March 23, 2012, by Camilla Jensen

Malaysia and the frontiers of growth

This concludes the trilogy of special blogs about the development and challenges facing the Malaysian economy.

The second lecture by Professor Ha-Joon Chang hosted by Khazanah Nasional at the Royal Mandarin in KL was equally exciting and took a more heterodox approach and included no neoclassical growth exercises but rather relied on a few stylized facts about economic growth that were very enlightening. The lecture centered on the now fashionable discussion in economic growth as to whether it is a problem for countries to have a burgeoning manufacturing sector or not. Professor Chang challenged our preconceptions about economies such as Singapore and Switzerland and showed that against traditional convictions these are heavily industrialized economies with a very significant contribution of manufacturing to total value added.

As with the doomsday prophecy of Malthus, this is a recurring debate in economics. It dates back to France and the claiming that from that times perspective only agriculture was productive whereas the artisan class (which we nowadays would call manufacturing) was not. These ideas were later transferred to the distinction between manufacturing and services. There has always been around the conception (and especially among the socialist thinkers and central planners) that services are not and can never be as productive as manufacturing activities. From a logical viewpoint I have great difficult to buy this hypothesis even though I know that lengthy works have been written on the topic and not least for the British economy. The latest trend is to use this hypothesis to explain the differences between economic growth in India and China. I do believe it is true that some of the difference may be because of sector differences, but I really do not believe in the fact that it has anything to do with any fundamental inferiority of service activities. If Malaysia could rely on ecotourism rather than a polluting electronics industry I think even it would be much better for the country and not at all bad for economic growth – because the issue is not so much about the activities themselves as the directions of demand at home and abroad.

That being said services may have special economic growth challenges that policy makers need to pay attention to, since much of the present policy making and intellectual thinking is still centered on a manufacturing model. For one thing manufactures remain much more tradable across borders than most services and the move towards more free trade in services is hampered by differences in national legislation and priorities. However, to insist that it is better to have an economy specialized in production of material goods (which is often polluting and creates a lot of tangible waste) rather than to have activities such as writing, theatre, communication, postal service, internet etc. that simply has no basis is logical thinking. For example I personally will prefer that my child consumes more theatre and painting classes and fewer plastic toys that eventually will just fill up the dump. And both types of activities rely on complementary services of finance, research and development, lawyers, design etc. What fundamentally matters is the direction of demand and in what direction the wind is blowing in terms of the tastes and desires of new populations.

Coming back to the real productivity advantage of China – could it be that it is easier to reverse engineer and use existing designs when emulating material goods? Whereas a hospital stay, a higher education diploma or an IT service is much more reliant on the human capital input and takes much more effort and is therefore also much more costly to emulate or transfer? (Neither India nor China are well endowed with human capital at the moment and therefore India being specialized more towards services renders her at disadvantage until of course a sufficient proportion of the labor force attains the necessary level of schooling to emulate services at higher value added). So certainly for a country specializing in services, investment in education would be paramount and of course also being able to retaining the educated at home once they are out of the schooling system. Maybe the transition to convergence will be slower for such a country but the end result may be a much more sustainable economy with a more healthy and ‘happy’ population that is capable of making informed decisions for their society.

Another major theme in the lecture I attended by Professor Chang that has always been a point of controversy both in the academic literature and in the public rhetoric on growth in Asia is the question about intervention. Asia as a region seems to be much more inclined towards intervention in the economy by the government. This was one of the main controversies in the aforementioned literature on the Asian Growth Miracle. The mainstream literature generally ascribed the miracle to the workings of free markets whereas economists of a more heterodox inclination more often ascribed the miracle to government intervention. From the perspective of today and the more recent Chinese growth record over the last three decades (1978 onwards) there seems to be a very strong vindication for an interventionist approach (a la gradualism in transition studies – even though that is fundamentally a study of the timing and sequencing of reforms during the move to liberalization of markets) and of course this is something that attracts the attention of Malaysia scholars. Lessons from South Korea and Japan lend similar experiences as to China – that more intervention rather than less is better.

To which extent should a country such as Malaysia continue the strategy of sectoral intervention as was for example the case of the electronics and the automobile industry in the past? This is one of the major questions it seems facing not only Malaysian but many other economic policy-makers in Asia.

Whether it is the role for governments to cherry pick on where a country has comparative advantage is a difficult question. Probably entrepreneurs or international entrepreneurs (such as foreign traders and investors) rather than governments or a central planner are more likely to be informed about where the comparative advantages are to be found. Simply because the people working at the shop, are much more likely to be well informed about the shop, rather than the people sitting elsewhere thinking about the shop and hundreds of other things. Friederich Von Hayek saw this better than anyone else in the great controversy about the experiment of central planning in mid-20th century Europe.

I agree with Professor Chang that there are wastes in the free market investment process. However, these wastes can be much minimized by precautious entrepreneurs, whereas government arm investors that will not bear the burden of loss are much more likely to invest in unsound or what Janos Kornai coined ‘prestige’ projects simply because they do not suffer a personal loss as the entrepreneur does. Therefore I found great inconsistencies in the speech that on the one hand advocated for intervention while at the same time advocated against the unhealthy alliance between the public and private sectors in some countries.

Overall we must expect that the entrepreneur rather than the government is the good investor and especially when it comes to private goods on the frontier of technological development, whereas of course governments have a large role to play when it comes to facilitation of infrastructure, provision of public goods including education and social services. In fact you may argue that if the government is too preoccupied with the provision of private goods it may fail to focus on providing vital public goods including good institutions. Governments should rather than trying to be entrepreneurs and engineers focus on tasks of taxation and public goods provision including the safeguarding of sound institutions in society. This will give a healthy balance between the private and public spheres of production and I think this is one of the important lessons from the Scandinavian model and how it has developed over time. (As opposed to some common perceptions that model is not centered on intervention in markets for provision of private goods.)

Another downside of the interventionist approach that the socialist countries suffered greatly from is the lack of innovation that will come about from this approach. Innovation can never be created alone from government intervention or through a planned process. There must be entrepreneurs that seize opportunities and take risk in order for innovation to happen. This was seen most vividly among the socialist countries by the lack of new emerging industries that had come about since the second world war in the free parts of the world. Socialist planners had simply neglected these – since planners can never serve the same function in the economy as the entrepreneur.

As long as you are behind the frontier of innovation you can to a certain extent free ride on the innovations of entrepreneurs in other countries and fairly easy as a planner predict changes in demand if they follow with a lag developments abroad, but once the frontier is reached countries will find out that they took the wrong bet because they through too much intervention failed to produce the skills pertinent to the entrepreneurial class that are to provide us with the next generation of innovations. In this sense yes there is a real danger of being caught in a trap of mediocrity which to me is the lack of internally driven creativity. It is no surprise that the industrial revolution happened in the country that was home to some of the most creative yet rigorously logical thinkers ever such as Shakespeare, Darwin and Newton. Or that it happened in the country where competition as an institution was born through the common law system as it developed during the late Middle Ages.

Prof. Chang claims that the washing machine is one of the most important innovations. As my second job is being a housewife I would not disagree but perhaps point out that it was introduced in competition among 100’s of small and medium sized firms in the United States at the beginning of the 20th century. Innovation undoubtedly requires entrepreneurship of a kind that the Korean Chaebols cannot produce, because non-market incentives within a hierarchy are simply not as effective as those of the market – as the author of ’23 things they don’t tell you about capitalism’ in fact has pointed out himself because he says in his book that managerial effectiveness does not depend on pay! Whereas to an entrepreneur the anticipated reward or valuation of the market will always be the most important incentive for committing innovation.

Lookout for my last blog on economic growth and Malaysia later this year which will be a book review of Hal Hill, Tham Siew Yean and Ragayah Haji Mat Zin (eds.) Malaysia’s Development Challenges: Graduating from the Middle.

Camilla Jensen (Associate Professor and Director of Studies of the Nottingham School of Economics at the University of Nottingham Malaysia Campus)

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