Malaysia achieved independence on 31 August 1957. At the time of independence, economic conditions in Malaysia appeared conducive to sustained economic growth. The newly independent government inherited from the British colonial administration a well-developed infrastructure, an efficient administrative system, and a growing primary export sector with ample potential for expansion. In terms of educational attainment and standard of living, Malaysia was well ahead of most of its neighbouring countries (Snodgrass, 1980).
Economic performance was generally regarded as very good after independence, as reflected by the rapid expansion of the economy. The First Malaysia Plan (1966-70), a five-year economic development plan, was outlined in the early 1960s to promote the welfare of all citizens. Increasing concern about income inequality among major ethnic groups accompanied this development, threatening the political and economic stability of the country.““ Although political power was dominated by Malays, who accounted for more than half of the population in the 1960s, they were relatively poor and mainly engaged in low productivity agricultural activities. Ethnic Chinese, who accounted for about one-third of the population, were relatively well-off and controlled most of the modem-sector productive activities. As a result, sustainable economic growth was questioned by native Malays, who felt the benefits of income growth were being concentrated in the hands of ethnic Chinese (Snodgrass, 1980; Bhalla and Kharas, 1992). Income inequality over the 1960s continued to worsen and resulted in growing inter-racial tension. In fact, from independence in 1957 to the general election in 1969,
household incomes of the bumiputras grew least rapidly, while those of ethnic Chinese
grew most rapidly (Chee, 1990; Lucas and Verry, 1996). This deteriorating situation eventually led to the bloody racial riot following the outcome of the general election in May 1969.
In response to the May 1969 riot, the New Economic Policy (NEP) was instituted in 1970 to improve inter-ethnic relations through the eradication of poverty by raising income levels and increasing opportunities for all Malaysians, irrespective of race, and through rapid reordering of the society to correct economic imbalances, so as to reduce, and eventually eliminate, the identification of race with economic function. Specifically, this twenty-year program aimed to expand the corporate shareholding,
employment and education opportunities of the bumiputras so they would be able to
improve their standard of living. The NEP became the key reference for the formulation of economic development policies, remaining in place for the next two decades and beyond. Given that the main political and economic objectives of the NEP were to
redistribute the financial wealth of the minority non-bumiputras to the bumiputras,
implementation of the NEP inevitably involved a series of pro-bumiputra affirmative
action programs. Since its inception, the inter-ethnic gaps in household incomes have narrowed significantly (Snodgrass, 1980; Lucas and Verry, 1996).
:: Malaysia is a plural society with the population made up from different ethnic groups. The major ethnic
groups are the bumiputras, which comprises Malays and other indigenous people (61.4 per cent), ethnic
A series of privatisation and restructuring of state-owned enterprise activities took place from the mid-1980s. Alongside this development was an emphasis on promoting heavy industry through government involvement under the fourth Prime Minister Mahathir’s “Look East” policy (Crouch, 1996). Huge saving and export growth, coupled with political stability, ethnic harmony, and effective reforms in the financial system, raised the status of Malaysia to middle-income level in the 1980s. This remarkable economic performance coincided with implementation of the NEP and the five-year economic plans.
The Malaysian economy was hit by the collapse of commodity prices at the end of 1985 (Corden, 1996). As a result, aggregate output fell dramatically by 4 per cent in 1985, unemployment increased from 5.8 per cent in 1984 to 8.3 per cent in 1986, and the economy entered a recession. In response to this adverse situation, the government carried out a privatization policy to promote the private sector as the key engine of economic growth. The government also spent massively on infrastructure to accelerate industrialization in line with the aim to transform Malaysia into a newly industrialized economy. At the same time, regulations on foreign equity participation in Malaysia were relaxed. Other measures introduced to stimulate growth and reduce unemployment included low-cost housing schemes, speedier approval of licenses for small business, new public infrastructural projects, retraining programs for the unemployed, etc. (Yusof, Hussin, Alowi, Lim and Singh, 1994).
The NEP was extended for another decade in 1990 with some modifications, under the new label of the National Development Policy (NDP) (Snodgrass, 1995). This policy was complemented by Vision 2020 formulated in 1991, which projected Malaysia to be a fully industrialized nation within the next three decades. Most of these proposals were related to providing a sound infrastructure base, maintaining macroeconomic stability, and developing human capital. Throughout the 1991-96 period, budget deficits were well-managed at a low level, and mainly financed by a non inflationary source - the Employee Provident Fund (EPF). The government was also able to service external loans and reduce borrowing due to the sound performance of the economy (Khan, 2002). In addition, the unemployment rate, prices and the exchange rate were well-managed and remained stable. There was also a considerable reduction in
the incidence of poverty, where the bumiputra racial group made significant progress in
the modem sectors of the economy.
Malaysia was severely hit by the Asian financial crisis in 1997-98, but rebounded quickly in 1999-2000 (Athukorala, 2001). The Asian financial crisis initially
started off as a currency crisis, but rapidly translated into a financial crisis following the weakening of the banking system. This subsequently deteriorated into an economic
recession. It is widely believed imprudent supervision and sustained strong credit
growth prior to 1997 were partly accountable for the crisis.24
While Malaysia’s initial approach to crisis management was to follow the measures prescribed by the IMF, the government eventually chose an unconventional route by adopting a capital control regime. Capital controls were deemed necessary by policy makers to prevent massive capital flight. For a small open economy like Malaysia, a drastic movement in short-term capital can lead to volatility in the financial system. Macroeconomic policies were aimed at reducing current account deficits, combating inflation, and managing the excess demand triggered by high credit growth. The National Economic Action Council (NEAC) was set up in January 1998 to address the deteriorating economic conditions and revitalize the economy. Six months later, the National Economic Recovery Plan was launched to provide a comprehensive framework for economic recovery (BNM, 1999). BNM took further action to deal with the adverse consequences of the crisis on the financial system by providing a deposit guarantee to depositors and liquidity support to banks to strengthen stability. Two
special agencies, namely Danaharta (an asset management company) and Danamodal
(a recapitalization agency), were set up to buy non-performing loans at a discount and inject new capital in certain institutions, respectively. These two agencies were complemented by the Corporate Debt Restructuring Committee (CDRC), which provided an opportunity for ailing banking institutions and debtors to work out feasible restructuring schemes without having to resort to legal proceedings. In addition, BNM was prompted to introduce selective capital controls and fix the exchange rate at US$1=RM3.80 effective from 2 September 1998. These measures brought about a stable domestic economic environment and remained in place until July 2005.
After the crisis, NDP has been replaced by the National Vision Policy 2001- 2010 (NVP), emphasizing achievement of rapid economic growth as the key policy for
23 Before 1997, there were many speculative bubbles and overheating in the Malaysian securities and real estate markets due partly to the ease of borrowing. As the crisis broke in Thailand, market confidence collapsed. Massive capital outflows exerted severe downward pressure on asset prices. These capital outflows accelerated in July when the Thai Baht was devalued. This was followed by a sharp depreciation in the Ringgit, and a significant reduction in both domestic and external demand. Equity values and real estate values plunged, resulting in a significant erosion of individual financial wealth. During this period, investment projects launched by highly leveraged firms failed, non-performing loans increased significantly, and much uncertainty surrounded the economy.
24 For more debates on the causes of the Asian financial crisis, see Corsetti (1998), Corsetti, Pesenti and Roubini (1998a, b), Radelet and Sachs (1998), Stiglitz (1999a, b) and Krugman (2001).
development. However, the new policy still contains some strong elements of affirmative action programs, mainly targeted at improving the living standards of the
bumiputras. Malaysia has mainly relied on the five-year economic plans to implement
its development strategy throughout the last few decades. These plans have been
basically aimed at charting the government development strategy to achieve a high level of economic growth and reducing economic disparities and poverty (Khan, 2002). To a large extent, these plans were designed to complement the objectives of other core policies, such as NEP, NDP and NVP. All of these national economic plans place strong emphasis on developing the infrastructure base, which has greatly facilitated the undertaking of investment activities. It is important to note that these Malaysia plans are basically “public sector investment plans” whereas plans for the private sector are largely “indicative plans”. The government has never been directly involved in planning private sector investment activities. This is one of the key reasons behind the success story of Malaysia’s economic development.