Malaysia and the Middle-Income Trap: Lessons from the Limits of Government-Linked Company Reform

Abstract

Malaysia is often described as a market-oriented economy, yet its development trajectory has been shaped by a large government-linked company (GLC) sector that functioned as an instrument of redistribution, industrial participation, and state–business coordination. This paper revisits Malaysia’s GLC reform experience to address a central middle-income trap question: why can sustained catch-up growth stall before a transition to productivity- and innovation-led upgrading is secured? This paper’s central claim is that the binding constraint was not government ownership per se, but the inability to enforce credible commercial discipline—hard budget constraints and performance-based restructuring—under strong distributive and political imperatives. This paper argues that the limits of early GLC reform—most notably the difficulty of imposing credible commercial discipline under strong distributive and political imperatives—help explain persistent upgrading constraints consistent with a middle-income equilibrium. Rather than focusing on recent reform initiatives, the analysis concentrates on the formative reform cycle from the late 1970s through the 1990s, centred on the shift from New Economic Policy (NEP)-era state expansion to early privatisation under Mahathir. Drawing on secondary evidence, the paper traces (i) how NEP objectives of Bumiputra participation were pursued through public enterprise expansion, regulatory and licensing requirements, and state financial institutions; (ii) how these instruments generated fiscal pressures and softened budget constraints that weakened efficiency incentives; and (iii) how privatisation, while formally framed as an efficiency-enhancing correction, frequently proceeded through partial divestiture, licensing, and politically mediated ownership transfers that preserved state leverage and rent channels. The Malaysian case suggests that the binding constraint on reform was not the absence of policy change but limited institutional capacity to enforce hard budget constraints and performance-based restructuring. It concludes that credible discipline—rather than ownership form alone—was the missing link between reform and upgrading, with implications for middle-income trap debates on governance, misallocation, and the productivity transition.