"Stamping" inflation out of national woes

The Star reports that the government is considering a food stamp programme to help alleviate the burdens of Malaysians in accommodating inflation. In a nice coincidence I was drafting this post a few days back, so in principle this is a programme that I endorse strongly.

The gradual phasing-out of subsidy programmes announced by the government has become a national woe, leading many to view the adjustment of commodities in the domestic market to world prices a painful pill to swallow in the short term. In all fairness the long term benefits that accrue from subsidy removal programmes
are huge. However that doesn’t mean that we should act as strict utilitarianism and ask those who are harmed the most by this transition to sacrifice for the greater good. As income is not catching up with the removal of subsidies and the general rise of the price level, most Malaysians are feeling the pinch as their purchasing power declines.

As an aside,there is a link between net disposable income (wages,capital gains etc minus taxes and added with subsidy/allowance/benefits), the price level and purchasing power. It follows logically from
purchasing power = net domestic income/price level that we get:
Change in purchasing power = change in net disposable income/change in price level

Why is a food stamp programme a good idea?
Perhaps if one were to ask Bill Clinton this question he might answer it all depends on what you mean by “good.”So let it be noted that the main criteria behind my support for the programme are 1) the efficacy of the food stamps to sustain the purchasing power of affected groups as Malaysia adjusts to the world price for hitherto subsidised commodities, 2) the potential role of the programme as a stabaliser, and 3)the empirical backing for the multiplier effect of the programme.

  1. Efficacy of food stamps to sustain purchasing power
    The efficacy of food stamps to sustain purchasing power should not be evaluated chiefly by how much it maintains purchasing power by increasing net disposable income to offset inflation. Purchasing power ought to be sustained and/or increased with a combination of nominal wage adjustments,tax effects, inflation management in addition to entitlement programmes like food stamp programmes and unemployment insurance. Furthermore the case for the efficacy of food stamps is consolidated in the sense that it achieves the objective of protecting the purchasing powers of citizens without introducing the price distortions, resource misallocation and deadweight loss to the economy introduced by subsidy programmes. In a related vein, my objection to the blanket-subsidy programme in place is that it applies to people for all levels of income. By subsidising say, the fuel of gas-guzzling cars we are essentially imposing an implicit penalty on people who do not own expensive gas-guzzlers. In essence this is a regressive penalty for the lower income group, it would be the same as asking residents in low-cost apartments to pay a 25% property tax so that we can levy a 15% property tax for those living in penthouses or condominiums. In addition, subsiding the high-income group is akin to saying at higher levels of income, an additional 1 dollar has the same utility as an additional 1 dollar at lower levels of income. This is a fallacy for a welfare state that justifies its social welfare programmes out of Benthamite philosophy! (See Reinhardt for instance).  So in summary the food stamp programme is a good idea for it achieves the desired social goal without the problems introduced by subsidy programmes. 
  2. The potential role of the programme as a stabaliserThe Economist newspaper recently published an article about the food stamp programme in the United States of America. The article observes that “spending on food stamps has risen so quickly because, unusually, almost all the needy are automatically and and indefinitely eligible for them.” This makes the progamme a good stabaliser since spending on the programme will automatically increase during a recession and decrease during a boom.So in instituting this programme we not only have a mechanism that maintains the purchasing power of citizens in an equitable manner, it also helps moderate the swings in recessions and booms. Of course architects of the programme must be careful to delineate the cut-off point and above all be sensitive to the marginal tax that may be affected, or else in its efforts to break out of the “middle-income nation trap” it might inadvertently introduce an income trap with its policies. This conjecture will be discussed in the policy challenges part of the post. 
  3. The empirical backing for the multiplier effect of the programme
    From the same Economist article above, 

“When Moody’s Analytics assessed different forms of stimulus, it found that food stamps were the most effective, increasing economic activity by $1.73 for every dollar spent. Unemployment insurance came in second, at $1.62, whereas most tax cuts yielded a dollar or less.”

So in addition to all of the advantages discussed above it appears that food stamps generate more   income per dollar spent. Automatic fiscal stabalisers that have a high (relatively speaking) multiplier effect is the holy grail of all fiscal policies. Rarely are there any effective mechanisms that can stimulate the economy automatically without having economic rationality hijacked by populist but harmful politicking.

Policy Challenges
Perhaps the greatest policy challenge is to delineate the cut-off points. Civil servants drafting out the proposal must first decide whether the value of food stamps issued is a linear function of income (that is decreasing value of food stamps issued as income increases), or would it be a much more “piece-wise” approach i.e. (food stamps valued at MYR X for the income range a to b; food stamps valued at MYR Y for the income range c to d etc etc). In addition it is worth reiterating that I said  “Purchasing power ought to be sustained and/or increased with a combination of nominal wage adjustments,tax effects, inflation management in addition to entitlement programmes like food stamp programmes and unemployment insurance.” I have warned of the dangers of inadvertently institutionalising an income trap in our efforts to break out of the middle-income nation trap. This blog post from Prof Greg Mankiw sums up my fear.

My suggestion to the DPM is to draw in officials from the revenue agency, central bank, treasury,social welfare department and the economic planning board to draft out the proposal together. The success of the programme, and that of eliminating the danger of an institutionalised income trap requires a broad view, not just implementing a food stamp programme in isolation.

Update:The minister for Women,Family and Community Development says that the programme is targeted mainly at the poor. The federal poverty(absolute) level in the Peninsula is RM430/month. So the effects discussed above would be small(since absolute poverty according to official figures have gone down) but still significant. Yes,I know someone fudged the data for poverty by redefining the baseline, but that is something for another blog post. This also means that policies targeting sustainable purchasing power will have to come from nominal wage adjustment(which is why the minimum wage law was legislated), marginal tax adjustments in the future and of course, whether the Central Bank will validate inflation (it elected not to raise interest rate in the last round). 


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