Malaysia: the challenge of avoiding the middle income trap - Articles

MALAYSIA: THE CHALLENGE OF AVOIDING THE MIDDLE INCOME TRAP

Professor Dwight H. Perkins, Harvard University

Malaysia since independence in 1957 has enjoyed six decades of sustained growth in per capita income. The per capita GDP growth rate over this period has averaged 3.8 per cent per year. This compares with a 1.8 per cent per year average for Latin America over the same time period and only 0.7 per cent for Sub-Saharan Africa. The average standard of living in Malaysia increased nearly 8 fold. Only a handful of economies, mostly in Northeast Asia, have done better. Furthermore, Malaysia achieved this growth while carrying out a major social program designed to both eliminate poverty and the identification of different occupations with race or ethnicity.

The attainment of these economic and social goals owes something to the pre-independence British colonial government. The country began independence with two strong natural resource industries (rubber and tin) and a transport and urban infrastructure that was well above the average of most of Asia and Latin America. But the profits from these endeavors went mostly back to England. It was the post-independence governments that brought these profits home to Malaysia and used the country's resources together with foreign direct investment to build a modern industrial economy with some of the best infrastructure in the world (Sultan Nazrin Shah, 2017). It was the post-1969 governments that also instituted policies that have gone a long way towards eliminating extreme poverty and eliminating the identification of particular occupations with race. These social programs have helped create a stable political environment without which sustained economic growth would not have been possible.

Past success, however, does not guarantee continued economic success in the future. GDP per capita growth has slowed slightly to 3.1 per cent a year over 2006 to 2016 but that in itself is not a problem (World Bank, 2016). No country that has reached high middle income status has continued to grow at the near double digit pace experienced in much of Northeast Asia. Malaysia is already at the upper end of what the World Bank considers to be high middle income status. The potential problems facing Malaysia lie elsewhere.

Many countries when they reach the high middle income level face new problems. This was true in much of Latin America where rich natural resources, largely in the hands of a few, were combined with a working age population mainly in factories rather than farms and a growing educated middle class. This generated political pressures that brought to power populist leaders and military dictators that gained support through policies that inhibited economic development. Argentina, one of the richest countries in the world in 1900, was ruled in the 1940s by Juan Peron and his policies have led the country from one crisis to the next ever since. Despite gaining independence in the 1820s, much of Latin America has been stuck at the middle income level for decades. These Latin American countries did not all follow the path of Argentina but most found other ways to reduce the performance of their economies, Venezuela being a recent extreme example despite, or because of, its great oil wealth.

High income status requires a high skilled service sectors that can compete internationally
Source: Laura Low

Every country to some degree has a unique history and Malaysia's potential problems going forward are not identical to those of Latin America. To rise from middle income to high income status, a country's industry must transition from labour intensive and low technology sectors eventually to industries that are based on frontier technologies some of which are developed within the country, not just imported from abroad. Furthermore, the labour force increasingly moves out of manufacturing which is mechanized and into the service sector - the parts of the service sector that require high skills ranging from research and development to finance and management. Success and high income status are achieved when the high technology industries and the high skill service sectors can compete internationally. If Malaysia is to achieve high income status over the next two decades, therefore, it will have to reach a level where its industrial and service sectors are on the frontiers.

Malaysia is not at that level today. The country did succeed in moving from one dependent for foreign exchange on natural resource based exports to exports dominated by manufactures, but that trend has to some degree stalled. Export growth in constant prices has slowed and more worrisome, the share of manufactured exports in total exports has fallen sharply, only partly due to the rise in resource prices in the first part of the twenty-first century. Perhaps Malaysia's situation is due to the general slowdown in world trade following the financial crisis of 2007-2009, but perhaps not.

A related problem is that Malaysia's manufactured exports are mostly produced by foreign owned corporations, not by domestic industrialists. There are economies that have reached high income status relying to a large degree on foreign direct investment (FDI), notably Singapore and Hong Kong, but these were comparatively small trading centers where FDI over the decade to 2016 averaged from 20 to over 30 per cent of GDP. Malaysia's FDI over that period only averaged 3.5 per cent of GDP (Perkins et. al., n. d.).

Finally, there is a question of whether Malaysia has sufficient highly trained personnel to lead the country to the frontiers of technology. If it does not, both domestic and foreign investors will look elsewhere. The state of Malaysia's education system is worrisome in this regard. At the lower education levels there is some question of whether the quality of education is actually declining, or at least not improving, and the country's achievements on international tests lag behind its GDP level (Figure 1). At the university level, Malaysia's universities compare favorably to most of the others in Southeast Asia, but are far behind those of Northeast Asia that have made possible the rise to high income status there. Many of the top Malaysian students go abroad for their education and many of them never return to work in the country. Even among those who do return, the best particularly among Chinese-Malaysians can easily move to Singapore without being far from their families. That exodus, for the most part, is a direct result of some of the social policies pursued since 1969.

Figure 1 Malaysia's score in mathematics low in comparison with its GDP per capita

The social policies introduced after May 13, 1969 have clearly done a service to the country by helping large numbers to move out of poverty and to make it possible for all ethnic groups to participate productively in all areas of the economy. There is no reason to reduce those policies that help the poorest parts of the population to rise out of poverty although it is always possible to find ways to improve them. For the social policies that primarily benefited and continue to benefit those who are in no sense poor, however, they have done their job of eliminating the relationship between ethnicity and occupation. Today they are often barriers to upgrading the quality of the universities and to facilitating the advance of domestic industries and services to internationally competitive status. If the politics of the moment leads to a doubling down on these high income social policies, there is a real danger that Malaysia will end up in the middle income trap.

Sources of data:
PISA data from OECD, GDP data from Worldbank databank.
GDP data for Taipei come from IMF (International Monetary Fund).
GDP data for Shanghai come from National Bureau of Statistics of China.

The fraction of Indians in Malaya’s population rose very sharply in the decades between 1901–1921, from just 6 per cent to 15 per cent, as rubber planting expanded and inflows were at their peak. But the Indian share of the population fell after 1931 and was just 11 per cent by 1947, as many Indian plantation workers were repatriated as a result of the rise in unemployment over the Great Depression years (Figure 1).

Beyond the plantations, Indians were recruited, inter alia, for public works, as police and guards, and also to serve in the lower ranks of the colonial bureaucracy. Most came from Tamil areas in south India. They were considered to be more accustomed to British rule, more amenable to discipline than the Chinese, and more willing to work for low wages. Access to low cost Indian labour migration helped ensure the rubber industry’s spectacular growth and profitability. Since there was work for wives and older children on the rubber estates, Indian migration included whole families. But low wages, indebtedness, poor social status, and physical isolation kept estate Indians apart and they tended to exercise little influence on Malayan society.