Sunday, August 3, 2014

Why are we Feeling so Squeezed when our Stock Market and Economy is Booming?


By Sam Chee Kong

As we are going through our daily chores, I am sure many of us realized that life is much tougher now than it was 20 years ago. We still remember those days when mum takes care of the family while dad is away for work. During those days it was possible to sustain a family even when only one family member worked. Gone are the days when we can afford a house with a salary slightly above RM 1000. Gone are the days when tuition fees in private colleges only cost about RM 1800 per year.

Today, we may work twice as hard and with two incomes (including our spouse) but our paycheck is not stretching that far or shall I put it more bluntly alarmingly thin. After paying for daily and monthly expenses such as gas, groceries, food, phone bills, broadband, utility, credit cards and so on, there isn’t much left to save. Even though our income may be many times that of our parents but we are still struggling to provide ends meet. In short why are we feeling more SQUEEZED?

Didn’t our leaders boast that our economy is going through a transformation and we are heading towards a ‘new economy’. We have our Economic Transformation Program, 10th Malaysian Plan, New Economic Model and Government Transformation Program to help fast track our economy to achieve its ‘develop status’ by 2020. As a result we often hear and read great economic news about our stock market, employment, productivity, economic growth, corporate profits and income growth in the mainstream media. Thus with the above so-called achievements, we should be making progress and life should be much easier. Instead, we faced a tougher life by getting heavily in debts when we try to secure basic things like health care or sending our children to better colleges. For those who can’t afford, they either have to do away with health coverage or sending their kids to lesser known colleges.

Before we look into the causes of the Squeeze, let’s take a look at the progress made by our economy.


            
Historical Data Chart

Our economy has been doing remarkably well when compared to most Western countries. Malaysia’s GDP has grown from RM 110.2 billion in 2003 to RM312.44 billion in 2013.


Historical Data Chart

Our unemployment rate dropped from 4% in 2003 to 2.98% in 2013. This is a commendable figure as unemployment rate below 3% is considered near full employment. This being one of the objectives pursued by Bank Negara which includes full employment, price and exchange rate stability.  


Historical Data Chart

The latest figure for our inflation rate is 3.3% in June 2014. As can be seen although the inflation rate spiked to more than 8% in 2008, during the past 10 years it averages about 3.5%. Thus it can be said that we have achieved price stability during the past few years.


Historical Data Chart


Next is the Stock Market. Currently our FBMKLCI is trading in near record territory at 1871 points. Our market has risen from about 850 points in 2008 which amounted to about 120%.

But wait a minute, with such fantastic news coming out from our economy, why are we still feeling Squeeze?

Why we feel Squeezed?

On one side our government is reporting excellent economic performance while on the other side we are feeling the pinch. So something doesn’t add up or should we say ‘the whole is not equal to the sum of its parts’. Before we go on to tackle the problem let me illustrate the root cause of the problem and how an economy manifested into such a situation.

In simple definition, an economy consists of production, distribution and consumption of goods and services by different actors. Different economic actors are governments, individuals and businesses and they always stride to best provide the goods and services that we want and need in an efficient manner. This process can best be illustrated with the following simple flow chart.


http://www.herinst.org/sbeder/images/traditional.gif


As can be seen in a free market economy the above process will be self-regulating without the need of government interference. As it is, rational consumers and investors will always look for ways to maximize their resource allocation through profit incentive. The problem begins when the government starts interfering into the activities of both consumers and investors.

To prevent the natural forces of supply and demand from cleansing the economy from excesses, governments seek to manipulate the economy through other remedies. They will unleash monetary and fiscal policies to artificially bolster the economy. Some methods commonly used are the following.

Increasing Money Supply

Countries that are running on the Keynesian track tend to believe that prosperity can be achieved by increasing the aggregate demand through increasing the money supply. They reckon that by increasing the money supply it will lead to ↑ spending, ↑ production, ↑ employment and subsequently ↑ standard of living. In reality it leads to both mal-investments and increases in prices. Due to the easy availability of money, governments tend to invest in riskier and less commercially viable projects, bailing out uncompetitive companies and so on.
Eventually it will lead to the liquidation or closure of these projects which cause unemployment to rise and spending to fall. We are led to believe that through Quantitative Easing (increase money supply), our government will be able to monetize its debts without causing prices to rise. But according to the classical Quantitative Theory of Money, there exists a positive correlation between the money supply and price level. The bigger money supply will eventually lead to higher prices. This can be shown by the following formula.
P=MV/T    where,
P = Price, M = Money Supply, V = Velocity and T = Transactions

Thus, when the money supply increases, so does the price.

Interest Rate Manipulation

It is of common view that anything that is low and cheap is good and that includes interest rates. Authorities tend to drive down interest rates artificially through open market operations. But sometimes driving down interest rates artificially will lead to unintended consequences such as a credit bubble, asset speculation and other distortion in the economy.
This is because interest rate is a product of the market where the rise or fall is determined by the demand and supply. Rates will automatically goes up when there is an excess demand over the supply for loanable funds. If rates are kept down so that banks can lend more to consumers through credit cards or personal loans then it will not be a productive venture. No doubt it will help boost consumption and hence production but at the expense of higher consumer and household debts which we are facing now. Household debt in Malaysia is already at boiling point (86% of GDP) and any attempt to rein it in will risk a credit contraction which might implode our economy.

Foreign Exchange Manipulation

To boost exports governments will lower their currency. Lower exchange rate will lead to cheaper exports and expensive imports. The winner will be the exporters as they will do more business and receive more foreign exchange. The increase in foreign currency receipts will eventually increase the money supply when it is converted into local currency.
The increase in money supply will push prices up forcing the authority to begin another round of currency depreciation so as to make prices cheaper. Eventually this feedback loop will cause price to increase further. The winners will be those who receive the money first such as the owners, employees and suppliers while the rest of us will have to live with higher price.

Thus, the above illustrates how the government manipulation of the economy will lead to unsustainable economic growth which looks good on paper but benefits only certain group of people. Those that are benefiting from the economic growth are the powers to be who are able to hijack the economy to their own benefit. Thus this prevented the fair distribution of benefits to all that would derive from any economic growth. As a result this gives rise to what economist called ‘income and economic inequality’.

Capping the power of trade unions

Government policy has been limiting the scope and bargaining power of the trade unions. A good example is the merging and consolidating the 58 banks during the last Asian Financial Crisis in 1998. To strengthen the banking sector our government took the initiative to consolidate the banks through mergers to form 10 anchor banks. As a result many jobs are lost and this also affected the membership of bank trade unions such as the National Union of Bank Employees. Fewer members mean less bargaining power.
Another step taken by the authority is to allow banks to form their own trade unions such as the Maynew in Maybank. By allowing internal unions, it also meant fewer employees are going to join external unions like NUBE whose objective goes against the banks direction. As a result NUBE suffered a drastic drop in membership, from more than 50,000 members at their peak to about 30,000 at the moment. Fewer members mean less monthly subscription and thus fewer resources to help them fight for the rights of workers.

Capping the bargaining power of workers

In recent years the loosening of the immigration policy in regard to foreign workers has altered the bargaining power and hence the fortunes of local employees. It is estimated that there are more than 5 million foreign workers both legal and illegal being employed in Malaysia. Due to the abundant supply of foreign workers, the bargaining power of our local workers had clearly diminished. Any form of discontent manifested in the form of strike, production disruption or ‘go slow’ or complains are met with job dismissal. Foreign workers are known to be hard working, less demanding and more conforming are more than willing to fill-up their places. This also helps explain why it takes so many years to raise the minimum wage to RM900.

By employing foreign workers, local companies gained not only from lesser disruption in their production flow but also lower cost of production. Lower cost means lower prices for our products and hence we are able to compete in the international market although this advantage may be temporary because other nations will soon catch up with us. Increasing exports means more profits and hence more tax and excise duties for our government. Most importantly it brings in the much needed foreign exchange.

Thus, you can see that there is no interest for the government to increase the minimum wage. History has shown that with the absence of near full employment or tight labor market, workers are not able to demand a higher compensation for their services. Any benefit generated from economic growth will not be equally distributed. Hence, you can see why the fortune of the top 20% of the population is protected at the expense of the rest and also contributed to the ever widening income gap.

Uneven economic recovery

As we have seen above our job recovery since the Global Financial Crisis in 2008 has not been rising in tandem with the economic recovery. Hence wages has not been growing as fast as the economy which is measured by GDP. The following two charts depict our wages and GDP growth from 2008 till 2013. I shall use the present/future value formula to approximate the compound rate of growth on both the wages and GDP.


Historical Data Chart

Using the present/future value formula below,

FV = PV (1+i)ⁿ  

FV = Future Value
PV = Present Value
I = Interest Rate
N = number of years compound

We are able to derive the compound rate of Malaysia’s GDP growth from 2008 to 2013 which is ± 6.2%.

Historical Data Chart

Again using the present/future value formula the compound rate of growth of Malaysia’s manufacturing wages come to ± 5.25%.

Thus it can be seen that our wages lags our economic growth. Bear in mind both are in nominal terms. Our next question is why has our economic recovery is not accompanied by a rising job market.

  1. Our Government policy on giving importance to macro-prudential prevented recessions from getting out of hand. Any sign of our economy slowing down will be dealt with loosening monetary policy like increasing money supply or rate adjustments. Thus we are always delaying our problems and prevented our economy from taking the natural course of action to rid itself of excesses like over consumption, mal-investment or credit and credit and real-estate bubbles. Thus, when recovery is on th8e way it will be a slow process. Unlike a recovery after a severe recession there will be a chance for the economy to experience what known as a ‘pent-up demand’. When an economy is experiencing a pent-up demand, production is unable to meet demand and hence the demand for labor. When there is a shortage of labor wages will increase commensurately.

  1. Due to the technological advance like the availability of production planning softwares like MRP and ERP, production planners are able to plan their production weeks and months ahead. This allowed them to stock up their inventory. During good times they stock up on their inventory while during bad times they can deplete it. Being able to plan ahead enabled them to practice ‘precision hiring’. Precision hiring means they can cut their workforce during lean times and beef up during better times. Moreover they can ‘fine tune’ their hiring process further by employing temporary or contract workers working alongside the permanent workers.


Income Inequality

Malaysia can be considered one of the most unequal nations in the Asia Pacific region in terms of income distribution. Income inequality can be measured by a statistical approach called Gini coefficient or index. The Gini index is used to measure the gap between the poor and the rich. The higher the reading the higher is the inequality. The following graph shows Malaysia’s standing in the Asia Pacific region.

.

As can be seen from above, Malaysia ranked third in terms of income inequality in Asia Pacific. High income inequality means higher proportion of the nation wealth held by a smaller group of individuals. This also implied that any benefits that derived from economic growth will flow to the higher income group instead of the lower income. To lessen the negative effects of income inequality on the provision of health care, education, housing and other social services, our Government increased the minimum wage to RM900 as of this year.
However this will not address the inequality problem as I will demonstrate with the following. According to the 2012 Household Income Survey, it found that the average monthly income of Malaysian households rose from RM4025 in 2009 to RM5000 in 2012. This is equivalent to an average rise of 7.2% per annum. A household by definition consists of 4.2 family members. Source:http://www.statistics.gov.my/portal/download_Prices/files/CPI/2013/SEP/BI/02Malaysia.pdf

Thus, it can be deduced that the average income per person in a household is RM1190 (RM5000/4.2). So, in essence raising the minimum wage to RM900 does not have much material effect on average household income since they already earned more. On the other hand, it benefits the foreign workers who are earning a basic salary of about RM600 per month. To be effective, the minimum wage should be raised close to the average household income per person of RM1190.

Another point that I want to stress is that when our government said that ‘the average monthly household income’ rose from RM4025 to RM5000. When they use average as a metric to describe how evenly the benefits of growth are being shared then it is clearly flawed. Why is that so?

Let me present to you a hypothetical economy with 10 workers. Each of them earns RM100 a month, then the average income for the 10 workers is RM100 x 10/10 which is RM100. What happens when we add in another worker whose earning is RM3400? The new average will then be :
((RM100 x 10) + RM3400) / 11 = RM400

But the problem is that the median income is still RM100 although the average income is RM400 which is 4x the median. This is because median takes the middle number in the series as shown below.

100,100,100,100,100,100,100,100,100,100,3400

This also helped to explain why the average household income of RM5000 does not represent the true earnings of an average Malaysian Household as trumpeted by our government. It should be much less when we take the ever widening gap between the rich and the poor into the equation.

Income Inequality

High income inequality means higher proportion of the nation’s wealth held by a smaller group of individuals. This also implied that any benefits that derived from economic growth will flow to the group instead to those from lower income. Our next question is how much wealth held by the ‘elite’ top 10% and bottom 10% of the population? It can best be described by the following two charts.




Source: Compiled from World Bank Data

As can be seen, the wealth held by the top 10% of the population increased from 28.77% in 2003 to 34.65% in 2009. At the other end of the spectrum, the wealth held by the bottom 10% of the population decreased from 2.67% in 2003 to 1.78% in 2009. This shows that the wealth held by the bottom 10% dropped by one third or 33.33% (2.67-1.78/2.67) whereas the top 10% increased their wealth by 20.4% (34.65-28.77/28.77) from 2003-2009. So what caused such a great disparity in our income distribution?

A look into the amount of wealth held by the top 20% should provide us a better understanding on the unequal flow of economic benefits. Below is the chart of the % of wealth held by the top 20% population in Malasia.

 malaysia income share held by highest 20percent wb data

When we have 20% of the population controlling 51.45% of our country’s wealth then we are in trouble. Any ‘trickle down’ effect resulted from economic growth will not benefit much the 80% of the population. To prove it, let take a look at the following statistical table taken from ASM (Amanah Saham Malaysia).  

Unit
Investors
Amount (RM)
5000 <
215,374
273,169,579
5001 - 10,000
56,293
395,879,842
10,000 - 50,000
187,331
4,366,845,165
50,001 - 500,000
79,918
8,497,724,998
500,000 >
953
805,805,416


Before we go on let’s do a bit of basic mathematics. From the table we can see that the last two groups (50,001 -500,000 and 500,000 >) in the Unit column control the lion share of the trust fund. To see how much they control I present you the following.

% of units held by investors in the 2 groups
= (79,918 + 953)/539,869 = 15%

% of total amount (RM) in funds held by the 2 groups
= (8,497,724,998+805,805,416)/14,339,419,000 = 64.8%

As can be seen 15% of investors controlled 64.8% of the funds in ASM. So when dividends are declared who benefit the most? The top 15% or the rest of the 85%?
In Wrapping Up
                   
Income inequality is a problem in any country. Governments tried various measures but still unable to overcome it. This is because only when income inequality is reduced then a country’s economic growth will be sustainable. A study by the IMF shows that the lower the income inequality the longer the number of years a country can enjoy sustainable growth. It can be shown by the following graph.

https://lh4.googleusercontent.com/OMkd1tH7KBrlb2pCOp5gIx0xexfvT7sefpZEQrckGsxgd6TFdMwS2LyjJ0I9rz1BqNTYJgrr85KnkpRELncChx9S86ubsDK1trhM8wqSJbF_n2OdOJQ


In Malaysia we tried to overcome it with cash hand outs, education, ethnic preferential economic policies but to no avail because all of them failed to create an environment for sustainable real wages growth. At the end the day the most important thing is to have a solid pay check to settle all your mortgages and bills.

Most importantly, we may have been barking at the wrong tree all along. Although our inflation rate is low, we are led to believe that the overall price increase is not out of hand. This is because while some things are falling in prices such as hand phones, computers, hi-fi sets, cameras and etc, other goods are increasing at heartbeat levels. Although some of us may have higher real wages growth but we are still falling behind some basic necessities such as education, health care, real estate and so on. The cost of health care, education and houses far outstripped the CPI or Consumer Price Index (at 3.3% in June) which is the measure of inflation.

So do you reckon that income inequality should be seriously incorporated into any future Government policy?


The author is the Economic Adviser to the National Union of Bank Employees

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