Happy 2013 from TTE!

Hi all, apologies for the delay in kicking off the year! 🙂

Welcome back to TTE in 2013, with a lot on the horizon not just for us but for the rest of the economy as well.

A few quick admin updates for now, before we start off 2013’s articles:

  • TTE is one year old as of 31 Dec! We hope you continue to keep checking back and reading our articles, we will be bigger and better – and hopefully more frequent! – this year.
  • We’ve had a change in our author line-up. JW and Dhruva are now our advisors, and will occasionally guest write, so keep an eye out for these! Jin Tik joins us officially as a regular writer, so please also look forward to more articles from him as well.
  • We will be launching a Facebook and Twitter account soon, so you can be updated through your favourite social media channels as well, and interact with us in an easier way than before.
  • TTE articles have been reposted over the past year on many other avenues, including UKEC’s CEKU, and the Asian Broadcasting Network. Thanks all, for spreading the pull-tea love!
  • We are constantly on the hunt for many new writers this year – if you’d like to guest write for us, please drop us a line!

 

Budget 2013: Eh, This is Not So Bad Lah!

With the next General Election on the horizon, Budget 2013 naturally attracted more public scrutiny than usual across the political spectrum. The political stakes are high as the central government attempts to establish an electorate-friendly yet fiscally responsible budget. I am no BN sympathizer or PR supporter, but at least on paper, I actually find Najib’s Budget 2013 reasonably progressive and sensible. Of course, several fronts remain work in progress, the biggest of which, is the progress towards cutting fiscal slippage or so-called “leakages”.

The primary concern on our minds: does Budget 2013 help or detract us from debt sustainability? As terrifying as it sounds, the fact that Malaysia has one of the largest fiscal deficits in the region does not really address this question. A simple, albeit rough quantitative method to do so is to determine a sustainable budget deficit ratio, defined by the product of the projected nominal GDP growth and the current debt-to-GDP ratio. The budget can be deemed as fiscally sustainable if the actual deficit ratio does not exceed this ideal deficit ratio. Assuming a median estimate of 7.8% nominal GDP growth (sum of 5.0% in real terms and 2.8% in inflation) and the latest debt ratio of 52.6%, we see that the sustainable deficit ratio of 4.1% (7.8%x52.6%) is marginally above the 2013 fiscal deficit target of 4.0%. Obviously, the margins are tight in this analysis, and if the government fails to deliver the necessary growth results, a 4.0% fiscal deficit will be insufficient to reduce the debt ratio.

Other indicators also suggest that for now, Malaysia’s public finances remain fiscally stable. First, the government projects to run an operating surplus of around RM2.15 billion next year, although this figure has shrunk gradually over the past decade due to the general outpacing of operating expenditure growth over tax revenue growth. Second, Malaysia is still running a current account surplus (latest figure of RM9.6 billion in Q2 2012). This does allow the government to spend a little bit beyond its means without triggering harmful inflationary pressures. The worry here is the slower export growth this year due to weaker external demand, and as such, the government still has to be fiscally vigilant to prevent  a “twin deficits” (trade and budget deficits) scenario that could undermine the Ringgit. And finally third, we have a very favorable federal debt structure. According to Bank Negara Malaysia, our foreign debt currently stands at RM16.9 billion, a mere 3.6% of the central government’s total current liabilities. None of the external debt is short-term as well, providing the Najib administration more breathing space to implement its investment-driven development agenda.

Alright, time to move on to the specific contents of Budget 2013. As expected, subsidies will be a major driver of operating expenditures again, constituting RM38 billion or 15.1% of the budget. Barring any major spikes in energy prices (and fiscal slippage), the subsidy bill in 2013 could actually be lower than that in 2012, which is projected by the Ministry of Finance to hit RM42.4 billion. I also appreciate the move to gradually replace inefficient, blanket subsidies with targeted subsidies. While it is too soon to expect the termination of subsidies on the widely-used RON 95 grade of petroleum, the government did call for the subsidy on sugar to be reduced by RM0.20 per kilogram. Other financial assistance appear to be more industry or income-group specific. For example, the government intends to subsidize RM20,000 for each unit of low and medium-cost apartments built under the Rumah Mesra Rakyat program, while loan interest rate subsidies will be provided to groups ranging from bus operators to youth entrepreneurs.

Budget 2013 also reveals the government’s intention to be less reliant on oil, which currently contributes about a third of its annual revenues. The plan to transform Malaysia from an oil producer to a high-tech, integrated trading hub for oil and gas might help that cause. Personally, I think that this is a very promising strategy, given that vertical integration would allow us to both manage the costs of oil production and move up the value chain in the energy sector. To attract foreign investment and the appropriate talent, the government will roll out investment tax incentives for oil refiners and liquefied natural gas (LNG) traders.  Another major project is the Tun Razak Exchange (TRX), a potentially vibrant regional financial center. If effectively implemented, the TRX could further expand services growth in Malaysia and reduce our dependence on oil. The biggest challenges of these ambitious projects are once again, minimizing fiscal slippage and coping with regional competitors such as Singapore.

In the past, some have criticized the government for failing to address the needs of the urban, middle-class segment. The rising costs-of-living coupled with stagnant wages have financially strained young working professionals in urban areas, at times to unbearable levels. I think Budget 2013 has fared slightly better in this compartment. I certainly welcome the government’s plan to build not just low-cost houses, but medium-cost houses that cater to the middle-class population in major cities in the country. The increase in real property gains tax should also help to stem speculative investment and slow the rise in housing prices. I was pleasantly surprised by the decision to reduce personal income tax rates by 1% for the first RM50,000 of chargeable income. Although this move does free up more disposable income, I suspect that it will be more difficult politically to raise income tax rates again should the time come for tougher fiscal consolidation.

Overall, I am quite satisfied by the contents and the principles underlying Budget 2013. Personally, it is reasonable to expect an “election budget” this time around, but I do think that Budget 2013 is balanced in terms of providing adequate safety nets and exercising fiscal responsibility. Unfortunately, the government does not have a track record of seamless implementation. It will take much political will to crack down on fiscal slippage that could threaten to unwind this otherwise sound budget plan.

This article reflects the personal opinion of the writer and does not reflect the official stand of Teh Tarik Economists (TTE) or any of the writer’s professional affiliations. 

No Skills or Low Skills?

The papers last week hinted of an important clue that should have been picked up in 2008 when the New Economic Model was tabled.

In the article titled “Economy too dependent on Form Five education level, says IKIM DG”, 80% of the economy was said to be too dependent on workers who had SPM, presumably as a minimum qualification. While he goes on to say that SPM-level workers may not be able to contribute due to their lack of skill, the keyword here should be ‘dependence’ -which can be taken to mean that jobs are being created that require no more than the basic rudimentary skills expected from a high school graduate. Which, really, is not very much to speak of.

In contrast, 2 years ago, the argument was about how the supply of university and college graduates was insufficient in Malaysia, thus impeding our move towards a highly skilled workforce.

The distinction is immediate: while the most recent article hinted at a possible lack of demand for university graduates, much of the discourse for moving towards a knowledge-based economy in previous years has been focused on increasing the supply of these graduates further.

Identifying the right scenario is important in deciding which policy path to take, which simple economics can illustrate.

An economy that focuses on the production of goods and services requiring low specifications and technical expertise is well-suited to the use of low-skilled workers, as opposed to their higher-skilled counterparts. This is common in emerging economies which continue to make the most out of a marketplace for goods and services sold on the basis of low cost and low wages. A low-skills equilibrium environment is created, which then reinforces itself: a lack of demand for highly skilled workers results in a diminished focus on producing these workers and/or providing more jobs suited for this category, which then leads to a further lack of skilled workers.

In this situation, arbitrarily increasing the supply of labour that is not in demand will not only reduce the average wage a worker can expect to attain – i.e. the worker’s value in the economy, now that there are more of them – but also increases overall unemployment.

Which, then, is the most accurate description of Malaysia’s labour market?

Data below illustrates job vacancies in Malaysia for May 2012, adapted from the Ministry of Human Resources’ Labour Market Report (click to enlarge):

This paints an interesting picture. A paltry 2.2% out of some 124,899 jobs available were in technical, professional & scientific activities – the ones requiring the most skilled members of the workforce. In contrast, the top three sectors with the most vacancies were agriculture, manufacturing and construction – eyeballing these three categories in the January 2012 data reveals that the picture was similar even 5 months ago.

The MOHR also provided data on vacancies for graduates by industry – and these, too, are interesting. In May 2012, the most jobs available for graduates were in construction with 1,788 jobs.

Meanwhile, supply data reveals that 30% of active registrants by education level comprised degree-holders. These and diploma holders (the third highest proportion in the workforce) make up a whopping 54% of registrants – a number that appears to suggest the opposite of a shortage in skills.

Could this, then, be an indication of a potential low-skills equilibrium in Malaysia?

A Simple Framework for Analysing the Sexiness of a City

By Nicholas Khaw

“Start spreading the news
I am leaving today
I want to be a part of it
New York, New York.”

– Frank Sinatra

“In New York, concrete jungle where dreams are made of
There’s nothing you can’t do
Now you’re in New York
These streets will make you feel brand new
Big lights will inspire you,
Let’s hear it for New York, New York, New York.”

– Jay-Z and Alicia Keys

When I was applying for college admissions way back in 2004, I confess, readily, that one of the major factors in deciding to which colleges to apply was if that particular college was located in a city. I’m a city kid, through and through, and I’ll happily state it unabashedly. Like a colleague of mine says, “There‟s a reason why Candace Bushnell did not write Sex and the Village: cities are sexy.”

The thing is, back in 2004, I never really understood the appeal of cities for me. I mean, sure, there were loads of things to do in a city. Way more options than in a rural area, certainly. But I never had a real analytical framework for understanding the sexiness of a city.

 Cue: Urban Economics.

Happily, while there are portions of economics that can be seriously dense and unnecessarily complicated, the basic analytical framework for Urban Economics is very straightforward. It’s taken from Edward Glaeser, a Harvard Professor and career city-vangelist, who recently crafted “The Triumph of the City”, where he argues that the “city” is humankind’s “greatest invention” and that cities make us richer, smarter, greener, healthier and happier. There’s a lot of “-ers” for one “invention.”

And so, with respect to cities, Glaeser states,

 “Economics judges policies by whether they increase the choices available to people, not on whether they help rebuild a particular locale. Economics does not preclude place-based policies, such as urban redevelopment, if they are the best way to help people, but economists do insist that these policies be judged on whether they improve individuals‟ lives, not on whether they make a place more pleasant.”

So, what is a measure of how much satisfaction a given person can derive from a given city? Well, hey, surprisingly enough(!), Glaesar the economist says, a utility function, of course!

Total Utility (Satisfaction) = Income + Amenities – Housing Costs – Transportation Costs

Granted, this is clearly a simplification but in terms of a basic analytical framework in which to think about cities, this is mighty straightforward. You can cover pretty much every aspect of living decision within this framework. More income is good, so you get higher utility. More amenities, which include stuff like healthcare, education, issues of liveability, are good, so you get higher utility. Higher housing costs are bad, so you get lower utility. Higher transportation costs are bad, so you get lower utility. Take the net effect of all these, and ta-da, you have a solid basic framework of considering the value of the city.

In cities, income is generally higher. The reasons for this have been proven empirically – cities have higher productivity, attract high-skilled individuals, drive most of productivity differences, and attract skill-intensive industries. Naturally, income is higher. For amenities, well, it’s straightforward – a more densely populated region (a city versus, say, suburbia) would require more healthcare specialists, more security, more places of entertainment and culture to serve the large population.

But, of course, on the flipside, since there is high demand for cities, we would expect the price of the city – essentially, the costs of living in a city – to be high as well. However, while these costs are high, empirical studies undertaken by the Economist Intelligence Unit (EIU) show that expensive cities are still competitive. By competitive, the EIU means a city’s “demonstrated ability to attract capital, businesses, talent and visitors.” Indeed, 8 of the 10 priciest cities in the world rank in the top 16 in global city demand, based on the EIU’s Worldwide Cost of Living Survey and the Global City Competitiveness Index.

What does that tell us?

Well, if we assume that people are (largely) rational, they would not live in a place where they derive negative utility. So, we should expect that the benefits from higher incomes and greater amenities outweigh the housing and transportation costs associated with living in a given city. And since, cities tend to cost more (but are still in high demand), it follows that cities provide larger benefits in terms of income and amenities, thereby giving utility of zero or more.

Of course, this is not to say that there is negative utility accruing to living in rural areas. And I am positive that people living in rural areas are just as rational as those living in urban areas. Given that, this must mean that there are people who derive positive utility from living in rural areas as well. However, the world is urbanizing. Fast. In 1900, 13% of the world lived in cities. In 2007, 50% of the world lived in cities. By 2020, something like 60% of the world will be living in cities.

If we assume that people are just as rational as one another, this means that more and more people have been deriving greater utility from living in cities than living in rural areas and this trend looks set to continue. Otherwise, why live in an urban area?

So, thanks to Edward Glaeser and Urban Economics, it is much easier for me to see now why I’m such a city kid. Cities are sexy. From New York to Paris to Tokyo to Kuala Lumpur to Gondor to Metropolis, the city is, in Sinatra’s words, “King of the hill/Top of the list/Head of the heap.”

—-

Nicholas Khaw is currently a practising economist at a local investment house.

Malaysia Endorses Jeffrey Sachs

For the Presidency of the World Bank (site).

Differing from the International Monetary Fund, the World Bank is often associated with matters of economic development – especially with regards to poverty reduction. Throughout its existence, it has received both flak and praises on an entire array of issues. One of thorny issues is the implicit agreement that the person running this institution “must” be an American – or at least backed by the United States. There has been a growing clamor for the selection process to be a little more inclusive, meritocratic and transparent. In a world where the developing nations are taking a larger burden in shaping the world’s agenda, it makes sense that they should at least have a shot at the top job. After all, they are still the major recipients of this institution’s work.

Source: here.

I don’t understand the politics behind Malaysia’s endorsement of Jeffrey Sachs, considering the candidate isn’t even the official choice of the United States (at least not yet) nor has he received many nominations himself. As of now, only three other nations have endorsed him: Kenya, Timor-Leste and Jordan (correct me if I missed any.) I would have expected Malaysia to go for Indonesia’s former Finance Minister, Sri Mulyani, who I personally think is a rather deserving candidate herself. There is an interesting site to visit if you’re interested in the ongoing race for the Presidency of the World Bank: World Bank President.

There are no qualms as to whether Jeffrey Sachs is qualified for the job – he is, though whether he’s the right person is an entirely different question altogether. It’s just that on a cursory glance, both the World Bank and the IMF face a growing challenge of legitimacy. Institutions of their sizes cannot claim to be the stalwart of the global interests if a majority of their clients feel that they have very little say on how things are run. Perspective and expectations matter in economic policy.

I would have opted for Lula (former President of Brazil) or Mulyani. Just because I think it’s time to have a breath of fresh air. That’s only my opinion.

After all, who listens to a low-fat-ketupat anyway? 🙂

Yay, FDI FTW! Wait a minute…

I rarely care enough to think about domestic issues in Malaysia, but a severe bout of college “senioritis”[1] has led me to this intellectual exercise. My attention is turned to Lynas, an Australian mining company that plans to set up a rare earth refinery plant in Gebeng, Pahang. At this juncture, the core of the dispute appears to be the refinery’s impact on public health and the environment. With the government’s decision to grant Lynas a Temporary Operating License, this issue has never been more politically-charged. I am going to “conveniently” ignore the health/safety dimension here, not because it is unimportant, but because there is little to add to a technical discussion that remains unresolved even among the experts. It is probably more fun to poke into the economics of the issue.

So how does Lynas justify the refinery plant economically? From the onset, it attempts to impress with big numbers. According to Lynas, the RM700mn operations will turn Gebeng into a major rare earth hub – one that is projected to meet a third of the global demand for rare earth materials within 2 years. By attracting advanced chemical companies to set up shop near the refinery, Lynas also claims a regional multiplier effect of at least tenfold. This would ideally spark the virtuous cycle of job creation, asset reflation, and capital reinvestments. Perhaps the biggest revelation is this – the refinery’s annual export is estimated at over RM5bn, a cool 1% of the nation’s GDP! Surely, that would be a huge boost to our aspiration to become a high-income nation by 2020. Has Christmas come early for Malaysia?

Well, I have my reservations. One crucial caveat to note is that Lynas secured a fat 12-year tax break from the government for the refinery. This represents billions of lost corporate tax revenues over the next decade – tax revenues that could have helped build infrastructure for complementary industries or lower income/sales taxes that affect Malaysians more directly. More importantly, this tax exemption substantially curtails our opportunity to raise income per capita via Lynas. The firm now gets to retain all of its earnings, which when repatriated back to its home country, actually contributes to the Gross National Income (GNI) of Australia, not Malaysia. One may easily conflate between the two, but GNI is the indicator (not GDP) that gauges our progress towards hitting the USD15000 per capita target by 2020. While it contributes to domestic output, foreign direct investment does not necessarily create localized wealth effects, especially if the government forgoes a chunk of the firm’s capital returns.

What about employment then? Doesn’t the refinery plant create jobs for its surrounding community? Yes, but only on a small scale. The refinery plant, also dubbed as the Lynas Advanced Materials Plant (LAMP), requires only 350 skilled workers. Compared to the thousands of livelihood that might be at stake, this figure is miniscule. Not to mention, rare earth refining lies relatively low in the sector’s global supply chain, preceding more value-adding activities such as R&D and manufacturing. The upside is no different from that of helping Intel or Dell to assemble chips and laptop computers. The downside however, is potentially daunting. Since our engagement with Lynas is in the commodities sector, the financial health of the refinery is susceptible to the fluctuations in the price of rare earth minerals. The fact that rare earth minerals are traded in private markets, instead of exchange-traded markets makes price monitoring and hedging activities even more difficult.

And now to the extraordinary claim that the Gebeng refinery would generate a tenfold multiplier effect. This projection substantially exceeds the baseline projections of typical industrial projects, which usually range from 1.2 to 1.4. Unless Lynas can single-handedly create a thriving, mega cluster of suppliers, competitors and consumers, in other words – a Silicon Valley of rare earth players in Malaysia, I am skeptical of the refinery’s multiplier effect. Indeed, commodities-based operations usually yield lower multiplier effects due to the little need for locally-manufactured components. Besides, the industry for rare earth processing and manufacturing barely exists in Malaysia. It is hard to imagine then, how new industry players could converge in the Gebeng locality, considering the potential lack of core competencies and other barriers to entry into the industry. If anything, Lynas would probably be vertically integrated throughout its refinery operations and operate alone in the area.

Economic analysis – a game of assumptions…

Based on my personal analysis, the economic benefits of setting up the refinery plant appear to be exaggerated. Then again, economics is a game of assumptions. One could always justify the construction of the refinery by tinkering with a favorable set of counterfactuals. The point is – conceptually at least, building that plant may not be a good idea.

[1] A dramatic loss of academic motivation that plagues graduating university students, caused by the possible illusion that one’s CGPA is (pretty much) set in stone and/or a premature anticipation to post-graduation plans, for better or for worse.