AS at 2015, Malaysia has spent 46 years in the middle-income country category, including 19 years in its upper tier. By comparison, South Korea, which joined the middle-income group of countries the same year as Malaysia, reached the upper middle-income level within 19 years in 1988. From there, South Korea took only another seven years to attain high-income status in 1995.

The slow pace at which Malaysia has been advancing towards high income threshold was among some disturbing made observations by the Organisation for Economic Co-operation and Development (OECD) as it reviewed the country’s innovation policy. The latter also noted “signs of weakening economic dynamism” that needs to be quickly tackled if Malaysia hopes to escape what some people call the “middle-income trap”.

In general, countries in the middle-income trap that do not grow fast enough to reach the high-income category find themselves “squeezed between the low-wage, poor-country competitors that dominate in mature industries and the rich-country innovators that dominate in industries undergoing rapid technological change”.

While the OECD reckons that “high-income status by 2020 is well within [Malaysia’s] reach” using “best scenario” projections, there are significant challenges. And there is no time to lose because the catching-up of latecomers “appears more complicated than it was for the first wave of emerging economies”.

One reason hampering the transition to high-income status is the failure to move away from “technology absorption” to achieving “creativity”, where a country successfully internalise skills and knowledge and has the capacity to create new innovative products. Simply put, most Malaysian firms are considered “adapters” of existing technology rather than “creators”.

Even in Malaysia’s important electronics industry, researchers have found “little evidence of technology deepening and rising value added” despite there being “some success stories”. “Participation in the most technology-intensive activities is still very low,” the OECD said in a recently released 245-page report.

Not only has Malaysia experienced significant growth deceleration post-Asian financial crisis, the country has yet to reach the level of labour productivity achieved by the US in the 1970s and is currently lagging 20 years behind Japan and 25 years behind Singapore.

Already, Malaysia’s exports are now increasing at a slower rate (4.5% annually over the 2000s and 5.1% over 2013-2014) compared to an annual average of 10% over 1970 to 2000, “which indicates that the [existing] model might be reaching its limit”, the report states.

To be sure, Malaysia’s export basket has changed radically over the past four decades, moving from commodities like tin and rubber (95% of total exports) in the pre-independence years to export-oriented manufacturing of electrical and electronic (E&E) goods since the 1980s. In fact, six out of 10 top export items are E&E products.

Yet, despite Malaysia having “high-technology” exports, its so-called high-technology content may well be confined to the assembly of imported components with low domestic value-added activity that does not require the desired intensive high-level research and development (R&D) expertise a country needs to move up the value chain.

In fact, OECD’s research found that Malaysia “also imports a disproportionate share of intermediary high-technology components” where several of the top E&E exports are also among its top imports. Malaysia’s high (40.6% of total gross exports) import content of exports is about twice as high as the average in both developing and developed countries.

“This means that Malaysia has not reaped the full benefits of the global value chain integration. Domestic content in exports of both final and intermediate products has actually decreased from 69.5% in 1995 to 59.4% in 2011. In contrast, it expanded in the Philippines, moving from 70% to 76.4% while it remained more or less at the same level in Indonesia (88%) and China (67.8%) in 2011,” the OECD report states.

Greater innovation is necessary for Malaysia to move up the value chain and innovation activity requires a medium- or long-term horizon and a sufficiently stable operating environment, particularly if one wants to attract R&D investments.

Other factors that can influence a country’s innovation performance include product and labour market regulation, the local tax system, the level and quality of entrepreneurship, and access and quality of financing and infrastructure. Vigorous competitive pressure is a powerful incentive for business innovation as the lack of competition allows inefficient firms and technologies to remain in the market, the OECD adds.

According to the report, Malaysia’s R&D efforts largely “remained at a low level until well into the 1990s”. While R&D expenditure of higher learning institutions, government research institutes and business enterprises of RM10.6 billion (US$3.4 billion) in 2012 was 20 times above that spent in 1996, the level of R&D intensity still falls short of the national goals as well as that of developed countries.

Even at the local institutions of higher learning, there is concern about the quality and usefulness of Malaysian research publications although quantity had increased seven-fold between 2001 and 2011. Commercialisation rates remain “limited”, owing to the lack of talent and studies that businesses and industries want to fund.

“Skills shortage and mismatch have received much attention due to their negative impact on the industry’s ability to upgrade its innovation capability… this is the root problem of attracting foreign direct investment (FDI) in higher-end activities and improving the absorption capacity of domestic firms,” the report reads.

This is despite the fact that Malaysia invests more in tertiary education than its peers in the region. Malaysia’s government expenditure for tertiary education was 2% of gross domestic product in 2009 and 1.5% of GDP in 2013, whereas South Korea invests around 0.6% and Singapore 1%.

“However, in terms of overall quality of university education as measured by international rankings, Malaysia’s position has improved within the region, but is still far from joining the top 100 universities of Asia or the world according to the QS World University rankings. This is in great contrast to universities of a similar age in Hong Kong (China), India, Singapore and even Saudi Arabia, which have made the top 100 in the Asian rankings over the last few years,” the OECD says, noting that Universiti Malaya was ranked 151st in 2014/2015.

“The constant migration of graduates and post-graduates (brain drain) has accentuated the lack of qualified professionals for local industry,” it adds, calling for closer collaboration between universities and businesses.

To its credit, Malaysia’s business regulatory framework had improved “substantially” over the last decade when the country moved up from 20th position in 2009 to 18th of the 189 economies ranked by The World Bank Ease of Doing Business — well above China’s 84th place and Indonesia’s 109th place. Areas where improvements are needed include “several government-related competencies, such as efficiency in bureaucracy and eradication of corruption”.

Still, according to OECD calculations, Malaysia is one of the few Asian countries to have a share of “modern services” comparable to that of advanced economies. Malaysia already has taken leading positions in Islamic banking and finance as well as halal food.

Malaysia also continues to attract FDI, although there are fewer new arrivals compared to earlier decades as suggested by a large share of FDI inflows being reinvested earnings of existing foreign affiliates rather than fresh capital. FDI had also reduced from 8% of GDP in the early 1990s to 3.1% of GDP in 2014.

Pertinently, “very few” multinationals or domestic firms succeeded in establishing their own local brand or performed significant R&D activity in Malaysia. Case studies suggest that the transfer of technological capabilities through FDI has been limited because tasks outsourced to local firms are confined to process improvement or testing mainly aimed at cost reduction or delivery timeliness rather than product quality improvement.

“A review of the most significant recent investment projects in the E&E industry approved by the Malaysian Investment Development Authority indicates that a majority of projects still relate to the assembly and testing of components. In the meantime, previous sources of Malaysian competitiveness of the E&E industry have eroded, while the position of competing countries with lower labour costs [such as Vietnam] in E&E has strengthened,” the OECD says, citing the World Bank.

Although new industry segments such as solar and LED sectors have emerged as a result of government efforts, “these two industries remain, to a great extent, focused on low value-added segments such as production of solar panels, while R&D is retained in the headquarters countries”.

Even in the local passenger car sector, researchers note that local producers Proton and Perodua “rely substantially on intellectual property owned by Japanese companies, in particular Mitsubishi Motors”. “They show that local firms are struggling to improve their technology sophistication and mainly perform incremental process innovation, if any,” the OECD says.

Nonetheless, the palm oil industry is reaping benefits from R&D that started to become significant as early as the 1960s. “In clear contrast with the situation prevailing in the E&E industry, Malaysia’s global leadership in palm oil rests on its position at the technological frontier in this area and its control over the entire value chain, from raw materials to final products,” the OECD’s survey found, adding that the biomass industry also draws upon Malaysia’s leading position in palm oil.

Malaysia needs deeper reforms, though, and the country’s success hinges on whether policymakers can successfully execute what needs to be done to speed up innovation.

“While the strength of Malaysia to identify the main challenges and derive the diagnostics for ambitious strategic plans is widely acknowledged, its capacity to implement and deliver them appears limited.

“The reasons for this weakness in implementation can be found at various levels — from inadequate governance, lack of policy sustainability and predictability and ill-conceived measures to insufficient capabilities of middle-management administrators in some ministries and agencies, as well as their ‘distance’ from the beneficiaries and operators of their policy,” the OECD says, advocating for the setting-up of a systematic evaluation process to measure policy effectiveness to improve government deliverability.

Will the setting up of the National Science Council kick-start greater reforms to deliver Malaysia’s science, technology and innovation agenda? 

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