This book charts the course of Malaya’s commodity-dependent economy during the first 40 years of the 20th century while under British colonial control, contrasting that course with the economic growth and development in contemporary Malaysia. It asks: What is the economic legacy of British colonialism in the Malay Peninsula, and how differently has the economy performed under national management? By deriving estimates of Malaya’s GDP and its components for 1900– 1939, and analysing trends and their interrelationships, it deepens understanding of the dynamics of economic performance during these four decades. 

The study of long-run economic growth in Malaysia in the 20th century had previously been held back by the absence of comprehensive statistical data on national income before World War II. Yet national income accounts are fundamental for measuring and understanding the anatomy and evolution of economies—and for planning and managing them. Today most countries keep detailed national accounts that are routinely compiled by government statistical agencies. Such accounts provide the evidence base for seriously challenging the prevailing views about the efficiency of markets and laissez-faire economic policy.  
The Malayan Economy and Its People 
During the late 19th century and in the first half of the 20th century much of the Malay Peninsula, like most of Southeast Asia, was under British control (Chapter 2). As the geopolitical spheres of influence of the colonial and ruling powers ebbed and flowed, territorial boundaries were frequently redrawn and renamed. 

Colonialism facilitated the control of lands, institutions, and peoples, as well as the exploitation of natural resources. British control over the territories of the Malay Peninsula was progressively established from the last quarter of the 19th century to the second decade of the 20th century. British Malaya comprised three loosely integrated territories: the Straits Settlements, the Federated Malay States, and the Unfederated Malay States. Singapore, which was a Straits Settlement, is not part of this study.

The present-day structure of the Malaysian economy is broad- based and reasonably diversified. The shares of agriculture and mining in GDP have declined to below 20 per cent combined, while that of services has grown to above 50 per cent. By contrast the economy of Malaya a century ago was largely agrarian, supported by two primary commodity pillars—tin and rubber—produced to meet the needs of the industries and people in European countries and North America following their industrial revolutions. These countries required continuous inflows of raw materials to produce manufactured goods, as well as supplies of food for their populations. Colonial territories such as India and Malaya served as sources for such supplies. While India was the jewel in the crown of the British Empire, among other British-governed territories Malaya was the natural resource cash cow.

An important feature of British-governed Malaya was its trade openness and free enterprise. Tin mining led the Peninsula’s economic development, but it was later eclipsed by rubber. By 1904 Malaya was producing more than half the world’s tin to meet the growing demand from Europe, especially following the surge in the use of tin cans for food preservation. It was around the early 1900s that the British, seeking to create a laissez-faire economy, began promoting the commercial production of rubber. Generous assistance to plantation companies included long-term security of land tenure and freedom to recruit low-cost foreign labour. Incentives were provided to encourage an industry that was dependent on substantial capital investment and where the period for returns on investment was long—it took between 5–7 years after land clearing and seeding before trees could be tapped. The massive trade boom in rubber during the first decade of the 20th century came as prices rose with the remarkable upsurge of the US motor industry and the related demand for rubber tyres.
Malaya’s early 20th century economic development was closely related to population dynamics. The tin mining and rubber industries (before the introduction of new technologies) were highly labour intensive and their development could not be sustained with local labour supply. Large inflows of foreign workers were recruited from China and India with the result that the population shares of these two communities increased substantially. Most Chinese were drawn to the new towns developing around the tin mines and to the port cities, while the Indians mainly lived and worked in the rubber estates. Migration markedly changed the Peninsula’s ethnic composition making it delicately balanced. 
Estimating Historical GDP 
In constructing historical GDP estimates for Malaya over 1900–1939 the expenditure components—consumption, government spending, investment, exports, and imports—were derived (Chapter 3). The expenditure method was employed without the benefit of controls from the production (value-added) or income estimation approaches. The detailed enterprise censuses or surveys on which these need to draw did not occur until after independence. And the first set of comprehensive national accounts—featuring production, income, and expenditure estimates—were collated for Malaysia only in the input- output accounts of 1978. 

Each of the GDP components was assessed based on the concepts and definitions used, the availability of data, the estimating method employed, and the choice of the most suitable deflators to obtain constant price series. The base year was taken as 1914, as it was relatively stable—rubber prices had fallen from a peak in 1910 and stabilised in 1914 and tin prices were relatively stable for that year. In putting expenditure estimates together for this period, the most important challenge was in estimating household consumption spending, as it accounted for a large portion of GDP. The approach adopted used direct and indirect estimation.
Growth and Volatility of Malaya’s Economy 
The historical national accounts series provided the quantitative evidence for assessing important questions about the growth and cyclical trends in the Malayan economy and the underlying drivers (Chapter 4). Real per capita GDP (valued in 1914 prices), frequently used as an indicator of economic welfare, was Straits$86 at the beginning of the 20th century: it more than doubled to Straits$197 in 1919, and by 1939 it reached Straits$269, or more than thrice the level in 1900. Unsurprisingly, given the critical importance of the tin and rubber industries, exports were a dominant component of GDP, accounting on average for about 60 per cent of Malaya’s GDP in nominal terms over the 40 years. The gap between Malaya’s gross domestic savings and its investment, the so-called investment gap, increased during World War 1 and remained sizeable until 1939. The counterpart to this large investment gap was an equally large trade surplus, the difference between export earnings and imports. The bulk of Malaya’s commodity export earnings were repatriated to colonial plantation and mine owners with comparatively little being recycled through investment in Malaya’s economy. 

A striking aspect of annual GDP growth is that while income trended upwards, growth fluctuated wildly. Aggregate GDP growth can be partitioned into the contributions of its component parts: household spending, government spending, investment, and export and import demand. The most conspicuous feature is the dominance of export and import demand in influencing Malaya’s aggregate growth. Changes in export and import volumes account for the bulk of growth, and so drive much of its volatility. Growth of domestic expenditure components (household consumption, government spending, and investment) appear to have played only a subsidiary role. This analysis suggests that the Malayan economy rode a commodity roller-coaster between 1900 and 1939.

Three large outside shocks were the main underlying causes of the economic downturns and booms: World War I 1914–1918, the Roaring Twenties 1920–1929, and the onset of the Great Depression 1929–1932. The most prominent feature of 1914–1918 is that Malaya’s GDP growth was maintained because of buoyant exports. Real GDP grew over this period at an average rate of 9.4 per cent per annum. The Roaring Twenties was a decade of high economic growth and prosperity driven by recovery from World War I and a catching-up with postponed spending. It heralded a revival of Malaya’s rubber and tin industries after European shipping restrictions were lifted. In the Great Depression, most countries, and in particular the United States, experienced very sharp economic declines. Malaya, by then heavily reliant on the US market for its exports, was not spared from the economic crisis, and its real GDP contracted very sharply in 1931–1932 due to an unprecedented collapse in exports.
Volatility and Sources of Growth in Historical and Contemporary GDP 
Economic volatility, identified with short-term fluctuations in real GDP around its longer-term trend, and its impact on economic growth are assessed using data for Malaya in 1900–1939 and contrasted with post- independence Malaysia over 1970–2009 (Chapter 5). Benchmarked against wider experience, volatility in pre-war Malaya was intense. Year-to-year swings in real GDP growth of 10 percentage points or more were common. The volatility in pre-war colonial Malaya, both in the frequency and the magnitude of shocks, is probably without modern precedent. 

The harmful effects of volatility, operating through reduced investment in built and human capital, have been found to outweigh any benefits from resource booms. The evidence for Malaya supports this contention and shows that extreme volatility had a depressing impact on long-run growth. Real annual exponential GDP growth for 1900–1919 was 7 per cent when volatility was lower, compared with 4 per cent for 1920–1939 when volatility was significantly higher. Stronger economic growth was accompanied by greater stability in post-colonial Malaysia.

In pre-war Malaya, real investment was even more volatile than real GDP: extreme volatility in real exports, particularly rubber, and the consequent volatility in real income, was associated with even more pronounced volatility in investment. Low and highly volatile investment rates held back economic diversification, which weakened the defenses against volatility and entrenched commodity-dependence. While investment rates in post-independence Malaysia also fluctuated, they were much higher than those in the colonial era, averaging well above 20 per cent of GDP and peaking at over 40 per cent on the cusp of the Asian Financial Crisis in 1997.

As an indicator of well-being, real per capita consumption, though imperfect, is of interest insofar as it records the material standard of living of the general population. Well-being is also usually considered to be linked to the volatility of consumption, with greater volatility eroding welfare. Consumption volatility was more pronounced in the first four decades of the 20th century than in 1970–2009. The likely reason stems from the dependence of employment and household income on exports of rubber and tin, which demonstrated extreme volatility. After independence, successful efforts to diversify the economy created more—and more varied— employment opportunities.

For the four decades 1900–1939, growth accounting suggests that of the annual average 5.5 per cent real GDP growth rate, growth of capital stock accounted for 1.7 percentage points and growth of employment another 1.8 percentage points, with total factor productivity (TFP) growth accounting for 2.0 percentage points. The corresponding estimates for the first half of these four decades show that growth of capital stock and TFP were markedly higher than in the second half. One caveat in interpreting these data is the likely presence of unknown and possibly large measurement errors that are conflated with the TFP estimates.

Considerable debate about the sources of growth has directed researchers to learn more about growth processes. It has also made countries more conscious of the importance of the role of productivity in economic growth. Malaysia since the mid-1990s has focused on enhancing innovation and productivity to transform from an input- driven to a knowledge-based economy.
From Colonial Control to National Economic Management  
The colonial authorities adopted a laissez-faire economic system (Chapter 6). They gave the British-dominated private sector—plantation and mining companies, agency houses, banks, and middlemen—carte blanche to maximise profits, and provided a supportive legislative and institutional environment. Agency houses were thus able to repatriate substantial profits. 

Laissez-faire practices led to highly uneven development, with economic growth and prosperity concentrated in and mainly benefiting the Peninsula’s west coast states. These were the centres of the tin and rubber industries, with better physical and social infrastructure, which served the commercial interests of the export-oriented private sector. A laissez-faire approach also led to high levels of inequality in ownership and control of the economy.

Real per capita incomes in Malaya were three times larger in 1939 than in 1900, equivalent to an exponential annual growth rate of 2.9 per cent. In post-independence Malaysia between 1970–2009 real per capita GDP grew at a cumulative average annual rate of 3.7 per cent, much the same level as in the earlier period.

Conversely, consumption per capita in real terms was just 51 per cent higher in 1939 than in 1900. While this improvement was positive it raises the question of why advances in the general standard of living, equivalent to growth of just 1 per cent per year, lagged so far behind GDP per capita growth, which was 2.9 per cent per year.

From 1970–2009 per capita consumption advanced at an average annual rate of 3.5 per cent, only marginally below average income growth of 3.7 per cent. Real GDP growth in the post-independence period led to rapid advances in the average standard of living and reductions in absolute poverty. The consumption dividend from growth over 1900–1939 was modest in comparison. Differences in the structure of the economy (primary export dependence) and in the structure of ownership (colonial control) are the likely explanation.

Investment rates in real terms averaging less than 10 per cent a year were also very small as was government expenditure, suggesting that little of the production surpluses were reinvested in the domestic economy. Pre-World War II inequality in consumption in Malaya is striking, with expenditures of the top 1 per cent of the population more than 21 times higher than the average for all population groups.

Unbalanced development, poverty, and inequities in corporate shareholdings were addressed after independence. In the first 10 years following independence much was achieved in terms of growth, infrastructure, rural development, and higher living standards. But less was achieved in poverty reduction, employment creation, and addressing economic imbalances among people, states, and regions.

The New Economic Policy was launched by the government in 1971, following the May 1969 racial clashes, to rectify inequalities of the colonial era. Foreign natural-resource-based companies were restructured through equity buyouts by public-sector enterprises and placed initially under government control and management. Resource revenues were used to redistribute income and reduce poverty through multiple pathways. National control over economic management was accompanied by a long-term vision for a more unified and socially just nation. That led to an impressive track record in employment creation, welfare gains, and poverty reduction.

c/o Asia-Europe Institute
University of Malaya,
50603 Kuala Lumpur

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