My Say: Boosting the local economy through myth busting

This article first appeared in The Edge Malaysia Weekly, on March 4, 2019 - March 10, 2019.
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The report “Structure of the Malaysian Economy: An Input-Output Analysis”, published by Khazanah Research Institute (and scheduled for launch on March 5), reviews the role and contribution of the country’s economic sectors, paying specific attention to inter-industry and inter-sectoral linkages, especially in relation to international trade.

Thus, the report distinguishes value-addition in and outside export-processing free trade zones (FTZs), and the role and respective contribution of small, medium and large enterprises. It uses the last available (2010) set of input-output (IO) tables, published every five years by the Department of Statistics Malaysia (DOSM), with the latest set for 2015 just out.

The report provides comprehensive data, not only on the contribution of each sector and industrial category, using the Malaysia Standard Industrial Classification (MSIC), but also on inter-linkages. It departs from conventional methodologies to identify sectors with the potential to contribute more domestic value-added, offering important insights into formulating better policies.

While largely in line with conventional wisdom, the report, prepared by a team led by Professor Yusof Saari, also shatters some popular myths. It acknowledges some limitations of policy analysis of the conventional approach for calculating gross domestic product (GDP).

It is commonly presumed that domestic demand contributes extensively to Malaysian GDP. However, conventional approaches to measure this contribution may be biased due to the misallocation of import components by overestimating domestic demand and underestimating trade’s contribution to GDP. Thus, the contribution of exports could be much greater if measured appropriately.

The review of the role of international trade in the Malaysian economy finds that for 2011 to 2014, the contribution of net exports to GDP was generally about thrice as much using the import-adjusted approach compared with the conventional one.

Conventionally, the contribution of net exports is obtained by deducting imports from exports, an approach that does not differentiate imported final goods from imported intermediate goods used to meet domestic and external demand.

The import-adjusted approach thus distinguishes intermediate from final imports for each final demand component instead of simply aggregating both as imports.

The second chapter discusses sectoral inter-linkages in the Malaysian economy. By considering both backward and forward linkages as well as size-adjusted, value-added multipliers, the report highlights the role of key sectors in the overall economy, domestic demand and exports.

The report shows that while manufacturing draws on inputs from all sectors, the service sector largely depends on other services. Thus, it highlights the different growth-inducing effects of various sectors by highlighting their different contributions to GDP.

A sector supporting domestic demand growth may have less effect on export growth while the choice of an appropriate multiplier to estimate an economic policy impact depends, inter alia, on the policymakers’ intent.

For instance, a size-adjusted, value-added multiplier should be used to forecast growth whereas a conventional value-added multiplier is better for likely investment returns.

Inter-industry linkages at the sectoral level are investigated in detail in the next two chapters. Chapter 3 distinguishes between “processing” in FTZs and “non-processing” activities, defined as those outside FTZs.

It shows that domestic value-added by manufacturing firms outside FTZs is not only relatively higher than by those within but it is also associated with greater backward linkages.

As FTZs are deemed to be outside the national customs area, there is considerable incentive to minimise global tax liability by overstating actual value-added in the national economy by understating the actual value of imports and exaggerating export value.

The sum of wages and salaries plus locally sourced supplies thus provide a better approximation of value-added in the economy than what is derived by subtracting trade merchandise declarations of imports from exports.

In Chapter 4, inter-linkages among sectors are distinguished by size among the small and medium enterprises (SMEs). It shows that the value of inputs that they provide to large domestic firms is slightly lower.

Conversely, SMEs are more dependent on large firms for acquiring intermediate inputs for their own output. However, large firms are less dependent on SMEs since most of their inputs are obtained from other large firms and imports.

Weak industrial linkages among small, medium and large firms may explain why final demand growth does not substantially affect the domestic economy. Greater and more sustained business cooperation between and among large firms and SMEs will help boost the latter’s growth and the national economy.

While the electrical and electronics (E&E) sector still contributes significantly to manufacturing output, employment, investment and exports, the report argues that a dedicated database and analysis are needed to ascertain what share of E&E products is actually made in Malaysia, and the extent to which the sector actually creates opportunities for local companies.

The question as to whether this will allow local SMEs to develop their capabilities is no longer only of academic interest, especially following the collapse and closure of some such companies, once celebrated as offering the prospect of sustainable foreign-led industrialisation.

As the E&E sector accounts for a large share of value-added in FTZs, this finding is in line with others that FTZ processing value-added is less than that by non-processing activities outside the zones.

Yet, while enterprise size appears related to export-orientation, there may be other differences among firms apart from size, which may be more significant for explaining their growth performances and potentials.

Similarly, other factors may be more relevant to determining which enterprises are likely to offer greater prospects for growing more rapidly or for becoming internationally competitive after temporary protection.

Clearly, such work will be crucial for informed policymaking to resume and sustain development following the de-industrialisation of the last two decades and the failure to achieve sustainable development despite considerable pronouncements and rhetoric to the contrary.

Jomo Kwame Sundaram, a former economics professor, was United Nations Assistant Secretary-General for Economic Development. He is the recipient of the Wassily Leontief Prize for Advancing the Frontiers of Economic Thought, and a member of the Economic Action Council.

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