Economics of Asia: FDI and Economic Development in Malaysia
It is common to argue over the role foreign direct investment (FDI) plays in the economic growth of a country. Developing economies have especially positioned themselves through laws and polices meant to attract FDI into the country; the guess for these incentives is that FDI has the potential to influence the local economy positively (Mun Lin and Man 11). Questions, however, present themselves over this assumption, fueled by the inability to see any positive influence of FDI in some developing economies. Malaysia is one of the countries that have historically been a recipient of FDI since the 70s (Mun Lin and Man 11). The country has seen a generous flow of FDI over the years, a factor attributed to the inflows of FDI into the country. Is it then possible, that FDI has a role to play in the country’s current level of development? Does FDI only have positive attributes to the recipient country, or does it have its disadvantages? While FDI is a tool for growth and economic development in small economies, Malaysia in particular, it has its problems as a growth model and requires small economies to look at it carefully, before wholly depending on it for economic development.
FDI and Development
Tearing down FDI, the discovery is that it is an international strategy where companies establish their presence in other countries. The companies responsible for FDI do this through the acquisition of productive assets (Shaari, Hong and Shukeri 100). In investing in the foreign countries, the companies hope to gain better returns, expand the market of their products, as well as enjoy the economies of scale that the foreign markets offer such as cheap labor, lowered to zero taxes or less operational regulations and restrictions.
Many developing nations believe that FDI can be a source of economic development for the countries. So much is the belief in FDI that such nation’s policy makers work to provide incentives for FDI including the creation of export processing zones, providing land or premises for operation of multinational companies (MNCs), in addition to offering tax incentives in the hope of attracting even more FDI (Shaari, Hong and Shukeri 100). With FDI increasing over the 90s, particularly in developing countries, there have been questions over the very advantage that FDI brings to the developing countries. As such, there have been many empirical studies looking into the benefits that come with FDI in both developed and developing nations. From the studies, it is clear that blanket assumptions of FDI as beneficial to the receiving nations, particularly developing nations, is dangerous without the consideration of the complexities of the relationship between FDI and economic growth and development.
Despite the questioning of the ability of FDI to spur growth and development in the developing nations, there is evidence of direct relationship between FDI and growth of gross domestic product (GDP) of the receiving countries. Studies of South-East Asia and Latin America, areas that have had a long relationship with FDI discovered a positive relationship between FDI and GDP (Shaari, Hong and Shukeri 101). Countries such as Brazil, Argentina, India, Chile and Guatemala have shown a positive relationship between FDI and development.
Studying the relationship between FDI and development must take into account several factors, before a conclusion on whether or not FDI has a positive or negative influence on a country. It is for this reason that empirical work into the relationship looks at different channels including the direction of causality between the two variables; determinants of growth; determinants of FDI; and the role of MNCs in the host countries (Duasa 84). Using these channels, studies have found positive effect between FDI and growth, especially as they relate to balance of payment features including savings, imports, investments, and economic growth (Duasa 84). The exception for a positive relation on FDI is on exports, which have been lagging according to the studies (Duasa 84). Noteworthy, however, is that the working of FDI and its relationship with balance of payment cannot be generalized. To prevent generalization, it is necessary to remember, “The balance of payment effects of FDI activity varies across countries and depends on the purpose on investments, the nature of the activity and the age of the project” (Duasa 84). There is no proof driving one into believing that MNCs contribute more or less to the balance of payment in the said country than local firms.
Perhaps what needs consideration in looking at the relationship between FDI and economic growth and development of the host country is the country’s preparedness to receiving the FDI and make a positive contribution to its economic growth. The preparedness in this case is the presence of human capital. According to Shaari, Hong and Shukeri “The foreign direct investment had a high productivity effect on a country’s economic growth when a country had a minimum threshold stock of human capital. It was obvious that foreign direct investment could lead to economic growth with the support of productive human capital” (101).
The positive attribute of FDI as it relates to the presence of human capital further relates to the development of the human capital. Over the years, FDI has increased the demand for skilled labor in the host countries. The demand for skilled labor in turn helps in the development of knowledge in education, training, public good, research and development, all of which generate spillover effects to other areas of the developing nations (Tanggapan et al 26). The result is that the “technical progress and growth can be based on creating a new knowledge by adopting and transferring existing technology, hence developing countries has the potential to grow faster than developed countries” (Tanggapan et al 26).
However, despite the studies, a number of factors work together for the positive attributes FDI to manifest themselves. In the absence of these factors, FDI is only beneficial to a small part of the host country, while the rest of the country remains underdeveloped. China is an example of a country, whose industrial areas and cities are well developed, while the rural population remains underdeveloped. Based on the location advantage theory, FDI only helps locations with high concentration of human labor, while leaving the other areas of the country underdeveloped (Tanggapan et al 26). Moreover, despite human capital development, lack of capital prevents the possibility of converting the technology and technical skill into any meaningful potential for the host country. Issues such as corruption, poor governance, ineffective policies, political will, tribalism, and unequal distribution of resources all work against any meaningful benefit from FDI and spillover effects of MNC operation in the host countries.
Trends and Patterns of FDI in Malaysia
Malaysia has been one of the recipients of FDI in Asia. Between 1970 and 2004, the country has been one of the major FDI recipients, most of the FDI growing from the 70s (Mun, Lin and Man 12). Up to 1974, inflows of FDI into Malaysia increased, declining slightly in 1975 due to a great recession that hit the country (Shaari, Hong and Shukeri 101). After the recession, FDI into the country started increasing again, as evidenced by figure 1. Between 1975 and 1990, the inflows of FDI into Malaysia had grown twenty-fold, moving from $94 million to $2.6 billion, even with the fluctuations in between the years (Shaari, Hong and Shukeri 101).
Between 1983 and 1985, FDI into the country reduced due to a recession that had hit the world at that time (Shaari, Hong and Shukeri 101). The world recession meant that not many countries and MNCs had the resources to expand into other countries. In addition to the world recession, the world was also experiencing an electronic crisis. The steady increase in FDI inflows into the country experienced a slowdown in incoming FDI, particularly in the 90s. The years 1993, 1998 and 2001 particularly experienced huge drops in FDI inflows into the country. The drop in FDI inflows in 1993 was because of reduced investment into the country by two of the main investors of the country: Japan and Taiwan (Mun, Lin and Man 12). Relative to the wages of other Asian countries, Malaysia had raised its wages, making the country uncompetitive. China, Vietnam and Indonesia all had lower wage rates than Malaysia, a fact that investors took seriously, therefore reducing their investment in Malaysia and looking into other possible countries for investment.
Foreign direct investment into Malaysia reached its highest point in 1996 when the country received $7.3 billion dollars. However, the financial crisis that hit Asia in 1997 also affected the country’s FDI inflows, which saw the inflows dropping from $7.3 billion in 1996 to just above $5 billion in 1997 and later to less than $3 billion in 1998 (Mun, Lin and Man 12). The crisis had affected most of the Asian countries, affecting the inflows of FDI in the other countries as well. From 2000, however, FDI inflows into the country have been uneven, moving up and down randomly (as seen in figure 1). The erratic trend of FDI inflows into the country after 2001 has the attack on World Trade Center in the U.S. to blame (Shaari, Hong and Shukeri 101). The attack worked to dull investor confidence in FDI, particularly in Asia, where there is general assumption that the attackers came from. Malaysia, however, has managed to maintain an average of $3 billion a year in FDI inflows.
Figure 1. FDI inflows to Malaysia 1970-2004. Source: Shaari, Hong and Shukeri
Looking at the trend of FDI inflows into the country, the period from1987 saw an increase in FDI inflows into the country. During this time, the country had adopted the Industrial Master Plan 1986-1995, whose purpose was to encourage FDI into the country (Shaari, Hong and Shukeri 101). The Master Plan brought changes to the Malaysian economic environment, making it fairly open, reducing tariffs to around 15 percent, and removing non-tariff barriers and foreign exchange controls (Mun, Lin and Man 12). The factors helped drive FDI into the country making it the second fastest growing economy in Southeast Asia with more than eight percent in GNP (gross national product) growth between 2001 and 2008 (Mun, Lin and Man 12). Moreover, “With a stable political environment, increasing per capita income, and the potential for regional integration throughout the Association of South East Asian Nations (ASEAN), Malaysia is an attractive prospect for FDI” (Mun, Lin and Man 12).
Foreign Direct Investment and Economic Growth in Malaysia
More than being one of the fastest growing economies in the world, Malaysia is the 29th largest economy by purchasing power parity, its GDP estimated at $357.9 billion as of 2007 (Karimi and Yusop 3). The country recorded steady growth between 1970 and 2005, with an annual average growth rate of 7 percent (Karimi and Yusop 3). Much of this growth is related to the openness of the economy in addition to relatively lax economic policies, which have made the business environment relatively favorable. Malaysia’s open economy makes it vulnerable to external events among them the oil crises of the 70s, electronics crisis in the 80s and the Asian financial crisis in 1997. These external events had especially pronounced effects on the country’s economy and FDI inflows as seen in figure 1. The impact of the Asian financial crisis took a long time, having been felt even in the early years of the 21st century.
Over the 30 years between 1970 and 2000, there was a positive change in the standards of living for the majority of the population as well as an improvement of GDP per capita (Karimi and Yusop 3). By 2000, Malaysia’s GDP had grown to become four times that of the country in 1970 (see figure 2). Between 1988 and 1996, Malaysia’s economy grew by about 7 to 10 percent per annum (Karimi and Yusop 3). Of the different sectors of the country’s economy, the manufacturing sector was the main source of the growth in GDP, contributing 31.4 percent of the GDP in 2005 (Karimi and Yusop 3).
Figure 2: GDP in Malaysia (1970-2005). Source: Karimi and Yusop
FDI is responsible for the strong economic performance and development experienced in Malaysia. Reforms in policies have chiefly been the main drivers of the increased inflows of FDI between 1970 and 2005. According to Karimi and Yusop,“the introduction of the Investment Incentives Act 1968, the establishment of free trade zones in the early 1970s, and the provision of export incentives alongside the acceleration of open policy in the 1980s, led to a surge of FDI in the late 1980s” (5). These large inflows of FDI not only improved the economy, but also helped the country achieve better levels of human capital development and technological advancements.
The Malaysian government put measures in place to encourage higher inflows of FDI into the country. Apart from the policy and legislative incentive mentioned above, the government also allowed larger percentage ownership of foreign equity in companies through the Promotion of Investment Act (PIA) of 1986. PIA encouraged larger inflows of FDI into the country after its passage in 1986 (see figure 1), growing the inflows by an average of 38.7 percent between 1987 and 1996, only slowing after the Asian economic crisis. It is important to point out that during the period of large inflows of FDI into Malaysia, the country’s GDP also increased significantly (see figures 1 and 2). Apart from these policy incentives, however, good macroeconomic management, constant economic growth and the availability of a functioning financial system helped make Malaysia attractive for FDI (Karimi and Yusop 5).
During the country’s exponential GDP growth period, which matched the increased FDI inflows, the manufacturing sector contributed the highest to the GDP. Major FDI inflows into the country were in the manufacturing sector including electronics and electrical products, scientific and measuring equipment, plastic products, chemical and chemical products, metallic products, non-metallic mineral products and food manufacturing (Karimi and Yusop 5). Indeed, FDI was the major driver of economic growth and development in Malaysia.
A study by Duasa, however reports a contrary conclusion in relation FDI and economic growth in Malaysia. Duasa argues that there is no direct causality between FDI and economic growth in Malaysia, apart from the fact that FDI inflows stabilize economic growth (Duasa 95). This argument, while pointing to the lack of relationship between FDI and economic development in Malaysia, still insists on the importance of FDI as an element in economic growth and stability of the country.
As a developing country, Malaysia has seen growth over the past four decade. There was specific exponential growth with increased FDI through the periods between 1970 and 2005. The evidence of growth during this period, and the slowing of growth at the reduced FDI inflow points to a direct relationship between FDI and economic growth in the country. Sustaining high FDI inflows is a difficult task for any country, and while FDI plays an important role in attracting the much-needed capital for economic growth and development, it is important for developing countries to be inward looking in their quest for economic stability. Malaysia has proven that FDI has contributed, in a large part, to its economic development. However, with reduced inflows of FDI, the country must look at other ways of growing and sustaining its economic development.
Duasa, Jarita. “Malaysian Foreign Direct Investment and Growth: Does Stability Matter?” Journal of Economic Cooperation, vol. 28, no. 2, 2007, pp. 83-98
Karimi, Mohammad, S. and Yusop, Zulkornain. “FDI and Economic Growth in Malaysia.” MPRA Paper No. 14999, 2009, pp. 2-23
Mun, Har, W., Lin, Teo, K. and Man, Yee, K. “FDI and Economic Growth: An Empirical Study on Malaysia.” International Business Research, vol. 1, no. 2, 2008, pp. 11-18
Shaari, Mohd, S., Hong, Thien, H. and Shukeri, Siti, N. “Foreign Direct Investment and Economic Growth: Evidence from Malaysia.” International Business Research, vol. 5, no. 10, 2012, 100-106
Tanggapan, Derrick et al. “The Relationship between Economic Growth and Foreign Direct Investment in Malaysia: Analysis Based on Location Advantage Theory.” International Journal of Economics and Management Sciences, vol. 1, no. 2, 2011, pp. 24-31