MySay: In search of higher income

This article first appeared in Forum, The Edge Malaysia Weekly, on December 30, 2019 - January 05, 2020.
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When the Federal Land Development Authority (FELDA) was formed in 1956, there were only a few oil palm plantations in Malaya. Planted areas were either rubber smallholdings or rubber estates, so the land development model developed by FELDA was one based on rubber.

Each settler, a couple, was allotted a 0.25-acre house plot and typically, 10 acres planted with rubber. Since there are about 180 trees per acre and rubber trees are tapped every other day, a daily labour supply of 16 hours was used to tap 900 trees; just over a minute a tree, which is very hard work but seems about right, matching labour supply with the demand of working on that 10-acre rubber smallholding.

When oil palm gained in popularity, initially as part of a crop diversification strategy and then because rubber prices weakened after the Korean War, right about the time FELDA started, more land was planted with the “golden crop” of Malaysia in the 1980s. Oil palm-planted area expanded phenomenally from a mere 55,000ha in 1960 to 5.74 million hectares in 2016. The production of palm oil grew significantly in tandem, from less than 100,000 tonnes in 1960 to about 17.32 million tonnes in 2016.

Although both crops have the same economic logic — land combined with low-end labour, producing healthy returns on the relatively small capital used — oil palm is very different from rubber, especially in terms of labour. There are only 50 oil palm trees per acre and at maturity, oil palm is harvested in cycles of 10 days or even longer.

For the FELDA couple on their 10-acre rubber smallholding, converting to oil palm results in excess supply of labour. The return on actual labour employed is likely higher than for rubber, which explains the reason for converting from rubber to oil palm. But from the settler’s perspective, his productivity drops unless he does something else with his excess labour. For the most part, FELDA settlers do not do that.

Not only is oil palm less labour-intensive than rubber but also the nature of labour input required for oil palm is physically more demanding than for rubber. Labour supply for rubber and oil palm is not necessarily substitutable, which suggests that a rubber smallholder would have to employ labour when converting to oil palm instead of working the land himself. This makes him a landlord earning rent but from an income perspective, the amount is less than before, when he earned both from labour and land.

This explains the relative deterioration of the FELDA settler’s income as he ages and especially when he replants and hires labour instead of working the land himself, which he likely would do after a 25 to 30-year cycle. This is true of all agricultural activities whose capital to labour-intensity ratio did not increase. More generally, this phenomenon tells a broader story about the Malaysian economy.

Going from rubber to oil palm did not change what economists call the “production function” of the economy much. It was just more input leading to more output as more land area was planted with oil palm. The switch changed the mix of factors used in the production function, however — one that does not improve the quality of labour input required and, therefore, its share of income generated.

The phenomenal growth of plantation area in the last four decades contributed to overall economic growth and developed some downstream industries but, by and large, it did not contribute to an increase in income levels. At any rate, some 80% of those who work in plantations are foreigners. What the economy got was profits — returns on capital employed; the largest share of income generated but not at favourable rates. In other words, while capital’s share of income is much higher than labour’s, the rate of return on capital is not high.

The high growth rates we had in the 1980s and 1990s were also due to the manufacturing sector, which grew during this period. But the manufacturing sector has a different logic from oil palm’s. It is mostly foreign capital and also much more capital-intensive. The oil and gas sector too grew from the 1980s, particularly the export-oriented gas industry. These industries are even more capital-intensive than the manufacturing sector. In many ways, capital goods come with embedded technology and knowledge, and therefore require labour that is correspondingly skilled, thereby, commanding higher income.

Capital intensity in the economy rose throughout the time. Labour associated with a more capital-intensive production process enjoyed much higher rewards than labour in less capital-intensive activities. Had it not been for the foreign direct investment-based manufacturing and oil and gas sectors, the income situation would have been worse. A Bank Negara Malaysia study looking at capital stock and intensity in the economy between 1980 and 2010 shows that stock of capital — a measure of capital assets — in agriculture (which includes oil palm) is absolutely and relatively low compared with that of manufacturing and oil and gas. The services sector has the largest capital stock.

In terms of capital intensity, similar results were obtained. While Malaysia’s incremental capital to output ratio — a measure of how much capital is required to generate output — improved throughout the 30 years from 1980 to 2010, driven by the oil and gas, manufacturing and services industries, agriculture, including oil palm, performed dismally. The plantation sector was just about more land and labour without much change in productivity.

While the quantity of labour keeps increasing — naturally and with the influx of legal and illegal migrant workers — the economy keeps doing the same thing. More than any other factor, the stagnation and even the relative decline in wages can be explained by this phenomenon. Returns on investments in education, especially tertiary, have fallen. Apart from the issue of supply quality, the more definitive explanation is demand failure — the demand for such people is not growing as fast as the supply.

The low median household income we see today is the result of the phenomenon described earlier. One can take any durable good as a numeraire — a car or even a house. The relative purchasing power in terms of the numeraire has declined, which suggests that the quality of life has suffered. That has to do with income levels rather than costs. Of course, the problem is exacerbated by inequality but that inequality is the result of the production function itself as discussed: how land, labour and capital are used.

Oil palm and, to a lesser extent, rubber are unsustainable in many ways and I agree with former finance minister Tun Daim Zainuddin’s recent view that “there is no future in palm oil”. To me, the hectarage of oil palm plantations is a good proxy for what is wrong with our economy. Evolving technologies notwithstanding, land and, therefore, location remains crucially important. If all we can do with land is to plant oil palm using foreign labour, we are quite doomed.

The economy will be stuck in this low-income equilibrium that will define purchasing power and shape the demand that firms operate under. We can already see the domestication of many firms and industries and how many of them are operating at the lower end of the demand curve with increasingly low margins — a low-cost, low-margin and, therefore, low-income outcome economic model.

Back to land use. Considering the massive market surrounding us as well as our own growing market, there is a great future for food but it requires a food industry that is capital, therefore technology, driven along its value chain, from agricultural production to processing and distribution, for it to be internationally competitive as well as generate the appropriate levels of labour income. The higher capital to labour intensity also suggests that these industries are a lot less labour-intensive than plantations even in upstream production.

Key to this agenda is promoting and facilitating foreign investments in the agri-food sector, particularly in ways that link it to external markets. In that way, the upstream parts of the industry will develop accordingly. It is this part of the value chain that will transform rural economies and raise income levels beyond subsistence agriculture (including padi) today and working on plantations.

Modern agri-food will be the cutting edge of overall change towards a higher-income economy and oil palm hectarage will be an indicator of how successful we are in this endeavour.

Dr Nungsari A Radhi is an economist and the views expressed here are not related to any of his organisational affiliations

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