Right Conclusion; Wrong Analysis

A commentator sent me this link (excerpt):

How our Winner Take-All Market Deepen Income Inequality while Decaying Our Education System?

Are we better off than we were 10 years ago? I am sure the majority of us will answer with a resounding ‘NO’. Why is this so? There are many reasons that contributed to this, among them are the following.

• Increased in income inequality
• Rising costs of living
• Income not catching up with inflation
• Longer working hours and less recreation
• More indebted than before
• Less opportunity for self-improvement due to time constraint
• Society is getting more competitive
• Crime on the rise

Wonder what caused the above? Listed above are the consequences or the price of economic development that are caused by forces that shaped our social economic fabric. We are living in a world where resources such as land, labor and natural resources are in limited supply or scarce. To maximize the usage we not only have to limit wastages but also need to efficiently allocate these scarce resources to the most important part of the economy.

For some strange reason, the Malaysian Chronicle carried the same article but under the much more provocative title, "In 'BUMI TAKE ALL' Malaysia, income inequality has worsened, education standards destroyed". When you actually read through Mr Sam's article, there is no mention of race or what that has to do with the content of the analysis. TMC appears to have caught TMI's disease.

Be that as it may, there are more than a few factual and methodological errors in Mr Sam’s analysis. In the interests of fairness, I’ll point those out, but also where I think he got things right. I won’t comment on the ideological section of the article – you can make up your own mind on those.

First of all, taking the list quoted above, the notion that income inequality has been increasing in Malaysia. That’s mostly not true:

…except for Malaysian-Indians. Overall inequality, as well as inequality within the Bumi and Chinese communities, has been dropping over the past decade. This is true whether you use the Gini coefficient, or a decile approach (i.e. looking at the income levels of the top 10% or 1% relative to everyone else).

Note that the comparison chart Mr Sam uses actually includes countries that report a mix of pre-transfer and post-transfer Gini numbers, while Malaysia’s Gini is always calculated on a pre-transfer basis. Singapore, Korea and Japan for instance report Gini coefficients after social transfers – their pre-transfer Gini’s are substantially higher (in Japan’s case, a full 10 pts higher; Singapore is about 3-4pts higher).

He follows this by comparing wealth data on the top 10% relative to the bottom 10% as proof that income trends are diverging. That’s wrong – wealth can increase without any increase in income.

Sounds strange to you? Here’s an example: Say you live on the dividend income of a portfolio of stocks valued at RM2 million that pays out RM100k a year. Next year, the stock market rises 10%, but companies keep to their dividend payout policy. Your net worth has increased RM200k, but your income growth? 0%. Take a simpler example: you own a RM200k home. Property prices shoot up the next year by 50%. You are now RM100k “richer”, but your increase in income? That’s right, zero.

Wealth is related to income, but its not the same thing. If you want further confirmation, try exploring the World Top Incomes Database. Based on the estimates in the WTID, the share in income of the top 10% in Malaysia has been fairly stable at about 24% – the peak was 32% in 1986. BTW, an annual income of RM80k in 2010 would have put you in the “top” 10% of Malaysian income earners.

Point two on the rising cost of living is spot on, though not quite as much as people seem to think. Most price increases have been highly concentrated in two distinct categories – food and transport; and in services. The former reflects higher global prices, the latter reflects higher wages. Prices of other goods have actually been either static or slowly declining. You can see my various posts on the CPI to check the data. I daresay the higher prices of housing are also a factor in people’s perceptions as well, though this is not included in the CPI (the CPI only includes rent, not the overall cost of housing).

Point three is totally wrong, and the data Mr Sam uses to prove his case is employed rather bizarrely. He compares the overall growth of the economy (in real GDP measured in USD) with the growth of average annual wages in the manufacturing sector (taken as representative of the whole labour force), leading to a huge gap of 145% economic growth against 65% wage growth. This is totally misguided for a number of reasons:

1. If you’re going to compare numbers like this, they should be conceptually similar;
2. They should also be in the same currency
3. The manufacturing sector is NOT representative of the whole economy

The correct comparison with average annual wages should be nominal GNI per capita in RM. Nominal because real numbers are adjusted for inflation; per capita because that takes away the bias introduced by population growth; and RM to take away the effect of changes in the exchange rate. You should also be using GNI instead of GDP because we’re interested in growth in Malaysian incomes, not growth in domestic production.

Based on DOS/BNM data, nominal GNI per capita in RM in 2004 was about RM17,600, growing to RM30,700 in 2012. That’s a growth factor of 75%, not the 145% claimed by Mr Sam. Given that labour income is not the only source of household income (capital returns and imputed rent can be as high as 15%-20% of household income), and due to differences between labour force and population growth, a 10% difference is not enough to make the case that wages are not keeping up with economic growth. Data inferred from employee compensation in the national accounts suggests the same thing – the wage share in economic growth has been fairly stable i.e. wages have kept up with growth.

A second point is that manufacturing is far from being representative of the Malaysian labour force. Competition from China has had a dampening effect on labour returns in Malaysia – in fact, the impact was pretty much worldwide. That’s not the case for the services sector, which is far less exposed to international competition.

Lastly, on the section on demographics, Mr Sam gets totally confused on the difference between levels and ratios:

Further, as you noticed the percentage of Malaysians aged between 0-14 years old has decreased from 31.2% to 29.5%. What does this tells us? It tells us that in future there will be a decline in students going to schools which also resulted in lesser students entering universities. Thus, colleges and universities will have to buck up and spend more on attracting and recruiting students in future. This inadvertently led to a winner take-all market because universities will have to outdo each other in attracting students. Again the loser will be the public universities if they are unable stand up to the challenge. The search for top educators and faculty staffs again will lead to an explosion in salaries.

Oh dear. Just because a ratio drops, doesn’t say anything about the change in levels. From DOS population projection estimates, the absolute numbers of kids 0-14 in Malaysia will continue climbing and only peak in 2030. Even then, we’re not talking about a huge difference in the potential student population.

Second, from pure economic theory, if the demand for something drops the result should be a drop in prices, not an increase. If the supply of students were to actually fall, so would the demand for academic staff and faculty. There wouldn’t be a scramble for lecturers if there were less students to go around. So wrong on both factual and theoretical grounds.

However, since the numbers of students are likely to increase, and also because we as a nation really need to increase the proportion the labour force with tertiary education, enrolment will have to be enlarged dramatically from the current level of around 40% to closer to developed country levels of between 50%-70%. Even the current 40% is more than a little generous, because it includes all post-secondary programs, not just university degrees.

So Mr Sam gets to the right conclusion – competition for qualified academic faculty is going to be really fierce going forward – but for all the wrong reasons.

[UPDATE]

I almost forgot about the rest of the points, so here’s a quick run down:

• Longer working hours? No data
• More indebted? Absolutely
• Less opportunity for self improvement? Make your own time
• Competitive society? Quite likely, though I’ve no idea how to measure this
• Rising crime? Yes, and I wonder why anyone is surprised. Crime is related to supply of criminals, which will naturally increase with an increase in the population, all other things equal.