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Economic realists argue that a liberal market with optimum public control is the most effective recipe for economic prosperity of developing nations Sowell 1985, p.7-12. The case of industrial development of Malaysia since 1960 to the present indicates that economic realism is an interesting approach. In this paper, Malaysia has been used as the main case study to illustrate the effectiveness of economic realism. South Korea is a comparative case to support economic realism in the industrialization process of developing countries. I will divide my arguments into six sections. The first section describes industrialization during the colonial era. The second section describes the first post-colonial industrial developments which is mainly Import Substitution Industrialization Strategy (ISIS). The third section describes Export Oriented Industrialization (EOI). The fourth section deals with phase II of ISIS. The fifth section describes the industrial development of South Korea and as a comparative assessment of the role of government policies in economic development. Finally, the last section describes lessons from industrialization of Malaysia for developing countries.
2.0 Industrial development of Malaysia
The industrial development of Malaysia can be classified into six phases. The first phase is colonial development, which took place between 1897 and 1957. The industry was largely characterized by exportation of Agricultural products and minerals such as rubber and tin (Shafaeddin 2011, p.1-14). The second phase of industrial development of Malaysia took place during the first few years of independence from the Britons. It happened between 1957 and 1969. The main characteristic of the second industrialization phase was Import Substitution Industrialization Strategy (ISIS) (Lall 1995,p.759-773), ISIS is an industrialization strategy where a country substitutes its imports by locally manufactured goods. The third industrialization phase, which took place between 1970 and 1980, was Export Oriented Industrialization Strategy (EOIS), EOIS is an industrialization strategy characterized by exportation of industrial goods to external markets. Then, Malaysia reintroduced ISIS in 1981 until 1986 when it reverted to EOIS in 1987. The Asian crisis and its recovery period (1997 to 2005) form the fifth industrialization phase. The sixth phase is 2006 and beyond, this last phase is characterized by globalization of Malaysian economy by increased industrialization and exportation. The next section of the paper discusses each phase of industrialization of Malaysian economy in brief.
2.1 Colonial industrialization
Foreign capital was an important element of economic growth of Malaysia before independence. The main economic activities were agricultural production and mining (Kinuthia 2009,p.2-4). Rubber and Tin were the main pillars of Malaysian economy (Rasiah 1995,p.74). Revenue from tin and rubber was used in the development of infrastructures. The high economic growth during this time increased the demand of manufactured goods. This demand attracted Chinese and Indian entrepreneurs who developed foreign firms in Malaysia (Kinuthia 2009, p.6). The entry of Chinese and Indian technology in Malaysia led to spillover of foreign expertise to the local industry. The worldview economic system employed by Malaysian government facilitated the entry of foreign players in the Malaysian economy. The system allowed foreign firms to operate freely and repatriate revenue back to their countries. This enhanced local Malaysian firms to learn production technology of the Chinese and Indian firms. The increase in competition from Chinese synthetic rubber industry, decline in prices of primary commodities, and depletion of tin led to diversification of Malaysian economy. This possible gloomy economic future of the prosperous Malaysian economy led to the adoption of import substitution industrial development in the 1950s. The government pursued tariff protection and encouraged local entrepreneurs, attracted foreign capital and provided industrial estate facilities and infrastructural development. Import substitution was also encouraged through tax and financial incentives such as exemptions from profit tax.
2.2 Industrial developments after independence
After independence in 1957, the Malaysian government embarked on import substitution industrial development strategy, which had started in 1950. The aim was to develop local industries to manufacture goods that were previously imported from other countries. The government employed economic realism by developing an industrial policy, which protected the local industry while providing incentives for foreign firms on a smaller scale. Most of the foreign firms that were attracted to Malaysian economy during this time engaged in manufacturing and assembly. The most active and fastest growing industries in this period were electrical machinery, textile, and motor vehicle assembly. By 1970, average consumer prices of products in Malaysia rose to 125% of the world market prices following the implementation of import substitution policy. The local industry also experienced an insignificant growth; the government was forced to loosen its ISIS industrialization policy. It was apparent that Import Substitution strategy failed. Following this, the Malaysian government reduced tariffs and quotas on imported goods in a bid to reduce the cost of living (Kuruvilla 1996, p.635). The government also adopted market liberalism by developing new industrialization policies that provided a favorable investment climate to the private sector. The mixed strategy of liberalism and economic realism allowed the Malaysian government to provide investment incentives to foreign private entrepreneurs during this time (Jomo 1993, p.31-36). The Malaysian government subsidized the construction of new factories and offered domestic market protection in a bid to promote local industrialization (Brookfield et al.1994, p. 58). In addition, the Malaysian government enacted the Pioneer Industries Ordinance (PIO) in1958 to promote industrial development. The Malaysian Industrial Development Finance Corporation (MIDC) was established in 1959 with the aim to develop industrial estates and providing investment capital to spearhead industrial growth. PIO was aimed at promoting industrial growth by offering income tax relief to industries through Tariff Advisory Board. The industrial development incentives attracted labor-intensive production and manufacturing industries in the Malaysian domestic market (Ritchie 2003,p.31-37).
Protection of local firms with import duties and quotas was the biggest incentive for industrial growth in Malaysia. The extension of industrial development incentives to foreign industrial entrepreneurs enhanced establishment of foreign companies that benefited from the protected domestic market. The government created Malaysia Industrial Development Authority (MIDA) to promote and monitor manufacturing development and growth in 1966 (Ritchie 2003,p.35). The above policy initiatives outline Malaysian government’s efforts to use economic realism and worldview perspective to stimulate industrialization. ISIS and other industrial development incentives played a positive role in industrialization of Malaysia from independence up to mid-1970s. ISIS was also instrumental in diversification of Malaysian economy, reduction of dependence on imported goods, utilization of domestic natural resources and creation of employment opportunities. However, the extension of entrepreneurial incentives to foreign entrepreneurs was not sustainable for Malaysian economy. By 1975, most of the Malaysian firms were foreign owned and thus repatriated revenue from Malaysian economy back to their home countries. The local Malays only controlled 1.5 to 2% of manufacturing and production industry (Ritchie 2003,p.39). There was also a massive rise in unemployment as foreign firms, majorly Indians and Chinese, employed their nationals. This social and economic imbalance led to an ethnic riot of 1969. The economic hardship evidenced during these years of turmoil underscores the failure of globalization effort. Following this riot, the Malaysian government repealed its industrial development policy from import substation to export-oriented industrialization. It was a clear lesson that globalization promotes infiltration of the market by foreign firms at the expense of local industries.
2.3 Export-Oriented industrialization
The Malaysian government pursued economic realism by promoting export oriented industrial development through Investment Incentives Act of 1968. The act widened the range of firms eligible for growth inducements such as exemption from payroll tax and deductions from campaigns in overseas markets (Kinuthia 2009,p.10). In response to the social tensions that led to ethnic riot of 1969, the Malaysian government launched the New Economic Policy (NEP) in 1970. The main objective of NEP was the eradication of poverty in Malaysia. Manufacturing sector was deemed the most effective in eradication of poverty through the provision of employment. According to the proponents of NEP, increased manufacturing was expected to spur economic growth through foreign export exchange. By mid-1970, the Malaysian government established Licensed Manufacturing Warehouses (LMWs) and Free Trade Zones (FTZs) (Kinuthia 2009, p.5-9). The main purpose of LMWs and FTZs was the promotion of manufacturing production for export. The Malaysian firms were encouraged to use imported materials and equipment to manufacture products for target overseas markets (Kinuthia 2009, p.11).
Through MIDA, the Malaysian government also integrated global economic view by encouraging foreign Multinational Corporations (MNCs) to relocate to Malaysia to enjoy economic incentives provided by the protected market. Political stability, skilled labor force, reliable infrastructure, and financial incentives encouraged economic and industrial growth of Malaysia (Lall 1995,p.760). In response to MIDA’s advocating for relocation of foreign MNCs to Malaysia, the following firms were established in Malaysia: Clarion, National Semiconductor Electronics, Microsystems International and Litronix among others (Kinuthia 2009, p.12-14). The increased industrialization resulting from the influx of foreign MNCs in Malaysia led to the creation of employment opportunities and economic growth.
In 1976, the Malaysian government enacted the Industrial Coordination Act (ICA), which mandated the Ministry of Trade and Industry to control industrial development in Malaysia. The ministry was also mandated to control the issuance of trade licenses to firms that complied with the goals of NEP (Kuruvilla 1996, p.19).
2.4 Phase II of ISIS industrialization
By the end of 1980, the economy of Malaysia relied heavily on Foreign Direct Investments (FDIs) as 76% of the country’s Gross Domestic Product (GDP) came from MNCs. There was an urgent need of embarking on import substitution industrialization. Between 1981 and 1986, the Malaysian government embarked on heavy investment in local industrial development. There was a renewed focus on Small and Medium Enterprise (SME) investments to enhance deeper domestic industrialization and job creation than before. While pursuing the second phase of ISIS, the Malaysian government was keen not to lose its revenue from FDIs. The government protected FDIs by instituting economic measures to control the outflow of capital and promoted relocation of many MNCs to Malaysia (Kinuthia 2009, p.10-12). In order to deepen industrialization, the Malaysian government encouraged linkages between foreign firms and local Malaysian industries. This was aimed at enhancing the transfer of foreign expertise and technological skills to the local industry. Increased linkages between local and foreign firms led to technological spillover of expertise from foreign to local firms. Spillover of foreign expertise enhanced competitiveness of the Malaysian local industries with foreign multinational corporations (Kinuthia 2009, p.10). Prior to this, the local industry faced a higher competition from foreign firms that were using technology as a competitive advantage. Technological spillover gave the Malaysian local industry a higher competitive edge as they had easier access to raw materials than their foreign counterparts did.
Apart from heavy injection of public funds in the Malaysian local industry, import restrictions and strict licensing policies gave the local industry a competitive advantage domestically and overseas. The period between 1985 and 1995 saw increased relocation of Indian, Japanese, American, and Korean corporations to Malaysia (Kuruvilla 1996,p.650). The main factors that attracted the foreign firms include availability of raw materials, favorable investment conditions, and availability of cheap labor force (Kuruvilla 1996, p.648). In 1993, the Malaysian government strengthened its industrial development further by establishing Malaysian Business Council (MBC), Malaysia Technology Development Corporation (MTDC), and Malaysia Industry-Government Group for High Technology (MIGHT) (Kinuthia 2009, p.23). Other institutions formed with the aim of strengthening Malaysian industrial development include Malaysian Institute of Micro Electric Systems (MIMOS) and Standard and Industrial Research Institute of Malaysia (SIRIM) (Kinuthia 2009, p.17-18). The above institutions brought Malaysian business leaders together on a consultative platform of the future industrial development of the new industrialized Asian country. The last phase of Malaysian industrial development is 2005 and beyond. This phase is characterized by globalization of Malaysian market through free trade policies. The membership of Malaysia to World Trade Organization (WTO) implies opening up of the domestic Malaysian Market to foreign goods.
Today, Malaysia is a home to most, if not all, of the microchip corporations in the world. Most MNCs that deals in computer technology have their production factories in Malaysia. Besides foreign corporations, many local Malaysian firms are leaders in exportation of microchip technology products.
The above case analysis underscores that economic Marxism or neoliberalism alone can not enhance industrialization of a developing economy. The case of industrial development of South Korea confirms the effectiveness of economic realism as a proven perspective of industrialization.
2.5 A case of Industrial development in Korea
Korea (also called South Korea) is an example of a country that has attained industrialized status with economic realism. The Korean government has been on the forefront in promotion of production of industrial goods for exportation through Export Promotion (EP) policies (Surendra 1992, p.767-769). In 1960, the Korean government began enacting economic policies that promoted import substitution. In 1964, the government embarked on export promotion policies dubbed “Export Number One” (Mah 2010, p.10). The slogan means export promotion is the most important policy in priority. The implementation of the policy saw the government of Korea raise export subsidies to attract local industrialists to produce goods for exportation.
The South Korean government also reduced tax on export profits by 50% in 1964 in a attempt to encourage export oriented industrial production. This was done through devaluation of exchange rates in 1974. Emphasis was placed on labor intensive light industries like textile which Korea had a comparative advantage (Mah 2010, p.11).
2.5.1 Export-led industrialization
In line with export promotion policy (EP), the Korean government reserved land for industrial estates and developed foundational infrastructures for industrial development. These infrastructures formed an essential foundation for rapid industrial growth in the 1970s. Specialization in Light Industries (LI) was important in ensuring rapid industrialization. Plywood, cotton fabric, raw silk, rubber products, potteries, radios electric appliances, and mushroom cans were given priority initiatives for export production. In 1967, Korea subscribed to General Agreements on Trade and Tariffs (GATT) to pursue worldview economic perspective. It was accorded the Most Favored Nation (MFN) status in international trade (Surendra 1992, p.4). In 1970, the government of Korea shifted focus from light industries to high value added industries such as shipbuilding, automobile assembly, and manufacture of electronics. The export promotion policy led to rapid industrialization of Korea in the 1970s and 80s.
2.5.2 Industrial promotion incentives in South Korea
The Korean government provided financial incentives, tax incentives, and establishment of Free Trade Zones (FTZs) to promote rapid industrialization. The government privatized the economy by providing greater incentives for export production. As a result, many local entrepreneurial firms were attracted to export-led production. In 1961, Tax Exemption and Reduction Law provided 80% tax reduction on export-led production. In 1978, the Korean government instituted Korea Credit Guarantee Fund (KCGF) for export-led production industries with 55% reduction in prevailing market rates.
Market liberalization coupled with good public policy spurred rapid industrial growth of Korea. In effect, industrialization of Korea was possible through economic realism principles. Today, Korea is one of the leading exporters of electronic goods.
3.0Lessons from Malaysia and South Korea
From the above discussion on industrialization of Malaysia, it is evident that economic realism is the best approach to economic and industrial growth for developing countries. That is a country needs to adopt market liberalism and good public policy. The government should play supervisory and protective role in economic growth of a country. In the case of Malaysia, there was a need for a strong public policy to protect local industries from foreign competitors. The government liberalized the economy by providing both tax and financial incentives to local industries to promote industrial production for export. It used tariffs and quota limitations to reduce overreliance on imported goods (Kuruvilla 1996,p.647). Malaysian government established MIDA and mandated it to promote relocation of MNCs to Malaysia in attempt to enhance ISIS and EOP (Kinuthia 2009, p.14). The government knew that it could not produce everything locally to be self-reliant. It thus provided domestic incentives to foreign industrial entrepreneurs to relocate to its domestic market to enhance its industrial growth. It was imperative that the government of Malaysia enhances technological spillover from foreign expertise to local entrepreneurs to promote the growth of the indigenous Malaysian industry. Therefore, Malaysian government encouraged linkages between local industries and foreign firms (Jomo 1993, p.39). Technological spillover enhanced competitiveness of local industries as they could also produce competitive products using advanced foreign technology of the Chinese, Indians, Koreans and Americans (Kinuthia 2009,p.14).
Besides the market protection, there was a need to extent the incentives to foreign MNCs to provide sufficient employment opportunities for the Malays. This led to the influx of many foreign companies. While pursuing industrial development through ISIS and EOIS with a controlled and protected domestic market, Malaysia pursued progressive liberalization of the economy. The market was eventually liberalized and globalized as seen in its subscription to free trade agreements (Maggi & Rodriguez-Clare 2007, p.1381). The rationale behind globalization was to gain overseas market for its industrial goods. According to Kinuthia (2009, p.2-8), the net trade balance in Malaysia has been a positive index since 1977 to 1998. This means that Malaysia exports more that it imports.
Just like Malaysia, South Korea also employed market realism to encourage active participation of domestic entrepreneurs in rapid industrialization. The success of Korean industrial development underscores the importance of government intervention in industrial and economic emancipation of a country. The government of Korean employed market liberalism to promote private sector participation in industrial development. It was much profitable for local industries to produce for exportation than to produce for the local market. Import substitution policy and export-oriented production saw the economic and industrial growth of Korea becoming larger quickly. The government of Korea also saw a need of pursuing market liberalism to create overseas market for its goods. The MFN status accorded to Korea because of its membership to GATT created preferential overseas trade relations with other GATT members. GATT (Later became WTO) enhances the creation of global markets for industrial goods of member states.
The only difference in industrial development policy between the two countries is that while Malaysia integrated ISIS and EOI interchangeably, South Korea laid emphasis on EOI. Unlike Malaysia, South Korea locked up its market for foreign MNCs. The initiative was meant to avoid unfavorable competition of the Korean domestic industry with foreign MNCs. Although the two countries industrialized at the same time, the unemployment crisis and general poverty that led to ethnic riot of 1969 in Malaysia was a sufficient lesson for Korea. Encouraging entry of foreign firms in Korean Market would have killed the country’s industrialization initiatives by increasing revenue outflow. Nevertheless, the case of South Korea confirms that it takes a strong government initiative to enhance industrial growth of a country.
From these discussions, it is paramount that economic realism is the most effective perspective of industrial development of a country. According to Sun et al.(2009,p.1-3), Internal market liberalization without a good and powerful public policy leads to exploitation of the masses by the elites. On the other hand, Marxism approach will promote equal distribution of resources, but kill industrialization spirit (Khalil 1986, p.542). This is because it does not create entrepreneurial incentives that promote hard work. Worldview perspective is not an effective approach for developing nations as seen in the struggle of poor third world countries in Africa (Moore 2011, p.109). It smothers industrialization effort of poor countries. It does this by promoting the influx of cheap industrial goods from industrialized nations to compete with poor quality domestic goods. The poor technology employed in the indigenous domestic production industries makes their products less competitive and expensive. In this case, the domestic market of a developing country will act as a dumping ground for cheap foreign goods. Realism advocates for a compromised ground between free market forces and a strong public policy. From the discussion of industrialization of Korea and Malaysia, economic realism is the most effective approach to industrial development of developing countries. At the starting point, a strong public policy is required to create industrialization incentives and protect the market against entry of foreign goods. Then, economic powers are ceded to the private sector and eventually to the global perspective. The essence of the last step is to create a global market for the country’s exports upon attaining industrialized status.
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