Wednesday, September 22, 2010

HIGH INCOME ECONOMY


As posted by Dr. Mahathir Mohamad at Che Det on July 29, 2010 4:00 PM

1. The Government has announced the intention to make Malaysia a high income country. I assume this means people will receive high wages, salaries and profits.

2. But if wages and salaries are to be increased by the private sector, the cost of doing business would have to increase as well. To cover this increase, prices of products must be increased. This will mean that the consumers will have to pay higher prices for whatever they purchase. There would be, by definition, inflation.

3. The increase in prices of goods and services should cover the higher wages and salaries and the profit margins from the business. But this will not be all. The cost of transport, fuel and raw materials would all increase as these businesses will also experience increased overhead costs as they too will have to increase wages etc. So the increase in product prices must also cover these costs.

4. Generally the cost of living would increase as prices increase. The rise in income may not increase the purchasing power of the wage earners. Higher incomes would not mean anything then. We know of many countries where people get higher incomes in terms of currency units but are extremely poor.

5. If there is to be an increase in income, it must be carefully managed so that it would result in increases of purchasing power and not just more money.

6. This can happen because the added cost of doing business may trigger unreasonable increases of prices for raw materials, goods (products) or services. For example a 10% increase in wages and salaries should not result in an increase of 10% in the prices of goods and services. This is because wages and salaries do not constitute the total cost of production.

7. Their contribution to cost of production varies. This has to be determined by careful scrutiny of all the cost of production including material cost, power cost, transportation, advertisement and promotion costs etc. If it is found that wages and salaries at all levels make up 20% of the cost of production, then a 10% increase in wages should contribute only 2% to the cost.

8. Similarly the increases in the other costs i.e. power, material, transport etc may increase by a much smaller percentage according to their percentage contribution to the cost. Assuming that together they contribute 50% of the cost, but the increase in their prices is 5%, i.e. 5% of 50% = 2½ %, the total increase in cost inclusive of wages and salaries should be 4½ %, or say 5%.

9. Thus the increase in wages by 10% will not increase overall cost by 10% but will only increase by 5%, after including increases of other costs.

10. The margin of profit varies. For wholesale and fast moving items the margin can be as low as 2%, while for some slow-moving luxury goods the margin may be as high as 300%. Assuming that the cost of production increases by 5% for a 10% increase in wages and salaries, there can be justification for only a 5% - 6% increase in price of products and service for those with low profit margins. For high profit margins there should be no increase in price at all.

11. The wage earners with a 10% increase in income should therefore have a 5% increase in purchasing power only; not 10%. In other words their increase in income would make them only slightly richer. Still with increase in purchasing power they would be able to contribute more to businesses. Eventually the Government would earn more by way of taxes to pay for the increases in wages and salaries in the Government service. Generally economic activity would be enhanced and there would be growth as the salary bill in Malaysia runs into hundreds of billions every year.

12. The above are some of the ways for preventing unfair cost increases when wages and salaries are raised. But there are also many other ways of reducing costs so that the cost of goods and services to the consumer is not increased much as a result of increasing incomes.

13. In manufacturing, a careful study of cost can result in ideas on cost cutting. The Japanese "Just In Time" manufacturing process is a good example. In this system the parts and components are produced just in time for them to go into the assembly of the final products. This eliminates the cost of storage and holding costs.

14. Automation and robotics are costly but they can work 24 hours a day and would reduce the cost of the three shifts of work by workers in one day. In ship-building, whole sections of the ship can be produced separately and then assembled. A lot of time can be saved this way. And time means money.

15. The classic case of reducing cost was invented by Henry Ford - namely mass production on assembly lines. Economies of scale can also contribute to lowering costs. We see the progress in retailing goods. The single specialised shops have given way to the supermarkets. Now the supermarkets are being replaced by the giant wholesale hypermarkets. These help increase volume and lower purchasing costs. Self-service also help to reduce costs in restaurants and supermarkets.

16. Various electronic devices can help in reducing costs. Because of additional capital needed for these devices, they contribute much when the volume is big.

17. Incomes can also be increased by better education and training. It is said that the Korean worker is three times more productive than the Malaysian worker. This is not just due to education and training but more because of work ethics. Obviously when a worker is more productive he should be paid higher wages.

18. Most manufacturing activities add higher value to basic material. Generally exporting raw material gives less return than exporting manufactured products. But other costs have to be taken into consideration.

19. The Malaysian strategy on industrialisation is also not conducive to reducing costs. Japan and Korea acquire foreign technologies and set up their own companies to produce their own products.

20. Malaysia adopted a different strategy. To create jobs for a large number of the unemployed, foreign investors were invited to set up labour intensive industries. Naturally wages were very low. Increased profits for the foreign owned industries did not necessarily result in increased income for Malaysian workers.

21. Over the years Malaysians had acquired the skills in manufacturing and the capital to invest. Today there are a lot of successful Malaysian companies. Should the Government help these Malaysian industries to grow they can become world class players. This means better income for the Malaysian entrepreneurs and better wages for the Malaysian workers.

22. We must not follow the route taken by the developed countries of the West to achieve high income. In the days when technology was exclusive to the European countries and North America increases in wages were largely due to the demands of the workers. To cover the increased cost of production prices were raised quite indiscriminately. This was sustainable when the Europeans were the only producer of manufactured goods.

23. But then the countries of East Asia, began to produce almost all the products of the West at lower cost. The workers of the West continued to demand for continuous increases in their wages. Very soon the high prices for their products caused them to lose the market.

24. Malaysia must never take this route in order to achieve high incomes. Instead it should study the other ways of increasing incomes which will not lead to inflation and loss of purchasing power.