This article first appeared in Forum, The Edge Malaysia Weekly on August 8, 2022 - August 14, 2022

“Interest rate hikes will not save us from inflation, but increasing economic production will.” — Robert Hockett, Edward Cornell Professor of Law, Cornell University US

The World Bank’s Malaysia Economic Monitor June 2022 is a very encouraging document. The publication suggests that the Malaysian economy is on an upward track to recovery from the impact of the recent pandemic. And it projected our 2022 economic growth to expand 5.5%, higher than that of the average global economy, which they projected at 3.2%. Good news all, don’t you think?

However, the report also cautioned us against taking an over-exuberant stance as external headwinds such as the war in Ukraine, the increasingly bellicose exhortations from the West against Russia and China (and vice versa), and our own internal weaknesses can put the brakes on our economic recovery. We need a more focused approach in managing our internal economic expansion.

Take for example our small and medium industries: they represent 97.5% of overall business establishments in the country (2021 figures). Yet, they labour under very challenging circumstances. The Covid-induced lockdown has impacted many of them in terms of customer loyalty, supply chain disruptions and a list of other difficulties. Many have thrown in the towel and many more are on the brink of a high financial cliff looking down a deep chasm.

As small and medium enterprises (SMEs) account for all but 2.5% of firms and the bulk of production and employment, they are central to Malaysia’s economic growth. SMEs form the bedrock of the private sector and innovation, and can contribute to that growth by supporting supply chains to multinationals or accessing international markets directly.

Despite their importance, the share of Malaysian SMEs in GDP (32%) and total exports (16%) is far lower than their competitors in the Philippines, Thailand, Hong Kong and Taiwan.

Most of our SMEs are under-capitalised, with banks understandably cautious about lending, and government agencies generally slow in their approval processes for business relief. So, what is a struggling entrepreneur to do? They have been lobbying their parliamentarians and ministers to enact more concrete policies that would enable them to access funds to ease their plight, with limited success.

I believe the time is ripe for the government to support a mechanism that is arguably more efficient in directing additional capital into the hands of these SMEs. Let us point our proverbial capital flows (the financial water hoses) to the side of the economy that increases employment, manufactures products and offers services, and literally adds to our exports.

Rather than depriving them of much-needed capital by increasing interest rates, the government should be encouraging private equity and venture capital firms to invest directly into our SMEs. But why stop there — the authorities should also greatly incentivise government-linked organisations to make capital more accessible directly to these entrepreneurs, instead of funding the financial sector via the acquisitions of publicly listed shares and bonds and weathering market volatility. It is time to focus on the real economy — that is, the productive economy.

Interest rate hikes when implemented will put more money in banks’ deposits; they do not alleviate cost-push inflation caused by supply crises — they make it worse. You see, policymakers, the present problem is there are too few goods being produced vis-à-vis their demand. Solve that problem and you will definitely enhance our country’s economic growth.

The push to raise interest rates rests on a curious notion that defies logic: It essentially suggests that if you make enough people jobless and poor by shuttering SMEs (thereby taking away their jobs), they will not be able to buy goods or services, which will result in lower demand and, eventually, lower prices.

Bank Negara Malaysia’s dallying with rate hikes will only make our inflation issue worse. When Bank Negara applies its go-to tool of interest rate hikes to suppress demand, the real problems continue unabated — supply shortages caused by prolonged Movement Control Orders (MCOs), supply chain disruptions, sanctions, and now wars. Rather than making money harder to get to, the government needs to focus on the supply side of the equation, stimulating local production to bring supply levels up.

Make no mistake — productivity-enhancing measures play a pivotal role in solving Malaysia’s current malaise. The country has faced challenges before in pivoting away from a “low-cost, high-volume” strategy towards a “high-value” one. And we succeeded in the 2000s by evolving into a more innovative and creative economy. 

Allowing the SMEs easier access to capital will enhance competition among them, thus providing choices and higher-quality products and services to the consumer. Additionally, increased funding into this component of the economy will drive research and development (R&D) efforts and allow for upskilling of the workforce.

Competition promotes productivity growth through increased incentives for innovation and through selection. If firms have strong incentives to innovate, many productivity-boosting innovations will come to market. Also, when only the firms with the highest productivity survive while the least productive firms are forced to exit the market, the average productivity will go up. I, for one, believe that there is room to improve competition in the Malaysian economy.

Improving the allocation of funding to R&D is another area that will improve prospects for productivity growth over the long run. It is noteworthy that the allocation of our federal funding for basic science R&D is skewed towards the life sciences and I argue that this is not a useful strategy. We can’t tell now what field of science will be useful in the future. It is just like investing in the stock market. We do not know which stocks are ten-baggers. All we can do is have a portfolio that is more balanced in basic science spending.

Policies to increase the skills of the workforce are essential to raising productivity as well. The more skilled the workforce, the better the chances of success.

The task of creating more robust, growing economies, in which the rewards of growth are more evenly shared, is growing ever more urgent. Unless governments’ funding policies are improved, we will remain ill-equipped to deal with future economic downturns — and these, I posit, are looming ever closer.

And at the root of this task lies the challenge of enhancing productivity. “I would be really concerned if we were to treat this as a temporary problem; something to get past,” concluded an old friend when we discussed this issue earlier. “We do that at our peril. Malaysia has felt a very serious economic shock as a consequence of the recent financial crisis and the 1MDB (1Malaysia Development Bhd) fiasco, and part of the roots of what ails the nation (and its productivity) can be found in how the economy has changed after that. We’ve seen sectors and industries virtually disappear.”

To really serve our population and give us resilience, the government must help our people and businesses adapt to this new challenge — supporting directly the sectors and industries that will foster renewed — and more productive — growth.

Zakie Shariff is executive chairman of Kiarafics Sdn Bhd, a strategy consulting group. He is also adjunct professor at the Faculty of Industrial Management, Universiti Malaysia Pahang.

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