Malaysian Economy ECON 3010: The Industrial Sector PDF

Malaysian Economy ECON 3010 Topic 5 The Industrial Sector  Outline Industrial Policy and Industrialization 1. Introduction 2. Phases of Industrial Policy Import-substitution trade regime Export-oriented trade regime 3. From expansion to slo...

Malaysian Economy ECON 3010 Topic 5 The Industrial Sector  Outline Industrial Policy and Industrialization 1. Introduction 2. Phases of Industrial Policy Import-substitution trade regime Export-oriented trade regime 3. From expansion to slowdown 4. Deindustrialization explanations  Introduction The Malaysian economy was transformed into a primary commodity exporter during British colonialism. British intervention in Peninsular started in Perak in 1874 with interests driven by mining and export of tin. Rubber became one of the significant export since the early 20th century.  Introduction Tin and rubber dominated Malaysian exports throughout colonialism and the early decades of independence until 1980. The depletion of tin resources and the replanting of rubber with oil palm had reduced the export of these two commodities in the late 1970s.  Introduction Despite Industrialization policy being initiated since 1958, the growth of manufacturing and employment were pretty much slow. The sector only saw a huge growth following the opening of export processing zones in 1972.  Introduction Driven by tax-free incentives in export processing zones, the manufacturing sector grew rapidly from the early 1970s. Malaysia manufacturing sector has become the leading contributor to Malaysian GDP in the mid-1980s.  Introduction Malaysia received huge capital inflows from the US, Europe and Japan since the mid- 1970s. The booming of Asian Tigers such as Hong Kong, Taiwan, South Korea and Singapore in the 1980s has contributed even higher capital inflows to Malaysia.  Introduction These huge capital inflows has helped Malaysia to become a major exporter of electric-electronic goods. The textile and clothing industry were also regarded among the main contributor to Malaysian manufacturing sector until the 1990s.  Introduction The manufacturing sector began to slow down from the late 1990s. Why? What had happened? – Asian Financial Crisis – Losing competitiveness – Ineffective government policies?  Phases of Industrial Policy Malaysia experienced 4 major phases of industrialization between 1968 and 2010:  Phases of Industrial Policy What are the different industrial policy regimes that the Malaysian government has implemented from 1958 to 2010? – Import-substitution (IS) strategies First round Second round – Export-orientation (EO) strategies First round Second round  Table 5.1 Industrial strategies and trade orientation, Malaysia, 1958–2010 Trade Period of Phases Policy instruments orientation dominance Phase 1 IS1 1958–1968 Pioneer Industries Ordinance,1958 Phase 2 EO1–IS1 1968–1980 Investment Incentives Act, 196 Free Trade Zone Act 1971 Phase 3 IS1–IS2 1980–1985 Heavy Industries Corporation of Malaysia (HICOM),1980 Phase 4 IS2–EO2 1985–2010 Industrial Master Plan,1986 Promotion of Investment Act, 1986 Action Plan for Industrial Technology Development (APITD), 1990 IMP2,1996; IMP3 2006  IS Trade Regime Import-substitution in the first phase in Malaysia was aimed at attracting investors to generate employment and reduce import. IS in other words was aimed at promoting the development of manufacturing industries to serve the domestic market.  IS Trade Regime The first round in the 1960s targeted at encouraging the development of light industries and final goods such as paint, food and clothing. In the second round, which began in the early 1980s, the focus was on the development of heavy industries such as the steel and car industries.  First Round of IS Regime Tariff protection was not used extensively between 1958 to mid-1960s. The trade policies favored the IS but were limited to tax and subsidies. The policy were concentrated on the provision of an extensive infrastructure (eg. Power and communication).  First Round of IS Regime Why tariff protection was not used extensively? – The govt. feared deterring imports which is a significant source of income – Rubber and tin producers were worried that increase in import duties would increase costs – Govt. reluctant to implement a policy that would be seen as favoring the Chinese business – Opposition from the large import agencies  First Round of IS Regime World Bank mission in 1963 recommended the establishment of two agencies: – Tariff Advisory Board (TAB) -1963 – Federal Industrial Development Authority (FIDA) – 1966 Nevertheless, there were not much immediate change. Tariff protection were only given on ad-hoc basis  First Round of IS Regime Very few industries enjoyed a tax incentive of more than 30%. Non-tariff barriers were almost non-existent. Import duties were levied only on a limited number of items (eg. Tobacco, liquor, petroleum and motor vehicles.)  First Round of IS Regime Only after the mid-1960s that tariff and non- tariff protection were used more extensively. The main objective of implementing a more comprehensive tariff protection is to stimulate new industries. Effective rate of protection (ERP) for manufacturing rose from 25% (1962) to 50% (1966) and 65% (1969).  First Round of IS Regime The proactive tariff protection had stimulated early industrialization in Malaysia. Enabling a diversification of the economy and reducing excessive dependence on imported consumer goods. The manufacturing sector recorded average 10.2% growth rate in the 1960s.  First Round of IS Regime Contribution of the manufacturing sector to GDP increased from 8% (1957) to 12% (1969). Nevertheless, the small domestic market discourage further industrial expansion by the early 1970s. Manufacturing accounted only 12% of overall exports in 1970.  First Round of IS Regime Of the 14 industries in food manufacturing, one-half had export shares lower than 10% in 1970. Of 39 non-food industries, 17 had export shares lower than 10%. Why export shares were very low during the first round of IS industrialization?  First Round of IS Regime Why export shares were very low during the first round of IS industrialization? – The IS protected industries were inefficient and unable to compete in overseas market. – The indirect anti-export bias of protection policy discouraged exports. – Ad-hoc basis of incentives, no appraisal and no monitoring of the impact of the given incentives.  First Round of EO Regime Given the very low export shares of the manufacturing sector, govt. started to initiate the export-oriented policy from 1970 onwards. The World Bank and the United Nations Industrial Development Organization (UNIDO) also played significant roles in pushing Malaysia for export-oriented policy.  First Round of EO Regime The 1970-1980 decade saw a marked shift in govt. policy to promote export orientation. This policy shift was viewed as necessary to revive the manufacturing sector growth as well as for employment absorption. Rising competition and production costs in developed countries were considered a huge opportunity to bring in foreign firms.  First Round of EO Regime The Investment Incentives Act (1968) which included tax holidays and tariff-free for exporting firms, managed to attract large capital inflows. This was supported by the Free Trade Zones (1972) as well as the special convoys to the targeted HQ of MNC by the govt. officials.  First Round of EO Regime The incentives given included: – Investment credits – Tax concession and exemption for exports – Tariff exemption on raw materials – Preferential treatment for import permits – World class infrastructural facilities  First Round of EO Regime Other supportive measures Labor regulations which favor MNC – Trade unions were not allowed until 1989  Second Round of IS Regime The launching of the Fourth Malaysia Plan (1981-1985) signaled a return to emphasis on IS policies. Nevertheless, this time it was through government –sponsored heavy industries. This phase was inspired by the success of Japan and South Korea whereby the govt. launched the “Look East Policy.”  Second Round of IS Regime The “Look East Policy” was emphasized on: – Discipline in work – Loyalty to the nation and to the business – Group priority over personal interests – Productivity and quality – Narrowing gaps between the executives and workers – Management system  Second Round of IS Regime The promoted industries included: – automobile assembly under Proton – Steel mills under Perwaja Steel – Petrochemical plants – Cement factories  Second Round of IS Regime Tariff and quotas were the main instrument of promotion for the IS policy. Between 1982 to 1986, over 60% of the tariff protection given was either maintained or raised. Heavy Industries Corporation of Malaysia (HICOM) was incorporated to spearhead the development of heavy industry in Malaysia.  Second Round of IS Regime Example of protectionism policies for IS: – Increased import duties – Price controls – Import restrictions – Duty exemptions – Pioneer status  Second Round of IS Regime The promoted heavy industries during the IS phase were characterized by: – High capital intensity – Long gestation periods – Substantial scale economies Although the heavy industries were highly protected, the industry remained in bad shape in the 1980s.  Second Round of IS Regime Reasons for heavy industries to perform badly in the 1980s: – Economic slowdown in the mid-1980s. – High cost of production relative to international standard. – Small market penetration. – Lack of linkages between industries and other sectors. – Lack of monitoring standards.  Second Round of IS Regime All heavy industries faced massive losses until the late 1980s. Perwaja Steel made losses close to RM 3 billion in the 1990s which resulted the govt. to allow imports. The failure of IS forced the govt. to renew emphasis on foreign capital and export orientation.  Second Round of EO Regime Industrial emphasis from 1986 moved from increasing IS orientation to EO again, though both strategies were run simultaneously. The Plaza Accord in 1985 drove a massive relocation of FDI into South East Asia. The Industrial Master Plan (IMP) helped expand manufactured exports sharply from the mid-1980s. Second Round of EO Regime Foreign fixed Asset in Malaysia Manufacturing (%)  Second Round of EO Regime The Industrial Master Plan (IMP) strategies: – To give priority to specific sub-sectors Food processing, rubber, palm oil, wood-based, (petro)chemical, electrical machinery, transport equipment, engineering products, apparel etc. – Consolidation of fiscal incentives Induce reinvestments, linkages, export and training. – Support R&D  Second Round of EO Regime The new EO policy mainly concentrated on incentives and infrastructure development. The processing of approvals was simplified. The most effective EO incentives was the extension of tax relief for another 5 years for eligible companies that were already in operation. Incentives for export promotion and advertisements.  Second Round of EO Regime Problems and challenges -The economy was overheated by the massive capital inflows. – Labor shortages and rising wages – Low productivity and efficiency – Newly competitive sites (China, Vietnam & Philippines)  From expansion to slowdown Manufacturing industries have not manage to reach the higher value-added segments of the value-chain. Average annual manufacturing growth fell from 11.7% (1990-1994) to 0.2% (2005-2009). Contribution of manufacturing to GDP had also declined from 30.9% (2000) to 26.6% (2009). From expansion to slowdown Sectoral GDP growth From expansion to slowdown Structure of GDP contributions From expansion to slowdown Manufacturing trade balance From expansion to slowdown Relative comparative advantage in manufacturing  12th Malaysia Plan Average manufacturing labor productivity growth Deindustrialization Explanations Researchers and Engineers per million persons Deindustrialization Explanations Gross expenditure on R&D in GDP  From expansion to slowdown Manufacturing industries have not manage to reach the higher value-added segments of the value-chain. Average annual manufacturing growth fell from 11.7% (1990-1994) to 0.2% (2005-2009). Contribution of manufacturing to GDP had also declined from 30.9% (2000) to 26.6% (2009).  From expansion to slowdown Manufacturing industries have not manage to reach the higher value-added segments of the value-chain. Average annual manufacturing growth fell from 11.7% (1990-1994) to 0.2% (2005-2009). Contribution of manufacturing to GDP had also declined from 30.9% (2000) to 26.6% (2009).  From expansion to slowdown Manufacturing industries have not manage to reach the higher value-added segments of the value-chain. Average annual manufacturing growth fell from 11.7% (1990-1994) to 0.2% (2005-2009). Contribution of manufacturing to GDP had also declined from 30.9% (2000) to 26.6% (2009).  From expansion to slowdown Manufacturing industries have not manage to reach the higher value-added segments of the value-chain. Average annual manufacturing growth fell from 11.7% (1990-1994) to 0.2% (2005-2009). Contribution of manufacturing to GDP had also declined from 30.9% (2000) to 26.6% (2009).  From expansion to slowdown Manufacturing industries have not manage to reach the higher value-added segments of the value-chain. Average annual manufacturing growth fell from 11.7% (1990-1994) to 0.2% (2005-2009). Contribution of manufacturing to GDP had also declined from 30.9% (2000) to 26.6% (2009).