Subsidies are not something wasteful

Wednesday, April 23, 2008
Author kaawai Category , ,

Written by arimi sidek

Government should consider gradually reducing the subsidies given to the people, in order to prepare them and the country for stiff competition in the future, say Tengku Razaleigh Hamzah (“Govt should consider reducing subsidies gradually: Razaleigh” DE 5.2.08 ).

I can understand that our government strives for mindset change of Malaysians. This includes change from subsidy mentality to self sufficient mindset.

Note: This is a reproduction of my article that was published in Daily Express newspaper [Sabah], aims to cater wider and more serious audience on the matter.

In January, Deputy Prime Minister, Datuk Seri Najib Tun Razak was quoted as saying that if government continues to subsidise fuel it may not be able to build schools, universities, hospitals and the like.

It likely indicates government attitude toward subsidies at present. They suggest that subsidies are the total waste of resources to our economy. I suspect this has something to do with economists as they advice government on the issues.

Perhaps Malaysia’s economists are ready to rewrite the foundation of modern macroeconomics by introducing new economics theory on subsidies. As the existing one, I dare to say here that they are not a waste at all.

I write this from macroeconomics perspective, to share my view with policy makers, economists as well as general public. I believe correct perception on subsidies is necessary rather than to treat them simply as financial burden and of pure waste.

John Maynard Keynes (1883 – 1946) advocated the idea of active government role in economy either in the form of public works of subsidies. Subsidies are among those methods ever tried by President Franklin D. Roosevelt as USA struggled with depression in 1930s. Reluctantly, he then adopted Keynes method in large scale geared US economy toward full recovery in 1944.

1930s depression, Roosevelt, and Keynes are the true sources of modern macroeconomics as far as government active spending activities such as provision to build schools, university, hospitals, etc. which known as "G" in macroeconomics, are concerned.

It was during depression that economics theories rigorously tested and many had been rewritten. Without Keynes, 1930s great depression, and the open mind of US president at the time, we probably never heard of physical policy, monetary and growth policy as we understand now.

Subsidies simulate spending in wherever sectors they go to. In households sector, they increase households spending. If subsidies go to business sector, they boast businesses spending (or investment). Since there are more spending activities, Gross Domestic Products (GDP) increases.

Not only GDP increases, but the amount of increase is much bigger than the initial amount of subsidies. This is because, money changing hands so many times in the economy within a year. The impact known is as "multiplier effect", where multiplier estimates value of any country is called as "k".

More GDP means more production and government gets more income from taxes. Subsequently, government can use the additional tax income to build more schools, universities, military etc., as necessary.

I will not crack your head with statistical antics here, but I found none of official key statistics pointing toward this direction as far as subsidies are concerned.

Lets calculate how far the RM35 billions of government’s fuel subsidies gone to. When government subsidized fuel, it means government pay on behalf of households and business sectors. Hence, Malaysians no longer have to pay RM35 billions worth of fuel. It is as if they have “extra” RM35 billions of money in hand to spend where necessary. If “k” value is 5, multiply RM35 billions by 5 we will get RM173 billions.

Therefore, RM35 billions fuel subsidy boasts additional production worth of RM173 billions in annual Malaysia’s GDPs. Let say government taxes mere 8pc of RM173 billions. That is 173 X 0.08, equal to RM14 billions.

Therefore, RM35 billions worth of subsidies create two major impacts in economy. First, it creates additional RM173 billions of GDP.

Second, government gets additional RM14 billions tax as “rebate” and the net amount of fuel subsidy actually is RM24 billions instead of RM35 billions. Talk about being competitive and subsidies are in fact one of the best government tools to speed it up.

Active spending, "G", does not permit government to have the luxury as much as subsidies in term of “rebate”. No, unless government starts to impose tax on schools, hospitals, military and the like, and this is highly unlikely.

Subsidies are always of better choice for steady economics growth in long run. Hence, it isn’t fair to focus solely on the real amount spent on subsidies. Instead, what the economy benefited from subsidies for example in term of GDP growth had to be taken into account.

In this view, RM24 billion net fuel subsidies are actually better than to let domestic fuel price fully exposed to open market supply and demand, i.e., to increase fuel price. That is definitely “kamikaze” and we actually are going many steps backward. Please bear in mind, it was becauseof shortcomings and failure of classical thought that Keynes emerged as savior. Later, those with this line of thinking are being called as “Keynesian”economists.

For believing that market forces (supply and demand) will magically adjust everything for the sake of competitiveness, what else can be said? True, what goes up will come down. But in the case of fuel price, once it goes up, it drags the whole general price index of the country along. In capitalist market system, the price may fall in future, but general price index will most likely not, due to a very simple reason – profit maximization placement above social obligation is the businesses mean. At the end, we get only overall nominal increases in GDP and personal income.

As far as the comparison between Malaysia with Singapore and Indonesia, I honestly can’t remember that Malaysia's economy is actually being modeled after them.

I believe Malaysian economists and policy makers always maintain UK and US as economics model base so far. What puzzled me is they don't stick with the duo when it comes to subsidies. They started to compare Malaysia with other countries such as Indonesia, Thailand and Singapore instead. That is terribly lame comparison.

The fact is that, until now USA and UK governments maintain subsidies as an integral part of government spending. Take USA for example, around 13pc (USD367 billion) of 2007 federal government budget is for unemployment and welfare alone, and these are subsidies! The amount is bigger if we calculate all types of subsidies in the budget.

Non economics solutions, instead of purely economics are required if it is all about mindset changes or “paradigm shift”, or for competitiveness reasons.

Change the people mindset, they will not ask for subsidies anymore. But so long government exists and collecting taxes, subsidies are there to stay perpetually, mindset change or not, or, whether people ask or not.

I really wish some good economics responses to prove that my economics understanding for more than two decades IS wrong.

Source: Daily Express Newspaper, 17 Feb 2008, pp.15.

caveat fair use notice

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