Wednesday, February 10, 2016

Raising The Foreign Worker Levy

The measure is on hold at the moment, but I want to put forward my thought process on the subject.

The main debating points are obvious - Malaysia relies too much on foreign workers, and they are generally paid wages below that of locals. The levies on foreign workers goes some way towards redressing that imbalance. On the other hand, raising the levy raises business costs and could force some industries to retrench without necessarily increasing demand for local labour, not to mention the impact on consumer inflation.

What most commentators might have missed is the existing discrepancy between employing a foreign worker relative to a Malaysian one, which boils down to one thing - EPF contributions.

Contributions to the EPF are mandatory for salaried workers below the age of 60 for Malaysian citizens and permanent residents, and for foreign workers who opted to contribute before August 1, 1998. The statutory rate is currently 8% for employees (unless you opted to retain the higher 11% rate under the revised budget), and 12% for employers. There's some variation to the rate depending on salary level, but I'm going to gloss over these differences (the precise details are in Schedule 3 of the EPF Act).

After August 1, 1998, foreign workers are also allowed to contribute to the EPF, but this is optional and not mandatory. More importantly for the latter, employers only pay a flat contribution of RM5 a month, irrespective of the level of pay. If foreign employees don't opt for contributing, employers pay nothing at all.

You can imagine the incentives at play here. Effectively, this discriminatory treatment imposes a de facto tax on businesses who want to employ locals. Hence the importance of the levy, which goes part way toward redressing that disincentive.

But the analysis gets more complicated. Because the levy is a flat fee, the higher up foreign worker wages rise, the smaller the impact the levy will have whether at the current rates or the proposed higher rates. In contrast, EPF contributions are a percentage of wages paid, which means the higher the pay, the higher the tax on companies for using local labour.

Then there's the issue of illegal aliens, who avoid the payment of levies entirely (I'm also leaving out the part about levies only applying for certain industries). But to balance that, approximately half the local workforce don't contribute to EPF either, so my sense is that this balances out.

So the flat rate levies on foreign workers aren't really an effective deterrent to the demand for foreign labour - it just shifts the wage levels where hiring foreign workers makes business sense. That in itself might make raising the levies a good policy, since one of our development goals is to force businesses to invest in higher productivity, which a higher cost of labour can induce. But I don't think it will reduce the demand for foreign labour relative to local labour, though an argument could be made that there is an impact on wage levels generally, though not in the way most people think.

I don't find convincing the argument that foreign labour "competes" with local labour, thus depressing wage levels. I think the mechanism is more through the effect on capital investment and intensity, as companies relying on low wage foreign workers can put off investing in productivity enhancing improvements, thus reducing the return (and thus the income) on both foreign and local labour.

If foreign workers really do compete with local labour, you would expect to find generally higher unemployment, but unemployment in Malaysia is ridiculously low by both developing and developed country standards. Foreign workers aren't "taking" jobs from local workers in that sense, especially since even the current levy is enough of a deterrent at the lowest wage levels. Nor do I think the argument that foreign workers using public facilities like healthcare a good enough argument against using foreign labour - some part of the income they receive is also spent locally, with the attendant multiplier effects on the rest of the economy. Remittances are neither here nor there - the amounts look big, but not in relation to the economy as a whole.

The net effect is I think to boost GDP and GDP growth - low wage foreign workers add to the economy, not subtract from local employment. The flip side is also likely to be true - reducing dependency on foreign workers will also likely reduce potential GDP growth, as Singapore is currently finding out. The arguments against low wage foreign labour is distracting people away from more important labour issues that I think we should deal with, like youth unemployment and skill mismatches.

Could we do without foreign labour? Yes, we probably could, and wage levels and the return to labour would likely be higher. Consumer prices would also be substantially higher, particularly for services industries, but that's the trade-off most developed economies make in the end.

But to return to the levy issue, I think the problem is less about whether foreign labour is good or bad, or whether the levy should be raised or maintained, but how the whole system is administered. The outsourcing of registration and the handling of immigration of foreign labour is prone to abuses of the worst kind, a national embarrassment. Just because these workers are foreigners does not mean they are not due certain fundamental rights. A second issue is our policy of non-assimilation, which is really a socio-political issue that I won't touch on.

Sorry if there doesn't seem to be a definitive conclusion to this post, but the issue is complex, and really boils down to what trade-offs you prefer. We could sustain the status quo, maintain our growth and inflation rates, but live with low wage levels and labour share of income. Or we could get rid of foreign workers, and have higher wage levels and a higher labour share of income, but at a higher cost of living and slower growth. Pick your poison.


  1. Say we pick "a higher labor share of income, but at a higher cost of living and slower growth". Would this only a short-term effect? Or would you feel rosy about the capital share of income growing in the future with more capital investment (and hopefully, more innovation taking place) in the medium term? This would bring into whether employees are able to adapt smoothly to more productive methods. I don't know how employers will actually behave, so I will leave it as that.


  2. Hmmm... I always thought in a perfect world wages should be an indicator of productivity. ie. if I want to be paid twice as much as a foreign worker, I should be twice as productive as him. If not, yes, it makes sense for my boss to hire the foreigner. That's the point I was trying to make in the Singapore context, that, hey guys the ball is in our court too, that you cannot expect a given right to higher wages just because of your citizenship. But I can see a lot of people didn't buy that. Or am I being too simplistic

  3. But, but, in rmk11 it is stated that levy shall be imposed based on the ratio of foreign workers hired?

  4. But, but, in rmk11 it is stated that levy shall be imposed based on the ratio of foreign workers hired?

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