As we are going through our daily chores, I am sure many of us realized that life is much tougher now than it was 20 years ago. We still remember those days when mum takes care of the family while dad is away for work. During those days it was possible to sustain a family even when only one family member worked. Gone are the days when we can afford a house with a salary slightly above RM 1000. Gone are the days when tuition fees in private colleges only cost about RM 1800 per year.
Today, we may work twice as hard and with two incomes (including our spouse) but our paycheck is not stretching that far or shall I put it more bluntly alarmingly thin. After paying for daily and monthly expenses such as gas, groceries, food, phone bills, broadband, utility, credit cards and so on, there isn’t much left to save. Even though our income may be many times that of our parents but we are still struggling to provide ends meet. In short why are we feeling more SQUEEZED?
Didn’t our leaders boast that our economy is going through a transformation and we are heading towards a ‘new economy’. We have our Economic Transformation Program, 10th Malaysian Plan, New Economic Model and Government Transformation Program to help fast track our economy to achieve its ‘develop status’ by 2020. As a result we often hear and read great economic news about our stock market, employment, productivity, economic growth, corporate profits and income growth in the mainstream media. Thus with the above so-called achievements, we should be making progress and life should be much easier. Instead, we faced a tougher life by getting heavily in debts when we try to secure basic things like health care or sending our children to better colleges. For those who can’t afford, they either have to do away with health coverage or sending their kids to lesser known colleges.
Before we look into the causes of the Squeeze, let’s take a look at the progress made by our economy.
Our economy has been doing remarkably well when compared to most Western countries. Malaysia’s GDP has grown from RM 110.2 billion in 2003 to RM312.44 billion in 2013.
Our unemployment rate dropped from 4% in 2003 to 2.98% in 2013. This is a commendable figure as unemployment rate below 3% is considered near full employment. This being one of the objectives pursued by Bank Negara which includes full employment, price and exchange rate stability.
The latest figure for our inflation rate is 3.3% in June 2014. As can be seen although the inflation rate spiked to more than 8% in 2008, during the past 10 years it averages about 3.5%. Thus it can be said that we have achieved price stability during the past few years.
Next is the Stock Market. Currently our FBMKLCI is trading in near record territory at 1871 points. Our market has risen from about 850 points in 2008 which amounted to about 120%.
But wait a minute, with such fantastic news coming out from our economy, why are we still feeling Squeeze?
Why we feel Squeezed?
On one side our government is reporting excellent economic performance while on the other side we are feeling the pinch. So something doesn’t add up or should we say ‘the whole is not equal to the sum of its parts’. Before we go on to tackle the problem let me illustrate the root cause of the problem and how an economy manifested into such a situation.
In simple definition, an economy consists of production, distribution and consumption of goods and services by different actors. Different economic actors are governments, individuals and businesses and they always stride to best provide the goods and services that we want and need in an efficient manner. This process can best be illustrated with the following simple flow chart.
As can be seen in a free market economy the above process will be self-regulating without the need of government interference. As it is, rational consumers and investors will always look for ways to maximize their resource allocation through profit incentive. The problem begins when the government starts interfering into the activities of both consumers and investors.
To prevent the natural forces of supply and demand from cleansing the economy from excesses, governments seek to manipulate the economy through other remedies. They will unleash monetary and fiscal policies to artificially bolster the economy. Some methods commonly used are the following.
Increasing Money Supply
Countries that are running on the Keynesian track tend to believe that prosperity can be achieved by increasing the aggregate demand through increasing the money supply. They reckon that by increasing the money supply it will lead to ↑ spending, ↑ production, ↑ employment and subsequently ↑ standard of living. In reality it leads to both mal-investments and increases in prices. Due to the easy availability of money, governments tend to invest in riskier and less commercially viable projects, bailing out uncompetitive companies and so on.
Eventually it will lead to the liquidation or closure of these projects which cause unemployment to rise and spending to fall. We are led to believe that through Quantitative Easing (increase money supply), our government will be able to monetize its debts without causing prices to rise. But according to the classical Quantitative Theory of Money, there exists a positive correlation between the money supply and price level. The bigger money supply will eventually lead to higher prices. This can be shown by the following formula.
P=MV/T where,
P = Price, M = Money Supply, V = Velocity and T = Transactions
Thus, when the money supply increases, so does the price.
Interest Rate Manipulation
It is of common view that anything that is low and cheap is good and that includes interest rates. Authorities tend to drive down interest rates artificially through open market operations. But sometimes driving down interest rates artificially will lead to unintended consequences such as a credit bubble, asset speculation and other distortion in the economy.
This is because interest rate is a product of the market where the rise or fall is determined by the demand and supply. Rates will automatically goes up when there is an excess demand over the supply for loanable funds. If rates are kept down so that banks can lend more to consumers through credit cards or personal loans then it will not be a productive venture. No doubt it will help boost consumption and hence production but at the expense of higher consumer and household debts which we are facing now. Household debt in Malaysia is already at boiling point (86% of GDP) and any attempt to rein it in will risk a credit contraction which might implode our economy.
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