Reinventing Malaysia’s economy

I must warn you that I have reproduced a very long piece from the Edge Daily. It is a first-part distillation of an interview that RB Bhattacharjee conducted with the Universiti Malaya Professor Rajah Rasiah:

Malaysia’s diminishing appeal to both foreign and local investors has been in the news of late. Energising the country’s economy will need some strategic policy shifts, Universiti Malaya Professor of Technology and Innovation Policy Rajah Rasiah, who has been appointed the Holder of the Khazanah Nasional Chair of Regulatory Studies, tells R B Bhattacharjee in a frank and free ranging interview. Here are some excerpts in the first of two parts:

TEFD: To what extent is Malaysia’s poor investment performance in recent years, as reported in the UN’s World Investment Report 2010, due to internal and external structural factors?

Rasiah: Investments have gone up this year, so the outlook isn’t bad. The government has made some changes that have had a positive impact. If the investment flow sustains, it is good.

Obviously the global recession has had an effect. Among members of a good neighbourhood that has done relatively well in relation to the global economy, foreign direct investment (FDI) having contracted only by 17% for Asean, you have us as really a bad example, showing a drop of 81%. That has sent a wrong message that things are not okay here, especially that Malaysia is probably the worst place to go and invest, because they have had the largest contraction.

But it could also be seen differently, that this is a country that does not really need massive FDI because it has the capacity to invest abroad, not only domestically.

There must be a holistic approach to investment dynamics, with government policy identifying FDI as an integral part of development policy.

The New Economic Model (NEM), as well as the 10th Malaysia Plan (10MP), addresses the need to focus on economic activities that provide the value-add required to bring Malaysia’s growth path back to the trajectory required to achieve Vision 2020.

We need to see how FDI can contribute. So far, a whole lot of FDI goes into manufacturing, and that’s one of the reasons why there has been a trend fall from the golden years of 1988-1993. It is because they are no longer competitive in low-end, labour-intensive manufacturing. We have delayed that by importing foreign unskilled labour.

It is recognised by the NEM, and 10MP, that we are facing a severe human capital deficiency problem. There have been attempts since the 1990s to overcome this, through the Private Investing Bill and a whole range of other instruments that were created. But they haven’t solved it; The deficit has been growing.

Malaysia is facing the problem of matured industrialisation. It is deindustrialising, meaning the share of manufacturing in GDP has started to fall since 2000, although the sector has not reached maturity status. The target is to achieve 20% value-add in Malaysia’s output, against 32% in Korea. In some sectors like steel, it is about 13%, it’s that low.

What that means is we are not migrating or upgrading our manufacturing sector sufficiently fast to keep up or at least stay in touch with Korea and Taiwan, as well as Singapore.

Prof Rasiah says there must be a holistic approach to investment dynamics, with government policy identifying FDI as an integral part of development policy.

Meanwhile, other countries that are growing rapidly — China, India and Vietnam — are closing the gap. Even more scary is their sheer size. Imagine, as India and China get closer, then surpass us, the consequences will be more difficult to deal with.

If you plan properly and address the shortcomings raised in the NEM and 10MP, at least you give yourself a fighting chance to make yourself attractive to those sectors where FDI is likely to come.

We must have the requisite human capital and macro-organisations that deal with R&D labs. This can be through specific sector specialisations, for example, R&D labs on electronics, like the Electronics Research and Service Organisation (ERSO) in Taiwan, and incubators then that are co-located.

That produces knowledge, which is critical. You have this systemic effect of knowledge that spills over into firms, which will find it attractive.

What advantage have we got in relation to India and China? We have much better basic infrastructure, comfort and choice of residence. These are things I’m picking up from interactions with CEOs of firms.

Once you have those serious deficiencies addressed, we will be better placed than our competitors, including Taiwan and Korea in many ways.

In these countries, there were clear government initiatives to develop indigenous capital. They saw that development meant the development of domestic capabilities.

They also recognised it is pointless reinventing the wheel. There are different paths to reach the frontier. They sought technologies that they thought the country should focus on.

Korea went into steel, electronics, shipbuilding and industries of that sort. They looked at the flagship firms in these industries in an attempt to catch up. Initially, because the gap was so wide, they went into licensing. Secondly, they hired Korean personnel working in those big firms because they carried passive knowledge, which includes experiential knowledge.

This allowed them to acquire a labour force that can really perform. They also remained networked to markets and R&D labs in all these places. They had a strategy of ensuring that all these flows of knowledge, either by licensing, using their own human capital or bringing back their diaspora, generated results.

They developed vetting, monitoring and appraisal instruments by evolving these capabilities. The equivalent of the Economic Planning Unit of Malaysia led the drive in Korea, Singapore, Taiwan and Japan. They improved by continuing to appraise and remove their mistakes, identifying new thrust areas and so on. They evolved planning and execution capabilities.

They relied on their diaspora for advice as well as foreigners whom they thought could contribute to them. If you have a mechanism with that sort of standards, then you can subject any performance to that measurement. They have that. We don’t. If you have that, then you can plan against the countries and firms you are catching up with, and close the gap. These are very critical.

FDI should not just be seen as capital flowing in, but includes multinationals which may not relocate here. One channel for developing our own skills is by either establishing an outsourcing link, and growing from there, or accessing technology through licensing.

What short- and medium-term measures are needed to restore business confidence in Malaysia?

In the next five years, the 10MP is seeking inward investment growth of RM115 billion, which translates to RM23 billion a year. This is not really impossible because we got more than that in 2007 and 2008. Only in 2009 it crashed.

If we say that we need FDI reviving, rebounding to the amounts that we recorded in 2007 and 2008, then we need to find out why those figures have gone down.

The dominant players that are coming in are industries that typically did not come here previously. In the 70s and 80s, it was electronics, garments. All that were big, and they went into manufacturing.

Now, it is Kuwaiti oil, even Indian firms into infrastructure and properties that are bringing in FDI. We need to go back to the drawing board and see if that is the sort of capital we still want. In those areas, we’ll have competition for our own producers.

Because we are also investing abroad a lot, and if you want them to allow us to build infrastructure in India, then you have to allow them to come here. Otherwise, bilateral arrangements don’t work.

But if you want to pursue the new growth policy, then we need to address and convince the firms that are here. Firstly, firms like Intel, for example, have been asking government leaders whether its plan to fast track applications for permanent residence (PR) has been executed.

Some, however, are concerned that this policy might lead to a dualistic economy where the set of foreigners who come may not have a long-term responsibility to the country.

It is still a fact that the government needs to tell investors that it means action. The officials must take the steps and put it out that we are already doing this, that foreigners working in firms here can now apply for PR.

We now have a one-stop agency that deals with the entire range of issues on this. So, those things must immediately take effect.

You are dealing with the FDI crowd here. These are flagship firms: Motorola, AMD and others. You are really dealing with the big guys in an industry I think is still important — electronics.

Secondly, Malaysia is known for its universal spread of MIDA offices, that were known to promote FDI, at least in the past, quite effectively, so that potential investors knew the investment opportunities here.

I feel the focus has shifted somewhat to tourism and related sectors. They must bring real information to potential investors. Don’t go back and promote the same thing because nobody believes it now.

In the 1990s, CEOs of Taiwanese companies told me they felt cheated coming to Malaysia. They were clearly told there was an abundant supply of cheap labour and they were literate in English. When they came, they had to go very far to get their workers. Once they got them, they brought them by the busloads to their factories. The next day, they had been poached by neighbouring firms.

Clearly, they didn’t have the labour force. The building was already up, so what could the investor do? One CEO was quite upset about this. It is unfortunate that they had to adopt practices such as holding back workers in the previous shift because they didn’t know how many would turn up in the next shift.

The officials have to recognise the transition that has taken place and they must have the requisite labour force. These need to go hand in hand. You can’t make statements about things you can’t deliver.

The longer you do that, the more people won’t believe you, like the boy who cried wolf.

The prime minister seems sincere in trying to see these things happen. But there must be execution by the officers who are made responsible. The line of responsibility should mean that the range of people involved must be made to recognise that they will be rewarded only if they continue to execute the things required of them.

Otherwise, if loyalty is the only thing that the leaders look for, then their officers won’t deliver.

Another measure would be to connect with the officials of the Ministry of International Trade and Industry and the Economic Planning Unit, who are looking at new species of industries to promote. The idea is not to create for the universe here, but to observe trends elsewhere, identify the right players and attract them here. For example, the planners are looking at solar energy and medical devices, which is already in the field, but now they want to go much broader into these areas.

This goes back to the same old strategy: you connect with a multinational value chain and attract them. The species are not new to the universe, but they are new to the country. Then it grows. It has happened before. The semiconductors moved to consumer electronics, then to disk drives. Suddenly, they went labour intensive, and on to other industries, computers and so on, and Dell came in.

But that strategy, I am reluctant to believe, connects with structural change. The structural change that is expected is not just about moving to different industries.

The most important thing is to move to higher value-add industries. They can be in the same industry category as such. If you’re looking at electronics, then it’s designing and wafer fabrication, where it gives you the higher value add which is necessary.

I’m not clear if they are going to reintroduce the policies which were seen before. You attract one industry, then you see a range of firms growing there, then suddenly they get up and go. That does not make for an economy that wants to progress from one level of income to another.

Taking up medical devices, there must be follow-up panels, comprising industries they want to promote. Previously, there was even avionics. In that case, you need to see that they will have at least design capabilities, if they don’t do basic research.

To do that, you need a different set of policies, which require a link with universities and R&D labs. All of them must be seen as an ecosystem that we need to have in order to have the sort of industries you think the country needs. Not simply industries by name, but industries that can support the value-add required to establish the growth rate so that we bring back the growth path to Vision 2020.

I wouldn’t like simply to do the promotion then, in economic terms, create a bubble; things that grow on the basis of perception. The prime minister is planning for a transformation, but when firms realise it’s not happening, then you see a huge fall because the requisite infrastructure, promotional instruments, macro organisations all have not been created.

You mentioned some concerns that industry representatives have raised about the business environment. What are the main hurdles in the way of attracting investments, from the political economy point of view?

We haven’t been successful at producing a responsible and capable labour force that can evolve with the expectations to become more productive. The kind of workers required can not only earn higher salaries but are able to support the upgrading of firms.

Political economy is one of the reasons why we have not been able to deal with the issue of targeting labour transformation. When the NEP was created in 1971, there were some shortcomings. The government had to introduce quotas for the Malays and non-Malays, for example, for places in education.

That was already flawed. Affirmative action should target providing equal opportunities. It should never be targeted at some because they have the colour or they think they were underprivileged before.

It gets worse because the community that you favour could have been financially much better endowed compared to the others who are competing for it.

We’ve got many things wrong, I think. The utility of money to the rich is low or zero. RM1 means nothing to the rich, but means a lot to the poor.

The dynamic argument is about moving the poor out of their situation by enabling their thinking faculties. Then they participate productively because they now have equal opportunities, and can perform better than the others. That’s the logic of affirmative action, not going along ethnic lines. If you do that, you may end up misallocating resources such that you may not establish equal opportunity. The beneficiaries could be the rich themselves.

Secondly, you no longer have the same standards for all. It becomes the right of one group to enjoy privileges.

In the initial stage, some good things happened. The restructuring targeted where the Malay communities were. They built canals, drains and roads. That integrated them into markets. That was enabling.

What was not enabling was the provision of 30% equity for bumiputeras. What do you establish from that, by simply fixing an artificial figure? That may even backfire because the poor Malays may not even enjoy it.

Because you have a framework of that sort, then a whole network of macro-organisations are created targeting bumiputeras. You have elements of collusion setting in.

I happened to have the opportunity to study Pusat Giat Mara and Institut Kemahiran Malaysia, both Malay-based.

I was visiting places in Johor, Perak, Selangor, I did not find the kind of skills they were teaching state-of-the-art.

When I spoke to the person in charge, I was told these students couldn’t grasp precision engineering and tool and die-making. I was surprised because this is the age at which you catch people’s attention. You never know how much they can learn. That’s the state-of-the-art skills the industry wanted, as reported in a 1994 World Bank study.

When I asked the Mara and polytechnic administrators, they said they were doing very well, because all their graduates get hired.

But when I went to the firms (this was at the peak of the labour shortage), they said they had no choice but to take them in and train them because they were already here and the misinformation was that skilled labour was in abundance here.

The training institutions claim they are market-oriented, but the firms say we pay lower salaries and we give them training. There’s no premium in that. They should bring the best to train the students. I would have preferred that they go to the poor irrespective of race, then you build nationhood, a society.

Even if you started with the Malays, the trainers shouldn’t have been those whose skills are mediocre. Get quality instructors even if you have to source them from abroad.

I criticised the political hierarchy in Johor on this point, and they said whatever you have said, we recognise and we’ll change, but I don’t think they have.

A World Bank official said, ‘Malaysia is an interesting country. Whatever FDI instrument there is in the world, it has, legislatively. But whether they enforce it and execute the policy properly, the answer is ‘no’.

When they say they don’t have the labour force etc, firms will say, they told us we can get tool and die makers and precision engineers from abroad, but approval is not easy. There is a lag period, sometimes they allow a few, sometimes they don’t. They talk about bureaucracy.

It’s also a tremendous waste of resources, isn’t it?

When I was doing the Iskandar Development Region strategic chapter, I spoke to many managing directors. Five of them told me they were keen on relocating their designing facilities from Singapore. Whatever Singapore has, Johor has. There are things Johor has that Singapore doesn’t have. Big land mass, more options for tourism, and they can have more people to work there, but unfortunately, after looking at a number of details they decided not to work there. Some CEOs decided they would drive to Johor daily from Singapore because Singapore is a better option. For example, education facilities are better.

I brought the matter to the state officials, who said, ‘This is the problem with Malaysians. Most of them run away to Singapore. Just 10% more wages, and they go there.’ One figure is that 50% of Singapore’s engineers are Malaysians.

We found some of these employees and talked to them. They said, ‘You think we’re fools? For 10%, we can’t get to see our children. They are asleep when we leave for work and again when we return. The real reason for choosing Singapore is that their problems with the local authorities are not solved because of bureaucracy. But they say we are a one-stop agency, we solve everything immediately.