My Say: Developing the neighbourhood economic logic

This article first appeared in Forum, The Edge Malaysia Weekly, on July 1, 2019 - July 07, 2019.
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For four decades, any discussion on the state of Malaysia’s macroeconomic performance would include the quantification of foreign direct investment (FDI) flow as a major economic indicator. A healthy inflow on its own, notwithstanding the other aggregate numbers, was considered good news — a testament to investor confidence and a leading gauge of private investments and employment creation.

FDI flow became an absolute barometer of sorts. This perspective of FDI is true when the current account is in surplus or in deficit. FDI flow is about getting foreigners, essentially multinational corporations (MNCs) from the US, Japan and Europe, to invest in Malaysia. How the flow affects exchange rates and relative prices and defines incentives or for that matter how this flow of capital is deployed at the company level does not matter as much as its volume. The numbers are what matter.

That Malaysia was able to attract FDI, based initially on the Penang model, since 1970 was fundamental in the economic transformation of the national economy. It was a success story that should be duly recognised. We grew the secondary sector of the economy as a result, albeit a transplanted one, which created significant employment and demand for the service sector, all of which propelled the economy forward. It was industrialisation using other people’s money and technology. But like everything else, too much of a good thing is bad and doing the same things in a changing environment is probably worse.

We did a bad job of capitalising on this FDI flow and after a while, we even attracted the wrong FDI, which did not incentivise structural change within the domestic economy. At some point, competition for FDI created distortions in factor markets, particularly labour, which skewed incentives economy-wide. The influx of lower-end migrant labour is one clear example of this.

Some incoming FDI created demand for foreign labour, raising a fundamental issue as the strategy of using other people’s money and technology now included the hiring of migrant workers.

National policy that created the influx of low-skilled workers effectively subsidised the MNCs. This was on top of positioning Malaysia’s competitive advantage as a low-cost input market and a labour market that was almost totally devoid of collective bargaining. There was also a policy meant for domestic markets that shaped incentives for FDI in the wrong way. Subsidised energy, for example, attracted high energy-consuming firms that enjoyed the subsidies but provided little by way of linkages to the domestic economy.

We basically became a location that facilitated the production decisions of MNCs, which were taken in a global supply chain context. They gained from such decisions to optimise production at the company level. However, the resulting aggregate allocation of capital to the economy was not an optimal one. The irony here is that efficient production decisions at company level among the MNCs did not, in aggregate, result in allocation efficiency economy-wide.

Our domestic service industries — those that provide auxiliary services to facilitate trade — too did not develop. For example, very few domestic transport and logistics companies, be they air, land or sea, developed from the high trade volume in the past four decades and we are still suffering a deficit in the trade for services. While financial services, including insurance, have done better than most other sectors, trade dominated by MNCs means that the terms for intra-company transactions — which are reflected as trade in aggregate numbers — are determined by the MNCs themselves. They choose their logistics providers, insurers and financiers. Our deficit in the trade in invisibles has therefore not improved much in the last four decades.

There are Malaysian companies that started as vendors to MNCs here that have since become part of the global supply chain in what they provide. But there are few such examples. Part of the problem is that entry into the global supply chain via the MNCs requires local companies to overcome very high entry barriers.

Another consequence of this dependence on MNC-driven FDI, given that the MNCs are basically from developed markets, is that trade is skewed towards the latter. This is reflected in our trading partners, yet we are surrounded by large neighbouring economies with which we have limited economic relationships.

The exception is, of course, Singapore, which is the trading hub for the region and thus engages in trade with many Asean members. MNCs choose Singapore as the location as well as the service provider to move goods into and out of the region. Despite a population that is a fifth of ours, its economy is slightly larger than Malaysia’s, which makes its per capita income more than five times larger.

Singapore has also developed into a major oil and gas player without having any production, very much in the same way it dominates the trading of commodities in the region. The city state is Asia’s leading oil trading hub and one of the world’s top three export refining centres. Oil and its products are priced here for the region. The development of Pengerang in Johor as Malaysia’s oil and gas hub is an example of regional complementarity that should be pursued with all our other neighbours.

Given Singapore’s income level and especially its cost structure, there are many other possibilities for cross-border business. Many of Malaysia’s agrofood businesses depend on the Singapore market, something that can be further exploited, given the island’s connectivity and therefore access to markets.

The Indonesian economy is the largest in the neighbourhood and is more than three times the size of Malaysia’s. It is also an economy with more than 260 million people whose real GDP has been growing in excess of 5% annually in the last decade or so. Yet our trade with Indonesia is very small.

Thailand’s economy too has been growing. Its economy, while only about 25% larger than Malaysia’s, is a market of 70 million people.

The idea of regional development is not new but it is something not pursued as vigorously as we have chased traditional developed market FDI. For example, the Indonesia-Malaysia-Thailand growth triangle (IMT-GT) was launched in 1993 as a platform for sub-regional economic cooperation and integration. The IMT-GT currently consists of 14 provinces in southern Thailand, eight states in Malaysia and 10 provinces in Sumatra, Indonesia. Similarly, in the eastern side, there is the East Asean Growth Area (BIMPT-EAGA), the sub-regional economic cooperation initiative involving Brunei, Indonesia, Malaysia, the Philippines and Timor Leste. It was founded in 1994, a year after IMT-GT.

Despite more than two decades, and two major economic crises since that called for stronger regional economic integration, there has not been much progress on both these sub-regional economic cooperation platforms. One reason may be that the Asean economies did well enough without having to cooperate better among themselves. That was certainly true of Malaysia since the 1997/98 Asian financial crisis, when the economy was buoyed by the long commodity super cycle that also fuelled growth in global trade in the same period. The end of that commodity boom a few years ago and the rise in more contentious global geopolitics have changed all that.

Another reason is the lack of leadership among member states that seem preoccupied with their domestic issues. But a small open economy like Malaysia can ill-afford a domesticated view of the world when much depends on external markets. The traditional markets and sources of capital — mostly from developed economies — will no longer be the same when the dust settles from this equilibrating process we are witnessing. The just re-elected Indonesian government has an archipelagic perspective of itself, something that fits a regional strategy for those in the region, provided we can minimise national political interests.

Malaysia and its businesses and investors would do well to look into opportunities in the region in these uncertain times where major economic blocs are realigning their interests and in the process, disrupting trade and investment flow, which small open economies like Malaysia cannot do anything about.

The combined economies of Singapore, Indonesia and Thailand are worth US$1.8 trillion. A 4% growth in an economy this size means additional demand of US$72 billion, which is about 20% the size of Malaysia’s economy. Such growth presents all kinds of opportunities in consumption, capital goods and services. We should look more towards the region and work at making the reverse perspective a compelling one as well. Cross-border trade and investments in the neighbourhood must be made easier. We need a much better neighbourhood strategy.

Dr Nungsari A Radhi is an economist and the views expressed here are not related to any of his organisational affiliations

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