NEM Part II 1Malaysia Supply Chain1

1. Introduction 2. Foundational Issues Malaysia needs to Urgently address 3. 1Malaysia Supply Chain Implementing the NEM Part II 4. Game-Changing Package to address Foundational Issues Political Funding Transformation Private Sector Transformation Government Transformation Social Inclusivity and Sustainability Transformation 5. Concluding Comments

This paper is one of many papers prepared by Group A of the National Economic Advisory Council (NEAC) under the guidance of Tan Sri Andrew Sheng. The paper was reviewed by the NEAC and its recommendations summarised into NEM Concluding Part Report.

1. Introduction The NEAC is honored to submit Part II of New Economic Model (NEM) for consideration of the Prime Minister. The release of the NEM Part I at the end of March 2010 has overall been well received by the Government and the public. NEM Part I outlined the goals of a high income, inclusive and sustainable economy and attempted a frank and realistic diagnosis and assessment of the current economic situation of Malaysia and its prospects to 2020. Domestic and foreign perception of Malaysia has improved, recognizing the candid assessment and commitment by the Prime Minister to move the country in a different approach to achieve Vision 2020 as a necessary and positive step forward. The NEAC recognizes that we must address the most important issues facing the country, but is pragmatic in noting that no single solution can solve all of the problems. The Part I Report identified eight Strategic Reform Initiatives (SRIs) to propel transformation and growth in the Malaysian economy. They are: 1. 2. 3. 4. 5. 6. 7. 8. Re-energising the private sector Developing quality workforce and reducing dependency on foreign labour Creating a competitive domestic economy Strengthening of the public sector Transparent and market friendly affirmative action Building the knowledge base infrastructure Enhancing the sources of growth Ensuring sustainability of growth

Focusing on these eight SRIs, the NEM Part II contains the NEMs strategic implementation plan outlining specific policy measures that are needed to achieve NEMs goals. The NEM Part II gives the NEACs views on the need to prioritize policy direction and resource allocation and in the various chapters accompanying this report, the NEAC also highlights key barriers, foundational and cross-cutting issues that have to be tackled head-on and urgently In its work to establish the NEM Part II, the NEAC is cognisant that a huge amount of work and research has been undertaken in the 10th Malaysian Plan and PEMANDUs twelve lab activities where various Entry Point Projects (EPPs) have been identified as having the potential to catapult the various sectors into inclusive, higher income and sustainable growth engines. The NEM Part II is consistent with 10MP and NKEAs but points out the need for a Program (rather than the current Project) approach to coordinate the consistency and delivery of government initiatives and services across whole-ofgovernment. The work conducted by PEMANDUs labs could be described as picking winner EPPs, which may lead to a reinforcement of a projects-focus strategy. The NEAC cautions that the foundational issues highlighted here in this NEM Part II must firstly be addressed for the outcomes targeted by the 10MP and NKEAs to be achieved. Determining the right mix of policies and practices is the biggest challenge faced by the Government today in its efforts to ensure that Malaysia does not get caught in a middle-income trap. NEACs key strategy is embodied in the 1Malaysia Supply Chain (1MSC), which is a unifying theme in the NEM Part 2, with a strategic policy direction to focus, simplify and integrate. The 1MSC serves as a blueprint for Malaysians to unite and co-operate to strengthen national competitiveness to achieve NEMs goals.

Given the urgency, the NEAC is proposing a game-change package with specific foundational policy measures that show Malaysias determination to transform into a high-income, inclusive and sustainable nation by 2020. The decision to adopt the NEM (Part 1 and Part II) is ultimately political and its successful implementation depends critically on the political will and determination of all Malaysians to work together and progress to an advanced nation status. 2. Foundational Issues Malaysia needs to Urgently address Since the release of the NEM Part 1, the NEAC has identified more issues in depth that have to be addressed that impede Malaysias progress out of the middle-income trap. Much time was spent obtaining feedback from the various relevant stakeholders to ensure the policies recommended in this document are relevant, well evaluated and will bring about the desired outcome. The constantly changing economic, business and living environments also means that policies which previously effective may have become irrelevant or in some case counter-productive. Domestically, the NEM has stimulated greater calls for protection of the disadvantaged groups or those who fear change. But the reality is that the problems faced by Malaysia are not sectoral or factional, but national and global in nature. Irrespective of ethnic or other issues, Malaysia has to address the fact that both capital and human talent have been flowing outwards, our fiscal debt to GDP ratio is rising, our graduate unemployment is increasing and that growth will slow unless we address the fundamental issues that impede our progress. In order to advance to a high income, inclusive and environmentally sustainable society by 2020, Malaysia needs to confront two fundamental but inter-related questions. First, can Malaysia achieve advanced country status without social cohesion and stability? Second, can we compete globally if our education system produces graduates and workers that are structurally ill-equipped for the employment market? The answer to both must be no. Social cohesion and stability must mean that the majority of our population should enjoy the benefits of growth and prosperity. It is also a brutal fact that our growing graduate unemployment may become structural if our education system produces graduates who are ill equipped for the modern day dynamic. If the New Normal in the Global Economy is flexible, innovative and creative economies that are highly competitive, then for Malaysia to advance into that category of economies, Malaysia must produce a labour force and enterprises that is nimble, innovative and constantly adjusts to the fast changing environment. There are certain economic realities that Malaysia has to accept, which provides the context to our current situation: The world is increasingly globalised and interconnected. There is free movement of capital and talent due to globalisation.

To achieve advanced nation status, Malaysia must leverage on greater openness to globalisation in order to compete. Although Malaysia has many natural resources and is richly endowed, it is too small an economy to compete directly with the large-population economies that have economies of scale. Hence, Malaysia must play to her comparative advantages and exploit the niches that enable Malaysia to advance in terms of income, quality of life and cultural and bio-diversity. The rapidly changing external environment has also become much more challenging. Since March 2010, the risks of a double-dip in growth are rising. As the effects of massive fiscal pump priming in 2008/2009 wear out, the recovery in growth in the advanced markets have begun to stall and Europe is facing a major fiscal crisis. The emerging markets have begun to recover, but they are also likely to compete more vigorously and directly with Malaysia for a share of slower growth in trade and inward investments. Hence, Malaysias progress into advanced income status will play out in a less favorable global economic environment than previously envisaged. The competition has become fiercer as South Korea, Singapore, China and Taiwan have launched new initiatives and plans to upgrade their competitiveness through ultra-fast Broadband connections to most businesses and homes. Countries such as India, Vietnam and Indonesia have also become much more attractive destinations to foreign direct investments (FDI) due to their cheap labor and large local markets. As a result, countries such as Indonesia are clearly on the verge of over-taking Malaysia. Larger economies also have scale advantages. Since independence, Malaysia has benefited hugely from her openness to global trade and investments, and has been fortunate to have a rich natural resource endowment that enabled massive social restructuring to take place whilst substantially reducing absolute levels of poverty. These resource endowments have also shielded us temporarily from the detriments of the global shocks due to the ability to provide high subsidies. But this has come at the cost of natural resource depletion and eroded fiscal sustainability. Malaysia is one of the most subsidized nations in the world, subsidies in 2009 were RM74 billion or 14 percent of the countrys Gross Domestic Product (GDP). Distorted energy prices have also led to inefficient consumption and pricing and unsustainable industrial policies. If nothing is done, Malaysia would become a net importer of energy as early as 2015, when the resource and fiscal constraints would force the nation to be more efficient and competitive. The NEAC recognizes that progress towards an advanced nation rests on social stability, inclusiveness and greater equality, but this has to be achieved through an open system that encourages growth and innovation. A mind-set change is urgently required. Distribution can only happen when the economy grows and if growth slows, we have less resources available to deal with inclusivity and legacy issues. Many of the issues Malaysia faces now are structural and stem from Malaysias political economy. There is currently no transparent way of funding political activities legitimately, so funding is done generally through projects issued out at the federal level or state-level. This has been identified by NEAC as the root cause of corruption in Malaysia, a view echoed by the many various stakeholders NEAC has communicated with. Government institutions lack independence to effectively dispense their duties for example the Malaysian Anti-Corruption Commission (MACC) has been relatively powerless to stop money politics effectively in Malaysia.

The bureaucracy is by and large project-driven and projects are vendor driven, there is therefore little consistency in delivery and desired outcomes. This has also resulted in a legacy government framework which is silo-based and fragmented. A bureaucracy that geared towards projects emphasizes protection and subsidies. Furthermore, unclear policy objectives and outcome have weakened transparency and accountability, creating opportunities for corruption. The poor implementation of previous subsidy policies has prevented Malaysia from attaining desired outcomes. Poor program delivery system as well poor monitoring and evaluation systems and a lack of an effective feedback mechanisms has segregated the economy into subscale silos. As a result, overall growth has stalled and distribution efforts do not reach the poor. Although the New Economic Policy (NEP) has succeeded in building a large Bumiputera Professional Community, it has not succeeded in creating a globally competitive Bumiputera Entrepreneurial Community. Malaysias quandary can be described as the optimization of non-connectivity. All stakeholders are equally not receiving an economically optimum solution the Rakyat are dissatisfied with low quality of public service delivery while the private sector feel business opportunities are limited and are increasingly investing abroad. SMEs face grave obstacles in opportunities or non-connectivity such as getting effective government support or in linking to the global supply chain. The bureaucracy is not aligned to effective delivery of programs that enhance capacity, but focus more on retaining and completing project allocations. Government-linked companies (GLCs) also face difficulty achieving economic value-add as in many instances GLCs are burdened with social objectives that conflict with business objectives. This situation needs to be addressed urgently given the wider implications to the stock market and unit-trust holders if GLCs do not deliver on bottom line improvements that sustain a healthy dividend payout. Regulations need to be reset to international standards. Existing laws and policies are not geared to globalization and technological innovation and do not provide the most optimum framework for enhancing domestic competitiveness. There is also a drain of talent and capital from globalization. Our best people and scarce capital are leaving to join neighbouring supply chains, enabling them to compete against Malaysia. Thus Malaysias true danger is slipping further down the Middle Income Trap. There are difficult policy choices ahead and foreign investment in the country as well as the confidence of the domestic economy greatly depends on the Government leveling the playing field to increase competitiveness in the country. The path forward, however unpleasant to some, must be free of rentseeking activities which are draining the Malaysian economy and greatly hindering the move towards an inclusive, high-income and sustainable society. Unless funding of political activities is structurally resolved, project-based corruption and rent-seeking activities will not be easy to unroot. This is a longterm issue in nature, but must fundamentally be addressed as pre-condition for successful attainment of Advanced Country status. Malaysia must aim for a game change package that will stimulate growth, as Growth with Distribution is the only feasible path ahead. It is only through growth that issues of distribution and inclusivity can be addressed. We are at a critical point and reversing Malaysias vicious cycle path needs all Malaysians to help uplift the capacity of Bumiputera Entrepreneurial Community (BEC) to compete, not just through government efforts. This underlines the need for 1Malaysia and the NEM Part II implementation strategy, the 1Malaysia Supply Chain.

3. 1Malaysia Supply Chain The NEM Part IIs implementation strategy begins with the important recognition that in a highly competitive and inter-connected world of trade and investments, national and global production of goods and services is in supply chains that constantly evolve with the needs of the domestic or export customers. As a leading exporting country, Malaysia is already part of the Asian Global Supply Chain, but as a relatively small economy, her supply chains are not well integrated with each other and on their own, are sub-scale. Given her small size, Malaysia has to be more nimble, focused, flexible and efficient in order to compete. It became very clear to the NEAC that unless Malaysia aligns herself into a seamless and integrated 1Malaysia Supply Chain, it will not be easy to compete on a global scale. In other words, Malaysia needs to re-tool itself into the Global Supply Chain in a manner where Malaysia benefits most from sales of its products and services through innovation-based comparative advantages (IBCA). National and global production and trade are increasingly defined by supply chains. Supply chains are defined as the system of organisations, people, processes, technology, activities, information and resources involved in moving a product from supplier to customer/end user. Henry Ford was the first to identify and create the car-manufacturing assembly line to improve efficiency in specialization of the labour force and sequential assembly and production. Toyota improved the production line efficiency through superior quality control, just-in-time assembly, and clusters of sub-contractors, inventory control and global distribution. Today, Wal-Mart and other multi-national companies have expanded the supply chain to connect not only the production chain in East Asia, but also the distribution channels in the advanced markets. Computer manufacturers expanded their supply chains globally whereby products, systems, operations can be outsourced to companies located throughout East Asia. The Malaysian Electrical and Electronics (E&E) industry is a major part of this supply chain, with products designed in California, chips made in Taiwan, drives in Korea, LED screens in Japan and other parts and assembly in Malaysia for ultimate export to the US and EU. Once a company or a nation successfully plugs into the global supply chain, it would have an advantage of scale and branding that would be difficult for competitors to dislodge. Hence, Malaysia benefits from the GSC because she has gained scale and quality through sourcing parts, processes, raw materials from companies around the world at an effective cost and quality to achieve higher levels of quality, customizability and price. Globalisation has allowed companies to expand their operational scope and target markets beyond that of a traditional company looking to sell to its neighbourhood, city or country. Being part of the Global Supply Chain gives exposure to higher level of standards and changes both the labour force and the consumer mindset and demand. This in turn feeds back into a virtuous circle to firms in the supply chain who then respond by upgrading their quality control, efficiency and standards to meet the end users needs. In the last 50 years, developing countries like Malaysia have advanced into middle-income and highincome status by essentially through joining the Global Supply Chain. Those countries that failed to join, such as North Korea, Myanmar and some African economies, have receded into low-equilibrium growth traps.

Globalisation is about cooperation and supply chain competition. The value of the network is larger than the sum of its parts. Wealth and income creation come from enhancing the value of the supply chain. In other words, Malaysias success must be geared towards generating income from being part of the Global Supply Chain. Every corporation, multi-national or domestic, small and medium enterprises (SME), non-governmental organizations (NGO), government or individual workers and government body is plugged into the Supply Chain. The key to Malaysias survival is finding our niche place in the global supply chain, where we can competitively and sustainably grow the economy. For example, within the manufacturing space, the local MNCs can serve as a backbone for the nation to supply the world with our products, the SMEs should either supply the local MNCs or serve as part of a foreign supply chain. The anecdotal example of this is the Nintendo Wii control, or the iPhone or iPod. These products are made from hundreds of different components. Each component is made by SMEs from different parts of the world, each working together to make the Wii, iPhone or iPod a reality. Therefore the aim of Malaysia is to get its SMEs and MNCs to integrate into the global supply chain. The Japanese harnessed a nation to support its auto industry to provide the world with its goods. The Koreans positioned themselves to provide electronics and digital content to the world. The Government is central to this drive and effort to be part of the global supply chain. This is by no means an easy feat. The nation needs to be orchestrated into achieving a national supply chain to provide the world with products and services. Malaysia must therefore find its place in the world by establishing a 1Malaysia Supply Chain. The Prime Ministers 1Malaysia concept can be operationalized so that all Malaysians in any Supply Chain (be it private, government, NGO) understand that we have a stake in Malaysias success and that we must cooperate to improve the efficiency and connectivity of the economy. To achieve NEMs goals, Malaysians need to work together to forge the 1Malaysia Supply Chain, so that it can compete globally and generate wealth and income to benefit all Malaysians. The 1Malaysia Supply Chain is the implementation concept under which four major transformation thrusts - political funding, government, private sector and social inclusivity and sustainability will be used to address NEMs eight SRIs and remove the key barriers hindering Malaysias progress towards an advanced nation. A key implementation consideration of the 1Malaysia Supply Chain is for four leaders to coordinate and push through execution to achieve 1Malaysia Supply Chain outcomes under the four key transformation thrusts. The NEAC also recommends establishing an independent Evaluation Unit, which closely monitors feedbacks and evaluates achievements against desired outcomes. Lessons learnt from previous implementation issues where national policies failed to achieve its outcomes should be used in improving future delivery of government programs. A first necessary step for Malaysia is therefore to integrate the countrys supply chains that are subscale. Most of the supply chains in Malaysia are segregated and do not function effectively or efficiently. To compound the problem further, inefficiencies in the Government processes which often sit right in the middle of these supply chains are responsible for their inability to function properly and compete on a global scale. The reason why the BCIC has not taken root is that the current delivery supply chain is not integrated

with the rest of the globally connected and competitive supply chains. Developing the 1 Malaysia Supply Chain is thus a prerequisite to a vibrant BCIC. This cannot be done in isolation and integration with the existing fragmented supply chain is essential, with every community having a role to play. The real danger to Malaysia is that if growth does not become top priority, our Supply Chains will be marginalized or worst, by-passed. Our decreasing proficiency in English and decreasing ability of being multilingual has been unfortunate not only have we failed to work on our strengths, we have weakened the little we do have. If left unchecked, we will soon be taken over by regional competitors particularly as capital and talent continue to leave the country. Malaysias largest obstacle is not its movement of physical goods, but the mindset to allow more free competition to raise competitiveness within the nation. This has resulted in inefficient transport and distribution systems, which hinder economic progress and connectivity. Another key legacy and inherent obstacle in the way of implementing the 1Malaysia Supply chain is the adversarial attitude between the Government or GLC entities vs. the private sector and the lack of integration and trust between the difference ethnic groups in Malaysia. The existing equity restrictions, liberalisation and deregulation policies all limit access to Malaysia from a global perspective and make it difficult and opaque for global players to enter the market. The 1Malaysia Supply Chain should serve as a blueprint for facilitating the national ability to compete where there needs to be guidelines for national policy making to support competitiveness. Benchmarking against international standards and best practices should be given a greater focus rather than rankings, while an efficient feedback loop needs also be put in place urgently to ensure policies are relevant and user driven; and achievements are appropriately measured against desired outcomes. Applying the 1Malaysia Supply Chain strategy of Simplify, Focus and Integrate will see the whole government network integrated and geared in cooperating to meet the needs of all its stakeholders and at the same time provide an environment to support business in improving value chains and finding new market niches and as well as improving sustainable practices. The 10th Malaysian Plan already recognizes the Supply Chain concept and with it, the need to integrate in order to achieve economic efficiencies. Although current operating structures cannot be changed overnight, reforms must begin now. The Government has a critical role as a facilitator and an enabler in creating an efficient and integrated 1Malaysia Supply Chain, ensuring Federal, State and Regulatory Level service delivery is simplified, focused and integrated.

4. Game-Changing Package to address Foundational Issues

Political Funding Transformation Private Sector Transformation Government Transformation

The role of government is important in achieving the objectives of High Income, Sustainability, and Inclusiveness under the NEM. Its economic and social objectives are still relevant to ensure the growth with distribution target is simultaneously achieved. It facilitates the growth of the economy by creating a more conducive environment for the private sector to lead economic growth. It regulates economic activities based on international standards on good governance to address market failures (e.g. inefficiencies caused by monopolies and externalities) for a competitive, sustainable and inclusive economic environment. Nevertheless, the fast pace and dynamic environment also poses various challenges to the Government in meeting the expectations of its people. It can no longer maintain the old approach to economic development through dominant interventionist approach in its participation in the economy. To remain relevant in improving the living standards and well-being of its people, it has to adapt to the changes that has been shaping the economic and social environment globally (e.g. making its economy globally competitive). It has to acknowledge that policy making and implementation is no longer the sole realm of Government. Increasingly, the non-government sector has been playing a significant role in policy work (e.g. provision of public goods such as education and social welfare). Traditional roles between the government and the private sector are already blurring in some policy areas, hence the need for a more collaborative approach in governing i.e. network government. Government may no longer know best. To achieve the objectives of the NEM under this demanding environment, the Government would need to strengthen and revamp its institutions (e.g. public sector) for better coordination and synchronization based on whole of government approach. It would need to create a regulatory framework that is not a burden to economic growth (e.g. by carrying out deregulation). At the same time, good economic governance and regulation are still needed to addresses instances of market failure (e.g. regulation of economic activities to ensure markets work efficiently). It would need to adapt and leverage on new platforms and channels to deliver programmes and services (e.g. ICT and e-government). It will also need to engage better with its citizens and other stakeholders who are beneficiaries of its programmes and services, in the policy making process to understand and meet their expectations better (e.g. better access to public data through the open data movement).

Social Inclusivity and Sustainability Transformation

New Economic Model Part Ii: Market Friendly and Transparent Affirmative Action As the NEP was seen as a key economic instrument for striving towards national unity, its wider socioeconomic impact on race relations have not been sufficiently acknowledged. The excessive concern with ethnic interests and the way the NEP was implemented for the past more than 35 years have contributed to the growth of segregation and fragmentation to the community at large, spilling over to the non-economic spheres e.g. political and social factors. The affirmative action of Part I of the NEM is seen to be consistent with Article 153 as it re-affirms Article 153 and is subject to Article 153. The affirmative action of the NEM is not propagating the removal of the special position of the Malays and the natives of Sarawak and Sabah and the legitimate interest of the other communities, but only seeks to modify the manner as to how the interests of all Malaysian are to be promoted through inclusiveness. Although there have been some progress on the affirmative action front, these successes have been achieved at considerable costs. Generally, the past affirmative action has propagated and embedded, a distributive and entitlement culture and rentier behaviour. The growth of bribery and corruption is closely associated with the growth of rent-seeking in the economy. The new approach to affirmative action must be revised and reformed to take into account of past practices, flaws and the lessons that have been learnt. The aim of an approach designated as market friendly affirmative action is to ensure, wherever possible, that the aims of affirmative action can be reached, without severely undermining the functioning of the market. Growth can be maximised if resources are used efficiently. However, in cases of market failure government intervention would be necessary to regulate and correct the failures of the market. Transparent procedures and criteria must be implemented in each and every affirmative action program. As the focus of affirmative action is on the bottom 40% of households, the initiative shall remain ethnically blind without any market distorting elements such ethnic quotas or preferences. The programs will be meted out based on needs and merit and will be focused on capacity and capability building programs. A pro-bottom 40 percent growth and an affirmative action that shifts its focus to the bottom 40 percent are expected to raise the income of this targeted group. Maintaining and expanding quality social services especially education and health for the bottom 9 Million in the inaccessible rural areas will be extra challenging but this needs to be pursued with even greater earnestness especially in Sabah and Sarawak, to reduce inequality between the states and regions. Households in the middle 40 percent and top 20 percent, therefore, will not be covered by the affirmative action programmes. Competition and merit would be used as a basis for the allocation of resources and access to support programmes for the middle 40 percent regardless of ethnicity. A distinction should be made between affirmative action programmes for the bottom 40 percent and

special programmes for targeted groups. Various factors, including the ethnicity of the targeted groups, can be taken into account in designing the programmes but they are not exclusively reserved for any ethnic groups. Gainful employment for the bottom 9 Million and the opportunities for moving to higher paying jobs and occupations would be vital for raising their income. Wage income will still be the key source on income for the bottom 40 percent rather than non-wage income, such as profits and dividends. Income derived from the ownership of assets, including share capital or other financial assets, is negligible for the bottom 40 percent of total household income and help reduce income inequality. These observations would suggest that the excessive focus on the 30 percent target for the ownership of share capital would be misplaced as far as it impact on raising the income of Bumiputera is concerned, and that resources would be far better utilised to raise the capacity and capability of entrepreneurs and enterprises. For enterprises in the middle 40 percent the approach should be to provide assistance to the small and medium-scale enterprises (SMEs). Policies and programmes that have been designed for the SMEs should benefit Bumiputera, Chinese and Indian enterprises and the criteria for granting assistance should be made transparent. The development of an inclusive Malaysian industrial and commercial community would take into account of the special position of the Malays and other natives of Sabah and Sarawak and the legitimate interests of the other communities. Access to economic opportunities is critical for raising livelihoods and for inclusive growth. Discrimination which leads to the deprivation and closure of opportunities and unequal treatment can take many forms, including on the grounds of race, age, gender and through wage and employment discrimination. Many of these practices have been embedded, fossilised and institutionalised in the system and their erosion and removal should start with the establishment of the EOC which shall be made subject to Article 153. The key tasks and features of the EOC are part of building the institutions for inclusive growth.