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economy Can Malaysia graduate into the league of high-income countries? If Malaysia doesn’t fix glaring flaws in education and labour quality, it can kiss goodbye to meaningful economic transformation. Saravanan Ramasamy C ases of rapidly growing economies stagnating at middleincome levels and failing to graduate into the league of high-income nations are not uncommon. This phenomenon, often described as the‘middle-income trap’, is best demonstrated by Latin American countries such as Mexico, Brazil and Peru where a period of growth was suddenly followed by noticeable slowdowns, resulting in rapid deviations from the upward growth trajectory. An IMF Working Paper entitled ‘Growth Slowdowns and the MiddleIncome Trap’ published in March 2013 compares several successful East Asian economies and some unsuccessful Latin American economies. Although Latin American countries such as Mexico, Brazil and Peru reached the middleincome level before any of the other countries, they did not progress further as compared to two of the Asian “Tigers”, Korea and Taiwan. Despite their relatively late start, Korea and Taiwan managed to 36 progress rapidly, increasing their per capita income from US$3,000 (MYR9,949.50) to surpass US$23,000 (MYR76,280.18) in a relatively short time. The IMF research went further, looking at drivers of growth and deceleration amongst these Latin American countries. It decomposed growth rates into physical capital, human capital and an expansion of the working age population and the residual is called Total Factor Productivity Growth (TFPG). TFPG, in its most fundamental definition, is the residual that measures ‘everything and anything’ that is not accounted for by input growth. Source : IMF Note : t = 0 defines as the year when GDP per capita for a particular country reached US$3,000 in PPP terms accountants today | JANUARY / FEBRUARY 2014 Can Malaysia graduate into the league of high-income countries? Source : IMF Source: Note • • IMF 1/12 refers to a low income threshold of US$1,000 and a high income threshold of US$12,000 in PPP terms Frequencies are calculated as the ratio of slowdown episodes to the total number of observations per income class Source : United Nations’ Statistics Division Adopted from: The Star Business 11 January 2014 It can also refer to the additional output generated through enhancement in efficiency arising from advancements in workers’ education, skills and expertise, acquisition of efficient management techniques and know-how, organisational improvements and gains from specialisation. The IMF paper claimed that steep falls in TFPG appear to have played an important role in past growth slowdowns of the Latin American countries in the 1980s. What’s also interesting to note is that the paper proved empirically that countries that have attained middle-income status are more likely to experience slowdowns than low-income and high-income countries. The Malaysian scenario Based on the World Bank’s 2012 definition which categorises a high-income nation as a country with a Gross National Income (GNI) per capita of more than US$12,615 (MYR41,838), Malaysia, with a GNI per capita of US$9,820 in 2012 (MYR32,568), is already ranked in the upper-middle income league. While Asia continues to set the pace as the world’s fastest growing region, some Asian middle-income countries are showing signs of economic slowdown and face stiff competition from lower-cost economies. Malaysia is not an exception. While the headline numbers continue to paint a somewhat rosy picture for Malaysia’s economy amid a weak global economic environment, these obscure the risks that may hinder the country’s continued progress. Indeed, one would question whether Malaysia can indeed graduate into the league of high-income countries. According to the IMF working paper, Malaysia, as compared to other Asian countries, faces a larger risk of slowdown stemming from institutions and macroeconomic factors (see table on page 38). The paper considered 42 growth factors, grouped into five categories, namely; (1) Institutions, (2) Infrastructure, (3) Macroeconomic Environment and Policies, (4) Trade Structure and (5) Others. JANUARY / FEBRUARY 2014 | accountants today 37 Can Malaysia graduate into the league of high-income countries? 1. Institutions include small government involvement in the economy, strong rule of law and light regulation. 2. Infrastructure includes telephone lines and road networks. 3. Macroeconomic factors include low gross capital inflows, the change over 2008-2012 in capital inflows and trade openness and the (negative of the) change in the investment-to-GDP ratio. 4. Trade structure includes strong regional integration. The findings of the IMF paper were also echoed in a report by The Asia Foundation (TAF), an international non-profit organisation headquartered in the United States. Source : IMF Note – A higher risk of slowdown arising from institutions in Malaysia than in Vietnam does not mean that the latter has “better” institutions than the former but rather that its institutions have improved more rapidly over the last period of the sample 2000-2007 2008-2012 2000-2012 Average Change (%) GDP 5.57 4.24 5.06 Labour 1.46 1.49 1.47 Labour Quality 0.19 0.18 0.19 Labour Quantity 1.27 1.31 1.29 Capital 1.99 2.00 1.99 Non-ICT Capital 1.09 1.04 1.07 ICT Capital 0.90 0.95 0.92 TFPG 2.12 0.76 1.6 GDP 100 100 100 Contribution to GDP (%) Labour 26.27 35.08 29.11 Labour Quality 3.46 4.19 3.69 Labour Quantity 22.82 30.89 25.42 Capital 35.65 47.09 39.34 Non-ICT Capital 19.50 24.63 21.16 ICT Capital 16.14 22.46 18.18 TFPG 38.08 17.83 31.55 Source : Department of Statistics, Malaysia Adopted from: The 20th Productivity Report, Malaysia Productivity Corporation 38 accountants today | JANUARY / FEBRUARY 2014 While institutions are important, indeed crucial, for growth, there has been much more attention paid recently to the role of institutions in Malaysia. According to the TAF report, there is a compelling need for Malaysia to shift from a race-based to a needs-based policy in order to address imbalances in society and improve the democratic process to ensure good governance and that the rule of law prevails. Poor institutions could deter innovation, hamper the efficiency of resource allocation and reduce the returns to entrepreneurship. The TAF report goes on to reason that despite the numerous bold policy measures and long-term plans introduced by the Government over the years, Malaysia’s economic progress continues to be plagued by a lack of innovation and skills, a low level of investments in technology, declining standards in education, relatively high labour cost and sluggish productivity growth. Productivity improvement badly needed Based on the 20th Productivity Report issued recently by the Malaysia Productivity Corporation, while Malaysia enjoyed an average GDP growth rate of 5.06% for the period 2002-2012, the economy grew at a slower pace during the period 2008-2012 at an average growth rate of 4.24%, as compared to 5.57% during the period 2000-2007. Decomposing the growth rates into Labour, Capital and TFPG contribution reveals that while TFPG contributed significantly at 38% during the period 2000-2007, the contribution decreased more than half to 18% during the period 2008-2012 (please see table on the left). The concern over the drop in TFPG was raised in the 20th Productivity Report. In order to ensure that the Malaysian economy remains on a sustainable growth path, the focus will have to be on labour quality, said the report. Countries like Hong Kong and South Korea reaped the benefits of a significantly high contribution of labour quality during the period 2008-2012. It was not so in Can Malaysia graduate into the league of high-income countries? Source: Labour Force Survey, Department of Statistics, Malaysia Cited in: The 20th Productivity Report, Malaysia Productivity Corporation the case of Malaysia, where labour quantity contributed much more than labour quality in improving TFPG’s contribution to economic growth. The growth of TFPG is expected to raise per capita income and living standards for the long-term. The report stressed that the driver of TFPG will have to be R&D, investment in human capital as well as investments in capital equipment that can fundamentally change the focus of the economy. This is where the level of ‘knowledge’ plays a critical role in raising TFPG. Increasing the level of knowledge will drive the level of ‘critical thinking’ and in turn improve the contribution and quality of labour productivity. Education reform is inevitable Education reform is the key to raising productivity and quality. A comparison of Malaysia’s labour composition over the period 2000-2012 showed total employment with secondary education remained high at 55%. Total employment with tertiary education increased by 12% from 14% to 26% which was substituted by the drop in primary education from 31% to 19% (see graph above). While tertiary education’s contribution has increased, nevertheless, total employment with secondary and primary education still remained the major employment group, constituting 74% of the total employment in 2012. This trend has to change. To put things into perspective, in a recently published report by Hong Kong’s Economic Analysis Division, it was report- ed that the proportion of the local workforce with tertiary education increased steadily from 31% in 2007 to 34% in 2012. If we want to compete and not just pay lip service to transformation, Malaysia must produce a high-quality workforce through improving the quality of education. But the journey will be arduous. A World Bank report entitled ‘Malaysia Economic Monitor: High Performing Education’, noted that the cognitive skills of Malaysian students, as measured by standardised international tests, is not on par with the country’s aspirations to become a high-income economy. While Malaysia spends billions on education, the end result is schooling, and not learning. The World Bank report stated that Malaysia has extensive coverage with its schools and achieved near-universal access that has 9 in 10 Malaysian adults undergoing at least lower secondary education. The Malaysian government spent the equivalent of 3.8% (approximately US$12 billion or MYR39.8 billion) of its GDP on basic education, or more than twice the average of 1.8% within ASEAN nations. This is also higher than the 2.2% average of the Asian tiger economies of South Korea, Hong Kong, Japan and Singapore. However, this larger spend does not commensurate with an increase in quality. As we all know, Malaysia underperformed shamefully in the Programme for International Student Assessment (PISA) survey results released in December 2013, ranking 52nd overall out of the 65 countries. Malaysia did not only trail high-performing education systems in East Asia, but also poorer nations such as Vietnam, which outperformed the country by a significant margin. Aside from the abysmal PISA performance, Malaysia continued to decline against the Trends in International Mathematics and Science Study (TIMSS) benchmark in which Malaysia once performed well. Although Malaysia attained the international average between 1999 and 2003, we dropped sharply in 2007 and further in 2011. What lies ahead? With the Malaysian economy aspiring to reach high-income heights by 2020, the focus of growth must increasingly lean towards an innovation-driven growth strategy. This strategy emphasises the creation of high value-added activities, of which a key ingredient is the quality of labour. Thus far, Malaysia’s education system has failed in producing the skills and talent required to take the country’s economy to the next level. Apart from labour quality, it is important to focus on government involvement in promoting a fair and open economy. Insufficient checks and balances continue to dog the country’s economy, thus leading to opaque governance practices. Reforms are critically needed to promote economic inclusion among all ethnic groups by doing away with rent-seeking behaviour and patronage politics. Reaching the target as set by the World Bank does not really make one a high-income nation as countries can always fall back to previous levels. What is important is for Malaysia to address the underlying dynamics that are deterring meaningful structural reforms – specifically those relating to labour quality and education. n JANUARY / FEBRUARY 2014 | accountants today 39