MONETARY POLICY. The centrality of competent execution of monetary policy to the stability of output is today a proposition which is virtually undisputed in macroeconomics. (In forthcoming articles, I shall hopefully be presenting the case as to why this is so.) Given this, I was therefore disappointed that not enough had been done to dampen domestic credit growth and hence money supply expansion. Bank Negara is now armed with the responsibility of reducing credit growth to approximately 20% per annum by the year-end of 1998, still a long way away from the levels proposed in the original commentary. With interest rates therefore scheduled to be lower than its `optimal' value, related problems such as the huge Current Account deficit, huge imports of food and inflationary pressures on prices and wages, are simply being deferred, rather than solved altogether.
Credibility is also an important issue here. Without a good track record of doing what we say we will do, investors will (understandably) be sceptical. This adds to our costs of doing business because investors will now demand a higher risk premium on their investment ventures. To this end, one hopes that Bank Negara will carry out its mandated objectives. Thus far, however, its actions seem to suggest otherwise _ money market dealers frequently report that Bank Negara has in fact been injecting liquidity into our money markets in a bid to prevent interest rates rising. Needless to say, injecting liquidity runs counter to the objective of reigning in credit growth.
TARIFF MEASURES. The notion that, "It's okay to increase tariffs
because it hits transport vehicles and construction equipment whose local substitutes exist." is in my view misplaced. I would have thought that the projected slower economic growth on its own would have done much to reduce imports of these items. As such, I question whether increasing these tariffs are really necessary and whether they would have a tangible effect upon the deficit.
The aforementioned misgivings become more potent when one considerswhat would now happen to the distribution of demand for these items. I have explained in the original write-up why it is tariffs lead to a misallocation of resources, and why this in turn implies a relatively more inefficient economic structure. That our automotive industry is relatively less efficient than those in the more advanced vehicle-producing countries is hardly a moot point. By augmenting these tariffs, the distribution of demand would shift in favour of local production. In turn, this will mean that more of our resources, at the margin, will be diverted away from relatively more productive industries; thereby reducing our (already negative?) Total Factor Productivity (TFP) growth. (Just as a reminder, growth accounting studies of Malaysia suggest the presence of a negative TFP growth, indicating amongst other things, a relatively inefficient economic structure; relative, that is, to the more industrialised nations.)
The same may be said of the hike in tariffs for heavy machinery used in construction. Attempts to make contractors substitute imported machinery for those locally-produced may once again be counter-productive to the objective of encouraging productivity growth. Unless our contractors have a positive distaste for locally-produced machinery, that they continue to import despite the presence of local substitutes suggests to me that foreign machinery offer more value-for-money. To the extent that this is true, the continued usage of imported machinery will yield a more efficient construction industry. A better policy to me would have been to close down local production-lines of construction equipment and re-use the capital and labour for export-oriented activities instead. Indeed, a group of economists at Lancaster University recently published an academic paper in which they present evidence where, on average, export-promotion activities yield a superior outcome to import-substitution for a country in receipt of foreign direct investment (FDI).
WITHDRAWAL OF TAX RELIEF. My misgivings with respect to the withdrawal of tax relief for children studying overseas is the potential effect it could have on the process of technological transfer; especially so inasmuch as the relief that is granted for those studying locally has been left unchanged, thereby creating a bias against the pursuit of an overseas education. Of course, this may be precisely the intended effect. However, in the light of efforts to promote TFP-growth, a part of which is technology upgrading, this measure seems to run contra to such efforts. No doubt all this is circumstantial and depends on the price elasticity of demand for an overseas education. If parents continue to be adamant about sending their children overseas, and react by reducing consumption for example, then the aforementioned disruption to technological transfer may not occur. But then that would mean a `no-win' situation: the intention of the Government to stem outflows of capital will not have been successful; whereas families would have had to bear a greater burden of the costs of education. (These losses I would have thought far outweigh the potential increase in tax revenues on the part of the Government; so that even recognising this potential gain, we still have a `net loss' and hence a `no win' situation.)
A NEUTRAL REACTION. The recognition of the importance of R&D in the Budget was a welcome sign. However, I am somewhat doubtful as to the aptness of the choice of fields the Government has suggested. In many countries where R&D is a major activity, innovation by small businesses _ some of which have a labour-force of only several dozen _ are often important complements to the major new breakthroughs that larger companies come up with. In the original write-up, I alluded to this fact by calling for the concentration on `micro-inventions', small improvements upon existing (and especially well-established) technology. I argued that, given the level of technological expertise we have vis-a-vis those in the industrialised nations, we are better suited to this type of R&D activity. I therefore wonder if the call to concentrate R&D in areas such as biotechnology and aerospace are at all appropriate. Given that production of electrical and electronic equipment account for the bulk of our manufacturing sector, I would imagine that R&D efforts directed towards this field would have yielded greater economic returns per unit of R&D spent.
POSITIVE MEASURES. There were however some encouraging measures in the Budget. These measures although will not do much to help with the immediate situation, will go some way in eliminating inefficiencies in our economy; provided, of course, the pace they set is continued in future Budgets. The first of these I'd like to mention is the contracting out of maintenance works on Government buildings and selected roads to the private sector. As I alluded to in the original write-up, experience in other nations provide hopeful evidence that this would encourage productivity and as such I hope their scope will be further expanded.
Then, there was the proposed SMI Fund of RM1bn to encourage small businesses, especially in their technological upgrading. Personally, I would have also liked to have seen these companies receive both a portion of the aforementioned R&D funds as well as some technical assistance from the Government. This would have tied in very well with the other very positive measure with respect to small businesses: to link them up with larger industries in the hope that they will gain exposure to competition in international markets.
Finally, that the Government has taken steps to dissolve three government agencies _ KEJORA, DARA and JENGKA _ and to merge several others is a welcome sign. I hope that such measures to downsize government will continue, especially so since, with a Federal Budget allocation of RM 64.124bn, government still accounts for approximately 46% of GDP. That is, for a country at our stage of development, the presence of government in the sphere of economic activity is still disproportionately large.
CONCLUSION: GOOD OR BAD? This always seems to be the question
uppermost in everyone's mind after the Budget! Well, let's just say that the measures introduced were perhaps the best the Government could have delivered given its approach to tackling the situation. That is, given that the Government always hinted very strongly that it would opt for the `soft and slow' option, preferring to apportion the pain of adjustment over a longer period of time than might have been necessary and thereby hoping to reduce its impact in any one year, there was really not much more that could have been advocated than what already was.
Of course, not all economists are convinced that the `soft and slow' option is preferable. Econometric studies I have come across are controversial and, in the wake of excitement over other developments on the frontiers of economic theory, the debate seems to have been relegated to the shelves, at least for the time being. Nevertheless, there are good reasons for believing that a `short and sharp' shock leads to a better outcome, both in a developed and developing economy context. Simulation exercises by Professor Patrick Minford of Liverpool University undertaken for the UK economy seem to confirm that an economic recovery would have been both faster and stronger following an acute deflation to an economy, rather than a protracted slowdown.
Indeed, when Mexico instituted a sharp deflationary policy after its own currency crisis, it led to the most severe economic recession it had ever seen this century. This acute contraction of output forced companies to embark upon a radical restructuring programme which today is paying off handsomely. Unit labour costs for example are virtually flat notwithstanding strong output growth; surely a sharp contrast to our own experiences of wage inflation in recent years. That the torrent of good news from Mexico continues seemingly unabated, it prompted a Morgan Stanley economics researcher to remark in his latest report that the Mexico-story "_is becoming a little boring."
We hope ours would be too. For the right reasons, of course.