## cr1862

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---

### Overview and context
- The 11th Malaysia Plan (11MP, 2016–20) marks the final five years of Malaysia’s Vision 2020 and sets strategies and targets to reach high–income status. Key labor market objectives include boosting productivity, improving labor market efficiency and institutions, encouraging female labor force participation, creating higher-skilled jobs, and reducing reliance on low-skilled non-citizen workers.
- Malaysia’s labor market has become more urban, with a higher share of female workers and workers with tertiary education; employment has kept pace with labor supply and unemployment has been stable for more than a decade.
- The share of non–citizen workers has increased against the backdrop of slower growth in the citizen population.

### Selected targets and baseline values
- Real GDP growth (percent, average): 10MP actuals 5.2; 11MP goals 5-6; 2016 actuals 4.2.
- Per capita GDP (U.S. dollars, end of period): 10,440; 11MP goal 15,690; 2016 actuals 9,850.
- Labor’s share in income (percent, end of period): ~35 (10MP actuals); 40 (11MP goal); 2016 actuals not reported ("...").
- Female labor force participation (percent, end of period): 54.1 (10MP actuals); 59 (11MP goal); 2016 actuals 54.3.
- Share of skilled employment (percent, end of period): 25.5 (10MP actuals); 35 (11MP goal); 2016 actuals 27.3.
- Labor productivity growth (percent, average): 1.8 (10MP actuals); 3.7 (11MP goal); 2016 actuals 3.5.
- Total factor productivity growth (percent, average)1/: 1.8 (10MP/IMF staff estimates); 2.3 (11MP goal); 2016 actuals 0.1.
  - 1/ IMF staff estimates for the 10th Malaysia Plan period (10MP, 2011–15) and 2016.

### A. Labor supply — key findings
- Urbanization and education:
  - Nearly three–fourths of Malaysia’s population now live in urban areas (mid–1980s: about 50 percent).
  - Average years of schooling increased from below 7 years in the mid–1980s to about 10½ years by 2010.
- Demographic shifts and participation:
  - Share of 15–24–year old participants in the labor force has declined; higher share in the 25–34 year age bracket.
  - Female labor force participation improved to about 54¼ percent in 2016 from 49½ percent in 2012.
- Labor force growth trends:
  - Labor force growth peaked in 2010 and has declined steadily since 2013.
  - Working–age population (15–64 years) compound annual growth: about 2.9 percent over 2002–09; slowed to 1.6 percent by 2017.
  - Labor force participation rate reached nearly 68 percent of the working–age population in 2016.
- Non–citizen workers:
  - Share of non–citizen workers increased since 2010, reaching about 15½ percent of the total labor force in 2016.
  - Non–citizen labor force characteristics: higher share of male or rural job seekers; significantly higher participation rates for both genders; younger; and fewer years of schooling compared to citizens.

### B. Employment structure and sectoral shifts
- Long–term employment creation: net employment creation occurred every year since the 1980s.
- Sectoral composition changes (2010–16):
  - Gains concentrated in wholesale and retail trade; accommodation and beverage services activities; administrative and support services; human health and social work activities.
  - Manufacturing and wholesale & retail trade together accounted for a little over one–third share in overall employment as of 2016.
  - Manufacturing’s share in economy-wide employment declined between 2011 and 2015 but partially reversed in 2016 and 2017.
  - Decline in public administration and defense employment reflects, in part, a hiring freeze.
- Occupational skills and firm structure:
  - Share of skilled workers increased to 27¼ percent of total employment in 2016 (2011–15 average: about 25 percent; 2001–10 average: about 26¼ percent).
  - Small and medium enterprises (SME) accounted for about 40½ percent share in total employment in 2015 (2010: about 33¼ percent).
  - Non–agricultural informal sector employment accounted for about 11½ percent of total employment in 2015 (2012: 8.2 percent); more than two–thirds of this employment comprised self-employed workers and employers.

### C. Female employment — trends, contributions, and drivers
- Growth and sectoral patterns:
  - Over 2010–16, female employment grew at a compound annual rate of about 4½ percent; male employment grew at about 2 percent.
  - Faster female employment growth concentrated in health and hospitality services and in the public sector.
- Contribution to GDP growth:
  - With human capital, contribution from female employment to real GDP growth increased from an average 4 percent in 2001–08 to 14 percent over 2011–16.
  - Contribution by male workers increased from about 7 percent to about 13 percent over the same periods.
- Education and participation:
  - By 2010, average years of schooling for females nearly caught up with males (lower by 0.2 years).
  - Under the 11MP, target to improve female labor participation rate by 5 percentage points to 59 percent by 2020.
- Potential impact of unchanged female participation:
  - If the female labor force participation rate had not changed since 2012, the direct impact would have led to a 3½ percent smaller labor force by 2016 and real GDP would have been about 1 percent lower (average growth lower by 0.2 percentage points).
- Drivers for low participation:
  - Housework or family responsibility is the dominant factor for women not seeking employment.
  - Faster decline in participation rates among married women aged 30 years and above.
  - Female participation is particularly low for less–educated women.

### D. Policy implications and recommendations to boost female participation and labor demand
- Tax and fiscal policy:
  - IMF (2012) evidence: female labor supply is more responsive to taxes than male labor supply.
  - Consider higher tax exemption for female workers than men and/or replacing family taxation with individual taxation to improve female labor participation.
  - Shift away from labor to consumption taxes could potentially boost labor demand by reducing non–wage labor costs; this implies further upgrading the GST tax framework, including reduction in the number of exempt items and raising the tax rate. Additional revenues could be used for growth–enhancing items, including physical and human capital.
- Childcare and family–friendly measures:
  - Increased access to childcare facilities and family–friendly labor laws could help boost female labor participation.
  - Government Transformation Program 2.0 target: 25 percent childcare enrollment by 2020 from 4 percent in 2012; limited success so far.
  - Tax incentives to firms for setting up childcare facilities and encouraging flexible work arrangements could help retain married women workers.
- Labor law and workplace protections:
  - Continue policies toward a gender–neutral employment law. Recent improvements include amendments to maternity benefits and a new sexual harassment regime.
  - Certain restrictions remain on employment of women (e.g., night work and/or for certain industries).
- Budget 2018 measures with potential to incentivize female participation:
  - Increasing the duration of maternity leave for the private sector to 90 days to match the public sector.
  - A minimum of 30 percent participation of women in Boards of government-linked companies and investment companies by end-2018.
  - Personal income tax exemptions on a maximum of 12 months consecutive salary for women with a career break of at least 2 years who intend to return to the workforce between 2018 and 2020.

### E. Non–citizen workers — composition, sectors, and macro effects
- Employment composition:
  - Non-citizens have a relatively higher share in lower–skilled occupations compared to citizens.
  - Non–citizen shares vary sharply by geography, sex, age, education, and skill level (visual data referenced in source).
- Sectoral concentration:
  - Non–citizen workers are primarily employed in agriculture, forestry, and fishing; manufacturing; and construction.
  - Manufacturing and construction together account for about two–thirds of total non–citizen employment.
  - Agriculture has a large share of non–citizen full–time workers in sector–specific skilled work or elementary occupations.
  - Construction: non–citizens mainly in building construction (residential and nonresidential).
  - Manufacturing: about one–quarter of manufacturing workers are non–citizens; higher shares in furniture and wood-work, textiles, and plastic and rubber products.
  - Electrical and electronics (E&E) manufacturing:
    - 2016: E&E accounted for about one–third of total goods exports and manufacturing employment, and about 6¼ percent of GDP.
    - Non–citizen workers account for between 20 and 30 percent of the workforce in E&E.
    - About two–thirds of non–citizen workers in E&E are females.
- Geographic concentration:
  - Five states accounted for nearly 80 percent share in total non–citizen employment in 2016 and a combined 64 percent share in national GDP.
  - Sabah: about 34 percent share in total non–citizen employment, with only 6.7 percent share in national GDP.
  - Selangor: about 22 percent share in total non–citizen employment; Sabah and Selangor together accounted for more than half of overall non–citizen employment in 2016.
- Observed macro-labor effects and counterfactual:
  - Citizen population growth fell from 2 percent y/y in 2003 to 1.1 percent y/y in 2017 (mid–year population estimates).
  - Counterfactual (2011–16): if the non–citizen labor force had grown at the lower rate observed over 2001–09, the total labor force would have been smaller by about 7 percent by 2016; average real GDP growth would have been lower by 0.4 percentage points (assuming no additional changes in the capital/labor ratio and/or in total factor productivity, and the same unemployment rate for non-citizens as observed during this period).
- Capital/labor ratio and investment:
  - Economy-wide capital/labor ratio grew at a slightly faster rate in the post–GFC period.
  - At industry level:
    - Agriculture and construction saw faster growth in capital/labor ratios over 2010–16.
    - Manufacturing saw a slowdown in growth in the capital/labor ratio.
    - In the E&E sub–sector, fixed investment has grown at slower pace than the manufacturing sector as a whole since 2010.
- Wages and unemployment:
  - Between 2010 and 2016, nominal average salaries and wages for all workers relative to national average compound annual rate of 5.4 percent:
    - Agriculture, forestry, and fishing: 7.4 percent.
    - Manufacturing: similar pace to the national average.
    - Construction: 5.1 percent.
  - Rising average salaries and wages for lower–skilled or less–educated workers have grown at a relatively faster pace than the highest–earning workers in recent years.
  - A World Bank study (2015) found a 10 percent rise in immigration has a small negative impact on wages of less–educated Malaysian workers, but about five and half times larger negative impact on immigrant workers’ wages.

### F. Policy considerations for non–citizen worker policies
- Reforming non–citizen worker policies and processes should be phased in and involve structural shifts in key sectors.
- Policy objectives and recommendations:
  - Rely increasingly on higher–skilled non–citizen workers within an overall limit while encouraging increased employment in high–skilled jobs and adoption of technology.
  - Phase in changes to allow important sectors time to adjust and continue consultation with industries on the pace of adjustment.
  - Rely on market–based mechanisms, as fixed numerical limits tend to lose relevance over time and lead to distortions and/or misreporting.

### G. Unemployment, skills mismatch, and education policy implications
- Unemployment:
  - Unemployment rate largely stable since late 1990s; fell from above 7 percent in mid–1980s to 2.4 percent in 1997.
  - Since 1997 unemployment has remained within 2.9 percent and 3.7 percent; 2016 uptick to 3.4 percent; ten months of 2017 largely stable around 3.4 percent.
  - Higher unemployment segments (2016): workers below age 30, particularly females; females in rural areas; workers with tertiary education; unemployment of non–citizen workers was lower than that for citizens on average.
- Skills mismatch and education:
  - Rising share of tertiary–educated workers in the unemployment pool points to skills mismatch.
  - Public spending on education as a share of GDP is much higher in Malaysia than in peer countries, but quality needs improvement.
  - Recommended actions:
    - Continue implementing Malaysia Education Blueprint initiatives.
    - Improve access to education and vocational training.
    - Modernize course contents in consultation with industries.
    - Train teachers.
    - Implement dual language program to strengthen English language literacy and other soft skills.
    - Improve infrastructural facilities in educational institutions.
  - Achieving a 35 percent share for skilled employment by 2020 appears optimistic given past pace.

### H. Labor compensation and productivity
- Labor compensation:
  - Labor’s share in national income increased from 30 percent in 2005 to about 35 percent by 2015.
  - Over 2011–16, average real salaries and wages increased at 3 percent compound annual rate.
  - Nominal average salaries and wages highest in mining and quarrying (also highest productivity), followed by real estate; information and communication; education; and financial activities.
  - Average salaries and wages in manufacturing and wholesale and retail sales were lower than the national average.
- Gender earnings gap:
  - 2016: female workers’ average salaries and wages were about 4 percent below the average for male workers.
  - Industry-wise: female workers earned about 30 percent less than males in agriculture, forestry, and fishing; female average salaries and wages were higher in construction.
- Minimum wages (Table 2):
  - 2013–15: Peninsular Malaysia 900; Sabah, Sarawak, and the Federal Territory of Labuan 800.
  - 2016: Peninsular Malaysia 1000; Sabah, Sarawak, and the Federal Territory of Labuan 920.
- Labor productivity:
  - Weakened over 2009–13, improved to about 3½ percent per annum average rate over 2014–16.
  - Decomposition indicates within–sector productivity improvements played the leading role in overall productivity growth.
  - Sectoral contributors: manufacturing (particularly 2001–05) and services main contributors to within–sector productivity gains; agriculture small positive contributor; mining and quarrying contributed negatively at times.
  - Labor productivity defined as ratio of value–added (real GDP) to total employment; not adjusted for hours worked and/or quality of labor inputs.
  - Labor productivity growth was about 4 percent year-on-year in the first nine months of 2017.

### I. Labor productivity versus real labor earnings and services sector outlook
- Productivity vs earnings (2010–16 and 2017):
  - Average labor productivity improved at about 1½ percent per annum during 2010–16.
  - This pace was about 1–1½ percentage points slower than the average rise in real earnings or unit labor costs.
  - Sectors with highest negative gaps between productivity and real earnings accounted for close to one–third of total employment.
  - For manufacturing and wholesale and retail trade, productivity and real wage growth were broadly similar on average.
  - In construction and information and communication, productivity gains outpaced real labor earnings growth.
  - First nine months of 2017: labor productivity growth outpaced real wage growth.
- Services sector role and medium-term projection:
  - 11MP aspiration: services sector productivity to reach 4.1 percent.
  - Historical: 2001–15 average services productivity 2.3 percent; 2016 services productivity 2.8 percent.
  - Staff view: sustained rise in services productivity to 4.1 percent seems optimistic.
  - Sub-sectors with potential: wholesale and retail trade; accommodation and food and beverages; education; transportation and storage; healthcare.
  - Staff medium-term baseline projects economy-wide labor productivity between 2 and 3 percent per annum on average, accompanied by capital deepening.

### J. Labor market conclusions and policy priorities
- Labor market has evolved and performed strongly over the last three decades; employment has kept pace with labor supply, maintaining a stable unemployment rate since the late 1990s.
- Labor’s share in income has increased in recent years.
- Remaining structural frictions and recommended priorities:
  - Improve delivery and quality of conventional and vocational education.
  - Create skills that meet industry’s needs.
  - Encourage R&D.
  - Incentivize further female labor force participation.
- Guidance on foreign labor policy reform:
  - Reforms aimed at inducing firms to switch to more capital-intensive technology should be market-based, clearly communicated, and gradually phased-in to allow adjustment by sectors that rely on foreign workers.
- Improved labor market outcomes, updated public infrastructure, and regulatory framework improvements will help further improve the business environment, support higher private investment, and contribute to lower external imbalances.

### K. Calibration of fiscal objectives — overview and methodology
- Fiscal anchors and objectives:
  - Objective of achieving a near balance over the medium term.
  - Ceiling of 55 percent of GDP for federal government debt.
  - Federal Government Debt expected to fall to less than 45 percent of GDP by 2022 (Debt Sustainability Analysis in Appendix IV of the companion Staff Report).
  - Legal ceilings: 55 percent of GDP for government securities; external debt ceiling: 35 billion ringgit; Treasury Bills ceiling: 10 billion ringgit.
- Methodology:
  - Follows FAD methodology (“How to Calibrate Fiscal Rules: A Primer”).
  - Uses annual data covering 20-year period from 1997 to 2016 to estimate a multivariate normal distribution of macroeconomic variables.
  - Generates N trajectories of the primary balance using an estimated fiscal reaction function (FRF) based on Bohn (1998).
  - Debt accumulation equation:
    - d_t = (1 + r_t)/(1 + g_t) * d_{t-1} - pb_t + ssa_t
    - where d_t: debt (% GDP); r_t: average effective real interest rate on debt; g_t: real GDP growth rate; pb_t: primary balance (% GDP); ssa_t: stock-flow adjustment (% GDP), constant for each period.

### L. Debt target selection, calibrated targets, and probabilities
- Staff analysis finding:
  - At current debt level, there is a 25 percent probability that debt could exceed the ceiling of 55 percent of GDP over a 6-year horizon, under unchanged policies and given past fiscal behavior.
- Calibrated debt targets and likelihoods:
  - Debt level of 34 percent of GDP implies overall debt remains under the ceiling of 55 percent of GDP with 95 percent probability.
  - If target debt is 39 percent of GDP, likelihood of remaining below ceiling is 90 percent.
  - Debt level of about 45 percent of GDP (staff baseline projection with deficit falling to 1.5 percent of GDP) is associated with likelihood of 85 percent of remaining below the ceiling.
- Policy options to reduce likelihood of high debt:
  - Build fiscal space in good times.
  - Exercise greater restraint when reacting to negative shocks.
  - Implement risk mitigation: sound financial sector, exchange rate flexibility, fiscal and monetary buffers.

### M. Operational deficit calibration — assumptions and deficit paths
- Calibration assumptions (Table 1):
  - d0 = 51%
  - d* = 34%
  - i = 5.5%
  - γ = 8.0%
  - b0 = -0.8%
  - ob = -2.8%
  - N = 15
  - T = 5
  - P = 10
  - δ = 0.5% (Incremental spending (% GDP))
  - Definitions:
    - Current debt ratio (% GDP) = 51%
    - Target debt ratio (% GDP) = 34%
    - Long-term nominal interest rate (%) = 5.5%
    - Long-term nominal growth rate (%) = 8 percent
    - Current fiscal balance (% GDP) = -0.8%
    - Overall balance (ob) = -2.8%
    - Convergence period for debt (years) = 15
    - Initial fiscal adjustment period (years) = 5
    - Period until spending increases in (years) = 10
- Deficit paths to reach 34 percent debt target:
  - A deficit of 2.5 percent of GDP sustained in the long term can take debt asymptotically to 34 percent of GDP; it would bring debt to about 40 percent of GDP in fifteen years.
  - A deficit of 1.9 percent of GDP sustained for fifteen years can bring debt to 34 percent of GDP.
  - If the deficit adjusts gradually over five years from the current level to 1.9 percent of GDP, debt reaches 34 percent over the same period.
  - Adding 0.5 percent of GDP of extra spending per year between the tenth and the fifteenth year would require an initial deficit of 1 percent of GDP to remain within the debt limit.
- Sensitivity:
  - Assuming 1 percent lower nominal growth and 1 percent higher interest rates implies a lower deficit is necessary to reach the debt target, though the difference is less than 0.5 percent of GDP.
- Credibility:
  - A credible long-term policy commitment can substitute for fiscal adjustment; sustaining current deficit level for the long term could achieve the same debt level as the baseline at the end of the projection period but over a longer period. An additional adjustment can create fiscal space for increased future spending.

### N. Fiscal policy conclusions
- Gradual consolidation is beneficial and validates authorities’ consolidation plans; consolidation increases likelihood of maintaining debt below the ceiling and builds fiscal space.
- Consolidation should occur when growth is strong.
- Analysis indicates fiscal policy flexibility in response to shocks: likelihood of debt remaining below the 55 percent ceiling varies between 75 and 85 percent by targeting debt levels between 34 and 45 percent of GDP.
- Deficit levels within the baseline projection range are consistent with calibrated debt targets.
- Different alternatives exist to gradually achieve deficit targets and build space for future spending.
- A long-term commitment is required; targets should be understood as average deficit over the business cycle.

*Prepared by Souvik Gupta with the assistance of Justin Flinner. Malaysia-specific data used in this analysis come from various data publications by the Department of Statistics, Malaysia. Sources cited include Economic Planning Unit, Prime Minister’s Department; Department of Statistics, Malaysia; World Bank; and IMF staff calculations.*

### 1. Selected Targets Under the 11th Malaysia Plan (2016–20) _________________________ 2

### 1. Selected Targets Under the 11th Malaysia Plan (2016–20)

### Overview and context
- The 11th Malaysia Plan (11MP, 2016–20) marks the final five years of Malaysia’s Vision 2020 and sets strategies and targets to reach high–income status. Key labor market objectives include boosting productivity, improving labor market efficiency and institutions, encouraging female labor force participation, creating higher-skilled jobs, and reducing reliance on low-skilled non-citizen workers.
- Malaysia’s labor market has become more urban, with a higher share of female workers and workers with tertiary education; employment has kept pace with labor supply and unemployment has been stable for more than a decade.
- The share of non–citizen workers has increased against the backdrop of slower growth in the citizen population.

### Selected targets and baseline values (Table 1)
- Real GDP growth (percent, average): 10MP actuals 5.2; 11MP goals 5-6; 2016 actuals 4.2.
- Per capita GDP (U.S. dollars, end of period): 10,440; 11MP goal 15,690; 2016 actuals 9,850.
- Labor’s share in income (percent, end of period): ~35 (10MP actuals); 40 (11MP goal); 2016 actuals not reported ("...").
- Female labor force participation (percent, end of period): 54.1 (10MP actuals); 59 (11MP goal); 2016 actuals 54.3.
- Share of skilled employment (percent, end of period): 25.5 (10MP actuals); 35 (11MP goal); 2016 actuals 27.3.
- Labor productivity growth (percent, average): 1.8 (10MP actuals); 3.7 (11MP goal); 2016 actuals 3.5.
- Total factor productivity growth (percent, average) 1/: 1.8 (10MP/IMF staff estimates); 2.3 (11MP goal); 2016 actuals 0.1.  
  1/ IMF staff estimates for the 10th Malaysia Plan period (10MP, 2011–15) and 2016.

### Data sources
- Sources: Economic Planning Unit, Prime Minister’s Department; Department of Statistics, Malaysia; World Bank; and IMF staff calculations.

---

### A. Labor Supply
- Urbanization and education:
  - Nearly three–fourths of Malaysia’s population now live in urban areas (mid–1980s: about 50 percent).
  - Average years of schooling increased from below 7 years in the mid–1980s to about 10½ years by 2010.
- Demographic shifts and participation:
  - The share of 15–24–year old participants in the labor force has declined, with a higher share in the 25–34 year age bracket.
  - Female labor force participation improved to about 54¼ percent in 2016 from 49½ percent in 2012.
- Labor force growth trends:
  - Labor force growth peaked in 2010 and has declined steadily since 2013.
  - Working–age population (15–64 years) compound annual growth: about 2.9 percent over 2002–09; slowed to 1.6 percent by 2017.
  - Labor force participation rate reached nearly 68 percent of the working–age population in 2016.
- Non–citizen workers:
  - Share of non–citizen workers increased since 2010, reaching about 15½ percent of the total labor force in 2016.
  - Non–citizen labor force characteristics: higher share of male or rural job seekers; significantly higher participation rates for both genders; younger; and fewer years of schooling compared to citizens.

---

### B. Employment: overall structure and sectoral shifts
- Long–term employment creation: net employment creation occurred every year since the 1980s.
- Sectoral composition changes (2010–16):
  - Gains in employment shares concentrated in: wholesale and retail trade; accommodation and beverage services activities; administrative and support services; human health and social work activities.
  - Manufacturing and wholesale & retail trade together accounted for a little over one–third share in overall employment as of 2016.
  - Manufacturing’s share in economy-wide employment declined between 2011 and 2015 but reversed partially in 2016 and 2017.
  - Decline in public administration and defense employment reflects, in part, a hiring freeze.
- Occupational skills:
  - Share of skilled workers increased to 27¼ percent of total employment in 2016 (2011–15 average: about 25 percent; 2001–10 average: about 26¼ percent).
- Firm size and informal sector:
  - Small and medium enterprises (SME), predominantly in services and micro-sized, accounted for about 40½ percent share in total employment in 2015 (2010: about 33¼ percent).
  - Non–agricultural informal sector employment accounted for about 11½ percent of total employment in 2015 (2012: 8.2 percent). More than two–thirds of this employment comprised self-employed workers and employers.

---

### C. Female employment: trends, contributions, and potential
- Recent growth and sectoral patterns:
  - Over 2010–16, female employment grew at a compound annual rate of about 4½ percent; male employment grew at about 2 percent.
  - Faster female employment growth concentrated in health and hospitality services and in the public sector.
- Contribution to GDP growth:
  - Growth accounting with human capital: contribution from female employment to real GDP growth increased from an average 4 percent in 2001–08 to 14 percent over 2011–16.
  - Contribution by male workers increased from about 7 percent to about 13 percent over the same periods.
  - By 2010, average years of schooling for females nearly caught up with males (lower by 0.2 years).
- International and regional comparisons:
  - Female labor force participation in Malaysia remains low in absolute terms and relative to male participation when compared with some regional economies and the OECD average.
  - Under the 11MP, target to improve female labor participation rate by 5 percentage points to 59 percent by 2020.
- Potential impact of unchanged female participation:
  - If the female labor force participation rate had not changed since 2012, the direct impact would have led to a 3½ percent smaller labor force by 2016 and real GDP would have been about 1 percent lower (average growth lower by 0.2 percentage points).
- Drivers for low participation:
  - Official statistics indicate housework or family responsibility is the dominant factor for women not seeking employment, in both urban and rural areas.
  - Faster decline in participation rates among married women aged 30 years and above.
  - Female participation is particularly low for less–educated women.

---

### D. Policy implications and recommendations for boosting female participation and labor demand
- Tax and fiscal policy:
  - IMF (2012) evidence: female labor supply is more responsive to taxes than male labor supply. Policies such as higher tax exemption for female workers than men and/or replacing family taxation with individual taxation could improve female labor participation.
  - Shift away from labor to consumption taxes could potentially boost labor demand by reducing non–wage labor costs; in Malaysia this implies further upgrading the GST tax framework, including reduction in the number of exempt items and raising the tax rate. Additional revenues could be used for growth–enhancing items, including physical and human capital.
- Childcare and family–friendly measures:
  - Increased access to childcare facilities and family–friendly labor laws could help boost female labor participation. Government Transformation Program 2.0 target: 25 percent childcare enrollment by 2020 from 4 percent in 2012; limited success so far.
  - Tax incentives to firms for setting up childcare facilities and encouraging flexible work arrangements could help retain married women workers.
- Labor law and workplace protections:
  - Continue policies toward a gender–neutral employment law. Recent improvements include amendments to maternity benefits, making termination of a female employee during her maternity leave an offence in situations other than closure of the employer’s business, and a new sexual harassment regime.
  - Certain restrictions remain on employment of women (e.g., night work and/or for certain industries).
- Budget 2018 measures with potential to incentivize female participation:
  - Increasing the duration of maternity leave for the private sector to 90 days to match the public sector.
  - A minimum of 30 percent participation of women in Boards of government-linked companies and investment companies by end-2018.
  - Personal income tax exemptions on a maximum of 12 months consecutive salary for women with a career break of at least 2 years who intend to return to the workforce between 2018 and 2020.

---

*Prepared by Souvik Gupta with the assistance of Justin Flinner. Malaysia-specific data used in this analysis come from various data publications by the Department of Statistics, Malaysia. Sources cited include Economic Planning Unit, Prime Minister’s Department; Department of Statistics, Malaysia; World Bank; and IMF staff calculations.*

### 10.      Non–citizen workers are mostly employed in lower–skilled jobs. This reflects their

### 10.      Non–citizen workers are mostly employed in lower–skilled jobs. This reflects their

### Employment composition by residency and demographics
- Non-citizens have a relatively higher share in labor supply for lower–skilled occupations compared to citizens; citizens’ higher education level is likely related to their relatively higher labor supply for higher–skilled jobs.
- Malaysia: Employment by Residency Status, 2016 (In percent) — visual data indicates notable differences by:
  - geography: Urban vs Rural (Citizens vs Non-citizens)
  - sex: Male vs Female
  - age: 15-24 years, 25-34 years, 35-44 years, 45-64 years
  - education: No formal edu., Primary, Secondary, Tertiary
  - skills: Elem. Occup., Semi-skilled, Skilled
- Malaysia: Share of Non-Citizen Employment by Market Segments, 2016 (In percent of each market segment) — non-citizen shares vary sharply across the same demographic and skill segments listed above.

### Sectoral and state demand for non–citizen workers
- Non–citizen workers are primarily employed in three sectors: agriculture, forestry, and fishing; manufacturing; and construction.
- Manufacturing and construction together account for about two–thirds of total non–citizen employment.
- Agriculture:
  - A large share of workers in the agricultural sector are non–citizens, primarily employed on a full–time basis and involved in sector–specific skilled work or in elementary occupation.
- Construction:
  - Non–citizen workers are mainly involved in construction of buildings, both residential and nonresidential.
- Manufacturing:
  - About one–quarter of manufacturing workers are non–citizens.
  - Within manufacturing, shares of non–citizen workers are relatively higher in furniture and wood-work related occupations; textiles; and plastic and rubber products.
  - Electrical and electronics (E&E) manufacturing:
    - In 2016 this sector accounted for about one–third of total goods exports and manufacturing employment, and about 6¼ percent of GDP.
    - Non–citizen workers account for between 20 and 30 percent of the workforce in E&E.
    - About two–thirds of non–citizen workers in E&E are females.
- Geographic concentration:
  - Five states accounted for nearly 80 percent share in total non–citizen employment in 2016.
  - These five states accounted for a combined 64 percent share in national GDP.
  - Sabah: about 34 percent share in total non–citizen employment, with only 6.7 percent share in national GDP.
  - Selangor: about 22 percent share in total non–citizen employment, similar to its share in national GDP.
  - Sabah and Selangor together accounted for more than half of overall non–citizen employment in 2016.

### Observed macro-labor effects and wage dynamics
- Non–citizen workforce growth occurred amid slowing working–age population growth:
  - Citizen population growth fell from 2 percent y/y in 2003 to 1.1 percent y/y in 2017 (mid–year population estimates).
  - Population growth has been largely negative for the 0–14 years age group.
- Counterfactual effect (2011–16):
  - If the non–citizen labor force had grown at the lower rate observed over 2001–09, the total labor force would have been smaller by about 7 percent by 2016.
  - Under this counterfactual, average real GDP growth would have been lower by 0.4 percentage points (assuming no additional changes in the capital/labor ratio and/or in total factor productivity, and the same unemployment rate for non-citizens as observed during this period).
- Capital/labor ratio:
  - Economy-wide capital/labor ratio has grown at a slightly faster rate in the post–GFC period.
  - At the industry level:
    - Agriculture and construction (sectors with relatively more non–citizen workers) saw faster growth in capital/labor ratios over 2010–16.
    - Manufacturing saw a slowdown in growth in the capital/labor ratio.
    - In the E&E sub–sector, fixed investment has grown at slower pace than the manufacturing sector as a whole since 2010.
- Unemployment and labor supply for low-education workers:
  - Despite higher growth in the non–citizen workforce, workers with no formal education and primary education saw a continued decline in their share in the total pool of unemployed workers, reflecting a decline in their share in total labor supply.
  - Unemployment rates for these workers have remained lower than the national average, except between 2010 and 2015 when the unemployment rate for workers with no formal education was higher; this rate has declined at the fastest pace since 2013.
- Salaries and wages:
  - Between 2010 and 2016, nominal average salaries and wages for all workers relative to the national average compound annual rate of 5.4 percent:
    - Agriculture, forestry, and fishing: 7.4 percent rate.
    - Manufacturing: similar pace to the national average (i.e., around 5.4 percent).
    - Construction: 5.1 percent rate.
  - Rising average salaries and wages for lower–skilled or less–educated workers have grown at a relatively faster pace than the highest–earning workers in recent years.
  - A World Bank study (2015) found:
    - Positive impact of immigration on overall employment and wages for Malaysian citizens.
    - A 10 percent rise in immigration has a small negative impact on wages of less–educated Malaysian workers, but about five and half times larger negative impact on immigrant workers’ wages.

### Policy considerations and recommendations on non–citizen worker policies
- Reforming non–citizen worker policies and processes will involve structural shifts in certain key sectors and should be phased in.
- Policy objectives and recommendations:
  - Malaysia aims to increasingly rely on higher–skilled non–citizen workers within an overall limit, and to encourage increased employment in high–skilled jobs and adoption of technology as the economy moves up the value chain.
  - Changes in non–citizen worker policies should be phased in to allow important sectors time to adjust.
  - Authorities should continue consultation with industries on the pace of adjustment.
  - Authorities should rely on market–based mechanisms, as fixed numerical limits tend to lose relevance over time and lead to distortions and/or misreporting.

### Unemployment: levels and distribution
- Economy-wide unemployment:
  - Unemployment rate has been largely stable since the late 1990s.
  - Unemployment fell from above 7 percent in the mid–1980s to 2.4 percent in 1997.
  - Since 1997 the unemployment rate has remained within a range of 2.9 percent and 3.7 percent.
  - 2016 witnessed an uptick to 3.4 percent.
  - In the ten months of 2017, the unemployment rate was largely stable around 3.4 percent.
- Higher unemployment segments (2016):
  - Workers below the age of 30 years (youth unemployment), particularly females in this age group, experienced higher unemployment rates.
  - Females in rural areas and workers with tertiary education experienced higher rates of unemployment.
  - Unemployment of non–citizen workers was lower than that for citizens on average.

### Skills mismatch and education policy implications
- Rising share of tertiary–educated workers in the unemployment pool points to skills mismatch.
- Public spending on education as a share of GDP is much higher in Malaysia than in peer countries, but quality needs improvement.
- Authorities’ focus and recommended actions:
  - Continue implementing Malaysia Education Blueprint initiatives.
  - Improve access to education and vocational training.
  - Modernize course contents, including in consultation with industries.
  - Train teachers.
  - Implement dual language program to strengthen soft skills like English language literacy.
  - Improve infrastructural facilities in educational institutions.
- Target on skilled employment:
  - Achieving a 35 percent share for skilled employment by 2020 appears optimistic given the pace of improvements so far.

### Labor compensation and productivity
- Labor compensation:
  - Labor’s share in national income increased from 30 percent in 2005 to about 35 percent by 2015.
  - Over 2011–16, average real salaries and wages increased at 3 percent compound annual rate.
  - Nominal average salaries and wages are highest in mining and quarrying (which also has highest labor productivity), followed by services sub–sectors: real estate; information and communication; education; and financial activities.
  - Average salaries and wages in manufacturing and wholesale and retail sales were lower than the national average.
- Gender earnings gap:
  - In 2016, female workers’ average salaries and wages were about 4 percent below the average for male workers.
  - Industry-wise:
    - Female workers earned about 30 percent less than males in agriculture, forestry, and fishing.
    - Female workers’ average salaries and wages were higher in the construction sector, reflecting higher share of female workers in skilled and semi–skilled occupations in that sector.
- Earnings premia and minimum wage:
  - Earning premia for higher–educated workers and skilled workers have declined slightly over 2011–16, partly because of implementation of a minimum wage framework since 2013 that benefitted lower wage earners.
  - Table 2. Malaysia: Minimum Wages (Monthly; in ringgit)
    - 2013–15: Peninsular Malaysia 900; Sabah, Sarawak, and the Federal Territory of Labuan 800
    - 2016: Peninsular Malaysia 1000; Sabah, Sarawak, and the Federal Territory of Labuan 920
- Labor productivity:
  - Labor productivity weakened over 2009–13, but improved to about 3½ percent per annum average rate over 2014–16.
  - Decomposition (following Klyuev (2015)) indicates within–sector productivity improvements played the leading role in overall productivity growth.
  - Sectoral roles:
    - Manufacturing (particularly 2001–05) and services were main contributors to within–sector productivity gains.
    - Agriculture maintained a small, positive contribution.
    - Mining and quarrying contributed negatively at times (e.g., 2008–09) reducing total contribution from within–sector productivity.
  - Labor productivity definition note:
    - Labor productivity is defined as the ratio of value–added across all industries (i.e., the real GDP) to total employment; it is not adjusted for hours worked and/or quality of labor inputs.
    - Labor productivity growth was about 4 percent on a year-on-year basis in the first nine months of 2017.

*Sources: Department of Statistics, Malaysia; and IMF staff calculations.*

### 20.      However, during 2010–16, labor productivity growth, on average, lagged the rise in

### cr1862 - 20.      However, during 2010–16, labor productivity growth, on average, lagged the rise in

### Labor productivity versus real labor earnings (2010–16 and 2017)
- Average labor productivity improved at about 1½ percent per annum during 2010–16.
- This productivity pace was about 1–1½ percentage points slower than the average rise in real earnings for workers or in unit labor costs.
- Sectors with the highest negative gaps between labor productivity and real earnings accounted for close to one–third of total employment.
- For the two largest employing sectors (manufacturing; wholesale and retail trade), productivity and real wage growth were broadly similar, on average.
- In construction and information and communication sectors, labor productivity gains were faster than real labor earnings growth.
- In the first nine months of 2017, labor productivity growth outpaced real wage growth.

### Services sector role and medium-term productivity projection
- Services sector should play a leading role in sustaining future increases in productivity.
- 11MP (National Plan) aspiration: services sector productivity to reach 4.1 percent.
- Historical performance:
  - 2001–15 average services productivity: 2.3 percent.
  - 2016 services productivity: 2.8 percent.
- Staff view: a sustained rise in services productivity to 4.1 percent seems optimistic given earlier performance.
- Sub-sectors with greater potential impact on sectoral and economy-wide productivity:
  - wholesale and retail trade;
  - accommodation and food and beverages;
  - education;
  - transportation and storage;
  - healthcare.
- Malaysia Productivity Blueprint: identified nine subsectors considered critical for improvements in productivity.
- Staff’s medium-term baseline projects:
  - economy-wide labor productivity between 2 and 3 percent per annum on average;
  - accompanied by capital deepening.
- Comparative note: projected 2–3 percent is faster than the historical average of about 2 percent, but slower than that assumed under the 11MP.

### Labor market conclusion and policy priorities
- Labor market has evolved and performed strongly over the last three decades; employment has kept pace with labor supply, helping maintain a stable unemployment rate since the late 1990s.
- Labor’s share in income has increased in recent years.
- Remaining structural frictions and recommended policy actions:
  - improve delivery and quality of conventional and vocational education;
  - create skills that meet industry’s needs;
  - encourage R&D;
  - incentivize further female labor force participation.
- Guidance on foreign labor policy reform:
  - reforms aimed at inducing firms to switch to more capital-intensive technology should be market-based, clearly communicated, and gradually phased-in to allow adjustment by sectors that rely on foreign workers.
- Improved labor market outcomes, updated public infrastructure, and regulatory framework improvements will help:
  - further improve the business environment;
  - support higher private investment;
  - contribute to lower external imbalances.

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### Calibration of fiscal objectives for Malaysia — overview
- Under unchanged policies, maintaining public debt below the policy objective over time would require a significant reduction in today’s debt-to-GDP ratio; otherwise policy response to shocks may be more restricted.
- Debt reduction can be achieved with a low deficit sustained over the long term.
- Federal Government Debt is expected to fall to less than 45 percent of GDP by 2022 (Debt Sustainability Analysis in Appendix IV of the companion Staff Report).
- Fiscal policy anchors:
  - objective of achieving a near balance over the medium term;
  - ceiling of 55 percent of GDP for federal government debt.
- Legal ceilings:
  - 55 percent of GDP for government securities (MGS, MGII, MITB);
  - external debt ceiling: 35 billion ringgit;
  - Treasury Bills ceiling: 10 billion ringgit.
- Authorities have conveyed policy of maintaining federal government debt below 55 percent of GDP but have not established this objective in legislation.
- A defined long-term fiscal framework would foster investment and growth by anchoring market expectations.

### Methodology for calibration and stochastic analysis
- Analysis follows FAD methodology (“How to Calibrate Fiscal Rules: A Primer”).
- Uses annual data covering 20-year period from 1997 to 2016 to estimate a multivariate normal distribution of macroeconomic variables involved in debt accumulation.
- Macroeconomic variables are forecast over a 6-year projection horizon N times by drawing from the calibrated multivariate distribution each year to generate N trajectories of the primary balance using an estimated fiscal reaction function (FRF).
- FRF specification is based on Bohn (1998), estimated separately for advanced and emerging market economies; allows asymmetric response to the output gap.
- Debt accumulation equation used:
  - d_t = (1 + r_t)/(1 + g_t) * d_{t-1} - pb_t + ssa_t
  - where variables are defined as:
    - d_t: debt (as a ratio of GDP);
    - r_t: average effective real interest rate on debt;
    - g_t: real GDP growth rate;
    - pb_t: primary balance (as a ratio of GDP);
    - ssa_t: stock-flow adjustment (as a ratio of GDP), constant for each period.

### Debt target selection and probability of breaching ceiling
- Debt target chosen by adjusting starting level of debt until a chosen percentile (e.g., 95th) of the debt distribution falls within [ceiling - 0.4; ceiling + 0.4].
- Fan charts can determine the probability of breaching the maximum debt limit conditional on any starting level.
- Staff analysis finding:
  - At current debt level, there is a 25 percent probability that debt could exceed the ceiling of 55 percent of GDP over a 6-year horizon, under unchanged policies and given past fiscal behavior.
- Policy options to reduce likelihood of high debt:
  - build fiscal space in good times (when output is above potential);
  - exercise greater restraint when reacting to negative shocks (with trade-offs);
  - implement risk mitigation strategies: maintain a sound financial sector, exchange rate flexibility, and build fiscal and monetary buffers.

### Calibrated debt targets and associated likelihoods
- Under unchanged policies, a debt level of 34 percent of GDP would imply overall debt remains under the ceiling of 55 percent of GDP with 95 percent probability.
- If target debt is 39 percent of GDP, the likelihood of debt remaining below the ceiling is 90 percent.
- A debt level of about 45 percent of GDP (staff baseline projection with deficit falling to 1.5 percent of GDP) is associated with a likelihood of 85 percent of remaining below the ceiling.

### Operational targets: calibration of the fiscal deficit
- Four methods to relate debt targets to operational deficit targets:
  1. Fiscal deficit calibrated to bring debt asymptotically to the target over the long term.
  2. Maintain a constant deficit that achieves the debt target in the long term.
  3. Gradually adjust the deficit from the current level to a sustained level.
  4. Sustain a deficit that allows for increased spending in the later period.
- Calibration assumptions (Table 1):
  - d0 = 51%
  - d* = 34%
  - i = 5.5%
  - γ = 8.0%
  - b0 = -0.8%
  - ob = -2.8%
  - N = 15
  - T = 5
  - P = 10
  - δ = 0.5% (Incremental spending (% GDP))
  - Definitions:
    - Current debt ratio (% GDP) = 51%
    - Target debt ratio (% GDP) = 34%
    - Long-term nominal interest rate (%) = 5.5%
    - Long-term nominal growth rate (%) = 8 percent
    - Current fiscal balance (% GDP) = -0.8%
    - Primary balance (pb)
    - Overall balance (ob) = -2.8%
    - Convergence period for debt (years) = 15
    - Initial fiscal adjustment period (years) = 5
    - Period until spending increases in (years) = 10

- Deficit paths to reach 34 percent debt target:
  - A deficit of 2.5 percent of GDP sustained in the long term can take debt asymptotically to 34 percent of GDP; it would bring debt to about 40 percent of GDP in fifteen years.
  - A deficit of 1.9 percent of GDP sustained for fifteen years can bring debt to 34 percent of GDP.
  - If the deficit adjusts gradually over five years from the current level to 1.9 percent of GDP, debt reaches 34 percent over the same period.
  - Adding 0.5 percent of GDP of extra spending per year between the tenth and the fifteenth year would require an initial deficit of 1 percent of GDP to remain within the debt limit.

- Sensitivity:
  - Assuming 1 percent lower nominal growth and 1 percent higher interest rates implies a lower deficit is necessary to reach the debt target, though the difference is less than 0.5 percent of GDP.

- Credibility:
  - A credible long-term policy commitment can substitute for fiscal adjustment; sustaining current deficit level for the long term could achieve the same debt level as the baseline at the end of the projection period but over a longer period. An additional adjustment can create fiscal space for increased future spending.

### Fiscal policy conclusions
- Gradual consolidation is beneficial and validates authorities’ consolidation plans; consolidation increases likelihood of maintaining debt below the ceiling and builds fiscal space.
- Consolidation should occur when growth is strong.
- The analysis indicates fiscal policy flexibility in response to shocks:
  - Likelihood of debt remaining below the 55 percent ceiling varies between 75 and 85 percent by targeting debt levels between 34 and 45 percent of GDP.
- Deficit levels within the baseline projection range are consistent with calibrated debt targets.
- Different alternatives exist to gradually achieve deficit targets and build space for future spending.
- A long-term commitment is required; targets should be understood as average deficit over the business cycle.

*Source: IMF staff report content provided in the supplied document.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2018/cr1862.pdf_