This article first appeared in Forum, The Edge Malaysia Weekly on March 4, 2024 - March 10, 2024

Malaysia finds itself at a critical crossroads in its economic policy as it grapples with the imperative of reforming its subsidy regime while safeguarding the welfare of its citizens. For decades, the country has allocated a significant portion of its budget to providing universal price subsidies, notably for commodities like petrol. However, this approach has led to distortions in resource allocation, hindered the transition to greener energy sources and strained public finances. With subsidies consuming a staggering 4.6% of gross domestic product (GDP) in 2022 — equivalent to the combined budget allocation for health and education — the need for reform has become glaringly evident. Despite the intention of universal subsidies to benefit all citizens, evidence suggests that they disproportionately favour higher-income groups, exacerbating income inequalities.

The Malaysian government is commended for initiating a process of correcting this distortion with the intention of completely withdrawing the universal subsidy system over the short run. However, the removal of a system of price subsidy is expected to cause inflationary pressure, which will ultimately result in a welfare loss for many households in the country.

To cushion the welfare loss resulting from this inflationary pressure, cumulative evidence shows the importance of accompanying the reform measure with a package of cash assistance in the form of periodic payments to vulnerable groups. If the package is designed well, the net impact of the combination of fuel subsidy removal and cash assistance can be a progressive social policy instrument. One example that stands out is the case of fuel subsidy in Iran, where poverty was halved (from 10.2% to 5.1% between 2009 and 2012, with bigger impact in rural areas).

To effectively address welfare loss, it is crucial to prioritise vulnerable segments of the population, particularly senior citizens and children. We propose providing monthly benefits of RM500 to senior citizens aged 70 and above, and RM50 to children and teens aged 17 and below, which can alleviate financial strain and ensure a more equitable distribution of assistance. The proposed benefits will cost about RM13.3 billion (0.61% of GDP). Over the projection period, even as benefits are assumed to maintain ringgit real value (indexed for inflation), the total costs will stay stable relative to GDP as the increase in senior citizens’ population will be offset by reduction of children.

Further complicating the issue of subsidy reform and welfare loss mitigation is the challenge of devising effective targeting mechanisms. While traditional poverty targeting approaches have been widely used, they often fall short in accurately identifying and assisting vulnerable populations. For instance, the most celebrated cash transfer programmes, Mexico’s Oportunidades and Brazil’s Bolsa Família ended up excluding 70% and 59% of the poorest 20% of eligible households respectively. Similarly, exclusion and inclusion errors in Bangladesh, Indonesia, Rwanda and Sri Lanka ranged between 57% and 71% when 10% was covered. In China’s Minimum Livelihood Guarantee Scheme (also known as Diabo), cities using more targeting were less likely to reduce poverty. In the case of BR1M (now STR) in Malaysia, similar evidence of high exclusion errors was found. Furthermore, programmes supposed to be exclusively for the poor tend to be stigmatising. In India, Thozilurappu Paddhathi (the “work guarantee scheme” or National Rural Employment Guarantee Act) is often referred to as Thozhiluzhappu Paddhathi, the “lazy work scheme”.

Therefore, we propose the adoption of a categorical targeting approach, which focuses on specific demographic groups such as senior citizens and children. By targeting assistance at these groups based on demographic characteristics rather than income levels, Malaysia can ensure that support reaches those most in need without the stigma and administrative burdens associated with traditional poverty targeting. Further, the use of technology, such as MyKad, Malaysia’s national identity card, can streamline the delivery of targeted assistance. MyKad’s built-in chip can store and retrieve programme-specific data, facilitating the identification and disbursement of benefits to eligible individuals. This approach not only reduces administrative complexities but also ensures that assistance reaches its intended recipients in a timely and efficient manner.

While the life-cycle approach ostensibly encompasses all individuals within a designated category, such as providing an old-age allowance to individuals aged 70 and above or extending a child allowance to all children, it is crucial to recognise the broader implications of financing mechanisms like fuel subsidy withdrawal. When coupled with allowance transfers, the elimination of fuel subsidies effectively translates into a targeted redistribution from wealthier households to those with lower incomes.

But if for political reasons it is thought to limit benefits only to the B40 and M40, it is recommended to create a wealth threshold (for instance, those who own three properties or more) and exclude those above the wealth threshold without targeting the poor. In other words, instead of targeting the poor (on whom we have limited to no information on their income), exclude the rich (who are more visible in existing administrative data).

The selected target groups are based on the following justifications:

a. Demographic changes: Old-age pressure and the need to increase investment on a smaller number of children

Malaysia has seen significant changes in its population structure. One of the notable changes is the rapid increase in the old-age dependency ratio (the ratio of elderly over 65 years old per working-age person), which will in 2049, for the first time in Malaysia, exceed that of the young dependency ratio (the ratio of pre-working population aged 0-14 to those over 65 years old per working-age person).

Malaysia’s population has been ageing at a much higher pace than that of other countries. Our calculation indicates that Malaysia reached the threshold of an “ageing nation”, defined when the post-working population (65+) constitutes 7% of the total population, in 2020. Further, it will reach an aged nation, defined when the post-working population (65+) constitute 14% of the total population, by 2045. This is a rapid transition and requires instruments to be put in place to provide income security for senior citizens, and at the same time, ensure that young Malaysians are receiving what they need to reach their full potential as they will have to face an increased burden due to this demographic situation.

The demographic dynamics in Malaysia highlight productivity as the main driver of the long-term growth path towards convergence with high-income economies. To unleash the nation’s productivity potential, investments in children are key. Vulnerability is positively correlated with age groups (for example, childhood). Targeting this group injects income into the households’ budget and supports reduction of vulnerability. Research has shown that school-age children who suffered from an episode of severe acute malnutrition in the first few years of life had poorer IQ levels, cognitive function and school achievement, as well as more serious behavioural problems compared with matched controls or siblings who were never malnourished.

b. Old-age poverty is alarming

The lack of a comprehensive income security system for old-age citizens has placed significant pressure on the existing social assistance programmes, which are unable to cope. Specifically, the Ministry of Women, Family and Community Development’s (MWFCD) social assistance programmes for senior citizens, the Bantuan Warga Emas (BWE), registered a very large increase (4.55-fold between 2008 and 2022) and currently covers a total of 141,114 old-age recipients. Parallel to the increase in covered population, allocation to the BWE programme increased 10.6-fold between 2008 and 2022, which constituted 33.35% of MWFCD’s social assistance budget in 2022. Similarly, the Employees Provident Fund’s statistics show that most EPF members have inadequate savings. In addition, early age of withdrawal, currently at 55, and the lump sum withdrawal result in old-age vulnerability.

Not surprisingly, and due to the weak old-age protection system, poverty in Malaysia has an age dimension, with senior citizens being particularly vulnerable. Department of Statistics Malaysia (DoSM) data showed that relative poverty among senior citizens is the highest and stands at more than 2.5 times higher than the national average.

c. Old-age allowance can correct the gender dimension of old-age protection

EPF is employment-related old-age protection. Therefore, participation in the labour market is a key determinant of whether an individual is protected or not. This is an inherent problem from the labour market in Malaysia, where there are participation rates differentials between male and female working-age populations. The latest administrative statistics in Malaysia show that the EPF’s active membership mirrors the general labour force pattern, where the sex ratio (female to male) peaks at age 25 before it starts declining.

This figure shows that the coverage gap starts widening between males and females starting age 25 and remains throughout the labour productive years. Low female labour force participation rates, as discussed earlier, is one reason for this, but the over-reliance on the insurance model (which is based on participation in the labour market) without any government intervention results naturally in a bias in the system against the female population, which has lower labour participation rates, have discontinued contributory record and engaged more in the informal labour market. Not surprisingly, women reached the age of retirement with much lower coverage compared to men, leaving them more vulnerable to old-age income insecurity.

Therefore, an intervention by the government, such as the proposed old-age allowance, will correct for the discriminatory labour market and result in protection in old age for all citizens. In fact, as women live longer, the old-age allowance proposed will benefit them more than men.

Dr Amjad Rabi is a visiting expert at Universiti Malaya’s Social Wellbeing Research Centre

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