Malaysia in a Middle Income Trap

This article discusses the challenges faced by Malaysia in escaping the middle income trap and suggests ways to overcome it. It provides an overview of Malaysia's economic growth, the definition of the middle income trap, factors leading to the trap, and potential solutions. The article also highlights the importance of total factor productivity growth in Malaysia's economic development.

ECN70104: - MALAYSIA IN A MIDDLE INCOME TRAP
MALAYSIA IN A MIDDLE INCOME TRAP
Abstract: -
Malaysia continues to struggle in addressing the identified challenges that are preventing or
delaying the country’s shift from middle income to high-income status. Malaysia progressed
from lower middle to upper middle income status in 1992 and has been stagnating in a middle
income-status for 55 years since 1960. Malaysia is caught in the middle trap right now and
getting it out is going to be challenging. The term ‘middle-income trap’ was first brought to
attention by Gill and Kharas (2007), to highlight growth slowdowns in many East Asian
economies. These countries experienced rapid growth, enabling them to reach the middle
income status but have not been able to catch up with developed countries and achieve high
income status. (Gill and Kharas, 2007). The paper conducts a review on the existing
literature on the background of Malaysia’s economy, the definition on Middle Income Trap
(MIT), factors which lead Malaysia to fall into the middle income trap and suggested ways
and method to escape from the middle income Trap.
Keywords:-
Submitted by: Anand Sharvanandan (0337677) Page 1

ECN70104: - MALAYSIA IN A MIDDLE INCOME TRAP
1. INTRODUCTION
Before independence, Malaya's economy (before Malaysia was formed) largely
depended on rubber and tin exports as the main source of income and Malaya was third,
after Japan and Singapore in terms of prosperity (Sukirno, 2004). Since independence
till now, Malaysia has enjoyed relative prosperity, initially as a commodity exporter
(rubber, tin, palm oil and petroleum) to a services-oriented economy. Figure 1.1 below
shows the economic growth experience by Malaysia under different periods of time.
 1960- 1985:- Commodity based economy that gradually began to modernise
and industrialise, commencing with import –substitution which then evolved
into export-oriented. Further to that, The New Economic Policy (NEP) was
introduced in 1971 with a goal to eradicate poverty and restructure economy
while aiming to eliminate the identification of ethnicity with economic function
(New Straits Times, 2006).
 1986- 1998:- Manufacturing based economy geared for trade cantered growth.
The Passage for Promotion of Investments Act of 1986 bolstered Malaysia’s
position as an attractive location for overseas investments (Murtada, 2019).
Malaysia had turned into a manufacturing oriented country which produces
electronic and electrical goods, iron, car and cement.
 1998 till present: - After going through two major financial crisis, Asian
Financial Crisis and Global Financial Crisis, the economy underwent major
reform to increase resilience and robustness of its existing sector. Malaysia had
become a service-oriented country. Under this sector, it contains of tourism,
finance and education. The percentage of GDP had the biggest share since year
1985. The economic growth of this sector is around 7% and the employment
rate has been more than 50% since year 1985. Malaysia continued to enjoy
good economic growth and in 2010, New Economic Model (NEM) was
unveiled by the then government to propel Malaysia into the high income
category by year 2020 (Chin, 2010). The goal of NEM was to improve
worker productivity across all sectors while tying it closely to sustainability,
(Star, 2010) besides empowering the private sector and to reduce the financial
disparity between the poor and wealthy Malaysians (Bernama, 2010).
Submitted by: Anand Sharvanandan (0337677) Page 2

ECN70104: - MALAYSIA IN A MIDDLE INCOME TRAP
Figure 1.1: Real GDP and Real Annual Median Income Household Income, 1960-2016 (Malaysia)
Source: - International Monetary Fund, World Economic Outlook Database, October 2018
Figure 1.1: GNI per capita, Atlas Method (current USD), GDP Growth (annual %) & GNI per
capita growth (annual %) (1980-2017) for Malaysia
Submitted by: Anand Sharvanandan (0337677) Page 3

ECN70104: - MALAYSIA IN A MIDDLE INCOME TRAP
In 1989, the World Bank (Datahelpdesk.worldbank.org, 2019) began categorising
countries as low, lower middle, upper middle and high income countries based on their
capita gross national income (GNI) as per Table 1.1 below.
GNI per Capita (USD) Classification
Less than $1025 Low Income
Between $ 1026 and $ 4035 Lower Middle Income
Between $ 4036 and $ 12, 475 Upper Middle Income
More Than $ 12,476 High Income
Source: - World Bank
Table 1.1: World Bank Country Classifications by Income level
According to World Bank’s classification, Malaysia progressed from lower middle to
upper middle income status in 1992. Its per capita gross national income (GNI) reached
USD 10,570 in 2015 (Refer Figure 1.2) or 15 percent short of the high income threshold
of USD 12,475. According to a study by Asian Development Bank, Malaysia has been
stagnating in a middle income-status for 55 years between 1960 to 2017. (Estrada et al.,
2017) as indicated in Figure 1.3 which is a common phenomenon for many developing
countries. Figure 1.4 shows that Malaysia is slowly approaching the threshold for a high
income country
Submitted by: Anand Sharvanandan (0337677) Page 4

ECN70104: - MALAYSIA IN A MIDDLE INCOME TRAP
Source: - World Bank, Asian Development Bank
Note :- Country income Classifcation before 1987 follows classification used in (Estrada et al.(2017), which
classifies country income levels using purchasing power parity in constant 2011 from Penn World Tables 9.0.
Country income groups post 1987 uses World Bank classification.
Figure 1.3: Income Group Classification and length of middle income status, Malaysia and selected
countries , 1960-2016
Source: - World Development Indicators
Figure 1.3: Distance to High Income Country threshold , 1987-2016
Submitted by: Anand Sharvanandan (0337677) Page 5

ECN70104: - MALAYSIA IN A MIDDLE INCOME TRAP
MIDDLE INCOME TRAP (MIT)
The term ‘middle-income trap’ was first brought to attention by Gill and Kharas (2007), to
highlight growth slowdowns in many East Asian economies. These countries experienced
rapid growth, enabling them to reach the middle income status but have not been able to
catch up with developed countries and achieve high income status. (Gill and Kharas, 2007).
When a country in stuck in between a low wage poor country which dominates in mature
industries and a rich country which dominates in rapid technological change industries, that
country can also be characterised as a Middle Income Trap country (Gill and Kharas, 2007).
They argued that three transformations were required for emerging Asian countries
(middle-income countries) to continue their growth: (1) transformation from diversification
to more specialization in production and employment; (2) transformation from a focus on
investment to a focus on innovation; and (3) a shift from equipping workers with skills to
adjust to new technologies to preparing them to shape new products and processes. (Gill
and Kharas, 2007).
For instance, Kharas and Kohli (2011) state that there seems to be a connection between
experiencing poverty and the MIT. Although there is no broadly agreed definition, the MIT is
also refers to a situation in which a middle-income country (MIC) falls into economic
stagnation and becomes unable to advance its economy to a high-income level for certain
reasons specific to MICs (Egawa, 2013). Egawa (2013) further suggests that a delay or
failure to change the economic structure from an input driven growth model into a
productivity-driven growth model is a factor in triggering the risk of a MIT.
In addition, Rigg et al. (2014) state that the MIT refers to countries that experience a growth
slow-down when they achieve middle-income status. Glawe and Wagner, 2016 states as per
definition, the Middle Income Trap is seen as sustained slowdown of growth for at least fifty
(50) years. In other words, Middle Income Trap can also be defined as a kind of political
failure whereby institutional and structural reforms are missing.
In order to analyse Middle Income Trap among middle income countries, World Bank
conducted a study in 2012 and found that out of 101 middle income countries in 1960, only
Submitted by: Anand Sharvanandan (0337677) Page 6

ECN70104: - MALAYSIA IN A MIDDLE INCOME TRAP
13 were able to achieve high income status by 2008. This phenomenon primarily hit East
Asian and Latin American countries and Malaysia is one of them.
Tho (2013) tabulates the factors behind triggering and getting stuck in the MIT as follows:
WHAT MADE MALAYSIA FALL INTO THE MIDDLE INCOME TRAP
There are various explanations that have been put forward to explain what causes the
Malaysia to fall into the middle income trap. The economic growth is closely linked to
the amount of human capital, physical capital and technology that people in the country
have accessed to.
 Total Factor Productivity Growth (TFP) in Malaysia
TFP is commonly referred so as a measure for technological progress. It incorporates
the impact of technological change and other factors that rise further than the
quantified contribution of factor accumulation (Solow, 1957). Various studies have
devoted to identify the role of TFP in economic growth dynamics of the country.
Eichengreen, Park and Shin (2018) compared the experience of middle income
countries that successfully moved to high income with that those that were
unable to do so. They found that whole physical and human capital played a
similar role, labor played a less role for the economy to grow and transition to a
high income. TFP growth was found slower and accounted for much lower share
to the GDP for Middle Income Trapped Countries.
Submitted by: Anand Sharvanandan (0337677) Page 7

ECN70104: - MALAYSIA IN A MIDDLE INCOME TRAP
HOW TO ESCAPE FROM THE MIDDLE INCOME TRAP
Submitted by: Anand Sharvanandan (0337677) Page 8

ECN70104: - MALAYSIA IN A MIDDLE INCOME TRAP
Submitted by: Anand Sharvanandan (0337677) Page 9