When then-Prime Minister Mahathir Mohamad launched his Vision 2020 in 1991, Malaysia's reputation as a prosperous and harmonious multi-ethnic country was the envy of much of Asia. One of the key pillars of the blueprint to propel Malaysia from a rapidly developing to a fully industrialized country was to accelerate and deepen policies that transferred economic power and resources to indigenous Malays in order to ensure the "fair and equitable distribution of wealth." Since then a number of World Bank experts and veteran Malaysia watchers, such as Professor Hal Hill from the Australian National University, are becoming increasingly worried about the country's long-term future. Even the current Prime Minister, Najib Razak, admits that reform in the sensitive but critical area of affirmative action appears to have stalled. In Najib's New Economic Model (NEM), which he announced in March 2010, a Malaysian leader for the first time criticized important aspects of these decades-old policies and linked them to many of the country's structural problems.
Najib is correct that Malaysia cannot make the transition from a middle- to high-income country without winding back these long-standing affirmative action policies. But there are significant barriers working against the possibility of meaningful reform.
As any Malaysian will tell you, the 1969 race riots between indigenous Bumiputra (the Muslim Malays who were then 50 percent of the population and constitute 65 percent of the current population) and Chinese-Malaysians remains the defining event in the country's history. The acceleration of affirmative action policies from 1971 onward was an understandable response to the national trauma of the violence. Even so, given that the race riots were largely caused by social-economic racial divisions within the country, many believe Malaysia's leaders could have responded by attempting to move the country away from ideologies and policies that emphasized and entrenched racial differences. But one has to concede that in important indicators, such as poverty reduction among Bumiputra Malays, much progress has been made over 40 years. It is arguable that overall national economic growth is as much, if not more, responsible than pro-Malay policies in raising the living standards of Bumiputras. Nevertheless, the number of Malays living in absolute poverty has fallen from 60 percent in 1971 to between 5 percent and 10 percent today.
A Legacy of Deficits
The obsession, however, with improving the lives of Bumiputra-Malaysians rather than all Malaysians has come at a heavy price. Improving the lot of the poorest—the majority of whom remain Malays—is essential. But implementing an ever-expanding program of state-led economic "restructuring" and "redistribution" initiatives is a seductive but dangerous path for governments to take. The National Economic Policy (NEP) began in 1971 and formally ended in 1991. Many NEP affirmative action policies are still in place today (and some have even been extended). This living legacy is behind much of the pessimism surrounding the country today.
There are several major reasons for this. First, many economists are rightly skeptical of the benefits of an ever-expanding role of the state within a "free market" economy—particularly when interventionist policies are designed to engineer social objectives rather than promote growth. The primary problem is one of numbers. In a global policy environment rightly wary of ballooning budget deficits, the fact that the Malaysian government has been in deficit every year since the introduction of the NEP in 1971 (except for a period from 1993 to 1998) is troubling. This is particularly the case since Kuala Lumpur spends much less on social services than do Western governments. The economic numbers look even more troubling when one considers that around 40 percent of the government's revenue comes from the state-owned oil and gas giant Petronas. This is the case for two reasons. First, Petronas is forced to pay a massive 60 percent to 70 percent of its profit in dividends each year—74 percent in 2010—just to sustain the government's spending programs. And second, the company's Malaysian-based reserves (which constitute the majority of Petronas' known reserves) are due to expire in around 15 years.
Second, an essential pillar of any successful economy is the emergence of a strong, independent entrepreneurial corporate class capable of competing with the best in the world. This is where Malaysia potentially has a problem. Although it is overreach to damn all Bumiputra-run businesses as lacking creativity and dynamism, there is no doubt that economic protection in the name of affirmative action can lead to unproductive and wasteful habits. If nothing else, foreign perceptions that Malaysia's affirmative action economic environment makes the country an uncompetitive place to invest is damage enough.
Decline in Foreign Direct Investment
Much of Najib's tough talk in his NEM is to make Malaysia once again a preferred destination for foreign capital. Malaysia's net foreign direct investment (FDI) fell from $2.56 billion in 2004 to negative $7.67 billion in 2008 and recovered to only $1.95 billion in 2009—the worse decline among its developing and developed neighbors. The U.N.'s World Foreign Investment Report 2010 revealed that Malaysia's net FDI trailed such neighbors as Thailand, Vietnam, Singapore, Indonesia, and the Philippines. Indeed, in an embarrassing comedown for the former rising star, Cambodia, Myanmar, Brunei, Laos, and East Timor are the only countries in the region attracting less FDI than Malaysia. Worryingly, even domestic entrepreneurs are voting with their capital, as public investment exceeds private investment in the economy.
Third, just as companies seek to retain their best talent, Malaysia has a reputation for pushing away its best Chinese and Indian citizens. More than 250,000 people left Malaysia from March 2008 to August 2009 (not including students studying abroad). There are no figures on the racial mix of those leaving, but overwhelming anecdotal evidence suggests that a high proportion of ethnic Chinese and Indians are in this group. Once again, not all exits can be blamed on affirmative action policies, but even Najib has admitted it is a priority to make the country more attractive so as to encourage thousands of the skilled (non-Malay) diaspora to return.
The honest appraisal of not just Malaysia's problems but the reasons behind these is admirable. But formidable obstacles block Najib. Most significant is the ruling United Malays National Organization (UMNO) reliance on such an affirmative action political and social contract between the party and Malay elites to remain in power. Among countries that hold elections, UMNO has been in government longer than any other party in the world. It is not surprising that Najib has few supporters in his own cabinet to revise and wind back existing policies significantly. In 2004, UMNO gained 63 percent of the popular vote. After the party's shellacking in the 2008 general elections, when it gained only 50.6 percent of the popular vote and lost its two-thirds majority in Parliament for the first time since Malaysian independence (and with it the capacity to make amendments to the constitution), it is even more unlikely that the UMNO's brain trust would seek to alienate its strongest supporters—or precipitate an all-out civil war over reform. One such manifestation of early internecine strife is the rise of Perkasa after the 2008 election. Perkasa is a nongovernmental, nationalist group lobbying to preserve and extend the economic, social, and cultural privileges of Bumiputras, and it claims to have more that 300,000 members—at least 60 percent of whom are UMNO members. Many Malays abandoned UMNO not because they wanted to abolish the affirmative action policies but because they wanted a larger slice of the affirmative action pie.
Furthermore, the role of Malaysia's 1.2 million public servants in implementing any reforms is critical. The problem is that these civil servants are the strongest supporters of affirmative action, since many of their jobs were created by a growing state apparatus designed to implement these policies. In the current political climate, Najib can hardly afford to alienate this constituency. The Prime Minister is also relying on these civil servants—95 percent of whom are Malays—to overcome the deeply entrenched pro-Bumiputra culture.
It is still too early to assess the capacity of the Malaysian government to introduce genuine reform. So far, little has been done to roll back pro-Bumiputra restructuring and redistribution policies or initiatives that would reduce the role of the state in the economy. Significantly, Najib has backed away from abandoning the four-decade-old sacred tenet that Malays own at least 30 percent of all corporate assets in the country. The Prime Minister's NEM is a brave political gamble—and a necessary economic one. But the battle has only just begun.