Monday, August 16, 2010

Malaysia's Middle Income Trap (or is it "Trapped")

A timely, but another "here we go again" charade, my comments at the end.

... a post by Michael Schuman on Time Magazine's Curious Capitalist blog, entitled, "Escaping the middle-income trap." The post focuses on how Malaysia's economic growth has been so consistently strong since World War II, yet has been slowing over the last few years and of how Malaysia just cannot seem to break into the league of developed nations. Schuman defines this "trap," as follows:

I returned a few days ago from Kuala Lumpur, the capital of Malaysia, where the talk of the town – well, at least among economists -- is the “middle-income trap.” What's that, you ask? A developing nation gets “trapped” when it reaches a certain, relatively comfortable level of income but can't seem to take that next big jump into the true big leagues of the world economy, with per capita wealth to match. Every go-go economy in Asia has confronted this “trap,” or is dealing with it now. Breaking out of it, however, is extremely difficult. The reason is that escaping the “trap” requires an entire overhaul of the economic growth model most often used by emerging economies.

The concept behind the “middle-income trap” is quite simple: It's easier to rise from a low-income to a middle-income economy than it is to jump from a middle-income to a high-income economy. That's because when you're really poor, you can use your poverty to your advantage. Cheap wages makes a low-income economy competitive in labor-intensive manufacturing (apparel, shoes and toys, for example). Factories sprout up, creating jobs and increasing incomes. Every rapid-growth economy in Asia jumpstarted its famed gains in human welfare in this way, including Malaysia.

However, that growth model eventually runs out of steam. As incomes increase, so do costs, undermining the competitiveness of the old, low-tech manufacturing industries. Countries (like Malaysia) then move “up the value chain,” into exports of more technologically advanced products, like electronics. But even that's not enough to avoid the “trap.”

To get to that next level – that high-income level – an economy needs to do more than just make stuff by throwing people and money into factories. The economy has to innovate and use labor and capital more productively. That requires an entirely different way of doing business. Instead of just assembling products designed by others, with imported technology, companies must invest more heavily in R&D on their own and employ highly educated and skilled workers to turn those investments into new products and profits. It is a very, very hard shift to achieve. Thus the “trap.”

Schuman sees South Korea as "probably the best current example of a developing economy making the leap into the realm of the most advanced." Schuman sees Malaysia as a long way from making that same leap:

Malaysia, though, is quite far from where it wants to be. That's a bit surprising based on its remarkable recent history. Malaysia has been among the best performing economies in the world since World War II, one of only 13 to record an average growth rate of 7% over at least a 25-year period. The country has an amazing record of improving human welfare. In 1970, some 50% of Malaysians lived in absolute poverty; now less than 4% do. Yet Malaysians also feel that they've become somewhat stuck where they are. GDP growth has slowed up, from an annual average of 9.1% between 1990 and 1997 to 5.5% from 2000 and 2008. Meanwhile, other Asian economies have zipped by Malaysia.

According to the World Bank, the per capita gross national income (GNI) of South Korea in 1970 was below that of Malaysia ($260 versus $380), but by 2009, South Korea's was almost three times larger than Malaysia's ($21,530 versus $6,760). Malaysia is getting “trapped” as a relatively prosperous but still middle-income nation.

Schuman does not see Malaysia making the leap. Its companies are not innovating. Its private investment is declining and it spends almost nothing on R&D. "If Malaysia is going to break the “trap,” it has to reverse all of these trends."

So what has made Korea so different from Malaysia?

Why has Korea jumped so far ahead? I think the reason is embedded in the different methods the two countries used to spur rapid growth.

Both countries relied exports to create rapid gains in income, but they did so differently. South Korea, from its earliest days of export-led development in the mid-1960s, had been determined to create homegrown, internationally competitive industries. Though Korean firms supplied big multinationals with components or even entire products, that was never enough – Korea wanted to manufacture its own products under its own brands. The effort was often a painful one – remember Hyundai's first disastrous foray into the U.S. car market in the late 1980s and early 1990s – but Korea is where it is today because its private companies have been working on getting there for a very long time, backed in full by the financial sector and the government.

Malaysia, on the other hand, relied much, much more on foreign investment to drive industrialization. That's not a bad thing – multinational companies provide an instant shot of capital, jobs, expertise and technology into a poor country. MNCs, however, aren't going to develop Malaysian products; that has to take place in the labs and offices of Malaysia's private businesses. But those businessmen have been content to squeeze profits from serving MNCs and maintaining their original, assembly-based business models.

Korea was at one time the second poorest country in the world, second only to Niger. Now, Seoul is more dynamic than Tokyo and Korea just continues to grow both economically and in terms of its political freedoms. Why is that? And why are countries like Malaysia and Thailand stuck in the middle ground? And what about China and Vietnam, will they be able to make "the leap?

Japan and Korea are important because they have spending power. Vietnam and Cambodia are important because they have very low wages. China is the most interesting because just three or four years ago, companies were going to China because of its low wages, but now, companies are going there to make money (mostly on the Coast) and going there to make things (more and more inland).

Where do Malaysia or Thailand fit into all this?

Malaysia and Thailand remind me a bit of the mid-size law firm. I can understand hiring the big firm for the big deal or the big case requiring a massive number of associates or legions of highly specialized partners. And I can understand hiring a highly efficient and focused small firm. But I rarely understand hiring the mid-sized firm, which usually tries to price itself along the same lines as the big firms, but without the corresponding depth or expertise. Why bother? And nothing against either Malaysia or Thailand, but I think many businesses have asked themselves this very question.


My Views: The way I see it, we always tend to blame corruption as the main bane to why Malaysia is trapped in the middle income trap. While that has some merit, it is not the pervading critical factor - Korea and Taiwan also have to deal with corruption, and at various times corruption was more ingrained and pervasive in Korea and Taiwan, maybe not to Malaysia's extent, but there are quite a lot of similarity, even today. Indonesia, whose corruption problem is much bigger than Malaysia, has surpassed Malaysia's per capita income measure as of last year - what gives?

Malaysia's strategy relied very heavily on import substitution while South Korea's revolved around creating export industries. Import substitution does nothing to bring in foreign exchange; it only stops outflows. To be fair, Malaysia does not have critical mass while South Korea and even Taiwan to a lesser extent can claim that. Having critical mass means a product will reach profitability much swifter, and will attract more capital to grow it for export markets later. Having ASEAN is supposed to help all countries get to critical mass faster, but all duties and related taxes have to be abolished to achieve that ~ no mollycoddling of any industries ~ if we are not effective competitor in producing cars, cement or steel bars, let someone else do it.

I see the main reason being our big picture strategy does not correspond to our actions or policies enacted or actions taken. We have wonderful big picture plans, we want to move away from mid-income to high income per capita ... but we still religiously allow millions of foreign workers in?????????????????????????????? Not to mention the additional millions of illegals unaccounted for - having a shadow workforce of 4m-5m when your actual local workforce is around 10m-12m will have immense repercussions. We know the solutions but we lacked the political to implement them.

The low paying jobs will all go to foreign workers who are happier to work in those jobs. But that reinforces the "low cost, labour intensive" mindset, causing businesses to continue to invest in those areas. Imagine if we have ZERO foreign workers = plantations cost will rise, well almost everything will rise as well ~ businesses will have to shut sunset industries and capital will have to find ways to get into higher value add businesses to stay afloat. There are plenty of ramifications on just that one issue which may explain a lot of things, but you can figure them out.

Another example of when big picture strategy or 1Malaysia does not gel with the actions taken: over subsidised local industries ~ we just never know when to stop with the breast feeding, do we??!! Take Proton, why are we Malaysians, and barely making the top 10 in Asia alone,... happens to be THE SECOND MOST EXPENSIVE PLACE ON EARTH to buy cars??????????????????????????????????? Talk about middle income, well a good chunk of it was taken to subsidise Proton.

Maknanya harga Persona kat Saudi = RM33,934 aje
Maknanya harga Proton Gen2 kat Saudi = RM32,256 aje
Maknanya harga Waja kat Saudi = RM35,673 aje

Is our per capita income higher than Saudi??? Why are Malaysians paying double the price ... after 30 years??? I mean if you cannot compete after we Malaysians have been dumping profits onto Proton for 10 years, 20 years, doesn't that tell you something?

I am all in agreement with subsidising large industries for a country to get traction, but OMG 30 years ... South Korea did the same thing but these industries were weaned off government subsidy much much earlier, and today they are the Samsungs, Hyundais, LGs etc... Mark my words, if we just talk cock all the time, 10 years from now Malaysia will still be the second most expensive place to buy cars, and its because we are still subsiding Proton, and Cambodia and Vietnam's per capita income would have probably surpassed us as well.

These sort of things, you don't need a brilliant person to tell you why we are stuck in middle-income ... we all know the answers, most Malaysians are smart as we do supply very smart graduates to work in Singapore, Taiwan, HK, US, UK, Australia and Indonesia anyway. Big picture - easy, strategy and war cries - easy, actual action ~~~~ ooohhh, susah la... vested interests, not now la, maybe another 3 years, this one cannot la... belongs to so-and-so, that one cannot give open tender la, that project already given .... lower price also kenot... actual contract $35m, final price after adjustment $95m ... how la.

Then add cultural and business factors. Koreans believe very strongly in education. That's partly because it really is a path to success there. Degrees really do get you promoted, unlike most of the rest of the world. Koreans make being educated into a really big deal. Here in Malaysia, yes, getting a good education is important ... but its not the end of the road if you don't ... you can still get plenty rich by knowing the right people. Do we even dare to eradicate that "cultural issue"??!!

Comments from a foreign observer: "Malaysia isn't really a mid-sized firm at all. More like a lethargic government operation with mediocre status quo as the prevailing mantra. There's no efficiency or any notable skill, there's also no scale or depth. There's zero marketing acumen.

It seems more concerned with internal cultural problems than growing commerce (divisions between locals/chinese, islamic issues and so on). There's also a culture of IP theft which is pretty prevalent You open a software co there, they'll be selling burned copies of your stuff for $5 a cd at the local mall before the end of the week. They largely strike me as free riders, not leaders. It very much feels like a small town / strip mall kind of economy, with bootlegging thrown in.

Even if you imported capital, equipment, innovation and good leadership, I don't think they are culturally interested in commerce enough to suffer hardships to prevail. They don't strike me as goal-oriented team players in the way Koreans do."

The last para was hard to take for me, as a Malaysian ... how about you? Its not just in finance but the entire misalignment is evident in our justice system, or regard with respect to human dignity and personal rights ~ the government is supposed to do what is good for the country, if there is sufficient anger, the people will act, sooner or later.

Anthems, war cries, sloganeering .... all emblematic of our problems, and yet thats where we excel in??!! Maybe we can supply those as exports to other emerging countries??? I cringe whenever I hear Malaysia Boleh ... boleh what??? ...

(Whistling and singing): ... When will they ever learn, when will we ever learn ....


walla said...

This, the most important blog post made.

Bad policies shooed away the brains of Ipoh.

except one, it seems.

hat's off.

ronnie said...

A pop quiz. What is the total amount spent on research & development by the top 100 Malaysia companies by market cap ? My guess would be less than RM20 million. I am confident that I am not far mee the mark. My guess is that more money is spent on green fees than R & D.

kl said...

Malaysia is managed for the benefit of a small coterie of conniving politicians and businessmen, not the 27 million populace. Those few privileged to power are very well off and not in the middle income trap. If anything, they are in the 'power corrupts' trap. They and their cohorts play destructive games to stay relevant and in power, they have little interest in improving the lot of all the 'others' in the trap, only in their own. This is one reality in Malaysia.

jazzmutant said...

it's a bit hard to get into the team player mindset when your mates are on the take and your coach is on their side

Tony@MAA said...

How can a individual Malaysian get out of the middle income trap ?

skyta (史開達) said...

You miss an important point when comparing Malaysia and Korea: the all powerful MACC like organization in Korea that investigates corporate heads and government heads up to the level of president for corruption practice.

croyio said...

One very important factor is IQ. Even if we were to implement the best economy policy, it is still very hard for us to reach the status of say South Korea, Singapore or other advanced country.

Malaysia average IQ: 92.
South Korea: 106.
Singapore: 103.
Taiwan: 104.
Japan: 105.


green said...

Government need to play a role here if we want to move from middle income to hi income. The economic development board must bear the cost willing to invest in critical education and training to upgrade the workforce.

Education/Training must be revised anually and make up to date. Schools here are still teaching outdated syllabuses and obsolete skill sets.
Depending only MNC is not the solution. Government think tanks need to play an active role into understanding the ever changing economics situation and blue ocean markets. Train and direct workforce to specialize in these potentially lucrative markets.
As we are a small country, every citizen counts. Discover them talent early and groom up the workforce to face the economic challenges to come.

joeyy132 said...

If I am not mistaken you mentioned that Indonesia's per capita income higher than Malaysia as of last year? I doubt that is true.

Salvatore_Dali said...


personally, you will need to get into the industry or sub industry in malaysia that still pays for talent and superior performance ... if you do well in sales, mgmt or finance yr remuneration scale will not be hampered by the overall income trap.


u r right, i have taken that line out

Kian Leong Soon said...

I think Tony has thrown a question which all bloggers might want to ask aslo.This might be more significant when Chinse New Year is around the corner now, to all married couples, giving angpaos etc..anyway, to leap from middle income to high income, it depends on a lot of things.You can either achieve it by getting promotion with a huge payrise or moving pasture new or start up your own business.