INTRODUCTION

Malaysia experienced the highest growth rates during the period between the first two economic recessions (namely in 1985 and 1998), from 1986 till 1997, with an average rate of growth of 8.3 per cent. The economy, however, recovered the year following each of the aforementioned crises. The global financial crisis (GFC) in 2008 contributed to another contraction in Malaysia's economic growth in 2009 and an equally rapid recovery the following year. Since then, Malaysia's average growth rate has fallen to 5.4 per cent from 1999 to 2009. The country's population has grown almost threefold from 10.8 million in 1970 to 27.8 million in 2009. Average GDP per capita has grown from RM1,932 to RM19,052 for the same period, placing Malaysia solidly in the upper-middle income group of countries. Although the economy recovered strongly in 2010, with a GDP growth of 7.2 per cent, growth dipped again to 5.1 per cent in 2011 and 2012. Nevertheless, as noted by Hill (2012), Malaysia's growth has been the most volatile, compared with Singapore, Thailand, Korea and China.

Since 2010, global uncertainty has continued to prevail, with recovery dependent on the continued sustainability and strength of private sector activity in the United States, while the need for structural reform and fiscal consolidation implies that recovery in the eurozone will take a longer period (Central Bank 2012). Japan's growth also depends on the success of the aggressive quantitative easing and expansionary policies that have been undertaken since April 2013 to reinvigorate its economy and overcome the output gap and mild deflation that have plagued it since the 1990s. Concurrently, China's slower growth will also have implications for the rest of the world.

In the face of these uncertainties, it is important to examine the key policy initiatives that have been undertaken in Malaysia since 2008, to ascertain the impact of these policies on key economic indicators. Looking ahead, it is equally important to identify the macroeconomic and trade challenges facing the country, as well as the prospects of attaining the status of a high-income economy — targeted for 2020.

The chapter is organized as follows: Section 2 outlines the main policy responses that have been undertaken since 2008, while Section 3 examines their impact on the economic performance of the country. The macroeconomic and trade challenges and prospects are presented in Section 4. The conclusion summarizes the key findings.

INTRODUCTION

Global imbalances emerged in the world economy after the 1997 Asian financial and currency crises, and policymakers and academics have since been concerned about the consequences and how to correct them. Subsequently, in 2008 the financial crisis erupted in the United States and spread to other developed countries, resulting in a deep and prolonged recession that has continued to plague the global economy until today. Most economists believe that the global imbalances are one of the major factors to have contributed to the crisis. There has been excessive consumption and deficits in current accounts of major industrial countries, while large surpluses and insufficient consumption have been observed in the emerging economies, mostly in East and Southeast Asia. Half a decade has passed since the 2008 crisis began, but the global imbalances remain. The large industrial countries together with major emerging economies (the G-20) initiated many meetings to coordinate international macroeconomic policies aimed at reducing the imbalances. All have agreed that exchange rates and macroeconomic adjustments should be made, but there is no agreement on who should take the action.

Before the 2008 crisis, neither the surplus nor the deficit countries were willing to adjust their exchange rates or macroeconomic policies to reduce the global imbalances. The Asian countries have been criticized for their continued pursuit of export-oriented policies which have rewarded them with a very rapid and successful growth performance over the past decades. Hausmann et al. (2004) claim that the rapid growth of trade and employment was associated with depreciation of these countries’ exchange rates in real terms. That is, once these countries shifted their policies towards an export orientation, attention was paid to maintaining their real exchange rates favourable to exports in order to achieve desirable rates of output and employment growth. On one hand, the relatively low real exchange rate enabled their exports to be attractive in the world markets; on the other, it prevented their imports from growing too fast. In a nutshell, currency appreciation or, to be more precise, attempts to keep real exchange rates from appreciation, have made it possible for Asian economies to pursue an export-led growth strategy and to continue to mount foreign reserves.

In 2005 the U.S. government strongly urged the country with the most current account surplus — China — to revalue its currency on the belief that the yuan was substantially undervalued. .

INTRODUCTION

The sub-prime crisis that began in the U.S. housing market in 2007 snowballed into a global financial and economic crisis and is described as the most serious crisis to hit the global economy since the Great Depression. The contagion of the crisis transmitted from the financial sector to the real sector through demand slump, production plunge, unemployment rise and credit seize. Most worryingly, world trade — the main channel of crisis transmission — fell sharply. The GDP growth rates fell for both advanced and developing economies, leading to first-time contraction in global GDP since World War II. The crisis forced countries around the world to come up with aggressive and unconventional monetary and fiscal policy measures. There were several instances of coordinated policy actions by the central banks, which helped to avert an escalation of the crisis and prevented a meltdown of financial systems.

The crisis also busted the myth that Asia was sufficiently decoupled from the Western financial systems and that it had become independent from the cyclical developments of the global economy (Yung 2011). This is reflected in empirical data which suggest that Asia has not been immune as indicated by losses to financial institutions in the region, impacts on the stock market, and widening sovereign spreads in the region.

Singapore was no different from most of the Asian economies. It was the first East Asian nation to fall into recession, reflecting the vulnerability of the economy to global economic shocks. In 2008, GDP slumped due to a contraction in manufacturing activity in the second quarter, which subsequently extended to construction and a broad range of services. Its year-on-year real growth rate had plunged from 9 per cent in 2007 to 1.7 per cent in 2008 and further to –0.8 per cent in 2009 (see Figure 4.1).

This prompted the policymakers of Singapore to come up with a series of fiscal and monetary policy measures that helped the city-state economy to catapult itself out of recession in the third quarter of 2009.

Given this background, this chapter seeks to summarize the effects of the 2008 global financial crisis (GFC) on Singapore, and analyses the government's policy response to the same. In the latter half it discusses Singapore's economic outlook in the face of continuing global economic uncertainties, and evaluates how the island nation is faring in light of the government's recent measures to revitalize the economy.

INTRODUCTION

Over the past two decades, Thailand, along with other Southeast Asian countries, has twice experienced severe economic downturns. The first, the infamous Asian financial crisis of 1997, originated in Thailand itself and then spread to other Southeast Asian countries. A combination of moral hazard in the financial sector, asset price bubbles, and mismanaged capital flow policy led to the country losing its competitiveness and this later prompted speculative attacks on the Thai baht; during 1998 the contraction of the Thai economy reached double-digit territory (–10.51 per cent) for the first time in its history. However, a heavily depreciated currency and explosive growth in exports helped the economy to recover quickly in the following years. Since then, the financial sector has been strengthened through the implementation of international-standard regulations as well as by close monitoring by the monetary authorities. Stabilization policy also aims to balance long-term growth and short-term price stability. In fact, Thai exporters enjoyed low inflation (averaging 2.5 per cent per year) and stable foreign exchange rates during the years 2000 to 2008, and international trade has thus been an important growth engine for the Thai economy over the past decade.

In late 2008 Thailand experienced a second episode of economic turmoil, but this time the shocks came from external economies. The subprime crisis, led by a real estate bubble and unregulated growth in financial derivatives in the United States, precipitated a global economic meltdown. Because Thailand has been dependent on external demand since the currency crisis of 1997–98, the country suffered greatly. Although Thailand has been actively promoting free trade agreements (FTAs) with regional economies, including the ASEAN Free Trade Agreement (AFTA), the Thailand-Australia FTA, and the ASEAN-China Free Trade Agreement (ACFTA) in order to diversify its trading partners and export destinations, in 2009 the subprime crisis immediately reduced Thailand's export growth to negative territory. This shows that Thailand is still vulnerable to fluctuations in the business cycle in the advanced economies, and this weakness has motivated policymakers to revisit their export-led growth policy.

The literature indicates that there are three possible transmission channels for financial crises. These are the financial channel (including both liquidity crunches and capital market slumps), the international trade channel, and contagion. Some research suggests that trade linkage between countries is one of the most important transmission channels for crises.

INTRODUCTION

The Association of Southeast Asian Nations (ASEAN) is a unique mixture of ten national economies at different stages of social and economic development, ranging from affluent Singapore to underdeveloped members, for example Myanmar, Cambodia and Laos. Embracing a more region-centred growth model, the process of ASEAN Community building has been monitored through various economic stimulus measures as well as the system of Dialogue Partnerships, the ASEAN Regional Forum, the ASEAN+3 process, and the East Asia Summit (ISEAS 2010) to successfully establish the ASEAN Community by 2015. The global uncertainties, however, remain potentially huge risks that will need to be effectively managed.

Since the Asian Financial Crisis in 1997, Southeast Asian countries have witnessed social deficits and the collapse of financial sectors. The process of ASEAN Community building has therefore been tested by uncertainties arising from internal and external challenges, particularly from advanced economies in the European Union, Japan, and the United States. These phenomena have significant implications on the establishment of ASEAN Vision 2020 and the plans for the ASEAN Community by 2015 (Srisangnam and Thamanovanish 2013).

The global uncertainties could thus be identified in terms of financial risks and non-financial risks, which illustrate the interconnectedness of economic and security issues within the region. ASEAN governments together with their counterparts, particularly those of ASEAN+3 countries, have been working closely to drive the region in the right direction.

FINANCIAL RISKS

Prior to the Asian Financial Crisis in 1997, most Southeast Asian countries had seen the flow of liquidity from European countries, the United States, and Japan injected into the global financial system — especially that of Southeast Asia — in search of higher returns. This short-term capital inflow owned by non-residents leads to the country's macroeconomic instability and harms the entire economy when the capital starts to flow out. The Global Financial Crisis in 2007 to 2008 deepened the financial turmoil in vulnerable Southeast Asian economies. The average GDP growth rate in ASEAN countries slowed down from 6.5 per cent in 2007 to 1.2 in 2009 due to export-oriented policies and weak macroeconomic management frameworks (SEAISI 2011).

Along with the global economic uncertainties generated by macroeconomic difficulties in advanced economies and the further economic slowdown of China, ASEAN is in dire need to restore confidence in the financial market, prevent the emergence of financial crises, and maintain growth.

INTRODUCTION

The countries of the Association of Southeast Asian Nations (ASEAN) are more regionally integrated and globally connected today than ever before. These features continue to grow, and have delivered significant benefits, but they also carry risks. Increased vulnerability to external shocks, as well as contagion that spreads rapidly across the region, are the main concerns. Five years after the global financial crisis (GFC), the economies of the United States and the eurozone continue to struggle, with the eurozone recovery lagging behind that of the United States. Monetary authorities have responded by sharply easing monetary policy. This has brought policy interest rates down to close to zero. Having quickly reached the interest rate floor, both the US Federal Reserve and the European Central Bank (ECB) have resorted to unconventional monetary policy through episodes of quantitative easing. The Bank of Japan, under new leadership, has recently followed suit. This has further increased liquidity in the banking system.

However, these policy moves have yet to produce the desired effect in the home countries, as private lending has failed to increase as expected. Banks are facing pressure to beef up their capital, making them hesitant to lend. Consumers and businesses are also reluctant to borrow as uncertainty remains high and confidence in the recovery remains low. All of this suggests that the problems in the eurozone are unlikely to end anytime soon. It also points to the very real possibility that the situation could indeed worsen. This remains true despite official figures showing that, technically, the recession in the eurozone came to an end in the second quarter of 2013. Nevertheless, the eurozone economy is still expected to shrink in 2013.

It is against this global backdrop that this chapter pays attention to the situation in Southeast Asia. How has the global financial turmoil affected ASEAN economies? Is there a real risk that this crisis could spread to the region? Given the fragility of the financial system, what are the possible effects of a shock to the eurozone financial system on the economies of Southeast Asia? This is a real possibility, given that vulnerability in the region has increased following massive inflows of capital and the buildup of debt related to successive bouts of quantitative easing, initially in the United States and now in Japan.

Driven by substantial cost advantages and proximity, industrialization processes have closely linked Singapore with its two immediate neighbours — the Malaysian state of Johor to the north; and Indonesia's Province of the Riau Islands to the south. Further encouraged by tax incentives, multinational firms headquartered in Singapore have established affiliates in one or both territories, and a well-developed network of couriers and logistics firms link operations across these locations almost seamlessly.

With a population of 3.3 million and a territory of some 20,000 square kilometres, Johor was, until recently, a plantationdependent economy. Following a downturn in agricultural prices in the 1980s, the state embarked on an export-oriented industrialization drive, seeking to “twin” with Singapore to acquire technological know-how and capabilities. A number of similar economic strategies have followed over the subsequent decades. At present, Johor houses one of Malaysia's three centres of industry, with an important concentration of electronics firms — many linked into Singapore-based regional headquarters. Of late, the state has sought to attract more value-added service activities, and, in 2012, its economy grew by 6.5 per cent (Department of Statistics 2013, p. 9).

To Singapore's immediate south, the Province of the Riau Islands (PRI) has a population of 1.7 million, and a land area of 8,200 square kilometres scattered across some 2,400 islands. The better known islands include: Batam, which includes the province's economic capital, Batam city, and much of its manufacturing sector; and Bintan, the site of the provincial capital, Tanjungpinang. As with Johor, the Riau Islands were agriculturally focused, and have experienced a similarly transformative industrialization process. Since 1990, substantial numbers of manufacturing firms have moved to the territory, linking the province to global production chains in the shipping and electronics sectors. At present, the secondary sector accounts for more than half of the PRI's regional Gross Domestic Product (GDP), making it one of the few locations outside Java to host significant manufacturing activities. Excluding the oil and gas sector, the Riau Islands is the second-richest province in Indonesia in per capita terms, growing at 7.6 per cent p.a. in 2011 (BPSb 2012, p. 147; BPSd 2014, p. 34).

The similarity in business cases put forward by Johor and Riau Islands Province — essentially more abundant land and cost-effective labour relative to Singapore — has meant that their industrialization processes have been quite analogous.

Multi-levelled government systems vary widely in how they allocate responsibilities and sources of revenue between central and non-central governments. While the optimal degree will vary from country to country, there are theoretical reasons for allowing sub-national governments to assume a significant role in stewarding their economies.

Proponents of what is called “first generation” fiscal federalism (FGFF) argue that responsibilities for service provision are best allocated according to where their benefits will be felt. Thus, services that deliver localized benefits are better provided by sub-national governments, as their closeness to end-users entails greater information regarding local needs and the best combination of taxes and services (Oates 1999).

In addition, sub-national governments are subject to market mechanisms to a greater extent than their national equivalents. Tiebout argues that, assuming perfect flows of information, firms and citizens will weigh a given state or province's tax burden and public services with its neighbours. Should a given territory's taxes or services be judged sub-optimal, firms and citizens will then “vote with their feet” for the jurisdiction that offers the best combination of both. This competitive pressure will improve efficiency, as states or provinces strive to retain investment and taxpayers (Tiebout 1956).

While theoretically sound, this work has been complemented by “second generation” fiscal federalists (SGFF). They first contend that it is relatively rare that countries satisfy most or all of the underlying assumptions needed for sub-national governments to effectively compete with one another. The necessary conditions for this so-called “market-preserving” federalism are: a clearly specified hierarchy and scope of authority for each level of government; a sufficient level of policy authority and autonomy for sub-national governments; a domestic market with freely mobile labour and capital; a hard budget constraint on sub-national governments; and the institutionalized allocation of political authority (Weingast 2009, p. 281).

For example, constitutionally specified revenue transfers or central government bailouts of state or provincial debt can undercut the potential of inter-provincial competition. And, clearly specified responsibilities for each level of government and sufficient policy autonomy for sub-national governments can be problematic in authoritarian political systems. This is because central governments in unitary and even most federal systems have the legal authority to intervene in states or provinces under “extraordinary circumstances”.

The previous chapter has looked at the “internal” state architecture of Malaysia and Indonesia as well as their political contexts in order to identify the implications these have for the incentive structures for regional leaders. With this as the backdrop, this chapter will compare and contrast the cases of Johor and the Riau Islands, seeking to understand when and under what conditions their respective leaders have chosen to pursue industrial transformation.

To this end, the two cases will be compared and contrasted over three periods. The first covers 1990–97, which is characterized by centralized state control and the pursuit of export-oriented industrialization in both countries. The second spans 1998–2003 — a transition period marked by the fallout from the Asian Financial Crisis in both countries, and, in particular, important structural changes in Indonesia — including the emergence of the Riau Islands Province as a discrete political entity. The third period comprises 2004–13, and is marked by direct competition between the two territories with each operating within dramatically diverging incentive structures.

The analysis for each of these periods will involve three parts. First, the context within which Johor and the Riau Islands were operating will be assessed, particularly Singapore's foreign economic policy and bilateral relations with Malaysia and Indonesia, respectively. Second, the political and policy context of each territory will be compared and contrasted, specifically the strategic choices of meso-level leaders — including their vertical strategies for engaging with their respective national governments and local electorates as well as their horizontal strategies for dealing with the private sector. Where relevant, structural changes in each country's internal architecture and, consequently, incentive structures for meso-level leaders will be brought in. Third, the progress of Johor and the Riau Islands towards structural transformation will be assessed, with specific reference to the development of the electronics sector.

1990–97: Mirror Images?

During this period, Johor and Riau Islands operated in similar national and regional contexts. Both Malaysia and Indonesia were authoritarian and centralized, and pursued exportoriented industrialization as a means of accessing markets and technology. Following a recession that hit the two countries in the mid-1980s, they relaxed investment and equity restrictions on foreign capital.