MALAYSIAN ECONOMIC POLICY AND FDI
Background And Country Attractiveness.
Malaysia is the second fastest growing economy in the South East Asian region with an average Gross National Product (GNP) growth of eight-plus percent per year in the last seven years. Since independence in 1957, Malaysia has moved from an agriculturally based economy to a more diversified and export oriented one. The Malaysian market is fairly openly oriented, with tariffs only averaging approximately fifteen percent and almost non-existent non-tariff barriers and foreign exchange controls. The open trade based economy is supported by the fact that the total two way trade almost amounts to 120 percent of the GNP (1994). Together with a stable political environment, increasing per capita income, and the potential for regional integration throughout the Association of South East Asian Nations (ASEAN), Malaysia is an attractive prospect for FDI.
Until 1993, foreign investment contributed 60% of all investment in Malaysia. FDI grew strongly in the late 1980s to reach a peak of RM17.7 billion in 1992. This was followed by a sharp drop to RM6 billion in 1993 due to the world rececession, but rose again to RM15.2 billion in 1994. Malaysia is among the top five recipients of foreign direct investment in the world and while in recent years it has come mainly from other Asian countries, 1993 saw the US as the biggest inward investor with RM1.7 billion. Japan and Taiwan are clearly the largest overall investors with the US third, followed by France, Singapore and the UK (McLeman 1994,i9).
The rationale of this report is not to promote Malaysia as an attractive destination for multinational entities, but rather to analyze how Malaysia’s economic policy impacts upon FDI. Malaysia, perhaps, represents one of the most successful developing nations that has been able to effectively incorporate economic policy objectives with foreign funds, knowledge and networking throughout FDI. FDI in Malaysia is an important catalytic factor, increasing exports, knowledge and provides an economic vehicle towards the Malaysian 2020 vision.
The Malaysia Plan and the New Economic Policy Framework
The Malaysian government uses economic planning to achieve economic and socio-economic goals in close coherence with the New Economic Policy (NEP) and the National Development Policy (NDP). The Fifth Malaysia plan and the Long-term Industrial Master Plan Malaysia, in particular, indicate specific future objectives and economic trends.
The Malaysian economic policy framework is based upon the NEP, which was launched in 1974? The political and economic objectives of the NEP are to reduce poverty by increasing income levels for all Malaysians and to restructure the Malaysian society in order to erase all racial identification in economic terms. In other words, the NEP calls for a financial redistribution from the minority of wealthy non-Bumiputra (native Malaysians also known as “Princes of the Soil”) racial groups to the Bumiputras (Goldsworthy 1991: 51). The goal is to achieve corporate equity of 30 percent Bumiputra, 30 percent foreign and 40 percent other-Malaysians (Onn 1988: 8). This goal can only be facilitated with an expanding economy, so that no racial group should suffer from economic or social deprivation. Other specific economic goals include; maintain high sustainable growth, low unemployment rates and ensure the stability of economic factors such as inflation. Under the NEP, FDI incentives were designed to achieve social rather than economic objectives (Goldsworthy 1991:53). According to the Malaysian Industrial Development Agency (MIDA), “Malaysia received political stability from the NEP. Racial turmoil attracts neither foreign nor local investments.”(Appelbaum et Al: 1993,180) The National Development Policy (NDP) replaced the NEP when it expired in 1990. This new policy can be considered an add-on document to the NEP, the objectives of which were not achieved in 1990. Furthermore, it provides a framework towards Dr. Mahathir’s new vision 2020 plan symbolizing “the way forward” policy towards a “developed” nation in 2020. This will require the nation to maintain a 7-plus percent growth rates for the next 25 years. Prime Minister Mahathir believes raising workforce quality and developing expertise in sophisticated industries are decisive elements in the country’s road to economic success and development (Brown 1993:43). In order to facilitate these growth requirements, the NDP has relaxed many of the FDI restrictions imposed by the NEP such as equity and licensing requirements and procedures.
The Fifth and the Sixth Malaysia plans (1986-1997) place great emphasis upon the privatization process of certain government owned industries and utilities. For instance, the major motor-highways now belong to “Plus”, a privately owned entity which is responsible for the construction of such transportation infrastructure. According to Dr. Mahathir, “The Malaysia Incorporated concept requires the private and public sectors see themselves as sharing the same fate and destiny as partners, shareholders and workers within the same ‘Corporation’, which in this case is the nation…”(Huq 1994: 189). The overall objective of this policy is rationalization of the government sector and to foster more initiatives from the private sector. The private sector is the driving force to economic prosperity and the government will provide the needed support. In close cooperation with the NDP, the Sixth Malaysia plan is the driving motivation for development.
The purpose of the Industrial Master Plan which was formulated by the United Nations Industrial Development Organization (UNIDO) is to focus private and government agencies on core competencies and develop industries with great export potentials in the next 15 years.
In the South East Asian region, most of the incoming FDI has been exported oriented rather than intended for domestic sales (World bank 1993:318). Presently, Malaysia has one of the world’s highest exports to GDP ratios (Petri 1994: 11). The economic rationale of Malaysia to promote exports provides the nation with three important advantages. First, it generates foreign-exchange that can reduce the amount of foreign debt needed to fund development. Second, it contributes to developing a competitive industry infrastructure from learning from investors- a move that brings technological excellence leading to higher value-added exports. By the promotion of specific industries, such as the semi-conductor industry, has speeded technology acquisition and enhanced the nation’s competitive worldwide positioning. Finally, FDI provides employment in the industry sector, which to a large extent is attracted from the agricultural sector.
Critics argue that Malaysia has become largely dependent on foreign technology and failed to develop its own technology base (Goldsworthy 1991: 58). For instance, it is true that Malaysia is the world’s largest manufacturer of Air conditioners, but it is also true that Japanese companies account for 90 percent of all exports. In this relationship, Malaysia is “sitting between Japanese capital and these sorts of exports”(Goldsworthy 1991: 58) If Malaysia cannot develop its own competitive industry with a solid technological base, it may be difficult for the nation to achieve its 2020 vision.
In the case of Malaysia, the critical success factor of FDI lay in the economic policy. FDI incentives such as taxable income deductions linked to domestic performance and local content, other tax allowances, location incentives, couble deduction for promotion of exports and political and economic stability have all contributed to the massive influx of FDI and increase of exports (Carrol, Errion 1991 21). In addition, nine Free Trade Zones (FTZ) provides tax-free areas with liberal custom controls for manufacturers that assemble at least 80 percent of their products.
Economic development in Malaysia was first built on the basis of Import Substitution, indicated by the large shift of GNP distribution from agricultural sectors to manufacturing sectors. Import substitution has increased in mainly three areas, transport equipment, Industrial chemicals and fertilizers and in Industrial machinery (Onn 1988: 28). However, exports constitutes the main source of growth in the manufacturing sector from 1970-1990. This trend can be explained by economic policy that places great emphasis on improving industrial competitiveness as a vehicle towards vision 2020.
According to Richards, “Malaysia has benefited considerably from its liberal trade policy” (1993: 29). Such policy has increased worldwide competitiveness through strategic exposure and promoted economic growth. Presently, Malaysia has one of the most liberal trade policies in the East Asian region.
The nation’s policy of liberalizing trade is not only incorporated with the WTO and AFTA objectives, but also micro-economic objectives. Reducing tariff levels will not only decrease inflationary pressures in the expanding economy but also increase the competitiveness of Malaysian industry throughout strategic exposure. Liberalization can also enhance export incentives from FDFs as seen in the nine FTZs.
In line with microeconomic change, trade restrictions have been aligned with development strategies which are often based upon the notation of comparative advantage. Selective protection promotes the development of industrial subsectors that have the potential to produce high value added products, which are intended “to replace light manufacturing activities as the main exporters” (Brown 1993:45).
As a link to the policy of maintaining a stable economy with past budget strategies of controlling inflation, there have been major reductions and abolition of import duties on goods and services. The 1995 budget proposes a reduction of tariffs imposed on over 2,600 items of which a majority is food items (Budget 1995: 22). Also, tariffs on building materials and household appliances have been reduced. These measures will not only control inflation, but also enhance the quality of life and favor the overall climate for investments. However Ad Valorem taxes are imposed on imported goods and services.
Strategic exposure represents a crucial component in Strategic Trade Theory. The rationale behind lowering barriers to trade and exposing local industry to foreign competition is to create a more competitive domestic industry (Hamilton 1989: 4). Such a Level Playing Field policy will force local firms to increase their competitiveness to survive.
Strategic exposure represents a direct link to becoming an industrialized nation by 2020 and the realization of economic goals. Incorporating FDI as a strategic measure to enhance technological know-how can reduce domestic learning and experience curves in selected industries. By giving foreign investors considerable tax deductible incentives in areas such as training of local employees, research and development and in promotion of exports Malaysia has been able to increase Worldwide competitiveness as demonstrated by increasing exports and GDP (Carrol, Errion 1991: 21). Malaysia aims for the year 2000 to have at least 1.6% of GDP spent on R&D and is predicting that at least 40% will come from the private sector.
Furthermore, all firms operating in Malaysia are expected to employ and train Malaysian and Bumiputra personnel so that the over-all employment represents the ethnic break-down of the nation (30:40:30). In recent years, this has put much pressure on companies in increasing the portion of Bumiputras in managerial and in professional positions (Hiebert 1995: 42). Foreign investors are allowed to have expatriate personnel, but are encouraged to attract local personnel for these positions. Improvement in the quality of education and training form a crucial part of the nation’s industrial development strategy (Brown 1993:47).
The Exchange rate policy is an important component in the Malaysian FDI promoting framework and in general economic policy. In recent years, Malaysia has substantially opened-up its foreign exchange regime and can now be considered fairly liberal. Bank Negara does not officially peg the Ringit to certain currencies and the currency floats. However, the bank does intervene in the foreign exchange market in order to avoid rapid fluctuations in coherence with its policy to maintain a stable value of the Ringit. This is achieved by comparing the market value to a unknown trade-weighted basket of currencies (Bureau Of Economic Analysis 1993: 2). Bank Negara has been accused of depreciating the value of the Ringit in order to promote exports. For instance, in 1993, the bank bought large amounts of US dollars causing the Ringit to depreciate (Cooke 1994:3). As a result, In 1993 alone, the national bank declared a loss of over 2.3 billion US dollars in foreign exchange (Economist: 1994 98). Naturally, the stability of the Ringit facilitated throughout government intervention has improved the overall climate for FDI and in particular, export oriented such.
Liberalization of Foreign Exchange Regulation
As noted by the World Bank, export oriented FDI provides the foreign exchange required to develop a nation without incurring huge debts. Malaysian economic policy has promoted a favorable climate for FDI, resulting in rapid industrial development and influx in foreign exchange that can promote new development projects.
Bank Negara is presently deregulating the financial industry, a move which may erase the distinction between local and foreign institutions (Astbury, 1995: 13).
Currently, specific permission from the Controller of Foreign Exchange is required for the operation and maintenance of a foreign currency account. A relaxation in that policy is proposed that will make it possible for exporters to maintain foreign currency accounts of a portion of their proceeds from exports. Furthermore, non-resident controlled companies will enjoy relaxation in the gearing ratio/capital structure of foreign entities by increasing the domestic debt to eligible capital funds ratio from 2:1 to 3:1 (Budget 1995: 25).
Government Policy on Investment
Despite of the fact that the NEP goal of 30 percent foreign ownership was not reached in 1990, The Malaysian government encourages FDI in most industrial areas. This is particularly true when opportunities for Bumiputras are enhanced. Moreover, export enhancing FDI has been denoted as the “engine to growth” in the private sector (Jayasankaran 1995:44).
Major Investment Incentives
Malaysian FDI incentives are in close coherence with the economic policy framework and can be considered competitive in comparison to other nations. The liberalization processes in foreign exchange controls and in trade together with stable political and economic conditions, serve as major incentives to FDL. In addition, there are major tax incentives through the Pioneer Status and Investment Tax Allowance.
The Pioneer Status gives a foreign investor 100 percent tax relief on Malaysian income tax over the first 5 years and the possibility to get it extended an additional 5 years if certain industry specific conditions are met (US Department of Commerce 1993:12). In order to get Pioneer Status, such an investor must show the potential for increasing Malaysian Exports employing new technologically advanced processes in production. Thus, in the agricultural sector, Pioneer Status can only be granted to the processing portion of investment.
Investment Tax Allowance is similar to the Pioneer Status, but the tax-free rate on income is negotiated on a case by case basis as a percentage of capital expenditure over the first 5 years (US Department of Commerce 1993: 12).
Furthermore, tariff protection can be enforced for competing overseas products and exemptions from custom duties on machinery, equipment and raw materials are available to most industry and agricultural sectors. The nine FTZs together with double taxation deductions on insurance premiums for exports also provide an incentive for exported oriented FDI. Also, the Malaysian government has progressively reduced the corporate income tax rate in order to improve the investment climate (Budget 1995:19). In addition, FDI Incentives benefiting the development of human knowledge and education in Malaysia include 100 percent tax allowances on technical or vocational training for up to ten years (Budget 1995:16).
Regulations of FDI tend to be concentrated in the financial service rather than in the manufacturing sectors. However, equity formulation, licensing and local capital accumulation are regulated.
In particular, FDI in the financial service sector has been discouraged up to now. Foreign ownership is limited to 30 percent of any financial institution, and foreign banks are not allowed full access to electronic fund transfer channels. Also, all FDIs have been asked to restructure their equity formulation in compliance with the NEP objectives of increasing the capital share of Bumiputras.
Licensing regulations are being liberalized, but investments are still regulated to a high degree. Any manufacturing company, local and foreign, needs a license specifying the nature of the business, production quantities, and performance expectations.
Certain equity restrictions are also imposed upon FDI. Foreign investors have the opportunity to hold 100 percent of equity. However, when the investor does not, the Malaysian equity will be distributed accordingly to the NEP distribution policy. The first 30 percent of equity not held by the foreign investor will be reserved for Bumiputras, and the rest to other Malaysians (US Department of Commerce 1993: 14).
The Overall Economic Climate of FDI
The sixth Malaysian Plan, notes that incentives will be “rationalized further to ensure that they are consistent with the overriding policy of encouraging private sector growth and foreign investment”(Brown 1993: 44). Furthermore, Brown notes that “private-sector led growth has pushed Malaysia to higher level of economic success and will be entrusted with a much bigger role in generating growth” (1990: 45-46).
The Sixth Malaysia Plan places great emphasis upon providing stable macroeconomic conditions that are necessary for providing growth of private investment and the encouragement of FDI. The Plan states that “fiscal and monetary policies will be directed toward maintaining stable prices, favorable exchange rates and a healthy balance of payments position” (Brown 1993: 49). Brown also argues that “macroeconomic policy has followed a constant path in recent years” (1993:49). Empirical evidence proves that economic growth in the past six years has been stable at above 7 percent per year, the inflation rate has been kept below the targeted 4 percent level, balance of payments have been stable, the unemployment rate has decreased and interest rates have been adjusted in order to safeguard against “overheating” the economy.
The Malaysian Budget outlines four major strategic goals; (l) Sustaining strong growth, (2) Reducing inflation, (3) Developing skilled manpower, and (4) Building a progressive and balanced society (1995: 1). These objectives certainly correspond to the historic strategies of the NEP, the current sixth Malaysia plan and Vision 2020.
Low Inflation Policy
The estimated inflation rate for 1994 was 3.8 percent and Bank Negara estimates that this rate will be further reduced in 1995 (Budget 1995:17). The commitment to ensure the stability of the economy is shown in a fairly conservative monetary policy, which has in recent years increased the required reserve requirements for banks to control monetary supply. Inflationary pressures will be more severe due to increased domestic demand and shortage of labor which may trigger a wage explosion.
Even though the Malaysian economy is extremely open-oriented, there is a large degree of state intervention in the economy. Critics argue that significant bank Negara expenditures in rural development schemes, heavy industries,
Bumiputra loans, and in maintaining national agencies have not produced the desired outcomes. The NEP goal of achieving social equality has not been realized. “The Malays still control the state apparatus and the Chinese still, even after 20 years of the NEP, dominate the domestic commercial and manufacturing sector” (Appelbaum et Al 1993,184). In comparison to its Asian neighbors, Bank Negara’s expenditures, which amount to more than half of GDP, are extremely high. Appelbaum further argues that if the cost of state intervention is higher than the relative gain from export enhancing FDI and if there are no potential synergy effects from such intervention (such as social policy framework of promoting the Bumiputra), there might be a negative effect on economic growth (1993, 183).
Malaysia is now reconsidering its inward investment policies, and will put greater emphasis on improving the infrastructure, rather than promoting these regions through financial incentives. Especially the power supply problem should receive more attention. Traffic jams and congested ports are another source of concern (McLeman 1994, 16).
Malaysia’s focus on FDI, enhancing exports, has served it well and contributed to its eight years of over eight percent growth (Jayasankaran 1995: 44). The primary success factor is that promotion of FDI is supported throughout the Malaysian economic policy framework. Careful economic five year planning in close cooperation with the NEP framework ensures coherence in policy making leading to economic stability. Petri argue that a stable macroeconomic environment conductive to investment and enterprise is a critical dimension of the successful implementation of FDI (1992: ix). In addition, Malaysia has identified a reachable vision, identical to that Michael Porter stresses is a crucial component to the success of an organization. Dr. Mahathir himself talks about “Malaysia Inc” (Woronoff 1992: 353). The Malaysian vision 2020 provides such a vision, which not only provides coherent direction in all policy areas, but also provides people with the desire of continuous improvement. This factor is crucial in the evolution of the private sector, which is indeed critical for achieving sustainable growth and future economic prosperity.
The FDI boom in Malaysia has been supported by Malaysia’s high standard of industrial infrastructure, political stability, and human capital resources. Also, Malaysia’s has build and maintained a comparative advantage in its traditional raw-material and commodity exports, further boosting export enhancement strategies. Export enhancement has provided the nation with valuable foreign exchange capital used for further developing higher value added products throughout forward integrating manufacturing processes. Export oriented FDI has indeed open-up new opportunities for Malaysia and facilitates economic growth. Low interest loans, increasing access to foreign exchange, and other incentives have contributed the massive influx in the number of FDI’s in Malaysia.