Malaysia struggles to escape the middle-income trap

Malaysia’s economic reforms are under question.

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The term ’middle-income trap’ possibly first entered Malaysia’s official policy lexicon when Premier Najib Razak referred to it as Malaysia’s greatest development challenge. He noted:

We have become a successful middle-income economy. But we cannot and will not be caught in the middle income country trap. We need to make the shift to a high income economy or we risk losing growth momentum in our economies and vibrancy in our markets.

The use of the term by the premier was courageous, as it was then still in its infancy. It had only been introduced into mainstream economics two years earlier through the World Bank publication, An East Asian renaissance: ideas for economic growth. This publication, timed to commemorate the 10th anniversary of the East Asian Financial Crisis (1997–98) and confirm East Asia’s return to a high-growth era, was overshadowed by the subprime crisis and the subsequent great recession (2008–09).

Nevertheless, the term and the concept gained traction. In the five years since, the middle-income trap has become shorthand to describe the challenges faced by rapidly growing economies.

It is not surprising that the middle-income trap (trap) hypothesis has gained traction, as more than 80 per cent of countries in the world are in that income band or lower, and it is a political imperative for all leaders and governments to raise the income levels of their citizens.

But becoming a high-income country is challenging and a long-term process. The majority of the countries that are now in the high-income level were in the middle-income level more than 100 years ago.

The Lead Economist with the Central and West Asia Department of the Asian Development Bank, Jesus Felipe (p.4), quoting the works of Angus Maddison, noted that the first country to reach $2000 per capita was The Netherlands in 1700, with Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Italy, Norway, Spain, Sweden, Switzerland, the United Kingdom and the United States, moving into the middle-income levels (lower and upper) at the end of the 19th century (around 1870).

This same study covering 124 countries, between 1950 and 2010, demonstrated that in 2010 there were 40 low-income countries (below $2000), 38 lower middle-income countries ($2000–$7250), 14 upper middle-income countries ($7250–$11750), and 32 high-income countries (above $11750).

A further study identified there were 101 middle-income countries in 1960. Only 13 of these became high income in 2008—Equatorial Guinea; Greece; Hong Kong SAR, China; Ireland; Israel; Japan; Mauritius; Portugal; Puerto Rico; Republic of Korea; Singapore; Spain; and Taiwan, China.

Stated differently, moving into high-income is the exception rather than the norm. The norm is therefore, for an economy/country to be in the middle-income level.

The World Bank classifies countries according to incomes (which is the global convention): lower income ($1035 or less); lower middle-income ($1036-$4085); upper middle-income ($4086-$12 615); and high income ($12 616 or more). It is relatively simple to move from lower income but tedious to move from lower to upper middle-income levels. For example, it would take a country 19 years at 5 per cent annual growth rates to move from $400 to $1035. It would take the same country 50 years to move from $1035 to $12 615 at the same growth rates.

The more challenging aspect of the middle-income trap debate, beyond issues related to classification, is the ability to differentiate between countries that are experiencing temporary growth slowdown and those which are in a trap.

According to one approach, a country is in a trap if at its growth rate, it will spend longer than the median country in that same income category (lower middle income or upper middle income). A country avoids the trap if it crosses the lower middle-income segment in less than 28 years; the upper middle-income segment in less than 14 years and experiencing growth rates that are more than 3.5 per cent. According to this approach, Malaysia entered the lower middle-income economy in 1969 and joined the ranks of upper middle-income countries in 1996. In this conceptualisation, Malaysia is a borderline case as it has been in the lower income for 27 years, and 15 years in the upper middle-income (in 2010) with average growth from 2000–10 at 2.6 per cent.

Another approach examines the middle-income trap as a special case of conditional growth slowdowns—i.e. the contribution of institutions, demography, infrastructure, macroeconomic environment, and output structure and trade structure in to growth slowdown. The focus is also on relative, sustained growth slowdowns. The findings suggest that middle-income countries are more likely to experience growth slowdowns, and that Malaysia is experiencing growth slowdown caused by institutional factors.

Najib Razak was partially correct when diagnosing that Malaysia was experiencing a middle-income trap. Others are suggesting that Malaysia is experiencing a special case of growth slowdowns. The bigger question is whether in making this diagnosis the premier had identified the correct economic reforms, and measures to implement them.

The outcomes are just as contentious as the debates on the middle-income trap. While Malaysia continues to record credible rates of economic growth (4.3 per cent for the period 2009–13), the sources of this growth are being questioned.

It has been argued that growth is being driven by pump priming of the economy through populist measures financed through debt. Najib Razak’s flagship policies to address the middle income trap—1Malaysia, the Government Transformation Programme and the Economic Transformation Programme—have largely faded into the background as pressing issues on race and religion, corruption and crime have persistently taken centre stage. At the recent general elections, the majority of Malaysians rejected these policies.

Despite the rejection, the premier continues to insist that his policies are sound. Notwithstanding, he was correct however, when he warned that unless Malaysia undertook the reforms successfully, it would risk losing growth momentum in our economies and vibrancy in our markets’.

This article first appeared in Asian Currents

Author: Greg Lopez

I write about Malaysia, Singapore, Southeast Asia and Australia’s policy towards the ASEAN region. I am also lecturer with Murdoch University’s Executive Education Centre, fellow at its Asia Research Centre, and a a member of its Centre for Responsible Citizenship and Sustainability. I am also a visiting fellow at the Department of Political and Social Change, Australian National University. Trained as an economist at the University of Malaya and the Australian National University, I have worked and researched the region extensively focusing on its economic and political reforms.

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