Is Malaysia becoming a welfare state?


Most Malaysians don’t pay income tax. So, how are hand-outs financed?

With cash payments to the poorer classes becoming standard policy in Malaysia, questions have been raised as to the efficacy of such measures. How do they help the needy, and how is the political economy affected?

The former mayor of Bogota, Enrique Peñalosa, once said, “A developed country is not a place where the poor have cars; it’s where the rich use public transportation.”

Does this interesting observation capture the essence of the subject? This is indeed worth a discussion.

Better to not work?

Take the UK for example. Although the UK welfare state lives up to the above description, it has encountered serious problems. In 2011-2012, the Department for Work and Pensions reported expenditure of over £159bil – approximately 22.8% of government spending! The main problems are the amount of benefits and the ease at obtaining them.

According to Migration Watch UK, an independent and apolitical think tank, the UK is the fourth most generous country of the EU151 in its provision of benefits to low income workers – after Denmark, Luxembourg and Ireland. Access to unemployment benefits, while paid at a lower rate than in many of the EU15, is much easier in the UK, where there are virtually no conditions of access compared to more robust controls elsewhere2.

The consequence of easy and abundant benefits is the creation of disincentives to work. The Institute for Fiscal Studies (IFS) finds that those who are most dependent on benefits – the poorest families – face a steep withdrawal of benefits when they move into work. 1.5 million persons were on an effective tax rate of 70% to 100% when they began working. They were better off staying unemployed, receiving benefits and having a large family.

Consider Mick Philpott. This man treated his 17 children as cash cows, earned £60,000 a year in benefits, and ended up killing six of them in a fire intended to win a custody case and secure a larger council house. In April 2013, following an eight-week trial, he and his wife Mairead, together with their friend Paul Mosley, were found guilty of manslaughter. He is serving a life sentence with a minimum of 15 years’ imprisonment.

Homeless man in England. The consequence of easy and abundant benefits is the creation of disincentives to work.

Furthermore, in 2011, there were 2.5 million people on sickness benefits3. In other words, they were too sick to work.

The need

However, the argument against welfare is not clear-cut.

The Labour party insists that benefits are needed because of the Conservatives’ inadequate economic policies and the consequent slow recovery.

The latest figures from the Office for National Statistics (ONS) showed that the unemployment rate was 7.7% from May to July, down 0.4 percentage points from a year earlier. It is still very high – there are almost 2.5 million people unemployed. Although inflation, measured by the Consumer Price Index (CPI), fell to 2.7% in the year to August, wages only rose one per cent. That means real wages fell by 1.7%. With lower real disposable income, consumption and GDP decrease. Thus, benefits are needed for household survival and the economy.

Wherever the level of benefits is set, there will be winners and losers.

Whether there are more cases of unscrupulous abuse of the system or of people who desperately need benefits to survive is unknown. Indeed, UK public opinion on this issue is still divided.

The Nordic model

Denmark, Finland, Norway and Sweden have enjoyed steady GDP growth, low unemployment and stable inflation. These countries also have high government spending and high trade union densities. Three aspects of the model that do not conform to current mainstream economic thought are highlighted below.

Fiscal policy

Neo-classicists claim that high real interest rate from expansionary fiscal policy crowds out the private sector crucial for sustainable GDP growth. On the other hand, Keynesians claim that in the short run, government spending increases GDP effectively if wages and prices are sticky and if there is excess capacity in the economy.

The fiscal debate surrounds the fiscal multiplier – the effect of a change in government spending on GDP. Neoclassicists believe that it is small, maybe even negative. Hence, austerity measures have a limited or even beneficial impact on GDP. However, Keynesians believe that the fiscal multiplier is big – that is, expansionary fiscal policy is effective at increasing GDP.

Given that Scandinavia has high government spending, the Keynesians are right, but not entirely. This is because they do not explain how GDP growth can be sustained in the long run without increasing inflation.

Welfare benefits

Pessimists claim that high benefits reduce the incentive to work, especially for workers on the margin. Wealth creation is affected adversely if people prefer to live off benefits. Their opponents claim that the welfare state is required to provide a safety net and improve the general wellbeing of society.

The optimists seem to be right. According to the UN’s second World Happiness Report, which ranks countries based on several measures of wellbeing, Denmark was the happiest country followed by Norway. Sweden was fifth and Finland was seventh. In contrast, the UK was 17th and Malaysia dropped five places to 56th.

Welfare benefits act as an automatic stabiliser. If the sole breadwinner of a family with a spouse and two children becomes unemployed, he receives generous welfare benefits that are as high as 100% of the previous household income in the case of Sweden4. This reduces the decrease in disposable income from unemployment or an economic recession and maintains consumption. Also, families with lower income tend to spend more from an additional dollar compared to high income earners. This increases the multiplier effect and hence GDP.

Man in Copenhagen. According to the UN’s second World Happiness Report, which ranks countries based on several measures of wellbeing, Denmark was the happiest country, followed by Norway.

Trade unions

The Nordic model’s success may be due to its high trade union density. The relationship between the degree of collective bargaining and unemployment is an “inverted U” by taking the variable factor as a proxy for union density5.

When there is little trade union activity, the labour market is competitive. Hence, unemployment is low because there are few imperfections and the cost of labour turnover and hiring is lower. Conversely, when trade union density is high, members have to consider the macroeconomic effects of their actions. They will moderate their wage demands and consequently unemployment is low. In the intermediate case, trade unions do not consider the social costs of their actions. Union members will price nonmembers out of the labour market, hence creating high unemployment.

Scandinavian countries with centralised trade unions and high union density fit the hypothesis. Lower unemployment means higher utilisation of resources and thus higher GDP. The UK had sectorspecific trade unions and its trade union density was lower than Scandinavia’s in the 1970s, causing the predicted high unemployment in the intermediate case.

How about Malaysia?

The Asian Development Bank (ADB) created a social protection index to show the breadth of coverage (the percentage of potential beneficiaries actually covered) and the depth (the amount of spending per beneficiary, expressed as a percentage of 25% of the country’s GDP per capita). A quarter of GDP per capita represents poverty line expenditure.

Begging for a living. A large proportion of Malaysia's poor find it increasingly hard to cope with the rising cost of living as the government rationalises subsidies.

The ADB’s 2012 report on social protection found that Malaysia achieved depth (spending 108% of poverty line expenditure on each beneficiary) without breadth (its efforts reached only 14% of potential beneficiaries)6. Consequently, a large proportion of the poor find it increasingly hard to cope with the rising cost of living as the government rationalises subsidies. The growth in real wages has not returned to levels before the 1997 crisis across all sectors of the economy 7.

Although government officials have insisted that Malaysia is not a welfare state, the policies suggest otherwise. Some of the initiatives are subsidised clothes and tyres, free milk and books for students, and even a governmentbacked fish market and grocery store. That is on top of essentials such as discounted healthcare and housing plus assistance for senior citizens and the disabled.

Now that the minimum wage in place, the other significant element of a welfare state missing is unemployment benefits. If left unchecked, the increase in BR1M 3.0 could be a slippery route to becoming a welfare state.

The problems

The proportion of income taxpayers in the population is only 5.6%8. In comparison, the statistic in the UK is approximately 47.1%9. If Malaysia becomes a welfare state with so few taxpayers, the national debt will increase as a result of recurring fiscal deficits.

According to Transparency International, another problem is the lack of trust in the government regardless of the party. Its survey in 2013 found that 69% of respondents in Malaysia felt that political parties were either corrupt or extremely corrupt. This translates into an unwillingness to pay the taxes required to fund a welfare state.

Perhaps the barometer of success of welfare policies has been wrongly identified in Malaysia. If the government continues with policies that provide nothing but temporary cash flow relief for 5.2 million households, Malaysia will need to wait longer before the rich begin using public transport.

1 Comparison of UK benefits with those of the EU14”, n.d., MigrationWatch UK, accessed September 11, 2013. (URL: www. document/284 )

2 Ibid.

3 Humphrys, J., August 8, 2013, The Daily Mail, accessed September 11, 2013. (URL: www.dailymail. html)

4 “Comparison of UK benefits with those of the EU14”, n.d., MigrationWatch UK, accessed 11 September 11, 2013. (URL: Susanne Nilsson

5 Calmfors, L., Driffill, J., 1988, "Bargaining Structure, Corporatism and Macroeconomic Performance”.

6 Ibid.

7 World Bank, “Reshaping Economic Geography Report in East Asia”, 2009.

8 “Pre-budget 2012: Caught in the Middle”, The Edge Malaysia, September 25, 2012.

9 The ONS’s mid-2012 estimate of the UK population is 63.7 million and HM Revenues and Customs’ estimate of the number of income taxpayers is 30 million for the 2012- 2013 tax year.

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