Issues Related To Economic Growth In Malaysia Economics Essay

Introduction

Malaysia is a growing and relatively open economy. Three years ago, the economy of Malaysia was the 29th largest economy in the world by purchasing power parity with gross domestic product for 2007 estimated to be $357.9 billion (World Bank, 2007).

For instance, Malaysia has a consistent record of economic growth in GDP over the period 1970-2005, averaging an annual rate of about 7 per cent. Because of its open economy, externalities have had a major impact from time to time including the oil crises of the 1970s, the downturn in the electronics industry in the mid 1980s, and especially the Asian financial crisis of 1997 (Rani, 2007). The impact of this crisis was still being felt early in the twenty-first century. Standards of living of the majority of the population were transformed over the 30-year period with the level of GDP per capita in 2000 being about four times that of 1970. The boom in the economy went uninterrupted from 1988 to 1996 when the economy grew by between 7 and 10 percent per annum. The main source of growth was the manufacturing sector whose share of GDP increased to 31.4 percent in 2005 (Ministry of Finance, 2006).

Moreover, Foreign direct investment (FDI) has been a key driver underlying the strong growth performance experienced by the Malaysian economy (Barlow, 2001).

Overview of the Malaysian Economic Growth and Developemnt

Since four decades ago, Malasyia through the World Bank's country‐classification system was qualified as a middle‐income country. Since then, it has continued to enjoy relative prosperity, initially as a commodity exporter (rubber, tin, then palm oil and petroleum), with total income rising at 6-7 percent each year from 1970 until 2000. As a result, Athukorala, (2001) the number of poor persons (that is, those consuming less than the purchasing power parity US$1 per day metric) has fallen to fewer than a million, or 3.9 percent of the population of 26.2 million people (compared to about half of the population in 1970) (Yusof, 1986).

With a per capita yearly income measured at about US$5,300 in 2007, Malaysia is now an upper‐middle‐income country. It has gone through several of the structural changes that its income comparators have experienced; nevertheless, it remains highly dependent on favorable external terms of trade to support domestic economic growth. Nonetheless, the share of agriculture has fallen from above 30 percent of GDP to below 10 percent, and that of industry (manufacturing) rose from 27 (12) to about 50 (31) percent. The initial growth response to the purposeful and increased industrialization of the economy from the mid‐1970s was favorable, with volatility declining and the overall rate of growth rising towards 10 percent per year in the late 1980s (Yusof, 1988).

Malaysia from its independence had a population of just 7.4 million. Its population has since grown rapidly, such that by 2005 the country had some 26.8 million people and, on current estimates, rise to nearly 29 million by 2010. The population shares reflect major changes over time in favor of the Bumiputera, largely because of their higher fertility levels (Yusof, 1997).

Apart from natural increase, population growth reflects a steady influx of immigrant labor, primarily from Indonesia, the Philippines, Bangladesh, and Nepal. However, before 1957, Malaysia was a low‐income agrarian economy, whose mainstays were rubber and tin production and entrepôt trade centered on Penang and Malacca. Business enterprises were small‐scale, largely localized, and predominantly family‐based. Over time, the economy has diversified beyond agriculture and primary commodities, such that manufactured goods now account for a larger share of GDP and total exports. Urbanization has been rapid; in 2005, some 63 percent of Malaysia's population lived in urban areas, compared with just about a quarter in 1957(Yusof, 1988).

Since the 1970s, Malaysia has based its economic development strategy on three long-term policies: the New Economic Policy (NEP), 1970-90, the National Development Policy (NDP), 1990-2000, and the National Vision Policy (NVP), 2001‐2010 (Yusof, 1989).

Although the emphasis in these long-term development policies has always been on economic growth, Malaysian development intends to benefit all groups or communities in society in an equitable manner. Beginning in the late 1960s, specifically following racial riots across the country, distribution issues became more important and moved to the forefront. The overriding objective of the NEP, maintained in the NDP and the NVP, was to preserve national unity by eradicating poverty irrespective of race, and by restructuring Malaysian society to reduce the identification of race with economic function and geographical location. Direct policies to assist the Bumiputera obtain parity with the non-Bumiputera in income and wealth lay at the heart of the distributive strategy. Growth with equity continues to be the guiding development strategy 2010 (Yusof, 1989).

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At the broadest level, the discussion of Malaysia's push for industrialization is motivated by three observations (Hausmann, et. al, 2005):

First, although there was rapid diversification away from resource‐based industrial exports towards non‐resource‐based industries, recent years have witnessed slightly faster growth in the latter.

Second, the future of labor‐intensive industries is a source of concern, not just because of the high dependence on electronics/electrical products and textiles but also because of rapidly increasing labor costs in Malaysia.

Third, and related to this, there has been a strategic push in recent years to seek out new growth areas and push towards higher value-added and knowledge‐based industries with the erosion in Malaysia's comparative advantage in labor costs and labor‐intensive manufacturing industries.

The 1970s ushered in a new phase of economic growth, marked by the rapid rise of construction and manufacturing and a strong strategic emphasis on equitable or fair distribution, specifically through affirmative action policies. By 1990, the economy was more industrialized, despite being buffeted by massive shocks. For example, the oil crises of 1973-74 and 1978-79 and the global slowdown in demand for electronics and primary commodities in 1985-86. 2010 (Yusof, 2005).

Export-oriented manufacturing industries gained momentum in the early 1970s. Foreign direct investment (FDI) in export-oriented firms was promoted actively with the introduction of the Investment Incentives Act of 1968, Free Trade Zone Act of 1971, and the Promotion of Incentives Act of 1986 (Yusof, 2005).

Prior to these investment promotion instruments, industrial growth was driven by an import substitution strategy (IS) with the introduction of the Pioneer Industry Ordinance, 1958. The establishment of the Malaysian Industrial Development Authority (MIDA) in the mid‐1960s was a landmark in the drive towards industrialization.

In addition to the focus on the industries, it is useful to illustrate two other contexts in which economic policy making and leadership played out during Malaysia's economic development.

The first is the early embrace (1983) of a "privatization" policy in Malaysia. This policy initiative stemmed, first, from concern about the rapid growth of Malaysia's public sector during the early stages of the NEP, and its relatively weak industrial performance. In addition, Malaysia's privatization initiative was also based on the "Japan Inc." model that viewed the country as a single corporation, with the government providing and helping maintain an enabling environment for business and the private sector operating as the engine of growth. This anticipated, by several years, the formalization of such an approach by the broader development community (Yusof, 1989).

A second set of strategies is equally important, because it illustrates the policy makers' return to some of the calculated risk‐taking behaviors seen prior to the promotion of industrialization in the 1970s, and referred to earlier. These strategies were the first concerted attempt at the national policy level to initiate a transition from development based on resources and traditional technology toward a knowledge-based economy, and thereby ride the wave of industrial change and globalization that was sweeping the world. The launch of the Multimedia Super Corridor (MSC) in 1996, although affected strongly by fallout from the Asian financial crisis of 1996-98, is intended to build on Malaysia's current strengths in electronics, skilled labor, and high-quality infrastructure to become a more visible regional and global player in the development and application of information and communications technology (ICT) (Ariff, & Goh Chen, 1998).

Growth and distribution issues occupied center stage during the leadership of Mahathir, with shifts in emphasis over the years. The Malaysian growth story over the last 35 years can be viewed as a constant tussle between concerns with distribution, especially its ethnic dimensions, and concerns with the growth of the economy. Even at the beginning, when the NEP was launched in 1971, the perceived tradeoff between growth and distribution occupied the minds of the policy makers.

The growth of public enterprises and other governmental institutions supplemented the other distributional approaches. Two broad approaches were utilized. First, public enterprises expanded in new growth areas, especially through the Urban Development Authority and the State Economic Development Corporations (SEDCs). These new growth areas provided opportunities for Bumiputera businesses and entrepreneurs. Second, institutional investors such as PNB provided the channel for individual Bumiputera to invest in unit trusts. These initiatives (public investment in new regional growth centers) produced mixed results but, overall, they were disappointing (Yusof, 1989).

Public investment in specific areas for urban renewal, and in new areas owned by the state to provide growth opportunities in commerce and industry, were predicated on the belief that it would be difficult and disruptive to restructure existing urban assets owned by non-Bumiputera. At the same time the takeovers of British-owned mining and plantation companies in the 1970s and 1980s, but not the Chinese plantation and mining companies, exemplified efforts in avoiding encroachments on the existing wealth of the Chinese. Although the economy grew at 7 percent per year over the 1971-85 period, there was a slowdown in the 1981-85 period. The close attention given to growth and distribution was well illustrated when growth slowed (Rasiah, 1992).

Political System and Leadership and their Impact on Economic Growth

An understanding of the politics and political system is helpful in understanding the nature of leadership and policy making in Malaysia. Ethnic considerations have and continue to dominate politics. Dealing with ethnicity issues has been a central task for leadership, and the Malaysian case study presents an example of how a leadership has dealt with economic efficiency, growth, and nation building in an ethnically divided community.

In attempting to understand leadership, it is not sufficient to consider only the personal traits of leaders. An examination of the access of leaders and their interaction with followers is also essential. Traditional values associated with Malay leadership include the need to avoid conflict, an emphasis on traditional courtesy and good manners, wide consultation, and the avoidance of direct confrontation. A test of leadership is whether followers trust a leader sufficiently to follow him when he embarks on a difficult and new course of action. A leader,

therefore, needs to instill loyalty, provide tangible material benefits, and to stamp his legitimacy. However, Mahathir, who was Prime Minister during much of the period covered, attempted to straddle both traditions and once remarked, "You have to lead. You should be sensitive to what your followers think. But if you do exactly what they want you are not a leader." (Milne and Mauzy, 1999).

Moreover, the specific performance requirements for Malaysian leaders are complex and reflect the interaction between communal traditions, the new ethnic politics, the distribution of rents from Malaysia's vast natural resources, and the growth imperative in an increasingly competitive international economy. This is not to suggest that personal traits do not matter.

The four desirable personal qualifications are that the leader should fight for the Malay cause, should not be aloof, should have style, and be of aristocratic birth (Milne and Mauzy, 1999).

Furthermore, it is interesting that the tensions within the leadership system have stemmed from factors related to the last of these, as seen in Mahathir's disagreements with the aristocratic leadership group during the 1980s and 1990s.

For instance, Malaysia has developed a political system that has been characterized as "an elite accommodation system." The Alliance/Barisan Nasional system of elite cooperation, or consotionalism, differed from the "ideal" model (Milne and Mauzy, 1999). Consotionalism, for example, includes the principle of proportionality (that is, the benefits received by groups or parties should be proportional to their numbers.

Under the Alliance/Barisan Nasional system, the workings of the system did meet one ideal of consotionalism closely; followers, generally, did follow their leaders. UMNO, as the dominant component of the consotional system, tends to propose and carry through most major items of policy and often rejects proposals from other members of the coalition, a practice described as "hegemonic consotionalism." Consotionalism depended on the capacity of the key political elites from each community to reach accommodative solutions to key public issues (Mauzy, 1983).

In the Alliance, sensitive and contentious issues need to be resolved within the governing councils by the representatives of the three communal parties. Demographic, political, and economic changes have, however, eroded the Malaysian elite accommodation system over the years. The system seems to have been terminated with the imposition of Emergency Rule following the May 13, 1969 racial clashes. Rukunegara, the national ideology, was launched and essentially it asserted that the fundamental agreements that had been struck earlier through inter‐ethnic bargaining, the "Racial Bargain," could not be challenged. Amendments on the sensitive ethnic issues were made in the Constitution, including sections on rights, citizenship, Malay special rights, status, and powers of the Malay rulers, status of Islam, and the status of Malay as the sole national language. The amendments also gave powers to the Yang Di‐ Pertuan Agung, the King, to reserve academic places in institutions of higher learning for Malays in areas where they were disproportionately few in number. Therefore, in in July 1971, the NEP was then launched, when the Second Malaysia Plan was presented to Parliament (EPU, 1971).

Consequently, the rise in the powers of the executive, and the role and power of the Prime Minister's leadership, can be illustrated with four cases over the period 1983-92, when Mahathir Mohamed was engaged in contests for power (Lee, 1978):

The first contest in 1983, involved the monarchy, the Agung, and the state's rulers, to ensure that their powers were defined sharply. In this case, constitutional amendments were made to reduce the royal powers in order to delay assent to a bill that had been enacted by Parliament.

The second case, in 1998, involved the removal of the Lord President of the Supreme Court of Malaysia. Five more Supreme Court judges were also suspended and two were dismissed.

The third case, which culminated with the 1987 UMNO General Assembly, was the contest to retain control of UMNO. This led to an UMNO split, the formation of a new political party, and a new UMNO, renamed "UMNO Baru." Following Mahathir's victory at the Assembly, UMNO's constitution was amended to enhance the power of the UMNO president.

The fourth case in 1992 involved a contest over royal immunity from the rule of law.

As state governments rely on federal financing for budgetary spending, a rational approach to reducing their dependence on the federal government would be to open up and liberalize the state economy for faster growth, while seeking greater amounts of external capital, including more FDI. These opposition states are also likely to test and stretch their powers as much as they can under the constitution. The potential for disagreements between the federal and state governments is high; it remains to be seen how these disagreements will be sorted out and their fallout contained.

Issues related to Economic Growth in Malaysia

Policy Design and Implementation Issues

The Malaysian growth story, like that of other developing countries, can be viewed as a narrative of the structural transformation of a predominant agricultural economy to a more industrialized economy, and then to attempts to transform it even further in the latter part of the 1990s towards a knowledge-based economy (Yusof, 1989).

Initially, primary commodities such as rubber, tin and, later, and palm oil dominated the economy. Subsequently, the export‐led growth of laborintensive manufactured products sustained economic growth. However, with rising competition from emerging economies, especially China, the prospects for long‐term growth looked bleaker, and the pressures for further structural transformation increased. A characteristic pattern of economic development policies in Malaysia is the underlying concern with economic diversification, with the ebbs and flows of official interest in promoting diversification determined strongly by the phase of the business cycle. Moreover, slowdowns and recessions have provided powerful impetus to official policies for economic growth through diversification. At the current juncture of Malaysian growth, given the post-Asian crisis slowdown that has largely persisted, there is a renewed search for structural transformation to reach a higher, sustainable growth plane (Yusof, 2005).

Nevertheless, to pinpoint the sources of policies, and of changes to policies, it is necessary to look at the institutional machinery. At the start, it is helpful to make a distinction between the federal government, state government, the nonfinancial public enterprises, the government‐linked companies (GLCs), and the private sector. These are the main sources of policy origination. The federal government has the authority and is, therefore, the source of macroeconomic policies. The three centers for macroeconomic policy initiatives are the EPU in the Prime Minister's Department, the Ministry of Finance (MOF) or the Treasury, and Bank Negara Malaysia, the central bank.

EPU is responsible for the formulation of the five‐year development plans and the mid‐term reviews of the five‐year plans. It is also tasked with preparing the long‐term development plans, that is, the outline perspective plans that cover a period of 15 or 20 years. EPU also initiates specific studies or master plans as the Privatization Master Plan for example (EPU, 1991a).

Monetary policy and exchange rate policy comes under the purview of the Bank Negara Malaysia (BNM). BNM has overall responsibility for the development of commercial banking and the insurance industry in Malaysia. It formulates and monitors the long‐term Financial Sector Master Plan. Fiscal policy is under the purview of the MOF, and this covers the areas of taxation, operating and development expenditures, and the preparation of the annual budget. BNM comes under the supervision of MOF (Bank Negara Malaysia, 2004).

Macroeconomic policy initiatives are usually coordinated by the EPU, BNM, and MOF. The agencies responsible for the development of the various sectors are also involved, but the lead is taken by the three key central agencies. There is an Inter‐Agency Planning Group (IAPG) with the three central agencies as members, supplemented by a selected number of ministries and departments (Bank Negara Malaysia, 2004)..

International agencies have been the source of significant policy ideas. The World Bank, International Monetary Fund (IMF), and the Asian Development Bank (ADB) have been the three leading agencies that have engaged the government on policy matters. World Bank, IMF, and, to a lesser extent, ADB missions to the country have been occasions for the review of policies and for the consideration of new policies. The World Bank's work on poverty in Malaysia, for example, has been an important source of policy ideas on poverty alleviation.

Policy Implementation Machinery Design

Implementation matters a great deal in the successful execution of economic policies. Even sound policies will be ineffective if they are implemented badly. Policies have to be turned into actions to deliver results that are tangible. The successful implementation of policies requires effective institutions; leadership; and clarity of purpose, processes, and mechanisms.

There is also a large measure of learning by doing so. Policies must be coordinated and be consistent. A good delivery system, therefore, is very essential for the implementation of economic policies. Too rapid a turnover of technocrats erodes continuity and institutional memory and weakens implementation capacity.

These are general principles, but useful in evaluating the Malaysian experience. The involvement of the executive arm of government (the Cabinet and Prime Minister's Office) in the implementation of policies is determined by the importance of the policies. Generally, implementation of policies is left to the lead agencies, for example the various ministries and departments, and the Cabinet or Prime Minister are involved only if policy issues cannot be agreed to or resolved by the agencies. Coordination among agencies is vital, and the lead is taken by the key agency responsible for the policy. Cabinet committees, with the Prime Minister or Deputy Prime Minister as chairman, are established to oversee implementation when it is thought that the policy is of some importance, and it is anticipated that there will be serious problems over coordination.

Technical and Financial Underpinnings

Industrial policy has been sensitive to the financial implications of the programs and projects designed to provide content to policy, as well as to their technical feasibility. The financial feasibility of the heavy industries projects, for example, has always been a matter of concern. Malaysia even requested a delay in opening up the automotive sector to ASEAN member countries. Detailed pre‐feasibility studies preceded most megaprojects in 1981 for setting up an engineering complex, for example. Fiscal incentives have always been used prolifically for manufacturing projects and these include the granting of pioneer status to FDI, which exempts investors from corporate tax.

As this said, investment tax allowances and export incentives have also been part of the fiscal incentives. In granting these incentives, the MOF provides estimates of the revenue that is forgone. An influential view on fiscal incentives and corporate tax is that when the full impact of investment incentives are taken into account, Malaysia's overall tax level on investors is not that much higher than other countries in the region (World Bank, 2007).

The financial underpinnings of privatization were a major plan of that policy. A key objective of the privatization was to reduce the financial burden of the government. The sale of enterprises to the private sector was seen as one method of earning revenue as well as reducing the financial burden of operational and other expenses on the government from underperforming entities. Increasingly, reducing the fiscal deficit of the federal government has become a major concern of the policy makers and the long‐term objective is to strive for a balanced, or near‐balanced, budget. As mentioned earlier, even the financial allocations for programs and projects for the distributional restructuring of society had to be trimmed down when growth slowed and financial tightness emerged.

Management of Growth and Distribution Issues

Equity, or distribution, was a major preoccupation of the post‐1969 period, and the effects of the racial riots of that year were seminal for development strategy and policy making. The NEP, launched after the riots, was a complex socio-economic policy. One prong of the policy emphasized eradicating poverty irrespective of race. The other focused on affirmative action for employment and asset‐creation programs for the restructuring of society to correct the identification of race with economic function. There has been a lot of progress in reducing poverty, but income imbalances remain sizable.

Although it had other ramifications, much attention and thought went into the effects a proactive distribution policy would have on economic growth. Growth and distribution issues occupied center stage during the leadership of Mahathir, with shifts in emphasis over the years. The Malaysian growth story over the last 35 years can be viewed as a constant tussle between concerns with distribution, especially its ethnic dimensions, and concerns with the growth of the economy.

Even at the beginning, when the NEP was launched in 1971, the perceived tradeoff between growth and distribution occupied the minds of the policy makers. Many sections of the leadership believed that too much emphasis on equity would undermine the economic growth.

For the private sector, particularly the Chinese private sector, the NEP was seen as discouraging private investment, and many felt it would dampen growth; this remained a continuing complaint of the private sector during the 1970s and 1980s. Yet, there was also a

substantial body of opinion on the other side, that a laissez‐faire approach to development or a trickle‐down path would only worsen distribution and accentuate the existing sharp economic imbalances between the Malays and non‐ Malays. In the end, the growth of the economy, despite the focus on distribution over the last 30 years, has been quite creditable.

The stated strategic approach to attaining the goals/targets of the NEP was one of distribution through growth (United National Development Program, 2005). Implementing the approach was not as straightforward. The original version of the statement was tied closely to the second prong of the NEP that relies on restructuring society to correct the identification of race with economic function and it focused more narrowly on the restructuring of the ownership of share capital. The two key implementation issues had to do with the notion of growth and whether the strategy was to be

implemented only at the macro or at the micro level too.

Moreover, a narrow definition of growth would mean that the distribution/restructuring of share capital could only be implemented when the share capital of a company had grown. It was recognized, of course, that a company could grow through recourse to loan capital rather than share capital and that sales, exports, and employment could also be used as indicators of corporate growth. It is a contentious implementation issue as the implementation of the strategy meant that large companies in the economy had to comply with the condition that at least 30 percent of their share capital was allocated to Bumiputera.

To recapitulate, the implementation of the distributive strategy led to the adoption of a variety of measures, mainly quotas, sometimes covering just the ownership of share capital and at other times more than share capital, at levels that were above the threshold for companies that are under the Industrial Coordination Act (ACT).

However, companies incorporating for business usually had to have at least 30 percent of their share capital allocated to Bumiputera, including those that were seeking public listing on the stock exchange. Corporate transactions through mergers and acquisitions, when they fall under the Guidelines of the Foreign Investment Committee (FIC) on Takeovers and Mergers, had to restructure their ownership structure to comply with the NEP.

To summarize, the growth of public enterprises and other governmental institutions supplemented the other distributional approaches. Thus, two broad approaches were utilized:

First, public enterprises expanded in new growth areas, especially through the Urban Development Authority and the State Economic Development Corporations (SEDCs). These new growth areas provided opportunities for Bumiputera businesses and entrepreneurs.

Second, institutional investors such as PNB provide the channel for individual Bumiputera to invest in unit trusts. These initiatives known as public investment in new regional growth centers produced mixed results but, overall, they were disappointing.

Finally, public investment in specific areas for urban renewal, and in new areas owned by the state to provide growth opportunities in commerce and industry, were predicated on the belief that it would be difficult and disruptive to restructure existing urban assets owned by non‐Bumiputera. At the same time the takeovers of British‐owned mining and plantation companies in the 1970s and 1980s, but not the Chinese plantation and mining companies, exemplified efforts in avoiding encroachments on the existing wealth of the Chinese.

5.0 Policy Adaptation, Learning, and Adjustment

Adapting strategies and policies to changing conditions is a prerequisite for sustaining growth. Speedy adaptation is even better for growth. A speedy response is a hallmark of decisive leadership and appropriate mechanisms for analysis and implementation, and enhances reputation while improving outcomes. In recent years, the demand for efficient and speedier decision making by the government has been mounting, promoted under the rubric of the government's "delivery system."

Adaptation commences with the external pressures for change that have been rising, and the Malaysian leadership is acutely aware of extra‐territorial developments. The international ranking of the economy in terms of various measures of competitiveness is monitored continuously, evaluated, and deliberated at the highest level. However, political and social conditions must also be conducive for implementing change without unproductive opposition. A discontinuity in institutions or leadership is often associated with purposeful policy adaptation. For example, as mentioned earlier, many policy changes introduced in the post‐1980 period were associated with the change in political leadership. Mahathir's 22‐year leadership started in 1981, and this change altered the course of Malaysian development.

Furthermore, the implementation of the policies is also reassessed continuously in the context of broader economic performance and specific targets.

A few examples illustrate how the process has worked in Malaysia. Following the sharp rise in world oil prices in 1979, the world economy experienced a sharp downturn in 1980. Malaysian GDP grew at 7.1 percent in 1981, slowed to 5.6 percent in 1982 and 5.8 percent in 1983, and the three‐year growth rate averaged well below the Fourth Malaysia Plan (1981-85) target of 7.6 percent (EPU, 1984). Manufacturing and construction also grew well below the plan's target, with manufacturing contracting in 1985, while private investment decelerated to 0.3 percent in 1982.

Moreover, growth expectations for 1984-85 were also downbeat. The adjustments made to macroeconomic policies moved in the direction of consolidating the public sector, seen in a decline in current and capital public sector expenditures. The burden of growth fell on private investment, and the policy of privatization and the Look East Policy (LEP) were launched in these difficult period. Further adjustments were made to the Industrial Coordination Act (ICA) of 1975, which was seen as constraining private investment. The government also listed the new directions in development and implementation strategies in the Mid‐Term Review of the Fourth Malaysia Plan, 1981-85 (EPU, 1985).

To add, growth slackened in the mid‐1980s with the collapse in commodity prices and stagnating exports. Slower private investment and the deflationary effects arising from the consolidation of public sector to contain the budgetary deficit lowered overall GDP growth for the first time since 1957. Output contracted by 1 percent in 1985, and grew by 1.2 percent in 1986, all below the growth target of the Fifth Malaysia Plan, 1986-90 (5 percent per year).

Private investment contracted in 1985 (−8.6 percent) and 1986 (−16.3 percent). Liberalization measures continued, including reductions in administrative controls, simplified bureaucratic procedures, the relaxation of the guidelines for the acquisition ofassets for foreign investors, and a reduction in the corporate tax rate. Public sector policy adjustments took the form of a reduction in investment (30.9 percent) of the NFPEs while public consumption growth was contained. Cutbacks were made for financial allocations to support the NEP restructuring programs; the plan's allocation of RM 4.2 billion was reduced to RM 2.7 billion.

The response to the Asian financial crisis in 1997/98 provides another example of the nimble policy adjustment process in operation in Malaysia.

Malaysia's response was unorthodox; ignoring the standard advice of the IMF, capital controls were imposed and the currency was pegged at RM 3.80 to the U.S. dollar in September 1998. The ringgit was de‐internationalized. At the same time, the government instituted a National Economic Action Council (NEAC) and launched a National Economic Recovery Plan (NERP) to cope withnthe financial crisis. Additional liberalization measures were also introduced. In 2006 the ringgit was unpegged from the U.S. dollar.

Similarly, the Eighth Malaysia Plan (2001-05) was launched in 2001 and hadnset a growth target of 7.5 percent per year. However, the uncertainties generated by international terrorism in the post-September 11 phase, wars in Afghanistann and Iraq, and the outbreak of Severe Acute Respiratory Syndrome (SARS) dampened GDP growth to 3 percent per year, and private investment declined by 11.1 percent during the 2001-03 period (EPU. 2001a).

In regards to the government response, incentives, including the revision of guidelines for private investment were introduced in the 2002 and 2003 budgets, and in May 2003 the Package of New Strategies to stimulate growth was launched.

Few years after (2006), additional liberalization measures were introduced to stimulate private investment and growth. The latest changes to economic policies were the loosening of conditions for FDI in the Iskandar Development Region in Johor. New measures have also been introduced to speed up decision making within the core and line ministries and to strengthen the delivery system (Beng, 2006).).

Re-engineering the Malaysian Financial System to Promote Sustainable Growth

The Malaysian financial landscape has undergone continuous transformation in the last decade, driven by financial liberalisation and consolidation, economic transformation, technological advancements and more discerning consumers. The Asian financial crisis has also played a meaningful role in the process. As a result, the Malaysian financial system has emerged stronger and more diversified and competitive since the Asian financial crisis.

The Malaysian economy was flourishing prior to the crisis, with strong broad-based economic growth amidst low and stable inflation. Growth in gross domestic product averaged 8% for eight consecutive years, with low unemployment and high domestic savings. Coupled with a strong fiscal surplus and low foreign indebtedness, Malaysia's economic fundamentals were relatively strong. The banking sector was also at its strongest position following periods of regulatory enhancements. At the time, Malaysia had already complied with 22 of the 25 Bank for International Settlements Core Principles (Bank Negara Malaysia, 2004).

These developments attracted the influx of capital flows, prompting the government to introduce measures to prevent further overheating in the economy and address the vulnerabilities that emerged.

Despite the strong fundamentals and responses of the government, the country was hit by the crisis through contagion. As conditions in the domestic and regional economies worsened, the government took a bold approach by prohibiting the internationalisation of the ringgit and adopting a fixed exchange rate regime to insulate the economy from external uncertainties and further disruptions, hence enabling the government to pursue its domestic agenda. Strategies were targeted at both near-term recovery of the domestic economy and at addressing structural inefficiencies that had emerged in the banking system (UNDP, 2005).

On the banking system front, the approach was holistic. The Financial Sector Masterplan (FSMP) sets the medium-and longer-term agenda to build a financial sector that is resilient, efficient and competitive, and responsive to the changing economic requirements. In realising the long-term agenda, emphasis was on putting in place the various critical components of the financial sector. By focusing on capacity building among the domestic financial institutions and on strengthening the regulatory and supervisory framework in the initial stage, Malaysia aimed to lay a solid foundation on which financial institutions can strengthen and compete effectively amidst further liberalisation without accumulation of risk factors that may adversely affect financial stability and economic growth (Securities Commission, 2004).

In this context, the FSMP spans over three phases, to provide sufficient time for a gradual, sequenced and comprehensive development of the financial sector over the next 10 years, covering the banking sector, insurance sector, Islamic banking sector, development financial institutions, alternative modes of financing and the Labuan International Offshore Financial Centre.

Embedded in the Capital Market Masterplan (CMP) is the comprehensive plan for charting the strategic positioning and future direction of the Malaysian capital market for the next decade in supporting the needs and aspirations for national growth.

Six key objectives have been identified and form the basis for the CMP's main strategic initiatives and specific recommendations:

Transform the domestic capital market into the preferred fund-raising centre for Malaysian companies;

Promote an effective investment management industry and a more conducive environment for investors;

Enhance the competitive position and efficiency of market institutions;

Develop a strong and competitive environment for intermediation services;

Ensure a stronger and more facilitative regulatory regime; and

Establish Malaysia as an international Islamic capital market centre.

Conclusion

The Malaysian growth experience over more than 30 years provides a useful case study that touches on the key themes that are of interest to the Growth Commission.

Like other emerging economies, Malaysia faces a multitude of challenges in its efforts to achieve a progressive and dynamic financial system. Balancing between financial stability on one side and monetary and economic stability on the other will become more challenging, particularly as the domestic economy becomes more interconnected and integrated with other economies and financial systems. In this environment, the responsibility of maintaining financial stability will become a collective effort extending beyond the national boundary, and require greater collaboration among countries.

Therefore, the Malaysian experience is an example of how an economy relatively rich in natural resources can escape the so‐called "resource curse" and transform itself into a more industrialized economy over a period of about 20 years. The process of structural transformation through diversification, with rising competition in the global export markets for manufactured products, needs to be continuous.