My Say: On economic rent and outlook

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This article first appeared in Forum, The Edge Malaysia Weekly, on January 25 - 31, 2016.


The term “BRIC” came about to describe a select group of emerging market economies — Brazil, Russia, India and China — which, some said, would collectively surpass the seven richest economies in the world, the G7, by 2050.

This created such excitement that BRIC themselves, while never formally organised as a bloc, started to organise annual summits among themselves, befitting their status as the would-be nouveau riche. BRIC became BRICS when South Africa joined to set up the New Development Bank BRICS last year.

The central thesis of the BRICS story is a compelling one. These are continental economies — they collectively cover over a quarter of the world’s land mass and constitute 40% of the world’s population between them. While they contributed only 8% to the global economy in 2001, in purchasing power parity terms, their share is almost 25%. The ingredients and track record are there to suggest a trajectory to surpass the G7.

The BRICS story was always about China to eventually dominate the global supply of manufactured goods while India dominated the service sector and Russia and Brazil dominated natural resources. It was predicted that only Brazil would be able to achieve a dominant position in all three sectors. Such was the potential. How quickly things can change!

The commodity boom — the so-called commodity super cycle — ended and the world is now witnessing a “new oil order” that is redefining the overall energy economics and, therefore, global geopolitics as well. Quite suddenly, the emerging economies, BRICS included, are looking quite different from the ones we saw in the last two decades. There have been some fundamental changes to the overall economic logic, whose consequences are only now unfolding and will affect business models of firms and the structure of production of economies everywhere.

China recorded its slowest growth rate in 25 years in 2015, an impressive 6.9% though it was, but among the BRICS, it is Brazil’s economy that seems to have really floundered; it slowed to stagnation from 2011 to 2014 and has been contracting since.

Its currency lost 60% of its value, inflation has accelerated to double digits and the persistent government deficits have ballooned to over 8%, resulting in accumulated government debt of some two-thirds of its GDP. Despite two decades of growth, Brazil seems to have failed to put in place a strong institutional foundation that is necessary to manage its finances effectively and diversify its economy from a dependency on natural resources.

The BRICS experience highlights how national accounting, which is based on financial valuations, can sometimes misrepresent economic value, a much broader concept that takes into account both explicit and implicit costs. These resource-rich economies are essentially based on land, the supply of which is inelastic.

The economic boom that drove the commodity boom exerted demand pressure on an inelastic supply or at the very least very chunky supply changes, thereby driving prices up. The price increases contained economic rent, increasingly so as demand increased. The growth story was not primarily driven by real productivity growth or value creation through innovations.

Resource-based economies thus enjoy economic rent in boom times — increases in valuation simply because of limited supply. The property boom that accompanies boom times is based on the same logic of increase in economic rent as the sector is land-based as well. While the price increases and profitability excite investors and asset managers, they worry the economists, who, while appreciative of the need for such “animal spirits”, see rent-based growth as a mirage on which a sustainable foundation for growth and development cannot be built.

That the BRICS are still struggling to build the right institutions despite their long periods of growth confirms how economies that are rent-based and extractive, to borrow the term used by Daron Acemoglu and James Robinson, tend to also produce non-inclusive political institutions that are ill-equipped to build the institutional foundation for a developed and mature society.

Being largely commodity-based, Malaysia is at the epicentre of this new global economic dynamics. There are emerging facts and certainties in this uncertain transitional stage. The US economy has sufficiently recovered — capacity utilisation has increased sufficiently that new job creation is now steady and household indebtedness has improved — and US monetary policy normalisation has begun. The level of liquidity and the cost of funds we have been familiar with since the onset of the global financial crisis (GFC) will not be there anymore. The cost of borrowing and of debt servicing will increase.

This will bring to the fore the problem of indebtedness in Malaysia as well as in the developing economies that have seen increasing indebtedness while those in the developed economies have deleveraged themselves since the 2008/09 GFC.

Malaysia’s fiscal policy has been too loose the last 20 years and throughout the commodity boom, although we were the beneficiaries of the boom, the fiscal consolidation has not been aggressive enough in my view, targeting a balanced budget only in 2020.

This administration has taken the brave and painful, and in my view, correct, policy decision of broadening the tax base on the revenue side but it has not shown enough resolve to consolidate spending. As a result of the ongoing deficit budgets, the level of debt is increasing.

We made the mistake of not putting aside the economic rent we enjoyed from the commodity boom. We may have instead made our expenditure structure based on cyclical commodity revenue. This outcome simply illustrates how difficult it is to break free from the grips of vested interests once the logic of economic rent takes hold.

Policies as well as business models that are based on rent capture and its quick realisation may excite bankers, which however, will not only be unsustainable, but also have detrimental effects on the overall economic environment, perverting incentive structures everywhere.

Beyond relying on land-based rent and being unduly influenced by interest groups protecting such rent, the country long ago embarked on policies that used economic rent to achieve so-called developmental goals.

The use of licences, quotas and permits in the name of creating bumiputera entrepreneurs, for example, has not only failed but it has also distorted the incentive structure. In fact, the whole thing has become an oxymoron. Instead of being the creators of economic rent, the so-called entrepreneurs are simply rent-seekers!

Economic rent is a creature of scarcity. While we abhor rent created through fiat, we should actually celebrate scarcity that is driven by innovation and creativity.

The long-term sustainable path of growth — of companies and economies — depends on a continuous supply of this sort of rent creation through the scarcity of innovation, which inevitably depends on talent and entrepreneurship. It is not regulatory intervention or even government participation that is required; what is required is a steady supply of talent and a good dose of competition and perhaps a more forgiving environment for failing.

The external outlook is ambiguous as economies transition into the new oil order that seems to also define a “new political order” globally. There will be clear winners and losers, and Malaysia and Malaysian companies will have to properly locate themselves within this new equilibrium. There is also the ongoing domestic dynamics that will determine Malaysia’s future and the competitiveness of its companies.

Will we continue on this path of increasing parochialism? Our diversity, pluralism and liberalism — the very ingredients of our competitiveness in this globalised world — have now been chastised as we grow increasingly bigoted and intolerant of differences. Or will we come to our senses?

Can we escape the grip of narrow vested interests and build strong national institutions? Is there enough will and perhaps even altruism to do so? Much depends on those entrusted with stewarding these institutions, which reminds me of the Greek saying, “A society grows great when old men plant trees, whose shade they know they shall never sit in.”

A corollary to this dictum on inter-generational transfer of collective memory and responsibility should be that “old men should take care of the trees they inherited whose shade they enjoyed”. Those entrusted with looking after the institutions should not betray that trust.

I am not sure but 2016 could be a year for clarifying things or it could be another year in which we muddle along.

Dr Nungsari Radhi is an economist and managing director of Prokhas Sdn Bhd, a Ministry of Finance advisory company. The views expressed here are his own.