About Nick: i am an economist based in malaysia. I write about development economics, while sneaking in a pop culture reference or two.

Patient Capital for the Long-Term

Published in The Edge Malaysia, June 2018.

In Daniel Kahneman’s book, Thinking Fast and Slow, he writes that the human brain is wired to search for cause and effect explanations in everyday life. The idea that the world is chock-full of random events, and that things can just happen without some pre-determined action or agent is often politely acknowledged, downplayed against the notion that it must be Event X or Person Y who drove that effect.

The difficulty in identifying true causality, particularly in real life, is the absence of the counterfactual. Michael Jordan is widely acknowledged as the greatest basketball player of all time. Of course, he worked extremely hard, was incredibly dedicated to his craft, and was a competitive freak to boot. He certainly is worthy and deserving of his success. But, would he have been as great had he been the average height of his parents, 5’7”, instead of his actual height of 6’6”? Michael Jordan’s parents were 5’9” and 5’5” respectively, yet he grew to be 6’6”. How much did this unusual genetic windfall matter?

Public policy is much the same way. We honestly cannot really tell whether a given policy had really worked unless there was some counterfactual. For instance, suppose we had a policy where the teacher to student ratio was halved as students went from Form 3 to Form 4. Now, if the students’ scholastic performance improved in Form 4, how do we know how much of it was a result of that policy move, rather than just a natural improvement in aptitude and maturity from Form 3 to Form 4?

Causality is complex and difficult, and continues to remain an enormous battleground for research in the social sciences. With that in mind, I have always been somewhat curious as to how brokers or analysts or business journalists seem to have a dead-on explanation for day-to-day movements in the financial markets. It can be really baffling. For instance, the markets can be negatively impacted by news flow on possible trade wars one day, but improve the next day despite more news flow on deterioration in international trade policies!

Of course, this is not to say that news flow cannot impact markets; of course it can. So, in the week of the 21st of May, when the KLCI took a substantial nose dive, a lot of the attribution was due to announcements by the government, particularly Tun Dr. Mahathir Mohamed and Lim Guan Eng, on Malaysia’s national debt and the 1MDB situation. Former Prime Minister Dato’ Sri Najib Razak jumped in on this (as any good opposition politician should) stating on his Facebook post that, “Our Bursa index fell 40.78 points today or 2.21% while the Indonesian stock index added 0.71%.”

I just want to make a couple of points on that statement. First, that statement is a clear example of cherry-picking and confirmation bias. Markets globally tanked. Benchmark indices in Singapore, Hong Kong, the United Kingdom, Germany and France all suffered as well, falling -1.32%, -1.82%, -1.13%, -1.47, and -1.32% respectively on that same day, but this wasn’t mentioned in Dato’ Sri Najib’s statement. Second, undoubtedly there is a set of reasons as to why markets tanked globally and why Malaysia performed particularly badly. I am not arguing that these movements were random, nor, indeed, am I arguing that the news flow out of Malaysia did not have an impact. Maybe it did, and if it did, I cannot say how much of the KLCI’s drop was due to global factors, and how much to domestic factors.

Yet, I will say this. Even if it were true that announcements made by the government adversely impacted investors, especially foreign investors who had been selling off their Malaysian positions over the course of the past few weeks, there is a broader point that I would make about the viability of using ‘the markets’ to determine the effectiveness or viability of a given government regime, especially in the short-term.

Markets love stability and abhor uncertainty and volatility. However, Malaysia is in the midst of a historic period of transition and change; its first change of ruling government since Independence. The last time there was a change of government in Malaysia, the British government was removed from power in the country. Considering such a monumental change, did anyone ever seriously think that there would be no adverse consequences? Did anyone really believe that everything would be smooth-sailing, and that markets would give Malaysia a free pass?

No true change and reform is straightforward. But markets, in almost all cases, prefer stability and the status quo – what is going on in Malaysia may be anathema to markets. It could be true, after all, that investors prefer the policies of Barisan Nasional; to prove this, we would need to compare the KLCI’s historical performance under Barisan National governance and Pakatan Harapan governance. There is one big problem – we have never had a different government post-Independence. Maybe by the next election, we will have collected some data points and maybe it will be true that Pakatan Harapan’s policies do not inspire confidence, but my suspicion really is that markets prefer stability. This period of change in Malaysia may be unstable for the time being, and maybe markets – especially foreign short-term investors – may not like it, but this is just the next phase in our nation-building Malaysian experiment.

Finally, could the government do a better job in managing this period of uncertainty and volatility? Perhaps it could. To assuage investors and the markets a little, maybe it could choose to be more strategic in its communications on news flow, and maybe it could also provide some longer-term views as to how they plan to tackle challenges to fiscal issues.   

All that is well and good, but ultimately, in my view, it really comes down to the reason behind the news flows that we are seeing. If it is an unveiling of the truth behind our fiscal position and our economy, then let the truth will out. And, if it happens to spook investors, maybe the nation needs to take the hit from markets, in the short-run, to reboot itself. Maybe our economy needs to go through a J-Curve. To suggest that the government, or any government, should prioritise short-term hot money capital flows over long-term transparency and accountability is rather preposterous.

Having a strong, stable market environment is unquestionably important. The issue is the time horizon. Market reactions – which typically oppose instability and uncertainty, hallmarks of any period of transition and change – may not be the best place to judge these transitions and changes, especially in the short-term. Indeed, these short-term fluctuations in the markets may very well end up being a small price to pay for true political, economic and social reforms in Malaysia – weeding out corruption, rent-seeking and the like, while increasing accountability, institutional strength and structural reforms.

The hope for all Malaysia, which we must collectively work to achieve, is that we and our markets emerge from these short-term jitters – J-curve though it may be – stronger than ever, setting ourselves and our long-term investors on a path of sustained stability and strength.

The World Cup and the World

"Maka Kami, Rakyat Malaysia"