ReportNo. 5906-MA Malaysia: Industrializinga Primary Producer OnTwo Volumes) Volume I Public Disclosure Authorized June, 19%6 EastAsia and PacificPrograms Department FOR OFFICIAL USE ONLY Public Disclosure Authorized Public Disclosure Authorized the WorldBank Public Disclosure Authorized Docunent-of Thisreport has a restficteddistribution and may be usedby recipients onlyin th performanceof ther officialduties. Its contents may not otherwise bedisdosed without World Bank authorization. CURRENCY EQUIVALENTS Currency Unit - Ringgit (M$) 1985 March 1986 US$1 = M$2.48 M$2.53 M$1 = US$0.40 US$0.40 FISCAL YEAR January 1 - December 31 ABBREVIATIONS 2MP - Second Malaysia Plan (1971-75) 3MP - Third Malaysia Plan (1976-80) 4MP - Fourth Malaysia Plan (1981-85) 5MP - Fifth Malaysia Plan (1986-90) ACI - Action Com,ictee for Incentives EPF - Employees Provident Fund FAMA - Federal AgriculturalMarketing Authority FAS - United States Dept. of AgricultureForeign Agriculture Service FELCRA - Federal Land Consolidationand Rehabilitation Authority FELDA - Federal Land DevelopmentAuthority FTZ - Free Trade Zone ICA - Industrial Coordination Act LMW - Licensed ManufacturingWarehouse LPN - National Paddy and Rice Authority MADA - Muda AgriculturalDevelopment Authority MAS - Malaysia Airlines System MIDA - Malaysian Industrial Development Authority MIPS - Malaysian Industrial Policy Studies MOA - Ministry of Agriculture MOPGC - Malaysian Oil Palm Growers' Council NEP - New Economic Policy NFPE - NonfinancialPublic Enterprise PERNAS - Perbadanan Nasional Berhad PETRONAS - Petroleum Nasional Berhad PNB - Permodalan Nasional Berhad RISDA - Rubber Industry Smallholder DevelopmentAuthority USDA - United States Department of Agriculture FOI eFmCI USE ONLY This report was prepared by a team that visited Malaysia in July 1985. The mission consisted of S. Yusuf (mission chief), D. Bhattasali, W. Cuddihy, S. Faruqi, and R. K. Peters, Jr. The Institute of Strategic and InternationalStudies in Kuala Lumpur prepared reviews on four industrial subsectors. Ms. Helen Callaghan provided assistance in Washington. The report was discussed with the authorities in January 1986 and the final versicn reflects the comments received and is updated on the basis of fresh statistics provided in April 1986. Mr. Vikraz Nehru contributed to the revision. Ths dowumenthu a timeddinrbuio and may be ued by rcipien ondyin te pefonne oftheir oiidudteL. Its ctent may not odrwe be dicked withut Word hnkauthoriatdon. ABSTRACT The report examines Malaysia's prospects for developing export- oriented manufacturing industries on the economic base provided by its primary sectors while persevering with the adjustment program begun in 198S. Malaysia has an efficient tree crop sector and substantialpetroleum resources, but oil production is approaching its peak, rubber output is on a declining trend and earnings from palm oil and cocoa, the two most lucrative agriculturalexports of recent years, will take time to recover from the price slump that has afflicted commodity markets. During the remainder of the eightiea, the contributionof these subsectors to the growth of the GDP is likely to be modest. The cut in energy and raw material prices in 1985-86 has also eroded government revenues and the economy's potential for saving. Achieving balance-of-payments equilibrium and containing the increase in external debt make a further spell of fiscal austerity unavoidable,and this is underlined by the restrained investment program outlined in the Fifth Five-Year Plan. As neither government spending nor the primary sector will contribute signifi- cantly to growth, the report emphasizes the importance of broadening the industrial base and promoting manufactured exports through major institutional changes and a reform of incentives as a way of regaining growth momentum. MALAYSIA INDUSTRIALTZING A PRIMARY PRODUCER Table of Contents Page No. SUN ARY AND CONCLUSIONSe.e e......................ei e.............. I. TRENDS AND PROSPECTS..RS....C TS..1....e.................... A Changed Environent ........... 1 Malaysia's Economy: Recent Developmnts...o............. 2 Sources of Growth: Demand Factors....................... 5 Sources of Growth: Sectoral Contributiono............... 7 Decomposition of Gro w th.... 8 Approach to Industrialization......... ............ o...o. 11 II. RESOURCE BALANCES AND THE PUBLIC SECTOR...................... 14 Deficits and Their Fiin .. .. 15 Revenue GenerationThrough the Tax Systemostem......... 20 Spending Cuts...us.................. .... ..... o.......... 23 III. THE ROLE OF LABOR AND EXCHANCE RATES IN EXPORT-ORIENTED DEVELOPfEfTessoooooeeeooooeeooooo.oo.ooooo.Esoo.o.ooe Tsoooose 28 Labor Markets in East Asia... sia....00............... 28 Population and Industrial Progress..........ogr e... ... 28 SectoralLabor Suppliesp....0..0.... ...... 0........ * ..... 29 ~~~ 'ages ~~~~~~~~~~~30 Wage Competitiveness .... .. 0. 00........0..... 35 ExchangeRate Policyo.....y 38 IV. THE FUTURE OF EXPORTS e. .....................................43 Export Prospects: Commodity Marketsr.k.e..et.s...... 44 Export Prospects: Petroleum............................. 51 Export Prospects: Manufactures............00O........ 53 Malaysia's Export Trader.................................. 59 International Trading Environment...... ................. 61 V. EXTERNAL BOnROWING AND CAPITAL FLS......................... 69 International Financial Markets........... 0 . 71 Equity Purchases and Capital Flows 71 Regulating Capital Movementsv.... ....... 72 - ii - Page No. VI. DIRECT FOREIGN INVESTMENT AND ECONOMIC MODERNIZAIION......... 74 Direct Foreign Investment in Malaysia.......o.o..oo ..... 74 MNC Strategy and the Future of DFI....................... 77 VII. INDUSTRIALSTRATEGY AND DEVELOPMENT...... .............. ..... o 82 Strategy ........................... .................89 Market Efficiency ........................................ 90 Regulation ................... ............................ 93 Industrial Deepening.....4......... ... 95 Sectoral Constraints and Policies ...........ii..e....s 98 Textiles and Clothing........... ........ .98 Electrical Machinery and Applianceso.....oo 101 Agricultural Machinery..... ....... o**o. .0.. .. .... * 103 Electronics...... 104 Wooden Furniture ...... o ............ oG6....o6......... 108 Rubber Products .... o... ..... ................... 109 VIII. THE FUTURE OF AGRICULTURE. .... -o............. .ooee............ 113 Rubber....... .... o...... -...... 00.........e......00 .... 114 Palm Oil ..... o........o............... ..... 122 Cocoa ..........o.................................oo... ....oe.woo.ooe.. 126 Tree Crop Sector Summary ........... .... .. ........-... 129 Rice Sectoro............oo............ ..... 60-000 ........ 130 Overview .............. ..............- . ...... 13.............136 IX. SIMULATINC THE FUT... .......... o.......................... 141 TABLES IN TEXT l.1 Malaysia: Principal Macro In dicators... .......... 3 1.2 Malaysia: Demand Decomposition, Sources of Growth ........ oo 6 1.3 Malaysia: Sectoral Decomposition, Sources of Growth ......... 8 1.4 Malaysia: Factor Decomposition, Sources of Gro wth ....g 9....- 1.5 Malaysia: Allocation of Credit by Sector............... 12 2.1 The Evolution of Resource Balances in the Economy...*......... 15 2.2 Public Sector RescurceBalance ............. .................. 16 2.3 Nonbank Sources of Budget Finance ............... ................... 17 2.4 Savings Performance of the Federal Government...............O.. 19 2.5 Public Enterprise Statistics..................... 19 2.6 Structure of Public Sector Revenues ..... ........................ 20 2.7 Tax Revenue Buoyancies, 1960-85................................ ... 21 2.8 Economic Classification of Federal Operating Expenditures..... 24 2.9 Federal Subsidy Expenditures ....................... ..... *...... 25 2.10 Federal Government Development Expenditures by Sector..o....... 27 -iii - Page No. 3.1 Malaysia: Real Average Monthly Earnings in Manufacturing 31 3.2 Malaysia: Employment and Productivityby Sector.....ctor..... 32 3.3 Trend in Employment by Major OccupationalGroups, Peninsular Malaysia, 1962-70 .......- .......................... 34 3.4 Occupational Structure of Public Sector Employment and All UrbanEmployment in Peninsular Malysia yi.a...e9oee*.*9e 34 3.5 Nominal Average Monthly Earnings in Manufacturing.....o....... 36 3.6 Value-Added per Worker...... 37 3.7 Malaysia: Female Participationin Employment by Sectors, 1 9 5 7 -79oee.*oee**.a..ooooo... es.9 . 38 3.8 Malaysia: Index of Nominal and Real Effective Exchange 41 4.1 Growth of Exports to the USA.............. ...... ....... 44 4.2 World Natural Rubber Demand, 1982-2000..........8 49 4.3 World Productionof Major Oils and Fats....................... 50 4.4 Annual Growth Rates of LDCs' ManufacturedExports............. 54 4.5 Share of ManufacturedExports in Total Exports................ 54 4.6 Share of Developed Market Economies in ManufacturedExports of LDCD.......C.......s. ........... 55 4.7 Largest ManufacturedExports from Selected Asian Countries to Major OECD Economies .................. .56 4.8 Fastest-CrowingManufactured Exports from Selected Asian Countries to Major OECD Economies.... ..... 57 4.9 Malaysia: MerchandiseEs p os............................... 59 4.10 Malaysia: Exportsby Destination.............................60 4.11 Malaysia: Largest Manufactured Exports to Major OECD E c o n .... o o.e.ooee..em i es-ooo...... ee..000 .... 0-900.04-.. 60 4.12 Malaysia: