Non-Equity Modes of Trade in ASEAN
Promoting new forms of trade between
Japan and ASEAN

Malaysia

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For inquiries, contact ASEAN-Japan Centre(ASEAN Promotion Centre on Trade, Investment and Tourism)
1F, Shin Onarimon Bldg., 6-17-19, Shimbashi,
Minato-ku, Tokyo 105-0004 Japan
Phone/Fax: +81-3-5402-8002/8003 (Office of the Secretary General)+81-3-5402-8004/8005 (Research and Policy Analysis (RPA) Cluster)+81-3-5402-8116/8005 (Capacity Building (CB) Cluster)+81-3-5402-8006/8007 (Trade and Investment (TI) Cluster)+81-3-5402-8008/8009 (Tourism and Exchange (TE) Cluster)+81-3-5402-8118/8003 (PR)e-mail address: info_rpa@asean.or.jp
https://www.asean.or.jp

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All Rights Reserved.
Paper 5 / July 2021 / Non-Equity Modes of Trade in ASEAN: Malaysia
Promoting new forms of trade between Japan and ASEAN

Non-Equity Modes of Trade in ASEAN
Promoting new forms of trade between
Japan and ASEAN

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NOTESThe terms “country” and/or “economy” as used in this study also refer, as appropriate, to territories
or areas; the designations employed and the presentation of the material do not express any opinion
whatsoever on the part of the ASEAN-Japan Centre (AJC) concerning the legal status of any country,
territory, city or area or of its authorities, or concerning the delimitation of its frontiers or boundaries.

The tables use the following symbols:• Two dots (..) indicate that data are not available or are not separately reported.
• A dash (-) indicates that the item equals zero or its value is negligible.
• Use of an en-dash (–) between dates representing years, e.g., 2015–2016, signifies the full period
involved, including the beginning and end years.
Reference to “dollars” ($) means United States dollars, unless otherwise indicated.

This series includes 10 papers in total. Seven (Cambodia, Indonesia, Lao People’s Democratic
Republic, Myanmar, the Philippines, Thailand and Viet Nam) have been published. The otherpapers will be produced subsequently.
Paper 1. Brunei Darussalam
Paper 2. Cambodia (published in August 2019)
Paper 3. Indonesia (published in May 2021)
Paper 4. Lao People’s Democratic Republic (published in March 2020)
Paper 5. Malaysia
Paper 6. Myanmar (published in March 2020)
Paper 7. The Philippines (published in March 2018)
Paper 8. Singapore
Paper 9. Thailand (published in April 2020)
Paper 10. Viet Nam (published in December 2018)

Prepared by Rajah Rasiah (University of Malaya, Malaysia) with assistance from Zhang Miao
and Michihiro Tanabe (AJC) under the direction of Masataka Fujita (AJC). The manuscript wasedited by Tora Estep and typeset by Laurence Duchemin. Errors and omissions are only thoseof the authors and should not be attributed to their respective organization.

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iii

CONTENTS
1. Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
2. Characteristics and scope of non-equity modalities. . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
2.1 Scale and scope of NEM. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  11

2.2 NEM by modalitie . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
3. Opportunities and challenges. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
3.1 Local capabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .26
3.2 Relationships between NEM modalities and industries. . . . . . . . . . . . . . . . . . . . . 27
3.3 Ownership and control . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
3.4 Localization strategies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
4. Policy implications. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
4.1 Enhancing capabilities of local firms. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30

4.2 Strengthening basic infrastructure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  31
4.3 Strengthening science, technology and innovation infrastructure. . . . . . . . . 32
4.4 Promoting connectivity and coordination. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33
4.5 Promoting integration into regional and global markets. . . . . . . . . . . . . . . . . . . .33

4.6 Mainstreaming sustainable development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37

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KEY MESSAGES• Non-equity modes (NEMs) of production value have grown rapidly in Malaysia. As an uppermiddle-income country, Malaysia has evolved strong participation in NEM exports.
• Several NEMs in Malaysia have achieved advanced status and connect strongly with the global
value chains of transnational corporations (TNCs).
• The electronics industry, which is dominated by TNC outsourcing (subcontracting) activities, is oneof the largest generators of exports and employment in Malaysia. The volume of direct and indirect
NEM electronics exports from Malaysia was estimated at 70 per cent of total exports in 2018,
an increase from 66 per cent in 2015.
• Malaysia has been a major exporter of electric-electronics and textiles-apparel products since the1970s. These sectors still offer tremendous growth potential in the country.
• Contract farming of food crops has risen following government promotion to ameliorate thefood trade deficit that has been growing since the 1980s. However, this industry needs massive
technological transformation to raise yields and become internationally competitive.
• Most hotels and resorts in Malaysia are operated using a franchise model, with strong marketingand management assistance. The largest hotels are listed in the Kuala Lumpur Stock Exchange,and several operate internationally. Foreign travel booking companies play a major role inpromoting bookings for hotels in Malaysia.
• NEMs in Malaysia face considerable challenges because TNCs can easily terminate their contracts
and long-term contracts are rare, particularly when the quality of services or goods supplied
does not meet their competitive standards or when more competitive suppliers emerge fromother countries.
• The government should strengthen science, technology and innovation infrastructure; expand
supply of human capital and promote connectivity and coordination between firms and organizations
and external markets for NEM firms to integrate competitively with global value chains and to
stimulate technological upgrading.

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1

1. INTRODUCTION
The Association of Southeast Asian Nations (ASEAN) includes some of the most open economies in
the world with largely liberal trade and investment policies. However, much of trade and investmentin these countries are associated with foreign-owned and joint-venture firms and focused on
aggregate trade and investment flows. Few, if any, non-equity modes (NEMs) of ownership thatconnect with global value chains (GVCs) have been analysed systematically. Malaysia is no exception:transnational corporations (TNCs) in the country have dominated trade, such as in electronics andautomotive manufacturing, through intra- and inter-firm trade, vertically or horizontally. Also,
Malaysia is increasingly focusing on expanding the domestic share of value added in its economic
activities. NEM participation in trade within global value chains started gaining significance following
the successful expansion of firms from Japan, the Republic of Korea and Taiwan Province of China.
Given the importance of balance of payments and the overall economic development of national
economies, NEM engagement in trade is increasingly recognized as important not only to checkresource outflows but also to evolve local productive capabilities. Trade between Japan and ASEAN
members is not an exception (box 1). While Malaysia is a highly trade-oriented country, the leakageof resource transfers has been high because of foreign ownership. Consequently, efforts to expand
NEMs of trade will help reduce the country’s vulnerability to external exposure.
NEM participation in trade has expanded strongly in Malaysia in the form of international
subcontracting in manufacturing industries, such as electronics and apparel; contract farmingin agriculture and food processing; international franchising in fast-food chains, hotels andretail stores; variations of build-own-operate transfer arrangements and other concessions ininfrastructure projects and management contracts (e.g., in international hotel chains). Informationand communication technology (ICT) firms have grown extensively in Malaysia, and these businesses
are largely undertaken through contractual agreements with foreign entities. This study examines
the case of Malaysia within the overall framework of the ASEAN-Japan Centre (AJC) project (box 1)targeted at NEMs with a focus on selected industries.

Box 1. The AJC NEM project
Other than arm’s-length relationships, equity-holding is not the only means of exerting control
over the international production chain. Companies can also enter contractual relationships withother independent firms. This trade is gaining importance as the system of global production
becomes more integrated and forms value chains and is an area lacking knowledge and researchin ASEAN. The growing importance of this trade also calls for an overall analytical framework toassess development impacts and propose a generic policy framework for dealing with this kind oftransaction. The fundamental difference with normal trade is that non-equity forms of operations
involve a contractual partnership between private parties. The role of the state in this partnershipis limited to setting the framework conditions within which the private parties can freely negotiate
the terms of their cooperation. By understanding this phenomenon better, including the scale andscope, and thus filling in a policy analysis gap, AJC will provide ASEAN country governments with
policies to consider to fully benefit from these new forms of trade and investment.
…/

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2

Box 1. The AJC NEM project (Concluded)
To understand the scale and scope of non-equity involvement in major industrial sectors, this paper
uses a case study methodology. The reasons for this approach are two-fold: (1) balance of payment
and supplementary statistics do not provide the detail necessary to accurately measure crossborder non-equity participation and (2) the relevant microdata are fragmented and disconnected.
As much as possible, each case study builds on existing research and statistics.
New opportunities are emerging for ASEAN countries owing to developments in the internationalinnovation networks of TNCs. While attracting foreign direct investment (FDI) and encouraging
foreign TNCs to establish affiliates remain an important option for ASEAN countries, governments
need to review their current regulatory regimes to appropriate synergies from internationalinnovation networks. A key objective of this study is to make recommendations on which policies(investment and GVCs and industrial policies) the government should consider to fully benefit fromthese emerging opportunities.
Source: AJC.

Manufacturing has been the most important export sector in Malaysia since the 1980s (Rasiah,1995), which grew from Malaysian ringgit (MYR) 548 billion ($174.1 billion) in 2013 to MYR768 billion($178.8 billion) in 2017 (see figure 1). Agricultural exports in terms of percentage contribution togross domestic product (GDP) have tended to fall since 1970. In fact, absolute exports fell from
MYR147 billion ($46.7 billion) in 2013 to MYR127 billion ($29.6 billion) in 2017. Other exports roseslightly from MYR25 billion ($7.9 billion) to MYR41 billion ($9.5 billion) during the same period.
Electric and electronics products have remained the prime export from Malaysia with its percentage
share rising in trend terms from 34 per cent in 2013 to 39 per cent in 2019 (see figure 2). Oil, gas andFigure 1. Exports by sector, Malaysia, 2013–2017 (MYR billion)

900
800
700
600
500
400
300
200
100
0
2013

2014

Manufacturing
Source: Plotted from Bank Negara Malaysia (2018).

2015

2016

Agriculture

Others2017

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3products were the next biggest export category, but its share in total exports fell from 23 per cent in2013 to 15 per cent in 2019 as a consequence largely of falling prices. Metal and machinery exportsrose from 8 per cent in 2013 to 9 per cent in 2019. Palm oil exports fell slightly from 6 per cent in2013 to 4 per cent in 2019. Transport equipment exports rose from 1 per cent in 2013 to 2 per cent in2017. Textiles, apparel and footwear exports remained at 2 per cent over the whole period 2013–2019with slight fluctuations.

Figure 2. Major exports in total exports by category, Malaysia, 2013–2019 (%)

45
40
35
30
25
20
15
10
5
0
2013

2014

2015

2016

2017

2018

2019

Electric and Electronics

Textiles, Apparel & Footwear

Metals & MachineryTransport Equipment

Palm Oil

Oil, Gas and Products

Source: Plotted from Bank Negara Malaysia (2018).

Malaysia has a long history of attracting foreign investment, originally through portfolio equity and
FDI under British colonialism starting in the 19th century, although the British had got control ofPenang from the Kedah Sultan in the late 18th century (Rasiah, 1995). Malaysia was one of the earliest
recipients of major FDI inflows in East Asia benefiting from various circumstances, including theclosed economy in China until 1978; the preference of Japan, the Republic of Korea, Taiwan Provinceof China and Indonesia for national investment; the communist insurgency in the Philippines; thesmall size of Singapore and efforts in Indo-China to install communist governments in the 1970s.
Unlike Thailand, which still focused on import-substitution policies in the 1970s, Malaysia moved
aggressively to promote FDI inflows starting with the launch of the Second Malaysia Plan in 1971
(Rasiah, 2010). Malaya became independent in 1957 and took the name of Malaysia following theentry of Sabah, Sarawak and Singapore in 1963 (Singapore left in 1965). The first attempt to promote
FDI in manufacturing started with the Pioneer Industry Ordinance of 1958, which gave incentives
to import-substituting (IS) firms. IS failed to galvanise the economy because of the small domestic
market and lack of focus on technical change (Rasiah, 1995). The promotion of FDI inflows also took
a new direction from the Investment Incentives Act of 1967, but especially starting with the opening

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of free trade zones in 1972, with the focus moving from import substitution to export orientation(Rasiah and Gopi, 2020).
Government efforts to stimulate national investment in general, and Bumiputera1 investment
in particular, became significant starting in 1981 when heavy industries were promoted using
Japan and the Republic of Korea as examples. After working with technology tie-ups with foreign
firms, including Mitsubishi Corporation, Proton acquired Lotus in the late 1990s to upgrade. Thisventure was unsuccessful as the company failed to transform its business to become competitive
internationally. Recognizing the direct and indirect losses it faced, the Government of Malaysia sold49.5 per cent of Proton’s shares to Geely of China. The Pakatan Harapan government that came to
power in 2018 promoted NEMs with greater value added recorded by local capital in the automotive
industry but was replaced by the Perikatan Nasional government in 2020.
Foreign firms, particularly those from Japan, behave differently than local firms in how they contributeto the development process. In Asia as well as Malaysia, the technological catch-up that enabled
local firms to transition from low to high value-added activities was initially very much based on
creative learning from knowledge acquired and imported from Western and Japanese firms with FDI
playing a critical role (Amsden, 1989; Kim, 1997). The successful leapfrogging experience of many
firms in ASEAN took place through this catch-up situation. However, despite evolving to become
an upper-middle-income country, Malaysia has yet to undergo economic transformation from low
to high value-added activities. Hence, the promotion of NEMs can act as a catalyst to stimulate
Malaysia’s transition from an upper-middle-income country to a high-income country (box 2).
Local firm participation in GVCs already emerged in several industries in Malaysia starting in the
1960s, initially as suppliers to IS industries, tin mining and rubber cultivation (Rasiah, 1995). Moreextensive local supplier networks supporting foreign TNCs evolved from the 1980s, particularly in theelectronics industry and in textiles and apparel (Rasiah, 1995). However, unlike the experiences of
Foxconn, Flextronics and Celestica, changes in such intra- and inter-firm production linkages havenot significantly transformed the nature of control exerted by buyer TNCs and by target markets,
although nationally owned Globetronics, Carsem and Unisem are on the brink of achieving thenature of control (Rasiah et al., 2015). This report seeks to examine the nature of control in the value
chains involving local firms in electronics, automotive and textile and apparel firms with a special
focus on Japanese firms in Malaysia and exporting links with Japanese markets.

1

This term is used in Malaysia to describe Malays and various indigenous peoples of East Malaysia.

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5Box 2. Factors that make countries attractive NEM locations: The case of Malaysia
When examining the factors that stimulate the emergence and growth of NEMs, addressing
overlapping factors that stimulate FDI inflows is important, especially the impact of FDI inflows
on the growth of NEMs. As with FDI, determinants of location include political and social stability,
efficient and competitive policies, financial incentives, smooth trading procedures and conducive
macroeconomic policies.
In addition to policy-related determinants that stimulate FDI, many other factors can support NEM
development in host countries. First, as NEMs essentially include forms of contract-based TNC
engagement in the host economy, these factors include stable contract laws and commercial laws.
For example, in franchises (e.g., Starbucks Coffee, KFC, Pizza Hut and McDonald’s) and contract
farming (e.g., Erets Agro, Tesco and Kraft Foods), establishing sufficient intellectual property rightprotection is important.
Second, as with FDI, facilitation measures for promoting businesses are critical for stimulating
the emergence and growth of NEMs. For example, promotion activities and financial incentives
must be applied over a wide scope, such as when investment promotion agencies partner foreign
franchisers with promising local companies. Also, access to capital procurement is an importantfactor for regional enterprises that has strong potential for promoting NEM expansion.
TNCs may also establish footholds from where they can support NEM businesses. These footholds
can be minimal commercial presence, such as purchasing and quality management organizations
that provide support for outsourced manufacturing, or, as in the case of retail and quick-service
restaurants business franchises, logistics support operations that provide materials to franchiselocations.
The existence of reliable and capable regional enterprises and the ability to engage them areimportant factors in NEM operations. Most NEMs require local partners that are powerful, efficientand capable of taking on risk on behalf of TNCs. For example, when TNCs do not enter contracts
directly with individual farms, agricultural cooperatives act as intermediaries to reduce businessrisk and provide reliability (Barrett et al., 2010).
The third factor supporting NEM development is the degree of economic development and its
association with social capital within a country. For example, consumer market scale and growth
and access to regional markets are equally important to NEMs, such as franchises and outlicensing, as they are to FDI. Basic infrastructure provision, transport, energy and communications
costs are all major areas of interest to companies.
Technological capabilities and the capacity to improve quality and productivity of regional
enterprises are critical to both TNC and NEM operations. Government policies targeted at
improving such capabilities in national firms and regulations to stimulate strong corporate social
responsibility (CSR) practices and minimum labour conditions are also important to stimulate
upgrading in both TNCs and NEMs. Such initiatives also help expand the pool of NEMs available
to network with TNCs. For example, the Government of Malaysia has introduced a law specificallyconcerning franchises and has implemented other measures for promoting TNC participation in
its regional economies.
Note also that idiosyncratic factors that prefer NEMs over FDI, including special treatment for
specific citizens, contribute significantly to the widening and deepening of NEMs. For example, theprohibition of sales of Native Customary Rights (in Sabah and Sarawak) and Malay (in Peninsular
Malaysia) land to foreigners and other Malaysian citizens offers Malaysia a significant opportunity
to promote contract farming (Rasiah and Salih, 2019). It is equivalent to the prohibition of foreign
ownership of land in Cambodia, Lao People’s Democratic Republic (Lao PDR) and Thailand that…/

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6Box 2. F actors that make countries attractive NEM locations: The case of Malaysia(Concluded)

has given local owners a significant advantage in establishing joint ventures with hotel and retailchains and contract farming.2
Factors such as these have contributed to the increased overall allure of ASEAN countries as sites forvarious types of NEMs. Box table 2.1 summarizes the major locational determinants of each mode.

Box table 2.1. Location determinants for FDI and NEMs in ASEAN
Relevant for FDI and NEMs

More relevant for FDI

More relevant for NEMs

Policy framework• Economic, political and social
stability• Competition policy• Trade policy• Tax policy• Rules regarding entry
and operations• Standards of treatmentof foreign affiliates• International investment
agreements• Privatization policy• Reduction of hassle costs(e.g., cost of doing business)• Investment promotion• Investment incentives• Provision of aftercare• Provision of social
amenities (e.g., qualityof life)• Stable general commercial andcontract law• Specific laws governing NEM
contractual forms (e.g., recognizing
licensing, franchising contracts)• Intellectual property protection

Business facilitation• Facilitation efforts aimed at- upgrading of technological quality
and productivity standards of local
firms- enterprise development, increasing
local entrepreneurial drive andbusiness facilitation- subsidies and fiscal incentives forstart-ups- information provision andawareness-building on NEM
opportunities with local groups- support for minimum standardsof working conditions and CSR in
local firms

Economic determinants• Infrastructure• Market size and per capita income• Market growth• Access to regional and global
markets• Country-specific consumer
preferences• Access to raw materials• Access to low-cost labour• Access to skilled labour• Relative cost and productivity ofresources and assets• Other input costs (e.g.
transportation,• communication, energy)22• Access to strategic
assets• Created assets (e.g.,technology andintellectual property)• Strategic infrastructure• Presence of credible local
entrepreneurs and business
partners• Access to local capital

Source: AJC.

ASEAN-Japan Centre, Non-Equity Modes of Trade in ASEAN, Paper 2 (Cambodia), Paper 4 (Lao PDR) and Paper 9(Thailand).

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7

Malaysia was a major recipient of FDI even before independence. Mining and agriculture were theprime targets of FDI during colonialism until 1972. Import-substitution industrialization generated
industrial growth between 1958 until 1972 following the Pioneer Industry Ordinance of 1958 (Rasiah,1995). However, the small domestic market restricted industrial expansion, which led to theintroduction of export-oriented industrialization (EOI) starting with the enactment of the Investment
Incentives Act of 1967. EOI effectively took off from 1972 following the opening of Free Trade Zones
in 1972. Like the Philippines and Singapore, Malaysia took advantage of increased production
fragmentation and internationalization of production by foreign TNCs to attract labour-intensive FDIfrom the early 1970s. Cambodia, Lao PDR, Myanmar and Viet Nam were closed to FDI at that timeowing to the spread of communism and subsequent communist rule in these economies. China wasclosed to FDI until economic reforms were introduced in 1978. NEMs have already emerged in most
sectors in the country to contribute to economic development, but primarily in manufacturing andservices. Out of the four leading exports from Malaysia—electric and electronics (EE) products, oiland gas, palm oil and textiles and apparel—the first and last were initiated by FDI, followed by NEMs
or together with NEMs. National firms largely dominate oil and gas and palm oil exports, which
are exported directly to customers abroad. Hotels and food chains are important services that offer
locational advantages to NEMs. Hence, the report focuses on EE, automotive products, textiles andapparel, hotels and food chains.
Agriculture was Malaysia’s leading sector in the 1950s and 1960s. However, the industrial sector(comprising mining, manufacturing and construction) had become the leading sector in Malaysia
by 1970 and was only overtaken by services starting in 2008 (see figure 3). Hence, although the
Malaysian economic structure experienced a gradual fall in the share of agriculture in GDP startingin the 1960s and in industry (and manufacturing) starting in 2000 as services have become theleading sector in the country (figure 3), Rasiah (2011a, 2011b) and Chamhuri et al. (forthcoming)argue that these sectors contracted prematurely. Rasiah and Salih (2019) also show that agriculture

Figure 3. GDP share by sector, Malaysia, 1960–2019 (%)

60
50
40
30
20
10

19

6
19 0
6
19 2
6
19 4
6
19 6
6
19 8
7
19 0
7
19 2
7
19 4
7
19 6
7
19 8
8
19 0
8
19 2
8
19 4
8
19 6
8
19 8
9
19 0
9
19 2
9
19 4
9
19 6
9
20 8
0
20 0
0
20 2
0
20 4
0
20 6
0
20 8
1
20 0
1
20 2
1
20 4
1
20 6
18

0

Agriculture

Source: Plotted from World Bank (2019).

Industry

Manufacturing(*within industry)

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8underwent productivity growth from the 1970s until the early 1980s in rural small-scale farming andplantation agriculture, but the former has gradually stagnated since the mid-1980s, so that net foodtrade worsened over the period 1989–2019. Meanwhile, Rasiah (2011a, 2011b) offers other evidence
to argue that Malaysia has undergone premature deindustrialization with productivity and wages
growing slowly since 2000. In addition, the services sector has grown without a significant rise inproductivity and wages. Hill et al. (2014) reinforce these arguments, considering Malaysia to be acountry facing the middle-income trap.
The early phase of economic development in Malaysia was successful because of the ability of
the country to sustain export diversification. In fact, except for the period 1989–1997, Malaysia
largely enjoyed positive trade balances because of constant diversification of exports—for
example, from tin and rubber to palm oil and subsequently a shift to export manufacturing (seefigure 4). However, this structural shift slowed starting in the late 1990s as Malaysia began to facepremature deindustrialization starting in 2000 and since the services sector started to dominate.
The concentration of exports has lessened (the lower Herfindahl-Hirschman Index in figure 4). The
share of manufacturing in GDP in the country fell from 30 per cent in 2000 to 21 per cent in 2018
(Rasiah, 2020).
While structural change is evident in the emergence of services as the leading sector in the Malaysian
economy, the government has tried to shift the focus of economic growth from low to high valueadded starting in 1991 when the New Development Policy was launched (Malaysia, 1991). However,
economic growth in the Malaysian economy has slowed significantly since 2000. While the shares of

Figure 4. Trade balance and concentration in Malaysia, 1976–2018

17

15

20

13

20

11

20

09

20

07

20

05

20

03

20

01

20

99

20

97

19

95

19

19

19

19

19

19

19

19

19

19

19

19

-5.0

93

0.3
91

0.0
89

0.4

87

5.0

85

0.5

83

10.0

81

0.6

79

15.0

77

0.7

75

20.0

0.2

-10.0

0.1

-15.0

0.0
TB

HHIX

Source: Data from Bank Negara Malaysia (2019) and World Bank (2019).
Note: Trade balance (TB, left) was computed using the formula (X-M)/(X+M) where X and M refer to exports and imports of goods
and services, respectively. The Herfindahl-Hirschman Index of exports (HHIX, right) refers to the export concentration index,
which was computed using the formula HHIX= [(S12+S22….Sn2)/10,000]1/2 where S1, S2 and Sn refer to export share ofindustries 1, 2 and nth biggest exports in total exports in year t.

PA P E R 5 M A L AY S I A

9manufacturing and agriculture in GDP have declined since 1970 and 2000, respectively, both sectors
have also started to experience a trend fall in the value-added share of gross output (Rasiah, 2018;
Rasiah and Gopi, 2020). While the services sector has become the dominant sector, it has not shifted
significantly to high value-added activities. Consequently, the government launched the Industry
4.0 Master Plan in 2018 to revive the structural shift to higher value-added activities in the country.
The Pakatan Harapan Government also embarked on strengthening and increasing the participationof local firms in the national economy, which offers NEMs a major fillip for their expansion.
Hence, a study on the promotion of NEMs in Malaysia is timely. The rest of the study is structured asfollows. The next section will explain the characteristics and scope of NEMs by type and introduce
types of NEMs with distinguishing characteristics in Malaysia. Section 3 will discuss opportunities
and challenges in the selected industries to draw implications of NEMs for the Malaysian economy.
The last section presents policy implications.

2. CHARACTERISTICS AND SCOPE OF NON-EQUITYMODALITIESUNCTAD (2011) estimates global NEM production at more than $2 trillion in sales in 2010.3 However,
the report also states that the analysis of NEMs is complex because “the web of directly owned,
partially owned, contract-based, and arm’s-length forms of international operation of TNCs isentangled, so that some of the distinctions between the different modes are blurred”. Thus, theanalysis is limited to industries in which NEMs are especially important.
NEMs have generated significant exports in all major sectors in Malaysia (table 1). The expansion of
the EE, automotive and textiles and apparel industries was originally dominated by the relocation of
TNCs from North America, Japan and Europe, and subsequently from the Republic of Korea, Taiwan
Province of China and Singapore with national firms also emerged starting in the 1980s. Oil palm
cultivation replaced rubber on a large scale from the 1970s as Malaysia sought to avoid the risk
associated with the exchange rate. These industries helped stimulate rapid economic growth andstructural change in the country (Rasiah and Salih, 2019).

3

Contract manufacturing and services outsourcing accounted for $1.1–1.3 trillion, franchising $330–350 billion,
licensing $340–360 billion, and management contracts around $100 billion (UNCTAD, 2011).

Edible oil and pineapple
fruits300,000 small farmers(oil palm)

United Plantations,
Barlow Boustead

Sime Darby, IOI, United
Plantations, FELDA Global
Ventures, Kepong Kuala
Lumpur, Genting Plantations$14.9 billion($13.9 billion) (processedpalm oil)Contract farming

1.6 million (total employment in agriculture)(1.5 million in NEMs)

12.0%(2018–2019)Japan, China, Singapore,
India

Assist poor farmers
with access to funding,technology and markets

Product/services

No. of companies(NEM-related firms,
estimation)

Major foreign firms

Major NEM companies

Estimated export volume(estimated export by NEM

NEM modality

Employment(estimated NEM employment)

Average export growth

Export markets

Product/service

Source: AJC.
Note: Selected industries only. OEM = Original equipment manufacturer.

Assist local NEMs to earn
income through provision ofmarkets and technology

Singapore, Brunei
Darussalam, Middle East

2.1%
(2018–2019)$120 million ($120 million)(poultry meat)

AyamasKFC

4,300 farms

Broiler chickens

Oil palm and pineapples

Industry(representative example)
Poultry farming

Primary

SectorTable 1. N
 EM operations in major sectors, 2018

More than 40% of electronics
products were exported to China,
which was the main market in 2018

-2.3%
(2018–2019)

580,000(350,000 in NEMs)

Subcontracting$53.5 billion($16.1 billion) (semiconductor)

Globetronics, Unisem, Carsem
ViTroxIntel, Texas Instruments, Motorola

Malaysian Association of Electricaland Electronic Association, 238
membersin 2019

Semiconductors

Electronics

Local NEMs access low-cost
Malaysia is a major exporter offabric from TNCs to operate as electronics products
international subcontractors

United States, Europe, Japan,
Australia, South America

4.2%(2018–2019)

252,000(252,000 in NEMs)

Subcontracting$4.2 billion ($4.2 billion)(apparel)Penfabric

Penfabric

Malaysian Textile
Manufacturers Association, 77
members

Apparel (OEM)

Textiles/apparel

Secondary

Local partners have access toforeign brand names and wider
coverage of markets

Mainly tourists from China,
Japan, United States andEurope3% average annual growthrate from 2019 to 2027

3.5 million (tourism industry)(2018)

Licensing,management contract

43,697 rooms (2018)

Berjaya Hotels and Resorts,
YTL

Shangri-La

Malaysian Association of Hotels,
more than 900 members

Welcome, comfort, quality, trustand safety services

Hotel

Tertiary

10

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PA P E R 5 M A L AY S I A

11The characteristics and scope of the different NEM modalities vary, and hence, the unique elements
associated with each of them are important to understand. Because several NEM modalities are
unique to Malaysia, this section provides a systematic discussion.

2.1 Scale and scope of NEMs
Table 2 shows various forms of NEMs. NEMs are comparable to FDI from the perspective of the
motivation of TNCs. For example, contract farming is motivated by a search for agricultural resource
supply. Contract manufacturing and outsourcing or subcontracting are motivated by the desire to
improve production efficiency by reducing costs. Licensing and franchising are motivated by thedesire to expand markets. All these modes typically spread the risks to local players at host sites.
Whereas subcontracting resembles FDI in that it consists of transferring resources, technologies
and expertise to contractors in the form of “packages”, licensing and management contracts involve
little direct transfer. The following is an overview of the features of each NEM.

Table 2. D escription of selected non-equity modalities, including examples of typicalindustries, in Malaysia
Modality

Subcontracting

Description(in the international context)

Agreement whereby a TNC contracts out toa host-country firm one or more aspects ofproduct design, processing or manufacturing.
Includes contract manufacturing and designand outsourcing in the case of services andbusiness processes.

Contract
farming/
MiningAgreement between a TNC buyer andhost-country farmers/miners (including
governments) that establishes conditions forthe production and marketing of farm/mining
products

LicensingContractual relationship in which a TNC(licensor) grants to a host-country firm
(licensee) the right to use an intellectual
property (e.g., copyrights, trademarks, patents,
industrial design rights, trade secrets) in
exchange for a payment (royalty); includes
brand licensing, product licensing, process
licensing. (n.b., cross-licensing and intra-firm
licensing)Franchising

Contractual relationship in which a TNC(franchisor) permits a host-country firm
(franchisee) to run a specified business model
on a system developed by the franchisor in
exchange for a fee

Typical industries

Company examples

Electronics

Globetronics,
Carsem,Unisem,ViTroxAutomotive
products

Inggress
Denso Malaysia

ApparelPen Apparel,
South Island Garments

Agriculture

KFC/Ayamas
SALCRAFAMAPower

YTL (Siemens)

Oil mining

Shell,
Exxon

Telecommunication

Motorola

Fast food

KFC,
McDonald’s,
Starbucks

Hotel

Berjaya Hotels andResorts/JW Marriot
YTL Hotels andResorts…/

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12Table 2. D escription of selected non-equity modalities, including examples of typicalindustries, in Malaysia (Concluded)
Modality

Description(in the international context)

Typical industries

Company examples

Management
contracts

Agreement under which operational control ofan asset in a host country is vested in a TNC
contractor that manages the asset in returnfor a feeHotel

LP Holding (Hilton
Worldwide)

Other, e.g.,
Includes concessions, leasing agreements,
build-operatebuild-operate-transfer arrangements, etc.,
transfer and the
involving public-private partnerships
likeInfrastructure

Straits Construction
Singapore

Source: AJC.

(1) Electronics: Subcontracting
The degree to which subcontracting accounts for overall production varies by industry type. In
the toy, sporting goods, electronics and automotive industries, subcontracting generates around50 per cent or more of value added. It accounts for less than 50 per cent of the value added inpharmaceutical products.4
Subcontracting grew significantly in the electronics industry starting in the 1990s as competition
drove TNCs to outsource a significant share of components and parts to other firms to lower
costs and to reduce inventory-holding risks, which offered firms from developing countries
a window of opportunity to connect and upgrade their operations. During this period, major
electronics companies dedicated themselves to peripheral aspects of research and development(R&D), product design and brand management, using electronics manufacturing services suchas Celestica (Canada), Flextronics (Singapore) and Foxconn (Taiwan Province of China). Important
TNCs that have stimulated spillover to local firms include Intel, Advanced Micro Devices (which
was sold to Mubadalla Corporation and renamed Global Foundries in 2007), Texas Instruments,
Fairchild, ST Microelectronics, Siemens (which sold its semiconductor division to Infineon and
Qimonda) and Renesas (Rasiah, 1994, 2010). Malaysia has also evolved its own NEMs in the EE
industry as Globetronics (box 3), Carsem and Unisem have expanded into successful subcontract
producers of electronics chips with original equipment manufacturer (OEM) and original design
manufacturing capabilities.

4

Interview with Federation of Malaysian Manufacturers undertaken on 19 September 2019.

PA P E R 5 M A L AY S I A

13Box 3. Globetronics: From a subcontractor to a chip integrator
Globetronics was established in 1991 by two former employees of Intel. The founding members
had 30 years of experience with Intel. When they established Globetronics, Intel offered them theopportunity to serve as a subcontractor. Intel provided their ex-employees with equipment andfacilities to launch their businesses to secure their initial costs. Another important area of support
that Globetronics obtained from Intel was Intel’s certification of quality for their products that wereto enter the supply chain.
After developing sufficient capabilities, Globetronics built on the initial support from Intel todiversify its operations. Through the process of product development and their own capabilities,
the founders of Globetronics understood that, while TNCs, in general were willing to teach small
and medium enterprises (SMEs) certain production methods, the level and volume of knowledge
that would be passed on was restricted. Globetronics conceived and executed joint development
work with its customers. For example, Intel outsourced just one item to Globetronics when thelatter started operations. It was more economical for Intel to outsource this item than to continue
producing it on its own as Globetronics was able to amortise its investments by supplying a wide
range of customers. Because the item that Intel outsourced was not new technology, the TNC
could minimize the risk in its initial dealing with Globetronics.5
Intel gave Globetronics a running start, which offered the latter the impetus to negotiate contracts
with other firms, such as Sumitomo as its local client in Malaysia.
Globetronics does little to no business with Intel today. In fact, all its end customers are overseas.
Globetronics proudly claims to be the first company in the world to integrate the proximity sensor
and emitter into a single chip, which most companies apparently cannot achieve due to limitations
in sensitivity and in technology.
Globetronics has significant exposure to the Apple supply chain, which produces components for
the Apple iPhone.6 This case study shows how engagement by a NEM firm with a TNC can be an
important avenue for entrepreneurs who wish to create new SMEs with the capacity to innovate.
TNCs such as Intel and Sumitomo Group Company could see mutual benefits from contracting out
to ex-employees endowed with tacit knowledge, rather than taking on risks with unknown firms.7

The value-added share of EE firms in Japan, Malaysia and the Republic of Korea were similar in
the early 1970s as export-oriented TNCs enjoyed tax holidays and tariff-free operations (figure 5).
TNCs then practiced transfer pricing to record most profits at host sites enjoying tax holidays, andMalaysia was one of the generous providers of such relief. However, the value-added recorded as ashare of gross output in the industry in Malaysia has fallen apart from a slight uptick between 2006
and 2012 (figure 5). A combination of the introduction of taxes (with tariff-free operations still intact)
and a slow upgrading is the cause of this shift. The revival starting in 2006 is the result of new firms
relocating to enjoy tax holidays again. While several local firms have emerged to strengthen the roleof NEMs in the industry, policy efforts must be implemented to stimulate catch-up as Malaysianelectronics firms have largely remained in low value-added activities (Rasiah et al., 2015).

5

6

7

Accessed on 06 April 2021 from http://www.globetronics.com.my/index.php?option=com_content&view=article&id=222:pioneering-semiconductor-player-globetronics-still-hungry&catid=35:press-releasecoverage&Itemid=123
Accessed on 06 April 2021 from https://www.klsescreener.com/v2/news/view/523102/Rebound_seen_in_smartphone_sales_boost_for_some_M_sian_tech_firms
Accessed on 06 April 2021 from http://www.ngked.co.jp/company/history.html

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14

Figure 5. Share of value-added in gross output, electric and electronics industry in Japan,
Malaysia and the Republic of Korea, 1970–2015 (%)

Japan

14

12

20

10

20

08

20

06

20

04

20

02

20

00

20

98

Republic of Korea

20

96

19

94

19

92

19

90

19

88

19

86

19

84

19

82

19

80

19

78

19

76

19

74

19

72

19

19

19

70

50
45
40
35
30
25
20
15
10
5
0

Malaysia

Source: Data from UNIDO (2017).

(2) Textiles and apparel: Subcontracting
Subcontracting has also expanded into low value-added industries, such as apparel, footwear andtoy industries. Whereas foreign textile TNCs in Malaysia, such as the Pen group of companies owned
by Toray (Japan), undertake polymerisation, texturization spinning and weaving, Malaysian NEMs
have grown to manufacture apparel and accessories with local brand names, such as Padini andAllan Dillon. While local brands have only managed to sell in Southeast Asia, Malaysian apparelfirms have been able to handle a wide range of segments in the apparel value chain, including
logistics. The main export markets are the United States, Japan, Turkey, Indonesia and China.
Japanese TNCs, such as the Toray group specializing in polyester and polyester-enhanced cotton
fabric, started operations in the early 1970s, while Taiwanese knitting firms relocated to Malaysia in
the 1980s. South Island Garments, TPI Industries (box 4), Whitex Garments (box 5) and South Island
Garment (box 6) are Malaysian NEMs that produce apparel for export. Although electronics TNCs
relocated operations to Malaysia in the 1960s and 1970s, apparel TNCs have remained the largest
manufacturing operations in Malaysia.

Box 4. TPI Industries
Founded in 1981, TPI Industries is in Malacca. The firm produces casual wear for women and men
with 70 per cent of output sold domestically and 30 per cent exported. Exports mainly go to theUnited States, Canada and Europe (United Kingdom). The company had a share capital of MYR22.8
million ($5.5 million) in 2019.
With 200 workers in 2019, TPI Industries has an automated production line with cutting-edge
inventory and quality control systems to reduce its dependence on foreign workers.8 The company
has started to use solar energy through its own installations, thereby increasing the use ofrenewable energy.

8

Accessed on 24 March 2020 from https://www.ctoscredit.com.my/business/TPI-INDUSTRIES-SDN-BHD-0074899D

PA P E R 5 M A L AY S I A

15

Box 5. Whitex Garments
Whitex Garments Limited Company is a fully locally owned firm incorporated in 1984. Locatedin the state of Selangor, the company employed 450 employees in 2019 with a paid-up capitalof MYR19.6 million ($4.7 million). The company specializes in knitted undergarments for men,
women and children. From operations in a single factory, Whitex Garments Limited Company now
has operations in three locations: West Malaysia, Bangladesh and Viet Nam. In June 2006, Whitex
Knitting Sdn. Bhd. was established in Malaysia to manufacture seamless undergarments, the firstof its kind in Malaysia.
Whitex Garments Limited Company manufacturers all types of knitted and seamless undergarments
as per customer requirements specified by the big brand holders. It supplied 59 customers in
2019. All output is exported. Although its main markets are in North America and Europe, thefirm exported 99.4 per cent of its output to the United States in 2019 with the balance going to Sri
Lanka and Mexico.9 The firm has modernized its operations to automate several processes, whilehandling the packaging and delivery of the apparel to the United States. It next plans to introduce
Industry 4.0 technologies to reduce the use of foreign labour.10

Box 6. South Island Garment
South Island Garment (SIG) is an international subcontracting firm started in 1975 by local
manufacturers utilizing largely fabric produced by foreign TNCs in Malaysia. SIG primarily
used woven fabric from Penfabric and knitted fabric from Eastern Knitters when it first started.
Penfabric, a Japanese multinational corporation, is its main supplier of polyester and polyestercotton blended fabric. Manufacturing a wide range of apparel for export, SIG, headquartered in
Penang, performed remarkably well with revenue growing from MYR0.7 billion ($214 million) in2014 to MYR1.1 billion ($272.9 million) in 2018. Its assets grew from MYR0.3 billion ($91.7 million)
in 2014 to MYR0.5 billion ($124 million) in 2018.11 It had 1,017 employees in 2019. Its export markets
in 2019 included the United States, Europe, South America, China, Japan, Mexico, Australia andCanada.
Equipped with computer-aided design and computer-aided manufacturing, the company has
skilled and technically trained personnel to coordinate inventory control and meet qualityand delivery specifications for global brand holders. It has also launched its own brands thatare sold domestically and marketed regionally. The principal activity of SIG is the manufactureof internationally renowned branded sports and leisure outerwear. With headquarters in
Penang, SIG also operates in Viet Nam through a strategic manufacturing partnership with its
Vietnamese partner.12

9
10
11

12

Accessed on 24 March 2020 from https://panjiva.com/Whitex-Garments-Sdn-Bhd/1315090
Firm interview and accessed on 24 March 2020 from https://panjiva.com/Whitex-Garments-Sdn-Bhd/1315090
Accessed on 24 March 2020 from https://www.emis.com/php/company-profile/MY/South_Island_Garment_Sdn_
Bhd_en_3725644.html
Accessed on 24 March 2020 from https://www.apollo.io/companies/South-Island-Garment-Sdn--Bhd-/55fa82e7f3
e5bb7f7e001e80?chart=count16

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With the withdrawal of the Multi-Fiber Arrangement in 2004, Malaysia was among the nations
that lost preferential access to major markets. Also, rising production costs stemming from rapid
industrialization and falling unemployment levels have undermined the competitiveness of theindustry in Malaysia. Malaysian firms have since hired foreign labour from Bangladesh, Indonesia
and Myanmar, which comprised 75 per cent of its labour force in 2016 (Malaysia, 2017). Industry
players now have the options of raising productivity through the implementation of Industry 4.0
technologies or/and back-integrating into producing fibres, yarn and fabric, the route Japan, theRepublic of Korea and Taiwan Province of China have taken. The other option is what firms in
Malaysia, the Republic of Korea; Taiwan Province of China; Hong Kong SAR, China and China took,
which was to relocate operations to Bangladesh and Cambodia to enjoy preferential access andcheap labour.

(3) Vegetables and fruits: Contract farming
TNCs use contract farming in more than 110 developing countries and are involved in a diverse
range of agricultural products, including fruits, vegetables and tubers. Contract agriculture is a toolfor efficient procurement of agricultural products because TNCs can secure the necessary quantityand quality while leaving production in the hands of national producers. Where strong regulatory
frameworks exist, farmers can also secure stable prices and sales to improve their income. TNCs
demand high quality from contract farmers, and the latter can sell at prices higher than domestic
market prices owing to demand from richer consumers in developed countries. In addition, contract
farming also offers farmers the opportunity to acquire new information and technology by tradingwith TNCs.
Contract farming contributes extensively to employment as it is largely undertaken by large numbersof small-scale farms. This employment has a measurable impact on reducing poverty. Although
the total number of contract farms is hard to quantify, individual projects can have several tens of
thousands of participating farms.
Malaysia is among the countries that has experienced economic synergies from contract farming.
Contract farming has evolved rapidly across the world, both in terms of the spread of host-country
farmers and in terms of the nature of contractual relationships. In Malaysia, government promotionof contract farming strengthened with the Ninth Malaysia Plan of 2006–2010 with most farm
products exported through the Federal Agricultural Marketing Authority (FAMA) (box 7) (Malaysia,
2006). Through FAMA the government announced in 2014 the opening of 7,500 hectares of land
involving 4,500 farmers for contract farming.13 While Kaur et al. (2015) argue strongly that contract
farming helped raise farmers’ incomes in Malaysia, the growing deficit in agro-food trade suggests a
serious need to raise productivity in the industry. Also, unlike other sectors, NEMs are less prevalent
in agriculture as plantation agriculture (e.g., palm oil, rubber and cocoa cultivation) exports directly
to final markets. Nevertheless, contract farming in Malaysia has strong potential to not only help
stem the chronic food trade deficit the country has faced since 1989, but it can also expand further
export revenue.

13

Accessed on 06 April 2021 from https://www.thestar.com.my/news/community/2014/10/31/fama-targets-7500hafor-contract-farming

PA P E R 5 M A L AY S I A

17

Box 7. The Federal Agricultural Marketing Authority: Nationwide contract farming tofoster the agricultural sector
FAMA was one of the leading agencies that promoted the contract farming programme in
Malaysia under the Ninth Malaysia Plan (2006–2010), which was aimed at raising the annual
growth rate of the agriculture sector to 4.1 per cent. Previously the annual growth rate in this
sector had been declining since the 1970s.
The objectives of this programme were to provide guaranteed markets for farmers andincrease their income, enhance fruit and vegetable production, ensure quality agricultural
production while meeting market needs and improve technology transfer along the entire
supply chain (box figure 7.1).

Box figure 7.1. Mechanism of the contract farming programme in Malaysia

FAMA

1. Provision of infrastructure facilities
2. Market information for pricing
3. Advisory and consultancy of crops
and livestock• 50% of total production to FAMAor
• Financial advances not more than
20% of production to farmers
Contracted farmers• The rest of 50% will be marketed
through various sakes channels

Wholesale markets

Retailers

Agro-entrepreneurs

Exports

Some examples of the implementation of contract farming programmes in developing countries
exist. However, usually only the private sector is involved, unlike the Malaysian scenario where thegovernment is directly involved as the contractor or buyer of produce from smallholder farmers.
To measure the income generation of and satisfaction with the contract farming programme, FAMA
conducted face-to-face interviews with 107 contract farmers. The results of income transitionindicated that prior to the contract farming programme, the average total income of farmers forthe five years in 2008–2012 was only MYR4.7 million ($1.45 million). However, in the five years after
the contract farming programme was implemented, the farmers’ average total income increased
by 34 per cent to MYR7.1 million ($1.92 million) (box figure 7.2).

…/

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18

Box 7. The Federal Agricultural Marketing Authority: Nationwide contract farming tofoster the agricultural sector

Box figure 7.2. Total income before and after implementation of contract farming
through the FAMA programme (MYR)

8 000 000

6 000 000

4 000 000

2 000 0000Pre-contract farming

Post-contract farming

Source: Kaur et al. (2015).

Out of all the respondents, 74 per cent also expressed that they felt confident to continue withthe programme thus giving a positive indication about the effectiveness of contract farming in
improving the country’s food production. The success of this programme has attracted more small
farmers to take part. In 2014, the government targeted a total of 1,620 new players. Within halfa year, 55.6 per cent of the target had already been achieved with a total of 901 new participantsjoining the programme (Shadiya et al., 2017).
Agriculture has enjoyed a positive balance of trade largely because of the strong performance ofthe palm oil sector. Indeed, palm oil exports have been a major driver of export growth in Malaysia.14

As part of national initiatives to power integration and upgrading, the government introduced thecorridor development policy in 2008. Contract farming was one of the initiatives involved. This initiative
took on a transformational shift following the launching of Industry 4.0 in 2018. The application of
artificial intelligence through robots and drones and the broadening of the digital infrastructure hashelped raise yields in Malaysia. For example, the Estate Management Model (EMM) programme, astrategic partnership between estate farmers and stakeholders that centralises farm management
has helped to double the income of farmers via increased padi (or “rice field” in Malay) yield from anaverage of 4 to 6 tons per season using EMM1.0. EMM2.0 is targeted to raise yield further to 8 tonsof rice per hectare per season.15

14

15

Accessed on 06 April 2021 from https://www.miti.gov.my/miti/resources/MITI%20Report/MITI%20REPORT%20
2017.pdf
Free Malaysia Today (1 July 2019), “Malaysia: Investment Corridor Courts High Tech Contract Farming,” accessedon 20 March 2020 from https://www.freemalaysiatoday.com/category/nation/2019/06/27/good-times-ahead-forfarmers-in-the-north-as-ncer-plans-take-off/PA P E R 5 M A L AY S I A

19Despite significant improvements in farm productivity after the launch of the New Economic Policy in1971, productivity improvements have only continued in the export-oriented plantation sector sincethe 1980s (Rasiah, 2018). Figure 6 shows that Malaysia’s value-added share of gross output in thefood and beverages industry has remained significantly lower than that of Japan and the Republicof Korea. Consequently, the Government of Malaysia is particularly concerned that the worsening
trend of the trade balance in the food and beverages industry will continue. Inter alia, contract
farming, which has thus far emerged as an important strategy to promote NEMs in Malaysia, wasalso earmarked in the Tenth Malaysia Plan 2011–2015 (Malaysia, 2011).

Figure 6. Value-addedin gross output in the food and beverages industry, Japan, Malaysia
and the Republic of Korea, 1970–2015 (%)
50
45
40
35
30
25
20
15
10
5

94
19
96
19
98
20
00
20
02
20
04
20
06
20
08
20
10
20
12
20
14

92

19

90

19

88

Japan

19

86

19

84

19

82

19

80

19

78

19

76

19

74

19

72

19

19

19

70

0

Republic of Korea

Malaysia

Source: Data from UNIDO (2017).

(4) Hotels and resorts: FranchisingFranchising is a well-known channel in marketing and distributing products and services. The
formula is being applied to the retail industry, including high street retail stores, restaurants,
hotels, business services, education and various other business practices. In franchise agreements,
franchisers normally provide franchisees with various types of support for franchise business
operations. This support can include initial and ongoing support, training, management guidance,
marketing and administration and human resource advice.
The tourism industry in Malaysia has grown rapidly over the years, and with that the number ofhotels has also risen sharply in the country. Both the number of arrivals and receipts show a rising
trend from 21.0 million and MYR53.4 billion ($15.5 billion) in 2007 to 25.8 million and MYR84.1
billion ($20.8 billion) in 2018, respectively. Both eco-friendly and traditional hotels and motels havemushroomed in the country. These figures are expected to contract sharply in 2019 and 2020 owing
to the coronavirus outbreak, which has devastated the travel industry. The Government of Malaysia
has responded by reducing visa fees and special charges on hotels to reduce this damage.
Nine hundred hotels were registered with the Malaysian Hotels Association in 2018. The Ministry of
Tourism, Art and Culture and several state governments play an active role in promoting tourism in
Malaysia through advertisements all over the world.

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Table 3 shows typical hotel operations by type. Given that Malaysia is an upper-middle-income
country, Malaysians run the bulk of the hotels, and hence, foreign managers do not dominate
their top management. Thus, the hotels examined in this report are largely made up of franchise
agreements with foreign brand holders. In addition, booking companies play an important role inpromoting hotel bookings.

Table 3. Hotel operations by type
FDI

Management contract

Franchise agreement

Ownership of the land
and hotel

owns hotels

without ownershipwithout ownershipManagement control

direct control

direct leadershipby expatriates fromheadquarters

management training
through manuals

Contract fees

not applicable

tend to be higher(10% or more of profit)

lower(less than 10% of profit)

Promotion and support

booking arrangements

booking arrangements

booking arrangements

Scale and speed of
the hotel chain

slow, smaller scale

faster, medium scalevery fast, larger scale

Hotel categories

first stage of hotel chain,
five-star hotels,
independent type hotel

mostly four- and five-star
classmostly four- and five-starclass

Source: Adapted and expanded from Shinomiya (2016).

The following examines three hotels with various NEM arrangements: YTL Hotels (box 8), Berjaya
Hotels and Resorts and Shangri-La Hotels and Resorts. All three enjoy promotional support fromtravel agencies, such as Traveloka, Booking.com and Expedia. YTL Hotels and Berjaya Hotels andResorts use foreign brands through franchising with national management, while Shangri-La Hotels
and Resorts uses its own brands with management largely from Malaysia.

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21Box 8. YTL Corporation Berhad: Malaysian conglomerate ventures into Japanese market
YTL Corporation Berhad (YTL Corp) is the parent company of YTL Hospitality Real Estate Investment
Trust (REIT), owning a 70 per cent stake. YTL Corp is among the largest companies listed on Bursa
Malaysia Securities Berhad (the Kuala Lumpur stock exchange). YTL Corp also has a secondary
listing on the Tokyo Stock Exchange since 1996 and was the first non-Japanese Asian company
listed on the Tokyo exchange.
In 2011, YTL Hospitality REIT acquired nine additional hotel properties, one of which was Hilton
Niseko Village, previously known as Niseko Higashiyama Prince Hotel, in Japan.16 In August 2018,
Starhill REIT Niseko GK, a wholly owned subsidiary of YTL REIT entered into a purchase agreementwith Niseko Village KK to acquire The Green Leaf for JPY 6 billion.17
Since then, Niseko Village, owned by YTL REIT, has NEM agreements with the Hilton Niseko
Village (franchising) and The Green Leaf (management contract), both of which are situated in
Hokkaido, Japan, and operate under fixed lease arrangements, ensuring stable income for YTLREIT (box figure 8.1). Therefore, Japanese properties contributed 5 per cent of total revenue, or
MYR25.24 million ($6.1 million) in 2019.

Box figure 8.1. Business structure of YTL CorpYTL Corp
Distributions

70% stock holder
YTL Hospitality REIT

Net property income

NEM:
Franchised

Hilton Niseko Village

Wholly-owned subsidiary
Niseko Village KK

NEM:
Direct management

The Green Leaf Niseko Village

The Niseko region’s tourism industry (a well-known ski resort in Japan) continued to register strong
tourist numbers from Japanese visitors and many international tourists, mainly from China; Hong
Kong SAR, China and Taiwan Province of China. Due to this strategic trend of the investment portfolio
of YTL REIT, the organization’s assets in Japan grew to MYR530 million ($127.9 million) in 2019, 11
per cent of their entire assets that year and almost two times as much as in 2017 (box figure 8.2).
…/

16
17

Accessed on 14 May 2021 from https://www.ytlhospitalityreit.com/overview.asp
Accessed on 06 April 2021 from https://www.theedgemarkets.com/article/ytl-reits-niseko-village-buy-seen-goodearnings-visibility

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Box 8. Y
 TL Corporation Berhad: Malaysian conglomerate ventures into Japanese market(Concluded)

Box figure 8.2. Asset breakdown of YTL REIT by country
2017(MYR billion)
Japan, 0.27

2019
(MYR billion)
Japan, 0.53

Malaysia, 1.66

7%

Malaysia, 2.2

11%
43%

47%
42%

50%

Australia, 1.92

Australia, 1.95

Malaysia

Australia

Japan

Source: Accessed on 18 March 2021,
https://www.ytlesolutions.com/iims2/ytlcommunity/upload/financialreports/YTL-HospReit-AR-2019.pdf andhttps://www.ytlesolutions.com/iims2/ytlcommunity/upload/financialreports/YTL-HospReit-AR-2017.pdf.

Furthermore, in December 2017, Marriott International and the owner of Niseko Village YTL Hotels
announced an agreement for three new hotels at Niseko Village: the Ritz-Carlton Reserve and the
EDITION and W hotels.18
Overall, this case study shows that Japan is becoming a major investment target of Asian
conglomerates by utilizing foreign brand franchise and contract management, which are major
NEM approaches.

18

Accessed on 06 April 2021 from https://www.niseko.ne.jp/en/news/niseko_village_signs_new_hotel_agreement_
with_marriott/

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23

2.2 NEMs by modalities
Table 2 illustrates the different NEM modalities and their significance in Malaysia. Each modality
varies with the industries specified. Table 1 summarizes the main industries where NEMs have
evolved in Malaysia.
Several foreign firms and TNCs are doing business with local partners under NEMs in various
industries in Malaysia. How they are involved in NEMs and FDI and their contribution to the Malaysian
economy vary by modality and industry (table 4).

Table 4. Outsourcing and offshoring by activity type
Location
Mode
ControlHome

AbroadInternal (equity)

Domestic operation

Captive offshoring

External (non-equity)

Outsourcing

Offshore outsourcing

Source: AJC.

The development of the Malaysian electronics industry started when Matsushita established thefirst assembly plant in 1965 in Shah Alam. Big component firms subsequently relocated starting in
the early 1970s to take advantage of low wages, good basic infrastructure and political stability andsecurity to relocate operations to Malaysia. U.S., Japanese and European firms such as National
Semiconductor (United States), Advanced Micro Devices (United States), Hewlett Packard (UnitedStates), Intel (United States), Clarion (United States), Hitachi (Japan) and Siemens (Germany) werethe earliest to start production in Malaysia. While the foreign-led electronics industry drove exportoriented manufacturing in Malaysia, the industry also evolved local suppliers that have become
internationally competitive as subcontract manufacturers (Rasiah, 1995).
Similarly, the textiles and apparel industry grew rapidly from the 1960s, but especially in the 1970s
when giant Japanese firms relocated polymerization, texturization, spinning and weaving activities in
Malaysia. Hong Kong and Taiwanese firms subsequently expanded operations. Penfabric, Penfibre,
Kanebo, Eastern Knitters and Pen Apparel are some of the major foreign, particularly Japanese,textile firms operating in Malaysia. The expansion of textile manufacturing helped support NEM
firms to emerge, and several eventually became internationally competitive subcontract apparel
manufacturers such as South Island Garment.

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3. OPPORTUNITIES AND CHALLENGES
Although Malaysia is an upper-middle-income country, its economic activities are largely confined
to low and medium value-added activities. This section analyses the opportunities and challenges
Malaysia faces in promoting and utilizing NEMs. Industries will face and benefit from several
opportunities and challenges by establishing NEM agreements with TNCs (figure 7; table 5).

Figure 7. Opportunities and challenges for NEMs in Malaysia

Local companies

Agreements between
TNCs and local firms
through NEMs

TNCs

Opportunities

Challenges
Subcontracting
Electronics industry

Non-equity modalities in Myanmar

Integration into export markets
Upgrade in value chains
Employment creation

Serious need to raise human capital
Stiff competition
Strong research universities
required for R&D

Contract farming
Agriculture
Raise self-sufficiency
Generate exports

Competition from imports
Scarce arable land

Subcontracting
ApparelIntegration into export markets
Upgrade in value chains
Employment creation

Stiff competition from low-wage sites
Lack of workers
Back-integration into synthetic fibres
requires R&D

Franchising and management contract
Hotels and resorts
Foreign brand holders undertake
marketingForeign firms help expand bookings
Opportunity to enhance local
employment and management

Source: AJC.
Note: Major industries only.

Large local investment required
Franchise maintenance requires
strong standards and quality staff

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Table 5. Opportunities and challenges for local firms engaged in NEM
Opportunities

Typical industries

Challenges

Electronics
ApparelContract farming

NEM firms are vulnerable totermination of contract agreements,and long-term agreements are
seldom available. Also, major lowcost competitors in contract farming
exist in Cambodia and Lao PDR.

Electronics
ApparelHotel

Difficult to sustain when demands
and markets are outside the country(e.g., customers of electronics,
apparel and contract farming
products).
Demands of buyers may change
depending on the interest andtaste of their clients (e.g., changes
in trends in tourism destinations,apparel markets, cash crops). The
coronavirus pandemic threatens tochange this further.

ApparelHotelContract farms

Not easy for local firms to build
further capacity apart from receiving
orders from customers, as they atmost only receive relevant know-how(e.g., upgrading value chain activities
only by local firms’ efforts is difficult).

Continuity problems
Easier to find TNC partners both inand outside the country through, forexample, matching events (because
TNCs do not invest directly in thebusiness).
Characteristic issues of NEMs
Easier to enter a new market or new
area even though demands are notpresent in the country. Skills, talentsor resources, which are available but
not required in the country can be
usefully utilized outside the country.

Capacity-building issues
Easier for local employees to workin apparel firms, hotels and contract
farms.

Initiatives and local embeddedness issues
Local firms adopt to foreign design
and management and do not needto think local values and localization
strategy (quicker for local firms
to make profits by using the TNC
business model).

Electronics
ApparelHotel
Local farmers could
eventually own thetechnology and become
independent

Local firms may lose own initiatives,
design ability and traditional values,
apart from designing for limited
products. (e.g., local firms may
follow TNC business models in
the electronics industry and hotelindustry as they do not need to
implement a localization strategy).

Source: AJC.

Much of Malaysian rapid economic growth was initiated under foreign aegis, starting with tin mining
and rubber, which became large-scale operations under colonial rule from the 19th and early
20th centuries (Kim, 1997). From initially import-substitution activities in the 1960s, the nascent
independent government promoted export-oriented industrialization through the opening of Free
Trade Zones and Licensed Manufacturing warehouses in the early 1970s. EE and textiles and apparelbecame major industries driven by foreign TNCs. While government focus on local agriculture started
in the 1960s and intensified in the 1970s and the 1980s, local manufacturing received a major push
starting with the introduction of the Look East Policy in 1981, which was largely oriented to imitate
the Japanese and Korean experiences (Jomo, 1985). Heavy industrialization and large-scale projects

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through technology tie-ups with Japanese and Korean firms expanded into automobile, cement,
steel and highways from the 1980s. However, this initiative lost steam as a cyclical downturn in theelectronics industry, falling commodity prices and a rising real effective exchange rate undermined
the Malaysian economy, which for the first time contracted in 1986.
The government responded by devaluing the ringgit and offered generous financial incentives
to attract Japanese, Korean, Taiwanese and Singaporean TNCs that were seeking to relocate
operations following the appreciation of their currencies after the Plaza Accord of 1985 and thewithdrawal of the Generalized System of Preferences from the newly industrialized countries in1988. Consequently, foreign capital in Malaysia began to rise again, which by the 1990s had started
to cause overheating owing to labour shortages and infrastructure bottlenecks (Rasiah, 1995). The
government took the initiative to stimulate technological upgrading, launching the Action Plan for
Industrial Technology Development. Key science, technology and innovation (STI) parastatals weredeveloped: for example, the Malaysian Institute of Microelectronic Systems was corporatized, andthe Human Resource Development Fund, the Multimedia-Media Development Corporation, theMalaysian Technology Development Corporation, the Multi-Media Super Corridor and Malaysia,
Industry, Government, High Tech were launched in the 1990s to provide the STI infrastructure tosolve firm-level collective action problems related to technological upgrading. The government also
started to offer R&D grants in 1991, although foreign TNCs were not allowed to access it until 2003.
Initiatives were taken to consolidate SMEs for their own growth and to strengthen linkages between
them and foreign TNCs (Rasiah, 1995).
The government launched a purposive policy to support SMEs in 2008 within the regional corridors
based on natural and evolved endowments. The policy was targeted to complement and integrate
SMEs by adding the missing components and synergizing them with incentives. The comprehensive
intersectoral development plans, which included the Northern Corridor Economic Region, theEast Coast Economic Region, Iskandar Malaysia in Johore, the East Malaysia corridors, the Sabah
Development Corridor and the Sarawak Corridor of Renewable Energy, were to provide the building
blocks for Malaysia to reach a developed status by 2020 (Malaysia, 2011; Rasiah and Gopi, 2020).
However, a combination of the 2007–2008 global economic crisis and a lack of technological upgradingslowed down economic growth, leading the government to defer its developed status target to 2030
through the Shared Prosperity Vision, which additionally sought to lower economic inequality in the
country (Malaysia, 2019). The Government of Malaysia launched three more major support policies
to stimulate the economy: the Eleventh Malaysia Plan 2016–2020, National Transformation 2050,
and Industry 4.0 Policy 2018. As an upper-middle-income country, the country is equipped largely
with global basic infrastructure, including transport and telecommunication systems, access to
education and health care with policies in place since 1991 to develop its STI infrastructure (Malaysia,
1991). Efforts to strengthen NEM modalities should act as a critical vehicle to achieve the goal of
becoming a developed nation and to achieve the country’s sustainable development targets. Hence,
this provides recommendations on how to synergize NEMs to achieve national policy goals.

3.1 Local capabilities
Linking up with TNCs’ global value chains as suppliers through the operations of local firms will
help realize far more profits in the country than would the direct operations of foreign TNCs, but thisalso presents challenges.
TNCs typically make decisions on whether to produce in-house or to subcontract out based on
many factors. One key factor is the existence or potential emergence of competent suppliers. TNCs
are likely to contract out to local firms if they benefit economically from outsourcing relative toPA P E R 5 M A L AY S I A

27

producing supplies in-house. Such contractual arrangements can benefit host countries as mostof the profits arising from such operations are most likely to stay within the host country. Thus,
potential opportunities exist for national firms in apparel, IT and hotel businesses, and in otherindustries, to have contractual agreements with TNCs. However, local firms can only take effective
advantage of such opportunities if they acquire and develop the requisite capabilities to participate
in such contract relationships. Such capabilities include management, inventory and quality control
systems and production technology. There will also be a pressing need to sustain rapid technologicalupgrading among national NEMs for them to remain connected to global value chains and to enjoy
movement to higher value-added activities. This is how Malaysian EE firms retain their contracting
businesses with foreign TNCs. Also, unless national NEMs succeed in remaining competitive, forexample in hotel franchising, TNCs will switch suppliers or terminate their brand licensing. NEMs
are often vulnerable to the vicissitudes of volatile demand fluctuations. In industries such as theapparel industry, TNCs often engage a few suppliers simultaneously so that orders from successful
upgrading firms can be stepped up to cover for orders terminated by poorly performing firms.

3.2 Relationships between NEM modalities and industries
As Section 2 shows, NEM modalities differ by industry and in some cases by the host country involved.
Malaysian EE and textiles-apparel industries have strongly evolved to have OEM capabilities, andseveral sell to TNCs in Malaysia and export abroad. In EE there is a different range of modalities
in Malaysia. TNC-owned subsidiaries still dominate in semiconductor manufacturing, but local
NEMs, such as Globetronics Technology, Carsem, Unisem and ViTrox have evolved to export. Thesesubsidiaries largely emerged from offshore outsourcing by foreign TNCs. This type of modality
creates opportunities for local employees to be integrated into the business activities of both local
NEMs and TNC subsidiaries. However, it does not provide opportunities for capacity building in
local firms. Initiatives to upgrade NEM firms beyond OEM to participate more in original design
activities will be important to sustain value-added increments. Local NEMs have experienced
considerable technology transfer in both industries from U.S., Japanese, European, Korean andTaiwanese firms. TNC affiliates also have a modality via captive offshoring, which is done through FDI(non-NEM) operations, but it will be potentially good for the Malaysian government to stimulate
more NEMs especially among SMEs. Being a complementary industry that supports all industries,
it is pertinent that the government promotes local IT firms that can then connect with TNCs
located abroad.
Different types of modalities are also linked to the hotel industry. Most brand holders in the hotelindustry use management contracts and franchising modalities. Several five-star hotels are owned
by local owners in Malaysia. Exceptions include the Shangri-La Hotel, which is owned by Robert
Kuok from Singapore. The management contract and franchising modality should be promoted as
foreign brand holders have demonstrated strong global marketing capability to attract tourists bothto Malaysia and to their hotels worldwide. Berjaya Hotels and Resorts and YTL use the brands of
JW Marriot and Hilton in several parts of the world. Foreign booking companies, such as Traveloka,
Booking.Com and Expedia have played important roles in expanding the customer base for Malaysian
hotels. However, because brand holders impose stringent conditions to protect their brands, local
owners must maintain high operating standards to remain attractive to the brand holders. Indeed,throughout ASEAN, management contracts and franchise agreements are typical modalities that
TNCs engage in, though some hotels are also owned and managed directly by foreign hoteliers (e.g.,
Shangri-La). Capitalizing on tourism synergies from the promotion of NEMs in the hotel industry
will also require that the government improves infrastructure (including IT support) and security
throughout the country.

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3.3 Ownership and control
Although foreign firms have no direct ownership in NEMs, foreign firms often control the operationsof NEMs. Such control can take the form of buyer firms dominating pricing decisions, assessmentof quality and determination of lead times. In apparel manufacturing, for instance, buyers determine
even the suppliers of inputs under the arrangements by CMP Products Ltd. Under free (or freight)
onboard operations NEMs have the autonomy to determine such sources but are completely reliant
on buyers with respect to lead times, specs used and materials sourced. Although local firms in
Malaysia have climbed the value chain, most still specialize in low value-added and OEM activities.
Globetronics Technology, Carsem, Unisem and ViTrox are examples of Malaysian firms that operate
as OEMs. Such modalities should be expanded to raise foreign exchange (Rasiah, 2020).
Similarly, in the hotel industry, franchise holders determine the terms and conditions under which
NEMs must operate, though several Malaysian companies, e.g., Berjaya Hotels and Resorts and
YTL, enjoy the experience and technological capabilities to function almost horizontally with foreign
franchise holders, such as JW Marriot and Hilton. The positive side of these conditions includes thepressure TNCs impose on NEMs to upgrade, though NEM firms that remain suppliers will always
be exposed to contract termination whenever TNCs are dissatisfied with their supplies or if morecapable suppliers emerge. Such circumstances often arise when TNC operations evolve to highvalue-added activities that require their suppliers to also upgrade. They can also emerge if the TNCs
find supplier bases in other countries to be more efficient. Nevertheless, NEM firms that catch thewave of competition major export markets offer to upgrade enjoy the opportunity to climb the value
chain and, in some cases, such as in the Republic of Korea and Taiwan Province of China, to leapfrog
incumbents. Samsung and Taiwan Manufacturing Company now lead the memory and logic chipvalue chains with late start of operations in 1975 and 1987, respectively (Rasiah et al., 2015; Yap andRasiah, 2017).
If the buyer subsidiaries of TNCs are in the host country, the control that TNCs exert can be stronger
than otherwise. In some cases such TNCs not only will train the workforce of the host country’s
NEM suppliers, they also often invest in skills development centers to develop the host country’s
human resources or implement rooting strategies for their own expansion (Rasiah, 1995). The
host government often plays a leveraging role to initiate and coordinate such developments. The
Economic Development Board of Singapore and the Penang Development Corporation successfully
played such a role (Rasiah and Yap, 2019, 2016a, 2016b). Also, this is how TNCs got together to jointly
finance the Penang Skills Development Center in 1989, which experts view as a world-class training
center (Rasiah, 1995). The EE and textiles and apparel industries in Malaysia have also benefitted
from adapting such a framework.
Given that linkages with foreign TNCs can never be taken for granted, local NEM firms musttake advantage of opportunities to launch new businesses, which will then stimulate sales
growth, job creation and exports. Governments often initiate promotional mechanisms to support
entrepreneurial synergies both in rich and in poor countries. Malaysia already has excellent basic
infrastructure in the Western corridor, and plans are already being implemented to develop similar
highways in the Eastern corridor and the Borneo corridor. In addition to basic infrastructure,
governments also need to develop the STI infrastructure needed to stimulate entrepreneurial
synergies. The Malaysian government initiated significant efforts to develop the STI infrastructure
starting in 1991 following the launch of the “Way Forward”. However, the government needs torethink its governance framework to synchronize the link among firms, start-ups, organizations,policy instruments and human capital to stimulate strong economic synergies from its scienceand technology parks and universities.

PA P E R 5 M A L AY S I A

29

3.4 Localization strategies
ASEAN governments have often launched localization strategies when foreign TNCs engage inmanufacturing for the domestic market. This is how Indonesia, Malaysia and Thailand initiallypromoted local suppliers in the automobile industry (Rasiah, 2009). However, such initiatives havebeen rationalized since the launch of the ASEAN Free Trade Area in 1992 and the establishment of
the World Trade Organization in 1995. Nevertheless, governments can still promote linkages withlocal NEM firms without infringing on the trade-related investment measures instrument of theWorld Trade Organization, which prohibits differential trade treatment based on national ownership(Rasiah, 2005). Linkage strategies can ensure that the government can use its bargaining strength
to impose conditions for TNCs to train national workers and to source from capable NEM firms,
especially when the TNCs enjoy incentives or benefit from sales in the domestic market in Malaysia,
such as poultry supply by Ayamas to KFC. The apparel, hotel and related industries can be targeted forthe development of NEMs as suppliers, which can then also export once sufficient capabilities havebeen developed. However, the challenges include the need to stimulate human capital development
and for local firms to undergo massive technological upgrading to meet international standards.
Several Malaysian apparel firms have successfully won contracts to manufacture and deliverproducts to the big stores (e.g., Walmart, JC Penney and H&M) in developed countries. Similarly,
foreign TNCs can outsource a part or the whole of several other goods or services, or even part oftheir GVCs to Malaysian local firms when the government uses its leverage to call for localization.
Globetronics Technology, Carsem, Unisem and ViTrox have the potential to upgrade further in theirvalue chains. Also, TNCs supplying the domestic market may also seek NEM suppliers to reducetransport costs and effectively coordinate the implementation of just-in-time inventory control
systems. For this reason foreign TNCs have evolved proximate suppliers in the automobile industry,though unless local capabilities are developed foreign suppliers often fill the void. In the apparelindustry, Malaysian NEM firms can back-integrate into fibre manufacturing and introduce Industry
4.0 technologies to improve quality, eliminate defects and lower unit costs. That way the apparelindustry can build stronger backward linkages right up to polymerization, texturization and theharvesting of synthetic and mixed fabric. Local NEM firms should take initiatives independently tointegrate their operations and activities with the overall production networks of TNCs and GVCs.

4. POLICY IMPLICATIONS
Although the protectionist forays in many parts of the world and the coronavirus outbreak in 2020 havedampened trade and economic growth worldwide, the attempt to strengthen trading ties in ASEAN
promises to enhance the role that NEMs can play in the newly emerging trading system. ASEAN
countries, including Malaysia, are introducing fiscal stimulus to mitigate the economic damage
from the coronavirus. These developments suggest that TNCs can be provided with opportunities tocontinue to facilitate trade around the world. NEMs then can help increase the value added enjoyedat host sites as trade grows. The deep integration of Malaysia into global trade particularly sincecolonialism and subsequently following the introduction of export-oriented manufacturing in 1971
enables the country to benefit from strong economic synergies from more open trading initiatives.
Furthermore, because firms owned fully or jointly by local and foreign TNCs rely on export markets,
they have been the most vulnerable to external shocks, such as those experienced by Malaysia, thePhilippines, the Republic of Korea, Singapore, Taiwan Province of China and Thailand during the30

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global financial crisis of 2007–2008. Consequently, it is prudent for countries highly integrated into
external markets to organize their macroeconomic (both monetary and fiscal) policies to face suchrandom crises. These countries learned from the 1997–1998 Asian financial crisis to keep their
non-performing loans low and to limit their exposure to external debt (Rasiah, 2001), which in turnhelped them minimize the damage caused by the global financial crisis of 2007–2008 (Stiglitz, 2010).
Nevertheless, because TNCs often repatriate their profits back to home countries, local NEM firms canhelp reduce the wholescale repatriation of profits as they are nationally owned firms. The developmentof resilient NEM firms will also help widen the reservoir of domestic capital for national expansion.
Hence, government policy should strongly consider the promotion of NEMs as a critical economic
growth strategy. The government can focus on the following broad institutional changes.

4.1 Enhancing capabilities of local firms
Several local firms and plantations have grown to at least undertake original design products in
manufacturing and original brand activities in agriculture. However, most firms and farms, especiallySMEs, still languish in the lower rungs of the technology ladder. Consequently, the capabilities of
local firms in both technological and management skills should be enhanced so that they can meetthe current and potential demand of TNCs and to eventually export directly. Once these necessary
capabilities have been attained, they can have more business initiatives or autonomy in theiroperations; they can find potential customers through networks; and independently from TNCs interms of autonomy or initiatives, local firms can then create their own business activities in the longrun. The government needs to support the development of the overall capabilities of local firms at
the individual firm level and at the industry level. At the individual firm level, the government can:• Strengthen the Human Resource Development Fund, launched in 1993. The Fund requires
manufacturing firms with more than 50 employees to contribute 2 per cent of their payroll, which
they can then reclaim using approved training receipts, to be complemented with the upgradingof technical and vocational education training and skills development centres in the country. The
Penang Skills Development Center is an exception here as it focuses on cutting-edge skills training
promoted by TNC members. SMEs with fewer than 50 employees are given double tax exemptions
on approved training receipts, but the take-up has been low, suggesting the need to introduce
complementary measures to raise its incidence. The Ministry of Human Resource Development
should assist by anticipating and coordinating changes in skills required from structural change.
• Establish a business advisory centre as a complementary body in the Small and Medium Industries
Board. The organization hosts experienced managers and members from various ministries where
local firms can learn NEM operations or activities. Local firms need to be aware of the big picture ofchanges or future demand in the industry rather than focusing solely on their current operations.
The government can support this by connecting individual firms—horizontally and vertically—in
the industry. The centre should cover all aspects of NEM establishment: forming, executing andevaluating contracts and increasing knowledge about NEM operations and recommending foraccess to preferential funds.
• Create a conducive environment for local firms to facilitate their globalization and localization
strategies. Local firms need to familiarize themselves with the changing strategies of TNCs to
be able to connect and evolve in their value chains. NEM firms need to learn their customers’
strategies, e.g., understanding the buyers, sellers and organizations supporting their activities.
Therefore, the government can offer support for different types of strategies in the different
industries at the individual firm level, without just focusing on the overall industry level.

PA P E R 5 M A L AY S I A

31At the industry level, industrial or business associations and the government can jointly support:• Creating a better environment for competition and cooperation so that NEM industries can become
more competitive internationally. This can be between local and foreign firms and between local
SMEs and large firms. The presence of TNCs can bring both the competition and demonstration
effects to raise the technological capabilities and competitiveness of local firms, be they smallor large.
• Promoting local firms to gradually upgrade within GVCs, which is necessary as shifts in demandby TNCs and changes in the GVC of TNCs are mostly due to TNCs driving toward cost reduction
and improvement of quality and shorter lead times. The government can promote upgrading of
local firm capabilities explicitly through support for innovation and technical upgrading activities.
Only then may NEMs be able to sustain their partnership with foreign TNCs. This would require thelaunching and upgrading of the STI infrastructure in the country.
• Implementing innovation policy for local firms to encourage and protect technologies required
to perform as NEM operators. While the country has paid attention to innovation policy andintellectual property rights, room exists for further improvement.

4.2 Strengthening basic infrastructure
The government should strengthen the four pillars of the systemic quad (table 6) simultaneously
to attract TNCs and to encourage them to upgrade. Malaysia generally enjoys excellent basic
infrastructure, especially in the Western Corridor of Peninsular Malaysia. Internet connectivity in the
country rose from 71 per cent in 2015 to 80 per cent in 2017 and 81 per cent in 2018. Its mobile
subscription rate was 134.5 per 100 people in 2018 (UNESCO, 2020). However, for NEMs to thrive in the
Eastern Corridor and East Malaysia the government must strengthen the basic infrastructure—thefirst of the four systemic pillars—where these firms would potentially locate. The states of Sabah andSarawak also lack adequate provision of power supply and water in remote areas. Contract farming inthese states would benefit strongly if NEMs can enjoy low cost and quick access to essential services.

Table 6. Critical pillars of the systemic quad
Basic Infrastructure

STI Infrastructure• Provision of water, power, roads andtelecommunications• Provision of financial needs• Customs coordination• Security• Health care
• Basic education• Technical and vocational training• University education and research• Skills development centres• Standards organizations• R&D incentives, grants and centres• Intellectual property rights• Science and technology parks• Venture capital

Network Cohesion(Connectivity and Coordination)

Integration in Global Factor
and Final Markets• Between firms and suppliers and buyers• Between firms and basic infrastructure• Between firms and high-tech infrastructure• Between firms and intermediary organizations andcustomers• Integration with input and product markets globally• Integration with knowledge nodes globally• Human capital suppliers• Research universities• Integration in GVCs

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32

4.3 Strengthening science, technology and innovation infrastructure
While an efficient basic infrastructure is important to raise efficiency levels of firms, STI infrastructure(the second systemic pillar in table 6) is critical to stimulate firms’ participation in innovative activities.
Several science parks equipped with incubators sprang up in Malaysia in the 1990s (Malaysia, 1996,
2001). However, none of these incubators has produced tangible commercialization in the country.
Although Singapore and Taiwan Province of China are significantly more developed economies,
science parks specialized in ICT and biotechnology have played major roles in the upgrading of firms(Rasiah, 2020). Figure 8 shows a stylized model for Malaysian policy makers to consider in reshaping
the country’s current national innovation framework.

Figure 8. Institutional framework to support industrial upgrading

Existing stocks ofembodied knowledge(manuals, machinery,
humans, methods andorganization, irrigation,
drainage and species),
foreign and domestic

Organizations(universities, training
centres, technical andvocational schools,
R&D labs and businessadvisory centres)

Creative imitation(incremental innovation)

Science and technology parks

Radical innovations

Firms, farms and organisations

Source: Rasiah (2020).

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33Through the Eleventh Malaysia Plan 2016–2020, the government continued to emphasize R&D
but prioritized the translation of innovation to wealth by strengthening relational capital to foster
stronger linkages, collaboration and trust among stakeholders (Malaysia, 2016). In doing so, thegovernment sought to meet the national STI policy target of achieving a gross expenditure on R&D
of at least 2.0 per cent by 2020.
The government subsequently launched the National Transformation Policy 2050 in 2017 targeted atusing science and technology to transform the national economy with the policy taking effect from2020 and to be achieved by 2050 (Malaysia, 2017). The blueprint focused on making the Malaysian
economy advanced and sustainable. Given its upper-middle-income status, both incremental andradical innovations will be critical for Malaysia to achieve the goals set out in the Eleventh Malaysia
Plan (Malaysia, 2016), the National Transformation Plan 2050 (Malaysia, 2017) and the Industry 4.0
Master Plan (Malaysia, 2019).
In addition to assisting the local community to address critical problems, the government mustrejuvenate science parks as incubators, which are critical to scale up innovations and to adapt
existing stocks of knowledge for innovation. Linking science parks with national universities andpublic laboratories, and with industry, will be important to stimulate technological upgrading in NEM
firms. Such essential knowledge support will not only ensure NEM firms meet the market demandsof contracting local firms and TNCs, it will also offer them the opportunity to raise value added.

4.4 Promoting connectivity and coordination
The co-location of organizational support for NEM firms is insufficient to stimulate technologicalupgrading. Connectivity and coordination between the basic and STI infrastructure organizations
and with NEM firms must be strengthened (the third systemic pillar in table 6). Whereas emphasison basic infrastructure will offer firms efficient business practices with short lead times and low
costs, the development of STI infrastructure—science parks, industry-university linkages, standards
organizations, quality technical and skilled workers and university graduates—will help stimulateinnovation synergies in firms. The latter is critical for NEM firms to upgrade technologically so thatthey can participate in high value-added activities in GVCs.
The government should form a one-stop agency like the Economic Development Board ofSingapore, which should promote investment and establish and increase interactions among firms,
organizations and government agencies responsible for providing basic and STI infrastructureservices. Basic infrastructure includes security, transport networks and customs control. The
broader human resource development organizations, such as schools, technical and vocational
education and training institutes and universities should also be connected with firms so that a twoway flow of demand-supply coordination exists between them.

4.5 Promoting integration into regional and global markets
External markets offer scale and scope opportunities and competition and learning effects for NEMs
to upgrade and operate with the highest possible efficiency and quality. Malaysia largely enjoys
excellent trade linkages in the global economy. Whereas such linkages are good when involving
large NEM firms, most local SME NEMs in Malaysia have yet to integrate with the global economy,
establish links with R&D labs and incubators and establish a sufficiently networked set of links withthe knowledge nodes in the Malaysian innovation system to take effective advantage of innovation
synergies. Thus, local Malaysian SME NEMs should be integrated into ASEAN, East Asian and global

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markets (the fourth systemic pillar in table 6). The ASEAN Economic Community offers low to zero
tariffs in almost all product lines for regional ASEAN firms.
The government can offer double deduction tax incentive on expenditures incurred on exported valueof firms, while seeking ways to lower transaction costs involving export and customs procedures andprovide preferential interest rates on loans to SME NEMs. The government can also include thesefirms in their international exhibitions to promote exports.

4.6 Mainstreaming sustainable development
Given the focus on sustainable development advanced by the United Nations, government initiatives
should shape the conduct of NEM firms to mainstream the 17 United Nations Sustainable
Development Goals, particularly climate change and the environment (goal 13) and workers’ humanrights (goal 8).
Climate change has become important in bilateral and multilateral trading relationships. Malaysia
is a signatory to the Paris Accord of 2015 and has submitted its Intended Nationally Determined
Contribution to the United Nations Convention for Climate Change, which agrees to shift torenewable energy to account for 45 per cent of overall energy consumption by 2030. The ministryin charge launched three large-scale solar projects to first raise the share of renewable energy to
20 per cent by 2025 from 5.2 per cent of total energy consumption in 2015 (Malaysia, 2019).19 The
Ministry of Science, Technology and Innovation was, inter alia, renamed as the Ministry of Energy,
Science, Technology, Environment and Climate Change (MESTECC).
In addition, the Sustainability Energy Development Authority began implementing the MySuria
programme, which aimed to install 1,620 homes from the bottom 40 per cent of income earners
with 3 kW solar photovoltaic systems by 2018. Furthermore, MESTECC implemented a campaign in2018 to eliminate the use of plastics and to scale down or stop all new dam construction projects
to check deforestation and landslides. Following a change in government again in 2020, MESTECC
was divided into three ministries to address the environment, energy, and science and technology
separately.
On labour, the government has ratified most covenants of the International Labour Organization(ILO), including minimum wages and freedom of association. However, Malaysia has yet to sign
the broader International Convention on the Elimination of All Forms of Racial Discrimination.
Nevertheless, NEM firms allow the unionisation of workers and freedom of association, among otherthings. Contract farming organizations should also observe the standards imposed as conditions
by TNCs and other buyers. Similarly, established hotel brands also require their hosts to observe
such standards. Such monitoring by developed country buyers has increased over the years. Manysuch monitoring systems use telemonitoring with buyers viewing at any time the production flow in
NEM firms. According to the United Nations (2011), due diligence on human rights “should cover
adverse human rights impacts that the business enterprise may cause or contribute to through its
own activities, or which may be directly linked to its operations, products or services by its business
relationship” (p. 17).

19

The first low sulphur fuel surcharge (LSS) resulted in the approval of 66 contractors to install solar panels togenerate 1,228 MW capacity of energy supply. The second LSS offering of 563 MW capacity was launched in 2018
and was expected to be fully operational by 2020 (accessed on 27 May 2021 from https://www.pv-tech.org/malaysiaannounces-winners-of-second-lss-solar-auction/). The third LSS was approved with solar capacity to establish
500 MW capacity in February 2019 (accessed on 29 February 2021 from https://www.thestar.com.my/business/business-news/2018/04/11/malaysia-awards-1228mw-projects/).

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35Within the overall policy framework of NEMs articulated previously, the Malaysian government should
consider evaluating NEMs or NEM-related operations in the country from time to time. Assumingthat no such evaluation methodology is available, AJC proposes the following checklist (table 7).
This proposal is based on the corporate code of conduct by the Tokyo Chamber of Commerce andIndustry, adapted with some alterations. It provides some hints for the government to check NEM
agreements and their operations.

Table 7. Checklist for NEM agreements and operations to maximize benefits from andminimize costs of NEMs
Whether there is an agreement on contract performance
Whether there is an agreement on contract terms (durations)
Compliancewith laws

Whether there is an agreement on contract termination and its
process
Whether there is an agreement on contract arrangement(additional contract) and its process
Whether there are rules on non-discrimination (ILO covenant)Whether there are rules on basic human rights

Respect for humanrightsWhether there are rules on harassment (power balance between
local NEM firms and TNCs)
Whether there are rules on freedom of association (ILO covenant)Whether there is minimum wage legislation (ILO covenant)Whether there are rules against forced labour (ILO covenant)Whether there are rules against child labour (ILO covenant)Whether there are guidelines on air pollution by local NEM firms

NEM policy by
the Malaysian
government

Whether there are guidelines on water contamination by local
NEM firms
Environmental
consideration

Whether there are guidelines on environmentally friendly goods orservices by local NEM firms
Malaysia submitted its Intended Nationally Determined Contribution
milestones to the United Nations Framework Convention on Climate
Change policy in 2016. It seeks to achieve 20 per cent renewableenergy by 2025 and 45 per cent renewable energy by 2030.
Whether there are employment rules (laws) on ages under the NEM
agreement
Whether there are employment rules (laws) on gender under the
NEM agreement
Whether there are guidelines on a safe and pleasant work
environment for local NEM firms

Work environment

Whether there are employment rules (laws) on working
environments under the NEM agreement
Whether there are employment rules (laws) on working conditions
under the NEM agreement
Whether there are employment rules (laws) on working hours under
the NEM agreement
Whether there are employment rules (laws) on taking holidays under
the NEM agreement…/

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Table 7. Checklist for NEM agreements and operations to maximize benefits from andminimize costs of NEMs (Concluded)
Whether there are employment rules (laws) on treatment of absence
under the NEM agreement
Work environment

Whether there are employment rules (laws) on maternity-related
leaves under the NEM agreement
Whether there are guidelines on provision of support system ofchildcare and nursing care
Whether there are employment rules (laws) on terminating
employment contracts under the NEM agreement
Whether there is a programme that local NEM firms can take toimprove their technology/capacity

For local firms’
development
NEM policy by
the Malaysian
government

Whether there is a programme that local NEM firm employees can
learn
Whether there is a programme that local NEM firms can take tounderstand NEM policy
Whether there is a programme that local NEM firms can take tounderstand the business environment of the industry

Subcontractors/
suppliers

Whether there are guidelines for similar NEM policies for local
subcontractors/suppliers

Earning the trustof customers andconsumers

Whether there are guidelines for TNCs to provide correct informationon their products or services
Whether there are guidelines for TNCs to respect free and fair-trade
rules

Mutual growth withpartner companies

Whether there are guidelines for TNCs to provide relevant
information required for trade
Whether there are guidelines for TNCs to develop relationships
based on trust with local NEM firms

Whether there are guidelines for TNCs to establish and maintain a
Coexistence with local
good relationship with the community where local NEM firms arecommunities
locatedSource: Adapted from Tokyo Chamber of Commerce and Industry (2013).

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37

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