Tuesday, 7 October, 2003
Mahathir's economic legacy
By Emma Clark
BBC News Online business reporter
Two decades ago, Malaysia's Prime Minister Mahathir Mohamad dreamed of transforming his country into an industrialised nation.
Today, as Dr Mahathir prepares to step down from power, Malaysia boasts a diversified and modern economy, which weathered the Asian financial crisis of 1997-98 better than many of its peers.
The consensus is that it will achieve growth of 5.4% next year, outshining almost every country in South East Asia, with the exception of Thailand.
"Malaysia's success has been in diversifying away from [the export] of palm oil and rubber to the assembly of electronics," says Anne Booth, professor of economics at the School of Oriental and African Studies (SOAS) in London.
"The transition over the last 20 years has been impressive and you have to give credit to Mahathir for that."
Malaysia's long-standing leader, seen by some outsiders as half-rational, half-quixotic, has exercised tight control over the country's purse strings.
He has provided political stability and papered over ethnic divisions," says Graham Richardson, regional director for Asia at the Economist Intelligence Unit (EIU).
"But he is a complex figure. At times, his rants have been off-putting for investors."
Famously, Dr Mahathir denounced the financier George Soros for sparking the Asian financial crisis, which dealt a mortal blow to Malaysia's 1990s boom.
Then, controversially, he moved to insulate the economy by imposing short-term capital controls to prevent foreign money from leaving the country.
In hindsight, his policy seems to have paid off, as Malaysia bounced back from a steep contraction in GDP in 1998.
The country's dependence on trade meant that the global economic slowdown inevitably took its toll in 2001, but government spending has helped it to ride out the storm.
However, this level of public sector spending - contributing 3.5% to the 4.8% growth achieved by Malaysia in 1999-02, according to investment bank HSBC - could become problematic.
Tax incentives and generous terms for public sector employees have helped to boost domestic demand, but have also contributed to a budget deficit equal to 5% of GDP.
SOAS' Anne Booth says that Mahathir's successor - the deputy prime minister Abdullah Ahmad Badawi - "might want to rein in budget spending".
Although, the country does not have excessive amounts of public debt, such spending is unsustainable in the long-term.
By pumping up domestic demand, the government has also counteracted a worrying decline in foreign direct investment. This has fallen from 6.4% of GDP in 1990-96 to 1.2% in 2000-02, according to HSBC data.
Much of this can be attributed to the rising dominance of China as a destination for low-tech manufacturing.
Lower costs in China mean that foreign companies are already beginning to transfer their manufacturing away from Malaysia, says the EIU's Graham Richardson.
The threat of China and its ability to provide a vast domestic market for foreign companies will force Malaysia to discover new niches in the electronics market, adds Ms Booth.
Already, the government has turned its attention to its service industries, such as healthcare and tourism.
It is developing a hybrid of the two with its "health tourism", which offers foreigners cheap operations and four-star recuperation in the country's many hotels.
"It is an attempt by the government to buttress against volatile external demand," says Vasan Shridharan, senior regional economist at HSBC in Singapore.
In the 2004 budget last month, the government also unveiled measures to boost the sluggish private sector with tax breaks for small- and medium-sized companies.
But, as Mr Shridharan points out, China also presents opportunities for Malaysia - exports to the country have jumped by 43% annually in the last two years, compared to a 0.6% increase in Malaysia's overall exports.
Malaysian unemployment has also remained fairly steady at about 3.5%, despite the falls in foreign investment.
Dr Mahathir's keen stewardship of the economy has spawned various projects - the latest of which is a "knowledge-based economy master plan" to upgrade Malaysia's electronics industry from low to hi-tech.
In the past few years, he has even acted as his own finance minister.
By contrast, Mr Badawi is expected to strengthen the financial team. "I have the impression that that's his style, he's not a one-man band like Mahathir," says Ms Booth.
As Malaysia enters a new phase of economic development, Mr Badawi will need to call upon his cabinet to neutralise the threat from China and steer the economy in yet another direction.