Monday, June 25, 2012

Malaysia's Middle Income Trap

Volume 4 Issue 26: Intelligent Investing

There are many Malaysians who are in denial and strongly believe that Malaysia is not in a middle income trap. One of the foremost arguments put across is that Malaysia is still in the factor accumulation stage of economic growth. What this means in layman's terms is that, Malaysia is still in a developing stage that relies on investment expenditure in terms of machinery and infrastructure to generate growth.
(Wonkish note on Long-Term Economic Growth:  
Conventional economic theory suggests that long-term economic growth is based on four key ingredients: natural resources, capital stock, labor and productivity. First and foremost, it is reasonable to assume that the supply of natural resources are fixed for any particular country. There is only so much land you can plant on, so much oil you can drill, and so much coal you can mine. So, you can't really generate economic growth by increasing the supply of natural resources. That is fixed.  
Secondly, capital stock is the amount of fixed assets in the economy. This includes machinery and infrastructure. Typically, in countries undergoing industrialization, a lot of the economic growth comes from investment in capital stock, which is used for manufacturing, which transforms and adds value to raw materials, and subsequently translates to income growth.  
Thirdly, of course, every economy needs a functioning labor force to grow. As long as you have the raw materials, machinery and land, you can always produce more goods by hiring more people. However, you can only hire so many people in an economy. Also, there is a certain point where you will hit diminishing marginal returns, but I will not get into that today.  
Last, and most importantly, productivity. This is the most crucial ingredient for the sustainability of long-term economic growth. The gist of productivity is basically this: "How to produce more, with less?". You can achieve long-term economic growth by finding new ways to produce more goods with less input. This is in fact, the only way, because inputs are always scarce and limited.  
End of wonkish note)
The trouble with this argument is that we have been "developing" for more than 50 years. How long should one country be developing before it becomes of developed status? The figure below is obtained courtesy of the Economist

The graph measures a country's GDP per capita relative to the US after accounting for purchasing power. The World Bank report done in collaboration with China's Development Research Center, China 2030, defines a high income country as those having at least 43% of the US's GDP per capita. Since the chart is in log-income terms, the high-income barrier is marked by the 3.76 lines (log 43).

If a country is rated below 3.76 on the horizontal axis, that means that in 1960, it had not achieved high income status yet. But if it had exceeded 3.76 on the vertical axis, that means that it had already achieved high income status in 2008.

Countries in the top right box are those that were already high income in 1960, and have stayed there in 2008. Note that Malaysia is in the middle box labelled "Middle-Income Trap". This means that Malaysia was already a middle-income country in 1960, and had failed to escape the middle-income status even after 48 years of developing. Of course, this box is the most highly populated, clearly showing that Malaysia is not alone in being stuck in the middle-income trap.

This is no reason for us to give a pat on the back to ourselves and say "It's OK". It is NOT OK. We need to escape this mentality that it is OK because other people have failed too. In fact, I would argue that this is an even bigger reason to worry. So many others have tried and failed. Clearly achieving high income status is not as easily achievable as those illustrated in Idris Jala's pretty charts.

Ideally, we would like to be in the middle-top box, labelled "Middle-Income to High Income". This box represents countries that have been able to move from middle to high-income status and count countries like South Korea, Taiwan, and most definitely Singapore, even though it was not labelled on the chart.

It is time to stop relying on capital accumulation. Malaysia does not need taller buildings, longer roads, bigger computers and what not. Malaysia needs to focus on productivity. Malaysians need to work harder and smarter, so that we can start producing more goods with less input. And this can only happen if we stop subsidizing the cronies and stop rewarding rent-seekers with mega-projects. The culture of meritocracy must also be ingrained so that effort is justly rewarded. Otherwise, how can we produce more with less when lazy buggers are allowed to piggy-back on the hard work of others?

This is what the Economic Transformation Programme should focus on. Not the myriad of capital accumulation projects that Idris Jala can't stop talking about.