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Submitted by Danny Quah on
Thank you for this blog post and for your work on the World Bank Malaysia Economic Monitor. The Economic Monitor is a wonderful collection of information; I will be referring back to it often over the next few months. While in the main I cannot disagree with your analysis, on a few points I might have placed somewhat altered emphasis: An observation brought to great attention in the early 1990s (especially by Paul Krugman and Alwyn Young for East Asia) is how economic growth cannot continue from just ever-greater capital and labour inputs, i.e., from "mere sweat alone". At some point, the law of diminishing returns sets in; truly enduring growth can come only from productivity increases through innovation. Although the World Bank Malaysia Economic Monitor achieves a lot more besides, one of its principal messages (indeed, its subtitle) ends up following that thinking in policy prescriptions: it leaves a reader with the impression that unless innovation occurs, the Malaysian economy will be held back at middle-income level plateau, unable to transit to high income. I agree that obstacles are, indeed, holding back Malaysia's economic development. But is the most critical of those bottlenecks that Malaysia's capital and labour inputs are already flush, so that unless there is innovation, Malaysia will not break out of its middle-income trap? I suggest that this last is just false. I don't disagree that Malaysia desperately needs a strong knowledge base, a lively scientific and intellectual community, and well-performing world-class universities and research laboratories. It needs all those but more besides. But, in my view, focusing overly on just one dimension - without the coordinated big push generating synergies across all the principal problems - runs the risk of misallocating resources and undermining economic performance. Why do I think this? Since 1997, physical capital investment in Malaysia has gone into free-fall. As a fraction of GDP, Malaysia's investment is now 50% what it was before 1997. That it has remained as high as it has is due to government pump-priming: private investment has declined even more sharply; as a fraction of GDP it is now just one-third what it used to be. Over 25% of local public university graduates remain unemployed 6 months after graduation. Four-fifths of Malaysia's current workforce is educated only up to high-school level. This is not an economy straining at the bit to escape the curse of diminishing returns, needing to be rescued by innovation. What it is, instead, is an economy desperately needing an integrated package of reforms, simultaneously to repair a grotesque under-employment of resources as well as to ignite innovation. In the short to medium term, breaking out of the middle-income trap might rely more on fixing the former than it does on succeeding with the latter. Your report is refreshingly up-front about how innovation is a complicated, multi-dimensioned, multi-faceted process. I might emphasize further only that patterns of development across the global economy have now reached a point where our understanding of innovation also needs to be enriched in new dimensions. Innovation to produce the next iPad or Google gadget is sexy. But not-so-sexy "frugal innovation" - using cheap labour to redesign products and processes, to make the world's cheapest, lowest carbon-footprint car, to run the world's largest assembly line for solar panels and zero-carbon energy storage - will likely have by far the greatest impact on the greatest number of people's lives in the next decade, and is likely where countries like Malaysia (or China or India or elsewhere in East Asia) need to lead. On the urgent need for structural reforms, we agree. But, again, I don't think those reforms are just to permit innovation (to drive growth), nor do I think Malaysia's middle-income problem is now because it has already reached the limits of what the economy can do with its workers and its capital.