[Asian Economic Journui 1996, Voi. 10 No I ] 29 Foreign Investment and Industrialization in Malaysia: Exports, Employment and Spillovers* Premachandra Athukorala Australian National Universiry Jayant Menon Monash University Over the past two decades, there has been a decisive shift in trade and industry policy in developing countries (DCs) away from import substitution and towards export-orientation. As part of this policy shift, an increasing number of DCs have become more receptive to foreign direct investment (FDI).Despite its policy relevance, the literature on the role of FDI in export expansion, employment generation and spillovers in DCs is sparse. This paper attempts to fill this gap through a case study of the role of export-oriented FDI in Malaysia’s rapid industrialization. The overall conclusion of the paper is that export-oriented FDI has brought significant returns to Malaysia principally because the general economic climate has been favourable for the internationalization of production for a considerable period of time. I. Introduction Over the past two decades, there has been a decisive shift in trade and industry policy in developing countries (DCs) away from import substitution and towards export-orientation. As part of this policy shift, an increasing number of DCs have become more receptive to foreign direct investment (FDI),marking a significant departure from the conventional distrust of FDI. Multinational enterprises (MNEs)’ are generally expected to play a major role in the process of export-oriented industrialization by providing easy access to foreign markets * We thank Richard Pomfret and an anonymous referee for comments. We are also grateful to Anant Menon and Ong Hong Cheong for valuable discussions, and to various staff at the Malaysian Department of Statistics and Saleha Abdul Rahman and Choo Wai Meng in particular from the Malaysian Industrial Development Authority (MIDA) for providing access to unpublished data. 1. In line with standard practice in this area of study, the MNE is defined as an enterprise that owns and controls business ventures in more than two countries, including its home country. When this definition is used, the bulk (if not all) of FDI in a given host country can be considered as MNE investment. The terms “foreign firm” and MNE are used interchangeably. ASIAN ECONOMIC JOURNAL 30 and bringing in experience and expertise in the many complex facets of product development and international marketing. In view of these considerations, enticing MNE participation has become an integral element of policy reforms toward export-led industrialization in many DCs. This new emphasis on FDI is not without its critics, however. By referring to the conflict between the global profit-maximization objective of MNEs and the national interest of the host DC, critics argue that there is little room for the host DC to influence either the locational decision of MNEs or their production performance. In this respect, the “footloose” nature of production and limited technology and skill transfer are often highlighted as intrinsic limitations of FDI. The purpose of this paper is to shed light on this debate by examining the case of Malaysia. For the purpose of closer scrutiny, we select three key aspects of the FDI-industrialization nexus: exports, employment and spillover effects. Malaysia provides an interesting case study of this subject. Since the mid-l970s, the Malaysian economy has experienced rapid growth and dramatic structural transformation through the expansion of manufactured exports. According to various indicators such as share of GDP, contribution to exports and employment generation, manufacturing is now the single most important sector of the economy. On the strength of this growth record, which is indeed unique among the DCs, Malaysia is now being hailed as the next Asian NIC (World Bank, 1993). The role of FDI is often cited as the most important contributory factor behind this success story. The paper is in five sections. Section I1 provides an overview of the foreign investment climate since independence (1957), and patterns and characteristics of FDI in Malaysia. The role of FDI in the recent surge of manufactured exports and its economic implications is examined in Section 111. The contribution of FDI to employment generation is analysed in Section IV. Linkages, technology transfer and other spread effects of FDI are the subject matter of Section V. A final section summarizes the key findings. 11. Policy Context and Trends and Patterns of Foreign Direct Investment The promotion of FDI, particularly in export-oriented manufacturing, has been on the Malaysian policy agenda since the late 1960s (Ariff and Lim, 1987; Nunnenkamp, 1991). In 1968, the Government enacted the Investment Incentives Act to promote manufacturing exports in response to the problem of internal market saturation faced by the manufacturing sector. The rich assortment of incentives offered to export-oriented FDI by the Act included exemptions from company tax and duty on imported inputs, relief from payroll tax, investment tax credits and accelerated depreciation allowances on investment. This was followed by the introduction of the New Economic Policy (NEP) in 1970 which earmarked the manufacturing sector as the growth sector to spearhead economic restructuring and employment generation. The development of Free Trade Zones FOREIGN INVESTMENT AND INDUSTRIALIZATION IN MALAYSIA 31 (FI’Zs) to entice foreign investor participation in this endeavour was a key element of the NEP.’ It is important to note that while Malaysia is not to be outdone in the sphere of specific incentives, such incentive schemes are not unique to Malaysia. Malaysia’s attractiveness for FDI cannot, therefore, be understood without a close look at the general business environment as it relates to MNE investment decisions. The trade and industry policy regime of post-independent Malaysia has consistently been much more favourable to export producers than that of many other countries in the region (Myint, 1967; Riedel, 1991). Even in the early years of heavy emphasis on import substitution industrialization, domestic industries were usually protected only through moderate rates of tariff rather than quantitative restrictions (QRs) and exchange restrictions. These features of the trade regime, coupled with prudent macro-management, were instrumental in avoiding significant exchange rate misalignment, and their deleterious effects on tradable goods production. Moreover, the choice of tariffs rather than QRs as the instrument of protection meant that the domestic incentive structure was not significantly insulated from changes in world market prices. FDI is by no means unrestricted in Malaysia. There are guidelines and regulations governing FDI in conformity with the country’s development priorities and overall sociopolitical objectives, which may at times run counter to the global profit maximization objective of MNEs (Ariff and Lim, 1987). Of particular relevance in this connection are attempts, under the NEP, to increase the share of Bumiputras (Malays) in the corporate sector from 2% in 1970 to 30% in 1990, and to reserve a certain percentage of employment in foreign ventures for Bumiputras. However, the 70:30 Malaysian - foreign equity ownership ratio represents a national target and is not meant to be implemented on an individual company basis. In fact, 100% foreign ownership is allowed in export-oriented ventures. Over the years, the government has also resorted to a more lenient policy stance relating to Bumiputra employment quotas with a view to ameliorating its adverse impact on export-oriented FDI. Moreover, unlike governments in many other DCs, the Malaysian government has taken care to make its policy stance towards FDI unambiguous and transparent. The government has pursued other specific objectives such as location of industries in “development areas”, increasing the use of local inputs, and diverting investment to certain “priority” industries. But, as in other East Asian export-oriented economies, these objectives have been pursued largely through prescriptive rather than proscriptive methods.3 Guarantees against nationalization of foreign assets without compensation are provided by the Constitution, and investment guarantee agreements have been concluded with several capital exporting countries. 2. The first FTZ was opened in Bayan Lepas (Penang) in 1972. By the end of the 1980s, Malaysia had ten FTZs. For details see Rasiah (1993). 3 . This terminology is due to Bhagwati (1988, pp. 98-100). Under proscriptive regimes, activities that are not specifically permitted tend to be prohibited. By contrast the prescriptive approach tends to rely more on incentives to achieve desired objectives. 2696 49 536 96 25 29 84 469 242 346 11 95 9 24 209 82 152 19 147 72 38.91 11.66 18.61 34.78 26.17 42.24 79.64 3 1.58 92.59 43.94 46.06 31.80 76.34 53.81 47.83 13.48 3 1.03 9.96 53.05 78.10 1980 Percentage 6847 548 1160 196 46 718 418 195 116 1331 235 49 65 100 76 1 429 376 19 76 9 RM mil. 34.05 25.68 70.21 52.51 47.50 8.47 16.36 19.08 21.22 37.01 41.35 14.70 30.67 32.61 22.75 38.93 76.58 2 1.52 92.45 46.10 1986 Percentage 11074 loo0 378 79 1 53 213 48 238 608 1136 678 156 846 276 287 189 3546 28 1 235 115 RM mil. 42.40 30.41 63.64 61.41 58.89 19.10 44.86 13.53 25.30 45.31 54.85 27.86 32.65 16.81 29.7 1 52.94 88.96 25.18 97.11 42.91 1990 Percentage 19035 993 383 1119 54 61 1 126 282 1I30 1613 884 415 1241 807 596 280 7160 622 477 242 RM mil. Source: Computed using unpublished returns from Malaysian Industrial development Authority’s Annual Survey of Companies in Production. Total Food Beverages Textiles Leather products Wood products Furniture Paper, printing products Chemicals Petroleum, coal products Rubber products Plastic products Non-metallic minerals Basic metal products Fabricated metal products Machinery Electronics Transport equipment Scientific equipment Miscellaneous RM mil. Table 1 The Share of Foreign Firms in Total Fixed Assets, (RM millions and percentage shares) 50.01 28.85 55.75 63.22 54.00 3 1.32 64.95 12.62 39.48 47.15 48.84 38.28 36.95 34.94 37.60 53.64 90.83 3 1.70 97.75 60.35 1992 Percentage z s W h, 3 n \ 1 0 8 h 0 b FOREIGN INVESTMENT AND 1NDVSTRIALlZATlON IN MALAYSIA 33 In the context of this favourable investment climate, FDI flows to Malaysia have grown impressively over the past two decades. Foreign capital inflows have increased almost ten-fold between 1987 and 1993. Since the mid-l980s, FDI flows to Malaysia have been increasing at a faster rate than those to the other ASEAN countries (Athukorala and Menon, 1995b). Since 1991, the volume of FDI flowing to Malaysia has remained higher than that to any of the other ASEAN countries (UNCTC, 1991; UNCTAD-CTC, 1995).4The contribution of majority-owned foreign firms in total fixed assets in the manufacturing sector increased from 39% in 1980 to 50% in 1992 (Table 1). Historically, the UK has been the dominant source of FDI; at the time of independence in 1957, the UK owned more than 90% of the stock of FDI in Malaysia. The British dominance in FDI continued until the early 1970s, when investment flows from the US, Japan and Germany began to expand rapidly in export-oriented manufacturing (Junid, 1980). By the early 1980s, Japan had become the largest single investor in terms of annual volume of inflow. The US share in total FDI has varied between 3 and 28% in the 1980s, although this share would be somewhat higher if only export-oriented investment were considered. Recent data exhibit a dramatic increase in the importance of FDI from other developing countries in East Asia (Menon and Athukorala, 1995). The share of approved investment accounted for by East Asian investors increased from 21.75% in 1980 to 40.25% in 1994. According to data on investment approvals, Taiwan displaced Japan as the largest investor in Malaysia in 1990 and 1994, with shares of 36 and 25.6%, respectively. However, in terms of total accumulated investment (value of fixed assets), Japan is still the pre-eminent investor, followed by Singapore, US, Taiwan and UK (Table 2, last row). Virtually all FDI (mostly British) in pre-independent Malaysia was in the primary sector (mainly in tin mines and rubber plantations) and related service sectors. FDI flows to manufacturing began only in the late-1950s and, for the next two decades, went predominantly into import-substitution production (Junid, 1980). Export-oriented FDI began to expand slowly but steadily from the mid1970s. By the late-l980s, FDI inflows had decisively shifted from production for the domestic market to using Malaysia as a base for manufacturing for the global market. The share of projects with an export orientation of 50% or more increased from 24% of total approved projects during 1984-85 to about 82% during 1988-89. The proportion of projects with an export orientation of 80% or above increased from one-fifth of the total in 1984 to about three-quarters in 1989 (Ariff, 1991). Foreign firms in export-oriented manufacturing are mostly in assembly operations in electrical goods and electronics, and diffused-technology consumer goods production. However, in recent years, FDI has begun flowing into the production of mature-technology final products such as radios, TVs, cameras, computers, 4. There is a sizeable literature that documents the trends and patterns of FDI flows to Malaysia; see, for instance, Athukorala and Menon (1995a) and literature cited therein. 7.23 4.53 53.10 0.00 16.03 10.67 15.48 30.96 14.37 9.11 48.95 38.69 62.15 13.49 65.99 45.02 40.33 48.88 28.24 33.57 8137 15.47 0.21 14.10 0.76 2 1.69 0.76 1.88 2.93 0.01 3.91 1.16 0.72 0.55 1.01 0.03 5.92 3.28 0.08 6.75 5.02 1218 Japan 0.83 202 0.00 0.00 0.00 4.63 0.99 0.07 0.02 0.00 0.80 0.00 7.29 0.00 0.22 1.05 0.57 0.00 0.00 0.01 0.00 Korea 14.75 3576 33.21 56.75 11.42 12.97 10.70 10.05 38.45 24.4 1 2.59 11.93 18.36 30.5 1 23.43 13.44 21.17 9.33 7.16 10.53 38.41 Singapore 6.93 1680 1.22 0.00 1.77 23.93 38.37 64.12 2.39 0.40 0.00 2.29 3.58 0.42 3.65 7.08 5.41 11.29 2.76 3.61 6.46 Taiwan 6.33 1534 15.54 16.69 1.85 0.03 0.53 3.30 3.36 16.06 18.44 8.85 0.00 6.54 2.10 0.96 0.29 1.26 13.45 1.97 2.07 UK 9.99 242 1 2.12 7.44 0.34 0.00 0.06 5.34 38.15 11.10 7.67 16.00 0.94 0.87 0.89 0.77 3.70 18.78 9.77 0.00 10.89 us 22.58 5472 25.23 14.38 17.43 62.30 7.99 4.75 0.2 1 14.12 56.92 47.11 27.01 14.96 7.23 63.05 2.36 7.82 23.26 34.94 7.18 Other 100 (24239) 24239 100 ( 100 (1259) 53) 100 ( 898) 100 ( 132) 100 ( 287) 100 (1519) 100 (2923) 100 ( 995) 100 ( 612) 100 (1311) 100 ( 806) 100 (1530) 100 ( 541) 100 (8066) 100 ( 919) 100 ( 461) 100 ( 272) 100 (1235) 100 ( 417) Total (RM mil.) Source: Computed using unpublished returns Erom Malaysian Industrial development Authority’s Annuul Survey of Companies in Pmducfion Total: percentage value (RM mil.) Food Beverages Textiles Leather products Wood products Furniture Paper, printing products Chemicals Petrol, Coal Rubber products Plastic products Non-metallic minerals Basic metal products Fabricated metal products Machinery Electronics Transport equipment Scientific equipment Miscellaneous Hone Kong Table 2 Foreign Investment (Fixed Assets) in Manufacturing, by Industry and Country, 31 December 1993 (percentage shares) a 5 u 3 h 2 FOREIGN INVESTMENT AND INDUSTRlALZATlON IN MALAYSIA 35 etc. This recent development is due mainly to the rapid improvement in the quality of infrastructure and increasing domestic demand associated with increasing income levels in the country. Malaysia’s efforts in attracting FDI in the electronics industry were so successful that by 1980 it had become the largest developing-country exporter (and one of the world’s major exporters) of electronic components, particularly integrated circuits (Grunwald and Flamm, 1985). The electronics industry accounted for 19% of foreign paid-up capital and 27.5% of foreign-owned fixed assets in Malaysia at the end of 1989. Despite the rich natural resource base of the country, recent foreign capital participation in “modern” resource-based industries (i.e. in areas other than conventional plantation-based product sectors) does not appear to be significant, particularly as compared to neighbouring Indonesia.’ 111. FDI and Export Orientation The export structure of Malaysia, as it evolved during the colonial era, was characterized by heavy reliance on a limited range of primary commodities. In the early 1970s, the share of manufactures6 in total merchandise exports was around 10% (Table 3 ) . Since then, manufactured exports have emerged as the most dynamic element in the export structure. Exports of manufactures grew (in current US dollar terms) at an annual compound rate of 35% during 1980-92, and by 1994 their share in total merchandise exports had reached 78% (Table 3). In the 1970s and early 1980s, resource-based manufacturing such as food, beverages, tobacco, wood products and basic metals loomed large in the structure of manufactured exports. The transformation of Malaysia’s export structure in line with emerging patterns of the international division of labour gathered momentum only in the late 1980s; by the 1990s, the share of resource-based exports had declined while the shares of electronics, electrical machinery and appliances rose sharply. In 1994, electronics, electrical machinery and appliances accounted for over 60% of Malaysia’s total manufactured exports. The share of Japanese firms in total manufactured exports from Malaysia increased from 5.2% in 1972-73 to 7.9% in 1986 and to 9.8% in 1989. A similar comparison for US firms was 33.6% in 1982-85 and 21.1 percent in 1977 (Naya, 1990; Ramstetter, 1993). Judging from the massive increase in exportoriented investment flows from the East Asian developing countries, the foreign share in total exports would have increased significantly since the late 1980s (Wells, 1993). Table 4 reports estimates of sales and exports (to the US) of US affiliates in Malaysian manufacturing in 1987 and 1992. The export-sales ratio for total manufacturing is greater than 50% in both years. Most of these exports 5. As a reflection of the historical pattern of FDI involvement in Malaysia, there is still a significant presence of foreign firms in the mining sector. Their share in total output, however, has been declining steadily since the mid-1970s. 6. Manufactures is defined to include commodities belonging to sections 5-8 in the Standard International Trade Classification (SITC). 100.00 11.9 598.5 100.00 23.2 6289.5 4.7 5.5 4.9 8.0 100.00 13.7 513.1 1.3 1.o 3.3 46.8 13.3 3. I 9.2 19.2 15.1 17.5 3.4 2.7 1.9 14.3 12.2 0.5 12.5 7.4 6.5 1981 18.6 4.0 5.8 5.8 6.6 33.6 2.2 2.7 1.3 11.0 1971 Source: Bank Negara Malaysia, Annual Report, Kuala Lumpur, various issues. Total: percentage of manufactured exports percentage of total exports value of manufactured exports (RM mil.) Food Beverages and tobacco Textiles, clothing, footwear Wood products Chemicals Petroleum products Rubber products Nan-metallic minerals Metal manufactures Electronics, electrical machinery, appliances Electronics Electrical machinery Electrical appliances Transport equipment Other manufacturing 1967 100.00 43.3 1.5126.0 5.7 0.2 10.9 3.5 4.0 4.2 1.o 1.3 3.5 55.7 38.3 3.5 13.5 4.5 5.5 1986 Table 3 Manufactured Exports by Industry, (percentage shares) 100.00 64.9 61440.8 3.4 0.3 7.7 2.8 2.9 1.9 2.8 1.4 3.0 58.0 21.2 30.9 5.9 5.4 10.4 1991 2 U 100.00 78.2 120200.3 3.8 1.8 2.3 1.2 3.0 63.5 20.7 37.5 5.3 4.8 8.0 m W ::: $ 2.4 0.2 1994 4 FOREIGN INVESTMENT AND INDUSTRIALIZATION IN MALAYSIA 37 Table 4 US Affiliates in Malaysian Manufacturing: Total Sales and Exports to the US, (US millions and percentage shares) Year Sales (US$ mil.) Exports (US$ mil.) Export-Sales Ratio (a) Electrical machinery and electronics Other 1987 1992 1987 1992 2139 3092 713 1867 1495 1891 40 812 69.89 61.16 5.61 43.49 Total 1987 1992 2852 4959 1535 2703 53.82 54.5 1 Source: Compiled from US Bureau of Economic Analysis, US Direct Investment Abroad: Operations of US Parent Companies and their Foreign AfSrliates, Washington, D.C.: US Bureau of Commerce, 1987 and I992 issues. emanate from affiliates in the electronics sector. While the share of exports in sales in other sectors was about 6% in 1987, this had increased to more than 43% by 1992. In value terms, total manufacturing exports to the US increased by more than 75% between 1987 and 1992. It is important to note that the figure for net exports generated by foreign firms is less than would be suggested by the gross figures reported in national trade statistics. The available data suggest that the share of imported inputs in gross export value of manufactured exports is as high as 75% (Onn, 1990). In addition, allowance has to be made for other leakages such as profit remittances, salaries of expatriates and payments of interest on foreign loans. Export-processing investments also offer possibilities for evading taxes by setting transfer prices such that profits are recorded largely elsewhere (Wells, 1993, p. 185). Obviously, the higher the net foreign exchange component in exports, the greater would be the benefit to the economy from FDI. However, overwhelming reliance on per-unit net foreign exchange earnings as a performance criterion can lead to the wrong policy prescriptions for the following reasons. First, the country’s principal objective in export expansion is to generate the largest possible volume of net foreign exchange earnings, not to maximize net foreign exchange earnings per unit of exports. In this respect, what is more relevant is market potential. Only a small and shrinking share of manufactured exports from DCs these days is resource-based (and hence high value-added) goods. On the other hand, market potential for labour-intensive manufactured goods that are made to local specifications in DCs is even more limited. The success in increasing the volume of net foreign exchange earnings therefore depends crucially on the country’s ability to enter the fast-growing markets for made-toorder manufactured goods and assembly operations in vertically integrated electronics and electrical industries which are essentially more import intensive (Keesing and Lall, 1992, p. 179). Second, unlike import-substituting firms, the ASIAN ECONOMIC JOURNAL 38 performance of export-oriented ventures is not subject to the “foreign exchange constraint” (which was a dominant consideration in industry policy under the import-substitution strategy). They create no drain on indigenous investible funds and other scarce resources. In the worst case scenario, the total net foreign exchange earnings would be equivalent to the payments to local labour (and tax paid to the Malaysian government). Third, rapid growth of gross export earnings per se can be considered an important policy objective yielding considerable national benefits. Entering international markets in manufactures is a challenging task and, therefore, export growth (in gross terms) is widely used as an indicator of efficiency and competitiveness of the domestic manufacturing sector. Thus, rapid export growth produces a conducive setting for further attraction of FDI and the mobilization of foreign loanable funds at competitive rates. Finally, there is evidence that the net foreign exchange earnings component would tend to increase with the passage of time as foreign firms began to forge backward linkages (see below). From the point of view of the host country, local firms’ access to market channels from the ICs is an important advantage offered by FDI. There is mounting evidence to suggest the important role that foreign firms in general play as catalysts for the development of local exporters (Wells, 1993; Keesing and Lall, 1992). Following the entry of foreign firms into garments and other light consumer goods industries in a given country, international buying groups which have long-established market links with these firms also set up buying offices in the country.’ These buying groups subsequently play a crucial role in linking local firms up to highly competitive international markets for these products. Moreover, joint-venture operations with foreign investors provide local entrepreneurs with an opportunity to acquire production and international marketing skills required for the successful operation of their own (independent) production units. Thus, export diversification offered directly by the foreign investors themselves may dramatically understate the actual contribution of these firms. IV. Employment There has been a remarkable increase in the number of employment opportunities generated by FDI projects. For instance, in the electrical machinery industry (including electronics)’ employment in US firms alone increased from 49,000 in 1977 to 86,000 in 1986 and to 135,000 in 1989 (Ramstetter, 1993, Table 10). Total employment in Malaysian FTZs increased from 23 1,500 in 1972 to 920,600 7 International buying groups are world-wide purchasing organizations of large retail chains In developed countries, which specialize in the purchase of labour-intensive manufactured goods such as garments, toys, sports goods etc. For details on their role in the expansion of manufactured exports from developing countries, see Keesing and La11 (1992). 8. Employment in the electronics sector provided more than 30% of total manufacturing employment in 1990. FOREIGN INVESTMENT AND INDUSTRIALIZATION IN MALAYSIA 39 Table 5 Share of Foreign Firms in Production and Employment by Industry (percentage shares) ~ ~~ ~ ~~~ 1983 Product ion 1985 1992 1983 Employment 1985 1992 Food Textiles Apparel Leather products Wood products Furniture Paper, printing Chemicals Petroleum, coal products Rubber products Plastic products Non-metallic minerals Basic metal products Fabricated metal products Machinery Electronics Transport equipment Scientific equipment Miscellaneous 28.93 42.86 31.25 0.00 4.5 1 2.56 2.22 26.33 79.76 42.48 6.72 2 1.45 46.79 24.61 26.50 82.85 21.69 90.91 55.77 18.71 43.38 44.19 0.00 7.55 2.00 4.74 20.37 88.13 41.63 7.09 13.91 32.81 11.92 28.49 80.07 14.38 96.36 56.86 23.64 47.06 39.61 33.33 10.26 32.50 10.26 25.27 95.26 42.46 19.59 17.97 35.62 16.38 62.35 85.52 13.30 100.00 58.82 19.60 30.85 30.43 0.00 2.87 3.70 2.43 31.07 40.63 33.77 9.45 10.40 20.90 13.15 16.16 83.16 8.16 91.15 56.38 16.92 32.87 39.85 3.03 5.77 3.06 3.44 30.00 32.69 33.67 8.10 10.53 15.57 8.88 16.78 80.13 6.67 95.04 62.07 14.94 33.48 38.72 38.89 11.58 27.17 10.59 31.18 40.00 42.71 22.40 19.12 26.03 17.17 47.98 85.09 10.93 100.00 75.81 Total 40.50 35.75 47.62 29.75 29.60 42.46 Source: Computed using unpublished returns from Malaysian Department of Statistics, Annuul Survey of Manufactur-ing Industries. in 1987 (Rasiah, 1993, Table 4.4). In general, the sub-sectors within manufacturing which have had the fastest growth of output and employment during the 1980s and 1990s are ones with greatest FDI participation. For instance, total employment in the electronics industry, the major magnet of FDI, increased from 78,000 in 1980 to 225,000 in 1992. While manufacturing employment almost doubled between these two years, over 40% of this growth originated in the electronics industry.’ Table 5 brings together data on the relative contribution of foreign firms to sectoral production and employment in manufacturing. The percentage of workers employed in foreign firms increased from about 30% in 1983 to 42% in 1992. This increase in employment has been faster than the increase in the share of output of these firms (from 41 to 48%). This suggests that with the rapid expansion of export-oriented manufacturing, the structure of manufacturing production has become more labour-intensive over the years. This pattern is particularly noticeable in non-metallic minerals, basic metal products, fabricated 9. These estimates are based on unpublished data from the Annual Survey of Companies in Producrion conducted by MIDA. ASIAN ECONOMIC JOURNAL. 40 metal products and miscellaneous manufacturing. In the case of electronics, the employment and output shares have remained virtually unchanged at comparable levels. This reflects the fact that the export-oriented electronics industry has been labour-intensive right from the start. Employment patterns in export-oriented foreign firms (in particular those in the electronics industry) is characterized by a heavy reliance on women workers (Rasiah, 1993). In this context, it is often questioned whether the job opportunities created within export-oriented foreign firms are a “net” addition to employment (see, for instance, Lee, 1984). Unfortunately, data are not available to provide a straightforward answer to this question. It is quite possible that these firms have contributed first and foremost to a rise in the labour force participation rates, notably through the entry of young women into the labour force. In the absence of FTZ employment opportunities, most of these young women workers would probably have remained outside the labour force. V. Linkages, Technology Transfer and Other Spread Effects Given the overwhelming reliance on imported inputs, export-oriented foreign firms are usually criticized for not having developed significant direct input linkages (backward linkages) with the domestic economy. Indeed, the consensus view from other country studies is that linkage effects of export-oriented firms operating in light manufacturing and assembly activities are generally less than those of import-substituting firms (Casson and Pearce, 1987, p. 109). This observed pattern can largely be explained in terms of the huge contrast between the shortage-ridden overly protected suppliers’ markets for import-substituting products, and the extremely competitive buyers’ markets for goods exported to highincome countries. Unlike meeting consumer requirements in the former, producing what is sought in the latter markets call for a vector of imported inputs meeting exacting quality requirements and specifications. Substituting such inputs with locally produced inputs of secondary quality may lead to significant market losses, and the cost involved in correcting any potential defect in a further stage may be prohibitive (Keesing and Lall, 1992; World Bank, 1993). It would, therefore, seem unrealistic to expect foreign firms to forge greater linkages at the formative stage of export-oriented industrialization. However, there may be a tendency for these firms to increase their local purchases as their operations in the given host country mature, provided the local business environment is conducive to such behaviour. This view is supported by studies of foreign firm behaviour in Malaysia (Lim and Pang, 1991; Liebau and Wahnschaffe, 1992; Aoki, 1992). Foreign firms operating in Malaysian FTZs originally procured almost all of their inputs from abroad. The situation has, however, changed rapidly since the latter half of the 1980s. For instance, according to a survey of Japanese firms operating in the Malaysian manufacturing sector conducted by the Japanese external trade organization (JETRO), the share of locally procured parts and materials in total output rose from 20% in 1987 to FOREIGN INVESTMENT AND INDUSTRIALIZATION IN MALAYSIA 41 24% in 1989 (as quoted in Aoki, 1992). Part of this increase has been caused by the rapid appreciation of the yen since 1985. In response to yen appreciation, many intermediate-input producing firms in Japan have set up production bases in Malaysia in order to maintain competitiveness in the supply of inputs to Japanese firms operating in Malaysia (Aoki, 1992). Linkage formation is not limited to firms of Japanese origin, however. For instance, in an extensive survey of semiconductor firms operating in Malaysia’s FTZs, Liebau and Wahnschaffe (1992) find convincing evidence of substantial integration of firms from all countries into the domestic economy since the mid- 1980s, thus abandoning the “satellite workbench” philosophy that first brought them there. Recently some electronics firms have begun to produce silicon logs, the base material of most semiconductor devices, locally (O’Brien, 1993). Closely related to the linkage aspect of export-oriented FDI is its alleged “footloose” nature. The critics of FDI argue that foreign companies engaged in export-oriented manufacturing operate “with their bags packed” in readiness to flee the scene as soon as wages begin to rise and tax incentives begin to expire. The Malaysian experience suggests that such concern may be misplaced. For instance, 19 of the 26 foreign semiconductor companies had exhausted their tax holiday status by 1988, but all of them not only continued to operate but also expanded their production in Malaysia during the ensuing years (The New Straits Times,23/3/1988). With the development of expertise in Malaysia over the years, many semiconductor firms which were originally involved in simple assembly-type activities, have relocated many end-of-line fabrication and final assembly processes to Malaysia (Rasiah, 1993). While the FTZs attracted most of the FDI initially, there has been growing geographical dispersion introduced by recent FDI flows. While most FDI projects were originally concentrated in the states of Selangor, Johore and Penang, an increasing number of projects are being located in other states such as Perak, Kedah, Negri Sembilan, Malacca, Sabah and Sarawak. There are a number of factors that account for this new industrial pattern in geographic terms which underlie the integration of FTZs into the wider economy. These include (i) the vast improvements in infrastructure, (ii) the rising cost of land in congested areas, particularly in the FTZs, (iii) the emergence of small and medium-sized firms in the FDI profile, a result attributable mainly to the increase in Taiwanese and Korean FDI, and (iv) the conducive policy environment - unlike in many other countries, FTZs in Malaysia have not simply been appendages to a highly regulated economy with a substantial anti-export bias; in fact, the relative attractiveness of FTZs has diminished over time.’” The degree of technology transfer associated with FDI was very limited in the initial stages. Labour in FTZs merely followed instructions from the parent 10. Unlike the case in a number of other countries, there has not been a mass migration of domestic fiims to FTLs in Malaysia. It is not unusual for up to one-third of all firms in FTZs to he fully-owned domestic fims (see Warr, 1990; ILO/UNCTC, 1988; Athukorala, 1995). ASIAN ECONOMIC JOURNAL 42 plants. Over time, however, there has been some increase in local management participation in the production process in electrical and electronic component production factories. An increasing number of locals are being trained in factories in home countries, and there have been many instances of Malaysian professionals being called to parent plants to help reorganize and rationalize production processes. For instance, Texas Instruments now send “Malaysian engineers to the United States to solve their problems” (Microelectronic Monitor, 1987, 32), while Nissan Japan uses its Malaysian plant as a training base (for personnel ranging from engineers to line workers) for its operations in Pakistan (The Star, 20/12/1994). In addition to these technological spillovers, the presence of foreign firms seems to generate considerable information-related externalities which are not directly reflected in market transactions and employment patterns. As we have already noted, market information gained through joint-venture operations and through international buyers who have come with foreign firms may have contributed to the export success of local firms. Foreign firms also expose the business community to examples of internationally-competitive industrial enterprises and this demonstration effect is undoubtedly valuable, especially in the early stage of industrialization. Drawing upon the new (endogenous) growth theory, one can argue that bringing in new knowledge and entrepreneurial skills is the key advantage of FDI. What this theory postulates is that ideas are as important as physical inputs, and an economy can grow just because new ideas beget more new ideas. International trade and foreign investment can be looked upon as vehicles for not only the transfer of goods and services but, more fundamentally, of ideas as well (Romer, 1992; Ruffin, 1993). This aspect of the role of FDI is more subtle because knowledge spill-over is an economy-wide issue, and is by no means limited to the particular industry in which the foreign firm is located. The introduction of new ideas of efficient management, inventory systems, worker training, or incentive systems may result in applications other industries.” VI. Conclusion Malaysia’s achievements in export-oriented industrialization over the past two decades has been unique in the developing world. Much of the growth dynamism has emanated from export-oriented FDI. Perhaps the most impressive contribution of FDI-led industrialization has been the enhancement of employment opportunities. The evidence supports the view that the expansion of domestic industry in developing countries in line with changes in internationalization of production tends to favour labour-intensive activities. The Malaysian experience runs counter to the widely-held view that FDI-led industrialization tends to 11. The extent to which FDI brings economy-wide benefits can only be demonstrated, however, by a more detailed analysis of FDI than has been possible in this study. Such an analysis would have to focus on individual FDI workplacc experiences. FOREIGN INVESTMENT AND INDUSTRIALIZATION IN MALAYSIA 43 be characterized by footloose firms and industries. The spread effects of FDI through backward linkages and direct technology transfer seem limited, but appear to be increasing. The evidence suggests that high import intensity and limited linkages are not intrinsic features of FDI-led export expansion. These are partly a reflection of the early stage of FDI participation in Malaysia, and there are already signs that foreign firms are beginning to generate greater linkages and spill-over effects. The signs are that, with the right policy environment and incentive structure, foreign firms can play an important role in the process of export-led industrialization in developing countries. References Aoki, T., 1992, Japanese FDI and the forming of networks in the Asia-Pacific region: experience in Malaysia and its implications. In Tokunaga, S., Ed., Japan’s Foreign Investment and Asian Economic, Interdependence. University of Tokyo Press, Tokyo, pp. 73-1 10. Ariff, M., 1991, The changing role of foreign direct investment. In Hishashi Yokoyama, H. and M. Tamia, Eds., Malaysian Economy in Transition. Institute of Developing Economies, Tokyo, pp. 67-90. Ariff, M. and Chee Peng Lim, 1987, Foreign investment in Malaysia. In Cable, V. and B. Persaud, Eds., Developing With Foreign Invrstment. Croom Helm, London, pp. 101-121. Athukorala, P., 1995, Foreign direct investment and manufacturing for export in a new exporting country: the case of Sri Lanka. World Economy, forthcoming. Athukorala, P. and J. Menon 1995a, Developing with foreign investment: Malaysia. Australian Economic Review, 109, pp. 9-22. Athukorala, P. and J. Menon, 1995b, Foreign direct investment in ASEAN: can AFTA make a difference? In Tan, J. L. H., Ed., AFTA and the Chnngin,? International Economy. Institute of Southeast Asian Studies, Singapore, forthcoming. Bhagwati, J., 1988, Protectionism. MIT Press, Cambridge, MA. Casson, M. and D. Pearce, 1987, Multinational enterprises in LDCs. In Gemmell, N., Ed., Sitrveys in Development Economics. Basil Blackwell, Oxford, pp. 90-132. Grunwald, J. and K. Flamm, 1985, The Global Factory: Foreign Assembly in International Trude. Brookings Institution, Washington, D.C. ILO/UNCTC, 1988, The Economic und Soc,ialEffects of Multinational Enterprises in Export Processing Zones. Geneva. Junid, S., 1980, British Inclustriul Investment in Maluysia. 1963-71. Oxford University Press, Kuala Lumpur. Keesing, D. and S. Lall, 1992, Marketing manufactured exports from developing countries: learning sequences and public support. In Helleiner, G. K., Ed., Trade Policy, Indu.strialisarion and Dei~elopment:New P erspectiws. Clarendon Press, Oxford. Lee, E., 1984, Export Proce.ssin,g Zones und Indu.striulisurion i n Asiu. ILO-ARTEP, Bangkok. Liebau, E. and P. Wahnschaffe, 1992, Management strategies of multinationals in developing countries. Intereconomics, 27, pp. 190-198. Lim, L. and E. F. Pang, 1991, Foreign Investment and Indu.strulisation in Maluvsia, Singapore. Taiwan and Tliailand. OECD, Paris. Malaysian Industrial Development Authority (MIDA), 1989, Muluysiu: Investment in the Manufacturing Sec,tor. MIDA, Kuala Lumpur. Menon. J. and P. Athukorala, 1995, Korean outward foreign direct investment: trends, determinants and prospects. World Cumperition, 18 (4), pp. 55-66. ASIAN ECONOMIC JOURNAL 44 Myint, H., 1967, The inward and outward looking countries of Southeast Asia. Maluyun Economic Review,, 12 ( I ) , pp. 1-13. Naya, S., 1990, Direct foreign investment and trade in East and Southeast Asia. In Jones, R. W. and A. 0. Krueger, Eds., The Political Economy of International Trade. Basil Blackwell, Oxford, pp. 288-312. Nunnenkamp, P., 1991, The structure of external financing in Malaysia: the policy framework for foreign direct investment and debt inflows. In Singer, H. W., N. Hatti and R. Tandon, Eds., Foreign Direc.f Investment. New World Order Series No. 11, Indus Publishing Company, New Delhi, pp. 571-592. O'Brien, L., 1993, Malaysian manufacturing sector linkages. In Jomo, K. S., Ed., Industriulising Muluysia: Policies, Performance. Prospects. Routledge, London, pp. 147-162. Onn, F. C., 1990, Direct foreign investment in Malaysia. In Chen, E. K. Y, Ed., Foreign Invesrment in Asia. Asian Productivity Organisation, Tokyo, pp, 191-230. Ramstetter, E. D., 1993, Prospects for foreign firms in developing economies of the Asian and Pacific region. Asiun Developnimr Revirw, 11 (l), pp. 151-185. Rasiah, R., 1993, Free trade zones and industrial development in Malaysia. In Jomo, K. S., Ed., l n ~ f ~ ~ s r r i f f / Mrhysiut is~ng Policies,Pei$/rmunce, Prospc~ts.Routledge, London, pp. 147-1 62. Riedel, J., 1991, Intra-Asian trade and foreign direct investment, Asian Development Review, 9 (I), pp. 111-146. Romer, P. M., 1992, Two strategies for economic development: using ideas and producing ideas. In Proceedin,qs of rhe World Bank Annual Conference on Development Economics 1992, World Bank, Washington D.C., pp. 63-10], Ruffin, R. J., 1993, The role of foreign investment in the economic development of the Asian and Pacific region. Asiun Duvelopmenr Review, 11 ( I ) , pp. 1-23. UNCTC, 1991, World lnvesrment Reporr 1991. United Nations, New York. LINCTAD-CTC, 1995. World Ittvestment Report 1994. United Nations, New York. Warr. P., 1990, Free trade zones. In Milner, C., Ed., Elport Promotion Strute,qies: Theory and Ei.idenccv fi-oni Developing Cuunrries. Harvester, London. Wells, L. T., 1993, Mobile exporters: new foreign investors in East Asia. In Froot, K. A,, Ed., Foreign Invesrmenr. University of Chicago Press, Chicago, pp. 173-196. World Bank, 1993, The East Asian Mil-uck: Economic Growth and Public Policy. Oxford University Press, New York.