As anxieties over Covid-19 fade, Malaysia has sought to rebuild the links shattered by two years of pandemic lockdowns. This means that trade, investment and regional integration are once again at the forefront.
In January, Malaysia ratified the Regional Comprehensive Economic Partnership (RCEP), with the Ministry of International Trade and Industry further signalling that it aims to ratify the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) before year end. On the investment front, a RM2 billion strategic investment fund was launched to attract foreign investments from multinational companies, while the Malaysian Investment Development Authority (Mida) recently set up a dedicated unit to accelerate the implementation of projects that have attracted foreign investments.
In many ways, this is good. Evidence suggests that greater international trade and investment tend to boost economic growth, productivity, employment and incomes. For developing countries like Malaysia, openness to trade promotes foreign investment, which creates opportunities for technology and knowledge diffusion from abroad.
Government policy can also play a large role in enabling this type of openness. Reducing trade barriers and deepening economic integration create avenues for greater trade intensity with our peers from across the region — directly reducing the costs of inter-regional trade and facilitating greater access to goods, services and technology.
Together, the forces of trade, investment and economic integration have allowed developing countries in the region to grow richer and more productive.
As many have noted, no country in modern history has succeeded without economic openness. After all, the same global forces that have catalysed the rapid industrialisation of East Asian economies like Japan, South Korea and Taiwan have also helped Malaysia scale the developmental ladder. But there’s a catch. While the globalisation of trade has transformed living standards in Asia over the past few decades, harnessing openness for economic prosperity is much more complicated than appearances suggest.
For one, economic openness has a cost too. Unbridled trade and investment liberalisation, particularly when coupled with premature financial deregulation, can expose an economy to the vagaries of global demand and the whims of short-term capital flows — a grave lesson many Asian countries learnt during the 1997 financial crisis.
A more pernicious pitfall is inequality. Even when trade and openness benefit a country as a whole, trade ultimately creates winners and losers, giving rise to significant distributional impacts within a country. Often, the gains from trade accrue to better-educated, higher-skilled workers in export-facing industries while the costs of trade fall on lower-skilled, lower-wage workers.
These gains and costs also tend to be geographically stratified, widening regional disparities. In India, poorer rural families were the most affected by lower trade protection, while in the US, families living in areas hit hard by import competition from China suffered huge job losses. Even the purported trade benefits of lower consumer prices are not felt equally: evidence suggests that consumers in remote rural areas saw only a tiny portion of the gains from lower trade barriers.
More importantly, international experience over the last few decades confirms that trade is a necessary but insufficient condition for development. Many countries have opened their economies and liberalised trade and investment but only a few have managed to grow rich doing it. This is because the ability of greater trade and investment to generate positive spillovers depends largely on a country’s characteristics.
A country with strong institutions, a sufficiently skilled labour force and good infrastructure will be able to capture the knowledge, technology and growth spillovers from international trade and capital flows. In fact, research suggests that in Asean, there is a non-linear relationship between trade openness and growth — opening a country up too quickly to trade without first building competitiveness can actually have a negative impact on long-term growth.
Japan, South Korea and Taiwan did not grow rich through opening trade and attracting FDI alone. Rising trade and foreign investment were supported by an emphasis on building domestic productive capabilities and accelerating the technological learning of home-grown firms. Large sums were spent on upgrading human capital and steadfast political will exercised to undertake difficult structural reforms.
In the case of the industrialised East Asian economies, domestic industries were fostered not through the creation of monopolies. Instead, industrial policy first favoured firm formation and domestic competition, incentivising home-grown firms to compete with each other. Subsequently, in South Korea, after local firms were sufficiently capable, they were forced to export and compete globally — or perish.
Since its attempts to emulate the development trajectory of the industrialised East Asian economies decades ago, Malaysia has only succeeded in doing a subset of these things. For too long, it has continued to rely on foreign-invested firms to produce, export and innovate. Despite various policy efforts over the years, the pace of local technological learning and indigenous capacity to innovate remains low. Carve-outs and restrictive local content requirements have seen limited success, managing only to produce politically connected local SMEs while large foreign multinationals continue to dominate most export-oriented industries.
An oft-cited example is Malaysia’s semiconductor industry. The first foreign semiconductor firms arrived in Penang in the early 1970s — creating jobs, exports and growth in the decades since. Yet, half a century and billions of ringgit spent in tax incentives later, Malaysia’s strengths today remain mostly in lower-value-added activities, such as chip assembly and testing.
Foreign-owned multinationals continue to dominate the local electronics manufacturing sector, with large Malaysian players in this space few and far between. This stands in stark contrast with the largest firms in the industrialised East Asian economies, such as Samsung, Toyota, and Taiwan Semiconductor Manufacturing Company (TSMC), which are all locally owned.
For all the myriad benefits of economic openness, policymakers should be wary not to ask trade and investment to do too much. Attracting FDI means little for economic development if its benefits are captured by foreign firms instead of being directed towards building local capacity to produce and innovate.
The same can be said for free-trade agreements and market access if foreign multinationals continue to command a large share of Malaysia’s exports, while local businesses are stuck as SMEs. Likewise, economic openness hardly matters if not directed towards a longer-term goal of local technological learning and the production of globally competitive Malaysian firms and brands.
Ultimately, large inflows of FDI make good press but focusing on building large domestic firms provides stable and sustained sources of growth and jobs that are far less likely to exit the country when costs rise and global demand conditions shift.
As Malaysia approaches the high-income economy threshold, these challenges will only become increasingly pivotal. Making trade and investment work for Malaysia will entail contending with its pitfalls — democratising the gains of trade and FDI across regions, industries and households — and redirecting the forces of globalisation towards indigenous technological learning for local firms and workers. If anything, policymakers would do well to note that openness alone is not a silver bullet for our developmental woes.
Calvin Cheng is a senior analyst at the Institute of Strategic and International Studies (ISIS) Malaysia