Malaysia’s journey to become the next Asian superpower

In the 1990s, Malaysia was tipped to become the fifth Asian Tiger, but a financial crisis and slow wage growth hindered its economic progress. Now, the country is on an upward curve once more

Malaysia's Vision 2020, plan, laid out in 1991, would see the country transform into a fully developed nation with the potential to become the next Asian Tiger 

In 1991, Mahathir Mohamad, who served as prime minister of Malaysia from 1981 to 2003, and again since 2018, pledged to transform the East Asian island nation into a prosperous, economically developed country by 2020. To achieve this goal, he set out nine key principles in a plan known as Vision 2020, which would see the country become “a nation that is fully developed along all the dimensions: economically, politically, socially, spiritually, psychologically and culturally”.

His vision almost came to fruition prematurely. In the mid-1990s, Malaysia posted such strong growth statistics that many wondered whether it would become the fifth Asian Tiger – a moniker given to Hong Kong, Singapore, South Korea and Taiwan, which were the regional frontrunners in economic development at the time.

The country’s skyward trajectory was derailed, however, by the 1997 Asian financial crisis, which, together with a range of sociopolitical issues, made Mahathir’s vision seem like a distant dream. But today, as the goal date for his transformation strategy draws nearer, the country is showing promising signs of growth once more. Nevertheless, it is still grappling with many societal issues that could easily impede its ambitions a second time.

Malaysia’s Asian Tiger aspirations were brought crashing down by the 1997 Asian financial crisis

Natural riches
Until 1963, when the country gained independence from British rule, Malaysia’s domestic economy had been supported by its strategic location on the Strait of Malacca, a narrow passage of water to the south of the Malay Peninsula that functions to this day as the main shipping channel between the Indian and Pacific Oceans. The occupying powers exerted a significant degree of control over goods that passed through the strait, bringing items such as spices and porcelain into the Malaysian market and establishing the island as a lucrative trading destination.

Malaysia’s strategic geographic position was bolstered by its natural resources, which include large tin, oil and natural gas deposits, along with an abundance of rubber and palm trees. “Natural resource exploitation agriculture was part of colonial trade patterns, from which Malaysia historically had not benefitted much – it was more the occupying powers that benefitted from their riches,” said Dr Ulrich Volz, Head of the Department of Economics at SOAS University of London. As such, these industries, while enough to subsist on post-independence, would not catalyse the level of recovery and growth that Malaysia sought.

Moreover, the prices of Malaysia’s natural resources were extremely volatile, meaning any economic progress was contingent on positive market movement. “Fluctuations in the price of oil [also] meant the Malaysian economy was highly vulnerable to negative external shocks,” added Dr Luke Emeka Okafor, Assistant Professor in the Department of Economics at the University of Nottingham’s Malaysia Campus. Rubber suffered particularly heavily in the 1960s, as the rise in usage of its synthetic alternative drove prices down: this weakened Malaysia’s rubber production sector, in which a third of the native Malay population worked. Constant competition to keep prices low propagated poverty among these workers, making both economic expansion and social mobility nearly impossible.

Tiger cub
For these reasons, in the 1970s, policymakers decided that a transition to a third-sector-driven economy was in order. “It became very clear that manufacturing in particular was really the key to industrialisation; commodity dependence was perpetuating underdevelopment,” Volz told World Finance. This tactic proved fruitful for the Asian Tigers, which had undergone a similar transformation a decade earlier. To achieve this evolution, the Malaysian Government invested heavily in manufacturing-based industries, particularly electrical and electronics products, which are seen today as the “spearhead of Malaysia’s industrialisation drive”, according to the World Bank’s Zainal Aznam Yusof and Deepak Bhattasali. Alongside domestic funding, the Malaysian leadership advocated strongly for foreign direct investment in the manufacturing sector, which was led predominantly by Japanese and American conglomerates.

The government’s diversification plan was successful, resulting in the country posting annual GDP growth of more than seven percent throughout the late 1980s and early 1990s. GDP expansion peaked in 1996, reaching 10 percent – an extraordinary feat for a country that had been under occupation 33 years earlier. “There was a great deal of optimism and a lot of planning going on,” said Volz. “The plan-driven [economic] approach was certainly part of the success of the East Asian economies. South Korea is maybe the best example… In the 1950s, it was one of the poorest countries in the world, then it caught up at incredible speed. South Korea became a role model for Malaysia [in that regard].”

Hit the floor
However, the country’s Asian Tiger aspirations were brought crashing down by the 1997 Asian financial crisis. This was initially caused by the collapse of the Thai baht in July that year, but contagion quickly spread across South-East Asia as stock markets were devalued and currencies, including the Malaysian ringgit, were heavily traded. Over the following six months, the ringgit lost 50 percent of its value, falling to a low of MYR 4.57 ($1.10) to the dollar in January 1998. To prevent the currency from collapsing entirely, Malaysia’s prime minister introduced strict capital controls and an MYR 3.80 ($0.92) peg to the dollar, which remained in place until 2005.

By that point, though, the damage to the country’s economic growth had been done. “Prior to the crisis, between 1990 and 1996, Malaysia had an average GDP growth of 9.48 percent,” explained Okafor. By contrast, in 1998, Malaysia’s GDP shrank by 7.4 percent – a far cry from previous gains. The burgeoning manufacturing industry shrank by nine percent, while the construction sector plummeted by 23.5 percent. The crisis also contributed to a loss of foreign investor confidence, which stemmed from the government’s decision to permanently suspend international trading of Malaysia-listed shares, effectively trapping $4.47bn worth of shares in the country’s fragile financial system.

Barriers to overcome
Some economists – one of the most prominent being Paul Krugman – have argued that the crisis was largely inevitable due to the unsustainable nature of maintaining such high growth, particularly when a proportion of that growth was fuelled by foreign-denominated investment. “It’s a very bad idea to fund long-term investment that generates domestic currency returns with short-term loans in foreign currency,” said Volz. “That really broke the neck of all the countries that experienced the crisis. There was too much hot money flowing into the country, driving up asset prices, driving up property prices, contributing to [the] overheating of the economy.”

However, Volz added, the crisis “was not the end of the East Asian growth story”. Malaysia was able to bounce back relatively quickly, albeit at a much slower rate than before, thanks to a programme of massive government investment in industries that had been badly hit by the crisis. Since 1999, the country has maintained an average GDP growth rate of 5.2 percent. Although this is seen by many as more sustainable, the slower pace has created issues with regards to wage growth, which has prevented the country from being classed as a fully developed economy.

Malaysia’s strategic geographic position was bolstered by its natural resources, which include large tin, oil and natural gas deposits

“It’s important to be aware that low wage growth is a reflection of low productivity – that is the key problem of the Malaysian economy,” Volz told World Finance. The country is often described as being caught in the middle-income trap, meaning it has lost its competitive advantage in the export of manufactured goods, notably because of China’s influence in the region, but is unable to ascend to the level of more developed economies. This is predominantly due to the fact that productivity – and therefore wage growth – did not grow in line with labour output because of a lack of high-calibre, inclusive educational institutions. “If you have an education system that manages to get people to [an adequate] level to do average manufacturing activities, then that’s the kind of activities that will dominate your economy,” said Volz.

Education development in Malaysia was complicated by a controversial policy introduced in the 1970s called the New Economic Plan (NEP), which also compounded social divisions in the country. At the time, the Malaysian population was divided into several distinct ethnic groups, the largest of which was made up of the indigenous Malay people and Chinese immigrants, many of whom had moved to Malaysia in the 1800s following the discovery of tin. The former made up around 60 percent of the population, while the latter made up around 30 percent. These figures have remained relatively stable ever since.

The relationship between these two ethnic groups has historically been a strained one, with tensions exacerbated by class and wealth inequality. Indigenous Malay citizens typically worked in low-paid jobs in the tin industry, meaning many were entrapped in poverty, while Chinese immigrants tended to be wealthier business owners. This tension reached a head on May 13, 1969, when Sino-Malay race riots took place in Kuala Lumpur following the announcement of that year’s general election results. Official reports stated the death toll to be 196 people, but a number of western diplomatic sources dispute this figure, claiming it to be closer to 600.

In response to the violence, the newly elected government quickly implemented the NEP, a social restructuring policy that aimed to eliminate ethnicity as a factor in economic circumstance. It sought to achieve this through the empowerment of indigenous Malay people, notably by increasing their ownership of all national enterprise to 30 percent, thereby lifting them out of poverty. It also gave them preferential access to land and education in a bid to improve Malays’ economic status.

Inequality reigns
With regards to its stated goals, in some ways, the NEP can be deemed a success: wealth in the hands of the indigenous Malay people increased from around four percent in 1970 to about 20 percent in 1997. However, the NEP also had a detrimental effect on the availability and quality of education in Malaysia, as it introduced a host of new secondary schools and universities across the country, offering classes taught in Malay, rather than in English. These schools aimed to boost the overall skill level of the indigenous population, but the quality of the education they provided was not sufficient to support the wage growth and productivity boost the country needed to escape the middle-income trap. “You’re not going to have a hi-tech economy with super high productivity if your workers are just not up to these kinds of jobs,” said Volz.

The policy has also been criticised for exacerbating existing racial tensions, allegedly causing laziness among the native Malay population due to the culture of hand-outs it was said to have created, and triggering a brain drain of educated non-Malays to other nations in the region with less hostile socioeconomic policies. “The fundamental problem with the NEP was that it allocated resources based on ethnicity, not on needs or capacity,” said Volz. This meant the poorest Malay people did not receive any sort of additional help compared with others of higher social standing.

The plan is technically still in place in Malaysia today, and is cited as a source of ongoing tensions between the indigenous Malay population and non-Malay residents. Indeed, a 2008 poll showed that 71 percent of Malaysians think any remnants of the NEP should be abolished and replaced with a merit-based, rather than race-based, affirmative action policy. This is something Okafor supports: “As the gap in skill sets and opportunities has now narrowed, the equity ground for pursuing the policy has become increasingly weak… The Malaysian Government should now identify the optimal time to replace the policy with one that is largely based on need… [which] will engender a sense of tolerance, inclusiveness and racial harmony.”

Cleaning up its act
Along with productivity issues, Malaysia is also plagued by corruption, which is a key contributing factor in its entrapment at emerging economy level. In its latest Corruption Perceptions Index, Transparency International scored the country 47 points out of 100, with zero being highly corrupt. Comparatively, Taiwan scored 63, Hong Kong 76, and Singapore 85 (see Fig 1). In a 2017 survey by the same organisation, 60 percent of Malaysian citizens said they believed the government was performing poorly in tackling corruption, while 23 percent said they had been forced to bribe a public official.

“Corruption is rampant in Malaysia,” said Volz. The most significant issue with regards to corruption is the revolving door between the private and public sector, meaning individuals at the highest level of government or business are able to switch easily between the two spheres. There are no rules against corporate ownership for politicians, which can lead to governmental decisions being made to benefit individual private enterprises as opposed to the overall economy. Moreover, officials are able to embezzle public funds with impunity, as evidenced by the 2015 1Malaysia Development Berhad scandal, during which the country’s prime minister at the time, Najib Razak, was accused of channelling almost $700m from a state development fund into his personal bank account. Razak is currently facing 42 charges of abuse of power, money laundering and breach of trust, among others, as a result of his role in the scandal, while his trial is expected to last several years.

“[It’s a positive sign] that the former prime minister is being investigated,” said Volz. “Some Chinese rogue investments have been scrutinised too,” he added, in reference to a decision by Mahathir in 2018 to limit dependence on Chinese capital, which he claimed was utilised by his predecessor Najib as a way of concealing corruption. “But these are high-profile cases – is everything else running as normal?” For the country to be able to catch up to its East Asian neighbours with regards to economic growth, it must take action against corruption at every level of society.

Reversal of fortune
In recent months, evidence has begun to emerge that Malaysia is taking action on the structural issues that are holding its economy back. According to current finance minister, Lim Guan Eng, the government has saved MYR 805m ($194m) since May 2018 by renegotiating infrastructure projects plagued by corruption – funds that can now be invested into new developments. The administration’s perceived commitment to transparency and its desire to tackle fraudulent practices has also drawn in overseas investors: FDI has increased by 48 percent over the past 12 months, Lim told The Star newspaper.

In a bid to boost competitiveness and the ease of doing business, the government brought in a new sales and service tax (SST) in September 2018 as a replacement for the now-defunct goods and services tax. The majority of essential consumer items, including fresh food, medicine, personal hygiene products and vehicles, are exempt from the SST, a move that will substantially bring down the cost of living for most Malaysians. This will leave them with more disposable income to spend, subsequently encouraging economic growth through an uplift in purchasing power. Similarly, businesses with an annual turnover of less than MYR 500,000 ($120,500) will not be liable to pay the SST, a move that is hoped to stimulate the start-up and SME sector.

According to Lim, these various policies will facilitate Malaysia’s entry to Asian Tiger status within the next three years. Okafor, meanwhile, is confident that the country is back on an upward curve, citing average GDP growth figures of 5.5 percent between 2010 and 2017. What’s more, foreign direct investment hit a seven-year high in March, reaching MYR 21.73bn ($5.24bn) (see Fig 2). “If Malaysia remains on a strong growth trajectory for some time to come, it will certainly be a strong contender as one of the Asian Tigers,” he told World Finance. “Assuming the current government manages the economy efficiently by minimising or eliminating corrupt practices and misuse of public funds, and proactively enacting policies that create an enabling environment for the private sector to thrive, then its actions and policies will likely help to stimulate… economic growth.” Volz, however, is certain that this ascension to Asian Tiger status will be a long time coming: “We can be very sure that Malaysia will not be at the level of [Tigers like] Hong Kong in three years’ time… That is virtually impossible. Just look at per-capita income figures.”

It is also debatable as to whether that would really be the best path for the country. “What does Asian Tiger status even really mean? It’s just symbolism,” Volz told World Finance. Even if Malaysia was able to close the substantial gap between itself and the Asian Tigers, it’s unlikely it would be first in line for entry to that prestigious club, due to competition from other emergent economies in the Asia-Pacific region. Indonesia, in particular, is a prominent rival; with an economy four times as large as Malaysia’s, it’s far more likely to catch up with the Tigers. “In geopolitical economic dominance terms, what happens in Indonesia will have much more impact,” said Volz.

Rather than engaging in figurative one-upmanship with its neighbours or pinning its definition of success to a single phrase with little objective fiscal meaning, Malaysia would do well to focus on creating an environment for sustainable growth that benefits all economic players in its society. After all, there is always space in the world economic order for a prosperous, transparent country with free-market values. If clout on a global level is what Malaysia is searching for, however, it could find strength in numbers by reinforcing its ties with other regional economies, which would prove a more prosperous strategy. “ASEAN is becoming a real economic powerhouse now,” said Volz. “But Malaysia alone – it’s not going to be the first show in town.”