Can Malaysia Take That Next Big Step?

Without a balanced growth plan, good times may not last

In Kuala Lumpur, Malaysia's capital, signs of rapid economic growth are everywhere. The skyline is undergoing dramatic changes, as huge new office towers reach for the heavens. The city's streets are packed with Mercedes, BMWs, and Protons, a boxy Malaysian assembled car. One in 20 Malaysians now owns a cellular phone.

But the good times may not last long. High growth has led to a soaring current-account deficit and caused foreign investors to look elsewhere. A labor shortage and a poor education system have created a workforce neither skilled enough for high-end jobs nor cheap enough for low-end ones. With a population of just 19 million, Malaysia can't compete for labor-intensive industries against the likes of Indonesia and China. And it can't beat high-tech success stories such as South Korea and Taiwan. "Malaysia is still trying to find a strong, clear position on industrialization," says Zainal Aznam Yusof, deputy director-general of the Institute of Strategic & International Studies in Kuala Lumpur.

Advisers to Prime Minister Mahathir Mohamad need to make up their minds fast. The economy is sucking in too many imports, swelling the country's current-account deficit to more than 9% of gross domestic product. That's far above the level in Mexico at the time of the peso's collapse in 1994. To protect the Malaysian ringgit against speculators, Bank Negara Malaysia, the central bank, jacked up interest rates nearly 50 basis points, to an average of 7.14%, in mid-January. The market is buzzing with rumors that the government might slap on exchange controls.

Even Mahathir, usually impatient with any criticism of his economic policies, is frustrated. He has long pushed for an economy like South Korea's, with large business groups leading the way to industrialization through exports. That has been a dismal failure. Instead, foreign investment--$17 billion in the past four years alone--has powered Malaysia's boom, as the high yen has prompted the likes of Sony Corp. and Sharp Corp. to produce camcorders and VCRs there. Now, Mahathir worries that the heavy reliance on imported Japanese components leaves Malaysia's exporters trapped. "We have to rethink if we should go in for export growth in a big way," says the Prime Minister.

That has given more urgency to the job of government planners, who are putting the finishing touches on a new industrial policy, the country's third in a decade. They want to persuade technology-rich foreign investors to help Malaysia create its own high-tech sector rather than merely build screwdriver assembly operations. The new policy will recommend government support for seven strategic industries, ranging from aerospace to biotech to electronics. Even without the new plan, foreign investors have promised three new semiconductor fabrication plants, the country's first commercial chip facilities.

To upgrade technical and engineering skills, Mahathir has begun a sweeping overhaul of the education system. For the first time, the government is allowing private universities to open in Malaysia. The new schools should stem the tide of Malaysians studying abroad and help curb the drain on foreign exchange. More spending on education, however, has a short-term cost: Last year, more than half the workers who quit Texas Instruments Malaysia, which has chip-packaging and assembly operations in Malaysia, took government scholarships for further study.

BREAKNECK PACE. Still, Mahathir seems more interested in building monuments than in investing in technology. Foreign economists are concerned that Malaysia has placed too heavy an emphasis on controversial infrastructure projects. At the vast Kuala Lumpur City Center on the edge of the business district, workers are close to finishing the world's tallest two buildings. A new $3.5 billion international airport is supposed to open in two years. Last August, Mahathir broke ground on a new, $8 billion capital city south of Kuala Lumpur. In Borneo, rain forests are being cleared to make way for a $5.5 billion dam.

The breakneck pace of construction is causing alarm in financial circles. Even an impressive 34% savings rate can't provide all the money that's needed, so foreign capital has to make up the difference. Keeping the money pouring in from abroad looks harder than before, especially with speculators betting against the ringgit. Foreign reserves cover less than four months of imports--a year ago they covered eight. Early government estimates are that the deficit grew two-thirds, to $7.1 billion, last year on the back of a 22% increase in imports.

The unwillingness of Mahathir, 70, to cool the economy raises fears that he won't establish a balanced growth strategy. "Mahathir has a pharaonic side to him," says University of Malaya economist Jomo Kwame Sundaram. "These are the modern pyramids--the biggest this, the tallest that."

The fast growth caused in part by these projects is prompting a serious labor shortage. At least one in nine workers is foreign. Immigrants sneaking in from Indonesia work illegally as airport porters, golf caddies, and gas station attendants. The Berjaya group brought in 250 Albanians to work on its luxury island resort near the Thai border, while architectural firms employ British graduates--on close to local terms, not fancy expatriate packages.

As a result of the shortage, companies are shifting production elsewhere, and the labor shortage contributed to a 19% drop in foreign investment approvals last year. It's a major reason why TI, for example, set up its newest $1.2 billion joint-venture chip fabrication plant in Thailand instead of Malaysia. The labor crunch also pushed up manufacturing wages an estimated 20% last year, fueling inflationary pressures.

Foreign investment in technologyrelated fields is declining even faster than overall capital spending. Approved foreign investment in the electronics sector fell 51% in 1995. Intel Corp. recently said it would spend $3.1 billion on new fabs in Israel and Ireland but would build only a modest motherboard factory in Malaysia, which analysts estimate will cost $30 million. With China, Indonesia, and Vietnam emerging as stiff competitors, analysts are skeptical that Malaysia can get the burst of new, more sophisticated investment its planners expect.

The high costs of doing business in Malaysia are even causing some local players to move offshore. Malaysia Airlines plans to set up an office in London to handle its accounting. With qualified accountants in Kuala Lumpur costing upwards of $47,000 a year, "I can employ people more cheaply in London and other places," says Chairman Tajudin bin Ramli. The airline is having such a hard time finding well-educated cabin crews that Tajudin plans to start recruiting in Burma.

HOOKED. Can Malaysia shift gears fast enough to regain its economic momentum? That is the key question. Take Malaysia's ambitions in finance. Finance Minister Anwar Ibrahim, who is expected to succeed Mahathir later this decade, last June launched an initiative to make Malaysia an international financial center. The hope is to build on an earlier plan promoting Labuan, a tiny island off Borneo, as an offshore banking center while developing Kuala Lumpur as a fund-management center. In the first nibble since the Anwar announcement, Morgan Stanley & Co. in January said that it will set up a fund-management operation in Kuala Lumpur in a venture with the Malaysian police pension fund.


Overall, though, financial institutions have been slow to pounce. "We are getting concerned" at the lack of interest, concedes Tong Kooi Ong, chief executive officer of Phileo Allied Securities, who is an adviser to Anwar and heads the country's seventh-largest bank. One reason for the absence of enthusiasm is that Malaysia isn't as open to foreign businesses as Hong Kong or Singapore, in part because it needs to maintain a delicate balance between ethnic Chinese, who control about 60% of the economy, and the politically dominant Malays. Unlike Hong Kong and Singapore, Malaysia remains cautious about letting foreigners work in finance. And it's even illegal to import copies of newspapers from neighboring Singapore because of long-standing rivalries between the two countries.

Looking at the year ahead, a weakening yen should cut Malaysia's trade deficit. But it won't help the country ratchet up its economy to a new level of sophistication. Singapore accomplished this task a decade ago by raising minimum wages and letting the currency appreciate. It was a successful, albeit painful, policy. Hooked on high growth, Malaysia hasn't yet shown that sort of political courage. But Malaysians can hope that Mahathir's economic pragmatism will triumph over his desire to leave a string of expensive monuments.

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