Innovation, Growth And Incentives: The Malaysian Example

Author

Capital Flows

February 15, 2017

Donald Trump recently threatened some big car producers (Ford, FAC and Toyota) of big border taxes in case they decided to move or start production plans in Mexico instead of further investing in the United States. The president demonstrated knowledge that our behavior is motivated by rewards and penalties, deciding to focus some of his policies on penalties, rather than rewards. However, convinced by the fact that one of the fundamental lessons of economics is that incentives matter, I believe that the mechanism of rewards might be more effective in driving a new growth trend, focused on profit expectations.

As Schumpeter taught us, economic development is driven by innovation, which manifests itself in the shape of investment. And such investments are, in turn, driven by profit expectations. The lesson to be learned seems straightforward: If you want to see growth, find the way to turn on profit expectations. Still, as the Trump’s case demonstrates, such a lesson only seldom appears to be used by policymakers with growth in mind. Rather, the idea of penalties is often used to halt economic behaviors judged as harmful, while the idea to use incentives to promote profit expectations does not often appear in policy agendas, in particular in the Western world, where profits are often seen as something to punish rather than to promote.

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A different attitude toward profit can be found, instead, in developing countries like Malaysia. After World War II, some developing countries in Southeast Asia realized that investments are key factors for growth, and some of them also understood that private investment needs to be promoted, rather than wasteful public plans. Malaysia is one of the countries that, since the second half of the 1960s, is implementing incentives to promote private investment, both foreign and domestic. Such incentives are mainly oriented to enhance four strategic sectors: manufacturing (broadly intended), agriculture, biotechnology and principal hub (a concept I will clarify).

For both the manufacturing and agricultural sectors, government-identified strategic activities are to be promoted. If incentives matter, and if the main incentive for economic activities is profit, then it is clear that the easiest way to direct investment is to cut taxes. Manufacturing and agricultural companies can apply for pioneer status or for the investment tax allowance. In the first case, taxes are paid, for five years, only on 30% of the statutory income; in the second case, instead, a company is entitled to an allowance of 60% on its qualifying capital expenditure incurred within five years of the first one. More incentives are applied to small-to-medium enterprises, strategic industries such as automotive, or to peculiar activities of food production and agricultural reinvestment.

Malaysian authorities are also very attentive to investment in biotechnology, where incentives can reach a 100% tax holiday for ten years. However, I believe that the most interesting instrument Malaysia was able to develop is the principal hub, defined as a local incorporated company that uses Malaysia as a base for conducting its regional and global businesses and operations to control, manage and support its key functions. The company serving as principal hub is paying taxes of 5-10%. However, here not only does the fiscal incentive play an important role; the key idea is to attract, via the fiscal incentive—foreign investment to be oriented on a regional scale. Indeed, this is making Malaysia a very attractive hub for multinationals, even when compared with neighboring countries like Singapore. In fact, if compared with Singapore, Malaysia presents several advantages, due in particular to the cost of living, which reached unbelievable levels on the Southeast Asia island. Like Singapore, Malaysia can be considered an English-speaking country, with good infrastructure and ability to grant a good standard of living for expatriates. At the same time, for a company it is much cheaper to relocate a high-level manager in Malaysia than in Singapore, where housing, education and healthcare are among the most expensive in the world.

Malaysia, therefore, played a very smart move with the principal hub regulation, trying to develop itself as an attractive hub for multinationals ready to develop a business unit in Southeast Asia. The incentives for the companies are not limited to the tax rate, but they also involve measures for importing raw materials, starting local productions and building offices and warehouses.

If I praised Malaysia for what it has done so far, a black dot remains on the background: the idea that the government, not the market, decides what is strategic, how to create incentives and how to promote growth while promoting investment. Like all the centralized plans, this one is also subject to the classical risks of corruption, inefficiencies and, above all, wrong identification of the real priorities for the countries, which can be properly understood only in a free market system. Still, the idea to promote profit opportunities, rather than punish them, looks in the right direction and deserves greater attention.

Dr. Ferlito is also adjunct professor at INTI International College Subang in Subang Jaya, Malaysia.

 

This article was written by Capital Flows from Forbes and was legally licensed through the NewsCred publisher network.

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