Assessing the double-edged sword of using imitation as a stepping stone to innovation: A case of Malaysia's k-economy puzzle

Policy prescription for middle-income economies struggling to achieve innovation-driven growth has often been rapid promotion of skills-driven industrial transformation. However, Malaysia, an upper middle-income economy aspiring to achieve innovation-led growth, presents a near decade of K-Economy Growth Puzzle in the 2000s, when its aggressive skills-driven transformation initiatives had somehow resulted in decline to a lower output growth path despite successful expansion in skilled labor and innovation production. We present a continuous time growth model with industrial transformation based on an existing model advocating rapid skills transformation. By solving the model as a two-point boundary value problem, coupled with country-specific calibration strategies, vastly different results are obtained for this middle-income economy with fixed, imitation-heavy production structure. There may be a double-edged sword to using imitation as stepping stone to innovation, which then requires a much different industrial transformation approach. By examining transformation with different labor market configurations in a stylized manner using numerical experiments, we find that a delicate reordering of labor incentives would have been enough to help Malaysia navigating through the output growth-skills transformation trade-off.