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

Complexity and the Services Sector

Published in The Edge, June 2019.

In 2016, Malaysia’s Gini Coefficient, a common measure of relative income inequality, stood at 0.399. This figure was lower than the corresponding Malaysian Gini Coefficient in 2007, which stood at 0.461. Given that a lower Gini coefficient implies lower income inequality, a first glance view of the change in Malaysia’s Gini Coefficient indicates that income inequality in Malaysia improved significantly from 2007 to 2016. 

Data from a 2017 paper by the IMF seems to bear this out. In a sample of 50 countries, including both developed nations as well as developing nations, Malaysia’s labour income share – in essence, the percentage of GDP or national income accruing to labour – increased by the most from 1991 to 2014. Indeed, some of the world’s most important economies saw a decline in that trend, including China, Germany, the United States and Japan. So Malaysia seemed to have bucked a common global trend – increasing returns accruing to capital owners, rather than to labour. 

On the surface, it therefore stood to reason that the state of inequality in Malaysia was improving. The Gini coefficient had been decreasing, and labour – more so than capital – was taking a greater share of national income. But, as always, with a mightily complex issue such as Inequality, a deeper understanding of what was really happening with the Malaysian economy was necessary.

A research paper by the Khazanah Research Institute in 2017 showed that, as per government policy, Malaysia had made the transition towards an economy where 60% of its GDP came from the Services sector. This was in line with policy direction at the time; the Economic Transformation Programme (“ETP”) stated that Malaysia will focus on developing a “large and thriving services sector.” Of the 11 sectoral National Key Economic Areas (“NKEAs”) under the ETP, 7 were Services NKEAs. 

While the ETP set out to develop high value-added services – and therefore to create high-income jobs – the reality turned out very differently. From 2005 to 2010, traditional services accounted for 41% of GDP, increasing to 44% of GDP over the period from 2011 to 2016. Modern services, however, stood still at 14% of GDP. As such, Malaysia’s economic structure did not evolve as quickly as policy intended; we still have an economic structure that prioritises traditional low value-added services, as opposed to high-technology sectors. 

As such, it makes sense that given the structure of the economy, we would see the prevalence of a labour-intensive economy, manifesting itself in the increase in the labour income share, as documented by the IMF. This, among other social assistance programmes such as the Bantuan Rakyat 1Malaysia (“BR1M”), also reduced the Gini Coefficient in Malaysia.

The question is – at what cost? In the short term, Malaysia’s growth may be more inclusive as rewards to labour rise, but in the long-term, we have managed to develop an economic structure that is less reliant on technology, thereby reducing our capacity to harness innovation and drive productivity growth. Of course, this is not to say that we should blindly allow inequality to run roughshod over the nation, but rather to say that approaches to tackling inequality need to take into account the larger picture of national development. We cannot miss the forest for the trees.

At the same time, even as we can all collectively agree that there is nothing inherently wrong with shifting to the Services sector per se, and that we should focus on high technology, high value-added Services, the complexity does not end there. For all the exponential growth in technology and innovation over the past decade or so, global growth hasn’t exactly responded in kind. In fact, global GDP growth remained at its highest in the late 1960s and early 1970s. As such, why is it that technology seems to be advancing rapidly, but we do not see those advances necessarily translating to productivity or growth?

Lukasz Rachel at the London School of Economics has a potential explanation. Rachel argues that a good chunk of innovation, particularly in the past decade, has been in leisure-enhancing innovation. According to Rachel, leisure-enhancing innovations are services that are supplied free of charge and are designed specifically to draw in viewers. Some of these innovations spring easily to mind – Facebook, Instagram, Snapchat, mobile games, and much more. 

Rachel shows that there has been an increase in leisure hours over the long-run which, in fairness, is not necessarily a bad thing – perhaps people have achieved a sufficient level of material comfort and are choosing to spend more time partaking in leisure. Next, he shows that there is also a dramatic rise in the use of leisure technologies more recently, across all sorts of media. 

Putting it together, given the rise of leisure hours, and the rise in the use of leisure technologies, as well as the ‘free’ nature of such innovations – revenues from the innovations come from advertising – it stands to reason that these leisure-based technologies garner a lot of our time and attention. Rachel’s paper then goes on to argue that once the leisure sector emerges, the growth rate of knowledge or productivity starts to decline. Given that the long-term growth of any unit of observation – household, firm, nation – ultimately depends on productivity growth, the increased focus on the leisure sector will therefore dampen long-term growth.

Rachel’s work still needs to be suitably verified through more empirical studies, but the logic makes sense. If our highly-skilled workers are all focused on developing more leisure-based technologies – say, the next Uber of pet grooming – are there actually significant benefits to productivity from simply moving up the value-added ladder in the Services sector? So, simply moving towards more high value-added Services is insufficient to drive productivity growth, we need to move towards high value-added productivity-enhancing Services. 

As such, as the government develops its strategies for the 12th Malaysia Plan and the New Industrial Master Plan, it needs to be as nuanced as possible in detailing the nature of industries – be it Services, Manufacturing or even Agriculture – to ensure that the priority is ultimately on both high value-added economic activities but also on economic activities that are productivity-enhancing. After all, the point of a strategic move towards more high value-added economic activities is to have a more sustainable long-term economic growth path, but that can only come with economic activities that are based on enhanced productivity. 

“All That Is Gold Does Not Glitter”

May 9th 2018 and the Evolution of a Nation