MNEs and Their Hosts: An Impact Assessment on Malaysia

Table of Contents

1 Introduction

2 Background of FDI in Malaysia

3 FDI Impact – Theoretical Analysis
3.1 Balance of Payment Effects
3.2 Employment Effects
3.3 Technological Effects
3.4 Sovereignty

4 FDI Impact – Empirical Analysis
4.1 Balance of Payment Effects
4.2 Employment Effects
4.3 Technological Effects
4.4 Sovereignty

5 Policy Implications

6 Conclusion

7 Appendices
7.1 Balance of Payments
7.2 FDI Outflows

8 Bibliography

Figures and Tables

Figure 1: FDI as % of GDP

Figure 2: Inward FDI Flows as a Percentage of Gross Fixed Capital Formation

Figure 3: FDI Flows Malaysia

Figure 4: FDI Inflows by Industry (Manufacturing)

Figure 5: FDI Inflows to ASEAN Countries 2004

Figure 6: Top 5 Sources of FDI in Malaysia in Manufacturing 2005

Figure 7: Top 5 Sources of FDI in Malaysia in Manufacturing 2004

Figure 8: Major Asian Sources of FDI Outflows 2004

Figure 9: Structure of Imports

Figure 10: Structure of Exports

Figure 11: Direct and Indirect Employment-Generating Effects

Figure 12: Differences in Average Wages Paid by Foreign Affiliates of MNEs and Domestic Companies

Figure 13: Strategic Options Available to a Foreign Affiliate to Obtain Inputs

Figure 14: Balance of Payments

Table 1: Employment, Value-Added and Labour Productivity

Table 2: Percentage of Employment by Major Occupational Groups

Table 3: Public Sector R & D Expenditure and Number of Scientists and Engineers

List of Abbreviations

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1 Introduction

Strategically positioned in the heart of Southeast Asia, Malaysia is one of the world’s most attractive locations for FDI. Since independence in 1957, Malaysia has moved from an agriculturally based economy to a more diversified and export orientated one. In 1963 the federation was enlarged by the accession of Singapore, which left in 1965. Since then, Malaysia has enjoyed a climate of political stability which was conducive to high economic growth based on industrialisation and stimulated by foreign investment. (China-Asean Business Net 2006)

The National Development Policy provides a framework towards the new vision 2020 plan of the Prime Minister, Dr. Mahathir, which symbolises "the way forward" policy towards a "developed" nation in 2020. (ibid) This can only be achieved by enduring high FDI which contributes positively to national wealth.

This report provides a descriptive base of FDI in Malaysia in Chapter 2. Chapter 3 analyses the impacts of FDI in theoretical terms, whereas Chapter 4 deals with empirical impacts on Malaysia. Chapter 5 suggests policy implications based on the findings of the previous chapters.

2 Background of FDI in Malaysia

FDI, especially in the manufacturing sector, has been primarily responsible for Malaysia’s rapid economic development over the last three decades and therefore has played an important role in the Malaysian economy. As Figure 1 shows, in the early nineties, FDI constituted more than 8% of the country’s GDP. (IISD, 2004: 2)

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Figure 1: FDI as % of GDP

Source: IISD, 2004: 2

Figure 2 indicates the dependence of Malaysia on foreign capital. In the early nineties Malaysia’s inward FDI contributed almost a quarter of the country’s annual Gross Fixed Capital Formation (GFCF). Malaysia’s share of Inward FDI on GFCF ranks above average among South-East Asian countries. Only Singapore attracts a higher relative share due to its small size, therefore its dependence on FDI is much larger.

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Figure 2: Inward FDI Flows as a Percentage of Gross Fixed Capital Formation

Source: UNCTAD, 2005b

Malaysia has always had a positive balance of FDI. In 2004, foreign MNEs invested $4.624bn in Malaysia compared to $2.473bn in 2003 (Figure 3). In 2005 FDI increased by 6.38%. (Bank Negara Malaysia, 2006: 55-57)

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Figure 3 : FDI Flows Malaysia

Source: UNCTAD, 2005a

The main service sectors attracting FDI Inflows were finance, insurance, shared services and outsourcing activities. Due to its excellent infrastructure, attractive fiscal incentive packages and the availability of multi-lingual labour, Malaysia ranks as the third most attractive investment destination for shared services and outsourcing (ibid). Third-party call and contact centres are growing at a rate of 100-200%. Many huge MNEs have all set up regional service hubs in Malaysia in order to serve the needs of their Asian customers (UNCTAD, 2004: 174).

However, the manufacturing sector continued to be the main recipient of FDI with 72% of the total (Bank Negara Malaysia, 2006: 55-57). In 2005 FDI was mainly concentrated in the Electronics and Electrical Products industry (E&E) and amounted to 63.29% compared to 51.93% in 2004. (Figure 4). The Malaysian Industrial Development Authority (MIDA) expects this trend to continue due to the strong presence of MNEs in the E&E Industry. The main purpose of FDI was plant expansion and upgrading of machinery and equipment in order to enlarge capacity (ibid).

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Figure 4: FDI Inflows by Industry (Manufacturing)

Source: MIDA, 2005: 142

In 2004, Malaysia was the 26th largest recipient of FDI inflows in the world and the second largest recipient in the ASEAN countries. Figure 5 shows the ASEAN countries with the largest FDI Inflows. While FDI Inflows to Singapore were mainly in services, those to Malaysia where mainly in manufacturing. (MIDA, 2005: 19)

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Figure 5: FDI Inflows to ASEAN Countries 2004

Source: MIDA, 2005: 19

Figure 6 shows the top five sources of FDI in manufacturing in 2005. These countries accounted for more than 78% of all FDI Inflows. (MIDA, 2005: 147)

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Figure 6: Top 5 Sources of FDI in Malaysia in Manufacturing 2005

Source: MIDA, 2005: 147

However, Figure 6 shows the top 5 investors in manufacturing in 2004. The comparison indicates, that the US, Singapore, and Japan are the most important long-term investors in Malaysia. (ibid)

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Figure 7: Top 5 Sources of FDI in Malaysia in Manufacturing 2004

Source: MIDA, 2005:147

More than 80% of FDI Outflows from developing countries came from Asia. The major Asian sources of FDI outflows are depicted in Figure 8. Malaysia was the 25th largest source of FDI outflows in the world in 2004. (op.cit. 18-20) For more detailed information see Appendix 7.2.

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Figure 8: Major Asian Sources of FDI Outflows 2004

Source: MIDA, 2005: 20

Figure 9 shows the development of imports from 1961 to 2004. Where the share of consumer goods decreased, the import of capital goods increased from 17.1 % to 38.2% and intermediate goods from 28.4% to 54.6%. This growth can be explained by the increased inflow of FDI because most MNEs sourced their inputs abroad and manufactured the products in Malaysia. (Aslam n.d., 17)

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Figure 9: Structure of Imports

Source: Aslam n.d., 18

The composition of exports shifted from agriculture and mining to manufacturing (Figure 10). This development indicates that the majority of products manufactured in Malaysia were exported. Electrical and electronic goods (E&E) mainly produced by MNEs are the major export and constituted more than 70% of total manufactured goods from 1990 to 2000. (ibid)

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Figure 10: Structure of Exports

Source: Aslam n.d., 18

Hence, many MNEs investing in Malaysia import materials such as electronic components, manufacture goods in Malaysia and then export finished products.

3 FDI Impact – Theoretical Analysis

3.1 Balance of Payment Effects

The effect of FDI on the balance of payments is an important issue for most countries attracting many foreign investors (Hill, 2002: 215). By assessing the impact of FDI, the current account and the capital account of the balance of payments have to be considered.

FDI can affect the balance of payments in many different ways:

Firstly, while the initial impact of FDI inflows has a positive effect on the balance of payments, the medium and long-term impact is often negative due to the repatriation of profits (Aslam n.d., 19). Such outflows of earnings or “invisibles” in the forms of interest, profits and dividends from the subsidiary to its parent company have an adverse effect and are debited into the current account (Stewart, 1989: 80). However not every foreign subsidiary is financed by an actual inflow of money. If huge sums are borrowed locally, interest rates might increase making capital more expensive for domestic operations (UNCTAD, 2004: 126).

The concept of “transfer pricing” could be viewed as another adverse effect on the balance of payments. Transfer pricing refers to the manipulation of internal prices charged within the same organisation in order to influence the amount of tax. This invisible effect reduces the tax burden and is hard to prove for the government. With regard to a study conducted in the UK, 83% of 210 MNEs were involved in a transfer-pricing dispute. (Dicken, 2003: 282-283)

The second impact of FDI on the balance of payments refers to the net effect of imports and exports and is therefore difficult to quantify. Hence, it is necessary to estimate to what extent inward FDI replaces imports or generates exports (positive effect) or even stimulates more imports of products (negative effect). (Stewart, 1989: 80-81) The usage of the host country as an export base in order to serve other markets has a positive effect due to increasing exports to other countries (Hill, 2002: 217).

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