Income Mobility and Needs-Based Targeting

So much for writing regularly again. No sooner did I commit to it, I got loaded with a whole load of extra responsibilities. As a result, the last 2-3 months have been a blur, and I only now feel like I can sit down and reflect a little. That and because I have something to say.

There's a very quiet public policy debate going on about the extent of social assistance the public sector should provide. The overwhelming majority, in part driven by distaste of the policies of the previous BN government, is to roll back cash transfers and institute tighter targeting of benefits, with a particular focus on the poor. My view on this is:

1. Don't throw the baby out with the bath water; and
2. Targeting the poor suffers the same problems as targeting any income-based subset of the population (like the B40)

The Ugly Secret About Needs-Based Poverty Eradication: It Doesn't Work

Nicholas Freeland takes us through the preconditions needed for poverty targeting to work (excerpt):

Poor targeting: a response to Pathways’ paper on how best to reach those in poverty

In an ideal world, poverty targeting would be sensible, which is why it intuitively appeals to those who are new to social protection, or who don’t understand the true complexities of poverty. I would even go so far as to accept that, if all of five conditions were met, there are circumstances in which poverty targeting might be the optimal choice. But we don’t live in an ideal world, and Development Pathways’ paper clearly demonstrates how very unlikely it is – in the real world – to fulfil each one of those five conditions, let alone meet all five simultaneously!

For poverty targeting to be the best option, all of the following five assumptions need to hold true:

• The poor represent a small residual group;
• The poor will remain poor (and the non-poor will remain non-poor);
• Inequitable outcomes are acceptable;
• The resource envelope is fixed; and,
• You can accurately identify the poor.

The CPI and the Cost of Living: Cross Country Comparisons

This is hopelessly unscientific, but it's an interesting exercise, and is a useful starting point for understanding what goes into the cost of living. So what I have here are comparisons of the weights in the CPI for various countries in comparison with Malaysia, selected from a set of relatively large countries with roughly (±10%) the same level of PPP-adjusted GDP per capita (as per the CIA's World Factbook). The CPI weights are taken from national sources (Malaysia, Poland), Haver Analytics (Mexico), or the IMF (Greece, Hungary, Portugal, & Turkey), and grouped according to the UN's Classification of Individual Consumption According to Purpose (COICOP).

Talking About Belanjawanku

I was on BFM yesterday, talking about UM's new Belanjawanku reference budget:




One thing I should have mentioned/emphasised more is the splendid work done by Prof Datuk Dr Norma Mansor and her team at the Social Wellbeing Research Centre in coming up with it. You can also hear her talking about it here:

The CPI Is Not A Cost Of Living Index (And Shouldn't Be Treated As One)

With all due respect to the Minister, I think he gets it wrong here (excerpt):

Minister: New index to reflect ‘real’ cost of living

KUALA LUMPUR, March 5 — The Domestic Trade and Consumer Affairs Ministry is confident that a new cost of living index can reduce the people’s cost of living, especially in the context of the price of goods.

Its minister Datuk Seri Saifuddin Nasution Ismail said the current Consumer Price Index (CPI) was not reflective of the real cost of living, especially for the price of goods.

He said the new index would guarantee and identify more accurately readings on price of goods and cost of living.

“All these while, we (the government) have relied on the CPI or inflation index. For example, the CPI or inflation index can be very low, but then it might not be felt by the people in real life.

“So, we (the government) feel that the new index is a necessity to be made the new guideline that will paint a true picture of what is happening,” he told reporters after officiating the 2018 Excellent Service Award here today.

The problem is the assumption that the CPI is a COL index. It isn’t, or at best, it’s a limited subset of a COL index. First understand what a consumer price index actually does – it tracks a fixed basket of consumer goods and services over time. The goods and services included in the index are based on surveys tracking what people actually spend on. Follow-on surveys are conducted to update the basket, again based on what people actually spend on. So the idea that it doesn’t accurately reflect actual prices of goods is a non-starter.

Here’s where the CPI diverges from a COL index – first, since the CPI averages data across the whole country, it would naturally gloss over differences between areas and regions. Given the disparities in income and expenditure between urban and rural on one hand, and differences in tastes and preferences geographically on the other, it’s no surprise that the national CPI would diverge from individual and regional experiences of inflation.

Second, the CPI is laser focused on consumer goods and services, and ignores capital expenditure. Specifically, it only models the consumption portion of housing (in Malaysia, cars are assumed to be “consumption” items), and ignores housing equity. As a result, the CPI includes rent and imputed rent, but not changes in house prices. Mortgage payments would include elements of rent (consumption use and effectively the opportunity cost of buying a house), home equity (the value of the house over and above it’s consumption use), and interest, but only the first element is a part of the CPI (for a more detailed discussion, see here).

I have to keep pulling out this chart to illustrate what I mean (I know it’s a little out of date, but I’m too lazy to dig up the data again):

The increase in the cost of home ownership has exceeded almost every other item in the household budget, including food and petrol.

As a result, the CPI will never be an accurate measure of the cost of living, because it excludes a very major portion of people’s budgets, especially since the home ownership ratio in Malaysia is fairly high. However, this is not equivalent to saying that it is not a good measure of consumer inflation, because all the empirical research on it suggests that it actually does a decent job of it. If anything, the methodology of constructing the CPI results in it usually over-stating inflation, not under-stating it. The problem here is that the cost of living is a mix of both consumer prices (which the CPI tracks) as well as asset prices (which the CPI doesn't).

But saying the CPI isn’t a good measure of the cost of living is like saying my cat is a bad dog because it won’t bark. We're really talking about different animals here.

Belanjawanku

So I was at the launch yesterday, moderating the panel session after all the speeches. So far, the reception to the guide has been…interesting, to say the least. But since the media gave little attention to the panel discussion, I though I’d set out what topics were discussed. Not that we had any definitive answers, but then part of the motivation for publishing this thing in the first place was to raise awareness. So these were the 3 main themes that I gave to the panel:

Calculating Real Interest Rates Under Price Level Shifts

"You take the blue pill—the story ends, you wake up in your bed and believe whatever you want to believe. You take the red pill—you stay in Wonderland, and I show you how deep the rabbit hole goes. Remember: all I'm offering is the truth." - Morpheus, The Matrix (1999)

As a follow up to yesterday's post on interpreting measured deflation, someone on Twitter remarked that since inflation is negative, real interest rates would be high, so BNM should cut the OPR. A Bloomberg Opinion article said roughly the same thing. I could respond by saying that since this analysis is based on the false premise that Malaysia is in a deflationary environment, that policy prescription would also be false. But the question is interesting enough that it bears both examination and explanation.

What is a real interest rate, and why does it matter?

When Deflation Isn’t Deflation

It’s been an awfully long time since I wrote a post. There have been a lot of reasons for the hiatus, both professionally as well as personally. The change in government last year also caused some switches in senior management where I work, and my workload has risen as a result. At a personal level, the passing of my father in June and wrapping up his estate has taken a toll on the entire family, which obviously took up a lot of time. I’ve also been spending more time on my fitness level, since hitting the big 50 milestone last year. With all these things going on, blogging has taken a bit of a backseat for the past year. On the other hand, I first started writing this blog 10 years ago this month, and it has been a major part of my life, and I’m determined that it will continue to be. So as an entrée back into blogging regularly, I’m going to address the hot topic of the week: Deflation.