. I need to the add a caveat to (2) above pertaining to Malaysia, where our healthy and virile procreation rate of 2.64 trumps the anemically frigid and essentially cockdead Singapore replenishment rate of 0.78 hands down anytime....hahahahaha

    Warrior 231

  10. Hi Hisham, I think it's useful for you to clear up the misconception of the supposed government debt limit. However what I think would be more useful for everyone is to have a discussion on what would be right amount of debt.

    No doubt there is no single answer, and it all depends on economic conditions, but we'd like to hear your views on whether the government is spending too much or too little (and consequently borrowing too much or too little).

  11. @Jasper,

    I've just checked - based on World Bank data, Singapore spends more as a percentage of their budget on education and health than Malaysia does. However, this is due to Singapore's lower expenditure generally (relatively smaller budget).

    As a percentage of GDP, Malaysia's public expenditure on education and health averages double that of Singapore.


    Welcome back.


    You're absolutely right - there's no single answer. It depends on the specific circumstances. Any given level of debt and expenditure would be "right" under one set of circumstances, and "wrong" in another.

    Having said that, my judgement for the current situation is that some consolidation is warranted this year and next (solid growth, low unemployment, higher private investment, higher imports). Bear in mind that doesn't necessarily mean a pay down of debt, only a slowdown in its accumulation.

  12. With regards to your last point, there is still something that doesn't quite sit with me. let us simplify matters as saying generation X are the previous workforce and savers who hold the government bonds as savings and generation Y are the current workforce who are currently building up their savings and generation Z is the future workforce. The government can easily repay gen X’s bonds (which gen X might sell to pay for retirement) by using the savings being put in by gen Y via EPF and we are fine. Now suppose however our population starts aging, and generation Z is smaller than generation Y. Now, when it comes to repaying the debt to generation Y, the money generation Z saves may not be enough, so the government will also have to raise taxes on generation Z to repay its obligations to generation Y. Essentially, generation Z is paying higher taxes to finance spending that was made on generation X. Thus, if what I say is not wrong, it is misleading to say there is no intergenerational wealth transfer eventhough my model is oversimplified. (although I would actually argue this transfer isn't necessarily something undesirable, especially if future generations have a greater earning capacity that previous ones). Even if I am wrong in my simplified illustration, i would like to draw your attention to the model of Lindbeck and Weibull (1986) who find that inheriting domestically held public debt generally has an adverse effect on the wealth of the young, unless the old have a very high tendency to build up final assets and presumably leave them as bequests. Please point out where I might be wrong, because I am unsure of all of this myself. Thanks for the article though, very thought-provoking and eye-opening.

    1. Hi,

      Your concern would be valid, but only if households were the only source of taxes and the only source of savings.

      The reality in Malaysia is that unlike in many Western countries, most individuals do not hold government debt - the only publicly available government debt is the National Savings Bond, which is a paltry RM5 billion. Most household savings are actually forced savings through EPF.

      Even then its but a small portion of total national savings. By my calculations, the discretionary household savings rate is averaging less than 1.5% of disposable income, and averaged just 0.6% of GNI over the past decade.

      Adding EPF savings (not including withdrawals) to that raises the number to about 14.2% and 6.2%. If we take the net EPF figure (contributions less withdrawals), it's a heck of a lot smaller. Households contribute only about 7% of annual national savings - almost all the rest come from companies.

      On the tax side, the household contribution varies, but personal income tax has averaged just under 10% of government revenue for the past decade (corporate income tax alone is about 2.5 times that). Indirect taxes might double that ratio, but we're still talking about just a fifth of government revenue.

      One last factor is that if you look at Malaysia's demographic tree (link here), we're a long, long way from worrying about an ageing population. By contrast, here's Thailand's and Singapore's.

    2. Thanks for the reply, that helps give me a clearer picture. But with regards to your point on taxes, there has been a lot of talk of diversifying the revenue base (presumably by a GST perhaps or perhaps higher income tax). The point is that even if our natural gas reserves last another 50 years, after that, it is not clear we will have much to fall back on apart from raising taxes on households and companies. In that sense, if most of the savings surplus (used to directly or indirectly buy government debt) is currently done by companies, then there is indeed a large redistribution in the process of repaying the debt. Eventually, taxes may have to be raised on (among others) households to pay back the debt while the beneficiary of this repayment are corporations who hold the debt (since you claim companies contribute a large proportion of the national savings). So from the point of view of the average Malaysian who does have much ownership in these large companies, it is a transfer and effectively an inter-generational transfer. Government spending benefits the average Malaysian now, but will have to be repaid in higher taxes by the future workforce/households if the composition of our revenues starts to change. In simple terms, while factually accurate, I think your claim that "the future burden on tax payers is offset by the future revenue stream from debt repayment." is highly misleading, and your lack of emphasis on the redistributions that are involved in the process of repayment conceal the existence of intergenerational transfers. Within certain classes of societies, what will happen certainly can be interpreted as an intergenerational redistribution.

    3. I'm not at all sure where your points of contention are:

      " is not clear we will have much to fall back on apart from raising taxes on households and companies."

      How did you arrive at this conclusion?

      "Eventually, taxes may have to be raised on (among others) households to pay back the debt while the beneficiary of this repayment are corporations"

      Again, I'm not sure how you arrived at this. Why, given that corporations are simultaneously the biggest savers and tax-payers both now and prospectively, should there be a structural change in the future? I don't see how this follows, unless you're reverting back to the assumption that households are constrained to be the ONLY payers of taxes.

      I did in fact note that redistributions can and will occur, but this redistribution occurs at the point in time where debt is repaid, not across generations. I don't see how this is not true both in spirit and in fact:

      Higher current taxes = higher rate of debt repayment = higher revenue stream

      Digression: I actually do support an increase in income and estate taxes on households and instituting capital gains tax on both corporations and households.

      This however has very little to do with public finances and more to do with reducing income and wealth inequality, which in Malaysia rivals Singapore and Hong Kong as the worst in East Asia.

      One of the key factors in the perpetuation of this has empirically been...wait for it...intergenerational transfers of wealth, particularly but not limited to property. Which rather nicely dovetails with the conclusions of the paper you quoted in your first comment.

    4. Sorry should have added - just as future generations might be burdened by higher taxes while benefiting from higher debt repayments, the same logic applies in the here and now.

      When the government is borrowing more to spend on current taxpayers, ask yourself where the money comes from. That too is a current redistribution, and not an intergenerational transfer.

    5. " is not clear we will have much to fall back on apart from raising taxes on households and companies."

      I arrived at this conclusion based on what I think is a reasonable assumption of having reduced resource revenues, say in 50 years down to the road.

      "Why, given that corporations are simultaneously the biggest savers and tax-payers both now and prospectively, should there be a structural change in the future?"

      The reason is not so much a rebalancing of revenue sources from corporations to households but rather a need to increase taxes on both corporations and households to fill the gap if and when our natural resources start depleting, natural gas in particular.

      "When the government is borrowing more to spend on current taxpayers, ask yourself where the money comes from. That too is a current redistribution, and not an intergenerational transfer."

      This I think summarises your interpretation of the issue nicely, and I think our differences lie simply in the interpretation. My point of contention with your argument is that at any one time, the current taxpayers and debtholders can and will to a certain extent be of different generations. So my point is simply that some of those redistributions you mention intergenerational. the assumption that taxpayers and bondholders are from the same generation is a simplification of the matter.

    6. 1. Declining oil and gas reserves are a global phenomenon and not a local one.

      As usage patterns are inelastic even over the medium term, that suggests that declining supply will be offset by higher prices (while at the same time making previously uneconomical sources profitable to exploit, e.g. shale gas, as well as increase demand for alternative fuels such as bio-diesel which Malaysia is also pursuing aggressively).

      In other words, there's not going to be much revenue shortfall until the stuff actually runs out. By which time of course, we'll have far more important things to worry about.

      2. As to your second point, much of the annual deficit can actually be attributed to oil & gas subsidies, even as revenue is bolstered by oil & gas proceeds. Some portion of government operational costs can also be attributed to oil & gas use (negative externalities arising from health and environmental cleanup spending).

      My estimate is that petrol prices need to be approximately doubled once subsidies are removed and externalities are taken account of. Declining use of oil & gas as it runs out half a century from now would affect both sides of the equation, not just one.

      Removal of gas subsidies alone would cut the deficit by two-thirds - these are borne by Petronas, and NOT by the government, and would release almost RM30 billion available for additional dividends.

      3. Fair enough. We'll agree to disagree. I did not actually make the point that current transfers and payments are necessarily within a certain "generation", only that the transfer of welfare does not occur across time.

      Economic models on this question are generally highly simplified, in that there is a different household "generation" in each period of the model, which makes things easier to define and resolve. Intergenerational in these terms encompasses both time and changes in agents, but at core are looking at the temporal effects.

    7. Just my two cents since this topic suddenly got interesting...

      I don't think there has been any widely accepted empirical evidence to support the Ricardian Equivalence (i.e. rational people saving their free handouts because they have to pay it back in some form - whether through tax or inflation - in the future).

      There's enough evidence to suggest that people - in general - tend to be very focused on themselves (or their own generation). If inter-generational optimizing behaviour were prevalent (not saying it doesn't exist, just not widespread) in households today nobody would be calling for more subsidies.

      From my perspective, that's one of the many roles of the Government - to enforce inter-generational optimizing behaviour, and here's where I diverge slightly with Hisham. When the Government borrows to finance a larger scale infrastructure projects, that to me is a form of a wealth transfer from future generations to the current one and not just a current transfer. I don't quite make the distinction between bondholder or taxpayer here as both have similar (hopefully), real wealth transfers from interest payments or inflation.

      @anon, if you find any widely accepted proof of Ricardian Equivalence do post it

      @hisham, I don't know how MARC did it last year (before you joined), we just finished our non-cyclical estimate of marginal propensity to consume in Malaysia and we came up with the same number as your office: 0.53. Coincidence?

    8. Jason,

      As I recall, Ricardo advanced the idea of equivalence to disprove it, not to advocate it :)

      As for the MPC, I really have no idea. I'll ask the boss about it later.

  13. Abdul Rahman Dahlan, MPSeptember 5, 2012 at 12:43 AM

    Hi Hisham,

    As usual, great article. I proud to say that I am now a regular visitor to your blog. Keep up the good work.

    Someone should do power point presentation of the article above. (Sorry, I know I am asking too much).

    Please allow me to reproduce the article above in my blog. Credit will be mentioned of course.

    Thanks in advance.

    Abdul Rahman Dahlan, MP

    1. YB,

      Thank you for the support.

      With respect to reproducing this post, by all means, go ahead.

  14. Even without borrowing, increase public debts is not good for the economy long term by squandering the capital towards government unproductive spending.

    "Money has simply been transferred from the public to the Treasury, and then the money is spent on other members of the public."

    Who benefits at the end?

    1. @anon

      For your first part, I'm sorry, your logic escapes me. Can you clarify? If you're not borrowing, how does public debt increase?

      As for the second part, one of the functions of government is to redirect society's resources from the better-off to the less well-off, necessary for a stable and well-functioning society.

      Borrowing is largely from surplus savings generated by companies and the better-off (even considering EPF funds), while tax revenue definitely comes from profitable corporations and the top 15% income earners. The bulk is spent on the provision of public services including universal healthcare and free education up to secondary level, while borrowing is used to fund rural infrastructure amongst others.

      While wastage can and does occur, the principle itself is sound.

  15. Just to add some stuff here. The redistributionary effect of budget deficits aren't always clear. You've mentioned the transfer from rich to poor. Here's an example of transfer in the opposite direction.
    "Many people hold little wealth and consume the income from their wages, while a small part of society holds most of the economy’s wealth. When crowding out raises the returns on capital and reduces wages, the wealthy gain at the expense of the less wealthy."

    this is from a paper mankiw wrote, obtainable here

    1. Quite right, though you don't need to have a budget deficit (or higher government spending) to achieve that effect. Lower taxes would do the same thing.

      Second, crowding out only occurs if government deficit spending causes the economy to exceed its potential output. That's a real tricky empirical question to answer, especially for an open economy where the supply response could equally be through higher imports rather than higher interest rates.

    2. hmm, it can be that we have low taxes and still record a budget surplus. in this case, don't we have crowding in instead of crowding out?

      As for the openness of Malaysian economy, I agree fully with you. Especially since Mankiw wrote this for US, an economy large enough to affect interest rates

    3. Actually my reference to lower taxes was really in respect of the impact on distribution of welfare (try here).

      On the other hand, the degree to which changes to a given level of expenditure and taxes would create "crowding out" effects depends on a number of variables, but particularly on the gap they cause between actual and potential output aka the output gap.

      In that sense, whether a greater deficit is arrived at by cutting taxes or increasing expenditure doesn't matter.

      Second, the size of the economy is also irrelevant when discussing crowding in or crowding out, its the degree of openness that matters.

      In any closed economy, even a very small one, higher deficits that exceed potential output would "crowd out" private consumption and investment through higher interest rates and inflation as government borrowing competes with private demand for the supply of credit.

      Higher interest rates increase the cost of borrowing, causing private consumption and investment to fall, while inflation reduces the purchasing power of money.

      Under these conditions, government efforts to boost growth beyond the potential output frontier will only result in a redistribution of economic activity from the private sector to the public sector, while at the same time increasing equilibrium inflation and interest rates.

      If however an economy is open, higher excess demand is more likely to result in higher imports rather than competition for capital (which is the mechanism for higher interest rates).

      Malaysia is a very open economy, with total trade exceeding 200% of GDP. The ratio of trade to GDP in the US is far smaller at just 31.6%. Hence the greater US sensitivity of borrowing costs (and crowding in and crowding out effects) to negative and positive output gaps.

  16. An excellent article Hisham. I like how there are sources for the relevant acts, rather than just quoting the '55%' debt ceiling when people see it fit. Keep it up!