the __earthinc

Growth of six per cent of gross domestic product  per capita per year for the next eleven years. That, according to the Prime Minister, is the rate of growth that Malaysia requires in order for the country to achieve the much coveted developed status. There is no doubt economic growth is very much needed. Whether that rate is achievable is dependent on a number of factors and of them involves public institutions.^[Erratum]

In the realm of growth, mainstream economic theory suggests that poorer countries can be expected to grow faster than richer countries and at some point, join the club of the rich. This phenomenon is called convergence and this is achieved through, largely technological progress and capital accumulation.

This theory has its shares of successes and failures. Japan, South Korean, Taiwan, Hong Kong and Singapore are proofs of the validity of this theory. To some extent, Malaysia and other so-called tiger economies that grew at magnificent rate in the 1980s and 1990s are proofs of how this growth theory may be true. Growth of China and India further lends credence to the theory.

Failure of this model comes in its incapability to explain why a majority of African countries and some others have yet to grow as fast as predicted by the model.

A number of explanations on why the theory fails to describe lack of further convergence and in fact, divergence among countries, have been put forth to supplement it. The one that I think is relevant for Malaysia at the moment is the stress on public institutions as one of the factors of growth.

When looking at countries that are failing to converge with richer countries, one of the noticeable factors is the lack of trustworthy institutions in these poor countries. The judiciary suffers from manipulation and is powerless to ensure application of rule of laws with equal weight to all of its citizens. With powerless judiciary and even meaningless enforcement system, abuse of power runs rampart. Individual rights, including rights to private property, meanwhile are frequently violated. A system that ensures smooth and peaceful transition of political power — which typically means free and fair elections — is largely absent.

Without trustworthy institutions, technological progress and capital accumulation are likely not to happen. Furthermore, the only likely source of economic growth — on aggregate and not in terms of per capita of course — is population growth.

None of such woefully inadequate institutions describes Malaysia thankfully. This Southeast Asian country certainly has much better institutions than countries that are still battling mass famine, witnessing extreme poverty and experiencing very unstable political environment that includes gunfights. Yet, it is not hard to hypothesize how the imperfection that scars public institutions in Malaysia is relevant in discussions involving economic growth.

While perhaps things have gotten slightly better, the general feeling in the past few years is that public institutions in Malaysia, be it the police, the courts or the civil service, do not command the confidence of many people. The separation of powers between the executive and the legislative arms of government, as seen in Perak for instance, is really non-existence. The V.K. Lingam case suggests that the separation between the executive and the judiciary is blurry. Even if that case is considered as a case of a lawyer that sounded like somebody, looked like somebody but it is not that somebody boasting and speaking only to himself and thus, of no consequence, the issues relating to the 1988 constitutional crisis still haunt Malaysia.

The flaws in Malaysian institutions put a natural limit in how much economic growth is possible. It would take more and more effort to maintain a certain rate of GDP per capita growth the higher the level of development of the country, given the level of institutional capacity of Malaysia. At some point, it becomes really expensive and hard to maintain that rate regardless how forceful the free market or the state runs the economic engine of growth, if the country’s institutions remain at a level not befitting of a developed country.

I suspect that this is the main reason why Malaysia is stuck in the so-called middle-income trap. Institutions matter. It may be imperfect institutions that prevent Malaysia from converging with richer countries like Singapore and South Korea or even western European countries, just as how really bad institutions prevent poor countries from moving forward at all.

A version of this article was first published in The Malaysian Insider on November 10 2009

^Erratum — I made a mistake by stating the Prime Minister said six per cent growth of GDP, instead of six per cent growth GDP per capita in the original article. I should not have relied on Bernama, which was sloppy in its reporting. It used growth of GDP and growth of GDP per capita as if the two concepts are synonymous and I simply relied on Bernama without corroborating it with the primary source, or by diversifying my sources:

PUTRAJAYA, Nov 9 (Bernama) — The government needs to redouble its efforts, identify new growth areas and ensure the nation maintains a six per cent annual Gross Domestic Product (GDP) growth from now to 2020 in order to achieve a developed status in 11 years, Datuk Seri Najib Tun Razak said here Monday. [Najib: Six Pct Annual GDP Growth Needed To Achieve Developed Nation Status. Bernama. November 9 2009]

Yet another article by Bernama

PUTRAJAYA: The government must redouble its efforts, identify new growth areas and ensure the nation maintains 6% annual GDP growth from now to 2020 in order to achieve a developed status in 11 years, said Datuk Seri Najib Razak.

The Prime Minister said on Monday, Nov 9 that measures to redouble the government’s efforts and identify new growth areas would be spelled out in the new economic model, expected to be launched by end of the year.

“The new economic model would provide a clear guideline on what needs to be done and obviously information, communications and TECHNOLOGY [] [ICT] would play a greater role in this,” he said after chairing the 21st Multimedia Super Corridor (MSC) Malaysia Implementation Council Meeting. This was the first meeting to be chaired by Najib after becoming the prime minister. [Najib: GDP must grow 6% yearly to be developed nation in 2020. Bernama via The Edge. November 9 2009]

My apologies.

Nevertheless, the idea on institutions is still valid. Hence, the removal of the following paragraphs. They were originally placed between the first and the second paragraph of the corrected version:

Yet, as a measurement of success, growth of six per cent of GDP per year and the application of industrial policy to achieve that in many ways are unsatisfying.

First off, the proper metric should be growth of GDP per capita. Malaysians who care for their own welfare should be more interested in improving their average standard of living rather than seeing the economy simply growing on aggregate. While it is true that having a large economy on aggregate makes a country more influential in terms of international diplomacy even when the wide population themselves in generally is poor — observe China and India — GDP growth alone is not particularly meaningful in measuring average well-being of individual Malaysians. To make concrete out of words, consider the following simple example: growth rate of GDP on aggregate could grow at a rate lower than population growth rate to make change of rate of GDP per capita negative; in even simpler terms, the economy could grow on aggregate but each person on average could be worse-off.

If aggregate GDP growth rate is the measure of success, and if I were the Prime Minister, my industrial policy would include encouraging Malaysians to multiply like rabbits by any means necessary and adopt a very, very liberal immigration policy, one which would solve the problem illegal immigrants that the Rudd government in Australia faces. Never mind the Malthusian scenario that may come, this policy would hit six percent growth of aggregate GDP sooner rather than later and then boldly go where no man has gone.

But I am no prime minister and I am not that crazy. I do not accept the aggregate GDP growth rate as a good metric. On top of that, I am a libertarian: I do not like industrial policy because it calls upon central planning policy that essentially runs on the assumption that government knows best.

Notwithstanding criticism leveled at the concept of GDP itself…