Comparison of Malaysia and Indonesia as Preferred Locations for FDI - Case Study Example

Economic stability: Comparison of Malaysia and Indonesia as preferred locations for FDI Word count: 2019 Introduction A country’s preference as a foreign direct investment (FDI) destination depends on its ability to provide a stable economic environment that can attract investors. Foreign firms are likely to invest in a country whose economic condition is steady since any form of instability is likely to adversely affect such firms. Against this backdrop, this paper aims to discuss the meaning of the term economic stability and analyse how it affects a country’s investment environment, especially the capacity of a country to attract FDI. The paper will then compare two ASEAN nations – Malaysia and Indonesia – in regard to their economic stability as preferred locations for FDI. Significance of economic stability to a country’s international business capacity There are many definitions of the term economic stability. However, according to the World Bank (2012), most definitions have in common that economic stability is about the nonexistence of system-wide occurrences characterised by a failure of the economy to function (that is, the occurrence of crises). Economic stability is also about the propensity of an economic system to withstand stress. This implies stability in both political and macroeconomic systems. Notably, a stable political system means that a country is able to provide an environment that is conducive for people and firms to conduct business. The World Bank (2012) also notes that a stable economic system has the capacity to efficiently allocate resources and manage financial risks, maintain employment levels close to the economy’s natural level, and eliminate relative price movements of financial or real assets that will impact the financial stability of employment levels. An economic system is also said to be stable when it able to dissipate economic imbalances that arise internally or those that emanate from significant widespread unexpected events. If the system is stable, it will be able to absorb the shocks mainly through self-corrective mechanisms, thus preventing adverse occurrences from having a disrupting impact on the real economy as well as other financial systems. As mentioned above, economic stability can also be viewed in terms macroeconomic stability and this takes into account factors such as a country fiscal policy, budget deficit, balance of payments, inflation and so forth (Buxheli, 2011, p. 34). These factors affect a country’s investment environment in different ways. For example, a large and continuous budget deficit as a ratio of a host country’s gross domestic product (GDP) may be an indicator of economic instability in the host country, and this may have a negative impact on the country’s ability to attract inward FDI (Banga, 2008, p. 128), which does not augur well with international business. A high real GDP growth rate is indicative of high economic productivity and can raise the level of international business and hence attract more FDI (Arbatli, 2011, p. 10). As well, Schneider and Frey (1985, cited by Banga, 2008) argue that a low rate of inflation is an indicator of internal economic stability in a host country. In contrast, high rates of inflation indicate that the governments of affected countries are not able to balance their budgets and their central banks have failed to conduct appropriate monetary policy. Although Banga (2008) does not relate this directly to a country’s economic stability, Neuhaus (2006, p. 147) asserts that a low level of inflation coupled with a stable fiscal balance raises the credibility of a government in regard to its long-term economic policy. Along the same line, Balasubramanyam and Mahambare (2004, p. 49) point out that macroeconomic stability, which is embodied by stable exchange rates and low levels of inflation, is an important factor in foreign investment decisions of firms. This means that countries which score highly in terms of taming inflation, making attempts to have stable exchange rates and reducing budget deficits are likely to engage in more effective international business than those which score poorly in these areas. Further finding by Buxheli (2011, p. 34) show that countries that are characterised by economic stability are more likely to enhance and sustain economic growth and thus offer more incentives for investment than unstable economies. Further, countries which have large deficits that are financed by the creation of more money tend to have high rates of inflation and this could disrupt the rate real of economic growth. If a country’s economy has large financial deficits and is financed by government borrowings, the country could be an unsafe place to invest (Goddard, 2006, p. 164). Overall, these findings indicate that economies that are more stable are likely to conduct more international business and also offer environments and incentives that are conducive for attracting foreign investors. Malaysia’s economic stability and preference as an FDI location According to Mansur, Mamalakis and Idris (2003), Malaysia is one of the ASEAN nations that have experienced high economic growth. Since 1957, the country has experienced rapid economic growth as well as rising per capita income and price stability. Between 1987 and 1995, Malaysia achieved an economic growth higher than seven percent (Mansur, Mamalakis & Idris, 2003) while its GDP doubled to reach RM192.2 billion (that is US$50.6 billion) in 1999 (International Business Publications, 2012, p. 61). In 2007, Malaysia’s economy was ranked the 29th largest in the world in terms of purchasing power parity and GDP which was estimated to be $357.9 billion (Karimi & Yusop, 2009, p. 4). Although the 1997 Asian financial crisis adversely affected the Malaysian economy, specifically due to speculators who attacked the ringgit (the Malaysian currency), the government intervened with policies aimed to isolate Malaysia from foreign speculators and hence restore financial stability. The government also promoted subsidies and introduced price controls to encourage confidence in the domestic market and price stability. On one hand, these measures were effective in helping Malaysia to go through the Asian economic crisis and thus they offered proof of resilience and strength of the Malaysian economy (International Business Publications, 2012, p. 61), but on the other hand, they were criticised because some analysts thought that they would make investors shun Malaysia in future (Marshall Cavendish Corporation, 2008, p. 1217). This came to pass as a study conducted by the Japanese Chamber of Trade and Industry in Malaysia in 2002 revealed that the country no longer had a competitive edge over its neighbours and that 22 per cent of Japanese firms doing business in Malaysia were mulling over pulling out (Mansur, Mamalakis & Idris, 2003, p. 1). The main reason identified for this action was high cost of labour (Mansur, Mamalakis & Idris, 2003), perhaps due to the government’s protectionism measures among other factors. In addition, the country’s annual GDP growth rate has decreased in recent years, from 7.2 per cent in 2010 to 5.1 per cent in 2011 (The World Bank, 2013) as shown in the appendix. The high cost of labour in Malaysia relative to other ASEAN countries implies an inflation in the price of some manufacturing services since inflation refers to a rise in the average price of goods and services in the macroeconomy (Harvey, 2011). As mentioned earlier, a low level of inflation reflects a commitment by the government in terms of fiscal policy to promote investment; and the opposite means that high inflation indicates some sort of instability in the investment environment. This coupled with Malaysia’s low annual GDP growth makes the country less attractive for FDI compared to other counties like Singapore (with an annual GDP growth of 14.8 per cent in 2010 as indicated by the World Bank, 2013) since as noted by Duasa (2007, p. 94), the performance of a country as depicted by its economic growth is critical to sustain the stability of foreign investment into the country in the long-term. Evidence that manufacturing firms seeking FDI locations prefer markets that offer cost advantages is presented by Chandran and Krishnan (2008, p. 87), who argue that China’s cost advantage coupled with enormous domestic demand has increased the possibility of shifting among investors, and a good example is that of contract manufacturers shifting their operations from Malaysia to China. Nonetheless, Malaysia still has the potential to attract FDI if it develops policies to boost manufacturing such as those dealing with human capital (Chandran & Krishnan, 2008). Indonesia’s economic stability and preference as an FDI location Although Indonesia’s annual GDP growth has been steady since 2009 (see appendix), other factors like failure by the government to manage economic crises and offer a stable environment in the past have made the country an unfavourable FDI location. To start with, there was a negative trend in FDI flows to Indonesia in the aftermath of the 1997 Asian economic crisis due to large repayment of intercompany loans, which outweighed steady capital inquiry inflow (United Nations, 2005, p. 81). According to Suryawati (2004), the Asian crisis substantially reduced FDI flow into Indonesia and significantly slowed the country’s economic growth. This can be attributed to the point that the government was perceived to be ineffective in managing economic stability disruptions. According to World Bank Governance Indicators as reported by Khan et al. (2012, p. 64), Indonesia’s government effectiveness plunged from a high of 63.03 in 1996 to a low point of 19.43 in 1997. This was largely because of the Asian financial crisis, which also led to the delegitimizing of the political power of an otherwise strong regime, leading to the resignation of the then president, Suharto. Even though the situation has improved since then, government effectiveness score for Indonesia was at 47.3 in 2008, compared to 100 for Singapore, 83.8 for Malaysia, 58.7 for Thailand and 54.9 for Philippines, with only Vietnam scoring below Indonesia among all the Southeast Asian nations, at 45.4. In addition to the Asian crisis, Indonesia also had to deal with a wide array of other predicaments including inefficiency, corruption, disappointing growth and political turmoil (Tanudiredja, 2010, p. 194). With the perceived low government effectiveness, it can be surmised that firms are wary of the conditions of the operating environment such as price stability, inflation, economic growth and the ability of the government to cushion them in case of another crisis like the Asian financial crisis or the 2008 global financial crisis. For instance, as discussed above, a high rate of inflation may indicate that the government is not committed to policies to ensure macroeconomic stability and this could scare potential investors. Some of the factors that investors consider when making FDI decisions according to Suryawati (2004) include the perception that investors could utilise cheap resources that are available in the host country and that multinational enterprises could utilise many facilities such as fiscal protection from the host country. If such elements are missing, then there is likely to be a lack of cheap resources in the FDI location due to high inflation and an uncertain business environment due to the government’s ineffectiveness in protecting the interests of the investors. Tanudiredja (2010) however notes that things are progressively changing and Indonesia can be regarded a viable FDI location due to strong economic growth, political stability, abundant labour availability and high demand for commodities. Conclusion In summary, economic stability is about the lack of occurrences or elements that could result in the failure of an economic system to function and is evidenced by factors like low inflation, price stability, low budget deficit and high economic growth. This affects international business since a stable economy is requisite for doing business as discussed about Malaysia and Indonesia. In the past, Malaysia enjoyed a relatively stable economy due steady economic growth and the government’s commitment to deal with disruptions such as the 1997 Asian crisis. However, these fortunes have been reversed by high costs of labour and slow economic growth which have made the country’s attractiveness for FDI to decline in recent years. Similarly, Indonesia’s attractiveness as an FDI location has been hampered by perceived lack of government commitment to deal with economic stress and to protect investors. Nevertheless, Malaysia can regain its attractiveness for FDI by changing policies in areas such as human capital to ensure cheap labour while Indonesia is also poised to be a good FDI location due to strong economic growth, political stability, abundant labour accessibility and high demand for commodities. References Arbatli, E. (2011). Economic policies and FDI inflows to emerging market economies. IMF Working Paper. No. WP/11/192. 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Oxford: Oxford Business Group. The World Bank (2012). Global Financial Development Report. Retrieved 21 April 2013, from http://econ.worldbank.org/WBSITE/EXTERNAL/EXTDEC/EXTGLOBALFINREPORT/0,,contentMDK:23268766~pagePK:64168182~piPK:64168060~theSitePK:8816097,00.html The World Bank (2013). GDP growth (annual %). Retrieved 21 April 2013, from http://data.worldbank.org/indicator/NY.GDP.MKTP.KD.ZG United Nations (2005). World Economic and Social Survey 2005: Financing for Development. Washington: United Nations Publications. Appendix Table 1: Comparison of annual GDP growth rate Malaysia Indonesia 2008 4.8 6.0 2009 -1.5 4.6 2010 7.2 6.2 2011 5.1 6.5 Source: The World Bank (2013) Read More