Thursday, March 22, 2007

Economic growth is not all in the numbers

Opinion: Economic growth is not all in the numbers
New Straits Times, 22 March 2007
by MOHAMED ARIFF

(Link edited by YM)

Trade is the lifeblood of the Malaysian economy. However, care must be exercised in interpreting trade statistics.

THAT Malaysia’s trade recently crossed the RM1 trillion mark was, indeed, great news. This represents an important milestone and a feather in the cap for the Malaysian economy. While the announcement was certainly newsworthy, the euphoria and hype it generated was a little disquieting. Some even went so far as to label Malaysia a trillion-ringgit economy, regardless of the fact that its gross domestic product (GDP) is still roughly one-half of that.

A closed economy’s GDP represents the sum of consumption and investment expenditures. With an open economy, exports are added to and imports are subtracted from the aggregate of domestic consumption and investment, to arrive at GDP. If exports exactly equal imports, trade numbers cannot affect the aggregate in the accounting sense. This does not mean that trade does not matter in the economic sense. It certainly does: In the absence of trade, domestic consumption and investment would be significantly lower.

The importance of trade to Malaysia can hardly be exaggerated. It is the lifeblood of the Malaysian economy. The country’s progress and prosperity is attributed primarily to its openness to foreign trade and investment flows. However, care must be exercised in interpreting the trade statistics.

There is much less to the RM1 trillion trade figure than meets the eye, as there is a lot of double, triple or even multiple counting. Most of the intermediate products imported are re-exported after domestic value-added. The high import content results in double counting, to the extent that a given item is counted twice, first as import and later as export.

What is more, since the bulk of the country’s international trade is conducted by multinational corporations with extensive regional production networks, intra-firm trade often entails movement of goods back and forth a number of times between countries for additional processing. Thus, it is possible for the same item to be imported twice and exported twice in a year, notwithstanding the greater value-added every time it is imported and re-exported. This seems to be typical for some of Malaysia’s trade with Singapore and China, which, by the way, is good for all. But the point is that domestic value-added in all this is only a small portion of the total RM1 trillion, which is not necessarily bad news either.

There is nothing sinister in all this. The trade figures are quite reliable and accurate. Given the ways in which trade flows are defined and measured the world over, RM1 trillion in trade is an achievement that Malaysia can rightly take pride in.

But care must be taken to ensure that no one is deluded into thinking Malaysia is already a trillion-ringgit economy. Malaysia has a long way to go before reaching the trillion-ringgit GDP threshold. If the economy can grow at an average annual rate of not less than seven per cent, it will take another 10 years to get there, which sounds fine. It will take a little longer if the average GDP growth rate were to fall below seven per cent per annum.

It is also noteworthy that, according to the Malaysian Institute of Economic Research (MIER) forecast, Malaysia’s trade will exceed RM2.6 trillion by 2020, with RM1.35 trillion exports and RM1.28 trillion imports. Given that trade accounts for roughly 200 per cent of Malaysia’s GDP, this would translate into a GDP of about RM1.3 trillion in 2020.

In the late 1980s and early 1990s, prior to the 1997-98 financial crisis, the Malaysian economy was growing at an average rate of about nine per cent per annum.

Such rapid growth cannot be repeated now, not only because the base is getting bigger but also because such growth, as experience has shown, is simply not sustainable.

The Malaysian economy was able to expand so fast, in excess of its potential, thanks primarily to imported labour and capital. It is now obvious that such input-driven growth is fraught with pitfalls. That Malaysia could grow too fast for its own good was one of the factors that contributed to the 1997-98 crisis.

Estimates at MIER show that Malaysia’s "potential" GDP growth, which implies full employment with no overheating, is 6.5 per cent. As an open economy, Malaysia will be subject to external fluctuations, with growth oscillating above or below the potential. The government’s target of six per cent average growth, seen in this light, appears to be fairly realistic, notwithstanding MIER’s somewhat conservative growth forecast of 5.8 per cent on the average for the medium term.

The trouble with GDP growth numbers is that the focus falls squarely on the quantum rather than the quality aspect of economic expansion. The kind of growth now taking place in the country is quite different from that experienced before, especially in terms of employment generation. Malaysia was quite successful in creating jobs not only for its own people but also for foreign migrant workers. This now seems to be a thing of the past. Last year, 249,000 jobs were created, which pales in comparison with the 429,000 new jobs added in 2005.Apparently, there is no meaningful relationship between Malaysia’s GDP growth and its employment growth.

Thus, it is hard to understand why employment could only expand by 2.3 per cent last year, despite the fairly robust GDP growth of 5.9 per cent. It is pertinent to recall that employment had grown at a faster pace of 2.8 per cent in 2001 despite sluggish GDP growth of just 0.4 per cent. Unemployment has remained stubbornly high at 3.5 to 3.6 per cent since 2001, despite reasonably good GDP performance. Also, the growing income disparity in the country (Malaysia) may have much to do with the fact that GDP growth does not readily translate into job growth.

The phenomenon of jobless growth is a cause for concern.

This trend is likely to persist, now that the Malaysian economy is moving up the value chain, away from unskilled, labour-intensive, low value-added operations towards skill-intensive, high value-added activities. As Malaysia is likely to create fewer jobs in the years ahead than before, care must be taken to ensure that a large chunk of them does not dissipate unnecessarily or carelessly into jobs for foreign migrant workers.


Professor Emeritus Mohamed Ariff is the executive director of the Malaysian Institute of Economic Research



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