Report No. 3851-MA FILE COPYMalaysiaDevelopment Issues and Prospects ofSmall Enterprises(In Three Volumes) Volume 1: Summary Report and RecommendationsJune 25, 1982Projects DepartmentEast Asia and Pacific Regional Office

FOR OFFICIAL USE ONLY

Document of the World Bank

This document has a restricted distribution and may be used by recipientsonly in the performance of their official duties. Its contents may not otherwisebe disclosed without World Bank authorization.

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CURRENCY EQUIVALENTS

Currency Unit - Ringgit (M$)

M$1 US$0.44US$1 M$2.25

ABBREVIATIONS

BEP - Bumiputra Entrepreneurship ProgramBPM - Bank Pertanian MalaysiaBPMB - Bank Pembangunan Malaysia BerhardBNM - Bank Negara MalaysiaCCDSE - Coordination Committee for Development of Small Enterprises

CCc - Credit Guarantee CorporationEDPs - Entrepreneurship Development Programs

EPU - Economic Planning UnitFA - Financial Assistance (programs)FMP - Fourth Malaysia PlanFTZs - Free Trade ZonesGOM - Government of MalaysiaICA - Industrial Coordination Act, 1975

LSEs - Large-Scale Enterprises (employing 200 or more persons)

MARA - Majlis Amanah Rakyat-CYSYD - Ministry of Culture, Youth and Sports - Youth DivisionMEDEC - Malaysian Entrepreneurship Development Center

MIC - Malaysian Industrial Classification (Updated)

MIDA - Malaysian Industrial Development AuthorityMIDF - Malaysian Industrial Development Finance Co.

MIDFIC - MIDF Industrial Consultants Sendirian BerhardMIEL - Malaysian Industrial Estate Sendirian BerhardMLEs - Medium- and Large-Scale Enterprises (employing 50 or more persons)

MSEs ! Medium-Scale Enterprises (employing 50 to 199 persons)

MTISED - Ministry of Trade and Industry - Small Enterprises Division

MTISSED - Ministry of Trade and Industry - Small-Scale EnterpriseDepartment

NEP - New Economic PolicyNPC - National Productivity CenterPE - Pernas-Edar BerhardSIRIM - Standards and Industrial Research Institute of Malaysia

SSEs - Small-Scale Enterprises (employing 5 to 49 persons)SSIs - Small-Scale (Manufacturing) Industries (employing 5 to 49 persons)SLS - Special Loan SchemeSLGS - Special Loans Guarantee SchemeTA - Technical AssistanceTSEs - Tiny-Scale (or Traditional) Enterprises (employing 1 to 4 persons)

GOVERNMENT OF MALAYSIAFISCAL YEAR

January 1. - December 31

FOR OFFICIAL USE ONLY

MALAYSIA

DEVELOPMENT ISSUES AND PROSPECTS OF SMALL ENTERPRISES

VOLUME I: SUMMARY REPORT AND RECOMMENDATIONS

Table of Contents

Page No.

PREFACE . ...... ... ............. . . . . ... (2)

BASIC DATA ..... . . . . . . . . . . . . . . . . . ...... . (3)

A. Scope of the Report . . . ...... ........... . ... . . . i

B. The Overall Setting .... . . . . . . . . ....... . . . i

C. Characteristics of the Tiny and Small-Scale EnterpriseSector . . . . . . . ... . ... .... ... . .... ....... .... ..... iii

(i) Tiny-Scale Enterprises . . . . . . . . . . . . . . . . . . iii(ii) Small-Scale Enterprises . . . . . . . . . . . . . . . . . . v

D. An Assessment of the Policy Framework and Government'sSSE Support Programs . . . . . . . . . . . . . . . . . . . . vii

(i) Problems of the Existing Incentives Environmentand Possible Solutions . . .viii

(ii) Key Issues in Direct Support Programs and Measuresto Improve Them . . . . . . . . . . . . . . . . . . . . . x

(a) Financial Support Services . . . . . . . . . . . . . . . x(b) Technical Assistance Programs . . . . . . . . . . . . . xiii(c) Measures to Increase SSEs' Access to Markets and

Improved Technology .... . . . . ........ . xvi,

E. General Directions and Priorities of Policy Adjustments . . . . xviii

F. Broad Effects of Proposed Measures . . . . . . . . . . . . . . xix

G. Concluding Remarks .... . . . . . . . . . . . . . . . . . . xx

This document has a restricted distribution and may be used by recipients only in the performance oftheir official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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PREFACE

A Bank sector review mission visited Malaysia from October 5 toOctober 28, 1981. The mission's purpose was to undertake a study of thecurrent situation and prospects of small enterprises in Malaysia with a viewto: (a) identifying the main problems facing Small-Scale Enterprises (SSEs)and (b) suggesting changes in the policy environment and institutional setupwhich would attempt to resolve these problems. This report presents themission's findings and a broad perspective for designing a program ofassistance for SSEs in Malaysia.

The mission's main counterpart was the new Small-Scale EnterpriseDevelopment Division of the Ministry of Trade and Industry established inearly 1981. The mission views this exercise as a cooperative effort betweenthe Government and the Bank to understand the nature of SSE activities andconstraints on their expansion, to make suggestions for improvement in theincentives and policy framework, and to develop a program of assistance whichwould attempt to remove these constraints and enable SSEs to participate morefully in the development process.

The main sector review mission consisted of the following members:

Fateh M. Chaudhri - Chief of MissionVinod Prakash - General EconomistHenry Warren (Consultant) - Technical Extension ExpertErnst Bolte (UNIDO) - SSE Subsector Analyst

Messrs. Hasan and Lesshafft provided the mission with anassessment of the existing financial support program for SSEs in Malaysia.

Mr. Chee Peng Lim of the University of Malaya also assisted themission as a consultant and provided background information on the statis-tical profile, entrepreneurship development programs and policy/incentivesframework affecting the SSEs in Malaysia.

A draft report was discussed with government officials in KualaLumpur during May 24-29, 1982, by a Bank team led by Mr. Edward V.K. Jaycox.This version of the report reflects those discussions.

This report consists of three volumes:

Volume I: Summary Report and RecommendationsVolume II: Main ReportVolume III: Annexes and Statistical Tables

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MALAYSIA: BASIC DATA: SMALL ENTERPRISE SECTOR STUDY /a

1980: Population: 13.55 million (11.25 million in Peninsular Malaysia)GNP per capita at current prices: M$3,650

M$ billion at Structure (%) Annual growth1970 prices 1970 prices Current rate (%)

Sectors 1971 1980 1971 1980 1980 73-78 71-80

GDP 13.0 26.1 100.0 100.0 100.0 7.0 8.0Manufacturing 1.9 5.1 14.3 19.4 n.a. 10.2 11.8Trade, hotels and

restaurants 1.7 3.3 13.2 12.5 n.a. 6.8 7.4Construction 0.5 1.2 4.2 4.6 n.a. 7.1 9.2

PRINCIPAL STATISTICS BY SIZE OF TOTAL EMPLOYMENT, 1978 /b

Establishments ('000 no.) Employment ('000 no.)Sectors TSEs SSEs MSEs LSEs Total TSEs SSEs MSEs LSEs Total

Manufacturing 4.7* 5.0* 1.1 0.4 11.2* 13.6* 80.4* 106.0 206.7 406.2*Retail trade 70.0 4.8 0.1 Neg. 74.8 137.3 38.7 10.9 2.4 189.3Wholesale trade 7.8 7.1 0.2 Neg. 15.1 21.1 71.0 14.7 4.0 110.9Construction 1.0* 4.7* 0.5 0.1 6.4 3.8* 56.9* 47.3 39.2 147.4Mining Neg. 1.1 0.2 Neg. 1.3 Neg. 28.0 18.2 3.5 49.7Produce brokers 1.9 0.7 Neg. Neg. 2.7 4.8 7.0 3.2 2.4 17.4

Total (34 sectors) 95.0 28.7 2.5 0.6 126.9 202.4 346.1 232.0 286.7 1,067.2

Value added (M$ million) Fixed assets (M$ million)TSEs SSEs MSEs LSEs Total TSEs SSEs MSEs LSEs Total

Manufacturing 65* 705* 1,700 2,981 5,452* 74* 587* 1,492 3,167 5,320Retail trade 407* 318* 156 27 907* 184* 181 71 28 464Wholesale trade 259* 1,414* 765 218 2,654* 99* 616 264 134 1,114Construction 7 370* 387 325 1,090* 3* 179 124 102 408Mining Neg. 295 407 104 806 Neg. 174 221 49 444Produce brokers 29* 212 223 139 602 11 45 24 23 103

Total (34 sectors) 863 3,784 4,160 4,088 12,894 594 2,466 2,619 4,249 9,928

LABOR PRODUCTIVITY (value added per person engaged in M$'000), 1978 /b(Absolute value and total sector index = 100)

Sectors TSEs SSEs MSEs LSEs Total

Manufacturing 4.8* (36) 8.8* (66) 16.0 (119) 14.4 (107) 13.4* (100)Retail trade 3.0* (62) 8.2* (171) 14.3 (280) 11.3 (235) 4.8* (100)Wholesale trade 12.2* (51) 19.9* (83) 52.1 (217) 53.9 (225) 24.0* (100)Construction 1.9* (26) 6.5* (88) 8.2 (111) 8.3 (112) 7.4* (100)Mining n.a. n.a. 10.5 (65) 22.4 (138) 29.7 (183) 16.2 (100)Produce brokers 5.9 (17) 30.4 (88) 69.6 (201) 58.6 (169) 34.6 (100)

Total (34 sectors) 4.3 (36) 10.9 (90) 17.9 (148) 14.3 (118) 12.1 (100)

CAPITAL PRODUCTIVITY (ratio of value added to value of fixed assets), 1978/c

Manufacturing 0.9* (86) 1.2* (118) 1.1 (112) 0.9 (92) 1.0 (100)Retail trade 2.2* (113) 1.7* (89) 2.2 (112) 1.0 (51) 2.0 (100)Wholesale trade 2.6* (110) 2.3* (96) 2.9 (121) 1.6 (68) 2.4 (100)Construction 2.8* (105) 2.1* (78) 3.1 (116) 3.2 (119) 2.7 (100)Mining n.a. n.a. 1.7 (94) 1.8 (102) 2.1 (100) 1.8 (100)Produce brokers 2.6 (44) 4.7 (80) 9.4 (160) 6.1 (104) 5.9 (100)

Total (34 sectors) 1.4 (112) 1.5 (118) 1.6 (122) 1.0 (74) 1.3 (100)

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AVERAGE ANNUAL GROWTH RATE (%), 1973/74-1978

No. of persons engaged Value addedSectors TSEs SSEs MSEs LSEs Total TSEs SSEs MSEs LSEs Total

Manufacturing n.a. 4.1* 5.9 9.8 7.6* n.a. 14.4* 18.9 20.0 19.0*Retail trade 0.1 2.5 27.0 11.4 1.6 11.1* 8.4* 42.0 -13.1 11.8*Wholesale trade 3.9 5.8 7.5 8.7 5.7 10.7* 10.1* 14.6 19.2 12.0*Construction 10.0* 9.8* 8.6 6.8 8.6 49.0* 30.0* 24.0 18.8 24.0*Mining -23.0 -3.4 1.4 -5.5 -1.9 -32.0 10.5 13.6 5.6 11.2

Total (5 sectors) 0.9 3.3 5.6 9.0 4.9 11.4 11.7 18.3 18.7 15.7

ECONOMIC SIGNIFICANCE AND RELATIVE EFFICIENCY OF MANUFACTURING SSIs, 1978/d

Total SSIs/VA total SSEs/MLEs (I)

Industries (M$ (%) FA VA VA LE GP RE indexmln.) VA TL TL TL FA TL FA A B

Canning, preserving & processing of fish 27 12 8 163 167 103 128 114 123 118Leather footwear 7 27 27 30 103 346 109 327 236 229Wood & cane containers 6 78 74 103 122 119 104 140 120 122Palm kernel oil 21 71 61 77 153 198 44 321 188 257Iron foundries 43 20 31 27 56 204 81 164 155 137

Agriculture machinery & equipment 11 48 48 62 102 165 76 194 142 152Clothing factories 70 16 21 58 70 122 84 104 98 95Soft drinks & carbonated water 49 7 16 71 37 52 54 46 49 48Paints, varnishes & lacquers 37 13 24 51 48 94 43 97 83 85Cables & wires 36 3 7 53 44 83 56 74 72 69

FINANCING OF SMALL ENTERPRISES, 1976 and 1980/e(Outstanding loans as on December 31 in M$ million)

1976 _ 1980Commercial Commercialbanks banks

Under Finance Under FinanceSectors Total CGC companies Total /f Total CGC companies Total /f

Agriculture 84 12 77 173 280 22 169 471Manufacturing 151 10 45 206 513 11 130 6'54Commerce 390 19 66 475 1,230 27 195 1,452Construction 114 10 64 188 338 10 203 5'51Others 451 38 110 599 970 54 385 1,409

Total 1,190 89 362 1,641 3,331 124 1,082 4,537

* Mission's estimate. Neg: Negligible. na: Not available or not applicable.

/a All statistics by employment size segments relate to 1978 for Peninsular Malaysia only.lb TSEs: <5, SSEs: 5-49, MSEs: 50-199 and LSEs: >200 persons engaged; MSEs + LSEs = MLEs.7- Total assets (fixed plus stocks) would be more appropriate, particularly for retail and

wholesale trade./d Manufacturing SSIs cover only establishments employing 10 or more paid full-time

employees, except in wooden and cane containers where establishments with 5 to 9, and inpalm kernel oil and paints, varnishes and lacquers where below 10, are also covered.VA = value added, TL = total employment, FA = fixed assets, LE = wages and salaries (laborearnings), GP = gross profit (= VA - LE); relative efficiency (RE) Indexes A and B arederived respectively from (relative labor productivity and relative capital productivity)and (relative labor earnings and relative return to capital) by assigning weights (laborearnings/value added, and gross profit/value added) to them.

/e Defined as loans of M$250,000 or less (excluding trade bills) extended to enterpriseswith fixed assets not exceeding M$500,000.

/f Includes loans from specialized institutions (MIDF, BPMB and BPM).

VOLUME I: SUMMARY REPORT AND RECOMMENDATIONS

A. Scope of the Report

1. This report presents the findings of a Bank sector review missionthat visited Malaysia from October 5 to October 28, 1981. The mission's aimwas to assess the current situation and growth prospects of the small-scale

enterprise (SSE) sector in Malaysia. This included:

(a) developing a broad statistical profile of SSEs in Malaysia;

(b) identifying the principal constraints hampering the growth ofSSEs, and suggesting possible solutions to help SSEs realize theirpotential;

(c) assessing the policy framework and its impact on the developmentof SSEs;

(d) ascertaining the effectiveness of the existing support programsand institutions (e.g. availability and terms of finance,technical assistance delivery systems, entrepreneurshipdevelopment programs, etc.); and

(e) formulating recommendations concerning the organizational/institutional setup and policy initiatives in the contextof future assistance and government strategy for the promotion ofSSEs in Malaysia.

B. The Overall Setting

2. The principal development theme in Malaysia since the adoption ofthe New Economic Policy (NEP) in 1971 has been the reduction of povertyamong all Malaysians and the eventual elimination of the identification ofrace with economic function and geographic location. Government hasreiterated this theme in its five-year plans and is trying to realize basicNEP objectives through rapid expansion of the economy.

3. By developing and exploiting its natural resources, Malaysia hasachieved a high per capita income of about US$1,800 in 1981. An impressiveGDP growth, about 8% p.a. in real terms over the last decade, was achieved in

an open economy (imports and exports are each equivalent to more than half of

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GNP) and was accompanied by considerable improvements in the quality of lifein the areas of health, education and nutrition for all Malaysians.While the aggregate numbers and indeed the trend indicators on the nationaleconomy and quality of life are impressive, the Malaysian Government estimatedthat about 40% of the population in 1976 had insufficient means to provide fortheir minimum basic needs. The probLems of poverty and uneven distribution ofincome remain serious. The incidence of poverty covers all ethnic groups butremains disproportionately high among Malays; their average per capita incomeswere only half those of the Chinese community. The Government has, therefore,continued to give top priority to the reduction of poverty and socialimbalance in incomes, employment and ownership of assets by emphasizing theneed for accelerated growth of the modern sector (i.e., outside traditionalagriculture). About 2 million jobs (or 90% of all new employment) need to becreated in the nonagricultural sectors during 1975-90.

4. The remarkable growth of the manufacturing sector - about 12% p.a.in real terms during 1960-80 - has greatly assisted the Governmenit in itsintention to use it as a vehicle to achieve the NEP objectives. liowever, acloser assessment of its performance also shows that: (a) much oE the growthhas come from medium and large enterprises (MLEs) and Free Trade :Zone (FTZ)firms, all of which received more incentives than SSEs; (b) most of theindustries showing deceleration in the growth of employment, incomes etc.(during 1973-78) were resource-based agroindustries in which SSIs areprominent; and (c) even among the nonresource-based industry groups, theengineering and machinery subsectors have remained small, and the metalproducts components of these subsectors, in which SSIs dominate, have onlymarginally contributed to and benefitted from the development process. Thepresent survey attempts to go beyond the above conclusions of an earlierreport /1 by delineating the Government's socioeconomic objectives in thepromotion of SSEs, by analyzing the operational and economic characteristicsof SSEs in relation to other segments and by assessing the policy frameworkand its impact on SSEs.

5. The Government's basic objectives in the promotion of SSEs are to:(a) develop bumiputra entrepreneurshLp; (b) increase productive employmentand ensure higher incomes for the largest and poorest segment of thepopulation; and (c) achieve regional dispersion of business and industrialactivities to secure better use of rural resources, wherever economicallyviable. These objectives provided the necessary perspective to the mission'sanalysis. Based on that analysis in Malaysia and similar analyses in manyother countries (particularly relating to their manufacturing secltor), thisreport concludes that certain categories of small-scale enterprises (SSEs) inMalaysia are a useful vehicle to achieve the broad socioeconomic objectives,because they: (i) employ workers wit:h limited formal training, of whom thereare many among the bumiputras; (ii) provide better opportunities Eor produc-tive outlets for the talent and energies of enterprising persons than largerorganizations and a testing place for new industries; (iii) utilize scattered

/1 "Malaysia's Manufacturing Sector: Development Issues and Policy Options,"The World Bank, April 1981.

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raw materials and offer effective means to serve limited and specializedmarkets that are not attractive to large enterprises; (iv) mobilize smallpersonal savings; and (v) promote agroindustrial linkages and provide flexibi-lity to the industrial structure by being complementary to large-scaleenterprises. But most importantly, the mission analysis has confirmed thatwithin the broad SSE segment, some manufacturing SSI activities score quitehigh relative to larger enterprises in terms of employment generation andefficient use of capital despite the severe constraints they face. In thisrespect the report argues that the establishment of a neutral policy regime(as between smaller and larger enterprises) would create an environment andclimate that would be more conducive to SSE promotion, which would, in turn,reduce the cost of achieving the above-stated objectives.

C. Characteristics of the Tiny and Small-Scale Enterprise Sector /1

(i) Tiny-Scale Enterprises (TSEs)

6. It is estimated that a total of 127,000 establishments, spread over34 sectors, were engaged in a wide variety of nonagricultural economicactivity in Peninsular Malaysia during 1978. Some 95,000, or about 75%,

/1 Available information on SSEs is meager and fragmentary. The difficul-ties faced by the mission in developing a profile of the small-scaleenterprise sector were enormous and have been discussed in Volumes IIand III of this report. The latest year for which the data weregenerally available in October 1981 was 1978. (The mission understandsthat the 1979 data became available in March 1982.) Even for 1978, thedata by employment or fixed assets by size groups were not fullyavailable for some important sectors. For example, for 63 manufacturingindustries out of a total of 118, no data were available forestablishments employing less than 10 paid full-time employees. Also,there are large gaps between the results of labor force andestablishment surveys: Some 270,000 persons (25% of the labor force) in1973 and 650,000 persons (40% of the labor force) in 1978 remainedunaccounted by the latter. Moreover, these surveys did not consistentlycover certain important activities (e.g. no consistent time-series dataare available for road transportation). Disaggregated data were notavailable in certain size groups (e.g. 20-29 and 30-49 employees) inimportant activities like retail and wholesale trade. Further, thestates of Sabah and Sarawak generally remained outside the purview ofthe statistical analysis due to the nonavailability of compatible data.

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were tiny or very small /1 enterprises (TSEs); very few of them employed even4 persons. These TSEs accounted for 19% of total employment, 12% of the grossoutput and only 6% to 7% of the fixed assets or value added of al-L 127,000establishments in 1978./2 As expected, TSEs were most dominant in the retailtrading sector. Over 90% of retail trading businesses belonged to thissegment, accounting for 70% of the emnployment and 45% of the value added orturnover of the entire retail trading sector in 1978. Other activityareas in which TSEs played an important role were: road haulage, producebrokers, and wholesale trade. Tiny manufacturing establishments, though largein number, contributed relatively little to value added, gross output or fixedassets.

7. The evidence from Taiwan (China) shows that the employment shareof manufacturing TSEs declined from 75% of the total manufacturing in 1915to 25% in 1940./3 During the postwar period the relative position of theTSEs continued to decline at a moderate pace, but after 1961 the rate ofdecline increased significantly. The evidence from Korea and Japan alsosuggests that as these economies developed, the significance ofmanufacturing TSEs declined, but the contribution of manufacturing SSIscontinued to be significant for a long time during the transition towardsthe modernized economy. Furthermore, other studies have shown that the moresuccessful entrepreneurs very often have a background in trading in whichtiny firms dominate in the early phase of development. These cross-countryexperiences suggest that the Government of Malaysia's (GOM's) involvement inthe strengthening of TSEs would be of a limited duration, but at the sametime these enterprises do offer a good breeding ground for successfulentrepreneurs in small-scale manufacturing. TSEs basically represent ascreening mechanism for future entrepreneurs and in this context theMARA-type socio-economic programs have a contribution to make.

/1 In general, the employment-size criterion was adopted in this report toclassify establishments into four segments: (i) tiny-scale enterprises(TSEs), employing less than 5 persons; small-scale enterprises (SSEs),employing 5-49 persons; medium-scale enterprises (MSEs), employing50-199 persons; and large-scale enterprises (LSEs), employing 200 ormore persons. While this classification is, in part, made necessary bythe availability of data, it does classify enterprises into groups withsignificantly different characteristics. Also, it enables us to treatSSEs not in isolation but in conjunction with enterprises of all sizes.For problems in defining and establishing a size standard, see Annex Iin Volume III of this report.

/2 This is perhaps an underestimation of the economic significance of TSEsbecause of a lack of statistical information about the unregistered(informal) sector, in which TSEs dominate.

/3 Samuel P.S. Ho, "Small-Scale Enterprises in Korea and Taiwan", WorldBank Staff Working Paper, Washington, D.C., 1980.

(ii) Small-Scale Enterprises (SSEs)

8. An interesting feature of the empirical analysis is that SSEsconstitute a very important segment of the Malaysian (nonagricultural)economy. A majority of SSEs - about 75% - were concentrated in four economicactivities: manufacturing, wholesale trade, retail trade and construction.The contribution of these four subsectors to the total employment, valueadded, and fixed assets of all SSEs ranged between 63-74%. SSEs wereresponsible for almost one-third (approximately 350,000) of all thenonagricultural jobs provided in Peninsular Malaysia during 1978. They aredominant both in employment generation and gross output and are a close secondto both medium-scale (MSEs) and large-scale enterprises (LSEs) in value added.These enterprises surpass TSEs in their contribution to value added, grossoutput, and fixed assets. SSEs also play a significant role in efficient andproductive employment creation in the Malaysian economy. This generalconclusion is reinforced by looking at the standard indicators of efficiencysuch as labor productivity and capital productivity in the various size-segments of economic activities./l

9. Labor productivity indicates the contribution made by a worker tovalue added that goes into the calculation of national income, when hisefforts are complemented by other factors of production. Similarly, capitalproductivity indicates the contribution made by a unit of capital towards thecreation of national income. Higher labor or capital productivity reflectsbetter utilization of a country-s scarce resources, such as labor or capital.We compared the labor and capital productivities of SSEs with those of othersize segments of the eight leading sectors in order to see whether SSEs wereperforming better or worse than others in terms of their contribution toincome generation and economic growth. The results of this analysis show thatthe index of labor productivity (measured as the value added per personengaged) of an average TSE in 12 sectors (which accounted for almost 95% ofthe value added in all 34 sectors) was 36 or about one-third of the overallindex of 100 for all four (tiny, small, medium and large) size segmentscombined while that of an average SSE was close to the overall index./2 Onthe other hand, the average productivity index in an average MSE was 148 but

/1 Ideally, econometric studies using economies of scale models would haveprovided a better indication of the activities in which SSEs show apronounced comparative advantage, but the nature of available data doesnot permit the use of such models. The second best approach would havebeen the use of comparative advantage revealed by domestic resource costestimates and the proportion of SSEs in the more efficient activities, buteven these studies would involve information that is not available atpresent.

/2 These results are subject to several qualifications, stated inVolume II. Specifically, the productivity indices of tiny and smallenterprises are likely to be underestimated. Among TSEs, the index maybe low partly because of part-time workers. But even if one were tocalculate full-time equivalency employment, average labor productivityamong TSEs would remain considerably lower than SSEs.

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tended to stabilize or decline as it graduated from MSE to LSE, at least inall of the five leading sectors (manufacturing, retail trade, construction,wholesale trade, and produce brokers).

10. Similarly, the relative efficiency of an average SSE in terms ofcapital productivity (measured as thte ratio of gross value added to the valueof fixed assets) particularly in the manufacturing sector, was superior tcithat of all other size segments. Capital productivity of the MSEs in allother sectors such as trade, produce brokers, housing developers, roadhaulage, etc. was somewhat higher th,an that of the SSEs.

11. Since SSEs represent a fairly heterogeneous group of economicactivities and analysis in terms of an average SSE may have limited useful-ness for policy purposes, the mission paid special attention to small-scalemanufacturing industries (SSIs) both at an aggregative basis and at a fairlydisaggregated level. An interesting general conclusion of the mission'sanalysis in this respect was that manufacturing SSIs generated almost twiceor more of the amount of value added, and twice or one-and-a-half times thenumber of jobs accounted for by the small retail trading or constructionfirms, although the number of small-scale manufacturing industry (SSI)establishments was fairly close to t:he number of small-scale firms in thetrading sector or construction industry (around 4,700 to 5,000).

12. The mission conducted a more detailed analysis of the manufacturingsector. For a large number of manufacturing industries we constructedindicators of efficiency by size segments in terms of rates of labor earningsand return to capital. In order to compare the efficiency of SSIs with thatof their larger counterparts (that is, medium- and large-scale establishments(MLIs) in the same industry), respective indicators for SSIs were divided bythose for MLIs. Moreover, for each industry the two indicators were combinedinto a single indicator of relative efficiency by assigning appropriateweights to them./l While higher values of individual indicators suggestbetter utilization of the respective scarce resource (such as labor orcapital), that of the combined indic.ator suggests an overall better utiliza-tion of both the scarce resources (labor and capital) in terms of financia[lcosts and benefits. Specifically, higher labor earnings reflect a more pro-ductive use of labor, which in turn, leads to an improved standard of living.Similarly, higher rate of return to capital reflects a more productive use ofcapital, which in turn, leads to generation of higher reinvestable funds orsavings. In a sense, these two indicators can be considered improved versionsof the labor and capital productivities used above, since they attempt toreflect the individual contribution of the use of each scarce input sepa-rately. The results of this analysis pertaining to 53 relatively homogenousindustries, covering almost half of the manufacturing activity in. terms of thevalue added in 1978, are summarized in the following paragraph.

/1 These weights were the contributions of respective factors of productionin a given industry, namely, the respective wages and salaries for labor,and the profit for capital.

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13. Small manufacturing establishments (SSIs) in industries such as fishpreservation and processing, rice milling, leather footwear, wooden furnitureand fixtures, pottery, china, earthenware, spare parts and accessories formotor vehicles were found to be the more efficient users of both capital andlabor than medium- and large-scale manufacturing enterprises (MLIs) in theseactivities. Since labor and capital scarcity may increase rapidly in Malaysiaduring the 1980s, the industries and size segments which use these factors ofproduction more efficiently should be given special consideration in thecountry's development plans. Particularly if a selective approach to SSIpromotion is to be applied and if subsectoral orientation of technical assis-tance (TA), especially in production processes, is to be achieved, then theabove industry groups have an important role to play. The mission'sanalysis also shows that in terms of capital use alone, small manufacturingunits were efficient in coconut and palm kernel oil, sago and tapioca,biscuits and confectionary products, knitting mills, saw mills, planing,window and door mills, rubber smoke house, structural clay products,foundries, wire and wire products, agriculture machinery and equipment,electrical industrial machinery, and assembly of bicycles, etc. On theother hand, these indices also showed that an average small manufacturingunit did worse than an average medium and large manufacturing unit - both inthe utilization of labor and capital - in such industries as meat processingand preservation, ice cream, bakery, soft drinks, animal feeds, meehoone andnoodles, tobacco manufactures, plywood and hard-board mills, cement andconcrete manufacturing, dry cells and storage batteries, etc. Surprisingly,this category also includes batek manufacturing.

14. The empirical analysis, therefore, suggests that many (but notall) SSEs are relatively productive and have the potential to grow andmodernize and thus make an important contribution towards greater productiveemployment, income generation and poverty alleviation as well as moreefficient use of labor and capital at this stage of development in theMalaysian economy. An assessment of the government support programs in thenext section suggests several benefits which can be reaped if the growthperformance of the more efficient SSEs can be sustained or acceleratedthrough appropriate policy measures and effective support programs.

D. An Assessment of the Policy Framework andGovernment's SSE Support Programs

15. The Government of Malaysia wants to promote and strengthen SSEs forsocio-economic reasons and there is a fairly strong case for so doing asmentioned above. At this stage of the country's development these enter-prises, especially certain manufacturing SSIs among them, offer goodopportunities for more efficient capital utilization, greater productiveemployment, entrepreneurship development, and better regional distribution ofindustry, all of which correspond to the NEP objectives. In the mission'sjudgement, a more systematic and integrated approach to their developmentwould help realize the SSE potential more efficiently and over a relativelyshorter period of time.

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16. In the mission's judgement the Government of Malaysia's effort toprovide an expanded supply of financial resources at relatively low interestrates to SSEs needs to be modified on the lines suggested below and supple-mented with other elements of the SSE promotion strategy: efficient entre-preneurship development and well-functioning, sharply focussed technicalassistance. Whereas considerable progress has been made in initiating andexpanding these various nonfinancial programs, the mission's assessment isthat their effectiveness could be greatly improved through consolidation,rationalization and clearer direction. But more importantly, despite theearly NEP commitment (since 1971) to the rapid develoment of SSEs, industrialpolicies and incentives- for them continue to be less favorable than those forMLEs. There was no effective "spokesman" for SSEs,/1 until 1981/82 whensmall industry enterprise divisions were set up in the Ministry of Trade andIndustry (MTISED), Ministry of National and Rural Development and theEconomic Planning Unit. Given the lack of direction and consolidatedorganizational setup, it is not surprising that no systematic effort wasmade to date even in assembling and analysing data on SSEs, and inevaluating the impact of government support programs and policies./2

(i) Problems of the Existing Incentives Environment and Possible Solutions

17. The mission believes that the policy and incentives framework is apowerful instrument that encourages or discourages certain activities in theSSE sector, determines their rates of growth as well as linkages to, andcomplementarity with, the rest of the economy, and influences the sector'soverall prospects and efficiency. The lack of an overall plan for thedevelopment of SSEs has left them without sufficient, well-defined policysupport and has allowed policies which inadvertently favored development oflarge-scale enterprises to the detriment of SSEs. In the mission's judgment,the relatively slow development of small enterprises in Malaysia /3 is duemore to an unfavorable incentives and policy framework than to the absence ofdirect support programs of which there have been many since 1971. Theexisting policies have, in general, provided substantially more incentives tolarger, capital-intensive firms than to SSE/SSI establishments. For example:

(a) under the existing case-by-case tariff setting and tariffexemption mechanisms only larger firms can handle the requiredinformation, meet the requirements of satisfying the substantialproportion of the domestic market and have the specialized skillsto successfully argue in favor of tariff exemption for their

/1 The earlier Small-Scale Enterprise Coordinating Council was not effectivein coordinating the activities of the many organizations involved in SSEpromotion, and was unable to provide guidance and direction to them.

/2 As a result of MTISED's initiative DOS plans, inter alia, to undertakedetailed tabulations, in terms of establishment size and ethnic back-ground, from the ongoing 1981 industrial census of Malaysia.

/3 In terms of the number of establishments and persons employed, thegrowth rates of SSEs during 1973-78 were about half to one third ofthose in MSEs and LSEs.

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products./l Consequently, the highest effective protection rates(EPRs) apply to those products in which larger firms dominate,viz. automobiles, tobacco and beverage products, electronics,industrial chemicals, fertilizers, etc. On the other hand, thepreliminary calculations show negative EPRs for products which mayhave potential for growth in SSIs such as fish canning, knittedgoods and wearing apparel, sawnilling, plastic products, metalfurniture, etc./2 The policy environment, together with negativeEPRs, therefore, makes many manufacturing SSIs a "disadvantaged"group in the economy;

(b) "pioneer status" (PS) activities may benefit from several incen-tives but the pioneer products list generally consists of productsmanufactured by large-scale, capital-intensive firms and excludes(by definition) most of the traditional products in which SSIsappear to have a considerable comparative advantage or potentialfor growth. Also under the the Pioneer Status the tax holidaysfor those investing less than M$250,000 (that is, manufacturingSSIs) is two years while for those investing more than M$1 millionit is five years;

(c) Labor Utilization Relief allows no tax advantage to thoseemploying less than 50 workers while those employing 350 workershave tax holidays for five years;

(d) most of the heavily subsidized space in industrialestates has been allotted to medium- and large-sized firms;

(e) the administrative procedures and legal fees involved to obtainthe Letter of Administration, needed to operate an enterpriseafter the death of a partner or proprietor, have a dispropor-tionately larger effect on small, unincorporated businesses thanon large, usually corporate firms;

(f) procedures and requirements relating to government procurement arerather complex for an average SSE; preference is given only tobumiputra suppliers who are not necessarily small; and

(g) virtually no fiscal incentives exist to encourage large firms toseek economically viable links with smaller enterprises.

/1 Although the existing case-by-case mechanisms are not, in principle,biased against SSEs, in practice, the larger firms are the mainbeneficiaries.

/2 These estimates of EPRs, prepared at EPU, are provisional and subject tochange when the results of the proposed UNDP/World Bank follow-up studiesare available around the end of 1983.

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In addition, SSEs often fail to meet the required standards for zoning,health, pollution, etc. and face disproportionately greater hardship inmeeting the requirements of social security benefits legislation (relatingto holidays, provident funds, workmen's compensation, social securitycontributions, etc.). These drawbacks in general have not allowed SSEs toflourish and prosper and therefore decelerated their growth in the 1970s.There is clearly an urgent need to review all policies which have adifferential impact between SSEs and larger firms.

18. While the 1982 budget took some steps /1 which may benefit SSEs,there is as yet no balance between the amount and extent of incentivesavailable to smaller and larger firms. Until now, the SSE sector has hadlimited access to government incentives, except the subsidized interest rate,which itself is generally not the most appropriate and needed incentive (seebelow.)

19. Pending the results of follow-up studies of incentives and otherissues under the proposed UNDP/World Bank project, which would suggest speci-fic measures to achieve balance in the incentives available to smaller andlarger firms, there are certain areas in which action can be taken to create amore conducive environment for SSE development. For example, considerationcould be given to: (a) removing the lower limit (now 50 employees) underLabor Utilization Relief so that even SSEs can take advantage of tax holidaysif they so choose, or if it is not possible, then for reasons of neutralitythe relief may be withdrawn from larger enterprises; (b) simplifying theadministrative procedures for the application of death duties on businessesowned by individual proprietors or partnerships; (c) simplifying the proce-dures and requirements for government procurements so they can be understoodby an average SSE; and (d) reducing those requirements of the social benefitslegislation which often lead to excessive overhead costs for SSEs.

(ii) Key Issues in Direct Support Programs and Measures to Improve Them

(a) Financial Support Services

20. The current approach is to make credit available to the SSE sectorthrough mandatory requirements imposed on commercial banks and finance com-panies, and to channel government funds through specialized banking institu-tions like MIDF, BPMB and BPM at various subsidized interest rates. Accord-ing to the mission's rough estimates, M$4.7 billion, accounting for 17% ofthe financial intermediaries' total lending (as of end-1981 on an outstand-ing basis) to the nonfinancial private sector, was lent to some 26,500enterprises. A majority of these enterprises may still need institutionalfinancing. The mission did not have the time or staff resources to assemble

/1 For example, the administration of import duties, surtax and salestax on imports of raw materials and machinery for the manufacturingsector is proposed to be streamlined. The proposed measures may havesome beneficial impact on SSEs but they fall considerably short ofthe required adjustments in this respect.

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information on the working of the informal financial sector but its impres-sion is that informal financing arrangements are not unusual among SSEs.Similarly it is not clear how much the trading/commercial credits are asource of financing to SSEs. These aspects need to be studied.

21. The interest rate subsidy is large where the "Government's" fundsare channeled through BPM, MARA, BPMB./1 The commercial banks are alsoreported to have a substantial negative spread (around 6-7%), have to workunder mandatory instructions and are subject to penalty for noncompliance withthe targets of SSE lending. The interest rate for SSEs is by far the mostimportant issue for commercial banks' lending to the SSE sector. The negativespread constitutes a considerable disincentive to SSE lending; it is likely toslow down the banks' involvement beyond the prescribed limits and would notcontribute in the long run to the development of a healthy environment for SSEfinancing. At the same time: (a) the credit-guarantee scheme has not beenworking as effectively as expected; (b) the commercial banks' organizationalstructure is not geared to efficient lending to SSEs; (c) the availability ofequity or venture capital is inadequate, and (d) proper technical assistancehas not been forthcoming to commercial banks' clients while their own capacityto provide such services remains limited. The mission's recommendations,designed to address these key issues in the lending programs for SSEs, aresummarized below.

22. While the creation of a more conducive environment for SSEs /2should have the highest priority in an effective SSE promotion strategy, it isalso essential to enhance the availability and efficient utilization offinance so that SSEs can fulfill their urgent, unmet needs. The mission'srecommendations on this point designed for more appropriate and effectivesupport programs are made in Chapter 4. With respect to finance, themission's assessment is that availability is more important than the cost offunds. As discussed in Chapter 4, there are also well-recognized distortionsand difficulties that the subsidized interest rates engender in the financialsystem. As a general proposition, if the Government must subsidize interestrates for social reasons, as in Malaysia, then the national budget, not theprivate financial institutions, should absorb the cost of such subsidies.However, if this is not feasible, then the Government should make the systemmore flexible so that the costs to the private sector are not excessive andlenders' long-term interest can be maintained. The commercial banks are theprincipal lenders and are essential for long-run development of SSEs. Thereare a number of ways to encourage their involvement in this sector e.g. by:

/1 Compared to the market rates of 12-14% p.a. in the commercial bankingsystem, and perhaps a multiple of that in the informal sector, BPM lendsat 0-2%, MARA at 5-7.5%, and commercial banks (under BNM guidelines) at7.5-8.5%, depending on the size of the loan, to SSEs.

/2 Especially one that reduces subsidies and policy orientation favoringonly medium and large-sized establishments.

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(1) gradually making SSE financing commercially profitable through aphased increase in interest rates and reduction in the negativespread under which the commercial banks currently operate;

(2) setting the targets for SSE lending in closer consultationsbetween the bankers' association and BNM, and allowing commercialbanks to include in the target, loans to viable SSEs at the goingmarket rate in addition to the loans made at the subsidized, belowcost, rates;/l

(3) allowing the banks to achieve the target of a particular year bymaking it up in the following year; and giving options to bankswith a limited branch network to deposit with BNM the amountsrepresenting the shortfall in targets at actual cost of funds orat a mild penalty rate;

(4) training loan officers from commercial banks and other financialinstitutions in appraisal methodology appropriate for SSEs, e.g.using a point scoring system and paying more attention toprospective cash flow rather than conventional appraisalprocedures which pay too much attention to collateral;

(5) eliminating, or at least reducing, banks' bias against newenterprises both by training loan officers in project appraisal,disbursement procedures andl supervision, and by encouragingsubsectoral studies illustrating SSEs' growth potential and makingthem available to commercial banks; and

(6) encouraging the commercial banks not to decline any loan applica-tion for lack of collateral; the guarantee of CGC should be reliedupon in cases where borrowers do not have adequate security./2

23. In addition, the flow and efficient use of finance can be promotedby:

/1 Bank Negara Malaysia feels that greater flexibility and indicativeapproach prior to the introduction of mandatory guidelines did notensure adequate flow of resources to the priority sectors suc'h as SSEs.While this may have happened, the mission's judgement is that mandatoryguidelines and penalties would also not ensure long-term interest ofcommercial banks in SSE lending, which is not only costly but alsoentails high risk.

/2 The Bank has already provided assistance for a study to analyze CGC'sproblem and enhance its effectiveness. Improvements in this area shouldbe based on the recommendations of this study, which would be submittedto the Government in June 1982.

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(1) providing in an integrated way need-orientci, in-plant, techniciland management assistance during the various operational stages ofan enterprise and linking this with financial services;/1

(2) organizing SSE divisions at larger commercial banks andspecialized financial institutions aimed at a sharper SSE focusand improved cost effectiveness of SSE operations;

(3) allocating more resources to development banks which haveconsiderable interest in SSEs, like BPMB, and encouraging them toraise their own resources from the private sector;

(4) expanding the role of existing equity/venture capital programs sothat viable projects of good technicians/entrepreneurs would nolonger be deprived of the needed credit;

(5) making up for the shortage of staff experienced in SSE lending byallowing part of the expenses incurred in their recruitment andtraining as tax deductible expenditure;

(6) expanding the hire-purchase and leasing operations of financecompanies for industrial equipment for SSEs; and

(7) expanding indirect bank lending by involving well-establishedtraders who have direct links with SSEs.

Also it will be highly desirable to introduce a refinancing facility at BankNegara Malaysia to supplement the resources available in the system.

(b) Technical Assistance Programs

24. While numerous government agencies /2 responded to the NEP callwith a variety of SSE development programs, they did not have the benefit of

/1 In the beginning it should be a modest operation based on the selection)f a manageable number of enterprises. Technical assistance for manage-aent, accounting, marketing, etc., could be generally available to all3SEs desiring to receive it but TA for production methods and processes,engineering and other technical problems should be subsector- andactivity-specific if it is to be cost effective and useful, particularlyto manufacturing SSIs.

/2 By one count, there were 8 ministries and 24 institutions involved withSSE development and programs. Almost all of these agencies areconcerned with other programs in addition to those for SSE development.

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a common framework or detailed development scheme to devote adequateresources and avoid overlaps and duplications. The existing programs varyin their degree of social and economic orientation. Given the unavoidableethnic orientation of some SSE support programs in Malaysia's multiracialsociety, the task of imparting the necessary economic orientation to majorprograms is extremely difficult. However, a reasonable balance between thetwo types of programs is necessary for the healthy and sound development ofthe SSE sector in the long run. Even, under less complex circumstances, thetask of establishing an effective TA delivery system for nonagriculturalactivities is a difficult one. Notwithstanding substantial progress, manyissues and problems remain which deserve the policymakers' close a,ttention.For example:

(1) the existing duplications, and in some cases voids in programmingwill continue and may become unmanageable if no common planningframework and integrated SSE development strategy is providedsoon;

(2) no meaningful evaluation of the existing programs and introductionof appropriate policy initiatives is possible without at. least aminimum knowledge of the number, structural features, operationalcharacteristics and relative efficiency of SSEs; greater knowledgec. the nature and dimensions of constraints on SSEs is alsorequired; /l

(3) past efforts to coordinate the SSE development programs have notbeen very effective, partly because of the noncomplementary natureof these programs and differences in design for their execution;

(4) almost without exception, the TA programs for SSEs are limited byinadequate personnel and suffer from inexperience, high turnoverand low morale of staff, due to limited advancement opportunitiesin small and fragmented programs as well as low pay andinsufficient job satisfaction;

(5) appropriate technology in packaged forms that are understandableand useable is not easily available and the present resources fordelivering them remain inadequate;

/1 One of the basic needs in this respect is to develop a country-wide sizestandard, and then collect data on the basis of an agreed definition forSSEs for analytical purposes and general information in order tostrengthen the empirical basis of government policy initiatives andsupport programs.

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(6) while the traders are performing this function to some extent,adequate marketing facilities and channels based on sound marketdemand analysis for various groups of SSI products as a componentof TA programs are virtually nonexistent;

(7) very little TA is provided by private (nongovernment)organizations and there are hardly any trade and industrialsubsector associations, which in other countries have made vitallyneeded contributions in training, subsectoral development plans,marketing and subcontracting for their members; and

(8) present efforts to properly monitor and evaluate TA work isfragmentary and highly inadequate; standard methods for theagencies involved have not been established.

25. As the experience of several countries, e.g., the Philippines,Pakistan, Korea, and India, has shown, technical assistance (TA) is animportant ingredient required to raise the productivity and performance ofSSEs in general and manufacturing SSIs in particular. There is at present aproliferation of agencies providing an assortment of entrepreneurial devel-opment, training and technical assistance programs but no common frameworkor detailed development scheme exists to ensure that all the needed inputsare of good quality, effective, and provided in adequate amounts, and thatoverlaps and duplications are avoided. This highlights the need for afar-reaching institutional and organizational reform in organizing anddelivering TA to SSEs. We must stress here that the mission's suggestions,in general, do not involve much expansion; they involve mainly a consolida-tion and rationalization of the existing TA efforts. Since the Governmentcannot afford to spread its scarce administrative and financial resourcestoo thinly, it is also suggested that the concept of a "negative list,"disallowing those subsectors where manufacturing SSI activities are clearlyless efficient users of labor and capital, be used to arrange for theestablishment and delivery of industry specific TA./1

26. Besides a common planning framework that not only encompasses thepresently established social objectives but also provides a more inclusiveeconomic perspective, the efficacy of the TA effort would be considerablyenhanced if adequate attention was paid, among other things, to:

(1) pruning and adjusting the existing SSE development programs anddesigning future expansion schemes/organizational setup only tothe extent they can ensure effective coordination;

/1 Such a list can initially be prepared on the basis of Annex Table 8.4.1in Vol. III.

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(2) providing an adequate number of personnel, first by consolidatingthose already involved, with relevant experience and recognizedability to properly carry out field assignments together withconsiderable advancement opportunity within the integrated TAprograms;

(3) allocating and developing sufficient resources for delivering TAthrough technical field consultants, technical informat:ion,production engineering services, design aid, quality controlstandards and other procedures (principally through SIRIM) to thepresently neglected manufacturing SSIs whose needs are expandingand changing in an open and rapidly growing economy;

(4) gradually encouraging the formation of trade and industrialsubsectoral associations in the private sector which couldeventually serve as vital conduits for government TA programs,training and procurement channels;

(5) establishing, as soon as possible, the standard methods for majorTA agencies to monitor and evaluate TA work that is presentlyfragmented and inadequate; and

(6) perhaps most importantly, consolidating the present fragmented SSEdevelopment by designating a central agency to formulate andreview SSE policy to avoid further development of incentives whichhave benefitted large-scale industry, but not SSEs. The agencyshould also try to estimateb the cost of the SSE support programs,including the administrative cost of delivering TA.

(c) Measures to Increase SSEs' Access to Markets and Improve[ Technology

27. The narrowness of the markets that they can reach is a majorproblem for SSEs. In order to enable! SSEs to compete with larger firms,SSEs' access to the wider marketing facilities should be improved and thefollowing measures could be considered:/l

(1) greater provision and better monitoring of the funds to municipalauthorities, Urban Development Authority, etc. to expand thepublic market places by building low-cost, low-rental shops,shopping centers and selected industrial estates for small tradersand manufacturers;

/1 The Government could also reduce the "undue advantage" to larger firmsby charging them the full economic price for rented or leased factorybuildings and sites, power and water charges, etc.

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(2) gradually encouraging, especially in public buildings, a greateruse of products which can be more efficiently produced by SSIssuch as bricks, ceramic floor and roofing tiles, wooden furnitureand fixtures, earthenware, etc. More generally the public sectorprocurement systems could be modified (in specifications,tendering procedures, costing, delivery batches, etc.) andpurchasers' cooperatives, manufacturers' associations and tradingintermediaries could be encouraged over time through temporaryfiscal incentives so that the buying power of the public sectorcould be harnessed for SSE promotion;

(3) establishment of subcontracting exchanges to facilitateeconomically viable subcontracting arrangements between larger(private and public sector) firms and SSIs, particularly thoseengaged in automobile, TV and radio assemblies, metal products,castings and other products sold as parts and components, as wellas those dealing with transportation and agricultural equipmentand implements; and

(4) more importantly, government help in developing sound marketdemand analysis for a number of important SSI products on acontinuous and regular basis; and the involvement of trade andsubsectoral associations would greatly assist SSIs to tapunrealized potential and break into new markets.

28. Manufacturing SSIs are vitally needed for a broad-based, economi-cally oriented development of the SSE sector and a well-balanced developmentof the manufacturing sector. They offer considerable opportunities forsubstantial productive employment and efficient use of capital, thoughimproved technological inputs are sometimes beyond their reach. In order toenhance the availability and wider application of improved technology, thepolicymakers could consider the following selective measures:

(1) temporarily providing infant industry protection to themetalworking and engineering industry where SSIs dominate byestablishing the tariff rates for them closer to the median fortariffs in general;/l

/1 This is suggested as an interim measure. More comprehensive reforms ofthe tariff mechanism should be based on the results of the proposedUNDP/World Bank follow-up studies mentioned above.

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(2) developing closer collaboration between the technologicalinstitutes /1 and the local engineering firms capable of solvingthe problems in prototype models and providing the commercialdrive and technical know-how to get the equipment installed inSSIs; and

(3) considering the market for simple power-driven equipment andmachinery in rural-based SSIs by giving priority to resource-richrural areas in electrification programs and allowing cost-recoveryof such programs over longer periods of time.

29. The above discussion has indicated a number of key areas in thepolicy framework and support programs which policymakers should focus on, ifthey wish to use SSEs as an effective vehicle to achieve NEP objectives. Inthe mission's judgement it is essential to gradually build up an effectiveorganizational structure to carry out the many tasks identified above, ViZ.research and planning, formulating appropriate policies, developing theneed-oriented human resources for technical assistance operations, designingand executing TA programs that are complementary, coordinating internal andexternal consulting resources, and monitoring and evaluating thesefunctions. The mission's suggestions on the organizational structure,presented in Chapter 5, support organizations which develop bumiputraenterprises and at the same time inject a broader economic orientation forthe longer-term interest of the economy.

E. General Directions and Priorities of Policy Adjustments

30. In the past, SSE support programs were prompted by social consid-erations and overall incentives tended to favor medium- and large-scale aswell as capital-intensive operations. The thrust of recommendations in thisreport is not only to enhance the cost effectiveness and efficiency of thesocial and ethnically oriented programs but also to inject a more expliciteconomic perspective in most of the existing programs for the lon.ger-termbenefits to the national economy. More importantly the report stresses acritical need for some important changes in the policy and incentivesenvironment.

31. In the mission's judgement the first priority should be to removethe negative features of the existing policy measures. The establishment of

/_ To increase the relevance and effectiveness of programs undertakenby SIRIM, it would be desirable to get the more active SSI entrepreneursinvolved in defining its work programs and priorities and raisingadditional resources for its functions.

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a more neutral policy regime would strengthen the SSEs' competitive basis.Some additional policy initiatives have also been suggested but a morecomprehensive set of new measures for the promotion of SSEs would be part ofbroad-based changes envisaged in the detailed overall incentives and otherUNDP/World Bank follow-up studies. However, immediate steps can be taken tomake fuller use of the powerful public sector procurement system andinitiate the subcontracting mechanism which would overcome some difficultiesSSEs face in these two areas and gradually bring them into the mainstream ofdevelopment. Another high priority should be assigned to enhance theeffective use and ensure an enlarged flow of financial resources availableto the SSE sector. Attention should be paid especially to improving theincentives to commercial banks in their SSE lending operations and theeffectiveness of the credit guarantee mechanisms injecting additionalresources to meet the needs of many SSEs and integrating TA with financialoperations. The second priority should be given to the process of consoli-dation, rationalization and effective monitoring of the current TA programsto avoid duplication and fragmentation and ensure coordinated development ofthese efforts and improved cost effectiveness. Simultaneously, steps shouldbe taken to fill certain critical voids in the existing programs of TAsupport; viz. adequate knowledge about SSE characteristics, their needs andconstraints; common planning framework and integrated strategy for SSEdevelopment; eventual subsectoral orientation of TA to the particular needsof manufacturing SSIs and cohesive formulation of extension and consultancyservices entrepreneurship development and technology improvement. Thethird priority should be given to the establishment of the necessary insti-tutional and effective organizational structures without which a cohesiveSSE promotion strategy cannot be implemented in a cost-effective manner.

F. Broad Effects of Proposed Measures

32. First, the proposed measures and policy changes would establish amore neutral incentives environment which would be helpful in realizing thefuller potential of SSEs in general and of manufacturing SSIs in particular.Second, the proposed measures would encourage a larger supply of investmentfunds and working capital which the SSEs need badly and suppliers would beoffered adequate returns on the resources they channel to these activities,thus ensuring their long-term interest in SSE lending. More importantly, anincreased effectiveness of the insurance mechanism and integration of techni-cal assistance with financial resources, wherever feasible, together withSSEs' greater access to public and private markets as well as appropriatetechnology, would lead these enterprises towards even more efficient use ofresources. This, in turn, would make them more competitive and give them thenecessary resilience and strength not only to survive but also flourish inMalaysia's open economy. Finally, the proposed changes would eventuallyconsolidate and coordinate the Government's SSE promotional efforts - acritical need at present.

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G. Concluding Remarks

33. Malaysia has not only achieved an impressive economic growth but hasalso made substantial progress in improving the quality of life during thepast decade. Considerable success has also been achieved in reducing theincidence of poverty. The twin objectives of the NEP - reducing the incidence

of poverty among all Malaysians, particularly the economically disadvantagedbumiputras, and eliminating the association of race with economic functionsand location - would continue to be the center of focus throughout the 1980s.

SSE development is expected to help in the creation of more productive jobs inthe nonagricultural sector and is one of the important routes that theMalaysian policymakers have adopted to achieve the key NEP objectives. T'hus,during the 1970s, an array of direct SSE support programs were initiated.These programs, however, remained fragmented and uncoordinated because thLeylacked a common framework and detailed development scheme. Their effective-ness and orientation to actual SSE problems and needs remained limited becauseof inadequate knowledge about their constraints. More importantly, however,SSEs have not received sufficient, well-defined policy support and the rightconditions and environment have yet to be developed for them to realize theirfull potential. While the narrower, and perhaps short-term, issues of directsupport programs in finance and technical assistance continue to, dominatet thethinking of those involved in SSE promotion, the mission believes moreattention should now be given to: (a) policy and incentives framework; and(b) consolidation, rationalization and effectiveness of the existing programsthrough the development of a common. planning framework, organizational setupand a long-run strategy for selective SSE development.

34. This report has suggested a number of policy initiatives, newmeasures, program and organizational improvements. While some policy ancdprogramming recommendations can be implemented quickly, other recommendations,such as more comprehensive development of policies, the need-oriented TAprograms for specific subsectors, and an effective organizational structure,would be feasible only in the medium and longer-term under a phased programwhen a number of remaining issues have been studied and when the Governmenthas first tested the effectiveness, feasibility and relevance of the basicorganizational changes suggested in. this report.