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Dear Anwar...


PUBLIC FINANCE. Anwar, it is already an open secret that you intend to increase this year's (government) budget surplus in order to contribute to higher savings and thus hope to reduce the Current Account deficit. You have also done much to publicly state that you intend to reduce wastage in Government, amongst the measures of which is the reduction of perks. Once again I laud you in this initiative. However, I think that there are also several other avenues which you should explore. One such avenue is to downsize Government itself, both Federal and State. In 1996, government expenditure as a proportion of GDP stood at almost 45%. This figure is rather high and is above the average of other countries at a similar stage of development. Government activity crowds out resources for the private sector, both in terms of capital as well as labour. By releasing labour into the private sector, you may also help alleviate the tight labour-market situation at present. I might have suggested further, privatisation of the non-financial public enterprises (NFPEs), as per MAS and HICOM, but I realise that many of them are unduly exposed to losses as a result of having to service foreign-denominated loans amidst a low ringgit. Nevertheless, I strongly urge you to commit the Government towards doing so as soon as these NFPEs are in a better position as many of them would be attractive to investors. This not only helps to create budget surpluses, it would also, if some of these investors are foreigners, help bring in capital into the country. Indeed, it would be easier to convince foreign investment of ongoing concerns than it is to get them to initiate a whole new concern altogether.

TARIFF AND NON-TARIFF BARRIERS. Anwar, amongst the most talked-about of the challenges which you face is reducing the Current Account deficit. There has been much talk from your colleagues that tariffs may have to be raised in order to achieve this. I would nevertheless urge you to the contrary. Raising tariffs maylead to a temporary reduction in the Current Account deficit in the short-run. In the long-run, however, it would not do so. The 'incidence of taxation' was one of the most exciting research avenues in Public Economics. Its conclusions demonstrated quite amply that usually, the burden of taxation is not borne by the party upon whom that taxation was initially placed. This occurs because of the ability of these parties to pass on the burden in the form of higher prices. In fact, it has been suggested that in Malaysia, a tariff increase will ultimately harm exporters as they face higher production costs from the more expensive imported goods. A reduction in exports would obviously be counter-productive to reducing the deficit.

Tariff barriers also lead to a misallocation of resources as false comparative advantages are created. This misallocation of resources in turn compromises total factor productivity (TFP) gains, which we so much lack and which is essential for our economic growth. As such, I propose that in this budget, you continue to lower tariff and non-tariff barriers. By lowering tariffs, you will also be exposing our industries to global competition. This is a much needed wake-up call for them to be more efficient in their production methods. Undoubtedly, not every one of them would be able to withstand the impact and might buckle under the pressure. On the whole and in the long-run, however, the economy gains from a re-deployment of resources from these industries into more efficient ones. Lowering tariff and non-tariff barriers also gives us more legitimacy to complain about others who do not open up their markets and the pressure to do so more substantial.

TAX REGIME. Anwar, it is generally recognised in economics that an ill-designed tax regime can be distortive in its effects upon production, just as tariff and non-tariff barriers do. The main drawback of an income-based tax regime, as we now have, is that it 'punishes' hard-workers and those who are resolute in thrift. Despite frequent exhortations by many (though, admittedly, not all) economists, many governments are still reluctant to shift their tax regime towards flat-rate taxation. Economists urge so inasmuch as any other tax-rule would lead to a misallocation of resources. A consumption-based tax regime is generally thought to be preferable because not only does the burden fall upon the heavy-spenders in the economy, it is inconceivable to any reasonable degree of practicality that a consumption-based tax regime would result in anything else but a flat-rate tax. As such a shift from the present progressive income-based tax system to consumption-based taxation would result in a real gain of output. This gain arises from a more efficient deployment of resources. As such, I propose as a first step to expand the scope of the Sales and Services Tax (SST) coupled with a corresponding reduction in income and corporate taxation. Also, I propose the conducting of a review of the tax system that would examine amongst other things how a consumption-based tax regime could be encouraged in Malaysia. I admit however that an immediate implication of such a policy will be a gradual widening of the income disparities. However, as I will argue below, fiscal redistribution is an inefficientway of ensuring relative income equality.

BUREACUCRACY. Finally, in the area of government, I would also urge you to reduce bureaucracy, especially for small enterprises. This is so because the costs of bureaucracy, in terms of uncertainty, time and of course monetarily, are unduly burdensome upon them compared to other types of companies. The small enterprises of today are the multinational corporations of tomorrow and we would all do well to encourage them. Their merits however do not end here; we will return to the issue of small enterprises once again below.

SPECULATIVE ACTIVITY. Anwar, we all recognise the harmful effects of speculation. Our Prime Minister has recently been one of the most vocal on the issue. If such effects are admitted for the foreign exchange (FOREX) markets, then they should be no less so for the stock market. Speculation of any sort channels money away from productive investment and as such constitutes a net deadweight loss to society. As such, I propose that the Ministry of Finance undertake an initiative to educate small-time investors as to the demerits of speculative activity, particularly of the dangers they expose themselves to by not being able to properly diversify their portfolio into a (relatively) risk-less one. I also propose a thorough evaluation of the listings procedure onto the Kuala Lumpur Stock Exchange (KLSE) as the procedure itself is creating incentives to speculate - an efficiently-priced stock should not be exuberantly over-subscribed; nor should it, in the absence of new and positive information, fetch an appreciably higher price than its offer price upon listing.

INTERNATIONAL ECONOMICS. Anwar, no doubt there are numerous attractions in fixing the rate of exchange, whether the rate is fixed against a particular currency or against a trade-weighted basket of currencies. Fixed exchange rates remove a great bane of uncertainty in foreign transactions. However, these attractions are illusory. These attractions are no more desirable or sensible than fixing the price of every single commodity sold in the economy. As such, I propose that you allow the ringgit to float freely and commit yourself to non-intervention in the FOREX markets. No doubt this you have done in recent weeks. However, I hope you will formalise it in your budget as official policy so as investors can be certain of your motives. A freely-floating ringgit is also a compatible policy with the one proposed earlier with respect to reigning in credit growth. It is a well-known dictum in economics that a monetary authority can either exercise control over the exchange rate, or over domestic credit; but not both.

Page 3: Longer-Term Considerations - Sustainability of Development



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