Solution to the problems of economic openness is not less openness but more openness

Malaysia’s Development Strategy Revisited (1)
by Dr. Mohamed Ariff*

Malaysia has turned 180 degrees since Independence in 1957, transforming itself into a thriving modern economy and leapfrogging from a low-income to a middle-income trajectory. The country owes its prosperity to its economic openness, with trade as the lifeblood and foreign direct investment (FDI) as the backbone of the economy.

Economic Openness and Vulnerability to External Shocks

The price Malaysia has had to pay for this success is greater vulnerability to external shocks, but it has learned to cope with cyclical ups and downs with remarkable dexterity. This does not mean, however, that all of the crises in the Malaysian economy were caused entirely by external forces, as if domestic policy missteps had nothing to do with them. The Malaysian experience shows that crises tend to be blessings in disguise, as they force the authorities to step back, take a hard look at their policies, learn lessons and move on.

The economy has recently arrived at yet another crossroads, this time in the aftermath of the global financial crisis of 2008–09. Like many other countries, Malaysia is in search of a new economic model with which to reposition itself.

The prospective ‘new economic model’ may be viewed from two different angles: as a short-term rebalancing exercise after the crisis, and as a long-term agenda for structural change. There has been much talk of the need to reorient the Malaysian economy towards the domestic market so as to render it more resilient. But although this is intuitively appealing, the reality suggests it would not work in practice. Malaysia’s domestic market is still too small to be a meaningful substitute for the huge external market.

This observation does not ignore the role the domestic market can play when external demand caves in, but it does help to underscore the point that there is only so much the domestic market can do when exports slump, even in large economies, not to mention small ones like Malaysia.

It is important to understand that the solution to the problems of economic openness is not less openness but more openness. There is nothing wrong with Malaysia being so trade dependent; it cannot afford to be otherwise. The question, rather, is whether the Malaysian economy is too trade dependent for its own good. Rhetoric aside, the optimum trade level relative to a country’s GDP can only be determined by market forces, not by administrative fiat. For market forces to work effectively, there is a need first to eliminate all distortions in the market place.

Distorted Factor Market

In Malaysia, the factor market is much more distorted than the market for goods and services, with a bias in favour of the traded versus non-traded sector or the external versus domestic sector. The proposal to reorient the economy towards domestic demand away from exports would warrant policies to reverse the bias in favour of the non-traded or domestic sector, but this would be a mistake in the opposite direction. What is needed is policy neutrality without any bias, so that resources flow more freely in response to market signals. This would ensure greater efficiency in resource allocation.

No doubt a robust and vibrant domestic sector would help offset the impact of external shocks on the economy. Domestic demand would have played a far more important role in the country’s economic growth and development had income distribution been less uneven and if social safety nets had been in place. It is evident that income inequality has widened in recent times, with the Gini coefficient rising for all ethnic groups in Malaysia.

A more equitable income distribution would have led to increased private consumption and greater economic resilience. After all, Malaysians tend to save more and spend less than their counterparts in the developed world, partly because there are no safety nets for them to fall back on when the chips are down.

This line of reasoning prompts policy makers to focus on social security and income redistribution so that people will save less and spend more, and militates against attempts to divert demand towards domestic consumption through trade distortions.

The rest of the world has also changed dramatically, with more and more economies opening up and joining the bandwagon of export-led growth. In the process, Malaysia has lost its comparative and competitive advantage in several products to newcomers. As a result, its potential growth rate has shrunk from 7.5 per cent in the late 1980s to 5.5 per cent now, putting at risk the goal of making Malaysia a developed country by 2020 with a per capita income of $20,000 in real terms. Estimates show that, to reach a per capita income of $17,000 in 2020, the Malaysian economy would have to grow at an average rate of 7.0 per cent per annum, which sounds like a tall order. At the slower pace of 5.5 per cent per annum – the current potential rate – per capita income would be just $15,000 in 2020.

(to be continued)