Malaysian Prime Minister Najib Razak wants to engineer a return to Malaysia's glory days between 1987 and 1996 when its economy boomed, investment poured in, and local share prices almost quintupled.
Although Malaysia's economy has expanded since those heady times, its average annual growth has declined from 7.2 percent in the 1990s to 4.7 percent in the last decade. A fast-rising China has attracted investment that might otherwise have gone to Malaysia, while neighbor Singapore has built new industries, wooed multinationals aggressively, and outstripped Malaysia in growth. "Beyond commodities, it's difficult to see Malaysia's competitive advantage vis-à-vis other Asian countries," says Joseph Tan, Singapore-based Asian chief economist at Credit Suisse Private Bank (CS).
In response, Najib, in office since April 2009, has moved to streamline the government, made it easier for foreigners to invest, backed cutting-edge industries, and promoted a productive, educated workforce. His most controversial initiative is to start dismantling the policies that favor the ethnic Malay majority that put him in office—policies adopted by his father 40 years ago, when Abdul Razak was Prime Minister and the country was still recovering from riots between the Malay majority and the Chinese minority that left hundreds dead.
Those 1969 riots started in part because the Malays felt the Chinese controlled the economy. To raise the share of national wealth held by Malays and indigenous groups to at least 30 percent, Najib's father crafted a policy that gave them cheaper housing as well as priority for college enrollment, government contracts, and shares of publicly traded companies.
For the most part, the pro-Malay policy has kept the peace. "Malaysia has done very well, and affirmative action was a strong contributor to the stability that allowed for such development," says Masahide Hoshi, a director at Phalanx Capital Management HK in Hong Kong. "However, these same policies could impede Malaysia in the long term. The government must make changes soon."
Najib and his advisers say changing the pro-Malay rules will level the economic playing field, encourage investment from both inside Malaysia and abroad, and promote ethnic harmony. Najib, 57, has already eased affirmative-action rules governing overseas investors, initial public offerings, and property purchases. Mark Mobius, the emerging-markets authority at Templeton Asset Management, is impressed: "Malaysia is going through a transformation with the political changes that we've seen," he says.
Najib's reforms are opposed by some politicians who helped him gain power, including ex-Premier Mahathir Mohamad. At a March rally, former Deputy Law Minister Ibrahim Ali brandished a traditional kris dagger as the crowd chanted "Long live the Malays." A spokesman for Ali's group says the dagger display was not meant to incite violence. Najib's Malay opponents say they are protecting the constitution and that his father's goals have not yet been reached. "Malays have not gained for themselves the 30 percent target in corporate ownership even," Mahathir blogged on Aug. 9.
Analysts wonder if Najib has the political capital to carry through. "Najib appears to be saying all the right things, but the actions of many within UMNO [the main Malay political group] are not necessarily in the spirit of what [he] is saying," says Stephen Hagger, head of Malaysian equities for Credit Suisse Group (CS). It will be up to the politicians and civil service to implement Najib's plan, Hagger adds. "This is where our confidence falters."
Some locals are voting with their feet. Leslie C., an ethnic Chinese, moved to Singapore in June. "I don't think any politician will be different," says Leslie, 36, who doesn't want his full name reported. "I want a better future for the kids, an opportunity for them to start on even ground."
The bottom line: As part of a drive to boost economic growth, Malaysia's Prime Minister is trying to dismantle policies that favor ethnic Malays.