This article first appeared in Forum, The Edge Malaysia Weekly on April 16, 2018 - April 22, 2018

Many of us participate in the debate on costs underlying production and doing business, either supporting the economic reforms initiated by the present government in our march to transform our economy, or criticising it.

To the opponents, reforms are seen as an obstacle and hindrance for businesses to thrive. Their perception is largely shaped by media reports of businesses winding up their local operations and relocating to neighbouring countries or retrenching employees. Anecdotal evidence seems to suggest that there is an overall increase in costs associated with reform initiatives. However, is this really the case or is there more than meets the eye?

We must be clear about what we are discussing. One ought to say what one means and mean what one says, otherwise any further discussion will only result in a futile academic exercise. To begin with, the Strategic Reform Initiatives (SRIs), the second critical component of the Economic Transformation Programme (ETP) is much maligned and unappreciated by many. Let us examine several of the least popular SRIs — namely the Goods and Services Tax (GST), implementation of minimum wages, subsidy reforms and rationalisation and finally, the implementation of the Competition Act.

However, we also need to understand what cost of doing business (CODB) is and how it is different from production cost. CODB is an aggregate measure gauging the economic competitiveness of a country. In order for a country to remain competitive, CODB must be reduced. In other words, CODB is the reciprocal of competitiveness.

Indeed, SRIs were introduced to reduce CODB and certainly, it can be reduced, but it takes time. The adjustment period is the time taken for the desired outcome to be realised and the outcome is permanent.

The relationship between CODB and cost of production is as follows: when CODB is reduced, production cost will also go down. However, during the adjustment period, various changes will occur and this is actually part of the “planned changes”. Various quarters may be unhappy with these changes, but they are overarching and unrelenting, and will weed out undesirable aspects to create a better economic environment.

What is undeniable, though, is that the short-term effect of the initiative to reduce CODB may increase production cost. However, this feature is only temporary. While CODB is an indicator of the economy at large, cost of production is an indicator at the individual firm level, and this may explain why the readings of the two indicators may be disconnected at times.

Let us look at the first SRI. A broad-based consumption tax, GST is levied on “value-added activities” along the delivery chain. However, most basic products (such as rice, raw meat, fresh fish and vegetables) and services (such as domestic public transport and healthcare) are tax-exempt or zero-rated.

This value-added tax is paid by consumers. GST is a bitter pill that is necessary to improve the revenue of the government. It is certainly more transparent, efficient, effective and business-friendly than the Sales and Service Tax (SST). Improving government revenue will enable more allocation to be given to the federal government’s development expenditure. This will translate into better infrastructure, increased technological efficiency and, ultimately, improved CODB.

Minimum wage was introduced to address many of the labour market’s imperfections. Empirical evidence suggests that wages were not determined freely by supply and demand; instead, employers were in a dominant position to determinate wage rates, aggravated by the rate of unionisation of less than 10%. In addition, there exists a somewhat big productivity-wage gap. We ought to bear in mind that the labour market is an integral component of the economic machinery and signs of imperfection should be given due attention.

There are two ways to remain competitive — keeping costs low and focusing on quality. In the long run, the cost advantage option may not be viable as firms shift their operations to countries with a lower cost advantage in Southeast Asia. An economy can remain competitive by focusing on quality, innovation and adding value. For that matter, our economy will be able to attract both domestic and foreign direct investment in high-value-added activities if we are competitive.

Among the most compelling reasons why subsidies should be managed properly is that inefficient allocation will encourage wastage. Furthermore, if not managed properly, the subsidies will not reach the intended recipients. Subsidies should be targeted and transferred to the right group. Adjustment might be painful in the short term but what results in the long-term is improved efficiency and reduced CODB, or an optimal allocation of expenditure.

Near-perfect competition in the labour market will not be possible should there be numerous distortions and inefficiencies. Protecting certain industries will result in the emergence of a few dominant players. These privileged players will tend to use their dominant position to prevent the entry of new players in the market and suppress free and fair competition. More often than not, they are in collusion with one another. It is precisely for this reason that the Competition Act was put in place to ensure that the playing field will be level for all.

Thus, it can be seen that the SRIs will induce changes through adjustments. It might be painful to some and may increase the cost of production — but not CODB. However, this weeding out process will cause inefficient industries to close shop and attract and hatch new high-value-added industries. What emerges is structural change. In relation to this, steps must be taken to mitigate those affected — for example, employees made redundant must be retrained.

In the final analysis, the government must facilitate the transition of our industries into lean and mean entities. Failure to do so will be costly to us in the long run.

Samirul Ariff Othman is an analyst with local think tank Malaysian Institute of Economic Research. He completed his graduate studies at Macquarie University, Australia. The opinions in this article are his own.

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