Affirmative action: Bad for growth?

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My post today is about a country that doesn’t usually get much attention in debates about global economic issues – Malaysia. But don’t be too quick to click to the next webpage. What’s going on these days in that small, tropical nation is raising interesting questions about the relationship between social justice and economic development.

Malaysia’s prime minister, Najib Razak, is in the process of overhauling what is likely the world’s most extensive and intensive affirmative action program, called the New Economic Policy, or NEP. First instituted in the early 1970s, the NEP was designed to expand the role of the impoverished Malay community in the national economy. The Malays represent the majority of the population, but back when the NEP was launched, Chinese immigrants and foreign firms owned the vast majority of the country’s assets. To fix that, the Malay-dominated government adopted all kinds of rules and regulations that gave special perquisites to Malays. Malay-owned companies received preferential treatment when bidding for state contracts, for example, while the government mandated Malay investors receive 30% of initial public offerings on the local stock market. It was an amazing experiment in social reconstruction.

The nature of NEP policies has been altered over the years, with some of the stricter requirements being softened or even eliminated. But now Najib and his government have come to believe that Malaysia’s affirmative action policies need further reform to ensure the future competitiveness of the Malaysian economy. He outlined his views a few days ago in a speech (you can read the whole text here), in which he said:

For the long-term strength of our nation, we cannot afford to duck these issues any longer. If we are to truly tackle inequality and become a beacon of progress in our region, we must bring a sense of urgency to reform.

Before I go any further, I’d like to make something clear. I fear that at this point in the post some readers are already warming up their fingers to type me some nasty comments. However, I want to state categorically that I am not – repeat, not – against affirmative action. In the theoretical world of classical economics, there is no need for affirmative action policies, since everyone gets equal opportunity in a market system that rewards and punishes entirely based on the wisdom of ideas and hard work. In the real world, however, economic decisions are sadly influenced by all kinds of prejudices and social networks, and sometimes laws are necessary to ensure fairness.

Clearly, the Malaysians (or at least the Malay segment of Malaysian society) believe that the NEP was necessary to achieve social justice and communal peace. The NEP was developed after race riots in 1969. That horrific event led the leadership to conclude they’d be unable to defuse tensions in Malaysia’s multiracial society without rectifying the economic balance between the diverse communities and lifting the Malays out of poverty. As Najib said of the NEP in his speech:

Its affirmative action policy has served the nation well, balancing the economic growth strategies of our nation with the need to address structural inequalities and promote social harmony…As a nation we should be proud of this achievement. It is one that many other multi-racial nations would like to emulate.

Yet at the same time, Najib acknowledged that there has been a cost to these policies as well. As he said:

We can no longer tolerate practices that support the behavior of rent-seeking and patronage, which have long tarnished the altruistic aims of the New Economic Policy. Inclusiveness, where all Malaysians contribute and benefit from economic growth – must be a fundamental element of any new economic approach.

The reason such inclusiveness is necessary, Najib said, is to make the Malaysian economy more competitive by capitalizing on the talents of all ethnic groups. He said:

We must recognize the imperative that we harness the potential of all Malaysians, and that all share in the proceeds of increased national prosperity…While perfect equality is in reality impossible to achieve in an open, global economy, an inclusive society will ensure that we can narrow inequalities in our nation, help those who need help most and engage all of Malaysia’s talents in our effort to build a competitive economic workforce.

What can this tell us about the impact of affirmative action policies on economies? I’ve been struggling with that question since reading Najib’s speech. It’s hard to take lessons from Malaysia that can apply elsewhere. The Malaysia case of affirmative action is an extreme one. Other countries that have instituted some affirmative action programs usually don’t do so on such a widespread, sweeping scale. Affirmative action in Malaysia has thus had an exaggerated impact on its economy.

Yet at the same time, it is interesting how even the supporters of these policies believe that in some ways there is a kind of trade-off between affirmative action and economic competitiveness, that they may have to choose between their affirmative action policies and what’s good for the overall economy. Najib’s current planned reforms aren’t the first time the Malaysian government has been confronted with this dilemma. In the mid-1980s, when Malaysia fell into a recession, the government identified the NEP regulations as a key impediment to investment growth. The then prime minister, Mahathir Mohamad, suspended parts of the NEP to allow certain foreign investors to have full ownership of their Malaysian operations in the hopes of attracting more capital and creating jobs. (It worked.) I think it is also interesting how the Malaysian government’s idea of social justice seems to have changed, from the redistribution of wealth to wealth generation for all. As Najib said:

Our first priority must be to eradicate poverty, irrespective of race. We cannot have the high income, sustainable and inclusive economy we seek when disparities in income are not addressed. So there will be a renewed affirmative action policy…with a focus on raising income levels of all disadvantaged groups.

Well said, Prime Minister.