The State of the Nation: Malaysia needs tough structural reforms to live up to imminent high-income status

This article first appeared in The Edge Malaysia Weekly, on March 22, 2021 - March 28, 2021.
The State of the Nation: Malaysia needs tough structural reforms to live up to imminent high-income status
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IT took Malaysia more than 23 years to graduate from a lower-middle-income country to an upper-middle-income country in 1992, during which per capita income increased fourfold. Malaysia’s transition to high-income status is expected to be slightly longer at 32 to 36 years, going by the World Bank’s projection of 2024 to 2028 in its 192-page report, “Aiming High: Navigating the next stage of Malaysia’s development”, launched last Tuesday.

While those closely tracking developments on this front would be aware that researchers from another global institution had projected that Malaysia would escape the middle-income trap as early as 2014 — seven years ago — the World Bank report’s emphasis is not so much when Malaysia will cross the high-income threshold, but it lists six key structural reforms that the country needs to make to ensure that growth is sustainable and equitably shared by the people after the transition.

“There is really not too much time” for Malaysia to make the tough reforms — especially amid the tougher external environment post-pandemic, including much higher debt globally and looming changes in comparative advantage from disruptive technologies — but the country can benefit from “many good lessons” at 19 other countries that have made that transition to high-income status in the past three decades, Firas Raad, World Bank Group’s country manager for Malaysia, told reporters after moderating a virtual panel discussion following the launch.

Malaysia really needs to “just do it”, said Tan Sri Rebecca Fatima Sta Maria, executive director of the Apec Secretariat and former secretary-general of the Malaysian Ministry of International Trade and Industry. She told the panel discussion that Malaysia has had “loads of discussions on structural reforms” and is “very good at coming up with plans and blueprints” but the constant challenge is to just “get on with it”.


Indeed, Malaysia — one of 55 countries that have yet to cross the high-income threshold — has set up committees to strategise its escape from the middle-income trap since at least 2009.

Richard Record, World Bank Malaysia’s lead economist, says Malaysia is within “striking distance” and “will cross the high-income country threshold by 2025 under a baseline [or business-as-usual] scenario; by 2024, under a high-case scenario; and by 2028, under a low-case scenario”. The baseline scenario assumes that the economy grows “around its potential rate, with the ringgit-US dollar exchange unchanged at around RM4 per US dollar throughout the forecast period, and with certain demographic expectations”. The high-case scenario assumes stronger GDP growth and exchange rate, and the opposite for the low episode, he explains.

“Compared with other countries that have already achieved high-income status in recent years, Malaysia’s economy has been growing slower, it has had a lower share of employment at high skill levels, and it has higher levels of inequality. Relative to OECD countries, it also collects less in taxes, spends less on social protection, and performs below its potential in the areas of environmental management, governance effectiveness and service delivery. Many of these weaknesses have come into greater focus during the pandemic. So, reforms are needed for the country to successfully navigate the next stage of development,” Record tells The Edge.

Danger of slippage

The emphasis on necessary reforms is because Malaysia needs to make sure its economy can continue to grow and remain above the desired threshold after (finally) crossing it.

“A number of countries went back from high-income to upper middle-income: Argentina, Bahrain, Croatia, Equatorial Guinea, Hungary, (South) Korea, Latvia, Puerto Rico, Russian Federation, Saudi Arabia, Venezuela. Some of those countries just had a temporary lull as they climbed, like Korea. Others suffered from more enduring shocks, like Saudi Arabia. Most recovered and continued to grow. But there are a number of countries that were once high-income and have still not yet returned to the category. This is perhaps another argument for the importance of structural reforms to ensure that growth is maintained beyond the high-income threshold,” Record says.

According to World Bank data, South Korea — which attained lower-middle-income status the same year as Malaysia in 1969 and took 19 years to become an upper-middle-income country in 1988 — first crossed the high-income threshold in 1995 but briefly slipped back to upper-middle-income-status between 1998 and 2000, following the Asian financial crisis, before crossing the high-income threshold again in 2001, where it has since remained. Meanwhile, Saudi Arabia — which became an upper-middle-income country in 1970 and was propelled to high-income status in the early 1980s as oil prices rose — slipped back to upper-middle-income status in 1990 and took 14 years to regain its high-income status in 2004.

Malaysia was at one point one of the fastest-growing economies in modern history, having sustained average annual growth rates of 9% between 1967 and 1997, but annual growth has since fallen to an average of 4%. “This is lower than the rates recorded by any of its transitional peers in the 10 years preceding their achievement of high-income status. At this rate, it would take Malaysia 28 and 43 years, respectively, to reach the current per capita income of [South] Korea or Singapore,” the World Bank report read. (The GNI per capita income threshold for high-income countries was US$12,535 as at July 1, 2020; Malaysia’s was US$11,230; South Korea; US$33,790; and Singapore, US$59,590.)

That Malaysia’s growth “appears to have slowed down more than it should have relative to its potential” indicates that the country “may not have adequately transformed the engine of its economy from factor accumulation [growth through increase in basic inputs of labour, capital and land] to the greater knowledge-intensive and productivity-driven boosts to growth that comes from innovation, where one moves beyond being mere users of technology to being creators and innovators”. The latter would require coordinated and targeted investments in research and development and its supporting digital ecosystem.

At its peak in 2003, Malaysia accounted for 5.6% of the world’s exports of electrical machinery, apparatus and appliances, the report notes, adding that the only countries that had higher share of electric and electronic (E&E) exports at the time had much larger populations and more established electronics industries, including China, the US, Japan, Germany and South Korea. By 2014, however, China had become dominant, accounting for more than a third of E&E exports worldwide, whereas Malaysia’s share had halved.

“Malaysia is among the world’s most competitive exporters and already ranks highly in measures of overall economic competitiveness. However, the drivers of growth are slowing and there is a gap with key comparators, especially when it comes to productivity. Both manufacturing value-added and the export of goods and services have declined in proportion to GDP from their highs in the 1990s. Manufacturing fell by nearly a third, with Malaysia being surpassed by China, Korea and Thailand, among others. Key traits of the most successful economies include the removal of distortions, an environment that encourages innovation, open and rigorous competition in markets, close linkages between industry and education institutions, fairness of opportunity across jobs and business, a streamlined investment climate and deep regional integration,” Record notes.

Technology, trade and ageing are the three major structural changes in the global environment that are likely to have the greatest impact on Malaysia’s future growth trajectory, the World Bank says in the report, which also noted, among other things, that aggregate investment-to-GDP in Malaysia — which ranged between 30% and 45% of GDP in the late 1980s and 1990s — had also fallen after the Asian financial crisis to hover at 20% to 25%.

An earlier report (Investment Trends Monitor) by the United Nations Conference on Trade and Development (Unctad) in January had noted that foreign direct investment (FDI) in Malaysia fell 68% last year to just US$2.5 billion, the worst among its Southeast Asian peers, underperforming the average of 31% year on year lost by the Asean region (to US$107 billion) and 42% lost globally (to US$859 billion). Notably, FDI flows into the Philippines rose 29% to US$6.4 billion in 2020 while Vietnam only saw a 10% year-on-year decline.

Still, Malaysia — whose economy contracted 5.6% in Covid-19-hit 2020 — has a chance of “almost doubling” its potential GDP growth rate compared with baseline projections of 2% by 2050, Record says, if the country successfully makes a combination of structural reforms to become a high-income and developed economy and remain so.

Tough reforms for quality growth

In its report, the World Bank lists six key areas of tough but necessary reforms that Malaysia needs to make to attain better quality growth: (1) revitalise long-term growth by investing in improving the quality of human capital, raising female labour force participation and accelerating productivity; (2) boost competitiveness by reforming key sectors and aligning incentives to transition to becoming innovators rather than just users of technology; (3) create a greater number of well-paying, high-quality jobs while closing gaps in terms of quality of education as well as upgrading skill sets, especially for jobs threatened by automation; (4) modernising and raising the quality of local institutions to meet rising expectations on public service; (5) promote inclusive and equitable growth for all citizens; and (6) enhance the government’s revenue generation and improve fiscal spending efficiency to finance shared prosperity (see sidebar on government finances).

“Some reforms, such as measures to boost the quality of human capital, have large payoffs, but will take several years to show results. And some reforms, such as deepening safety nets, will require complementary measures to increase revenue collection. However, there are also a number of reforms that would generate comparatively quick results and don’t need to cost a large amount fiscally. For example, closing the gap in female labour force participation and reducing barriers to economic opportunities for women; reforming key services sectors to promote more open and competitive markets; increasing the effectiveness of competition policy; modernising the investment ecosystem to make it more efficient and to attract higher-quality investments; and improving immigration and emigration policies by making the foreign worker management system more systemic and transparent are just a few areas in which reforms could show results in a comparatively short space of time,” Record says.

There is need to get private sector buy-in, given that the declining effectiveness of private investments “makes the largest contribution to falling GDP growth in the baseline scenario”, the report says, pointing out that a two-percentage point increase in private investment-to-GDP, from 18% to 20%, could boost GDP growth by 0.36 percentage points (from 2021 to 2030) while raising public investment-to-GDP from 6% to 7% would boost GDP growth by 0.13 percentage points.

While the World Bank acknowledged that ongoing political uncertainty and a significant increase in government debt to finance large economic policy responses to the pandemic could be a drag on the economy for years to come, its policy experts noted that Poland had successfully transitioned to high-income status and has managed to make structural reforms to sustain growth despite seeing political change.

“An important message that we highlight in the report [on Poland] was how a shared policy vision of a market economy characterised by solidarity was accompanied by remarkable policy continuity, despite spanning 17 democratically elected governments since the beginning of Poland’s transition from plan to market,” Record says, citing the World Bank’s 202-page report on Poland in 2017.

Poland, which transitioned from communism, attained upper-middle-income status in 1996, gained high-income status in 2009 and had a GNI per capita of US$15,350 in 2019, “thanks to two-parts perspiration (investment) and one-part inspiration (innovation). And prosperity was shared. Jobs and income growth were broad-based and lagging regions were catching up”.

Among other things, the report noted that reforms were properly sequenced and anchored: First, it quickly “got the prices right”. Later, it “got the institutions right”, that is, the rule of law, property rights, democratic accountability and basic market institutions. It then used European Union accession and membership to anchor, reinforce and further deepen the reforms. Sound macroeconomic policies provided considerable stability and resilience.” The report also noted that structural transformation — which required that labour had sufficient education to move to high-skilled jobs — made up 25% of the total increase in Poland’s high-skilled employment. The reallocation of resources from low-productivity to high-productivity firms accounted for three-fourths of total productivity growth. Like its recommendation for Malaysia, the World Bank had said Poland must continue to secure productivity gains from existing and frontier innovations to sustain economic growth.

“The most important step is recognising that the development model that worked in the past is no longer equipped to help Malaysia get to the next stage of development. ‘Business as usual’ is not an option. A different set of policies and a realignment of institutions will be required to improve the quality, inclusiveness and sustainability of economic growth in the future,” Record says.

There is no doubt that Malaysia knows reforms are necessary. In his speech last Tuesday, Minister in the Prime Minister’s Department (Economy) Datuk Seri Mustapa Mohamed acknowledged that factor-driven growth — which has brought Malaysia to the cusp of attaining high-income status but is yielding less GDP growth than in the past — “will not be enough” to carry [Malaysia] past the high-income threshold.

“New sources of growth are needed to ensure that it is driven by multifactor productivity. We need to build a workforce for the future, drive digitisation and spur productivity improvements at the sector and enterprise levels. With this in mind, Malaysia has strengthened its resolve in intensifying the digitisation journey, which began with the Multimedia Super Corridor, [and continues] with the Malaysian Digital Economy Blueprint, launched by the Prime Minister on Feb 19 this year,” Mustapa said. “We need to learn from our shortcomings and [consider] how we can do things better, as well as take into account the best practices in other countries.”

Whether Malaysia can indeed raise not just the rate but also the quality of economic growth lies in its execution.

 

See also Page 47: ‘World Bank signals twin threat of debt and political instability’

 

 

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