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# **From Farms to Factories and Firms**

# **Structural Transformation and Labor Productivity Growth in Malaysia**

# **1. Introduction**

Since independence in 1957, Malaysia has undergone a profound development process that has radically improved nutrition, health care, and social service provision. During the last decades, Malaysia has also achieved an increasingly low mortality rate, a decline in fertility rates, and increases in life expectancy. As a result of generally favorable economic and demographic developments and in spite of more recent challenges like the COVID-19 crisis, Malaysia has also seen relatively high levels of economic growth. Among the 88 countries for which comparable data on GDP per capita in both 1960 and 2019 are available in the World Bank’s World Development Indicators, Malaysia recorded the seventh highest growth rate in the intervening years (in local currency units). These relatively high levels of economic growth have propelled it to becoming the uppermiddle income country at the cusp of high-income status that it is today (World Bank forthcoming).

During the last decades, Malaysia has also gone through a rapid and sustained structural transformation, defined by the reallocation of economic activity across sectors such as agriculture, manufacturing, and services. Within only two generations, the South-East Asian country moved from an agriculture-centric economy to one with an important manufacturing base and then one dominated by services firms. In 1957, agriculture accounted for 58 percent of employment (World Bank 2019a). Since then, its share of employment has declined to 10.6 percent in 2018, releasing labor first to the manufacturing sector and then increasingly to the services sector. Similarly, the share of agriculture in value-added was 32.6 percent in 1970 and has since declined to 7.4 percent in 2018. As Malaysia pursues further development toward becoming a high-income and developed nation but faces a slowdown in both structural change and productivity growth, questions have been raised whether the reallocation of production factors can be a driver of the country’s future economic growth.<sup>1</sup> Against this backdrop, this study analyzes the process of structural transformation in Malaysia between the years 1987 and 2018 (the time horizon for which granular comparable data are available). It describes the patterns of output, employment, and labor productivity in each of the three decades. In addition, it decomposes the growth of output per capita into contributions from within- and between-sector labor productivity growth, employment growth, and changes in the demographic structure at both the aggregate and the sectoral level and investigates the contributions of static and dynamic reallocation of labor to overall labor productivity growth. These decompositions provide insight into the medium-term drivers of Malaysia’s economic growth, including the factors underlying the relative stagnation of growth in output per capita since the early 2000s.<sup>2</sup> The study confirms that Malaysia has undergone a very rapid structural transformation from an agriculturecentric to a services-driven economy. This transformation has included both a period of rapid industrialization and a period of relative deindustrialization. From the mid-1980s through the early 2000s Malaysia’s manufacturing sector grew at a fast pace, both in the terms of the share of employment and the share of output. Since then, while the manufacturing sector’s output has continued to grow in absolute terms, its growth has been at a slower pace and its share of overall output has stagnated. Coupled with a declining share of the

> 1 In this paper, structural change refers to labor reallocation to more productive sectors, while structural transformation refers to the overarching process of the reallocation of resources across the broad sectors of agriculture, manufacturing, and services over time.

> 2 In addition to the factors analyzed here, international trade can also influence the reallocation of resources across sectors and be an important component of economic growth (Matsuyama 2009; Herrendorf et al. 2014). However, it is beyond the scope of this study. It is also beyond the scope of this study to investigate whether the apparent decline in productivity growth in Malaysia can be partly explained by the difficulties in measuring productivity rather than an actual decline in productivity, as discussed in the context of the United States by Byrne, Oliner and Sichel 2013; Brynjolfsson and McAfee 2014; Feldstein 2015; Mokyr 2015; and Syverson 2017.

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