Monday, January 21, 2008

Cooking Up A Storm

My article on the cooking oil fiasco appeared in Malaysiakini column last Tuesday. I'll reproduce it here below ;-)

On 7th January, the Government imposed the shocking move of having to ration the purchase of cooking oil by Malaysian to 10kg each, to temporarily resolve its shortage. It certainly wasn't the first time that this drastic action has to be put in place. In 2006, the supply of sugar faced the same problem. Now, there's talk of potential shortage in wheat flour.

What is of note, is that there is no shortage of global supply of cooking oil, flour or sugar during this period of time. Why is it then that the Malaysian micro-economy appear to be failing so miserably?

From an economic perspective, the answer is simple. The Government's seemingly iron-clad price control mechanisms for basic essentials emulates those put in place by the failed command economies of the new defunct Soviet Union and Eastern Europe. Yes, believe it or not, it appears that Malaysia is a market economy practising impractical communist policies.

In the 1980s it is commonplace to find Russians queueing up in front of stores to purchase basic good such as bread and butter. In fact, I learnt to drink coffee with honey in Moscow as the restaurant could not secure supplies of sugar back in 1989, prior to the fall of the Berlin Wall.

The communist Soviet Union attempted to control the prices of all goods and services, the quantity of supplies as well as who produces these goods, independently of the global economic environment as well as the market demand and supply forces. It was certainly no joke when you hear of stories of factories producing only left sided shoes, without its matching right counterpart. As complacency, corruption, incompetence and downright obstinance sets in, the Soviet Union economy imploded, precipitating the rise of populist Boris Yeltsin and ultimately, the dissolution of Soviet Union.

Why would such command economy policies fail so spectacularly, when purportedly, they were meant to increase fairness, equality and equity amongst its population? Similarly, why did Malaysia's price and supply control measures meant to benefit the poor fall apart like the house of cards?

Very simply, the Governments attempt at all cost to give the false public perception, particularly before the impending general elections, of the impressively low inflation rate of 2% via policies which are out-of-sync with global realities are the real cause of shortages of essential goods.

Just as in the Soviet Union where there wasn't any profit incentive for businesses to thrive, local licensed and controlled producers have little incentives to manufacture and supply these price-controlled goods. This is because there is little or no profits to be made despite government subsidy given the record-breaking commodity prices in the past year. For example, wheat flour prices have increased by 70% in the international markets.

It is hence unsurprising that these manufacturers and suppliers choose to focus on other related products which don't face any price controls, such as premium flours or fine sugar. For example, non-general-purpose flour are sold between RM2.60 and RM2.90 per kilo while general-purpose flour is RM1.35 per kilo.

What makes the situation even worse in Malaysia's case is the heavily regulated licensing requirements for the production of these essential goods whereby competition is limited. For example, as the nation faced various supply shortages, the Government refuses to increase the number of permits to import wheat flour despite the call by Federation of Malaysian Consumer Association (Fomca) president Datuk N. Marimuthu for the Government to do so in order to curb price increases.

Such price-control policies which are substantially divergent from global realities will also result in a negative externality, that is the creation of a “grey market”. Due to shortages in supply in the Soviet Union, the “grey market” thrived with great incentives for traders to sell these goods at higher prices to willing buyers due to heavy pent up demand. This will in turn create a vicious cycle which exacerbates the shortage faced in the supply of these goods via the normal markets.

Similarly, in Malaysia, consumers are now facing significantly higher grey market prices. The Star reported on 7th January that a hawker complained that “lately, I have had to make more visits to sundry shops for my cooking oil supply. Some shops are taking advantage of the shortage and selling the oil at RM14.40 per bottle, which is 90 sen higher than the normal price.”

As for flour, it was complained that “wholesalers are charging between RM5 and RM15 more than the price-controlled rate of RM33.60 for the 25kg bag of flour.”

Of course the fact that our basic essentials are priced articifically low, the incentives for smuggling and foreign purchases becomes extremely high for traders to profit from the arbitrage in pricing between Malaysia and its neighbours, Singapore, Thailand and Indonesia.

The Government consistently blamed panic buying as a result of rumours of price hikes the cause of a shortage in cooking oil and flour. Unfortunately such panic buying and hoarding of goods is not the cause of the shortages but instead are the direct symtoms of an ineffective and distortionary price-control policy.

Hence when Domestic Trade and Consumer Affairs Minister, Datuk Shafie Apbal confirmed that these shortages were “artificial”, the irony is that he is indeed correct because these shortages were indeed artificially created by poorly-formulated, politically motivated Government price control policies.

Before readers complain that I have only provided criticisms and not constructive proposals to assist those most affected by inflationary pressures, we have in the DAP's Budget 2008 for Malaysia proposed various more effective measures to assist those most in need.

In the short term, the prices of essential goods will have to be more aligned to global prices to avert such unnecessary and embarrassing episodes of shortages. The savings in subsidies should instead be channelled directly towards the middle and lower income earners to help them cope with the price increases. Under the current distortionary subsidy mechanism, the wealthier segments of the population are able to benefit proportionately more as they have greater access to these goods either via the grey market or more funds to hoard goods, which in turn exacerbate these shortages.

We have consistently proposed that those gainfully employed with income lower than RM3,000 per month be granted a Malaysia bonus of up to RM3,000 to cope with these challenges. Such a measure will have the additional benefit of reduced leakages which results in unbudgeted increased government subsidies arising from smuggling and the grey market.

Over the longer term, it is critical for the government to raise the productivity levels of the Malaysian labour force which has not increased substantially over the past decade. The only way to beat global inflation is not to keep prices artificially and unsustainably low, but to increase income by a rate significantly higher than the real price inflation.

While the growth rate in Malaysia's economy remains “healthy” at 5-6% levels, it masks the fact that growth is driven strongly by the oil and gas, as well as the commodities sector via record global prices and not due to increased worker productivity, human capital and efficiency. Without the latter, which can be achieved via a real, as opposed to a rhetorical transformation into a knowledge economy, middle and lower income Malaysians, particularly those in the urban areas will continue to face hardship in their economic circumstances.
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