When investments are not all good: Chinese ventures in Iskandar Malaysia

2024 marks the 50^th anniversary of the establishment of diplomatic ties between Malaysia and China. In his June 2024 visit to Malaysia, Chinese Premier Li Qiang especially highlighted both nations’ flourishing economic cooperation. As expected, a series of deals in areas ranging from the digital economy, agriculture, and housing, to tourism were signed by the leadership of both countries. 

While these deals are generally viewed positively, it is timely to take a step back and unpack how Malaysia-China economic engagement has evolved over a longer period, drawing meaningful implications for the private and public sectors.

Those with long memories will recall that economic cooperation was largely driven by bilateral trade. In particular, trade ties deepened starting in the 1990s, marked by China’s closer integration into what is loosely termed “Factory Asia”. Meanwhile, Chinese foreign direct investment (FDI) took longer to enter Malaysia. It only emerged as a significant player by the mid-2010s, challenging traditional FDI providers like Japan and the US. 

The Belt and Road Initiative (BRI)’s announcement in 2013 undoubtedly served as an important clarion call for Chinese business groups to venture overseas, but many of their projects in Malaysia have fundamentally been driven by commercial logic.

For example, telecommunications giants Huawei and ZTE had invested in Malaysia as early as 2001 and 2004 respectively. They were largely motivated by Malaysia’s desire to refurbish its telecommunications infrastructure, the country’s business-friendly environment and its relatively skilled and affordable manpower. These two enterprises have since flourished, in the process supporting Malaysia’s pursuit of digital transformation. 

The more important question now and going forward is: have China’s FDI inflows resulted in meaningful industrialisation? This is, of course, not an easy question to answer.

However, a recent study on this subject co-written by this author has uncovered some potentially useful insights. Several findings are instructive. Firstly, despite its latecomer status and the increasingly volatile international environment, Chinese FDI has emerged as a top five player in recent years.  

Secondly, Chinese firms entering Malaysia have invested mostly in services, followed by the manufacturing sector. Chinese FDI’s services-heavy slant is a marked contrast to that of Japan (and to a smaller extent, Singapore).

Although a detailed breakdown of the composition of Chinese FDI within the services sector is publicly unavailable, data triangulation reveals that real estate is likely the most important player, contributing close to 40% of the sector between 2015 and 2020.

While there are of course other high-profile Chinese-financed undertakings, ranging from Alibaba’s Digital Free Trade Zone (logistics) and Zhejiang Geely’s partial acquisition of local automobile producer Proton (manufacturing), their financial commitments have thus far not come close to that brought in by real estate.

In either case, this real estate bonanza per se is not worrying as it has most definitely sparked some positive externalities (e.g. employment opportunities). However, is it an appropriate antidote for a Malaysian economy struggling to break out of the middle-income trap? 

Much ink has been spilt on the proximate and longer-term causes miring the Southeast Asian nation in middle income. The consensus is that Malaysia, since at least the late 1990s, has failed to progressively climb the technological ladder and to capture more value from the production and sales of increasingly complex products.

To break out of the trap, the Malaysian economy requires structural transformation to enhance productivity and foster advancement in technology-intensive industries, in addition to reducing reliance on highly regulated, non-tradable industries such as utility provision and real estate. 

Forest City project and its embedded services

The impact of this real estate-fuelled development is most easily observed in Iskandar Malaysia in Johor, the country’s largest economic corridor. The corridor plays host to some of the most prominent Chinese investments to date.

Forest City, promoted by China’s Country Garden Group, by far ranks as the most consequential real estate undertaking due to its sheer size (estimated to reach over 1,386 ha across four manmade islands). It is also the most capital-intensive project in Iskandar Malaysia.

However, this real estate-heavy FDI has almost certainly altered Iskandar Malaysia’s incentive structure, fuelling its already noticeable slant towards services. More specifically, the corridor’s apparent ambivalence towards manufacturing can be attributed to the perception that activities such as electrical and electronics are unstable, footloose and insufficiently value-added.

In its defence, Forest City offers not just residential property. It also promotes industrial development by attracting businesses to operate eight key industries: tourism and meetings, incentives, conferences and exhibitions (MICE); healthcare; education and training; regional headquarters; offshore finance; e-commerce; emerging technology; and green and smart industry.

Nevertheless, a closer look at these eight activities reveals that they are almost entirely services in nature. Furthermore, nearly 70-80% of Forest City is designated for high-end residences, with the remaining 20-30% allocated for industrial development. This spatial arrangement in turn caps how much services (and to the extent that they are highly productive and tradeable) could be embedded into the project.

Luxury property-related services targeting the Chinese

Question marks can also be raised when one unpacks a series of “symbiotic” luxury property-related services that have emerged in and around projects like Forest City such as medical tourism, private education, migration advisory and general high-end consumption.

While not intentionally excluding Malaysians, these services seem to be primarily designed to target wealthy Chinese clients. In addition, their scale tends to be modest, which implies an inability to absorb large quantities of local labour.

Put together, the ways in which such projects are pushed have indirectly prevented Iskandar Malaysia from pursuing more sustainable activities with a higher economic multiplier effect such as high-technology manufacturing.

Mismatch of needs exploited by politicians

Iskandar Malaysia’s welcoming stance towards these Chinese projects also exacerbates its longstanding housing supply quagmire. Despite clear demands for low- and medium-cost houses, the launching of luxury homes has increased steadily since 2010.

Marketed at an average price of 1,200 ringgit (US$315) per square foot, nearly equivalent to those of high-end residential units in Kuala Lumpur, residential units in projects like Forest City are effectively priced out of the reach for the majority of locals. More worryingly, this mismatch of homes has hit the ethnic Malays hardest as they are disproportionately represented in the low-income segment.

Along with multiple hot button issues, this powder keg of disenchantment was seized by politicians in the run-up to Malaysia’s watershed general election of 2018, leading to the fall of the Barisan Nasional government. At that point, it was one of Asia’s longest-ruling administrations after the conclusion of World War Two.  

The analysis thus far provides much food for thought. For one, there needs to be a greater understanding of the nature of modern services.

Relative to manufacturing, it tends not to be very dynamic and internationally tradable. There are exceptions, such as investment banking and business consulting, but these services are typically highly skill-intensive and do not possess the scale to absorb labour, at least compared to manufacturing.

Relatedly, while it is tempting to tap FDI from Chinese firms eager to internationalise their portfolio, it is just as important to ensure a proper fit with the host state’s development trajectory.

For Malaysia at least, the ambition to break the middle income trap means that it can no longer rely on its traditionally open stance towards trade and FDI, which are showing signs of diminishing returns. Rather, policy focus should go beyond mere liberalisation of ownership and attraction of investments.

More pertinent are factors that increase productivity such as human capital development and linkage creation. Parallel to this is the need to more systematically target FDI with dense positive externalities, while also phasing out unproductive, speculative ones that do not directly contribute to domestic capability building.

This also means that priority must shift from simply welcoming investors (from China or elsewhere) to embedding them more purposefully into the domestic organisational ecology in a mutually beneficial coalition.

This message seems to be well noted by policymakers, judging from the rather detailed measures outlined in several recent master plans such as the New Industrial Master Plan 2030. As the nation progresses into the second half of the 2020s, the emphasis should be a closer implementation of these policy prescriptions.   

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