1. Knowledge Deepening and Industrial Change in Malaysia Policy Options Shahid Yusuf DRG World Bank February 25, 2008

2. Malaysian Context Growth during 2000-2007 has slowed averaging 5.0% per annum as against 7.3% during the 1990s. The growth of TFP averaged 1.3 percent per annum during 2000-2005. Rate of saving in 2006 was 36% of GDP but investment rate, which has been falling, was 19% in 2006. Population/workforce is growing at about 2% per annum (not including migrants). Policy questions: Can Malaysia achieve higher growth, in the 6+% range? If so, which industrial sector(s) (including services) could serve as the main engines of growth?

3. Growth Rates in East Asia

4. Policy Options Seven policies for enhancing Malaysia’s growth prospects: –Strengthen the leading sectors (electronics, electrical engineering, food processing, wood products and palm oil); –Re-evaluate future role of auto and auto parts industries; –Focus R&D and applied technology development on a limited number of fields; –Raise supply and quality of human capital, especially in STEM skills; –Encourage major domestic firms to take the lead in targeting and assimilating foreign technologies and building own research capacity; –Concentrate efforts to improve knowledge economy potential in a few selected cities where major universities, HQs, logistics capabilities, and urban amenities are present; –Enhance quality and capacity of IT infrastructure. Successful outcome requires combining well-targeted policies identified above with market signals.

5. Industrial Focus Malaysia’s revealed comparative and innovation advantages, export performance, in-bound FDI, manufacturing capacity, and new starts all point to electronics, electrical engineering industries, food processing, wood products and palm oil, as the current and future leading sectors. There is little evidence that other industrial or services subsectors are emerging with the potential to serve as leading sectors. The key to increasing domestic value added and improving competitiveness lies in raising the technological capabilities of the key industries. This has to come from the greater efforts by the domestic firms. MNCs have not contributed much to Malaysia’s technological capabilities in the past, and are unlikely to do so in future in view of the intensifying global competition and MNCs guarding their intellectual properties more tightly.

6. Export Composition

7. Export Composition (excluding Electronics)

8. Industrial Focus (continued) The emphasis on key leading subsectors needs to be complemented with a reassessment of policy support for the automotive sector. The future outlook of the automotive sector in Malaysia needs to be viewed with reference to acquired capabilities, apparent potential given domestic market saturation, and the emergence of automotive clusters in Thailand, China, and India. Consolidation and restructuring of this industry could enhance competitiveness and free up resources to be reallocated to other more promising sectors.

9. R&D Effort R&D by firms, universities and research institutes in Malaysia is on a limited scale (0.7% of GDP) and widely dispersed across fields. Spreading the small amount of R&D resources (both in terms of funding and R&D personnel) is not yielding fruitful outcomes for key leading subsectors (e.g. as measured by patents). Innovative western economies and Japan doubled R&D expenditures from 1% of GDP to 2% of GDP in about ten years. China and Korea were also able to double expenditures in that time period. R&D efforts should be coordinated among different entities and focused on fewer areas that are viewed as having good longer term prospects. Innovation within the universities should be encouraged with the proper institutional support (such as technology commercialization offices, incentives to staff to conduct and commercialize research, better liaison with firms, and involvement of universities in regional development programs). Intermediary institutions to facilitate more efficient technology transfers from universities and GRIs to firms would also help.

10. R&D Spending (as share of GDP)

11. R&D Spending by Subsector

12. R&D Spending by GRIs

13. R&D Spending by Universities

14. Patents Granted by USPTO

15. Role of Major Firms Leading Malaysian firms need to base future competitiveness on technology acquisition and incremental in-house innovation. Currently technology licensing accounts for (1% of GDP) compared to 10% of GDP in Ireland and 7% in Singapore. A technology led strategy for Malaysian firms could entail (besides higher R&D spending), a global market orientation for manufacturing firms, investment in equipment embodying advanced technology, open innovation practices, closer ties with local and foreign research universities, and networked alliances with overseas firms to absorb ideas and guide strategy.

16. Human Capital Efforts to increase the supply of science, technology, engineering, and math (skills) must continue (with the help of university reform), alongside parallel improvement in English and IT skills. Private firms must raise their own outlay on training so as to strengthen the skills of those who are already employed. Upgrading and expanding public training institutions and streamlining the application and approval processes for firms to utilize these skill development centers, would complement in-house actions of firms.

17. Dynamic Urban Regions The geography of innovation strongly favors large urban centers with diverse economic activities, which benefit from urbanization economies. Experience of advanced countries points to significant concentration of patents issued, high-tech employment, and venture capital in a few large urban centers and established industrial clusters. Innovation is an urban phenomenon. A high percentage of new ideas typically comes from the large core urban centers. This is true for the US, Japan, and other East Asian economies. The ingredients of a dynamic innovative urban center are: a collection of leading universities (suppliers of skills and basic research), corporate HQs (much R&D is done near to HQs), availability of other supporting business services (law firms, finance including VCs, management consultants, accountants, logistics experts, etc.). In addition, the city needs to be able to attract knowledge workers by offering affordable housing, social services, and urban amenities.

18. Knowledge Economy Potential

19. IT Infrastructure ICT infrastructure and IT skills contribute to firm-level productivity, Availability, pricing and accessibility of telecom services also linked to research collaboration, community networking, international connectivity, local economic development, formation of software clusters and innovations related to IT and multi-media. Investment is needed in soft and hard IT infrastructure (e.g. to increase bandwidth) so as to improve the access to information, and facilitate exchange of ideas with others and innovation.

20. E-Readiness Scores

21. International Bandwidth

22. Policy Suggestions: A Summing Up Malaysia should aim to double R&D spending from public and private sources over the next ten years. This must be supported by higher education policies and incentives that raise quality and volume of STEM training. The larger firms, public and private, need to take the lead role in industrial deepening through backward and forward integration and by stimulating knowledge assimilation as well as domestic innovation. Measures to strengthen the knowledge economy must be concentrated on at the most one or two urban areas where the main universities and corporate headquarters are located. Urban centers must create the environment and culture which will attract and retain talented people from Malaysia and overseas. This calls for a mix of policies including policies affecting urban design. A dynamic urban knowledge environment which is conducive to the exchange of ideas, to both research and business related networking, and to innovation, demands an IT infrastructure that is comparable to the best in Asia. Polices that enhance openness and market competition can reinforce technological upgrading. Better, more detailed and current data to monitor changes in innovativeness and productivity across subsectors and increasing access to public data to encourage research on socio-economic issues, would assist in policy formulation.