6 - Malaysia's Investment Malaise: What Happened and Can It be Fixed?

Summary

“Unfortunately, the protection and privileges accorded by the NEP may weaken the Malays further by lulling the next generation into complacency, thinking that the NEP's affirmative action will always be there for them to fall back upon. I have spoken about this danger many times, likening the NEP to crutches which, when used too long, would result in atrophy of the muscles. The NEP can make the users so dependent that their inherent capability regresses.”

— Tun Mahathir Mohamad (2011) Former Prime Minister of Malaysia

Introduction

It was not long ago that the Malaysian development story was hailed as a model of foreign direct investment (FDI)-driven, export-led industrialization worthy of emulation by aspirants in the developing world. The transformation from a largely agrarian economy in the 1950s and 1960s to a manufacturing-based one was rapid and spectacular, with the share of agriculture in gross domestic product (GDP) falling from 30 per cent in 1970 to 8 per cent today, and that of industry increasing from 27 per cent to 55 per cent over the same period. Per capita income almost doubled each decade to reach more than US$8,000 per year in 2012. These economic achievements are reflected in dramatic improvements in social conditions. Extreme poverty has almost been eliminated, despite persistently high inequality, and access to all kinds of social services has improved dramatically. FDI played a critical role in this transformation. Domestic investment was also robust at around 40 per cent of GDP at the onset of the Asian Financial Crisis (AFC). Yet, although the slump in economic growth during the AFC was quickly reversed in the ensuing V-shaped recovery, private investment — both foreign and domestic — never really recovered.

These days, references to Malaysia in the development economics literature tend to highlight it as a classic case of the “middle income trap”. No longer able to compete in the labour-intensive manufacturing activities that drove its transformation, due to factor price adjustments, it also finds itself unable to move up the value chain to more sophisticated activities within manufacturing and services in order to graduate to developed country status. The revival of domestic and foreign private investment must play a key role in raising productivity levels in order to break out of the middle income trap.