Academic journal article International Journal of Management

The Effect of Trade Openness on Manufacturing Industry in Malaysia: Strategies to Enhance Its Competitiveness

Academic journal article International Journal of Management

The Effect of Trade Openness on Manufacturing Industry in Malaysia: Strategies to Enhance Its Competitiveness

Article excerpt

In this paper, we empirically examine the impact of trade openness on the manufacturing sector of a small developing country - Malaysia. Using a robust econometric formulation called the Unrestricted Error Correction Model (UECM), we show that trade openness has a positive impact on Malaysian manufacturing sector. However, the Malaysian manufacturing sector is labour intensive and seemed to be losing its competitiveness. Supply side policies and demand side policies to enhance the competitiveness of the Malaysian manufacturing sector are discussed in this paper.

1. Introduction

Over the past few decades the relationship between trade openness and economic growth in developing countries has been a major issue of debate among policy makers and economists. There have been two schools of thought on the impact of trade openness on

an economy. Proponents of trade openness argue that trade openness tends to promote export and productivity through comparative advantage. They also argue that trade openness and exposure to foreign competition have several spillovers benefits. Among them include enhanced technical development, increased industrial efficiency due to increased importing capacity, and reduction of allocative inefficiency (Jayanthakumaran 2002).

A second school of thought argues that success or failure of free trade will depend greatly on several factors. This includes the abundance of traditional factors of productions (land, labour and capital), absorbability of the human capital in the country, innovative capabilities of the domestic firms, and level of advancement of the infrastructure and institutions in the country. The types of foreign direct investment (FDI) depend on the level of deepening of the factors of production.

In many developing countries, due to the lack of innovative capabilities and low levels of human capital development, the inflows of FDI are mainly to the labour intensive sector. These FDIs are sensitive to domestic and global macroeconomic environment.

The primary objective of this study is to examine the impact of trade openness on the Malaysian manufacturing sector. Since the middle of the 1980s, the manufacturing sector has been an important engine of growth for the Malaysian economy. From Figure 1, we observe that the Manufacturing sector's contribution to the Malaysia gross domestic product (GDP) has been on an upward trend with a peak contribution of 33% of the GDP in 1995.

Government had introduced the Malaysian Industrial Master Plan (IMP)' and National Development Policy (NDP) to enhance the growth in Malaysian manufacturing industry. Manufacturing export has risen 156% from 1975 to year 2000. During the same period, import reliance also increased reflecting on the openness of the manufacturing domestic market. Malaysia had been successful in encouraging FDI in the manufacturing sector through various fiscal and non-fiscal incentives.

A significant proportion of the foreign direct investment (FDI) in the Malaysian manufacturing sector is from Japan and the US. A large portion of the FDI has been in the following sector: electrical & electronics, machinery, chemical & chemical products, and transport equipment industries. However, competitions for FDIs have been very intensive due to the following events: China's entry into WTO, the emergence of the Eastern European countries in the European Union, and the potential of the North American Free Trade expansion into the Latin American countries.

Major export destinations for Malaysian manufactured goods are given in Table 1. Note that the US, Singapore and the EU are the top three destinations for Malaysian manufactured goods. Further, export to the USA and the EU has diminished in 2000. The share of manufactured exports to Japan in 2000 is back to the level before the 1997 Asian Financial Crisis.

As mentioned above, competition for FDIs and market for Malaysian manufactured goods have intensified globally since the middle of 1990s. …

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