Malaysia’s Dr Zeti and the future of the GST

It was an honour to have Dr Zeti Akhtar Aziz make the overnight flight to Beijing on 23 May to receive the Bill Seidman Lifetime Achievement Award from The Asian Banker despite her tight schedule in the middle of the newly formed “Council of Elders” to guide Malaysia’s economic decisions after the recent stunning elections. The award citation referred to her world class defence of currency controls in the aftermath of the 1997 crisis, despite pressure from the West that floating a currency was the desirable trend, and her valiant defence of the role of the central bank and the integrity of Malaysia’s banking system against a corrupt administration in 2015 that cost her career. Her defence of the institutions of regulation and corporate governance is admired widely worldwide.

But even as she made the trip to Beijing to receive the award for one lifetime, she was co-opted into yet another, that of guiding Malaysia through its post-traumatic period of rebuilding its economy and institutions. Core to that role was the defence of stepping back on the Goods and Services Tax (GST), accepted without question as the desired format to raise government income by now more than 160 countries around the world.

I did have the chance to chat with her briefly on her views and it was clear that I was talking to someone who fully understands the mechanics and benefits of a GST and the ramifications for taking a step back in the interest of other priorities. It is already been branded by some that Malaysia is taking a “populist” step backwards. A Moody’s analyst was quoted saying that the RM44b downfall in income it represents will affect the perception of its sovereign credit quality.

The key members of the Council of Elders – Professor Jomo, Robert Kuok, Hassan Marican and Dr Zeti – and the new minister of finance himself, Lim Guan Eng, cannot by any imagination be considered “populists”. They are principled individuals with a lifetime of proven integrity and making difficult decisions, including tightening budgets, selling off unprofitable businesses and other painful measures in their policy decisions and businesses. I am curious about Daim Zainuddin, given his track record in government, but I have been following his post-political career as a reasonably decent investor in banks and other assets in Africa.

Anyone who knows Dr Zeti will know that her standing in the international community is important to her. So when she made it clear to me that she was supporting this decision, I had the sense that she knew exactly why she saw that the zero-rating GST for now was a wise move.

Without attribution to the conversation I had with Dr Zeti, these are my thoughts on the GST, and the lessons that other emerging market countries that are watching developments in Malaysia today can take from this decision.

1. GST is based on the assumption that the corporation is a better conduit for taxing the economy than individuals because it captures not just spending, but also price discovery, productivity, inflation and other moving parts that keep the economy growing. Although it is the individual final buyer (consumer or business) who presumably carries the final cost, taxing the system through the supply chain is like a marker placed to detect the efficiencies from production to consumption. It is as much the central banker’s tool as it is a revenue stream for the administration. Tax the system too much and you risk burdening it, tax it too little and the state will not benefit from the economic activity.

2. Some central banks think that four percent is optimal, beyond which a GST starts to be counterproductive and even start affecting the daily lives of ordinary people, which it is not designed to do. When a government starts charging six percent GST without the attendant productivity gains or in the absence of the need to fight inflation in a consumption-based economy, it sets a chain reaction starting with a defensive demand for a rise in income that knocks on to prices, inflation and other non-productive indicators in the chain. The “four percent” optimal number may be different for different economies based on how productive it is, how much imported inflation it has to deal with through capital flows and so on.

3. Th previous Malaysian administration had started with six percent, with the intention of making the GST an important means of raising income to support its over-sized deficit budget. The lesson here is that governments should never be over-ambitious in the implementation of a GST. Too high, and it has a counter-effect on inflation, productivity and the growth of the economy. Hardly any economy in the world today has the ability to generate the productivity or the foreign capital flows to support rising prices once it is triggered.

4. Once a GST is seen to be prohibitive, it sets in motion a chain reaction that not only raises prices, but makes the population increasingly sensitive to the government’s accountability. This is where an otherwise docile general population that would vote the government in every election becomes activated and starts scrutinising every income, expense and even lifestyle of elected officials, potentially leading to their downfall.

5. The new Malaysian administration appears to be confident that it will be able to make up for the fall in income from the savings it hopes to generate from cancelling over-priced mega-projects, failed government-linked companies and investments, bloated number of employees in the civil service and government-linked companies and corruption in general. It is interesting to note that the practice of implementing GST in several countries is accompanied by really ambitious and even deficit budgets. It is almost as if after having won the mandate to impose a GST, governments tend to go on a spending spree. In other countries, these also include high salaries and benefits for the administration officials, exorbitant military spending on fighter jets and advanced armaments as well as the usual outsized sea tunnel, airport and bridge projects. It’s a bad habit that politicians, in the Barbara Tuchman’s tradition, act against their own self-interest in this way.

6. Of all the budgetary items in Malaysia’s case to counter the effects of zero-rating the GST, I did not understand the desire to reinstate energy subsidies. I think this is the one item that together with several other items, has the unspoken agenda of re-creating the capital intensive industrial economy, which is now on the wane around the world. Also, Malaysia’s education system has been decimated so that it will take another 10 years to build the critical mass of a professional class for the networked economy that is on the rise. In the current euphoria, there is no one dreaming the Malaysia of that future.

7. The media kept saying that the GST is being “abolished”. That is not the conversation I have been having. GST was being “zero-rated” not abolished in Malaysia, to be reintroduced in a sustainable manner in the future. In the process, it sets in motion the culture of accountability that should have existed in the first place.

The effect of the GST and consumption taxes in the Anglo-Saxon economies has been the rise of this language of “accountability” where the population checks on everything from the cost of public libraries to the dress the president’s wife wears at state dinners.

This in itself is a desirable goal, but carried to the extreme, such a mindset can be perverse, it introduces cynicism and kills the building of shared aspirations in society. Everything becomes unnecessary and unaffordable. At the same time, neither are corruption and white elephant projects. It is this language that every country and society has to shape for itself, drawing from the checks-and-balances that may well already exist in their respective cultures.

The sub-text should be that 160 countries are not widgets in a global economy. Some are net importers, others are net exporters of manufactured goods, many in the old economy. Some are dependent on tourism receipts. Some are helpless to hot capital flows while others need to work hard at foreign direct investments. Each has a different nuance that is captured in the productivity of its population, imported or self generated inflation and GDP growth,and as such the tax-base has to be sustainable.

Receiving one lifetime award, Dr Zeti flew back to Kuala Lumpur to start on what for anyone else would be a second lifetime’s adventure of pushing back on conventional wisdom and perhaps rewriting it as she did in the past.