How does Foreign Direct Investment affect the Malaysia economy

II. Literature Review

FDI in Private Sector (Private Investment)

Economic report (2010/2011) indicates that the private investment was rebound from -17.2% in year 2009 to 15.2% in year 2010 and in year 2011, private investment will stable in 10.2%. Department of Statistics, Malaysia (DOSM) (2010) indicates that in first half of 2010 the private sector capital grew by 46.6%. The largest contribution in private investment is services sector 47.2%, following mining and electricity sector and manufacturing sector which is 25.4% and 21.1% (Economic Report, 2010/2011). In the first seven months of 2010, Malaysian Industrial Development Authority (MIDA) approved 545 investment projects which are totally RM16.6 billion to improving domestic economy and FDI (Economic Report, 2010/2011). The three main largest foreign direct investment countries from Singapore, Japan, and United States and in term of location in Malaysia, the state of Selangor, Johor, and Penang was become the largest approved investment (Economic Report, 2010/2011). Economic Report (2010/2011) also indicate that FDI fall from USD7.3 billion in year 2008 to USD1.4 billion in year 2009 which is drop by 81.1%. Economic Report (2010/2011) point out Malaysia government should more focusing on more sizable and high-impart investment, promote private sector-led growth and as facilitator to enhance private investment and attract more domestic and foreign investments. “FDI inflows are projected to increase because supported by government which government provided a conductive business environment and gradual revival of capital expenditure.” (Economic Report, 2010/2011). Most foreign company are making profits because Malaysia’s investments is broad-based which largely in manufacturing, agriculture, oil and gas, and services (Economic Report, 2010/2011).

AmResearch Sdn Bhd senior economist, Manokaran Mottain said that if want attract more foreign investors to improve FDI, the Malaysia government will introduce public-private sector partnership as role in business (Tan, The Star, 2010). In Najib Tun Abdul Razak (2010) 2011 budget speech, one of the strategic to improve the private investment is “Reinvigorating Private Investment”. In reinvigorating private investment strategic got around 20 different sub-strategic, different strategic will enhance in different aspects in private investment. So, the main strategic to improve the whole private investment is public-private partnership initiatives, high impart strategic development, and revitalizing capital market (2011 Budget Speech, 2010).

In public-private partnership (PPP) initiatives, Najib Tun Abdul Razak (2010) indicates that “The government will provide allocation as a tipping point for infrastructure support to ensure viability of private sector-led projects”. All the PPP projects identified in 10th Malaysia Plan will enhance the private sector investment, for example, construction of highway, construction of a 300-megawatt combined-cycle gas power plan, and development projects like hospital. The total private investment will be implemented in 2011 is RM12.5 billion.

In high impact strategic development, 1Malaysia Development Berhad (1MDB) agree to develop the Kuala Lumpur International Financial District (KLIFD) which will commencing in 2011 and the value of KLIFD will be reach at RM26 billion. The important of develop KLIFD is strength Malaysia’s position as the premier international Islamic financial hub and government is consider to promote special incentive packages to attract foreign investor to KLIFD. Another project in this strategic are the Mass Rapid Transit (MRT) in Greater KL, estimate of RM40 billion in private investment; Malaysian Rubber Board land in Sungai Buloh, estimate of RM10 billion in private investment and also Petronas Twin Tower, estimate of RM5 billion in private investment.

Malaysia government will implement seven measures to enhance the cooperation with foreign bourses which is first, divest their shareholdings in major companies by government-linked investment companies (GLICs); second, for better return to foreign investors, GLICs allowed to increase investment in overseas market; third, certain listing company will offer higher public shareholding like Petronas Chemicals Sdn. Bhd.; forth, launch sukuk and conventional bond by Bursa Malaysia; and the last one is Securities Commission (SC) will offer three new stock broking licenses, increase the number of Proprietary Day Traders, and facilitate process and procedures for listing companies.

Foreign direct investment (FDI) and Economic growth in Malaysia

A large number of studies was suggest that foreign direct investment (FDI) is an important source to the economic growth in Malaysia, the FDI bring in the capital investment, technology, create new job opportunity for economic growth. FDI not only stimulate the economic growth but also stimulate the growth of industrial sector and transform the Malaysia economic structure from agricultural into major producer and exporter of manufactured goods (Jajri, 2009).

Karimi and Yusop (2009) examine that causal relationship between foreign direct investment (FDI) and economic growth in Malaysia. Karimi and Yusop (2009) suggest that FDI has indirect effect on economic growth in Malaysia. The Toda-Yamamoto causality test done by Karimi and Yusop (2009) suggest that there is no strong enough evidence of a bi-directional causality between FDI and economic growth. Karimi and Yusop (2009) indicate that two variables such as technology transfer and productivity have indirect relationship in FDI and growth of economic and the most important mention by them is the performance of one variable does contribute to stability of another variable. This meaning that the performance in a sector will be affect to each other, for example, stability of manufacturing sector will enhance the private investment in private sector.

Har, Teo & Yee (2008) examine that the relationship between FDI and economic growth in Malaysia for the period 1970 to 2005 using the time series data. Har et al. (2008) determined that there is a positive relationship between the FDI and economic growth based on their empirical result and FDI was played an important role in Malaysia’s economy. To achieve economy development of Malaysia, government should concern the importance of FDI in economy growth; for example, encourage more foreign direct investment to increase the employment in Malaysia and advance technology in production can increase more skilled labor to increase productivity (Har et al., 2008). Although the empirical result showed that has a positive relationship between FDI and economic growth, but it has bringing some negative effect on some sector, for example, domestic producer, they will facing difficulties to survive in the market because the foreign investor become monopoly and losing the market power. Therefore, Har et al. (2008) were suggesting that government should implement some policies like joint venture to make a win-win situation between domestic producer and foreign direct investor. Har et al. (2008) also indicate that the political stability is an important role in FDI because the new policies implemented by government will be affects the decision making of foreign direct investor.

Jajri (2009) examines the influence of foreign direct investment (FDI) over the growth of the Malaysia for the period of 1970 to 2003. Based on the empirical result done by Jajri (2009), the result showed that FDI was significant influence on the growth rate of Malaysia’s economy and has a strong market and macroeconomic stability to promote FDI. Jajri (2009) shown the human capital was more important in FDI because it can improve the productivity, innovative capabilities, and strengthening the supporting industries to attract more foreign investment.

Foreign Direct Investment (FDI) in manufacturing sector growth

Yusop and A.Ghaffar (1994) examined that several quantitative factors that was influence FDI in Malaysian manufacturing sector. In this study, Yusop and A.Ghaffar (1994) indicate that gross national product (GNP), interest rate, external reserve, manufacturing output, economic health, currency stability, local financing, availability of adequate human and physical infrastructure are important factors to influence the FDI in manufacturing sector. Oman (1984) defined that a foreign entity own majorities of the equities in firm should be consideration involve in FDI activities. So, the purpose of Yusop and A.Ghaffar (1994) in this study is measure the company is consider as FDI company if the company has at least 50% of equities. After this study was done, Yusop and A.Ghaffar (1994) suggest few aspects can improve the FDI in manufacturing sector. First, the result show that between the (LMOG) and FDI have a positive relationship, that meaning human aspect and physical infrastructures are related to manufacturing sector and it is important for foreign investor (Yusop and A.Ghaffar, 1994). So, to attract the foreign direct investment in manufacturing sector, Yusop and A.Ghaffar (1994) suggest “the provision of a well trained and efficient labour force, special or subsidized industrial sites, and other infrastructural facilities.” Second, to increase the flow of FDI, the allocation of special fund or credit facilities for firm also important, for example, the local finance is the important consideration for foreign investor because it will affect their FDI decision (Yusop and A.Ghaffar 1994). Third, tax incentive is the important element to improve and increase the flow of FDI, the policy maker can utilize tax incentive to leading the FDI activities in manufacturing sector (Yusop and A.Ghaffar 1994).

Chandran V.G.R (2008) found that FDI was a determinant in manufacturing sector in his empirical analysis about examines the FDI over manufacturing growth in Malaysia which is in developing country during 1970 to 2003. Chandran V.G.R (2008) suggests that to improve the FDI in manufacturing sectors, the first action is focus on improving productivity and innovative capabilities. “Quality of FDI can only be attracted if the host country has the ability to improve the manufacturing outputs through productivity gain rather than depending on the traditional factor of production” (Chandran V.G.R, 2008). Chandran V.G.R (2008) also suggests that to more focus on education institution and the industrial needs to build up human capital stock and improve the level of education. In additional, the networks of foreign universities affiliation with local institution are important because those will enhance the competitive advantage of the manufacturing sectors. The last strategic suggest by Chandran V.G.R (2008) is the relationship between the local supplier and foreign investor must strengthened through network cohesion for many manufacturing firms. A strong supply chain must be establish so that foreign investors will realize that the local supplier in Malaysia also capable to fulfill their need in delivering material.

Incentives and maintain attractiveness in Malaysia for FDI

Oti-Prempeh, Abenaa A. (2003) examines the concept of FDI in developing country such as Malaysia, Mexico and South Africa in his paper. Oti-Prempeh, Abenaa A. (2003) showed that there are some reasons to make the Malaysia become attractive in FDI like the Malaysia undervalue currency, low inflation rate, low cost of labor. Malaysia’s National Economic Program (NERP) also became a attractive for foreign investor, it is because the six objective of the NERP enhance the confident of the foreign investor and Malaysia plans to become industrialized nation by year 2020 (Oti-Prempeh, Abenaa A., 2003). Oti-Prempeh, Abenaa A. (2003) indicate that the Labuan is the city with tax haven, free regulation and law, and full natural resources like oil and gas to attract foreign investor to invest in Malaysia. The Malaysia’s investment policy provides incentive to foreign investor such as Promotion of Investment Act 1986 and the Income Tax Act 1967. This Act provides incentive in many sector so that foreign investor can enjoy the advantages like full or partial exemption from income tax, for example, Malaysia current income tax rate was 30%. Consequences, foreign investor can get higher rate of return on their investment (Oti-Prempeh, Abenaa A., 2003). Duasa, J (2007) also indicate that Malaysia has attract a large portion of FDI inflow after Malaysia introduce the Investment Incentive Act 1968 and the Free Trade Zone during the second Malaysia Plan (1971-1975).

In Chandran V.G.R (2008) opinion, the Malaysia can maintaining their attractiveness for FDI is because of moderate overall cost, political stability, and good infrastructure. In the other hand, FDI liberalization in Malaysia also provide incentives to foreign investor, Chandran V.G.R (2008) suggest that Malaysia should focus on providing labor force and complementary asset in the long run to maintaining the attractiveness of Malaysia.

In manufacturing and agricultural sectors, Malaysia was providing incentives to let the foreign company or investor to enjoy different advantages when they invest in Malaysia. The two major incentives provide by Malaysia government are pioneer status and investment tax allowance (ITA). In Pioneer Status, “A company grated Pioneer Status enjoys a 5-years partial exemption from the payment of income tax and it pays tax on 30% of its statutory income.” (MIDA, 2010). In addition, Malaysia also provides the promoted area to encourage foreign direct investment. Invest in promoted area such as Sarawak, Perlis, Sabah and some certain area can enjoying a 100% tax exemption on statutory income during in 5 years exemption period (MIDA, 2010). In investment tax allowance (ITA), a company can apply ITA to grant an allowance of 60% on qualifying capital expenditure within 5 years. In the other hand, for each year of assessment, a company may be able to offset this allowance to against 70% of its statutory income and the rest of 30% will be taxed at the prevailing company tax rate (MIDA, 2010). The Malaysia also provides promoted area in ITA incentive which is if any company invests in the promoted area; a company can enjoy 100% allowance on qualifying capital expenditure in 5 years. In addition, for each year of assessment in promoted area, the allowance can be utilized to offset against 100% of the statutory income. Different additional incentives also provided by government in many sectors, here just discuss one major of additional incentive for all sectors which is Reinvestment Allowance (RA). From the MIDA website, reinvestment allowance is given if a company involves in manufacturing or agricultural activities, operation at least 36 months from year assessment 2009, and purposely reinvest in expansion, automation, modernization or diversification business (MIDA, 2010). Reinvestment allowance is given 60% on the qualifying capital expenditure, 15 consecutive years, can be offset against 70% of statutory income and can fully against of statutory income if a company invest in promoted area or attain productivity level exceeding the level determined by Ministry of Finance.