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

Gearing Up in the New Trade Ecosystem

Published in The Edge, August 2019.

From the 3rd to the 5th of August, the Melaka in Fact (www.melakainfact.com) team hosted a conference themed, “Melaka in the Long 15th Century.” The conference lined up Malaysian and international speakers to discuss an Asian-centered perspective of Melaka in the 15th century, drawing from across a range of academic sub-disciplines including history, language, philology, architecture and archaeology.  

Perhaps most remarkable about the whole thing is that a trading port in our little neck of the woods in this wide world held enough interest that it was worth experts travelling from all over the world just to engage in the study of that port. As we are aware, the success of Melaka was due to its role as a trading center within the region. And, indeed, the success of Malaysia – and the bulk of kingdoms located in this piece of land we call home – is effectively a history of trade. 

The trade war between the United States and China – two of Malaysia’s largest trading partners – is dominating global economics and business news flow. Should US President Donald Trump win re-election next year, the likelihood is that this trade war will continue up to 2024. Indeed, bookmakers have tipped Trump as the favourite to win the 2020 elections. 

Back in the 15th century, Melaka benefited from being in the middle of the giants: China and India. Today, Malaysia faces both the benefits and the challenges of dealing with two giants as well, namely China and the United States. However the trade war plays out, I think there is a tremendous opportunity for Malaysia to re-define its identity as a trading nation and seize control of a new global trade paradigm. This may be a watershed moment for Malaysia, much like it was in the 1980s, after the Japanese re-valuation of the Yen in 1985 as a result of the Plaza Accord agreements.

Yet, while doors and windows may be opening, albeit in a haphazard and unpredictable manner, to seize on global trade opportunities, we still need to come back to an irrefutable fact – we need to produce stuff worth trading. As I have argued before, there is a big misconception on trade. The objective of trade is actually imports, not exports. By importing things, we are able to consume things that we either could not make or that we would make for a far greater cost. Imports expand the choice set for consumers. But to be able to afford to import, we need to export. We need to provide the rest of the world something that they would want in order to get something that we would want from the rest of the world. Unfortunately, imports often gets a bad reputation as it is given as a GDP-reducing (and therefore growth reducing) factor in the GDP equation.

Therefore, whether or not Malaysia can seize opportunities in this era of a global trade war comes down to if we can produce things that the world wants. This juncture is critical. What those ‘things’ that we produce are is entirely up to us. We can go on and do more of the same, or exploit our commodities (just like Melaka did), or we can try to move towards exporting more complex and sophisticated products. It is a choice that, as a nation, we can make. Indeed, it is a choice that should not be left solely to the private sector, but is a whole-of-nation responsibility.

The choice of what economic activities to pursue – and therefore, what things to export – is the domain of Industrial Policy. Much like imports, Industrial Policy has also gotten a bad reputation over the past few decades. The reputation came from an ideological belief, championed by international institutions such as the World Bank and the International Monetary Fund, among others, that strong government intervention in the economy was necessarily sub-optimal and that an economy should operate on the back of its private sector as much as possible. 

However, the tide has begun to turn. Two economists at the IMF, Reda Cherif and Fuad Hasanov, published a paper in June 2019 entitled, “The Return of the Policy That Shall Not Be Named: Principles of Industrial Policy.” It probably tells us something about how Industrial Policy was perceived that these economists basically labelled it as the Lord Voldemort of policies. 

In that paper, the authors write that it is the state that “sets the level of its ambition – that is, the level of sophistication of the new sectors and the degree of domestic ownership of technology.” To that, the authors argue that there are three gears. Low gear is a “snail crawl” approach that ultimately achieves very limited outcomes. This approach is the standard Washington Consensus recipe of merely improving business environment, institutions and infrastructure, preserving macro-stability, and investing in education with almost no government intervention in the economy.

To be clear, these measures are necessary for any economy. But the problem is that they are not sufficient to sustain prolonged economic development. We move on then to medium gear which the authors call a “leapfrog” approach, relying on attracting Foreign Direct Investment in sophisticated industries, or climbing the quality ladder around existing industries. If this sounds familiar to you, it should – this has been Malaysia’s general economic strategy. As the authors write, this approach “may provide relatively high growth, leading to the middle-income status, but it is unlikely to lead to high-income status within two generations.”

Finally, there is high gear. Countries such as Japan, South Korea and Taiwan have used this strategy – the authors call it a “moonshot” approach – in which the objective is to create competitive domestic firms in frontier technologies. In this approach, state intervention is crucial in fixing market failures and developing sophisticated sectors, thereby creating conditions for long-term development. Lessons from the experiences of these countries are readily searchable, the question is – are we committed enough?

In essence, taking advantage of this external shock in the global trade ecosystem requires us to be fully committed – Go big or stay home. But are we ready to do this? Yes, we need to fix the “low gear” things, but are we bold enough to shift from medium gear to high gear? Critics will inevitably raise the point – why should the government do this at all, why not let the private sector take control?

While private sector firms could theoretically invest in industries that are totally new without any precedent firms, often with high fixed costs, and at the frontier of technologies which may or may not be scaleable, it is the equivalent of an individual investing in property on Jupiter. Yes, it may work out splendidly one day, but wouldn’t it be nice if we saw a first mover on this? This ‘first mover’ in many industries around the world has historically been the state, giving the industry a “Big Push.” 

We need to make bold decisions about our economy. It is a collective choice and even a collective partnership between the people, the private sector firms, and the state. Leaving our economy in the hands of the private sector alone ensures that we will do more of the same, and innovate only incrementally. Industrial Policy in high gear requires so much more than that. If we are to not just survive but thrive in this new global trade ecosystem, we can’t allow ourselves to drive on in medium gear.

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