The Problem Of Middle Income Trap Economics Essay

Introduction

Everyone knows that Vision 2020 is impossible without economic, social and government transformation. Since the introduction of Vision 2020 by the former Prime Minister of Malaysia, Tun Dr. Mahathir Mohamad during the tabling of the Sixth Malaysia Plan in year 1991 until now, the hot talk of the nation which is “middle income trap” has not been chilled. And, we don’t think it will get chilled for the next ten years. First and foremost, let us define the meaning of middle income country – it is a developing nation that is facing an uphill struggle to maintain consistent growth rate. The concept behind the “middle-income trap” is 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. Modern growth theory predicts that these countries should witness three transformations: first, countries become more specialized in production and employment causes diversification slow and then reverse; second, innovation required as investment become less important; third, education shift its focus to produce skilled workers that allow them to embrace new technologies and produce new products and processes. (Gill, 2007)

Indeed, 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. (Schuman, 2010)Malaysian economy did sustained growth from year 1970 to 2010. Although Malaysia’s average GDP growth had fluctuated since year 1970, but Figure 1 still shows positive value except for several years where there were economic recession (1970s and 1980s) and economic crisis (1997 and 2008). However, the stagnancy of Malaysia’s economic well being making Malaysia unable to gallop away under the scenario of a rapidly expanding world.

Source: World Databank

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. Technically speaking, economies are divided according to 2009 GNI per capita, calculated using the World Bank Atlas [] method. The groups are: low income, US$995 or less; lower middle income, US$996 – US$3,945; upper middle income, US$3,946 – US$12,195; and high income, US$12,196 or more. (Worldbank)In year 2010, Malaysia’s GNI per capita was US$7469 approximately (Fong, 2010). Clearly, this implies that Malaysia is currently classified as an upper middle income country.

Source: World Databank

It can be seen that Malaysia have been stuck in a middle income trap for a long time when we compare our economic performance with, for example, that of South Korea, Singapore, Hong Kong which started industrializing at around the same time and were equality with Malaysia in the early 1970s. Now, South Korea’s real per capita gross domestic product (GDP) was US$16,450, Singapore US$34,346, Hong Kong US$29,559, while Malaysia is still at US$7,469 (Fong, 2010)

Country

Malaysia

Singapore

Year

GNI Per Capita (current $)

1970

400

960

1975

910

2800

1980

1830

4910

1985

1940

6990

1990

2390

12050

1995

4030

23570

2000

3450

23350

2005

5200

28340

2007

6420

34640

2008

7270

37650

2009

7350

37220

Source: World Bank Database

According to Figure 2, taking Singapore to compare with Malaysia’s GNI per capita, it indeed shows that both Malaysia and Singapore started at almost the same figure during the 1960. Based on the income group definition by World Bank, in year 1970, both of them are still categorized as low income group. However, Singapore’s GNI Per Capita (current $) grew on a more rapid rate than Malaysia’s and entered the high income group in year 1991. By referring to the statistics on GNI Per Capita, it can be shown that Malaysia itself is in the middle income group starting late 1977 and still belongs to the group till today.

In order to solve the problem, we need to admit and understand the problem first. This means we need to understand and appreciate what is happening around Malaysia. Due to the global financial crisis, the advanced countries will grow slower in the near future and many countries are revisiting their growth strategy. Recalling the term “creative destruction” by Joseph Schumpeter, undeniably, the global financial crisis is creatively destroying the old order, opening up opportunities in the new. And if we go through locally, the old growth model provided three decades of outstanding performance, allowing Malaysia to offer necessary health and education of its people, effective poverty eradication, build a world-class infrastructure and become a major exporter globally. But the progress over the past half-century has slowed and economic growth prospects have weakened considerably. For instance, by comparison, Singapore’s GNI per Capita was increasing at a higher rate than Malaysia until Singapore currently is categorized as High-income countries where Malaysia is still labelled as “Upper Middle income countries” (Worldbank)

And by looking globally, the pre-crisis era of overwhelming economic dominance by the G-7 is over. The new world growth engines, such as ‘BRIC” (Brazil, Russia, India and China) and other emerging economies like Indonesia, will grow faster and richer, have strengthened their voice in the G-20 and are set to play a more prominent position on the world stage.

The most important question remains here is, “Can Malaysia escapes from the trap?”

How did Malaysia get itself into the “middle-income trap”?

Malaysia is at a critical period in our history. Malaysia stuck in the middle between low labour cost countries and knowledge-intensive economies. Malaysia no longer a centre for cheap labour and low-cost production as compared with countries like Thailand, China, India or Vietnam, while also unable to compete with knowledge-intensive countries like South Korea, Taiwan or Singapore. It is becoming increasingly difficult to make the transition because of the stiff competition from Asian as well as South America & Eastern Europe and growth is not a given, GDP growth of 6% p.a. becomes a real challenge. (A New Economic Model to Face a Rapidly Changing Global Economy)

This is because of the following factors:

Price Control

Malaysian government controls the price of basic necessities like sugar, milk, chicken, rice, flour and bus and taxi fares. This price control policy made these necessities’ price lower compared to world price. For example, rice per kilo is RM2.75 compared to world price of RM6.75 in last year December. As cumulative effect of price controls for over 60 years has been a gross divergence between Malaysia Consumer Price Index (CPI) and world CPI because basic commodities compose a large part of the Malaysian CPI. Our nation CPI are also linked to workers’ wages, gross divergence of CPI will led to a corresponding significant different of wage between Malaysia and the world. Low growth rate of Malaysian CPI causes Malaysian wages fallen behind wages of the rest of the world. For example, a fresh graduate teacher gets RM2, 500 per month in Malaysia, compared to RM6,196 in Singapore and RM15,661 Hong Kong. Other than that, price controls also severely distort the domestic economic factor proportions, causes many manufacturer using non-efficient economic production processes. For example, price control of diesel and fuel, and workers’ wages suppressed, manufacturers prefer to use more fuels and labour as inputs instead of machines-intensive. This results in low-quality Malaysian products and low productivity growths. (Fong, 2010)

Subsidies

A subsidy is an amount support by government to the manufacturers who produced basic commodities in order to reduce manufacturers and society’s burden. Malaysia’s subsidies system starts in 1961 and under the Control of Supplies Act 1961. Subsidies mostly go to the price control items such as petrol, gas, rice, and some other basic commodities. In the 1970s, the price of oil was under US$12 per barrel, government still bearable to this price and subsidies it. In spite of that, the present oil price was increase to over US$75 per barrel. This is such huge amount and government cannot continue to bearing these subsidies items. As the world CPI increase, it means that world commodities price has increase. However, Malaysia governments just allow a small increase in these basic commodities price and have to bear a huge amount of subsidies. Thus, the cost of subsidies has ballooned from 3% (1980) of government operating expenditure to 30% (2008). This subsidy was one of the government expenditure, as government spend more on subsidies, it cannot spend much on other government spending such as upgrade infrastructure. The high cost of subsidies will lower the government’s ability to upgrade infrastructure such as public transport especially in rural area. This will retard the economic activity to run faster. Besides that, higher cost of subsidies will lower the government’s ability to provide competitive incentives to attract high income activities into our country. As a result, Malaysia economic cannot growth further to become high income nation and stuck in the “middle-income trap”. (Fong, 2010)

Prolonged Dependence on Unskilled Workers

Malaysia is one of the biggest net importer of labour in Asia. According to Ministry of Human Resource (MoHR) Malaysia, there are around 1.8 million foreign workers or 22% of the labour force in Malaysia and of the total, 1.2 million engaged in low-skill (unskilled and semi-skilled) jobs and uncounted unregistered ones. Figure below shows that the proportion of unskilled workers has grown throughout the time. (Himalayan Times, 2011)

Source:http://www.intanbk.intan.my/i-portal/dl/ppa2010/govindan.pdf

Prolonged dependence on unskilled worker will inadvertently making Malaysia fallen into a middle income trap. This situation getting worse where no young generation nowadays wish to take up those 3D jobs – difficult, dirty and dangerous jobs especially in agriculture and manufacturing sector. This job remain rely on foreign workers but most of the foreign workers is unskilled worker and cannot transform those sectors into a more developed. For example, the process to harvesting oil palm and rubber tapping still remained manual in nature and not easily mechanized. Businesses and enterprise prefers foreign to local citizens, because they are ready to accept lower pay than offered to local workers, diligent, docile and willing to work overtime including public holidays and weekends, prepared to risk their lives and work in deplorable conditions and foreigners may be easily exploited as they do not normally seek recourse to law and justice given their temporary status. As a consequence of easy access foreign workers had led to over-reliance on low-cost and unskilled workers, which has sustained and profitability of low-value-added business in the short term and provides no incentives to move up the value chain. Furthermore, these migrant workers would depress wages in the country and throttle productivity improvement as manufacturer choose to use labour-intensive instead of using more machines, this will slow down the production process and the quality of the product cannot be standardized. However, government cannot simply refuse the presence of foreign workers in the agriculture and manufacturing sector, this will cause both the activities to stop working or processing as most of the labour force in the sectors are foreign workers and yet there are shortage of local labour that interested to take up job there. (Arif, 2010)

How to overcome the problem of Middle Income Trap

It will be a very important issue to ensure that in future, Malaysia will escape from the middle income trap. Particularly, there is a need of keeping the GNI per Capita increasing at least with the same direction with GDP growth despite the rate of growth might not be the same. However, in order for Malaysia to escape from Middle Income Trap, one of the initiatives taken by Malaysian government was the introduction of New Economic Model (NEM) [] by National Economic Advisory Council (NEAC) emphasised high-skilled human capital, efficient public services, a reinvigorated private sector and equal opportunity for all Malaysians as introduced by the Prime Minister and Minister of Finance, YAB Dato’ Sri Mohd. Najib Tun Abdul Razak in the Budget 2010 Speech in October 2009. These policies can be consisting of Micro Incentives, Macro Balances, and Reformation.

Micro Incentives

Micro incentives may include subsidies, setting of market prices and taxes implemented on the peoples. Subsidies and prices are one of the possible tools Malaysia can use to ensure economic growth. Subsidies and price controls are one of the tools for government to help the people. However, excessive subsidies and lower price would be slowing the economic growth by distorting domestic factors and prevent the economic efficiency. This implies that even government wants to provide aid to the public, it must be planned and look through to ensure that Malaysia can achieve a certain economic growth every year. Lower prices, it would be a benefits to the public in the short term. However, in another point of view, it could cause the CPI (Consumer Price Index) [] to be suppressed from rising. Some people would think that low CPI is considered good, but low CPI would also give effect to the worker’s wage level. For instance, Malaysia in December 2009, a kilo of raw sugar in Malaysia was RM1.35, while the world price was RM2.20; that of rice is RM2.75 per kilo compared to world price of RM6.75; a graduate teacher starts at RM2, 500 per month in Malaysia, compared to RM6, 196 in Singapore, and RM15, 661 in Hong Kong. (Fong, 2010) . Referring to the first set of figures about basic commodities, it is undeniable that it was relatively cheap compared to the world price, which might be a good thing. On the other hand, would Malaysia’s starting salary of a graduate teacher which is lower than other country a good thing for economic growth? This implies that by keeping the prices down, it might affect the wage of workers and would give effect to the GNI Per Capita to either increase in a slower rate or staying constant. Too high amount of subsidies given by the government might also reduce the amount of budget that can be allocated to enhance Malaysia’s infrastructure to ensure economic growth. As Malaysia started to reduce its fuel subsidies, it could mean that there more money to be spent on other development, particularly infrastructure to encourage growth of industries.

‘Reduced expenditure will allow investment in Malaysia’s future. Our subsidy spending has become a barrier to achieving our goal of becoming a high-income nation by 2020. The reduction in government expenditures will allow investment in the nation’s future, such as education, healthcare, infrastructure, community development, training and job creation. These investments will provide lasting benefits for the current and future generations.’

(New Strait Times, 2010)

Wages

Wage is one of the biggest concerns for almost all the workers. To help Malaysia to get out of middle income trap, the government may implement a minimum wage policy. The initial issue arise might just because of the GNI Per Capita would increase. However, a bigger concern is that how can Malaysia get out of the middle income trap if the level of wage is not high enough to retain the skilled labour in Malaysia to secure long term economic growth.

‘The NEAC advocates a productivity-linked wage-setting system but, given the failures in the current wage-setting mechanisms, accepts the need for the introduction of a minimum wage policy in the interest of inclusiveness.’

(National Economic Advisory Council, 2010)

Malaysia depressed wages distorting market forces for too long. Government should increase the wages with the world. People may take home more pay, make them better, and then adjusted to the realities of international prices will get out of control and subsidies.

In the middle trap to catch a lot of countries have been deliberately jump start the high-wage policy, and economy. Singapore is a good example of the 80’s in the 20th century, economic stagnation [] , the Singapore Government intends to force the company to increase the salaries of more than 50%. Although painful at first, leading to “second industrial revolution” in Singapore when the company became a capital intensive manufacturing and high-end financial activities and more focused.

Malaysia can introduce the basic quality of the same wages, the initial requirements, such as planting and agriculture, labor -intensive manufacturing, construction and services sectors (such as restaurants and hotels) have a decent minimum wage. Of course, another effect was an increase in wages will raise people’s incomes. This will effect in increased spending, generating demand for goods and services which will in turn rise demand for labour. Higher incomes also consequence in higher saving which contributes to increased investment, as resources saved by individuals and deposited in banks can be borrowed to businesses for investment in capital. Both higher spending and saving will lead to higher economic growth. (Veon Szu & Allwright, 2010)

Macro Balances

Macro balance in a country is consist of fiscal balance, investment balance, balance in budget priorities. (Woo, 2009) These balances have to be achieved in order for Malaysia to get out of the middle income trap. Firstly, for the fiscal balance, it is crucial to have a suitable amount of taxes imposed on people so that it will not be a burden and consequently reduces the GNI per Capita. Moving on, investment balance is the most important to help Malaysia getting out of the middle income trap. Public investment can be on infrastructure, poverty alleviation and environmental restoration and protection. Investment is also important to Malaysia since the FDI helps develop local industries and for high technology products. However, it is dangerous to support private investment with public investment because it would cause the original target of public investment to be reduced. Budget priorities would also be a concern in macro balances. A country should spend on what really the people wants and what that can ensure long-term growth to ensure that their long-term goals are achieved. For example, Malaysian government did spent on Human Resource Development in 2006 where 608962 employees were trained, involving financial assistance amounting to RM 2.89 million. (Yusuf & Nabeshima, 2009)

Reformation

Reformation in this context means there is a need of change in a country’s institutional framework or even the financial framework. One of the issues that arise frequent is on Quota, including those for share ownership or education. The quota system need to be abolished or reduced the effects so that people will not start leaving the country. Although it might not be a serious matter that people start pursuing their studies overseas because they cannot get it locally, but it will be coming a big concern if they start migrating away from Malaysia. If things get worst, in long-term Malaysia would have a problem of lack of workers.

‘ Prime Minister Mohd. Najib’s announced on June 30, 2009 of the relaxation of racial quotas on the ownership structure of firms is a step in the correct direction to boost private investment in Malaysia. What decides the effectiveness of Najib’s measures, however, is not whether the investment regime in Malaysia in July 2009 is more liberalized than the investment regime in July 2000 but, rather, how much more business-friendly is the investment regime in Malaysia today compared with the investment regimes in Indonesia, Thailand, China, and India today. The investment-strangulating Industrial Coordination Act (ICA) of 1975 is still untouched. Najib has only changed some interpretations of ICA by the government agency (Foreign Investment Committee) that implements the ICA. To make a more credible change in Malaysia’s investment climate, Najib should also significantly relax the ICA (better yet, repeal it) in order to neutralise the twin developments that investment capital has gotten more mobile, and that the neighbouring countries have greatly improved their investment incentives in the last decade.’ (Woo, 2009)

The reformation is also needed to make sure that Malaysia economy to become a knowledge-based economy. Another type of reformation is encouraging students to be more innovative, diversifying the economy, encourage research and development among local Universities and firms.

Source: Asian Economic Bulletin, Volume 26, Number 1, April 2009, pp 25-43

The above figures shows the current stage of Malaysia in the Stages of Catching-up Industrialization is in stage two where Malaysia’s local industries are mainly still relying on foreign guidance. Innovation can be considered as medium for Malaysia to move out from middle income trap because more innovated products means that there are more value added and it would boost Malaysia’s competitiveness in the international market. However, incentives taken by Malaysian government are not sufficient enough to encourage innovation. Therefore, government need to implement policies that would encourage innovation in order to obtain long-term economic growth. For instance, the Brain Gain Malaysia [] programme with the mission of transforming Malaysia into an innovation-led economy by leveraging the talent pool of Malaysian Diaspora and/or foreign Researchers, Scientist, Engineers and Technopreneurs (RSETs) residing abroad through incentive offerings for mutual benefit targeting on several prioritised on Bio-informatics, Renewable Energy, Biotechnology-Food production, Emerging Technology for Curing Diseases, Climate Changes-Related Technologies, Nanotechnology and Cybersecurity industries. (Ministry of Science,Technology and Innovation Malaysia). Besides that, Local Research Universities or local industries can also work together to develop something new by sharing the costs.

Besides that, a convenient financial framework is also important for Malaysia to move out of middle income trap. Financial services such as microfinance should be introduced and funding of SMEs should be supported in order to sustain the economic growth and get out of the middle income trap. These financial aids would help encouraging not only SME industries to grow, but it would also help local entrepreneurs to develop their business then increase their income.

Moving on, government will have to encourage human capital development in forms of education for instance. Malaysia need to ensure that the people’s literacy rate are high enough since the younger generation are the future leader of the country. Besides literacy rates, initiatives also needed to provided training for vocational skills such as in Malaysia offers on Automotive, Hospitality, and Engineering in Vocational Secondary Schools. (Ministry of Education Malaysia). Therefore, Malaysia’s government need to be concern on the issues about the actual balance between the two types of Education, Literal and Technical. The balance is essential to ensure that Malaysia to have a more balanced growth and will not be facing any problem of shortage or excessive of skilled workers that could led to other issues such as unemployment.

Conclusion

Malaysia had caught in the middle income trap since 1970s, it is important for the government of Malaysia to ensure that Malaysia will escape from the middle income trap. Actions should be taken more specifically and not too general in order to curb the problem of middle income trap from inside out.

“You can’t change the wind; you can however adjust your sails”. So goes a saying. Means that economic change necessitate a revaluate of economic development policies and strategies. So, I think that we should make use of our advantages like well established network of infrastructure facilities, strategic location in a high growth area, strong natural resource endowment forms good basis to develop new industries, among the mega diverse countries that will generate tourism, recreation, pharmaceutical and nutrition products so that Malaysia able to make the high-income transition.