During this time, Malaysia also successfully preserved social harmony in its multiracial society, relying on economic openness to sustain growth under an expensive affirmative action program that skewed incentives, the New Economic Policy (NEP). In this sense, the NEP performed an important signalling role and played its part in delivering the peace and stability that enabled Malaysia to sustain high growth. This growth, combined with revenues from large oil reserves, facilitated a massive tax-transfer scheme that favoured the majority, without significantly eroding macroeconomic stability.

But all that changed after the Asian financial crisis. FDI flows fell sharply and continued to remain low even after recovery. While foreigners continue to shun Malaysia, even domestic investors seem to have fled, with Malaysia becoming a net exporter of capital since 2005. Malaysia continues to grow, but without private investment it is unlikely to break out of the middle-income trap. Indeed, these days Malaysia is often discussed as a classic case of the middle-income trap. Growth without private investment is also unsustainable and Malaysia risks sliding back.

What happened and can it be fixed?

The investment malaise can be attributed to two interrelated factors: distortions introduced by the NEP and its subsequent policies, and the widespread presence and overbearing influence of government-linked corporations (GLCs) that deter private investment. While the impacts of both factors may have been masked during the heady days leading up to the Asian financial crisis, this is no longer the case in the current competitive environment, where residency options for both capital and skilled labour are much greater. Fixing the problem requires addressing the distortions of the NEP and curtailing the influence of the GLCs.

The NEP is now past its use-by date. Many of Malaysia’s economic problems, including the slump in private investment, are rooted in the distortions resulting from the workings and implementation of the NEP and its subsequent policies. Quotas and other types of selective quantitative restrictions are the most distortionary instruments of protection. They affect almost every aspect of economic and social life — from gaining entry to post-secondary education and all the way to the boardroom and back down to the factory floor. Since the NEP had the redistribution of wealth — rather than the redistribution of income — as its target, many GLCs were created to pursue this objective. Thus, the link between the NEP and the GLCs implies that any solution must address both constraints.

It is estimated that the dominance of GLCs is highest in the utilities sector, at 93 per cent, and transportation and warehousing sectors, at 80 per cent. The dominance of GLCs is also greater than 50 per cent in the agricultural sector, banking, information communications and the retail trade. In the aggregate, the GLC share is approximately one-third — unusually high for a country representing itself as an open and modern market economy. The influence of GLCs is so pervasive in some sectors that it crowds out private investment. It is arguably more important to address the GLC problem rather than the NEP for the revival of private investment.

It remains to be seen whether the government’s plans for divestment in some of these GLCs will remove the barriers that have discouraged new firms from entering what have been traditional strongholds. Whether the proceeds from the government divestment will be channelled back into government involvement in different sectors, as has been happening lately, is another concern. Although the reforms embedded in the government’s New Economic Model, Economic Transformation Program and Tenth Malaysia Plan (TMP) signalled a departure from the previous government’s priorities and approach to development, implementation has been lacklustre at best and mendacious at worst. The devil is not in the detail but in its implementation. The fact that the TMP itself includes several new affirmative action measures is also telling.

Malaysia has always opted for economic expediency during times of impending crises. It is unclear whether the changed political landscape and tighter electoral prospects that prevail today — in the context of a slowing world economy with negative impacts threatening to spill over domestically — will prevent such risky but necessary policy change. Although there have been a few recent moves to dilute the NEP, some of these measures have already been reversed. Similarly, while there is an active program of divestment from GLCs, there are also GLC acquisitions in new sectors, making it more of a diversification than a divestment program. Malaysia’s investment malaise can be fixed, but not in this way.

Jayant Menon is Lead Economist (Trade and Regional Cooperation) at the Asian Development Bank. The views expressed in this paper are those of the author and do not necessarily reflect the views and policies of the Asian Development Bank, or its Board of Governors or the governments they represent.