Possibly the biggest question I have in thinking about economic development today, especially for a middle-income country like Malaysia, is, “Just where is all the economic growth going to come from?” In the second half of the 20th century, we saw an abundance in growth both in more advanced nations such as the US as well as in emerging countries such as the East Asian Tigers, and certainly countries like Malaysia as well.
We have heard a lot about a so-called “Middle Income Trap”, where low-income countries manage to successfully transition towards being middle-income countries, but then fail to make the next step towards becoming high-income nations.
Now, I don’t necessarily believe that there really is a “trap” per se, but I would like to highlight an International Monetary Fund research paper that came out in 2019 by Reda Cherif and Fuad Hasanov. The paper showed that between 1960 and 2014, only 16 of the 182 economies of the paper’s sample reached high-income status from either low- or middle-income status. The authors placed these 16 economies into three categories: countries that discovered large quantities of oil; those that benefited from joining the European Union; and the Asian Miracles.
Malaysia has benefited, for sure, from our oil discoveries, but not to the extent of the wealthier Gulf nations, of course. And we can probably join BRICS, but we definitely will not be able to join the European Union. For us, the closest model that has worked that we can try to replicate and calibrate to our own local context is that of the Asian Miracles — typically Japan, South Korea and Taiwan.
There is plenty of literature on this, but a recent very accessible work is by Joe Studwell. His book, How Asia Works, provides a good historical review of East Asian economic development with a three-step recipe of land reform; export-oriented state-driven industrial policy; and financial direction. What he demonstrates and what history will show is that these countries have developed on the back of proactive state interventions that generate early accumulation of capital and technological learning, in collaboration with local private sector firms — via capacity development in large Japanese keiretsu, the Korean chaebol, and the small and medium enterprises of Taiwan. This is a very important point that I will return to later.
Now, for the most part, Malaysia has done a pretty good job in driving its industrial policy. If you look at our exports in the 1960s, our top three were natural rubber (52%), unwrought tin and alloys (14%), and iron ore and concentrates (6.2%). In 2022, our largest exports were electrical and electronics equipment (37%), mineral fuels, oils and distillation products (14%), and machinery and boilers (10%). We have done a fantastic job of diversifying our economy, and this increase in economic complexity or sophistication has come with the rapid economic growth that we have experienced in the late 20th century.
But, here’s a thought experiment. In evaluating any investment proposal, one of the very first questions we should ask ourselves is, “What are we really buying here?” For instance, if you’re buying a grocery chain in Malaysia, what you are really buying — the underlying trend — is rising private consumption in Malaysia: a wealthier middle class who can afford higher quality food products. So, we know that Malaysia had gross domestic product growth rates of more than 9% per annum in the early 1990s, driven by our industrialisation push in the 1970s and 1980s. If you wanted to invest in Malaysia’s export phenomenon via investing in a public market stock, what could you have invested in? The answer is actually probably the Intel stock on the Nasdaq.
This is because the primary driver behind our industrialisation was foreign direct investment (FDI), driven by multinational corporations. To be clear, there is nothing fundamentally wrong with that to kick-start an industry. Nissan built on its initial foundations by licensing technology from a British automobile company to drive improvements in quality and standardisation of its car production. Samsung and Siemens formed a joint venture in semiconductors and electronics in the 1970s. As an aside, it’s cool to note that Samsung originally started as a grocery trading store. Even the mighty TSMC in Taiwan allowed Philips from the Netherlands to take an equity stake in it to transfer process technology.
However, what becomes a problem is when countries fail to turn this initial reliance on foreign multinational corporations (MNCs) into building their own domestic powerhouses. Japan, South Korea and Taiwan developed globally competitive companies that could take on the US and Germany, but for the most part, Malaysia did not succeed as much in developing such domestic firms. Thus, while the Asian Tigers could rely on their own companies to drive capacity and capability upgrading in their economies, we remained an outsourced hub for MNCs who, let’s be honest, chose Malaysia for low labour costs at the time.
We can see a very stark example of this. If you look at the MSCI Asia ex-Japan Index in the 1990s, Malaysia’s weight in the index (which tells investors roughly how they should allocate their capital) was about 20%. Today, that is now close to a rounding error at about 1%. TSMC alone is 10.9% of the index. A single Taiwanese super-company is worth more than the entire Malaysian market. This is the power of globally competitive firms.
To be clear, the domestic companies of the Asian Tigers did not succeed on their own. The governments of those economies undertook all kinds of state interventions to support the critical industries that they cared about. These included policies that restricted FDI, directed credit allocation, high tariffs and quotas to protect infant industries, technology licensing, heavy investment in public research and development institutes, export processing zones and, in my view, just as important as anything else, performance-contingent support. Firms either met export targets or were forced to be subsumed or consolidated under better-performing firms. The states did not let zombies survive.
What has seemed to work historically is for countries to be able to grow domestic or local companies which then become regionally and globally competitive. And developing those companies has been a ballad between private sector entrepreneurial risk-takers and public sector support, where the latter is typically in the form of being initial risk-taker, being extremely patient capital, and being a coordinator of multiple moving parts. Furthermore, if you read that description, it is clear that we should expect a fair amount of failures along the way; the question is whether we can fail in a smart way and learn from those failures.
Now, the question is whether these lessons from history still serve us in a world that is pretty different from the context of that history. For once, global value chains are far more fragmented and controlled by a few large mega giants, the global policy space has also shrunk with the more restrictive World Trade Organization versus the General Agreement on Tariffs and Trade of the 1960s and 1970s (although who knows what trade rules are these days), and while countries may have been deglobalising recently, corporates still remain especially globalised, making it far more difficult for challengers.
A question we have to ask ourselves is, “What actually matters?” Does it really matter if Malaysia — or any developing country — hits some arbitrary threshold of “high-income”? Or is it more important that we maintain steady, sustainable economic growth and economic development? And what do we need to do, regardless of whatever global conditions might be? We still need to build regional-class or world-class firms; we still need to undertake structural reforms; we still need to build a strong talent base. And so, escaping a “trap” may be much tougher today; but doing the right things, adapted to present day conditions, to build a resilient and productive economy, remains. We should not lose sight of where our real priorities lie.