About Nick: i am an economist based in malaysia. I write about development economics, while sneaking in a pop culture reference or two.

The “Distance to the Frontier” Narrative of Malaysia’s Economic Growth

Published in The Edge Malaysia, March 24 – March 30 2014 as, “Innovation Key to a Forward-Looking Economy.

A large part of Development Economics, particularly from a macro- perspective concerns itself with attempting to explain cross country differences in economic prosperity, economic growth and growth patterns. Models such as the Solow model, the endogenous growth model, the human capital growth model and the neoclassical growth model are common building blocks in the Development Economics literature. However, it has not always been an easy task relating the experience of Malaysia’s growth path with these models. While the narratives pertaining to these models flow very well logically, I would not be confident in conjecturing that they accurately describe Malaysia’s growth experience well.

However, I was particularly struck by one paper which attempted to describe the role of policy in economic growth based on innovation and technology. Upon reading that paper, I thought it did a fantastic job providing a narrative for Malaysia’s growth history and the implications for Malaysia’s growth future. The paper, published in 2006, is called, “Distance to Frontier, Selection, and Economic Growth,” and it is written by Daron Acemoglu, Philippe Aghion and Fabrizio Zilibotti. While I will discuss the gist of the paper, I strongly assert that every policymaker and development policy researcher in Malaysia should spend some time and read the paper for themselves. It is not overly technical and reads very smoothly.

The firm analyzes an economy where firms can undertake either innovation technology or adoption technology. Innovation technology is where the economy is at the world technology frontier and thus, innovates to push the world technology frontier out further. If it does not do that, it stagnates and risks being overtaken by an incumbent who innovates further than that economy. An adoption technology is where an economy simply adopts the technology at the global technology frontier, primarily because it is not at the technology frontier. Thus, it grows faster from adopting technology than from innovating technology; this growth from adoption is sometimes called the “advantage of backwardness.”

The main assumption of the analysis is that innovation become more important as an economy approaches the world technology frontier. As the theory goes, countries at early stages of development pursue an adoption-based strategy to grow. As they get closer to the frontier, simply adopting technology will be insufficient and more costly; there is a need to switch to innovation-based technology as the marginal returns to adoption would have flattened out. Thus, as countries develop, innovation becomes more important.

At the adoption-based technology stage, the type of policies that encourage such technologies – usually via subsidies or other such anti-competitive policies to allow monopolistic/oligopolistic firms to appropriate rents in the economy – may work well in the short run but, over time, a delayed switch to an innovation-based technology strategy weakens growth as the economy is not making the best use of innovation opportunities. Economic rents that have become entrenched in the monopolistic/oligopolistic firms acts as a type of shield that protects insiders from more efficient entrants.

Furthermore, the authors posit that there exists a level of development, based on the distance to the technological frontier, such that, if an economy fails to switch out of the adoption-based strategy before this threshold, it will be stuck in a non-convergence trap where convergence to the frontier grinds to a halt. In other words, if an economy fails to switch its policies in time or holds on to old policies which allow old incumbents to maintain rents on the economy, it will get stuck in some non-convergence trap which, in the case of Malaysia, we can conveniently call the “Middle-Income Trap.”

Thus, policies that support innovation must be put in place before an economy crosses over the frontier distance threshold; otherwise, it may get stuck in a trap. It is entirely possible that Malaysia, with its remarkable economic growth in the late 20th century, may have crossed that threshold while still maintaining its old policies that foster the more ‘backward’ form of technological growth. As such, introducing innovation-based policies now – which, to the credit of the government and the business sector in Malaysia, has been ongoing in the 2000s – may have come slightly too late to prevent Malaysia from entering the non-convergence trap.

Yet, if governments realize this, why then do they not switch their policies to support innovation as the economy approaches the technology frontier? Well, one easy reason is that they may not have an idea of how close they are to the technology frontier, especially if data availability is scarce in that economy due to an irrationally overprotective department of statistics. Another answer, posited by the authors is that policies that favor the adoption-based strategy at the initial stage of development create and enrich their own supporters. When economic power becomes entrenched with political power, it becomes difficult to reverse policies that have an economically and politically powerful constituency. Consequently, societies may remain trapped with “inappropriate institutions” and relatively backward technologies.

The questions for Malaysia public policy, in terms of economic growth via innovation, are, firstly, are current innovation policies enough to get Malaysia growing close to or, in some industries, at the global technology frontier? The government has certainly recognized the importance of innovation for the Malaysian economy but it is not clear that current efforts are sufficient. After all, innovation is stochastic; we do not know where it will come from. If we go on banning things, even seriously innocuous things like Ultraman comics, how can we keep ourselves open to channels of innovation?

The second question relates to the persistence of adoption-based technology policies. Have we adequately diverged away from such policies? For the sake of Malaysia’s economic growth, it makes no sense to have growth driven by innovation-based technologies close to the frontier be dragged back by policies that maintain the old order adoption-based technologies designed for an economy that is “backward.” If we are to be a “forward” economy, let us be forward all the way. Policies that are not consistent with leading Malaysia to be an advanced economy should be phased out as soon as possible lest we remain in our ongoing “non-convergence” trap.

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