Malaysia Is Winning the U.S.-China Trade War

The drastic depreciation of the Malaysian ringgit, comparable in magnitude to the 1998 Asian Financial Crisis, has spooked many and triggered debates on the nation’s economic performance. External headwinds such as persistent high inflation in the United States, sluggish economic prospects in China, and ongoing geopolitical tensions are significant influencing factors. Still, some see the weaker ringgit as a sign of the nation’s dwindling competitiveness.

That view is overly pessimistic. Key economic indicators are evolving favorably. Headline inflation is declining and unemployment has remained steady at 3.3 per cent since November 2023, returning to pre-COVID-19 levels. If the government can address some of the nation’s systemic structural inefficiencies, it could pave the way for a second economic take-off.

Ongoing competition between China and the United States, compounded by the supply chain disruption witnessed during the pandemic, has spurred both Western and Chinese companies to re-evaluate their sourcing and supply strategies. The “China+1” model and “Taiwan+1” model are direct responses and stand to benefit Malaysia. Intense interest from multinational corporations looking to start or expand manufacturing activities that would have been done in China previously, for example, foreign semiconductor companies looking to invest in Penang, has risen.

The semiconductor industry is a case study of how Malaysia can position itself to take advantage of global trends. During the first economic take-off, the government had the foresight to introduce incentives that attracted specific steps in the semiconductor value chain. Intel opened its first plant in Penang in 1972 and by the early 1980s, there were 14 semiconductor firms operating in Malaysia.

This familiarity led to Malaysia becoming an unexpected “winner” of the geopolitical friction between the United States and China. Semiconductor industry players looked towards Malaysia when it became necessary to relocate other steps in the value chain, placing Malaysia in an excellent position to benefit from the growth of the semiconductor industry. Efforts to create a comprehensive Semiconductor Strategic Plan are headed in the right direction, though it is crucial to incorporate appropriate incentives and create the right business climate to attract high-value operations.

But other Southeast Asian countries are catching up fast. On top of generally cheaper labor, they also offer lucrative incentives to entice companies to invest. For Malaysia to stay competitive, it needs to strengthen its existing semiconductor ecosystem to move up the value chain.

Endeavors such as the formation of the Penang Automation Cluster in the Batu Kawan Industrial Park illustrate strategies aimed at providing one-stop supply chain hubs for multinational corporations. They also enhance knowledge sharing and capacity building for local small- and medium-sized enterprises and supply chain integration. The lower-value tasks that make up most of the sector in Malaysia, such as assembly, packing, and testing, will gradually become automated or are at risk of moving to lower-cost locations.

Structural reforms are needed to strengthen the nation’s fiscal position to promote catalytic investments, build a highly paid and highly skilled workforce, and enhance the overall industrial ecosystems. Thriving industrial ecosystems are a necessary condition to move up the value chain, and also anchor industries in the country. The April 2024 announcement of what will be the largest integrated circuit design park in Southeast Asia is a testament to the government’s ambition.

Another example is Johor — which instead of merely serving as a hinterland to Singapore’s seaport — is ambitious enough to build its own capacity and capture some of the maritime shipping business. In doing so, it increases its economic complexity by diversifying into logistics services and in turn improves the attractiveness of the state to investors. The Port of Tanjung Pelepas’ free trade zone model smooths the shipping trade, and at the same time increases economic development through the provision of ancillary services and support.

But a second take-off will not be achieved through competition alone. Against the backdrop of the U.S.-China trade war, two major free trade agreements were signed and ratified — the Regional Comprehensive Economic Partnership and the Comprehensive and Progressive Agreement for Trans-Pacific Partnership — both of which Malaysia is part of. This underlines the country’s commitment to freer international trade. Prime Minister Anwar Ibrahim’s intention to facilitate discussions on a Malaysia–EU Free Trade Agreement further signals the administration’s ambition to cooperate and partner on a global scale.

More than 140 countries have signed up for the Global Minimum Tax deal, which aims to reduce tax competition between countries. Treaties like these could eventually reshape the flow of multinational foreign investments, and factors like the quality of the workforce and available infrastructure will become more important in investment decisions.

The urgency to address climate change has culminated in various initiatives with potentially global consequences, such as the EU Taxonomy for Sustainable Activities and the ASEAN Taxonomy for Sustainable Finance. It is vital for Malaysia’s industries to implement these international requirements.

Malaysia must act fast. The economy already has the necessary components to move into the production of electric and autonomous vehicles, establish artificial intelligence hubs, build more smart factories, and enhance decarbonization efforts. Malaysia’s mission-oriented approach introduced in its New Master Industrial Plan 2030 showcases a holistic way to guide strategic directions to channel industries’ purposes and trigger innovation that produces solutions with spillover effects for the economy. Penang’s semiconductor supply chain success can and must be emulated in other sectors.

This article was originally published on the East Asia Forum.