Phase I: From Merdeka to the May 1969 Riots

At independence, economic conditions in Malaysia (then the Federation of Malaya² ) appeared conducive to rapid growth. The colonial inheritance included a well-developed infrastructure, an efficient administrative mechanism and a thriving primary export sector with immense potential for expansion. In terms of per capita income, literacy and health care, Malaysia was well ahead of most of its neighbors. Even though population growth was already very rapid, the highly favorable ratio of land and other natural resources to total population offered great potential to raise income per head (Athukorala and Menon, 1997).

Despite these favorable economic conditions, building the new independent Malaysian economy proved challenging nonetheless, as it had to be done under the sometimes conflicting goals of preserving ethnic peace and pursuing economic growth. At the time, the Malays accounted for about 52% of the population and dominated politics, but they were relatively poor and were involved mostly in low-productivity agricultural activities.³ The ethnic Chinese, on other the other hand, accounted for about 37% of the population, but enjoyed greater economic power and dominated most of the modern-sector activities. Thus, in postindependence Malaysia, economic policymaking, especially macroeconomic management policy, turned out to be a continuing struggle to achieve development objectives while preserving communal harmony and political stability.

Government policy during this early post-independence period is perhaps best described as a “holding” program, designed to suppress simmering inter-communal rivalries. The policy thrust was to continue with the colonial open-door approach relating to trade and industry policy, while addressing ethnic and regional economic imbalances through rural development schemes and the provision of social and physical infrastructure. Like in many other developing countries, import-substitution industrialization was on the policy agenda in Malaysia during this period. However, unlike in other countries, attempts were not made to achieve “forced” industrialization through direct import restrictions and the establishment of state-owned industrial enterprises.

Snodgrass (1980, p. 206) ascribes this policy neutrality to the influence of advice from a major World Bank mission to Malaysia in 1954. There are, however, two other factors which might have been at least as influential in determining the direction of Malaysian policy. First, Malaysia enjoyed a sound balance of payments position (due mainly to booming rubber and tin exports) for most of this period, and hence felt no compulsion to resort to stringent import restrictions. Second, the ethnic tension that existed between the Malay political leadership and the Chinese business community may have held back any concerted effort to promote local industry through trade protection and other means of direct government involvement (Leigh, 1992). The industrialization strategy of the Malaysian government at the time was largely a “promotional effort, geared to the provision of an investment climate favourable to private enterprise, especially to foreign private enterprise” (Wheelwright, 1993, p. 69). Very few industries enjoyed nominal tariffs of more than 30% and non-tariff barriers were almost non-existent (Alavi, 1996, p. 70).

The counterpart to a liberal trade regime was a receptive environment for foreign direct investment (FDI). Even in the 1950s and 1960s, when distrust of FDI and multinational corporations held strong sway in the developing world, Malaysia had a relatively open and welcoming policy (Athukorala and Menon, 1995). The policy regime relating to purely financial flows was more restrictive—a historical conservatism that may have underwritten, to some extent, future policy choices. Nevertheless, even in the non-FDI sphere, Malaysia’s policy regime throughout the post-war period was much more liberal than in most other developing countries (Williamson and Mahar, 1998). In terms of monetary policy, this period was typical of the general approach taken by the Central Bank, the Bank Negara Malaysia (BNM), which is one of minimal intervention. For the most part, BNM has been mainly focused on ensuring stable interest rates and has not often used its instruments to conduct counter-cyclical policy (Ariff, 1991).

By the late 1960s, there was growing recognition that the so-called easy stage of importsubstitution industrialization was coming to an end, and that future prospects for industrial development would require the expansion of export-oriented industries. Through the enactment of the Investment Incentives Act in 1968, policy shifted to promoting export-oriented activities, especially through FDI. The Act offered a rich assortment of incentives to exportoriented FDI, including exemptions from company tax and duty on imported inputs, relief from payroll tax, investment tax credits, accelerated depreciation allowances on investment, and some tariff protection (but not non-tariff barriers). In 1970, new legislation provided for the establishment of special export processing zones.

Economic growth during 1957 to 1969, although respectable, failed to make a substantial contribution towards improving the economic status of the Malays. At the same time, with rising urban unemployment and education and language again looming as issues, non- Malays began to question the extent to which their interests were being safeguarded in the new Malaysia. The growing disenchantment among all segments of the population ultimately erupted in the bloody communal riots of May 1969. This event resulted in a reassessment of economic and development policy in order to explicitly deal with economic imbalances along racial lines

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