What Will A Service-Based Malaysian Economy Look Like?

One of the things running to my mind with all this discussion of KPIs, KRAs and a new economic model for Malaysia is that while this may put us on the road to becoming the high income economy that everyone wants, we will have to handle a fresh set of challenges and structural changes along the way.

I`ve described what one of those changes will be: taking into account the Balassa-Samuelson hypothesis (BSH), a strategy encompassing services (which is mainly composed of non-tradables) as the engine of growth will have the impact of putting upward pressure on the MYR exchange rate. That is a consequence of labour arbitrage that is less subject to international competition, and thus less subject to the downward pressure on wages and prices exerted by low-cost economies such as China. An economy that is biased toward services would therefore be better able to support an elevated exchange rate than one concentrated on export manufacturing, all else being equal. Productivity differentials would of course have an impact (Germany and Japan for example), but the general rule remains valid.

But BSH was originally proposed for something quite different – an appreciated exchange rate for high-income, service led economies is just one of the consequences. The original research by Bela Balassa* and Paul Samuelson** (yes, that Paul Samuelson) was an attempt at explaining an emprirical regularity that was inconsistent with purchasing power parity. That emprirical truism was that high-income economies were also high cost economies.

In other words, high income economies also characteristically have high general price levels.

So one of the consequences of pursuing a services-led economy is that as incomes rise so will the price level of non-tradables, which will have the effect of raising living costs generally (housing for instance). That in turn brings to mind the probable impact on income and wealth distribution. Given that Malaysia already has high income inequality, we have a potential problem in the making - one that is not at all being discussed in the rush towards defining a new economic model.

One thing I'd like to point out is that a high-income economy doesn't necessarily marginalise the “low” income group – insofar as job creation will be concentrated in the services sector, where wages are less subject to international arbitrage, low-skilled work can be had in the services sector that could potentially provide a relatively sufficient level of income to accommodate the higher price level. Having a high-income economy does not imply that all jobs must also be high-value added with a high knowledge and skill-base requirement, as some have automatically assumed. Look at how much garbage collectors and electricians earn in advanced economies for instance.

But does not mean we won’t have a problem. For one, those working in sectors which produce tradable goods would find their purchasing power eroded as the structure of the economy shifts. This covers not only manufacturing, but also agriculture (think food, not plantations). Also, given the high immigrant worker population we have, wages in the services sector might not increase enough to cover increasing costs of living.

So creating equitable income distribution will become increasingly important as the services sector gains momentum. How we solve that is going to be ticklish, especially with the racial and urban/rural divide that already bedevils Malaysian society.

In the 1Malaysia session I talked about earlier, Tan Sri Lee Lam Thye raised the question of introducing a minimum wage requirement – I think it’s about time Malaysia thinks about this seriously. As an economist, my first instinct is to say that a minimum wage introduces distortions into the labour market, as well as another avenue for unwelcome government intervention into the economy. I’m also worried about administration of a minimum wage, given the disparities in costs and incomes between rural and urban areas, as well as the political economy dimensions it will involve. But ensuring sufficient income to keep pace with increases in the price level might be called for, if the price in terms of lower profits and unemployment are low enough.

I’m thinking that part of the "tsunami" that was the 12th General Election occurred because the political battleground has shifted from eradicating absolute poverty, to handling relative poverty instead. I don’t think disgust with rentiers and economic elites is the real issue, no matter what the rhetoric of the opposition. To my mind it’s rather the relative stagnation of purchasing power and job creation for the bottom income quartiles in the face of increases in the cost of living. It is the lower-middle class and the working class who have been most affected, and this issue will become more acute if and when Malaysia makes the transition to developed status, where living costs will become higher even without the kind of commodity-led inflation we’ve seen in the past three years. This is not to say that poverty is a dead issue, but rather that the poor should no longer be the sole distributional focus for government assistance and policies.

Beyond distribution issues, we will also have to deal with changes in employment structure. Self-employment and temporary employment will increasingly play a role in the labour market – this website caught my eye the other day, and seems indicative of the kind of changes we will see. But this in turn means that mechanisms of savings, access to financial products and healthcare will need to be adjusted to the realities of the labour market. For instance, how do you apply for a housing loan without salary slips or a big chunk of wad in fixed deposits? I’m encouraged by the government’s current move to provide alternative private pension schemes, which will help narrow this gap at least in the realm of retirement planning.

But more needs to be done, and there are no easy answers.

Technical Notes:
*Bela Balassa, "The Purchasing-Power Parity Doctrine: A Reappraisal", The Journal of Political Economy Vol 72, No 6 (Dec 1964) pp584-596
**Paul A Samuelson, "Theoretical Notes on Trade Problems", The Review of Economics and Statistics Vol 46 No 2, (May 1964) pp145-154