Sunday, February 7, 2010

The Middle Income Trap

Dr Fong Chan Onn has a long article in today's Star on why Malaysia is in a middle income trap, and some of the things we can do to get out of it.While I have my doubts about some of his reasoning - lower inflation results in lower wages? really? it's not about demand and supply?- the article forms a good preface of the new economic model that the government will announce this month. Worth the investment of time to read.

His proposals:
  1. Phase out price controls and subsidies
  2. Institute a high wage policy
  3. Innovative incentives for high tech activities
  4. IT infrastructure and public R&D centres
  5. Leverage on Malaysian professionals and experts overseas
  6. Emphasize our strategic location
  7. Promote green energy
  8. Promote medical care and pharmaceutical trials
  9. Go downstream in oil & gas

Mostly policies I would agree with, and much what I would expect from the government in due course. I do have a couple of criticisms of his analysis though, of the use in the article of comparing Malaysia against the UK, Singapore, and Hong Kong.

First the wage comparisons are of policemen, teachers, accountants and clerks across the four countries. Note that these are all service occupations i.e. in the non-tradable sector. A comparison here would only be valid if all four countries had a single labour market, where demand and supply would equate the level of remuneration. Since they're not, wages will not necessarily be equalized even assuming the same development policies were pursued. Dr Fong relates that foreign multinationals are willing to leave if foreign (i.e. low wage) workers were restricted from working in Malaysia - this is in the tradable sector, where the labour market is more exposed to international competition. He misses the distinction between the two sectors, as well as the policy implications.

My second critique is one of omission. I think there's a simpler explanation of why Malaysia is in a middle income trap, while the rest of our regional peers have progressed more rapidly. There's a fundamental factor that many commentators appear to have missed in discussing Malaysia's middle income conundrum, and that's the demographic profile of the country.

Here's the median age and dependency ratios of Malaysia against the Asian tigers (all figures are 2009 estimates):

Malaysia Singapore South Korea Hong Kong Taiwan
Median Age 24.9 39.0 37.3 42.3 36.5
Dependency Ratio 57.2% 30.4% 38.2% 34.0% 37.7%

Do you think maybe, just maybe, that our population characteristics might have something to do with this? Stay tuned, I'll have much, much more to say on this subject.

Technical Notes
1. Caught in middle-income trap By Dr FONG CHAN ONN; The Star Online February 7, 2010.
2. Population data estimates from the US Census Bureau's International Database.


  1. i enjoy reading ur argument. but thinking the effect of demographic, perhaps our talented resources (mostly beyond the median) work in other countries for obvious reason?

  2. Funny thing: virtually every advanced and middle-income country complains about the brain drain, not just Malaysia. Since not everyone can lose smart people simultaneously, it seems to me that there's as much a perception problem as a real one.