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Propelling Malaysia MADANI’s Economy (Part II) – Breaking out of the Handout Mentality

Resource rich economies tend to create societies that are dependent on subsidies. These subsidies are usually financed by windfalls from the natural occurring resources that the country has. See how Saudis and Bruneians are tax exempt as one extreme. Left unchecked, such windfalls can lead to the underdevelopment of policy and governance capabilities, as well as damaging inequality between resource owners and the masses, which in turn leads to low human capital development. Some resource rich African countries are an extreme example of this.  On the other hand, experience has also shown that a country can be successful despite lacking in basic resources, by relying solely on human capital development, strategic planning and meticulous execution. Examples are provided by countries such as Singapore and Switzerland. 

Malaysia luckily does not suffer from the resource curse as badly as the examples cited above. We industrialised from the late 1980s to the 1990s, becoming one of the Asian tiger economies, diversifying our economic base away from agriculture, mining, oil and gas. We managed to generally eradicate extreme poverty and raise our living standards. While Malaysia has clearly come a long way, our industrialisation and development have opened up new issues, not least the country’s widening fiscal deficit and its dependence on subsidies, in particular fuel subsidies, which is in effect a universal handout to consumers and businesses. 

Malaysia has spent more than RM50bn a year on fuel subsidies alone in recent years. By capping the price of petrol and diesel, this has helped to dampen inflationary pressures and ease cost of living burdens for the rakyat. However it has also led to market distortions and inefficiencies: low cost of energy contributes to lower incentives for industries to improve their efficiency and productivity. It also leads to distortions in demand and excessive use of energy by both consumers and producers. The government is rightly biting the bullet by embarking on fuel subsidy rationalisation. It will be a necessary but bitter pill to swallow. The sooner industries and consumers are prepared for the consequences, the gentler the path towards a successful weaning off of this subsidy. 

As I argued in my earlier article titled “Fuel subsidies and Malaysia MADANI – taking a systems approach” published in The Edge on 16th March 2024, such a move would be highly contractionary to the economy. Countless studies both from economic modelling as well as real world examples have shown that higher inflation coupled with a contraction in household spending, output and employment are to be expected. However the same studies have also demonstrated that these can be eased with expansionary measures such as cash transfers and a reduction in sales tax. Concurrently, Malaysia has launched its national database system PADU to ensure more efficient and accurate targeting of taxes and subsidies, based on household incomes. This demonstrates that the government is also thinking along these lines and is making preparations to ensure the poor are somewhat cushioned from the negative impacts. 

Furthermore, industry readiness is also key. Decades of fuel subsidies have created a somewhat cosy environment for companies that rely on energy as a main input; their subsidised costs mean that these industries have enjoyed a windfall without having to be any more efficient in their operations. The question is, after removing this advantage, will our industries remain competitive? Industries form the backbone of our economy, providing employment and also generating foreign exchange through exports. A change in energy costs will affect almost all industries, some more than others. They need to know the effects on their businesses – the direct effects of a change in energy prices, as well as the indirect effects of input price increases – to plan their mitigation measures. There will also be induced impacts due to changes in business and consumer behaviours in response to increased energy prices, some of which may be negative. The economy is in effect a living, breathing eco-system, and a change in energy prices coupled with other policies could be akin to a “butterfly tsunami”.

Similarly, subsidised fuel has distorted household decision-making. From choosing where to live and work, choice of service providers (example where to shop or where to send children to school), transport modes (eg type of car) to choice of household appliances (energy or non-energy saving, gas or electric stoves), rationalising fuel subsidy may induce households to make more energy efficient decisions at the margin. While some households already factor the cost of energy into their decision-making, there are also many who do not. How large the impact will be on consumer behaviour will depend on many factors; some will happen immediately and some will happen over the longer term. This will in turn impact businesses as mentioned earlier.

Properly implemented, PADU can be a powerful signal to households, businesses and the government apparatus of a shift in mindset from the top down. Social welfare and subsidies have an important role to assist the underclass to better opportunities and improved quality of life, to correct market failures – it is NOT an entitlement. The country’s wealth belongs to its people, not to a select few who control decision-making. Subtle nuances on how policies are communicated and framed has a big impact on shifting mindsets, as demonstrated by many real-world behavioural economics work worldwide. Malaysia must no longer rely on subsidies and handouts, from government windfalls from oil and gas to blanket handouts that yes, help the populace in the very short-term but also promote a sense of entitlement and lack of competitiveness. In fact, one could argue that a nation’s most valuable natural resource is its people. It is the people that form the nation’s governing body, consumers and producers. Similarly, it is the people that could also be one of its biggest drags on growth, from politicians and businessmen to the hourly wager, especially when a sense of entitlement and corruption become endemic in society. 

First, Malaysia needs to realise its windfall can only go so far – it only provides fish and the fish is limited. Taking this analogy further, it is knowing how to fish, farm, manufacture and invent competitively that unlocks so much more value than merely consuming the fish. It is this mindset that needs to change and PADU is one of the tools and policies that the government has embarked on that I believe if properly implemented and utilised, can catalyse this shift. In my next series of articles I plan to touch on how the potential negative consequences of the fuel subsidy rationalisation can be eased using policy tools and measures that fulfil Malaysia MADANI’s other goals.

Published in Forum, The Edge Malaysia Weekly on 25 March 2024

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