Thursday, January 6, 2011

Malaysia's journey to attain developed status

Jan 5, 2011


MALAYSIA is one of the developing world's great success stories. Since its independence in 1957, its per capita income has risen eight-fold, and absolute poverty has been all but eliminated in the country. But it currently faces three key, interrelated challenges.

The first: how to graduate to the rich-country club. As Prime Minister Najib Razak has acknowledged, Malaysia is 'now at a critical juncture, either to remain trapped in a middle-income group or advance to a high-income economy'. It has 'to shift to a new economic model based on innovation, creativity and high value added activities'.

The second is the country's slower development trajectory since the 1997-98 Asian financial crisis. Even before the current global financial crisis, Malaysia's economic growth in the 2000s was about two percentage points below that of average growth in the decade 1986-96.

Particularly worrisome is the slump in investment, which has been stuck at little more than 20 per cent of gross domestic product (GDP) since the late 1990s. This is 10-15 percentage points of GDP lower than the country's historic ratio.

With savings buoyant, the country's external position has been transformed dramatically. In 2002, the country had net liabilities equivalent to 35 per cent of GDP. By 2008, this had been transformed to net assets of 20 per cent of GDP. Put simply, Malaysians have been finding overseas investment increasingly attractive, while foreigners have been less attracted to Malaysia.

The third challenge is to develop high-quality institutions that underpin a modern market economy in a country that has experienced continuous one-party rule since independence. Malaysia's ruling United Malays National Organisation (Umno) is in fact the world's longest-serving governing party currently in power among all the 'quasi democracies'. Not surprisingly, some elements in Umno exhibit the complacency and arrogance that one expects from entrenched one-party dominance.

But Malaysia's strengths are not to be underestimated. It has always been one of the most open economies in the developing world. It has rarely had severe macroeconomic crises. It derived a major early mover advantage from its adoption in the early 1970s of export-oriented industrialisation through foreign direct investment. It is a major player in the global electronics industry. In 2006-07, it accounted for 3.8 per cent of global parts and components exports, behind only China, Japan and South Korea in East Asia.

But Malaysia is struggling to move out of low-skill activities, where it is no longer competitive. This difficulty has been exacerbated by its vigorous promotion of one of the longest-running affirmative action programmes in the developing world.

Designed to redistribute employment and wealth to bumiputeras - principally ethnic Malays - the so-called New Economic Policy (NEP) and its successors have played an important role in promoting racial harmony in the country. But the programmes have also created a culture of entitlement, and they have resulted in institutionalised leakages that permeate practically every aspect of Malaysian commercial, social, political and educational life.

The programmes to advance bumiputeras have benefited the politically well-connected among Malays, through preferential contracts, share allocations and general commercial advancement. All too little has trickled down to the general community. The programmes can hardly be justified as anti-poverty programmes when their principal beneficiaries are already wealthy.

Some of the country's industry policies have backfired because of these programmes. For example, Malaysia might have been expected to be the leading South-east Asian automotive producer. Instead, Thailand has become the 'Detroit of Asia', owing to Malaysia's disastrous national car programme.

In addition, the 'spillover' benefits from the large multinational presence in manufacturing have been limited by the fact that Malaysia's small and medium-sized enterprises (SMEs), which are predominantly owned by ethnic Chinese, prefer to stay small, below the threshold above which bumiputera employment quotas become mandatory.

The country's public universities, once among the region's best, have also slipped in East Asian rankings owing to ethnic quotas as well as heavy bureaucratic control.

The civil service is bloated and in need of reform, while there is a very large state enterprise sector that functions in a non-transparent manner. And the country continues to experience a substantial brain drain as a result of the exodus of skilled professionals from the Chinese and Indian communities.

It is fashionable in Malaysia to attribute its current malaise to China. While the 'export similarity index' - that is the composition of their exports - for the two countries is quite high, the notion that the rise of China explains Malaysia's current difficulties is untenable. Such a view overlooks the positives for Malaysia of China's rise. As a resource-rich economy, Malaysia has benefited from the general China-fuelled rise in commodity prices.

The writer is the H.W. Arndt Professor of South-east Asian Economies at the Australian National University. He co-edited the forthcoming Graduating From The Middle: Malaysia's Development Challenges (Routledge).

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