Poverty Reduction in Malaysia By Bethuel Kinyanjui Kinuthia PhD Fellow, Africa Studies Centre, Leiden University, The Netherlands

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1 Poverty Reduction in Malaysia By Bethuel Kinyanjui Kinuthia PhD Fellow, Africa Studies Centre, Leiden University, The Netherlands Paper submitted for the Tracking Development Falsification Award Competition Submitted on 1 st May 2010 Abstract This paper examines the extent to which the pre conditions for poverty reduction as proposed by tracking development were met in Malaysia. Tracking development suggests that for poverty reduction to take place there must be adequate macro economic management, economic freedom for peasants and small entrepreneurs and pro poor, pro rural public spending and the three preconditions must be met simultaneously. Malaysia in the last three decades has been able to industrialize as well as reduce poverty levels significantly. Using the Malaysian experience this paper does not find a convincing evidence to support the three hypotheses. There is need to redefine the concept of turning point and the preconditions for poverty reduction as presented by tracking development and some useful thoughts are presented. 1. Introduction Prior to the Asian Crisis, Malaysia was often regarded as a show case of successful economic development. Malaysia, a multi-racial country, managed to reduce the incidence of poverty and lessen income inequality, while achieving rapid economic growth and maintaining racial harmony. The incidence of poverty fell from 49.3 percent in 1970 to about 9.6 percent in Rural incidence of poverty fell from 58.6 percent in 1970 to 16.1 percent in 1995 while the Urban incidence of Poverty fell from 25.5 percent in 1970 to 4.1 percent in 1995( see Table 1 in the appendix). In Sabah and Sarawak, the incidence of poverty declined from 58.3 per cent and 56.5 per cent in 1976 to 34.3 per cent and 21.0 per cent, respectively in 1990 (Nawai and Bashir, 2009; Masud and Haran, 2008). This economic success in Malaysia as well as in other newly industrialised countries in East Asia has been interpreted differently by various scholars. In the early incarnation of this debate, some attributed the high growth Asian economies to market friendly approaches (World Bank 1993, Krueger 1995, Collins and Bosworth 1996, Krugman 1994) 1. Others characterise government strategies in the region as targeted intervention, not laissez-faire, arguing that the experiences showed how getting prices wrong and picking winners were the road to catching up with industrialized nations (Amsden 1994, Wade 1990). Evans (1995) attributes the success to state led macroeconomic planning in East Asia hence the term developmental states 2. More recently in 2010, Tracking Development scholars have argued that poverty reduction 1 With the comparative advantage of developing countries in international production being in relatively labour intensive production, so the argument goes, the expansion of manufactured exports translates into higher employment. Given the fact that labour is the most widely distributed factor of production in the economy, employment expansion and the subsequent increase in real wages reduce poverty and income inequality 2 A developmental state possesses vision, leadership and capacity to bring about a transformation society within a condensed period of time. 1

2 in these countries as well in other developed countries has been as a result of three preconditions being met simultaneously: adequate macro economic management, economic freedom for peasants and small entrepreneurs and pro poor, pro rural public spending 3. This paper endeavours to investigate to what extent these preconditions existed in Malaysia. The paper is structured into five sections. In the next section an overview of Malaysia is presented. A discussion on the preconditions for poverty reduction follows in section three. In section four is a discussion of the implications while a conclusion is presented in section five. 2.0 Overview of Malaysia The Federation of Malaysia formed in 1963, originally consisted of Malaya, Singapore, Sarawak and Sabah. Due to internal political tensions Singapore was obliged to leave in Malaya is now known as Peninsular Malaysia, and the two other territories on the island of Borneo as East Malaysia. Prior to 1963 these territories were under British rule for varying periods from the late eighteenth century. Malaya gained independence in 1957, Sarawak and Sabah (the latter known previously as British North Borneo) in 1963, and Singapore full independence in 1965.The present government is a parliamentary system at the federal level (located in Kuala Lumpur, Peninsular Malaysia) and at the state level, based on periodic general elections 4. Each Peninsular state (except Penang and Melaka) has a traditional Malay ruler, the Sultan, one of whom is elected as paramount ruler of Malaysia (Yang dipertuan Agung) for a five-year term (Drabble 2000). Malaysia is a multiethnic society whose characteristic was inherited from the British during their occupation in Malaya from It has a population of about 25 million people with the Malays, Chinese and Indians forming the major ethnic groups 5. It is far less unified than the famously homogenous societies of Japan and South Korea, even Taiwan or better still Singapore (which has the same ethnic groups like Malaysia but 75 percent Chinese) (Snodgrass, 1995). Malay which is the largest group in Malaysia is politically dominant but has far average lower income and wealth than both the Chinese and Indians. The imbalance became untenable in the late 1960s, when racial riots occurred in May The riots proved to be damaging for nation-building. This has created a strong impetuous to use political power to improve the economic position of the Malays. Although the Malaysian constitution did stress that the social economic development of the Malays was to be promoted, this did not take effect immediately until after the riot. This worsening economic situation coupled with frustration, especially among the Malay elites and recent graduates formed the basis for the promulgation of the New Economic Policy (NEP) in The NEP aimed at fostering national unity and nation building through eradication of poverty and economic restructuring so as to eliminate the identification of ethnicity and economic function. These dual objectives 3 For some details on the thinking behind the hypothesis sketched here, see the essay 'Tracking development in Southeast Asia and Sub-Saharan Africa: the primacy of policy', on the TD project website ( under the rubric 'Project documents'. 4 The country consists of 13 states - 11 in Peninsular Malaysia and 2 in Malaysian Borneo- and 3 federal territories 5 By 2007 the population distribution by ethnic groups was as follows: 54 percent Malayan, 25 percent Chinese, 7.5 percent Indians, 11.8 percent other types of Bumiputera, and 1.7 percent other ethnic groups. 2

3 were to be achieved through rapid growth. The First Outline Perspective Plan (OOP1) set the broad social economic framework for the achievements of the NEP targets. The first prolong was to reduce poverty irrespective of ethnicity. The target set was to reduce poverty from 49.3 percent of households in 1970 to 16.7 percent in 1990 for Peninsular Malaysia. The target for rural-urban breakdown was a reduction from 58.7% and 21.3% respectively in 1970 to 23.0% and 9.1% by Ethnically, the incidence of poverty in 1970 was 65% for Malays, 26% for the Chinese, 39% for the Indians and 45% for the other ethnic groups for Peninsular Malaysia (Table 1 & 2 in the appendix). The second prolong was to be achieved through the restructuring of employment, ownership of capital in the corporate sector and the creation of Bumiputera 6 Commercial Industrial Community (BCIC). The achievement of the second objective inevitably meant expanding Bumiputera participation in the formal sectors. Bumiputera employment in agriculture, secondary, and tertiary sectors were 66.2%, 12.1% and 21.7% respectively in The NEP aimed at restructuring these figures to 37.4% in agriculture, 26.8% in secondary and 35.8% in tertiary sectors respectively in Bumiputera employment contribution to these sectors was 67.6%, 30.8% and 37.9% in agriculture, secondary and tertiary sectors in The NEP aimed at changing the Bumiputera participation to 61.4% in agriculture, 51.9% for secondary and 49% for the tertiary sector respectively in the In corporate equity terms, Bumiputera, non Bumiputera, and foreign participation were set at 30%, 40% and 30% respectively for It was 2.4%, 32.3% and 63.3% respectively in 1970(Table 4). These targets were accompanied by specific growth targets which were to be met by Average annual growth rates targets for GDP, private and public investments, exports, imports, employment, savings, and unemployment were set with manufacturing sector being identified as the key driver for growth (Table 5). Tables 2, 4 and 5 show that the government generally succeeded in achieving these targets and in many respects surpassed them. Poverty fell to 15.1% of households, below the set target of 16.7% and this was also the case with the rural and urban households (Table 2). Income inequality dropped as well; the Gini coefficient fell from in 1970 to in 1990 and a similar trend can be observed among the various ethnic groups (Table 3). Bumiputera participation in the secondary and tertiary sector expanded surpassing the set target, reaching 30.5% and 40.5 percent respectively in Bumiputera corporate equity of 20.3% in 1990 was one of the very rare cases that fell well below the target. At the same time the non-bumiputera in these shares also exceeded the target. In addition savings and investment shares in 1990 were well above the targets (Table 4 and 5). Thus, the NEP was basically an affirmative action, pro-malay economic policy. The New Development Policy (NDP) succeeded the NEP when it came to an end in While there were differences in priorities and strategies between the two, the NDP was still basically a pro-malay policy. During the implementation of NEP and NDP, Malaysia achieved a very rapid economic growth and significantly reduced poverty. This brought the Malays into the mainstream economic activities (Roslan, 2001). 6 Bumiputera or Bumiputra is a Malay term used widely in Malaysia embracing indigenous people of the Malay Archipelago. The term comes from the Sanskrit word bhumiputra which can be translated literally as son of earth or soil. 3

4 3.0 Discussions on the pre conditions for poverty reduction According to tracking development sustained poverty reduction takes place in any country where the following three preconditions are all simultaneously and consistently met: adequate macroeconomic management; economic freedom for peasants and small entrepreneurs; pro-poor, pro-rural public spending. By poverty reduction is meant a decline in the proportion of the national population living in poverty. Adequate macro economic management hypothesis is fulfilled when government finances are managed such that inflation does not exceed 20 percent; there is no administrative overvaluation of the national currency: that is, no black market exchange rate alongside the official rate. The economic freedom for peasants and small entrepreneurs hypothesis is fulfilled where the state does not place coercive restrictions on the economic activity of small farmers and small entrepreneurs. For instance: no restrictions on which crop to plant; no state-imposed monopolies or monopsonies; no price controls other than by means of public subsidy. Economic freedom means that there is no state regulation. It does not rule out state subsidy: for instance, provision of agricultural inputs (such as fertilizer and credit) at below market prices, and the purchase of farm products at above market prices. The above criteria apply to the local level; at national level, the import and export of food may in some cases be regulated. Finally Pro-poor, pro-rural public spending criteria is fulfilled when public spending is directed more to agriculture, the countryside, and the poor than to industry, the cities, and the rich. As a very general rule of thumb, this precondition can be said to be met if: at least 10 percent of all public spending, and/or 20 percent of development spending (public investment), goes to the agricultural sector as funding for research, extension services, input subsidies, crop price support, irrigation, drainage, and agricultural settlement schemes; government spending on manufacturing and mining is low relative to agriculture. These, however, are only first indications, subject to further scrutiny. Agricultural spending is not pro-poor, for instance, if it disproportionately benefits large-scale farmers. It may also be counterbalanced by heavy taxation of small farmers 7. To what extent were these conditions fulfilled in Malaysia? 3.1 Adequate macroeconomic management Using the tracking development criteria Malaysia does not appear to have had a macroeconomic management problem. From graph one below one observes that the Malaysia has been able to maintain low inflation below double digit except during the first oil shock in Inflation was also high in early 1980s owing to the blow out in public expenditure as a result of massive government investment programs under the industrialization drive. This was reflected in the widening of the budget and current account deficit 8. During these two periods Malaysia although pursuing a conservative monetary policy departed from the general hands off approach. Monetary policy became quite interventionist in the mid 1970s and money supply was 7 Obtained from 8 The scale and of fiscal expansion during this period was unprecedented and the macro imbalance compounded by the terms of trade decline and the subsequent world recession in the mid 1980s. 4

5 squeezed, pushing interest rates sharply in order to quell inflation pressure. Monetary policy for most of the first half of the 1980s continued to remain restrictive, in order to contain inflation and further deterioration in the current account (Mohammed 2000). To maintain stable prices, the Malaysian government intervened in the markets of a small number of food and essential items. These interventions took place to rectify market imperfections and unwarranted price increases in each of the items 9. This strategy was aimed at maintaining stable prices for essential items related to benefit the poor and Malaysian consumers in general. Good as this may appear, empirical evidence show that the effect of inflation on poverty, after controlling for the rate of economic growth is at best mixed (Pasha and Palanivel, 2003). In addition to low inflation, a competitive exchange rate is an important component of sound macro economic management. Prior to 1973, Malaysia maintained a fixed exchange rate system. From June 21, 1973, the fixed rate was abandoned following the floating of the sterling pound in 1972 and also the floating of the Singapore currency in June, Since the adoption of a flexible exchange rate, the value of the Malaysian Ringgit has been determined in terms of a composite of the principal currencies of Malaysia s trading partners. Under this arrangement, any movements of exchange rate will reflect the balance of payment s position. Malaysia has maintained a stable and competitive exchange rate (see graph one). According to tracking development successful South East Asian countries have never overvalued their currencies enough to allow for the black market premium to emerge. However this claim is simply not true. In South East Asia there exists a black market suggesting that currencies in these markets are overvalued due to government restrictions placed on the foreign sector (See Sarwar, 1997, Lee and Azali 2005). In Malaysia for example since the floating of the exchange rate, Malaysia s capital account has been progressively liberalized. There remain, however, a number of restrictions that, from time to time, have been increased to serve so-called national objectives. These restrictions explain partly the 1997 currency crisis which eventually led to greater controls until the crisis was resolved ( Abdelal and Alfaro, 2003). Graph 1: Macroeconomic prices for Malaysia percentage Years CPI Exchange rate Source: World Development Indicators 9 The first was to fix a ceiling retail price for a certain item, after due analysis of its market, including discussions with market players. Then if necessary, producers and suppliers of the item would be provided with a subsidy to cover part of their costs. The second mode was to ease or eliminate supply bottlenecks by taking action against illegal hoarding and facilitating larger imports of the item in short supply. 5

6 What is the link between macroeconomic stability and poverty reduction? Understanding the relationship between macro policies and poverty remains a key policy challenge. The macro economic impacts on poverty can be both direct and indirect. The direct impact works through prices and public spending on the poor whereas the indirect impact works through its effects on economic growth. In general macroeconomic policy may contribute to maintaining macro economic stability which in turn helps economic growth and may contribute to poverty reduction. Tracking development suggests that this is a necessary, not a sufficient precondition for the developmental take off. In "The East Asian Miracle" (The World Bank, 1993), rapid growth of human capital, productivity improvement and high investment levels were pointed out as the primary factors contributing to the rapid economic growth of so called High Performing Asian Economies (HPAEs). 1 On top of these supply-side factors, favourable and stable economic management and macroeconomic performance provided an important framework for private investment 10. Macro economic management is indeed a pre condition for economic growth but its impact on poverty reduction is not certain. Azis (2003) for Indonesia observes that only after identifying the detailed transmission mechanism from macro policy to poverty can we be certain of the impact. The mechanisms involve some complex relations in whom growth, income inequality and poverty are all endogenously interrelated. One component of macroeconomic stabilization which tracking development does not consider is the interest rate. Prior to the liberalization of the interest rate in 1978, the government focused on maintaining stable and low interest rates which was crucial for capital accumulation in the early 1970s. Since 1960s the Bank Negara has stipulated the maximum deposit rates and minimum lending rates for commercial banks. The prime rate is the lowest lending rate to the best creditworthy customers. The preferential rate is half percent below the prime rate. It applied to advances to Federal and state governments and public authorities, to advances against government or municipal securities, and advances against local agricultural produce. Even after interest rate liberalization, the Bank has continued to give directives of especially low interest rates for Bumiputras, small businesses and other priority sectors (Sheng Li, 1990). The average lending rate of commercial bank reached nearly 11.6 percent in 1985, the highest point since independence. It gradually declined to 7 percent in In Malaysia successful macro economic policy has not only been about economic stabilization but also addressing income disparities along racial lines in order to preserve social harmony. In addition macro economic stabilization has had more to do with capital accumulation and economic growth in Malaysia than poverty reduction. Thus to define adequate macro economic management in terms of monetary policy as tracking development does is insufficient. It clearly ignores other important aspects of macro economic stabilization, the fiscal side and other aspects including trade policy, balance of payments, foreign borrowing among others. As a matter of fact monetary policy in Malaysia has been used during the periods of crisis management. Fiscal policy has been the main discretionary instrument 11 (Menon, 2009). 10 The macroeconomic stability was based on fiscal discipline and prudent financing. The low inflationary pressures contributed to keep real interest rates positive, and maintain real value of financial assets, of which helped increase domestic savings. 11 As a small, open economy, fiscal policy has served the role of a counter-cyclical stabilizer, to minimize the impact of exogenous shocks, with monetary policy playing an accommodating role. But fiscal policy has also been 6

7 3.2 Pro-poor, pro rural public spending The Malaysian government embarked on deliberate poverty reduction efforts with the introduction of the NEP in Table six confirms tracking development assertion at face value. The actual development expenditure in agriculture from 1960 till end of the 1970s was more than 20 percent which reduced drastically in the 1980s. At the same time the allocation of development expenditure to the manufacturing sector increased progressively from 3.3 percent in 1970 to 27.3 in the 1980s overtaking the allocation to agriculture in the 1980s. Bulk of the Malaysian development expenditure was spent on infrastructure taking more than 30 percent of the budget except in the early 1980s where it fell to 26.1 percent. Under the first plan ( ) the major vehicle continued to be large land development schemes, agricultural diversification and infrastructural development. The rate of growth of agricultural output showed the strongest gains during this first period as the use of high yielding rubber trees, diversification into oil palms, cocoa and intensification of rice production paid off 13 (Drabble 2000:210). Although this did generate economic growth there was a growing concern of income inequality during this period which was addressed with the introduction of the NEP 14. This period was characterised by worsening inequality which was not sustainable. The NEP targets were contained in the second to the fifth Malaysian master plan. The major areas of activity were; (i)continued rural development principally through land schemes, to commercialise peasant agriculture (ii) the promotion of manufacturing industry, especially export oriented industrialization, (iii) regional development to even out disparities in between different areas (iv) ancillary policies involving the preferential treatment of the bumiputeras in access to higher education and government employment to help them move into the mainstream economy as administrators, professionals, entrepreneurs and so on. This focus saw the share of development expenditure allocated to agriculture begin to decline while there was a drastic increase in allocations to other sectors. This is very different from what tracking development suggests that in Southeast Asian planners saw that the obvious way to address the problem of mass poverty, given that most of the population lived in the countryside and depended on agriculture, was by raising farm incomes. One way to do this was to increase the productivity of export crops, such as palm oil, cocoa and rubber in Malaysia or coffee and cashew nuts in Vietnam. The growth in this sector was declining after 1970 in Malaysia. Much of the growth experienced in agriculture was mainly due to opening up virgin land through the agencies that were established (Drabble 2000:212). The immediate concern of the NEP was to stimulate economic growth while maintaining national unity. To do this there was a deliberate attempt to increase the actively employed in an attempt to address the disparities in income along racial lines. The affirmative action policies of the NEP, designed to improve the status of the Malay population, did constrain the flexibility of fiscal policy to some extent, but never in a significant way. 12 The existence of the substantial inter ethnic income inequality in peninsular Malaysia was evident in the early post war years. The first 15 years after independence saw a further growth in disparity (Drabble 2000: 276) 13 Growth in agriculture slowed in the following subsequent periods. 14 The perception was that, except for a few who had benefited from government contracts, for instance in the rural development projects, Malays had not received a proportionate share in the general economic progress particularly in the expanding non rural sector culminating to the riot in 1969 (Drabble 2000: 196). 7

8 participation of the bumiputeras in the modern sector. This entailed increasing their participation in other sectors other than agriculture (see table 4) an objective which was largely achieved by Thus although Malaysia did develop agriculture and the rural areas, resources did shift toward industry and infrastructure. The government also set up institutions and all these efforts were aimed at employment opportunities for the Malays something that tracking development does not acknowledge. As a matter of fact employment creation is the best way to fight poverty something that Malaysia did quite well 16. Tracking development further suggests that the most concentrated effort, however, went into food production, and was inspired by a desire for national self-sufficiency in food. This is not entirely true for Malaysia. The rice industry in Malaysia represents rather a minor segment of the national output in terms of its share of total output. It is however economically and culturally central in the rural people largely bumiputeras throughout the territories and therefore politically sensitive. By 1975 Malaysia had achieved 95 percent self sufficiency in food, this begun to fall due to growing doubts over the economic justification of the original aim. In addition a fall in world prices from affected rice production. These factors saw majority of the workers leave the industry with many turning to off farm activity in manufacturing and construction 17. It was simply not viable. Although poverty reduction reduced from 88 percent of households 1970 to 50 percent it was still well above the rural average of 22.4 percent by It can be argued that since Malaysia enjoyed a surplus in the balance of payments as a result of its natural resources, it was not necessary to go for food self sufficiency as it would have been cheaper to import rice from neighbouring countries 19. Malaysia s policy of national self sufficiency tends to beggar thy neighbour in so far as her opportunity cost of increasing rice production is higher than in the neighbouring exporting countries. 3.3 Economic freedom for peasants and small entrepreneurs As noted earlier, most of the rural poor were mainly the Malays who were mainly involved in the production of rice. The government policy towards the rice industry was protective having the objectives of (i) achieving the highest possible degree of national self sufficiency through land development and technology innovation, (ii) increase income of farmers and (iii) supplying rice to consumers at reasonable prices. The first objective of self sufficiency was achieved mainly through expansion in the planted area up by over 50 percent in In addition two thirds of the increase in yield between 1955 and 1973 came from this source despite the emphasis 15 Overall Malaysian agriculture was showing signs of stagnation in the 1980s, facing problems of labour shortages in many areas. The sector contributed to only 1 percent of national growth during the NEP period, compared to 2.1 percent from manufacturing and 3 percent from services (Drabble 2000:210). 16 Most of the industrial labour between came from women, many from the rural areas. 17 A 1981 survey found 40 percent of peninsular rice land idle, with 18 percent thus for over three years. 18 The general thrust of official policy followed that in Peninsular Malaysia: introduction of high yielding varieties, fertilizers, irrigation, double cropping and so on. The notable differences which emerged, though, were that the opening of fresh land, use of technical inputs and the spread of double cropping fell well short of target( Drabble 2000: 214) a fact that tracking development largely ignores. 19 Due to diminishing returns for heavy investment, it was clear that even percent self sufficiency in food was uneconomical. Peninsular Malaysia production cost was nearly twice that of Thailand, and an estimated 500,000 tonnes of Thai rice, or 30 percent of consumption, was smuggled annually from (Drabble 2000: 212). 20 Even though rice in the rice sector poverty was reduced to 57.7 percent in 1984 and indicated a significant increase in the average level of income among rice farmers, more than half of the farmers remained poor( Fujimoto, 1991). 8

9 of technological progress. It was not as a result of increased productivity as tracking development emphasises. The main technical measures were the use of high yielding seed varieties, coupled with chemical fertilizers, pesticides and water control methods to enable double cropping. Farmers received support under guaranteed minimum price schemes which increased from $16 to $28-30 per picul in This price was obtained by selling direct to the National Padi and Rice Board (LPN) set up in 1971 (Pletcher 1989). The Malaysia Agricultural Research and Development Institute (MARDI) created in 1969, carried out basic research, whilst Farmers Organization Authority (FOA) established in 1973, provided a composite package of interest loans and credit, subsidised inputs such as fertilizers e.t.c. In spite of all these efforts, thir returns did not increase greatly compared to other sectors. The yield only increased up to 1973 then began to fall. It was very expensive for the government to maintain these schemes and farmers left this industry for other sectors due to better earnings. In the face of these circumstances, the government formulated a New Agricultural Policy (NAP) in There was a shift in the generally protective attitude of the NEP towards rice farmers to a focus on developing a more efficient and commercialised industry in some areas. In addition farmers were encouraged to venture into production of other non rice crops such as coffee, maize and ground nuts. The degree of self sufficiency in food was revised to percent. There was a reduction in payment of subsidies to rice producers which represented 69 percent of farmers annual net income in This was clearly uneconomical and the cost of production was prohibitively high. In addition there was a continued decline in average farm size due to the Muslim law of inheritance. The problems of incompatibility between small farm size and technical innovation were difficult enough for mono crop rice farmers who received bulk of government assistance. Peasants who did not did not engage in mono cropping were affected most and faced a dilemma in the face of modernization. Their lack of specialization put them outside the scope of most government programs which is tantamount to interference with economic freedom. This was not the case in the export crops which were dominated by the Chinese who benefited largely from government support. Their crops generated decent incomes due to world demand and favourable prices (see Brown 1973, Fujimoto 1991 and Drabble 2000: ). On small entrepreneurs, the Chinese community was able to take advantage of the growth in the economy mainly in the areas of construction, banking among other sectors. Some used the capital saved from rubber, tin, trading and so on to set up manufacturing ventures. Majority of the Chinese however lacked capital and the expertise to enter this sector in a matter comparable to foreign investors. Private bumiputera at this stage showed no signs of being able to develop outside their traditional areas such as handicrafts, timber, transport and contracting. The government took initiative to encourage them to pool their resources such as National Investment Company (1961) to buy shares in companies that had pioneer status but the progress was slow. By 1970 most of the efforts put in place to support the malays to break into new areas in the economy had not borne fruits but foreign and non malay capital was strongly entrenched. The NEP objectives led to the government establishing an Industrial Coordination Act in 1975 to increase the malay participation in business. Malaysian firms (except foreign) were forced to reserve at least 30 percent of equity for bumiputeras interests. In addition the government expanded the role of the public sector financed by official revenues, from mainly petroleum. This is 9

10 a form of interference on the economic freedom of the small entrepreneurs since the Malay government forced established a state regulation where Malaysian firms most of which were owned by non Malays were forced factor in the interest of the bumiputeras a fact that tracking development does not acknowledge (Rasiah 1995: 76-82, Drabble ). 3.4 Summary Based on the above discussion tracking development hypotheses are inadequate in explaining poverty reduction in Malaysia casting doubts to their validity as preconditions for poverty reduction. Firstly it is not clear from their discussion whether macroeconomic stabilization and macro economic management are synonymous. Macro economic stabilization is definitely an important factor in economic development but in Malaysia monetary policy performed a more accommodating role. The fiscal aspect which has been completely ignored under macro economic management happens to have been most important and useful tool especially for distribution of wealth and therefore poverty reduction. Other macro economic aspects which were important in Malaysia include among others interest rate policy and trade policy which seem to be unimportant in the tracking development analysis. Secondly, although pro poor spending was important, which is part of the expansionary fiscal policy, tracking development fails to realise that during the period of although allocation in agriculture was the highest, there was also high inequality which culminated into a riot in This necessitated a change in economic policy. It led to the share of development expenditure allocated to agriculture reduced, while there was a steady increase in the allocations to manufacturing and its related infrastructure as attention shifted towards industrialization. In addition it is wrong to assume that manufacturing industry is only concentrated in urban centres. In Malaysia manufacturing played a significant role, though not the largest initially. It provided the range of rural non farm activities which formed an increasingly vital component in the incomes of rural dwellers, of whom an estimated 25 percent were primarily dependent on these sources in mid to late 1970s. Hence development in the rural areas was also good for these industries. In addition, Malaysia could have done without self sufficiency in rice due to its surplus in balance of payment. It was due to political reasons mainly to protect the Bumiputeras who over the years have increasingly abandoned rice production and moved to other more rewarding sectors of the economy. Thirdly is the notion of economic freedom. In Malaysia although there was economic freedom of peasants this was not the key to poverty reduction as evidenced by the shift from agriculture towards industry by women and mainly bumiputeras who were involved in rice farming. Many peasants who did not engage in specialization of given crop were also left out of government programmes. Issues of production costs and land sub division due to Islamic culture affected the rice industry. Even with all the incentives given most of the peasants left rich production for other sectors due to low returns. Thus economic freedom of peasants is not a guarantee of poverty reduction. On small entrepreneurs, the government interfered with their economic freedom by introducing statutes requiring the inclusion of the Malay interests in their capital ownership. This has been largely protested especially by the Chinese most of whom 10

11 were in small businesses although it did not interfere much with foreign investors. Needless to say that, this policy worked to some extent in ensuring Malay participation in business but affect the development of the non foreign Malaysian firms. This however does not mean that Malaysia did not achieve their objective but rather that tracking development does over emphasis the role of economic freedom. Finally is the assumption of simultaneity and consistent of the three hypothesis. If one assumes that the economy is a system with inter relations then it would follow that one aspect would affect the other. All these measures are interrelated. For example good macro economic management would entail macro economic stability as well as good fiscal discipline. Successful economic freedom is also dependent on good macroeconomic management. Tracking development assumption of simultaneity does not take into account dynamism in a society. Some sectors could grow faster than others rendering it unnecessary to give them due attention. Managing growth and distribution issues is a continuous process and adjustments are required as policies are implemented. It also assumes that countries do not face budget constraints when in real life countries will have to face some tough choices which will involve sacrifices. In addition all these three objectives are difficult to achieve without adequate capacity including the relevant expertise among others. Poverty alleviation requires a multi dimensional approach and tracking development approach is too restrictive as it does not take into account other factors that could inhibit poverty reduction in spite of meeting the hypotheses for example changing people s attitude and mentality and cultural aspects. 4.0 Implications and Conclusions Before discussing the possible pre conditions for poverty reduction, it is important to first discuss the issue of the turning point. According to tracking development, the turning point in Malaysia was in the pre 1960 which they define as dates at which two crucial development indicators, GDP and poverty incidence showed a lasting turn for the better, leading to sustained growth in association with sustained poverty reduction. This approach is too general and not scientific. Historically turning points have been analysed using the Simon Kuznets curve and both cross country regression studies and case studies have been used to analyse this concept. Randolph and Lott (1993) provide one of the most sophisticated and appropriate estimate of the turning point which is largely accepted. The mean turning point of the gini coefficient from their six models is $ dollars. This was achieved in Malaysia in 1970 (see Bowman, 1997). This is perhaps more convincing due to several reasons. Given the definition of a turning point one would expect a steady increase in per capita GDP accompanied by a fall in poverty reduction and income inequality. In Malaysia although prior to 1970 there was a steady increase in per capita GDP, the riot of the 1969 threatened to undo the benefits earned due to high poverty levels and increased inequalities. The poverty level in Malaysia was 49.3 percent in 1970 while the gini coefficient was at It had worsened for the period and there was little reason to expect improvement in the near future. Thus prior to 1970, Malaysia had not reached a turning point. It was after the enactment of NEP as a response to the riot that life changed in Malaysia. The government acknowledged that national unity was unattainable without greater equity and balance among Malaysia s social and ethnic groups..(and) accelerating the process of restructuring Malaysian society to correct economic imbalance (Bowman, 1997). Thus a turning point ought to be 11

12 defined in terms of per capita GDP, poverty incidence as well as poverty inequality. All these three are correlated. The notion of pre conditions for take off which I consider related to our discussion here, has historically been associated with Rostow s take off model of economic growth of The model argues that economic modernization and economic growth occurs with five basic stages of varying lengths namely the traditional society, preconditions for take off, take off, drive to maturity and high mass consumption. According to Rostow, the precondition stage is a transition era when a society prepares itself or is prepared by external forces for sustained growth. This required fundamental changes in well established traditional society: changes which touched and substantially altered the social structure and political systems as well as techniques of production 21. The nature of transition has many dimensions. A society predominantly agricultural, with, infact, usually more than 75 percent or more of its working in agriculture, must shift to predominance for industry, communications, trade and services. Other important changes would include a society: reorientation towards commerce from regional, to national and international; controlling birth-rates in line with progress and a decline in the need for unskilled farm labour; high level of savings to allow for investment in infrastructure, increased specialization of labour and production of goods and services (Rostow 1960: 14). The essence of transition was described legitimately as a rise in the rate of investment to a level which regularly, substantially and perceptibly outstrips population growth, although this does not imply that the rise in investment rate is an ultimate cause (Rostow 1960:21). The rise in the investment rate, as well as reflecting these more profound changes in the society is also the consequence of development in particular sectors of the economy, where the transformation of the economy usually takes place. A revolution in agriculture precedes the pre condition for take off as it must supply food, markets and loanable funds to the modern sector 22. In addition to a well developed agricultural sector, a very high proportion of total investment must be allocated into transport and other social overhead outlays. Social overheads tend to have long gestation periods and pay offs, are generally lumpy and have indirect route of payoffs which implies that governments must generally play an extremely important role in the process of building social overhead capital and therefore in the preconditions period (Rostow 1960:25). Apart from these economic preconditions, Rostow emphasised the importance of new leadership emerging to be given scope to begin the building of a modern industrial society. Sociologically this new elite must to some degree supersede in social and political authority the old land based elite to allow for the development of a modern sector. This leadership would as a matter of necessity not work for profit but for the national interest. Men holding effective authority or influence have been willing to uproot traditional societies not, primarily, to make more money but because the traditional society failed or threatened to fail to protect them from humiliation by foreigners Rostow 1960: Some countries in the western world would be exempted from a s traditional society especially because they were either created mainly out of Britain already far long in the transitional process (Rostow 1960: 17). 22 Agriculture output was expected to expand to feed the enlarging and increasingly urban population, at least until industrialization has so progressed that foreign exchange can be earned economically and massively to finance food imports ( Rostow 1971: 57). 12

13 Although the idea of identifying preconditions for take off is a complex one, using the Malaysian experience one can identify several conditions that must be fulfilled in order to alleviate poverty inline with Rostows arguments. Firstly it is impossible to think about poverty reduction without considering economic growth in Malaysia. While establishing the NEP, it was clear in the Malaysian government that economic growth was paramount to achieving this objective. A study by Swiss Agency for Development and Corporation (SDC) in 2004 revealed that for the period Malaysia was able to reduce its poverty by 19.1 percent and the growth component accounts for 16.4 percent. In that case, the effect through the decrease in inequality of 3.9 is rather weak compared to the effect due to growth. Ishari (2000) observes that rapid growth of the economy laid the necessary foundation that enabled poverty alleviation and reduction of income inequality during the period Export oriented industrialization, driven primarily by foreign capital, generated demand for labour, thereby reducing unemployment and raising household incomes. Many factors were associated with the economic growth of Malaysia. Among the demand side factors, private expenditure contributed significantly to growth in general. In years of slow growth and recession, however, this role was taken over by public expenditure. International trade was another driver for growth. Among the supply side factors, the most important contributor to growth was the transformation of the structure of the economy, macro economic management and human capital development while among the non economic factors was the peace and security Malaysia enjoyed. High economic growth in Malaysia and the East Asian region has been attributed to sustained high rate of capital accumulation (see table 7). Indeed a number of studies suggest that it is this element, rather than rapid factor productivity growth, which underlies growth in the region (Drabble 2000, Lucas and Verry, 1996, Kinuthia 2010). Secondly following after Rostows argument, is massive investment in social overheads including transportation. In Malaysia there was massive investment in infrastructure both in urban and rural areas. In addition resources were strategically allocated in some agricultural export crops like rubber, palm oil which generated the finances required for this investment to take place. In addition, tin and petroleum and other natural resources generated sufficient resources for this purpose. Export of manufactured goods has equally contributed to this venture. With all these sources of incomes, a healthy balance of payments account and occasional borrowing both domestic and foreign, the Malaysian government was able to support most of the projects. It also established public institutions as well as expanding public sector s participation in the economy. These efforts guaranteed employment to the bumiputeras in order to alleviate poverty and raise incomes of the poor. Lastly, the nature of the leadership is of paramount importance. Leadership has played a crucial role in Malaysia s economic development. The new leadership that emerged in Malaysia following the riot in 1969, was committed to the development of the country as well as national unity. The formulation of the NEP in the 1970, its implementation and the outcome in the 1990s clearly leaves no doubt that leadership in Malaysia was committed to national interest. Overall, there was political stability and security, which helped growth. The Barisan Nasional, a coalition government comprising the three major ethnic groups, managed to contain the inherent tendencies towards inter-ethnic conflicts and succeeded in sustaining the political and social 13

14 commitment to the growth process. The emphasis on growth with equity, despite the difficulties, helped to sustain stability. Adjustments to the growth-with-equity policy thrust will always be needed, and the continued success of Malaysia s economic growth efforts will depend on how well this is managed. 14

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