Malaysia's New Economic Model: Making choices

In June 2009, Malaysia's Prime Minister Datuk Seri Najib Razak asked if I would serve on his council of economic advisors, the National Economic Advisory Council (NEAC). This Council was to come up with a New Economic Model for the country. It would not be a group that got together every month to finetune the economy. This Council was not to sift through the entrails of inventory reports, and propose economic policies to lean against the wind.

1. Background

No, the task assigned the NEAC was to put Malaysia back on a high-growth path, reinstating Vision 2020 that Malaysia would within these next 10 years achieve the status of a developed nation. Council was to do this against a post-1997 background of annual economic growth having nearly halved; investment as a fraction of GDP having plummeted to 50% what it used to be (private investment, to one third); with the economy relying on a workforce of which four-fifths were educated only up high-school level while over one quarter of local public university graduates remained unemployed 6 months after graduation, and with the human capital brain-drain becoming freshly re-energized (350,000 Malaysians in 2008 lived and worked abroad, half of them with university education).

By 2007, Malaysia seemed as far from the World Bank's notion of a high-income economy as a decade earlier, in contrast to economies such as Slovakia, the Czech Republic, and Poland, all of whom had by 2008 broken through that high-income boundary but had earlier been roughly level with Malaysia.

Yet, Malaysia had been previously identified by the Spence Commission on Growth and Development as one of only 13 countries in the world that had for more than 25 years grown at rates exceeding 7% annually. At different times since the 1960s, despite having a population not even one-third the UK's, Malaysia had been the world's largest producer of tin, of rubber, and of palm oil.

Today, forty percent of Malaysia's households earn less than US$15 a day (RM1500 a month), two thirds the World Bank's low-income threshold. With Malaysia's domestic income distribution what it is, only one million people pay income tax at the highest rate of 26%; there is no goods and services tax. Oil and gas revenues have, on occasion, provided up to nearly half the government's total revenues, although by 2014 Malaysia is expected to become a net importer of oil. As much as 20% of the nation's public expenditures routinely get spent on subsidies that keep prices of basic goods low but distort reality for Malaysia's citizens.

Certain policy questions - for instance, monetary control and inflation; financial markets oversight, regulation, and development - are outside the NEAC's remit, and rightly so. In Malaysia, all those issues were taken care of by others, and already attain world-class standards of performance.

The large facts I've just described seemed to me (and many other observers) precisely the ones raising the critical, first-order challenges for economic policy in Malaysia. The problem was how to organize them coherently and understand their resolution. But there is, further, the other critical, first-order challenge unmentioned so far: namely, Malaysia's 40-year-old program of affirmative action.

I say unmentioned but of course that is not how the outside world viewed this. The international press emphasized most of all this dimension to Malaysia's policy framework; I will bring this out further in the discussion that follows. For now, however, I just note that some foreign financial houses I spoke to about NEAC work downplayed the significance of all the other problems I have mentioned. They said to me, "Malaysia needs to fix its affirmative-action program; everything else follows."

That proposition, by itself, is almost surely demonstrably false. On the other hand, the perception is obviously one that colors the views of many market participants who actually shift significant financial resources.

Article 153 of Malaysia's Constitution, ratified in 1957, requires that the King protect the special position in Malaysia of the Bumiputras (ethnic Malays and a small number of other indigenous groups). The Article allows the federal government to protect Bumiputra interests by establishing quotas for public scholarships, public education, and the civil service.

In 1971, following racial riots, declaration of a state of national emergency, and suspension of Parliament, the then-Prime Minister Tun Abdul Razak---father of the current Prime Minister---introduced the New Economic Policy (NEP). This policy sought to eradicate poverty regardless of race and to eliminate the identification of ethnicity with economic function. The enabler for both these goals would be rapid economic growth, the speedy expansion of the economic pie to divide across all Malaysians, so that no subgroup would feel absolutely disadvantaged. A key feature of the NEP was its effort to raise Bumiputra equity ownership from 2.4% in 1971 up to 30% within two decades.

What has NEP progress been? At a fixed absolute income threshold (its exact value holding no significance as long as it's fixed and applies across the board), poverty rates for Bumiputras declined from 65% in 1970 to 5% in 2007, while that for Malaysians overall, from 49% to 4%; Chinese, 26% to 1%; Indians, 39% to 2% (Table 4, p. 57, NEM). Wealth figures are widely disputed but most sources give Bumiputra equity ownership of 2--4% in 1971; official KL Stock Exchange statistics suggest Bumiputra shares of 29% by 1990 and 37% by 1996.

That was the background when in August 2009 PM Najib Razak delivered his keynote speech at the NEAC's inaugural meeting, asking Council for ideas and direction to transform Malaysia into a developed nation by 2020. Malaysia, having successfully drawn foreign investment as low-cost producer was populated with businesses that, at the margin, had neither incentive nor vision to climb the quality ladder. Infrastructure and expertise in key areas remained under-developed. For Malaysia as small open economy, the global trading environment has already shown time and again how it could change suddenly, as it had just done during the 2008 global financial crisis, and further looked set to change even more dramatically but less suddenly from longer-term global carbon considerations. Reforms already begun in Malaysia by the Central Bank, the Securities Commission, and others were already liberalizing capital markets and taking forwards expertise and comparative advantage in Islamic Finance. Government transformation work had already begun to introduce meritocracy and performance measurement in the public sector itself.

What could Council do to help Malaysia re-locate its strategic position in the global economy?

2. The New Economic Model

In the ensuing six months, Council met 4 times in Kuala Lumpur. At these meetings, Council members listened to presentations, mapped strategic visions, and debated subtle differences in emphases. Now and then, we would as a group take such a big-picture perspective that we would form a collective blindspot over the single largest difficulty in whatever we were discussing, completely missing the key concern. Now and then, we would micro-drill down and heatedly argue over whether the appropriate punctuation should be a comma or a semi-colon. But all of us remained energetic and enthusiastic and committed, and sometime during the 15 hours of meeting each day, or in seemingly interminable rounds of email 24/7, we would correct course and converge on the right balance.

We agreed our report had to be in two steps: First, to identify, propose, and persuade on the over-arching framework and strategic vision; second, to steer from that vision its delivery to be led by the executive branch and implemented by the civil service. Without successfuly convincing on the first, the second would never be executed. Without successfully executing the second, the first would have been in vain.

The single big-picture vision was that Malaysia had to become an advanced economy by 2020. Sure that included the Malaysian economy generating sufficiently high income. But that vision also included a subtext of inclusiveness - so that the poorest and most vulnerable in society would be taken care of - and one of sustainability, so that higher economic growth would continue into the future, not at the expense of degrading the environment for generations to follow.

Council concluded many of Malaysia's malperforming situations were inter-linked. Underperformance in one setting was the rational response to underperformance in the next: Why work hard in school if you're convinced it doesn't benefit you afterwards? Why work hard in your job if your productivity is held back by so many unskilled around you? In these circumstances, what is needed is a big push to break out of that vicious circle of under-performance. But disruption would be needed not just in your own circle of school-mates and colleagues, but everywhere in the economy. Hence, we emphasized the big push of economic transformation needed to break the logjam of entrenched, special interests. We sought to build momentum and confidence in the mindset of citizens that more positive changes would continue to emerge but all of us needed to keep pushing.

This economic transformation would come with reform along eight strategic initiatives - slightly more concrete but only slightly:

1. Re-energize the private sector so it could lead the process of economic growth;
2. Develop a high-quality workforce;
3. Create a competitive domestic economy;
4. Streamline and make efficient the public sector as facilitator for private enterprise, when in the past large government-linked corporations (GLCs) had been viewed as competitors instead;
5. Move to affirmative action that is (a) transparent, (b) market-friendly, (c) merit-based, and (d) conditioned on need ;
6. Build infrastructure for a knowledge base;
7. Enhance the sources of growth;
8. Ensure the sustainability of growth.

Early on, Council decided it couldn't be swayed by arguments about whether it was doing something truly novel or new or different. The only thing that mattered should be whether a proposal for implementation was likely to succeed and whether it would bring the highest benefits to the greatest number. Good ideas are hard enough to come by generally; why straitjacket oneself to not look at certain of them? This isn't an exam: why not copy good ideas however and wherever you find them?

Nonetheless, having come to the end of putting in place the over-arching vision, we could see several ways where our approach differed from earlier ones.

First, we focused on growth through enhancements in productivity, not the sheer brute force of capital accumulation. It's not that we ignored the latter - if we had, we wouldn't have expressed concern about the sharp fall off in Malaysia's investment. Instead, it is that we figured it would be innovative processes and cutting-edge technologies that would provide the surest platform for Malaysia's producing high value-added goods and services in the future.

Second, we envisioned economic growth being private sector-led and market-driven, no longer dominated by large public investment through GLCs in selected economic sectors.

Third, we described the benefits of the government moving towards local autonomy in decision-making. State and local authorities needed to be empowered to develop and support more of their own growth initiatives - without unnecessarily duplicating function or project. While flat-out competition to produce identical public goods, over and over, would be obviously wasteful, a little competition between local authorities is healthy.

Fourth, we wanted to encourage local geographies to emerge - whether in clusters or corridors - as long as they exploited economies of scale and concentration, and thus raised productivity over the long term.

Fifth, we saw the need for continuing government support of private industry, as long as that support was geared towards innovation, entrepreneurial risk-taking, and high value-added goods and services. It would be those general principles that guided support, not past principles of picking winners.

Sixth, we welcomed talent and skills from everywhere: as long as anyone, local or foreign, is able to contribute to Malaysia's transformation to an innovative, high-value added economy, they would be accepted and welcomed.

Finally, we emphasized how the global economy was changing, and we figured Malaysia's strategic position within it needed to re-orient as well. For the entire 20th century, the world's strongest economic powers have been the US, Western Europe, and Japan. Malaysia, like many others, tuned production and supply networks to service those markets. While we weren't arguing that policy should be based on the economic centre of the world suddenly shifting tens of thousands of kilometers east, we felt that it was reasonable to acknowledge the change in that global landscape, and to develop further new regional networks centred on the fast-growing, Asia-focused emerging economies.

In a nutshell, that's it. That's the New Economic Model (NEM).

3. After, for now

For a relatively technocratic problem and solution, the NEM announcement on 30 March by PM Najib attracted unexpectedly heavy attention from the international press. All the major world press worked in discussion of Malaysia's affirmative action program, both historical and prospective. The New York Times (30 March 2010) described the revision of Malaysia's policy to focus on need, not race.

The Wall Street Journal ran articles on two successive days (30 March, 01 April 2010), talking about the recalibration of Malaysia's decades-old affirmative action and asserting how "the New Economic Policy has hindered Malaysia's competitiveness in recent years. The U.S. and European Union have singled out Malaysia's insistence on maintaining preferences for ethnic-Malay owned businesses in government procurement contracts for stalling the development of free-trade pacts". The Journal's Opinion Asia column (01 April 2010) contextualized PM Najib's speech by observing how 'A few years ago it was inconceivable that a Malaysian premier would express dissatisfaction with the "rent-seeking and patronage" inherent in the country's four-decade-old affirmative action policies and call for a more "transparent" system based on merit and need. Former strongman Mahathir Mohamad used to label people with such ideas "extremists."'

Great cynicism continues to be expressed by some of my friends, Malaysian and otherwise, who say they have seen over the years many politician promises made only to be broken subsequently. Personally, however, I see great optimism instead. Why? I contrast PM Najib's 30 March speech with what I imagine someone wanting an easy ride through life might have said, in light of both the general skepticism and fervent fear-mongering in the runup to the event.

Two days before the NEM announcement, Kevin Brown wrote in the Financial Times (28 March 2010) how there was "widespread doubt" that PM Najib would take any political risk at all of dismantling Bumiputra special privileges, not least in a new economic model that might greatly dilute that historical affirmative action. James Hookway's Wall Street Journal article of 22 March 2010 gave considerable space to Ibrahim Ali, a right-wing extremist Malay MP, and to Perkasa, the NGO that Ibrahim Ali founded devoted to defending Malay rights, reporting how "Mr. Ibrahim reckons Mr. Najib is misreading the depth of anger many Malays feel toward any change in a policy that has given many a leg up and helped to build a large middle class." The Economist newspaper (11 March 2010) extrapolated from their interview with Najib and with others to sub-lead their article, "Najib wavers over undoing affirmative-action policies".

Not least, of course, there is the now-infamous interview Ibrahim Ali granted Al-Jazeera on 29 March 2010, the eve of the launch of the NEM, where Ibrahim Ali gets bleeped three times speaking, with some vitriol, on the position of other races in Malaysia.

Domestic reporting too emphasized the emerging political tensions (e.g., Malaysian Insider, 04 March 2010; 28 February 2010; and many others). And the Malaysian blogosphere - sometimes thoughtful and insightful; sometimes not; always vicious - don't even go there.

Now, contrast what PM Najib actually said with what all these observers predicted he would say. Think of the political onslaught, the wavering, the self-protection going on around him. If Najib had wanted an easy way out, he could have taken it and no one would have been surprised. He didn't. He continues along that difficult but worthwhile path.

One final comment. In this international reporting, by far the greatest attention has gone towards Malaysia's New Economic Policy and its possible adjustment. In Council's work, we knew this was important, but so too were all other seven strategic initiatives. Affirmative action matters. No significant advanced country in the world gets by without affirmative action programs of some kind - it is in human nature to take care of the weakest and most vulnerable in our society. So too for the members of Council, where that bottom 40% of the Malaysian population is targetted to receive significant help and attention. But fixing all the other problems matters too: it's one big push for all of them.

Council has now finished Step 1. Step 2 starts. Everyone likes to say, Now the hard work begins - as if I've never heard that one before. But I am energized. I continue to do this work (and, for the record, for practically no pay compared to outside options) because I think things actually are looking up in Malaysia.

(This appeared also on Wednesday 14 April 2010 Business Times, New Straits Times Malaysia B4ff and, in Chinese, in Sinchew Daily, again 14 April 2010.)