Written by Carmelo Ferlito, Senior Fellow of IDEAS
First appeared in The Malaysian Reserve on 26th of March 2020
THE Malaysian government had on Feb 27 revealed stimulus package to help the rakyat to deal with the economic impact of Covid-19.
At the same time, Bank Negara Malaysia (BNM) cut the reference interest rate to a historically low level and more recently the statutory reserve requirement was cut from 3% to 2%.
Unfortunately, since then the health emergency worsened, forcing the new Cabinet to take extraordinary measures to limit people’s movements. What can we expect from the stimulus? Will we require further actions from a policy perspective? Is there something we should avoid?
It is not easy to discuss these topics through the ‘emotionless’ lens of economics, but it is necessary. The analysis, moreover, needs to take into account that we are experiencing a partial economic lockdown — economic activities which, for safety reasons, cannot operate, cannot be stimulated either.
With regard to monetary policy, at this moment, I have serious doubts about the efficacy of easier credit conditions; I believe that the main mover for investments is profit expectations — in the present circumstances, such expectations are frustrated by the general climate of uncertainty and credit facilitations do not stand a chance in reviving them.
With regard to fiscal policy, instead, the government has enacted both tax reliefs and cash handovers such as the temporary reduction in the employee’s Employees Provident Funds quota. Most of these measures are clearly limited in time as this will help the government to minimise the impact on the federal deficit.
Personally, I believe more in tax cuts than indirect support to people spending; in fact, in the latter case, we encounter two major problems: The limited temporal effect and the peculiar situation created by Covid-19.
A temporary support to consumption will not bring a structural change to the economy and its effects will likely end when the stimulus end, revealing the real structure of demand.
In the present moment, moreover, an additional factor has to be kept into consideration which is people are avoiding restaurants or flights, not because of the lack of purchasing power but because restaurants and flights are either forbidden or constitute a threat to individual health.
No matter how much cash in hand, in this period we are simply not going to spend money on eating outside and we are not going to travel.
Rather than una tantum cash handovers to the general public, it would be more appropriate to use the present circumstance to revise the social support system for the weaker population sectors when facing emergencies like the present one.
I also think that temporary tax cuts which support the demand side are unlikely to produce significant effects.
What instead would be helpful are supply-side tax cuts because they can create a structural incentive to invest and this type of fiscal incentive can represent an important player in awakening profit expectations.
I emphasise on the role of the supply-side also for another reason that is goods need to be produced before being purchased. From this perspective, the most important measures taken by the government are the tax deduction (up to RM300,000) on renovation and refurbishment costs, import duty and sales tax exemption on importation or local purchase of machinery and equipment used in port operations for three years.
In this direction more could be done to restore a damaged global supply chain. For example, in order to strengthen the local manufacturing sector, more import duty exemptions on raw materials could be studied together with further tax reliefs for strategic industries.
This kind of stimulus, in supporting production, can also boost profits, and therefore generate more fiscal revenues. It goes without saying that the efficacy of such measures can fully unfold only after the undergoing economic lockdown.
I would like to spend a few words on further extraordinary measures that could come to the policymaker’s mind that should be avoided, even if it may seem against the common good.
I am thinking particularly on the temptation of introducing price controls. There are no signs of such directions, but a brief analysis would be helpful.
The emergency situation can drive people to hoard essential goods which may create a shortage situation and with the risk, in case of serious disruptions in the supply chain, goods’ price increases.
In such a scenario, the government may think to call for price controls. However, such a measure would only make things worse. What do we need in case of shortage, in order to make the price hike as short as possible?
We need more supply. The only way to create an incentive for new supply to enter the market is to keep prices high because the incentive created by higher profit opportunities will stimulate new entrepreneurs to produce what is needed and in high demand. Subsequently, the inflow of new supply would allow prices to correct downwardly. Of course, this process will require time but it will happen.
A price control, instead, will impede the creation of supply-side incentives, keeping the prices at the current level but making the shortage permanent and there is no point in having good prices for products that are nowhere to be found.
In the current scenario, thus, what will help the economy is permanent supply-side fiscal reliefs (primarily tax and import duty cuts), while direct spending support may turn to be just a waste of resources. Special attention, instead, should be paid to the system of social protection for the weaker segment of the population.
Moreover, we need to avoid the temptation of a higher degree of control of the economic system, trusting that market forces can help, in time, to overcome emergencies.
This time of struggle will also probably be a useful time to appreciate more the value of many things we have taken for granted for decades — freedom of movement, availability of goods, possibility to choose where and when to eat.
These are all marvels created by human interactions in the market.