Tuesday, May 20, 2014

Is Malaysia Doomed?

Malaysia’s debt fuelled economy on steroids was the result of Bank Negara’s policy of low interest rates and the abundant availability of credit. To avert the economy from free falling credit expansion measures are taken to stabilize the economy. Economic growth as measured by the GDP is now a function of Government and private consumer spending financed by the credit expansion or put it simply ‘debts’. In the short run this might help mitigate the pain associated with a slowing economy such as a recession. Preventing a recession also means preventing the economy from performing its natural task on rebalancing such as getting rid of excesses accumulated along the way. One of the side effects of excesses is the inflating of assets prices to bubble levels. As a result we have various bubbles blown in the stock market, real estate, bonds and futures market in Malaysia.

Mis-allocation of Resources

Bubbles are created by misallocation of resources because credit is not directed to the most efficient part of the economy. Take for example to prevent a downturn in our housing market, interest rates are kept low and credits are made easily available. With low down payments our local speculators are able to purchases a few houses in one go due to the low monthly mortgage payments. It is like buying a lottery ticket where the returns are very high with a small investment. This can happen in the housing market if speculators can find greater fools to buy it from them every few months. With leverage of up to 300% in margin accounts, it will be difficult to prevent people from buying lottery tickets in the stock markets as well. Betting on such high leverage can only go on as long as the markets kept going up. There will be bloodbath when the markets implode sooner or later. Other form of misallocation of resources or mal-investments happening around  our country includes the following.

  • Crony capitalism. Bankrolling cronies at the expense of other businesses in the economy. A good example will be supplying cheap electricity to IPPs (Independent Power Producers).
  • Bailing out GLCs. Bailing out loss making GLCs like MAS, Proton and so on does not help improve the economy. It’s like throwing money into a bottomless pit. Better channel the funds to provide credit to other industries to help improve their capacity and efficiency.
  • Cost Overruns in public projects. A good example is the recent KLIA 2 project. Construction costs have ballooned from an initial RM1.7 billion to more than RM 4 billion. One way to justify cost overruns due to the rise in raw material prices, raining season and so on is by issuing VO or Variation Orders. Variation Order is one method used by companies participating in a tender exercise to quote at a very low price. Once they landed the projects then they will use Variation Orders to mark up the costs of the project and hence generate hefty profits in the end.       
  • Overpriced Public Sector Procurement. Recent report by the Auditor General reveals of exorbitantly over priced items supplied to our Government. Procurements of RM500 screw drivers, RM2000 car jacks and RM30,000 notebooks are common occurrence in the public sector.
  • Wastages. Again the Auditor General also reveals massive wastage in the public sector. Buying things like odd sized safety shoes, under powered computers, building unusable open air public futsal courts, unsuitable or unusable defence assets and so on.     

The above shows how our Government literally throw ‘good money after bad’ but that is just the tip of the iceberg. Earlier attempts to bolster consumer spending to lift the economy is not a long term solution either. As a result of the easy availability of credit through channels such as personal loans and credit cards, consumers are spending recklessly on fine dining, overseas travel, luxury goods and so on. The following graphs illustrate the composition and extent of the debts incurred by both the private and public sector in 2012.




From above we can see that our households are spending un-necessarily. More than 70% of the debts are incurred by properties and followed by vehicles purchase. This unscrupulous spending has led to many of them unable to repay their debts and thus went into bankruptcy.  The following graph shows the number of bankruptcy cases in Malaysia is on the rise since 2002 and heightened after 2008.

  Historical Data Chart

Repercussions of Debt Addiction

A recent study by HSBC shows that Malaysia’s addiction to debt has gone to unsustainable level and being one of the highest in Asia after China. Malaysia’s credit intensity of Growth has increased to more than 2x in 2013. Credit intensity to growth measures the amount of borrowing or debt to achieve a unit of growth. Studies have shown that in normal circumstances in an efficiently managed economy a $1 debt will generate an increase of $1.60 in GDP growth. This is because due to the effects of fractional reserve banking and the multiplier effect generated from bank loans, the resultant GDP growth should be higher than money supply.  

However as shown by the chart below, the credit intensity of growth in Malaysia soared from 0.7x during 2003-2007 to about 2.3x in 2013. This means that efficiency of capital utilization in Malaysia has been decreasing. To make it simple, during 2003-2007, we needed about RM0.70 to produce RM1 of GDP but in 2013 it went up to RM2.30. Thus our Government need to borrow more money to maintain the existing level of GDP growth.


There are many ways a country can increase its economic growth like increasing productivity, capital investments, enhancing efficiency through technology, production processes and so on. To achieve any meaningful level of economic growth, the amount of funds invested into the economy should produce at least an equal amount of economic growth. In an efficient economy, this will mean that an X amount of investment should produce an X amount of growth. In layman’s term a RM 1 input (debts) should produce a RM 1 output in GDP.  In a debt laden economy like Malaysia, our Government has to increasingly rely on debts to enhance its economic growth.
Before we go on let me present you two graphs which are important for our analysis. Those are the GDP annual growth rate and Government Debt to GDP.

Malaysia GDP Annual Growth Rate

Malaysia Government Debt To GDP

The following table is generated from the above GDP growth, Government Debt to GDP and the GDP growth rate to Government Debt.

GDP Growth %
Debt/GDP %
GDP Growth/Debt %
Source: Department of Statistics Malaysia

As can be seen, the third column which is the GDP/Debt growth rate has been sliding since 2010. The negative ( -6.7%) growth rate in year 2009 was due to the effects of the Global Financial Crisis in 2008. However economic growth did picked up in 2010 to 7.55% but at the expense of higher debt load which seen soared from 41.24% to 52.82%. This represents an increase of 28% in the Debt/GDP. This can be illustrated graphically below.

The above chart illustrates the effects of earlier mal-investments on our economy. Due to misallocation of resources much precious capital are wasted because they are redirected to inefficient sectors of the economy. Thus there is not much economic benefit or productivity generated from those investments.  As a result the GDP Growth/Debt or economic growth generated by debt has been sliding downwards since 2010 from 14.1% to 8.4%. Although our Government Debt to GDP increased to a record 54.8% which is only a tad lower than the stipulated 55%, we achieved a lower GDP growth of 4.65%. The reason for this is that we have reached a diminishing return on our debts which can be shown by the following graph.


As seen there will be a saturation point where any additional debt will not boost productivity and thus increasing the debt load will lead to lower productivity.
Another setback of depending on debts to finance economic growth is the increasing amount of future interest payments. If we use the current benchmark of 10 year bond rates which is 4.01% as our costs of funds then the interest rates due to our Government in 2013 will be (4.01% x RM456 billion) = RM18.69 billion. Please note that our interest payment will rise this year because not only our Government Debt/GDP has risen to 54.8% last year but our GDP also rose by 4.65% last year. Below I present to you the estimated amount of interest due to our Government this year, where:

10 Year Interest rate = 4.01%
Government GDP/Debt in 2013 = 54.8%
GDP in 2012 = US$303.53 billion
GDP in 2013 = (4.65% x US$303.53) = US$317.64 billion
Today’s Exchange rate USD/MYR = 3.21
Interest Due = 4.01% x $317.64 billion x 3.21 x 0.548 = RM 22.4 billion.

What other repercussions?

There are three consequences arises from using debts to finance economic growth.
Firstly, there is a trade off in what we called ‘opportunity costs’ in economics. Opportunity costs in this case refer to alternative ventures that are forgone in order to pay for the interest rates. Money used to pay interest rates instead can be diverted to build more schools, hospitals, roads, bridges or parks for that matter for the benefit of the people.
Secondly, due to the diminishing return on debts, more money will be needed to achieve the same amount of growth. To further accelerate growth obviously more debts will be incurred due to the mal-investment arises as a result. So, what is the point of diverting more money into a bottomless pit? The following chart shows this phenomena that is affecting not only Malaysia but most of Asia.


Lastly and most importantly our Government is plundering tomorrow’s treasure today.  As seen, our interest payments will keep rising when as long as we are addicted to debts. Put it simply, we are spending our children’s wealth and leaving them paying the bills tomorrow. What used be the traditional Capitalistic model of economic growth where capital is generated from savings as a result surplus production. It has now transformed into a something for nothing economic system where we don’t need to save in order to generate capital. Governments can now generate capital by a new technology called the ‘Printing Press’ where they can churn out as much money as they can. The ability to print money has led to an enormous abuse of power by our politicians as they can buy influence and power through corruption. And at the same time they can prohibit capitalism, competition and freedom which led to many monopolies in our country. Monopolistic companies such as Tenaga Nasional and Plus are able to maintain high prices and raising prices without the need to worry about competitors. Thus, we don’t need to be a rocket scientist to figure out why RM1 in debt generates less than RM1 in GDP growth is not sustainable. It is just a matter of time when our economy will be crash landing. The current state of affair of our country can best be summed up by the following phrase.

When you see that in order to produce, you need to obtain permission from men who produce nothing; when you see that money is flowing to those who deal not in goods, but in favors; when you see that men get rich more easily by graft than by work, and your laws no longer protect you against them, but protect them against you...you may know that your society is doomed.
- Ayn Rand

Friday, May 2, 2014

How the world's wealth is distributed - the top two percent own half of it

How the world's wealth is distributed - the top two percent own half
December 6, 2006
Figure 1 - World Wealth Levels in Year 2000
Figure 1 - World Wealth Levels in Year 2000
Image Gallery (8 images)
December 7, 2006 A new study on The World Distribution of Household Wealth by the Helsinki-based World Institute for Development Economics Research of the United Nations University was launched earlier this week. The study shows the richest 2% of adults in the world own more than half of global household wealth. The most comprehensive study of personal wealth ever undertaken also reports that the richest 1% of adults alone owned 40% of global assets in the year 2000, and that the richest 10% of adults accounted for 85% of the world total. In contrast, the bottom half of the world adult population owned barely 1% of global wealth. The research finds that assets of US$2,200 per adult placed a household in the top half of the world wealth distribution in the year 2000. To be among the richest 10% of adults in the world required US$61,000 in assets, and more than US$500,000 was needed to belong to the richest 1%, a group which — with 37 million members worldwide — is far from an exclusive club.
  • Figure 2: Regional Wealth Shares
  • Figure 4: Regional Composition of Global Wealth Distribution
  • Figure 7: Asset Composition in Selected Countries
  • Figure 6: Percentage Membership of Wealthiest 1%

The UNU-WIDER study is the first of its kind to cover all countries in the world and all major components of household wealth, including financial assets and debts, land, buildings and other tangible property.
‘One should be clear about what is meant by “wealth”,’ say co-authors James Davies of the University of Western Ontario, Anthony Shorrocks and Susanna Sandstrom of UNU-WIDER, and Edward Wolff of New York University. ‘In everyday conversation the term “wealth” often signifies little more than “money income”. On other occasions economists use “wealth” to refer to the value of all household resources, including human capabilities.’
‘We use the term in its long-established sense of net worth: the value of physical and financial assets less debts. In this respect, wealth represents the ownership of capital. Although capital is only one part of personal resources, it is widely believed to have a disproportionate impact on household wellbeing and economic success, and more broadly on economic development and growth.’
Wealth levels across countries
Using currency exchange rates, global household wealth amounted to US$125 trillion in the year 2000, equivalent to roughly three times the value of total global production (GDP) or to US$20,500 per person. Adjusting for differences in the cost-of-living across nations raises the value of wealth to US$26,000 per capita when measured in terms of purchasing power parity dollars (PPP$).
The world map shows per capita wealth of different countries. (Figure 1: World Wealth Levels in Year 2000) Average wealth amounted to $144,000 per person in the USA in year 2000, and $181,000 in Japan. Lower down among countries with wealth data are India, with per capita assets of $1,100, and Indonesia with $1,400 per capita.
Per capita wealth levels vary widely across countries. Even within the group of high-income OECD nations the range includes $37,000 for New Zealand and $70,000 for Denmark and $127,000 for the UK.
Wealth is heavily concentrated in North America, Europe, and high income Asia-Pacific countries. People in these countries collectively hold almost 90% of total world wealth. (Figure 2: Regional Wealth Shares) Although North America has only 6% of the world adult population, it accounts for 34% of household wealth. Europe and high income Asia-Pacific countries also own disproportionate amounts of wealth. In contrast, the overall share of wealth owned by people in Africa, China, India, and other lower income countries in Asia is considerably less than their population share, sometimes by a factor of more than ten. (Figure 3: Population and Wealth Shares by Region)
The study finds wealth to be more unequally distributed than income across countries. High income countries tend to have a bigger share of world wealth than of world GDP. The reverse is true of middle- and low-income nations. However, there are exceptions to this rule, for example the Nordic region and transition countries like the Czech Republic and Poland.
The authors of the UNU-WIDER study explain that in Eastern European countries ‘private wealth is on the rise, but has still not reached very high levels. Assets like private pensions and life insurance are held by relatively few households. In the Nordic countries, the social security system provides generous public pensions that may depress wealth accumulation.’
World wealth inequality
The concentration of wealth within countries varies significantly but is generally high. The share of the top 10% ranges from around 40% in China to 70% in the United States, and higher still in other countries. The Gini value, which measures inequality on a scale from zero to one, gives numbers in the range from 35% to 45% for income inequality in most countries. In contrast, Gini values for wealth inequality are usually between 65% and 75%, and sometimes exceed 80%. Two high wealth economies, Japan and the United States, show very different patterns of wealth inequality, with Japan having a wealth Gini of 55% and the USA a wealth Gini of around 80%.
Wealth inequality for the world as a whole is higher still. The study estimates that the global wealth Gini for adults is 89%. The same degree of inequality would be obtained if one person in a group of ten takes 99% of the total pie and the other nine share the remaining 1%.
Where do the world’s wealthy live?
According to the study, almost all of the world’s richest individuals live in North America, Europe, and rich Asia-Pacific countries. Each of these groups of countries contribute about one third of the members of the world’s wealthiest 10%. (Figure 4: Regional Composition of Global Wealth Distribution)
China occupies much of the middle third of the global wealth distribution, while India, Africa, and low-income Asian countries dominate the bottom third.
For all developing regions of the world, the share of population exceeds the share of global wealth, which in turn exceeds the share of members of the wealthiest groups. (Figure 3: Population and Wealth Shares by Region)
A small number of countries account for most of the wealthiest 10% in the world. One quarter are Americans and another 20% are Japanese. (Figure 5: Percentage Membership of Wealthiest 10%)
These two countries feature even more strongly among the richest 1% of individuals in the world, with 37% residing in the USA and 27% in Japan. (Figure 6: Percentage Membership of Wealthiest 1%)
According to Anthony Shorrocks, a country’s representation in the rich person’s club depends on three factors: the size of the population, average wealth, and wealth inequality.
‘The USA and Japan stand out’, he says, ‘because they have large populations and high average wealth. Although Switzerland and Luxembourg have high average wealth, their populations are small. China on the other hand fails to feature strongly among the super-rich because average wealth is modest and wealth is evenly spread by international standards. However, China is already likely to have more wealthy residents than our data reveals for the year 2000, and membership of the super-rich seems set to rise fast in the next decade.’
Composition of household wealth
The UNU-WIDER study shows major international differences in the composition of assets, resulting from different influences on household behaviour such as market structure, regulation, and cultural preferences.
Real property, particularly land and farm assets, are more important in less developed countries. (Figure 7: Asset Composition in Selected Countries) This reflects not only the greater importance of agriculture, but also immature financial institutions.
The study also reveals striking differences in the types of financial assets owned. Savings accounts feature strongly in transition economies and in some rich Asian countries, while share-holdings and other types of financial assets are more evident in rich countries in the West. (Figure 8: Composition of Financial Wealth in Selected Countries)
According to the authors of the UNU-WIDER study, savings accounts tend to be favoured in Asian countries because ‘there appears to be a strong preference for liquidity and a lack of confidence in financial markets. Other types of financial assets are more prominent in countries like the UK and USA which have well developed financial sectors and which rely heavily on private pensions.’
Surprisingly, household debt is relatively unimportant in poor countries. As the authors of the study point out: ‘While many poor people in poor countries are in debt, their debts are relatively small in total. This is mainly due to the absence of financial institutions that allow households to incur large mortgage and consumer debts, as is increasingly the situation in rich countries’
The authors go on to note that ‘many people in high-income countries have negative net worth and—somewhat paradoxically—are among the poorest people in the world in terms of household wealth.’
The World Institute for Development Economics Research of the United Nations University (UNU-WIDER) was established in 1985. The institute undertakes multidisciplinary research and policy analysis on structural changes affecting the living conditions of the world’s poorest people; provides a forum for professional interaction and the advocacy of policies leading to robust, equitable, and environmentally sustainable growth; and promotes capacity strengthening and training for scholars and government officials in the field of economic and social policy making.