BANGKOK -- As emerging countries develop, they tend to shift their engine of growth from manufacturing to the service sector out of a belief that higher costs associated with growth erode manufacturers' export-competitiveness. But enhancing added value in services is no easy task, and putting manufacturing on the back burner can lead to stagnation.
For Malaysia, such a gloomy scenario might become a reality.
"I didn't know there used to be a factory here," a truck driver delivering rice to a nearby supermarket says, looking at a building construction site across the street. Chic houses line this neighborhood of Petaling Jaya, a city next to Kuala Lumpur in the state of Selangor.
A Panasonic group air conditioner factory stood at the site just several years ago. The property developer that acquired the site is now building a complex to house a shopping mall with office space on top. Similar projects are underway in many parts of the area.
Petaling Jaya was an industrial hub. But once an emerging country's per capita gross domestic product exceeds $5,000 or so, simple assembly is not enough to sustain growth. Malaysia's per capita GDP crossed the threshold back in 2005. Because manufacturers moved production to countries with late development and lower costs, growth in early-developing emerging countries slowed, plunging their economies into the doldrums.
As prime minister from 2003 to 2009, Abdullah Ahmad Badawi aimed to avoid this trap by shifting his country's focus from manufacturing to Islamic finance and other services. Growth was maintained, and ex-factory workers got jobs at malls and offices. Manufacturing's contribution to the economy fell from 31% in 2004 to 25% in 2013, according to the Japan External Trade Organization.
Malaysia maintained growth of at least 5% per annum almost every year, and the shift in its industrial structure apparently succeeded -- until the ongoing currency crash revealed worse-than-expected weakness. The ringgit lost 10-20% in the first half of 2015 year on year, but exports fell 3.1%. As domestic demand softens, the brakes have been put on foreign demand, making slower growth unavoidable.
A softer currency normally helps lift exports. But with Malaysia's manufacturing weakening, its cheaper currency is not leading to more exports. Having manufacturers that can ship goods abroad provides tolerance to a financial crisis. During the 1997 Asian currency crisis, the ringgit and Thailand's baht tumbled, triggering economic chaos. But the weaker currencies strengthened manufacturing's competitiveness, and exports helped bring about rapid economic recoveries, guiding the countries out of the crisis.
The situation was different in Argentina and elsewhere in South America, where a quick economic turnaround did not happen even after the currency dropped. Economic data explains this: Manufacturing accounted for 38% of Thailand's GDP in 2013 but just 13% in Argentina's. Malaysia's ability to weather a crisis is sure to erode if manufacturing's contribution there continues to shrink.
South Korea and Taiwan alone have escaped the pitfall of middle-income nations and boosted their economies to a level close to those of industrialized countries. Both have rising manufacturing ratios: South Korea's climbed from 24% in 2004 to 29% in 2013, while Taiwan's increased from 25% to 31%. That they did not focus too hard on the service sector, and enhanced production technologies, helped sustain their growth.
To increase a country's GDP, such services as real estate, finance and tourism might seem attractive as alternatives to manufacturing. But taking that route does not guarantee long-term growth, given that the service sector will face intense competition with developed economies. Going beyond simple assembly work is a key issue for not only Malaysia, but also other middle-income nations.