Malaysia's structural economic change: past, present, and future - Articles

MALAYSIA'S STRUCTURAL ECONOMIC CHANGE: PAST, PRESENT, AND FUTURE

Professor Jeffrey D. Sachs, Columbia University

Thanks to the pioneering scholarly investigations of Sultan Nazrin Shah, magnificently compiled in his new book Charting the Economy: Early 20th Century Malaya and Contemporary Malaysian Contrasts, we now have a panoramic view of Malaysia's economic history since 1900. It is a dramatic story, with the rise and fall of key economic sectors and with major changes in politics, demography, and strategy. I believe that Malaysia, and the world, are on the cusp of another major transformation, this one to Sustainable Development.

Malaysia's transformation since 1900 is comprised of four key periods, roughly 1900-1945, 1946-1969, 1970-2000, and 2000-present. While these dates are somewhat arbitrary, they help to delineate Malaysia's economic transformation and highlight the deep role of politics as well world markets. Malaysia has always been an outward-looking economy, with changing patterns of exports generally guiding the structural changes within Malaysia's economy and society.

The first period, roughly from the start of the 20th century to the end of World War II, was the era of Colonial-led, resource-based growth. Malaysia was a model colony (or actually group of colonies) of the British empire. It developed rapidly under imperial institutions. As Sultan Nazrin Shah notes, Malaysia benefited from three geographical factors: its tropical climate, its ample (even remarkable) natural resources, and its proximity to the major trade route between Europe and East Asia. Under these circumstances, Malaysia offered enormous profits to British private investors who invested in Malaysia's tin and rubber, the two dominant exports. The British imperial institutions enforced an imperial laissez faire for British private interests, while exercising sovereign decisions over foreign policy, commercial law, and the in-migration of workers, especially from China (mainly related to tin) and India (mainly related to rubber).

Wage growth remains very low as British maximized investment returns

Source: The National Archives of Malaysia

2001/0053029

This was, of course, a policy made by and for the imperial power. The Gross Domestic Product grew rapidly, roughly 3.7 per cent per year between 1900 and 1939, but national income and consumption of native Malays grew much more slowly, with domestic consumption rising around 1 per cent per year during this period. The difference in growth between output and consumption, of course, reflects the huge profits earned by British private interests as they secured the economic rights to develop and export Malaysia's tin and rubber with only small revenue collections for public services for the local population. As late as 1970, around 60 per cent of the capital in limited liability companies was foreign owned.

Moreover, rather than allowing the expansion of tin and rubber (and related industries) to bid up Malay wages, the British imperial power, with the support of Malay sultans, facilitated the in-migration of low-wage workers from China and India, ensuring that wage growth would remain very low and the returns to British investments would be maximized. The ethnic Malay population declined from around 62.8 per cent of the population in 1901 to less than half (49.5 per cent) in 1947.

With the end of World War II in 1945, the end of imperial rule was in sight, though of course nearly two decades would be needed to give birth to today's Malaysia. The period 1946-1970 therefore constitutes an era of political change as well as social and economic change. In 1946, the Malayan Union was established, with limited sovereignty; then in 1957, the independence of the Federation of Malaya; and in 1964, the political formation of today's Malaysia. This was also a period of massive economic change, entailing the first period of real nation-building, with increased investments in infrastructure (roads, rail, power, and ports) and in human capital (health and education). This period set the foundations for a significant rise in living standards and a significant decline in poverty, including among the still-poor and mainly rural Malay population of the 1940s.

The year 1969 marked another turning point, with the racial unrest and the adoption of the New Economic Policy, aiming for broad social inclusion and especially a catching-up of the Malay population with the more urban and more prosperous Chinese population. One of the tenets of the NEP was economic diversification. By then (around 1970), tin and rubber were in any event shifting to hydrocarbons (oil and gas) and oil palm. After 1970, this shift would continue, but would be significantly augmented by the rise of labour-intensive export-oriented manufacturers, mainly the development of a labour-intensive electronics assembly export industry tightly interconnected with US multinational companies.

Education expanded rapidly but quality remain mixed
Source: The National Archives of Malaysia

The era between 1970 and 2000 was an economic success based on several standards, but one with a growing number of problems. The diversification into urban-based services, and middle-skilled labour-intensive industry, was successful in reducing poverty, extending education, and improving population health and longevity, but it continued Malaysia's heavy dependence on a few export sectors (oil and gas, oil palm, electronics) and failed to catapult Malaysia into endogenous growth, meaning self-sustaining innovation based on science and technology. While education expanded rapidly, the quality of education remained mixed. Malaysia's attempt from the 1980s onward to emulate the Republic of Korea's success in heavy and innovation-based industries, fell short.

These vulnerabilities revealed themselves after 2000, when the rise of China's export-oriented manufacturing sector created a huge competition for Malaysia, and in effect put a ceiling on the growth, employment, and income of Malaysia's "middle-tech" industries. Economic progress continued, but now at a much slower pace. Income inequalities tended to widen. And the high environmental costs of Malaysia's resource-based development became increasingly evident. Malaysia's burgeoning land area planted to palm oil, coupled with massive deforestation and tropical logging destined for Chinese markets, threatened the biodiversity of many parts of Malaysia, especially Sabah and Sarawak.

Air and water pollution increased, including the "imported" air pollution from the mass peat burning of Java and Sumatra. And in an era of global warming, Malaysia's heavy dependence on and use of fossil fuels raised red flags at home and internationally.

Malaysia therefore finds itself at the start of a fifth era of transformation, starting in 2015, this one very well characterized by the United Nations' Agenda 2030. The aim of the globally agreed Agenda 2030 is sustainable development, meaning the combination of economic development with social inclusion and environmental sustainability. The three pillars of sustainable development – economic, social, and environmental – are made more precise and quantitative in the 17 Sustainable Development Goals (SDGs) that are part of Agenda 2030. Of course, Malaysia is not alone in having to move from economic development (based largely on the growth of GDP per capita) to sustainable development according to the 17 SDGs. All UN member states adopted Agenda 2030 and the 17 SDGs in September 2015, because all countries are in need of ensuring that their economies not only produce high levels of GDP per person but do so in a way that is also socially inclusive and environmentally sustainable.

In the most recent ranking of global progress to the SDGs, the SDG Index and Dashboard for 2017 (which I help to produce for the UN Sustainable Development Solutions Network), Malaysia ranked 57 out of 157 countries (view video). This position reflects Malaysia's upper-middle-income status as well as its vulnerabilities regarding economic development, social inclusion and environmental sustainability.

Regarding economic development, Malaysia's most urgent task is to upgrade its education and innovation systems, the key to overcoming the "middle-income trap" and becoming a high-income country. While the access to education is relatively strong, international testing shows that the quality of education, notably in science and mathematics, still lags far behind the world leaders. And while the share of national income devoted to research and development has been rising (and currently stands at around 1.3 per cent of national income), there is clearly much more to do to enable Malaysia to be home to a bustling, vibrant, innovation-based economy as called for in SDG 9.

Regarding social inclusion, Malaysia still lags behind the SDG 5 goal of gender equality (especially in the role of women in politics) and the SDG 10 goal of reduced income inequality, with a relatively high Gini Coefficient of around 40.0 (29^th out of 143 countries with suitable data).

Moreover, many of the pro-Malay policies introduced in the New Economic Policy remain in place, leading to ethnic-based policies in the allocation of public funds, school positions, and hiring. Regional development policies are also affected.

On the dimensions of environmental sustainability, Malaysia faces an enormous and increasingly urgent challenge. Malaysia is a fossil-fuel-based economy in an era when fossil-fuels must give way to low-carbon energy sources such as wind, solar, geothermal, ocean, hydro, and nuclear power. The entire world must quickly reduce carbon-dioxide emissions, mainly from fossil-fuel use but also from deforestation, to near zero by 2050. Yet Malaysia's starting point today is a high rate of energy-linked CO₂ emissions of 8 tons per person per year. Malaysia's land-use practices are also unsustainable, with considerable ongoing deforestation, loss of biodiversity, and chemical pollution.

Fortunately, the Government of Malaysia and the university sector are increasingly putting the 17 SDGs at the heart of Malaysia's post-2015 development policy. This requires not only attention to the SDGs but an enhanced quality of government. The public perceptions are that politics are corrupt, a sentiment associated with lower levels of subjective wellbeing and lower quality of overall sustainable development. There is a feeling that politics, both ethnic and party-based, too often take precedence over transparency, merit, and quality of public services.

Malaysia therefore enters a new and promising phase of its historic trajectory. I recommend that the government mobilize more total revenues as a share of GDP so that it can channel more funds towards high-quality education, research and development, low-carbon energy systems, air and water pollution control, and transfer payments to those in need (the elderly, disabled, indigenous populations, and remaining pockets of poverty). Of course, Malaysia's success will depend not only on the mobilization of resources but on the quality of their use, and therefore on the honesty, skills, integrity, and creativity of public policies in partnership with the private sector. More funds without governance reforms will not suffice; both public investments and governance reforms in tandem will be crucial. Fortunately, as Sultan Nazrin Shah's wonderful book reminds us, Malaysia has more than a century of experience in economic development and transformation of which it can be very proud, and which it can utilize to help chart the way forward in this new age of sustainable development.