Inflation:Now you see it,now you don’t?

Priscilla Lim,a PhD candidate at the University of Nothingham Malaysia campus recently wrote an op-ed to The Star questioning whether empirical evidence catches up with anecdotal ones on the erosion of purchasing power due to inflation.From what I could gather she argues that for the moment there doesn’t appear to be adverse effects from inflation since “residents in Kuala Lumpur have similiar purchasing power with their counterparts in Singapore.Their purchasing power also tops that of Shanghai,Beijing and nearby Bangkok and Jakarta.” Her reasoning is that since all these comparison countries do not implement subsidies but “wages have risen in tandem with the rapidly rising costs of living in those countries” there shouldn’t be an erosion in purchasing power. However she noted that due to the subsidies and “stickiness” (in my own words) of domestic prices to adjust to changes in world prices, along with wage adjustment lags would eventually lead to upward pressure on wages. The implication is of impending cost-push inflation (which may or may not lower purchasing power,depending on how nominal wages adjust).

My thought is that inflation(with a lag in wage adjustment) is not only imminent but it is already upon us after the round of subsidy rationalisation as measured by upswings in Core Inflation (Inflation excluding food and transportation prices), as pointed out by Hisham in this post. I will now summarise why the statistics cited by Priscilla understates the reality that we are in fact affected by inflation at this moment and would like to point out empirical inconsistencies with her explanation for “stagnant wages.”

On Catching Up with Purchasing Power
It would be misleading to generalise the purchasing power of citizens between nations with the purchasing power of the residents between major cities of nations.Major cities become so because they tend to specialise in important economic activities that affords their residents a higher standard of living compared to their counterparts in other parts of the country.Confounded data leads to false conclusion. It is conceivable that in a country afflicted with extreme regional economic inequality that residents living in major cities tend to have a higher standard of living compared to their counterparts in other countries and the majority of their fellow citizens in other regions. As an analogy suppose you were asked to investigate the educational level of countries. If we select the highest-ranked universities as comparison groups the United States of America would be leading other countries, but does that mean that on average Americans have the highest standard of education in the world? According to OECD, the answer is no. Likewise we cannot generalise that because the residents in Kuala Lumpur have coped well with inflation by achieving purchasing power parity with other advanced cities, Malaysians as a whole are doing well.

Empirical inconsistency for the explanation of stagnant wages
Stagnant Wages is explained in the op-ed by invoking labour theory with  “an over-supply of labour.” This is achieved by looking at 2 groups, the low-skilled labours and the market for “fresh-graduates or junior executives.” The hypothesis required to support the phenomenon observed with the former group is rejected by empirical data (elaborated below) while the latter group would be more apt as evidence for “inadequate training” rather than the effect of the over-abundance of junior executives. 

Implicit Xenophobic and protectionist tendencies affect public and economic policies much more than we are aware of. Malaysians in particular are prone to the heuristics of blaming immigrants for unemployment and stagnant wage issues. Arguments like “(The Willingness of immigrants to accept lower wages) undermines the job opportunities for many of the “low-income to hardcore poor” Malaysians who do not mind taking on these jobs as it may be their only opportunity to earn a living” sound intuitively appealing, but it is worth knowing that economists analysing the impact of immigrant inflows to the labour market in the United States of America have failed to find statistically significant net impact of immigrants on the net job growth of American-born workers. 

However in rejecting the explanation the onus is upon me to show why it is false. In order to confidently express that immigrants do not affect the job prospects of local workers we would ideally want a study that studies the net impact on productivity after controlling for all factors except for the flow of immigrants. A study by Giovanni Peri (summary here) does just this, and concludes that

“Data show that, on net, immigrants expand the U.S. economy’s productive capacity, stimulate investment, and promote specialization that in the long run boosts productivity. Consistent with previous research, there is no evidence that these effects take place at the expense of jobs for workers born in the United States.”

Of course the data is drawn from the United States of America, yet there is no reason to assume that the same explanation cannot be applied in Malaysia.

P/S Of course a high nominal inflation would not be a problem if wages adjust to keep real inflation at bay. However, resentment and disapproval on the way inflation is handled by the authorities even if real inflation remains at zero is possible, since people have a bias towards nominal evaluation.
For further reading on the matter see “Money Illusion” published in The Quarterly Journal of Economics, 112:2,341-74 by Eldar Shafir,Peter Diamond and Amos Tversky. 


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