This article first appeared in Forum, The Edge Malaysia Weekly on July 19, 2021 - July 25, 2021

The issue of foreign labour dependence is neither new nor unique to Malaysia. The New Economic Model (NEM), launched in 2010, was designed to lead the country out of the middle-income trap and become a high-income economy. The NEM expressed the concern that the continued and significant presence of foreign workers could delay industrial transformation.

This issue was raised again in the post-pandemic Covid-19 economic reform plan that includes specific measures for managing and reducing foreign worker dependence. Given the high unemployment rate, foreign worker dependence may have to be reduced to absorb local workers. This intervention could reduce unemployment among Malaysians.

It is clear that we need to revise the policy on foreign worker dependence. The key question to policymakers is: Should we reduce foreign worker dependence in all sectors by empowering a self-sufficient approach (replacement by local workers)? Or should we adopt a model that combines both the self-sufficient approach and foreign worker dependence as an optimal solution?

Before we anticipate the ideal solution to the question, let us briefly understand some stylised facts about foreign worker dependence in Malaysia and the economic cost of having them.

Levels of dependence on foreign workers

Almost all Malaysians notice the size and level of foreign worker dependence in the economy. Cost saving is one of the key factors that explains the tendency of firms to hire foreign workers, and past and current policies on hiring them have been less stringent.

According to official estimates, there are more than two million registered legal foreign workers in the country, or about 15% of total employment in 2016 and 2020. These exclude the unregistered illegal foreign workers, which are estimated to be about one-third of the number of legally recruited workers.

The chart shows the size and distribution of foreign labour across five broad economic sectors between 2011 and 2020.

Three important observations can be made. First, it seems that foreign worker dependence is almost of the same magnitude in 2016 and 2020, which implies that efforts to reduce our reliance on foreign labour have not been effective. The introduction of the minimum wage is likely to have had a marginal effect on reducing foreign worker dependence.

Second, more than 90% of foreign workers occupied semi- and low-skilled jobs. The large concentration in these two areas may crowd out job opportunities for local workers because 61% of the jobs created in our economy are semi- and low-skilled. Third, foreign labour employment is distributed across all sectors in the economy, with services, agriculture and manufacturing being the top three sectors.

This is a unique case because the distribution of foreign workers in other labour-importing countries such as South Korea is different from Malaysia, and is concentrated only in selected sectors, particularly the manufacturing sector. When the distribution of foreign workers is diverse, policies to reduce the dependence on them are challenging to implement and require sector-specific interventions.

The level of dependence on foreign workers in Malaysia is like cancer cells that have already spread all over the body. Thus, “treatment” requires strong and extensive medication.

Some recruitments occur outside labour market equation

It is well documented that Malaysian policy towards managing foreign workers has been reactive rather than proactive in responding to periodic needs. This is unlike other countries such as Singapore and South Korea, where a national well-designed labour policy guides the hiring and requirement of foreign workers.

In Malaysia, there is a low coordination ecosystem among policymaking bodies and regulatory agencies. In turn, this situation creates “blind spots” in the recruitment process, contributing to hiring outside the labour market equation. When this situation is prolonged, the labour market will always be in disequilibrium because the recruitment, vacancies and job seekers are not in the same operating system.

Economic cost of foreign workers

The costs of over-reliance on foreign workers in the Malaysian economy is well documented in scientific literature. Being overly reliant on foreign workers suppresses domestic wage growth, with adverse implications for productivity growth.

Studies show that an over-reliance on them in the manufacturing sector delayed upgrading the sector from low-end (labour-intensive production) to higher-end (capital and technology-intensive) activities by relieving employers from the pressure of rising wages. By keeping wage costs low, the urgency to upgrade to labour-saving technologies and production methods was reduced.

The Fourth Industrial Revolution (IR4.0) blueprint, which was launched on July 1, charts another vital journey for the Malaysian economic transformation. Technological change is exogenously expected to reduce the demand for foreign workers if the technologies complement their skills.

The ideal approach

Any approach or model that proposes to reduce foreign worker dependence should not distort the market and cost of productivity and efficiency in production. Efforts to reduce or maximise foreign workers’ potential depend on the nature of production, and whether the foreign and local workers are substitutes or complements.

Policies to reduce foreign workers are more effective in sectors where foreign and local workers can be substituted for each other, meaning local workers can directly replace the foreign workers. In contrast, when the foreign and local workers complement each other (when both are used and needed in production), reducing foreign workers can imply a decline in demand for local workers as well. In this situation or type of economic sector, policymakers should carefully address the issue.

The chart shows substitutability and complementarity elasticities between foreign and local workers in five main broad sectors. Notice that elasticities at detailed sub-sectors are required for better policy intervention.

Negative elasticities for the agriculture, mining and quarrying, and services sectors indicate foreign and local workers can be substituted. The highest substitutability is found in the services sector, where more local workers can replace foreign workers. Positive elasticities for the manufacturing and construction sectors imply both foreign and local workers are complementary to each other.

Once the targeted sectors are determined, the next step is to set the magnitude of the reduction. Recall that the size of foreign workers used in the Malaysian economy is considerable. Therefore, gradual efforts to reduce dependence on them are preferable to a radical reduction insofar as productivity and efficiency are concerned.

Some have proposed setting specific thresholds for foreign worker utilisation rates that vary across sectors. This is an innovative suggestion, but the thresholds must not be set at the expense of productivity and efficiency in those sectors.

Dr Mohd Yusof Saari is chief economist at the EIS-UPM Centre for Future Labour Market Studies (EU-ERA)

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