Friday, January 23, 2009

Four months later…

by Tengku Razaleigh Hamzah @
January 23, 2009 at 4:50 pm

“We are in the midst of a once-in-a-century credit tsunami” ---Alan Greenspan, October 23, 2008

After the Great Depression, economists thought they had banished economic crashes to the history books. We were said to be in a new economic era in which carefully calibrated management of interest rates and money supply by Central Banks would keep the system humming without major disruption. Today’s crisis, sparked by a reckless greed which implicates the entire US financial establishment, has rubbished that view. The policy thinking of John Maynard Keynes, who puzzled over the causes of the Great Depression and described the remedy that Franklin Delano Roosevelt applied, has been dusted off and brought back to life. Suddenly everybody is a Keynesian again.

Keynes diagnosed recessions as a failure of aggregate demand. Today’s recession is caused by a loss of confidence triggered by credit failure. A mass of worthless American mortgages, packaged and resold all over the world, wiped out trillions of dollars in the value of savings and investments and sparked a global collapse of credit, the oxygen of business. Consumers cut back on spending and businesses cut down on production and investment, reducing demand for materials and labour and leading to even lower confidence. If this self-reinforcing process is not arrested, the system goes into a tailspin.

The government is the only economic agent with the scale and freedom of action to turn things around. It does this either by increasing its own expenditure or lowering taxes, or some combination of both. Each of these measures stimulates demand. By increasing its own expenditure, the government creates demand directly. By reducing taxes, it leaves more money in the pockets of citizens so that they demand more goods and services. The latter can fail if citizens are so uncertain that instead of spending that extra money they save it away. Either way, such fiscal measures are temporary, targetted remedies aimed at reversing a destructive cycle of lowered demand, or at least to cushion its shock to the most vulnerable members of society. It is remedial, like reviving a patient, putting out a fire, or preventing a landslide.

Like all remedies, successful fiscal policy must have the right ingredients in the right dose applied at the right time.

Let me stress this again.

a) It must consist of the right spending. The right type of spending will aim for a combination of short term relief and stimulus, and long term improvement in the productive capacity of the economy via infrastructure investment, economic restructuring and institutional reform. Both the size of the expected multiplier and how quickly it can take effect in the economy need to be taken into account in selecting any particular project.

b) The stimulus must be large enough.

c) And it must be applied on time. Delay allows time for the down cycle to turn, enlarge its effects and cause long term damage. Stimulus measures can take months to take effect. Some of the right decisions have to have been made yesterday.

I am not sure that the two stimulus measures that the government has announced in the last four months fulfill any of the above criteria.


In October the government made EPF put RM5 Billion into Valuecap Sdn Bhd, a company formed in 2002 to buy stocks on the basis of loans, for Valuecap to buy “undervalued stocks.” But just what is an “undervalued” stock? Undervalued by whom? Given that the entire market is perpetually on the lookout for “undervalued stocks” to make a buck off, I’m not sure if this was a helpful instruction. It asks for Valuecap to be smarter than the market. And it’s not as if EPF itself didn’t have perfectly capable fund managers investing in the stock market. So we entrusted RM5 Bil from the retirement savings fund of our workers to a company with a proven track record of being unable to locate that value, a company that prior to this already owed creditors RM5.1Bil that it is unable to pay.

Valuecap’s merits aside, it was not clear how propping up the stock market was supposed to stimulate aggregate demand. But it was clear that RM5Bil, representing 1% of the capitalization of the KLCI, or the value of 3 days’ trading, was barely enough to cause a blip in the KLCI, after which it continued to decline along with other global markets.

If picking ‘undervalued stock’ is a hopeless vague instruction, the real criteria Valuecap uses for picking companies need to be scrutinised. The Valuecap deal was so opaque, so economically senseless, that EPF contributors and the investing public may be forgiven for wondering if the real intention was to cash out favoured parties, leaving the government and EPF contributors holding the bill.

One international fund manager described it as “daylight robbery” of the very people we were supposed to be helping through the recession.

This kind of perception of the Malaysian government’s capacity for governance and policymaking does little to improve confidence in the Malaysian economy. Right now we are in particular need of that confidence.

The 7 Billion stimulus package

It’s hard to comment on the RM7Billion stimulus package the government announced on November 4 because none of its details have been filled in, none of its projects has gotten off the ground, and none of its effects noticed yet. It appears to be a hodgepodge of projects driven by special interest with no economic plan behind it.

The most memorable element in it for me was the provision for RM200 million of this fiscal stimulus to go towards “re-engineering” all Malaysia’s toddlers into “holistic human capital” whatever that is, in nurseries run by an organization led by the wife of the Deputy Prime Minister. Permata curriculum will now be the national early-childhood curriculum and Permata’s teachers will be absorbed into the Ministry of Education’s payroll.

In this grave crisis, it is interesting to see the government support a private effort to the extent of absorbing it into the government and giving it RM200 million to spend. How will that money be spent? Has the Ministry of Finance taken over policymaking on early childhood education? What does this say about governance and transparency?

How this constitutes an economic stimulus in the sense I described above is a question I almost forgot to ask.

In a press statement in October last year, I underlined the urgent need for action. I said we must be vigilant, coordinated and bold in our response to the crisis. The government ignored that view. To date we have seen only denial, indirection and inaction. What measures have been announced have yet to be implemented.

What’s even more worrying is the thought these failures may arise from a failure of capacity, not of knowledge. Our current leadership, and the way it is organized and supported, may lack the very capacity to deal with major crises.

That may explain why it continues to deny we are in a serious crisis, both economic and political. ---Tengku Razaleigh Hamzah

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