Budget measures to spur investment, employment

Like the snake-and-ladder board game, after a steady climb in the global competitiveness ranking to 18th position last year from 25th position in 2012, the recently released Global Competitiveness Report 2016-2017 by the World Economic Forum (WEF) shows Malaysia’s ranking had slid back to where it had been before.

While Malaysia is still ahead of its neighbouring countries like Indonesia and Thailand and the larger economies of China and South Korea, the sharp decline suggests the need for the government, industries and firms to sustain microeconomic reforms, pursue business transformation and strengthen growth foundations in an increasingly competitive global economy.

Sustaining microeconomic reforms

Well-designed microeconomic reforms are able to generate sustained growth dividends and promote improved domestic stability as increases in economic efficiency help to also slow cost inflation and raise national output from the same inputs, improve competitiveness and increase employment in the longer term.

Besides raising the competitive ability of firms and industries, reforms are needed to overcome structural problems, market failures and distortions and poor business conditions, all of which prevent the country from achieving its full growth potential.

Presently, the major structural problems confronting the country include the continuing high dependence on unskilled foreign labour, slow pace of industrial deepening, technology adoption and automation, inadequate indigenous technological capabilities combined with low innovation and skills development and prevalence of organisational cultures that resist change and performance improvement.

Private investment level, which has risen in recent years, also has slowed. Weakening investment could jeopardise the country’s escape from the middle-income trap as it is one of the three variables, besides production capabilities and rule of law, cited by the WEF to be common explanatory factors for economies caught in the middle-income trap.

Overall budget strategy for sustaining growth

At the macro level, a growth-friendly and pragmatic budget that is not out of line with the medium term fiscal consolidation strategy will help to ensure macroeconomic stability, which is a prerequisite for maintaining economic growth. Persistent deficits reduce aggregate savings in the economy and potentially could lead to inflation, high interest rates, and balance of payments pressures.

Unlike developed economies where fiscal consolidation would be harmful to growth in the face of weak domestic demand and monetary policy being constrained by low or negative interest rates, Malaysia’s ability to keep in line with its medium term fiscal consolidation strategy will enhance policy certainty and credibility.

Studies have shown that policy uncertainty created by macroeconomic instability affects growth through the volatility of investment returns and misallocation of resources due to distorted price signals.

Investment-friendly measures

At the micro level, well-designed tax and spending allocation can boost investment, productivity and employment. Well-designed tax incentives can stimulate private investment and enhance productivity through research and development (R&D).

Corporate income taxes by increasing the user cost of capital have been shown to have a negative impact on domestic investment and foreign direct investment (FDI).

In Malaysia, corporate income tax is an important source of revenue, accounting for close to 30 percent of the total revenue collected by the government in 2015. With the implementation of the goods and services tax (GST), there is scope to gradually cut corporate and individual income tax to reduce its distortionary impact on investment.

Besides lowering the income tax rates to reduce investment distortions, some countries have limited the tax to “excess returns” or rents, thereby promoting long-term growth while still generating revenue.

Under the allowance for corporate equity (ACE) scheme, investments that earn a “normal” return, which is the risk-free rate of return as represented by the return on government bonds, are exempt from taxation through a deduction of an imputed return on equity.

ACE’s advantage has been touted as being able to reduce the bias toward debt-financing created by the deductibility of interest expenses. This debt bias has contributed in part to the credit boom seen in many developing economies, including Malaysia.

Other well-targeted incentives that directly reduce the cost of capital, such as accelerated depreciation schemes, investment tax credits, and super deductions are considered superior to profit-based tax holidays which can erode the tax base.

Incentives to reduce graduate unemployment and low skilled workers

Targeted tax credits can have positive net employment effects particularly for low-skilled workers. Given the preference of employers for unskilled foreign workers, tax credits for employment and upskilling of Malaysians in low skilled jobs could help to reduce the country’s high dependency on foreign workers. Likewise hiring subsidies could be used to boost employment of unemployed graduates and it could be complemented by employers tapping into the Human Resource Development Fund for skills enhancement training.

Despite the broad-based decline in Malaysia’s efficiency enhancers that caused the drop in its global competitiveness ranking this year, an appropriate response in the forthcoming budget in the form of more targeted spending and incentives to boost the business environment and investment climate will help to reassure investor confidence and sentiments on the country’s long term prospects.

While expectations are running high on a people-friendly budget, it is important to also have a business-friendly one that promotes growth, employment creation and productivity improvements.

By Prof. Yeah Kim Leng | 1 Dec 2016

Professor Yeah Kim Leng is the Director of Economic Studies Program at Jeffrey Cheah In­stitute on Southeast Asia at Sunway University and Professor of Eco­nomics at Sunway University Business School. He is also an external member of Bank Negara Malaysia’s Monetary Policy Committee. The views expressed in this article are his own.

First appeared in the New Straits Times

Modified by Low Wai Sern