Malaysia catches the Dutch Disease

An interesting article I read in Facebook. For the original article, click here. Digest it, assimilate it and disseminate it.

Written by William Leong

Global investors are not going to put money into the country if the government does not address the Malaysian resource curse.

Pump priming: Wrong diagnosis

Prime Minister Najib Tun Razak announced that the government will prime the economy with an additional RM1 billion monthly till the end of 2010 in a bid to bolster the country’s economy.

Unfortunately, allocating RM200 billion under the 2010 budget or pump priming the economy will not return Malaysia to economic competitiveness. Malaysia’s economy was ill long before the sub-prime implosion and the consequent global financial crisis.

Najib Tun Razak will not be able to redress Malaysia’s economic woes unless and until he and the Barisan Nasional government has the honesty and courage to deal with the Malaysian resource curse and have the political will to carry out the necessary fundamental structural reforms.

The Dutch Disease

Malaysia has exhibited the classical symptoms of the ‘Dutch Disease’ or ‘the Resource Curse’. The term “Dutch Disease” was coined in 1977 by the Economist to describe the decline of the manufacturing sector in the Netherlands after the discovery of a large natural gas field in 1959, culminating in the world’s biggest public-private partnership, N.V. Nederlandse Gasunie between Esso (now ExxonMobil) Shell and the Dutch government in 1963 only to see the rest of its economy shrinking.

It refers to the paradox that countries with an abundance of natural resources, specifically resources like minerals and fuels, tend to have less economic growth and worse development than countries with fewer natural resources.

The Dutch resource curse is an economic concept to explain the relationship between the exploitation of natural resources and a decline in the manufacturing sector combined with moral fallout. The concept explains that an increase in revenues from natural resources will de-industrialize a nation’s economy by raising the exchange rate, which makes the manufacturing sector less competitive. It also leads to the public administrators getting entangled with business interests.

Political corruption

One of the negative effects of the Dutch Disease is that it is often easier for a natural resource rich government to maintain authority through allocating resources to favoured constituents than through growth-oriented economic policies and a level, well-regulated playing field.

Huge flows of money from natural resources fuel this political corruption. The government has less need to build up the institutional infrastructure to regulate and tax a productive economy, so the economy remains undeveloped.

Rent-seeking behaviour

Another negative effect is the creation of rent-seeking behaviuor. ‘Rent seeking’ in this sense does not mean the usual payment of a lease but stems from Adam Smith’s division of income into profit, wage and rent.

Rent-seeking behaviour is distinguished from profit-seeking behaviour in that in profit seeking-behaviour, entities seek to extract value by engaging in mutually beneficial transaction.

On the other hand, in rent-seeking behaviour, entities seek to extract uncompensated value from others without making any contribution to productivity through manipulation and exploitation, such as by gaining control of land and other pre-existing natural resource or by imposing burdensome regulations or other governmental decisions that may affect consumers or businesses.

Loss of entrepreneurial skills

The rationale for identifying rent seeking as the problem in economies suffering from the Dutch resource curse is that resource revenues constitutes vast wealth, and when individuals or groups of individuals attempt to take control over it, they become less entrepreneurial.

Rent-seeking activity involves several detrimental aspects. First the attempts themselves are time consuming and draw valuable labour hours from productive, innovative activities. Talent is wasted in the pursuit of existing wealth instead of being employed at producing new growth.

Second when the activities are successful, the wealth may be disposed of in ways that are not conductive to growth. If the wealth is spent for personal consumption abroad for the successful rent seeker and it is not invested in domestic technological progress and human capital, growth suffers.

Few individuals acquire wealth to act for the common good. The country’s resource rent is converted to luxury items, not research and development. So growth stagnates. Rent seeking degenerates into corruption which discourages investment and limits growth.

Rich become richer

Think of Ghana and Zambia, countries abundantly endowed with minerals or oil and gas that have swung from booms to busts and back again. Their politics are hopelessly corrupt. The central government, far from being an effective regulator, serves as the handmaiden to a group of powerful oligarchs, making it easier for the rich to become richer while the poor become poorer.

Now think of Malaysia.

The Malaysian resource curse

Malaysia’s economic growth is a three legged growth model based on:-

* Manufacturing trade
* Commodity trade
* Public sector economy

Petroleum and natural resources provides 40% of the Malaysian government’s revenues. This in turn supports the largest public sector economy in Asia with 27% of the GDP. Malaysian manufacturing exports are under structural pressures and are losing competitiveness. The real effective exchange rate (REER) appreciated 11% between 2005 and 2008. This has led to competitiveness erosion of the manufacturing sector.

The natural resources sector provided the revenues to allow the Government to sustain economic growth through government spending. This has reduced the urgency to increase productivity and allowed marked inefficiencies to set in; the erosion of education standards, distortion and suppression of the labour market and sustaining unprofitable and ineffective affirmative action policy projects.

The end result is the erosion of manufacturing exports and a fall in inward FDI that will undermine the economy.

Underperformance in education standards

The oil and gas revenue-driven economic growth lulled Umno and the BN government to misconstrue the importance of maintaining excellence in our education system. This allowed misguided and mismanaged policies to turn our schools and universities into factories churning out unemployed and unemployable graduates.

This has resulted in our nation suffering a severe underperformance of our education standards. Malaysia tertiary enrolment and completion ratio has lagged that of some of our Asian counterparts. At 28.6% and 15%, Malaysia’s gross tertiary enroll ratio and completion ratio are 7% and 6% lower than the average expected of economies with similar level of GDP per capital.

This means Malaysia is having a tertiary skills shortage. This point to Malaysia lacking the necessary skills and knowledge human capital essential to move the Malaysian economy up the value added chain.

Skills mismatch

With the labour force growing, unemployment rate has stayed range bound at around 3% and with the skills shortage, graduates surprisingly continues to make up an increasing proportion of the unemployed group from 15.2% in 2000 to 25.1% in 2007.

The government, in answer to a question I posed in Parliament, gave the following breakdown of unemployed graduates:-

Ethnic breakdown of unemployed graduates in Malaysia
Year——— Total—-Chinese—-Indian——Malay
2004———4,594………163……………207………….4,060
2005——– 2,413………..31…………..3170…………2,186
2006——–56,750……….110…………1,346……….50,594
2007——–56,322……..1,348…………1,401……….49,075
2008
(until June)—47,910………1,403…………4,694……….41,813
Source: Ministry of Human Resources

[Editor’s note: The figures above refer to graduates who registered with the Human Resources Ministry to find jobs. Compared with Malay graduates, Chinese and Indians may prefer to use job recruitment services from the private sector.]

The predominance of Malay unemployed graduates who are overwhelmingly from public universities suggests that we have a problem of graduate skills mismatch.

Singapore in comparison has its universities design their curriculum in collaboration with the industry players. The majority of the students are offered jobs before they graduate and 82% are employed within three months of their graduation.

Labour force a key business constraint

The education gaps have led to skills shortage and skills mismatch. 42% of Malaysian businesses rate the unavailability of a skilled labour force as the most severe business constraint compared to 37% in East Asia and 35% globally.

The shortage of skilled labour is compounded by short-sighted and misconceived immigration policies. These policies instead of attracting the talented and the best and the brightest, discourages and prevents them from working in the country.

The rejection of Vijay Singh’s citizenship application and the resulting loss to the nation of a world golf champion is one example. The thousands of tertiary graduate and professional foreign spouses of Malaysians being consigned by these immigration policies to become housewives is another.

These same policies are the causes for the severe brain drain suffered by our nation. Due to the skills shortage, we will be unable to move the economy up the value added chain.

Falling FDI

The net inward FDI in Malaysia has been in decline. As net FDI in the region, China, India, Singapore and Thailand) continues to climb, Malaysia has experienced a downward trend from the peak in the early 1990s and is now in negative territory. The net FDI stood at -3.8% of GDP in June 2009 from +2.4% of GDP in June 2004.

Malaysia has fallen from 67th in the Inward FDI Index in 2006 to 71st in 2008. The outward FDI has exceeded the inward FDI for the past three years and this trend is expected to continue and increase in the future.

Loss of manufacturing trade surplus

Malaysia manufacturing trade surplus of machinery and transport equipment fell from USD 10.5 billion in 2000 (11.2% of GDP) to USD 9 Billion in 2008 (4.1% of GDP).

In comparison China had a trade surplus for the same period from USD 9.3 billion to USD 231.3 billion, Korea USD41.2 billion to USD 119.1 billion, Taiwan USD 19 billion to USD 45.1 billion and Singapore from USD 11.2 billion to USD 22.9 billion.

Suffering in silence

We are in the throes of the Malaysian resource curse. The rent seekers have privatized and created monopolies of every conceivable resource and amenity in the country from roads, to bridges, water, electricity, disposal of rubbish and sewerage.

Petronas revenues have been used to pay for mega personal enhancing projects such as the Petronas Twin Towers where US 1.6 billion (RM5.6 Billion) was spent to enjoy the brief moment of fame in owning the tallest building in the world.

Petronas money was again used through 40% equity in Putrajaya Holdings to pay the total costs of building the new Federal administrative capital of Putrajaya amounting to RM11.831 billion. There many more of such project in the past decade. The public have been suffering in silence as the Malaysian resource curse takes its toll.

Prescription

Malaysia no doubt is affected by the global financial crisis but its problems have a deeper underlying cause. It is this underlying cause that has to be addressed. The Malaysia resource curse must be exorcised. There are many resource rich countries that have escaped and avoided the disease.

The key is governance. Well-governed countries find ways to insulate their economies from the down side of commodities and natural resources trade. Resource rich countries such as Norway has shown that this can be done by adopting straightforward economic fundamentals, sound monetary policies, and having open trading and investment regimes.

The enforcement of laws against corruption is a basic requirement. The strengthening of political and economic institutions by giving effect to the democratic institutions and constitutional guaranteed fundamental liberties is another. Investing in education and infrastructure will increase competitiveness of the manufacturing sector. Sadly these have been ignored by the Prime Minister in his push for pump priming.

A global investor said that if Najib and BN do not recognize the Malaysian resource curse and do not have the political will to address it, neither he nor any other investor is going to put money into Malaysia. Without the structural reforms, pouring RM1 billion a month into the rent seeking economy is just pouring good money into the drain.

How long can the Malaysian public continue to suffer in silence?

William Leong Jee Keen, Member of Parliament, Selayang


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