The problem of straitjacket economic thinking

Yeah Kim Leng, an economist at Sunway University, said Bank Negara Malaysia’s reduction of the OPR to 2% from 2.5% on Tuesday would boost domestic aggregate demand.

The 50 basis points cut will result, Yeah says, in a “substantial monetary surplus”. It will. But Yeah doesn’t say how big the surplus will be. Bank Negara will need to cut its statutory reserve requirement from current 2%. And M3 – broad money supply – is stuck at 3.9%.

None of these will do anything to generate domestic aggregate demand in the face of large capital outflows. Not even the RM30 billion liquidity that has been pumped into banks will help if bank loan books are made stricter and aggregate demand is falling while aggregate supply dries up.

Yeah’s argument is that the OPR savings will help bring the economy out of recession. His underlying assumption is that more money will end up in the hands of households and firms who’ll then spend on purchasing goods and services, and that firms will invest their savings. This looks good on paper. But Yeah ignores the “what if” questions.

Example: What if firms spend their savings on their fixed cost assets rather than upping production? Or what if firms don’t invest those savings at all? What if households use their new savings to pay outstanding debts or bills?

The fact that Bank Negara made a complete mess of the loan moratorium illustrates Malaysians mired in debt, living from pay-check to pay-check. It smashes historical claims that Asians enjoy the highest savings rate in the world.

Yeah must have seen the long queues at pawn shops around Kuala Lumpur. Odds are it’s the same phenomenon around the country. Since banks are unwilling to lend to overextended households, pawn shops have become lenders of the last resort – even if they are slitting customers’ throats in the name of risk.

Of course a fraction of the savings from the interest rate cut will go towards purchasing everyday essentials, though I’m more inclined to think the bulk of savings will go towards debt repayments and utilities. The richer classes will more than likely save their OPR savings than spend in times of tremendous economic uncertainty.

If the latter proves true, there won’t be any boost to domestic aggregate demand. And if firms use the OPR relief on new plant machinery, it’ll help but it won’t be enough to put a floor under a still-sinking Malaysian economy. It certainly won’t help if firms merely repair their existing fixed cost assets instead of updating them.

Shaun Edward Cheah of the Malaysian International Chamber of Commerce has admitted that much: that the lower OPR would take some pressure off some companies’ debts. He should spell out what his members plan to do with the savings from the interest rate cut.

A lower OPR doesn’t spell a turnaround in unemployment, consumption and investment. Not by a long shot.

Businesses, like consumers, take cues from government policies. As yet there’s no evidence that the Muhyiddin Yassin-PN regime has a clear plan for the economy. Opening up businesses, at it did on May 4, doesn’t equate to consumers thronging businesses.

That’s because, one, households will be looking harder at their balance sheets before deciding to spend the additional increase in disposable income on discretionary items. Food to cook, yes. Eating out, no. Paying bills and debts, yes. Clothing et cetera, no.

And even with food, most will forego meat, leaving butchers with surplus supplies. That’ll be good for prices but it doesn’t mean consumers will buy more meat at lower prices. The problem with neoclassical economics is its historical problem of the fallacy of composition.

Two, no firm will ramp up production if it can’t see future demand. It’ll run down inventories before stepping up production again – if demand is at least constant. When it does increase production, it’ll be by the slimmest margin, but not if the price of its product is more than its average total cost, or if its marginal costs are greater than its average variable cost.

None of these will see aggregate supply rise or boost aggregate demand.

Three, and importantly, Malaysia, being an export-dependent economy, can’t rely on domestic aggregate demand to lift the economy out of trouble. It simply doesn’t have the population of China or India to do this.

It’s even doubtful that Beijing’s planned transition from export-dependence to domestic demand will see mainland China growth go back up to the 6% average rate of the past few years.

Four, the world economy is slumping – badly. Besides China, the world’s largest economy, the US, has shed 20.2 million jobs in less than the full month of April alone. More job losses are projected. The US services sector has been the hardest hit. Construction, manufacturing and other industries are grinding to a halt. Boeing is scrapping 16,000 jobs or 10% of its workforce and cutting the number and models of planes it used to make.

Five, China, which has long depended on the sustained rabidity of US consumerism, is fretting – as is the rest of Asia. Malaysia included. Especially as the euro area economies are in deep trouble, too. The European Union economies look likely to slump 7.4% this year, meaning ballooning debts, fiscal deficits, chronic unemployment, and the collapse of investments in real terms.

Let’s hope these conditions don’t swarm Malaysia, because it would be a disaster. No amount of fiscal and monetary policy tweaking would boost aggregate demand to save Malaysians from a very bad place.

Malaysia will have to run down its international reserves to keep the economy from going totally pear-shaped. Or Bank Negara might have to entertain quantitative easing measures.

It’s one thing to adhere, as Sunway University economist Yeah does, to neo-classical economic thinking as if it’s the gospel of all economics when it has proved to be inadequate since at least the early 1970s.

It’s another thing when plainly – and Yeah would do well to acknowledge it – governments across the world have turned to Keynesian economics, as they did during the late 90s Asian crisis and the 2007 global financial crisis, thus dumping the straitjacketed thinking and failed policies of neoclassical economics and free-market ideology.

What Malaysia needs is real structural economic reforms. The question is: does the current Muhyiddin regime have what it takes to undertake these painful reforms or will it continue to play politics? I suspect the PN government is out of its depth in dealing with pressing economic issues. So it’ll be back to playing its old hand at surviving regime change by upping the ante of disgusting racist politics.

Manjit Bhatia is an FMT reader.