Monday, October 10, 2011

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.


  1. Nobody satisfied becoz of high desire,people now become demanding, Gov just provide NEEDS not WANTS!!

  2. Sounds also like Barro-Ricardian equivalent and vaguely similar to RBC. I'd say more, except that I've forgotten my RBC (not that there's any one RBC that represents, well, the RBC).

  3. I wasn't thinking of Ricardian equivalence to be honest, though it does sound similar doesn't it? Actually I don't think it would apply here, as the demographic involved (pensioners, low income households) don't pay tax anyway, now or in the future.

    I was thinking more along the lines of the difference in consumption at the margin between government and consumers. My hypothesis is that the government is paying for the handouts by cutting expenditure in other areas - all thing being equal, the money will be spent if it was in the hands of government. That's uncertain in the case of consumers.

  4. I think it does, if you take consumption tax into account, ie the GST. That said, the difference between income and consumption tax might mean that it depends on individual consumption basket and the availability of substitutes.

  5. minimum wage can be a good thing. It can help us reduce our addiction to cheap foreign labour. Encourage locals to take up jobs in plantations and constructions sites. More importantly spur innovation and investment into automation (which increases skilled technical jobs) and increase productivity. That's the key point, minimum wage (especially if higher than current low wages)must come with increased productivity. And why not. I was visiting a friend in Perth. After arriving at the airport, I bought a bus ticket from a woman manning a simple stand. The bus driver is also the ticket collector, puts my baggage at the back of the bus and is also a tour guide. Happily giving sight seeing tips. When I arrived back home in Malaysia, there are 3 persons manning the kiosk selling taxi tickets. There was hardly any crowd. At the tax stand, one person collects the ticket, and the driver puts our bags in the taxi and drives us home. Like in Australia, I think people don't mind doing more work if they are paid more. And why not? If you ask the ticket seller to work alone but earn the salary of 2 persons - I am sure she would do it.

  6. @anonymous,

    The problem with higher wages and higher productivity is that if one person gets paid double while also doing the work of two, how's the excess labour to be employed?

    To take an example, there's considerable angst in the US about offshoring and industrial decline - except US industrial production hasn't actually declined (it's been increasing steadily), only employment in US manufacturing.

    Some of that labour has been taken on by service industries, but there's a serious skill mismatch involved as demand has increased for high skilled knowledge workers while the supply of labour is largely of low-skilled blue-collar workers.

    That's the main fear I have relative to our drive for high income status. We may find that higher incomes comes at the cost of higher unemployment and/or lower job security for the majority of our citizens in the lower income brackets. We need better social welfare protection, which is something a minimum wage will not provide.

    Unfortunately, neither political camp appears to be doing anything serious about this.