EVALUATION OF THE NEW ECONOMIC POLICY (NEP)

(2) Implications of the NEP on economic growth (cont'd)

(e) The NEP removes the factor of meritocracy
We will first examine the manner in which the Malaysian government notoriously engaged in massive localisation of firms (mainly, British and Chinese firms) as part and parcel of the NEP. In particular, attention will be centred on the takeover of foreign firms by Perbadanan Nasional Berhad (Pernas) and Permodalan Nasional Berhad (PNB). Subsequently, we will examine the transformation (for the worse) in the manner in which the companies that were acquired were managed and how such changes often result in the loss of economic growth.

[i] How did the government embark on its localisation process?

Pernas and PNB were established
Pernas was set up in Nov 1969 as a wholly government-owned company to carry out the resolutions passed at the second Bumiputra Economic Congress. Its principal objectives were: (a) To enter into undertakings that would yield high returns; (b) To be the majority stockholder and to have controlling interests when it entered into joint ventures; and (c) To employ Bumiputras at all levels of its endeavours. During the early 1970s, Pernas actively sought to establish joint ventures with the Japanese, American and European companies. However, in the latter part of the 70s, Pernas' strategy evolved and it began placing more emphasis on the acquisition of stocks in existing foreign firms operating in the primary industry. Its main targets were British companies, which had dominated the primary industry, particularly mining, since colonial times.

Similar to Pernas, PNB was set up in 1978 to facilitate the advancement of Bumiputra interests. It was established in 1978 to replace the National Investment Company (NIC), which was set up in 1961 to accumulate and manage capital on behalf of the Bumiputra community. This move was due to the fact that despite the implementation of various policies to encourage Bumiputra equity ownership, the NIC was unable to facilitate accumulation of wealth amongst the Bumiputras, as it was unable to prevent the Bumiputra community from selling their assets to the non-Bumiputra community, particularly the Chinese, for quick gains. To rectify the shortcomings of the NIC, the government introduced a new unit trust scheme and PNB, in collaboration with Yayasan Pelaburan Bumiputra (YPB), were given the responsibility to get the new scheme organised. Using YPB's interest-free loans and other interest-free and non-collateral loans from the government, PNB acquired interests in highly profitable companies. Such investments included firms concentrated in the plantation, financial and industrial sectors. The investment in plantations was aimed primarily at buying up British enterprises while that in the financial sector was focussed on Chinese-owned enterprises.

The localisation of British enterprises
Prior to the implementation of the NEP, ownership of capital in the primary sector, especially in plantation and mining, were by and large, British dominated. Foreign ownership, primarily British, comprised 70.8% and 57.8% of fixed capital in plantation and mining respectively. In comparison, Bumiputra ownership stood at less than 1%.

However, between 1973 and 1982, the government thoroughly restructured ownership in the said industries by purchasing foreign investments via Pernas and PNB and placing acquired investments under the control of public enterprises. With this, Bumiputra capital ownership in the tin mining industry soared from less than 1% in 1970 to 34% in 1982.

Until Pernas embarked on its acquisition streak, 2 British companies, ie London Tin (LT) and Charter Consolidated Ltd (CC), dominated the Malaysian tin mining industry. LT was established in 1925 and grew to become the largest tin mining group in the world, with operations in Malaysia, Thailand, Burma, Nigeria and Bolivia. In 1973, the government began to extend its influence on the tin mining industry by extensively acquiring London Tin Corporation, the holding company of London Tin. The acquisition was primarily carried out via New Tradewinds, established under Pernas' subsidiary, Pernas Securities Sdn Bhd. Thereafter, New Tradewinds was renamed Malaysia Mining Corporation Bhd (MMC).

Subsequently, MMC succeeded in forming an affiliation with CC, a mining group that dominated the mining industry in South Africa, through an exchange of stock. Through this exercise, MMC became the largest mining corporation in the world, with Pernas holding 71.4% equity ownership and the remaining 28.6% held by CC.

Similarly, in the plantation sector, by 1982, 31% of the total area cultivated by plantation companies had been acquired by Bumiputra capital. Table 1 shows PNB's share of capital ownership in 5 of the 10 largest estate agencies in the early 80s and illustrates PNB's role as a major stockholder in many plantation companies.

Table 36: PNB's share of capital ownership

Artificial demand, natural shortage of skilled Bumiputras
As mentioned earlier, although Pernas, in collaboration with Charter Consolidated (CC), established Pernas Charter Management (PCM) to replace Associated Mines as the agency that managed MMC's mining operations, the government was forced to retain the majority of Associated Mines' existing employees in the initial stages of change due to the lack of local expertise. However, over time, PCM's personnel was gradually localised and Bumiputra employment in the mining industry increased from 23.4% to 48.8% over the course of the NEP. How then did this phenomenon contribute to Malaysia's relative loss of economic growth?

Since the main purpose of localisation was to serve the advancement of Bumiputra interests, it created new demand for Bumiputra personnel, as foreign management who were equipped with the required expertise were phased out.

A hypothetical study conducted by an economist in 1976 showed that in order for the government to achieve its employment targets under the NEP, given the projected rate of growth of the various industries, a significant proportion (if not all) of the new jobs created would have to accrue to Bumiputras. Table 37 shows the incremental share of new employment that would have to accrue to Bumiputras in order to achieve the NEP's employment targets over the next 10 years, given the respective projected rates of growth.

Table 37

Therefore, the process whereby foreign management who possessed the required expertise were phased out and replaced by Bumpiutra personnel inevitably led to the loss of economic growth. This is due to the fact that unlike the goal of acquiring new firms, which can be achieved in a relatively short time span, obtaining Bumiputra management who possess the necessary expertise to run the business takes far longer. This is due to the nature of education and training, which involve long gestation periods. Hence, although the government was desperate to localise management, the supply of Bumiputra with the relevant skills could only slowly respond to policy-induced changes, resulting in supply constraints. Consequently, there were either unfilled slots in the occupational structure, or at best, slots filled by under-qualified persons. In either case, the government's desperation to localise management led to a mismatch between the skills required for vacant positions and the skills available for such positions. Moreover, because of the mismatch in skills, productivity, efficiency and competitiveness were compromised and thereby, economic growth was sacrificed.

Systemic localisation, entrenched cronyism
Besides the fact that grooming the right talent to fill newly created positions for Bumiputra personnel in a short span of time is a near impossible task and definitely an uphill battle, what is worse is that with localisation, came a new corporate culture. Unfortunately, along with the phasing out of foreign management came the phasing out of meritocracy in the reward system. It has become a common notion among Malaysians that the journey to riches is naturally eased when one is politically well-connected. Allegations that cronyism, which the NEP has unfortunately facilitated, are rampant. Table 38, which shows that the ratio between directors with political affiliation to those without is extremely disproportionate, proves this point. It illustrates the extent to which cronyism has become entrenched and the lack of meritocracy in our system.

Table 38: Distribution of Bumiputra Directors by Status and Political Affiliation, 1984

Almost all studies on corruption categorise cronyism as a subset of corruption. Unfortunately, numerous studies have proven time and again that corruption deters FDI and the loss of FDI led to the loss of economic growth and development. In an empirical study published in the Quarterly Journal of Economics (1995), it was shown that a negative relationship clearly exists between the level of corruption and the level of FDI, ie if corruption increases, FDI declines; and vice versa. To conduct this study, Mauro, the author, used various indices provided by Business International to measure the degree of corruption. Likewise, other empirical studies that used other corruption indices from other sources such as Political Risk Services, World Bank, University of Basel and Transparency International also produced similar results. Therefore, the lack of meritocracy, aka cronyism, in our system has deterred FDI and this has thereby, led to loss of economic growth and development.

At this point, we shall examine the importance of the merit system in facilitating economic growth. To do so, we shall examine America's experience. Time and again, i Capital has stressed the major role that productivity growth has played in sustaining America's long boom. Although rapid technological advancement has been a major contributor to productivity gains, reforms in the remuneration system, whereby "merit pay" was introduced, has also played a crucial role.

Before the 80s, salary adjustments were rarely tied to performance; it was common for every employee to receive an average salary adjustment that merely covered the increase in living expenses. Therefore, employees were equally rewarded irrespective of their performances.

However, problems became apparent. As employees realised that even performing above the "average" level did not yield significantly larger increases, they tended to perform only at the "average" level. This was because there was no perceived incentive to work harder or smarter. As a result, improvement in organisational performance became a factor of technological advancement rather than employee effort or performance. Due to the lack of incentive to outperform fellow employees, the absence of merit-based remuneration facilitated complacency and this led to a decline in productivity.

Unfortunately (or rather, fortunately), in the early 80s, international competition pummelled American firms and made them desperate for survival. Frantic to regain competitiveness, corporations began to experiment with measuring individual worker performance and began establishing pay incentives to quantify what were formerly considered "hard-to-measure" or "un-measurable" categories. Over time, multi-faceted, comprehensive compensation plans were devised to account for intangibles such as customer service, which were believed to be crucial in determining the long-term growth prospects of firms. As a result of tying in salary adjustments to individual performance, the US saw zooming productivity gains thereafter, which have been successfully sustained till this day - see figure 20.

Figure 20: Productivity Growth

From America's experience, it is evident that meritocracy is a crucial factor in promoting productivity gains. Therefore, because the NEP, to a large extent, facilitates the situation highlighted in table 37, it is only logical to deduce that the lack of meritocracy has caused loss of economic growth.