Preparing the Malaysian private sector to compete at the highest level

With more than a year into the pandemic, there is still some good news: Malaysia’s goal of achieving high income nation status while delayed, can still be achieved. However, with rising debt burdens, the available fiscal space is scarce over the medium term, and the post-pandemic recovery will need to be more heavily driven by the private sector. This situation puts the private sector under the spotlight. Empowering it the right way will help it compete better in both domestic and international markets. And a more competitive private sector will help create jobs, increase incomes, and reduce poverty. So, what will it take to make Malaysia’s private sector more competitive and an engine of growth as the country transitions towards high-income nation status? 

Malaysia has been an open economy that has benefited from export-led growth in the past. Its high level of openness to trade has made it an active player in Global Value Chains (GVCs) since the 1990s. Within this context, it would be advisable for the Government to consider ratifying the Regional Comprehensive Economic Partnership (RCEP) as well as the Comprehensive and Progressive Trans-Pacific Partnership (CPTPP) trade agreements to help boost external trade and further integrate the country’s firms into existing and potentially changing GVCs. 

As part of this effort, it will also be critical to strengthen Malaysia’s industrial base by accelerating productivity growth and boosting innovation.  This agenda of enhancing productivity and innovation has become the country’s central economic challenge.  Productivity gains and technological innovation can have significant economic impacts. They can reduce the price of key products consumed by the poor thereby increasing their household purchasing power and elevating standards of living. Innovative technologies can reduce the cost and improve the efficiency and efficacy of service delivery in all spheres of life.

Yet, existing impediments to drive greater productivity and innovation gains through the reallocation of resources towards more efficient economic activities —such as trade barriers, poor regulation, or overbearing state-owned-enterprises —can discourage innovation by existing firms and the market entry of new and potentially innovative firms. Without enterprising firms introducing new products and processes, the economic system will cease to reap gains from reallocation. Analyzing these elements, in the recently launched publication, Aiming High- Navigating the Next Stage of Malaysia’s Development, we suggest policy actions to improve the operating business environment, human capital, and firm capabilities with a view to increase firm-level productivity and competitiveness. 

The productivity gap between Malaysia and other comparator countries is increasing and is prevalent across multiple sectors and sizes. The gap is considerably wide for the small and medium enterprises that make up 98.5 percent of firms in Malaysia. The extent to which innovation promotes productivity is likely to depend also on other complementary factors, that include firm-specific factors (e.g., management capabilities, foreign ownership) and business-environment characteristics (e.g., market competition and availability of financial services). Openness to foreign trade and investment is critical to the process of innovation that includes technological adoption and diffusion, not only for the competitive pressure that it exerts on management and corporate governance but also for the exposure to global best practices, technology and management techniques provided to local firms. 

Effective market competition is also key for increased productivity and growth. Firms facing vigorous competition have strong incentives to reduce their costs, to innovate, and to become more efficient and productive than their rivals. Competition in input markets, such as transportation, financial services, energy, telecommunications, and construction services, is a key driver of efficiency and productivity growth in downstream sectors—the users of these inputs. In Malaysia, key enabling sectors such as professional services, remain relatively closed. On average, professional services in Malaysia are more restrictive than in regional peers such as Singapore and the Philippines. Malaysia’s regulations impose significant restrictions on foreign ownership and entry into certain regulated professions, including accounting, legal, and architecture. As a result, the sector is dominated by small firms with limited capacity to compete on a larger scale, thus hampering their competitiveness. Addressing government regulations and practices that restrict market competition or weaken the enforcement of competition policies is necessary for markets to work better. 

Another important dimension of Malaysia’s competitiveness and innovation challenge relates to SMEs. While they represent the majority of firms and account for half of manufacturing employment (48.4 percent), they only make up 17.9 percent of total exports. Furthermore, digital adoption amongst SMEs is relatively low in Malaysia. This modest level of utilization by SMEs of ICT tools for process improvement shows that they face a hurdle to move beyond computerization to digitalization of their businesses. Increased digitization and automation in light of Industry 4.0 and more recently due to the pandemic, will require Government attention towards fostering greater technology adoption by SMEs. 

Closely linked to this effort would be the role of human capital investments through new policies and programs to improve educational outcomes and skill levels of the workforce.  In large part, such human capital gains will help Malaysia to embrace the latest technologies and to remain competitive in ever-changing global markets. 

On another front, SMEs continue to rely on banks and informal sources for their financing needs. While the share of financing flowing to SMEs has increased in the last decade, they continue to cite financing as a barrier to growth – mainly because of the lack of collateral. On the positive side, alternative sources of capital markets are evolving to cater to a wider spectrum of SMEs, connecting underserved issuers with untapped pools of investors. 

As Malaysia aspires towards transitioning to a high-income nation, it will be important to ensure policy priorities and tradeoffs are adequately identified to better prepare the country for the future. Current strategies and policies to upgrade the manufacturing sector, such as Industry 4WRD, address many of the new challenges facing the manufacturing sector, which are essential for GVC participation. Increasing competitiveness still requires, however, that its basic pillars are soundly managed. The diagram above lays out some of the recommended policy measure to strengthen these pillars. It is time for Malaysia to aim high.