Wednesday, September 4, 2013

The Meaning of a Price Increase

A price increase is nothing less than a rationing device. You are likely to spend more if you consume the same quantity as before. Or, if you have a fixed budget (all budgets are limited in this sense), then you will consume less at a higher price. A higher price therefore means that there is a reallocation of resources - through the agency of money - from consumers to producers or the government.

In the current scenario of an increase in the fuel price, the objective is for the government to cut its subsidy by cutting the subsidy to those who are not intended to enjoy the subsidy. In other words, the government wants to give the subsidy to the poor (we can argue who is poor). By giving the subsidy across the board, the government also gives the subsidy to the unintended groups, as such the local rich (who can argue about who is rich) and all foreigners who drive their foreign cars here to fill up (what about foreigners driving local cars to fill up). The official argument goes on to say that the only way to give subsidy to a well-defined group is to give cash to this well-defined group.

But, of course, the price increases affects everybody even those who receive the  cash subsidy (the latter have to make sure that they do not spend on fuel more than the subsidy; the counter-argument is that, at least, you have got "some" subsidy). In an evolved supply chain with lots of linkages, there will be multiple impacts from a simple increase to the end of the line - the so-called "butterfly effect" where the flutter of the butterfly in the tropics eventually causes a typhoon in the ocean. The official solution to this butterfly effect is to disallow this effect to multiply - a 10.5% increase in the price of petrol by 20 sen from RM1.90 per litre is now allowed to have an impact of 0.1% on food prices nationwide.

Simple arithmetic tells you that fuel enters only as 0.01% of a supplier in the supply chain and if the supply chain has 20 linkages and each product has say another 20 inputs with price increases (think of the transportation), the net impact is 4% - by this very crude method of calculation.

It would be foolhardy to imagine that the price increase will have little or no impact on the welfare of the general population. This is rationing, as the price increase will reduce consumption - and probably domestici production (bad) or imports (good?). If not, then the price increase will force people to dissave or to borrow and get into debt - and this will be a transfer of the government deficit to the household deficit or the corporate deficit.

In any case, do not argue that the price increase will have no impact on the domestic economy or the domestic consumers except an arrest in the deterioration of the government balance sheet because we are only reducing our subsidy to (unwarranted) foreign beneficiaries. There will be collateral damage, all right, over and above the direct impact.


hishamh said...

The corporate "deficit" is actually an enormous surplus. 90% of Malaysia's national savings is corporate.

etheorist said...

Fair comment.

walla said...

hishamh said...


EPF represents a portion of the stock of personal household savings, not the savings rate (which is a flow variable).

The operative number would be the net increase in contributions, which in 2011 was just RM13.9 billion. Gross national savings for 2011 in contrast was RM308.3 billion.

The household savings rate via EPF is thus just 4.5% of national savings, and 1.6% of national income.

Horrifying numbers.

walla said...


Thanks. I am much concerned for the majority of EPF contributors whose savings will only last them a few years after their retirement.

With the imminent wave of price hikes, those savings will now sustain them for even shorter periods and much less. Then what after is the question.

We may say a weak ringgit will spike exports. But standing at the interface of commodities and SMEs every day, i don't get to see that.

Commodities are bulk and cannot be stockpiled for too long.

The SMEs we have in most places deliver low valueadds and depend on foreign labour.

With commodity and industrial export prices weak, imported tools and materiel prices high and domestic prices increasing, many people who depend on those two backbones for their livelihood will have less to take home. Household savings will dwindle faster.

We are talking about a window of two years. What can change for the better in two years?

It cannot be those infrastructure projects which at best will only deliver secondary effects after protracted gestation. They were never econo-engineered to deliver primary impact of immediate revenue generation.

On the contrary, they will add short-term and accumulate mid-term debts, both at a time when our ratings have gone south with the implication of higher sovereign charges unless we want local banks to again subsidize financing with its own effect on interest rates.

At the end of the day, each working day in fact, things like 'national' and 'corporate' are reduced at the 'selamat datang' doormat of each home to 'household' and 'family'.

How much have all our economic policies so far made such transitions less painful and without sacrificing resilience and flexibility? For that matter, with real positive results where it matters, namely food on the family table, roof over their heads, adequate savings for their retirement and capital to cushion the unintended consequences of life's cycles let alone invest for development and growth?

Midway, we now try to put the horse before the cart.

James said...


Invest in growth? Since when has Malaysia invested in growth? All the government seems interested is allocation of resources from one segment of the population to another and ensuring the profitability of certain politically affiliated businesses. Investment in growth was dumped in the drain the day the government imposed barriers to level field competitiveness all across religious and ethnic base using economics as the excuse. The lack of value added manufacturing and continued reliance on labor intensive commodity sector spells disaster, which is compounded by leakages in all sectors from the rampant corruption and the inefficient use of financial resources. The need to increase fuel costs simply reflects a government coming to grasp with the fiscal mess it is in.