Saturday 12 October 2013

How the middle class is subsidizing the Corporate Elites and why it has to stop

There is a feeling that Malaysia’s middle class are generally not a happy lot. Many moan about the rising cost of living, education and healthcare, their relatively low wages and rising debt as they borrow more to buy homes and cars.

Is their financial pain a mere perception and nothing more than the usual middle-class gripe or is it a reality? And what can we do to resolve this?

We dug up some numbers and analysed them in an attempt to seek some answers.

Our extrapolation of data from the Employees Provident Fund shows that the income levels of Malaysians have generally kept pace with economic growth, and have outpaced inflation.

Between 1990 and 2012, Malaysian wages, as extrapolated from the EPF data, increased from RM7,039 to RM31,426 per person (see Chart 1). Income growth during this period averaged about 7% per year. On a macro basis, looking at the labour costs’ share of Malaysia’s GDP, the ratio has also been relatively constant throughout the years.

What is interesting, though, is that the growth in the average Malaysian worker’s income — in local currency — has actually accelerated in the past decade, even faster than in the US.

Average income levels, in ringgit terms, have grown between 1.6% and 13.8% annually, doubling between 2000 and 2012. Combined with a ringgit that has appreciated after being unshackled from its peg, Malaysian workers have actually gained in terms of purchasing power over the past decade.

If wages are rising, why is there then discontent among the middle class?

One reason is because there are actually two types of “middle class” in Malaysia. One is the “urban” middle class, which is unhappy. 

The other is the “rural or semi-urban” middle class, which is relatively contented. Their incomes have also risen, but their cost base is very much lower.

The disconnect in expectations between the two middle classes was evident in the recently concluded general election, when a majority of the urban people voted for Pakatan Rakyat while those in the semi-urban and rural areas supported Barisan Nasional.

How did this disconnect come about?

A major problem lies in the weak ringgit, which results in different purchasing power for the two “middle classes”.

The ringgit crashed during the 1997/98 Asian financial crisis, and was subsequently pegged at RM3.80 to the US dollar from 1998 to 2005, from around RM2.50 before the crisis (see Chart 2).

We estimate it took eight years — from 1997 to 2005 — before income levels reached 1997 levels again in US dollar terms. It is only in the past seven years that Malaysian income in US dollar terms has started growing again but it is still low.

In US dollar terms, Malaysian salaries are 22% of the level in the US, 16% of Australia and 24% of Singapore. It is true that the cost of living in these countries is much higher, and one should not compare apples with oranges. But if we compare purchasing power based on McDonald’s Big Mac index, which is widely used, we are still very much worse off.

Let us look at the statistics.

In the US, average salaries are US$3,643 per month and a Big Mac costs US$4.37. A worker there gets to buy 27 Big Macs a day.

In Australia, the average monthly salary is US$5,169 and a Big Mac costs US$4.89, which means a worker there gets to buy 35 Big Macs a day.

In Singapore, a worker gets to buy 23 Big Macs a day based on his monthly wage of US$3,417 with a Big Mac priced at US$4.85.

In Malaysia, the average salary is US$830 and Big Macs are priced at US$2.62. The Malaysian worker gets to buy only 10 Big Macs a day — less than half of his peer in Singapore and the US, and one-third of his peer in Australia (see Charts 3 and 4).

The comparison using Starbucks is even more telling, as a cup of Starbucks coffee is priced roughly the same throughout the world — in US dollar terms. Using the Starbucks comparison, our purchasing power is 26% of a worker in the US, 20% of Australia and 31% of Singapore (see Chart 5).

One could argue that not all of a person’s expenses are US dollar-denominated or consist of imported products. But in an increasingly internationalised and commercialised world, sadly they are.

The reality is that the urban middle class has a lifestyle and consumption pattern that is largely US dollar-based or dependent on international prices — from dining, groceries and shopping to education and travel. This class is feeling the squeeze due to the weak ringgit.

In contrast, the rural or semi-urban middle class is not feeling the pinch yet, thanks to a different consumption lifestyle. They substitute Ramly burgers for Big Macs for half the price, and drink kopi-O at the “Mamak” restaurant instead of Starbucks for a fifth of the price. This class is largely contented, and also largely pro-establishment.

Indeed, if we were to create a “Ramly index”, the purchasing power of this class of consumers would be roughly the same as those who consume Big Macs in the US, Australia or Singapore. They will get to buy roughly 21 “Ramly” burgers a day (see Chart 6).

Ringgit kept weak to help industries

The weak ringgit is clearly a major problem for the urban middle class as local salaries can’t keep up with an increasingly US dollar-denominated and international cost base.

Why did the currency weaken?

The main reason was actually our own industrialisation policy, which was started by former prime minister Tun Dr Mahathir Mohamad.

Mahathir took office in 1981 and introduced a well-intended policy to transform the economy into a newly industrialised country. The policy centred on attracting foreign direct investment (FDI), especially from Japan and East Asia with the “Look East Policy”, and the creation of a corporate elite class, especially among bumiputeras.

The strategy saw many successes. FDI poured in strongly, and Malaysia was viewed as a roaring Asian Tiger in the 1990s. A largely agriculture-based economy was transformed into an industrialised one. Our large middle class today is a successful creation of that policy.

However, there were also unintended consequences of that policy on the ringgit.

To make Malaysia more export competitive, the ringgit had to be kept low. With export sales denominated in US dollars and costs in ringgit, a lower ringgit helped to make products cheaper in US dollar terms and, at the same time, boosted the profits of Malaysian corporates and industries.

This was further assisted by a policy that kept interest rates low and reduced the funding costs for big businesses to grow through debt.

In fact, real interest rates were very low and negative in some years, even though Malaysia’s Consumer Price Index understates real inflation for urban dwellers. The ringgit has also been on a depreciating trend since 1981, even before the big decline during the 1997/98 Asian financial crisis (see Charts 2 and 7).

The weakening ringgit was also a consequence of the fact that many of these new industries were not globally competitive. In other words, we had import costs from a weak ringgit but no export gains for some of our huge industrial projects.

The strategies and consequences above helped create the corporate elite of all races.

The effects of this policy are now mostly felt by the urban middle class who suffer from low US dollar purchasing power and negative real interest rates on their savings.

Eventually, though, the rural and semi-urban middle class will begin to feel this as their lifestyle changes. Going forward, this is a potential political risk for Barisan Nasional.

The solution: Promote a stronger ringgit

Mahathir’s economic policies worked well in the past to industrialise Malaysia and created the middle class. It was indeed necessary in the 1980s with high levels of unemployment and fluctuating commodity prices.

Today, however, all our cheap labour consist of foreigners. FDI is falling. The old low-cost manufacturing hub model no longer works, and indeed it now creates major social costs and problems.

A new strategic policy is needed to bring the country to the next stage.

It is time to have a policy of positive real interest rates and to promote a gradual appreciation of the ringgit.

Corporates and industries must be forced to become more efficient and make products that are more globally competitive, and capital must be more efficiently utilised. We can learn from countries that have successfully moved out of the middle-income trap.

This report and the accompanying charts are published in The Edge, Oct 14-20 issue.

Thursday 10 October 2013

il buono, il brutto, il cattivo

The Good, The Bad, The Ugly

This week, in the coming issue of The Edge, I write about three companies listed on Bursa Malaysia. Borrowing from the epic 1966 Italian movie starring Clint Eastwood, Lee Van Cleef and Eli Wallach, the plot revolves around three gunslingers looking for buried gold. One died and one rode away a hero. As for ugly, he lost his bullets and got half the money as charity.

The GOOD is a company trading at half the industry’s valuation, and with substantial cash in the bank. It pays 7% to 9% yield at current stock price. The business model is defensive as demand for its products are sustainable even in economic slowdowns. New developments will further enhance demand, and provide opportunities to increase prices.

The BAD is a company that has yet to account for the lost of almost 90% of its cash balance. What else is there to say.

The UGLY was a beautiful swan. It was much loved and had a fantastic business model that generated growth in sales and profits for over twenty years. It pays good dividends, while accumulating huge cash in the bank. From an underdog, it became the Establishment.

Then everything changed. It began losing its appeal.  Changes to technology and lifestyle preferences began to chip away the very business model that made it successful. Going forward, it will get worst.  More changes to technology and new players will reduce further its value proposition. What works in the past will no longer work going forward.  I wonder if the management is aware?

I hope you will enjoy reading this as much as it was fun for me to write. And if you disagree, I won’t be offended.

By the way, I do not own any shares of the above companies, either directly or indirectly.