Malaysia is emerging strongly from the worst export slump in its economic history. With a robust recovery underway, Malaysia is now focusing on the medium-term growth agenda and a New Economic Model has been proposed. It is against this backdrop that the World Bank launched its new report on the Malaysian economy on April 19 (full disclosure: I lead the team who authors the report).
The key message from the report is that Malaysia cannot afford to go slow on the implementation of structural reforms. Our analytical work suggests three reasons why:
- High-income economy. Growth to date has been driven primarily by greater quantities of capital and labor. To break the glass ceiling between middle and high income, growth will need to be based on innovation with greater emphasis on the quality of capital and labor as well as the efficiency with which these are combined in production. Structural reforms, as argued in the report, will be essential to unleash Malaysia’s innovation potential and achieve the high-income objective.
- Inclusive growth. Affirmative action is an essential policy instrument in many countries around the world and can be designed and implemented in ways that are conducive to growth. Pro-growth affirmative action requires a refocusing on needs so that the errors of inclusion and exclusion are minimized. More broadly, structural reforms that boost growth and enlarge the pie of national income make it easier to meet distributional challenges which remain significant. Poverty in Malaysia is four times higher than in Korea and Singapore, and inequality remains high at levels comparable with Indonesia and Vietnam.
- Government debt sustainability. Extraordinary times call for extraordinary measures and governments around the world expanded their balance sheets. The experience in Malaysia has not been different. Structural reforms, however, will be essential to ensure that the growth momentum is sustained and the debt level is gradually reduced. Slippages on the structural reform implementation front could be costly and cause the debt to rise relative to national income, which in turn would require additional fiscal consolidation. Structural reform thus matters not only for growth but also for debt sustainability.
Whether policy changes translate into tangible outcomes will depend on the scope of the reform effort and on the capacity of the institutions implementing them. As picking and choosing individual reforms measures would diminish synergies between reforms, a comprehensive effort is more likely to yield success. Institutional capacity matters as well and further efforts to coordinate and streamline the government machinery would be conducive to effective reform implementation particularly where numerous stakeholders are involved.
If reforms can be implemented both comprehensively and timely, the benefits are likely to be considerable. Addressing the imperfections in the enabling environment could generate, for example, a powerful transitory boost particularly to the services sectors, where further liberalization could boost productivity by as much as 40 percent, as our research suggests. Over time, additional momentum can be squeezed from reforms that unleash Malaysia’s innovation potential. These measures would bring Malaysia significantly closer to the objective of becoming a high-income economy.