67944 MALAYSIA ECONOMIC MONITOR APRIL 2012 MODERN JOBS World Bank Office—Bangkok Country Director: Annette Dixon Chief Economist: Bert Hofman Comments to: Mathew A. Verghis mverghis@worldbank.org Frederico Gil Sander fgilsander@worldbank.org 30th Floor, Siam Tower 989 Rama I Road, Pathumwan Bangkok 10330, Thailand +66 (0) 2 686-8300 www.worldbank.org/my Acknowledgements This report was prepared by Frederico Gil Sander (task team leader) and Marek Hanusch, with contributions from and in collaboration with Ximena del Carpio, Rajeswari Karupiah, David Margolis, Mohamed-Ali Marouani, David Robalino, Akhmad Rizal Shidiq, Aleksandra Posarak, Mark Dorfman, Luisa Fernandes, Alex Usher, Victor Levine, Intan Nadia Jalil, Antonio Postigo and Miki Matsuura, under the overall guidance of Annette Dixon, Mathew Verghis and Xiaoqing Yu. Contributions from the Economics Department of Bank Negara Malaysia are gratefully acknowledged. The team wishes to thank Reena Badiani, Bryce Quillin, Philip Schellekens and Sudhir Shetty for helpful comments, suggestions and guidance. The team also thanks Sofia Busch, Anna Elicano and Trinn Suwannapha for assistance in external relations and web production, Indra Irnawan for designing the cover, and Noppakwan Inthapan, Angkanee Luangpenthong and Piathida Poonprasit for handling the processing of the document and providing extensive support. Cover photos by Tristan Savatier (surveyor), Ali Badri Abdul Karim (oil engineers), Hafiz Itam (pharmaceutical worker), Yeow Chin Liang (Indian sundry shop), and Terenze Lim/Malaysian Solar Resources Sdn. Bhd. (solar worker). The Malaysia Economic Monitor further benefited from fruitful discussions, extensive comments, and information from the Economic Planning Unit, Bank Negara Malaysia, Department of Statistics, Ministry of Finance, Performance Management and Delivery Unit (PEMANDU), Ministry of Human Resources, Ministry of Trade and Industry (MITI) and numerous other Government ministries and agencies. We are indebted to the Economic Planning Unit for their collaboration with the World Bank and in particular their assistance in the launch of this report. We also thank representatives from Japan External Trade Organization, the Federation of Malaysian Manufacturers, the American Malaysian Chamber of Commerce, and academics from the Institute of Strategic and International Studies, Singapore Management University, and analysts at several financial and rating institutions for helpful discussions. The findings, interpretations, and conclusions expressed herein do not necessarily reflect the views of the World Bank‘s Executive Directors, or the governments they represent. The report is based on information current as of March, 2012. i ABBREVIATIONS AEC ASEAN Economic Community AFAS ASEAN Framework Agreement on Services ALR Average Lending Rate ASEAN Association of Southeast Asian Nations BIS Bank for International Settlements BNM Bank Negara Malaysia CA Current Account CAGR Compound Annual Growth Rate CCI Communications and Content Infrastructure CPI Consumer Price Index CSR Corporate Social Responsibility DECPG Development Economics Department, Economic Prospects Group (World Bank) DOS Department of Statistics (Malaysia) E&E Electronic and Electrical E&O Errors and Omissions EA Employment Act EPF Employee Provident Fund EPP Entry Point Project EPU Economic Planning Unit ETP Economic Transformation Programme EU European Union FA Financial Account FDI Foreign Direct Investment FTA Free Trade Agreement FWA Fair Work Act G&S Goods and Services GATS General Agreement on Trade in Services GDP Gross Domestic Product GFCF Gross Fixed Capital Formation GLC Government-Linked Company GNI Gross National Income GST Goods and Services Tax GTP Government Transformation Programme HIS Household Income Survey HSC Higher School Certificate IC Industrial Court ICT Information and Communication Technology IFS International Financial Statistics ILO International Labor Organization IMF International Monetary Fund IRS Interest Rate Swap JACTIM Japanese Chamber of Trade and Industry JETRO Japan External Trade Organization JKM Jabatan Kebajikan Masyarakat (Social Welfare Department) JPJ Jabatan Pengangkutan Jalan (Road Transport Department) KAR1SMA 1Malaysia Rakyat‘s Welfare Programme KR1M Kedai Rakyat 1Malaysia KWAN Kumpulan Wang Amanah Negara (National Heritage Fund) LFS Labor Force Survey ii LIH Low Income Households LNG Liquefied Natural Gas LRT Light Rail Transit MCE Malaysian Certificate of Education MEM Malaysia Economic Monitor MOF Ministry of Finance (Malaysia) MRT Mass Rapid Transit NDTS National Dual Training System NEM New Economic Model NFPE Non-Financial Public Enterprise NKEA National Key Economic Area NKRA National Key Results Area NOSS National Occupational Skills Standards NTEP National Talent Enhancement Programme O&G Oil and Gas OECD Organization for Economic Cooperation and Development OPR Overnight Policy Rate PDRM Polis Diraja Malaisia (Royal Malaysian Police) PEMANDU Performance Management and Delivery Unit PICS Productivity and Investment Climate Survey PISA Program for International Student Assessment PITA Petroleum Income Tax Act PMR Penilaian Menengah Rendah (Lower Secondary Assessment) PPI Producer Price Index RHS Right Hand Side RM Malaysian ringgit SA Seasonally Adjusted SME Small and Medium Sized Enterprise SOCSO Social Security Office SPM Sijil Pelajaran Malaysia (Certificate of Education Malaysia) SPR Sijil Pelajaran Rendah (Certificate of Primary Education) SRI Strategic Reform Initiative SRR Statutory Reserve Ratio STPM Sijil Tinggi Persekolahan Malaysia (Malaysian Higher School Certificate) TERAJU Unit Peneraju Agenda Bumiputera TI Transparency International TIMSS Trends in International Mathematics and Science Study TUKAR Transformasi Kedai Runcit (project for transformation of grocery stores) TVET Technical and Vocational Education and Training UISA Unemployment Insurance and Savings Account UN United Nations UNESCO United Nations Educational Scientific and Cultural Organization UPSR Ujian Penilaian Sekolah Rendah (Primary School Evaluation Test) UPSRA Ujian Penilaian Sekolah Rendah Agama (Primary School Assessment Test) US United States USD United States Dollar WARP Weighted Average Realized Price WB World Bank WDI World Development Indicators WDR World Development Report WEF World Economic Forum iii TABLE OF CONTENTS Executive Summary ................................................................................................................................................................... 1 The Malaysian Economy in Pictures ......................................................................................................................................... 3 Modern Jobs in Pictures ............................................................................................................................................................ 4 1. Recent Economic Developments ....................................................................................................................................... 5 Economic growth surprised on the upside .............................................................................................................................. 5 The global economy slowed in 2011 .................................................................................................................................... 6 Exports continued on a two-speed mode........................................................................................................................... 6 Consumption was the main driver of growth ...................................................................................................................... 8 Resource-intensive industries and services performed well.............................................................................................. 9 Unemployment reached a new low, but wage growth has been modest .................................................................... 10 Inflation eased in the fourth quarter ....................................................................................................................................... 11 Fiscal and monetary policies still accommodative .............................................................................................................. 12 Expenditures grow rapidly, but higher revenues boost overall fiscal performance ..................................................12 Monetary policy remained on hold and supportive of growth .....................................................................................13 Robust credit growth continued despite new prudential measures ................................................................................ 13 Commodity exports supported Malaysia‘s external position ............................................................................................. 15 High-frequency indicators for early 2012 have been mixed .............................................................................................. 17 2. Economic outlook .............................................................................................................................................................. 18 Near-term outlook points to continued but modestly slower growth in 2012 ................................................................. 18 Global outlook cautiously improving ..................................................................................................................................18 The Malaysian economy is likely to grow cautiously as well ..........................................................................................20 Inflation to stabilize near current levels ..............................................................................................................................23 The current account balance is likely to narrow slightly .................................................................................................23 Fiscal consolidation proceeds while monetary policy remains watchful ....................................................................24 Risks to the outlook center on the global environment ..................................................................................................25 The medium-term outlook hinges on the implementation of structural reforms............................................................. 27 The Government Transformation Programme continues to show progress ................................................................28 The ETP has performed better on investments than structural reforms ........................................................................30 Economic transformation must boost productivity to prevent ‗Dutch Disease‘ ........................................................35 3. Modern jobs ........................................................................................................................................................................ 40 Modern jobs: higher wages, secure workers, competitive firms ........................................................................................ 40 What is the current landscape of Malaysia‘s labor markets? ............................................................................................ 42 How to create higher wage jobs? .......................................................................................................................................... 51 Boosting the quality of skills in the labor force is crucial ..................................................................................................51 A well-implemented minimum wage can help ................................................................................................................59 Leveraging foreign skills – at all ends of the spectrum ....................................................................................................62 Flexible and inclusive jobs, secure workers ............................................................................................................................ 65 Labor regulations can be modernized ..............................................................................................................................67 Social safety nets protect workers.......................................................................................................................................72 Modern social insurance also replaces informality as a shock-absorber ....................................................................75 Implications of a higher wage structure ................................................................................................................................ 76 Conclusions.................................................................................................................................................................................. 80 References ................................................................................................................................................................................ 82 iv BOXES Box 1. Exposure of Malaysia‘s exports to advanced economies .............................................................................................. 7 Box 2. The potential impact of a slowdown in China on commodity prices ........................................................................19 Box 3. Will Malaysia still benefit from higher oil prices? ..............................................................................................................25 Box 4. Liberalization of services sectors in context of broader trade liberalization in Malaysia .........................................33 Box 5. Changes to the National Heritage Fund (KWAN) in 2012 .............................................................................................39 Box 6. The World Development Report 2013 on Jobs ................................................................................................................41 Box 7. Denmark‘s flexicurity: increasing contestability, the gentler way................................................................................66 Box 8. Australian Fair Work Act 2009 .............................................................................................................................................71 Box 9. The institutional foundations of skill formation in four advanced economies ...........................................................72 Box 10. Unemployment Insurance and Savings Account .........................................................................................................74 Box 11. Results from a JETRO survey on challenges experienced by Japanese firms in Malaysia ....................................78 FIGURES Figure 1. Growth picked up in the second half of 2011 .............................................................................................................. 5 Figure 2. Year-on-year growth was relatively stable .................................................................................................................... 5 Figure 3. Growth in 2011 exceeded expectations… ................................................................................................................... 5 Figure 4. … thanks largely to higher public consumption ........................................................................................................... 5 Figure 5. The recovery in advanced economies lost momentum in 2011 ............................................................................... 6 Figure 6. But commodity prices remained firm ............................................................................................................................. 6 Figure 7. Exports to the US and the EU declined, while China‘s market share increased ..................................................... 7 Figure 8. Events in Europe affect Malaysia both directly and indirectly through supply chains.......................................... 8 Figure 9. Correlation between non-commodity exports to Asia and exports to US/EU remains high ................................ 8 Figure 10. Public consumption and fixed investment boosted GDP in the second half of 2011 ......................................... 9 Figure 11. Resource-intensive industries spear-head production ............................................................................................10 Figure 12. Domestic-oriented sectors, driven by services, have registered robust growth .................................................10 Figure 13. Resource-intensive industries experienced consistent wage growth ...................................................................10 Figure 14. Wages appear to increase in anticipation of job vacancies................................................................................10 Figure 15. CPI inflation in Malaysia is low among regional peers, but PPI is among the highest .......................................11 Figure 16. Supply factors were the main drivers of inflation but demand factors also played a role ..............................11 Figure 17. Federal Government debt levels came down in 2011 and remained below 55 percent ...............................12 Figure 18. Despite higher subsidy and personnel expenditures the deficit was lower in 2011 ...........................................12 Figure 19. Real interest rates are low, supporting growth .........................................................................................................13 Figure 20. BNM bills and bonds become more important instruments for sterilization since 2008 .....................................13 Figure 21. Housing loans continued to expand robustly while working capital loans picked up ......................................14 Figure 22. Approvals of car loans declined for most of the second half ...............................................................................14 Figure 23. The current account has been consistently in surplus... ..........................................................................................15 Figure 24. ... driven increasingly by commodity-related exports .............................................................................................15 Figure 25. Foreign direct investment fell and portfolio investment flow partly reversed in late 2011 ...............................16 Figure 26. Foreign direct investment is concentrated on the manufacturing and distributive sectors ............................16 Figure 27. Malaysia‘s real effective exchange rate appreciated in line with Thailand and Indonesia ...........................16 Figure 28. Net forward position declined much more than official reserves .........................................................................16 Figure 29. Industrial production declined in January .................................................................................................................17 Figure 30. Demand indictors have been mixed .........................................................................................................................17 Figure 31. Business confidence shows tentative signs of improvement .................................................................................19 Figure 32. The deceleration of growth in China has been concentrated on investment ..................................................19 Figure 33. Chinese demand is one of the main contributors to rising oil prices ....................................................................20 Figure 34. A considerable amount of Malaysian exports to China are commodities .........................................................20 Figure 35. Car sales have decelerated further into 2012 along with car production ..........................................................21 Figure 36. Income growth for households dependent on agriculture is likely to moderate on stable or lower prices .21 Figure 37. Forecasts for 2012 growth have been deteriorating since August 2011… ..........................................................22 Figure 38. … as expectations about manufacturing and investment worsened .................................................................22 Figure 39. Inflation expectations declined in October as the global environment deteriorated .....................................23 Figure 40. Inflation is expected to decelerate from 2011, but is likely to remain above the pre-crisis average ............23 Figure 41. The current account is expected to remain in surplus, albeit a slowly narrowing one .....................................24 Figure 42. Despite higher expenditures, the federal balance is expected to come in line with the budget .................24 Figure 43. Fuel subsidies paid by the Malaysian Government have increased since 2000 ................................................26 Figure 44. Oil production exceeds consumption but the gap is narrowing .........................................................................26 Figure 45. The net price differential between Tapis and Brent oil increased since January 2011 .....................................26 v Figure 46. A third of ETP projects are operational.......................................................................................................................30 Figure 47. Services increasingly constitute the backbone of the Malaysian economy ......................................................33 Figure 48. Services are more protected in Malaysia compared to high-income OECD economies ...............................33 Figure 49. The commodity balance has increased as a percent of GDP .............................................................................35 Figure 50. The real effective exchange rate has appreciated in line with other currencies in the region......................35 Figure 51. Manufacturing output also moved in line with regional peers in the 2000s ........................................................36 Figure 52. The nominal exchange rate was similarly stable ......................................................................................................36 Figure 53. An increase in the commodity balance was followed by an increase in FDI from Malaysian companies abroad ...............................................................................................................................................................................................36 Figure 54. Reserves counteracted volatile flows ........................................................................................................................36 Figure 55. Only half of expenditures are financed through non-oil revenues .......................................................................37 Figure 56. Inflation in Malaysia is low compared to regional peers ........................................................................................38 Figure 57. Malaysia‘s population is young... ................................................................................................................................42 Figure 58. ... and relatively well educated ..................................................................................................................................42 Figure 59. Employment grew less than the working-age population in the 2000s…............................................................44 Figure 60. ...but unemployment was stable as participation declined… ..............................................................................44 Figure 61. …because both young men… ....................................................................................................................................44 Figure 62. ...and women… ..............................................................................................................................................................44 Figure 63. … pursued further studies rather than join the labor force .....................................................................................44 Figure 64. Women‘s labor force participation is low relative to other Asian and OECD economies ...............................46 Figure 65. Labor force participation of women peaks before marriage and declines steadily thereafter ....................46 Figure 66. Employment shares in services increased…..............................................................................................................46 Figure 67. … with significant gains in finance jobs. ....................................................................................................................46 Figure 68. Most jobs created since 2001 have been skilled… ..................................................................................................47 Figure 69. … but the largest share of existing jobs is still relatively low-skilled ........................................................................47 Figure 70. Wage growth lagged productivity in manufacturing… .........................................................................................48 Figure 71. … but grew faster in services .......................................................................................................................................48 Figure 72. Malaysia‘s greatest absolute advantage remains ‗cost competitiveness‘ ........................................................49 Figure 73. Malaysia‘s indicators on labor costs are closer to lower-income countries ........................................................49 Figure 74. The number of registered foreign workers quintupled between 1999 and 2008 but fell since ........................50 Figure 75. Most foreign workers in Malaysia have low skill levels .............................................................................................50 Figure 76. High redundancy costs are perceived as reducing Malaysia‘s overall competitiveness ................................50 Figure 77. Informality appears in line with Malaysia‘s income level ........................................................................................50 Figure 78. Wages are linked to productivity by region ..............................................................................................................52 Figure 79. Across different types of jobs, compensation is linked to productivity ................................................................52 Figure 80. The share of university graduates in the labor force increased rapidly in the past decade… .......................53 Figure 81. … but remains below that of advanced economies and even some regional peers .....................................53 Figure 82. Enrollment ratios need to rise further for Malaysia to catch up.............................................................................54 Figure 83. Boosting the quality of education, especially basic education, remains a key challenge .............................54 Figure 84. There has been an increase in demand for tasks complementary with technology .......................................56 Figure 85. While returns to routine tasks (such as basic auto mechanics) have stagnated ...............................................56 Figure 86. Firms generally identify non-routine and other soft skills as a key constraint ......................................................57 Figure 87. Applicants‘ lack of skills leads to job vacancies ......................................................................................................57 Figure 88. English proficiency is less of a concern in manufacturing… ..................................................................................59 Figure 89. …whereas firms in business support services require more of that skill .................................................................59 Figure 90. Median wages in petrochemicals are the highest of the resource intensive sectors .......................................60 Figure 91. Wages in services are generally higher than in manufacturing and agriculture ...............................................60 Figure 92. Labor-intensive, low-skill sectors would be more highly affected by the minimum wage ...............................61 Figure 93. There is significant geographic variation in the concentration of low income earners ...................................61 Figure 94. Following rapid increase, the share of migrants in the labor force has stabilized .............................................62 Figure 95. The low share of non-citizens among the unemployed reflects strong demand ..............................................62 Figure 96. In total employment, few foreign workers have high-skill jobs ..............................................................................63 Figure 97. Secondary educated Malaysian workers rose rapidly, unlike migrants...............................................................63 Figure 98. In total employment, increasingly fewer foreign workers have high-skill jobs ....................................................64 Figure 99. Secondary-educated Malaysian workers rose rapidly, unlike migrants ..............................................................64 Figure 100. Migrant wages are generally lower, except for highly-educated migrants .....................................................64 Figure 101. Migrant wages are lower across occupations, except for the high-skill ones ..................................................64 Figure 102. Migrant and Malaysian Workers, by Sector of Employment ................................................................................65 Figure 103. Malaysia ranks low in the region in terms of labor market flexibility ...................................................................67 Figure 104. While improvements were made in some areas, labor dismissal regulations consistently lower the overall labor regulation ranking ..................................................................................................................................................................68 vi Figure 105. The statutory notice period in Malaysia is higher than in most Asian countries for workers with long tenure .............................................................................................................................................................................................................69 Figure 106. Termination benefits also become relatively high for workers with longer tenure, exceeding levels in the OECD ..................................................................................................................................................................................................69 Figure 107. Social security coverage around the world (percent labor force) ...................................................................73 Figure 108. Social security coverage around the world (percent labor force) ....................................................................75 Figure 109. Informal workers earn less than formal-sector workers… ......................................................................................76 Figure 110. …especially in Manufacturing… ...............................................................................................................................76 Figure 111. …but also in services ...................................................................................................................................................76 Figure 112. Prices rise with income ...............................................................................................................................................78 TABLES Table 1. GDP growth is expected to slow… ................................................................................................................................22 Table 2. … mainly due to slower growth in government consumption ..................................................................................22 Table 3. Many of the 2011 targets for the GTP have been achieved ...................................................................................29 Table 4. Progress on SRIs has been incremental .........................................................................................................................31 Table 5. The non-oil primary deficit has grown substantially ....................................................................................................37 Table 6. This has been helped by subsidies and price controls ...............................................................................................38 Table 7. Traditional vs. Modern .....................................................................................................................................................41 Table 8. Working Age Population as of 2009 ...............................................................................................................................43 Table 9. Labor Force as of 2009 .....................................................................................................................................................45 Table 10. Compensation, Hours, and Distribution.......................................................................................................................48 Table 11. Degree recipients receive wages 5.5 times higher than those with no formal education ...............................52 Table 12. Wages increase with education levels, but the largest rewards come from tertiary education.....................52 Table 13. Distribution of Bachelor‘s-level Graduates by Income Band, at 18 and 30 months after the end of classes (graduating classes of 2006 and 2007) ........................................................................................................................................53 Table 14. School autonomy at lower secondary – TALIS 23-country study ...........................................................................55 Table 15. Non-routine skills will be increasingly demanded as routine skills are automated. ............................................56 Table 16. Employment Status of 2006 and 2007 Graduates at the end 2008, By Institution Type and Level .................57 Table 17. Graduate Unemployment Rates 18-30 Months after End of Classes by Discipline, Level and Type of Institution ............................................................................................................................................................................................58 Table 18. Cross-country comparison of regulations regarding fixed-term contracts .........................................................70 Table 19. Cross-country comparison of regulations regarding work hours ...........................................................................70 Table 20. Reasons for Japanese firms to invest in Malaysia .....................................................................................................79 Table 21. Challenges Japanese firms face in securing high quality labor ............................................................................79 Table 22. Top Six Challenges Japanese Firms Face in Asian Countries ..................................................................................80 vii Executive Summary ECONOMIC DEVELOPMENTS AND OUTLOOK The gradual return of monetary policy to pre-crisis The Malaysian economy grew robustly in 2011, settings was put on hold in the second half of the outperforming forecasts. Growth was driven by year. With earlier rate hikes only partially offsetting domestic demand. Public consumption picked up previous rate cuts, the policy interest rate remained more than expected toward the end of the year and supportive of growth and credit growth was healthy. fixed investment was also buoyant on higher The authorities turned to prudential measures to investments by public and private companies. ensure sustainable credit expansion, especially to Private consumption spending remained strong, lower income households. sustained by solid consumer credit, civil service bonus payments, and firm commodity prices benefiting The current account remained in surplus on strong smallholders. Inventories were a drag on growth as commodity-related receipts. Capital flows were post- financial crisis restocking was completed. volatile, with large inflows earlier in 2011 partly reversed in September and October. Reserves were Exports and manufacturing production remain in a relatively stable and, overall, the ringgit appreciated two-speed mode. Production and export growth was slightly in 2011. sustained in petroleum, palm oil and rubber based products (though crude oil exports suffered from The Malaysian economy is expected to post ongoing production bottlenecks afflicting the mining continued but slower growth in 2012. Investment is sector). Meanwhile, electrical and electronics (E&E) likely to expand further while private consumption is production and shipments continued to face projected to remain resilient overall. However, headwinds from weak global demand and supply government consumption is bound to moderate, disruptions in Thailand and Japan. Although while inventories will be a drag. Net exports subtract commodity-related exports have gained share in from growth as strong domestic demand combined Malaysia‘s trade basket, most exports are still ―non- with moderate exports lead to faster growth in commodities‖ and remain highly vulnerable to imports, especially of capital and consumer goods. developments in advanced economies. Overall, GDP growth is expected to come at 4.6 percent in 2012 and, assuming a continuation of the Unemployment held steady at low levels but real global recovery, 5.1 percent in 2013. wages made only modest gains. Job creation was healthy, accommodating new workers and a higher Downside risks have eased but persist. Given participation rate. The two-speed pattern of growth Malaysia‘s export orientation, ongoing risks to the in manufacturing was reflected in real wages, with global recovery constitute risks for Malaysian growth. higher wage growth in resource-intensive Further increases in oil prices are generally beneficial, manufacturing industries as compared to E&E. but bring challenges as well. Inflation started to decline, with stabilizing food prices There is momentum to the reform agenda, but and falling transport costs. A decline in producer implementation could be accelerated. The price inflation confirms that price pressures are government‘s transformation programs registered easing. notable progress, but the challenge now is to go beyond quick wins and accelerate the Higher-than-forecast revenue collection reined in the implementation of more difficult—but critical— deficit of the federal government. Healthy revenue structural reforms that lie at the core of transforming collection was predicated on higher oil prices but the economy into a high-income one. there were notable increases in non-oil revenues. Implementation can be assisted by increasing the Operating expenditures outgrew revenue but were coordination of related reform efforts (such as safety partly offset by lower development expenditures as nets and education), building capacity within the post-crisis fiscal stimulus was unwound. As a result, the civil service to lead reforms, and working towards deficit and public debt levels were better than consensus in key areas such as educational reform, expected. subsidy rationalization and broadening the tax base. 1 « MALAYSIA ECONOMIC MONITOR APRIL 2012 MODERN JOBS quality of skills in Malaysia‘s labor force remain below high-income peers. Targeting underserved areas and The transformation to a high-income nation involves groups for scaling up enrollments and quality creating modern jobs. Jobs lie at the core of a improvements can lead to the quickest gains. The strategy to achieve Malaysia‘s objective of types of skills supplied to labor markets also need to becoming a high-income economy that benefits all adapt to the demands of modern jobs and match Malaysians. In this regard, Malaysia needs to create the needs of firms. Measures to boost the supply of more modern jobs and modernize its labor markets. relevant skills can help create demand for skills, but are not sufficient. Rather, structural reforms are Modern jobs are higher productivity jobs that needed to facilitate industrial upgrading that creates command higher wages. Modern jobs need not be in sustained demand for high-skilled, high wage jobs. futuristic sectors but they involve more complex, non- routine tasks and require more and more diverse A well-implemented minimum wage can be helpful types of skills. They can be found in all sectors in the but is no panacea. A minimum wage can correct economy, but increasingly will be service-based. distortions in labor markets, potentially raising wages Modern firms in a high-income economy derive their for some workers and attracting more Malaysians to competitiveness not from low wages but the the labor force. However, a minimum wage is not the productivity of their workers and are willing to pay for most effective policy to address poverty or inequality talent accordingly. concerns, nor is it the best tool to compel firms to move up the value-chain. Modern labor markets protect workers rather than jobs. Flexibility for firms and workers to allocate With regard to foreign workers, the focus should be resources more efficiently boosts productivity growth. on attracting more highly-skilled migrants and But added flexibility should be balanced with security addressing the underlying factors that lead firms to for workers through well-designed social safety nets display a high demand for low-skilled labor. that facilitate job transition and provide protection in downturns. Greater flexibility also helps draw talent A better balance between job flexibility and worker from all segments of society—especially women. protection can be achieved. Although modern in many respects, Malaysia‘s labor markets retain a Some recent trends in Malaysian labor markets are ‗traditional‘ structure of high levels of job protection encouraging. Unemployment has been low, more (through high retrenchment costs) and limited young people are deferring entry into the labor protection for workers who may find themselves out markets to acquire higher education, more high-skill of a job or in the informal economy. Here the priority jobs are being created, and more women have would be to develop unemployment insurance within entered either labor markets or higher education. the broader context of a modern social safety net, Labor markets are already flexible in many areas, and in parallel create more flexibility in labor markets and reform efforts are ongoing. by reviewing current dismissal regulations. But further efforts are needed as much of the stock of Modern jobs meet women’s work-life balance needs jobs remains low-skilled and pays relatively low through greater flexibility and supportive social wages. Wage growth has been muted and Malaysia policies. Firms should be encouraged to adopt more is still seen as a ‗low-cost‘ country. The low-cost flexible working arrangements and the provision of production model has been supported by inflows of child and elderly care can be enhanced. Greater low-skilled foreign workers. Despite improvements, availability of modern jobs, which command higher women‘s labor force participation remains low by wages and entail performing fewer manual tasks, is international standards, leaving a large pool of talent also likely to attract more women to the labor force. untapped. Finally, high redundancy costs weigh on the competitiveness of Malaysia‘s labor markets. Higher productivity in a more efficient labor market can enhance competitiveness while raising living Pulling wages higher through more and better skills standards. The key to modernizing Malaysia‘s labor and higher productivity should be the focus of policy. markets is to ensure that unit labor costs—wages Increasing wages through productivity gains requires adjusted for productivity and other employment- creating and retaining more, better and new types of related costs—remain competitive by making sure skills. Despite recent improvements, the quantity and that both sides of the equation increase in tandem. MALAYSIA ECONOMIC MONITOR APRIL 2012 » 2 The Malaysian Economy in Pictures GDP growth accelerated Non-commodity exports are synchronized Real GDP, seasonally adjusted, annualized change from last quarter, percent Change from the previous year, percent 15 12.3 12.4 US + EU 9.2 11.4 60 9.2 China Non-Commodities 10 6.9 7.3 6.7 5.2 50 ASEAN Non-Commodities 4.4 Other Asia Non-Commodities 5 2.6 2.5 40 0.5 0 30 20 -5 -1.9 10 -10 0 -10.8 -15 -10 -15.3 -20 -20 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 -30 1/1/2002 1/1/2005 1/1/2008 1/1/2011 2008 2009 2010 2011 Domestic-oriented sectors drove growth Inflationary pressures eased Contributions to year-on-year GDP growth, percentage points Consumer and producer price inflation, percent 10 15 PPI Domestic-oriented 10 5 CPI 5 0 0 Export-oriented -5 -5 -10 -10 -15 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2008 2009 2010 2011 2007 2008 2009 2010 2011 Commodity-related exports increasingly drive the current GDP growth solid but likely to moderate in 2012 account Balances, 12-month rolling sum, RM billions Actual and forecast GDP growth, percent 120 8 7 100 Commodity 6 Non-commodity balance 5 80 balance 4 7.2 3 60 4.8 5.1 4.6 5.1 2 1 40 0 -1 -1.6 20 -2 0 -3 Jan-01 Jan-04 Jan-07 Jan-10 2008 2009 2010 2011 2012f 2013f The federal budget deficit is expected to improve The share of expenditures financed by oil is up Balance of the federal Government, percent of GDP Index, Total Expenditures = 100 100.0 0.0 Deficit Financing 90.0 -1.0 80.0 -3.2 -2.0 -4.0 70.0 -4.8 -5.0 -4.7 Oil Revenues -3.0 -5.6 60.0 -7.0 50.0 -4.0 Non-Oil 40.0 Deficit Non-Oil -5.0 30.0 Revenues -6.0 20.0 10.0 -7.0 0.0 -8.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2007 2008 2009 2010 2011 2012f 2013f 3 « MALAYSIA ECONOMIC MONITOR APRIL 2012 Modern Jobs in Pictures The working age population grew faster than employment Fewer young men and women joined the labor force Index, 1982 = 100 Labor force participation rate by age group, percent 230 120 Population 210 15-64 100 190 Jobs 80 170 150 60 130 40 110 20 90 2000, Men 2010, Men 2000, Women 2010, Women 0 15-19 20-24 25-29 30-34 35-39 40-44 45-49 50-54 55-59 60-64 The share of young men and women in tertiary education has The number of registered foreign workers jumped five-fold increased significantly between 1999 and 2008 Gross tertiary enrollment, percent Thousands 50 2,500 2,045 1,918 45 2,000 1,815 1,803 40 Women 1,500 1,337 35 1,000 850 30 Men 410 500 25 0 20 1999 2001 2003 2005 2007 2009 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Wage levels are low in many industries Most new jobs created in the past decade are high- and mid-skill Median wages (as of 2009), RM per month Number of net new jobs created between 2000 – 2010 Petrochemicals 1,000 910 900 826 Mining & extractive industries 800 Utilities 700 Mfg of transport equipment 600 500 Mfg elec equip and electronics 400 Construction 300 200 Mfg food & bev (inc palm oil) 37 100 Ag, fishing and forestry 0 High Skill Mid-skill Low-skill 0 1,000 2,000 3,000 Skills mismatches remain a challenge Malaysian labor markets are generally competitive, except for redundancy costs Reason firms report difficulty in filling vacancies, percent WEF Rankings 80 Cooperation in labor-employer 70 relations 60 Manufacturing 50 Services Pay and Flexibility of wage 40 Productivity determination 15 30 4 28 20 19 10 30 Redundancy costs,104 Rigidity of 0 weeks of salary employment index Universities are not Applicants do not have Applicants do not have producing sufficient required basic skills required technical skills graduates Hiring and firing practices MALAYSIA ECONOMIC MONITOR APRIL 2012 » 4 1. Recent Economic Developments Economic growth surprised on the upside Malaysia’s economy expanded a robust 5.1 percent in 2011, exceeding forecasts. Real Gross Domestic Product (GDP) expanded by 4.4 and 6.7 percent in the third and fourth quarters of 2011 on a sequential (quarter-on- quarter, seasonally-adjusted annualized) basis, taking growth for the year to 5.1 percent (Figure 1). On a year-on- year basis, growth was fairly stable (Figure 2). Growth in the first two quarters was revised up largely on account of higher Government consumption. GDP growth exceeded the World Bank‘s earlier estimate of 4.3 percent, as well as the consensus forecast of 4.7 percent (Figure 3). The difference between the actual outcome and the World Bank‘s forecast can be largely explained by the Government stepping up consumption spending (Figure 4). Although year-on-year growth in 2011 was lower than in 2010, growth was less volatile, and average sequential growth (reflecting the momentum of the economy) accelerated from 4.8 percent in 2010 to 5.2 percent in 2011. Figure 1. Growth picked up in the second half of 2011 Figure 2. Year-on-year growth was relatively stable GDP adjusted for inflation and seasonal fluctuations, change from the previous GDP adjusted for inflation, change from previous year, percent quarter (line), and previous year (bars), percent 15.0 12.0 10.0 10.0 7.2 8.0 4.8 5.1 5.0 6.0 10.1 4.0 9.0 0.0 7.5 6.7 5.1 4.6 5.3 4.8 5.2 4.3 5.8 5.2 -1.6 2.0 0.2 -5.0 0.0 -1.2 -10.0 yearly -2.0 -3.9 -6.2 quarterly (annualized, SA) -4.0 -15.0 -6.0 -20.0 -8.0 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2008 2009 2010 2011 2008 2009 2010 2011 Source: Haver and World Bank staff calculations. Source: Haver and World Bank staff calculations. Figure 3. Growth in 2011 exceeded expectations… Figure 4. … thanks largely to higher public consumption Forecasts of GDP growth for 2011, percent Contributions to the year-on-year growth rate, percentage points 7.0 High Low WB forecast Mean forecast GDP 4.3 6.0 5.1 Actual value 5.0 Private Consumption 3.6 3.7 4.0 Public Consumption 1.3 2.2 3.0 GFCF 1.3 1.3 2.0 Stocks -0.5 1.0 -0.7 MEM Nov. 2011 Actual 0.0 Net Exports-1.5 -1.4 H1 H2 H1 H2 2010 2010 2011 2011 -2.0 -1.0 0.0 1.0 2.0 3.0 4.0 5.0 6.0 Source: Consensus Economics and World Bank staff Source: World Bank (2011a) and CEIC. calculations. Note: Values are based on individual forecasts reported by 12 to 16 investment banks. The mean forecast is sensitive to the composition of the sample. 5 « MALAYSIA ECONOMIC MONITOR APRIL 2012 The global economy slowed in 2011 The recovery of advanced economies lost momentum in 2011, weakening demand for imports from emerging economies. Optimism in early 2011 was dampened by weak realized economic performance in advanced economies and then by heightened policy risks following the debt ceiling debate in the US and uncertainty surrounding Greek debt restructuring (Figure 5). Member economies of the OECD only grew by 1.7 percent in real terms, compared to 2.9 percent in 2010 and 2.5 percent between 2002 and 2007. Weak economic growth slowed imports from emerging economies, which as a result also experienced a moderation of growth. In the US, real imports grew by 2.1 percent in 2011, down from an average growth from 2.9 percent between 2002 and 2007. In China, nominal imports grew by 29 percent, down from 39 percent in 2010. As a result, although countries in developing East Asia still grew considerably faster than developed economies, both China and Singapore, Malaysia‘s major trading partners, also experienced a deceleration of growth in 2011. Figure 5. The recovery in advanced economies lost Figure 6. But commodity prices remained firm momentum in 2011 GDP, change from previous year, percent Index (2008=100) 10 250 2009 Oil (Brent) 8 2010 Rubber 200 Palm oil 6 2011E WB Food Price Index 2002-2007 (avg.) 4 150 2 100 0 -2 50 -4 0 -6 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Eurozone Japan US Source: World Bank (DECPG). Source: World Bank (DECPG). Note: World Bank (WB) Food Price Index for emerging markets. Despite weakness in global demand, renewed tensions in the Middle East halted the decline in commodity prices. Europe and the US have intensified political pressure on Iran, with the EU recently imposing a ban on Iranian oil imports. In response to a potential further escalation of the conflict, hedging and speculating activities have also increased. The result of these developments has been higher oil prices, despite relatively slack global growth. Other commodities have followed the lead of high oil prices (Figure 6), although partly these increases can be explained by China‘s steady appetite for commodities. Some of Malaysia‘s key commodity exports, especially LNG, palm oil and rubber, have benefited from this rally in commodity prices. Food prices have moderated in the second half. Exports continued on a two-speed mode Exports expanded modestly amid continued divergence between commodities and non-commodities. Exports of goods and services grew by 8.8 percent in nominal terms (4.5 percent in real terms) in the second half of 2011. Shipments of commodities grew by 26.1 percent, while non-commodities expanded by only 1.7 percent. For the year overall, exports expanded 7.8 percent in nominal terms (3.7 percent in real terms), indicating an acceleration in the second half. However, on a seasonally adjusted basis, exports are yet to return to pre-crisis levels. Shipments of crude oil declined because of ongoing production bottlenecks, but export values increased due to elevated price movements. Meanwhile, exports of palm oil and rubber increased both in volume and value terms. Commodities now represent one-third of Malaysia's exports, up from about 1/6 in 2000. In addition to weak demand from advanced economies, exports of non-commodities were affected by supply chain disruptions first due to the Tohoku earthquake in Japan, then by the flooding in Thailand. Box 1 explores the linkages between two-speed export growth and the shifting in export market shares noting that despite recent shifts in the composition of the export basket and export destinations, Malaysia‘s exports remain highly dependent global growth. MALAYSIA ECONOMIC MONITOR APRIL 2012 » 6 One consequence of this two-speed export growth has been faster growth in the domestic value-added of exports. Domestic value-added of Malaysian exports (in nominal terms, estimated as the difference between goods exports and intermediate goods imports) expanded by 13.3 percent in 2011 largely due to the greater share of resource- related goods in the export basket. Notwithstanding the higher domestic value-added of exports, net trade contributed negatively to year-on-year growth due to higher imports of capital goods (up 9.8 percent in nominal terms) and consumer goods (up 19.0 percent), which reflect strong domestic demand. Consumption goods have increased from 5.7 percent of all imports in 2007 to 7.1 percent in 2011. Box 1. Exposure of Malaysia’s exports to advanced economies The share of Malaysian exports going to Asia has increased significantly over the past 10 years at the expense of exports to advanced economies. While the share of the US and Europe in Malaysia‘s exports has declined from nearly one-third percent between 2002 and 2007 to under 20 percent in 2010 – 2011, China‘s share has increased from 5.5 percent to 14.4 percent (Figure 7). The decline in trade with advanced economies has been concentrated in office and automatic data processing machines (which include computers and parts), whereas the growth in intra-Asia trade, especially with China, has focused on commodities (especially palm oil, mineral fuels and petrochemicals). This is in line with the two speed pattern of export growth. Figure 7. Exports to the US and the EU declined, while China’s market share increased Average share of Malaysian exports (nominal terms) EU: 13.0 12.2 10.4 USA: 19.8 China: 5.5 14.4 9.2 Japan: 11.3 9.1 14.4 9.5 10.5 ASEAN: 25.6 25.9 24.8 Average 2002-2005 Average 2007-2008Q3 Average 2010-2011Q3 Source: CEIC and World Bank staff calculations. The shift in export destinations appears to reflect two important trends. First, it reflects a shift in export products from electronics to commodity-based raw and industrial products. Firms such as Dell have moved from manufacturing to business support services in Malaysia whereas new investments in solar industries have yet to generate substantial export growth. As of 2011, E&E output was 13 percent below its pre-crisis peak in 2006. On the other hand, the production of petrochemicals in 2011 was 22 percent above 2006 levels and may surpass E&E output in 2012. Second, supply chains have become more fragmented. ASEAN countries, particularly Singapore, Thailand and Indonesia, remain the main export markets for Malaysia, absorbing about 22 percent of its exports largely through transnational supply chains whose final output is ultimately destined to advanced economies. The elasticity of overall Malaysian exports to European import growth has been relatively stable at 0.4 (Figure 8). However, the elasticity of Chinese imports from Malaysia to Chinese exports to Europe is considerably higher and has increased from 0.78 to 0.84 during the economic crisis. The elasticity is even higher when only focusing on electronics where Chinese demand for Malaysian exports is almost perfectly synchronized with European demand. This suggests that the share of intermediate exports to China remains high, forming a key ingredient of Chinese exports to Europe. 7 « MALAYSIA ECONOMIC MONITOR APRIL 2012 Therefore, while trade with advanced economies declined, exports of non-commodities to Asia and exports to the US and EU remains fairly synchronized (Figure 9). Although exports from Malaysia constitute less than one percent of European imports and only 3.5 percent of Chinese imports, Malaysian exports remain highly dependent on demand from both economies and as a result remains vulnerable to a new negative shock in advanced economies. Figure 8. Events in Europe affect Malaysia both directly Figure 9. Correlation between non-commodity exports and indirectly through supply chains to Asia and exports to US/EU remains high Elasticity Change from the previous year, percent CHN imports US + EU from MYS: 60 CHN imports 1 from MYS: CHN exports to China Non-Commodities EU (electronics) CHN exports 50 ASEAN Non-Commodities 0.9 CHN imports to EU from MYS: Other Asia Non-Commodities 0.8 CHN global 40 imports 0.7 30 0.6 EU imports 20 from MYS: 0.5 EU global imports 10 0.4 0 0.3 0.2 -10 0.1 -20 0 -30 2000-2008 2008-2009 2010-2011 1/1/2002 1/1/2005 1/1/2008 1/1/2011 Source: CEIC, Eurostat, and World Bank staff calculations. Source: CEIC and World Bank staff calculations. Notes: Deflated by CPI of importing country (CPI and PPI where China is the importer). Results based on univariate ordinary least squares regressions. EU refers to the Eurozone. Notes: a: Dell stopped shipping notebook computers from Penang to the US, Canada and parts of South America in 2009. According to Dell (2006), in 2005, Dell computer accounted for 28 percent of Malaysia‘s electronic equipment exports and almost 7 percent of its GDP. On the other hand, in November 2011 Dell opened a global business center in Cyberjaya. b: It should be borne in mind that as the financial crisis of 2008 and 2009 translated to an extent into a trade credit freeze these elasticities are driven not only by demand but also credit conditions. See World Bank (2011c), p. 31. Consumption was the main driver of growth Domestic consumption—both public and private—was the main driver of growth in 2011. Private consumption continued to expand in the final quarter of 2011, posting 7.1 percent year-on-year growth, while public consumption surged 23.6 percent (Figure 10) following higher expenditures on emoluments, supplies and services. The contribution of public consumption to year-on-year growth for the fourth quarter (4.1 percentage points) was the highest since at least 2000. For 2011 as a whole, consumption (both public and private) contributed 5.9 percentage points to GDP growth, of which 3.7 private and 2.2 public. Vigorous growth of household consumption was underpinned by still-accommodative credit conditions, firm prices for Malaysia‘s main commodities (which boosts incomes of rural households), public transfers such as civil servant bonuses and declining inflation in the fourth quarter. Fixed investment also expanded robustly on higher investments from the private sector and public enterprises. Gross fixed capital formation expanded by 6.0 percent in real terms from 2010 despite a 2.4 percent contraction in public investments. This implies private investments expanded by 14.4 percent, down from 17.7 percent in 2010 (quite respectable given base effects in 2010). Federal Government development expenditures contracted by 12 percent (in nominal terms) during the year following the lapse of the second stimulus package, which had added MALAYSIA ECONOMIC MONITOR APRIL 2012 » 8 an exceptional RM5 billion to the development budget in 2010.1 Strong capital spending of the non-financial public enterprises (NFPEs) partially offset the decline in development expenditure: net development expenditures of NFPEs surged by 52 percent in 2011. The increase in capital spending by NFPEs was mainly in the mining, transportation, utilities and communication sectors. Mining sector investments by PETRONAS, the national oil company, alone may have accounted for as much as 1/3 of the growth in nominal investments in Malaysia in 2011 2. Capital spending in the utilities and communication sectors was focused on expanding Malaysia‘s electricity generation capacity and extending the coverage of High-Speed Broadband services respectively. Fixed investment expanded particularly strongly in the fourth quarter, as development spending became less of a drag and NFPEs accelerated investments. Figure 10. Public consumption and fixed investment boosted GDP in the second half of 2011 GDP adjusted for inflation and seasonal fluctuations, contributions to quarterly growth rate (not annualized), percentage points 10 5 0 -5 Inventory investment Private consumption -10 Public consumption Fixed investment Net exports GDP -15 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2008 2009 2010 2011 Source: Haver and World Bank staff calculations. Inventories became a drag on growth as the restocking cycle was completed. After an extended period of inventory restocking – following the sharp drawing down of inventories during the global financial crisis in 2008 – the contribution of inventories to year-on-year growth turned negative again in the second quarter of 2011 (Figure 10). Resource-intensive industries and services performed well Commodity-related industries performed well despite external weakness and ongoing bottlenecks in the mining sector. The manufacturing sector as a whole expanded by 4.5 percent in real terms in 2011 compared to 11.4 percent in 2010.3 Subdued external demand, particularly from advanced economies, weighed down on the large export-oriented E&E sub-sector. In contrast, companies producing non-metallic mineral products and metals have done particularly well and well exceeded their pre-crisis levels of output (Figure 11). Together with industries that produce petroleum, chemicals (both petrochemicals and oleo-chemicals), rubber, and plastic products, these sectors had the largest contributions to growth in 2011. The mining sector remained a drag due to ongoing operational problems the Kikeh oil field off the coast of Sabah. 1 Allocation for development expenditures including the second stimulus package declined by 13 percent (from RM56.2 billion to RM49.3 billion) between 2010 and 2011, whereas executed development expenditure declined by 12 percent (from RM52.8 billion to RM46.4 billion (sources: Economic Report 2009/2010, Economic Report 2010/2011 and EPU). 2Based on financial statements available at http://www.petronas.com.my/investor-relations/Pages/financial-results.aspx, capital expenditures increased by RM7.8 billion in calendar year 2011. Based on the fiscal year (ended March 31st) 2011 breakdown of domestic and foreign capital expenditures (available at the PETRONAS Annual Report, page 33) this represents approximately RM5.2 billion in additional domestic investments in 2011, which compares with nominal gross fixed capital formation growth of RM15.9 billion. 3 The average sequential growth rate also slowed, though less dramatically since the year-on-year growth rate in 2010 included substantial base effects due to recovery from the global financial crisis. 9 « MALAYSIA ECONOMIC MONITOR APRIL 2012 Figure 11. Resource-intensive industries spear-head Figure 12. Domestic-oriented sectors, driven by services, production have registered robust growth Percent Contributions to year-on-year GDP growth, percentage points Non-Metalic 20 Mineral 10.0 Prdts, Basic & Fabricated 15 Petroleum, Metal 5.0 Textiles, Chemical, average yoy growth in 2011 Wearing Rubber & Food, Apprarel, etc 10 Plastic Prdts Beverages & 0.0 Tobacco 5 Transport Wood EO - contribution Equip & Oth -5.0 Prdts etc Electricity DO - contribution Manufacture 0 EO - growth -30 -10 10 30 50 70 DO - growth -10.0 -5 DO - growth: services only Electrical & Electronic Mining -15.0 -10 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Dec 2011: pct. increase over 2007 avg 2008 2009 2010 2011 Source: CEIC and World Bank staff calculations. Source: CEIC and World Bank staff calculations. Notes: EO stands for ‗export oriented‘ sectors and DO for ‗domestic oriented‘ sectors. Sectors more closely linked to domestic demand, especially services, expanded vigorously. Sectors producing primarily for domestic demand contributed 3.6 percentage points to overall year-on-year real growth in 2011, more than double the 1.5 percentage points contributed by sectors where demand comes primarily from external markets (Figure 12). As a result of strong investment in the fourth quarter, the construction sector expanded by over 6 percent though it remains a small contributor to overall growth. Services sectors contributed the largest share of Malaysia‘s economic growth in 2011 and will keep playing a key role in Malaysia‘s economic transformation. Unemployment reached a new low, but wage growth has been modest Unemployment has returned to pre-crisis levels. Seasonally adjusted unemployment stood at 3.0 percent in the final quarter of 2011 and declined further to 2.8 percent in January. Malaysia created 285 thousand jobs between January 2011 and January 2012 (a growth rate of 2.3 percent), exceeding the growth rate of the working age population in the period (260 thousand) as well as absorbing new entrants into the labor market, which led to an increase in labor force participation by 0.4 percentage points to 65.1 percent in January. Figure 13. Resource-intensive industries experienced Figure 14. Wages appear to increase in anticipation of consistent wage growth job vacancies Real wage growth, percent Vacancies (thousands) RM per month 30 85 2,700 25 20 75 2,600 15 2,500 65 10 2,400 5 55 0 2,300 -5 45 2,200 -10 35 2,100 -15 -20 25 2,000 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jul-10 Jan-11 Jul-11 Resource-intensive E&E Resource-intensive (avg.) E&E (avg.) New Vacancies Avg. payroll (ringgit, RHS) Source: CEIC and World Bank staff calculations. Source: CEIC and World Bank staff calculations. Notes: Seasonal adjustment by World Bank staff. Note: Vacancies data depicted as 4-month lead. MALAYSIA ECONOMIC MONITOR APRIL 2012 » 10 On the other hand, manufacturing wage growth has been modest. Manufacturing wages (adjusted for inflation) increased by 0.8 percent in January and 0.6 percent for 2011 on average—below the real output growth of the manufacturing sector. Within manufacturing, wages in resource-intensive industries gained the most, reflecting the good overall performance of the industry. Wages in petroleum, chemicals, plastics and rubber products posted a 4.6 percent gain in real terms in 2011, compared to an increase of just 0.8 percent in E&E. 4 This represents the continuation of a trend, and the gap in wages between resource-intensive petroleum and chemical industries and E&E has increased from -0.2 percent (i.e. E&E wages used to be higher) to 11.2 percent in 2011. In addition, wage growth in resource-intensive industries has been less volatile, expanding even during the crisis period (Figure 13). Wages seem to increase about four months before vacancies increase suggesting that, as labor markets tighten, firms will initially try to create incentives to improve labor productivity and retain workers before opening new vacancies (Figure 14). Inflation eased in the fourth quarter Inflation started declining in the fourth quarter of 2011 as food prices stabilized and transport inflation declined. Consumer price inflation averaged 3.2 percent over the year after peaking at 3.4 percent in the third quarter. By December inflation had fallen to 3.0 percent, down from the year-high in June of 3.5 percent. Among its neighbors, Malaysia has experienced the lowest headline inflation rate, likely due to more extensive subsidies on fuel and transportation costs, as food price inflation in Malaysia is comparable to other countries in the region (Figure 15). While consumer price inflation may not reflect underlying inflation pressures due to price controls and subsidies (as evidenced by the higher gap between PPI and CPI in Malaysia compared to other countries; see Figure 15), the downward trend in producer price inflation is suggestive that inflationary pressures have indeed declined steadily since mid-2011. At 6 percent year-on-year it has come down to its lowest value in 2011. The gap between PPI and CPI has also narrowed to 3.2 percentage points, compared to an average of 5.8 percentage points for the year. Figure 15. CPI inflation in Malaysia is low among Figure 16. Supply factors were the main drivers of inflation regional peers, but PPI is among the highest but demand factors also played a role Percent Percent Capacity utilization (percent) 20.0 80 12.0 Q3 Q4 15.0 70 10.0 60 10.0 8.0 50 5.0 6.0 40 0.0 30 4.0 Output gap -5.0 M3 (%) 20 2.0 CPI (%) -10.0 10 PPI (%) 0.0 Capacity utilization rate (RHS) -15.0 0 CPI Food PPI CPI Food PPI CPI Food PPI CPI Food PPI Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Malaysia Thailand Singapore Indonesia 2007 2008 2009 2010 2011 Source: CEIC, IMF (IFS) and World Bank staff calculations. Source: Haver and World Bank staff calculations. Note: Output gap and capacity utilization rates for domestic oriented sectors. Output gap calculated using the Hodrick- Prescott filter to estimate potential GDP. Supply factors were the main drivers of inflation. Rising inflationary trends in early 2011 were underpinned primarily by supply factors, notably higher global commodity prices, as suggested by the predominant role of food and energy prices in driving inflation. In particular, prices of raw food rose faster than those of prepared foods (including 4Overall wages expanded by less than both referenced industries due to a contraction in wages in motor vehicles and medical and optical devices. 11 « MALAYSIA ECONOMIC MONITOR APRIL 2012 ‗food away from home‘), suggesting that raw material costs rather than labor costs were driving inflation. Demand factors also appeared to play a role, however, as the output gap was consistently positive in 2011, growth in the monetary base was strong and capacity utilization in domestic industries picked up (Figure 16). Both supply and demand factors subsided in the fourth quarter. Fiscal and monetary policies still accommodative Expenditures grow rapidly, but higher revenues boost overall fiscal performance Fiscal performance was better than expected mainly due to strong revenue collection. The federal budget deficit for 2011 came in at 5.0 percent of GDP, better than the 5.4 percent projection in the last Malaysia Economic Monitor and the Government‘s Economic Report 2011/2012. Revenue collections were higher than expected: the Federal Government collected RM185.4 billion in receipts, a 16 percent increase from 2010 and 12 percent above the RM165.8 billion that were budgeted for. Total spending also expanded, coming in at RM229 billion, 12 percent above 2010 levels and 8 percent above the RM212 billion that had been budgeted. As a result of the lower deficit and robust GDP growth, the Federal Government debt declined to 53.5 percent of GDP at end of 2011, below the Government‘s informal fiscal rule that the federal debt should remain below 55 percent of GDP (Figure 17). Revenues expanded as a result of high oil prices and improvements in tax collections. High commodity prices were the main contributor to higher revenues. Oil-related revenues expanded by 17 percent (year-on-year), with collections of the petroleum income tax up nearly 50 percent from 2010 (Figure 18). But performance of non-oil revenues was also strong, increasing by 15.5 percent (the largest expansion since 2001). Revenue from corporate taxes rose by 29.2 percent compared to 2010 and 6.6 percent more than budgeted. Individual income tax revenue was RM20.2 billion, a 13.5 percent increase from 2010 and 2.5 percent higher than what was budgeted. Some of these gains may be explained by improvements in tax administration such as expanding audit coverage. Operating expenditure increased more than revenues, but this was offset by lower development expenditures. Operating expenditure (about 80 percent of federal spending), rose by 20.4 percent over 2010 primarily due to higher spending on fuel subsidies and personnel costs. The flipside of high oil revenues are higher fuel subsidies, which were up by 112.1 percent over the year (Figure 18; see also Box 3). Civil service emoluments grew by 7.5 percent, with an upswing in the second half of the year due to bonus payments. Expenditures on pensions and gratuities grew by 17.8 percent. Development expenditures contracted by 12.1 percent, which resulted in overall Federal Government expenditures growing by 13 percent. As operating expenditures grew faster than revenues, the ‗fiscal current account balance‘ (revenues less operating expenditures) contracted 0.7 percentage points to 0.3 percent of GDP. Figure 17. Federal Government debt levels came down Figure 18. Despite higher subsidy and personnel in 2011 and remained below 55 percent expenditures the deficit was lower in 2011 RM million Percent of GDP Federal Government finances, RM million 500 Domestic 60 Foreign Deficit 450 2011 Actual Total (percent of GDP, RHS) 50 2011 Budget 400 Dev. Exp. 350 2010 40 Other Op. Exp. 300 250 30 Subsidies 200 20 Personnel 150 100 10 Other revenues 50 0 0 Oil-related revenues 2001 2003 2005 2007 2009 2011 Q1 Q1 Q1 Q1 Q1 Q1 -100 -50 0 50 100 150 Source CEIC, Bank Negara Malaysia, and World Bank staff Source: CEIC, MoF and World Bank staff calculations. calculations. Note: ‗Personnel‘ includes emoluments, pensions & gratuities. MALAYSIA ECONOMIC MONITOR APRIL 2012 » 12 Monetary policy remained on hold and supportive of growth The normalization of monetary policy towards pre-crisis levels was put on hold in the second half of 2011 as inflation stabilized while risks to growth increased. Following a cumulative increase of 100 basis points since 2010, Bank Negara Malaysia (BNM) kept its overnight policy rate (OPR) unchanged at 3.0 percent in the second half of 2011. This ensured that monetary conditions remained accommodative given the heightened risks to global demand observed since September. At 0.4 percent, the real policy rate remains low in historical perspective, as recent rate increases only partially offset rate cuts totaling 150 basis points since the onset of the global financial crisis and inflation has been higher compared to the pre-crisis period (Figure 19). Although low in absolute terms, real rates remain among the highest in the region and there would be room for further monetary accommodation should a new shock to global demand materialize. Figure 19. Real interest rates are low, supporting growth Figure 20. BNM bills and bonds become more important instruments for sterilization since 2008 Percent RM million 1.00 500,000 BNM Bills & Bonds Dec 10 Dec 11 0.73 400,000 Net Domestic Assets (ex bills) 0.80 0.64 0.60 MB 0.60 300,000 0.40 Net Foreign Assets 0.38 0.40 200,000 0.20 0.09 100,000 0.00 0 -0.20 -100,000 -0.13 -0.40 -200,000 -0.60 -300,000 -0.56 -0.80 -400,000 -0.74 -1.00 -500,000 1 1 1 1 1 1 1 1 -1.20 -1.04 1998 2000 2002 2004 2006 2008 2010 2012 China Indonesia Thailand Philippines Malaysia Source: CEIC. Source: BNM and World Bank staff calculations. Note: Calculated subtracting expected inflation for the Note: MB stands for Monetary Base or ‗M0.‘ following year from the policy rate. Liquidity was ample despite increases in the statutory reserve ratio (SRR) earlier in 2011. Private sector liquidity, as measured by broad money (M3), expanded by 14.4 percent as of end-December 2011 on account of sizeable capital inflows in the first half of 2011, as well as higher credit extension by the banking system. The expansion in M3 was in part contained by the central bank‘s sterilization operations and capital outflows in the third quarter. The central bank conducted sterilization operations through a wide range of instruments including direct borrowing, repos and short term central bank bills (Figure 20). This was in addition to the raising of the statutory reserve requirement (SRR) by three times between April and July 2011, from 1.0 percent to 4.0 percent, to provide longer term sterilization of the liquidity. Robust credit growth continued despite new prudential measures Growth of credit to businesses accelerated in 2011 while household credit moderated somewhat. Net financing raised by the private sector through the banking system and the capital markets expanded at a faster annual pace of 12.5 percent in 2011 compared to 10.9 percent in 2010. Total financing extended through financial institutions and the capital markets to the business sector expanded by 11.5 percent in 2011 compared to 7.7 percent in 2010. Banking system loans to businesses expanded by 13.5 percent (compared to 9.4 percent in 2010) as investment and working capital loans picked up (Figure 21). Business demand for funds from the capital markets was also higher, with new issuances of private debt securities amounting to RM69.6 billion in 2011. Financing via the equity market, however, declined to RM12.6 billion from RM32.1 billion in 2010 as turbulent market conditions took their toll on domestic markets in the second half: net financing to the private sector via capital markets during the 13 « MALAYSIA ECONOMIC MONITOR APRIL 2012 second half of 2011 amounted to RM14.7 billion, a 33.7 percent decline on a year on year basis. The increase in financing to businesses was driven by improved retail sales and higher investment activity in response to strong domestic demand. Outstanding household loans rose by 12.9 percent in 2011, a deceleration from the 13.4 percent recorded in 2010. Loan growth for passenger cars moderated to 6.0 percent in 2011 from 7.3 percent in 2010 (Figure 22). This may reflect the impact of amendments to the Hire Purchase Act in June 2011, but also supply disruptions stemming from the impact of natural disasters in Japan and Thailand. Prudential measures may have played a part in the moderation of household credit but their impact is more likely to be felt in 2012 and beyond. Household debt in 2011 stood at 76.6 percent of GDP, over 10 percentage points higher than the 62.7 percent of GDP recorded in 2008. While BNM highlights that overall household balance sheets remained at a prudent level, with a debt-to-financial-assets ratio of 43.5 percent, household debt is not homogeneous across income groups. The ratio of average outstanding debt to median annual income of borrowers earning less than RM3,000 a month is between 4.4-9.6 times annual income, compared to 2.3-3.3 times for those in the upper-middle and high-income groups (those earning above RM4,000). To avoid an unsustainable build-up in debt especially among lower income households, BNM has implemented a number of prudential measures including a reduction of the loan-to-value ratio to 70 percent for third home purchases and above, increased risk weights for housing loans with loan-to-value above 90 percent and personal financing with tenure above 5 years.5 Further prudential measures were announced in November 2011 which stipulated that income eligibility should be assessed using income net of statutory expenses6 rather than the previous methodology of gross income. In addition, the loan tenure for passenger cars has been restricted to not more than nine years. Although more data is required to assess the impact of the regulations, a decline in auto sales in January, when the rule started to take effect, has been attributed to the new regulations. Figure 21. Housing loans continued to expand robustly Figure 22. Approvals of car loans declined for most of while working capital loans picked up the second half Loans (banking system), year on year change, percent Year-on-year change, percent 16.0 Working Cap Auto 110 Approved: cars Personal Housing Approved: property 14.0 90 Applied: cars Total 12.0 Applied: property 70 10.0 50 8.0 30 6.0 10 4.0 2.0 -10 0.0 -30 Apr May Oct Apr May Oct Jul Jul Jan Jun Mar Aug Sep Jan Jun Nov Dec Mar Aug Sep Feb Feb Nov Dec -2.0 2010 2011 Source CEIC and World Bank staff calculations. Source: CEIC. Note: Working Cap stands for working capital. Banks remained healthy and well capitalized despite the persistent headwinds from global financial markets. The domestic banking system has been insulated from the renewed financial turbulence arising from the debt crisis in the euro area. Risk-weighted and core capital ratios, at 15.1 and 13.2 percent respectively, remained comfortably above levels required by national authorities and Basel III, and actually rose from levels seen at the end of the first 5 The authorities also tried to reduce the proliferation of credit cards. In addition to a RM50 service charge imposed earlier in 2010, in March 2011 Bank Negara increased minimum income requirements and restricted credit cards to two issuers per person for those belonging to the lowest income bracket. The measures have shown some effect, with the number of credit cards decreasing since 2010, albeit at a lower rate in 2011. Meanwhile, the amount of credit lines extended has risen, leaving the effect on consumer borrowing ambiguous at this stage. 6 Defined as tax payments, provident fund contributions and social security contributions. MALAYSIA ECONOMIC MONITOR APRIL 2012 » 14 half of 2011. Tier 1 capital comprised 86.8 percent of total capital while capital in excess of the minimum 8 percent regulatory requirement remained high at RM71.4 billion. The ratio of non-performing loans declined to 1.8 percent as of December 2011, an improvement compared to the ratio of 2.3 percent as at end-2010. Although earlier rate hikes were largely passed through to base lending rates, the effect on the average lending rate (ALR) varied between segments. The ALR for passenger car loans actually declined in tandem with the decline in interest rate swap (IRS) rates, while the ALR for business loans rose at a lower rate than that for households. Commodity exports supported Malaysia’s external position The current account surplus remained substantial thanks to robust commodity exports. As Figure 23 shows, the current account has posted fairly steady surpluses around 10 to 12 percent of GDP. However, the composition of the current account has shifted. The two-speed nature of export growth is reflected in a widening gap between the trade balances of commodities and non-commodities (Figure 24). While net commodity exports surged 22 percent in 2011 to RM133.6 billion, the non-commodity balance of goods fell by 37 percent to RM15.9 billion as capital goods imports picked up while manufacturing exports, especially of E&E products, remained sluggish. The overall balance of goods and services expanded by 3.4 percent as services imports expanded faster than exports. Outflows from the income account decelerated while current transfers were stable. As a result, the overall current account posted a surplus of 11.5 percent of GDP, the same level as in 2010. Figure 23. The current account has been consistently in Figure 24. ... driven increasingly by commodity-related surplus... exports Percent of GDP Balances, 12-month rolling sum, RM billions 30.0 120.0 20.0 10.0 100.0 Commodity 0.0 balance 80.0 -10.0 Non- commodity 60.0 balance -20.0 -30.0 40.0 -40.0 20.0 -50.0 2005q1 2007q2 2009q3 2011q4 Current Account Financial Account 0.0 Errors and Omissions Overall Balance Jan-01 Jan-04 Jan-07 Jan-10 Source: CEIC and World Bank staff calculations. Source: Haver. Notes: Commodity-related exports include food, beverages & tobacco; mineral fuels & lubricants; chemicals; animal and vegetable oils and fats. Non-commodities include manufactured goods and miscellaneous categories. After a surge in the first half of the year, Foreign Direct Investment (FDI) in Malaysia declined in the second half with retrenching Japanese investment. Net FDI in Malaysia fell from 5.4 percent of GDP in the first quarter of 2011 to 2.9 percent in the final quarter (Figure 25). The decline was most marked for Japanese investments, which had driven the original surge in late 2010 and early 2011. The drop in FDI could be partly be explained by Japanese firms‘ ramping up of investments in Japan to restore production facilities in response to the Tohoku earthquake and tsunami of March 2011. For the year as a whole, FDI expanded by 12.3 percent. FDI remains concentrated in the distributive trade and manufacturing sectors (Figure 26). FDI by Malaysian companies abroad increased more modestly than in the previous year, but remains larger than FDI by foreign companies in Malaysia. Portfolio flows contracted sharply in September and October due to fears of a new shock to global financial markets caused by sovereign debt troubles in the Eurozone. A surge of inflows in the second quarter (when portfolio inflows reached 23 percent of GDP) was partly reversed in the third quarter when the deterioration in the global environment led to outflows equal to 11 percent of GDP. This development was also reflected in the liquidation of 15 « MALAYSIA ECONOMIC MONITOR APRIL 2012 debt holdings by non-resident investors which subsequently led to some upward pressure on Government bond yields. The equity market was also affected by foreign investors selling off their positions, particularly in the third quarter, when the stock market declined by 12.2 percent. Inflows started to return in the fourth quarter, buoyed by optimism surrounding better-than-expected economic performance in the region, including Malaysia. Figure 25. Foreign direct investment fell and portfolio Figure 26. Foreign direct investment is concentrated on investment flow partly reversed in late 2011 the manufacturing and distributive sectors Financial account, percent of GDP Composition of average 2011 FDI inflows, percent Financial and Information Insurance, 6.6 and Comm., Q1 2.1 Other services, 6.9 Manufacturing , 43.1 Q2 Wholesale Q3 Direct Investment (Abroad) and Retail Direct Investment (Malaysia) Trade, 32.7 Portfolio Investment Q4 Other Construc'n & Agriculture, Mining and 1.2 -20 -10 0 10 20 30 Quarrying, 7.4 Source: CEIC and World Bank staff calculations. Source: CEIC. Note: Comm. stands for communication. The ringgit resumed a modest appreciation trend following a decline in September and October. Capital outflows in September and October led to a depreciation of the nominal and real exchange rates. The real effective exchange rate depreciated by 4.6 percent in October from its high in January (Figure 27), but by December it had regained 0.7 percent. As has been generally the case in recent times, this pattern was similar to that followed by other currencies in the ASEAN region. Figure 27. Malaysia’s real effective exchange rate Figure 28. Net forward position declined much more appreciated in line with Thailand and Indonesia than official reserves Index, 2010=100 USD billions 160 110 China 150 Indonesia Malaysia 140 Singapore 130 Thailand 105 120 110 100 100 90 80 Jul-08 Jul-09 Jul-10 Jul-11 Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 95 Official reserve assets Net foward position Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Source: Bank for International Settlements. Source: IMF. External reserves remained relatively stable. While BNM accumulated reserves rapidly during the surge of capital inflows in the first half of 2011, reserves declined more modestly in third quarter when investors withdrew. Net international reserves declined from a peak of USD 136.3 billion in August 2011 to USD 131 billion in September 2011 (for comparison, capital outflows in the third quarter were over USD 7 billion). External reserves remained stable in the following months, amounting to USD 134.1 billion as of end-January 2012. This level of reserves is sufficient to MALAYSIA ECONOMIC MONITOR APRIL 2012 » 16 finance 9.6 months of retained imports and is 4.1 times the short-term external debt. Notwithstanding such developments, the reduction of net foreign exchange forward position of the central bank was greater than that of the official reserves during the period of heightened uncertainty (Figure 28). This suggests that during times of external liquidity stresses, such as the second half of 2011, the central bank may have unwound its long foreign exchange forward position to inject foreign exchange liquidity into the system. A similar trend was also evident during the height of global financial crisis in 2008. High-frequency indicators for early 2012 have been mixed Recent indicators for the Malaysian economy are mixed. Although production levels remain stable and generally above the twelve-month moving average, industrial production declined in January across all sectors, possibly due to the Chinese New Year holidays. Except for mining production, which has been on a declining trend since 2009, recent momentum in manufacturing production appears modestly positive (Figure 29). Demand-side indicators appear to be slowly improving but are also mixed. Exports and imports also declined in January but appear to remain on a generally upward trend (Figure 30). Sales of manufactured goods continued to expand, although auto sales declined, possibly already reflecting the new guidelines on lending practices recently introduced by Bank Negara. Consumer confidence declined in Q4, but the decline in average consumer sentiment in 2011 compared to 2010 was not correlated with weaker consumption growth. Figure 29. Industrial production declined in January Figure 30. Demand indictors have been mixed Industrial Production Index, seasonally adjusted Indices Thin black lines represent moving averages 130 MIER: Consumer Sentiment Index Manufacturing Sales, 12mma, Jan 2009=100 130 120 Exports (sa), Jan 2008=100 Imports (sa), Jan 2008=100 120 110 110 100 100 90 90 Industrial Pruduction Index (sa) 80 80 IPI (sa): Mining IPI (sa): Manufacturing 70 IPI (sa): Electricity 70 60 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Source: CEIC and World Bank Staff calculations. Source: CEIC and World Bank staff calculations. 17 « MALAYSIA ECONOMIC MONITOR APRIL 2012 2. Economic outlook Near-term outlook points to continued but modestly slower growth in 2012 With global demand still subpar and some domestic drivers unlikely to post the same performance as 2011, Malaysia’s highly open economy is expected to slow modestly in 2012. Although the outlook for advanced economies has improved somewhat, prospects for global demand remain subdued as advanced economies continue on the lengthy path of repairing public and private balance sheets. Reconstruction from the Tohoku earthquake in Japan and the reestablishment of production following the Thai floods offer some upside risks, but external demand is expected to remain below 2008 levels. Domestic demand is expected to continue to support growth in 2012 and the outlook for fixed investment in particular is somewhat more favorable than in 2011. However, three factors are likely to reduce the contribution of domestic demand to growth. First, public consumption, while still expected to remain robust in 2012, cannot be expected to continue growing at the 17 percent pace of 2011. Second, private consumption faces both headwinds and tailwinds: on the one hand, wages may increase with the introduction of the minimum wage, inflation is trending down, and Government transfers are likely to support consumption. On the other hand, stricter rules on credit and stable commodity prices and output (especially in palm oil) may dampen growth. Finally, inventory accumulation is likely to contribute more negatively to growth in 2012 since the restocking cycle is expected to have been completed in 2011. Global outlook cautiously improving Growth in advanced economies is likely to remain subpar in 2012 but the probability of further deterioration in global prospects has declined. Excessive optimism in early 2011 gave way to excessive pessimism late in the year. The combination of disappointing performance of major economies in 2011 and heightened risks of both a disruptive sovereign default in Europe and greater fiscal drag in the US led many observers to mark down growth forecasts for 2012 even as the data coming out was best described as mixed. Considering the steady improvements in labor markets and strong business confidence (Figure 31), growth in the US in 2012 is likely to be an improvement over 2011, even if still below pre-crisis levels. Fears of a disruptive event in Europe remain, with a mild recession as the baseline scenario (the European Commission forecasts a 0.3 percent contraction for the Eurozone).7 Nevertheless, business confidence has picked up since December 2011 and Greece‘s debt restructuring appears to have proceeded without causing major disruptions. Japan is likely to post relatively robust growth, reflecting the recovery and reconstruction from last year‘s Tohoku earthquake. Growth in China is expected to slow, but the slowdown will be focused on investment with consumption expected to continue to grow robustly. According to the IMF‘s World Economic Outlook (January 2012), Chinese growth is expected to come at 8.2 percent in 2012. This is down from 9.2 percent in 2011 and 10.4 percent in 2010. However, this slowdown mostly reflects a cyclical deceleration in fixed capital formation, especially through a moderation of real estate investments (Figure 32). Domestic consumption growth is expected to grow above 9 percent. The composition of China‘s slowdown has important implications for emerging markets (see Box 2). Growth in ASEAN is also expected to remain robust, with Thailand rebounding strongly from devastating floods and Indonesia continuing to post a solid expansion in 2012. Low interest rates in advanced economies increase the risk of a renewed surge of capital flows to emerging economies. Central banks in Europe and the US continue to provide exceptional support to mitigate risks to the recovery. The US Fed for example recently vowed to keep interest rates at zero percent until 2014. In an environment of uncertainty, investors still prefer relatively safe Government bonds in advanced economies to riskier assets in emerging markets. However, if the global economic environment remains on an improving trend, risks exist of renewed surges in capital inflows into emerging markets, such as those Malaysia experienced in the second quarter of 2011. 7 Source: http://ec.europa.eu/economy_finance/articles/eu_economic_situation/pdf/2012/2012-02-23-interim-forecast_en.pdf. MALAYSIA ECONOMIC MONITOR APRIL 2012 » 18 Figure 31. Business confidence shows tentative signs of Figure 32. The deceleration of growth in China has been improvement concentrated on investment Seasonally-adjusted Purchaser’s Managers Index Contribution to real growth, percentage points 20 70 Net exports Investment Consumption 15 60 10 50 China 5 40 Eurozone Japan 30 US 0 20 -5 Jan-08 Sep-08 May-09 Jan-10 Sep-10 May-11 Jan-12 09Q1 Q2 Q3 Q4 10Q1 Q2 Q3 Q4 11Q1 Q2 Q3 Q4 Source: Haver. Source: World Bank (2012). Note: Scores above 50 reflect business optimism. Although fundamentals support firm commodity prices in the medium- to long-term, near-term developments are more difficult to anticipate. On the one hand, slowing investment in China and subdued demand from advanced economies will ease pressure on commodity prices. On the other, the risks that the conflict over Iran‘s nuclear program will intensify are likely to keep oil prices high until a resolution appears on the horizon. Oil prices trickle down into other commodities as they are an important input to production and distribution, and therefore pressures on commodity prices overall may intensify. Box 2. The potential impact of a slowdown in China on commodity prices China‘s appetite for commodities is fuelled by increasingly resource-intensive export-processing and by domestic investment. While in 2000 China still predominantly exported consumption goods, by 2009 about half of its exports have been capital goods (IMF, 2011). These goods tend to require a higher share of natural resources in their production. Moreover, China has invested heavily in construction, both for infrastructure and housing. This has increased its demand for construction materials, intensifying its demand for commodities such as steel and energy. In addition, domestic consumption is increasingly driving commodity imports. Investment growth fell from 12.1 percent in 2010 to 10.3 percent in 2011. However, consumption growth increased from 7.8 percent to 10.0 percent. Imports of final consumption goods have remained relatively stable over the past 20 years, at less than 10 percent of total imports, although it appears that an increasing amount of intermediate goods is imported for production pitched at the domestic market. One area in which domestic consumption seems to strongly translate into import demand is food, where imports have soared for such products as vegetable oils, sugar, and beef (Jenkins, 2011). Strong demand for passenger vehicles in China sustains demand both for rubber and fuel. Global commodity prices are riding partly on Chinese demand. China is the world‘s third largest economy and its economic weight makes it a price-setter in global markets. Chinese demand for oil has become a key driver of oil prices (Figure 33). Indeed, China‘s demand for oil increased by 48.7 percent between 2002 and 2007, while demand for oil in the rest of the world increased by only 6.6 percent. Global demand for oil was thus 2.7 percent higher than it would have been if Chinese and world demand had grown at the same rate. This translates into global oil price increases of 10.8 to 27.1 percent according to the analysis in Jenkins (2011). The expected slowdown in investment will ease the pressure on commodity prices, yet this effect will partly be offset by strong domestic consumption growth. The IMF‘s most energy forecasts anticipate that Chinese energy consumption is going to double by 2017 and triple by 2025 from its 2008 level. 19 « MALAYSIA ECONOMIC MONITOR APRIL 2012 Figure 33. Chinese demand is one of the main Figure 34. A considerable amount of Malaysian exports contributors to rising oil prices to China are commodities Increase since 2004, percent Crude Price Index, 2004=100 Percent of total Chinese imports from Malaysia Other, 3.8 Animal or Mineral Vegetable Products, Fats and 10.0 Oils, 7.4 Products of Chemcial or Allied Industries, 3.3 Plastics, Rubber and Articles Machinery, Thereof, 8.5 Electrical Equipment, 62.8 Base Metals and Articles, 4.2 Source: IMF (2011). Source: CEIC and World Bank staff calculations. Note: Precautionary demand, which is the residual, includes some part of China's effect. In the context of a slowdown driven by investment, China‘s demand for Malaysian commodity exports is likely to be relatively resilient. The large majority of Malaysian exports to China is E&E products; yet about a quarter of Malaysian shipments to China are commodity-related, with 10.0 percent in mineral products, 8.5 percent in plastics and rubber, and 7.4 percent in organic oils (Figure 34). Of the latter, the majority is related to palm oil. In 2009, China alone consumed a quarter of all Malaysian palm oil exports (Global oils and Fats, 2010, pp. 2-3). With demand for capital goods slacking in a still fragile global economy and Chinese investment expenditure declining, Chinese demand for metals may soften, yet metals only constitute a small portion of Malaysian exports to China. Chinese demand for Malaysia‘s key commodity exports, on the other hand, may uphold as energy needs remain high and domestic consumption sustains palm oil prices and, assuming demand for passenger vehicles remains robust, rubber. Source: IMF (2011) and Jenkins (2011). The Malaysian economy is likely to grow cautiously as well Export growth is assumed to pick up under a baseline of stronger global recovery in the second half of 2012. Exports are expected to accelerate from 3.7 percent to 6.6 percent on a modest recovery in advanced economies coupled with solid growth in emerging Asia. This compares with pre-crisis export growth rates of 7.6 percent. Non- commodity exports should post some improvement from the near-zero growth rates of 2011, driven by modest improvements in demand from advanced economies towards the second half of the year, and continued growth in consumption in Asia, albeit from a low base. Normalization of supply chains following the Thai floods and the reconstruction in Japan offer additional support against a backdrop of structural weakness both in the Malaysian E&E sector but also in advanced economies, which are not expected to return to pre-2008 growth rates for some time. Growth in commodity exports is likely to decelerate somewhat given base effects and capacity constraints in the production of palm oil. However, the possible resolution of production problems in the oil sector could offer some upside, especially in the second half of the year. Domestic demand is expected to remain the main growth driver in the economy, but the performance is unlikely to match that of 2011. Value-added consumed or invested in Malaysia is expected to expand by 6.4 percent in 2012 compared to 7.2 percent in 2011. Domestic demand as defined in the national accounts is expected to contribute 5.3 percentage points to GDP growth, down from 6.5 percentage points in 2011. MALAYSIA ECONOMIC MONITOR APRIL 2012 » 20 Private consumption growth is expected to decelerate modestly due to prudential measures to rein in credit growth and slower growth in commodity revenues outweighing favorable developments in labor markets and government transfers. The prudential measures discussed in Chapter 1 to avoid an unsustainable build-up of household debt may slow down consumer credit and indeed, January data document a drop in loans for cars, properties, and personal uses, both on a sequential and a year-on-year basis. Car sales and production appear to be slowing, although this may also be due to the impact of the Thai floods (Figure 35). In addition, output and prices of agricultural commodities are unlikely to be as buoyant in 2012, with risks that further increases in oil prices could again dampen global demand and put further downward pressure on volumes. This implies slower income growth for large number of smallholders (Figure 36). Finally, risks to global demand may impact consumption behavior through asset prices and labor market prospects. On the other hand, government transfers to lower income individuals (with high propensity to consume), stable inflation, still-accommodative monetary policy and possibly higher wages following the announcement of a minimum wage as well as higher civil servant salaries should support growth. On average, private consumption is expected to maintain the vigorous growth rate of 2011 and expand by 6.6 percent. Figure 35. Car sales have decelerated further into 2012 Figure 36. Income growth for households dependent on along with car production agriculture is likely to moderate on stable or lower prices Left Axis: Prices, USD per metric ton (palm oil) and per 100kg (rubber), and average incomes (rubber estate workers), RM per month Index, January 2009=100 Right Axis: Palm oil small holder incomes, RM million 140.0 1,200 Palm Oil Prices 3,500 Rubber Prices Car Production 130.0 Rubber Average Monthly Incomes 3,000 1,000 Palm Oil Small Holder Incomes Car Sales 2,500 120.0 800 2,000 110.0 600 World Bank forecast 1,500 100.0 400 1,000 90.0 200 500 80.0 0 0 1/1/2009 1/1/2010 1/1/2011 1/1/2012 Source: CEIC. Source: CEIC, BNM, World Bank (DECPG). Note: World Bank forecasts as of January 2012. Government consumption is likely to remain robust, but it will be difficult to repeat the 17 percent expansion of 2011, considering that the Government intends to stay on a fiscal consolidation path. With elections widely expected to be announced in 2012, growth in Government consumption will still be robust at 9 percent before slowing into 2013. Overall consumption is expected to contribute 4.9 percentage points to growth from 5.9 percentage points overwhelmingly on account of a lower contribution from government consumption. Fixed capital formation is expected to expand further supported by robust investments from Government-Linked Companies (GLCs). Private investment growth is expected to accelerate as entry-point projects from the Economic Transformation Programme such as the MRT continue to come online. In addition, liberalization in services sectors could bring higher levels of FDI in services in the second half of the year assuming implementation proceeds apace. On the other hand, private investments are weighed down by large uncertainties in the global environment (which affect FDI) as well as uncertainties about the timing of Malaysia‘s parliamentary elections (which may have a small impact on domestic investments). PETRONAS has announced plans to spend RM 300 billion over 5 years, and based on recent patterns of capital expenditures, at least 2/3 of these investments are likely to be in Malaysia. Specific PETRONAS investments include regasification terminals in Sungei Udang (Melaka), Pengerang (Johor) and Lahad Datu (Sabah), the Sabah Oil and Gas Terminal and Sabah-Sarawak Gas Pipeline between Kimanis and Bintulu, and the development of Gumusut-Kakap Oil and Gas field (expected completion in November 2012). In addition, 21 « MALAYSIA ECONOMIC MONITOR APRIL 2012 broadband roll-out is expected to continue into 2012. As a result, gross fixed capital formation is expected to accelerate from 6.0 to 7.5 percent in 2012 and increase its contribution to growth from 1.3 to 1.7 percentage points. The outlook for 2013 is predicated upon a sustained global recovery. Projections for 2013 assume a continuation in the recovery of advanced economies and therefore a more substantial pick up in exports although external demand continues to contribute negatively given a further acceleration of investment growth, which involves the a pick-up in the growth of capital goods imports. Similarly, imports of consumer goods are also likely to expand. Without the drag from inventories, domestic demand contributes 6.6 percentage points to growth. Table 1. GDP growth is expected to slow… Table 2. … mainly due to slower growth in government consumption Year-on-year growth, percent Percentage contributions to GDP growth 2011 2012 2013 2011 2012 2013 GDP 5.1 4.6 5.1 GDP 5.1 4.6 5.1 Domestic demand 7.2 5.8 7.0 Domestic demand 6.5 5.3 6.6 Final Consumption 8.9 6.8 6.3 Final Consumption 5.9 4.7 4.5 Private sector 6.9 6.5 7.0 Private sector 3.7 3.5 3.9 Public sector 16.8 7.6 4.0 Public sector 2.2 1.1 0.6 GFCF 6.0 7.5 8.2 GFCF 1.3 1.7 1.9 Change in Stocks n.a. n.a. n.a. Change in Stocks -0.7 -1.0 0.2 External demand -14.4 -9.6 -22.5 External demand -1.4 -0.7 -1.5 Exports of G&S 3.7 6.6 9.0 Exports of G&S 4.0 7.2 9.9 Imports of G&S 5.4 7.9 11.0 Imports of G&S -5.4 -7.9 -11.4 Source: CEIC, World Bank staff projections. Source: CEIC, World Bank staff projections. Figure 37. Forecasts for 2012 growth have been Figure 38. … as expectations about manufacturing and deteriorating since August 2011… investment worsened Real GDP, year-on-year growth, actual (2011) and forecasts (2012), percent Real GDP components, year-on-year growth, actual (2011) and forecasts (2012), percent 7.00 Median forecast for 8.00 Growth 2012 in 2011 7.00 6.00 6.00 5.00 5.00 4.00 4.00 3.00 Shaded area indicates range of forecasts for 3.00 Private consumption 2012 2.00 Fixed investment 2.00 Manufacturing production 1.00 1.00 0.00 0.00 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb 2011 2012 2011 2012 Source: Consensus Economics. Source: Consensus Economics. In summary, on a year-on-year basis Malaysia is expected to register real GDP growth of 4.6 percent in 2012 and 5.1 percent in 2013. On a sequential basis, the expectation is for growth to accelerate from 2.9 percent (annualized) in the first quarter, to 6.2 percent in the third quarter, before normalizing towards 4.8 percent into 2013, in line with the post-2008 potential output. The World Bank‘s forecast lies above the March median consensus forecast of 3.9 percent (Figure 37), which is based on a more bearish assessment of investment and the global recovery, affecting production (Figure 38). The new GDP growth forecasts are lower than the 4.9 percent forecast in the previous edition of the Malaysia Economic Monitor mainly due to a revision of domestic demand in light of MALAYSIA ECONOMIC MONITOR APRIL 2012 » 22 the somewhat stronger headwinds expected to affect the domestic economy (especially consumption) and higher base from the strong performance in 2011. Inflation to stabilize near current levels Amid cooling commodity prices and moderate domestic growth, consumer prices are likely to increase more slowly in 2012 compared to 2011. Malaysia‘s headline inflation rates are projected to come between 2.7 and 2.8 percent in 2012, virtually unchanged from our earlier forecast of 2.7 percent in the November Malaysia Economic Monitor and in line with consensus estimates for a reading of 2.6 percent (Figure 39). The producer price index, which tends to lead trends in the CPI, has started to decline more decisively in 2012, but the difference between the PPI and CPI has been relatively high, suggesting the possibility of pass-through from producer to consumer prices if the domestic economy continues to perform well. The forecast for 2012 is slightly higher compared to the average rate observed during the 2002-2007 period (2.2 percent) given the expected impact of higher wage growth (including from the introduction of the minimum wage) and firm oil prices (Figure 40). Figure 39. Inflation expectations declined in October as Figure 40. Inflation is expected to decelerate from 2011, the global environment deteriorated but is likely to remain above the pre-crisis average Change from the previous year, percent Change from previous year, percent 6.0 4.0 Median forecast for 2012 3.5 Inflation in 5.0 2011 3.0 4.0 2.5 3.0 5.4 2.0 Shaded area indicates 2.0 1.5 range of forecasts for 3.2 3.0 2.8 2012 1.0 2.2 1.7 1.0 0.6 0.5 0.0 0.0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb 2011 2012 Source: Consensus Economics. Source: Consensus Economics and World Bank staff forecasts. Global commodity prices and the timing of key reforms remain the key risks to the inflation outlook. Notwithstanding price controls and subsidies, historical experience suggests that prices in Malaysia are sensitive to large swings in global commodity prices, as was the case in 2008. Should the conflict in the Middle East escalate and global oil prices accelerate further, inflation in Malaysia would accelerate as well. Given the increased frequency of extreme weather events, the risk of supply shocks to domestic food production cannot be ignored, although the Government has adequate stockpiles of key staples such as rice. Key reforms announced by the Government are likely to have a short-term impact on inflation – namely the introduction of the minimum wage, the implementation of a goods and services tax (GST) and the rationalization of consumer price subsidies. The Government has indicated that the latter two reforms are unlikely to be implemented in 2012, whereas the former is only expected to have a modest impact on prices, already taken into account in the baseline projections. Risks to inflation are relatively balanced, however, as a new shock to global demand could lead to a sharp drop in commodity prices and domestic demand, which would lead to lower inflation. The current account balance is likely to narrow slightly The current account balance is expected to narrow slightly as imports pick up and export demand remains below par. In light of subpar global demand and a slowdown in investment demand from China, commodity prices are unlikely to post the same gains as in 2011 even as political tensions and solid consumption demand in China may keep them from declining. Meanwhile, exports of non-commodities are likely to gain only modestly in volume terms, and price dynamics remain constrained by global excess capacity. On the other hand, imports of capital and consumer goods are expected to grow robustly in tandem with the strength of domestic demand. The income, 23 « MALAYSIA ECONOMIC MONITOR APRIL 2012 services and transfer accounts are expected to post a smaller deficit as a percent of GDP as Malaysia‘s service exports begin to slowly pick up. Therefore, although the current account is still expected to widen in nominal terms, it narrows slightly as a percentage of GDP from 11.5 percent in 2011 to 11.1 percent in 2012 (Figure 41). Fiscal consolidation proceeds while monetary policy remains watchful Fiscal consolidation is expected to continue in 2012 despite the recently-announced pay raises for civil servants. Expenditures are likely to exceed the budget (and a supplementary budget is therefore likely) as the Government has recently announced pay rises for civil servants between 7 and 13 percent, replacing in the near-term the reform of civil service pay that had been proposed in the Budget 2012. In addition, as oil prices remain high, expenditures on subsidies are likely to exceed the budget as well. However, the latter category of expenditures (subsidies) is naturally hedged by higher oil-related revenues, which exceed oil-related expenditures. Moreover, administrative reforms and continued growth in gas-related revenues (which may be partly captured in corporate taxes, in addition to their contribution to oil-related revenues) are likely to lead to further increases in non-oil revenues in 2012. On balance, the Government is likely to achieve the target of reducing the deficit to 4.7 percent of GDP as proposed in the budget (Figure 42). Consolidation is expected to continue into 2013, supported by higher growth but also by the assumption that key reforms such as the introduction of GST and subsidy rationalization will go ahead. Figure 41. The current account is expected to remain in Figure 42. Despite higher expenditures, the federal surplus, albeit a slowly narrowing one balance is expected to come in line with the budget Current account balance, as a percent of GDP Balance of the federal Government, percent of GDP 20.0 0.0 17.7 18.0 16.5 -1.0 15.9 16.0 -2.0 14.0 11.5 11.5 11.1 -3.0 12.0 10.6 -3.2 10.0 -4.0 -4.0 8.0 -5.0 -4.7 -4.8 6.0 -5.0 -6.0 -5.6 4.0 -7.0 2.0 -7.0 0.0 -8.0 2007 2008 2009 2010 2011 2012f 2013f 2007 2008 2009 2010 2011 2012f 2013f Source: DOS, World Bank staff projections. Source: MoF, World Bank Staff projections. The debt-to-GDP ratio will decline modestly in 2012 and fall further in 2013—assuming consolidation efforts are maintained. With the fiscal balance is predicted to improve in 2012 the ratio of federal debt to GDP is expected to decline slightly to 53.2 percent of GDP in 2012 from 53.5 percent of GDP in 2011. As both fiscal consolidation and economic growth pick up further steam in 2013, the federal debt is expected to fall to 52.5 percent of GDP. Therefore, short of a new shock to the economy, federal debt levels are likely to remain below the Government‘s stated target of 55 percent of GDP. Monetary authorities remain watchful of external events. In its March policy statement, BNM stated that viewed risks linked to the European debt crisis as partially alleviated and noted tentative signs of improvements in the US economy. The authorities remain cautious of subdued growth in advanced economies, however, and also expect Malaysia‘s economy to slow in 2012 compared to 2011. At the same time, while headline inflation is likely to continue its moderate descent, BNM acknowledges the potential for price shocks due to supply disruptions and the ‗financialization‘ of commodities – which is partly a response to hedging against the risk of shocks to energy prices. MALAYSIA ECONOMIC MONITOR APRIL 2012 » 24 Risks to the outlook center on the global environment The main risks to the outlook are external to Malaysia. While concerns about fiscal sustainability in Europe have receded from their peak, the challenges faced by peripheral economies remain significant, especially in an environment of near-zero growth. Moreover, the signals coming from the US economy are not all positive. In February, the Case-Shiller index of home prices declined again. The US unemployment rate remains well above historical averages and there is a risk that fiscal concerns (or fiscal drag) could reemerge. Finally, there is a risk (though small) of a sharp deceleration of growth in China. A steeper decline in Chinese investments would have significant implications for commodities, as discussed in Box 2. Higher oil prices are generally beneficial to Malaysia, but a substantial escalation due to geopolitical risks may have negative consequences (see Box 3). Within Malaysia, there are some risks linked to the timing of elections, where the concerns are related to potential delays in the Government‘s reform agenda (and the corresponding impact on investor confidence), which is crucial for medium- and long-term prospects. Box 3. Will Malaysia still benefit from higher oil prices? The price of Brent crude oil rose steadily in the first quarter, reaching USD 125 in March, up 16 percent from December levels. This raises the specter of a repeat of the price movements seen in the first half of 2008, when oil prices climbed 45 percent over six months. At that time, prices spiked due to strong oil demand amidst high economic growth, especially in emerging economies. This time around, the main drivers of rising oil prices are elevated geopolitical risks that could lead to disruptions in the key oil producing region of Middle East and North Africa. As a net oil and gas exporter, Malaysia stands out from its Asia-Pacific peers who are mostly net oil and gas importers. It is a generally held view among regional economists that Malaysia will benefit from higher oil prices from two main channels: higher exports, leading to elevated trade surplus, and higher Government revenues through the Petroleum Income Tax (PITA), royalties, export duties and dividends from PETRONAS. However, Malaysia‘s position as a net gainer from oil price increases has been increasingly challenged. First, the higher the oil price goes, the higher the subsidy burden will be on the Government‘s expenditures, especially with the continued use of the Automatic Pricing Mechanism in determining the retail price of RON95 petrol and diesel. The Government had committed to a capping of subsidies of these fuels to 30 sen per liter under the Subsidy Rationalization Plan announced in 2010; however, as of March 2012, the subsidies paid to RON95 and diesel are at 92 sen and 101 sen respectively, primarily because the crude oil price rise has not been passed through to the consumer. In 2008, the oil subsidy borne by the Government reached nearly RM18 billion (Figure 43). Although this was still well below the RM30 billion dividend payment paid by PETRONAS or the RM24 billion collected in petroleum income tax (PITA) later than year, the surge in the subsidy bill is likely to have posed challenges to cash flow management since the subsidy payments are monthly in frequency while the oil-related revenues are realized only once or twice a year depending on the source. This was one of the reasons for the Government‘s decision to move the PITA payment based on current, rather than previous year‘s profits a. The mismatch in oil-based revenue and expenditure also contributed to the Government in May 2008 embarking on a fuel subsidy restructuring exercise that led to a sharp 40.4 percent hike in retail fuel prices. Second, Malaysia‘s oil production has been declining over the past decade, with output at only 572,845 barrels per day in 2011, the lowest since 1988. Meanwhile, consumption continues to rise (Figure 44). The lower output is due to natural depletion in existing mature fields and major issues with new oil reservoirs, particularly the deepwater Kikeh oil field offshore Sabah. Fuel subsidies have distorted incentives for domestic oil consumption, which has risen steadily to about 530,000 barrels per day in 2011, according to the US Energy Information Administration. These dynamics have led to a decline in net exports of about 43,000 bpd in 2011 from an average of 142,000 bpd between the years of 2005 and 2010 (Figure 44). Nevertheless, steps have been taken to address the challenges on both the production and consumption sides of the equation. PETRONAS has embarked on aggressive efforts to increase domestic oil production through higher capital expenditure, mostly through developments of marginal oil fields (with attractive tax holidays offered to private oil and gas companies, both foreign and domestic) and enhanced oil recovery of existing maturing fields. 25 « MALAYSIA ECONOMIC MONITOR APRIL 2012 With new deepwater oil fields also coming onstream in late 2012 and 2013, oil production is expected to recover sufficiently by then. In terms of consumption, near and longer term measures to reduce vehicle mileage have been announced by the Government. The former includes the promotion of renewable energy in vehicles through a differentiated tax regime that favors the use of hybrid and electric vehicles, while the latter includes the construction of a new Mass Rapid Transit (MRT) line and extensions to the two existing Light Rail Transit (LRT) lines. Figure 43. Fuel subsidies paid by the Malaysian Figure 44. Oil production exceeds consumption but Government have increased since 2000 the gap is narrowing RM billion Thousands of barrels 20 800 18 Fuel subsidies 700 16 600 14 Net exports 12 500 10 400 8 300 6 200 4 Oil Production 100 2 Oil Consumption 0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 1980 1985 1990 1995 2000 2005 2010 (b) Source: MOF. Note: (b) = budget Source: PETRONAS & US Energy Information Administration. Figure 45. The net price differential between Tapis and Brent oil increased since January 2011 USD per barrel 130 125 120 115 Net price differential 110 105 Tapis Blend 100 Brent 95 J F M A M J J A S O N D J F 2011 2012 Source: Thomson Reuters & Bloomberg. Moreover, Malaysian crude oil is of the light and sweet variety (defined as having a low amount of sulfur), which continues to be in high demand. As a result, Tapis Blend, the benchmark oil grade for Malaysia, currently enjoys a premium of USD9 to 10 per barrel over Brent, as of January and February 2012 (Figure 45). This is important, for this shows that Malaysia has the unique advantage of an inherent ‗double surplus‘ element in its oil exports (‗surplus volume, surplus price‘ effect). Malaysia is both a net volume exporter and a net price exporter of oil, with sufficient domestic refinery capabilities. Malaysia relies mostly on cheaper imports of heavy and sour crude oil, in addition to domestic crude oil, to refine fuel for domestic consumption. This price differential helps to insulate Malaysia somewhat from an oil import price shock. As such, Malaysia is different from other oil producer nations, such as Nigeria and Iran. While these countries may have significant net exports of crude oil, due to insufficient domestic refinery capacities, they import a substantial volume of refined petroleum products such as gasoline and diesel, which leaves them more vulnerable to an oil import price shock. MALAYSIA ECONOMIC MONITOR APRIL 2012 » 26 Finally, the pricing of Malaysia‘s liquefied natural gas or LNG exports is determined by crude oil prices using the Japanese Crude Cocktail formula. This is important as LNG exports have overtaken crude oil exports in value terms since 2009, and are second only to palm oil as the biggest commodity exports in Malaysia. In 2011, LNG exports (at RM50 billion) are about 1.7 times bigger than oil exports (RM32 billion). This was due to a couple of factors, namely the rise in crude oil prices during 2011, and, most significantly, the up shift in LNG demand from Japan, Malaysia‘s biggest LNG buyer, following shutdowns of 52 out of its 54 nuclear plants following the Fukushima nuclear incident in March 2011. As a result, this caused a sharp rise in LNG prices to about RM2,400 per ton in January 2012 compared to RM1,530 per ton a year earlier and RM1,073 per ton on average between 2000 and 2010. Along with the higher crude oil price, and with demand from Japan likely to remain elevated amidst the continued shutdown of nuclear plants throughout 2012, the rise in LNG prices will help support Malaysia‘s exports and trade surplus. Therefore, a medium-term trend of firm or rising oil prices is likely to benefit Malaysia overall. Nevertheless, as a small, open economy, Malaysia‘s non-commodity exports (which are still the bulk of the country‘s exports) leave the country highly exposed to risks to global growth should oil prices reach high and unsustainable levels (see Box 1). As oil prices moved beyond USD140 per barrel in mid-2008, this caused the phenomenon of ‗demand destruction,‘ a sharp reduction in consumption in the major advanced economies, which are mostly net oil importers. In addition, as noted earlier, the benefits of higher oil price do not preclude stress to the Government‘s cash flows; this may exacerbate the pressure to implement further subsidy rationalization as seen in 2008. If retail fuel prices are allowed to increase, this will have a direct impact on cost-push inflation, with the resultant worries over second-round wage- price spiral effects, and, inevitably, lower growth, especially if accompanied by a slowdown in global demand. Thus, managing the sensitivity of rising oil price to the domestic economy in 2012 may be just as challenging for oil- exporting Malaysia as it is for the rest of Asia and the world as a whole. Note: a. The main reason for changing the timing of the PITA assessment was to standardize the tax system and align PITA with corporate and individual income taxes. The medium-term outlook hinges on the implementation of structural reforms Implementation of structural reforms lies at the core of Malaysia’s economic transformation and medium-term prospects. Malaysia has embarked on a series of reform efforts with the overall goal of transforming its economy towards a high-income, inclusive and sustainable nation by 2020. The New Economic Model (NEM) identifies a set of structural reforms to achieve these goals—which the NEM suggests should be ―at the core of the ETP [Economic Transformation Programme]‖ (NEM, p. 116). The implementation of the NEM has taken an innovative approach to combine projects with the structural reforms, which were grouped under six Strategic Reform Initiatives (SRIs). While the projects can catalyze economic transformation with targeted, strategic investments, the ‗core‘ of economic transformation remains the reforms that are needed to lock in the progress in creating an enabling environment conducive to higher productivity and private sector-led growth. Similarly, while the Government Transformation Programme (GTP) aims to make improvements in a number of critical areas, these initiatives may be best viewed as providing valuable support to the broader structural reform agenda rather than as ends in themselves. Notable progress has been made, especially in the GTP’s National Key Results Areas (NKRAs). The progress on crime reduction has been solidified, with indices declining and trust in the police increasing. There were also improvements delivered through better management at the municipal level, for example public transport and public infrastructure in Kuala Lumpur. Achievements in pre-school enrollment and rural infrastructure were also significant. On education, an important development has been the ranking all schools according to student performance. PEMANDU is working to improve the poor performers, though publishing the schools‘ rankings (even within broad bands) would help increase accountability and accelerate improvements. On the SRIs, there have been encouraging announcements with respect to international standards and the liberalization of services sectors. Divestments from GLCs are going ahead, most prominently with the recent sale of the national-car-maker Proton to a private sector investor. The competition law has been in effect since January 1, and while it is still too soon to assess its impact, increasing competition in the economy will be critical to economic transformation. 27 « MALAYSIA ECONOMIC MONITOR APRIL 2012 Structural reform needs to go beyond ‘quick wins.’ Structural reforms are by their nature more time-consuming, as they require greater efforts to build consensus. Therefore, while the progress registered in GTP objectives is laudable, Malaysia needs to look beyond the narrow targets of the NKRAs and integrate them in a renewed focus on implementing the more difficult, but potentially more rewarding, structural reforms identified in the NEM. For instance, while NEM Part 1 included a recommendation to ―review the education system – shift educational approach from ‗rote-learning‘ to ‗creative and critical thinking‘‖ (NEM, p. 123), this critical reform is only implicitly included in the GTP and ETP. Although the report from the National Education System Evaluation Panel, which was set up in December 2011, is due to be completed this year, it remains to be seen whether the Panel‘s recommendations will fall under the ambit of the ETP or the GTP, which would ensure more effective implementation and follow-through. Reforms need to be seen as a package: partial implementation will lead to less-than-partial results. For example, as one of the members of the international review panel of the ETP noted, ―It is very difficult for Malaysia to achieve the target share of public transport in overall transport while the current structure for the subsidy of petroleum continues to exist‖ (ETP Annual Report 2011, p. 248). Another example, discussed in greater detail below, is ensuring the consistency of significant investments in commodities8, reduced subsidies, and higher wages with maintaining Malaysia‘s competitiveness in tradable sectors—in other words, avoiding ‗Dutch disease‘. Without the higher productivity from a more skilled labor force and a competitive business environment, higher wages could result in higher costs. Finally, improving education and the supply of skills will not suffice without parallel reforms to create a vibrant private sector that demands, and rewards, talent. These examples illustrate the broader point that the reform agenda needs to make steady progress on all fronts, lest it become less than the sum of its parts. In sum, there is momentum to structural reforms, but a steady focus on implementation should be maintained. In that regard, the message from the ETP Annual Report for 2012 is encouraging: ―[2012 is a year] where we must follow through on our existing programme and execute, execute, execute‖ (ETP Annual Report 2011, p. 16). Implementation can be assisted by increasing the coordination of related reform efforts (for example on safety nets), building capacity within the civil service to lead reforms, and continuing to build consensus around major reforms such as educational reform, subsidy rationalization and the introduction of the goods and services tax. The Government Transformation Programme continues to show progress The Government Transformation Programme has made significant strides. Among the six National Key Results Areas (NKRAs) for which 2011 targets were set (a seventh NKRA on cost of living was introduced early in 2011), targets were generally met or exceed. All targets were met with respect to reducing crime and extending rural infrastructure (Table 4). Notable improvements are higher public satisfaction with the Royal Police Malaysia. Moreover, a quarter more rural households than targeted now have access to clean water, as well as welcome developments in education with respect to pre-school enrollments and quality improvements. A new cost of living NKRA focuses on cash transfers and discounted supply outlets targeted at low income earners. The initiatives under the new cost of living NKRA can be grouped into three categories. First, a number of discounted supply outlets targeted at low income earners will be created. Second, a number of cash transfer schemes were proposed with the 2012 budget. Notably, a total of RM1.92 billion was distributed to 3.8 million households through early March under the BR1M scheme and final figures are likely to be higher as some households that were denied the benefit are appealing and others had until the end of March to file. The outcome exceeded the target of 3.4 million beneficiaries (and the budget of RM1.8 billion). Finally, two special funds were created to assist fishermen and support small holders. While these initiatives are welcome, they risk becoming fragmented efforts unless they are placed under a broader framework for modernization of social safety nets. As the absolute poverty is low, the policy focus on low income households has shifted towards households at the bottom forty percent of the income distribution. The incidence of general poverty and hard core poverty has been reduced, respectively, to 3.8 percent and 0.7 percent in 2009. Following up on programs to eradicate hard core 8Over 40 percent of the total expected GNI contribution from EPPs comes from commodity-related sectors (oil, gas, energy, palm oil and rubber). MALAYSIA ECONOMIC MONITOR APRIL 2012 » 28 poverty under the NKRA on low income households (LIH), a comprehensive blueprint is being developed to increase income and raise the living standards of the bottom 40 percent of households. As with the NKRA on cost of living, the shift of focus to relative rather than absolute poverty is welcome, however it needs to be inserted into a broader framework for modernization of social safety nets towards a more comprehensive system with a robust targeting mechanism. As of 2009, data from the household income survey suggests that only 27 percent of the bottom 10 percent of the income distribution received assistance through social programs. Although the LIH NKRA is likely to have improved these figures, the lack of a robust targeting mechanism remains a major obstacle. The Government faced challenges to achieve its targets in some areas. In its anti-corruption drive, the Government aimed to close 70 per cent of corruption trials within one year but achieved 59 per cent. In addition, Malaysia declined to 60th place in Transparency International‘s rankings of corruption perceptions. The 21 per cent target for public transport modal share was also missed, hitting only 15 per cent, as growth of private transport usage outstripped the growth of public transport ridership. Table 3. Many of the 2011 targets for the GTP have been achieved NKRA Measure Target Actual Cost of Living Supply outlets targeted at low-income earners Development of Kedai Rakyat 1Malaysia (KR1M) Menu Rakyat 1Malaysia Klinik 1Malaysia Cash transfers Incentives for taxi drivers Cash assistance of RM 500 for households with income of RM 3,000 3.4 mn more than 3.8 and below beneficiaries mn RM 100 cash assistance for school children from Year 1 to Form 5 nationwide. RM 100-200 book voucher to all Malaysian students 1Malaysia Rakyat's Welfare Programme (KAR1SMA) Special Funds Special Housing Fund Commercial Agro Fund Crime Index crime 5 percent 11.1 percent Street crime 40 percent 39.7 percent Fear of Crime Index 50 percent 52.9 percent Arrest cases brought to trial 20 percent 23.4 percent Public Satisfaction with police 60 percent 70.5 percent Corruption EPPs under Corporate Integrity Pledge 70 percent 64 percent Ministries scoring above 90% in Procurement Accountability Index 19 18 Number of arrest cases brought to trial 20 percent 23.4 percent Number of people in the database of convicted offenders 100 496 Number of summons issued vs. Total hours of operation (PDRM Traffic) 12 12.41 Number of summons settled vs. number of summons issued by JPJ 60 percent 49 percent Transparency International (TI) Corruption Perception Index 4.9 4.3 TI Global Corruption Barometer survey 50 percent 49 percent Government contracts under Integrity Pact 80 percent 77 percent Trials completed within one year 70 percent 59 percent TNS perception survey on how much enforcement agencies are 3.5 2.9 perceived to be affected by corruption Produce a clear procedure for effective implementation of Whistle n.a. implemented Blower Act and begin the process of reporting actual numbers of whistle blower cases Completion of compliance unit activities 60 percent 99 percent Rural basic Km of rural roads 905.12 1,013 Infrastructure Number of rural houses with clean water supply 58,087 73,227 Number of rural houses with electricity supply 26,882 27,004 Housing delivery (number of units) 9,146 14,365 Urban public Increase modal share 17 percent 16 percent Transport Population within 400m of public transport route 70 percent 67 percent Customer satisfaction survey 50 percent 53 percent Bus peak hour load factor 56 percent 96 percent Reduce KTM Komuter load factor 125 percent 105 percent Rapid KL Kelana Jaya line load factor 80 percent 80 percent 29 « MALAYSIA ECONOMIC MONITOR APRIL 2012 Urban public AM peak public transport ridership 346,184 321,487 Transport (cont.) Reduce weighted average ratio of public journey time to private 1.70:1 1.49:1 journey time Road Safety (deaths per 10,000 vehicles) 3.12 3.21 Low income Number of households in 1AZAM 57,793 63,147 households Backlog cases verified under eKasih 100 percent 96 percent To train and develop women entrepreneurs n.a. n.a. Number of low-cost houses handed over 4,965 4,865 Improving student LINUS Numeracy rate (Cohort 1=Primary 2) 95 percent 97.5 percent outcomes LINUS Literacy rate (Cohort 1=Primary 2) 95 percent 99 percent LINUS Numeracy rate (Cohort 2=Primary 1) 90 percent 91 percent LINUS Literacy rate (Cohort 2=Primary 1) 90 percent 95 percent Number of Higher Performing Schools 50 52 Pre-school enrollment rate 80 percent 77 percent New Deals—Primary school principals exceeding target 3 percent 5 percent New Deals—Secondary school principals exceeding target 2 percent 4 percent New Deals—Primary school principals performing below target 8 percent 1.17 percent New Deals—Secondary school principals performing below target 10 percent 10.89 percent Increase Band 1 and 2 schools 8 percent 22 percent Reduce Band 6 and 7 schools 20 percent 40 percent Source: PEMANDU. The ETP has performed better on investments than structural reforms The ETP continues to make progress with respect to investments. Between October 2010 and December 2011 72 Entry Point Projects (EPPs) were announced. These EPPs are divided into a total of 110 sub-projects of which 92 have commenced or are already operational (Figure 46). Within the ETP framework, in 2011, RM 179 billion of investments were committed against the 10-year target of RM 1,700 billion (10.5 percent) while 313,741 jobs are projected to be created, against the 10-year target of 3.3 million (9.5 per cent). Figures on realized investments and job creation are not readily available, and it is challenging to link firm-level investments in the EPPs to national account aggregates. Nevertheless, progress on the ground is visible both large and small: from the recently-opened RM150 million Johor Outlets to the TUKAR program, which helped 519 ‗mom-and-pop‘ shops increase their productivity through capacity building and technology upgrades. Figure 46. A third of ETP projects are operational Number of projects Work-in- progress, 18 Operational, 34 Commenced, 58 Source: PEMANDU. Incremental achievements on some SRI’s were made, but implementation is only slowly gaining momentum. The competition law has gone into effect, and high profile divestments have taken place (e.g. Proton) or are expected shortly (e.g. Felda Global Ventures). PEMUDAH continues to make impressive strides to improve the business environment by reducing the number of permits. There was progress – if not yet full implementation in other areas. With regard to the SRI on standards, amendments have been made to the Standards Act to allow the establishment of multiple standard development agencies to accelerate the adoption of international standards. A minimum wage, part of the SRI on human capital, is expected to be announced in the first half of 2012. The MALAYSIA ECONOMIC MONITOR APRIL 2012 » 30 liberalization of 17 services sectors has started and is expected to be fully implemented by the end of 2012. This could be a key reform to attract new investments and increase competition in the economy in the medium-term, but implementation details will be critical such as ensuring sustainability of the reform momentum, coherence with domestic regulations and coordination with bilateral and multilateral liberalization efforts (Box 4). On the other hand, important reforms such as the introduction of the GST and the rationalization of subsidies have been postponed (and indeed subsidies to sugar were increased in January), and implementation of comprehensive reforms in the educational sector, while under study and debate, has yet to commence. Table 4. Progress on SRIs has been incremental SRI MAIN POLICIES WHAT HAS BEEN ACHIEVED EXPECTED OUTCOMES  Malaysia Competition  Prevent anti-competitive agreements Commission set up in April 2011 Competition Act 2010 & abuse of dominant position or  Law came into force on 1 monopoly January 2012  Amendment to Standards Act  Reduction of timelines for adoption of to enable appointment of Multiple standard international standards (6-9 months vs. multiple standard development development agencies 1 year) & development of local agencies has been gazetted on standards (1-1.5 years vs 3 years) Competition, 9 February 2012 Standards &  Seven sectors were effectively  Up to 100 percent foreign equity Liberalization liberalized since 1 January 2012: participation will be allowed in phases (i) courier services; (ii – iii) during 2012 for remaining 10 sectors technical & vocational  Sectors include teaching hospitals; secondary education (incl. for Services sectors telecommunication services (2 sub- children w/ special needs); (iv) liberalization sectors); international schools; private skills training services; (v) hospital services; stand-alone department & specialty stores; specialized medical & dental clinics (2 (vi) incineration services; and sub-sectors); architectural, engineering (vii) accounting and taxation and legal services services  Proposed policies will be tabled to the  New accounting policies have Accrual accounting Accrual Accounting Steering been drafted Committee for approval in 2012  E-bidding‘s original threshold value was reduced from RM200,000 to RM50,000 for the  Value Management (VM) for OE Transparent procurement procurement of goods and Procurements: Est. savings of RM296 services and implemented in million in 2012 April 2011; savings estimated at Public Finance RM 25mn in 2011  Review of the Promotion of Rationalization of incentives Investments Act targeted to be tabled to Parliament in the 3rd quarter of 2012  Enhancement of audits & en- forcement implemented in the  Targeted additional revenue in 2012 of Improve Tax Collection second half of 2011. Estimated RM 1.9bn additional revenue of RM 67 mn  Government remains committed to Implementation of GST implementing GST at appropriate time Expenditure control  Identified licenses abolished by June Business Process  405 of 761 business licenses 2012 Reengineering identified to be abolished  272 licenses simplified and incorporated into an online system  Tender for Real Time Performance Real-time performance  Counter rating system Public Service Monitoring System in October 2011, monitoring & counter rating implemented in 82 police Delivery with pilot in five agencies to be system stations in Selangor launched in Q2 2012  The Government intends to implement open recruitment for senior and middle Increase the talent pool in management posts the civil service  Enhance portability characteristics of current pension scheme 31 « MALAYSIA ECONOMIC MONITOR APRIL 2012  Phase I of amendments to Employment Act 1955 passed in Parliament in Dec 2011 including 28 amendments to  To be tabled in Parliament: Minimum the current provisions, 17 new Retirement Age; Industrial Relations provisions, 2 provisions repealed Act; Private Employment Agencies Act Modernize labor legislation  National Wage Consultative  Minimum wage to be endorsed by Council (NWCC) set up in Cabinet and announced in the first September 2011 pursuant to the half of 2012 National Wage Consultative Council Bill passed in Parliament July 2011  National Occupational Skills Standards (NOSS) for TVET  ―Train the Trainer‖ program in solar Curriculum in O&G launched installation  Pilot batch of eco-nature guide  Recommendations to enhance as well training programs as standardize the eco-nature guide  NTEP launched covering 5 curriculum will be announced and Upskilling, reskilling and states/regions and 550 implemented in 2012. upgrading the workforce placements across Malaysia  NTEP will expand to seven regions with  MyProCert program launched 650 placements across Malaysia October 2011 for business  MyProCert targets to produce 5000 Human Capital services & CCI new certified professionals by 2014 Development  E&E PSD Fastrack attracted 104  MyUniAlliance aims to upskill at least apprentices with 101 of them 12,000 undergraduates by 2015 recruited Strengthen human resource  National Human Resources management Centre (NHRC) launched  Legalize and set-up 800 childcare centers and train up to 4,000 childcare minders Leverage on women‘s  Re-train 280 women who wish to re- talent to increase enter the workforce productivity  200 corporate women who will be trained in 2012 to be ready for promotion into Board of Directors level  The Institute of Labour Market Undertake a labor market Information and Analysis (ILMIA)  Labour market analysis reports for two forecast and survey was set-up to provide NKEA sectors (E&E and Oil & Gas) to program comprehensive and timely be produced labor market information  MOHR has appointed the ILO to Enhance labor safety net by undertake a comprehensive  2012: completion of the study; introducing unemployment study and to propose  2013: implementation of UIS insurance recommendations on the design of the UIS  11 divestments have been completed in 2011 and 1 in Government’s Divestment from GLCs 2012  Additional 12 targeted for completion Role in Business through listing, paring down  High profile divestments include in 2012 and remaining nine in 2013. of stakes or outright sale PLUS, EON Capital, Pharmaniaga, Felda and Proton Market friendly, transparent,  Bumiputera Economic needs and merit-based Transformation Programme  Bumi SMEs to contribute 20 percent of programs to support (BETP) launched national GDP by 2020 (from current 13 Bumiputera SMEs  Setting up of TERAJU, which will percent) lead the BETP and drive  30 SMEs have been selected to Narrowing Capacity building programs Bumiputera participation undergo the TERAS Program, with an Disparity provided to Bumiputera as through new and existing additional 170 companies are currently well as non-Bumiputera initiatives being evaluated by the independent SMEs with a focus on  Setting up of TERAS a program selection panel building talent, identifying to increase Bumiputera SMEs‘ new technologies and participation in the economy enhancing collaboration Source: PEMANDU. MALAYSIA ECONOMIC MONITOR APRIL 2012 » 32 Box 4. Liberalization of services sectors in context of broader trade liberalization in Malaysia Transforming Malaysia into a high-income economy by 2020 requires diversifying sources of growth towards greater reliance on the services sectors. This is for two reasons. First, the manufacturing sector needs to shift the source of its comparative strength from high-volume and low-cost to unique value, which will require transitioning to more skill- intensive tasks in the production process. Efficient services are not only drivers of economic growth on their own but are also critical for the transformation of manufacturing and primary sectors. Second, with the emergence of new manufacturing hubs such as Vietnam and Indonesia, Malaysia needs to deepen the diversification of its export structure and in this respect the services sectors offer promising opportunities. Accordingly, the Third Industrial Master Plan anticipates that services will represent over 65 percent by 2020 (Figure 47) and the sector has been receiving increasing interest from investors. During 2011 the services sector captured RM 64.4 billion or 43.3 percent of total approved investments, followed by manufacturing (37.8 percent). In contrast with the latter, investment in services originated mostly from domestic sources (74.8 percent). Figure 47. Services increasingly constitute the Figure 48. Services are more protected in Malaysia backbone of the Malaysian economy compared to high-income OECD economies Percentage share to GDP by sector Foreign equity ownership indexes (100 = full foreign ownership allowed) 100% 100 90% 90 27 30.5 26.9 28.5 80 80% 70 60 50 70% 7 40 14.1 30 60% 17.5 20 29 10 0 50% 40% 30% 64.5 59 52 20% 44 10% Malaysia 0% High-income OECD 1990 2000 2010 2020 Services Agriculture & Mining Manufacturing Source: MITI Weekly Bulletin (various issues). Ministry of Finance Source: World Bank Investing Across Borders. Economic Report (various issues). Department of Statistics. Estimates for 2020 from Third Industrial Master Plan. Notes: Services includes Government and construction services. The services sectors in Malaysia have grown to cover a wide range of economic activities, some increasingly internationalized and sophisticated (e.g. logistics, banking, consulting, telecommunications, etc.) that have been radically transformed by advances in technology. Development of a variety of strong services subsectors involves the existence of adequate physical infrastructure and human capital but also the reduction of barriers to investment and trade, and the strengthening of domestic regulatory frameworks. Gradual exposure of incumbent domestic providers to domestic and foreign competition fosters their productivity. In addition to new capital, relaxation of restrictions in foreign ownership is likely to result in efficiency and technology gains. In this line, Malaysia has a relatively liberal FDI regime in most manufacturing industries but foreign participation in services has traditionally been more restrictive (Figure 48). In addition, Malaysia‘s Government-linked companies (GLCs) continue to have an important presence in some services subsectors. As part of its economic transformation initiatives, Malaysia has committed to further liberalization of its services sectors to increase competitiveness. Malaysia has had a generally protected services sector, restricting commercial presence for foreign firms and practice by foreign professionals. For most subsectors, foreign firms could only 33 « MALAYSIA ECONOMIC MONITOR APRIL 2012 operate in partnership with local companies but without exceeding 30 percent of total equity. In addition, in most cases, at least 30 percent of the issued and paid-up capital upon listing had to be held by Bumiputera. In 2009, the Government eliminated foreign equity restrictions on 27 services subsectors—including healthcare and social services, tourism, transport, business services and computer-related services—and relaxed barriers and issued new licenses for foreign financial firms. In late 2011, the Government unveiled plans for the liberalization of 17 more subsectors during 2012. This new liberalization round will allow full foreign control in selected subsectors in healthcare, education and training, telecommunications, department and specialty stores and certain professional services (see Table 4 above). Since 2010, trade in goods has been liberalized among the largest ASEAN economies, but services are lagging. A commercial presence in one ASEAN country does not automatically allow providers to supply their services to other ASEAN members. In 1995, ASEAN countries adopted the ASEAN Framework Agreement on Services (AFAS) that established a schedule for liberalization beyond national commitments under the General Agreement on Trade in Services (GATS). ASEAN accorded to progressively eliminate all barriers for cross-border supply of services and consumption abroad, raise the foreign equity ceiling for commercial presence and improve the movement of natural persons. Up to now, ASEAN Economic Ministers have signed eight liberalization packages covering construction, telecommunications, business services, financial services, air and maritime transport, and tourism. As part of AFAS, Malaysia has already made commitments in 96 services subsectors. ASEAN members have also been negotiating mutual recognition arrangements (MRAs) for qualifications in selected professional services. In 2007, ASEAN members endorsed a blueprint for the establishment of the ASEAN Economic Community (AEC) with the goal of achieving regional economic integration by 2015, including free flow of services. While there has been significant progress, liberalization of services within ASEAN lags behind liberalization of goods trade. Some liberalization has taken place in the context of other FTA negotiations. As of February 2012, Malaysia has implemented five bilateral Free Trade Agreements (FTAs) and is part of five ASEAN+ regional FTAs. Most of these FTAs contain chapters covering trade in services as well as MRAs for academic and professional qualifications. Concessions on services included in most FTAs have been, however, limited. In the Malaysia-Pakistan FTA, Pakistan offered Malaysian firms up to 60 percent of equity participation in all services subsectors and lifted all restrictions to the employment of Malaysian professionals. On the other hand, Malaysia granted Pakistani services firms the possibility of full ownership in information and communication technology (ICT) and Islamic financial services. The FTA with New Zealand grants Malaysian firms easier access for the provision engineering, environmental and ICT- related services in that country. Meantime, the Malaysia-Japan FTA exchanges concessions in several services— including financial—and offers Japanese cooperation for the development of Malaysia‘s manufacturing- and ICT- related services. Commitments to facilitate trade in services, including movement of natural persons, are also part of the Malaysia-India FTA. The FTA with Chile entered into effect in February 2012 for trade in goods and mandates that negotiations on services and investment liberalization should start within two years. Provisions in services are also part of ongoing FTA negotiations with Australia, the European Union, and members of the Trans Pacific Partnership group. Under ASEAN+ FTAs, Malaysia has offered commitments beyond GATS in selected subsectors including business, ICT, telecommunications, distribution, educational, tourism, transport and financial services. Liberalization efforts in services in Malaysia have generally been undertaken unilaterally and have proceeded at varying speeds across sectors. The rationale for the deliberate and variable pace of liberalization is to prepare the domestic private sector and allow them time to build capacity before the signature of legally-binding external agreements. Upcoming liberalization during 2012 in legal, courier, accounting and taxation services will help reduce business costs across the economy, but the varying speed of liberalization across sectors may reduce the potential for reaping vertical (through segments in a production/distribution value chain) and horizontal (across subsectors) synergies emanating from services reforms. At the same time, sectoral- or firm-level productivity gains in liberalized segments of a value chain (e.g. manufacturing) could be eventually reduced or neutralized by inefficiencies in protected segments. Contributed by A. Postigo MALAYSIA ECONOMIC MONITOR APRIL 2012 » 34 Economic transformation must boost productivity to prevent ‘Dutch Disease’ In the face of escalating commodity prices in the 2000s, Malaysia implemented what has in practice amounted to a very successful strategy to avert so-called ‘Dutch Disease.’9 Oil prices increased significantly from an average of USD 29 per barrel in 2000 to USD 80 per barrel in 2010. The prices of other key commodities such as palm oil and rubber have also increased significantly in the meantime. This has resulted in Malaysia‘s commodity balance (the amount of commodity exports less commodity imports, except food), to increase from 10 percent of GDP in 2000 to 14 percent of GDP in 2010 (Figure 49). Such an increase in flows from commodity revenues brings the risk of so- called ‗Dutch Disease,‘ whereby higher supply of foreign currency leads to some combination of nominal exchange rate appreciation and higher inflation, causing an appreciation in the real effective exchange rate. This, in turn, affects the competitiveness of the tradable sectors (such as manufacturing). Since tradable sectors tend to have higher productivity growth compared to non-tradable sectors, the result can be a deceleration of potential non-resource output. However, while some evidence of Dutch Disease is visible in a composite of oil-exporting countries, the real effective exchange rate in Malaysia has moved in line with its peers that are net commodity importers (Figure 50). As a result, Malaysian manufacturing remained competitive and performed in line with its peers through most of the 2000s (Figure 51). Figure 49. The commodity balance has increased as a Figure 50. The real effective exchange rate has percent of GDP appreciated in line with other currencies in the region Percent of GDP (Commodity Balance) US dollars per barrel (Oil Prices) Index (January 2000=100) 140.0 20.0 120.0 Malaysia China 18.0 Commodity Balance 130.0 Other ASEAN 100.0 Oil Producing 16.0 Oil Prices 120.0 80.0 14.0 110.0 12.0 60.0 10.0 100.0 40.0 8.0 90.0 20.0 6.0 80.0 01-2000 10-2000 07-2001 04-2002 01-2003 10-2003 07-2004 04-2005 01-2006 10-2006 07-2007 04-2008 01-2009 10-2009 07-2010 04-2011 01-2012 4.0 0.0 Source: CEIC. Source: BIS and World Bank staff calculations. Note: ―Oil producing‖ includes Russia, Saudi Arabia, UAE and Venezuela On the external side, a key piece of Malaysia’s strategy was an increase in direct investments abroad by Government-Linked Companies. Despite the high current account balances and a floating exchange rate, as Figure 52 shows, the nominal exchange rate has remained fairly stable over time. A key factor in driving exchange rate stability has been the balancing effect of higher overseas investments of Malaysian companies. Starting in the 1990s, PETRONAS started re-investing some of its earnings overseas. Globally, PETRONAS has investments in pipeline operations in Argentina, Australia, Indonesia and Thailand, as well as gas storage and LNG regasification facilities in Europe (Petronas Annual Report 2011). This trend was intensified in the 2000s, when PETRONAS was joined by other GLCs such as Sime Darby, Maybank, CIMB, and Telekom Malaysia in making large overseas investments, partly as a result of the GLC Transformation Programme. As a result, FDI by Malaysian firms increased from about 1.2 percent of GDP in 2000-2001 to 5.5 percent of GDP in 2006-2008.10 The increase in outflows of 4.3 percentage points of GDP 9Back in the 1980s Malaysia already had in place a National Depletion Policy to avoid the ‘Dutch Disease.‘ The main objectives and strategies of National Depletion Policy are: (i) to safeguard the depleting oil reserves; and (ii) to limit the total of production of crude oil. 10Despite a decline since the global financial crisis, as of 2011, Malaysian investments abroad on mining and financial services totaled RM25.3 billion and RM23 billion respectively. With CIMB‘s recent expansion into the Philippines and Maybank‘s acquisition of Kim Eng Holdings, Malaysian banks now have a presence in 14 markets around the world. 35 « MALAYSIA ECONOMIC MONITOR APRIL 2012 partially offset an increase in a 5.6 percentage points in the commodity balance during the same period (Figure 53). As GLCs moved to invest overseas, however, they imported less capital goods into Malaysia, which led to an increase in the non-commodity balance. Figure 51. Manufacturing output also moved in line with Figure 52. The nominal exchange rate was similarly regional peers in the 2000s stable Manufacturing output (Index, 2000=100) Nominal effective exchange rate index (2000=100) 300 120.0 China Singapore Korea 110.0 250 Malaysia Philippines 100.0 200 90.0 80.0 150 70.0 Malaysia China 100 60.0 Other ASEAN Oil Producing 50 50.0 Source: CEIC and World Bank staff calculations. Source: BIS and World Bank staff calculations. Note: ―Oil producing‖ includes Russia, Saudi Arabia, UAE and Venezuela Figure 53. An increase in the commodity balance was Figure 54. Reserves counteracted volatile flows followed by an increase in FDI from Malaysian companies abroad Percent of GDP Percent of GDP 20.0 Commodity balance & outward investment 20 Non-commodity balance & other net investment flows 15.0 15 Reserves Non-Commodity CA 10 10.0 Commodity Balance 5 FDI of Malaysian Firms Abroad 5.0 Other FA, E&O, Reserves 0 0.0 -5 -10 -5.0 -15 -10.0 -20 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 -15.0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: CEIC and World Bank staff calculations. Source: CEIC and World Bank staff calculations. The final component of the external part of the strategy was reserve accumulation by BNM. Reserve accumulation generally counter-acted volatile portfolio flows to stabilize the exchange rate, but on average also accelerated in the second part of the decade (Figure 53 and Figure 54). The balance in capital flows achieved by increasing FDI abroad, maintaining large outflows of bank deposits overseas (something that was already taking place in the early 2000s) and some reserve accumulation effectively reduced the supply of foreign currency, reducing pressures on the money supply and nominal exchange rate. Some resource receipts made their way to the economy through the fiscal accounts. The non-oil primary deficit increased from 6.5 percent of GDP in 2000-2004 to 9.7 percent of GDP in 2006-2010 (Table 5). Put it differently, by MALAYSIA ECONOMIC MONITOR APRIL 2012 » 36 2010 oil revenues and debt financed about half of all expenditures, up from less than 40 percent in the early 2000s (Figure 55). While development expenditures declined as a share of GDP during the period, operating expenditures climbed about 2.5 percentage points of GDP. Subsidies accounted for most of the increase (1.4 percentage points), of which 0.8 percentage points were contributed by fuel subsidies. Therefore, while an additional 3.7 percentage points of GDP was made available to the Government through oil revenues, only 0.8 percentage points were used for fuel subsidies. The remainder of the additional revenues, net of the reduction in development expenditure, (4.8 pp) was used for emoluments (0.7 pp), non-fuel subsidies (0.6 pp), other operating expenditure (0.4 pp), deficit reduction (0.2 pp) and reduced effort for non-commodity revenues (2.8 percentage points). Table 5. The non-oil primary deficit has grown Figure 55. Only half of expenditures are financed through substantially non-oil revenues Percentage points of GDP Index, Total Expenditures = 100 100.0 35 2000-2004 2006-2010 Change Deficit Financing 80.0 Other Operating Expenditure 9.9 10.3 0.4 33 Oil Revenues 60.0 Emoluments 6.3 7.0 0.7 Non-Oil 40.0 Subsidies 1.6 3.0 1.4 30 Revenues 20.0 Develompent Dev elompent Expenditure 8.2 6.3 -1.9 Expenditure 0.0 28 Other Operating Oil Rev enues 4.7 8.3 3.7 -20.0 Expenditure Non-Oil Rev enues 16.3 13.5 -2.8 -40.0 25 Subsidies Deficit Financing -5.0 -4.8 0.2 -60.0 Emoluments 23 Non-Oil Primary Deficit -6.5 -9.7 -3.2 -80.0 Non-Oil Primary Expenditures (% GDP) 26.0 26.6 0.6 -100.0 20 Deficit Expenditures (% GDP) Source: CEIC, MoF, World Bank Calculations. Source: CEIC, MoF, World Bank Calculations. Any inflationary pressures from higher emoluments, transfers, and lower taxes were contained through an extensive network of subsidies and price controls. Inflation in Malaysia has been low by regional standards, and certainly by standards of oil-producing countries (Figure 56). This is remarkable considering the demand boost provided by increased Government spending, as described above. The Government has used some of the resource revenues to keep fuel prices contained. As of last September, the price of RON95 fuel was RM2.75; yet the price at the pump was RM1.90, implying a subsidy of 31 percent of the actual price (these figures have since increased). Some off- budget subsidies have also been implemented, such as PETRONAS sale of subsidized gas to electrical utilities, which reduces the price of electricity to consumers. Importantly, a number of prices, especially of food items, are controlled by the Government (Table 6). According to BNM, price administered items make up nearly 30 percent of the CPI basket (BNM, 2010). The final piece of the puzzle has been increased reliance on low-skill foreign workers. A key channel through which the Dutch disease may erode competitiveness in tradable sectors is through an increase in low-skill wages in excess of productivity. This is because excess demand from resource revenues increases demand of both tradables and non-tradables, but only the price of non-tradables tends to rise as the price of tradables is largely determined in global markets. The main component of the cost of non-tradables (such as services) tends to be labor. As wages rise in the non-tradable sector, they push up low-skill wages throughout the economy, diminishing the competitiveness of manufacturing. Returns on skilled labor have been increasing rapidly on a global scale, and therefore the key added pressure would come from low-skill labor. Enter foreign workers, which have become a significant part of Malaysia‘s labor force (see the next chapter) in the past decade. This helps explain why manufacturing wages, as well as prices of services, have not risen noticeably in the past decade. 37 « MALAYSIA ECONOMIC MONITOR APRIL 2012 Figure 56. Inflation in Malaysia is low compared to Table 6. This has been helped by subsidies and price regional peers controls Price Level Indices (2002=100) 250 Price-administered goods Malaysia - Services Price Control Act, retail price Items where any changes in prices require Malaisia - Overall determined by the Government Government approval 225 China - Overall Kazakhstan - Overall Items Items Korea - Overall Food Alcoholic Beverages and Tobacco 200 Singapore - Overall Rice Beer Thailand - Overall Flour & other cereal grains Wines Philippines - Overall Bread & bakery products Spirits & Liquors 175 Fresh meat Cigarettes, cigars, etc. Oils Housing, water, electricity, gas and other fuels 150 Sugar Water supply Non-food Electricity Gas Communication 125 Fuel & lubricants Telephone and telegraph services & equipment 100 Postal services Transport services Passenger transport (rail, road, air, sea) 75 Other transport charges Source: CEIC and World Bank staff calculations. Source: BNM (2010), p. 51. Although this strategy has served the country well, it is unlikely to be compatible with Malaysia future aspirations. A growth strategy based on commodity revenues is, at a minimum, risky. Fuel subsidies, coupled with a national automotive policy, have led to high growth in oil consumption. Production, meanwhile, has been falling, which has led to a decline in Malaysia‘s status as a net exporter of oil in volume terms (see Box 3). Although significant investments are being made in oil and gas, including in downstream activities, the sustainability of a surplus in the commodity balance is uncertain. In addition, high oil prices may continue into the near term, but risks of both downside and upside shocks are elevated and could be highly disruptive. Even if commodity revenues were to continue to increase, the ‘medicines’ against the Dutch Disease are likely to become less effective. Although global prices of commodities are likely to remain firm, to ensure the growth in domestic production, PETRONAS has switched towards a higher share of domestic investments, which along with a continued large surplus in the commodity balance and renewed FDI inflows from the ETP could put further upward pressure on the exchange rate. Subsidies are becoming increasingly distortionary as global prices rise, and most importantly, pressures for higher wages are mounting, with manufacturing firms starting to switch to more human- and physical-capital intensive production in anticipation for a reduction in the availability of foreign workers. Finally, based on recent trends, the dependence of the budget on oil revenues is likely to increase absent any reforms. Without implementing the structural reforms in the SRIs, partial implementation of the ETP could exacerbate the Dutch Disease. The ETP calls for renewed investments in oil and gas in Malaysia to leverage on high oil prices, higher levels of FDI, the introduction of a minimum wage, rebalancing of foreign workers towards higher skills, rationalization of subsidies, expenditure reform and broadening of the tax base through the introduction of a GST. The consistency of these ETP objectives with long-term growth depends crucially on structural reforms to improve productivity growth in the tradable sectors. This is compatible with the central preoccupation of the New Economic Model that ―future growth must come from higher factor productivity, nurtured by more innovative processes as well as supported by a healthy dose of private investment and talent‖ (NEM, p. 102). As discussed in the NEM and previous editions of the Malaysia Economic Monitor, productivity growth would be enhanced by building up capabilities and enhancing competition in the economy. Without these crucial changes, partial implementation of the ETP could aggravate the Dutch Disease. A new strategy for Malaysia to avoid ‘Dutch Disease’ that is consistent with the NEM rests on two pillars: increasing productivity growth through structural reforms and making the use of oil revenues more rules-based. First, it is critical to invest in skills to increase the productivity of Malaysia‘s labor force and boost innovation. Higher productivity is the only sustainable and non-inflationary source of wage growth, and requires both supply and demand measures. Higher wages and improved social protection would also offset higher inflation that may result. The second pillar MALAYSIA ECONOMIC MONITOR APRIL 2012 » 38 passes through Government finances, which needs to be fundamentally reformed as envisaged by the New Economic Model, and beyond. Measures anticipated in the NEM include the adoption of a goods and services tax, which will increase the tax base and the share of non-oil revenues. Subsidies should be rationalized, with savings converted to transfers to the bottom 40 percent of households. In addition, Malaysia should consider building on recent announcements (see Box 5) to transform the National Trust Fund (‗KWAN‘) into an ‗oil stabilization fund‘, which manages all of the country‘s oil wealth and revenues and invests most of its assets overseas. 11 This would compensate for the reduction in the overseas investments of GLCs. The Fund would make disbursements to the budget, but these would be based on rules dependent on oil prices, production, and return on assets in the fund. Box 5. Changes to the National Heritage Fund (KWAN) in 2012 Beginning in 2011, the rules governing PETRONAS‘s contribution to Malaysia‘s National Heritage Fund (KWAN) have been modified to a new formula, with contributions to vary depending on the ‗Weighted Average Realized Price‘ or WARPa of oil for a given year: - If WARP is less than USD70 per barrel, contribution to KWAN is RM100 million - If WARP is between USD70 and USD100 per-barrel, contribution is RM500 million - If WARP is more than USD100 p/b, contribution is RM1 billion For 2011, as the WARP was above USD100 per barrel, PETRONAS contributed RM1 billion to KWAN, with the asset size of KWAN at RM4.8 billion (as of 31 December 2011). This compares with a yearly dividend payment to the budget of RM 30 billion. Note: a/ WARP: Weighted average price of all foreign and domestic oil grades produced by PETRONAS Source: BNM, Accountant General‘s report, PETRONAS. 11 A discussion of the potential impact of such fiscal rules can be found in the November 2011 Malaysia Economic Monitor. 39 « MALAYSIA ECONOMIC MONITOR APRIL 2012 3. Modern jobs Modern jobs: higher wages, secure workers, competitive firms Becoming a high-income nation will involve the creation of modern jobs in the Malaysian economy.12 The ultimate goal of becoming a high-income nation is not to achieve an abstract statistic but rather to raise the living standards of individual Malaysians. Therefore, supporting higher and more secure incomes for Malaysian households is central to Malaysia‘s efforts to transform its economy. Since the majority of household income comes from labor, transforming jobs and labor markets will be critical. ‗Traditional jobs‘ have involved the performance of simple, routine tasks and commanded low wages. Meanwhile the lack of modern social safety nets placed the burden to provide job security on large firms or on the informal sector (including family-run businesses). Firms‘ competitiveness was partly derived from a steady flow of low-wage, low-skill labor coming largely from agriculture. Malaysia‘s transformation to a high-income economy requires a transformation of the types of jobs available in its labor markets, from ‗traditional‘ to ‗modern‘ (Table 7). Modern jobs are higher-productivity jobs, justifying higher wages. Malaysia‘s economic transformation will require the creation of new types of jobs (and the upgrading or ‗modernizing‘ of existing jobs) that involve the performance of increasingly complex tasks and command higher wages. This would generally demand higher levels and different types of skills compared to those involved in ‗traditional jobs.‘ Whereas memorization and manual skills were crucial to early stages of industrialization, modern, high-wage jobs involve soft skills such as communication, problem-solving, and proficiency in modern information technology. Modern jobs are related to high productivity growth, as well as innovation, but are not restricted to ‗modern‘ sectors: the TUKAR program, which aims to modernize small shops, including through providing training to shop owners and increasing the use of information technology, can be viewed as ‗modernizing‘ jobs in the retail sector. Modern labor markets are flexible: workers are protected, not jobs. Modern labor markets allow firms and workers to adapt to changing market conditions, make room for ‗creative destruction‘ that benefits the economy as a whole, and facilitate the matching between workers and firms. Although modern jobs may lack some traditional protections, they are not incompatible with greater income security. On the contrary, flexibility in labor markets should come hand-in-hand with well-designed and comprehensive social safety nets that facilitate job transitions and balance the flexibility in labor markets with security for individuals and their families. In Malaysia‘s case, this means that a vital component of modernizing labor markets and introducing more flexibility in labor regulations is moving from ‗traditional‘ social assistance based primarily on consumer price subsidies to comprehensive social insurance based on targeted transfers. Modern jobs are inclusive and leverage on the entire stock of talent in the economy. In Malaysia‘s case, women are currently a substantial untapped source of talent, and creating more inclusive jobs can help draw this talent into the economy. Modern jobs can help achieve this objective by offering flexible working arrangements, including part-time assignments, job sharing and flexible hours, that make it easier for women to reconcile family with work. Social policies can also support inclusiveness in the labor market by ensuring adequate provision of child and elderly care. Modern jobs are likely to be more attractive to women, both because of flexible working arrangements and greater support for household tasks, but also because they command higher wages and tend to be in sectors where the type of work is more attractive. Modern jobs are offered by competitive firms. The competitiveness of firms in a high-income economy is not derived from low wages but rather from the productivity of its workers. In addition, transitioning to protecting workers instead of protecting jobs contributes to the competitiveness of firms by lowering costs and promoting an efficiency-enhancing reallocation of risks from firms to workers and the government. A country‘s competitiveness is 12In this chapter ―modern‖ is not meant to imply jobs in a specific sector, nor is it equivalent to ―skilled jobs‖. Rather, it is meant to reflect (i) higher labor incomes for workers derived from higher productivity; and (ii) modern labor market and social safety net policies that protect workers rather than jobs and promote inclusion. MALAYSIA ECONOMIC MONITOR APRIL 2012 » 40 to a considerable degree a function of its institutions and human capital.13 Malaysia has benefited from good institutions during its development, but other countries are catching up. That calls for a focus on skills and the quality of human capital as Malaysia‘s long-term source of competitiveness. Germany is an example of a country that remains highly competitive internationally – and whose firms are also globally competitive – but where wages are fairly high. Table 7. Traditional vs. Modern Traditional Modern Simple, routine and standardized tasks Complex, analytical and differentiated tasks High supply of low-skill labor that can perform the tasks Tight supply of specialized labor and higher productivity  low wages  High wages Most jobs in agriculture, labor-intensive manufacturing Most jobs in knowledge intensive tasks across all economic sectors Strict labor regulations make it difficult to hire and fire Flexible labor regulations reduce the cost of hiring and workers, effectively placing the burden of providing firing and increase efficiency, while effective social income security on firms at the cost of lower efficiency safety nets protect workers Rigid job structures and expectations that are not Jobs that leverage on the entire stock of human capital conducive to the participation of large segments of by making it easier and more attractive for women to the population, especially women join the labor force Competitiveness derived from institutions, security of Competitiveness derived from the quality of human investments capital, in addition to good institutions The New Economic Model (NEM) recognizes the need to develop a quality workforce and improve the functioning of labor markets as critical requirements to achieve both its high-income and inclusiveness objectives. According to the NEM, ―[l]abour markets must work well: jobs and workers must be matched efficiently to increase productivity and thus raise wages for all.‖ It further recognizes the central role of skills: ―High income emanates from skilled people applying their talents to successfully meet the economic challenges faced by society.‖ To achieve the NEM‘s aspirations, the 10th Malaysia Plan emphasizes ―Revamping the education system to significantly raise student outcomes; raising the skills of Malaysians to increase employability; and reforming the labour market to transform Malaysia into a high-income nation.‖ As part of the Economic Transformation Programme, the NEM’s recommendation has been translated into the Human Capital Strategic Reform Initiative (SRI). Key pillars of the SRI include: (i) modernizing labor legislations; (ii) up- skilling and upgrading the workforce; (iii) leveraging on women‘s talent to increase productivity; and (iv) enhancing safety nets by introducing unemployment insurance. Also incorporated in the SRI are reforms to implement a minimum wage, and to increase the retirement age. Other Government reform programs that can facilitate the creation of modern jobs include the Education NKEA and NKRA, which are now being integrated with the Human Capital SRI. Jobs have also gained prominence on the global agenda. Increasing income inequality in many advanced and emerging countries (or at least increasing popular awareness of income inequality) has contributed to social tensions in a number of places from the United States to the Middle East. While redistributive schemes can help reduce inequality, sustainable improvements and truly inclusive economic growth involve raising labor market returns for a majority of workers. Reflecting the importance of the jobs agenda and the transformational nature of jobs, the World Bank‘s World Development Report for 2013 currently under preparation focuses on the topic (see Box 6 below). Box 6. The World Development Report 2013 on Jobs The conceptual framework of the World Development Report (WDR) 2013 focuses on jobs as the link between individual, household and societal opportunities and assets (such as education, land, and capital), and outcomes 13Costinot (2009) argues that good institutions (such as security, contract enforcement and macroeconomic stability) make it easier to form teams (firms themselves, or teams within firms) to solve complex problems. High levels of human capital on the other hand reduce the average number of team members needed to solve a given complex problem. 41 « MALAYSIA ECONOMIC MONITOR APRIL 2012 (economic and social). The development process is about some jobs improving, and others disappearing; about people taking jobs and changing jobs; and about jobs migrating from some places to others. The report will focus on three aspects of jobs: (i) the relationship between jobs and living standards; (ii) the relationship between jobs and enterprises, where the creation, destruction and evolution of jobs are at the root of productivity gains; and (iii) the importance of jobs in the context of social cohesion, for example through their effect on equity, empowerment, engagement of certain groups, and political stability. The report will present jobs as the ‗hinge‘ on which rest three transformations that are key to development: rising living standards, greater productivity, and tighter social cohesion. Since jobs play a mediating role between opportunities and outcomes, the policy emphasis of the report will be on public interventions that stimulate the types of jobs that, all other things equal, increase living standards, raise aggregate productivity, and promote social cohesion. Source: WDR 2013 Board Paper. This chapter is organized as follows: the first part surveys the current landscape of Malaysia’s labor markets. It acknowledges positive developments in employment growth, rising educational attainment of the labor force, and the growth in skilled jobs, while noting where further improvements are needed. The second part is about increasing productivity and wages. It looks at the issue of skills provision, the role of a minimum wage, and of foreign workers in the wage structure. The third turns to the themes of inclusiveness and flexibility with security as characteristics of modern labor markets. Namely, it considers labor market regulations and discusses possible reforms to increase flexibility. It then considers existing social safety nets and the way forward. The final part provides an overview of the implications of a higher wage structure. It emphasizes the importance of the structural reform agenda to address productivity issues, without which higher wages can lead to diminished competitiveness. What is the current landscape of Malaysia’s labor markets? Malaysia’s working-age population is relatively young compared to other high- and middle-income countries, and well-educated compared to low- and middle-income countries. As shown in Table 8, as of 2009 over 60 percent of the working age population was under 40 years old, and over 35 percent was under 25 years old. Malaysia‘s working age population is not expected to start declining until after 2060 (see Figure 57), whereas countries such as Thailand and China can expect to see declines in their working age population in 2021 or sooner. About 57 percent of the workforce has some form of secondary education certification and 14.4 percent has a post-secondary certification, with over 5 percent having a tertiary education degree. This is in line with countries of similar income level and higher than other ASEAN nations such as Vietnam and Indonesia, but below the levels of OECD countries (Figure 58). Finally, there are clear regional disparities. For example, the working age population in East Malaysia, especially Sabah/Labuan, has less education than that of Peninsular Malaysia (see Table 8). Figure 57. Malaysia’s population is young... Figure 58. ... and relatively well educated Projected growth rate of working age (15-64) population, percent Share of the population 25+ with completed tertiary education, percent 2.5 18 Malaysia Thailand 2.0 China Republic of Korea 16 2005 2010 14 1.5 12 1.0 10 0.5 8 0.0 6 4 -0.5 2 -1.0 0 -1.5 -2.0 2011 2016 2021 2026 2031 2036 2041 2046 2051 2056 Source: UN Population Projections. Source: World Bank EdStats. MALAYSIA ECONOMIC MONITOR APRIL 2012 » 42 Table 8. Working Age Population as of 2009 Peninsular Sarawak Sabah and Total Labuan General Demographics Male 50.3 49.4 50.0 50.2 Malaysian Citizen 95.6 96.5 75.6 93.7 Never Married 46.8 42.7 47.3 46.5 Married 48.9 53.4 48.9 49.3 Widowed 3.3 2.7 2.6 3.2 Divorced / Separated 1.0 1.1 1.2 1.0 Highest certificate obtained Not Applicable 3.6 10.2 13.1 5.1 No Certificate 10.0 12.8 16 10.8 UPSR/UPSRA or equivalent 11.5 17.1 17.9 12.6 PMR/SRP/LCE 23.9 24.3 20.8 23.7 SPM/MCE 35.3 27.6 22.5 33.4 STPM/HSC or equivalent 2.9 2.4 2.9 2.9 Certificate 1.5 0.8 0.9 1.4 Diploma 5.4 2.3 2.6 4.8 Degree 5.8 2.6 3.4 5.3 Age 15-24 37.7 37.2 43.4 38.2 25-39 26.2 25.9 25.8 26.1 40-44 23.3 23.7 21.9 23.2 55-64 12.8 13.1 8.9 12.5 Source: DOS – Labor Force Survey 2009. Note: The Labor Force Survey does not sample collective housing. All figures are percentages using LFS sample weights. Employment growth has lagged population growth since 2000 but the unemployment rate has remained low and stable as more young men and women entered tertiary education rather than the labor force. Between 2000 and 2010, Malaysia experienced growth in employment, but even faster growth in the working age population (Figure 59). The adult population grew by an average of 2.9 percent annually over this period, while employment grew by an average of 2.3 percent. The unemployment rate remained stable at around 3.3 percent as the labor force participation rate declined during the period from 65.3 percent in 2000 to 62.7 percent in 2010 (Figure 60). This was largely due to a decline in the participation rate of men, and corresponds to an increase in tertiary enrollment ratios for young men during the period. The labor force participation of men aged 20–24 dropped from 85.4 percent in 2000 (above the overall male labor force participation rate of 83 percent) to 72.4 percent (well below the overall labor force participation rate for men of 78.7 percent, see Figure 61). Meanwhile, labor force participation of women aged 20–24 also declined (by 10 percentage points), but this was offset by higher participation of women aged 25–39 so that overall the labor force participation of women was largely unchanged (Figure 62). The decline in labor force participation from young men and women was likely associated with an increase in enrollments in tertiary education (Figure 63). Women‘s gross enrollment ratio increased nearly 20 percentage points between 2000 and 2009, while men‘s enrollment ratios climbed 10 percentage points. Table 9 summarizes the characteristics of the Malaysian labor force as of 2009. 43 « MALAYSIA ECONOMIC MONITOR APRIL 2012 Figure 59. Employment grew less than the working-age Figure 60. ...but unemployment was stable as population in the 2000s… participation declined…14 Index (1982=100) Index (1982=100) Difference in indices (bars and dotted line) Employment (1982=100) Empl. - Wk-age pop 230 Labor Fce - Wk-age pop 205 Work-age pop. (1982=100) 205 30 Employment (1982=100) 180 Labor Force (1982=100) 180 20 Empl. - Labor Fce 155 155 130 10 105 130 0 80 55 105 -10 30 80 5 -20 Source: DOS – Labor Force Survey Time Series Data, 1982-2010 Source: DOS – Labor Force Survey Time Series Data, 1982-2010 Figure 61. …because both young men… Figure 62. ...and women… Participation rate of men in the labor force, percent Participation rate of women in the labor force 100 100 90 90 80 80 70 70 60 60 50 50 40 40 30 30 2000 2000 (all ages) 20 20 2000 2000 (all ages) 2010 (all ages) 2010 10 10 2010 (all ages) 2010 0 0 15-19 20-24 25-29 30-34 35-39 40-44 45-49 50-54 55-59 60-64 15-19 20-24 25-29 30-34 35-39 40-44 45-49 50-54 55-59 60-64 Source: CEIC. Source: CEIC. Figure 63. … pursued further studies rather than join the labor force Gross enrollment in tertiary education, percent 50 Male 45 Female 40 35 30 25 20 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Source: UNESCO Institute for Statistics. 14 In Figure 60, the dark blue bars illustrate the excess growth of employment vis-à-vis the working-age population; light blue bars illustrate the excess growth of the labor force vis-à-vis the working age population (i.e. changes in the labor force participation rate). The difference between employment changes and changes in the labor force (red dotted line) translates into the change of the unemployment rate compared to 1982: as shown, the unemployment rate in 2010 was virtually the same as in 1982. MALAYSIA ECONOMIC MONITOR APRIL 2012 » 44 Table 9. Labor Force as of 2009 General Demographics Male 50.7 51.1 51.6 Malaysian Citizen 94.8 95.7 74.2 Nev er married 39.7 35.3 38.0 Married 56.2 61.0 58.3 Widowed 2.9 2.3 2.4 Div orced/Separated 1.2 1.4 1.3 Highest certificate Not Applicable 3.3 8.7 11.3 No Certificate 9.0 12.3 15.9 UPSR 12.5 17.8 18.6 PMR 18.4 19.2 17.1 SPM 37.7 29.1 24.8 STPM 3.6 3.3 3.5 Certificate 1.8 1.1 1.1 Diploma 6.8 4.0 3.8 Degree 7.0 4.4 3.9 Status Employment Not employed 3.3 4.6 5.6 Employer 3.7 2.8 2.7 Gov ernment Employee 13.5 14.8 13.5 Priv ate employee 59.9 49.9 54.6 Own Account worker 16.0 18.7 18.2 Unpaid family Worker 3.5 9.3 5.5 Age 15-24 28.2 27.8 32.2 25-39 34.7 34.8 36.5 40-44 10.0 10.4 9.6 55-64 10.4 10.4 7.3 Source: DOS – Labor Force Survey 2009. Note: The Labor Force Survey does not sample collective housing. All figures are percentages using LFS sample weights. Labor force participation, especially among women, is low by regional and international standards. Despite the increase in the labor force participation of women aged 25–49 noted above (and therefore the effective combined increase in participation in tertiary education and the labor force), women‘s labor force participation remains low compared to regional and higher income peers (Figure 64). Participation is relatively low at all ages and tends to decline after marriage (Figure 65). Unlike the ‗double-peaked‘ pattern observed in some countries, Malaysian women tend not to return to the labor force after marriage and child birth. In fact, Malaysia is the only country in the region that has a single-peaked profile of labor force participation for women. Although the combined enrollment in tertiary education and participation in the labor market have increased, many of Malaysia‘s peers have also experienced increases in tertiary enrollment while maintaining relatively higher labor force participation rate of women. 45 « MALAYSIA ECONOMIC MONITOR APRIL 2012 Figure 64. Women’s labor force participation is low Figure 65. Labor force participation of women peaks relative to other Asian and OECD economies before marriage and declines steadily thereafter Women’s labor force participation rate (percent) Women’s labor force participation rate (percent) 90 70 80 2000 2009 60 70 60 50 50 40 40 30 30 20 10 20 0 10 1980 1990 2000 2010 0 15-19 20-24 25-29 30-34 35-39 40-44 45-49 50-54 55-59 60-64 Source: World Development Indicators (WDI). Source: CEIC and ILO Laborstats. Most new jobs created during the past decade were in the services sectors. As a result, since 1980 the share of total employment in services sectors expanded from 39 to nearly 60 percent of total employment (Figure 66). Within services sectors, the financial sector posted the strongest employment growth (157 percent between 2000 and 2010), while community, social and personal services grew by only two percent (Figure 67). Meanwhile, the share of total employment in the agriculture sector fell by 25 percentage points to 13 percent. The industrial sector grew as a share of total employment between the 1980s and the 1990s, but since the early 2000s it has started to decline as well. Overall, between 1980 and 2009, the share of industry has increased from 24.1 to 27.0 percent of total employment. The reduction in agricultural employment towards industry and then services represents a natural transition path as Malaysia has moved up the income ladder. Figure 66. Employment shares in services increased… Figure 67. … with significant gains in finance jobs. Share in employment, percent Index based on number employed, 1982 total=100 300.0 Community, social and personal services 70 Agriculture Industry Services Finance, insurance, real estate and business services Transport, storage and communications 60 250.0 Wholesale and retail trade, restaurants and hotels Services 50 200.0 40 150.0 30 100.0 20 50.0 10 0.0 0 1980 1987 1994 2001 2008 Source: CEIC. Source: DOS – Labor Force Survey Time Series Data, 1982-2010. Note: Data up to 2009. Most jobs created over the past ten years have been for skilled professionals. With the growth in the services sectors and decline in the share of manufacturing in employment between 2000 and 2010, most jobs created in the past decade have been at the middle- or high-skill level (Figure 68). Professional occupations grew at an average pace of 5 percent per year while technicians and associate professional positions expanded at a similar pace of 4.3 MALAYSIA ECONOMIC MONITOR APRIL 2012 » 46 percent. Positions of plant and machine operators have declined at an average pace of 1.3 percent during the period. This suggests that labor markets have started moving in a modernizing direction. Figure 68. Most jobs created since 2001 have been Figure 69. … but the largest share of existing jobs is still skilled… relatively low-skilled New net jobs created between 2001 and 2010 by skill level (thousands) Number of jobs in 2010 by skill level (thousands) 1,000 6,000 910 900 826 4,934 5,000 800 Elementary 700 occupations 4,000 600 Plant and 3,188 3,007 machine- 500 3,000 operators and assemblers 400 Craft and 2,000 300 related trade workers 200 1,000 Skilled 100 agricultural and 37 fishery workers 0 0 High Skill Mid-skill Low-skill High Skill Mid-skill Low-skill Source: DOS – Labor Force Survey 2001, 2010. Source: DOS Labor Force Survey 2010. Note: ‗High Skill‘ includes legislators, senior officials, managers, professionals, technicians and associate professionals; ‗mid-skill‘ includes clerical workers, service workers and shop and market sales workers; ‗low-skill‘ includes agricultural and fishery workers, craft and related trade workers, plant and machine operators and assemblers, and elementary occupations. See also Footnote 15. But the majority of jobs in Malaysia, especially in the private sector, are still low-skill. 15 While the flow of new jobs has been towards skilled service-sector jobs, the largest portion of the stock of jobs in the Malaysian economy is still relatively low-skilled (Figure 69). Service and other retail workers are now the largest category of employment, comprising nearly 17 percent of jobs, but low-skill occupations still account for 44 percent of all jobs. In addition, considering that a majority of the 1.4 million jobs in the civil service would be classified as skilled or semi-skilled, among private sector jobs, only about one quarter would be classified as skilled, with another quarter as semi-skilled and about half as low-skill. Wage growth has been slow and lagged productivity growth in manufacturing, though service wages appear to be growing faster. Whereas labor productivity in manufacturing (measured simply as real value-added per worker) grew by an average of 5.0 percent per year over the past decade, real average manufacturing wages expanded by a much slower 2.4 percent per year during the same period (Figure 70). As a result, the estimated share of wages in manufacturing value-added has declined from 36 percent in 2000 to 26 percent in 2010. This could suggest that manufacturing growth has been largely capital-intensive, or that firms have wage-setting powers in labor markets. As would be expected given the rising commodity prices, wages in the commodity-related petroleum, palm oil and related industries rose the fastest among manufacturing sectors. Labor productivity in services expanded at a similar pace (4.7 percent) compared to manufacturing, but wages appear to have grown faster on average since 2005, when data become available (Figure 71). 15 This is not a standard definition of skill levels in Malaysia. Based on the Malaysian Standard Classification of Occupations (MASCO) 2008, only ―elementary occupations‖ are regarded as unskilled, with agricultural and fishery workers; craft and related trade workers; and plant and machine operators and assemblers generally regarded as mid-skilled. 47 « MALAYSIA ECONOMIC MONITOR APRIL 2012 Figure 70. Wage growth lagged productivity in Figure 71. … but grew faster in services manufacturing… RM per month, in constant 2000 prices RM per month, in constant 2000 prices (line) Year-on-year growth rate, percent (bars) 3,600 20 Value-added in Manufacturing y = 2074.7e0.0517x Average wages, Manufacturing 8,000 Average wages, E&E 3,000 15 Average wages, Petroleum, Palm Oil & Allied Industries 7,000 Average wages, other Manufacturing 2,400 10 6,000 y = 3866.6e0.0562x 5,000 1,800 5 4,000 3,000 1,200 0 Real Value-Added per Worker 2,000 600 Real Average Wage per worker -5 1,000 Real Value-Added per Worker y= 1410.7e0.0197x 0 0 -10 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Source: DOS, CEIC, and World Bank Staff calculations. Source: DOS, CEIC, and World Bank Staff calculations. There are substantial regional and other disparities in wage levels. Compensation is lower and informality higher in East Malaysia, especially in Sabah/Labuan where hourly wages are only 57 percent of the rate paid in Peninsular Malaysia. Young people (under 25 years of age) earn less than half as much as 40 to 54 year olds despite being more likely to be employed in a formal job. As Table 10 shows, earnings for the least educated are very low and their rate of informality very high. Lastly, wages in the primary sectors (especially agriculture) are the lowest. Manufacturing, on the other hand, pays RM2.3 more per hour, on average, than primary sector jobs, and the EPF and SOCSO extend pension coverage to almost 85 percent of all wage and salary jobs in the sector. The variation in compensation, hours worked and formality among groups (gender, region, age, level of education, and sector of activity) is also important. For example, men‘s base monthly compensation is on average 17 percent higher than women‘s total monthly compensation (and hourly compensation is 15 percent higher). Table 10. Compensation, Hours, and Distribution Share Formal: Base Monthly Total Monthly Total Weekly Total Hourly Share of Share Formal: Wage & Salary Compensation Compensation Hours Worked Compensation Employment All Jobs Jobs Women 1,246 1,331 44.0 7.41 33.5% 53.5% 68.0% Men 1,456 1,580 46.0 8.51 66.5% 46.5% 61.5% Peninsular 1,484 1,596 45.1 8.69 81.3% 37.9% 64.2% Sarawak 1,012 1,094 44.9 6.13 8.5% 30.9% 62.0% Sabah_and_Labuan 821 938 47.2 4.94 10.3% 31.1% 62.0% Age 15-24 790 854 46.1 4.55 20.6% 34.5% 67.8% Age 25-39 1,514 1,635 45.2 8.86 39.6% 33.4% 69.7% Age 40-54 1,705 1,844 44.8 10.14 29.7% 22.9% 57.3% Age 55-64 1,442 1,548 44.5 8.64 10.2% 9.3% 35.8% Completed Primary or Less 802 862 46.1 4.55 32.7% 9.6% 43.3% Completed Lower Secondary 987 1,059 46.0 5.60 15.3% 16.9% 58.1% Completed Upper Secondary 1,163 1,274 45.5 6.87 35.5% 22.3% 68.8% Completed Pre-Univ ersity 1,952 2,125 43.6 11.89 10.1% 25.0% 72.2% Completed Higher Education 4,111 4,358 42.7 24.29 6.4% 26.1% 73.4% Resource-Based Industry 952 1,027 44.7 5.62 8.4% 10.8% 44.1% Manufacturing 1,355 1,454 44.6 7.93 38.1% 55.0% 84.0% Serv ices 1,668 1,952 43.7 11.36 53.5% 34.2% 58.6% Source: DOS – Labor Force Survey 2009 (compensation, hours and employment share); HIS 2007 (share of formal jobs). Notes: Base Monthly Compensation, Total Monthly Compensation, and Total Hourly compensation are expressed in 2010 RM by using the CPI to convert the nominal 2009 figures. Figures refer only to wages and salaries received and do not include any residual income earned by entrepreneurs. Calculations include private employees and own-account workers for employment share, hours, and compensation. MALAYSIA ECONOMIC MONITOR APRIL 2012 » 48 Malaysia still derives much of its competitiveness from low-cost labor. As noted in the November 2011 Malaysia Economic Monitor, Malaysia does very well in the A.T. Kearney Global Services Location Index (ranking 3 rd out of 50 countries) because its business environment compares favorably against lower-income countries and labor costs remain much closer to lower-income countries than advanced economies (Figure 72). Meanwhile, China and India rank highly despite relatively poor business environments because they have high levels of skills. To some extent this is due to their large labor forces (a separate sub-index for availability of labor), but even focusing only on the experience and education sub-indices still shows these countries on par with advanced economies (see Figure 73). According to the Malaysia Productivity Corporation, industry profits are often derived not from innovation and creativity but from low wages. As Malaysia moves to becoming a high-income economy, the source of its competitiveness needs to shift to skills and the business environment and away from ‗cost competitiveness.‘ Figure 72. Malaysia’s greatest absolute advantage Figure 73. Malaysia’s indicators on labor costs are closer remains ‘cost competitiveness’ to lower-income countries Index (max = 10) Index (max = 10) 12.0 Malaysia USA Frontier Singapore 10.0 Exp. & Education ASEAN* Distance China India Malaysia 8.0 USA Singapore 6.0 Business Environment ASEAN* China India Malaysia 4.0 USA Singapore 2.0 Compensation ASEAN* China India Malaysia 0.0 Cost Business Environment Skills 0.0 2.0 4.0 6.0 8.0 10.0 Source: A.T. Kearney and World Bank staff calculations. Source: A.T. Kearney and World Bank staff calculations. Note: A high index for ‗cost‘ means lower costs. Note: ASEAN includes Thailand, Philippines, Indonesia and Vietnam. The low-cost production mode has been linked to a large inflow of low-skill foreign workers. Since the 1970s, the number of legally recruited foreign workers has increased exponentially, reaching around 2.06 million in 2008 or about 17.5 percent of the labor force (Figure 74). The number of migrants declined starting in 2009 due to the global financial crisis, and by 2010, the number of legal migrants in Malaysia was 1.8 million according to the Ministry of Home Affairs. As Figure 75 indicates, most foreign workers have low levels of skills and command low wages. About 35 percent of legal foreign workers were in the manufacturing sector in 2008, where they comprise over a quarter of the labor force.16 This is consistent with the previous argument that industrial activities in Malaysia still derive a large share of their competitiveness form low labor costs; in the absence of Malaysians to perform the tasks, and the upgrading to more skill-intensive tasks, firms have resorted to a growing use of foreign labor. Another way to view the growing participation of foreign workers is to contrast it with the growth in enrollment of young Malaysians in tertiary education. In a sense, foreign workers replaced the young men and women who in the past may have entered the labor force without acquiring additional education. 16 As noted later, the figures related to foreign workers obtained from the labor force survey differ markedly from official numbers from the Ministry of Home Affairs (published by EPU at http://www.epu.gov.my/populationandlabourforce). 49 « MALAYSIA ECONOMIC MONITOR APRIL 2012 Figure 74. The number of registered foreign workers Figure 75. Most foreign workers in Malaysia have low skill quintupled between 1999 and 2008 but fell since levels Thousands Foreign workers 2,500 800 Thousands 2,0452,063 700 1,918 2,000 1,8151,869 1,803 FORMAL INFORMAL 600 1,470 500 1,500 1,337 1,068 400 1,000 807 850 300 200 410 500 100 0 0 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Low Medium High Source: EPU, Ministry of Home Affairs. Source: DOS – Labor Force Survey 2009. Note: Includes legal migrants only. Malaysia’s labor regulations are generally flexible, except for redundancy costs. According to the World Economic Forum‘s Global Competitiveness report, Malaysia ranks 20 th in the world for labor market efficiency. Performance is not uniform, however. While Malaysia performs well in linking pay to productivity and having generally good cooperation in labor-employer relations, hiring and firing practices (especially redundancy costs) drag down the overall ranking (Figure 76). Moreover, the WEF report noted that ‗restrictive labor regulations‘ ranked the third most important obstacle to doing business in Malaysia according to survey respondents. Many of Malaysia‘s labor regulations have not changed since the country‘s independence and, as the NEM recognizes, some would benefit from being modernized. Figure 76. High redundancy costs are perceived as Figure 77. Informality appears in line with Malaysia’s reducing Malaysia’s overall competitiveness income level Ranking among 140 countries Log of GNI per capita (y axis); Size of the shadow economy, % of GDP (x-axis) Cooperation in 12 labor-employer relations 11 10 Pay and Flexibility of wage Productivity determination 9 15 28 4 Malaysia 8 19 30 7 Redundancy costs,104 Rigidity of weeks of salary employment index 6 R² = 0.5337 Hiring and firing 5 practices 4 Source: World Economic Forum (2011). 0 10 20 30 40 50 60 70 80 Source: Schneider (2005), WDI, World Bank Staff calculations. Social protection is not comprehensive and Malaysia lacks a formal unemployment insurance scheme. Social insurance in Malaysia comprises three programs: (i) a scheme for pensionable public service workers, funded by the budget; (ii) disability social insurance for private sector employees administered by SOCSO, and (iii) mandatory old- age savings plan for private sector workers administered by EPF. There are several issues with regards to social insurance in Malaysia, including: (i) the three schemes cover only about 60 percent of labor force, thus leaving a significant fraction of workers unprotected; (ii) EPF‘s contribution rate is very high by international standards and may adversely impact labor costs, competitiveness, job creation and wage reporting; and (iii) there is no income protection against unemployment in Malaysia. MALAYSIA ECONOMIC MONITOR APRIL 2012 » 50 The informal sector is estimated to account for about 30 percent of Gross National Income (GNI) and between 35 to 40 percent of all workers.17, In the absence of formal safety nets, the informal sector serves effectively as a ‗safety net‘ in many developing countries. In Malaysia, the informal economy includes a range of heterogeneous activities, from unregulated firms and salaried workers to undeclared or unpaid employment. Although estimates of informality are likely to be subject to significant uncertainty, Figure 77 suggests the size of the informal sector in Malaysia is in line with what would be predicted by its income level, but likely larger than in high-income countries Malaysia aspires to emulate. Some of the negative implications of informality include inferior working conditions for workers, a lack of formal benefits (health and pensions), low wages, and low productivity levels for firms.18 How to create higher wage jobs? Although measures to both pull and push wages higher can help create higher wage jobs, pulling wages higher through more and better skills and higher productivity growth should be the main policy focus. The earlier discussion suggests that two tracks should be considered to raise the wages of Malaysian workers: the most important is to boost the volume and quality of skills in the labor force to pull wages higher through higher productivity growth. In addition, to the extent that multiple equilibriums exist and market imperfections are contributing to a low-wage equilibrium, push measures, such as well-designed minimum wage and migration policies, can also help. But it must be noted from the outset that push measures must be accompanied by structural reforms to address fundamental issues in the enabling environment for firms to switch to higher value-added activities that create demand for well- paid workers. Inadequate supply of skills in the labor market is a key factor limiting industrial upgrading19 and provides support to the low-wage/simple-task equilibrium, as relatively slow growth in opportunities for skilled workers reduces incentives for acquiring skills or for using them in Malaysia20, which in turn further reduces firms‘ incentives for upgrading. Boosting the quality of skills in the labor force is crucial Wages are linked to productivity. Although wages have not kept up with productivity over time in Malaysia, there appears to be a contemporaneous link between productivity and wages across regions (Figure 78), as well as across different types of jobs (Figure 79). The link between pay and productivity varies across sectors of activity, but is always positive and statistically significant. As shown in Figure 79, the link is strongest for production workers compared to other types of employees in some sectors (manufacturing food and beverages, including palm oil; plastic, glass and non-metals), and strongest for non production workers in others. The average elasticity across sectors for which estimates were possible lies between 0.58 (managers and supervisors) and 0.69 (non production workers). There is also a robust correlation between skill levels and wages. As shown in Table 10 and Table 11, higher levels of formal education are associated with higher wages in Malaysian labor markets. A university graduate can expect to earn wages nearly 5 times higher than a worker without any formal education. This relationship is confirmed by regression analysis, which suggests that completing a university education increases earnings by an average of 88 percent compared to someone who did not complete university, even when controlling for other characteristics. The median income of graduates 18 months after graduation is about RM2,100 per month and is RM2,300 per month a year later (Table 12). This is actually an extremely high level of financial achievement, because bachelor‘s students‘ families have an average income of RM2,100 per month. Thus, one can infer that bachelor‘s degrees 17For the purposes of this report, employment in the ―formal sector‖ is defined as holding a job for which the employer makes EPF or SOCSO contributions. DOS estimates that 8 to 9 percent of workers are in the informal sector based on the Informal Sector Survey. This lower figure excludes agricultural and household employees, which are considered informal in this report. The definition of informal economy used here refers to the share of a country‘s production of goods and services that does not comply with Government regulation. 18 Labor informality in Malaysia is primarily a micro and small firm phenomenon (Mohammed, 2004). Smaller firms are often engaged in low-productivity operations with limited access to finance, limited need of key Government services, and a relatively large informal customer base. The April 2010 Malaysia Economic Monitor – Growth through Innovation identifies talent, technology and finance as the requisite 19 capabilities required for innovation-led growth. 20A comprehensive discussion of issues related to the incentives for Malaysians to use their skills abroad rather than in Malaysia can be found in the April 2011 Malaysia Economic Monitor on ‗Brain Drain.‘ 51 « MALAYSIA ECONOMIC MONITOR APRIL 2012 bring great benefits to their holders: after only two years in the labor market, bachelor‘s holders already have salaries equal to their parents‘ combined income. Figure 78. Wages are linked to productivity by region Figure 79. Across different types of jobs, compensation is linked to productivity Productivity (left axis) and hourly wages by state (right axis) Link between Total Compensation and Productivity, by Sector and Type of Job 1.2 140,000 12 Production Workers Value-added 1.0 120,000 Correlation = Non-Production Workers per worker 10 0.95 0.8 Managers and Supervisors 100,000 (Highly Wage per significant) 8 hour 80,000 0.6 6 60,000 0.4 4 40,000 0.2 20,000 2 0.0 0 0 Source: DOS – Labor Force Survey 2009 and Establishment Source: Establishment surveys (various years) and World Bank staff Surveys (various years). calculations. Note: Hourly wage data include formal and informal jobs, value added per worker only calculated on formal (registered) establishments. Table 11. Degree recipients receive wages 5.5 times higher than those with no formal education Total Basic Total salaries and salaries and salaries and wages including wages wages overtime payment UPSR/UPSRA or eq. 800 750 800 PMR/SRP/LCE 900 800 950 SPM/MCE 1200 1000 1200 STPM/HSC or eq. 1568 1218 1597 certificate 1500 1232 1515 diploma 2355 2000 2400 degree 3350 2905 3350 not applicable 560 500 600 no certificate 725 700 750 Source: DOS – Labor force survey, 2009. Table 12. Wages increase with education levels, but the largest rewards come from tertiary education. Total Basic Total salaries and salaries and salaries and wages including wages wages overtime payment no formal education 560 500 600 primary 750 700 789 secondary 1065 950 1121 tertiary 2538 2148 2600 Source: DOS – Labor force survey, 2009. The links between skills and wages, and between productivity and wages, suggests a relationship between skills and productivity. Although the causality has not been established in the Malaysian case, international evidence supports the hypothesis. Research by Moretti (2005) using US data finds that a one-percent increase in the city share of college graduates is associated with a 0.5-0.6-percentage-point increase in output. Moretti also finds that MALAYSIA ECONOMIC MONITOR APRIL 2012 » 52 productivity gains are translated into higher wages for workers: an extra percentage point in the share of tertiary- educated workers in a city is associated with 1.3 percentage points in higher wages, after controlling for individual observable characteristics. Similarly, Glaeser and Ressenger (2009) find that productivity in skilled cities was much higher than in unskilled cities. Table 13. Distribution of Bachelor’s-level Graduates by Income Band, at 18 and 30 months after the end of classes (graduating classes of 2006 and 2007) 18 months 30 months RM500 or less 1% 1% RM501-1000 8% 6% RM1001-1500 16% 13% RM1501-2000 20% 15% RM2001-2500 29% 25% RM2501-3000 17% 23% RM3000+ 10% 18% Source: Ministry of Higher Education – Laporan Kajian Pengesanan, Graduan SKPG II 2008/9. The quantity of skills of the work-force has increased but remains low compared to aspirational high-income countries. Between 2000 and 2010, tertiary graduates joined the labor force at a rate of 7.3 percent per year (net of tertiary graduates leaving the labor force; see Figure 80). This resulted in the share of university graduates in the labor force going up by 10 percentage points to nearly 25 percent. However, compared to the high-income countries Malaysia aspires to emulate, these are still relatively low levels. For example, 35 percent of Korea‘s labor force had a tertiary education in 2007 (Figure 81). Moreover, as noted in the November 2010 Malaysia Economic Monitor, low educational endowment and skills level is particularly pronounced among the poor. About 62 percent of poor households were headed by a person with primary education or less, and only 1 percent of poor households had a head with a tertiary level of education. This implies that, even if labor market opportunities in higher paying sectors become available, many of the poor will be unable to take advantage of them. Figure 80. The share of university graduates in the labor Figure 81. … but remains below that of advanced force increased rapidly in the past decade… economies and even some regional peers Labor force composition by highest level of education Tertiary-educated workers in the labor force in 2005 – 2007 (percent) 40 100% 90% 35 80% 7.3 pct CAGR 30 70% 25 60% Tertiary 20 50% Secondary 15 40% Primary 10 30% No formal 5 20% education 10% 0 0% Sources: DOS. Source: World Bank EdStats. One priority is therefore to increase the supply of skills by targeting underserved areas and groups. Although enrollment rates have increased rapidly in the past decade along with the share of graduates in the labor force, as Figure 82 indicates other countries also continue to expand their enrollments. OECD enrollment ratios, which have stabilized at 62 percent, are still 22 percentage points above Malaysia‘s. This will require expanding enrollment in 53 « MALAYSIA ECONOMIC MONITOR APRIL 2012 higher education, especially through private universities and targeting groups that lagged the enrollment growth in recent years.21 In this context, the Government must at the same time ensure access and financing, where necessary, for students to be able to take advantage of private higher education, as well as mechanisms to ensure quality control for private universities. Growing the private higher education sector, including through new partnerships with foreign universities, could support the objective of expanding enrollments further. Targeting underserved areas and groups can bring the largest gains. As noted in Table 8 above, Sabah‘s population has a lower educational attainment compared to peninsular Malaysia, suggesting room for quick improvements. Figure 82. Enrollment ratios need to rise further for Figure 83. Boosting the quality of education, especially Malaysia to catch up basic education, remains a key challenge Gross tertiary enrollment, percent Average scores 120 Asean Median China 600 OECD-Science OECD-Math Malaysia Turkey Thailand Chile OECD-Reading Science 100 OECD Median Korea 550 Math Reading 80 500 450 60 400 40 350 20 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Source: World Bank EdStats. Source: OECD. Note: Malaysia values for 2010, all others 2009. As important as increasing the supply of skills is ensuring that there is robust demand to retain skills in Malaysia. The large numbers of skilled Malaysians who choose to work abroad suggest that retaining talent is a key challenge. Addressing structural challenges in the economy will be necessary to ensure that companies will take advantage of the increased availability of skills. This will require companies to pay for skills, which in turn increases incentives to retain skills in Malaysia. Structural challenges relate to increasing competition within the economy to drive innovation and productivity growth. SMEs, which would be expected to make a large contribution to the demand for skills, are squeezed between large multinationals, Government-linked companies, and cumbersome regulation. Modernizing the Government‘s inclusiveness policies towards need-based criteria would also effectively remove what is effectively a tax on firms and individuals. As the quantity of graduates increases, it is important to make parallel efforts to improve the quality of skills produced by the educational system, starting with basic education. The concerns with the quality of basic education in Malaysia are well-recognized. As noted by EPU, there remain significant gaps to close in order to achieve a first-world talent base with Malaysia increasingly at risk of falling behind. Student performance, as benchmarked by international surveys, has been declining. In the TIMSS 2007 report, around 20 percent of Malaysian students failed to meet minimum benchmarks for both Science and Mathematics, compared to only 5 percent in science and 7 percent in Mathematics in 2003 (Tenth Malaysia Plan, p. 193). The results of the recent PISA+ assessment were also a concern (Figure 83) as Malaysia performed significantly below OECD average levels. There are also significant urban-rural disparities in test results that suggest that as with increasing quantity, targeting underserved areas and groups can bring the largest payoffs in quality improvements as well. Higher quality education will require greater autonomy for individual schools and universities. Accountability requires frequent and rigorous assessments of the quality of education. This can be accomplished through a 21MOHE expects 50 percent of the cohort between the ages of 17-23 to be in tertiary education by 2020, with the number of private institutions increasing to 29 private universities, 22 university colleges, 6 branch campuses and 411 private colleges. MALAYSIA ECONOMIC MONITOR APRIL 2012 » 54 comprehensive, ICT-based, assessment system that is used for diagnostics, policy analysis, planning, and monitoring of teacher and school effectiveness. The Government has moved in this direction by ranking all the schools in the country and working with low-performing schools to improve their performance under the NKRA on education. While this is a promising step, disclosing the rankings of individual schools (within bands), as is done with universities, would help empower the communities in which schools are located to demand equal access to quality services. This is likely to be particularly effective in rural areas. A parallel step is to provide schools with greater autonomy. Compared to the 23 countries covered by the 2009 OECD‘s Teaching and Learning International Survey (TALIS), Malaysia ranks poorly in terms of delegation of authority to schools (Table 14). In this regard, the Government may wish to pilot systems of increased school autonomy, including delegation of authority for hiring and firing staff and greater control of the budget, as well as the option of increased use of contract teachers. The same logic flows through to universities: greater accountability (such as through the refinement of rankings to include standardized university-wide tests) and autonomy can help ensure that the expansion in enrollments in higher education is producing quality graduates. 22 Table 14. School autonomy at lower secondary – TALIS 23-country study Malasia 23 Country Rank Malaysia Korea Talis Average of 23 1 Selecting Teachers 6.9 31.2 67.7 23 2 Firing Teachers 6.8 20.8 60.7 23 3 Establish Teacher Salaries 4.0 5.7 24.3 18 4 Determine Salary Increases 11.4 3.5 25.6 15 5 Professional Development 33.8 63.2 60.3 17 6 Formulate School Budget 68.8 77.3 75.3 17 7 Allocations within budget 62.5 94.9 88.2 21 8 Discipline Policies 56.7 56.7 93.1 23 9 Assessment Policies 21.6 91.1 88.9 23 10 Admission Policies 21.6 85.8 85.0 23 11 Course Offering 35.4 88.7 72.2 22 12 Course Content 33.3 85.4 65.7 20 13 Choosing Textbooks 19.0 96.7 90.0 23 Average 29.4 61.6 69.0 20.6 Source: OECD (2009, Table 2.7) and World Bank staff calculations. In addition to the quantity and quality of skills, the types of skills produced by the education system are also important. As the price of automating certain types of tasks declines, skills related to procedural, rule-based tasks will tend to decline in value (Acemoglu and Autor, 2010). On the other hand, the productivity of those jobs which are complementary to automation and technology more generally is increasing rapidly (Figure 84). Such jobs require the performance of non-routine tasks, especially analytical, creative and interpretive skills that cannot be automated. In addition, manual but non-routine tasks have also seen their returns increase even as similar but more standardized manual tasks have stagnated (Figure 85). This has important implications for curriculum reform: memorization and rote learning are not particularly suitable for modern jobs. Rather, as noted in Table 15 below, curricula—as well as teacher training—need to emphasize critical thinking over memorization and a greater role for the development of soft skills such as communication and interpersonal skills through sports or other team activities. Employers report that Malaysian workers are weak in soft skills such as communication, creativity, innovation, team work and leadership (Malhi, 2009). To address these concerns, as part of the SRI on human capital the Government has recently announced changes to National Occupational Skills Standards(NOSS) and university curricula to include finishing classes and soft skills training. Public and private universities are rated by the Malaysian Qualifications Agency and the ratings are public. Private colleges and 22 polytechnics are also rated periodically. In terms of autonomy, five of the public research universities, namely UKM, USM, UPM, UM and UTM have been given autonomy in areas related to governance, financial and income generating, human resource and academic management as well as students‘ intake. Private higher education institutions at all levels are fully autonomous. 55 « MALAYSIA ECONOMIC MONITOR APRIL 2012 Figure 84. There has been an increase in demand for Figure 85. While returns to routine tasks (such as basic tasks complementary with technology auto mechanics) have stagnated Change in percentile mean task input (percent) Wages per hour of US mechanics performing different tasks, current USD Sources: McKinsey Global Institute (2009) based on Autor, Levy Source: McKinsey Global Institute (2009). and Murnane (2003). Table 15. Non-routine skills will be increasingly demanded as routine skills are automated. Non-routine cognitive: Non-routine cognitive: Non-routine manual Skills Analytical Interpersonal Routine cognitive Routine manual physical Establishing and Importance of Operating v ehicles, Analyzing maintaining personal repeating the same Pace determined by mechanized dev ices, data/information relationships tasks speed of equipment or equipment Spend time using Guiding, directing and hands to handle, Tasks motiv ating Importance of being Controlling machines control or feel objects, Thinking creativ ely subordinates exact or accurate and processes tools or controls Structured v . Interpreting Coaching/dev eloping Unstructured work Spend time making information for others others (rev erse) repetitiv e motions Manual dexterity Spatial orientation Examples of occupations Industrial truck demanding high levels of Lawyers, engineers, higher education Telephone operators, Assembly line worker, operator, security, food these skills professionals, medical doctors, managers book keeping, cashiers elev ator operator preparation Source: Acemoglu and Autor (2010). A related concern regarding types of skills produced by the educational system is ensuring that they match requirements from firms. According to the 2007 Productivity and Investment Climate Survey (PICS), Malaysian firms also view shortages of non-routine skills as key constraints (Figure 86). Such shortages have led to job vacancies. More than 40 percent of firms have reported vacancies of skilled production workers, and the average time to fill a vacancy is about four weeks (World Bank, 2009). The main reasons given by the firms for this long process were that the applicants did not have the required basic skills or the right technical skills needed to carry out the jobs in question (Figure 87). Lacking choices, firms often hire workers who do not have the appropriate skills for the job. The 2007 PICS shows that many workers lack the appropriate level of education for their jobs or their skills don‘t match what they were hired to do. Only 10-15 percent of workers believed their chosen field of education suited their current job; likewise, more than 15 percent believed their educational qualifications were irrelevant to their current occupation. Not surprisingly, the PICS found that shortage of skills is the top obstacle to firms, with about 40 percent of participating firms reporting this as one of their top three constraints. MALAYSIA ECONOMIC MONITOR APRIL 2012 » 56 Figure 86. Firms generally identify non-routine and other Figure 87. Applicants’ lack of skills leads to job soft skills as a key constraint vacancies Percent of firms Percent of firms reporting 80 Information technology 48.0 English language 45.8 70 Manufacturing Communication 36.9 60 Creativity/innovation 29.9 Services Technical/professional 28.3 50 Problem solving 25.0 40 Numerical 24.1 30 Time management 23.3 Leadership 21.9 20 Adaptability 17.5 10 Social 13.7 0 Teamworking 9.8 Universities are not Applicants do not have Applicants do not have producing sufficient required basic skills required technical 0 10 20 30 40 50 graduates skills Source: World Bank (2009). Source: World Bank (2009). Further evidence of skills mismatches come from the employment outcomes of tertiary graduates. Given the shortages reported earlier, one would expect very low unemployment rates for graduates in the absence of skills mismatches. The results—shown below in Table 16—suggest that graduate unemployment is relatively high23: on aggregate 17 percent among bachelor‘s graduates at public universities and 19 percent among bachelor‘s graduates of private ones, with substantially higher rates at lower levels of certification. High unemployment among graduates is not unheard of – in most developed countries, youth unemployment runs at least twice the level of overall unemployment, for instance. And nor is it unheard of to have high unemployment among graduates in countries with a rapidly expanding system of education: see in particular recent reports from China with respect to graduate unemployment rates of 20 percent or higher. Nevertheless, rates such as these in the context of overall unemployment of 3 percent are indicative of some degree of skills mismatch. Table 16. Employment Status of 2006 and 2007 Graduates at the end 2008, By Institution Type and Level IPTA IPTS Bachelor's Below Bachelor's Bachelor's Below Bachelor's Employment Status Level Level Level Level Employed 73.1% 46.8% 77.5% 57.2% Waiting for placement 3.1% 0.7% 0.4% 0.5% Pursuing further study 6.6% 27.4% 2.9% 11.4% Unemployed 17.1% 25.1% 19.1% 30.8% Source: Ministry of Higher Education – Laporan Kajian Pengesanan, Graduan SKPG II 2008/9. High graduate unemployment even in science and business are further indication that curricula are not meeting firms’ needs. Table 17 decomposes the data in Table 16 somewhat to look at whether or not the differences by sector are explainable by the composition of enrollment. When decomposed by field of and level of study, we find that the IPTS sector has a weaker record than the public sector in all cells except Science at the Bachelor‘s level. The gap would appear to be especially large in Arts and Business at the Bachelor‘s level (a sector which in the IPTS 23Every second year, the Ministry of Higher education conducts two surveys, one of graduates-to-be, as well as a follow-up survey 18 months after graduation. This incorporates information about the first 18 months of students‘ time in the labor market and provides insights regarding the matching of skills. The survey results do not appear to distinguish between ―unemployed‖ in the sense of being unable to find a job and ―not employed‖ in the sense of not participating in the labor market due to having children, etc. The translation ―unemployed‖ is retained here even though it seems likely that some of the people should not technically be described that way. In addition, it should be noted that 2008 figures may reflect the impact of the global financial crisis and therefore exaggerate unemployment figures. 57 « MALAYSIA ECONOMIC MONITOR APRIL 2012 sector is almost exclusively ‗business‘). Interestingly, the only category with low unemployment is education, where graduates are virtually guaranteed a position with the government. Table 17. Graduate Unemployment Rates 18-30 Months after End of Classes by Discipline, Level and Type of Institution IPTA (Public) IPTS (Private) Field of Study Bachelor's Level Below Bachelor’s Bachelor's Level Below Bachelor’s Arts/Business 22.9% 28.4% 28.2% 35.4% Science 16.6% 23.4% 13.2% 26.4% Technical 11% 20% 11.6% 28% ICT 13.4% 28.7% 16.8% 30.8% Education 0.6% - - 50% Source: Ministry of Higher Education – Laporan Kajian Pengesanan, Graduan SKPG II 2008/9. Limited private sector involvement in skills provision contributes to skills mismatches. A recent assessment of the Malaysian National Dual Training System has yielded some insight into why skill training programs remain mismatched with industry in Malaysia (Pang, 2010). The NDTS was modeled after the very successful German vocational training system. However, the study found that the two systems are very different in one critical respect – the role played by the private sector in shaping the program. In the Malaysian system, unlike the German one, the Government plays a critical role in developing, funding, implementing, and overseeing the system, while the private sector plays a supportive role. In terms of coordination and quality control, the Malaysian system is centralized, mostly through the Economic Planning Unit (EPU) and the Department of Skills Development, with no role for employers and workers organizations. Improving the take-up and quality of technical and vocational education and training (TVET) can also help bridge the skills mismatches. Despite the seemingly comprehensive approach to vocational training in Malaysia, the take- up rate of TVET opportunities is low.24 A recent study attributed the low and declining take-up rates partly to the fragmentation of the training system, which overwhelms students and parents as they lack the necessary information in order to make informed decisions among the plethora of available options. It also pointed out that the quality of the training offered is very variable, which leads industry to distrust the qualifications produced by the vocational training sector as a whole (EPU, 2009). Similarly, a past study found that the complicated financial schemes available for vocational training in Malaysia may have led to low take-up rates by students (Tzannatos and Johnes, 1997) Developing an employer-led skills development system will be an important step in improving the performance of Malaysia’s TVET system. The Government could consider adopting measures to encourage employers or industry representatives to participate in the skills standard and certification process, designing the curriculum, providing apprenticeships, and offering internship and scholarship programs to workers to improve their skills. As Figure 88 and Figure 89 indicate, the needs of industries vary greatly and change significantly over time. Therefore, it is only when those industries and employers are closely involved in training decisions that the training system can respond effectively to their needs. 24MOHE is in the process of finalizing the framework of TVET‘s pathway in which students from Certificate level are allowed to continue into Diploma and degree programs through the MTUN (Malaysia Technical University Networks). MALAYSIA ECONOMIC MONITOR APRIL 2012 » 58 Figure 88. English proficiency is less of a concern in Figure 89. …whereas firms in business support services manufacturing… require more of that skill Percent of firms Percent of firms 0% 20% 40% 60% 0% 20% 40% 60% English Proficiency English Proficiency Communication Communication Social Social Teamworking Teamworking 2002 2007 2002 2007 Leadership Leadership Time Management Time Management Adaptability Adaptability Creativity/Innovation Creativity/Innovation Numerical Numerical Problem Solving Problem Solving IT IT Technical/Professional Technical/Professional Source: World Bank (2009). Source: World Bank (2009). In sum, improving the quantity, quality and type of skills provided in Malaysia will require greater information, incentives and capacity. Parents and employers need better information on the performance of skills providers at all levels to hold them accountable for improved performance. Skills providers require better information on skills demand, R&D and technology needs, and entrepreneurship opportunities. Policy makers need better information on why some programs are failing to perform – highlighting the importance of constant monitoring and evaluation. This requires better communication and engagement between employers, Government and skills providers. The private sector needs to be more involved in the provision of skills, including financing it, so that it has more of a stake in its success. Skills providers will have incentives to perform better if their performance is more transparently communicated to the public, and if there are consequences for non-performance. Greater autonomy to schools and universities can create more competition and also provide better incentives for performance. Finally, teachers need to be retrained to teach a more problem-oriented and analytical curriculum that also emphasizes soft skills. Firms need adequate capacity to signal the demand for specific skills and influence skills development policies and curriculum development. The capacity of the Government in policy formulation and implementation, including quality assurance and enforcement, will also be critical. A well-implemented minimum wage can help A minimum wage policy is likely to be announced in the first half of 2012 and, if well implemented, can help push up wages. It has been reported that the Government will announce a minimum wage in the first half of 2011 (ETP Annual Report 2011). This section briefly reviews the rationale for a minimum wage in Malaysia, its potential impact, and offers some considerations on the implementation process. In a nutshell, a well-implemented minimum wage can help push up wages by correcting labor market imperfections and moving Malaysia to an equilibrium of higher wages and higher productivity—though possibly at the cost of slightly higher unemployment or informal employment. Adequate implementation is critical, as long-term predictability regarding minimum wage revisions is likely to be as important to firms as the current level of the minimum wage. A minimum wage can help correct imperfections in labor markets. When firms face limited competition in labor markets they may be able to pay workers lower wages and keep some workers out of the labor force. There is some evidence of such wage-setting power by firms considering that productivity growth has not been linked to wage growth in some sectors and over time. The declining labor participation rate and growing numbers of foreign workers contribute to the view that firms can keep some local workers unemployed (or out of the labor force) while tapping on large supplies of low-wage foreign workers. It is also possible that a minimum wage can lead to some productivity improvements. If it is costly to supervise workers' performance, it may be optimal to pay a higher wage and supervise more sporadically. A higher wage increases the cost of losing the job from the worker's point of view, and increases incentives for effort (and higher productivity) even with more limited supervision. In this context, a minimum wage would help markets move to an equilibrium with higher wages and higher productivity. Georgiadis 59 « MALAYSIA ECONOMIC MONITOR APRIL 2012 (2007) finds evidence of such a wage-supervision trade-off in the context of the introduction of a minimum wage in the UK in 1999. A minimum wage is not an effective instrument to address poverty and inequality. Policymakers have often argued that the minimum wage, by increasing the income of low-income workers, can be used as a tool to reduce poverty and inequality. However, evidence suggests that even though a well implemented minimum wage at a moderate level can have positive social welfare effects, it is not the most appropriate instrument to address poverty and inequality. Indeed, many poor people are not employed or are employed in the informal sector where minimum wages are not binding. Also, poor people often have limited skills and low productivity and thus tend to be among the first to be laid off when wages increase in line with the legislation. Nor is a minimum wage the right policy to stimulate the productivity of firms. A minimum wage policy can cause low-productivity firms that cannot afford the higher cost of labor to go out of business, and this may result in an increase in the average productivity in the economy. However, if the objective is to provide incentives for innovation, the adoption of new technologies, and economic diversification that truly contributes to higher productivity growth across business and sectors, then other policies may take priority. These might include investing in skills and infrastructure and improving the business environment in ways that encourage competition, investment, and entrepreneurship. Workers with the lowest earnings—those most likely to benefit from a minimum wage—are largely those who work in agriculture and other sectors intensive in low-skill labor that are also characterized by a high degree of informality. Figure 90 illustrates that the typical wage in agriculture was under RM600 in 2009, while other labor intensive sectors such as textiles, furniture, and food also exhibit relatively low wages. Workers in the modern services sectors have the highest earnings on average, and those in the manufacturing sector fall in between (see Figure 90 and Figure 91). Jobs in labor-intensive sectors including agriculture pay only slightly more than RM1,000 per month on average, but only 15.3 percent of these jobs are formal. On the other hand, jobs in the manufacturing sector pay over RM1,450 per month on average, and over three-quarters of those jobs are formal. Therefore, while most potential beneficiaries from the minimum wage may be in wood products, agriculture, and restaurants (Figure 92), they may not be covered: the impact on these workers would depend on whether low wages were due to workers‘ low productivity or their limited market power, and on the enforcement or influence of the minimum wage in informal labor contracts. Workers in the services sectors, with the possible exception of restaurant workers, are less likely to be affected as typical wages already exceeded RM1,000 per month in 2009. Due to the significant geographic variation in wages (Figure 93), at a level of RM 700 per month (in 2010 prices) up to 30 percent of workers in Peninsular Malaysia would potentially benefit from the introduction of the minimum wage, whereas as many as half of those in Sabah and Sarawak would. Figure 90. Median wages in petrochemicals are the Figure 91. Wages in services are generally higher than highest of the resource intensive sectors in manufacturing and agriculture Median wages by sector (RM per month) Median wages by sector (RM per month) Construction Culture, news, entertainment Utilities Organizing & associative acts Mfg of transport equipment Health and Social Work Mfg elec equip and electronics Education & training svcs Mfg of paper, publishing Administration, other govt svc Mfg of furniture and mfg NEC Bus & prof services (not IT) Mfg textiles, apparel, fur IT services Rubber based industry Finance, insur & real estate Mfg chem & prods (incl pharma) Logistics(rental,transp,trav) Restaurants, bars & canteens Petrochemicals Tourism (excl travel ag,tours) Mining & extractive industries Distributive trade Mfg food & bev (inc palm oil) Sale, repair, rent motor veh Ag, fishing and forestry 0 1000 2000 3000 0 1000 2000 3000 4000 Source: DOS – Labor Force Survey 2009. Source: DOS – Labor Force Survey 2009. MALAYSIA ECONOMIC MONITOR APRIL 2012 » 60 Figure 92. Labor-intensive, low-skill sectors would be Figure 93. There is significant geographic variation in more highly affected by the minimum wage the concentration of low income earners Share of workers earning less than various wage levels Share of workers earning less than various wage levels (total compensation) Mfg wood & prods excl furn W P Putrajaya W P Kuala Lumpur RM 700 Ag & fishing & forestry Selangor RM 800 Restaurants & bars & canteens RM 900 Pulau Pinang RM 1000 Johor Mfg food & bev inc palm oil RM 1100 Negeri Sembilan RM 1200 Mfg textiles & apparel & fur W P Labuan Melaka Distributive trade Terengganu Rubber based industry Sarawak RM 600 Perak Plastic & glass & non metal NEC RM 700 RM 700 Kedah RM 800 RM 800 Sale & repair & rent motor veh Pahang RM 900 RM 900 RM 1000 Sabah Mfg of furniture & mfg NEC RM 1000 RM 1100 Kelantan RM 1100 Construction RM 1200 Perlis 60% 70% 80% 90% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% Source: DOS – Labor Force Survey 2009. Note: Base monthly compensation is expressed in 2010 RM by using the CPI to convert the nominal 2009 figures for private sector employees only (excludes non-wage earners and public sector employees). All earnings are converted to full-time equivalent values. All figures are percentages for the state using LFS sample weights. The potential negative impact of the minimum wage on firms and employment will depend on the degree of competition in labor and product markets, the extent of enforcement especially in the informal sectors, as well as productivity dividends. To the extent that labor markets were at a low-wage, low employment equilibrium, the introduction of the minimum wage may have a positive employment effect as some workers rejoin the labor force. However, to the extent that labor markets are competitive, higher labor costs would be passed along to consumers, and potentially lead in the reduction of employment. As noted earlier, most of the potential beneficiaries of the minimum wage are in sectors characterized by a high degree of informality. To the extent that enforcement in these sectors is limited, there would be few changes in employment even if firms do raise wages. A single minimum wage for all occupations facilitates compliance, but regional differentiation may be desirable to account for different productivity levels. Some countries differentiate the minimum wage by occupation. However, this has proven to be detrimental in terms of compliance and market distortions, so most countries are moving away from differentiating wage levels by occupation or sector towards having just one national level for the minimum wage. Regional differentiation in the level of the minimum wage should be based on productivity in each region and not the cost of living. As discussed above, the minimum wage is not meant to address insufficient purchasing power or poverty, but to the extent that different wages in different regions are linked to different productivity levels, different minimum wages could be considered based on geography. Economic and social circumstances justify extending coverage of the minimum wage to migrant workers. A significant segment of these migrant workers are young and employed in low-skilled activities (mainly construction, manufacturing, and agriculture) that earn the lowest wage levels in the labor market. Excluding migrant workers would be counterproductive as it would make migrant workers even cheaper than lower-skilled Malaysians. In any case, by law and international conventions migrants deserve to be accorded the same treatment as Malaysian workers due to the contributions that they make to the Malaysian economy. Nevertheless, since a large number of foreign migrant workers are in Malaysia illegally, they would not receive the minimum wage. The process by which the minimum wage is reviewed is important. Businesses require policy stability in order to make forward-looking plans, and any concerns about arbitrary changes in the minimum wage policy are likely to add a risk premium to investment decisions. Accordingly, the process for adjusting the minimum wage rate should be evidence-based and should avoid excessive rigidity by allowing an appropriate dose of discretion. One of the 61 « MALAYSIA ECONOMIC MONITOR APRIL 2012 main challenges in some countries has been that the frequency and level of adjustments to the minimum wage has depended on the discretion of bureaucrats and policymakers. Rather, the minimum wage should be reviewed regularly (every one or two years by a pre-set date), and the review process should take into account reliable technical information on pre-set criteria such as consumer prices, producer prices, productivity, unemployment, and GDP growth. Most importantly, the process of adjusting the minimum wage should take into account a rigorous evaluation of the policy with regard to its goals. Monitoring and evaluation of the minimum wage and any other policy initiative is essential to evidence-based revisions in the future. This section contains a number of conjectures, which should be tested with data once the policy is in place. Leveraging foreign skills – at all ends of the spectrum Foreign workers of all skill levels are a characteristic of successful economies with well-functioning labor markets. Global cities are characterized by relatively large numbers of immigrants of different skill levels. New York, Hong Kong, Singapore, London and Paris count with over one million foreign-born residents across the skills spectrum. High-skilled foreign labor can help create economies of scale through agglomeration of human capital, generating more high-skilled jobs for Malaysians. Low-skilled foreign labor can complement high-skilled labor, for example in manufacturing industries where research and development activities take place around a manufacturing core that still requires a number of machine operators, or in the labor-intensive hospitality sector. The challenge for Malaysia is not to push out low-skilled foreign workers, but rather to rebalance its economy so that it attracts more skilled immigrants vis-à-vis low-skill ones. After growing rapidly through 2008, the number of foreign workers has declined since 2008. After peaking at 2.1 million in 2008, the number of registered foreign workers has declined to about 1.8 million as of 2010. 25 In addition to registered foreign workers, there are also an uncertain number of undocumented migrants (estimates range from as few as 500,000 to as many as 2 million). The share of migrants in the labor force doubled from 8 to 16 percent between 2000 and 2008 as foreign workers largely took the place of young men, whose participation rate declined (Figure 94). The low unemployment rate among migrants suggests that demand-pull forces were the main drivers of migration (Figure 95). Figure 94. Following rapid increase, the share of Figure 95. The low share of non-citizens among the migrants in the labor force has stabilized unemployed reflects strong demand Percent Percent of total unemployed 7 25 24 23 Share of Foreign Workers in LF 22 Share of 15-24 Year-Olds in LF 21 22 21 6 20 20 19 19 20 18 18 5 15 4 3 10 15 15 16 16 2 14 14 12 12 5 10 8 8 1 4 0 0 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 1982 1986 1990 1996 2000 2004 2008 Source: EPU, DOS, CEIC and World Bank staff calculations. Source: World Bank (2011b). 25 This section uses a combination of data from the Malaysian labor force survey (LFS) and other sources, which sometimes offers contradictory conclusions. The labor force survey for 2007 contained only 1.03 million foreign workers whereas the official figure from the Ministry of Home Affairs was about double that as cited in the text. The gaps between these numbers highlight the potential undercounting issue in the labor force survey. The most important limitation of the labor force survey data used in this analysis is that it does not cover workers living in group housing or similar communal housing arrangements. This implies that most workers in plantations and mining are likely to be undercounted or omitted altogether. Nevertheless, the LFS provides important insights into the sectoral composition of migrant workers. It also covers both formal and informal workers, which provides a better snapshot of migrant workers in Malaysia than if only formal workers had been included. MALAYSIA ECONOMIC MONITOR APRIL 2012 » 62 Most foreign workers in Malaysia are low-skilled and have only primary education or less. Two-thirds of foreign workers in Malaysia are low-skill and only four percent are high-skilled. Accordingly, the vast majority of migrants work in low-skill jobs (Figure 96). The education levels of workers who are Malaysian citizens have risen rapidly along with economic development and are significantly higher than those of migrants. Among migrants, 60 percent had less than secondary education, whereas among Malaysians the corresponding figure is less than 20 percent. The growing gap between the education levels of migrant and Malaysian workers is evident in Figure 97. The widening gaps further suggest that migrants are filling the demand for low-skill labor in the Malaysian economy as the domestic labor force becomes more skilled. Figure 96. In total employment, few foreign workers Figure 97. Secondary educated Malaysian workers rose have high-skill jobs rapidly, unlike migrants Percent Percent 12 90 80 10 70 8 60 50 6 40 4 30 20 2 10 0 0 1982 1986 1990 1996 2000 2004 2008 2001 2002 2003 2004 2005 2006 2007 2008 % share of employed citizen with secondary education Share of migrants in total employment of lower skill occupations % share of employed non-citizen with secondary education Share of migrants in total employment of higher skill occupations % share of employed citizen with tertiary education % share of employed non-citizen with tertiary education Source: World Bank (2011b). Source: World Bank (2011b). The skills levels of migrants have been declining, as the high-skill expatriate base has shrunk by a quarter since 2005. As Figure 97 indicates, the number of expatriate skilled workers has declined by about 25 percent since 2005. In parallel, as Figure 98 shows, the share of employed non-citizens with tertiary education has declined, and the share of migrants with no formal education increased (Figure 99). Considering that Malaysia aims to move towards higher value-added activities, efforts to attract more highly skilled foreigners are warranted and the Government has taken a number of measures in that regard. In addition to the introduction of the resident pass, the Government has relaxed employment pass conditions, removing the need to advertise executive positions and the 10-year limit for key expatriate executive positions. Not only are migrants primarily in low-skill, low-wage occupations, but they also tend to earn less than natives of the same level of education and within the same occupation. Figure 100 shows that migrants get paid significantly less than natives for all education levels except tertiary education. The wage gap is negligible for workers without any formal education and higher for workers with a primary education. The largest gap is for workers with a secondary education, in other words, the medium-skilled. Most importantly, a significant portion of migrants with a secondary education (the medium-skilled) earn less than the proposed minimum wage levels, whereas similarly educated natives earn more than these levels. Migrant workers also earn significantly less than Malaysian workers in most occupations (Figure 101), except in those that have the highest wage levels and are the most skill-intensive (and which probably require a tertiary education). There are two basic reasons for these differences. First, migrants within any given sector tend to be less skilled than natives. Second, even with the same level of education, migrant workers earn less. This pattern suggests that the extensive use of migrants may be playing a role in holding down wages in the economy. 63 « MALAYSIA ECONOMIC MONITOR APRIL 2012 Figure 98. In total employment, increasingly fewer Figure 99. Secondary-educated Malaysian workers rose foreign workers have high-skill jobs rapidly, unlike migrants Percent Percent 50,000 40 Share of migrants with no formal education 45,000 35 -26% Share of migrants with primary education 40,000 30 35,000 25 30,000 25,000 20 20,000 15 15,000 10 10,000 5 5,000 0 0 1982 1986 1990 1996 2000 2004 2008 2005 2006 2007 2008 2009 2010 Source: EPU. Source: World Bank (2011b). Figure 100. Migrant wages are generally lower, except Figure 101. Migrant wages are lower across for highly-educated migrants occupations, except for the high-skill ones RM per month RM per month 4,000 9,000 8,000 3,500 Wage of non-citizen Wage of non-citizen 7,000 3,000 Wage of citizen 6,000 Wage of citizen 2,500 5,000 2,000 4,000 3,000 1,500 2,000 1,000 1,000 500 0 Tech Total Elementary Skilled Craft Assembler Clerical Services Professional Manager 0 No formal Primary Secondary Tertiary Total education Source: World Bank (2011b). Source: World Bank (2011b). The sectoral allocation of migrant workers differs considerably from that of Malaysian workers, with migrants concentrated in the agriculture and manufacturing sectors. For example, 15 percent of the total labor force and 9 percent of citizens in the labor force are in agriculture, which employs 53 percent of all migrant workers (Figure 102). Similarly, the construction sector employs 10 percent of migrant workers but only 6 percent of Malaysian workers. The shares of Malaysian and migrant workers employed in manufacturing (26 compared to 21 percent) and accommodation services (6 percent for both) are similar. At the other extreme, 37 percent of natives and only 5 percent of migrant workers are employed in other service sectors, which tend to require higher skills. MALAYSIA ECONOMIC MONITOR APRIL 2012 » 64 Figure 102. Migrant and Malaysian Workers, by Sector of Employment Percent 60% Total Citizens Migrants 50% 40% 30% 20% 10% 0% Agriculture Manufacturing Construction Trade Accomodation Other Services and restaurants Source: DOS – Labor Force Survey 2009. Three key conclusions emerge from this discussion of foreign workers in Malaysia: First, migration inflows are responding to underlying demand-pull forces. The large numbers of foreign workers in Malaysia are a reflection of underlying structural patterns in the Malaysian economy. Some of these patterns may be unwelcome, such as the lack of industrial upgrading that makes firms rely on low-cost, low-skill workers. But others may be neutral or even desirable, such as the role of foreign workers in replacing young men who now are more likely to be enrolled in tertiary education. Therefore, policies that focus only on restricting the supply of foreign workers are likely to be of limited use – or may yield undesired consequences. Second, low-skilled foreign workers put downward pressure on the wages of low-skill workers – but not on skilled workers – highlighting the critical importance of improving skills. The conclusion here is not that Malaysia should reduce the numbers of foreign workers to artificially raise the wages of local low-skill labor, but rather to highlight the critical importance of making faster progress on expanding the supply of skills in the economy. As discussed earlier, most new jobs that are being created are skilled, and therefore the pressure on the earnings of low-skill workers will continue to grow with or without foreign workers, suggesting that upskilling the existing labor force and investing in skills are the sustainable solution for increasing wage levels. Third, Malaysia can benefit from rebalancing the skills composition of its foreign workers towards the high-skilled. As highlighted in the previous two editions of the Malaysia Economic Monitor, the greatest difference between Malaysia on the one hand and Hong Kong and Singapore on the other with regard to inward and outward migration of skilled labor is not the rate at which natives leave the country, but rather the lack compensating inflows in Malaysia. If Kuala Lumpur aspires to become a global city and an international financial center comparable to Singapore, Hong Kong or New York, the focus should not be on reducing the numbers of low-skilled workers but rather in attracting more high-skilled workers. Flexible and inclusive jobs, secure workers Modernizing job markets requires a reallocation of risks between the Government, firms and workers. The rationale for a number of labor laws that regulate how firms and workers interact is essentially to reallocate risks to household income from workers to firms. Firms are perceived to have greater bargaining power vis-à-vis workers, which in the absence of any legislation could lead firms to transfer most risks related to economic and firm performance shocks on to the workers.26 Workers in turn would suffer from excessive volatility of their earnings, with potential negative spillovers such as excess savings, depressed aggregate consumption and reduced investment in human capital. 26 See for example Hacker (2006) for a more detailed exposition of these ideas. 65 « MALAYSIA ECONOMIC MONITOR APRIL 2012 Labor laws are meant to ensure that firms take on some risks to performance, for example by creating disincentives to lay off workers during downturns. However, such risk transfer comes at a cost, namely lower profitability for firms, and potentially less employment creation. Recently, there has been greater recognition that the government can play a helpful role in reallocating some of the risks to worker‘s incomes in a way that increases efficiency in labor markets without reducing the security afforded to workers. Modern labor markets reflect a balance between flexibility and security. Advanced labor markets aim to strike a balance between protection (or security) and flexibility. This has been termed ‗Flexicurity‘ following the Danish model (see Box 7 below). Accordingly, this section argues that modernizing labor market require two parallel reform tracks: the first entails reducing regulations and increasing job flexibility (transfer risks away from firms); the second entails the implementation of social safety nets, which is essentially the Government charging both firms and employees a premium for taking some of the risk in the form of social insurance. Box 7. Denmark’s flexicurity: increasing contestability, the gentler way Every year, about 20 percent of Danes lose their jobs. But they do not lose their incomes. Unemployment benefits replace close to two-thirds of their earnings, and the Government helps them find work. Flexicurity, the combination of flexibility for employers and income security for workers, has been in place since at least the 1970s, but it has evolved over time as the active component has been strengthened. And it seems to work well. Between 1995 and 2008, Danish unemployment rates averaged 4.9 percent, while the rest of the EU15 suffered rates close to 8.5 percent. Denmark has been getting a lot of attention among policymakers. Danish employment laws have evolved from the ‗Gent system,‘ when labor and trade unions, not the Government, paid unemployment benefits. In the 1970s and 1980s, unemployment rates remained high, while those without jobs got good incomes. The arrangements became too expensive and were reformed in the 1990s. The new approach is sometimes called the ‗Golden Triangle,‘ because it added both generous unemployment benefits and active labor market programs to flexible hiring and firing laws. • The first component, flexibility of firing and hiring, remained practically unchanged. The OECD employment protection legislation index for Denmark fell from 2.4 in 1983 to 1.5 in 2009; the OECD average is 1.9. Relatively flexible laws work in Denmark because the country has a history of self-regulation by employers and unions, going back to the ‗September Compromise‘ of 1899, which set rules for resolving labor disputes. • The second part of the Danish model is unemployment insurance financed from contributions and taxes. Membership is voluntary, but it covers around 80 percent of the labor force. Benefits last up to four years, and replacement rates cannot exceed 90 percent of wages, capped currently at €2,173 a month. After four years of benefits, recipients have to switch to social assistance, which means a reduction of between 20 and 40 percent of their benefit income (Andersen and Svarer 2007). • The new system uses active labor market programs like job search assistance and training to nudge the unemployed back to work. The spending on these programs is sizable: out of €13 billion spent on labor market programs in 2010, about 75 percent was on active instruments. How well does flexicurity work? The unemployment rate dropped from 10 percent in 1993 to 3.3 percent in 2008. The incidence of long-term unemployment (being out of work for more than a year) decreased from a third of total unemployment in 1994 to a tenth in 2009. Despite liberal firing and hiring practices, employment has not fluctuated too much in response to output variability. All this is good. There are some qualifications. First, though official unemployment has fallen, there is a gap between actual unemployment (adding up the unemployed, those in ‗activation,‘ and early retirees) and official statistics. Second, it is difficult to assess how much of the fall in unemployment is due to flexicurity on its own. Economic performance matters too: active labor policies are useless if the economy is not producing jobs. Finally, the already high fiscal MALAYSIA ECONOMIC MONITOR APRIL 2012 » 66 burden can become enormous in a protracted slowdown. The Danish model costs 4.5 percent of GDP in terms of active and passive labor market measures. And Denmark spent 2.6 percent of GDP for labor market programs in 2008 (a good year), compared with 1.4 percent for the OECD as a whole, 1.5 for Sweden, 2.2 for Finland, and 2.3 in the Netherlands. The Danes have flexicurity because of their history and can afford it in part due to high participation rates of 81 percent; the OECD average in 2009 was 71 percent. Those wishing to learn from the Danes should note this. Source: Andersen and Svarer (2007); Bredgaard and Larsen (2007); Hansen (2010); OECD (2010); reproduced from Gill and Raiser (2011). Finally, modern labor markets offer flexibility for women to reconcile family and work. Malaysian women tend to drop out of the labor force following marriage and childbirth. Modern labor markets that offer flexible working arrangements, including part-time work and work-from-home provisions, can help women balance work with family life, thus facilitating their return to the labor force after childbirth as is the case in a number of neighboring countries. Complementary policies to facilitate access to childcare are also important in this regard. Labor regulations can be modernized Although Malaysia tends to rank highly with regard to labor market regulations, there is room for improvement. A worldwide survey of labor market flexibility, which rates all countries according to six distinct categories—hiring and minimum wage, hiring and firing, centralized collective bargaining, hours worked, mandated costs of worker dismissal, and conscription—shows that Malaysia moved down in the ranking over a 20-year period (dropping from 15th in 1990 to 22nd in 2008; Figure 103). Although Malaysia still ranks well relative to most countries, it is below Singapore (1st in the ranking on labor flexibility) and Hong Kong (3rd in the overall ranking). Figure 104 shows that Malaysia‘s score is weighed down by the burden put on firms by the mandated costs associated with worker dismissal and by hiring and firing regulations. Figure 103. Malaysia ranks low in the region in terms of labor market flexibility Index (10=highest) 10 8 6 4 2 0 Hong Kong Singapore Malaysia Thailand Indonesia Korea Hiring and Firing regulations Centralized collective bargaining Hours regulations Mandated cost of worker dismissal All Labor Market Regulations Source: Fraser Index of Freedom, 2009. Many of the labor laws currently enforced in Malaysia date back to pre-independence years. Although many laws have been amended, such an old and complex system of labor laws increases management costs and undermine competitiveness, especially because many amendments in place are not well integrated into the Consolidated Employment Act, thus complicating the structure of the labor legislation even further. For instance, overlapping provisions in the laws prompt contradictions and create inefficiencies. Efforts should be made to harmonize the Employment Act of 1955, with the Weekly Holiday Act 1950, the Employment Information Act 1953, the Employment Restriction Act 1968 and various regulations supporting EA 1955. Restrictions regarding termination of employment are relatively rigid. Although in Malaysia the right of the employer to reorganize the business is recognized and termination resulting from business reorganization is treated as termination 67 « MALAYSIA ECONOMIC MONITOR APRIL 2012 with just cause, the selection of employees to be retrenched must be based on specified criteria including length of service. In this regard, the most junior employees in each category are expected to be retrenched before the more senior employees. Lastly, employers must fulfill the retrenchment criteria of the ‗foreign workers first out‘ rule. Figure 104. While improvements were made in some areas, labor dismissal regulations consistently lower the overall labor regulation ranking Index (10=highest) 12 10 8 6 4 2 0 1995 2000 2005 2007 2008 Hiring and Firing regulations Centralized collective bargaining Hours regulations Mandated cost of worker dismissal All Labor Market Regulations Source: Fraser Index of Freedom, 2009. There is also a risk that retrenching employers may be liable to pay compensation. Termination or dismissal from employment has to be with proper cause. This statutory provision is important as its scope extends to each worker in Malaysia. Every worker who has lost his job and deems that he or she has been dismissed without just cause or excuse may file a claim for reinstatement in the Industrial Relations Department of the Ministry of Human Resources. The remedy for unjust dismissal is reinstatement and back wages up to 24 months or compensation in lieu of reinstatement and back-wages of up to 24 months. Employers‘ perceive this risk as a substantial one because of the costs and because a claim could be filed whenever a worker loses his employment for any reason. The length of the required notice period is comparable to OECD countries. In Malaysia, the length of the required notice to terminate an employment contract is the same for both employer and employee and is at least a) four weeks' for employment that is less than two years; b) six weeks' for employment that is more than two years but less than five years; and c) eight weeks' if the employee has been employed for five years or more. The statutory notice period in Malaysia is stringent when compared to the U.S., Brazil, and most Asian countries, but is near the typical OECD country (see Figure 105). Retrenchment benefits are generous and above levels observed in the OECD. Retrenchment benefits are usually based on the term of the employee‘s employment contract, and the Industrial Court (IC) has in practice recognized payment of retrenchment benefits in the amount of one month‘s last drawn salary of the employee for every year of service. For employees covered under the Employment Act, minimum retrenchment benefits step up from zero for workers with less than one year of service to 20 days of wages per year of service for workers with more than five years of service. There are no caps, except that imposed by the retirement age. Figure 106 places the levels of termination benefits in Malaysia in international context. Although in line with levels practiced in many emerging countries in Asia, termination benefits are higher than in countries with well-developed social safety nets in the OECD. Given the considerable evidence suggesting that strict employment protection including hiring and firing rules as well as severance pay reduces employment, 27 Malaysia may consider reviewing its retrenchment benefits in parallel with the introduction of modern safety nets. 27Fallon and Lucas (1991) show that strengthening job security regulations led to a strong decline of employment in India and Zimbabwe. More recent studies confirming the link between job security and lower employment levels include Heckman and Pages (2000), for OECD and Latin American countries, Besley and Burgess (2004) and Ahsan and Pages (2009) for India, and Saavedra and Torero (2004) for Chile. See Holzmann et al. for additional references. MALAYSIA ECONOMIC MONITOR APRIL 2012 » 68 Figure 105. The statutory notice period in Malaysia is higher than in most Asian countries for workers with long tenure Legally mandated notice period for redundancy dismissal, weeks 12.0 After 1 year 10.0 After 10 years 8.0 8.0 6.0 4.0 4.0 2.0 0.0 Source: Doing Business. Figure 106. Termination benefits also become relatively high for workers with longer tenure, exceeding levels in the OECD Termination benefits, weeks of pay 60.0 After 1 year 50.0 After 10 years 40.0 33.3 30.0 20.0 10.0 1.7 0.0 Source: Doing Business. Malaysia has a fairly open approach to fixed-term contracts. Studies have shown that fixed term contracts promote flexibility in labor markets and may increase productivity.28 Fixed Term employment contracts have been in usage in Malaysia for many years and unlike in some other countries there is no legislative provision that prevents the use of fixed term contracts in employment (Table 18). In fact, Section 11 EA 1955 gives recognition to contracts of employment that may be for a fixed period of time or for performance of a specified task. 28 World Bank SP Discussion Paper No 1006 states that fixed term work provides a buffer for cyclical fluctuations of demand, allowing companies to adjust employment levels without incurring high firing costs. Fixed-term work also allows companies to reap market opportunities by engaging in projects of short duration without bearing disproportionate personnel costs. On the other hand, a study by the Dutch Bureau for Economic Analysis (Cörvers et al., 2011) finds that temporary workers receive less employer-funded training due to the greater risk that they will leave the firm after training is received. 69 « MALAYSIA ECONOMIC MONITOR APRIL 2012 Table 18. Cross-country comparison of regulations regarding fixed-term contracts What is the maximum cumulative duration of a fixed-term Are fixed-term contracts employment relationship (in prohibited for permanent tasks? months), including all renewals? Malaysia No No limit Singapore No No limit Korea, Rep. No 24 Denmark No No limit Germany No 24 United States No No limit United Kingdom No No limit Japan No No limit Thailand Yes No limit Vietnam No 72 China No No limit Brazil Yes 24 Source: Doing Business. Flexible hiring practices such as part-time employment and work-from-home can make labor markets more inclusive and attract more women into the labor force. Part-time and flexible working arrangements are not the norm in Malaysia. The Government has recognized this and as part of the effort to encourage flexible working arrangements it has introduced the Employment (Part-time Employees) Regulations 2010. This is a subsidiary legislation to the EA 1955. This Regulation provides for the minimum conditions to be fulfilled by employers when employing part-time employees, including EPF and SOCSO contributions. Flexible hiring practices can be helpful in making it easier for women to return to the labor force while they are still responsible for taking care of children. Table 19. Cross-country comparison of regulations regarding work hours Can the workweek for a single What is the worker extend to 50 hours per week Are there maximum (including overtime) for 2 months Are there restrictions on number of each year to respond to a restrictions on ‗weekly working days seasonal increase in production? night work? holiday‘ work? per week? Malaysia Yes No No 6 Singapore Yes No No 6 Korea, Rep. Yes Yes No 6 Denmark Yes No No 6 Germany Yes No No 6 United States Yes No No 6 United Kingdom Yes No No 6 Japan Yes No No 6 Thailand Yes No No 6 Vietnam Yes No No 6 China Yes No No 6 Brazil Yes Yes No 6 Source: Doing Business. Working hours regulations can be made more flexible by fixing weekly (rather than daily) standard work hours. Flexible work hours allow women to align work hours with the hours their children are in school, and represent another example of flexibility that promotes inclusiveness in labor markets. The EA 1955 provides for minimum working conditions that include fixed hours of work, overtime, and rest periods applicable to employees falling MALAYSIA ECONOMIC MONITOR APRIL 2012 » 70 under its scope. The present fixed 8 hours of work per day causes employees to be paid for the time worked rather than for productivity. Pay premiums that range from 150 percent to 300 percent of the hourly rate of wages for work performed outside the fixed hours increases cost and creates rigidities. Many countries have fixed the principal 40- hour as the length of the normal working week. This enables the employers and employees to agree on work hours that suits the firm‘s business, the employee‘s needs and ensures productivity. Except for the fixed 8-hour day, regulations regarding working hours are fairly flexible and compare well with other countries (Table 12). For example, unlike Korea and Brazil, Malaysian firms do not face restrictions on night work. Options to modernize labor regulations: First, the Government can consider restructuring and consolidating the existing labor legislation. The different pieces of legislation, regulations, orders and directives relating to labor should be comprehensively reviewed with the objective of modernizing and integrating these laws to eliminate overlapping provisions, inconsistencies, reduce gaps and simplify these laws to encourage efficient and easy compliance. The Government is already reviewing labor legislation in the context of the Human Capital SRI, and the first set of amendments has been passed (see below). Further revisions can be benefit from international experience (see Box 8 for the example of the Australian Fair Work Act), but should also be appropriate to Malaysia‘s institutional set-up (see Box 9). Box 8. Australian Fair Work Act 2009 The Fair Work Act and the supplementary Fair Work Regulations 2009 were created to ensure a balanced framework for cooperative and productive workplace relations. It aims to promote national economic prosperity and social inclusion by providing workplace rules that:  Are fair to working persons  Are flexible for businesses  Promote productivity and economic growth for future economic prosperity  Take into account international labor obligations  Ensure a safety net that is fair and relevant  Ensure that workplace agreements that undermine the safety net of workers are not part of the national workplace relations system  Help employees balance work and life commitments by offering flexible working arrangements  Enable fairness at work and prevent discrimination in the workplace  Achieve productivity and fairness by emphasizing workplace-level collective bargaining between the employer and employees and their representatives. The FWA establishes the national industrial relations system. Features of the national industrial relations system include a set of 10 minimum National Employment Standards, modern awards that apply nationally for specific industries and occupations, a national minimum wage order, enterprise bargaining, and protection from unfair dismissal. The changes were introduced gradually, starting from July 2009; the most significant changes were introduced in January 2010 and have been implemented during the last two years. Source: Government of Australia. Second, greater flexibility in employment mandates could be considered: A. Following international best practices on fixed-term contracts; placing limits to hiring on successive fixed term contracts. B. Allowing greater flexibility to employers in human resource management, in particular with respect to hiring and dismissal decisions, including a revision to the current severance payment levels. C. Giving flexibility for employers to introduce working hours that suit both the employer‘s and employee‘s needs. Computing work hours on a per week basis. D. Promoting part-time and work-from-home arrangements that improve the work-life-balance of women and caregivers in general. 71 « MALAYSIA ECONOMIC MONITOR APRIL 2012 The Government has already embarked on a path to reform of labor laws as part of the ETP. As noted in Table 4 above, the first set of revisions to the Employment Act was approved by Parliament in December. Among the amendments were a new definition of contractor for labor to clarify the relationship between principal contractor and sub-contractors who supply labor; inclusion of new provisions to address sexual harassment issues in the workplace and application of these provisions to all employees; flexibility on the time of payment for overtime; maternity protection to all female employees and expansion of the scope of coverage of employees earning up to RM1,500 to employees earning up to RM2,000. With this, the number of employees covered under the Act will increase from 50 to 70 percent. Box 9. The institutional foundations of skill formation in four advanced economies Kathleen Thelen (2004) traces the institutional foundations of skill formation in the UK, the US, Germany, and Japan to the early stages of industrial development. The experience of these four countries suggests that institutions, including labor market institutions, emerge from a country‘s distinctive political and economic realities governing the interaction of key decision makers. They are the result of an organic process. In labor markets, skills are a valuable commodity. As in all markets, the price is determined by demand and supply, creating opposing incentives for workers, keen on restricting the supply of skills in return for higher wages, and employers, eager to keep labor costs low. In an early phase of industrialization in the UK and the US, unions increasingly limited the supply of skilled labor. In response, firms resorted to snatching skilled workers from their competitors, reducing the value for individual firms of investing in human capital formation – the cost of training workers simply exceeded the cost of attracting skilled workers from elsewhere. This led to the demise of firm-level training and explains why neither the UK nor the US developed vocational training systems comparable to those in Germany or Japan. Both Germany and Japan overcame the collective action problem in skills formation by laying institutional foundations for skills formation that made it rational for companies to train workers. Japan followed the classical remedy to collective action problems: Government intervention. The Japanese Government ordered public companies to develop internal corporate training systems which private companies began to emulate. In order to ensure that investing in their workers paid off, they increased incentives for their employees to stay, including seniority wages, internal career ladders, and corporate-level unions, creating large and internal labor markets shielded from outside competition. Germany, on the other hand, drew on its experience with strong training systems in its traditional artisanal sector (so- called guilds). The newly emerging industrial sector had to compete with the guilds for workers, attracting them with high-quality training justifying high wages. As opposed to the US and UK, unionization in a more authoritarian Germany was weak, eliminating pressures to tighten the labor market, and when there is no shortage of skills there is no incentive for companies to poach workers. Guilds and industrialists thus joined forces in building national vocational training systems that would generate a sufficiently large pool of high-skilled labor. The diverse experience of these four countries suggests that it is useful to bear in mind the broader institutional landscape of countries when considering adopting lessons from their development experience, as adopting institutions that do not fit the institutional landscape of a country may yield unintended consequences. Source: Thelen (2004). Social safety nets protect workers In parallel with modernizing labor market regulations, it is essential for Malaysia to develop modern social insurance schemes to protect workers. Modernizing labor markets entail two parallel and equally important reforms: the first, discussed in the previous section, is to reform labor market regulations to reduce the risk that is borne by firms from shocks to worker‘s incomes. This reduces costs to firm, but more importantly increases the efficiency in the economy MALAYSIA ECONOMIC MONITOR APRIL 2012 » 72 as workers can be allocated to jobs where they can contribute the most. The second is for the government to take up some of that risk in the form of social insurance programs, funded through general taxation. Workers would also be expected to gain from the change as firm-based job protection only covers formal workers, and even then workers still face potentially severe income shocks as firms still fail and redundancies still take place even with restrictive regulations. The cost of restrictive regulations such as high mandatory severance payments relative to social insurance schemes increases with the level of development. Mandatory severance pay as is practiced in Malaysia is an attractive system in developing countries because it requires little administrative capacity to monitor the unemployment status, does not require the collection of social contributions, and given that it is paid as a lump sum, does not act as a disincentive to job search. For low income countries with low capacity to administer social insurance programs, low capacity to raise revenues to fund such programs, and low trust in Government, placing the burden of social insurance on firms is not an unreasonable strategy for social protection. However, for a country at Malaysia‘s stage of development (and certainly the stage that Malaysia aims to achieve), this rationale no longer holds. Malaysia currently has three main social insurance schemes focused on disability and old-age security. Social insurance in Malaysia comprises three programs: (i) a scheme for pensionable public service workers, funded by the budget; (ii) disability social insurance for private sector employees administered by the Social Security Office (SOCSO), and (iii) mandatory old-age savings plan for private sector workers administered by the Employee Provident Fund (EPF). Only the first one is funded by public resources; the other two are funded by contributions levied on wages (2.25 percent and 23 percent, respectively). Since social insurance schemes cover about 60 percent of the labor force, a significant fraction of workers is left unprotected. About 5.2 million workers are currently contributing to EPF and SOCSO, with another 1.4 million civil servants covered by the PSD pension scheme. In 2010, there were about 950,000 recipients of benefits provided through PSD and SOCSO, of which about 850,000 received a regular monthly pension. Among the pension recipients, about 600,000 are from the public service scheme and approximately 250,000 are disability pension recipients provided through SOCSO. Although Malaysia performs relatively well compared to other countries (Figure 107), at 40 percent, the coverage gap is significant. Those not covered include self-employed, farmers and in general informal sector workers. Nevertheless, evidence indicates that pensions play an important role in poverty reduction in Malaysia: without pensions, the household poverty rate would increase from 3.8 to 5.0 percent. The poverty gap would increase as well: from 0.86 to 1.29. Figure 107. Social security coverage around the world (percent labor force) Coverage (active members / labor force) 0 to 25 25 to 50 50 to 75 75 to 100 Source: Holzmann et al., 2009. 73 « MALAYSIA ECONOMIC MONITOR APRIL 2012 The largest gap in social insurance in Malaysia is the lack of unemployment insurance. Increasing flexibility in labor markets and invigorating the forces of competition in product and labor markets also increases the risks of job and income loss for workers and their families. In these circumstances, countries around the world have found it useful to introduce an unemployment insurance system. A system of this kind that covers most or all of the formal labor force can pool risks and cushion the impact of shocks. How expensive such a program will be and how much impact it will have on the amount of effort a recipient is willing to make will depend critically on the level of the benefit and the duration of the eligibility period. Introducing an unemployment insurance scheme such as an Unemployment Insurance and Savings Account (UISA) (Box 10) would obviate the need for large severance payments and other restrictions to hiring and firing workers. 29 Box 10. Unemployment Insurance and Savings Account Many countries are increasingly relying on unemployment insurance savings accounts (UISA). An appropriately designed unemployment insurance scheme can provide adequate protection to workers in the context of a more flexible labor market. Balance between economic efficiency and worker protection could be achieved if the Government set as an overarching goal ‗to protect the income of workers as opposed to protecting particular jobs‘ (often unproductive). Labor markets characterized by high informality, weak enforcement, and moral hazard issues could benefit from a model of UI that relied on unemployment insurance savings accounts. Traditional UI schemes tend to be abused in developing countries. The general operation of UISAs is straightforward, transparent, and less prompt to abuse, although they allow for only limited risk pooling, as savings in the accounts can be depleted faster than what is needed. Employers deposit some specified fraction of each worker‘s earnings in a special individual savings account on a regular basis. In Chile, workers are also required to make regular contributions to their accounts. Upon separation workers can make withdrawals from their savings accounts as they deem fit (some programs allow access before separation for health, education, and housing reasons). UISAs are a relatively new program, although Brazil has used them since the 1960s. More recently, several other Latin American countries (Argentina, Chile, Colombia, Ecuador, Panama, Peru, Uruguay, and Venezuela) have introduced UISAs. Source: Robalino and Sanchez-Puerta(2008). Lack of child care is an important obstacle for Malaysian women to join the labor force. In addition to inflexible work hours and limited opportunities for part-time work, lack of childcare is another important obstacle for women to join the labor force. In 2011 five children died in unlicensed health care centers, which are estimated to comprise as many as two-thirds of the 3,200 child care centers in Malaysia. The Income Tax Act has provisions for tax deductions to be provided to employers for the purpose of establishing childcare centers near or at the workplace (UNDP, 2007), but as of 2009 only 436 registered child care centers were established at workplaces (EPU, 10th Malaysia Plan). In addition, child care expenses are not deductible from individual income taxes. 30 The 10th Malaysia Plan anticipates increasing the number of community-based nurseries and day care centers under the Social Welfare Department (JKM), and actively promoting CSR programs to sponsor the establishment of licensed day care centers in partnership with NGOs. Options to modernize the existing social insurance and assistance schemes would include: (a) As part of the overall social protection development strategy, adopt a strategy for the development of an integrated social insurance system. (b) Introducing adequately designed unemployment benefits to replace severance pay in its current form so as to facilitate labor market transitions. 29As part of the Human Capital SRI, the Government has commissioned a study to the International Labor Organization in preparation for implementing unemployment insurance in 2013. 30 Women, Business and the Law Database (accessed at: http://wbl.worldbank.org). MALAYSIA ECONOMIC MONITOR APRIL 2012 » 74 (c) Search for innovative approaches to extend affordable and sustainable social insurance coverage to farmers, self-employed and informal sector workers. Modern social insurance also replaces informality as a shock-absorber Modern social safety nets also replace another risk absorber in low-income contexts: the informal economy. In the absence of social safety nets and when the firm-based income protection fails them, workers often find themselves in the informal economy. On the other hand, well-designed social safety nets with moderate tax wedges and flexible labor markets reduce the incentives for firms to remain in the informal economy. Informal workers are less productive, earn lower wages and enjoy limited (usually family-based) income protection in case of shocks. Therefore, modernizing jobs requires understanding the informal economy and ensuring that reforms create incentives for formalization of firms and businesses. Many Malaysian workers are either employed in informal firms or in formal firms that offer them informal contracts (thus avoiding having to pay mandatory pension contributions). While the informal economy in Malaysia is not particularly large for its income level or within East Asia, about 40 percent or more informal workers work in agriculture, fishing, forestry, and restaurants and bars (Figure 108). Similarly, more than 30 percent of workers in the distributive trades, retail, sales, construction, and textile, apparel, and furniture manufacturing are informal. On the other hand, less than 10 percent of workers in ICT, electronic manufacturers, medical equipment manufacturers, and chemical product producers are informal. Figure 108. Social security coverage around the world (percent labor force) Informality by sub-sectors, based on contributions to the EPF and SOCSO 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Mfg elec equip and electronics ICT mfg (excl measuring) Mfg med & meas equp, clocks Mfg chem & prods (incl pharma) Mfg elec valves & components Mfg of transport equipment Petrochemicals Rubber based industry Tourism (excl travel ag tours) Mfg of paper, publishing Plastic, glass & non-metal NEC Leather, luggage, footwear Finance, insur & real estate Utilities IT services Mining & extractive industries Metal, machinery, equipment Bus & prof service (Not IT) Mfg of furniture and mfg NEC Mfg food & bev (inc palm oil) Mfg wood & prods (excl furn) Culture, news, entertainment Logistics(rental trans, trav) Mfg of tobacco products Sale, repair, rent motor veh Distributive trade Mfg textiles, apparel, fur Construction Organizing & associative acts Other svcs, extr-terr orgs Restaurants, bar & canteens Ag, fishing and forestry Share of informal workers Share of formal workers Source: DOS – Household Income Survey, 2009. Informal workers earn significantly less than formal workers, especially in manufacturing. About 4.2 percent of formal workers earn total monthly compensation of less than RM800 while almost one-third of all informal workers earn less than that each month (Figure 109). The average monthly wages of formal and informal workers also differ within sectors, especially in manufacturing. About half of all informal workers in the manufacturing sector have average total compensation of less than RM1,200 per month, while 14 percent of formal workers in the sector earn that amount or less (Figure 110). The difference in the wages of formal and informal workers within the service sector 75 « MALAYSIA ECONOMIC MONITOR APRIL 2012 is smaller though still significant (Figure 111). About 12 percent of workers in the formal sector currently earn RM1,200 or less, slightly fewer than in the manufacturing sector. Figure 109. Informal workers earn less than formal-sector workers… Distribution of earnings of formal and informal workers, RM Source: DOS – Household Income Survey, 2009. Figure 110. …especially in Manufacturing… Figure 111. …but also in services Distribution of earnings of formal and informal workers, RM per month Distribution of earnings of formal and informal workers, RM Source: DOS – Household Income Survey, 2009. Source: DOS – Household Income Survey, 2009. Implications of a higher wage structure Firms can remain competitive in a higher-wage environment as long as productivity rises and non-wage labor costs decline. The agenda of creating modern, highly paid jobs and raising incomes of most Malaysians is not incompatible with maintaining Malaysia‘s competitiveness as it is unit labor costs that matter and unit costs need not rise with wages. This will be the case if productivity increases (from increased skills and competition in the economy) and if other employment costs decline due to greater flexibility in employment contracts. It is important to emphasize that reforms aimed at increasing productivity and lowering labor costs must be pursued as the same speed as other reforms to pull up wages. Similarly, it would not be socially sustainable to pursue the reduction labor costs through greater flexibility ahead of reforms to expand the social protection system: both should be pursed in parallel. The agenda of moving up the value chain and innovation-led growth is very much linked to the agenda of creating modern jobs. Moving up the value chain essentially means performing more complex tasks within firms. The requirements for moving up the value chain include the provision of more and better skills and improved regulations MALAYSIA ECONOMIC MONITOR APRIL 2012 » 76 in labor markets, but skills alone will not suffice. As noted in the April 2010 Malaysia Economic Monitor, other requirements include upgrading home-grown technological capabilities, improving access to finance for innovation, enhancing competition (the driving force for innovation), and facilitating the fluid entry and exit of firms. All of these elements must be in place to create the demand for modern jobs and ensure the sustainability of the higher wage structure. Most jobs will be created in services sectors – to ensure these are modern jobs Malaysia needs to emphasize growth in knowledge-intensive services. Given the experiences of other countries, the structural change towards a higher income economy includes a relatively higher growth rate in services. Accordingly, the weight of the services sector in Malaysia‘s GDP is expected under the 10 th Malaysia plan to increase from 58 percent of GDP in 2010 to 61 percent by 2015. Not only will services grow faster than manufacturing, but manufacturing growth will come from deepening of both human and physical capital, and therefore the sector is unlikely to generate the large number of high-income jobs required to drive robust domestic demand. Therefore, most new jobs will be in services, but which services jobs will be created? Services sectors are diverse and service jobs range from the least to the most skilled. The challenge for Malaysia will be accelerate the growth of services jobs that entail the performance of non-routine tasks. Most of these sectors are knowledge-intensive and creative sectors, which have high skills requirements but also high wages. Foreign firms can adapt to higher wages. A survey of Japanese firms (see Box 11) finds that only one-third of respondents are concerned with the introduction of the minimum wage policy. In contrast, more firms are concerned about employees‘ low retention rates, the difficulty in hiring Malaysian workers, high litigation risk and difficulty in recruiting technicians, specialized workers, and managerial employees. Because globally competitive foreign firms can choose in which country to perform higher-value-added tasks, they will respond to the endowments in the economy rather than try to change the economy‘s comparative advantage. But if Malaysia successfully transforms its economy, foreign firms will remain interested in investing even with higher wages, as is the case in Korea, Singapore, or other higher income countries. Higher labor costs may bring about somewhat higher inflation that will require careful management. As economies grow, their price levels tend to increase, a phenomenon known as the Balassa-Samuelson Effect (see Figure 112 for a non-rigorous demonstration). This effect is partly caused by higher wages, which drive up the costs of non- tradable goods and services, and unlike ‗Dutch disease‘ can take place in the presence of economy-wide productivity gains. Although this effect only prevails in the long-run, it should be kept in mind, since Malaysia has been actively managing prices and wages (as evidenced by Malaysia falling below the regression line in Figure 112) whereas economic transformation implies allowing prices to adjust and wages to rise. In other words, Malaysia may face more, and more imminent, pressures on prices from structural sources compared to other economies. The implications for monetary policy are that it will be therefore important to differentiate between structural and cyclical inflation. There are also important implications for social policy since the distribution of the beneficiaries from higher wages likely will not entirely overlap with the groups affected by higher prices, with the latter group larger than the former. Policies to support low-income groups that may not immediately benefit from higher wages will be important to help them cope with any increases in inflation. Support should be targeted, suggesting that direct transfers such as the recently implemented BR1M scheme should be preferred to consumer price subsidies. 77 « MALAYSIA ECONOMIC MONITOR APRIL 2012 Figure 112. Prices rise with income Vertical axis: cost of a ‘Big Mac’ (USD); Horizontal axis: log of GNI per capita 9 8 7 6 R² = 0.4534 5 4 3 2 Malaysia 1 0 6 7 8 9 10 11 Source: The Economist, WDI. Box 11. Results from a JETRO survey on challenges experienced by Japanese firms in Malaysia Japanese Investment in Malaysia Japanese firms are the second largest investors in Malaysia after Singaporean investors. In 2010, Japanese FDI stood at RM4.02 billion (13.9 percent of total FDI) with 61 investments, out of which 44 investments (3.25 billion, 80.8 percent of the total) were expansion and diversification of current projects while 17 investments (0.77 billion, 19.2 percent of total) were new projects. These Japanese investments are mostly concentrated in the sectors of non- metal mining, food manufacturing, transportation equipments, and electronics. As of January 2011, 1,407 Japanese firms were operating businesses in Malaysia, out of which 730 firms were engaged in manufacturing. How Japanese firms assess investment opportunities in Malaysia According to the ‗Survey of Japanese Firms Business Activities 2011‘ conducted by The Japanese Chamber of Trade and Industry, Malaysia (JACTIM) and the Japan External Trade Organization (JETRO), the top three reasons that Japanese firms regard Malaysia as an attractive investment destination are (i) a stable political situation, (ii) high safety and security, and (iii) well-developed infrastructure (see Table 20). Compared to regional peers such as Thailand, China, Vietnam and Indonesia, Japanese firms value Malaysia‘s political stability and predictability with regards to long-term investments due to low political risk. Although many firms feel the need for further improvements in internet and telecommunications systems in Malaysia, more than half of Japanese firms regard power systems to be well-developed and improving over the past years. Although safety and security are considered a major attraction for investing in Malaysia, and increasingly so over recent years, more than half of the Japanese survey respondents have encountered business related theft and crimes. Incidents include theft of raw materials and products from factories and warehouses (31 percent); theft of cash and office equipment (17 percent); and carjacking on highways (7 percent). One of the reasons for the increase in theft and crimes may lie in the soaring price of metal products in recent years. Other major disincentives for investing in Malaysia are the Government‘s role in the private sector (2 percent), especially with a view on tedious administrative procedures. In particular, businesses feel that customs clearance procedures are cumbersome and take too long; they contend that it takes too much time to issue Certificates of Origin, and that HS codes are altered frequently, which makes it difficult to anticipate the cost of imports. MALAYSIA ECONOMIC MONITOR APRIL 2012 » 78 Table 20. Reasons for Japanese firms to invest in Malaysia Reasons % Political stability 63% Safety and security 57% Infrastructure 54% Employees‘ language skills 51% Favorable living condition 36% Labor cost 23% Government investment preferential policy 17% Inexpensive energy resource 15% Concentration of mechanical parts industry 13% Favorable market 12% Ethnic diversity 11% Quality of technical labor 10% Natural resources 6% Quality of low-skill labor 5% Gateway to Islamic countries/markets 5% Government business attitude 2% Source: JACTIM/JETRO, Survey of Japanese Firms Business Activities 2011. What investment challenges do Japanese firms face? According to the ‗Survey of Japanese Firms in Asia and Oceania 2011‘, administered by JETRO, major challenges Japanese firms in Asian countries face in their investment and business management are: (i) cost increases, including procurement and wages; (ii) pressures from cost reductions including competition with other firms, cost reduction requests from major business partners; and (iii) the quality of labor, including human capacity of local employees, quality of workers, and difficulty in recruiting workers for managerial positions. Japanese firms in Malaysia face similar challenges to Japanese firms in neighboring countries. They perceive significant challenges in (i) procurement cost increases; (ii) competition with other firms in terms of cost reduction; (iii) wage increases; (iv) exchange rate fluctuations; and (v) the quality of labor. Japanese firms anticipated adverse effects from the minimum wage policy that the Government is intent to introduce as it would increase the labor cost. 70 percent of all the firms surveyed indicated that this policy would affect their business negatively. On the other hand, Japanese firms are also confronted with challenges in securing high quality labor, which appears to be a larger concern than the minimum wage (Table 21). Challenges include a low retention rate (62 percent), difficulty in finding low-skill labor (42 percent), high litigation risk (40 percent), and difficulty in recruiting technicians, specialized workers, and managerial employees. The domestic labor market has been at a full employment and the employees actively move across companies depending on conditions offered. Table 21. Challenges Japanese firms face in securing high quality labor Challenges % Employees‘ low retention rate 62% Difficulty in hiring Malaysian workers 42% High litigation risk 40% Difficulty in recruiting technicians, specialized workers, 40% managerial employees Introduction of minimum wage policy 33% Difficulty in hiring non-Malaysian labors 32% Employees‘ low attendance rate 24% Trade unions 15% Long litigation period for dismissal 14% Difficulty in making changes to labor contract 10% Labor issue is not a problem 5% Source: JACTIM/JETRO, Survey of Japanese Firms Business Activities 2011. 79 « MALAYSIA ECONOMIC MONITOR APRIL 2012 Where do Japanese firms place Malaysia in a regional context? The JETRO survey compares the concerns of Japanese companies in Asia across six major challenges (i) cost increase in procurement, (ii) competition with other firms, (iii) wage increase, (iv) quality of labor, (v) quality control, (vi) difficulties in procuring raw materials and parts at host country. Table 22 shows the comparison of concerns of Japanese firms in Malaysia with those of Japanese firms in regional peers, including China, Korea, Singapore, Vietnam, Thailand, and Indonesia. According to Table 22, wage increases are a major concern for most Japanese firms in Asian countries. Japanese firms in other Asian countries such as China (84.9 percent) and Vietnam (83.3 percent) perceive it as a serious problem. In Malaysia this concern is less pronounced in relative terms (55.1 percent). Rising procurement costs are a major concern for Japanese firms in Malaysia (61.5 percent) more than in other Asian countries except China. Japanese firms in Malaysia are also facing severe competition from other firms in reducing their cost of production and business management (57.4 percent). Although quality of labor and quality control are not as important problems as wage increases overall, Japanese firms in Malaysia regard it as a challenge and more so than in other countries such as Singapore, Indonesia, and Thailand. Obtaining raw materials in Malaysia does not appear to be a considerable problem. Table 22. Top Six Challenges Japanese Firms Face in Asian Countries Percentage of firms identifying issues as significant obstacles to operate, percent Obtaining raw Cost increase Competition Wage Quality of Quality materials and in with other increase labor control parts at the host procurement firms country Malaysia 55.1 61.5 57.4 44.7 41.0 32.8 China 84.9 64.1 53.3 47.6 43.4 41.3 Korea 60.2 50.0 48.9 27.3 19.4 19.4 Singapore 65.7 55.8 56.0 31.4 19.2 13.5 Vietnam 83.3 53.6 38.5 48.7 39.3 61.6 Thailand 68.3 56.7 55.4 40.9 40.7 36.3 Indonesia 75.2 51.9 57.8 42.2 28.7 44.4 Sri Lanka 41.9 61.5 55.2 38.7 23.1 38.5 Source: JETRO, Survey of Japanese Firms in Asia and Oceania 2011. Sources: JACTIM/JETRO, Survey of Japanese Firms Business Activities 2011 and JETRO, Survey of Japanese Firms in Asia and Oceania 2011 Conclusions The challenge of creating modern jobs is closely related to the challenges for Malaysia’s overall economic transformation. The strong link between productivity and wages means that the structural factors that have suppressed Malaysia‘s wage growth—inadequate skills, an inefficient regulatory environment, and insufficient social safety nets—are the same forces that threaten to suppress Malaysia‘s transformation into an inclusive and sustainable high-income economy. Hence, transforming the shape of Malaysia‘s labor force from one that is ‗traditional‘ to one that is ‗modern‘, and therefore productive, requires the same structural reforms that will drive Malaysia‘s economic transformation. While direct measures to increase Malaysia‘s wage rates such as well- designed minimum wage can help, they must be implemented in tandem with efforts to shift Malaysia‘s production frontiers for wage increases to be sustainable in the long-term. Nurturing, attracting and retaining skills lie at the core of creating modern jobs. Nurturing skills will require an overhaul of the education system towards more autonomy and accountability, and towards more non-routine cognitive and other soft skills. This is in line with the NEM recommendation mentioned earlier that the education system needs to be reviewed and the educational approach shifted from ‗rote-learning‘ to ‗creative and critical thinking.‘ Once skills are nurtured, they need to be retained, by pursuing transformational reforms to increase competition and update inclusiveness policies. Finally, skills can also be brought from abroad to complement Malaysia‘s talent base. One example raised in the previous Malaysia Economic Monitor that is worthy of MALAYSIA ECONOMIC MONITOR APRIL 2012 » 80 consideration is extending a nearly automatic work permit for foreign graduates of Malaysia‘s universities, as it is done in the United States with ―optional practical training.‖ Labor markets can be modernized to be more dynamic while creating greater inclusiveness and providing protection for workers. Malaysian‘s labor regulations appear reasonably flexible, but they can be modernized in two directions. First, by reducing redundancy costs and introducing unemployment and other social insurance to protect workers, not jobs. Second, by promoting flexible work arrangements, complemented by adequate childcare, to tap on women – a great untapped source of skills in Malaysia. 81 « MALAYSIA ECONOMIC MONITOR APRIL 2012 References Acemoglu, Daron and David H. 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