Study suggests Pakatan’s answer to income inequality could be based on faulty markers

Syed Jaymal Zahiid
The study’s authors argued that LIS — a key inequality indicator, according to the International Labour Organisation (ILO) — could be misleading, particularly in the case of Malaysia. — Picture by Hari Anggara

KUALA LUMPUR, Jan 20 — Pakatan Harapan’s (PH) policies to narrow the country’s income gap may be based on a flawed marker could thwart the country's  industrialisation drive, according to Khazanah Research Institute.

The criticism was outlined in a study titled “Income Inequality in Malaysia: Examining the Labour Income Links”, which analysed the coalition’s income redistribution policies.

Authors of the study, Christopher Choong, Alyssa Farha Jasmin and Adam Firouz, believe that the ruling coalition’s goals were built around a marker — labour income share (LIS) — that could mask true inequality through statistics, increasing the likelihood of a wrong policy response.

LIS is the share of a country’s total income that accrues to labour. It is seen as a key inequality indicator, according to the International Labour Organisation (ILO), but the study’s authors argued that it can also be misleading, particularly in the case of Malaysia.

“Available evidence shows that anchoring inequality on a higher labour income share may be at odds with Malaysia’s ambitions of technological upgrading and moving towards higher productivity, capital-intensive modes of production,” the paper said.

“It suggests a disconcerting trade-off between the country’s growth and distribution objectives.” 

KRI’s study followed the first-term PH administration’s plan to raise labour income share as a way to narrow the widening wage gap. LIS is one of two components that form national income. The other is income derived from capital.

Under the Shared Prosperity Vision 2030 (SPV2030), the coalition broadened discourse on inequality by drawing attention to LIS as a measure of the inequality between labour and capital.  

Compensation of employees (CE) in Malaysia also remains low compared to its more developed peers, Economic Affairs Minister Datuk Seri Azmin Ali said when unveiling the 10 year plan. 

Wage inequality

For the next decade, the government aims to raise CE share to 48 per cent. It was 35.7cent in 2018. 

But this approach can be problematic in two ways, the KRI study suggested. First, analysis of LIS from 2005 to 2016 revealed an underlying trend of deindustrialisation. 

A 2019 working paper that aimed to explain the increase in labour income share within that period found that while income share may have increased, it was attributed to the growth in low- to medium-skilled industries that tend to rely on low technology solutions and a large labour pool. 

Secondly, KRI argued that LIS is neither a good indicator of income inequality nor a good driver to reduce it. The reasons given to explain the second point are more technical, involving sample tests and statistical calculation. 

When LIS data was subject to a modelling technique called the regression analysis, the Gini coefficient — a statistical measure used especially for income inequality — responded negatively. 

This meant the link between wage share and inequality was tenuous.

So the researchers suggested that a third component could provide answers to some of the lingering questions about income inequality in Malaysia that LIS could not: labour income dispersion (LID), a measure of wage disparity across or within a particular economic sector.

This premise was based on several reasons, among it a KRI study that found wider disparity among paid workers and the self-employed compared to overall income inequality. 

Wage or salary is one of several types of labour income, and is the largest share of personal income followed by earnings from self-employment, according to official data. 

By scrutinising the salary gap and including the data as a component to calculate the Gini coefficient, the study’s authors concluded that LID provided a more accurate picture of household well-being.

Wage inequality trends over the years also appeared to be in line with other analyses that measured overall inequality, which strengthens the case for LID as a key component to explain the country’s income problem, Choong, Alyssa and Adam argued.

Structural issues

By calculating data from a 2019 study of wage disparity based on the Salaries and Wages Survey (SWS) between 2010 and 2017, the researchers produced a Gini coefficient score that matched the official income inequality score.

“Examining the relationship between the dispersion ratio and structural features of the economy can shed more light on the sectoral forces driving wage inequality over time,” the authors concluded. 

Malaysia’s Gini coefficient score in 2016 was 0.399, which is considered to be in the moderately high bracket. The PH government aims to improve its Gini coefficient to 0.340 by 2030.

Under SPV2030, the PH administration will look to industrialisation to drive growth but with priority given to equitable policies that aim to lift the population’s economic status with high skills. 

But achieving these targets will require the right policies and tools especially concerning income inequality, Choong, Alyssa and Adam said.

“To drive technological upgrading, there should be a shift away from targeting factor income (income accrued to factors of production like workers, machines etc.) shares to understanding the parameters that shape them,” the study said.

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