Rethinking Economics - Sage 3

RethinkingEconomicsA FRAMEWORK FOR MALAYSIA TO ESCAPE THE MIDDLE INCOME TRAP

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Rethinking economics - A Framework for Malaysia to Escape the Middle Income Trap iii

Contents

1. Measuring the Economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

2. Economic Complexity Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

3. Role of the Government . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

4. A Better Understanding of Economics, Differing from the Mainstream . . . . . . . . . . . . . . . . . . . . . 3

5. Evolving the Way Forward . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

6. The Big Picture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

7. Rukun Negara . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

8. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

Acknowledgement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

Contact us . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

Rethinking economics - A Framework for Malaysia to Escape the Middle Income Trapiv

GLOSSARYNotation DescriptionAFC Asian Financial Crisis 1997

AFTA ASEAN Free Trade Area

ASEAN Association of Southeast Asian Nations

BNM Bank Negara Malaysia

CIDB Center for International Development

ECI Economic Complexity Index

EU European Union

GDP Gross Domestic Product

GFC Global Financial Crisis 2008

GLC Government Linked Company

MSC Multimedia Super Corridor

PH Pakatan Harapan

PPP Purchasing Power Parity

USA United States of America

USD US dollars

Rethinking economics - A Framework for Malaysia to Escape the Middle Income Trap 1

In the decade leading up to the Asian

Financial Crisis (AFC), Malaysia was

regarded as an Asian tiger economy,

achieving GDP growth rates north of

9%. However, post crisis the nation’s

GDP growth and more importantly per

capita income, whilst encouraging

has been lower than other leading

emerging/East Asian economies. The

proponents of Rethinking Economics

are of the view that new innovative

ideas in economics can be harnessed

to reshape Malaysia’s economy to

become an Asian tiger economy once

again.

1. MEASURING THE ECONOMY

Per capita income, measured in

USD, has declined in recent years.

Associated with this, over the last

decade there has been a healthy

debate on Malaysia being stuck in the

Middle Income Trap. Whilst a healthy

debate raged on about the Middle

Income Trap, these discussions were

mainly qualitative in nature and very

much within a framework of traditional

macroeconomic theory. However,

before pursuing a discussion on a

path to higher growth status as a

developed country and breaking

away from the Middle Income

Trap, it is important to examine the

measures of wealth and economic

performance. Reliance on per capita

income measured in local currency

has drawbacks as it could ostensibly

be increasing but real wealth could

be diminishing, eroded by inflation

and reduction in the purchasing

power of the domestic currency due

to devaluation.

Moreover, it misses the critical point

that being wealthy is a relative

concept. Thus, the paper draws on

research by the World Bank in terms

of long-term trends of countries per

capita income relative to the United

States of America. Regrettably, by

this measure, Malaysia’s economic

performance over the past five

decades is less than inspiring.

In Rethinking Economics, there are

deeper questions raised on economic

measurement in applying GDP per

capita income. However, these are

issues beyond the scope of this report

and the use of relative per capita

income to USA is relevant in having a

meaningful discussion on wealth and

escaping the Middle Income Trap.

Accordingly, much of the discussion

in the report centres around per

capita income relative to USA.

Rethinking Economics: A Framework for Malaysia to Escape the Middle Income Trap

Rethinking economics - A Framework for Malaysia to Escape the Middle Income Trap2

2. ECONOMIC COMPLEXITY INDEX

In the next chapter, this paper examines the

drivers of per capita income based on the

concepts of economic complexity which provides

a comprehensive and credible explanation of

the correlation between the drivers of economic

growth and growth in per capita income. Economic

complexity is based on the concept of productive

knowledge within society which then translates

to the economy being able to produce diverse

as well as complex products and services. Both

diversity and complexity are measurable using

statistical and mathematical models to produce

an index of economic complexity. The index

with data over 40 years shows a high correlation

(regression factor 0.73) between a country’s

index of economic complexity and growth of

per capita income. These concepts form the

foundation of evolving a long-term strategy

to increase per capita income and escape the

Middle Income Trap. The analysis in this paper

provides new insights by comparing per capita

income and ECI of Malaysia with selected

countries. For example, comparisons over 40

years of these factors between Malaysia and

South Korea clearly explains why South Korea,

which had lower per capita income than Malaysia

in 1975, has a per capita income that is currently

approximately three times that of Malaysia. In

March 2018, BNM published a paper comparing

ECI of Malaysia with other ASEAN countries and

pointed to the recent improvement in the ECI of

all ASEAN countries exceeding that of Malaysia.

A worrisome trend. Furthermore, the authors of

this paper caution at the current rate, Thailand,

in the short/medium term, will likely have a per

capita income exceeding Malaysia’s as Thailand’s

ECI is already likely to surpass Malaysia’s ECI.

An analysis of Malaysia’s economy using the

tools from Harvard’s Centre for International

Development, the institution that developed the

“Atlas of Economic Complexity”, is produced. In

the analysis, attention is drawn to long term risks

from high dependence of oil and gas as well as

palm oil industries.

Whilst the CIDB at Harvard’s research on ECI

is ground breaking and provides invaluable

insights regarding development and wealth,

it is important to understand that the tools are

still being enhanced and there are drawbacks.

The drawbacks include the exclusion of export

of services in the ECI as well as non-tradable

services. However, this does not diminish the

value of concepts of know-how, proximity

etc. i.e. findings produced by the research.

Therefore, these concepts have relevance to the

development of more complex and sophisticated

services.


3. ROLE OF THE GOVERNMENT

In addition to drawing on the new research on

per capita income growth, the proponents of

Rethinking Economics also re-examine the role

of the government which they believe can be

the catalyst to guide changes and accelerate

growth. This is a breakaway from current

capitalist economic thinking which associates

governments with inefficiency and wastage while

the whole of the private sector is associated with

dynamism and efficiency.

Rethinking Economics identifies the role of

government other than just the public good i.e.

in development of industry and intervention in

markets. Critics of government intervention of the

economy will quickly point to, in the Malaysian

context, the spectacular losses of Proton, Perwaja

Steel, Eagle aircraft or involvement of Malaysia

Mining Corp in cornering the tin market, etc.

Yet the paper argues for government to have a

strategic role when the radical risks are involved

i.e. new markets and new technologies or as

previously for certain industries such as oil and

gas, shipping, airlines, rail etc., which domestic

private sector did not have the capital to

undertake such business investment.

Moreover, the critics miss the point that the

successive governments in Malaya/Malaysia

were prime movers for the development of

rubber, palm oil, MSC, Industrial Master Plan

and unorthodox policy responses to the AFC.

Government has a role to develop critical

industries where new industries cannot emerge

by themselves. Government can also play a role

to accelerate growth of complex industries. Whilst

importance and support must be given for such

industries to be promoted, this must be subject

to market discipline even if it is just domestic

competition. Further, emphasis on exports is a

must i.e. demonstrating truly competitive business

on a world stage. Even in respect of privatisation/

private public partnership, there must be a sound

understanding of what works and what doesn’t.

We, as a nation, must avoid privatizing projects

which cannot in effect be privatized as it gives

a false sense of reduced government deficit

prior to inevitable nationalization. Similarly, in

terms of tenders for government procurements,

there needs to be a balance of lowest costs and

value for money. Otherwise on a pure lowest cost

selection process, implementation of important

projects could be delayed due to suppliers being

unable to deliver projects and the economy

will operate sub optimally. Further, costs could

escalate with variation orders and the project

issues could be compounded by a very legalistic

approach to undertaking projects becoming the

culture which is not conducive for business and

government. It goes without saying that this does

not mean transparency and good governance for

tenders are compromised one iota.

4. A BETTER UNDERSTANDING OF ECONOMICS, DIFFERING FROM THE MAINSTREAM

Rethinking Economics encourages enlightened

understanding of important economic concepts

which are wrongly or not addressed by

mainstream economics. Post-GFC, there is a

deeper understanding of the growth of debt

and the role commercial banks play in creating


money. Additionally, in this respect, how creation

of money/increase of debt impacts aggregate

demand. Debt in itself is not necessarily

detrimental to economic growth, entrepreneurs

borrowing and increasing the economic cake is

an absolutely positive thing. However, there must

be vigilance against debts that create dangerous

speculative bubbles. The other source of growth

of the money supply excluding the external sector

is the government vide deficit budgets, which

should be applied for the public good. Therefore,

federal government policymakers should not be

constrained by thinking similar to corporations

or state governments. This unorthodox thinking

espouses federal government with fiat currency

to pursue deficit spending, which is viable option

if inflation remains in check and the balance

of payment is positive. No doubt of immediate

concern would be the country’s debt rating.

However, innovation of “equity” type instruments

issued by the government could be used to raise

funds without incurring debts, thus addressing

any concerns of higher debt ratios. However,

even these concerns on high government

debt to GDP ratios have been debunked, as

the original works by Reinhart and Rogoff are

mired by controversial articles1 that have been

written on their research. For completeness,

the role of exports in the creation of money is

illustrated and this has been the basis for the

success of the East Asian economic model, a

path advocated by the authors of this paper for

Malaysia. Further, in respect of government

deficit (without external sector), the net effect is

the household and commercial sector are able to

save. It is critical that policymakers grasp these

1 John Cassidy: The Reinhart and Rogoff Controversy: A Summing Up (2013) Retrieved from: https://www.newyorker.com/news/john-cassidy/the-reinhart-and-rogoff-controversy-a-summing-up

concepts, otherwise there will be a serious risk

that economic growth will be suboptimal as

expenditure required to accelerate economic

growth and relieve the burden of hardship on the

population will remain curtailed.

In respect of aggregate demand and credit

creation, we reviewed new research on credit

guidance and its impact on the economy. The

recent research shows that in advanced countries,

financial deregulation has resulted in less credit

being directed towards producing goods and

services but more towards existing assets. This

has a negative impact on productivity and wage

rise, not to mention further exacerbating the

wealth distribution as increase in asset prices

advantage rich households. Further, the research

points to deregulation that caused the shift in

credit direction is to be blamed for the booms

and busts economic cycles.

Consistent with the research, our recommendation

is for government to play a pivotal role in

increasing capital to grow industries by

implementing policies that avails credit for

targeted industries e.g. green industries,

domestic technology-based industries i.e.

using direct government funds or policies that

encourage commercial banks to lend to targeted

sectors. Further, this enables and encourages the

build-up of specialist knowledge in banks to lend

towards targeted sectors.


5. EVOLVING THE WAY FORWARD

The concept above derived from Rethinking

Economics can be evolved as a way forward

that achieves the goal of increasing wealth by

moving up the index on economic complexity.

The approach is based on the concepts of

proximity of industries i.e. to develop new

industries to increase diversity and complexity of

products and services produced by the economy.

The global economy is visualised as a large

network of interconnected nodes in which each

industry is represented by a node. This enables

policymakers and planners to identify areas

where new industries can emerge given the

country’s existing industries are well positioned

to branch out into new industries which require

similar set of skills and capabilities. The

proposed approach relies heavily on private

sector initiatives and government’s role is to

ensure an effective and efficient domestic

network of finance, HR, logistics, communication

and conducive regulation to create extensions

of industries. However, consistent with the

view taken on the role of government, the way

forward depends on the government perhaps as

a last resort to make significant investments that

facilitate new industries which otherwise will not

2 Chemical industries: Cellulose acetates, silicones, heterocyclic compound & nucleic acids, phenols & phenol-alcohol & their derivatives, sulphonamides, sultones & sultams, acrylic and methaacrylic polymers, acyrlo-methacrylic copolymers, other polymerization and copolymarization products, oxygen-function amino compounds, halogenated derivatives hydrocarbons and cyclic hydrocarbons.

3 Medical industries: X-ray apparatus and equipment, accessories & parts, electro-medical equipment, orthopaedic appliances, hearing aids, artificial body parts.

4 Machinery industries: Complete digital central processing units & digital processors, electric shavers & hair clippers, fans, blowers & the like, other electronic valves and tubes, electric filament lamps & discharge lamps & arc-lamps, analogue & hybrid data processing machines.

5 Vehicles industries: Motor vehicles piston engines & headings; automotive electrical equipment; work trucks used in factories & dock areas, passenger motor vehicles (excluding bus).

emerge without the right catalyst. A flow chart

to applying the concept has been produced and

serves as a guide in developing new industries

and moving up the ECI.

To this end, a strategy has been evolved defining

industries into four quadrants with a clear path

towards higher ECI is set out based on proximity

i.e. capitalizing on Malaysia’s industrial strengths

and opportunities. The opportunities have been

identified by comparing the scale of global

industry with Malaysia’s relative position. Based

on the analysis, the target industries which

would be critical for Malaysia to move up the

ECI are chemicals2, healthcare3, machinery4 and

vehicles5.

Further, the industries that could be developed

by leveraging nodes in Singapore are explored as

the countries’ economies are well integrated and

the concepts in the Atlas of Economic Complexity

can be fully exploited, in particular the concept

of growing businesses which are connected to

Singapore’s network of industries. As we see

it, the industries in Singapore are within close

proximity and there is a sound basis to develop

selected industries in Malaysia, especially in the

Southern Corridor.


In that vein of networks in neighbouring countries,

the report explores seizing opportunities by

convincing those industries that should ideally

develop in Thailand due to proximity of other

industries in Thailand to choose Malaysia instead.

This out of the box thinking is suggested as supply

/ value chain of Thailand could be exploited

by Malaysia as we are neighbours to Thailand,

jointly part of AFTA and businesses in Malaysia

are already connected to those in Thailand.

A variant to the theme of leveraging network

industries in other countries is the relocation

of Japanese industries to Malaysia. This idea

presupposes a win-win arrangement between

Japan and Malaysia wherein Japan has an aging

population and need industries to relocate

to Malaysia which has a growing population.

This option merits serious consideration, given

strengthening relation between Malaysia and

Japan following Tun Dr Mahathir return as prime

minister.

The concept of industries having proximity to

other industries to grow is captured in an index

of opportunity value which is an indication for

capacity of countries to move up the ECI. The

positive take away is Malaysia is relatively well

positioned in the index for opportunity value.

This gives us hope for optimism as it indicates the

potential to break away from the Middle Income

Trap.

6. THE BIG PICTURE

The paper concludes by providing a big picture

on the interaction between the firm, employees

and intermediaries and how the capitalist

economy ought to be shaped and the role of

government as well as cultivating an environment

which is facilitative of economic growth. Clearly,

there are needs for the government to have

a sound understanding of the current share

of wealth between employees, entrepreneurs

and financial firms and the underlying trends.

As employees and entrepreneurs in small &

medium sized companies represent the largest

portion of the population, ensuring a reasonable

share without discouraging business activity of

larger firms ensures fairer wealth distribution.

Furthermore, a focus on per capita income which

is a measure of the mean is defective, thus a

focus on median income will shift the discourse

on wealth distribution to be more meaningful

and hopefully this will lead to evolution of better

policies to increase wealth across the entire

Malaysian society.

In this paper, there is a strong reminder for the

government to move away from the previous

project management approach of transforming

the economy to be policy driven to drive effective

change as Malaysia did in the mid to late 80’s.

Whilst Malaysia has had previous success with

reforms which transformed the economy post

Mid-80s crisis and AFC, the changes were not

anchored by institutional reforms. The changes

which can be brought by the transformation

of the economy by the PH Government can

benefit from the institutional reform which will

anchor change and prevent future governments

from resorting to policies that undermine the

long-term progression of the economy due to

political self-interest. In this respect, much can

be learned by comparing Turkey with Eastern

European countries where ascension to EU


ensured economic reforms that were anchored by

institutional reforms prescribed by membership

of the EU. These countries have had stable

economic growth and prosperity compared to

Turkey which is now mired by economic crisis.

There is also a reminder to accelerate

privatization especially in areas where the

private sector is capable and willing to take on

the risks of those GLCs (state owned companies).

In respect of entrepreneurship, the paper draws

attention to the creation of large companies

playing an important role in the economy. It also

expresses innovative ideas around markets not

traditionally served by businesses i.e. ideas from

concept advanced in the book by C.K Prahalad

on “Fortune at the Bottom of the Pyramid”. In

Rethinking Economics, we urge the government

to address issues surrounding distress companies

as another source of economic growth by

improving industrial productivity.

7. RUKUN NEGARA

Noteworthy is the fact that countries that have

indeed escaped the Middle Income Trap have

societies built on science and technology; and

a liberal view to diversity i.e. consistent with

the ethos of the Rukun Negara. Therefore, it is a

sound and compelling reason to reinvigorate

Rukun Negara’s role as the guiding principle to

shape the political economy of our country and

the society we live in.


8. CONCLUSION

As a final remark, readers are advised that

the paper and its recommendations are not

prescriptive, instead serve as an impetus for a

meaningful discourse and debate. It is hoped that

from this discourse and debate, sound strategies/

policies for long term economic development

can be emplaced, but always being mindful that

the economic policy must remain flexible and

can adapt to the ever-increasing pace of change.

Digressing in the short term, the paper provides

idea for economic stimulus, addressing youth

employment and cost of living, matters for urgent

attention. With the right strategies/policies and

ability to execute, reinstating Malaysia as an

Asian Tiger Economy and escaping the Middle

Income Trap will become a reality.


Acknowledgement

Our sincere thanks to the many parties we have

consulted both locally and internationally and their

invaluable inputs in helping us prepare this report.

Our special thanks to Faceberry Communications

and Faceberry Publications of the BAC Education

Group for assisting with the artwork and layout of

the report.


CONTACT US

Sage 3 Sdn Bhd

Our address: No 2&4, 2nd Floor, Jalan Medan Setia 2, Plaza Damansara, Bukit

Damansara, 50490 Kuala Lumpur

Our web address: www.sage3.com.my

Datuk Mohd Anwar Yahya | Executive Director of Sage 3

Prior to joining Sage 3, he was Senior Partner of PricewaterhouseCoopers & was head

of Public Sector. He was also overseeing the corporate finance business, capital project

and infra practice in PwC and developed strategies which are mission critical for the

development of the Malaysian economy.

Office number: 03-2011 8268

Email 1: [email protected]


Website: www.sage3.com.my

Ravindran Navaratnam | Executive Director of Sage 3

Prior to co-founding Sage 3, Ravindran has held senior positions including CIO of Bursa

Malaysia, Director of PwC Consulting Financial Services Practice and Danaharta’s

General Manager for Corporate Services which included research coverage of the

Economy. In respect of financial distress affecting economies, he has presented papers

across the world and conducted various strategic consulting assignments in Indonesia,

China and Malaysia. He is the prime mover for the technical matters contained in this

report.





Dato’ Dr Zaha Rina Zahari | Advisor of Sage 3

She has held senior positions in financial sector and her views are highly sought in

respect of the development of Capital Markets as well as Islamic Finance which involves

in-depth issues of the economy.





RethinkingEconomicsA FRAMEWORK FOR MALAYSIA TO ESCAPE THE MIDDLE INCOME TRAP

SAGE 3

Sage 3 Sdn BhdNo 2&4, 2nd Floor, Jalan Medan Setia 2, Plaza Damansara, Bukit Damansara, 50490 Kuala Lumpur.

www.sage3.com.my

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