Roubini On Malaysia

Malaysia's policy makers have been forced to confront the factors blocking the country’s rise to high-income status. Facing higher labor costs, the economy has been unable to maintain a growth model based on low-value-added manufacturing that was largely successful for the 30 years prior to the 1997 Asian financial crisis.



One of the most noticeable manifestations of this so-called middle-income trap has been the secular decline of Malaysia’s once-dominant electronics and electrical products (E&E) sector, examined in “Still Not a Tiger: The Decline of Malaysia’s Electronics Sector,” available exclusively to clients. At the sector’s height in 2000, E&E accounted for more than one-third of the country’s total value added in manufacturing, over 70% of revenue from manufacturing exports and almost 4% of world E&E exports.

Since then, Malaysia’s E&E sector has witnessed dramatic deceleration in productivity, stagnation in exports and deterioration in its global market share. The sector remains dominated by downstream industries that increasingly face competition from lower-cost producers in the region, including the Philippines and China. Confronting similar challenges, the Asian Tigers (South Korea, Singapore, Taiwan, HK) were largely successful in transitioning to higher-value-added E&E production.

Beginning in the 1960s, Malaysia and Singapore (and, to a lesser extent, Taiwan and South Korea) industrialized by encouraging multinational corporations to take advantage of their relatively cheap labor forces and establish downstream E&E production facilities. In Singapore in particular, the presence of multinationals spurred local entrepreneurs to begin “clustering” around downstream enterprises, acting as suppliers and logistics managers.

Over time, this led to the development of a robust, indigenous E&E sector that increasingly produced further upstream, which typically included the stages in the supply chain in which labor adds more value—i.e., the stages with higher levels of labor productivity. By the time labor cost increases forced downstream production facilities to lower-cost markets, local firms were experienced and competitive enough to continue operating in the E&E supply chain at higher levels of value added. In this way, Singapore has managed to increase its global market share of E&E since 2000.

In contrast, Malaysia’s E&E sector has been unable to adjust to shifts in the country’s comparative advantage. One important barrier has been ethnicity-based affirmative action policies, which have stifled the evolutionary process that other export-driven economies in the region were able to ride to higher-value-added production on their way to high-income status. Established under the New Economic Policy of 1971, affirmative action in Malaysia seeks to rectify socioeconomic disparities within the local population by expanding opportunities for ethnic Malays (bumiputra or bumiputera) in areas like education, housing and investment, often at the expense of other ethnic groups (namely ethnic Chinese).

These policies have not only exacerbated the country’s brain drain of talented non-bumiputra; they also have created a strategic disadvantage for local firms by limiting both human and Financial capital and perpetuating an unlevel playing field for entrepreneurs. All domestic companies incorporated in Malaysia must reserve at least 30% of new shares for bumiputra to purchase at discounted prices. This essentially taxes local start-ups that wish to go public and makes expansion more difficult, which helps explain why initial public offering growth was relatively flat through the 2000s and why equity remains a minor source of manufacturing investment financing. Meanwhile, the continued presence of the government in the economy—via procurement policies and access to joint ventures with the nearly 500 government-linked corporations—has provided ample opportunity for rent-seeking by well-connected bumiputra who can take advantage of favorable policies.

The New Economic Model—presented in 2010 as a 10-year vision for Malaysia’s ascension to high-income status—proposes “revamping” affirmative action “to remove the rent seeking and market distorting features” and shifting the basis for eligibility to socioeconomic status, rather than ethnicity.

Yet given the governing party’s reliance on bumiputra support, major changes are unlikely until new elections are held and the government has the political confidence to confront popular resistance to reform. The underperformance of the E&E sector over the past 10 years should serve as a warning to the country’s policy makers that the continuation of distortionary policies may limit Malaysia's future growth prospects.