Malaysia after regime change

— Hal Hill
The Malaysian Insider
May 14, 2012

MAY 14 — There is much to admire about Malaysia, in addition to it being arguably the world’s best place to eat. Its development record is admirable. Since independence in 1957, its per capita income has risen eight-fold. It has long since left behind its two earlier comparators, Ghana and Sri Lanka. It features prominently and positively in all major international economic comparisons, from the World Bank’s 1993 East Asian Miracle to the 2008 Growth Commission report. The 2.5 million to three million migrant workers are there for a good reason — even if they are sometimes subject to abuse, life is a lot better than in their homelands.

As a result of the country’s adept macroeconomic management, it has suffered just one serious economic setback, in 1997-98. That event had its origins at least partly in external factors, and it was promptly overcome, without the “assistance” of the IMF. The country has managed to avoid the “resource curse”, which has bedevilled the majority of resource-rich developing countries. It features well on most comparative rankings, such as the Bank’s Doing Business, and the Global Competitiveness Report.

Along with Singapore, it has enjoyed an early mover advantage from its adoption in the early 1970s of export-oriented industrialisation through foreign direct investment, before it was fashionable to do so. As a consequence, it is a major player in the global electronics industry. And although inequality remains high, there is no doubt that the bottom 40 per cent of Malaysian citizens have benefitted materially from the country’s economic growth.

What’s the economic problem, then? Principally, that the economy has yet to regain the dynamism evident before the 1997-98 Asian financial crisis. Even before the more recent global financial crisis, which Malaysia navigated quite successfully, economic growth in the new millennium was at least two percentage points below that of the decade 1986-96.

Particularly worrisome is the slump in investment, which has been stuck at little more than 20 per cent of GDP. This is 10-15 percentage points of GDP lower than the country’s historic ratio. With savings remaining 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 nub of the problem is that, from a position of early leadership, the country has failed to keep up with fast reforming economies, including the Asian NIEs, China, and even the politically messy states of India and Thailand. That is, insufficient attention has been paid to developing high-quality institutions to underpin a vibrant, modern, internationally competitive market economy.

For example, the country’s industrial policies have backfired. Malaysia might have been expected to be the leading Southeast Asian automotive producer, but Thailand has become the “Detroit of Asia” owing to Malaysia’s disastrous national car programme. This is a puzzling outcome when one considers the country’s early successes as the world’s most efficient producer of tropical cash crops, based on its effective R&D, infrastructure and agricultural extension.

In addition, the “spillover” benefits from the country’s large multinational presence in manufacturing have been limited by the fact that Malaysia’s SMEs, that are predominantly owned by the ethnic Chinese community, prefer to stay small, mainly outside the export zones, and below the threshold above which Bumiputera employment quotas become mandatory.

The country’s public universities, once among the region’s best, and still well-funded, have also slipped in East Asian rankings owing to these ethnic quotas, as well as heavy bureaucratic control. The country is now well established to be a regional higher education hub, with the establishment of several major international campuses. However, while welcome, these institutions cannot be expected to lead the country’s transition into a research and knowledge-based economy.

One striking feature of Malaysia’s policy settings is that, although the country is generally very open, it has been slow to liberalise several major service sectors, such as telecommunications and various business services. In turn, this reflects the continuing large presence of state-owned enterprises, termed “government-linked corporations”. These GLC’s constitute an unusually large proportion of the economy, and their operations constitute something of a “black box”. The slow pace of GLC reform, and in particular the government’s reluctance to expose them to competition and public scrutiny, is testimony to the widespread suspicion that they operate as sinecures for the politically well-connected, in addition to the role they play in the ubiquitous NEP-style contracting and preference schemes.

Although Malaysia has always has always had an impressive commitment to education, the country’s human resource performance is indifferent. The public universities as noted are in need of reform. The country continues to experience a substantial brain drain as a result of the exodus of skilled professionals, mainly those disaffected in the Chinese and Indian communities. The civil service is bloated and in need of major reform. Its growth in recent years reflects in part the pressure the government is under to employ the many (mainly Bumiputera) graduates who are the products of a university system insufficiently attuned to the needs of the market place.

Moreover, paradoxically for a country so concerned about equity, there are major distributional concerns. For all the attention, inequality remains very high, little changed since the 1970s. Malaysia has one of the longest-running affirmative action programmes in the developing world. Designed to redistribute employment and wealth to the dominant Bumiputera community after the nasty communal conflict of May 1969, the NEP and its successors played an important role in promoting racial harmony in a country with very large differences in living standards across racial groups. But the programmes have 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 NEP needs to be reformulated as a genuine pro-poor policy instrument, based on need not ethnicity.

The case for reform is also highlighted by the drift in fiscal policy. Fiscal deficits have become institutionally embedded since the Asian financial crisis, regardless of the state of the economy. The budget is riddled with large, poorly directed subsidies, which are unsustainable for three reasons: they are reliant on declining petroleum revenue; they are maintained in part owing to a large pool of compulsory savings (the EPF) that has a sub-par return to its contributors; and the demographic clock will start ticking in about a decade, as the currently youthful Malaysian population begins to age.

It is fashionable in Malaysia to attribute its current malaise to China, a country that is able to out-compete Malaysia in low-end and increasingly a sophisticated range of manufactures. While the “export similarity index” (that is the composition of their exports) for the two countries is quite high, and thus there has some been some loss of market share to China from Malaysia in third-country export markets, the notion that the rise of China explains Malaysia’s current difficulties is untenable. That view overlooks the positive sum game for Malaysia from China’s rise. As a resource-rich economy, Malaysia has benefited from the general China-fuelled rise in commodity prices, for example its exports of palm oil and oil and gas. Similarly, commercial opportunities in tourism and education have been rising rapidly, with two-way investments rising very quickly. And Malaysia is a central player in the increasingly China-centred East Asian production networks that export to the world.

There is also currently a muddled narrative in Malaysia and elsewhere that the country is in some sense “stuck in the middle”. It is true that growth has slowed, that the country has been in the ranks of middle-income developing countries for some decades, and that export-oriented economies may not be able to rely on strong global trade growth for the next few years. But the notion of being “stuck in the middle” is devoid of analytical content. It is one thing to observe that, at very high levels of per capita income, as countries approach the frontiers of wealth, growth slows down. But Malaysia is way off such a point. The country’s slowdown is self-inflicted, and there is nothing mysterious about the way out. What is needed is determined, reform-oriented government.

I leave it to better informed analysts to explain the deeper political obstacles. The overwhelming impression is of a party in continuous power for 55 years, one of the world’s longest-serving governing parties currently in power among all “quasi democracies”. Not surprisingly, elements of Umno exhibit the problems of complacence and arrogance that one expects from such entrenched dominance.

One thing is for sure: the solutions to the current malaise are well known, and Malaysia is blessed with many able people who understand the problems and know what to do. For this optimist, it is just a matter of time before these two irresistible forces are aligned. — New Mandala

* Hal Hill is the H.W. Arndt Professor of Southeast Asian Economies at the Australian National University. This note draws on his February 2012 Boustead Lecture delivered at the Nottingham University Malaysia Campus, which in turn draws on the 2012 volume he co-edited with Tham Siew Yean and Ragayah Haji Mat Zin, “Malaysia’s Development Challenges: Graduating from the Middle”, Routledge, London.