Minimum Wage Revised Part II: Some Evidence on Wages

Part I dealt with some of the criticisms of the minimum wage. Part II here will look at some of the data around the impact on wages and prices. For a look at the impact on employment, see this old post.

How do wages react to an increase in the minimum wage? To try to answer this question, I'll use some estimates from the EPF on wages at various parts of the distribution. To my knowledge, I've only shown this particular data in public just once before, and that was many years ago. Since then there has been multiple revisions of Malaysia's minimum wage, with varying results at least in terms of boosting wages, as you shall see.

Minimum Wage Revised Part I: Theoretical Considerations

So the government has finally announced a new revision to Malaysia's minimum wage, two years after the last one. This time though, it's a whopping 25% increase to RM1,500, from the RM1,200 in 2020. Even after all these years (nine to be exact), the minimum wage continues to be the subject of a lot of arguments, so I thought I'd lay out some of the theory and Malaysian evidence (such as it is).

First of all, what we learned in Econ 101 is that when you establish a price above that of the market determined price, quantity supplied increases while quantity demanded decreases, and the market does not clear. In the context of labour, this implies higher unemployment, as more people are willing to work, but less employers can afford to take them on. But in empirical studies, this generally does not happen with the minimum wage. Why?

An Alternate Measure of Inflation

The US likes to go its own way on many things, from using the imperial system of measurement (feet, pounds, miles) to American Football. In monetary policy, the Federal Reserve - which itself is an awkward conglomeration of 12 privately owned regional banks rather than a properly constituted central bank - uses Core PCE inflation as its primary policy target, unlike virtually every other central bank in the world, which use the Consumer Price Index. Since I was playing around with the GDP data, I'd thought I'd might as well do a comparison for Malaysia. It turns out there's not a whole lot of difference, but what differences there are, are really interesting.

First some theory, and why differences exist between these two measures. The CPI is fixed basket of goods and services, where the choice of components is determined by a household expenditure survey at some reference period. Holding the basket constant allows for clear measurement of changes in costs, and the basket is periodically revised to take into account changes in consumption. The PCE price index isn't a fixed basket, and components are effectively whatever people happen to be spending on right now.

The plus point is that this takes into account substitution effects, as people will switch away from goods or services where prices have increased to lower cost alternatives. This is especially important when there are large swings in prices (either up or down), as the CPI would tend to ignore such changes and thus overstate or understate actual inflation. On the debit side, this difference really muddies the water when trying to measure changes in living standards, as substitution does not imply there are no changes in quality.

The Drivers of Inflation

What is driving inflation in Malaysia? For the last four months of 2021, the CPI jumped a full two points, or 1.6%, which is equivalent to an annualised increase of 5%. That would mark the strongest annual inflation reading since 2008, when the lifting of price controls on RON95 petrol saw it hitting RM2.70.

If you read yesterday's post, you'll suspect its food and petrol, and you would be mostly right. There is however some nuance here. To satisfy my curiosity, I cut the data based on different time periods, looking at the contribution of each COICOP category to total inflation:

The Contours of Inflation

This has been the hot button topic of the year, pretty much everywhere around the globe. Inflation has accelerated in many countries, but at very different rates. Regardless, there has been a general withdrawal from both fiscal and monetary stimulus across both developed and developing countries, though the results remain to be seen.

Before getting into any analysis, this is what inflation in Malaysia looks like (log annual and monthly changes; 2000=100):

For those coming across this for the first time, I generally track inflation via four different indices: the CPI and PPI from DOSM, a core measure that excludes food and transport, and a pain index that is only food and transport. I haven't talked much about the PPI in the past, but I'll include that in a future post because in this particular period, it's quite important. Also, my core measure is slightly different from the one compiled by DOSM, but they're pretty close.

The first and most important point from the chart above is that overall inflation in Malaysia is roughly back to its long term average. The second important point is that it is almost exclusively food and transport that is driving the increase in the price level. Core inflation has also been rising, but nowhere near to the same extent and its also been going up in fits and starts, not a steady continuous rise.

Here's looking at the three indices from a level perspective (2000=100):

Looking at the raw levels is always useful, especially when you get structural breaks in the data (like yes GST, no GST, or a sudden pandemic).

Note that core prices, ie everything but food and transport, has not seen anything like the increase in those prices. A second point is that the steepness of the line for core prices has been relatively flat for the last five years or so. Inflation (the rate of change of prices) is evaluated as the slope of the price index over time, so a flatter slope indicates weak price pressures. All that is rather telling, pointing to weakness in domestic demand generally, even with the slight uptick in the most recent data. The indications are that inflation is Malaysia is being driven by external prices, not domestic pressures.

In the queue after this, delving into national comparisons, theory, empirics, and MMT.

Technical Notes:

CPI data from DOSM

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.

Stuck in the Middle

The Deputy PM thinks middlemen are the culprits for high prices (excerpt):

Zahid: Higher prices of goods and services the work of 'cartels', not GST

BAGAN DATUK: The rise of market prices were not caused by the Goods and Services Tax (GST) but the actions of middlemen and “cartels” who manipulated prices for their own gain.

Deputy Prime Minister Datuk Seri Dr Ahmad Zahid Hamidi, who is also chairman of the National Cost of Living Action Council, said these middlemen and cartels also made things worse by accusing the government of raising the prices of goods and services when it was they who were the ones responsible.

“They blame GST as the main cause, but these cartels and middlemen are the ones who, before this, avoided paying the Sales and Service Tax (SST). It is because of these people that the government decided to (do away with SST and) implement GST….

…Zahid said it was true that there had been an increase in production, import, foreign exchange costs at one time, but this was due to the fact that the ringgit had fallen against the dollar.

However, he said, the ringgit had now risen against the Greenback but the prices of goods had yet to come down.

Despite the “cartels/middlemen” explanation being a fairly widespread belief, I’d like to see some evidence for it first. While the DPM might be using this to deflect the perfectly valid point that GST is not wholly and certainly not primarily responsible for higher prices, I don’t see it reflected in any of the (patchy) census data on distributive trade. If this was true, profits (value-added, less wages) in the wholesale/retail sector should be rising. Instead, margins have been declining, largely due to higher wage bills.

That last point is mostly wrong too. Based on the interaction between prices and the exchange rate, there has been very little passthrough of exchange rate movements into domestic prices, which implies margins shrank when the Ringgit declined, and just reverted to “normal” as the Ringgit regained value. This isn’t to say that there hasn’t been isolated cases of direct passthrough into prices (I’m looking at you, Apple), but there hasn’t been a general wave in that direction. Moreover, the exchange rate should be completely irrelevant for prices of services.

What disturbs me most about this, however, is that the last two times I’ve heard this sentiment being publically aired by a top government official was in Zimbabwe and Venezuela. Both were cases of hyperinflationary environments, and governments who’d prefer to scapegoat rather than address the real causes of price increases.

Would addressing distributional inefficiencies and monopolies/oligopolies reduce prices? If they exist, quite possibly. However, any such improvement would be a temporary one-off reduction in the price level, and won’t change underlying inflation.

More on Seafood Prices

Nobody can deny inflation in food prices, and seafood is a major contributor to that. The biggest reason behind seafood price inflation is a supply-demand mismatch – the world as a whole is eating more than the seas can provide, with obvious long term consequences unless this is managed. But China is a major factor behind that mismatch (excerpt):

China's Real Offshore Disaster
There isn't much left for a million tons of light oil to kill.

Last Sunday's sinking of an Iranian oil tanker 180 miles off the coast of Shanghai certainly looks like an environmental disaster. Depending on how many of the ship's 1 million barrels of condensate were released into the ocean and not burned off, the accident could end up being one of the biggest oil spills in half a century. The irony? Even that wouldn't represent the biggest disaster to befall the area.

The fact is, thanks to massive overfishing in China's territorial waters, there isn't much marine life left to kill in the disaster zone. According to He Pemin of Shanghai Ocean University, those waters have been so denuded over the last three decades that fishermen "normally bypass the area and go further afield for a bigger catch."

It's a dark twist to an accident that has the potential to send oil drifting to the California coast. And it should encourage the Chinese government to rethink how it manages its marine environment. The need is urgent: China's hunger for seafood is fast outstripping its domestic resources. Consequences already loom, including food inflation, a depleted environment for the hundreds of millions of Chinese who live along the coast, and rising international tensions.

Chinese fishermen traditionally concentrated on inland and coastal waters. But as the economy opened up in the late 1970s and private fishing fleets grew in size, those areas were quickly fished out.

Seeing the industry as a jobs creator, local officials were loath to restrain it. The national government didn't do much better. Instead of crafting policies to sustain inshore fishing (by controlling catches and combating massive coastal pollution, for starters), authorities offered subsidies and technical support to help fishermen venture further offshore into the East China Sea. (The money also supported other "blue economy" industries such as shipbuilding and offshore drilling.) In 1985, just 10 percent of China's catch was netted in those far-flung fishing grounds; by 2000, it was 35 percent.

The shift was driven by a massive jump in China's seafood consumption as its population has become more affluent. Growth has averaged 7.9 percent annually since the late 1970s. Chinese seafood consumption increased 50 percent in just the last decade, to 62 million tons annually. That accounts for nearly two-thirds of global growth.

Lesson 1: Unless we do something to manage fisheries on a sustainable basis, the situation will only get worse.

Lesson 2: Politicians can say what they like, but no amount of fiddling with taxes or the local economy will make a difference. This is a global problem and needs a global solution.

Housing, Inflation and the Cost of Living

I came across a couple of really good articles over the last couple of days on the subject of housing, inflation and GDP that I wanted to share (jump to the end for a summary of both articles).

First, the treatment of housing in the construction of the Consumer Price Index, which is commonly used to measure inflation (excerpt):

Headline inflation measures shouldn’t ignore costs of home ownership
Mojmir Hampl, Tomas Havranek 12 September 2017

Statistical offices of many countries measure the costs of home ownership by computing imputed rents, which are then included in headline inflation measures. This is the case for the US, Japan, and Switzerland, among others. In contrast, the harmonised index of consumer prices (HICP) – the EU’s most important inflation statistic – excludes owner-occupied housing, for the technical reason that imputed transactions are inconsistent with the definition of the HICP, and a more complex approach based on net acquisitions would be required (Eurostat 2012, 2013).….

…Because house purchases involve a substantial investment component, their inclusion in headline inflation makes many statisticians uneasy. Conceptually, however, homes are a special case of durable goods, because they provide a claim on a stream of future services. Cecchetti (2007), for example, showed the long-term capital gain from home ownership is very small….

Teaching Moments

Angst over GST seems to be rising, or at least being more deliberately aired. I’m feeling like a broken record (for those under the age of 40, this is what that phrase means).

First up (except):

On Bruce Gale’s Najibnomics
By TK Chua

…The author wrote as if 1MDB, FGV and the controversial Arab donation are trivial matters. Are these not matters closely related to the poor governance, malfeasance and lack of confidence that the country is facing now? How else is the management of an economy perceived to be in good hands if not through the manner in which public finance is managed?

The author talked about “inherited” problems, such as public debt, which is strictly not the fault of the current administration. It was due to a single year’s pump priming in 2009 when the present prime minister first assumed office.

Perhaps it is time for the author to look further afield – at off budget agencies, public enterprises and GLCs, the massive loans of which are guaranteed by the federal government. Perhaps he should also look at new loans to be disbursed soon on new mega projects such as the ECRL and other gateways, the viability of which are deemed doubtful by many….

Inflation Perceptions

The Guv on inflation perceptions (excerpt):

Why doesn’t inflation rate reflect cost of living? All about perception, BNM says

KUALA LUMPUR, May 19 ― Bank Negara Malaysia (BNM) suggested today that public perception of inflation tends to be higher than the actual rate, with the bias shaped by their personal experience of paying for food and transport.

This comes as the central bank announced a headline inflation rate of 4.3 per cent in the first quarter this year compared to 1.7 per cent in the previous quarter, owing to the hike in fuel pump prices and shortages of fresh fruit.

“Public perception of inflation is in fact influenced by frequently purchased price such as food. This item typically experience higher inflation.

“However household also spends on other items, such as clothing which are in fact experiencing price decline,” BNM governor Datuk Muhammad Ibrahim said in a press conference here.

This perception is also formed by spending on transport, a sector high price volatility, he said.

In comparison, Muhammad said the Consumer Price Index (CPI), or the inflation rate, is a reflection of overall price changes in economy that reflects average consumption of an average household.

I’ve been writing about this for years (latest here). BNM has also published an article in their quarterly bulletin that actually measures the degree of “misperception” (link here). The latter especially is worth a read. For a really deep look into the whole subject, buy the book!

Chart of the Week: Core Inflation and the Impact of GST

I was struck by a graph I saw the other day, and I’ve tried to reproduce it here. This is the still relatively new Core Inflation Index from DOSM (index numbers, log annual changes; 2010=100):

The graph of the growth (inflation) of the index is truncated because that’s more or less what’s publicly available, but trust me that the longer series shows core inflation at roughly 2% for the two years prior.

This shows very, very clearly the impact of GST, and fulfills the prediction I made nearly four years ago – GST caused an upward shift in the price level, but didn’t cause inflation (as narrowly defined by economists) to rise. It was purely a price level change, and didn’t change the slope of the index. The impact appears to be a roughly 1.8% peak to trough increase in the price level, in line with the MOF/BNM forecast.

Core inflation is currently appearing to accelerate, but that can’t be ascribed to the imposition of GST, which after all happened exactly two years ago.

Technical Notes:

Data from various Consumer Price Inflation reports from the Department of Statistics. NOTE: DOSM’s core inflation index excludes both highly volatile prices (certain seasonal foods such as vegetables) as well as petrol prices (which have been very volatile since the float in 2014). It also excludes prices of goods that are “administered” i.e. those whose prices are either fixed by the government (e.g. rice), or move due to changes in government tax policies (e.g. tobacco and alcohol). Therefore a presents a truer picture of underlying price pressures in the economy. Note that this doesn’t mean stuff doesn’t get more expensive, it just takes away the volatility in inflation, which makes it more useful for policymakers such as BNM.

The Return of Inflation?

A couple of things here:

1. Malaysian inflation will zoom this year. No, really, for real!
2. Uh, no, not really.

What’s with the two seemingly contradictory statements?

This is what we have up to January 2017 (log annual and monthly changes):

Explaining Inflation…Again

I had some input into an article the Malay Mail published last month:

Is there really a gap between the official inflation rate and reality? Well, yes and no

KUALA LUMPUR, Sept 5 — As Malaysia’s urbanites begin to feel the bite of soaring living costs, there is growing suspicion that the official inflation rate does not quite reflect the economic reality….

…So is there a gap between real consumer experience and official data? The explanation itself is quite technical but in short, it’s a yes and no.

On one hand, economists worldwide have long decried the method used to measure inflation—the consumer price index (CPI) — saying it is far from reliable.

Domestically, there have been debates about whether or not the CPI model accurately depicts the reality on the ground....

They only used some of my reply (because, as usual, it was long-winded), so I thought I might take the liberty of publishing my remarks in full:

Close But No Cigar

You’re nearly there Tan Sri, just a little bit further (excerpt; emphasis mine):

The alchemy of money
BY ANDREW SHENG

…When money was fully backed by gold, money was tied to real goods. But when paper currency was invented, money became a promisory note, first of the state – fiat money, supported by the power to impose taxes to repay that debt, and today, bank-created money, which is backed only by the assets and equity of the bank. The power to create “paper” money is truly alchemy – since promises by either the state or the banks can go on almost forever, until the trust runs out.

Never Reason From A Price Change: Inflation Edition

The quote comes from Scott Sumner, and I’m not using it in the original sense (identifying causality in a supply-demand equilibrium), but there’s a certain truth to it when applied to monetary policy.

There’s a lot of speculation in the market right now that Bank Negara will cut interest rates in the next two meetings of the MPC, largely because (1) political pressure and (2) the coming drop in inflation. I think (1) is nonsense (I see no evidence of it, nor have I heard anything), and (2) is mistaken.

This post is about point 2.

The Consumer Price Index: Updated and Revised

In case you missed it, last month’s CPI numbers from DOS came with some changes.

First, the basket weights and components were updated to reflect 2014’s Household Expenditure Survey. This included adding 32 items, and removing 12. Weight changes were also made – as I suspected might happen, the drop in crude oil prices resulted in a reduced weighting for transport costs. Utilities costs (rent, water, electricity and gas) saw the biggest increase in weighting.

Second, the approach that DOS had taken previously was to rebase the CPI series to the new base year (2015 in this case). Instead, this time they’ve added to their methodological arsenal by chain-linking the new series to the old 2010 series. Essentially, they’ve saved researchers a lot of time and grief by splicing the new and old series together, so we don’t have to.

Seeing The Forest Through The Trees

Of all the mind-boggling things to suggest (excerpt):

Forex broker proposes raising Malaysia's interest rates

KUALA LUMPUR: Cutting interest rates is not an option for Bank Negara to prevent further weakness in the ringgit, said international forex broker FXTM.

A better option for the central bank would be to raise interest rates, said its chief market analyst Jameel Ahmad….

…He added that interest rates in Malaysia were relatively low, at 3.25%, compared to Indonesia at 7.5%.

“If you cut interest rates, people are not going to be encouraged to keep their capital in Malaysia.

“So, any reduced interest rates will not help the ringgit at all,” he said.

Ringgit Fallacies: Imported Inflation and International Reserves

Another week, another multi-year low for the Ringgit. Since BNM appears to have stopped intervening, the Ringgit has continued to weaken against the USD, to what appears to be everyone’s consternation. There is this feeling that BNM should do something, anything, to halt the slide – cue: rumours over another Ringgit peg and capital controls.

To me, this is all a bit silly. Why should BNM lift a finger? Both economic theory and the empirical evidence is very clear – in the wake of a terms of trade shock, the real exchange rate should depreciate, even if it overshoots. NOT doing so would create a situation where the currency would be fundamentally overvalued, and we would therefore be risking another 1997-98 style crisis. Note the direction of causality here – it isn’t the weakening of the exchange rate that gave rise to the crisis, but rather the avoidance of the adjustment.

Pegging the currency under these circumstances would be spectacularly stupid. I’ll have more to say about this in my next post.

Assessing July

I’m back from my usual Ramadhan blogging break, and my, aren’t there lots of things to comment on. This will be a kind of omnibus blog post, covering some of the developments over the past month.

2Q2015 GDP Growth

A funny thing happened with the change in national accounts base year to 2010 – the economy all of a sudden got a lot harder to forecast. The usual indicators no longer seem to matter as much – for example, MIER’s confidence indices appear to have totally decoupled from GDP – which makes forecasting growth more than a little bit more difficult. IPI and trade remain good predictors, but their standard deviations have doubled and the forecasts are suggesting two completely different pictures of the economy.