Importance of incentives in determining economic and social outcomes
In my entire professional life as an economist, the one thing that I have observed repeatedly is that economic and social outcomes are primarily determined by the types of incentives that exist in that economy and society. Given what is going on currently in the Malaysian economic and social scene, I have been thinking about the role of incentives in explaining the current alienation of the population, the huge disparities in social well-being and opportunities, the erosion of governance, and the growing mediocrity in Malaysian public life.
Incentives play a key role in economic and social life. In the corporate sector, various incentives have been extensively explored to align the interest of employees with the interest of the corporation, and the interest of management to the interest of shareholders. In social life, the robust enforcement of traffic rules creates incentives for good driver behaviour on the roads, and conversely, poor enforcement encourages bad behaviour. An independent and trustworthy judiciary creates incentives that discourage unlawful behaviour by reducing the opportunity for wrong doers to escape punishment by buying off judges.
In my view, the New Economic Policy (NEP) has been a key factor in creating incentives which has overtime created the Malaysia we see today. These incentives do not align with the long-term interest of the Malaysian economy. But before I go there, let me first draw on a corollary from economics to explain what I am trying to get at.
The infant industry thinking has a long history in economics going back to the 19th century. The fundamental idea being that new industries lack the experience and economies of scale to compete effectively against established competitors. Hence, such infant industries need to be protected until they achieve those economies of scale. This protection comes in many forms and often includes government subsidies to these firms, privileged access to government procurement, and tariffs/taxes and quotas on competing imports. Domestic competition is controlled through licensing and other means. The idea is that once the infant industry grows up and becomes competitive, these protections will be removed.
The fundamental problem is that it is difficult to breed competitive champions in a protected environment. If industries have only learnt to operate in a protected environment, how can they be expected to transition effectively to a competitive environment? They cannot. The only way to do so is if there is a fixed term for the protection and the industry is gradually exposed to increasing competition. It was exactly for this reason that when Bank Negara Malaysia (BNM) formulated the Financial Sector Masterplan after the Asian Financial Crisis, a key element of the plan was to gradually ratchet up the level of competition in the financial industry, first among domestic financial institutions and then with new foreign entrants into the financial system. However, beyond the financial system, this kind of thinking has not permeated the rest of the economy, especially the public sector.
If industries are not prepared for such competition, then the general experience is that they are unable to operate without protection. They have not learnt how. As a consequence, the protection remains in place for an extended period. Who pays the price? Not politicians or the shareholders of these firms. Rather, it is consumers and tax payers – being burdened with often expensive and poor-quality products as well as seeing their tax dollars being used not to improve public services but rather to bail out these infant industries.
Malaysia has had its own experience with infant industries, particularly in the 1970s and 1980s, most notably with the national car project. Even after decades of protection, and tens of billions of ringgits in transfers from car buyers and tax payers, the national car project failed to deliver a car company that was even regionally competitive. But Malaysia’s highly protected car market ended up deflecting car industry FDI to other regional economies.
The infant industry experience in the context of developing countries has generally not been positive. Due to their national nature, such businesses often had members of the elites on their management and boards who had little or no industry experience. This corporations were also not insulated from political influence. Standards of performance were weak, with large losses requiring bailouts from the government. Even when some of these entities are “privatised,” they end up in the hands of elites, which means that the protection and subsidies continue. Over time, the losses incurred by these corporations become part of the national debt.
Instead of spurring economic growth, badly managed infant industries tend to act as a drag on the rest of the economy.
The New Economic Policy (NEP)
The NEP was formulated around the time when Malaysia started experimenting with infant industries and that same ideology probably infiltrated the thinking on the NEP. The underlying rationale for the NEP was essentially the same as that for infant industries – provide a protected eco-system free from competition, reduce performance thresholds, target government procurement and expenditures toward the targeted groups, and undertake wealth transfer programmes from the rest of the economy to the targeted groups.
Clearly, those who saw the opportunities created by the NEP were not the rural poor but the urban elites of that community. The protection, privileges and financial flows under the NEP was manna from heaven for those with political connections. It became a get rich quick scheme for many. However, it did not deliver the anticipated supply of competitive businesses or entrepreneurs that would have expanded the economy. Instead, it created a large group of individuals who were unwilling to let go of the financial opportunities created under the guise of the NEP.
Therefore, it was unsurprising that even after 20 years of protection and privileges, these elites concluded that the community was still not ready to forego the protections and privileges and stand on its own feet. The community was effectively cast as a helpless infant who could not survive outside the protective cocoon of the NEP. Hence, the experience of the NEP replicated the infant industry experience. Those protections and privileges could not be withdrawn. As a result, the lifespan of the NEP has gone from 20 years to 30 years, to 40 years, to 50 years and beyond.
As with infant industries, those that are protected will never have the experience and confidence to be able to transition to a competitive environment. The sad part is that the longer the protection is maintained, the more handicapped it makes those who are being protected. It is my experience that you cannot develop confident individuals by telling them that they are weak and unable to compete. To say otherwise would be an exercise in deviant psychology – or political opportunism if one is putting oneself up as their defender. Such confidence can only be achieved by encouraging individuals to compete on their own merits. Some will fail, but others will succeed, and those successful ones will become inspirations for future generations.
The NEP has done a great disservice to the Malay community that it is supposed to be helping. The Malays have allowed themselves to be conned into believing that they lack the capacity to compete and therefore need the protection of their leaders. For a community to stereotype itself in such a negative manner is sad. For a community to then try so hard to live up to that negative stereotype is tragic. For selected members of that community to leverage on that stereotype to enrich themselves by gaining unwarranted economic privileges is opportunism at its worst. Fifty years of the NEP has hurt the Malay community more than they realize. It has also downplayed the achievements of many outstanding Malay intellectuals and professionals whose accomplishments are blemished by the shadow of the NEP.
I do not buy into the view that any race is inherently weak and incapable of achievements. It is all about the incentives we create in our environment and the expectations that we choose to place upon ourselves. While in BNM, I was proud to have highly competent professional colleagues of all races. Among the five people who I consider to have had the greatest impact on me professionally during my early days in BNM, three were Malays: Dr. Awang Adek Hussin, the late Dr. Jaafar Ahmad, and the late Dr. Zainal Aznam Yusof. The others were Dr. Hooi Eng Phang and the late Kwan Kwong Seong. Dr. Zainal in particular encouraged my interest in economic research and gave strong support for me to pursue my Ph.D. studies. I am forever grateful to him.
The Economic Implications of Infants That Don’t Grow Up
The half-century of NEP has had adverse consequences all across the economy. Nowhere is this more evident than in the national education system. The national education system should have been a key pillar in building a resilient and competitive Malaysia, especially given the size of public financial resources that had been directed at it over the years. Regrettably, it has significantly undershot that aspiration. At the primary and secondary school level, with its extensive focus on one religion, it has failed to provide a nurturing environment for unity. The history books are akin to fairy tales and propaganda, and fail to give due recognition to the diverse cultural and economic confluences that were instrumental in Malaysia's development. At the tertiary level, there is overwhelming preference for the NEP favoured community in both admissions and academic positions. The lack of competitive pressures for excellence has stunted intellectual development of those who emerge from this education system. Then some of these intellectually stunted individuals re-enter the education system to teach another generation who will emerge even more impaired. Once this stone of mediocrity starts rolling down the hill, it will continue and there is no stopping it. Malaysia's public education system is too far gone to be rescued and the political will to undertake the necessary reforms is non-existent. That is the conclusion of many middle-income parents, who are abandoning the national education system and putting their children in private schools at great personal financial sacrifice. In fact, it seems to be also the conclusion of the NEP elites – who were instrumental in creating the current state of our education system – sending their own children to prestigious schools abroad rather than putting them through the national education system.
A weak and compromised national education system is turning out too many people who do not have the capacity to deal with the issues that Malaysian society and economy are facing. Instead, as expected, small minds tend to focus on small and largely inconsequential issues. At a time when Malaysia is experiencing stunted economic growth, and many Malaysians are confronted with economic hardships, the barely literate leaders are consumed by concerns on the labelling of liquor bottles. Instead of focusing on issues of economic competitiveness and the implications for Malaysia of potential changes in the global supply chains, our politicians are obsessed with expropriating for themselves ownership in the domestic logistic industry, even if it ends up making our logistic industry less competitive. There is no better indictment of the NEP than the greed, avarice and mediocrity that we see in our society today. It is also this belly-button gazing among many of our leaders and their followers that makes me worry whether Malaysia still has what it takes to compete in the global economy.
In my view, the incentives that the NEP created has undermined its stated objectives. Beyond that, the results of the NEP are now undermining the future of the Malaysian economy and the functioning of its society. Rather than create economic champions, the dominant achievement of the NEP has been to create economic parasites and to put Malaysia on the road to mediocrity. These failings are glossed over by the vested interest parties by diverting the focus to race and religion. Yet, even here the failings are only too apparent. For instance, it is difficult to reconcile the fact that there is so much religion on public display in Malaysia but there seems to be so little of spirituality and good ethics. There seems to be no link between the former and the later. Religion is no longer an instrument for making us better human beings – inculcating decency, humility and compassion – but rather has become a camouflage for immorality, avarice, intolerance, narrow-mindedness and bad intentions. What can one say of such a society and its leaders?
Related: Is Your Environment Holding You Back?
The really discouraging thing about the NEP is that it has led to so much waste of human potential. To convince such a large portion of our society that they are cripples who cannot walk without crutches has been the greatest disservice to the country by the proponents of the NEP. To ingrain into such a large group of Malaysia’s population that they are incapable of competing without government assistance and that they have a right to such assistance, even at the expense of others, is truly tragic. The abuse of power, the erosion of governance, wide-spread corruption, the fragmentation of society, the huge waste of human potential – is absolutely disheartening.
The large expenditures undertaken by the government to finance the support programs for these infants come at a huge cost. In particular, the bloated and inefficient civil service has been a huge drain of government revenues, as has been the high proportion of waste due to corruption and mismanagement of public funds. As I have noted in an earlier article, the government’s budget has been in a permanent deficit since the Asian Financial Crisis, even when economic conditions and revenues were relatively good. For many years now, the government has financed its expenditures through large borrowings and the sale of government assets. What will happen in the future when the debt burden will demand an even larger share of government revenue? What happens when those demands cannot be met by the diminished economy?
What happens when domestic investors join the flight of talent from Malaysia? When domestic investors are challenged by increasingly unfair and unwarranted expropriation of their investments to support the beneficiaries of the NEP, there will come a time when a growing number of domestic investors will choose to invest elsewhere. In fact, it is a trend that is already happening, although it may have been temporarily slowed by the pandemic. The jobs will naturally flow out too. As it is, for an economy that is supposed to be on the brink of achieving high income status, the economy is creating a disproportionately high number of low paying jobs. A significant portion of our shrunken manufacturing sector has already lost its competitive advantage and remains viable solely on the basis of employing large amounts of cheap foreign labour.
Essentially, when infants do not grow up, be they businesses or groups in society, they burden the economy – and it is a burden that increases over time. Malaysia could have been so much more than what it is today. If today, we do not stand shoulder to shoulder with economies like South Korea, Taiwan and Singapore, we have only ourselves and our polices to blame. If today, we have been economically left far behind by these economies, it is because of the economic and political choices we made. If we choose to not wake up to the economic realities confronting us, and other economies in the region who are not fettered by NEP-like policies bypass us in terms of their growth and dynamism, there is no one to blame but ourselves.
It is high time we eliminate all forms of discrimination in our country. Let us start looking at each other on the basis of merit and strength of character rather than race and religion. Assistance should be provided to all needy Malaysians irrespective of race. It is also timely to rid the economy of the parasites that have taken advantage of the NEP to enrich themselves at the cost of an increasingly dysfunctional economy. It is time for us to set right the distorted incentives in our economy and society, so that in every aspect of our society, politics and economy we have leaders who are public-minded, smart and capable – instead of stupid, greedy, illiterate and bigoted.
The Malaysian economy today is like a tree whose roots are being attacked by termites. At the moment, except for some thinning of the foliage, the tree seems to be otherwise healthy. But the damage is happening and there will come a tipping point when the tree will no longer be able to withstand the damage caused by the voracious appetite of the parasites. Then, one day, a strong wind will blow and the tree will collapse.
Unless we opt for drastic change, the future for our children, and their children, would be less promising than what it was for their parents and grandparents. Left to its own, I do not see things changing in Malaysia. The choice lies largely in the hands of those who are supposed to be benefiting from the NEP. The global track record for people willingly giving up their privileges is rather disappointing. Those who have wallowed in the riches and benefits provided by the NEP are unlikely to have any incentive to change that situation. They will keep the system going as long as they can.
Nevertheless, the incentive to force change could come from both domestic and external sources. On the domestic side, decisions by regions and groups that have been side-lined by the NEP could significantly affect the future economic environment in this country. The unsustainable strain on fiscal policy and possible ratings downgrades may also force change. Externally, there are plenty of headwinds to contend with. For instance, the pandemic has brought its own climate change to the global economy. If we are not able to comprehend these changes and adapt our economy accordingly, the global relevance of the Malaysian economy, and consequently, its growth, will be adversely affected. The beneficiaries of the NEP will find themselves fighting with each other for a piece of the shrinking economic pie. Disparities in economic welfare among members of this group will become so prominent that it will finally remove the cloud of intoxication created in their minds by the NEP. Unfortunately, by the time that happens, the economic slide of Malaysia may have progressed too far to be reversed. What will happen then to these infants who did not grow up?
This article was also published on Dr. Sukudhew (Sukhdave) Singh's LinkedIn