Photo: Nafise Motlaq / World Bank
Authors: Amanina Abdur Rahman and Achim Schmillen
Similar to the trajectory of development seen in many other countries (see blog #3 in the series), over the decades since independence in 1957, Malaysia has seen a significant increase in GDP per capita from labor productivity. The country also underwent a sustained structural transformation.
As Malaysia has developed, it has seen a range of drivers of per capita income growth, along the different dimensions of structural transformation characterized in the economic literature, including sectoral transformation, spatial transformation, occupational transformation and organizational transformation. This structural transformation and accompanying economic growth, led to Malaysia’s transition from a lower-middle income country (LMIC) to an upper-middle income country (UMIC) at the cusp of high-income country (HIC) status.
Among the 88 countries for which comparable data on real GDP per capita in both 1960 and 2019 are available in the World Bank’s World Development Indicators, Malaysia recorded the seventh highest real per capita growth rate in the intervening years (in local currency units). Sustained high growth makes it valuable to study the different phases of structural transformation that Malaysia has undergone, with an emphasis on its sectoral transformation from an agriculture-driven economy, to one with an important manufacturing base, and then more recently, one which is driven by services.
Malaysia’s transition: at the cusp of HIC status
Around independence, Malaysia had some of the characteristics of a lower income economy. In 1957, 58 percent of workers in Malaysia were employed in the agriculture sector. By 1990, this was 26 percent. The manufacturing sector accounted for just 8.7 percent of employment in 1970, but by 1990 had risen to 20 percent. Since then, the share of employment in agriculture has fallen to just 10.6 percent in 2018, releasing workers first to the manufacturing sector and thereafter increasingly to the services sector.
Similarly, the share of agriculture in value added was 32.6 percent in 1970 and has since fallen to 7.4 percent in 2018. Overall, real output growth was highest in the business, trade, and transport services sectors, with output in all three sectors growing more than ten-fold. Aside from the highly cyclical mining sector, the agriculture sector experienced the lowest growth, with agricultural output increasing by “only” 79 percent.
Three key periods in Malaysia’s sectoral transformation
We can divide the period of 1987 to 2018 into three subperiods of about ten years each:
- Rapid industrialization from 1987 to 1997, when real output growth was highest, averaging around 8.2 percent, driven by manufacturing, which expanded by 13.9 percent per year on average. With average annual output growth of only 1.1 percent, agriculture’s share of output halved from 22.5 percent in 1987 to 11.4 percent in 1997, and Malaysia turned from a net exporter of food to a net importer.
- Slowdown of industrialization and transition to service-led growth from 1997 to 2007, with slower average real output growth at 4.2 percent between 1997 and 2007. The growth of the manufacturing sector was slower than in the previous period, at an average of 5.1 percent per year.
- Service-led growth from 2007 to 2018, with growth driven by the services sector, and average real output growth at 4.7 percent between 2007 and 2018 – still respectable but much slower than seen between 1987 and 1997, or the period of industrialization.
Economic growth: within-sector labor productivity vs sectoral transformation
Whereas labor left agriculture, sustained growth of within-sector labor productivity accounted for the largest share of Malaysia’s economic growth between the years 1987 and 2018, beyond sectoral transformation. More specifically, 75.9 percent of growth in output per capita in the period can be attributed to within-sector labor productivity growth, while only 3 percent can be attributed to sectoral transformation. In addition, 5.9 percent of economic growth was due to changes in the employment rate – primarily reflecting an increase in female labor force participation in the past decade – while 13.1 percent was due to reaping the rewards of a demographic dividend (see blog #11 in the series). However, within-sector productivity growth between 2007 and 2018 was lower than between 1997 and 2007, while Malaysia has started aging in 2020, and is unlikely to continue benefiting from changes in its demographic structure.
The contribution of sectoral transformation to Malaysia’s growth was largest when the country underwent rapid industrialization between the mid-1980s to the early 2000s, and labor was reallocated from the agriculture to the manufacturing sector, with workers more likely obtaining waged jobs (see blog #4 in the series). While during this period of industrialization growth in manufacturing output was primarily due to improvement in within-sector labor productivity rather than sectoral transformation (see Chart 1), 6.8 percent of overall economic growth was due to sectoral transformation. The contribution of sectoral transformation fell to 1.5 percent in the period between 1997 and 2007, and to -7.8 percent between 2007 and 2018. Compared to the relatively small contributions of sectoral transformation to economic growth, within-sector labor productivity growth contributed 77.2 percent, 103.2 percent, and 67.1 percent of growth between 1987 and 1997, 1997 and 2007, and 2007 and 2018, respectively.
Chart 1: Decomposition of growth in output per capita by sector, 1987-2018
Source: Authors’ calculations based on data from Department of Statistics Malaysia
Productivity and employment: no clear relationship
A closer look at the data for the between-sector shifts in employment reveals that sectors that had a relatively high labor productivity in 1987 and 1997 later increased their share of overall employment. However, between 2007 and 2018, the share of employment in sectors that had a relatively high labor productivity at the beginning of the period actually decreased, suggesting that workers moved from more productive sectors to less productive sectors on average. Overall, the relationship between labor productivity and subsequent employment growth was negative for the three decades between 1987 and 2018, although the correlation coefficient is small (see Chart 2). Indeed, there is no clear relationship between productivity and employment in Malaysia. Chart 3 shows that in 2018, sectors with relatively high levels of productivity, like transport services and business services, make up relatively low shares of employment. In the same year, trade services, which have a relatively low level of productivity, have a higher share of employment than the two more productive sectors. These patterns further illustrate the relatively small contribution of sectoral transformation to growth as the country got richer.
| Chart 2: Relationship between initial productivity and changes in employment share, 1987-2018
Source: Authors’ calculations based on data from Department of Statistics MalaysiaNote: Sectors depicted are agriculture (agr), business services (bus), construction (con), manufacturing (man), trade services (trd), transport services (trn), and other services (oth). The size of the bubbles indicates the share of employment in1987. |
Chart 3: Relative productivity and share of employment by sector, 2018
Source: Authors’ calculations based on data from Department of Statistics Malaysia
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What is Malaysia’s path to high-income status?
As Malaysia recovers from the impacts of the COVID-19 pandemic and pursues further development toward becoming a high income and developed nation, it faces a slowdown in the speed of both sectoral transformation and productivity growth. This is typical of economies transitioning to high-income status.
Can the reallocation of labor across sectors be a driver of Malaysia’s future economic growth, given that the country has already passed the typical phase of industrialization? The evidence on the past drivers of economic growth presented here suggests that potential gains from sectoral transformation may be relatively limited. Still, significant productivity gaps between sectors show that there may at least be a certain potential for growth-enhancing reallocation of labor toward the most productive sectors, such as the business and transport services sectors. In turn, this would require investments in fundamentals such as human and physical capital that can contribute to both sectoral transformation and within-sector productivity growth.
Nevertheless, the main policy challenge for Malaysia going forward will be to reverse, halt, or at least moderate the declining within-sector labor productivity growth. New strategies for growth, including the strengthening of productivity growth through technology and skills development will be needed. Some avenues for achieving this include overcoming skills gaps, maintaining the high quality of infrastructure, building innovation capacity, addressing distortions in output markets and improving management quality.
