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Sunday, 3 July 2011

Inflation in Malaysia: Myths and perceptions!


The general view on the street is that Malaysia suffers from rising inflation. Do the statistics back the claim?

RECENT headlines in the Malaysian media have highlighted the issue of the unholy alliance of rising inflation, stagnant wages and subsidies rationalisation.

It is an “unholy” alliance simply because subsidies rationalisation and imported inflation result in rapidly rising price levels. Coupled with the problem of slow rising wages, it implies that our buying power as consumers is decreasing.

Certain quarters would have us believe that Malaysia is a ship headed for an iceberg and a Titanic-style tragedy could happen any time now. To add salt to the wound, they argue that those at the helm, like the captain on the Titanic, are sleeping and that like the passengers on the Titanic, we will not survive this tragedy. But is this gospel truth or an urban myth?

Is our purchasing power shrinking?

In a recent article, it was claimed that Malaysians have been suffocated in recent months by rising prices of food and necessities as well as a wage rate that is as difficult to move as a buffalo on a padi field.

It was implied that Malaysians are incapable and not resilient enough to cope with the price hikes as their purchasing power is relatively lower than in many countries.

A quick check with the industry standards on price levels and wage data, the Swiss bank, UBS, Price and Earnings Report, indicates that residents in Kuala Lumpur have similar purchasing power with their counterparts in Singapore. Their purchasing power also tops that of Shanghai, Beijing and nearby Bangkok and Jakarta. We are also not far behind Taipei and Seoul in terms of purchasing power (see Chart 1).

Absence of subsidies in these countries has led to rapidly increasing price levels. As a result, employers have had to compensate workers with a higher wage which then increases the costs of production. This increase is passed on to consumers, causing prices to increase again and thus begins the vicious cycle economists call wage-push inflation.

To put it simply, wages have risen in tandem with the rapidly rising costs of living in those countries.

Is inflation on the rise?

The general perception on the street is that Malaysia suffers from rising inflation, at a level much higher than what the common Malaysian can cope with. Anecdotal evidence suggests that price levels have been rising at a much faster pace than what is officially reported. Many recount stories of how our much favoured teh tarik cost only 80 sen five years ago but today, it is between RM1.50 and RM1.80.

In pure MythBusters ingenuity, The Economist has created a rough method to test whether the statisticians have been toying with the inflation figures. It makes use of its famous Big Mac Index, which attempts to roughly measure inflation by tracking the increase in price of a McDonald's Big Mac over the years.

To achieve an accurate measure of inflation, one requires a basket of goods that is identical and commonly available across many countries. The McDonald's Big Mac was chosen because it is produced to a common specification in 120 countries around the world.

In order to determine the reliability of official inflation figures, The Economist compared the difference in the 10-year average of the Big Mac Index and the official reported inflation. A positive figure would indicate that the government has been under-reporting inflation and a negative figure implies otherwise, i.e. the government has been over-reporting inflation.

The Economist (The McFlation Index, Jan 27, 2011), in reporting its findings, accepted an error margin of +/- 2%. It expects the Big Mac inflation to exceed overall inflation as food prices have escalated much faster in recent years. Furthermore, the Big Mac basket of goods (food, materials, wages and rent) differs only slightly from the common basket of goods for overall inflation (food, fuel, rent, healthcare and transport, among other things). To compare how Malaysia fares against other countries, see Chart 2.

Malaysia scored a “positive” 2% point difference between the Big Mac Index and the official inflation rate. While the “positive” 2% may mean that Malaysia's reported official inflation rate is under reported, the inflation rate of the US and Japan is also marginally under reported, where the quantum is similar to Malaysia.

Thus, compared with other countries, Malaysia can be considered as faring rather well. We are on par with China and the US while just slightly above Japan and the European region. Considering that we are just under the +2% threshold with an error margin of +/- 2%, we can definitely conclude that our inflation figures are rather reliable.

Why then is the price of teh tarik increasing faster than the reported inflation? The main culprits of such inflation are unscrupulous traders who take advantage of the situation to earn a hefty profit. Tales have been told of how the price of a cup of coffee at the kopitiam increased by 20 sen when the price of 1kg of sugar was increased by 20 sen. Such price increases often go unreported, hence resulting in the disparity between the popular anecdotes and the official inflation rate.

Is the captain steering this ship sleeping?

The reported inflation rate in May 2011 increased 3.3% from May last year. The biggest increase came from the alcohol and tobacco group (6.3%), followed by transportation and hotels and restaurants (6%). Food and non-alcoholic beverages is third at 4.5%.

Economists, and politicians on both sides of the divide, concur that inflation has been rapidly increasing in recent months, sparked by the wave of subsidy rationalisations.

The argument for cutting subsidies is a logical and rational one. Malaysians have been enjoying artificially low food and fuel prices compared with regional peers so much so that we have grown reliant on these subsidies to maintain the lifestyle that we now enjoy.

Our reliance on these low food and fuel prices has rendered Malaysia's economy vulnerable to price shocks happening internationally. World prices of essential items such as sugar, fuel, cooking oil and flour have been increasing rapidly due to shortages in world supply.

How so? Prices are signals given by the economy-at-large regarding the supply and demand of the products we want. An artificially low price will cause us to consume more than what is available, thus leading to a misallocation of scarce resources.

In order to mitigate the effects of subsidy rationalisations, the government increased the price of petrol systematically so as to cushion the impact of the price hike on consumers. RON95 was introduced in December 2009 at the price of RM1.75 per litre as an alternative to RON97 after the government announced plans to fully remove the subsidy from RON97. All subsidies for RON97 were removed from July 2010.

The increase in food prices has also been limited to sugar, cooking oil and flour. The government has explained that this is due to the escalating prices of these products in the world market. The price increases, however, have been gradual rather than immediate.

Subsidies for other produce such as rice and fish, which are locally produced, remain. The subsidies for these sectors also remain as those that will be most affected should these subsidies be removed are the hardcore poor and low-income families. Table 1 and Table 2 outline the various subsidies provided and the amounts allocated by the government to fund these subsidies.

For the hardcore poor, the Agriculture and Agro-based Ministry has the Rice Subsidy Programme for the People (Subur) programme. It issues coupons to the hardcore poor and other targeted low-income groups three times a month to purchase 10kg of ST15% grade rice at a discounted price of RM14 rather than the retail price of RM24.

Stagnating wages?

Much to the disappointment of economists around the world, the Democratic Capitalist view that market forces alone are efficient enough to determine fair wages is no longer valid. Employers today no longer play the passive role of adopting the market wage rate. They are instead active participants and key players in the wage determination.

Researchers at the Federal Reserve of Cleveland found that standard factors such as type of occupation, human capital, demographics and industry characteristics only accounted for half of the wage variation between employees. The other half has been attributed to employer characteristics.

This implies that the bargaining power of workers today has declined not only in Malaysia but across the world as well. The imbalance of power and control at the bargaining table has caused the Malaysian labour market to become uncompetitive and inefficient, resulting in stagnating wage levels.

Here, I would like to suggest two reasons why wage levels in Malaysia have been stagnating over the years.

1. Over-supply of labour 

According to basic economics, employers will not have the incentive to offer higher wages should there be a large number of employees who are first able and then willing to work at the offered wage.

The logic is similar to the goods market where oversupply of a product causes prices to drop since the demand for the product can be easily fulfilled. This scenario is relevant to two large groups of Malaysians the low-skilled workers and fresh graduates or junior executives.

Low-skilled workers are often in jobs labelled as 3D dirty, dangerous and demeaning. We have foreign workers who are eager to perform these jobs at wages that are lower than what Malaysians would accept. This undermines the job opportunities for many of the “low-income to hardcore poor” Malaysians who do not mind taking on these jobs as it may be their only opportunity to earn a living.

Included in this category of workers are domestic maids, cleaners, construction workers, odd-job labourers, and coffee shop waiters.

As such, it is highly relevant that the government has taken its first step to a minimum wage for workers with the passing of the National Wages Consultative Council Bill in the Dewan Rakyat last week.

A mandatory minimum wage for low-skilled workers will ensure that they are not exploited by unethical employers and will not be vulnerable to the tides of change that are common in today's globalised economy.

With most of these jobs being performed by foreign workers, millions if not billions of ringgit are transferred out of Malaysia in remittances, and the country loses out in foreign exchange. When the Minimum Wage regulations kick in, there should be no wage differential for the same job, eliminating the advantages of having foreign workers instead of local Malaysians.

More low income Malaysians would have more job opportunities.

In the case of fresh graduates/junior executives, a simple survey of Salary Guides available in the market showed that their wages have not increased by much. Salaries for non-executives, however, showed the largest increase of between 6% and 12% across the industries in the last five years.

Industry experts suggest that there is an oversupply of graduates with similar skill levels. Employers often lament the inability to hire good quality graduates that are not just head-smart but have the initiative and relevant soft skills to bring value to the company.

A study done by the National Higher Education Research Institute (IPPTN) revealed that most Malaysian graduates are not aware of the realities of the working environment as well as employer expectations. Most are caught up in their own world and have an apathetic attitude towards the world around them.

2. Price levels of commodities/basket of goods and services

Wage increases are motivated by increasing price levels. The employment of labour in economics is described as a derived demand.

This suggests that increases in the demand, hence price, of goods and services generate employment and increase in wages.

Domestic price adjustments in Malaysia to world prices have been slow due to the many subsidies that are provided by the government. As such, many private sector employers do not find the need to increase basic wages in order to keep their employees. Instead, they provide other forms of compensation such as better healthcare coverage, share options, higher EPF contributions, etc. While some doomsday soothsayers only compare the wage and purchasing powers, how does Malaysia's rate of EPF contributions compare with those in other countries?

Wage adjustments have also been known to lag behind inflation as wages are more difficult to change compared with the price of a cup of teh tarik at your favourite coffee shop. Employment contracts and company budget allocations come only once a year compared with the menu that can be reprinted overnight. With the subsidy rationalisations, it would be a matter of time before the pressure mounts on employers to increase wages.

Gospel truth or urban myth?

Gone is the era where unity among Malaysians is not just about racial harmony and living peacefully together but also encouraging one another in the spirit of muhibbah to be resilient and brave the troubled times that challenge our path as a young nation. Fifty-four years down the thorny road, a much expressed opinion is that the younger generation today is either apathetic to nation building or unpatriotic.

As a member of this young “Y” Generation, I would like to believe that we are not unpatriotic. Instead, I believe we lack the understanding of what it means to build a nation together as one community with “blood, toil and tears”.

Building a nation is not just about building its economy. It's also about building its people. We are the heartbeat of the Malaysian economy. It is not the government nor the Opposition that is steering this ship and selecting the course that this ship takes. It is people like you and me, the Malaysian rakyat.

> The writer is a Gen-Y Malaysian who is currently pursuing her PhD with the University of Nottingham (Malaysian campus) in Economics. She graduated with a First Class Honours in Economics from the same university and hopes to become a person in high demand without the prescribed side effects of permanent head damage.