Online Extra: Behind Malaysia's Economic Miracle

Australian National University's Hal Hill discusses the making of an economic development success story

In 1980, the year before Mahathir Mohamad became Prime Minister, Malaysia's gross domestic product was just $12 billion. By last year, it had grown to $210 billion, and per capita income stood at $3,540, the third-highest in Southeast Asia. Hal Hill, professor of Southeast Asian Economies at Australian National University in Canberra, Australia, explains how Malaysia managed that remarkable growth. Following are edited excerpts from his conversation with Michael Shari, BusinessWeek's Singapore bureau chief.

Q: What can we say has been achieved during Mahathir's rule?


Malaysia has been one of the most successful economies in the Third World. There are fairly straightforward reasons. It's one of the most open economies in the world. There are a few trade barriers but not very many. It's very open to foreign investment. Of course, [after the 1997-98 Asian crisis] there were capital controls on short-term flow. But that didn't affect foreign investment.

Second, Malaysia has been pretty good on macroeconomic management. It consistently has very low inflation. It has never had a balance-of-payments crisis in its history, which is a very important achievement. Third, Malaysia has always had excellent physical infrastructure -- great roads, harbors, and telecoms. Fourth, institutions have been fairly high quality and reasonably independent. It inherited a British-style civil service, which has been maintained.

The question of political interference of course arrives from time to time, but its legal system is clearly pretty high quality. When you think about why some countries do well and some don't and you have a sort of analytical checklist for your success stories, Malaysia scores pretty well on most of the variables.

Q: Has wealth become more equally distributed among Malaysians since Mahathir came to power?


Almost all members of the community have benefited from the economic growth. Therefore, you've got people with a stake in the system, and you've got the social stability that results from that. The inequality of income distribution fell significantly from the 1970s to the early 1990s. It would clearly be New Economic Policy [NEP, an affirmative-action program for Bumiputras, a term that generally refers to ethnic Malay Muslims] that made an impact.

Q: So on balance you'd say that the NEP was a positive factor?


The NEP clearly made an impact. Malaysia started off as a very high-inequality country. That's what you'd expect from a plantation economy. It was actually higher than the Philippines, which is often regarded as the Southeast Asian country with the greatest degree of inequality. It fell quite quickly because political power was not in the hands of a wealthy minority -- which in the Philippines was the landholders -- but the Malay community. And Malaysia invested very heavily in Malay education.

I think on balance the NEP was probably a positive thing. The various asset redistribution schemes that were part of the NEP -- the share reallocations, the fact that foreign companies had to have Bumiputra partners, and so on -- they've helped the Malay community. But among Malays there has been increasing inequality. The well-connected members of the Bumiputra community benefited disproportionately from the various elements of the NEP.

Q: Oil and gas make up about 7% of GDP now. Is this something that the Malaysian economy can continue to rely on to keep growing?


Malaysia has always been a resource-rich economy. That was part of the reason for its success, that it managed its natural resource base pretty well. And its resources are pretty diversified. It had plantations. It used to be the world's largest rubber producer. It has been a major palm oil producer. It has had oil and natural gas. It has been very successful in export-oriented manufacturing, especially electronics. And it had tourism.

Diversified economies tend to do better over time because they're able to manage the shocks that occur, so one sector might go down, but other sectors are doing O.K. Oil is quite important but on the other hand Malaysia is not a petroleum economy. It has always been quite a small part of the economy compared to other oil exporters.

Q: How long will Malaysia's oil resources last?


Domestic consumption is growing quickly. My expectation is that oil and gas exports are probably going to start tapering off. While they've got the oil they want to be able to reinvest it wisely, forming a basis for future growth. You want to be investing in R&D and education and skills for the time when oil exports run out.

Q: Is Malaysia doing that?


One third of Malaysian university students are studying abroad. The domestic universities were initially quite high quality, but they have failed to keep up. So as you're growing into this high-skilled economy, there's got to be a pretty high transformation in the university sector. It's no coincidence that math and science were the first subjects for which English instruction is being introduced. There is an awareness of the need for change. The question is how quickly the system is able to do it.

Q: Malaysia is increasingly stuck between a rock and a hard place, unable to compete with lower-cost economies in manufacturing, and unable to move up the value chain. What should Malaysia do?


That's an important issue. It has been a country that has grown quickly in labor-intensive areas. But it can't really go on forever just keeping to a low-wage strategy. Malaysia is about where Singapore, Taiwan, and Korea were in the late '80s, losing competitiveness in low-wage activity and having to upgrade pretty quickly.

Government expenditure on R&D is increasing quickly. It's now 0.5% of GDP, more than double what it was few years ago. The norm for OECD [Organization for Economic Cooperation & Development] economies is around 2%, and Indonesia and Thailand are about 0.1% or 0.2%. Malaysia is a pretty rich country, and so it can afford to do all this. It has the same choices that Taiwan and Korea and others faced in the late 80s, and it has the benefit of being able to learn from their experiences.

This can be seen in Penang. The island has been one of the most successful export-oriented manufacturing economies in Southeast Asia since the early 1970s. But it's now at a turning point. It's losing a lot of its low-end electronics to China. It has to have a new strategy, and the new strategy has to be based on skills and R&D and so on.

Of course, that also links to the government's ethnic restructuring objectives. It's sometimes tough for foreign companies to meet the ethnic quotas, so they are sometimes competing with one hand tied behind their back.

Q: What has been Mahathir's greatest achievement?


It has been maintaining the inherited economic development success story. He did well, but in a sense he inherited a well-functioning machine from his predecessors. In Malaysia politicians can come and go without having all that much effect on outcome because it's a reasonably well institutionalized country.

Q: As Mahathir hands power over to Abdullah Badawi, is there any danger of a military coup?


There will never be a military takeover. Malaysia inherited a strong division between the bureaucracy and the military, with the bureaucracy in control. It has been by and large a successful economy. And the military have been very well looked after. Malaysia's military expenditure is fairly high, about 6% of GDP. It has pretty good hardware, pay, and conditions, so why would they want to upset the apple cart?

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