Research Proposal 2009

STUCK IN THE MIDDLE:

Malaysian Industrial Transition Standstill

December 2009
First draft

Andrew Kam Jia Yi

(U4078984)

  1
 Table of Contents

No. Contents Page

1.0 Introduction 4

1.1 Scope of the study 8

2.0 Theoretical framework: The middle income-trap 8

3.0 Possible research questions and objectives of the study 12

4.0 Analytical narrative on Malaysian economic development 13

• Supporting the Manufacturing Sector: Industrial policies 20

• Supporting the Manufacturing Sector: Fragmentation trade in

23
electronics industry.

5.0 What kept Malaysia in the trap? : Review on various hypotheses 25

• End of surplus of labour and rising real wages 25

• Internalizing technology & technology absorption challenges: Low

26
Industrial human development and Weak support linkages

• Social and ethnic restructuring policies 31

(a) Education 31

(b) Ethnic-oriented ownership policies 33

• Dwindling export competitiveness 36

6.0 Research Proposal – testing the elements. 42

• Proposed Thesis Chapters 45

 

  2
 List of terms

FTZ - Free Trade Zones

ICA - Industrial Coordination Act 1975

IGS - Industry Research and Development Grant Scheme

IRPA - Intensification of Research in Priority Areas

MASTIC - Malaysian Science and Technology Information Centre

MIDA - Malaysian Industrial Development Authority

MIGHT  - Malaysian Industry - Government Group for High Technology

MIMOS  - Malaysian Institute of Microelectronic System

MITI - Ministry of International Trade and Industry

MSC - Multimedia Super Corridor

MTDC - Malaysian Technology Development Coorporation

NDP - National Development Policy

NEP - New Economic Policy

PNC - Parts and Components

  3
 Stuck in the Middle? – Industrial transition in Malaysia

“History shows that while many countries have been able to make it from low-income to
middle income, relatively few have carried on to high income…”

- World Bank’s East Asia and Pacific Update 2007 “ East Asia 10 years after crisis”

1.0 Introduction

The report from the World Bank carried two noteworthy messages: on the negative, it
highlighted the difficulty of middle-income countries in graduating into the high-income level,
but on the positive side, “the relative few” successful ones showed that graduation is not
impossible. Therefore, this announced a challenge for a middle-income country such as Malaysia
to move away from its current status to join the ranks of developed countries in the world. To
further illustrate the concerns, it is pertinent to first look at various formal categorizations of
middle income countries and a few caveats on measuring what “economic graduation” entails.

First there is a need to understand what is being measured. For example, according to the
World Bank 1 , a country is classified as ‘high income’ when the per capita wealth of its nation
exceeds USD 12,000. Figure 1 shows the changes in GNI per capita between various middle-
income countries in comparison with aggregated high-income countries. Based on the
benchmark set by the World Bank, for over 30 years, Malaysia has been “stuck” within the
middle-income bracket. In fact, Malaysia’s GNI per capita was higher than Korea in the 1960s
until early 1980s. While Korea today achieved “developed” status, Malaysia is still progressing
slowly towards that stage. The bigger question here is whether the approach hinging solely on
rigid income categorization should be the main criteria for measuring upgrading. This
benchmark should not be the panacea of success as it does not reflect the general development
status of a country. Furthermore, there are also arguments that the measurement (GNI per capita)
suffers from a number of limitations (Rajapatirana S, 2006), hence there should be some
measurements that encapsulate the development dimension when assessing the wealth status of a
country.

                                                            
1
Economies are divided according to 2008 GNI per capita, calculated using the World Bank Atlas method. The
groups are: low income, $975 or less; lower middle income, $976 - $3,855; upper middle income, $3,856 - $11,905;
and high income, $11,906 or more.

  4
 Figure 1: GNI per capita (USD)

Source: WDI Online.

Going beyond income measurement, the United Nations (UN) benchmarks the
development status of a country in the form of Human Development Index (HDI) 2 . As argued in
the Human Development Report (HDR), HDI provides a much more complete picture of a
country’s development than other indicators such as GDP per capita. The index is a combination
of life expectancy index, education index and standard if living. Table 1 below shows the
performance of the index and country ranking based on the 2009 report 3 .

Table 1: Human Development Index.

Country 1980 1985 1990 1995 2000 2005 2006 2007

Rank Country
10 Japan 0.887 0.902 0.918 0.931 0.943 0.956 0.958 0.96
23 Singapore 0.785 0.805 0.851 0.884 n.a n.a 0.942 0.944

Korea
26 0.722 0.76 0.802 0.837 0.869 0.927 0.933 0.937
(Republic of)
66 Malaysia 0.666 0.689 0.737 0.767 0.797 0.821 0.825 0.829
87 Thailand 0.658 0.684 0.706 0.727 0.753 0.777 0.78 0.783
105 Philippines 0.652 0.651 0.697 0.713 0.726 0.744 0.747 0.751
111 Indonesia 0.522 0.562 0.624 0.658 0.673 0.723 0.729 0.734
Source: Human Development Report 2007 n.a – not available.
                                                            
2
A HDI < 0.5 and below represents “low human development” and a HDI > 0.8 represents “high human
development”. Develop countries have HDI > 0.9 represents “very high human development” (2007)
3
2009 HDI represents statistical values for year 2007

  5
 The table shows that Malaysia, Korea and Singapore, were all below the “high human
development” level in 1980. Singapore and Korea moved into “high human development” in the
1990s and it took them less than 20 years to enter the “very high human development” category.
Clearly, this shows that there have been differences in development intensity rather than delayed
starts. Improvements in HDI for Malaysia and other Southeast Asian countries (excluding
Singapore) have been very slow. Although the HDI provided an outline on the criteria for
moving into a higher development level, this measurement has also been questioned in different
fronts – relating to coherence, multidimensionality, ambitions, robustness, sensitivity and
universality (McGillivray M, 1991; Mozaffar Q, 2002; Bryan C, 2009). The general conclusion
here is to emphasize that measuring income and development levels between countries should
not be bounded entirely by the tyranny of these formal definitions.

Second, instead of solely using indicator-based analysis, comparative analysis on the

productivity of successfully graduated countries can share light on the path towards graduation.
Comparison studies can also indicate the developmental goals that a country should aim for in
leveling up. For middle-income countries, catching-up in terms of productivity and income
convergence into a higher level is not impossible under certain conditions. In fact, according to
some literatures, being “backward” has its advantages (Gershenkron 1962, Abramovitz. M,
1986; Paul. D, 1994). However, there are also studies that showed the speed of catching-up is
variable and not confined to “backwardness” (Ohno. K, 2009).

Figure 2: Different Speed of Catching Up

Source: Author’s Calculation from WDI

  6
 Figure 2 shows the per capita of income (based on World Bank Atlas Method) on
selected economies relative to the United States level. Since 1960, these economies showed no
signs of catching up (except for Singapore). The obvious laggards seen in the figure are the
Southeast Asian countries. Compared to the per capita income of the US, Malaysia, Thailand,
Indonesia and Philippines are stuck below then 20th percent of US per capita GNI since 1965.
Hence, this counters the idea that there exists an advantage for productivity lagging country in
catching-up. The diverging growth performances come from the variable speed in catching up. It
can be vaguely concluded that it is not because of the general “latecomer” argument. However,
this analysis should also be treated with caution on grounds of internal heterogeneity such as
differential in historical and initial conditions, political and institutional complexities, social
diversity, labour capabilities, economic policy orthodoxy and exposure to globalization –
involvement in global production and network in trade and services.

When drawing examples from “graduated” countries, one should consider the factors
above before making general conclusions: for there is no one-size-fits-all model. For example,
Korea moved from a war-torn country in the 1950’s into the OECD, a club of advance industrial
countries in 1996. It is difficult to take Korea experience into the Malaysian context because the
latter relied heavily on FDI support in manufacturing and technology upgrading while the former
imposed a restricted FDI regime (Hill H, 2001). Taiwan, a country which fled from Mainland
China in 1949, became the leading producer of electronic products in 1980s. In parallel, Taiwan
struck some similarities with Malaysia in ways of pillaring growth on small manufacturing
enterprises (SMEs). However, in the Malaysian context, there is an additional emphasis on the
social dimension that has to comply with the national agenda on the development of SMEs 4 .
Therefore, it is difficult to pin down the ideal growth trajectory. However, the more feasible
approach is using the result-based identifications. Questions on how to improve the current
economic performances rather than searching for a static target to upgrade, forms the main focus
of this research

                                                            
4
The New Economic Policy in 1970 and The Industrial Coordination Act 1975 attempted to close the social
economic gap between ethnic groups. The Malays and the indigenous groups (Bumiputeras) are the poorest circa
1970.

  7
1.1 Scope of the study

This study will focus on Malaysia for a few particular reasons. First, among the Southeast
Asian middle-income countries, Malaysia stands out as the one with the highest potential in
terms graduating from the middle (refer Figure 1 and Table 1). Malaysia has actually set the
target of being a modern country (in its own mould) by year 2020 (now reassessed into 2030)
under its Vision 2020 initiative. Therefore, this research will provide a fertile ground for analysis
in terms identifying the general “it” factor that separates the rich and the middle income nations.

Although moving from middle into high-income requires upgrading in various political,
economic and social aspects, the emphasis of this study will be the economic dimension. In
general (at least in Southeast Asia), middle-income countries participated heavily in the
manufacturing sector. The declining share of agriculture and the rising share of industrial
production reflect the most common patterns of structural changes in developing countries
(Perkins, Radalet & Lindauer, 2006). Malaysia’s manufacturing share of its GDP is almost 30%
in 2008 (Bank Negara Report, 2008) and the average manufacturing share of its total exports
between 2006 to 2007 accounts to almost 80% (Athukorala & Hill, 2009). Therefore, it is not an
overstatement to say that the manufacturing sector is the main growth engine of Malaysia. This
justifies the reason why this sector is selected as the main focus of this research.

This study will attempt to capture the Malaysian industrial transition process beginning
post-independence period from 1957 to 2009 (subjected to data availability). It will focus on
both internal (domestic policies and industrial efforts) and external forces (globalization
management) that changed the face of industrialization in Malaysia over the years.

2.0 Theoretical framework:

The middle income-trap

Studies on the transition of middle-income into high-income countries have received

marginal attention in the past. Equally lesser can be mentioned about studies that explains the
middle-income trap phenomenon. This is due to the immense amount of emphasis being
concentrated towards graduation issues of least developing countries (LDCs); which if viewed in

  8
terms of severity requires greater attention 5 . The most current theoretical framework was
produced by Kenichi Ohno (2009) 6 . Figure 3 below shows the analytical framework used in
explaining the middle-income trap or “the glass ceiling” that is preventing ASEAN countries
from moving on to the next level.

Figure 3: Middle-Income Trap Framework

Source: Kenichi Ohno (2009)

According to the figure, there are four stages in industrialization catching-up. A low
income country basically starts at stage zero. This stage consists of countries that have either just
obtained independence or have just gone through a period of political turmoil (war). Initially,
agriculture is the key engine of growth and trade relies heavily on monoculture exports. There

                                                            
5
For example, the Economic and Social Council of UN have used a set of criteria identifying the lists of LDCs –
low income, human resource weakness and economic vulnerability index, and conducts triennial reviews to identify
graduation status if a country from the list. No such exercise being conducted for middle-income countries. The
Asian Development Bank (ADB) also monitors LDCs status in offering the Asian Development Fund (ADF) – for
Group A, B1 and B2.
6
The interesting contrast between this model and the famous Akamatsu (1962) “flying-geese” paradigm is the
direction of development. While Ohno (2009) structure the model as an upward industrial movement, Akamatsu
(2009) depict the phenomenon as a trickle down effect from developed to developing nations. While Japan may be
the head of the flying-geese formation, the more interesting issue here is how middle income countries can fly in
parallel with Japan.

  9
are also countries that relied heavily on foreign aid for its development. Public policy emphasis
in this stage pivots on meeting subsistence level of needs.

Based on the East Asian experience, the arrival of manufacturing FDI firms is
considered the economic take-off factor into the first stage of industrialization. Manufacturing
activities consists of simple assembly and light industry products for exports such as footwear,
garments and foodstuffs (Ohno. K, 2009). Almost 30 years ago, Malaysia and Singapore were
also in this stage. Influx of Japanese FDIs into the country started off with labour intensive and
low-skilled assembly activities in the electronics and component manufacturing sector. Key
materials and parts were imported while technology, designs, productions and marketing
decisions were all under the control of foreigners. There was an increase in employment
opportunities but the internal value-added was small. Vietnam is the country best represented in
that stage at this moment in time. The accumulation (from the previous stage) of FDI and the
expansion of production activities has created economies of scale. The economy of
agglomeration slowly takes its form and indirectly, moves the country into the second stage.

At the second stage, foreign firms have already established a range of network and
linkages with local suppliers. The supply of parts and components will increase due to the
spillover of experiences from foreign firms that consequently created a network of local
suppliers. Assembly firms will therefore face more competition (Ohno. K, 2009). The industry
will expand due to the increase of physical inputs supplied internally (and externally depending
on the level of skills required to produce its parts and components). Malaysia and Thailand are
the best example of countries sitting on this stage. Even though internal value creation has
increased fairly, the dependence on foreign firms still remained substantial – especially in areas
of foreign technology and management. Breaking free from the over dependency on FDI is one
of the key element in moving upward. This requires substituting the skills and expertise of
foreign firms with local ones. Obviously, in order to achieve that, there is a need to absorb as
much knowledge and experiences (both hard and soft skills) as possible from them.

Upon absorbing sufficient knowledge to internalize skills and build human capital, the
country is ready to gradually replace foreign producers with home-grown ones. The increase in
local participation in production process will indeed increase internal value in areas such as
management, technology adaptation (minor innovations), moderate product creations and

  10
independent decision making in marketing strategies. Products created will be better in quality
compared to previous stages and embeds higher technological content. Thus, export values will
increase substantially along with its export share in the world. Korea and Taiwan are example of
countries that have reached this stage. Both are major players in the global ICT industry, housing
major conglomerates such as Samsung, LG, Acer, ASUS; with Korea being more diversified in
the automotive industry as well (Hyundai, Kia, etc). Although for year 2006/2007, Malaysia has
almost equal world export shares in ICT product with Korea 7 , the differences lie in the global
presence of Korean indigenous manufacturing firms and its higher value-added element of
exported 8 goods.

The proposed final stage involves creativity, innovation and the ability to adapt to the
changes in global demand. These factors separate the leader and follower within the high-income
groups. Japan, US and EU are countries that have reached this stage.

Countries in stage three and beyond are considered developed with high per capita
income. Therefore the transition from Stage two into Stage three forms the main interest of this
research. Breaking the glass ceiling is a difficult task not just for Southeast Asian countries, but
for middle-income countries in general. For that reason, it is defined as the middle income trap.
Taiwan and Korea are “the relative (successful) few” that fit the description quoted by the World
Bank report at the beginning of this chapter. Malaysia is known for having consistently
successful economic performance with favorable historical conditions and physical infrastructure
(Hill. H, 2005). Yet these complimentary features are still insufficient in bringing the country
into high-income status. The mystery deepens even more taking the fact that Malaysia was also
regarded as one of the earlier industrial movers in the region back in 1970s.

                                                            
7
Korea 6.5% and Malaysia 6.0% (Hill. H & Athukorala. P 2009)
8
Malaysia and Korea are both heavily involved in global production network, producing parts and components for
ICT trade. While export data may have been on par with Korea, the domestic value added remained low due to
foreign firm manufacturing activities concentrated mostly in (labour intensive) assembly operations in electrical
goods and electronics, and diffused-technology consumer goods production. There is also a limited spread effect of
FDI through backward linkages and technology transfer (Menon, J & Athukorala P.C 1996). However, to be fair, the
conditions have slowly changed since then.

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3.0 Possible research questions and objectives of the study

Based on the previous section, the big question focuses on the middle income trap. The
main debate here questions why the Malaysian industrial transition has come to a standstill. The
first objective is to take an intricate look at the success story of this country and identify forces
that have contributed to Malaysia’s economic growth over the years. The plan here is to draw an
understanding on the development processes that have taken place in Malaysian during post-
independent period. The development process will help draw the background setting of the
analysis.

The bigger question this research attempts to answer is to identify what are the forces
preventing Malaysia from breaking away the middle income trap. The objective of this section is
to identify all possible hypotheses and test their validity to identify the critical factors that have
kept Malaysian manufacturing sector behind the glass ceiling. Analysis will cover both internal
and external forces that may (or may not) affect the development progress of this sector. Ohno’s
framework (figure 3) assumed that external competition is at equilibrium and countries can move
up the ladder in line with the existing global competition. There should be some focus on the
global economic environment as well. However, external factors beyond the control of domestic
government should not be used as defense of being stuck in the middle. Rather, the management
of these factors (i.e. globalization) should be crucial in determining economic success. (Stiglitz,
2006 pp.4).

Finally the biggest question of all is how. How to break away from the middle-income
trap? The objective here is to attempt a tailor-made solution for Malaysia by addressing the
impeding forces that is holding the nation back. Since the focus of this research is on the
manufacturing sector, the objective of this final section is to identify various determinants of
middle-income trap. This may provide long and short-term policy suggestions either on a
nationwide context (i.e for the Economic Planning Unit, EPU) or specific policies targets for
various involved ministries in the sector (i.e MITI, MIDA, MASTIC, etc). As mentioned earlier,
there is no one-size-fits-all model but looking at the Malaysian experience might just expand the
scarce literature on middle-income trap.

  12
4.0 Analytical narrative on Malaysian economic development

• On the surface

On the 31st of August 1957, Malaysia (or Malaya pre-1964) achieved its independence
from the British colonial rule. Despite having a fusion of different political views, culture and
identity from a dominantly plural society, the transition into independence was peaceful, smooth
and relatively well prepared compared to other colonies (Hill. H, 2005; Menon. J, 2008). The
mix of different ethnic groups handed an early challenge for the then-ruling party to perform a
balancing act between economic growth, income redistribution and preserving harmony. The
early post-independence characteristic of the Malaysian economy inherited the same spirit that
was introduced by the British 9 , namely, an export-oriented regime, a country with well
developed infrastructure system, minimal state interventions and a well-organized government
administration.

Since independence, the structural changes in Malaysian economy followed the natural
pattern experienced by most developing countries namely, a shift out of the agriculture and into
the industrial sector. Figure 4 depicts the mentioned scenario. Value added share of agriculture
decreased along with the rise of manufacturing sector. This pattern mirrors the employment trend
when there is also a shift of employment share from the agriculture into the expanding
manufacturing sector. In shades of Lewis Model (Lewis. A, 1954), the end of labour surplus
arrived in late 1980s. The luxury of having a low manufacturing wage is slowly diminishing
starting from the “turning point”. Figure 5 shows the rise in manufacturing wage since mid
1980s, signaling the end of labour surplus for Malaysia. There are various internal and external
forces that may have contributed to the expansion of the manufacturing sector. First, before
identifying them in specifics, there is a need to understand the salient factors that have
contributed to the general success story of the Malaysian economy. These fundamental forces are
complementary to the accomplishment of the present Malaysian manufacturing sector. In line
with the first objective of the paper, the selected few are listed in Table 2 below.

                                                            
9
Some scholars attribute the early success of the Malaysian economy was attributed to the impact of colonialism
before independence (B. Higgins, 1976). This was echoed by the “inherited institutions” argument that contributed
to Malaysia’s high growth success story (Hill. H, 2005).

  13
Figure 4: Structural Change in the Malaysian economy

Value Added and employment by economic activity

60.0
Agri
50.0

% total employment
Manufacturing
(% of GDP)

40.0

30.0 Services

20.0
Employment Agri
10.0
Employment
0.0 Manufacturing
Employment Services
19 0
19 5
19 0
19 5
19 0
19 5
19 0
20 5
20 0
20 5
07
6
6
7
7
8
8
9
9
0
0
19

year

Source: WDI note: Employment figures are based on share in total employment

Figure 5: Change in total manufacturing wages

Wages and Salaries

10.00

8.00
Billions (US)

6.00
Malaysia
4.00

2.00

0.00
89

01

04
74

77

80

83

86
68

71

19

19

20

20
19

19

19

19

19

19

year

Source: ILO *Data from 1990 – 2000 is unavailable.

  14
Table 2: Malaysia Development: Stylized facts

Growth by Decade (%)

1961- 1971- 1981- 1991- 2001-
Country / Year 1970 1980 1990 2000 2008 Volatility*
Indonesia 4.2 7.9 6.4 4.4 5.2 89.5
Japan 9.4 4.5 4.0 1.3 1.3 87.2
Korea, Rep. 10.4 7.3 8.7 5.3 4.4 118.3
Malaysia 6.5 7.9 6.0 7.2 5.1 105
Philippines 4.9 5.9 1.8 3.1 4.8 88.2
Singapore 9.9 8.8 7.5 7.6 4.9 117
Thailand 8.2 6.9 7.9 4.6 4.8 99.1
Openness indicator Trade (% of GDP)
Year 1960 1970 1980 1985 1990 1995 2000 2005 2007
Country/Group
Indonesia 26.9 28.4 54.4 42.7 49.1 54.0 71.4 64.0 54.9
Japan 21.0 20.4 28.4 25.3 20.0 16.9 20.5 27.3 n.a
Korea, Rep. 15.8 37.4 72.0 63.4 57.0 58.7 74.3 75.8 82.3
Malaysia 89.0 78.7 111.0 103.2 147.0 192.1 220.4 212.1 200.1
Philippines 23.4 42.6 52.0 45.9 60.8 80.5 108.9 99.3 84.8
Singapore n.a n.a n.a n.a n.a n.a n.a 444.3 428.7
Thailand 32.7 34.4 54.5 49.2 75.8 90.4 124.9 155.8 144.1

Malaysia: Foreign direct

investment, net inflows (% of n.a 2.2 3.7 2.2 5.3 4.7 4.0 2.9 4.5
GDP)
Selected Malaysian Macroeconomic Management indicators
Inflation (%) 1.8 6.7 0.3 2.6 3.5 1.5 3.0 2.0
Official exchange rate (LCU
n.a 3.1 2.2 2.5 2.7 2.5 3.8 3.8 3.4
per US$, period average)
External debt stocks (% of 12.0 27.5 68.6 36.4 40.6 48.6 39.5 29.4
GNI)
Total reserves (% of total
n.a 133.0 87.1 28.0 69.5 71.9 68.4 135.5 189.9
external debt)
Human Capital and Innovation indicators (different years and country comparison)
YEARS
Tertiary Enrolment (% of
1991 1999 2000 2001 2002 2003 2004 2005 2006
gross)**
• Malaysia 8.1 23.0 25.9 25.5 28.0 31.2 30.6 28.6 30.2
• Thailand 33.0 35.2 39.4 41.0 42.3 43.6 46.0 45.9
R&D expenditure (% GDP) 1996 1998 2000 2002 2004 2006
• Malaysia 0.22 0.40 0.49 0.69 0.60 0.95
• Singapore 1.37 1.81 1.88 2.16 2.24 2.39
Patents Applications*** 1985 1990 1995 2000 2002 2004 2006
• Malaysia 8 92 141 206 322 522 531
• Singapore 4 n.a 145 516 624 641 626
Source: WDI, Growth by decade calculated by author, *Coefficient of variation (standard deviation as a % of mean),
** UNESCO, ***WIPO – World Intellectual Property Organization

  15
 Table 2 gives a surface analysis on the Malaysian economic performance throughout the
years. The most general conclusion from the table points to the fact that Malaysia has a stable
and high long-term growth pattern. Among Southeast Asian countries, its growth is consistently
above 5 percent in post-independence periods. Although it is high by developing country
standards, it is also quite volatile. One reason for such volatility can be explained by the degree
of external exposure. As an indicator of openness, trade as a percentage of GDP has been very
high since the 1960s. Malaysia has always been a trade oriented economy. This attribute along
with various export promotion activities and low tariffs attracted many foreign export-orientated
FDIs as early as the 1970s.

Apart from being always open (Sach & Warner, 1995), another important feature of the
Malaysian economy is its prudent macroeconomic management. Economic stability, policy
orthodoxy, predictability and consistency are crucial to any explanation of its economic success.
(Hill. H, 2005). Macroeconomic management has been very impressive in comparison with other
developing nations. From Table 2, inflation has been kept below 5%, indicating institutional
stability and policy credibility. Using exchange rates per USD as a rough proxy for macro
stability, the fluctuations between 1970s to present is rarely aggressive. It was pegged with
during the Asian financial turmoil and along with other Keynesian stimulatory measures, it
actually gave a competitive boost to the tradables sector. Historically, Malaysian government
exhibits prudential controls in foreign borrowing and consistently possesses sufficient reserves 10
to cover external debt. Although the pegging of the Ringgit was controversial and debatable, the
strong macroeconomic management and favorable macro conditions to some extend, has offered
help in paddling out of the muddy crisis (Kaplan. E, & Rodrik. D. 2001; Athukorala. P.C 2008).

Another important feature of Malaysian economy is its inclusive development approach

(Hill. H, 2005). During the colonial era, different ethnic groups were allocated into different
economic functions under the Divide and Rule system. Upon independence, the Malaya
government was given the challenge to repair the inherited social-equality misalignments.
Although economic growth before 1970 was decent, on the social front, various questions were
raised. The non-improving economic status of the largest ethnic group (the Malays, or

                                                            
10
9th January 1998 the Malaysian government rejected IMF rescue on grounds of sufficient foreign reserves.

  16
Bumiputera 11 ), rising urban employment and the dissatisfaction among the non-Malays about
their education and language rights (Menon. J, 2008) highlighted the fragile social relations circa
1960. The growing discontentment was ultimately erupted in a form of bloody riot on the 13th of
May 1969. This event then altered Malaysian development strategy to include assessments on
economic imbalances along racial lines. The Malays / Bumiputera are the main targets for
economic upgrading since they were considered the poorest. While the credibility of the policy is
left to be questioned later in this chapter, one certainty from this policy practice is the show of
commitment by the government in creating a politically stable and equal society. These are
crucial elements in explaining economic growth. Table 3 below shows some of the most
important national economic policies that have embedded the agenda for building an equally
distributed society (affirmative action policies)

Table 3: Affirmative Action Policies

Policy Selected highlights / objectives
• The NEP underscored the importance of achieving socio-economic goals alongside
pursuing economic growth objectives as a way of creating national unity. Two major
strategies were adopted:
1. To reduce absolute poverty irrespective of race through raising income levels and
increasing employment opportunities for all Malaysians; and
2. To restructure society to correct economic imbalances so as to reduce and
eventually eliminate the identification of race with economic function.
• In terms of corporate equity restructuring, the NEP set a restructuring target of
30:40:30, where by 1990, the holdings of the Bumiputeras should reach 30 per cent,
other Malaysians 40 per cent and the foreigners 30 per cent, in the context of an
New Economic expanding economy.
Policy (NEP) Some of the societal restructuring programmes generally focus on the following
(1970 – 1990) strategies :
• Direct intervention by Government through the creation of specialized agencies
to acquire economic interests and hold in-trust for Bumiputeras until such a time
when they are capable of taking over;
• Introduction of specially designed rules and arrangements, whereby the
involvement and participation of Bumiputeras are assisted and facilitated over a
period;
• Increasing Bumiputera ownership through privatization projects; and
• Reduce progressively, through overall economic growth, the imbalances in
employment so that employment by sectors and occupational levels would
reflect racial composition.

Industrial • The main aim is to maintain and orderly development and growth in the country’s
Coordination Act
                                                            
11
Literally translated as “sons-of-soil”. It is a widely used Malaysian term embracing ethnic Malays and other
indigenous ethnic groups.

  17
 (ICA) manufacturing sector
1975
• The ICA requires manufacturing companies with shareholders' funds of RM2.5
million and above or engaging 75 or more full-time paid employees to apply for a
manufacturing license for approval by the Ministry of International Trade and
Industry (MITI).
• Section 4 Subsection (3), The licensing officer shall, in deciding whether an
application for a licence should be approved or refused, consider whether the issue of
a licence is consistent with national economic and social objectives and would
promote the orderly development of manufacturing activities in Malaysia
• Based on the “Malaysian Incorporated” Concept – taking the idea that a nation is a
business entity
• Objectives: “Encourage growth of the private sector and increase the overall
economic efficiency in line with the New Economic Policy and National
The Privatization Development Policy’
Policy 1983 • In respect of ownership of wealth, the privatisation policy forms an integral part of
the Government's strategy in realizing active participation by Bumiputera in corporate
sector to correct the imbalances in the corporate sector participation. The privatised
entity should allocate 30% of its equity to Bumiputera. Foreign participation in a
privatized entity is limited to a maximum of 25 % of its share capital.
• The target of 30% corporate equity share of bumiputera in the economy have not been
achieved, therefore, there is a need to continue the gap-closing policy.
• Replacing NEP. New dimensions include:

(a) Shift the focus of the anti-poverty strategy towards eradication of hardcore
poverty while at the same time reducing relative poverty;
(b) Focus on employment and the rapid development of an active Bumiputera
Commercial and Industrial Community (BCIC) as a more effective
strategy to increase the meaningful participation of Bumiputera in the
modern sectors of the economy;
National (c) Rely more on the private sector to be involved in the restructuring
Development Policy objective by creating greater opportunities for its growth; and
(NDP) – 1991 (d) Focus on human resource development as a fundamental requirement for
achieving the objectives of growth and distribution.
Also include
• The efforts under the NDP to correct economic imbalances will focus on the
National Vision
expansion of capacities to generate income and create wealth as well as to provide the
Policy (NVP) - 2020
skills for the Bumiputera to effectively retain and manage their wealth.
• ….In line with this new emphasis and in order to increase Bumiputera participation in
the commercial and industrial sectors of the economy, more attention will be given
towards strengthening the capacities of the Bumiputera to effectively manage, operate
and own businesses rather than on achieving specific numerical targets of equity
restructuring and ownership.
• …efforts will continue to be made under the NDP to increase Bumiputera ownership,
no specific time frame has been set for the attainment of the equity restructuring
target of at least 30 per cent.
Source: The Economic Planning Unit (EPU), the Malaysian Industrial Development Authority (MIDA), Second
Outline Perspective Plan (1991 – 2000).

  18
 The main objective of these policies is national unity. In related to the inclusive
development feature, another feature worthy of mention is the country’s comprehensive long-
term development vision such as industrial policy plans embedded with concrete goals. In 1991,
the Malaysian government declared its intention to become a developed nation by the year 2020
through its Vision 2020 Initiative. The complementing policy papers along with the support of
institutions towards the targets are some of the reasons why the Malaysian government is
considered dynamic and forward looking. The eighth strategic challenge for Vision 2020 is to
ensure an economically just society, in which there is a fair and equitable distribution of the
wealth of the nation. This aim once again is a manifestation of Malaysia’s ‘inclusive
development’ style.

Figure 6: Malaysian Overlapping Policy Structure

Source : Ohno. K (2009)

Finally, on human capital development, Malaysia’s performance is generally mediocre.

Education expansion since 1970 has been introduced with the NEP objectives. This complicated
the intake process for local university as national agenda have the interpretation to override
meritocracy. Nevertheless, in spirit of NEP this policy offered opportunities for lower-income
students to acquire higher education, hence empowering them in the job-market. Tertiary
education enrolment has been increasing yearly since 1990. Pubic expenditure on education is
one of the highest in East Asia but it is still catching up with the NIEs (Hill. H, 2005). R&D
efforts have been low in comparison to advance country like Singapore. Although innovation
seems to be thriving since 1985 (based on paten applications data in table 2), it is very difficult to
ascertain the commercial values from these research spending and innovation activities.

  19
 • Supporting the Manufacturing Sector: Industrial policies

Malaysian industrialization process can be summarized in Table 3 below. Following the

steps of many developing countries, import-substitution industrialization was on the earliest
policy agenda. The promotion of infant industries began after the World Bank trade mission visit
in 1963. The use of tariffs and non-tariff protection at that time was aimed at reducing the
dependency on the import of foreign consumer goods. However, the success of import-
substitution policy was impeded by the limited size of the domestic market. This is showb by the
lower growth figure between 1960 and 1970. Towards the end of the 60s, export-oriented
industrialization strategy was once again given priority.

The introduction of the Investment Incentives Act 1968 initiated a new phase for export
promotion strategy nearing the end of the 1960s. The act offered various incentives from
company tax exemption, duty exemptions from procuring imported inputs, investment tax
credits, accelerated depreciation allowances on investment and various tariff protections (Menon,
J, 2008). The main aim of the government is to prepare an attractive economic environment for
foreign FDIs. This effort is equivalent to the movement from Stage zero to Stage one in Figure 3.
Also, upon realizing the needs to attain higher technology, improve learning curves and capital
accumulation, efforts in drawing foreign FDIs were further augmented by the development of
Free Trade Zones (FTZs) in the early 1970s. The FTZs provided foreign firms an appealing
domain to set up their production bases as part of their bigger network of parts and component
trade. The best example emanated from the electronics sector; which was formed by the nature of
this fragmentation trade (More discussion on this will be in the up-coming section).

Based on Ohno’s (2009) framework, the formation of FTZ inaugurated the agglomeration
effect for the industry - In the mid 1980s, large amounts of intermediate-input producing firms
from Japan have set up production bases in Malaysia. Integration of FTZs into the wider
economy is then reflected by the increasing emergence of small and medium size firms in the
FDI profile (Athukorala. C & Menon. J, 1996). Consequently, net inflows of FDI to the country
increased more than twofold from 1970 to 1990. A brief return to the import substitution policy
occurred at the beginning of 1980s due to the government’s ambitious effort to shift Malaysia
into heavy industry manufacturing. By then, Malaysia was already in Stage two of the
development ladder. With a surplus of oil revenue and inspiration from successful East Asian

  20
countries (Look East Policy), the government anticipated that growth in the heavy industries will
eventually push Malaysia into developed countries status. However, this did not occur. Among
debated reasons for the failure was directed towards the over-protective state-led 12
industrialization strategies such as heavy tariff protection, government procurement provisions
and subsidized credit (Menon. J 2008). In brevity, they were all contrary to market and
performance-based efforts.

Table 4: Industrial strategies, development stages and trade policies in Malaysia, 1957 –
2009
Phases and Industrial Trade / industrialization Policy instruments and emphasis in Manufacturing
ladder* Policies production
Phase 0 Inherited export-oriented • Agriculture – Rubber, black pepper. Manufacturing – tin
• Stage Zero strategy. (pre-1957) mines
• Divide and rule policy
Phase 1 Implemented Import – • Domestic market focus
• Moving to Stage 1 - Substitution Strategy • Substituting simple imported consumer goods
Arrival of (1957 -1970) • Investment Incentives Act, 1968 – moving into export
Manufacturing FDI orientation
Phase 2 Export orientation • Establishment of Free-Trade Zones
• Moving to Stage 2 – Strategy (1970 – 1980) • New Economic Policy
Agglomeration effect • Industrial Coordination Act 1975
• Electronics & textiles for exports
Phase 3- Import Substitution II • Selected Heavy industry program - HICOM
• Stage 2 (1980-1985) • Look East Policy (1981)– learn from Japan and Korea
Phase 4 Export orientation II • Industrial Master Plan 1 & 2
• Stage 2 (1985 – 2005) • Promotion of Investment Act and ICA guideline relaxed.
• Action Plan for Industrial Technology Development
• Resource-based industries
• Manufacturing ++
• Cluster approach – Internationally Linked and Policy driven
• Vision 2020 (1991)
Phase 5 Continuation on Export • Industrial Master Plan 3**
• Stage 2 orientation strategy (2005 • Various “Strategic Thrusts” and policy measures for specific
– 2009) areas of External trade; Investments; Development of SMEs;
Branding; Growth areas in the manufacturing sector; Growth
areas in the services sector; Development of the halal
industry; Enhancing domestic capabilities; Human resource
requirements; ICT and other technology developments; and
Logistics.
* based on Figure 3 ** The plan extends from 2006 to 2020

                                                            
12
In 1980, The Heavy Industries Corporation of Malaysia (HICOM) - a public-sector holding company was formed
to forge partnership with foreign companies in setting up industries in selected sectors. These projects however are
selected merely using traditional import-substitution criteria.

  21
 The performance of heavy industries was below expectation despite strong protection
from the government. The excessive spending in the early 1980s has widened both the budget
and current account deficit by 5 and 14% respectively. The uninvited world recession in the mid
1980s exacerbates the already weaken economy, reducing GDP growth by 1.1%. At this point,
the government was forced to re-orientate its industrial policy by restructuring and privatizing
the state-owned enterprises, including the heavy industries. Privatization was in vogue moving
into the 1990s with the Malaysia Inc. concept. They eventually became part and parcel of a
bigger liberalization drive that witnesses once again the return to export oriented industrialization
phase.

In a move to attract investments, the1968 Investment Incentives Act was replaced by the
1968 Promotion of Investments Act. Special incentives were targeted for small and medium-
scale industries that exhibited linkage-creation potential. Further liberalization efforts included
relaxation of foreign equity guidelines where foreign investors were able to own up 100 % equity
subjected to their export targets. The Investment Co-ordination Act 1975 was also amended to
promote small and medium enterprises (SMEs) 13 . Industrial development was guided by a ten-
year Industrial Master Plan (IMP), which provided a framework for development direction
focuses of the manufacturing sector. The first IMP (1986-1995) emphasized on industrial
development in comparative-advantaged sector, namely the resource-based industries. Part of the
plan also involved diversification of non-resource products and incentive systems for “priority
products”. The second IMP (1996 – 2005) was more academically documented with the
Manufacturing ++ (plus plus) theory and cluster-based approach to industrial development. The
plan was seen as a response to Krugman’s highly critical stand on growth in Asian countries
which are based on perspiration rather than inspiration (Krugman. P, 1994). Manufacturing ++
strategy focused on changing the industrial structure from basic assembly (and production
operations) into higher skilled activities such as R&D and product development. Along with
those developments, downstream activities such as distribution and marketing will be expanded
as well. Industrial developments seek to promote higher value added activities around industrial
clusters and its supportive linkages.

                                                            
13
Initially, companies with RM 250,000 shareholder funds or 25 workers are subjected to operating licenses but the
amendment relaxed the requirement to RM 2.5 million and 74 full time workers.

  22
 The Third IMP (2006-2020) marked the government’s effort in addressing global
competitiveness. The transformation and innovation of manufacturing and services sectors are
the main focuses in this plan. Various quantitative targets have been imposed on the
manufacturing sector, non-government services, external trade and productivity growth. Along
with the targets, there will be 10 strategic thrusts to steer Malaysia into a developed nation by the
year 2020. Malaysia has kept export orientation as the preferred industrialization strategy by
imposing two strategic thrusts: Enhancing Malaysia’s position as a major trading nation, and
Integrating Malaysian companies into regional and global network. Up to this stage, Malaysia
stands behind the glass ceiling and have been stuck in Stage 2 since 1980 (Figure 3). However,
this condition in hope will change following Malaysia’s commitment to internalize technology
through facilitating development and application of knowledge-intensive technologies; and
developing innovative and creative human capital.

• Supporting the Manufacturing Sector: Fragmentation trade in electronics industry.

The dominance of electronic, electrical machinery (EEM) industry within the

manufacturing sector deserves special attention. While further analysis on the nature of final
goods and parts and components trade will be explained in a different chapter, this section will
provide a simple history on trade in parts and components (fragmentation trade). The
establishment of Masushita plant in 1965 marked the beginning of electrical and electronics
industry in Malaysia. More than two decades later, the industry has employed more than 300,000
workers with a total output of US 30 billion in 1997. This industry played a significant role in
Malaysia’s exports accounting more than half of the nation’s export revenue and about two-
thirds of manufactured product (Best and Rasiah, 2003).

The influx of electronics firms into Malaysia happened sequentially. The first cohort was
dominated by multinationals from Silicon Valley and Japan, both taking advantage on the low
wages in their labour-intensive assembly branch. Initially, foreign investment in electronics was
devoted to components (almost over 80 per cent of value added until 1986). This pattern later
evolved with Asian electronics firms arriving into Malaysia in the late 1980s. One historical
factor that has to be taken into account was the signing of the Plaza Accord in 1985 which has
appreciated the yen and sent the world into an outsourcing frenzy. This second wave of Asian
foreign investment (mostly from Japan, Korea, Taiwan) expanded the consumer and industrial

  23
goods segment of the industry in the form of component assembly. Since then, electronic,
electrical machinery (EEM) and appliances have been Malaysia’s largest exported manufactured
good. Share of EEM exports covers above 55 per cent to total exports of manufactured goods
(Table 5). Although the share is decreasing in recent years, it still plays a significant part of the
Malaysian exports. Table 6 shows the share of network products in manufacturing exports. For
Malaysia, although total trade have increased since 1992, trade in final goods have actually
decreased. The increase of manufacturing exports is dominated by parts and components (PNC)
where the share almost doubled in the last 15 years. Therefore, standard trade data can be
misleading. It is important to assert the differences between these two categories. As seen on
table 6, the expansion of the Malaysia manufacturing sector depended heavily on PNC as its
main export driver.

Table 5: Top Five Exports of Manufactured Goods (% of total manufacturing)

2002 2003 2004 2005 2006 2007 2008
Electronics, electrical machinery and
69.6 67.7 65.1 64.9 62.7 59.8 55.3
appliances
• Semiconductors 23.9 25.8 22.6 20.7 19.5 20.0 17.7
• Electronic equipment and parts 27.7 25.0 25.1 27.1 26.6 24.3 21.9
• Machinery and electrical products 18.0 16.9 17.3 17.1 16.6 15.5 15.6
Chemicals, chemical and plastic products 6.3 7.1 7.7 7.6 7.7 8.6 9.4
Petroleum products 2.9 3.3 3.9 4.5 5.1 5.4 7.8
Iron, steel and metal products 2.9 3.5 4.1 4.0 4.8 5.5 6.0
Wood products 3.1 3.1 3.2 3.0 3.1 3.0 2.9
Source Department of Statistics, Malaysia

Table 6: Share of network products in manufacturing trade

Regional/country composition (%)
Total trade Parts and Final goods
components

1992/3 2006/7 1992/3 2006/7 1992/3 2006/7

EXPORTS
ASEAN 56.8 66.1 22.7 44.2 34.1 21.9
Indonesia 9.3 38.4 3.8 21.5 5.6 16.8
Malaysia 68.4 78.8 27.7 53.6 40.7 25.1
Philippines 53.4 87.3 32.9 71.7 20.5 15.6
Singapore 74.9 66.5 29.0 49.3 45.9 17.2
Thailand 43.1 62.9 14.1 29.9 29.0 33.0
World 45.5 50.9 19.3 27.1 26.3 23.8
Source: Athukorala. P.C & Hill. H 2008

  24
5.0 What kept Malaysia in the trap? : Review on various hypotheses

“We have become a successful middle income economy. But we cannot and will not be caught in
the middle income country trap. We need to make the shift to a high income economy or we risk
losing growth momentum in our economies and vibrancy in our markets,”

- Malaysian Prime Minister Datuk Seri Najib Tun Razak keynote address during Invest Malaysia
2009 (30th June 2009)

• End of surplus of labour and rising real wages

Figure 4 and 5 highlighted a problem for the Malaysian manufacturing sector. Rising real
wages deteriorated one of Malaysia’s comparative advantages. One of the main reasons MNEs
set up production bases is because of the labour problems they face at home, namely rapid
domestic wage increase, labour reluctance to engage in blue collar activities and import
restrictions of foreign labour (Athukorala. P.C, 2009). The relatively cheaper labour in Malaysia
provided an alternative solution for them. Firms in electronics industry from NIEs have begun to
produce components and sub-assemblies in Malaysia using the lower labour cost since the 1970s.
Various empirical studies have showed that relative wage differentials are significant
determinants to cross-border trade (Athukorala. P.C & Yamashita. N 2006; Baldone et al. 2001).
Real wages grew most during the 1979-1985 and 1990 – 1997 periods, with the former was due
to deflationary conditions and retrenchment of low-wage transient workers. The latter was due to
the rapid growth of export-oriented industries as well as labour market tightening (Rasiah. R,
2002). Although the presence of foreign workers helped to moderate wage growth in the 1970s,
rapid economic growth and full employment in the 90s, increased wages in excess of
productivity 14 , hence reducing the profitability of manufacturing firms. Along with insufficient
skilled workers and rising competition from other labour intensive low-cost countries (i.e China
and Vietnam) Malaysia’s path to higher income status became even more challenging.

                                                            
14
Wages of unskilled workers seem to have risen faster than those of skilled and semi-skilled workers during
roughly the same period, suggesting that in the 1990s pressure on the labour market was driving wage increase more
than it was raising demand for higher skills (Rasiah. R, 2002).

  25
 • Internalizing technology & technology absorption challenges: Low Industrial human
development and Weak Support linkages

“We cannot expect to be a high-income developed nation through incremental change. We need
a model which is more relevant to current times…To move to a higher income-based economy,
we have to move towards a knowledge and innovation-based economy where skilled labour is
needed,”
- Minister in the Prime Minister’s Department Tan Sri Nor Mohamed Yakcop, Bernama, May 7, 2009

Ohno’s framework (figure 3) stated that there is a need to internalize technology before a
country is able to move to a higher income level. Ohno’s argument is in-line with many other
studies addressing the importance of technology transfer from FDI firms in increasing the
productivity of local manufacturing firms. The complexity of the issue here is on the
measurement of technology itself. The ideal measurement for technology begs as many questions
as they answer. There are two concerns on literatures that measures technology. First, concerns
on the use of growth accounting measurement such the Total Factor Productivity Growth
(TFPG) is warranted due to the way it is computed. As a residual concept, it is also in part a
‘measure of ignorance’. TFP figures also masks the microeconomics of technical progress such
as improvement of products and processes (Hill, Hal 2001). The same measurement critique
applies for various researches that attempted to create various weighted “technology stock”
variables. The variables created depended heavily on the manipulation of weights being applied.
The second concern is on literatures that ‘matches’ the level of technology with product. Very
often the terminologies can be misleading. For example, electronic devices are high tech and
palm-oil is low tech (or resource based). This approach overlooked the long value chain in
electronics production process which includes both low-skilled and high-skilled activities. Palm-
oil, being converted to biodiesel requires higher skills than labour intensive computers assembly.
This research will attempt to argue that there are more dimensions than restricting technology
innovations to mere indexes and terminologies.

The research views technology progress as an incremental and cumulative capacity-

building process that occurs through sustained investment in the absorption and application of

  26
new knowledge and skills.  From literature reviews, the following are various issues pertinent to
the technology absorption and management debate:

1. Role played by transnational corporations (TNCs) in technology transfer and local

technological upgrading through training,
2. Investment in technological deepening and linkage formation with local firms;
3. Firm-level managerial strategies and their effect on technological learning;
4. The technological positioning of Malaysian affiliates in global TNC networks;
technology choice;
5. Government-business relations and rent-seeking;
6. The role of trust in joint-venture collabourations
7. Effects of government policies.

This research will attempt to re-address these issues under a broader research umbrella of
industrial human resource upgrading and industrial - linkages effect.

. Malaysia has high literacy and a compulsory primary education system. They are
necessary but insufficient for the increasingly competitive labour market. Workers in Malaysia
have yet to reach their full productivity potential when compared to developed countries like
Singapore. Labour productivity measured by manufacturing value-added per manufacturing
labour is shown in figure 7 below.

Figure 6: Labour Productivity in Manufacturing Sector

120000

100000

80000
Malaysia
60000
Singapore
40000

20000

0
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006

Value Added per Manufacturing Labour

 
Source: Author’s calculation * disconnected points represents unavailability of data

  27
 The difference in manufacturing productivity between Malaysia and Singapore is
significantly wide. The quality of labour is also a call for concern. Table 7 shows the top five
most critical skill shortages in the Malaysian labour force. Most of them are technical skills.

Table 7: Top five most critical skills shortages (% firms’ response)

Skill 2002 2003
IT skills 4.1 20.4
Technical and professional skills 3.2 18.0
English language proficiency 47.5 16.5
Creativity and innovation skills 4.1 10.0
Professional communication skills 14.0 6.4
Source: Yusuf, S & Nabeshima. K (2009) based on investment climate data for 2007
Both figure 6 and 7 shows that indeed, Malaysia is in need of skilled and competent
workers. The problem is not with the shortage of graduates but with graduate unemployment
problems. In 2002, among the unemployed, 18.3 percent finished tertiary education. By 2006, the
share of tertiary graduates  among unemployed has increased to 24.5 percent (Department of
Statistics 2003; 2007). The keyword here is the mismatch between the demanded skills and the
supply of graduate’s expertise. Others argued that the socio-political constraints associated with
the NEP have restricted competitiveness in university intake, faculty recruitment and student’s
performance (Yusuf. S & nabeshima. K 2009). As mentioned earlier, this poses two problems;
First FDIs find it difficult to diversify their production into higher value-added activities due to
the limited absorptive capacity by the low pool of high-quality local human capital. Secondly,
the rising wages of low-skilled workers has deterred further new incoming FDIs and may
pressure existing ones to resolve to its ‘footloose’ nature by shifting to a lower-cost alternative 15 .

Another mode of technology absorption comes in the form of linkages between MNCs
and indigenous firms (backward linkages). There are potentials for knowledge and technology
transfer from foreign affiliates to their local suppliers under various conditions (i.e sufficient
human capital as explained above). Foreign direct investment (FDI) in terms of technology
transfer and spillovers to the host economy can be enhanced considerably through extended

                                                            
15
Athukorala. P.C and Menon. J (1996) argued that this concern is misplaced. But the current growing
competitiveness of other low cost countries may change the scenario entirely

  28
vertical linkages 16 (Brannon, Dilmus, & Lucker, 1994; Lall, 1995; Turok, 1993). These forms of
linkages are able to benefit local suppliers in terms of contents upgrading and complements the
industrial human resource upgrading process as well. Vertical linkages also supplies local
employment and trade balance effects of the investment projects (Belderbos. R, Capannelli. G,
Fukao. K 2001).

However, there is a need to qualify this line of argument. First, at the formative stage, it
is impossible to expect foreign firms to forge greater linkages with local suppliers (backward
linkages) due to the inability of the latter in meeting the specification and quality requirements of
the MNCs (Keesing & Lall, 1992; World bank 1993, Athukorala. P.C & Menon. J, 1996).
Linkage formation is formed either through a synergy process generated naturally between
MNCs and its local supplier or it is a formation driven by market forces 17 . It is therefore, not the
breath of this research to study the need for imposition of local sourcing rules as suggested by
some researchers (refer Yusuf. S & Nabeshima. K, 2009 pp.11). Rather, the more important take
is to identify how a Malaysian supplier may learn new technologies and improve its productivity
by applying knowledge acquired via linkage with the foreign subsidiary. The identification of the
determinants of spillovers from FDI through backward linkages is one of the main focuses in this
thesis. Very often the idea between linkages and spillover has been used interchangeably.
However, it is incorrect to do so as pointed out by figure 7 below.

Linkages are relationships between foreign firms and local establishments, whereas
spillovers are externalities that may result after linkages have taken place. Therefore, the
hypothesis here states that the presence of foreign firms in the Malaysian manufacturing sector
will have impact on supporting local industries by upgrading them through linkages and
technology transfer. Industrial human resource upgrading and incidents of positive spillovers are
closely connected because the absence of spillovers is usually explained by the weak absorptive
(due to weak human capital) capacity of domestic firms.
                                                            
16
Vertical linkages involve a direct relationship between subsidiary and local suppliers (backward or upstream
linkages) of customers (forward of downstream linkages). (Giroud, A & Joanna, S-K, 2006). Similarly, vertical
technology spillover means technology and know how that are transferred between firms and their suppliers.
17
For example, the Yen appreciation in 1985 has encouraged many intermediate-input producing firms in Japan set
up production bases in Malaysia (Aoki. T, 1992)

  29
Figure 7: Interdependence between linkages and spillover

Source :Giroud, A & Joanna, S-K, (2006)

In the early stages of industrialization, the degree of technology transfer was very limited.
The activities were known to be confined largely in the FTZs. Even so, labour in FTZs merely
followed the directives from the parent MNCs. Initially, Malaysia’s technology development has
been overlooked ahead of industrial policies. The launch of the First National Science and
Technology Policy in 1986 and its implementation in 1990 through the National Plan of Action
for Industrial Technology Development (APITD), highlighted the government’s inaugurated
effort to impart higher skills on the national workforce in order to build knowledge competencies
for all key industries. Various research grants and incentives (i.e IRPA, IGS), infrastructures
(such as technology parks, and the MSC) and institutions (i.e MIGHT, MTDC, MASTIC) were
initiated as part of skill and industrial value-added upgrading plan. Along with government’s
efforts, there are also incidents of MNCs participation in training their local work forces 18 .

                                                            
18
…excerpts from Athukorala. P.C & Menon. J (1996), Texas Instruments are sending Malaysian engineers to the
United States (Microelectronic, Monitor, 1987,32) and Nissan Japan uses its Malaysian plant as a training base for
its operations in Pakistan (The Star, 20/12/1994).

  30
 While the technology policies seem to be navigation Malaysia into higher-skilled, higher
value added and higher-income position, “the” question still remained: Why is Malaysia still
stuck in middle income status? The answer lies in a bigger picture. First, the long term plans
beginning 1990 on various skills and industrial upgrading was forced to an abrupt halt due to the
1997 Asian financial crisis. The crisis resulted a shift in policy focus and ambitious projects such
as the Multimedia Super Corridor never really took off (Hill, H, 2005). Next, some argued that
the innovation culture in Malaysia came late the due to various NEP driven policies thus created
an over-dependency on government support ala “subsidy mentality” and rent seeking behaviors
(Bakri. M, 1999; Yusuf. S & Nabeshima. K, 2009 pp.11, Menon. J 2008). Malaysia too has been
over-dependent on MNCs to provide export oriented platform. Indigenous technology
development remained low. All those mentioned above acts as deterrent factors for MNCs to
deepen its backward linkages. Local suppliers are therefore stuck in low value-added production.
Although the presence of MNCs is significant, their knowledge contribution remained marginal.
Finally, the familiar challenges of rising competitions from lower-cost countries such as China
and Vietnam provided an alternative investment options for new FDIs. The fact that China is
slowly moving up the value chain (Sleigh. A & Lewinski, 2006) and is developing the similar
technology-led policies like (Malaysia in the 1990s) calls for faster response from the Malaysian
government in addressing these issues,

• Social and ethnic restructuring policies

(a) Education

Table 3 provided a list of Malaysia policies constructed to build and maintain racial
harmony in Malaysia. The intention of these policies is unity. One cannot argue more the
importance of social equality in the economic development process. It is crucial to bridge the
widening income gap among different ethnic groups in an ethnically heterogeneous country such
as Malaysia. In the 1970s, the Bumiputeras are indeed the critical left-behind income group
hence, various help in areas of corporate ownership, education and employment quota has been
extended to alleviate them from that category. The policy did generate success in improving the

  31
standard living of the Bumiputeras and have also successfully created a middle and high income
class. However, the best policy response should be a needs-based rather than a race-based. The
most critical matter here is the impact these policies have on human capital development. First,
with an education system tied to various ethnic requirements 19 , the essence of meritocracy has
been distorted. Although the quota restriction was lifted in 2001, student intake was based solely
on a dual system. The first system is STPM, a national exam taken after a 2-year course. The
other is based on Matrikulasi, an in-house one-year course for Bumiputra (and very limited non-
bumiputra) students. The dual system has left various criticisms due to the differential
assessment standards in university intake system. As a result, the ethnic intake ratio remained
unchanged as shown in table 8 below:

Table 7: Enrolment in public university by ethnicity (% of total)

2002 2003
Bumiputera 68.7 62.6
Chinese 26.4 32.2
Indian 4.7 5.2

Source: Department of Statistics Malaysia. Buletin Perangkaan Sosial Malaysia (2001). (Monthly Bulletin 2001)

For other ethnic groups, an alternative to local university is private colleges which
involve higher costs and investments. As for the higher income ones, many have resolved to
foreign universities and although statistics are vague, many have remained abroad. This
contributed to the critical “brain-drain” problem. The loss of human capital through emigration
(brain drain) argument was highlighted in by Penang’s Chief Minister Lim Guan Eng when the
state lost US 3 Billion worth of foreign investment because it could not “commit to having 1,000
engineers” (The Straits Times, 2009). The article also raised concerns about the quality of
graduated being produced through the education system. Therefore, meritocracy is crucial in
determining the quality cycle of input (student intake) into the university in order to produce
good output (university graduates). The loss of high quality human capital and the creation of
human capital are both central to the skills-upgrading and technology absorption capacity debate.

                                                            
19
Under the Malaysian constitution: Article 153, 8(A), reservation of places for Malays and natives in University,
College and other educational institution is required. A provision empowering government to set a quota system was
included in the amendments to the Federal Constitution in 1971.

  32
(b) Ethnic-oriented ownership policies

Another policy that calls for concern is the Industrial Coordination Act (ICA) 1975 (refer
details in Table 3). Under the act, manufacturers are subjected to operation licensing consistent
with the national agenda. Enterprises with equity over a certain limit have to sell 30 % of their
shares to Bumiputeras. The Foreign Investment and Capital Issues Committee have similar
regulatory control over large firms’ investments and equity issues, enforcing 30 % redistribution
to the Malays. Indirectly, the aim of the Act is to improve the relative position of the
Bumiputeras in the modern sector of the economy (Menon. J, 2008). Other supporting measures
included preferential access for transport and timber licenses, 25% quotas for government
contracts and so on (Lim. M.H, 1985; Tan. J, 2008). There are many criticisms for this
interventionist policy because it manifested as a form of market distortion masked under the aims
of distributional agenda. In economic logic, these measures are highly inefficient and created a
sense of over-dependency on state support.

The non-Bumiputera responded in five ways. First, investments were shifted from
manufacturing to commerce, property development, and other sectors not subjected to the ICA
(Jesudason. J.V, 1989; Yasuda. N, 1991; Hara. F, 1991). Second, larger companies shifted their
manufacturing headquarters abroad resulting in “capital flight” phenomenon. Third, companies
changed their business strategies and adhere to the act by partnering influential Bumiputeras and
integrating Bumiputera capital into their family-owned business (Gomez. T, 1999; Searle. P
1999). Forth, companies remained small so that their paid-up capital just below the threshold that
required a company to offer 30 % of its equity for Bumiputera shareholders. Finally, the act
paved way to a rise in a business trend called the “Ali Baba” 20 alliances where every non-bumi
business establishment will include a non-active bumi partner (sleeping partner). Over the years,
this policy regulation is considered successful in bridging the inter-ethnic income gaps because
sino-Bumiputera partnerships have led to an emergence of a capitalist and new Malay middle
class (Embong. A.R, 2002).

                                                            
20
The “Ali”, being the less active Malay partner contributes his political presence and connections while the “Baba”
who are the non-Malay half of the partnership will contribute his expertise, capital and skills.

  33
 Without discounting the successes the policy achievements, there are a few concerns to
the responses above. First, the capital flight issue is self explanatory. The forth response forms
one hypothesis as to why Malaysia is still stuck in the middle-income trap. There were loopholes
in the ICA. One would be the exemption on Bumiputra ownership requirement given to firms
exporting over 80 percent of their output. With this exception, manufactured export industries in
Kuala Lumpur and Penang (and firms in FTZs) were unaffected by this ownership requirement.
The problem emanated from manufactured import-substituting light industries where firms in
this category are non-bumiputra owned small and medium-sized enterprises (Woo.W.T, 2000).
The dilemma can be depicted as follows: if local non-bumiputera firms increase in size and hit
the ICA threshold, they are subjected to the regulations but then again if they do not expand their
scale in operation, they are unable to export. The interventionist policy functions as an
impediment for these small and medium firms in expanding the scale of their operations. This
has also deterred future export-oriented non-bumiputera entrepreneurs from venturing into the
manufacturing sector. While all the discussions about promoting backward linkages often points
to the economic factors, one should seriously consider this fundamental flaw that have stunted
the development of indigenous firms.

To be fair, the Malaysian government has been dynamic in amending policy and equity
regulations in-line with the country’s economic conditions. ICA restrictions were relaxed 21
between 1985 and 1986 in response to the global recession and terms of trade decline 1980s.
During the 1997 financial crisis, further relaxations were conducted on the equity policy
guidelines. Previously, foreign ownership was permitted from 30 through 100 % subject to
export orientation, however to weather the crisis, as of 31st July 1998, foreign investors could
hold 100 % of the equity (on selected products) irrespective of the level of exports. Effective 17th
June 2003, foreign investors are permitted to hold 100 % of equity irrespective of the level of
exports and products/activities. (MIDA – Guidelines to Equity Policy). However, equity
restrictions imposed on companies prior to 17th June 2003 were maintained but negotiable under

                                                            
21
Initially, Industrial Coordination Act in 1975, requiring firms to obtain licenses once they had 25 or more
employees (or paid up capital exceeding RM 250,000) and this was used to control entry of firms and to make sure
that firms complied with the objectives of the NEP (C. Lee 2007) but in 1986, paid up capital for the regulation
requirement was increased to RM 2.5 million with 75 employees.

  34
certain conditions 22 . Due to the need to increase FDI, the license requirement in ICA was finally
liberalised in 2008. Effective 1st December 2008, automatic issuance of manufacturing license
was granted with the exception on certain manufacturing activities related to security, safety,
health, environment and religious considerations.

While it is too early to ascertain the effects on the removal of manufacturing license, two
observations can be made on the policy discussion so far. First, there seems to be a complex
setting in the industrialization process. On one hand, when foreign equity was being gradually
liberalised, it indicated the urgency of the Malaysian government to increase manufacturing FDIs
into the country. But on the other hand, the development of local manufacturing SMEs has been
stunted by these regulations. This tightened the argument on Malaysia’s over-dependency on
foreign support and perhaps, has overlooked the importance of competitive-based local SME
development. Second observation raises the question whether timing of the liberalisation efforts
were a little too late. Regardless the answer, the on-going challenge of attracting FDI and
building supportive local-linkages remained vital.

A reform from an ethnic-based into a needs based-policy is indeed difficult. Using game
theoretical comparative institutional analysis,  social equilibriums can be achieved due to
institutional complementarity, strategic complementarity,  and path dependence (Aoki 2001a, 
2001b). Institutional complementarity explains the secured social system created by the
interconnections between institutions. Strategic complementarity means society created by
institutional complementarity has little incentive to deviate from the dominant strategy. For
instance, NEP has been successful in closing income gaps between different ethic groups. The
ethnic group that benefitted the most has little incentive to champion a change in the policy.
Finally, path dependence explains the importance of initial policy that created the momentum of
certain social norms and practices. When NEP was installed early in the 1970s, the social system
requires a large amount of political and social energy to change them.

                                                            
22
Up to 100% of their output for those products with nil duty or those not produced locally. Up to 80% of their
output if the domestic supply is inadequate or there has been an increase in imports from ASEAN for products with
Common Effective Preferential Tariff (CEPT) duties of 5% and below.

  35
 • Dwindling export competitiveness

“You can’t change the wind but you can adjust your sails”… German proverb

The race to attract FDI among South East Asian countries heighten ever since the
appreciation of Yen through the Plaza Accord (Plaza Agreement 1985). Among the developing
economies, Malaysia is considered as one of the first movers in export-oriented manufacturing
strategy. Even so, that did not guarantee a continuous lead in the race. Total manufacturing
export performance as well as value-added share of manufacturing in GDP has been declining
since 2000. In 2005, share of Malaysia’s largest (final product) export, electrical and electronics
declined from 72.5 % to 65.8 % since 2000. Some research has linked the downturn to the
declining global electronics industry and the increase competitiveness of countries such as
China. (Mahani, Z & Loke W.H 2008; Devadson. E, 2008). As mentioned in the earlier section,
Malaysia has always been a very open economy and has taken various tariff-liberalization
measures to ensure competitiveness in the manufacturing sector (except for some selected sectors
such as the automobile industry). However, while trade liberalization contributed significantly to
competitiveness, part of the concern was also targeted at the difficulties in moving up the value-
chain. The lack of innovation and technology creation in these industries is slowly extinguishing
the lead in the competition.

Although total trade electrical and electronics goods have declined, when analyzed
separately, trade in parts and components in the electronics industry has increased marginally.
Again, separate chapter will be dedicated on the methodology of obtaining the part and
component measurements. However, using methodology based on Athukorala and Yamashita
23
(2006), the top 5 trade value of parts and component (PNC) exports have been identified in
Table 8 and its aggregated export performance is shown in Figure 8. Figure 8 showed a sluggish
increase in these top 5 exported goods which can either mean a shift in the composition of PNC
export intensities away from SITC 7 and 8, or it can also mean a contraction in the sector. Here,

                                                            
23
The selection criteria for these parts are based on the amount of times these products appeared as the top 10 in
export value based on 1990 (base year), 1997 (crisis year) and from 2000 to 2008. This method is similar to the term
“picking winners” and is subjected to the “picking potential winners” criticism. However, the methodology is used
for the sake of brevity. It also implies the products are consistently ‘steady’ in demand.

  36
the latter is alleged because the top valued exported parts are contracting and they contribute to
almost 30% of total trade in machinery and transport equipment.

Table 8: Top 5 exports in parts and components in SITC 7 and 8 (Revision 3)

Number of times the product

Code Top 5 PNC from 2000-2008 plus control years of 1997 and 1990. appeared in Top-ten.
75779 Parts and accessories for the machines of group 752 11
Parts and accessories suitable for use solely or principally with
9
76493 the app
Transistors (excluding photosensitive transistors) with a
9
77633 dissipation rat
77643 Non-digital monolithic integrated units 9
77645 Hybrid integrated circuits 9
Source: calculated from UN COMTRADE database

Figure 8: Aggregated top 5 PNC exports as a share of SITC 7

40.0

35.0

30.0
% of total SITC 7

25.0

20.0 Top 5 PNC products

15.0

10.0

5.0

0.0
1990 1997 2000 2004 2006 2007

Source: Author’s calculation based on UN COMTRADE database

More formally, competitiveness can be tested using Finger and Kreinin (1979) Export
Similarity Index (ESI) and Balassa (1965) Revealed Comparative Advantage (RCA)
methodology (refer Appendix 1). The results are shown in Table 9, 10 and 11 below. ESI studies
the structure of exports between Malaysia and other countries. If the export structure is becoming
more similar (figure converges to 100), then there are signs of competition. The RCA measures
the comparative advantages between two countries. A value exceeding unity shows that the
country’s export is higher than the world average. Although these methodologies are often

  37
subjected to criticism (Nogami. H, 2008), the main objective here is to provide a coarse overview
on the increasing competition Malaysia is facing from various countries.

Table 9: Export Similarity Index (%) on Total trade and Aggregated Top 5 PNC (in
reference to Malaysia)
Total
trade China India Singapore Indonesia Thailand Philippines Japan
1990 40.4 58.6 49.2 48.7 n.a 55.4
1997 52.2 37.1 54.4 48.5 68.2 79.2 79.6
2000 57.4 33.9 58.2 52.3 69.5 79.6 83.2
2004 69.8 44.5 57.6 58.4 74.4 73.1 79.4
2008 58.6 59.1 67.6 64.8 67.4 60.6 64.1
PNC China India Singapore Indonesia Thailand Philippines Japan
1990 43.3 71.3 37.8 44.3
1997 72.1 63.9 83.9 61.5 80.4 67.3 71.0
2000 73.9 60.2 75.8 70.7 88.6 67.1 74.2
2004 58.5 42.7 71.8 54.6 67.5 74.0 82.5
2006 64.1 47.5 72.4 63.6 66.0 62.5 74.7
2007 37.6 43.7 26.9 65.6 43.8 71.6 31.8
2008 67.0 50.5 77.7 68.2 78.5 50.2 43.3
Source: Author’s calculations based on UN COMTRADE database

Export structure of China, Singapore and Thailand in PNC is increasingly similar with
Malaysia. One way to interpret this result is the confirmation that increasing competition exists
because countries are exporting the similar products as Malaysia. The result also highlights the
importance of taking parts and components into trade analysis. For example, export structure
between Malaysia and Thailand may seem different in terms of total goods trade, but in terms of
parts and component trade, Thailand is viewed as a serious competitor for Malaysia.

Table 10: Reveal Comparative Advantage in non-resource based manufactures

Product Group (Total trade) 2001 2002 2003 2004 2005
Manufactures of machinery (except electrical) 1.47 1.60 1.39 1.51 1.11
Manufactures of electrical products and electronics 2.82 2.95 2.97 3.01 3.19
Manufactures of metal 0.43 0.41 0.49 0.52 0.54
Textile, clothing and footwear 0.55 0.53 0.51 0.55 0.70
Transport equipment 0.05 0.05 0.05 0.07 0.11
Source: (Mahani, Z & Loke W.H 2008)

  38
Table 11: RCA on Malaysia’s Top 5 PNC
SITC code 1990 1997 2000 2004 2006 2007 2008
75997 0.44 1.14 1.49 0.88 0.99 0.59 1.00
76493 1.20 0.81 0.24 0.34 0.37 0.22 0.38
77633 6.46 3.32 2.36 2.32 1.68 0.98 1.73
77643 2.38 1.51 1.48 1.02 0.92 7.23 11.86
77645 8.28 2.12 1.32 3.86 5.33 7.46 11.93
Source: Author’s calculation from UN COMTRADE database

Based on table 10, there are no significant changes in Malaysia’s manufacturing RCA.
When analyzed using PNC data, two out of five of Malaysia’s top export in PNC has lower
comparative advantage compared its level more than 25 years ago. However, at this point of
research (methodology criticism aside), it is challenging ordeal to give a general conclusion on a
product-specific level.

The second argument is the rise of China and other external competitors that may have
created a hostile environment for Malaysia to upgrade. There are substantial amount of
literatures that debated the influence of China on global economy. Similar conclusion on this
debate pointed to China’s growth is only complementary to the exports growth of its neighbor
until a stage where it moves up the value-chain. Then on, China may pose a threat (Devedson. E,
2008; Lall. S & Albaladejo. M 2003). Another important finding shows that FDI flows to other
Asian countries are being stimulated, rather than being crowded out by FDI flows to China
(Athukorala. P.C, 2009). A more empirical approach using Dynamic Comparative Advantage
(refer Appendix 2) have been used to differentiate the products that constitutes a threat, non-
threat and partial threat. For example, the methodology takes bilateral trade between Malaysia
with US and China with US and compares them on product-specific level to determine the level
of threat China imposes on Malaysia. Table 12 shows the top five Malaysian PNC exports to
USA and Japan with the level of threat China poses. Malaysian top PNC exports to the USA are
only partially threaten by China’s growth. China poses a more credible threat to Malaysian PNC
exports to Japan than to the USA. In general, China’s level of threat is considered only moderate.

  39
Table 12: China’s threat level to Malaysia’s top 5 PNC exports for year 2005/06
To Threat
USA 2005/06 China Malaysia Level
75997 Parts and accessories for the machines of group 752 -0.1 8.0 No
Parts and accessories suitable for use solely or principally with
Threat
76493 the app -3.1 -13.2
Transistors (excluding photosensitive transistors) with a
Partial
77633 dissipation rat 1.6 0.6
77643 Non-digital monolithic integrated units 19.6 0.4 Partial
77645 Hybrid integrated circuits 7.6 0.6 Partial
To
JAPAN
75997 Parts and accessories for the machines of group 752 -0.19 -0.61 Partial
Parts and accessories suitable for use solely or principally with
Threat
76493 the app 0.39 -0.04
Transistors (excluding photosensitive transistors) with a
Partial
77633 dissipation rat 0.00 0.21
77641 Digital monolithic integrated units 0.19 -0.73 Threat
77643 Non-digital monolithic integrated units 0.08 0.46 Partial
77645 Hybrid integrated circuits 0.00 0.19 No
Source: Author’s calculation from UN COMTRADE database

Up to this point, rising global competitiveness should be viewed as a challenge and not an
excuse for being stuck in the middle-income trap. Rather than taking it as an unstoppable
phenomenon, the management of external competition should be better response. Malaysia is
standing at a losing ground if all its challenges are not being addressed critically and rapidly. It
may seem Malaysia still has the competitive edge on certain electronics components, however,
the rapid upgrading in China and the catching-up of Vietnam may well be view as a lesson rather
than a threat. Otherwise, Malaysia will be as mention at the beginning of this paper: Stuck in the
Middle (and will be left behind).

In conclusion, the overall the depiction of “middle-income trap” can be summarized in

figure 9 below. For Malaysia, being stuck in the middle means the industrial transition has come
to a standstill. Within the industrial transition process, contains factors that are holding Malaysia
from progressing forward in the grey area which is termed as the middle income trap. The
theoretical industrialization ladder shows the gap between GNI of high-income and an
extrapolated line of Malaysian current GNI back into the 1970s. 30 years ago, when Malaysia
reached the middle income status, industrialization process has yet to bring the country into the
high-income level. Since then, the country has been “stuck” despite all its industrial efforts.

  40
Figure 9: Overall Malaysian Industrialization Development Model (1957 – 2008) *Source: Author’s illustration

Income Level (Based on 2008 WB

GNI Atlas method) National
Development Non-Linear High
Malaysia achieved middle Income country’s GNI
Policy (NDP) and
income status since late 1970s theoretical trajectory
Vision 2020 in
based on 2008 criteria
1990
High Income
Stage 2

Malaysia’s
Stage 1 Agglomeration Middle
(1970s) Income
- FTZ,
Theoretical Industrialization ladder Trap
Fragmentation
Middle trade (Malaysia)
Arrival of FDI
Income (1957 – 1970)
World Upper
recession and Middle
economic
income
crisis, 1985

Low
Middle
income

2008 Year
Heavy 1985
industries Asian Financial
initiatives 1980 Crisis 1997
Export-oriented Malaysia’s
Industrialization Strategy GNI per
(NEP, ICA) capita
Import-substitution Industrialization Export-oriented Industrialization Strategy
Strategy (IMP 1,2 & 3, Manufacturing ++, Cluster based )
(Look East Policy, Privatization Policy)

  41
6.0 Research Proposal – testing the elements.

Literature has not documented this phenomenon extensively. Therefore, this research attempts to
look at Malaysian industrial transition on 4 important fronts. Fragmentation trade, industrial
human capital upgrading, support linkages, and firm level studies on competitiveness.

Overall Middle Income Trap model: (Simultaneous Model perhaps)

ΔPGNI = f{FDI, Wage, Skills, Fragmentation, Linkages, Productivity}
With ΔPGNI = PGNI HighIncome − PGNI Malaysia = Middle Income Trap Indicator (MITI)

• Fragmentation Trade

ln XM mal , j = α + β 1 ln PGDPmal + β 2 ln PGDP j + β 3 ΔnPGDPmal , j  

+ γ 1 LABPROmal + γ 2 LABPRO j + β 6 ln Dist mal , j

+ γ 1 LABPROmal + γ 2 LABPRO j + β 6 ln Dist mal , j

| X mal , j ,k − M mal , j ,k |
IITmal , j ,k = 1 −
With X mal , j ,k + M mal , j ,k

XM Bilateral trade (exports of imports or total trade (exports plus imports)) between
Malaysia and country j.

PGDP Real GDP per capita (- or +) measuring market size (+)

|∆PGDP| Absolute difference in GDP per capita (- or +)

LABPRO Labour productivity (GDP per person employed (1990 US$)) (+ or -)

Dist The distance between Malaysia and country j (-)

REER Real effective exchange rate (- or + depend on exports or imports)

VIITD A Trade intensity within ASEAN countries or dummy representing ASEAN Free Trade
Area (AFTA), unity representing the trading partner is within AFTA and zero for
otherwise (+)

ε mal , j A stochastic error term, representing omitted other influences on bilateral trade

New Suggestions

Wage Test the effect of turning point

END
End of labour surplus effect on manufacturing trade (dummy from 1990) – proxy for

  42
 end of low cost labour.

• Industrial Human Capital – (Yamashita, N 2008)

Shz ,t = φ0 + φ1Yz ,t + φ2 K z ,t + φ3 R & Dz ,t + φ4 FRGzm,t + φ5 FRGzz,t + α z + γ t + ε z ,t  

FRG import = Imports of PNC / Intermediate inputs

FRG exp ort = Exports of PNC / Gross output

where subscripts z and t denote industry and time, respectively, and superscripts m and x
represent imports and exports, respectively.
(Sh) Employment share of skilled workers as examined in Ito and Fukao (2005).

(FRG) fragmentation intensity across industries (+) / (-)

(Y) The industry scale of production. Industry value-added (depends)

(K) The ratio of capital stock to value-added capital intensity of production (+/-) Depends whether
complementary of substitutes.

R&D R&D intensity is a ratio of the R&D expenditure to value added. (+)

(α) The industry fixed effect

(γ) Time-specific effect

SUGGESTED ADDITIONAL VARIABLES

EDUC Local university graduate statistics – Measuring local efforts in providing skilled workforce

• Determinants of backward linkages - (Batra, Morisset, Saggi) - 2003

Method: Tobit
⎛ Ex ⎞
bi = α 0 + α 1 ∑ Yi + α 2 ⎜⎜ i ⎟⎟ + α 3Tari + α 4 Tgap i + α 5 N i + α 6 Ti + α 7 i ∑ inddumi + ε i
⎝ Yi ⎠
i refers to firms
b Level of subcontracting (in or out) MNCs established in Malaysia – MNCs decision incorporate
explicitly the possibility that the firm may decide not to use local suppliers (+)It is positive if the
present value of subcontracting exceeds the cost, and equals zero otherwise. The net benefits of
subcontracting (benefits minus costs) are not directly observed or measured, but are hypothesized
to be related to a set of observable attributes.

ΣY Market size (+) - demand for vertical linkages is positively associated to the
market size because it will increase the demand for intermediary goods (also agglomeration effect

  43
 proxy)

Exi
Yi Export propensity of MNEs, the demand effect

Tar The SIC 4 import tariffs. Degree of tradability of the intermediary goods as an explanatory

Tgap Proxy the difference between the share of R&D to sales of foreign firms and the similar share of
domestic firms. Higher this difference; greater is the technology gap between foreign and
domestic firms.

N Level of competition among suppliers -- measured by the number of suppliers in the market (+ / -
). Increase in competition leads to more efficient suppliers and hence a smaller technological gap
between them and potential buyers. On the other hand, it is possible, that a higher number of
suppliers reduce the incentives of the potential buyer to develop linkages because its technology
could then spread out more easily.

T Level of technology transfer from the MNE to local suppliers. Measured the level of technology
transfer from the ILTD survey and tested two indicators –one to capture technology transfer to
local firms and one to capture such agreements with foreign firms.

inddumi Industry dummy. To account for heterogeneity across industries, we introduced industry
indicators (SIC 2 digit dummies). This heterogeneity can help to capture the complexity of
technology used in each industry, which can influence the MNE’s decision to use local
intermediaries (see Kokko (1994) for such an explanation).
SUGGESTED ADDITIONAL VARIABLES

Skill Skilled workers.

Productivity model - Impact of vertical linkages on productivity

Method: 2SLS

Y Measured as the natural logarithm of value added, that is gross output less the value of
intermediate inputs like raw materials and energy

K Book value of physical equipment or machines (data availability)

L Labour. Total employment

bbi Aims at capturing the eventual correlation between out-sourcing and the buyer’s productivity.
(Vertical linkages proxy)

bs Looks at the impact of in-sourcing on the supplier productivity. (Vertical linkages proxy)

T SIC4 import tariffs

Age Age of firms – Proxy of learning. Older firms learn more.

  44
inddum Industry dummy

SUGGESTED ADDITIONAL VARIABLES

ICA dummy Effect of Industrial coordination act 1975 (impediment to local firms)

Alternative analysis: Full sample of firms and with sub-samples including only foreign or
domestic firms. The results are presented for the full sample since they were not significantly
different from each other and the size of the sample is much larger than if we were only
considering foreign companies, especially given the limited number of foreign suppliers
established in Malaysia

Description of the Data

The data requirements for addressing issues on linkages are high. We use two main sources of
information. The first consists of a survey instrument, called the ILTD survey, was carried out in
1997 by the World Bank in collabouration with the Economic Planning Unit. It contains detailed
information on vertical linkages as well as on technology transfers across firms in Peninsula
Malaysia as well as the states of Sabah and Sarawak in East Malaysia. Its main limitation is that
this data is only available for 1996. The ILTD Survey received usable information from a total of
2,290 respondents with a diversified set of characteristics in terms of size, ownerships, and
industries. The second source is the Annual Survey of Manufacturing conducted regularly by the
Malaysian Government, which is less detailed, but available over a longer period of time, from
1985 to 1995. The sample with usable (complete) backward linkages information totals over
64,000 with 14,900 individual establishments being observed repeatedly over this 11-year
period.
Proposed Thesis Chapters

Chapter 1 Introduction
Chapter 2 Literature review
Chapter 3 Malaysian Fragmentation Trade and Export Competitiveness
Chapter 4 Industrial Human Capital Upgrading
Chapter 5 Determinants of Vertical Backward Linkages and Firm Productivity
Chapter 6 Conclusions

  45
Appendix 1

• Export Similarity Index (Finger and Kreinin 1979)

Si (ab,c) = { ∑
i
Minimum [ Xi (ac), Xi (bc) ] } 100

where Si (ab, c) is similarity between exports of country a and b to a common market c in

commodity i, Xi (ac) is the share of commodity i in a’s (i.e Indonesia) exports to c (world);
and similarly Xi (bc) is the share of commodity i in b’s (Malaysia) exports to c (world). The
index varies between zero and 100, with zero indicating complete dissimilarity and 100
representing identical export composition. This measure is subject to aggregation bias (as the
data are more finely disaggregated, the index will tend to fall) and hence embodies a certain
arbitrariness due to product choice.

• Revealed Comparative Advantage Index (Balassa 1965)

Measures of revealed comparative advantage (RCA) have been used to help assess a country’s
export potential. The RCA indicates whether a country is in the process of extending the
products in which it has a trade potential, as opposed to situations in which the number of
products that can be competitively exported is static. It can also provide useful information about
potential trade prospects with new partners. Countries with similar RCA profiles are unlikely to
have high bilateral trade intensities unless intraindustry trade is involved. RCA measures, if
estimated at high levels of product disaggregation, can focus attention on other nontraditional
products that might be successfully exported. The RCA index of country I for product j is often
measured by the product’s share in the country’s exports in relation to its share in world trade:

RCAij = (xij/Xit) / (xwj/Xwt)

Where xij and xwj are the values of country i’s exports of product j and world exports of product j
and where Xit and Xwt refer to the country’s total exports and world total exports. A value of less
than unity implies that the country has a revealed comparative disadvantage in the product.
Similarly, if the index exceeds unity, the country is said to have a revealed comparative
advantage in the product.

  46
Appendix 2

Dynamic Revealed Competitiveness Position (DRCP)

⎛ X j ,i , y 2 X j ,i , y1 ⎞⎟
DRCPj, i, y1 − y 2 = ⎜ − *100
⎜ ∑ X j ,i , y 2 ∑ X j ,i , y1 ⎟
⎝ j j ⎠

X j ,i , y 2 = Represents exports of country (j) in sector (i) in year y2 and the

∑ j
X j ,i , y 2 = Represents world exports for the same sector (i) in the same year y2.

Note: For instance, if the DRC is negative for a commodity exported by Malaysia but it is
positive for China, then the commodity is said to be in “direct threat”. However, if the DRC is
positive for both Malaysia and China, then it is in “partial threat”.

Definitions:
Patent applications are applications filed with a national patent office for exclusive rights for an
invention--a product or process that provides a new way of doing something or offers a new
technical solution to a problem. A patent provides protection for the invention to the owner of
the patent for a limited period, generally 20 years.
Source: World Intellectual Property Organization (WIPO), WIPO Patent Report: Statistics on
Worldwide Patent Activity. The International Bureau of WIPO assumes no responsibility with
respect to the transformation of these data.

School enrolment ratio. Ratio of total enrollment, regardless of age, to the population of the age
group that officially corresponds to the level of education shown. Tertiary education, whether or
not to an advanced research qualification, normally requires, as a minimum condition of
admission, the successful completion of education at the secondary level.

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