Thursday, November 06, 2008

The 3% EPF Cut

Let us create some intuitive economic sense. Before
  1. the oil price hike
  2. the reduction in petrol subsidy
  3. the increase in food prices
  4. the increase in transportation costs
  5. and finally the increase in a basket of consumer goods

Assume that our spending power, on average, is 1 unit of each good.

Income disparities between individuals are not taken into consideration because each income group has their own basket of consumer goods.

This means that higher income groups will perhaps buy free range poultry, eat in quality restaurants, purchase higher priced clothes and drive bigger cars that consume more petrol.

On the other hand, the middle income groups will perhaps buy caged poultry, eat in normal food courts, purchase reasonably priced garments and drive a lower cc car.

The basket of goods measured is the same and given their respective incomes, we take their spending power as 1 unit of each good in the basket.

Over the time period of an increase in the listed sequence of 5 events above, our spending power per unit of goods in the basket has fallen to, say 0.5 units of each good.

That is, assuming we maintain all wages, taxation, and EPF contributions. Realistically, that is not true. In fact we have a case where

  1. income per month can possibly increase with bonuses, contractual wage increase, and non labor income
  2. taxes have fallen in Malaysia in a “caring budget” by Pak Lah

With these “safety nets” handed out to the people, our purchasing power of the basket of good can possibly increase to say, 0.7.



And now, we have Najib handing out candies to the work force - EPF contributions can be slashed to 8% from (optional) in a “stimulus package” by Najib.

This can probably make us well off with a purchasing power of greater than 0.7 per unit of the goods in the basket.

That is the side of the consumers. Let us move to the producers.

Producers that sell above costs are said to be earning supernormal profits. I will term it as extraordinary profits.

A plate of rice that sold for RM 5 after a petrol price hike should only be sold now at say, RM 4 since the lower revised petrol price. But food prices stayed the same!

If the people are still pressured by their lower spending power, we will spend every dollar wisely.

Consumers and producers will sort themselves out in equilibrium. Similar goods producers will have to differentiate their products, innovate and create as well as subscribing to price wars to win consumers’ dollars.

With the option to reduce EPF contributions to 8%, the people will surely have more dollars to keep themselves at the spending power before the oil price hike or just slightly worse off.

This will surely keep the demands of consumers still “carefree” and maintained at their “habitual” level.

Demands by consumers, unchanged and reasonably unaffected by prices now, will allow producers to continue earning “abnormal profits”.

The prices of goods will be sustained to be brought forward to the future period.

Do not forget also that year after year, food prices – especially the Chinese traders – will rise to see the Sun but never slashed to see the Earth.

Annual inflation will also be factored into their pricing strategies.

We can expect the prices in future to be higher than what it is now because producers will not compete to provide efficiently and at socially optimal levels to consumers – i.e. disequilibrium.

Upon retirement, we will have 3% lesser EPF savings. But 3% is not the real value forgone because we have to take into account the percentage of dividends given out annually by EPF discounted at the inflation rate. We must also not forget we can earn dividends on dividends.

This move will not be beneficial for us in the future. Unless of course, we take the 3% away to invest in stocks, insurances, currency holdings or any financial assets that will ensure returns greater than EPF dividend rates.

Otherwise, the 3% cut might not do us any good in the long run. At least, that is what I think on the surface, without going in depth to consider the intertemporal budget constraints and utility maximizations of each unique individual.

Personally, for now with a shallow thought, I disagree with the option to take up the 3% EPF contribution cut.


Thankfully, though, Najib proposed that this scheme is to be enforced for two years only (i.e. temporary policy) beginning from Jan 1 next year. So, the effects on EPF savings might not be great.

Perhaps the Government is right that if all contributors take the cut, it will boost private spending by RM 4.8 billion a year and money circulation in the economy will help maintain our markets.

But again, I am looking at the “reluctance” of the traders to reduce their prices even after the petrol price hike.

A spending power pressure on consumers will certainly be a winner for us because traders of food or raw materials have no choice but to slash their prices to near competitive equilibrium prices to win market share.

This is just me in my own world doing some surface thinking.

-end-

4 comments:

Anonymous said...

I think you're right. Taking the 3% cut is a bad idea for workers. Also, mostly poor people will take this up, making it even more difficult to finance their retirement.

Retirement savings should never be compromised to prop-up the economy in the short-term.

Anyone who suggests this is not thinking about the welfare of our workers.

It is troubling that this plan was announced by our next PM-designate.

If he is not thinking about the workers, who is?

Jimmy Tham said...

My verdict is mixed on this one.

Did basic economy in ANU b4 and just like how every policy contributes a domino effect/cycle, you just don't know which affect which sometimes.

I could also say with increase in profit & economy, its effect will get trickle down to the lower tier economy group some how but Wei Liang disagrees but I don't know for what reason there.

Besides, EPF might not be able to produce real div that is able to compensate the losses accrued from inflation (due to current financial turmoil) and it might be better off for the depositors to invest on their own.

Frankly speaking, we never once see a trader slash the price of their goods down after a series of event. Blame it on traders or blame it on the consumers themselves, traders are motivated by profits and if profits keep coming in, they will just do business as usual. My point is, the article shifts the blame to end producer but how do you expect them to lower their price if their suppliers are reluctant to cut the price down? See, it's the domino effect.

Never once can you bring the price of goods down unless in a rarecase, a severe disflation. On theory yes, we can form a working group, pressure the char kuey teow seller who in turn will pressure the noodle supplier. But if you're working on weekdays and foodcourt price although expensive, is much more reasonable than bringing ur own bread or cooking ingredients to company to be cooked, will you pay the extra for the char kuey teow?

As I had said earlier, prices never come down, heck even in time of crisis and havoc, they will fucking jack the price up and rip you off. Once you raise the fuel price, never expect price of goods to come down. Things don't just work that way unless you're in a socialist country of course.

Wei Liang Goh said...

Given a reduction in EPF contributions, we are endowed with an additional 3% of income to spend every month.

Naturally, consumers in the economy will consume more normal goods in this period, and luxury goods to some. A proportion of it might be saved also.

Bringing the savings into the next period, we are faced with lower spending power - if prices maintain at its level. It will be even worse if prices continue to go up.

If we spend the money, and we save some of the 3%, it will of course contribute to the GDP. The effects might be felt in the short term where businesses and money change hands at a reasonable velocity.

Offshore expansion of our businesses and the effects of retained profits will best explain why the effects might not go back to the people.

In the long run, it will affect the savings rate and spending power of the people. That is why Najib made the policy temporary only.

As for the suppliers, in an economy with N suppliers of a particular good, given that prices are not controlled or no collusion is at hand, then consumers will be able to pressure producers to provide efficiently and optimally.

Consumers can look for the best option in terms of price and quality. This will apply pressure to the N-1 producers left to engage in a better provision of goods by pricing and product differentiation.

In a food court, there are multiple food stalls. If a food stall sells at RM 10 when we can afford only RM 5, we adjust our taste and preferences to a cheaper seller of noodles at around RM 3 - 5.

That is my justification of how we can ensure sellers in even a food court are pressured to maintain reasonable prices.

As we browse through shops, in bad times, we begin to see more and more restaurants and food courts selling set meals. These set meals are a form of package to attract customers.

In good times, nobody will care even to provide any of these. Even if they did, it will not look cheap.

Thank you for your comments, bro.

Anonymous said...

When times are bad and uncertainty is thick in the air i.e. now, people behave a little differently than they normally do in good times.

For one, a rational and informed consumer, when given extra cash to spend, will not be inclined to spend.

A strong urge to save that money to weather through an expected recession is more likely. Workers will be in survival mode not purchasing mode.

This is why, knowing that hardly anyone will take up the offer of a 3% instant increase in disposable income, our PM-designate cleverly made the 3% reduction in EPF contributions the default option. Sweats.

If you want out, then you fill up a form and your contribution will be restored at 11%. Not the other way round, as it should be.

Anyway, the problem is, pushing people to spend when clearly they would rather not in this uncertain environment is doomed to fail. If this is the strategy, then alamak!

Here's the real issue. Uninformed workers who live on a day-by-day basis (poor and not highly educated) will probably spend the increase in income. Coz, when faced with bread and butter issues, they hardly look beyond the short-term horizon.

Fast forward 30 years later, they are retired and now face a diminished retirement pool of cash. When it hits them. They ask "How can this be? Izin't EPF suppose to take care of me?"

Well, yeah. But your PM-designate needed to take care of the economy. Economy trumps you!