Malaysia Government Budget 2010: Big Conflict??

Today Malaysia Government announced the annual budget for 2010. Some were happy and some were not. One thing for sure: everybody is still busy debating on it.

Prime Minister of Malaysia really make me confuse. There are big conflicts between what he plan and what he implement in terms of economics.

The main goal / objective of this government budget is reducing budget deficit! Malaysia's budget deficit is at 7.4% of GDP in 2009 which is severe. That mean Malaysia government spent 7.4% more that what it earned. FYI, US recorded 7.4% government deficit in 2008, around the same figure as Malaysia.

In Economics (Keynesian), to cut deficit, government need to implement contractionary Fiscal policy which increase tax, decrease government spending or both. The cost of contractionary fiscal policy is slower GDP growth as higher tax or lower government spending will hit both private and public spending.

Classical economics basically has the similar idea.

This is simple: government spend more than they earn so either slow the spending(government spending) or increase the earning (tax revenue).

However, that is opposite of what government is doing!

Annual government budget 2010 implement lower taxes both company tax and personal income tax by 1%. This is clearly not contractionary but rather expansionary fiscal policy. Lower deficit by lower tax?????

Do they know what they are doing???

Fortunately, they also implement slower government spending. However, that's not clear. No clear information introduced by government. The only thing we know is:

"The main spending cuts came from reduced “operating expenditure”, lower food and fuel subsidies, a sensitive political issue for an unpopular government, and less money for development spending."

I am not sure they know this or not, but operating expenses of government is not part of government spending. Eg wages of public servants. So up until now, the only thing we know is that government will reduce subsidies in both food and energy sector.

Basically this is good idea in economics as subsidy is always a "bad" thing that interfere the free market system.

So that's a big surprise, instead of focus on demand side spending cut, Malaysia government focus on supply side spending cut. That's a very dangerous thing as unlike demand side spending cut, supply side spending cut will not only mean slower economy (slower GDP) but also higher prices (higher inflation).

This basically mean although Malaysian can expect slower economic growth, prices won't go down with it.

According to government consensus, government deficit will decrease from 7.4% in 2009 to around 5.6% in 2010. We know that taxes will be cut 1%. If I forecast 1% cut in taxes will result in 2-3% in tax revenue for government, then operating expenditure and subsidies will need to be cut around 3.8-4.8%.

If half of the cut is on subsidies, which is around 1.9-2.4%, we can at least expect 3 times (300%) the rise in actual prices which is around 5.7-7.2%.

So for Malaysian or people who will live in Malaysia next year, save now to buy expensive food and fuel next year!