Impact of Foreign Direct Investment and International Trade in Malaysia - Case Study Example

IMPACT OF FOREIGN DIRECT INVESTMENT AND INTERNATIONAL TRADE IN MALAYSIA Lecturer Impact of Foreign Direct Investment and International Trade in Malaysia Introduction In the recent past, there has been a decisive change in industry and trade industry in most emerging economies away from import substitution towards export orientation. As a result of the policy change, many countries have become receptive to foreign direct investment that has marked significance take off from the conventional distrust to foreign direct investment. The changes expect multinational enterprises to play a significant role in the process of export-oriented industrialization through the provision of easy access to diverse foreign markets. Similarly, it ought to bring experience and expertise in the numerous multifarious facets of international marketing and product development. In view of the considerations, enticing multinational enterprises participation has turned out to be a vital element of policy reforms aimed at the export-led industrialization of many countries Malaysia included. Therefore, foreign direct investment is turning out to be an increasingly important aspect that is aimed at improving the economy at the same time solves issues of unemployment. Apart from supplementing capital inflows, foreign direct investment is essential for technology and management practices transfers, access to international marketing networks, as well as enhancement of skills and innovations. For instance Malaysia is one of the nations that have greatly benefited from foreign direct investment flow over the past decade1. Foreign direct investments are a major contributor to the development of the manufacturing industry in Malaysia with the primary target being the foreign market. Their economy has been reliant on foreign funding as the primary source of capital, modern technology, and skills and with globalization the international financial integration and the increase in global production foreign direct investment are going to flourish. Malaysia being a middle-income economy is growing fast though because of their foreign direct investment policy. Over the past decade, foreign direct investment declined by a huge margin although that for Malaysian companies abroad increased substantially2. However, Malaysia remains a vibrant economy in Asia ahead in attracting foreign direct investors from China, South Korea, India, and the Middle East. Nevertheless, environmental investment has proved to be challenging and competitive for foreign direct investment. Foreign direct investment in Malaysia Prior to the 1997 financial crisis, foreign direct investment inflows in Malaysia had been increasing the drop was witnessed during this period of economic hard times3. However despite the crisis Malaysias foreign investment regime has continued to be liberal and the presence of multinational enterprises has seen various sectors reach new height than before the crisis. The growth indicates that foreign direct investment slowdown in Malaysia does not reflect a reversal in attitudes of investors towards the nation as an investment destination but a rather temporary adjustment. The developments account for expansion of international trade that is an important measure of economic growth. The high and sustained growth in the economy in conjunction with the opening to foreign trade plays a crucial role in economic policy. Some of the foreign direct investment determinants that have contributed to attracting of investors in Malaysia include export expansion, foreign exchange trade, and infrastructural development. However, other factors such as capital flight, growth rate and balance of payment have minimal impact on the inflows of foreign direct investment. The Malaysian policy agenda particularly the export-oriented manufacturing has greatly promoted foreign direct investment in the country over the years. The investment inventive act enacted by the government has expanded production of exports to counter the problem of international market saturation that the manufacturing sector faces. The Act provides an affluent assortment of incentives to export-oriented foreign direct investment including company tax exemptions and duty on imported products, investment tax credits, relief from payroll tax and accelerated depreciation allowances on investments4. The new economic policy earmarks the manufacturing sector in Malaysia as the primary sector to drive economic restructuring and employment. Development of free trade zones has greatly encouraged participation of foreign investors in direct investment as a primary element of the new economic policy. Therefore, the attractiveness of Malaysia to foreign direct investment over the years can be attributed to the healthy business environment in the country that appeals to the multinational enterprises investment decisions. Similarly, the industry policy regime in Malaysia favors export producers than in most states in the region and thus with emphasis on import substitution domestic industries remain protected through moderation of tariffs rather than exchange and quantitative restrictions. The subtle conditions in Malaysia coupled with the trade regime remain influential in having exchange rate misalignment on the check and the deleterious effects associated with the production of tradable products. In Malaysia, foreign direct investment is unrestricted but, however, there are guidelines that govern its conformity with the nations development priorities that may run counter to the overall profit maximization goal of most multinational enterprises. The Malaysian government allows 100% ownership of export-oriented business enterprises and over time it has resorted to a lenient policy regarding employment quotas with the aim of ameliorating its impact on export oriented direct investment5. Unlike most developing economies, the Malaysian government has taken care to make its policy bearing on foreign direct investment to be transparent and unambiguous. It has strategized most of its operations in line with its objectives such as locating industries in developing regions so as to exploit the available local inputs hence diverting investment to particular priority industries. Their constitution guarantees against nationalization of foreign assets devoid of compensation and they have also agreed investment guarantees with most of the capital exporting countries which works well with most multinational enterprises. The favorable investment environment has seen foreign direct investment flows to Malaysia increased tremendously over the past two decades with foreign capital inflows increasing almost tenfold in that period. The foreign direct investments flow after the shift to export-oriented manufacturing that has turned Malaysia as a manufacturing base for the global market6. Initially, the foreign firms that engaged in export-oriented manufacturing operated mostly on the assembly of electrical and electronic product and diffused technology production but that has changed with a recent focus on the mature technology of final products. The expansions in foreign direct investment are attributed to the rapid infrastructural development and the growing domestic demand that is associated with increased levels of income in the country. The evolution of the Malaysian export structure over the year from reliance on primary products to export manufacturing has similarly seen an increase in foreign direct investment flows. There has been an increasing trend in the export structure in Malaysia with manufactured products emerging as the dynamic element of the export market7. The transformation of the export structure in line with emerging trends of the international division of labor grew in momentum with the share of resource-based export declining while that of manufactured products rose accounting for over 60% of exports8. Statistics indicates that the share of imported inputs in gross export value in Malaysia of manufactured products is relatively high forming three-quarters of total exports. Therefore, the higher net foreign exchange element in exports works to the benefit of the economy from the foreign direct investment. However over-reliance on the net foreign exchange returns can lead to wrong prescriptions and this raises a challenge to the effectiveness of foreign direct investments ability to boost the economy. The governments primary objective on export expansion ought to be maximization of net foreign earnings and not maximizing net foreign exchange earnings per unit exports thus of essence is market potential. Most developing economies shifted to export manufacturing with minimal resource-based production and, on the other hand, the market potential for these products seems to be limited. Therefore success in increasing net volume in exchange earnings depends on the ability of the country to create their market niches. Similarly another challenge, unlike import-substituting firms, export-oriented enterprises performance is not subject to foreign exchange constraint since there is no drain on local investible funds and the scarce resources. Therefore in a worst case scenario the overall net foreign exchange returns will be at equilibrium with local labor payments and tax remission to the Malaysian government9. However the rapid growth of gross export earnings can be considered a policy objective that has more national benefits. However entering the international markets will prove to be challenging thus it can only be used as an indicator of domestic efficiency and competitiveness in the manufacturing sector. The rapid growth consequently attracts more foreign direct investment to the country and enlistment of foreign funds that can be loaned at competitive rates. In this view, Malaysian local firms have benefited from access to market channels of multinational enterprises as a merit of foreign direct investment. Evidence shows that foreign firms play a significant role as a catalyst for the local exporters. Following entry of multinationals in Malaysia in the export manufacturing industry, international marketing groups with established links with the firms established buying offices in the country10. The groups thus play an important role in linking local firms with competitive international markets for their products. Moreover, these joint operations with foreign investors have provided the local entrepreneurs in Malaysia with the opportunity of acquiring production and international marketing skills necessary for their production units. For that reason, diversification of export manufacturing by the foreign investors understates the contribution of these multinational enterprises in market expansion and hence growth of the economy. The foreign direct investments projects have created numerous employment opportunities in Malaysia, for instance, the electrical and electronics industry has witnessed an increase primarily from United States firms. The sub-sectors within the export manufacturing industry with the significant participation of foreign direct investment have had fast growth of output and employment in the past decades11. The share of workers employed by the multinational entities has been increasing tremendously with the rise even faster that the increase in the share of output of the firms. Therefore with the rapid expansion of export-oriented manufacturing it goes that the structure of production shifted to be labor intensive over the past decades. The pattern is evident particularly in fabricated metal products, non-metallic minerals, basic metal products and miscellaneous manufacturing. Nevertheless, the patterns have remained static for the electronic industry where employment and output shares have remained unchanged at comparable levels reflecting the fact that the export-oriented electronics industry has always been labor intensive all along. The Malaysian employment trends in the export-oriented foreign companies are mainly attributed to the heavy reliance on female workers however it is unclear whether the opportunities are a net addition to employment. There is a possibility that these foreign firms have contributed to the rise in the workforce participation rates notably through engaging young women in the force that in the absence of these opportunities would have remained outside. Because of the overreliance on imported input, the export-oriented foreign firms have always been questioned for failure to develop adequate direct input linkages with the local economy. It is evident that linkage effects of export-oriented manufacturers that operate in assembly and light manufacturing industries are less compared to those of import-substituting firms. There is a huge contrast between the protected suppliers markets for import-substituting products and the competitive buyers markets for products shipped to high-income countries. Therefore substituting the goods of secondary quality may lead to substantial market losses, and the involved cost in rectifying any potential defect may be prohibitive. Consequently, a challenge arises for these foreign firms to forge strong linkages at the formative stage of export-oriented manufacturing. However, there is a tendency of the foreign firms to increase their purchases locally as their operations mature in the host country provided the business climate remains conducive to such tendencies as demonstrated by the case of Malaysia. The firm operating in the Malaysian foreign trade zones procured almost all their input from abroad at the infant stages of investment. The trend, however, changed over time with the foreign firms increasing their procurement of domestic parts and materials hence boosting total output. For instance, Japanese firms operating in the Malaysian manufacturing industry increased the share of procurement of domestic parts and materials. The increase was mainly attributed to the appreciation of the Japanese yen that brought about much intermediate inputs producing firms from Japan setting base in Malaysia12. It was mainly to maintain competitive edge in the supply of input to the foreign Japanese firms based in Malaysia. However the linkages are not limited to only Japan multinational enterprises but also semiconductor firms operating in Malaysia have shown integration of firms from all over into the domestic economy hence doing away with the satellite workbench philosophy that was in place. The linkage aspect of an export-oriented foreign direct investment is closely related to its footloose nature. In this case, the foreign firms that operate in export-oriented manufacturing are in toes to flee the scene the moment wages begin to rise, and tax incentives expire. Therefore, the Malaysian experience shows how the concern might have been misplaced. For instance in 1990s most foreign firms in Malaysia in the semiconductor industry had exhausted their tax status but they continued to operate and even expanded their operations in the ensuing years. Further with the advancement in expertise most of these firms that were initially involved in simple assembly activities have gone a step to major at the end of line fabrication and final assembly operations in Malaysia. The free trade zones initially attracted foreign direct investment and ever since there has been increasing geographical dispersion witnessed by the introduction of foreign direct investment flow. Even though most of the development projects by these foreign firms were located in major states, there has been a trend to devolve such projects to other states also13. Many factors account for the new industrial patterns in Malaysia in geographical terms that underlie the integration of free trade zones into the wider economy. Some of the factors include improved infrastructure, the high cost of land particularly in the congested areas in foreign trade zones, subtle environment policy and the rise of small and medium enterprises that have the profile of foreign direct investments. In contrast to other neighboring states, the foreign trade zones in Malaysia cannot be seen as the pillars of the highly regulated economy that has significant anti-export predisposition whose appealing nature has diminished over time. At the initial stages, the degree of technology transfer associated with the foreign direct investment was limited to labor tin the trade zones following directives from the mother firms. However with time there has been an increase in engaging local management in the production more especially in the electronic and electrical industries. With an increase in information dissemination in home countries of the foreign firm, there have been instances involving outsourcing of professionals from Malaysia to the parent firms to help in reorganizing and rationalizing the production processes. For example, Texas Instruments United States international firm sends Malaysian engines back to the United States to go help solve problems in their parent manufacturing plant14. Similarly, Japanese car manufacturing company uses its Malaysian plant as a training facility for various personnel ranging from line workers to engineers to operations of neighboring Pakistan. Apart from the technological spillovers, the presence of the foreign multinational entities has seemed to generate substantial information related to externalities that cannot be reflected directly in market transactions and employment trends. The market information provided by the foreign international buyers contributed significantly to the success of local export firms in Malaysia. The foreign firms also exposed the Malaysian business community to the international competitive industrial operatives that are valuable particularly in the infant stages of industrialization. Therefore, foreign direct investments are advantageous as they come along with new knowledge and entrepreneurial skills that are as important as the material input hence the economy can grow because these new ideas result in innovations. Consequently foreign direct investment and international trade can be seen as vessel for not only exchange of the product but also for sharing information and new ideas15. Therefore, the foreign direct investment aspect is important because the spillover in knowledge is an economic extensive factor that is not limited to a given sector in which the foreign firm operates. Conclusion The achievement in export-oriented manufacturing in Malaysia over the past decades seems to be exceptional among the developing economies in the globe today. Most of the growth changes have sprung from the foreign direct investments that are export oriented. Perhaps the most profound contribution of the foreign direct investments in Malaysia is the enhancement of employment opportunities that has seen a significant share rise especially for female workers. Statistics, however, support the notion that the expansion of local industries in the growing economies like in Malaysia is in line with adjustments in the internationalization of production that favors labor intensive activities. The experience of Malaysia runs parallel to the widely held view that these foreign direct investments drove development tends to be characterized by footloose manufacturing firms and industries. Even though there is a limitation in spread effect of these foreign direct investments through direct technology transfer and backward linkages, they seem to be increasing in a general way. However limited linkages and high import intensity are not intrinsic characteristics of these foreign direct investment export expansion. The effects can be said to be a reflection in part of the initial stages of foreign direct investment participation in Malaysia. The signs already indicate how the foreign investors began to establish linkages and spillover effects. Therefore with the appropriate incentive structure and policy environment foreign multinational enterprises can play a significant role in the course of development of export-led industrialization in third world and developed economies. 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