With trade figures that are galloping along at this rate, it is easy to see how China cannot be ignored by policy makers and the business community in Malaysia. The ASEAN-China Free Trade Agreement (ACFTA) that was implemented on 1 January 2010 only adds more sparks to these racy developments.

With the introduction of the ACFTA, Malaysia can expect more benefits to pour its way from China. But there is no guarantee that Malaysia will experience unalloyed gains from the ACFTA. Malaysia does not have China’s advantage of an abundant low-cost labour force, and the subsidies that China’s manufacturers enjoy may add to this surplus labour equation. The outcome can be felt even now, with companies in Malaysia feeling the effects of Chinese competitors. Manufactures of industrial valves and steel fasteners are examples of such voices from Malaysia, and they are by no means isolated.

The solution would be for Malaysia to resort to more knowledge-intensive, higher value-added production processes. This is easy to suggest but may be very difficult to implement, at least in the short run. The valve manufacturers in Malaysia have intuitively grasped this problem and are shifting to water valves which require greater technological sophistication. If these companies are to remain competitive, they have to shift to products where they will not be in direct competition with their Chinese counterparts. This is hardly a subtle point, since similar low-technology products from China are between 15 and 20 per cent cheaper than those produced in Malaysia.

The imperative to move up the value-chain, to invest in technological upgrading, and to produce goods that require knowledge-intensive production methods is garishly written all over the wall. As it stands, the major products that are exported to China from Malaysia, using preferential market access under the ACFTA, are agricultural commodities. Compound rubber, mixed vegetable oil, stearic acid and crude palm oil are among these products. In 2008 they were valued at US$1.9 billion worth of exports. This is no trifling sum.

The export of low value-added products may not continue indefinitely. It is likely that the FTA and provisions that are made under the agreement on investment will expedite China’s interest in locating its interests in Malaysia. Perhaps the first investments likely to be considered are those that will process and add value to raw materials and primary commodities. It will make sense to the Chinese to have their own factories in Malaysia to process these commodities and to push them up the value chain.

Events such as this will direct the flow of investments from China into Malaysia. By the same stroke they will also drive up the threshold of competitiveness in Malaysia. While Malaysia will gain from increased trade with China and also from the inflow of direct investment into the country, the ACFTA may also have the effect of edging Malaysia to reconsider its competitiveness in various sub-sectors. The net effect may well be positive, but the transition could be uncomfortable unless Malaysian business and policy makers act proactively.

Shankaran Nambiar is Senior Research Fellow and Head, Policy Studies Division at the Malaysian Institute of Economic Research.