FOREIGN DIRECT INVESTMENT
IN MANUFACTURING SECTOR IN MALAYSIA
Noor Al-Huda Abdul Karim, Paul C. Winters, Tim J. Coelli and Euan Fleming
School of Economics
Faculty of Economics, Business and Law
University of New England
Tel: 02 67733159
Fax: 02 67733607
Paper prepared for the 47th Annual Conference of the Australian Agricultural and
Resource Economics Society (AARES), Fremantle, 11-14 February 2003.
This paper analyses the determinants of foreign direct investment (FDI) in the
manufacturing sector in Malaysia from eleven countries during the period 1988 to
2000. The empirical results indicate that gross domestic product, lending interest rate,
labour productivity, exports to home country and imports from home country
significantly influenced the level of FDI inflows into Malaysia. However, exchange
rate, exchange rate variation, wage and openness index were not important in
Key words: foreign direct investment, manufacturing sector
The authors acknowledge a grant provided by the Universiti Utara Malaysia, Kedah State, Malaysia
through the Postgraduate Research Support programme.
Malaysia’s rapid industrialisation was largely the result of its early openness to the
inflows of foreign direct investment (FDI). Before independence in 1957, Malaysian
foreign direct investment activities were concentrated in mining, plantation
agriculture, commercial enterprises and utilities. After its independence, the pattern of
FDI changed as activities in existing sectors expanded and there was diversification
into other agricultural crops and into manufacturing. During the 1960s, Malaysia’s
FDI policy focused on the development of import-substituting industries (ISIs). Later,
during the 1970s, Malaysia switched to more export-oriented industries (EOIs) and, in
particular, labour-intensive industries. Because Malaysia’s labour force was relatively
inexpensive, educated and abundant, it fulfilled the needs of foreign firms (Tham
1997:1-2; Lin 1994; Sulong 1990).
The Malaysian government has long considered manufacturing as the most dynamic
sector and central to Malaysian economic development. A proactive industrial policy
began with the establishment of the Federal Industrial Development Authority (FIDA)
in 1965 by the Malaysian Government. FIDA was responsible for promoting and co-
ordinating industrial development activities. In 1979, the Authority was renamed the
Malaysian Industrial Development Authority (MIDA). From then on, MIDA has been
the primary government agency responsible for the large flows of foreign investment
into the manufacturing sector (MIDA 1996: 45). Realising FDI as an important source
for Malaysia’s industrial development, the Government has initiated various
incentives and liberal policies to promote foreign investments in the manufacturing
sector. These include the enactments of Investment Incentives Act and Free Trade
Zone Act, liberal policies on equity, tax incentives and so forth (Ministry of Finance
From 1980 to 1989, the average annual FDI flow into Malaysia’s manufacturing
sector was RM2.33 billion (nearly US$1 billion). In 1980, it was about RM0.73
billion (US$0.34 billion) but in 1990, it increased significantly to RM17.63 billion
(US$6.5 billion). The share of FDI for the sector was 42.8 per cent in 1980 and it
exceeded 50 per cent after 1990 (Tham 1997:18). In 1993, the United States (USA)
and Japan provided more than 50 per cent of total FDI in the sector. In the year 2000,
the USA, Japan, Netherlands, Singapore, Germany and Taiwan were among the major
sources of FDI in Malaysia. For the period 1996~2000, proposed FDI in approved
manufacturing projects totalled RM73.7 billion (US$19.4 billion). This amount
constituted 53.8 per cent of total proposed capital investment (TPCI) that consists of
both domestic and foreign investments (MIDA 2001).
This paper is divided into six sections. Section 2 outlines the research problem and
objectives. Section 3 reviews some theoretical and empirical literature of FDI.
Section 4 describes the sources of collected data, method and model applied to the
analysis of FDI. Section 5 presents the empirical results and interpretation, and
section 6 ends this paper with conclusions.
For Malaysia, FDI is strongly promoted to help achieve its sustainable economic
growth, improve employment conditions, accelerate modernisation in industrialisation
programme and raise living standards of its society. In the present era of globalisation
and liberalisation, trade and investment activities are expanding rapidly, which leads
Problem Statement and Objectives
to increasing multilateral relationships between Malaysia and other countries
regardless of their stage of development.
The Asian financial crisis of 1997-1998 severely affected the economic growth of
Malaysia. The real Gross Domestic Product (GDP) growth rate declined from 7.4 per
cent in 1997 to -7.4 per cent in 1998. By 1999, growth rebounded to 5.3 per cent. In
Malaysia’s manufacturing sector, foreign investment flows in the total proposed
capital investment (TPCI) were also affected. The amount of FDI in terms of
applications received for the establishment of manufacturing projects decreased from
RM14 billion (US$5 billion) in 1997 to RM12.6 billion (US$3.2 billion) in 1998. It
further decreased to RM9 billion (US$2.4 billion) in 1999.1
For more than five years prior to the crisis period, the exchange rate of the Malaysian
ringgit varied only in the range of RM2.36 to RM2.51 per US dollar. But when the
crisis occurred, the ringgit depreciated against the US dollar by almost 50 per cent
(RM4.88=US$1) (Athukorala 1998). Because of the volatility, Malaysia’s currency
has since been pegged at RM3.80=US$1. Malaysia’s experience of the currency crisis
seems to show that foreign exchange rates have an impact on the inflows of FDI. The
question is: are they a significant influence on total inflows of FDI in Malaysia? What
other factors influence the level of FDI in Malaysia? How will all these factors be
treated in order to improve the level of inward FDI? Based on the questions, the
objectives of this paper are (i) to analyse factors that determine the inflows of FDI and
(ii) to evaluate some policy actions related to FDI promotion in the manufacturing
sector of Malaysia.
Various theories are developed by economists to explain the existence and expansion
of FDI in open economies. In the theory of location, Dunning (1993) and Vernon
(1974) explained locational decisions and activities of multinational enterprises
(MNEs) from the aspects of production cost and market size of the host countries. The
expansion of foreign firms in the host countries is commonly in response to the
calculations of labour cost, transport cost, tax rates and other costs. In searching for
profits and risk reduction, MNEs’ production activities are diversified with emphasis
on industrial innovation in existing markets.
Dunning’s eclectic theory (1988, 1981) explains three factors that cause differences
between countries in their international investment involvement and structures. First,
capability to possess specific ownership advantages by the MNEs. The possession
enables the enterprises of one nationality to compete with those of other nationalities
in the host countries. Second, capability of the enterprises to internalise these specific
advantages. The internalisation is done either through extension of existing value-
added chains of production or establishing new ones. Lastly, whether it is profitable
for the enterprises to locate any part of their production facilities in their own country
or a host country.
In theory of comparative advantage, Kojima (1978: 103-118) identified the
characteristics of two different models of FDI: trade-oriented investment model and
the anti-trade-oriented investment. In the first model, trade is promoted when business
1 RM – Ringgit Malaysia (Malaysia’s currency). In annual average, Malaysia’s exchange rates were at
RM2.8:US$1 in 1997, RM3.9:US$1 in 1998 and RM3.8:US$1 in 1999.
decision-making in investment is subject to the comparative profit rates, which
correspond to the comparative costs. The second model takes place when the
comparative profit rates contradict comparative costs due to existing monopolistic
elements in industries. Kojima (1975) used different terms to explain the models of
FDI, arguing that FDI works either as a complement to international trade (trade-
creating type) or as a substitute for it (trade-destroying type). The trade-creating type
of FDI is a complement to commodity trade and it creates a harmonious trade with the
host country. It relates to the first model of FDI. Meanwhile, the trade-destroying type
of FDI is a substitute for commodity trade, which relates to the second model of FDI.
Other theories such as the product cycle theory of Vernon (1979, 1966), industrial
organisation theory of Hymer (1960/1976) and Caves (1971), internalisation theory of
Buckley and Casson (2000, 1976), internationalisation process approach of Bell and
Young (1998) and Johanson and Wiedersheim-Paul (1975), and risk diversification
theory of Agmond and Lessard (1977) and Grubel (1968) are provided in the area of
FDI too. For empirical studies, all the theories help identify many determining factors
that influence FDI in host countries.
In their empirical analysis of Japanese direct investment flows in the individual
countries of the European Community (EC) and in the United States, Barrel and Pain
(1999) selected labour cost, anti-dumping cases, interest rates, exports and two
dummy variables for accession of Spain and Portugal into the EC (set to zero before
1986 and unity thereafter) and for membership of the Exchange Rate Mechanism
(ERM) of the European Monetary System as determining factors. Their results
suggest that anti-dumping cases, labour costs and interest rates have influenced
Japanese direct investment in the host countries. Barrel and Pain (1996) selected
market size, as measured by Gross National Product (GNP), labour cost and capital
cost and found them as important factors in the decision of US companies to invest
In their analysis of the determinants of FDI in China, Liu et al. (1997) selected nine
variables namely, wage, GDP, exchange rates, exports, imports, interest rates, country
risk, total cultural difference between China and the home country, and the
geographic distance between China and the home country. Their estimation results
indicate that inward FDI was determined by most of their selected variables (except
interest rate, country risk and total cultural difference). Wang and Swain (1997)
selected factors to explain inflow of FDI in Hungary and China that included market
size, as measured by GDP, cost of capital, labour cost, tariff barriers, exchange rates,
import volumes, economic growth, productivity (only for China) and political
stability. They found that market size, growth rate, cost of capital and political
stability were the main determinants of FDI in Hungary while market size, labour
cost, exchange rates, cost of capital and political stability were the main determinants
of FDI in China.
Based on the above theoretical and empirical literature, determining factors of FDI
inflows into the manufacturing sector in Malaysia are identified. The analysis uses a
panel data set of FDI inflows in the sector by country of origin.
ADB (Asian Development Bank) 2002, Key Indicators 2002: Population and Human
Resource Trends and Challenges, vol. 43, ADB, Manila.
Agmon, Tamir & Lessard, Donald R. 1977, ‘Investor recognition of corporate
international diversification’, The Journal of Finance, vol. 32, no. 4, pp. 1049-
Athukorala, Prema-chandra 1998, ‘Swimming against the tide: Crisis management in
Malaysia’, ASEAN Economic Bulletin, vol. 15, no. 3, pp. 281-289.
Bank of Canada (accessed 20 June 2002), Exchange Rates,
Barrell, Ray & Pain, Nigel 1996, ‘An econometric analysis of U.S. foreign direct
investment’, The Review of Economics and Statistics, vol.78, issue 2, pp. 200-
Barrell, Ray & Pain, Nigel 1999, ‘Trade restraints and Japanese direct investment
flows’, European Economic Review, vol. 43, pp. 29-45.
Bell, Jim & Young, Stephen 1998, ‘Towards an integrative framework of the
internationalization of the firm’, in Internationalization: Process, Context and
Markets, eds Graham Hooley, Ray Loveridge & David Wilson, MacMillan
Press, London, pp. 5-28.
Buang, Ambrin (ed) 1990, The Malaysian Economy in Transition, INTAN Malaysia,
Buckley, Peter J. (ed) 2000, Multinational Firms, Cooperation and Competition in the
World Economy, MacMillan Press, London.
Buckley, Peter J. & Casson, Mark C. 1976, The future of the Multinational
Enterprise, MacMillan, London.
Buckley, Peter J. & Casson, Mark C. 2000, ‘Analyzing foreign market entry
strategies: Extending the internalization approach’, in Multinational Firms,
Cooperation and Competition in the World Economy, ed Peter J. Buckley,
MacMillan Press, London, pp. 61-93.
Buse, A. 1973, ‘Goodness of fit in generalized least squares estimation’, American
Statistician, vol. 27, pp. 106-108.
Caves, Richard E. 1971, ‘International corporations; The industrial economics of
foreign investment’, Economica, vol. 38, pp. 1-27.
CEPD (Council for Economic Planning and Development) 2001, Taiwan Statistical
Data Book 2001, CEPD, Taipei.
Cheng, Ming Yu, Sayed Hossain & Law, Siong Hook 2001, An Introduction to
Econometrics Using SHAZAM, McGraw-Hill, Kuala Lumpur.
Dornbusch, Rudiger, Fischer, Stanley & Kearney, Colm 1995, Macroeconomics,
Dunning, John H. (ed) 1974, Economic Analysis and the Multinational Enterprise,
Allen & Unwin, London.
Dunning, John H. 1981, ‘Explaining the international direct investment position of
countries: Towards a dynamic or developmental approach’,
Weltwirtschafliches Archiv, vol. 119, pp. 30-64.
Dunning, John H. 1988, Explaining International Production, Unwin Hyman,
Dunning, John H. 1993, Multinational Enterprises and the Global Economy,
Federal Reserve Board (accessed 19 June 2002), Statistics Releases and Historical
Data: H.10 Foreign Exchange Rates,
Görg, Holger & Wakelin, Katherine 2001, The impact of exchange rate variability on
US direct investment, paper presented to the GEP conference on FDI and
Economic Integration, University of Nottingham, June.
Green, William H. 1993, Econometric Analysis, MacMillan Publishing, New York.
Grubel, Herbert G. 1968, ‘Internationally diversified portfolios: Welfare gains and
capital flows’, The American Economic Review, vol. 58, pp. 1299-1314.
Hooley, Graham, Loveridge, Ray & Wilson, David (eds) 1998, Internationalization:
Process, Context and Markets, MacMillan Press, London.
Hung, Bill Wan Sing (accessed 31 March 2002), HKBU Econ3110 International
Economics: Openness of Selected Economies,
Hymer, Stephen H. 1976, The International Operations of National Firms: A Study of
Direct Foreign Investment (PhD thesis 1960), published MIT Press,
ILO (International Labour Office) 1990, Yearbook of Labour Statistics 1989-90, ILO,
ILO 2000, Yearbook of Labour Statistics 2000, ILO, Geneva.
ILO (accessed 10 March 2002), ILO Data Base on Labour Statistics,
IMF (International Monetary Fund) 1992, Direction of Trade Statistics Yearbook
1992, IMF, Washington D.C.
IMF 1995, Direction of Trade Statistics Yearbook 1995, IMF, Washington D.C.
IMF 2001, Direction of Trade Statistics Yearbook 2001, IMF, Washington D.C.
IMF 2000, International Financial Statistics Yearbook 2000, IMF, Washington D.C.
IMF 2001, International Financial Statistics Yearbook 2001, IMF, Washington D.C.
INTAN Malaysia [ Institut Tadbiran Awam Negara Malaysia (National Institute of
Public Administration Malaysia)] (ed) 1994, Malaysian Development
Experience – Changes and Challenges, INTAN Malaysia, Kuala Lumpur.
Johanson, Jan & Wiedersheim-Paul, Finn 1975, ‘The internationalization of the firm
four Swedish cases’, The Journal of Management Studies, vol. 12, pp. 305-
Kojima, Kiyoshi 1975, ‘International trade and foreign investment: Substitutes or
complements’, Hitotsubashi Journal of Economics, vol. 16, pp. 1-12.
Kojima, Kiyoshi 1978, Direct Foreign Investment, Croom Helm, London.
Lin, See Yan 1994, ‘The Malaysian economy, 1957-91: An overview’, in Malaysian
Development Experience – Changes and Challenges, edited by INTAN
Malaysia, INTAN Malaysia, Kuala Lumpur, pp. 553-590.
Liu, Xiaming, Song, Haiyan, Wei, Yingqi & Romilly, Peter 1997, ‘Country
characteristics and foreign direct investment in China: A panel data analysis’,
Weltwirtschafliches Archiv, vol. 133, no. 2, pp. 313-329.
McTaggart, Douglas, Findlay, Christopher & Parkin, Michael 1999, Economics,
MIDA (Malaysian Industrial Development Authority) 1996, Annual Report 96,
MIDA, Kuala Lumpur.
MIDA 2001, Malaysia Your Profit Centre in Asia, MIDA, Kuala Lumpur.
Ministry of Finance Malaysia 2001, Economic Report 2001/2002, Percetakan
Nasional Malaysia Berhad (PNMB), Kuala Lumpur.
OECD (Organisation for Economic Co-operation and Development) 2001, Main
Economic Indicators of April 2001, OECD, Paris.
PRS Group (accessed 28 April 2002), International Country Risk Guide – The ICRG
Rating System, http://www.icrgonline.com/icrgMethod.asp
Reserve Bank of Australia (accessed 19 June 2002), Bulletin Statistical Tables,
Statistics Bureau & Statistics Center (accessed 8 April 2002), Monthly Statistics of
Sulong, Zainal Abidin 1990, ‘The past, present and future role of foreign direct
investment (FDI) in Malaysia’, in The Malaysian Economy in Transition, ed
Ambrin Buang, INTAN Malaysia, Kuala Lumpur, pp. 59-70.
Tham, Siew Yean 1997, Foreign direct investment and productivity growth in
Malaysia, paper presented to the Seminar Kebangsaan Pertumbuhan Ekonomi
dan Kualiti Hidup di Malaysia (National Seminar on Economic Growth and
Quality of Life in Malaysia), Universiti Utara Malaysia, January.
Vernon, Raymond 1966, ‘International investment and international trade in the
product cycle’, Quarterly Journal of Economics, vol. 80, pp. 190-207.
Vernon, Raymond 1974, ‘The location of economic activity’, in Economic Analysis
and the Multinational Enterprise, ed John H. Dunning, Allen & Unwin,
London, pp. 89-114.
Vernon, Raymond 1979, ‘The product cycle hypothesis in a new international
environment’, Oxford Bulletin of Economics and Statistics, vol. 41, pp. 255-
Wang, Zhen Quan & Swain, Nigel 1997, ‘Determinants of inflow of foreign direct
investment in Hungary and China: Time series approach’, Journal of
International Development, vol. 9, no. 5, pp. 695-726.
White, Kenneth J. 1997, SHAZAM: Econometrics Computer User’s Reference
Manual Version 8.0, McGraw-Hill, Vancouver.
World Bank 2001, World Development Indicators 2001, World Bank, Washington