The most notable announcement in the Budget 2025 speech by Prime Minister and Minister of Finance Datuk Seri Anwar Ibrahim in parliament, at least to me, was on the issue of RON95 subsidies. He said the government will implement targeted subsidies on RON95 beginning in mid-2025 but only for the top 15% of income earners in Malaysia. The prime minister reiterated several times that 85% of the population that currently benefits from the existing blanket RON95 subsidies would remain unaffected.
Whether you believe that 85% is the right threshold or you question how they are going to determine the 85% or 15%, the point still stands that this is a positive move. There isn’t a single economic analyst I have come across who thinks that blanket subsidies on petrol are good for the government’s fiscal position, let alone the country. And given that this government has already moved to rationalise diesel subsidies, it is worth commending this continued commitment to overall subsidy rationalisation.
The primary argument for the ongoing price regulation — be it via subsidies or price controls — of several goods in the economy is to help Malaysians manage increasing cost-of-living issues. And, as such, by ensuring that 85% of the population continues to be covered by these RON95 subsidies, the government believes it is helping this 85% manage their day-to-day costs. It is true, to an extent, of course, but ultimately, this measure must still be seen as only a stopgap from resolving a longer-term issue.
I argued in this column (“Income, not cost, in an increasingly inflationary world”, Issue 1543, Sept 30) that, “Malaysia’s main problem is not so much that costs are getting higher — this is true everywhere. Our main problem is that incomes are not rising as quickly and this is where the bulk of our attention should be.” Purchasing power, as I put it, is two-sided — incomes and costs. And right now, all the subsidies really do is reduce pressure on the costs side, they do nothing for the income side. Even some of the criticism of the 85% targeting mechanism fail to appreciate this point, or at least they fail to tie it to the more fundamental issue. These critiques focus too much on what household incomes fall in the top 15%, and argue that many of these households will not be able to fully afford the removal of subsidies.
Over the long run, with cost structures reversing from the past few decades due to megatrends like deglobalisation, ageing demographics, climate change and so on, unless we really tackle the income problem, we are not really addressing the fundamental problem in the Malaysian economy. The primary reason that the government cannot fully remove subsidies is not, at its very core, because it will impact the cost of living for Malaysians, but rather because our wages are far too low. And this has all to do with the structure of the economy.
If we look at the evolution of the economy from, say, the 1970s on, much of the competitiveness of the firms in our economy have come from being lowest-cost producers. This is true in manufacturing, in plantations and in service provision. Electrical and electronics products may hold our largest share of exports, but the value add of those exports is generally low, primarily because we tend to import parts, assemble them and then re-export them. For instance, we know that the country’s vaunted semiconductor ecosystem is largely in the assembly and testing subcomponent of the value chain, which has the lower profit pool in the entire value chain.
Another example comes from a recent report on the Southeast Asian technology space by top-tier global venture capital firm Lightspeed, which argues that, “Most Southeast Asians are value-focused users of online services who focus on value rather than convenience …” In other words, for Southeast Asia, most customers primarily engage with discounts and are high cost-conscious consumers, as opposed to convenience-focused “power consumers” willing to spend on comfort and experiences. Power users in Malaysia are estimated at 38% versus more cost-conscious users at 62% (the numbers in Singapore are 90% and 10% respectively).
So, this creates a chicken and egg issue — if consumers are so cost-conscious, businesses will compete primarily on lowering costs, which then means a race to the bottom in terms of wages, which then keeps consumers unable or unwilling to spend more differentially. And so on. Well, the solution to a chicken and egg issue (according to a former managing director of Khazanah Nasional Bhd) is to have a rooster. Side diversion: science will tell you the egg came first, and due to evolutionary needs to continue perpetuating our genes, the egg essentially created the chicken to produce more eggs, so to speak.
Anyway, the rooster for Malaysia is not just to create more competitive firms, but to create regionally or globally competitive firms that do not compete primarily on being lowest-cost producers. In more business-y jargon, this is to create firms whose “moats” do not depend on a race to the bottom on costs. According to Warren Buffett, this analogy of an economic moat around a given business is meant to capture a sustainable competitive advantage, with moats ideally being deep and wide enough to fend off intruders. Sustainable competitive advantage, to be more precise about it, means being able to generate returns on capital above the cost of capital (pure profit alone does not necessarily mean value creation) for an extended period of time.
What are some of these moats? According to Morningstar, a global investment research and financial services firm, there are five kinds of moats — network effects (when companies capture value with “thicker” markets of buyers and sellers — think Visa); intangible assets (when companies possess patents, licences and so on — think Pfizer); cost advantage (self-explanatory); switching costs (when it would be too expensive or troublesome to stop using a company’s products — think your favourite commercial bank); and efficient scale (natural monopolies — think something like Tenaga Nasional Bhd’s grid).
Some companies may have more than one moat, of course. But the broader point is that we need more Malaysian companies whose moat goes beyond “cost advantage”. Ideally, we should want to create more companies that can leverage network effects, intangible assets and switching costs (efficient scale from natural monopolies is much more limited in scope). Globally, these are the companies that are the most profitable because these moats are the most sustainable. And, more importantly, they are also capable of paying higher wages to their employees.
And so, tying this back to subsidy rationalisation, if we fail to create more companies with moats other than cost advantage, then all we’re doing is just treading water to stay afloat. If we don’t address the more fundamental issue of higher wages, we will never be able to fully remove subsidies. So, I actually think it’s fine for the government to stagger the subsidy removal, but not because (or only because) it provides an adjustment time for households. Rather, we need it to buy time for the creation of companies with more sustainable non-cost-based moats to hike wages for Malaysians, such that they can finally get ahead on the rising cost of living.