Najib walks the Malaysian tightrope

(Simon Montlake in The Far Eastern Economic Review of September 4, 2009)

Najib Razak's background led many to believe that he would seek to preserve the status quo rather than embrace reform. But since becoming Malaysia's sixth prime minister, this consummate political insider has begun to grasp the nettle of change. Not all his reforms are substantive, and the payoff in terms of investment in a shrinking economy is still elusive, but even his critics concede that Mr. Najib seems prepared to stare down what his predecessor was unwilling to face: protectionism, corruption and ethnic-based discrimination that has made Malaysia's economy increasingly unattractive to investors.
The contrast with Mr. Najib's past career is instructive. The eldest son of Abdul Razak, Malaysia's second prime minister, he was born into privilege and studied in the United Kingdom. In 1976 at age 23, he was elected as a member of parliament. He steadily ascended the ladder at the United Malays National Organisation, the party that has governed Malaysia via a coalition since independence from the U.K. in 1957.

Once former Deputy Prime Minister Anwar Ibrahim was defrocked in the tumult of 1998, Mr. Najib was destined for the top job. He would have got it in 2003 had not then Prime Minister Mahathir Mohamad opted instead for Abdullah Badawi, a Muslim scholar who was a seat-warmer for the younger Mr. Najib. On April 2, 2009, Mr. Najib finally brushed aside Mr. Abdullah to assume what many saw as his birthright.
Yet Mr. Najib has shown a surprising willingness to challenge longstanding UMNO policies. He began his term by opening up parts of the service sector to unrestricted foreign investment, including health care and logistics. He also unveiled a campaign called 1Malaysia, a nod at interethnic and interfaith unity that implicitly acknowledged the corrosive impact of UMNO's pro-Malay ideology.
Then, in late June, Mr. Najib dropped a much larger bombshell. At a foreign-investment forum in Kuala Lumpur, he announced that public companies would no longer have to allocate 30% of their equity to bumiputra, or sons of the soil. This category comprises ethnic Malays, who are defined as Muslim and speakers of Malay, and indigenous groups in eastern Malaysia. Bumiputra privileges include subsidized housing, college places and priority for government contracts.
Introduced in 1971, the New Economic Policy (NEP) was designed to redress historic social and economic inequities. Its architect was none other than Abdul Razak. His son has now taken an axe to some, though not all, of its cherished rights. Mr. Najib argues that the need to expand the overall economy must take precedence over the ethnic-based division of the spoils. Other restrictions on foreign investment were also relaxed, and included an end to a cumbersome approval system for inbound acquisitions and takeovers. Foreign firms can now hold majority stakes in securities companies and fund management companies.
Taken together, the economic reforms were a pitch for foreign investment, which had begun to falter long before the current global downturn. In recent months, Mr. Najib has courted domestic constituencies with giveaways, including new taxi permits and toll-road discounts. In a concession to disaffected Indians, he released two imprisoned activists who led mass protests that stirred interracial tensions in 2007. He also promised to set benchmarks for more efficient government services and for tackling crime.
Malaysia's pliant mainstream media dutifully hailed the benevolence of its new boss. "Najib Gives Hope to Ordinary Folk," ran a column in the New Straits Times after Mr. Najib marked his first 100 days in office with 11 populist policies. Never mind that 100-day markers properly belong to presidential systems, not parliamentary ones.
What lies behind this reformist zeal? In a word, desperation. Mr. Najib heads a political party that has badly lost its way, particularly among young voters who cannot be placated anymore by feel-good bromides.
As one former government advisor told me, Internet-savvy youth "couldn't care less that you built a road" in their district. Their demands have changed as Malaysia has changed. Increasing affluence has raised the bar for the governing elite that built its legitimacy on fast-track growth and social stability.
To fend off a resurgent opposition led by Mr. Anwar, his former rival for the UMNO crown, Mr. Najib needs to reconnect with voters. That means systemic reforms that go beyond the half-measures of his predecessor. Such reforms incur a cost, however. That Mr. Abdullah failed to make substantial changes was largely a function of resistance within UMNO. Mr. Najib faces the same challenge from party bosses. The difference, according to Khairy Jamaluddin, a senior UMNO executive, is that Mr. Najib doesn't have room to fail. "It's either sink or swim. It's survival," he said in an interview. It's a point echoed by other UMNO officials.
Loosening the rules for foreign investment is essential to Malaysia's goal of being more than a middle-income country that exports manufactured goods such as electronics and commodities such as palm oil. First outlined by Mr. Mahathir, Malaysia 2020 sets a target of becoming a fully developed country over the next decade. According to the government's economic planning unit, this means the economy must grow at an average annual rate of 7%. That is more than Malaysia has managed since the 1997 Asian crisis.
Clearly, a trajectory that relies on old models is not enough, and that's why the NEP, long held sacred by UMNO, is in Mr. Najib's cross-hairs. No serious economic overhaul is possible as long as ethnic privileges determine how and where businesses operate in Malaysia. Foreign investors aren't the only ones chafing at these restrictions. Nazir Razak, Mr. Najib's brother and the chief executive of Malaysia's second-largest bank, has called the NEP a major impediment to competitiveness and a brake on investment.
For non-Malays, moreover, the NEP is a divisive symbol of injustice and the prime reason why Malaysia is experiencing a brain-drain of ethnic minorities. Talented Chinese and Indians go overseas to study and work, and inevitably some never return. Ironically, given the historical rivalry, Singapore is the largest beneficiary of this outflow. By relaxing the 30% bumiputra equity rule, Mr. Najib is encouraging both foreigners and the influential Chinese business community to invest in a country that can offer natural resources, manpower and, at least until recently, political stability.
Reforming the NEP goes hand-in-hand with promises of a more inclusive style of UMNO leadership. An opinion poll taken in June, before the reforms were unveiled, showed a jump in Mr. Najib's approval rating among Indians and Chinese. His overall rating was 65%, up from 42% prior to his accession to the job. Pro-UMNO commentators seized on the poll as proof that replacing the unpopular Mr. Badawi had rejuvenated the ruling coalition.
However, the political enmity between the UMNO-led coalition and Mr. Anwar's rival bloc continues to cleave the country along ethnic lines. UMNO's tactic of denouncing Mr. Anwar as a traitor to Malays for plotting with minorities to oust the ruling coalition may play well with its base, but it undercuts the conciliatory 1Malaysia campaign. It's also dangerous territory for Mr. Najib, who must also watch his back against Malay nationalists who decry any sellout to minorities. Dismantling the NEP by stealth is a tightrope walk for a leader whose supporters hold its privileges to be as much a birthright as a correction of inequities.
For its part, the opposition has to tread carefully in provoking police crackdowns on its rallies. Such heavy-handed treatment of peaceful protesters may appall foreign observers, but it is easily spun by supporters of the UMNO into a cautionary tale of freedom run amok.
Mr. Najib's goal of raising efficiency through a more level playing field for business may be laudable, but it's anathema to those who benefit from a tilted field, particularly in the awarding of government contracts and permits. This is where his reformist project may flag. Thousands of Malay contractors are locked into patronage networks with UMNO officials -- a pattern mirrored among other ethnic-based parties in the ruling coalition. Government procurement rules give priority to bumiputra companies and any attempt to dilute this privilege is bound to encounter serious resistance from UMNO bosses.
Moreover, the small print of June's announcement insists that initial public offerings still allocate half of new equity to the bumiputra. And a new government investment agency is being set up to support bumiputra companies, creating a fresh source of patronage politics. The level playing field is a work in progress.
A careful recalibration of the NEP, one that admits its flaws and redefines its economic goals, is in Malaysia's interests. If it brings enough voters back to the UMNO-led camp, it also makes for smart electoral politics. Mr. Anwar campaigned on a platform of ending the NEP and focusing on nondiscriminatory antipoverty programs, so Mr. Najib has stolen some of his rival's thunder.
But it may be too little, too late. Malaysia's export-led economy is in trouble, and that means less government largesse to distribute. Fund managers say the dilution of NEP privileges and other market-friendly reforms are positive but probably won't bring in fresh short-term investment. It's hard to be even-handed when the pie is shrinking. It also increases the risk that the government will aggressively milk its cash cows -- notably Petronas, the state-owned oil company -- for pump-priming budgets. Starving Petronas of investment capital is not the way out of a crisis.
Mr. Najib could overcome resistance to reform by calling snap elections and seeking an electoral mandate. A victory at the polls would give him a more free hand to liberalize the economy and face down dissent within UMNO. Otherwise he may go the way of Mr. Abdullah, a reformer-in-waiting who never quite arrived.
Some politicians in Mr. Anwar's camp, beset by its own internal troubles, are on guard for elections, possibly as early as November. But it would be risky for Mr. Najib to bet too heavily on a bump in his personal approval ratings. Voters in key states of peninsular Malaysia rejected the UMNO-led coalition in March 2008, so that only the loyalty of political allies in Eastern Malaysia maintained its federal majority. Anti-UMNO sentiment is still running dangerously high.
Polls carry other risks in a charged political climate. One dire scenario would be an election defeat that UMNO attempts to scupper by invoking emergency rule. Mr. Anwar and other opposition lawmakers acknowledge the risk but say the public pressure would be too intense for such tactics to work.
Asked if that was true, Mr. Khairy shook his head emphatically. To cling to power in the face of an electoral defeat would be "a catastrophe," he said.

Mr. Montlake is a free-lance writer based in Bangkok.