Tuesday, November 9, 2010

The World Bank’s Malaysia Economic Monitor: Talking About Income Inequality

From the World Bank’s blog (emphasis added):

Why Updating Malaysia’s Inclusiveness Strategies is Key

Compare South Korea and Malaysia in 1970 and compare them again in 2009. South Korea was a third poorer back then and is now three times richer. Even more remarkable has been South Korea’s ability to widely share the benefits of this spectacular feat across broad segments of society. South Korea’s strong focus on broad-based human capital development allowed the country to transform itself into a high-income economy, while at the same time reducing income inequality and improving social outcomes.

Malaysia’s inclusiveness strategies have produced some remarkable successes as well. Malaysia dramatically reduced poverty and has all but eliminated hardcore poverty. But the country has been far less than successful in reducing income inequality which, since 1970, steadily fell for two decades but has stagnated at high levels ever since…For Malaysia to remain competitive, it became clear that it needs to compete on value, not cost, and this requires a refocusing on getting the incentives right for innovation, creativity and entrepreneurship.

The comparison with South Korea is partly flawed and unfair…

…Leaving these caveats aside, the sheer difference in growth performance, as well as South Korea’s remarkable success in improving social outcomes, is nevertheless instructive…The New Economic Model, the Tenth Malaysia Plan and the Economic Transformation Programme all speak to the need to update Malaysia’s inclusiveness strategies so as to realign them with the objective of becoming a high-income economy.

The need to update Malaysia’s inclusiveness strategies reflects both new realities and new challenges. The new reality is that poverty is no longer the key issue when thinking about inclusive growth. Poverty still exists—and pockets of poverty remain deep and concentrated—but inequality is now in the spotlight and is presenting a tremendous challenge. The other new reality is that inequality is no longer what it was four decades ago. Nowadays over 90 percent of the level of inequality is explained by differences within ethnic groups rather than differences between these groups. Individual socio-economic characteristics, such as activity status, sector of employment, urban versus rural stratum, and educational attainment are now the capital explanatory factors, no longer ethnicity.

Malaysia’s high-income aspiration is also raising a whole new set of challenges. High-income economies tilt the demand for labor in favor of the skilled, sharpening income inequality across the skills spectrumThey are also open to competitive forces, creating challenges for those who are unable to compete or unlucky as a result of such competition

…Our recommendations on this highly charged topic do not come out of the blue—they are based on a detailed analytical study of the latest household income, labor force, and enterprise surveys, which the authorities have made available to our team. We are also leveraging on the experiences of other countries around the world, who have addressed or are coping with similar challenges.

You can get the full report here (I’m still reading it). Also included in the report are growth forecasts for this year (7.4%) and 2011 (4.8%). I also like Box 1 in the report, which echoes my second ever blog post back in 2009.

In any case, this issue of the Malaysian Economic Monitor (the third so far), touches on some of my own thoughts on the state of the economy and what will happen in the future.

I’m going to break a rule here and talk a little about NEP policies. Considering the situation at the time (1970s), the NEP with its broad based affirmative action policies was appropriate – but that isn’t the case now. As this report points out, income inequality is now largely within ethnic groups and not between ethnic groups.

Household income metrics based on mean or median will mislead, as they paint a picture of Bumiputeras and Indians lagging Chinese households as a whole, rather than the problem being mainly in the bottom income quintiles. That’s something I’ve thought has been true for a while now, but couldn’t prove. Now this report provides some substantiation for my gut feeling.

The obvious policy solution is therefore not in broad based affirmative action policies, but more nuanced and targeted policy action aimed at the poor and lower middle class. In effect, benefits have to be means-tested to ensure the greatest, cost-effective impact on economic outcomes.

The second aspect of this report that got my attention is the reality-based assessment of what will happen in the job-market under the ETP. If high-value added jobs offering higher incomes requiring a certain level of knowledge and skills are generated, what happens then to those who pass through a rote-based education system that doesn’t equip them with the required skills? What happens to those in the existing workforce who never had the knowledge, aptitude or opportunity to gain these skills?

There’s a fundamental disconnect between the ETP goals and programs, and the existing and prospective state of human capital development in Malaysia– again something that I feared will happen. Some will benefit, but some will be unable to adjust.

I figure we need to do three things to help ameliorate this problem:

  1. Reform the education system – pronto – preferably from the ground up;
  2. Considerably boost spending on vocational and retraining programs;
  3. Provide a social insurance safety net for those who simply can’t adjust.

Even with these changes in place, there’s going to be some difficult structural adjustments (read: rising structural unemployment) taking place in the labour market over the next ten years. It’s not all going to be peaches and cream.


  1. fuel subsidy, the biggest "safety net" of Gs outlays, is very well poorly targeted. something need to be done with it b4 other specific and targeted measures to enhance the real safety net can take place.

  2. Yes, most subsidies have to be rationalised and retargeted.

    Though I don't see why we can't do it all at once, instead of one by one.

  3. Any comments on the political economy of these reforms.

    I think the government knows what to do but is unsure on how to do it?


  4. Hi Greg,

    I think a close read of the NEM shows the government is very well aware of these issues - but notice that it's not something that's mentioned publicly except in very broad strokes.

    There's a lot of controversy and misunderstanding regarding what the constitution and what the NEP/NDP provides in terms of Bumi rights, hence the confused and partisan debate about it (read: Perkasa).

    So I think progress on these matters will be slow and tortuous. Which means we're probably not going to be solving the inequality issue very soon.

  5. Hi Hisham,

    Sorry for this very late reply. Just finished my PhD proposal.

    I'm working on the link between institutional quality/governance and efficiency/growth and the literature is very clear on the importance of high quality institutions.

    Reviewing on the literature on middle income trap also notes that institutions are vital.

    A priori - market preserving federalism (Weingast, 1995) is the best form of government/governance for growth.

    Do you reckon that the govt has a strategy on institutional change.


    p.s. Be happy to chat with you more. I like your positive (as in not normative) analysis on the Malaysian economy. I am quite partisan unfortunately.


  6. Hi Greg,

    I think the government has made an ostensible commitment to quality institutions - hence the GTP, which is the public sector counterpart to the ETP.

    But implementation and effectiveness as you know is always an issue.

    You've picked a fascinating subject for your PhD and I think one of the hardest. How do you see the identification problem with institutional quality and growth? Is there any thing in the literature that can really show the direction of causality?

    I'd be glad to drop you a line when I'm free - kinda busy at the moment though.

  7. Yes its challenging Hisham but I think its critical.

    You know they say that Malaysia has the best plans but fail in implementation. I think the problem is larger than that.

    This article provides the relationship between governance and efficiency.

    Meon, P.G., and L. Weill., 2005, Does Better Governance Foster Efficiency? An Aggregate Frontier Analysis: Economics of Governance, v. 6, p. 75-90.

    The more famous articles on institutions and growth are:

    Acemoglu, D., Simon Johnson & James Robinson (2005) Institutions as a fundamental cause of long-run growth in “Handbook of Economic Growth” Vol 1A, Aghion, P. & Steven Durlauf, North & Holland.

    Barro, R. J., (1991), Economic Growth in a Cross Section of Countries: National Bureau of Economic Research Working Paper Series, v. No. 3120.

    Lin, J. Y. & Jeffrey Nugent (1995) Institutions and economic development in “Handbook of Development Economics” Vol IIIA, Behrman J. & T.N. Srinivasan, Elsevier.

    Dani Rodrik and Douglass North is also key.

    Appreciate to discuss with you when your free.


  8. Greg,

    Thanks for the refs, I'll look them up.