Relationship between Malaysia’s economic growth and China’s outwards FDI

1216 word (5 pages) essay in Economics

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The present paper examines the short-run as well as long-run relationship between Malaysia’s economic growth and China’s outwards FDI. Besides, the determinants of China’s FDI flows into Malaysia, namely Malaysia’s market size, exchange rate, and human capital development are also being examined.

By employing the technique of co-integration (specifically the ARDL approach), an endogenous growth model is estimated for Malaysia, with the sample period from 1987 to 2009. Our results showed that China’s FDI played a crucial role in promoting growth of the Malaysian economy, while Malaysia’s trade openness and financial development also have their influence on domestic economic growth in the long-run, though the former appears to be independent of Malaysia’s economic growth in the short-run. Nevertheless, it is worth to highlight that other than the direct contribution, China’s FDI also stimulate Malaysia’s economic growth via its interaction with financial development and our results provide further empirical evidence that this relationship is without uncertainty. Therefore, domestic absorptive capability in transferring the benefits embodied in China’s FDI outflows into higher economic growth is important.

On the other hand, it was also concluded that China’s outwards FDI into Malaysia is positively affected by market size, exchange rate, and human capital development in a statistically significant manner. Meanwhile, our empirical results also indicated that there is a unidirectional short-run causal effect runs from China’s FDI to Malaysia’s economic growth.

Since China’s FDI has become increasingly crucial, policies focusing on enlarging domestic market size, strengthening the exchange rates, and human capital development are primarily proposed. For the first case, larger market size should receive more FDI inflows compared to smaller countries that have smaller market size. This is because the larger the market size, the better the opportunity for foreign investors to reduce entry costs and to attain economies of scale, that is reducing average cost as a result of mass production. In this case, the government is encouraged to promote cooperation on FDI policy among neighbouring regions in order to obtain higher investment. Regionalism expands the size of the market, and thus makes the region more attractive for FDI. The market size advantage of regionalism is important for Malaysia because our country is small in terms of both population and income. While for the second case, when the exchange rate is strengthened, FDI tend to rise because there is a greater rate of return in the region. Countries that require FDI can attract it also by development of resources like human capital. Corporations seek out societies with a skilled, educated, and productive workforce. In other words, investors increasingly target countries where the quality of human capital is high. Human capital is also a fundamental element of increasing per-worker labor productivity. Moreover, widespread respect for human rights facilitates the ability and enhances the opportunity for the host country’s citizens to attain higher levels of education and training.

Generally, current policies aimed at attracting FDI will have to be revisited in terms of selecting the specific type of investment that is required. Governments have to emphasize on the economic reform policies and the shift towards a free market which able to continue to help the economy to reallocate its resources efficiently. When trade account is being liberalized, less restrictions or cost will be imposed on international trade, namely import and export. Therefore, higher importation level of raw material with lower cost (due to lower import duties and competition) enable firms to produce more output in a more efficient manner, and hence enhance productivity and economic growth. On the other hand, greater export (as a result of lower export tax) increases the level of firms’ production and export in our country, and this will rise up firms’ revenue or profit, which will in turn increase national income. Besides, greater export will also contribute in the reduction of current account deficits. In addition, it is also proposed that improving productivity and innovative capabilities of the economy (especially manufacturing sectors), as well as strenghthening the supporting industries and institutions are important. All these will in turn lead Malaysia to become attractive (especially to China) in terms of FDI destination.

Recently, Malaysia’s FDI inflows from China has been gradually dropping annually due to the competition from other countries like Vietnam, Indonesia, India and other emerging countries. They have both skilled and unskilled labor, as well as relatively lower labor costs. As a result, Malaysia needs to enhance its production efficiency or reduce its relatively higher labor cost in order to compete with its rivals. In the longer term, rather than its direct dependency on FDI, Malaysia should focus on developing new industries for their individual growth and not solely for purpose of FDI inflows. If that is the case, the industrial development in the country will be in a rapid path, which in turn will ultimately lead to a growth in FDI inflows from China (Jajri, 2009).

Furthermore, in order to spur growth, Malaysia should not mainly focus on attracting China’s FDI, but simultaneously ignore the development of domestic infrastructure and facilities like macroeconomic stability, human capital development, and financial system evolution. Malaysia can also influence the technology change by reforming its absorptive capacity via further promotions on financial reforms to gain sustainable economic growth and fully utilize FDI inflows. This suggesting that in order to be benefited from the positive interaction between FDI and economic development, one should liberalize the economy while deregulating the financial sector, that is, a country should focus on strategies that promote financial development in the economy.

5.2 Limitations and recommendations for future Studies

It is common that every research has its own limitations. Our study is not an exception. First of all, small degree of freedom in our models would be a limitation. In particular, the degree of freedom is being seriously exhausted due to the widely use of lagged variables, and it left very few after the ARDL estimations. Although the ARDL technique to cointegration is suitable for small sample size studies, the lack of degrees of freedom might not be a desirable outcome as the estimations might be poor in terms of accuracy. However, there are not much work can be done in order to overcome this limitation except resorting to panel data. In the field of development economics, the lacking of statistical data is not an unusual phenomenon. For our case, limited China’s FDI data (from 1987 to 2009 only) might influence our results or produce undesirable results. According to MIDA, the tiny size of data is because China started their projects in Malaysia only from 1987 onwards.

We were also unable to obtain sufficient sample size of China’s FDI outflows into Malaysia while characteristics of FDI data are not clarified. Future researchers are recommended to include industry characteristics into the analysis in order to investigate the impact of industry-specific factors. Analysis across industries could be conducted to identify industrial patterns of location distribution of China’s FDI.

In addition, examining the relative importance of different channels through which FDI affects economic growth in the developing economies versus the developed economies is another possible future work in this area (Ghosh & Wang, 2009).

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