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The articulation of state and foreign capital in an export processing zone: The case of Bayan Lepas, Malaysia

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Content THE ARTICULATION OF STATE AND FOREIGN CAPITAL IN AN
EXPORT PROCESSING ZONE:
THE CASE OF BAYAN LEPAS, MALAYSIA
by
Carmen Sue Barker Lemay
A Dissertation Presented to the
FACULTY OF THE GRADUATE SCHOOL
UNIVERSITY OF SOUTHERN CALIFORNIA
In Partial Fulfillment of the
Requirements for the Degree
DOCTOR OF PHILOSOPHY
(Political Economy)
December 1992
Copyright 1992 Carmen Sue Barker Lemay
U M I Number: DP23389
All rights reserved
INFORMATION TO ALL USERS
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a note will indicate the deletion.
Dissertation Publishing
UMI DP23389
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THE GRADUATE SCHOOL
UNIVERSITY PARK
LOS ANGELES, CALIFORNIA 90007 — , —v
P K v U ,
t c.
' Q L
L_
This dissertation, w ritten by
under the direction of hA.fr. Dissertation
Committee, and approved by all its members,
has been presented to and accepted by The
Graduate School, in partial fulfillm ent of re
quirements for the degree of
D O C TO R OF PH ILOSOPH Y
Dean of Graduate Studies
Date November 3 0 , 1992
DISSERTATION COMMITTEE
Chairperson
TO BILL AND WAILANA BARKER
for instilling the dream
ACKNOWLEDGEMENTS
This work evolved out of a trip I took to Malaysia in 1986-87 under the
auspices of the Fulbright Fellowship program. Although my research at that time
was not directly related to the zone, both living in Penang as I did, and spending
many hours interviewing state officials, the issue of the zone policy and its effects
on Penang often arose. After returning to the states and beginning my doctoral
program in political economy, I became intrigued with discrepancies within
development theory, specifically between the theory on multinationals' role in
affecting developing countries' growth, the intended effects of the zone policy, and
the reports I had received in Malaysia.
Further investigation suggested that the use of economic zones to lure
multinationals to developing countries was a popular policy despite its many
critics. Even non-market economies established economic zones. I was interested
in trying to understand how the zone policy had endured despite its inability in
many cases to meet the economic objectives set forth by its implementors. After
having accumulated empirical data on the Malaysian case I felt ready to expound
some reasons which explain this phenomena.
In acknowledging their support of my efforts, many thanks go to the
faculty, staff and students of the Political Economy and Public Policy program
(PEPP) at the University of Southern California. A thank you is in order to Dr.
Farideh Motamedi, Executive Assistant to the PEPP program whose tireless
efforts on my behalf have not gone unnoticed. I owe much gratitude to the
following scholars/teachers: my chairman, Dr. Gary Dymski whose belief in my
"take" on this issue saw me through many uninspired days of A.B.D.hood; Dr. Eun
iii
Mee Kim for providing excellent source materials and challenging me to be clear
about my assumptions; Dr. Carol Thompson for her many thoughtful comments on
this manuscript in its earlier forms; and Dr. Michael Robinson for suggestions on
where to take the work from here.
To my husband Norm Lemay for providing an environment in which I
could create this work as painlessly as possible, and for assisting in the technical
output; I owe a large debt of gratitude. And to my parents for keeping the faith,
much thanks. Now we have a doctor in the family!
TABLE OF CONTENTS
PART I. ECONOM IC ZONES AND THE PURSUIT OF
DEVELOPMENT
Introduction
Why study zones? 1
Why employ a critical political-economic analysis? 4
Employing a game model 5
Utilizing a case study 8
Definitions 1 1
Outline of Chapters 12
Chapter 1 Economic Development, Foreign Direct Investment and the Role of the State
Introduction 15
Overview of Development theory 15
The Argument for Foreign Investment 16
Expectations of a Zone 18
Evaluation of the Zone Experience 19
The Distortions Created by the Zone 20
What Role for the State 23
Challenges to the New Orthodoxy 25
Performance of Zones in the NICs 27
Conclusion 28
Chapter 2 The Political Economy of an Export Processing Zone
Introduction to the Concept of the State 30
The State and Legitimacy 32
Securing International Recognition 33
The State, Accumulation and Distribution 34
The State and Autonomy 37
Conclusion 40 '
Chapter 3 Modeling the Zone Experience
Introduction. 41
Players, Strategies, Actions and Payoffs 42
Assumptions and Limitations of Game Theory 43
Agents: Their Interests and Influence on the Zone Game 43
Laissez Faire Strategy and the Zone Game 47
Rent-Seeking Strategy and the Zone Game 58
Developmental Strategy and the Zone Game 64
Conclusion 71
PART H. THE CASE OF THE BAYAN LEPAS FREE TRADE ZONE
Chapter 4 Economic Development, Foreign Direct Investment and the Role of the State
Introduction 74
Legacies of Colonialism 74
Economic Development in the Post-Independence Era 76
Challenges to the State's Legitimacy 81
Revewing State Legitimacy 82
Preserving International Recognition 84
Enhancing Accumulation and Distribution 84
Securing a Level of Autonomy 86
Concllusion 89
Chapter 5 Malaysia's Bayan Lepas Zone: A Game Theoretic Analysis
Introduction 90
Penang Creates a Zone 90
Agents: Their Interests and Influence on the Zone Policy 92
The Laissez Faire Strategy and the Zone Game 94
The Rent-Seeking Strategy and the Zone Game 105
The Developmental Strategy and the Zone Game 111
Outcomes 117
PART H I LOOKING AHEAD
Chapter 6 Conclusions
Introduction 120
Prospects 122
Policy 123
Further Inquiry 125
Bibliography
Appendices
126
142
LIST OF TABLES
DIAGRAM 3.1 DECISION MAKING TREE WITH A LAISSEZ FAIRE
STRATEGY
TABLE 3.1 PAYOFF MATRIX
DIAGRAM 3.2 DECISION MAKING TREE WITH A RENT-SEEKING
STRATEGY
TABLE 3.2 PAYOFF MATRIX
DIAGRAM 3.3 DECISION MAKING TREE WITH A DEVELOPMENTAL
STRATEGY
TABLE 3.3 PAYOFF MATRIX
TABLE 3.4 COMPARISON OF THREE STRATEGIES
DIAGRAM 5.1 DECISION MAKING TREE WITH A LAISSEZ FAIRE
STRATEGY
TABLE 5.1 PAYOFF MATRIX
DIAGRAM 5.2 DECISION MAKING TREE WITH A RENT-SEEKING
STRATEGY
TABLE 5.2 PAYOFF MATRIX
DIAGRAM 5.3 DECISION MAKING TREE WITH A DEVELOPMENTAL
STRATEGY
TABLE 5.3 PERIODIZATION OF MALAYSIAN POLITICAL ECONOMY
ABSTRACT
i
This study is first and foremost a critical policy analysis o f a policy to
! create export-processing zones in developing countries. It embarks on an
i
I
evaluation of the zone in its broader context to determine those state actions that
enhance zone performance. In so doing it explores the evolution o f state-market
: relations in an economy noting three distinct state strategies toward the market:
laissez faire, rent-seeking and developmental.
i
This work is organized into three parts. Part I explores the literature on
development and the recent attention on the role of a developmental state in the
success of the NICs. It introduces the concepts of legitimacy, international
i
recognition, accumulation, distribution, and autonomy in an attempt to understand
the state's objectives in conducting economic policy. It employs a game
framework to highlight the interactions between players in a zone game and offers
the means with which to evaluate zone performance.
Part II reveals the political economy of post-independence Malaysia noting
the ways in which the state sought to create an environment for capital
accumulation and the distribution of resources while maintaining legitimacy,
autonomy and international recognition. The state promoted different strategies
including laissez faire, rent-seeking and developmental strategies at different times
to promote economic growth. The impacts of these strategies on the zone game
are explored.
Part III offers some policy proposals for improving the zone's performance
and suggests further research.
PART I. ECONOMIC ZONES AND THE PURSUIT OF
DEVELOPMENT
Introduction
A notably common policy utilized over the last thirty-odd years to influence
the movement of foreign direct investment has been the creation of export
processing zones. A territory of land distinguished by preferential treatment of
foreign investors, an export processing zone lures foreign investors for their
resources, namely capital and technology, which the host country finds scarce. At
the same time, the host country can offer the firm cheap labor relative to that
found in their home country. Therefore, each can offer the other something of
value.
Within the zone the state essentially offers the multinational company two
of the three requirements for production: land, including the infrastructure
necessary for modem production facilities; labor-inexpensive, educated and
controlled through legislation either outlawing or severely restricting union
activity. In most cases the firm provides the capital it needs, however in a few
select cases the state provides finance capital as well. I More often the host-
country state assists with the provision of capital saving measures— in the form of
tax holidays, exemptions from duties and free trade agreements.
WHY STUDY ZONES?
The policy of creating export processing zones to attract foreign
investment enjoys worldwide popularity. The modem version of the export
1 This is true in the case of Mauritius; Dakar, Senegal; Kandla, India; and Bataan, Philippines.
1
processing zone appeared in Ireland during the 1950s (Vittal 1977:1). Later the
developing countries of Taiwan, South Korea, Brazil, Mexico, and many others
introduced export processing zones. Seventy-nines zones were in operation in 25
countries by 1975. Then by 1986 a total of 176 zones operated in 47 countries
(Kreye 1987:6).
The proliferation of the policy continues despite a widely available
empirical record that suggests that zones rarely meet their economic objectives,
and in many cases create other distortions in the host country. The large number
of zones and the discrepancy between outcome and expectation of the policy has
fostered many zone studies both case studies and comparative works (Crane 1991;
Kreye 1987; Warr 1983,1986,1987; Kelly 1987; Maex 1983) So why does the
author embark on yet another study of this policy? Consider the following
statement:
The interest of the EPZ lies essentially in its physical, social
and economic segregation from the rest of the country. This
segregation, coupled with the presence of good
infrastructure and a favorable administrative environment,
has been one of the keys to the success of EPZs. At the
same time it raises a number of complex questions as to
their effective benefits to the host country, their contribution
to social development and their role in the process of
technological innovation and industrial growth.
(UNCTC/BLO 1988:7)
The above statement and the two that follow represent the ambiguous
conclusions found in works that attempt to evaluate the zone experience.
2
One of the keys to success for an EPZ is its exclusive j
preoccupation with exports and employment promotion; a j
simultaneous focus on regional development, social policy |
or the promotion of technological development is likely to j
detract from its main task and hamper its development.
i
yet |
As a physical, economic and even social enclave in the host j
country, the EPZ is perhaps the most achieved mechanism
fo r preventing the development o f technological linkages
between the foreign firms in the EPZ and the enterprises in
the host country. (UNCTC/ELO 1988:118, emphasis added) j
It is this "successful yet troublesome" designation that I seek to explore in j
I
this study. I will suggest that this dichotomous approach to analyzing EPZs is not i
useful. What is needed is a process to evaluate whether those agents with j
i
interests in a zone got what they wanted and the effect of these outcomes on the j
I
host country. This work emphasizes the state's approach to foreign investment, J
including the joint gains anticipated by such investment and the policy environment i
created to influence foreign investment within a zone. \
i
I
It starts with the state not because a priori the state has the sole interest in j
the zone or takes action isolated from other agents. Rather it takes this approach !
I
because recent literature investigating the success of the Newly Industrialized !
i
Countries (NICs) of Taiwan, South Korea, Singapore and Hong Kong points to j
i
the importance of the state's market augmenting role in promoting and sustaining j
economic development (Deyo 1987; Haggard 1990; Gereffi and Wyman 1990; |
Koo and Kim 1992; Lubeck 1992; Castells 1992). This literature gives rise to two j
questions: first, does the state's relationship with the market change zone
outcomes? and second, what factors determine the state's choice of strategy and
then persuade a state to change strategies?
WHY EMPLOY A CRITICAL POLITICAL-ECONOM IC ANALYSIS?
To answer these questions, this study merges two methods: critical policy
analysis and the technique of formal modeling as found in game theory. Critical
policy analysis
encourages dialogue and criticism by disseminating
information and questions, counteracts noise emanating
from or circulating within bureaucracies, offers suggestions
for action, and exposes unwarranted exercise o f political
power. (Bobrow and Dryzek 1987:176)
Applying a critical policy analysis means clearly defining the costs and benefits of a
policy accruing to all segments of the population given a keen sense of the culture,
politics, and history of the area or group in question. Through application to
social problems, critical policy analysis seeks to empower those with little influence
so that they may have a larger role in democratic decision making and development
efforts.
The social problem identified herein is the high cost of public funds used to
subsidize multinational production in the export processing zones of developing
countries. Many believe that establishing export processing zones hastens
economic development in less developed countries. Export promotion takes a
smaller investment of capital and yields a quicker return than investment in
domestic heavy industry or the development of human capital (Vittal 1977:5).
Nonetheless, the relative underdevelopment of the periphery, the lack of
infrastructure, of trained labor, of technological capacity, of production materials,
and of effective demand for goods due to the low standard of living, make them
4
otherwise unattractive to the majority of foreign investors. Therefore, the
peripheral state is obligated to "offer a suitable package o f investment incentives"
to attract foreign investment (Vittal 1977:1). The development of export
processing zones reflects the relative weakness o f peripheral countries in the world
economy.
Whereas various bodies of the United Nations once encouraged the
development o f export processing zones as a popular policy option, "these bodies
now conclude that EPZs are of limited utility in industrialization" (Crane 1991:10).
EPZs are troubling precisely because, "the competition to attract industry to
[zones]...has resulted in under-utilization of the infrastructure created to receive it,
leading to the waste of already scarce resources" (Basil and Germidis 1984:9).
Many existing zone studies suggest that zones do not meet their economic
objectives, and therefore, impose a cost on the state. Nonetheless, a few zones
have realized at least limited success. Existing studies have not clearly j
differentiated either state activities that support the success of the policy, or those
that detract from zone efforts. Part of the problem has been clearly identifying
what success means in the zone context. This work would suggest that previous [
i
works have not taken a critical look at the objectives of state managers and the j
requirements o f state organizations, therefore, they have not identified the gains j
that the state realizes from investment in the zone. ^
|
|
(
EMPLOYING A GAME MODEL j
i
Political economy is "mapping economic constraints through the choices !
and institutions facing political actors" (Haggard 1992:631). Policy is conducted
5
within this realm of choices and constraints, in an environment of competing
interests vying to improve their position in the marketplace. These interactions
between domestic agents, the state and representatives of the multinational
companies at the level of the international economy provide the level of analysis
for this study.
Bargaining between dominant groups and their representative agents
characterizes the policy process Game theory can offer an insight into the
bargaining process by offering a model of negotiation. Characterizing the
interactions of agents as a game is useful in that it 1) formalizes agents' interests
and actions in the policy process, 2) suggests changes in the relative strength of
agents over time, and 3) offers a means by which to map the options open to them
and to evaluate the payoffs associated with these actions.
Game theory is a technique of mapping the set of possible actions open to a
player and the payoffs assigned to these actions. It "is concerned with the actions
of individuals who are conscious that their actions affect each other" (Rasmusen
1989:16). An agent is an individual who has an interest in the outcome of the
policy but is unable to influence the outcome directly. A player is an agent actively
involved in the policy process. Each player can affect the others' actions. A
strategy set includes possible courses of action and their associated payoffs. A
game tree traces the actors' strategy set. Payoffs constitute a player's preferences.
These can be ordinal (rank) or suggest utility through a comparison of absolute
value. Payoffs must be independently determined from the outcome of the game if
they are to have any meaning.
6
Determining payoffs offers an exercise in political economy, as it involves
understanding players' preferences in a historical perspective, as well as the
political, economic, and social context in which actions gain value. Furthermore,
as many agents get excluded from any particular game; and overall the most
powerful agents participate much more frequently in the bargaining process,
gaming models can mimic the real world of social structural constraints facing
agents and the exclusivity of the policy making process.
Modeling actions within a game framework assumes that players act
"rationally." Striving to achieve preferred ends, players rank alternatives based on
their goals and interests, and then choose the highest ranking alternatives. The
assumption of rationality does not imply in any way that the resulting actions best
serve societal interests, or that one player's choices are better than any others.
Rather it assumes individual self-maximizing behavior in absence of centralized
authoritative institutions. Within the conditions of the game, players can assess
their interests and rank courses of actions based on their desire to have these
interests fulfilled.
This work employs a game as a metaphor to reveal the evolving political
and economic forces in the context of a zone. Within the game framework
elements most often absent from traditional economic analysis can be introduced.
The introduction of these additional factors aid us in establishing the political
economic context within which state activities are properly evaluated.
This work will offer three models of the actions of state managers and state
organizations conducted in the context of bargaining with multinational
corporations producing in export-processing zones. It will suggest three different
7
state strategies: 1) laissez faire, letting the market lead while maintaining a hands-
off approach, 2) rent-seeking, extracting side payments for the benefit o f state
managers, and finally, 3) developmental, selective state intervention to overcome
market failures and to lead the market. These three strategies represent real-life
responses to foreign direct investment but may not exhaust the possibilities. After
modeling the strategies, this work offers an explanation of the benefits and costs
that each offers, and the conditions associated with the selection of the strategy.
i
UTILIZING A CASE STUDY |
i
According to Stephen Haggard the neo-classical economic literature on j
development has focused on policy effects rather than policy determinants thereby j
i
making policy exogenous, while the dependency literature makes policy irrelevant !
i
in a world of all-powerful industrialized countries. Both bodies of literature j
neglect the domestic political forces and institutions which shape developing j
I
country policies toward foreign investment (Haggard 1990:2-3).
i
A country's political economy and social structure are o f utmost
importance to understanding its economic growth and the policies employed to J
reach development objectives. Like all domestic policies, a zone policy reflects
I
"domestic coalitional and bureaucratic conflict" (Haggard 1989:204). To ;
understand these forces one must delve into the social fabric of the host country.
i
Toward these ends, this work necessarily employs a case study of Malaysia's j
i
Bayan Lepas zone.
Malaysia has been chosen primarily for two reasons. First, Malaysia's post
independence experience reveals many signs of successful economic development:
8
high and sustained levels of economic growth, low inflation, and increased
diversification in production and exports, to name a few. As a result Malaysia is
often cited as one of the "second-tier” NICs. Unlike the "first-tier" NICs,
however, Malaysia faces the social and political challenges of an ethnically diverse
population. Therefore, a second reason to examine the Malaysian experience is
that Malaysia's ethnically diverse population more closely reflects the experiences
o f other developing countries with similarly diverse populations
This work will review the literature on zones, noting the generally poor
i
performance of this policy in developing countries. In assessing this literature it
seems prudent to move beyond the simple success or failure dichotomy imposed
i
on zone experiences, and to differentiate among three distinct situations: 1) those j
in which the zone contributes to the transfer of technology and development of
I
workers' skills, 2 ) those where growth of employment has occurred, and 3 ) finally j
I
those characterized by mere wealth transfers to state officials through rent seeking :
behavior. Making such distinctions is important. Without development, the zone
j
policy uses public funds and resources to subsidize the production activities of
multinational firms.
The cost involves more than mere monetary considerations, When part of
a broader free market export oriented industrialization (EOI) strategy, the
maintenance of an export-processing zone threatens to land a developing country
in a low level trap. This is because those firms traditionally attracted to a zone
offer primarily low skill jobs and few opportunities for workers to acquire
transferable skills, little foreign exchange, and minimal technology transfer. The
trap is, therefore, very real unless the state steps in and alters the free market
outcomes of the policy.
The argument put forth here is that a zone policy is more likely to
contribute to the broader development objectives o f the host country state in those
countries where the host country state intervenes to overcome market failures, and
thereby acts against the new economic orthodoxy. In other words, the
shortcomings of zone policy are the more general shortcomings of free market
l
export-oriented industrialization, and therefore, selective interventions improve the j
outcome. It is the author's wish that this work will contribute to ongoing debates
i
in the political economy of industrialization, the appropriate role of the state in ,
development, the incentives which politicians and state managers respond to in j
creating policy, and the structural constraints that limit some agents' access to the
policy process.
Three distinct bodies of literature form the foundation for this study: 1) the
role of the state and foreign direct investment in development; 2) the global and
domestic political economic context in which multinational companies, the state j
and other domestic agents form relations and bargain with one another to meet j
their objectives; and 3) empirical evaluations of zone policies generally and ;
Malaysia's Bayan Lepas zone in particular.
Much of the work in development economics remains at the level of
I
macroeconomic strategies, not concerning it self with the particulars of policy or
other details of a country's political economy. In this way it has for the most part
l
!
remained highly theoretical and unable to account for the richness of country |
experiences with industrialization. |
i
!
10
Works on the political economy o f development are just beginning to
provide in-depth country studies that elaborate state activities, their outcomes, and
changing power relations within the development process. These include the work
of Gold on Taiwan; Amsden, Koo, and Kim on Korea; Jesudason, and Doner on
Malaysia; and comparative works by Haggard, and Gereffi and Wyman, to name a
i
few. It is in the spirit of these works that this study commences.
DEFINITIONS
Export processing zone: "a clearly delineated industrial estate which
constitutes a free trade enclave in the customs and trade regime of a country, and
where foreign manufacturing firms producing mainly for export benefit from a
certain number of fiscal and financial incentives" (UNCTC/ILO 1988:4). Also
commonly called free trade zone, free zone, export free zone, industrial free zone,
etc. The EPZ is a mechanism for rationing scarce resources such as investment
funds, infrastructure, and licenses (UNCTC/ILO 1988:156).
Development: A dynamic concept that suggests the creation of
employment, degree of equality, political empowerment, growth of per capita j
income, efficiency o f industrial production, development of capital goods industry, !
growth of industrial output, growth of industrial exports, stability of growth
(adapted from Griffin 1989).
State: " An organization composed of numerous agencies led and
coordinated by the state's leadership (executive authority) that has the ability or
authority to make and implement the binding rules for all the people as well as the
parameters of rule making for other social organizations in a given territory, using
11
i
force if necessary to have its way" (Migdal 1988:19). In this work the term state
will be used to refer to both state managers which includes elected officials and
civil servants, and state organizations.
Developmental State: A state acting autonomously from societal agents I
l
that can create and implement economic policies that have as their objective long- j
. I
term market-promoting goals (Koo and Kim 1992; Haggard 1990). !
Rent-seeking State: The state intervenes in the market creating a !
regulatory environment of "quantitative controls in which state officials can
appropriate surplus" (Blomqvist and Mohammad 1986:161).
Laissez Faire State: The state supports private accumulation and
distribution with a minimum amount of intervention in market activities. i
i
M ultinational Corporation or MNC: is "an enterprise which operates !
through affiliates, simultaneously in several jurisdictions at the same time" (Vernon i
t
1981:53).
i
OUTLINE O F CHAPTERS
This work is divided into three parts. Part I develops the theoretical and
methodological foundation for the work. Part II analyzes the case study. Finally, j
part III offers policy recommendations and ideas on further research. j
Part I begins with chapter one exploring the literature on the role of foreign j
direct investment in economic development and the appropriate role of the state in
1
the market. The expectations of export processing zones and the performance of
!
zones is explored. Explanations for zone's failings are compared.
i
I
I
12
Chapter Two lays out the objectives of a capitalist state. These include the
pursuit of legitimacy, the need to accumulate and distribute resources, and ,
necessity for autonomy from other societal agents. State strategies affect how
these needs are met.
Chapter Three explores the relations between domestic and multi-national
interests in getting their needs met in the zone It models the activities of a laissez
faire state in the zone context and contrasts these with those of a rent-seeking
state. Emerging from the experiences of Japan and the newly industrialized j
countries (NICs), another body of literature suggests a very different articulation
between the state and capital which enhances long-term development of the host
country. The activities of a developmental state in the zone context will be
modeled.
Part Two begins with the recognition that development is pursued within a
domestic political economic context. Within this context power is distributed,
actions and strategies chosen, relationships between agents established, and
outcomes of general strategies and particular policies interpreted. Toward
understanding these phenomena Chapter Four introduces key aspects of the
Malaysian political economy, noting particularly the challenges confronting the
state in a communal society. This will be followed by a periodization of the state's
I
development strategies with a focus on how a zone policy and foreign direct
*
investment fit into the broader strategy. Finally the costs and benefits of the Bayan
Lepas Zone are identified noting that the zone contributed to the legitimacy of the
state, aided in accumulation and distribution of resources and enhanced the ;
autonomy o f state managers and state organizations. 1
13
Chapter 5 identifies the emerging relations between the state, foreign
capital, domestic capital and labor in the context of the zone. This analysis
suggests that the state's strategy appeared to change over the life of the zone
policy fundamentally changing the game. Agents and players in the zone game will
be differentiated, and the information and other endowments available to them will
be noted Each player's strategies, actions and payoffs will be explained and the
dominant strategy will be marked. A comparison of the zone game under each of
the state's strategies is provided.
Finally, in Part Three an extension of the discussion considers policy
recommendations to improve the zone's performance, and suggests further
research in this area.
14
Chapter 1 Economic Development, Foreign Direct Investment and
the Role of the State
INTRODUCTION
This chapter begins with the literature on economic development strategies
to reveal the ascendance of the export-oriented industrialization (EOI) strategy
since the phenomenal growth of the newly industrialized countries (NICs) of
Taiwan, South Korea, Singapore and Hong Kong. The theoretical tradition in
economics called the new orthodoxy attributes the superiority of EOI and the NIC
success to the preponderance of market forces, and relative openness of these
economies. Recent writings refute this claim and introduce the concept of a
developmental state to understand the NICs success. These ideas will be
contrasted herein.
OVERVIEW OF DEVELOPMENT THEORY
In the twentieth century three macro strategies for economic growth have
gained prominence: primary product export, import substitution industrialization
and export-oriented industrialization. Most countries have employed the first
strategy at some point in their history, and for some it has created a necessary
economic surplus to begin the industrialization process. However, these strategies
do not constitute a natural progression from one to another. The empirical record
is much too rich in detail to allow for this oversimplification. These three
strategies may be complimentary during a given period in a country's history, and
sometimes at odds as both global and domestic forces influence the choice of
strategies and their outcomes.
I
By the early part of the twentieth century PPE was falling into disfavor in i
i
many parts of the developing world. Severe price declines in commodities since
the Great Depression caused increasingly negative terms of trade for primary
product producers. Leaders in these nations sought to upgrade their products to
realize increased value-added in exports, as well as to substitute domestically
produced goods for imports to save foreign exchange. Out of these practices the
logic of import substitution industrialization emerged.
Recognizing that "a country can't get rich importing manufactured goods if
it can possibly manufacture them itself' (Sklair 1991.15), ISI moves away from the
external dependence o f PPE. While the state sanctions a variety of measures to
promote domestic industrialization, the degree of inward orientation can vary from
discriminating against all imports to the limited application of import substitution. 2
At the same time, domestic producers cannot enjoy economies of scale and
frill capacity utilization due to low effective demand in the domestic market
(Balassa 1988:S280). This leads to inefficient production activities and higher
prices for goods. Often the state must subsidize these production activities thereby '
exacerbating its budget difficulties. Unless the country can sustain economic self !
i
reliance, or find other countries willing to barter for goods, the severe budget
I
constraints facing the state and the shortfall of foreign exchange become critical '
i
problems in the continuation of the ISI strategy. j
THE ARGUMENT FOR FOREIGN INVESTMENT
To overcome the shortage of foreign exchange state managers invite
multinational companies to locate within the tariff walls and produce for the
16 |
I
I
domestic market. However, with a sufficiently small domestic economy, foreign
firms may push to export in order to realize economies of scale. Export-oriented
industrialization (EOI) is relatively more outward oriented than ISI. The logic
behind EOI rests in neo-classical trade theory that recognizes the gains to trade in
an otherwise more open economy. These gains include increased efficiency and
productivity, as a result of specialization in areas where the country has a relative
comparative advantage. Relative comparative advantage suggests lower
production costs due to lower costs in one or more production factors ;
The logic of EOI suggests that by pursuing comparative advantage in
whatever resources a country finds itself relatively more endowed, the economy of
the country expands. As long as an economy maintains its openness, factors of
production find it attractive and relocate to take advantage o f its resource base.
i
The ex ante calculation of gains from FDI include the efficient use of resources on
a global scale leading to the provision of cheap and readily available goods on the «
i
world market (Balassa 1988). Supporters of EOI include the World Bank and '
i
agencies of the UN, developing countries' officials in need o f foreign exchange and
employment opportunities for their citizens, and foreign investors looking for
cheap labor and access to markets (Kelly 1986:823). ;
Export-oriented industrialization encourages an open economy, allowing |
i
access to the domestic market for both foreign goods, and foreign production and I
I
service activities. Because multi-national companies often have a comparative
advantage capital-intensive production processes, the logic of EOI includes the
rationale for encouraging MNC expansion within developing countries. MNCs
operate with more fully developed production capabilities and markets. j
!
I
17 !
i
I
Encouraging their expansion and proliferation makes for good policy (Balassa
1988; Krueger 1985) With the economic success o f the NICs the debate over
development strategy may have been put to rest as "sufficient cumulative evidence
exists to suggest that countries more open to world trade have higher GNP growth
rates" (Corbo et al. 1985:11). Establishing export-processing zones provided one
means that the NICs opened their economies and produced exports.
EXPECTATIONS OF A ZONE
Some consider EPZs "a novel and efficient expression of the basic principle
of comparative advantage," (Crane 1991:10). Establishing an export-processing
zone encourages non-traditional exports in developing countries by expanding the
principle o f comparative advantage to include labor. Rather than "exporting" its
cheap labor, a developing country welcomes multinational companies to invest and
utilize its abundant and relatively cheap production factor. This enhances the
export of non-traditional exports, exports that "may absorb more labor than import
replacement thereby meeting objectives o f greater employment and improved
income distribution" (Meier 1976:143).
MNCs find the relatively low wages of developing countries attractive
(Jomo 1986:226). Low wages reduce production costs. The promise of a "special
labor code" within the zone that the state imposes by restricting labor organizing
and relaxing certain labor laws, appeals to many multinationals in highly
competitive industries (Grunwald and Flamm 1985:245-46). Furthermore, the
provision o f infrastructure within the zone including production facilities,
18
transportation and communication networks, and often housing for workers,
subsidizes multinational production costs.
A portion o f displaced peasants, rural labor, small manufacturers and the
urban unemployed benefit as a variety o f newly created production activities
emerge and soak up a portion of previously underutilized labor and facilities. This
improves overall productivity in the economy. Besides its employment effects,
policy makers suggest an export processing zone provides foreign exchange by
way of taxation on firm profits, rents on facilities and wages; and technology
otherwise unavailable to their country. By creating the zone, the state can realize
economies of scale in its provision of infrastructure and minimize the
administrative apparatus overseeing the in- and out-flow of zone products because
the zone concentrates foreign investment in a defined area. The results of dozens
of zone experiences will be summarized below.
EVALUATION OF THE ZONE EXPERIENCE
Four industries comprise the majority of zone firms worldwide: toys,
plastics, textiles and electronics. Due to the relatively low cost o f transporting
products particularly in the latter two industries, these industries have found
themselves able to relocate certain portions o f their production processes in less
developed regions to take advantage of cheaper labor found in these countries and
to avoid tariff barriers (Grunwald and Flamm 1985:215). Although the incentives
embodied in a zone policy are not decisive in a firm's choice to relocate the labor
intensive portion of its production activities abroad, they do offer yet another
means by which to lower production costs.
19
The International Labor Office (ILO) concludes that the zones create
positive employment effects, despite the low-wage and low-skill jobs created
(Maex 1983:49). In some countries, zones expand manufacturing employment,
while at the same time providing a response to regional unemployment problems
(Maex 1983:65). As for the expansion of tax revenues, creation of foreign
exchange and the transfer o f technology however, the results have been much less
encouraging.
The zone often provides physical signs of productive activity in the
proliferation o f modem factories, and the employment of a few thousand people,
who presumably would otherwise be un- or under employed. However, as a
conduit of long-term, comprehensive development for the home country, the
creation of economic zones is problematic at best.
DISTORTIONS CREATED BY THE EXISTENCE OF THE ZONE
Crane (1991) summarizes the charges commonly leveled against EPZs:
The structure of industry in EPZs tends to be 'noncomplex,'
consisting mostly of simple processing and assembly firms
with low capital investment per enterprise. These sorts of
operations are not effective vehicles for technology transfer.
Moreover, employment gains are seen as minimal because
many EPZ companies hire mostly young women at very low
wages under exploitative working conditions. The impact of
zone exports on the host country's balance of payments has
generally been less than expected. EPZ exports have a high
import content, reducing foreign exchange potential.
Furthermore, foreign exchange receipts are reduced by the
repatriation of profits that is found in virtually every zone.
Finally, EPZs have retained their enclave nature as isolated
islands of foreign investment and have had little impact on
the domestic economies of host LDCs. (Crane 1991:9)
20
Some even suggest that zones become an end in themselves as countries may get
stuck at an early stage of export industrialization with these low-skill level, enclave
industries (Kelly 1986:833). Furthermore, the competition for foreign investment
leaves less developed countries in a situation characterized by the prisoners'
dilemma where no one country "can unilaterally take the risk of scrapping
incentives" (SEADAG 1974:14; Guisinger 1986:166). Zone incentives prove
costly to the host country economy .
A large amount of macro economic data suggests that export-processing
zones are "poor public investments" due primarily to their inability to provide
technology transfer (Fitting 1982:736; Warr 1983:39; Fuentes and Ehrenreich
1983:5; Maex 1983:41-42; Kelly 1986:828) and second, that the host-country
treasury acquires inappreciable amounts of foreign exchange (Pepper 1988:5, 11;
Warr 1983:39; Maex 1983:38). Third, Sklair notes that zones lack linkages to the
domestic economies. For example, in the cases of Egypt, Mexico and China only
1-2% of zone inputs represent domestically produced goods (Sklair 1991 55).
Furthermore, zones create a class of low-skilled female factory workers (Maex
1983:53; Kelly 1986:834; Kreye 1987:17; Andors 1988:39).
A large number of studies elaborate the economic and social costs of
zones.2 Among these are Otto Kreye et al. (1987), the United Nations Conference
* While zones pose an economic cost to the host country, other studies note the costs imposed on
the tens of thousands of young women employed in the zones. Notable examples include the
works of Phyllis Andors (1988) on China; Deirdre Kelly (1987) on St. Lucia; Maria Patricia
Fernandez-Kelly (1983) on Mexico; Kimori Mai (1989), Fatima Daud (1988), Aihwa Ong (1987,
1983), Annette Fuentes and Barbara Ehrenreich (1983), and Rachael Grossman (1980) on
Malaysia; Linda Arrigo (1980) and Norma Diamond (1979) on Taiwan. These works examine
the long working hours, health and safety hazards, few opportunities for advancement, job
instability, dismissal o f labor organizers, sexual harassment and isolation from the local
21
on Trade and Development (UNCTAD 1985), and Rudy Maex (1983) on zones
generally; David Bachman (1989), Phyllis Andors (1988), Suzanne Pepper (1988),
Harry Harding (1987) and Joseph Fewsmith (1986) on China's Special Export
processing zones; George Fitting (1982) comparing Taiwan's and China's zones;
Peter Warr (1987) on the Philippines' Bataan Export Processing Zone; Peter Warr
(1983) on Indonesia's zones; and Peter Warr (1986), and The Penang Town
Planning Department (1986) on the Bayan Lepas zone in Malaysia
community that zone workers frequently experience. Kelly's work emphasizes the women's own
perception of their zone experience. Female zone workers suggest that their employment is on
the whole exploitative rather than liberating. Their concerns include low wages, stressful work
environments, the lack of benefits such as uniforms or transportation to the factories, and the
health and safety hazards of the job (Kelly 1986:826-27, 834). This closely parallels the view of
workers in other zones (Ong 1983:434). The women of Kelly's study cite the lack of alternative
opportunities as the reason for their continued employment in the zone. Women workers find
themselves trapped in the low-wage, unskilled jobs within the zones (Daud 1988:119), because
"foreign investors, particularly the TNC, perpetuate a sexually segmented labor market where
most women are assigned to low-paying jobs that lack skill development opportunities. This
makes promotion and mobility harder for women...[and, therefore], do[es] not challenge the
primary duties of women as household workers and mothers" (Andors 1988:39). Men control
zone firms, and male administrators control female zone workers (Andors 1988:40; Arrigo
1980:25; Kelly 1986:824). Patriarchy as practiced in the zone reflects the culture of the host
country, as well as the structural conditions of the world market. Capitalism erects barriers to
women's' equal participation and the development of their potentials and capacities because it
separates domestic labor from the realm of paid labor (Fernandez Kelly 1989:623 ; Daud
1988:119). Within the zone a woman's domestic responsibilities must not interfere with her
production work, lest she finds herself without employment. Women in China's zones must
maintain their single status and abide by strict curfews, while pregnancy leads to certain
dismissal in many zones (Andors 1988; Fuentes and Ehrenreich 1983:6). Despite the difficulties
of zone employment, women still flock to the zone in search of work. In an example given in
Ong's study of a rural zone, there were five applications for every one job opening (Ong
1989:153). Some studies suggest that the women's eagerness to work in a zone reflects the level
of autonomy zone employment offers from repressive family relations (Daud 1988; Lim 1983).
Furthermore, women in need of wage employment to support their lamilies often believe that
working conditions and wages in the zone compare favorably with those in domestic firms of
similar size (Fernandez Kelly 1989:623; Grunwald and Flamm 1985:228; BW 1983:58).
Attempting to secure zone employment is then a rational response to the need for a cash income
and the availability of zone employment given the constraints these women face. Ong offers
another explanation when she suggests that the large number of women attempting to secure
zone jobs is a result of "the relative oversupply [of female labor] and the eagerness of peasants,
village elders, and local institutions to send otherwise non-cash-eamihg village women to the
FTZ" (Ong 1989:153).
22
Warr's work is noteworthy in that he develops an exhaustive framework for
calculating economic costs and benefits that he then applies to the cases of the
Philippines' Bataan zone, Indonesia's zones, and Malaysia's Bayan Lepas zone.
Costs and benefits noted include the number employed and the value o f their
wages and benefits; the source of capital invested and the ownership status of zone
firms; the industrial composition of the zone; the absolute value of local raw
materials used; the value of foreign exchange deposited locally, the tax revenues
generated; and the infrastructure and administrative costs incurred by the state
(Warr 1987:235).
After implementing this framework, he suggests that the Philippine case is
conclusive: there is a net loss to society from continued state investment in the
zone (Warr 1987:238, emphasis added). In the case of Indonesia, only when
"unofficial levies" to state officials become "social benefits," does the zone
"generate positive economic benefits" (Warr 1983:44). In the case of Malaysia's
Bayan Lepas, Warr suggests that net benefits exceeded net costs within ten years
of establishment According to his analysis, however, the benefits could have been
higher (Warr 1986:206).
WHAT ROLE FOR THE STATE?
The new orthodoxy attributes zone failure to the inappropriate intervention
of the state into market activity. Supporters point to the Indonesian case identified
by Warr (Warr 1983), in which state managers intervene in zones with excessive
regulations that constrain MNC activities and their attempts to form linkages with
23
domestic firms. In the new orthodoxy as in classical economics, the state should
confine its activities to the absolute minimum.
Laissez faire implies that the market mechanism makes the appropriate
distribution o f resources and income, provides a stable economy at full
employment and promotes economic growth. Under these conditions the state
need only intervene in those areas where market failure dominates. Any other
intervention by the state would be construed as rent-seeking behavior.
State Managers as Rent-Seekers
Theories of rent-seeking behavior suggest that state managers pursue the
activities they do, because by imposing regulatory mechanisms on economic
activities, they can extract side-payments for themselves. Rent-seeking serves the
self-interests Of state managers, but is welfare reducing for the country as a whole.
This is so because the side payments worsen the distribution o f income, promoting
the production or import of luxury items that use up scarce foreign exchange,
while hindering the growth of productive activities. Rent-seeking behavior is the
exception rather than the rule, however, and reflects the nature o f the political
regime.
Warr (1983) identifies a rent-seeking strategy linked to an export
processing zone policy in Indonesia. In this case, Warr shows that foreign
multinationals must go through many channels to set-up and maintain production
activities. As a result, state managers can collect "unofficial levies." As Warr's
work suggests, however, Indonesian state managers strategy of collecting rents
from MNCs in the zone is a relatively rare phenomena.
24
An export-processing zone provides a relatively regulation-free
environment for the production activities of multinational firms. This deregulatory
environment favors the profit-making efforts of foreign capital. Consequently, few
opportunities exist for sequestering rents. The brunt o f "economic surplus"
created in the zone goes to foreign multinationals.
CHALLENGES TO THE NEW ORTHODOXY
With the economic surplus going to MNCs, critics of the zone policy and
the open economy model generally suggest that the logic of comparative
advantage traps developing countries into providing cheap labor and low value-
added exports to the world market. Furthermore, it displaces local producers,
exacerbates social inequalities in the host country, introduces inappropriate
technology, and recreates relations o f dependence between countries. EOI makes
the developing-country economy particularly vulnerable to contractions in the
world market.
Others argue that an open economy with exports is a necessary but not
sufficient condition for economic development. In their view, the lesson learnt
from the economic success of the NICs is the fundamental role that the state plays
in promoting research and development, and otherwise intervening in the economy
in a market-promoting way (Koo and Kim 1992:121). Recent literature analyzing
the dynamic growth of South Korea, Taiwan, Singapore and Hong Kong suggests
a significant role for state managers and state organizations.
In South Korea, Taiwan and Singapore state-owned enterprises dominated
in capital-intensive industries or other natural monopolies However, "in other
25
sectors where private investors were capable of organizing production, the state's
role was to reduce risk by subsidizing credit, extending infrastructure and technical
support, and providing market information" (Lubeck 1992:178; Haggard
1990:158). The state in these countries also played a pivotal role in providing
quality education and seeing to it that job-growth would continue (Castells
1992:35, 51).
Defining a developmental state
The definition of a developmental state suggests both superior types of
state activities and a unique type of relationship between the state and other
influential agents. State managers must maintain a degree of autonomy from other
agents. This relative autonomy allows the state to pursue long-term growth-
enhancing economic policies in the absence of political pressures (Castells
1992:64; Haggard 1990:159). So while the developmental state has forged close
relations between private firms and itself, at the same time a degree of autonomy
exists to insulate the state from direct pressures from business and other interests
(Lubeck 1992:178). Lubeck sums it up in this way
The essential characteristic of the NIC model rests upon the
negotiated relationship between privately accumulating
capitalist firms and target-setting state officials; a seminal
relationship that links domestic and export-oriented
strategies, so as to increase value-added, raise technical
expertise, and maintain global competitiveness. (Lubeck
1992:178)
26
PERFORMANCE OF ZONES IN THE NICS
Evidence exists to support the claim that the zones in the NICs performed
better than zones in other countries. In the NICs, zone success is attributed to the
fact that zones followed a cycle of "successive kinds of specialization" (Basile and
Germidis 1984:61). This cycle began with the state's infrastructure development
that supported significant foreign investment. Exports increased as foreign
production took off in the zone. However, as the zone reached maximum
occupancy, foreign investment flows leveled off. At this point divestment by
foreign firms occurred as they sold existing assets to domestic firms and began to
move into more sophisticated manufacturing activities (Basile and Germidis
1984:61).
Basile and Germidis report that this cycle occurred in the zones of
Singapore, Hong Kong and Taiwan and to a lesser extent in South Korea (Basile
and Germidis 1984:62). In the Korean case although there existed a process of
substituting local inputs for imported ones in the production of zone goods, and
while sub-contracting arrangements between domestic firms and zone firms
existed, little technology transfer occurred between the zone and the domestic
economy (Basile and Germidis 1984:48, 50, 54).
It would seem that in the Korean case as in so many other zone
experiences, the state failed to offer the proper incentives to promote dynamic
linkages between small and medium-sized domestic manufacturing firms and zone
firms. As a result technology transfer failed to occur.
27
CONCLUSION
The zone policy, as originally formulated and implemented throughout
dozens of developing countries, embodies many of the precepts of the new
orthodoxy in economics including: 1) an open economy with free trade, 2) reliance
on private investment as the engine of growth, and 3) relatively little state
intervention into the market. That is to say that after the host country state
provides the necessary infrastructure, assures administrative efficiency and offers
financial incentives for private profit making, it does little to further zone activities.
Other state strategies can accompany the zone policy however. Where
zones have failed, the new economic orthodoxy points to rent-seeking activities on
the part o f state managers to explain the less than desired outcomes. However,
the record of rent-seeking activities in EPZs is quite small. On the other hand state
intervention of another kind, that is market-augmenting activities are associated
with improved performance o f the zone. The economic failure of EPZs may be
associated with too little state intervention.
"Rent-seeking is not an inevitable accompaniment and distortion of
government intervention; it is a function of the political regime" (Wade 1989:76).
The success of the NICs and their zones supports this statement. The zone policy
is established in an environment that may be laissez faire, rent-seeking or
developmental. Both global and domestic factors influence the state's choice of
strategies. However, one important consideration is the assessment of the zone's
contribution toward fulfilling the state's need for legitimacy, international
recognition, resources to accumulate and distribute, and autonomy from other
28
societal agents. These non-economic benefits of a zone policy have been ignored
in previous studies and need further elaboration.
29
Chapter 2 The Political Economy of an Export Processing Zone
INTRODUCTION TO THE CONCEPT OF STATE
The whole of executive, parliamentary and military institutions of a country
comprise the state In capitalist economies the state acts to maintain capitalist
relations of production. However, at the same time the state must mediate conflicts
that ensue between agents because o f the inequalities arising within capitalist
institutions Wright (1978) distinguishes these roles as the 1) allocative and 2)
indirectly productive activities of the state, or as defined in O'Connor's work
(1974) as distribution and accumulation activities.
Due to the inequalities created in capitalist societies, the state finds it
necessary to take on distributive activities. These activities reduce the state's
resource base. Nevertheless, to avoid a more serious challenge to the status quo,
the state pursues them (Wright 1978:158). Meanwhile, indirectly productive
activities "assist in the integration of highly specialized units of production"
(Wright 1978:162). In other words, the state acts to integrate independent
capitalists' production processes and thereby assist in accumulation.
The state takes on these responsibilities because it has an interest in
enhancing economic growth so that its own institutional foundation is secure. As
Camoy notes, "the actors o f the State apparatus depend for their survival (as well
as for any political goals they want to achieve) upon resources derived from the
private accumulation process, primarily through taxation" (Camoy 1984:134). Offe
notes that this imperative of accumulation "functions as a selective principle upon
state policies" (Offe 1975:126).
30
Although the state's dependence on economic resources stemming from
production brings the interests of the state in line with the interests of capital, the
democratic state must maintain some autonomy from the capitalist class to
maintain legitimacy. The democratic state not only creates the conditions for
capital accumulation, and fosters capitalist relations of production, but also
responds to the demands of other organized groups (Alford and Friedland
1985:436; Vincent 1987:38). Such are the contradictory roles of the democratic
state.
The degree o f autonomy the state enjoys from interests in society will
determine the amount of time and resources the state allocates to the two
functions. A strong state characterized by relatively more autonomy from
dominant economic interests, can pursue its social and political objectives. The
weak, or relatively less autonomous state, remains more open to organized
pressures (Migdal 1988).
The idea of the strong state arose in the literature attempting to explain the
economic success stories o f the newly industrialized countries (NICs) These
works noted the "soft authoritarian" nature of the NIC state. Earlier Chalmers
Johnson developed the idea of the developmental state to explain the rapid
economic expansion o f Japan (Johnson 1982; Evans 1987; Gereffi and Wyman
1991). Distinguishing these concepts, Kim suggests that soft authoritarianism
refers to "the interrelationship between state and society," while the idea of a
developmental state focuses on institutional history and organization (Kim 1991:3-
4).
31
Both images of the state have certain explanatory strengths, and
shortcomings. 1 More relevant to this discussion, however is that both agree on the
objectives of an effective state, that is it uses selected policies to ensure the
"physical, social and institutional viability of the country" (Castells 1992:59).
A zone policy suggests attracting foreign investment for the purpose of
gaining technical know-how and improving the value-added of exports. Therefore
it is conceivable that a zone policy fit into a larger developmental strategy if
properly managed.
THE STATE AND LEGITIMACY
Legitimacy implies that the state secures its mandate from a critical mass of
the popular sector— that they have agreed to work under the existing economic
system, and support the state's efforts to maintain the system.
Legitimation is the idea that only if (and only as long as) the
capitalist state manages, through a variety of institutional
mechanisms, to convey the image of an organization of
power that pursues common and general interests of society
as a whole, allows equal access to power and is responsive
to justified demands, the state can function in its specific
relationship to accumulation. (Offe 1975.127)
The image of pursuing the common good is difficult to maintain in
capitalist society. This is due to the special relationship between capitalists and the
state necessary to assure accumulation. As a result, the state attempts to secure
legitimacy through distributive services, primarily through the distribution of
1 For a discussion of these issues see Kim 1991: 4-5 .
32
economic goods. In other words, providing consumption goods is easier than
ceding political power (Castells 1975:177).
In this way popular demands for increased political participation or an
expanded role in the production process meet with attempts to "transform political
demands into economic demands" (Wright 1978:157). The state assumes this role
to maintain the support o f dominant economic forces. The exact role that the state
assumes in distribution varies from state to state, but the key is the amount of
services needed to transform the political desires o f the subordinate groups.
Legitim acy and the Zone
The zone policy enhances state legitimacy in two ways. Potentially the zone
policy offers opportunities to expand the economic pie. Presumably such
expansion as an increase in the level of exports, benefits all groups by way of a
trickle down effect. Therefore, the expansion of production activities in the zone
appears to universally increase the level of consumption. At the same time,
employment opportunities created in the zone get distributed through a patron-
client network to select groups, thereby securing their continued support of state
activities.
SECURING INTERNATIONAL RECOGNITION
Internationally, the state gains approval by operating within the rules of the
world capitalist system This involves being open to the forces of international
capital and honoring property rights and international financial and trade
agreements. The zone policy secures approval in that it establishes a framework for
33
! the introduction of foreign capital into the host country with preferential terms. It
♦
; supports the creation and extraction of profits by private companies with little
! incursion by the state.
I '
!
s -
i
International Recognition and the Zone
I
t
1 The policy o f creating export processing zones adheres to many of the
I precepts o f capitalism as set forth by such agencies as the World Bank. These
I '
j include: the law o f comparative advantage, openness to world market forces, and
j the production and trade o f goods with minimal state interference. Thus the zone
l does much to focus attention to the host country’ s willingness to immerse itself in
i
! the world capitalist system, and as such it enhances the state's position amongst
I other states of this system.
!
THE STATE, ACCUMULATION AND DISTRIBUTION
As Camoy notes, "the actors o f the State apparatus depend for their
survival (as well as for any political goals they want to achieve) upon resources
derived from the private accumulation process, primarily through taxation"
(Camoy 1984:134.) Without operating resources, agents of the executive,
parliament and the military bodies would be unable to carry out the various tasks
assigned them.
Most developing states, however, find long-term forced domestic savings
and taxation unpopular or insufficient due to the low income levels of the majority
of the population. The state requires other sources of revenue. Often states turn
to domestic entrepreneurs as a source of state revenues. However, this source o f
34
funds is not always available to the state for one of two reasons: either the typical
firm is operating at break even or very low level o f profit, or the firm holds
monopoly power in its industry. Both phenomena are often the remnants of the
colonial economy, and both prevent the state from extracting sufficient resources
to successfully cany out its activities. This often leads the state to turn to foreign
capitalists in an attempt to secure the means of accumulation.
In stratified societies, patron-client relations facilitate distributional
activities. In patron-client relations, parties o f unequal status, wealth or influence
come together in the exchange of goods or-services, with "the patron frequently
controlling scarce resources needed for the client's survival" (Flynn 1974:142).
The power of the patron emerges from his/her control o f needed resources. The
client's dependence on the patron results from his/her inability to command
resources alone. The client’ s inability to secure these resources arises out of the
social hierarchy and his/her subordinate position in the production process.
Although the parties enter into the patron-client relationship without overt
coercion, initiating the relationship does not suggest its desirability. Rather it
suggests the lack of alternatives available to the client (Eisenstadt 1985). As long
as the patron continues to provide for clients, clients reciprocate with political
support for the patrons. If for some reason the patron becomes unable to provide
for the client, the future o f the patron in the existing social order may be in
jeopardy.
State patronage offers a special case of patron-client relations. The state
acting as patron provides the goods to secure legitimacy for the state Although at
first glance, giving special treatment to select groups may seem to threaten the
35
legitimacy of a democratic state, this may not be the case. Where barriers to entry
into the political realm exist, such as informational costs, a sizable portion of the
population will be excluded from the political discourse Therefore, the state can
appeal to select groups, offering them access to the patron's power, without
finding its legitimacy threatened.
Accum ulation/Distribution and the Zone
Typically the zone does not solve the state's short-term revenue crises, and
involves significant outlays o f revenue. The creation o f the zone involves the
provisions of infrastructure; as well as the granting of tax holidays, usually ten to
twenty-five years; little or no rents; and free lease-holds for a given time.
Nonetheless, the zone does provide immediate employment opportunities. In the
long-run the state can tax workers' wages
What is more important the zone policy provides access to international
funds through such organizations as the World Bank. The promotion of exports
through a zone policy can be part of a package of austerity measures imposed by
the Bank in order to improve an economy's current account (Solman 1992) In
this way the zone indirectly provides the means of accumulation by securing
foreign loans for the host country.
Countries that adopt export-oriented manufacturing with a zone policy
have funds available for distributional purposes. More directly the zone firms
create job opportunities which elected state officials like to attribute to the
effectiveness of state policy. In this way zone jobs appear as goods created by the
state for the benefit o f the popular sector.
36
THE STATE AND AUTONOMY
The need for state autonomy from dominant forces in society arises from
the contradictory roles of the democratic state. To both legitimate its existence and
maintain its ability to distribute and accumulate, the state must represent itself as
looking out for the interests of capital as well as looking out for the broader
interests o f the population. Some level o f autonomy offers officials the ability to
make and implement decisions without always being accountable to organized
groups. A zone policy enhances autonomy from domestic sources of power.
Autonomy from Domestic Capital
The zone provides for the potential involvement of domestic entrepreneurs
by creating opportunities for joint ventures in the zone, for supplying intermediate
goods within the production process, and supplying auxiliary services. Because
state managers control licensing and registration o f zone activity, they can
accommodate or exclude traditional producers from relations with foreign firms if
they so choose. Furthermore, because the location and expansion of foreign
capital in certain sectors and certain locales of the host country economy may
erode or enhance the competitiveness o f domestic production activities, state
policy can severely weaken or strengthen particular forces of domestic capital.
Playing off domestic and foreign producers in this way, may be in the
interests o f the state, as the practice creates a certain degree o f autonomy for the
state. Whereas domestic sources of investment have national or even local
political interests to impose on the state, state officials consider foreign sources of
37
investment more politically neutral in domestic affairs (Deyo 1981:20). Therefore,
by constraining the economic position of certain factions o f domestic capital, the
state has essentially weakened their bargaining power. As a result domestic capital
proves less threatening to the state.
Autonomy from Labor
At the same time, the zone enhances state autonomy from the demands of
organized labor. This form o f autonomy evolves from a number o f factors. First,
the export-oriented industrialization strategy relies on cheap labor in a highly
competitive world market of many producers. To maintain cheap labor, the state
must contain the bargaining strength of labor. Typically laws strictly control the
realm of acceptable employee behavior within the zone, and use the threat of force
to invoke if necessary. Laws restrict labor organizing as well, and often the only
acceptable union is the in-house union. The promotion of in-house unions and the
strict control of independent unions provides centralization and control of the labor
movement (Deyo 1981:10).
Second, the export processing zone acts as both a legal and a physical
entity. Spatially separated from other productive activities and often located in an
area relatively remote from the centers of commerce, the zone isolates zone
workers from the forces o f traditional community and makes them more dependent
on their employer and other fellow workers for social and community activities.
At the same time, given that the production processes in labor intensive
manufacturing are highly differentiated, zone jobs break down into a series of
discrete and repetitive tasks. Each task involves little if any skill and workers learn
38
their tasks quickly with minimal training. Because each job involves little skill the
firm can easily hire and dismiss workers at little cost.. Consequently many
employees are hired on a temporary contract basis making their positions fleeting.
Both these phenomena lend themselves to high worker turnover. High worker
turnover means weak organizational commitment, which therefore, enhances the
demobilization of labor (Deyo 1981:10)
All these forces: the control of labor organizing, the remote location of a
zone, a highly structured work environment, and high worker turnover, all act to
demobilize labor, and in this way assist in the autonomy of the state from the
demands of labor.
Autonomy from Traditional Authority
The location o f MNCs in developing countries allows for the development
of new relationships that may enhance or diminish traditional centers of power. In
developing countries, the source o f traditional authority rests in agriculture, and in
the production of primary products. In supporting the development of
manufacturing industries, and removing resources from the agricultural and mining
sectors, the state assists in the erosion of the traditional economy and power base
of traditional institutions.
The movement of large portions of the labor force from rural to urban
areas in search of employment erodes these institutions further. "Young,
unmarried women predominate in the zones. The absence of family households
with their restrictions and obligations weakens traditional authority" (Andors
39
1988:37). This growing autonomy from the traditional sources of authority offers
a greater centralization o f power in the urban-based state administration.
CONCLUSION
This chapter offered an overview of the theoretical literature on the
*
constraints facing the democratic capitalist state It suggested that the state's ability
to maintain legitimacy rests on the success of accumulation and distribution
activities, given a certain degree of autonomy from dominant interests The zone
can assist the state in these various objectives. The extent to which the state
reaches its objectives rests in its ability to bargain with the MNCs located in the
zone.
40
Chapter 3 Modeling the Zone Experience
INTRODUCTION
To understand the relations between the parties interested in the export
processing zone it is necessary to employ a method that can adequately capture the
many and varied interactions between these agents. Gaming models provide
conceptual tools that reveal the interdependence among players' decisions and
suggest the likely outcomes of such interactions (Schelling 1984:240)
A game involves a multi-person decision problem (Gibbons 1992:xi), in
which players devise strategies and take actions to maximize their own self-interest
given their understanding of the other players' likely moves and the power that
they and the other players command. These models encompass the idea of
bargaining as found in the new dependency literature, that recognizes that political
economic outcomes vary and no one player holds infinite power over time
(Newfarmer 1985:17).
The relative strength of players changes over time thereby affecting the
outcome o f the game. Perhaps more telling, certain agents become players in the
game, and some get excluded altogether. Both the relative power o f the players
and the composition of the game change. In this way, gaming models mimic the
real world of social structural constraints facing agents and the exclusivity of the
policy making process (Bennett and Sharpe 1985:81).
The interactions between the state and the private sector reveal an
interdependence that a game model can capture. The game's outcome is not pre
determined despite the often differential power revealed in some games. Given the
41
wide range of interests in an export processing zone, the zone policy potentially
attracts a large number o f players: the state, domestic firms, MNCs and the
popular sector. An evaluation of the roster of players and their relative strengths
follows.
PLAYERS, STRATEGIES, ACTIONS AND PAYOFFS
Game models allow for the formalization of players' interests and actions in
the policy process. This offers some means by which to map the strategies that
players choose and to evaluate the payoffs of their subsequent actions. A strategy
offers a rule of behavior in a repeated game (Kalai 1990:136), while a payoff
constitutes the expected utility of a given action (Rasmusen 1989:24). Payoffs
must be independently determined from the outcome o f the game if they are to
have any meaning. Determining payoffs is truly an exercise in political economy,
as it involves understanding players' preferences in historical context.
Payoffs not only involve monetary rewards, but also include anything the
agent values. For example, firms measure payoffs in monetary terms, that is in an
action's ability to enhance profits, noted herein as (+) for profit enhancing, or (-)
for profit reducing. Meanwhile state managers prefer activities that will enhance
the state's legitimacy, increase state autonomy from competing sources of power,
offer opportunities for the state to accumulate and distribute resources, and accrue
recognition in the international arena.
An equilibrium "is a strategy combination consisting of a best strategy for
each o f the N players in the game" where best is defined by the modeler based on
all strategy combinations and their payoffs (Rasmusen 1989:26-27).
42
ASSUMPTIONS AND LIMITATIONS OF GAME THEORY
Game theory assumes goal-seeking behavior in absence of centralized
authoritative institutions. In other words, the structural constraints of society
although very real, are not deterministic. The assumption o f rationality suggests
strategic decision making, not superior outcomes. Each player develops a strategy
which s/he believes will lead to her/his own desired outcomes takes action in line
with the strategy. Players reveal their preferences when repeatedly confronted
with comparable choices. The values of players, their preferences, beliefs and
definition of self, are all exogenous to the model and may change over time.
Therefore, players behavior must be closely monitored.
Unexpected events may occur at the same time as the players' actions, and
as a result totally alter the outcome of the game. These events may change the
players' strategies altogether forcing the game from its original equilibrium and
pushing players to find a new equilibrium. A shift in strategy may also reveal a
tension between the expected returns from a given action and the actual payoffs.
AGENTS: THEIR INTERESTS AND INFLUENCE ON THE ZONE
POLICY
The State
State managers invest significant amounts of state funds in the development
and provision of infrastructure in the zone and hope to realize an expanded
economy in return. Such growth provides the means for accumulation and
distribution and thus legitimates the state. This keeps the ruling party in power
and the state managers working.
At the same time the zone enhances the state's international reputation by
suggesting to the world that the host country state will accommodate foreign
investors. Their comprehensive development strategy: including the position taken
on foreign investment, and the degree to which the other developing countries are
competing for foreign investment affects state managers' bargaining practices
(Encamation and Wells 1986:77).
Furthermore, the growing number of zones in the world creates a situation
in which zones compete against one another for foreign investment. All other
things being equal, with each additional zone in the world the bargaining position
of state managers vis-a-vis incoming or veteran zone firms weakens. State
managers must continually reestablish their country's comparative advantage and
cannot risk scrapping incentives (Guisinger 1986:166). State managers turn to
economic zones because the developing economy faces the ever pressing problem
of job creation. Unless state managers have an alternative to the employment that
the zone firms offer, they need to offer and maintain an incentive package
attractive to foreign firms.
Furthermore, cutting back on any state program is potentially a source of
delegitimation for state managers and state institutions (Wright 1978:157).
Nowhere is this more evident than in a zone. Because of the concentrated nature
of the state's investment, the zone assumes a high profile amidst development
efforts. Any visible lack o f activity within the zone questions the appropriateness
of the state's initial commitment of resources and infrastructure development. The
44
zone's high level o f visibility, and its ability to absorb large numbers of workers
becomes a liability if at any time state managers desire to reduce the zone subsidy.
Domestic Firms
The domestic private sector desires to increase its productive activities and
thereby increase profitability. When domestic producers can link their activities
with those of zone firms and supply inputs that zone firms need, there is the
potential for domestic producers to benefit from the establishment of a zone. Two
kinds of domestic firms must be distinguished. Small and medium-sized firms, and
large conglomerates.
Small and medium-sized firms generally lack technical sophistication and
capital resources. Therefore, they face great obstacles to linking with the large,
and relatively more technology and capital intensive foreign firms. Furthermore,
they lack the informational resources necessary to link with multinational firms
producing within zones.
Although domestic firms are not prohibited from locating inside the
zone."...the advantages and incentives offered to industries located in the [export-
processing zone] are generally much greater than those provided for domestic
industry (Basile and Germidis 1984:40) The size o f lots and production facilities
are often too big, and, therefore, too expensive to meet the needs of the generally
small and medium-sized domestic producers (Fong 1990:85).
Large domestic export-based manufacturing firms lobby state officials to
receive incentives similar to those offered to multinational firms. They desire
either to have the same production incentives offered to them, or they want
45
legislation mandating domestic content requirements for goods produced in the
zone (Jomo 1986:214). When this is unsuccessful, lobbying against the policy
itself or those who promote it, is one alternative. Large domestic firms often
object to the policy privileges extended to the multinationals in the zone.
The Popular Sector
The popular sector's interest in the establishment and continuity of the zone
is in its ability to provide employment. This group supports the zone policy in two
ways: first, by providing labor to the zone and second, supporting those elected
officials who align themselves with the policy. In democratic nations the popular
sector indirectly affects the zone policy by forcing their elected officials to be
accountable for the results of the zone.
The zone absorbs excess labor power from the rural villages. Rural
residents desire zone jobs despite long hours and low pay. A job opening in a zone
firm typically amasses many interested applicants. The lack o f alternative
employment opportunities for this group of unskilled laborers makes zone
employment attractive. Multinational firms' preference for the "nimble fingers" and
low-wage labor power o f females creates the demand, while money income and
"bright lights" bring a pool o f young women workers to the zone (Andors 1988;
Ong 1987) Despite the large number of zone workers, labor as an organized
group wields little direct impact on the policy process, as the result o f laws
restricting workers' activities. Labor's exclusion from the policy process acts to
perpetuate a strategy centered on the use of low-cost labor manufacturing goods
for export (Deyo 1989:4).
46
Multinational Corporations
Multinational corporations benefit from the creation and maintenance of an
export processing zone due to its relatively low wage bill, tax holidays and
freedom from import duties, which lower costs of production and maintain firm
"competitiveness" within the world market. Furthermore, it stands to benefit from
the provision of infrastructure in the zone. All such inducements assist in profit
maximization.
THE LAISSEZ FAME STRATEGY AND THE ZONE GAME
Under laissez faire, the state essentially abdicates power to the private
sector which it believes is the appropriate conduit of economic growth and change.
The private sector creates the jobs, products, and taxable revenues that will
presumably grow the economy. Frequently in developing countries, however, a
bi-polarity exists in the structure of production activities as a result of the colonial
experience. On the one hand, a few very large, monopoly producers account for a
large portion o f the economy's output and income but employ a relatively few
number of individuals. On the other hand a large number of very small, generally
family-owned companies, each produce very little output or revenue. While they
contribute a minuscule amount to the economy, as a group these firms employ the
vast majority of workers.
As a result, if conditions in a developing country call for the creation o f a
large number of jobs, or the acquisition o f foreign exchange and/or advanced
technologies, state managers often bypass domestic producers and instead turn
47
their attention to wooing foreign investors with incentives and the provision of
infrastructure necessary for production. While developing country states depend
on MNCs for job creation, the transfer of technology, and the creation of foreign
exchange, MNCs rely on host-country states as well The state defends property
rights, guarantees the free circulation o f production factors, and maintains social
control. It also builds infrastructure, and reproduces the labor force (Martinelli
1975:429).
Players* Actions
Initially state managers and representatives o f foreign firms conduct
negotiations to get the zone up and running. After initially establishing the
conditions for MNC production in the zone, state managers step back and use
state organizations solely for zone maintenance. The state attempts to maximize
its expected return such that
E(R) = g + a + a/d + ir + u,
where E(R) = expected return, g = legitimacy, a = autonomy, a/d =
accumulation/distribution, ir = international recognition and u = an error term.
The E(o) - 0. The additive nature of this function is merely suggestive of how
state managers go about evaluating the expected payoffs o f their actions.
Firms attempt to maximize expected profit such that
E(p) = QP - LW - kR + u
where E (p) = expected profit, QP = total revenue, LW = labor costs, kR = costs
of other factor inputs, and o =. an error term. The E(u) - 0.
48
Power and Informational Asymmetries
State managers as the initiators o f the game can set the parameters
according to their objectives, as well as veto entrance to the zone of any particular
firm based on its perceived lack o f contribution to these obj ectives. Given the
desire to attract foreign investment to the zone, the bargaining position of the state
depends on the importance of the particular industry and the degree o f competition
the host country state faces with other developing countries for the investment
(Encamation and Wells 1986:77).
The bargaining process between the representatives o f foreign firms and
state managers' results in a certain distribution of gains. Organizational capacity,
economic and political resources, as well as bargaining strategies affect this
outcome (Haggard 1990:220-21). Over time, one would expect, however, that
they could offer less favorable terms to the MNC and thereby enhance their own
gains. This greatly depends on the nature of zone industries and to what extent the
development strategy relies on zone firms for employment creation. For example,
in high technology manufacturing industries, Doner notes that rapid technological
change makes it difficult for the host country to acquire the expertise necessary to
produce for export without the MNC (Doner 1991:7).
The bargaining power of state managers is weak when they attempt to
attract uncommitted foreign investment (Crane 1990:18; Doner 1991). In the
context of this game this suggests that the player who moves last, in this case the
firm, gains some leverage by the ability to take an action that worsens the payoffs
for the state On the other hand, the relationship between MNCs and the host
country state is a mutually dependent one. The zone firms rely on state
49
organizations to defend property rights and guarantee the free circulation of
production factors. The state also reproduces the labor force, creates
infrastructure, and maintains economic and social control (Martinelli 1975:429).
State managers use state organizations to favor the growth of zone activity.
Quite often however, these individuals lack information on the firm's true cost o f
production, or its profit margin, therefore, they must rely on the firm to provide a
signal on the value of the subsidies to its production activities . However, because
ultimately the host-country state's incentive package will affect firm profitability, it
is in the interest o f the firm to offer information to state managers that
overestimates the cost of doing business in the host country in hopes of
maintaining or securing the best possible package of incentives. This asymmetry of
information weakens the bargaining position o f the host-country state, and
proceeds to increase the cost of the zone policy
The other way in which power is differentiated in this context is the
altogether exclusion of some potential players from the zone game. State
managers and state organizations could offer similar incentives to domestic firms.
However, these firms would be unlikely to produce large numbers o f jobs, secure
foreign exchange or develop high-tech goods and processes in the short-term, due
either to their small size or monopoly power as noted above.
At the same time, the production processes o f the average domestic firm
and the zone firms are so very different— one labor-intensive, capital poor and
technologically unsophisticated, the other capital-intensive and technologically
sophisticated. As a result o f these disparities, these firms are unlikely to develop
relations spontaneously. Data on existing zones suggests that the multiplier from
50
zone production is small as forward and backward linkages are negligible. Where
this is the case, zone firms become the consumers of scarce state resources, rather
than producers stimulating the local economy (Kreye 1987:15; MPPP 1986:60;
Warr 1987:238).
The Role of Commitments
Getting the firm to commit is a tricky business for the host-country state.
In negotiations with state managers, it is in the best interest o f the firm to try to
extract and maintain the maximum level of subsidy. The most effective way for the
firm to do this is to exercise the threat o f their departure. MNCs use the threat of
packing up shop to further enhance their bargaining positions (Vernon 1981:54-
55). Due to their ability to "exit," MNCs have an advantage in any zone game.
For example, if state managers propose to eliminate any subsidies to multinational
companies, the multinational may threaten to move operations to a "more
hospitable" environment. State managers have little way o f knowing how credible
this threat is, therefore, they must assess the cost of such a departure on their
future actions.
This is a game known as "stag hunt" in which an actor may prefer
cooperation, but employs threats o f non cooperation to impress upon the other the
value of cooperation (Conybeare 1984:17-18). The structural characteristics of
export-oriented manufacturing make the threat realistic (Haggard 1990:222).
These producers tend to be relatively small and mobile with their assets resulting in
low relocation costs (Doner 1991:7-8).
51
At any given time, the number of firms for which locating in developing
countries is a cost-effective move is likely to be less than the number o f zone
opportunities. Therefore, there is swift competition among sellers, to present their
zones as the highest quality product, or as a better deal than the competition. This
competition favors the buyers. After state managers offer their generous
incentives to a zone firm, they rely on the commitment of the firm to maintain its
production activities in the zone. However, the state has no power to force the
firm to remain or to make new demands on the firm as the state precommits to
making few interventions in the market.
I
►
I
\ Decision making Tree and Associated Payoffs
Given the state's initial investment in the zone, with a laissez faire strategy
only one other point in the history of the zone calls for state intervention. That is
at the point, typically five to ten years after the commencement of a zone when tax
holidays and other incentives expire. State managers must determine at this time
whether to extend the holidays and other incentives, or suspend such subsidies to
multinational firms. State managers necessarily consider the impact of their actions
on the MNCs, because they depend on the MNCs for the aforementioned political-
economic benefits. Given the host-country state's decision, multinational firms
must determine whether production remains profitable or not, and then whether to
maintain production levels in the zone, or to decrease their investment.
Given the political-economic context, state managers choose either to
continue to subsidize foreign production activities in the zone, or to suspend
subsidies. Diagram 3.1 displays these choices. The state moves first, with firms
52
following. Four possible outcomes exist: node #1 the state continues subsidies
while the foreign firm continues to produce; node #2 the state continues subsidies,
nevertheless, the firm decreases its level o f investment; node #3 the state
discontinues subsidies but the firm continues to produce; finally, node #4 the state
discontinues subsidies and the firm reacts by decreasing the level o f investment.
The later may mean totally divesting from the given country and moving to a more
"hospitable" climate.
Diagram 3.1 Decision making Tree with a Laissez Faire Strategy
Firm
State t+F^Node fi
Firm
State
Node #3
If the state continues to support the zone with subsidies, it hopes to sustain
or enhance the four factors o f its objective function: legitimacy, international
recognition, accumulation and distribution and autonomy from domestic sources o f
influence. Given that subsidies are forthcoming, the firm then decides on its level
o f production based on its calculation o f expected profit. However, the state
might choose to suspend subsidies to the zone for any number o f reasons. This
53
‘ action suggests that the ex post calculation of benefits from the zone did not
| warrant such subsidies or perhaps the state can no longer afford the subsidies.
! Table 3.1 maps the payoffs associated with the four strategies. All other
I things being equal, if both players maintain the status quo— that is the state
j continues to subsidize production and the MNC continues to produce-then
! presumably both players will benefit. With continued subsidy o f the zone activities
i
j ceteris paribus, employment will remain the same or increase. Therefore, the
| state’ s accumulated resources remain unchanged thereby allowing it to distribute as
l
[ it sees fit. The state's international reputation for providing an atmosphere
t
i conducive to private accumulation remains secure as well. Meanwhile, state
p
j managers can take credit for keeping the people employed and expanding output
of export commodities, thereby maintaining the legitimacy state organizations. No
i
1 reduction in state autonomy results. This is the outcome associated with node #1
(extend/produce).
Table 3.1 Payoff Matrix
State/Firm Produce Contract
Extend # 1 (2 ,2 ) # 2 (4 ,1 )
Suspend # 3 (1 ,4 ) #4 (3, 3)
Ranked payoffs to (State, Firm) where 1 equals first preference.
Node #2 (extend/contract) considers the case when the state continues to
subsidize firms, and yet firms cut back on their level of investment despite the
i
incentives. Reduced firm activity and rising unemployment hampers state
accumulation. Therefore, state managers have fewer resources to distribute to an
|
54
I
increasingly needy populace. The foolishness of wasting resources on firms whose
labor pool is shrinking does not threaten state legitimacy, however, if state
managers can impress upon the people that zone firms and not state organizations
have reneged on their obligation to produce in the zone.
Meanwhile, because state managers and state organizations continue to
support the private accumulation process, the state's international reputation
remains in good standing. Likewise, state autonomy may increase by the declining
influence o f contracting zone firms. However, in a situation o f rising
unemployment, labor may take to mobilizing, making demands upon state
organizations, thereby reducing its autonomy from domestic agents. For simplicity
we assume that these two conditions balance each other out, and the net effect on
state autonomy is, therefore, zero
At node #3 (suspend/produce), state managers choose to end subsidies to
the zone, but zone firms maintain their level o f investment. With the end of
subsidies such as tax holidays, the state will begin to receive revenues that it can
then channel to other sectors. This has the potential of increasing legitimacy o f
state organizations. However, the state's international reputation suffers as the
state moves away from accepted rules of the international market game whereby
states assist in the private accumulation process. State autonomy increases as the
suspension of subsidies distances the state from the interests o f foreign capital. At
the same time, the newly acquired resources get distributed through the patron-
client network, thereby buying-off influential domestic agents and increasing
autonomy further.
55
At node #4 (suspend/contract) state managers choose to suspend subsidies
and the firm reacts with decreased investment. The potential cost to the state
becomes quite large if the firm goes so far as to relocate its production in another
country. In the case of firm contraction or relocation, state organizations
experience constraints on accumulation and distribution similar to that at node #2
(extend/contract). Unlike that experience, however, state managers have not
simply thrown resources into the wind
Corresponding with the decrease in subsidies, the contraction of zone
activity will negatively affect the state's distributional efforts. As a result the
potential loss o f legitimacy is severe, as state actions may appear to be the cause of
the economic contraction. Whereas at node #2 (extend/contract) state managers
could blame the firm for the contraction and present their own actions as in the
national interest, at node #4 (suspend/contract), this is not the case. Like node #2
(extend/contract), however state autonomy remains unchanged as the decrease in
foreign firm influence equals an increase in domestic influence as groups become
mobilized by poor economic conditions.
Equilibrium and Solution Concept
Given this analysis of the actions taken by players and the various payoffs,
the state prefers node #3 (suspend/produce). In this case the state discontinues
subsidies and yet production and employment in the zone continues. As a result of
their actions, state managers enhance accumulation and distribution amongst state
organizations, and secure legitimacy and autonomy from both foreign and
domestic agents. However, if state managers cannot guarantee the continuation of
56
firm production in the zone without the subsidies, then choosing this path may be
too risky.
Likewise, if the blow to its international reputation experienced in this case
is so profound as to slow future investment or the ability to secure foreign loans,
then this path is undesirable. The second best option for the state is node #1
(extend/produce) where present payoffs persist.
The firm prefers node #2 (suspend/contract). The willingness of the host-
country state to offer subsidies and workers' desire for zone employment creates
an ideal environment in which to keep costs down. Cutting operating expenses
with a limited contraction boosts profitability in the short run. This position is an
unstable one, however, as presumably state managers would catch on to the firm's
activities and suspend subsidies in the future.
The equilibrium occurs at node #1, the point at which the state provides
subsidies and the firm continues to produce. This node is a second-best strategy
for each player. However, if we assume that conflict is costly this provides the
best possible course o f action they can sustain in the game.
Outcomes
Both host-country state and investing firms would like to maximize their
individual self-interests in this game. Their preferences lead them to different
outcomes, however, and the terms o f laissez faire do not promote cooperation
between players. The laissez faire game can be considered a non-cooperative
game with conflict.
57
Free market outcomes favor neither the transfer o f technology nor the
provision o f large amounts o f foreign exchange to the host country treasury. This
game, played in the context o f a zone policy, favors the extraction o f wealth from
the host country to the M NCs home countries through the repatriation o f profit.
Increased state intervention may improve the outcomes The two games that
follow characterize a different level of state intervention.
A RENT-SEEKING STRATEGY AND THE ZONE GAME
Rent-seeking behavior suggests that the state intervenes in the market
creating a regulatory environment of "quantitative controls in which state officials
can appropriate surplus" (Blomqvist and Mohammad 1986:161). Rent-seeking
behavior is a rational response by state managers to political-structural conditions.
State managers assert their power by intervening in the market and in a sense, hold
the market for ransom. This type of behavior assumes some degree of relative
autonomy from the private sector and alternative means o f accumulation, if the
state is willing to create barriers to private profit making.
Due to its unofficial nature, there is a great deal of uncertainty and risk
associated with rent-seeking behavior. Such uncertainty increases costs to those
engaged in this type o f activity. In a democratic country, rent-seeking behavior by
state officials could cost state institutions their legitimacy. Given the dictums of
the international economy it could cost the country's international reputation.
Nevertheless, for the individual state manager, such activities could create large
windfalls and, therefore, represent individual self-maximizing activities.
58
Players’ Actions
I This game is the exclusive abode o f state managers and representatives of
[ large foreign and domestic firms. The need to make side payments to receive
serious attention from the state, adds yet another burden on small, capital-poor
domestic producers. Because they cannot pay the price, they cannot become
: serious players in the game.
State managers desire to maximize their expected return such that
l
| E(R)==g + a + a/d + ir + sp + o,
where E(R) = expected return, g= legitimacy, a = autonomy, a/d =
I
I accumulation/distribution, ir = international recognition, sp = side payments and o
| = an error term. E(u) = 0. Side payments become a reward for having the power
i -
; to grant special favors to private firms.
I
| Firms prefer to maximize profits while minimizing these payments as they
see them as a burden on their ability to make profits. Therefore, the firm again
wishes to maximize expected profit such that
E(p) = Q P -L W -k R + o
However, each firm must weigh the value o f producing in a particular zone at any
given time and the extent to which such payments allow production activities to
continue or infer other types of benefits (Macrae 1982:679). With side payments,
then the firm's calculation o f expected profits becomes
E(p) = QP - LW - kR - sp + u,
i
where the additional term reveals the cost o f the side payment to the firm.
59
j Power and Information Asymmetries
j State managers can never know with any precision the value o f the tax
i
holidays and other production incentives given to the zone firms. Therefore, if
state managers seek side payments from zone firms, the amount o f the payment is
necessarily negotiable. Likewise any given firm cannot know whether other firms
are indulging in this type of behavior, or what they are willing to pay to the host
country state. Therefore, the value of side payments will be very fluid and not
j easily identifiable.
I
I
i
(
Decision making Tree and Associated Payoffs
j The decision making tree includes conditional activities. Diagram 3.2
I suggests that the state extends tax holidays and other incentives to firms if, and
only if side payments are forthcoming. After the provision of side payments, the
firm will continue to enjoy the aforementioned subsidies thus lowering its cost of
doing business. The firm then chooses either to expand (+), or contract (-) its
activities.
To earn rent on zone activities, the state must create a scarcity condition.
One way may be to restrict entry into the zone by offering a limited number of
production licenses that all zone firms would hold, or a limited number of
opportunities to take up the state-offered incentives. If the value of the license to
a given firm #1 is X, then a reasonable side payment to make to state officials to
assure that the firm gets sufficient consideration in the licensing process equals
something less than X. If, the payment does not significantly reduce the firm's
utility, such that
i
60
(Ufi-X)>Uf2t
where Uj2 is the utility of a firm without side payments. In this case state
managers will continue to receive side payments.
Diagram 3.2 Decision making Tree with a Rent Seeking Strategy
F irm
Firm
S tate
Node #3
Node #4
In contrast to the game within a laissez faire strategy, this game involves
i
conditional actions on the part of the state The state signals to firms the j
conditions under which they will extend subsidies to the zone. Firms must then
initiate the payment o f rents in order to influence the state toward continued
subsidy of the zone. In the previous game, no present activity of firms could affect
state decision making as to whether to continue subsidies Rather state managers
made decisions based on the past performance o f the zone and the amount o f !
resources available to state organizations.
Under a rent-seeking strategy, however, if state managers exhibit rent- j
seeking behavior and no side payments appear, all subsidies stop, leaving the firm
6, j
1
I
j to conduct its affairs without the state's assistance in the form of capital saving
j measures. The firm must determine the value o f the subsidies to its profit-making
' activities. If the firm is in a position in which it does not need the inducements to
, produce in the zone, then it can refuse to indulge state managers.
j Under what conditions would rent-seeking behavior flourish, given that a
1 ’
large number of competitive sellers exist, presumably not all requiring such
i
payments? State managers could extract a rent if the product, in this case the
1
| zone, had some unique attribute. This could mean offering significantly lower
! production costs than in other zones, a better educated or more highly skilled
workforce, access to a very promising domestic market, or access to a rich
! resource base for the development o f export products. Any one, or a combination
l
j of these measures might differentiate a zone from others, thus allowing for the
j possibility o f rent-seeking behavior by state officials.
Table 3.2 Payoff Matrix
State \ Firm Side payment No Side payment
Seeks
Arrangements
#1 (2,2) #2 (4,3)
No Arrangements #3(1,4) #4(3,1)
If state managers believe that firms will unilaterally attempt to make side
payments, it won't be necessary to overtly seek such arrangements. Seeking
behavior implies the expenditure of state resources which state managers would
rather preserve. At the same time, seeking side payments is risky. If state
managers get caught seeking or receiving side payments, the popular sector might
62
lose confidence in them, causing delegitimation. In taking side payments state
managers and state organizations begin a new relationship with firms, and thereby
lose some autonomy.
Equilibrium and Solution Concept
If the likelihood o f getting caught remains small or the penalties
insignificant, state managers prefer to operate at node #3 as shown in Table 3.2.
This node represents state managers not expending resources in rent-seeking
activities, yet nonetheless receiving side payments from motivated private interests.
The firm prefers to operate at node #4, not having to use its resources to
make side payments to state managers. Nonetheless, if the firm thinks that state
managers remain open to such arrangements and that other firms may be making
such payments, then if it desires consideration as a key player in the zone, it had
best make the payment. On the other hand, if state managers appear uninterested
in such activities, it had best keep its money in tow lest it offends the host-country
officials.
The equilibrium occurs at node #1 where state managers seek
arrangements and side payments are forthcoming This solution occurs because it
provides a second-best strategy for both players.
Outcomes
The increasing number of zones limits the use o f a rent-seeking strategy.
Only in those situations where state managers can persuasively argue that they
offer a different product, that is a zone with significantly different characteristics
63
, from other zones, are they able to extract side payments from firms. The rent-
l
! seeking strategy perpetuates a cooperative game with conflict that serves the
| short-term interests o f a small elite in the host country, while shifting the
distribution o f income from investment to consumption goods. For the country as
a whole this proves welfare reducing as a significant loss in tax revenues and
| increasing inequality between individuals results (Macrae 1984:685.)
i
I
THE DEVELOPMENTAL STRATEGY AND THE ZONE GAME
The developmental state is distinguished by its willingness to augment
l market rationality by reducing risk and uncertainty for producers, while generating
: jobs and income in the economy (Castells 1992; Lubeck 1992:178). State
j managers and state organizations actively collect and disseminate information in an
J attempt to foster linkage between domestic producers and firms in the zone.
i. ■
Focusing on long-run gains, state managers commit fiscal resources to the
provision o f high quality education and training opportunities for the citizenry, the
establishment of consulting and technological service centers for both domestic
and foreign firms, and the provision of infrastructure. There is an ongoing effort
to upgrade the economy to higher value-added production through both human
and capital improvements.
State managers attempt to restrict firm entrance to only those firms likely
to transfer technology and/or skills to local producers and workers. In line with
this objective, those firms more likely to transfer technology are sought out and
|
1 often offered a better package of incentives than other firms State managers make
these distinctions by seeking information on potential investors. Wade
characterizes the activities o f the Taiwanese state as developmental because it
"identified gaps in industries then helped to find foreign companies willing to share
the needed technology, and negotiated with them on the terms" (Wade 1990:240).
Players’ Actions
The players in the developmental game include the state, foreign firms and
large domestic firms as in the two previous games. However, state managers and
state organizations effectively lower the cost o f participation for small and
medium-sized domestic firms by providing them with needed information on the
production activities o f foreign producers. As the state steps in to enhance their
ability to interact with zone firms, a large number o f domestic producers thereby
become an integral part o f this game.
To pursue its developmental course, the state must tap some existing
resources. These resources may come from foreign assistance, or revenues earned
from the sale of a valued commodity or service on the world market. Given this
minimum level o f accumulation, the state can focus its energies on distributing
resources and opportunities across the economy. By definition a developmental
state has secured a level o f autonomy from both domestic and international
interests. Therefore, it is not necessary in this game for the state to expend
resources to secure autonomy and international recognition. The state desires to
maximize its expected gains such that
E(R) - g + a/d + o,
where expected return equals legitimacy and accumulation and distribution and an
error term. E(o) = 0. The state will find satisfying its interests easier if it can
65
convey the idea that legitimacy equals economic growth and consumption— that is
that g = a/d. In that case,
E(R) = 2a/d + u
As long as the state is able to maintain autonomy from domestic and international
interests it should be possible to secure legitimacy through the accumulation and
distribution o f resources in this fashion.
Firms, both domestic and foreign, maintain their interest in profit-making
with the production and distribution o f their products and services. Domestic
producers desire to increase demand for their products through sales to zone firms.
Both groups of players seek to maximize expected profit such that
E(p) = Q P -L W -k R + o
In this case, however, with the increase in factor productivity the firms realize a
greater QP than in the previous games. Therefore, E (p) is greater in this game.
Power and Information Asymmetries
In the developmental game state managers and state organizations know
firm types and capabilities because a pre-commitment exists to finding out such
information. However, both foreign and domestic firms face informational
problems. The firm is unaware of domestic producers' capabilities, while domestic
producers' are unaware of what they might produce as zone inputs. The state's
role then becomes clear— to bridge these informational chasms. The developmental
state is both willing and able to do so. Neither zone firms nor domestic producers
object to such state activities because it has the potential o f enhancing their profit-
making abilities.
66
The Role of Commitment
Given firms' suspicions about intervention by state organizations, state
managers must reassure firms that their activities will not impede private profit-
making, nor do they imply any rent-seeking behavior. Besides reassuring firms on
these issues, state managers' objective of developing indigenous technologies must
not be perceived as an attempt to nationalize MNCs. If managers fail to properly
signal their commitment to private profit-making, zone investors will quickly pull
up shop and go elsewhere. Similarly, domestic firms will not show great
enthusiasm for playing the game either.
Decision making Tree and Associated Payoffs
In this game it is assumed that the state has made a pre-commitment to
developmental objectives. The state goes about its developmental activities,
anticipating that firms will respond. Existing zone firms will either expand or
contract and new firms may be enticed to begin production in the zone.
Diagram 3.3 exemplifies the developmental game. The game begins in the
same manner as the previous two. The host-country state creates the zone
infrastructure and capital-saving measures . After the initial period, however, it
targets incentives to those MNCs that it believes are likely to transfer technology.
67
Diagram 3.3 Decision making Tree with a Developmental
Strategy
S ta te
M N C
D FIR M
S ta te
M N C
Node
#1
Incentives
Node #2
Node #3
D
Node #4
Node
#5
No Incentives
4 ^ . Node
m
Node #7
4 $ b 'v *
Node #8
This game becomes rather more complicated because under the
developmental strategy the state conducts developmental activities noted by (D),
rather than merely subsidizing the zone. Attempting to induce the transfer of
technology and skills from zone firms to domestic firms and workers, the state
offers additional incentives to firms or selectively targets existing incentives. Zone
firms then act by either involving themselves in the transfer o f technology (T)
above, or not (NT). This game also differs from the two previous games in that
an additional player has been added noted by the participation of domestic firms.
These firms will either produce in consort with zone firms (P), or they will not
(NP). Laid out in the following table, the eight possible outcomes of these
activities are noted with the rank o f the expected payoff to the players.
68
Table 3.3 Payoff Matrix
#1 #2 #3 #4 #5 #6 #7 m
State 2 4 8 7 1 3 6 5
MNC 3 4 1 2 7 8 5 6
Dfirm 2 7 8 6 1 3 5 4
Ranked payoffs to (State, MNC and domestic Firms) where 1 equals first
preference.
The rankings in Table 3.3 are based on a few assumptions. It is assumed
that state managers value technology transfer. This assumption fits well the
original arguments for a zone. Second, it is assumed that technology transfer
imposes some costs on the MNCs. On the other hand, domestic production if
coordinated with MNC efforts, lowers MNC costs. Finally, by producing in
conjunction with zone firms it is assumed that the domestic firm increases its total
revenue.
Given the proper incentives, MNC investors will likely find it profitable to
upgrade to more technologically sophisticated processes and higher value-added
lines o f production (node #1). Under these conditions domestic producers often
find it possible to integrate their activities with those of zone producers, or may
even absorb foreign firms' previous activities as these firms now move into more
technologically sophisticated processes. Finally, as the state improves the quality
of capital and labor inputs, more firms invest. Therefore, the number o f ancillary
services that firms consume increases opening up many other types of
opportunities for domestic producers.
69
Equilibrium and Solution Concept
Node 5, Node 3 and Node 5 comprise the individual maximizing strategies
for the three players: state, MNCs and domestic firms respectively. However,
Node #1 offers an equilibrium— a second-best strategy for the state and domestic
firms, and a third-best strategy for the MNC. This equilibrium proves welfare
maximizing in the long-run as productivity increases while costs decrease for the
private sector, and the state enhances its ability to accumulate and distribute.
When repeated the developmental game becomes cooperative and without conflict
as players strive to jointly maximize their interests at node #1.
Outcomes
The developmental game differs significantly from the previous two games
in that new players enter the game and the state takes a much more active role in
coordinating activities of economic agents. The inclusion o f domestic producers
provides for a more dynamic economic growth scenario than in either of the
previous two games. However, the inclusion of domestic firms in the game may
lessen the autonomy o f the state in the long run, particularly as their economic
strength increases.
70
CONCLUSIONS
Table 3.4 summarizes the preceding chapter's arguments. The items
marked in bold distinguish long-run costs or benefits. The developmental strategy
is superior precisely because it increases long-run profitability for firms thereby
providing resources for reinvestment and the provision o f state programs.
Whereas the rent-seeking strategy clearly diverts resources into non-productive
activities, the developmental strategy harnesses those very resources and realizes
efficiency gains. While the laissez faire strategy offers profit-making opportunities
for the firm, these gains could be larger if the state took on developmental
activities.
The three strategies elaborated above reflect a dynamic context. The
movement away from any particular strategy may reflect tension between the
expected and actual returns to that strategy, thereby pushing the state towards a
new course. At the same time such shifts in strategy can result from external
shocks to the domestic political economy that cause the E(u)>0. In this case, the
entire character of the game changes as the state's endowments change.
Table 3.4 Comparison o f Three Strategies
Costs Benefits Net Gain
Laissez Faire a/d, E(p), g a, ir
' m
Rent-Seeking g, a, ir, E(p) a/d
Developmental g, a, a/d, ir E(p), g, a/d, Ir E(p), a/d
71
! PART II THE CASE OF THE BAYAN LEPAS FREE TRADE
j ZONE
I
i .
! Introduction
i
! An export processing zone functions within a domestic political economic
context. In this context power is distributed, actions and strategies chosen,
| relationships between agents established, and outcomes of development strategies
! and particular policies interpreted. Therefore to evaluate outcomes in the zone
■ one must closely examine the domestic political economy and the establishment of
i
j development objectives. An overview o f Malaysia’s post-Independence political
economy is provided in chapter 4.
' This study suggests that the Malaysian state has pursued three distinct
1 development strategies characterized by very different relations between the state
and the market: laissez faire (1957 - 1974), rent-seeking (1975 - 1985) and
i developmental (1986 - present ). This analysis is in line with that o f Spinager
(1986) who suggests that a regime shift occurred in the development strategy of
the Malaysian state. He delineates two distinct periods 1957-67, and post-1968.
The first, he characterizes as a period of state investment in agricultural
infrastructure, and human capital, accompanied by attempts to enhance new
industry with the enactment of the Pioneer Ordinance and establishment of
industrial estates. In contrast to this first period of limited state engagement in
; market activities, the post-1968 period revealed much larger state involvement
(Spinager 1986:13). In her work, Fong makes a two-period distinction in the
Malaysian state's development activities: pre- and post-1986; This date marked
the first time that tax incentives were made available to small domestic firms This
72
revealed the state's willingness to enhance the profit-making abilities o f small,
domestic (ethnic Chinese) firms (Fong 1990:85). Clearly 1985 marked a turning
point in modern Malaysian political economy when the state profoundly changed
its course.
Chapter five models the emerging relations between the state and the
market in post-Independence Malaysian political economy. It examines the
policies toward the export-processing zone and the zone outcomes as one
manifestation o f these relations. The economic costs and benefits o f the zone
contrast to the non-economic gains to the state— specifically the ways in which the
zone enhanced legitimacy, offered international recognition, provided resources for
accumulation and distribution opportunities, and increased autonomy from
influential societal agents during the different phases o f development
In applying the game framework developed earlier, chapter 5 identifies
agents and players in the zone game, and the information and other endowments
available to them. It suggests players' strategy sets and the payoffs to their various
actions in the creation and maintenance o f the Bayan Lepas zone. Each players'
preferred strategy and the equilibrium is noted . Finally, this chapter suggests the
broad costs and benefits to society o f the zone policy under the various
development strategies.
73
Chapter 4 Economic Development, FDI and the Role of the State
| in Malaysia
INTRODUCTION
Jesudason (1989) argues that Evans' notion of a triple alliance (Evans
1979) cannot be applied to an ethnically divided society such as Malaysia. This
work suggests that the laissez faire period o f 1957 - 1974 could be characterized
: as such an alliance. At that time, the interests of MNCs, large domestic firms, and
I
state managers aligned to enhance their mutual objectives. Jesudason's claim that
i in societies such as Malaysia, "constraints exist to forging an effective
entrepreneurial alliance for development because of ethnic considerations," may be
j true but is perhaps overstated (Jesudason 1989:3). Although alliance formation
j proves difficult because political and economic power is divided between ethnic
groups, it not impossible. The emergence o f this division is a part o f Malaysia's
l colonial past.
LEGACIES OF COLONIALISM
Malaysia is a country rich in resources and with a climate favorable to
tropical agricultural production. Within the territorial boundaries of the modem
nation state exist reserves of tin, oil, natural gas, and tropical timber, commodities
which have at various times proven important to the country's economy. Resource
extraction along with plantation agriculture formed the foundation o f the colonial
i
economy. Prior to Independence in 1957, natural rubber and tin comprised 85%
o f total gross export earnings (Andaya & Andaya 1982:207)
74
This colonial government took a market-led approach toward the
development o f the economy, while providing infrastructure and maintaining a
! cheap and readily available labor supply. These activities were enough to entice
i
European capital to invest in the country (Andaya and Andaya 1982:208-09). As a
! result, Malaya's economy consisted primarily of large, foreign-owned, commercial
1
1 interests predominating in the production and export o f primary products
( With independence from Britain eminent after World War II, the World
I Bank sent a mission to Malaya in 1954. The report of the mission reported that
*
| Malaya had the highest per capita national income in the Far East (IBRD 1955:13),
I
• and a substantial body o f industrial activity to complement the production of
! primary products. It attributed the healthy state o f the economy to the openness of
1 trading opportunities and the vast reserves o f natural resources (IBRD 1955:421).
i
, The report recommended continued reliance on the market for the allocation of
! resources to efficient sectors.
I
! The mission did suggest some changes in the structure o f the economy,
I however, to decrease reliance on the volatile world market for primary products,
and to encourage further industrialization. Along these lines it was suggested "that
consideration be given to extend the concept o f the 'industrial estate' along lines
which have proved successful in the United Kingdom and elsewhere" (EBRD
1955:437).
Despite the favorable economic conditions the British left behind in
' Malaysia, Malaysians also inherited a harsh racial dichotomy: a predominantly non-
Malay commercial class located in urban areas, and a Malay governing class whose
support came from the majority o f Malay peasants (Lim and Canak 1981:210).
75
The newly created constitution attempted to lessen the racial dichotomy by
granting special privileges to the Malays: creating hiring quotas in the civil service
that favored Malays 4 to 1; offering educational scholarships, offering licenses and
reserved lands; declaring Malay the national language and Islam the national
religion; recognizing Malay monarehs; and reserving for Malays the positions of
prime minister and deputy prime minister in the national legislature (Bowie
1991:58-59). While these provisions benefited Malays, those o f other ethnic
origins who had lived in the country a given number of years, received the rights of
citizenship in the newly independent Malaysia.
ECONOMIC DEVELOPMENT IN THE POST-INDEPENDENCE ERA
Laissez Faire
The post-Independence state led by Tunku Abdul Rahman received an
overwhelming popular mandate. The Tunku, as head of the Alliance government
from 1957 to 1971, oversaw the creation o f an expanding post-colonial economy
based on laissez faire principals that did not severely alter the colonial framework.
The production of primary commodities continued to play an important role in the
Malaysian economy with the main market for such products still the United
Kingdom. However, other markets proved receptive to Malaysian goods as well.
In this period in Malaysia's history, the state headed by Tunku Abdul
Rahman, representatives o f foreign firms, and domestic Chinese capitalists formed
a triple alliance that allowed for capital accumulation and increasing wealth and
power for these agents (Evans 1979). Attempting to lower the import bill, the
state provided some financial incentives for private investment in the commercial
76
and industrial sectors, and erected some tariff barriers to protect domestic
producers from foreign competition (Bowie 1991:69; Lim and Canak 1981:211).
This first attempt at import-substitution industrialization lasted for a relatively
short period of time, roughly the decade of the 1960s, and proved rather
insignificant in its impact on the economy's profound extroversion.
The passage of the Pioneer Ordinance of 1958 offered manufacturing firms
exemption from the companies' tax in an attempt to stimulate domestic
manufacturing . Despite these incentives, the growth of import-substituting
industries became constrained by the low level of private disposable incomes
amongst the majority o f Malaysians (Malaysia 1986:345). Furthermore, by
protecting the domestic market behind tariff walls, ISI enhanced foreign and non-
Malay capital interests, thereby exacerbating structural inequalities in the economy
(Tan 1990:34; Lim and Canak 1981:211).
The large, capital-intensive firms that benefited most from ISI could not
absorb but a small portion of the excess labor in the economy. As a result, with an
expanding urban labor force and too few jobs to absorb them, unemployment in
major urban centers increased. The state sought to discover those areas in which
Malaysia might be able to upgrade existing labor-intensive commodity export
industries in order to absorb excess labor.
While the laissez faire approach to economic growth expanded
opportunities for foreign-owned firms in the plantation sector, and enhanced
opportunities for Chinese capitalists in urban centers, it did little to enhance the
livelihoods of poor, rural Malays who rarely owned their own land. Despite the
expansion of the economy at an average rate of 6% per year, income inequality
77
continued to worsen after 1957 (Mann 1977:11). Rising inequality within the
population, the growing poverty o f the rural sector, and insufficient employment
creation in the urban areas suggested to many, that the Tunku had aligned himself
and the Ruling Alliance too closely with the interests o f non-Malay capital.
State Initiatives to Encourage Increased Foreign Investment
Foreign corporate investment provided Malaysia's traditional source of
capital inflows. Given the sluggish economy and rising unemployment in the late
1960s, Malaysian state officials took the advice of the World Bank and adopted
the Investment Incentives Act of 1968, a program that offered incentives to
investors who would produce manufactures for export (Jomo 1987:124). Thus
began the Malaysian state's venture into export-oriented industrialization. Even
while the Malaysian economy experienced output growth during this period,
however, unemployment continued to increase rising in some urban areas above
10% (Jomo 1986:222-24).
Economic Stagnation
As economic growth stagnated in the urban centers and rural poverty
increased, opposition politics expanded its base of support. The rural Malays
increasingly began to show interest in the Pan-Malayan Islamic party (later known
as Parted Islam seMelayu or PAS, Tan 1990:35; Jomo 1986:244). At the same
time, a growing number o f urban Chinese voters were voicing concern with their
elected leadership as well. A sense that the Malaysian Chinese Association or
MCA, had abandoned the interests of the ethnic Chinese small business owners,
led to the increasing popularity o f opposition parties in the late 1960s.
78
In the elections of May 1969 opposition parties captured parliamentary
seats in unprecedented numbers in Malaysian history, taking from the ruling
alliance the two-thirds majority it had enjoyed since Independence. The Malaysian
Peoples' Movement (Gerakan Rakyat Malaysia), a Chinese opposition party,
secured the most votes in Penang capturing that state government, while other
non-Malay opposition parties won in all major cities (Lim and Canak 1981:216).
In the rural areas the Pan-Malayan Islamic Party captured votes in record numbers,
The strong support behind the Chinese opposition parties suggested that
the Chinese at least, would no longer back the status quo represented by the
coalition government. As a result the United Malay National Organization
(UMNO) could no longer count on its alliance partner the Malaysian Chinese
Association (MCA) to deliver the Chinese vote. The consensus on Malaysia's
future embodied in the constitution stood in danger. Despite the constitutional
recognition of the diverse functions o f the various ethnic groups, succeeding
generations have been frustrated by these distinctions, and have challenged the
state to provide more opportunities for them regardless o f race.
In the 1969 elections, both Chinese and Malay citizens voted for their
respective opposition parties in numbers suggesting that more people than ever
were unhappy with the status quo. Clearly the traditional patron-client relations
which sustained the communal parties of the Alliance had broken down. As the
state is founded on the basis o f racial parties serving their separate ethnic
communities, any challenge to the recognized ethnic formula is a challenge to the
state as well.
The coalition o f parties known as the Ruling Alliance (Barisan National, or
National Front after 1974), has ruled Malaysia since Independence. Despite the
coalitional characteristics o f the BN, one party dominates— the United Malay
National Organization or UMNO. UMNO, is both the largest and most influential
party within the coalition, and the party which provides the prime minister and
deputy prime minister due to its constitutional mandate to do so (Bowie 1991:74).
Because UMNO dominates the legislature, it is able to dominate patronage
opportunities as well (Mitchell 1991:378) Communally based parties o f the
coalition government reach out to their various communities to secure legitimacy
for the Malaysian state, and at the same time, serve to secure the communities'
legitimacy as well.
Malaysia has a tradition of patrimonial institutions. Historically the
interactions between the bangsawan (ruling class) and the rakyat (people) were
characterized by patron-client relations. In the countryside, the traditional
landlord-peasant relationship operated in this way. The British colonial system
introduced a similar dependent relationship in which the colonial patron utilized the
relations with the client state to gain resources while offering certain goods in
return Since Independence, Malaysia's communal political parties operate along
these lines as well (Ali 1976:201-02). Patronage between the ethnically based
parties o f the coalition government and their respective communities has been a
significant factor in maintaining the legitimacy of the Ruling Alliance (Tan
1990:42; Jomo 1986:244).
80
CHALLENGES TO THE STATE’S LEGITIMACY
Legitimacy suggests that the state can claim to speak in the public interest
(Alford and Friedland 1985:233). But like other developing nations, Griffin notes
that
The great problem confronting statesmen in the Third
World is that many governments lack legitimacy in the eyes
o f their own people. Equally, many people— those of
different language, religion or ethnic origm— lack legitimacy
in the eyes o f their own government. (Griffin 1985:20)
The events o f 1969 provided a watershed in modern Malaysian history by
challenging the legitimacy of the ethnic formula (Hirschman 1989:75). Despite its
loss of a two-thirds majority in parliament, however, the Ruling Alliance headed by
the United Malay National Organization, remained in control and took decisive
action to ensure the future o f the coalition government. Marshall law was invoked
in the aftermath o f the urban riots, and a National Operations Council (NOC)
superseded parliament. Before parliament reconvened, the three major victors of
the elections Gerakart, the People's Progressive Party (PPP), and Partai Islam
seMelayu (PAS) moved from their opposition status to join a new National Front
coalition, formally established in 1974 (Jomo 1986:255).
The threat to the legitimacy o f a Malay-dominated state which the elections
represented, and the potential for racial conflict which the riots revealed, suggested
that in order for the state to maintain legitimacy a much more active patron-state
would need to provide for its clients. So while the negotiations with the
opposition parties continued, the state embarked on an ambitious program to raise
the economic conditions o f the Malays. This program represented a most
81
ambitious attempt at state patronage and ensured a more pervasive role for the
state in the economy and other aspects o f daily life.
'' ■ ■
RENEW ING STATE LEGITIMACY
The NEP and Export Processing Zones
Although traditionally presented as highly personalized relations
characterized by face-to-face contact, James Scott notes that in the case of
Southeast Asia patron-client relations are often carried out through both modem
political parties and a modernized administrative apparatus (Scott 1972). The
crisis of state legitimacy experienced in 1969 initiated a transformation in which
patronage became an institutionalized form o f relations conducted by the state on
behalf o f state patrons. In this way UMNO hoped to preserve and advance its
political predominance in the wake o f the civil unrest (Jomo 1986:244). In order
to solidify the state's political dominance an economic base had to be created for
the Malays. In other words, the state desired to create a Malay bourgeoisie to
counterbalance the po wer o f the Chinese capitalists in order to assure Malay
political hegemony (Tan 1990:35). In order for the state to do this, it found it
necessary to move away from its previous laissez faire strategy, and involve state
managers and state organizations much more intimately in the activities of the
economy. The civil unrest o f the late 1960s
In Malaysia as elsewhere, an expanding economy enhances stability by
"lubricating the relations amongst the ethnic groups" (Jesudason 1989:169). After
the challenge to its legitimacy in 1969, the state's interests clearly included shoring
up its claim to power with a strong economic base— so began the redistributional
efforts of the NEP to provide economic opportunities for Malays, and the
82
concerted push to attract foreign investment with the Free Trade Zone Act of
! 1971.
1 Economic growth and the promise of a more equal distribution of gains to
, all ethnic groups with a New Economic Policy (NEP) promised to be the new
source o f legitimacy for the state. As outlined in the Second Malaysia Plan (1971-
! 1975) the NEP moved to eradicate the connection between occupation and race,
and to eliminate poverty It attempted to do this through the promotion o f
bumiputra in the public sector as well as in modern, urban employment
i
j opportunities and by securing equity participation on their behalf in all sectors o f
t '
the economy. Bumiputra, literally "sons of the soil,” refers to ethnic Malays and
other indigenous peoples o f the peninsula.
\
The NEP established employment quotas for bumiputras for all firms of a
certain size, required equity shares for bumiputras, and backed it up with the
creation of dozens of quasi-state agencies whose purpose it was to transfer
company shares to bumiputra trust agencies. Beyond acquiring shares, these
agencies acquire companies to be operated by, or on behalf of, bumiputras. Other
agencies offer low-interest loans to facilitate the creation o f bumiputra-owmd
businesses
Educational components of the policy offered bumiputra preferential
opportunities for admittance to centers o f higher education and began technical
training and entrepreneurial skill development programs. While many of the
provisions of the NEP simply confirmed the special privileges o f Malays embodied
in the constitution, the NEP created state agencies to see that these objectives
were carried out. The state continued to perform more functions on behalf of the
83
Malays and to empower itself to carry out the functions. The increasingly
centralized state became the source o f patronage opportunities (Tan 1990:35-37).
After the dramatic rise in the price o f oil in the early 1970s, the Malaysian state
had the means immediately available by which it could fund such broad reaching
programs.
PRESERVING INTERNATIONAL RECOGNITION
By promoting multinationals in manufacturing through the zone policy, the
Malaysian state maintained its reputation in the world market as open to foreign
investment, even while the state radically transformed foreign participation in the
primary export sector with the NEP. In this way, the zone policy played an
indirect role in the state's ability to accumulate wealth on behalf o f Malays, and
therefore, to meet its political objectives through the restructuring o f other sectors
of the economy (Jesudason 1989:131, 186)
ACCUMULATION AND DISTRIBUTION
The greater employment capacity o f MNCs in the short run made them
attractive candidates for state attention, while the ideology of an economic rivalry
between the Malays and Chinese made an alliance between a predominantly Malay
state sector and the largely non-Malay local private sector politically difficult (Lim
and Canak 1981:269). The Malay-dominated state found it politically difficult to
private accumulation efforts if this meant supporting non-Malay capital, because
the political "threat from non-Malay capital is greater if its economic muscle is
strengthened" (Lim and Canak 1981:220). Foreign firms in the zone offered
84
welcome partners for joint ventures with state companies which together, could
promote Malay interests as well as provide a check against the strength of
domestic, Chinese capital.
The expansion o f employment opportunities for rural, Malay young women
in export-processing zones, serves the political interests o f state officials by
increasing the economic resources of the Malays (Lim and Canak 1981:220). The
zone provides a means by which the state can alter the economies o f rural villages
without pursuing a more aggressive rural development strategy In the absence of
more direct action, the zone provides a safety valve for excess rural labor power
(Gnanathurai 1990:130; Tan 1990:35). Furthermore, the skills that Malays
would acquire in the modem manufacturing sector of the zone, would enable them
to enrich their community and bring about a renewed sense o f pride amongst
Malays (Jesudason 1989:111).
Second, in that a daughter working in the zone may be their only
connection to the modem, wage economy, families o f zone employees become
dependent on their labor power for money incomes. The rural sector's dependence
on the zone for money incomes arises directly from the inadequacy o f rural
development efforts. These families then find it in their interests to support the
zone policy, and therefore, the ruling coalition. The patron has a good to offer
clients. In return the clients must offer something to the state, and that is
cooperation with the ruling coalition, rather than support for opposition
candidates. An economically stronger constituency enhances Malay political
hegemony.
85
SECURING A LEVEL OF AUTONOM Y
The continued reliance on communal politics and the politics o f patronage
as embodied in the NEP, promised to offer the state a level of autonomy by
hierarchically ordering ethnic cleavages (Jesudason 1989:20; Reuschemeyer and
Evans 1985:65). Dependence on patron-client relations and the emphasis on
communal political parties, quells the development of other sources of
identification such as class or gender, while at the same time creating a degree o f
popular participation. As such these relations insulate the state from the demands
of organized groups and maintain the stability o f the state. Through patron-client
relations the state can control the demands placed upon it while distributing the
spoils of political power in a controlled fashion (Patton 1986:61).
Autonom y from the Aristocracy
The opposition challenge which the Alliance faced in the 1969 elections
Came at a time when a group o f "young Turks" within the Tunku's own party
began to plan for an UMNO future without the "Father of Malaysia" at the helm
(Jesudason 1989:194). Malaysia's monarchy and aristocracy o f which the Tunku
was a member, historically held powers o f granting land rights, and concessions for
timber and other natural resources. These powers provided the foundation for the
patronage relations between the ruling class and the Malay rural sector.
After Independence, the needs of a fledgling and increasingly urban-based
Malay leadership conflicted with the traditional powers of the rural sector. As this
new group o f leaders began to enhance their power in the party, and
correspondingly in the Ruling Alliance, their relations with the Malay rural sector-
86
the source of UMNO support— necessarily needed attention (Tan 1990:39). The
electoral significance o f Malaysia's rural sector is well known. Gerrymandering
weighs rural votes more heavily than urban votes by over representing the rural
constituency (Tan 1990:42; Das 1984; McGee 1969:566). Because the party that
can win the support o f the rural sector can take the election, this fuels patron-client
relations between Malay parties whose base comes from the rural sector.
The events surrounding the 1969 elections, propelled this group to the
forefront of the UMNO. The NEP encouraged rural-urban migration as a way to
bring Malays into the modem economy and reduce rural poverty. Zone
employment offered an opportunity for modem employment and in many cases
required the physical relocation of peasants to outside of their villages. This
mobilization of people from the countryside reduced the base of traditional
authority.
Autonom y from Domestic Firms
The National Operations Council that replaced parliament from 1969 -
1971 and the new coalition government which succeeded it, secured a level of
autonomy not only from sources o f traditional authority but also from powerful
domestic Chinese capital. Offering increased opportunities for Malays under the
NEP and encouraging foreign investors implied a smaller role for ethnic Chinese
firms in the future (Jomo 1986:213-14)
Government-led growth since the 1970s attempted to promote Malay
interests and as a result Malay capital has seen a precipitous growth since the
onset o f the NEP Numerous state and quasi-state agencies were established to
87
promote Malay equity in the economy. These agencies receive direct subsidies
from federal government budgets, as well as transfers o f shares from state „
development corporations (SEDCs). They have, therefore, been able to establish
great wealth.
Autonom y from Labor
In the hope o f securing foreign investment, the state offers foreign firms the
assurance they risk little by investing in the country. This involves many things,
including the nurturing of'responsible' unions, and maintaining low wages. Both
objectives have been quite successful in Malaysia via the ban on new union
formation in the zones. Labor legislation associated with the Investment
Incentives Act o f 1968, keeps the cost o f labor cheap in particular "preferred
industries." The rationale behind this is that
Proponents o f an export-oriented industrialization strategy,
hinging primarily on being able to attract and retain certain
industries, are necessarily committed to policies maintaining
a relatively low-wage, 'disciplined' labor force, and other
aspects of a 'stable and attractive investment climate'. (Jomo
1986:232)
In this way, export-oriented industrialization has given way to new forms of labor
control in Malaysia. The state promotes in-house unions as the alternative to
industry or federated unions. At the same time,
Labor laws have been tightened to ensure that the labor
force is politically controlled which actually offers a very
favorable opportunity for profit maximization to the
company. These foreign corporations are consequently able
to escape U. S. and European trade union demands for
certain health and safety standards as well as higher wages
and benefits. In practice, Malaysian labor legislation, both
by omission and weak enforcement, has enabled the
multinational corporation to manipulate the local population
as a labor reserve to be hired and fired according to their
'whims and fancies.' (Daud 1988:123)
CONCLUSIONS
The New Economic Policy foreshadowed a shift in the state's economic
development strategy from one o f limited intervention in the market, to one with
significantly more state involvement. However, the state did not have the
resources to make the shift until 1974 when oil revenues rose significantly due to
the OPEC oil embargo, and firms began production for export in Malaysia's new
EPZs.
89
Chapter 5 Malaysia's Bayan Lepas Zone: A Game Theoretic
Analysis
INTRODUCTION
The alliance between the state and MNCs which the zone policy represents
creates a perverse set of economic payoffs. It promotes the state's dependence on
MNCs for a large number of jobs— jobs highly dependent on the international
demand for a select number o f products. The concentration o f zone firms in a
handful o f industries with few connections to domestic firms creates structural
weakness in the economy. Nonetheless, this alliance provides an opportunity for
the state to pursue its economic, social and political objectives without having to
rely on local sources of capital thereby enhancing the state's autonomy.
Therefore, the state has a keen interest in the success o f the zone.
PENANG CREATES A ZONE
The riots which broke out in major cities immediately after the
announcement o f the 1969 election returns posed an immediate threat to the
Malaysian state. Always challenged with overcoming the ethnic cleavages it
inherited from its colonial past, the Malaysian state's claim to legitimacy now faced
a physical threat as chaos erupted in the streets. The poor economic conditions in
the major urban areas provided a catalyst for the post-election riots. Nowhere was
this more true than in the state o f Penang.
By the mid-1960s [Penang's] economy, lacking an
alternative base, [to entrepot trade] stagnated;
unemployment rose and net outmigration occurred. It was,
therefore, inevitable that Penang, a Chinese-dominated
peripheral state, was won by the Opposition in the 1969
general elections. (Salih and Young 1987:181)
Following on its electoral promises, the opposition Gerakan government
o f Penang created the Penang Development Corporation (PDC) in 1969 to begin
to regain the economic vitality that Penang had enjoyed previously with free port
status (PDC(l) 1986:26). In the eyes of PDC officials establishment o f an export-
processing zone offered immediate relief for Penang's unemployment problem
j (MPPP 1986:44).
j Beyond its employment potential, however, PDC officials sought expansion
I
of multinational production activities in Penang to expand its economic base
thereby offering the island a level o f autonomy from the federal government.
■ Furthermore, Gerakan represented the interests of small and medium-sized Chinese
business owners. The zone as originally conceived promised to bring foreign
; innovation and entrepreneurial skills that would transfer to local firms. Similarly,
the skills that employees acquired in the modem, multi-national production
facilities in the zone would enable them to enhance local production activities
when they took new jobs or began their own companies.
However, legal arrangements necessary for the development of a free trade
zone lay outside the purview of the state government.
91
j Such things as rates of taxation, foreign exchange rules, and
! many other issues important to foreign investors could only
' be legislated at the federal level. The power to declare any
area an FTZ lies with the Minister o f Finance, however
! state-level development authorities are responsible for the
physical development and financial administration o f the
FTZs and must first apply to the Treasury before an area
may be gazetted as an FTZ. . (USDOL/BDLA 1990:136)
With the passage o f the Free Trade Zone Act of 1971, the federal
authorities essentially cleared the way for the State Economic Development
Corporations (SEDC) to establish and operate zones. Why would the federal
I
1 government clear the way for an opposition-led state government to enhance its
power with economic expansion? In this case, the interests o f these factions of the
i state aligned. These interests will now be explored further.
| AGENTS: THEIR INTERESTS AND INFLUENCE ON A ZONE POLICY
Potentially all existing and historically active agents in the economy may
have an interest in the zone policy. However, as this work will suggest later, as
the development strategy changed, agents and their interests, as well as their
power over the game's outcomes changed as well
State Sector
The state sector includes public and government-backed enterprises, state
managers and state organizations. In Malaysia's case a distinction needs to be
made between the interests of the state government and the federal government
because these levels o f government are often controlled by different parties that
reflect different class interests.
92
j In the eye's o f federal officials the development of an export processing
I zone in Penang offered the hope o f an expanding economy with increased
I
j opportunities for Malays. The expansion of economic activities in Penang could
I
provide jobs for Malays, diffuse the immediate tensions created in the wake of the
| . . .
election results, and fulfill objectives of theN EP without directly enhancing
domestic firms' interests.
I Penang state officials had a somewhat different outlook. In proposing the
idea o f a zone they hoped to turn around Penang's ailing economy by providing
j employment and opportunities for local manufacturing firms to expand their
I
| markets and improve their technological capacities.
i
i
, Domestic Firms
j Both large and small domestic firms stood to benefit if the zone activity
stimulated the economy in such a way as to open up new areas o f production as in
supplying zone inputs and services. These firms' interest in profit maximization
gave them a keen interest in the possibility that the zone policy would stimulate
growth in the broader economy.
Popular sector
In need o f employment, both the urban labor force and under-employed
peasants could benefit from the new opportunities that the zone promised.
93
MNCs
MNCs desired to locate in Malaysia and take advantage o f the inexpensive
and yet highly educated supply of labor. Lower labor costs would enhance
revenues, thereby increasing profitability. Malaysia's relatively well developed
infrastructure also made it a preferred location for production activities in
Southeast Asia.
The ability of these agents to meet their objectives depends on their power
and position in the development strategy. These strategies will now be elaborated.
THE LAISSEZ FAIRE STRATEGY
Players' Actions
During the laissez faire period of development (1957 - 1974) the state
enacted the Pioneer Ordinance (1958), the Foreign Investment Act (1968), the
New Economic Policy (1971), and the Free Trade Zone Act (1972). All these
measures upheld the primacy o f private profit-making ventures and attracted the
interest of both MNCs and large domestic firms. These firms responded to the
incentives and targeted their production to receive the maximum benefit.
Power and Inform ation Asymmetries
Given the incentives offered by the Malaysian state the firm is in a powerful
position to enhance profit-making activities. The firms' ability to act last, in this
case to respond to the state's incentives with investment or to seek "a more
hospitable climate" elsewhere, puts it in an advantageous position as well.
Decision making Tree and Associated Payoffs
Diagram 5.1 Decision making Tree with a Laissez Faire Strategy
Firm
State (+)^Node # 1
Firm
State
Node #3
The state sent a clear signal to firms that it would support private efforts o f
accumulation with the provision o f infrastructure, tax holidays and reproduction of
the labor force, noted by (Z). With these measures the state attempted to stimulate
certain sectors o f the economy, however, it did not engage itself directly in any
production activities. The state moves again when it comes time to extend or
suspend the tax holidays. Firms responded by expanding (+) or reducing (-) their
operations. Table 5.1 suggests illustrative payoffs associated with the laissez faire
strategy.
Table 5.1 Payoff Matrix
State/Firm Produce Contract
Extend #1(2, 2) # 2 (3 ,1 )
Suspend # 3 (1 ,4 ) # 4 (4 ,3 )
Ranked payoffs to (State, Firm) where 1 equals first preference of players.
95
i As the economy continued to expand, the state secured legitimacy evidenced by
i
the popularity o f Prime Minister Tunku Abdul Rahman and the mandate received
by the Ruling Alliance in the 1959, 1964 and 1969 elections (McGee 1969:566).
i
Furthermore, with this strategy the state enhanced its international recognition by
j continually opening its markets to foreign investment and reducing obstacles to
i .
1 private profit making as the World Bank had recommended.
Nonetheless, the state's efforts at promoting private accumulation and
distribution o f opportunities throughout the economy appeared insufficient to
! moderate the rural-urban migration or to stimulate sufficient job growth in urban
areas (McGee 1969:567). Both Malay and Chinese interests began to suggest that
the Ruling Alliance appeared to have lost its autonomy from influential agents,
I
thereby compromising its ability to build a dynamic multi-racial society (McGee
i
1969:567). In the long-run the legitimacy of the multi-racial state appeared
threatened.
The state them implemented the NEP (1971) to hasten the pace of
economic growth and job creation in the economy. The NEP foreshadowed an
increased state involvement in the market with the establishment of quasi-
government bodies to promote Malay interests. Even with these developments,
however, there remained a willingness on the part o f Malay state managers to
work with non-Malays in the civil service and business in order to increase the rate
o f development (Rogers 1972:172) The establishment of Malaysia's Bayan Lepas
zone in 1972 represented the cooperation between Malay and non-Malay state
managers in the promotion o f business interests.
96
The fast growing electronics industry and the increasingly popular practice
o f off-shore sourcing converged for the quick growth of Malaysia's zones. From
1973-79 employment in export-oriented electronics industry grew quickly making
a significant contribution to Malaysia's industrial employment. The growth o f the
zone firms and the employment opportunities they provide in manufacturing for
rural Malay households, not only provide opportunities for Malays to enhance their
economic positions, but also fulfills the restructuring objectives o f the NEP. The
Bayan Lepas zone did absorb labor, primarily rural Malay labor and this was in the
political interests of state managers and state organizations. The zone employed
more than 31,000 workers by 1986, with roughly 70% females aged fifteen to
twenty-four years (PDC 1986:1, 5).
Critique of the Zone
Despite the quick growth of the zones, criticism of the policy spread.
These criticisms centered around the low skill level o f the employment created,
little linkage o f the zone industries to those outside the zone, over-concentration of
zone activity in a few industries, and foreign domination of zone firms leading to
the repatriation of profits and little improvement in the host country's foreign
exchange account. Locally published reports readily acknowledged the policy's
shortcomings.
A report issued in 1986 by the Penang Municipal Council suggested that
the low-skill jobs created in the Bayan Lepas zone had been "a mismatch to the
highly educated labor force supply available in Penang" (MPPP 1986:52). As a
97
. result of this mismatch, the brain-drain of skilled non-Malay from Penang
! proceeded rapidly during the 1970s and 80s (Wong 1990:114).
i The literature on export-processing zones suggests that countries often get
i
stuck at an early stage o f export-industrialization with low-skill level enclave
i
industries (Kelly 1986:833). It has been said of the Bayan Lepas zone that the
t
, ‘ 'vertical division of production has given rise to a peculiar division of labor which
leaves Penang entrenched in labor intensive, low value-added stages of
I production" (Rajah 1988:36, emphasis added). The promise of meaningful
| opportunities for Malays as voiced in the NEP, means little more than a low
' paying, dead-end job for the young, female Malays employed in the zone.
; In Malaysia's semi-conductor industry (a rough approximation of zone
employment), Malay are divided between 9% professional and 91% low skilled
! workers with virtually no room for advancement (Rajah 1988:32). The objectives
o f the zone as originally formulated; to create jobs, obtain technology transfer and
management skills, and earn foreign exchange to finance development projects,
coincide with a government policy "eager to preserve low wages and a largely
docile nonunion work force" (BW 1983:58). In regards to zone firms, the state
has tolerated temporary contracts, easier dismissals and longer working hours than
otherwise permitted (Grunwald & Flamm 1985:245-46). While wages in the zone
have typically kept pace with increases in the cost of living, they do not reflect
gains in productivity (Sassen 1988:113; Jesudason 1989:171)
Although it is not the zone which brought labor control to Malaysia, the
logic of EOI and its emphasis on Malaysia's comparative advantage in cheap labor
98
! supports labor control in the zone.-* Labor laws tailor-made for zones are
! common (Deyo 1990:187), as the zone is an ideal medium in which to curtail labor
1
I .
i demands. It is common in zones to ban unions, and suppress wages.
J In Malaysia's case, existing unions may not organize the young, female
; employees in the zone (Bowie 1991:107). Zone employees can only form in-house
! unions These in-house unions are believed to foster healthy worker-employer
t relations (BW 1983:58). Plant management encourages the formation o f in-house
I
t
umons, and in a few cases heads the unions as well Existing unions charge that
"employers were deliberately sponsoring such unions in order to avoid giving
recognition to stronger unions that were nationally or regionally organized”
(Arudsothy 1990:326).
^Malaysia has a long history of labor control. The British colonial state strictly supervised trade
; unions for political purposes and utilized the law to do so. After the world depression o f the
1930s both political agitation and worker unrest arose in British Malaya. The colonial
! government began institutional change which resulted in the implementation of the Trade Union
Ordinance, 1946. This legislation ushered in "a long period of trade union inactivity"
! (Arudsothy 1990:312). Arudsothy notes that because the "early developments in trade union
organization after the War [World War II] coincided with the post-War acceleration of
Communist insurgency," unions and Communism became inextricably entwined in the minds of
both colonial and post-Independence state officials (Arudsothy 1990:311).
Because o f the fear of the spread o f Communism and the victory of the Communists in
China in 1949, and owing to Malaysia's large ethnic Chinese population, "even after
Independence in 1957, the Government of Malaysia maintained a considerable level of suspicion,
if not hostility, towards the labor movement" (Anidsothy 1990:312). Although the trade union
movement has historically played a small role in Malaysia, there have been acts of militancy.
Nevertheless the state pursued policies to restrict the growth of unions (Jesudason 1989:57). The
Trade Union Act of 1959 contained within it all provisions of the restrictive 1946 ordinance
Under the colonial state, while amassing power in the hands in an all-powerful Registrar of Trade
Unions. As a result this new act could be considered more coercive than its colonial predecessor
(Arudsothy 1990:312)
Succeeding labor legislation was to follow this pattern of severely restricting labor
organizing. Under the Industrial Relations Act of 1967, Compulsory arbitration expanded to a
wider range o f "essential services", and the formation of new unions in manufacturing was
banned (Jesudason 1989:57). Restrictions on union formation and collective bargaining in this
sector continue to temper worker activism and to slow the growth of unions.
99
In-house unions have little room in which to maneuver. The scope of
activities is circumvented not only by internal control, but also through the external
control o f state-sponsored legislation. Activities like collective bargaining are
closely curtailed and disputes can rarely be submitted before a neutral arbiter due
to such legislation. Similarly, strikes by zone employees are barred, because the
production o f foreign firms in the zone is considered in the national interest. Any
disruption of zone production purportedly threatens the national interest. Through
legislation aimed at controlling labors' ability to organize and press its demands,
the state has successfully weakened the labor movement and in so doing upheld
autonomy from labor.
At the same time, conditions within the zone disempower workers in a
more subtle manner. Rules govern the physical entity o f the zone including the
close monitoring of entrance and exit to and from the zone. Employees arrive in
the zone properly identified by their uniform and badge often in company buses,
while visitors must have a pass stating the nature of their visit. A zone worker's
day is strictly regulated by exact break times and lunch periods. In some cases for
a worker to move away from their work station they must be in possession of a
pass. Discussions of salaries and working conditions are not tolerated and can be
grounds for dismissal (Mai 1989). Meanwhile labor legislation is selectively
enforced by the state during periods o f economic slowdown, thereby enhancing
the position of the firms at the expense of labor (Bowie 1991:107).
Low value-added is due in part because of the difficulty linking zone
production to other sectors o f the economy . A Penang Town Planning
Department official suggested that,
100
the linkages between the large modem export-based
industries in the industrial estates and the smaller scale
locally-owned ones are very weak. The multiplier effect of
the export-based industries on the local economy is lacking
with the result that the local industrialists do not benefit
much from the new industries. (Transcribed from an
interview with the author, 1987, and MPPP 1986:60)
A US Department o f Labor study confirmed that the history o f the Bayan Lepas
zone suggested that "like other FTZs, [Penang's zone] sells few items locally, while
local purchases o f raw material and capital equipment are insignificant as well"
(USDOL/BELA 1990:137).
As for industrial concentration, by 1982 twenty-five o f the forty-four
factories in the Bayan Lepas Free Trade Zone "deal[t] in electronic products. All
[being] export based industries" (MPPP 1986:54). With well over fifty percent of
the zone's jobs in the electrical/electronics sub-sector, in times o f low worldwide
demand for electronics goods as experienced in the early 1980s, large layoffs ensue
in the zone (Salih and Young 1987:194-95) This is a result not only o f the
concentration o f zone jobs in electronics assembly, but also the lack o f linkages
between the zone and the local economy which could potentially expand the
markets for zone products (MPPP 1986:59; Clad 1986:27).
At the same time, the negative impacts o f the high degree of foreign
ownership in the zone has also been recognized. Thirty-five o f the forty-four
factories in the Bayan Lepas zone are either one hundred percent, or majority
foreign-owned, with fifteen percent of the total management expatriate. While
Malaysia’ s electronics industry developed very rapidly from
virtually nothing in the early 1970s to the point where it
accounts for over half of manufactured exports, Malaysia
has not developed a sizable electronic equipment industry,
either for consumer or industrial electronic products. The
industry's growth has been inextricably linked to
investments by multinational semiconductor firms which
come to Malaysia in search of cheap labor for the assembly
o f semiconductors. (World Bank 1989:101)
! Because o f the high concentration of foreign ownership in the zone, the
I
j leakage o f profits is a real problem. Analyzing the export surplus created by
I ■
j Malaysia's zone production from 1973-79, Jomo noted that the original M$30
! million current account credit was substantially reduced after subtracting profit
i
I
I remittances, and royalties and fee payments paid to the parent firms of zone
! companies (Jomo 1987:140). This suggests that the zone makes a minimal
contribution to the economy's foreign exchange reserves. Therefore,
Although foreign participation in new industrial
development is essential because of their capital and
technology, the situation if prolonged will not be desirable.
This will mean not only high leakage o f profits accruing
from these industrial activities but also inadequate transfer
o f entrepreneurship. (MPPP 1986:48, 60)
That the zone created low skill level jobs did not create a problem for state
managers since their objectives included employing Malay peasants. The lack of
linkage with firms in the local economy did not constitute a problem either as this
would have only meant expanded opportunities for domestic Chinese firms. The
over-concentration of zone employment in the electronics industry was perhaps
unfortunate but likely a temporary difficulty in the minds o f state managers as they
102
envisioned expanding opportunities outside the zone as well. Foreign domination
i
of zone firms did not pose a problem either, as the state reduced overall foreign
presence in the economy by restructuring the primary sector Finally, the small
! amount of foreign exchange that the zone provided had little effect during a period
in Malaysia's history when vast amounts o f foreign exchange were coming from
the sale o f oil and other primary commodities on the world market.
The criticisms leveled against the zone by Penang's opposition government,
the representatives o f domestic Chinese firms, labor organizers, and/or the voices
; of foreign economists and critics generally, did not resonate with Malaysia's state
managers and state organizations. Rather despite the criticisms o f the zone's
' performance, during the late 1970s and early 1980s the state continued to "[look]
to the [foreign] electronics sector to absorb labor since its priorities were
i
J elsewhere” (Jesudason 1989:175, emphasis added).
I
\
i
Equilibrium and Solution Concept
From 1970 to 1980 the state of Penang witnessed a significant
demographic shift. The Free Trade Zone attracted in-migrants from the rural
regions north of Penang from which young Malay women come hoping to secure
factory operative positions (MPPP 1986:49). At the same time, net out-migration
occurred amongst Penang's population o f young, non-Malay males. The
corresponding change in the ethnic character of urban Penang held potential
electoral significance for the BN and particularly for UMNO. Therefore, for
whatever its shortcomings, continuing to promote the EPZ remained in the
interests o f state managers and state organizations. In this game a partial
103
equilibrium is reached in which the state continues to provide incentives to firms as
long as firms continue to expand investments. No player has any incentive to
deviate from this strategy given that no other player deviate.
Outcomes
During this period, the Alliance
Attempted to follow a policy o f government investment in
the rural sector to uplift the standard of living of the Malay
population while providing incentives for private enterprise
to invest in the industrial expansion o f the cities. It has also
attempted to ease Malays into the urban sector by providing
government positions and industrial jobs. Despite
considerable success in solving their complex dilemma, the
pace has evidently not been sufficient to create sufficient
labour opportunities for either the Malays or Chinese, and
indeed a growing dissatisfaction in both communities has
become apparent. (McGee 1969:567)
This dissatisfaction fueled the civil unrest of 1969 and gave rise to state efforts
including the NEP and Free Trade Zone Act. Both policies remained within the
realm o f a laissez-faire/ private profit promotion strategy. It wasn't until the
windfall in oil revenues and sharp increase in other commodity prices during the
mid-1970s that the state began to intervene in the market in a wholly different
fashion in order to bolster legitimacy and secure autonomy from domestic firms.
104
THE RENT-SEEKING STRATEGY AND THE ZONE GAME
Players’ Actions
The Industrial Coordination Act o f 1975 provided a way in which the state
could directly intervene in the activities o f the manufacturing sector. Under the
ICA companies with fixed assets o f M$500,000 were required to seek
government approval before issuing shares, or changing board members. Both the
firm's board and personnel needed to reflect the racial composition of the country,
and the firm was to use the services o f Malaysian owned companies, and have its
goods distributed through Malaysian owned distributors whenever possible. Under
the ICA companies were expected to "install suitable and modem machinery in
accordance with up-to-date and efficient layout," and they were not permitted to
enter into any agreement particularly for starting up
operations, technical know-how and assistance, service,
management, purchasing, marketing, payment of royalty,
patent and trademarks, without the prior written approval o f
the Ministry of Trade and Industry. (Yong 1987:169)
The Ministry o f Trade and Industry became an active partner in manufacturing
firms under the conditions o f the ICA. The Act applied to all manufacturing firms
with fifty or more employees and M$100,000 in paid up capital (Tan 1990:38). It
induced firms to sell equity shares until the ownership of the firms more accurately
reflected the distribution o f the population at large. Failure to comply could result
in the suspension of the manufacturing license or difficulty receiving permission to
produce a new product Immediately after its implementation, outcries came from
both domestic and foreign firms as they reacted to the extensive licensing and
oversight powers which the state assumed under this act.
105
i
f
Within one year o f its implementation, amendments to the ICA effectively
1 exempted firms that exported the majority o f their products thereby maintaining
i
the original ownership structure of MNCs (Seaward 1986:77). At the same time,
i
the act successfully imposed state oversight into small and medium-sized domestic
manufacturing efforts. In this way "small- and medium-sized non-Malay capital,
I were forced to share their slowly accumulated wealth and profits with outsiders"
j (Tan 1990:38; Jesudason 1989:163). The state's different standards for foreign as
opposed to non-Malay firms became blatantly obvious. The new regulations
I
effectively imposed an entry requirement on those domestic firms wishing to
manufacture and provided the opportunity for state managers to secure economic
! rents.
t
I.
The history o f the ICA reveals the state's strong interest in accommodating
1 foreign manufacturing multinationals while controlling domestic firms (Jesudason
i
1989:131; Lim and Canak 1981:220). In spite of the concern about foreign
ownership and the desire for local equity participation, rather than pushing for
more domestic equity participation in zone firms, during the early 1980s the
Mahathir administration further relaxed equity requirements, and ushered in
"greatly liberalized foreign investment rules" (Clad 1986:27). Exemption from the
equity requirements of the NEP, previously offered only to those firms exporting
100% o f their product, expanded in the 1980s (Seaward 1986:82).
, The Malaysian state went beyond mere intervention in private firms and
established its own. For example, in 1981 Prime Minister Mahathir launched a
state-sponsored heavy industry drive with the creation ofHICOM, a 100%
government-owned holding company. With the heavy industry drive, the state
106
essentially applied a two-pronged approach promoting foreign firms in
manufacturing for export and supporting state firms in the primary and heavy
industry sectors for import-substitution industrialization.
This was in line with Mahathir's frequent assertion that he desired to follow
the Korean model of economic development. The Korean model involved a
political system "dominated by an executive that maintained direct ties with large
firms that dominated a highly concentrated industrial structure." The advantages
o f this system include "tremendous directive power and ability to act swiftly." The
disadvantages include a "high level o f discretion and absence o f checks on
executive action" (Haggard 1990:158). Establishing state firms
in sectors that had been wholly or partly dominated by
Chinese, often in combination with foreign capital,
represented an advance in economic restructuring and in
efforts to expand the Bumiputera managerial and
entrepreneurial classes. Moreover, such initiatives created
new opportunities for dispensing patronage which was Of
growing importance to top UMNO leaders seeking further
to expand and cement their political dominance. (Machado
1992:7)
Machado suggests that the role of HICOM in Malaysian industrialization
reveals "a long-term shift in policy making power from career bureaucrats to the
top political leaders, a shift which was accelerated greatly by Mahathir" (Machado
1992:4).
After 1970 the establishment of public enterprises with
generous financial allocations gave political factions
(especially within UMNO) access to extensive resources
which could be used as patronage, The nature of Malaysian
politics began to change as clientilist networks extended
into the economy and government bureaucracy. (Gale
1981:194)
Power and Information Asymmetries
Gale's analysis suggests that "favoritism, parochialism, 'corruption,' and
allegiance to particular clienteles" provide the fundamental features of the this
model (Gale 1981:12). Therefore, those on the inside o f a patronage network
clearly were strengthened while those on the outside lost out. This empowered a
number o f Malays who had simply not been significant players in the previous
game.
Decision making Tree and Associated Payoffs
Diagram 5.2 Decision making Tree with a Rent Seeking Strategy
Firm
In this game the state imposes regulations that the firm must abide by in order to
continue to receive the zone subsidies. This is noted by the conditional state action
in the second round. Table 5.2 suggests the payoffs to the state and firms under
the rent-seeking strategy.
Firm
N ode #2
State
z
N ode 0 4
N ode 0 3
108
Table 5.2 Payoff Matrix
State \ Firm Side payment No Side payment
Seeks
Arrangements
#1(2,2) #2 (4,3)
No Arrangements #3 (1,4) #4(3,1)
Ranked Payoffs to (State, Firm) where 1 equals players first preference.
Equilibrium and Solution Concept
The state prefers to operate at node #3 because seeking arrangements
implies costs. At the same time, firms would prefer to operate at node #4 where
they would expend no resources on side payments. However, given the
implementation of additional regulations an action which signals increased rent-
seeking activity, the game reaches an equilibrium at node #1. At this point no
player has an incentive to deviate from this point unless the player believes that
some other player will deviate.
Outcomes
A shift in power into the hands o f political leaders during the 1970s
institutionalized patronage. Despite the NEP rhetoric of reducing poverty and
inequality, however, between 1957 and 1985 the gini coefficient o f income
inequality increased from .42 to .49, perfect income inequality being equal to 1.0
(Griffin 1989:14; Mann 1977:11). Furthermore, the primary beneficiaries of state
expansion under the NEP and restrictions on domestic manufacturing imposed
under the ICA, have not been poor rural Malays. Rather it has been either well-to-
do Malays who 1) traced their roots to the colonial state apparatus, and/or had 2)
109
strong connections to landed interests who have benefited most. At the same time,
some ethnic-Chinese already relatively well to do as owners o f large conglomerates
have fared well during this period as well as they turned their attention away from
manufacturing and into investments in housing construction, property development
and other activities spurred on by the growth of state agencies and investments in
heavy industry in the 1980s (Jomo 1986:269; Tan 1990:35-36). Rather than facing
the state as a direct partner in their business dealings as imposed under the ICA,
they found these new ventures more profitable Therefore, they too, became
beneficiaries under the rent-seeking strategy (Jesudason 1989:159).
Malaysian capital accumulation remained stifled due to the state's
unwillingness to foster linkages between the foreign electronics sector in the zone
and the local electronics firms. Without tax breaks, incentives, or research and
development incentives, small and medium sized firms stagnated in the 1970s
(Jesudason 1989:17-18). Furthermore, the Industrial Coordination Act effectively
denationalized the domestic supplier network by imposing costly regulation on
these firms while allowing foreign firms exemptions (Lubeek 1992:195-96).
The imposition of the ICA stands in stark contrast to the NIC model of a
developmental state augmenting the market. The Malaysian state's massive
intervention since 1970 "does not replicate the articulated relationship between
business and the state, nor, in structural terms, [provide] a deeper, innovative, and
dynamic process o f Malaysian, as opposed to foreign, capital accumulation"
(Lubeck 1992:181).
110
THE DEVELOPMENTAL STRATEGY AND THE ZONE GAME
Players’ Actions
During the mid-1980s the Malaysian state experienced new constraints and
challenges. The recession that had shook the industrial countries in 1981 hit
Malaysia a few years later with its most profound effects being felt in 1985. The
decline in demand for Malaysia's traditional exports, a reduction in foreign capital
inflows, weak demand in the domestic property market, and sluggish performance
in the stock market threatened to ruin the economy. To make matters worse, the
state had to make payments on a large foreign debt accumulated during the state
initiated heavy industry push o f the early 1980s (Tan 1990:39; Jomo 1987:146-
47).
Not surprisingly then, the Fifth Malaysia Plan (5MP, 1986-90) maintained
the importance o f export-led growth with a substantial role envisioned for foreign
investment. The Plan promised to provide the best possible environment for the
location of multinational firms in the country. The state's debt obligation to the
World Bank made any other course o f action difficult to pursue (Jomo 1987:146-
47). The Fifth Plan also maintained the importance o f the manufacturing sector in
creating " opportunities required for the attainment of the NEP objectives"
(Malaysia 1986:346).
The heavy emphasis placed on foreign investment did not include the
creation of more export-processing zones, however. Since 1978 no new zone has
been created The number o f zones has remained at eight. The notion of
concentrating firms in a zone has been abandoned for one which disperses
production activities. The introduction o f Licensed Manufacturing Warehouses
111
(LMWs) essentially offers zone status to single firms with the attendant incentives.
This status can be conferred on any manufacturer that exports more than 80
percent of its products . Additional incentives are offered to firms which locate in
more economically backward regions (USDOL/BILA 1990:136). Like previous
incentives to manufacturers, LMW status discriminates against small and mid-sized
domestic firms with the emphasis on production for export.
Prior to 1986, indifference characterized the Malaysian state's "response to
creating linkages between booming foreign electronic firms and the local electrical
sector" (Lubeck 1992:195). Therefore, multinational firms in the Bayan Lepas
zone created few linkages with domestic producers during the 1970s and early
1980s. The transfer o f technology and creation of foreign exchange was limited to
the effects o f employing a few managers and a large number o f unskilled female
factory workers. Griffin suggests that
if the linkages are strong, an expanding export sector will
generate activity throughout the entire economy, but if the
linkages are weak, the export sector may be little more than
a foreign enclave (Griffin 1989:29)
During the 1970s and '80's the zone functioned as an enclave quite distinct from
the heavy industry push of the state and/ or the local production o f the domestic
firms. Therefore, outside o f its employment effects, the zone had little impact on
the economy.
Malaysia's zones in the early 1980s accounted for only 2% of total
employment (Maex 1983:34). Zones do nevertheless, play an important role in the
Malaysian political economy. In 1985 Malaysia became the "preeminent Asian
location for assembly o f U.S. semiconductors, followed by the Philippines, Korea
and Taiwan" (Grunwald and Flamm 1985:75). The electronics industry was
Malaysia's "main stimulus for growth" in manufacturing during the period 1981-
1985 due largely to foreign investment in the free trade zone (Malaysia 1986:334).
Zone products made up 40.9 % of total exports in 1979, and "since their
establishment EPZs have accounted for at least 60% of the manufacturing
employment expansion in Malaysia" (Maex 1983:18, 34). By 1989, total zone
employment equaled 80,800. Combined FTZ and LMW employment comprised
roughly one-quarter o f total manufacturing employment (USDOL/BILA
1990:139).
The importance of the zone is underscored by the structural weakness of
the economy. Despite the structural change which occurred in the Malaysian
economy in the twenty years between 1965-85, the country's industrial base
remains shallow (MPPP 1986:52). Job growth in manufacturing came largely from
the foreign sector in a single industry. With this in mind, and given the poor state
o f the economy in the mid-1980's, the Malaysian Industrial Development Authority
under the auspices of the United Nations, prepared an Industrial Master Plan
(IMP) that was issued in 1985. The IMP recommended
rationalizing protected import-substituting industries,
diversifying and deepening export-oriented industries,
pushing modem manufacturing beyond the [zone] enclaves,
and stimulating spin-off industries. (Machado 1992:5)
Within the zone the state can lay the groundwork for more dynamic
economic growth. In the cases of both Singapore and South Korea, state
managers took initiative and made concessions to allow wages to rise in the zone,
upgrade the labor force and promote upstream integration (Basile and Germidis
113
1984:59). Similar trends were observed in the Taiwanese case as well, where state
managers took actions to "move towards specialisation in activities with a high
technology content" (Basile and Germidis 1984:60).
Power and Information Asymmetries
The exclusion o f the domestic private sector during the promotion of
manufacturing for export and the obstacles facing their production efforts under
the ICA, resulted from efforts to "circumvent existing Chinese interests" (Doner
1991:106) Significant opportunities exist to further deepen the industrial base if
the state in alliance with domestic private industries can formulate an appropriate
policy environment (Doner 1991:125, 229).
Decision making Tree and Associated Payoffs
In 1986 the Promotion o f Investment Act was introduced. This policy
offered tax holidays and investment tax credits to small domestic firms for the first
time. Fong notes that
Up until 1986, the tax incentives have tended to favour
large-scale enterprises because they were linked to the size
o f investment and employment. (Fong 1990:85)
With the new legislation state managers seem to have come to the
realization of the importance of a dynamic small business sector to the growth of
the economy. Overall, because of the labor-intensive nature o f this sector, it
provides more employment opportunities than the large multinational electronics
firms. Therefore, rather than continuing to pursue the expansion o f assembly
114
operations in the zone, integrating these firms into the domestic economy provides
the greatest long-term benefit (Grunwald and Flamm 1985:247).
Doner shows in his study of the Malaysian automotive industry that to gain
leverage against MNCs and to avoid serious distortions in a particular industry, the
state needs input from domestic producers. This cooperation between the state
and the domestic private sector occurred for a short time in the automotive sector
leading to the designation of "Malaysia Inc" (Doner 1991:99, 104, 112). It is only
this cooperation which enhances domestic bargaining power and makes real the
potential linkages and technology transfer which MNCs offer.
Diagram 5.3 Decision making Tree with a Developmental Strategy
State
M NC
DFIRM
State
M NC
Node
#1
Incentives
Node #2
Node #3
D
4
Node #4
Node
#5
No Incentives
Node
#6
Node #7
Node
#8
(D) represents the state's new developmental activities that it previously did not
have the will or economic resources to pursue. This game is also notably different
in the inclusion of domestic firms that state developmental activities promotes.
For example, due to conditions in the global market, and with the
assistance of the Penang Development Corporation, in the late 1980s local
115
sourcing of components and training workers for more highly skilled positions
began to take place to a limited degree in the Bayan Lepas zone. While the zone
does seem to finally be stimulating some industrial deepening, the instability of
world demand and/or the provision o f even cheaper labor in other countries makes
long run dependence on this source o f industrial maturation particularly
problematic (Wong 1990:114-16).
A World Bank study completed in the late 1980s suggested that the factors
which allowed for the expansion of semiconductor exports from Malaysia in years
past simply did not exist anymore. New opportunities for growth exist, but
these require building on strategic advantages, [and]
inducing a new round of major investments in plant and
equipment... what is clear is that simple provision of an
undistorted location in Free Trade Zones and an abundant
supply of relatively skilled but cheap labor will no longer be
a sufficient guarantor o f exporting success. (World Bank
1989:102)
Specific recommendations included inducing firms to 1) invest in new products of
greater value and quality, 2) exploit Malaysia's comparative advantage in electronic
testing, and 3) develop niche products for Singapore’ s related industries (World
Bank 1989:102).
The state could also expand the economic benefits o f multinational
companies by tying incentives to foreign firms with some or all o f the following
criteria: the amount of foreign exchange created; the number and type of new jobs
created; the percentage of local parts, marketing and services in exported products;
the value of subcontracts to the economy; and the number of trained employees the
firm provides. Only a dynamic export sector with linkages can positively impact
116
the rest of the economy. Anything else either has no impact or negatively affects
the larger economy by using up resources (Griffin 1989:76).
Payoffs
Given that no historical precedent exists for the Malaysian state's venture
into developmental activities, it is difficult to assign payoffs to the various actions
However, some indications can be gleaned from the following example. After
relaxing equity requirements on small and medium-sized firms and offering new
incentives for upgrading technology and training during 1986, domestic investment
surged (Wong 1990:115; Doner 1991:254). By 1988-89 the growth in private
domestic investment in manufacturing outpaced foreign investment (Wong
1990:115). So the payoffs to the developmental strategy, although it is too soon
to predict with any certainty appear to be quite large indeed.
Outcomes
Certainly the use of the game model has involved some simplifying
assumptions. However, the case study suggests that when state began to offer
incentives to domestic firms they responded enthusiastically. As the recession
abates for Malaysia in the late 1980s and the economy revives in the 1990s will the
new policies toward small and medium-scale domestic firms last? Furthermore,
will the centralization of power that occurred under Mahathir enhance or diminish
developmental objectives?
Tolerating a sub-optimal policy towards manufacturing while promoting
the primary and secondary sectors for political purposes may have worked for as
long as oil revenues and other primary products commanded a high price on the
world market. Clearly those days are now past and state managers risk a lot by
failing to further diversify the Malaysian economy with proper incentives to
domestic producers regardless of size.
118
Table 5.4 Periodization of Malaysian Political Economy 1957 - present
State Strategy LAISSEZ FAIRE
1957-74
RENT-SEEKING
1975-85
DEVELOPMEN
TAL 1986-
present
econ. conditions good prices for
Malaysian primary
products and off
shore sourcing of
MNCs, late 1960s
unemployment
rising in urban
areas
early '70s rise in
prices o f all
primary
commodities,
world recession
1979-82 causes
price declines for
all major exports
including ICs,
massive layoffs
1984-85
cooperatives
failure (1986),
high
unemployment
amongst new
graduates, new
investment from
Taiwan, Korea
and Japan (1988)
policy Investment
Incentives Act
(1968), NEP
(1971), Free
Trade Zone Act
(1972)
Industrial
Coordination Act
(1975)
Industrial Master
Plan (1986),
Promotion of
Investment Act
(1986)
agents & their
objectives
state: maximize
growth and
exports, firms:
increase
profitability
state: maximize
employment for
Malays,
nationalize
primary sector,
firms: increase
profitability and
avoid ICA
regulations
state: maximize
technology
transfer, integrate
production of
foreign and
domestic firms,
firms: increase
profitability
alliances state, foreign
firms, large
Chinese
conglomerates
state, foreign
firms
foreign and
domestic firms
with state as
catalyst
outcomes growth in
economy but
firms do not
provide enough
jobs to keep up
with the demand
large domestic
firms invest in real
estate speculation
and finance while
avoiding
manufacturing
long-run
expansion in
diversified
economy,
employment
119
PART III LOOKING AHEAD
Chapter 6 Conclusions
INTRODUCTION
This work has attempted to reveal the constellation of political forces that
determine and implement policy in Malaysia. This work complements recent
works by Bowie (1991), Jesudason (1989) and Jomo (1986) that seek to
understand broadly Malaysia's post-Independence political economy. However,
this work is unique in its synthesis o f three bodies of literature: the literature of
economic development, the emerging literature on the political economy of
development and the developmental state, and the policy studies literature.
While focusing on the domestic influences on growth and change in the
Malaysian economy, this work maintain the importance of international political
economic factors in shaping the policy choices of state managers. The models
utilized herein suggest that macroeconomic shocks can fundamentally alter state
strategies: such as the rapid increase in oil prices in the early 1970s, and the world
recession o f the early 1980s.
Whereas the elaboration of the agents' motives, actions, and outcomes of
events in "a zone game" reflects a respect for rational choice theorizing, these
models also reveal that agents make such choices within institutional constraints.
In the Malaysian context some of these constraints are revealed in the "ethnic
formula" embodied in the constitution, and laws that affect firms and labor that
have not been fundamentally altered since British rule.
120
! Like other zone studies, this work suggests that the Bayan Lepas
t
experience included both successes and failures. The creation o f a large number of
:
jobs in a relatively short period did attenuate some regional unemployment
i .
problems. More importantly it provided opportunities for rural Malay households
| whose rising aspirations in a less than dynamic economic environment, threatened
the legitimacy of the Malay dominated state. At the same time, the state's focus on
attracting foreign investment to the zone and the generous incentives it offered
! foreign firms, provided few opportunities for the better educated and more highly
skilled non-Malays in Penang. As a result they migrated in large numbers to the
j capital city and beyond to Singapore taking their skills with them. Meanwhile the
1 zone contributed only marginally to the accrual o f foreign exchange and the
transfer of technology to domestic firms.
Modeling the zone policy within a game framework has made sense of
what economists dismiss as politics, or reduced what econometricians dismiss as
"noise.” The state's continued subsidy of foreign firms in the zone, behavior that
initially appeared irrational or short-sighted, makes sense when we are sensitive to
the political economic context that imposes both domestic and international
constraints within which state managers make choices.
The game framework in this study is indeed schematic and used primarily
as an organizing device to understand the variety of interests in the zone and the
expected payoffs to players. Nonetheless, even these simple models are an
advance on previous zone studies which did not clearly elaborate the varied
interests of societal agents, or suggest the evolution of power in these relations and
121
the policy process The elaboration o f political costs and benefits incurred by the
state in the policy process is an advancement as well
W hat explains shifts in state strategy?
Changes in the international political economy are reflected in the state's
shifting strategy. In the case o f a transition from a laissez faire strategy to the
more interventionist rent-seeking state, the civil disturbances o f the late 1960s and
the rise of "ethnic chauvinism" amongst some political leaders provided the
justification while the windfall o f oil revenues provided the means Therefore, the
state was able to set out on a fundamentally different course buying up formerly
foreign held interests in the primary sector, and beginning new import-substituting
ventures.
The world recession o f the early 1980s began to really affect Malaysia
during the period 1984- 86. At the same time many of the state's import-
substituting ventures were proving to be very expensive indeed. Malaysia's foreign
debt rose to an all time high Restructuring efforts of the NEP were set aside until
the economy improved and gradually the state seemed to be altering its historical
bias towards large, foreign-owned firms by offering incentives to small and
medium sized domestic firms.
PROSPECTS
In the late 1980s and early 1990s Malaysia was again experiencing an
investment boom primarily from the Newly Industrialized Countries (NICs). It is
in these times o f increasing foreign investment in the economy when the state
122
experiences the most favorable bargaining position vis-a-vis MNCs. Like the
commodity boom in the early 1970s, the state is again in a position when it can
push its own agenda.
But will the state's agenda continue to include providing incentives to
domestic firms and otherwise promoting linkages and technology transfer between
multinational and domestic firms? Fong warns that policy efforts aimed at small
and medium-sized businesses have only been coherent in recessionary times (Fong
1990:127). Will the state stay on its developmental course and if so what are the
long term costs and benefits o f this strategy?
POLICY
The developmental state in Malaysia is certainly a new phenomena.
Comparing it with the Taiwanese state gives a sense o f these differences. Whereas
the Taiwanese state backs widespread education and training programs, Malaysia's
educational program on the other hand, has been mired in ethnic politics divided by
the language question and fixing racial quotas in existing institutions. And whereas
the Taiwanese made a concerted effort to promote linkages between foreign and
local firms, indifference characterized the Malaysian state's "response to creating
linkages between booming foreign electronics firms and the local electrical sector"
(Lubeck 1992:195).
The Taiwanese approach to foreign investment in their economic zones
suggests a long-term vision in which foreign firms played a less significant role.
Whereas, with the implementation of the Industrial Coordination Act (ICA), the
Malaysian state effectively denationalized downstream industries (Lubeck
123
1992:196), and enhanced dependence on foreign manufacturing firms and their
suppliers.
These differences in policy and outcome can be traced to the political
economic environments in which the policies were implemented. Taiwan's
authoritarian state faced few challenges from internal sources in the mid-1960s.
The perceived threat to the policy process and successful economic expansion
came from the mainland. The people could be rallied in light o f the messianic
mission of the Gumindong state. Furthermore, Taiwan’s strategic geopolitical role
in the Cold War resulted in military and economic ties with the United States that
secured a level of growth and security.
In Malaysia the zone was introduced at a time when the legitimacy of the
coalition type government and the Malay-led state was at an all-time low.
Quick economic expansion was essential if the Ruling Alliance was to maintain its
position vis-a-vis opposition parties. But the economic expansion would not
politically benefit the Malay leadership if it disproportionally benefited the Chinese
who traditionally controlled the economy. Therefore the state turned to the
foreign sector to enhance its legitimacy through economic expansion and
redistribution to the Malays.
If in the post-NEP era the state is willing to embrace the ideal of a multi
ethnic Malaysia, it will be in a position to maintain a developmental strategy.
Given the recent growth of investment in the economy, the state is in a position to
promote joint ventures, to push for local content requirements, and encourage an
assertive attitude on the part o f domestic firms. The state should continue to
encourage private think tanks and university research units to work with the
124
private sector. In the spirit of development and cooperation, the domestic private
sector can assist the state's gatekeeper role, by providing technical expertise in the
assessment of potential up and down stream linkages and opportunities for
technology transfer.
FURTHER INQUIRIES
As new and additional investment from the NICs settles in Malaysia it
would be interesting to track this movement to discover to what extent it links
with existing zone investment. Does this new investment encourage the type of
transfer o f technology from MNCs in the zone to domestic firms as originally
conceived in the zone policy? What state actions accelerate the transfer of
technology? Does zone labor have increased bargaining strength given the
increased demand for labor, and if so, how does this change the zone game? These
questions arise naturally from this study and point to interesting and pertinent
extensions of the analysis provided herein.
125
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APPENDIX 1
SELECT LIST O F EPZS IN ASIA
COUNTRY #EPZs YEAR
HONGKONG
INDIA
INDONESIA
MALAYSIA
PHILIPPINES
SINGAPORE
SOUTH KOREA
TAIWAN
THAILAND
8
14
12*
1965
1965
1974
1973
1972
1973
1974
1978
1973
1967
1972
1973
1974
N.A.
1966
1970
1971
1987-92
*These zones are in the formative stage Sources: Sassen 1988:123; Warr 1983;
Thailand: Office of the Board of Investment 1990.
142
APPENDIX 2
COMPOSITION OF MALAYSIAN STATE, 1986
General Government
Federal Government
13 State Governments
4 Local Governments: Penang, Ipoh, Kuala Lumpur, Malacca
Non-Financial Public Enterprises
National Oil Corporation (PETRONAS)
National Corporation (PERNAS)
Telecommunications Department*
Urban Development Authority (tJD A)
Malaysian Airline System (MAS)*
Malayan Railway*
Malaysian Highway Authority (LLM)
Malaysian International Shipping Corporation (MISC)
Perbandanan Nasional Shipping Line (PNSL)
Malaysia Shipyard and Engineering (MSE)
Sabah Shipyard
Penang Port Commission (PPC)
Port Authorities: Kelang, Kuching, Bintulu, Johor, Rajang, Sabah
National Electricity Board (NEB)
Sabah Electricity Board (SEB)
Sarawak Electricity Supply Corporation (SESCO)
Sabah Energy Corporation
Sabah Gas Industries
Heavy Industries Corporation of Malaysia (HICOM)
Cement Industries of Malaysia (CIMA)
Perak Hanjoong Cement
Kedah Ce ment
Cement Manufacturers (Sabah)
Cement Manufacturers (Sarawak)
Federal Land Development Authority (FELD A)
Malaysian Rubber Development Corporation (MARDEC)
Sabah Forest Industries
Food Industries of Malaysia (FIMA)
♦Slated to be privatized. Source: Fifth Malaysia Plan 1986-89:225.
APPENDIX 3
VALUE OF MALAYSIAN EXPORTS, 1975-90
(mil. M$)
YEAR 1975 1980 1985 1990
RUBBER 2026 4618 2864 2930
TIN 1206 2505 1595 763
SAW LOGS 670 2617 2667 2274
SAWN TIMBER 441 1178 1020 968
PALM OIL 1320 2515 3944 4845
PETROLEUM 861 6709 8970 7613
MANUFACTURES 1978 6270 12229 17365
OTHER 730 1313 4805 5536
TOTAL 9232 27725 38094 42294
18000
16000
14000
12000
10000
8000
4000
2000
1975 1980 1985 1890
SAWN
TIMBER
TIN
SAW LOGS
RUBBER
PALM OIL
# OTHER
- I PETROLEUM
• ------—MANUF.
-an
other includes natural gas, coca, copper, pepper and other exports.
Source: Jomo et al. 1987:31; 5MP 1986:70.
APPENDIX 4
MALAYSIAN POPULATION BY STATE AND ETHNIC GROUP, 1980
STATE MALAY CHINESE INDIAN OTHER TOTAL
JOHORE 898499 628937 103328 2465 1633229
KEDAH 802429 208428 86612 18671 1116140
KELANTAN 830337 47911 6716 8789 893753
MELAKA 249273 1766673 35561 3247 2054754
N. SEMBILAN 264968 209743 97121 1746 573578
PAHANG 532112 209631 55360 1679 798782
PERAK 808184 737234 255595 4185 1805198
PERLIS 116082 25765 4231 4198 150276
P. PINANG 312520 521455 109384 11279 954638
SABAH 838141 163996 5613 3296 1011046
SARAWAK 905800 385200 3300 133300 1427600
SELANGOR 671063 567474 269386 7613 1515536
TERENGGANU 510065 26693 2675 1194 540627
TOTAL 7739473 5499140 1034882 201662 14475157
% 53.47 37.99 7.15 1.39 100
ETHNIC CONFIGURATION OF PULAU PINANG 1980
CHINESE 54.62%
INDIANS 11.46%
OTHER 1.18%
MALAYS 32.74%
SOURCE: 1980 CENSUS as cited by Karim 1989.
145

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Asset Metadata

Creator Lemay, Carmen Sue Barker (author)

Core Title The articulation of state and foreign capital in an export processing zone: The case of Bayan Lepas, Malaysia

Degree Doctor of Philosophy

Degree Program Political Economy

Publisher University of Southern California (original), University of Southern California. Libraries (digital)

Tag economics, general,OAI-PMH Harvest

Language English

Contributor Digitized by ProQuest (provenance)

Advisor Dymski, Gary A. (committee chair), Kim, Eun Mee (committee member), Robinson, Michael (committee member)

Permanent Link (DOI) https://doi.org/10.25549/usctheses-c20-285766

Unique identifier UC11259303

Identifier DP23389.pdf (filename),usctheses-c20-285766 (legacy record id)

Legacy Identifier DP23389.pdf

Dmrecord 285766

Document Type Dissertation

Rights Lemay, Carmen Sue Barker

Type texts

Source University of Southern California (contributing entity), University of Southern California Dissertations and Theses (collection)

Access Conditions The author retains rights to his/her dissertation, thesis or other graduate work according to U.S. copyright law. Electronic access is being provided by the USC Libraries in agreement with the au...

Repository Name University of Southern California Digital Library

Repository Location USC Digital Library, University of Southern California, University Park Campus, Los Angeles, California 90089, USA