FDI and spillovers: New evidence from Malaysia’s manufacturing sector

• Published date: 01 May 2022
• Author: Miao Zhang,Rui Yang
• Date: 01 May 2022
• DOI: http://doi.org/10.1111/rode.12857

Rev Dev Econ. 2022;26:847–877. wileyonlinelibrary.com/journal/rode

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847

© 2022 John Wiley & Sons Ltd

Received: 19 October 2021

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Revised: 28 December 2021

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Accepted: 3 January 2022

DOI: 10.1111/rode.12857

REGULAR ARTICLE

FDI and spillovers: New evidence from

Malaysia’s manufacturing sector

MiaoZhang1

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RuiYang2

1Institute of Malaysia Studies, Center

for Southeast Asian Studies, Xiamen

University, Xiamen, China

2School of International Relations/

Center for Southeast Asian Studies,

Xiamen University, Xiamen, China

Correspondence

Rui Yang, School of International

Relations/Center for Southeast Asian

Studies, Xiamen University, Xiamen,

361005, Fujian Province, China.

Email: clara@stu.xmu.edu.cn

Funding information

National Office for Philosophy and

Social Sciences, Grant/Award Number:

21CGJ034

Abstract

The spillover effects of foreign direct investment (FDI)

are often viewed as potential contributors to economic

growth and development in developing countries. As a

developing country that adopts a proactive stance to-

wards FDI, Malaysia provides a good setting to investi-

gate whether and to what extent FDI- induced spillovers

potentially benefit national firms. Using an unpub-

lished establishment- level dataset comprising 10,953

manufacturing firms in 2015, this study examined the

productivity and spillover effects of foreign manufactur-

ing firms on national firms in Malaysia. While foreign

firms exhibited higher productivity than national firms,

the results showed that FDI generates high spillovers

on national firms among FDI- concentrated industries,

but not on industries with low FDI concentrations. In

response to methodological call by Melitz’s new- new

trade theory to include firms’ heterogeneity to under-

stand the economy at macro- level, this study contends

that the presence and extent of FDI- induced spillover

benefits on national firms depends on industry and firm

characteristics. Thus, policy instruments must consider

sector- and firm- specific characteristics to appropriate

FDI spillovers as an enabler for national firms to sur-

vive, learn, catch up, and eventually compete in the

global market.

KEYWORDS

Foreign direct investment, Malaysia, manufacturing, spillovers

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INTRODUCTION

Early theories on foreign direct investment (FDI) and multinational corporations (MNCs) orig-

inated from empirical studies on international capital movement when Hymer (1960) first en-

capsulated his seminal concept of monopoly advantages that drive MNCs to site production in

developing countries. Subsequently, Vernon (1966) used the product cycle theory to explain inter-

national relocations. Helleiner (1973) provided empirical evidence suggesting that relative factor

endowments are the main reason for relocating labor- intensive FDI subsidiaries to developing

countries. While early hallmark theories were developed to explain internationalization, much

attention has been directed toward analyzing the motives and factors driving MNCs from devel-

oped economies to target investments overseas. The relocation of production operations from

developed to developing economies remained dominant until the 1970s, and attention gradually

shifted toward examining its impact on developing economies.

There may be very few topics on FDI that arouse so much controversy over its impact on

host sites.1 Despite the successful development of Japan and South Korea through technological

licensing and acquisition of MNCs rather than FDI (Amsden,1992), a large number of resource-

rich countries such as Malaysia, Thailand, the Philippines, and Indonesia have not broken out

of the so- called ‘middle - income trap’ notwithstanding significant FDI inflows (Rasiah,2020).

While there are abundant examples to demonstrate the transformative role of FDI in driving

economic growth in countries such as Singapore and Ireland (Rasiah,2004), there is a need for an

overall evaluation of MNCs’ willingness to transfer technology, and of the ability of local hosts to

absorb it, recognizing that MNCs possess advanced managerial and technological skills (Huynh

etal.,2021; Orlic etal.,2018).

The economic growth witnessed in Northeast Asia over the past few decades corroborates

evidence on the importance of technology and export- oriented policies in latecomers’ structural

transformation from low- to high- value- added economic activities (Wade & Kalisz,1990). From

the 1960s, the economies of Southeast Asia embarked on promoting manufacturing growth

with a strong focus on FDI to stimulate economic growth and structural change (Rasiah,2009).

Several studies have since attempted to explain the industrialization that has occurred in these

countries, including Rasiah (2020) who showed that the most significant contributions appro-

priated by host countries were expansion in investment capacity and employment and export

growth. Using a leveraging strategy, Singapore was the first Southeast Asian country to achieve

high- income development status by the 1990s. Meanwhile, Indonesia, Malaysia, the Philippines,

and Thailand started facing premature deindustrialization by 2010. The deflection of these coun-

tries from the path of Singapore calls for an examination of the extent of technological spillovers

generated from FDI and local absorptive capacity.

Malaysia offers a useful laboratory for this study for several reasons. First, Malaysia's manufac-

turing sector has contributed significantly to the country's gross domestic product, peaking at 30.9%

in 1999 before gradually declining to 22.3% in 2020 (World Development Indicators, 2021). Second,

Malaysia is a major recipient of FDI among Southeast Asian countries. While Singapore attracted the

largest (over 58% of the total) FDI in Southeast Asia, Malaysia was ranked the third largest destina-

tion for FDI inflows among the Association of Southeast Asian Nations (ASEAN) in 2019 (ASEAN

Statistical Yearbook, 2020). In addition to trade openness, the government has initiated a series of

FDI- friendly strategic policies since the 1970s to attract foreign capital to spur the economy (Ariff &

Yokoyama,1992). Even though the global economic prospects remain subdued and uncertain due

to the Covid- 19 pandemic, the manufacturing sector attracted the largest portion (62.0%) of the total

FDI in 2020, with an increase of 15.6% from MYR 74.8 billion in 2019 (Bank Negara Malaysia,2021).