Grand designs for a new leap forward

Tong Yee Siong

Malaysia has high hopes of turning itself into one of the world’s richest countries in the next ten years, and this will clearly require a new round of far-reaching structural reforms.

Malaysia was one of only 13 economies in the world to have sustained high growth over the last six and a half decades, according to a recent assessment by the World Bank’s Commission on Growth and Development. And while it has remained an ‘upper middle-income’ country since 1992, Malaysia has graduated no further, having been left behind by those few states in the region that have grown all the way to highincome levels, namely Hong Kong, Japan, South Korea, Singapore and Taiwan.

The relative performances of these countries serve to underline Malaysia’s remarkable economic achievements as well as the limitations that now stand in the way of it making the next big leap. The question on everyone’s mind is indeed whether Malaysia can become a high-income economy (HIE) by 2020 – a goal that was originally envisaged by the country’s fourth premier, Dr Mahathir Mohamad, and one that is being pursued vigorously by the sixth prime minister, Najib Razak.

Economists believe the goal is still achievable, provided there are swift reforms to address Malaysia’s structural barriers.

But World Bank economist Philip Schellekens noted in a recent interview that “the breathing space is shrinking”. For a start, the global economic landscape is now very different from what it was when Mahathir proclaimed his Vision 2020 in 1991. In the years that followed the Asian financial crisis, private investment has not recovered to its pre-crisis level. This has been partly as a result of over-investment in the pre-crisis period but also because regional economies like Vietnam and Indonesia are now seen as competitive alternatives to Malaysia’s lowcost, low-value-added economic model.

Weaker external demand and greater uncertainties will from now on weigh heavily on the trade-exposed Malaysian economy, with its key export markets – the USA, the EU and Japan – facing a prolonged period of low growth. Already, Malaysia’s real GDP growth in the first quarter of 2011 moderated to 4.6 percent after a sharp rebound of 7.2 percent for the whole of last year.

By Malaysia’s own estimates, the economy would have to expand by an average of 6 percent annually to become an HIE by the end of this decade. The government has identified 11 industries with the growth potential to achieve this. The emphasis is on the service, energy, mining and agriculture sectors.

Most of the growth needed for achieving HIE status would come from oil, gas and energy, palm oil and financial services.

The plan also envisages making Greater Kuala Lumpur more vibrant, with the help of an upcoming mass rapid transit project costed at MYR36.6 billion ($12.02 billion), so as to enable it to compete with other international cities. This will be Malaysia’s largest infrastructure project to date.

Together, the 11 industries and Greater Kuala Lumpur are forecast to attract more than MYR1.4 trillion ($370 billion) of investment over the next decade, of which 92 percent will come from the private sector.

Private investment and consumption are expected to be the main drivers of growth In the Tenth Malaysia Plan (10MP), which sets targets for the five years from 2011 to 2015. There is only limited room for public spending. The government wants to hold its fiscal deficit this year to 5.4 percent of GDP, although a forecast from Roubini Global Economics in May suggests it will be closer to 5.8 percent as fuel subsidies are set to double to more than MYR20 billion ($6.8 billion).

Several economists have warned that the 10MP projections for private investment and consumption could be tenuous, not least because its predecessor under-delivered on all targets during the 2006-2010 period, even before the global recession made matters worse in 2009. The reliance on private consumption to drive growth in the next five years also raises some concerns.

Malaysia’s household debt-to-GDP ratio climbed steadily over a decade to reach 75.9 percent in 2010, a level considered high given the country’s current development stage and income level.

Stagnant private investment growth is not in itself the problem but rather a symptom of what needs to be fixed about the investment climate. Economists believe that the structural barriers that must be urgently addressed include a shortage of human capital, a number of distortions in the economy and weaknesses in the institutional framework.

Malaysia’s workforce is considered relatively too low skilled to transform the economy from an investment-driven to an innovation-driven one. Some 80 percent of workers are only educated to the upper-secondary level or equivalent, and only about 20 percent have tertiary education qualifications, and this is significantly lower than that of advanced economies.

This is not simply a matter of not producing enough graduates. Quality, too, is an issue. Boston Consulting Group estimates that in 2008, over a quarter of graduates of public universities were still unemployed six months after completion of their studies, while among those employed, more than a third were doing jobs that require less than a degree-level qualification. Employers often cite the lack of basic, technical and soft skills as the reason why they take a long time to fill vacancies.

Malaysia also faces the challenge of attracting and retaining talent. A recent World Bank report points out that the number of skilled Malaysians residing abroad has reached new highs. The country’s diaspora worldwide is conservatively estimated at 1 million (the country has a population of 28.5 million). About a third of all migration is attributed to the brain drain and the skilled diaspora is now three times larger than two decades ago. Malaysia’s poor skills base is aggravated by a continuing influx of low-skilled migrant workers.

The main distortions in the economy relate to prices and markets. The pervasive subsidies and price controls, apart from complicating fiscal management, have led to inefficiency among businesses and misallocation of resources. For example, Malaysia’s use of energy to produce one unit of GDP is well above the global average, while its carbon emissions grew by 221 percent between 1990 and 2004, faster than any other country. Policies that allow an excessive number of low-skilled migrant workers in Malaysia also distort the price of labour, keeping wages artificially low.

As well as the price distortions, market distortions exist in multiple forms of protection for various sectors, industries and even firms. These include quantity limits imposed on exports and imports, direct controls on distribution, and restrictions through procedures like approved permits and licences.

Malaysia’s institutions are also up against some critical issues. In pushing for private sector growth, economists urge an easing of the heavy regulatory burden and the introduction of competition policy. These are in theory being addressed since the establishment in 2007 of a special task force to streamline business rules and regulations and with the recent setting up of a Competition Commission, although the impact of these efforts on investor perception remains unclear.

While Malaysia has largely eradicated poverty, there have been mixed results in addressing income inequality between ethnic groups and localities. Undoubtedly, the government has to step up its efforts in distribution to ensure that the growth process is inclusive. But the decades-long, ethnic based affirmative-action programmes are proving to be a blunt policy tool for addressing inequality; not to mention that such programmes have at times added to the cost of doing business, bred corruption and created a class of rent-seekers.

 Prime Minister Najib has acknowledged this problem by pledging to make affirmative action “needs and merit based, transparent and market-friendly” in order to eliminate abuse of the system. The challenge lies in operationalising what he has in mind, and in discovering whether he has the political base to press ahead with this and other bold reforms.

About the author:

Tong Yee Siong is a former Research Team Leader at Malaysia’s National Economic Advisory Council.


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