DANGER UP AHEAD

Malaysia 2016 | ECONOMY | FOCUS: MIDDLE INCOME TRAP

Under the leadership of Tun Mahathir in the 1990s, Malaysia set out its vision to become a developed nation by 2020—defined by achieving a per-capita income of $15,000—however, the country's rate of growth in recent years has slowed leading to fears that it may be heading into a middle-income trap.

Currently, Malaysia is classified as an upper middle-income nation. GDP per capita stands at $11,000 (non PPP-adjusted figures as of 2014), making it the third richest country in ASEAN, behind Singapore and Brunei. Malaysia has been successful in eradicating absolute poverty—less than 1% of the population today is considered “absolute poor," down from around 50% in 1970—and it is one of only 13 countries identified by the Commission on Growth and Development to have recorded an average growth rate of more than 7% per year for 25 years or more.

But, like in many emerging economies, Malaysia's rate of growth has slowed, leading to worries that it has fallen into the so-called middle-income trap—when a country loses its growth momentum in the final leg towards achieving high-income nation status, effectively becoming stuck at the middle-income level. The term was coined in 2007 by two World Bank economists and quickly entered the vernacular of mainstream economics. The Prime Minister Dato' Seri Mohd Najib bin Tun Hj Abdul Razak has himself embraced the term, describing the avoidance of the middle-income trap as Malaysia's greatest development challenge.
According to the economic theory of convergence, it is normal for countries' rate of growth to slow as they reach higher levels of development, since it easier to move from low to middle income than it is from middle to high income. Poorer countries develop at a faster rate because they are able to exploit the advantages of being poor such as cheap labour, to create a competitive manufacturing industry and pursue an export-led growth strategy. Eventually, as a country prospers and wages rise, it becomes more reliant on technological innovation to remain globally competitive. Countries fall into the trap when they are unable to concurrently compete with the technology of advanced economies and with the low wages of less developed ones. Differentiating between a temporary growth slowdown and the trap will depend on the amount of time spent at the middle-income level and for Malaysia, which entered the upper middle-income group 20 years ago, the threat certainly looms.
According to a recent working paper by the IMF, Malaysia should seek to emulate those countries that have managed to avoid the trap, in particular, South Korea and Taiwan. The former, whose GNI per capita in 1970 was at $260, below Malaysia's $380, surpassed it in 1985 and by 2009 was three times larger at $21,530 compared to $6,760. South Korea's success is often attributed to its focus on home-grown innovation driven by local firms, rather than by foreign MNCs, which Malaysia relied on for technology diffusion and knowledge transfer. According to this assumption, Malaysia should move away from investment-based growth and adopt an innovation-based growth strategy, focusing on local technology creation rather than the adoption of foreign technology.

At the heart of this is a strong education policy to boost skills and productivity, as well as investment in and commercialization of R&D by local firms. Efforts to boost tech innovation and entrepreneurship in Malaysia have been lauded: Malaysia recently became the first country in ASEAN to define crowd-funding laws, which is set to see entrepreneurship and small businesses flourish, and through the creation of the Malaysian Global Innovation & Creativity Centre (MaGIC) the government seeks to create a hub for start-ups in the region.
The global economic slowdown and weak commodity prices will challenge the country's ability to regain its growth momentum. Official IMF growth forecasts have been revised downward to 4.8% for 2015 and 4.9% for 2016, a significant drop from the 6% recorded in 2014. Another issue is Malaysia's high levels of income inequality, which raise the question of whether surpassing a certain income per capita threshold is sufficient for it to join the ranks of developed nations. As the 2020 deadline approaches, addressing the productivity gap and income disparities should be at the top of the government's agenda.