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This article first appeared in The Edge Malaysia Weekly on May 15, 2017 - May 21, 2017

MALAYSIAN cigarette manufacturing has gone up in smoke.

Last week, JT International Bhd (JTI Malaysia) announced that it would shutter its cigarette production plant in Shah Alam and with it, about 270 jobs (held mostly by locals).

JTI Malaysia’s departure isn’t entirely surprising. It was the last holdout among the Big Three tobacco boys. The exodus began as far back as 2012 when Phillip Morris International (M) Sdn Bhd announced it would close its cigarette manufacturing plant in Seremban, Negeri Sembilan, axing 220 jobs.

With the illicit cigarette trade continuing to flourish and ravage market share, British American Tobacco (M) Bhd last year announced that it would shut its landmark plant in Petaling Jaya, Selangor. The closure, done in stages, is expected to be completed by the second half of this year, and cut 230 jobs in total.

JTI is now headed down the same path.

The loss of 270 jobs is a drop in the ocean compared with the size of the Malaysian labour market. However, it comes at a time when unemployment numbers are hovering near all-time highs.

As at February, the total number of unemployed in the labour force was 514,800. To be fair, this translates into an unemployment rate of 3.5% against a labour force of 14.4 million.

While it is relatively high compared with recent historical averages, an unemployment rate of 3.5% is still within the range economists consider “full employment”  — a healthy level of structural unemployment that reflects mobility in the workforce as employees change jobs.

A closer look at the data, however, reveals some troubling trends.

 

Low value-add but highly automated

The departure of cigarette companies is probably not reflective of deeper structural problems facing manufacturers.

Instead, it was mainly due to the illicit cigarette trade that has taken up an estimated market share of 57%. With legal cigarette volumes on the decline, domestic manufacturing began to lose economies of scale, pushing companies like BAT and JTI Malaysia to move operations abroad.

However, it is also important to ponder if such industries should and could be retained.

After all, policymakers are trying to steer Malaysia away from low value-add and labour-intensive manufacturing towards one that is high value-add, technologically advanced and highly automated.

Cigarette manufacturing is not a high value-add industry. After all, cigarettes are relatively low-value before prices are inflated by taxes.

For perspective, illicit cigarettes are selling for as low as RM3.50 per pack while legal cigarettes cost around RM17 a pack.

However, it is interesting to note that cigarette manufacturing is highly automated, utilising minimal labour input. Channel checks in the industry reveal that the combined 500 jobs shed by BAT and JTI Malaysia almost entirely involved Malaysian employees.

Virtually no foreign workers were utilised on the production floor of both companies.

“Cigarette manufacturing in Malaysia is on a par with operations anywhere else in the world. Although the product is relatively low value, the equipment used to manufacture cigarettes is quite expensive,” explains one industry veteran.

The bulk of JTI and BAT’s soon-to-be redundant staff would have been semi-skilled machine operators, topped off by a handful of managers.

While the jobs that have been and will be lost in the coming months are not exactly high-income, they look far from the low-wage jobs that the country should be aiming to trim.

For context on wage levels in the country, the recent Salaries & Wages Survey Report 2016, by the Department of Statistics (DOSM), shows that the median monthly income was only RM1,703. While this marks a 6.2% year-on-year increase, it is still very low. Half of the employees in Malaysia still earn less than RM1,703 a month.

Information on JTI Malaysia and BAT’s staff wages are kept under wraps. However, it is interesting to note that DOSM statistics show that the average monthly wage in manufacturing was RM3,300.58.

On the basis of wages alone, it would appear that the loss of cigarette manufacturing jobs, even if they only involved machine operators, is not something that Malaysians can just shrug off.

 

What about exports?

Despite the challenging local operating environment, JTI Malaysia still managed to keep the Shah Alam plant temporarily viable by exporting.

While the company declined to comment, given the sensitive nature of the plant closure, past interviews with JTI Malaysia show the company has been exporting the bulk of its production.

It is estimated that JTI Malaysia has been exporting about 80% of its production. On top of that, the plant has been operating at near full capacity in order to maximise economies of scale.

In other words, the slowdown in the domestic market had to be compensated by exports.

“Having a strong domestic market is certainly key to the viability of cigarette manufacturing in Malaysia. But in the absence of sufficient volume, the balance could always be compensated by exports,” says one industry veteran.

Perhaps a more interesting question is this: was Malaysia not attractive enough to retain export-oriented manufacturers?

In the case of BAT and JTI Malaysia, it would appear that domestic market conditions took priority.

After all, both groups have various manufacturing hubs across Asean and Asia. Of course, this still begs the question: why couldn’t Malaysia position itself as a regional manufacturing hub?

Tobacco players typically concentrate production around several hubs in a region to maximise economies of scale. At the same time, multiple hubs are needed to diversify production risks and to move production closer to key markets.

Overall, it simply made commercial sense for the tobacco boys to transfer their manufacturing operations out of Malaysia. This should not come as a surprise since the tobacco industry receives little to no incentive to invest in Malaysia.

Looking at the big picture however, the country may not have the luxury to let such industries depart. Once gone, it will not be easy to convince tobacco players to return and incur high costs associated with starting up new manufacturing plants.

 

Manufacturing stagnating

Last year, manufacturing still made up 23% of gross domestic product and the sector expanded by 4.4% y-o-y. This is not unexpected.

With the weaker ringgit, export-oriented manufacturing has seen a strong boost arising from improved cost competitiveness. However, the Industrial Production Index shows a clear deceleration in domestic-oriented manufacturing. This would include cigarette manufacturing.

Last year, export-oriented manufacturing expanded by 4.7% y-o-y on average. In contrast, domestic-oriented manufacturing only grew 3.1% y-o-y on average, down from 4.8% the previous year.

Note that domestic-oriented manufacturing was largely dragged down by the “transport equipment” segment that saw large contractions last year. This segment includes automotive production, including vehicles and parts.

Of course, the IPI is a lagging indicator. Slightly more worrying is the stagnation in manufacturing-related foreign direct investment. Total net FDI in 2016 was RM41.18 billion, down 5.2% y-o-y. However, manufacturing-related FDI contracted by 35.6% y-o-y to RM11.02 billion in 2016.

This is troubling, considering that almost 40% of 311,524 registered job vacancies in 1Q2017 came from manufacturing, based on Bank Negara Malaysia statistics.

Against this backdrop, the loss of 500 Malaysian jobs via the tobacco industry is relatively small. But it is something that policymakers should be concerned about.

Between the deceleration in domestic manufacturing and manufacturing FDI, the country cannot afford to have more businesses ship their production abroad — especially if the unemployment number continues to rise.

 

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