The structural transformation in Japan, Indonesia and Malaysia from 1880 to 2010: part 2—analysis and policy implications - Articles

THE STRUCTURAL TRANSFORMATION IN JAPAN, INDONESIA AND MALAYSIA FROM 1880 TO 2010:
PART 2—ANALYSIS AND POLICY IMPLICATIONS

Professor Emeritus C. Peter Timmer, Harvard University

No country has been able to sustain a rapid transition out of poverty without raising productivity in its agricultural sector, if it had one to start (Singapore and Hong Kong are exceptions). The process involves a successful structural transformation where agriculture, through higher productivity, provides food, labour, and even savings to the process of urbanisation and industrialisation. A dynamic agriculture raises labour productivity in the rural economy, raises wages, and gradually eliminates the worst dimensions of absolute poverty. Somewhat paradoxically, the process also leads to a decline in the relative importance of agriculture to the overall economy, as the industrial and service sectors grow even more rapidly, partly through stimulus from a modernising agriculture and migration of rural workers to urban jobs.

Modernising agriculture contributed to successful structural transformation in Malaysia

Source: Laura Low

Part 1 of this article documented the basic data and trends for the key dimensions of the structural transformation from 1880 to 2010 for Japan, Indonesia and Malaysia. Part 2 examines these comparative data in more detail, focusing on Malaysia’s economic performance relative to these two important neighbours (see Figures 1 and 3 for separate visual comparisons of Malaysia’s structural transformation with those of Japan and Indonesia). Both the similarities and the differences are striking.

Despite similar starting points in the late 19th century, Malaysia has clearly followed the Japanese experience, while Indonesia has lagged significantly behind. This is especially true for progress in reducing the gap between labour productivity in the agricultural sector and that in non-agriculture. As Figure 1 shows clearly, despite higher levels of both agEMPshr and agGDPshr, Malaysia’s downward trajectory after recovery from WWII was much steeper than Japan’s. The result was that Malaysia was able to close the GAP in labour productivity faster than Japan, and now has a similar level. Reducing this GAP is closely correlated with reductions in poverty.

Figure 1 Long-run patterns of structural transformation in Japan and Malaya/Malaysia

Note: Dashed lines indicate Japan’s trajectory; solid lines show Malaya/Malaysia’s trajectory

As Figure 2 shows, absolute poverty has fallen especially rapidly in Malaysia since 1970, a result of rapid economic growth and significant government efforts to direct some of that growth to poor households. Still, by the early 1990s it was apparent that most of the remaining absolute poverty was in rural households, so a conscious policy decision was made to use the new National Agricultural Plan (NAP) 1992–2010 to promote the commercialization of smallholder agriculture (the home of most of Malaysia’s poverty in 1990), and the rapid exit of rural labour to more productive jobs (Sivalingam, 1993). This active effort to stimulate Malaysia’s agricultural transformation seems to have been very successful, but that is the topic for further research.

Figure 2 Malaysia is close to ending absolute poverty; Declined from 50 per cent in 1970 to 12 per cent in 1992 and <1 per cent in 2014

Source of data: Leete (2017) using data from Economic Planning Unit-Malaysia.

Note: * Data are for 1976

The comparison with Indonesia’s history of structural transformation is also instructive (Figure 3). Again, in the early years when per capita GDP was low in both countries, the levels and paths of both agEMPshr and agEMPshr are similar. Malaysia has a higher share of GDP originating in agriculture, and thus a lower agGAPshr, but the paths are similar. Still, it has been difficult for Indonesia to close its agGAPshr, resulting in continuing high levels of poverty compared with Malaysia.

Figure 3 Long-run patterns of structural transformation, Malaysia and Indonesia, 1880–2010

Note: Solid lines indicate Malaysia’s trajectory; dotted show Indonesia’s trajectory

Making structural transformation work for the poor: The role of agriculture

Asia shows distinct patterns of structural transformation (Timmer and Akkus, 2008), suggesting that country-specific policies have the potential to alter not just the rate of economic growth, a result that is well known, but also the structural character of that growth. That potential sparked a search for the determinants of ‘pro-poor growth’, defined to mean rapid economic growth that reaches the poor in at least proportionate terms (Besley and Cord, 2006; Timmer, 2004). The treatment of the agricultural sector, especially via the incentives for rapid gains in agricultural productivity, has been the key factor in explaining the extent to which economic growth has been ‘pro-poor’.

The role of government in stimulating growth in agricultural productivity and reaping the benefits of all the positive linkages to overall economic growth and poverty reduction noted in the general literature on agricultural development, is highly controversial (Timmer, 1988, 2002). A set of economic (and political) basics provide the foundation for such growth—macro economic stability, public sector investments in public goods (especially rural infrastructure and facilities for household investments in human capital), and effective institutions that provide property rights and a societal capacity to innovate. The nature of incentives needed to stimulate growth in agricultural productivity, and the role of price and trade policy in putting those incentives in place, are sub-sets of these larger issues.

In the broadest, economy-wide perspective, incentives to raise agricultural productivity are reflected in the terms of trade between agriculture and the rest of the economy. The agricultural terms of trade (AgToT) can be calculated easily as the ratio between the GDP deflator for agricultural value added in national income accounts and the GDP deflator for value added in the rest of the economy. This variable is an index, based on whatever year is used as the base for the GDP deflator in these accounts. As a practical matter, the World Development Indicators published by the World Bank use a common year for all countries, so the AgToT variable only captures relative movements in time across countries, but not any initial differences in relative price incentives at a given point in time.

Empirically, world markets are an important determinant of the domestic terms of trade between agriculture and non-agriculture, but most of the variance between countries and over time is due to specific domestic economic and policy factors. Understanding the extent to which domestic policy makers influence the terms of trade between the two sectors is key to understanding the political economy of the structural transformation and its ability to reduce poverty.

A worsening sectoral income gap—a deteriorating Gini coefficient between urban and rural areas—spells political trouble. Policy makers feel compelled to address the problem, and the most visible way is to provide more income to agricultural producers. The long-run way to do this is to raise their labour productivity and encourage agricultural labour to migrate to urban jobs, thus raising rural wages, but the short-run approach—inevitable in most political environments—is to use trade policy to affect domestic agricultural prices. Agricultural protection is a child of growing income inequality between the sectors during the structural transformation.

Asian countries have used agricultural price policy very aggressively to protect their farmers, especially in the rapidly growing countries of East Asia (Anderson and Hayami, 1986). Their agricultural terms of trade declined at only half the rate as for non-Asian countries between 1965 and 2000, despite being subject to the same global market forces. Asian countries devoted greater policy attention to agriculture across the board, and had the advantage of more equal landholdings than in most other countries. As a result, Asian countries were able to generate a far more rapid and equitable pattern of economic growth than Africa or Latin America (there are several exceptions, the Philippines being perhaps the most obvious). The sheer pace of growth created great political pressures to assist agriculture during the transformation process, but the economies of Asian countries were able to keep the gap from growing too fast because agricultural productivity was growing rapidly, and productive jobs were available in the urban sector.

The relevance of historical experience: Lessons for and from Malaysia

Several broad implications stem from this basic analysis of the structural transformation. Two main implications are worth noting. They focus on how agricultural trade policy changes during the structural transformation, at least from the perspective of the role of agriculture in poverty reduction for contemporary developing countries:

For poor countries, growth in agricultural productivity is the main driver of poverty reduction in the short to medium term (5-20 years). The type of investments needed to raise agricultural productivity varies by country and even agro-ecological zone within countries, but these investments are not small. The payoff to these investments in narrow financial terms may not be large at current commodity prices. Valuing non-market payoffs such as differential impact on poverty reduction, the role of agricultural households as macro economic safety nets for the urban poor, and contributions to a sustainable carbon economy, may be necessary to pass financial thresholds dictated by standard benefit-cost analysis (World Bank, 2007). At least for its rice-producing households, Malaysia has long been willing to invest in on-farm profitability at levels well above those indicated by the financial standards that are linked to rice prices in nearby world markets (Goldman, 1975).
Connecting rural economies to dynamic urban economies is the long-run solution to rural poverty, and this involves a process of structural transformation that lasts for generations. But the convergence of rural labour productivity with urban labour productivity, the ultimate welfare manifestation of the structural transformation, has become increasingly difficult over the past three decades. Active government policies are needed to connect small farmers and rural landless workers to the economic growth process, and Malaysia has also indicated a clear willingness to make these investments, whether in human capital or rural institutions and infrastructure (Sivalingam, 1993). These policies are also likely to include interventions to affect commodity prices at the border, but such policies are easier to implement for imports than for exports. As a major agricultural commodity exporter, Malaysia has been very careful to keep its cost structures competitive. Even the import controls on rice, and the degree of rice self-sufficiency, have been pragmatically reviewed for their impact on consumers and the overall cost structure of the economy.

The fraction of Indians in Malaya’s population rose very sharply in the decades between 1901–1921, from just 6 per cent to 15 per cent, as rubber planting expanded and inflows were at their peak. But the Indian share of the population fell after 1931 and was just 11 per cent by 1947, as many Indian plantation workers were repatriated as a result of the rise in unemployment over the Great Depression years (Figure 1).

Beyond the plantations, Indians were recruited, inter alia, for public works, as police and guards, and also to serve in the lower ranks of the colonial bureaucracy. Most came from Tamil areas in south India. They were considered to be more accustomed to British rule, more amenable to discipline than the Chinese, and more willing to work for low wages. Access to low cost Indian labour migration helped ensure the rubber industry’s spectacular growth and profitability. Since there was work for wives and older children on the rubber estates, Indian migration included whole families. But low wages, indebtedness, poor social status, and physical isolation kept estate Indians apart and they tended to exercise little influence on Malayan society.