Struggle for ethnic unity in Malaya after WWII (Pt 2)

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Category: British Colony

Published: Tuesday, 29 December 2009 05:14

Posted by Ariffin Omar

The Federation of Malaya Agreement of 1948 was just a political arrangement leading to the birth of a political entity. It did not create a nation state nor did it bring about unity ......

Read more: Struggle for ethnic unity in Malaya after WWII (Pt 2)

November 2007 Protest Gathering – A Wake-up Call For Need-based Affirmative Action

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Category: Dr. R. Thillainathan

Published: Monday, 23 June 2008 01:00

Posted by Dr. R.Thillainathan

I view the illegal gathering of 25.11.07 as a wake-up call. It consisted mainly of young and disadvantaged Indians. Unless their grievances are addressed their unhappiness may only get worse. The detention on 13.12.07 of the gathering’s organizers and advisors under the ISA is likely to turn them into martyrs and aggravate the situation. If they have committed sedition or treason as alleged it is best to try them in an open court. It is heartening in this regard to note that the 31 individuals who faced a few charges including attempted murder now face a reduced charge for illegal assembly, (partly and interestingly for lack of evidence).


I.An Analysis Of Issues & Problems

I.1Proximate causes of the protest gathering

There are many causes for the protest gathering. The government’s handling of matters related to Hindu converts and the demolition of very old temples had led to mounting dissatisfaction. I am not competent to comment on this but unless a solution is found sentiments will remain fragile. I will confine my remarks to economic matters.


I.2Under-investment in human capital & how to remedy it

Since 1970 the relative performance of the Indian community (IC) has deteriorated across many key performance indicators (KPIs). The decline was partly reversed in the 90s with respect to some KPIs but not with respect to the key human capital variable. This turnaround is therefore not sustainable as the IC’s under-investment in human capital persists and as the alienation of Indian youths is becoming an increasing problem.

On tertiary education, the % of Indians with tertiary education in 2004 was only 16.9% versus 21.1% for Chinese and 20.9% for Malays. For degree level education, the % of Indians was only 6.7% versus 8.9% for the Chinese and 7.7% for the Malays. In the second half of the 60s when I went to university, the relative position was certainly more favorable to the Indians. The IC has always invested more in human capital and less in physical and financial capital. Therefore its relative under-performance in the acquisition of human capital has been a source of great concern.

On basic education, the % of the labor force with primary and secondary education is more or less the same for all the communities. However there was an important difference. Fifty per cent of the Indian children (of working class background) have been going to Tamil schools at the primary level for many years now. The pass rate of Tamil school children in mathematics and science, which are common subjects in all schools, has been around 75%. This is more or less comparable to the performance of kids in other mediums (some of whom are middle class kids). However, the pass rate of Tamil school children has been only around 40% in Bahasa Malaysia. This high failure rate in BM has been the cause of the high failure rate of Tamil school children in the standard six examination for many years now.

Automatic promotion means all these children are able to continue their education. But at the secondary level, the medium of instruction is BM and its level is also higher. Therefore on entry into secondary school the Tamil school kids face double jeopardy – continuing to do badly not only in BM but also in the mathematics and science subjects. Therefore these children invariably get relegated to the worst classes, loose interest, become alienated, some drop out and some end up taking to crime.

The high failure rate in BM has persisted for many years now. But the government has not addressed the problem as a key problem and by hiring better teachers or extending the contact hours for BM and motivating the children.

The government has been making massive investments in many business enterprises. It is not the business of government to go into business. Therefore some of the investments have been wasted with losses running into billions. On the other-hand it has been under-investing in education and training. I believe that, even if one over-invests in education and training, the risk of losses are a lot less. Therefore there is a very strong case for a sizeable increase in investment in education and training, especially since in many countries it is the business of government to provide good education. By redirecting its investment to education (and the provision of other basic services) the government can improve the quality of education in all schools including Tamil schools. That way we will be able to motivate as many children to acquire basic skills and knowledge to absorb on-the-job training for work in a modern economy, one which requires the application of a rapidly growing body of scientific knowledge in the production process.

I.3Unrestricted import of unskilled labor & its adverse effect on job mobility

Historically Indians were involved in plantations. Employment in this industry did not provide any scope for upward job mobility. Construction offers such openings. But the free import of foreign workers and their willingness to work under less favorable terms deprived the unskilled Malaysians including Indians of opportunity to move into this sector. Manufacturing also provides such opportunities. Better employment terms and need for a more stable labor force or restriction on entry of imported labor provided openings for unskilled Malaysians to enter this sector in greater numbers.

Training foreign workers may not be beneficial. Country looses the benefits of such training when these workers return home. A policy rethink is therefore in order. To encourage geographical mobility, government and community action groups must arrange for hostel accommodation, financial assistance and training for the workers making the move from the rural to the urban sector.

The unrestricted import of unskilled labor into Malaysia from 1990 has kept wages of low income earners down (thereby not enabling them to enjoy the real fruits of the country’s growth and development). It has also prevented the upgrading of the economy from labor to capital or knowledge intensive activities. This upgrading has not been commensurate with the rapid growth of the economy (as labor market policy was not right and as the workers had not been retrained to make the switch). And this is unlike the situation in Hong Kong and Singapore where restriction on entry of unskilled labor, unrestricted import of knowledge workers and focus on training and retraining enabled these economies to make the transition relatively smoothly. I believe it is still not too late for Malaysia to make the right choices. The country is relatively well endowed with the required funds to provide the training and retraining and ease the transition for the workers forced to make the switch. This will benefit all disadvantaged Malaysians including Indians.

I.4Performance by occupational groups

I now briefly look into how well Indians are faring in the various occupational groups.

The Indian share of doctors and lawyers is still well above its employment share. However its share of engineers, accountants, and architects is well below its employment share. As a result the Indian share of jobs in the broad professional and managerial categories is below its employment share. The situation will deteriorate further if existing government policies continue to favor the Malays (at the expense of other groups) through the active use of special residential schools and matriculation programs as well as the extensive provision of scholarships to facilitate the relatively smooth entry of Malays into local and foreign universities. If such a trend continues there will be even more Indians to swell the ranks of the disenchanted and disgruntaled and not just among the Tamils.

Indians were over-represented in clerical jobs in 1970. But by 2000 Indians were substantially under-represented in clerical jobs. Many clerical jobs (eg legal, accounting and audit) offer good prospects for formal and informal training and upward mobility. Under-representation of Indians in accounting and audit is a big drawback for those who cannot afford the high cost of formal education. Therefore it will be good if the government and the community can find ways of increasing the Indian share of clerical positions at least to its employment share.

Indians are better suited by temperament for teaching and nursing jobs. But they are substantially under-represented because the government is the big employer and hires bumiputras on a preferential basis. Therefore there is a need for a more balanced hiring to rectify the imbalance that has developed in recent years in these areas of employment.

I.5Low income earners & poverty

On the basis of data given in the 8MP it was possible for one to say lower income Indian households were better than higher income Indian households in relation to the growth in their earnings for the period reviewed. However there was no corresponding data in the 9MP for 2004 possibly because the income inequality worsened for all races between 1999 and 2004 (as suggested by the movement in the gini coefficient over the period). Further the least improvement was registered for Indians in poverty and there was no improvement in % terms for those Indians who were the hardcore poor between 1999 and 2004. This adverse trend suggest the need for the government to pay more attention to the needs of the poor including the Indian poor.

I.6Newspaper reports – some glaring errors

It is interesting to highlight in passing some of the glaring errors made by commentators and even the newspapers on the Indian economic position, including during the current crisis.

Dr. Chandra Muzaffar had claimed in the NST of Dec 12, 2007 that Indians are over-represented in the middle and upper echelons of Malaysian society. That is certainly a glaring error. I am not sure if he has got anything else wrong in his commentary that the NST carried. Of the total Indians employed, those employed as managers was 6.3% and those as professionals was 5.2% in 2005. Therefore he stated that the total employed broadly as managers and professionals was 11.5% as against their share in population of 8%. But this is not correct. To determine whether Indians are over- or under-represented, the number to look at is not 11.5% but a weighted average which is 5.8%. The corresponding figure for Malaysians as a group is 7.2%. Therefore Indians are under-represented by almost 20% in these two high-end occupational groups.

The NST of Dec 10th had stated in bold print that 19.4% of Indian employees are associate professors, lecturers and nurses. That again is not correct. Of that 19.4%, as per the 9MP, 14.9% were only technicians and associate professionals and only 4.5% were lecturers (including associate professors), teachers and nurses.

The NST of Dec 10th had also stated that 22.9% of Indian employees were sales personnel. That again is not correct. As per the 9MP, 13.3 % were sales personnel and service workers. And 9.6% were clerical workers.

I am prepared to accept that these errors are not intentional. But nonetheless the likes of Chandra Muzaffar must exercise more care in their assertions to maintain their credibility.


II. Priorities For Action

II.1 Case for Affirmative Action Program Based on Need

The Malay economic up-liftment in the post-1957 period has been attained via the government’s strong affirmative action program. With the single-minded focus of government Malays are now able to compete even on merit and get seats in educational institutions in excess of its population share. There is therefore a compelling case for a review and re-orientation of the affirmative action program to equalize opportunities of as many poor Malaysians as possible including disadvantaged Indians.

The majority of beneficiaries of any need-based program will still be the Bumiputras because of their sheer size and there are more needy amongst them. Under the current stance of the affirmative programs a lion’s share of the benefits are being captured by the well-connected elites of all the communities.

II.2 Equalizing outcome vs opportunities & issues related to efficiency & equity

In a multi-ethnic environment, how optimal is it to talk about over- or under- representation of Indians in the desirable things of economic life? Should one really work to equalize outcome? That is for an exactly balanced representation? If Indians are a bunch of under-achievers, are we than not likely to compromise the growth potential of the Malaysian economy if we opt to equalize outcomes? However, on grounds of efficiency and equity, one can easily justify opting for a goal to equalize opportunities – so as to level the playing field (as much as possible). Thus the granting of low or interest free loans to poor students can certainly be justified on grounds of efficiency as well as equity (as is being done presently). And given that education and on-the-job training is a key driver of economic growth, opening university admission to all qualifying students and under a scheme of financial assistance is also justified. And before we can say whether Indians are under-achievers admission into local universities should not be based on two types of exams – one on the STPM and the other on Matriculation. To be fair it is best to base it only on one type of exams or otherwise to ensure fairness all students should be given equal opportunity to enroll in the STPM or Matriculation programs. Further, as far as possible, the standard of teaching and facilities provided in all schools should be the same. As there are special residential schools, to level the playing field all students, and in particular the disadvantaged, should enjoy the same opportunity for entry into such schools (with adequate facilities for comfortable, mixed living).

II.3 Neglect of poverty groups & how to device programs to tackle problem more effectively

Devising affirmative action programs based on race has its limitations. It cannot address the needs of the really needy. By targeting say the Bumiputras as a whole (because their average income is lower than that of the non-Bumiputras) and not the poor Bumiputras (especially those in East Malaysia and Kelantan) we can end up benefiting those less in need of help. Similarly by targeting Indians as a whole (whose average income is slightly higher than that of the Bumiputras and because of the inclusion of small sub-groups who are much better off) we are not tackling the problem of the most needy amongst them. The most Indian needy are likely to be the unskilled casual laborers and those engaged in elementary occupations as well as single parents and those without birth certificates or citizenship (which prevents them from being enrolled in schools or from getting jobs in the organized sector).

If the affirmative action program is to be equitable, it has to be more targeted. The anti-poverty programs which target the poor peasants through land resettlement and double cropping irrigation schemes or input subsidies are of course more targeted. But a great deal of what can be done in this direction has already been undertaken (especially under the past Malaysia plans). However, apart from these schemes that target directly the poor peasants, there are no specific anti-poverty programs currently in place which address the needs of the poor and unskilled low income earners working as employees whether in the rural or urban areas. And as most jobs are generated in urban areas, the provision of allowance and inexpensive hostel facilities may also be necessary to support the move from rural to urban areas. (And the problem of those Malaysians without birth certificates or citizenship has also to be addressed on a priority basis to ensure that they go to schools or get proper jobs).

An increase in welfare payments is an option until the breadwinners are retrained and reequipped for more gainful employment in the wage sector or as petty traders (as is being done to an extent by the likes of MARA for some selected individuals and families).

The Mahathir era price support and control programs (whose cost runs into tens of billions of RM annually) are benefiting the most deserving only at the margin. It is time to review and rationalize these programs. The more targeted anti-poverty programs referred to above may only use a small % of the resources saved from the discontinuation or rationalization of the current inefficient and inequitable price support and control programs. And again only a portion of the remaining savings need to be utilized to invest and improve the education system that is necessary to prepare our students if they are to work in a modern economy and contribute to its continued growth.


II.4 Government’s target of balanced employment.

The government has been addressing the racial imbalance in employment by sector and occupation through the pursuit of growth-oriented policies (which have substantially increased the demand for workers), through the provision of education and training (to create the supply of workers with the requisite skills but a lot more needs to be done in this direction), as well as the aggressive employment of Bumiputras in the public sector and government-linked companies. The government has however refrained from imposing any explicit race-based quotas on employment in the private sector (for fear of its adverse effects on the investment climate and economic growth).

The combination of the above set of policies (and some biases) may have had the unintended consequence of squeezing out or causing the under-representation of Indians and other minorities (who have little or no political or economic power) in at least some areas of employment.

I am completely in favor of not imposing any race-based quotas on employment in the private sector. I do believe there is a case for more employment of minority groups in the public sector (from current levels) to address the problem of disadvantage as well as to make government more accessible to all (given the nature of services it provides). While there is a case for more balanced employment within the public sector, we must be extremely mindful in using it as an employer of last resort, as there has been a tendency to do in the post-1970 period, given efficiency and cost considerations.

II.5 Increased participation in business ventures

The track record of community-based business ventures in Malaysia is poor irrespective of the groups involved whether they are Malays, Chinese or Indians. Many in fact have been colossal failures. These ventures have failed even when the oversight of these ventures had been entrusted to eminent businessmen. Mismatch between cashflow and control rights and the absence of a market for corporate control may have led to the managers maximizing their private benefits of control and not necessarily shareholder value. Or the risk-averse bias may have made the directors and managers timid.

Given the poor track record of community-based business ventures, I am sure it is not the aim of any group to seek government assistance to promote or run such ventures. On the other hand, Indian individuals or families have been faring reasonably well in small business ventures. This has been so even in non-traditional areas of activities.

The government’s restrictive licensing practices has been holding back the progress of Indians in certain types of businesses. Therefore, the MIC and the community should continue to press the government (so long as such restrictive practices continue) for fair treatment in respect of those business centres or facilities that are provided or regulated by the government or government-linked companies e.g. wet/dry markets and highway shopping centres. Fair treatment means the Indians should be allocated licenses in urban areas proportionate to their population share. But the Indian share should be based not on the national average but on such factors as the demographics of the appropriate urban settlement, the profile of travelers on the highway and so on as the case may be.

Where the government is still directing credit e.g. small business loans or CGG loans, the MIC or the community should also ask the authorities for a fair share of the allocation for Indians. However, the extent of directed lending is a lot smaller from the 1990s. As the government has set up a bank to take care of the financing needs of small and medium scale enterprises or SMEs, then the MIC and the community can also ask for a fair share of such financing for Indian SMEs.

The Indian SMEs should also be introduced to the rudiments of modern business practices such as book-keeping and inventory control. Regular courses could be organized by MIC’s or MAICCI’s advisory unit on SMEs, which could persuade small businessmen to move into new lines of activities, update them as to the various types of credit facilities offered by the financial institutions and help them obtain licenses.

II.6 Increasing equity participation

We now turn to Indian equity ownership. The 8MP had targeted to increase Indian equity ownership from 1.5 to 3%. Instead as at 2005 it has ended up at 1.2%. The 9MP is again targeting a 3% share but by 2020.

In this context it is interesting to note that the 30% bumiputra equity target has been a non-binding target either because the requirement has been waived or because no firm time line had been set to achieve the target. In 2000, the Old Administration under Dr Mahathir Mohamed reset the bumi equity target to be achieved by 2010. But in practice Dr MM did not do anything specific to achieve the target. And as there was a significant shortfall as at 2005 the New Administration under Prime Minister Abdullah Badawi has reiterated the 30% equity target to be achieved by 2020.

It has been normal in IPOs for 30% of the issue to be reserved for the Bumiputras. But from the second half of the 1990s, the IPOs have been priced by a book-build and not at a pre-determined price-earnings multiple below the corresponding market multiple. Any reversal in IPO pricing to the pre 1995 period is highly unlikely. It will be a major set-back for the Malaysian capital market.

Given the government’s budgetary constraints of the late 1990s and early 2000s, the budgetary allocation for equity ownership programme has not been the same. And given the current global environment, any substantial increase in borrowing or taxes to step up such allocations can also undermine the competitive position of the Malaysian economy.

Given the change or constraint on the government stance, the best the MIC can ask is for the government to set up a Special Purpose Entity (SPE) for the Indian community (akin to the PNB), for 3% of shares in an IPO (initial public offering) to be reserved and allocated to this SPE and for the government to fund its operations for a specified period of time until such time as the SPE refinances its IPO shares through the setting up of a unit trust, again akin to the ASN. ASN’s marketing of its units on a nation-wide basis had been facilitated by the use of the network of offices of the Post Office as sales outlet. Many banks had also come forward to lend monies to the prospective unit-holders against the pledge of the ASN units. The banks were then prepared to engage in such lendings as the market value of the shares backing the ASN units were significantly above their subscription price and the dividends declared were not significantly different from the loan interest rate. But banks will be less willing to do the same now as the pricing of an IPO at its going market value will leave little or no buffer to the lending bank and the dividends declared may not cover the loan interest rate.

Where the Indian community feels a strong need to save and invest to increase its equity stake, it is best to do so by investing on a portfolio basis and passively. And to ensure that the market timing is not wrong, it is best to save and invest in the equity market on a regular basis. These decision rules are based on the time-tested findings of the best minds in finance.


II.7 Restrictive licensing practices promotes rent-seeking & not development – So it is not the way forward

Given the easy and seductive profits to be made (through the monopolization of supply or creation of contrived scarcities), there has been a tendency to build institutions that are geared to extract rent (and not necessarily to promote development) through the use of restrictive licensing practices.

Restrictive practices with respect to licensing requirement was broadened to cover entry into nearly all areas of economic activities in the post-1970 period. And after the accession of Dr. Mahathir Mohamed as Prime Minister in 1981, not only were import tariffs raised on certain goods but their imports were also subject (more extensively) to quota restrictions and APs had to be applied to import these goods (namely motor vehicles, sugar, flour, cement & drugs). With respect to award of contracts Dr M introduced negotiated tenders in place of competitive bidding.

It is true that extractive institutions only characterize some sectors of the economy. Nonetheless, the number of sectors/activities which are subject to restriction on competition/monopolization, through licensing or award of concessions, has been on the increase in particular from the 70s.

True not all sectors are characterized by extractive institutions. But institutions conducive for economic development were undermined during the Mahathir era. Thus even those sectors without any extractive institutions had become vulnerable. Owner managers can use a corrupt bureaucrat or judge to thwart competition or contract and hence undermine efficiency and growth.

The distribution bias in policy of the type currently in force in the country may be necessary to win political support and maintain political stability. But with a distribution bias, one captured by special interests, the risk to the Malaysian economy is not just one of under-performance. There is even the possibility that it may stagnate or decline.

By special interests, we refer to politicians from all political parties. By special interests, we also refer to businessmen from all groups. The driving force of a special interest group is to seek rent, or a share in rent, to seek monopoly right or a share in monopoly right as well as to seek contracts or a share in contracts.

And all special interests try to secure this special position through a restriction of competition or through a creation of an artificial or contrived scarcity and they are often opposed to the opening up of markets to competition.

Unless Malaysia becomes more open and less constraint by distribution (of the type we are referring to), there is a real risk that the prospects for the country to become developed by 2020 may be adversely affected.

R.Thillainathan

Past President, Malaysian Economic Association
(Some of the issues and remedies discussed in this Note were also raised in a dialoque with the Prime Minister on Dec 14, 2007. )

References

1. Iyngkaran, N. (2002), “A review of the performance of Tamil schools???, paper presented at the Conference on The Malaysian Indian in the New Millennium – Rebuilding Community in Kuala Lumpur on June 1-2, 2002.

2. Nagarajan, S. (2006), “Ensuring Effective Targeting of Ethnic Minorities: The Case of Low Income Malaysian Indians???, Paper delivered at the Workshop on Indians in East Asia organized by the Institute of South East Asian Studies (ISEAS) in Singapore on October 26-27, 2006.

3. Nagarajan, S. (2004), A Community in Transition: Tamil Displacements in Malaysia, PhD Thesis, University of Malaya, KualaLumpur.

4. Thillainathan, R. (2006), “A critical review of Indian economic performance in Malaysia & priorities for action???, paper presented at the October 2006 ISEAS conference. This is a revised and updated version of the paper presented at the June 20002 Millennium conference.

5. Thillainathan, R. (2005), “Indian participation in equity & business ventures – A critical assessment of strategic directions???, paper presented at the MIC Forum on Malaysian Indians & The Ninth Malaysia Plan, 20.2.2005, Kuala Lumpur.

6. Thillainathan, R. (1977), “The NEP – What is in store for the Indians???? paper delivered at the University of Malaya Tamil Language Society Forum on the same subject on 22.99.1977 and included in the Catholic Research Centre publication, Information & Formation, Kuala Lumpur, 1978.

Dr. R. Thillainathan is past president of the Malaysian Economic Association. He obtained his 1st degree from the University of Malaya and Masters and PhD at the London School of Economics.

Struggle for ethnic unity in Malaya after WWII (Pt 1)

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Category: British Colony

Published: Monday, 28 December 2009 11:27

Posted by Ariffin Omar

In our study of Malaysian history we are always told that the best approach for achieving unity in this plural society is the Barisan Nasional way........

Read more: Struggle for ethnic unity in Malaya after WWII (Pt 1)

A Critical Review of Price Control & Subsidies in Malaysia

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Category: Dr. R. Thillainathan

Published: Friday, 20 June 2008 01:00

Posted by Dr. R.Thillainathan

A Critical Review of Price Control & Subsidies in Malaysia

(A Note prepared for delivery at LSE Alumni’s Forum on Rise & Fall of Subsidies on 26.5.08)


The Forum is on the subject of the Rise & Fall of Subsidies. Under DrM the extent and size of subsidies widened and expanded. The framework he created for the control of prices of petroleum products was a time bomb. I am sorry it did not explode in his face. Instead it exploded in the face of his chosen successor PM DB. In the process it led to subsidizing consumption on a colossal scale and on an indiscriminate and inequitable basis. More areas of investment were also subsidized. Such investment subsidies is being further expanded under DB.

Production & consumption subsidies – nature, extent & implications

Historically, the economic and financial management of Malaysia has been generally prudent. Reliance on subsidies and price control was limited and very selective. But DrM was more radical with his price control experiment. An experiment that has turned out to be a nightmare for Malaysia and his successor. It distorts resource allocation, makes for inequity and threatens to undermine the country’s sacred legacy of fiscal prudence.

Before DrM subsidies were aimed at production and investment and not at consumption. A more serious problem with subsidies then – it was implicit and opaque and not explicit or transparent. Therefore it was less amenable to public scrutiny. And it made it more difficult to question the government on its subsidy program.

Investment activities that were subsidized heavily but implicitly were as follows:

- double cropping of padi (with irrigation provided free of charge);

- land development and resettlement (with the administration cost of the scheme not recovered from the settlers);

- provision of education (where fees charged were small relative to cost and more so for higher education) and

- key areas of manufacturing and tourism (where profits earned were exempted from tax).

As the padi farmers and settlers were amongst the poorest in the country, the subsidies extended to them were not wholly inequitable. University graduates and businessmen (in non-traditional areas) singled out for subsidies were less deserving no doubt. But in the first few decades of independence it may have been justifiable to subsidize graduates and businessmen given the high rate of unemployment and the critical importance of knowledge workers for development.

DrM greatly widened fiscal incentives (to cover agriculture and IT services) and expanded the size of implicit subsidies (by exempting profits earned over a longer period).

Dato Seri DB has also aggravated inequities. Firstly by widening the class of exempt investors. It now covers even those engaged in real estate development. And secondly by withdrawing the tax-exempt status of equity investments of workers with the EPF and of retail investors with PNB and the likes (by replacing the imputed system of taxation of dividends with a single tier system of taxation).

Let us now look at explicit subsidies. Its coverage and size was always limited until DrM’s time bomb exploded in DB’s face. The handouts under the school food & nutrition program are the only items of consumption that were subsidized and strictly in a limited way. Production inputs subsidized were fertilizers as well as (to an extent) credit in padi farming and textbooks for schooling. The payment of a guaranteed price to local padi farmers has been, until recently, more in the nature of a production and not a consumption subsidy. (See footnote 1 in the attached Annex Schedule). Now with a run-up in the world price of rice and a near unchanged guaranteed price, the padi farmers are likely to be the real losers and the licensed traders/importers the big winners.

DrM’s consumption subsidy time bomb took the form of the approved price mechanism (APM). He erected this back in 1982 for petroleum products. The mechanism maintained the price payable by the consumer to the government’s fixed (or controlled) price. To ensure that the producer received the market price, it adjusted the tax payable by the oil companies or the subsidy payable to them.

DrM was the lucky PM. During his long over-stay as PM, to maintain the fuel price (paid by consumers), only the tax rate had to be adjusted and little or no subsidy was payable.

DB was not so lucky. Since he became PM oil price has escalated, (partly thanks to the easy money policy of the US).

In 2008, assuming an oil price of USD100-120 pb, the fuel subsidy is estimated at RM18 billion and the tax forgone at RM7b. Therefore the total consumption subsidy to motor vehicle owners, the well-off in Malaysia, is a colossal RM25b.

In 2006, when oil price averaged USD70 pb, the total subsidy paid was RM10 billion. Of this RM7.6b was captured by motor vehicle owners and operators. This excludes the tax revenue forgone of RM7.3b.

In 2002, during DrM’s last full year in office, when oil price averaged USD25.50 pb, the total subsidy paid was only RM3.7b (of which fuel subsidy was probably RM2b).

DrM’s rotten legacy (with respect to price control and the resulting consumption subsidy) was not confined only to controlling the price payable by the consumers (to an arbitrary price it had fixed).

It also extended to a second type of price control – one aimed at regulating profit of utilities with monopoly power. A utility was permitted to increase its price provided the return on its capital was below the prescribed threshold return. However, under the Mahathir Administration, the maintenance of price of a utility (at an unchanged level), was accepted as an end in itself.

This applied not only to the utilities such as water, electricity and telecommunications but also to gas.

Petronas, which is the producer and distributor of gas in Malaysia, is required to sell it at a controlled price to the electricity generators at a price well below its international price. The Mahathir Administration had decided to control the price of gas because it was also controlling the price of electricity. This has led to cross-subsidization of not only electricity generators but also electricity users. It interferes with the smooth operation of the market mechanism and distorts resource allocation. To the extent that the subsidy is an off-budget financing arrangement it is more opaque and makes meaningful analysis of such arrangements more difficult

For an oil price of USD100-120 pb, the implicit subsidy from the control of gas price is estimated at RM20b.

It is staggering to note that now the consumption subsidy, and just for fuel, will far outstrip the development expenditure of the public sector. The fuel subsidy in 2008 is estimated at RM45b versus the projected total development expenditure of RM40b. Interestingly the RM200b 9MP development expenditure target was itself a record. The size had worried many economists on its likely inflationary or crowding out effects.


Fuel price control & subsidy – an inspired insight or a monumental folly

I am surprised that some had viewed DrM’s design of the APM as an inspired insight. It was in fact a monumental folly. Stabilizing the fuel price through an adjustment in duty (which offered in any case only a limited cushion) or through a subsidy payable, leads to the squandering of a scarce resource. And as this is a depleting resource the government failed to take into account the real risk of a continued rise or a sudden jump in price (as has certainly been the case from 2004). And once the public gets used to a fixed price, the government will find it very costly (except in a crisis) to raise the price, and hence remove the subsidy especially in a democracy, (again as is amply evident in Malaysia).

The massive subsidy for fuel (almost the only consumer good subsidized in the country) is enjoyed by motor vehicle owners and operators, the better off segment of society. There is no case for the granting of this subsidy. No such subsidy is being granted to non-vehicle owners and operators, the worse off segment of society. Only some users of public transport may deserve the subsidy but there are less indiscriminate and inequitable ways of addressing their needs.

The removal of the fuel subsidy will no doubt greatly increase the cost of owning and operating motor vehicles and force the less well off amongst them to use public transport. As the coverage and frequency of public transport services is not satisfactory this will greatly inconvenience this group. Therefore the removal of the subsidy has to be accompanied by a corresponding improvement in public transport, (both bus as well as mass transit rail transport including an effective system of feeder buses to support mass rail transport). And given the very bad state of traffic congestion encountered by road users in getting to their work place and back, priority should also be given to the introduction of urban congestion charge on road users. There is a strong case for the revenue collected from this charge to be spent on cross-subsidizing public transport. Of course the imposition of the congestion charge will immediately reduce the number of motor vehicles getting into the city. Public bus transport can be stepped up concurrently (which is not very difficult) to cope with the increased demand (with mini buses re-introduced to service commuters in the suburbs)

The removal of the subsidy will also impose a painful readjustment on energy-intensive industries or force them to become more fuel efficient. But this is something to be welcomed in the interest of building a more competitive and resilient economy.


An aside on DrM’s zero inflation target & price control

In passing it is also instructive to refer to a third type of price control - reliance on which was greatly increased by DrM as a means to achieve his so-called zero inflation target[1]. This form of price control was aimed at price maintenance as an end in itself, and applied to industries dealing in so-called essential goods such as sugar, cement, steel, motor vehicles and even chicken. To make price control more palatable to the businessmen, the authorities protected their profits by strictly regulating competitive imports or entry into these industries, and by allowing the businessmen to seek a price review based on changes in their cost of operations. This type of price control activity with import or entry restriction can expose the regulator to capture by the regulated.[2] It can enable the businessmen to charge a higher price or short-change on quality thereby undermining the welfare of consumers or the competitive position of other businessmen who are end users of the controlled products.[3] Where the authorities have been slow in allowing price adjustments in the face of major shifts in supply or demand conditions, such price control activities have led to shortages and black marketeering. This has been found to be the case from time to time in the cement and steel industries.

Where the Government control activity has taken the form of a severe restriction on imports regulated through the issue of import permits with a nominal regulation of prices, as is the case with the import of motor vehicles, this has led to abnormal profits in such distributive trades and intense competition amongst rent-seekers to capture such profits.[4] Rent-seekers are always on the lookout for opportunities to create contrived scarcities to earn monopoly rents. To eliminate such incentives and opportunities, the Government has to make a firm commitment to competition in all its economic pursuits.


Badawi Administration’s limited attempt at curbing growth in consumption subsidies

The Badawi Administration, after the general elections of March 2004, started raising the prices of petroleum products. But it halted this process from 2007, partly on account of some public disquiet and more in order not to prejudice its prospects in the subsequent general elections which it called in March 2008. Now that the elections are over it has no choice but to raise the fuel price and eliminate the unprecedented and massive subsidisation of consumption if the country’s legacy of fiscal prudence is to be restored.

In 2004, the total Government revenue was around RM100b. But only RM8.8b was generated from taxes on motor vehicles. However, petroleum products were enjoying a subsidy that year of RM4.2b. Less the subsidy net taxes on motor vehicles was only RM4.2b. In 2008 motor vehicle owners are likely to end up enjoying a subsidy on a net basis of around RM10b.

There is no case for motor vehicle owners, certainly a very well-off group, to enjoy such subsidies. There is also a strong case for the Government to subject the consumption of petroleum products to sales tax. The level of the sales tax on petroleum products in Malaysia is a lot lower than most countries, including those in the Region. At the current level of oil prices, the duty has to be waived. In fact the Government has to provide a substantial subsidy, in addition, to keep prices at the current level. Even if Malaysian consumers pay prices which reflect market prices and which includes the full Malaysian duty, the prices paid by Malaysian consumers will still be lower than overseas prices. Therefore, in the interest of fiscal prudence as well as equity the Government should let prices rise to the desired level, at least on a phased basis.

Collecting taxes on motor vehicles through a duty on petroleum products is also more efficient as the duty payable will be related to usage. Therefore, it will create the right incentive for users to be less wasteful and to economise on their use when prices are higher.

Road tax as well as import and excise duties on motor vehicles are a less efficient form of tax.[5] They cannot be justified as a wealth or luxury tax as other forms of wealth or luxury consumption are not subject to such taxes. If the purpose is to regulate the car population, it is best to require a certificate of entitlement (COE) to own a car (as in Singapore) or to operate the car (as can be done for use of a car in Kuala Lumpur’s Central Business District or CBD.) The certificates can then be auctioned off amongst the higher bidders. The Government is now better placed to make this policy shift with the sizeable investment it has made on mass transit rail transport. The additional investment required to improve this form of public transport will be a lot less than that required on flyovers and elevated highways. The massive investments for an improved road network in any case can alleviate traffic congestion only on a temporary basis.

The Government continues to build more flyovers and elevated highways in the Klang Valley instead of improving the inter-face between the different mass rail systems, extending their coverage, reintroducing a mini bus feeder system within each suburb and by ensuring a more effective enforcement of traffic rules. One wonders if the DB administration’s continued reliance on the system of negotiated tenders – another rotten legacy of the DrM administration – (and in spite of the DB Administration’s declared intention to rely on it only on an exceptional basis when it came to power in October 2003), has distorted incentives of the decision makers.

Where improvements in public transport (including better bus services) are combined with a Road Pricing System for entry into KL’s CBD, the use of revenue generated from COEs and the Road Pricing System to cross-subsidise public transport can be easily justified as users of public transport do not impose any external costs on other road users.

The improvements will greatly reduce the multi-billion RM losses the economy is presently suffering from the time lost in commuting within the Klang valley and from the enormous stress traffic congestion imposes on commuters.


Conclusions

Price control and price subsidy has been on the rise in Malaysia from DrM’s early years as PM. There is no sign of its fall under the DB administration.

Price control is inefficient for attaining economic or welfare goals for several reasons. Firstly, it distorts resource allocation. Secondly, it dispenses with the services of the price mechanism which provides a costless way of coordinating economic activities which are by their very nature extremely complex and involved. Thirdly, beneficiaries cannot be targeted and thus ends up benefiting those who do not deserve any assistance. Often those who deserve the assistance are only a small minority and there are other more efficient and less inequitable ways (such as income transfers) of reaching out to them. Fourthly, price control encourages illegal and immoral activities including bribery, corruption, smuggling as well as illicit manufacture.

The size of consumption subsidy, (and almost entirely due to the control of fuel price), has gone almost completely out of control. Ineptitude, opportunism or lack of grit is now threatening the integrity of the government’s finances as well as the very fabric of the economy.

The production subsidies accorded to businessmen through a system of fiscal incentives (or tax breaks) have been increasing from the early years of the Mahathir administration. Many corporations including MNCs have thus not paid taxes for many, many years running. More importantly, under the current full employment environment, investments generated by fiscal incentives create no additional jobs and in fact reduces tax revenue. Why is this so? With full employment, the new investment displaces an existing investment which is currently paying taxes. And hence the country ends up collecting less tax revenue.

The alternative to a system of fiscal incentives is to rely on a lower tax regime to promote investment. A lower tax regime can make for more investment, higher profits and hence more taxes. This happened in Malaysia in spite of the big reduction in tax rates during the mid and late 80s. If there are no tax breaks, there will be more corporate taxpayers. The resulting gains on tax revenue from the removal of fiscal incentives will far outweigh any likely losses in tax revenue from the reduction in the tax rate. These reforms will also make for less distortion in resource allocation.


R. Thillainathan

25.5.08

Appendix: Relationship between total subsidies1 paid and oil price, 1999-2007

Source: MOF Treasury Economic Reports for relevant years.



Notes:

1.As per 2002/03 TER goods accorded subsidies were as follows: diesel & LPG, rice, fertilisers, textbooks as well as items given under the food & nutrition program for school children. With respect to rice, the government controlled the price payable to padi farmers. Those licensed to buy the poorer quality rice from the local farmers are also licensed to import the higher quality rice from abroad such as Thailand. The higher the guaranteed price for local rice, the more likely is the buyer/importer to make a loss from engaging in the rice trade business. So where the government fixes a high guaranteed price it has to subsidise the rice trader to cover his losses and make a normal return for engaging in the business.

2.As is clear form the data DrM’s administration did raise the fixed price in response to the increase in oil price from 2001. Fortunately for him the extent of the rise in price was small relative to the rise in oil price in the mid-2000s. There is no doubt that he would also not have raised the fixed price from 2007 on account of electoral considerations. This is readily evident in his decision not to introduce the VAT/GST in spite of its widespread adoption the world over. In designing the APM he should have realized that once set up it becomes an excellent tool in the hands of any populist politician to maintain himself in power and he is probably no exception.

3.In 2006 as per the TER fuel subsidy accounted for 76% of the total subsidy paid.

4.These are best estimates and not actual.





[1] DrM’s infamous experiment with price control (through the restructuring in 1994 of the Department of Domestic Trade into the Ministry of Consumer Affairs) was aimed at achieving his target of zero inflation. In this context he had opined that the pursuit of inflation targeting by economists via the control of money supply and interest rate was simplistic and easy.

[2] This type of price control was dealt with at length in R. Thillainathan, Malaysia’s Experiment with Zero Inflation and Price Control – An Assessment, Malaysian Institute of Economic Research, 1995 (See MIER Monograph Series No. 4).

[3] In the steel industry, end users who wish to import steel products on account of their more stringent quality requirements, have to convince a panel made up of domestic steel manufacturers and regulators as to why they should be given a permit to import the products. The domestic car makers have also faced this requirement but as they are in a promoted industry, one promoted by the previous Administration, their challenge was a less onerous one.

[4] From January 2004 until 2007, the Ministry of Domestic Trade & Consumer Affairs started the practice of licensing jobbers to supply diesel and Mogas to independent distributors in the rural areas who are not a franchisee of an oil company. As the price of diesel was controlled well below its market price for many classes of consumers, this opened up possibilities for smuggling diesel to foreign countries or reselling it to consumers who are not eligible for such a subsidy. This licensing requirement therefore opened up a new rent-seeking opportunity in classic text book terms.

[5] High road tax has led to evasion. And bribery of enforcement officers by the evaders is not uncommon.

Dr. R. Thillainathan is past president of the Malaysian Economic Association. He obtained his 1st degree from the University of Malaya and Masters and PhD at the London School of Economics.