Pivoting from consumption to production

According to the World Bank, gross ­domestic product among developed economies will shrink 7% this year while that of emerging and developing nations will drop by 2.5%, the first collective contraction in at least six decades.

The restrictive movement measures resulted in huge unemployment, disruptions to global supply chains and may have tipped millions back into poverty. There were massive distortions to both the demand and supply sides of the economic equation (see Chart 1).

Central banks and governments have reacted swiftly to mitigate the economic impact through the injection of unprecedented amounts of liquidity into the global financial system and huge fiscal stimulus packages worth trillions of dollars.

The initial measures were focused on protecting productive capacities during the lockdowns — for instance, loan moratoriums for businesses and households as well as government/central bank loans-grants — and wage subsidies to prevent mass unemployment. Emergency benefits for the temporarily jobless and direct cash handouts were crafted to protect people’s livelihoods.

Nevertheless, we should expect a wave of business failures over the coming months, especially micro and small and medium enterprises (SMEs) suffering from insufficient cash flow and limited access to bank loans. Despite economies reopening, demand remains well below pre-pandemic levels and will only gradually normalise.

Every company, big or small, is going to be very cautious in terms of hiring and new investments, and is more likely than not to continue cost-saving measures as well as limit dividends and share buybacks to conserve cash. That means unemployment will stay elevated for some time.

In short, the worst may be over but economies are going to require a lot of help to fully recover from the shock.

As such, globally, both monetary and fiscal policies will remain expansionary.

Major central banks of the developed world — including the US Federal Reserve, European Central Bank, Bank of England and Bank of Japan — are all in on quantitative easing and near-zero or negative interest rates. Interest rates are going to stay very low for the next two years, at least.

By aggressively cutting the price of money, they are pushing banks to lend and businesses to invest, to take on more risks. Liquidity is also driving prices for almost all asset classes — stocks, bonds and commodities such as gold — higher. This should, in turn, create the wealth effect, which will further spur the recovery in consumer spending.

The traditional Keynesian macroeconomics response to recession is to stimulate aggregate demand, through tax cuts and fiscal spending (see Chart 2).

For example, in the US, the Trump administration is preparing a US$1 trillion ($1.38 trillion) infrastructure package. The German government agreed to a EUR130 billion ($208.54 billion) stimulus package that includes a temporary reduction in the value-added tax rate, rebates for electric car purchases and cash handouts for families.

We think Malaysia should take a higher-level approach. Rather than only focusing on stimulating aggregate demand (consumption), we should take this opportunity to also execute an economic structural reset. As Winston Churchill once said, “Never let a good crisis go to waste.”

What we would really like to see is a pivot from consumption to production, instead of pushing growth from more consumption and spending. It is time to push growth by raising production and efficiency, generating higher income and employment.

In simple layman’s terms, this means extracting more output from proportionately less resources. How? By transforming the existing structure-ecosystem of industries, making processes more efficient by leveraging technology and removing friction and leakages, improving ease of doing business and getting approvals as well as ensuring a more transparent and competitive domestic marketplace.

All of the above would effectively lower the average costs of production (price) and thereby the cost of living for Malaysians — while also enhancing Malaysia’s competitiveness in the global market — and reinvigorate investments that will raise employment, disposable incomes, purchasing power and, finally, our standard of living.

A little background on Malaysia’s economic evolution

Before we go into more details on the how and why we believe the best — and only — way forward is to pivot from consumption to production, it is useful take a look back at the evolution of the Malaysian economy over the last 60 years (see Chart 3).

In the earliest years following the formation of Malaysia, we were primarily an agrarian economy and the key exports then were rubber, tin, logs and timber, mainly in the form of raw commodities. Investments were primarily for basic infrastructure and development of the agriculture and mining sectors.

The first major transformation came in the 1980s, when Malaysia pivoted from a resources-based economy to one based on manufacturing. Exports shifted to manufactured goods such as electronics and electricals. Our industrialisation programme was driven by foreign direct investments from multinational companies. This was accompanied by rapid urbanisation and gains in per capita incomes as the standard of living improved significantly.

The country’s growth progression was interrupted by the severe economic shock from the Asian financial crisis (AFC) in 1997/98. In the ensuing years, investments fell sharply as the financial system and businesses grappled with a debt burden and overcapacity while capital controls affected foreign capital inflows.

At the turn of the century and for the better part of that decade, GDP growth downshifted but fortuitously, net exports grew strongly, boosted by the global commodities boom. Prices for our main exports, crude oil and crude palm oil, surged to record-high levels. The commodities super cycle ended in 2008 with the onset of the global financial crisis (GFC).

The Malaysian economy underwent yet another major transition through the 2010s. The investment-export-driven model of the previous three decades gave way to one that is now underpinned by consumption and government spending, focused on mega infrastructure projects.

Heading into the 2020s, it is clear that Malaysia can no longer rely on this consumption-driven model to drive future economic growth. Why do we say this?

Consumption-driven growth model no longer a viable option

As mentioned above, the majority of countries in the world are focused on stimulating aggregate demand in the aftermath of the pandemic. This is the traditional response. For Malaysia, however, this path is full of pitfalls.

Aggregate demand = Consumption + Investment + Government + Net Exports

The government has actively encouraged domestic consumption as the key driver of economic growth for the better part of the past two decades.

From a macro perspective, this is a natural progression for most economies as they develop — from agriculture to industrialisation and ultimately transitioning to a services-based economy supported by consumer spending. In the US, consumer spending accounts for 70% of economic activities.

Back on the home front, consumer spending accounted for 43.8% of GDP in 2000, gradually rising to nearly 60% in 2019. So, the strategy worked — from a limited perspective.

The trouble is, per capita income growth has consistently lagged consumption growth since 2000. This is best reflected in the sharp rise in household debt and corresponding decline in savings rate. Our household debt as a percentage of GDP is now among the highest in the region (see Charts 4 to 7).

In other words, we have been living beyond our means — taking on more and more debt to maintain our lifestyles at the expense of the future. Clearly, this is not sustainable. The average Malaysian has limited savings to meet emergency needs and even less for retirement.

The commodities boom in the early 2000s propelled exports — and our current account surplus — higher. But after the bubble burst, surplus as a percentage of GDP has consistently declined as imports growth exceeded exports. The domestic consumption boom contributed to this decline, as consumers spent on imported goods and services, such as travel expenses (see Charts 8 and 9).

With the disruption in supply chains and global economic recession owing to the pandemic, exports are likely to decline further in the near to medium term. Prices for crude oil and crude palm oil, too, have fallen sharply and are expected to stay low for some time. Thus, we cannot depend on exports alone to lift the country out of recession.

In fact, Malaysia’s current account may fall into deficit, for the first time since the AFC. If so, this means that we are looking at twin deficits — the current account deficit and government budget deficit. Left unchecked, such a situation will create downward pressure on the ringgit.

This situation also restricts the government’s ability to implement large fiscal stimulus packages, which were already limited at the outset of the pandemic owing to years of profligate spending. The drop in global oil prices further cuts into government revenue while tax revenue will fall in line with the economic downturn.

Unlike the US — and its unique status as having the global reserve currency — a much smaller economy such as Malaysia does not have the luxury of running huge deficits without (much) consequences.

A laser focus on stimulating demand (without raising supply) could also lead to price increases, which would further inflate the cost of living. The average Malaysian is already struggling to cope with the relentless rise in living expenses.

For all of the reasons detailed above, it is clear that the old and tried — easy — strategy of pushing consumption to grow the economy is no longer a viable one. We have exhausted this option, at least for the immediate future.

Moving from consumption to production

Consumption could be a sustainable driver for economic growth in the longer term. But first, we need to raise people’s disposable incomes and lower the cost of living — so that consumption growth is sustainable, without having to resort to higher and higher debts.

We will not pretend to have all the answers. However, we know that addressing the supply side of the equation today is the right path forward (see Chart 10).

Reinvigorating investments as key driver for sustainable growth

Part of the answer has to lie with rejuvenating investments. And by that we mean investments in productive assets as well as in intangibles — research and development (R&D), innovation, technology, education and training — all of which will enhance future productivity, create higher-paying jobs and lift overall disposable incomes in the country.

Investment as a percentage of GDP has declined sharply since the AFC, when the drivers of economic growth shifted to consumption and, to a lesser degree, government spending (see Chart 11).

Between 2000 and 2019, the compound annual growth rate (CAGR) in investments slowed to 4%, on average — below GDP growth of 4.8% — and far below that for government spending (5.6%) and consumer spending (6.6%).

This trend is in sharp contrast to the previous decades, when the key growth driver was investments. Investments grew at a CAGR of 9.5% between 1980 and 1997, and 9.2% from 1960 to 1979.

Incidentally, this shift also corresponds with a period when per capita income grew at a much slower pace compared with previous decades, albeit from a larger base.

Investing in the ‘right’ sectors

In short, moving forward, Malaysia must return to an investment-driven economic growth, a strategy that has served us well in the past. That said, we must also learn with the benefit of hindsight.

For instance, back in the 1980s, Malaysia’s government-led industrialisation plan included a focus on capital-intensive heavy industries such as auto, steel and cement. These are sectors in which we do not have a strong competitive advantage and economies of scale owing to a lack of technological knowledge and limited population size.

Many survived only on the basis of rent-seeking, where high prices and limiting imports created higher costs to other businesses and individual Malaysians.

Furthermore, it is no secret that Malaysia has failed to capitalise on our early manufacturing success and move up the value chain. This is a fact well supported by evidence, from data and surveys conducted by various institutions, including Khazanah Nasional and Bank Negara Malaysia.

Our manufacturing base has mostly languished in the cookie-cutter assembly-line type. And in the absence of sufficient spending on R&D and proprietary intellectual property, productivity stagnated.

In not moving up the value chain, we have become overly dependent on cheap, low-skilled foreign labour, producing low value-added manufacturing goods. At this level, we are competing against other less-developed countries such as Vietnam, Laos and Myanmar, where labour is abundant and starting wages are low.

To maintain competitiveness within this low value-added, labour-intensive market segment, Malaysia too has been forced to cap its wages. As a result, income per capita growth slowed.

Competition in the global market and a rise in other operating costs resulted in falling profit margins for businesses — leaving less and less for reinvestments. This has become a vicious cycle.

The pandemic crisis is the opportunity for a great reset. Not only must we re-emphasise investments as the key driver of growth, they must be the “right” type of businesses.

Private sector-driven investments the answer

Again, we do not presume to know exactly what are the best industries and businesses to be in. If we do, we would be rich! We can venture some guesses in broad strokes — they must involve technological upgrading, manufacturing of greater complexities and with deeper domestic linkages, higher value-added and knowledge-based services industries and industries with a high multiplier effect.

Fortunately, Malaysia has many far more intelligent and capable entrepreneurs who do have the answers. In short, future investments must be driven by the private sector.

The government has a very important role and that is to be the catalyst and facilitator — to provide a regulatory environment that supports innovation and attracts private investments, foreign and domestic, and removes friction for businesses to operate efficiently.

This is all the more crucial now that there is intense competition for investment (FDI) dollar — the investment strategy is being pushed by almost every other country in the world to boost their recoveries even as domestic policies take on a greater nationalist tone.

Transparent framework to minimise friction for businesses

Based on the results of various surveys, the two biggest drawbacks of investing in Malaysia are the levels of red tape and corruption.

To improve the ease, and lower the cost, of doing business, the government can start by simplifying and streamlining procedures for its interactions with the private sector.

Most existing processes can be migrated online, which would not only be faster and convenient but, more critically, transparent and consistent. A clear and transparent process will remove rent-seeking and corrupt practices, which only sap the country’s resources and discourage genuine investments.

In fact, integrating the many services among public utilities, municipalities, state and federal governments and the people into one common nationwide digital platform would lead to greater convenience and timeliness (and therefore, compliance), reduce the administrative burden, duplication and costs, and enhance overall productivity.

Injecting confidence with less conventional measures

One of the biggest obstacles to investing in the country now is the lack of confidence, given the political uncertainties and years of built-up trust deficit in the public sector. The government must address this issue head on.

One possibility is for the government to underwrite the debt servicing on select high-impact investments, if pre-agreed milestones — say, GDP or banking sector loan growth targets — are not achieved within a specific time frame.

This would give entrepreneurs the confidence to plough money into new investments while avoiding the moral hazard of promising returns without downside risks. The businesses-projects still have to succeed on their own merits against a positive macroeconomic backdrop.

This is but one suggestion. We are confident the combined brainpower of the private-sector entrepreneurs, economists and technocrats at the Ministry of Finance and Bank Negara will surely come up with many more viable propositions. The key is to inject confidence in the country and cultivate a dynamic private sector within a competitive market structure.

Productivity beyond physical assets

Enhancing productivity goes beyond physical investments and infrastructure. It is also about getting the most out of every ringgit of investment in productive capacities. Clearly, a rapid and committed transition to the digital economy is one key component.

To fast-track Malaysia towards a digital economy, the country needs reliable high-speed broadband and 5G connectivity nationwide — at affordable prices.

A common shared infrastructure — such as fiberisation and submarine cables, data centres and cloud infrastructure — with universal access will avoid unnecessary capex for network duplication, which only serves to raise overall prices for the people.

Next, the government must undertake the push for all micro and SMEs to get on board this digital transformation — on both the front and back-end of their businesses. Ideally, there will be a national platform to coordinate all the policies and programmes to ensure maximum efficacy.

The pandemic has highlighted the importance of e-commerce, which can significantly expand the addressable market (domestically, regionally and globally) for businesses.

Necessity during lockdowns has onboarded many consumers, including the less digitally literate older generation. How many of us actually bought groceries, fresh fruit and vegetables online pre-pandemic?

Most micro and small businesses that had previously neglected this sales channel too have realised the benefits from the expanded market, sales effectiveness (say, via social media) and cost efficiencies.

On the back end, businesses can improve efficiency and productivity — for human resources, IT, accounting and finance, procurement, inventory, supply chain, sales and marketing, among other things — through the adoption of task automation, digitisation and migration to the cloud.

The application of artificial intelligence, super computing power and analytics can further turn massive amounts of data into useful information that will enhance the company’s ability to compete more effectively.

For instance, collecting and analysing data on shopper purchases will offer insights that help businesses tailor more effective (even customised) future sales, marketing and promotions. Meanwhile, predictive data can lower repair expenses and costly downtime at production lines.

For production, the switch to greater mechanisation, automation, robotics and internet of things can also enhance productivity — for example, by reducing human error and wastage.

To summarise, we address the supply side of the equation — production — through a multi-pronged approach. Firstly, we must reinvigorate private-sector investments with the government in the key role as catalyst, facilitator and enabler.

Productivity can be enhanced through digital transformation. To accelerate the adoption of digitalisation, the people must be effectively trained and equipped with the necessary digital skills.

Critically, Malaysia must undertake structural reforms of existing ecosystems. We have included four case studies (see sidebars) where restructuring can result in greater productivity — that is, growth without unnecessary cost inflation, thereby leading to lower overall prices.

Raising production — more for less

If all of these — and more — can be achieved, Malaysia can raise production output with a less than proportionate increase in investments. This would kick-start a new virtuous cycle (see Chart 10).

Higher productivity translates into lower costs and higher profits for businesses even as average selling prices are lowered. There will be more money for reinvestments. New, and higher-paying, jobs would be created, translating into higher per capita incomes for the people.

Meanwhile, increased productivity and competitiveness in the global market translate into higher exports and larger trade and current account surpluses for the country — and stronger purchasing power for the ringgit, thereby lowering the cost of living.

Consumption can grow anew, only this time, the growth will be sustainable along with an improving standard of living.