Despite its limitations, tracking gross domestic product (GDP) is important because it gives information about the size of the economy and how an economy is performing.
Generally, if GDP is growing at a sustainable rate, businesses and companies are expanding, generating more jobs and increasing people’s income.
GDP growth is largely determined by the growth rate of potential output, the rate at which an economy would grow when labour and capital are fully employed efficiently, augmented by technology and productivity improvement.
Hence, it is necessary, implicitly or explicitly, to make judgements about the economy’s underlying growth potential.
Malaysia’s potential output growth has continued to moderate in recent decades.
Bank Negara’s Economic and Monetary Review 2023 report showed that the country’s potential output expanded by 3.7% in 2023, slowing from 4.2% in 2022 and an average growth of 4.9% a year in the 2011–2019 timeframe. In 2024, the potential output is projected to grow between 3.5% and 4.5%.
The moderation in potential output growth was driven by slower capital accumulation.
This was evident in private investment, lower total factor productivity (TFP) or multifactor productivity (MFP) growth, which measures the impact of technological advancements and changes in worker knowledge on the long-term output of an economic system amid the expansion in labour force participation but the labour productivity growth remained moderate.
The World Bank’s policy research working paper Malaysia’s Economic Growth and Transition to High Income – An Application of the World Bank Long Term Growth Model (LTGM) showed that the median TFP growth over the past 30 years (1985-2014) was 0.9%.
The human capital growth rate has experienced a downward trend since the early 1990s and it has averaged roughly 0.6%-0.7% in 2010-2014.
Productivity improvements through strong reforms can bring back our growth. The MFP is a major driver of economic growth through innovation and productivity, and improves the living standards of people. Higher contributions from MFP are vital to drive high quality economic growth ahead.
In the 12th Malaysia Plan (12MP) from 2021 to 2025, the MFP contributions to GDP growth is expected to reach 40.4%, higher than 39.3% in the 11MP (2016-2020) and 23.7% in the 10MP (2011-2015).
In the 10MP, MFP contributed only 1.2 percentage points to the average GDP growth of 5.3% a year, and only one percentage point contribution to an average GDP growth of 2.7% a year in the 11MP.
In the 12MP, MFP is expected to contribute a higher two percentage points to the projected GDP growth between 4.5% and 5.5% in 2021-2025. (Note: Based on GDP at constant 2015 prices. Source:12MP).In labour-productivity growth, Malaysia’s labour productivity merely increased by 1.8% a year in 2015-2023, lagging behind our regional peers such as Vietnam (5.4% a year), Indonesia (2.4% a year), the Philippines (2.3% a year), and Singapore (2.1% a year).
By the kinds of economic activity, Malaysia’s overall labour productivity increased by 1.2% a year in the 11MP, with increases in the manufacturing sector (1.8% a year), services sector (1.3% a year) and construction sector (1% a year).
Labour productivity growth in the agriculture sector was subdued (0.4% a year) while that of the mining sector declined by 0.7% a year. During the period 2021-2022, overall labour productivity growth improved to 3.7% a year, on track.
Since the growth rate of potential output is the overriding long-run force for ensuring sustained economic expansion and reductions in poverty, this moderating trend of potential output raises concern about the durability of economic growth rate ahead.
How then to build strong foundations to raise our potential growth?
We need reforms for growth in human capital, physical capital, the labour market as well as investment-climate reform to unlock potential growth through the unlocking of total multi-factor productivity.
Despite achieving the current economic cyclical upswing (real GDP growth of 5.2% a year in 2021-2023 versus minus 5.1% in 2020), there should not be complacency in our policy improvements to reverse the moderating trend in potential growth, raising and sustaining future potential growth.
Growth reforms are critical at the current juncture.
In the past decades, the domestic economy has been disrupted by economic and financial crises of varying breadths and severity.
Hence, it would require a sustained policy push to avoid lasting damage to our growth potential.
A combination of quality and value creation investments, especially high technology as well as skill and knowledge-intensive investments, better educational outcomes, effective skills enhancement and demand-driven technical and vocational education and training to stem a slowdown in potential growth or raise the potential growth prospects over the next decade as Malaysia transitions to a high-income economy.
Broader reform packages to improve institutional quality and governance as well as build conducive business climates for businesses to invest and hence, paying important economic dividends.
We need proper execution and implementation of the Malaysia Madani framework, New Industrial Master Plan 2030, the National Energy Transition Roadmap and the Mid-Term Review of the 12MP.
Fiscal structural reforms when complementing other structural reforms could also yield important productivity dividends.
The growth enhancing effects stemming from a shift in budget spending towards healthcare, education, and transport from the savings derived from the targeted rationalisation of subsidies would help.
On the revenue side, the efficiency of the tax revenue system, which is switching from taxing on employment and capital income to consumption, could raise long-term growth.
Innovation, digital transformation, technological advancement and automation are a productivity game changers for firms though there is no one-size-fits-all digital investment strategy to improve productivity and capital efficiency of companies.
The government needs to support businesses, especially small and medium enterprises, to embrace more digital technologies through tax and non-tax incentives, financing, system support, consultancy services, technical assistance and advice . For example, digital platforms (such as social networks and eCommerce marketplaces) provide significant scope to optimise certain operations at very low cost with the help of artificial intelligence solutions from knowledge markets, business intelligence and data analytics services.
Improving human capital requires strong reforms on the quantity and quality of education and vocational training, addressing pervasive skills mismatches, enhancing learning outcomes and providing adequate social protection programmes as well as supportive policies for more women to participate in the labour force. Better performance rewards and productivity linked-wage systems can induce an upgrading of skillset and retain talent.
Reforms on the business environment should focus on reducing unnecessary administrative burdens, simplifying regulations and rules, maintaining clear and consistent policies, improving the efficiency of public delivery services (through digitalisation), easy data access, strengthening a fair and healthy competition, and cutting red-tape. Heavy regulations can stifle innovation.
The reforms must be well-timed and properly sequenced in a manner to avoid significant adjustment to the economy. Hence, targeted mitigating measures are needed to protect vulnerable households and businesses against the pressures from the short-term reform costs. The reform payoffs will take time to materialise but the growth dividends will be high.
The reforms are not easy as policymakers will have to contend with some form of resistance from vested interest groups that can create obstacles to the implementation of the necessary reforms. Hence, the government has to reconcile competing interests to implement the reforms with effective public communication. Another consideration is the limited fiscal space would constrain the implementation of reforms as more financial resources are needed at the implementation stage to mitigate those affected by the structural reforms.
Lee Heng Guie is executive director of the Socio-Economic Research Centre. The views expressed here are the writer’s own.
