Fundamental drivers of the FDI inflows in Malaysia and long-term structural reforms

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FOREIGN direct investments (FDI) are an injection of resources from the rest of the world into a country.

FDI usually brings new technology and forms of organisation, thus promoting growth and economic progress. Nonetheless, Malaysia was among the Asean countries leading in attracting FDI, illustrating an overall success story over the past decades.

However, Malaysia demonstrated a reversal of this behaviour in the period preceding the pandemic, with a significant decline in these flows, thus agitating the economic and political debate following these adverse outcomes.

This raised the pressure on the government to focus on its responsibility in creating an efficient and viable environment as well as tailored incentives to stimulate FDI.

The recent data released by the Deaprtment of Statistics Malaysia showed a new high in FDI reached in 2021, with RM48 billion in monetary terms, reigniting the debate about the government’s merits and demerits in attracting foreign investment and investors.

The graph above shows the FDI measured in real terms (at constant prices), apart from the 2009 international financial crisis that bent the trend of FDI and reduced the economy’s growth.

It clearly shows the two distinct periods of positive FDI trend - with 2001-2007 signifying a more substantial upswing while 2011-2016 seeing a more moderated one.

However, given the fact that Asean FDI was on the rise, 2017-2019 appear with an odd perception.

As a result, it has sparked debate and criticism of the government, given that the sharp decline in FDI was unjustifiable.

The general academic explanation of FDI is based on a series of push and pull factors, but no one-size-fits-all model applies.

Both macro and micro perspectives in extensive studies focus on structural characteristics of the economy, like natural resources, market size, infrastructure, the openness of the economy, labour productivity, human capital, operating costs, and financial determinants like interest rate, exchange rate, and inflation.

The micro aspects added to the explanation are typically qualitative in nature, focusing on proactiveness and effectiveness in dealing with attraction related to the host country’s offers and policies.

Nevertheless, the general perceptions of corruption and political stability also play a critical role in building the investors’ confidence.

In short, the investors are typically clear about the objectives, and the attraction stems primarily from the rent seek benefit enabled by the host country.

To understand better the prevalent nature of the FDI determinants in Malaysia, we conducted an econometric analysis, contrasting two different approaches within the eclectic theory of Dunning.

The theory was inspired by the belief that investors were meant to benefit from the host country’s market, resources, efficiency, and strategic assets.