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SPA 507 Issues in Malaysian Economy: FDI & Manufacturing Sector

Compiled by Dr. Radziah Adam, PPPJJ

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Current scenario

http://www.miti.gov.my/cms/documentstorage/com.tms.cms.document.Document_8fe91317-c0a8156f-4b8f2f00-b41b196b/MITI%20Weekly%20Bulletin%20Volume%20280%20-%204%20March%202014.pdf

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Global FDI inflows

Developing economies again attracted more FDI than developed countries in 2013. With historically high levels of FDI inflows recorded in Asia, Latin America and the Caribbean, the developing world attracted US$759 billion of global FDI inflows (52%) in 2013, slightly more (6%) than the US$715 billion achieved the year before but 32 per cent more than the FDI inflows into developed economies (US$576 billion).

http://www.mida.gov.my/env3/uploads/PerformanceReport/2013/IPR2013

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Global FDI inflows

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Current scenario

http://www.miti.gov.my/cms/documentstorage/com.tms.cms.document.Document_8fe91317-c0a8156f-4b8f2f00-b41b196b/MITI%20Weekly%20Bulletin%20Volume%20280%20-%204%20March%202014.pdf

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Current scenario

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Current scenario

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Current scenario

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Current scenario

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Learning Outcomes:

To review the pattern & strategy of Malaysia’s industrialization with emphasize on the role of the government in manufacturing sector & FDI:• What, Why, Where from, Where to &

Determinants - of FDI• Stages of Industrialization

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What? FDI

• a category of international investment that reflects the objective of a resident in one economy (the direct investor) obtaining a lasting interest in an enterprise resident in another economy (the direct investment enterprise); ≥10% of the ordinary shares @ voting power (IMF, 1993)

http://economics.dstcentre.com/The%20Changing%20Role%20Of%20FDI%20In%20The%20Malaysian%20Economy%20By%20Azmi%20Shahrin.pdf

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Why? Role of FDI in Malaysian Economy

1. to generate economic growth by increasing domestic capital formation

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Why? Role of FDI in Malaysian Economy

• “FDI has been an important source of economic growth for Malaysia, bringing in capital investment, technology & management knowledge needed for economic growth.” Using time series data (1970-2005), there is significant relationship between economic growth & FDI inflows in Malaysia (Mun, Lin, & Man, 2008).

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Why? Role of FDI in Malaysian Economy

(Karimi & Yusop, 2009):• “No strong evidence of a bi-

directional causality & long-run relationship between FDI & economic growth (1970-2005). This suggests that FDI has indirect effect on economic growth in Malaysia.”

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Crowding Out?

Do public investment and FDI crowd in or crowd out private domestic investment in Malaysia?• Using multivariate cointegration

techniques, both public investment & FDI are found to be complementary to, rather than competing with private domestic investment (PDI). (Ang, 2009)

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Why? Role of FDI in Malaysian Economy

2. to fuel export growth

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Why? Role of FDI in Malaysian Economy

(Goh, Wong, & Tham, 2013):

“findings reveal that inward FDI conforms to the observed pattern of a complementary relationship between FDI and trade”

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Why? Role of FDI in Malaysian Economy

3. to facilitate the transfer of new technology

“FDI provides the fastest and most effective way to deploy new technologies in developing host countries (UNCTAD 2000)”• indirectly through licensing, reverse

engineering, adaptation & eventually innovation by MNCs

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APAKAH TEKNOLOGI?

• Def: Pengetahuan teknik untuk mengeluarkan output dalam perusahaan.Mengandungi komponen: Fizikal (mesin) & Manusia (pengetahuan)

• PENGUKURAN TEKNOLOGIJumlah daya pengeluaran faktor (Total Factor Productivity, TFP) mengukur sumbangan teknologi

• Teknologi vs. Teknik?

• TEKNOLOGI TERKANDUNG (embedded) Teknologi yang terdapat dalam modal @ kelengkapan jenteraataupun buruh

• TEKNOLOGI TERPISAHTeknologi yang menjadi sisa dan menjelaskan pertumbuhan output bukan disebabkan oleh modal @ buruh.

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Q = T f( K, L ); fungsi pengeluaran Cobb Douglas

Qt = TtKtβLt

1-β, dgn Tt= T0eαt;

Qt = T0eαt KtβLt

1-β

Q = output/keluaran;K= modal; β = keanjalan output modal

L= buruh; 1-β = keanjalan output buruh

T= teknologi; menentukan anjakan fungsi pengeluaran

SUMBANGAN TEKNOLOGI: PERTUMBUHAN EKONOMI

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Daya Pengeluaran Faktor Keseluruhan (TFP)

Αlpha (α) adalah terpisah & eksogen; bukan

berpunca drp input modal atau buruh. Sebaliknya, berpunca drp kecekapan-X, kaedah yang lebih baik, organisasi yang lebih baik.

Jumlah daya pengeluaran faktor (TFP) = α, nisbah keluaran benar & faktor benar= pertumbuhan output yg tidak boleh dijelaskan oleh pertambahan jumlah input

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FDI Spillovers

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Why? Role of FDI in Malaysian Economy

http://competitiveness.in/wp-content/uploads/2012/02/FDI-MNEs_Mind_Map.jpg

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Why? Role of FDI in Malaysian Economy

4. lead to higher employment through the expansion of the economy & job creation

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Why? Role of FDI in Malaysian Economy

5. as the agent of transformation in the Malaysian economy

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Why? Role of FDI in Malaysian Economy

(Karim & Ahmad, 2009): Poverty Reduction

“The empirical (data for 1984-2005) results show that the FDI coefficient has a statistically significant negative sign, suggesting that the poverty incidence could be reduced by increasing FDI inflows into the (13+1) Malaysian states.”

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Why? Role of FDI in Malaysian Economy

FDI, Growth & the Environment: Impact on Quality of Life in Malaysia• benefits and costs of FDI?• “The results indicated that environmental

Kuznets curve exists and foreign direct investment increases environmental degradation.” (Hitam & Borhan, 2012)

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Where from? Sources of FDI

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Where from? Sources of FDI

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Where to? Sub-sectors

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Where to? Sub-sectors

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Where to? ASEAN competition

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Where to? ASEAN competition

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Where to? ASEAN competition

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Where to? NEXT SECTOR

“Studies have also shown that the services sector of developed countries contributed as much as 70% of GDP. The Malaysian Services sector currently accounts for about half of GDP. Thus there is clearly a potential for foreign investment into the Malaysian services sector.”

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Socialism & Market Failures

Role of Govt.

Capitalism & Government Failures

Increasing role of Govt.

Different views on the role of government in industrialization:“The market oriented economy & the government's strategic industrial policy that maintain a business environment with opportunities for growth & profits have made Malaysia a highly competitive manufacturing & export base.” (Mun, Lin, & Man, 2008)

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Timeline:

http://www.dipity.com/Radziah/Malaysia-Industrial-Policies/

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Industrialization in Malaysia

Stages Strategies 1867-1957; colonial rule export of agricultural products and minerals,

mainly rubber & tin, under free market

a. 1957 (independence) - late 1960s

import substitution industrialization (ISI)

b. Early 1970s (10 years) new focus on export oriented industrialization (EOI); BUT limited linkages between foreign & domestic firms

c. 1981 - 1986 second round of ISI

d. 1987 – 1997 (pre-crisis) return to EOI 

e. from 2006 onwards move towards global competitiveness

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Industrialization in Malaysia

Source: Rokiah Alavi, 1996, Industrialisation in Malaysia: Import Substitution and Infant Industry Performance, Routledge.

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Industrialization:

Stage a. ISI• to encourage foreign investors to set up

production, assembly & packaging plants in the country to supply finished goods previously imported from abroad

• the government directly & indirectly subsidized the establishment of new factories & protected the domestic market (Jomo, 1993)

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Industrialization:

Stage I - ISI• government focused on the development of

infrastructure & the rural sector, while industrialization was left to the private sector

• enacted the Pioneer Industries (Relief from Income Tax) Ordinance (PIO) of 1958, & also created the Malaysian Industrial Development Finance Corporation, which was responsible for providing investment capital & for the development of industrial estates

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Industrialization:

Stage I - ISI• ISI helped to diversify the economy, to

reduce excessive dependency on imported consumer goods & to utilize some domestic natural resources.

• Created opportunities for employment & contributed to economic growth (Alavi, 1996).

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a. ISI (1957-1968)

• Substitute imported consumer goods with local production (to reduce import leakage & generate employment)

• Use of fiscal incentives (subsidies & taxes) as industrial promotion tools; provision of extensive infrastructure (industrial estates, power & communication facilities)

Tariff protection not used extensively(1958-mid 1960s) due to:• Govt feared deterring imports, which was a major source

of revenue• Rubber and tin producers were worried that increase

import duties would increase costs and pressure wage increases

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a. ISI (1957-1968)

• Contribution of manufacturing to GDP increased from 8% (1957) to 9% (1960-1965) but rose to 12% (1969)

• Growth rate of manufacturing 10.2% in 1960s

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SETBACKS OF ISI

• Dependence on import of capital & intermediate goods aggravated BOP

• Linkages with rest of the economy was weak & limited• Did not create enough employment opportunities &

unable to reduce unemployment rate substantially. Employment grew slowly because screw driver industries only introduced final touches to consumer goods production to enjoy the incentives.

• Small domestic market. No pressure to seek foreign markets & unable to compete in overseas markets. In 1970, manufacturing only accounted for 12% of overall exports.

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Industrialization:

Stage b. EOI• outward looking export orientation to revive manufacturing growth & employment absorption

• 1971: FTZs were established. Duty free import parts & components and export products without customs formalities

• Rising competition & production costs in DCs were driving foreign assembly & processing operations away to LDCs Cheap & docile labour important – labour regulations tightened to favour transnational operation (TU not allowed in electronics industry until 1989 & thereafter only in-house unions were permitted)

• 75% of FTZ are foreign-owned & industries involved are mostly EO industries, e.g. E&E products, textiles, food manufacturing

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Industrialization:

Stage b. EOI• 1975: Industrial Coordination Act to provide

coordination & orderly development of manufacturing activities. To encourage joint venture projects to increase Malaysian participation

• Although protectionist policies were blamed for inefficiency& lack of competitiveness of IS industries, they were further strengthened during EO phase to enable industries to develop and meet foreign competition

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SETBACKS OF EOI

• Firms in the FTZ could import parts & components duty free - encouraged firms to use imported parts

• By the end of 1970s govt recognised that the export of manufactured good was limited to a narrow range of products and there was minimum integration between IS and EO sectors.

• Absence of linkage between domestic economy and FTZ• Policy discourages FTZ firms from making downstream

investment since these investments would not enjoy the same incentives as those in FTZ

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Industrialization:

Stage c. ISI2• Heavy industries established (inspired by success of

Japan, South Korea) • To broaden the industrial sector; promote greater

linkages with domestic economy; to provided basis for acquisition and development of indigenous technology.

• Active government participation in country’s industrial development (PROTON and Perwaja Steel)

• Promoted industries (Proton, Perwaja Steel, Kedah Cement) by use of tariff and quotas, duty exemptions, other investment incentives, e.g. pioneer status

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SETBACKS of ISI2

• Poor performance in 1980s due to economic slowdown & finally recession in 1985. Falling commodity price, appreciation of yen & rise in yen-denominated debt service, slowdown in electronics export, rise in imports (infrastructural & heavy industry items) aggravated current account balance

• Recession in 1985/86 & Heavy Industries Corporation of Malaysia (HICOM) encountered problems (excess capacity, market glut, heavy debts).

• The promoted heavy industries during IS2 phase- high-capital intensity, long gestation period, substantial economies of scale.

• Costs of production & management were high relative to international competitors. The markets were small

• Lack of linkages with other sectors

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Industrialization:

Stage d. EOI2• Initial failure of IS2 and recession of 1980s forced govt to

renew emphasis on foreign capital and EO from 1986 to generate investment and employment.

• Policies concentrated on providing incentives and infrastructure development.

• Processing of approvals simplified• Tax and tariff holidays• Exporters allowed greater access to subsidized interest

(4%) credit prior to or upon shipment of products

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Determinants of FDI inflow

(Ang, 2008)• the results suggest that increases in

the level of financial development, infrastructure development, & trade openness promote FDI

• higher statutory corporate tax rate & appreciation of the real exchange rate appear to discourage FDI inflows.

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Determinants of FDI inflow

(Fakhreddin, Nezakati, & Vaighan, 2011):• “positive & significant effect of (a)

domestic credit to private sector provided by banking system & (b) development expenditure of government on FDI.”

• “negative & significant effect of (c) corruption on FDI's growth”

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Determinants of FDI inflow

(Choong & Lam, 2010): “Using Granger causality test, we find that there exist unidirectional causality from real GDP of both Malaysia & China (larger potential demand for their products), degree of openness (more liberalized economic reforms) & literacy rate (human capital development) to FDI inflow.”

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Determinants of FDI inflow (by industry)

to ASEAN (Indonesia, Malaysia, Philippines, Thailand, and Vietnam):

“results show that GDP of the host & home countries, GDP per capita of the host & home countries, industry imports from home country, industry exports to home country, industry tariff rates, & industry output levels all have a positive effect on FDI. Distance, wage & education have a negative effect on FDI.” (Changwatchai, 2010)

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57http://www.miti.gov.my/cms/documentstorage/com.tms.cms.document.Document_77a6edc8-c0a8156f-4b8f2f00-d53a67ce/Malaysia%20Investment%20Performance%20Report%202013.pdf

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Food for thought?

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Learning Outcomes:

To review the pattern & strategy of Malaysia’s industrialization with emphasize on the role of the government in manufacturing sector & FDI• What, Why, Where from, Where to &

Determinants - of FDI• Stages of Industrialization

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References:

Abdul-Rahim, A.S., The Changing Role Of FDI In The Malaysian Economy - An Assessment, Retrieved from http://economics.dstcentre.com/The%20Contributions%20Of%20Foreign%20Direct%20Investments%20In%20The%20Development%20Of%20Malaysia%20by%20Azmi%20Shahrin.pdf

Fakhreddin, F., Nezakati, H., & Vaighan, B. M. (2011). The determinants of FDI inflow in manufacturing sector of Malaysia. Journal for International Business and Entrepreneurship Development, 5(4), 299–314. doi:http://dx.doi.org/10.1504/JIBED.2011.042386

Goh, S. K., Wong, K. N., & Tham, S. Y. (2013). Trade linkages of inward and outward FDI: Evidence from Malaysia. Economic Modelling, 35, 224–230.

Hitam, M. Bin, & Borhan, H. B. (2012). FDI, Growth and the Environment: Impact on Quality of Life in Malaysia. Procedia - Social and Behavioral Sciences. doi:10.1016/j.sbspro.2012.08.038

Karim, N., & Ahmad, S. (2009). Foreign Direct Investment: Key to Poverty Reduction in Malaysia. IUP Journal of Applied Economics, 8(5), 55–65. Retrieved from http://search.ebscohost.com/login.aspx?direct=true&profile=ehost&scope=site&authtype=crawler&jrnl=09726861&AN=44622926&h=B4jE4%2B0m3RQ2JZhdrw6q7cZbu8UkFCEIRGXseuRitrx2dWK0V9%2Blsu8JaFhcEZpxnoLufny19xTYuQy3tVbtSA%3D%3D&crl=c

Karimi, M. S., & Yusop, Z. (2009). FDI and Economic Growth in Malaysia. Munich Personal RePEc Archive, (14999). Retrieved from http://mpra.ub.uni-muenchen.de/14999/

Khalifah, N. A., & Adam, R. (2009). Productivity Spillovers from FDI in Malaysian Manufacturing: Evidence from Micro-panel Data. Asian Economic Journal, 23(2), 143–167. doi:10.1111/j.1467-8381.2009.02011.x

Kinuthia, B. K. (2011). Markets vs. government foreign direct investment and industrialization in Malaysia . Mercados O Gobierno: Inversión Extranjera Directa E Industrialización En Malasia, 20(2), 409–443. Retrieved from http://www.scopus.com/inward/record.url?eid=2-s2.0-83455200093&partnerID=40&md5=32519a60d72a484ab87d47f7cc6b2563

Mun, H.W., Lin, T.K. & Man, Y.K. (2008). FDI and Economic Growth Relationship: An Empirical Study on Malaysia. International Business Research, 1, 11–18.

Rajah Rasiah, FDI, Government Policy And Industrial Transformation In Malaysia , UNU-INTECH

H. Osman-Rani, H. & Mohd. Haplah Piei, Malaysia's Industrialisation and Trade: Issues, Options and Strategies, Journal Ekonomi Malaysia, 21 & 22 (1990) 13-44. Retrieved from http://www.ukm.my/fep/jem/pdf/1990-21-22/jeko_21-1.pdf

Rokiah Alavi, 1996, Industrialisation in Malaysia: Import Substitution and Infant Industry Performance, Routledge.