5 Myths about Malaysia's Subnational Development

By Deisigan Shammugam and Apurva Sanghi Malaysia is on the cusp of reaching high-income status. But currently, only 5 of 16 Malaysian states and federal territories have attained the World Bank’s high-income threshold. Spatial disparities run deep: average incomes in Kuala Lumpur exceed those in Portugal, a high-income country. By contrast, average incomes in Kelantan are comparable to those in Sri Lanka — and almost eight times lower than those in Kuala Lumpur. Even if Kelantan grows at an above-average rate of 5 percent annually, it will still take nearly three decades for it to reach the current high-income threshold. Such disparities are evident when it also comes to what matters most to Malaysians: high quality and dignified jobs. Kelantan and Terengganu bear high levels of underemployment: over 4-in-10 people work below their skill levels. But that ratio falls by almost half for Kuala Lumpur and Penang. The fact that disparities are large may not be news to most Malaysians, and indeed, they are also a feature in most developing countries. But how do these disparities in Malaysia stack up against those in other countries, especially other federations? What are the causes and potential solutions? These are the questions that spawned an intensive two-year effort, which culminated in the World Bank report “Understanding and Unlocking State-Level Growth Potential in Malaysia”. In this article, we shed light on “5 myths” about Malaysia’s spatial disparities: Myth 1: Malaysia's regional inequality is “normal” for a developing country Truth. It is not; in fact, comparable economies such as Brazil, China, and the European Union all saw their subnational/states income distributions narrow over roughly the same period that Malaysia's diverged. One reason is that Malaysian states have limited capacity to generate their own revenues, which in turn leads to them carrying far narrower functional responsibilities and smaller fiscal envelopes compared to subnationals in other countries. Another is that states rely on a sizeable share of federal transfers (about one-third): in states like Terengganu and Kelantan, such transfers account for more than half of total state revenue. Moreover, these transfers are discretionary in nature. All these reasons can make it difficult for states to plan their budgets. Compared to others, Malaysia’s story is not that of normal growing pains. Malaysian states have relatively low shares of total revenues compared to other federations Share of state revenue of total federal government revenue, Percentage Source: World Bank “Understanding and Unlocking State-Level Growth Potential in Malaysia” report The capacity of each state government to generate its own revenue and its reliance on federal transfers varies significantly Average share of state revenue from 2018 to 2022, Percentage Source: World Bank “Understanding and Unlocking State-Level Growth Potential in Malaysia” report Note: Own-source revenue includes tax revenue, non-tax revenue, other non-revenue receipts What it means. If this were a race, the richer states in Malaysia are running faster than poorer ones, causing the economic gap between them to widen – and not shrink -- as in other countries. One reason is the discretionary and unpredictable nature of federal transfers which leave states with limited ability to shape their own economic trajectories. Greater transparency in how allocations are made, for example, through a more empowered National Finance Council, could help. Myth 2: Poorer states are falling behind because they lack potential Truth. Poorer states actually have higher potential growth rates than richer ones – but their actual growth rates consistently fall short. We estimate, for the first time, “potential growth” of Malaysian states. Potential growth is simply the growth a state should be able to achieve over time, given its people, investment, and how efficiently the economy works. Most Malaysian states fall short of their potential Average potential and actual GDP growth from 2011-21, Percent Source: World Bank “Understanding and Unlocking State-Level Growth Potential in Malaysia” report What goes wrong is that poorer states consistently have been unable to grow as fast as their own potential suggests. As a result, the gap between actual and potential growth becomes larger for poorer states than for richer ones. Put simply, the poorer a state is, the more it falls short of its own potential. Kelantan, Sabah, and Perlis are not missing potential. They are missing the conditions to realize it. Lower-income states face greater challenges in realizing their full potential Gap between actual and potential growth, Percentage points Source: World Bank “Understanding and Unlocking State-Level Growth Potential in Malaysia” report What it means. This finding reframes the policy question. The problem is not necessarily that poorer states lack endowments, but that regulatory, structural, and institutional changes are needed to convert high potential growth into high actual growth. Myth 3: Malaysia's cities are too big and growing too fast Truth. The data suggests the opposite problem. We find that Malaysia's urban system is top-heavy, with Kuala Lumpur dominant at one end while mid-sized cities fail to grow proportionally. Malaysia's major cities are not dense enough. Rather than growing upward they are sprawling outward. Our analysis of granular satellite imagery data shows that economic activity is expanding fastest -- not in established urban cores -- but in the peripheral areas around them. This pattern of sprawl raises infrastructure costs, reduces efficiency, and does not produce the kind of agglomeration that drives productivity gains in the way that genuinely dense cities do. Large cities are growing larger than mid-sized ones Log rank Source: World Bank “Understanding and Unlocking State-Level Growth Potential in Malaysia” report What it means. Malaysia needs to invest in the density and depth of its cities. Mid-sized cities in poorer states, such as Alor Setar, Kota Bharu, and Kuantan, represent particularly underutilized opportunities for inclusive urban growth. Myth 4: Lowering barriers to mobility can help equalize incomes across states Truth. In theory, workers moving from low- to high- income states should help equalize incomes. But in Malaysia, such internal migration runs at just 0.5 percent, lower than Thailand’s and far below the United States – and it is declining. Moreover, our findings suggest that those who do move are not primarily motivated by income. Only 1 out of 4 people cite job or career opportunities as a reason for moving. Cultural ties, family networks, and non-economic factors dominate migration decisions. And even when Malaysians do move, 3 out of 5 people stay within their own state. Most of the migration in Malaysia is intrastate migration as opposed to interstate migration Overall migration rate across years in Malaysia, Percentage Source: World Bank “Understanding and Unlocking State-Level Growth Potential in Malaysia” report What it means. Betting on the “pull” force of migration to address regional inequality is not necessarily a winning strategy in Malaysia. Explicit policy levers including investment in poorer regions, removal of capital mobility barriers (for example, the Kelantan Land Enactment 1938 restricts transfers of land from Kelantan natives to non-natives without prior state approval), and targeted fiscal transfers are equally important. Myth 5: If a state is poor, then its districts must be poor as well Truth. Poor states can have high-performing districts and vice versa. Indeed, our report's district-level analysis, another methodological first for Malaysia, finds enormous variation within states. High-potential districts exist within poorer states. Low-potential districts exist within ostensibly leading ones. We develop, for the first time, an “Economic Potential Index” at state- and district- levels. This index measures the building blocks a district possesses for achieving high productivity, covering factors like infrastructure, human capital, and market access. And the results are striking: Take Sarawak, which scores lower on the Index at the state level, yet Kuching within it contains significant economic activity and latent capacity. Across all states, a sizeable 28 percent of district GDP sits in high-potential but low-performance districts – these are places with the right ingredients that are not yet delivering results. Another 23 percent sits in low-potential but high-performance districts. These are the ones punching well above their weight. A policy designed at the state level would miss much of this texture. Richer states can mask low-potential districts, while poorer states may also be home to high-potential ones EPI of Malaysian Districts Source: World Bank staff calculations based on DOSM data Many districts across states – rich and poor -- are well-placed to benefit from targeted policy interventions EPI and performance quadrants weighted by district GDP Source: World Bank “Understanding and Unlocking State-Level Growth Potential in Malaysia” report Note: Performance is calculated based on predicted GDP (proxied by night lights and other variables) vs actual GDP by districts What it means. The district – and not the state – is where spatial development policy needs to operate. ______________ Malaysia's development story is often told as a single national narrative, and it is a good one. But headlines can overly flatter a country's development story. For Malaysia, headlines mask the stark reality that millions of Malaysians will not live as high-income citizens long after the high-income flag is planted. Zooming in, a more complicated picture emerges. States that look poor on the surface contain districts of real promise – and vice versa. States that are perpetually viewed as “laggards” actually have higher potential – and in which policy can make a difference – much like Perak’s successful pivot from tin and commodities into manufacturing and services. Malaysia's next development challenge will be won city by city, district by district, and state by state. PS: If you want to know how your state does compared to others, click here for the scorecards. Read the full report here.