My Say: Budget 2022 and emergency room economics

This article first appeared in Forum, The Edge Malaysia Weekly, on September 27, 2021 - October 03, 2021.
The economic downturn in 2020 and the economic slowdown in 2021 did not result from a negative demand-side shock, but from the shutdown of the supply side by government restrictions on most businesses, especially SMEs and service firms (Photo The Edge)

The economic downturn in 2020 and the economic slowdown in 2021 did not result from a negative demand-side shock, but from the shutdown of the supply side by government restrictions on most businesses, especially SMEs and service firms (Photo The Edge)

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It has become popular in discussions on Budget 2022 to propound that since government expenditure will be going up to counteract the negative economic consequences of Covid-19, this increased expenditure should be geared towards restructuring the economy to place it on a higher growth path.

This suggests basic measures be taken, for example, to reskill and upskill workers to become programmers and bio-engineers, and to incentivise firms to acquire cutting-edge production technologies. The appeal of this “building back better” (BBB) proposal for Budget 2022 is the cost-effective promise of killing two birds with one stone — that is, while boosting GDP, it should in the process also reorient the economy towards production of high-value-added goods and services.

I support the BBB proposal in principle but I recommend most strongly that Budget 2022 incorporate a switching mechanism that enables the Ministry of Finance (MoF) to quickly re-allocate large dollops of BBB-designated funds to disaster relief and medical programmes. This is because the BBB proposal cannot be the panacea that it is claimed to be.

The economic downturn in 2020 (GDP growth rate was -5.6%) and the economic slowdown in 2021 (predicted GDP growth rate has fallen from 7% to 3%) did not result from a negative demand-side shock, for example originating from pervasive bank failures, but from the shutdown of the supply side by government restrictions on most businesses (especially SMEs and service firms). This type of economic collapse is extraordinary in that it was deliberately induced by the state as a key part of its efforts to limit the transmission of Covid-19.

The government had intentionally incurred this collateral damage to the economy because saving lives was more important, and also because only the elimination of Covid-19 (or good control of it to a very low level) would allow dynamic long-term economic growth to return. This extraordinary output-reducing measure reflects the fact that an extraordinary national disaster like Covid-19 requires extraordinary economic management. One key recommendation from this situation is that a temporary unconventional fiscal policy in 2022 is optimum for addressing the present extraordinary pandemic.

As the deliberate shutdown of production makes a significant reduction in GDP inevitable, the expansionary fiscal policy to counter Covid-19 should really be an emergency disaster relief effort and not a Keynesian-type economic stimulus injection. Temporary large government expenditure on correctly executed emergency disaster relief activities will protect the livelihood of the rakyat and enhance the economic resilience of Malaysian firms without causing a significant rise in the Consumer Price Index (CPI). An untargeted Keynesian-type of general economic stimulus will produce mostly a rise in CPI and in imports without bringing comparable benefits to the rakyat and Malaysian firms.

It is most fundamental to recognise that two types of fiscal programmes with very different implications have just been prescribed above on how to direct the expansionary fiscal policy. These are (1) a disaster relief programme that saves lives and preserves economic resilience by bringing immediate relief to the extreme suffering of the B40 (bottom 40% income group) and SMEs; and (2) a growth-oriented macro-stabilisation programme that puts Malaysia on a higher growth path but does not alleviate the hardship of the B40 and SMEs immediately.

Another key difference between the two expenditure programmes is that (1) the implementation of the disaster relief programme makes sense only when the economic collapse is caused by the state shutting down overall production with administrative means, and (2) the implementation of the growth-oriented macro-stabilisation programme makes sense at any time, regardless of the cyclical phase of the business cycle, albeit less so in the upturn phase.

Stepping over the pitfalls of Wall Street shibboleths on fiscal deficits

The MoF must kill two sacred cows in conventional fiscal management in the present pandemic/endemic situation. The first sacred cow to be sacrificed is downgrade-phobia. The usual warning given by investment banks is that a developing country is safe from a downgrade on its sovereign bonds when its fiscal deficit is under 3% of GDP, and is headed for a downgrade of its financial standing when its fiscal deficit exceeds 7%.

This mechanical rule makes no economic sense when a 7% to 10% fiscal deficit is not only temporary but is also crucial to maintaining social stability and keeping the recovery mechanism well-oiled with ready-to-resume-operations firms. Any downgrade that happens will not last because a V-shaped recovery in GDP will occur and transform these same investment bankers into cheerleaders for Malaysia. And a severe downgrade will definitely happen when sociopolitical disturbances break out after prolonged economic stagnation. It is better to risk a minor temporary downgrade in bond rating than to risk igniting the vicious cycle of economic fatigue, political instability and social malaise.

The second sacred cow in fiscal management that has to be slaughtered during Covid-19 times is the fright over significant currency depreciation. The usual International Monetary Fund (IMF) warning about currency depreciation from a higher budget deficit is valid only when higher budget deficits are not also occurring in most other countries. Today, enlarged budget deficits is a general global phenomenon, and the increase in budget deficits is much higher in the G7 than in Malaysia. As the ringgit’s exchange rate is determined not just by economic conditions in Malaysia but also by the economic situation in other countries, the MoF should not be cowed by this mantra in the IMF’s operational manual.

Putting unconventional fiscal policy into action

The government should not shy away from undertaking temporary direct income distributions to the poorest and the most vulnerable. Two groups should be targeted in the emergency relief efforts, the B40 and SMEs (with extra emphasis given to SMEs engaged in production, transport and distribution of food).

Since tax credits and tax reductions do not benefit the B40, direct cash transfers to this group become necessary. The usual worries about work disincentives should be dismissed because the current economic fatigue has not been caused by workers taking French leave.

It must also be recognised that tax credits, tax deductions and lower tax rates do not help SMEs survive when they are running losses. They need help in paying rent, servicing debts and keeping their workforce intact. Legislations to impose either temporary moratoriums on, or temporary reductions in, the rent and debt servicing obligations of SMEs are hence needed, where the government does not already have the regulatory power to do so.

The MoF should also urge Bank Negara Malaysia to give Covid-19 loans to commercial banks for imbursements to SMEs solely for wages, rents and debt service. Bank Negara will write off its Covid-19 loans to commercial banks over time, thereby permitting commercial banks to do the same for their Covid-19 loans to SMEs.

Most importantly, the MoF must greatly strengthen the capability of the medical system to bring the pandemic under control. The funding to the public health service must be increased to improve its ability to test and track Covid-19, and public hospitals must be able to both scale up and upscale their treatment of the disease, especially for traditionally marginalised communities.

The MoF must start funding new educational access programmes to enable primary and secondary schools to offer effective online delivery of education, to provide computers to children of low-income families and to expand broadband internet availability throughout the country, especially in rural areas, and at a low price.

We note that both of the preceding extra medical-related funding and extra education-related funding in Covid-19 times are really disaster relief measures rather than BBB measures. Both sets of activities are cases where two birds are killed with one stone.

The positive effects from this unconventional fiscal policy will be that the rakyat will have access to near-normal level of food, shelter, medical care and educational access for their children; businesses will avoid closure during the pandemic, allowing them to resume operations immediately upon lifting of shutdown requirements; the production of food, and its transport and distribution will be near normal level; and the medical system can quickly ramp up its capacity in testing, tracking and treating Covid-19 cases.

Balancing between disaster relief and BBB

The budgetary allocation situation is analogous with one where a decrepit apartment building is on fire. Should the director of operations focus entirely on getting all the residents out of the building and putting the fire out, or should he also start fixing the leaky pipes and painting the house at the same time?

The government budget in 2022 would naturally fund both a disaster relief package and a BBB package. The MoF must incorporate vigilance and flexibility into the budget oversight and disbursement process to be able to respond appropriately to the course of the Covid-19 disease in 2022. Should the Covid-19 situation suddenly worsen, the BBB programme should be cut back and not postponed, and the released funds should be redirected to disaster relief activities, and vice versa.

In 2022, the need to be unusually quick in large-scale budget reallocations on the part of the government is evident. How could the construction of projects proceed when anti-Covid-19 measures do not permit workers to go to their job sites?

Woo Wing Thye is president of the Jeffrey Cheah Institute on Southeast Asia and director of the Jeffrey Sachs Center on Sustainable Development at Sunway University

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