Malaysian industrialization and the global factory - Articles

Malaysia’s economic transformation over the past half century has been dramatic. The country has rapidly transitioned from an economy based on rubber, tin, and other resource-based sectors to export-oriented manufacturing centred on electronics and related sectors. This transformation has been driven by a combination of fundamental changes in the organization of global manufacturing activities, sometimes referred to as global production sharing (GPS), and the country’s successful record of adapting to and participating in this new industrial order. This article examines the origins of GPS, Malaysia’s successful participation in it, and the challenges ahead.

The rise of global production sharing

The most important international industrial organization innovation over the past half century is the vertical disintegration of production, with separate stages carried out in different countries, widely known as GPS. This has replaced the fully integrated, single-country, and typically single-firm, production process with decentralized multi-country operations in which the production process is ‘sliced up’ into separate, highly specialized and tightly integrated supplier networks. Particularly in the electronics, automotive, machinery, and precision-goods industries, it is now common for the final assembled product to consist of components produced in several countries.

The cross-border dispersion of production processes is generally organized by large multinational enterprises (MNEs) with subsidiaries or long-term subcontractors in the producing countries. The location of these various suppliers is primarily market-driven: simple, labour-intensive activities are found in lower-wage economies; R&D-intensive activities are located in countries with the necessary scientific base; while final assembly typically occurs in countries that can manage large-scale, diverse production activities for export to the rest of the world.

GPS is not a new phenomenon. There is ample anecdotal evidence of evolving trade in parts and components within branch networks of MNEs dating back to the early 20th century. What is unprecedented about the contemporary process of GPS is its wider and ever-increasing product coverage, and its rapid spread from mature industrial countries to developing countries. Over the past four decades or so, production networks have gradually evolved, encompassing many countries and spreading to many industries such as sporting goods, garments, footwear, automobiles, televisions and radio receivers, sewing machines, office equipment, electrical machinery, machine tools, cameras, watches, light-emitting diodes, solar panels, and surgical and medical devices. In general, industries with the potential to break up the production process without significantly increasing transport costs are more likely to move to peripheral countries. From about the late 1970s, there were two other important developments in the process, setting the stage for the rapid expansion in the share of fragmentation-based trade in world trade.

First, as an outcome of advances in modular production technology, some fragments of the production process in certain industries have become ‘standard fragments’ that can be effectively used in several products. Examples include long-lasting cellular batteries, originally developed by computer producers and now widely used in cellular telephones and electronic organizers; transmitters, which are now used not only in radios (as originally designed) but also in personal computers and missiles; and semiconductors, also called integrated circuits or chips, which have spread beyond the computer industry into consumer electronics, motor vehicle production, and many other product sectors.

Second, there has been a rapid expansion of the coverage of global assembly operations from component production and assembly to assembly of final products such as computers, cameras, TV sets, motor cars, and medical devices. In final assembly, labour costs, while significant, are of secondary importance compared with the availability of world-class operators; technical and managerial skills; a good domestic basis of supplies and services; relatively free access to world-priced inputs, including capital; and excellent infrastructure.

The resulting global manufacturing value chains (GMVCs) are complex and diverse cross-border trading arrangements, ranging from arm’s-length, one-off commercial transactions through to long-term, vertically integrated, intra-firm transactions. In terms of the organizational structure of production sharing, GMVCs take two major forms: buyer-driven production networks and producer-driven production networks. Buyer-driven GMVCs are common in consumer goods industries with relatively standardized technologies, such as clothing, footwear, travel goods, and toys and sporting goods.

Penang leading Malaysia's global manufacturing value chain.
Source: Wikipedia, 2024

The ‘lead firms’ in such production networks are the international buyers: large retailers such as Walmart, Marks & Spencer, H&M, or brand manufacturers such as Victoria’s Secret, Gap, Zara, Nike, Adidas, Calvin Klein, and more recently Shein. Production sharing within them takes place predominantly through arm’s-length relationships, with global sourcing companies— value-chain intermediaries—playing a key role in linking producers and lead firms. Therefore, there is room for local firms to directly engage in export through links established with foreign buyers, without the direct involvement of foreign investors. If foreign investors are involved, usually it is through joint ventures with local entrepreneurs, rather than by forming fully owned subsidiaries. The lead firm monitors input procurement, but there is room to use domestic inputs that meet the quality standards.

Producer-centred GMVCs are common in vertically integrated global industries such as electronics, electrical goods, automobiles, and scientific and medical devices. In these networks, the ‘lead firms’ are MNEs, such as Intel, Motorola, Apple, Toyota, and Samsung. Global production sharing takes place predominantly through the lead firms’ global branch networks and/or their close operational links with established contract manufacturers that undertake assembly for these global corporations. In these high-tech industries, production technology is specific to the lead firm and is closely protected to limit imitations.

Further, the production of final goods requires highly customized and specialized parts and components, whose quality cannot be verified or assured by a third party. Therefore, the bulk of global production sharing takes place through intra-firm linkages rather than in an arm’s-length manner. As the production unit becomes well established in the country and forges business links with private- and public-sector agents, arm’s-length subcontracting arrangements for components procurement could develop, depending on the conduciveness of the domestic business climate. However, the overall production process continues to be governed by the lead firm.

H&M Store in Putrajaya, Swedish brand with product manufacturing in Bangladesh and China.
Source: IOI City Mall, tenant listing: https://www.ioicitymall.com.my

The expansion of global production sharing has been driven by three mutually reinforcing developments.

First, rapid advancements in production technology have enabled industry to slice up the value chain into finer, ‘portable’ components. Advances in modular production technology have made some components of the production process in certain industries ‘standard fragments’, which can be effectively used in several products.

Second, the ‘death of distance’—the declining costs of international transport and telecommunications’—has also been crucial. Technological innovations in communication and transportation have shrunk the distance that once separated the world’s nations, and improved the speed, efficiency, and economy of coordinating geographically dispersed production processes. This has facilitated, and reduced the cost of, establishing ‘service links’ needed to combine various fragments of the production process across countries in a timely and cost-efficient manner.

Third, liberalizing policy reforms across the world over the past four decades have considerably reduced barriers to trade and foreign direct Investment. Trade liberalization is far more important for the expansion of GPS trade compared to the conventional horizontal trade. This is because a slice/task of the production chain operates with a smaller price-cost margin, and the profitability could be erased by even a small tariff. To operate effectively, these global networks require a liberal business environment for all participating firms; they especially require the unhindered movement of goods across international boundaries. Participating countries also need to be signatories to the WTO Information Technology Agreement (ITA) and similar trade-facilitating measures.

Measuring the dimensions of global trade

We have measured the international dimensions of trade within GMVCs (‘GMVC trade’) since the late 1980s using the United Nations Standard International Trade Classification system (SITC) Revision 3. This allowed the delineation of GMVC trade from total manufacturing trade, while separating GMVC trade into trade in final (assembled) goods and parts and components used in their production. It is important to note that parts and components, as defined here, represent only a subset of intermediate goods, even though the two terms are often used interchangeably in recent literature. Parts and components are inputs that are employed further along the production chain. Unlike standard intermediate goods—such as iron and steel, industrial chemicals, or coal—parts and components are relationship-specific inputs. In most cases, they lack reference prices, are not traded on open markets, and require more complex contractual arrangements.

SITC classification at the five-digit level permits the identification of parts and components within total manufacturing trade, defined as products belonging to SITC sections 5 to 8 less SITC 68, non-ferrous metal. Guided by the existing literature on production sharing, the following 11 product categories were identified to approximate separated GPS trade into final assembly and parts and components:

office machines and automatic data processing machines (SITC 75);
telecommunications and sound recording equipment (SITC 76);
electrical machinery (SITC 77);
road vehicles (SITC 78);
other transport equipment (SITC 79);
travel goods (SITC 83);
clothing and clothing accessories (SITC 84);
footwear (SITC 85);
professional and scientific equipment (SITC 87);
photographic apparatus (SITC 88); and
toys and sporting goods (SITC 894).

It is assumed that these product categories contain virtually no items produced entirely within a single country. Among these, SITC 83, 84, 85, and 894 are primarily traded through buyer-driven production networks, while the remaining categories are associated with producer-driven production networks. Trade in final assembly is approximately estimated as the difference between reported trade in these 11 product categories and parts and components specifically assigned to them. Total GMVC trade is the sum of estimated final assembly and total parts and components.

Malaysia’s role in global production sharing

Southeast Asia has been a global leader in the evolution of GMVCs. The region’s engagement in global production networks began with Singapore’s decisive embrace of the ‘MNE-led development strategy’. Singapore’s strategy was well timed: semiconductor producers in the US were then just beginning to shift labour-intensive production processes within the electronics industry. Until about the late 1980s, Singapore’s specialization within GMVCs was heavily concentrated in semiconductor assembly and testing, and parts and components assembly of consumer electronics and electrical goods.

But as Singapore upgraded, the labour-intensive segments of the industry began to relocate to neighbouring countries, initially mainly to Malaysia, where the state government of Penang had been proactively courting MNEs since the early 1970s. Other Malaysian states also attracted export-oriented MNEs, but GMVC-related manufacturing in Malaysia has remained heavily concentrated in Penang. By 2024, about 85 per cent of Malaysian GMVC exports—more than half of total manufacturing exports—came from Penang.

To put the Southeast Asian role in global perspective, exports within GMVCs (‘GMVC exports’) have accounted for over two-thirds of total world manufacturing exports over the past four decades, with producer-driven GMVCs contributing the lion’s share, at over 80 per cent. Specialization in GMVCs has played an even more significant role in the expansion of manufacturing exports from Southeast Asian countries. Total manufacturing exports from the region recorded a 15-fold increase—from $60 billion to $932 billion—between 1989–1990 and 2021–2022, with GMVC exports on average accounting for over 70 per cent.

The region’s share of total world GMVC exports rose from 3.5 per cent in 1989–1990 to 8.4 per cent in 2021–2022. Southeast Asian GMVC exports have increased in all sectors. Particularly notable has been the region’s increased prominence in buyer-driven exports, its global share rising from 6 per cent in 1989–1990 to 17.8 per cent in 2021–2022. Indeed, a key factor behind the region’s export diversity and success is its successful penetration into some of the fastest-growing segments of global trade across a wide range of product categories. For example, Southeast Asia’s share of global exports exceeds 10 per cent in the dynamic trade categories of SITC 75–78 (IT products, electronics, machinery, and so on), SITC 87 (scientific equipment), and SITC 83–85 (garments, footwear, and travel goods).

Malaysia has been a significant GMVC exporter from the 1970s onwards, reaching over $105 billion by the late 2010s. During the past three decades these products accounted for between 75 per cent to over 80 per cent of the country’s total manufacturing exports (Figure 1). Parts and components account for about half of total GMVC exports, although there has been a slight decline in the share over the past decade to 2022. This decline reflects a combination of diversification of the production base to encompass non-GMVC products, and the waning prospects for production within buyer-driven GMVCs and final assembly within producer-driven GMVCs, with the rapid increase in domestic wages.

Figure 1: Malaysia: GMVC engagement and export performance, 1988–2022

Sources of data: UN Comtrade database, https://comtradeplus.un.org/

As an early mover in the 1980s, Malaysia was second to Singapore, contributing about one-quarter of Southeast Asian exports of these products by the end of that decade (Table 1). By the end of the 20th century, Malaysia had overtaken Singapore, which was shifting into service-related activities such as product design and R&D. In 2019–2020 Malaysia accounted for 1.4 per cent of total world GMVC exports, more than double its share in 1979–1980 of 0.52 per cent.

Table 1: Southeast Asian countries: Indicators of export performance within GMVCs

Sources of data: UN Comtrade database, https://comtradeplus.un.org/

In the first two decades of the 21st century, Thailand, and particularly Vietnam, emerged as major players (Table 1). Producer-driven products account for over 90 per cent of Malaysia’s GMVC exports, which are heavily concentrated in electronics and electrical goods (SITC 75, 76, 77). Buyer-driven goods have been relatively unimportant, mainly because Malaysia has always been a relatively high-wage economy, which renders it less competitive in sectors like garments and footwear. Moreover, unlike Thailand, Malaysia missed the opportunity to join the regional automobile network due to its long-standing commitment to developing a national car industry through trade protection and subsidies, without imposing export discipline on its two national carmakers. Penang has continued to be by far the most innovative GMVC centre among the Malaysian states, a role further enhanced in recent years by MNE ‘China + 1’ strategies.

Turning to the role of GPS in Malaysian manufacturing performance, the available production-side data (based on manufacturing surveys) do not permit directly linking network trade with manufacturing performance. A second-best approach adopted here is to delineate the industries in which global production sharing is heavily concentrated—as revealed by the above analysis of trade patterns, referred to here as ‘GMVC-related industries’—and compare their performance with the other non-GPS industries.

The data are compiled from the INDSTAT-4 database of the United Nations Industrial Development Organization (UNIDO), which brings together data from the annual surveys of manufacturing conducted in individual countries under a uniform format at the four-digit level of the International Standard Industry Classification (ISIC). The contribution of GMVC engagement with the process of industrialization is examined in Table 2 with reference to five performance indicators:

share in total manufacturing output (value added);
composition of employment;
average monthly wage;
share of value-added in gross output; and
labour productivity.

The share of GMVC-related industries in Malaysia’s total manufacturing increased from 31.4 per cent to 44.7 per cent between 2010 and 2020, with electronics dominating the product mix. In 2020, electronics accounted for over 70 per cent of output and 75 per cent of employment in GMVC industries. The difference between the two figures supports the view that specialization within GMVCs tends to promote employment generation.

Kulim Hi-Tech Park, Kedah, SilTerra operates Malaysia’s largest semiconductor wafer foundry, jointly owned by Dagang NeXchange Berhad (DNeX) and Beijing’s High-End Equipment Equity Investment Fund.
Source: Google Map: https://www.google.com/maps SilTerra Kulim High-tech Park photos.

Table 2: Key indicators of manufacturing performance in Malaysia, 2010 and 2020

Source of data: UNIDO INDSTAT-4 database, https://stat.unido.org/data/table?dataset=indstat&revision=4#data-browser
Notes: ^aValue added; ^bValue added per worker at current price.

The pessimistic school of thought on national gains from GPS argues that, while this form of international exchange may generate employment in host countries, it often fails to deliver broader income gains. MNEs, as the primary actors in GPS, tend to restrain wage growth in a given production location as part of their broader profit-maximization strategy. Proponents of this view argue that these firms possess the flexibility to relocate production facilities across borders in response to changing labour market conditions, a luxury not typically available to import-substitution MNEs, which are more 'location-bound'. As a result, under stable labour supply conditions, workers employed in export-oriented production sharing ventures are likely to experience slower real wage growth than their counterparts in domestic market-oriented MNE affiliates and local firms.

Yet the data do not support this argument. Wages in producer-driven GMVC-related industries have been significantly higher compared to those in other industries. Labour productivity, measured as value added per worker, is also notably higher in producer-driven GMVC-related industries compared to other manufacturing sectors. Nevertheless, the productivity of total GMVC-related industries is slightly lower compared to the non-GMVC industries because buyer-driven industries tend to exhibit lower productivity levels compared to the average for total manufacturing.

Challenges

Malaysia will continue to be a significant player in manufacturing-based GPS. It has a well-established, and well-deserved, country reputation as an attractive and stable destination for export-oriented manufacturing. However, it remains an open question whether it can sustain past growth rates, for two main reasons. First, at the internation level, trade barriers are rising and China-US economic relations are volatile. To date, at least, global trade flows in aggregate have remained reasonably buoyant. The protectionist rhetoric has not in the main translated into severe trade barriers, especially for the 86 per cent of trade that does not involve the US. But things could change rapidly.

Second, except for Penang, Malaysia has been relatively slow to upgrade its industrial base as it has lost comparative advantage in labour-intensive sectors. It has not yet been able to replicate the earlier experience of Japan, the Newly Industrialized Economies, and more recently China in transitioning to more R&D-intensive activities. A large literature on this issue alleges that an impediment to the diversification into more sophisticated product lines is deeply rooted in the country’s long-standing ethnic-based New Economic Policy of 1971. Of particular importance is the growing scarcity of skilled manpower resulting from the apparent deterioration in the quality of education and the emigration of skilled workers—the ‘brain drain’.

Endnotes:

This article draws from our forthcoming book Revisiting Globalisation: Southeast Asia in the Global Factory (Elements in Development Economics), Cambridge: Cambridge University Press. The book provides a detailed discussion of data sources and methodology, and also includes the many references on which this article has drawn. This book will be available as open access on Cambridge Core.

Readers may also like to refer to Gregg Huff’s EHM article: Malaysia’s electronics industry—Are its best days behind it? https://www.ehm.my/publications/articles/malaysias-electronics-industry—are-its-best-days-behind-it.