Can a country undo its development stage?

This writing is inspired by an insightful presentation by Professor Hal Hill about his and Ramon Clarete, and Emmanuel Esguerra's upcoming book 'The Philippine economy: no longer the East Asian exception?'

Their book was about how the Philippine development was lagging compared to its neighbours accelerating growth. In the 1960s where GDP per capita in the Philippine was higher, but in the 2000s it became less than others. That political dynamics, bad regulation, and conflicts have made it 'an exception' compared to the other countries miraculous growth.

What intrigue me about Pak Hal's presentation is that he said that the Philippine has skip a development stage, from agriculture to manufacturing and to service. Instead, the main economic sector has transformed from agriculture directly to the service sector. He elaborated that this is mainly due to restrictive internasionalisation in its trade and FDI policies, crony capitalism, bad labor and industry regulation, and infrastructure deficit. Taking account these factors and benefit by its people English language proficiency, the Philippine excels on the service sector exporting semi-skilled and unskilled workers with minimum intervention from the government. As a result, its growth trend is on average the same with its counterparts in the region, but cannot accelerate as fast as South Korea or Taiwan and become the NIE.

South Korea, for instance, has remarkable growth because of its electronic industry which made it a high income country now. The development formula of having a solid manufacturing base before taking off to the service sector seems to be the narative of many successful countries. Manufacturing sector has a comparative advantage for the economy since it absorbs formal workers, it has high forward and backward linkages to other sectors, and it contributes foreign reserve if exported.

In the case of the Philippine, and also Indonesia which manufacturing was vaguely developed, can service sector do the same thing for the economy ? can a country undo its development stage from service, back to manufacturing again ? is there any case study who experience a backward development cycle ?

Improving vocational education in China’s rural area

Introduction

Inequality is a complex socio-economic issue for policy makers in many countries. China’s rapid development with rising inequality provides a setting for many developing countries to learn. From the 1980s China’s income inequality is rising particularly between urban and rural (Shi, 2012). Urban and rural income inequality in China is high compare to other developing countries (ADB, 2007) and even though there is a recent slow-down on the inequality indicator it may have under-estimated the actual condition.  

Rapid growth has transformed the economy from agricultural to knowledge-based industrial economy which requires more skilled workers (Roberts, 2014). The rapid rise of Chinese skill premium in conjunction with an upward trend in relative demand means that the recent technological change has been skill-biased (i.e. Li & Baoping, 2008; Li, 2010).  To overcome the skill mismatch in the labor market, the government has established vocational education training (VET) institution particularly in industrial area close to urban settings. Furthermore, Chinese government has set regulations for VET’s national curricula and teacher’s qualification. However, more needs to be done to improve VET access particularly to solve the urban rural inequality problem. The paper would like to suggest that the Chinese government should increase fiscal spending to the rural areas for establishing upper secondary VET school.

Does inequality matter in China?

From the 1980s to the present, China’s remarkable growth has resulted to a structural change in the economy, transforming from an agricultural to knowledge-based industrial driven economy (Brandt & Rawski, 2008). This poses challenges on income distribution where growth is mainly concentrated in urban area. The ratio of urban household income per capita to rural one rose to 3 times higher in the last decade (Shi, 2012 p.1), which makes China as one of the highest urban-rural income gap country in the world (Sicular et al, 2007 p.4).

After an increasing trend of income inequality, the indicator is slowing down in recent years. However, the slow-down is unconvincing since the under-representativeness of people with extremely high income in the sample (Li and Luo, 2011) and the household income survey is based on registration instead of residency which pose a serious problem of rural migration omission (World Bank, 1997 p.19). Despite the survey’s measurement error, China’s income inequality is high compare to other developing countries creating several challenges to the economy.

China’s inequality can limit poor people opportunities, undermine their utility, and in the long term can be harmful for political stability. Knight & Li (1993) found that Chinese children in poor rural household has lower education compared to children from rich household, implying high intergenerational educational persistence, which may in economic drag. Poor household has lower utility indicated by urban residents’ life satisfaction is 60% higher than rural residents (He et al., 2007 pp.30-32). In addition to the drawback from the utilitarian framework, the income gap has cause symptoms of social distress which may threaten the power of ruling party and creating political instability in the future (Fortune, 2013).

The urgency in improving VET

As the economy transforms from agricultural to knowledge-based industrial driven, the country’s productivity increase. Under the production function, Solow explains that productivity is the residual of growth thereby indifferent in the changes of production factors, or factor neutral. However, there are evidences in several countries that labor, as one of the production factors, is segregated between skilled and unskilled workers, consequently as productivity increases skill premium also rises (i.e. Kiley, 1999; Violante, 2016). This implies that productivity is factor biased. As technology grows the demand for skilled labor rise faster. This is known as skill-biased technological progress which leads to income inequality (Goldin and Katz, 2008). The analysis is compatible with China case study, where manufacturing worker mainly located in the urban has higher income compare to agricultural workers located in rural area.

The industry is facing rising wage from urban labor (Li & Baoping, 2008). This creates opportunity for rural labor. However, the rural residents are mostly agriculture workers who have lack of education and skill to work in the manufacturing sector. Only a small portion of rural workforce attend school and vocational institution (SCMP, 2015). Moreover, a report from Chen, Mourshed, & Grant (2013) elaborates that manufacturing companies are failing to find high skilled employees (p.3). Furthermore, the report predicts that there will be shortage of 16 million vocationally-trained workers by 2020 (p.6), emphasizing the high demand for VET.

The government has formulated VET policy with limited focus on rural vocational education to reduce urban rural inequality. There is an existing VET policy for teacher’s qualification that teachers must undergo trainings and work in the industry and national VET curricula (Ministry of Education, 1996). However, vocational institution is mainly established in industrial area while technical training opportunities for rural workforce remains limited (Lai et al., 2011 p.2) and vocational institutions in rural area are under-resourced (OECD, 2010 p.1).

To reduce inequality, the government has approved an Income Distribution Plan by enhancing social safety net and adjust taxes for the rich. These are supported by an anti-corruption policy. From 2012 China has put anti-corruption as a serious agenda. They arrested more than 100,000 officials, which is a striking figure compare to previous years (Economist, 2015). In addition, from the list of income distribution plan, the Chinese government will increase education funding. However, the education policy formulation and implication is unclear. It does not specifically elaborate which types of education policy. If it is concerning basic compulsory education, then is not a sufficient solution for inequality. In particular, it does not solve China’s inequality problem which is caused by skill-biased technological change.

Recommendation

I recommend that the Chinese government should increase funding for the vocational education in rural area so that providing opportunity for rural worker to increase their skill and to work. VET will give benefit for rural people a higher return on education. This is particularly significant since poor rural students are giving larger relative investment for lower return compared to affluent urban students (Bingqi, 2011).  Furthermore, VET education should be provided in upper secondary school, instead in tertiary level as the government mainly focused, since rural worker can work as soon as they graduate from secondary school, furthermore providing the industry with younger thus cheaper labor. Accordingly, Chinese economy will also benefit since it increases the supply of skilled worker needed.

The VET school should use a benchmark from the success of Germany’s dual-system. The system creates institutional linkage between schools and workplace that after several years of schooling the student has the opportunity to take apprenticeship. This is in line with the government concern to increase trained-workers (Roberts, 2014). The system which combines vocational education in school and training in the workplace is feasible to be implemented in rural China for several reasons. Firstly, because the government is a central-planned government which can impose policy to regional level. Secondly, Chinese government is already familiar with the system since they already have collaboration with German government and companies such as German Technical Cooperation in various VET projects (Li, 2013 p.3).

However, in implementing the policy, the government may face challenges which are budget constraint and ensuring quality amongst local VET. Firstly, Chinese government may face fiscal budget constraint. To reduce fiscal burden, the government can divide the transfer to several phases. Regions are selected according to their income per capita for different phase of funding. This means that regions with lower income per capita should have the priority to receive funding. Another solution is the government should cooperate with countries who have business linkage and also interested in improving vocational education in China, such as Australia (Smith, 2006).

Secondly, the government will face challenges to ensure the quality of the rural VET. To ensure the rural VET meet the national standard, the government should closely monitor each local VET. Furthermore, as business engagement in the program is essentially important in meeting skill demand, the government should encourage business commitment to provide apprenticeship for teachers and students by imposing regulation, or collective action through industrial associations, or giving incentive through tax reduction, as some OECD countries have applied (Hoeckel, 2008 p.8-9). By involving in the local VET, the industry can ensure the prospectus worker’s technical qualification, reduce time and cost in training, and have early engagement with workers thus improving labor loyalty and reducing turn over.

Conclusion

Traditional theory suggests that in a growing market wealth will be distributed efficiently.  However, China’s growth has resulted in an increase in income inequality between rural and urban workers. Over the decades, China economy has transformed from agricultural economy to knowledge-based industrial driven requiring more skilled workers. The structural change has led to income inequality which suggest that China is experiencing skill-biased technological change as many countries also experienced. To meet the skill demand, the government has provided VET policy and institutions; however, the VET is mainly available in the industrial area agglomerated near urban settings. Accordingly, the government should increase the access of VET in the rural area.

A reform on Malaysia’s technology transfer program

Introduction

The world’s economy is divided into several stages, of which the countries with lower stages are formulating different ways to step up the ladder by achieving higher growth. Furthermore, middle income countries are finding ways on how to thrust themselves to the high income status. Some, like Taiwan and South Korea, have achieved the higher status faster than the others, such as Malaysia. Malaysia is blessed with geographical advantages, macroeconomic and political stability, and trade openness (Cherif & Hasanov, 2015 p.4). For almost 50 years it has sustained a steady growth and in the next few years it may achieve the high-income status. But, why does the set of advantageous has not support Malaysia to achieve high-income status faster?

Discussion on economic growth has defined many growth determinants with the most recent theory is Romer’s endogenous growth. It emphasizes the importance of technological progress on productivity and it’s spill-over effects to economic development. Malaysia’s economic openness has created an opportunity for export, the establishment of foreign companies to operates and invest in the country, and most importantly technology transfer to the domestic firms. However, the spill-over effects are limited (Cherif & Hasanov, 2015) which hinder the higher rate of technological diffusion and the emergence of innovation driven local champions.

To help improve the diffusion flow in the economy, the government implement Vendor Development Program (VDP) which then was revised to Industrial Linkage Program (ILP). It is targeted to industrial clusters, with multinational companies (MNCs) as the anchor firms and their domestic supplier as the vendor firms. The program has helped to increase knowledge transfer; however, the result is below optimal (Karikomi, 1998). This paper would like to recommend a reform of the ILP structure to generate active linkages. To be precise, this paper suggests that instead the MNCs, the local suppliers should be the leader of the partnership along with enhancement of the research institutions’ role in the program. Accordingly, it will improve the spill-over effect, transforming to knowledge based economy, and therefore resulting rapid economic growth.

Industrial policy to accelerate economic growth

Technological progress and spill-over are crucial to achieving higher economic growth. Malaysia has a stagnant growth over the years with a tendency of a slower pace in recent periods (Hill, 2012 p. 28), while other countries who had the same initial condition in the 1970s has achieved high-income status (Cherif & Hasanov, 2015 p. 5). Why growth rate can change over time and the income per capita differentials among countries has become a topic of interest to many economists, with Romer’s theory of endogenous growth emerged to answer the question (Parker, 2012 p.2).  The theory suggests that technological progress is needed so that the country achieve higher economic growth, or else it will decelerate and converge to it’s steady state growth. On doing this, economists promote to embrace openness which then is assumed to give spill-over effects to the economy (i.e. Jones & Romer, 2010; Rodrik, 2003). The spill-over will then creates technological progress and sustain a higher economic growth.

However, there are barriers on Malaysia’s trade openness spill-over effect. Interconnectivity through trade and FDI has played an important role in Malaysia’s economy, as it improves export sophistication, industrial sector, and investment in the country. Nevertheless, there is a hurdle on the diffusion. Malaysia’s technological diffusion is less than 5% of total public R&D projects, and less than 3% were commercialized (Thiruchelvam, 2013 p. 21). One of the reasons is the growth seems to be segregated for the foreign companies excluding domestic firms with lower competitive advantage (Cherif & Hasanov, 2015 pp. 10-11). To overcome this problem, government intervention is needed to improve the knowledge flows.

Government intervention particularly through industrial policy is not necessarily to pick a winner, instead, it can be used to rebalance the economy and fix market failures. Industrial policy, particularly subsidies and promotion of champions, can discourage competition and heavily influence by political interest. On the other side, a sound industrial policy should avoid targeting particular firms, instead, it should support a range of technologies and players, promote competition, and assure accountability (OECD, 2012). Accordingly, Malaysian government designed ILP program to fix diffusion failures on a range of industrial subsectors. Through ILP, technological diffusion and innovation are expected to grow knowledge capital which then can improve the economy.

Why local firms gain limited benefit from the ILP ?

The ILP program gives the advantage for the local firms in the MNCs supply chain to receive technical assistance, management support, and the market for their products from the MNCs or the anchors. Karikomi (1998, p. 23) evaluated that the program was participated by 27 anchors and their first and second tier domestic suppliers. The MNCs reported that there is an improvement in the suppliers’ product quality, sales, and price. Furthermore, the MNCs benefited from operational expenses tax deductions and creating domestic value chains.

Nevertheless, the partnership is heavily driven by the MNCs since they do the planning, implementation, and evaluation which resulted from a more one-way partnership in ILP. Japanese Chamber of Trade and Industry in Malaysia (JACTIM) stated that most of the suppliers are very dependent on the anchor’s support. In addition, some MNCs complaint that their participation in the program was due to the political pressure from the government (Karikomi, 1998 pp. 24-26).

The institutional structure of the ILP program creates a disadvantageous in achieving a higher rate of technology transfer and the emergence of innovation driven local winners. The local firms participating in the program does not take a step further to develop a new product or more effective production. The main cause of this problem are the local firms are passive participants and the research institutions are only connected to the MNCs. The limited partnership between the local firms and research institutions hinder the opportunity of innovation cooperation. These institutional features differentiate Malaysia’s ILP with Muro & Katz (2010) examples of successful clusters in USA, Germany, and Canada whereas the local firms are the leader and research institutions are the main partner in the clusters.

Recommendation

To overcome the problems of low involvement of local firms and disruption in innovation flows, this paper proposes that the local firms should be the leader with the support of the research institutions. Local firms of each ILP group should choose a local firms leader. The leader then plan the assistance needed from the MNCs or having the planning role, in contrast of the existing structure, which the MNCs do all the planning. The partnership should develop a two-way communication between the research institutions to provide prototype and the local firms to test the product’s marketability so that the cluster become an incubator and creating a cycle of technology development of a series of testing and prototyping through the local firms and research institutions interactions.

Nevertheless, there would be two major problems arise in the program, which are choosing the wrong leader and the MNCs disapproval with the proposed plan. First of all, the chosen local firm can be politically strong but have a lack of technical capacity. Since there is a strong influence from the government to the business sector, it is possible that a strong candidate of a local firm is politically linked with the ruling government. In addition, a more active local firm can be seen to overpower a less dominant firm. Therefore, research institution and anchor companies should work together and assess the technical capacity of each local supplier in choosing the leader. The assessment should be accountable and transparent to the public so that avoiding political conflict. By increasing the transparency, the ILP can choose the local leader without political pressures. In addition, the candidates should have the willingness to actively participate as a leader and also supporting other local firms in the ILP.

Secondly, local firm’s proposed plan can be rejected by the MNCs due to technical and financial constraints. In planning a technical assistance, research institutions should play an important role to formulate it. The research institution as a neutral-side and a think-tank should accommodate technological adoption needs from the local firms and also the demand of product quality and price while taking account technical and financial constraints of the MNCs. The proposed plan then reviewed and discussed together with the ILP participants to reach consensus.

In addition, local firms’ leadership in the program must be supported by a strong human capital. Technological adoption involves a complex interaction between human capital and institutions. The local firms should have a qualified human capital to support the program. On doing this, the government should specifically respond to the local firms’ need through enhancing the role of research institution. The research institutions should conduct training programs to develop talent pool specifically for each type of industry.

Conclusion

Take-off growth can be achieved through technological progress by promoting economic openness while assuming there is a knowledge spill-over. However, the spill-over in Malaysia is hampered and a reform in the industrial policy is needed. Malaysia has implemented a program called ILP to increase the effectiveness of the technology diffusion. However, the program has not ensured the emergence of competitive local firms which are able to create marketable high technological products. On doing so, a reform in ILP structure is crucial by enhancing the role of local firms and research institution.

To achieve the technological frontier, Malaysia needs a total reform on the manufacturing industry, political institutions, and socio-cultural structure. Nevertheless, deep and extensive reforms are often not the best way, only a significant and focus reform is needed to have the biggest and fastest effect.

(1596 words)

References

Cherif, R & Hasanov, F 2015, ‘The leap of the tiger: how Malaysia can escape from the middle-income trap’, International Monetary Fund Working Paper WP/15/131, International Monetary Fund, .

Hill, H. 2012, ‘Malaysian economic development: looking backward and forward’, in Hill, H. Yean, T.S. and Zin, R.M.H. (eds.), Malaysia’s development challenges: graduating from the middle, London and New York: Routledge.

Jones, CI, Romer, PM 2010, ‘The new Kaldor facts: ideas, institutions, populations, and human capital’, American Economic Journal: Macroeconomics 2010, vol. 20, no. 1, pp. 224-245, < http://www.aeaweb.org/articles.php?doi=10.1257/mac.2.1.224>.

Karikomi, S 1998, ‘The development strategy for small and medium enterprises in Malaysia’, IDE APEC Study Centre, Working Paper Series 97/98 No. 4 .

Muro, M & Katz, B 2010, ‘The new cluster moment: how regional innovation clusters can foster the next economy’, Metropolitan Policy Program, < https://www.brookings.edu/wp-content/uploads/2016/06/0921_clusters_muro_katz.pdf>.

OECD, see Organization of Economic Cooperation and Development

Organization of Economic Cooperation and Development 2012, ‘Resurrecting industrial policy’, OECD Observer No. 292, .

Parker, J 2012, ‘Theories of endogenous growth’, Economics 314 coursebook, .

Rodrik, D 2003, ‘Introduction: what do we learn from country narratives?’, In search of prosperity, Princeton University Press.

Thiruchelvam, K 2013, ‘Malaysia’s quest for innovation: leveraging on science and technology’, 11^th Malaysia Plan kick off conference, viewed 4 August 2016, .

Will Indonesia learn her lesson from the Dutch Disease phase?

Inspired by Pierre van der Eng work

Indonesia experienced commodity boom several times. Before 1930 when there was a strong demand for sugar, the country increased its production and gained international trade surplus. In this time of Dutch colonialization, the trade was run without any policies of protection or transfer to other sectors. Resulting minimum utilization on the trade revenue for the country's capital stock which led to non-optimum long-term growth rate.

Then, came the time of oil boom in 1970s. In this era, the New Order implemented a trade protection for manufacturing and received high tax revenue from the oil extraction. The government at that time had medium term plans for the manufacturing sector which lead to industrialization, particularly of state-owned enterprises. Well-design development plan for the industry made slight Dutch Disease of commodity boom-bust and took Indonesia's industry to a step forward.

The world then experienced another commodity boom from early 2000 to the end of 2011, which was led by mining commodities such as coal and oil. Indonesia benefits from this boom indicated by strong GDP growth of around 6%, the highest after the Asian monetary crisis. However, the government on those years were relaxed, had unclear manufacturing policies, which intensified pressures to real effective exchange rate; thus, resulting industrial products less competitive. The recurring commodity boom in this cycle had no advantage in Indonesia's manufacturing sector. On the other hand, profit of mining sector which has low labor absorption could only be obtained by the businessman than the poor, resulting larger income gap.

So, will Indonesia learn her lesson from the recurring phase of commodity boom-bust? Or, will it only be a part of good-to-know economic history book? We will see in the next cycle....

Jokowi's Vision of the Economy : Investment-led Growth?

[Comments on Prof. Bambang Brodjonegoro's Public Lecture on 24 March 2016 in ANU]

Indonesia in the leadership of Mr. Joko Widodo has set it's goal to transform the economy from consumption-led growth to investment-led growth. An approach that has led several countries like Japan, Hong Kong, Taiwan, Singapore, South Korea and China from low income country to distinguished economic powers. These countries increase capacity of production and stimulate firms to increase their capital, and expect that bigger supply will eventually increase demand and support growth and employment. A side of the monetary terminology, investment-led growth may also means building a better human capital, i.e. health, education, and productivity.

For Indonesia, this could be a good solution since the country has strong demand, in particular household consumption which over the last decades consumption expenditure share has been around 60% of the GDP. With the strong growth of consumption accompanied by the supply side inelasticity, this has caused Indonesia is heavily reliant on import. An argument that support Jokowi's decision on this matter.

So where should the investment be directed to? First, investing to make production in Indonesia more efficient or in other words to lower the cost of production. Infrastructure is a good way to make logistic cost lower, additionally efforts like to reduce transportation barrier, red tapes are essentially needed. Java island, the biggest consumer and producer base, must have lower cost of distribution, on the other hand Eastern Indonesia infrastructure projects should also be mended. Another area of improvement, is the cost of energy. Until now, the availability and continuity of electricity is a big problem in Indonesia which leads to higher electricity cost of the industry. Second, producing the right product to meet domestic demand. We have seen how investment-led growth created Great Depression in America which the increase of supply insufficiently considers the power of demand. Thus, Indonesia should increase the basic industries and sectors, i.e. food, agriculture, processed food products.

Now, the next question is 'Can Indonesia achieve it?'. Challenges for the government are to ensure good business climate, reducing corruption and creating political stability, investment and infrastructure should avoid to compete over land which creates asset price hikes, plus the labor market and wage must be competitive. Financially, the financial sector should have the intermediation capacity to distribute loans, giving low cost of capital, and better resource allocation. This also means encouraging people to have higher saving rates, and curtailing consumptive. Business wise, does the firms eager to invest? since government capacity is limited, private business investment should be the locus of growth.

All in all investment led growth might look like a solution to Indonesia, however if planned carelessly would made investment wasteful. Moreover, excessive and wrongly directed expansionary policies may lead to stagflation like Japan.