Stop the subsistence

THE latest announcement that employers will have to absorb the levy of foreign workers with effect from Jan 1, 2018, has met with a chorus of protests from a number of trade associations, both large and small. The common contention is that it would cause a sharp rise in the cost of doing business, with the added cost being passed on to the consumers. As a result, the impact would be higher prices and a likely escalation in inflation.

On the surface, this polemical and populist argument makes a lot of sense. However, let us attempt to get down to simple economics to have a better understanding of this issue. Firstly, the Government had announced the impending change to the act sometime back.

If the supply of foreign workers continues to be subsidised, there would be distortionary pricing in the labour market. Employers would continue to beg for more foreign workers at the expense of hiring locals. There are many local companies out there which are paying locals an average of RM2,000 per month and they do not face that much difficulty in recruitment.

Other than the 3D (dirty, dangerous and difficult) sectors which many locals tend to shun, are local employers prepared to pay RM2,000 per month for their staff? Homemakers would not be willing to work for less as the cost of a babysitter would amount to at least RM700 monthly. Can a local employee survive on a monthly salary of less than RM2,000?

For Malaysia to graduate to a developed nation status, the bulk of the population or median (rather than mean) should have the income level to positively affect spending power. If many locals are earning below RM2,500, where is the impetus for a consumption-driven or demand-led economic growth?

With the cost of labour distorted by the foreign workers, there has been a lack of incentives to automate and raise productivity per capita. Can we still depend on traditional factors of production such as lower labour cost to drive our economy into the next decade?

Let us do the math and analyse. Assuming that labour constitutes about 20%-30% of manufacturing costs, a 10% hike in labour cost would only increase the Cost of Goods by 2%-3%. Underpaid employees do not provide the expected higher productivity levels. The continued suppression of labour costs as a means to maintain profits begs the understanding of Economic Profits. These implicit costs of subsidised wages have to be deducted from Net Income when Economic Profits are calculated. The net effect is lower Economic Profits which reflect the lower efficiency of the business performance.

The other factor of production besides labour is capital. If the cost of capital is artificially kept depressed for long periods of time, economic distortions would inevitably occur. Many entrepreneurs have been lulled into a false sense of complacency that interest rates would remain subdued.

As such, decisions to embark on new ventures or expansions become distorted by the cheaper source of capital. Feasibility studies are usually not based on the real cost of funds. Hence, there is a proliferation of investments in businesses that generates a net return of 6%-8%. With fixed rate returns of about 4% for bank deposits (riskfree), would it be viable for new capital to be raised to fund riskier ventures that afford a return of 6%-8%? Many of these businesses should not even see the light of day to begin with, unless totally funded by their own money.

The same principle applies to the provision of soft loans or grants. Does the government agency look at the net profits of these ventures? Do they have the expertise to evaluate such proposals?

An alternative approach would be to outsource the processing of such applications to a qualified third party. This private entity should raise their own funds to co-invest. Assuming that RM1mil is needed, 50% of the funding should come from the private fund company in the form of Redeemable Preference Shares (RPS) while the other half could be grants from the Government.

Such a model reduces the information asymmetry issues as the private fund company has a vested interest to ensure that the RPS can be repaid. The efficiency in the evaluation is optimised as the fund company is motivated by the desired outcome of viability of the business. Higher success rate by the fund company will be incentivised with a larger grant allocation to manage.

The continued dependence on subsidised inputs such as labour and capital would only lead to prolonged distortions in the economy. These factors would not be channelled into the most efficient or productive ventures.

As the economy is already extensively globalised, our local businesses should be in a position to compete and excel. The jaguh kampung moniker cannot be promoted if our nation is to advance to developed nation status. In a nutshell, the subsistence mentality should be obliterated at the private sector as well if there is a will for an efficient economic outcome.