Income Distribution in Malaysia: Old Issues, New Approaches

Ragayah Haji Mat Zin Institute of Msian & International Studies Universiti Kebangsaan Malaysia rogayah@pkrisc.cc.ukm.my

11th International Convention of the East Asian Economic Association 15-16 November 2008 Manila

Outline 1. Introduction 2. Structural Transformation of the Malaysian Economy 3. Trends in Income Inequality 4. Main Factors Influencing Income Distribution 5. Shift in Approach to Narrow Inequality 6. Concluding Remarks

1. Introduction
How income is distributed is crucial because it determines national unity & poverty incidence Diagram shows clearly that both growth and inequality changes play a major role in generating changes in poverty red area due to growth & blue area due to redistribution. Thus need both growth & distribution policies.

Introduction

Density (Share of pop)

Growth and Distributional Effects on Poverty Eradication

Income ($ a day, logarithmic scale)

Introduction

The neglect of ensuring equitable distribution of the economic pie was said to lead to the 13 May 1969 racial riot as well as probably one of the causes of the National Front loss on 8 March 2008 Gill and Kharas (2007: 271): one of the hurdle for mid-Y ctries like M'sia to leap to the developed status is how widely the benefits have been shared. While the growth record of East Asian countries, including Malaysia, "is both impressive and uncontroversial, concerns remain about .. how widely the benefits have been shared and whether . the economic and social opportunities for the vast majority of the citizenry" have appreciably improved as socioeconomic disparities can also threaten economic growth.

2. Structural Transformation of the Malaysian Economy

Msia experience high economic growth, due to rapid growth of the mfg sector. GDP share of mfg sector rose from 13.9% in 1970 to 30.1% in 2007 while that of the agric. sector fell from 29.0% to 7.6%, while share of the services sector also rose from 36.2% to 53.6%. Unbalance changes in sectoral GDP shares & empt. resulted in uneven productivity, with those in the industrial sector far > that of the agric. sector--implies inequitable income distribution.

Trends in Income Inequality

3. Trends in Income Inequality: How the economic pie has been shared?

Trends in Income Inequality

3.2.3 Income Disparity Ratios by Strata 1970-2007

D'parity Ratio Urban: Rural 1970 1979 1984 1987 1990 1993 1995 1997 1999 2002 2004 2007

2.14

1.90

1.87

1.72

1.70

1.75

1.95

2.04

1.81

2.11

2.11

1.91

Trends in Income Inequality

3.2.4 Decomposition by Strata

Decomposition of household income by strata, ie. urban and rural areas, shows that most of the inequality is explained by the "within group" component and a much smaller proportion is explained by the "between group" component. Generally, the between group inequality seems to explain 3.88% to 16.01% of total inequality, depending on the parameter of the GE and Atkinson indices being used. This contradicts the widely accepted view that urbanrural income disparity accounts for a very large part of the existing inequality, as is implied by the core strategy of reducing urban-rural inequalities to narrow Malaysian inequalities (Ninth Malaysia Plan 2006-2010).

Trends in Income Inequality

3.3 Ethnic Income Distribution, Malaysia: 1970 - 2007

Trends in Income Inequality

Mean Household Income of Major Ethnic Groups Relative to National Mean, 1970-2007

Trends in Income Inequality

3.3.3 Disparity Ratio by Ethnic Groups, 1970-2007

D'parity Ratio Chin : Bumip Indian : Bumip 1970 1979 1984 1987 1990 1993 1995 1997 1999 2002 2004 2007

2.29

1.90

n.a

n.a

1.76

1.78

1.80

1.83

1.74

1.8

1.64

1.54

1.11

1.29

n.a

n.a

1.31

1.29

1.33

1.46

1.36

1.28

1.27

1.20

Trends in Income Inequality

3.3.4 Decomposition by Ethnicity

Most of the inequality is also explained mostly by the within group component; eg. GE(1Theil Index) for 2004, 93.71% is accounted for by the within group differences while only 6.29% is explained by the ethnic differences. Between group component has been declining since 1995 from 10.06% to 10.0% in 1997, 9.69% in 1999 and 9.32% in 2002 and 6.29% in 2004, implying that the policies implemented to narrow inter-ethnic differences have been effective. It also means that some of these policies might have been causing the within group inequality to widen, eg. privatization of projects in favor of Bumiputeras.

4. Main Factors Influencing Income Distribution

4.1 During NEP & beyond: Rural Developmentwhile improved income & welfare of rural households, their efficacy in achieving this objective as well as redistribution of income can still be improved Education and employment Export-oriented industrialization Restructuring of equity ownership and asset accumulation Other policies and programmes including
Provision of basic services, infrastructures & housing NGOs, eg. Amanah Ikhtiar Malaysia (AIM) & Yayasan Basmi Kemiskinan (Poverty Rradication Foundation)

4.2

Explaining Inequality after NEP

Gill and Kharas (2007): Growth occurs as a result of the exploitation of scale economies through specialization and innovation and is reflected in international integration via the trade in goods, money, and ideas. This integration triggers spatial and social changes that have an impact on domestic integration and the process on urbanization and income distribution. But economies of scale may not be geographically or sectorally evenly distributed. The authors have proposed five major drivers of inequalities trade and globalization labour market reform the formation of clusters and agglomeration effects the process of fiscal decentralization impediments to the process of internal migration.

Explaining Inequality

4.2.1

Lag in the growth of the agriculture sector

Due to uneconomic farm size that hinders technology transfer as well as labour shortage, ageing farm labour, declining competitiveness of the smallholder unit of production, lack of opportunity for off-farm income. Recent rejuvenation in agricultural output and favourable commodity prices had helped faster rise in rural income than urban income, resulting in a narrowing of income disparity between urban and rural areas.

Explaining Inequality

4.2.2 Trade and globalization As M'sia tries to move-up the K- & technology-intensive ladder, demand for skilled and highly educated workers increased. As supply lagged, then these skilled workers were able to command an increasing premium. Divergence of the wages is also enhanced by the massive entry of unskilled foreign labour into the M'sian economy that dampened the wages of the unskilled labour. Liberalization and creation of BCIC through the acceleration of privatisation both contributed to the subsequent widening of income inequality.

Explaining Inequality

4.2.3 Impacts of the process of internal migration Percentage of urban-rural migration in the top occupational categories > percentage of rural-urban migration, but opposite is true for the lowest occupational category. The former stretched the income range at the top in the rural areas while the latter at the lower-end in the urban areas, thus widening inequality. Moreover, migrants to urban areas are not the poorest, but are more likely to be relatively young, have certain abilities and educational attainment as well as some resources to support them while they look for work. This process would then leave on average the aged, those with less ability and without resources in the rural areas, further enhancing inequality.

Explaining Inequality

4.2.4 State-Government-Party Collusion State-government-party collusion (corruption, cronyism and nepotism)ownership and control of the economy by political parties, & parties linked to noted business tycoons or cronies, many of whom are engaged in rent-seeking enterprisesthe common thread is that the leaders of ruling parties have been able to use their political clout and influence to earn enormous rents for themselves or their political cronies and families. This phenomenon transcends ethnicity and enabled a selected section of the Malaysian society to accumulate income and wealth very rapidly, thus accentuating inequality.

5. Shift in Approach to Narrow Inequality

Should focus more on reducing inequality within both urban & rural areas as well as within each state, although economic development in the laggard states have to be geared up in order to reduce the regional gaps. Shift the focus of reducing inter-ethnic inequality to intraethnic inequality, and to re-conceptualise the strategies of attaining ethnic income parity such that they do not worsen within group inequality among the the various ethnic groups. Move from race-based policies to national policies, which are inclusive of all ethnic groups. The urban poor and lowincome groups should be seen as socio-economic groups rather than groups aggregated based on ethnic origins.

New Approaches

Education is the sharpest tool for poverty eradication and moderating income inequality. Thus, need more access to quality education for the poor. Assistance should favour the disadvantaged. Better-off parents take the responsibility of educating their children, if not fully, at least part of the costs. A mechanism must be developed to ensure that beneficiaries, esp. those getting the privatization projects or benefiting from any other direct redistributive policies, to give back to society. Projects need to be allocated based not on political connections, the influential and powerful, but according to genuine ability criteria. Eg. through the community or bottom-up approach. Transparency and proper governance should always be part of the guidelines in the allocation.

New Approaches

The issue of foreign labor must be resolved. Although the Government is encouraging greater automation and mechanization of labour-intensive industries in order to reduce the dependence on foreign workers, these measures must seriously be implemented. The demand for minimum wage or higher wages to be paid to the local workers needs serious consideration. Since most of the taxes have become less progressive, a study should be carried out to explore the viability of introducing 'leveling taxes', such as hereditary or wealth taxes.

6. Concluding Remarks
The decomposition of income inequality indicates that the "within group" far > "between group" inequalities, questions regarding certain present income distribution policies, as "within group" reduction would be more effective than pursuing the "between group" option. Some decomposition results reflect that past government policies have been successful and need no longer be emphasized as others should be given priority. Many policies are still appropriate in handling the inequality issues, but their approaches to solving them must change, esp. this should be done according to the needs-base rather than ethnic-base approach.