The State of the Nation: 'Reforms in four areas will help Malaysia gain more from trade pacts'

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This article first appeared in Corporate, The Edge Malaysia Weekly, on July 4 - 10, 2016.


THERE are four areas where Malaysia can carry out reforms to gain more from trade deals such as the Trans-Pacific Partnership Agreement (TPPA), says Rafael Munoz Moreno, the World Bank’s senior country economist for Malaysia.

“We tried to single out four areas that we thought could gain more from these trade agreements and they are services, investments, competition and SMEs,” Moreno tells The Edge in an interview.

He was speaking about the bank’s latest biannual flagship publication — the Malaysia Economic Monitor (MEM): Leveraging Trade Agreements — which focuses on how the country can use trade agreements to bring new opportunities to the economy and accelerate its transition to high-income status.

The reforms Moreno highlights include those around raising productivity of small and medium enterprises (SMEs), bolstering competition across sectors, liberalising services to further support exports and attracting higher valued-added foreign investment.

He points to the area of services, where Malaysia’s services contribution to gross domestic product (GDP) and exports still trails that in many other peer countries. He notes, in the report, that an efficient services market is essential in enhancing the country’s competitiveness, by supporting other export sectors.

For instance, the value of services embedded in gross manufacturing exports was just 12% in Malaysia compared with 28% in Japan, 25% in the US and 22% in Canada.

“There is more to be done in the services sector. [We think] the country, despite opening up many services over the last few years, remains still relatively closed up compared with other countries. While current trade agreements help, they may not be binding enough for the type of opening up that the country may need in services — in the sense that they will not be forced open. So, some services remain somehow closed. For one, the legal profession. It remains closed even after the trade agreements we have seen,” says Moreno.

“So, we get the sense that this (services) is an area that probably the government may want to think about pushing forward the agenda beyond what the trade agreements have committed to,” he adds.

In Malaysia, while some professional services like accounting and taxation, as well as medical and veterinary services, appear fully committed to the terms of the TPPA, others like architecture, engineering and, especially, legal services remain heavily restricted, including limitations on foreign ownership, nationality and residency, and performance requirement.

In the area of investment, Moreno says improved investment policies can further support Malaysia’s businesss environment and help to attract a new wave of foreign direct investments (FDI) that supports the country’s economic diversification.

As Malaysia becomes more integrated with the global economy, the new trade agreements do provide additional investment safeguards for domestic firms investing abroad. These include the Investor State Dispute Resolution (ISDR) mechanism.

“On investments, what we see is that the country has a lot to gain from these trade agreements in two senses. First, the trade agreements that they try to promote are providing additional assurances for investment. And they do it, for instance, by introducing an ISDR mechanism. What they try to do with this new mechanism is to provide additional assurances to foreign investors that their investments will be treated according to certain rules that will be predetermined,”Moreno says.

“For instance, when we look at the TPPA, one thing that we realised is that these new mechanisms are clear, so they simplify the way to use it, they clarify how they have to use it, which is good. Everything that provides more certainty is something we think is useful. That will help Malaysia to attract further FDI and also a different type of FDI — one that is more value-added, that will require more investment protection, patent protections, for example.

“Second, Malaysia is now an outward investor and has a significant amount of investment abroad. These additional assurances is also going to play in the favour of many of the Malaysian investors abroad.”

Competition-wise, Moreno says a more open and level playing field in the economy would facilitate the entry of new firms, and a reallocation of resources to more productive companies.

“What these trade agreements try to do is have a level playing field ... Something like providing equal opportunities to everybody, not just domestic investors and firms but also foreign investors and firms. I think they do it around three main blocks. One is trying to remove all the regulatory hindrances, the second is trying to clarify the government’s involvement in the economy. We perfectly understand that the government has means to support the economy, but are they selecting the means to do it in the less intrusive or less competitive way? And the third is, to try to strengthen (competition policy).

“What we see here, for Malaysia, is that the government-linked companies (GLCs) have been significantly carved out of these chapters. And this is (an) important (point) because GLCs are very prevalent in Malaysia, across many sectors. That influences the competition in many sectors. I think the challenge there for the economy and for the government particularly is to design a medium-term plan that explores how we move forward with the competition in these sectors, but at the same time, how we move forward with strengthening the GLCs to compete in this new environment,” he says.

On SMEs, Moreno is of the view that their level of productivity needs to be raised. SMEs in Malaysia represent 97.3% of total firms in the country and accounted for 35.9% of GDP in 2015, but they only account for 17.8% of exports.

“They are substantially less productive than large firms, which limits their capacity to integrate into the global value chain. Thus, undertaking productivity enhancing reforms that enable SMEs to compete effectively in the global market would be essential,” he says.

Moreno says the challenge lies in closing the productivity gap between SMEs and large firms. “One way is to try to provide a more level playing field for SMEs to get into market and grow. The second is to relook the mechanism that the government has to support such companies. We’re happy to see that SME Corp Malaysia is now reviewing its policies to see how effective they are and if they need to be fine-tuned in order to support the companies that they serve,” he remarks.

Moreno concludes that reforms in these four areas have high payoffs because they broaden market access and could also lead to higher investment. They are also facilitated by firm-level incentives as heightened foreign competition will raise the need for less-performing firms to adjust.