## _wp15131

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---

### I. Introduction — Malaysia’s trajectory and the central question
- Malaysia experienced strong economic growth and became one of the Asian newly industrialized countries.
- GDP per capita grew by an average 2.8 percent per year over 1970-2010, reaching $10,830 per capita (in 2005 purchasing power parity, PPP, terms).
- Malaysia is classified in the upper-middle income group of countries.
- The country diversified its export base and increased export sophistication substantially.
- Human development indicators improved: average years of schooling increased; infant mortality fell; life expectancy rose.
- Central question: whether Malaysia can reach high-income status and which policies are needed.
- Cross-country evidence on the “middle-income trap”:
  - Using real income per capita relative to the US, only nine out of 167 economies in the sample in 2010—Cyprus, Czech Republic, Greece, Ireland, Korea, Malta, Portugal, Slovenia, and Taiwan Province of China—reached high-income status in the past 40 years.
  - Only two economies that were below Malaysia’s income in 1970 made it to high-income status: Korea and Taiwan Province of China.
- Malaysia’s total factor productivity has not grown as much as Korea and Taiwan Province of China.
  - Malaysia relied substantially on multinational corporations and foreign direct investment for export upgrading and technological transfer.
  - Technology creation and diffusion by local firms remained limited; industry linkages and agglomeration were not widespread.
- Policy implications identified:
  - Increase research and development (R&D) spending.
  - Improve education quality and increase share of science and engineering graduates.
  - Pursue policies used by Korea and Taiwan Province of China to create local firms and clusters in high-tech sectors to break through the middle-income trap.

### II. The middle-income trap: definitions, thresholds, and methodology
- Thresholds and empirical findings from literature:
  - World Bank 2014 thresholds: upper middle-income threshold of $4,125 and high-income threshold of $12,746 (current GNI per capita).
  - Felipe (2012) transforms thresholds into 1990 PPP: upper-middle and high-income range of about $7,250-$11,750 (1990 PPP).
  - Aiyar et. al. (2013) define $15,000 (2005 PPP) as the threshold for high-income countries.
  - Eichengreen, Park, and Shin (2013) find growth slowdowns at GDP per capita of $10,000-$11,000 (2005 PPP) and $15,000-$16,000.
  - Overall, high income thresholds and growth slowdowns occur in the $11,000-$15,000 (2005 PPP) range.
- This paper’s relative-income methodology and thresholds:
  - Uses relative income (GDP per capita 2005 PPP dollars relative to the US) and the distribution in 1970 as a benchmark.
  - Upper-middle income threshold defined with the median: 16 percent of the US income per capita.
  - High-income threshold defined as the 75th percentile: 46 percent of the US income per capita.
  - In 2010, the upper-middle income threshold was about $6600, while the high-income threshold was about $19,050.
  - In 1970, these thresholds were $3250 and $9300, respectively.
- Implications:
  - The relative thresholds raise the bar for escaping the middle-income trap and reaching high-income status.
  - Over the past 40 years, only nine of 167 economies in the 2010 sample crossed the 75th percentile of the relative income distribution.
    - Seven of those nine are European countries that were already upper-middle income and later became part of the European Union.
    - Two economies—Korea (KOR) and Taiwan Province of China (TPC)—started below Malaysia (MYS) in 1970 and reached high-income status.
  - The 1970 benchmark year was chosen because country coverage and data quality decline in earlier decades.

### Comparative growth performance and trajectories (1970-2010)
- Growth averages 1970-2010:
  - Korea: about 7.1 percent per year.
  - Taiwan Province of China: about 5.3 percent per year.
  - Malaysia: 2.8 percent per year.
- Relative position changes:
  - Taiwan Province of China overtook Malaysia around 1975.
  - Korea caught up around 1985 and by 1990 reached a level of income that took Malaysia 30 years to achieve.
  - Malaysia grew from about $4100 to about $10,800 over 1970-2010 but moved from 20 percent to 26 percent of the US income per capita.
  - Korea and Taiwan Province of China increased from less than 20 percent of the US income in 1970 to above 65 percent in 2010.
- Comparisons with Chile and Thailand:
  - Chile: started at about 30 percent of the US income per capita and was about 32 percent in 2010; average growth 2.1 percent per year over 1970-2010.
  - Thailand: started at about 10 percent of the US income per capita and grew at about 4.4 percent per year, reaching 20 percent in 2010.
  - Chile’s GDP per capita was relatively close to Malaysia’s over time but increased substantially in the 2000s with rising copper prices.
  - Thailand’s GDP per capita did not catch up with Malaysia’s.

### Productivity patterns and evidence on the middle-income trap
- Total factor productivity (TFP) growth, 1970-2010:
  - Korea and Taiwan Province of China: about 1.8 percent per year on average.
  - Malaysia: 0.8 percent per year on average.
- Dynamics and sectoral evidence:
  - Taiwan Province of China and Korea experienced substantial rises in productivity as they overtook Malaysia in GDP per capita terms.
  - Malaysia witnessed stagnant and declining productivity levels in the mid-70s to mid-80s.
  - Manufacturing output per worker: Malaysia lagged behind Korea and Taiwan Province of China (1975-2005 data referenced).
- Mechanism:
  - Gains from low-cost labor and foreign technology imitation diminish as countries move from low- to middle-income stages.
  - Moving away from labor-intensive manufacturing requires innovation (new ideas, methods, processes, and technologies) rather than imitation.

### Innovation, human capital, and infrastructure as escape mechanisms
- Theoretical mechanisms and risks:
  - Innovation-driven growth is key to avoiding the middle-income trap (Aghion and Howitt 1992).
  - Failure to switch from investment-based to innovation-based strategies risks a “non-convergence trap” (Acemoglu, Aghion, and Zilibotti 2006).
  - Misallocation of talent and limited access to advanced infrastructure can produce a low-growth trap (Agenor and Canuto 2012).
- Empirical determinants:
  - Export sophistication and education (secondary and tertiary) are important determinants of growth (Hausmann, Hwang, and Rodrik 2007; Eichengreen, Park, and Shin 2013).
  - Bulman, Eden, and Nguyen (2012) identify escapees as characterized by:
    - rapid structural transformation from agriculture to industry,
    - higher human capital and innovation,
    - greater export orientation,
    - macroeconomic stability with inflation less than 10 percent,
    - small increases in inequality.

### Malaysia’s performance on growth determinants and key gaps
- Export sophistication and schooling:
  - Malaysia fares relatively well on export sophistication and schooling compared to Korea of 1990.
  - Export sophistication grew substantially in the 1990s but stagnated in the 2000s.
  - Malaysia’s level in 2006 was about the level of Korea in 1990.
  - Years of schooling in 2005 were about the same as Korea in 1990.
- Gaps in local technology creation:
  - US patents granted:
    - When Korea overtook Malaysia in 1985, Korea received about 50 patents per year; Malaysia was granted less than five.
    - Malaysia’s patents granted in 2013 (about 220) remained below Korea’s when Korea had comparable income in 1990 (about 300).
    - The gap between Malaysia and Korea in 2013 widened to about 50 times.
  - R&D spending:
    - Malaysia R&D expense in 2011: a little over 1 percent of GDP.
    - Korea R&D in the 1990s: more than 2 percent of GDP; Korea in mid-80s: 1.3 percent in 1984.
  - Tertiary graduate composition:
    - Korea in the 1990s: about 35 percent of tertiary graduates in engineering, manufacturing, and construction; about 21 percent in social sciences.
    - Malaysia in the late 2000s: about 25 percent of tertiary graduates in engineering, manufacturing, and construction; about 33 percent in social sciences.

### Role and limits of multinational corporations (MNCs) and technology diffusion
- Malaysia’s FDI-led strategy:
  - Liberalization of the mid-80s and FDI-led export promotion attracted MNCs and diversified exports.
  - Despite incentives, technology creation and high productivity gains did not follow to the extent seen in Korea and Taiwan Province of China.
  - Export-oriented industries often had poor linkages with the rest of the economy; few local firms in electronics managed to grow.
- Reasons for limited diffusion from MNCs:
  - MNCs preferred their own suppliers, in-house production, or imports; repatriated profits; and sourced simple content to local firms.
  - Weak local absorption capacity (including low R&D intensity) and lack of conditions for proximate R&D reduced spillovers.
  - MNCs’ R&D tends to be located near marketing and headquarters; foreign affiliates may receive limited R&D activity.
  - MNC-driven activity may not introduce sufficient new products at foreign locations to sustain learning-by-doing-led productivity gains.
- Empirical literature:
  - Mixed results on spillovers: positive transfers via demonstration effects, competition, worker mobility, information sharing (Javorcik 2010) but possible negative effects; positive and negative spillovers can cancel out (Hayakawa, Kimura, and Machikita 2010; Smeets 2008).
  - Export activities of domestic firms, not foreign ownership per se, are most strongly associated with innovation (Sun and Hong 2011; Jarreau and Poncent 2012).

### Case studies: Taiwan Province of China and Korea — institutional paths to local technology creation
- Taiwan Province of China: ITRI/ERSO spin-off model and government-directed leapfrogging
  - Institutional innovations:
    - Industrial Technology Research Institute (ITRI) created in 1973 and Electronics Research Services Organization (ERSO) in 1974.
    - Science and Technology Advisory Group (STAG) founded in 1978; Hsinchu technology park created in 1980.
  - Spin-off process and government role:
    - ITRI/ERSO negotiated technology-sharing agreements with US firms, trained staff abroad, set up experimental production units, and spun off firms with about 40-50 percent of initial capital from government.
    - Examples:
      - United Microelectronics Company (UMC): spin-off initiated mid-1970s from RCA agreement; about one-half of initial funding from government; 259 ERSO personnel trained at RCA; UMC founded in 1980.
      - TSMC: spun off in 1987 from ERSO in partnership with Phillips; led to “pure-play foundry model.”
    - Government acted as a venture capitalist in early ventures (examples: UMC initial $14 million, TSMC $206 million; VLSI project budget $72 million over 1983-88).
  - Human capital and technical community:
    - Massive investment in training engineers abroad in the 1970s-1980s despite low early return rates (less than 10 percent returnees among US-trained graduates in 1970s-early 1980s).
    - Returning skilled workers in the 1990s formed a technical community with informal links to Silicon Valley.
  - Outcomes:
    - Spin-off system created 18 firms in semiconductor subsectors in the 1980s.
    - By the late 1980s, Taiwan Province of China caught up with the world technology frontier in terms of integrated circuit resolution.
- Korea: chaebols and state-led push to export and firm consolidation
  - Strategy and enforcement:
    - State-supported chaebols and a push for several firms to develop products and export aggressively (“move first, then learn and adjust”).
    - State support included loans with low and often negative real interest rates; loans often conditional on explicit and quantified export targets with strong political enforcement.
    - Not reaching export targets often implied senior management dismissal; accountability was strongly enforced.
  - Industry outcomes:
    - Multiple chaebols entered automotive (Daewoo, Hyundai, KIA, Asia Motors, Samsung); major restructuring by early 2000s left industry largely dominated by Hyundai-KIA.
    - Contrast: Proton (Malaysia’s national car company, launched 1985) achieved managerial and engineering skill gains and annual production capacity about 500,000 cars, but limited export success.
      - Proton cumulative exports since creation: about 12 percent of total production (400,000 out of 3.5 million cars); peak annual exports about 30,000 cars, mostly to the UK in the late 1990s, later insignificant.
  - Learning-through-competition rationale:
    - Export push exposed firms to global competition, enabling learning, adjustment, and emergence of globally competitive firms (e.g., Hyundai).

### Strategic sectoral choices, risks, and examples of supplier-cluster policy
- High risk–high return rationale:
  - Entering sectors far from comparative advantage implies high risk and long gestation (examples: Nokia’s mobile unit losses for about 20 years; Toyota had not been profitable for 30 years) (Chang and Lin 2009).
  - “How far from comparative advantage the state should push” is the core policy question (Chang and Lin 2009).
- Norway oil and gas supplier cluster example:
  - Government procurement authority could impose inclusion of Norwegian firms and change awardees (Leskinen et al. 2012).
  - Licensing required foreign operators to plan for developing local suppliers’ competencies (Heum 2008).
  - From late 1970s, a minimum of 50 percent of R&D needed to develop an oil field had to take place in Norwegian entities; restrictions lifted in 1994 but support continued via INTSOK (Leskinen et al. 2012).
  - Suppliers’ cluster employed directly about 114,000 workers in 2009, or more than five times the employment of the operators in the oil and gas sector (Sasson and Blomgren 2011a, 2011b).
- Trade-offs:
  - To create “system integrators,” high-tech clusters, and global brands, the state needs to tackle market failures, accept high risk, and provide targeted support so firms can pursue technology creation and clustering.

### The perils of relying on comparative advantage and services
- Chile case and outcomes:
  - Chile’s evolution included reintegro simplificado export subsidy (1985–2003), CORFO coordination, Fundación Chile start-up creation, and a mid-2000s National Strategy of Innovation for Competitiveness (NSIC).
  - Chile achieved strong poverty reduction, real GDP growth, and macro-stability, but productivity lagged.
  - Natural resource producers (Malaysia, Mexico, Indonesia) outperformed Chile in export sophistication over past two decades.
  - Chile’s total factor productivity has not increased beyond its 1970 level despite increases in schooling and manufacturing output per worker.
- Limits of services focus:
  - Non-tradables and services often represent large GDP shares; advanced economies may have smaller manufacturing shares but much higher manufacturing productivity.
  - Many developing countries switch to services early; manufacturing remains a more likely source of high productivity gains.
  - Empirical finding: an increase in the tourism sector share of exports by 8 percent increases growth by only one-half percentage points a year (Arezki et al. 2009).
  - Malaysia’s net service balance has been negative since 1960 (except 2007-2009, which recorded a small surplus).
- Policy conclusion:
  - Overemphasis on services (tourism, logistics, transportation, finance) is unlikely to generate the sustained productivity gains needed to escape the middle-income trap.
  - Preferred strategy: combine high value-added manufacturing and services that are interlinked, creating networks of tradable and non-tradable high-skilled activities.

### Policy implications and priorities for Malaysia
- Core policy priorities implied by the analysis:
  - Support creation of domestic technology and firms at or near the technology frontier rather than rely primarily on MNC-led diffusion.
  - Invest in R&D to raise spending well above a little over 1 percent of GDP (Malaysia 2011) toward levels observed in successful convergers (e.g., Korea more than 2 percent in the 1990s).
  - Promote engineering and technology-oriented tertiary education and increase the share of graduates in engineering, manufacturing, and construction (benchmarks: Korea ~35 percent vs. Malaysia ~25 percent).
  - Foster institutional structures that actively create and finance spin-offs, coordinate public research institutes, and provide training and experimental production facilities (the Taiwan Province of China ITRI/ERSO example).
  - Encourage firms to engage in exporting early and aggressively to learn and move up the “quality ladder” (Korea’s “move first, then learn and adjust” export push).
  - Address absorptive capacity of domestic firms (R&D intensity, supplier linkages) and design policies that promote domestic firms’ own innovation and export activities rather than sole reliance on FDI.
  - Accept state involvement in selecting and supporting sectors far from comparative advantage when aiming to create system integrators and high-tech clusters.

### Concluding diagnosis: Malaysia’s position and lessons from successful convergers
- Definition recap:
  - The 75th percentile that defines the high-income threshold is 46 percent of the real income per capita in the United States, $19,050 (2005 PPP terms) in 2010.
- Malaysia’s dynamics and outlook:
  - With an average growth rate of about 2.8 percent per year, Malaysia moved from 20 percent to 26 percent of the U.S. income per capita during the 1970-2010 period, far below the high-income threshold.
  - Malaysia has been stuck in the “middle-income trap” for the past four decades; at that speed, escaping it may take a long time.
  - Government reforms (Economic Transformation Program and the 10th Malaysia Plan) are being implemented; it is too early to assess results.
- Key diagnostics:
  - Malaysia improved schooling, business climate, infrastructure, and openness; manufacturing exports rose as oil exports dwindled.
  - Export sophistication improved (electronics sector with MNC support), but productivity gains lagged and local technology diffusion from MNCs was limited.
  - Malaysia accounts for a small share of patents filed in the United States and has relatively low R&D spending compared to Korea.
- Lessons from Korea and Taiwan Province of China:
  - Importance of local technology creation spearheaded by government.
  - Korea used chaebol incentives to push multiple sectors and enforced export pressures; only a few firms survived in each industry.
  - Taiwan used spin-off systems and returnees to create innovative SMEs and firms in GVCs.
- Policy implication:
  - Target high value-added tradable manufacturing and high-tech innovation to foster local technology creation, large spillovers, and sustainable employment.
  - State policy will likely involve sectors far from comparative advantage and require direct government involvement to “create winners.”

*Source PDF chapter/section: _wp15131 - 2010. Slovakia was just under $19,000 in 2010, a bit below the high-income threshold.*

### References .............................................................................................................

### References

### I. Introduction
- Malaysia experienced strong economic growth and became one of the Asian newly industrialized countries.
- GDP per capita grew by an average 2.8 percent per year over 1970-2010, reaching $10,830 per capita (in 2005 purchasing power parity, PPP, terms).
- Malaysia is classified in the upper-middle income group of countries.
- The country diversified its export base and increased export sophistication substantially.
- Human development indicators improved: average years of schooling increased; infant mortality fell; life expectancy rose.
- Key remaining question: whether Malaysia can reach high-income status and which policies are needed.
- Cross-country evidence indicates low odds of reaching high-income status—“middle-income trap.”
  - Using the definition of real income per capita relative to the US, only nine out of 167 economies in the sample in 2010—Cyprus, Czech Republic, Greece, Ireland, Korea, Malta, Portugal, Slovenia, and Taiwan Province of China—reached high-income status in the past 40 years.
  - Only two economies that were below Malaysia’s income in 1970 made it to high-income status: Korea and Taiwan Province of China.
- Malaysia’s total factor productivity has not grown as much as Korea and Taiwan Province of China.
  - Malaysia relied substantially on multinational corporations and foreign direct investment for export upgrading and technological transfer.
  - Technology creation and diffusion by local firms remained limited; industry linkages and agglomeration were not widespread.
  - Research indicates multinationals are generally not keen on transferring technology to other countries.
  - Korea and Taiwan Province of China mostly relied on creating technology by local firms, which was more successful in innovating and increasing productivity.
- Policy implications identified:
  - Increase research and development (R&D) spending.
  - Improve education quality and increase share of science and engineering graduates.
  - Pursue policies used by Korea and Taiwan Province of China to create local firms and clusters in high-tech sectors to break through the middle-income trap.

### II. The middle-income trap: Malaysia in perspective
- Definitions and thresholds discussed:
  - World Bank 2014 thresholds: upper middle-income threshold of $4,125 and high-income threshold of $12,746 (current GNI per capita).
  - Felipe (2012) transforms thresholds into 1990 PPP: upper-middle and high-income range of about $7,250-$11,750 (1990 PPP).
  - Aiyar et. al. (2013) define $15,000 (2005 PPP) as the threshold for high-income countries.
  - Eichengreen, Park, and Shin (2013) find growth slowdowns at GDP per capita of $10,000-$11,000 (2005 PPP) and $15,000-$16,000.
  - Overall, high income thresholds and growth slowdowns occur in the $11,000-$15,000 (2005 PPP) range.
- This paper’s methodology:
  - Uses relative income (GDP per capita 2005 PPP dollars relative to the US) and the distribution in 1970 as a benchmark.
  - Upper-middle income threshold defined with the median: 16 percent of the US income per capita.
  - High-income threshold defined as the 75th percentile: 46 percent of the US income per capita.
  - In 2010, the upper-middle income threshold was about $6600, while the high-income threshold was about $19,050.
  - In 1970, these thresholds were $3250 and $9300, respectively.
- Implications of relative thresholds:
  - The thresholds raise the bar for escaping the middle-income trap and reaching high-income status.
  - Over the past 40 years, only nine of 167 economies in the 2010 sample crossed the 75th percentile of the relative income distribution.
    - Seven of those nine are European countries that were already upper-middle income and later became part of the European Union.
    - Two economies—Korea (KOR) and Taiwan Province of China (TPC)—started below Malaysia (MYS) in 1970 and reached high-income status.
  - The 1970 benchmark year was chosen because country coverage and data quality decline in earlier decades.
  - Bulman, Eden, and Nguyen (2012) define middle-income range at 10-50 percent of the US GDP per capita.
  - There were 143 countries in the sample in 1970; data for a few European countries in 1970 were not available.

### Comparative growth performance and trajectories
- Growth averages 1970-2010:
  - Korea: about 7.1 percent per year.
  - Taiwan Province of China: about 5.3 percent per year.
  - Malaysia: 2.8 percent per year.
- Relative position changes:
  - Taiwan Province of China overtook Malaysia around 1975.
  - Korea caught up around 1985 and by 1990 reached a level of income that took Malaysia 30 years to achieve.
  - Malaysia grew from about $4100 to about $10,800 over 1970-2010 but moved from 20 percent to 26 percent of the US income per capita.
  - Korea and Taiwan Province of China increased from less than 20 percent of the US income in 1970 to above 65 percent in 2010.
- Comparisons with Chile and Thailand:
  - Chile started at about 30 percent of the US income per capita and was about 32 percent in 2010, growing at an average 2.1 percent per year over 1970-2010, less than Malaysia.
  - Thailand started at about 10 percent of the US income per capita and grew at about 4.4 percent per year, reaching 20 percent in 2010.
  - Chile’s GDP per capita was relatively close to Malaysia’s over time but increased substantially in the 2000s with rising copper prices.
  - Thailand’s GDP per capita did not catch up with Malaysia’s.

*Source: _wp15131 - References .............................................................................................................*

### 2010. Slovakia was just under $19,000 in 2010, a bit below the high-income threshold.

### _wp15131 - 2010. Slovakia was just under $19,000 in 2010, a bit below the high-income threshold.

### Productivity patterns and evidence on the middle-income trap
- Total factor productivity (TFP) growth, 1970-2010:
  - Korea and Taiwan Province of China: about 1.8 percent per year on average.
  - Malaysia: 0.8 percent per year on average.
- TFP dynamics:
  - Taiwan Province of China and Korea experienced substantial rises in productivity as they overtook Malaysia in GDP per capita terms in the mid-70s and mid-80s, respectively.
  - Malaysia witnessed stagnant and declining productivity levels in the mid-70s to mid-80s.
- Manufacturing output per worker:
  - Malaysia has lagged behind Korea and Taiwan Province of China (1975-2005 data referenced).
- Sectoral and structural drivers:
  - Gains from low-cost labor and foreign technology imitation diminish as countries move from low- to middle-income stages.
  - Moving away from labor-intensive manufacturing requires innovation (new ideas, methods, processes, and technologies) rather than imitation.

### Innovation, human capital, and infrastructure as escape mechanisms
- Theoretical mechanisms:
  - Innovation-driven growth is key to avoiding the middle-income trap (Aghion and Howitt 1992).
  - Failure to switch from investment-based to innovation-based strategies risks a “non-convergence trap” (Acemoglu, Aghion, and Zilibotti 2006).
  - Misallocation of talent and limited access to advanced infrastructure can produce a low-growth trap (Agenor and Canuto 2012).
- Human capital and export sophistication:
  - Empirical findings: export sophistication and education (secondary and tertiary) are important determinants of growth (Hausmann, Hwang, and Rodrik 2007; Eichengreen, Park, and Shin 2013).
  - Bulman, Eden, and Nguyen (2012) identify escapees as characterized by:
    - rapid structural transformation from agriculture to industry,
    - higher human capital and innovation,
    - greater export orientation,
    - macroeconomic stability with inflation less than 10 percent,
    - small increases in inequality.

### Malaysia’s performance on growth determinants
- Comparisons to Korea (when Korea reached Malaysia’s 2010 income level):
  - Malaysia fares relatively well on export sophistication and schooling compared to Korea of 1990.
  - Export sophistication:
    - Malaysia’s export sophistication grew substantially in the 1990s but stagnated in the 2000s.
    - Malaysia’s level in 2006 was about the level of Korea in 1990.
  - Years of schooling:
    - Malaysia’s years of schooling in 2005 were about the same as Korea in 1990.
- Key gaps identified for Malaysia:
  - Local technology creation was relatively low, as indicated by patenting and R&D:
    - US patents granted:
      - When Korea overtook Malaysia in 1985, Korea received about 50 patents per year; Malaysia was granted less than five.
      - Malaysia’s patents granted in 2013 (about 220) remained below Korea’s when Korea had comparable income in 1990 (about 300).
      - The gap between Malaysia and Korea in 2013 widened to about 50 times.
    - R&D spending:
      - Malaysia R&D expense in 2011: a little over 1 percent of GDP.
      - Korea R&D in the 1990s: more than 2 percent of GDP; Korea in mid-80s: 1.3 percent in 1984.
    - Tertiary graduate composition:
      - Korea in the 1990s: about 35 percent of tertiary graduates in engineering, manufacturing, and construction; about 21 percent in social sciences.
      - Malaysia in the late 2000s: about 25 percent of tertiary graduates in engineering, manufacturing, and construction; about 33 percent in social sciences.

### Role and limits of multinational corporations (MNCs) and technology diffusion
- Malaysia’s strategy and outcomes:
  - Liberalization of the mid-80s and FDI-led export promotion attracted MNCs and diversified exports.
  - Despite incentives, technology creation and high productivity gains did not follow to the extent seen in Korea and Taiwan Province of China.
  - Export-oriented industries often had poor linkages with the rest of the economy; few local firms in electronics managed to grow.
- Reasons for limited technology diffusion from MNCs:
  - MNCs preferred their own suppliers, in-house production, or imports; repatriated profits; sourced simple content to local firms.
  - Weak local absorption capacity (including low R&D intensity) and lack of conditions for proximate R&D reduced spillovers.
  - MNCs’ R&D tends to be located near marketing and headquarters; foreign affiliates may receive limited R&D activity.
  - MNC-driven activity may not introduce sufficient new products at foreign locations to sustain learning-by-doing-led productivity gains.
- Empirical literature on MNC spillovers:
  - Mixed results: positive knowledge transfer to foreign affiliates and local suppliers through demonstration effects, competition, worker mobility, information sharing (Javorcik 2010).
  - Positive and negative spillovers can cancel out depending on domestic firm responses (Hayakawa, Kimura, and Machikita 2010; Smeets 2008).
  - Export activities of domestic firms, not foreign ownership per se, are most strongly associated with innovation (Sun and Hong 2011; Jarreau and Poncent 2012).

### Case studies: Taiwan Province of China and Korea—paths to local technology creation
- Taiwan Province of China: ITRI/ERSO spin-off model and government-directed leapfrogging
  - Institutional innovations:
    - Creation of Industrial Technology Research Institute (ITRI) in 1973 and Electronics Research Services Organization (ERSO) in 1974.
    - Science and Technology Advisory Group (STAG) founded in 1978; Hsinchu technology park created in 1980.
  - Spin-off process:
    - ITRI/ERSO negotiated technology-sharing agreements with US firms, trained staff abroad, set up experimental production units, and spun off firms with about 40-50 percent of initial capital from government.
    - Examples:
      - United Microelectronics Company (UMC): spin-off initiated mid-1970s from RCA agreement; about one-half of initial funding from government; 259 ERSO personnel trained at RCA; UMC founded in 1980.
      - TSMC: spun off in 1987 from ERSO in partnership with Phillips; led to “pure-play foundry model.”
    - Government acted as a venture capitalist in these early, risky, modest-capital ventures (examples: UMC initial $14 million, TSMC $206 million; VLSI project budget $72 million over 1983-88).
  - Human capital and technical community:
    - Massive investment in training engineers abroad in the 1970s-1980s despite low early return rates (less than 10 percent returnees among US-trained graduates in 1970s-early 1980s).
    - Returning skilled workers in the 1990s formed a technical community with informal links to Silicon Valley, facilitating VC and sector dynamism.
  - Outcomes:
    - Spin-off system created 18 firms in semiconductor subsectors in the 1980s.
    - By the late 1980s, Taiwan Province of China caught up with the world technology frontier in terms of integrated circuit resolution.
- Korea: chaebols and state-led push to export and firm consolidation
  - Korean strategy:
    - State-supported chaebols and a simultaneous push for several firms to develop products and export aggressively (“move first, then learn and adjust” approach).
    - Firms faced restructuring and bankruptcies (e.g., KIA in the 1990s) but Hyundai emerged as a global brand.
  - Contrast with Malaysia’s Proton:
    - Proton (national car company, launched 1985) achieved managerial and engineering skill gains and annual production capacity about 500,000 cars, but limited export success.
    - Proton cumulative exports since creation: about 12 percent of total production (400,000 out of 3.5 million cars); peak annual exports about 30,000 cars, mostly to the UK in the late 1990s, later insignificant.
  - Key differentiators for Korea:
    - A strong export push and willingness to expose firms to global competition led to learning and adjustment that supported emergence of globally competitive firms.

### Implications for policy focus
- Core policy priorities implied by the analysis:
  - Support the creation of domestic technology and firms at or near the technology frontier rather than rely primarily on MNC-led diffusion.
  - Invest in R&D to raise spending well above a little over 1 percent of GDP (Malaysia 2011) toward levels observed in successful convergers (e.g., Korea more than 2 percent in the 1990s).
  - Promote engineering and technology-oriented tertiary education and increase the share of graduates in engineering, manufacturing, and construction (benchmarks: Korea ~35 percent vs. Malaysia ~25 percent).
  - Foster institutional structures that actively create and finance spin-offs, coordinate public research institutes, and provide training and experimental production facilities (the Taiwan Province of China ITRI/ERSO example).
  - Encourage firms to engage in exporting early and aggressively to learn and move up the “quality ladder” (Korea’s “move first, then learn and adjust” export push).
  - Address absorptive capacity of domestic firms (R&D intensity, supplier linkages) and design policies that promote domestic firms’ own innovation and export activities rather than sole reliance on FDI.

*Italic: Source PDF chapter/section: _wp15131 - 2010. Slovakia was just under $19,000 in 2010, a bit below the high-income threshold.*

### 2013. It was in those days when Proton acquired the UK’s Lotus and started seriously

### 2013. It was in those days when Proton acquired the UK’s Lotus and started seriously 

### Korean automotive strategy and chaebol-driven industrial policy
- Hyundai’s export-led push: in the mid-1980s Korean total sales were about 250,000 per year; Hyundai decided to build a 300,000 annual production capacity plant mainly targeting the US (Steers 1999).
- Early quality and learning strategy:
  - Hyundai had barely started designing its own car and its quality was lagging behind other car manufacturers.
  - Management expected early export attempts to be failures but planned to learn and adjust.
  - By 1991, Hyundai produced its first engine according to its own design and its first electric car.
- State-backed incentives and enforcement:
  - State support included loans with low and often negative real interest rates.
  - Loans often conditional on explicit and quantified exports targets; political pressure from highest levels of government.
  - Not reaching exports targets often implied senior management dismissal; accountability was strongly enforced.
- Industry structure and outcomes:
  - Multiple chaebols entered automotive (Daewoo, Hyundai, KIA, Asia Motors, Samsung) though only a few succeeded.
  - Major restructuring by early 2000s (e.g., Asia Motors closed in 1999; Hyundai took over KIA in 1998) left industry largely dominated by Hyundai-KIA.
  - Early protection (subsidies, high tariffs) screened firms but intense domestic competition and export pressure remained.

### Toward a high productivity and high linkages economy
- Strategic objective:
  - High productivity and high value-added sectors that generate extensive linkages are crucial to sustainable growth.
  - Building domestic capabilities and creating own technology in these sectors is key.
- High risk–high return rationale:
  - Entering sectors far from comparative advantage implies high risk, long gestation (examples: Nokia’s mobile unit incurred losses for about 20 years; Toyota had not been profitable for 30 years) (Chang and Lin 2009).
  - “How far from comparative advantage the state should push” is the core policy question (Chang and Lin 2009).
- Sectoral focus and examples:
  - Malaysia attempted upstream/downstream moves (medical materials based on rubber; biotechnology to improve palm production) but some industries (e.g., tire industry) failed to take off (Jomo 1997).
  - Petronas pursued international diversification and “global brand” creation.
  - Norway’s oil and gas suppliers cluster (1970s onward):
    - Government procurement authority could impose inclusion of Norwegian firms and change awardees (Leskinen et al. 2012).
    - Licensing required foreign operators to plan for developing local suppliers’ competencies (Heum 2008).
    - From late 1970s, a minimum of 50 percent of R&D needed to develop an oil field had to take place in Norwegian entities (Leskinen et al. 2012); restrictions lifted in 1994 but support continued via INTSOK.
    - Suppliers’ cluster employed directly about 114,000 workers in 2009, or more than five times the employment of the operators in the oil and gas sector (Sasson and Blomgren 2011a, 2011b).
- Policy implication:
  - To create “system integrators,” high-tech clusters, and global brands, the state needs to tackle market failures, accept high risk, and provide targeted support so firms can pursue technology creation and clustering.

### High value-added manufacturing and innovation as core strategy
- Priority sectors:
  - High-productivity manufacturing (e.g., automotive) and innovation/high-tech sectors, including high-skill services, should be targeted.
  - Growth of global value chains (GVCs) can support entry of local firms into supplier roles.
- Emphasis on own technology creation:
  - Policy should emphasize domestic technology creation rather than solely integration into MNC-led production.
  - Successful examples (Korea, Taiwan Province of China) show early engagement in frontier technologies and direct government role in creating innovative firms (spin-off system; returnees played key roles).
- Trade-off and timeline:
  - The larger the technological leap (farther from comparative advantage), the larger the risk and the longer it may take to discover the outcome (Rodrik 2005; Chang and Lin 2009).

### The perils of relying on comparative advantage: the case of Chile
- Chile’s policy evolution:
  - 1970s: very liberal policies; after the 1982 crisis tariffs were raised.
  - 1985–2003: “reintegro simplificado” export subsidy to help firms export in non-traditional sectors (Varas 2013).
  - 1990s–2000s: CORFO coordinated SME support, technical assistance, funding, and performance assessment.
  - Fundación Chile (public–private partnership) helped create start-ups and sold shares to pursue new projects; successes include salmon and blueberries exports.
  - Mid-2000s: National Strategy of Innovation for Competitiveness (NSIC) reaffirmed neutrality and focus on comparative advantage, identifying 7 clusters (mainly agro-industry, tourism, logistics, communications, transport) with emphasis on SMEs, skills, productivity, and innovation (Varas 2013).
- Outcomes and concerns:
  - Chile’s achievements in poverty reduction, real GDP growth, and macro-stability are strong, but productivity lagged.
  - Natural resource producers (Malaysia, Mexico, Indonesia) outperformed Chile in export sophistication over past two decades (Figure 7).
  - Chile’s total factor productivity has not increased beyond its 1970 level despite increases in schooling and manufacturing output per worker.

### The pitfalls of focusing on services
- Structural caveats:
  - Non-tradables and services often represent large GDP shares; advanced economies may have smaller manufacturing shares but much higher manufacturing productivity.
  - Many developing countries switch to services early; but manufacturing remains a more likely source of high productivity gains.
- Empirical findings:
  - Specialization in tourism yields limited growth benefits: an increase in the tourism sector share of exports by 8 percent (one standard deviation in a sample of more than 80 countries over 1980-1990) increases growth by only one-half percentage points a year (Arezki et al. 2009).
  - London’s finance and insurance sector directly employed less than 10 percent of workers in 2012.
  - Malaysia’s net service balance has been negative since 1960 (except 2007-2009, which recorded a small surplus).
- Policy conclusion:
  - Overemphasis on services (tourism, logistics, transportation, finance) is unlikely to generate the sustained productivity gains needed to escape the middle-income trap.
  - The preferred strategy is a combination of high value-added manufacturing and services that are interlinked, creating networks of tradable and non-tradable high-skilled activities (examples: Norway’s oil cluster; ICT spillovers to manufacturing; marketing services linked to R&D).

### Concluding remarks and Malaysia’s position
- Definition and thresholds:
  - Middle-income trap thresholds are percentile-based relative to the United States income distribution.
  - The 75th percentile that defines the high-income threshold is 46 percent of the real income per capita in the United States, $19,050 (2005 PPP terms) in 2010.
- Malaysia’s dynamics:
  - With an average growth rate of about 2.8 percent per year, Malaysia moved from 20 percent to 26 percent of the U.S. income per capita during the 1970-2010 period, far below the high-income threshold.
  - Malaysia has been stuck in the “middle-income trap” for the past four decades; at that speed, escaping it may take a long time.
  - Government reforms (Economic Transformation Program and the 10th Malaysia Plan) are being implemented; it is too early to assess results.
- Key diagnostic points:
  - Malaysia improved schooling, business climate, infrastructure, and openness; manufacturing exports rose as oil exports dwindled.
  - Export sophistication improved (electronics sector with MNC support), but productivity gains lagged and local technology diffusion from MNCs was limited.
  - Malaysia accounts for a small share of patents filed in the United States and has relatively low R&D spending compared to Korea.
- Lessons from Korea and Taiwan Province of China:
  - Importance of local technology creation spearheaded by government.
  - Korea used chaebol incentives to push multiple sectors and enforced export pressures; only a few firms survived in each industry.
  - Taiwan used spin-off systems and returnees to create innovative SMEs and firms in GVCs.
- Policy implication:
  - Target high value-added tradable manufacturing and high-tech innovation to foster local technology creation, large spillovers, and sustainable employment.
  - State policy will likely involve sectors far from comparative advantage and require direct government involvement to “create winners.”

*Source: IMF working paper content unit _wp15131 - 2013. It was in those days when Proton acquired the UK’s Lotus and started seriously*

### Part 1,” Asian Development Bank Economics Working Paper Series No. 306.

### _wp15131 - Part 1,” Asian Development Bank Economics Working Paper Series No. 306.

### Major thematic groupings in the cited literature
- Industrial policy, state roles, and developmental state histories
  - Felker, Greg, 2001. “The Politics of Industrial Investment Policy Reform in Malaysia and Thailand,” in Jomo K. S. (ed.), Southeast Asia’s Industrialization: Industrial Policy, Capabilities and Sustainability, New York: Palgrave, 129-182.
  - Greene, Megan J., 2008, The Origins of the Developmental State in Taiwan: Science Policy and the Quest for Modernization, Cambridge, Massachusetts: Harvard University Press.
  - Hong, Sung Gul, 1997, The Political Economy of Industrial Policy in East Asia: The Semiconductor Industry in Taiwan and South Korea, Cheltenham, England: Edward Elgar.
  - Low, Linda, 2001. “The Role of the Government in Singapore’s Industrialization,” in Jomo K. S. (ed.), Southeast Asia’s Industrialization: Industrial Policy, Capabilities and Sustainability, New York: Palgrave, 113-128.
  - Woo, Meredith Jung-en, 1991. Race to the Swift: State and Finance in Korean Industrialization, New York: Columbia University Press.
  - Gerschenkron, Alexander, 1962. Economic Backwardness in Historical Perspective, Harvard University Press.
  - Lucas, Robert Jr., 1993. “Making a Miracle,” Econometrica, 61(2), March: 251-272.

- Case studies of electronics, semiconductors, and high-technology sectors
  - Fuller, Douglas B., 2002, “Globalization for Nation Building: Industrial Policy for High-Technology Products in Taiwan Province of China,” MIT Japan Working Paper 02.02.
  - Lee, Chung-Shing and Michael Pecht, 1997. The Taiwan Electronics Industry, The Electronics Industry Research Series, Boca Raton, Florida: CRC Press.
  - Mathews, John, 2006. “The ‘how to’ of Technological Change: The Case of Electronics in Taiwan” in Vandana Chandra (ed.), Technology, Adaptation and Exports: How Some Countries Got It Right, Washington, DC: World Bank, 83-126.
  - Saxenian, AnnaLee and Jinn Yuh Hsu, 2001. “The Silicon Valley–Hsinchu Connection: Technical Communities and Industrial Upgrading,” Industrial and Corporate Change, 10(4): 893-920.
  - Saxenian, AnnaLee, 2001. “Taiwan’s Hsinchu Region: Imitator and Partner for Silicon Valley,” Stanford Institute for Economic Policy Research Discussion Paper No. 00-44.
  - Hong, Sung Gul, 1997, The Political Economy of Industrial Policy in East Asia: The Semiconductor Industry in Taiwan and South Korea, Cheltenham, England: Edward Elgar.

- Foreign direct investment, technology transfer, ownership, and firm productivity
  - Javorcik, Beata, 2010. “Foreign Direct Investment and International Technology Transfer,” prepared for the Encyclopedia of Financial Globalization.
  - Rasiah, Rajah, 2007. “R&D and Export Intensities in Automotive Parts Firms in China, Malaysia, Philippines and Taiwan: Does Ownership Matter?” RIETI Discussion Paper Series.
  - Rasiah, Rajah, 2004. “Foreign Ownership, Technological Intensities, and Network Strengths: Electronics Firms in East Asia,” OECD conference paper on The Impact and Coherence of OECD Country Policies on Asian Developing Economies.
  - Sun, Xiaonan and Junjie Hong, 2011. “Exports, Ownership and Firm Productivity: Evidence from China,” World Economy, 34(7): 1199-1215.
  - Ma, Hong, Zhi Wang, and Kunfu Zhu, 2013. “Domestic Value-added in China’s Exports and its Distribution by Firm Ownership,” US International Trade Commission Working Paper.
  - Smeets, Roger, 2008. “Collecting the Pieces of the FDI Knowledge Spillovers Puzzle,” World Bank Research Observer, 23(2): 107-138.

- Export composition, export sophistication, and economic growth
  - Hausmann, Ricardo, Jason Hwang, and Dani Rodrik, 2007. “What You Export Matters,” Journal of Economic Growth, 12(1), March: 1-25.
  - Jarreau, Joachim and Sandra Poncet, 2012. “Export Sophistication and Economic Growth: Evidence from China,” Journal of Development Economics, 97(2): 281-292.
  - Moretti, Enrico, 2013. The New Geography of Jobs, New York: Houghton Mifflin Harcourt.
  - Varas, Maria Elena, 2012. “Economic Diversification: The Case of Chile,” Revenue Watch Institute.
  - World Bank and the Development Research Center of the State Council, P. R. China, 2013. China 2030: Building a Modern, Harmonious, and Creative Society, Washington, DC, World Bank.

- Supplier development, local content, and natural-resource linked industry clusters
  - Heum, Per, 2008. “Local Content Development – Experiences from Oil and Gas Activities in Norway,” SNF Center for Applied Research at Norwegian School of Economics, Bergen.
  - Leskinen, Olivia, Paul Klouman Bekken, Haja Razafinjatovo, and Manuel García, 2012. “Norway Oil and Gas Cluster: A Story of Achieving Success through Supplier Development,” Harvard Business School.
  - Sasson, Amir and Atle Blomgren, 2011a. “Knowledge Based Oil and Gas Industry,” Knowledge-based Norway, March, Report No. 4.
  - Sasson, Amir and Atle Blomgren, 2011b. “Developing NODE: Mediating Strategy for Sustainable Growth,” Working Paper, Oslo: Norwegian Business School.

- Regional development, networks, and globalization impacts
  - Hayakawa, Kazunobu, Fukunari Kimura, and Tomohiro Machikita, 2010. “Firm-level Analysis of Globalization: A Survey of the Eight Literatures,” Economic Research Institute for ASEAN Discussion Paper Series.
  - Saxenian, AnnaLee and Jinn Yuh Hsu, 2001. “The Silicon Valley–Hsinchu Connection: Technical Communities and Industrial Upgrading,” Industrial and Corporate Change, 10(4): 893-920.
  - Smart, Alan and Josephine Smart, 2005. Petty Capitalists and Globalization: Flexibility, Entrepreneurship, and Economic Development, Albany: SUNY Press.

- Policy frameworks, growth strategies, and critiques of growth models
  - Rodrik, Dani, 2014. “New Growth Strategies,” presentation at the World Bank conference on New Growth Strategies: Delivering on their Promise? October.
  - Rodrik, Dani, 2005. “Growth Strategies,” in Philippe Aghion & Steven Durlauf (ed.), Handbook of Economic Growth, edition 1, volume 1, chapter 14, Oxford: Elsevier, 967–1014.
  - Jomo, K. S., 2001. “Introduction: Growth and Structural Change in the Second-Tier Southeast Asian NICs,” in Jomo K. S. (ed.), Southeast Asia’s Industrialization: Industrial Policy, Capabilities and Sustainability, New York: Palgrave, 1-29.
  - Jomo K. S. with Chen Yun Chung, Brian Folk, Irfan ul-Haque, Pasuk Phongpaichit, Batara Simatupang, and Mayuri Tateishi, 1997. Southeast Asia’s Misunderstood Miracle: Industrial Policy and Economic Development in Thailand, Malaysia, and Indonesia. Westview Press, Oxford.
  - Tran, Van Tho, 2013. “The Middle-Income Trap: Issues for Members of the Association of Southeast Asian Nations,” Asian Development Bank Institute Working Paper 421.
  - Ramírez, Carlos and Ling Hui Tan, 2004. “Singapore Inc. versus the Private Sector: Are Government-Linked Companies Different?” IMF Staff Papers, 51(3): 510-528.

- Firm- and network-level studies of technological capabilities and entrepreneurship
  - Rasiah, Rajah, 2001. “Southeast Asia’s Ersatz Miracle: The Dubious Sustainability of its Growth and Industrialization,” in Jomo K. S. (ed.), Southeast Asia’s Industrialization: Industrial Policy, Capabilities and Sustainability, New York: Palgrave, 86-112.
  - Mathews, John, 2006. “The ‘how to’ of Technological Change: The Case of Electronics in Taiwan” in Vandana Chandra (ed.), Technology, Adaptation and Exports: How Some Countries Got It Right, Washington, DC: World Bank, 83-126.
  - Steers, Richard M., 1999. Made in Korea: Chung Ju Yung and the Rise of Hyundai, London: Routledge.

*Source: _wp15131 - Part 1,” Asian Development Bank Economics Working Paper Series No. 306.*

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