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# **5.3 Measuring Allocative Distortions in Selected Industries**

The results presented so far are for the manufacturing sector weighted by the industry value added shares. While the broader picture provides an overview of the extent of the misallocation of resources, it might mask subtle but important differences between industries. An industrylevel analysis will provide a sharper focus on the extent of misallocation in each industry and would be more informative for policy prescriptions.

In terms of productivity gains by industry, the petroleum and chemical products industry and the food and beverage industry are estimated to gain the most if distortions are removed and resources are allocated more efficiently to the more productive firms. The lowest productivity gains are estimated for the textile and apparel industries (figure 18). The export-oriented industries, such as the textile, wood products, and electrical and electronics industries, appear to be more efficient in the allocation of resources. Their efficiencies could be induced by the need to compete, interact with, and respond to global forces and trends. While average productivity gains for the transport equipment industry appear to be low, the estimated gains are derived from a small sample of 499 firms in the three census periods. In comparison, other industries are represented by at least three times the number of firms.

The F&B (food and beverage) industry, which produces mainly for the domestic market, appears to be the worst in terms of allocative efficiency, with an estimated average productivity gain of 196%. The large estimated productivity gain could also be partially attributed to the large varieties of output in the food manufacturing industry, which is made up of 8 subindustries, ranging from firms in the processing and preserving of meat to producing dairy products and grain mill products.<sup>23</sup> However, the large hypothetical productivity gains may also reflect the large subsidies received by the food industry. Basic food items such as rice, sugar, flour, and cooking oil are highly subsidized by the government. Government expenditure on various subsidies, including food, increased by a compound annual growth rate of 17% from 2000 to 2010 and accounted for an average share of 11% of the federal government’s total expenditure between 2006 and 2010. Subsidies, which artificially depress prices, can distort not only prices but consumption and production decisions, resulting in misallocation of resources. Therefore, subsidy reforms started in 2010 as the government gradually reduced the subsidies for some key commodities such as sugar, cooking oil, and flour,<sup>24</sup> and replaced them with targeted cash transfers for poor households. The subsidy rationalization program was part of the broader agenda to remove distortions in the economy, improve competitiveness and market efficiency, and ensure a more optimal usage of resources in the economy.

The petrochemical industry, which is mainly an export-oriented industry, appears to have performed badly compared to the other export-oriented industries. Its performance could be influenced by the volatile prices of its inputs, which could in turn have implications for the efficiency of the allocation of resources. Furthermore, production decisions could also be

> 23 For simplicity, our industry estimates are based on the 2-digit Standard Industrial Classification Code (SIC), which includes beverages in the estimation.  The less narrowly defined industry classifications may result in larger TFPR differences. 24 The rationalization of subsidies for fuel and sugar resulted in an estimated savings of RM750 million in 2010 (IMF Article IV Consultation 2010, 2015, and 2016).