metadata: authors: 0: author: Devadas,Sharmila
1: author: Guzman,Jorge P.
2: author: Kim,Young Eun
3: author: Loayza,Norman V.
4: author: Pennings,Steven Michael
count: Malaysia
docna: 0: docna: Malaysia's Economic Growth and
            Transition to High Income : An Application of the World Bank
            Long Term Growth Model (LTGM)
docty: Policy Research Working Paper
subtopic: Educational Sciences,Economic Growth,Industrial Economics,Economic Theory & Research,Labor Markets,Health Care Services Industry
teratopic: Education,Macroeconomics and Economic Growth,Social Protections and Labor,Industry
abstracts: cdata!: This paper studies economic growth in
            Malaysia, with the purpose of assessing the potential to
            attain the status and characteristics of a high-income
            country. Future economic growth is simulated under a
            business-as-usual baseline, where the growth drivers follow
            their historical or recent trends, and under different
            scenarios of reform, using the World Bank Long-Term Growth
            Model (LTGM). Under the business-as-usual baseline,
            Malaysia's GDP growth is expected to decline from 4.5
            to 2.0 percent over the next three decades, following the
            country's transition to high income in 2024 (which
            might be delayed due to the effects of COVID-19). This
            decline is partly due to demographics, but also a declining
            marginal product of private capital and slowing growth rates
            of total factor productivity and human capital. Strong
            reforms are required for Malaysia to grow beyond what is
            expected based on historical trends, especially for human
            capital, female labor force participation, and total factor
            productivity. In the strong reform scenario, based on growth
            drivers achieving a target corresponding to the 75th
            percentile of high-income countries, GDP growth is expected
            to have a substantially higher trajectory, reaching 3.6
            percent by 2050.
geo_reg_key: 517198,517191
repnme: repnme: Malaysia's Economic Growth and
            Transition to High Income : An Application of the World Bank
            Long Term Growth Model (LTGM)
display_title: Malaysia's Economic Growth and
            Transition to High Income : An Application of the World Bank
            Long Term Growth Model (LTGM)
listing_relative_url: /research/2020/06/32133066/malaysias-economic-growth-transition-high-income-application-world-bank-long-term-growth-model-ltgm
topicv3: Economic Growth m1326241 471,Education m1327048 470,Population, Aging and Health m1327736 640,Labor Force Participation m1504050 2746,Health m1504661 3480
publishtoextweb_dt: 2020-06-15T00:00:00Z
historic_topic: Education,Macroeconomics and Economic Growth,Social Protections and Labor,Industry
origu: DECRG: Macroeconomics & Growth (DECMG)
no_of_pages: 42
author_keys: 0: author_key: 1463367
1: author_key: 868681
2: author_key: 1462381
3: author_key: 97109
4: author_key: 1324256
model_extractions: Policy Research Working Paper 9278 Malaysia’s Economic Growth and Transition to High Income An Application of the World Bank Long Term Growth Model (LTGM) _Sharmila Devadas_ _Jorge Guzman Young Eun Kim Norman Loayza Steven Pennings_ Development Economics Development Research Group June 2020
Policy Research Working Paper 9278

# **Abstract**

This paper studies economic growth in Malaysia, with the purpose of assessing the potential to attain the status and characteristics of a high-income country. Future economic growth is simulated under a business-as-usual baseline, where the growth drivers follow their historical or recent trends, and under different scenarios of reform, using the World Bank Long-Term Growth Model (LTGM). Under the business-as-usual baseline, Malaysia’s GDP growth is expected to decline from 4.5 to 2.0 percent over the next three decades, following the country’s transition to high income in 2024 (which might be delayed due to the effects of COVID-19). This decline is partly due to demographics, but also a declining marginal product of private capital and slowing growth rates of total factor productivity and human capital. Strong reforms are required for Malaysia to grow beyond what is expected based on historical trends, especially for human capital, female labor force participation, and total factor productivity. In the strong reform scenario, based on growth drivers achieving a target corresponding to the 75th percentile of high-income countries, GDP growth is expected to have a substantially higher trajectory, reaching 3.6 percent by 2050.

This paper is a product of the Development Research Group, Development Economics. It is part of a larger effort by the World Bank to provide open access to its research and make a contribution to development policy discussions around the world. Policy Research Working Papers are also posted on the Web at http://www.worldbank.org/prwp. The authors may be contacted at sharmdas@gmail.com, jguzmancorrea@worldbank.org, ykim10@worldbank.org, nloayza@worldbank.org, and spennings@worldbank.org.

_The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent._ Produced by the Research Support Team
# **Malaysia’s Economic Growth and Transition to High Income:**

# **An Application of the World Bank Long Term Growth Model (LTGM)**

Sharmila Devadas Jorge Guzman Young Eun Kim Norman Loayza Steven Pennings Development Research Group The World Bank .

**Keywords:** Economic growth, human capital, investment, labor force participation, total factor productivity, innovation, education, market efficiency, infrastructure, institutions, Malaysia **JEL:** D24, G14, G18, H54, I15, I25, J16, O16, O33, 043, 053

**Note:** The views expressed herein are those of the authors and do not necessarily reflect the views of the World Bank, its Executive Directors, or the countries they represent. We appreciate comments from Yew Keat Chong, Firas Raad, Richard Record, Shakira Binti Teh Sharifuddin, and seminar participants at the World Bank. To download the Long Term Growth Models, visit www.worldbank.org/LTGM
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empowerment (growth drivers and enablers), environmental sustainability, and social re-engineering (essentially improving the well-being of the people and social cohesion).

This paper simulates Malaysia’s long-run growth prospects using the World Bank Long-Term Growth Model (LTGM), a suite of spreadsheet-based tools building on the celebrated Solow-Swan growth model (Loayza and Pennings 2018, and Hevia and Loayza 2012). The Long-Term Growth Model – Public Capital Extension (LTGM-PC) is used as the base model (Devadas and Pennings 2018), which allows for private and public investment to have different effects on growth. Human capital and TFP growth are endogenized using LTGM’s Human Capital extension (LTGM-HC) and TFP extension (LTGM-TFP), respectively. The LTGM-HC combines average years of schooling by age cohort with the quality of education and health components to determine human capital. In the LTGM-TFP (Kim and Loayza 2018), the TFP growth rate is calculated as the composite effect of TFP determinants: innovation, education, market efficiency, infrastructure, and institutions. The models are described in more detail in Appendix 1 and most are available for download at www.worldbank.org/LTGM.

Our first result concerns a Malaysia’s business-as-usual baseline growth path, where the growth drivers ─public and private investment-to-GDP ratios, total factor productivity (TFP), human capital, and labor force participation rates ─ follow their historical or recent trends (future demographic projections taken from the United Nations (UN). We find trend GDP growth in Malaysia is likely to fall from around 4.5 percent in 2020 to 2.0 percent in 2050, driven mostly by demographics, falling private investment effectiveness and declining TFP growth. Declining growth is common among peer countries as they transition to high-income status.

However, this decline is growth is not destiny, and our second finding is that it can be partially offset by economic reforms. Specifically, we simulate weak, moderate, and strong reforms for each growth driver, with targets set with reference to the distribution of those values among high-income (HI) countries. While weak reforms have little effect (relative to the baseline), moderate and strong reforms generate growth in 2050 that is 1.5 to 1.8 times that in the business-as-usual baseline (respectively).

The rest of the paper is organized as follows. Section 1 presents the historical developments for each growth driver. Section 2 discusses the assumptions regarding growth drivers and parameters used in the baseline simulation. Section 3 shows the baseline GDP growth trajectory over the next three decades and analyzes the contribution of each growth driver to both current growth rates and changes in the growth rate over 2020-50. Section 4 presents the impact on GDP growth of the different levels of reforms for each determinant of growth: “weak” reform benchmarking at the 25th percentile among high-income countries; 3
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and historical trends suggest that Malaysia is expected to pass the threshold in the mid-2020s. However, this projection might be delayed due to the effect of COVID-19, causing a reduction in the forecasted growth in 2020 and possibly in the early 2020s (Figure 1.1).<sup>3</sup> Aggregate investment-to-GDP has averaged 24% over the last two decades (Figure 1.3), with public investment trending down and private investment trending up (Figure 1.4). During the late 1980s and 1990s **,** investment rates in Malaysia increased rapidly, reaching over 40% of GDP just before the 1997 Asian financial crisis. High private investment-to-GDP rates were buoyed by the First Industrial Master Plan (1986-1995), and liberalization and deregulation in the economy. In the 1990s, excessive investments also occurred in certain sectors, especially the property sector. After the Asian financial crisis, the investment-to-GDP ratio declined, with the fall mostly due to lower levels of private investment (not shown). In the last 10 years, investment-to-GDP has averaged 24.6%. A closer look at the split between public and private investment shows that public investment has been declining since 2012, falling from around 11% to 7% of GDP in 2018. This is reflective of the government’s fiscal consolidation plan. At the same time, some rebalancing has been observed with private investment rising from 15% to 17% of GDP.

The median TFP growth over the past 30 years (1985-2014) is 0.9% (Figure 1.5). Since TFP is calculated as a residual – growth less factor accumulation – it is volatile and oscillates with the economic cycle.

The human capital growth rate has experienced a downward trend since the early 1990s and it has averaged roughly 0.6-0.7% in the 2010-2014 period (Figure 1.6). Human capital is a commonly measured using the average years of schooling, though in our forward-looking simulations we use a broader measure based on the World Bank Human Capital Index that includes schooling quality and population health. In the 1980s and early 1990s, human capital grew at around 2% but now has slowed to 0.6%. As it is harder to increase the average years of education when people are already well educated, countries often experience a slowing growth rate of human capital over time. We expect this trend will continue for Malaysia as it moves to high income status.

Total population growth was close to 1.3% over the past 5 years, after experiencing a downward trend since 1990 (Figure 1.7). Before 1990, population growth averaged 2.5-3%. Slower population growth is typical of developing economies that transition into high-income economies and is expected to continue. Slowing population growth also affects the share of population of working age (15-64), which in turn affects the size of the labor force (Figure 1.8). The share of the population between the ages 0 to 14 has 3 World Bank (2020) projects a growth rate of -0.1% under the baseline and -4.6% under a low-case scenario for 2020. 5
<!-- Start of picture text --> 8.0%<br>6.0%<br>4.0%<br>0.0% As fattesteer fe<br>1961 1966 1971 \isys 9 86 1991 1996 {2001 2006\ 2¢11 2016<br>-2.0%<br>-4.0%<br>--TFP Growth PWT 9.0 —-30-year median (PWT9)<br>-6.0%<br>Source: PWT9<br><!-- End of picture text --> <!-- Start of picture text --> 2.5%<br>2.0%<br>1.5%<br>10%<br>0.5%<br>0.0%<br>1960 1968 1976 1984 1992 2000 2008<br>Source: PWT 9.0<br><!-- End of picture text -->
<!-- Start of picture text --> 3.5 -<br>100<br>3 90<br>80 —e—Pop Age 0-14<br>25 Pop Age 15-64<br>70 4a Pop Age 65 and above Or~~ aes<br>50 |*eooeeeeeeeTM<br>15 40<br>30<br>1<br>20<br>0.5 10<br>ie} ste heh tehth beh te hh deh de teh beh te de Ahk hea te det dete de te hots beh ae dkdeh beh te bch beh<br>0 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015<br>1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 Source: WDI. Codes: SP.POP.0014.T0.2S, SP.POP.1564.TO.2S, SP.POP.65UP.TO.ZS<br>Source: WDI & UN Population Projections. Code: SP.POP.TOTL<br><!-- End of picture text -->

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1.2<br>100<br>1 90<br>0.8 o_O<br>oa +0 seeeeeeeee<br>50 Pa<br>0.2 wm mn nn no ee eeeereer<br>40 *+* Labor Force Participation Rate —— Male Male Labor Force Participation Rate<br>0<br>1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 30 = =Female Labor Force ParticipationRateRate<br>-0.2<br>20<br>-0.4 10<br>-0.6 0<br>1990 1995 2000 2005 2010 2015<br>Source: WDI. Code: SP.POP.1564.TO<br>Source: WDI. Code: SL.TLF.ACTI.MA.ZS, SL.TLF.ACTI.FE.ZS, SL.TLF.ACTI.ZS.<br>90%<br>80%<br>70%<br>60% Y Y7<br>50% Z 7 7<br>ZZ ZYZ<br>40%30% : 7G ]<br>10% | Y Y<br>Y<br>0% is<br>&RSo &&x SSxs5 vw&ee. gESNssFESN aSRS> x Ag© &eeéESN Ss<br>Source: WDI using data for 2018. Code: SL.TLF.ACTI.FE.ZS<br><!-- End of picture text -->

<!-- Start of picture text --> 100<br>90<br>o_O<br>+0 seeeeeeeee<br>50 Pa<br>wm mn nn no ee eeeereer<br>40 *+* Labor Force Participation Rate —— Male Male Labor Force Participation Rate<br>30 = =Female Labor Force ParticipationRateRate<br>20<br>10<br>0<br>1990 1995 2000 2005 2010 2015<br>Source: WDI. Code: SL.TLF.ACTI.MA.ZS, SL.TLF.ACTI.FE.ZS, SL.TLF.ACTI.ZS.<br><!-- End of picture text -->
# **2. Growth drivers in the business-as-usual baseline**

In this section we explore the assumptions that are required to calibrate the LTGM-PC to simulate Malaysia’s business-as-usual baseline over 2020-50. To create a business-as-usual baseline for the Malaysian economy in the long run, we need to calibrate the future paths of the growth drivers like investment, the growth of both TFP and human capital, as well as other key parameters. These assumptions are summarized in Table 2.1. We calibrate the LTGM-PC as the foundation of the analysis and add the LTGM-TFP extension and the LTGM-HC extension to simulate TFP growth and human capital growth, respectively. Additionally, short-to-medium term forecasts produced by the IMF in its Article IV report help us calibrate the future paths of public and private investment. We use population growth projections (by age cohort) from the UN for demographic trends until 2050. The remaining projections are determined by assuming that long-term trends in Malaysia remain constant and by performing some steady state calculations. The labor share of income is calibrated to 50%, which is close to its value from Penn World Tables version 9.0 (PWT 9).

**Table 2.1. Summary of Assumptions for the Malaysia Business-as-Usual Baseline**

|**Variable**|**Baseline**|**Source/Comments**|
|---|---|---|
|Labor Share|50.0%|Similar to the 2014 PWT 9 figure of 53%|
|Depreciation Rate(aggregate)|5.8%|PWT 9 figure for 2014|
|Capital-to-Output Ratio|2.25|At steadystate value|
|Human Capital Growth|0.6% 0.1%|Calculated usingthe LTGM Human Capital Extension|
|TFP Growth|0.9% 0.6%|Similar to the last 15-year average and the last 30-year<br>median usingPWT 9|
|Investment-to-GDP Ratio|24%|Based on projections of public and private-investment-<br>to-GDP|
|Public Investment-to-GDP Ratio|6.0%|Based on recent trend and IMFprojection upto 2023|
|Private Investment-to-GDP Ratio|18.0%|Based on recent trend and IMFprojection upto 2023|
|Population Growth|1.3% 0.4%|UN Populationprojections(via WB HDN)|
|GDP Growth 2020-50|4.5% 2.0%|4.6% is MTI forecast for 2020 and 4.8% is the IMF Oct.<br>2019 WEOprojections average for 2020-23.|
|Atlas GNI PC Level|US$ 10,460|World Bank WDI for 2018|

Investment-to-GDP is assumed to remain around 24% given recent trends and the IMF Article IV projections for the next few years. For the baseline, we calibrate public investment-to-output and private investment-to-output ratios ( and ) of 6 percent and 18 percent respectively (Figure 2.1). This is based on projections made by IMF (2019), which forecast that declines from 7 percent in 2019 to II<sup>GG</sup> /YY II<sup>PP</sup> /YY II<sup>GG</sup> /YY 8
6.2 percent by 2023, and increases from 17.5 percent to 18.4 percent over the same five-year period.<sup>5</sup> The calibrations are consistent with (i) the gradual downward trend in in recent years amid fiscal II<sup>PP</sup> /YY consolidation, and (ii) a rebalancing towards private investment.<sup>6</sup> II<sup>GG</sup> /YY

# **Figure 2.1. Baseline Investment-to-Output Ratios**

<!-- Start of picture text --> A. Public Investment (% of GDP) B. Private Investment (% of GDP)<br>12.0 20.0<br>11.0 19.0<br>18.0<br>10.0<br>17.0<br>9.0<br>16.0<br>8.0<br>15.0<br>7.0<br>14.0<br>6.0 13.0<br>5.0 12.0<br>WDI IMF (2019) Calibration WDI IMF (2019) Calibration<br>2010 2012 2014 2016 2018 2020 2022 2024 2026 2028 2030 2032 2034 2036 2038 2040 2042 2044 2046 2048 2050 2010 2012 2014 2016 2018 2020 2022 2024 2026 2028 2030 2032 2034 2036 2038 2040 2042 2044 2046 2048 2050<br><!-- End of picture text --> The baseline projections put Malaysia between the 75<sup>th</sup> and 90<sup>th</sup> percentiles of the distribution of among high-income countries and at the 50<sup>th</sup> percentile for (Table 2.2). Generally, declines II<sup>GG</sup> /YY and increases as countries move from lower to higher country income group classifications. One II<sup>PP</sup> /YY II<sup>GG</sup> /YY reason underlying the comparatively high in Malaysia is that public investment includes investment II<sup>PP</sup> /YY spending by state-owned enterprises (SOEs).<sup>7</sup> While the classification of expenditure by SOEs as public II<sup>GG</sup> /YY investment may differ country-to-country, there are some indications that public investment tends to be higher in countries that have a significant presence of SOEs.<sup>8</sup> 5 These baseline projections by the IMF assume GDP growth of 4.8 percent, debt-to-GDP remaining around 50 percent, a fiscal deficit around 3 percent, and roughly stable revenue mobilization rates over the next five years. 6 Our projections, indicative of longer-term trends, are also consistent with the near-term projections of the government for , but higher in the case of . Ministry of Finance Malaysia (2019) estimates and at 6.5 percent and 16.8 percent respectively for 2019 and forecasts these ratios at 6.1 percent and 16.3 percent respectively for 2020. 7 II Known as non-financial public corporations (NFPCs) in Malaysia, these enterprises are public sector agencies undertaking<sup>GG</sup> /YY II<sup>PP</sup> /YY II<sup>GG</sup> /YY II<sup>PP</sup> /YY the sale of industrial and commercial goods and services. They include government-owned and/or government-controlled companies. The government’s monitoring and reporting are focused on major NFPCs, which have government ownership of more than 50 percent of total equity, minimum annual sales of at least MYR100 million and/or significant impact to the economy (Ministry of Finance Malaysia 2018). 8 In a list of 21 countries with the highest shares of SOEs among their top 10 firms and which also have at least 10 firms on the Forbes Global 2000 list (Kowalski et al. 2013), Malaysia is ranked fifth. Among the top 10 countries on this list (China, United Arab Emirates, the Russian Federation, India, Malaysia, Saudi Arabia, Indonesia, Brazil, Norway and Thailand), we calculate the median value for average over 2006-2015 as 7 percent. Our calculations also indicate that the baseline projection of 6 percent for Malaysia’s is slightly below the 75<sup>th</sup> percentile value for average over 2006-2015 (6.8 percent) of high-income fuel-based economies (fuel exports/merchandise exports >15 percent). II<sup>GG</sup> /YY II<sup>GG</sup> /YY 9 II<sup>GG</sup> /YY
**Table 2.2: Investment-to-Output Ratios by Country Income Groups, Average over 2006-2015 (percent)**

|**Incomegroup**|**P10**<br>|**P25**<br>|**P50**<br>|**P75**|**P90**|
|---|---|---|---|---|---|
||**P**<br>|**ublic investment-t**<br>|**o-output, **I<sup>G</sup>/Y<br>|||
|High|2.3|3.1|4.0|4.8|6.8|
|Upper middle|3.2|4.2|5.4|6.7|10.8|
|Lower middle|2.7<br>|3.6<br>|5.6<br>|7.7|11.5|
|Low|4.7<br>|5.8<br>|7.0<br>|8.6|11.5|
||**P**|**rivate investment-t**|**o-output, **I<sup>P</sup>/Y|||
|High|13.7|15.9|18.2|19.8|22.3|
|Upper middle|12.9|16.0|17.7|21.0|23.7|
|Lower middle|7.8|13.8<br>|16.3<br>|21.5|25.2|
|Low|7.6|11.2<br>|12.8<br>|18.4|22.6|
|||**Investment-to-o**<br>|**utput, **IY<br>⁄<br>|||
|High|18.9|20.3|22.5|23.8|27.3|
|Upper middle|19.4|21.3|24.2|27.3|32.6|
|Lower middle|15.9|17.9|23.0|28.2|31.1|
|Low|13.5|18.4|22.3|24.6|33.0|

Notes:

- Data reported are 10-year average (2006-2015) investment to GDP shares at various percentiles (from 10 to 90) of each income group distribution.

- The sample comprises 144 countries: 43 high income, 38 upper-middle-income, 34 lower-middle-income and 29 low income. Countries are categorized into income groups based on World Bank classification.

- ⁄ data is obtained from WDI. and are calculated by splitting the WDI data on ⁄ using public and private investment shares of total investment from the IMF Fiscal Affairs Department Investment and Capital Stock Database (which has data available up to 2015)IIYY II<sup>GG</sup> /YY. II<sup>PP</sup> /YY IIYY

- Our baseline projections for Malaysia places it between the 75<sup>th</sup> and 90<sup>th</sup> percentiles of the high-income country distribution for <u>/ , and at the 50</u><sup>th</sup> <u>percentile for /</u> II<sup>GG</sup> YY II<sup>PP</sup> YY.

The efficiency of public investment, as reflected by the Infrastructure Efficiency Index (IEI) in the LTGMPC, is high in Malaysia. Malaysia’s IEI score of 0.877 puts it at about the 50<sup>th</sup> percentile among highincome countries. This indicates that infrastructure in Malaysia is well-constructed and of high quality, which is supported by the World Economic Forum’s survey on infrastructure quality for its Global Competitiveness Index – Malaysia ranked 21 of 137 countries in 2017/18. Given the high base, the potential growth impact from improvements in this measure of efficiency is limited, and so we assume quality is constant at its current rate in the baseline and all scenarios.

The IEI is best thought of as capturing public capital construction quality, which does not capture other less quantifiable, but important, aspects of public capital quality like poor project selection or an inflated cost of construction. We are, thus, unable to properly examine the implications of improvements on these elements in the model, especially, in the context of cross-country comparisons. However, it does not mean that these elements are not important for Malaysia. For instance, IMF (2019) notes that fiscal 10
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1.0%<br>---- ~~<br>~ 090%<br>0.8%<br>0.6%<br>0.4%<br>0.2%<br>0.0%<br>2019 2024 2029 2034 2039 2044 2049<br>— -Median over 1985-2014 —=—=Business-as-usual baseline<br><!-- End of picture text -->
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<!-- Start of picture text --> VOY<br>: HL GDP Growth ——GDP PC Growth<br>6.0%<br>: 5 ****Forecast HL GDP Growth == Forecast GDP PC Growth<br>5.0% i<br>4.0% —=— =<br>3.0% ay<br>4<br>2.0% v4%sof4<br>“na<br>1.0% “a<br>ee)<br>a<br>1.0%0.0%cccSPRHARSHEESneseesraeasreeneeesygesresseegSesssssssssessssessgsssssssssssRBRARARRARARARARARAAARANRANAARAAA—¥4 AK<br>'<br>ee<br>Sources: LTGM Calculations & East Asia and Pacific Economic Update April 2020<br><!-- End of picture text --> <!-- Start of picture text --> 14%<br>12%<br>x<br>10% Ly y<br>a 0 \\ \<br>8% Y \ Vv<br>| 4 y\ f<br>6% f A\\\ \<br>\\s,<br>4 ; L \,<br>69<br>4% - HRS<br>S/N<br>“China,; Hong Kong SAR ~®- Republic of Korea yy<br>2%<br>t-Singapore —<Taiwan<br>1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010<br>Source: PWT 9 Note: smoothened using 5 year moving average<br><!-- End of picture text -->
# **What explains current trend growth rates?**

Private investment, followed by productivity growth, are the largest drivers of current economic growth. Current growth rates can be decomposed using a log-linear approximation of the production function as in Devadas and Pennings (2019) (Equation 16). Private investment is the most important growth driver, with a net contribution of about 2ppts of the current 4.5 percent GDP growth (Figure 3.3, graph A). Private investment makes such a large contribution because of the current low private capital-to-output ratio – driven by many years of low private investment following the Asian Financial Crisis – which increases the current marginal product of private capital (Figure 3.3, graph B). Note, however, that both the marginal product and growth contributions change over time, which we discuss in detail below. After private investment, the next largest contribution is from TFP growth, with a contribution of 0.9ppts. Next, population growth and public investment each contribute around 0.65ppts, with human capital growth contributing 0.3ppts.<sup>11</sup>

## **Figure 3.3. Net Investment Contribution to GDP Growth and Marginal Product of Capital**

<!-- Start of picture text --> A. Net Investment Contribution to GDP Growth 1/ B. Marginal Product of Capital<br>Percentage points %<br>of GDP growth 35.0<br>2.50 30.0<br>2.00 25.0<br>20.0<br>1.50<br>15.0<br>1.00 10.0<br>5.0<br>0.50<br>0.0<br>0.00<br>Marginal product of measured public capital (MPK Gm ) 2/<br>Public investment Private investment<br>Marginal product of private capital (MPK P ) 3/<br>(I G /Y) (I P /Y)<br>1/ t �<br>Net public investment contribution to GDP growth ≈ G .<br>GG � �<br>HH YYtt<br>t �<br> Net private investment contribution to GDP growth ≈ φφ�KKtt YYtt −δδPP GG � �.<br>HH YYtt<br>2/ Marginal product of measured public capital, M G(1 −ββ−φφ) �= Gφ� is obtained by taking the derivative of Equation (16) in KKttPP YYtt −δδ PP<br>3/Appendix 1 with respect to Marginal product of private capital, IIttGG⁄YYtt. θθ NN =M θθtt, that is the efficiency of new investment remains the same as past investment. PP = 1−βKK�β−φ , is obtained by taking the derivative of Equation (16) in Appendix KKtt YYtt<br>1, with respect to ⁄ . KK KKttPP YYtt<br>PP<br>tt tt<br>II YY<br>2019 2021 2023 2025 2027 2029 2031 2033 2035 2037 2039 2041 2043 2045 2047 2049<br>2019 2021 2023 2025 2027 2029 2031 2033 2035 2037 2039 2041 2043 2045 2047 2049<br><!-- End of picture text -->

> 11 Changes in the working-age to total population ratio contribute approximately zero as Malaysia in the middle of a transition between a demographic dividend and an aging population (see Figure 1.9). Labor force participation is assumed to be constant in the baseline, and so makes no contribution.

14
# **Why is the baseline growth rate declining?**

A natural explanation for the declining baseline GDP growth rate might be declining population growth. While this falling population growth is part of the explanation, GDP per capita growth also falls from 3.2% to 1.5% over the same period (Figure 3.1). The same set of peer countries in Figure 3.2 also experienced declining GDP per capita growth (not shown).

To understand what is driving the fall in baseline growth, we run counterfactual simulations where the path of each growth driver (or its marginal product, for investment) is kept constant at current levels. Table 3.1 depicts the impact of each driver on the fall in GDP growth. These are normalized contributions, which means that the individual contributions, which are shown in Appendix Figures 2.1-2.12, are scaled so that they add up to the total fall in growth over 2020-50. The normalization is necessary because over the long term, the model is substantially non-linear.<sup>12</sup> As foreshadowed above, population growth is expected to fall by 0.8ppts over 2020-50 which has a normalized contribution of around 0.6ppts to the total baseline fall in GDP growth over the same period. Declining population growth reduces the growth of the labor force, which directly reduces GDP growth. This reduces also the marginal product of capital (which is proportional to the capital-to-output ratio), which reduces the effect of investment on growth.<sup>13</sup>

**Table 3.1 Understanding the Drivers of Malaysia’s Falling Economic Growth Rates**

||Total Fall G<br>|DP Growth(2020-2050)<br>|
|---|---|---|
|Baseline|-2.5ppts|100%|
||Normalized Contribution|Normalized Share of Fall in Growth|
|Population Growth|-0.63ppts|20%|
|WATP Growth|-0.33ppts|11%|
|TFP Growth|-0.40ppts|13%|
|HC Growth|-0.39ppts|12%|
|Public Investment (falling marginal<br>product)|-0.04ppts|1%|
|Private Investment (falling marginal<br>product)|-1.37ppts|43%|

Source: Authors’ calculations.

> 12 Because the model is nonlinear, the sum of the effects of changing growth drivers one-by-one is not equal to the total change in growth when the growth drivers change together. This is especially true over the long term when G ⁄ and ⁄ change. 13 tt tt This direct effect is about 0.4ppts of GDP growth, with the indirect effect via the effectiveness of investment being the rest. PP KK YY tt tt KK YY 15

> 13
Declining population growth affects GDP growth and GDP per capita growth differently (in contrast, other growth drivers have the same effect on GDPPC and GDP growth).<sup>14</sup> Falling population growth actually raises per capita GDP growth: a 1ppts fall in population growth rate reduces the denominator (“per capita”) by 1ppt, but reduces GDP growth by less than 1 percentage point. In the baseline, GDPPC growth falls by 1.66% in the baseline, but only 1.88% with constant population growth (Appendix Figures 2.1-2.2).

The falling working age-to-total population ratio (WATP ratio) reduces GDP and per capita GDP growth in the mid-2020s and also late 2040s (Appendix Figures 2.3-2.4). The growth rate of the WATP falls by 0.6ppts by the end of the simulation period, resulting in a contribution of 0.33ppts to the overall fall in GDP growth over 2020-50.

Falling TFP growth and HC growth over 2020-50 both account for around 0.4ppts of the fall in the GDP growth over 2020-50. The median TFP growth rate over 1985-2014 is 0.9% (the value for the counterfactual), and the baseline TFP growth rate is expected to decrease from 0.9% to 0.6% over the next three decades (Figure 2.2B above). Human capital growth falls from 0.6% (the value in the counterfactual) to 0.1% in the baseline, a 0.5ppts decline (Figure 2.3 above). While this decline in human capital growth is larger than that of TFP, GDP growth rates are also less sensitive to human capital, resulting in similar contributions (Appendix Figures 2.5-2.8).

Overall, the declining effectiveness of private investment makes the largest contribution to falling GDP growth in the baseline (1.4ppts, or 40% of the total). In contrast, changing public investment effectiveness makes little contribution. Investment rates (public and private) are constant in the baseline, but they can still contribute to declining growth through changing marginal products. The marginal product of private capital is currently very high, reflecting low rates of private investment after 2000 and solid historical growth rates. As private investment is now higher, and growth is slower, the marginal productivity of private investment is expected to fall through 2050 back to more normal levels.

private investment is expected to fall through 2050 back to more normal levels. In our model, the initial private capital-to-output ratio, is relatively low at 1.14 (about the same as the public capital-to-output ratio of 1.11), thus allowing for a much higher marginal product of KK<sup>PP</sup> /YY private capital. However, with high at a constant 18 percent, also increases faster than KK<sup>G</sup> /YY (which increases only slightly, due to a public investment share-to-GDP of 6%). As such in the baseline II<sup>PP</sup> /YY KK<sup>PP</sup> /YY KK<sup>GG</sup> /YY the marginal product of private capital shows a larger decline, and the GDP growth effect of falls more noticeably over time. II<sup>PP</sup> /YY

> 14 Note however, that the _normalized_ contributions of the other growth drivers will be different for GDP and GDPPC growth. 16
<!-- Start of picture text --> 0.20%<br>0.15% whe he the he peg. peg.<br>iam ore oy bosale<br>oii, sale ST<br>4 co co A<br>0.00%<br>2024 2029 2034 2039 2044 2049<br>-0.05%<br>-0.10%<br>-0.15%<br>-0.20%<br>—@Weak reform reform = --&-- Strong reform<br><!-- End of picture text --> <!-- Start of picture text --> 8.00% 0.20%<br>7.00% bee kek hho ho te ke kk hh bn hk ke kkk ho ho kk ke ehh th ok 0.15% whe he the he peg. peg.<br>6.00% | &e—ee]’,/ SSS S$ _ A | oii, iam ore oy bosale ST<br>5.00% OOOO OOO OOOO OOOO OOO OH OO HH! | 4 co co A<br>4.00)% 0.00%<br>2024 2029 2034 2039 2044 2049<br>3.00%<br>-0.05%<br>2.00%<br>-0.10%<br>1.00%<br>-0.15%<br>0.00%<br>2019 2024 2029 2034 2039 2044 2049 -0.20%<br>—Baseline --@-Weakreform -4-Strong reform —@Weak reform reform = --&-- Strong reform<br><!-- End of picture text -->
<!-- Start of picture text --> 0.60%<br>0.20%<br>0.00% ;:: 2024 2029 2034 arn oan<br>-0.20% :33 ae®ene®®ene®ene®®<br>3 «o®<br>3 oo”<br>ad<br>-0.60%<br>+-@--Weak Reform —#&-Strong Reform<br><!-- End of picture text --> <!-- Start of picture text --> 25.00% 0.60%<br>Heegee| | 0.20%<br>15.00%<br>0.00%<br>10.00% ;:: 2024 2029 2034 arn oan<br>-0.20% :33 ae®ene®®ene®ene®®<br>5.00% 3 «o®<br>3 oo”<br>0.00% ad<br>2019 2024 2029 2034 2039 2044 2049 -0.60%<br>——Baseline --@--Weak Reform -—te-Strong Reform +-@--Weak Reform —#&-Strong Reform<br><!-- End of picture text -->
**Box Article 2. Rebalancing Components while keeping** ⁄ **unchanged - A Comparison of the effects of and on GDP Growth** IIYY We consider two scenarios, in which total ⁄ remains unchanged from the baseline at 24 percent. In the II<sup>GG</sup> /YY II<sup>PP</sup> /YY first scenario, we increase by 1ppt to 7 percent and reduce to 17 percent from 2020. There is an IIYY initial decline in GDP growth vis-à-vis the baseline (line with marker in graph A of Box Figure 3) given the loss of private investment impact at a high II<sup>GG</sup> /YY M but the differential turns positive by 2029 and remains so II<sup>PP</sup> /YY thereafter because rises more slowly compared to the baseline and M is therefore higher (line with KK<sup>PP</sup> marker in graph B of Box Figure 3). KK<sup>PP</sup> /YY KK<sup>PP</sup> In the second scenario, we reduce by 1ppt to 5 percent and increase to 19 percent from 2020. In contrast to the first scenario, there is an initial increase in GDP growth vis-à-vis the baseline, but the II<sup>GG</sup> /YY II<sup>PP</sup> /YY differential turns negative by 2027 (dotted lie in graph A of Box Figure 3), as rises more quickly compared to the baseline and M declines faster (dotted line in graph B of Box Figure 3). KK<sup>PP</sup> /YY **Box Figure 3. Rebalancing Investment Components – Impact on GDP Growth** KK<sup>PP</sup>

<!-- Start of picture text --> Percentage A. Real GDP growth % B. Marginal Product of Private Capital (MPK P )<br>points (difference versus baseline)<br>30<br>0.15<br>0.10<br>25<br>0.05<br>0.00<br>20<br>-0.05<br>-0.10<br>15<br>-0.15<br>+ 1pp Ig/Y, -1p1pp I G /Y, -1 p Ip/Yp I P /Y -1pp Ig/Y, +1pp Ip/Y-1pp I G /Y, +1pp I P /Y Baseline + 1pp Ig/Y, -1p1pp I G /Y, -1 p Ip/Yp I P /Y -1pp I-1pp Ig/Y, +1pp Ip/Y G /Y, +1pp I P /Y<br>2019 2021 2023 2025 2027 2029 2031 2033 2035 2037 2039 2041 2043 2045 2047 2049<br>2020 2022 2024 2026 2028 2030 2032 2034 2036 2038 2040 2042 2044 2046 2048 2050<br><!-- End of picture text -->

# **4.2 Total Factor Productivity Growth**

We model three TFP scenarios with different levels of reform by benchmarking Malaysia against highincome countries. The simulations include a weak reform scenario which targets a low value over a long period, a strong reform scenario which targets a high value over a short period, and a moderate reform scenario in the middle. We assume each subcomponent index for innovation, education, market efficiency, infrastructure, and institutions, which are identified as main determinants of TFP based on a literature review (Kim and Loayza 2019), increase linearly to the 25<sup>th</sup> , 50<sup>th</sup> , and 75<sup>th</sup> percentiles among high-income countries for the scenarios of weak, moderate, and strong reforms, respectively. The number of years to reach the target is 75th (long), 50th, and 25th (short) percentile, respectively, in the distribution of years that the high-income countries took from the Malaysia’s current level (in 2018) to the target. For example, for the strong reform scenario for education, there are 5 high-income countries which achieved the target 20
of 77.53 (75<sup>th</sup> percentile in the education index and Sweden’s current level). There is variation in the number of years these countries took from the current Malaysia’s level (52.07 in 2018) to the target. We then calculated the 25<sup>th</sup> percentile among the years the 5 countries took, 20 years, as the duration to reach the target for Malaysia. Table 4.1 lists Malaysia’s values for each component of the TFP index, the different targets and number of years to target.

**Table 4.1. Scenarios of weak, moderate, and strong reforms for the projection of TFP growth for 2020-2050**

|||Sub-co|mponents of the<br>Market|TFP Index||
|---|---|---|---|---|---|
||Innovation|Education|<br>Efficienc|Infrastructure|Institutions|
|Malaysia in 2018|||y|||
||24.79|52.07|85.26|60.20|69.45|
|Scenario 1. Weak ref|<br>orm|||||
|Target value|21.03|60.28|71.66|60.47|72.99|
|Country|-|Spain|-|Portugal|Slovakia|
|Years to target|-<sup>a</sup>|8|-<sup>b</sup>|1|16|
|<br>Scenario 2. Moderate|reform|||||
|Target value|40.24|71.49|86.89|68.68|82.22|
|Country|France|Netherlands|Italy|Finland|France|
|Years to target|9|21|2|13|19<sup>c</sup>|
|<br>Scenario 3. Strong re|form|||||
|Target value|59.46|77.53|90.98|73.93|91.70|
|Country|Denmark|Sweden|Germany|Switzerland|Germany|
|Years to target|10|20|4|16<sup>d</sup>|39<sup>e</sup>|

a, b The subcomponent indexes are assumed to increase over the next 3 decades with Malaysia’s historical trend of the last 10 years (2009-2018). c, e All high-income countries achieved Malaysia’s current level before 1985, the initial year in our database. We used the path of Japan of which the institutions index is the closest (74.01) in 1985 to the current Malaysia’s level (69.45). The institutions index of Japan is assumed to linearly increase in 2019 and onwards with the average annual change of the last 10 years (2009-2018). d All high-income countries achieved Malaysia’s current level before 1985, the initial year in our database. We use the path of Slovenia of which the infrastructure index is the closest (62.62) in 1985 to the current Malaysia’s level (60.20). Note 1. All indexes range from 1, the worst performance, to 100, the best. Note 2. See Appendix 1: LTGM-TFP or Kim and Loayza (2019) for more details on the construction of the determinant indexes.

Only in the strong reform scenario are the growth rates of TFP, GDP, and GDP per capita expected to exceed those of the business-as-usual baseline. Figure 4.3 shows the path of the TFP determinant index under the scenarios of weak, moderate, and strong reforms and Figures 4.4-4.6 show the results of the simulations for the growth of TFP, total GDP, and GDP per capita (respectively). In the weak-reform 21
<!-- Start of picture text --> 140<br>120 ae<br>eae «<br>100 ae aol<br>ae<«*«a«x*<br>80 ek eee ad o¢¢ooo<br>60 Wee PeeoS«*eee <2 wo ee<br>40<br>20<br>0<br>2019 2024 2029 2034 2039 2044 2049<br>—— Baseline ++@- Weak reform —®- Moderate reform ~~ Strong reform<br><!-- End of picture text --> <!-- Start of picture text --> 3.50%<br>Sa<br>3.00% %<br>Se eteeee.~ A- A 4-<br>-<br>i RAM te tetet<br>“hy.<br>2.50% an Sq—Oo o6.4 car .sa,<br>2.00% 4. ea<br>Peg *<br>ba<br>1.50% +... “?<br>1.00%<br>0.50%<br>0.00%<br>—Baseline2020 2025+-@-Weak reform2030 ~®-Moderate2035 reform2040 -a- Strong2045 reform 2050<br><!-- End of picture text --> <!-- Start of picture text -->
1.40%<br>1.20%<br>Oe-h-h-h-hetait Sa-,<br>«* cana a<br>1.00% | 4-H “hhaAha a<br>a 3Fey. -<br>0.80% ae aa<br>“OO.... 'O-O.o.6.<br>0.60% + 96-05<br>0.40%<br>0.20%<br>0.00%<br>2019 2024 2029 2034 2039 2044 2049<br>—— Baseline ++ Weak reform —®- Moderate reform ~ a= Strong reform<br><!-- End of picture text -->

<!-- Start of picture text --> 5.00%<br>4.50% |O~_<br>ae<br>=te te<br>4.00% Se ey<br>> arOr<br>3.50% > os Oy tte “he=<br>3.00% > ss. /<br>“o-a8 ia<br>2.50% 5 the<br>2.00% woe “?<br>1.50%<br>1.00%<br>0.50%<br>0.00%<br>2020 2025 2030 2035 2040 2045 2050<br>—— Baseline. *-@-Weak reform —®- Moderate reform ~A- Strong reform<br><!-- End of picture text -->
the TFP determinant subcomponent indexes and lower initial levels of TFP (see Kim and Loayza 2019). In Malaysia’s case, the current TFP overall determinant index is higher than in other developing countries on average; increasing it further is harder than in other countries with lower levels of the overall index. Also, Malaysia’s current level of TFP is moderately high as compared to other developing countries. For these reasons, achieving higher TFP growth in Malaysia is more difficult than in the past and in comparison to many other developing countries. Only with the scenario of strong reform, the growth rates of TFP, GDP, and GDP per capita are expected to be higher than those of the business-as-usual baseline.

# **4.3 Human Capital Growth**

This subsection models shocks to the quantity of education, quality of education, and health components (adult survival rates and children under 5 years of age who are not stunted) to the 25<sup>th</sup> , 50<sup>th</sup> , and 75<sup>th</sup> percentiles of high-income economies. The distribution of those four components are explored in Figure 4.7-4.10 below and it can be observed that Malaysia is behind other high-income economies in all four areas. We perform two sets of simulations: first by shocking all the components together to the different high-income percentiles, and second by shocking each HC component to the high-income country median one-at-a-time – to investigate the quantitative importance of each component.

By shocking the components of quality and quantity of education and health components of human capital to the 25<sup>th</sup> , 50<sup>th</sup> , and 75<sup>th</sup> percentiles of high-income economies, GDP growth is boosted by roughly 0.10ppts, 0.30ppts, and 0.40ppts on average during the 2020-2050 period (Figures 4.11-4.12). The dynamics are also important. This immediate policy change causes no change in the growth rates of human capital or GDP until the mid-late 2020s, which is when the oldest children who were affected by the policy change start to join the labor force. Even then, the effects are small as the oldest cohort of children spent the majority of their education under the old regime, and so only enjoy a fraction of the benefits. It takes until almost 2040 for the reforms to have their full effect: when today’s toddlers – who received the full benefit of the reforms – start to join the labor market.

23
<!-- Start of picture text --> 08 Tt 8 j i 4<br>‘pineet {| Sothipetl<br>08 rtf} 7 ' =<br>SOth dctl if: —~"<br>o7 Malaysia 2018 boA St \ rod<br>i fia ‘25th pct! / } i<br>ifr 6 Malaysia 2018] } rot bth pctl<br>asthpcl fod 5 | Distribution Distribution Upper Middle Income countries | rot Korea<br>Distribution High Income countries fof 4 H tot<br>04 ' H H Singapore<br>03 Distribution Upper Middle Income countries ptt io<br>io Distribution High Income countries |/ tot<br>02 i— 2 : tt<br>:<br>0.1 1 H tot<br>_ ! iy<br>° 7 8 9 10 11 12 13 0 : ot<br>0.5 0.6 0.7 0.8 0.9 q<br>Expected Years of Schooling<br>Source: HCI Source: HCI Quality of Education (Based on test scores)<br>7 25 T er<br>WR 20 2Sthipctl 5th prtl<br>: ba |<br>5 Malaysia 2018 ' Malaysia 2018 | 50th pd<br>H ' H Singapore<br>4 fH 1H Ysth pc} a5 :''<br>Distribution Vp, H H 10 :<br>2 Upper Middle Income countries ' H Distribution Upper Middle Income count '<br>: ; 5<br>1 Distribution Hig WAries :' '' Distribution High y :<br>Oo 4 s fo} i<br>0.5 0.6 0.7 0.8 0.9 0.7 0.8 0.9<br>Source: HCI Children under 5 who are not stunted Source: HCI Adult Survivalii Rate<br>1.20% 5.00%<br>1.00% A&Rcakes, s 4.50%<br>va* aay Oe“e 4.00% Rs<br>0.80% / tetera! | 3.50% 3.50% Eos ~_<br>a a Oe ~<br>«*-a** 3.00% + 0.,“Oh.“Oh. hans ~4~ ~<br>0.60% A* 2.50% oy<br>0.40% Bg4 oO O4, ~*OO e.,*, 2.00% *<br>: *-0.5-0" Oty.-o.¢.@.@| | 150% 150%<br>1.00%<br>0.20%<br>0.50%<br>0.00% 0.00%<br>2019 2024 2029 2034 2039 2044 2049 2020 2025 2030 2035 2040 2045 2051<br>——Baseline ++@--Weak reform (25th pct! HI) ——Baseline ++@--Weak reform (25th pctl HI)<br>—®- Moderate reform (50th pctl HI) -4- Strong reform (75th pctl HI) —®- Moderate reform (50th pctl HI) -&- Strong -&- Strong Strong reform (75th pct! HI)<br><!-- End of picture text -->

<!-- Start of picture text --> 8 j i 4<br>{| Sothipetl<br>7 ' =<br>—~"<br>\ rod<br>‘25th pct! / } i<br>6 Malaysia 2018] } rot bth pctl<br>5 | Distribution Distribution Upper Middle Income countries | rot Korea<br>4 H tot<br>' H H Singapore<br>io<br>Distribution High Income countries |/ tot<br>2 : tt<br>1 H tot<br>! iy<br>0 : ot<br>0.5 0.6 0.7 0.8 0.9 q<br>Source: HCI Quality of Education (Based on test scores)<br><!-- End of picture text -->

<!-- Start of picture text --> 25 T er<br>20 2Sthipctl 5th prtl<br>|<br>Malaysia 2018 | 50th pd<br>' H Singapore<br>a5 :''<br>10 :<br>Distribution Upper Middle Income count '<br>5<br>Distribution High y :<br>fo} i<br>0.7 0.8 0.9<br>Source: HCI Adult Survivalii Rate<br><!-- End of picture text -->

<!-- Start of picture text --> 5.00%<br>4.50%<br>4.00% Rs<br>| 3.50% 3.50% Eos ~_<br>a Oe ~<br>3.00% + 0.,“Oh.“Oh. hans ~4~ ~<br>2.50% oy<br>2.00% *<br>| 150% 150%<br>1.00%<br>0.50%<br>0.00%<br>2020 2025 2030 2035 2040 2045 2051<br>——Baseline ++@--Weak reform (25th pctl HI)<br>—®- Moderate reform (50th pctl HI) -&- Strong -&- Strong Strong reform (75th pct! HI)<br><!-- End of picture text -->
<!-- Start of picture text -->
1.00% 5.00%<br>Idre inder S not<br>0.90% sunted 4.50%<br>Adult Survival Rate<br>0.80% cara 4.00%<br>?<br>0.70%0.60%0.50% ¥ -:Quality(3 of EducatioF- »ywors ae“hehe ea] | 3.00%3.50%2.50% 3.00%3.50%2.50%3.50%2.50%2.50% “ay RN >. mS.aneorice;aneorice; ay "Og_— 2+6...+...Oy_— 2+6...+...Oy 2+6...+...Oy+6...+...Oy“e.gFeFe “e.gFeFe Fes<br>OO @., oom, +.<br>0.40% Sad en gee ‘+. 2.00% *<br>oe *.Og.<br>0.30% QuantityEducationof “+...* 0.6.6.4] | 150%<br>0.20% 1.00%<br>0.10% 0.50%<br>0.00% 0.00%<br>2019 2024 2029 2034 2039 2044 2049 2020 2025 2030 2035 2040 2045 205<br>——Baseline --#--Qty —®-Qty+QIty -a-Qty+Qlty+ASR ——Qty+ Clty + ASR + Stunting ——Baseline --#--Qnty —®-Qty + + Qity -a-Qty + Qity+ ASR —-—Qty+ Qity + ASR ASR + Stunting<br><!-- End of picture text -->

<!-- Start of picture text --> 5.00%<br>4.50%<br>4.00% “ay RN >. orice; ay<br>mS.aneorice;aneorice; Oy<br>| 3.00%3.50%2.50% 3.00%3.50%2.50%3.50%2.50%2.50% "Og_— 2+6...+...Oy_— 2+6...+...Oy 2+6...+...Oy+6...+...Oy“e.gFeFe Fes<br>+.<br>2.00% *<br>150%<br>1.00%<br>0.50%<br>0.00%<br>2020 2025 2030 2035 2040 2045 205<br>——Baseline --#--Qnty —®-Qty + + Qity -a-Qty + Qity+ ASR —-—Qty+ Qity + ASR ASR + Stunting<br><!-- End of picture text -->
<!-- Start of picture text --> 0.045 80.00%<br>0.040 :eT50th pctl ; 75.00% aa*®—<—<<br>Malaysia 2018 i f ‘ a<br>(0.035, 25thipcf' t \ 75th pctl 70.00% «* «<br>H ' ' -“«<br>0.030 —— 7 ‘ Ht H' oaAcaa<br>Distribution High Income countries [ ' ' 65.00% ro os<br>0.025 f- y A}r\ 4 H' « Pere ante +oo +oooo<br>/ i \h \ 60.00% = °Par aii<br>0.020 / i} Oo 6 ooo ore ore<br>Distribution Upper Middle Income countries/ H ‘\ ' 55.00% 2.¢-¢°<br>0.015 } t—+-A4<br>(0.010 A J 1| 'i \\ 50.00%<br>— / ' H : \ 45.00%<br>H H H > 40.00%<br>0.000<br>. 2019 2024 2029 2034 2039 2044 2049<br>0 10 20 30 40 50 60 70 80 90 1q<br>Source: WD! Female Labor Force Participation % ——Baseline --@--Weakreform —@®-Moderatereform -aA-=Strong reform<br>4.00% 6.00%<br>3.50%<br>aw 5.00%<br>3.00% Sees<br>OOO... ~-- 4.00% -9.3°6-<br>2.50% +: O-o-@.4. O-0-6..9, A i > e A<br>O09. ey RSS a4 -<br>2.00% ane “e. 3.00% o-4.9. +-o..9.ce,ce,<br>e..hare “? o-4 “@-.9. +.=,=,<br>1.50% 2.00% +.++.++.<br>1.00%<br>1.00%<br>0.50%<br>0.00% 0.00%<br>2020 2025 2030 2035 2040 2045 2051 2020 2025 2030 2035 2040 2045 205!<br>——Baseline --@-Weakreform —@®-Moderate reform -aA-Strong reform ——Baseline --@-Weakreform —®=-Moderatereform -a-Strong reform<br><!-- End of picture text -->

<!-- Start of picture text --> 80.00%<br>75.00% aa*®—<—<<br>a<br>70.00% «* «<br>-“«<br>oaAcaa<br>65.00% ro os<br>« Pere ante +oo +oooo<br>60.00% = °Par aii<br>Oo 6 ooo ore ore<br>55.00% 2.¢-¢°<br>50.00%<br>45.00%<br>40.00%<br>2019 2024 2029 2034 2039 2044 2049<br>——Baseline --@--Weakreform —@®-Moderatereform -aA-=Strong reform<br><!-- End of picture text --> <!-- Start of picture text --> 6.00%<br>5.00%<br>4.00% -9.3°6-<br>i > e A<br>RSS a4 -<br>3.00% o-4.9. +-o..9.ce,ce,<br>o-4 “@-.9. +.=,=,<br>2.00% +.++.++.<br>1.00%<br>0.00%<br>2020 2025 2030 2035 2040 2045 205!<br>——Baseline --@-Weakreform —®=-Moderatereform -a-Strong reform<br><!-- End of picture text -->
<!-- Start of picture text --> 4.50% 6.00%<br>4.00% Ay ere SS a,<br>fA tetera .!<br>3.50%3.00% | ’?*'3‘ ee AAA ete “an bey ey‘anrN 4.00%5.00% | fA;22tro.4.*;22tro.4.*22tro.4.*2tro.4.*tro.4.*o.4.* tte hefalefale eae Oeatat -wyawyaa ae wy,<br>2.50% :careA OOOO --O:-O-O--O--O OO: OO OE 3.00% ‘PH O.@a‘OOOa‘OOO‘OOO 0g 0-0-5735<br>2.00% -<br>1.50% 2) | 2.00% 2.00% “<br>1.00%<br>1.00%<br>0.50%<br>0.00% 0.00%<br>2020 2025 2030 2035 2040 2045 205) 2020 2025 2030 2035 2040 2045 2051<br>——MYS Baseline --#--Weak reform —®-Moderate reform -aA-Strong reform ——MYS Baseline --@--Weakreform —®-Moderate reform -aA-Strong reform<br><!-- End of picture text -->

<!-- Start of picture text --> 6.00%<br>a,<br>.!<br>5.00% | tte<br>4.00%5.00% * hefalefale eae Oeatat -wyawyaa ae<br>fA;22tro.4.*;22tro.4.*22tro.4.*2tro.4.*tro.4.*o.4.* wy,<br>3.00% ‘PH O.@a‘OOOa‘OOO‘OOO 0g 0-0-5735<br>| 2.00% 2.00% “<br>1.00%<br>0.00%<br>2020 2025 2030 2035 2040 2045 2051<br>——MYS Baseline --@--Weakreform —®-Moderate reform -aA-Strong reform<br><!-- End of picture text -->
growth in the first 10-15 years in the moderate reform package is mostly due to higher FLFP. After that, the boost to growth increases further as today’s children, with higher human capital, start to join the labor force around 2035-40. While GDP growth does still decline, it does so at a reduced rate and the downward trend in GDP per capita growth is checked until 2040.

Finally, in the strong reform scenario, based on growth determinants at the 75<sup>th</sup> percentile of high-income countries, growth is about around 1.5ppts higher than the baseline over 2020-2050. The decline in GDP growth (relative to 2020) is delayed until 2042, and GDP per capita growth is higher than its 2020 rate at almost all horizons. Growth increases initially to 5.5%, mostly based on higher private (and public) investment. Higher TFP growth and FLFP boost GDP growth as well, joined by human capital after around 2035-40. It should be noted, however, that such a path represents the most optimistic path for growth and reforms.

# **6. Conclusions**

The main findings of the paper can be summarized as follows. With the business-as-usual baseline, the GDP growth rate is expected to fall from 4.5% to 2.0% over the next 30 years (2020-2050), which covers the period of the country’s transition to high-income status and beyond. This decline is partly due to demographics, but the other main causes are 1) a smaller contribution from private investment as private capital accumulates and its marginal product declines, and 2) the gradual moderation in the growth rates of TFP and human capital, for which continuous improvements at a high growth rate become more difficult as their levels increase.

Under the scenario of weak reform, the GDP growth rate is expected to decrease from 4.5% to 2.0% over the next 30 years, which is similar to the result of the baseline. The impact is minimal compared to the baseline because the expected paths of growth drivers under this scenario are similar to those of the baseline. Under the scenario of moderate reform, the GDP growth rate is expected to decrease from 4.5% to 2.9%, which is around 1.5 times the GDP growth rate of the baseline in 2050. Under the scenario of strong reform, GDP growth rate is expected to decrease from 4.5% to 3.6%, which is around 1.8 times higher than that under the baseline in 2050. Higher overall investment-to-GDP due to a better fiscal position and private investment ecosystem supports growth in the short-to-medium term but its weakening incremental effect must be offset by other factors. The strong reform scenario clearly illustrates how the stronger contributions emanating from growth in human capital (0.28ppts growth increase with respect to the baseline, or 39% of the growth differential), TFP (0.02ppts or 30%), and female labor force 28
participation rate (0.30ppts or 24%) can, to some extent, mitigate the diminishing returns to physical capital accumulation over the long term (7% of the growth differential vis-à-vis the baseline).

The policy implications are derived from these results. Strong reforms are required to grow beyond what is expected based on historical trends, especially for human capital (the quantity and quality of schooling, and health), female labor force participation, and TFP. If Malaysia stays at the current level of educational quality and health (similar to the 25<sup>th</sup> percentile of high-income countries), human capital will not contribute much to economic growth. Improving human capital requires more focus on enhancing learning outcomes, improving child nutrition, and providing adequate protection through social welfare programs (World Bank 2018). Current female labor force participation is lower than the 25th percentile of highincome countries, which is the benchmark of the weak-reform scenario. Increasing it requires reducing or eliminating barriers to economic opportunities for women through legal reforms, introducing more economic and societal support for parents, and addressing gender norms and attitudes that perpetuate disparities (World Bank 2019). Strong reforms to increase TFP growth require efforts from diverse stakeholders. Our study shows that the gap between Malaysia’s current level (in 2018) and a target corresponding to the 75<sup>th</sup> percentile of high-income countries is relatively small for market efficiency but becomes increasingly wider for innovation, infrastructure, education, and institutions. Some of them, such as education and institutions, are expected to require two decades or more to improve to the target level of high-income economies. As these determinants are intercorrelated, sustainable collaboration and cooperation among the government, private sector, and civil society will be necessary.

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