Friday 02 Jun 2023
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This article first appeared in Forum, The Edge Malaysia Weekly on March 16, 2020 - March 22, 2020

The conclusion of Harvard Business School’s recent case study on Malaysia poses a probing question: “Malaysia seemed to be an ocelot (a small wild cat that is about twice the size of a house cat) aspiring to be a tiger. Could Mahathir Mohamad effectively implement a genomic strategy to yield the latter?” Perhaps, Malaysia’s eighth prime minister Tan Sri Muhyiddin Yassin should be asked this question now.

Despite the rhetoric in 2018 likening Malaysia’s economic trajectory to that of “a crouching tiger”, the narrative was forgotten shortly after. Then came the launch, amid much fanfare, of the Shared Prosperity Vision (SPV), which is certainly commendable. However, one cannot say with conviction that it has won serious buy-in from the population, unlike Vision 2020 that was introduced in 1991 but which still failed to achieve what was envisioned.

In line with greater discourse, the proponents of Rethinking Economics believe any attempt to put forward a vision would only be acceptable if the populace sees a track record of improved economic performance measured by a higher standard of living. Nonetheless, it should be noted that the transition between the old and new governments in 2018 was handled exceptionally well and confidence in the economy continued to be maintained due to the government’s efforts and also the genuine interest of the business community to support the then government.

Credit goes to the architects of the transition because in most countries, when there is a change in regime that was in power for a long time, economic contraction ensues. Furthermore, in 2018 and last year, Malaysia recorded reasonable economic growth, contrary to what was expected following the change from 60 years of a one-party government. We trust the current transition to Perikatan Nasional will proceed with similar economic stability and growth.

Notwithstanding perceptions of economic performance, we advocate a serious discussion on broad policies that will enable an increase in the creation of wealth and its much better distribution in line with the SPV. However, we caution against economic plans that are generic or lengthy verbiage of initiatives, which only muddle up national plans. Policymakers and technocrats should grasp the fact that nations must set out policies that are fully understood so that actions carried out by the civil servants are aligned with the agenda. Over-reliance on the private sector’s style of a project management office is unlikely to deliver the deep changes required to improve the economy.

In terms of wealth creation, the East Asian countries have enjoyed fast growth and managed to achieve developed status in record time. Two key policies employed by these countries revolved around an “export-oriented economy” and “directed lending”, which supported the creation of export-oriented industries and the industrialisation of the economy.

At Rethinking Economics, we hope to revive the discussion on these policy options by providing a deeper understanding obtained from the papers prepared by the leading research institutes in these areas and also by critically analysing previous attempts by Malaysia to deploy these policies.

Directing policies to exports to increase demand

Expanding the economy with a trade surplus has been vital to the success of East Asian economies. Table 1 shows the converse, when a country has a trade deficit with the rest of the world.

In this example, the Bank of England will have to create the British pound, which then gets converted to the currency of countries that have a trade surplus with the UK, for example, the yen and the yuan. This will lead to money creation in those countries. Thus, it is not surprising that East Asian economies have huge levels of savings while both the UK private sector and government are net borrowers. Before the 1997/98 Asian financial crisis, the Malaysian government had a budget surplus but with a trade deficit. Therefore, the only possible solution was to increase private-sector leverage and strong inflow of “hot money” — a recipe for disaster.

Given the lessons learnt from the Asian financial crisis, we would argue that Malaysian policymakers should prioritise maintaining growth (aggregate demand) and the country’s trade surpluses instead of overemphasising the reduction of the budget deficit.

Table 2 provides a prescient case for sustaining budget deficits and a higher debt-to-GDP ratio, which is feasible if the country runs a high current account surplus, more so in an environment of low interest rates.

It can be observed from the table that China and Japan have far larger fiscal deficits and total debt-to-GDP ratios than Malaysia, yet they have not suffered any financial crisis in years despite dire predictions by the prophets of gloom and doom. It is noteworthy that both China and Japan have enjoyed substantial trade surplus/foreign direct investment and built huge foreign reserves.

That being said, policymakers must understand that deficit spending/debt is only sustainable if borrowings are denominated in ringgit. Malaysia’s previous experience of borrowing in foreign currency should serve as a warning — its borrowings in yen with low interest rates were seemingly low-cost initially but resulted in much higher costs following the appreciation of the Japanese currency against the ringgit.

In order to have a sustainable export surplus, the country requires a high degree of economic complexity, one built on the high value of export goods that cannot be easily produced or replicated. Ideally, these industries should be homegrown for a greater value-added component in the exports. Our technocrats who have accepted and adopted the concepts of economic complexity in nurturing and prioritising industries in which Malaysia could be leaders should be praised.

However, in respect of creating homegrown corporations with greater value-added, there must be clarity on when and how the government protects domestic industries and what it expects in return for the protection afforded. If the government decides to protect domestic industries and turn them into regional champions, we believe there must be clarity on the following factors:

•    The scale that needs to be achieved by these industries to compete effectively, both domestically and internationally. Policymakers need to determine if the required scale is realistically attainable. Such evaluation should also have a clear assessment of the supply chain and the existence/development of domestic players as well as their capability to be competitive;

•    There must be sufficient domestic competition for these protected industries to ensure complacency does not set in. Policymakers need to learn from the lessons provided by Proton and Perwaja, both of which recorded huge profits at one time due to unfettered protection and gave us a false sense of success. The creation of regional champions requires a limit to the number of players (licensing), sufficient time for them to develop, and for them to have sufficient resources (be it financial or otherwise). A well-defined and effective monitoring system of the policy needs to be established to ensure regional champions are being forged and prevent complacency or, worse, abuse of the system, resulting in crony capitalism; and

•    Strong export ability, meaning a sizeable portion of production is for export, demonstrating genuine competitive ability.

There are Malaysian companies — for example, the national oil company (Petronas), commercial banks, low-cost carriers, major plantation players, health groups and construction companies — that have achieved the requisite scale, are efficient given domestic competition and export their products and services (including setting up foreign operations). The question is, what other industries can be nurtured?

Directing credit to more productive activities

At Rethinking Economics, we presented and argued that the largest creation of money (endogenous money) in a capitalist economy is by commercial banks. Therefore, the direction of their lending has a material effect on aggregate demand. In many advanced countries, credit creation is directed towards real estate. Much of this can be attributed to financial deregulation.

For example, in the UK, mortgage lending was mainly provided by building societies before financial deregulation. These societies were funded by the fixed deposits of members and had to follow very strict rules when it came to borrowing. Thus, the speculative property bubble experienced by the UK during the global financial crisis would not have occurred if banks had not been involved in mortgage — lending by the creation of money and deposits. Moreover, studies in the US show that before financial deregulation, a substantial part of credit (a third) was subsidised by the federal government or guaranteed by federal government programmes. This enabled credit to be directed to preferred industries and services.

The effects of credit guidance can be better understood by reviewing trends in credit from 1973 to 2005, where researchers found that financial sector deregulation in advanced economies is significantly associated with a lower share of bank loans going towards financing the production of goods and services (non-financial services).

A research paper entitled “Credit where it’s due: A historical, theoretical and empirical review of credit guidance policies in the 20th century” by Bezemer, D. et al (2018) points out that credit directed to investment results in an increase in productivity and wage growth while credit directed at assets of goods already produced drives up home prices and eventually leads to more frequent booms and busts. Moreover, as houses get more expensive, and there is no increase in wages, wealth inequality worsens. A rise in the price of properties generally benefits rich households. To ensure income equality, poor households need to benefit from an increase in wages. For the sake of completeness, the authors of the paper also point to stock buybacks using debt, which has a similar detrimental effect.

Regrettably, the direction of credit in Malaysia is not much better, as shown in Table 3. Thus, our economy could face a future that is similar to developed economies in respect of a widening wealth divide. The notion of shared prosperity demands that credit guidance should be incentivised by the Treasury and enforced by the central bank — shifting the trend towards greater financing to the productive sectors.

An equally important argument for credit guidance is the success of the export-based economies of East Asia that were linked to credit being guided by a powerful central bank, ministry of finance and ministry of international trade and industry. This was possible because the banks were often state-owned or highly dependent on important licences awarded by the government. In China, the policymakers were keen to follow the Japanese model where lending was directed.

In Malaysia, before the Asian financial crisis, bank financing went significantly to corporations but due to the weaknesses in our economic and political system, this did not produce the results achieved in Japan, South Korea, Taiwan or even in China. We reiterate that such policies are effective only if domestic industries are competitive. Otherwise, more capital will simply go towards inefficient industries. One of the largest non-performing loans during the Asian financial crisis — that of Hottick Development Corp, which was used to acquire shares in National Steel Corp of the Philippines — is a sharp reminder of what can go wrong with misdirected credit. Nonetheless, there is merit in reconsidering such policies if they are combined with improved governance and democratic institutions.

If our policymakers are serious about the SPV, then policies on credit guidance to productive industries should be in their arsenal in order to propel Malaysia back to a high-growth economy. Several articles, including one by Jomo Kwame Sundaram, have rightfully pointed out that the current banking practices in the country will widen the income gap.

If the government wants to seriously implement the SPV, then it must be willing to have meaningful discussions on issues of directed lending and also on the structure of the current financial system, which continues to create asset bubbles. However, bold moves in directed lending can only work if the government is focused and its governance is strong. Otherwise, the errors before the Asian financial crisis will be repeated.


Governments have the ability to shape industries and markets, including credit markets. The idea of markets being absolutely free and unfettered is a fallacy. Surely, the law of the jungle cannot be the way a modern economy is managed. Policymakers must shape markets in a mould that is not only fair and efficient but also acts in the best interests of the nation.

In summary, policymakers need to formulate policies that nurture exports (preferably homegrown) and provide capital, including patient capital, that supports the wealth creation capacity of the Malaysian economy and benefits poor households. Unless there is clarity of the broad policy issues, any national plan, including the upcoming 12th Malaysia Plan, with endless initiatives will continue to miss the forest for the trees.

Datuk Mohd Anwar Yahya is a partner and an executive director at Sage 3, a boutique corporate finance advisory, and currently serves on the boards of directors of several Malaysian public and private corporations. He has over 25 years of experience in public policy, corporate finance and strategy at a Big Four accounting firm.

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