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RethinkingEconomicsA FRAMEWORK FOR MALAYSIA TO ESCAPE THE MIDDLE INCOME TRAP
SAGE 3 www.sage3.com.my
Rethinking economics - A Framework for Malaysia to Escape the Middle Income Trap iii
Contents
1. Measuring the Economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
2. Economic Complexity Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
3. Role of the Government . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
4. A Better Understanding of Economics, Differing from the Mainstream . . . . . . . . . . . . . . . . . . . . . 3
5. Evolving the Way Forward . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
6. The Big Picture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
7. Rukun Negara . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
8. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Acknowledgement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Contact us . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Rethinking economics - A Framework for Malaysia to Escape the Middle Income Trapiv
GLOSSARYNotation DescriptionAFC Asian Financial Crisis 1997
AFTA ASEAN Free Trade Area
ASEAN Association of Southeast Asian Nations
BNM Bank Negara Malaysia
CIDB Center for International Development
ECI Economic Complexity Index
EU European Union
GDP Gross Domestic Product
GFC Global Financial Crisis 2008
GLC Government Linked Company
MSC Multimedia Super Corridor
PH Pakatan Harapan
PPP Purchasing Power Parity
USA United States of America
USD US dollars
Rethinking economics - A Framework for Malaysia to Escape the Middle Income Trap 1
In the decade leading up to the Asian
Financial Crisis (AFC), Malaysia was
regarded as an Asian tiger economy,
achieving GDP growth rates north of
9%. However, post crisis the nation’s
GDP growth and more importantly per
capita income, whilst encouraging
has been lower than other leading
emerging/East Asian economies. The
proponents of Rethinking Economics
are of the view that new innovative
ideas in economics can be harnessed
to reshape Malaysia’s economy to
become an Asian tiger economy once
again.
1. MEASURING THE ECONOMY
Per capita income, measured in
USD, has declined in recent years.
Associated with this, over the last
decade there has been a healthy
debate on Malaysia being stuck in the
Middle Income Trap. Whilst a healthy
debate raged on about the Middle
Income Trap, these discussions were
mainly qualitative in nature and very
much within a framework of traditional
macroeconomic theory. However,
before pursuing a discussion on a
path to higher growth status as a
developed country and breaking
away from the Middle Income
Trap, it is important to examine the
measures of wealth and economic
performance. Reliance on per capita
income measured in local currency
has drawbacks as it could ostensibly
be increasing but real wealth could
be diminishing, eroded by inflation
and reduction in the purchasing
power of the domestic currency due
to devaluation.
Moreover, it misses the critical point
that being wealthy is a relative
concept. Thus, the paper draws on
research by the World Bank in terms
of long-term trends of countries per
capita income relative to the United
States of America. Regrettably, by
this measure, Malaysia’s economic
performance over the past five
decades is less than inspiring.
In Rethinking Economics, there are
deeper questions raised on economic
measurement in applying GDP per
capita income. However, these are
issues beyond the scope of this report
and the use of relative per capita
income to USA is relevant in having a
meaningful discussion on wealth and
escaping the Middle Income Trap.
Accordingly, much of the discussion
in the report centres around per
capita income relative to USA.
Rethinking Economics: A Framework for Malaysia to Escape the Middle Income Trap
Rethinking economics - A Framework for Malaysia to Escape the Middle Income Trap2
2. ECONOMIC COMPLEXITY INDEX
In the next chapter, this paper examines the
drivers of per capita income based on the
concepts of economic complexity which provides
a comprehensive and credible explanation of
the correlation between the drivers of economic
growth and growth in per capita income. Economic
complexity is based on the concept of productive
knowledge within society which then translates
to the economy being able to produce diverse
as well as complex products and services. Both
diversity and complexity are measurable using
statistical and mathematical models to produce
an index of economic complexity. The index
with data over 40 years shows a high correlation
(regression factor 0.73) between a country’s
index of economic complexity and growth of
per capita income. These concepts form the
foundation of evolving a long-term strategy
to increase per capita income and escape the
Middle Income Trap. The analysis in this paper
provides new insights by comparing per capita
income and ECI of Malaysia with selected
countries. For example, comparisons over 40
years of these factors between Malaysia and
South Korea clearly explains why South Korea,
which had lower per capita income than Malaysia
in 1975, has a per capita income that is currently
approximately three times that of Malaysia. In
March 2018, BNM published a paper comparing
ECI of Malaysia with other ASEAN countries and
pointed to the recent improvement in the ECI of
all ASEAN countries exceeding that of Malaysia.
A worrisome trend. Furthermore, the authors of
this paper caution at the current rate, Thailand,
in the short/medium term, will likely have a per
capita income exceeding Malaysia’s as Thailand’s
ECI is already likely to surpass Malaysia’s ECI.
An analysis of Malaysia’s economy using the
tools from Harvard’s Centre for International
Development, the institution that developed the
“Atlas of Economic Complexity”, is produced. In
the analysis, attention is drawn to long term risks
from high dependence of oil and gas as well as
palm oil industries.
Whilst the CIDB at Harvard’s research on ECI
is ground breaking and provides invaluable
insights regarding development and wealth,
it is important to understand that the tools are
still being enhanced and there are drawbacks.
The drawbacks include the exclusion of export
of services in the ECI as well as non-tradable
services. However, this does not diminish the
value of concepts of know-how, proximity
etc. i.e. findings produced by the research.
Therefore, these concepts have relevance to the
development of more complex and sophisticated
services.
Rethinking economics - A Framework for Malaysia to Escape the Middle Income Trap 3
3. ROLE OF THE GOVERNMENT
In addition to drawing on the new research on
per capita income growth, the proponents of
Rethinking Economics also re-examine the role
of the government which they believe can be
the catalyst to guide changes and accelerate
growth. This is a breakaway from current
capitalist economic thinking which associates
governments with inefficiency and wastage while
the whole of the private sector is associated with
dynamism and efficiency.
Rethinking Economics identifies the role of
government other than just the public good i.e.
in development of industry and intervention in
markets. Critics of government intervention of the
economy will quickly point to, in the Malaysian
context, the spectacular losses of Proton, Perwaja
Steel, Eagle aircraft or involvement of Malaysia
Mining Corp in cornering the tin market, etc.
Yet the paper argues for government to have a
strategic role when the radical risks are involved
i.e. new markets and new technologies or as
previously for certain industries such as oil and
gas, shipping, airlines, rail etc., which domestic
private sector did not have the capital to
undertake such business investment.
Moreover, the critics miss the point that the
successive governments in Malaya/Malaysia
were prime movers for the development of
rubber, palm oil, MSC, Industrial Master Plan
and unorthodox policy responses to the AFC.
Government has a role to develop critical
industries where new industries cannot emerge
by themselves. Government can also play a role
to accelerate growth of complex industries. Whilst
importance and support must be given for such
industries to be promoted, this must be subject
to market discipline even if it is just domestic
competition. Further, emphasis on exports is a
must i.e. demonstrating truly competitive business
on a world stage. Even in respect of privatisation/
private public partnership, there must be a sound
understanding of what works and what doesn’t.
We, as a nation, must avoid privatizing projects
which cannot in effect be privatized as it gives
a false sense of reduced government deficit
prior to inevitable nationalization. Similarly, in
terms of tenders for government procurements,
there needs to be a balance of lowest costs and
value for money. Otherwise on a pure lowest cost
selection process, implementation of important
projects could be delayed due to suppliers being
unable to deliver projects and the economy
will operate sub optimally. Further, costs could
escalate with variation orders and the project
issues could be compounded by a very legalistic
approach to undertaking projects becoming the
culture which is not conducive for business and
government. It goes without saying that this does
not mean transparency and good governance for
tenders are compromised one iota.
4. A BETTER UNDERSTANDING OF ECONOMICS, DIFFERING FROM THE MAINSTREAM
Rethinking Economics encourages enlightened
understanding of important economic concepts
which are wrongly or not addressed by
mainstream economics. Post-GFC, there is a
deeper understanding of the growth of debt
and the role commercial banks play in creating
Rethinking economics - A Framework for Malaysia to Escape the Middle Income Trap4
money. Additionally, in this respect, how creation
of money/increase of debt impacts aggregate
demand. Debt in itself is not necessarily
detrimental to economic growth, entrepreneurs
borrowing and increasing the economic cake is
an absolutely positive thing. However, there must
be vigilance against debts that create dangerous
speculative bubbles. The other source of growth
of the money supply excluding the external sector
is the government vide deficit budgets, which
should be applied for the public good. Therefore,
federal government policymakers should not be
constrained by thinking similar to corporations
or state governments. This unorthodox thinking
espouses federal government with fiat currency
to pursue deficit spending, which is viable option
if inflation remains in check and the balance
of payment is positive. No doubt of immediate
concern would be the country’s debt rating.
However, innovation of “equity” type instruments
issued by the government could be used to raise
funds without incurring debts, thus addressing
any concerns of higher debt ratios. However,
even these concerns on high government
debt to GDP ratios have been debunked, as
the original works by Reinhart and Rogoff are
mired by controversial articles1 that have been
written on their research. For completeness,
the role of exports in the creation of money is
illustrated and this has been the basis for the
success of the East Asian economic model, a
path advocated by the authors of this paper for
Malaysia. Further, in respect of government
deficit (without external sector), the net effect is
the household and commercial sector are able to
save. It is critical that policymakers grasp these
1 John Cassidy: The Reinhart and Rogoff Controversy: A Summing Up (2013) Retrieved from: https://www.newyorker.com/news/john-cassidy/the-reinhart-and-rogoff-controversy-a-summing-up
concepts, otherwise there will be a serious risk
that economic growth will be suboptimal as
expenditure required to accelerate economic
growth and relieve the burden of hardship on the
population will remain curtailed.
In respect of aggregate demand and credit
creation, we reviewed new research on credit
guidance and its impact on the economy. The
recent research shows that in advanced countries,
financial deregulation has resulted in less credit
being directed towards producing goods and
services but more towards existing assets. This
has a negative impact on productivity and wage
rise, not to mention further exacerbating the
wealth distribution as increase in asset prices
advantage rich households. Further, the research
points to deregulation that caused the shift in
credit direction is to be blamed for the booms
and busts economic cycles.
Consistent with the research, our recommendation
is for government to play a pivotal role in
increasing capital to grow industries by
implementing policies that avails credit for
targeted industries e.g. green industries,
domestic technology-based industries i.e.
using direct government funds or policies that
encourage commercial banks to lend to targeted
sectors. Further, this enables and encourages the
build-up of specialist knowledge in banks to lend
towards targeted sectors.
Rethinking economics - A Framework for Malaysia to Escape the Middle Income Trap 5
5. EVOLVING THE WAY FORWARD
The concept above derived from Rethinking
Economics can be evolved as a way forward
that achieves the goal of increasing wealth by
moving up the index on economic complexity.
The approach is based on the concepts of
proximity of industries i.e. to develop new
industries to increase diversity and complexity of
products and services produced by the economy.
The global economy is visualised as a large
network of interconnected nodes in which each
industry is represented by a node. This enables
policymakers and planners to identify areas
where new industries can emerge given the
country’s existing industries are well positioned
to branch out into new industries which require
similar set of skills and capabilities. The
proposed approach relies heavily on private
sector initiatives and government’s role is to
ensure an effective and efficient domestic
network of finance, HR, logistics, communication
and conducive regulation to create extensions
of industries. However, consistent with the
view taken on the role of government, the way
forward depends on the government perhaps as
a last resort to make significant investments that
facilitate new industries which otherwise will not
2 Chemical industries: Cellulose acetates, silicones, heterocyclic compound & nucleic acids, phenols & phenol-alcohol & their derivatives, sulphonamides, sultones & sultams, acrylic and methaacrylic polymers, acyrlo-methacrylic copolymers, other polymerization and copolymarization products, oxygen-function amino compounds, halogenated derivatives hydrocarbons and cyclic hydrocarbons.
3 Medical industries: X-ray apparatus and equipment, accessories & parts, electro-medical equipment, orthopaedic appliances, hearing aids, artificial body parts.
4 Machinery industries: Complete digital central processing units & digital processors, electric shavers & hair clippers, fans, blowers & the like, other electronic valves and tubes, electric filament lamps & discharge lamps & arc-lamps, analogue & hybrid data processing machines.
5 Vehicles industries: Motor vehicles piston engines & headings; automotive electrical equipment; work trucks used in factories & dock areas, passenger motor vehicles (excluding bus).
emerge without the right catalyst. A flow chart
to applying the concept has been produced and
serves as a guide in developing new industries
and moving up the ECI.
To this end, a strategy has been evolved defining
industries into four quadrants with a clear path
towards higher ECI is set out based on proximity
i.e. capitalizing on Malaysia’s industrial strengths
and opportunities. The opportunities have been
identified by comparing the scale of global
industry with Malaysia’s relative position. Based
on the analysis, the target industries which
would be critical for Malaysia to move up the
ECI are chemicals2, healthcare3, machinery4 and
vehicles5.
Further, the industries that could be developed
by leveraging nodes in Singapore are explored as
the countries’ economies are well integrated and
the concepts in the Atlas of Economic Complexity
can be fully exploited, in particular the concept
of growing businesses which are connected to
Singapore’s network of industries. As we see
it, the industries in Singapore are within close
proximity and there is a sound basis to develop
selected industries in Malaysia, especially in the
Southern Corridor.
Rethinking economics - A Framework for Malaysia to Escape the Middle Income Trap6
In that vein of networks in neighbouring countries,
the report explores seizing opportunities by
convincing those industries that should ideally
develop in Thailand due to proximity of other
industries in Thailand to choose Malaysia instead.
This out of the box thinking is suggested as supply
/ value chain of Thailand could be exploited
by Malaysia as we are neighbours to Thailand,
jointly part of AFTA and businesses in Malaysia
are already connected to those in Thailand.
A variant to the theme of leveraging network
industries in other countries is the relocation
of Japanese industries to Malaysia. This idea
presupposes a win-win arrangement between
Japan and Malaysia wherein Japan has an aging
population and need industries to relocate
to Malaysia which has a growing population.
This option merits serious consideration, given
strengthening relation between Malaysia and
Japan following Tun Dr Mahathir return as prime
minister.
The concept of industries having proximity to
other industries to grow is captured in an index
of opportunity value which is an indication for
capacity of countries to move up the ECI. The
positive take away is Malaysia is relatively well
positioned in the index for opportunity value.
This gives us hope for optimism as it indicates the
potential to break away from the Middle Income
Trap.
6. THE BIG PICTURE
The paper concludes by providing a big picture
on the interaction between the firm, employees
and intermediaries and how the capitalist
economy ought to be shaped and the role of
government as well as cultivating an environment
which is facilitative of economic growth. Clearly,
there are needs for the government to have
a sound understanding of the current share
of wealth between employees, entrepreneurs
and financial firms and the underlying trends.
As employees and entrepreneurs in small &
medium sized companies represent the largest
portion of the population, ensuring a reasonable
share without discouraging business activity of
larger firms ensures fairer wealth distribution.
Furthermore, a focus on per capita income which
is a measure of the mean is defective, thus a
focus on median income will shift the discourse
on wealth distribution to be more meaningful
and hopefully this will lead to evolution of better
policies to increase wealth across the entire
Malaysian society.
In this paper, there is a strong reminder for the
government to move away from the previous
project management approach of transforming
the economy to be policy driven to drive effective
change as Malaysia did in the mid to late 80’s.
Whilst Malaysia has had previous success with
reforms which transformed the economy post
Mid-80s crisis and AFC, the changes were not
anchored by institutional reforms. The changes
which can be brought by the transformation
of the economy by the PH Government can
benefit from the institutional reform which will
anchor change and prevent future governments
from resorting to policies that undermine the
long-term progression of the economy due to
political self-interest. In this respect, much can
be learned by comparing Turkey with Eastern
European countries where ascension to EU
Rethinking economics - A Framework for Malaysia to Escape the Middle Income Trap 7
ensured economic reforms that were anchored by
institutional reforms prescribed by membership
of the EU. These countries have had stable
economic growth and prosperity compared to
Turkey which is now mired by economic crisis.
There is also a reminder to accelerate
privatization especially in areas where the
private sector is capable and willing to take on
the risks of those GLCs (state owned companies).
In respect of entrepreneurship, the paper draws
attention to the creation of large companies
playing an important role in the economy. It also
expresses innovative ideas around markets not
traditionally served by businesses i.e. ideas from
concept advanced in the book by C.K Prahalad
on “Fortune at the Bottom of the Pyramid”. In
Rethinking Economics, we urge the government
to address issues surrounding distress companies
as another source of economic growth by
improving industrial productivity.
7. RUKUN NEGARA
Noteworthy is the fact that countries that have
indeed escaped the Middle Income Trap have
societies built on science and technology; and
a liberal view to diversity i.e. consistent with
the ethos of the Rukun Negara. Therefore, it is a
sound and compelling reason to reinvigorate
Rukun Negara’s role as the guiding principle to
shape the political economy of our country and
the society we live in.
Rethinking economics - A Framework for Malaysia to Escape the Middle Income Trap8
8. CONCLUSION
As a final remark, readers are advised that
the paper and its recommendations are not
prescriptive, instead serve as an impetus for a
meaningful discourse and debate. It is hoped that
from this discourse and debate, sound strategies/
policies for long term economic development
can be emplaced, but always being mindful that
the economic policy must remain flexible and
can adapt to the ever-increasing pace of change.
Digressing in the short term, the paper provides
idea for economic stimulus, addressing youth
employment and cost of living, matters for urgent
attention. With the right strategies/policies and
ability to execute, reinstating Malaysia as an
Asian Tiger Economy and escaping the Middle
Income Trap will become a reality.
Rethinking economics - A Framework for Malaysia to Escape the Middle Income Trap 9
Acknowledgement
Our sincere thanks to the many parties we have
consulted both locally and internationally and their
invaluable inputs in helping us prepare this report.
Our special thanks to Faceberry Communications
and Faceberry Publications of the BAC Education
Group for assisting with the artwork and layout of
the report.
Rethinking economics - A Framework for Malaysia to Escape the Middle Income Trap10
CONTACT US
Sage 3 Sdn Bhd
Our address: No 2&4, 2nd Floor, Jalan Medan Setia 2, Plaza Damansara, Bukit
Damansara, 50490 Kuala Lumpur
Our web address: www.sage3.com.my
Datuk Mohd Anwar Yahya | Executive Director of Sage 3
Prior to joining Sage 3, he was Senior Partner of PricewaterhouseCoopers & was head
of Public Sector. He was also overseeing the corporate finance business, capital project
and infra practice in PwC and developed strategies which are mission critical for the
development of the Malaysian economy.
Office number: 03-2011 8268
Email 1: [email protected]
Email 2: [email protected]
Website: www.sage3.com.my
Ravindran Navaratnam | Executive Director of Sage 3
Prior to co-founding Sage 3, Ravindran has held senior positions including CIO of Bursa
Malaysia, Director of PwC Consulting Financial Services Practice and Danaharta’s
General Manager for Corporate Services which included research coverage of the
Economy. In respect of financial distress affecting economies, he has presented papers
across the world and conducted various strategic consulting assignments in Indonesia,
China and Malaysia. He is the prime mover for the technical matters contained in this
report.
Office number: 03-2011 8268
Email 1: [email protected]
Email 2: [email protected]
Website: www.sage3.com.my
Dato’ Dr Zaha Rina Zahari | Advisor of Sage 3
She has held senior positions in financial sector and her views are highly sought in
respect of the development of Capital Markets as well as Islamic Finance which involves
in-depth issues of the economy.
Office number: 03-2011 8268
Email 1: [email protected]
Email 2: [email protected]
Website: www.sage3.com.my
RethinkingEconomicsA FRAMEWORK FOR MALAYSIA TO ESCAPE THE MIDDLE INCOME TRAP
SAGE 3
Sage 3 Sdn BhdNo 2&4, 2nd Floor, Jalan Medan Setia 2, Plaza Damansara, Bukit Damansara, 50490 Kuala Lumpur.
www.sage3.com.my