Monday, April 29, 2013

Escaping The Middle-Income Trap

OVERCOMING LIMITATIONS: Transformation plan created to help Malaysia reach high-income nation status.

THE Middle Income Trap Hypothesis (henceforth, the MITH) has been the core ideology behind the attempted transformation of Malaysia's economy in recent times, and is considered by some to be one of the biggest problems of global economic development. 
At its heart is the question of why some countries reach developed status while others do not. Malaysia's national transformation plan is aimed squarely at overcoming the limitations and constraints identified with the MITH paradigm.

Yet surprisingly, there is little convincing research support in the economics literature for the MITH. In theory, economic growth and development is initially driven by increasing population, capital accumulation and a rising technological level. 

When growth in these "factors of production" slow, as they inevitably do as incomes rise, the only way countries can continue to grow is through improving the way these factors are combined to produce goods and services, or what's called "total factor productivity", or TFP. When a middle income country is unable to overcome this dilemma, this is termed the middle income trap.

For Malaysia, the evidence that the country is in a MITH appears compelling - growth in the last decade has been slower than in the 1990s while investment and population growth have been sharply down as well.

Other factors, like a workforce skewed towards low wage labour intensive industries, low value-added in manufacturing and a purported "Brain Drain", are also suggestive of an economy that hasn't been able to make the leap forward needed. 

Hence, the importance of the economic transformation.

Yet, other evidence suggests that there is more to this story than that. On a per capita basis, growth hasn't slowed as much as suggested by overall growth, which means slowing population growth has been a bigger factor than productivity. 

Living standards have continued to converge towards high income status almost without pause since the the 1997-98 crisis. Productivity growth, whichever measure one cares to use, hasn't dropped significantly either. 

Taking a longer term view, the growth takeoff of the 1990s appears to have been the period outside the norm, and the period of slower growth that has followed is in reality a return to normalcy.

Recent research at the International Monetary Fund suggests that a MITH-driven growth stagnation in Malaysia really only occurred in two distinct periods - the early 1980s, and the late 1990s. Both these periods encompassed deep and damaging recessions that put back economic progress for six years to eight years. 

Otherwise, Malaysia's drive towards developed status has been unhindered. In other words, Malaysia is not in a middle income trap.

Be that as it may, the transformation plan remains relevant even as we make progress towards high income status. Improving the structure and efficiency of the economy is hardly harmful, and could help sustain growth even if we run into another crisis. The historical record is replete with cautionary tales of countries poised for prosperity but due to one circumstance or another, fail to advance or even fall back. 

Even if the MITH is truly a myth, taking national development seriously still requires constant vigilance and flexibility.

The writer is vice-president of Economic Research with the Malaysian Rating Corporation Berhad (MARC). The article represents the author’s personal views and opinions and do not necessarily represent those of MARC.


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