30

**Table 5:** Hypothetical Contribution of the Different Factors of Growth with a Partial <u>Elimination of Distortions</u>

||Baseline p<br>|rojections<br>|B|aseline using|11MP|Basel|ine using M|A(3)|
|---|---|---|---|---|---|---|---|---|
||11 MP|ARMA(p,q)|**S1**|**S2**|**S3**|**S1**|**S2**|**S3**|
||(2016–20)|(2016–20)|||||||
|Capital|2.6|2.2|2.6|2.6|2.6|2.2|2.2|2.2|
||(44.8)|(44.8)|(41.6)|(39.0)|(36.8)|(41.0)|(38.1)|(35.7)|
|Labor|0.9|0.8|0.9|0.9|0.9|0.8|0.8|0.8|
||(15.5)|(15.5)|(14.4)|(13.5)|(12.7)|(14.2)|(13.2)|(12.4)|
|Total factor<br>|2.3|2.0|2.7|3.2|3.6|2.4|2.9|3.3|
|productivity|(39.7)|(39.7)|(44.0)|(47.5)|(50.4)|(44.8)|(48.7)|(51.9)|
|Gross<br>domestic<br>product (%)|5.8|5.0|6.2|6.7|7.1|5.5|5.9|6.3|
|**Additional**<br>**growth**|||**+0.4**<sup>a</sup>|**+0.9**<sup>a</sup>|**+1.3**<sup>a</sup>|**+0.5**<sup>b</sup>|**+0.9**<sup>b</sup>|**+1.3**<sup>b</sup>|

Source: Authors’ calculations and Eleventh Malaysia Plan (11MP). Note: Top row = percentage point contribution to growth. Bottom row in brackets = percent contribution. 11MP = Eleventh Malaysia Plan; MA(3) = moving average 3; S1, S2, and S3 = Scenarios 1, 2, and 3, respectively; TFP = total factor productivity. The assumption is that the manufacturing sector’s share of approximately 25% of the economy is also reflected in its share contribution to the aggregate TFP.

a. Calculated from the baseline growth of 5.8%. b. Calculated from the baseline growth of 5%.

# **6.0 Conclusion**

The current state of the debate is such that TFP explains a big part of the per capita income differences across countries. According to Hsieh and Klenow (2010), human capital accounts for 10%–30% of differences in country income, physical capital accounts for about 20%, and residual TFP explains the largest portion, 50%–70%.

As economic growth becomes increasingly dependent on improvements in productivity, it is important for Malaysia to harness the sources of productivity growth in the manufacturing sector, which accounts for 25% of the economy. Conventionally, TFP is often linked to innovation, technology, and human capital. However, Restuccia and Rogerson (2008) and Hsieh and Klenow (2009) put forth an idea that the misallocation of resources across heterogenous firms could also hamper productivity. They argue that allocative efficiency is maximized when two firms identical in technologies can allocate the inputs to the point where they have the same marginal revenue product. Shifting resources to productive firms enhances productivity because it allows productive firms to grow, and less productive ones to shrink or eventually exit from the industry.

Our results show that market distortions exist. We find large revenue productivity (TFPR) differences between firms in the 90<sup>th</sup> and 10<sup>th</sup> percentiles, and 75<sup>th</sup> and 25<sup>th</sup> percentiles, with estimated ratios of 7:1 and 2:1, respectively. These differences are caused by an inefficient allocation of resources. They can be reduced by removing the distortions in the capital and output markets. A counterfactual analysis suggests that a complete removal of distortions or partial removal to the level of efficiency of the United States in 1997 will raise aggregate TFP