Malaysia’s investment policy
In 1991, a broad reform of Malaysia’s investment policy regime was carried out by phasing out tax incentives for exports and reducing the scope of the pioneer status. However, full tax exemptions were granted to investments in specific higher technology and strategic sectors. Incentives were increasingly tied to technological deepening, exports and domestic sourcing of inputs. Applications for pioneer status were to be more rigorously screened using four broad criteria: value added of 30-50 per cent, local content levels of 20-50 per cent, depth of technology and linkage effects (Felker and Jomo, 2002).
However, the East Asian financial crisis in 1997/98 spurred Malaysia to further liberalization. Restrictions on foreign equity in most new manufacturing investments were lifted regardless of export orientation (National Economic Recovery Plan, 1998). Exemptions from import duties were granted to imports of machinery and equipment locally unavailable, as well as to all inputs used in export production while a “hands off” attitude towards existing foreign investors’ compliance with the terms of their investment licences was explicitly declared (Felker and Jomo, 2002).
Finally, to conform with the WTO TRIMs Agreement the local content requirement was removed in 2000. For more than three decades, export growth has been an integral part of the development strategy of Malaysia. Since the early 1970s, a combination of favourable tax incentives, special zones and various export requirements have been used to induce TNCs to use the country as an export platform. Although the types of export oriented industries that qualified for incentives changed over the years (for example, from labour-intensive to high technology), the main goal has been the same: to industrialize via exports.
In 1968, under the Investment Incentives Act, tax exemptions were given to export-oriented industrial investments. Export oriented manufacturing was given a further boost under the Second Malaysia Plan, 1971-75, with more generous and effective incentive schemes. In the early days the key incentive for labour-intensive and export oriented investments was the establishment of free trade zones and, later, the granting of licensed manufacturing warehouse status. In the 1970s, ten free zones were established to attract FDI seeking to assemble and export electronics products as well as textiles.
These initiatives also provided subsidized infrastructure and duty-free imports of raw materials, intermediate products as well as equipment for the purpose of manufacturing and exports of products. With the Promotion of Investment Act, new incentives contingent upon export performance were introduced. In particular, the pioneer status tax holiday replaced the Investment Incentives Act and offered a five-year tax holiday, with an extension of five more years for selected productive activities, including export-oriented FDI.
The link to export performance was abolished in the 1990s, partly in response to WTO obligations (UNCTAD, 2002, pp. 206- 207). Export requirements were also linked to equity requirements. For instance, with some exceptions, investments that produced more than 80 per cent of products for export were allowed 100 per cent foreign ownership. This export requirement prevailed until 1998. These policies appear to have contributed to a dramatic structural change in Malaysian exports, with the share of manufactures in total merchandise exports rising rapidly from 12 per cent in 1970 to 85 per cent in 2001.
However, manufactured exports only displayed their rapid expansion after the mid-1980s. Furthermore, the exports of manufactures were heavily biased towards the electrical and electronics industry, which started to dominate manufactured exports during the 1980s. In 2001, that industry accounted for more than 70 per cent of manufactured exports. The increased exports, however, had a more limited positive impact on Malaysia’s trade balance, as imports of capital and intermediate goods also expanded fast.
It was only after 1997 that the trade balance improved significantly. The expansion of manufactured exports was closely correlated with a rapid increase in the volume of FDI approved. Of the FDI flows into Malaysia, the electronics industry accounted for a major part. As a result, Malaysia’s share of world electronic components exports increased from almost nothing in 1970 to about 10 per cent in 2000. Meanwhile, export-oriented FDI was also received in textiles and apparel, wood and wood products, chemical and chemical product and rubber products.
The creation of free trade zones and incentives contingent on exportation was important in this process but not the only determining factors. Foreign firms were also attracted by the availability of low-wage labour, reasonable infrastructure facilities and political stability. The export requirements and related incentives exerted their greatest influence on FDI in the electronics and textiles industries, which are not based on the presence of natural resources and are therefore more mobile.
Over time, export manufacturing has moved beyond the free trade zones partly in response to incentives granted to encourage industrial dispersion. At the same time, it is difficult to assess how important the export requirements were in encouraging inward FDI. Exports may well have increased even without such requirements since most of the FDI came mainly to take advantage of lower costs precisely for exports to markets in the United States, Japan and Europe. For such investments, Malaysia was an attractive and profitable production site.
Even recent export-oriented foreign investors like the Dell computer company, which came to Malaysia in the mid-1990s, testify that they picked this country as its Asia-Pacific centre “because of proven infrastructure, proven management talent, supplier base and pioneer status incentives” (interview). Although they were obliged to export 90 per cent of their output to retain full ownership that was never an obstacle, mainly because production at the outset was intended for regional and global markets, rather than for Malaysia. 2.
Employment A key development objective of attracting FDI to Malaysia has been to create new employment. In 1970, the share of Bumiputeras in manufacturing employment was only 29 per cent. In the second prong of the New Economic Policy, a target was set to increase this ratio to 50 per cent by 1990. A shift towards the promotion of labour-intensive industries was initiated in the late 1960s and continued up to the early 1990s. Employment requirements were introduced in 1972 with the introduction of the Labour Utilisation Relief incentive.
It provided increasingly generous tax exemptions for pioneer status industries the greater the number of full-time employees. Under the Industrial Co-ordination Act, the manufacturing licence had ethnic composition requirements attached at all levels of employment to encourage firms as far as possible to recruit more Bumiputera workers at all levels. The employment requirements continued into the 1990s. Manufacturing employment grew dramatically from 318,000 in 1970 to 2,126,000 in 2000, corresponding to a doubling of its share to 23 per cent of total employment.
This contributed to a reduction of unemployment to below 4 per cent. Since the economic downturn that began in 2000, however, a number of TNCs in electronics have decided to relocate some activities from Malaysia (notably to China), with a resulting increase in unemployment. Data on investments approved by the Malaysian Industrial Development Authority (MIDA) show that of the 7,385 approvals granted between 1972 and 1986, only 90 (just over 1 per cent) received the Labour Utilisation Relief incentive.
Furthermore, these 90 projects generated a mere 16,749 job opportunities, as compared with the more than 730,000 jobs created from projects approved during the same period. This, however, does not necessarily mean that the Labour Utilisation Relief incentive was ineffective. Rather, since projects can only enjoy the pioneer status or the Labour Utilisation Relief incentives, most projects were aimed at acquiring the more attractive pioneer status. According to information from MIDA the unemployment rate was 3. 6% in 2001 and is estimated to be 3. 5% for 2002.
While it was relatively easy for firms to comply with requirements to increase overall Bumiputera participation, ensuring that Bumiputera were adequately represented at various levels of employment has been more challenging. Still, interviews with both foreign and local firms have shown that conscientious efforts were taken by many companies also to recruit Bumiputera employees, at the higher levels, but often with limited impact. In the absence of detailed national statistics, employment data for industries located in Penang can serve as an illustration. In Penang, Bumiputera employment is mainly concentrated in the lower hierarchies.
Although significant improvements were registered in the supervisory category, Bumiputera representation at the managerial level remains low. While the employment requirements may have incurred some cost concerns, interviews and other evidence do not indicate that they have deterred FDI in Malaysia. Firms need workers, and since the Bumiputera ethnic ratio is higher, it stands to reason that anyway they would generally hire more Bumiputera workers. The entry of Bumiputeras into the manufacturing labour force also helped to keep wages down during the expansion phase.