How can Malaysia get out of the middle income trap?

Malaysia is caught in the middle trap right now and getting it out is going to be tough. With an income that is not too high and not low, Malaysian find it hard to reach a higher level of income. To really get out from the middle income trap, Malaysia needs to change what it has been doing economically for the past 40 years. Middle income trap concept refers to an easy transition of a low income to a middle income economy due to its competitive nature in terms of cheap wages and labour- intensive industries. It is easy to transit from low income to middle income but it will be hard to transit from middle income to high income due to several factors. Malaysia is getting into middle income trap and is likely to experience a small change in factor- price ratio. This means that wages received by both skilled and unskilled labour does not increase a lot and doesn’t reach high income level.

In our research paper, we will divide into the four main parts. First, we discuss the background of Malaysia’s economy and then the factors which lead Malaysia to fall into the middle income trap, in this part we find out that there are about six factors which lead Malaysia into the trap. After that, we discuss on people who are affected due to the middle income trap. Lastly, ways or method to escape from the middle income trap is also our main concern. We have some ways to implement to make developing nations can graduate into becoming fully advanced economies.

When we look at our economic background, we can clearly see that from independence to the 1980s, Malaysia progressed rapidly. From an agricultural society in the 1950s, it evolved into an Asian Tiger Economy by the 1980s, mainly labour- intensive industrialisation. However, subsequent effort in deepen our industrialisation make our economic to remain stagnant while other countries continue to expand rapidly.

Recently, country’s performance has been disappointing with GDP growth rate declining to 5.5 percent in 2002 to 2008 from 9.1 percent in 1990-1997. In the past 1970, about 50% of Malaysian live in absolute poverty but now decrease to less than 4%. However, Malaysian feels that they are stuck from increasing where GDP growth has slowed up. However, when we look at other countries for example Korea, they are at one time the poorest country in the world but they are growing both economic and politic. Reason that their economic can grow is because they have higher purchasing power compared to Malaysia. This is because they receive averagely higher income and with higher income they will have more spending power which will boost their economy. Countries such as Cambodia and Vietnam have very low wages while Malaysia traps in the middle ground.

How to get into middle income trap

One of the factors Malaysia trapped into the middle income is due to over dependence on FDI and lack of doing research and development (R&D). Multinational companies will only provide instant of capital, expertise and technology into Malaysia but they will not develop or improving Malaysia’s product. Malaysia’s businessmen seem to be satisfied in making profit by serving the MNCs and maintaining their original, assembly- based business models. Besides, labour productivity is growing quite slow than in the 1990s. Manufacturing in Malaysia has a low value added and had spent a very low R&D spending. For example, Malaysia had spent only 0.6% of GDP in R&D compared to South Korea which is 3.5%. South Korea is probably the best example of a developing country which shifts to a advance country. Companies in Korea like Samsung and LG dominates in the market. Taiwan is also not far behind. China’s policymakers are aware that they need to suit with the changes in market if the labor costs rise.

With a low tech manufacturing industries and lack of skilled labour compared to country such as Singapore, the production in Malaysia is less competitive and thus less profit which means lower wages paid to the workers.

Migrant workers which depress wages also one of the factors which cause Malaysia to fall into the middle income trap. It is a mistake in letting migrant workers to overflow in Malaysia and depresses wages. This will limit the improvements of the productivity. Malaysia has too huge amount of foreign workers which is reportedly has 1.9 million registered workers and another 600000 unregistered ones accounting for nearly one- fifth of the working population. These workers are not confined to the so- called 3D jobs where the jobs are difficult, dirty and dangerous that the locals are unwilling to do those kinds of jobs. Too many of unskilled labour will lead to low value added in the productivity. Malaysian worker are forced to receive low wages since competition with the migrant workers are keen because the migrant workers are willing to accept lower wages and longer hours of working. Besides, when we take account the negative externalities which associates with the excessive presence of migrant workers, we found that migrant worker is a burden to Malaysia’s economy as the migrant workforce turns out to be a costly affair. There are cases where the migrant workers cause social problem in Malaysia and there were also cases where the migrant workers are abused by their employer. They are also forced to receive low wages since there is no law to protect their rights. It is not denied that Malaysia needs the services of foreign workers, both skilled and unskilled but government need to ensure that they are well treated and wages should be increased align to the local wages so that Malaysian wages can be raised higher. In the case of Malaysia, high wage need not mean high labour costs if an increase of wages are backed by an increase in productivity. In the other words, low wages does not mean lower labour costs if the productivity declines.

Apart from that, over subsidies of the subsidised item leads to middle income trap. Subsidy was implemented in 1961 under the Control Act 1961 and subsidised items include petrol, sugar, gas, rice, salt and other basic items. Subsidy of these items has made the Government spending to increase and it is too heavy for government to continue to bear the cost. For example, the oil price in 1970s was under US$12 per barrel. However, it increases to almost US$75 per barrel which causes a cost that is unbearable to the government. Moreover, over subsidies in local industries for example proton is a burden to the government spending. If compared to South Korea, such industry had do the same thing in the beginning but they were weaned off from the government subsidy much earlier and where Proton is still now subsidised. The high cost of subsidies restrains the government ability to upgrade infrastructures and involve in more research and development which increase the productivity and competitiveness in order to become a high income country.

Price control has been one of the major causes of falling into middle income trap. The policy where government enforced price control in Malaya to avoid hardships after World war2 holds until today. Price control items include basic necessities such as rice, flour, sugar, milk and even taxi fares. Price of commodities in Malaysia is much cheaper because of the controls compared to other countries. The problem with the price control is that workers’ annual pay raises are linked to the nation’s CPI which is consumer price index. This mean that with a low CPI, the salary received by the worker remain low and a shift to a higher income will be very hard. Since 1980s, Malaysian wages have fallen behind wages of the rest of the world. For an example, a graduate policeman earn at RM 2300 per month compared to RM4400 in Singapore. Apart from restraining Malaysian wages, price controls also sternly distort domestic economic factor proportions which cause many factories ending up in inefficient economic production processes. When we compared through GDP, South Korea has a GDP per capita of US$16450, Singapore US$34,346, while Malaysia still remain at US$7469. The table below shows that the breakdown weightage allocated for the different categories of items consumed on a daily basis. For example, “Food and non- alcoholic beverages” and “Housing, water, electricity, gas and fuels” make up over 52.8% of the weightage. We can see that most of the items are heavily subsidised or price controlled. Apart from the raw materials, value added items such cooked food and beverages are always levied at the market price but not captured in the CPI. Besides, transport which contribute 15.9% of the weightage does not include hire purchase for cars and motorcycle or the cost of imported spare part for repairing. Some construction materials such cement and clinker maybe price controlled but for certain price of rental are determined at market rate.

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Low inflation rate causes wages to be artificially suppressed and it creates a wide gap between Malaysian working domestically and those workers who work abroad. With low wages, we will be unable to attract talent from other countries even though our product and services are relatively cheaper. Moreover, low or middle income creates a technology gap making Malaysia to be uncompetitive. Technology goods and services have become more expensive for Malaysian to purchase including items such as Iphone, laptop which it is common nowadays. With a cheap currency, we find it difficult to purchase the most advanced technology to improve productivity.

Malaysia was emphasizing on agriculture sector in the early 1950s but when Malaysia’s economic had shift from agriculture sector to manufacturing sector, agriculture sector had became a drag to the economy. The dominance of oil palm and rubber in the agriculture sector is unfortunately a significant drag and had caused the nation’s to cease from shifting to a high income economy. Those plantation terrain, paddy harvesting and rubber tapping are not easily mechanised and remaining done by manual. Agriculture sector with high technology and mechanised makes more profit by having much efficient and more productivity. Until today, agriculture with manual worker still remain as low wage activities and most of the agriculture depend a lot on foreign labour. For example, textile industry hires most of the workers from Bangladesh since the local workers are not willing to work in this sector because of the low wages. The mobility of the foreign workers in plantation is also easy and they move from estates to factories which mean it is hard for government to disallow the foreign workers to work in the non- plantation sector. The cumulative effect is that there are now about 2.3 million low- skill foreign workers in Malaysia, making up about 20% of the workforce. They are in the manufacturing, petroleum, construction and domestic- help sectors. Lately, they are also involving in retailing, food and beverage, tourism and hotel industries. Such a massive inflow of foreign workers into those industries will therefore suppress wages in Malaysia and causes middle income trap.

Effects of the Middle Income Trap

Malaysia’s caught in the “middle-income trap” right now give awareness to our policymakers that the export-led growth strategy, according to some, is no longer an optimal development strategy for developing countries especially Malaysia. Continued emphasis on export-led growth will, among other things, increase the reliance of developing countries on the developed world and dampen domestic market growth. Many export-dependent developing countries started tweaking their growth strategies especially after external demand for their exports dried up on account of the current global financial and economic crisis. Though Malaysia’s growth strategy had started emphasizing domestic demand since about a decade back, it still remains largely dependent on external demand for its economic growth (Quah, 2009). Ex-World Bank chief economist and Brookings Institution’s Wolfensohn Centre for Development, Global Economy and Development’s senior fellow, Homi J. Kharas, said there was an impetus for change and rethinking on policies and strategies in Malaysia every 10 years based on economic developments. “Malaysia has been very successful as an exporting nation but has also been very export dependent. About 90% (of products) are being exported to the United States, Europe and Japan,” he said, adding that Malaysia needed to diversify its exports (Malaysia needs to be high-income economy, 2009). However, the main challenge is domestic market of Malaysia is too limited due to only 28 million of populations. That’s why we are facing the dilemma of the exploration of external and domestic market. However, 2010 GDP performance sets strong momentum for a robust 2011. Given the marked improvement in economic growth in the first half of the year, domestic demand was clearly the chief momentum driver for the recovery. Moving forward, the country is anticipated to register a robust GDP growth of 5.6% in 2011, with domestic demand once again acting as the back-bone for momentum (RAM Rating Services, 2011).

Besides, middle-income trap also lead to declining private investments. The old growth model provided three decades of outstanding performance, permitting Malaysia to provide for the health and education of its people, largely eradicate poverty, build a world-class infrastructure and become a major exporter globally. But the progress we have made over the past half-century has slowed and economic growth prospects have weakened considerably. We are caught in a middle income trap. Malaysia has been susceptible to external shocks, as seen during the past crises. Increases in international commodity prices, like fuel or food, have direct impact on domestic prices. Similarly, unless production costs and productivity in Malaysia can keep pace with those abroad, exports are likely to lose ground with negative effects on national employment and income.

Malaysia’s economic engine is slowing. Since the Asian financial crisis of 1997-1998, Malaysia’s position as an economic leader in the region has steadily eroded. Growth has been lower than other crisis affected countries, while investment has not recovered. Private investors have taken a back seat. Since the Asian crisis, aggregate investment as a share of GDP in Malaysia has continued to decline, with private investment remaining stagnant due to several factors. In some industries, heavy government and government linked company (GLC) presence has discouraged private investment. Cumbersome and lengthy bureaucratic procedures have affected both the cost of investing, and the potential returns on investment. Malaysia’s place within the Global Competitiveness Index dropped to 24th in the 2010 report from 21st previously, indicating that the country is losing its attractiveness as an investment destination (New Economic Model For Malaysia, 2010)

A plunge in exports wounded this trade-sensitive economy in 2009. The impact of weak exports spread to private investment, which fell sharply, and to private consumption, which was nearly flat. Fiscal stimulation packages provided some buffer for aggregate demand. Economic growth will rebound during the forecast period, underpinned by a recovery in exports and rising incomes. Annual inflation is set to pick up from low levels. The government plans renewed efforts to encourage private investment. Fixed investment fell sharply by 5.5%, with many firms cancel ling or deferring investment decisions. Investment acted as the major drag on GDP in 2009. The ringgit, having depreciated by 5.0% against the dollar during the first 3 months of 2009, when increased risk aversion and deleveraging activities by international investors increased the demand for dollars has since appreciated. Economic growth, while impressive, has slowed and private investment, averaging about 30% of GDP just before the Asian financial crisis, has fallen to around 9.5% of GDP. These indicators point to the need to address deficiencies in the investment climate and to reappraise the role of public sector companies that compete with the private sector. (Rajapakse, 2010)

Other than that, the effect of middle-income trap include lack of appropriately skilled human capital caused by brain drainA graduate teacher starts at RM2,500 per month in Malaysia, compared to RM6,196 in Singapore and RM15,661 in Hong Kong. Malaysian wages have fallen behind partly due to the gross divergence between the suppressed Malaysian CPI and that of the world (FONG, 2010). Globalization, outsourcing, offshoring and business process outsourcing gave rise to mobility of resources, investment, companies and skilled workers. Skilled workers flow to locations where they are paid higher and companies move to locations that are more competitive. Many skilled Malaysian workers have been leaving the country, lured by higher pay (Altfa, 2011). Many Malaysians could be found working overseas as they were often adaptable, multi-lingual and inexpensive. In terms of composition of the economy for most developed countries, more than 60% of annual gross domestic product (GDP) came from the services sector, with Malaysia somewhere just over 50%. Deputy director in the Public Private Partnership Centre and Secretariat to the Economic Council of the Economic Planning Unit Dr Soh Chee Seng said: “Our productivity levels are not really low, it is just that they are falling behind other rapidly developing countries like China, India, Indonesia and Thailand:’ According to HSBC Bank Bhd executive director Jon Addis the country’s infrastructure was still “patchy” such as in terms of public transit, which had some idiosyncrasies. (Min)

Malaysia stuck in middle income trap will lead to bring to affect of low value added industries. According to Wikepedia, value added can be refers to “extra” features of an item of interest for example product, service, person and etc that go beyond the standard expectations and provide something “more” while adding little or nothing to its cost. Value-added features give competitive edges to companies with otherwise more expensive products. (Wikipedia) In Malaysia, Small and Medium Enterprises (SMEs) have evolved to become a key suppliers and service providers to large corporations, inclusive of Multinational Corporation and Transnational Corporation (MNCs & TNCs). SMEs contributed to expanding output, providing the value added activities in the manufacturing sector, creating employment opportunities, contributing to broadening Malaysia export based. Our Prime Minister Datuk Seri Najib Tun Razak has urged SMEs to adopt technology as a core part of their business strategy to gain a sustainable competitive edge. He said that the SME community in Malaysia was not adopting technology as rapidly as it should. (Adopt new technology, Najib urges SMEs, 2011) For this point, SMI Association of Malaysia president Chua Tiam Wee urged the government should concern about the problem faced by SMEs, such as securing adequate financing at competitive rates for new start-ups, the issue of frequent policy changes in employing foreign workers to overcome shortage, and also the problems in dealing with government agencies to acquire halal certification and other licences. (Mustaza, 2011) Besides that, there are many factors have contributed to the country’s slower growth over the past year among them to caused less invest from FDIs to Malaysia, we are loss of comparative advantage with other emerging economics such as India, Vietnam and China which being supplanted as a low-cost export and services based. (The Middle Income Trap, 2010)

Another effect of the middle income trap is that Malaysia providing a low skilled jobs and low wages to attract foreign worker migrant into our countries. To become one of the high income countries, mean that the income of an individual is high. The main goals of the New Economics Model(NEM) are that Malaysia will toward become a high income country with target of US$15,000 until 20,000 per capital by 2020. But now Malaysia stuck in the middle income trap because there are not enough high wages job created in Malaysia. Normally, high wages are often related to the high skilled worker. In fact the share of skilled labour has declined across industries. The figure as shown as below shown that the use of high skilled labour for differences industries for 2002 and 2007. The E&E as one of the largest industries contribute in GDP of Malaysia. From the diagram, the use of high skilled labour in E&E was declined from 54% to 46%.

The regional competition did lead to some minor transformation over the years. Although the manufacturing sector in Malaysia was grew rapidly, but that is resulting shortage of Malaysian workers with higher wages. Therefore, the foreign labours are welcome to Malaysia to fill the gap. So the companies could enjoy low wages and production costs to comfortable profit. The skilled labour force is also linked to education. The labour force with tertiary education for advanced countries is usually high, so many skilled Malaysian worker will leaving the country to pursue a higher pay.

The central themes of the 10th Malaysia Plan (10MP) is encapsulated in 10 Big Ideas, says the Economic Planning Unit (EPU) of the Prime Minister’s Department. These 10 Big Ideas, if vigorously and consistently implemented would see Malaysia through the challenging times and enable the nation to be a high-income and developed nation by 2020, said the Unit under the Prime Minister’s Department. (10MP Encapsulates In 10 Big Ideas, Says EPU, 2010) One of the ideas of the Tenth Big Ideas is to unleashing productivity-led growth and innovation. Malaysia stuck in the middle income trap will cause lacking in talent and innovation to do so. Malaysian graduates tend to more interested to work in abroad because they offered a high income from the other countries. As they leaving from Malaysia, it will lose the skilled talent needed to make innovation to develop the country. Therefore, Malaysia lack of holistic approach and systematic assessment of innovation. Besides that, the growth model eventually runs out of steam. As the incomes increase, so the costs also have to be concern. The low-tech manufacturing industry was undermining the competitiveness. Therefore, Malaysia tend to move “up the value chain,” into exports of more technologically advanced products, like electronics. The economy has to innovate and use labor and capital more productively. To get to become a high income country, the economy needs to do more than just make stuff by throwing people and money into factories. That requires an entirely different way of doing business. 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. (DAN, 2010)

Based on the effects of middle-income trap stated above, we strongly suggest that government has to consider thoroughly before Goods and Services Tax (GST) is imposed. . Such a plan has pros and cons and serious implications and has to be thoroughly studied and extensive consultation made before a final decision is made. Public consultation on this policy that would have great impact on the Malaysian economy and investment is seen as vigorous enough that would have an impact on poorer Malaysians and the government coffers (Altfa, Minimum wage policy can hurt manufacturers’ competitiveness, 2011). GST wills worsening the poverty condition in Malaysia as well as deteriorates the private consumption in economy. The ripple impacts of GST will deepen the situation of middle-income trap in our country.

WAYS TO GET OUT OF MIDDLE INCOME TRAP

Brain drain refers to significant emigration of educated and talent individuals to another country. Malaysia being criticised for mismanaging its talent human resources as skilled and talent Malaysian moved to countries whom provide better earnings [1]. The problem grew serious as the statistics of brain drain increasing dramatically. Federal Government stated that between the beginning of 2008 and August 2009, slightly more than 300,000 Malaysians migrated to overseas. It is estimated that in 2009 there were over 700,000 Malaysians living abroad, with up to two-thirds of them are professionals workers. Therefore it effects the economic transformation of our country from a low to a high value-added economy.

Therefore to curb brain drain problem, a new Talent Corporation will be formed to find out and deliver top talent from overseas and locally that are beneficial to stimulate economic sectors. The Government will attract Malaysians currently living and working in other countries to return Malaysia in order to build their careers in Malaysia. According to the Minister in the Prime Minister’s Department, Tan Sri Nor Mohd Yaacob, this corporation hopes to draw back at least 70,000 Malaysians from overseas over the next 10 years by offering a package of very attractive incentives [2].

Strategies were taken to succeed the talent corporation plan. Three areas have been identified in 10th Malaysian Plan including soft infrastructure investment such as skills development, providing enablers to support concentrated industrial clusters and specialisation and increasing Research & Development and venture capital funding [1].

Government scholarships especially Public Service Department scholarship will be given to top students from around the world to further their studies in Malaysia whom later will be encouraged to contribute to the Malaysian talent pool [1]. The civil service will increase its focus on hiring high-caliber young talent and will offer 60,000 scholarships to students in local and foreign universities [1].

Moreover, under the 10MP open visas will be offered to highly-skilled foreign professionals and there will be no time limit on visas for skilled foreign workers whom earns more than RM8, 000 per month [1].

Despite that, living conditions will also be improved in order to attract more world-class talent to make their homes in Malaysia. Kuala Lumpur will be set as a city for people seeking quality and diverse lifestyles, in close proximity to nature, cultural richness and excellent infrastructure [1]. Therefore Talent Corporation able to draw back Malaysian talented workforce to stimulate economy of Malaysia and indirectly could help Malaysia get out of middle income trap.

Foreign Direct Investment (FDI) plays a significant role in Malaysia’s economic development. In the 14th century, Malacca had attracted FDIs in services because of its strategic location in the Straits of Malacca [3]. First, FDI has provided an additional source of capital which directly helps host country to expand their production activities and thereby generate more profit.  The profits can be used for the purpose of making contributions to the revenues of corporate taxes of the recipient country [4]. FDI assists in increasing the income that is generated through revenues realized through taxation [4].

[1] Lee Wee Lian (2010) The Malaysian Insider: Najib bets on move from hardware to software.

[2] Malaysian Today online news (2010): Attracting talents back through the Talent Corporation

[3] 2010 Foreign Direct Investment vs Domestic Investment. New Straits Times.

FDI allows the transfer of technologies. In general, FDI provides the fastest and most effective way to deploy new technologies in developing host countries (UNCTAD 2000). Innovative technologies can help not only increase returns to investment but also improve productivity [4].

FDI also promoted exports and trade. Without foreign capital, Malaysia might not have experienced rapid increase in their exports. Exports have been the main engine of economic growth, especially for Malaysia, where it moved from mainly primary goods exporters to major exporters of manufactured goods. The shift in exports reflects the structural transformation of Malaysia from being agriculture-based to industry-based. Meanwhile, the countries that get FDI from another country can also develop the human capital resources by getting their employees to receive training and learn extra skills on the operations of a particular business.

FDI can significantly relevant to boost economy. Therefore, we have to create more opportunities for major investors to invest in the domestic economy as FDI able to help Malaysia get out from the middle income trap. Malaysia will focus and worked out more to strengthen its investment attraction activities to attract both the domestic and foreign investment required. As a beginning, corporatization and empowerment of MIDA announced in the Tenth Malaysia Plan and the expansion of its scope to cover domestic investment [5]. There are two categories of investor attraction. First, targeted outreach to potential investors and secondly, partners as well as broader-marketing campaigns [5]. A Roadmap for Malaysia Targeted outreach activities include identifying and negotiating with specific investors to participate in identified projects will be conducted [5].

[4] Economy Watch: Benefits of Foreign Direct Investment

[5] Chapter 1: New Economy Model of Malaysia: Economic Transformation Programmed

Fiscal stimulus packages helped increased the spending on green technologies in many countries. Several countries have focused to technologies that help improve energy efficiency. Recently, statistics shows that only 13 percent of China’s domestic electricity consumption is provided through cogeneration facilities.

Meanwhile, when cogeneration facilities are combined with district heating and cooling (DHc) systems, further synergies can be created. Through implementation of a DHc facility and as well as the size and number of buildings the cost of total capital and investment can be lower than the cost of traditional methods for heating and cooling individual buildings. This energy efficiency significantly reduces carbon emissions. (Article: Escaping the Middle Income Trap)

Moreover, some green technologies have ability to reduce poverty or inequality gap. For example, renewable energies such as solar power can facilitate rural electrification, which can help to reduce poverty [6].

Investment to keep green technology efficient could help a country to escape from middle income by reducing poverty and inequality. However, public funds get misallocated or finance “white elephant” projects, with less contribution to the economy. For example, plenty of China’s green investments are in wind technology. However, some analysts report shows that a high proportion of China’s current wind assets might be either not in use or not connected to the national power grid. In other cases, promoted new technologies can be far from the economy’s comparative advantage or their subsidization can harm competitiveness. In this case, measures that allow the market provide guide when subsidizing or investing in green economy are required. (Article: Escaping Middle Income Trap)

[6] World Bank. 2000. Energy Services for the World’s Poor. Energy And Development Report 2000. ESMAP, World Bank, Washington, Dc.

There are many ways to Malaysia be escape from the Middle trap income. One of it is by New Economic Model (NEM). NEM is an economic plan in Malaysia discovered on 30th March, 2010 by Najib Tun Razak, Malaysian Prime Minister. It is intended to more than double the per capita income in Malaysia by 2020. According to Najib, the goal of NEM is to transform the Malaysian economy to become one with high incomes and quality growth. The keys to the plas as described by Najib are “high income”, “sustainability” and “inclusiveness”. For the “high income” key, there are lifting the real growth rate to an average of 6.5% per annum over the 2011-2020 period. Per capita GDP will rise to about USD 17,700 by 2020 and aggregate demand will have to grow at a robust pace as well. [7]

Moreover, the “high income” key in NEM will unlock the value of in