Leverage in The Time of Coronavirus

The ongoing coronavirus crisis in China highlights how dependence on foreign inputs can affect export-dependent countries such as Malaysia

China is currently the top foreign input provider for Malaysia’s total imports. (Photo: Martin Cox, Unsplash)

Tham Siew Yean

3 March 2020

The on-going shut-downs in China due to the Covid-19 crisis have led to supply chain disruptions in the export sector in Southeast Asia, including Malaysia. The disruptions underscore how, for many Southeast Asian economies, the dependence on foreign inputs can negatively affect the export sector in these countries.

Manufacturing exports contributed towards 58.4 per cent of Malaysia’s Gross Domestic Product (GDP) in 2018. Data from the World Trade Organization (WTO) indicates the foreign value-added content in Malaysia’s gross exports of manufactures is the highest at 44.5 per cent compared to services (21.5 per cent) and agriculture (16 per cent) in 2015. Within manufacturing, resource-based manufacturing is less dependent on foreign inputs as compared to non-resource based manufacturing. While the share of intermediate inputs in Malaysia’s food imports from the world is 46 percent, it is considerably higher for the imports of electronic components and boards (97 per cent).

The top three foreign input providers for Malaysia’s total imports, are China (20.8 per cent), followed by the United States (10.3 per cent) and Japan (8.1 per cent). In the case of electronic components and boards, all the imports from China are in the form of intermediate goods (97 per cent), while the remaining three percent are capital goods.

Given this trade pattern, diversification in input markets is needed to counter the current supply chain challenges. The Federation of Malaysian Manufacturers (FMM) president Tan Sri Soh Thian Lye, has urged that “Malaysia should look to other Asian countries like Japan, Korea or India, and some European Union countries as alternative sources”.

But diversification in output markets is also equally important in the wake of a slowing down in domestic exports. Gross exports are only increasing because of increasing re-exports. Re-exports are defined as goods taken out of the country in the same form as they were imported, without any transformation. The average re-exports to exports ratio from 1990-2017 is 6 per cent. The ratio has been on an upward trend since the Global Financial Crisis (GFC) in 2009 and has escalated to double-digit growth since 2013. Re-exports are largely fuelled by machinery and transport equipment (MTE) re-exports due to increased transhipment and redistribution activities based in Penang. Domestic exports will doubtless continue to slow down with the weakening of final demand from China due to the Covid-19 outbreak. The ongoing trade war between China and the US is compounding export growth even further.

Policies that promote quality improvements in export management should be prioritized over those that focus on cost reductions

While the government’s recently unveiled stimulus package of RM20 billion provides some relief for the ailing economy that is reeling from external and internal problems, the export sector did not receive any direct fiscal support. This is deemed crucial, as shifting sources of inputs to other countries will undoubtedly increase the cost of production because imports from China are generally the most cost competitive, more so in the face of a weakening ringgit.

In the long term, however, there is an even better way. Instead of adhering to the two-pronged strategy of price competitiveness based on cheap sources of imported inputs and labor coupled to fiscal support, Malaysian manufacturers should think long-term and re-strategise their competitive advantage. Competing based on differences in product quality is more sustainable as cost structures change with diversification in sources of inputs as well as export markets. Policies that promote quality improvements in export management should be prioritized over those that focus on cost reductions. In particular, for exports, international accreditation and certification are acutely important as quality markers, especially for exports to developed economies like the European Union. Securing these accreditations and certifications can be challenging and costly, particularly since they are not one-off endeavors. Additional government support in terms of the provision of information and defraying the cost for first-time efforts can be a better form of assistance. This would help facilitate the much-needed restructuring of the manufacturing sector.

Ratifying free trade agreements such as the concluded Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) will also facilitate the shift in both supply and demand markets for the manufacturers. Similarly, the incoming Regional Comprehensive Economic Partnership (RCEP) agreement will also play an important role in market diversification for inputs and outputs. This holds true, even without India, which has formally withdrawn from the RCEP. The government can also play an important role in educating small and medium enterprises (SMEs) about how to access the gains that accrue from such free trade agreements.

The same applies for other countries in Southeast Asia such as Vietnam, which is facing similar challenges. Leveraging on current disruptions in supply chain to push for restructuring is a better long-term solution than a temporary diversion of sources of inputs and markets. It will create a more sustainable competitive advantage for countries that are willing to bite the bullet of change.

Tham Siew Yean is a Visiting Senior Fellow at the ISEAS – Yusof Ishak Institute and Professor Emeritus, Universiti Kebangsaan Malaysia.

ISEAS Commentary – 2020/23

The facts and views expressed are solely that of the author/authors and do not necessarily reflect that of ISEAS – Yusof Ishak Institute. No part of this publication may be reproduced in any form without permission.