Wednesday, January 21, 2009

Budget for Crisis of Confidence

The PAP government will announce its annual budget for this "extraordinary" year tomorrow. I have read quite a few reports on how people wanted the budget to be. However, I feel that some of them are not very well thought of.

We are facing an EXTRAORDINARY crisis at the moment. It is not merely an economic crisis, not merely a financial crisis, not merely a currency crisis but as Nobel prize winner Paul Krugman has put it, the mother of all crisis. It is a crisis of confidence and economic irrationality prevails.

In a textbook assumption of "free market principles", Rationality of human beings is a paramount assumption. Paul Krugman himself has written about "Expected Rationality" in an economic system. But for this present crisis, it defies all economic theories of rationality basically because it involves an IRRATIONAL Crisis of Confidence.

Irrational behavior exists in stock markets during two extremes:

1) Boom Time where even money losing companies could have their stocks flying higher and higher. This is a sign of bubble forming.

2) Doom Time where even money making and fundamentally sound companies suffered drastic drop in their stock prices. This is due to a crisis of confidence brewing.

But as I have said, this mother of all economic, financial and currency crisis is more than merely stock digits moving up and down. It affects both savings/investment and consumption when all confidence of the world economic system collapse. While we need effort in building a NEW WORLD ECONOMIC-FINANCIAL-CURRENCY ORDER, for a small open economy like Singapore, we must maintain investment/savings (from Economics 101, Savings=Investment) and consumption confidence. This is the main paramount priority that this budget should be all about. It is not about "cost cutting", nor merely "giving money" out. The results of this crisis are credit crunch (which affect investment funding) and consumption confidence (which affect trades).

The most common policies that PAP government would melt out are the predictable few, though it may vary in the size of the budget. The following are the few perspectives that we have witnessed so far:

1) Cut Wages
2) Cut CPF
3) Cut Tax (along with GST increase?)
4) Rebates of all sorts
5) Simply give out money

In an extraordinary crisis like this one, an expansionary budget is unavoidable. But how far the budget is into REAL (well, we know that for many years, PAP may claim deficits but it turns out to be surplus in the end!) deficits is not the only consideration. The money pumped into the economy must be able to jumpstart the economy engine again.

If you take economic boom and bust as a motorcycle, you will understand the logic better. For a motorcycle, you could only keep it balance if and only if the engine keeps running. For economy, it is the same. To keep the engine running, the money (fuel) within the economy must keep moving around, from savings to investment to consumption to income and back again. What we are facing right now is a choked engine of the economy whereby credit crunch prevents the savings to become investment and the irrational fear hinder the consumption. This will ultimately cause loss of jobs and thus, no more money for savings and consumption.

It is a vicious cycle, in reverse of proper economic function. The worst thing is that with the credit crunch, a serious problem of "De-leveraging" will arise. In a proper economic functioning system, with every dollar of investment, it may create 5 dollars of economic worth of income. When the credit crunch comes, due to some irrational fear of banks and financial institutions over bad debts, the reverse of value creation will happen. For every dollar that the banks or financial institutions refused to lend, there will be a potential loss of 5 dollars of economic worth. This is what we call, "De-leveraging".

Thus for any country to counter this big economic-financial-currency (the currency system will ultimately fall into chaos due to the loss in confidence of world financial economy) tsunami crisis, it will have to address or at least PREVENT the further erosion in the confidence of investment and consumption.

Could the predictable PAP policies solve this crisis of confidence? I shall examine some of them here.

1) Cut Wages

The most common call from employers is to cut wages of workers. This is understandable because to them, cutting wages will help them lower business operation cost. However, cutting wages will only solve one part of the problem while creating or enhancing the other part of the problem.

Cutting wages will further erode consumers' confidence. Even when it is simply a mention of wage cut, workers will start to tighten their belt in expectation of a wage cut. This is simply a further erosion of consumption confidence and bringing down the economy as a whole. When there are less consumption, local business revenues will continue to suffer.

In Singapore's context, while we cannot control the global economy which we depended so much for our export-orientated industrial economy, further erosion of local consumption confidence will add salt to injury.

Of course, I will only support the cutting the bloated million dollar salary of ministers, permanent secretaries and high ranking civil servants. This is simply because their salaries are just too high.

(2) Cut CPF

Cutting CPF has the same effect of cutting wages, both in terms of lowering business cost as well as eroding consumption. Most Singaporeans finance their mortgage through CPF and when CPF is being cut, they may have to fork out extra money to pay their mortgages. This will force them to cut down on consumption in the economy.

Furthermore, cutting CPF will only push the problems to retirement financing. As we are now already at a point where we are already short of funds to sustain our people's retirement, further reduction of CPF contribution will only worsen this situation.

3) Cut Tax and Rebates

Most wealthy individuals and profit making companies will favor tax cut. However, such move has proven to be very ineffective in managing economic crisis, least a crisis of this scale. Tax cut may improve our nation's attractiveness in attracting foreign investment but we are now facing a big crisis of confidence, not fundamental problem of economic competitiveness.

Furthermore, tax cut could only benefit those who are paying tax. Those people who are poor don't pay tax. It is very unlikely for tax cut to transform into massive consumption if only a small percentage few benefits from it. Unless the PAP is going to cut GST PERMANENTLY, then that's worth the effort. Changing GST will incur huge administrative cost to businesses. An exercise of making adjustment to business system to cope with any adjustment of GST (be it lower or higher) will cost small and big business a huge sum of money. Unless the change is going to stay for a long while to come, else, the cost of such changes will erode the benefits.

For companies that are facing reds in their books, any tax cut will be meaningless simply because they are making a loss. Tax cut will not help them to stay afloat at all. If they go bust, more jobs will be lost.

Tax cut will not help to withhold confidence in business as well as consumption. It does not address the fundamental problem of confidence at all.

But there is one thing I think the PAP government should do away with. The Annual TV License fee of $110 and property taxes for HDB flats! HDB flats are basically overpriced public housing with 99 years lease which is packaged into a guise of "house ownership". In doing so, those who stay in HDB will have to pay property taxes.

4. Giving money

The most favorite vote-buying technique by the PAP government is giving money to everyone. This is populist move but it comes with a cost.

I would prefer the PAP government to direct such handouts to those who really need them. It should set up a formal system of social welfare for the unemployed. In Taiwan, they have such system whereby those who are jobless could seek unemployment social welfare for 6 months (now they are considering to increase to 9 months). This is to help those who cannot find any jobs to tie over this difficult period.

An all money giving exercise may make PAP looks good but it has little impact in saving those who are truly needy, those who are unemployed, regardless of what types of HDB flats they are staying in.

What are the more effective ways?

After looking at the flaws of the predictable PAP's policies, I will deal with what I think should be the more effective policies to address the present crisis of confidence.

1) Restoration of Confidence in Investment Funding

Hong Kong government has put up a policy of guarantee to loans to local small and medium enterprises (SME), up to a certain amount. Singapore government has some similar instruments but strange enough, it only targets at certain aspects like investment in technology, computerization and such. It does not provide guarantee to loans that cater to company cash flows in this difficult times for them to tie over the period.

PAP government must also come up with a solution to the mis-selling of Minibonds, DBS HIGH Notes are any structured-linked financial products. This is because if this problem is not solved, everybody including those who are unaffected by these investments, will hold back their investment decisions on other instruments.

The decline in investment in other unit trusts, funds and insurance-related instrument is an obvious effect of this Minibonds crisis.

In my view, the solution will include the allocation of responsibilities to each players, which include the Financial Institutions, Government (via MAS role) and investors.

The Financial Institutions that earned commissions by selling these products should bear the most responsibility. The government's lapses in its regulatory role via MAS must be held responsible as well. The Taiwanese government, via an independent Control Yuan, has found the administration guilty of lapses in its regulatory role. I cannot see how MAS can wash off its hands from its regulatory responsibility. Finally, I think investors have to bear their part of responsibility as well.

My allocation of responsibility is as follows:

1) 50% for Financial institutions as they are the immediate gainers from the sales of these products. And it seems that there is a systematic problem with their sales and marketing process which leads to wide mis-selling practices.

2) 20% for Government as they have failed in their role as regulators, to allow such complex products to be sold to retail investors or even retirees and fixed depositors.

3) 30% investors. No matter how, investors will have to bear some responsibility on their part for their imprudence.

Some other people may have other view of "fair solution" to this problem but that doesn't matter. I can live with different views but the fact is, whatever solutions there might be, it must solve this Minibond-related saga once and for all.

I cannot imagine what would become to the whole system when layman no longer trust the banks any more because there are instances of such Minibond mis-selling. This is the implicit crisis of confidence we are having right now. If even the banks cannot be trusted to safe keep your savings, help you to invest prudently, then who else could you trust with your money?

2) Subsidies to Employers' contribution to Employee's CPF account

I feel that if we are to help ALL businesses, not just those who are making money and paying taxes, to cut cost without affecting consumers' confidence in consumption and affecting mortgage payment and future retirement financing, one way is for the Government to pay on behalf of Employers 3% or even 5% of CPF contributions they have made to their employees. But this should be done on one important condition that wage will not be cut, neither should there be massive retrenchment (maybe not more than 5% cut in total number of SINGAPORE employees).

This will enhance workers' confidence and expectation of no substantial wage cut and thus, not affecting their consumption behavior. This will also help companies, especially those who are facing bigger losses to effective cut cost without further eroding their employees' morale.

This is a FAIR scheme whereby rich and wealthy people who are already making great money will not benefit further from any tax cut, while those workers' anxiety of job loss would be addressed effectively.

This scheme should be set for one year and reviewed later. According to my rough estimate, such scheme will cost the PAP government about $4 to $5 billion dollars for a year.

3) Social Welfare scheme of Temporary Unemployment Benefits

As I have mentioned earlier, I favor a more specifically targeted means of distributing money to those who are really needy. For those (Singapore citizens only) who lost their jobs, we should help them to maintain their livelihood for this temporary hardship. A scheme like what Taiwan has, to provide a maximum 9 months of unemployment benefits would help to cushion hardship and maintain consumption level in local economy.

During this 9 months, any expenses on skills upgrading for these workers should heavily subsidized up to 90%. After 9 months, the government will have the right to review each individual case. If the unemployed regained employment, the data should be captured by the CPF contributions and the unemployment benefits would be automatically terminate.

4) Business seeding funds

Singapore under PAP, has long skewed towards dependency on foreign investment as well as their own Government Linked Companies (GLCs) which "monopolized" almost all aspect of industries in Singapore.

This model of economic development and growth is not sustainable for Singapore if a balance is not struck with grooming of local privately own companies. The crowding effect of GLCs are crippling local enterprises.

Due to the monopolistic nature of industrial and commercial land use by GLCs, rentals of all kinds have grown far beyond economic growth. If the economy grow by 5%, rental for commercial use (like retail shopping malls and such) have grown to a horrifying 30% or more.

This bubble is taking a great toll on local enterprises. It is amazing that while PAP government sees it fit to control wage increases during boom time, it does not see the need to control excessive rental increase due to its GLCs' monopoly power in this area. REITS have in fact, aggravated the excessive increase in rental many times.

It is about time to cut down on such excess and practice more prudence in rental increase, taking the same view that rents increase will affect business cost and consumer prices as well.

Beside controlling the rent as a means of business seeding for local enterprises, the government should setup a Local Small Enterprise Seeding Funds. This is to solve the problems of credit crunch during this period where new entrepreneurs could not find funding from any financial institutions at all.

5) Moderation of Credit control by Financial Institutions

Our financial institutions have stepped into another extreme of mortgage loans. During the boom time, all sorts of mortgage loans are being approved and refinancing done on mortgages to further lend the "excess value" of the properties to property owners. Such loose credits will naturally result in heavy losses when credit crunch and De-leveraging take place.

At this moment, I have gathered that banks and financial institutions have gone into another extreme of tightening credits. A small forgetfulness of paying your credit bill on time in the past may just deprive you of a mortgage loan eventually! Such over conservativeness in assessing credit loans at this moment will only aggravate the crisis as a whole.

The government must find a way to address this problem. Either the government provides certain percentage of guarantee to genuine, non-investment related loans (such as HDB loans to first time buyers) or it comes up with a plan or guidelines of moderation for the financial sector.

The above are some of my personal thoughts about what should be included in the coming budget. Unless we get the main theme and priorities right for tackling this mother of all crisis, we may just end up worsening the situation with some ineffective or even detrimental policies.

Goh Meng Seng

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