4: Malaysia's economy growth

• Manufacturing sector as a leading sector

Manufacturing Development in the 1960s & 1970s

• During the 1960s, industrial development reflected the country’s comparative advantage. Malaysia has comparative advantages of a well educated workforce and low labor cost. There was a shift in emphasis from import-substitution to the promotion of exports.

• Labor intensive industries flourished. Examples, textile & electronic, rubber & palm oil processing, and wood based industries.

• During the 1970s, the manufacturing sector became the leading sector in the expansion of the Malaysian economy and the main pillar for achieving the objectives of the NEP in terms of growth of output, restructuring, exports, income generation, and employment expansion.

• Manufacturing sector grew by 11.6% during 1971-72.

• Oil crisis hit in 1973-74.

• World recession during 1974-75.

• During 1976-80, the sector grew faster (14.3%) due to pioneer status; investment tax credit (under Investment incentives Act 1968). 1253 manufacturing products amounting to a total investment proposal of RM3.2 billion were carried out. Products involved are food manufacturing, industrial chemical, electronic and electrical, fabricated metal products, paper, printing and publishing, and wood based products.

• The bulk of the growth lied in the high growth in export sector. (Average of 18.8 %).


Manufacturing Development in the 1980s

• The success of the sector was due to first, the development of world trade. Second, the domestic market. Third, the Industrial Master Plan (IMP 1986-90).

• Key recommendation of IMP.
- fiscal incentive to promote investment
- to induce reinvestments, linkages, exports and training
- to foster industrial development
- to provide a more conducive environment for investment.
- Changes to legislation to promote further growth.
- Policies were made more attractive and procedures were simplified.
- Examples, the introduction of Promotion of Investments Act (PIA) 1986; the amendments made to the Income tax Act 1967 which provided liberal investment incentives to potential investors.
- More examples, the exemption order under the industrial Coordination Act (ICA) 1975 was liberalized to exempt manufacturing companies with share holders’ funds of less than RM2.5 million or 75 workers from being licensed.
- Also, liberalization of equity guidelines for foreign investment with a view to further enhances the pivoted role in the expansion of the investment activities.

• The sector managed to increase its growth from 4.6% in 1981 to 11.6% in 1984. The growth was due to resource-based industries (wood based and non-metallic minerals).

• For the period 1986-90, the main contributors to growth were the two non-resource based export industries- electrical & electronic and textiles.
• The rapid growth of the export contributed significantly to employment. Employment expanded rapidly by 8.6% during 1980s. In the later part of 1980s, the sector experiencing a tight labor market.


Manufacturing Development in the 1990s

• Measures to promote further were as follows.
o The review of investment incentives with objectives of encouraging investments more selectively, emphasizing towards achieving higher levels of local content, value added, technology development and intra-industries linkages.

o The restructuring and rationalization of the industrial base through the Industrial Adjustment Fund (IAF) 1991, aimed at increasing efficiency and competitiveness.

o The need to vigorously pursue FDI.

• The Domestic Investment Initiative (DII) was launched to encourage a higher level of domestic investments. Strategies included
- organizing campaign and investments promoting awareness
- encouraging increased domestic content
- strengthening and deepening the local capital market
- developing anchor companies and SMI to promote greater inter-industry linkages

• The hunt for FDI continues even in the years of economic crisis. As such FDI between 1997 and 1998 increased dramatically. Investment increased from RM11.5 billion in 1997 to RM13.1 billion in 1998.


• Understanding the Foreign Direct Investment

FDI Inflows and Malaysian Investments Abroad


The flow of FDI in Malaysia can be said to have evolved through four major phases.
• FDI in early development phase
• FDI in the import-substitution phase
• FDI in the export-led phase
• FDI inn the MSC development

FDI in the early development phase

• Took place before the First and second Malaysia Plan indicated that the Malaysian economy was heavily dependent on agricultural resources.
• 70% of FDI was in agriculture.
• Invested by British colonial masters mainly because to provide raw materials to feed the industries in Britain and Europe in general.
• FDI was greatly determined by the demands of agricultural sector.
• Rubber and tin contributed 86.3 % of GDP, 85.1% in 1955 and 79.9% in 1960.

FDI in the import-substitution phase

• Between 1965 and 1980, total FDI is estimated to have increased by 145% from RM300m to RM1.4b in 1980.
• Bulk of FDI was in manufacturing sector.
• Covered the periods of First, second and Third Malaysia Plan.
• Significance and dependence on agriculture was slowly being reduced.
• Contribution of agriculture declined to 31% of GDP in 1970, 28% in 1975 and 28% in 1980.
• Manufacturing sector was increasingly gaining prominence. 13% in 1970, 16% in 1975, and 20% in 1980.
• Investors were provided with various forms of incentives mainly to meet local market production.
• Joint ventures were highly encouraged.

FDI in the export-oriented phase

• Given the limited local market size, government embark on a market-oriented strategy or better known as export-led strategy.
• Between 1980 and 1995, Malaysia received FDI by TNCs totaling RM120b.
• By 1995, Malaysia was already the largest recipient of FDI in ASEAN.
• The massive influx of FDI meant job opportunities, shortage of manpower and less dependence on primary sector.
• Primary sector grew 0.8% in 1986 and 1.0% in 1988. Manufacturing grew 1.5% in 1986, and 4.0% in 1988.
• Since early 1990s, FDI flow has been directed to the high-tech industries in support of the establishment of MSC and the realization of Vision 2020.

FDI in the MSC Development Phase

• The successful attraction of FDI inflow between 1996 and 2020 is crucial to achieve industrialized status.
• To use information as a foundation in all aspects of its national development.
• The country’s comparative advantage lies in the development of MSC-seen as a ladder to leap from towards attaining a fully developed industrialized status.
• MSC covers an area 15 km by 50 km in size next to Putrajaya.
• The main purpose is to make the corridor as the center of electronic economic development.

FDI trend

- Two opposing view on the impact of FDI.

• First, FDI is beneficial to output, the standard of living, employment creation, technology transfer, external markets, balance of payments, various linkages, and above all, experience for local investors.
• Second, FDI tends to be more capital intensive and brings with it problems of high capital outflows in the form of future payments of dividends and other remittances abroad.

- FDI causes “crowding-out” or possible displacement of local entrepreneurship. Export-led entrepreneurship is limited particularly in perceiving opportunities in industrial ventures, in innovating, in scouting for technology and developing markets for long-term profits.

- Those who have concentrated on being labor-intensive have decided to upgrade to being capital-intensive.
- Foreign firms have found it viable to move downstream and upstream into the production of end products, thus forging linkages with the electronic components industry and providing substantial opportunities for small and medium scale industries.


Sources

During 1991 to 1997, most FDI came from five countries: Japan, US, Taiwan, Singapore, and Korea. They accounted for 67.4% of the total proposed FDI.

Distribution

- Japan, concentrated in electrical and electronics sector, chemical and chemical products and non-metallic mineral products.

- United States, concentrated in petroleum refining, electronic and electrical industry.

- Taiwan, concentrated in electronic, textiles, wood-based products and petroleum refining.

- Singapore, concentrated on electric and electronics sector, basic metal products and petroleum refining.

- Korean, concentrated on non-metal products, electric and electronic industry.


Contribution

• The manufacturing is the second largest contributor of employment after services, followed by agriculture, forestry, livestock and fishing, government services, construction, transport, storage and mining and quarrying.

• Based on MIDA approved investments, the number of potential jobs generated by FDI rose from 40351 in 1980 to 171646 in 1990. But, as FDI shifts in favor of capital investments to overcome labor shortages, the n umber of potential jobs dropped to 56835 in 1997.


The effect of an open economic policy

• Invest in Malaysia because of the country’s political stability and strong economic fundamentals

• Malaysian government had an open economy with tax incentives for foreign investment to attract more FDI.


Why open policy?

• The open policy is defined as promoting transparency in their operations in terms of export and import trading.

• Malaysia is not strong enough to be independent and stand solely on its own feet. Therefore, the open policy is an ideal means to boost sales with the involvement of foreign direct investment
• Malaysia would have been unable to achieve the current standard of living without the participation of FDI in recent years. In fact, the absence of active FDI would have a negative impact towards its economic growth.

Why Firms Invest Oversea?

I Perfect Market View

• The objective of the firm is to maximize profit. Accordingly, it is the search for locations with relatively higher profits that causes oversea investments.

• FDI flows out of countries with low returns to those expected to yield higher returns.

• Major criticism: First, firms are regarded as primitive with no distinction between complex conglomerates on one hand, and a sole trader on the other. Second, the approach neglected the fundamental importance of technology by TNC as major determinant of FDI


II. Market Imperfect View

• FDI is determined by monopolistic advantages possessed by firms.

• The host country possesses specific resources, cultural and institutional characteristics that are favorable to the firm so much so that they are willing to accept cost and risks associated with an oversea venture,


III. Product Life Cycle Theory

• A product goes through the cycle of birth, maturation, and standardization.

• In the first stage, when the product is new, it is produced by innovating firm in its home market, This is due to the fact that the absolute advantage in financial, organizational and intellectual resources to undertake the requisite research and development can only be met at home

• In the second stage, the product is mature. Some standardization is introduced in design and production. New competitions are introduced in the market either by producing exactly the same product or imitation. But in as much as the marginal production costs plus the transport costs of the goods exported by the “original investor” are lower than the average costs of prospective production in marketing, the investors would export and avoid FDI.

• In the final stage, the product goes through standardization. The priority then is the lowest cost supply point. The firm starts to invest abroad in cheaper locations and near foreign markets so as to exploit its technological quasi-rent to the utmost. The production then shift in location. It is an alternative to the export of a new product.

Comparative advantage Theory

The theory evolves around four major orientations:

• Japanese FDI-Natural resources orientation, labor orientation, and trade barrier induce market orientation.
- These are trade oriented.
- FDI are mostly aimed at exploiting natural resources and most output are shipped back to Japan.
- Profitable to established oversea operation because of domestic constraints on factors of production.


• American FDI- Oligopolistic market orientation.
- It is anti trade oriented.
- It is to serve the recipient country.
- It produces highly sophisticated, technology-based products for local markets.
- Anti trade for 3 reasons.
- First, the product life cycle type of FDI cuts-off the investing country’s own comparative advantage. As such FDI takes place to defend markets and maintain an oligopolistic position.
- Second, High-cost industries require protection from foreign competition.
- Third, The new industries, which it established in the host country, are unsuited to their factor proportions and therefore unlikely to be come internationally competitive.



Malaysia’s Direct Investment Abroad

• Malaysia’s direct investment abroad is determined by two sets of phenomenon.
- First, the objective conditions of profitability for capital as determined largely by factor prices.
- Second, a set of objective determinants.

• Malaysia’s direct investment abroad is unevenly distributed.
- Singapore as the biggest recipient, amounting to about 20% of the total for the period 1990-1997.
- Hong Kong is second and is aimed at taking advantage of the China market.
- Malaysia invests in U.K because of the European Single Market, research, and development and technology transfer. Example Proton taking over the prestigious British car producer, Lotus.


• And Multi-National Corporations

A multinational corporation (MNC) or transnational corporation (TNC), also called multinational enterprise (MNE), is a corporation or enterprise that manages production or delivers services in more than one country. It can also be referred to as an international corporation.

Multinational corporation (MNC) – a large company with plants or other direct investment in one or more foreign countries. It is also called an international corporation or a transnational corporation.

Typically, the multinationals have operated in developing countries, where they provide technology, finance capital, and marketing skills in return for a profitable market. But even advanced industrial nations may be the scenes of investment by multinational companies.

The power that multinationals can exert over foreign governments has been the target of criticism, but many host countries have imposed regulations that have given them a larger share of profits, jobs, and markets.

The first modern MNC is generally thought to be the British East India Company, established in 1600. Very large multinationals have budgets that exceed some national GDPs. Multinational corporations can have a powerful influence in local economies as well as the world economy and play an important role in international relations and globalization.

Market imperfections
A multinational enterprise is facing the paradox that although it doesn't have the contacts and knowledge of local customs and business practices as indigenous competitors and located in one country, it does business in another country. If there are unique assets of value overseas, why not sell or rent these assets to local entrepreneurs, who could then combine them with local factors of production at lower costs than those experienced by foreign direct investors?

The answer to this paradox is that there might be circumstances under which using market exchange to coordinate the behavior of agents located in two separate countries is less efficient than organizing their interdependence within a multinational firm. When this is the case, a firm located in one country may find it profitable to incur the additional costs of operating in a foreign environment.

The idea that MNEs owe their existence to market imperfections was first put forward by Hymer, Kindleberger and Caves.[2] The market imperfections they had in mind were, however, structural imperfections in markets for final products. Hymer, for example, considered two firms, each a final product monopolist in its own market, isolated from competition by high transportation costs and tariff and non-tariff barriers.

A decline in these costs exposed them to each other's competition and reduced their profits. A combination of the two firms, through merger or acquisition, into an MNE would then maximize their joint income by forcing them to take into account the gains and the losses competition inflicts on them.

The transformation of two domestic firms into one MNE thus internalized pecuniary externalities and produced a gain for the owners of these tow firms, but not necessarily for society, since it redistributed income towards the MNE and away from its customers.

A similar case arose when the technology had often few substitutes and the number of potential licensees in any given foreign market was also often limited, thus creating a biletaral monopoly. The consolidation of licensor and licensee within an MNE (by acqusition or merger of the potential licensee or by vertical integration of the innovator into overseas manufacturing) reduced haggling and made it easier to enforce price discrimination schemes across countries. This analysis of the reasons behind the emergence of multinational firms led Hymer to take a negative view of MNEs, which he considered an instrument for restraining competition between firms of different nations.

According to Hymer, market imperfections are structural, arising from structural deviations from perfect competition in the final product market due to exclusive and permanent control of proprietary technology, privileged access to inputs, scale economies, control of distribution systems, and product differentation], but in their absence markets are perfectly efficient.

By contrast, the insight of transaction costs theories of the MNEs, simultaneously and independently developed in the 1970s by McManus (1972), Buckley and Casson (1976), Brown (1976) and Hennart (1977, 1982), is that market imperfections are inherent attributes of markets, and MNEs are institutions to bypass these imperfections.

Markets experience natural imperfections, i.e. imperfections that are due to the fact that the implicit neoclassical assumptions of perfect knowledge and perfect enforcement are not realized.

International power

Tax competition

Multinational corporations have played an important role in globalization. Countries and sometimes subnational regions must compete against one another for the establishment of MNC facilities, and the subsequent tax revenue, employment, and economic activity.

To compete, countries and regional political districts sometimes offer incentives to MNCs such as tax breaks, pledges of governmental assistance or improved infrastructure, or lax environmental and labor standards enforcement.

This process of becoming more attractive to foreign investment can be characterized as a race to the bottom, a push towards greater autonomy for corporate bodies, or both.

However, some scholars, for instance the Columbia economist Jagdish Bhagwati, have argued that multinationals are engaged in a 'race to the top.' While multinationals certainly regard a low tax burden or low labor costs as an element of comparative advantage, there is no evidence to suggest that MNCs deliberately avail themselves of lax environmental regulation or poor labour standards. As Bhagwati has pointed out, MNC profits are tied to operational efficiency, which includes a high degree of standardisation.

Thus, MNCs are likely to tailor production processes in all of their operations in conformity to those jurisdictions where they operate (which will almost always include one or more of the US, Japan or EU) which has the most rigorous standards. As for labor costs, while MNCs clearly pay workers in, e.g. Vietnam, much less than they would in the US (though it is worth noting that higher American productivity—linked to technology—means that any comparison is tricky, since in America the same company would probably hire far fewer people and automate whatever process they performed in Vietnam with manual labour), it is also the case that they tend to pay a premium of between 10% and 100% on local labor rates.

Finally, depending on the nature of the MNC, investment in any country reflects a desire for a long-term return. Costs associated with establishing plant, training workers, etc., can be very high; once established in a jurisdiction, therefore, many MNCs are quite vulnerable to predatory practices such as, e.g., expropriation, sudden contract renegotiation, the arbitrary withdrawal or compulsory purchase of unnecessary 'licenses,' etc. Thus, both the negotiating power of MNCs and the supposed 'race to the bottom' may be overstated, while the substantial benefits which MNCs bring (tax revenues aside) are often understated.

Market withdrawal

Because of their size, multinationals can have a significant impact on government policy, primarily through the threat of market withdrawal.[8] For example, in an effort to reduce health care costs, some countries have tried to force pharmaceutical companies to license their patented drugs to local competitors for a very low fee, thereby artificially lowering the price. When faced with that threat, multinational pharmaceutical firms have simply withdrawn from the market, which often leads to limited availability of advanced drugs. In these cases, governments have been forced to back down from their efforts. Similar corporate and government confrontations have occurred when governments tried to force MNCs to make their intellectual property public in an effort to gain technology for local entrepreneurs.

When companies are faced with the option of losing a core competitive technological advantage or withdrawing from a national market, they may choose the latter. This withdrawal often causes governments to change policy. Countries that have been the most successful in this type of confrontation with multinational corporations are large countries such as United States and Brazil], which have viable indigenous market competitors.

Lobbying

Multinational corporate lobbying is directed at a range of business concerns, from tariff structures to environmental regulations. There is no unified multinational perspective on any of these issues. Companies that have invested heavily in pollution control mechanisms may lobby for very tough environmental standards in an effort to force non-compliant competitors into a weaker position.

Corporations lobby tariffs to restrict competition of foreign industries For every tariff category that one multinational wants to have reduced, there is another multinational that wants the tariff raised. Even within the U.S. auto industry, the fraction of a company's imported components will vary, so some firms favor tighter import restrictions, while others favor looser ones. Says Ely Oliveira, Manager Director of the MCT/IR: This is very serious and is very hard and takes a lot of work for the owner.

Multinational corporations such as Wal-mart and McDonalds benefit from government zoning laws, to prevent competitors from competing.

Many industries such as General Electric and Boeing lobby the government to receive subsidies to preserve their monopoly.

Patents

Many multinational corporations hold patents to prevent competitors from arising. For example, Adidas holds patents on shoe designs, Siemens A.G. holds many patents on equipment and infrastructure and Microsoft benefits from software patents.[12] The pharmaceutical companies lobby international agreements to enforce patent laws.

Government power

In addition to efforts by multinational corporations to affect governments, there is much government action intended to affect corporate behavior. The threat of nationalization (forcing a company to sell its local assets to the government or to other local nationals) or changes in local business laws and regulations can limit a multinational's power.

Micro-multinationals

Enabled by Internet based communication tools, a new breed of multinational companies is growing in numbers."How startups go global".

These multinationals start operating in different countries from the very early stages. These companies are being called micro-multinationals. What differentiates micro-multinationals from the large MNCs is the fact that they are small businesses.

Some of these micro-multinationals, particularly software development companies, have been hiring employees in multiple countries from the beginning of the Internet era. But more and more micro-multinationals are actively starting to market their products and services in various countries.

Internet tools like Google, Yahoo, MSN, Ebay and Amazon make it easier for the micro-multinationals to reach potential customers in other countries.

Service sector micro-multinationals, like Indigo Design & Engineering Associates Pvt. Ltd., Facebook, Alibaba etc. started as dispersed virtual businesses with employees, clients and resources located in various countries. Their rapid growth is a direct result of being able to use the internet, cheaper telephony and lower traveling costs to create unique business opportunities