Local Innovation: Key for Malaysia to Escape Middle Income Trap

In 1970’s, almost half of Malaysian still lived below the poverty line with a GDP per capita of around $USD 390. Currently, GDP per capita has reached more than $USD 10,000 and less than 1% of Malaysians live below the international poverty line of $1.25 per day (World Bank, 2011). Huge growth rate between 1980s and 1990s that averaging at 9% per year has successfully transformed its economy from a poor, agriculture based economy into a modern, upper-middle income country. However, from 2000 onwards, Malaysia’s economic growth started to decline and its GDP per capita remained stagnant at middle-income level. Countries such as Taiwan, Korea and Singapore that have relatively same GDP per capita level with Malaysia in the early 1970s have overtaken Malaysian in term of economic growth and successfully put their countries at high-income level status. Therefore, Malaysia needs to reform its economy in order to escape from middle-income trap that could transform the country into high-income nation.

Research done by Foxley and Sossdorf (2011), that examine the successful cases of Korea, Finland, Spain and Ireland to escape middle income trap has identified four main factors that enable these countries to transform from middle income to high income economy: 1) good macroenomic management 2) flexible exchange rates and labour markets 3) high rate of investment in education and innovation 4) stable political and social condition. Malaysia seems to fulfill all the requirements mentioned above except for investment in education and innovation.   Malaysia’s main economic  growth contributor relies heavily on export-oriented manufacturing supported by foreign investment. Malaysia’s local companies have not done enough innovation to add value to their products. Report done by World Bank (2010) that examnie the innovation growth in Malaysia found that there is a huge decline in private investment in Malaysia from mid-1990s onwards and R&D spending stays low, at about 0.6% of GDP (compared to 3.5% in South Korea). Malaysia’s educational policy that is racially biased where it discriminates Chinese and Indian racial minority admission to public universities hinders the true potential for Malaysia to fully develop its human capital. 

If Malaysia is going to escape the middle-income trap, the government must implement a massive reform in educational and research institution.  Strengthening the education system by giving equal access to all people is important to enable Malaysia to have better human capital that can fulfill high skilled labor demand that can drive innovation in the country. Instead of relying from foreign firms’ technology, Malaysia should innovate locally in order to maintain sustainable growth in the future. Unlike in Taiwan and South Korea, there are only a few industries in Malaysia that has become world-class industries. As stated by Foxley & Sossdorf, (2011), South Korea successes in achieving high income status are largely due to its local innovation successes that have been able to create homegrown, internationally competitive industries. South Korea for example has more than 15 companies listed as Fortune Global 500 Company whereas Malaysia only has one, which is PETRONAS, Malaysian national Oil and Gas Company.  Government can help to foster local innovation by channeling more financial resources to local start-up companies and other potentially innovative firms. Economic Transformation Programme, a Malaysian government initiative that have been introduced in 2010 to attract private investments in national key economic areas such as oil and gas, financial services, and manufacturing might help to resolve this issue.

Works Cited

Foxley, A., & Sossdorf, F. (2011). Making the Transition: From Middle-Income to Advanced Economies. Washington DC: Carnegie Endownment.

Hazri, H. (2011, January 26). Malaysia’s Middle-Income Trap. In Asia .

 World Bank . (2010). Malaysia Economic Monitor: Growth through Innovation. Thailand : The World Bank .

World Bank. (2011). World Development Indicators. World Bank.

How Effective is Malaysian Capital Control Policy in Handling 1997-1998 Financial Crisis?

Financial crisis in Asia during 1997-1998 have created a huge economic downturn for South East Asian economy, particularly in Thailand, Indonesia, and Malaysia. Thailand and Indonesia were forced to follow IMF policies to handle the financial crisis in return for IMF’s financial assistance. These countries were obliged to float their exchange rates, increase interest rates, tighten their fiscal policy, shut down troubled banks and liberalize their capital account (Stiglitz, 2002).  However, Malaysia took a very different path in handling the financial crisis. Instead of relying on IMF financial assistance, Mahathir Mohammad, Malaysia’s prime minister at that time reduced interest rate, imposed strict capital controls, and fixed the exchange rate at RM 3.80 against the US dollar. Malaysian economic policies were seen as “radical” and many economists at that time criticize Malaysia’s decision to abandon IMF measures. On the contrary, Malaysia’s choice to impose capital control have able the country to recover faster and stronger compare to Indonesia and Thailand.    

Stiglitz (2002) argues that imposing capital controls was an effective way to stabilize the economy at that time and he criticizes the IMF decision to interfere with Thailand’s economic policy. He argues that the interventions of IMF in the Thailand economy that force it to liberalize its capital account have dampened the economic recovery process in the country.  IMF utilized similar measures that they have done in Latin America to improve Thailand and Indonesia economic condition, but the situation is not exactly the same. Most of IMF measures have negative effect for targeting countries. For example, IMF has forced Thailand and Indonesia to increase their interest rate. Alas, increasing these countries’ interest rate has dampened the consumption demand in these countries and makes matters worse. High interest rates implementation have put many firms and businesses to be in high levels" of indebtedness because the cost to borrow money has become more expensive. This has led to reduce in investment in most of the major driver of economy in the country.

Malaysia’s decision that was very contrary with Thailand and Indonesia, which is to reduce interest rate instead of increasing it and to suspend capital account, have revived the domestic demand in the country. Malaysia’s capital control policy put an end to speculative activities in the currency and stops the investment rush to exit the country. Due to the effective capital control policy in handling 1997-1198 Asian financial crisis, Malaysia was able to recover faster and stronger compare to other Asian crisis economies such as Indonesia and Thailand. Malaysia has accumulated large surpluses from the external current account allowing an accumulation of international reserves. Unemployment in the country has steadily declined, and inflation remained low (Meesook, et al., 2001). The econometric analysis presented by Kaplan and Rodrik (2001) that compare the control of capital in Malaysia with the International Monetary Fund’s policies in other countries are consistent with the conclusion that control of capital was the best response to the crisis at that time.  

Bibliography

Kaplan, E., & Rodrik, D. (2001). Did the Malaysian Capital Controls Work? NBER Working Paper, No. w8142.

Meesook, K., Lee, I. H., Liu, O., Khatri, Y., Tamirisa, N., Moore, M., et al. (2001). Malaysia: From Crisis to Recovery. International Monetary Fund.

Stiglitz, J. E. (2002). The East Asia crisis: how IMF policies brought the world to the verge of a global meltdown. In J. E. Stiglitz, Globalization and its Discontents (pp. 89-132). New York : Norton.