These findings are consistent with the literature’s observation that Malaysia underwent a rapid process of industrialization followed by relative deindustrialization (Rasiah 2011b; Tan 2014). In the period from 1987 to 1997, Malaysia pursued industrial policies that led to a rapid expansion of the manufacturing sector but might have also resulted in a domestic manufacturing sector that suffered from ongoing structural weaknesses (see Jomo and Edwards 1993; Menon 2008; Rasiah 2011a and Tan 2014 for detailed discussion of Malaysia’s industrialization experience, including the relevant national policies). Since then, Malaysia’s economic policies have been less successful in moving the country toward manufacturing-led growth, leading to a relative deindustrialization. Rasiah (2011b) attributes this deindustrialization to the lack of effective institutional change, partly due to ethnicity-based policies. Similarly, Tan (2014) suggests that ethnicity-based policies have contributed to premature deindustrialization in Malaysia.

Whatever the causes of Malaysia’s industrialization and ensuing relative deindustrialization, this study highlights the importance of understanding that these processes were to an overwhelming extent driven not by structural change but by within-sector productivity growth. While an international benchmarking of this study’s findings with broadly comparable estimates by McMillan et al. (2014), Timmer et al. (2014) and Martins (2019) for various different regions of the world shows that the dominance of within-sector productivity growth as a driver of overall economic growth is a common pattern across the world, at 3 percent, the contribution of between-sector reallocation of labor to growth in output per capita in Malaysia has been particularly low.

This study’s findings shed light on the welfare and policy implications of Malaysia’s experience of relative and potentially premature deindustrialization. The relevant literature prominently documents that the share of manufacturing in Malaysia’s aggregate employment and output began to decline in the early 2000s and has since stagnated, while growth in output per worker in both the manufacturing sector and the economy as a whole has declined over time. Rasiah (2011b) argues that Malaysia experienced premature deindustrialization and suggests that the slowdown of economic activity and productivity, as well as the slowdown in trade performance are signs of negative deindustrialization. In contrast, Tan (2014) suggests that while the deindustrialization of Malaysia has been premature, it has not been negative as unemployment has not increased and living standards have continued to improve.

Without making an argument whether Malaysia’s relative deindustrialization has been negative or not, this study documents that this deindustrialization has gone hand in hand with a decline in the reallocation of labor toward the most productive sectors, especially during the period from 2007 to 2018 when labor tended to be reallocated to less productive sectors. That said, structural change was never Malaysia’s prime driver of growth – not even during the country’s rapid industrialization from 1987 to 1997. At the same time, the productivity gaps between sectors in Malaysia remain large, with the productivity of the most productive sector in 2018 (business services) more than three times that of the least productive sector (construction).

Accordingly, the main challenge for Malaysia going forward will be to reverse, halt or at least moderate the decline in within-sector productivity growth in manufacturing and to enable the increasingly important services sector to generate sustainable within-sector productivity growth. In this context, World Bank (2020, p. 3) argues “that overcoming skills gaps, maintaining high quality of infrastructure, building innovation capacity, and addressing distortions in output markets are all important policies that could serve to accelerate productivity growth.” In addition, World Bank (2020) contends that beyond implementing strategies that are largely about the quality of factors of production such as capital, land and labor, raising productivity growth will necessitate a fresh look at the way these factors are put together and organized, and thus at management practices. In addition, Chuah et al. (2018) find that in the period between 2000 and 2010, allocative efficiency within relatively narrowly defined sectors in Malaysia worsened. Conversely, reallocating resources to more productive firms within sectors can potentially lead to a significant increase in economic growth but will require a conducive policy environment – for instance with regard to competition and financial market policies – that ensures that product markets remain contestable with low barriers to entry.

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