Malaysia today is filled with the sound and fury of a trapped tiger. The unravelling of its economic dynamism following the Asian financial crisis (AFC) has eroded political stability by reducing the amount of patronage power available, and worsened social polarisation by reducing opportunities for social mobility. The sociopolitical malaise has, in turn, helped keep the economy stuck in the middle income trap (MIT).

The cause of the large collapse in Malaysia’s annual GDP growth rate trend from 7.7% in 1970-1997 to 4.7% in 2001-2019 is the sustained quantum drop in its investment-to-GDP ratio. Total investment in 1995 was 46% of GDP, with private sector investment accounting for 33 percentage points. The same indicators two decades later were 26 and 17 respectively. The smaller annual increases in national production capacity translated directly into lower GDP growth rates.

The New Economic Policy (NEP) cannot be the reason (at least not the direct reason) for this precipitous fall in post-1997 investment because the NEP had been in existence since 1970, and the 1970-1997 period saw rapid growth. The abrupt permanent investment decline came from two developments: one external and one internal.

The external development was the November 1999 signing of the bilateral US-China agreement on China’s World Trade Organization accession, which quickly led to similar treaties with other Group of Seven (G7) countries. As these treaties guaranteed the access of Chinese goods to the markets of the rich nations, global foreign direct investment (FDI) was instantaneously diverted from Asean to China (the lower-cost producer), causing the FDI component of Malaysia’s investment to plummet - an outcome that the Malaysian government could not have prevented.

The second negative investment shock to Malaysia was, in contrast, self-inflicted. In response to the AFC-damaged balance sheets of Malaysian financial institutions, the government forced small and medium banks and finance companies to be acquired by the biggest banks to create a monopoly banking system of 10 anchor banks. The number of domestic commercial banks went from 22 in 1990 to 10 in 2002, and the number of finance companies from 45 to 10.

All over the world, small and medium banks (SMBs) and small and medium finance companies (SMFCs) are the primary sources of working capital and investment capital to small and medium enterprises (SMEs). Big banks always seek to avoid the mountain of paperwork generated by small loans because the paperwork burden from a humongous loan to a ginormous corporation is nearly the same as that from a teensy-weensy loan to an itsy-bitsy workshop.

Big banks also have much greater difficulties than small banks in making sound loans to SMEs, especially those located outside of the big cities. The manager of a small bank is likely to be someone from the local community who had grown up with the entrepreneurs in that community, and hence have informal knowledge about the financial resources and strength of bonding within the extended family of each local entrepreneur as well as about his idiosyncrasies. The manager of the local branch of a big bank, on the other hand, is likely to have been promoted from an office in one of the big cities and lacks the tacit knowledge about the local entrepreneurs.

This post-2002 worsening of the SMEs’ perennial problem of capital shortage led the government to establish SME Bank in 2005. The unsurprising failure of this government-owned SME Bank to ameliorate the extreme capital shortage faced by SMEs has induced the flowering of illegal Ah Long financiers, who have to charge very high interest rates to cover the legal risks involved.

Malaysia’s SMEs are not only less productive than big domestic enterprises but are also “inefficient compared with their foreign peers [in China, OECD, and some Asean countries]” (SME Corp, 2019-2020 annual report). The lower productivity of SMEs in Malaysia is not only from technological backwardness but also from operating below their production capacity because of shortages in working capital and labour.

The low productivity translates into low profits, which means SMEs can only afford to pay low wages to their workers. The desire to increase profits is why the SME sector supports the large-scale import of low-skill foreign workers which, if done, will maintain the wage stagnation of low-skill Malaysian workers.

The better solution is for the government to create a situation where SMEs have adequate access to working credit and fixed-asset-investment capital, and the way to do this is to expand the pool of capital available to SMEs tremendously by allowing SMBs and SMFCs to exist again.

Giving every qualified Ah Long financier a banking licence and regulating the new SMBs and SMFCs appropriately will release a deluge of private funds for SMEs to expand production capacity to achieve economies of scale and to invest in new technology to move up the value chain. The resulting higher levels of efficiency and technology will enable SMEs to earn higher profits and pay higher wages to workers.

Furthermore, a modernised SME sector would not need foreign workers because modernised SMEs would have substituted technology for foreign workers. In short, solve the SME capital shortage problem and the SME labour shortage problem will disappear.

The outbreak of Cold War 2.0 means that the rich countries will greatly reduce imports from China and increase them from Asean. This avalanche of new export orders requires Malaysia to choose between the orders being produced by FDI (note the record FDI into Penang in 2021 and Johor in 2022) and SMEs. Which national jersey should the soon-to-be leaping tiger wear? Malaysia should empower SMEs to implement the New Industrial Master Plan 2030.

Finally, the economic lift-off from the re-emergence of SMBs and SMFCs can be guaranteed to free Malaysia from the orbit of the MIT if the government will boost the lift-off by implementing complementary policies like modernisation of bankruptcy laws, decentralisation of the fiscal system and administrative governance, and improved manpower training.

Prof Woo Wing Thye is vice-president for Asia at the UN Sustainable Development Solutions Network and a research professor at Sunway University 

https://www.theedgemarkets.com/node/683714