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PSD Occasional Paper No. 10 September 1995

Vision, Policy and Governancein Malaysia

Jomo K. Sundaram, Khoo Boo Teik,and Chang Yii Tan

I | I The World Bank

Private Sector Development Department

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Private Sector Development DepartmentOccasional Paper No. 10

Vision, Policy and Governance in Malaysia

Jomo K. Sundaram, Khoo Boo Teik, and Chang Yii Tan

September 1995

The authors gratefully acknowledge the assistance of Khoo Khay Jin, Henry Loh, and T, Rajayiayan Jn thepreparation of this paper. This paper has been cleared for inclusion in the occasional paper series by R. ShyamKhemani, Manager, Competition & Strategy. The views expressed are those of the author(s) and sould not beattributed to the World Bank. This paper forms part of a forthcoming volume, Leila Fxischtak and zak Atiyas (eds.),"Governance, Leadership and Communication: Building Constituencies for Economic Reform."

The World BankPrivate Sector Development Department

Contents

1. Introduction .................................... .I

The "Fifth Tiger?'? . . 1

2. Governance Capacity and Vision .. 3

3. Ethnicity and Class .5

4. Political Economy under the Alliance, 1957-69 .9

5. Economic Adjustment and State Intervention: NEP, 1970-81 .13

NEP: Problems and Tensions .18

6. Mahathir's Policies, Reforms, and Vision: 1981-83 .21

7. The Political Economy of Adjustment, 1985-66 .23

The Collapse of Commodity Prices .24The Rise in Public Debt .25Decline in Private Investment .27Holding NEP in Abeyance .27Responses to Adjustment .. 28

8. Consolidation after the Crises: Vision 2020 ...... ............................... 31

9. Conclusions .. 35

Bibliography . . .37

iii

1

Introduction

The "Fifth Tiger?"

1.1 For much of the thirty-eight years since it gained independence from Britishcolonial rule in 1957, Malaysia was regarded as a moderately successful, middle-income,commodity-producing, and net oil-exporting developing country. But the last eight years ofuninterrupted high, export-oriented, and manufacturing-led economic growth, beginning in 1987and averaging over 8 percent annually, has transformed Malaysia into a second-tier, newlyindustrializing country. Now ranked nineteenth among the world's industrialized nations,Malaysia has arguably become East Asia's "fifth tiger," after the Republic of Korea, Taiwan(China), Hong Kong, and Singapore.

1.2 There are several remarkable features in this economic transformation. First, itseems to have started in the late 1980s, in the wake of Malaysia's severe economic recession of1985-86 and some of its most intractable political crises. Second, the transformation isassociated with the privatization, including economic liberalization, launched by Prime MinisterDatuk Seri Dr. Mahathir Mohamad, previously regarded as a staunch ideologue of stateeconomic intervention. Third, it appears to have been scripted to follow Mahathir's post-1990National Development Policy, more popularly known as "Vision 2020," which capturesMahathir's hope of propelling Malaysia into the ranks of the developed countries by the year2020. Fourth, the economic transformation features a regime "rolling back the frontiers of thestate," in a Malaysian variation of the "strong state, free economy" model that was mostemphatically advocated by Margaret Thatcher for the United Kingdom in the 1980s. In short,Malaysia's progress since the late 1980s appears to have been a composite of farsighted vision,firm economic adjustment, and high governance capacity.

I

2 Vision, Policy and Governance in Malaysia

2

Governance Capacity and Vision

2.1 How might this Malaysian experience of economic recovery and transformationilluminate the junctures between the sociopolitical vision of a leader, the governance capacity ofa state or regime, and the outcome of economic adjustment under stressful circumstances? It isthe objective of this paper to provide some answers to this fundamental question.

2.2 We might first delineate how the concept of governance capacity is used in thispaper, albeit without engaging in a theoretical exegesis of the concept. In principle, governancecapacity denotes the ability of a state or regime to govern based on a claim to legitimateauthority, which is acknowledged and accepted by the governed. Governance capacity may ormay not be enhanced by the coercive (even repressive) capacity that all states and regimes retain,and the former should be differentiated from the latter. In practical terms, governance capacityrefers to the ability of a state or regime to set, shape, offer, gain acceptance for, and implement itsagendas-the social, economic, and political agendas, subject to variations or changes dependingon circumstances that cannot be determined in advance.

2.3 It is assumed that social groups, vested interests, and political forces will exhibit avariety of responses to these agendas, including support, indifference, criticism, and rejection.Some of these forces may well contest the state or regime agendas with their own alternatives.Thus, a regime may be said to have a high governance capacity if it can consistently gain asufficiently broad acceptance of its agendas in competition with the alternatives. In multiethnicsocieties with class divisions cutting across the ethnic groups (such as Malaysia), a regime'sgovernance capacity probably hinges on its ability to promote its agendas as national rather thanmerely sectarian, or to frame its public discourses as universalizing instead of particularistic.This applies even if the agendas and discourses address limited ends or narrow interests (as,indeed, they frequently do).

2.4 A leader's "vision" may mean quite different things to different social classes andethnic communities, reflecting competing, if not antagonistic, claims. Thus, acceptance of aleader's vision may be grudging or forthcoming depending on whether it can be shared ratherthan imposed. This may be critical when a regime undertakes a stringent program of economicadjustment, and can only promise the populace, or certain segments of it, future gain in exchangefor immediate pain.

2.5 But governance capacity is not merely a function of persuasion and discourse. Itis grounded in the performance of a state or regime, or its success or failure in carrying outpolicies, programs, and projects it is committed to implement. If an overarching policy with

3


clearly established objectives and targets exists (such as Malaysia's New Economic Policy), aregime's governance capacity will be enhanced by their attainment; conversely, it will beimpaired by inadequate performance (whatever its root causes may be). Similarly, vision enduresand captivates to the degree that experience suggests that it works.

2.6 On the basis of the above understanding of governance capacity and vision, thispaper provides a comparative study of two Malaysian experiences with economic adjustment.The first involves the New Economic Policy (NEP), which was promulgated in 1970, withplanned implementation to extend until 1990. The second is based on Mahathir's policyinitiatives and management of the economy, especially after 1986. Although Mahathir'spremiership began in 1981, and several of his major policies were attempted between 1981 and1985, this paper focuses on Mahathir's policy responses to the Malaysian recession of 1985-86,later consolidated after 1990, particularly in the form of Vision 2020. To set the stage for such acomparative study, the paper provides an overview of Malaysian society and political history anddiscusses the failure of the first postcolonial regime to solve critical problems of politicaleconomy in Malaysia's "race and class" society.

2.7 This paper seeks to demonstrate that while vision and governance capacityfacilitate successful economic adjustment, their roles are neither fixed a priori nor unchanging inrelation to economic constraints and political realities. It cautions against any mechanisticassumption that vision supplies a blueprint for adjustment, while governance ensures itsimplementation. It is hoped that the paper will illustrate that the Malaysian experience with NEPand Mahathir's Vision 2020 raise the general propositions that vision can be an outcome ofeconomic failure as well as a precondition for successful adjustment, and high governancecapacity facilitates, but is also constrained by, adjustment performance.

3

Ethnicity and Class

3.1 To help us understand and analyze these issues, it is useful to begin with a quickoverview of Malaysian society and politics. Geographically, the country is made up of two majorentities. There is Peninsular Malaysia-that is, the Malay Peninsula-which is contiguous withthe land mass of Thailand to the north, and linked by a causeway to the island-state of Singaporeto the south. The other region of Malaysia consists of Sabah and Sarawak on the northwesternflank of Borneo Island, the rest of Borneo being the small state of Brunei, and IndonesianKalimantan. This region was once referred to as East Malaysia, but the name has been droppedfrom official use.

3.2 The federation of Malaysia includes a total of thirteen states, with eleven states inPeninsular Malaysia, which made up the Federation of Malaya until 1963. The Federation ofMalaya merged with Sabah, Sarawak, and Singapore in 1963 to form Malaysia. Singapore,however, separated from Malaysia in 1965 as a result of irreconcilable differences between thefederal government of Malaysia and the state government of Singapore.

3.3 The population of Malaysia (excluding Singapore) was approximately 8.9 millionin 1963, and has since grown to almost 20 million today. The population is composed of manydifferent ethnic communities. Official classification divides the population between theBumiputera, or indigenous, people of Malaysia and the non-Bumiputera, or nonindigenouspeople. By this classification, the Bumiputera consists largely of the Malays and the aboriginalgroups in Peninsular Malaysia and the various "natives" of Sabah and Sarawak. The Sabah andSarawak Bumiputera include numerous groups, such as the Kadazan, Murut, and Bajau of Sabahand the [ban, Melanau, Bidaiyu, Kayan, Kenyah, Kelabit, Berawan, and Penan of Sarawak. Thenon-Bumiputera category chiefly refers to the Chinese and Indians, whose presence in Malaysiabecame significant with the waves of immigration from China and India, which were tolerated orencouraged by the British colonial administration, especially in the nineteenth and early twentiethcenturies.

3.4 In recent years there has been an official tendency to differentiate the populationalong religious lines, the most important dividing line being that between Muslims and non-Muslims. Without exception, the Malays, including those of Sabah and Sarawak, are Muslims.There are sizable numbers of indigenous non-Malay Muslims in Sabah and Sarawak, as well asIndians and Muslims in Peninsular Malaysia, and a small number of Muslim converts of otherethnic backgrounds. Other Malaysians are classified or regard themselves as non-Muslims.

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According to the Constitution, Islam is the official religion of the country, but there is freedom ofworship.

3.5 These major ethnic and religious differentiations do not exhaust the culturalcomplexity and diversity of Malaysian society. They do, however, crudely reflect the reality ofMalaysia's pluralistic society, a characterization of Malaysian society that has been compellingfor many observers because Malaysian social and political life appears to be overwhelminglyorganized around this plural society and its trends of fluctuating interethnic competition,compromise, and conflict. Political parties are mainly ethnically based, all kinds of issues arereadily "communalized," and political coalitions represent attempts at interethnic compromise.National economic, educational, and cultural policies, to take prominent examples, eitherexplicitly or subtly discriminate on the basis of ethnic and religious differentiation.

3.6 Nevertheless, Malaysian social and political life is not-and historically, neverwas-exclusively determined by the realities of its plural society, as many analysts, viewingMalaysian society from this ethnic perspective, tend to insist. They overlook other features ofpostcolonial Malaysian society, which has deep class cleavages, for example, that are no lesssignificant than the ethnic distinctions.

3.7 From the immediate post-World War II years until the late 1960s, the mostimportant (Peninsular) Malaysian class and occupational divisions coincided with the mainethnic divisions. The Malay aristocracy was relatively small but influential, with membersgroomed by British colonialism to help run the state apparatus. The "commanding heights" ofthe Malaysian economy, which were unmistakably dominated by foreign nationals duringcolonial times, remained under foreign control after Malaysia's experience of politicaldecolonization without economic nationalization. But this foreign presence was arguably lessvisible than that of the ubiquitous local Chinese capitalists. Some of the latter had compradororigins in colonial times, and most continued to be primarily engaged in commercial andfinancial pursuits, rather than industry. The working class was mainly composed of an urban,Chinese component, based in services and industry, and an Indian component, primarily engagedin public works and services. Among agriculturists there was a sizable group of Chinese squatter-farmers, but the Malay peasantry was by far the single largest component. Again, this summaryof the structure of newly independent Malaysia does not reflect all the complexities of its classdivisions. It merely seeks to show that postcolonial Malaysian society had an ethnic division oflabor that reflected the classic, colonially bred pattern that was found in several other formerBritish colonies.

3.8 Hence, before the 1970s, the class conflicts and ethnic tensions that arose fromMalaysia's pluralistic society and ethnic division of labor combined to produce the majorpolitical crises of the Malayan and Malaysian states. Between 1948 and 1960, the state fought aninsurrection led by the Communist Party of Malaya, composed mainly of Chinese communists,left-wing Malay nationalists, former wartime partisans, radical sections of the Chinese and Indianworking class, and Chinese squatter-farmers. The insurrection was virtually defeated by acounterinsurgency program, officially called the "Emergency."

Ethnicity and Class 7

3.9 In the process of winning this victory, the state extended its writ in several ways.Its military was bolstered by the creation of a Malay "ethnic soldiery" (Enloe 1980). The SpecialBranch of its police was strengthened by the recruitment of anti-Communist Chinese officers(Zakaria 1978). The colonial state's bureaucracy was reestablished and gradually Malayanized.Perhaps the colonial state's coercive capacity was best illustrated by its forcible resettlement ofabout half a million (mostly Chinese) squatter-farmers in "new villages" (Loh 1988), theprototype for Vietnam's "strategic hamlets."

3.10 With the Emergency, the colonial state gained time to come to terms with aconservative Malay nationalist movement led by Malay aristocrats. It gained space for amultiethnic elite, led by Malay aristocrats and Chinese capitalists, to experiment with coalitionpolitics in preparation for a new polity based on the electoral franchise and party politics. By1957, the Alliance, a tripartite coalition of the United Malays National Organization (UMNO),the Malayan Chinese Association (MCA), and the Malayan Indian Congress (MIC), had beenformed to govern a newly independent Malaya. The Alliance governed Malaya, and thenMalaysia, for the next twelve years.

4

Political Economy under the Alliance, 1957-69

4.1 During its tenure, the Alliance continued the colonial repression and policeharassment of its class opponents, this time the parliamentary left, which included the SocialistFront, made up of a Chinese-majority Labour Party and the Malay-majority Partai Rakyat Malaya(PRM, or Malayan People's Party). But the Alliance did have wide electoral support. It won the1959 and 1964 general elections, each time retaining a two-thirds majority in Parliament. (It alsowon the 1969 election but came to grief in the process, as will be discussed below.)

4.2 Its success rested on at least two major points relevant to this discussion. First, asthe "party of independence," it had inherited the mantle of Malayan nationalism, which theradical anticolonialists forfeited in defeat. The mantle conferred a mandate to govern. Second,the Alliance's so-called formula of balancing Malay special rights with non-Malay citizenshipand improving the Malays' economic position, while protecting the non-Malays' economicposition, appeared to embody the kind of interethnic compromise and cooperation that a newlyindependent, multiethnic Malaya required. To that end, the Alliance consistently occupied themiddle ground, offering and conducting itself as a coalition that had won support from all ethnicgroups, unlike the extremist or chauvinistic opposition parties that were rather more captive tosingle, ethnic constituencies. In that sense, not only had the Alliance inherited a sophisticatedmilitary-police-bureaucratic apparatus left behind by the British, but it had also built up its ownconsiderable governance capacity.

4.3 The Alliance's governance capacity grew increasingly tenuous as the 1960s woreon. The anticolonial and class struggle of the Emergency was followed by the ethnicrecriminations that dominated Malaysian politics in the 1960s. Disenchantment with theAlliance grew with increasing unemployment, worsening income inequalities, and the regime'sinability to stem increasing ethnic polarization. The poor and marginalized Malay peasantryexpressed its dissatisfaction through the religious-nationalist idiom of Parti Islam SeMalaysia(PAS, or Pan Malaysian Islamic Party) (Kessler 1978). The Malay intelligentsia, middle class,and bureaucrats-led by some of the ruling UMNO's own politicians-were impatient with theAlliance's laissez faire, which left them commercially and financially well behind their Chinesecounterparts, and Chinese capital in particular. Middle-class and working-class non-Malaysconsidered themselves disadvantaged by the constitutional provision of certain "special rights"for the Malays. Those special rights entrenched the position of the Malay rulers, the Malaylanguage as the national language, a preferential quota for Malay recruitment into the civilservice, and, most important, enhanced state economic assistance for Malays, all in support of

9


their special position within the country. Between a Malay anxiety to protect their specialposition from non-Malay encroachment and a non-Malay insistence on a "Malaysian Malaysia,"a chasm of interethnic recrimination was created. The politics of the 1960s were increasinglycharacterized by interethnic accusations and chauvinistic brinkmanship, most of all during thecampaign for the May 1969 general election.

4.4 The Alliance regime was committed to a policy of laissez faire, a pillar of theindependence compromise struck among British colonialists, the Malay aristocracy, and theChinese capitalists. This meant a mild strategy in developmental terms, perhaps matching PrimeMinister Tunku Abdul Rahman's reputed moderation in politics. The state urged plantation-oriented agricultural diversification geared toward exports in commodity production andindustrialization through low-level import substitution. Neither threatened foreign capital or localbusinesses. Rural development was planned to provide basic infrastructure to rural residents andto raise their productivity and income without land reform; in this way, politically influentiallanded interests were not offended.

4.5 Under the circumstances, the Alliance's formula of leaving business very much toitself was disastrous in at least two major ways. First, it failed to meet the mass expectations ofimprovements in living conditions, expansion in economic opportunities, and greater scope forsocial mobility that were raised by decolonization in Malaysia, as they had been elsewhere.Those expectations were keenly felt among very broad sections of the Malaysian populationwhen manufacturing employment and land development could not keep pace with the growth ofthe labor force in the 1960s. Second, while staying out of business seemed consistent with the"Alliance formula" and Tunku's vision of leaving "politics to the Malays" and "economics tothe Chinese," the policy sowed the seeds of its own destruction, proving to be unsustainable inthe long run (Jesudason 1989, pp. 47-75). A nascent Malay business class, a vocal Malay middleclass, and a marginalized Malay peasantry could not accept "economics for the Chinese"(Mahathir 1970, p. 15), while a resentful non-Malay middle class and a repressed non-Malayworking class rejected "politics for the Malays."

4.6 When the May 1969 elections were contested in this conjunction of ethnic andclass disaffection, the Alliance's middle ground partially collapsed, as the Islamic PAS, the"Malaysian Malaysia" Democratic Action Party (DAP),' and the social democratic GerakanRakyat Malaysia (Gerakan, or Malaysian People's Movement) made substantial electoral gains.2UMNO lost eight of its fifty-nine parliamentary seats, while the MCA lost fourteen out oftwenty-seven. The losses were insufficient to topple the Alliance, but enough to damage the"consociationalism" of its ethnic elites. Perhaps the overall result did not justify the desperateanger of UMNO's Malay supporters or the reckless exuberance of the non-Malay oppositionparties' followers, but on May 13, only two days after the elections, Kuala Lumpur was engulfedby interethnic violence. The May 13 incident, Malaysia's crisis of decolonization, ended the

1 DAP, widely perceived as a Chinese party, advocated a "Malaysian Malaysia" platform that opposed ethnic privileges. Sincethe 1970s. DAP has won most of the urban non-Malay parliamentary seats, making it the most important opposition party.

2 The most complete account of the May 1969 election and the ensuing violence, from a point of view sympathetic to theAlliance, was given by Von Vorys 1975.

Political Economy under the Alliance, 1957-69 1 1

Tunku regime. Using emergency powers, Deputy Prime Minister Tun Abdul Razak convened aNational Operations Council (NOC) and became its director. While the new regime had tokenrepresentation from the Chinese (MCA) and Indian (MIC) partners of the Alliance, in reality,Razak; select UMNO leaders; and the chiefs of the Malay-dominated army, police, andbureaucracy ruled Malaysia, while the newly elected Parliament remained suspended.

5

Economic Adjustment and State Intervention:NEP, 1970-81

5.1 We need not rehash the many administrative details regarding NOC's bout ofauthoritarian but effective rule, which lasted until March 1971. But it is essential to note thatNOC showed that the state's governance capacity was equal to the crisis (Von Vorys 1975).NOC was immediately able to confine the violence to Kuala Lumpur and to end the uprisingwithin a matter of weeks. Within months it had reestablished a semblance of normalcy in KualaLumpur and in the rest of the country. Within one and a half years it had restored parliamentaryrule, albeit by strengthening the Sedition Act, which reduced the scope of parliamentaryimmunity for debates on sensitive issues-constitutional provisions pertaining to the Malayrulers, Malay language, Malay special rights, and non-Malay citizenship.

5.2 More pertinently, within a year, the state was able to promulgate NEP. NEP'spremises were that poverty, Malay resentment of interethnic income and wealth inequalities, andthe ethnic division of labor lay at the heart of the mass dissatisfaction with the Tunku regime thatexploded in May 1969. To overcome those problems, NEP had two objectives: "povertyeradication irrespective of race" and "restructuring to abolish the identification of race witheconomic functions." For poverty eradication, NEP's "Outline Perspective Plan 1970-90"proposed a decline in the poverty rate from 49 percent in Peninsular Malaysia in 1970 to 16percent in 1990. Restructuring was intended to raise the Bumiputera share of corporate equityfrom 2.5 percent in 1970 to 30 percent in 1990. And in seeking to "eliminate the identification ofrace with economic function," NEP proposed a massive affirmative action program that wouldfavor Bumiputera and limit non-Bumiputera access to tertiary education and civil serviceemployment.

5.3 Malaysia's economic planning has traditionally been carried out in five-yearincrements. Accordingly, NEP's implementation began with the first post-1969 plan, the SecondMalaysia Plan, 1971-75. But the full elaboration of NEP also involved subsequent plandocuments, up to the Fourth Malaysia Plan. In the process, NEP encompassed several majordevelopments.

5.4 First, although restructuring had officially been promoted as an exercise to redressinterethnic imbalances-principally by redistributing corporate wealth ownership as well asemployment-it became, in practice, a huge social engineering project that altered the classstructure of Malaysian society. It accomplished this primarily by sponsoring the rise of a Malay

13


capitalist class, which has come to be known in recent years as the Bumiputera Commercial andIndustrial Community (BCIC). NEP-sponsored Malay capitalists have variously been calledstatist capitalists, because of their bureaucratic associations and reliance on state power andpatronage (Jomo 1988); distributional coalitions, for their involvement in powerful rent-seekingensembles (Mehmet 1986); and ersatz capitalists, because of their orientation toward short-termaccumulation rather than long-term industrial development (Yoshihara 1988).

5.5 Second, the state radically reversed the Alliance's policy of leaving economics toprivate capital. Laissez faire was replaced by growing state intervention in the economy.Allocations for public sector expenditure vastly increased during the NEP years. Compared withthe RM 4.6 billion allocated under the pre-NEP First Malaysia Plan (1966-70), the allocation forthe first NEP five-year plan (the Second Malaysia Plan, 1971-75), was RM 10.3 billion (Jomo1990, p. 106, Table 5.1). In the Third Malaysia Plan (1976-80) the allocation rose to RM 31.1billion, while in the Fourth Malaysia Plan (1981-85) the figure was RM 48.9 billion (Jomo 1990,p. 106, Table 5.1). Indeed, total public expenditure as a proportion of GNP rose from 28.7percent in 1970 to 61.2 percent in 1982 (Mehmet 1986, p. 133, Table 6.1).

5.6 The state also entered businesses in a large way, seeking to expand public sectorownership of corporate equity and to build up state-owned business enterprises. The state'senlarged role in business spawned a proliferation of public enterprises. The number of public orstate-owned enterprises grew from 22 in 1960, to 109 in 1970, to 656 in 1980, and to 1,014 in1985. The early NEP period was the heyday of state agencies, banks, and funds that sought andheld equity in trust for the Bumiputera.3 Some of the best known of these were Bank BumiputeraBerhad, PERNAS (Perbadanan Nasional, or National Corporation), PNB (Permodalan NasionalBerhad, or the National Equity Corporation), ASN (Amanah Saham Nasional), UDA (UrbanDevelopment Authority), MARA (Majlis Amanah Rakyat, or the indigenous People's Council ofTrust), and the SEDCs (state economic development corporations). Such a proliferation ofpublic agencies required an expansion of public sector employment, which grew, excludingmilitary and police personnel, from 139,476 employees in 1970 to 521,818 in 1983 (Mehmet1986, p. 9, Table 1.3)

5.7 Third, the state became a determined regulator of business, mostly local Chineseenterprises, although foreign companies operating in Malaysia were also affected. The statestrengthened its regulatory powers through the Industrial Coordination Act (ICA) of 1975 and theestablishment of the Foreign Investment Committee (FIC) to ensure compliance with NEP'srestructuring requirements. In practice, this meant a quota of at least 30 percent for Bumiputeraequity participation and employment in companies covered by the ICA (Jesudason 1989, pp. 128-47). ICA, originally applicable to any manufacturing firm with RM 100,000 or more inshareholder capital and employing at least twenty-five workers, was unpopular with non-Malay(including foreign) businesses. It was especially irksome to local Chinese business, whichconsidered itself to be the ICA's main target. The ICA gave the minister of trade and industrytremendous discretionary powers over licensing, ownership structure, ethnic employment,product distribution quotas, local content, and the pricing of products (Jesudason 1989).

3For a critical analysis of what Malay trusteeship involved, see Mehmet 1986 (pp. 6-11, 132-54).

Economic Adjustment and State Intervention: NEP, 1970-81 15

5.8 Given the interethnic violence that prompted its response, the state was verycareful in its ideological presentation of NEP. Razak, Tun Dr Ismail, Ghazali Shafie, and theircolleagues, who crafted NEP, offered a vision of achieving interethnic economic parity in orderto attain genuine national unity, which had eluded the Alliance.4

5.9 They justified NEP as a policy to correct the Malays' historical "backwardness" inrelation to the non-Malays. Restructuring, then, was unavoidable, and socially desirable and just,but they reassured the non-Malays that it would be carried out in an expanding economy so thatthere would be no sense of deprivation among the non-Malays. NEP's restructuring actuallytargeted increases for both the Malay and non-Malay shares of corporate wealth-at the expenseof the foreign share.

5.10 Was this a shared national vision rather than an imposed ethnic perspective? Itwould be unsatisfactory to give a categorical or static answer to this question. Inadequate as itmay sound, the answer is: probably a little of both. Insofar as a comprehensive response to anational tragedy tends to contain a shared or universalizing potential, most sections of theMalaysian nation (with differences, most certainly) could accept the rationale for NEP fornational reconstruction. Therein lay NEP's bonding, or shared, qualities. Whatever one'snotions of social justice or interethnic relations, there was no mistaking that 13 May 1969 hadbrought Malaysian society to a watershed. Tunku, nominally still prime minister in 1969-70,had been sidelined while NOC ruled. The Alliance regime and what it stood for were things ofthe past, a reality capped by Tunku's retirement in September 1970. Something akin to NEP inits capacity to redelineate the politico-economic parameters of Malaysian society would have hadto have been invented even if NEP had not been promulgated in 1970. NEP, when it came, hadthe advantage of being a visionary and comprehensive response to national trauma: it supplied adiagnosis, imposed a treatment, and specified a period of recovery.

5.11 But NEP's discrimination also had to be imposed by law and admninistrative fiat,because its ideological justification remained flawed. At a general level, the Malays applaudedrestructuring as affirmative action, while the non-Malays tended to resent it as ethnicdiscrimination. At the level of party and coalition politics, only the UMNO politicians andMalay bureaucrats were really persuaded by NEP's "national unity" rationale. Most wouldconcede that NEP contributed to ethnic polarization in later years, but UMNO's non-Malaypolitical partners, who claimed to support NEP in principle, were also apt to complain about itsoverzealous implementation, leaving others to wonder about their commitment to NEP. In thesphere of commerce, Malay businesses and regulators tended to think of corporate restructuringas interethnic sharing, while non-Malay businesses were more likely to regard it as unwarrantedcontrol.

5.12 In other words, there were discernible divergences in the way NEP's vision wasperceived. NEP's architects stressed its national unity objectives, its (Malay) beneficiaries

4 In pursuit of national unity, NOC also proffered a national ideology, the Rukunegara, but it never quite caught the publicimagination. It was the bread-and-butter NEP-and mostly restructuring-that has generated the fervor of both NEP supportersand detractors.


supported its remedial features, while those (non-Malays) adversely affected protested itsdiscrimination. These divergences in perception were partly occasioned by the impact of thepolitico-economic adjustment that NEP entailed, which has been succinctly summarized by KhooKhay Jin (1990, p. 50):

Whatever the sources of inspiration for NEP, it spelled a new phase in Malaysia'sdevelopment, overturning the relationship between state and economy andrecasting the balance of power within the "pact of domination." NEP spelt theend of an alliance between the Malaysian state and private capital in which thestate was content to support the efforts of private accumulation, both local andforeign, restricting itself to limited programs aimed at ameliorating ruraldiscontent and the frustrations of a rising Malay intelligentsia. Instead the roleswere to be reversed with the state playing the leading role and laying down theagenda with private capital in tow. The choice of this particular alternativeexpressed primarily the demands of the Malay business and intelligentsia network,many of the latter being in bureaucratic positions, who wanted the state to beinterventionist in favor of 'Malay' interests. To the degree that state powerdepended upon its ability to command votes in the countryside, where povertylevels were atrocious, the policy also expressed incorporating intentions towardssuch strata, primarily the peasantry. In power terms, it spelled a shift of power totechnocrats and bureaucrats. In implementation, it was geared towards theutilization of state resources to sponsor a Malay capitalist class. In realization, itassumed in large part the form of public corporations acquiring assets for and onbehalf of Malays and run by political appointees and bureaucrats.

5.13 Under the circumstances, several factors were crucial to NEP's acceptance andviability. Politically, the "NEP state" had to maintain a high level of governance capacity.Economically, NEP years had to show demonstrable success. Administratively, the bureaucratsand technocrats to whom power had shifted had to be able to deliver on NEP promises. Inhindsight, the Razak and Hussein Onn administrations succeeded on all three counts.Consequently, they were able to ensure that NEP's radical adjustment was executed in the"power," "implementation," and "realization" terms mentioned in the passage quoted above.

5.14 NEPs acceptance came almost by default. Politically, there was no room foroppositionist objections to NEP's promulgation, because NEP was formulated when NOC ruled,and P.rliament, or politics, was suspended. But Razak envisioned a political corollary to NEP'ssocioeconomic restructuring that would enhance his regime's governance capacity. After theMay 1969 election unveiled wide pockets of anti-Alliance disaffection, Razak moved to co-optthe major parties, which had capitalized on that disaffection. In Peninsular Malaysia, these werethe PAS, which ruled Kelantan, and Gerakan, which held the state government of Penang. Razakhad the foresight and diplomatic skills to restructure the old Alliance's interethnic, elitist,consociational framework into a much broader, power-sharing, Barisan Nasional (BN, orNational Front). A number of smaller parties traded their opposition for a small voice in theRazak administration. Consequently, BN embodied a wide spectrum of political parties. DAPwas left isolated as the only significant opposition party. At the same time, BN's power-sharing


was predicated on an UMNO dominance far exceeding the party's preeminence in the oldUMNO-MCA-MIC Alliance. UMNO's position (indeed, its hegemony) in BN became the sinequa non of a much more Malay state, one that was more consistent with NEP's Malayorientation. BN succeeded the Alliance and has ruled Malaysia to this day.

5.15 Public debates over NEP were sometimes acrimonious. Nevertheless, two generalaspects of those debates underscore how well received NEP actually was. On the one hand,criticism, including non-Malay criticism of NEP, as suggested earlier, was almost entirelyconfined to disagreement over the details of its implementation. It very rarely questioned NEP'spremises and objectives. If anything, criticisms of that kind typically began with an endorsementof NEP in principle. On the other hand, there emerged what one might call a quota fixation,which dominated the public psychology and political imagination of the time. Both sides of theMalay-non-Malay divide appeared to fasten their sights on increasing or protecting their quotasin education, employment, and business, submitting, consciously or otherwise, to NEP'srestructuring discourse. As a result, alternative views of remaking or reforming the Malaysianpolitical economy that refused to accept NEP's parameters appeared to be unrealistic andnonpragmatic, and failed to move beyond the fringes of public debate and consciousness.Unsavory though it was, the quota fixation showed how successfully the NEP state's governancecapacity had dictated the parameters of public debate over its sociopolitical agenda.

5.16 Economically, the 1970s coincided with Malaysia's discovery of offshorepetroleum and an international commodities boom, both of which bolstered state revenues. In1970 Malaysia became a net oil exporter for the first time. Petroleum exports grew from RM203 million in 1970, to RM 861 million in 1975, and to RM 6,709 million in 1980. Malaysia'spetroleum exports peaked at RM 9,683 million in 1985 before the collapse of oil prices in 1986brought the export value down to the 1980 level (Jomo 1990, p. 54, Table 3.10). The value ofMalaysia's nonpetroleum commodity exports rose from RM 4.96 billion in 1970, to RM 8.37billion in 1975, and RM 21.46 billion in 1980 (Jomo 1990, p. 54, Table 3.10).

5.17 On the strength of these sharply increased petroleum and commodity receipts, thestate was able to finance its intervention in the economy without imposing undue stress on thenational budget or the country's balance of payments. State-led demand and public enterpriseinvestments during the first NEP decade helped to maintain the economy's growth rate at aconsistently high level. The average real annual GDP growth rate for 1970-80 was 7.6 percent.The average annual growth rate for the Second Malaysia Plan period of 1971-75 was 7.3 percent,while that for the Third Malaysia Plan period of 1976-80 was 8.6 percent. Employmentexpanded steadily, rising from 4.0 million in 1970 to 4.8 million in 1980. The unemploymentrate declined from 7.8 percent in 1970 to 5.7 percent in 1980. Per capita income rose from RM1,100 in 1970 to RM 3,700 in 1980.

5.18 The high growth rates seemed to vindicate the NEP architects' scenario of anexpanding economy in which all communities could share. Sheltering under the BCIC umbrella,Malays already in business or aspiring to business were nurtured on easy credit, reservedgovernment contracts, reserved corporate shares, access to restricted business licenses, and otherforms of preferential treatment. It was not just the Malays who benefited from the economic


opportunities NEP opened up for them. Many well-connected Malays and non-Malays formed"Ali Baba" joint ventures, whereby the Malay partner ("Ali") secured the necessary contracts,licenses, and the like controlled by the state, while the Chinese partner ("Baba") supplied thefinance, expertise, and, all too often (so it was charged), the real work itself. Whether moregenuine interethnic cooperation in business-avoiding the "sleeping (Malay) partner"syndrome-could have been fostered by NEP during that first decade is debatable. But underheady conditions of high growth, unlimited opportunities, and quick profits, it did seem as ifrestructuring, or interethnic redistribution, could be carried out without causing too much of asense of deprivation among the non-Malays.

5.19 At the same time, the state apparatus vigorously pursued its administrativeimplementation of NEP. Staunch advocates of restructuring in the late 1970s, such as Mahathir(then deputy prime minister) and Tengku Razaleigh Hamzah (then finance minister), did not balkat the implications of a single-minded remaking of Malaysian, and especially Malay, society.Mahathir, for example, viewed with equanimity the massive rural-to-urban migration of youngMalays, whether into the civil service, educational institutions, or factories. Razaleigh readilyemployed state resources to buy into, buy out, or start companies that were pivotal to securingBumiputera control of the "commanding heights" of the economy. The state also strove to lureforeign (manufacturing) investment into newly created free trade zones (FTZs). The state'sforeign investment incentive package of cheap industrial land; good physical infrastructure;nonunionized, low-wage labor; pioneer status; and export tax and other incentives helped tolaunch a successful wave of export-oriented industrialization (EOI). Whatever the costs or otherbenefits of this FTZ-based EOI program might be, it was important to the state because it openedup mass factory employment opportunities for young Malays (especially young Malay women) ina modem and expanding sector of the economy that-unlike the traditional, local, Chinese-dominated sector-was amenable to fulfilling the employment quotas required by ICA. This wasone very visible aspect of NEP's intention to "abolish the identification of race with economicfunction." At the same time, but at a higher and more rewarding level, at least for itsparticipants, the state enlarged its corps of Malay graduates and professionals. It accomplishedthis by the establishment of new state universities and all-Malay residential schools and collegesat home, and generous financial support to send tens of thousands of young students and mid-career officers to overseas universities. This was the heyday of the bureaucrats and technocrats.With single-minded vision, technical planning, and virtually unlimited expenditure on physicaland social infrastructure, they seemed to have proven themselves equal to the tasks of povertyeradication, restructuring, and abolishing the identification of race with economic function.

NEP: Problems and Tensions

5.20 To say that NEP gained a wide measure of acceptance is not to overlook severalproblems and tensions that arose from its implementation. A number of difficulties emerged inthe first half of NEP's two-decade span, but intensified during the second half, as well as whenworsening economic conditions exposed the inefficiency of the bureaucracy and the limitationsof state intervention and undermined the governance capacity of the Mahathir regime.


worsening economic conditions exposed the inefficiency of the bureaucracy and the limitationsof state intervention and undermined the governance capacity of the Mahathir regime.

5.21 First, it was well known that the public enterprises (PEs) were, on the whole,economically inefficient. Their poor management, rapid expansion (for example, into newbusiness areas), and lack of accountability led to heavy losses. In 1984, for instance, only 269out of more than 900 PEs submitted their annual returns to the Ministry of Public Enterprises,recording a collective accumulated loss of RM 137.3 million (Supian 1988). Ideologically, thePEs were too willing to consider themselves as social enterprises and to rationalize their losses asthe price to be paid for Bumiputera advancement and learning.

5.22 Second, there was something of a parting of ways between what is commonlyidentified as a Malay public sector and the non-Malay (mainly Chinese) private sector. This waspartly a result of the state's strong interventionism, and partly because of the post-1969 rupture inrelations between the state and (Chinese) private capital. The public sector generally regardedthe private sector as rapacious, while the private sector considered the public sector to beinefficient and incompetent. Most non-Malay businesses resented the heavy hand of stateregulation. Local Chinese capital tended to adopt a short-term investment outlook, preferring toconcentrate their investments in nontradable sectors, especially property and construction(Jesudason 1989). Some foreign investors were probably discouraged from investing because ofrestructuring and other measures of the ICA (Marican 1987).

5.23 Third, the relatively easy access of Malay business to credit and contracts, theirhigh failure rate in spite of the advantages, and the frequency of Ali-Baba arrangements causedconcern that Malay businesses were becoming too accustomed to handouts, bailouts, andsubsidies. The majority of Malay professionals, trained at state expense, looked to the state foremployment. There were suggestions-some of the most pointed coming from Mahathir-thatexcessive state protection and preferential treatment had fostered a dole mentality that renderedtoo many Malays dependent and noncompetitive, thus defeating the NEP goal of creating a BCICthat could hold its own with the non-Malays.5

5.24 Fourth, there was a tension between NEP's poverty eradication and restructuringobjectives. In ethnic terms, few state-supported programs of "poverty eradication irrespective ofrace" were designed to serve the non-Malay poor, whether in the rural or urban areas; the officialassumption was that poverty was predominantly a rural Malay condition.6 There was also asteady shift in emphasis from poverty eradication to restructuring, which benefited the newpolitically and bureaucratically well-connected Malay businesses disproportionately (Jomo andIshak 1986).

5 Mahathir Mohamad, "Speech at the Pemuda and Wanita UMNO General Assembly," Kuala Lumpur, 25 June 1981 (reprintedin Harun Derauh and Shafie Nor 1982).6 For a BN component party's views on the plight of the mainly Chinese "new villages," which were poor but bypassed byofficial rural development efforts, see Partai Gerakan Rakyat Malaysia 1986.


5.25 Fifth, there was a persistent tension between growth and distribution. Somecritics maintained that NEP's restructuring retarded the country's growth, although it is virtuallyimpossible to prove whether the high-growth 1970s would have seen even higher growth withoutNEP's interethnic distribution. But even UMNO and Malay business circles-generally thosemost devoted to restructuring-began to show a polarity of opinion between pro-growth and pro-distribution advocates when the national economy began to falter in the early and mid-1980s.7

7 For a candid and insightful analysis of this growth versus distribution split among Malay political and business circles, seeMarican 1987.

6

Mahathir's Policies, Reforms, and Vision: 1981-83

6.1 The Mahathir era began when Mahathir succeeded Hussein Onn as prime ministerin July 1981, about midway in NEP's two-decade Outline Perspective Plan (OPP) period of1970-90. The problems of NEP, outlined above, were well-known to Mahathir. He also wouldhave known that a potentially divisive and bitter interethnic accounting on the attainments orshortcomings of NEP could take place as the end of NEP drew nearer. Mahathir stood in anunusual position in relation to NEP. When it was formulated in 1970, he was in a kind ofpolitical wilderness. He had lost his parliamentary seat in the 1969 election, and had beenexpelled by UMNO in late 1969 for openly blaming Tunku for the May 13 violence. Yet thegeneral public impression, gained from following his controversial career as a Malay nationalistand reading his book, The Malay Dilemma, was that Mahathir was NEP's ideological soul. Hehad advocated state-managed social engineering to restructure Malaysian society to promoteeconomic advancement of the Malays. In government, since his 1974 appointment to the Razakcabinet he had consistently defended NEP, although he had his own reservations about the ICAand Malay economic performance.

6.2 Early in his term in the prime minister's office, Mahathir appeared to have asocioeconomic agenda that differed in focus and priorities from NEP's core concerns. Apartfrom reassuring everyone that NEP would be continued and fairly implemented, he proposed astarkly novel agenda for the nation. In short, he wanted a nationalist-corporatist venture totransform Malaysia into a newly industrializing country. He wanted his cabinet to provideleadership by example, the people to "Look East" to emulate an Eastern work ethic, thebureaucracy to become "clean, efficient and trustworthy," the public and private sectors tocooperate in a "Malaysia Incorporated," and the economy to move ahead on the basis ofprivatization.8 He committed the state to heavy industrialization through joint-ventures withJapanese and Korean manufacturers of automobiles, motorcycle engines, steel, and cement.

6.3 Mahathir's early economic policies and bureaucratic reforms came so quickly that,initially at least, what he was aiming for was not altogether clear to a lot of Malaysians. It wasgenerally acknowledged that he had a modernizing vision and a nationalist mission. Thebureaucratic reforms were just beginning, and his anticorruption campaign seemed less thanwholehearted. But to a public long weary of bureaucratic ills, his reformism was welcome. To a

s "Leadership by example," "Look East," "Eastem work ethic," "Clean, efficient, and trustworthy," "Malaysia Incorporated,"and "Privatization" were all catchwords and slogans associated with the early Mahathir policies, examined at length in Khoo BooTeik 1995.

21


public used to political detention without trial, his release of many political prisoners seemedquite liberal, although a battery of repressive legislation remained. Even his rather undiplomatic"buy British last" campaign and his spuming of the Commonwealth Heads of GovernmentMeeting (CHOGM) in Melbourne in 1983 evinced some national pride in being able to stand upto the West. In sum, Mahathir, and his deputy, Musa Hitam-both former rebels against Tunkuin 1969-managed to weave a populist, dynamic, reformist, and liberal aura over their "2-M(Mahathir-Musa) administration." Vision, aura, persuasion, and leadership: these were critical,if intangible, factors in the enhancement of the early Mahathir regime's governance capacity, asdemonstrated by the incorporation of Anwar Ibrahim, president of ABIM (Angkatan Belia IslamMalaysia), into UMNO, and BN's strong victory in the 1982 general election.9

6.4 In those early years Mahathir conducted himself as if he had all the answers to theproblems spawned by NEP. His bureaucratic reforms seemed to speak to the issues ofbureaucratic ineptitude and lack of fiscal discipline and accountability. Privatization, still in itsinfancy, appeared as an answer to the perennial losses of NFPEs and offered a way to distributestate assets to able and successful Bumiputera entrepreneurs. "Malaysia Incorporated" proposedto mend the rift between the public and private sectors now that there was a nationalist mission toaccomplish. The work ethic, at once Eastern and Islamic, stressed the need for hard work andself-reliance and was offered as the corrective to Malay dependence. Exhortations do notordinarily mean much in politics, but Mahathir's exhortations were backed up by his bureaucraticreforms, industrialization drive, and Islamization projects (including the establishment of anIslamic bank and an Islamic university). These actions did much to prepare Malaysian societyfor change and adjustment under his leadership. By and large, Mahathir brought home thethemes of change, adjustment, and innovation to many Malaysians in small, but personal, ways:for example, setting Peninsular Malaysia's time back by a half-hour to synchronize with Sabah'sand Sarawak's and installing a punch-card system in all government departments. He hadimposed a new agenda and a national purpose that was different from the old concerns of NEP,and moved toward the attainment of "NICdom." It is critical to appreciate and remember thisbecause, ironically, the Mahathir regime's governance capacity was soon to be tested fully.

9 Without this, Mahathir might not have locked horns with the Malay rulers whose prerogatives he tried to reduce during theconstitutional crisis of 1983. The crisis ended in a stalemate, but Mahathir took advantage of more favorable circumstances togain a major victory over the Malay rulers in 1992-93.

7

The Political Economy of Adjustment, 1985-86

7.1 The Malaysian economy began to slide into recession at about the time Mahathircame to power. Perhaps Mahathir and Finance Minister Tengku Razaleigh Hamzahunderestimated the impact of the recessionary global economy on the national economy, orperhaps they took no chances with the 1982 general election. In any case, they responded to therecession by countercyclical spending through increased public sector consumption, investment,and employment. The economy had a mild recovery in 1983, but by 1985 it had fallen into amuch worse recession, which lasted until 1986 (Table 1). There were at least three majorcomponents to the 1985 recession-a global collapse in commodity prices; a sharp rise in public,especially foreign, debt; and a substantial decline in private investment.

Table 1: Macroeconomic Indicators, 1973-93(million ringget)

Fixed ca.ptIta formationYear Public Private Consumption Investment Exports/ Imports/ Real GNP Inflation

/GNP /GNP GNP GNP growth1973 1,203 2,908 74.53 26.52 50.51 50.27 - 10.51974 1,644 4,154 78.73 25.93 47.08 46.61 7.67 17.41975 2,110 3,492 69.90 22.96 53.84 42.98 2.22 4.51976 2,505 3,701 71.47 24.03 52.20 44.39 11.42 2.61977 3,078 4.387 73.08 24.53 53.70 47.71 7.47 4.81978 3,419 5,058 67.02 25.15 60.27 50.31 6.59 4.91979 4,135 6,701 71.33 30.19 61.65 57.73 7.76 3.61980 5,338 9,559 76.11 34.72 54.44 60.87 8.55 6.61981 7,206 12,044 74.88 38.11 53.35 62.49 7.23 9.71982 11,378 11,367 72.44 38.48 54.62 60.72 10.16 5.71983 12,521 12,692 69.20 34.23 58.20 56.15 3.86 3.71984 12,046 13,345 72.54 32.13 59.11 53.59 6.69 3.61985 10.854 12,270 72.63 28.18 60.20 53.68 -1.26 0.41986 8,639 10,226 66.81 24.46 68.03 52.98 2.70 0.61987 7,271 11,009 67.45 25.56 71.62 60.64 5.41 0.81988 7,946 13,976 69.23 31.09 77.73 71.15 9.45 2.51989 11,097 18,966 69.60 33.85 80.12 78.04 9.13 2.81990 13,283 24,207 72.30 37.38 85.37 91.55 11.29 3.11991 14,749 31,432 67.98 36.14 82.15 80.33 7.46 4.41992 16,653 34,044 64.68 34.88 83.74 78.65 7.55 4.71993 18,632 36,836 63.28 35.13 85.32 80.19 8.70 3.51994 22,340 40,224 8.57 3.4

Source: Ministry of Finance, Economic Report, various years.

23


The Collapse of Commodity Prices

7.2 Practically all of Malaysia's major commodities showed huge declines in earningsby the mid-1980s (Table 2). With crude petroleum prices having fallen from US$36.5 a barrel in1980 to US$14.7 a barrel in 1986, an even higher volume of petroleum exports earned less in1986 than earnings in 1980. Palm oil earnings fell from RM 4.5 billion in 1984 to RM 3.0billion in 1986. The tin industry in Malaysia had virtually collapsed by late 1985, when theInternational Tin Council Buffer stock manager ran out of money to maintain tin prices. Thevalue of Malaysia's tin exports in 1986 barely exceeded 25 percent of the 1980 figure.

Table 2: Unit Prices of Major Commodities, 1970-92Rubber Tin Sawlogs Palm oil Petroleum

Year (sen/kg) (RM/tonne) (RM/m3) (RM/tonne) (RM/tonne)

1970 128.1 10,938.7 72.3 657.5 43.11971 105.0 10,394.4 73.2 663.5 49.21972 95.1 10,311.9 64.9 520.3 52.41973 153.0 11,000.6 97.5 584.7 70.41974 183.9 17,671.3 107.9 1,204.1 214.01975 138.8 15,473.9 79.1 1,136.9 226.91976 192.4 18,724.5 120.9 914.6 244.61977 204.4 25,610.0 113.4 1,292.6 258.81978 223.1 28,800.8 99.6 1,235.3 245.51979 271.5 32,111.2 108.2 1,300.4 350.11980 302.7 36,048.7 172.7 1,152.7 597.61981 250.0 32,182.2 155.5 1,131.1 682.41982 192.7 30,543.1 175.3 973.4 642.61983 234.4 30,070.5 149.9 1,015.6 553.41984 230.8 29,351.5 165.7 1,524.6 529.61985 191.8 28,711.4 141.2 1,226.2 520.81986 209.9 16,086.2 150.8 696.6 287.41987 241.6 16,907.4 186.5 802.8 349.51988 326.3 18,625.4 195.0 1,089.6 307.41989 265.6 23,463.3 206.4 944.9 370.21990 229.1 17,118.4 198.5 776.6 481.21991 237.6 16,126.3 212.2 906.8 451.21992 227.8 15,962.0 214.8 974.1 405.0

Source: Bank Negara Malaysia, Quarterly Economic Bulletin, September 1993.

7.3 During this period, the government authorized increased timber extraction, giventhat sawlogs were the only primary commodity to sustain its prices. In addition, contractualexports of liquefied natural gas (LNG) to Japan, which had begun in 1983, grew in volumedespite lower prices. These two exceptions to the general decline in commodity export earningseased an otherwise (for Malaysia) unprecedentedly severe recession.

7.4 The overall effect of the commodities collapse on export earnings and staterevenues was tremendous. Optimistic after a threefold increase in export earnings between 1975and 1980, Malaysia's economic planners had forecast total export earnings of RM 63.1 billion in1985; the actual figure turned out to be only RM 37.6 billion!

The Political Economy of Adjustment, 1985-86 25

The Rise in Public Debt

7.5 Malaysia's public debt rose sharply during the first half of the 1980s. It hadbegun to rise in the 1970s as a result of deficit spending associated with NEP's implementation(Table 3). As real interest rates increased in the early 1980s (beginning from 1979 with theVolcker-induced deflationary liquidity contraction), Malaysia borrowed heavily from abroad.The Mahathir administration probably thought that it could spend its way out of the internationalrecession. Much of its countercyclical spending came in the form of Isi Penuh (a massive civilservice recruitment exercise), an expansion of NFPE activities (particularly those related to theheavy industrialization drive), and the commencement of some large-scale projects ininfrastructure and heavy industry. One other factor was responsible for the rapidly escalatingforeign component of the public debt-the sizable appreciation of the yen against the U.S. dollarfollowing the G-7 Plaza Accord of 1985.

7.6 Total public debt, which stood at RM 34.16 billion in 1981, rose to RM 46.18billion in 1982, RM 57.83 billion in 1983, RM 66.73 billion in 1984, RM 72.43 billion in 1985,and RM 87.06 billion in 1986, before it fell to RM 82.43 billion in 1987 (see Tables 4 and 5).The federal government foreign-debt-servicing ratio alone rose from 4 percent in 1980 to 13percent in 1984, and to 39 percent in 1985 (although this last figure included some major loanprepayments).10

Table 3: Federal Government Surplus/Deficit, 1975-93(million rlnggit)

Operating Development Total Overall OverallYear Revenue expenditure expenditure expenditure deficit deficit/GNP (%)1975 5,117 4,900 2,113 7,013 -1,896 8.81978 8,841 8,041 3,699 11,740 -2,899 8.41979 10,926 10,040 4,151 14,191 -3,265 7.61980 13,926 13,617 7,331 20,948 -7,022 14.21981 15,806 15,686 11,135 26,821 -11,015 19.91982 16,690 16,671 11,189 27,860 -11,170 18.71983 18,608 18,374 9,416 27,790 -9,182 14.01984 20,805 19,806 8,074 27,880 -7,075 9.51985 21,114 20,066 6,756 26,822 -5,708 7.91986 19,518 20,498 7,521 28,019 -8,501 12.71987 18,143 20,185 4,741 24,926 -6,783 9.11988 21,967 21,812 5,231 27,043 -5,076 5.91989 25,273 22,982 7,696 30,678 -5,405 5.61990 29,521 25,026 10,689 35.715 -6,194 5.61991 34,053 28,296 9,565 37,861 -3,808 3.11992 39,250 32,075 9,688 41,763 -2,513 1.81993 41,231 32,315 9,921 42,236 -1,005 0.6


1I For an extended analysis of Malaysia's fiscal and debt problems of the 1980s, see Jomo 1990 (pp. 166-200).


Table 4: Total Public Sector Debt, 1975-93(million ringgit)

Domestic debt, Extemal debt,Year Domestic debt percent of total debt External debt percent of total debt Total debt1975 8,927 75 3,013 25 11,940

1976 10,573 71 4,312 29 14,885

1977 12,709 73 4,740 27 17,449

1978 14,074 72 5,439 28 19,513

1979 16,744 72 6,636 28 23,380

1980 19,206 72 7,264 28 26,470

1981 22,929 67 11,231 33 34,160

1982 29,305 63 16,873 37 46,178

1983 34,612 60 23,215 40 57,827

1984 38,773 58 27,592 42 66,725

1985 41,510 57 30,918 43 72,428

1986 46,960 54 40,102 46 87,062

1987 54,796 66 27,629 34 82,425

1988 63,097 71 25,922 29 89,019

1989 65,763 73 24,182 27 89,945

1990 69,988 74 24,726 26 94,714

1991 73,654 74 25,418 26 99,072

1992 76,083 78 20,922 22 97,005

1993 78,402 80 19,834 20 98,236


Table 5: Outstanding External Debt, 1981-93(million ringgit)

Federal Government- Public sector Private sector Federal debt, Public debt, Total debt,govemment guaranteed debt debt Total percentage of percentage of percentage

Year debt debt debt GNP GNP of GNP1981 8,278 3,071 11,349 4,019 15,368 15 21 281982 13,158 3,715 16,873 7,410 24,283 23 29 421983 17,728 5,487 23,215 8,600 31,815 28 36 491984 20.848 7,105 27,953 9,665 37,618 28 38 511985 23.070 12 ,02 7 a 35,097 7,210 42,307 32 49 591986 28,310 14,585 a 42,895 7,474 50,369 43 66 751987 27,629 16,771 a 44,400 6,289 50,689 41 64 681988 25,922 16 ,183 a 42,105 4,868 46,973 30 49 551989 24,182 1 3 ,2 76 a 37,458 4,680 42,138 25 39 441990 24,726 11,819 36,545 4,943 41,488 22 33 371991 25,418 11,657a 37,075 6,713 43,788 21 30 351992 20,922 11,401 a 32,323 10,464 42,787 15 23 311993 19,362 16,5 16 a 35,878 14,875 50,753 12 23 32

Note:These figures include drawings from the IMF facility in federal government debt and are thus higher than the Ministry of Financefigures.

*: NFPEs only from 1985.

Source: Bank Negara Malaysia, Annual Report, various years.


Decline in Private Investment

7.7 Total private investment declined from RM 13.3 billion in 1984 to RM 10.1billion in 1986 (Table 1). Foreign corporate investment alone fell from a high of RM 3,262million in 1982 to RM 2,926 million in 1983, RM 2,138 million in 1984, RM 1,725 million in1985, and RM 1,262 million in 1986. Private investment as a proportion of GNP fell from about19.0 percent in the 1979-84 period to 14.0 percent in 1987. The decline in foreign and domesticinvestments continued until after 1987, when tightening labor costs, loss of Generalized Systemof Preferences (GSP) privileges, and rising production costs brought East Asian newlyindustrialized country (NIC) investment into Malaysia.

Holding NEP in Abeyance

7.8 After fifteen years of continued high growth, the economy contracted by 1.0percent in 1985 and managed to register a meagre 1.2 percent growth in 1986. Per capita GNP,having peaked at RM 4,800 in 1984, fell to RM 4,600 in 1985, and to RM 4,100 in 1986, beforerising to RM 4,500 in 1987. This time around (1985-87) there was no countercyclical spendingto cushion the recessionary effects. If anything, Mahathir and his new Finance Minister, DaimZainuddin (who had been appointed to replace Razaleigh in 1984), imposed heavy restraint onmost public spending. The federal government's development expenditure was severelyreduced-the 1987 development expenditure of RM 6,673 million was just over half the 1983figure of RM 11,670 million (Table 4). Increases in operating expenditure were stringently helddown, mostly by means of a job and wage freeze. Besides HICOM (Heavy IndustriesCorporation of Malaysia), which was engaged in Mahathir's heavy industrialization projects, thePEs were subjected to tighter budget constraints, greater monitoring, privatization, and evenclosure.

7.9 The Mahathir-Daim regime of fiscal austerity and contraction in state expenditurecontained bitter medicine for several groups. Unemployment shot up from a low of 5.0 percentin 1982 to 8.6 percent in 1987, and the total number of unemployed doubled between 1982 and1986. For the first time since the expansion of the universities under NEP, graduateunemployment, of Malay graduates in particular, became a serious problem. Bankruptcy becamefrequent among businesses dependent on state support and contracts, with the hardest hit thesmaller Malay companies. These were mostly contractors whose main source of business hadlong been government contracts and jobs. Not only was there a reduction of allowances forsenior bureaucrats, but these bureaucrats, along with those running the PEs, were publiclycriticized and ridiculed for low productivity and inefficiency, and some were told to resign if theycould not improve their performance.

7.10 Amid such economically difficult conditions, and facing widespread criticismover financial scandals and political crises, Mahathir led the BN to another victory in the August1986 general election. A detailed analysis of that victory, and of UMNO's landslide triumphagainst PAS (eighty-one out of eighty-two contests), is beyond the scope of this paper. Suffice it


to say that rising interethnic tensions, the prospects of a big DAP gain (which materialized),PAS's poor electoral campaigning, and Mahathir's political skills kept UMNO's Malayconstituency loyal to the party. Mahathir apparently considered this electoral triumph as a

popular vindication of his policies.

7.11 Before the election in 1986, he had initiated several measures to stimulate growth.Guidelines for foreign equity ownership in manufacturing were liberalized in July 1985. TheICA was amnended in December 1985 to make it easier for manufacturers to start new projects,expand their capacity, or diversify their products. In May 1986 the Promotion of InvestmentsAct provided additional tax incentives for manufacturing, agriculture, and tourism. The statealso launched a New Investment Fund to allocate funds at preferential interest rates for newprojects in these three sectors. With his August 1986 electoral victory, Mahathir was ready to

unveil the most drastic of his counter-recessionary measures-the suspension of NEP'srestructuring objective, or what he called keeping "NEP in abeyance."

7.12 At the end of September 1986, he announced a set of new, more liberal conditionsfor foreign equity and expatriate staffing in an effort to attract new foreign investment. Acompany that exported at least 50 percent of its output or hired at least 350 Malaysian workerswould be permitted to hold whatever level of foreign equity it requested. The only major

stipulation was a requirement that employment in new foreign ventures should approximate theethnic composition of Malaysia, and Mahathir promised foreign investors who committedinvestments between I October 1986 and 31 December 1990 that they would not be required torestructure their equity at any time.

7.13 Mahathir knew that placing NEP in abeyance could be politically risky. He

justified it on entirely pragmatic grounds: without new investments, there would be noemployment; without growth, there could be no distribution. The liberalization of foreign equityownership in September 1986 was followed by another amendment to the ICA so that only firmshaving more than seventy-five workers or RM 2.5 million in paid-up capital had to comply withthe ICA requirements." This was a major concession in NEP implementation to benefit localChinese capital. Thus, the fiscal adjustments induced by the recession eventually led toderegulation, economic liberalization, and a virtual end to state intervention.

Responses to Adjustment

7.14 How was the overall adjustment-deregulation package received? There appear tohave been no clean class or monolithic ethnic cleavages in the response. Labor was generally tooweakly organized and too divided to mount a coherent opposition to Mahathir's initiatives.Workers in a sector such as tin mining, which had been virtually shut down, or employees in theFTZs, which were effectively prohibited from unionizing, were not in a position to respond to thefinance minister's call for a voluntary three-year wage freeze (without a concomitant price

1 Until the December 1985 amendment, ICA requirements covered firms employing more than twenty-five workers or havingRM 250,000 in paid-up capital. The December 1985 amendment raised the minimum number of workers to fifty and the paid-upcapital to RM I million.


freeze) in October 1986. One segment of labor that still had some bargaining power wasCUEPACS, the Congress of Unions of Employees in the Public and Civil Services. For sometime since Mahathir had become prime minister, CUEPACS had demanded a pay revision forgovernment employees. After rounds of inconclusive negotiations, with the state intransigentand CUEPACS mildly threatening industrial action, the government decided not to run the riskof offending one of the state's traditional electoral bases before an impending general election.In 1985 a 6 percent wage increase was granted to about 800,000 category C and D employees-that is, those on the lowest two scales of the civil service.

7.15 The urban non-Malay middle class had mixed reactions. It had been extremelydiscontented with the Mahathir administration's handling of several financial scandals-themajor ones involving Bumiputera Malaysia Finance (BMF), Pan Electric Industries (PanEI),Maminco, the Employees Provident Fund (EPF), and Makuwasa. It had expressed itsdisaffection during the August 1986 election, sweeping DAP into most of the large, urban, non-Malay constituencies. But as a class, it was relatively well-insulated against the (relatively short-lived) recession. It was not unfavorably disposed toward deregulation, suspension of NEPrestructuring, privatization, and economic liberalization because it had long resented bureaucraticpower, ineptitude, and shortcomings. For the urban non-Malay middle class, privatization,deregulation, and reduced state intervention implied fewer restrictions and greater opportunities.Holding NEP in abeyance had symbolic significance as well, given the non-Malay middle-classgrievances against NEP's ethnic discrimination.

7.16 Local capital, especially Chinese, generally welcomed the deregulation. The"NEP in abeyance" policy immediately satisfied their long-standing opposition, to the ICA inparticular. Mahathir and Daim's firmness in reducing state expenditure and debt, holding downwage levels, and reducing state intervention went down well with both local Chinese and foreigncapital. Significantly, most of the larger and more successful Malay capitalists were notnecessarily opposed to deregulation, especially those who gained from privatization. For thosewho had been groomed and protected by the state, but had succeeded and become economicallymore resilient, growth had a higher priority than distribution. They saw NEP's protection of theMalays as less critical than the need to counter the negative impact of excessive intervention andregulation in economic performance.

7.17 This left essentially two social groups, who arguably lost the most from theMahathir-Daim adjustment policies. One group comprised mainly small to medium-size Malaybusinesses badly affected by the contraction in state expenditure and the shortening of theirlifeline of state contracts, finance, and assistance. This group of businesses saw the narrowing ofstate patronage as cronyism, and blamed Daim. The other group mainly consisted of middle-ranking bureaucrats and PE managers, whose base in government and the PEs had been eroded.This group was more staunchly in favor of redistribution, and continued to press for acontinuation or even an extension of NEP restructuring. One observer noted that relaxations onforeign investment, equity conditions, and the ICA, as well as the "strong undertaking to promoteeconomic growth came as a major shock" to these groups of Malays (Marican 1987, p. 10).

8

Consolidation after the Crises: Vision 2020

8.1 During the period from 1987 to 1990, a good part of disenchantment withMahathir's adjustment policies was mediated through UMNO itself, and expressed in the form ofRazaleigh's initially strong, but ultimately unsuccessful, challenge to Mahathir's leadership ofthe party and, by extension, of the nation. In the wake of this challenge and other opposition tothe major policies of the Mahathir regime there were three major political crises: the mass arrestof opposition politicians, nongovernmental organization (NGO) representatives, and otherdissidents in October 1987; the High Court declaration that UMNO was an illegal party inFebruary 1988; and the sacking of the lord president of the Supreme Court in mid-1989. ButMahathir weathered all those political storms, and by the time he led BN into general electionsfor the third time, in October 1990, his position had been well consolidated. In November 1990BN once more gained a comfortable electoral victory.

8.2 By then, however, the "politics of economic adjustment" had ended. The year of1987 still saw modest economic growth of 5.2 percent, but from 1988 to 1990 there was anaverage annual growth rate of over 9 percent. Part of the turnaround arose from improvedcommodity prices and increased commodity export earnings, which climbed to RM 28.97 billionfrom RM 23.93 billion in 1985. By 1990, the value of manufacturing exports had risen to RM48.05 billion from RM 12.47 billion in 1985, an average annual increase of 31 percent (BankNegara Malaysia, Annual Report 1993). Manufacturing employment grew at an average annualrate of 12 percent between 1986 and 1990. The previous trend of declining private investmentwas reversed. In manufacturing alone, the proposed capital investment of all industrial projectsapproved for 1990 was RM 28.17 billion, compared with RM 5.69 billion in 1985. Foreigninvestments in approved industrial projects amounted to RM 17.63 billion in 1990, comparedwith RM 959 million in 1985. The principal sources of these post-1986 investment inflows wereTaiwan (China),'2 Japan, and Singapore, economies that were prompted to relocate some of theirmanufacturing activities because of rising production costs, tightening labor markets, and stricterenvironmental restrictions at home. Such considerations would have combined with a post-1986investment regime of liberal equity requirements, easier start-up conditions, substantial ringgitdepreciation, and lower labor costs to make Malaysia an attractive site for industrial relocation.

12 Total investment from Taiwan (China) in Malaysia during the Fifth Malaysia Plan period of 1986-90 reached RM 9.58billion. For 1990 alone, Taiwanese investment was RM 6.34 billion, compared with RM 32 million in 1985. See Malaysia1991b ( p. 133, table 4.6).

31


8.3 From the point of view of understanding vision acceptance and governancecapacity in relation to structural adjustment and economic reform, the fact and scale ofMalaysia's dramatic economic turnaround are far more important than whether one candisaggregate the differential effects of home-based factors as opposed to Mahathir's policies onthe decisions of foreign investors. Mahathir could well claim that he and Daim contained therecession by their austerity drive, boosted foreign investment by suspension of NEP, andstimulated economic growth by their reliance on the private sector. Certainly he would haveconsidered the expansion of the manufacturing sector to be a sign that his vision of NICdom wasnot far from being realized.

8.4 The empirical evidence of a strong post-1987 economic performance would havebeen enough to vindicate Mahathir's policies, not just in his own eyes, but in public perception aswell. Mahathir had previously justified his adjustment policies on the entirely pragmatic groundsof reversing recession and stimulating growth. The rationale for holding NEP in abeyance wasdifferent from the National Development Policy (NDP) promulgated after 1990. But some of theadministration's convictions and assumptions, particularly those associated with deregulation,economic liberalization, and privatization, were retained as major components of an ideologicallymore coherent and more assertive Mahathirist vision, now known as Vision 2020.

8.5 NEP was promulgated with a two-decade span for achieving its povertyeradication and restructuring targets. Notwithstanding some problems engendered by NEP, orthe suspension of NEP itself in 1986, both NEP objectives and targets had been substantiallyattained by 1990. Despite some controversy over official data, the incidence of poverty haddeclined from 49 percent in 1970 to about 17 percent, according to official statistics. Despite asimilar controversy over the extent of Bumiputera equity, there had also been an increase of theBumiputera share of corporate equity, from 2.5 percent in 1970 to at least (and probablyconsiderably more than) 20 percent in 1990. Bumiputera companies, including some stateagencies and funds, now controlled the "commanding heights" of the Malaysian economy.Bumiputera professionals, who made up less than 5 percent of major professional categories in1970, constituted over 29 percent in 1990. The working class in the modern manufacturingsector probably best reflected the ethnic composition of the labor force. Whatever one's positionon NEP might have been, it had been a success by the standards it set for itself.

8.6 It was with that kind of an assurance that on 28 February 1991, Mahathirpresented a working paper-"Malaysia: The Way Forward"-to the Malaysian Business Council,a newly formed, sixty-two-member body comprising the state elite and captains of commerce andindustry. Mahathir's inaugural speech unveiled his socioeconomic agenda for the nation, whichwas later elaborated as the NDP associated with the post-NEP Second Perspective Plan, 1991-2000, released just before the Sixth Malaysia Plan, 1991-95. But Mahathir's post-1990 agendahas been more popularly known as Vision 2020.

8.7 Vision 2020 seeks to propel Malaysia into the ranks of the developed countries bythe year 2020. This ambitious objective is to be attained through a combination of intensifiedindustrialization, increased productivity, enhanced managerial ability, improved technologicalproficiency, heightened competitiveness, and corporatist cooperation between the state and the

Consolidation after the Crises: Vision 2020 33

private sector. Strategically, Vision 2020 relies on export-led growth, direct foreign investment,privatization, deregulation, and promotion of small-scale industries. Politically, it also talks ofnational unity, but veers away from the narrower ethnic concerns of NEP. For Vision 2020 to beattained, the Malaysian economy must fulfill a targeted average annual growth rate of 7 percentbetween 1990 and 2020. This was a realistic target, Mahathir declared, given that the Malaysianeconomy had grown by an average annual rate of 6.9 percent in the preceding twenty years.

8.8 Soon after 1990, NEP's catchwords were no longer heard. High growth andexpanded economic opportunities have relegated the 1980s' ethnic disputes to obscurity.'3 TheNFPEs have lost their influence; the social enterprises that once aggressively carried outrestructuring have been superseded by the private enterprises now aggressively pursuing profits.The state has put itself "out of business" and has turned to private capital with touching faith.Now Vision 2020's catchwords are dominant: free enterprise, market forces, productivity,competitiveness, excellence, and so forth. Vision 2020 already seems to have gained ageneralized acceptance within Malaysian society. It was never absolutely clear that NEP wouldcome to an end in 1990 and be superseded by an overarching successor policy. Perhaps the"grandiose" and "universalizing" Vision 2020 fulfilled, and thereby profited from, long-feltsocial desire for, and expectations of, a new foundation for a post-1990 Malaysian society. WhenMahathir's reforms, policies, and pet projects first appeared, they were sometimes greeted withskepticism. When deregulation was initiated, it met opposition. It has been entirely differentwith Vision 2020. Almost no one greets it with derision, and one finds no trace of an alternativeor competing agenda being offered for public debate. In that sense, Vision 2020 benefited fromone unimpeachable factor: the 1985-86 recession was relatively short, and the recovery wasdramatic. In the end, probably nothing breeds acceptance better than success.

13 Except for Sabah, where the rise of a Kadazan cultural nationalist movement defied Mahathir's attempts to defeat it until justafter the February 1994 Sabah state election.

9

Conclusions

9.1 Of our two Malaysian experiences of structural adjustment-that is, NEP andVision 2020 (or the reversal of NEP)-the 'visionary" aspect of NEP appears, at first glance, tohave been the stronger. Then, in 1970, there arose a dire political need for a vision of areconstructed, post-1969 Malaysia. Then vision preceded and laid the foundation for economicadjustment, principally in the form of state intervention in pursuit of interethnic redistribution.There is no need to repeat our discussion of the role governance capacity played in getting NEPaccepted, although not without reservations and differences.

9.2 It is possible to argue that it was partly the failure of governance in handling stateintervention and public sector expansion during NEP's first fifteen years that precipitated theeconomic and political crises and generated the need for the structural adjustment policies of1986. Public enterprises are not preordained to fail, as their record in Malaysia's neighbor,Singapore, shows. But too many of Malaysia's PEs, established in the name of NEP andinterethnic restructuring, were badly managed or provided a license for inefficiency, politicalpatronage, or corruption, with little regard for accountability, profitability, and budgetarydiscipline. Malaysia's bureaucracy has neither been a model of efficiency and competence, noran appalling example of hopeless ineptitude. It could be more accurately characterized as havingvacillated among different levels of competence and ability-between rising effectively to NEPstargets and falling into the PEs' insolvency. Seen in terms of administrative capability, thegovernance capacity of the Malaysian state has, at most, been inconsistent-buoyed by favorableeconomic conditions, but threatened in the face of recession.

9.3 In contrast, perhaps, executive capacity to initiate policies and program-vision-building-has been rather more apparent, whether in the aftermath of the violence of 13 May1969, or when faced with the recession and crises of the mid-1980s. In the latter instance,particularly in relation to post-1990 policy, it would seem that Vision 2020 attempts toconsolidate the relatively successful policy adjustments around 1986, when Mahathir took thebold step of suspending NEP. If one views it from that viewpoint, then Vision 2020 seems lesslike a new initiative than an afterthought, a fate accompli, which consolidated rather thanprescribed the success of Mahathir's economic adjustment.

35

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