This article first appeared in The Edge Financial Daily on August 27, 2018

KUALA LUMPUR: The structural transformation of Malaysia has put the nation on the road to premature deindustrialisation, said an Asian Development Bank (ADB) economist, stressing the need for a revival of private investment in manufacturing.

Deindustrialisation happens when there is a reduction in industrial activity or capacity, which Dr Jayant Menon said usually takes place in developed nations that are moving into the mature and high-end service sector from the manufacturing sector.

“Normally, deindustrialisation happens because of technological shocks, disruptions, or some kind of globalisation or trade policy factors,” he told The Edge Financial Daily. According to Menon, it is too early for Malaysia to make the big shift from manufacturing to services because its manufacturing sector has not matured to a point where it has achieved an advanced level of technological sophistication.

In Malaysia, he said, premature deindustrialisation (a trend publicised by Dani Rodrik, a Turkish economist at Harvard University) can be seen from the limited investment in high-technology sectors, while the investment climate appears unattractive to foreign and local investors.

“[Malaysia has] started moving back towards processing agriculture and petroleum [resources] because the environment is not conducive to that kind of investment (in high-technology sectors),” said Menon, the lead economist of ADB’s Economic Research and Regional Cooperation Department. The main concern is that this generates relatively low-productive, low-skilled jobs, said Menon, adding that petroleum refining and palm oil processing are capital-intensive.

Despite their importance in overall output, Menon said the agro- and petrol-processing industries only account for a small share of employment. The number of workers employed in manufacturing refined petroleum products is less than 10% of the workforce, compared with electronics manufacturing. Also, added Menon, greater reliance on commodity processing increases vulnerability to commodity price volatility, as witnessed in 2015.

Another concern raised by the economist is that Malaysia is suffering a skills mismatch, which has its roots in a deteriorating education system that is underfunded and wrought with distortion.

“[Malaysia] does not have local engineers and technicians with the right kind of quality skills. The ecosystem of distortion is created by affirmative action programmes,” he said, blaming the mismatch on a broken education system, which resulted in a lack of quality graduates.

“Malaysia may be a net importer of labour, but is a net exporter of skills,” he added, saying there is a growing number of professionals migrating to Singapore or industrialised countries in North America and Europe.

“A starting point would be to remove the discrimination in labour markets by reforming the bumiputera policy,” he opined.

“It is not surprising that Malaysia’s fortunes have reversed in recent years, both in manufacturing and across the economy in general,” he said. Today, youth unemployment in Malaysia is three times the national average at 10%, while 25% of university graduates are still unemployed six months after graduating.

He said the high rate of youth unemployment, which Malaysia is experiencing, is typically only seen in first-world economies. While the entry of foreign labour is blamed by many as the reason for the limited upgrade seen in the manufacturing sector, Menon disagreed, saying it is due to the skills mismatch, with policy distortion due to the government’s affirmative action programmes.

“The skills required to upgrade were not fully available. If the conditions were right for upgrading, [and] both the skills and the policy framework for upgrading were present, I think they would have been able to do so,” he said.

Hence, Menon said, Malaysia needs labour-absorbing growth, not just in the manufacturing sector but the service sector as well.

To change its path of premature deindustrialisation, Menon suggested that Malaysia change its policy framework to one that is based on meritocracy and put in more efforts to upgrade its electronics manufacturing industry.

He said Malaysia should be moving up the value chain within the manufacturing sector, which is referred to as “industrial upgrading”. Noting that Malaysia has failed to move up the value chain, due mainly to a lack of appropriate domestic skills, Menon said: “The shift towards services is not a panacea as the service sector is a very diverse one.”

“Increasing the share of services now will not produce the expected high-paying jobs that we observe in most industrialised countries,” he added, explaining that the manufacturing sector first needs to upgrade in order to set the proper base for the move into high-level services.

Menon said the obvious candidate for industrial upgrading is the electronics sector. There are a few examples of successful upgrading in this sector, but this needs to be broadened beyond just a few firms.

Additionally, said Menon, to ensure good-quality economic growth in the long run, there must be improvement in productivity. “To improve productivity, it comes back to the local human capital issue, which [means] we have to fix the broken education system,” he said.