The optimism at the dawn of the new millennium which saw Malaysia relatively buoyant has gone awry, thus necessitating a new policy framework if we are to re-start sustained high growth.
Boosted by the rapid rebound from the Asian Financial Crisis of 1997-1999, Malaysia greeted the start of the new millennium in 2001 with confidence.
The Third Outline Perspective Plan projected that the average annual GDP growth rate in 2001-2010 would be 7.5 percent, up from the 6.7 percent annual growth rate in 1971-1990 period, and from the 7.0 percent in the 1991-2000 period. This higher growth rate would be the outcome of Malaysia’s accelerated emergence as a knowledge-based economy.
Technological innovations would cause Total Factor Productivity (TFP) to increase its contribution to GDP growth to 3.2 percentage points from 1.8 percentage points in 1991-2000 and 0.9 percentage points in 1971-1990. Malaysia Boleh.
However, this optimism has proved to be ill-founded even before the arrival of the global financial crisis in the last quarter of 2008. Instead of surging to a 7.5 percent growth rate, the average annual real GDP growth rate turned out to be only 4.5 in the first five years of the second millennium, and 6.1 percent in the 2006-2007 period.
The fact that, in the same 2001-2007 period, economic growth accelerated in the neighboring countries of China, India and Indonesia certainly makes credible the possibility that Malaysia has descended to a much slower growth path, and would not transition fully to a knowledge- based economy by 2020.
What happened?
Looking at the big picture
There is a need to stage specific obstacles and for constant re-invention. The growth process creates new challenges that have to be overcome in order for growth to continue. Each stage of economic development has its own set of obstacles to moving on to the next stage.
Central planning allowed the Soviet Union to urbanize and industrialize quickly to middle-income status in 1970 but could not allow USSR to continue to catch up with USA and Western Europe. The lack of technological innovation in non-military industries and service sectors was simply appalling.
Bureaucratically-directed interventions in collusion with large private businesses allowed Japan to catch up to the living standards of Western Europe and the USA in 1992. Japan then entered into period of slow economic growth (that bordered on stagnation), in which it is still mired.
Looking at the policy actions of USSR in the 1975-1990 period, and the policy actions of Japan in 1995-2009 period, it is clear that “doing more of the same (even more intensively)??? did not work, and will not work.
New growth strategies were needed in USSR and Japan in order for them to enter into their respective new growth phases. In the case of Russia, the switch to market allocation and the entrenchment of market-infrastructural institutions (e.g. commercial courts) were necessary to re-start growth.
Malaysia has moved from being a raw commodity exporter to an industrial product exporter, from a banana chip exporter to a computer chip exporter. Malaysia has become a middle-income country, and knowledge-led growth is the next development stage for Malaysia.
Socio-political conditions changed
In 1957, ethnic identity was the primary determinant of political allegiance in Malaysia. With increased inter-ethnic interaction and rising levels of education, national identity has been growing in its appeal to political allegiance. In large and growing segments within each ethnic community, national identity has replaced ethnic identity as the primary determinant of political identity. Nation-building has succeeded in Malaysia.
Social expectations of government’s performance have also been rising. Positive qualities like “competence, accountability and transparency??? are now much more valued.
The growing Malay middle-class and the increasing cosmopolitanism of Malaysian society are accelerating the above social and political trends. The New Economic Policy (NEP) framework of 1970-2009 is inconsistent with knowledge-led growth. The NEP anchor is preventing forward movement on economic and socio-political fronts.
The quantity target of NEP framework is anathema to quality upgrading emphasis of a knowledge-based society. A knowledge-based economy requires meritocracy. Institutionalized discrimination prevents full mobilization of human resources (e.g denying education to women amounts to using only half of the brain for thinking; denying top leadership positions to Chinese and Indians amounts to employing less than 60 percent of the national talent pool).
Ethnic quotas on ownership structure are anti-growth. Ownership quota either discourages successful Chinese Malaysian firms from tapping local stock market to fund expansion or drives Chinese Malaysian firms to move headquarters to foreign lands. This is why, unlike the Taiwan case, there are very few Malaysian firms that have moved from producing import-substituting (import-competing) goods to become major exporters of these goods.
Ethnic quotas on bank loans, business licenses, government contracts, and employment promote corruption throughout society. Side effects of such ethnic quotas include the perpetual infant industry phenomenon, ‘money politics’, and increasingly frequent outrageous rulings by the Malaysian courts.
NEP focuses too much on the redistribution of income and not enough on the generation of income. NEP is hence at odds with the basic truth that “a rising tide raises all ships???.
Essentially, by denying existence of the ‘trickling down mechanism’ and the importance of self-help, the over-interventionist NEP undermines high growth by
* enshrining mediocrity at best, and rewarding incompetence in general
* providing a social justice justification for corrupt practices
* undermining investor confidence through concerns about escalating inter-ethnic tensions created by unfair government practices.
Conditions for knowledge-led growth
There is now the need for a new vision in order to come up with new policies that will ignite knowledge-based growth. An effective strategy to transit to knowledge-led growth requires the government
* to get the microeconomic prices right
* to get the framework institutions right, and
* to get the macroeconomic balances right.
‘Getting the microeconomic prices right’ means that the government has to reduce significantly its interference in the price-setting mechanism by withdrawing the near-monopoly status enjoyed by government-linked companies and by firms affiliated with families of prominent politicians.
The federal and state procurement systems should be open tender systems, and the licensing of small businesses (e.g. taxis) should be race-blind. The price-setting mechanism should be an economic instrument of resource allocation and not a political instrument of rent disbursement.
The greatest price distortion is the growth tax on firms imposed by the NEP. Until June 30, 2009, the following situation was true, with some exceptions, under the label of ownership restructuring by race:
• a non-Malay firm that wants to tap the Malaysian stock market in order to grow had to sell 30 percent of its total equities at a discounted price to Malay individuals selected by the government; and
• when, in the future, this firm seeks to tap the stock market a second time to finance further growth it would have to sell 30 percent of its (expanded) total equities at a discount to government-designated Malay individuals if those favoured Malay individuals in the first round had taken profits by selling all the shares to non-Malay investors.
On June 30, 2009, this NEP tax on firm growth was cut to 12.5 percent, and fundraising by already-listed firms would be exempted from this NEP growth tax.
Addressing social equity
Corruption and political patronage are the main obstacles to ‘getting the prices right’.
Issues of social equity are more efficiently addressed through direct income transfer programs (like access to medical coverage, access to education scholarships) rather than through indirect allocation of rents generated by legal restrictions.
“Getting the Framework Institutions Right??? means reform of the key economic, social and political institutions to modernize the governance framework.
Specifically, the large- scale institutional reforms undertaken in Indonesia after the dismissal of President Suharto should be studied for possible relevance to Malaysia, e.g. the decentralization of a significant amount of economic policy decision-making to the provinces, and the structure of its new anti-corruption agency.
There must be a larger number of independent policy research centers to generate and test ideas of how to move Malaysia to its next stage of economic development. To ensure satisfactory progress on the road to a knowledge society, Malaysia cannot rely primarily on just one think tank, the Economic Planning Unit (EPU).
The ‘home biasness’ of EPU and the federal government is evident in the over-concentration of federal-subsidized projects, educational institutions, and industrial development in the Klang Valley.
There has to be a wider national dialogue right now on the government’s economic policy framework and the regional aspects of the national development strategy. The last such national dialogue was in 1969 when Malaysia was in a more primitive stage of economic development.
It violates common sense to expect the policy framework adopted then, the NEP framework, to still be effective (not to mention, optimum) 40 years later.
The drastic growth slowdown in the new millennium reveals that new framework institutions and new policy instruments are needed now to manage the Malaysian economy better.
Malaysia should study the regional outcomes in China’s post-1978 reform experience:
• the decentralization of policy-making on economic issues allows each province to promote investment initiatives that are in line with the comparative advantage of each province;
• the empowerment of local decision-making led to growth competition among the provinces that accelerated economic development, and to positive cross-provincial spillover effects; and
• the empowerment of local decision-making requires that each province has considerable autonomy in local public finance, i.e. local revenue is not just allocation from central government, it is also based on local sources. This independent fiscal base enables the local government to respond to the particular infrastructure bottlenecks of the region quickly, and avoid the lengthy process of seeking central budget allocation.
Balancing state rights
Everyone talks about the 1957 compact among the races in Malaysia but what has been forgotten is the other social compact made to enable the formation of the Federation of
Malaysia: the compact among the states. Because of prolonged rule by the National
Front at the Federal level and in almost all of the states, federal-state relations have been reduced to mostly intra-Umno bargaining (and for a brief time span in the case of Penang, there was intra-coalition bargaining).
State rights have largely disappeared in economic policy-making. This is best exemplified by the absence of a meaningful revenue base for each state, e.g. Terengganu’s oil resource income is almost entirely expropriated by the Federal government, and, even then, Terengganu’s share of the oil income has also not been reliably transferred to the state government of the day.
Since the Federal Government has monopolised revenue collection and rendered state development expenditures near-totally dependent on federal allocations, Kelantan has long been punished for its political exceptionalism despite of it being a low-income state.
The recent comprehensive cancellations by the Federal government of promised infrastructure projects in Penang makes it appear that Penang is now slated for the Kelantan treatment. In the past decade, Penang has been receiving an annual allocation from the Federal government that is much less than 20 percent (more often, about 10 percent) of the amount that it turned dutifully over to the Federal treasury.
The longevity of PAS in controlling Kelantan suggests that the practice of starving an opposition state of development funds is not a very efficacious way to win the hearts and minds of voters. Voters have ideals and these ideals are not always for sale. The Kelantanese have rejected “money politics??? with their votes in most national and state elections just as consistently as Umno politicians have rejected “money politics??? in their speeches before each Umno election.
While it is not certain that starving Penang even more of development funds would return the state to the Barisan Nasional fold, what is certain is that the growth rate of Malaysia would be lowered because there would now be a reduction in the positive spillover effects from Penang to the neighbouring states of Kedah and Perak.
This prediction is based on the experience of exceedingly large positive spillover effects on these two states from the establishment of semi-conductor manufacturing firms in Penang in the 1970-2000 period. Trickling down is an economic phenomenon that cannot be denied – a rising tide lifts all ships.
Federal-State fiscal relations has to be put on a more even keel so that the Federal government can no longer engage in white elephant type of mega-projects concentrated in the Klang Valley at the expense of economic development in areas with even higher growth potential, e.g. it is hard to justify the expenditure on Putrajaya on development grounds (how does Putrajaya add to the national production capacity or facilitate national production?).
“Getting the centre-state fiscal institution right??? is important for raising the average national growth rate and for promoting equitable development in Malaysia.
* The second and concluding part of this article will appear tomorrow.
